Tax News

CCH (cch.taxgroup.com) reports:

The IRS has issued proposed regulations relating to the treatment of transactions involving intercompany obligations and insurance payments from one member of a group to a captive insurance member.
On December 21, 1998, the IRS issued proposed regulations (NPRM REG-105964-98) clarifying the treatment of the transfer or the extinguishment of rights under intercompany obligations. After considering comments, the IRS is withdrawing the 1998 Proposed Regulations and issuing new proposals. However, for purposes of determining the tax treatment of transactions undertaken prior to the finalization of these proposed regulations, taxpayers may continue to rely upon the form and timing of the recast transaction, as clarified by the 1998 Proposed Regulations.
Revised Deemed Satisfaction-Reissuance Model
The current regulations and the 1998 proposed regulations generally provide that an obligation is treated as satisfied and, if the obligation remains outstanding, reissued as a new obligation. This is the deemed satisfaction-reissuance model. The new proposed regulations are intended to minimize the effects of intercompany obligations on a consolidated group's taxable income.
The proposed regulations adopt new and more precise mechanics for the application of the deemed satisfaction-reissuance model to certain intragroup and outbound transactions. In general, the new model deems the following sequence of events to occur immediately before, and independently of, the actual transaction: (1) the debtor is deemed to satisfy the obligation for a cash amount equal to the obligation's fair market value; and (2) the debtor is deemed to immediately reissue the obligation to the original creditor for that same cash amount. The parties are then treated as engaging in the actual transaction but with the new obligation.
For inbound transactions, the deemed satisfaction-reissuance model mirrors the mechanics and single-entity policies underlying the Code Sec. 108(e)(4) regulations. However, the deemed satisfaction-reissuance model also applies to obligations acquired for a premium and governs the treatment of the creditor as well as the debtor.
For outbound transactions, the deemed satisfaction-reissuance model furthers single-entity treatment by treating a consolidated group as a single issuer and an intercompany obligation acquired or assumed by a nonmember as newly-issued debt. The proposed regulations provide several exceptions to the application of the deemed satisfaction-reissuance model, discussed below.
The Deemed Satisfaction-Reissuance Amount
If a transaction is an intragroup exchange of an intercompany obligation for a newly issued intercompany obligation, the proposed regulations provide that the obligation would be deemed satisfied and reissued for its fair market value. In addition, for all intragroup debt exchanges, other than routine intragroup debt modifications, the newly issued obligation would be treated as having an issue price equal to its fair market value.
If a member's amount realized with respect to an intercompany obligation results from a mark to fair market value under Code Sec. 475, then the obligation will be treated as satisfied and reissued under these regulations but will not otherwise be marked to fair market value under Code Sec. 475
immediately thereafter.
Limitations on the Application of the Deemed Satisfaction-Reissuance Model
The proposed regulations apply the model upon a "triggering transaction," which is defined as any intercompany transaction in which a member realizes an amount, directly or indirectly, from the assignment or extinguishment of all or part of its remaining rights or obligations under an intercompany obligation (or from a comparable transaction). However, the proposed regulations provide a number of exceptions from the application of the deemed satisfaction and reissuance model. One exception involves certain transfers and assumptions of intercompany obligations in intragroup exchanges to which Code Sec. 332 or Code Sec. 361 apply. These proposed regulations also provide an exception to the application of the deemed satisfaction-reissuance model for taxable intragroup sales of assets where intercompany obligations are assumed as part of the transaction. Another exception involves an intragroup transactions in which an intercompany obligation is extinguished. Also excepted are routine intragroup modifications of intercompany obligations.
These proposed regulations retain the exceptions in the current regulations for transactions involving an obligation that became an intercompany obligation by reason of an event described in Reg. §1.108-2(e), and for amounts realized from reserve accounting under Code Sec. 585. However, consistent with the 1998 Proposed Regulations, the new proposals do not include the exception in the current regulations for transactions in which the deemed satisfaction and reissuance will not have a significant effect on any person's federal income tax liability for any year.
Material Tax Benefit Rule
In order to prevent distortions that may result from the shifting of built-in items from intercompany obligations, the proposed regulations include a special rule, the material tax benefit rule, that applies to intragroup transactions otherwise excepted from the deemed satisfaction-reissuance model under the exceptions for certain intragroup nonrecognition exchanges, taxable assumption transactions, extinguishment transactions, and routine debt modifications.
The material tax benefit rule generally applies to an intragroup assignment or extinguishment that would otherwise be excepted from the deemed satisfaction-reissuance model if, at the time of the transaction, it is reasonably foreseeable (regardless of intent) that the shifting of items of built-in gain, loss, income, or deduction from an intercompany obligation between members will secure a material tax benefit that would not otherwise be enjoyed.
Off-Market Issuance Rule
These proposed regulations also include a special rule, the off-market issuance rule, that generally applies if an intercompany obligation is issued at a rate of interest that is materially off-market, and at the time of issuance, it is reasonably foreseeable that the shifting of built-in items from the obligation from one member to another member will secure a material tax benefit.
Outbound Transactions
The new proposals retain the deemed satisfaction-reissuance model, with the new mechanics applied, as well as the current exception for outbound transactions involving an obligation that became intercompany obligation in an event described in Reg. §1.108-2(e). Two new exceptions have been added.
A new "subgroup" exception provides that the deemed satisfaction and reissuance model would not apply if the creditor and debtor to an intercompany obligation cease to be members of a consolidated group in a transaction in which neither member otherwise recognize an item with respect to the intercompany obligation and, immediately after the transaction, such creditor and debtor are members of another consolidated group.
A second exception would apply to an intercompany obligation that is newly issued in an intragroup reorganization and, pursuant to a plan of reorganization, is distributed to a nonmember shareholder or creditor in a transaction to which Code Sec. 361(c) applies.
Inbound Transactions
The proposed regulations retain the deemed satisfaction-reissuance model for inbound transactions, but also include a "subgroup" exception for certain of these transactions. The subgroup exception for inbound transactions is similar to the subgroup exception for outbound transactions discussed above. In addition, the proposed regulations provide a special rule that prevents inappropriate acceleration of a deduction for repurchase premium in certain inbound transactions.
Single Entity Treatment for Significant Insurance Members
The proposed regulations provide that when a significant portion (five percent or more) of the business of the insuring member arises from insuring the risks of other members, either by issuing insurance contracts directly to members or by reinsuring risks on contracts issued to members, it is appropriate to take into account the items from the intercompany transactions on a single entity basis. In such cases, the treatment of the members' items from the insurance transactions would be subject to the matching and acceleration rules of Reg. §1.1502-13. Under these rules, the insured member's deduction and the significant insurance member's income from the transaction would generally be taken into account currently. However, the effects of the intercompany transaction would otherwise be treated in a manner comparable to "self-insurance" by a single corporation.
The proposed regulations continue to except intercompany insurance transactions from single entity treatment where intercompany insurance represents less than five percent of the insuring member's business.
Comments
Before these proposals are adopted as final regulations, consideration will be given to any written or electronic comments that are submitted timely to the IRS. Comments are specifically requested on the following:
--whether it would be beneficial to eliminate any disparity between issue price and basis created upon the issuance of an obligation (for example, by treating such obligations as issued for fair market value);
--whether additional rules are needed for instruments intercompany obligations that are not debt instruments;
--whether some or all of these exceptions discussed above are appropriate, as well as suggestions for other exceptions;
--the relationship between the intragroup off-market issuance rule and the other limitations imposed by the code and regulations on lending transactions;
--whether the exclusion from the definition of intercompany obligation of executory obligations to purchase or provide goods or services is appropriate in all instances;
--whether special rules for the treatment of intercompany obligations transferred or assumed in transactions under Code Sec. 338
are needed;
--whether gross premiums written during the tax year less return premiums and premiums paid for reinsurance is an appropriate measure of an insuring member's business, as well as suggestions for alternatives;
--whether the status of an insuring member as a "significant insurance member" should be an annual determination and whether additional rules are needed when an insuring member's status changes; and
--whether any additional special rules are needed to accomplish single entity treatment for intercompany insurance transactions.
Written or electronic comments and requests for a public hearing must be received by December 27, 2007.
Proposed Regulations, NPRM REG-107592-00, 2007FED ¶49,766
Other References:
Code Sec. 1502
CCH Reference - 2007FED ¶33,159
Tax Research Consultant
CCH Reference - TRC CONSOL: 39,202.05
CCH Reference - TRC CONSOL: 39,304.10