Tax Election to Treat Disposition of Stock of a Subsidiary as a Sale of Its Assets
Sullivan & Cromwell
On May 10, the Internal Revenue Service (the “IRS”) and Treasury Department released final regulations (the “Final Regulations”) under Section 336(e) of the Internal Revenue Code of 1986, as amended (the “Code”), relating to an election to treat certain dispositions of stock of a subsidiary as a sale of its assets. The Final Regulations, which generally adopt the approach of regulations proposed on August 22, 2008 (the “Proposed Regulations”), provide an election under which the sale or distribution of the stock of a domestic corporation by another domestic corporation or, in the case of an S corporation, by its shareholders, is treated, in certain circumstances, as if a sale of assets had occurred, thus permitting a step-up in the asset basis of the sold corporation. The Final Regulations generally use the rules that would apply if stock of a subsidiary were sold and purchaser and seller made a Section 338(h)(10) election to treat the sale as a sale of the subsidiary’s assets. Twenty-seven years after the enactment of Section 336(e) expressly inviting the issuance of such rules, the Final Regulations will finally allow an elective step-up in the basis of a subsidiary’s assets in cases where no election could be made under Section 338(h)(10) (for example, where there are multiple purchasers of stock, or purchaser is not a corporation), thus reducing the possibility of multiple layers of tax in respect of the same economic gain. The Final Regulations differ from the Proposed Regulations in certain key respects, including: The Final Regulations enable S corporation shareholders to make a Section 336(e) election so long as all shareholders of such S corporation, whether selling shareholders or not, consent. The Final Regulations modify the method of making a Section 336(e) election, generally requiring notice to or consent of the target or, in the case of an S corporation, shareholders. The Final Regulations generally limit the disallowance of losses to the net loss that could result in the deemed asset disposition (i.e., if realized losses in the deemed asset disposition exceed the amount of realized gains) to the extent attributable to distributions of target stock during the 12-month disposition period.