It seems the government wants to be very clear about tax issues related to the bailout. To that end, the Internal Revenue Service has issued another clarification with respect to loss corporations, and the potential tax benefits that await loss corporations that participate in its rescue programs.
Indeed, in releasing its second clarification on the subject, the IRS issued Notice 2009-14 in late January to address the limitations on net operating losses (NOLs) that may arise from the Treasury Department’s purchase of preferred stock from failing companies. In general, a loss company uses NOLs to offset current taxable income – thereby lowering its corporate tax bill.
But the IRS substantially limits the amount of NOLs that can be used when there is a change of ownership. In that way, the government prevents companies from trafficking in NOLs; essentially buying loss companies just get hold of their NOLs and the attendant tax benefits. The NOL limitation rule is found in Section 382 of the tax code, which provides a definition of change of ownership for this purpose, as well as how the NOL limitation works.
The new IRS notice offers guidance on these issues with respect to the Treasury Department’s Trouble Asset Relief Program (TARP), in particular its capital purchase program (CPP) and target investment (TIP) program. All of these programs are part of the larger Emergency Economic Stabilization Act of 2008, which was signed into law late last year.
The CPP and TIP programs aim to infuse failing banks and other select companies – particularly auto companies – with cash by permitting the Treasury Department to buy preferred stock in the companies. In some cases, such a purchase would have constituted a change in ownership under Section 382, thereby triggering NOL limitations. But the government has made an exception for companies in need of TARP money.
To be sure, the new IRS notice makes it abundantly clear that a corporate issuer participating in one or more of these programs will not – no matter how extensive the government’s investment in the securities of the issuer – experience an “ownership change” as it is defined by Section 382(g) of the tax code.
Under the tax code, an ownership change usually occurs if immediately after the close of the “testing date” the percentage of stock owned by one or more 5-percent shareholders is increased by more than 50 percentage points. The testing period is generally a 3-year period. (See Regulation Section 1.382-2T(a)(1).) As a result, Section 382 states that the taxable income of a loss corporation following an ownership change that may be offset by pre-change losses cannot exceed the “Section 382 limitation” for the year.
However, Notice 2009-14 expands on the original TARP guidance issued in Notice 2008-100 to clarify its guidance on TARP acquisitions. The highlights of the IRS notice are listed here:
Debt and equity treatment remain steadfast. Any financial instrument issued to the Treasury Department related to the rescue programs will be treated as “an instrument of indebtedness” if designated as debt; and as stock as described in Section 1504(a)(4) if designated as preferred stock. This will be the case whether the instrument is owned by the Treasury Department or subsequent holders.
Treasury purchases are taken into consideration regarding ownership change. If the loss corporation experiences an ownership change as a result of increases in the ownership of its stock on the part of entities other than the Treasury Department and its transferees, the preferred stock issued to Treasury will be taken into account in determining the value of the loss corporation’s stock for purposes of calculating the Section 382 limitation.
Acquired stock is really an option. Regarding the public CPP, TIP, TARP and TARP Auto programs, any warrant to purchase stock acquired by the Treasury Department – while owned by Treasury or subsequent holders – will be treated as an “option” rather than stock. Moreover, while held by the Treasury Department, the warrants will not be deemed exercised under the tax rules – specifically Regulation Section 1.382-4(d)(2).
In addition, warrants to purchase stock acquired by Treasury under the private CPP program, will be treated as an ownership interest in the underlying stock for tax purposes (see ownership description in Section 1504(a)(4). )
Treasury stock is considered outstanding, most of the time. The ownership interest represented by the stock (other than preferred stock) acquired by the Treasury Department under the bailout programs does not trigger Treasury’s ownership in the issuing corporation. Further, in most cases, the stock is considered outstanding for purposes of determining the percentage of stock owned by other 5 percent shareholders on the NOL limitation testing date.
The “outstanding” exception. The exception relates to the shift in ownership that occurs on or after the date on which the issuing company redeems stock held by Treasury and acquired through the bailout program. In a nutshell, the stock redeemed is treated as if it had never been outstanding in the wake of a shift in ownership by any 5 percent shareholder on any testing date.
The tax code does not always apply to capital contributions. Any capital contribution made by the Treasury Department as part of the bailout programs is not considered a tax avoidance plan with respect to affect the Section 382 limitation. Accordingly, if the loss corporation experiences an ownership change, it will not be required to reduce the value of its stock (for purposes of calculating the Section 382 limitation) by the amount of any capital contributions received from Treasury. That is the case even if, for example, a contribution was made during the two year period ending on the date on which the ownership change took place.
In light of the newest IRS notice, it appears that the Emergency Economic Stabilization Act gives the Treasury Department the authority to issue the new guidance. Therefore, it should not, we would hope, be nullified by Congress in the way lawmakers invalidate the first attempt by the IRS (Notice 2008-83) to address the TARP Section 382 issues. That attempt was dashed because Congress determined the guidance was not within the Treasury Department’s aegis.
Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com