The proposed regulations also provide guidance regarding certain elections relating to the carry back of consolidated net operating losses (CNOLs) to separate return years.
Text of the 102-page proposed regulations: REG-140668-07 [PDF 333 KB]
Section 172(a) generally allows a net operating loss (“NOL”) to be carried back to the two tax years preceding the tax year of an NOL and then carried forward to the 20 tax years subsequent to the tax year of the NOL. During the 1980s, leveraged buyouts or restructurings would often result in an NOL (due to large interest deductions) that could then be carried back to a prior profitable tax year to generate a refund that would effectively help to finance the transaction. In reaction to these leveraged transactions, the “CERT Rules” (found in sections 172(b)(1)(E) and 172(h)) were enacted in 1989.
The CERT Rules are designed to restrict the carry back of the portion of an NOL generated by interest deductions allocable to certain debt-financed stock acquisitions or distributions (i.e., CERTs). For purposes of the CERT Rules, a consolidated group is treated as a single taxpayer, except as provided in regulations.
A CERT is defined as a “major stock acquisition” or an “excess distribution.” A major stock acquisition is generally the acquisition of at least 50% of the stock (by vote or value) of a corporation by another corporation (unless an election under section 338 is made with respect to such acquisition). An “excess distribution” generally occurs when a corporation’s aggregate distributions (including redemptions) made during a tax year exceed the greater of two thresholds: (1) 150% of the average of such distributions during the three preceding tax years, or (2) 10% of the fair market value of the corporation’s stock as of the beginning of the tax year.
The CERT Rules only apply to “applicable corporations.” An applicable corporation is a C corporation (or successor corporation to such corporation) (1) that is the acquiring or acquired corporation in a major stock acquisition, or (2) that makes a distribution with respect to its stock (or redeems its stock) in connection with an excess distribution. An NOL carry back is only limited under the CERT rules if it arose in a “loss limitation year” (“LLY”). An LLY is the tax year in which the CERT occurred and, generally, each of the two following tax years.
If an applicable corporation has engaged in a CERT and there is an NOL in an LLY, the amount of the NOL that may not be carried back to a year preceding the year in which the CERT occurred must be determined. This amount is referred to as a Corporate Equity Reduction Interest Loss (“CERIL”). More specifically, a CERIL is the excess, if any, of the NOL for the tax year, over the NOL for the tax year determined without regard to any “allocable interest deductions” that are otherwise taken into account in computing the loss. Allocable interest deductions are the deductions for interest on the portion of the corporation’s debt allocable to the CERT, determined under an “avoided cost method,” rather than a tracing method. Thus, the amount of the debt that is treated as incurred to finance the CERT is generally based on the amount of interest expense that would have been avoided if the CERT had not occurred.
The statutory rules left many questions unanswered and there are no current regulations. Today’s proposed regulations provide general rules addressing whether a CERT has occurred, the computation of a CERIL, and the treatment of successors. The proposed regulations also address issues specific to the application of section 172(b)(1)(E) and (h) to consolidated groups, including: (1) treatment of the consolidated group as a single taxpayer; (2) determination of the group’s three-year average that is relevant to a particular consolidated return LLY; (3) application of these rules if the corporation participating in a CERT becomes a member of a consolidated return group; (4) application of these rules if a group member deconsolidates after the group has participated in (or is treated as having participated in) a CERT; (5) apportionment of a CERIL (and other special status CNOLs) to members of a consolidated group for carry back or carryover to separate return years; and (6) application of section 172(b)(1)(E) and (h) to a life-nonlife group. The proposed regulations also provide rules that would amend the loss carry back waivers available to deconsolidating group members.
Further analysis of these proposed regulations will be included in a forthcoming TaxNewsFlash.
Comments and requests for a public hearing concerning the proposed regulations must be received by the IRS by 90 days after publication of the proposed regulations in the Federal Register which is scheduled for Monday, September 17, 2012.