In this article, I will highlight a few comments on the proposed Treasury Regulations under tax code Section 382(h) related to built-in gain and loss from a panel discussion at the Practicing Law Institute (PLI)’s Corporate Tax Strategies for Acquisitions, Dispositions, Spin-offs, Joint Ventures, Financings, Reorganizations and Restructuring Program (the Program) held on Oct. 17, 2019. William Burhop, Senior Technical Reviewer at the Office of the Associate Chief Counsel (Corporate), Branch 5, represented the government on this panel. I will conclude with a few observations and thoughts. I hope this article will provide some food for thought for those considering submitting comments to Treasury by the Nov. 12, 2019 deadline.
Taxpayers have relied on the guidance provided by IRS Notice 2003-65 (the Notice) on the application of Section 382(h) for the past 16 years and may continue to rely on it until Treasury issues final and/or temporary regulations. The Notice provided two approaches or safe harbors in recognizing built-in gains or losses (RBIGs and RBILs, respectively) during the recognition period—namely, the Section 1374 (1374 Approach) and the Section 338 approach (338 Approach).
A taxpayer electing the 338 Approach would recognize income on certain depreciable or amortizable assets, because the 338 Approach deems the taxpayer to have made a Section 338 election on the ownership change date. Therefore, the taxpayer would recognize as an RBIG income generated by the built-in gain asset. The depreciation or amortization deduction on the built-in gain portion of the asset’s tax basis is used as a proxy for the income generated by the built-in gain asset. This concept is commonly known as the “wasting of assets.”
In contrast, a taxpayer electing the 1374 Approach would not recognize RBIGs from the “wasting” of built-in gain assets as the 1374 Approach relies on the accrual method of accounting principles. Therefore, the 338 Approach is particularly helpful to taxpayers with an overall net unrealized built-in gain because taxpayers can recognize RBIGs (and thereby increase their Section 382 limitations) without disposing of built-in gain assets.
The Proposed Regulations
Burhop began the discussions on the proposed regulations by emphasizing that the regulations are in proposed form and they serve to open a dialogue between the government and taxpayers. The government seeks to understand the economic and business issues taxpayers are going to face if these proposed regulations are finalized and Burhop encouraged taxpayers to submit comments.
The proposed regulations adopts the 1374 Approach (with modifications, not discussed in this article) and eliminates the 338 Approach. This change (amongst other changes under the proposed regulations) appears to have caught the most attention from taxpayers and was the focus of much of the panel discussions at the PLI Program. Burhop explained the key reasons for the elimination of the 338 Approach.
First, Treasury felt the need to promulgate the proposed regulations because the Tax Cuts and Jobs Act of 2017 (TCJA) added a number of new code sections. These code sections would require numerous coordinating rules with Section 382(h) and would increase the difficulty in computing the tax bases of certain assets. These complexities would make the administration of the 338 Approach untenable. Burhop pointed out, for example, it took considerable effort to address issues presented by the interaction of Section 382(h) and the new Section 168(k). See IRS Notice 2018-30.
Second, the government is of the view that there is “insufficient basis grounded in statute” to support the recognition of RBIGs on the wasting of assets provided by the 338 Approach. Specifically, Burhop points out Section 382(h)(6) requires an item of income to be properly taken into account [emphasis added] to be an RBIG. Linda Swartz, a panelist at the PLI Program, countered that the IRS must have believed there were statutory grounds for tying the wasting of assets to income when Notice 2003-65 was issued. Burhop reiterated that the government welcomes comments, particularly on how RBIG with respect to the wasting of assets can be supported by statute and how to establish a proper connection between the built-in gain assets and the income it would earn over the recognition period.
Finally, the government clearly desires to have a single approach to recognizing built-in gains and losses.
Observations and Comments
The proposed regulations, if finalized, will take away taxpayers’ ability to recognize built-in gains in the absence of an actual recognition event e.g., the sale of assets. This is not the first time the IRS changed its position on Section 382(h). In TAM 200217009, the IRS disallowed a taxpayer from recognizing as RBIGs income generated by a customer base that existed at the time of the ownership change. The IRS explained the “wasting of assets” concept could not be inferred by the flush language in Section 382(h)(2)(B) and Section 382(h)(6). Yet the IRS issued Notice 2003-65 in the following year while the statute remained unchanged. Perhaps the IRS had in mind the “neutrality principle” (the principle was mentioned a few times in the preambles to the proposed regulations) when it issued Notice 2003-65? Why should taxpayers be recognizing RBILs on the depreciation and amortization of built-in loss assets under Section 382(h)(2)(B) but they are not permitted to recognize RBIGs on the depreciation and amortization of built-in gain assets?
The adoption of the 1374 Approach creates another concern. It incentivizes taxpayers to sell their built-in gain assets. In fact, some predict that the adoption of the 1374 Approach would motivate taxpayers to engage in wasteful (pun intended) tax planning techniques or “self-help” to access their pre-change losses. What policy objectives are achieved? Some of these businesses may be struggling and disposing of assets would likely hurt, rather than help, the businesses. Are these the intended consequences of the proposed regulations? Are these rules fair for taxpayers? Taxpayers who are publicly traded companies have little or no control over their changes in their shareholder base and these companies will be hurt by the proposed regulations.
I don’t have the answers, but I encourage taxpayers to submit their comments to Treasury on this very important topic. It is my hope that Treasury will consider the comments it receives, and issue final guidance that is reasonable and balanced for all taxpayers.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Betty Mak is a senior tax manager with Maxar Technologies Inc. (Maxar), a global provider of advanced space technology solutions, headquartered in Westminster, Colo. Betty is participating in the Tax Executives Institute (TEI)’s working group which will be submitting comments to Treasury on the proposed Regulations under Section 382(h). Betty is a U.S. and Canadian CPA. Views expressed this article are those of the author and may not reflect the views of Maxar or TEI.