Bankruptcy restructurings eliminated two excess loss accounts without gain

Plain-English summary

A consolidated corporate group proposed a multi-step restructuring under a confirmed Chapter 11 plan. Before the restructuring, one subsidiary had an excess loss account in the stock of another subsidiary, and that lower-tier subsidiary had an excess loss account in its own subsidiary's stock. The lower-tier subsidiary would convert to a disregarded limited liability company in a section 332 liquidation. The other subsidiary would then merge into its corporate parent in a transaction represented to qualify as both a section 332 liquidation for the parent and a reorganization for public shareholders. The IRS ruled that each excess loss account would be eliminated without gain under Treasury Regulation section 1.1502-19(b)(2).

Ruling snapshot

• Question: Would the subsidiary conversion and merger eliminate the two excess loss accounts without recognizing gain?
• Outcome: approved for both excess loss accounts
• Key authorities: IRC §§ 332, 368(a)(1)(A), 1001, 1502; Treas. Reg. §§ 1.1502-19, 1.1502-32, 1.1502-36

Full text (IRS public release)

Internal Revenue Service                                          Department of the Treasury
                                                                  Washington, DC 20224

Number: 201930012                                                 Third Party Communication: None
Release Date: 7/26/2019                                           Date of Communication: Not Applicable
Index Number: 1502.00-00, 1502.19-00
                                                                  Person To Contact:
------------------                                                --------------------------, ID No. ----------------
------------------------------------                              -----------------
------------------------                                          Telephone Number:
-------------------------------------                             ----------------------
------------------------------------                              Refer Reply To:
                                                                  CC:CORP:B5
                                                                  PLR-129385-18
                                                                  Date:
                                                                  April 29, 2019


                                                    LEGEND

Parent                     =         --------------------------
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Sub 1                      =         ----------------------------------------
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Sub 2                      =         -----------------------------------------
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Sub 3                      =         -----------------------------------------------------
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Sub 4                      =         ----------------------------------------
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DE 1                       =         --------------------------------------
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DE 2                       =         ---------------------------------------
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DE 3                       =         ------------------------------
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DE 4                       =         ----------------------
                                    ------------------------

Newco                      =        --------------------------------

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Business 1                 =        ----------------------

Business 2                 =        -------------------------

Bankruptcy Court =                   --------------------------------------------------------------------------------
------------------------------------------------------------------------------------------------------------------

State A                    =        --------------

State B                    =        ---------

State C                    =        -----------

Year 1                     =        --------

Year 2                     =        --------

Date 1                     =        ---------------------------

Date 2                     =        ----------------------

Date 3                     =        ------------------------

Date 4                     =        --------------------------

a                          =        ------

b                          =        ------

c                          =        ------

d                          =        ----

e                          =        --------------

f                          =        ------------

g                          =        ----------------

h                          =        ----------------


Dear ------------:


This letter responds to your authorized representatives’ letter dated September 28,
2018, requesting rulings under section 1502 of the Internal Revenue Code with respect
to certain tax consequences of the Proposed Transaction (defined below). The
information provided in that request is summarized below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalties of perjury statement
executed by an appropriate party. While this office has not verified any of the material
submitted in support of the request for rulings, it is subject to verification on
examination.

                                 SUMMARY OF FACTS

Parent is a State A corporation and the common parent of an affiliated group of
corporations that join in the filing of a U.S. consolidated federal income tax return (the
“Parent Consolidated Group”). The Parent Consolidated Group is currently engaged in
two distinct business segments: (i) Business 1 and (ii) Business 2.

The relevant corporate structure of the Parent Consolidated Group prior to the
Proposed Transaction is as follows:

Parent wholly owns DE 2, which in turn, wholly owns DE 1. DE 1 and DE 2 are State A
limited liability companies that are disregarded for federal income tax purposes.

DE 1 wholly owns Sub 1, a State B corporation. In turn, Sub 1 wholly owns (i) Sub 2, a
State C corporation, and (ii) multiple directly and indirectly owned subsidiaries.

Sub 2 wholly owns multiple directly and indirectly owned subsidiaries (the “Business 1
Subs”). Certain Business 1 Subs are debtors to third-party creditors. The underlying
assets and operations of Business 1 are held and operated by the Business 1 Subs,
and by Sub 1 and certain of its subsidiaries (other than the Business 1 Subs).

Sub 2 also owns, directly and indirectly, through its ownership of DE 3 and DE 4,
approximately a% by value and b% by vote, of the issued and outstanding shares of
Sub 3, a State A corporation. DE 3 and DE 4 are State A limited liability companies that
are disregarded for federal income tax purposes. The remaining c% by value and d% by
vote of the issued and outstanding shares of Sub 3 are publicly traded. Sub 3, in turn,
wholly owns Sub 4, a State A corporation. The underlying assets and operations of
Business 2 are held and operated by Sub 3 and its subsidiaries (the “Sub 3 Subgroup”),
and by Sub 1 and certain of its subsidiaries (other than members of the Sub 3
Subgroup).

Prior to the Proposed Transaction, Sub 2 has an excess loss account within the
meaning of Treas. Reg. § 1.1502-19(a)(2) (“ELA”) in its Sub 3 stock (including the

shares held through DE 3 and DE 4) (the “Sub 3 ELA”) of approximately $e. The Sub 3
ELA was generated as a result of an intercompany dividend that Sub 3 made to Sub 2
in Year 2, and has been further adjusted by additional intercompany dividends made to
Sub 2 and investment adjustments under Treas. Reg. § 1.1502-32 in subsequent years.

Prior to the Proposed Transaction, Sub 3 has an ELA in its Sub 4 stock (the “Sub 4
ELA”) of approximately $f. The Sub 4 ELA was generated as a result of an
intercompany dividend that Sub 4 made to Sub 3 in Year 2, and has been further
adjusted by investment adjustments under Treas. Reg. § 1.1502-32 in subsequent
years.

As of Date 1, Sub 1 and certain of the Business 1 Subs were obligated on
approximately $g of long-term debt. Sub 2 is a guarantor with respect to a portion of this
debt. In addition, as of Date 1, Sub 1 was obligated on an intercompany note to Sub 3
(the “Intercompany Note”). On Date 2, Parent and certain of its subsidiaries filed for
relief under Chapter 11 of the Bankruptcy Code with the Bankruptcy Court. On Date 3,
the Bankruptcy Court confirmed Parent’s plan of reorganization (the “Plan”).

                               PROPOSED TRANSACTION

For what are represented by Parent to be valid business reasons, and in connection
with the Plan, Parent desires to undertake the following steps, some of which have
already occurred (the “Proposed Transaction”):

(i) On Date 4, Sub 2 formed NewCo, a State A corporation.

(ii) DE 3 and DE 4 distributed all of their Sub 3 stock to Sub 2.

(iii) Sub 4 will convert to a State A limited liability company that will be treated as
disregarded entity for federal income tax purposes (the “Sub 4 Conversion”).

(iv) Sub 2 will be released from its guarantee of Sub 1’s indebtedness.

(v) Sub 2 will contribute all of the stock of the Business 1 Subs to NewCo in exchange
for the common stock and non-voting preferred stock of NewCo (the “Business 1 Subs
Transfer”).

(vi) Pursuant to a pre-arranged and binding commitment, Sub 2 will sell the non-voting
preferred stock of NewCo to one or more third parties in exchange for cash (the
“NewCo Preferred Stock Sale,” and together with the Business 1 Subs Transfer, the
“NewCo Transfer”).

(vii) Sub 2 will distribute the common stock of NewCo, and the cash proceeds of the
NewCo Preferred Stock Sale, to Sub 1.

(viii) Sub 1 and its subsidiaries will transfer certain assets used in Business 2 to the
Sub 3 Subgroup, and the Sub 3 Subgroup will transfer certain assets used in Business
1, if any, to Sub 1 and its subsidiaries.

(ix) Sub 3 will merge with and into Sub 2 pursuant to a statutory merger under
applicable state law, with Sub 2 surviving the statutory merger (the “Sub 3 Merger”).
The public shareholders of Sub 3 will receive common stock of Sub 2 as consideration
in the Sub 3 Merger.

(x) Sub 2 (as successor to Sub 3) is estimated to receive approximately $h as its
recovery under the Plan with respect to the Intercompany Note.

(xi) Sub 2 will issue non-voting preferred stock to one or more third parties for cash (the
“Sub 2 Preferred Stock Issuance”).

(xii) Parent will contribute newly issued common stock and/or warrants to Sub 1.

(xiii) Sub 1 may, but will not necessarily, contribute consideration to one or more of its
subsidiaries to be distributed to certain creditors under the Plan (the “Contribution”).

(xiv) Certain Business 1 Subs that are issuers of third-party debt will each issue an
intercompany note to Sub 1 in an amount not greater than the value Sub 1 will pay to
certain creditors with respect to claims that are allocated to such certain Business 1
Subs for tax purposes, reduced by the amount of consideration contributed to such
certain Business 1 Subs in the Contribution.

(xv) Sub 1 will transfer consideration, which includes all of the common stock of Sub 2
held by Sub 1, to certain creditors pursuant to the Plan. To the extent that Sub 1
contributes consideration to any subsidiary pursuant to the Contribution, such subsidiary
will distribute such consideration to certain creditors pursuant to the Plan. No right of
subrogation or contribution shall arise in favor of any subsidiary of Sub 1 with respect to
or on account of any distributions under the Plan.

                                  REPRESENTATIONS

(i) The Sub 3 ELA and Sub 4 ELA existed before the Proposed Transaction was
contemplated.

(ii) The Sub 4 Conversion will qualify as a complete liquidation under section 332.

(iii) The fair market value of the assets of Sub 4 will exceed the amount of liabilities both
immediately before and immediately after the Sub 4 Conversion.

(iv) Sub 2 will recognize gain or loss (to the extent permitted by Treas. Reg. § 1.1502-
36) in the Newco Transfer under section 1001.


(v) The Sub 3 Merger will qualify as a complete liquidation under section 332 with
respect to Sub 2, and a reorganization under section 368(a)(1)(A) with respect to
Sub 3’s public shareholders.

(vi) The fair market value of the assets of Sub 3 will exceed the amount of its liabilities
both immediately before and immediately after the Sub 3 Merger.

(vii) If the Sub 3 ELA and/or the Sub 4 ELA were taken into account under Treas. Reg.
§ 1.1502-19, the only federal tax consequence identified by Parent is that the
corresponding gain might result in positive investment adjustments, which would be
factored into any Treas. Reg. § 1.1502-36 analysis (and the relevant impacts of other
provisions of the Code or regulations as a result of such adjustments) in connection with
the transfer of the stock of Sub 2.

                                         RULINGS

Based solely on the information and representation submitted, we rule as follows with
respect to the Proposed Transaction:

(i) The Sub 3 ELA will be eliminated without the recognition of gain as a result of the
Sub 3 Merger. Treas. Reg. § 1.1502-19(b)(2).

(ii) The Sub 4 ELA will be eliminated without recognition of gain as a result of the Sub 4
Conversion. Treas. Reg. § 1.1502-19(b)(2).

                                         CAVEATS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter. In particular, no opinion is expressed concerning any aspect of any
transaction or item occurring as part of the Plan, whether prior to or following the
Proposed Transaction, or the effect of any such transaction or item on the rulings
above.
                                PROCEDURAL STATEMENTS

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of this
letter ruling.


                                       Sincerely,


                                        Gerald B. Flemings
                                       Gerald B. Fleming
                                       Senior Technician Reviewer, Branch 2
                                       Office of Associate Chief Counsel (Corporate)