A former consolidated-group member may deduct only its allocable share of interest paid on a prior-year group tax deficiency, not the entire interest payment

Plain-English summary

This Chief Counsel email conveys internal analysis concluding that a taxpayer should be challenged on its deduction of the entire interest payment made on a consolidated group's tax deficiency for a prior year. Relying on Koppers Co. v. Commissioner, 8 T.C. 886 (1947), the author explains that when a former member of a consolidated group pays interest on a prior consolidated-year deficiency in a later separate return year, general tax-law principles allow that member to deduct only the portion of the interest allocable to it based on its share of the group's adjusted consolidated net income. A taxpayer can deduct interest only on its own indebtedness, not on another's, even if it is legally liable for the whole. Because the taxpayer here was not a member of the group for most of the year, the author doubts it can show the entire interest payment was allocable to it, so it likely cannot deduct the full amount.

Ruling snapshot

• Question: May a former consolidated-group member deduct the entire interest it paid on the group's prior-year tax deficiency, or only its allocable share?
• Outcome: Advice given (only the allocable share is deductible; the full deduction should be challenged)
• Key authorities: IRC § 163; Koppers Co. v. Commissioner, 8 T.C. 886 (1947), supp. op. 11 T.C. 894 (1948)

Full text (IRS public release)

ID: CCA_2020022409502240
UILC: 163.10-05

Number: 202141007
Release Date: 10/15/2021
From: ---------------------
Sent: Monday, February 24, 2020 9:50:22 AM
To: ----------------
Cc: ---------------------------------------------------------------------
Bcc: ---------------------
Subject: --------------------------------------------------------------------------------------------------------------------

-------------------,

I have found something very important and I am now sure that we
should challenge ------------ deduction of the entire interest payment on
the consolidated group’s tax liability for the tax year ended June 30, --
-------. ---------- may show that it is entitled to take some portion of the
interest deduction but it doesn’t seem likely that it can take the entire
amount of the interest deduction on what I confirmed this morning in
my research.

I will explain what happened: ------- was of course correct that the consolidated
regulations that require allocation of tax liability are for specific purposes of allocating
E&P and basis. But, I think that ------- may not be familiar with a requirement to allocate
tax liability to determine the correct portion of interest that is deductible on an income
tax deficiency for a former member that pays in a subsequent separate return year
because it is not explicitly found in the consolidated regulations and I think it is an
unusual or unique fact pattern. The law is based on case law and general tax law
principles.

While I was revising the memo for you, I was reading Federal Income Taxation of
Corporations Filing Consolidated Returns (also known as Dubroff) and I found that there
is a requirement under general tax law principles (as I’ve been reading in other sources)
to determine quote:

“Each member’s deductible portion of interest paid on an income tax
deficiency for a prior consolidated return year, if the deficiency is paid
in a subsequent separate return year.” Federal Income Taxation of
Corporations Filing Consolidated Returns, section 54.01 fn. 6 citing
2

Koppers Co. v. Comm’r, 8 T.C. 886 (1947), supplemental opinion 11
T.C. 894 (1948). (page from Dubroff is attached).

I had found the Koppers supplemental opinion but I did not see the original case until
this morning. Koppers Co. v. Comm’r 8 T.C. 886 (1947). In this case, Koppers was
part of the consolidated group in 1930. It left the group in 1934. In 1940, the Service
assessed a tax deficiency for the consolidated group of $545,898 in tax and 316,631 in
interest. Koppers, an accrual method taxpayer paid most of the liability and
interest: $501,136 in tax and $290,659 in interest and deducted that interest. The Tax
Court held that Koppers was entitled only to deduct the portion of interest payment that
was allocable to it based on its share of the adjusted net income in 1930. The Tax
Court gave Koppers leave to show that it was entitled to take the interest deduction
based on its share of adjusted consolidated net taxable income. As it turned out,
Koppers was able to show that the portion of the tax liability it paid was its fair and
equitable share in the supplemental opinion and it was entitled to the entire interest
deduction. I think our case is different than Koppers because I do not think --------- can
show that the entire interest payment was allocable to it based on its share of the net
consolidated income in ------- because it was not even a member of the group for most
of the year. -------------------------------------------------------------------------------------

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Some important excerpts from the Koppers case (8 T.C. 886):

“Petitioner paid the major portion of the deficiency and interest. Although
respondent has determined that none of the interest is deductible, it would
seem that petitioner is entitled to an interest deduction in some
amount, at least to the extent it paid interest on its part of the tax.
Respondent concedes this on brief, but rightfully places upon petitioner the
burden of proving the exact amount. Since there really is no dispute on this
3

point, we need not discuss the question further, and hold that petitioner is
entitled to deduct the interest paid on that portion of the deficiency properly
assignable to it upon the basis of its share of the adjusted consolidated net
income.

Although petitioner and the other affiliates were thus severally liable to the
Government for the full deficiency and interest, as between themselves,
each affiliate was mutually obligated under principles of general law to pay
only its fair share of the common burden. See Phillips-Jones Corporation v.
Parmley, 302 U.S. 233

We think that respondent is correct in claiming that if
petitioner paid more than its proportionate share of the
deficiency and interest of the companies not in existence in
1940 a right of contribution did accrue to it from the other
affiliates. The right of contribution is not founded upon contract
and arises as a matter of general law whenever one pays on a
common obligation in excess of the share proper as between
himself and others similarly liable. Restatement Restitution, secs.
81 and 82; a Williston on Contracts, Rev. Ed., sec. 345. *892 To
us, however, the existence of a right of contribution has a
significance different from the one claimed for it by respondent. A
taxpayer can deduct interest qua interest only in so far as the
interest is paid on the taxpayer's own obligation. William H.
Simon, supra; Colston v. Burnet, 59 Fed.(2d) 867. Mere legal
liability or obligation to the creditor is not enough, for, as was said
in Eskimo Pie Corporation, 4 T.C. 669; affd., 153 Fed.(2d) 301:

• • • The statutory deduction for interest is confined to amounts chargeable
      against the taxpayer on his own indebtedness, and he may not deduct
      interest on the indebtedness of another, even though he has by legal
      contract agreed to pay such interest. William H. Simon, 36 B.T.A. 184;