Consolidated group may exclude deferred intercompany gain after subsidiary conversion

Plain-English summary

A member of a consolidated corporate group sold interests in a foreign subsidiary to another group member, creating deferred intercompany gain under the consolidated-return rules. Later reorganizations caused stock of a domestic subsidiary to become the successor asset that continued to carry the deferred gain. The group proposed converting the buyer and then the successor-asset subsidiary into limited liability companies disregarded from the seller, with each conversion represented to qualify as a complete liquidation. The IRS ruled that the second conversion would trigger the deferred gain under the matching rule. It also ruled that the gain would be redetermined as excluded from the seller's gross income for the consolidated-return year containing that conversion. The excluded amount would not enter any member's earnings and profits and would not count as tax-exempt income for consolidated stock-basis purposes.

Ruling snapshot

• Question: How do the consolidated intercompany-transaction rules treat deferred gain when the successor-asset subsidiary converts into a disregarded entity?
• Outcome: The gain is triggered under the matching rule, then redetermined as excluded from gross income, without earnings-and-profits or tax-exempt-income treatment.
• Key authorities: Treas. Reg. §§ 1.1502-13, 1.1502-32; IRC §§ 332, 337(a), 368(a)(1).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202516005 Third Party Communication: None
Release Date: 4/18/2025 Date of Communication: Not Applicable
Index Number: 1502.00-00, 1502.13-00
Person To Contact:
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------------------------------------------------ Telephone Number:
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---------------------- Refer Reply To:
-------------------------------------- CC:CORP:B04
PLR-114440-23
Date:
January 17, 2025

                                              LEGEND

Parent = ------------------------------------------------------------------------
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Parent Group = ------------------------------------------------------------------------
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Sub 1 = ------------------------------------------------------------------------
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Sub 2 = ------------------------------------------------------------------------
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Sub 3 = ------------------------------------------------------------------------
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PLR-114440-23 2

Sub 4 = ------------------------------------------------------------------------
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DRE 1 = ------------------------------------------------------------------------
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Foreign Sub 1 = ------------------------------------------------------------------------
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Foreign Partnership = ------------------------------------------------------------------------
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Country A = ---------------------

Country B = ----------------

a = -----------------

b = ---------------

c = -----------------

d = --------

e = --------

f = ---

g = --

Year 1 = -------

Year 2 = -------

Year 3 = -------

Year 4 = -------

Year 5 = -------
PLR-114440-23 3

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

This letter responds to your letter dated July 14, 2023, requesting rulings on certain
federal income tax consequences of proposed transactions (collectively, the “Proposed
Transactions”). The material information submitted in that request and in subsequent
correspondences is summarized below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty 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

In Year 1, Parent was a domestic corporation and the common parent of the Parent
Group. Parent directly owned 100 percent of the stock of Sub 1, a domestic corporation.
Sub 1, in turn, owned 100 percent of the stock in both Sub 2 and Sub 3, both domestic
corporations. Sub 1, Sub 2, and Sub 3 were members of the Parent Group. Sub 1 and
Sub 2 owned f percent and g percent, respectively, of the issued and outstanding
membership interests in Foreign Sub 1, a Country A eligible entity treated as a corporation
for U.S. federal income tax purposes.

In Year 1, Sub 1 sold all of its Foreign Sub 1 membership interests, representing f percent
of the total Foreign Sub 1 membership interests (the “Foreign Sub 1 Transferred
Interests”), to Sub 3 in exchange for a $a note (the “Year 1 Sale”). The Year 1 Sale was
an intercompany transaction under Treas. Reg. §1.1502-13(b)(1) where Sub 1 was the
selling member and Sub 3 was the buying member. Accordingly, Sub 1 had an
intercompany item equal to the difference between the fair market value of the
consideration received and the tax basis in the property exchanged (the “DIG”). At the
time of the Year 1 Sale, Sub 1 had a tax basis in the Foreign Sub 1 Transferred Interests
of $b. The amount of the DIG therefore equaled $c.

In Year 2, Foreign Sub 1 acquired from Sub 3 various related foreign entities in
transactions that Parent determined constituted section 368(a)(1)(D) reorganizations for
U.S. federal income tax purposes.

Between Year 2 and Year 3, Sub 2 converted to a domestic limited liability company, DRE
1, that was treated as a disregarded entity for U.S. federal income tax purposes. Then
Sub 1 and Sub 3 formed Foreign Partnership, a Country B partnership that was treated
as a partnership for U.S. federal income tax purposes. Sub 1 contributed DRE 1 in
exchange for d percent of the membership interests of Foreign Partnership, while Sub 3
contributed other assets and liabilities in exchange for the remaining e percent of the
membership interests of Foreign Partnership. After this internal restructuring, Sub 3
continued to own f percent of the outstanding membership interests of Foreign Sub 1,
PLR-114440-23 4

and Foreign Partnership, through DRE 1, owned the remaining g percent of the
outstanding membership interests of Foreign Sub 1.

In Year 3, Sub 3 and Foreign Partnership (for U.S. federal income tax purposes)
contributed their interests in Foreign Sub 1 to a newly formed domestic corporation, Sub
4 (the “Year 3 Contribution”). Subsequently, Foreign Sub 1 elected to be treated as a
disregarded entity for U.S. federal income tax purposes (together with the Year 3
Contribution, the “Year 3 Reorganization”). Parent reported the Year 3 Reorganization as
a tax-free reorganization pursuant to section 368(a)(1)(F). In Year 4, Foreign Sub 1 was
legally dissolved.

Parent determined that the Sub 4 shares held by Sub 3 constitute a successor asset to
the Foreign Sub 1 Transferred Interests under Treas. Reg. §1.1502-13(j)(1). Following
the Year 3 Reorganization, the DIG continued to be reflected in the difference between
Sub 3’s basis in the Sub 4 stock and the basis the Sub 4 stock would have if Sub 1 and
Sub 3 were divisions of a single corporation.

In Year 5, and immediately prior to the Proposed Transactions described below, Parent
is the common parent of the Parent Group. Parent indirectly owns 100 percent of the
stock of Sub 1. Sub 1 owns 100 percent of the stock of Sub 3, and each is a member of
the Parent Group. Sub 1 and Sub 3 own d percent and e percent, respectively, of the
membership interests of Foreign Partnership. Foreign Partnership owns 100 percent of
the membership interests in DRE 1. Sub 3 and DRE 1 own f percent and g percent,
respectively, of the stock of Sub 4.

The DIG has not been taken into account under the rules of Treas. Reg. §1.1502-13.

                        PROPOSED TRANSACTIONS

Parent plans to undertake the following Proposed Transactions in the order specified
below.

1. Sub 3 will convert to an LLC and become a disregarded entity of Sub 1 for U.S.
   federal income tax purposes (the “Sub 3 Conversion”).

2. Sub 4 will convert to an LLC and become a disregarded entity of Sub 1 for U.S.
   federal income tax purposes (the “Sub 4 Conversion”).

                            REPRESENTATIONS
   

The Parent Group has made the following representations with respect to the rulings
requested:

1. The Parent Group have filed or will file all consolidated returns consistent with the
   treatment of the Proposed Transactions described below.
   PLR-114440-23 5

2. The effects of the DIG have not previously been reflected, directly or indirectly, on
   the Parent Group’s consolidated return.

3. The Parent Group has not derived, and no taxpayer will derive, any federal income
   tax benefit from the Year 1 Sale that gave rise to the DIG or the redetermination of
   the DIG (including any adjustment to basis in member stock under Treas. Reg.
   §1.1502-32).

4. If an excess loss account (“ELA”) would have existed in the Sub 4 stock absent
   the Year 1 Sale, the Parent Group did not implement any steps that would have
   triggered such ELA.

5. Except for the transactions described above, no other transactions subsequent to
   the Year 1 Sale would have impacted the tax basis in the Foreign Sub 1
   Transferred Interests.

6. Prior to the Year 1 Sale, Sub 1 had tax basis in its membership interests in Foreign
   Sub 1 of $b.

7. At the time of the Proposed Transactions, all of the relevant entities will be solvent
   for U.S. federal income tax purposes (i.e., the fair market value of their assets will
   exceed the amount of their liabilities).

8. Sub 1 will become a successor person as defined in Treas. Reg. §1.1502-13(j)(2)
   to Sub 3 as a result of the Sub 3 Conversion.

9. The stock of Sub 4 deemed distributed in the Year 3 Reorganization is considered
   a successor asset to the Foreign Sub 1 Transferred Interests pursuant to Treas.
   Reg. §1.1502-13(j)(1).

10. The Sub 3 Conversion will qualify as a complete liquidation to which sections 332
    and 337(a) apply.

11. The Sub 4 Conversion will qualify as a complete liquidation to which sections 332
    and 337(a) apply.

                                    RULINGS
    

Based solely on the information submitted and the representations set forth above, we
rule as follows:

1. The Sub 4 Conversion will require Sub 1 to take into account the DIG under the
   matching rule of Treas. Reg. §1.1502-13(c).
   PLR-114440-23 6

2. The DIG will be redetermined to be excluded from Sub 1’s gross income for the
   Parent Group’s consolidated return year that includes the day of the Sub 4
   Conversion under Treas. Reg. §1.1502-13(c)(6)(ii)(D).

3. The amount of the DIG that is redetermined to be excluded from gross income will
   not be taken into account as earnings and profits of any member and will not be
   treated as tax-exempt income under Treas. Reg. §1.1502-32.

                                   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 under any provision of the Internal Revenue Code (the “Code”) and the regulations
thereunder. Furthermore, no opinion is expressed or implied with respect to the
appropriate amount of the DIG that is redetermined to be excluded from gross income
under Treas. Reg. §1.1502-13(c)(6)(ii)(D).

                         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.

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 the letter
ruling.

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

                                   Sincerely,




                                   Katherine H. Zhang
                                   Senior Counsel, Branch 5
                                   Office of Associate Chief Counsel (Corporate)

PLR-114440-23 7

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