A company's stock was bought in a deal where the parties made a federal § 338(h)(10) election, so the company was 'deemed' to acquire its own manufacturing assets. Can it claim Tennessee's franchise & excise industrial-machinery credit on those assets?

Plain-English summary

A company was sold. A buyer bought 100% of the company's stock from its former parent, and the buyer and seller jointly made a federal I.R.C. § 338(h)(10) election — which, for federal income tax, treats a stock sale as if the company sold and re-bought all its assets. The company owned manufacturing equipment that qualifies as "industrial machinery." It asked whether, going forward, it could claim Tennessee's franchise & excise (F&E) industrial-machinery credit on the machinery it was "deemed" to have acquired through that election.

The Department said no. Tennessee gives manufacturers a credit against their combined franchise and excise tax — generally 1% of the purchase price of qualifying industrial machinery located in Tennessee — but to claim it, the taxpayer has to actually purchase the machinery in the tax period. And here, nothing was purchased. The thing that changed hands was stock (the owners sold their shares); the "asset sale" exists only as a federal income-tax fiction under § 338(h)(10).

The key principle is that Tennessee's franchise and excise tax laws are not controlled by federal income tax elections. Where an F&E provision isn't expressly tied to the federal code, leaving out a federal reference is read as the legislature's intent to depart from federal law (Oak Ridge Land Co.). Tennessee's F&E laws neither adopt nor disallow § 338(h)(10) and have no comparable state election, so the federal deemed transactions are not deemed to occur for Tennessee F&E. No real purchase, no industrial-machinery credit. (Because that first requirement failed, the Department didn't reach the credit's other requirements.)

The instructive twist is the contrast with the income side. A § 338(h)(10) election is not ignored for Tennessee in general — its effect on federal taxable income flows straight into Tennessee net earnings, because the excise tax starts from federal taxable income (and for S corporations, specific add-backs make sure the gain or loss is captured). So the same election that does push gain into a company's Tennessee net earnings (the income side) does not create a deemed purchase that earns a credit (the credit side). The Department also pointed out the symmetry: if a deemed purchase did count, it would cut the other way and trigger recapture of any industrial-machinery credits previously claimed on those very assets.

What this means for you

Buyers and sellers structuring a § 338(h)(10) deal

Don't assume the federal "deemed asset purchase" buys you Tennessee tax attributes. For the F&E industrial-machinery credit, Tennessee looks at what really happened — a stock sale — so the target gets no fresh credit on assets it already owned, even though federal law treats them as re-acquired. Budget the deal on that basis, and remember the flip side: the election's income effects do reach Tennessee net earnings.

Manufacturers claiming the industrial-machinery credit

The credit hinges on an actual purchase of qualifying industrial machinery (as defined in § 67-6-102(44)) located in Tennessee. Deemed, constructive, or fictional acquisitions don't count. And if you later sell credited machinery within its useful life, expect recapture (§ 67-4-2009(3)(D)). Keep the credit mechanics in mind: generally 1% of purchase price, capped at 50% of F&E liability, with a 15-year carryforward (and enhanced rates for larger capital investments).

Accountants and tax professionals

This is the credit-side companion to the Department's income-side § 338(h)(10) rulings (LR 14-01, LR 14-15). The throughline: Tennessee F&E departs from the federal code unless expressly tied to it (Oak Ridge Land Co.; Little Six Corp.), so a federal election changes Tennessee results only through the channels Tennessee law actually adopts — here, federal taxable income feeding net earnings (§ 67-4-2006(a)(1)), not a deemed asset purchase feeding the credit (§ 67-4-2009(3)(A)).

Common questions

Q: Does a § 338(h)(10) election let the target claim Tennessee's industrial-machinery credit on its assets?
A: No. The credit requires an actual purchase of qualifying industrial machinery. A § 338(h)(10) election is a federal income-tax fiction treating a stock sale as an asset sale; Tennessee F&E doesn't recognize that deemed purchase, so no credit arises.

Q: But doesn't Tennessee follow the § 338(h)(10) election at all?
A: Only through federal taxable income. Because Tennessee net earnings start from federal taxable income, the election's income effect (gain or loss) does flow into Tennessee net earnings. What it does not do is create a deemed purchase that generates the industrial-machinery credit.

Q: What happens if credited machinery is later sold?
A: Tennessee recaptures part of the credit. Selling industrial machinery during its useful life increases the taxpayer's franchise/excise liability for that period by the remaining-useful-life percentage of the credit originally taken (§ 67-4-2009(3)(D)).

Q: Can I rely on this letter ruling?
A: No. A Tennessee letter ruling binds the Department only as to the specific taxpayer and facts, and it can be revoked or modified. The Department also doesn't rule on federal tax. Confirm your own deal with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann.):

• § 67-4-2009(3)(A) (F&E industrial-machinery credit — generally 1% of purchase price); § 67-4-2009(3)(A)(ii) (certain computer-related assets); § 67-4-2009(3)(B) (50%-of-liability cap); § 67-4-2009(3)(C)(i) (15-year carryforward); § 67-4-2009(3)(I) (enhanced credit for larger investments)
• § 67-4-2009(3)(D) (recapture on sale of credited machinery during its useful life)
• § 67-6-102(44) (definition of "industrial machinery," incorporated into the credit)
• § 67-4-2006(a)(1) (corporation's net earnings start from federal taxable income — the channel through which the § 338(h)(10) income effect reaches Tennessee); § 67-4-2006(b)/§ 67-4-2006(c) (adjustments); § 67-4-2006(b)(1)(M)/(2)(Q) (S-corporation § 338(h)(10) add-backs)

Federal law cited:

• 26 U.S.C. § 338(h)(10) (joint election treating a stock sale as a deemed asset sale); Treas. Reg. § 1.338(h)(10)-1, § 1.338-1(a) (the deemed/fictional transactions: Old Target / New Target)

Tennessee cases cited by the ruling:

• Oak Ridge Land Co. v. Roberts, 2012 WL 5962002 (Tenn. Ct. App. 2012) (omitting a reference to the federal code shows intent to depart from it); Little Six Corp. v. Johnson, 1999 WL 336308 (Tenn. Ct. App. 1999) (federal tax rulings don't control Tennessee tax law)

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/14-06fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
LETTER RULING # 14-06

Letter rulings are binding on the Department only with respect to the individual taxpayer
being addressed in the ruling. This ruling is based on the particular facts and
circumstances presented, and is an interpretation of the law at a specific point in time. The
law may have changed since this ruling was issued, possibly rendering it obsolete. The
presentation of this ruling in a redacted form is provided solely for informational purposes,
and is not intended as a statement of Departmental policy. Taxpayers should consult with a
tax professional before relying on any aspect of this ruling.
SUBJECT
The availability of the Tennessee franchise and excise tax industrial machinery credit to an entity
that has made an I.R.C. § 338(h)(10) election.
SCOPE
This letter ruling is an interpretation and application of the tax law as it relates to a specific set of
existing facts furnished to the Department by the taxpayer. The rulings herein are binding upon
the Department, and are applicable only to the individual taxpayer being addressed.
This letter ruling may be revoked or modified by the Commissioner at any time. Such revocation
or modification shall be effective retroactively unless the following conditions are met, in which
case the revocation shall be prospective only:
(A) The taxpayer must not have misstated or omitted material facts involved in the
transaction;
(B) Facts that develop later must not be materially different from the facts upon which
the ruling was based;
(C) The applicable law must not have been changed or amended;
(D) The ruling must have been issued originally with respect to a prospective or
proposed transaction; and
(E) The taxpayer directly involved must have acted in good faith in relying upon the
ruling; and a retroactive revocation of the ruling must inure to the taxpayer’s detriment.

FACTS
Prior to [TRANSACTION DATE], [TAXPAYER] (the “Taxpayer”) was a subsidiary of
[SELLER] (the “Seller”). On [TRANSACTION DATE], [BUYER] (the “Buyer”) acquired
100% of the stock of the Taxpayer from the Seller (the “Sale”). At the time of the Sale, the
Taxpayer possessed manufacturing assets (the “Manufacturing Assets”) that qualified as

industrial machinery under TENN. CODE ANN. §§ 67-4-2009(3), -6-102 (2013). The Buyer and
the Seller jointly elected to treat the stock sale as a sale of assets for federal income tax purposes
under I.R.C. § 338(h)(10).
RULING
For tax periods following the Sale, is the Taxpayer eligible to claim the Tennessee franchise and
excise tax industrial machinery credit under TENN. CODE ANN. § 67-4-2009(3)(A) (2013) with
respect to the Manufacturing Assets that the Taxpayer was deemed to have acquired upon
making the I.R.C. § 338(h)(10) election?
Ruling: No. The Taxpayer is not eligible to claim the Tennessee franchise and excise tax
industrial machinery credit under TENN. CODE ANN. § 67-4-2009(3)(A) with respect to the
Manufacturing Assets that the Taxpayer was deemed for federal income tax purposes to have
acquired as a result of the Sale.
ANALYSIS
I.R.C. § 338(h)(10) Election
Under federal law, I.R.C. § 338(h)(10) provides an elective, alternative federal income tax
treatment for qualifying sales of corporate stock. When a buyer acquires corporate stock in a
target corporation, the purchase generally has no federal income tax consequences for the target
corporation. Instead, the target corporation’s former shareholders recognize gain or loss on the
sale or exchange of the target corporation’s shares. Conversely, when a buyer acquires the assets
of a corporation, the asset acquisition causes the target corporation to recognize gain or loss on
the sold assets, but the transaction has no immediate federal income tax consequences on the
target corporation’s shareholders.
Provided certain requirements are met, the buyer and the target corporation’s owners may jointly
elect under I.R.C. § 338(h)(10) to treat a stock sale as an asset sale for federal income tax
purposes. To facilitate the correct computation of federal income tax under an I.R.C.
§ 338(h)(10) election, Treas. Reg. § 1.338(h)(10)-1 instructs electing taxpayers to compute their
respective federal tax liabilities as though a series of fictional transactions had occurred. In
general, the buyer is deemed to have contributed the purchase money to a wholly owned
subsidiary; the target corporation is deemed to have transferred all of its assets to the buyer’s
fictional subsidiary in exchange for the purchase money; and the target corporation’s
shareholders are deemed to have ultimately received the purchase money upon liquidating the
target corporation.
For federal income tax purposes, if an election under I.R.C. § 338(h)(10) is made, the target
corporation is treated as though it were two separate corporations, Old Target and New Target.1
Old Target is treated as if, before the close of the acquisition date, after the deemed asset sale,
and while Old Target is a member of the selling consolidated group, it transferred all of its assets
1

Treas. Reg. §§ 1.338-1(a) (as amended in 2013), 1.338(h)(10)-1(d)(2)-(3) (as amended in 2007).

to members of the selling consolidated group and ceased to exist. Members of the selling
consolidated group are treated as if, after the deemed asset sale and before the close of the
acquisition date, they received the assets transferred by Old Target. In other words, immediately
after the deemed asset sale, Old Target is treated as having liquidated into its parent company or
companies. New Target is treated as a separate corporation that acquired the assets of Old
Target.
Industrial Machinery Credit
Tennessee imposes on all persons doing business within Tennessee an excise tax at the rate of
6.5% on net earnings and a franchise tax at the rate of $0.25 per $100, or major fraction thereof,
of net worth.
Taxpayers who purchase qualifying industrial machinery that will be located in Tennessee are
entitled to take an industrial machinery credit against their combined Tennessee franchise and
excise tax liability for the period in which the purchase occurs.2 The industrial machinery credit
is generally equal to 1% of the purchase price of the qualifying machinery.3 For Tennessee
franchise and excise tax purposes, qualifying industrial machinery includes “industrial
machinery” as defined in TENN. CODE ANN. § 67-6-102,4 as well as certain additional computerrelated assets outlined in TENN. CODE ANN. § 67-4-2009(3)(A)(ii).
Thus, the following requirements must be met in order for the Taxpayer to qualify for the
industrial machinery credit with respect to the Manufacturing Assets that the Taxpayer was
deemed for federal income tax purposes to have acquired upon making the I.R.C. § 338(h)(10)
election: 1) the Taxpayer must have purchased the Manufacturing Assets during the tax period in
which the credit will be claimed; 2) the Manufacturing Assets must be industrial machinery; and
3) the Manufacturing Assets must be located in Tennessee.
The first requirement is not met because the Taxpayer did not, for Tennessee tax purposes,
purchase the Manufacturing Assets as a result of the Sale.
Importantly, the Tennessee franchise and excise tax laws are not controlled by federal income
tax laws, regulations, and elections.5 For all provisions of franchise or excise tax law that are not
2

TENN. CODE ANN. § 67-4-2009(3)(A) (2013).

3

Id. With certain exceptions, the credit shall not exceed fifty percent of the combined franchise and
excise tax liability shown by the return before the credit is taken. TENN. CODE ANN. § 67-4-2009(3)(B).
Any unused credit may be carried forward for a maximum of fifteen years. TENN. CODE ANN.
§ 67-4-2009(3)(C)(i). Note that industrial machinery credits of up to ten percent of the purchase price are
available to qualifying taxpayers making certain levels of capital investments. See, e.g., TENN. CODE
ANN. § 67-4-2009(3)(I).
4

5

See TENN. CODE ANN. § 67-6-102(44) (2013).

See Oak Ridge Land Co. v. Roberts, No. E2012-00456-COA-R3-CV, 2012 WL 5962002, at 3 (Tenn.
Ct. App. Nov. 29, 2012), app. denied (April 9, 2013); Little Six Corp. v. Johnson, No. 01-A-01-9806CH00285, 1999 WL 336308, at 3 (Tenn. Ct. App. May 28, 1999).

directly and expressly tied to federal law, “[t]he omission of a reference to or reliance upon the
federal code . . . should be construed as the legislature’s intent to depart from the federal code.”6
The Tennessee franchise and excise tax laws neither adopt nor disallow the provisions of I.R.C.
§ 338(h)(10) and accompanying federal regulations, nor do they provide for a comparable
election to treat a stock sale as a deemed asset sale. Accordingly, transactions deemed to have
occurred for federal income tax purposes per Treas. Reg. § 1.338(h)(10)-1 are not deemed to
have occurred for Tennessee franchise and excise tax purposes.7
The Taxpayer’s deemed transfer of the Manufacturing Assets for federal income tax purposes
pursuant to Treas. Reg. § 1.338(h)(10)-1 neither occurred in fact nor were deemed to have
occurred for Tennessee franchise and excise tax purposes. Rather, the owners of the Taxpayer
sold their stock in the Taxpayer, and the parties made a federal election to treat the stock sale as
an asset sale for federal income tax purposes. Accordingly, the Sale did not involve the purchase
by the Taxpayer of the Manufacturing Assets for purposes of qualifying for the industrial
machinery credit.
As a result, the Taxpayer is not eligible to claim the Tennessee franchise and excise tax industrial
machinery credit under TENN. CODE ANN. § 67-4-2009(3)(A) with respect to the Manufacturing
Assets that it was deemed for federal income tax purposes to have acquired as a result of the
Sale.8
Because the first requirement is not met, this ruling will not address the additional requirements
under TENN. CODE ANN. § 67-4-2009(3).
6

Oak Ridge Land Co., 2012 WL 5962002, at *3.

7

Nevertheless, the effect on a taxpayer’s federal taxable income from an I.R.C. § 338(h)(10) election is
reflected in a taxpayer’s Tennessee net earnings. As a general matter, capital gains and losses realized
pursuant to an I.R.C. § 338(h)(10) election are incorporated into net earnings in the same manner as any
other gains or losses. The Tennessee excise tax expressly uses specific elements of a taxpayer’s federal
taxable income in the computation of taxable net earnings. For example, corporations use “federal taxable
income or loss before the operating loss deduction and special deductions provided for in 26 U.S.C. §§
241, 242 [repealed], 243-247” as a starting point for computing their Tennessee net earnings. TENN.
CODE ANN. § 67-4-2006(a)(1) (2013). While TENN. CODE ANN. § 67-4-2006(b) and (c) make several
adjustments to a taxpayer’s federal taxable income starting point, these adjustments do not alter the
effects of an I.R.C. § 338(h)(10) election on a taxpayer’s federal taxable income. Note that in the case of
S corporations, TENN. CODE ANN. § 67-4-2006(b)(1)(M), (2)(Q) function to ensure that the gains or
losses realized pursuant to an I.R.C. § 338(h)(10) election are reflected in net earnings.
8

Note that if the Taxpayer were deemed for franchise and excise tax purposes to have purchased the
Manufacturing Assets in conjunction with the Sale, the Taxpayer would be subject to recapture of
industrial machinery credits previously claimed with respect to those same assets. TENN. CODE ANN.
§ 67-4-2009(3)(D) provides that if industrial machinery, for the purchase of which a tax credit has been
allowed, is sold during its useful life, the Department shall be entitled to recapture a portion of the credit.
The recapture is effected by increasing the taxpayer’s franchise and/or excise tax liability for the taxable
period during which the machinery was sold, in an amount equal to the percentage of useful life
remaining on the industrial machinery at the time of sale times the total credit taken on the purchase of
the machinery. Id.

Robert Guth
Assistant General Counsel

APPROVED:

Richard H. Roberts
Commissioner of Revenue

DATE:

August 25, 2014