If a company sells 100% of a subsidiary's stock to an unrelated third party, but makes federal tax elections treating the deal as an asset sale followed by a liquidation into another group member, does the subsidiary's Texas franchise tax temporary credit for business loss carryforward stay with the combined group?

Plain-English summary

A publicly traded holding company tried to preserve a Texas franchise tax "temporary credit" for business loss carryforward that originated with a subsidiary it later sold. The company sold 100% of the subsidiary's stock to an unrelated third party for cash, but separately made federal income tax elections (under IRC §§ 336(e) and 368(a)(1)(C)) to treat the deal, for federal tax purposes only, as an asset sale followed by a tax-free liquidation of the subsidiary into a different group member. The company kept claiming the subsidiary's temporary credit on its Texas franchise tax reports after the sale, arguing the federal "liquidation" treatment meant the credit should transfer to the surviving group member.

The Comptroller disagreed and disallowed the credit. Texas's temporary-credit rule preserves a combined group's use of a member's business loss carryforward only if that member merges into another group member; if a member instead leaves the group (dissolves, terminates, or is sold out), its carryforward credit is no longer usable by the group, and the statute separately says the credit can never be assigned or transferred. Here, the actual legal transaction was a straightforward stock sale to an unrelated buyer — the subsidiary's own liquidation-plan paperwork even said the plan was "adopted for income tax purposes only" and wouldn't actually dissolve the subsidiary under state law. Because Texas franchise tax has no provision recognizing the federal IRC §336(e)/368(a)(1)(C) elections as changing that reality, the subsidiary was simply sold to — and became a member of — the buyer's combined group, and its temporary credit stayed behind with the buyer's group, unusable by the seller.

What this means for you

Companies planning to sell a subsidiary that carries a Texas franchise tax credit

Making federal tax elections (like IRC § 336(e) or a reorganization under § 368) to characterize a stock sale as an asset sale or liquidation for federal purposes does not change how Texas franchise tax treats the transaction. If the actual legal event is a sale of the subsidiary's stock to a party outside your combined group, expect to lose that subsidiary's temporary credit — federal tax-election "form" won't override the underlying state-law substance.

Corporate tax departments handling combined-group restructurings

The key distinction under 34 Tex. Admin. Code Rule 3.594(c)(3) is merger-within-the-group (credit stays) versus dissolution/exit-from-the-group (credit is lost) — and Section 171.111(d)'s independent bar on assigning or transferring the credit means even a genuine merger argument wouldn't let you move a departing member's credit to an entity outside the original combined group.

Accountants and tax professionals

Note this document is a General Information Letter, not a Private Letter Ruling, even though the taxpayer requested a PLR — the Comptroller's response explicitly says so and states it provides no detrimental reliance relief. It's useful general guidance on how Texas treats federal M&A tax elections for combined-group credit purposes, but it doesn't bind the Comptroller even as to the requesting taxpayer.

Common questions

Q: Does a federal IRC § 336(e) or § 368(a)(1)(C) election change how a transaction is treated for Texas franchise tax purposes?
A: No. This letter found no Texas statute or rule that recognizes those federal elections, and concluded their absence means Texas doesn't follow the federal "deemed" characterization for combined-group credit purposes.

Q: Can a Texas franchise tax temporary credit ever be transferred to another entity?
A: Only when a group member merges into another member of the same combined group (the carryforward stays with the group). Section 171.111(d) otherwise bars conveying, assigning, or transferring the credit, and a member that dissolves, terminates, or leaves the group any other way loses eligibility to use it.

Q: Can another taxpayer rely on this letter for its own restructuring?
A: No — the Comptroller's own response states this is a General Information Letter, not binding on the Comptroller and providing no detrimental reliance relief, even for the company that requested it.

Citations and references

Statutes and rules:

• Tex. Tax Code § 171.111 (Temporary Credit on Taxable Margin)
• Tex. Tax Code § 171.111(d) (credit may not be conveyed, assigned, or transferred)
• 34 Tex. Admin. Code Rule 3.594(c)(3) (Margin: Temporary Credit for Business Loss Carryforwards — merger vs. group exit)
• 26 U.S.C. § 332 (Complete liquidations of subsidiaries)
• 26 U.S.C. § 336(e) (Gain or loss recognized on property distributed in complete liquidation)
• 26 U.S.C. § 368(a)(1)(C) (corporate reorganizations)

Cited prior guidance:

• STAR Accession No. 201411985L (Nov. 20, 2014) — temporary credit treatment when one combined-group member merges into another

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=MAR
• Opinion: https://star.comptroller.texas.gov/view/202204015L

Original ruling text

April 4, 2022

RE: PLR Request No. PLR20220203114556

Dear **:

We issue this response in accordance with Rule 3.1, Private Letter Rulings and General Information Letters. [ENDNOTE 1] You requested a Private Letter Ruling on Jan. 18, 2022. However, this response is a General Information Letter that provides general information relating to Section 171.111, Temporary Credit on Taxable Margin. This letter does not provide detrimental reliance relief under Rule 3.10, Taxpayer Bill of Rights.

You requested a ruling related to the unused temporary credit for business loss carryforward (temporary credit) that originated with a member of the Taxpayer combined group.

Relevant Facts Presented

The relevant facts are based on the following documents provided for review by Taxpayer:

Taxpayer’s Request for a Private Letter Ruling dated Jan. 18, 2022;

PricewaterhouseCoopers LLP memorandum discussing the federal tax implications related to the sale of Subsidiary A to an unrelated third party;

Plan of Complete Liquidation of Subsidiary A;

Adoption of Plan of Complete Liquidation;

IRC Section 336(e) Election Statement; and

Treas. Reg. § 1.368-3(a) Election Statement.

Taxpayer is a publicly traded holding company and the reporting entity of a combined group that consists of several entities including Subsidiary A and Subsidiary B. Taxpayer directly owned 100 percent of the issued and outstanding stock of Subsidiary A and B.

In 2008, Subsidiary A preserved its right to claim the temporary credit for business loss carryforward and Taxpayer’s combined group claimed the temporary credit on subsequent franchise tax combined group reports.

Taxpayer undertook the following transaction steps in a prearranged plan to liquidate Subsidiary A, pursuant to and in accordance with Internal Revenue Code (IRC) Section 332 (Complete liquidations of subsidiaries). The plan was effective as of January 9, 2019.

Between June 1, 2018, and Jan. 8, 2019, Subsidiary A sold approximately 80 percent of its assets to Taxpayer in exchange for an intercompany receivable.

On Jan. 9, 2019, Subsidiary A formally adopted a plan of liquidation.

Subsidiary A then assigned its intercompany receivable to Taxpayer and Taxpayer then contributed the assets purchased from Subsidiary A to Subsidiary B in exchange for no consideration.

On Jan. 22, 2019, Taxpayer transferred 100 percent of the issued and outstanding stock of Subsidiary A to a third party solely in exchange for cash of equal value.

Taxpayer filed an IRC Section 336(e) (Gain or loss recognized on property distributed in complete liquidation) election in connection with Taxpayer’s transfer of Subsidiary A’s stock.

Under IRC Section 336(e), a seller (Taxpayer) and target organization (Subsidiary A) may make an election to treat the disposition of the stock of the target corporation as a disposition of the target corporation’s assets. In other words, the transaction is treated as a deemed asset sale for U.S. federal income tax purposes.

Following the deemed asset sale, any remaining assets of Subsidiary A were liquidated into Subsidiary B in an IRC Section 368(a)(1)(C) (Definitions relating to corporate reorganizations) tax-free reorganization.

After Subsidiary A’s “liquidation,” Taxpayer continued to claim Subsidiary A’s temporary credit on its Texas Franchise Tax Report. When Taxpayer claimed Subsidiary A’s temporary credit on its 2021 Franchise Tax Report (the first report that did not include Subsidiary A as a member of Taxpayer’s combined group), the Comptroller’s office disallowed the claimed credit. Taxpayer contacted the Comptroller’s office to explain its transaction and the federal tax elections. Since Taxpayer could provide neither liquidation nor merger documentation to the Comptroller’s office to prove that Subsidiary A no longer existed, the Comptroller’s office staff would not move Subsidiary A’s temporary credit to Subsidiary B. Comptroller’s office staff instructed Taxpayer to request a private letter ruling to resolve the disagreement.

Question, Ruling, and Analysis

Our restatement of your question is shown below, followed by our response and analysis.

Question: Can Taxpayer and its combined group continue to use Subsidiary A’s temporary credit?

Ruling: Subsidiary A’s temporary credit is not available to Taxpayer’s combined group for the franchise tax report due on May 17, 2021, or any subsequent reports.

Analysis:

Taxpayer claims that it has been unable to identify relevant or current guidance that would disallow the surviving entity of a combined group from maintaining the right to the temporary credit following IRC Section 336(e) and IRC Section 368(a)(1)(C) elections. Taxpayer claims that without a Texas statutory provision or rule that specifically prohibits the carryover of the credits by a corporation implementing an IRC Section 368(a)(1)(C) reorganization, federal treatment of such a reorganization should be considered in evaluating if the transaction would be treated as a liquidation/merger for Texas purposes.

Taxpayer cites Rule 3.594(c)(3) (Margin: Temporary Credit for Business Loss Carryforwards) which states, “If a member merges into another member of the group, that member’s business loss carryforward will remain with the group. If the member dissolves, terminates, or otherwise leaves the group, the business loss carryover of that member is no longer eligible for use.” Taxpayer claims this provision and other guidance related to the temporary credit does not distinguish how a merger is determined and that the intended structure of transaction outlined in its submitted documents was a liquidation/merger of a significant majority of Subsidiary A’s assets into Subsidiary B.

Taxpayer further cites STAR Accession No. 201411985L (Nov. 20, 2014) as addressing what happens to the temporary credit when one member of a combined group merges into another member of the combined group. In the provided example, the combined group member that survived the merger was able to utilize the credit of the member entity that was merged. Taxpayer notes that the letter does not address mergers as a result of tax elections.

Taxpayer is correct in that there is no Texas statute or rule that specifically discusses how an IRC Section 336(e) and 368(a)(1)(C) election is treated for franchise tax purposes. This omission indicates that the Texas franchise tax does not recognize such elections. There is no provision in Texas Tax Code, Chapter 171 (Franchise Tax) that obligates Texas to recognize these federal tax elections.

Further, Section 171.111(d) provides that a temporary credit may not be conveyed, assigned, or transferred. Taxpayer’s transaction to “liquidate” Subsidiary A transfers the temporary credit from Subsidiary A to Subsidiary B, which is not allowed under the plain meaning of the statute.

Taxpayer claims that Subsidiary A was liquidated/merged into Subsidiary B; however, the facts provided by Taxpayer are clear in that Taxpayer sold 100 percent of the issued and outstanding shares of Subsidiary A to an unrelated third party. Subsidiary A was neither merged nor liquidated into Subsidiary B. As noted in the Adoption of Plan of Complete Liquidation, the plan “is being adopted for income tax purposes only, and its adoption shall not result in the liquidation or dissolution of [Subsidiary A] under the Act.”

Subsidiary A is now a member of the third-party purchaser’s combined group. Under Rule 3.594(c)(3), if a member of a combined group changes combined groups, the business loss carryforward of that member will no longer be included in the temporary credit calculation of the group. “Treating” the sale of stock as a sale of assets for federal tax purposes does not change the true nature of the transaction. Taxpayer sold Subsidiary A to another combined group; therefore, Subsidiary A changed combined groups, and Subsidiary A’s temporary credit may no longer be claimed by Taxpayer.

Comptroller’s Decisions and STAR documents cited can be found on the Comptroller’s State Tax Automated Research (STAR) system. The Texas Tax Code, Texas Administrative Code, and the STAR system are accessible at www.comptroller.texas.gov/taxes/.

If you have questions about this private letter ruling, please email us through our website at https://comptroller.texas.gov/web-forms/tax-help/ and reference Private Letter Ruling Request No. PLR20220203114556.

Sincerely,

Tax Policy Division – Direct Taxes

Texas Comptroller of Public Accounts

ENDNOTE

1. Unless otherwise indicated, all references to “Section” are to the Texas Tax Code, and all references to “Rule” are to Title 34 of the Texas Administrative Code.