Deloitte - Tax Issues and Entities

The Dbriefs Federal Tax series presents:

Legal Entity Simplification: Federal Tax Opportunities and Pitfalls Kay Pitman, Partner, Deloitte Tax LLP

Russ Hamilton, Partner, Deloitte Tax LLP

Jeff Shaw, Director, Deloitte Tax LLP November 7, 2013

Copyright 2013 Deloitte Development LLC. All rights reserved.

Benchmarks and potential cost savings

Basic federal tax considerations

Triggering existing tax losses

Internal spins and deferred gains

Insolvent subsidiaries

Agenda

Benchmarks and potential cost savings


One measure of legal entity efficiency is the ratio of the number of legal entities within the organization for each billion dollars of annual revenue; where does your company fall, based on this benchmark?

Benchmarking legal entity efficiency

1

0

10

20

30

40

50

60

70

80

Num

ber o

f For

tune

500

Com

pani

es

Legal entities / billions of revenue

Fortune 500 Legal Entities Per $1Bn of Revenue, 2012 50

th P

erce

ntile

40th P

erce

ntile

30th P

erce

ntile

10th P

erce

ntile

More efficient Less Efficient 0-5.0 5.1-8.0 8.1-11.0 11.1-18.0 18.1 - 80

Deloitte Tax 2013 study based on public company data


Legal entity complexity impacts process costs across functional areas. A recent Deloitte study1 shows the correlation between finance process cost and the number of legal entities.

Opportunity for savings

2

0.00%

0.20%

0.40%

0.60%

0.80%

1.00%

1.20%

5 LE 10 LE 20 LE

% o

f Tot

al R

even

ue

Legal Entities per Billion of Revenue

Fortune 500 Finance Process Costs, % of Revenue1

PerformanceManagement

Tax and Treasury

Controls

General Accounting

Transaction Processing

0.299% have difference 1 Source: Deloitte Global Benchmarking Center analysis of 400 enterprises conducted in 2011


Is your company considering simplifying its legal entity structure?

Yes, likely in the next 12 months Yes, but probably more than 12 months from now Maybe, were currently studying the issue No Dont know/not applicable

Poll question #1

Basic federal tax considerations

Copyright 2013 Deloitte Development LLC. All rights reserved. 3

Is your legal entity structure properly aligned with the way your business is run?

Advantages of a properly aligned structure - Limiting asset drift between similar companies

Avoiding potential deferred intercompany gains (DITs) on inadvertent transfer of appreciated assets, including goodwill and other intangibles

- Readiness for future transactions Preserving basis when and where it likely will be needed Avoiding incremental tax costs in future transactions

Tax considerations before you begin


Triggering IRC 165 losses Structuring into loss transactions Loss of outside tax basis in stock Use of internal spins to align entities properly Triggering Excess Loss Accounts (ELAs)/DITs Complications from existing intercompany debt Disqualifying transactions previously undertaken that

were intended to be tax-free (or taxable)

Tax transition challenges and opportunities


Stock DITs are forever (one new exception) ASC 740-10 (FIN 48) brings extraordinary discipline to

this analysis Premium on the right way, including complete documentation Premium on appropriate involvement/consultation with

financial statement auditors Discipline is also necessary due to possible future

transactions Certain transactions undertaken in close proximity to

disposition transactions may be recast resulting in tax leakage

Implementation pitfalls exist

Triggering existing tax losses


Foreign Sub

6

Rev. Rul. 2003-125 (Situation 2) Facts Parent owns 100% of the stock of Foreign Sub. The amount of Foreign Subs liabilities exceeds the

fair market value of its tangible and intangible assets. Parent causes Foreign Sub to make a CTB election

to be disregarded as separate from its owner.

Rev. Rul. 2003-125 holds that: Parent may claim worthless stock deduction under

IRC 165. Creditors of Foreign Sub, including Parent, if applicable,

may claim a bad debt deduction under IRC 166.

CTB Election to Treat Insolvent Subsidiary as a Disregarded Entity for U.S. Federal Tax Purposes

Liabilities > FMV of Assets

Parent


Transaction Structure: 1. U.S. Parent transfers a 35% interest in wholly owned Foreign Sub 1 to wholly owned Foreign Sub 2 in

exchange for IRC 351(g)(2) non-qualified preferred stock of Foreign Sub 2. 2. Foreign Sub 1 then makes a CTB election to be a partnership for U.S. tax purposes

Tax Consequences: Provided certain requirements are met, Parent recognizes a capital loss on the liquidation (65% of the

built-in loss) under IRC 331. FS1 recognizes gain or loss under IRC 336 for U.S. tax purposes. However, Parents loss on the transfer of the 35% interest in FS1 to FS2 continues to be deferred until

Parent and FS2 are no longer members of the same controlled group.

Planning into 331 Granite Trust 1. Transfer of 35% Interest of FS1 to FS2 2. Subsidiary makes a CTB election

(or convert and check) to be a partnership

FS1

100%

FS2

35% of FS1s

o/s shares

100%

Newly issued FS2 NQPS U.S.

Parent FMV = $40 Basis = $200

U.S. Parent

65% FS2

35%

FS1


Simplification will often eliminate outside basis, or at a minimum make it more difficult to access it in future stock sales

Relevant when outside basis is higher than inside basis - So generally not a factor when a consolidated return entity that was

formed or acquired in a section 338(h)(10) transaction versus a stock purchase transaction

Full business integration can make it somewhat less likely that individual units are sold separately

Take into account the manner in which business units might be sold in the future, attempting to collect all outside basis in the appropriate entity so that the basis is not lost

Loss of outside basis


In your company, which groups are normally consulted before an entity is eliminated?

Tax, Finance, Legal Tax, Finance, Legal, HR Tax only Some other combination of internal groups We havent eliminated any companies in the recent past Dont know/not applicable

Poll question #2

Internal spins and deferred gains


Internal Spin Transactions P (Common Parent of the P Consolidated Group) would like to operate the C business as a direct

subsidiary of P. Cause D to convert to a DRE or Liquidate under Section 332? (Loss of $400M of Stock Basis) Internal Spin-Off under Section 355? (Splitting of Ps Basis in D Between and C in a Tax Free Transaction)

Spin-off transaction accomplishes business purpose via a tax free transaction, assuming all statutory and judicial requirements to qualify under IRC 355 are met

Allocates Ps basis in the stock of D between D and C

C Opco

S Opco

D Holdco

P IRC 355

Distribution of C Shares

Stock Basis = $600M FMV = $1,000M

Stock Basis = $100M FMV = $500M


Pre-Transaction

C Opco

S Opco

D Holdco

P Stock Basis = $300M FMV = $500M



Post - Transaction


The problem The gain is deferred

P, S1, S2, and S3 are members of a consolidated group. P wants to own S4 or its assets directly, but does not want to operate S1, S2, S3 as LLCs. The easy solution is for S1, S2 and S3 to distribute their S4 stock to P as a dividend.

This creates IRC 311(b) gain to S1, S2 and S3 that is deferred under the intercompany transaction regulations. However, this gain may have current state tax consequences.

P

S3 S2 S1

S4

10


Deferred gain in stock is almost always problematic Gain is triggered when:

Selling member leaves the group Buying member leaves the group Property leaves the group (e.g., liquidation of S4) Other?

Gain will NOT increase asset basis (double corporate tax often results)

Deferred gain frequently impedes business transactions such as a spin off of one business or the contribution of the business into a joint venture

Deferred gain in assets may be less problematic

The problem The gain is deferred (contd)

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The solution Upstream reorganizations

P

S3 S2 S1

S4

P

New S3 New S2 New S1 S4

S1, S2 and S3 merge into P. P thereafter contributes the subsidiaries assets other than the stock of S4 into newly-formed New S1, New S2 and New S3.

Alternatively, S1, S2 and S3 merge into LLCs owned by P, the LLCs distribute their S4 stock to P, and P thereafter contributes the LLCs into New S1, S2 and S3.

12


Treas. Reg. 1.1502-13(c)(6)(ii)(C) Gain in member stock

In Year 1, S distributes the stock of T to P, recognizing a $90 gain. This gain is deferred under the intercompany transaction regulations.

AB = $10 FMV = $100

1

P

T S

T

13


Treas. Reg. 1.1502-13(c)(6)(ii)(C) Gain in member stock (contd)

In Year 9, S liquidates tax-free under IRC 332 into P. In Year 10, T liquidates tax-free under IRC 332 into P. Treas. Reg. 1.1502-13(c)(6)(ii)(C) may apply to redetermine Ss

intercompany gain to be excluded from gross income.

Deferred Gain = $90

Liquidation Liquidation

P

T S

3 2

14


Special rule for deferred gains in member stock intercompany gain with respect to member stock is redetermined to be excluded from gross income to the extent that: 1. A member (M) holds the target (T) member stock with respect to which the

intercompany gain was realized and M is either (i) B or S (with respect to the T stock), as a successor to the other party; or (ii) a third member that is the successor to both B and S.

2. Ms basis in such stock is eliminated without the recognition of gain or loss (and such basis is not reflected in a successor asset);

3. The group has not and will not derive any federal income tax benefit from the intercompany transaction or the redetermination of the intercompany gain (including any -32 adjustments); and

4. The effects of the intercompany transaction have not previously been reflected, directly or indirectly, on the groups consolidated return.

For this purpose, the redetermination of the intercompany gain is not in and of itself considered a federal income tax benefit.

Deferred gain in stock Eliminating the DIT

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What would be the most compelling reason for your organization to simplify its entity structure?

Systems burden/systems upgrades Tax compliance burden State tax planning Planning for strategic events General ease of doing business/one face to customer Dont know/not applicable

Poll question #3


If intercompany advances to the subsidiary exist, is the subsidiary insolvent and therefore not eligible for Section 332 treatment? - Are those advances to be respected as debt or treated as equity? - Last-minute forgiveness/capital contributions to create solvency will

not be respected


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Even though IRC 332 is not available, does that always lead to a bad result? - Consider separate company tax attributes, separate company state

consequences, etc. - Will the debt discharge income equal the bad debt deduction? - Keep in mind potential gain (deferred) on appreciated intangibles

held by the insolvent subsidiary (whether or not recorded on the subsidiary's books), and the potential application of the anti-churning rules


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What is the most significant barrier to entity simplification in your organization?

PoliticalManagement and/or other functions not supportive TaxTechnical issues make a tax-free simplification difficult FocusOther company-wide challenges preventing legal

entity simplification effort SystemsInformation technology issues have no obvious

solution Other Dont know/not applicable

Poll question #4

Question and answer

Join us February 11 at 2 PM ET as our Federal Tax series presents: Tangible Property Capitalization Rules: Practical Application of the Final Regulations


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Click the CPE icon in the dock at the bottom of your screen.

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Kay Pitman Partner Deloitte Tax LLP [email protected] Russ Hamilton Partner Deloitte Tax LLP [email protected]

Contact info

19

Jeff Shaw Director Deloitte Tax LLP [email protected]


This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor. Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

About Deloitte Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited, a UK private company limited by guarantee, and its network of member firms, each of which is a legally separate and independent entity. Please see www.deloitte.com/about for a detailed description of the legal structure of Deloitte Touche Tohmatsu Limited and its member firms. Please see www.deloitte.com/us/about for a detailed description of the legal structure of Deloitte LLP and its subsidiaries. Certain services may not be available to attest clients under the rules and regulations of public accounting. Copyright 2013 Deloitte Development LLC. All rights reserved. Member of Deloitte Touche Tohmatsu Limited

Deloitte - Tax Issues and Entities

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