Subject: Survival of Tax Attributes
Title: Survival of Tax Attributes After Merger of Commonly Controlled Companies
IRC Sections: 381, 382
Date Produced: 2/98
Copyright 1998, The Tax Resource Group. All
rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com
Two corporations are wholly owned by the same parties. Profit company (ProfitCo)
has a fiscal year ending February 28. Loss company (LossCo) has a fiscal
year ending May 31. LossCo has a substantial NOL carryover. The two companies
will merge effective after close of business on February 28, 1998. ProfitCo
will be the survivor of the merger. The merger will take the form of an
A-type reorganization as defined by Section 368(a)(1)(A).
It is assumed--and this should be rigorously
confirmed--that the stock ownership of these two companies has not changed
at all during the five year period ending on the date of the proposed merger.
It is further assumed that the transaction in question is a valid A- reorganization
for federal tax purposes. Absence of a valid A-reorganization invalidates
the conclusions set forth in this memo as regards the survivability of LossCo's
1. Does the NOL of LossCo survive the merger?
2. If LossCo's NOL's survive, is there a limitationcaused
solely by reason of the mergeron the utilization of the LossCo's NOL's both
in the first post-merger year and subsequently?
1. Provided the merger is a valid A-type reorganization,
the LossCo's NOL's survive the merger.
2. There is no limitation on the utilization
of LossCo's NOL's as a result of the merger. The only limitations are the
general NOL rules.
Note: Unless otherwise stated, this memorandum
addresses federal income tax consequences only.
When two companies merge and one of the parties
to the merger loses its corporate identity, the issue is whether various
tax attributes of the distributing corporation the company that lost its
corporate identity in the merger carry over to the acquiring (survivor)
corporation. Section 381 controls the determination of which attributes
carryover and specifies the types of transactions eligible for attribute
carryovers in the first instance.
One of the carried-over attributes specified under Section 381 is the net
operating loss. Section 381(c)(1). If the transaction in question is qualified
under Section 381, then the net operating loss of distributing corporation
(LossCo in this case) is carried over and is subject to utilization by the
acquiring corporation (ProfitCo).
Section 381(a)(2) provides that various specified types of tax-free reorganizations,
including the A-type reorganization under Section 368(a)(1)(A), allow attribute
carryover from the distributing corporation to the acquiring corporation.
Thus, it is clear that LossCo's NOL's survive the merger into ProfitCo provided
that the merger is indeed a valid A-type reorganization.
Section 382 imposes significant limitations on the utilization of net operating
losses after certain changes of corporate ownership. A merger is a transaction
that can give rise to such a change. Under Section 382, the limitation-triggering
mechanism is the magnitude of the change of ownership of the loss corporation,
LossCo in this case.
In a simple sale of a loss corporation's stock, generally speaking it is
necessary to compare the amount of stock held prior to the sale with the
holdings of those same owners after the sale. If there has been a more-than-50-percentage-point
decrease in ownership, then the limitations of Section 382 come into play.
In a merger situation in which a loss corporation merges into another corporation,
the determination is more difficult. Here, one must compare the level of
ownership of the loss corporation prior to the merger with the level of
ownership of those same owners in the surviving, merged entity. Since the
same parties own 100% of the stock of each company, there is no decrease
in the ownership level of LossCo's shareholders: the LossCo shareholders
owned 100% of LossCo's stock before the merger, and those same parties own
100% of the merged company's shares. Thus, there is no decrease in ownership
whatsoever, and the limitations of Section 382 are inapplicable.
For a discussion of determining the controlling accounting methods for
the survivor entity in a merger see Merger/Accounting Methods; Survival of method of accounting
after merger; IRC 381.