Rev. Rul. 81-84

1981-1 C.B. 451, 1981-11 I.R.B. 43.

                       Internal Revenue Service
                                 Revenue Ruling

     CONSOLIDATED RETURNS; INTERCOMPANY SALE OF SUBSIDIARY'S STOCK; EXCESS

                                  LOSS ACCOUNT

                           Published: March 16, 1981

SECTION 1502.--REGULATIONS, 26 CFR 1.1502-19: Excess losses

  Consolidated returns; intercompany sale of subsidiary's stock; excess loss account.  A member of an affiliated group sold all the stock of its wholly owned subsidiary in which it had an excess loss account to its parent in a consolidated return year.  The excess loss account is not included in the seller's income at the time of the sale, but is treated as deferred gain to be included in income under section 1.1502-13(d), (e) and (f) of the regulations.

ISSUE

  Is a subsidiary's excess loss account in the stock of an affiliated member included in the income of the subsidiary upon an intercompany sale of such stock?

FACTS

  P, S, and X are members of an affiliated group of corporations that file a consolidated income tax return.

  P owns all the stock of S, and § owns all the stock of X. An excess loss account with respect to the X stock was created as a result of § utilizing losses of X that were in excess of S's basis in the X stock.  § sells the X stock to P for cash at its fair market value during a consolidated return year and § and X become brother-sister corporations with P as the common parent.

LAW AND ANALYSIS

  Section 1.1502-32(a) of the Income Tax Regulations provides that, as of the end of each consolidated return year, each member owning stock in a subsidiary may be required to make certain negative or positive adjustments to the basis of such stock.

  Section 1.1502-32(e)(1) of the regulations provides that a member owning stock in a subsidiary shall apply its net negative adjustment to reduce its basis for such stock.  Any excess of such negative adjustment over the basis of the subsidiary's stock is referred to as an "excess loss account."

  Section 1.1502-19(a)(1) of the regulations provides that immediately before the disposition of stock of a subsidiary, there shall be included in the income of each member disposing of such stock that member's excess loss account with respect to the stock disposed of.

  Section 1.1502-19(b)(1)(i) of the regulations provides that a member of a consolidated return group shall be considered to have disposed of a share of stock in a subsidiary on the day such share is transferred to any person.

  Section 1.1502-19(a)(2) of the regulations provides that the amount included in income under section 1.1502-19(a)(1) shall be treated as gain from the sale of stock.

  Section 1.1502-13(a)(1)(i) of the regulations provides that the term  "intercompany transaction" means a transaction during a consolidated return year between corporations which are members of the same group immediately after such transaction..

  Section 1.1502-13(a)(2)(i) of the regulations provides that the term  "deferred intercompany transaction" includes the sale or exchange of property in an intercompany transaction.

  Section 1.1502-13(c)(1) of the regulations provides that if gain or loss on a deferred intercompany transaction is recognized under the Internal Revenue Code for a consolidated return year, such gain or loss shall be deferred by the selling member.  Such gain or loss is deferred until it is restored to income pursuant to sections 1.1502-13(d), (e), or (f).  These sections provide that gain or loss on a deferred intercompany transaction is restored to income (1) as the property transferred in the transaction is depreciated, amortized, or depleted;  (2) if the property transferred in the transaction is sold in an installment sale, as the installments are paid;  (3) when the property transferred in the transaction is sold outside the group; (4) in the case of nonmember obligations, when such obligations are satisfied or become worthless;  (5) in the case of stock, when such stock is redeemed or becomes worthless;  (6) when the selling member leaves the group;  (7) when the member holding the property that was the subject of the transaction leaves the group;  (8) in the case of inventory, any time the group shifts from consolidated to separate returns;  (9) in the case of intercompany transactions involving all types of property, when the group shifts from consolidated to separate returns after having filed consolidated returns for less than three years;  and (10) in the case of inventory valued at the lower of cost or market, when the inventory value is written down to market value.

  In the present case, the sale by § of the X stock is a disposition of the stock within the meaning of section 1.1502-19(a)(1) of

the regulations, and the excess loss account that § has in the X stock becomes an item includible in S's income.  The amount includible in S's income is treated as gain from the sale of stock.  Since the sale of the X stock occurred during a consolidated return year between corporations that are members of a consolidated return group, the sale of the X stock constitutes a deferred intercompany transaction and the gain recognized by § on the transaction is deferred.  Such gain will be restored to S's income upon the occurrence of the events specified in sections 1.1502-13(d), (e), and (f).

HOLDING

  The excess loss account that § has in the stock of X is not included in the income of § upon the sale of the X stock to P.  The excess loss account is treated as deferred gain and will be includible in S's income in accordance with sections 1.1502-13(d), (e), and (f) of the regulations.

Rev. Rul. 81-84, 1981-1 C.B. 451, 1981-11 I.R.B. 43.