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
Agenda
Benchmarks and potential cost savings
Basic federal tax considerations
Triggering existing tax losses
Internal spins and deferred gains
Insolvent subsidiaries
Copyright 2013 Deloitte Development LLC. All rights reserved.
Benchmarks and potential cost

savings
Benchmarking legal entity efficiency

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?
Fortune 500 Legal Entities Per $1Bn of Revenue, 2012
50
10th Percentile
60
30th Percentile
50th Percentile
70
Number of Fortune 500 Companies
40th Percentile
80
40
30
20
10
0-5.0
5.1-8.0
More efficient
1
8.1-11.0
11.1-18.0
Legal entities / billions of revenue
Deloitte Tax 2013 study based on public company data
18.1 - 80
Less Efficient
Opportunity for savings

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.
Fortune 500 Finance Process Costs, % of Revenue1
1.20%
Performance
Management
% of Total Revenue
1.00%
Tax and Treasury
0.80%
Controls
0.60%
0.40%
General Accounting
0.20%
Transaction Processing
0.00%
5 LE
10 LE
20 LE
Legal Entities per Billion of Revenue
0.299% have difference

1
Source: Deloitte Global Benchmarking Center analysis of 400 enterprises conducted in 2011
Poll question #1
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
Basic federal tax

considerations
Tax considerations before you begin

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 transition challenges and

opportunities
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)
Implementation pitfalls exist

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
Triggering existing tax losses
CTB Election to Treat Insolvent Subsidiary

as a Disregarded Entity for U.S. Federal
Tax Purposes
Rev. Rul. 2003-125 (Situation 2)
Facts
Parent
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:
Foreign
Sub
Liabilities > FMV of Assets
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.
6
Planning into 331 Granite Trust

1. Transfer of 35% Interest of FS1 to FS2
Basis = $200
100%
FS1
U.S.
Parent
Newly issued
FS2 NQPS
U.S.
Parent
FMV = $40
2. Subsidiary makes a CTB election

(or convert and check) to be a partnership
100%
35% of
FS1s
o/s
shares
65%
FS2
35%
FS2
FS1
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.
7
Loss of outside basis

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
Poll question #2
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
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)
Post - Transaction
Pre-Transaction
P
Stock Basis = $600M
FMV = $1,000M
IRC 355
Distribution of
C Shares
Stock Basis = $300M

FMV = $500M
D
Holdco
Stock Basis = $100M
FMV = $500M
S
Opco
Stock Basis = $100M

FMV = $500M
Stock Basis = $300M

FMV = $500M
Holdco
Opco
Stock Basis = $100M

FMV = $500M
Opco
Opco
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
9
The problem The gain is deferred

P
S1
S2
S3
S4
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.
10
The problem The gain is deferred (contd)

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
11
The solution Upstream reorganizations
S1
S2
S3
New S1
New S2
New S3
S4
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
P
T
1
AB = $10
FMV = $100
In Year 1, S distributes the stock of T to P, recognizing a $90 gain.

This gain is deferred under the intercompany transaction regulations.
13
Treas. Reg. 1.1502-13(c)(6)(ii)(C)

Gain in member stock (contd)
P
2
Liquidation
Liquidation
Deferred Gain = $90
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.
14
Deferred gain in stock Eliminating

the DIT
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.
15
Poll question #3
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
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
16
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
17
Poll question #4
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
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
Eligible viewers may now

download CPE certificates.
Click the CPE icon in the dock at

the bottom of your screen.
18
Contact info
Kay Pitman
Partner
Deloitte Tax LLP
kpitman@deloitte.com
Jeff Shaw
Director
Deloitte Tax LLP
jeshaw@deloitte.com
Russ Hamilton
Partner
Deloitte Tax LLP
ruhamilton@deloitte.com
19
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
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The Dbriefs Federal Tax series presents:

Legal Entity Simplification:

Copyright 2013 Deloitte Development LLC. All rights reserved.

Benchmarks and potential cost

Benchmarking legal entity efficiency

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

Number of Fortune 500 Companies

Legal entities / billions of revenue

Deloitte Tax 2013 study based on public company data

Opportunity for savings

Tax and Treasury

0.299% have difference

Copyright 2013 Deloitte Development LLC. All rights reserved.

Yes, likely in the next 12 months

Copyright 2013 Deloitte Development LLC. All rights reserved.

Basic federal tax

Tax considerations before you begin

- Readiness for future transactions

Copyright 2013 Deloitte Development LLC. All rights reserved.

Tax transition challenges and

Triggering IRC 165 losses

Copyright 2013 Deloitte Development LLC. All rights reserved.

Implementation pitfalls exist

Discipline is also necessary due to possible future

Copyright 2013 Deloitte Development LLC. All rights reserved.

Triggering existing tax losses

CTB Election to Treat Insolvent Subsidiary

Parent owns 100% of the stock of Foreign Sub.

Rev. Rul. 2003-125 holds that:

Parent may claim worthless stock deduction under

Copyright 2013 Deloitte Development LLC. All rights reserved.

Planning into 331 Granite Trust

2. Subsidiary makes a CTB election

Copyright 2013 Deloitte Development LLC. All rights reserved.

Loss of outside basis

So generally not a factor when a consolidated return entity that was

Full business integration can make it somewhat less likely that

Copyright 2013 Deloitte Development LLC. All rights reserved.

Tax, Finance, Legal

Copyright 2013 Deloitte Development LLC. All rights reserved.

Internal spins and deferred

Internal Spin Transactions

Stock Basis = $300M

Stock Basis = $100M

Stock Basis = $300M

Stock Basis = $100M

Copyright 2013 Deloitte Development LLC. All rights reserved.

The problem The gain is deferred

Copyright 2013 Deloitte Development LLC. All rights reserved.

The problem The gain is deferred (contd)

Deferred gain in assets may be less problematic

Copyright 2013 Deloitte Development LLC. All rights reserved.

The solution Upstream reorganizations

Copyright 2013 Deloitte Development LLC. All rights reserved.

Treas. Reg. 1.1502-13(c)(6)(ii)(C)

In Year 1, S distributes the stock of T to P, recognizing a $90 gain.

Copyright 2013 Deloitte Development LLC. All rights reserved.

Treas. Reg. 1.1502-13(c)(6)(ii)(C)

Deferred Gain = $90

In Year 9, S liquidates tax-free under IRC 332 into P.

Copyright 2013 Deloitte Development LLC. All rights reserved.

Deferred gain in stock Eliminating

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.