Avoiding the Section 338 Consistency Rules

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LTRS 201213013 and 201214012 are the same ruling, evidently issued to a buyer and a seller, in the common scenario where the seller consolidated group wants to sell subsidiary stock and the buyer wants to buy assets and obtain a cost basis; both taxpayers got what they wanted, including placing the target corporation into the buying consolidated group, without having a qualified stock purchase and thereby avoiding the consistency rules.

Facts. Seller and Buyer are both privately owned domestic consolidated groups. Seller has a domestic subsidiary, Seller 2, which holds the stock of Seller’s foreign subsidiaries in two lines of business, directly or indirectly. Seller wants to sell Seller 2. Buyer is a domestic group that wants to buy Seller 2’s assets in one l line of business, principally the foreign business.

Certain shareholders of Buyer organize a domestic partnership, which organizes a chain of disregarded entities or partnerships (evidently for financing purposes), which is superimposed on top of the Buyer consolidated group. The partnerships and disregarded entities of Buyer’s shareholders buy principally foreign assets and stock from or of various Seller entities. Seller 2 distributes the cash and unwanted assets up the chain. Then a merger sub owned by one of the Buyer partnerships (i.e., not a corporation) effects a reverse subsidiary cash merger into Seller 2. Finally the Buyer common parent is dropped into Seller 2.

At the end, Seller 2 is the new common parent of the Buyer group, which does not own any of the Seller assets besides Seller 2 itself, and the rest of the purchased Seller assets are owned by disregarded entities owned by Buyer shareholders through partnerships.

Ruling. The ruling concludes that the various asset sales occurred before the stock sale; that the basis of the stock sold was adjusted by the gain recognized on the asset sales, the tax liabilities accrued thereon and the distributions; that there was no qualified stock purchase for section 338 purposes. Therefore the consistency rules of section 338 could not apply and the Buyer obtains a cost basis in the purchased assets.

The ruling required very few representations: only that the non corporate Buyer entities would remain non corporate entities, the purchased assets would not be moved into the Buyer group and the Buyer owners were not a corporation that could have the stock of Seller 2 attributed to it.

Discussion. Although not explained in the ruling, the reason the stock purchase of Seller 2 was not a qualified stock purchase is that Seller 2 was not purchased by a corporation. Rather it was purchased by a disregarded entity owned by a partnership owned by another partnership, owned by the shareholders of Buyer. So far the ruling is unremarkable.

But the ruling acknowledges that as an integrated step Seller 2 will become a member of Buyer’s consolidated group. If Buyer had bought Seller 2, a QSP would have occurred. But Seller 2 gets into Buyer’s group not through being purchased but by virtue of receiving the stock of Buyer as a contribution to capital, making Seller 2 the new common parent of the Buyer group (although the ruling does not discuss consolidated return issues).

If Buyer had bought the stock of Seller 2, and affiliates owned by its shareholders had bought the assets, the consistency rule of section 338 might have been applied to require a carryover basis in the purchased assets.