SERVICE ISSUES TEMPORARY GUIDANCE ON TREATMENT OF CONVERTIBLE STOCKS WITH RESPECT TO NOL CARRYFORWARD LIMITATIONS.

Notice 88-67

The Internal Revenue Service intends to amend the temporary Income Tax Regulations under section 382 of the Internal Revenue Code to, among other things, (i) clarify that certain convertible stock constitutes an "interest that is similar to an option" within the meaning of section 1.382-2T(h)(4)(v)(A), (ii) provide that such an instrument does not constitute "stock" for the purpose of testing whether an ownership change has occurred if, at the time the instrument is issued, it would be described in section 1504(a)(4) by disregarding subparagraph (D) thereof and by ignoring the potential participation in corporate growth that the conversion feature may offer ("convertible pure preferred stock"), (iii) identify certain convertible stock that will be treated as not constituting an "interest that is similar to an option", and (iv) grant the Service the authority to issue revenue rulings providing additional exceptions under section 1.382-2T(h)(4)(x).

Except as provided in regulations, section 382(k)(6)(A) of the Code defines "stock" as stock other than stock described in section 1504(a)(4). Section 1504(a)(4) provides that the term "stock" excludes any stock that is not entitled to vote, is limited and preferred as to dividends and does not participate in corporate growth to any significant extent, has redemption and liquidation rights which do not exceed the issue price of such stock (except for a reasonable redemption or liquidation premium), and is not convertible into another class of stock. Thus, any convertible stock generally constitutes "stock" under section 382(k)(6)(A). But see section 1.382-2T(f)(18)(ii).

Convertible stock also may be subject to the option attribution rules of section 1.382-2T(h)(4)(i) of the temporary regulations (the "option rules"). Section 382(1)(3)(A) of the Code generally provides that the option attribution rules of section 318(a)(4) shall apply to an option or similar interest if application of that rule would result in an ownership change. Section 1.382-2T(h)(4)(v)(A) sets forth a nonexclusive list of interests that are similar to an option for purposes of section 382 (e.g., warrants, puts, convertible debt instruments, etc). Although the term "convertible stock" is not specifically enumerated in that list, such an instrument provides the owner with a right to acquire stock of the loss corporation and, subject to the exception set forth below in the first paragraph under the heading "Other Classes of Convertible Stock", will be subject to the option rules.

CONVERTIBLE PURE PREFERRED STOCK

The Service has determined that, for purposes of section 382(k) of the Code, convertible pure preferred stock should be treated similarly to convertible debt. Accordingly, the Service will, pursuant to its regulatory authority under section 382(k)(6)(B)(ii), treat convertible stock as not constituting stock if, at the time the instrument is issued, it would be described in section 1504(a)(4) by disregarding subparagraph (D) thereof and by ignoring the potential participation in corporate growth that the conversion feature may offer. Instead, such an instrument will be treated solely as an "interest that is similar to an option." Such an instrument nevertheless shall continue to be treated as "stock" for purposes of section 382(e) (which does not exclude stock described in section 1504(a)(4)).

OTHER CLASSES OF CONVERTIBLE STOCK

The Service also plans to clarify the treatment of classes of convertible stock other than convertible pure preferred stock (e.g., convertible preferred stock that has voting rights) for the purpose of analyzing whether there is an ownership change on any testing date. Any class of convertible stock not described in the preceding paragraph will be treated solely as stock and will not be treated as an option or an interest similar to an option under section 1.382- 2T(h)(4)(v) of the temporary regulations as long as the terms of the conversion feature do not permit or require the tender of any consideration other than the stock being converted. This clarification that the option rules will not be applied to such convertible stock will not prevent the recharacterization of such an ownership interest as constituting "not stock" under section 1.382- 2T(f)(18)(ii). For purposes of that analysis, the conversion feature shall be taken into account in determining the likely participation of the instrument in future corporate growth.

The Service is studying the appropriate treatment under section 382 of interests that are both stock and subject to the option rules (e.g., convertible stock, other than convertible pure preferred, that permits or requires the tender of any consideration other than the stock being converted). The Service invites taxpayers to comment on the rules described in this notice. In particular, comments are invited regarding any additional rules that may be appropriate in applying the option rules to convertible stock.

The amendments to the temporary regulations described in this notice (including the rules described below under the heading "Effective Date") will not affect the rules that may apply under section 1.382-2T(f)(18)(ii) of the temporary regulations to recharacterize "stock" as "not stock".

EFFECTIVE DATE

The amendments to the temporary regulations generally will apply with respect to stock issued on or after July 20, 1988. Unless the election described below is timely filed to make the amendments retroactive, convertible stock (including convertible pure preferred stock) issued prior to July 20, 1988 will be treated as "stock" and not as an "interest that is similar to an option" for purposes of section 382 of the Code. But see section 1.382-2T(f)(18)(ii).

Loss corporations may elect to treat the amendments to be made to the temporary regulations described in this notice as effective on and after May 6, 1986. The election, if made, is effective (i) for all classes of convertible stock of the loss corporation outstanding at any time on or after May 6, 1986, and, (ii) solely for the purpose of determining if there is an ownership change with respect to the loss corporation making the election, for all classes of convertible stock outstanding at any time on or after May 6, 1986, of a corporation owning, directly or indirectly, stock of the loss corporation.

The election must be made by filing a statement of election on or before the later of (i) October 18, 1988 or (ii) the due date (including extensions) of the first information statement required by section 1.382-2T(a)(2)(ii) of the temporary regulations following June 20, 1988. The statement must be filed with the District Director with whom the loss corporation would file its Federal income tax return. The statement may be filed on a plain sheet of paper at the top of which is typed "STATEMENT OF ELECTION FILED UNDER NOTICE 88-67" and must (i) contain the taxpayer's name, address, and employer identification number and (ii) be signed by a person authorized to sign the income tax return of the loss corporation.

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or revenue procedure.

The collection of information in this notice has been submitted to the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1980 and has been approved by OMB (Control Number 1545-0123).

FOR FURTHER INFORMATION

For further information contact Keith E. Stanley of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service, on 202-566-3458 (not a toll-free number).