Full Text: Unofficial Transcript Of IRS Hearing On Consolidated Return Regs.

The unofficial transcript is available of an IRS December 11 hearing at which government officials appeared interested in modifying temporary and proposed regulations (T.D. 8598; CO-24-95) that disallow losses recognized when a subsidiary disposes of common parent stock.

E. Daniel Leightman of Cooper Industries testified that the regulations are appropriate insofar as they attempt to thwart the transaction cited in the regulations' preamble, but should be modified to provide that gain and loss arising from a subsidiary's dealings with parent stock will be recognized if the subsidiary cannot escape recognition of gain or loss from the transaction.

Others speaking at the hearing were David Weisbach, Treasury associate tax legislative counsel; Philip Levine, acting assistant chief counsel (corporate), who asked Leightman for specific ideas on how to draft regs that would address his concerns; Michael H. Frankel of KPMG Peat Marwick, who asked the government to expand the single entity concept to allow the use of parent stock held by another member of a group, provided the stock has never been held by a nonmember; Rose Williams, Treasury's tax legislative counsel; and Eric Solomon, deputy associate chief counsel (domestic technical).

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PROCEEDINGS

IRS Hearing -- 12/11/95

MR. SOLOMON: Good afternoon. This is the hearing with respect to temporary and proposed regulations under 1.1502-13T(f)(6), 1.1502- 13T(f)(6), which provide rules for disallowing loss and excluding gains for certain dispositions and other transactions involving stock of the common parent of a consolidated group. These regulations were issued on July 12, 1995.

Before our speakers, what I'd like to do first is introduce our panel. Starting from my far left and moving to my right, Rose Williams from Treasury; Seth Green, from Treasury; David Weisbach from Treasury; I'm Eric Solomon from the IRS; to my right is Phil Levine from the IRS; Roy Hirschhorn from the IRS and Ed Cohen from the IRS.

We have two speakers today. At the conclusion of their remarks, if there's anyone else who would like to make comments, please feel free to do so. Our two speakers today are E. Daniel Leightman from Cooper Industries and Mike Frankel from KPMG Peat Marwick.

First, Mr. Leightman from Cooper Industries. Before you get started, we normally have a ten minute clock. But since we only have two speakers, feel free to take all the time that you need.

MR. LEIGHTMAN: You'll be pleased to hear I have an airplane flight at 2:40. (Laughter.)

MR. SOLOMON: So, we'll be done by 2:30.

MR. LEIGHTMAN: But I appreciate your offer in any case.

I am vice president of tax from Cooper Industries. We are a relatively large manufacturing company. We make hard-line, American cost-effective products, electrical power distribution equipment, we make hand tools such as crescent wrench and Lufkin tape measure. We have a lot of automotive after market products. Champion spark plug is the most well known of those. I don't have a financial product to sell. I'm not here as a user of a financial product; and I currently have no transactions under consideration that would utilize such products.

Nonetheless, I notice what I viewed as an unacceptable asymmetry in the proposed regulation and I felt the need to come here and discuss it with this panel. The basic concept that I think the regs are focused on reminded me of the Will Rogers quotation about how to make money in the stock market. The quote, as you may recall, is: "Buy a few good stocks. When they go up, sell them. If they don't go up, don't buy them." That is the Will Rogers theory. (Laughter.)

MR. LEIGHTMAN: I think the example in the preamble is the tax annotation of the Will Rogers theory. The abuse -- I think the retrofocalstat -- is, the subsidiary buys a good stock from its parent. If it goes down, sell at a loss. If it doesn't go up, don't take the gain; sell some other stock that has high basis. I think that is a valid concern.

As a significant taxpayer in a revenue neutral environment, I'm quite interested in other people's abuses being stopped by the regulatory process. On the other hand, it occurs to me that if a subsidiary were to purchase a warrant on the shares of the parent, the gain -- if the warrant were to expire worthless on exercise, the gain would be recognized by the subsidiary. If the stock went up and the subsidiary suffered a loss on the warrant, the subsidiary would incur a loss.

It appears to me that there is no easy way for a subsidiary to escape the gain on the warrant. I think the same thing would be true with certain transactions with put options. I think the same thing would be true with call options; and I think it could be true with equity swaps. It depends on the value of the parent stock.

Therefore, it seems quite unfair to me that the subsidiary would pay tax on the gain -- which is the way I read the regulations, except for that very narrow exception, which I perceive to be a cure for the zero basis problem. But, a tax on the gain may not be entitled to deduct the loss.

I guess there are two fair rules. One would be, no gain, no loss on the tax return. In other words, all transactions in the parent stock are off the tax return, win or lose. That would be at least symmetrical or gain or loss. Both would be recognized and taken into account.

The rule I would prefer and the rule I think is correct is that gain and loss be recognized, but limited to transactions where the subsidiary cannot escape the gain. So the subsidiary cannot escape the gain.

So, the circular abuses that are referred to in the preamble would be stopped. In other words, I believe the rule is too broad. I think there are many instances where there are business purposes for the subsidiary to deal in the parent stock. Ones that come to mind quickly are when the parent has restrictive covenant. That covenant that the subsidiary may be free of. Some corporations are subject to regulatory requirements that would prevent it from dealing in their stock; yet the subsidiary would be free of such requirements.

In many instances, the subsidiary has a better credit rating than the parent. In which case, the subsidiary is the more efficient vehicle into borrowing on behalf of the consolidated group. Frequently such borrowing includes equity kickers such as warrants. There may be a minority interest in a subsidiary, which could give a business purpose for wanting a subsidiary to deal in the parent stock.

Finally, there may be employee compensation plans which deal with equity. It may be good business procedure for the subsidiary to hedge its exposure in that area.

For state tax purposes, of course, most subsidiaries are separate corporations and it may matter for state tax planning where certain transactions are executed or implemented within the corporate group.

These are the primary business purposes, I think, for such transactions. I do not think it is an abuse of the revenue to have -- if you do a transaction, win or lose, either have it on your tax return or not have it on your tax returns. As long as both sides are on the tax return.

Obviously, if I were able to predict the movement of the stocks so I knew whether it would be win or lose, my flight at 2:40 today would not be to Houston, Texas; but would be to a warmer destination. (Laughter.)

MR. LEIGHTMAN: Finally, I'd like to point out, I think there are transactions now where if the parent had done the transaction directly, the parent would be entitled to a loss or a deduction, namely an equity swap. If the subsidiary did the transaction, I think the regulations as proposed would deny the loss. This, too, strikes me as an area where correction is possible.

In spite of your offer for additional time, I think I had prepared for ten minutes and here we are. I thank you for your attention. I'm happy to answer questions.

MR. WEISBACH: Could I just ask you -- just the transactions you ran through, because I want to make sure I understand them all. On one of them you said, the subsidiary may issue debt, and I guess it may be convertible in the parent stock is what you're talking about?

MR. LEIGHTMAN: Well, I think it would be with warrants. If it were simply convertible in the parent stock, I think Section 249 of the Internal Revenue Code would deny a deduction for a loss related to movement in the underlying equity. So, assume it's coupled with warrants.

MR. WEISBACH: What do you mean? You mean it's issued as an investment unit initially?

MR. LEIGHTMAN: Yes. Yes, that coupled -- that bundled with warrants.

MR. WEISBACH: The subsidiary is sold, warranted and pieced off essentially and is buying warrant from P in that transaction?

MR. LEIGHTMAN: Well, the subsidiary would sell warrants and at some point the subsidiary would need to purchase shares from the parent to satisfy the warrants, or the subsidiary could deal with the warrants in the open market as appropriate.

MR. WEISBACH: And if the warrants -- on the warrant holder exercise, the warrant won't have to buy P stock, then I guess if the subsidiary exercises the warrant with respect to P -- it buys P stock -- wouldn't it get relief then on the gain side, in that case? Because it would immediately deliver the stock to the debt holder or the warrant holder?

MR. LEIGHTMAN: Yeah, I believe -- I mean, under the exception in the regulation, yes, I believe it would under those facts. I'm not necessarily assuming that the subsidiary would have purchased the warrant from the parent as part of the transaction.

MR. GREEN: But, in fact, they close out the warrant by delivering P stock, if they purchase the P stock at the time the transaction closes, they would still qualify for the exception, I think.

MR. LEIGHTMAN: Okay, in other words, they purchase stock from the parent at fair market value?

MR. GREEN: Yeah.

MR. LEIGHTMAN: Yes, that's correct.

MR. WEISBACH: I think your basic principle, which is that we shouldn't eliminate loss where we're assured you are going to pick up the gain, seems sound. I am just trying to run through these transactions and see which ones they can eliminate the gain on and which ones they can't.

One of the ones we thought about, which we put the relief in for, was this transaction. So I thought they could eliminate the gain in that case.

MR. LEIGHTMAN: Yes, I understand. Warrants may well be cash settled, apparently, and choose not to issue the stock.

MR. WEISBACH: Right.

MR. LEIGHTMAN: And, perhaps -- and I could spend some time and produce some language. I've not done that, but perhaps the warrant would -- perhaps there needs to be an election at the beginning of the transaction in a revocable election.

But I understand, the way it's drafted, you could avoid gain by -- on the issue.

MR. WEISBACH: On the employee stock one, 80-76 isn't enough protection for them on the gain side in that case? 80-76 is the rule that says no gain in delivering stock to employees.

MR. LEIGHTMAN: Depending on -- yes, it is, depending -- if you get the stock from the parent at that time, that purchased stock earlier or a warrant earlier, I think there could be gain within the meaning of that revenue.

MR. WEISBACH: So this would be 80-76 doesn't apply to warrants?

MR. SOLOMON: Or, if the stock is held by the subsidiary for a long period of time before it's used to compensate the employee.

MR. GREEN: If they're hedging. I was just curious. I thought you were suggesting that preferred treatment would be that you have gain and loss on most of these transactions.

I guess my question is, most of the common transactions that you were talking about seemed to be a transaction -- aside from the employee comp, I should say -- transactions on behalf of the group where using the sub is just the most efficient way of doing the transaction? I was wondering, is on behalf of the group -- I understand your desire for symmetry. It makes a lot of sense to the extent we can get there. But I was wondering whether symmetry -- both taxable or symmetry tax free, why you think that both taxable makes more sense?

MR. LEIGHTMAN: Well, many times a sub is borrowing on behalf of its own business. A classic example would be General Electric Credit Corp. or the other financed subsidiaries, and the proceeds of the borrowing aren't on behalf of the group.

Secondly, I believe, for state tax purposes that the transactions will be taxable and I feel that symmetry with state tax is not necessary; but it seems to me that for many purposes, the entities are considered separate.

Yes, we may file a consolidated return this year; and yes, we will file a consolidated return next year, but there will be companies that have left the group from year-to-year, companies that have joined the group from year-to-year.

It just seemed to me if you have economic gain you should pay tax, you have an economic loss you should have a deduction.

MR. SOLOMON: Is your view that -- as I understand it -- that we should be consistent? Either all gains and losses are recognized, or all gains and losses are not recognized. Is that correct?

MR. LEIGHTMAN: Yes.

MR. WEISBACH: Except in cases where they can eliminate the gain, where there's self-help on the gain side.

MR. LEIGHTMAN: Right.

MR. GREEN: I thought he still wanted consistency.

MR. WEISBACH: Just the stock -- the basic stock case for the self-help. Right? He came in and said, "Well, if you're never going to recognize the gain, then we want to take away the loss in that case."

MR. LEIGHTMAN: That's right.

MR. WEISBACH: If there's no self help, then some attrition.

MR. LEIGHTMAN: That's right. I view the reg as being focused at the abuse situations where the gain could be buried forever and the loss would be recognized when it occurred. Yes.

MR. LEVINE: Does that end up meaning that we have to -- how do we define those cases? I mean, do we just make a list of things that we know of, transactions we know of? I mean, people may differ as to what gain could be reasonably avoided.

MR. LEIGHTMAN: Well, yes, I'm sure you're aware, I'm sure your thought is that any list that you make will have 25 additions to it a week later.

MR. LEVINE: That's right. That's one of the problems.

MR. LEIGHTMAN: But, I think the general principle should be stated in a regulation and I think perhaps an election by the taxpayer at the beginning. There are other areas in the Internal Revenue Code where you make an election.

One that comes to mind immediately is Section 988, I think it's (a)(1)(C) where you can elect to have capital or ordinary treatment when you deal with a regulated futures contract, and there are other examples in Section 1256 where you make an election typically on the day of the transaction and then the taxpayer lives with it, win or lose.

A regulatory example, that's in the 988 regs under integrated financial contracts in the currency area as well.

MR. HIRSCHHORN: So you'd say it's an irrevocable election.

MR. WEISBACH: I'm sorry, I'm not understanding. What would the election be?

MR. LEIGHTMAN: The election would be that the gain would be recognized regardless of the form which it takes on completion of the transaction. And the loss would be recognized if you made that election. Otherwise, no gain, no loss.

To regulate otherwise would mean that economic gains and economic losses are being excluded from the tax base.

MR. WEISBACH: I guess it depends on your notion of single entity or not. We have a notion of consolidated being a single entity. Some people pushed us further to say that we should have the single entity notion stopped, that subs dealing in P stock should be treated as no gain nor loss.

MR. LEIGHTMAN: I understand. The reality is, it's not a single entity, because there frequently is minority interest and the attributes leave the group, attributes come into the group, there's surly losses. You don't need me to explain the complexities of the regime.

MR. SOLOMON: Just tell me another example. I'm still trying to understand. P owns S. S goes out in the market and buys some P stock and it just sits there in S. Okay? If it goes down -- are you saying at that point you make an election when it comes into the group?

MR. LEIGHTMAN: I guess my belief is that, when S buys P stock, the regulation that you promulgated is an appropriate regulation other than the potential of the gain being taxed, if S were to turn around and sell the P stock.

In other words, if Section 1032 applies to the loss, it should apply to the gain. The example that I'm thinking of is S goes out and sells a warrant on P stock. S receives so many dollars per share for selling the warrant, and if that warrant were to expire unexercised, S has taxable income, at which case I think that if S has a loss on the warrant -- and the regulation, the exception that you're talking about, when the warrant is exercised, that's when the loss occurs.

The gain -- I don't know how you avoid the gain even with exercise. I'm going back to the example I think that someone mentioned a few minutes ago. The warrant expires unexercised, S has income. I don't know of a way to avoid it. Yes, the gain -- if the warrant is exercised, the subsidiary has a loss. The exception you referred to wouldn't --

MR. GREEN: I think that exception probably only applies if -- instead of issuing a warrant it purchases a put. I think if you track it through on puts you can get to exclusion. But I think when you're talking about writing a warrant, I think you're right.

MR. LEIGHTMAN: Okay, purchasing a put?

MR. GREEN: Right. In other words --

MR. LEIGHTMAN: So, they're betting on the stock going down.

MR. GREEN: -- a sub buys a warrant for $10. If the stock goes up, it purchases stock from P, delivers on its put, excludes any gain under this reg.

MR. SOLOMON: It's gain if the stock goes down.

MR. GREEN: Oh, right. I got it backwards, but right.

MR. LEIGHTMAN: Right. I don't think purchase of a put would be appropriate. Sale of a put, I think -- again, the sub would -- if the stock moved the wrong way the sub -- if the stock moved the proper way, the way the sub expected it to, the sub would have a gain that it could not avoid.

You sell a put on a parent stock, the parent stock increases in value, the put expires worthless, you have taxable income equal to the put premium.

MR. GREEN: On an expiration, I agree. I don't think there's any way to avoid it on expiration.

MR. SOLOMON: Any other questions?

(No verbal response.)

MR. SOLOMON: Thank you very much.

MR. LEIGHTMAN: I'll be glad to follow up in writing with anything you deem appropriate. Thank you.

MR. LEVINE: Just one last thing. Is the point of your distinction that in some cases sort of the gain or loss is not controlled by the sub, it's controlled by some third party, the wire holder or perhaps employees retiring, if it's some sort of a benefit grant; and that, therefore, the company doesn't have the option of just holding on to the stock in perpetuity?

MR. LEIGHTMAN: That's right. It's actually the market and the terms of the --

MR. LEVINE: Could you come back to the mike? I just wanted to give you some exercise.

MR. LEIGHTMAN: I could use it.

It's really the market forces and the terms of the instrument itself. In other words, the warrant has a date in which tax will be reckoned. There's nothing you can do to avoid it. The terms of the warrant expires. If the warrant is, as they call it, in the money, the warrant will be exercised.

MR. LEVINE: But, isn't your point that that expiration or whatever happens is something -- is outside the company's control?

MR. LEIGHTMAN: That's right.

MR. LEVINE: Or it's perhaps in the control of some third -- unrelated, third party?

MR. LEIGHTMAN: But the gain occurs when the warrant is out of the money, so the warrant is worthless. So it just simply expires. No third party does anything.

MR. LEVINE: Right.

MR. LEIGHTMAN: And it's the term of the contract that --

MR. LEVINE: Yeah, I guess --

MR. LEIGHTMAN: -- forces the taxable event.

MR. LEVINE: I guess you can quibble as to whether the third party didn't do an uneconomic action, but I understand.

MR. LEIGHTMAN: I understand what you're saying.

MR. SOLOMON: Thank you.

MR. LEIGHTMAN: Thank you again.

MR. SOLOMON: Our next speaker is Michael Frankel from KPMG Peat Marwick.

MR. FRANKEL: Good afternoon. I'm glad I have an hour now to finish. Actually, I think that most of my comments or my outline I did get to you this morning. I had not originally expected to testify on this reg and submit specific items; but, when I heard last week while I was away that you were having this hearing, I said, "Great, I might as well come and see you all."

I would like to go on the record for the idea of the single entity aspect. I believe in single entity and I realize that there are certain problems with it in specific cases; but I would like to see it expanded in the stock area. The specific situation is, when a member's stock -- or a member owns stock of P, that should be allowed, with a no gain or loss situation.

Certainly P could issue its own stock, and that would be okay. Now, also, it does not make a difference to me. The first rule I put in here is that, if that stock has never been held by a nonmember of the affiliated group -- a little bit more of an extension than even just the consolidated group. But that member who is a member of the affiliated group then becomes a member of a consolidated group.

If for some reason they could not be a member of the consolidated group, that member should be able to issue P stock. There's no avoidance transaction. Is there anything wrong with it? I have not heard anybody address why there's a problem with it. So I think that should be allowed.

The second example I have is a situation where a company has acquired its parent stock through a repossession, a foreclosure event on a note. With respect to a note, bad debt, acquired at fair market value, but it's a regulated company. It cannot distribute the stock up to its parent at that time, and in this situation that just came to light, they are now able to do it. But, of course, you've got your regulation, -13(f)(4) in which the stock has appreciated that would say that gain is taxable.

There is no reason for that situation to be so adverse. I do have problems with - 13(f)(4), and as I say, well, you've already thought about that in the prior regulation, at least it gives me another chance to raise this issue and maybe you should look at it again, and it gives yourself a chance to take a look at it again.

Then there are several what I call smaller points. Number one, I think the P stock should be able to be issued to a related party. If you need certain safeguards in there, you can put them in there. But P could issue its stock directly to the related party. Why should S be able to issue it to the related party, especially where it's acting on behalf of P? P's dropped it down to S, S issues it out to that related party.

The same thing in the substituted basis transaction, the same reasoning it seems in my view follows.

One situation which has been pointed out in Rich Bailine's eloquent letter in September is the zero basis problem, where P stock goes to the sub, the sub acquires assets or stock in a taxable transaction, and as a result of the transaction, the member is merged out of existence. There's no reason not to allow it in that situation.

Another aspect, which actually Larry Axelrod mentioned somewhat in his letter is the fact of the netting of gains or losses with respect to stock. Now whether you have to limit it to stock of the same class, that may be important from your viewpoint; but a netting rule, I think, is important for gains and losses.

Another aspect -- and these are just going through the various requirements that you have in there, and I hate to pick them apart, but I am just trying to bring them to your attention, my thinking on it. Why should P have to continue as a common parent of the group? Using the example where the member gives out P stock in exchange for assets, the person who ends up with that stock is another corporation. If it's over 80 percent of the stock and it's a new affiliated group, why should that not qualify under this regulation? What is the problem?

If you need to put limitations in rules in order for it to qualify, fine. But at the same time, I think they should allow these types of exceptions.

The same thing as far as the option rule is that should be expanded. Also where it's a no loss rule, if you're going to go no loss, let's go no gain. Why exclude it?

I'll be pleased to answer any questions you may have.

MR. WEISBACH: Could you just give me your substitute basis transaction that you're concerned about?

MR. FRANKEL: Excuse me?

MR. WEISBACH: Your point number five in your letter, substitute basis transactions, you suggest that additional relief is needed in that case. Could you just walk me through an example that needs relief?

MR. FRANKEL: Where P transfers its stock to M and M transfers the P stock to a company in a 351 transaction. Okay, I guess that would be a no gain or loss, so, let's say they transferred -- I guess I don't -- I'm trying to figure out the problem that you're after in that kind of a situation.

MR. WEISBACH: But why are you asking for relief?

MR. FRANKEL: Well, I don't see any problems with it. I'm not sure that there is any problem. You seem to put limitations in here without explaining why.

MR. WEISBACH: Well, that's right. The reg says what it says, but -- well, okay, you don't have any particular example.

MR. FRANKEL: No, I do not. No situation's been brought to my attention at this point.

MR. GREEN: On the issue of the affiliated group -- the stock ownership by an affiliated group member that was not a consolidated group member at the time of acquisition. I guess if the loss disallowance rule does not apply to nonconsolidated affiliates, wouldn't there be some potential for whipsaw given that immediately before joining the group and unaffiliated group member could sell and recognize loss on common parent stock, but otherwise could wait until it joins -- until it's allowed to consolidate and then sell and take advantage of the no-dan rule?

I'm just trying to see if we can answer some of your concerns and still try to maintain a measure of neutrality.

MR. FRANKEL: Well, I mean I guess you call it neutrality. It's one of the few examples where it seems to me you want consistency with gain and loss, but what I'm thinking of is a situation where you have a company that the stock has been transferred at a time which the Code said, for five years it cannot be a member of the group. After that five-year period expires, it can be a member of the group and does become a member of the group. All of a sudden, it's hit with this rule and while -- yes, I agree, technically, it could have taken the stock when it was transferred to it and disposed of it.

Actually, if it had taken the stock, it would have had a zero basis in this situation that I'm aware of and would have had tremendous gains and no chance for loss.

MR. GREEN: I guess, first of all I'd like to say, although I understand the relief given in the temporary proposed reg was fairly limited. I think all of us up here would like to get symmetry and neutrality to the extent that we believe it can be enforced in a way as not to give rise to a kind of one-sided transactions that were described in the preamble where, you know, you can just pick and choose.

So, I think to the extent we can find workable solutions that provide for symmetry, we're all in favor of that. The zero basis problem, again, I understand your concern. That may well be your fact pattern that you're thinking of. I'm just looking at, you've got an affiliate that's a nonmember the day before its five-year period is up and it's going to join the group. It looks at any P stock it owns and if it has a loss, it's going to sell it and claim the loss. If it has a gain, it's going to sit there. The next day it's going to be a member of the consolidated group and can sell it tax free. Given the seat I sit in, that has to concern me.

MR. FRANKEL: Well, if you wanted to put another limitation on it in that kind of situation that it does not have a -- it has a zero basis in it, then at least in that situation you cannot be abusive.

I mean, the problem is that these rules are written on such a broad spectrum, there are no exceptions for them. Here you have a case -- at least in my mind -- that is not abusive. There's no question about it. It acquired it for capital purposes many, many years ago; and just became a member of the group and now all of a sudden it's hit in the head because of -13(f)(4) and it never relied on 39-608, so I just --

I think there should be relief in these kinds of situations. I agree, I can understand your concern. Yes, in the appropriate situation if the sub had bought the stock and was not a member of the affiliated group and then the day before the five-year period, they had decided to sell it because they were going to be able to sell it at a loss, maybe yes, you would feel like you were caught in the middle. But I don't think those transactions happen generally along those lines.

MS. WILLIAMS: Mike, I have a question.

You're talking that you would like to see greater single entity concepts with respect to stock. Right?

MR. FRANKEL: Okay.

MS. WILLIAMS: That was one of your first comments, I believe.

One of the comments or one of the questions that I would have is, you know, when you're coming into a group; and let's say T owns some P stock and they're coming into the group. You know, we don't have a mandatory redemption on coming in. Because at that point we're saying that, you know, it's a single entity concept when the P stock comes into the group. It's not as if P had redeemed that stock.

If we decided to expand further into single entity, do you think that it's necessary for us to have a redemption at the time it comes into the group -- owning P stock?

MR. FRANKEL: No, I don't see any reason why it does have to have a mandatory redemption. Of course, you do have the situation in there that if T comes into the group owning P stock, if it does anything with that stock, it will recognize a gain and maybe it should be able to recognize a loss, which your rule disallows.

MS. WILLIAMS: Right. So that your idea here is that you have expanded single entity treatment only with respect to stock that has always been within the consolidated -- or, in your instance, the affiliated group?

MR. FRANKEL: Well, I'm not really going to limit it to that aspect. I'm just saying that when it comes into the group, it does not mean that it has to be treated as a redemption.

You're saying that, in effect, every situation -- I would probably first of all say, "Well, if we're going to go single entity and do it along the lines of the mandatory redemption, maybe these rules should be expanded that no gain or loss is recognized with respect to any member stock that is issued by any other member."

That was actually at first on one of my lists.

MR. WEISBACH: What if P just sells to the subsidiary?

MR. FRANKEL: Maybe that should be covered.

MR. WEISBACH: No gain?

MS. WILLIAMS: Well, do you treat that as all asset sale at that point?

MR. WEISBACH: It's got a truck, it just sticks it in the subsidiary, it sells the stock, no gain --

MR. FRANKEL: No, I realize the problems with that, but I'm just saying, there are certain aspects of single entity along those lines.

As I said, that was originally in some of my thinking that I had dropped.

MR. GREEN: But getting back to Rose's point, actually I think it's a good one. Just focusing on P stock for now and ignoring the stock of subs. If you want full single entity treatment of P, then when someone comes into the group holding P stock, that would be deemed redemption.

At that point, it would be very easy to say, "And any further gain or loss on that stock should be permanently ignored either way, up or down, totally squared. Don't worry about zero basis. You know, once it comes in it's in, and when it goes out, no gain or loss."

But, failing that then you've got these kind of tad of history. You've still got the exact same problem that was addressed in the preamble, which is that people can look at how it came in and choose what to do. So I think we have to look at coming into the group as a significant event either one that triggers deemed redemption or one that makes us reconsider how broadly 13(t) would apply.

MR. FRANKEL: And, of course, you've only sort of recognized it on one side, though, to say that there's no loss and still hitting us with gain.

MR. SOLOMON: I have just a practical question, I guess, for you and for the panel. Rose's question really starts to ask a broader question of whether or not in finalizing this regulation we should make decisions with respect to all the issues of whether stock should be treated on a single entity basis in a consolidated group? Is this the time or place to analyze all those issues and make decisions or not? I think that's part of the question you're asking.

MS. WILLIAMS: Right, part of --

MR. SOLOMON: You started to ask the collateral question, what happens if appreciated stock comes into the group?

MS. WILLIAMS: Right.

MR. SOLOMON: Should we answer that question here and what's Mike's view with respect to that?

MR. FRANKEL: Well, I don't think you're necessarily are ready to go that far. What I am really saying is that partial movement at this time -- because I don't know when you're ever going to visit it again, or at least maybe not during the time that I'm practicing you may not visit it again -- let's get some of these aspects of where I see problems in the practical day-to-day approach that needs to be addressed.

MR. SOLOMON: What you're saying is, that there are certain sympathetic cases. You're not saying to us, now go to a single entity approach. What you're saying is there are some sympathetic cases.

MR. FRANKEL: Right.

MR. SOLOMON: For example, if the stock has always been in the group. So you're saying, we should broaden the gain side rule in those sympathetic cases. But you're not necessarily advocating that we go to a complete single entity notion at this time?

MR. FRANKEL: That's correct. I mean I realize a lot of the problems such as, when you have T coming in holding parent stock, is that a deemed redemption? But, of course, as I say, it's a redemption as far as you're concerned, if there's gain, I'm sure there would be a no-loss allowed rule in there, also.

To me, that's not congruous.

MR. GREEN: I just have one -- this is more kind of curiosity than anything else. In your letter you talked -- I guess your second point -- about a subsidiary acquiring P stock in the ordinary course through foreclosure.

MR. FRANKEL: Uhm hum.

MR. GREEN: How does that happen? How do you foreclose and get P stock in an ordinary course transaction? I've never come across it. I'm just curious.

MR. FRANKEL: I have no idea of -- at least I don't remember the facts as far as how much stock of P a shareholder of P held, but they had borrowed money from P's subsidiary and the -- P actually suffered some financial hardship, as some holding companies have in the past several years, and the shareholder could not pay off the debt.

Therefore, the subsidiary foreclosed on the debt, took back the stock of P; but because of the sub's capital aspect, they could not distribute up the parent and the parent did not have the financial wherewithal to buy back its stock.

MR. GREEN: Okay, I think I understand now. I guess I was just a little confused, loaning money to one's shareholders or indirect shareholders -- I don't always think of that as ordinary course. But now I understand the transaction. Thanks.

MR. FRANKEL: I mean, we've seen a lot of -- and this is not, as far as I know, is not one you've read in the papers about.

MR. GREEN: Okay, thanks.

MR. WEISBACH: On the -- actually to be honest with you, really if we gave on the gain side, we were thinking of specific transactions. That's how we came up with the rules we have. On your number three, allow P stock to be issued to a related party. What is your specific transaction you have in mind?

MR. FRANKEL: I don't have one. But again, there is no reason to put a prohibition along these lines. If there is, kindly lay it out in the preamble.

I mean, I do applaud the situation that you took care of, the avoidance loss transaction, which was plainly laid out in your preamble. I have no problems with situations along those lines. But I'm also saying, "Hey, let's craft the rules. If we have to put limitations on them, fine."

MR. LEVINE: But I guess, what you've done here is, you haven't really -- what you said, you're not trying to go to a total single entity approach, so you've taken cases that you think the rule should be expanded -- I'm just picking up on what David has been saying.

I mean, we crafted the rules with transactions in mind because we have an overall concern. It's a little hard -- you know, we could invent all kinds of possible transactions that people might do and put the rules in. It's a little hard to do it if, you know, somebody doesn't have a transaction in mind that we can understand and can appreciate why it's not abusive.

MR. FRANKEL: Well, but you're telling me that you proposed these rules with transactions in mind, then you ask for my comments and you don't tell me what these transactions are so that maybe I can help you work through something.

MR. LEVINE: Well, I think what we -- the rules that I'm discussing is the rules where we allowed for gain nonrecognition. We had thoughts in mind, you know, as to what transactions we can up with there. It's just a little difficult to talk abstractly about it.

MR. FRANKEL: That's exactly my problem.

MR. SOLOMON: Any other questions or comments?

(No verbal response.)

MR. SOLOMON: Thank you very much.

Is there anyone else who would like to speak at today's hearing?

(No verbal response.)

MR. SOLOMON: Seeing none, this concludes the hearing. Thank you very much.

(Whereupon, at 1:45 p.m., the proceedings were adjourned.)