The consolidated group net operating loss carryback rules provide welcome relief for post-2017 corporate acquisitions, but fall short of eliminating some unintended deal consequences stemming from the temporary revival of NOL carrybacks.
Treasury and the IRS on July 2 released temporary section 1502 regulations (T.D. 9900) — which also serve as part of simultaneously released proposed rules (REG-125716-18) — addressing specific effects of retroactive statutory changes extending the section 172 NOL carryback period, such as those enacted in March allowing taxpayers to carry back NOLs arising in tax years 2018 through 2020.
Bryan Collins of Andersen Tax LLC applauded the IRS and Treasury “for getting this guidance out relatively quickly” to address an important consolidated return aspect of the NOL carryback changes under the Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136). That is the ability of the group to elect to “to waive an acquired member’s NOL carryback to the extent the NOL would be carried back to a different consolidated group,” he said.
The five-year carryback period in the CARES Act wreaked havoc for some post-2017 merger and acquisition transactions because dealmakers generally didn’t contemplate potential refunds from NOL carrybacks, causing unintended consequences and shifting the economics of some deals after they had closed.
The Tax Cuts and Jobs Act eliminated the two-year carryback provision for most corporations. That means purchase agreements generally didn’t have provisions governing whether the acquiring group's post-acquisition consolidated NOLs (CNOLs) attributable to the acquired member could be carried back to the selling group’s prior consolidated return years while the target company was a member of that group.
The new split-waiver election regs, however, don’t address myriad situations that without further guidance could cause inequitable results for deals negotiated after the TCJA was enacted under the presumption that companies couldn’t carry back losses.
Retroactive Statutory Changes
Under current rules (reg. section 1.1502-21(b)(3)(ii)(B)), an acquiring consolidated group may make an irrevocable split-waiver election to waive all CNOLs attributable to the target corporation for the portion of the carryback period during which it was a member of another consolidated group.
That election, however, must be made in a separate statement filed with the acquiring consolidated group’s original income tax return for the year in which the corporation became a member. Because many companies didn’t contemplate NOL carrybacks post-TCJA, they likely didn’t make that election in the acquisition year. If that was the case, absent any contractual agreement, the acquiring group could still make the general waiver election for any year of the group for its entire CNOL carryback.
That all-or-nothing election, however, requires the acquiring group to forgo other portions of its losses that it could otherwise carry back to its own prior years under the CARES Act. Thus, the need for guidance similar to that in now-expired 2010 temporary consolidated return regs implemented to address statutory changes in the NOL rules amid the Great Recession.
“The temporary regs provide the flexible mechanics requested by taxpayers for split waivers in a manner consistent with prior approaches” under reg. section 1.1502-21, said Andrew J. Dubroff of EY. That includes providing an “extended window to make new split-waiver elections in response to the CARES Act, reflecting the delay in issuance of this guidance,” Dubroff said.
Generally, the acquiring group must file the election with its timely filed consolidated return (including extensions) for the year in which the amended carryback CNOL is incurred, but under some circumstances may make the election on an amended return if filed within a specified time frame.
For post-acquisition CNOLs that arose in tax years 2018 and 2019 that would be carried back to a former consolidated group under the CARES Act, an acquiring group may make a split-waiver election via an amended return if it’s filed by November 30.
Collins noted the “particularly creative” approach in the temporary regulations that attempts “to provide rules that will address not only the CARES Act changes but future legislative changes to the NOL carryback rules as well.”
If a statutory amendment extending the loss carryback period occurs after a consolidated group acquires a new member from another group, the acquiring group may make one of two elections concerning the carrybacks of CNOLs attributable to the new member in a year in which the amended carryback rules apply.
The options are to waive the part of the extended carryback period during which an acquired member was a member of a former consolidated group (amended statute split-waiver election), or to waive only the additional carryback years provided under the amended statute (extended split-waiver election).
The acquiring group may make a separate irrevocable election for each tax year to which the amended carryback rules apply.
Limited Flexibility
Acquiring groups can only make an irrevocable election to relinquish the portion of the carryback period for CNOLs attributed to the new member if, among other things, the acquired corporation was a member of another consolidated group before joining the new group.
“Some taxpayers had requested that the ability to make split waivers apply more generally, regardless of whether there is a prior consolidated group in the carryback period,” Dubroff said. The government, however, “has never supported this approach, so it’s not surprising that it’s not reflected in the temporary regs,” he said.
Rules addressing an amended statute split-waiver election for situations in which “there wasn’t a prior group in the oldest years of the carryback period but there is a prior group in the more recent years of the carryback period” would be helpful, according to Dubroff.
Another concern is that the split-waiver election rules appear to require that the acquiring group making the election waives the loss carryback to “any prior group of the acquired corporation,” Collins said.
This is consistent with prior iterations of this provision, but the current consolidated group might want flexibility to “waive the carryback to one but not all of the prior groups,” Collins suggested.
“For example, assume Group 1 acquired an operating company from a selling consolidated group [and] one year later, Group 2 acquired Group 1,” Collins said. Group 2 may want to carry the operating company’s NOLs “back to years during which it was a member of Group 1 but not to years while it was a member of the original selling consolidated group,” he said.
“This does not appear to be permitted under the regulations and the policy rationale for that conclusion seems unclear,” Collins said.
Potential Inequities Remain
Notwithstanding the new guidance, traps remain from unexpected consequences stemming from the CARES Act’s loss carryback provision, according to Dubroff.
“For example, the P consolidated group might have sold S to the P1 consolidated group in 2018 to 2020, before enactment of the CARES Act, with both P and P1 anticipating that S would carry forward its share of the P group’s consolidated NOLs to the P1 group,” Dubroff said.
Under the CARES Act’s loss carryback provision, however, that can mean in some situations that “S first carries back and absorbs its share of the P group’s 2018 to 2020 consolidated NOLs,” which could result in losses carried back to a prior consolidated group that would retain the resulting refund, Dubroff said. In that case, “the new carryback ability significantly alters the amount of unused S NOLs carried forward to the P1 group,” he added.
The parties could equitably resolve that change in expectations concerning the P1 group’s ability to acquire S NOL carryforwards only if they “had addressed the issue in the purchase agreement for S, requiring a carryback waiver election for the NOLs,” Dubroff said.
“The temporary regs don’t address this issue [because] there’s no provision requiring one of the new waiver elections to be made,” Dubroff said, but he added that including a mandate in the regs wouldn’t necessarily work in all cases.
In other situations, Dubroff said that S’s newly allowed carrybacks from 2018 through 2020 wouldn’t be eligible for the relief under the new consolidated return regs.
For example, the CNOL waiver elections don’t apply if “the P group could carry S’s share of the consolidated NOLs back to its own prior consolidated return years, or if S didn’t join in a consolidated return in its NOL year and was carrying back to a prior consolidated group,” Dubroff said. Because “there’s no single rule or approach that would address all permutations of purchase scenarios . . . it’s not really an issue that can be easily addressed by regs,” he said.
No Blanket Disregard
Several tax professionals with KPMG LLP noted in an April 2 letter to the editor of Tax Notes that not all issues for consolidated groups stemming from the five-year loss carryback rule can be resolved under a split-waiver election.
The letter recommended that Treasury and the IRS — along with providing the split-waiver election guidance — consider “a new consolidated return election to allow [the acquiring group] to preserve the economic deal agreed to in the original transaction.”
Specifically, the letter pointed to relief in Notice 2000-53, 2000-2 C.B. 293, saying there was precedent for allowing the acquiring consolidated group “to determine the NOL carryovers of acquired subsidiaries without regard to the CARES Act changes to the NOL carryback rules.”
In Notice 2000-53, the IRS allowed a departing member of a consolidated group — that would otherwise be affected by the application of some provisions of the final 1999 consolidated return regulations — to ignore a specific rule while it was a member of the group.
In that guidance, the IRS acknowledged that the application of a consolidated return overlap rule had inappropriate adverse tax consequences for some acquisitions of corporations from consolidated groups that occurred during a tax year to which the regs applied but before the regs were issued.
The IRS allowed departing members in some situations to elect to determine its NOL and capital loss carryovers to post-acquisition tax years by treating specific provisions of the regs as not applying while it was a member of its prior group.
Situations that arose under Notice 2000-53 and those occurring under the CARES Act, “are quite similar in that they illustrate situations where a significant change in law disturbed the legitimate expectations of the parties, resulting in a detriment to the acquiring group that could not have been reasonably foreseen as of the acquisition,” the letter said.
Adopting an approach like that of Notice 2000-53 would mean “the selling group applies existing law but the acquiring group may elect to determine its NOL carryover into the acquired group without regard to the CARES Act carryback rule,” according to the letter.
The relief would allow the target company “to unilaterally preserve its portion of a CNOL as a carryforward while also allowing the selling group to include the loss in a carryback of the CNOL,” Jeffrey L. Vogel of KPMG LLP told Tax Notes. Vogel, one of the authors of the April letter, said that would “protect the original economics of the acquisition” — that is, the target would retain a tax attribute for future use.
In most situations, that treatment won’t create a double benefit because the use of the same loss by the two groups would be mitigated or eliminated by the corresponding reduction in stock basis of the target subsidiary and increase the gain or decrease the loss on the acquisition, according to Vogel.
Vogel said that allowing the target to preserve its CNOL carryforward would also minimize disruption to already completed transactions by, for example, eliminating the acquiring group’s need to file amended returns.
“We are hopeful the government will provide relief similar to Notice 2000-53 for the limited transactions that occurred prior to the enactment of the CARES Act,” Vogel said.