Mellon Bank Seeks Retroactive Application of Regs on Loss Carryovers of Acquired Subsidiaries

Dear Sir or Madam:

[1] We appreciate this opportunity to recommend that the IRS and Treasury give further consideration to the retroactive application of the temporary and proposed regulations.

[2] In response to Rite Aid Corp. v. United States, 255 F. 3d 1357 (Fed. Cir. 2001), the IRS and Treasury filed Temporary Regulations (T.D. 9048) under §§ 337(d) and 1502 on March 7, 2002. The temporary regulations provide new rules for determining allowable losses on the disposition of subsidiary stock by a consolidated group member.

[3] Additional adjustments to the temporary regulation were provided in the proposed regulations. In this section of the proposed regulations, the IRS and Treasury indicate that they are attempting to ameliorate situations where taxpayers relied on the provisions of § 1.1502-20 in prior periods, and therefore, they are permitting amendments to elections to waive loss carryovers. The IRS and Treasury also acknowledge that transactions may have been structured as asset sales or deemed asset sales under § 338(h)(10) rather than stock sales, due to the taxpayer's reliance on the loss disallowance rules under § 1.1502-20. However, the IRS and Treasury do not believe that taxpayers should be permitted to unwind prior transactions and calculate the allowable loss on the sale of stock under the new § 1.337(d)-2T. The Temporary Regulation under § 1.337(d)-2T are effective for dispositions or deconsolidations on or after March 7, 2002. The IRS and Treasury recognized that the loss disallowance rule in § 1.1502-20 affected the manner in which transactions were structured, yet drew the line by not permitting taxpayers to amend a § 338(h)(10) election and apply the new regulations retroactively to a transaction where taxpayers elected to treat a stock sale as an asset sale under § 338(h)(10).

[4] The court ruled in Rite Aid that the § 1.1502- 20 regulations were "manifestly contrary to the statute," and held that the duplicated loss component of § 1.1502-20 was an "invalid exercise of regulatory authority." Therefore, as you know, the regulations were ruled invalid. In order for a regulation to be valid, it must be consistent with the statute. In response to the Rite Aid decision, the IRS and Treasury filed temporary regulations to correct the prior regulations.

[5] In comparing taxpayers who made loss carryover elections to those who made § 338(h)(10) elections, similar economic losses have occurred in each situation. A taxpayer, in reliance on an invalid regulation, did not obtain the tax result intended by Congress. Taxes were over-collected by the IRS and Treasury as a result of invalid regulations issued by the IRS and Treasury. Congress has not expressed any intention that taxpayers who relied on the invalid regulations should be treated differently whether they made elections regarding loss carryovers or § 338(h)(10).

[6] If an election under § 338(h)(10) was made because of the tax implications that would result under § 1.1502-20, the parties to a transaction should be permitted to amend the election because the decision to make the election was based on regulations that were contrary to the intent Congress.

[7] The temporary regulations provide relief to taxpayers for transactions that occurred prior to March 7, 2002, only if a statement is attached to a timely filed original return. We believe that the IRS and Treasury should provide equitable relief to all taxpayers who relied on § 1.1502-20 when making any election, including elections under § 338(h)(10) to treat a sale of stock as a deemed asset sale, provided the statute of limitation has not expired for the year in which the election was made. The remedy would require both buyer and seller in a transaction to mutually agree to amend the election and amend prior years' income tax returns to recalculate the allowable loss under the new § 1.337(d)-2T.

[8] Accordingly, we urge you to consider the retroactive application of the temporary regulations under §§ 337(d) and 1502 to tax years prior to 2001. Further, relief is appropriate for both loss carryover elections and § 338(h)(10) elections.