In Notice 2008-100 issued on October 14, 2008, the Internal Revenue Service (IRS) announced that, pending further guidance, any purchase by the U.S. Treasury Department (the Treasury) of equity of qualifying financial institutions under the Capital Purchase Program (CPP) pursuant to the Emergency Economic Stabilization Act of 2008 (EESA) will not result in an ownership change for purposes of section 382. Notice 2008-100 is discussed in a previous McDermott Will & Emery On the Subject entitled “IRS Issues Guidance That Treasury’s Purchase of Stocks Will Not Result in Ownership Change Under Section 382.”
On January 30, 2009, the IRS issued Notice 2009-14 (the Notice) providing additional guidance regarding the application of section 382 to other purchase programs under the EESA. Specifically, guidance was issued with respect to the following purchase programs under the EESA: the Capital Purchase Program for publicly-traded issuers (Public CPP); the Capital Purchase Program for private issuers (Private CPP); the Capital Purchase Program for S corporations (S Corp CPP); the Targested Investment Program (TARP TIP); and the Automotive Industry Financing Program (TARP Auto). Collectively, the five programs described above are referred to here as the Programs. The Notice significantly expands guidance previously issued in Notice 2008-100 to include purchases by the Treasury of instruments other than equity in financial institutions. The Notice supercedes Notice 2008-100.
Section 382 of the Internal Revenue Code imposes certain limitations on the use of net operating losses (NOLs) and certain other tax attributes, including deductions for “built-in losses” of corporations following an “ownership change.” An “ownership change” for purposes of section 382 occurs when the ownership of a “loss corporation” (a corporation with NOLs or built-in losses) by 5 percent shareholders changes by more than 50 percent over a three-year period (or since the last ownership change). This can occur, for example, when ownership of a corporation changes hands pursuant to a stock purchase, a tax-free reorganization or, under certain circumstances, a new issuance of stock.
To ensure that a purchase of stock of a loss corporation by the Treasury (directly or via option exercise) under the Programs does not result in an ownership change under section 382 for the loss corporation, the Notice provides the following general rules.
Any instrument issued pursuant to the Programs, whether owned by Treasury or subsequent holders, shall be treated as an instrument of indebtedness, if denominated as such, and as such described in section 1504(a)(4) (so-called, “pure preferred stock”), if denominated as preferred stock. Thus, no instrument denominated as indebtedness or preferred stock will be treated as stock for purposes section 382, except that preferred stock will be treated as stock for purposes of section 382(e)(1) (i.e., the stock will be treated as stock for purposes of determining the value of the old loss corporation when calculating any section 382 limitation that otherwise results from an ownership change).
Any warrants acquired by the Treasury under the Public CPP, TARP TIP and TARP Auto, whether held by the Treasury or another person, will be treated as options of the loss corporation and not as stock. While held by Treasury, such warrants will not be deemed exercised under regulations promulgated under section 382. Warrants acquired by the Treasury under the Private CPP are be treated as preferred stock described in section 1504(a)(4). Any warrant acquired by Treasury under the S Corp CPP is treated as an ownership interest in the underlying indebtedness (and therefore will not otherwise affect the validity of the corporation’s S election).
The Treasury’s purchase of shares of a loss corporation pursuant to the Programs will not be treated as increasing the Treasury’s ownership in the loss corporation over its lowest percentage owned on any earlier date.
While shares purchased by the Treasury generally will be treated as outstanding for purposes of determining the ownership of the loss corporation by other 5 percent shareholders, to the extent shares purchased by the Treasury are redeemed, such shares will be treated as if they had never been outstanding.
Any capital contribution made by the Treasury to a loss corporation pursuant to the Programs will not be considered to have been made as part of a plan, a principal purpose of which was to avoid or increase any section 382 limitation (i.e., the “anti-stuffing” rule of section 382(l)(i) is turned off for Treasury contributions).
Taxpayers may rely on the Notice unless and until there is further guidance issued by the IRS.