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 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 .”
In Notice 2009-14 issued on January 30, 2009, the IRS provided additional guidance regarding the application of section 382 to other purchase programs under the EESA. Notice 2009-14 significantly expanded guidance previously issued in Notice 2008-100 to include purchases by the Treasury of instruments other than equity in financial institutions. Notice 2009-14 superseded Notice 2008-100. Notice 2009-14 is discussed in a previous McDermott Will & Emery On the Subject entitled “IRS Expands Guidance on Application of Section 382 to Treasury’s Purchase of Financial Instruments.”
On April 13, 2009, the IRS issued Notice 2009-38 (the Notice) further expanding on earlier guidance regarding the application of section 382 to purchase programs under the EESA. Specifically, guidance was issued with respect to the following purchase programs under the EESA:
Capital Purchase Program for publicly traded issuers (Public CPP)
Capital Purchase Program for private issuers (Private CPP)
Capital Purchase Program for S Corporations (S Corp CPP)
Targeted Investment Program (TARP TIP)
Asset Guarantee Program
Systematically Significant Failing Institutions Program
Automotive Industry Financing Program (TARP Auto)
Capital Assistance Program for publicly traded issuers (TARP CAP)
Collectively, the programs described above are referred to as the Programs. The Notice amplifies and supersedes Notice 2009-14.
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.
A. Any instrument issued pursuant to the Programs, except for TARP CAP, whether owned by Treasury or subsequent holders, shall be treated as an instrument of indebtedness, if denominated as such, and as 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). With respect to TARP CAP, the appropriate classification of the instrument is made under general principles of federal tax law.
B. Any warrants acquired by the Treasury under the Programs, other than Private CPP and S Corp CPP, 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).
C. Any amount received by an issuer in exchange for instruments issued to the Treasury under the Programs shall be treated as received, in its entirety, as consideration for such instruments.
D. 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, for section 382 purposes.
E. 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.
F. 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).
G. Rules C to F above apply to so-called “covered instruments” as though such instruments were issued directly to Treasury under the Programs. For purposes of the Notice, the term “covered instrument” means any instrument acquired by Treasury in exchange for an instrument that was issued to Treasury under the Programs. In addition, the term also includes any instrument acquired by Treasury in exchange for a covered instrument.
Taxpayers may rely on the Notice unless and until there is further guidance issued by the IRS.