Section 382 proposed rules impact troubled business transactions

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November 2019

Overview

PwC’s Washington National Tax Services on October 16 hosted the live webcast “Tax Readiness: Recession or not, how troubled businesses will be affected by the Section 382 proposed regulations”, featuring PwC Tax and Deals specialists. They discussed economic risk factors for US companies, and the tax impact that the proposed regulations under Section 382(h) (the Proposed Regulations), released by Treasury on September 9, may have on troubled businesses. In addition, the panelists addressed common M&A strategies in the context of distressed companies.

In this context, buyers and sellers of loss corporations must prepare for finalization of the Proposed Regulations. Moreover, the proposed rules could reduce the value of tax attributes in M&A transactions even before they become effective. Generally, Section 382 limits a corporation’s ability to offset income with losses arising before an ownership change, with adjustments for certain recognized built-in gains or losses (RBIG or RBIL) recognized by the loss corporation. 

Prior to the Proposed Regulations, Notice 2003-65 (the Notice) provided two alternative safe harbor approaches for calculating RBIG and RBIL: the “1374 approach” and the “338 approach”. The Proposed Regulations would make mandatory the safe harbor provided in the Notice, generally following the 1374 approach and eliminating the so called “wasting asset” or 338 approach. Further, the Proposed Regulations address the treatment of numerous specific items accounted for in the Section 382(h) computations, including the treatment of cancellation of indebtedness income and excess business interest expense allocated from a partnership.

The takeaway

If economic downturn indicators rise, so will the risks for US companies’ finances going forward. The ability to use tax attributes of loss corporations will decrease significantly compared to the currently available method, if the Proposed Regulations are finalized in their current form. Anticipation of the potential finalization could reduce overall deal consideration. In distressed transactions, such reduction might result in an increase in asset sales as opposed to stock sales. 

Buyers and sellers of companies should analyze the Proposed Regulations in the context of contemplated transactions and consider strategies designed to reduce any negative impact.  Given that the Proposed Regulations also address the further complexity of having Section 163(j) applied at the partnership level with regard to determining the basis of partnership interests, additional attention should be paid to structures involving partnerships.

See Also: 

For an in-depth discussion of the provisions in the Proposed Regulations, see our Tax Insight, Treasury issues comprehensive proposed regulations under Section 382(h)

For a deal-focused discussion of the Proposed Regulations, see our Tax Insight, Proposed Regulations under Section 382 reduce tax attributes’ value in M&A transactions.

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Julie Allen

National Tax Services Market Leader and Mergers and Acquisitions Tax Leader, PwC US

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