Consolidated Returns; Applicability of
Other Provisions of Law; Non-applicability of Section 357(c)

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-137519-01] RIN-1545-BA09

TITLE: Consolidated Returns; Applicability of Other Provisions of
Law; Non-applicability of Section 357(c)

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rule-making and notice of public hearing.

SUMMARY: This document proposes amendments relating to the
consolidated return regulations dealing with the non-applicability
of section 357(c) in a consolidated group. The proposed amendments
clarify that, in certain transfers described in section 351 between
members of a consolidated group, a transferee's assumption of
certain liabilities described in section 357(c)(3) will not reduce
the transferor's basis in the transferee's stock received in the
transfer. This document also provides notice of a public hearing on
these proposed regulations.

DATES: Written or electronic comments and requests to speak (with
outlines of oral comments to be discussed) at the public hearing
scheduled for March 21, 2002, must be submitted by February 28,
2002.

ADDRESSES: Send submissions to: CC:ITA:RU (REG-137519-01), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8. a.m. and 5 p.m. to: CC:ITA:RU
(REG-137519-01), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers
may submit comments electronically via the internet by selecting the
"Tax Regs" option on the IRS Home Page, or by submitting comments
directly to the IRS internet site at The public hearing will be held
in room 4718, Internal Revenue Building, 1111 Constitution Avenue,
NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, T. Ian
Russell of the Office of Associate Chief Counsel (Corporate), (202)
622-7930; concerning submissions, the hearing, and/or to be placed
on the building access list to attend the hearing, Donna M.
Poindexter (202-622-7180) (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

Section 357(c)(1) generally provides that, in the case of certain
exchanges described in section 351, if the sum of the amount of the
liabilities assumed by the transferee corporation exceeds the total
of the adjusted basis of the property transferred pursuant to such
exchange, then such excess shall be considered as gain from the sale
or exchange of a capital asset or of property that is not a capital
asset. Section 357(c)(3), however, excludes from the computation of
liabilities assumed liabilities the payment of which would give rise
to a deduction, provided that the incurrence of such liabilities did
not result in the creation of, or an increase in, the basis of any
property.

Section 358(a) generally provides that, in the case of an exchange
to which section 351 applies, the basis of the property permitted to
be received without the recognition of gain or loss is decreased by
the amount of any money received by the transferor. For this
purpose, under section 358(d)(1), the transferee's assumption of a
liability of the transferor is treated as money received by the
transferor on the exchange. Section 358(d)(2), however, provides an
exception for liabilities excluded under section 357(c)(3).

On August 15, 1994, final regulations (TD 8560) adding paragraph (d)
to §1.1502-80 were published in the Federal Register (59 FR
41666). A correcting amendment adding a sentence to the end of
paragraph (d) of §1.1502-80 was published in the Federal
Register for March 14, 1997 (62 FR 12096). As currently in effect,
§1.1502-80(d) provides that "[s]ection 357(c) does not apply to
any transaction to which §1.1502-13, §1.1502-13T,
§1.1502-14, or §1.1502-14T applies, if it occurs in a
consolidated return year beginning on or after January 1, 1995." The
example in that regulation contemplates that, to the extent that the
transferor does not recognize gain under section 357(c) by reason of
the rule of §1.1502-80(d), the transferor's basis in the stock
of the transferee that it receives in the exchange is reduced, with
the result that an excess loss account may arise.

A concern has been raised that, as currently drafted,
§1.1502-80(d) may produce an unintended basis result in certain
intragroup transfers described in section 351. In particular, it is
possible that one might conclude that, because §1.1502-80(d)
provides that section 357(c) does not apply to certain intragroup
section 351 exchanges, no liabilities can technically be excluded
under section 357(c)(3). If that analysis were correct, in the case
of a transfer described in section 351 between members of a
consolidated group, the transferor's basis in the stock of the
transferee received in the transfer would be reduced by liabilities
assumed by the transferee, including those liabilities described in
section 357(c)(3) that would not have reduced basis had section
357(c) applied. Assuming the transferor and the transferee are
members of the consolidated group at the time the liability does in
fact give rise to a deduction on the part of the transferee and is
taken into account on the consolidated return, the transferor's
basis in the stock of the transferee would be reduced a second time
under the principles of §1.1502-32. This duplicated basis
reduction, i.e., once at the time of the transfer described in
section 351 and again at the time the liability is taken into
account by the consolidated group, may ultimately cause the
transferor to recognize an amount of gain on the sale of the stock
of the transferee that does not clearly reflect income.

Explanation of Provisions

These proposed regulations clarify that, in certain transfers
described in section 351 between members of a consolidated group, a
transferee's assumption of liabilities described in section 357(c)
(3)(A), other than those also described in section 357(c)(3)(B),
will not reduce the transferor's basis in the transferee's stock
received in the exchange.

Proposed Effective Date

These regulations are proposed to apply to transactions occurring
in. consolidated return years beginning on or after the date these
regulations are published as final regulations in the Federal
Register.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It is
hereby certified that these regulations do not have a significant
economic impact on a substantial number of small entities. This
certification is based on the fact that these regulations will
affect affiliated groups of corporations that have elected to file
consolidated returns, which tend to be larger businesses. Therefore,
a Regulatory Flexibility Analysis under the Regulatory Flexibility
Act (5 U.S.C. chapter 6) is not required. Pursuant to section
7805(f) of the Internal Revenue Code, these regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (preferably a
signed original and eight (8) copies) that are submitted timely to
the IRS. The IRS and Treasury request comments on the clarity of the
proposed regulations and how it may be made easier to understand.
All comments will be available for public inspection and copying. A
public hearing has been scheduled for March 21, 2002, beginning at
10 a.m., in room 4718, Internal Revenue Building, 1111 Constitution
Avenue NW., Washington, DC.

Because of access restrictions, visitors will not be admitted beyond
the Internal Revenue Building lobby more than 15 minutes before the
hearing starts. The rules of 26 CFR 601.601(a)(3) apply to the
hearing. Persons that wish to present oral comments at the hearing
must submit timely written comments and an outline of the topics to
be discussed and the time to be devoted to each topic (preferably a
signed original and eight (8) copies) by February 28, 2002.

A period of 10 minutes will be allotted to each person for making
comments.

An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.

Drafting Information

The principal author of these regulations is T. Ian Russell, Office
of Associate Chief Counsel (Corporate). However, other personnel
from the IRS and Treasury Department participated in their
development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is
proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in
part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. In §1.1502-80, paragraph (d) is revised to read as
follows: §1.1502-80 Applicability of other provisions of law.

* * * * *

(d) Non-applicability of section 357(c)--

(1) In general. Section 357(c) does not apply to cause the
transferor to recognize gain in any transaction to which
§1.1502-13 applies, if such transaction occurs in a
consolidated return year beginning on or after the date these
regulations are published as final regulations in the Federal
Register. Notwithstanding the foregoing, for purposes of
determining the transferor's basis in property under section 358(a)
received in a transfer described in section 351, section 358(d)(2)
shall operate to exclude liabilities described in section 357(c)(3)
(A), other than those also described in section 357(c)(3)(B), from
the computation of the amount of liabilities assumed that is treated
as money received under section 358(d)(1), if such transfer occurs
in a consolidated return year beginning on or after the date these
regulations are published as final regulations in the Federal
Register . This paragraph (d)(1) does not apply to a transaction if
the transferor or transferee becomes a nonmember as part of the same
plan or arrangement. The transferor (or transferee) is treated as
becoming a nonmember once it is no longer a member of a consolidated
group that includes the transferee (or transferor). For purposes of
this paragraph (d)(1), any reference to a transferor or transferee
includes, as the context may require, a reference to a successor or
predecessor. For rules regarding the application of. section 357(c)
to transactions occurring in consolidated return years beginning on
or after January 1, 1995, but before the date these regulations are
published as final regulations in the Federal Register , see
§1.1502-80(d) in effect prior to the date these regulations are
published as final regulations in the Federal Register (see 26 CFR
part 1 revised April 1, 2001).

(2) Examples. The principles of paragraph (d)(1) of this section are
illustrated by the following examples:

Example 1. P, S, and T are members of a consolidated group. P owns
all of the stock of S and T with bases of $30 and $20, respectively.
S has assets with a total fair market value equal to $100 and an
aggregate basis of $30 and liabilities of $40. S merges into T in a
transaction described in section 368(a)(1)(A) (and in section 368(a)
(1)(D)). Section 357(c) does not apply to cause S to recognize gain
in the merger. P's basis in T's stock increases to $50 ($30 plus
$20), and T succeeds to S's $30 basis in the assets transferred and
the $40 of liabilities.

Example 2. P owns all the stock of S1. S1 has assets with a total
fair market value equal to $100 and an aggregate basis of $30. S1
has $40 of liabilities, $5 of which are described in section 357(c)
(3)(A), but not section 357(c)(3)(B), and $35 of which are not
described in section 357(c)(3)(A). S1 transfers its assets to a
newly formed subsidiary, S2, in exchange for stock of S2 and S2's
assumption of the liabilities of $40 in a transaction to which
section 351 applies. Section 357(c) does not apply to cause S1 to
recognize gain in connection with the transfer. For purposes of
determining S1's basis in the S2 stock it received in the exchange,
section 358(d)(2) operates to exclude $5 of the liabilities from the
computation of the amount of liabilities assumed that are treated as
money received under section 358(d)(1). S1's basis in the S2 stock
received in the exchange is a $5 excess loss account (reflecting its
$30 basis in the assets transferred reduced by $35, the amount of
liabilities assumed that are not described in section 357(c)(3)(A)).

* * * * *

Deputy Commissioner of Internal Revenue.

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