The IRS recently ruled (PLR 202140002) that the gross receipts of a corporation included the historic gross receipts of its liquidated subsidiary corporation for purposes of the gross receipts test under Section 165(g)(3) for the worthless stock deduction.
The private letter ruling addressed a corporation (“US Sub”) that directly and wholly owned a foreign subsidiary holding corporation (“Holding Co.”), which in turn directly and wholly owned two foreign subsidiary corporations (“Foreign Sub 1” and “Foreign Sub 2.”). Foreign Sub 1 was formed to develop a specified product and Foreign Sub 2 was formed as the European operating corporation to facilitate the development and ultimate exploitation of the product.
The U.S. corporation later concluded that the monetization of the product was impossible, and eliminated Foreign Sub 2’s workforce and disposed of substantially all of its assets, eventually leading to its insolvency. Holding Co. elected to treat Foreign Sub 2 as a disregarded entity (DRE) for U.S. federal income tax purposes, which was represented by the taxpayer to qualify as a liquidation under Section 332. Then, US Sub elected to treat Holding Co. as a DRE. A third-party appraiser determined that the stock of Holding Co., Foreign Sub 1, and Foreign Sub 2 were worthless on the effective date of the election for Holding Co.
At issue was whether the taxpayer could take an ordinary worthless stock deduction for the Holding Co. stock based on the historic gross receipts of Holding Co.’s prior subsidiaries even though it had not had any gross receipts itself since its incorporation.
Section 165(g)(3) provides that certain taxpayers may claim an ordinary loss for worthless securities in a corporation if certain requirements are met—including a requirement that more than 90% of the corporation’s aggregate gross receipts for all taxable years were from sources other certain specified passive sources. The legislative history of Section 165(g)(3) provides that Congressional intent for enacting the gross receipts test was to determine whether a subsidiary was: (i) an operating company—for which an ordinary loss may be allowed; or (ii) a holding or investment company—for which an ordinary loss is not allowed.
The IRS ruled that US Sub can take into account the historic gross receipts of Foreign Sub 2 for purposes of the gross receipts test of the Holding Co. stock. Because Holding Co. had no gross receipts since its inception, presumably it would not have met the gross receipts test without the gross receipts of Foreign Sub 2.
Jeff Borghino is a partner in the corporate tax group of Grant Thornton’s Washington National Tax Office in Washington, D.C. He focuses primarily on the taxation of corporate and financial transactions, including taxable and tax-free acquisitions, general corporate tax matters, recapitalizations and debt workouts, and financial instruments. Prior to joining the Washington National Tax Office, Borghino worked in Grant Thornton’s San Francisco office as part of the federal tax group.
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