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IRS rules on cancellation of DRE’s debt

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Tax Hot Topics newsletter The IRS ruled in PLR 202050014 that a series of proposed transactions pursuant to a bankruptcy plan would not result in gain or loss to a corporation and that Sections 61(a)(12) and 108(a) were not applicable to the cancellation of debt owed by its disregarded entity.

In the PLR, a corporation, Distributing, was the common parent of a business group (the Distributing Group) that included corporations and disregarded entities (DRE) separate from their sole regarded owners for U.S. federal income tax purposes. Distributing owned 100% of the membership interest of LLC1, which was a DRE. LLC1 had outstanding debt consisting of first lien debt, second lien debt, and unsecured debt. The LLC1 debt was not, and never had been, guaranteed by Distributing.

Pursuant to a proposed plan of restructuring, confirmed by the Bankruptcy Court, the Distributing Group consummated a series of restructuring transactions. As part of the proposed restructuring transactions, Distributing will contribute any assets that it directly owns to LLC1, LLC1 will, for U.S. tax purposes, form a new corporation (Newco), and LLC1 will contribute all of its assets to Newco in exchange for: 1) Newco stock and stock rights, 2) cash proceeds and 3) newly issued Newco debt (the Newco Consideration). LLC1 will then distribute the Newco Consideration and additional cash on hand to LLC1’s first lien creditors. Following the proposed transactions, Distributing and LLC1 will liquidate and any equity in Distributing will be cancelled for no consideration.

The IRS ruled that Distributing will not recognize any gain or loss with respect to the Newco Consideration transferred to the LLC1 first lien creditors provided that the transaction qualifies as a reorganization under section 368(a)(1)(G). The IRS also ruled that the LLC1 Debt will be treated as nonrecourse liabilities of Distributing for purposes of Treas. Reg. Sec. 1.1001-2 and that the cancellation of the LLC1 first lien debt will result in amount realized under section 1001 with respect to the Newco Consideration transferred by LLC1 to the LLC1 first lien creditors. The IRS specifically ruled that Sections 61(a)(12) and 108(a) were not applicable to the cancellation of the LLC1 first lien debt.

Contacts:
Jeff Borghino
Partner
Washington National Tax Office
T +1 202 521 1532

Jack Stringfield
Manager
Washington National Tax Office
T +1 202 521 1518

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