Par. 2. Sections 1.172(h)-0 through 1.172(h)-5 are added to read as follows:
(a) In general.
(1) Scope.
(2) CERIL defined.
(b) Computation of allocable interest deductions.
(1) In general.
(2) Operating rules.
(3) CERT costs defined.
(i) Major stock acquisition.
(ii) Excess distribution.
(iii) Borrowing costs included in CERT costs.
(4) Accumulated CERT costs.
(i) Major stock acquisition.
(ii) Excess distribution.
(iii) CERT costs incurred in a year prior to a CERT.
(iv) Year constitutes loss limitation year with regard to multiple CERTs.
(5) No netting of interest income and deductions.
(6) Certain unforeseeable events.
(7) Examples.
(c) Effective/applicability date.
(a) In general —(1) Scope. The portion of a net operating loss (NOL) that is treated as a corporate equity reduction interest loss (CERIL) (as defined in paragraph (a)(2) of this section) cannot be carried back to a taxable year preceding the taxable year in which the corporate equity reduction transaction (CERT) occurs. This section provides rules for computing allocable interest deductions necessary to compute a CERIL for purposes of applying section 172(b)(1)(E) and (h), §§ 1.172(h)-1 through 1.172(h)-5, and § 1.1502-72 (the CERT rules ).
(2) CERIL defined. A CERIL means, with respect to any loss limitation year, the excess (if any) of the NOL for such taxable year over the NOL for such taxable year determined without regard to any allocable interest deductions otherwise taken into account in computing such loss.
(b) Computation of allocable interest deductions —(1) In general. Allocable interest deductions are deductions allowed for interest on the portion of indebtedness allocable to a CERT. Except as provided in section 172(h)(2)(E) (relating to adjustments for certain unforeseeable events), indebtedness is allocated to a CERT in the manner prescribed in section 263A(f)(2)(A), without regard to clause (i) thereof (relating to traced debt). Generally, interest deductions are allocable to a CERT if the interest expense could have been avoided if the CERT had not been undertaken (for example, if the amount of CERT costs (as defined in paragraph (b)(3)) had instead been used to pay down debt). See section 263A(f)(2)(A)(ii) and § 1.263A-9(a)(1). For purposes of applying the avoided cost rules of section 263A(f)(2)(A)(ii), all CERT costs are treated as if they were cash expenditures.
(2) Operating rules. This section provides a method for identifying the pool of costs to be treated as arising from a CERT (CERT costs). The interest allocable to those CERT costs is then computed under the principles of the avoided cost rules under section 263A(f)(2)(A) (without regard to paragraph (i) thereof) and the regulations thereunder, but substituting “CERT costs” or “accumulated CERT costs” (as defined in paragraph (b)(4)) for “production expenditures” or “accumulated production expenditures,” where those terms appear. In addition, for purposes of applying the avoided cost rules to compute interest allocable to a CERT, the “production period” is treated as beginning on the first date of the taxable year in which the CERT occurs (year of the CERT) on which there are accumulated CERT costs. Because the principles of section 263A(f)(2)(A)(i) are inapplicable to CERT computations, the principles of § 1.263A-9(b) (relating to traced debt) are also inapplicable. Instead, accumulated CERT costs are treated in their entirety as expenditures allocable to non-traced debt as that term is defined under § 1.263A-9(c)(5), and interest allocable to a CERT is calculated without tracing debt under the provisions of § 1.263A-9(d)(1). Limitations apply to the amount of interest allocable to a CERT. See, for example, section 172(h)(2)(C)(ii) and § 1.172(h)-3 (generally relating to three-year average interest history).
(3) CERT costs defined —(i) Major stock acquisition. CERT costs with regard to a major stock acquisition (MSA) include the fair market value of the stock acquired, whether that stock is acquired in exchange for cash, for stock of the acquirer, or for other property. In addition, CERT costs include the fair market value of any distributions to shareholders that are treated as part of the MSA under § 1.172(h)-1(d)(2). CERT costs also include the sum of amounts paid or incurred to facilitate any step of the MSA to the extent that those amounts are required to be capitalized under section 263(a), and any amounts disallowed under section 162(k). See also § 1.1502-72(a)(4) for additional rules regarding CERT costs in the case of a reverse acquisition.
(ii) Excess distribution. CERT costs with regard to an excess distribution (ED) include the fair market value of any distributions to shareholders during the year of the CERT. CERT costs also include the sum of amounts paid or incurred to facilitate the distributions to the extent that those amounts are required to be capitalized under section 263(a), and any amounts disallowed under section 162(k). To the extent that neither section 263(a) nor section 162(k) applies or if only section 162(k) applies to a distribution included in an ED, additional CERT costs associated with the distribution are determined under the principles of § 1.263(a)-4(e) (relating to the capitalization of certain costs incurred to acquire or create intangibles), applied as if the distribution were a transaction within the scope of § 1.263(a)-4.
(iii) Borrowing costs included in CERT costs. For purposes of identifying CERT costs with regard to an MSA or ED under this paragraph (b)(3), the determination of whether costs facilitate an MSA or ED is made without regard to §§ 1.263(a)-5(c)(1) and 1.263(a)-4(e)(1)(iv) (excluding borrowing costs). Therefore, certain costs of debt financing are included in CERT costs.
(4) Accumulated CERT costs —(i) Major stock acquisition. Except as otherwise provided in this paragraph (b)(4), accumulated CERT costs with regard to an MSA as of a particular date are the total CERT costs described in paragraph (b)(3) of this section that have been taken into account as of that date under the applicable corporation's method of accounting. For example, CERT costs incurred in the taxable year after the year of the CERT are not included in accumulated CERT costs in the year of the CERT, but are included in accumulated CERT costs during the taxable year in which they are incurred and in any succeeding loss limitation year. Similarly, CERT costs include costs incurred after the date on which a CERT occurs if the CERT consists of multiple steps. See § 1.172(h)-5(a).
(ii) Excess distribution. Except as provided otherwise in this paragraph (b)(4), accumulated CERT costs as of a particular date with regard to an ED are the total CERT costs described in paragraph (b)(3) of this section that have been taken into account as of that date under the applicable corporation's method of accounting, multiplied by a fraction, the numerator of which equals the amount of distributions constituting an ED during the year of the CERT pursuant to § 1.172(h)-1(c)(3), and the denominator of which equals the total amount of distributions made during the year of the CERT. CERT costs include costs incurred after date on which a CERT occurs if the CERT consists of multiple steps. See § 1.172(h)-5(a).
(iii) CERT costs incurred in a year prior to a CERT year. CERT costs incurred in a year prior to the year of the CERT are treated as incurred on the first day of the year of the CERT.
(iv) Year constitutes loss limitation year with regard to multiple CERTs. If a single taxable year constitutes a loss limitation year with regard to more than one CERT, the accumulated CERT costs on any particular date during that year include accumulated CERT costs under this paragraph (b)(4) with regard to all such CERTs. See § 1.172(h)-3(d) for rules regarding computation of a CERIL if a year constitutes a loss limitation year with regard to multiple CERTs.
(5) No netting of interest income and deductions. Allocable interest deductions under paragraph (b)(1) of this section are the deductions allowed for interest on any indebtedness allocable to a CERT. Allocable interest deductions are not netted against a taxpayer's interest income.
(6) Certain unforeseeable events. [Reserved].
(7) Examples. The following examples illustrate the rules of this paragraph (b). Unless otherwise provided, assume that all entities are domestic C corporations that do not join in the filing of consolidated returns and are accrual method taxpayers. Assume that all applicable corporations have substantial NOLs in their loss limitation years:
Example 1.
CERT costs in MSA. (i) Facts. On February 1, Year 5, Corporation A begins investigating the possible acquisition of Corporation T. On March 1, Year 5, A enters into an exclusivity agreement with T. On July 1, Year 5, A engages in an MSA when it acquires all of the stock of T in exchange for cash. A incurs costs for services rendered by its outside counsel and an investment banker. A's outside counsel and the investment banker conduct due diligence on T, determine the value of T, negotiate and structure the transaction with T, draft the purchase agreement, secure shareholder approval, and prepare SEC filings. In addition, the investment banker arranges borrowings to fund both the stock acquisition and A's operations. A also pays a bonus to one of its corporate officers, who negotiated the acquisition of T. Before and after the acquisition is consummated, A incurs costs to relocate personnel and equipment, and to integrate records and information systems.
(ii) Analysis. The CERT costs taken into account by A in computing interest allocable to the CERT include the fair market value of the T stock. See paragraph (b)(3)(i) of this section. The costs incurred on or after the date of the exclusivity agreement, March 1, Year 5, (but not before) to conduct due diligence are also included in A's CERT costs. See paragraph (b)(3)(i) of this section and § 1.263(a)-5(e)(1). A's CERT costs also include all amounts incurred to determine the value of T, negotiate and structure the transaction with T, draft the purchase agreement, secure shareholder approval, and prepare SEC filings. See § 1.263(a)-5(e)(2). In addition, A's CERT costs include borrowing costs that facilitate the CERT. See paragraph (b)(3)(iii) of this section. A's CERT costs do not include any portion of the bonus paid to the corporate officer or the costs incurred to relocate personnel and equipment, and to integrate records and information systems. See § 1.263(a)-5(c)(6) and (d).
Example 2. CERT costs in ED.
(i) Facts. X corporation is a calendar-year taxpayer. On July 1, Year 5, X makes a distribution of $80,000 to its shareholders, $60,000 of which constitutes an ED. X makes no other distributions during Year 5. At previous regular quarterly board of directors meetings, the directors discussed the July 1, Year 5 distribution. On March 30, Year 5, X incurs $2,500 in borrowing costs that constitute CERT costs under paragraph (b)(3)(iii) of this section. In addition, on March 30 and April 15, Year 5, X incurs $500 and $3,000, respectively, for work performed by its outside counsel which facilitates the ED under the principles of § 1.263(a)-4(e). During Year 5, X pays its directors for attendance at the regular quarterly board of directors meetings. No additional CERT costs are incurred in Years 6 and 7.
(ii) CERT costs. X's CERT costs include the fair market value of all distributions made during the year of the CERT ($80,000), as well as the $2,500 of borrowing costs. See paragraph (b)(3)(ii) and (iii) of this section. In addition, under the principles of section § 1.263(a)-4(e), X's CERT costs include the costs incurred for work performed by A's outside counsel related to the ED. See paragraph (b)(3)(ii) of this section and § 1.263(a)-4(e)(1)(i). X's CERT costs do not include amounts paid to X's board of directors to attend the regular board of directors meetings. See § 1.263(a)-4(e)(4)(ii)(B).
(iii) Accumulated CERT costs. Under paragraph (b)(4)(ii) of this section, X's accumulated CERT costs as of a particular date with regard to its ED are the total CERT costs that have been taken into account as of that date multiplied by a fraction the numerator of which equals the amount of distributions constituting ED during the year of the CERT, and the denominator of which equals the total amount of distributions made during the year of the CERT. Here $60,000 is divided by $80,000, which equals 3/4 . The CERT occurs during X's Year 5, and that year is a loss limitation year with regard to the CERT. X's accumulated CERT costs on March 30, Year 5 are $2,250 (3,000 x 3/4 ). X's accumulated CERT costs are $4,500 (6,000 × 3/4 ) on April 15, Year 5 and $64,500 (86,000 × 3/4 ) on July 1, Year 5. X's Years 6 and 7 are also loss limitation years. Because no additional CERT costs are incurred in Years 6 and 7, throughout those years, X's accumulated CERT costs are $64,500.
Example 3.
Accumulated CERT costs in an MSA. (i) All CERT costs incurred in year of CERT. X corporation is a calendar-year taxpayer. On March 1, Year 5, X acquires all of the stock of unrelated corporation T in an MSA. X's loss limitation years are calendar Years 5, 6, and 7. During Year 5, X incurs the following CERT costs: $4,000 on January 30; $50,000 on March 1; and $9,000 on March 15. During Year 5, X's accumulated CERT costs are: $4,000 as of January 30; $54,000 as of March 1; and $63,000 as of March 15. See paragraph (b)(4)(i) of this section. No additional CERT costs are incurred in Years 6 and 7. As a result, throughout Years 6 and 7, X's accumulated CERT costs are $63,000.
(ii) Portion of CERT costs incurred prior to year of CERT. The facts are the same as in paragraph (i) of this Example 3, except during Year 4, X incurs $2,000 of CERT costs. During Year 5, X's accumulated CERT costs are: $2,000 as of January 1 (reflecting costs incurred during Year 4); $6,000 as of January 30; $56,000 as of March 1; and $65,000 as of March 15. See paragraph (b)(4)(i) and (iii) of this section. X is treated as having no accumulated CERT costs during Year 4.
(c) Effective/applicability date. This section is applicable to CERTs occurring on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . This section is also applicable to the deconsolidation of a member from, or the acquisition of a corporation by, a consolidated group that occurs on or after the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register . However, in each case, this section does not apply to any CERT, deconsolidation, or acquisition occurring pursuant to a written agreement that is binding before the date of publication of the Treasury decision adopting these rules as final regulations in the Federal Register .