Par. 2. Sections 1.172(h)-0 through 1.172(h)-5 are added to read as follows:
(a) Scope.
(b) Loss limitation years.
(1) In general.
(2) Example.
(c) Computation of a CERIL.
(1) CERT costs.
(2) Limitation on allocable interest deductions.
(i) Lookback period.
(A) In general.
(B) Successor not in existence on date of CERT.
(ii) Computation of three-year average.
(A) In general.
(B) Year of successor transaction.
(3) Examples.
(d) Three-year distribution average.
(e) Effective/applicability date.
(a) Scope. This section provides guidance with regard to the application of section 172(b)(1)(E) and (h), §§ 1.172(h)-1 through 1.172(h)-5, and § 1.1502-72 (the CERT rules) to predecessors and successors (as defined in § 1.172(h)-1(b)(2)).
(b) Loss limitation years —(1) In general. This paragraph (b)(1) applies to identify loss limitation years of a successor. The taxable year in which a corporate equity reduction transaction (CERT) actually occurs is a loss limitation year. See § 1.172(h)-1(e). Any taxable year of a successor (potential loss limitation year) of any applicable corporation is a loss limitation year with regard to the CERT if, under the carryover rules of sections 172(b)(1)(A)(ii) and 381(c)(1), the potential loss limitation year constitutes the first or second taxable year following the taxable year of the corporation that actually engaged in the CERT which includes the date on which the CERT occurred. See § 1.172(h)-5(a) (defining date on which CERT occurs in multiple-step transaction); but see § 1.1502-72(a)(3) (defining loss limitation years of consolidated groups and corporations that were previously members of a consolidated group).
(2) Example. The following example illustrates the rules of this paragraph (b):
Example.
Loss limitation years of successor. T is a domestic C corporation that maintains a calendar taxable year and does not join in the filing of a consolidated return. On March 31, Year 6, T engages in a CERT. On June 30, Year 6, T merges into Corporation A, a calendar-year taxpayer, in a transaction to which section 381(a) applies. T's taxable Year 6 ends on the date of the merger, and A succeeds to T's tax attributes. See section 381(a) and (b)(1). T's only loss limitation year with respect to the Year 6 CERT is its short taxable year ending June 30, Year 6. See section 172(b)(1)(E)(ii) and § 1.172(h)-1(e). Following the merger, A is the successor to T, and A is treated as an applicable corporation with regard to the Year 6 CERT. See § 1.172(h)-1(b)(2). A's calendar Years 6 and 7 are the second and third loss limitation years with regard to the Year 6 CERT. See section 172(b)(1)(E)(ii) and paragraph (b)(1) of this section.
(c) Computation of a CERIL —(1) CERT costs. For purposes of computing any corporate equity reduction interest loss (CERIL) under section 172(h)(1) and § 1.172(h)-2(a)(2), any CERT costs incurred (or treated as incurred under this paragraph (c)) by a predecessor are attributed to the successor. However, such costs are treated as having been incurred by the successor only for purposes of applying the avoided cost rules of section 263A(f)(2)(A) to any measurement date (as defined in § 1.263A-9(f)(2)) after the date of the section 381(a) transaction.
(2) Limitation on allocable interest deductions —(i) Lookback period —(A) In general. The lookback period with regard to a CERT is the three taxable years preceding the taxable year in which the CERT occurs. See § 1.172(h)-3(a). The lookback period that is relevant to the calculation of any CERIL of a successor (successor's lookback period) is the three years preceding the taxable year of the successor that includes the date on which the CERT occurred. See §§ 1.172(h)-5(a) (defining the date on which a CERT occurs if the CERT consists of multiple steps) and § 1.172(h)-3(c) (regarding corporations with insufficient lookback periods).
(B) Successor not in existence on date of CERT. If a successor was not in existence on the date on which the CERT occurred, for purposes of determining the lookback period, the successor is deemed to have additional 12-month periods that end on the calendar date that is one day prior to the date of the corporation's organization. The successor is deemed to have a sufficient number of such additional periods such that the successor is treated as having a year that includes the date on which the CERT occurred and as having three years (the lookback period) immediately preceding the deemed year that includes the date of the CERT. See § 1.172(h)-3(c)(1) regarding lookback period for corporation lacking three-year history.
(ii) Computation of three-year average —(A) In general. Except as otherwise provided in this paragraph (c)(2)(ii), for purposes of determining any three-year average of a successor under section 172(h)(2)(C)(ii) and § 1.172(h)-3, the interest paid or accrued by a successor includes interest paid or accrued by all corporations that are its predecessors as of the end of the successor's taxable year. If the dates of any taxable year of a predecessor do not precisely correspond to the dates of a taxable year of the successor, the interest paid or accrued by the predecessor is apportioned equally to each date of the predecessor's taxable year. The successor is treated as having paid or accrued in any year during the lookback period all predecessor interest that is apportioned to a date within that lookback period year.
(B) Year of successor transaction. In computing the three-year average that is relevant to the taxable year of a successor that includes the date of the section 381(a) transaction that resulted in successor status, the successor includes only a pro rata portion of the predecessor's amount of interest paid or accrued during the successor's lookback period. The pro rata amount equals the predecessor's interest treated as paid or accrued for the dates of the successor's lookback period, multiplied by a fraction, the numerator of which equals the number of days in the loss limitation year of the successor that follow the date of the transaction that resulted in successor status, and the denominator of which equals the number of days in the successor's loss limitation year. The predecessor's amount of interest treated as paid or accrued that is subject to proration under this paragraph (c)(2)(ii)(B) is the interest history of the predecessor that would otherwise be fully combined with the interest history of the successor under paragraph (c)(2)(ii)(A) of this section.
(3) Examples. The following examples illustrate the rules of this paragraph (c). Unless otherwise provided, assume that all entities are domestic C corporations that do not join in the filing of consolidated returns and that maintain calendar taxable years. Assume that all applicable corporations have substantial net operating losses in their loss limitation years:
Example 1.
Predecessor corporation engages in CERT. (i) Facts. Corporation X is a calendar-year taxpayer. On February 1, Year 5, X engages in a CERT. On August 1, Year 5, X merges into unrelated corporation Y in a transaction to which section 381(a) applies. Y is a calendar-year taxpayer and all of its taxable years are full calendar years. All of X's taxable years prior to the year of the merger are full calendar years.
(ii) Analysis. X's only loss limitation year is its short year ending August 1, Year 5. X's lookback period relevant to the Year 5 CERT includes X's calendar Years 2, 3, and 4. See paragraph (c)(2)(i)(A) of this section; see also § 1.172(h)-3(b)(1) (computation of three-year average for a short loss limitation year). Following the merger, Y is the successor to X, and Y is treated as an applicable corporation with regard to the Year 5 CERT. See § 1.172(h)-1(b)(2). Because Y's calendar Year 5 follows a single loss limitation year of X with regard to the same CERT, Y's calendar Years 5 and 6 are loss limitation years with regard to the Year 5 CERT. See paragraph (b)(1) of this section and § 1.381(c)(1)-1(e)(3). Y's lookback period for the Year 5 CERT is its calendar Years 2, 3, and 4. See paragraph (c)(2)(i)(A) of this section. The computations of Y's three-year averages relevant to its loss limitation Years 5 and 6 include interest paid or accrued by Y and by all of Y's predecessors, including X, during the lookback period. See paragraph (c)(2)(ii)(A) of this section. However, because Year 5 is Y's taxable year that includes the date of the section 381(a) transaction that resulted in Y's successor status, for purposes of computing Y's three-year average for Y's loss limitation Year 5, Y includes only a pro rata portion of X's amount of interest paid or accrued. In the proration, X's amount of interest paid or accrued during the 3 year lookback period is multiplied by 151/365 (the number of days in Y's loss limitation Year 5 that follow the date of the section 381(a) transaction that resulted in Y's successor status, divided by the number of days in Y's loss limitation Year 5). See paragraph (c)(2)(ii)(B) of this section.
(iii) Predecessor and successor have different taxable years. The facts are the same as in paragraph (i) of this Example 1, except that X maintained a taxable year ending June 30 before its merger into Y. X's full taxable year ending June 30, Year 5, and its short year ending August 1, Year 5, are its loss limitation years with regard to its February 1, Year 5 CERT. See section 172(b)(1)(E)(ii) and § 1.172(h)-1(e). Following the merger of X into Y, Y is a successor to X and is treated as an applicable corporation with regard to the Year 5 CERT. Y's calendar Year 5 is the third loss limitation year with regard to the CERT. See paragraph (b)(1) of this section. Y's lookback period is Y's three taxable years preceding Y's taxable year that includes the date of the CERT, which are Years 2, 3, and 4. Further, because the dates of X's taxable years do not precisely correspond to the dates of Y's taxable years, X's interest paid or accrued is apportioned equally to each date within each of X's taxable years. Y is treated as having paid or accrued in any year during the lookback period all of X's interest that is so apportioned. See paragraph (c)(2)(ii)(A) of this section. However, because Y's taxable Year 5 includes the date of the section 381(a) transaction that resulted in Y's successor status, for purposes of computing Y's three-year average for loss limitation Year 5, Y includes only a pro rata portion of X's interest history. See paragraphs (c)(2)(ii)(B) of this section.
Example 2.
Successor corporation not in existence for entire lookback period. (i) Facts. Corporation A is formed on October 1, Year 3, and thereafter maintains a calendar taxable year. Immediately after A is formed in Year 3, a second corporation, T, merges into A in a transaction that meets the requirements of section 368(a)(1)(A). During Year 5, A engages in a CERT.
(ii) Analysis. A's loss limitation years are its calendar Years 5, 6, and 7. See section 172(b)(1)(E)(ii). For purposes of computing any CERIL related to the Year 5 CERT, section 172(h)(2)(C)(ii) and § 1.172(h)-3 require that A measure its interest deductions for the three years preceding the taxable year of the CERT (three-year average). However, A is in existence for only two taxable years before the year in which the CERT occurs. Therefore, pursuant to § 1.172(h)-3(c)(1), A is deemed to have an additional taxable period (October 1, Year 2, through September 30, Year 3). Further, in computing the three-year average, A is treated as having paid or accrued zero interest during the deemed year. See § 1.172(h)-3(c)(2). However, because T is the predecessor of A, the computation of A's three-year average relevant to its loss limitation Year 5 includes interest paid or accrued by T during the lookback period (October 1,Year 2, through December 31, Year 4). See paragraph (c)(2)(ii)(A) of this section and § 1.172(h)-3(c)(2). Because T merges into A in a year prior to any loss limitation year, there is no proration of T's interest history under paragraph (c)(2)(ii)(B) of this section.
(d) Three-year distribution average. For purposes of determining any three-year distribution average of a successor under section 172(h)(3)(C)(ii)(I) and § 1.172(h)-1(c)(3), the distributions made by a successor include distributions made by all corporations that are its predecessors as of the end of the successor's taxable year. If the dates of any taxable year of a predecessor do not correspond to the dates of a taxable year of the successor, the distributions made by the predecessor are apportioned equally to each date of the predecessor's taxable year. The successor is treated as having made in its taxable years all predecessor distributions that are apportioned to a date within those taxable years.
(e) 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 .