Section 1.385-4 also issued under 26 U.S.C. 385 and 26 U.S.C. 1502.
Par. 5. Section 1.385-4 is added to read as follows:
(a) Scope. Section 1.385-1(e) provides that members of a consolidated group are treated as one corporation for purposes of the regulations under section 385. This section provides rules for applying § 1.385-3 to consolidated groups when an interest ceases to be a consolidated group debt instrument or becomes a consolidated group debt instrument. For definitions applicable to this section, see § 1.385-3(f).
(b) Debt instrument ceases to be a consolidated group debt instrument but continues to be an expanded group debt instrument —(1) Member leaving the group. When a corporation ceases to be a member of the consolidated group but continues to be a member of the expanded group (such corporation, a departing member ), a debt instrument that is issued or held by the departing member is treated as indebtedness or stock pursuant to paragraphs (b)(1)(i) or (b)(1)(ii) of this section.
(i) Exempt consolidated group debt instrument that ceases to be consolidated group debt instrument. Any exempt consolidated group debt instrument that is issued or held by the departing member is deemed to be exchanged for stock immediately after the departing member leaves the group. For these purposes, the term exempt consolidated group debt instrument means any debt instrument that was not treated as stock solely by reason of the departing member's treatment under § 1.385-1(e). See paragraph (d) of this section, Example 3, for an illustration of this rule.
(ii) Non-exempt consolidated group debt instrument that ceases to be consolidated group debt instrument —(A) In general. Any consolidated group debt instrument issued or held by a departing member that is not an exempt consolidated group debt instrument ( non-exempt consolidated group debt instrument ) is treated as indebtedness unless and until the non-exempt consolidated group debt instrument is treated as a principal purpose debt instrument under § 1.385-3(b)(3)(ii) and (d)(1) as a result of a distribution or acquisition described in § 1.385-3(b)(3)(ii) that occurs after the departure.
(B) Coordination with funding rule. Solely for purposes of applying the 72-month period under § 1.385-3(b)(3)(iv)(B) (the per se rule), a non-exempt consolidated group debt instrument is treated as having been issued when it was first treated as a consolidated group debt instrument. For all other purposes of applying § 1.385-3, including for purposes of applying § 1.385-3(d), a non-exempt consolidated group debt instrument is treated as issued by the issuer of the debt instrument immediately after the departing member leaves the group.
(2) Consolidated group debt instrument that is transferred outside of the consolidated group. Solely for purposes of § 1.385-3, when a member of a consolidated group that holds a consolidated group debt instrument transfers the debt instrument to an expanded group member that is not a member of the consolidated group, the debt instrument is treated as issued by the issuer of the debt instrument (which is treated as one corporation with the transferor of the debt instrument pursuant to § 1.385-1(e)) to the transferee expanded group member on the date of the transfer. For purposes of § 1.385-3, the consequences of such transfer are determined in a manner that is consistent with treating a consolidated group as one corporation. Thus, for example, the sale of a consolidated group debt instrument to an expanded group member that is not a member of the consolidated group will be treated as an issuance of the debt instrument to the transferee expanded group member in exchange for property. To the extent the debt instrument is treated as stock upon being transferred, the debt instrument is deemed to be exchanged for stock immediately after the debt instrument is transferred outside of the consolidated group. For examples illustrating this rule, see paragraph (d) of this section, Examples 1 and 2.
(c) Debt instrument entering a consolidated group. When a debt instrument that is treated as stock under § 1.385-3 becomes a consolidated group debt instrument, immediately before that debt instrument becomes a consolidated group debt instrument, the issuer is treated as issuing a new debt instrument to the holder in exchange for the debt instrument that was treated as stock in a transaction that is disregarded for purposes of § 1.385-3(b).
(d) Examples —(1) Assumed facts. Except as otherwise stated, the following facts are assumed for purposes of the examples in paragraph (d)(3) of this section:
(i) FP is a foreign corporation that owns 100 percent of the stock of USS1, a domestic corporation, and 100 percent of the stock of FS, a foreign corporation;
(ii) USS1 owns 100 percent of the stock of DS1, a domestic corporation;
(iii) DS1 owns 100 percent of the stock of DS2, a domestic corporation;
(iv) At the beginning of Year 1, FP is the common parent of an expanded group comprised solely of FP, USS1, FS, DS1, and DS2 (the FP expanded group);
(v) USS1, DS1, and DS2 are members of a consolidated group of which USS1 is the common parent (the USS1 consolidated group);
(vi) The FP expanded group has more than $50 million of debt instruments described in § 1.385-3(c)(2) at all times;
(vii) No issuer of a debt instrument has current year earnings and profits described in section 316(a)(2);
(viii) All notes are debt instruments described in § 1.385-3(f)(3) and therefore have satisfied any requirements under § 1.385-2, if applicable, and are respected as debt instruments under general federal tax principles;
(ix) No notes are eligible for the ordinary course exception described in § 1.385-3(b)(3)(iv)(B)( 2 );
(x) Each entity has as its taxable year the calendar year;
(xi) No domestic corporation is a United States real property holding corporation within the meaning of section 897(c)(2); and
(xii) Each note is issued with adequate stated interest (as defined in section 1274(c)(2)).
(2) No inference. Except as provided in this section, it is assumed for purposes of the examples that the form of each transaction is respected for federal tax purposes. No inference is intended, however, as to whether any particular note would be respected as indebtedness or as to whether the form of any particular transaction described in paragraph (d)(3) of this section would be respected for federal tax purposes.
(3) Examples. The following examples illustrate the rules of this section.
Example 1.
Distribution of consolidated group debt instrument. (i) Facts. On Date A in Year 1, DS1 issues DS1 Note to USS1 in a distribution. On Date B in Year 2, USS1 distributes DS1 Note to FP.
(ii) Analysis. Under § 1.385-1(e), the USS1 consolidated group is treated as one corporation for purposes of § 1.385-3. Accordingly, when DS1 issues DS1 Note to USS1 in a distribution, DS1 is not treated as issuing a debt instrument to another member of DS1's expanded group in a distribution for purposes of § 1.385-3, and DS1 Note is not treated as stock under § 1.385-3. Under paragraph (b)(2) of this section, when USS1 distributes DS1 Note to FP, the USS1 consolidated group is treated as issuing a debt instrument to FP in a distribution. Accordingly, DS1 Note is treated as DS1 stock under § 1.385-3(b)(2)(i). For this purpose, DS1 Note is deemed to be exchanged for stock immediately after DS1 Note is transferred outside of the USS1 consolidated group.
Example 2.
Sale of consolidated group debt instrument. (i) Facts. On Date A in Year 1, DS1 lends $200x to USS1 in exchange for USS1 Note. On Date B in Year 2, USS1 distributes $200x to FP. On Date C in Year 2, DS1 sells USS1 Note to FS for $200x.
(ii) Analysis. Under § 1.385-1(e), the USS1 consolidated group is treated as one corporation for purposes of § 1.385-3. Accordingly, when USS1 issues USS1 Note to DS1 on Date A in Year 1, USS1 is not treated as a funded member, and when USS1 distributes $200x to FP on Date B in Year 2, § 1.385-2(b)(3) does not apply. Under paragraph (b)(2) of this section, when DS1 sells USS1 Note to FS, the USS1 consolidated group is treated as issuing USS1 Note to FS in exchange for $200x on Date C in Year 2. Because USS1 Note was issued by the USS1 consolidated group to FS within 36 months of the distribution by the USS1 consolidated group to FP, § 1.385-3(b)(3)(iv)(B)( 1 ) treats USS1 Note as issued with a principal purpose of funding that distribution. Accordingly, USS1 Note is a principal purpose debt instrument that is treated as USS1 stock under § 1.385-3(b)(3)(ii)(A). Under paragraph (b)(2) of this section, immediately after USS1 Note is transferred outside of the USS1 consolidated group, USS1 Note is deemed to be exchanged for stock.
Example 3.
Treatment of exempt consolidated group debt instrument when a consolidated group member leaves the consolidated group. (i) Facts. On Date A in Year 1, DS1 issues DS1 Note A to USS1 in a distribution. On Date B in Year 2, USS1 lends $100x to DS1 in exchange for DS1 Note B. On Date C in Year 4, FP purchases 25 percent of DS1's stock from USS1, resulting in DS1 ceasing to be a member of the USS1 consolidated group.
(ii) Analysis. (A) Under § 1.385-1(e), the USS1 consolidated group is treated as one corporation for purposes of § 1.385-3 until Date C in Year 4. Accordingly, when DS1 issues DS1 Note to USS1 in a distribution on Date A in Year 1, DS1 is not treated as issuing a debt instrument to a member of DS's expanded group in a distribution for purposes of § 1.385-3(b)(2), and DS1 Note A is not treated as stock under § 1.385-3 on Date A in Year 1. DS1 Note A is an exempt consolidated group debt instrument because DS1 Note A is not treated as stock on Date A in Year 1 solely by reason of § 1.385-1(e). Under paragraph (b)(1)(i) of this section, immediately after DS1 leaves the USS1 consolidated group, DS1 Note A is deemed to be exchanged for stock.
(B) DS1 Note B is a non-exempt consolidated group debt instrument because DS1 Note B, which is issued in exchange for cash, would not be treated as stock even absent the application of § 1.385-1(e) because there have been no transactions described in § 1.385-3(b)(3)(ii) that would have been treated as funded by DS1 Note B in the absence of the application of § 1.385-1(e). Accordingly, under paragraph (b)(1)(ii)(A) of this section, DS1 Note B is not treated as stock when DS1 ceases to be a member of the USS1 consolidated group, provided there are no distributions or acquisitions described in § 1.385-3(b)(3)(ii) by DS1 that occur later in Year 4 (after Date C).
Example 4.
Distribution after a funded consolidated group member leaves the consolidated group. (i) Facts. The facts are the same as in Example 3, except that on Date D in Year 6, DS1 distributes $100x pro rata to its shareholders ($75x to USS1 and $25x to FP).
(ii) Analysis. The per se rule in § 1.385-3(b)(3)(iv)(B)( 1 ) does not apply to DS1 Note B and the distribution on Date D in Year 6 because under section (b)(1)(ii)(B) of this section, for purposes of applying § 1.385-3(b)(3)(iv)(B)( 1 ), DS1 Note B is treated as issued on Date B in Year 2, which is more than 36 months before Date D in Year 6.
Example 5.
Treatment of non-exempt consolidated group debt instrument when a consolidated group member leaves the group. (i) Facts. On Date A in Year 1, DS2 lends $100x to DS1 in exchange for DS1 Note. On Date B in Year 1, DS1 distributes $100x of cash to USS1. On Date C in Year 1, FP purchases 25 percent of DS2's stock from DS1, resulting in DS2 ceasing to be a member of the USS1 consolidated group.
(ii) Analysis. After DS2 ceases to be a member of the USS1 consolidated group, DS1 and USS1 continue to be treated as one corporation under § 1.385-1(e), such that DS1's distribution of cash to USS1 on Date B in Year 1 continues to be disregarded for purposes of § 1.385-3. Accordingly, DS1 Note is a non-exempt consolidated group debt instrument because DS1 Note, which is issued in exchange for cash, would not be treated as stock even absent the application of § 1.385-1(e) to DS2, because, taking into account the continued application of § 1.385-1(e) to USS1 and DS1, DS1 Note does not fund any transaction described in § 1.385-3(b)(3)(ii). Accordingly, under paragraph (b)(1)(ii)(A) of this section, DS1 Note is not treated as stock when it ceases to be a consolidated group debt instrument, provided there are no distributions or acquisitions described in § 1.385-3(b)(3)(ii) by DS1 that occur later in Year 1 (after Date C).
(e) Effective/applicability date and transition rules —(1) In general. This section applies to any debt instrument issued on or after April 4, 2016, and to any debt instrument treated as issued before April 4, 2016 as a result of an entity classification election made under § 301.7701-3 of this chapter that is filed on or after April 4, 2016.
(2) Transition rule for distributions or acquisitions occurring before April 4, 2016. For purposes of this section, a distribution or acquisition described in § 1.385-3(b)(3)(ii) that occurs before April 4, 2016, other than a distribution or acquisition that is treated as occurring before April 4, 2016 as a result of an entity classification election made under § 301.7701-3 of this chapter that is filed on or after April 4, 2016, is not taken into account.
(3) Transition rule for debt instruments that would be treated as stock prior to the date of publication in theFederal Registerof the Treasury decision adopting this rule as a final regulation. When this section otherwise would treat a debt instrument as stock prior to the date of publication in the Federal Register of the Treasury decision adopting this rule as a final regulation, the debt instrument is treated as indebtedness until the date that is 90 days after the date of publication in the Federal Register of the Treasury decision adopting this rule as a final regulation. To the extent that the debt instrument described in the preceding sentence is held by a member of the issuer's expanded group on the date that is 90 days after the date of publication in the Federal Register of the Treasury decision adopting this rule as a final regulation, the debt instrument is deemed to be exchanged for stock on the date that is 90 days after the date of publication in the Federal Register of the Treasury decision adopting this rule as a final regulation.