Loss on Sale to a Commonly Controlled Corporation
As a general rule, taxpayers cannot deduct losses on transactions between related parties. IRC section 267(f) provides a special rule for losses between "commonly controlled" corporations. The loss is deferred rather than denied and is recognized based on the consolidated tax return regulations. A recent Tax Court decision examined the scope of IRC section 267.
Tracinda Corp., a publicly-owned company, controlled MGM, which, in turn, owned UA Corp. In a set of preplanned transactions in 1985, Tracinda sold MGM to Turner Broadcasting Systems (TBS) and then bought UA back. The sale price of UA created a loss in excess of $200 million. Both Tracinda and TBS claimed the loss. The IRS denied the loss to both companies, arguing that the substance of the transaction was a stock redemption rather than a sale resulting in a nondeductible loss.
Result. For TBS. Although the Tax Court decided the case based on temporary regulations under section 267, the decision also applies under the final regulations.
The court first addressed the IRS's reclassification of the transaction under the substance vs. form doctrine and rejected its argument. While the government, the court said, has the right to look through a series of transactions and tax their true substance, meaning it can disregard steps taken solely for tax purposes, it may not create additional new steps nor disregard steps that have economic significance. Each step in the above plan had economic substance; therefore, the court concluded the IRS must determine the taxation based on the actual plan.
The IRS also argued that the two sales were actually one transaction or, if not, they could be treated as sequential. The court rejected this argument as well. It is possible for two transactions to be treated as occurring simultaneously. It is not necessary to treat them as either one transaction or a set of sequential steps. The two sales were independent simultaneous transactions and should be taxed as such.
Finally, the IRS argued that control is measured at the start of the process and that the sale of UA took place at a time when a binding commitment to sell existed—while Tracinda still owned MGM. The Tax Court concluded that section 267(f) applies only to sales between corporations that are commonly controlled after the sale. At the time Tracinda bought UA back, it did not control MGM. Since control must exist after the sale, it is incorrect to apply the binding commitment rule to sales before the affiliation is broken. Instead, the deferral of loss under section 267(f) applies only to actual sales between companies that are commonly controlled after the transaction.
This case restricts the government's right to reclassify transactions to ones that result from multiple steps created solely to generate a tax benefit. It permits taxpayers to plan simultaneous transactions and limits the deferral under section 267(f) to transactions in which control exists after the sale.
- Tracinda Corp . v. Commissioner ; Turner Broadcasting Systems, Inc. v. Commissioner. 111 TC no. 18.
Prepared by Edward J. Schnee, CPA, PhD, Joe Lane Professor of Accounting and director, MTA program, Culverhouse School of Accountancy, University of Alabama, Tuscaloosa.