The IRS issued final regulations (TD 9534) intended to clarify and simplify rules concerning continuity of accounting methods and inventory methods in certain tax-free corporate reorganizations and liquidations.
The regulations revise regulations under IRC §§ 381(c)(4) and 381(c)(5) and adopt with nonsubstantive modifications proposed regulations issued in 2007 (REG-151884-03). They are intended to provide greater clarity and certainty to rules by which a corporation acquiring the assets of another corporation in a section 381(a) transaction—a distribution under section 332 (liquidation of a subsidiary) or transfer under section 361 (reorganization solely for stock or securities)—determines the method of accounting and inventory it will use.
Under section 381(a), the acquiring corporation succeeds to and takes into account specified items of the distributor or transferor corporation, including its method of accounting and inventory method. Under Treas. Reg. § 1.381(c)(4)-1, if the trades or businesses of the parties to a section 381(a) transaction are operated as separate trades or businesses after the transaction, an otherwise permissible accounting method used by the parties is carried over and used by each trade or business of the acquiring corporation (“carryover method”). If, on the other hand, an integrated trade or business results, the acquiring corporation must determine and use a “principal method.”
The principal method generally is that used by the acquiring corporation before the transaction. However, if the distributor or transferor corporation is larger than the acquiring corporation, the principal method is that of the distributor or transferor corporation immediately before the transaction.
Similar rules under Treas. Reg. § 1.381(c)(5)-1 apply to inventories.
To determine which party to the transaction is larger, for accounting methods, the adjusted bases of the assets and gross receipts are compared to determine the accounting method. For inventories, the fair market value of the parties’ inventories are compared. The final regulations modify this test to specify that the attributes of only the trades or businesses that will be integrated after the transaction are compared, rather than those of the entire entities.
The final regulations also provide rules for identifying a principal method where either of the parties operates more than one separate and distinct trade or business for which it uses more than one method of accounting on the date of the distribution or transfer, and those trades or businesses are combined after the transaction. In addition, the final regulations also clarify the definition of “cut-off basis.”
The final regulations are effective 30 days after their publication in the Federal Register.
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