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UNDER THE
"TARP"
TROUBLED ASSET RELIEF PROGRAM
TAX ISSUES - THINGS TO
CONSIDER
The U.S. Treasury Department's
Troubled Asset Relief Program ("TARP") and Capital Purchase
Program ("CPP") (Click
here to read Clark Hill's prior articles on TARP
and CPP) raise a variety of federal income tax issues for
participating financial institutions. The IRS has issued a
series of guidelines to address these issues. Most of them relax the
limits on the use of net operating losses and built-in losses after a
change in ownership. By relaxing these limits, the IRS is attempting
to facilitate the relief for distressed financial
institutions.
TARP, CPP and
the IRS: New Guidelines and Unanswered Questions
Section 382
limits. Section 382 of the Internal Revenue Code limits the
use of net operating losses and built-in losses after a change in
ownership. The purpose is to discourage the acquisition of a
corporation (a "loss corporation") for the purpose of
acquiring the tax losses against future income.
The section
382 limit is based on the value of the loss corporation, the
long-term tax-exempt interest rate, and built-in gains (if any) on
assets of the loss corporation. Ownership changes are defined
in terms of changes in the percentage of stock owned by shareholders
who own 5% or more of the loss corporation's stock. Ownership
changes are measured on testing
dates.
In
Notice 2008-76 the IRS states the Treasury's
acquisition of securities issued by Fannie Mae and Freddie Mac won't
trigger a "testing date" for the section 382 limit.
In
Notice 2008-78 the IRS states a capital contribution
will not be presumed to be part of a plan to avoid or increase the
section 382 limit solely because it is made during the two-year
period ending on the date of an ownership change. In addition
to eliminating the normal adverse presumption, the IRS also provides
safe harbors for taxpayers to use in making capital contributions
that will not be treated as part of such a plan.
In
Notice 2008-83 the IRS states a deduction properly
allowable to a bank after an ownership change for losses on loans or
bad debts (including any deduction for a reasonable addition to a
reserve for bad debts) will not be treated as a built-in loss or a
deduction that is attributable to periods before the ownership
change.
In
Notice 2008-84 the IRS states a date will not be
considered a "testing date" for the section 382 limit if,
at the end of the day, the Treasury directly or indirectly owns more
than a 50% interest in the loss
corporation.
In
Notice 2008-100 the IRS states stock purchases by the
Treasury will not be considered an increase in the percentage of
stock owned by the Treasury, but the stock will be considered
outstanding for purposes of measuring increases in the percentage of
stock owned by other 5% shareholders.
Section 597
assistance. Section 597 of the Internal Revenue Code authorizes
the IRS to issue regulations on the tax treatment of transactions
involving federal financial assistance to banks and building and loan
associations. For example, the IRS has issued regulations on
the allocation of basis among assets purchased with federal financial
assistance. The regulations are supposed to prevent any double
tax benefit such as a deduction for amounts that were, in effect,
reimbursed by nontaxable federal financial assistance.
In
Notice 2008-101 the IRS states no amount furnished by
Treasury to a financial institution pursuant to TARP will be treated
as the provision of federal financial assistance.
Character of
gain or loss on Fannie Mae and Freddie Mac preferred stock. Section 301
of the Emergency Economic Stabilization Act allows qualifying
financial institutions to claim ordinary losses on Fannie Mae or
Freddie Mac preferred stock that was sold after January 1, 2008 and
before September 7, 2008 (if the seller was a qualifying financial
institution at the time of the sale) and preferred stock that was
held on September 6, 2008, and is sold after that date (if the seller
is a qualifying financial institution at all times between that date
and the date of the sale). In
Revenue Procedure 2008-64 the IRS explains how this
applies to qualifying preferred stock sold indirectly through
subsidiaries and pass-through entities and qualifying preferred stock
acquired in transactions resulting in a carryover basis for the
stock.
Analysis and
comments. As usual with taxes, the guidelines are more
complicated than the simple descriptions provided above. They include
many qualifications, limitations, and
exceptions.
The IRS states
the rules provided in the notices are subject to change, but the IRS
promises generally that changes will not be applied
retroactively.
As noted at
the beginning, the IRS is attempting to facilitate relief for
distressed financial institutions, including acquisitions. For
example, Notice 2008-83 may provide the tax savings that, according
to recent news articles, PNC will use to pay for the acquisition of
National City Bank.
But there are
still some unanswered questions. For example, although the Treasury's
investment can be disregarded for certain purposes under section 382,
the Treasury's investment still may be an obstacle to one type of
nontaxable acquisition under section 368. In a nontaxable reverse
triangular subsidiary merger (a common acquisition structure), the
acquiring company must acquire "control" of the target.
This means at least 80% of the target's voting stock and at least 80%
of all other classes of the target's stock (not 80% of the total
value, but 80% of each class). Unless the Treasury's investment
can be disregarded under section 368, too, the parties would have to
find a work-around to satisfy "control" requirements if the
Treasury has made an investment in the target, although not if the
Treasury has made an investment in the acquirer.
So, in
evaluating proposed investments under the CPP, it appears the
Treasury may analyze whether the applicant is (or maybe should be) an
acquirer or a target, and this may affect a bank's prospects for
approval and participation in the CPP. This appears to be what
happened with PNC and National City Bank. In other words, the
CPP seems to put the Treasury in the position of selecting the
survivors.
Clark Hill
will strive to keep you consistently updated and informed about the
Troubled Asset Relief Program and the government's evolving response
to the turmoil in our capital markets. Please contact one of
our Clark Hill banking and financial institutions team members should
you have any questions about TARP or the CPP.
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