Section 382 Update - PLR 201032032

On August 13, the IRS released Private Letter Ruling 201032032. For a copy of the ruling, please visit our website

The ruling involved Parent, a publicly traded loss corporation that filed a consolidated return with various entities. On Date 1, Parent had a single class of outstanding Common Stock, all of which was owned by public shareholders, Company 1, and 5 identified shareholders.

On Date 2, Parent issued a new class of stock (Series A Redeemable Convertible Preferred) to Company 2, a new shareholder. The Series A Preferred was convertible into an equal number of shares of Common Stock, participated in dividends on the same basis as the Common stock and had a liquidation preference over the Common Stock. The Series A Preferred was mandatorily redeemable upon either the 10th anniversary of its issuance of a “change of control” event.

On Date 3, Parent redeemed all of the Series A Preferred from Company 2 in exchange for cash, warrants for Common Stock, and shares of a new class of stock – Series B Redeemable Preferred. Unlike the Series A Preferred, the Series B Preferred was not convertible into any other class of Parent stock. However, as the holder of the Series B Preferred, Company 2 held certain voting rights.

PLR 201032032 raised two questions. Specifically, what methodology could Parent, a loss corporation with multiple classes of outstanding stock, use to measure owner shifts for purposes of Section 382(l)(3)(C)? The answer: Parent could use a methodology that employed the Hold Constant Principle (“HCP”). However, in so doing, the IRS ruled that Parent had to meet two consistency requirements. First, Parent’s tax return position must be consistent with its return for the taxable year that it used the HCP methodology. Second, Parent must continue to use the HCP methodology through the first testing date in which it resulted in an “ownership change”.

If anything, this aspect of PLR 201032032 makes clear that taxpayers who use the HCP methodology will have to satisfy certain consistency requirements. Apparently, the IRS is concerned about a taxpayer’s ability to “pick and choose” different methodologies and the ruling clearly precludes that.

The second question in PLR 201032032 involved the transactions occurring on Dates 2 and 3. Specifically, how should the recapitalization of the Series A and Series B Preferred Stock be treated for Section 382 purposes? The answer: It depends. Specifically, it depends on whether the recapitalization is a value-for-value exchange of stock. Without directly addressing the taxpayer’s transaction on Dates 2 and 3, the IRS ruled that when a transaction qualifies as a value-for-value recapitalization, it should be disregarded for Section 382 purposes. In other words, it’s as if the transaction never happened. Therefore, as applied to the facts of PLR 201032032, Company 2 (the exchanging shareholder) would be deemed to have acquired the Series B Preferred Stock on Date 2 – the actual date it acquired the Series A Preferred stock from Parent because the transaction on Date 3 is to be disregarded.