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Liquidation of Subsidiaries

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    Liquidation of SubsidiariesDefinitionBefore explaining ‘liquidation of subsidiaries’ being the scope of our study in this paper, it is highly essential that we define some of the commerce terms that are frequently used in reference to taxation of corporation/partnerships with, of course,  a passing reference to the US tax system, for the purpose of clarity and easy understanding of the subject under discussion..

    CorporationA corporation is the simplest form of business organization, which is created through a contract with a state. Functioning as an individual entity, separate from its owners, a corporation has the privilege of many legal rights. A corporation is a form of business that has limited liability of its owners and has absolute authority to independently issue shares of transferable stock. A corporation, therefore, is formed by a group of shareholders also called owners.

    The shareholders elect a board of directors, who in turn appoint managers to run the corporation. The management sets goals for the corporation so as to provide a substantial return to its shareholders. But there are various tax implications on these corporations, which make them different from either limited partnership firms or sole proprietorship companies.  (Investment Dictionary – Investopedia, 2007)The C-corporationA C-corporation in the US is one that is formed under the state law.

    Also there is no requirement of election at the federal level for its creation or for its treatment as a small business corporation. But a C-corporation is liable to pay corporate income tax on its profits. The shareholders of C-corporation are equally taxed on their gains or dividends at rates that are ordinary on any income. This two-tier tax application is frequently referred to as the ‘Dual Taxation”.

    (Bernard and Rea, 2004)PartnershipPartnership is an agreement between two or more persons in a joint business venture. The partners pool their funds, skills and sources and pledge to share both profits and losses in the business. Those, looking after day-to-day management of the partnership’s activities, are called ‘General Partners’. Whereas those supplying only money and are not concerned with decisions of the management are called ‘Limited Partners’, and as their name suggests, their liability is restricted to investment alone.

    Partnerships can either be public or private, and therefore in more general terms partnership is a relationship of two or more people running business for mutual profit. (Financial ; Investment Dictionary, 2007)LiquidationLiquidation, an act of liquidating or state of being liquidated, in law means to turn over one’s accounts and assets  to a trustee so that confirmation of one’s debts could be made officialy , and then the assets be made avaialable toward their discharge. Hence liquidation is also the second name for the termination of business and selling of the assets. The proceeds too are used to pay off creditors’ outstanding balances, and leftovers, if any, are distributed among the shareholders.

    (ADVFN 111, n.d.)SubsidiariesThe word subsidiary, which ordinarily means contributory, auxiliary or functioning in a supporting capacity, assumes a significant importance when it is used as an economic term. A subsidiary company, therefore, is the one that is controlled by another company.

    Hence subsidiaries are small companies, which are part of larger companies and are owned and controlled by them. (Encarta and Free Dictionary, 2007)TaxationThe ‘taxation’ is a system of generating funds for government for use in its various services. To raise this money, governments impose tax on both businesses and people. The tax revenue so collected is used by governments to complete their diverse public projects.

    As the role of governments expanded in modern times, the need for tax revenue also increased. But the taxpayers, who are always averse to tax increases, advocate the frugal spending by the government in their activities and services. (Meade, n.d.

    )There are a number of taxes, which governments levy on people and businesses. Some of the important kinds of taxes include.a)      Property Taxesb)      Income Taxesc)      Taxes on Transactions, andd)     Other TaxesThe “Other Taxes” include:I.      Gift taxes, and Estate taxesII.

          Inheritance taxesIII.      Taxes on wealth also called ‘net worth’Note:  It is the federal government in the US, which levies estate and gift taxes while the US state government levies inheritance taxes. (Meade, n.d.

    )Taxation in the United StatesThe United States Constitution gave Congress the authority to levy federal taxes. Using its right, the Congress first introduced a tariff, which was the chief source of federal revenue in 1789. But due to the huge costs in World War-1 (1914-1918), the US government levied a series of additional taxes like the excise taxes. Next a tax on individual incomes called income tax, which was levied in 1894, remained a major source of federal revenue during the1900s.

    Although local as well as state governments depended mainly on property taxes, a large percentage of their tax revenue came from income taxes and sales taxes in 1930s, a period of Great Depression in the US history. Then vide a historic program of ‘New Deal’ President Franklin D. Roosevelt greatly enhanced federal services to help bring economic relief to the already suffering country. The local and federal governments kept increasing their services during the times of World War II (1939-1945) with the result that the US tax system also grew proportionately so as to cope with the new federal projects.

    But in the United States today it is the ‘Individual’, the  ‘Corporate Income Taxes’ and the ‘Social Security Contributions’ which are the chief federal taxes, and bigger portion of the revenue collected from these taxes are used by the state and local governments for projects like public-housing and road-building. (Meade, n.d.)Liquidation of Subsidiaries in the US HistoryInitially, the New Deal had to struggle against various holding companies and like-wise multipart corporate organizations.

    The administration utilized taxation tool to achieve its goals. President Roosevelt pushed the congress through his famous address of 1935, “Taxation the simplification of our corporate structures through the elimination of unnecessary holding companies in all line of business.”As a result of this assertion, voluntary simplification of such corporations began. At the time when the corporate liquidations were in progress, the existing tax law too was in force.

    Therefore, due to the employment of taxation upon the total profits realized, there was hardly any inspiration for the subsidiaries to merge with parent corporations. Then the chairman of the Senate Finance Committee, Senator Harrison issued an amendment in the Revenue Act (1935) just for the purpose of creating an incentive. It was by virtue of this amendment that corporations were substantially provided with an incentive, essentially an option for the parent corporations to postpone profit or loss as a result of liquidation occurring up to 80% of the controlled subsidiaries under the assurance that their assets would be disposed-off by the parent corporation sometimes later. But in spite of the fact that inter-corporate gains were wholly taxable, and the apprehension of a failure in making such distributions, which would make corporations liable to 42½% of full tax on their total retained earnings, there was no provision of a single alike bill within the House.

    (John, 1949)How & When to Liquidate a Subsidiary?Since businesses cannot be transferred to a relative, there is no option for the owner but to sell the business if he or she desires to quit. For selling the business very careful planning is required in advance. The most appropriate time for selling a business is when it is growing as a profitable concern. Before going for a sale, it is important that you take a stock of financial position and allied activities so as to determine the facts on ground and the problems if any.

    It is also advisable to get an valuation of your business from an expert in order to find the true worth of your business project.  The next step is getting a potential buyer located.. One of the trusted ways to locate a prospective buyer is through a business broker who can be hired for this job.

    It has to be preplanned whether you are going for a sale of the company’s stock; its assets, or as merger. The factors influencing your sale plan may include:i.        The tax issuesii.      The seller’s liabilities andiii.

        The terms of contract of the seller. (David and Harlan, 2004) Internal Revenue Code (IRC)The United States Internal Revenue Code (IRC) is published as ’Title 26’ of the USC (United States Code). The salient sections of the IRC under  Title-26 include:a)      The Income Taxesb)      The Estate and Gift Taxesc)      The Employment Taxesd)     The Miscellaneous Excise Taxese)      The Alcohol, Tobacco, and Other Taxes including Excise Taxesf)       The Procedure and Administrationg)      The Taxation’s Joint Committeeh)      The Financing of Presidential Election Campaignsi)        The Trust Fund Codej)        The Coal Industry Health Benefitsk)      The Group Health Plan Requirements (U.S.

    Code collection, 2006)Internal Revenue Code (IRC) – ‘Title-26’ referring to Liquidation of SubsidiariesSection-332 under ‘title 26’, which relates to the  complete liquidation of subsidiaries is located within Internal Revenue Code (IRC) as under: Ø  Title-26 – Internal Revenue CodeØ  Subtitle A – Income TaxesØ  Chapter-1 – Normal Taxes & SurtaxesØ  Subchapter C – Corporate Distributions and AdjustmentsØ  Part-11 – Corporate  LiquidationsØ  Subpart A – EffectsSection. 332. – Complete Liquidations of Subsidiaries1.            The general rule is that “no profit or loss shall be accounted for on the receipt by a corporation of property distributed in complete liquidation of another corporation.

    ”2,            Liquidation to which section.332. meant for the purposes of a distribution which shall deemed to be considered as a complete liquidation provided the following conditions are met:a.

                             At the time of liquidation, the corporation receiving the property would, until the receipt of the property, continue to be the owner of stock that met the requirements of section 1504(a)(2);:orb.                         the distribution by similar corporation in full cancellation of all its stock, as well as the transfer of the entire property shall occur during the taxable year; orc.                         such distribution; total cancellation of istock, transfer of property  vide the liquidation would be completed within 3 years from the time the taxable year gets closed.3.

                The liquidating distributions which are deductible of investment companies. If a corporation receives a distribution from an investment company that is regulated and which is to be treated under subsection-b, then, despite other provision of this chapter, such corporation shall be liable from such company an amount equal to the deduction for dividends paid allowable to such company simply because of such a distribution. 4.            Acknowledgement of Profit on Liquidation of the Holding Companies in particular.

    TaxAlmanac – Sec. 332. (n.p.

    n.d.)The Treasury RegulationsThe Treasury regulation, usually called the ‘Federal tax regulations’ by the U.S.

    Department of Treasury, start off where the IRC (Internal Revenue Code) ends. The Treasury (tax) Regulations, which had been last updated in March 2007 are given below.I.      The Agreements for Payment of Tax Liabilities in Installments: For the purpose of payment of liabilities in installments, provisions are given under Section-6159 of the IRC (Internal Revenue Code), which permits the IRS to make contract with taxpayers.

    The motive behind this program is to brush up the regulations covered under section-6159 so as to highlight some of significant amendments in this section and statutes related to it. The regulations mentioned therein then manage the rejection or acceptance of agreements involving installments. Also these regulations would decide upon the terms of such agreements and as to when they might have to be changed or ceased by the Service. They would also be governing the appeal procedures in case the Service makes a decision about rejection or closure.

      (Reg.-100841-97.  Published March 5, 2007)II.      Distributions of Stock in Certain Tax-Free Reorganizations: Despite that many of the provisions via tax-free re-organization demand a corporation acquiring another corporation to issue stock the shareholders of the acquired corporation, the IRS yet not demands the tax-payers to issue stock on the basis of all-cash-sale of assets within the two corporations, especially when the same people or person possesses the same percentage of stock in both the above corporations.

    Also guidance is provided by the recent regulations on when the same people or person is considered to be owners of the same percentage of the stock in case of both the acquired as well as the acquiring corporation. As a result, therefore, the stock would will not necessary have to be issued on the basis of all-cash-sale of assets between the mentioned corporations. (Reg. No: 157834-06.

      Published March 1, 2007)III.      Depreciation Relating to Like-Kind Exchanges or Involuntary Conversions: By virtue of these regulations, a taxpayer is provided with necessary instructions as to how he might determine the annual depreciation allowance for the property depreciation, which is either relinquished or acquired in such an exchange or through an involuntary exchange.(Reg. No: TD 9314.

      Published March 1, 2007 – Internal Revenue Service) IRS Revenue RulingsThe low-income housing credit bound factor has come out as a satisfactory bond. This IRS Revenue ruling declares the monthly bond factor whose amounts are to be used by taxpayers who sell off eligible low-income buildings or interests involved in these during the period January through March 2005. Vide the revised ruling No: 90-60, 1990-2 C.B.

    3, the IRS (Internal Revenue Service) extended counseling to the taxpayers concerning the general tactics applied by the U.S. Department of Treasury in multiplying the bond factor amounts used in calculating the amount of bond considered satisfactory by the Secretary under Section-42(j)(6) of the Internal Revenue Code. Furthermore it declared that the Secretary in the successive monthly issue of their Internal Revenue Bulletin would publish a Bond Factor Table, amounting to the value of dispositions caused.

    The revised. Proclamation No: 99-11, 1999-1 C.B. 275, established a parallel program as a substitute to the provisions of a surety bond for taxpayers to evade the recapturing of the low-income housing tax credits under s 42(j)(6).

    Under this program, taxpayers are allowed to institute a ‘Treasury Direct Account’ and pledge quite a many United States Treasury securities to the Internal Revenue Service as a security. The revenue ruling as this offers the bond factor amounts for measuring the bond amount that is considered satisfactory under s 42(j)(6) or the United States Treasury securities amounts to be pledged in a ‘Treasury Direct Account’ under revised proclamation No: 99-11 for the outlooks of qualified low-income buildings or interests involved in these for the period from January 2005 to March 2005.(McDonnell, 2005)Federal Tax ProceduresThe procedures described under Federal Tax cover mostly the procedural aspects involved in determining and solving disagreements within federal tax cases, ranging from audits of taxpayers in the IRS to suing tax disputes in the federal courts. The heads under which these controversies are resolved pertain to the following topics:a)      The Refund Claimsb)      The Statutes of Limitationc)      The Administrative Appealsd)     The Forum for Tax Litigatione)      The Refund Litigationf)       The Tax-Court Litigationg)      The Tax Crimes, andh)      The Collection Procedures(Lederman.

    & Mazza. n.p.n.

    d.)Federal Tax CasesProperty Distribution in Complete Liquidation of a SubsidiaryBefore commenting on the no-profit no-loss by a parent company on liquidation of property subsidiary, there is a need to define property tax in its true perspective. The property taxes, which are now levied on the assessed value of properties such as houses, , factories, stores farms, and agriculture equipment, were the first taxes of its kind to become famous in the earlier days. Even in the modern times of today, property taxes are the major source of revenue for state or local governments.

    Property taxes, also called ‘direct taxes’ in the US, are levied on people holding such property and are in force in almost all states of the USA.Liquidating A Controlled C Corporation SubsidiaryThe ‘corporate liquidation’ normally calls for the liquidating corporation to identify gain or loss on the property distribution in absolute liquidation such that the property were sold at its FMV (fair market value) -Sec. 336(a). Under Sec.

    337(a), however, no gain or loss is identified by a ‘liquidating subsidiary’ on a distribution in the entire liquidation of 80% or even greater to the controlling parent company. Whereas under Section 332(b), if two of the below conditions are met, the parent corporation identifies no profit or loss in the property receipt that is distributed in full liquidation of a subsidiary. The conditions are:a)      From the time the liquidation plan is adopted till after the receipt of the distribution, the property receiving parent corporation would remain the owner of the stocks as well as posses at least 80% of the complete voting power of the subsidiary. It will also possess nearly 80% of the total value of the stocks of the subsidiary.

    b)      If the distribution is in the cancellation of all the stocks of subsidiary, and the transfer of entire property occurs within a tax year.Case StudyA]The S corporation Parco, Inc., possesses 100% of Subco, Inc.’s stock, the latter being a C corporation.

    A few shareholders who wish to liquidate Subco in order to lessen the administrative costs involved in running the two companies simultaneously hold the stocks of Parco. But since the Subco possesses significant assets, the shareholders are most worried about the tax cost, which is required to liquidate the subsidiary.As Parco’s liquidation of Subco meets the conditions under Secs. 337 and 332; therefore, Parco will be able to adopt a liquidation plan and directly distribute asset of the Subco in a liquidation that would be tax-free.

    But the assets, which Parco would be receiving, will, however, be subject to the huge tax under Sec. 1374 as a built-in profit for the 10-year period starting from the receipt date. (Albert, 2006)B]The company is assumed as Z in this case study. A corporation named ‘Z’ had 80 % ownership interest in a number of corporations.

    The agreements were made by the Z with its subsidiaries for the filing of a Federal consolidated income tax return for the whole group. According to the terms of agreements each subsidiary was required to pay to the parent corporation an amount equal to their respective shares of amounts, which they would have paid independently had the Federal income tax returns were filed separately for each of its subsidiary. The Z corporation then paid the consolidated income tax amount for all of its subsidiaries combined together and considered as one unit, and especially for the years involved, held back an excess received under the agreements over the amount revealed and made public by the consolidated return.Many of these subsidiary corporations sold their assets, and later the shareholders of each adopted plans of liquidation.

    The liquidations thus made were considered under the provisions under Section 24502 of the Bank and Corporation Tax Law, providing for utter disconcern to profit or loss on the liquidation of certain subsidiary corporationsNote: The Rule of thumb is:The intercorporate payments by the subsidiary corporations or franchise would be considered after the start of liquidation. Also payments by subsidiary corporations to their parent corporation especially after the start of liquidation, would be treated as a distribution in liquidation and interpretted within the meaning of section-24501 of the Revenue and Taxation Code.(Lederman. & Mazza.


    ) ConclusionVide IRS Letter Ruling 200710004 there is a break of dawn on the new reason in establishing the plight of a worthless stock deduction in a consolidated group. Owing to the lack of direct ruling and the absence of clear statutory support for the ruling’s encouraging conclusions, taxpayers may have to recognize the seeking of their own profit via their independent letter rulings through the interpretations of Service’s Letter Ruling No.200710004, in accordance with the principles involving situations outside of a consolidated group. Although according to the Service rule (Rev.

    Rul. 2003-125), a taxpayer can claim a stock deduction under Sec. 165(g) on the conversion of Holding into an LLC, yet it is not considered recommendatory.Hence It should suffice to say that the taxpayer acknowledges a loss, because no amount is considered to have been received with respect to the Holding common stock held by Taxpayer especially when there is no complete liquidation to be found.

    (Lederman. & Mazza. n.p.

    n.d.)ReferencesADVFN 111. “Liquidation.

    ” Retrieved from: Albert B.

    Ellentuck. (2006- Vol. 37, Issue 4 ). “Liquidating A Controlled C Corporation Subsidiary”.

    Retrieved from: Bruce D. Bernard and Rea & Associates Inc.

    Legal Basics for Small Business. The Ohio State Bar Association Funded by the Ohio State Bar Foundation (2004), & D. David Carroll and Harlan S. Louis.

    (2004). “Sale of the Business”. Retrieved from: http://downloads.ohiobar.

    org/pub/LegalBasics/LegalBasics_full.pdf Definition: “ Liquidation.” Retrieved from: http://dict.die.

    net/liquidation/ Encarta. “Subsidiary” (definition). Retrieved from: http://encarta.msn.

    com/encnet/features/dictionary/DictionaryResults.aspx?search=subsidiaries Financial & Investment Dictionary: “Partnership”. Retrieved from: http://www.answers.

    com/topic/partnership?cat=biz-fin Accessed November 14, 2007Internal Revenue Service.

    “Tax Code, Regulations and Official Guidance.” Retrieved from:,,id=98137,00.

    html Investment Dictionary – Investopedia. “Corporation: (definition)”. Retrieved from: http://www.answers.

    com/topic/corporation?cat=biz-fin John A. Busterud .  “The Liquidation of Subsidiaries”.  Section 112 (b)(6).

    The Yale Law Journal, Vol. 58,  (1949), pp. 1050-1067. Retrieved from: http://links. McDonnell, David.

    “Revenue Ruling.” (Tax Links – pub Jan 10, 2005). Retrieved from: http://www.taxlinks.

    com/rulings/findinglist/revrulmaster.htmMeade, Janet A. “Taxation.” Retrieved from: http://www. The Free Dictionary. ‘Subsidiary’ (definition). Retrieved from: http://www. U.S. Code collection.

    (Jan. 2, 2006). “Title 26—Internal Revenue Code.” Retrieved from: http://www. TaxAlmanac.

    Internal Revenue Code:Sec. 332. Complete liquidations of subsidiaries. Retrieved from: http://www.

    _Complete_liquidations_of_subsidiaries Lederman, & Mazza, (Tax Controversies, 2nd ed). Federal Tax Procedure. Retrieved from:     

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