internal_revenue_service number release date index number ----------------------------------- ----------------------------------------------- ------------------------ -------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------- id no ----------------- telephone number -------------------- refer reply to cc psi b01 plr-115625-12 date october legend x ------------------------------------------- ----------------------------------------------- a b --------------------------- ---------------------- trust1 -------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------ ------------------------------------------ trust2 ------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------- ------------------------------------------------------ ----------------------------------------- d1 d2 -------------------------- -------------------------- year ------- dear --------------- this responds to a letter dated date submitted on behalf of x by x’s representative requesting relief under sec_1362 of the code plr-115625-12 facts according to the information submitted x is an s_corporation during a’s life a a shareholder of x transferred shares to trust1 trust1 was a_trust described in sec_1361 and was an eligible shareholder of x a died on d1 following a’s death it was intended that the x shares be transferred from trust1 to trust2 trust2 is represented to be eligible to elect to be a qualified_subchapter_s_trust qsst however a qsst election was not made for trust2 the x shares held by trust1 were not transferred to trust2 by d2 as of d2 trust1 was treated as a qsst by x and b the income_beneficiary of both trust1 and trust2 trust1 was however not eligible to elect qsst accordingly x’s s election terminated on d2 when shares of x were held by trust1 and trust1 became an ineligible shareholder x represents that the circumstances resulting in the termination of x’s s_corporation_election were inadvertent x further represents that x and its shareholders have filed their income_tax returns consistent with having a valid s election in effect for all taxable years since x elected to be an s_corporation law and analysis sec_1361 defines a small_business_corporation as a domestic_corporation which is not an ineligible_corporation and which does not a have more than shareholders b have as a shareholder a person other than an estate a_trust described in sec_1361 or an organization described in sec_1361 who is not an individual c have a nonresident_alien as a shareholder and d have more than class of stock sec_1361 of the code provides that for purposes of sec_1361 a_trust all of which is treated under subpart e of part i of subchapter_j of this chapter as owned by an individual who is a citizen or resident_of_the_united_states may be an s_corporation shareholder sec_1361 of the code provides that in the case of a qualified_subchapter_s_trust with respect to which a beneficiary makes an election under paragraph d such trust shall be treated as a_trust described in sub sec_1361 and for purposes of sec_678 the beneficiary of such trust shall be treated as the owner of that portion of the trust which consists of stock in an s_corporation with respect to which the election under paragraph d is made sec_1361 of the code defines the term qualified_subchapter_s_trust as a_trust all of the income within the meaning of sec_643 of which is distributed or plr-115625-12 required to be distributed currently to one individual who is a citizen or resident_of_the_united_states in addition the terms of the trust must require that i during the lifetime of the current income_beneficiary there shall be only one income_beneficiary of the trust ii any corpus distributed during the life of the current income_beneficiary may be distributed only to such beneficiary iii the income_interest of the current income_beneficiary in the trust shall terminate on the earlier of such beneficiary's death or the termination of the trust and iv upon the termination of the trust during the life of the current income_beneficiary the trust shall distribute all of its assets to such beneficiary sec_1362 provides that if an election under a by any corporation was terminated under paragraph sec_1362 or the secretary determines that the circumstances resulting in such termination were inadvertent no later than a reasonable period of time after discovery of the circumstances resulting in such termination steps were taken so that the corporation for which the termination occurred is a small_business_corporation and the corporation for which the termination occurred and each person who was a shareholder in such corporation at any time during the period specified pursuant to sec_1362 agrees to make such adjustments consistent with the treatment of such corporation as an s_corporation as may be required by the secretary with respect to such period then notwithstanding the circumstances resulting in such termination such corporation shall be treated as an s_corporation during the period specified by the secretary conclusion based solely on the facts submitted and representations made we conclude x’s s election terminated on d2 when trust1 became an ineligible shareholder we also conclude that the termination of x’s s_corporation_election was inadvertent within the meaning of sec_1362 accordingly under sec_1362 x will be treated as continuing to be an s_corporation from d2 and thereafter provided that x’s s election is valid and not otherwise terminated under sec_1362 this relief is contingent upon b filing a qsst election for trust2 effective d2 within days from the date of this letter a copy of this letter should be attached to the election in addition within days of the date of this letter trust2 must file original and amended returns treating trust2 as a qsst and treating the x stock as having been transferred to trust2 effective d2 trust1 must file amended returns for all years subsequent to year treating the x stock as having been transferred to trust2 as of d2 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically no opinion is expressed or implied concerning the eligibility of x as an s_corporation or trust2 as a qsst plr-115625-12 this ruling is directed only to the taxpayer requesting it sec_6110 provides that it may not be used or cited as precedent in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to the taxpayer’s authorized representative sincerely faith colson faith colson senior counsel branch office of the associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes cc


internal_revenue_service national_office technical_advice_memorandum date number release date index uil no case mis no tam-117173-02 cc corp b2 taxpayer's name taxpayer's address taxpayer's identification no years involved date of conference legend taxpayer parent subsidiary product unaffiliated product dealer year year year tam-117173-02 issues a under the circumstances described below do the intercompany_transaction regulations require parent to defer the deduction of its rate support payments to subsidiary in year b under the circumstances described below do the intercompany_transaction regulations require subsidiary to accelerate its inclusion of income related to the rate support payments made by parent in year sec_2 and under the circumstances described below is parent prohibited from changing its treatment of its rate support payments to subsidiary for year sec_1 and without the consent of the commissioner conclusions a under the circumstances described below based on the decision in 112_tc_270 the service will not apply sec_1_1502-13 to cause parent to defer the deduction of otherwise currently deductible expenses in year b under the circumstances described below sec_1_1502-13 applies to the rate support transactions in year sec_2 and however application of that regulation does not require subsidiary to accelerate its inclusion of discount income from the retail installment_sales contracts under the circumstances described below parent is prohibited from changing its treatment of its rate support payments to subsidiary for year sec_1 and without the consent of the commissioner facts the information submitted indicates that parent is the common parent of an affiliated_group filing consolidated tax returns on a calendar-year basis subsidiary a wholly-owned subsidiary of parent is a member of parent’s consolidated_group parent and subsidiary maintain separate books_and_records are engaged in separate trades_or_businesses and report their income for federal_income_tax purposes using the accrual_method of accounting parent is in the business of distributing product related parts and accessories parent distributes product primarily through unaffiliated product dealers who purchase product from parent for resale to retail customers tam-117173-02 subsidiary is a captive finance company and provides financing for retail customers of unaffiliated product dealers when a retail customer purchases product from an unaffiliated product dealer the retail customer has the option to execute a retail installment_sales contract risc with the unaffiliated product dealer under which the retail customer agrees to pay for product over the term of the risc subsidiary’s principal business is to acquire these riscs from unaffiliated product dealers parent is responsible for promoting product sales in order to stimulate interest in product and increase sales volume parent provides various incentives to retail customers these incentives include cash rebates discounts and below-market-rate financing in general when both a cash rebate and below-market-rate financing are available the retail customer must choose between these options the retail customer is not eligible for both incentives when a retail customer buys product that is subject_to a cash rebate the cash rebate is paid directly by parent to the retail customer parent treats the payment of a cash rebate as a sales incentive ie a marketing expense when a retail customer buys product subject_to below-market-rate financing parent makes a cash payment the rate support payment to subsidiary the purpose of which is to reimburse subsidiary for having purchased the risc from the unaffiliated product dealer for more than its fair_market_value parent also treats the rate support payment to subsidiary as a sales incentive ie a marketing expense during the years in issue parent sponsored and subsidiary participated in a below-market-rate financing program the retail financing program this retail financing program was for retail customers who purchased from unaffiliated product dealers specified products that the unaffiliated product dealers had previously purchased from parent a the structure of the retail financing program the retail financing program involved parent subsidiary unaffiliated product dealers who elected to participate in the program and retail customers who obtained below-market-rate financing when purchasing a specified product from those dealers the retail financing program was structured as follows parent sold a specific product to an unaffiliated product dealer when a risc carries a below-market interest rate the risc’s fair_market_value is less than its face_amount at issuance tam-117173-02 an unaffiliated product dealer sold the product to a retail customer the retail customer made a cash down payment and executed a risc with the unaffiliated product dealer for the remaining purchase_price at a below-market interest rate established by parent the unaffiliated product dealer assigned the risc to subsidiary in exchange for a cash payment from subsidiary equal to the face_amount of the risc unaffiliated product dealers were not legally required to assign any risc to subsidiary and subsidiary was not legally required to accept any risc offered by unaffiliated product dealers however subsidiary accepted assigned riscs from unaffiliated product dealers provided the retail customer and the terms of the risc met its credit standards when subsidiary acquired a risc from an unaffiliated product dealer subsidiary paid or credited the unaffiliated product dealer the face_amount of the assigned risc at the time of purchase even though the risc carried a below-market interest rate ie the risc’s fair_market_value was less than the risc’s face_amount at issuance subsidiary billed parent for an amount equal to the excess of i the amount subsidiary paid for the risc the risc’s face_amount over ii the risc’s value on the date the unaffiliated product dealer assigned the risc to subsidiary this excess_amount is hereafter referred to as the rate support amount parent paid the rate support amount the rate support payment to subsidiary on a monthly basis as an up-front lump sum amount b the tax_return treatment of the program by parent and subsidiary the information submitted indicates that during years on its books parent accrued each rate support payment as a marketing expense in the year of the transaction with subsidiary solely for purposes of this technical_advice_memorandum we assume that this sales incentive would be deductible currently by parent if it were filing separate_income tax returns subsidiary did not treat each rate support payment as income in the year of its receipt rather subsidiary recorded an amount equal to application of the intercompany_transaction regulations may change tax_accounting treatment of items that are otherwise deductible includible etc under a member’s otherwise applicable method_of_accounting see sec_1 b and a the questions presented under issue do not go to the proper time for taking into account items under the members’ separate methods_of_accounting rather the questions concern whether the intercompany_transaction regulations might override the members’ timing of items under their separate methods_of_accounting tam-117173-02 the rate support payment as unearned discount income from the retail customers and took that amount into income over the term of the associated risc subsidiary took a fair_market_value basis in the risc instead of a basis equal to the risc’s face_amount the amount_paid to the unaffiliated product dealer parent and subsidiary treated the rate support payments as intercompany_transactions pursuant to sec_1_1502-13 in each of the years at issue in an effort to comply with the applicable regulations parent deferred its deductions for the rate support payments so that the deductions would match subsidiary’s discount income earned over the term of the riscs to which the rate support payments related c taxpayer’s proposed position during the course of the audit cycle for years taxpayer filed claims with the internal_revenue_service seeking immediate rather than deferred deductions for the amount of the rate support payments to subsidiary taxpayer now asserts that the intercompany_transaction regulations do not require deferral of parent’s deductions in addition taxpayer asserts that the timing change for the deduction of the rate support payments is not a change in method_of_accounting that requires the prior approval of the commissioner issue a - regulations no intercompany_transaction taxpayer primarily maintains that the rate support payments from parent to subsidiary do not constitute intercompany_transactions under sec_1_1502-13 taxpayer bases its position on the holding of 112_tc_270 issue b - regulations a no corresponding_item of income or intercompany_transaction taxpayer maintains that in order for sec_1_1502-13 to apply in the context of the rate support payments the following basic elements must exist an intercompany_transaction that gives rise to and a member’s transfer of property or services parent’s rate support payment that results in an item of deduction because subsidiary’s basis in the risc is less than the risc’s face_amount subsidiary earns both stated_interest income and discount income from the risc as payments are received from the retail customer for year the relevant authority is sec_1_1502-13 for year sec_2 and the relevant authority is sec_1_1502-13 tam-117173-02 taken into account in one taxable_year and a member’s receipt of the property or services subsidiary’s receipt of the rate support payment that results in a corresponding_item of income in a different taxable_year taxpayer argues that the matching_rule of sec_1_1502-13 does not apply because i the rate support payments are not income to subsidiary but instead reduce subsidiary’s bases in the riscs ii the discount income that subsidiary earns from retail customers is not a corresponding_item of income to parent’s deduction and iii the discount income is not earned from an intercompany_transaction with parent but is earned from a third party the retail customer b clear_reflection_of_income taxpayer emphasizes that the purpose of the regulations under sec_1502 is to ensure that the tax_liability of a consolidated_group may be determined in such manner as to clearly reflect the group’s tax_liability taxpayer maintains that the retail financing program was intended to generate current sales of product taxpayer argues that treating parent’s rate support payments as a non-deferred current deduction clearly reflects the group’s income by matching the rate support payment to parent’s current sales being generated taxpayer argues that deferral of the rate support payments would distort the group’s economic_income issue no change in method_of_accounting taxpayer asserts that the timing change for the deduction of the rate support payments is not a change in method_of_accounting that requires the prior approval of the commissioner law and analysis the filing of consolidated_returns is a privilege extended to affiliated groups sec_1501 by electing to file consolidated_returns members of a consolidated_group consent to be bound by the regulations issued under sec_1502 sec_1501 taxpayer designates parent as s and subsidiary as b in the terminology of the intercompany_transaction regulations we note that these designations should be reversed see sec_1_1502-13 and c ii ex tam-117173-02 a deferral of deductions for parent’s rate support payments to subsidiary in year sec_1_1502-13 provides a definitions intercompany_transaction the term intercompany_transaction means a transaction during a consolidated_return_year between corporations which are members of the same group immediately after such transaction b treatment of intercompany_transactions other than deferred intercompany_transactions special rule if in an intercompany_transaction other than deferred intercompany_transactions one member would otherwise properly take an item_of_income or a deduction into account for a consolidated_return_year earlier than the year whether consolidated or separate for which another member of the group can properly take into account the corresponding_item of income_or_deduction then both the item_of_income and the deduction shall be taken into account for the later year whether consolidated or separate the information submitted indicates that during year parent and subsidiary treated parent’s rate support payments to subsidiary in the retail financing program as i a reduction in the bases of the riscs assigned to subsidiary resulting in discount income and ii intercompany_transactions other than deferred intercompany_transactions under sec_1_1502-13 as a result parent deferred its deductions for those payments in year pursuant to sec_1 a and b taxpayer now claims that the application of sec_1_1502-13 and b to parent’s rate support payments to subsidiary in year was erroneous therefore taxpayer maintains that it was entitled to take into account immediately in its consolidated_return the full amount of the deductions for those rate support payments unless otherwise stated for year all references to sec_1_1502-13 are to the consolidated_return_regulations effective for transactions occurring in years beginning prior to date hereinafter the regulations subsidiary did not take the rate support payments into income currently rather it recorded an amount equal to the rate support payments as discount income earned from the retail customers and took the payments into income over the term of the riscs tam-117173-02 the tax_court recently addressed this issue in 112_tc_270 under facts substantially_similar to those at issue here the tax_court held inter alia that under the regulations rate support payments did not constitute intercompany_transactions thus sec_1 b did not require general motors to defer its deductions for rate support payments to its captive finance subsidiary general motors corp t c pincite based upon the decision in general motors the service will not apply sec_1_1502-13 to parent’s rate support payments to subsidiary consequently parent is not required to defer under sec_1_1502-13 the deduction of otherwise currently deductible expenses in year b acceleration of income inclusion for subsidiary’s receipt of discount income related to rate support payments in year sec_2 and sec_1_1502-13 provides a in general - purpose this section provides rules for taking into account items of income gain deduction and loss of members from intercompany_transactions the purpose of this section is to provide rules to clearly reflect the taxable_income and tax_liability of the group as a whole by preventing intercompany_transactions from creating accelerating avoiding or deferring consolidated_taxable_income or consolidated_tax_liability separate_entity and single entity treatment under this section the selling member s and buying member b are treated as separate entities for some purposes but as divisions of a single corporation for other purposes the amount and location of s’s intercompany items and b’s corresponding items are determined on a separate_entity basis separate_entity treatment for example s determines its gain_or_loss from a sale of property to b on a separate_entity basis and b has a cost_basis in the property the timing and the character source and other attributes of the intercompany items and corresponding items see issue below for discussion of whether parent may change without authorization from the commissioner from deferral to current deduction of parent’s rate support payment unless otherwise stated for year sec_2 and all references to sec_1_1502-13 are to the consolidated_return_regulations effective for transactions occurring in years beginning on or after date hereinafter the regulations tam-117173-02 although initially determined on a separate_entity basis are redetermined under this section to produce the effect of transactions between divisions of a single corporation single entity treatment for example if s sells land to b at a gain and b sells the land to a nonmember s does not take its gain into account until b’s sale to the nonmember timing rules as a method_of_accounting -- i in general the timing rules of this section are a method_of_accounting for intercompany_transactions to be applied by each member in addition to the member’s other methods_of_accounting see sec_1_1502-17 s’s or b’s application of the timing rules of this section to an intercompany_transaction clearly reflects income only if the effect of that transaction as a whole on consolidated_taxable_income is clearly reflected b definitions for purposes of this section - intercompany_transactions - i in general an intercompany_transaction is a transaction between corporations that are members of the same consolidated_group immediately after the transaction s is the member transferring property or providing services and b is the member receiving the property or services intercompany_transactions include - a s’s sale of property or other transfer such as an exchange or contribution to b whether or not the gain_or_loss is recognized b s’s performance of services for b and b’s payment or accrual of its expenditure for s’s performance c s’s licensing of technology rental of property or loan of money to b and b’s payment or accrual of its expenditure and d s’s distribution to b with respect to s stock intercompany items - i in general s’s income gain deduction and loss from an intercompany_transaction are its intercompany items an item is an intercompany_item whether it is directly or indirectly from an intercompany_transaction tam-117173-02 iii amounts not yet recognized or incurred s’s intercompany items include amounts from an intercompany_transaction that are not yet taken into account under its separate_entity method_of_accounting for example if s is a cash_method taxpayer s’s intercompany income might be taken into account under this section even if the cash is not yet received similarly an amount reflected in basis or an amount equivalent to basis under s’s separate_entity method_of_accounting that is a substitute for income gain deduction or loss from an intercompany_transaction is an intercompany_item corresponding items - i in general b’s income gain deduction and loss from an intercompany_transaction or from property acquired in an intercompany_transaction are its corresponding items an item is a corresponding_item whether it is directly or indirectly from an intercompany_transaction or from property acquired in an intercompany_transaction recomputed corresponding items the recomputed_corresponding_item is the corresponding_item that b would take into account if s and b were divisions of a single corporation and the intercompany_transaction were between those divisions for example if s sells property with a dollar_figure basis to b for dollar_figure and b later sells the property to a nonmember for dollar_figure b’s corresponding_item is its dollar_figure loss and the recomputed_corresponding_item is dollar_figure of gain determined by comparing the dollar_figure sales_price with the dollar_figure basis the property would have if s or b were divisions of a single corporation although neither s nor b actually takes the recomputed_corresponding_item into account it is computed as if b did take it into account based on reasonable and consistently applied assumptions including any provision of the internal_revenue_code or regulations that would affect its timing or attributes c matching_rule for each consolidated_return_year b’s corresponding items and s’s intercompany items are taken into account under the following rules timing - i b’s items b takes its corresponding items into account under its accounting_method ii s’s items s takes its intercompany_item into account to reflect the difference for the year between b’s corresponding_item taken into account and the recomputed_corresponding_item tam-117173-02 divisions of a single corporation as divisions of a single corporation s and b are treated as engaging in their actual transaction and owning any actual property involved in the transaction rather than treating the transaction as not occurring the precise accounting issue as to the rate support transactions described herein is different under the regulations than under the regulationsdollar_figure as illustrated in general motors v commissioner supra under the regulations at issue was the current deduction of parent’s expense see sec_1 b in contrast under the regulations it is clear that parent’s otherwise deductible expense corresponding_item is not to be deferred see sec_1_1502-13 b takes its corresponding items into account under its accounting_method rather the issue is whether subsidiary is required to accelerate its income to match parent’s deduction in order to clearly reflect the income of the consolidated_group see sec_1_1502-13 s takes its intercompany_item into account to reflect the difference for the year between b’s corresponding_item taken into account and the recomputed_corresponding_item based on the foregoing under sec_1_1502-13 the two possible resolutions in the case at hand are parent currently deducts the rate support payment and subsidiary takes discount into income over the term of the risc ie under subsidiary’s otherwise applicable separate method_of_accounting or parent currently deducts the rate support payment and subsidiary accelerates the related discount income to match parent’s deduction deferral of parent’s item is not an option the information submitted indicates that during year sec_2 and parent and subsidiary treated parent’s rate support payments to subsidiary in the retail financing program as i a reduction in the basis of the riscs assigned to subsidiary resulting in discount income and ii intercompany_transactions under sec_1_1502-13 as a result parent deferred its deductions for those payments in year sec_2 and in an attempt to comply with sec_1_1502-13 b and c we note that for year sec_2 and the examination_division and taxpayer have framed the issue in terms of parent’s current deduction of the rate support payments based upon the changes made to the intercompany regulations in we have reframed the issue to focus upon subsidiary’s inclusion of the discount income related to these rate support payments subsidiary recorded an amount equal to the rate support payment as discount income earned from the retail customers and took the payments into income over the term of the riscs tam-117173-02 taxpayer now claims that the application of sec_1_1502-13 to parent’s rate support payments to subsidiary in year sec_2 and was erroneous taxpayer maintains that the intercompany_transactions regulations do not apply to the rate support payments because the rate support payments do not constitute intercompany_transactions and neither the rate support payments nor the discount income on the riscs constitute corresponding items to subsidiary further taxpayer argues that even if the intercompany_transactions apply parent must currently deduct the rate support payments in order to clearly reflect the income of the consolidated_group therefore taxpayer maintains that it was entitled to currently deduct on its consolidated_return the full amount of the rate support payments as indicated above based upon the tax court’s decision in general motors the service will not apply the intercompany_transaction regulations to parent’s rate support payments however the tax court’s discussion and analysis in general motors is expressly limited to the regulations and thus is inapplicable to the regulations the intercompany_transaction regulations were significantly altered in the amendments apply to transactions occurring in years beginning on or after date thus they apply to year sec_2 and at issue herein applicability of the regulations -- existence of intercompany_transaction and corresponding_item taxpayer asserts that the intercompany_transaction regulations do not apply to the rate support payments from parent to subsidiary during year sec_2 and because such payments do not constitute intercompany_transactions however under the regulations the definition of intercompany_transaction is very broad a transaction between corporations that are members of the same consolidated_group immediately after the transaction sec_1_1502-13 in addition the examples in the regulations make clear that a wide variety of transactions were intended to fall within the rule see sec_1_1502-13 sale of property performance of services licensing of technology rental of property extension of loan corporate distribution and c ii ex sec_351 contribution and ex manufacturer incentive payment further the definitions of intercompany_item and corresponding_item discussed below reinforce the broad reach of these regulations therefore we conclude that the rate support payments from parent to subsidiary constitute intercompany_transactions taxpayer also argues that the intercompany_transaction regulations do not apply to the transaction because neither the discount income received by subsidiary over the the tax_court states the amendments are not before the court therefore we make no conclusions as to whether these amendments are valid general motors corp t c pincite n tam-117173-02 term of a risc nor the rate support payment itself constitutes a corresponding_item to subsidiary under the regulations we note here that because parent is the paying party in the transaction it is designated as the buying member or b under the regulations therefore parent’s expense item would constitute the corresponding_item in the transaction see sec_1_1502-13 and i subsidiary’s income would constitute the intercompany_item or items see sec_1 b i see also sec_1_1502-13 ex however because of the similarities in the definitions of intercompany_item and corresponding_item taxpayer’s misapprehension is of no consequence in substance taxpayer asserts that the discount income cannot constitute an intercompany_item because subsidiary receives it from a third party however the broad definitions of intercompany_item and corresponding_item adopted by the regulations make clear that such items may flow directly or indirectly from an intercompany_transaction sec_1_1502-13 and i therefore the regulations contemplate a situation in which a group member may receive from a non-member party a payment containing either a corresponding_item or an intercompany itemdollar_figure thus we conclude that the discount income received by subsidiary constitutes an intercompany_item we have concluded that under the regulations the rate support payments from parent to subsidiary constitute intercompany_transactions parent’s rate support payments constitute corresponding items and subsidiary’s discount income receipts from the riscs constitute intercompany items therefore we next examine how application of the regulations will effect the timing of these items proper application of the regulations -- clear_reflection_of_income standard taxpayer argues that even if the intercompany_transaction regulations apply to the rate support transactions application of the regulations should result in no deferral of parent’s otherwise deductible rate support payment taxpayer argues that current deduction is necessary to clearly reflect the income of the consolidated_group the purpose of the intercompany_transaction regulations is to clearly reflect the taxable_income and tax_liability of the group as a whole by preventing intercompany_transactions from creating accelerating avoiding or deferring consolidated_taxable_income or consolidated_tax_liability sec_1 see eg sec_1_1502-13 ex see also sec_1 b iii an amount reflected in basis under s’s separate_entity method_of_accounting that is a substitute for income gain deduction or loss from an intercompany_transaction is an intercompany_item tam-117173-02 a therefore these regulations must be applied in such a way as to reach a timing result that clearly reflects the income of the consolidated_group under the regulations the timing of the inclusion of b’s corresponding_item in any year generally controls the timing of the inclusion of s’s intercompany_item sec_1_1502-13 and ii however the clear_reflection_of_income principle controls the overall timing of items that clear reflection standard is represented in the calculation of the recomputed_corresponding_item which is the hypothetical item that b would take into account if s and b were divisions of a single corporation and the intercompany_transaction were between those divisions sec_1_1502-13 the clear_reflection_of_income standard is imposed in each year by application of the following formula recomputed_corresponding_item minus corresponding_item equals intercompany_item that is the amount of s’s intercompany_item taken into income in any year equals the hypothetical amount that the single-entity would take into account for that year recomputed_corresponding_item minus the amount of b’s corresponding_item in this case the amount of subsidiary’s intercompany_item discount income to be taken into income in each year is equal to the group’s hypothetical single entity item minus parent’s corresponding_item rate support payment dollar_figure therefore the proper application of the intercompany_transaction regulations hinges on the appropriate single-entity tax treatment of the risc-acquisition transaction that is for this purpose we assume that a hypothetical parent-subsidiary single-entity acquired a below-market interest rate risc at face value rather that fair_market_value in order to stimulate interest in product and to increase sales volume the question to be answered is whether the hypothetical single-entity’s income would be clearly reflected to the extent that it currently deducted eg as a marketing expense the spread between fair_market_value and face value of that risc deductibility on hypothetical single-entity basis sec_162 provides that a deduction is allowed for all ordinary and necessary expenses paid_or_incurred during the taxable_year in carrying on any trade_or_business sec_1_162-1 provides that selling_expenses generally constitute business_expenses within the meaning of sec_162 as discussed in the facts section of this document the current deductibility of the rate support payment by parent if it were filing a separate_return is not addressed by this technical_advice_memorandum tam-117173-02 sec_1012 provides that the basis_of_property is generally the cost of such property sec_1_1012-1 provides that the cost is the amount_paid for such property in cash or other_property thus in a money-for-property transaction cost is equal to the price paid for the property 19_tc_275 acq 1953_1_cb_4 however this rule does not apply where a transaction is not conducted at arm’s length between two economically self-interested parties or where there are peculiar circumstances that influence the purchaser to agree to a price greater than the property’s fair_market_value see eg 77_tc_1326 acq 1983_2_cb_1 58_tc_757 acq 1975_2_cb_1 regan v commissioner t c memo in such cases the basis in purchased property may be limited to its fair_market_value see eg lemmen t c pincite 17_tc_870 41_bta_223 aff’d 117_f2d_187 7th cir the amount_paid in excess of fair_market_value should be treated in accordance with the substance of the transaction see lemmen t c pincite in lemmen the taxpayer purchased two herds of cattle one for dollar_figure and one for dollar_figure at the time of purchase the fair_market_value of each herd was about dollar_figure simultaneously with each purchase the taxpayer entered into a maintenance contract under which the seller agreed to breed and provide care for the herd the stated consideration for the maintenance contracts was worth less than the fair_market_value of the services to be provided under the contracts the court found that the dealings between the parties were carried on at arm’s length and that the buyer and seller were each economically self-interested however because the stated price for the herds was inflated while the stated consideration for the maintenance contracts was unrealistically low the court found that the taxpayer in substance purchased a package that included the herd and the maintenance contract because of these peculiar circumstances for depreciation and investment_tax_credit purposes the court limited the taxpayer’s basis in the cattle to the cattle’s fair_market_value dollar_figure per herd the court held that the amount_paid in excess of the fair_market_value of the cattle was allocable to the maintenance contracts see also regan t c memo same result on similar facts in revrul_89_102 1989_2_cb_202 a foreign_corporation agreed to sell a product to a foreign government at a price in excess of the product’s fair_market_value as a condition of this transaction the foreign government required the domestic corporate parent of the foreign_corporation to purchase another product also at an inflated price from an unrelated third party the service ruled that the two transactions were related and limited the domestic corporation’s basis in the property it purchased to the property’s fair_market_value tam-117173-02 in other cases courts have also limited a taxpayer’s basis to the fair_market_value of acquired property where special circumstances or the relationship between the parties have caused a taxpayer to pay more than fair_market_value for the property in 120_f2d_12 8th cir the taxpayer purchased securities from a bank at a price in excess of fair_market_value virtually all of the taxpayer’s stock was owned by stockholders of the bank or relatives of a principal_stockholder of the bank the court held that the excess_amount paid for the securities was actually paid to improve the condition of the bank and was not part of the taxpayer’s basis in the securities for purposes of computing gain_or_loss on a subsequent sale in 2_tc_708 nonacq c b aff’d 146_f2d_697 1st cir an insurance_company repurchased its own stock from some of its agents at a price above fair_market_value the insurance_company paid the excess_amount because of a moral obligation to keep faith with its agents who had purchased the stock as an investment before its value declined the court stated that p rices in excess of market paid for personal reasons are not the correct measure of cost n h fire ins co t c pincite the court held that the taxpayer did not incur a deductible loss upon the subsequent resale because the excess_amount was not part of the taxpayer’s basis in the stock in 60_tc_872 aff’d 514_f2d_1209 8th cir the taxpayer along with others organized an insurance_company and received options to purchase the company’s stock other shareholders subsequently sued the corporation and its incorporators for violating s e c rules by not disclosing that stock sold to incorporators was unrestricted as to resale while stock sold to the general_public had provisions restricting subsequent sales as a result the taxpayer and other incorporators purchased some of the stock from other shareholders at a price in excess of fair_market_value at that time the taxpayer made these purchases to protect his business reputation and future earnings not to acquire more stock in the insurance_company the taxpayer deducted the excess_amount paid for the stock the court held that the taxpayer’s basis in the stock was equal to the entire amount_paid for it and that no part of the payment was deductible the court distinguished majestic securities corp and new hampshire fire insurance co on the grounds that the parties in those cases were related and set a higher price to enhance the financial position of the seller in jordan however the parties were dealing at arm’s length and the price did not reflect the taxpayer’s desire to aid the seller under the retail financing program the hypothetical single-entity parent and subsidiary pays a price in excess of fair_market_value to acquire a risc from an unaffiliated product dealer the parent-subsidiary single-entity would not ordinarily pay a premium to acquire a risc that carried a below-market interest rate parent initiated the retail financing program to encourage retail customers to purchase product from unaffiliated product dealers as a result parent hoped to increase its sales of product thus the rate support payment should not be treated as part of the basis in tam-117173-02 the risc because in substance it was not part of the cost of acquiring the risc rather it was an incentive payment that was essentially passed along to the customer in the form of below-market-rate financing therefore the rate support payment is properly treated as a selling or marketing expense paid to stimulate sales of product as such the rate support payment should be deductible under sec_162 in the taxable_year paid_or_incurred conclusion - issue b the facts of this technical_advice_memorandum assume that parent b is entitled to currently deduct its rate support payment corresponding_item to subsidiary under its separate method_of_accounting we have concluded above that the hypothetical single-entity would be permitted to deduct the intentional overpayment ie the spread between face_amount and fair_market_value on acquisition of a risc therefore subsidiary’s intercompany_item inclusion for the year of the rate support payment transaction computes as follows under sec_1_1502-13 full amount of the spread recomputed_corresponding_item minus full amount of the spread corresponding_item equals intercompany_item consequently we conclude that under the given facts no acceleration by subsidiary is required in the year of the rate support transaction to satisfy the clear_reflection_of_income standard embedded in the purpose statement of the intercompany_transaction regulations see sec_1_1502-13 the intercompany_transaction regulations will not cause a change in the timing of subsidiary’s income inclusiondollar_figure c change in method_of_accounting sec_446 of the internal_revenue_code provides that taxable_income shall be computed under the method_of_accounting on the basis of which the taxpayer regularly computes its income in keeping its books no uniform method_of_accounting can be prescribed for all taxpayers each taxpayer may adopt such forms and systems as are in its judgment best suited to its needs however no method_of_accounting is acceptable unless in the opinion of the commissioner it clearly reflects income a method_of_accounting which reflects the consistent application of generally_accepted_accounting_principles in a particular trade_or_business in accordance with accepted conditions or practices in that trade_or_business will ordinarily be regarded as clearly reflecting income provided all items of see issue below for discussion of whether parent may change without authorization from the commissioner from deferral to current deduction of parent’s rate support payment tam-117173-02 gross_income and expense are treated consistently from year to year sec_1_446-1 sec_446 requires that a taxpayer use a method_of_accounting that clearly reflects income if a method_of_accounting does not clearly reflect income the taxpayer may be required to compute taxable_income using a method that in the opinion of the commissioner does clearly reflect income sec_446 prohibits a taxpayer from changing the method_of_accounting used to compute taxable_income without first securing the commissioner’s consent the term method_of_accounting includes not only the over-all method_of_accounting but also the accounting treatment of any material_item sec_1 e ii a a material_item is any item which involves the proper time for the inclusion of the item in income or the taking of a deduction see sec_1_446-1 in most cases a method_of_accounting is established by a pattern of consistent treatment of an item id when a taxpayer treats a material_item in the same way in determining gross_income or deductions on two or more consecutively filed tax returns such treatment represents consistent treatment of that item for purposes of sec_1_446-1 and the taxpayer has effectively adopted a method_of_accounting for that item see revrul_90_38 1990_1_cb_57 see also 891_f2d_1579 fed cir cert_denied 498_us_823 the commissioner’s consent is required even where the method currently being used is not proper or permitted under the code and regulations sec_1_446-1 see also 115_tc_554 a method_of_accounting includes ‘the consistent treatment of a recurring material_item whether that treatment be correct or incorrect ’ quoting 53_tc_439 aff’d 443_f2d_965 6th cir sec_1_446-1 provides that a change in method_of_accounting does not include correction of mathematical or posting errors or errors in the computation of tax_liability such as errors in computation of the foreign_tax_credit net_operating_loss percentage_depletion or investment_credit the filing of consolidated_returns is a privilege extended to affiliated groups see sec_1501 sec_1502 provides that the secretary shall prescribe such regulations as he may deem necessary in order that the tax_liability of any affiliated_group_of_corporations making a consolidated_return and of each corporation in the group both during and after the period of affiliation may be returned determined computed assessed collected and adjusted in such manner as clearly to reflect the income_tax_liability and the various factors necessary for the determination of such liability and in order to prevent avoidance of such tax_liability tam-117173-02 sec_1_1502-12 provides that the separate_taxable_income of a member is computed in accordance with the provisions of the code covering the determination of taxable_income of separate corporations subject_to certain modifications found in sec_1_1502-12 through r sec_1_1502-12 provides that transactions between members and transactions with respect to stock bonds or other obligations of members shall be reflected according to the provisions of sec_1 and sec_1_1502-12 provides that transactions between members and transactions with respect to stock bonds or other obligations of members shall be reflected according to the provisions of sec_1 sec_1_1502-12 provides that the method_of_accounting under which separate_taxable_income is computed and the adjustments to be made because of any change in method_of_accounting shall be determined under sec_1_1502-17 sec_1_1502-13 provides that an intercompany_transaction means a transaction during a consolidated_return_year between corporations which are members of the same group immediately after such transaction sec_1_1502-13 provides that if in an intercompany_transaction other than deferred intercompany_transactions one member would otherwise properly take an item_of_income or a deduction into account for a consolidated_return_year earlier than the year whether consolidated or separate for which another member of the group can properly take into account the corresponding_item of income_or_deduction then both the item_of_income and the deduction shall be taken into account for the later year whether consolidated or separate sec_1_1502-13 acknowledges that its purpose is to provide rules to clearly reflect the taxable_income and tax_liability of the group as a whole by preventing intercompany_transactions from creating accelerating avoiding or deferring consolidated_taxable_income or consolidated_tax_liability sec_1_1502-13 states that the timing rules of this section are a method_of_accounting for intercompany_transactions to be applied by each member in addition to the member’s other methods_of_accounting sec_1_1502-17 provides that the method_of_accounting to be used by each member of the group shall be determined in accordance with the provisions of sec_446 as if such member had filed a separate_return tam-117173-02 sec_1_1502-17 provides that if a member of a group changes its method_of_accounting for a consolidated_return_year the terms and conditions prescribed by the commissioner under sec_446 shall apply to the member for the years at issue subsidiary treated the rate support payments as a reduction in its basis in the riscs and reported an equivalent amount as discount income over the term of the related riscs believing that these transactions constituted intercompany_transactions under sec_1_1502-13 parent deferred its deductions for the rate support payments until subsidiary took the amounts into income on march taxpayer filed a refund claim for each of year year and year the claim_for_refund asserts that rate support payments made by parent to subsidiary are not intercompany_transactions that must be accounted for pursuant to sec_1_1502-13 of either the regulations or the regulations in addition taxpayer asserts that the timing change for the deduction of the rate support payments is not a change in method_of_accounting that requires the prior approval of the commissioner whether parent may change the time for deducting rate support payments in year without first securing the commissioner’s consent16 sec_446 prohibits a taxpayer from changing an accounting_method used in the computation of taxable_income without first securing the commissioner’s consent thus once a taxpayer has established a method_of_accounting the taxpayer cannot unilaterally begin using a different method_of_accounting to compute its taxable_income the consent requirement applies even where the method currently in use is an impermissible method timing and consistency are the hallmarks of a method_of_accounting the consistent treatment of a material_item establishes a method_of_accounting a material_item is any item that involves the proper time for including an item in income or the taking of a deduction thus a taxpayer establishes a method_of_accounting by the application of a timing rule to a particular type of expense in two or more consecutive tax returns see revrul_90_38 1990_1_cb_57 see also 891_f2d_1579 fed cir cert_denied 498_us_823 unless otherwise stated for year all references are to sec_1_1502-13 tam-117173-02 parent’s separate_taxable_income for all years at issue was computed under sec_1_1502-12 which incorporates the timing provisions of sec_1_1502-13 sec_1_1502-12dollar_figure under taxpayer’s reading of sec_1_1502-13 parent consistently deferred its deductions for the rate support payments made to subsidiary so that the deductions would match subsidiary’s discount income the amount of each rate support payment parent deducted in a particular year was equal to the amount of discount income that subsidiary took into account from the risc to which the rate support payment related parent’s treatment of rate support payments did not affect whether rate support payments would be deducted it only affected when those payments would be deducted indeed taxpayer acknowledges that parent’s treatment of rate support payments only involved the timing of the deduction for rate support payments taxpayer argues that parent’s consistent treatment of rate support payments did not establish a method_of_accounting even though such treatment only affected the proper time for taking a deduction taxpayer’s assertion is based on the central premise that parent’s tax_accounting method for rate support payments was the accrual_method taxpayer argues that parent’s systematic deferral of deductions for rate support payments that were otherwise allowable for a particular year under the accrual_method was not an accounting_method thus according to taxpayer the claim_for_refund is based on the proper application of parent’s previously-established accrual_method for rate support payments not a change from a deferral method to the accrual_method taxpayer believes that parent’s tax_accounting method was the accrual_method because it consistently deducted rate support payments in the year made on its separate corporate books it then made adjustments for purposes of computing taxpayer’s consolidated_taxable_income those adjustments taxpayer argues were not part of parent’s method_of_accounting but part of the consolidated group’s method of reporting we disagree sec_446 requires a taxpayer to compute its taxable_income under the method_of_accounting used in keeping the taxpayer’s books for nearly a half-century the term books for purposes of sec_446 has been interpreted so as to include memorandum journal entries and accounting workpapers containing accounting adjustments necessary to convert the items of income and expense recorded in the under sec_1_1502-12 and a member’s separate_taxable_income is computed as if it were a separate corporation subject_to certain modifications found in sec_1_1502-12 through r including adjustments required under sec_1_1502-13 the group’s consolidated_taxable_income is determined by taking into account the separate_taxable_income of each member of the group and certain other listed items sec_1_1502-11 tam-117173-02 taxpayer’s books to the tax_accounting method see 258_f2d_544 this interpretation is necessary because financial_accounting and tax_accounting have different criteria for income inclusion and expense deductiondollar_figure for example a business_entity may establish a reserve for estimated expenses for financial_accounting purposes but is not eligible to deduct those expenses for tax_accounting purposes until the all-events test is satisfied thus an adjustment must be made to the financial books so that the tax accrual_method is properly applied similarly amounts that are deductible in a certain period for financial purposes that also meet the all-events test may be capitalized into inventory or into other_property for tax purposes but not financial_accounting purposes here again an adjustment for tax purposes is necessary these adjustments are part of the taxpayer’s books for purposes of sec_446 and the result of the adjustments from the books of original entry to the income_tax computation is the taxpayer’s method_of_accounting for federal_income_tax purposes in the instant case parent made accounting adjustments to its original bookkeeping entries so that the rate support payments that otherwise met the all-events test for accrual of deductions during the taxable_year were taken into account over several years these accounting adjustments were part of parent’s books_and_records for purposes of sec_446 moreover these adjustments resulted in the computation of parent’s separate_taxable_income using the method_of_accounting that parent used in keeping its books thus taxpayer’s assertion that parent’s method_of_accounting was the accrual_method because parent consistently deducted rate support payments in the year made on its separate corporate books is incorrect insofar as sec_446 is concerned for purposes of sec_446 parent’s method_of_accounting was to defer its deductions for the rate support payments made to subsidiary so that the deductions would match the amount of discount income that subsidiary took into account from the risc to which the rate support payment related whether parent’s deferral of deductions for rate support payments was permissible or not its treatment of the deductions constituted a method_of_accounting and under sec_446 cannot be changed without first securing the commissioner’s consent this interpretation is also necessary for the appropriate application of the consent requirement of sec_446 on its face sec_446 requires the commissioner’s consent to a tax_accounting method change only where the taxpayer has also changed its book accounting_method nonetheless since the adjusting entries are part of the book accounting_method the commissioner’s consent is also necessary in situations where a taxpayer changes its tax_accounting method without changing its basic bookkeeping method without the patchen rule the accounting oversight role congress assigned to the commissioner in sec_446 would be severely limited because taxpayers could change their tax_accounting methods without the commissioner’s approval so long as they did not also make similar changes for book and financial_accounting purposes tam-117173-02 in 112_tc_270 relied on by taxpayer the service stipulated that general motor’s method_of_accounting was to deduct rate support payments as incurred the tax_court held that subsequent adjustments made to comply with sec_1_1502-13 of the regulations was a method of reporting rather than a method_of_accounting for the general motors consolidated groupdollar_figure here in contrast we believe that parent’s method_of_accounting for purposes of sec_446 was to defer its deductions for the rate support payments so that the deductions would match the amount of discount income that subsidiary took into account from the riscs to which the rate support the general motors court made other statements in regard to the relationship between sec_446 and sec_1_1502-13 that taxpayer relies on to support its position in one passage the court stated that since the matching_rule of sec_1_1502-13 is not mentioned as a permissible method in sec_446 it is not a method_of_accounting general motors t c pincite in making this statement the court apparently overlooked the regulations under sec_446 providing that the commissioner may authorize a taxpayer to use a method_of_accounting not specifically described in chapter of the code or the regulations thereunder if the commissioner determines that the method_of_accounting clearly reflects the taxpayer’s income sec_1_446-1 moreover sec_446 only describes permissible methods_of_accounting it is well-settled that improper or impermissible methods_of_accounting are nonetheless methods_of_accounting and cannot be changed without first securing the commissioner’s consent sec_1_446-1 see 53_tc_439 aff’d 443_f2d_965 6th cir accord 891_f2d_1579 fed cir cert_denied 498_us_823 513_f2d_391 d c cir 317_f2d_604 2d cir cert_denied 375_us_993 292_f2d_225 3d cir cert_denied 368_us_898 thus the fact that a taxpayer’s accounting treatment of an item is not described in sec_446 is not determinative as to whether that treatment qualifies as a method_of_accounting in another passage the tax court’s opinion seems to suggest that sec_446 is inapplicable in cases where the taxpayer does not also use the method being changed for financial_accounting purposes however the tax_court subsequently approved the commissioner’s rejection of an accounting_method change that the taxpayer made solely for purposes of computing taxable_income see 115_tc_554 for the reasons explained in note supra we believe that the court’s conclusion in fpl group is the correct interpretation of sec_446 tam-117173-02 payments relateddollar_figure thus to the extent that the general motors court relied on the stipulation that general motor’s method was to deduct rate support payments as incurred the holding of the case is inapplicable here parent’s separate_taxable_income was not computed by taking into account the full amount of its payments to subsidiary only to have those deductions adjusted in calculating taxpayer's consolidated_taxable_income rather parent’s separate_taxable_income computed under sec_1_1502-12 was itself computed by application of the timing provisions of sec_1_1502-13 to rate support payments made to subsidiary taxpayer also relies on 52_tc_1 aff'd per curiam 433_f2d_309 5th cir vernon c neal inc v commissioner t c memo united contractors inc v 344_f2d_123 4th cir none of these cases involved the deferral of deductions generally or the application of sec_1_1502-13 in particular these cases involved regulations in effect prior to the regulations where income gains losses and deductions were zeroed out eliminated between members of a consolidated_group therefore timing questions regarding the reporting of these items could never arise however the regulations in effect in year specifically provide for systems where the timing of income and deductions is matched between members of a consolidated_group consequently those cases do not address the issues presented here although taxpayer has not specifically argued that the proposed correction falls within the scope of sec_1_446-1 which lists certain adjustments that do not constitute accounting_method changes we note that none of the provisions of that regulation applies to taxpayer’s facts whether parent deferred its deductions due to its erroneous application of the timing rules of sec_1_1502-13 or any other timing principle is irrelevant that deferral was a method_of_accounting not merely a reporting error see 115_tc_554 taxpayer capitalized and depreciated certain expenditures based on regulatory accounting requirements that might have been different from tax_accounting requirements the tax_court has previously held that the deferral of an otherwise accruable expense until a related_party includes the amount in income is a method_of_accounting summit sheet metal co v commissioner tcmemo_1996_563 that method_of_accounting is similar to the method used by parent in this case where parent deferred the deduction of its rate support payments to subsidiary so that the deductions parent took in a given taxable_year would match the amount of discount income that subsidiary took into account in the same taxable_year tam-117173-02 whether parent may change the time for deducting rate support payments made in year and year without first securing the commissioner’s consent parent attempted to apply the timing provisions of the intercompany_transaction regulations in computing its taxable_income for year and year as discussed above in our analysis of issue parent’s interpretation of those regulations was erroneous in effect parent applied the timing provisions of the regulations parent now attempts to change its timing rule for rate support payments to conform with a correct reading of the regulations as determined above at issue b whether parent’s attempt to change its treatment of rate support payments for year and year is a change in method_of_accounting must be analyzed under the regulations although parent did not correctly apply the timing rules of sec_1 to its rate support payments parent did apply a consistent timing rule for those intercompany_transactions in computing its taxable_income for two consecutive years this consistent treatment of rate support payments satisfies the requirements for establishing a method_of_accounting under the general rules of sec_446 which are incorporated into sec_1_1502-17 the regulations specify that the timing rules set forth in the intercompany_transaction provisions are a method_of_accounting to be applied by each member of a consolidated_group in addition to the member’s other methods_of_accounting see sec_1_1502-13 therefore parent’s attempt to change its consistently applied timing rule for rate support payments to conform the timing of its deductions with a correct reading of the intercompany_transaction regulations is by definition a change in method_of_accounting sec_1_1502-17 requires members of a consolidated_group to follow the rules of sec_446 by securing the commissioner’s consent before changing a method_of_accounting taxpayer argues however that because parent is entitled to change its accounting treatment of the rate support payments for year parent is permitted to carry-through the new treatment to all succeeding taxable years thus notwithstanding the fact that parent consistently applied a timing rule to its rate support payments in year and year taxpayer argues that parent is permitted to change its accounting treatment of rate support payments in those years to conform to the revised treatment of those payments in the immediately preceding_taxable_year stated differently taxpayer argues that though parent’s prior consistent accounting treatment unless otherwise stated for year sec_2 and all references are to sec_1_1502-13 taxpayer’s argument assumes that parent did not establish a method_of_accounting prior to year under the regulations applicable to those prior years tam-117173-02 of rate support payments is not a method_of_accounting for purposes of sec_446 in year the treatment of those payments on the final amended_return for year establishes parent’s method_of_accounting for purposes of applying sec_1_1502-13 in year and following taxpayer’s position in this regard is clearly incorrect even if parent had not established the deferral method_of_accounting for rate support payments prior to year the consistent use of that method in year and year establishes it as parent’s method_of_accounting for purposes of sec_1_1502-13 and sec_1_1502-17 under sec_446 a taxpayer may not change from a consistently used method_of_accounting whether the method is proper or improper without first securing the commissioner’s consent this principle is incorporated into sec_1_1502-17 thus parent may not change its accounting_method for rate support payments in year and year through the filing of an amended_return by taxpayer conclusion - issue parent consistently deferred deductions for its rate support payments to subsidiary until subsidiary took those payments into income over the term of the risc parent in determining its separate_taxable_income under sec_1 consistently deferred deductions for its rate support payments to subsidiary this treatment regardless of sec_1_1502-13's applicability established a method_of_accounting for parent the refund claim filed on march for year year and year represents a retroactive change_of_accounting_method for those years without following the procedures under sec_446 applicable to requesting the consent of the commissioner since taxpayer did not timely file the required form_3115 and obtain permission from the commissioner for those years parent is prohibited from changing its treatment of the rate support payments to subsidiary in year year and year caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc fip b03 plr-109995-01 date date legend taxpayer lessee bankruptcy court properties industry claims z date date date date date this responds to your request for a ruling filed on behalf of taxpayer dated date and subsequent correspondence requesting that based upon the facts and representations submitted a portion of the stock that taxpayer is to receive under a plan_of_reorganization for lessee will not be treated as securities held by taxpayer for purposes of determining the percentage of total voting power or value held by taxpayer under the asset test of sec_856 of the internal_revenue_code the code or under the gross_income_test of sec_856 facts taxpayer elected status as a real_estate_investment_trust reit under sec_856 through of the code on its federal_income_tax return for its taxable_year beginning on date taxpayer is in the business of owning or leasing the properties which are plr-109995-01 primarily leased to and operated by lessee or its subsidiaries taxpayer conducts all of its business through a wholly owned operating partnership on date lessee filed a petition for protection under chapter of the federal bankruptcy code taxpayer filed a proof_of_claim on date listing numerous claims against lessee including a claim for unpaid rent at or about the time lessee filed its petition in bankruptcy taxpayer leased substantially_all the properties to lessee under four master lease agreements and a single facility lease collectively the leases and derived approximately z percent of its income from lessee on date lessee and its creditors including taxpayer submitted an amended plan_of_reorganization the plan the bankruptcy court confirmed the plan on date in accordance with the plan taxpayer and lessee have restructured the existing leases to grant the newly reorganized lessee substantial rent concessions effective retroactively to date in exchange for these concessions taxpayer will receive equity interests in the newly reorganized lessee under the plan taxpayer will receive a distribution of lessee’s common_stock taxpayer anticipates that the distribution of common_stock will be less than percent by vote or value of lessee’s total common_stock outstanding immediately upon lessee’s emergence from bankruptcy if however the distribution represents percent or more by vote or value of lessee’s total common_stock outstanding taxpayer will assign immediately prior to the effective date of the plan its rights to receive that number of lessee shares that exceed dollar_figure percent by vote or value to certain trusts established for the benefit of taxpayer’s shareholders the trusts taxpayer will declare a dividend to each of its shareholders of record that will irrevocably assign a pro-rata interest in taxpayer’s right to receive that number of lessee shares that exceed dollar_figure percent the excess shares in addition to the right to receive the excess shares the assets of the trusts will include any actual excess shares received registration rights other_property and securities issued in exchange for the same and any income or distributions earned on the assets collectively the trust assets the date on which taxpayer declares the dividend and assigns its rights to receive the excess shares is known as the dividend record_date taxpayer will establish a separate trust for the benefit of each shareholder of record on the dividend record_date the beneficiaries taxpayer represents that the trusts will be treated for federal_income_tax purposes as liquidating trusts under sec_301_7701-4 of the procedure and administration regulations for the purpose of holding the excess shares until the shares may be distributed to the beneficiaries of all the trusts and that as a result of the distribution the shares are freely tradeable in the hands of the beneficiaries taxpayer will treat the trusts as grantor trusts for federal_income_tax purposes under sec_671 et seq plr-109995-01 interests in the trusts are separate from interests in taxpayer’s stock and no person acquiring taxpayer’s stock after the dividend record_date may acquire an interest in any of the trusts subsequent issues of common_stock in taxpayer will not dilute the rights of holders in the trusts and subject_to limited transferability rights the trusts will be owned only by those beneficiaries identified on the dividend record_date in addition taxpayer represents that no beneficiary will own percent or more of lessee’s shares issued on the effective date of the plan law and analysis sec_856 provides that a corporation trust or association trust shall not be considered a reit for any taxable_year unless at the close of each quarter of the taxable_year not more than percent of the value of its total assets is represented by securities other than those includible under sec_856 not more than percent of the value of its total assets is represented by securities of one or more taxable reit subsidiaries and except with respect to a taxable_reit_subsidiary and securities includible under sec_856 a not more than percent of the value of its total assets is represented by securities of any one issuer b the trust does not hold securities possessing more than percent of the total voting power of the outstanding voting_securities of any one issuer and c the trust does not hold securities having a value of more than percent of the total value of the outstanding securities of any one issuer sec_856 requires at least percent of a reit’s gross_income to be derived from passive sources including rents_from_real_property sec_856 requires at least percent of a reit’s gross_income to be derived from real_property interests including rents_from_real_property sec_856 generally excludes from the term rents_from_real_property any amount received or accrued directly or indirectly from any person if the reit owns directly or indirectly i in the case of any person which is a corporation stock of such person possessing percent or more of the total combined voting power of all classes of stock entitled to vote or percent or more of the total value of shares of all classes of stock of such person or ii in the case of a person which is not a corporation an interest of percent or more in the assets or net profits of such person sec_856 provides that for purposes of sec_856 the rules prescribed by sec_318 for determining the ownership of stock shall apply in determining the ownership of stock assets or net profits of any person except that percent shall be substituted for percent in subparagraph c of sec_318 and sec_318 sec_318 provides that stock owned directly or indirectly by or for any portion of a_trust of which a person is considered the owner under subpart e or part plr-109995-01 i of subchapter_j relating to grantors and others treated as substantial owners shall be considered as owned by such person the legislative_history to the rent exclusionary provision described above is found in h_r rep no 86th cong 2nd sess the legislative_history provides that the reason for the limitations found in sec_856 is to prevent the avoidance of the gross_income requirements under sec_856 through the device of related_organizations and to foreclose the opportunity of any substantial relationship between the trust and the business of any tenant the service has considered the treatment of the momentary ownership of stock for purposes of facilitating a divisive_reorganization in the context of a small_business_corporation in revrul_72_320 1972_1_cb_270 a small_business_corporation created another corporation and transferred assets in connection with a reorganization under sec_368 in exchange for stock in the new corporation immediately thereafter stockholders of the original corporation exchanged their stock for the stock of the new corporation in a transaction that qualified under sec_355 the ruling holds that the momentary ownership of stock in the new corporation did not terminate the original corporation’s election as a small_business_corporation because more than momentary control of the new corporation was never contemplated based solely upon the facts presented and the representations made we conclude that lessee’s common_stock that is irrevocably assigned to the trusts under the proposed trust agreement presented by taxpayer will not be treated as securities held by taxpayer for purposes of determining the percentage of total voting power or value held by taxpayer under the asset test of sec_856 or under the gross_income_test of sec_856 except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter in particular no opinion is expressed concerning whether taxpayer qualifies as a reit under sec_856 of the code prior to or following the proposed transaction described above further no opinion is expressed whether the trusts qualify as liquidating trusts under sec_301_7701-4 for federal_income_tax purposes taxpayer has represented that it intends to treat the excess shares as additional rental income so that taxpayer will be deemed to have received such excess shares for federal tax purposes and that taxpayer will recognize gross_income equal to their fair_market_value no opinion is expressed as to whether any of the shares received by taxpayer in accordance with the plan including the excess shares qualify as rents_from_real_property under sec_856 this ruling is directed only to the taxpayer s requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-109995-01 a copy of this letter must be attached to any income_tax return to which it is relevant sincerely yours acting associate chief_counsel financial institutions products by alice m bennett chief branch enclosure copy


t c no united_states tax_court melea limited petitioner v commissioner of internal revenue respondent docket no filed date r sought production of certain transcripts of depositions taken in a patent infringement suit in which p was a defendant pursuant to stipulation and agreement of the parties to the infringement suit the u s district_court entered a protective_order regarding materials that any of the parties could label as confidential without leave of the district_court in response to r’s request p refused to produce the deposition transcripts contending that to do so would be in violation of the protective_order the transcripts are otherwise discoverable and relevant to the tax issue before this court the infringement suit is closed and expense loss of time and inconvenience would be occasioned by requiring the parties in this case to proceed to the district_court to attempt to reopen the closed infringement suit held p will be compelled to produce the protected materials and this court’s compulsion order will incorporate the requirements of the district court’s protective_order to continue the protection of -- - any proprietary business information that may be contained in the deposition transcripts bric j zinn for petitioner michael j cooper for respondent opinion gerber judge we consider respondent’s motion seeking to compel production of transcripts of certain depositions from petitioner petitioner’s refusal to produce is based on its argument that production would result in a violation of a protective_order issued by another court we consider whether it would be appropriate to compel petitioner to produce under such circumstances background melea limited is a gibraltar corporation with a business address in geneva switzerland michael ladney ladney who is the petitioner in a related case pending in this court is a u s citizen who was the prior owner of several patents associated with petitioner’s business activity as it relates to plastic injection molding lladney is the principal_shareholder of several u s_corporations involved in the manufacture of plastic parts at some time ladney transferred patents and other assets to offshore entities including petitioner without detailing the relationships of the various entities that respondent contends exist we note that respondent determined generally that certain u s entities related to ladney are dependent agents of petitioner which within the context of sec_864 negotiated contracts on behalf of petitioner on that premise respondent determined that petitioner’s income is from sources outside the united_states which are effectively connected with petitioner’s u s trade_or_business apparently petitioner does not deny that it hada u s trade_or_business but disputes that its income from sources outside the united_states is effectively connected with its u s trade_or_business respondent seeks copies of deposition transcripts taken in connection with litigation in the u s district_court for the middle district of florida petitioner was a defendant in litigation styled cinpres ltd v hendry case no 96-752-civ-t- 24b m d fla date cinpres case that case involved a patent infringement action brought by cinpres a british company against petitioner and a competitor of petitioner petitioner a foreign_corporation questioned the u s district court’s jurisdiction over it and depositions were taken in part to discern the relationship between petitioner ' section references are to the internal_revenue_code and rule references are to the tax_court rules_of_practice and procedure q4e- and two of ladney’s u s entities the same ones that respondent determined were petitioner’s dependent agents pursuant to stipulation and agreement of the parties in the cinpres case the district_court entered a protective_order on date in order to expedite the flow of discovery material facilitate the prompt resolution of disputes over confidentially adequately protect material entitled to be kept confidential and insure that protection is afforded only to material so entitled although there had been disagreement between the parties as to the content of the order the parties after assistance from the district_court stipulated and agreed to an order which the district_court approved under the protective_order any party without court approval could designate documents as either confidential or attorney’s eyes only by stamping same on the document only documents containing highly sensitive business or technical information could be stamped for attorney’s eyes only the cinpres case was closed on date without a trial and following a settlement reached by the parties in pertinent part the cinpres protective_order contained the following prohibition on the use of documents classified as confidential by the parties other than use by the parties to the cinpres litigation and their counsel disclosure of a classified document was not permitted without prior written - - consent of the party that had classified the document as confidential parties could apply to the court for declassification of a document confidential information in depositions could be classified as confidential by underlining the confidential portion and designating that portion as under the protective_order if a classified document was subpoenaed or ordered produced by another court the party that classified the document was to be advised classified documents were to be used only for preparation and trial in the cinpres case the protective_order provisions did not terminate at the conclusion of the cinpres case and within days of the termination of the cinpres case the parties’ counsel were permitted to maintain one set of protected matter and all other copies were to be returned to originating party or destroyed at the option of the originating party initially petitioner refused to produce any of the depositions but now has produced redacted versions to respondent the redacted versions reflect that the redacted portions had been classified as confidential under the protective_order ’ respondent contends he is entitled to the redacted portions petitioner contends that to the extent it has not produced there is no indication who classified the redacted portions as protected we assume that the deponent classified the redacted portions the deponents were generally either parties or their agents -- - documents or provided the redacted portions it is unable to do so because of the protective_order entered in the cinpres case discussion petitioner urges this court to respect the terms of the protective_order which prohibits disclosure without modification of the order and or approval of the district_court that issued the order petitioner suggests that respondent should first attempt to request the district_court that issued the order to modify it in order to accommodate the disclosure petitioner further postulates that this court should not entertain respondent’s discovery request until after respondent has shown that he was unable to obtain the materials from the district_court petitioner however also argues that respondent is not entitled to the protected material we note that petitioner who was a party in the cinpres case and would have standing under the terms of the protective_order has not offered to approach the district_court to facilitate respondent’s access to the protected material petitioner is vigorously attempting to keep we observe that petitioner has resisted the production of the depositions petitioner appears to be using another court’s protective_order as a shield or bar to compliance with respondent’s discovery request petitioner has not suggested any alternatives and has displayed an aversion to seeking modification of the protective_order under consideration petitioner does not contend that any portion of the deposition transcripts it has withheld contains proprietary business information that would be in need of protection from respondent the redacted portions of the deposition transcripts the material sought by respondent is relevant to the issues we consider as stated in 82_tc_105 rule b limits discovery to information or responses which are relevant to the subject matter of the pending litigation and which are not otherwise protected from discovery on the ground of privilege or other limitation the standard of relevancy in a discovery action is liberal 73_tc_469 the burden of establishing that the documents or responses sought are not relevant or otherwise not discoverable is on the party opposing production 81_tc_937 branerton ii supra pincite pbp t l construction co v commissioner supra pincite petitioner has not shown that the material sought by respondent is not relevant petitioner however has raised the question of whether the protective_order issued in the cinpres case is a limitation on production in this proceeding this is our first occasion to consider whether this court should order the production of material which was subject_to another court’s protective_order in a case which has been closed under the district court’s protective_order a party or aggrieved entity was permitted to intervene to declassify a document clearly petitioner would have been entitled to seek to declassify the redacted portions of the deposition to the extent petitioner is the classifying party it may have been entitled to disclose without declassification respondent --- - possibly as an aggrieved entity would have been able to seek declassification of the materials sought here ’ there appears to be no question about whether the protective_order survived the cinpres litigation and continues to have full force and effect on the parties subject_to it or about the issuing district court’s ability authority to modify or revoke the order see 858_f2d_775 1st cir matters of comity influence courts’ decisions whether to issue orders that affect or modify protective orders issued by other courts see eg 120_frd_648 d md 111_frd_65 d p r these principles while unquestionably important are not absolute and courts asked to issue discovery orders in litigation pending before them also have not shied away from doing so even when it would modify or circumvent a discovery order by another court 191_frd_495 d md respondent did not have the opportunity to intervene in the cinpres case to seek access to the materials and we are not we must assume from petitioner’s argument that respondent should first attempt to obtain the documents by seeking them from the district_court that petitioner believes that respondent had standing under the protective_order to seek declassification of a document --- - certain that respondent has standing to currently seek modification of the protective_order that was entered the materials in question go to the heart of the merits of the tax controversy in this case ie the relationship between petitioner and certain u s_corporations under similar circumstances courts have recognized that a practical solution may be needed in that regard the cinpres case is closed and considerable delay and expense would be occasioned by the reopening of that case or the filing of a new action to seek modification of a protective_order tucker v ohtsu tire rubber co supra pincite one pivotal consideration is whether the court issuing the order merely sanctioned the agreement of the parties or whether the terms of the order instead reflect the issuing court’s deliberative_process where the issuing court has merely sanctioned the parties’ agreement those circumstances have been considered to be more like a private contract between the parties than a holding of a court id the circumstances of the case before us appear to fit within the guidelines that have been established by other courts for compelling discovery of material that was specifically or generally under a protective_order of another court we proceed with caution and employ a pragmatic approach to a difficult procedural problem in doing so we follow the direction of -- - several other federal courts the court in tucker v ohtsu tire rubber co supra formulated guidelines which it distilled from various court holdings to assist in deciding whether it is appropriate to enter a discovery order that would have the effect of modifying an order issued by another court we find that formulation helpful in our consideration of respondent’s motion to compel petitioner’s production of the deposition transcripts in question the first area of inquiry is the nature of the other court’s protective_order this inguiry focuses on whether the order was issued by a court as its resolution of a controversy or whether the court simply approved the parties’ agreement courts have afforded less deference to orders based on an agreement of the parties and merely approved by the court conversely more deference has been afforded in situations where a court’s order resulted from a holding that is based on the court’s deliberative_process cases where one court compelled production of material from a prior proceeding subject_to a protective_order morton intl inc v atochem n am inc u s p 2d d del 123_frd_527 w d n c and 92_frd_67 s d n y cases where production was denied 136_frd_334 d d c 120_frd_648 d md and 111_frd_65 d p r concerning this aspect petitioner contends that the protective_order in the cinpres case was entered after an extended period of disagreement by the parties hearings by the district_court and assistance involvement of the judge petitioner also points out that the protective_order that was finally entered was different in some respects from those originally proposed by each party petitioner contends that the order we consider did not merely represent a ministerial_act by the district_court and accordingly more deference should be afforded the order respondent points out that the parties stipulated and agreed to the protective_order entered by the district_court in that regard the order and the matters it covers were not subjected to deliberation by the district_court although the district_court played a role mediator or monitor in resolving the parties’ disagreement negotiations regarding the content of the proposed protective_order the district_court did not deliberate or decide the controversy ultimately the district_court entered a protective_order which had been stipulated and agreed to by the parties under those circumstances less deference need be afforded the protective_order on the theory that it is essentially an agreement of the parties although we pay less deference to the order conceptually we defer to its substance and intent to protect the confidential materials that may be contained in the deposition transcripts the second tucker factor concerns the identity of the party from whom discovery is sought this factor focuses on whether the document sought is from a person originally entitled to have it as a party to the cinpres case petitioner was entitled to the transcript of depositions and therefore petitioner was an original holder of this document petitioner points out that the tucker case involved a one- sided order ie the protected materials flowed from one source petitioner contends that the circumstances of this case are different because it was not a one-sided sole source order respondent counters that the documents sought depositions could have been designated as protected by any of the parties in the cinpres case in effect the deposition transcripts are the rightful property of each litigant and could have been treated by any as confidential in that regard petitioner has not shown or contended that the redacted portions of the deposition testimony were exclusively sourced in another party in the cinpres case additionally petitioner does not contend that the redacted portions of the deposition transcripts contained material that if petitioner had shown that the protected material was exclusively sourced in another the protective_order provides for notice to that party before production of a protected document pursuant to another court’s order in substance requires protection such as proprietary business information the third tucker factor concerns whether the case in which the order was issued is still pending and if not the court is to consider the burden and expense that will be incurred in order to seek modification of the order the district_court proceeding was settled by the parties and is no longer pending on this aspect petitioner recognizes that expense and delay would be occasioned by an action to reopen the infringement proceeding simply to seek modification of the protective_order petitioner however contends that it is the only avenue by which the protective_order should be approached and that this court should not circumvent the district court’s order respondent contends that he is not a party to the cinpres case in addition intervention in the cinpres case would require the involvement of the u s department of justice which would further complicate this matter and increase the expenditure of public resources respondent also contends that it would be an imposition on the district_court to interject it into a discovery dispute in the u s tax_court we agree with respondent the district_court would have to be asked for the first time to interpret and or to modify an order negotiated by the parties in a case that is now closed and final the additional cost in expense time and inconvenience of the courts and the parties to seek review by the court that issued the order is not warranted in this setting the final factor concerns whether this court by incorporating similar terms and protections in our order could continue the protections originally approved in the district court’s order on that point petitioner argues that neither petitioner nor respondent has moved this court for such a protective_order petitioner’s concern is that the cinpres case involved patent infringement and the possible need to protect any proprietary business information in that regard the district court’s protective_order appears to adequately provide for protection of any proprietary business information if we incorporate the terms of the district court’s protective_order into an order compelling the production of the requested deposition materials the same obligations and restrictions will be imposed with the exception that they will now be imposed on respondent we see no reason why the terms of the district court’s protective_order cannot be incorporated into this court’s order compelling any production of materials from the cinpres case as explained the information respondent seeks is relevant to the issues we consider it would be unjust to permit petitioner continued access to this type of information with no access to respondent another approach to remedying this -- - situation would have been to order petitioner to produce the materials without addressing the protective_order to simply order such production would however place petitioner in the position of having to seek modification of the cinpres order and to bear the expense of same as a practical matter petitioner has not shown why the approach we have chosen order production with continued protection under the terms of the protective_order is not appropriate under the conditions we consider to reflect the foregoing an order will be issued granting respondent’s motion to compel and providing for continued protection of the materials to be produced