Opinion ID: 779340
Heading Depth: 2
Heading Rank: 1

Heading: Validity of the 1984 Temporary Regulation.

Text: 30 UnionBanCal argues that the statute requires two things that the temporary regulation denies: (1) that the loss on a sale between controlled group members must be deferred, not denied; and (2) that seller's loss in an intra-group transaction must remain for the use of the seller. We cannot disagree with the first point: section 267(a)(1) says that loss deductions for sales between the related persons specified in section 267(b) are disallowed, but section 267(f) says that loss deductions for sales between members of controlled groups shall be deferred. 27 Congress plainly meant to draw a distinction between members of controlled groups and other related parties and to provide for deferral rather than disallowance of losses arising from sales of property within controlled groups. 31 But UnionBanCal's second point is not persuasive. Section 267(f) says such loss — that is, the loss from the sale of property between members of the controlled group — shall be deferred. 28 The statutory language does not compel the conclusion that once the deferred loss is recognized, the seller must be the one who gets the tax benefit. Members of a controlled group do not deal with one another at arms length, so the financial and tax consequences of intra-group transactions are entirely controllable and manipulable by the group. When members of a controlled group accomplish an intra-group sale, the price between them is arbitrary and any loss is without economic substance for the group as a whole. So deciding who actually bore the loss in such a transaction is inherently arbitrary. 32 Since Standard controlled Union Bank and, through intermediaries, owned it, it could buy the depressed loans from Union for face value, for $11 million below fair market value, for $88 million below face value, or for whatever price it believed would best serve the group's financial and regulatory objectives. So the existence and magnitude of any loss Union Bank suffered was entirely a matter of Standard's choice and without any practical financial consequences. The words of section 267(f), especially when read in light of the practicalities of controlled group transactions, do not support the inference that the tax benefit of a loss must remain with the purported seller. 33 The phrase such loss shall be deferred in section 267(f) doesn't imply that the purported seller gets the tax advantage of the loss, but that the loss won't be recognized for tax purposes at the time of the sale. This inference is compelled by the phrases that follow such loss shall be deferred — until the property is transferred outside the controlled group or until such other time as may be prescribed in regulations. 29 When read together, these phrases show that Congress is not assuring the paper seller that, come hell or high water, it gets to use the loss sometime. Rather, Congress is assuring the fisc that, so long as the property remains within the controlled group, the loss won't be recognized. After all, so long as the property and both parties to its sale remain within the controlled group, the loss is like the loss to your left pocket when you move money to your right pocket, somewhat like a sham transaction, so the general principle that transactions without economic substance will not be recognized for tax purposes supports nonrecognition in these circumstances as well. 30 34 Section 267(f) provides alternative dates for when the deferred loss on an intra-group sale may be recognized. The first date is whenever the property is transferred outside such controlled group and there would be recognition of loss under consolidated return principles. 31 The second date is such other time as may be prescribed by regulations. 32 This gives the Commissioner authority to prescribe the time for recognition, which is what the Commissioner used to issue the 1984 temporary regulation. 33 As regulations commonly do, this temporary regulation dealt with a complexity not fully covered by the statute: what happens if one member leaves the controlled group before the other member sells the property to an outsider? The temporary regulation provides the answer: if the seller leaves the group before the buyer sells the property to an outsider, the seller's deferred loss never gets restored to it. 34 UnionBanCal cries foul over the word never, and claims it contradicts the statutory command that the loss must be deferred. 35 But we can't see any inconsistency between this regulation and the statute: the loss still gets deferred, not disallowed; it just gets recognized by the buyer as a stepped-up basis, instead of by the seller as a deduction. UnionBanCal's complaint is that the loss doesn't get restored to the seller, but as we've discussed, the statute doesn't require that result. As the Tax Court below put it, Under the literal language of the statute, ... what is deferred under section 267(f)(2)(B) is not the seller's recognition of the seller's loss, but rather the `loss' itself. 36 35 Under the temporary regulation, the deferred loss stays with the property until the property leaves the controlled group. This is consistent with the general scheme of section 267. Under section 267(d), which provides for the recognition of losses disallowed under section 267(a)(1), recognition of the loss follows the property. 37 Under section 267(a)(1) and (d), when a husband sells stock to his wife, as in the hypothetical case we set out earlier, he doesn't get the loss when the wife calls a stockbroker and sells the stock — she gets the gain or loss on her sale, but gets to use his basis. The recognition of the loss follows the property, and gets triggered when the property goes to an unrelated party. Likewise, the temporary regulation makes recognition of the deferred loss follow the property and stick with it until the property is sold to an outsider: the loss is preserved within the group because no member of a group should under section 267(f) be able to recognize a loss while the group continues to hold property it purchased from itself. 38 True, Congress defers recognition of losses for controlled groups, 39 instead of disallowing them as with the husband and wife example. 40 But the distinction between disallowance and deferral is not so sharp because in both cases who gets the tax benefit doesn't matter because of their identity of interest; it's when the loss gets recognized that matters. There's no reason why Congress should care about who gets the loss when the parties are so closely related or controlled, but Congress has a great concern with whether there is a real loss. 36 The primary rationale for deferring loss on transfers between members of the same group is to prevent the premature recognition of loss merely because the property is transferred to a related person.... [A]n ancillary rationale for deferring loss is to prevent artificially increasing the amount of a loss taken by a member on the sale or exchange of property at less than fair market value to another member.... 41 37 UnionBanCal argues that the legislative history shows that Congress intended something contrary to what the temporary regulation says. UnionBanCal cites a passage in the House Conference Committee Report saying that Congress wanted losses on sales within controlled groups subject to deferral (rather than denial). 42 This legislative history adds nothing whatsoever to what the statute plainly says. True, a Senate Finance Committee Report says that the bill was intended to defer recognition until the property was sold to an outsider or the parties are no longer related. 43 That would imply recognition as soon as UnionBanCal's predecessor left the controlled group, contrary to the temporary regulation. But the law — the bill that was passed by both houses of Congress and signed by the President 44 — doesn't say or the parties are no longer related. It says or until such time as may be prescribed by regulations. 45 38 UnionBanCal argues that the Temporary Regulation is arbitrary and capricious because it allows recognition to the wrong party at the wrong time. We reject this argument because, so long as the controlled group maintains its existence, it is within the group's control which party within it bears the paper loss. As for when the loss is recognized, one could reasonably choose either alternative, when the property is sold to an outsider, as the temporary regulation provides, 46 or when the seller leaves the controlled group, as the final regulation provides. 47 While they are together in the controlled group, and when they agree on terms for ending membership in the group, the parties can avoid unfairness to themselves from the way the taxes fall by adjusting their affairs in accord with tax regulations. 39 UnionBanCal argues that we ought not to defer to the regulation because, as a temporary regulation, it was adopted without notice and comment. 48 We need not decide generally whether absence of notice and comment would affect the degree of deference to a temporary regulation adopted by the Commissioner of Internal Revenue (which may differ from other temporary regulations issued by agencies dealing with other subject matters). In this case, Congress by law provided that the time for recognition, if the Commissioner adopted a regulation, would be such other time as may be prescribed in regulations. 49 And Congress empowered the Commissioner to issue regulations without notice and comment, such as the temporary regulation the Commissioner issued here. 50 This is an express delegation of authority, and the temporary regulation is neither arbitrary nor capricious, 51 so it stands. 52 40 The regulation arguably would be arbitrary if it not only denied the loss to the seller within the controlled group if it ceased to be a member while the property was still owned by another member, as it does, but denied the loss to anyone. That is, if the loss were altogether disallowed, that might be inconsistent with the Congressional directive that it be deferred rather than disallowed. But the temporary regulation doesn't do that. It gives the benefit of the loss to the member of the controlled group that bought the property, by increasing its basis by the amount of the seller's deferred loss. Thus when the property does eventually get sold to an outsider, the loss is recognized. In this case, no one got the benefit. But that wasn't because of the temporary regulation. It was because British tax authorities wouldn't give Standard the increased basis. Standard, which owned Union Bank, and which owned the loan portfolio when Union Bank left the controlled group, was a British corporation. Under American, but not British, tax law, when Standard sold the loan portfolio, it would be entitled to have its basis increased by the amount of Union Bank's deferred loss. That is not a failure of the temporary regulation to conform to the statute. Rather, it is a difference between British and American taxation. 41