Legal Entity Simplification: Impossible? Part II

Monday, 26 July 2010 07:12

Legal Entity Simplification: Impossible? Part II

Written by Kelley Lear

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This blog is the second in a two-part series regarding Corporate Legal Entity Simplification, inspired by Red Moon Solutions Managing Director Kelley Lear’s participation in the Chicago Tax Club (CTC) meetings in June.

In today’s regulatory environment, we cannot talk about structural changes and advantages in simplification without talking about code sections in place to watch out for certain strategies and behaviors deemed to be put in place due specifically for income tax savings…For example, Sec. 7701(o) adopts a conjunctive test in which “the transaction changes in a meaningful way (apart from federal income tax effects) the taxpayer’s economic position,” AND “the taxpayer has substantial purpose (apart from federal income tax effects) for entering into such transaction.” The second prong of that code section is subjective to include “state and local tax benefits” and “financial accounting benefit”. Again, these cannot be relied upon solely if you also have a federal benefit. Those darn regulators.

The codification of economic substance penalties were a bit scary…Sec. 6662(b)(6) added to the list of accuracy related penalties with 20% of underpayment, if adequately disclosed in the return or on statement attached to the return, otherwise 40% of underpayment.

The discussion on basic considerations for these structures/transactions included things such as where the assets will end up (parent or brother/sister), state of entity, solvency, timing of transaction, and identifying the tax treatment of transactions. This last consideration resonated with me as we have dealt a lot with Section 382 in our Built-in Gain Solution (BIG) that allows companies to simplify the complexities of calculating and tracking built-in gains and losses associated with ownership changes so that they can maximize their NOLs. The solution facilitates asset projections and tracking while also handling the compliance requirements imposed by Section 382.

In this discussion, they focused on deferring intercompany gains/losses for federal purposes, and did some dive into states and local conformity, settling in on some lengthier discussions on NOLs. The remainder of the talk walked us through many different structure changes, use of SMLLC conversions, internal separation strategies, North/South, ordering and “check the box” issues. There were pros and cons presented for each strategy and a lot of sore brain cells upon our departure.

My one recommendation coming from this discussion is to ensure that as you embark and/or even consider these structural changes, that you have a very experienced team working through the pros/cons and considerations. Experts in these areas are worth their weight in gold.

Learn more about Red Moon Solutions’ Built-In Gain (BIG) Solution for Section 382 today.

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Kelley Lear

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2 comments

Comment Link Tuesday, 27 July 2010 08:50 posted by Kelley
I was trying to post this…I agree wholeheartedly. Further, I am constantly amazed at how many companies still let the tax tail wag the dog. And some those that are brought in from the beginning might not encompass all areas of tax. Bringing in the entire C-suite is the way to make sure that the substance is there and that good decisions are being made.
Regards, Kelley Lear
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Comment Link Monday, 26 July 2010 17:53 posted by Mark Banks-Golub
Kelley,

I agree that the codification of the economic substance doctrine is an important factor to consider in any entity rationalization structure. However, consideration of the rule should ultimately not prove to be a problem if the plan is implemented properly.

Entity rationalization should ordinarily allow an entrerprise to realign its invested capital, trim burnt-out or unwanted subsidiaries, more efficiently align human with invested capital, and achieve operational effficiencies.

A taxpayer that can demonstrate that it has reduced its corporate footprint, moved employees eithr into a central staffing/management company, reduced the intercompany accounting, transfer pricing, and record-keeping burden it faced previously, and achieved an increase in cash flow should not have trouble convincing any examiner of the economic substance of an internal restucturing.

In a restructuring, as in any deal, it is vital not to let the tax tail wag the dog. The client should involve th entire C-suite, HR, Facilities Management, as well as Legal and Tax managers and advisors. The client should be able to document that its mergers, liquidations, conversions, etc. fit in with the enterprise's vision for the future and furthers that vision.

In summary, if you restructure for substantial reasons, you need never fear economic substance.
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Jim is the CEO of Red Moon Solutions, Traci and Kelley are Red Moon's Managing Directors, Stacy serves as Project Manager and Susan is the Manager of Client Services. While each author has a specific role within the Red Moon Solutions team, their overall goal is simple: giving you the information you want. To learn more about an individual author, visit the About the Authors page.