Report of the American Bar Association Tax Section Task Force on the Tax Recommendations of the National Bankruptcy Review Commission

CONSOLIDATED RETURN ISSUES WHERE COMMON PARENT, BUT NOT ALL SUBSIDIARIES, IS A DEBTOR

(COMMISSION TRACK NUMBER 604A)

Present Law

Under the Consolidated Return Regulations (Treas. Reg. Section1.1502-1 et. seq.) authorized by Section 1502 of the Internal Revenue Code (the "Consolidated Return Regulations"), an affiliated group of corporations, as defined in Section 1504 of the Internal Revenue Code, has the right to file a consolidated income tax return for Federal income tax purposes. The Consolidated Return Regulations require the members filing such a consolidated return (a "Consolidated Group") to report their combined results of operations and provide intricate and detailed rules for determining the consolidated tax liability of the Consolidated Group. These regulations also provide that each member of the Consolidated Group for any part of the year is severally liable for all of the taxes of the Consolidated Group for the year. Treas. Reg. Section 1.1502-6 (fn. 231). Moreover, if a corporation ceases to be a member of the group it nevertheless remains liable for all the taxes of the Consolidated Group for any year during which it was a member of the group. Only the Common Parent of the Consolidated Group has authority as the sole agent for each of the members of the affiliated group to act for the subsidiaries in determining the tax liability of the group.

When the Common Parent is under the jurisdiction of the Bankruptcy Court, the court has the power under Section 505 to determine the taxes of the corporation. When other members of the Consolidated Group are also subject to the jurisdiction of the same Bankruptcy Court, it is not difficult to obtain a single determination of the tax liabilities of all of the members subject to the court's jurisdiction. It is not clear whether such a determination by the Bankruptcy Court of the tax liability of the Common Parent (and other filed members) for a tax year is binding on the Internal Revenue Service or the other corporations that were members of the Consolidated Group during such tax year, but that are not in cases under title 11 and joined in the proceeding. By the same token, when the Common Parent is in a title 11 proceeding, the other members of the Consolidated Group are precluded from filing a petition with the Tax Court for the redetermination of the Consolidated Group's tax liability. J & S Carburetor Co. v. Commissioner, 93 T.C. 166 (1989).

Proposals Before the Commission

Commission Track Number 604A. This proposal.

Task Force Position

The Task Force proposes that Section 505 and related provisions of the Bankruptcy Code be amended to provide that whenever the Common Parent of a Consolidated Group is under the jurisdiction of the Bankruptcy Court, the Bankruptcy Court has jurisdiction to determine the tax liability for all members of the Consolidated Group in a proceeding to determine the tax liability of the Common Parent, and that payment provisions applicable to the Common Parent, such as the priority of such tax liability under Section 507(a)(8) and the deferred payment provisions of Section 1129(a)(9)(C), apply equally to such members.

Reasons for Position

Under the Consolidated Return Regulations, the Common Parent of the Consolidated Group is appointed the agent for the Consolidated Group. For nearly all purposes, the Common Parent is the sole agent for each member of the Consolidated Group, "duly authorized to act in its own name in all matters relating to the tax liability for the consolidated return year" to the exclusion of the subsidiary. Treas. Reg. Section 1.1502-77(a). Among the enumerated powers of the Common Parent is the power to "file petitions and conduct proceedingsbefore the Tax Court of the United States." Id. Any such petition is considered as also having been filed by each subsidiary. Craigie v. Commissioner, 84 T.C. 466 (1985).

The Commissioner of Internal Revenue is not precluded by the automatic stay provisions of Section 362(a) from issuing a notice of deficiency to the Consolidated Group. The other members of the Consolidated Group have no individual authority to file Tax Court petitions seeking redeterminations of such tax liability, even if the Common Parent is in a title 11 proceeding and precluded by Section 362(a)(8) from filing a timely petition with the Tax Court for redetermination of the Consolidated Group's tax liability. J & S Carburetor Co. v. Commissioner, 93 T.C. 166 (1989). See also Entertainment Systems, Inc. v. Commissioner, 70 TCM (CCH) 460 (1995). This is true even if the corporations are former subsidiaries no longer members of the same

Consolidated Group with the Common Parent

The effect of these rules is that the unfiled corporations may have no effective prepayment remedy and may be subject to collection of the entire asserted consolidated return tax liability (fn. 232). For example, the Internal Revenue Service could issue a Notice of Deficiency (90 day letter) to the Common Parent in respect of the entire Consolidated Group demanding payment of $30 million dollars. The parent and the other filed subsidiaries, while subject to the automatic stay of Section 362, would not be at risk of collection efforts by the Internal Revenue Service. The unfiled subsidiaries would have no clear prepayment forum to litigate with the Internal Revenue Service the asserted tax deficiencies and at the end of the ninety days they might be subject to collection efforts by the Service. In order to provide absolute protection to its subsidiaries from collection of asserted consolidated return taxes and postpetition interest (as measured by the date of filing of the petition of the Common Parent) in respect of such consolidated return taxes, the Common Parent would be forced to cause bankruptcy petitions to be filed for subsidiaries that otherwise need not be subjected to the jurisdiction of the Bankruptcy Court. This needlessly increases the administrative burden on the Bankruptcy Courts.

In addition to the authority of the Common Parent with respect to Tax Court petitions, under the Consolidated Return Regulations, the Common Parent is authorized to file claims for refunds of taxes and, in general, payment to the Common Parent discharges any liability of the Internal Revenue Service. But see Treas. Reg. Section 301.6402-7T (regarding refunds on carrybacks from insolvent financial institutions). Moreover, the Common Parent in its name will execute waivers of the statute of limitations (see Treas. Reg. Section 1.1502-77(c)) and execute closing agreements. Clearly, the Common Parent by its actions can bind all of the members of the Consolidated Group.

The effect of these rules can be seen clearly by the following. At present it is unclear that a final order of the Bankruptcy Court following a Section 505 proceeding to determine the consolidated return tax liability in the Common Parent's case would bind the unfiled subsidiaries. The unfiled subsidiaries would not have been parties to the proceeding under Section 505. In contrast, the Common Parent, while subject to the jurisdiction of the Bankruptcy Court and prior to a final order of the court, could enter into a settlement of such tax matters and execute a closing agreement with the Internal Revenue Service with respect to the tax liability of the Consolidated Group for such tax year. The unfiled members would be bound by the administrative actions of the Common Parent in settling the tax liability of the Consolidated Group. Given the broad scope of the sole agency authority of the Common Parent, it is not inappropriate to make the actions taken with respect to the Common Parent in the parent's title 11 case the determinant for all members of the Consolidated Group. Since the Bankruptcy Court is authorized by Section 505 to determine the tax liability of the Common Parent when that corporation is subject to its jurisdiction, it makes little sense in terms of administrative and judicial efficiency not to stay collection efforts against the unfiled members of the Consolidated Group while action is stayed under Section 362 against the Common Parent and for such unfiled members not to be bound by such any determination of the consolidated tax liability of the Common Parent in a proceeding under Section 505.

As noted earlier, two other items deserve similar treatment. In addition to the determination of the tax liability of the Consolidated Group by reference to the determination with respect to the Common Parent, the priority status of the consolidated tax liability, the prepetition or postpetition status of interest payable with respect to the consolidated tax deficiency, the priority status of the taxes and any penalties and the payment terms under Section 1129(a)(9)(C) applicable to the Consolidated Group should also be determined by reference to the status of the Common Parent.

Finally, a similar rule should apply for state and local tax purposes where consolidated or combined returns are filed if the applicable law does not provide for a separate liability and separate contest rights for the nondebtor corporations.

*************************FOOTNOTES**********************************

fn. 231: But see In re Imperial Corp. of Am., 91-2 U.S. Tax. Cas. (CCH) Paragraph 50,342 (Bankr. S.D. Cal. 1991) (income taxes estimated by bankruptcy ourt and accorded priority status as adminstrative cliams in savings and loan subsidiary's bankruptcy proceeding, not accorded priority treatment as administrative expense in bankruptcy proceeding of Common Parent).

fn. 232: The Consolidated Return Regulations do provide that the District Director may assess and collect the departed member's proportionate share of the tax liability if the termination of affiliation was as a result of a bona fide sale or exchange oat fair market and collection of the balance of the deficiency is not jeoparidzed. Treas. Reg. Section 1.1502-6(b).

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Last updated June 1, 1997