IRS Provides Favorable Guidance Regarding the Application of Code Sections 382 and 597 to Participants in the CPP and the TARP

October 16, 2008

The IRS has issued guidance that the issuance of stock and warrants to the Treasury pursuant to the Capital Purchase Program ("CPP") will not be treated as increasing Treasury's ownership in a loss corporation for purposes of determining whether an ownership change, which limits the prospective use of net operating losses, occurred under Code Section 382.  In addition, amounts furnished to financial institutions under the TARP will not be treated as income under Code Section 597.

Internal Revenue Code Section 382 provides that a corporation's deduction for net operating loss carryovers and certain built-in losses is limited after an ownership change.  An ownership change occurs with respect a corporation if, immediately after a testing date, the percentage of stock of such corporation owned by one or more 5-percent shareholders has increased by more than 50% over the lowest percentage of stock of such corporation owned by such shareholders at any time during the three-year testing period.

IRS Notice 2008-100 provides that, for purposes of applying Code Section 382, stock of a loss corporation acquired by Treasury pursuant to the CPP will not be treated as increasing Treasury's ownership in such corporation for purposes of determining whether an ownership change has occurred.  Such Notice also provides that:

• stock, other than preferred stock, issued to Treasury pursuant to the CPP and not redeemed will be considered outstanding for purposes of determining the stock ownership by 5-percent shareholders other than Treasury, increasing the threshold for subsequent transactions to effect an ownership change under Code Section 382;
• for purposes of testing whether an ownership change has occurred on or after the date the loss corporation redeems stock issued to Treasury under the CPP, the stock redeemed will be treated as if it were never issued; 
• for all federal income tax purposes, preferred stock issued to Treasury pursuant to the CPP, whether held by Treasury or another person, will be treated as preferred stock described in Code Section 1504(a)(4) and thus disregarded in determining whether an ownership change occurred under Code Section 382 and affiliation under Code Section 1504;
• warrants issued to Treasury pursuant to the CPP, whether held by Treasury or another person, will be treated as options and such options held by Treasury will not be deemed exercised for purposes of applying Code Section 382; and
• amounts contributed by the Treasury pursuant to the CPP will be included for purposes of determining the value of a loss corporation for purposes of computing the amount of any subsequent Code Section 382 limitation.

IRS Notice 2008-101 provides that amounts furnished to a financial institution under the TARP will not be treated as the provision of Federal financial assistance under Code Section 597.  Code Section 597 generally provides that Federal financial assistance is includable in income by the financial institution and that certain acquisitions are treated as taxable asset acquisitions if Federal financial assistance is provided in connection with such acquisition.