There are different sections of the ICFR, which defines the rules and regulations for liquidating subsidiary corporations and the role of the parent corporation. These provisions include section 331, section 332, section 334, and section 337. All these sections define the process of liquidating and the legal procedures that both parent and subsidiary corporations should follow. These legal procedures include the requirements that the two corporations need to meet for them to qualify for non-recognition. All the properties that parent corporation receive from Subsidiary Corporation may or not qualify for non-recognition depending whether the two corporations meet all the other requirements.
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In this case, the parent corporation has owned 60 percent of the single class stock of the subsidiary corporation for several years. Tyrone owns the rest 40 percent of the subsidiary corporation stock. On August 10, 2010, the parent corporation purchases the stock owned by Tyrone for cash. This is followed by liquidation plan adopted by the subsidiary corporation on September 15 the same year and finally a single liquidating distribution on October 1, 2010. The subsidiary then continues operating as a separate division of the subsidiary.
Section 331 of the Company Act defines the general rules of treating distribution after the liquidation of a subsidiary corporation. This section treats the amount of stock one corporation receives as a result of a full liquidation of another corporation just like full compensation in exchange of stock to the other corporation. Section 1001 provides the method for calculating loss or gain from such receipt. Section 332 of ICFR provides exception from the general rule some properties that one corporation receives under some circumstances as a complete liquidation of another corporation (Internal Revenue Code, 2011). If a property meets all the statutory requirements, this section also provides for recognition of loss or gain from such property. However, section 367 places some limitation to the provision of section 332 especially when dealing with foreign corporations. Section 334(b) provides basis for determining loss or gain from the sale of such properties, which the parent receives after complete liquidation of one corporation.
In this scenario the parent corporation initially owned sixty percent of the stock of the subsidiary corporation and intend to buy the remaining forty percent which was initially owned by Tyrone. The subsidiary then adopts the plan of liquidating by determining the distribution of the stock after the liquidation. The main question at hand is whether the subsidiary corporation will qualify for non-recognition provision as section 332 and section 337 of the ICFR provides. As seen in the legal principles applicable in this situation, “the sections treat the full payment one corporation receives after the liquidation of another corporation as full payment in exchange of stock that purchasing corporation receives” (Internal Revenue Code, 2011). This payment does not qualify for non-recognition provision provided by section 332. The section treats any gain or loss the purchasing company gains like any other receipt that a company may receive and therefore does not qualify for non-recognition. Section 332(b) “deems the corporation that is receiving the property of the liquidating corporation to have received that property after the redemption or complete cancellation of the stock of the subsidiary corporation” (S-Corporation, 2011). As this section further stipulates, there is no recognition of loss or gain on the side of the receiving corporation when distributing the assets of the subsidiary. However, it is important to note that there is recognition of the loss or gain if the subsidiary corporation does not finish distribution within a period of three years. This rule also applies if the receiving corporation does not meet all the other statutory requirements.
Section 337 has provisions for corporate level exceptions, which stipulate that no recognition for loss or gain from a corporation that is distributing its property to a distributee with 80 percent stock interest. According to this provision, the parent corporation should own at least 80 percent of the total stock voting power for it to qualify for non-precognition requirements. In this case, the parent corporation owns only 60 percent of the total stock voting power before liquidation of the subsidiary corporation. This may make it not to qualify for complete non-recognition. The parent corporation in this scenario meets the other requirements for non-recognition such as timing of the liquidation, which it must provide, liquidation plan and ensuring that the subsidiary corporation remains in liquidation during distribution period. The provision of section 332 does not cover the parent corporation because it only owns sixty percent of the total stock during the time of liquidation. In this scenario, the subsidiary continues to operate separately from the parent corporation even after liquidation. Section 332 requires the subsidiary corporation to remain in liquidation state during the whole period of distribution (S-Corporation, 2011). Thus for the subsidiary corporation to continue operating as a separate division from the parent corporation is not in accordance with this requirement.
The timing of the liquidation should strictly adhere to the liquidation plan. The parent corporation starts by purchasing the remaining forty percent of the stock initially owned by the Tyrone in August. Next is the espousal of the liquidation plan in September after the parent company has leveraged all the shares of the subsidiary corporation. This action of purchasing all the stock is necessary since liquidation law does not allow a corporation to adopt the liquidation plan before the parent corporation attains the adequate percentage of the total stock. Attaining adequate share proportion will increase its voting power, which is required during the process of adopting the liquidation plan. After adopting the liquidation plan, the distribution process starts in the month of October. Proper timing is necessary for the corporation to qualify for non-recognition requirement. Section 337 requires that the liquidation process should take place within a given time bound for it to meet the entire requirements for non-recognition.
According to the provision of section 332, the parent corporation may not fully qualify for non-recognition requirements. For the corporation to qualify for this requirement, it must own at least 80 percent of the total stock interest. In this case, however, the corporation does not meet this requirement since it owns only sixty percent of the total stock interest. Therefore, it is necessary for the parent corporation to look for ways to increase its ownership of the total stock interest before liquidation of the subsidiary corporation. The parent corporation has met all the other requirements to qualify for the non-recognition provisions such as the proper timing, ensuring the subsidiary corporation remains in liquidity state for entire period of distribution among others. As it is evident in this case, meeting some requirements of non-recognition and missing others does not qualify the parent corporation for this provision and thus it is necessary for it to meet all the requirements. As provided in section 332 about the status of the subsidiary corporation, it is necessary for it to remain in liquidation for the whole period of distribution for it to qualify for non-recognition (S-Corporation, 2011). This means that for Subsidiary Corporation to remain in this status during distribution period, the parent corporation needs to assume all the operations of the subsidiary corporation including E & P balance. Thus, it is a requirement for the parent corporation to assume this balance for the corporations to qualify for non-recognition.
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It is very important for the parent corporation to ensure it meets all the requirements for it to qualify for non-recognition during the process of liquidating Subsidiary Corporation. Section 332 of the ICFR provides all the requirements necessary for Parent Corporation to qualify for non-recognition and section 337 provide exceptions on the same provision. In this case, though the parent corporation has met most of the requirements, there are some requirements that make it not to qualify for non-recognition. It is therefore necessary for the parent corporation to raise its ownership to eighty percent for it to qualify non-recognition requirement before the full liquidation of the subsidiary corporation. The subsidiary corporation also needs to stop operating as a separate division of the parent corporation for it to qualify for the non-recognition provision. This will include letting the parent corporation to assume E & P balance of the subsidiary corporation.
Internal Revenue Code. (2011). 26 CFR 1.332-1 – Distributions in liquidation of Subsidiary Corporation; general. Code of Federal Regulations – Title 26: Internal Revenue. Web.
S-Corporation. (2011). Liquidations of Controlled Subsidiaries. Web.