IRC 382 is considered as one of the Code’s most complex sections enacted for preventing “trafficking” in Net Operating losses (NOLs). This section limits the utilization of corporate NOLs against profits in the event of an “ownership change”, hence is of critical importance for corporations with significant NOLs. In the context of this section, an ownership change is defined as more than 50% change in ownership of stock involving 5% shareholders within three year period, occurring as a result of a merger, significant funding or other shifts in equity ownership structure. However, it is important to note that this change in ownership has to be calculated in terms of the fair market value and not the % of equity stake held based on outstanding shares.
If an ‘ownership change’ event is triggered under IRC 382, the ability of a company to utilize NOLs is dependent upon its assessed value at time such change as the limit on utilization of NOLs is calculated by multiplying the value of ‘loss corporation’ with long term tax-exempt rate. Therefore, the lower the value of ‘loss corporation’, lower the resulting limitation; restricting its ability to utilize NOLs against future income in future years.
In addition, IRC 382 rules prescribe certain limitations for calculating the value of ‘loss corporation’ like capital contribution limitation (generally referred as the “anti-stuffing” rule), which requires an analysis of capital contributions for a period of three years preceding the date of ownership change. Equally, the IRS has also issued notices that provide limited relief and improve ability of profitable entities to utilize the target loss corporation’s tax attributes to offset its income in future years.
Hence, in order to assess the availability of NOLs under IRC 382, companies need to conduct a detailed analysis of changes in capital and ownership structure over a three-year period as well as valuation of the company at different dates. Given the complexities involved, companies should be cautious in relying on rough estimations and other short cuts to determine applicability of IRC 382.
Aranca’s in-depth understanding of tax provisions, extensive experience of dealing with complex capital structures and expertise in business valuation services can help companies to deal with the challenges posed by IRC 382. Our highly qualified professionals work collaboratively with clients to ensure that they stay compliant with the rules and achieve effective corporate tax planning.