The Internal Revenue Service (the “IRS”) on April 13, 2009 issued Notice 2009-38 (the “Notice”) to provide guidance to corporations whose instruments are acquired by the Treasury Department under the Capital Purchase Program of the Emergency Economic Stabilization Act (“EESA”) and the Troubled Asset Relief Program (“TARP”). The Notice clarifies the interplay of many of the bailout programs with Section 382 of the Internal Revenue Code of 1986 (the “Code”), which addresses losses following an ownership change.
Notice 2009-38 applies to corporate issuers following the Treasury’s acquisition of instruments under the Capital Purchase Program for a broad range of entities, including publicly traded issuers, private issuers, and Subchapter S corporations. It also provides guidance for an expanded list of EESA acquisition programs, including the Targeted Investment Program, the Asset Guarantee Program, the Systemically Significant Failing Institutions Program, the Automotive Industry Financing Program, and the Capital Assistance Program for publicly traded issuers (“TARP CAP”).
Notice 2009-38 states that any instrument (other than warrants) issued to the Treasury pursuant to any of the programs, except for TARP CAP, whether owned by the Treasury or subsequent holders, “shall be treated for all federal income tax purposes as an instrument of indebtedness if denominated as such, and as stock described in Section 1504(a)(4) of the Code if denominated as preferred stock.” Importantly, no instrument so denominated shall be treated as stock for purposes of Section 382 of the Code while held by the Treasury or by other holders, except that preferred stock described in Section 1504(a)(4) will be treated as stock for purposes of Section 382(e)(1). However, for any instrument issued to the Treasury under TARP CAP, the appropriate classification shall be determined by applying general principles of Federal tax law.
The Notice further indicates that the IRS will treat warrants to buy stock issued to the Treasury (with the exception of two of the programs) as options and not as stock, and not “be deemed exercised” under Treasury Regulation Section 1.382-4(d)(2). The two exceptions are the Capital Purchase Program for private issuers and the Capital Purchase Program for S corporations. For both programs, the IRS will treat any such warrant as an ownership interest in the underlying instrument: warrants for stock in the private-issuer Capital Purchase Program will be treated as an ownership interest in the underlying stock, and thus treated as preferred stock under Section 1504(a)(4); and warrants issued in the S corporation program will be treated as an ownership interest in the underlying indebtedness.
Significantly, the Notice indicates that no matter what the Treasury’s ownership of the stock is on any given date, it will not be considered to have caused the Treasury’s ownership in the issuing corporation to have increased over its lowest percentage owned on any earlier date. In general, Section 382 of the Code limits a corporation’s deduction for net operating loss carryovers and recognized built-in losses subsequent to an ownership change. An ownership change, as defined in Section 382(g) of the Code, is generally a change of 50% or more of the ownership of a corporation within a three-year period. Prior to this Notice and similar earlier guidance, the Treasury Department’s acquisition of certain stock of a corporation could have resulted in an ownership change, thereby limiting the corporation’s ability to utilize prior losses to reduce its taxable income.
Notice 2009-38 addresses the measuring of shifts in ownership by any 5 percent shareholder on any testing date occurring on or after the date on which an issuing corporation redeems its stock from the Treasury. The IRS noted that the stock so redeemed shall be treated as if it had never been outstanding. However, the stock will be considered outstanding for purposes of determining the percentage of stock owned by other 5 percent shareholders on a testing date.
Any capital contribution made by the Treasury pursuant to the EESA acquisition programs shall not be considered to have been made as part of a plan a principal purpose of which was to avoid or increase any Section 382 limitation, by for instance, artificially increasing the value of the loss corporation. Also, any amount received by an issuer in exchange for instruments issued to the Treasury under the EESA acquisition programs is treated as received, in its entirety, as consideration for such instruments.
Corporations may choose to rely on the rules described in the Notice, as the guidance is optional for taxpayer use. Moreover, the rules will continue to apply “unless and until there is additional guidance.” The federal tax consequences of instruments not described in the Notice will continue to be determined based upon the application of general principles of Federal tax law. Notice 2009-38 supersedes and amplifies Notice 2009-14, which provided similar guidance but was unable to address subsequently developed programs.