Behind the Eight Ball, Brunswick Scratches on Tax Case

If your company is still dealing with a Section 338 tax election from years past, you may want to double check on how the Internal Revenue Service is likely to view the expected depreciation deductions. In some cases, the tax rule may have triggered some unexpected consequences, as was the case in a recent ruling against Brunswick Corporation, the consumer goods maker that manufactures products for the marine, fitness, bowling and billiards sectors.

In this particular case, the issue dates back 23 years. On Dec. 8, 1986, Brunswick acquired all of the stock of BM Corporation, an 'S' corporation, as well as all the shares of USM Corporation, a C corporation. Each acquisition constituted a "qualified stock purchase"¹ and, in connection with each acquisition, Brunswick executed an election under Section 338(g) of the U.S. tax code.²

As a result of the Section 338 election, BM and USM were first treated as having sold all of their assets as of the acquisition date (12/8/86), and then treated as new corporations that purchased all the assets of the old corporations that placed those assets in service as of the day after the acquisition, Dec. 9, 1986.

Under the tax code — and unless otherwise stated in Section 338(a)(1) and Regulation Section 1.338-1(b)(1) — the new target is treated as a new corporation that is unrelated to the old target for purposes of subtitle A of the Internal Revenue Code. In addition, on December 30, 1986, Brunswick acquired the stock of R Corporation, a C corporation. The acquisition of R Corp.'s stock also constituted a qualified stock purchase, and Brunswick executed a Section 338 election with respect to that purchase as well.³

In each case, the assets acquired by the trio of new companies (Newcos) included tangible personal property which qualified recovery property. For the 1986 tax year, Brunswick filed a consolidated income tax return that included BM, USM, and R Corp. as its members for the portion of the year beginning after their acquisitions. As Section 168(b)(1) of the tax codes was in effect at the time, the rule required taxpayers to depreciate all tangible personal property placed in service at any point during "the taxable year" as if such property was placed in service at the mid-point of such year.

An exception was noted: If the taxable year of a corporation is less than 12 months in duration, the annual depreciation deduction otherwise allowable is limited to a pro-rata portion of the annual depreciation deduction. As such, Brunswick contended that the taxable year at issue was its taxable year.

More specifically, Brunswick contended that it was entitled to calculate depreciation by applying the half-year convention method to the full taxable year. The company based the argument its use of its taxable year to control the amount of depreciation deductions, rather than the length of the taxable year for each acquired subsidiary while in Brunswick's consolidated group.

Accordingly, in Brunswick's estimation, the half-year convention applied and would allow a claim of six months of depreciation (from July 1, 1986 through Dec. 31, 1986) for the property.

The Internal Revenue Service saw it differently. The IRS argued that the Newcos' taxable year was the relevant taxable year, and they were all short taxable years. Therefore, Brunswick was entitled to only one-twelfth of the annual depreciation deduction otherwise allowable under the half-year convention. To be sure, the government reasoned that the Newcos placed in service the assets they were treated as having purchased, and the depreciation deduction with respect to those assets depended upon their short taxable years — and not on the length of Brunswick's taxable year.

Subsequently, a U.S. district court in Illinois found in favor of the IRS in Brunswick Corp. v. United States, F.Supp 2d_ (USDC N.D. Ill. 2008).

Which Corporation Purchased the Assets?
In the court case, the parties agreed that the property was placed in service by the Newcos on the day after Brunswick acquired the stock of the old corporations. After the acquisitions, each Newco was part of a consolidated group, and did not file its own tax return.

As a result, Brunswick asserted that it — not the Newcos — acquired the assets of the old corporations and therefore was entitled to claim depreciation deductions. Further, Brunswick contended that the short taxable year provision, on which the government relied, was applicable only if the consolidated group had a short taxable year, which Brunswick claimed was not the case.

But court disagreed. In fact, the court noted that under the relevant tax code provisions the Newcos, not Brusnwick, directly acquired the assets of the old corporations. The only property acquired by Brunswick was the stock in each of the old corporations.

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