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As it emerges from bankruptcy, commercial lender CIT uses the tax code to shield its net operating losses from a technical "change of ownership."
Robert Willens, CFO.com | US
December 28, 2009
CIT Group Inc. has emerged from bankruptcy with its stock in the hands of its creditors and with its debt substantially diminished. The reduction of its debt has given rise to substantial amounts of cash on delivery income, which, because it was realized while CIT was under court jurisdiction in a Title 11 case, will be excluded from the company's gross income. (Apparently, CIT will not be making a Section 108(i) election to defer the realization of this COD income.)
However, in these cases, the debtor's "tax attributes" (most notably, its net operating losses) must be reduced by the amount of the excluded COD income. This reduction is made after the tax is determined for the year in which the debt discharge takes place. Nevertheless, despite the large amount of COD income, it's not sufficient to absorb the entirety of CIT's NOLs. As a result, CIT is taking steps to "protect" those residual NOLs against further erosion.
To that end, the company has adopted a charter amendment that provides that any attempted transfer of its stock prior to the "restriction release date" shall be void ab initio, to the extent that, as a result of such transfer: (1) any person shall become a "five percent shareholder" of the company or (2) the percentage of stock ownership interest of any 5% shareholder shall be increased.
With the institution of these restrictions — which can be waived at the discretion of the board of directors — the company is attempting to prevent an ownership change. To be sure, an ownership change occurs when one or more of the loss corporation's 5% shareholders increase their percentage ownership of the loss corporation's stock by more than 50 percentage points relative to their lowest percentage ownership of the loss corporation's stock at any time during the "testing period." In this case, the testing period should begin no earlier than the day following the date of emergence from bankruptcy.
The restriction release date may occur imminently. Therefore, the date is the earlier of (1) the date that is 45 days after the second anniversary of the effective date and (2) the date on which the board determines that (a) the plan does not satisfy Section 382(l)(5) of the tax code or Section 382(l)(5) is not in the "best interests" of the company, (b) an ownership change would not result in a substantial limitation on the ability of the company to use "tax benefits," or (c) no significant value attributable to tax benefits would be preserved by continuing the restrictions.
The tax code's Section 382(l)(5) applies when a loss corporation experiences an ownership change while under the jurisdiction of a court in a "Title 11 or similar case" (a receivership, foreclosure, or similar proceeding in a federal or state court) and the corporation's old shareholders and "qualified creditors" own, after such ownership change, at least 50% of the loss corporation's stock, by both voting power and value.
So, apparently the restrictions will be lifted if the company determines that (1) it is not eligible for the benefits of Section 382(l)(5) or (2) it is so eligible, but the company would be better served by "electing out" of Section 382(l)(5).
If Section 382(l)(5) applies, the corporation's preownership change losses will not be subject to the Section 382 limitation. Thus, such losses can offset unlimited amounts of taxable income for any year ending after the change date. However, Section 382(l)(5) is not an unmitigated positive. Indeed, if an ownership change qualifies under Section 382(l)(5), the loss corporation must reduce the absolute amount of its NOLs by interest paid or accrued during a specified period1 on debt converted into stock in the bankruptcy arrangement. In addition, under Section 382(l)(5)(D), the corporation's NOLs will be entirely lost if it undergoes a second ownership change within two years of the one that occurred as a result of the bankruptcy.
Thus, it appears that CIT has not yet determined whether its ownership change qualifies under Section 382(l)(5) and, if it does, whether it makes sense to elect out of the section's benefits. The good news is that if Section 382(l)(5) is found unavailable or unattractive, the company will, at that point, lift the restrictions on the trading of its stock.
Contributing editor Robert Willens, founder and principal of Robert Willens LLC, writes a weekly tax column for CFO.com.
1 The period from the beginning of the third taxable year preceding the year in which the ownership change occurs through and including the change date.