Information Release

CFT 2004-02
CORPORATE FRANCHISE TAX INFORMATION RELEASE – The franchise tax effects of the IRC section 338(h)(10) election - Issued June, 2004

The purpose of this information release is to explain how making the Internal Revenue Code (IRC) section 338(h)(10) election impacts the Ohio corporation franchise tax, including certain tax credits. This information release does not change any portion of the Department of Taxation’s previously established policy regarding the franchise tax effects of the IRC section 338(h)(10) election.

Federal Income Tax Effects of the IRC 338(h)(10) Election

  • The IRC 338(h)(10) election permits the seller (S) of a controlled subsidiary (here referred to as the target (old T)), and the purchasing corporation (P) to treat S’s sale of T stock as if T sold its assets to itself as a newly-formed entity (new T) while T was still a member of S’s consolidated group. Old T is then deemed to liquidate tax free into S under IRC section 332.
  • Old T files its final federal return in consolidation with S for old T’s taxable year ending on the date of the sale. Old T must include in that return the income from the deemed sale of assets to new T. That is, T recognizes gain on the deemed sale of assets to itself while still a member of the S’s consolidated group.
  • New T begins a new federal taxable year on the day following the deemed asset sale.
  • New T is the same legal entity as old T and carries on the business with the same federal employer identification number.
  • S recognizes no gain on its sale of T stock to P.
  • Following the deemed asset sale, new T takes a stepped-up basis in the assets. The stepped-up basis reflects the purchase price of the stock along with the liabilities assumed. Following the election, new T depreciates the stepped-up basis.
  • Following old T’s deemed liquidation into S, the tax attributes of old T carry over to S pursuant to IRC section 381. Thus, for federal income tax purposes, S generally can claim T’s unused NOLs, capital loss carryovers, credit carryovers, and other federal income tax attributes.

    Franchise Tax Effects of the IRC section 338(h)(10) Election

    Note: A taxpayer is not required (nor can it elect) to make a separate 338(h)(10) election for Ohio franchise tax purposes. If the taxpayer makes the federal election, then that election applies for purposes of the Ohio corporation franchise tax to the extent set out below.
  • For franchise tax purposes T is not considered a new taxpayer following the federal 338(h)(10) election because old T and new T are the same legal entity.
  • Pursuant to Ohio Revised Code section (R.C.) 5733.031 and Administrative Rules 5703-5-01 through 5703-5-04, T must combine the federal taxable incomes for the two short period federal taxable years and include that income on one franchise tax report.
  • T must recognize gain from the deemed sale of assets, and T can depreciate the stepped-up basis of the assets resulting from that deemed sale.
  • S recognizes no gain from its sale of T stock.
  • T is not subject to the R.C. 5733.06(H) “exit tax,” and neither T nor S is subject to the R.C. 5733.053 transferor statute.
  • All of T’s franchise tax attributes (such as Ohio NOL carryforwards and credit carryforwards) remain with T.
  • For purposes of the R.C. 5733.33 manufacturer’s credit, the 338(h)(10) deemed sale of assets is ignored. Therefore, following the deemed sale any remaining 1/7 manufacturer’s credit amounts that were generated from T’s purchases of qualifying equipment in a purchase year prior to the date of the 338(h)(10) election are not disallowed under R.C. 5733.33(C)(4). (However, if T subsequently sells the assets, or if T moves the assets from the county for which the credit is computed before the end of the seven year period over which the credit is claimed, and if those assets are not fully depreciated at the time the assets are sold or moved from the county, then any remaining 1/7 credit amounts are lost).
  • For all purchases of qualifying equipment on or after January 1, 2001, corporations that are related by more than a 50% ownership interest must compute the R.C. 5733.33 manufacturer’s credit on a consolidated basis. For purposes of computing the consolidated credit the members of a qualifying controlled group are determined on January 1 of the tax year immediately following the purchase year regardless of whether those same corporations were members of that qualifying controlled group prior to that date.

    Because T is a member of P’s qualifying controlled group on January 1 following the date of the 338(h)(10) election, T and P (along with all the other members of P’s qualifying controlled group on that date) must determine the R.C. 5733.33 manufacturer’s credit on a consolidated basis for the purchase year that includes the date of the 338(h)(10) election. So, in computing the consolidated credit for each Ohio county for the purchase year that includes the date of the 338(h)(10) election the sum of T’s purchases of qualifying equipment for the county prior to and after the 338(h)(10) election are consolidated with those of P (and with the qualifying purchases of all the other members of P’s qualifying controlled group on January 1 following the date of the 338(h)(10) election), and T’s purchases of new manufacturing equipment for each Ohio county during the related baseline years are consolidated with those of P (and with those of all the other members of P’s qualifying controlled group on January 1 following the date of the 338(h)(10) election).
  • For the purchase year that includes the date of the 338(h)(10) election, S may not determine the R.C. 5733.33 manufacturer’s credit in consolidation with T because T is not a member of S’s qualifying controlled group on January 1 following the 338(h)(10) election.

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1. The term “qualifying equipment” as used in this information release means “new manufacturing machinery and equipment,” (R.C. 5733.33(A)(2)), which is purchased during the “qualifying period” (R.C. 5733.33(A)(4)) beginning July 1, 1995 and ending December 31, 2015.
2. The term “purchase year” as used in this information release means the period July 1, 1995 to December 31, 1995 and each of the calendar years 1996 through 2015 in which the taxpayer purchased qualifying equipment for which the credit is computed.
3. R.C. 5733.33(C)(4) provides in relevant part as follows: “Except for carried-forward amounts, the taxpayer is not allowed any credit amount remaining if the new manufacturing machinery and equipment is sold by the taxpayer or partnership or is transferred by the taxpayer or partnership out of the county before the end of the seven-year period unless, at the time of the sale or transfer, the new manufacturing machinery and equipment has been fully depreciated for federal income tax purposes.”
4. R.C. 5733.33(I) provides that a “qualifying controlled group” must compute the manufacturers’ credit on a consolidated basis “as if as if all corporations in the group were a single corporation. . .”
5. R.C. 5733.04(M) defines a qualifying controlled group as “two or more corporations that satisfy the ownership and control requirements of division (A) of section 5733.052 of the Revised Code.”

 

Example

S – Seller and old parent corporation that sold its stock in T
P – Purchaser and new parent corporation that purchased T stock.
T – Target corporation whose stock was sold by S and purchased by P.
Old T and new T are the same legal entity and the same franchise taxpayer.