(b) Resulting from transactions prior to consolidated return period. No deduction shall be allowed during a consolidated return period for intercompany accounts receivable or other obligations resulting from intercompany transactions during the period for which separate returns were made.

(c) Limitation on allowance after consolidated return period. The rules applicable to the allowance of losses upon the sale of bonds shall be applicable to the allowance after the consolidated return period as a bad debt of an intercompany account receivable or other obligation resulting from an intercompany transaction during the consolidated return period. (See § 4.62.) * [Art. 40]

SUBPART D-PORTION OF REGULATIONS RELATING TO CONSOLIDATED RETURNS OF AFFILIATED CORPORATIONS UNDER SECTION 141 (b) OF THE REVENUE ACT OF 1928

(Made applicable by section 113 (a) (11) of the Revenue Act of 1936) 4.71 Sale of stock; basis for determining gain or loss-(a) Scope of section. This section prescribes the basis for determining the gain or loss upon any sale or other disposition (hereinafter referred to as "sale") by a corporation which is (or has been) a member of an affiliated group which makes (or has made) a consolidated return for the taxable year 1929 or any subsequent taxable year, of any share of stock issued by another member of such group (whether issued before or during the period that it was a member of the group and whether issued before, during, or after the taxable year 1929), and held by the selling corporation during any part of a consolidated return period. (For the basis in the case of sales of bonds, see § 4.72.) The paragraphs of this section are applicable to sales during different periods of time, as follows:

(1) Sales which do not break the affiliation-paragraph (b);

(2) Sales which break the affiliation and which are made during the period that the selling corporation is a member of the affiliated group (whether or not during a consolidated return period)-paragraph (c); (3) Sales made after the selling corporation has ceased to be a member of the affiliated group-paragraph (d).

(b) Sales which do not break affiliation. If notwithstanding any such sale the issuing corporation remains a member of the affiliated group, such basis shall be determined and adjusted in the same manner as if the selling corporation and the issuing corporation had never been members of an affiliated group. (See sections 111 to 115, inclusive, of the Revenue Act of 1928, 45 Stat. 815-822.)

(c) Sales which break affiliation made while selling corporation is member of group. If the sale is made during a period during which the selling corporation is a member of the affiliated group (whether or not during a consolidated return period), and if, as a result of such sale, the issuing corporation ceases to be a member of the affiliated group, such basis shall be determined as follows:

(1) The aggregate basis of all shares of stock of the issuing corporation held by each member of the group (exclusive of the issuing corporation) immediately prior to the sale, shall be determined

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**For statutory and source citations, see note to § 4.61.

separately for each member of the group, and adjusted in accordance with the Act (see sections 111 to 115, inclusive, of the Revenue Act of 1928);

(2) From the sum of the aggregate bases, as determined in subparagraph (1) above, there shall be deducted the aggregate of the losses of such issuing corporation sustained during each of the consolidated return periods (including only the taxable year 1929 and subsequent taxable years) after such corporation became a member of the group and prior to the sale of the stock, to the extent that such losses could not have been availed of by such corporation as a net loss in computing its tax for such periods if it had made a separate return for each of such periods;

(3) The total aggregate basis of all shares of stock, after making the deduction under subparagraph (2), shall then be allocated to each member of the group which holds stock in the issuing corporation, in the ratio that the basis of each, as determined under paragraph (1), is to the sum of the bases of all;

(4) The aggregate basis as determined under subparagraph (3) for each member of the group shall then be equitably apportioned among the various classes of stock held by such member according to the circumstances of the case-ordinarily in the ratio that the basis of each class of stock held by it at the time of the sale is to the sum of the bases of each class of stock held by it;

(5) The basis of each share of stock of each class held by a member of the group shall then be determined by dividing the basis apportioned to such class under subparagraph (4) by the total number of shares of such class held by it.

Examples: (1) Application of (c) (2). Corporations P and S are affiliated and file consolidated returns showing the following gains and losses (losses indicated by parentheses):

January 1, 1933, P sells the stock of S. The adjustment to be made to the basis of the stock for losses sustained by Š during the consolidated return periods is $30,000, computed as follows:

(2) Application of (c) (3). Corporations P, S1, and S2, are affiliated and file consolidated returns for 1929, 1930, and 1931. The investments in stocks of affiliated corporations are as follows:

January 1, 1932, P sells its stock in S2. The aggregate basis of S2's stock determined under subparagraph (1) is $100,000. Assuming that the adjustment under subparagraph (2) is $20,000, the total adjusted basis becomes $80,000. Proportioning this adjustment basis to P and S1, in the ratio of the basis of each ($50,000) to the sum of the bases ($100,000), gives an adjusted basis to each of ($40,000). (d) Sales after selling corporation has ceased to be a member of the group. If the sale is made after the selling corporation has ceased to be a member of the affiliated group, such basis shall be determined in accordance with paragraph (c) of this section, except

that

(1) The aggregate basis (under subparagraph (1) of such paragraph) shall be determined for all shares of the issuing corporation held by each member of the group immediately prior to the time the selling corporation ceased to be a member of the group (rather than immediately prior to the sale); and

(2) The allocations (under subparagraph (3) of such section) shall be made to each member of the group which held stock of the issuing corporation immediately prior to the time the selling corporation ceased to be a member of the group (rather than to the members holding such stock at the time of the sale); and

(3) The basis of each share of stock held by the selling corporation (determined, as above, as of the time the selling corporation ceased to be a member of the group) shall then be adjusted in accordance with the Revenue Act of 1928 (see, particularly, sections 111 to 115, inclusive, of the Act) in order to determine the basis at the time

of the sale.

(e) Limitation on adjustment for losses. No deduction shall be made under paragraph (c) (2) of this section, in the event of a consolidated net loss which was sustained more than 2 years prior to the close of the taxable year during which the sale was made and which was not availed of by the members of the affiliated group in computing the tax for the consolidated return period, for that portion of such net loss which the losses of the subsidiary for the year in which such net loss was sustained bears to the aggregate losses of each of the members of the group.

Example: Corporations P and S are affiliated and file consolidated returns showing gains and losses, as follows:

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January 1, 1933, P sells the stock of S. In computing the adjustment to be made to the basis of the stock of S under paragraph (c) (2), no adjustment will be made for the loss for 1929, since none of the consolidated loss for that year was availed of in computing the tax for the consolidated return periods.

(f) Definition of "losses" and "net losses." As used in this section the term "losses" means the excess of the allowable deductions over the gross income, determined in accordance with the provisions of the Revenue Act applicable to the period; and the term "net loss" means a net loss determined in accordance with the provisions of the Revenue Act applicable to the period.*+ [Art 34].

*88 4.71 to 4.75, inclusive, issued under the authority contained in sec. 141 (b), 45 Stat. 831.

†The source of 88 4.71 to 4.75, inclusive, is Regulations 75, Bureau of Internal Revenue, Jan. 3, 1929.

4.72 Sale of bonds; basis for determining gain or loss. In the case of a sale or other disposition by a corporation, which is (or has been) a member of an affiliated group which makes (or has made) a consolidated return for the taxable year 1929 or any subsequent taxable year, of bonds issued by another member of such group (whether or not issued while it was a member of the group and whether issued before, during, or after the taxable year 1929), the basis of each bond, for determining the gain or loss upon such sale or other disposition, shall be determined in accordance with the Revenue Act of 1928 (see, particularly, section 113 of the Act, 45 Stat. 818), but the amount of any loss otherwise allowable shall be decreased by the excess (if any) of the aggregate of the deductions computed under § 4.71 (c) (2) over the aggregate of the basis of the stock of the issuing corporation as computed under paragraph (c) (1) or (d), as the case may be, held by the members of the affiliated group. (See, also, § 4.75, relating to disallowance of loss upon intercompany bad debts.)*† [Art. 35]

4.73 Basis of property-(a) General rule. Subject to the provisions of paragraph (b), the basis during a consolidated return period for determining the gain or loss from the sale or other disposition of property, or upon which exhaustion, wear and tear, obsolescence, and depletion are to be allowed, shall be determined and adjusted in the same manner as if the corporations were not affiliated (see sections 111 to 115, inclusive, of the Revenue Act of 1928), whether such property was acquired before or during a consolidated return period. Such basis immediately after a consolidated return period (whether the affiliation has been broken or whether the privilege to file a consoli

**For statutory and source citations, see note to § 4.71.

Page 559

dated return is not exercised) shall be the same as immediately prior to the close of such period.

(b) Intercompany transactions. The basis prescribed in paragraph (a) shall not be affected by reason of a transfer during a consolidated return period (whether by sale, gift, dividend, upon dissolution, or otherwise) from a member of the affiliated group to another member of such group.

(c) Basis not affected by acquisition or sale of stock. Neither the acquisition of stock of a corporation nor its sale or other disposition shall affect the basis of the property of such corporation for determining gain or loss or upon which exhaustion, wear and tear, obsolescence, and depletion are to be allowed.*† [Art. 38]

4.74 Inventories-(a) Consolidated return filed after separate return. Where a corporation has filed a separate return and in the succeeding taxable year is a member of an affiliated group which makes a consolidated return, the value of its opening inventory to be used in computing the consolidated net income for such succeeding taxable year shall be the proper value of the closing inventory used in computing its net income for the preceding taxable year. For example, corporation S filed a separate return for the taxable year 1928. It becomes a member of an affiliated group for the taxable year 1929. Its closing inventory for 1928 was $100,000. The opening inventory for 1929 will be $100,000, assuming that its closing inventory for 1928 was properly computed."

(b) Separate return filed after consolidated return. If a corporation has been a member of an affiliated group which has filed a consolidated return and in the succeeding taxable year files a separate return, the value of the opening inventory to be used in computing its net income for such succeeding taxable year shall be the proper value of the closing inventory used in computing consolidated net income for the preceding taxable year. For example, corporation S filed a consolidated return for 1929 and a separate return for 1930. The proper value of its closing inventory for 1929 after eliminating intercompany profits was $90,000. Accordingly its opening inventory for computing its net income for 1930 will be $90,000.*+ [Art. 39]

4.75 Bad debts-(a) Resulting from transactions during consolidated return period. Intercompany accounts receivable or other obligations which are the result of intercompany transactions during a consolidated return period shall not be deducted as bad debts during a consolidated return period.

(b) Resulting from transactions prior to consolidated return period. No deduction shall be allowed during a consolidated return period for intercompany accounts receivable or other obligations resulting from intercompany transactions during the period of filing separate returns.

(c) Limitation on allowance after consolidated return period. The rules applicable to the allowance of losses upon the sale of bonds shall be applicable to the allowance after the consolidated return period as a bad debt of an intercompany account receivable or other obligation resulting from an intercompany transaction during the consolidated return period. (See § 4.72.)*+ [Art. 40]

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**For statutory and source citations, see note to § 4.71.