Sec. 382 requires a taxpayer corporation to track the ownership shifts among “five percent shareholders.” If the positive shifts among such shareholders exceed 50 percent over the lowest percentage of stock held by such shareholders within the applicable testing period, then the result is an ownership change that will limit the taxpayer’s ability to use its net operating losses (NOLs) and other attributes after that ownership change. The determination of what constitutes a five percent shareholder and how such shareholders are tracked is governed by a complex set of Treasury regulations. For Sec. 382 purposes, the five percent ownership threshold for tracking is concerned with economic ownership (which person holds the rights to dividends, proceeds on liquidation, etc.).

Public vs. Privately Held Corporations

The regulations under Sec. 382 provide a number of simplifying conventions and assumptions to enable taxpayers to comply with the mandates of Sec. 382 without the process becoming exceedingly cumbersome. However, there is a natural difference between a privately held corporation and one that is publicly traded. In the case of a privately held corporation, the taxpayer ought to have actual knowledge of all shareholders on all testing dates when Sec. 382 consequences need to be determined. This knowledge will typically be in the form of a stock registry or stock ledger. Thus, when determining five percent shareholders of a privately held corporation, the taxpayer will typically be able to rely on actual knowledge and the simplifying conventions and assumptions are available mostly to further help the taxpayer.

In the case of a publicly traded corporation, the taxpayer is not likely to have that information. If the taxpayer is an SEC registrant, SEC filing rules generally require any person who acquires more than five percent of the beneficial ownership of a company’s stock to file an SEC Schedule 13D, Statement of Beneficial Ownership or 13G, Short Form Statement of Beneficial Ownership, as appropriate. Temp. Regs. Sec. 1.382-2T(k)(1) allows a taxpayer to rely on the existence or absence of the Schedule 13D and 13G filings on testing dates to establish those persons who have a direct ownership interest of five percent or more. This provision ostensibly simplifies the process for the taxpayer, who can turn to an established source for information on the company’s ownership. However, the SEC filings are concerned with beneficial ownership, while Sec. 382 tracks changes in economic ownership. Although these interests can be co-extensive, they are not necessarily the same. This becomes especially problematic with SEC filings by investment advisers.

The Investment Adviser SEC Filing Conundrum

Section 202(a)(11) of the Investment Advisers Act of 1940 defines an investment adviser as any person who … engages in the business of advising others … as to the value of securities or as to the advisability of investing in, purchasing or selling securities or who, for compensation and as part of a regular business, issues or promulgates analyses or reports concerning securities.

An investment adviser within the meaning of the Investment Advisers Act who has beneficial ownership of more than five percent of a corporation’s stock must file a Schedule 13D or 13G, the same as an individual or corporation with a direct beneficial and economic ownership interest. However, the investment adviser may well not be the true economic owner of the stock it reports as beneficially owning.

Example: L Co. is an SEC registrant with 1,000 shares of common stock issued and outstanding on Date 1. X, an individual, files on Date 1 reporting a 10 percent beneficial ownership interest of 100 shares. Y, Inc., a corporation, also files on Date 1 and reports a 20 percent beneficial ownership interest of 200 shares. Z, LP, an investment adviser, also files on Date 1 and reports a six percent beneficial ownership interest of 60 shares. There are no other SEC filings that shed further light on the other 640 shares on Date 1.

In the case of X and Y, it is reasonable to conclude that their beneficial interests of 10 percent and 20 percent, respectively, are equal to their economic interests. Thus, for Sec. 382 purposes, the taxpayer would report X and Y as owning economic interests of 10 percent and 20 percent, respectively. (The prudent practitioner should also note that Y is a “first-tier entity” and should perform a lookthrough analysis to make sure there are no indirect owners who need to be separately tracked as five
percent shareholders.)

Z presents the problem. If Z were an investment adviser to a single person who had economic ownership of all 60 shares, then the proper treatment would be to track that person as a five percent shareholder (subject to possible lookthrough rules if the person were a first-tier entity and not an individual) and the remaining 640 shares would be treated as owned by a direct public group (due to the absence of more SEC filings). However, if Z were an investment adviser to a group of unrelated persons, none of whom economically owned at least 50 shares, then the proper treatment would be to add the 60 shares to the direct public group of L for a total of 700 shares in the direct public group as of Date 1.

This creates the issue of how a practitioner should interpret information in SEC Schedules 13D and 13G, especially when the filer is an investment adviser. Ordinarily, a practitioner would look to Item 6 on the filing (“Ownership of more than five percent on behalf of another person”) or to ward the end of the filing or even perhaps an attached statement, to see if there are further details on the persons advised by the investment adviser who have economic ownership. However, often there is no additional information or the answers provided are ambiguous.

Letter Ruling 200747016

There had been no additional guidance on the issue of how to address this aspect of SEC filings until the Service issued Letter Ruling 200747016. The lengthy ruling addressed 12 different SEC Schedule 13G filing scenarios and ruled on the proper interpretation of such forms for Sec. 382 purposes. Although a letter ruling is not precedential authority, this is the first published material addressing this frequently encountered issue and the general method in which the IRS chose to analyze the 12 filers merits scrutiny. In general, the 12 different filers fell into one of three classes discussed in more detail below.

SEC Filers Who Provide No Additional Information and Taxpayer Has No Actual Knowledge

Assume, from the above example, that the SEC Schedule 13G for Z lists beneficial ownership of 60 shares, but there is no further detail in either Item 6 of the filing (which states “not applicable”) or any attached schedule or elsewhere in other SEC filings, from which to determine true economic ownership. In addition, L has no actual knowledge in its own records and has not made any further inquiries with Z.

This situation is similar to that of Filers 2, 4 and 5 in Letter Ruling 200747016. The IRS ruled that in such circumstances, because the SEC filer failed to indicate that it had no economic ownership, the filing must be taken into account. In other words, the assumption is that the beneficial ownership is, in fact, economic ownership in the absence of additional evidence to rebut the assumption.

SEC Filers Who Provide No Additional Information but Taxpayer Has Actual Knowledge

Assume, from the above example, that the SEC Schedule 13G for Z lists beneficial ownership of 60 shares and there is no further detail in either Item 6 of the filing (which states “not applicable”) or any attached schedule or elsewhere in other SEC filings, from which to determine true economic ownership. L, however, sends an e-mail to Z and gets written confirmation that it is only an adviser and that its clients, none of whom owns five percent or more of such stock, have economic ownership.

Conclusion

The letter ruling does not provide more detail on the SEC filings, so it is difficult to match the many different manifestations of an SEC filing with the select, redacted group of filers addressed in the ruling. However, there appears to be an overall theme with respect to how the Service treats filers who are investment advisers. If there is no additional information in the filing or additional actual knowledge, then the letter ruling appears to stand for the proposition that beneficial ownership will be treated as economic ownership for Sec. 382 purposes, notwithstanding the fact that the filer is an investment adviser. Also, even if there is no additional information in the SEC filings, a taxpayer can ask beneficial owners for additional information (and document it) about economic ownership. The weight and probity of that additional information can then be determined to reach similar conclusions on economic ownership for Sec. 382 purposes.

Greg A. Fairbanks, J.D., LL.M., Washington, DC, is a contributing writer for The Tax Adviser. His views as expressed in this article do not necessarily reflect the views of the AICPA or The Tax Adviser.