Bankruptcy’s Corporate Tax Loophole
44 Pages Posted: 5 Apr 2014 Last revised: 28 May 2014
Date Written: 2014
Imagine you are a company with a failing business that is drowning in debt. On the bright side, you also possess a very valuable asset. This asset is unique because, unlike most assets, if you liquidate the business through a Chapter 7 bankruptcy, it will be extinguished and its value will not be realized by any shareholders or creditors. On the other hand, even if you substantially liquidate the business using Chapter 11, you can, thanks to an extraordinary ambiguity in the law, preserve this valuable asset. Even better, you can direct the value of this asset to your preferred stakeholders — whether they are shareholders or creditors — rather than have the asset’s value allocated among stakeholders according to bankruptcy’s absolute priority rule. You can do this because you have the most information about this valuable asset and because bankruptcy law and courts effectively ignore its existence, leaving you to allocate its value as you see fit. What is this unique asset? Valuable tax attributes, including net operating losses and credit carryovers. This scenario is not purely hypothetical; Solyndra and Washington Mutual, among others, have effectively used Chapter 11 to divert the value of tax losses and credits to a select group of shareholders and creditors in contravention of bankruptcy‘s distributional norms. This Article recommends statutory revisions to the tax and bankruptcy laws to remove the unintended tax advantage and thus neutralize the tax consequences of corporate restructuring decisions.
Keywords: Corporate Bankruptcy, Chapter 11, Corporate Taxation
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