On December 1, 2011, the Franchise Tax Board (FTB) decided to begin a formal regulatory process on numerous proposed regulations¸ including Proposed Regulation 25106.5, implementing the Finnigan Rule, codified in Cal. Rev. & Tax. Code § 25135(c); and Proposed Regulation 25106.5-1, modifying the rules governing Deferred Intercompany Stock Accounts (DISAs). The FTB staff’s request to begin a formal rulemaking process on these proposed regulations comes after numerous interested parties meetings in which stakeholders provided feedback to the FTB regarding the scope and language of necessary regulatory guidance.

The interested parties process surrounding Proposed Regulation 25106.5 (Finnigan Rule) did not generate debate. However, Proposed Regulation 25106.5-1 attracted debate regarding the extent to which California’s DISA rules should conform to the federal Excess Loss Account (ELA) regime. The federal ELA provisions allow gain from an intercompany distribution in excess of basis to be deferred leading to the creation of an ELA. The distributee may make a subsequent capital contribution to the distributor to eliminate the ELA.

Similarly, Proposed Regulation 25106.5-1 allows a subsequent capital contribution to cure a California DISA. However, the FTB has declined to agree that a liquidation can cure a DISA to the same extent that it can cure an ELA under the federal consolidated return rules. Hopefully, these issues and others will be resolved in the formal regulatory process that is expected to begin soon.