April 17, 2014

Worthless Stock Deductions: Valuation, Transfer Pricing and Technical Considerations

When a multinational enterprise (MNE) has affiliates that have become insolvent, the overall tax planning objective frequently is to secure a U.S. tax deduction (often ordinary) for worthless stock or debt.  The essential requirement to qualify for such treatment is that the owner of the stock receive no assets on a hypothetical liquidation.  There are a number of transfer pricing and valuation issues that should be taken into account to ensure a full and consistent determination, and to mitigate potential exposure upon examination.

When a multinational enterprise (MNE) has affiliates that have become insolvent for one reason or another, the overall tax planning objective frequently is to secure a U.S. tax deduction (often ordinary) for worthless stock or debt under Section 165(g)(3).  (If the requirements of this section cannot be satisfied, a liquidation of a subsidiary corporation would be a capital transaction under Section 331 or the potential stock loss would be eliminated under Section 332,which would have entirely different U.S. tax consequences.)  The essential requirement to qualify for such treatment is that the owner of the stock receive no assets on a hypothetical liquidation.  In determining whether this is the case, a variety of valuation and transfer pricing issues can be taken into account, as indicated by the following illustration.


USCo is a U.S.-based MNE engaged in the development, production, distribution and servicing of Unique Products.  In the United States, USCo files a consolidated income tax return with its affiliates.  The U.S. corporate structure is as follows:


ProdCo is responsible for the production process for Unique Products.  It has U.S. subsidiaries that handle various aspects of the supply chain.  B (which may be a domestic or foreign subsidiary) is believed to be insolvent, and ProdCo would like to claim an ordinary worthless stock deduction under Section 165(g)(3).

The financial statement of B is as follows:


In such a situation, the availability of a Section 165(g)(3) and/or a Section 166 deduction will depend upon a variety of valuation, transfer pricing and technical matters.


  • Valuation of assets (book versus fair market value)
  • Valuation of liabilities, such as discounts for aging, collectability and so on
  • Others depending on the situation

Transfer Pricing

  • Do accounts receivable and payable meet arm’s-length requirements under Section 482?
  • Are there guarantees or other inter-company matters to be addressed?
  • Are historic transfer pricing arrangements arm’s length under Section 482—i.e., is there any basis for a belief that B received inadequate returns on its functions and risks, or paid excessive amounts to affiliates?
  • Others depending on the situation

Technical Tax

  • What is the “identifiable event” that triggers the worthlessness determination?
  • Does B have sufficient active gross receipts to qualify the deduction as ordinary in character?
  • Is B worthless for Section 165(g)(3) purposes?
  • Are B’s inter-company obligations wholly or partially worthless?
  • Are B’s inter-company obligations properly treated as debt or equity?
  • Will ProdCo receive so much as a “peppercorn” (a very small payment, a nominal consideration, used to satisfy the requirements for the creation of a legal contract) of consideration in its capacity as a shareholder (as opposed to other capacities)?
  • If B is a member of the USCo consolidated group, how do the unified loss rules apply?
  • Others depending on the situation

This newsletter was developed with contributions from Carlo Carpino, director of American Appraisal’s financial valuation practice.  American Appraisal has teamed with McDermott’s international tax and transfer pricing practice to deliver transfer pricing solutions on a global basis.

© 2014 McDermott Will & Emery

About the Author

Chief Economist, Transfer Pricing

A. Tracy Gomes is Chief Economist for the Transfer Pricing practice in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Houston office.

Tracy advises firm clients on a range of tax matters relating to international transfer pricing and competent authority proceedings, as well as the valuation of intellectual property, business enterprises and financial products.  He has particular experience in the valuation of technology and brand intangibles.


About the Author


Cym H. Lowell is a partner in the law firm of McDermott Will & Emery LLP and is based in the Firm’s Houston office.

Cym advises multinational companies and high-net-worth individuals based in the United States and around the world on a broad spectrum of tax planning and controversy matters.  He is Vice-Chairman of the International Chamber of Commerce Taxation Commission (based in Paris), as well as a member of the Business and Industry Advisory Committee to the OECD (also based in Paris) and U.S. Council of Business.  On behalf of his clients, Cym has handled...


Boost: AJAX core statistics

Legal Disclaimer

You are responsible for reading, understanding and agreeing to the National Law Review's (NLR’s) and the National Law Forum LLC's  Terms of Use and Privacy Policy before using the National Law Review website. The National Law Review is a free to use, no-log in database of legal and business articles. The content and links on are intended for general information purposes only. Any legal analysis, legislative updates or other content and links should not be construed as legal or professional advice or a substitute for such advice. No attorney-client or confidential relationship is formed by the transmission of information between you and the National Law Review website or any of the law firms, attorneys or other professionals or organizations who include content on the National Law Review website. If you require legal or professional advice, kindly contact an attorney or other suitable professional advisor.  

Some states have laws and ethical rules regarding solicitation and advertisement practices by attorneys and/or other professionals. The National Law Review is not a law firm nor is  intended to be  a referral service for attorneys and/or other professionals. The NLR does not wish, nor does it intend, to solicit the business of anyone or to refer anyone to an attorney or other professional.  NLR does not answer legal questions nor will we refer you to an attorney or other professional if you request such information from us. 

Under certain state laws the following statements may be required on this website and we have included them in order to be in full compliance with these rules. The choice of a lawyer or other professional is an important decision and should not be based solely upon advertisements. Attorney Advertising Notice: Prior results do not guarantee a similar outcome. Statement in compliance with Texas Rules of Professional Conduct. Unless otherwise noted, attorneys are not certified by the Texas Board of Legal Specialization, nor can NLR attest to the accuracy of any notation of Legal Specialization or other Professional Credentials.

The National Law Review - National Law Forum LLC 4700 Gilbert Ave. Suite 47 #230 Western Springs, IL 60558  Telephone  (708) 357-3317 If you would ike to contact us via email please click here.