[Congressional Record Volume 153, Number 96 (Thursday, June 14, 2007)]
[Senate]
[Pages S7743-S7745]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. BAUCUS (for himself and Mr. Grassley):
  S. 1624. A bill to amend the Internal Revenue Code of 1986 to provide 
that the exception from the treatment of publicly traded partnerships 
as corporations for partnerships with passive-type income shall not 
apply to partnerships directly or indirectly deriving income from 
providing investment adviser and related asset management services; to 
the Committee on Finance.
  Mr. BAUCUS. Mr. President, I am pleased to join my friend and 
colleague, Senator Grassley, in introducing legislation to preserve the 
corporate tax base.
  The Federal Government taxes corporations. The tax law treats 
corporations as economic entities, and taxes them separately from the 
corporation's shareholders. And the tax law treats partnerships 
differently from corporations.
  Recently, some private equity and hedge fund entities have sought to 
go public without paying a corporate tax. The bill that we introduce 
today would treat all publicly traded partnerships that directly or 
indirectly receive income from providing investment advisory or asset 
management services as corporations. The tax law ought to treat as 
corporations entities that function as corporations.
  Congress enacted the publicly traded partnership rules in 1987 to 
preserve the corporate tax base. Congress was concerned that publicly 
traded partnerships might be able to enjoy the privilege of going 
public like a corporation without the corporate toll charge. The House 
committee report stated:

       These changes [referring to the corporate minimum tax 
     included in the 1986 Act] reflect an intent to preserve the 
     corporate level tax. The committee is concerned that the 
     intent of these changes is being circumvented by the growth 
     of publicly traded partnerships that are taking advantage of 
     an unintended opportunity for disincorporation and elective 
     integration of the corporate and shareholder levels of tax.

  Congress carved out an exception for those partnerships that receive 
90 percent or more of their income from passive income. Passive income 
includes dividends, rents, royalties, interest, and the sale of capital 
gains. But Congress generally treated publicly traded partnerships that 
derive income from active businesses as corporations.
  To emphasize that point, in 1987, the House committee report stated:

       In general, the purpose of distinguishing between passive-
     type income and other income is to distinguish those 
     partnerships that are engaged in activities commonly 
     considered as essentially no more than investments, and those 
     activities more typically conducted in corporate form that 
     are in the nature of active business activities.

  This year, some private equity and hedge fund management firms are 
attempting to qualify for partnership tax treatment. They seek to do so 
even though they derive virtually all of their income from providing 
asset management and financial advisory services. These management 
firms argue that they are able to achieve this result by claiming that 
all of their income from asset management and investment advisory 
services is passive. But objective observers would say that this income 
actually arises from active businesses. Congress's intent in 1987 was 
to treat such publicly traded partnerships as corporations. In the 
legislation that we introduce today, we seek to ensure that Congress's 
original intent is carried out.
  This legislation is also important to ensure that some corporations 
are not disadvantaged because they conduct business in the corporate 
form and pay taxes as a corporation. Asset management service and 
investment advisory partnerships provide the same types of active 
business services as their corporate competitors. Our tax system 
functions best when it is fair. The tax law ought to treat similarly 
situated taxpayers the same. Thus, these publicly traded partnerships 
should be taxed as corporations.
  The legislation that we introduce today would clarify the purpose of 
the publicly traded partnership rules. Our bill would deny the ability 
of an active financial advisory and asset management business to go 
public and avoid a corporate level tax on a significant amount of its 
income.
  Senator Grassley and I have asked the staff of the Treasury 
Department for their views on these transactions, how they plan to 
address this issue, and whether they think additional statutory changes 
are necessary to clarify the intent of the publicly traded partnership 
rules. If a statutory change is needed, then this legislation will 
accomplish that change. If a change is not needed, then this 
legislation does not alter the ability of Treasury Department and the 
Internal Revenue Service to issue guidance and enforce congressional 
intent.
  I urge my colleagues to join with Senator Grassley and me to protect 
the original intent of Congress, to protect the tax base, and to treat 
similarly situated entities similarly. I urge my colleagues to support 
this bill.
  I ask unanimous consent that the text of the bill and an explanation 
and reasons for change be printed in the Record.
  There being no ojection, the material was ordered to be printed in 
the Record, as follows:

                                S. 1624

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. EXCEPTION FROM TREATMENT OF PUBLICLY TRADED 
                   PARTNERSHIPS AS CORPORATIONS NOT TO APPLY TO 
                   PARTNERSHIPS DIRECTLY OR INDIRECTLY DERIVING 
                   INCOME FROM PROVIDING INVESTMENT ADVISER AND 
                   RELATED ASSET MANAGEMENT SERVICES.

       (a) In General.--Section 7704(c) of the Internal Revenue 
     Code of 1986 (relating to exception for partnerships with 
     passive-type income) is amended by adding at the end the 
     following new paragraph:
       ``(4) Exception not to apply to partnerships providing 
     certain investment adviser and related asset management 
     services.--This subsection shall not apply to any partnership 
     which directly or indirectly has any item of income or gain 
     (including capital gains or dividends), the rights to which 
     are derived from--
       ``(A) services provided by any person as an investment 
     adviser (as defined in section 202(a)(11) of the Investment 
     Advisers Act of 1940, 15 U.S.C. 80b-2(a)(11)) or as a person 
     associated with an investment adviser (as defined in section 
     202(a)(17) of the Investment Advisers Act of 1940, 15 U.S.C. 
     80b-2(a)(17)), or
       ``(B) asset management services provided by any person 
     described in subparagraph (A) (or any related person) in 
     connection with the management of assets with respect to 
     which services described in subparagraph (A) were provided.
     For purposes of subparagraph (A), the determination as to 
     whether services provided by any person were provided as an 
     investment adviser shall be made without regard to whether 
     the person is required to register as an investment adviser 
     under the Investment Advisers Act of 1940.''.
       (b) Effective Date.--
       (1) In general.--Except as provided in paragraph (2), the 
     amendment made by this section shall apply to taxable years 
     of a partnership beginning on or after June 14, 2007.
       (2) Transition rule for certain partnerships.--In the case 
     of a partnership--
       (A) the interests in which on June 14, 2007, were--
       (i) traded on an established securities market, or
       (ii) readily tradeable on a secondary market (or the 
     substantial equivalent thereof), or
       (B) which, on or before June 14, 2007, filed a registration 
     statement with the Securities and Exchange Commission under 
     section 6 of the Securities Act of 1933 (15 U.S.C. 77f) which 
     was required solely by reason of an initial public offering 
     of interests in the partnership,
     the amendment made by this section shall apply to taxable 
     years of the partnership beginning on or after June 14, 2012. 
     Subparagraph (B) shall not apply to a registration statement 
     which is filed with respect to securities which are to be 
     issued on a delayed or continuous basis (as determined under 
     the rules of the Securities and Exchange Commission 
     promulgated under such Act).

[[Page S7744]]

     
                                  ____
  A. Treatment of Publicly Traded Partnerships Directly or Indirectly 
  Deriving Income From Investment Adviser Services and Related Asset 
                          Management Services


                              Present Law

       Under present law, a publicly traded partnership generally 
     is treated as a corporation for Federal tax purposes (sec. 
     7704(a)). For this purpose, a publicly traded partnership 
     means any partnership if interests in the partnership are 
     traded on an established securities market, or interests in 
     the partnership are readily tradable on a secondary market 
     (or the substantial equivalent thereof).
       An exception from corporate treatment is provided for 
     certain publicly traded partnerships, 90 percent or more of 
     whose gross income is qualifying income (sec. 7704(c)(2)). 
     However, this exception does not apply to any partnership 
     that would be described in section 851 (a) if it were a 
     domestic corporation, which includes a corporation registered 
     under the Investment Company Act of 1940 as a management 
     company or unit investment trust.
       Qualifying income includes interest, dividends, and gains 
     from the disposition of a capital asset (or of property 
     described in section 1231 (b)) that is held for the 
     production of income that is qualifying income. Qualifying 
     income also includes rents from real property, gains from the 
     sale or other disposition of real property, and income and 
     gains from the exploration, development, mining or 
     production, processing, refining, transportation (including 
     pipelines transporting gas, oil, or products thereof), or the 
     marketing of any mineral or natural resource (including 
     fertilizer, geothermal energy, and timber). It also includes 
     income and gains from commodities (not described in section 
     1221 (a)(1)) or futures, options, or forward contracts with 
     respect to such commodities (including foreign currency 
     transactions of a commodity pool) in the case of partnership, 
     a principal activity of which is the buying and selling of 
     such commodities, futures, options or forward contracts.


                           Reasons for Change

       The rules generally treating publicly traded partnerships 
     as corporations were enacted in 1987 to address concern about 
     long-term erosion of the corporate tax base. At that time, 
     Congress stated, ``[t]o the extent that activities would 
     otherwise be conducted in corporate form, and earnings would 
     be subject to two levels of tax (at the corporate and 
     shareholder levels), the growth of publicly traded 
     partnerships engaged in such activities tends to jeopardize 
     the corporate tax base.'' (H.R. Rep. No. 100-391, 100th 
     Cong., 1st Sess. 1065.) Referring to recent tax law changes 
     affecting corporations, the Congress stated, ``[t]hese 
     changes reflect an intent to preserve the corporate level 
     tax. The committee is concerned that the intent of these 
     changes is being circumvented by the growth of publicly 
     traded partnerships that are taking advantage of an 
     unintended opportunity for disincorporation and elective 
     integration of the corporate and shareholder levels of tax.'' 
     (H.R. Rep. No. 100-391, 100th Cong., 1st Sess. 1066.)
       These same concerns hold true today, as industry sectors 
     that have never conducted business as publicly traded 
     partnerships start to shift into that form of doing business. 
     News reports have called attention to transactions set in 
     motion in recent months in which partnerships earning income 
     from investment adviser and related asset management services 
     made or will make their interests available on an exchange or 
     market. This trend causes deep concern about preservation 
     of the corporate tax base as it presages the transfer of 
     corporate assets to publicly traded partnerships. When 
     corporate assets are moved to partnership form without 
     relinquishing that hallmark of corporate status, access to 
     capital markets, some businesses are able to lower their 
     cost of capital at the expense of the Federal Treasury. 
     This result subverts a principal purpose and policy of the 
     present-law rules treating publicly traded partnerships as 
     corporations: to preserve the corporate tax base.
       To the extent these transactions represent a trend toward 
     increased utilization of publicly traded partnerships in the 
     case of businesses earning income from investment adviser and 
     related asset management services, there is the additional 
     concern of distortions caused by inconsistent treatment under 
     the tax law. The present-law exception in the case of 
     partnerships, 90 percent or more of whose gross income is 
     qualifying income, is not intended to encompass income from 
     investment adviser and related asset management services. The 
     bill serves to address this troubling trend by strengthening 
     the rules treating publicly traded partnerships as 
     corporations.


                        Explanation of Provision

       The bill provides generally that the exception from 
     corporate treatment for a publicly traded partnership, 90 
     percent or more of whose gross income is qualifying income, 
     does not apply in the case of a partnership that directly or 
     indirectly derives income from investment adviser services or 
     related asset management services. Thus, such a partnership 
     is treated as a corporation for Federal tax purposes and is 
     subject to the corporate income tax.
       Under the bill, the exception from corporate treatment for 
     a publicly traded partnership does not apply to any 
     partnership that, directly or indirectly, has any item of 
     income or gain (including capital gains or dividends), the 
     rights to which are derived from services provided by any 
     person as an investment adviser, as defined in the Investment 
     Advisers Act of 1940, or as a person associated with an 
     investment adviser, as defined in that Act. Further, the 
     exception from corporate treatment does not apply to a 
     partnership that, directly or indirectly, has any item of 
     income or gain (including capital gains or dividends), the 
     rights to which are derived from asset management services 
     provided by an investment adviser, a person associated with 
     an investment adviser, or any person related to either, in 
     connection with the management of assets with respect to 
     which investment adviser services were provided. For purposes 
     of the bill, these determinations are made without regard to 
     whether the person is required to register as an investment 
     adviser under the Investment Advisers Act of 1940. In the 
     absence of regulatory guidance as to the definition of a 
     related person, it is intended that the definition of a 
     related person in section 197(f)(9)(C)(i) apply.
       For example, a publicly traded partnership that has income 
     (including capital gains or dividend income) from a profits 
     interest in a partnership, the rights to which income are 
     derived from the performance of services by any person as an 
     investment adviser, is treated as a corporation for Federal 
     tax purposes under the bill. As a further example, a publicly 
     traded partnership that receives a dividend from a 
     corporation that receives or accrues income, the rights to 
     which are derived from services provided by any person as an 
     investment adviser, is treated as a corporation for Federal 
     tax purposes under the bill.
       Under the Investment Advisers Act of 1940 definition, an 
     investment adviser means any person who, for compensation, 
     engages in the business of advising others, either directly 
     or through publications or writings, 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. Under this 
     definition, exceptions are provided in the case of certain 
     banks, certain brokers or dealers, as well as certain others, 
     provided criteria specified in that Act are met. These 
     exceptions apply for purposes of the bill. No inference is 
     intended that income from activities described in the 
     exceptions is qualifying income for purposes of section 7704.


                             Effective Date

       The bill generally is effective for taxable years of a 
     partnership beginning on or after June 14, 2007.
       Under a transition rule for certain partnerships, the bill 
     applies for taxable years beginning on or after June 14, 
     2012. The transition rule applies in the case of a 
     partnership the interests in which on June 14, 2007, were 
     traded on an established securities market, or were readily 
     tradable on a secondary market (or the substantial equivalent 
     thereof). In addition, the transition rule generally applies 
     in the case of a partnership which, on or before June 14, 
     2007, filed a registration statement with the Securities and 
     Exchange Commission under section 6 of the Securities Act of 
     1933 (15 U.S.C. 77f) that was required solely by reason of an 
     initial public offering of interests in the partnership. 
     However, the transition rule does not apply if the 
     registration statement is filed with respect to securities 
     that are to be issued on a delayed or continuous basis 
     (pursuant to Rule 415 under the Securities Act of 1933). 
     Thus, a shelf registration on or before June 14, 2007, of 
     interests in a partnership does not cause the partnership to 
     be eligible for the transition rule. Rather, in the case of 
     such a partnership, the bill is effective for taxable years 
     of the partnership beginning on or after June 14, 2007.

  Mr. GRASSLEY. Mr. President, this legislation that Senator Baucus and 
I are introducing addresses an important issue--preserving the 
integrity of the Tax Code. Recent public offerings, effected and 
announced, by private equity and hedge fund management firms have 
raised serious tax concerns that if left unaddressed have the potential 
to fundamentally reduce the corporate tax base over the long run, 
leading other individuals and business taxpayers with a greater share 
of the Nation's tax burden.
  Congress enacted the publicly traded partnership rules in 1987 out of 
concern with erosion of the corporate tax base. Given the ease with 
which taxpayers can choose the type of entity for their business, an 
appropriate ``bright line'' to define entities that should be subject 
to a corporate level tax was considered to be those entities that are 
publicly traded. A hallmark of corporate status is access to public 
markets. Another concern was that the ability to be publicly traded 
without paying an entity level tax would create an unwarranted 
competitive advantage over publicly traded corporations.
  These concerns--corporate tax base erosion and a tax-created 
competitive advantage--were not considered to be implicated in cases 
where the partnership's income is from passive investments because 
investors could earn

[[Page S7745]]

such income directly--e.g., interest--or because the income is already 
subject to a corporate level tax--e.g., dividends. The following key 
quote from the legislative history illustrates this point:

       In general, the purpose of distinguishing between passive-
     type income and other income is to distinguish those 
     partnerships that are engaged in activities commonly 
     considered as essentially no more than investments, and those 
     activities more typically conducted in corporate form that 
     are in the nature of active business activities.

  The recent and proposed public offerings of private equity and hedge 
fund management firms claim to qualify for partnership tax treatment, 
even though virtually all of their income is derived from providing 
asset management and financial advisory services. This result is 
claimed to be accomplished by structuring service fees in a way that 
purports to characterize those fees as passive-type income. Whether or 
not these structures comply with the letter of the law, they are 
inconsistent with the purposes of the publicly traded partnership 
rules.
  This legislation clarifies the purpose of the publicly traded 
partnership rules by denying the ability of an active financial 
advisory and asset management business to go public and avoid a 
corporate level tax on a significant amount of its income. Senator 
Baucus and I have asked Treasury for their views on these structures, 
how they plan to address this issue, and whether they think additional 
statutory changes are necessary to clarify the intent of the publicly 
traded partnership rules. If a change is necessary, this legislation 
will accomplish that change. If a change isn't necessary, this 
legislation does not alter the ability of Treasury and the Internal 
Revenue Service to issue guidance and enforce Congressional intent.
  In his introductory remarks, Senator Baucus gave a technical 
description of this legislation and reasons for change, which reflects 
my understanding and intent in introducing this bill.
                                 ______