[Federal Register Volume 73, Number 97 (Monday, May 19, 2008)]
[Proposed Rules]
[Pages 28765-28767]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: E8-11174]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[REG-100798-06]
RIN 1545-BF28


Contributed Property

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking.

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SUMMARY: These proposed regulations under section 704(c) of the 
Internal Revenue Code (Code) provide that the section 704(c) anti-abuse 
rule takes into account the tax liabilities of both the partners in a 
partnership and certain direct and indirect owners of such partners. 
The proposed regulations further provide that a section 704(c) 
allocation method cannot be used to achieve tax results inconsistent 
with the intent of subchapter K of the Code. The proposed regulations 
affect partnerships and their partners.

DATES: Written or electronic comments and requests for a public hearing 
must be received by August 18, 2008.

ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-100798-06), Room 
5203, Internal Revenue Service, POB 7604, Ben Franklin Station, 
Washington, DC 20044. Submissions may be hand-delivered Monday through 
Friday between the hours of 8 a.m. and 4 p.m. to: CC:PA:LPD:PR (REG-
100798-06), Courier's Desk, Internal Revenue Service, 1111 Constitution 
Avenue, NW., Washington, DC. Alternatively, taxpayers may submit 
comments electronically via the Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-100798-06).

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Laura Fields or Steven A. Schmoll at (202) 622-3050; concerning 
submissions of comments, and hearing requests, e-

[[Page 28766]]

mail [email protected], (202) 622-7180 (not toll-
free numbers).

SUPPLEMENTARY INFORMATION: 

Background

    Under section 704(c), a partnership must allocate items of income, 
gain, loss and deduction attributable to contributed property to take 
into account any variation between the property's adjusted tax basis 
and its fair market value at the time of contribution. Section 1.704-
3(a) permits the use of any reasonable allocation method that is 
consistent with the purposes of section 704(c). Section 1.704-3 
provides three allocation methods that are generally reasonable and 
consistent with the purposes of section 704(c): The traditional method, 
the traditional method with curative allocations and the remedial 
method.
    Section 1.704-3(a)(10) provides that an allocation method (or 
combination of methods) is not reasonable if the contribution of 
property (or event that results in reverse section 704(c) allocations) 
and the corresponding allocation of tax items with respect to the 
property are made with a view to shifting the tax consequences of 
built-in gain or loss among the partners in a manner that substantially 
reduces the present value of the partners' aggregate tax liability (the 
anti-abuse rule).
    In 2003, the Staff of the Joint Committee on Taxation (JCT) 
prepared The Report of Investigation of Enron Corporation and Related 
Entities Regarding Federal Tax and Compensation Issues, and Policy 
Recommendations (JCS-3-03), February 2003 (Enron Report). As part of 
the Enron Report, the JCT considered a transaction identified as 
``Project Condor.'' See Enron Report, pgs. 208-221. Responding to the 
Enron Report, Congress enacted section 755(c) in the American Jobs 
Creation Act of 2004, Public Law 108-357 (118 Stat. 1418) to address 
the unwarranted tax benefits for transactions similar to Project 
Condor.
    In addition to the legislative recommendation, the Enron Report 
states that the rules of section 704(c) should not be used by related 
parties to shift basis among assets in the manner attempted in Project 
Condor. Although the Enron Report noted that the anti-abuse rule of 
Sec.  1.704-3(a)(10) ``* * * should apply to preclude the tax benefits 
Project Condor purported to generate,'' the Enron Report recommended 
strengthening the anti-abuse rule relating to ``* * * partnership 
allocations for property contributed to a partnership, especially in 
the case of partners that are members of the same consolidated group to 
ensure that the allocation rules are not used to obtain unwarranted tax 
benefits.'' See Enron Report, pg. 220.
    These proposed regulations address the JCT recommendation by 
clarifying certain aspects of the anti-abuse rule. These clarifications 
are consistent with the general principles of sections 701 and 704, and 
make conforming changes to those that were recently adopted in Sec.  
1.704-1(b)(2)(iii).

Explanation of Provisions

    Under the anti-abuse rule, an allocation method (or combination of 
methods) is not reasonable if the contribution of property and the 
corresponding allocation of tax items with respect to the property are 
made with a view to shifting the tax consequences of built-in gain or 
loss among the partners in a manner that substantially reduces the 
present value of the partners' aggregate tax liability. Failing to 
consider a substantial reduction in the present value of an indirect 
partner's tax liability when analyzing the reasonableness of an 
allocation method would be inconsistent with the purposes of section 
704(c) because it would allow a partnership to adopt a tax-advantaged 
allocation method if the tax advantages of the method accrued to an 
indirect partner, rather than a direct partner. Accordingly, Sec.  
1.704-3(a)(10) is amended to provide that, for purposes of applying the 
anti-abuse rule, the tax effect of an allocation method (or combination 
of methods) on both direct and indirect partners is considered. The 
proposed regulations provide that an indirect partner is any direct or 
indirect owner of a partnership, S corporation, or controlled foreign 
corporation (as defined in section 957(a) or 953(c)), or direct or 
indirect beneficiary of a trust or estate, that is a partner in the 
partnership, and any consolidated group of which the partner in the 
partnership is a member (within the meaning of section 1.1502-1(h)). 
However, an owner of a controlled foreign corporation is treated as an 
indirect partner only with respect to the allocation of items that 
enter into the computation of a United States shareholder's inclusion 
under section 951(a) with respect to the controlled foreign 
corporation, enter into any person's income attributable to a United 
States shareholder's inclusion under section 951(a) with respect to the 
controlled foreign corporation, or would enter into the computations 
described in this paragraph if such items were allocated to the 
controlled foreign corporation.
    The Treasury Department and IRS believe that this amendment merely 
confirms the proper application of the anti-abuse rule contained in the 
existing regulations. This clarifying addition is consistent with the 
recent modification to Sec.  1.704-1(b)(2)(iii) (substantiality test) 
confirming that, for purposes of the substantiality test, the tax 
consequences to an owner of a look-through entity that is a partner in 
the partnership must be taken into account when evaluating an 
allocation to such partner.
    These proposed regulations further provide that the principles of 
section 704(c), together with the allocation methods described in Sec.  
1.704-3, paragraphs (b), (c) and (d), apply only with respect to the 
contributions of property to the partnership. In that regard, the anti-
abuse rule of Sec.  1.701-2(b) provides that, if a partnership is 
formed or availed of in connection with a transaction a principal 
purpose of which is to reduce substantially the present value of the 
partners' Federal tax liability in a manner inconsistent with the 
intent of subchapter K, the IRS may recast the transaction for federal 
tax purposes as appropriate to achieve tax results that are consistent 
with the intent of subchapter K. Thus, even though a transaction may 
satisfy the literal words of the statute or regulations, the IRS may 
recast a transaction as appropriate to avoid tax results that are 
inconsistent with the intent of subchapter K, including but not limited 
to: (i) Disregarding purported partnerships, in whole or part, so that 
partnership assets are treated as owned by the partner; (ii) 
disregarding one or more contributions or (iii) disregarding one or 
more purported partners. The proposed regulations also provide that, in 
determining if a purported contribution of property to a partnership 
should be recast to avoid results that are inconsistent with subchapter 
K, one factor that may be relevant is the use of the remedial method in 
which allocations of remedial items of income, gain, loss or deduction 
are made to one partner and allocations of offsetting remedial items 
are made to a related partner.

Proposed Effective Date

    These regulations are proposed to apply for taxable years beginning 
after the date of publication of the Treasury decision adopting these 
rules as final regulations in the Federal Register. No inference should 
be drawn from this effective date with respect to prior law.

[[Page 28767]]

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It has also 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these regulations, and because 
the regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this notice of proposed 
rulemaking has been submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Comments and Public Hearing

    Before the proposed regulations are adopted as final regulations, 
consideration will be given to any written (a signed original and eight 
(8) copies) or electronic comments that are submitted timely to the 
IRS. The IRS and Treasury Department request comments on the clarity of 
the proposed rules and how they can be made easier to understand. All 
comments will be available for public inspection and copying. A public 
hearing will be scheduled if requested in writing by any person that 
timely submits written comments. If a public hearing is scheduled, 
notice of the date, time, and place for the public hearing will be 
published in the Federal Register.

Drafting Information

    The principal authors of these proposed regulations are Laura 
Fields and Steven A. Schmoll, Office of the Associate Chief Counsel 
(Passthroughs and Special Industries), IRS. However, other personnel 
from the IRS and Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR part 1 is proposed to be amended as follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read, 
in part, as follows:

    Authority: 26 U.S.C. 7805 * * *

    Par. 2. Section 1.704-3 is amended by:
    1. Adding five sentences to paragraph (a)(1) at the end of the last 
sentence and revising paragraph (a)(10) to read as follows.
    The revisions and additions read as follows:


Sec.  1.704-3  Contributed property.

    (a) * * * (1) * * * The principles of this paragraph (a)(1), 
together with the methods described in paragraphs (b), (c) and (d) of 
this section, apply only to contributions of property that are 
otherwise respected. See Sec.  1.701-2. Accordingly, even though a 
partnership's allocation method may be described in the literal 
language of paragraphs (b), (c) or (d) of this section, based on the 
particular facts and circumstances, the Commissioner can recast the 
contribution as appropriate to avoid tax results inconsistent with the 
intent of subchapter K. One factor that may be considered by the 
Commissioner is the use of the remedial allocation method by related 
partners in which allocations of remedial items of income, gain, loss 
or deduction are made to one partner and the allocations of offsetting 
remedial items are made to a related partner. The preceding four 
sentences are effective for taxable years beginning after the date of 
publication of the Treasury decision adopting these rules as final 
regulation in the Federal Register.
* * * * *
    (10) Anti-abuse rule--(i) In general. An allocation method (or 
combination of methods) is not reasonable if the contribution of 
property (or event that results in reverse section 704(c) allocations) 
and the corresponding allocation of tax items with respect to the 
property are made with a view to shifting the tax consequences of 
built-in gain or loss among the partners in a manner that substantially 
reduces the present value of the partners' aggregate tax liability. For 
purposes of this paragraph (a)(10), the tax effect of an allocation 
method (or combination of methods) on direct and indirect partners is 
considered.
    (ii) Definition of indirect partner. An indirect partner is any 
direct or indirect owner of a partnership, S corporation, or controlled 
foreign corporation (as defined in section 957(a) or 953(c)), or direct 
or indirect beneficiary of a trust or estate, that is a partner in the 
partnership, and any consolidated group of which the partner in the 
partnership is a member (within the meaning of Sec.  1.1502-1(h)). An 
owner (whether directly or through tiers of entities) of a controlled 
foreign corporation is treated as an indirect partner only with respect 
to allocations of items of income, gain, loss, or deduction that enter 
into the computation of a United States shareholder's inclusion under 
section 951(a) with respect to the controlled foreign corporation, 
enter into any person's income attributable to a United States 
shareholder's inclusion under section 951(a) with respect to the 
controlled foreign corporation, or would enter into the computations 
described in this sentence if such items were allocated to the 
controlled foreign corporation.
    (iii) Effective/applicability date. The last sentence of paragraph 
(a)(10)(i), and paragraph (a)(10)(ii) of this section are effective for 
taxable years beginning after the date of publication of the Treasury 
decision adopting these rules as final regulations in the Federal 
Register.
* * * * *

Linda E. Stiff,
Deputy Commissioner for Services and Enforcement.
 [FR Doc. E8-11174 Filed 5-16-08; 8:45 am]
BILLING CODE 4830-01-P