[Federal Register Volume 84, Number 57 (Monday, March 25, 2019)]
[Proposed Rules]
[Pages 11005-11009]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-05545]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-135671-17]
RIN 1545-BO44
Partnership Transactions Involving Equity Interests of a Partner
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations to amend final
regulations that prevent a corporate partner from avoiding corporate-
level gain through transactions with a partnership involving equity
interests of the partner or certain related entities. These regulations
affect partnerships and their partners.
DATES: Comments and requests for a public hearing must be received by
June 24, 2019.
ADDRESSES: Send submissions to: CC:PA:LPD:PR (REG-135671-17), Room
5203, Internal Revenue Service, P.O. Box 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-
135671-17), Courier's Desk, Internal Revenue Service, 1111 Constitution
Avenue NW, Washington, DC 20224, or sent electronically, via the
Federal eRulemaking Portal at http://www.regulations.gov (IRS REG-
135671-17).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
Kevin I. Babitz, (202) 317-6852, or Mary Brewer, (202) 317-6975;
concerning submission of comments or to request a public hearing,
Regina L. Johnson at (202) 317-6901.
SUPPLEMENTARY INFORMATION:
Background and Explanation of Provisions
This notice of proposed rulemaking contains amendments to the
Income Tax Regulations (26 CFR part 1) under section 337(d) of the
Internal Revenue Code (Code) set forth in Sec. 1.337(d)-3 (final
regulations) that prevent a corporate partner from using a partnership
to avoid recognition of corporate-level gain. The final regulations
largely adopted proposed regulations (REG-149518-03) published in the
Federal Register (80 FR 33451) on June 12, 2015 (2015 regulations) with
minor, nonsubstantive clarifying changes in response to requests for
further certainty in the single comment letter received on the proposed
regulations. See the Explanation of Provisions section of the preamble
to TD 9833 (83 FR 26580 (June 8, 2018)) for a detailed discussion of
each of the specific points raised in the comment letter received on
the 2015 regulations.
The rules set forth in this notice of proposed rulemaking contain
substantive modifications to the final regulations relating to the
definition of Stock of the Corporate Partner. Accordingly, the Treasury
Department and the IRS determined it appropriate to publish these
modifications in the form of new proposed regulations to afford the
public the opportunity to submit additional comments.
1. Stock of the Corporate Partner: Attribution
The final regulations apply to certain partnerships that hold stock
of a Corporate Partner. For this purpose, a Corporate Partner is
defined as a person that holds or acquires an interest in a partnership
and that is classified as a corporation for federal income tax
purposes. The final regulations define Stock of the Corporate Partner
expansively to include stock and other equity interests, including
warrants, other options, and similar interests, either in the Corporate
Partner or in a corporation (referred to in this Background and
Explanation of Provisions section as a Controlling Corporation) that
controls the Corporate Partner within the meaning of section 304(c),
except that section 318(a)(1) and (3) would not apply. Stock of the
Corporate Partner also includes an interest in any entity to the extent
that the value of the interest is attributable to Stock of the
Corporate Partner.
The final regulations adopted a definition of Stock of the
Corporate Partner that was modified as compared to the definition in
the regulations that the Treasury Department and the IRS proposed on
December 15, 1992 (PS-91-90, REG-208989-90, 1993-1 CB 919) (1992
proposed regulations). The final regulations broadened the definition
of Stock of the Corporate Partner with respect to the relationship
needed for a Controlling Corporation to be treated as controlling the
Corporate Partner (using a modified section 304(c) standard instead of
section 1504(a)) but also narrowed the definition, generally excluding
sister corporations and subsidiary corporations of the Corporate
Partner from being treated as Controlling Corporations.
More specifically, the final regulations define Stock of a
Corporate Partner by including stock and other
[[Page 11006]]
equity interests of any corporation that controls the Corporate Partner
within the meaning of section 304(c), except that section 318(a)(1) and
(3) shall not apply (section 304(c) control). In contrast, the 1992
proposed regulation's definition was limited to stock or other equity
interests issued by the Corporate Partner and its ``section 337(d)
affiliates''--that is any corporation that is a member of an affiliated
group as defined in section 1504(a) of the Code without regard to
section 1504(b).
Section 304(c) control generally exists when there is ownership of
stock of a corporation possessing at least 50 percent of the total
combined voting power of all classes of the corporation's stock
entitled to vote or at least 50 percent of the value of the shares of
all classes of stock of the corporation, while control of a corporation
under section 1504(a)(2) requires ownership of stock of the corporation
possessing at least 80 percent of the total voting power of the stock
of the corporation and at least 80 percent of the total value of the
stock of the corporation. The Treasury Department and the IRS adopted
this lower ownership threshold for determining control in the final
regulations as a more appropriate standard for this purpose because
General Utilities repeal could more easily be avoided by acquiring
stock of a corporation that owns less than 80 percent of the vote and
value of the Corporate Partner's stock. See General Utilities &
Operating Co. v. Helvering, 296 U.S. 200 (1935).
While section 304(c) incorporates the constructive ownership rules
of section 318(a) with some modifications, the 2015 regulations
excluded the application of section 318(a)(1) and (3) from their
definition of control.
The commenter that submitted the only comment on the 2015
regulations demonstrated that families could use the exclusion of
section 318(a)(1) attribution from the determination of section 304(c)
control to structure transactions using partnerships to eliminate gain
on appreciated assets or contravene the purposes of section 337(d) in
other ways. For example--
Husband owns 90 percent of corporation A, which owns 49 percent
of Corporate Partner (CP). Wife owns 90 percent of corporation B,
which also owns 49 percent of CP. CP owns an interest in partnership
PRS. Under these facts, because the 2015 regulations determined
section 304(c) control without applying the section 318(a)(1) family
attribution rule, neither A nor B control CP. Accordingly, other
partners in Partnership could contribute stock of A and B to PRS in
exchange for an interest in PRS without triggering gain to A or B.
The Treasury Department and the IRS agree with the commenter that
excluding section 318(a)(1) attribution from the determination of
section 304(c) control could produce unintended results. In addition,
the Treasury Department and the IRS have determined that taxpayers can
structure transactions to take advantage of the exclusion of section
318(a)(3) attribution from the determination of section 304(c) control.
For example, in the preceding fact pattern, if the interests held by
Husband and Wife were instead held by a single corporation, X, neither
A nor B would control CP without the application of section 318(a)(3)
attribution.
As a result, the Treasury Department and the IRS propose to modify
the definition of Stock of the Corporate Partner to eliminate the
exclusion of section 318(a)(1) and (3) attribution from the
determination of section 304(c) control. However, as explained below,
the Treasury Department and the IRS propose to limit this expanded
definition of Stock of the Corporate Partner to entities that own a
direct or indirect interest in the Corporate Partner.
The exclusion of attribution under sections 318(a)(1) and 318(a)(3)
in the 2015 regulations and the final regulations was intended to limit
section 304(c) control to entities that own a direct or indirect
interest in the Corporate Partner, while excluding entities that do not
own a direct or indirect interest in the Corporate Partner. To
implement this intent more precisely, the Treasury Department and the
IRS propose to limit the proposed scope of section 304(c) control to
ownership, direct or indirect, of an interest in the Corporate Partner.
For the purpose of testing direct or indirect ownership of an interest
in the Corporate Partner, ownership of Stock of the Corporate Partner
would be attributed to an entity under section 318(a)(2) (except that
the 50-percent ownership limitation in section 318(a)(2)(C) would not
apply) and under section 318(a)(4), but otherwise without regard to
section 318. Thus, sections 318(a)(1), 318(a)(3), and 318(a)(5) would
not apply for determining whether an entity directly or indirectly owns
an interest in Stock of the Corporate Partner, but once an entity is
found to directly or indirectly own an interest in such stock, then the
section 304(c) control definition would apply in its entirety to
determine whether the tested entity is a Controlling Corporation. The
Treasury Department and the IRS continue to study the appropriate scope
of the definition of Stock of the Corporate Partner, and request
comments regarding these provisions.
2. Definition of Stock of the Corporate Partner: Affiliated Groups
These proposed regulations, if finalized, would make a second
change to the definition of Stock of the Corporate Partner. The final
regulations provide that the term Stock of the Corporate Partner does
not include any stock or other equity interests held or acquired by a
partnership if all interests in the partnership's capital and profits
are held by members of an affiliated group as defined in section
1504(a) that includes the Corporate Partner (Affiliated Group
Exception). The 1992 proposed regulations included affiliate stock
within its definition of the Stock of a Corporate Partner, but the 2015
proposed regulations instead set forth this Affiliated Group Exception,
which the final regulations adopted. Thus, the final regulations do not
apply if a domestic corporation and its wholly owned domestic
subsidiaries (each of which is an includible corporation under section
1504(b)) are the only partners in a partnership and any of these
corporations contributes stock of another affiliate to a partnership.
The preamble to T.D. 9722 (80 FR 33402 (June 12, 2015)), which
contained temporary regulations that accompanied the 2015 regulations,
stated that the Treasury Department and the IRS had determined that the
Affiliated Group Exception is appropriate because ``the purpose of
these regulations is not implicated if a partnership is owned entirely
by affiliated corporations.''
After further study, the Treasury Department and the IRS have
determined that the Affiliated Group Exception may result in abuse and
therefore is not appropriate. Specifically, the Treasury Department and
the IRS believe that a partnership held entirely by members of an
affiliated group could enter into transactions that permanently
eliminate the built-in gain on an appreciated asset that one partner
contributes to the partnership. For example--
Assume that P, a corporation, owns all of the stock of S1, and
S1 owns all of the stock of CP. P, S1, and CP are members of an
affiliated group. P and CP form a 50-50 partnership; CP contributes
an appreciated asset to the partnership; and P contributes S1 stock
with basis equal to fair market value. After seven years, the
partnership liquidates and distributes the S1 stock to CP and the
appreciated asset to P. At that time, the asset may be sold outside
of the group with an artificially increased basis. The built-in gain
that was in the asset is now preserved in the S1 stock held by CP.
The group may permanently eliminate the gain without tax
[[Page 11007]]
by liquidating CP under section 332. CP would receive nonrecognition
treatment on distribution of the S1 stock to S1 under section 332,
and S1 would receive nonrecognition treatment on the receipt of its
own stock under section 1032. Thus, the liquidation of CP
permanently eliminates the built-in gain on the appreciated asset
that attached to the hook stock CP held in S1 after the liquidation
of the partnership.
This ability to increase the basis of an appreciated asset
artificially and to eliminate the built-in gain permanently contravenes
the purposes of section 337(d) and these regulations. The Treasury
Department and the IRS are also aware that practitioners have observed
that the Affiliated Group Exception runs counter to the general rule
that related-party transactions are subject to greater scrutiny. In
light of these concerns, these proposed regulations would remove the
Affiliated Group Exception contained in the final regulations.
However, because there may be specific circumstances under which
the elimination of the Affiliated Group Exception could adversely
impact ordinary business transactions between affiliated group members
and group-owned partnerships, the Treasury Department and the IRS
request comments describing situations in which a more tailored version
of the Affiliated Group Exception would be warranted.
3. Definition of Stock of the Corporate Partner: Value of an Interest
Attributable to Stock of the Corporate Partner
These proposed regulations would modify the scope of the rule in
the final regulations that Stock of the Corporate Partner includes
interests in any entity to the extent that the value of the interest is
attributable to Stock of the Corporate Partner (Value Rule). Under the
final regulations, the Value Rule applies to all interests in an entity
regardless of whether the entity is controlled by the Corporate
Partner. The sole commenter responding to the 2015 regulations agreed
that the scope of the Value Rule was appropriate if the entity was
controlled by the Corporate Partner. However, for entities that are not
controlled by the Corporate Partner, the commenter asked that the scope
of the Value Rule be narrowed to apply only if 20 percent or more of
the assets of an entity were Stock of the Corporate Partner.
The Treasury Department and the IRS agree that the Value Rule in
the 2015 regulations and the final regulations could be overbroad in
certain circumstances. For example--
Assume X, a publicly traded corporation, owns a portfolio
investment in P, a publicly traded corporation. P controls CP, a
Corporate Partner under the final regulations, within the meaning of
section 304(c); thus, P's stock is Stock of the Corporate Partner
under the final regulations. Under the Value Rule, X's stock would
be Stock of the Corporate Partner to the extent that the value of X
is attributable to Stock of the Corporate Partner. If CP contributed
appreciated property to a partnership, and another party contributed
X stock to the partnership, CP would be unable to determine whether
it had engaged in a Section 337(d) Transaction (within the meaning
of Sec. 1.337(d)-3(c)(3)) or otherwise apply the rules of the final
regulations because CP (through P) might have no way to determine
that the X stock used in the transaction could be Stock of the
Corporate Partner. Alternatively, if CP were aware that X owned a
portfolio investment in P, it would have no ability to determine the
amount of X stock that is Stock of the Corporate Partner under the
Value Rule. This is because, absent actual or constructive knowledge
(for example through required disclosures such as filings with the
Securities and Exchange Commission), a widely held corporation might
not know or have the ability to know who owns its stock.
For this reason, the Treasury Department and the IRS have
determined that narrowing the scope of the Value Rule is appropriate.
However, the Treasury Department and the IRS decline to adopt the
commenter's specific suggestion that interests in an entity not be
subject to the Value Rule unless 20 percent or more of the assets of
the entity consisted of Stock of the Corporate Partner. Such a rule
would cause the Value Rule to be overly narrow and could permit
taxpayers to structure transactions that would contravene the purpose
of section 337(d) and these regulations. Instead, the Treasury
Department and the IRS propose to narrow the scope of the Value Rule
through an alternate measure. Under the proposed regulations, if an
entity is not controlled by the Corporate Partner and is not a
Controlling Corporation, the Value Rule would apply to treat interests
in the entity as Stock of the Corporate Partner only if the entity
owns, directly or indirectly, 5 percent or more of the stock, by vote
or value, of the Corporate Partner. For this purpose, direct or
indirect ownership would mean ownership of stock that would be
attributed to a person under section 318(a)(2) (except that the 50-
percent ownership limitation in section 318(a)(2)(C) would not apply)
and under section 318(a)(4), but otherwise without regard to section
318. The Treasury Department and the IRS believe that using a 5-percent
ownership threshold is appropriate because entities have the ability to
determine whether they have 5-percent or greater owners, and
corporations may track their 5-percent shareholders for other reasons
(such as for section 382 purposes). Further, the Treasury Department
and the IRS propose to apply this 5-percent threshold to direct or
indirect stock ownership, rather than all equity interests, in the
Corporate Partner in order to make the Value Rule more readily
administrable.
The proposed regulations also would clarify how taxpayers should
apply the Value Rule to determine the extent to which the value of an
equity interest is attributable to Stock of the Corporate Partner. The
proposed regulations would provide that taxpayers would multiply the
value of the equity interest in an entity by a ratio, the numerator of
which is the fair market value of the Stock of the Corporate Partner
owned directly or indirectly by the entity and the denominator of which
is the fair market value of all of the equity interests in the entity.
For this purpose, direct or indirect ownership would mean ownership of
stock that would be attributed to a person under section 318(a)(2)
(except that the 50-percent ownership limitation in section
318(a)(2)(C) would not apply) and under section 318(a)(4), but
otherwise without regard to section 318. The proposed regulations would
also provide that the ratio may not exceed one. The Treasury Department
and the IRS determined that the fair market value of all of the equity
interests in the entity is the most appropriate measure to determine
the value of the entity because the Value Rule seeks to determine what
portion of the value of an equity interest in an entity reflects the
value of Stock of the Corporate Partner owned by that entity.
Additionally, the proposed regulations would clarify that, if an
equity interest is Stock of the Corporate Partner because it is an
interest in the Corporate Partner or in an entity with a direct or
indirect ownership interest that controls the Corporate Partner within
the meaning of section 304(c), then the Value Rule will not apply. The
Treasury Department and the IRS request comments on all aspects of the
proposed changes to the scope of the Value Rule, including the
appropriate measure of the value of the entity.
4. Exception for Certain Dispositions of Stock
Finally, these proposed regulations would make a modification to
the exception for certain dispositions of stock in Sec. 1.337(d)-
3(f)(2) to make its language consistent with the modified definition of
Stock of the Corporate
[[Page 11008]]
Partner. Under this exception, the final regulations do not apply to
Stock of the Corporate Partner that (i) is disposed of (by sale or
distribution) by the partnership before the due date (including
extensions) of its federal income tax return for the taxable year of
the relevant transaction; and (ii) is not distributed to the Corporate
Partner or a corporation that controls the Corporate Partner. With
respect to the second requirement, the final regulations refer to a
corporation that controls the Corporate Partner within the meaning of
section 304(c), except that section 318(a)(1) and (3) shall not apply.
For the same reasons that these proposed regulations modify the
definition of Stock of the Corporate Partner, these proposed
regulations also modify the second requirement of this exception to
refer to a corporation that controls the Corporate Partner within the
meaning of section 304(c), but only if the controlling corporation owns
directly or indirectly stock or another equity interest in the
Corporate Partner, in order to conform the second requirement with the
modified definition of Stock of the Corporate Partner.
Proposed Effective Date
These regulations are proposed to be effective as of the date of
their publication as final regulations in the Federal Register.
Taxpayers may rely on these proposed regulations for transactions
occurring on or after June 12, 2015 and prior to the date that these
regulations are published as final regulations in the Federal Register,
provided that the taxpayer consistently applies all of the proposed
regulations to such transactions.
Special Analyses
These proposed regulations are not subject to review under section
6(b) of Executive Order 12866 pursuant to the Memorandum of Agreement
(April 11, 2018) between the Treasury Department and the Office of
Management and Budget regarding review of tax regulations.
These proposed regulations do not impose a collection of
information on small entities. Further, pursuant to the Regulatory
Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that these
proposed regulations would not have a significant economic impact on a
substantial number of small entities. This certification is based on
the fact that these proposed regulations would primarily affect
sophisticated ownership structures with interlocking ownership of
corporations, partnerships and corporate stock. Accordingly, a
regulatory flexibility analysis is not required. Pursuant to section
7805(f) of the Internal Revenue Code, these regulations have been
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Requests for a Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to comments that are submitted timely to
the IRS as prescribed in this preamble under the ADDRESSES heading. The
Treasury Department and the IRS request comments on all aspects of the
proposed rules. All comments will be available at http://www.regulations.gov or upon request. A public hearing will be scheduled
if requested in writing by any person that timely submits written or
electronic 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 regulations are Kevin I. Babitz,
Office of the Associate Chief Counsel (Passthroughs and Special
Industries) and Mary Brewer, Office of the Associate Chief Counsel
(Corporate). However, other personnel from the Treasury Department and
the IRS 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 I--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.337(d)-3 is amended by revising paragraphs (c)(2),
(f)(2)(ii) and (i) to read as follows:
Sec. 1.337(d)-3 Gain recognition upon certain partnership
transactions involving a partner's stock.
* * * * *
(c) * * *
(2) Stock of the Corporate Partner--(i) In general. With respect to
a Corporate Partner, Stock of the Corporate Partner includes stock,
warrants and other options to acquire stock, and similar interests
(each an equity interest) in the Corporate Partner. Stock of the
Corporate Partner also includes equity interests in a corporation that
controls the Corporate Partner within the meaning of section 304(c),
and which also has a direct or indirect equity interest in the
Corporate Partner. Solely for purposes of determining whether a
corporation that controls the Corporate Partner also has a direct or
indirect equity interest in the Corporate Partner under this paragraph
(c)(2), a direct or indirect ownership of an equity interest in the
Corporate Partner includes ownership of Stock of the Corporate Partner
that would be attributed to a person under section 318(a)(2) (except
that the 50-percent ownership limitation in section 318(a)(2)(C) does
not apply) and under section 318(a)(4) (but otherwise without regard to
section 318).
(ii) Equity Interests with value attributable to Stock of the
Corporate Partner. If an equity interest in an entity is not Stock of
the Corporate Partner within the meaning of paragraph (c)(2)(i) of this
section, then the equity interest will be treated as Stock of the
Corporate Partner to the extent that the value of that equity interest
is attributable to Stock of the Corporate Partner. The preceding
sentence will apply only if either--
(A) The Corporate Partner is in control (within the meaning of
section 304(c)) of that entity; or
(B) That entity owns directly or indirectly 5 percent or more, by
vote or value, of the stock in the Corporate Partner.
(iii) Determination of value attributable to Stock of the Corporate
Partner. The value of an equity interest in an entity that is
attributable to Stock of the Corporate Partner under paragraph
(c)(2)(ii) of this section is equal to the product of--
(A) The fair market value of the equity interest; and
(B) The lesser of--
(1) The ratio of the fair market value of the Stock of the
Corporate Partner owned (directly or indirectly (as defined in
paragraph (c)(2)(i) of this section), by the entity to the fair market
value of all the equity interests in the entity; or
(2) One.
* * * * *
(f) * * *
(2) * * *
(ii) Is not distributed to the Corporate Partner or a corporation
that controls the Corporate Partner within the meaning of section
304(c) and owns directly or indirectly stock or other equity interests
in the Corporate Partner. For purposes of this paragraph (f)(2), a
[[Page 11009]]
direct or indirect ownership of an equity interest in the Corporate
Partner means ownership of Stock of the Corporate Partner that would be
attributed to a person under section 318(a)(2) (except that the 50-
percent ownership limitation in section 318(a)(2)(C) does not apply)
and under section 318(a)(4) (but otherwise without regard to section
318).
* * * * *
(i) Effective/applicability date. The regulations in this section
are effective as of the date of their publication as final regulations
in the Federal Register.
Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2019-05545 Filed 3-22-19; 8:45 am]
BILLING CODE 4830-01-P