sapartnership in consolidated...

THERE’S A PARTNERSHIP INMY CONSOLIDATED GROUP: OPPORTUNITIES AND PITFALLS AT THEINTERSECTION OF SUBCHAPTER KAND CONSOLIDATED RETURNS

Grace Kim, Grant Thornton LLP

Joshua T. Brady, Morgan Lewis & Bockius LLP

March 16, 2016

Agenda

• Aggregate vs. Entity Overview• Breaking Consolidation• Dividends Received Deduction and Dividend Elimination• Intercompany Transfers of Partnership Interests• Contributions to Partnerships• Sales to Partnerships• Partnership Incorporations• Anti-Abuse Rules• Sales of Partnership Interests• Interaction with Section 368 COBE and Section 355 ATB Requirements

2

Aggregate vs. Entity

3

Aggregate vs. Entity Overview:

4

• From the enactment of subchapter K in the 1954 Internal Revenue Code, it was recognized that partnerships represent a blending of two views:– For some purposes, a partnership is an aggregation of separate taxpayers

with each owning an undivided interest in the partnership's assets– For some purposes, a partnership is recognized as a separate entity

• In general, the determination of whether a partnership is to be treated as an aggregate or an entity is made in light of the purpose of the Code section in question (see, e.g., Reg. § 1.701-2(e))

Aggregate vs. Entity Overview:

5

Aggregate Approach:

• Predominates in taxation of partnership income to partners and nonrecognition provisions for contributions to, and distributions from, partnerships.

• But entity notions apply to: section 703 (computation of partnership taxable income), section 706(b) (adoption of a separate taxable year for the partnership), and section 707 (treatment of certain transactions between partners and partnerships).

Entity Approach:

• Predominates in transfers of partnership interests as transfers of interests in a separate entity rather than in the assets of the partnership.

• But aggregate notions apply to: section 751(a) (character of gain on sale of partnership interest determined by reference to character of partnership assets) and section 743(b) (adjustments made to transferee partner’s share of basis of partnership assets).

Breaking Consolidation

6

Breaking Consolidation:Affiliation Requirements

7

Section 1504(a) Ownership:

• One or more chains of includible corporations connected through stock ownership with a common parent, but only if:̶ Common parent owns directly at least 80% of the vote and

value of at least one of the other includible corporations, and ̶ At least 80% of the vote and value of the stock of each of the

includible corporations owned directly by one or more other includible corporations

Section 1504(c) Includible Corporations:

• Any corporation except:̶ Subchapter S corporations;̶ Exempt corporations;̶ Foreign corporations;̶ Life insurance companies;̶ Section 936 possession tax credit corporations;̶ RICs and REITs; and̶ DISCs

Breaking Consolidation:Partnerships with Unrelated Partner(s)

8

LLCLLC

(DRE)

P

S1

100%

100%

• P and S1 are members of the same affiliated group and can file a consolidated return with P as the common parent.

P

99%

3rd Party

S1

100%

1%

• P and S1 are not members of the same affiliated group and cannot file a consolidated return.

Breaking Consolidation:Intra-group Partnerships

9

LLC

P

S2

1%

• P, S1, S2, and S3 are members of the same affiliated group and can file a consolidated return with P as the common parent.

S2

S1

100%

99%

P

S1

100%

S3

100%

S3

100%

1%99%

100%

• P and S1 are members of the same affiliated group and can file a consolidated return with P as the common parent.

• S2 and S3 are members of a separate affiliated group and can file a consolidated return with S2 as the common parent.

• Must consider Reg. § 1.1502-13(h) anti-abuse rule.• Compare TAM 200611032 (deconsolidated factoring subsidiary

permitted) with CCA 201044003 (deconsolidated cooperative not permitted).

Breaking Consolidation:Inadvertent Partnership and Disaffiliation

10

P

100%

• If S1’s loan to LLC is treated as equity, LLC is a partnership and S2 is not a member of the P consolidated group.• See, e.g., Hambuechen v. Commissioner, 43 T.C. 90 (1964) (loans to partnership reclassified as equity).

S1

100%

S2

100%

LLC (DRE)

Loan to LLC

Dividends Received Deduction and Dividend Elimination

11

Dividends Received Deduction:Introduction

• Section 243 – Dividends from domestic corporations can be reduced as follows:

Percent Owned (Vote and Value) Deduction

Less than 20% 70%

Between 20-80% “owned by the taxpayer” 80%

Member of same affiliated group (80% or greater) 100%

12

Dividends Received Deduction:70% DRD Example

• Section 702(a)(5) provides that dividends received by a partnership retain their character as dividends to the partners.

• Section 243(a) refers to “amounts received as dividends.” No direct ownership is required.• Each of Corp A and Corp B should be entitled to a 70% DRD on their allocable share of the

dividend received by PRS.

PRS

50%50%

Corp A Corp B

Corp C

10%Dividend

13


• Should section 243(c) ownership test be applied at partner level (i.e., aggregate approach) because the “taxpayer” is the corporate partner claiming the deduction?

• No direct authority. But see Rev. Rul. 71-141 (section 902 credit available to corporate partner indirectly owning 20% of stock of foreign corporation through partnership).

• If aggregate approach applies, each of Corp A and Corp B should be entitled to an 80% DRD on their allocable share of the dividend received by PRS.

PRS

50%50%

Corp A Corp B

Corp C

100%Dividend

14


• S1 is a member of the P consolidated group.• P should eliminate dividend received directly from S1 under Reg. § 1.1502-13(f)(2)

and make corresponding basis reduction to its S1 stock under Reg. § 1.1502-32.• Corp A should be entitled to a 70% DRD on its allocable share of the dividend received by PRS. • P should be entitled to a 100% DRD on its allocable share of the dividend received by PRS

under section 243(b)(1) (100% DRD if dividend is received by a corporation that is a member of the same affiliated group as the corporation distributing such dividend).

PRS

50%50%

P

S1

90%

Dividends

15

10%

Corp A

Intercompany Transfersof Partnership Interests

16

Intercompany Transfers:Example 1 – Sale of Minority Interest with § 754 Election

17

PRSw/ 754

Facts:• On January 1, Year 1, S sells its PRS interest to B at a $15 gain. PRS has a section 754 election in effect.• During Years 1-15, PRS amortizes the Intangible Asset, and B’s amortization deductions from PRS reflect the increase

in the basis of the Intangible Asset under section 743(b).Analysis:

• Under Reg. § 1.1502-13(c) (the matching rule), in each of Years 1-15, S takes into account $1 of its $15 gain to reflect the difference between B’s $1 amortization deduction (B’s corresponding item) and the $0 amortization deduction B would have been entitled to if it succeeded to S’s $0 basis in the PRS interest (B’s recomputed corresponding item).

• S’s gain is ordinary income under section 751 (because the Intangible Asset is section 1245 property).

P

S

15%

B3rd Party

IntangibleAsset

Intangible Asset:value 100com. basis 0gain 100

85%

$15

PRSw/ 754

P

S($15 gain)

15%

B3rd Party

IntangibleAsset

85%15% PRS Interest:value 15basis 0gain 15

15% PRS Interest:value 15basis 15gain 0

Intangible Asset:value 100com. basis 0gain 100B's § 743(b) adj 15

18

Facts:• Same as Example 1, except that on January 1, Year 6, PRS sells the Intangible Asset to X for $120.• Under Reg. § 1.743-1(j)(3), although B is allocated $18 of gain from PRS's sale of the Intangible Asset under section

704, because B has a $10 remaining positive § 743(b) basis adjustment in the Intangible Asset, B recognizes $8 of gain from PRS's sale of the Intangible Asset.

Analysis:• Under Reg. § 1.1502-13(c), in Year 6, S takes into account all of its remaining $10 gain to reflect the difference

between B’s $8 gain (B’s corresponding item) (which reflects the basis increase to the Intangible Asset under section 743(b)) and the $18 gain B would have recognized if it succeeded to S’s $0 basis in the PRS interest (B’s recomputed corresponding item).

PRSw/ 754

P

S($10 gain)

15%

B3rd Party

IntangibleAsset

85% 15% PRS Interest:value 18basis 10gain 8


X


$120

19

Facts:• Same as Example 1, except that on January 1, Year 6, B sells its PRS interest to X for $18 and recognizes $8 of gain.

Analysis:• Under Reg. § 1.1502-13(c), in Year 6, S takes into account all of its remaining $10 gain to reflect the difference

between B’s $8 gain (B’s corresponding item) and the $18 gain B would have recognized if it succeeded to S’s $0 basis in the PRS interest (B’s recomputed corresponding item).

PRSw/ 754

P

S($10 gain)

15%

B3rd Party

IntangibleAsset



X


$18

Intercompany Transfers:Example 4 – Stacking Issues with § 743(b) Adjustment

20

PRSw/ 754

Facts:• In Year 1, S sells its PRS interest to B for $20 and recognizes $4 of gain. PRS has a section 754 election in effect.• Neither of the capital gain assets nor the ordinary loss asset is depreciable or amortizable.

Analysis:• Under Reg. § 1.1502-13(c) (the matching rule), S does not take into account any of its $4 gain until PRS disposes

of the Intangible Asset or B disposes of its PRS interest.

P

S

20%

B3rd Party

Cap. GainAsset 1

Gain Asset 1:value 25com. basis 20gain 5

80%

$15

PRSw/ 754

P

S($4 gain)

20%

B3rd Party



Ord. LossAsset

Loss Asset:value 50com. basis 60loss (10)

Cap. GainAsset 2

Gain Asset 2:value 25com. basis 0gain 25

Cap. GainAsset 1

Ord. LossAsset

Cap. GainAsset 2

Gain Asset 1:value 25com. basis 20gain 5B's § 743(b) 1

Loss Asset:value 50com. basis 60loss (10)B's § 743(b) (2)


Intercompany Transfers:Example 5 – Stacking Issues with § 743(b) Adjustment

21

PRSw/ 754

P

S($4 gain)

20%

B3rd Party


Cap. GainAsset 1

Ord. LossAsset

Cap. GainAsset 2


Loss Asset:value 50com. basis 60loss (10)B's § 743(b) (2)


X

$25

Facts:• Same as Example 4, except that in Year 2, PRS sells capital gain asset 2 to X for $25.• Under Reg. § 1.743-1(j)(3), although B is allocated $5 of gain from PRS's sale of Capital Gain Asset 2 under section

704, because B has a $5 positive § 743(b) basis adjustment in the asset, B recognizes $0 gain.Analysis:

• It is not clear how much gain S takes into account under Reg. § 1.1502-13(c).• All $4, because if B succeeded to S’s $16 basis in the PRS interest B would recognize $5 of gain on the sale?• A proportionate amount based on relative built-in gain ($5/$30 x $4 = $3.33)? What if relative gains change?

Intercompany Transfers:Example 6 – Sale of Minority Interest, no § 754 Election

22

PRSno 754

Facts:• On January 1, Year 1, S sells its PRS interest to B at a $15 gain. • Because PRS does not have a section 754 election in effect, PRS does not amortize the Intangible Asset.

Analysis:• Under Reg. § 1.1502-13(c) (the matching rule), S does not take into account any of its $15 gain until PRS disposes of

the Intangible Asset or B disposes of its PRS interest.

P

S

15%

B3rd Party

IntangibleAsset


85%

$15

PRSno 754

P

S($15 gain)

15%

B3rd Party

IntangibleAsset




23

Facts:• Same as Example 4, except that on January 1, Year 6, B sells its PRS interest to X for $12 and recognizes a $3 capital

loss.Analysis:

• Under Reg. § 1.1502-13(c), in Year 6, S takes into account its entire $15 gain to reflect the difference between B’s $3 loss (i.e., B’s corresponding item) and the $12 gain B would have recognized if it succeeded to S’s $0 basis in the PRS interest (i.e., B’s recomputed corresponding item).

• Under Reg. § 1.1502-13(c)(4)(i), $3 of S’s gain is redetermined to be capital gain, in order to offset B’s $3 capital loss. • The net result is that the P group recognizes $12 of ordinary income, consistent with single-entity treatment.

PRSno 754

P

S($15 gain)

15%

B3rd Party

IntangibleAsset

85% 15% PRS Interest:value 12basis 15loss (3)


X


$12

Intercompany Transfers:Example 8 – Sale of Majority Interest

24

PRS

Facts:• On January 1, Year 1, S and 3rd Party form PRS by contributing $75 and $25, respectively. PRS purchases a

Depreciable Asset for $100. Assume for simplicity the asset is depreciable over 5 years on a straight-line basis (i.e., $20 depreciation per year, which is allocated $15 to S and $5 to 3rd Party).

• On December 31, Year 2, the basis of the Depreciable Asset is $60 and S’s basis in its PRS interest is $45.• On that date, S sells its PRS interest to B for $75 and recognizes a $30 gain. PRS has a section 754 election in effect.

Analysis:• See following slide.

P

S

$75

B3rd Party

Depr.Asset

$25

PRSw/ 754

P

S

75%

B3rd Party

Depr.Asset

Depreciable Asset:value 100com. basis 60gain 40

25%

$ 75


$100

Jan. 1, Year 1: Dec. 31, Year 2:

Intercompany Transfers:Example 8 – Sale of Majority Interest, cont’d

25

Analysis:• S’s sale of its 75% PRS interest results in a partnership termination under section 708(b)(1)(B) (termination upon sale

or exchange of 50% or more of the capital and profits interests in the partnership in a 12-month period).• Under Reg. § 1.708-1, PRS is deemed to contribute the Depreciable Asset to a new partnership and liquidate.• Under section 168(i)(7), PRS must restart the 5-year basis recovery period for its remaining $60 basis in the

Depreciable Asset (i.e., $12 depreciation per year, which is allocated $9 to S and $3 to 3rd Party). Compare to Reg. §1.1502-13(c)(7)(ii), Ex. 4 (B continues S’s basis recovery upon direct sale of depreciable property from S to B).

• Does Reg. § 1.1502-13(d)(1)(i)(B) acceleration rule apply to trigger S’s $30 gain?• Does the PRS (a nonmember) “reflect[], directly or indirectly, any aspect of the intercompany transaction”?

• If Reg. § 1.1502-13(c) matching rule applies, S’s $30 gain and B’s additional $30 depreciation under section 743(b) will offset in Years 4-8.

“New”PRS

P

S($30 gain)

75%

B3rd Party

Depr.Asset



Intercompany Transfers:Example 9 – § 368 Transfer of Majority Interest

26

PRS

Facts:• Same as in Example 8, except that on December 31, Year 2, S merges into B in a section 368(a)(1)(D) reorganization.

Analysis:• The section 361 transfer of S’s 75% PRS interest results in a partnership termination under section 708(b)(1)(B).• See Rev. Rul. 87-110 (transfer of partnership interest under sections 361(a) is an exchange for purposes of section

708(b)(1)(B), unless pursuant to section 368(a)(1)(F) reorganization (e.g., if B were a newly-formed corporation)); GCM 39673 (1987).

• See also Rev. Rul. 81-38 (section 351 transfer is an exchange for purposes of section 708(b)(1)(B)).

P

S

$75

B3rd Party

Depr.Asset

$25

PRSw/ 754

P

S

75%

B3rd Party

Depr.Asset

Depreciable Asset:value 100com. basis 60gain 40

25%

Merger


$100


Contributions to Partnerships

27

Transfers to Partnerships:Example 1 – Acceleration of Intercompany Gain

28

Facts:• On January 1, Year 1, S sells Asset 1 to B for $25 and recognizes a $15 gain.• On December 31, Year 2, B transfers Asset 1 to PRS in exchange for a 25% interest in PRS in a section 721 contribution.

Analysis:• As a result of the transfer of Asset 1 to PRS, a nonmember, S’s entire $15 gain is taken into account under the Reg. §

1.1502-13(d)(1)(i)(B) acceleration rule (because PRS's $25 basis in Asset 1 reflects the basis that was created in an intercompany transaction).

P

S$25

B

Asset 1 PRS

P

$75

B 3rd Party

Asset 1:value 25basis 10gain 15

S($15 gain)

Asset 1



75%25%

Transfers to Partnerships:Example 2 – Acceleration of Intercompany Loss

29

Facts:• On January 1, Year 1, S sells Asset 2 to B for $25 and recognizes a $5 loss.• On December 31, Year 2, B transfers Asset 2 to PRS in exchange for a 25% interest in PRS in a section 721 contribution.

Analysis:• As a result of the transfer of Asset 2 to PRS, a nonmember, S’s entire $5 loss is taken into account under the Reg. §

1.1502-13(d)(1)(i)(B) acceleration rule (because PRS's $25 basis in Asset 2 reflects the basis that was created in an intercompany transaction).

P

S$25

B

Asset 2 PRS

P

$75

B 3rd Party

S($5 loss)

Asset 2



Asset 2:value 25basis 30gain (5)

75%25%

Transfers to Partnerships:Example 3 – Disallowed Intercompany Loss

30

Facts:• On January 1, Year 1, S sells Asset 3 to B for $75 and recognizes a $5 loss.• On December 31, Year 2, B transfers Asset 3 to PRS in exchange for a 75% interest in PRS in a section 721 contribution.

Analysis:• Because PRS is related to S under sections 267(b) and 707(b) (greater than 50% ownership), S’s entire $5 loss is

disallowed under section 267. See Reg. § 1.267(f)-1(c)(1)(iii); § 1.267(f)-1(j), Ex. 6.• Under section 267(d), PRS can exclude $5 of any gain subsequently recognized on the disposition of Asset 3.

P

S$75

B

Asset 3 PRS

P

$25

B 3rd Party

S($5 loss)

Asset 3




25%75%

Sales to Partnerships

31

Transfers to Partnerships:Example 1 – Gain on Sale to Controlled Partnership

32

Facts:• S1 sells Asset 3 to PRS for $75 and recognizes a $25 gain.

Analysis:• S1’s sale is not an intercompany transaction.• S1 recognizes its entire $25 gain.

PRS

P

S2 3rd PartyS1

Asset 1


40%60%

$75

Transfers to Partnerships:Example 2 – Loss on Sale to Controlled Partnership

33

Facts:• S1 sells Asset 2 to PRS for $75 and recognizes a $25 loss.

Analysis:• S1’s sale is not an intercompany transaction.• Under section 267(a)(1), S1’s entire $25 loss is disallowed because S1 and PRS are related under section 267(b)(10) (P

owns 100% of S1 and is treated as owning 60% of PRS by attribution from S2 under section 267(e)(3)).

PRS

P

S2 3rd PartyS1

Asset 2


40%60%

$75

Transfers to Partnerships:Example 3 – Loss Allowed on Sale to Partnership

34

Facts:• S1 sells Asset 3 to PRS for $75 and recognizes a $25 loss.

Analysis:• S1’s sale is not an intercompany transaction.• Section 267(a)(1) and section 707(b) do not apply because PRS and S1 are not related under those provisions.• Reg. § 1.267(b)-1(b) would treat the transaction as (1)(a) a sale of 40% of Asset 3 from S1 to S2 and (b) a sale of

60% of Asset 3 from S1 to 3rd Party, followed by (2) a contribution to PRS of 40% and 60% of Asset 3 from S2 and 3rd Party, respectively.• Under such construct, Reg. § 1.267(f)-1(c)(1)(iii) would disallow 40% of the loss (or $10) on the deemed sale

from S1 to S2 and subsequent contribution to PRS.• The continuing validity of Reg. § 1.267(b)-1(b) after the enactment of section 267(b)(10) is unclear.

PRS

P

S2 3rd PartyS1

Asset 3


60%40%

$75

Rev. Rul. 99-6 and Related Issues

35

Underpinnings of Rev. Rul. 99-6:McCauslen v. Comm’r, 45 T.C. 588 (1966)

Facts:• B purchased A’s interest in PRS from A’s estate.• Less than six months later, B sold a portion of the former PRS assets and recognized capital gain from the sale.

Holding:

Since petitioner's purchase of the decedent's partnership interest resulted in a termination of the partnershipunder section 708(b), it is our view that petitioner acquired the partnership assets relating to such interest bypurchase, rather than by any distribution from the partnership, and that petitioner's holding period for suchassets begins from the date of such purchase. Consequently, we agree with respondent's determination thatpetitioner's holding period for the assets attributable to the purchased interest was less than 6 months at thetime of their sale by petitioner..., with the result that the portion of the gain attributable to such assets is taxableas short-term capital gain.

36

PRS

A’s Estate B

Cash

PRS Interest

Rev. Rul. 99-6:Situation 1 – Sale from A to B

• LLC terminates under section 708(b)(1)(A).• A treats the transaction as the sale of a partnership interest under section 741.• Under McCauslen, for purposes of determining the tax treatment of B, (1) LLC is treated as making a liquidating

distribution of all of its assets to A and B, and following this distribution, (2) B is treated as acquiring the assets deemed to have been distributed to A in liquidation of A’s interest in LLC.

• With respect to assets deemed acquired from A:– B’s basis in the assets is $10,000 under section 1012.– B takes new holding period.

• With respect to assets deemed distributed to B:– B must recognize gain or loss, if any, on the deemed distribution under section 731(a).– B’s basis in the assets is determined under section 732(b).– B’s holding period for the assets includes LLC’s holding period under section 735(b).

37

LLC

A B$10,000

LLC InterestB

LLC (DRE)

• No liabilities• No § 751(b) assets

Rev. Rul. 99-6:Situation 2 – Sale from A and B to C

• LLC terminates under section 708(b)(1)(A).• A and B are treated as selling their LLC interests and must report gain or loss under section 741.• For purposes of determining the tax consequences to the third-party buyer, LLC is deemed to make a liquidating

distribution of its assets to A and B, and C is deemed to buy those assets from A and B.• C’s basis in the assets is $20,000 under section 1012.• C takes a new holding period for the assets

38

LLC

A B $10,000

LLC Interest

C

LLC (DRE)

• No liabilities• No § 751(b) assets

C

LLC Interest

$10,000

Rev. Rul. 99-6:Overlap with Rev. Rul. 84-111, Situation 3

• No gain or loss is recognized by A or B on the transfer of the LLC interests to Newco in exchange for Newco stock under section 351.

• LLC terminates under section 708(b)(1)(A).• Under section 358(a), A’s and B’s basis of the Newco stock equals the basis of their LLC interests, reduced by LLC’s

liabilities assumed by Newco, the release from which is treated as a payment of money to A and B under sections 752(d) and 358(d).

• Newco’s basis in the assets received in the exchange equals A’s and B’s basis in their LLC interests allocated in accordance with section 732(c). Newco’s holding period includes LLC’s holding period in the assets.

• Under section 1223(a)(1), the holding period of the Newco stock received by A and B includes each respective member’s holding period for the LLC interest transferred, except that the holding period of the Newco stock that was received by A and B in exchange for their interests in section 751 assets of LLC that are neither capital assets nor section 1231 assets begins on the day following the date of the exchange.

39

LLC

A B

LLC (DRE)Newco

A B

Newco

Rationale forRev. Rul. 84-111, Situation 3

40

GCM 37540 (1978) • Cites McCauslen.

Proposed Partnership Merger Regulations (2000)

In the context of partnership incorporations, Rev. Rul. 84-111distinguishes among all three forms of incorporation.

However, with respect to the Interest-Over Form [Situation 3],the revenue ruling respects only the transferors‘ conveyancesof partnership interests, while treating the receipt of thepartnership interests by the transferee corporation as thereceipt of the partnership's assets (i.e., the Assets-Up Form).

The theory for this result, based largely on McCauslen v.Commissioner, 45 T.C. 588 (1966), is that the transfereecorporation can only receive assets since it is not possible, asa sole member, for it to receive and hold interests in apartnership (i.e., a partnership cannot have only one member;so, the entity is never a partnership in the hands of thetransferee corporation).

Rev. Rul. 99-6 orOverlap with Rev. Rul. 84-111, Situation 3

41

LLC

AB stock

LLC Interest

LLC (DRE)

Corp B Corp B

B BA

• Can be governed by Rev. Rul. 99-6 (if taxable) or Rev. Rul. 84-111 (if section 351 applies).

Rev. Rul. 99-6:Interaction with Consolidated Groups

42

LLC

• Under Rev. Rul. 99-6, LLC terminates under § 708(b)(1)(A) when Sub distributes its interest LLC to Parent.

• Sub recognizes $20 of gain on the distribution under § 741. • For purposes of determining Parent’s basis in the assets of LLC,

(1) LLC is first to make a liquidating distribution of all of its assets to Sub and Parent (the “LLC Liquidating Distribution”), then (2) Sub is to distribute to Parent the portion of each asset it was to have received in the LLC Liquidating Distribution (the “Sub Distribution”).

• Parent’s basis in the portion of each asset it was to have received in the LLC Liquidating Distribution (the “Liquidated Portion”) is determined under § 732(b).

• Parent’s basis in the portion of each asset it was to have received in the Sub Distribution (the “Distributed Portion”) is equal to such portion’s fair market value under § 301(d).

• Under PLRs 200334037 and 200737006, the Sub Distribution is an intercompany transaction under § 1.1502-13(b).

• Sub’s $20 gain recognized upon the Sub Distribution is an intercompany item under § 1.1502-13(b)(2) and is taken into account under § 1.1502-13(c) (the “matching rule”).

• Section 1.1503-13(c)(2) requires Sub to take into account its intercompany gain based on the difference between Parent’s corresponding items and its “recomputed” corresponding items.

• Under § 1.1502-13(b)(3)(i), Parent’s corresponding items with respect to Sub’s $20 intercompany gain recognized upon the Sub Distribution will be Parent’s items of income, gain, deduction, or loss recognized with respect to the Distributed Portion of each asset.

GainAsset

LossAsset

Sub's 50% Interest:value 100basis 80gain 20

P's 50% Interest:value 100basis 80gain 20

Loss Asset:value 100basis 120loss (20)

Gain Asset:value 100basis 40gain 60

Parent

Sub

Rev. Rul. 99-6:Interaction with Consolidated Groups, cont’d

43

GainAsset

LossAsset

Gain Asset:Distributed Liquidated

Portion Portion value 50 50basis 50 20gain 0 30

Loss Asset:Distributed Liquidated

Portion Portion value 50 50basis 50 60loss 0 (10)

$20 deferred gain

Parent

Sub

LLC (DRE)

• The PLRs do not address how to match Parent’s corresponding items with Sub’s intercompany gain if the terminated partnership held both gain and loss assets.

• Nevertheless, it would be inconsistent with the general construct of § 1.1502-13(c) if Parent’s subsequent recognition of a loss with respect to Loss Asset were to cause Sub to take into its $20 gain recognized upon the Sub Distribution.

• It is logical that Sub’s $20 gain recognized upon the Sub Distribution should be taken into account by reference to Parent’s recognition of $20 of recomputed gain with respect to (or the depreciation, or amortization of $20 of basis of) the Distributed Portion of Gain Asset.

• In order to match Parent’s corresponding gains with Sub’s $20 gain recognized upon the Sub Distribution, Parent’s recomputed corresponding items with respect to the Distributed Portion of Gain Asset must be determined by reference to:▪ $20 basis in such portion that Parent would have had if each

asset were received by Parent in a liquidating distribution, plus▪ $10 basis decrease in the Distributed portion of Loss Asset.

• Example: LLC later sells Gain Asset for $50.▪ Parent recognizes $30 gain with respect to the Liquidated

Portion;▪ Sub’s $20 intercompany gain is taken into account (equal to

difference between Parent’s $0 corresponding (i.e., actual) gain recognized with respect to the Distributed Portion and the $20 recomputed gain it would recognize if it computed its gain in such portion by reference to the $30 recomputed basis.

▪ The group’s total $50 gain recognized is $10 less than it would have recognized if Gain Asset were sold by LLC while it was still a partnership, reflecting a $10 basis shift from Loss Asset to Gain Asset.

Anti-Abuse Rules

44

Anti-Abuse Rules:Consolidated Return Anti-Abuse Rule

45

Reg. § 1.1502-13(h): If a transaction is engaged in or structured with a principal purpose to avoid the purposes of this section [Reg. § 1.1502-13] (including, for example, by avoiding treatment as an intercompany transaction), adjustments must be made to carry out the purposes of this section.

Reg. § 1.1502-13(a): The purpose of this section is to provide rules to clearly reflect the taxable income (and tax liability) of the group as a whole by preventing intercompany transactions from creating, accelerating, avoiding, or deferring consolidated taxable income (or consolidated tax liability).

Anti-Abuse Rules:Partnership Anti-Abuse Rule - Reg. § 1.701-2

46

Intent: • Subchapter K is intended to permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity-level tax.

Power to Recast:

• If a partnership is formed or availed of with a principal purpose to reduce substantially the present value of the partners' aggregate federal tax liability in a manner that is inconsistent with the intent of subchapter K, the Commissioner can recast the transaction as appropriate, including –• Disregarding the purported partnership;• Disregarding one or more purported partners;• Modifying partnership’s accounting methods;• Reallocating the partnership’s items of income, etc.; and• Adjusting the ”claimed tax treatment.”

Anti-Abuse Rules:Partnership Anti-Abuse Rule, cont’d

47

Factors: • The present value of the partners' aggregate federal tax liability is substantially less than had the partners owned the partnership's assets and conducted the partnership's activities directly;

• The present value of the partners' aggregate federal tax liability is substantially less than would be the case if purportedly separate transactions that are designed to achieve a particular end result are integrated and treated as steps in a single transaction;

• One or more partners who are necessary to achieve the claimed tax results either have a nominal interest in the partnership, are substantially protected from any risk of loss from the partnership (through distribution preferences, indemnity or loss guaranty agreements, or other arrangements), or have little or no participation in the profits from the partnership's activities other than a preferred return that is in the nature of a payment for the use of capital;

• Substantially all of the partners are related to one another;• Partnership items are allocated in compliance with the literal language of

§§ 1.704-1 and 1.704-2 but with results that are inconsistent with the purpose of § 704(b) and those regulations;

• The benefits and burdens of ownership of property nominally contributed to the partnership are in substantial part retained by the contributing partner; or

• The benefits and burdens of ownership of partnership property are in substantial part shifted to the distributee partner before or after the property is actually distributed to the distributee partner.

Anti-Abuse Rules:Partnership Anti-Abuse Rule - Reg. § 1.701-2

48

Abuse of Entity Treatment (Reg. §1.701-2(e)):

• The Commissioner can treat a partnership as an aggregate of its partners in whole or in part as appropriate to carry out the purpose of any provision of the Code or the regulations promulgated thereunder.

Treatment as Entity Where Clearly Contemplated Entity Treatment:

• Aggregate treatment does not apply to the extent that (i) a provision of the Code or the regulations promulgated thereunder prescribes the treatment of a partnership as an entity, in whole or in part, and (ii) that treatment and the ultimate tax results, taking into account all the relevant facts and circumstances, are clearly contemplated by that provision.

Anti-Abuse Rules:Example 1 – Sale of Partnership Interest

49

PRSno 754

Facts:• S owns land with a $10 basis and $100 value. B has NOLs from separate return limitation years (“SRLYs”) subject to

limitation under Reg. § 1.1502-21(c).• In Year 1, Pursuant to a plan to absorb B’s NOLs without limitation by the SRLY rules, S transfers the land to PRS, an

unrelated partnership in exchange for a 10% interest in PRS in a transaction to which section 721 applies.• PRS does not have a section 754 election in effect.• In Year 2, S sells its PRS interest to B for $100 and recognizes a $90 gain.

P

S B(SRLY NOL)

3rd Party

Land

Land:value 100basis 10gain 90

PRSno 754

P

S

10%

B(SRLY NOL)

3rd Party

Land

Land:value 100com. basis 10gain 90

90%

$100


Other($900 value)

Other($900 value)

Year 1: Year 2:

Anti-Abuse Rules:Example 1 – Sale of Partnership Interest, cont’d

50

PRSno 754

Facts:• In Year 3, PRS sells the land to a nonmember for $100. Under section 704(c), PRS’s $90 built-in gain is allocated to B,

and B’s basis in its PRS interest increases to $190 under section 705.• In Year 4, B sells its PRS interest to a nonmember for $100 and recognizes a $90 loss, which triggers S’s $90 gain.• Ordinarily, under Reg. § 1.1502-21(c), PRS’s $90 gain allocated to B increases B’s SRLY limitation, and B’s $90 loss

from its sale of the PRS interest is not subject to any SRLY limitation.Adjustments:

• Because the contribution of the land to PRS and the sale of PRS interest were part of a plan a principal purpose of which was to reduce the P group’s consolidated tax liability, B’s allocable share of PRS’s gain from its sale of the land is not treated as increasing B’s SRLY limitation.

Analysis: But cf. Reg. § 1.1502-13(h), Ex. 5 (sale-leaseback with non-member to increase SRLY limitation not abusive).

P

S($90 gain)

B(SRLY NOL)

3rd Party

PRSno 754

P

S($90 gain)

10%

B(SRLY NOL)

3rd Party

Other($1000 value)

90%

Land

Land:value 100com. basis 10gain 90


Other($900 value)

10%90% 10% PRS Interest:value 100basis 10gain 90

Year 3: Year 4:

$100$100

Anti-Abuse Rules:Example 2 – Partnership Mixing Bowl

51

PRS

Facts:• S1 owns a self-created intangible asset with a $0 basis and a fair market value of $100.• S2 owns land with a basis of $100 and a fair market value of $100.• In Year 1, with a principal purpose of creating basis in the intangible asset (which would be eligible for amortization

under section 197), S1 and S2 form partnership PRS; S1 contributes the intangible asset and S2 contributes the land.• X, an unrelated person, contributes cash to PRS in exchange for a substantial interest in the partnership.• (For ease of presentation, X and the contributed cash are not depicted after the contribution.)• PRS uses the contributed assets in legitimate business activities.

P

S1 S2

X

Intangible


PRS

P

S1 S2

Land

S2 PRS Interest:value 100basis 100gain 0

Land

Intangible

Year 1: Result:

Cash

Intangible:value 100basis 0gain 100 Intangible:

value 100basis 0gain 100



Anti-Abuse Rules:Example 2 – Partnership Mixing Bowl, cont’d

52

Facts:• In Year 8, PRS liquidates, distributing the land to S1, the intangible to S2, and cash to X.• The P group reports no gain under sections 707(a)(2)(B) and 737(a) and claims that S2's basis in the intangible asset

is $100 under section 732 and that the asset is eligible for amortization under section 197.Adjustments:

• Because a principal purpose of the formation and liquidation of PRS was to create additional amortization without an offsetting increase in consolidated taxable income by avoiding treatment as an intercompany transaction, appropriate adjustments must be made.

Analysis: • What adjustment?• Create taxable exchange of land for an intangible asset?

Year 8: Result:

PRS

P

S1 S2

Land


Intangible

Intangible:value 100basis 0gain 100



P

S1 S2

Land Intangible

Intangible:value 100basis 100gain 0


Sales of Partnership Interests

53

Purchases and Sales:Example 1 – Sale of Minority Interest

54

Facts:• P sells all of T’s stock to X, and T becomes a nonmember on June 30, Year 1.• T has a 10% interest in PRS, a calendar-year partnership.

Analysis:• Under Reg. § 1.1502-76(b)(2)(vi)(A) and Reg. § 1.706-2(c)(2)(iii), T is treated, solely for purposes of determining T’s

tax year in which PRS’s items are included, as selling or exchanging its entire interest in PRS as of P's sale of T's stock.

• Thus, the deemed disposition is not taken into account under section 708, it does not result in gain or loss being recognized by T, and T’s holding period is unaffected.

• However, under section 706(a), in determining T’s income, T is required to include its distributive share of partnership items for PRS’s year ending within or with T's tax year.

• Under section 706(c)(2), PRS's tax year is treated as closing with respect to T as of P's sale of T's stock.• The allocation of T's distributive share of partnership items is made under Reg § 1.706-1(c)(2)(i).• Absent Reg. § 1.1502-76(b)(2)(vi)(A), the portion of T’s income (or deductions) from PRS for the period T was a

member would include only income from the PRS years that end “within or with the taxable year of the partner.”• In the example, that would mean the full year of PRS’s income (or loss) allocated to T would be included on the X

group’s consolidated return

P12/31

T12/31

X12/31

PRS12/31

3rd Party

10%90%

P12/31

T12/31

X12/31

PRS12/31

3rd Party

10%90%

Purchases and Sales:Example 2 – Sale of Majority Interest

55

Facts:• Same as Example 1, except T owns a 75% interest in PRS.

Analysis:• Under Reg. § 1.1502-76(b)(2)(vi)(B), because T owns more than 50% of PRS, the method that is used to determine

the inclusion of PRS’s items in P or X consolidated return must be the same method that is used to determine the inclusion of T’s items under Reg. § 1.1502-76(b)(2) generally.

• Thus, if the general closing of the books method under Reg. § 1.1502-76(b)(2)(i) applies, T's distributive share of PRS’s items must be determined under Reg. § 1.706-1(c)(2)(i) by an interim closing of PRS’s books.

• Conversely, if ratable allocation is elected for T's items that are not extraordinary items, T's distributive share of PRS’s nonextraordinary items must also be ratably allocated under Reg. § 1.706-1(c)(2)(i).

P12/31

T12/31

X12/31

PRS12/31

3rd Party

75%25%

P12/31

T12/31

X12/31

PRS12/31

3rd Party

75%25%

Purchases and Sales:Example 3 – Different Tax Years

56

Facts:• P owns a 10% interest in PRS, a partnership with a tax year ending January 31. • For the PRS year ending January 31, Year 1, PRS incurs a $1,000 loss, $100 of which is allocable to P.• For the PRS year ending January 31, Year 2, PRS has $50 of income, $5 of which is allocable to P. • On March 31, Year 1, P acquires all the stock of S and the S group terminates on that date.

Analysis:• Reg. § 1.1502-76(b)(2)(vi) addresses the allocation of PRS income for the tax year ending January 31, Year 2. Under

this provision, PRS 's $50 of income for the tax year ending January 31, Year 2 is allocable to the final consolidated return year of the S group ending March 31, Year 1.

• For example, if PRS uses the closing-of-the-books method, S 's share of each item taken into account by PRS for the 2-month period ending March 31 of Year 1 will be allocated to the S group.

• But Reg. § 1.1502-76(b)(2)(vi) does not address the allocation of PRS items for the period ending January 31, Year 1 (the year in which $100 of loss was allocated to S) or whether the $100 loss is required to be allocated entirely to the S group for its final consolidated return year ending March 31, Year 1.

• For example, if the ratable allocation method of Reg. § 1.1502-76(b)(2)(ii) is elected to allocate the S group items for Year 2, the regulations may permit the allocation to the P group of $75 of the PRS $100 loss allocated to S for the year ended January 31, Year 2.

S12/31

P12/31

PRS1/31

3rd Party

10%90%

P12/31

S12/31

PRS1/31

3rd Party

10%90%

3/31/Y1

Interaction with Section 368 COBE and Section 355 ATB Requirements

57

Partnerships and Continuity of Business Enterprise: COBE Introduction

58

Business Continuity:

• P continues T’s “historic” business.• The fact P is in the same line of business as T tends to establish

the requisite continuity, but is not alone sufficient. • If T has more than one line of business, continuity of business

enterprise requires only that P continue a “significant” line of business.

• In general, a corporation's historic business is the business it has conducted most recently.

Asset Continuity:

• P uses a “significant” portion of T’s historic business assets in a business.

• A corporation’s historic business assets are the assets used in its historic business.

• In general, the determination of the portion of a corporation's assets considered “significant” is based on the relative importance of the assets to operation of the business

Partnerships and COBE:Partnership Ownership and Conduct Rules

59

Ownership of Partnership Assets:

• Each partner of a partnership treated as owning the T business assets used in a business of the partnership in accordance with the partner’s partnership interest.

Conduct through a Partnership:

• Issuing corporation treated as conducting a business of the partnership if:• Qualified group members own an interest in the partnership

collectively representing a significant interest in the partnership business, or

• One or more qualified group members have active and substantial management functions as a partner with respect to that partnership business.

• Fact that P is treated as conducting T’s business through a partnership tends to establish requisite continuity but is not sufficient.

Partnerships and COBE:Active Management through Partnership

60

• COBE satisfied.• Reg. § 1.368-1(d)(5), Example 8.

Corp P

Sub

Merger

PRS

Corp T

T assets

20% + active management

80%

3rd Party

Partnerships and COBE:Active Management not Sufficient

61

• COBE not satisfied.• Reg. § 1.368-1(d)(5), Example 9.

Corp P

Sub

Merger

PRS

Corp T

T assets

1% + active management

99%

3rd Party

Partnerships and COBE:Significant Interest without Management

62

• COBE satisfied.• Reg. § 1.368-1(d)(5), Example 10

Corp P

Sub

Merger

PRS

Corp T

T assets

33% passive67%

3rd Party

Partnerships and COBE:No Aggregation of Partnership Interests

63

• Is COBE satisfied?• Sub-1 is the issuing corporation.• P is not a member of the Sub-1 qualified group.

Corp P

Sub-2

Merger

PRS

Corp T

5%95%

Sub-1

T assets

Partnerships and COBE:Post Acquisition Drops of T Stock

64

• COBE satisfied.• Reg. § 1.368-1(d)(4)(iii)(D) – If members of the qualified group own interests in a partnership meeting the requirements

of the equivalent of section 368(c), any stock owned by the partnership is treated as owned by the members of the qualified group.

Corp P

Sub-2

T stock

PRS

Corp T T stock

80%20%

3rd Party

Sub-1

T stock

3rd Party

P stock

Section 355: Active Trade or Business Conducted through Partnership

• Revenue Ruling 92-17, 1992-1 C.B. 142 – Considers whether D, a corporate general partner in a limited partnership, is engaged in the active conduct of a trade or business within the meaning of section 355(b).– For more than 5 years, D owned a 20 percent interest in LP, a limited partnership that owned several commercial

office buildings leased to unrelated third parties. D’s officers performed active and substantial management functions with respect to LP, including the significant business decision-making of the partnership, and regularly participated in the overall supervision, direction, and control of LP's employees in operating LP's rental business.

– D is engaged in the active conduct of trade or business within the meaning of § 355(b).• Rev. Rul. 2002-49, 2002-2 C.B. 288 – Corporation owning a 20-percent interest in a state law partnership or limited

liability company (LLC) that is classified as a partnership can be treated as engaged in the active conduct of the trade or business of the partnership if the corporation performs active and substantial management functions for the partnership’s business (even if another partner also performs active and substantial management functions for the partnership’s trade or business).

65

ControlledPRS interest

PRS

A Controlled

PRS

3rd Party

(Active Business) (Active Business)

Distributing

Biographies

66

Grace Kim

Grant Thornton LLPPractice Leader, Tax Technical, Washington National Tax Office Washington, D.C.+1.202.521.1590 [email protected]

Grace Kim has more than 20 years of experience in the area of partnership taxation, which includes IRS, law firm and accounting firm positions. Her diversified experience includes working on a broad range of structuring and operational issues in a variety of industries and areas. Additionally, she has a strong working knowledge of administrative practice before the IRS.

Biographies

67

Joshua T. Brady

Morgan, Lewis & Bockius LLPDeputy Practice Group Leader – Tax Washington, [email protected]

Josh Brady’s practice encompasses a broad range of corporate tax issues involving corporations, partnerships, and their owners and investors. He is widely recognized for his work on mergers and acquisitions, distributions, financings, restructurings, and corporations filing consolidated returns.

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