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Proposed regulations: Corporate partners, transactions involving equity interest of partner

Corporate partners, equity interest of partner

The U.S. Treasury Department and IRS today released for publication in the Federal Register proposed regulations (REG-135671-17) that would amend final regulations (June 2018) 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.

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The preamble to today’s proposed regulations [PDF 436 KB] states that there are “substantive modifications” to the June 2018 final regulations relating to the definition of “Stock of the Corporate Partner.” Read about the June 2018 final regulations in TaxNewsFlash.

The preamble to the proposed regulations indicates that the proposed amendments are generally intended to prevent taxpayers from structuring partnership transactions that allow corporations to eliminate gain on appreciated assets or otherwise contravene the purposes of section 337(d). The proposed regulations are proposed to be effective as of the date of publication as final regulations. Taxpayers, however, may rely on the proposed regulations for transactions occurring on or after June 12, 2015, and prior to the date of final regulations, provided that the taxpayer consistently applies all of the proposed regulations to such transactions.

The proposed regulations contain four specific proposed amendments:

  • Attribution rules. The final regulations define Stock of the Corporate Partner to include the Corporate Partner's stock or stock of a corporation that controls the Corporate Partner within the meaning of section 304(c) (except that section 318(a)(1) and (3) do not apply).  The preamble indicates that the Treasury Department and the IRS have determined that excluding section 318(a)(1) and (3) attribution could produce unintended results and allow taxpayers to structure transactions to take advantage of this attribution exclusion.  In response, the proposed regulations would eliminate the exclusion of section 318(a)(1) and (3) attribution from the determination of section 304(c) control, but would limit this expanded definition of Stock of the Corporate Partner to entities that own a direct or indirect interest in the Corporate Partner.
  • Affiliated groups. Under the final regulations, Stock of the Corporate Partner does not include stock held by a partnership if all of the interests in partnership capital and profits are held by members of an affiliated group as defined in section 1504(a).  After further study, the Treasury Department and IRS have determined that this affiliated group exception may result in abuse and therefore is not appropriate. The proposed regulations would remove this exception for affiliated groups, but the preamble requests comments on whether a more tailored exception would be appropriate.
  • Value of an interest attributable to Stock of a Corporate Partner. The final regulations provide that Stock of a Corporate Partner also includes interests in any entity to the extent that the value of the interest is attributable to Stock of the Corporate Partner (the “Value Rule”). Under the final regulations, this Value Rule applies to all interests in an entity regardless of whether the entity is controlled by the Corporate Partner.  The preamble indicates that the Treasury Department and IRS have determined that the Value Rule could be overbroad in certain circumstances. The proposed regulations would narrow the Value Rule by providing that, if an entity is not controlled by the Corporate Partner, the Value Rule would generally apply only if the entity owns, directly or indirectly, 5% or more of the stock, by vote or value, of the Corporate Partner.
  • Exception for certain dispositions. The final regulations do not apply to Stock of a Corporate Partner that (i) is disposed of by the partnership before the due date of its federal income tax return for the tax year during which the Stock of the Corporate Partner was acquired (or for the tax year in which the Corporate Partner becomes a partner) and (ii) is not distributed to the Corporate Partner or a corporation that controls the Corporate Partner within the meaning of section 304(c), except that section 318(a)(1) and (3) do not apply.  Consistent with change in the attribution rules discussed above, the proposed regulations would 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 directly or indirectly owns stock of the Corporate Partner.

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