As seen in Bloomberg BNA
The Internal Revenue Service released three pieces of guidance for partnerships, addressing disguised sales and allocation of liabilities that ease off some previously proposed provisions and introduce new restrictions on leveraged partnership transactions.
The new rules take a multi-faceted approach, with final regulations addressing some of the accepted provisions and withdrawing and reproposing some of the aspects tax attorneys were concerned about. The rules seek to tighten the conditions under which a partner bears the economic risk of loss and can then have tax-advantaged basis in a recourse liability.
Final and temporary regulations (T.D. 9788) treat all partnership liabilities as nonrecourse liabilities solely for disguised sale purposes and are allocated based on the share of the partner's profits. The rules are effective Jan. 3 and are also part of the proposed rules (REG-122855-15) the IRS also published Oct. 4. The rules raise questions about whether taxpayers can use leverage to circumvent the disguised sale rules.
“I think the answer is pretty much ‘a qualified no' at this point,” Michael Greenwald, a partner at Friedman LLP, told Bloomberg BNA.
Disguised Sales, Guarantees
Final rules (T.D. 9787) seek to curb disguised sales of property under tax code 707 and tighten provisions relating to a partnership's allocations of excess nonrecourse liabilities to partners for disguised-sale purposes under Section 752.
“Over the years, the exception from disguised-sale consideration for reimbursement of preformation expenditures has proven important. While targeting some abuses that have surfaced, the final regulations also helpfully expand the exception,” Michael Grace, counsel at Whiteford Taylor & Preston LLP, told Bloomberg BNA in an e-mail. “The new rules recognizing capital expenditures incurred by a transferor in a nonrecognition transfer, based on ‘stepping in the shoes of' another person, should prove useful.”
The temporary rules continue to attack so-called bottom-dollar guarantees, when a partner agrees to pay a partnership debt only if the bank collects less than the guaranteed amount from the entity, as was the case in the proposed rules. However, the rules in this version are much more straighforward, Grace said.
“Many will find the new regulations’ requirement to disclose bottom dollar payment obligations intrusive,” Grace said. “The Treasury and IRS seems to be saying, ‘OK, if you believe that your payment obligation confers economic risk or loss, then you shouldn't fear shining a spotlight on it and letting us exam it.”
The regulations permit so-called vertical slice guarantees, where partners have several, but not joint, liability on an obligation. This is a change from the proposed regulations that treated them as nonrecourse liabilities.
The vertical slice guarantee approval is notable because it can be important for partnerships in underwriting debt, securing a better interest rate or even just to borrow, Greenwald said.
Proposed Rule Perspective
The proposed rules withdraw part of a proposal the agency published in January 2014 and contain new provisions addressing when certain obligations to restore a deficit balance in a partner's capital account are disregarded under Section 707 and when partnership liabilities are treated as recourse liabilities under Section 752.
The proposed rules remove a provision of Treas. Reg. Section 1.752-2(k) dealing with disregarded entities. Eric Sloan, a partner at Gibson, Dunn & Crutcher LLP, told Bloomberg BNA that this would be a mistake.
“I understand a desire to simply the regulations, but taxpayers need certainty regarding disregarded entities and allocation of partnership liabilities,” Sloan said. “If simplification carries the day, it will be critical for the regulations to make clear that the rule can be invoked by taxpayers and ‘bad intent' isn't needed.
The rule should function so that a taxpayer that is a general partner through a disregarded entity shouldn't be treated as having the economic risk of loss for partnership liabilities except to the extent of its assets other than the interest in the partnership, he said. Under the provision, intent does currently not matter, and this isn't an anti-abuse rule, Sloan said.
The IRS first proposed these rules in 2014 and received strong criticism from tax attorneys who said the rules drastically changed how liabilities are treated and could aversely impact the structure of many transactions (20 DTR G-1, 1/30/14).
The approach used with this regulations package—incorporating feedback and rewriting parts of the regulations that didn't work—is something that Linda Carlisle, a member at Miller & Chevalier Chartered, hopes to see repeated with the pending debt-equity regulations (REG-108060-15). The IRS proposed the regulations in April under tax code Section 385. They are intended to stop multinational companies from shifting profits out of the U.S. through loans to offshore subsidiaries. In some cases, they would recast entire loans as expensive equity instead of taxfavored debt. In others, they would call for bifurcation—splitting financial instruments into part debt and part equity.
The rules have garnered lots of criticism and requests for large-scale revisions. They are expected to be released this year.
“I so hope that the Treasury Department takes this approach with the 385 regulations,” Carlisle said. “They have taken into account a lot of the comments that have been made and revised accordingly.”