Recently, in PLR 201820013
, the IRS Office of Chief Counsel ruled that the anti-churning rule in section 197(f)(9) did not apply to limit the amount of amortization otherwise allowable with regard to cost basis in property deemed purchased and contributed to a partnership in a transaction described in Situation 1 of Rev. Rul. 99-5, 1999-1 C.B. 434.
In so ruling, the IRS applied the related party rule in Treas. Reg. Sec. 1.197-2(h)(6)(ii) to the relationships that would be present immediately after the last acquisition in a multi-step structured acquisition that involved an initial purchase of an LLC membership interest followed by a subsequent membership interest purchase pursuant to a binding commitment. That is, the IRS apparently viewed the overall acquisition as part of a series of transactions and was willing to disregard the relationships present at the first acquisition, in favor of examining the relationships that would be present at the time of the last acquisition.
Under the PLR’s facts, the “Taxpayer” was an LLC that was the successor to a corporation that, together with its subsidiaries, had operated a legacy business that had operated before the effective date of section 197. The Taxpayer LLC entity was formed as part of a pre-acquisition restructuring. The Taxpayer entity, nonetheless, was not treated as an entity separate from its owner, B, which was an S corporation. Owner B had section 197(f)(9) intangibles consisting of goodwill that was not amortizable in the hands of B.
In the multi-step acquisition, the purchaser (“Member”) purchased an undisclosed portion (“A” percent) of the membership interests of the Taxpayer LLC from B. The PLR states that the purchase was treated as a transaction described in Situation 1 of Rev. Rul. 99-5 for federal income tax purposes. Accordingly, Member was treated as purchasing an undivided A percent interest in the assets of Taxpayer and its subsidiaries, followed by Member’s contribution of such assets, along with the contribution by B of the remaining undivided interest in the assets of Taxpayer and its subsidiaries, to Taxpayer, a partnership pursuant to section 721(a).
The Taxpayer’s LLC agreement specifically provided for a plan that on a later date (the “M” anniversary of the effective date of the agreement), Member would purchase from B (the buyout) a portion of the membership units held by B (the buyout units), and B would immediately redeem the entire equity interests of B held by the certain of its shareholders, including its founders, but not the interests held by certain individuals in management. Upon the buyout, management would own all of B and B would own less than 20% of Taxpayer. Under the LLC agreement, there were no contingences related to the buyout, apart from the passage of time. The LLC agreement established a binding commitment for Member to purchase the buyout units that would be outstanding at the time of the first purchase and explicitly set forth the terms for Member’s acquisition of these units. However, the PLR does not reveal the terms or formula for determining the purchase price of the buyout units, and the period of time between the first purchase and the buyout is not clear. The PLR does explain that Member’s acquisition of the Taxpayer was structured in this manner “in order to allow Member to have the benefit of the industry expertise of the founders and management for at least three years following Member’s acquisition.”
Treas. Reg. Sec. 1.197-2(h)(2) provides in relevant part that, except as otherwise provided in Treas. Reg. Sec. 1.197-2(h), a Section 197(f)(9) intangible acquired by a taxpayer after the applicable effective date does not qualify for amortization under section 197 if the taxpayer or a related person held or used the intangible or an interest therein at any time during the transition period (i.e., generally the period beginning on July 25, 1991, and ending on Aug. 10, 1993).
Treas. Reg. Sec. 1.197-2(h)(6)(ii) provides for the timing of testing for relationships. Generally, a person is treated as related to another person for purposes of this paragraph if the relationship exists (1.) in the case of a single transaction, immediately before or immediately after the transaction in which the intangible is acquired; and (2.) in the case of a series of related transactions (or a series of transactions that together comprise a qualified stock purchase within the meaning of section 338(d)(3)), immediately before the earliest such transaction or immediately after the last such transaction.
Relationship for this purpose generally looks to section 267(b) or section 707(b)(1), with 20% substituted for 50%.
Relying on the Taxpayer’s representation that the LLC agreement establishes a binding commitment for Member to purchase the buyout units and explicitly sets forth the terms for Member’s acquisition of those units, the IRS states that the section 197 intangibles “are acquired in a series of related transactions and the (buyout) is the last transaction.” Relying solely on the Taxpayer’s representation that immediately after the buyout, management would own all of B and B would own a partnership interest of less than 20% in the Taxpayer, the IRS concludes that the anti-churning rules do not apply with respect to Member’s purchased basis in the section 197 intangibles deemed acquired pursuant to Rev. Rul. 99-5 as a result of Member’s acquisition of A percent of Taxpayer’s membership interests in the first purchase. Additionally, the PLR makes clear that the Taxpayer commences amortization of Member’s tax basis in the section 197 intangibles in the month of the first purchase.
The facts of the PLR appear similar to those of Example 18 of Treas. Reg. Sec. 1.197-2(k), except for the fact of the buyout. In that example, “A” (as defined in Treas. Reg. Sec. 1.197-2(k)) had acquired an intangible in 1990. A sold a one-half interest in the intangible to “B” (also per Sec. 1.197-2(k)), who was unrelated to A. Immediately after the sale, A and B formed partnership “P” (per Sec. 1.197-2(k)) as equal partners and each of A and B contributed its one-half interest in the intangible to P. The example concludes that the anti-churning rules apply to B’s transfer of its one-half interest in the intangible to P because A, who is related to P “immediately after the series of transactions” in which the intangible was acquired by P, held B’s one-half interest in the intangible during the transition period. In the PLR, the last transaction in the series of related transaction is the buyout, and it was represented that upon the buyout, B (who had held the interest of the Member (per Sec. 1.197-2(k)) in the intangible during the transition period) would hold less than 20% in the Taxpayer (per Sec. 1.197-2(k)).
Though not clear, the Taxpayer presumably sought the ruling because B held an interest of 20% or more in the Taxpayer upon the first purchase, potentially casting a cloud over the Taxpayer’s ability to amortize the tax basis in the section 197 intangibles derived from Member’s cost basis. The PLR provides a helpful confirmation and illustration that where there is a binding commitment for multiple steps in an acquisition plan, the timing of testing for relationships under Treas. Reg. Sec. 1.197-2(h) looks to the last step in the plan.
Principal, Partnership Tax Technical Leader, Washington National Tax Office
+1 202 521 1590
Senior Manager, National Tax Standards Group, Washington National Tax Office
+1 202 521 1552
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