The IRS ruled in Private Letter Ruling 201906002
that Section 197(f)(9) anti-churning rules would not prevent amortization of certain increases to the basis of an intangible asset under Section 743(b) in connection with a publicly traded partnership’s conversion to a corporation.
In the ruling, a publicly traded partnership (aka “PTP”) owns an interest in another, lower-tier partnership (aka “LTP”). As part of the formation of LTP, PTP contributed cash and property, and another partnership (aka “UTP”) contributed intangible assets each in exchange for an interest in LTP. The intangible assets were subject to the “anti-churning” rules under Section 197(f)(9) and were not amortizable in the hands of LTP. PTP and UTP represented that they were not related under Sections 267(b) or 707(b)(1) (as modified for purposes of applying the Section 197(f)(9) anti-churning rules).
After the formation of LTP, 95% or more of the interests in PTP changed ownership through public trading and issuances of limited partnership interests. Also, PTP periodically acquired additional interests in LTP from certain partners in UTP. The acquisitions occurred when a partner exercised an undescribed right in the UTP. The exercise resulted in UTP distributing an interest in LTP to the partner, who would then transfer or sell the LTP interest to PTP. The taxpayer represented that any such acquisition of additional LTP interests by PTP was not related to the initial formation of the LTP.
PTP later decided to convert to a corporation. As part of the conversion, PTP transferred all of its assets, including its interest in LTP, to a newly formed corporation (aka “Newco”). LTP computed an adjustment to the basis of its assets under Section 743(b) for the benefit of Newco. A portion of the basis adjustment was allocated to the anti-churning intangible asset held by LTP.
The anti-churning rules found in Section 197(f)(9) and associated regulations generally disallow the amortization of certain intangibles that were in existence prior to the effective date of Section 197 (Aug. 10, 1993) and that were not amortizable under prior law. The regulations later issued under Section 197 provide that basis adjustments computed under Sections 743(b) resulting from the sale or exchange of a partnership interest, with respect to an item of intangible property, are treated as a separate intangible asset. Treas. Reg. Sec. 1.197-2(h)(12)(v)(A) provides that the portion of a Section 743(b) adjustment that is allocated to an anti-churning intangible asset is amortizable in a few situations. One example of this could be when a transferor of a partnership interest is unrelated to the transferee. This was not the case in this ruling because PTP was related to Newco immediately after the transfer of the interest in LTP.
Under Treas. Sec. Reg. 1.197-2(h)(12)(v)(A)(2), a Section 743(b) basis adjustment with respect to an anti-churning intangible asset is also amortizable if a three-part test is met: (1) the partnership acquired the anti-churning intangible asset after Aug. 10, 1993, and the intangible is not amortizable with respect to the partnership; (2) the partnership interest that that the transferee receives was previously held after the partnership acquired the anti-churning intangible asset by a person that is not related to the transferor; and (3) the acquisition of the partnership interest by such other person was not part of a transaction, or series of related transactions, in which the transferor (or a related person) acquired its partnership interest.
The IRS concluded that the first and third parts of the test were satisfied based upon the facts and representations discussed in the ruling. For purposes of the second test, the IRS’s analysis was based on the portions of the interests in LTP that had been acquired by PTP. With respect to the portion of the LTP interest that was acquired by PTP upon the formation of LTP, the IRS applied the concepts contained in Rev. Rul. 87-115. This ruling states that when an upper-tier partnership has a Section 754 election in effect, the transfer of an interest in the upper-tier partnership is treated as a transfer of an interest in the upper-tier partnership’s interest in the lower-tier partnership for purposes of Section 743(b), and any resulting basis adjustment is allocated solely to the transferee of the upper-tier partnership interest. The IRS also noted that, under Section 197(f)(9)(E), with respect to any increase in the basis of partnership property under Section 743, a partnership is treated an aggregate of its owners under the anti-churning rules. Accordingly, when a public owner acquired an interest in PTP, the owner is treated as acquiring a portion of PTP’s interest in LTP. Thus, such portion of LTP’s interest is held by an owner that is unrelated to the owner that held such interest when LTP was formed.
The IRS also concluded that the portion of PTP’s interest in LTP that it acquired from the partners of UTP satisfied the second test. The taxpayer represented that PTP was not related to UTP. Therefore, that portion of the interest was previously held by a person other than PTP (or a related party), satisfying the second test. This was the case even though the intangible asset was originally subject to the anti-churning rules in the hands of UTP.
The ruling concludes that increases to the tax basis of the anti-churning intangible asset under the Section 743(b) adjustment for the benefit of Newco are amortizable to the extent the basis adjustments are attributable to (1) the interests that PTP previously acquired from the partners of UTP and (2) the interests that were treated as previously acquired by the public owners of PTP after the formation of LTP. The ruling highlights the ability under the anti-churning regulations to “cleanse” an interest in an anti-churning intangible when the interest is transferred to an unrelated person, even if the unrelated person may be related to another partner or the partnership. The ruling also serves as a reminder that, even more than two decades after their enactment, the anti-churning rules continue to require careful consideration in structuring partnership transactions.
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