Transfers to partnerships, related foreign partners, controlled transactions

Transfers to partnerships, related foreign partners

The IRS today released an advance version of Notice 2015-54 that announces that the Treasury Department and IRS intend to issue regulations under section 721(c), to provide that when a U.S. person transfers certain property to a partnership that has foreign partners related to the transferor, the income or gain attributable to the property will be taken into account by the transferor either immediately or periodically.


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Notice 2015-54 [PDF 194 KB] states that the regulations are intended to apply to transfers occurring on or after August 6, 2015, and to transfers occurring before August 6, 2015, resulting from entity classification elections made on or after August 6, 2015.

The IRS notice also announces that Treasury and the IRS intend to issue regulations under section 482—specifically concerning the cost sharing rules under Reg. section 1.482-7—applicable to controlled transactions involving partnerships so that the valuation of such transactions is appropriately determined. Read also TaxNewsFlash-United States 

The following provides a very brief overview of the IRS notice, based on an initial read of the notice.

Reasons for future regulations

According to today’s notice, the IRS and Treasury are aware that certain taxpayers purport to be able to contribute—consistently with sections 704(b), 704(c), and 482—property to a partnership that allocates the income or gain from the contributed property to related foreign partners that are not subject to U.S. tax. The notice further states that many of these taxpayers choose a section 704(c) method other than the remedial method and/or use valuation techniques that are inconsistent with the arm’s length standard.

Based on the experience of the IRS with such taxpayer positions, it has been decided that it will be appropriate to exercise the regulatory authority granted in section 721(c) to override the application of section 721(a) to gain realized on the transfer of property to a partnership (domestic or foreign) in certain circumstances in which the gain, when recognized, ultimately would be includible in the gross income of a foreign person.

Regulatory authority

As the IRS explained, while Congress provided specific authority in section 367(d)(3) to address transfers of intangibles to partnerships, the IRS and Treasury have concluded that acting pursuant to section 721(c) is more appropriate because the transactions at issue are not limited to transfers of intangible property.

Although section 704(b) provides partnerships a measure of flexibility to make special allocations of partnership income, Notice 2015-54 states that it is the belief of the IRS and Treasury is that in some instances, partnership transactions involving special allocations lead to inappropriate results. The IRS and Treasury also are aware that certain taxpayers may be valuing property contributed to partnerships, or the property or services involved in related controlled transactions, in a manner contrary to section 482. As a result, partnership interests or consideration received in related controlled transactions also may be incorrectly valued—thereby reducing the amount of income or gain allocated to U.S. partners.

Notice 2015-54 continues by stating that, for example, a partnership agreement might provide a domestic partner with a fixed preferred interest in exchange for the contribution of an intangible that is assigned a value that is inappropriately low, while allocating a greater share of the income from the intangible to a related foreign partner. While the IRS has broad authority under section 482 to make allocations to properly reflect the economics of a controlled transaction, administrative challenges arise, for example, when the IRS must make adjustments years after a transaction occurred. Because taxpayers have better access to information about their businesses and risk profiles, the IRS may be at a disadvantage in evaluating the transactions. Therefore, along with providing rules under section 721(c), today’s notice states that the IRS and Treasury intend to augment the section 482 rules as they apply to controlled transactions involving partnerships.

Notice 2015-54 proposes to require the recognition of gain when a U.S. person contributes of built-in gain property (721(c) property) to a foreign or domestic partnership, if after the contribution:

  • A related foreign person is a direct or indirect partner of the transferor, and
  • The related person own more than 50% of the interests in partnership capital, profits, deductions or losses.

Notice 2015-54 indicates that an exception to gain recognition will apply if the partnership adopts the “gain deferral method.” The gain deferral method requires:

  • The remedial method to be adopted with respect to the section 721(c) property,
  • During any tax year in which there is a remaining built-in gain in the section 721(c) property, the partnership allocates all section 704(b) items with respect to the property in the same proportion,
  • Certain reporting requirements are satisfied,
  • The transferor recognizes gain upon an acceleration event, and
  • The “gain deferral method” is adopted for all subsequently contributed section 721(c) property until the earlier of 60 months of the initial contribution or no built-in gain remains.

As an additional requirement to the “gain deferral method,” the IRS notice indicates that the transferor (and in some cases the partnership) must extend the statute of limitations of assessment for eight years.

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