The IRS publicly released a legal advice memorandum* relating to certain “bad boy” nonrecourse carveouts and their impact on debt allocations under section 752 and at-risk basis under section 465. AM2016-001 (release date April 15, 2016, and dated March 31, 2016)
Read text of the legal advice memo [PDF 67 KB]
*The memorandum is legal advice, signed by executives in the National Office of the Office of Chief Counsel and issued to IRS personnel who are national program executives and managers. The memo is issued to assist IRS personnel in administering their programs by providing authoritative legal opinions on certain matters, such as industry-wide issues. It is not to be used or cited as precedent..
Earlier this year, in ILM 201606027, the IRS concluded that certain “bad boy” acts that, upon occurrence would create personal liability for guarantors, would cause partnership debt subject to the carveouts to be treated as recourse under section 752 with respect to the guarantor, and that the debt would no longer qualify as qualified nonrecourse financing for purposes of section 465. Of particular concern to the IRS was a carveout provision that would be invoked if the borrower “admits in writing or in any legal proceeding that it is insolvent or unable to pay its debts as the come due.”
In AM 2016-001, the IRS has reversed course and concluded that the carveout provisions addressed in ILM 201606027 will not cause the debt to be treated as recourse under section 752 until such provisions are actually invoked. The IRS reached the same conclusion under section 465, such that these carveouts will not prevent debt from being treated as qualified nonrecourse financing until invoked.
In justifying its conclusion with respect to the “admission of insolvency” carveout, the IRS in the legal advice memorandum stated:
[T]he fundamental business purpose behind such carve-outs and the intent of the parties to such agreements is to prevent actions by the borrower or guarantor that could make recovery on the debt, or acquisition of the security underlying the debt upon default, more difficult. The “nonrecourse carve-out” provisions should be interpreted consistent with that purpose and intent in mind. Consequently, because it is not in the economic interest of the borrower or the guarantor to commit the bad acts described in the typical “nonrecourse carve-out” provisions, it is unlikely that the contingency (the bad act) will occur and the contingent payment obligation should be disregarded under § 1.752-2(b)(4). Therefore, unless the facts and circumstances indicate otherwise, a typical “nonrecourse carve-out” provision that allows the borrower or the guarantor to avoid committing the enumerated bad act will not cause an otherwise nonrecourse liability to be treated as recourse for purposes of section 752 and § 1.752-2(a) until such time as the contingency actually occurs.
The ILM released earlier this year gave rise to concerns for a number of entities that now may find good news with the reversal of IRS prior position with the release of AM 2016-001.
© 2018 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.