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Firm Provides Treasury With Examples for UBTI Guidance

MAY 20, 2019

Firm Provides Treasury With Examples for UBTI Guidance

DATED MAY 20, 2019
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[Editor's Note:

For an attachment with diagrams of the examples, see the PDF version.

]

From: Hancock, Harold

To: Ramey, Elinor

Subject: Follow Up on Meeting Request

Date: Monday, May 20, 2019 1:41:08 PM

Attachments: UBTI Examples for Notice 2018-67 for Treasury Draft_(19249693_1).DOCX
UBTI Examples for Treasury Draft.pdf

Elinor,

I know you are busy and your schedule is uncertain. I assume you have been working on the endowment excise tax regs that were just sent to OMB.

Attached are two documents. A word document that with the examples we would like to discuss, and then a pdf that diagrams the examples, but also adds a couple more that are variations on the other examples.

I apologize for the delay in sending these. Took us longer than I thought to finalize.

Would you be available to meet next week?

Thanks,

Harold

Harold Hancock
Brownstein Hyatt Farber Schreck, LLP
1155 F Street N.W., Suite 1200
Washington, DC 20004
202.383.4422 tel
703.598.4723 cell
hhancock@bhfs.com


Example for Aggregating Qualifying Partnership Interests under the De Minimis and Control Tests Set Forth in Notice 2018-67

Notice 2018-67 — Qualifying Partnership Interests

Notice 2018-67 provides guidance on how tax-exempt organizations should handle investments made through partnerships for purposes of new section 512(a)(6). If a tax-exempt organization has a Qualifying Partnership Interest (a QPI) in a partnership, it may use one of two aggregation rules for administrative convenience to limit the number of unrelated trades or businesses under section 512(a)(6).

A QPI is an interest that meets the de minimis or the control test.

De minimis Test. Under the Notice, a partnership interest meets the requirements of the de minimis test if the exempt organization holds directly no more than 2 percent of the profits interest and no more than 2 percent of the capital interest.

Control Test. Under the Notice, a partnership interest is a Qualifying Partnership Interest that meets the requirements of the control test if the exempt organization (1) directly holds no more than 20 percent of the capital interest; and (2) does not have control or influence over the partnership. All facts and circumstances are relevant for determining whether an exempt organization has control or influence over a partnership. An exempt organization has control or influence if the exempt organization may require the partnership to perform, or may prevent the partnership from performing, any act that significantly affects the operations of the partnership. An exempt organization also has control or influence over a partnership if any of the exempt organization's officers, directors, trustees, or employees have rights to participate in the management of the partnership or conduct the partnership's business at any time, or if the exempt organization has the power to appoint or remove any of the partnership's officers, directors, trustees, or employees.

If a tax-exempt organization has a QPI, it may use one of the following aggregation rules:

UBTI Aggregation. An exempt organization may aggregate its UBTI from its interest in a single partnership with multiple trades or businesses, including trades or businesses conducted by lower-tier partnerships, as long as the directly-held interest in the partnership meets the requirements of either the de minimis test or the control test; or

All Income Aggregation. An exempt organization may aggregate all QPIs and treat the aggregate group of QPIs as comprising a single trade or business for purposes of section 512(a)(6)(A).

Example 1: Qualifying Partnership Interests

Organization X is exempt from tax under section 501(c)(13) of the Internal Revenue Code of 1986 (the “Code”). Organization X invests monies it receives from consumers through a statutory endowment care fund (“ECF”) which can only be used for the care, maintenance, and embellishment of the tax-exempt cemetery. To best care for the cemetery, the ECF makes a variety of investments, some of which may generate unrelated business taxable income (“UBTI”). For example, the ECF invests in Fund #1 as a limited partner. ECF has no other investments funds structured as partnerships. Fund #1 invests in numerous private equity funds, including PE Fund A and PE Fund B. Fund #1 is a limited partner in both PE Fund A and B, with a partnership interest that is less than 2 percent of the profits and capital of both funds. PE Fund A and PE Fund B typically invest in 10-15 different active trades or businesses which are typically C corporations. However, PE Fund A also invests in Shipping Business, which is taxed as a partnership and generates UBTI, and PE Fund B also invests in an Airplane Leasing Business, which is taxed as a partnership and generates UBTI. How does ECF treat these investment activities under section 512(a)(6) and the rules for UBTI generally?

Possible Answers: Organization X (through ECF) is able to use one of the two aggregation rules, and the receipt of UBTI through these investments does not affect its tax-exempt status.

1) UBTI Aggregation: ECF is able to aggregate all the UBTI generated by the Fund #1 investment into a single bucket (with all the investment income in a separate bucket). with other partnership investments that are qualifying partnership interests.

If Fund #1 has no other exempt organization investors or all remaining exempt organization investors meet the de minimis or control tests, reporting UBTI is straight forward. Even if an exempt organization has multiple qualifying partnership interests, all the information is available to choose one of the aggregation options. However, should Fund #1 have any exempt organizations that do meet either the de minimis or the control test, all information on UBTI will need to be reported separately by each investor in Fund #1. In addition, should the aggregation rules not apply to all exempt organizations, for example a 501(c)(13) because of the specific language of its exemption, the upper tier investment fund will also need to have all UBTI information reported separately through all the investment tiers.

2) All Income Aggregation: ECF is able to aggregate all QPIs as comprising a single trade or business. In this case, there is only the investment in Fund #1. This aggregation rule would appear to apply in cases where there is also an investment in at least one other partnership or fund (for example, Fund #2). This aggregation rule does not explicitly include lower-tier partnerships, which may cause difficulties with reporting income up through tiers, but it seems to contemplate that a tax-exempt organization can treat its investment in the Fund (and other QPIs in other Funds) as a single trade or business.

This option raises the same reporting/aggregation issues the UBTI Aggregation rule. First: if there is an exempt organization at the Fund #1 level that does not meet the de minimis or control test with regard to Fund #1, and Second: if Fund #1 has an investment that does not meet the de minimis or control test such that the investment could not be aggregated and must be reported separately. But, if the investors at the Fund #1 level are tested separately for aggregation purposes, an exempt organization could still aggregate the Fund #1 investment with any other qualifying partnership interests.

Example 2: Special Purpose Investment Vehicle

Same facts as above, except ECF owns 100 percent of a special purpose investment vehicle (SPIV), LLC, which invests in PE Fund A and PE Fund B rather than ECF investing in Fund #1. ECF hires a third party investment advisor to make all investment decisions for ECF through SPIV, LLC. While ECF controls SPIV, LLC, it is a disregarded entity, and ECF is treated as making the investments directly in PE Fund A and PE Fund B.

Is ECF able to take advantage of the aggregation rules as described in Example 1 for the investments in PE Fund A and PE Fund B?

Is ECF able to able to aggregate all income from partnerships in which it holds a direct interest and does not otherwise have control?

Example 2A: Fund of One

Same facts as Example 1, except that Fund #1 is structured so that ECF is the only investor. ECF has a 99 percent limited partnership interest and a professional third party manager has a 1 percent general partner interest in Fund #1. The general partner makes all investment decisions, including the investments in PE Fund A and PE Fund B. While ECF has a greater than 20 percent capital interest in the partnership, ECF does not otherwise have control over the partnership. The general partner makes all investment decisions based on agreed plan determined at the time Fund #1 is formed.

Is ECF able to take advantage of the aggregation rules as described in Example 1 for the investments in PE Fund A and PE Fund B?

Is ECF able to able to aggregate all income from partnerships in which it holds a direct interest and does not otherwise have control?

Should the answer to Example 2 and Example 2A be the same?

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