CORPORATE USE OF PARTNERSHIPS TO AVOID EFFECTS OF THE GENERAL UTILITIES REPEAL WILL RESULT IN GAIN RECOGNITION AFTER MARCH 9, 1989.

Notice 89-37

Section 631 of the Tax Reform Act of 1986 (the "1986 Act") was intended to repeal the General Utilities doctrine which, under certain circumstances, permitted a corporation to distribute appreciated assets to its shareholders without recognizing gain. Following the 1986 Act, the Internal Revenue Code generally requires a corporation to recognize gain upon the distribution of appreciated property (see sections 311(b) and 336(a)). Section 631 of the 1986 Act also added section 337(d) to the Code, as amended by section 1006(e)(5) of the Technical and Miscellaneous Revenue Act of 1988, to protect the integrity of the repeal of the General Utilities doctrine. Section 337(d) directs the Secretary to prescribe the regulations that may be necessary or appropriate to carry out the purposes of the 1986 Act's repeal of the General Utilities doctrine, including regulations to ensure that such purposes are not circumvented through the use of any provision of law or regulations.

The Service has determined that, in certain circumstances, the acquisition (or mere ownership) by a partnership of stock in one of its corporate partners (or stock of any member of the affiliated group of which such partner is a member) results in avoidance of General Utilities repeal. These circumstances are present to the extent the corporate partner, in substance, relinquishes an interest in appreciated property in exchange for an interest in its stock (or the stock of any member of the affiliated group of which such partner is a member). The Service intends to prescribe regulations under its general rulemaking authority and section 337(d) to provide for gain recognition by a corporate partner in such circumstances.

APPLICATION OF SECTION 311(b) NOTWITHSTANDING SECTION 731

The Service has determined that, in order to carry out the purposes of the repeal of the General Utilities doctrine, a partnership distribution to a corporate partner of the stock of such corporation (or the stock of any member of the affiliated group of which such partner is a member) should be characterized as a redemption of the corporate partner's stock with property consisting of its partnership interest. Therefore, the Service will issue regulations providing that section 311(b), rather than the general nonrecognition rule of section 731(a), will be applicable whenever a partner receives a distribution of its own stock (or the stock of any member of the affiliated group of which such partner is a member). Accordingly, under section 311(b), gain (but not loss) with respect to the partner's partnership interest will be recognized. This rule will apply to all such distributions of corporate stock occurring after March 9, 1989.

DEEMED REDEMPTION

The Service also intends to adopt rules under which gain will be recognized at the time of, and to the extent that, any transaction (or series of transactions) has the economic effect of an exchange by a corporate partner of its interest in appreciated property for an interest in its stock (or the stock of any member of the affiliated group of which such partner is a member) owned or acquired by the partnership. In general, the gain that would be required to be recognized by the corporate partner under this rule would include the gain attributable to appreciation accruing during the period (i) before the property was contributed by the corporate partner to the partnership, and (ii) after the property was contributed to, or acquired by, the partnership and prior to the deemed redemption.

For example, if a corporation contributes appreciated property to a partnership in exchange for a thirty percent interest in the partnership and another person exchanges stock of the corporate partner for the other seventy percent interest in the partnership, the corporate partner can properly be treated as having relinquished seventy percent of its interest in the appreciated property in exchange for a thirty percent interest in its own stock at the time of the acquisition of such stock, without regard to whether such stock is or will be distributed to the corporate partner. Other transactions to which the deemed redemption rule may apply include, but are not limited to, partnership purchases of a corporate partner's stock, disproportionate distributions, and amendments to the partnership agreement. The Service is considering whether any exceptions, such as a de minimis rule, might be appropriate. The deemed redemption rule will apply to any transaction (or series of transactions) with the above described economic effect occurring after March 9, 1989.

OTHER PRINCIPLES AND RULES

Certain transactions that would be subject to the regulations to be issued, as described in this Notice, also may be subject to taxation under the "substance over form" principle or section 707(a)(2)(B). For example, the "substance over form" principle and section 707(a)(2)(B) are each relevant to the analysis of any transaction in which a corporate partner contributes appreciated property to a partnership that acquires (or owns) stock of the corporate partner pursuant to an understanding that such stock will be distributed to the corporate partner by the partnership.

No inference should be made based upon this Notice regarding the scope of the "substance over form" principle or the disguised sale rules of section 707(a)(2)(B).

ADMINISTRATIVE PRONOUNCEMENT

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or a revenue procedure. See Rev. Rul. 87-138, 1987-2 C.B. 287.

FURTHER INFORMATION

For further information regarding this announcement, contact either John N. Geracimos (CC:CORP:4) or Dexter A. Johnson (CC:P&SI:3) at (202) 566-3651 or (202) 566-4751, respectively (not toll-free calls).