Foreign Entity Possibly a 'True' Partner

[3] Field Service Advice is not binding on Examination or Appeals and is not a final case determination. Such advice is advisory and does not resolve Service position on an issue or provide the basis for closing a case. The determination of the Service in the case is to be made through the exercise of the independent judgment of the Field office with jurisdiction over the case.

2. Is * * * or * * * the "true" partner of * * * under the Culbertson test?

3. Can Section 482 of the Code be applied to reallocate income between * * * and * * *?

2. The Culbertson test generally determines who is the partner of the partnership. The facts must be developed further before the Culbertson test can be applied.

3. Whether and how section 482 of the Code might apply to reallocate income depends on the further development of the facts concerning the nature, terms and other circumstances of the transactions among the various parties.

[7] In the years in issue, * * * and * * *, * * * experienced significant losses. The International Examiner believes that a portion of those losses should be reallocated from the U.S. entities to * * * to reflect that * * * is the "true" partner of * * *.

[8] According to the International Examiner, * * * was involved with * * * in the following ways: (1) it provided a significant portion of the funds for the construction of the paper mill yet apparently never demanded repayment of the funds from * * * or * * * ; (2) it directed the construction and financing of the mill; (3) it acted as the managing partner of * * *; (4) it guaranteed the following: * * *'s debt to the partnership, (ii) * * * 's performance under the construction agreement, and (iii) * * *'s performance as managing partner; and (5) it received many, if not all, of the notices related to the funding of the paper mill.

[9] * * * was audited during its construction phase (* * *-* * *) and during operations (* * *-* * *). The * * * year was surveyed. The result of this survey was not provided to * * *. In the survey, the Service determined that the losses claimed by * * * were proper and closed the case.

[11] Section 704(a) of the Code provides generally that a partner's distributive share of income, gain, loss, or credit shall, except as otherwise provided, be determined by the partnership agreement.

[12] Section 704(b) of the Code provides generally that a partner's share of income, gain, loss, deduction or credit (or item thereof) shall be determined in accordance with the partner's interest in the partnership (determined by taking into account all facts and circumstances), if --

[14] Section 761(a) of the Code provides generally that the term "partnership" includes a syndicate, group, pool, joint venture or other unincorporated organization through or by means of which any business, financial operation, or venture is carried on, and which is not, under the Code, a corporation or a trust or an estate. The Code does not define a partner. The Code only states that a partner is a member of a partnership. Consequently, who is a partner will depend on the same case law and regulatory principles that determines what constitutes a partnership.

[15] Section 1.701-2(a) of the Income Tax Regulations provides generally that Subchapter K is intended to permit taxpayers to conduct joint business (including investment) activities through a flexible economic arrangement without incurring an entity level tax. Implicit in the intent of subchapter K are certain requirements. The requirement under section 1.701-2(a)(3) is that the tax consequences under subchapter K to each partner of partnership operations and of transactions between the partner and the partnership must accurately reflect the partner's economic arrangement.

[16] In Commissioner v. Tower, 327 U.S. 280, (1946), the Supreme Court said that a partnership is "created when persons join together their money, goods, labor, or skill for the purpose of carrying on a trade, profession, or business and when there is community of interest in the profits and losses." Id. at 286.

[17] Later, in Commissioner v. Culbertson, 337 U.S. 733 (1949), the Court stressed the intent of the parties as the paramount factor in determining a partnership:

[19] Section 1.701-2 of the regulations does not tell you who the partner is -- economics and case law tell you who the partner is. Section 1.701-2 tells you that the Service can take a transaction and rearrange it to properly reflect the tax consequences under certain circumstances. This case does not present those circumstances. The issue is whether * * * or * * * is the partner.

[20] Section 704 of the Code is designed to determine a partner's share of income, gains, losses, deductions and credits of the partnership.

[21] Section 704(b) of the Code requires that the allocation of these items have substantial economic effect. If a partnership's agreement does not meet the substantial economic effect test, then the allocations are determined based on the "partners' interest in the partnership."

[22] While the rules refer to the "interest" of the partner, the rules assume that the partner's interest is valid and determines allocations based on that assumption. The rules do not analyze who is the partner of the partnership. The same rationale that applies to the section 704 rules applies to the section 705 rules. The section 705 rules determine a partner's basis in its partnership interest. Section 705 does not determine who is the partner of the partnership.

THE CULBERTSON TEST

INTENT

[23] Generally, if a party is a member of the partnership under the partnership agreement then the party is presumed to be a partner. Assuming that * * * is a partner under the * * * partnership agreement, there is a strong presumption that * * * intends to be a partner of * * *.

RELATIONSHIP BETWEEN THE PARTIES

[24] It is our understanding that it is rare for a foreign entity to do business in the U.S. without using a U.S. affiliate. If done properly, there is no question that we would recognize the tax consequences that flow from a U.S. subsidiary being the partner. In fact, the tax consequences of the U.S. partnership to the U.S. partner would be clearly contemplated by the Code and regulations. The close relationship between the parties also suggests that any contributions by * * * to * * * reflect careless accounting methods between the related parties rather than an intent of * * * to be a partner. We believe the relationship of the parties favors finding that * * * is a partner.

CAPITAL CONTRIBUTIONS AND SECTION 482

[25] * * *

[26] In this regard, it would be helpful to know * * *. Please ensure that if a former name of one of the parties is being used, its current name is identified.

[27] We reviewed the "guarantee" document you provided us. The document is from * * *, addressed to * * * and dated * * *. The document mentions that * * * has borrowed a large amount of money from * * *. It states that * * * is receiving a guarantee from * * * of the amount * * * has borrowed from * * * through the partnership. Section (j) of the document states that "Each Partner Subsidiary (including * * *) is engaged solely in the business of holding and performing its obligations under the Collateral Agreements to which it is a party and (ii) has no Indebtedness other THAN UNSECURED INDEBTEDNESS TO THE GUARANTOR or any Affiliate of the Guarantor and no assets other than its partnership interest in the Company (* * *) and assets incidental to holding the same." (emphasis added). * * *.

[28] International has suggested that IRM 4232 (13) 512 provides guidance for performing a functional analysis in the context of a section 482 audit. If you wish assistance in performing such an analysis, you may wish to contact a member of the International Field Assistance Specialization Program (IFASP). The section 482 specialists are Paul Chmiel (201-437-9217), Jon Tamaki (408-291-4094) and Jim Guidone (201-357-4037).

[29] Should you have any questions, or require further assistance, please do not hesitate to contact Ann M. Veninga at (202) 622-7653.