Clarify Partnership Issues in Proposed Debt-Equity Regs, Firm Says

The proposed regulations under section 385¹ should be modified to clarify that such proposed regulations do not apply to applicable instruments between a member of a consolidated group and a partnership that is wholly owned by members of the same consolidated group.

The proposed regulations under section 385 do not apply to applicable instruments between members of a consolidated group. As the preamble explains, "the concerns addressed in the proposed regulations generally are not present when the issuer's deduction for interest expense and the holder's corresponding interest income offset on the group's consolidated federal income tax return." See Preamble, 81 Fed. Reg. at 20914. The proposed regulations achieve this result by treating, for purposes of such regulations, all members of a consolidated group as "one corporation." See Prop. Treas. Reg. § 1.385-1(e); Preamble, 81 Fed. Reg. at 20920. Therefore, for purposes of the documentation requirements under Prop. Treas. Reg. § 1.385-2, so long as the issuer and holder are members of the same consolidated group, the applicable instrument is treated as not outstanding. See Prop. Treas. Reg. § 1.385-2(c)(4)(i).

As in the case of applicable instruments between members of a consolidated group, the concerns addressed in the proposed regulations are equally not present in the case of applicable instruments between a member of a consolidated group and a partnership that is wholly owned by members of the same consolidated group (either directly or indirectly looking through any partners that are themselves partnerships). In each case, the issuer's interest expense deduction and the holder's corresponding interest income offset on the group's consolidated federal income tax return. Also in each instance, the applicable instruments, which in our case arise from routine treasury functions and necessary intercompany services, have no federal tax effect. Finally, the compliance burden of applying the documentation requirements in this context would far outweigh any potential benefit or policy concerns. Importantly, among large corporate taxpayers the existence of lower-tier partnerships (generally LLCs) wholly owned by members of the same consolidated group is commonplace.

For purposes of the documentation requirements under Prop. Treas. Reg. § 1.385-2, the proposed regulations treat a controlled partnership as an entity separate from its partners. Specifically, the documentation requirements apply to applicable instruments between members of an "expanded group," and, for purposes of such documentation requirements, "a controlled partnership . . . is treated as a member of an expanded group." See Prop. Treas. Reg. §§ 1.385-2(a)(4)(ii), (c)(6)(i); Preamble, 81 Fed. Reg. at 20920. A "controlled partnership" is a partnership with respect to which at least 80 percent of the interests in partnership capital or profits are owned, directly or indirectly, by one or more members of an expanded group. See Prop. Treas. Reg. § 1.385-1(b)(1). Any partnership that is wholly owned by members of the same consolidated group (either directly or indirectly looking through any partners that are themselves partnerships) would fall within the definition of a "controlled partnership." As a result, the documentation requirements under Treas. Reg. § 1.385-2 would appear to apply to applicable instruments between a member of a consolidated group and a partnership that is wholly owned by members of the same consolidated group (either directly or indirectly looking through any partners that are themselves partnerships).

 

 

Accordingly, we respectfully request that the proposed regulations be modified to clarify that such proposed regulations (or, at the very least, that the documentation requirements under Prop. Treas. Reg. § 1.385-2) do not apply to applicable instruments between a member of a consolidated group and a partnership that is wholly owned by members of the same consolidated group (either directly or indirectly looking through any partners that are themselves partnerships). This clarification could be made in any one of a several ways, including, but not limited to, (i) adding one or more examples on the relationship between the "one corporation" rule under Prop. Treas. Reg. § 1.385-1(e) and the entity classification rules under Treas. Reg. § 301.7701-3, (ii) modifying the scope of the definition of a "controlled partnership" under Reg. § 1.385-1(b)(1), (iii) modifying the scope of the "one corporation" rule under Reg. § 1.385-1(e), or (iv) modifying the rule under Reg. § 1.385-2(c)(6) that treats all "controlled partnerships" as members of the "expanded group" for purposes of the documentation requirements.

Thank you in advance for your consideration of our comments.