Advisories January 4, 2016

Federal Tax Advisory: Investment Company Rules

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Alston & Bird

Sections 351 and 362 contain investment company rules that have nothing to do with mutual funds. They define certain corporations as investment companies in counterintuitive ways and then deny the usual nonrecognition treatment of Sections 351 and 368 and the other sections governing reorganizations, when investment companies are involved. Of course these limits are of great importance, but they are easy to overlook.

For about the last year and a half, the IRS and Treasury have been working on the definition of investment companies as part of the 2014–2015 and 2015–2016 Priority Guidance Plans. The first evidence of some progress was released in November in LTR 201547003. It is a very limited ruling that illustrates how the statutes are too strict, and the existing regulations make some attempt to relieve the force of the statute, but not nearly enough.

The ruling actually concerns a contribution to a partnership. Section 721(b) provides that the normal nonrecognition rule for contributions of property to a partnership does not apply if the partnership would be an investment company under Section 351(e).


Two corporations merged. One was a new corporation and another was the general manager of a master limited partnership #1, which is a publicly traded entity not taxed as a corporation. The assets received by the corporation evidently were mostly the general partner’s interest in the partnership #1. Immediately after the merger, the corporation contributed its general partner interests to X, another publicly traded partnership that owned interests in other publicly traded partnerships, #2, #3 and #4. The issue was whether X was an investment company.

The problem was that interests in “a publicly traded partnership (as defined in section 7704(b))” owned by X must be treated as cash in determining whether X in a Section 721 exchange is an investment company under
Section 351(e). That matters because putting appreciated property into a cash box can be treated as a contribution to an investment company, which is a taxable exchange.

The 1996 vintage regulation provides a lookthrough rule for subsidiary corporations, but not subsidiary partnerships. So X owned some interests in three publicly traded partnerships that were treated as cash or securities and that necessarily made X an investment company. X did not own any subsidiary corporations that it could look through.


The IRS ruled that if X owned more than half of the value of one of the three other publicly traded limited partnerships in which it owned interests, it could look through to the assets of that partnership for purposes of determining whether the corporation was an investment company. Evidently it did own that much of one and evidently a lookthrough would produce noncash assets that could help X escape the investment company label. It is curious that the fact that X itself is a publicly traded partnership does not make it a per se investment company, but Reg. Section 1.351-1(c) could because X’s assets are mostly marketable securities.

This ruling expands the regulation, which predates the current statute, to apply the lookthrough to a partnership interest. In a way, that is not usual because some adaption must occur to make Section 351(e) work for partnerships. But the issue here was not that the asset transferee was a partnership but that the assets of that partnership were publicly traded partnership interests, which can occur when the potential investment company is a corporation too.

LTR 200211017 is an earlier ruling that may have contained the same interpretation.


One of the confusions in this area and one of the reasons for the regulation project is that the definitions of investment companies in Section 351 and Section 368 are not the same. We can hope that the regulation project goes beyond expanding lookthrough rules and somehow coordinates the two rules, making them less of a trap for the unwary.

For additional information, call Jack Cummings at 919.862.2302.


This advisory is published by Alston & Bird LLP’s Federal Tax practice area to provide a summary of significant developments to our clients and friends. It is intended to be informational and does not constitute legal advice regarding any specific situation. This material may also be considered attorney advertising under court rules of certain jurisdictions.

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