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Private Foundations and UBTI
The IRS has ruled privately that gains from sales of real property interests by investment partnerships held by a private foundation do not constitute unrelated business taxable income.
The IRS has ruled that a private foundation's distributive share of gains from sales of real estate holding company investments made by investment partnerships or investment limited liability companies organized in the United States will not be unrelated business taxable income assuming these interests are not debt-financed.
The trustee of the private foundation is a foreign corporation. The private foundation's exempt activities are financed through an investment portfolio which it plans to diversify with investments in domestic and foreign partnerships and other entities taxed as partnerships, as well as other investments. The domestic investment partnership interests would be acquired through a domestic holding company. Because these gains are not unrelated business taxable income under Code Section 512(b)(5), the IRS notes that it is not necessary to determine whether the gains would be treated as income effectively connected with a United States trade or business under Code Section 897(a). The IRS also rules that no withholding would be required under Code Section 1446 to the extent that the gains are not unrelated business taxable income.
POINTS TO PONDER:
Even though a partnership is a pass through entity, the IRS did not review the nature of the activities of the partnership nor was it apparently concerned about the excess business holdings rules (see companion PLR 9844033). The characterization of the income as passive may address these two issues. It is also interesting to note the special application of UBTI to a foreign organization.
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Date: July 30, 1998
Refer Reply to: CC:INTL:Br4-PLR-109840-98
Taxpayer = * * *
Year 1 = * * *
X = * * *
Trustee = * * *
Country A = * * *
Dear * * *
This responds to your March 31, 1998 letter requesting a ruling under section 512(a)(2) and section 512(b)(5) of the Internal Revenue Code that the Taxpayer's distributive share of a U.S. partnership's gains attributable to the disposition of U.S. real property interests that are not "debt-financed property" within the meaning of section 514 ("Debt-Financed Property") will not be subject to U.S. federal income tax. Additional information was submitted in a letter dated May 29, 1998. The information submitted is substantially as set forth below.
The rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party. This office has not verified any of the material submitted in support of the ruling requests. Verification of the information, representations, and other data may be required as part of the examination process.
The information submitted indicates that the Taxpayer is a charitable trust established in Year 1 under the will of X. The sole trustee of the Taxpayer is Trustee, a company incorporated in Country A. The Taxpayer has been recognized by the Service as exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code and has been determined to be a private foundation within the meaning of section 509(a) of the Code.
The Taxpayer's charitable activities are financed with the returns from its investment portfolio, consisting in large part of direct and indirect holdings of publicly-traded stocks and securities. In recent years, however, the Board of Governors of the Trustee has determined that a percentage of the Taxpayer's portfolio should consist of investments in private equity and equity-related securities. As trustee of the Taxpayer, the Trustee, with the assistance of financial advisors, is therefore in the process of acquiring a diversified portfolio of limited partnership interests (and, to a lesser extent, interests in limited liability companies) engaged in venture capital and other securities investment activities and managed by professional managers. The Taxpayer does not currently borrow money from any source to make investments or for any other purpose.
The Trustee intends to acquire limited partnership interests in investment partnerships (or non-manager member interests in limited liability companies) organized in the United States (the "Domestic Funds") and in investment entities treated as partnerships for U.S. federal income tax purposes that are organized outside of the United States (the "Foreign Funds" and, together with Domestic Funds, the "Funds").
The management, policies and control of each Fund will be vested solely in the general partner(s) or managing members(s) of that Fund. The Trustee has adopted a policy of acquiring, from each Domestic Fund, less than ten percent of the aggregate interests of all investors in that Domestic Fund, and typically will acquire substantially less than ten percent of those interests.
The Domestic Funds themselves will invest in debt and equity securities issued by domestic corporations and by other entities treated as corporations for United States federal income tax purposes (the "Corporate Portfolio Companies"). Some Domestic Funds will also invest in equity interests issued by entities treated as partnerships for U.S. federal income tax purposes (the "Partnership Portfolio Companies," and together with any Corporate Portfolio Companies, the "Portfolio Companies"). Most of the Funds will be organized as "blind pools": Portfolio Companies in which a Fund ultimately acquires interests will not be identified at the time the Taxpayer becomes a limited partner or member of that Fund.
In certain circumstances, a Domestic Fund will acquire interests, other than solely as a creditor, in one or more domestic Corporate Portfolio Companies that are (or during the Fund's holding period, become) "United States real property holding corporations" ("USRPHCs") within the meaning of section 897(c)(2) of the Code. Any such interest will constitute a "United States real property interest" ("USRPI") within the meaning of section 897(c).
The Trustee plans to hold its interests in Domestic Funds through a U.S. entity (a "Domestic Holding Company") treated as a tax transparent entity for tax purposes both in the United States and in the United Kingdom.
Section 511 imposes a tax on the unrelated business taxable income (as defined in section 512) of organizations described in section 501(c).
Section 512(a)(1) defines the term "unrelated business taxable income" as the gross income received by an exempt organization from any unrelated trade or business regularly carried on by it, less deductions which are directly connected with the carrying on of such trade or business, both computed with the modifications in section 512(b).
Section 512(a)(2) provides that the unrelated business taxable income of an organization described in section 511 which is a foreign organization is:
"(A) its unrelated business taxable income which is derived from sources within the United States and which is not effectively connected with the conduct of a trade or business within the United States, plus
(B) its unrelated business taxable income which is effectively connected with the conduct of a trade or business within the United States."
Section 512(b)(5) excludes from an organization's unrelated business taxable income all gains from the sale, exchange, or other disposition of property other than (i) stock in trade or other property of a kind which would properly be includible in inventory if on hand at the close of the taxable year or (ii) property held primarily for sale to customers in the ordinary course of the trade or business.
Section 512(b)(4) of the Code provides that notwithstanding paragraph (5), in the case of debt-financed property (as defined in section 514), there shall be included, as an item of gross income derived from an unrelated trade or business, the amount ascertained under section 514(a)(1) (with a deduction allowed under section 512(a)(2)).
First we must determine whether the Taxpayer's distributive share of a Domestic Fund's gain from the sale of a USRPI is unrelated business taxable income ("UBTI") under section 512(a)(1) and (b)(5). If the Taxpayer's distributive share of the gain is UBTI, in order to determine whether that amount is taxable under section 512(a)(2)(B), we must determine whether the Taxpayer's distributive share of the gain is treated as income effectively connected with a U.S. trade or business ("ECI") under section 897(a). If the Taxpayer's distributive share of the gain is not UBTI, it is not necessary to determine whether that amount is treated as ECI under section 897(a) because, whether or not it is ECI, it is not subject to tax under section 512(a)(2)(B).
The Taxpayer has represented that each Domestic Fund's debt and equity interests in Corporate Portfolio Companies are property other than (i) stock in trade or the property of a kind which would properly be includible in inventory of that Fund or the Taxpayer if on hand at the close of the taxable year, or (ii) property held primarily by that Fund or the Taxpayer for sale to customers in the ordinary course of the that Fund's or the Taxpayer's [sic] trade or business. Therefore, assuming that a Domestic Fund's interests in a particular Corporate Portfolio Company are not Debt- Financed Property, under sections 512(a)(1) and 512(b)(5), the Taxpayer's distributive share of that Domestic Fund's gain attributable to the sale, exchange or other disposition of its interest in a Corporate Portfolio Company (including a USRPHC) is disregarded in calculating the amount, if any, of the Taxpayer's UBTI.
Because the Taxpayer's distributive share of a Domestic Fund's gain attributable to the sale, exchange, or other disposition of its interest in a Corporate Portfolio Company (including a USRPHC) is not UBTI, it is not necessary to determine whether that gain is treated as ECI under section 897(a).
Based on the information submitted and the representations set forth above, we rule as follows:
(1) The Taxpayer's distributive share of a Domestic Fund's gain that is attributable to the disposition of a U.S. real property interest that is not "Debt-Financed Property" within the meaning of section 514 will not be subject to U.S. federal income tax under sections 511-514.
(2) No withholding under section 1446 is required with respect to the Taxpayer's distributive share of a Domestic Fund's gain that is attributable to the disposition of a U.S. real property interest that is not Debt-Financed Property to the extent the gain is not UBTI (Rev. Proc. 89-31 (sec. 6.02, LAST SENTENCE), 1989-1 C.B. 895, 898).
The Internal Revenue Service expresses no opinion about the tax treatment of the proposed transactions under other provisions of the Code and regulations, or about the tax treatment of any conditions existing at the time of, or effects resulting from the transactions not specifically covered by the above rulings.
A copy of this letter must be attached to any Federal income tax return to which it is relevant.
This ruling is directed solely to the taxpayer requesting it. Section 6110(j) provides that this ruling may not be used or cited as precedent.
In accordance with the Power of Attorney on file in this office, a copy of this letter is being sent to the first two authorized representatives.
ASSOCIATE CHIEF COUNSEL(INTERNATIONAL)
By: Charles C. Saverude
Assistant to the Associate Chief Counsel (International)