In an IRS Chief Counsel Advice (CCA) memorandum (CCA 201517006), the agency concluded that the restructuring of certain profits interests held by a general partner did not result in a taxable transaction. To arrive at this conclusion, the IRS appears to have relied on the partnership's ability to revalue its property due to a simultaneous contribution of cash by the general partner's corporate owner parent in exchange for new interests.
The CCA states that the taxpayer ― a corporation ― originally held both a general partner interest and Incentive Distribution Rights (IDRs) in a publicly traded partnership, which is treated as a partnership through the operation of Section 7704 for federal income tax purposes. The IDRs are non-publicly traded limited partnership profits interests that entitled the taxpayer to a share in future partnership profits and quarterly distributions. Once the partnership reached certain thresholds, as stipulated in the original partnership agreement, the taxpayer's allocation of distributions and income increased, but capped at an agreed-upon maximum percentage.
At a future date, the partnership and taxpayer entered into an exchange agreement and an amended partnership agreement to replace the taxpayer's current IDRs with common units and "less valuable" IDRs, while holding the same general partner interest. In the restructuring, the taxpayer received new publicly traded common units and new IDRs with higher thresholds and lower maximum entitlements to income allocations and distributions. The new IDRs and common units were calculated in a manner that produced the same distribution to the taxpayer that the old IDRs would have produced prior to the restructuring.
The CCA additionally states that at the restructuring date, the taxpayer would have been allocated a substantial amount of proceeds under the old IDRs, if the partnership were to have liquidated. The partnership had not experienced a revaluation event in a while, and, thus, the partnership property and partners' capital accounts had not been booked up to reflect such appreciation. Therefore, the taxpayer's capital account did not reflect its entire economic entitlement at the restructuring date, which would have caused the taxpayer's capital accounts with respect to the newly issued publicly traded common units to be lower than the capital accounts of other publicly traded common units in the partnership.
On the same date as the restructuring of the taxpayer's units, the taxpayer's corporate owner parent made a contribution to the partnership in exchange for newly issued publicly traded common units. The partnership decided to revalue its property immediately prior to the contribution made by the parent.
The CCA concludes that (1) the restructuring was an adjustment of partnership items among the existing partners and not a taxable exchange, and (2) no taxable capital shift occurred because the partnership was allowed to revalue because the parent's contribution was a revaluation event under Treas. Reg. Sec. 1.704-1(b)(2)(iv)(f)(5) and the partnership had enough built-in gain in its property to increase the taxpayer's capital account without needing to shift capital away from other partners.
Interesting to note is that the IRS states within the CCA that the restructuring of the taxpayer's rights under the partnership agreement was not a valid revaluation event under Treas. Reg. Sec. 1.704-1(b)(2)(iv)(f)(5). Recapitalizations are not explicitly listed as a revaluation event under the existing regulations. However, proposed regulations (REG-151416-06) issued on Nov. 3, 2014, would add recapitalizations as a permissible revaluation event under Treas. Reg. 1.704-1(b)(2)(iv)(f)(5) for transactions occurring on or after the date that such rules are adopted and published as final regulations.
The CCA also refers to Rev. Rul. 84-52, which addresses the conversion of a general partnership into a limited partnership under state law. The revenue ruling states that in such a conversion, the partners are viewed as exchanging their interests in the general partnership for interests in the limited partnership in a Section 721 transaction. Some practitioners use this revenue ruling to state that if recapitalizations can be viewed as partners exchanging their existing interests for new interests in the partnership via a Section 721 transaction, then recapitalizations might be a permissible revaluation event under the current regulations. The CCA does not address such an application.
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