Pooled mortgage investment interests qualify as registered obligations

Plain-English summary

An investment manager proposed a tiered structure of partnerships, statutory trusts, and series trusts that would hold mortgage loans. The underlying mortgage loans were not in registered form, but interests in each pooled entity could be transferred only by surrender and reissuance or through a qualifying book-entry system. The IRS concluded that the entity interests were similar evidences of interest in similar pooled funds. If the stated transfer procedures were followed, those interests would be obligations in registered form, although the IRS did not rule that payments on them qualified as portfolio interest.

Ruling snapshot

• Question: Would interests in the pooled mortgage entities be obligations in registered form despite the underlying loans not being registered?
• Outcome: Approved, if the represented transfer and book-entry requirements were satisfied.
• Key authorities: IRC § 163(f); Temp. Treas. Reg. §§ 1.163-5T and 5f.103-1

Full text (IRS public release)

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Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201610015 Third Party Communication: None
Release Date: 3/4/2016 Date of Communication: Not Applicable
Index Number: 163.08-00
Person To Contact:
------------------------------------ ----------------, ID No. ------------
------------------------------ Telephone Number:
----------------------------------- ---------------------
------------------------------ Refer Reply To:
CC:FIP:B02
PLR-131562-15
Date:
November 24, 2015

Legend

Taxpayer = -----------------------------
-------------------------
Foreign HoldCo = ---------------------------------------------
GP = ----------------------------------------------
-------------------------
Holdings LP = -----------------------------------------------------
-------------------------
Mortgage LP = -----------------------------------------
-------------------------
Upper Tier Trust = ----------------------------------------------
-------------------------
Trust = -----------------------------------------
-------------------------
Series A = -------------------------------------------------------------------------
Series B = -----------------------------------------------------------------------
State = -------------
Country = -----------------
Treaty = ----------------------------------------------------------------

Dear ---------------:

   This is in response to your letter dated September 23, 2015, requesting that

certain interests held in a disregarded entity and a partnership will be considered
obligations in registered form, if the interests in those entities are transferable according
to the procedures described in section 5f.103-1(c) of the Temporary Income Tax
Regulations.
PLR-131562-15 2

                                     FACTS

  Taxpayer is the ultimate manager of a family of private investment funds.

Taxpayer is a limited liability company organized under the laws of State. Taxpayer
uses a fiscal year ending -----------for federal income tax reporting and an accrual
method as its overall method of accounting.

   Taxpayer formed the following six entities in connection with the transactions

described in this letter. Each entity is a distinct entity type formed under the laws of
State and is taxable for federal income tax purposes as outlined below. Each entity
(other than GP and entities designated as disregarded entities) uses a fiscal year
ending -----------for federal income tax reporting and an accrual method as its overall
method of accounting. GP uses the calendar year for federal income tax reporting and
an accrual method as its overall method of accounting. As disregarded entities, Upper
Tier Trust, Class A and Class B do not possess an annual accounting period or have
their own method of accounting.

Entity Name Entity Type Formation Entity Taxable As:
Holdings LP Limited partnership State Partnership
Mortgage LP Limited partnership State Partnership
Upper Tier Statutory Trust State Disregarded entity
Trust
GP Limited liability company State Corporation
Series A Series Trust State Disregarded entity
Series B Series Trust State Disregarded entity

   Foreign HoldCo is an existing Country company held indirectly by Taxpayer and

is taxable as a corporation for federal income tax purposes. Taxpayer represents that
Foreign HoldCo is not engaged in the conduct of a trade or business in the United
States within the meaning of Section 882(a) and does not maintain a permanent
establishment in the United States within the meaning of Article 5 of Treaty.

   Foreign HoldCo will become the limited partner in Holdings LP as well as the sole

owner of GP. GP will serve as the general partner of Holdings LP and Mortgage LP.
The primary activity of Holdings LP will be to invest money contributed to various
investment vehicles sponsored by Taxpayer, including Foreign HoldCo. A number of
these investors will be non-U.S. persons who are not engaged in the conduct of a U.S.
trade or business. Foreign HoldCo will use all the funds that are contributed to it to
purchase a limited partnership interest in Holdings LP.
PLR-131562-15 3

     Mortgage LP will hold all of the interests in Series A, a series of Trust. Mortgage

LP will own all of the beneficial interests in Upper Tier Trust. Upper Tier Trust will hold
all of the beneficial interests in Series B, a series of Trust.

    As a result of Taxpayer’s interest in Foreign HoldCo, Taxpayer will share in

profits and losses allocated by Mortgage LP and Holdings LP. Taxpayer represents that
none of Series A, Series B, Upper Tier Trust, Mortgage LP or Holdings LP will operate
in a manner that will cause Foreign HoldCo to be engaged in the conduct of a trade or
business in the United States within the meaning of either section 871(b) or 882(a)(l) of
the Internal Revenue Code (the “Code”).

   Series A and Series B will use the amounts received as capital contributions to

acquire performing, re-performing and non-performing Mortgage Loans (each, a
“Mortgage Loan”). The phrase “performing loan” as applied to Mortgage Loans
generally refers to loans for which no payment of principal or interest has been past due
at any time during the twelve month period preceding any date of determination and the
current loan-to-value ratio is less than 100 percent. The phrase “re-performing” as
applied to Mortgage Loans generally refers to loans that are no more than 59 days past
due preceding any date of determination. These mortgagors have experienced
employment challenges or occasional missed payments but are generally improving in
credit-worthiness.

   A non-performing Mortgage Loan refers to any loan for which any payment of

principal or interest is more than 60 days past due or the obligor is in bankruptcy. The
point at which certain lenders classify a loan as non-performing, and when it becomes
bad debt, may vary depending on local regulations. A nonperforming loan is either in
default or close to being in default. Once a loan is nonperforming, the odds that it will be
repaid in full are considered to be substantially lower.

   Taxpayer represents that Mortgage Loans secured by mortgages are not in

registered form within the meaning of section 5f.103-1(c).

    Taxpayer anticipates that the independent servicers engaged by Trust to service

nonperforming Mortgage Loans will be required to negotiate modifications to certain of
these loans in order for the mortgagors to make regular payments on their respective
loans. The modifications on these certain Mortgage Loans would constitute “significant
modifications” within the meaning of section 1.1001-3(b) of the Income Tax Regulations.
Taxpayer expects that significant modifications will be made to Mortgage Loans after
the initial 60-day period following Trust formation. Series A and Series B will have the
right to acquire Mortgage Loans more than 60 days the formation of Series A and
Series B, as well as the ability to dispose of Mortgage Loans at any time. The parties
expect that the Mortgage Loans will be acquired by Series A and Series B after such
60-day period, either by purchase or by contribution.
PLR-131562-15 4

   Upper Tier Trust may accept additional contributions that it will contribute to

Series B. Series B will use this cash to acquire additional mortgages. Additionally, the
owners of Series A and Series B will contribute cash to the relevant Series to fund
acquisitions of additional Mortgage Loans. Because Upper Tier Trust, Series A, and
Series B have the ability to accept additional contributions of cash and acquire
additional Mortgage Loans, Taxpayer represents that Upper Tier Trust, Series A, and
Series B have the power to vary their investments.

    Taxpayer represents that interests in Series A, Series B, Upper Tier Trust,

Mortgage LP and Holdings LP will be transferable only pursuant to procedures
described in section 5f.103-1(c)(1) and therefore are in registered form within the
meaning of this regulation. Specifically, interests in these entities will be transferable
only by surrender of the old interest and either reissuance by these entities of the old
interest or through issuance of a new instrument to the new holder. Alternatively, the
right to receive distributions of principal and interest on the assets held by each of
Series A, Series B, Upper Tier Trust, Mortgage LP and Holdings LP will be transferable
only through a book entry system maintained by such entity. If a book entry system is
employed, such system will meet the requirements of section 5f.103-1(c)(2). Taxpayer
further represents that Mortgage LP and Holdings LP have no trustees, will be managed
by GP, and have a profit-making activity as one of their purposes.

   Taxpayer’s business reasons for the transaction include providing indirect

investors in Holdings LP and Foreign HoldCo with a return on their investment that is
above-market on a risk-adjusted basis. The business reasons also include enabling
Taxpayer to earn income from the overall performance of Mortgage Loans.

                                         LAW

   Section 163(f)(1) disallows a deduction for interest on any registration-required

obligation unless such obligation is in registered form. Section 163(f)(2) defines the
term, “registration-required obligation” as an obligation (including any obligation issued
by a governmental entity) other than an obligation which (i) is issued by a natural
person, (ii) is not of a type offered to the public, or (iii) has a maturity (at issue) of not
more than one year.

    Section 1.163-5T(d)(1) provides that a pass-through or participation certificate

evidencing an interest in a pool of mortgage loans which under Subpart E of Subchapter
J of the Code is treated as a trust of which the grantor is the owner (or similar evidence
of interest in a similar pooled fund or pooled trust treated as a grantor trust) (“pass-
through certificate”) is considered to be a “registration-required obligation” under section
163(f)(2)(A) and section 1.163-5(c) if the pass-through certificate is described in section
163(f)(2)(A) and section 1.163-5(c) without regard to whether any obligation held by the
fund or trust to which the pass-through certificate relates is described in section
163(f)(2)(A) and section 1.163-5(c).
PLR-131562-15 5

   Section 1.871-14(a) provides that no tax shall be imposed under section

871(a)(1)(A), 871(a)(1)(C), 881(a)(1) or 881(a)(3) on any portfolio interest as defined in
sections 871(h)(2) and 881(c)(2) received by a foreign person. Under sections
871(h)(2) and 881(c)(2), interest must be paid on an obligation that is in registered form
to qualify as portfolio interest. The term “registered form” has the same meaning given
such term by section 163(f). Sections 871(h)(7) and 881(c)(7). Section 1.871-
14(c)(1)(i) provides that the conditions for an obligation to be considered in registered
form are identical to the conditions described in section
5f.103-1.

    Section 1.871-14(d)(1) provides that interest received on a pass-through

certificate qualifies as portfolio interest if the interest satisfies the conditions in section
1.871-14(c)(1) without regard to whether any obligation held by the fund or trust to
which the pass-through certificate relates is described in section 1.871-14(c)(1)(ii). This
paragraph only applies to payments made to the holder of the pass-through certificate
from the trustee of the pass-through trust and does not apply to payments made to the
trustee of the pass-through trust.

    Section 5f.103-1(c)(1) provides generally that an obligation is in registered form if

(i) the obligation is registered as to both principal and any stated interest with the issuer
(or its agent) and transfer of the obligation may be effected only by surrender of the old
instrument and either the reissuance by the issuer of the old instrument to the new
holder or the issuance by the issuer of a new instrument to the new holder, (ii) the right
to the principal of, and stated interest on, the obligation may be transferred only through
a book entry system maintained by the issuer (or its agent) as described in section
5f.103-1(c)(2), or (iii) the obligation is registered as to both principal and stated interest
with the issuer (or its agent) and may be transferred through most of the methods
described in (i) and (ii) above.

    Section 5f.103-1(c)(2) provides that an obligation will be considered transferable

through a book entry system if the ownership of an interest in the obligation is required
to be reflected in a book entry, whether or not physical securities are issued. A book
entry is record of ownership that identifies the owner of an interest in the obligation.

   Section 301.7701-4(c)(1) of the Procedure and Administration Regulations

provides that, an investment trust with a single class of undivided beneficial interest in
the trust assets is classified as a trust if there is no power under the trust agreement to
vary the investment of the certificate holders.

                                     ANALYSIS

  The purpose of the registration requirement for certain obligations is to prevent

the underreporting of tax on gains on sales on both taxable and tax-exempt securities
PLR-131562-15 6

and to ensure that securities will be sold (or resold in connection with the original issue)
only to persons who are not United States persons. See section 1.163-5(c)(1)(i).

    Taxpayer has represented that Mortgage Loans are not in registered form.

Section 1.163-5T(d)(1) provides that an interest (a “pass-through certificate”) in a trust
that is treated as a grantor trust is considered to be an obligation in registered form if
the pass-through certificate is in registered form “without regard to whether any
obligation held by the fund or trust to which the pass-through certificate relates” is in
registered form. None of Mortgage LP, Holdings LP, Upper Tier Trust, Series A or
Series B is treated as a grantor trust under section 301.7701-4(c)(1). Section 1.163-
5T(d)(1) does not specify what type of arrangements may qualify as similar pooled
funds.

    In this case, the interests in each of Mortgage LP, Holdings LP, Upper Tier Trust,

Series A, and Series B will be transferable only pursuant to the procedures described in
section 5f.103-1(c)(1). Interests in each of Mortgage LP, Holdings LP, Upper Tier Trust,
Series A, and Series B will be transferred in accordance with section 5f.103-1(c)(1)(i).
Alternatively, each of Mortgage LP, Holdings LP, Upper Tier Trust, Series A, and Series
B will maintain a book entry system (as described in section 5f.103-1(c)(2)), and the
right to receive distributions of principal and interest on Mortgage Loans will be
transferable only by such book entry system.

                                  CONCLUSION

   We conclude, based on the facts of this case, that the interests in each of

Mortgage LP, Holdings LP, Upper Tier Trust, Series A, and Series B are similar
evidences of interest in a similar pooled fund within the meaning of section 1.163-
5T(d)(1), and that if the requirements of section 5f.103-1(c)(1) are satisfied, the interests
in each of Mortgage LP, Holdings LP, Upper Tier Trust, Series A, and Series B will be
considered obligations in registered form.

   Except as expressly provided herein, no opinion is expressed or implied

concerning the tax consequences of any aspect of any transaction or item discussed or
referenced in this letter. In particular, no opinion is expressed or implied regarding
whether any payment of interest on the interests in any of Mortgage LP, Holdings LP,
Upper Tier Trust, Series A, and Series B will qualify as portfolio interest for purposes of
sections 871 and 881. Furthermore, no opinion is expressed or implied as to whether
Mortgage LP, Holdings LP, Upper Tier Trust, Series A, or Series B is engaged in a trade
or business within the United States or whether the interest in Mortgage LP, Holdings
LP, Upper Tier Trust, Series A, or Series B is effectively connected with that trade or
business.

  This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of

the Code provides that it may not be used or cited as precedent.
PLR-131562-15 7

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representatives.

                                   Sincerely,


                                   _______________________________
                                   Susan Thompson Baker
                                   Senior Technician Reviewer, Branch 2
                                   Office of Associate Chief Counsel
                                   (Financial Institutions & Products)

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