Currency gain from passive investment entities is qualifying partnership income

Plain-English summary

A limited partnership invested in corporate portfolio companies, often through partnership or disregarded holding companies that served only as passive conduits. Some holding companies used a different functional currency, so distributions could produce foreign-currency gain under section 987. The IRS concluded that this gain was other income derived from the partnership's business of investing in stock or securities under the regulated investment company income rule. It therefore qualified under section 7704(d)(4) for the gross-income exception that can keep a publicly traded partnership from being taxed as a corporation.

Ruling snapshot

• Question: Does section 987 currency gain from passive holding companies count as qualifying income for a publicly traded partnership?
• Outcome: approved, because the gain was derived from the partnership's business of investing in stock or securities
• Key authorities: IRC §§ 851(b)(2)(A), 987, 989, and 7704(c) and (d); Treas. Reg. § 1.989(a)-1

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 202005011 Third Party Communication: None
Release Date: 1/31/2020 Date of Communication: Not Applicable
Index Numbers: 7704.00-00, 7704.03-00
Person To Contact:
---------------------------------- -------------------------, ID No. -----------------
------------------------------------------------------------ -----------------------------------------------------
----------- Telephone Number:
---------------------------- ----------------------
----------------------------------- Refer Reply To:
----------------------- CC:PSI:B03
PLR-110318-19
Date:
October 29, 2019

                                                 Legend

X = ----------------------------------

Country = ------------

Currency = -------

Date = ----------------------------

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

    This letter responds to a letter dated April 23, 2019, and subsequent

correspondence, submitted on behalf of X by its authorized representative, requesting a
ruling that gain recognized under section 987 constitutes qualifying income within the
meaning of § 7704(d) of the Internal Revenue Code (“Code”).

                                         FACTS

    According to the information submitted, X is a limited partnership formed under

the laws of Country on Date. X was formed for the purpose of making investments in
privately held companies (“Portfolio Companies”). The Portfolio Companies are
classified as corporations for federal income tax purposes. For a variety of business
reasons, X regularly invests in the Portfolio Companies indirectly through other entities
treated as partnerships or disregarded entities for federal income tax purposes
(“Holding Companies”). X and the Holding Companies do not engage in active trades
or businesses. Instead, X’s and the Holding Companies’ sole activity is to passively

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invest in Portfolio Companies, either directly or indirectly through one or more Holding
Companies.

    X’s functional currency is Currency. However, because X invests on a global

basis, it is not unusual for X to invest in a Portfolio Company through a Holding
Company with a functional currency other than Currency. Accordingly, X may recognize
gain under § 987 of the Code when X receives distributions from Holding Companies
treated as partnerships, due to exchange rate fluctuations between X’s functional
currency and the Holding Companies’ functional currency (“§ 987 gain”). X seeks a
ruling that this § 987 gain will be qualifying income for purposes of § 7704(d) of the
Code.

                       LAW AND ANALYSIS

  Section 7704(a) provides that, except as provided in § 7704(c), a publicly traded

partnership shall be treated as a corporation.

   Section 7704(b) provides that the term “publicly traded partnership” means any

partnership if (1) interests in that partnership are traded on an established securities
market, or (2) interests in that partnership are readily tradeable on a secondary market
(or a substantial equivalent thereof).

   Section 7704(c)(1) provides that § 7704(a) shall not apply to any publicly traded

partnership for any taxable year if such partnership meets the gross income
requirements of § 7704(c)(2) for the taxable year and each preceding taxable year
beginning after December 31, 1987, during which the partnership (or any predecessor)
was in existence.

   Section 7704(c)(2) provides, in relevant part, that a partnership meets the gross

income requirement of § 7704(c)(2) for any taxable year of 90 percent or more of the
gross income of the partnership for the taxable year consists of qualifying income.

   Section 7704(d)(4) provides that the term “qualifying income” includes any

income that would qualify under § 851(b)(2)(A) (relating to a gross income test for
regulated investment companies) or § 856(c)(2) (relating to a gross income test for real
estate investment trusts).

   Section 851(b)(2)(A) provides that a corporation shall not be considered a

regulated investment company unless at least 90 percent of its gross income is derived
from dividends, interest, payments with respect to securities loans (as defined in
§ 512(a)(5)), and gains from the sale or other disposition of stock or securities (as
defined in § 2(a)(36) of the Investment Company Act of 1940 [15 USC § 80a-2], as
amended) or foreign currencies, or other income (including but not limited to gains from

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options, futures or forward contracts) derived with respect to its business of investing in
such stock, securities, or currencies.

    Section 987 provides that, in the case of any taxpayer having one or more

qualified business units with a functional currency other than the dollar, taxable income
of such taxpayer shall be determined (1) by computing the taxable income or loss
separately for each such unit in its functional currency, (2) by translating the income or
loss separately computed under § 987(1) at the appropriate exchange rate, and (3) by
making proper adjustments (as prescribed by the Secretary) for transfers of property
between qualified business units of the taxpayer having different functional currencies,
including (A) treating post-1986 remittances from each such unit as made on a pro rata
basis out of post-1986 accumulated earnings, and (B) treating gain or loss determined
under this paragraph as ordinary income or loss, respectively, and sourcing such gain
or loss by reference to the source of the income giving rise to post-1986 accumulated
earnings.

  Section 989 provides that, for purposes of subpart J of part III of subchapter N of

Chapter 1 of Subtitle A of the Code, the term “qualified business unit” means any
separate and clearly identified unity of a trade or business which maintains separate
books and records.

  Section 1.989(a)-1(b)(2)(i)(C) provides that, subject to certain exceptions, a

partnership is a qualified business unit.

                               CONCLUSION

    Based solely upon the facts submitted and the representations made, including

X’s representations that all of the Portfolio Companies of X are corporations for federal
tax purposes and that X uses its Holding Companies solely as passive conduits to
invest in the debt and equity of X’s Portfolio Companies, we conclude X’s § 987 gain is
“other income” derived with respect to X’s business of investing in stock or securities
within the meaning of § 851(b)(2)(A). Accordingly, based solely on the facts as
submitted and the representations made, we conclude that X’s § 987 gains constitute
qualifying income under §7704(d)(4).

   Except for the specific ruling above, we express or imply no opinion concerning

the federal tax consequences of the facts of this case under any other provision of the
Code.

   The ruling contained in this letter is based upon information and representations

submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the ruling request, it is subject to verification on examination.

PLR-110318-19 4

  This ruling is directed only to the taxpayer requesting it. According to

§ 6110(k)(3), this ruling may not be used or cited as precedent.

    Under a power of attorney on file with this office, we are sending copies of this

letter to X’s authorized representatives.

                                      Sincerely,



                                      Adrienne M. Mikolachek
                                      Chief, Branch 3
                                      Office of the Associate Chief Counsel
                                      (Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes

cc: