Interests in a pooled loan-investment partnership can qualify as obligations in registered form under § 163(f)

Plain-English summary

Federal tax law generally denies an interest deduction, and withholds certain foreign-investor benefits, unless a debt-like obligation is held in "registered form" (ownership tracked through the issuer's books rather than by bearer paper). Here a holding company treated as a partnership, partly owned by foreign investment funds, pooled investor money into another partnership that buys interests in loans such as residential mortgages and receivables. The taxpayer asked the IRS to treat the interests in these partnerships as "similar evidence of interest in a similar pooled fund" under Treas. Reg. § 1.163-5T(d)(1) and, if the book-entry transfer requirements are met, as obligations in registered form. Because each partnership will let ownership and the right to principal and interest be transferred only through a compliant book-entry system, the IRS concluded the interests are that kind of pooled-fund evidence of interest and, if the section 5f.103-1(c)(1) conditions are satisfied, will be obligations in registered form. The IRS pointedly expressed no opinion on whether interest payments qualify as tax-free "portfolio interest" or on the entities' U.S. trade-or-business status. The ruling helps structure pooled loan-investment vehicles so their interests meet the registered-form rules.

Ruling snapshot

• Question: Are interests in a pooled loan-investment partnership "similar evidence of interest in a similar pooled fund" and, if the book-entry conditions are met, obligations in registered form under § 163(f)?
• Outcome: approved
• Key authorities: IRC § 163(f); Treas. Reg. §§ 1.163-5T(d)(1), 5f.103-1(c); § 1.871-14

Full text (IRS public release)

 Internal Revenue Service                                     Department of the Treasury
                                                              Washington, DC 20224

 Number: 202039001                                            Third Party Communication: None
 Release Date: 9/25/2020                                      Date of Communication: Not Applicable
 Index Number: 163.08-00
                                                              Person To Contact:
 --------------------------                                   ------------------------, ID No. -----------------
 -------------------                                          Telephone Number:
 ---------------------------------------------                --------------------
 ------------------------------------------------             Refer Reply To:
 -------------------------                                    CC:FIP:1
                                                              PLR-100166-20
                                                              Date:
                                                               June 29, 2020




LEGEND

Taxpayer                  = ----------------------------------------------------------------------
State                     = -----------------------------
Partnership               = -------------------------------------------------------------------------------------
                            -------------------------------------------------------------------------------------
                            -------------------------------------------------------------------------------------
                            ----------------


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

This is in response to your letter dated November 27, 2019, requesting that certain
interests in partnerships be considered “similar evidence of interest in a similar pooled
fund” within the meaning of section 1.163-5T(d)(1) of the Temporary Income Tax
Regulations and that, if the requirements of section 5f.103-1(c)(1) are satisfied, those
interests in partnerships be considered obligations in registered form.

FACTS

Taxpayer is an entity formed under the laws of State and treated as a partnership for
federal income tax purposes. Taxpayer uses the calendar year as its accounting period
for federal income tax purposes and the accrual method as its overall method of
accounting. Partnership is an entity formed under the laws of State and treated as a
partnership for federal income tax purposes. Taxpayer is treated for federal income tax
purposes as directly owning a capital interest in Partnership.

Taxpayer is a holding company owned in part by a family of investment funds, some of
which are not United States persons within the meaning of section 7701(a)(30) of the
Internal Revenue Code (the “Code”). These investment funds will make capital
PLR-100166-20                                 2

contributions to Taxpayer, and Taxpayer will invest all such contributions, net of
expenses and reserves, into Partnership. Taxpayer principally holds its interest in
Partnership and may, in the future, hold interests in other entities that are treated for
federal income tax purposes as partnerships or disregarded entities and that principally
hold debt instruments. Partnership will use the amounts received as capital
contributions from Taxpayer to acquire beneficial interests in certain loans, including but
not limited to residential mortgage loans and structured loans collateralized by certain
leases and other types of receivables (the “Underlying Loans”). Some of the Underlying
Loans will not be in registered form within the meaning of section 5f.103-1(c).
Partnership may hold the Underlying Loans directly or through one or more entities
disregarded for federal income tax purposes. Partnership will principally hold debt
instruments and beneficial interests in debt instruments.

Taxpayer represents that all interests in Taxpayer and Partnership will be transferable
only pursuant to procedures described in section 5f.103-1(c). Specifically, the right to
receive distributions of principal and interest on the assets held by the Taxpayer or
Partnership will be transferable only through a book entry system maintained by each
entity in accordance with the requirements of section 5f.103-1(c)(2).

Taxpayer’s business reasons for the transaction include providing investors in the
Taxpayer with a return on investment that is above-market on a risk-adjusted basis.
Taxpayer represents that neither Taxpayer nor Partnership operates in a manner that
will cause either entity to be engaged in the conduct of a trade or business in the United
States within the meaning of section 871(b) or section 882(a)(1).

LAW AND ANALYSIS

Section 163(f)(1) disallows a deduction for interest on any registration-required
obligation unless the obligation is in registered form. Section 163(f)(2) defines the term
“registration-required obligation” as any 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-100166-20                                   3

Section 1.871-14(a) of the Income Tax Regulations 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 in part 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 both 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 a
record of ownership that identifies the owner of an interest in the obligation.

Neither Taxpayer nor Partnership is a trust that is treated as a grantor trust. However,
Taxpayer and Partnership are both entities treated as partnerships for federal income
tax purposes. Taxpayer principally holds its interest in Partnership, and Partnership
principally holds the Underlying Loans, which are a pool of debt instruments and
beneficial interests in debt instruments. Taxpayer represents that Taxpayer and
Partnership will each maintain a book entry system in accordance with section 5f.103-
1(c)(2) and that the right to receive distributions from each entity with respect to
principal and interest on the Underlying Loans will be transferable only through such
book entry system.
PLR-100166-20                                  4

CONCLUSION

We conclude that the interests in both Taxpayer and Partnership are “similar evidence
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 Taxpayer
and Partnership will be considered obligations in registered form.

The ruling contained in this letter is based upon information and representations
submitted by 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 request for rulings, it is subject to verification on examination.

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 Taxpayer or Partnership will qualify as portfolio
interest for purposes of sections 871 and 881. Furthermore, no opinion is expressed or
implied as to whether Taxpayer or Partnership is engaged in a trade or business within
the United States or whether any payment of interest 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.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.


                                                         Sincerely,


                                                      Spence Hanemann
                                                      Senior Counsel, Branch 1
                                                     Office of the Associate Chief Counsel
                                                     (Financial Institutions and Products)




Enclosure:
Copy for section 6110 purposes

cc: