In a stack of affiliated REITs and LLCs, which entities are 'captive REITs,' which are 'public REITs,' and who has to add back the dividends-paid deduction and file a combined Tennessee franchise and excise tax return?

Plain-English summary

This ruling sorts out, for Tennessee franchise and excise (F&E) tax, how a stack of related real estate investment trusts (REITs) and LLCs that own Tennessee real property should be classified and taxed. Two labels do the heavy lifting:

• A "captive REIT" is a REIT that (1) has a federal REIT election in effect under I.R.C. § 856(c)(1), (2) is at least 80% owned (directly or indirectly) by another single entity or individual, and (3) does not have its own shares traded on a national stock exchange (Tenn. Code Ann. § 67-4-2004(7)). Why it matters: a captive REIT loses the usual REIT tax break. Ordinarily a REIT gets the benefit of the federal dividends-paid deduction (so it pays little entity-level tax), but a captive REIT must add that deduction back to its Tennessee net earnings (§ 67-4-2006(b)(1)(O)), and a captive REIT and its affiliated group must file a combined F&E return.

• A "public REIT" is a REIT that files with the SEC and whose own shares are traded on a national securities exchange registered with the SEC (or a comparably regulated foreign exchange) (§ 67-4-2004(39)). Being a public REIT — or being owned by one — turns off the captive-REIT penalties.

Applying those rules to the structure in front of it (a publicly traded partnership, "PTP," sitting over REIT A, REIT B, REIT C, and two LLCs), the Department ruled:

1. REIT B and REIT C are captive REITs. Each has a federal REIT election, each is about 99% owned by one upstream entity (PTP owns ~99% of REIT B; LLC 1 owns ~99% of REIT C), and neither has shares traded on a national exchange.
2. REIT A and REIT B are not public REITs. Their own shares are traded only privately. The fact that their parent, PTP, is publicly traded does not make the REITs themselves public REITs — the test looks at the shares of the entity being classified, not its owner.
3. LLC 2 is not part of a captive REIT affiliated group. That group is a captive REIT plus the entities it owns more than 50% of (§ 67-4-2004(8)). REIT C owns 30% of LLC 2 and REIT B owns about 30.3%; since no single captive REIT owns more than half, LLC 2 stands alone and files a separate F&E return.
4. & 5. The public-REIT exception splits REIT B and REIT C. A captive REIT that is owned — which the Department reads as at least 80% owned, directly or indirectly — by a bank, bank holding company, or public REIT is exempt from the dividends add-back and combined-filing rules. Assuming PTP is wholly owned by a public REIT: REIT B is ~99% indirectly owned by that public REIT, so it is exempt. REIT C is less than 10% owned by it, so REIT C is not exempt — it must add back the dividends-paid deduction and file combined with its captive REIT affiliated group.
5. LLC 2 can deduct what it passes up to a public REIT. If PTP is owned by a public REIT, then under § 67-4-2006(a)(5) LLC 2 (a partnership for tax purposes) may reduce its net earnings by amounts it actually distributes, directly or indirectly, to the public REIT — provided it submits the public REIT's name and federal ID number with its return.

The backdrop: Tennessee imposes a 6.5% excise tax on net earnings (§ 67-4-2007(a)) and a franchise tax on net worth (§ 67-4-2105(a)/§ 67-4-2106(a)), and REITs and LLCs are "persons" subject to both (§ 67-4-2004(38)). Because the captive-REIT statute is "clear and unambiguous," the Department applied its plain meaning even though the taxpayer argued its structure differed from the abusive arrangements the legislature had in mind.

What this means for you

Owners and sponsors of multi-tier REIT/LLC structures

Whether a Tennessee-property REIT is a "captive REIT" turns on a hard three-part test, and the consequences are real: a captive REIT adds back the dividends-paid deduction and files combined. The two escape hatches are being a public REIT yourself (your own shares trade on a qualifying exchange) or being at least 80% owned by a public REIT, bank, or bank holding company. Ownership percentages and how shares trade — not the economic "feel" of the deal — decide the outcome. Note the asymmetry this ruling illustrates: an 80%+ chain to a public REIT shields one captive REIT (REIT B) while a thin (<10%) chain leaves a sibling (REIT C) fully exposed.

Accountants and tax professionals

The mechanics to track: net earnings start from federal taxable income before the NOL and special deductions (§ 67-4-2006(a)(1)); captive REITs add back the federal dividends-paid deduction (defined under I.R.C. § 561, allowed under § 857(b)(2)(B)) per § 67-4-2006(b)(1)(O); captive REIT affiliated groups file combined (§ 67-4-2007(e)(3), § 67-4-2114(d)) while everyone else files separately (§ 67-4-2007(e)(1), § 67-4-2106(c)). The "owned, directly or indirectly, by … a public REIT" exception is read as an 80% threshold by reading the captive-REIT scheme in pari materia. For partnerships sitting under a public REIT, preserve the § 67-4-2006(a)(5) deduction by filing the public REIT's name and FEIN with the return.

Common questions

Q: What makes a REIT a "captive REIT" in Tennessee?
A: Three things together: a federal REIT election under I.R.C. § 856(c)(1); at least 80% ownership (by value, directly or indirectly) by one other entity or individual; and shares that are not traded on a national stock exchange (Tenn. Code Ann. § 67-4-2004(7)).

Q: My REIT's parent is publicly traded — does that make my REIT a "public REIT"?
A: No. The public-REIT test looks at whether your REIT's own shares trade on a qualifying exchange, not your parent's. In this ruling, PTP was publicly traded but REIT A and REIT B were not public REITs because their own shares traded only privately.

Q: What does being a captive REIT actually cost?
A: A captive REIT must add the federal dividends-paid deduction back to its Tennessee net earnings (§ 67-4-2006(b)(1)(O)), and a captive REIT affiliated group must file a combined Tennessee F&E return — unless the captive REIT is at least 80% owned, directly or indirectly, by a bank, bank holding company, or public REIT.

Q: When does a captive REIT escape the add-back and combined filing?
A: When it is owned — read as at least 80% owned, directly or indirectly — by a bank, a bank holding company, or a public REIT. Here, REIT B (99% under an assumed public REIT) escaped; REIT C (under 10%) did not.

Q: Can I rely on this revenue ruling?
A: No. Tennessee revenue rulings are advisory and are not binding on the Department; no taxpayer can rely on one as binding, and the law may have changed since 2014. Treat it as the Department's reasoning, not a guarantee, and confirm your own structure with a tax professional.

Citations and references

Tennessee statutes (Tenn. Code Ann., 2013):

• § 67-4-2004(7) (definition of "captive REIT": federal REIT election + ≥80% ownership + shares not traded on a national stock exchange)
• § 67-4-2004(39) (definition of "public REIT": files with the SEC and shares traded on a qualifying national/foreign exchange)
• § 67-4-2004(8) (definition of "captive REIT affiliated group"; >50% ownership; exception where the captive REIT is owned by a bank, bank holding company, or public REIT)
• § 67-4-2006(a)(1) (net earnings = federal taxable income before NOL and special deductions, as adjusted by § 67-4-2006(b)/§ 67-4-2006(c)); § 67-4-2006(a)(5) (partnership deduction for amounts distributed directly or indirectly to a public REIT, name + FEIN required)
• § 67-4-2006(b)(1)(O) (captive REIT adds back the federal dividends-paid deduction; bank/bank-holding-company/public-REIT exception)
• § 67-4-2007(a) (6.5% excise tax on net earnings); § 67-4-2007(e)(1) (separate-entity filing); § 67-4-2007(e)(3), § 67-4-2114(d) (captive REIT affiliated group combined filing); § 67-4-2106(c) (separate-entity filing)
• § 67-4-2004(38) (REITs and LLCs are "persons"); § 67-4-2105(a), § 67-4-2106(a) (franchise tax on net worth); § 67-4-2108(a) (franchise tax floor = value of Tennessee real/tangible property)

Federal law cited:

• 26 U.S.C. § 856 / I.R.C. § 856(c)(1) (federal REIT qualification and election); I.R.C. § 7704 (publicly traded partnership)
• I.R.C. § 561 (dividends-paid deduction) and § 857(b)(2)(B) (allowed in computing real estate investment trust taxable income)

Tennessee cases cited by the ruling:

• Walker v. Sunrise Pontiac-GMC Truck, Inc., 249 S.W.3d 301, 309 (Tenn. 2008) (quoting Eastman Chem. Co. v. Johnson, 151 S.W.3d 503, 507 (Tenn. 2004)) (statutes given their plain meaning in normal and accepted use)
• James Cable Partners, L.P. v. City of Jamestown, 818 S.W.2d 338, 341 (Tenn. Ct. App. 1991) (apply the definition the legislature chose to enact)
• Owens v. State, 908 S.W.2d 923, 926 (Tenn. 1995) (citing Lyons v. Rasar, 872 S.W.2d 895, 897 (Tenn. 1994)) (resolve statutory ambiguity by reading the whole scheme; statutes in pari materia construed together)

Subject

Application of the definitions of “captive REIT” and “public REIT” for purposes of the Tennessee franchise and excise taxes

Source

• Landing page: https://www.tn.gov/revenue/tax-resources/legal-resources/tax-rulings.html
• Original PDF: https://www.tn.gov/content/dam/tn/revenue/documents/rulings/fae/14-07fe.pdf

Original ruling text

TENNESSEE DEPARTMENT OF REVENUE
REVENUE RULING # 14-07

Revenue rulings are not binding on the Department. This ruling is based on the particular
facts and circumstances presented, and is an interpretation of the law at a specific point in
time. The law may have changed since this ruling was issued, possibly rendering it obsolete.
The presentation of this ruling in a redacted form is provided solely for informational
purposes, and is not intended as a statement of Departmental policy. Taxpayers should
consult with a tax professional before relying on any aspect of this ruling.

SUBJECT

Application of the definitions of “captive REIT” and “public REIT” for purposes of the
Tennessee franchise and excise taxes.

SCOPE

Revenue Rulings are statements regarding the substantive application of law and statements of
procedure that affect the rights and duties of taxpayers and other members of the public. Revenue
Rulings are advisory in nature and are not binding on the Department.

FACTS

The issues presented in this ruling concern a complex real estate investment structure consisting
of multiple affiliated real estate investment trusts (“REITs”) and limited liability companies
(“LLCs”). The ownership structure, described below, is also illustrated on Appendix A and

Appendix B.

The ultimate parent company (“PTP”) is a limited liability company that is classified as a
publicly traded partnership for federal income tax purposes, pursuant to I.R.C. § 7704.’ For
purposes of Rulings 4 through 6, however, PTP is assumed to be wholly-owned by a Public
REIT as defined in TENN. CODE ANN. § 67-4-2004(39). PTP files reports with the Securities and
Exchange Commission, and its shares are traded on a national securities exchange. PTP’s
connection with Tennessee is limited to its direct and indirect ownership of subsidiaries that own
real property in Tennessee. PTP directly owns stock in two subsidiary corporations: REIT A and
REIT B. The taxpayer asserts that PTP is not subject to Tennessee franchise and excise taxation.

REIT A is a real estate investment trust, properly qualified as such pursuant to I.R.C. § 856.”
PTP owns approximately a 10% interest in REIT A, with the remaining 90% of REIT A shares
owned by public investors. While REIT A shares are owned by members of the general public,
the shares are not listed on a national securities exchange, but rather are traded privately. REIT A
conducts no business activities in Tennessee on its own account. REIT A’s contacts with

" (West, Westlaw through P.L. 113-93 (excluding P.L. 113-79)).

(West, Westlaw through P.L. 113-93 (excluding P.L. 113-79)).

Tennessee are limited to indirect ownership of lower tier entities that own real property in
Tennessee.

REIT B is a real estate investment trust, properly qualified as such pursuant to I.R.C. § 856. PTP
owns approximately a 99% interest in REIT B. The remaining 1% interest in REIT B is owned
by outside investors who are unaffiliated with PTP (but who may own minority interests in PTP).
REIT B shares are not listed on a national securities exchange, and its shares, to the extent they
are traded, are sold in private offerings. REIT B owns real property located in Tennessee and
direct and indirect interests in lower tier entities that also own real property in Tennessee.
REIT B is subject to Tennessee franchise and excise taxation.

PTP also has indirect interests in the following other entities through its ownership interests in
REIT A and REIT B.

LLC 1 is a limited liability company that is classified as a partnership for federal income tax
purposes. Its activities are limited to owning an approximately 99% interest in REIT C. REIT A
owns an approximately 99% membership interest in LLC 1, and REIT B owns an approximately
1% membership interest in LLC 1. The purpose of LLC 1 is to provide a vehicle by which
investors in both REIT A and REIT B may own an interest in REIT C. The taxpayer asserts that
LLC 1 is not subject to Tennessee franchise and excise taxation.

REIT C is a real estate investment trust, properly qualified as such pursuant to I.R.C. § 856.
LLC 1 owns approximately a 99% interest in REIT C. Outside investors own the remaining 1%
of the shares of REIT C. REIT C directly owns real property in Tennessee and indirectly owns
real property in Tennessee through one or more federally disregarded limited liability companies
of which it is the sole member. REIT C is subject to Tennessee franchise and excise taxation.

LLC 2 is a limited liability company that is classified as a partnership for federal income tax
purposes. REIT B and REIT C each individually own approximately a 30% interest in LLC 2.
The remaining 40% of LLC 2 is owned by unrelated third party investors. LLC 2 owns real
property in Tennessee and is subject to Tennessee franchise and excise taxation. LLC 2 is also
the single member of one or more limited liability companies that own property in Tennessee
and are disregarded to LLC 2 for federal income tax purposes.

RULINGS

1. Are REIT B and REIT C captive REITs pursuant to TENN. CODE ANN. § 67-4-2004(7)
   (2013)?

Ruling: Yes. Both REIT B and REIT C are captive REITs pursuant to TENN. CODE ANN.
§ 67-4-2004(7) (2013), because both have federal REIT elections in effect, are at least
80% owned by another entity, and do not have their shares traded on a national exchange.

2. Do REITA and REITB qualify as public REITs pursuant to TENN. CODE ANN.
   § 67-4-2004(39) (2013)?

1.

Ruling: No. Neither REIT A nor REIT B qualify as public REITs pursuant to TENN.
CoDE ANN. § 67-4-2004(39) (2013), because their shares are not traded on a national
securities exchange registered with the SEC or a regulated national securities exchange of
a foreign country.

Is LLC 2 part of a captive REIT affiliated group pursuant to TENN. CODE ANN.
§ 67-4-2004(8) (2013)?

Ruling: No. LLC 2 is not part of a captive REIT affiliated group.

. Assuming that REIT B is determined to be a captive REIT and PTP is owned by a public

REIT, is REIT B_ subject to the rules under TENN. CODE ANN.
88 67-4-2006(b)(1)(O), -2007(e)(3), -2114(d) (2013) requiring a captive REIT to file on a
combined basis with its captive REIT affiliated group and to increase net earnings by any
federally recognized dividends paid deductions?

Ruling: No. REIT B is exempt from the rules under TENN. CODE ANN.
88 67-4-2006(b)(1)(O), -2007(e)(3), -2114(d) (2013) requiring a captive REIT to file on a
combined basis with its captive REIT affiliated group and to increase net earnings by any
federally recognized dividends paid deductions, because REIT B is at least 80% owned,
indirectly, by a public REIT.

. Assuming that REIT C is determined to be a captive REIT and PTP is owned by a public

REIT, is REIT C_ subject to the rules under TENN. CODE ANN.
88 67-4-2006(b)(1)(O), -2007(e)(3), -2114(d) (2013) requiring a captive REIT to file on a
combined basis with its captive REIT affiliated group and to increase net earnings by any
federally recognized dividends paid deductions?

Ruling: Yes. REIT C is not exempt from the rules under TENN. CODE ANN.
88 67-4-2006(b)(1)(O), -2007(e)(3), -2114(d) (2013) requiring a captive REIT to file on a
combined basis with its captive REIT affiliated group and to increase net earnings by any
federally recognized dividends paid deductions, because REIT C is not at least 80%
owned, indirectly, by a public REIT.

. Assuming that PTP is owned by a public REIT, what are the franchise and excise tax

consequences for LLC 2?

Ruling: For all tax periods that PTP is owned by a public REIT, LLC 2’s net earnings
could be reduced by any amount distributed directly or indirectly to the public REIT.

ANALYSIS

Application of “Captive REIT” Definition

REIT B and REIT C are captive REITs, as defined in TENN. CODE ANN. § 67-4-2004(7) (2013).

Tennessee imposes an excise tax at the rate of 6.5% on the net earnings of all persons doing
business within Tennessee.” Tennessee also imposes a franchise tax at the rate of $0.25 per $100,
or major fraction thereof, on the net worth of a person doing business in Tennessee."

Persons subject to the Tennessee franchise and excise taxes include, but are not limited to,
taxpayers that have elected under federal income tax law to be treated as real estate investment
trusts (“REITs”) — such as REIT A, REIT B, and REIT C — and taxpayers that are formed as
limited liability companies (“LLCs”) — such as PTP, LLC 1, and LLC 2.°

The computation of net earnings subject to the Tennessee excise tax generally depends on the
taxpayer’s federal filing status.° For taxpayers that are corporations or are classified as
corporations for federal tax purposes (including REITs), TENN. CODE ANN. § 67-4-2006(a)(1)
defines net earnings as “federal taxable income or loss before the operating loss deduction and
special deductions provided for in 26 U.S.C. §§ 241, 242 [repealed], 243-247” and as adjusted by
TENN. CODE ANN. § 67-4-2006(b) and (c).

The specific adjustments to federal taxable income that a REIT will make in order to compute its
Tennessee net earnings depend on whether or not the REIT is classified as a “captive REIT.” In
general, a REIT may compute its Tennessee net earnings without adding back the federal
deduction for dividends paid;’ the result is that the REIT’s net earnings are effectively reduced
by virtue of the REIT having taken the deduction at the federal level. The benefit of the
dividends paid deduction is effectively denied, however, to captive REITs; a captive REIT must
add to net earnings the amount of the federal dividends paid deduction taken by the captive REIT
on its federal return.® Additionally, captive REIT affiliated groups are subject to a special
combined filing requirement, discussed below.

“Captive REIT” is defined, for Tennessee franchise and excise tax purposes, as

an entity with an election in effect under § 856(c)(1) of the Internal Revenue
Code, codified in 26 U.S.C. § 856(c)(1), in which any other entity or individual,

TENN. CODE ANN. § 67-4-2007(a) (2013).

“ TENN. CODE ANN. §§ 67-4-2105(a), -2106(a) (2013). Note that the measure of the franchise tax shall in no case be
less than the actual value of the real or tangible property owned or used in Tennessee, excluding exempt inventory
and exempt capital investments. TENN. CODE ANN. § 67-4-2108(a) (2013).

° TENN. CODE ANN. § 67-4-2004(38) (2013) (defining “person” to include real estate investment trusts and limited
liability companies).

° See TENN. CODE ANN. § 67-4-2006(a) (2013).
’ The deduction for dividends paid is defined under I.R.C. § 561 (West, Westlaw through P.L. 113-93 (excluding
P.L. 113-79)) and allowed in the computation of “real estate investment trust taxable income” under I.R.C.

§ 857(b)(2)(B) (West, Westlaw through P.L. 113-93 (excluding P.L. 113-79)).

® See TENN. CODE ANN. § 67-4-2006(b)(1)(O) (requiring taxpayers to increase their net earnings by the amount of
“[a]ny deduction by a captive REIT for dividends paid . . . that is allowed and taken”).

directly or indirectly, has at least eighty percent (80%) ownership interest by
value determined in accordance with generally accepted accounting principles and
whose shares are not traded on a national stock exchange.”

The definition of “captive REIT” thus applies to any entity that (1) is a REIT, (2) is at least 80%
owned by one entity or individual, and (3) is not publically traded on a qualifying exchange.'°

Both REIT B and REIT C come within the scope of this definition and are therefore properly
considered captive REITs for Tennessee franchise and excise tax purposes. First, each have
elections in effect under I.R.C. § 856(c)(1)"' to be treated as REITs. Second, REIT B is
approximately 99% (i.e., more than 80%) owned by PTP, and REIT C is approximately 99%
(i.e., more than 80%) owned by LLC 1. Finally, neither REIT B nor REIT C has shares traded on
a national stock exchange.

Because REIT B and REIT C possess the three statutory attributes of captive REITs, REIT B and
REIT C are captive REITs for Tennessee franchise and excise tax purposes.

2. Application of “Public REIT” Definition

Neither REIT A nor REIT B are properly considered a public REIT pursuant to TENN. CODE
ANN. 8 67-4-2004(39), because their shares are not traded on either a national securities
exchange registered with the SEC or a regulated national securities exchange of a foreign
country.

Publicly traded real estate investment trusts (“public REITs”) enjoy certain benefits for purposes
of the Tennessee franchise and excise taxes.'’ A “public REIT” is defined under TENN. CODE
ANN. § 67-4-2004(39) as a REIT

° TENN. CODE ANN. § 67-4-2004(7) (2013) (emphasis added).

'° The language “whose shares are not traded on a national stock exchange” must refer to the shares of the entity
being tested for captive REIT status, not that entity’s owners. Otherwise, the statutory definition would read, “means
an entity with an election in effect under § 856(c)(1) of the Internal Revenue Code, codified in 26 U.S.C.
§ 856(c)(1), and in which any other entity . . . .” The fact that the drafters used a comma rather than an “and”
between the first and second requirements shows that the definition of “captive REITs” possesses a third
requirement, namely that the REIT’s “shares are not traded on a national stock exchange.”

" (West, Westlaw through P.L. 113-93 (excluding P.L. 113-79)).

The taxpayer has suggested that the REITs described in the facts operate under materially different circumstances
from the entities that the General Assembly intended to classify as captive REITs. However, the General Assembly
codified a definition of captive REIT that is clear and unambiguous, and we must apply TENN. CODE ANN.
§ 67-4-2004(7)’s “plain meaning in its normal and accepted use, without a forced interpretation that would limit or
expand the statute's application.” Walker v. Sunrise Pontiac-GMC Truck, Inc., 249 S.W.3d 301, 309 (Tenn. 2008)
(quoting Eastman Chem. Co. v. Johnson, 151 $.W.3d 503, 507 (Tenn. 2004)). This is true even if the General
Assembly’s purpose in enacting this definition was to redress particular abusive practices by particular types of
owners. The General Assembly ultimately chose to craft the definition as enshrined in TENN. CODE ANN.
§ 67-4-2004(7), which encompasses all entities that meet the three statutory requirements. See James Cable
Partners, L.P. v. City of Jamestown, 818 S.W.2d 338, 341 (Tenn. Ct. App. 1991).

that files with the securities and exchange commission and whose shares are
traded on a securities exchange that is either registered as a national securities
exchange with the securities and exchange commission . . . or is a national
securities exchange of a foreign country and regulated in a substantially similar
manner by a foreign financial regulatory authority.

For a REIT to be considered a public REIT, the REIT’s shares must be traded on a qualifying
securities exchange.

Neither the shares of REIT A nor the shares of REIT B are publicly traded on a qualifying
exchange. To the extent that ownership in either REIT A or REIT B is traded, such trading
occurs privately and not on a qualifying exchange. The only entity described in the facts whose
shares are traded on a qualifying securities exchange is PTP, the common parent of REIT A and
REIT B. However, that fact is irrelevant to the determination of whether REIT A and REIT B are
considered public REITS.

Since neither REIT A shares nor REIT B shares are traded on a qualifying securities exchange,
neither entity is considered to be a public REIT for Tennessee franchise and excise tax purposes.

3. Captive REIT Affiliated Groups

LLC 2 is not part of a captive REIT affiliated group and must therefore file a separate Tennessee
franchise and excise tax return.

As a general rule, each taxpayer is considered a separate and single business entity for Tennessee
franchise and excise tax purposes and must file its Tennessee franchise and excise tax return on a
separate entity basis.'* Captive REIT affiliated groups, however, are required to file on a
combined basis."”

The term “captive REIT affiliated group” refers collectively to a captive REIT and its majority-
owned subsidiaries, specifically all entities “in which the captive REIT, directly or indirectly, has
more than fifty percent (50%) ownership interest.”’° However, if the captive REIT is “owned,
directly or indirectly, by a bank, a bank holding company, or a public REIT,” that captive REIT
and its subsidiaries do not constitute a captive REIT affiliated group.”

'S See infra Rulings 4-5.

"4 See TENN. CODE ANN. §§ 67-4-2007(e)(1), -2106(c) (2013).
' TENN. CODE ANN. §§ 67-4-2007(e)(3), -2114(d) (2013).

16 TENN. CODE ANN. § 67-4-2004(8) (2013).

'” TENN. CODE ANN. § 67-4-2004(8) (2013).

LLC 2 is not a majority-owned subsidiary of a captive REIT. The only captive REITs in the
factual scenario presented are REIT B and REIT C, as previously discussed in the response to
Ruling 2. While both REIT B and REIT C own significant interests in LLC 2, neither REIT B
nor REIT C directly or indirectly holds more than a 50% interest in LLC 2. REIT C holds only a
30% interest in LLC 2, while REIT B directly and indirectly holds a cumulative interest of
roughly 30.3% in LLC 2.

Since neither REIT B nor REIT C holds more than a 50% interest in LLC 2, LLC 2 is not part of
a captive REIT affiliated group.

4-5. Captive REIT Directly or Indirectly Owned by a Public REIT

Assuming that PTP is wholly-owned by a public REIT, REIT B is not subject to the rules under
TENN. CODE ANN. §§ 67-4-2006(b)(1)(O), -2007(e)(3), -2114(d) requiring a captive REIT to file
on a combined basis with its captive REIT affiliated group and increase net earnings by any
federally recognized dividends paid deductions. REIT C, however, is subject to the captive REIT
rules for dividends paid deductions and combined filing.

As discussed above, captive REITs are subject to rules that require the captive REITs to add back
the federal dividends paid deduction when computing net earnings’® and require captive REIT
affiliated groups to file franchise and excise tax returns on a combined basis.'” Neither rule
applies, however, to captive REITs that are “owned, directly or indirectly, by a bank, a bank
holding company, or a public REIT.””°

Viewed within the statutory context of the captive REIT rules, the requirement that the captive
REIT be “owned, directly or indirectly, by a bank, bank holding company, or public REIT”
requires that the captive REIT be at least 80% owned, directly or indirectly, by such an entity.”"

'® TENN. CODE ANN. § 67-4-2006(b)(1)(O) (requiring captive REITs to add back to net earnings “[a]ny deduction
... for dividends paid, as defined under 26 U.S.C. § 561, that is allowed and taken under 26 U.S.C. § 857(b)(2)(B)
[the federal REIT dividends paid deduction rule].”).

'9 TENN. CODE ANN. §§ 67-4-2007(e)(3), -2114(d).

°° See TENN. CODE ANN. § 67-4-2006(b)(1)(O) (“[T]his subdivision (b)(1)(O) shall not apply to a captive REIT that
is owned, directly or indirectly, by a bank, a bank holding company, or a public REIT.”); TENN. CODE ANN.
§ 67-4-2004(8) (“[P]rovided, however, that a ‘captive REIT affiliated group’ does not include a group in which the
captive REIT is owned, directly or indirectly, by a bank, a bank holding company, or a public REIT.”).

*! TENN. CODE ANN. §§ 67-4-2004(8), -2006(b)(1)(O) except from the captive REIT rules a captive REIT that “is
owned, directly or indirectly, by” certain entities. The quoted language is ambiguous because it fails to specify what
amount of ownership is necessary to trigger operation of the statute. It is a well-established principle of Tennessee
law that where statutory ambiguity exists, the courts “look to the entire statutory scheme in seeking to ascertain
legislative intent,” and that “[s]tatutes ‘in pari materia’ — those relating to the same subject or having a common
purpose — are to be construed together.” Owens v. State, 908 S.W.2d 923, 926 (Tenn. 1995) (citing Lyons v. Rasar,
872 S.W.2d 895, 897 (Tenn.1994)).

Because the intent of the captive REIT rules is to correct issues that arise when a REIT is “captive” to (or, in other
words, is at least 80% controlled by) another entity, it is most consistent to infer that the exceptions to these rules

Assuming that PTP is wholly-owned by a public REIT, REIT B is 99% owned indirectly by the
public REIT, and therefore is not subject to the add back of the dividends paid deduction or to
the combined filing requirement. REIT C, however, is less than 10% owned, directly or
indirectly, by the public REIT. Accordingly, REIT C is subject to the add back of the dividends
paid deduction and required to file a combined basis with the members of its captive REIT
affiliated group.

6. Partnerships Owned by Public REITs

Assuming that PTP is wholly-owned by a public REIT, LLC 2’s net earnings may be reduced by
any amounts actually distributed, directly or indirectly, to the public REIT. Pursuant to TENN.
CoDE ANN. § 67 4 2006(a)(5), taxpayers that are treated federally as partnerships deduct from
their computation of net earnings any amounts distributed directly or indirectly to a public REIT,
provided that each public REIT’s name and federal identification number are submitted with the
taxpayer’s return. So long as LLC 2 properly submits the public REIT’s name and federal
identification number on a schedule attached to its return, LLC 2’s net earnings will be reduced
by any amounts distributed directly or indirectly to the public REIT.

Robert Guth
Assistant General Counsel
for Taxation

APPROVED: Richard H. Roberts
Commissioner of Revenue

DATE: August 25, 2014

apply to REITs that are “captive” to banks, bank holding companies, and public REITs. Any other inference would
yield peculiar results inconsistent with the captive REIT statutory scheme.

Appendix A

• ~
  / \
  ( [Publicly !
  \ Traded] /
  \ 7
  _ ~ _ a
  ie
  |
  [Privately
  Traded]
  PTP
  90%
  I :
  | |.
  99% 10%
  | |
  REIT B REIT A
  é TN Property Y
  1% 99%
  LLC 1
  99%
  |
  REIT C

30% / TN Property y

30%
REIT C’s wholly-
owned LLC(s) in
Tennessee.

é r

LLC 2

é ™ Property ~~

Appendix B

Public REIT

i [Privately 5
i Traded] i
PTP
90%

99% 10% |

REIT B REITA
a
1% 99%
LLC 1
99%
|
REIT C

0, im 7,
30% TN Property

30%
REIT C’s wholly-
owned LLC(s) in
Tennessee.

é r

LLC 2

é TN Property y