t c memo united_states tax_court bob jones university museum and gallery inc petitioner v commissioner of internal revenue respondent docket no 717-95x filed date john c stophel richard w bethea jr and stephen s duggins for petitioner charles b burnett and monice rosenbaum for respondent memorandum opinion foley judge petitioner seeks a declaratory_judgment under sec_7428 that it is exempt from federal income_taxation under sec_501 as an organization meeting the requirements of sec_501 pursuant to rule this case was submitted for decision based on the stipulated administrative record as defined in rule b petitioner has exhausted its administrative remedies within the internal_revenue_service as required by sec_7428 and rule c received a final adverse_ruling dated date and invoked the jurisdiction of this court by a petition filed on date unless otherwise indicated all section references are to the internal_revenue_code_of_1986 and all rule references are to the tax_court rules_of_practice and procedure background petitioner was incorporated as a nonprofit corporation under the laws of south carolina on date petitioner is a museum and art gallery located on the campus of bob jones university the university in greenville south carolina the university first opened an art gallery in and prior to petitioner's incorporation the art gallery was a part of the university the museum and art gallery have been housed in their present location since petitioner represents that the museum contains one of the greatest collections of religious paintings and works_of_art in the western hemisphere at one time the university was a tax-exempt_organization the university's exempt status was revoked however as a result of a supreme court decision see 461_us_574 the university maintains a policy that prohibits students from engaging in interracial dating and marriage and the supreme court found that policy to be contrary to public policy petitioner's charter states that petitioner was organized for the following reasons to operate a museum and art gallery which will be open to the public with the hope that it will contribute substantially to the need of the southeastern united_states for cultural and artistic opportunities akin to that of other regions long recognized for their outstanding art galleries which enrich the lives of their people to solicit collect receive accumulate administer and disburse funds and property in such a manner as will in the sole discretion of the board_of directors most effectively operate to further religious charitable scientific literary or educational_purposes either directly or by contributions to any organization described in sec_501 of the internal_revenue_code with the exception of organizations testing for public safety in essence petitioner is taking over all of the operations of the museum previously managed by the university at the outset the museum operated by petitioner will display the same artwork retain the same employees and be housed in the same building the building as the museum operated by the university unlike the university however petitioner does not prohibit interracial dating or marriage petitioner and the university entered into a 3-year lease agreement beginning date under which petitioner is renting the building under the terms of the lease agreement petitioner is to pay the university a total of dollar_figure per year the building contains big_number square feet of floor space the rent charged thus equals dollar_figure per square foot an amount substantially below the building’s fair market rental value of dollar_figure-dollar_figure per square foot the lease agreement states that all works_of_art furniture fixtures and other items of personal_property located on or in the leased premises are owned by the university and are being lent to petitioner free of charge for the 3-year term of the lease the artwork initially to be displayed by petitioner consists exclusively of artwork on loan from the university but petitioner over time intends to acquire additional artwork to display in addition the lease agreement states that the university is responsible for the payment of taxes and repair and utility costs as well as for the maintenance of personal injury and property damage liability insurance relating to the building petitioner however must provide routine maintenance and care for all artwork it borrows to the extent that petitioner’s employees perform any restoration services on artwork owned by 1the lease agreement provides that petitioner shall have the option to extend the term of this lease for additional terms of three years each at a rental rate to be determined after consideration of all of the facts and circumstances at the time of renewal the original 3-year term ended on date the administrative record does not indicate whether the lease agreement has been extended the university petitioner will insist on reasonable remuneration according to its bylaws petitioner is governed by a board_of directors that must consist of at least three members and that is self-perpetuating the board appoints officers for 1-year terms both the directors and the officers serve without compensation from petitioner petitioner's board_of directors currently consists of five persons bob jones chancellor of the university and the son of the university’s founder bob jones iii president and a member of the board_of the university and the son of bob jones john brausch an accountant terry e haskins an attorney and r dana sullivan a businessman petitioner's officers are as follows bob jones iii president bob wood vice president mr wood is also a vice president of the university roger syrja treasurer and roy a barton jr secretary mr barton is also the executive director of financial affairs for the university in recent years the number of visitors to the museum has exceeded big_number annually approximately percent of the visitors have no connection with the university the museum is open to the public free of charge petitioner anticipates that substantially_all of its revenue will come from contributions the balance of its revenue will come from sales of artwork reproductions in a gift shop discussion i in general sec_501 exempts organizations described in sec_501 from federal_income_tax sec_501 includes corporations organized and operated exclusively for religious charitable or educational_purposes no part of the net_earnings of which inures to the benefit of any private_shareholder_or_individual no substantial part of the activities of which is carrying on propaganda or otherwise attempting to influence legislation and which does not participate in or intervene in any political campaign the requirement that a corporation be organized exclusively for permitted purposes is referred to as the organizational_test the requirement that a corporation be operated exclusively for permitted purposes is referred to as the operational_test only the operational_test is at issue in this case sec_1_501_c_3_-1 income_tax regs provides that an organization will be regarded as operated exclusively for one or more exempt purposes only if three requirements are satisfied the organization engages primarily in activities that accomplish exempt purposes and no more than an insubstantial part of its activities is in furtherance of a nonexempt purpose the net_earnings of the organization do not inure in whole or in part to the benefit of private shareholders or individuals and the organization is not an action_organization that attempts to influence legislation by propaganda or otherwise sec_1_501_c_3_-1 income_tax regs expressly includes museums within the scope of sec_501 museums of course must also satisfy all other requirements of sec_501 to qualify for exemption in her final adverse_ruling respondent provided the following explanation for denying petitioner’s application_for exempt status this ruling is made for the following reasons you are not operated exclusively for exempt purposes your operation results in substantial private benefit to bob jones university which is not exempt from income_tax under sec_501 of the code because of its racially discriminatory policies your earnings inure to private shareholders or individuals furthermore you are operated for a substantial non-exempt purpose this explanation appears to set forth four separate justifications for denying petitioner’s application_for exemption in substance however it sets forth a single justification respondent contends that the university derives an impermissible benefit from petitioner’s operation and that petitioner by providing such benefit furthers a substantial nonexempt purpose respondent argues that the university receives an impermissible benefit based on petitioner’s payment of rent to the university petitioner’s payment of salaries to employees formerly employed by the university petitioner’s exhibition of artwork on loan from the university the university’s influence on petitioner’s board petitioner's location on the campus of the university and the reputational benefit that the university will derive from its association with petitioner even if none of these factors alone is found to be disqualifying respondent maintains that their cumulative effect precludes petitioner’s qualification for exempt status as a preliminary matter we address respondent’s contention that petitioner has conceded that it furthers a substantial nonexempt purpose respondent emphasizes that petitioner’s application_for tax-exempt status contained the following statement one of the purposes behind the establishment of the organization is to allow for gifts to be made to the museum and art gallery as charitable_contributions whereas no such deduction would be allowed for such contributions if they were given to the university emphasis added we do not agree with respondent that this statement constitutes a disqualifying admission of a nonexempt purpose the purpose of allowing donors to deduct contributions which presumably induces a larger number and greater amount of contributions to an organization motivates virtually every organization’s decision to seek exempt status if that objective precluded an organization from qualifying for tax exemption few if any organizations would ever satisfy the sec_501 requirements more importantly the sentence in petitioner's application immediately following the one quoted above states contributions to the organization will be used solely for the operation of the museum and art gallery and for acquisition of additional art as available funds permit petitioner’s stated purposes thus are consistent with those of any museum respondent contends that notwithstanding petitioner’s stated purposes one of petitioner’s actual purposes is to funnel tax-deductible contributions to the university for support respondent quotes 71_tc_661 which states it has been recognized that an organization engaged in a single activity may have more than one purpose in conducting the activity so we must be concerned with both the actual as well as the stated purposes for the existence of the organization and the activities it engages in to accomplish those purposes we reject respondent’s contention that petitioner's actual purpose is to funnel tax- deductible contributions to the university we see nothing improper about an educational organization's having as one of its purposes the receipt of tax-deductible contributions and the use of those contributions to pay ordinary and necessary business_expenses in addition we find christian manner international readily distinguishable from the present case in christian manner international the founder of a nonprofit corporation wrote books that advanced a purportedly religious message and received proceeds from the sale of the books the court concluded that the corporation’s activities resembled ordinary commercial publishing practices and that the corporation’s principal purpose was commercial in nature in the present case there is no doubt that petitioner is a bona_fide museum that furthers educational_purposes ii private benefit factors we now turn our attention to the specific factors cited by respondent as the basis for her final adverse determination a petitioner’s payment of rent to the university respondent contends that petitioner’s payment of rent to the university confers on the university an impermissible private benefit respondent states this fundraising by the museum will result in direct economic benefit to bob jones university because tax-deductible contributions made to petitioner will be used to reimburse bob jones university for rental of the building on the university campus where the art collection is housed this will relieve bob jones university of the cost of operating the museum itself and will allow bob jones university to have the benefit of the museum on its campus financed by tax-deductible contributions the principal inquiry in determining whether rental arrangements create private benefit or inurement is whether the rental payments are excessive see 72_tc_681 focusing on whether comparable services would cost as much if obtained from an outside source in an arm’s-length transaction in the present case petitioner is to pay the university dollar_figure per year which is substantially less than the building's fair_market_value respondent contends that payments for less than fair_market_value can create private_inurement for support respondent quotes 412_f2d_1197 which states that the benefit conveyed may be relatively small does not change the basic fact of inurement id pincite f 2d pincite this quotation however is taken out of context the same case concludes that an organization may incur ordinary and necessary expenditures in the course of its operations without losing its tax-exempt status id pincite f 2d pincite we conclude that petitioner's payment of below-market rent constitutes an ordinary and necessary expenditure and does not confer an impermissible private benefit on the university b petitioner’s payment of employees’ salaries respondent states that petitioner has retained the same museum employees that the university had employed because the burden of paying the employees’ salaries has shifted from the university to petitioner respondent maintains the university is receiving a private benefit we reject respondent's argument petitioner is an independent organization that conducts its own operations petitioner pays its employees to perform services for the museum although petitioner's employees previously worked for the university they do not currently provide any services to the university in exchange for their salaries therefore we conclude that petitioner's payment of its employees' salaries does not confer a private benefit on the university c petitioner’s use of artwork lent by the university the lease agreement between petitioner and the university restricts to the building the use of all leased artwork furniture and fixtures respondent contends that this restriction unduly limits petitioner’s operations we disagree the terms of the lease agreement are somewhat restricting but the lease agreement expires after years moreover respondent concedes that displaying artwork on loan is a common practice of museums respondent further concedes that petitioner is not paying the university an excessive_amount for its use of the artwork in fact petitioner is not paying the university anything for its use of the artwork based on these facts we conclude that the lease agreement does not confer an impermissible private benefit on the university d excessive control respondent contends that persons on petitioner’s board_of directors who are affiliated with the university will manage petitioner for the purpose of benefiting the university there are no bright-line standards that address the effect on exempt status if any of overlapping boards of directors in revrul_66_358 1966_2_cb_218 the commissioner concluded that a nonprofit organization spun off from a taxable corporation was tax exempt even though the nonprofit organization’s directors consisted of the taxable corporation’s officers thus the commissioner has recognized that overlapping boards of directors do not automatically prevent an organization from qualifying for exempt status two factors in the present case weigh in petitioner’s favor first the university controls less than percent of the votes on petitioner’s board_of directors only two of petitioner’s five directors bob jones and bob jones iii are employed by the university second we agree with petitioner that the issue of control would be relevant only if petitioner and the university were to engage in transactions in which petitioner paid the university unreasonable amounts for goods or services see 74_tc_531 if members of the harberts family which made up the entire board_of directors were actually engaged in performing employment services compensating them in reasonable amounts for those services would not disqualify petitioners for exemption affd 670_f2d_104 9th cir given that university officials do not control a majority of petitioner’s board_of directors and that the record does not lead us to believe that petitioner will make unreasonable payments to the university we conclude that the current composition of the board does not preclude petitioner from satisfying the requirements of sec_501 e location respondent contends that petitioner’s location on the university’s campus confers a private benefit on the university in particular respondent emphasizes that the university requires all of its students to visit the museum as part of a required freshman course and as part of several elective courses petitioner contends that the university’s requirement that students visit the museum is not problematic petitioner emphasizes that other schools may require students to visit museums as part of their academic curricula and that whether those museums are located on or off campus does not affect the tax-exempt status of the schools imposing the requirement we conclude that any benefit the university derives from petitioner’s location is merely incidental see 78_tc_921 respondent has not cited nor have we found any cases that suggest that the location of an organization may affect its eligibility for exempt status moreover approximately percent of all visitors to the museum are not affiliated with the university evidently the location does not deter public visitors f enhancement to reputation respondent contends that petitioner’s name and location serve to enhance the university’s educational and spiritual reputation and thus confer a private benefit on the university while we agree that the university receives an intangible benefit from petitioner’s name and location we conclude that the benefit is minimal and incidental see id respondent is especially concerned about preventing the university from circumventing the supreme court’s decision in 461_us_574 respondent contends that if petitioner prevails bob jones university will be able effectively to achieve the tax exempt status which was denied to it by the supreme court by spinning off component parts respondent states the university may achieve an aura of tax-exempt status itself by being associated with various tax-exempt spin-offs respondent further contends that a decision for petitioner would create a slippery slope she believes that if the university is allowed to spin off its museum it may next attempt to spin off other component parts such as its library cafeteria and bookstore respondent’s concerns about spinoffs are misplaced for several reasons first as petitioner aptly points out respondent does not cite any cases to support her aura argument nor does she clearly define this exempt status- defeating aura second libraries cafeterias and bookstores are essential parts of a university while most universities do not maintain art museums third a cafeteria or bookstore spun off from a taxable corporation might not independently qualify for exempt status finally while additional concerns may arise if a university were to attempt to spin off one of its essential parts those concerns are not implicated here we find problematic and reject the notion that enhancement of another entity’s educational and spiritual reputation may preclude exempt status respondent has not cited nor have we found any cases supporting her position g cumulative effect of these factors ultimately respondent concedes that most of the individual factors may not appear to result in more than incidental private benefit but contends that the cumulative effect of these factors creates a private benefit we disagree based on our review of the record we conclude that petitioner satisfies the requirements of sec_501 in substance as well as in form petitioner is a museum open to the public free of charge that displays what petitioner claims is one of the greatest collections of religious art in the western hemisphere respondent has not challenged this claim with respect to all financial dealings between petitioner and the university respondent has conceded that petitioner is paying the university fair_market_value or less while there is no doubt that the university receives certain benefits from petitioner's existence these benefits are merely incidental iii conclusion respondent’s arguments ultimately lead to the conclusion that a taxable corporation could never spin off a tax-exempt_organization and conduct subsequent financial dealings with it because funds raised by a tax-exempt_organization generally come from tax-deductible donations respondent’s position implies that any transfer by an exempt_organization to a taxable corporation would create a private benefit or inurement problem we reject this position accordingly we hold that petitioner’s operation does not result in an impermissible private benefit to the university and that petitioner’s net_earnings do not inure to the university to reflect the foregoing decision will be entered for petitioner


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc corp 2-plr-115688-02 date date legend holdco holdco parent sub sub sub sub state x business a business b business c plr-115688-02 y dear this letter responds to your date request for rulings on certain federal_income_tax consequences of a proposed transaction on behalf of the above-captioned taxpayer additional information was received on july august september and date the information submitted indicates that holdco holdco and parent are state x corporations that are accrual_method taxpayers who each file tax returns on a calendar_year basis in addition parent is the common parent of an affiliated_group that joins in the filing of a consolidated_return sub sub sub and sub are all members of the parent consolidated_group the parent group has in effect an election under sec_1504 of the internal_revenue_code to include eligible life_insurance_companies in the consolidated_return the ownership structure of the corporations involved is as follows holdco wholly owns holdco holdco owns y less than percent of parent parent wholly owns sub parent owns greater than percent of sub sub wholly owns sub sub owns greater than percent of sub sub and sub each own several subsidiaries the principal business of holdco and parent is the conduct of business a as currently structured most of the business b companies are owned by sub through its ownership of sub another group of business b companies are owned by sub and its subsidiaries however sub and its subsidiaries are primarily engaged in business c the taxpayer alleges that this structure creates confusion and troublesome management issues for holdco parent and their subsidiaries in order to address the structural problems raised the taxpayers have proposed the following transaction a b holdco will be liquidated into holdco through a transaction purported to qualify under sec_332 of the code parent will then be merged into holdco with holdco surviving in a transaction purported to qualify under sec_368 of the code after the transaction pursuant to an election to be filed under sec_1_1502-75 the former shareholders of parent will own over of the fair_market_value of holdco 1's stock as a result of their prior ownership of parent c the business b subsidiaries will be distributed by sub to sub and then by sub to holdco plr-115688-02 d e holdco will then transfer the business b subsidiaries to sub sub will distribute the stock of business c subsidiaries to holdco in connection with the proposed transaction the taxpayer represents that the transfer of the business b subsidiaries by holdco to sub and sub 2's transfer of its business c subsidiaries to holdco were fundamental and necessary parts of the overall transaction without which the transaction would not have been undertaken further it is stated that the substitution of assets ie the business b subsidiaries for the business c subsidiaries is required for regulatory purposes and to preserve sub 2's rating it was also stated that without the corresponding transfer the distribution of the business c subsidiaries might be viewed by regulators as a threat to sub 2's solvency also while the taxpayer has not obtained an independent appraisal of the enterprise values of the business b and business c subsidiaries they believe them to be of substantially equivalent value based solely on the information submitted and the representations set forth above we rule as follows the parent consolidated_group will remain in existence under sec_1_1502-75 to the extent that an election is made under sec_1_1502-75 and that the appropriate shareholders end up owning greater than fifty percent of the requisite stock the parent group’s life-nonlife election under sec_1504 of the code shall continue after the transaction described herein is consummated sec_1_1502-47 the distributions described in c above will constitute intercompany distributions to which sec_301 and sec_311 apply subject_to the provisions of sec_1_1502-13 the transfer and distribution described in d and e are subject_to sec_351 and sec_311 of the code respectively and are subject_to the provisions of sec_1_1502-13 and sec_1_1502-32 the rulings contained in this letter are 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 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 plr-115688-02 referenced in this letter in particular we express no opinion on the tax consequences of holdco liquidating into holdco nor do we express an opinion on the tax consequences of parent merging into holdco this ruling is directed only to the taxpayer s requesting it sec_6110 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 a copy of this letter must be attached to any income_tax return to which it is relevant sincerely edward s cohen chief branch office of associate chief_counsel corporate


department of the treasury washington dc person to contact --------------- id no ------------- telephone number --------------------- refer reply to cc ita - plr-133256-06 date date internal_revenue_service number release date index number ----------------------------------- --------------------------------------------- ---------------------- ------------------------------ ----------------------------------------- ----------------------- dear ------------- this letter responds to your authorized representative’s letter and submissions of date requesting on your behalf a private_letter_ruling that a certain form_8716 election to have a tax_year other than a required tax_year be considered timely filed under the authority of ' of the procedure and administration regulations taxpayer s form_8716 electing to retain a taxable_year ending november was due on or before date but was not filed by that date however the information furnished shows that taxpayer intended to make the election and to file form_8716 on a timely basis and had engaged a qualified_tax professional in order to assure a proper filing due to an error or misunderstanding however the form was not timely filed the error was not due to any lack of due diligence or prompt action on the part of taxpayer sec_1_444-3t of the temporary income_tax regulations provides among other requirements that form_8716 must be filed by the earlier of i the 15th day of the fifth month following the month that includes the first day of the tax_year for which the election will first be effective or ii the due_date without regard to extensions of the income_tax return resulting from the ' election sec_301_9100-1 set forth rules respecting the granting of extensions of time for making certain elections under these rules the commissioner in his discretion may grant a reasonable extension of time to make a regulatory election under subtitle a provided the taxpayer acted reasonably and in good_faith and that the granting of relief will not prejudice the interests of the government plr-133256-06 sec_301_9100-2 sets forth rules governing automatic extensions for regulatory elections including elections to use other than the required tax_year under ' if the provisions of ' do not apply to the taxpayer's situation as in the instant case the provisions of ' other extensions may apply sec_301_9100-3 sets forth standards that the commissioner will employ in determining whether to grant discretionary relief in situations that do not meet the requirements of ' the standards applied are whether the taxpayer acted reasonably and in good_faith in the matter and whether the granting of relief will prejudice the interests of the government generally a taxpayer will be deemed to have acted reasonably and in good_faith where for example the taxpayer reasonably relied on a qualified_tax professional and that professional failed to make or advise the taxpayer to make the election at issue the information submitted and representations furnished by taxpayer and its tax professionals establish that taxpayer acted reasonably and in good_faith in respect of this matter furthermore we have determined that the granting of relief in this case will not prejudice the interests of the government within the intendment of ' c accordingly the requirements of ' for the granting of relief have been satisfied a copy of this letter and taxpayer's form_8716 filed in connection with this ruling_request are being forwarded to the service_center where the taxpayer files its returns of tax with instructions that the form be considered timely filed and processed so as to affect a taxable_year ending november effective for taxpayer's taxable_year beginning date and ending date this ruling is conditioned on taxpayer complying with ' 7519-1t a which provides in relevant part that for each tax_year that an s_corporation has an election under ' in effect the corporation must i file a return as provided in ' 7519-2t a and ii make any required_payment as provided in ' 7519-2t except for the specific ruling above which is restricted to the filing of form_8716 we express or imply no opinion concerning the federal_income_tax consequences of the facts of this case under any other provision of the code or regulations that may be applicable thereto plr-133256-06 in accordance with the provisions of a power_of_attorney currently on file with this office a copy of this letter_ruling is being sent to the taxpayer’s authorized representative this ruling is directed only to the taxpayer that requested it under ' k sincerely of the code this ruling may not be used or cited as precedent by other taxpayers s george f wright enclosures copy of this letter copy for sec_6110 purposes george f wright senior technician reviewer branch office of associate chief_counsel income_tax accounting


office_of_chief_counsel internal_revenue_service memorandum number release date cc corp ------------- postu-156340-03 uilc date date to --------------------- ------------------ ------------------------------------------------------------------ ---------------------------- ------------------------------------------------------ -------------------------------------- from associate chief_counsel corporate cc corp b03 subject notice whether acquisition of the foreign_currency in a stock subscription is a substantially_similar transaction to the transaction described in notice_2002_21 this chief_counsel_advice responds to your request for advice dated date chief_counsel_advice is not binding on examination or appeals and is not a final case determination this chief_counsel_advice should not be cited as precedent legend taxpayer --------------------------------------------------------------------------------- -------------------------------------------------------------------- taxpayer subsidiary --------------------------------------------------------------------------- --------------------------------------------------------------------- foreign_affiliate ------------------------------------------------------------------------------------- -------------------------------------------------------- ------------------------------------ --------------------------------- postu-156340-03 ------------------ --------------------- ---------------------- ------------------------ --------------------------------------------- --------------------------------------------- foreign_affiliate foreign_currency investment program llc ------------------------------------------------------------------------------------------------------------------ bank ----------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------- -------------------------------------------------------------------------------------------------------------------- affiliate bond issuer bank bank promoter manager year year month gain company vice president of taxes fc fc1 country a country b floating interest rate fixed interest rate ----------------------------------------------- ----------------------------------- ------------------------------- -------------------------- - ---------------------- ------------------ --------------- ------------- ------------ ----------- --------- ------- ------- postu-156340-03 ---------------------------------------------------- ------------------------------------------------ -------------- ----------------- ----------------- -------------------- --------------------------- --------------------------- --------------------------- date date date custodian ----------------------------------------------------------------------------------------- ----------------------------------------------------------------------------- dollar_figurea dollar_figureb dollar_figurec d units e units f units g units h i dollar_figurej k l m n units dollar_figureo p q ------------------------ ------------------------ ------------------ ------------- -------- ----- ---- --- --- --- -- -- postu-156340-03 ------------------------------------------------------------------------ ------------- ----------------- ----------------- -------------------- --------------------- ---------------------- ---------------------- ------------------------ --------------------------------- r units s units dollar_figuret treasurer country c bank business x -------------------------------------------------------------------------------------------------------------- u units dollar_figurev dollar_figurew x units issues 2002_1_cb_730 claimed and if not under what theory or theories should it be disallowed conclusion in whole or in part for the following reasons incurred no genuine indebtedness to bank and therefore the purported assumption of such indebtedness by taxpayer subsidiary has no effect for federal_income_tax purposes as a result there is no sec_357 gain on the purported sec_351 exchange no increase in the basis of the conveyed foreign_currency fcs under sec_362 and thus no loss on the subsequent sale of the conveyed fcs defined in the sec_351 transaction section below whether the transaction in the instant case falls within the scope of notice the taxpayer’s dollar_figureb currency loss deduction for year should be disallowed should the taxpayer’s dollar_figureb currency loss deduction for year be allowed as the transaction described below falls within the scope of notice_2002_21 a the deduction should be disallowed in its entirety on the grounds that llc ----------------------- postu-156340-03 d the currency loss should be denied in its entirety until if and when taxpayer b alternatively if upon further development of the facts it appears that the e sec_351 does not apply in the instant case because there was no bona parties did intend for taxpayer subsidiary to assume and pay some portion of the liability on the llc note then taxpayer subsidiary’s basis under sec_362 in the conveyed fcs should only be increased to the extent of the portion actually assumed c taxpayer subsidiary had no money or property at risk or at most it may include only d units which ultimately was made available to foreign_affiliate in its amount_at_risk under sec_465 of the code the result is that the loss deduction should be disallowed either in its entirety or at most allowed only in the amount of the dollar equivalent of d units can clearly demonstrate that with respect to the fcs which it could substantively use exchange rate changes between the period it acquired and disposed of the fcs resulted in the loss this is consistent with the intent of congress and sec_1_988-2 fide non-tax business_purpose for the transaction as a result neither sec_357 nor sec_362 applies accordingly the transaction should be treated as an exchange under sec_1001 with the basis rules of sec_1012 and the case law both discussed in notice_2002_21 controlling the result is that the basis of the conveyed fcs will be limited to the fair_market_value of such assets upon their acquisition by taxpayer subsidiary thus the loss purportedly resulting from the transaction in the instant case is not allowable to the extent taxpayer derives a tax_benefit that is attributable to a basis in excess of the fair_market_value of the conveyed fcs facts corporations that file a consolidated federal_income_tax return its primary business consists mainly of business x the taxable years under examination are return year through year in month taxpayer sold its interest in gain company realizing a capital_gain of approximately dollar_figurea the transaction undertaken by taxpayer described below created a non-economic dollar_figureb foreign_currency_loss intended to qualify under sec_988 of the internal_revenue_code which it carried back to its year consolidated_return the carryback neutralized the gain recognized on the sale of gain company while taxpayer states that no promoter was involved in the transaction it was billed dollar_figurec dollars by promoter a recognized tax_shelter promoter moreover the transaction appears to have been brought to the attention of taxpayer by its vice president of taxes not by a business group this was the only time a venture originating in the tax department was ever undertaken by taxpayer the transaction described below closely resembles the custom adjustable rate debt card tax_shelter described in notice_2002_21 taxpayer a domestic_corporation is the common parent of an affiliated_group of background postu-156340-03 formation of llc and creation of note on date llc a newly-formed domestic company owned by country a nationals purportedly unrelated to the taxpayer entered into a contract with bank under a credit agreement dated date between llc as borrower and bank as both lender and administrative agent llc requested and lender agreed to make a loan in the principal_amount of e units pursuant to the terms and conditions under the credit agreement loan principal on the loan was due in years and interest was initially set at floating interest rate due quarterly and subject_to reset after four years reset would occur annually thereafter at which time the borrower would be free to find a new lender to assume the loan section dollar_figure of the credit agreement requires lender to make available to the administrative agent the amount of the loan proceeds in immediately available funds and the administrative agent is required to deposit such amount to a cash collateral account the cash collateral account is defined as a segregated interest-bearing deposit account established with the custodian in the name of the llc but under the control of the administrative agent which constitutes part of the collateral for the loan and is required to be held until disbursed or invested in accordance with section dollar_figure of the credit agreement before the loan date a cash collateral account defined above and a securities account the securities account is defined as an account established by llc at the custodian in the name of the llc but under the control of the administrative agent which shall constitute part of the collateral provided for in the company pledge agreement to hold the eligible investments and other investments made with the proceeds of the loan section dollar_figure of the credit agreement limits disbursements or releases from the cash collateral account and the securities account to the following circumstances -- under section dollar_figure of the credit agreement llc was required to establish on or i payments of principal and interest on the loan in accordance with section ii iii b transfers from the cash collateral account to the securities account for the purpose of purchasing eligible investments and other investments transfers from the securities account to the cash collateral account representing the proceeds of the sale of any eligible investments or other investments and iv transfers in accordance with the llc’s pledge agreement eligible investments are defined as investments that are reasonably acceptable to the administrative agent having a maturity which is not more than one year and which are i backed by the full faith and credit of the country b government ii commercial paper issued by a country b person and acceptable to lender iii time it is our understanding that this entity is classified as a partnership for us tax purposes while the original loan amount was to be x units the promissory note from llc dated date as well as the assumption_agreement and the assumption closing_agreement provide that the loan between llc and lender was in the principal_amount of e units postu-156340-03 sec_351 transaction under a subscription agreement dated date among llc taxpayer llc entered a series of interest rate swaps with affiliate an affiliate of bank section dollar_figure of the credit agreement requires that llc maintain an aggregate deposits with banks acceptable to lender in its sole discretion or iv certificates of deposit or interests in money market funds reasonably acceptable to lender collateral value in the collateral accounts equal to the sum of i the outstanding principal_amount of the loan plus ii all accrued and unpaid interest thereon and other_amounts payable hereunder plus minus the termination cost value of the hedge agreements plus iv any other amount outstanding hereunder or under the other financing documents which converted its floating rate of interest on the loan to a fixed rate of approximately fixed interest rate as further described below earnings on the collateral account covered the first four year’s interest although affiliate agreed to advance funds if the account earnings were insufficient subsidiary and manager the manager of llc llc agreed to transfer to taxpayer subsidiary g units the conveyed fcs which represented h percent of the total e unit loan amount plus dollar_figurei million3 or the fc equivalent thereof in exchange for i thousand shares of non-voting preferred_stock par_value dollar_figurej per share of taxpayer subsidiary and the assumption by taxpayer subsidiary of all the payment obligations of llc under the credit agreement in a transaction intended to qualify under sec_351 of the internal_revenue_code the h percent of the total e unit loan amount contributed by llc to taxpayer subsidiary equaled the present_value of the principal_amount of the e units loan due in years as part of a side agreement between llc and taxpayer subsidiary taxpayer subsidiary agreed to be liable for the payment of the principal and llc agreed to be liable for the interest payments on the loan simultaneously and as part of the same purported sec_351 transaction taxpayer agreed to transfer assets with a fair_market_value of dollar_figurek million and dollar_figurel million for m shares of taxpayer subsidiary common_stock and l thousand shares of taxpayer subsidiary preferred_stock respectively the preferred_stock paid an l percent dividend llc and lender in its capacity as both lender and administrative agent llc proposed to transfer the conveyed fcs to taxpayer from the collateral account and lender consented to the transfer provided that taxpayer supply substitute collateral to cover the partial withdrawal of the loan proceeds from the collateral account in consideration for the transfer taxpayer subsidiary agreed to assume on a joint and according to the daily cash management report of parent the dollar_figurei million appears initially to have been paid_by promoter on llc’s behalf a few months later llc borrowed dollar_figureo from bank for the purpose of making this purchase llc pledged the taxpayer subsidiary preferred_stock as collateral for the loan and instructed taxpayer subsidiary to remit the l percent dividend directly to bank to pay off the loan in granting the loan bank considered the true borrower to be taxpayer under an assumption_agreement dated date among taxpayer subsidiary postu-156340-03 several basis all the obligations of llc under the credit agreement and note without modifying reducing releasing or discharging the obligations of llc under the credit agreement and the note in addition taxpayer subsidiary provided for the issuance of letters of credit for the benefit of lender in the aggregate stated amount of n unit sec_4 taxpayer guaranteed taxpayer subsidiary’s obligations under the letters of credit the assumption closing_agreement dated date among llc taxpayer subsidiary and lender in its capacity as both lender and administrative agent provides that the proceeds of the loan were deposited by llc in time deposits with financial institutions other than lender in an aggregate principal_amount of e units in sec_1 of the assumption closing_agreement the administrative agent agrees to instruct the custodian to make the following transfers and releases from the collateral accounts on the assumption closing date - i ii iii iv purchase with funds on deposit in the cash collateral account and for deposit in the securities account country b government securities purchase with funds on deposit in the cash collateral account and for deposit in the securities account short-term country b government securities release f units from the cash collateral account and prepay the custodian in full for all custodial fees for the period between the closing date to the first re-set date and release the remaining funds in the cash collateral account and pay such amount to taxpayer subsidiary’s account the amount to be used to purchase country b government securities was to be determined by oral agreement on the assumption closing date between the administrative agent and taxpayer subsidiary sec_3 of the assumption closing_agreement provides that llc has no right to request or agree to any amendment modification or supplement waiver under or termination of any terms of the financing documents under an assignment and cash collateral_agreement dated date between taxpayer subsidiary and lender taxpayer subsidiary agreed to deposit an amount5 of fcs in a special cash collateral account with bank in the name of taxpayer subsidiary but under the sole control and dominion of bank the assignment and cash collateral_agreement was a condition to the assumption_agreement dated the same date without notice to taxpayer subsidiary to transfer to or to register in the name of bank or any of its nominees any or all of the collateral sec_3 provides that bank shall have the right at any time in its discretion and this total was sufficient to cover the g units withdrawal from the collateral account plus the interest that would be due on that amount on date the amount deposited pursuant to the assignment and cash collateral_agreement was left blank in the copy provided postu-156340-03 the custodian agreement between llc and custodian and lender as both lender and administrative agent authorized the custodian to open and maintain one or more securities accounts s and a cash collateral account under article of the custodian agreement the administrative agent was authorized to give instructions for and on behalf of llc with respect to the accounts and such instructions are conclusively binding on llc article provides that the custodian agreement could be terminated only with the consent of the administrative agent and upon termination the custodian was required to act on all instructions from the administrative agent sale of foreign_currency when taxpayer subsidiary received the conveyed fcs in the purported sec_351 exchange it immediately sold them and purchased fc1s taxpayer subsidiary sold the fc1s one week later and purchased fcs with the proceeds from the sale taxpayer subsidiary transferred the fcs to a new investment subsidiary foreign_affiliate which placed the fcs into a money market account with bank funds equal to approximately half of that amount were required to be placed in restricted accounts with bank as security for the letters of credit foreign_affiliate later invested a small portion of the funds in bond issuer and country b treasuries taxpayer alleges that the primary motive for entering into this transaction was to obtain funds for investing in its foreign_affiliate foreign_currency investment program taxpayer’s tax treatment of the transaction taxpayer subsidiary claimed a dollar_figureb loss on the sale of the conveyed fcs which is equal to the excess of the stated principal_amount of the loan e units over the fair_market_value of the conveyed fcs g units that is taxpayer subsidiary claims basis in the conveyed fcs equal to the sum of llc’s tax basis in the conveyed fcs dollar_figurev plus the amount of gain recognized by llc under sec_357 on the transfer dollar_figureb for a total basis of dollar_figurew see sec_362 taxpayer asserts that the entire principal_amount of the loan is included in its basis in the conveyed fcs because of taxpayer’s purported assumption of joint_and_several_liability on the entire amount of the loan as a result taxpayer’s year consolidated_return reflected a dollar_figureb ordinary_loss under sec_988 from taxpayer subsidiary’s sale of the conveyed fcs law and analysis notice_2002_21 covers transactions involving the use of a loan assumption_agreement to claim an inflated basis in assets acquired from another party this inflated basis is claimed as a result of a transfer of assets in which a u s taxpayer taxpayer becomes jointly and severely liable on indebtedness of the transferor of the application of notice_2002_21 the transactions described herein occurred prior to the effective date of sec_357 and sec_362 postu-156340-03 pursuant to a separate side-agreement between transferor and taxpayer in the transaction discussed in the notice transferor borrows money from a transferor uses the proceeds to purchase assets the assets which may be assets transferor with the indebtedness having a stated principal_amount substantially in excess of the fair_market_value of the assets transferred lender lender on a long term basis such a sec_30 years the loan the amount borrowed is frequently in a foreign_currency interest is payable at regular intervals and principal is due at maturity the loan is made with full recourse to transferor denominated in a foreign_currency the assets serve as collateral for the loan pursuant to a loan agreement as each interest payment becomes due the collateral is used to satisfy such payments upon maturity or earlier payment the loan is satisfied by its terms first from the collateral and only then against transferor or transferor and any party that has assumed the liability as a joint_and_several obligor to satisfy any shortfall transferor transfers a portion of the assets to taxpayer in consideration for taxpayer's agreement to pay the principal only in years under a separate side assumption_agreement with the lender taxpayer agrees to be jointly and severally liable on the entire loan the fair_market_value of the assets transferred to taxpayer the conveyed assets equals the present_value of the loan's principal payment at maturity determined by using a market rate of interest thus the fair_market_value of the conveyed assets is substantially less than the loan's stated principal_amount taxpayer provides substitute collateral for the loan equal in value to the conveyed assets the remainder of the assets purportedly owned by transferor continues to serve as collateral for the loan transferor agrees to make all interest payments on the loan and taxpayer agrees to pay the principal due at maturity the co-obligors and lender anticipate that the collateral will be substantially if not entirely sufficient to repay the loan value taxpayer claims that as a result of its assumption of joint_and_several_liability on the entire amount of the loan the entire principal_amount of the loan is included in taxpayer's basis in the conveyed assets as a result taxpayer claims a loss for federal_income_tax purposes in an amount equal to the excess of the stated principal_amount of the loan over the fair_market_value of the conveyed assets if the conveyed assets are nonfunctional_currency taxpayer claims an ordinary_loss taxpayer subsequently disposes of the conveyed assets for their fair market also pursuant to the side-agreement between transferor and taxpayer application of notice_2002_21 to the instant case the instant transaction is substantially_similar to the transaction described in notice_2002_21 and therefore it falls within the scope of notice_2002_21 postu-156340-03 the taxpayer’s dollar_figureb currency loss deduction for year should be disallowed in whole or in part for the following reasons there was no real liability and therefore no assumption of a liability in the purported sec_351 exchange a a loss is allowable as a deduction for federal_income_tax purposes only if it is bona_fide and reflects actual economic consequences see generally 293_us_465 904_f2d_1011 5th cir in certain circumstances courts will recognize that even if a transaction actually does occur that transaction may be lacking in economic_substance 939_f2d_44 n 3d cir see also 861_f2d_494 7th cir for instance with respect to transactions involving loans i t is well settled that the mere fact that a note is given does not prove the existence of a loan if there was no indebtedness existing which the note evidenced leonard v commissioner tcmemo_1985_51 citing 45_bta_685 and 54_tc_742 aff'd 445_f2d_985 10th cir in 364_us_361 the supreme court held that a loan transaction entered into by a taxpayer may be disregarded for tax purposes if there was no genuine indebtedness the supreme court held that no valid indebtedness existed where the taxpayer never acquired a meaningful beneficial_interest in the loan in 39_tc_1064 aff'd 325_f2d_180 4th cir a taxpayer purportedly borrowed funds from banks to buy treasury notes and bonds which were pledged as collateral to secure the loans with the proceeds upon maturity or resale being applied to the repayment of the loans the court described the transaction as merely providing the facade of a loan because the taxpayer never had control of the funds purportedly borrowed or the collateral the treasury notes and bonds and the collateral amply secured the purported loan in the typical notice transaction the facts and circumstances of the loan transaction support the conclusion that the credit arrangement lacks economic_substance on the original loan date the lender purportedly transferred funds to the borrower contemporaneously with this transfer however the entire loan proceeds were then deposited into a collateral account held by the lender per the loan agreement the borrower assigned all its rights in the collateral account back to the lender therefore borrower never obtained unfettered use of or control_over the borrowed funds the facts of the instant case relating to the transfer of loan proceeds are substantially_similar to the typical notice_2002_21 transaction in accordance with the credit agreement upon issuance the loan proceeds were immediately deposited in an account with lender under the sole control of lender transfers from the account were limited to transfers to lender to make principal and interest payments on the loan or purchases of eligible investments which were limited to short-term investments in postu-156340-03 country b government bonds certificates of deposit or time deposits with banks or commercial paper all of which were subject_to the consent of lender furthermore the credit agreement requires that the loan be fully collateralized there was no provision for llc acquiring the loan proceeds or the collateral for its own use in light of these facts it appears that llc never obtained use of or control_over the loan proceeds in addition there is similar doubt as to whether there was a real transfer of any under these facts it appears that in substance lender never relinquished b taxpayer subsidiary assumption of portion of llc loan in sec_351 exchange portion of the loan proceeds to taxpayer subsidiary under the assumption_agreement under the assignment and cash collateral_agreement between taxpayer subsidiary and lender taxpayer subsidiary agreed to deposit r units in a special collateral account with lender in the name of taxpayer subsidiary but under the sole control and dominion of lender control of the borrowed funds and is protected from any credit risk because it holds sufficient funds in the collateral accounts to satisfy the loan obligations lender simply made offsetting bookkeeping entries debiting the appropriate amount from the collateral accounts and applying these funds to pay the interest due on the loan at no time did llc or taxpayer subsidiary obtain the unfettered use of any additional money as a result of the credit agreement since llc incurred no genuine indebtedness the purported assumption of such indebtedness by taxpayer subsidiary has no effect for federal_income_tax purposes as a result there is no sec_357 gain on the purported sec_351 exchange no increase in the basis of the conveyed fcs under sec_362 and thus no loss on the subsequent sale of the conveyed fcs did intend to make the loan and for taxpayer subsidiary to assume and pay some portion of the liability on the llc note then taxpayer subsidiary’s basis under sec_362 in the conveyed fcs should only be increased to the extent of the portion actually assumed loan only to the extent that it has not been satisfied from collateral thus the collateral is the primary and expected source of repayment at the inception of the transaction bank holds some p percent of the collateral while taxpayer subsidiary holds the remaining h percent immediately after the sec_351 transaction in some cases courts have limited the portion of an assumed indebtedness that may be taken into account for federal_income_tax purposes for example where two or more persons are liable on the same indebtedness or hold separate properties subject_to the same indebtedness the amount taken into account for federal_income_tax purposes by each person generally is based on all the facts and circumstances including the economic realities of the situation and the parties’ expectations as to how the liabilities will be paid see maher v united_states no w d mo alternatively if upon further development of the facts it appears that the parties in this case taxpayer subsidiary is responsible for the principal balance of the postu-156340-03 the concept of limiting basis from debt to the fair_market_value of the property property was not in substance subject_to liability where lender was not actually relying on property as collateral 469_f2d_225 8th cir corporation’s assumption of primary liability on shareholder’s indebtedness becomes taxable dividend only as corporation makes payments as promised in appropriate cases courts have rejected attempts to assign an inflated basis to property and have limited the basis_of_property to its fair_market_value for example the basis_of_property acquired with the issuance or assumption of recourse indebtedness has been limited to the acquired property’s fair_market_value where a transaction is not conducted at arm’s-length by two economically self-interested parties or where a transaction is based upon peculiar circumstances which influence the purchaser to agree to a price in excess of the property’s fair_market_value 77_tc_1326 citing 58_tc_757 webber v commissioner tcmemo_1983_633 aff’d 790_f2d_1463 9th cir see also 42_bta_698 aff’d 120_f2d_12 8th cir the general_rule that the price paid is the basis for determining gain_or_loss on future disposition presupposes a normal business transaction acquired also is found in case law concerning nonrecourse debt the effect of nonrecourse debt on basis was considered by united_states supreme court in 331_us_1 where the court held that a taxpayer’s basis in inherited property was its fair_market_value on the date of decedent’s death and was not reduced by the amount of nonrecourse debt that encumbered the property the court also held that upon disposition of the property the amount_realized included the amount of the debt second crane holding which treated the nonrecourse debt as part of the amount_realized upon disposition of the encumbered property the taxpayer argued that this rule should not apply when the amount of debt exceeds the fair_market_value of the property the court rejected this argument and noted that the taxpayer had included the debt in basis for depreciation purposes and had based upon a repayment expectation failed to include the loan proceeds in income upon receipt a taxpayer must account for the proceeds of obligations he has received tax-free and included in basis id pincite nonrecourse debt so unreasonably exceeds the fair_market_value of encumbered property that repayment is unlikely this is explained in 748_f2d_908 4th cir in 461_us_300 the taxpayer challenged the tufts however does not foreclose an inquiry into whether the amount of we see nothing in tufts to alter the well-established rules that a taxpayer may not inflate his depreciation_deductions as did taxpayers here by including in his basis for depreciation nonrecourse debt when that debt so postu-156340-03 far exceeds actual value at the time that it is incurred that there is no economic incentive to pay it in reaching these conclusions we note that while tufts did state that crane also stands for the broader proposition that a nonrecourse loan should be treated as a true loan u s pincite it emphasized that crane was predicated on the assumption that the mortgage will be repaid in full id pincite and that the original inclusion of the amount of the mortgage in basis rested on the assumption that the mortgagor incurred an obligation to repay id in regents park partners v commissioner ria tc memo big_number the court limited a partnership’s basis in property to the property’s fair_market_value the court noted that one rationale for disregarding the nonrecourse debt in its entirety from basis is the theory that a taxpayer in such circumstances lacks incentive to pay the debt t he purported purchaser had no incentive to pay off the nonrecourse note because by abandoning the transaction the taxpayer can lose no more than a mere chance to acquire an equity in the future should the value of the acquired property increase estate of franklin v commissioner supra pincite the underlying rationale of these cases that a taxpayer acquires basis as the ria tc memo big_number pincite the court also cites 863_f2d_263 3d cir as authority for a more limited approach that in lieu of disregarding debt in its entirety limits basis to the fair_market_value of the encumbered property without resolving the issue of whether excessive debt should be disregarded in its entirety or only in part the court in regents park did find that under the circumstances of that case the debt was to be renegotiated bore below-market interest etc a partnership did have an incentive to continue to make payments so that it was appropriate to grant basis but only to the extent of the encumbered property’s fair_market_value id pincite3 result of debt only when the circumstances indicate that the taxpayer will pay the debt is very relevant to this transaction the amount that taxpayer subsidiary was likely to pay is much less than the full amount of the loan and its claim to basis premised on payment of the full amount of the loan is unreasonable based in large part on many of the above authorities the service in notice_2002_21 announced its position with respect to the basis_of_property acquired by taxpayers in transactions similar to the transaction at issue here notice_2002_21 concludes that the basis in certain assets conveyed to the taxpayer which in certain circumstances include the use of a loan assumption_agreement to claim an inflated basis in assets acquired from another party is equal to the fair_market_value of such assets upon their acquisition by the taxpayer consequently losses purportedly resulting from such transactions are not allowable to the extent the taxpayer derives a tax_benefit that is attributable to a basis in excess of the fair_market_value of the assets that were the postu-156340-03 c sec_465 - deductions limited to amount_at_risk in sum taxpayer subsidiary’s basis in the conveyed fcs should be limited to for any particular taxable_year sec_465 limits losses from the activities listed in subject of the conveyance in addition the service announced that it may impose penalties including the accuracy-related_penalty under sec_6662 on participants in such transactions their fair_market_value when acquired by taxpayer subsidiary because of the manner in which the loan was collateralized the amount of the loan that taxpayer subsidiary can be considered to have assumed does not exceed this amount accordingly the claimed loss should be disallowed sec_465 to individuals and c corporations with respect to which the stock ownership requirements of sec_542 are met under that section losses are limited to the aggregate amount with respect to which the taxpayer is at risk for the activity at the close of the taxable_year under sec_465 for taxable years beginning after date sec_465 applies to each activity engaged in by the taxpayer in carrying_on_a_trade_or_business or for the production_of_income an affiliated_group is treated as a single_taxpayer under sec_465 in addition under sec_1 a taxpayer is entitled to include a loss from one of its subsidiary’s activities on its consolidated_return only to the extent that the loss does not exceed taxpayer’s amount_at_risk in the subsidiary activity at the close of the subsidiary’s taxable_year and does not exceed the amount for which the taxpayer is at risk in the subsidiary at the close of the subsidiary’s year meets the ownership requirements of sec_542 because taxpayer subsidiary is an entity to which sec_465 applies and because taxpayer subsidiary claims to have engaged in this transaction to earn a profit sec_465 limits taxpayer subsidiary’s losses from the activity to its amount_at_risk in the activity sec_465 may still exclude taxpayer subsidiary from sec_465 if taxpayer subsidiary’s foreign_affiliate foreign_currency investment program activity is a qualified_business under sec_465 and if taxpayer subsidiary is a qualified_c_corporation under sec_465 the field’s submission indicates that this exception does not apply that submission indicates that although taxpayer subsidiary is a qualified_c_corporation taxpayer subsidiary is a qualified_c_corporation because although it meets the personal_holding_company ownership test in sec_542 it does not meet the personal_holding_company_income test in that section the field’s submission indicates that taxpayer subsidiary’s foreign_affiliate foreign_currency investment program activity was not a qualified_activity because neither of the direct participants taxpayer subsidiary and foreign_affiliate had any employees determined under sec_465 that section includes in the amount_at_risk money the adjusted_basis of other_property that the taxpayer contributes to the activity and because sec_465 applies to taxpayer subsidiary its amount_at_risk in the activity is because taxpayer wholly owns taxpayer subsidiary taxpayer subsidiary postu-156340-03 it is questionable whether taxpayer subsidiary was the payor of last resort for amounts that the taxpayer borrows with respect to such activity that are included in sec_465 sec_465 includes amounts borrowed for use in the activity to the extent that the taxpayer is personally liable for the repayment of the borrowed amounts and to the extent of the fair_market_value of the taxpayer’s interest in property not used in the activity pledged as security for the borrowed amounts property that is directly or indirectly financed by indebtedness which is secured_by the property described in sec_465 is not considered at risk the entire e units the terms of the assumption_agreement provided that taxpayer subsidiary and llc were jointly liable for the entire e units liability with no right of contribution or indemnification however those terms also provided that llc would make current interest payments and taxpayer subsidiary would make the principal payment in years the assumption_agreement permitted taxpayer subsidiary to trigger prepayment at any time which obligated llc under the subscription agreement to make a capital_contribution to taxpayer subsidiary in the amount by which the principal payment due under the loan exceeded taxpayer subsidiary’s accreted principal_amount the accreted principal_amount was the g units with a q percent yield compounded annually viewed as a whole the formalities of the financing_arrangement appear to cause taxpayer subsidiary to be the payor of last resort with regard to only the g units unless taxpayer subsidiary failed to trigger repayment before the expiration of the 30-year term any indication that the parties intended to terminate the arrangement before the close of the 30-year term would strengthen the argument that taxpayer subsidiary was the payor of last resort with regard to only g units documents it was the payor of last resort with regard to the entire e units it is questionable whether that entire amount can be considered as having been borrowed with respect to the activity which was the foreign_affiliate foreign_currency investment program under sec_465 arguably taxpayer subsidiary should be treated as having borrowed with respect to the foreign_affiliate foreign_currency investment program activity only that amount over which taxpayer subsidiary had sufficient control to invest it in the activity the only portion of the assets that bank was to release under the documents was g units there may be an argument that taxpayer subsidiary should be treated as having borrowed only d units with respect to the foreign_affiliate foreign_currency investment program when bank released g units from the collateral account to taxpayer subsidiary it required taxpayer subsidiary to simultaneously substitute that amount with letters of credit from bank and bank and agree to the terms of the credit facility the credit facility between bank bank bank and taxpayer subsidiary required taxpayer subsidiary to maintain a balance of at least s units on deposit with bank at all times therefore taxpayer subsidiary may have only had sufficient control_over approximately d units g units - s units for investment in the foreign_affiliate foreign_currency investment program loss through non-recourse financing guarantees stop loss agreements or other similar sec_465 excludes from amounts-at-risk any amount protected against assuming that taxpayer subsidiary can establish that under the financing postu-156340-03 we believe the better analysis as adopted by the second eighth ninth and arrangements the case law construing sec_465 to borrowed amounts is not in complete accord the second eighth ninth and eleventh circuits look to the underlying substance of the borrowing arrangement to determine whether an amount is protected against loss under sec_465 waters v commissioner 978_f2d_1310 2nd cir citing 904_f2d_477 9th cir 926_f2d_1083 11th cir 914_f2d_1040 8th cir other circuits will not find that a borrowed amount is protected against loss under sec_465 if the formal arrangements reflect that in a worst-case scenario the taxpayer is liable for repayment see 949_f2d_841 6th cir stating that the issue of whether a taxpayer is at risk for purposes of sec_465 must be resolved on the basis of who realistically will be the payor of last resort if the transaction goes sour and the secured_property associated with the transaction is not adequate to pay off the debt quoting 91_tc_838 eleventh circuits and the tax_court is that in determining who bears the ultimate liability for an obligation the economic_substance and the commercial realities of the transaction control see waters f 2d pincite 103_tc_120 94_tc_439 89_tc_1050 a court applying this approach first examines under sec_465 who if anyone will ultimately be obligated to pay the recourse obligations if the borrower is unable to do so and second whether that ultimately liability is limited by an arrangement described in sec_465 to determine whether such an arrangement exists the substance and commercial realities of the financing arrangements presented by each transaction are taken into account thornock t c pincite to avoid the application of sec_465 there must be more than a theoretical possibility that the taxpayer will suffer economic loss american principals f 2d pincite interpreting sec_465 in this way any part of a formal obligation the risk of which is practically eliminated by some other arrangement is disregarded from the amount_at_risk risk that it would be liable for any loss or diminution of the entire e units because all of the loan proceeds apart from the g units that bank released to taxpayer subsidiary were required to remain on deposit with bank or in bank selected investments at all times and bank indemnified taxpayer subsidiary for any diminution or loss of collateral value resulting from failure of any of bank to perform its obligations under any of the agreements it seems like there are minimal circumstances under which taxpayer subsidiary could be liable to repay the e units from its own funds proceeds should be viewed as a pledge includable in their amount_at_risk under sec_465 that section excludes from the amount_at_risk pledged property that is used in the activity taxpayer subsidiary cannot likely justify including e units in its amount_at_risk by arguing that it pledged that amount as security for the loan because the e units is the property that taxpayer subsidiary purportedly borrowed for use in the the terms of the financing_arrangement insulated taxpayer subsidiary from the taxpayer subsidiary may argue that bank’s possession of the bulk of the loan postu-156340-03 d sec_988 - treatment of certain foreign_currency_transactions sections which were enacted as part of the tax_reform_act_of_1986 foreign_affiliate foreign_currency investment program activity sec_465 does not include in a taxpayer’s amount_at_risk borrowed amounts secured_by pledged property that is used in the activity set forth a comprehensive set of rules for the treatment of foreign_currency_transactions sec_988 provides that foreign_currency_gain_or_loss attributable to a sec_988 transaction is computed separately and treated as ordinary_income or loss foreign_currency_gain on a sec_988 transaction is generally defined as the gain on the transaction to the extent such gain does not exceed gain realized by reasons of changes in exchange rates on or after the booking_date and before the payment_date sec_988 foreign_currency_loss is similarly defined in sec_988 in this manner congress intended that only gain_or_loss to the extent it is realized by reason of a change in exchange rates between the date the asset or liability is taken into account for tax purposes and the date it is paid or otherwise_disposed_of will be treated as foreign_currency_gain_or_loss s rep no 99th cong 2d sess in addition any gain_or_loss from the disposition of nonfunctional_currency is treated as foreign_currency_gain_or_loss under the assumption that any gain_or_loss realized on the disposition of nonfunctional_currency must be attributable to the fluctuation in the foreign exchange rates between the purchase and sale of the currency sec_988 this is confirmed by committee reports describing the principles of sec_988 prior to its amendment the house ways_and_means_committee report to the miscellaneous revenue act of stated that i n the case of any disposition of nonfunctional_currency the relevant period for measuring rate changes is the time between acquisition and disposition of the currency h_r rep no 100th cong 2d sess motivated transactions the senate_finance_committee report accompanying the tax_reform_act_of_1986 stated that one of the two reasons were enacted was prior_law provided opportunities for tax_motivated_transactions s rep no 99th cong 2d sess accordingly in enacting congress granted broad authority for the service to promulgate regulations as may be necessary or appropriate to carry out the purposes of sec_989 the legislative_history to the technical_and_miscellaneous_revenue_act_of_1988 tamra in discussing the law prior to the enactment of tamra stated that t he secretary has general authority to provide the regulations necessary or appropriate to carry out the purposes of new subpart j for example the secretary may prescribe regulations appropriately recharacterizing transactions to harmonize the general realization and recognition provisions of the code with the policies of sec_988 h_r rep no 100th cong 2d sess s rep no 100th cong 2d sess containing identical language the legislative_history of suggests a consistent concern about tax postu-156340-03 in response to congress’s concern about tax_motivated_transactions the service sec_1_988-2 states that i f the substance of a transaction described in under sec_988 any gain_or_loss from the disposition of nonfunctional under the authority of sec_989 promulgated sec_1_988-2 and sec_1_988-1 sec_1_988-2 states that if the substance of a transaction differs from its form the commissioner may recharacterize the timing source and character of gains or losses with respect to the transaction in accordance with the substance of the transaction sec_1_988-1 states in part that the commissioner may exclude a transaction or series of transactions which in form is a sec_988 transaction from the provisions of sec_988 if the substance of the transaction or series of transactions indicates that it is not properly considered a sec_988 transaction currency is treated as foreign_currency_gain_or_loss as indicated previously congress adopted this rule under an assumption that any gain_or_loss realized on the disposition of nonfunctional_currency must be attributable to the fluctuation in the foreign exchange rates between the purchase and sale of the currency this assumption is confirmed by the house ways_and_means_committee report to the miscellaneous revenue act of stating that i n the case of any disposition of nonfunctional_currency the relevant period for measuring rate changes is the time between acquisition and disposition of the currency h_r rep no 100th cong 2d sess sec_1_988-1 differs from its form the timing source and character of gains or losses with respect to such transaction may be recharacterized by the commissioner in accordance with its substance in this case the currency loss should be denied in its entirety until if and when the taxpayer can clearly demonstrate that with respect to fcs which it could substantively use exchange rate changes between the period it acquired and disposed of the fcs resulted in the loss this is consistent with the intent of congress and sec_1_988-2 units borrowed from bank even though it was jointly liable with llc to repay such amount r units were required to be deposited with bank in the collateral accounts as collateral on the loan and was beyond taxpayer subsidiary’s reach taxpayer subsidiary did have access to g units which it used to generate the claimed foreign_currency_loss however its use of these funds was also restricted since a balance equal to s units was required to be maintained as collateral for the letters of credit issued to bank that guaranteed_payment of n units at best the taxpayer can argue that it was substantively exposed to currency fluctuation on the g units of borrowed funds to which it had access as noted in the previous paragraph it is not clear that the taxpayer had economic use of the full g units because of the collateral arrangements which were an integral part of the transaction whatever the proper amount under sec_1_988-2 any foreign_currency_loss should be limited to loss resulting from changes in exchange rates with respect to funds that the taxpayer economically had access to it is clear that taxpayer subsidiary did not have substantive use of the full e postu-156340-03 e sec_351 -- lack of bona_fide business_purpose a transaction meeting the statutory provisions of sec_351 will not qualify for in the instant case there was no bona_fide business_purpose to the transaction nonrecognition treatment if it lacks a bona_fide non-tax business_purpose see 688_fsupp_1129 n d tex aff’d on other issues 865_f2d_644 5th cir 714_f2d_977 9th cir opinions discussing other sec_351 issues often point out that the taxpayer had a valid business_purpose for the transaction in question see 490_f2d_1172 3d cir cert_denied 419_us_826 revrul_55_36 c b but merely the creation of tax benefits the linchpin of the scheme was taxpayer subsidiary’s disposition of the high-basis conveyed fcs that disposition created a tax loss that offset the tax_liability taxpayer otherwise would have had to pay on its gain from the sale of its interest in gain company the only remotely constructive result of the scheme was the foreign_affiliate foreign_currency investment program which after taking fees expenses and other commitments into account wound up with only dollar_figuret this was the approximate value of d units converted into dollars at that time for investment purposes and never engaged in many of the activities purportedly planned for it anyway in fact foreign_affiliate lent u units back to taxpayer within two months clearly the tax loss was taxpayer’s primary goal the foreign_affiliate foreign_currency investment program merely lent a cloak of legitimacy to the scheme and the other complexities set up conditions such as co-obligation on a foreign bank loan to generate the tax loss from the sale of the conveyed fcs subsidiary taxpayer’s capital_contribution to taxpayer subsidiary was merely to meet the control requirements of sec_351 taxpayer subsidiary assumed joint_and_several_liability on the loan simply to generate sec_357 gain for llc which would never be taxed in the u s neither llc nor the llc owners are considered to be engaged in a trade_or_business in the united_states and last the gain generated by llc could be added to the tax basis of the conveyed fcs received by taxpayer subsidiary thereby artificially creating an ordinary_loss under sec_988 when the conveyed fcs were disposed of with sound professional judgment in this area taxpayer’s treasurer testified that upcoming elections in country b made him and his colleagues nervous and jumpy about the stability of the fc when they received them from bank to protect their investment according to taxpayer’s treasurer they decided to convert the fcs into fc1s for a short_period of time because that made them more comfortable in fact since the monetary policy of the central bank of country c bank had been to maintain the fc1 fc exchange rate as absolutely stable and since the two currencies had fluctuated within a margin of no more than percent thus anyone who viewed the fc as a risky currency for whatever reason would not logically have furthermore taxpayer’s stated reason for changing the fcs into fc1s conflicts the transaction was contrived to create a foreign_currency_loss for taxpayer postu-156340-03 since the transaction was engineered to create a high basis-low value asset that chosen fc1s as an alternative a fact with which a person of taxpayer treasurer’s expertise would undoubtedly have been well-acquainted upon disposition would generate a tax loss in excess of dollar_figurea for taxpayer an amount grossly disproportionate to any non-tax consequences realized by the parties a bona_fide business_purpose is lacking consequently the requirements for a valid sec_351 exchange are not satisfied as a result neither sec_357 nor sec_362 apply in this case accordingly the transaction should be treated as an exchange under sec_1001 with the basis rules of sec_1012 and the case law both discussed in notice_2002_21 controlling the result is that the basis of the conveyed fcs will be limited to the fair_market_value of such assets upon their acquisition by taxpayer subsidiary thus the loss purportedly resulting from the transaction in the instant case is not allowable to the extent taxpayer derives a tax_benefit that is attributable to a basis in excess of the fair_market_value of the conveyed fcs conclusion and summary currency loss either should be disallowed in its entirety or disallowed in part as the case may be moreover it is our view that the transaction in this case is substantially_similar to the transaction described in notice_2002_21 and therefore it falls within the scope of the notice this writing may contain privileged information any unauthorized disclosure of this writing may undermine our ability to protect the privileged information if disclosure is determined to be necessary please contact this office for our views by ________________________________ richard e coss senior counsel branch please call john tarrant at if you have any questions based on all of the arguments set forth above we conclude that the claimed