department of the treasury internal_revenue_service washington d c date number release date tl-n-8774-97 cc intl b2 uilc internal_revenue_service national_office field_service_advice memorandum for from subject this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be used or cited as precedent legend corp a corp b sub c sub d sub e bank m bank n bank o date tl-n-8774-97 date date year f year g year h notional amount p notional amount q notional amount r sum u sum v sum w sum x sum y sum z country a area b issue sec_1 should the entire transaction described below which took the form of a notional_principal_contract between the u s parent and an unrelated foreign bank followed by the assignment of some of the contract’s cash flows to two foreign subsidiaries of the u s parent be recharacterized as a set of loans from the foreign subsidiaries to the u s parent on the ground that the transaction lacks economic_substance if the transaction described below is recharacterized as a set of loans from the foreign subsidiaries to the u s parent do such loans constitute an investment in u s property under sec_956 of the internal_revenue_code conclusions the transaction should be recharacterized as a set of loans from the foreign subsidiaries to the u s parent on the ground that it lacks economic_substance such recharacterized loans constitute an investment in u s property under sec_956 tl-n-8774-97 a tax planning background facts corp a a domestic_corporation owns indirectly all of the stock of corp b also a domestic_corporation corp b owns directly all of the stock of sub c which owns directly all of the stock of sub d which owns directly all of the stock of sub e sub c sub d and sub e are all country a corporations in general sub c generated substantial earnings from its foreign manufacturing operations none of which was subject_to current u s taxation under subpart_f of the code in contrast the second- and third-tier country a subsidiaries sub d and sub e traded mostly with affiliates and generated a small amount of income all of which was subject_to current u s taxation under subpart_f and thus constituted previously_taxed_income pti under sec_959 of the code all of sub d’s and sub e’s earnings were distributed to sub c as pti corp a’s treasury_department in the united_states provided cash management services to corp a corp b and the country a subsidiaries management in country a had only minimal authority over the operating budgets of the country a subsidiaries a significant portion of sub c’s earnings were transferred to sub e which held them in bank accounts in the united_states as of date sum w had been transferred to sub e these transfers were booked as intercompany advances from sub c to sub e but were designated on the balance_sheet included with forms on corp a’s tax returns as increases in trade accounts_payable receivable they were not evidenced by any notes no interest was paid and they were not disclosed on schedule m of the forms corp a explains these discrepancies by claiming that these transactions were actually capital contributions to sub d which were disguised to avoid liability for the country a stamp tax on capital contributions the issues in this case arise because corp a wanted to unlock sub c’s non-pti earnings and have use of these funds for its own operations without incurring any adverse tax consequences non-pti earnings_of sub c could not be made directly available to corp a ie through a dividend distribution or a loan without triggering an inclusion in corp a’s income under either sec_61 in the case of a dividend or sec_956 in the case of a loan at strategic planning meetings in years f g and h numerous discussions were held to identify ways to repatriate cash_out of country a on a tax-free basis in this regard corp a was approached by bank m corp a had a close relationship with bank m tl-n-8774-97 bank m offered corp a a solution that if successful would achieve corp a’s goals corp a was to engage in a transaction with a third party that would be documented as a notional_principal_contract but would result in sub c’s available cash being transferred to corp a without it being taxed immediately to corp a as either an actual dividend or a deemed_distribution under sec_951 for purposes of illustrating the effect of the transaction the promotional materials assumed that the interest rates used to compute payments under the notional_principal_contract would be floating payments for fixed payments the promotional materials thus focused on the benefits derived from repatriation of the cash and assumed that potential differences in interest rates were irrelevant further analysis by corp a also focused on the benefits of cash repatriation and ignored the potential hedging benefits that could have been derived from the transaction sometime on or around the end of year f corp a agreed to adopt bank m’s proposal as part of this agreement corp a agreed to pay bank m an engagement fee in the amount of sum u there is also an indication that corp a and bank m may have negotiated a fee based on the expected tax savings derived by corp a from of the proposed transaction although it is not clear whether such a negotiation if it occurred resulted in an agreement between the parties b the transaction1 on date as per the plan presented by bank m corp a entered into a twenty-year basis_swap with a notional_principal_amount of sum v with bank n while the charts in the promotional materials used by bank m in its presentation reflected fixed rate payments in exchange for floating rate payments corp a and bank n ultimately agreed to exchange similar floating rate payments libor in the case of corp a and federal funds in the case of bank n semi-annually on the notional_principal_amount it was contemplated from the outset that this swap would be broken into its component parts and rather than a single confirmation for the swap in the amount of sum v there were several confirmations in various amounts in anticipation of the subsequent assignment of portions of the swap to related and unrelated parties in fact the agreement between corp a and bank n specifically anticipated and permitted the assignment of portions of the swap to some of corp a’s foreign affiliates 1corp a actually engaged in two of these transactions for purposes of brevity only one is described herein tl-n-8774-97 at the core of the plan was corp a’s anticipated assignment in year of the receiving leg of the swap for years to ie a stream of payments starting in year and ending in year to sub c in exchange for an immediate lump-sum payment corp a however had to ensure that it could support the validity of the pricing set for the assignment in addition except to the extent of sub c’s pti corp a wanted to ensure that sub c would not appear to be the originator of the funds used to make the lump sum payment to inject the appearance that the transaction was priced at market corp a initially assigned the right to receive payments with respect to notional amount p of the receiving leg of the swap for years through to bank o an unrelated party in exchange for sum x with this market price in hand corp a assigned the right to receive payments with respect to notional amount q of the receiving leg of the swap for years through to sub c in exchange for sum y and it assigned the right to receive payments with respect to notional amount r of the receiving leg of the swap for years through to sub d in exchange for sum z sum y and sum z were obtained by sub c and sub d respectively from the funds that sub c had earlier advanced to sub e as increases in sub e’s accounts_payable and which sub e held in u s bank accounts the transfer of sum y which amount approximated sub c’s pti by sub e to sub c was booked as a decrease in sub e’s accounts_payable to sub c the transfer of sum z by sub e to sub d was booked first as a decrease in amounts payable by sub e to sub c and then as an increase in accounts_payable by sub d to sub c these transfers appear to have been intended to move cash funds of sub c to sub d an entity that had no earnings_and_profits c corp a’s tax_return position during the first five years of the swap corp a treated the net amount of the swap payments as an adjustment to interest_expense it did not report as income any portion of sums y and z during those years instead in years through corp a treated these amounts in the same manner as a prepayment on a notional_principal_contract relying on notice_89_21 1989_1_cb_651 which provides that a swap prepayment must be amortized over the life of the swap in some reasonable manner corp a amortized the receipt of sum y and sum z over years through the transaction therefore gave corp a the use of a significant amount of its foreign subsidiary’s revenues in year of the swap and allowed it to defer tax on that income until years through of the swap tl-n-8774-97 d elimination of economic risks the transaction engaged in by corp a sub c sub d bank n and bank o had the potential of putting corp a its affiliates and the participating banks at risk the parties however engaged in further activities and took certain positions in order to eliminate such risk corp a entered into a series of mirror swaps with bank m to eliminate any market risk associated with the basis_swap bank n also entered into a mirror swap with bank m in order to eliminate its market risk associated with the basis_swap as a result neither corp a nor bank n could incur any losses from the notional_principal_contract regardless of how interest rates moved during the life of the swap bank n also had to protect itself against credit risk in this regard the agreement provided that if corp a’s credit rating fell below a threshold level or if corp a failed to make a payment bank n would have the right to terminate the transaction although these rights were supposed to be suspended with respect to any permissible assignee of corp a’s rights under the basis_swap bank n’s view was that the occurrence of either event was grounds for dissolution of the swap regardless of whether some or all of corp a’s rights were assigned to its subsidiaries in other words following the assignments bank n continued to view corp a as the obligor under the notional_principal_contract this view was reflected in both the original credit proposal and in internal bank n memoranda written after the swap agreement was executed corp a’s own actions were consistent with bank n’s view that corp a was ultimately the obligor under the notional_principal_contract the original agreement provided for the netting of payments unless corp a assigned any of its rights under the swap to a permissible assignee in such a case payments were to be made on a gross basis ie the assignee’s right to receive its payments from bank n were independent of corp a’s obligation to perform in order to be able to net the swap payments on its balance_sheet corp a took the position that the assignments did not affect its right of offset on the ground that the assignees were entitled to require corp a to repurchase the assigned rights at any time at current market_value without the consent of bank n the assumption implicit in this position is that the decision as to whether to assign the rights back to corp a would be made by corp a’s treasury_department in the united_states as was the case with bank n bank o had to be protected from both market and credit risks in connection with its purchase of the right to receive payments with respect to notional amount p of the receiving leg of the swap this was accomplished by ensuring that bank o never actually received any of the payments for years through from bank n specifically bank n held a call option on the tl-n-8774-97 portion of the basis_swap purchased by bank o effective in year of the swap and bank o was given a put option on the purchased portion effective in year of the swap the evidence in the record shows that the parties contemplated that bank o would be cashed out prior to that time so that consequently the underlying transaction would never take place e rewards limited to fees corp a claims that it engaged in the transaction for dual purposes with respect to the basis_swap corp a states that its purpose for entering into this part of the transaction was to hedge against the interest rate risk attributable to the differences in the commercial paper rates of its domestic debt versus the libor rates earned on its overseas cash which amounts were held primarily by sub e according to corp a the basis_swap was an appropriate means of accomplishing this goal for at least two reasons first although libor rates historically had exceeded corp a’s commercial paper rates the spread between these rates had narrowed during years f g and h corp a claims that it entered into the basis_swap out of concern that the spread might turn negative documents generated by corp a contemporaneous to the transaction however do not reflect this concern specifically although there is evidence that the taxpayer analyzed interest rate movements in general in connection with the swap it did not prepare an analysis of the impact of the swap as an interest rate hedge another reason given by corp a for its decision to enter into this particular basis_swap notwithstanding the fact that its debt consisted primarily of short-term obligations was its tendency to enter into long-term deals and because the length of the swap helped in the creation of the financial_asset with one leg ie the longer the swap the greater the value of the asset that was to be sold to sub d corp a apparently did not analyze the cost of terminating the swap if changes in interest rates rendered the swap uneconomical moreover it acknowledged that at the time it entered into the swap it was aware that no liquid secondary trading market for derivatives like the swap existed according to corp a these issues were irrelevant since corp a fully intended to continue the swap throughout its year life with respect to the assignments corp a acknowledged that the sole reason for this part of the transaction was to repatriate cash and that the transfer of ownership of the receiving leg of the swap from corp a to its country a subsidiaries had no economic significance apart from the transfer of cash in the case of the banks all three received accommodation fees for their participation in the transaction bank m which initially presented the transaction to tl-n-8774-97 corp a and which provided the hedges to the various parties was paid an engagement fee of sum u and possibly other fees by corp a bank n which entered into the swap with corp a and hedged its exposure by entering into a mirror swap with bank m was allowed to lock in a basis point spread between the basis_swap and its hedge bank o which agreed to establish the market price for the assigned portions of the swap by purchasing the right to receive payments with respect to notional amount p of years through of the receiving leg of the swap was to receive a basis point fee over the life of its transaction law a substance over form principle sec_1 general as a general_rule taxpayers have the right to arrange their affairs in order to minimize their taxes 293_us_465 the key question in analyzing a tax-motivated transaction is whether what was done apart from the tax motive was the thing the statute intended id in gregory the court disregarded the potential tax consequences of a corporate_reorganization despite the fact that the taxpayer had complied with all statutory requirements because the transaction had no valid economic purpose and on its face lay outside the intent of the statute subsequent to its decision in gregory the court held that to be respected for federal_income_tax purposes a transaction must have economic purpose beyond a tax reduction 364_us_361 in 435_us_561 the court looked to objective realities rather than form in that case however the court found that the taxpayer had a business_purpose sufficient to justify a sale-leaseback the court found this to be a genuine multiparty transaction with economic_substance that was compelled by regulatory considerations and not shaped solely by tax_avoidance features that had meaningless labels attached id pincite the court stressed that the taxpayer had a downside risk of loss and the possibility of a significant return transactions that lack economic_substance have been routinely struck down by the lower courts as stated by the seventh circuit in 765_f2d_643 7th cir aff’g 80_tc_955 the freedom to arrange one’s affairs to minimize taxes does not include the right to engage in financial fantasies with the expectation that the internal_revenue_service and the courts will play along the commissioner and the courts are empowered and in fact duty-bound to look beyond the contrived tl-n-8774-97 forms of transactions to their economic_substance and to apply the tax law accordingly see also compaq computer corporation v commissioner t c no economic_substance in evaluating the validity of a transaction the courts typically attempt to determine first whether it genuinely occurred or whether it was merely papered in order to generate unwarranted tax benefits transactions that are determined to be factual shams are of course disregarded see eg malden knitting 42_tc_769 35_tc_136 a transaction that is determined to have genuinely occurred is analyzed next in terms of its economic_substance generally the courts have developed a two- pronged approach to the economic_substance analysis that looks to the subjective business_purpose and the objective profit potential of the transaction see 81_tc_184 aff’d in relevant part 752_f2d_89 4th cir united parcel service of america inc v commissioner tcmemo_1999_268 date these aspects of the inquiry do not constitute a rigid two-step test but represent related factors in the analysis of whether the transaction had sufficient substance apart from its tax consequences to be respected for tax purposes 157_f3d_231 3rd cir aff’g in relevant part 73_tcm_2189 various articulations of the subjective prong of the economic_substance analysis have been set forth by the courts see eg acm t c m pincite whether the transaction is rationally related to a useful nontax purpose in light of the taxpayer’s economic situation and intentions acm f 3d pincite whether the transaction was intended to serve any useful non-tax purpose rice’s toyota world f 2d pincite whether the taxpayer was motivated by no business_purpose other than obtaining tax benefits in entering in the transaction 90_tc_1054 same see also 861_f2d_494 7th cir judges can’t peer into people’s minds or ’weigh’ motives rather the usual approach is to focus the analysis on whether any non-tax goals or functions were or plausibly could have been served by the action the common thread of these articulations however is whether the transaction has a business_purpose other than obtaining tax benefits like the subjective prong of the economic_substance analysis the phrasing of the objective test has varied among the different courts for example the tax_court in acm articulated the objective prong as requiring that there be a reasonable expectation that the non-tax benefits would be at least commensurate tl-n-8774-97 with the transaction costs t c m pincite the third circuit on appeal of the same case repeatedly searched for any practical economic effects of a transaction other than the creation of income_tax benefits by examining the taxpayer's financial condition before and after the transaction f 3d pincite- under the fourth circuit’s expression of the objective prong in rice’s toyota world a transaction has no economic_substance where no reasonable possibility of a profit exists f 2d pincite see also friendship dairies t c pincite cf 864_f2d_1214 5th cir objective analysis involved examination of profit making potential while the specific articulation of the objective prong has differed among the courts the fundamental principle is that a transaction must have real and practical economic effects other than the creation of income_tax benefits in order to satisfy the objective aspects of the sham analysis central to this notion is that where profit derived from the transaction is infinitesimally nominal and vastly insignificant when considered in comparison with the claimed tax_benefit the fact of the profit does not automatically preclude a finding that the transaction failed the objective prong of the economic_substance analysis see eg 94_tc_738 step transaction in contrast to transactions that have no substance and that can be disregarded as shams others do have substance but are disguised typically through the interposition of meaningless steps these steps however are to be ignored for a given result at the end of a straight path is not made a different result because reached by following a devious path 302_us_609 in the context of a sale of property the supreme court has stated the incidence of taxation depends upon the substance of a transaction the tax consequences which arise from gains from a sale of property are not finally to be determined solely by the means employed to transfer legal_title rather the transaction must be viewed as a whole and each step from the commencement of negotiations to the consummation of the sale is relevant a sale by one person cannot be transformed into a sale by another by using the latter as a conduit through which to pass title to permit the true nature of a transaction to be disguised by mere formalisms which exists solely to see 843_f2d_351 9th cir cert_denied 488_us_824 objective and subjective factors are considered in determining whether the transaction had any practical economic effects other than generating tax benefits 868_f2d_851 6th cir chapman v commissioner 73_tcm_2405 tl-n-8774-97 alter tax_liabilities would seriously impair the effective administration of the tax policies of congress 324_us_331 see also 702_f2d_1234 5th cir the step-transaction doctrine is a corollary of the general principle that the incidence of taxation depends upon the substance of a transaction rather than its form the step-transaction doctrine is invoked when a taxpayer interposes economically meaningless steps in an otherwise economically significant transaction in order to avoid certain tax consequences and can result in the recharacterization of the transaction according to its true substance the step- transaction doctrine treats a series of formally separate ‘steps’ as a single transaction if such steps are in substance integrated interdependent and focused toward a particular result 88_tc_1415 as noted in penrod courts have used any one of three different tests to apply the step-transaction doctrine the narrowest alternative is the ‘binding commitment’ test under which a series of transactions are collapsed if at the time the first step is entered into there was a binding commitment to undertake the later step at the other extreme the most far-reaching alternative is the ‘end result’ test under this test the step transaction will be invoked if it appears that a series of formally separate steps are really pre-arranged parts of a single transaction intended from the outset to reach the ultimate result the end result test is based upon the actual intent of the parties as of the time of the merger i n contrast to the binding_commitment_test the end result test is flexible and bases tax consequences on the substance of the transactions not on the formalisms chosen by the participants the third test is the ‘interdependence’ test which focuses on whether ‘the steps are so interdependent that the legal relations created by one transaction would have been fruitless without a completion of the series ’ this test concentrates on the relationship between the steps rather than on their ‘end result’ however since the interdependence test requires a court to find whether the individual steps had independent significance or whether they had meaning only as part of the larger transaction the court may be called upon to determine the result the participants hoped to achieve thus the interdependence test is a variation of the end result test citations omitted t c pincite0 tl-n-8774-97 the substance_over_form_doctrine has also been applied in some cases in which the courts were asked to recharacterize what purported to be sales transactions as loans the cases involved primarily taxpayers that for various reasons wished to accelerate income and who would sell future cash flows in exchange for an immediate discounted lump sum payment courts that have recharacterized the sales as loans have relied in large part on the minimization of risk and the lack of the usual benefits associated with ownership of property the virtual certainty that the lender would be paid back that the borrower was not free to dispose_of the proceeds as it wished that the lender was only to receive a sum certain at an interest rate approximating the standard prevailing rate generally the courts also took note of the fact that the transactions at issue were tax motivated see 556_f2d_1107 ct_cl b investments in u s property3 during the taxable years at issue sec_951 provided in part that a u s shareholder of a controlled_foreign_corporation cfc must include in income currently its pro_rata share determined under sec_956 of the cfc’s increase in earnings invested in u s property for such year sec_956 provided in part that a united_states shareholder’s pro_rata share of the cfc’s increase for any taxable_year in earnings_invested_in_united_states_property was the amount determined by subtracting the united_states shareholder’s pro_rata share of the amount of the cfc’s earnings_invested_in_united_states_property at the close of the preceding_taxable_year reduced by certain amounts under sec_959 from the amount of the cfc’s earnings_invested_in_united_states_property at the close of the current taxable_year sec_956 provided that the amount of earnings_of a cfc invested in united_states_property at the close of any taxable_year is the aggregate amount of such property held directly or indirectly by the cfc at the close of the taxable_year to the extent such amount would have constituted a dividend if it had been distributed to the cfc’s shareholders the term controlled_foreign_corporation means any foreign_corporation if more than percent of the total combined voting power of all classes of its stock or more than percent of the total value of its stock is owned by united_states_shareholders on any day during the taxable_year of such foreign_corporation sec_957 the term united_states_shareholder means any united_states_person as defined in sec_957 who owns within the meaning of sec_958 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign_corporation sec_951 a united state sec_3all references to the internal_revenue_code in this section are to the internal_revenue_code as in effect during the years at issue tl-n-8774-97 person is defined as including a domestic_corporation sec_957 sec_7701 sec_956 defined the term united_states_property as including an obligation of a united_states_person the term does not include however obligations of domestic corporations that are unrelated to the cfc making the investment sec_956 see also sec_1_956-2 for purposes of this rule a domestic_corporation is considered unrelated to the cfc making the investment if it is neither a united_states_shareholder of the cfc nor a corporation percent or more of whose total combined voting power of all classes of stock entitled to vote is owned or is considered as owned within the meaning of sec_958 by a united_states_shareholder of the cfc sec_1_956-2 the term obligation is defined generally as including any bond note debenture certificate bill receivable account receivable note receivable open account or other indebtedness whether or not issued at a discount and whether or not bearing interest temp_reg sec_1_956-2t temp_reg sec_1_956-1t provides that a cfc will be considered to hold indirectly investments in united_states_property acquired by any foreign_corporation that is controlled by the cfc if one of the principal purposes for creating organizing or funding through capital contributions or debt such other foreign_corporation is to avoid the application of sec_956 with respect to the cfc for purposes of this rule a foreign_corporation is considered to be controlled by a cfc if the cfc owns more than of the total combined voting power of all classes of stock of the foreign_corporation temp_reg sec_1 1t b i analysis bank m’s plan called for a complex structure that would disguise corp a’s true purpose which was to repatriate cash from its foreign subsidiaries and avoid the consequences of sec_956 this plan required corp a to enter into a basis_swap with an unrelated party and then to assign a portion of its right to receive income under the swap to several of its foreign subsidiaries in exchange for an upfront cash payment corp a argues that the tax_accounting rules in existence at the time of the transaction allowed it to defer recognition of the payment until a period beginning five years after the year in which it received the payment in effect corp a is arguing that it is entitled to complete tax free use of the payment for the first five years of the basis_swap and substantial deferral for the remaining years corp a’s position is dependent on full recognition being given to all parts of the transaction that generated the upfront cash payment this recognition is not warranted since the facts indicate that no tax-independent considerations underlay the plan corp a has acknowledged that a principal purpose of the transaction and the sole purpose of the assignment portion of the tl-n-8774-97 transaction was to repatriate cash tax-free from its foreign subsidiaries as will be discussed below several theories support recharacterization of the transaction as a set of loans from the foreign subsidiaries to the u s parent on the ground that the transaction lacks economic_substance a the transaction lacks economic_substance it appears from the facts currently available that the transaction was not a factual sham fund transfers actually occurred and the transaction cannot be characterized as fictitious the next step therefore is to determine whether the transaction lacked economic_substance as the third circuit noted in acm f 3d pincite a transaction must have either a subjective non-tax purpose or objective economic consequences in order to survive a challenge on the ground of a lack of economic_substance corp a concedes that the basis_swap transaction was tax motivated particularly the assignment portion of the transaction however it argues that it entered into the swap portion of the transaction for a legitimate business_purpose namely the hedging of its short term domestic debt corp a’s claim cannot be sustained under either the subjective prong or the objective prong of the economic_substance analysis moreover the transaction is subject_to step transaction principles lack of non-tax purpose corp a claims that it entered into the swap portion of the transaction specifically to hedge its short-term domestic liabilities according to corp a historical differences between the libor rates earned on its overseas cash and the commercial paper rates paid_by it on its domestic liabilities had provided consistent positive arbitrage opportunities for corp a in the years immediately preceding the taxable years in issue however these rates had been narrowing and in corp a’s view were in danger of becoming reversed corp a claims that it entered into the basis_swap in order to hedge its liabilities in the event the spread turned negative corp a’s arguments are contestable on several grounds first and most significantly corp a’s argument is belied by the fact that any hedging benefit achieved by corp a as a result of entering into the basis_swap was effectively nullified by the mirror swaps between it and bank m the promoter of the basis_swap transaction thus the swap once fully hedged became a meaningless product with no economic_substance much like a riskless straddle that would clearly be the case where the broker guaranteed the investor that the only consequences of the straddles would be tax consequences there would be no market risks downside or upside straddles that involve no market risks are not economically substantial straddles and hedges they are artifices created by tl-n-8774-97 accomplices in tax_evasion the brokers yosha v commissioner f 2d pincite another factor contradicting corp a’s purported hedging motivation is corp a’s choice of a long-term ie 20-year instrument to hedge short-term liabilities such a mismatch between instruments effectively exposed corp a to potential interest rate risk once the hedged liabilities expired or were disposed of this potential for such market risk was further exacerbated by the absence of a liquid secondary trading market for derivative instruments like the basis_swap a fact that corp a knew before it entered into the transaction third all of the promotional material prepared by bank m as well as documentation prepared by corp a during its consideration of bank m’s proposal were directed at achieving a single goal -- the tax-free repatriation of cash -- and ignored other aspects of the swap such as its potential hedging benefits see heltzer v commissioner 62_tcm_518 promotional materials focused only on tax benefits and taxpayer did not investigate brokerage firm's profit record for example the schedules prepared by corp a which were circulated among key members of the accounting and treasury departments only analyzed the impact of the repatriation of the cash not the hedging potential of the swap in these studies the impact of the differing legs of the swap was assumed away fourth every aspect of the transaction ie the basis_swap portion the assignment portion and the offsetting hedges was meticulously pre-arranged to avoid subjecting any of the participants to economic risk and to ensure that the only change to any of their economic positions was either the payment of fees in the case of corp a the receipt of fees in the case of bank m bank n and bank o or the cash flows from sub c and sub d in the case of corp a the intentional elimination of all economic risk strongly supports the proposition that corp a lacked any non-tax purpose for this transaction finally some documentation exists that suggests corp a and bank m may at one time have discussed basing a portion of bank m’s fee on the expected tax savings derived by corp a from the proposed swap transaction such a fact if established strongly suggests that corp a’s sole purpose in entering into the transaction was tax-related lack of objective economic consequences in general courts have declined to recharacterize or otherwise disregard a transaction on the ground of lacking economic_substance if the transaction had real and practical economic effects other than the creation of income_tax benefits see eg acm f 3d pincite from the facts presented the basis_swap transaction entered into by corp a had no real and practical economic effects tl-n-8774-97 other than the creation of income_tax benefits as described above the swap between corp a and bank n was fully hedged resulting in an economic nullity indeed when the substantial transaction costs of sum u are taken into account the transaction lacked from the outset any reasonable prospect of profit moreover while the dynamic nature of the hedges might generate some fortuitous gain such amount would likely be de_minimis relative to the tax benefits achieved by the transaction overall in this regard any such gain would not materially affect this analysis sheldon t c pincite accordingly the basis_swap transaction fails the objective prong of the economic_substance analysis step-transaction corp a followed a prearranged plan to reach its stated goal of repatriating sub c’s available cash it disguised a self-amortizing loan from sub c as a notional_principal_contract the economic impact of which it hedged through an assignment of the receiving leg of years through of the swap to sub c in exchange for a lump sum payment from sub c in year of the swap bank n became the accommodation party through which the principal and interest payments from corp a were routed to further disguise its tax planning part of the receiving leg of the swap was assigned to sub d rather than sub c the affiliate that held the cash to make its lump sum payment to corp a sub d had to obtain the needed cash from sub c in this case therefore bank n was acting as the accommodation party for the principal and interest payments from corp a while sub d was acting as the accommodation party that received the loan principal on behalf of such c these unneeded steps were added to disguise the true substance of the transaction and must be ignored the facts presented indicate that the various steps of the transaction at issue were entered into as part of an overall plan for sub c to make a self- amortizing loan to corp a the facts presented suggest that the parties were committed to this overall plan from the outset thus it appears that the binding_commitment_test could be met however further factual development is necessary t he end result test is flexible and bases tax consequences on the real substance of the transactions not on the formalisms chosen by the participants penrod t c pincite the facts reflect that the parties had a single goal a single end result in mind all the steps of these transactions were planned in order to reach corp a’s stated goal to repatriate sub c’s cash and avoid subpart_f the series of formally separate steps - the swap the assignment to bank o the assignment to sub c and sub d - were pre-arranged parts of a single transaction intended from the outset to reach the ultimate result sought after see penrod t c pincite0 and cases cited therein tl-n-8774-97 the charts from the various presentations made by bank m focused on a single goal the repatriation of the cash held by sub c if the primary purpose of the swap was to hedge an interest rate risk the presentation would have focused on those particular rates instead the presentation assumed away the economic impact of changes in interest rates by assuming each leg of the swap paid the same rate the number of confirmations for the swap confirm the intent of the parties rather than a single swap confirmation several were prepared each in the amount of the anticipated assignments to bank o sub c and sub d finally the fact that corp a and bank n hedged the positions resulting from the swap establishes that nothing other than the repatriation of cash from corp a’s foreign subsidiaries was contemplated an analysis under the interdependence test which looks to the relationship between each of the steps of the transaction also supports its recharacterization each step in the transaction by itself would have been meaningless if the assignment of years through had not been made the entire swap would have been an economic sham with no substance this is because the entire swap was hedged and thus its potential economic impact was nullified moreover the assignment of notional amount p of years through of the swap to bank o was to be quickly nullified through the exercise of the options granted to the parties similarly the advances from sub c to sub d were not meaningful sub d did not need the cash rather that step was merely an intermediate step and was to be immediately followed by the transfer of the cash to corp a the participation of third parties does not affect the conclusions reached herein the transactions cannot be characterized as genuine multi-party transaction s as was done frank lyons supra here the third parties participated in the tax_avoidance promotion in exchange for a fee they did not have a stake in the transaction’s outcome and were fully insulated from risk the courts have repeatedly held that the insertion of a third-party straw_man that acts as a conduit between related parties can be ignored under the step-transaction doctrine del commercial properties inc v commissioner t c memo gaw v commissioner tcmemo_1995_531 aff’d without published opinion 111_f3d_962 d c cir 533_f2d_152 5th cir it should also be noted that while the cases such as mapco supra that examine the difference between sales of future cash flows and loans support the economic_substance theories an analysis under the doctrines described herein is more appropriate this is because rather than attempting to sell a genuine future cash_flow the parties created a cash_flow from a transaction lacking economic_substance and assigned part of it to foreign related parties under these circumstances it is appropriate to ignore the components of the transaction that tl-n-8774-97 are properly characterized as economic shams and eliminate the unnecessary steps undertaken by the parties under the step-transaction doctrine the application of these principles reveals the true nature of the transaction a self- amortizing loan b because the transaction lacks economic_substance it can be recharacterized as a series of loans from the foreign subsidiaries to the u s parent under economic_substance and step transaction principles the transaction at issue should be recharacterized to reflect its true economic nature the swap followed by the assignment of portions of the receiving leg to subs c and d effectively resulted in a self-amortizing loan disguised as the purchase_price for the sale of the swap leg in other words corp a borrowed sums y and z from subs c and d respectively when it sold its right to receive payments under the swap to repay this loan a third-party intermediary ie bank n was engaged to receive periodic principal and interest payments from corp a disguised as swap payments and to forward such payments to subs c and d based on their purchase of the swap cash flows although the transaction was structured to hide the loan through the use of different floating rates in the basis_swap the use of hedges to negate this difference reveals the true nature of the transaction specifically the use of the hedges enabled bank n to effectively convert the amount of cash it received from corp a under the basis_swap to equal the amount of cash it was obligated to pay subs c and d under the assignment thus the differing interest rates set forth in the swap agreement does not negate the use of economic_substance principles to recharacterize this transaction as a loan tl-n-8774-97 original swap payments economic_effect of the planned structure corp a floating rate floating rate bank n disguised repayment of principal interest labeled as a swap payment bank n used a conduit corp a disguised loan labeled as a sale of the right to receive swap payments in years disguised repayment of principal interest labeled as a swap payment sub c presumably to further disguise the source of the funds for the loans from sub c to corp a sub d was inserted as a second entity through which the loans were made this was accomplished through the advance of substantially_all of sub c’s non-pti cash to sub d through the accounts of sub e which were used by sub d to purchase its portion of the assignment such advances had no economic_substance as they were not evidenced by any notes no interest was paid and they were not disclosed on schedule m of the forms filed by corp a the diagram below shows that if the parties were required to made periodic_payments on an arm’s length basis and if the unnecessary intermediaries were eliminated the transaction was nothing other than a loan from sub c to corp a tl-n-8774-97 corp a principal interest payments disguised as swap payments bank n principal interest payments disguised as swap payments principal interest that would have been payable on advance made at arm’s length sub c funds advanced by sub c and loaned to corp a disguised as the purchase of the right to receive swap payments in years sub d sub c funds advanced and economically used by sub d as principal on its loan to corp a c the loans from the foreign subsidiaries to the u s parent constitute investments in u s property under sec_956 general if the transaction is recharacterized as a loan from sub c to corp a the next issue that arises is whether such loan is an investment in u s property under sec_956 corp b is a united_states_shareholder within the meaning of sec_951 since it is a domestic_corporation that owns directly of the stock of sub c sub c is a cfc within the meaning of sec_957 since of its stock was owned by corp b a u s shareholder during all of the tax years at issue accordingly if sub c’s loan to corp a constitutes u s property within the meaning of sec_956 corp b will be required to include in income currently its pro_rata share of sub c’s increase in earnings invested in that u s property because sub c’s loan to corp a constitutes indebtedness of corp a a domestic_corporation such loan constitutes u s property within the meaning of sec_956 unless it falls within the exception in sec_956 that section provides that the term u s property does not include obligations of domestic corporations that are unrelated to the cfc making the investment for purposes of this rule a domestic_corporation is considered unrelated to the cfc making the investment if it is neither a united_states_shareholder of the cfc nor tl-n-8774-97 a corporation percent or more of whose total combined voting power of all classes of stock entitled to vote is owned or is considered as owned within the meaning of sec_958 by a united_states_shareholder of the cfc sec_1_956-2 this definition thus requires that a domestic_corporation must meet two requirements if it is to be considered unrelated to a cfc holding its obligation it must not be a u s shareholder with respect to the cfc and no more than of its total combined voting power of all classes of its stock entitled to vote can be owned by a united_states_shareholder of the cfc for purposes of the application of the exception in sec_956 corp a is considered to own of sub c’s voting_stock see sec_1_958-2 thus it qualifies as a united_states_shareholder with respect to sub c for purposes of sec_956 see sec_951 accordingly for each of the tax years in issue corp b is required to include in its income currently its pro_rata share of sub c’s earnings_invested_in_united_states_property sub d’s loan to corp a in an apparent effort to hide the fact that sub c was the originator of the cash to be repatriated corp a assigned a large portion of the receiving leg of the swap notional amount r for years through to sub d sub d in turn obtained the funds it needed to purchase notional amount r from sub c through an advance from sub c that was booked as an increase in sub d’s accounts_payable to sub c corp a now seeks to recharacterize these transfers as equity contributions to sub d corp a’s attempt to recharacterize as an equity contribution the amount received from sub c and used to purchase sub d’s assignment does not affect the analysis under sec_956 as described above temp_reg sec_1_956-1t provides that a cfc such as sub c will be considered to hold indirectly investments in u s property acquired by another foreign_corporation controlled by the cfc such as sub d if the funding whether through capital contributions or debt for such investment originated from the cfc and was designed to avoid the application of sec_956 sub d is controlled by sub c since sub c owns of sub d’s stock temp_reg sec_1_956-1t moreover as was the case with sub c’s loan to corp a sub d’s loan to corp a constitutes an investment in u s property within the meaning of sec_956 and sec_1_956-2t by sub c the various bookkeeping entries indicate that the ultimate source of the funds used by sub d to purchase its share of the assignment was sub c an entity that generated substantial non-subpart f revenues whether sub c transferred these funds to sub d as either equity or debt is irrelevant since sec_1_956-1t expressly contemplates both types of funding accordingly sub c will be considered to hold indirectly sub d’s investment in u s property if a principal purpose for transferring the funds to sub d was to avoid the application of sec_956 such a purpose need not comprise tl-n-8774-97 the sole purpose for engaging in the transaction as long as it is one of the principal purposes see the 113_tc_169 the facts as developed thus far strongly suggest that such a purpose was present in particular corp d had no earnings_and_profits while corp c had substantial non-pti earnings_and_profits if corp c had made a loan directly to corp a such a loan would clearly have qualified as an investment in u s property under sec_956 in contrast if corp d had made the loan there would have been no investment in u s property because corp d had no earnings_and_profits the documents underlying this transaction are replete with references to accomplishing the tax-free repatriation of sub c’s revenues to corp a in an attempt to accomplish this goal sub d was interposed into the transaction in order to make it appear that the funds were derived from an entity with no earnings_and_profits d inapplicability of notice_89_21 corp a relies upon notice_89_21 1989_1_cb_651 to support its treatment of the basis_swap transaction the notice addresses the proper method_of_accounting for a notional_principal_contract with respect to the years at issue because we believe that the basis_swap substantively is not a notional_principal_contract we believe that notice_89_21 does not apply to the transaction economic_substance and step transaction principles apply before application of any technical rules in the notice it is well established that compliance with the literal terms of a statute or regulation will not insulate a taxpayer from the requirement that its transactions have economic_substance a transaction must have a bona_fide commercial purpose as a condition_precedent to the receipt of any_tax benefits associated with the transaction except in the rare instance where a tax_motivated_transaction is unmistakably within the contemplation of congressional intent 82_tc_1001 thus as with statutes and regulations an economic_substance and step transaction analysis precedes consideration of the technical rules in notice_89_21 as the third circuit stated in weller v commissioner thus the principle laid down in the gregory case is not limited to corporate_reorganizations but rather applies to the federal taxing statutes generally the words of these statutes which describe commercial transactions are to be understood to refer to transactions entered upon for commercial purposes and not to include transactions entered upon for no other motive but to escape taxation tl-n-8774-97 270_f2d_294 3d cir aff’g 31_tc_33 this principle was recently confirmed by the tax_court in acm which held that o nly after we conclude that a transaction has economic_substance will we consider the transaction’s tax consequences under the code t c m pincite see also leema enterprises inc v commissioner t c memo date if you have any questions please call or jeffrey dorfman chief branch phyllis e marcus chief branch


o f f i c e o f t h e c h i e f c o u n s e l department of the treasury i n t e r n a l r e v e n u e s e r v i c e w a s h i n g t o n d c date -------------- ------------------ cc tege qp4 genin-119910-18 number release date uil --------------- -------------------------- ------------------------------------- dear i am responding to your email dated date concerning your difficulty in obtaining a withdrawal from your employer’s sec_457 plan to pay for repairs in your email you ask if the plan can refuse your withdrawal request sec_457 plans are retirement plans set up by certain employers including state and local governments to provide a means for employees to contribute part of their pay towards their retirement to help ensure funds in the plan are available at retirement sec_457 of the internal_revenue_code prohibits early_withdrawals from the plan while still employed except when the plan participant is faced with an unforeseeable_emergency whether a participant satisfies the plan’s rules for a withdrawal is determined by the plan_administrator some people affected by hurricane irma were helped by the disaster tax relief and airport and airway extension act of this law authorizes retirement plans including sec_457 plans to make distributions to individuals who suffered an economic loss because of hurricane irma these distributions which have to be made before date are eligible for favorable tax treatment see irs publication disaster relief which can be found on our website at irs gov for more information a sec_457 plan is not required to make special distributions on account of hurricane irma and even if it does the plan may impose conditions on obtaining a distribution if you feel you have been wrongly denied a distribution you may be able to appeal the denial through the plan’s appeal procedures genin-119910-18 at i hope this information is helpful if you have additional questions please call me or --------------------------- -------------------- sincerely joyce kahn branch chief qualified_plans branch employee_benefits tax exempt and government entities


internal_revenue_service number release date index number ------------------------- ------------------------------------- --------------------------- ------------------- --------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------- id no ----------- telephone number ---------------------- refer reply to cc fip b5 plr-131462-16 date april legend issuer entity x date date date year year year bonds -------------------------------------------------------------------------- -------------------------------------------------------------------------- ----------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------- --------------------------- ---------------------- ---------------------------- ------- ------- ------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- ---------------------------------- plr-131462-16 d e project a project b project c ----------- ------------------------- ---------------------------------------------- -------------------------------------------------------------------------- ---------------------------------------------- ---------------------------------------------- utilities --------------------------------------------------------------------------------------------------------------------- ----------------------------------------------------------------- ---------- region sales agreement buyer contracts share prior resolutions ------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- ------------------------------------------------ -------------------------------------------------------------------------- -------------------------------------------------------------------------- ---------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- ------------------------------------------------------------------ -------------------------------------------------------------------------- -------------------------------------------------------------------------- --------------------------------------- ------------------------------------------------------------------------- -------------------------------------------------------------------------- ------------------------------------------------ plr-131462-16 new resolutions dear ------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- -------------------------------------------------------------------------- --------------------------------------------- this responds to issuer’s request for rulings described below regarding its proposed issuance of the bonds and the implications under sec_103 of the internal_revenue_code of the code b of the internal_revenue_code_of_1986 the 1986_code h of the income_tax regulations and h v d facts generally issuer is authorized to acquire construct and operate plants works and other facilities for the generation and transmission of electric power issuer is further authorized to issue revenue notes bonds or warrants for these purposes entity x a governmental person blends the electric power from project b with other electric power that entity x has available to market and provides that power on an undifferentiated basis to meet entity x’s power sales and related obligations project b was synchronized to the transmission grid all critical tests were completed and project b was able to operate at its rated capacity on date construction on project a was suspended in year and project a was terminated in year construction on project c was suspended in year and project c was terminated in year the bonds issuer first issued tax-exempt obligations under sec_103 of the code to finance the costs of acquiring and constructing project a project b and project c the projects issuer also has issued tax-exempt obligations subject_to the 1986_code to finance capital expenditures_for project b in addition issuer has issued tax-exempt obligations under both the code and 1986_code to refund those new money obligations collectively the refunding bonds issuer now proposes to issue the bonds to refund certain of its outstanding obligations and to finance capital expenditures_for project b if no reference is made to either the code or the 1986_code assume the code cite is referencing the 1986_code plr-131462-16 the sale agreements d law requires entity x to offer to sell electric power to meet the utilities’ net requirement loads in the region and entity x does so pursuant to the sale agreements d law also requires entity x to give preference to utilities in the sale of its available power this means that entity x must meet the requests of utilities in the region for available power from entity x before meeting a competing request from an entity that is not a utility for the same power the current sale agreements cover the period commencing on date or such later date when a buyer’s sale agreement commenced and terminate on date the contracts prior to the commencement of construction on each project issuer and entity x entered into separate but materially identical contracts with certain utilities including utilities with sale agreements each of the contracts relates to a single project under a contract the utility is required to make payments with respect to the costs only of the project to which the contract relates certain utilities have entered into contracts for more than one project under each contract issuer sold a designated share of the related project to a utility in return the utility agreed to pay issuer a proportionate share of issuer’s annual net costs for operation maintenance repairs renewals and replacements of the related project including debt service on notes and bonds to be issued for that project the proportionate share of costs of the project for which the utility is obligated to make payments is equal to the utility’s share of that project simultaneously with its purchase of its share from the issuer the utility assigned its share to entity x in return for that assignment of project generating capability entity x agreed to provide the utility a dollar amount of credits credits and or cash payments up to the dollar amount which the utility is required to pay issuer for purchases of power and transmission services from entity x the credits reduce the cash payments the utilities would otherwise make to entity x for such purchases under the contracts it is possible that the dollar amount of credits received or to be received by a utility under its contract s may be greater than the cost of the power needs of the utility an insufficiency the insufficiency may be eliminated in two different ways subject_to some restrictions the assignment of all or a part of that utility’s excess share to one or more other utility customers of entity x or subject_to the availability of money from appropriations or otherwise for such purpose cash payments by entity x to the utility if neither option is feasible the utility may direct plr-131462-16 issuer to deliver all or a portion of the energy associated with its share of the project to a point of delivery specified by the utility throughout the many decades during which the contracts have been in effect the participating utilities’ conditional right to take energy from a project directly from issuer as described above has never been exercised and conditions which would have given rise to the exercise of such rights never occurred issuer does not expect that any utility will ever make such a request under the contracts and represents that the chance of any nongovernmental utility ever taking delivery of energy from issuer pursuant to the utility’s contract is contingent and remote financing allocations the prior resolutions were adopted prior to date as required by the contracts and the prior resolutions separate series of tax-exempt obligations were issued for each of the projects after date the prior resolutions were replaced by the new resolutions and tax-exempt refunding bonds were issued pursuant to each of the new resolutions in addition tax-exempt new money obligations have been issued pursuant to the new resolution for project b like the prior resolutions the new resolutions require that separate series of obligations be issued for each of the projects as of the proposed issue_date of the bonds obligations issued under only one of the prior resolutions will remain outstanding the bonds will not directly refund any obligations issued under a prior resolution issuer represents that for e law and contract purposes it cannot allocate the bonds between the projects pursuant to the methods outlined in paragraph b or paragraph c of sec_1_148-9 an allocation of the proceeds of each substantially identical bond pro_rata as provided in paragraph a of sec_1_148-9 among each of the purposes of the issue of bonds would require a portion of proceeds of bonds issued for each project to be treated as used to finance or refinance costs of one or both of the other projects although issuer could apply a pro_rata cross-project allocation method for tax purposes but apply a project-specific allocation method for purposes of documenting compliance with e law and the contracts this would require issuer to maintain a separate set of books resulting in additional complexity and burdens issuer represents that allowing it to allocate the bonds pursuant to sec_1 h v d will not result in a greater burden on the market for tax-exempt obligations than would occur using the pro_rata method set forth in sec_1_148-9 rulings requested the contracts among issuer entity x and utilities that are nongovernmental persons do not give rise to private_business_use within the meaning of plr-131462-16 sec_141 the 1986_code or cause proceeds of the bonds to be treated as used in a trade_or_business of a nonexempt_person within the meaning of sec_103 of the code sec_1_141-7 and corresponding principles of prior_law do not require output of project a project b and project c in amounts corresponding to a utility’s share to be allocated to such utility that purchases electric power from entity x pursuant to a sale agreement issuer may apply sec_1_148-9 to treat the bonds which comprise a single multipurpose issue as separate issues of bonds a for all purposes of sec_148 of the 1986_code except those purposes specified in sec_1_148-9 b for all purposes of sec_141 of the 1986_code except sec_141 and sec_141 of the 1986_code and c for all purposes of sec_103 of the code law and analysis requested ruling prior to enactment of the tax_reform_act_of_1986 sec_103 of the code defined the term industrial_development_bond to mean any obligation a which is issued as part of an issue all or a major portion of the proceeds of which are to be used directly or indirectly in any trade_or_business carried on by any person who is not an exempt_person within the meaning of sec_103 of the code the trade_or_business test and b the payment of the principal or interest on which under the terms of such obligation or any underlying arrangement is in whole or in major part -- i secured_by any interest in property used or to be used in a trade_or_business or in payments in respect of such property or ii to be derived from payments in respect of property or borrowed money used or to be used in a trade_or_business the security_interest test subparagraph i of sec_1_103-7 clarifies the trade_or_business test and the security_interest test with respect to certain output contracts and provides that the use by one or more nonexempt persons of a major portion of the output of facilities constructed reconstructed or acquired with the proceeds of an issue satisfies the trade_or_business test and the security_interest test i f such use has the effect of transferring to nonexempt persons the benefits of ownership of such facilities and the burdens of paying the debt service on governmental obligations used directly or indirectly to finance such facilities so as to constitute the indirect use by them of a major portion of such proceeds such benefits and burdens are transferred and plr-131462-16 a major portion of the proceeds of an issue is used indirectly by the users of the subparagraph output of such a facility which is owned and operated by an exempt_person where -- a or two or more nonexempt persons each of which pays annually a guaranteed minimum payment exceeding percent of the average annual debt service with respect to the obligations in question agree pursuant to contracts to take or to take or pay for a major portion more than percent of the subparagraph output of such a facility whether or not conditioned upon the production of such output and b payment made or to be made with respect to such contract or contracts by such nonexempt_person or persons exceeds a major part more than percent of the total debt service with respect to such issue of obligations except as provided in sec_103 of the 1986_code sec_103 provides that gross_income does not include interest on any state_or_local_bond sec_103 provides in part that sec_103 shall not apply to any private_activity_bond which is not a qualified_bond within the meaning of sec_141 sec_141 provides that the term private_activity_bond means any bond issued as part of an issue which meets the private_business_use_test of sec_141 and the private security or payments test of sec_141 or the private_loan_financing_test of sec_141 sec_141 provides that an issue generally meets the private_business_use_test if more than percent of the proceeds of the issue are to be used for any private_business_use sec_141 states a in general for purposes of this subsection the term private_business_use means use directly or indirectly in a trade_or_business carried on by any person other than a governmental_unit for purposes of the preceding sentence use as a member of the general_public shall not be taken into account b clarification of trade_or_business for purposes of the 1st sentence of subparagraph a any activity carried on by a person other than a natural_person shall be treated as a trade_or_business if percent or more of proceeds is used to finance or refinance costs of output facilities sec_141 provides the issue may be private_activity_bonds if the nonqualified_amount with respect to the issue together with the nonqualified amounts with respect to plr-131462-16 all other outstanding issues that finance or refinance the same project exceeds dollar_figure million sec_141 defines nonqualified_amount to be the lesser_of a proceeds used for a private_business_use or b proceeds in respect of which there are private payments sec_1_141-7 sets forth rules to determine whether arrangements for purchases of output from an output_facility cause an issue of obligations to meet the private_business_use_test an output_facility is defined by sec_1_141-1 to include electric generation transmission distribution and related facilities sec_1_141-7 provides that a nongovernmental person’s purchase of available output of an output_facility financed with the proceeds of an issue is taken into account under the private_business_use_test if the purchase has the effect of transferring to the nongovernmental person the benefits of owning the facility and the burdens of paying the debt service on the obligations used directly or indirectly to finance the facility the benefits and burdens test sec_1_141-7 provides that the benefits and burdens test generally is met if a nongovernmental person agrees pursuant to a take contract or a take_or_pay_contract to purchase available output of a facility sec_1_141-7 provides the following definition of a take contract or a take_or_pay_contract a take contract is an output contract under which a purchaser agrees to pay for the output under the contract if the output_facility is capable of providing the output a take_or_pay_contract is an output contract under which a purchaser agrees to pay for the output under the contract whether or not the output_facility is capable of providing the output sec_1_141-7 provides that retail requirements_contracts generally do not meet the benefits and burdens test sec_1_141-7 provides safe harbors pursuant to which wholesale requirements_contracts do not meet the benefits and burdens test including a safe_harbor if the amount of output to be purchased under the contract and any other requirements contract with the same purchaser or a related_party with respect to the facility does not exceed percent of the available output of the facility the contracts provide a number of available methods of remediating insufficiencies other than providing a utility with any energy associated with its share throughout the decades during which the contracts have been in effect the participating utilities’ conditional right to take energy from a project directly from issuer as described above has never been exercised and during that time period conditions which would have given rise to the exercise of such rights never occurred issuer does not expect that any utility will ever make such a request under the contracts and plr-131462-16 represents that the chance of any nongovernmental utility ever taking delivery of energy from issuer pursuant to the utility’s contract is contingent and remote accordingly during the measurement_period s for the bonds the contracts have not provided and are not expected to provide nongovernmental utilities that are parties to the contracts any rights transferring the benefits of owning the facility and the burdens of paying the debt service with respect to output of the projects that give rise to private_business_use under either sec_103 of the code and b promulgated thereunder or sec_141 of the 1986_code and promulgated thereunder requested ruling sec_1_141-7 provides that the determination of whether output sold under an output contract should be allocated to a particular facility for example a generating unit to the entire system of the seller of that output net of any uses of that system output allocated to a particular facility or to a portion of a facility is to be based on all the facts and circumstances significant factors to be considered in determining the allocation of output from a financed output_facility among the various uses of output available to the owner of that output are the following i ii iii iv the extent to which it is physically possible to deliver that output to or from a particular facility or system the terms of a contract relating to the delivery of that output such as delivery limitations and options or obligations to deliver power from additional sources whether a contract is entered into as part of a common plan of financing for a facility the method of pricing output under the contract such as the use of market rates rather than rates designed to pay debt service of tax- exempt bonds used to finance a particular facility throughout the measurement_period s of the bonds the rights of nongovernmental utilities to take delivery of energy from issuer pursuant to their contracts have been and are expected to continue to be contingent and remote in addition allocating all of the output of project b solely among those utilities that have shares in project b would fail to take into account the use by buyers who take some portion of project b output through their sale agreements plr-131462-16 requested ruling for purposes of sec_103 sec_148 provides that the term arbitrage_bond means any obligation issued as part of an issue any portion of the proceeds of which is reasonably expected at the time of issuance of the obligation to be used directly or indirectly to acquire higher_yielding_investments or to replace funds which were used directly or indirectly to acquire higher_yielding_investments for purposes of sec_148 an obligation is treated as an arbitrage_bond if the issuer intentionally uses any portion of the proceeds of the issue of which such obligation is a part in a manner described above sec_1_148-9 provides that the portion of the obligations of a multipurpose issue reasonably allocated to any separate purpose under paragraph h is treated as a separate issue for all purposes of sec_148 except for certain arbitrage purposes listed therein a multipurpose issue is an issue the proceeds of which are used for two or more separate purposes determined in accordance with sec_1_148-9 sec_1_148-1 defines the term multipurpose issue to mean an issue the proceeds of which are used for two or more separate purposes determined in accordance with sec_1_148-9 sec_1_148-9 provides in part that separate purposes of a multipurpose issue include refunding a separate prior issue financing a separate purpose_investment financing a construction_issue as defined in sec_1_148-7 and any clearly discrete governmental purpose reasonably expected to be financed by the issue sec_1_148-9 provides that sec_1_148-9 applies to allocations of multipurpose issues including allocations involving the refunding purposes of the issue except as otherwise provided in sec_1_148-9 proceeds investments and bonds of a multipurpose issue may be allocated among the various separate purposes of the issue using any reasonable consistently applied allocation method an allocation is not reasonable if it achieves more favorable results under sec_148 or sec_149 than could be achieved with actual separate issues allocations under sec_1_148-9 may be made at any time but once made may not be changed for each multipurpose issue that is used in whole or in part to refund a separate prior issue sec_1_148-9 provides that an allocation of obligations is reasonable only if the allocation results from a pro_rata allocation under paragraph h ii of this a section plr-131462-16 b reflects aggregate principal and interest payable in each bond year that is less than equal to or proportionate to the aggregate principal and interest payable on the prior issue in each bond year results from an allocation of all the bonds of the entire multipurpose issue c in proportion to the remaining weighted average economic life of the capital projects financed or refinanced by the issue determined in the same manner as under sec_147 or results from another reasonable allocation method but only to the d extent that the application of the allocation_methods provided in this paragraph h v is not permitted under state law restrictions applicable to the bonds reasonable terms of bonds issued before or subject_to a master indenture that became effective prior to date or other similar restrictions or circumstances this paragraph h v d shall be strictly construed and is available only if it does not result in a greater burden on the market for tax-exempt_bonds than would occur using one of the other allocation_methods provided in this paragraph h v see also sec_1_148-11 except for purposes of sec_141 and sec_141 sec_1_141-13 provides that allocations of multipurpose issues as defined in sec_1_148-1 including allocations involving the refunding purposes of the issue must be consistent with allocations made for arbitrage purposes under sec_1_148-9 pursuant to sec_1_141-15 sec_1_141-13 applies to bonds that are sold on or after date and that are subject_to the treasury regulations sec_1_150-1 provides for bonds of a multipurpose issue to be treated as separate issues if certain requirements are met and the allocation of such bonds is made in writing on or before the issue_date pursuant to sec_1_150-1 sec_1 c applies to bonds that are issued after date to which sec_1_148-1 through apply if any such separate issue consists of refunding bonds sec_1_150-1 further requires that the allocation rules in sec_1_148-9 must be satisfied sec_1_150-1 provides sec_1_150-1 does not apply for purposes of sec_141 sec_144 sec_148 sec_149 and sec_149 for multipurpose issues that meet these requirements but are not subject_to the treasury regulations sec_1 c ii provides that sec_1_150-1 does not apply for purposes of sec_141 sec_141 sec_141 sec_144 sec_148 sec_149 and sec_149 the issuer represents that e law and the contracts prohibit it from allocating the bonds pursuant to the methods outlined in paragraph b or paragraph c of sec_1 h v the issuer also represents that limitations placed upon the use of proceeds plr-131462-16 of the bonds pursuant to e law and the contracts do not allow a pro_rata allocation as outlined in paragraph a of sec_1_148-9 of substantially_all identical bonds to each purpose of the bond nevertheless issuer concedes that it could meet one or more of the allocation_methods described in sec_1_148-9 for federal tax law purposes and adopt an allocation that meets the requirements of e law and the contracts however to do so would impose undue complexity and burdens under the facts and circumstances of this case we conclude that these additional burdens are unnecessary issuer represents that the use of another reasonable allocation method as outlined in paragraph d of sec_1_148-9 will not result in a greater burden on the market for tax-exempt_bonds than would occur using one of the other allocation_methods conclusions accordingly we conclude that the contracts among issuer entity x and utilities that are nongovernmental persons do not give rise to private_business_use within the meaning of sec_141 of the 1986_code or cause proceeds of the bonds to be treated as used in a trade_or_business of a nonexempt_person within the meaning of sec_103 of the code further amounts corresponding to a utility’s share need not be allocated to such utility that purchases electric power from entity x pursuant to a sale agreement finally issuer may apply sec_1_148-9 to treat the bonds which comprise a single multipurpose issue as separate issues of bonds a for all purposes the 1986_code except those purposes specified in sec_1_148-9 b for all purposes of sec_141 except sec_141 and sec_141 and c for all purposes of sec_103 of the code except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter specifically no opinion is expressed or implied as to whether the issuer’s method of allocation under sec_1_148-9 is a reasonable method of allocation 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 this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-131462-16 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely associate chief_counsel financial institutions products s by __________________________ timothy l jones senior counsel branch financial institutions products cc


internal_revenue_service number release date index number ------------------ ------------------ ------------------------- ------------------------------- ------------------ - department of the treasury washington dc third party communication none date of communication not applicable_person to contact --------------------------- id no ------------ telephone number -------------------- refer reply to cc corp b02 plr-135798-05 date date ------------------ ------------------ ------------------------------ ---------------------------------------------------- ty ------------------- legend parent ---------------------------------------------------------------------- electing subsidiary ------------------------------------------------------------------------- year date date company official ---------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------ --------------------------------------------------------------------------------------------------------------------- ---------------------------------------------------------------- tax professional ------------------------------------------------------------------------------------------------ dear ------------ subsidiary dated date requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election the extension is being requested in order to allow parent and electing subsidiary to file an election to this letter responds to a letter submitted on behalf of parent and electing ---------------------------- --------------------- ------------------ pursuant to sec_1_382-8 the value of parent stock was reduced by the value plr-135798-05 restore value under sec_1_382-8 of the income_tax regulations hereinafter referred to as the election additional information was received in letters dated june and date the material information submitted in the request and subsequent correspondence is summarized below at the end of year parent was the parent of a controlled_group_of_corporations the parent group and owned directly or indirectly percent or more of the stock of electing subsidiary electing subsidiary is a foreign_entity treated as a corporation for federal tax purposes and is not engaged in the conduct_of_a_trade_or_business within the united_states parent underwent an ownership_change as defined under sec_382 of the code on date therefore the use of the parent’s net operating losses for carryovers are subject_to limitation under sec_382 for year of the stock it owned directly in electing subsidiary sec_382 provides that the amount of the taxable_income of any new_loss_corporation for any post-change_year which may be offset by pre-change losses shall not exceed the sec_382 limitation for such year under sec_382 the sec_382 limitation is determined by multiplying the value of the old_loss_corporation by the applicable long term tax-exempt rate a special rule designed to prevent double counting by controlled groups is set forth in sec_1_382-8 sec_1_382-8 requires the value of the stock of each component_member of the controlled_group be reduced by the value of the stock directly owned by that component_member in any other component_member component members of a controlled_group can elect to restore some or all of the value to another component_member under sec_1_382-8 the election to restore value is made following the procedures set forth in sec_1_382-8 parent and electing subsidiary are component members of a controlled_group under sec_1_382-8 the election to restore the value of electing subsidiary was due on date however for various reasons parent and electing subsidiary failed to make the election in a timely manner extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i commissioner will use to determine whether to grant an extension of time to make a regulatory election sec_301_9100-1 sec_301_9100-2 provides automatic extensions of time for making certain elections requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 under sec_301_9100-1 the commissioner has discretion to grant a reasonable sec_301_9100-1 through provide the standards the in this case the time for filing the election is fixed by the regulations ie based on the facts and information submitted including the representations plr-135798-05 sec_1_382-8 therefore the commissioner has discretionary authority under sec_301_9100-3 to grant an extension of time for parent and electing subsidiary to file the election provided parent and electing subsidiary show they acted reasonably and in good_faith the requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied and granting relief will not prejudice the government the information affidavits and representations submitted by parent company official and tax professional explain the circumstances that resulted in the failure to timely file the election the information establishes that parent and electing subsidiary reasonably relied on a qualified_tax professional who failed to make or advise parent and electing subsidiary to make the election and that the interests of the government will not be prejudiced if relief is granted see sec_301_9100-3 made we conclude that parent and electing subsidiary have shown they acted reasonably and in good_faith the requirements of sec_301_9100-1 and sec_301_9100-3 are satisfied and granting relief will not prejudice the interests of the government accordingly an extension of time for parent and electing subsidiary to file the statement described in sec_1_382-8 is granted under sec_301_9100-3 until days from the date on this letter a copy of this letter must be attached to the statement electing subsidiary’s tax_liability if any being not lower in the aggregate for all years to which the election applies than it would have been if the election had been timely made taking into account the time_value_of_money no opinion is expressed as to the taxpayers' tax_liability for the years involved a determination thereof will be made upon audit of the federal_income_tax returns involved further no opinion is expressed as to the federal_income_tax effect if any if it is determined that the taxpayers' liability is lower sec_301_9100-3 concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter in particular we express no opinion with respect to whether an ownership_change occurred whether parent and electing subsidiary are component members of a controlled_group the amount of value if any that may be restored or as to values or amounts of nols in addition we express no opinion as to the tax effects or consequences of filing the election late under the provisions of any other section of the code or regulations or as to the tax treatment of any conditions existing at the time of or effects resulting from filing the election late that are not specifically set forth in the above ruling statements and representations made by parent parent's authorized representative the above extension of time is conditioned on the taxpayers' parent's and except as expressly provided herein no opinion is expressed or implied for purposes of granting relief under sec_301_9100-3 we relied on certain plr-135798-05 company official and tax professional under penalties of perjury however the director should verify all essential facts moreover notwithstanding that the extension is granted under sec_301_9100-3 to file the election any penalties and interest that would otherwise be applicable still apply provides that it may not be used or cited as precedent sent to your authorized representatives pursuant to a power_of_attorney on file in this office copies of this letter are being this letter is directed only to the taxpayer s who requested it sec_6110 sincerely ken cohen senior technician reviewer branch office of associate chief_counsel corporate cc