internal_revenue_service number release date index number -------------------------------- --------------------------------------------- --------------------------------------------- --------------------------------------------------- ---------------------------------- department of the treasury washington dc third party communication date of communication month dd yyyy person to contact -------------------------- id no ---------------- ----------------- telephone number ---------------------- refer reply to cc fip b02 plr-123730-13 date date legend taxpayer a ---------------------------------------------- ------------------------------------------------ taxpayer b --------------------------------------------------- ------------------------------------------------ state -------------- corporation a ---------------------------------- corporation b ------------------------------------- corporation c -------------------------------------- a ----------- b -- c -- d -------- e ----- f -- g -------- h ---- i -- j -------- k -------- l ---- m ---- n ---- o ----- p ---------------- q ---- r -- plr-123730-13 dear ------------------ this is in reply to a letter dated date and subsequent correspondence requesting rulings on behalf of taxpayer a and taxpayer b together taxpayers specifically you have requested rulings that the issuance by taxpayers of more than one class of common_stock with fee structures suited to the distribution channel for each class of common_stock will not cause dividends_paid by taxpayers with respect to its shares to be preferential dividends within the meaning of sec_562 of the internal_revenue_code that the issuance of more than one class of common shares with different fee structures will not cause either taxpayer to fail to qualify as a real_estate_investment_trust reit under part ii of subchapter_m of the code and that the issuance of shares pursuant to taxpayers’ dividend reinvestment plans drips at a price net of the upfront fees will not cause the dividends_paid by taxpayers with respect to their shares to be preferential dividends under sec_562 facts taxpayers are corporations organized under state law taxpayers have filed initial registration statements with the securities_and_exchange_commission with the intent to offer shares of common_stock to the public the dealer manager of the taxpayers’ offerings will be corporation a taxpayers’ shares will not be listed on a securities exchange each taxpayer intends to elect to be taxed as a reit taxpayer a will be externally managed by corporation b and taxpayer b will be externally managed by corporation c hereafter advisors the advisors are affiliates of corporation a taxpayers intend to primarily invest in commercial properties through operating partnerships in order to attract investors that invest through a variety of placement channels taxpayers each intend to issue up to eight classes of common_stock each class of shares will have fee structures suited to a particular placement channel the operation of taxpayers’ classes including the fees and expenses that are allocated on a class- specific basis is governed by taxpayers’ articles of incorporation the charters state general corporation law multi-class plans adopted by taxpayers taxpayers’ prospectuses and the securities laws that govern their contents and state laws that govern the operation of reits whose securities are offered in their states the first class of stock class a-1 shares would be issued to investors who purchase shares through registered representatives of participating broker-dealers who are compensated following the completion of the sale of the shares these shares would be sold at dollar_figurea per share plus a one-time upfront selling commission of up to b percent of the offering price per share and a one-time upfront dealer-manager fee of up plr-123730-13 to c percent of the offering price per share for a total offering price to the investor of up dollar_figured per share the upfront selling commission and dealer-manager fee would be paid to the dealer-manager which would then reallow e percent of those fees to the participating broker-dealer thus the net_proceeds to taxpayers would be dollar_figurea per share class a-2 shares would be designed for those investors who purchase their shares through a registered_representative of a participating broker-dealer these shares would be sold at dollar_figurea per share plus a one-time upfront selling commission of up to c percent of the offering price per share and a one-time upfront dealer manager fee of up to i percent of the offering price per share for a total offering price to the investor of up to dollar_figurej per share taxpayers would pay the selling commission and dealer manager fee to the dealer manager which would then reallow e percent of those fees to the participating broker-dealer thus the net_proceeds to taxpayers per class a-2 share would be dollar_figurea taxpayers also expect that these shares would be subject_to a trailing distribution fee of up to h percent of the net offering price of dollar_figurea per share which would be paid to the dealer manager who would then reallow up to e percent of the distribution fee to the participating broker-dealer class b-1 shares would be designed for those investors who purchase their shares through a registered_representative of a participating broker-dealer and pay an upfront selling commission these shares would be subject_to a one-time upfront selling commission of up to i percent of the offering price per share and a one-time upfront dealer manager fee of up to c percent of the total offering price per share for a total offering price of dollar_figurej per share thus the net_proceeds to taxpayers per class b-1 share would be dollar_figurea taxpayers also expect that these shares would be subject_to a trailing distribution fee of up to i percent of the net offering price of dollar_figurea per share which would be paid to the dealer manager who would then reallow up to e percent of the distribution fee to the participating broker-dealer class b-2 shares would be designed for investors who purchase their shares through a registered investment_advisor or a registered_representative of a participating broker-dealer in wrap or fee-based accounts but who do not pay an upfront selling commission these shares would be subject_to an upfront dealer manager fee of up to c percent of the offering price per share for a total offering price of dollar_figurek per share the upfront dealer manager fee would be paid to the dealer manager who would then reallow up to e percent of that fee to the participating financial advisor this class of shares would also be subject_to a trailing service fee of up to l percent of the net offering price per share of dollar_figurea which is payable to the dealer manager class c-1 shares would be designed to be sold through a registered investment_advisor in a wrap or fee based account these shares would be offered at dollar_figurek per share and would be subject_to an upfront dealer manager fee of c percent per share thus the net_proceeds to taxpayers per class c-1 share would be dollar_figurea the upfront dealer plr-123730-13 manager fee would be paid to the dealer manager who would then reallow up to e percent of that fee to the participating registered investment_advisor or to a financial intermediary that provides services relating to taxpayers’ shares for clients of the registered investment_advisor class c-2 shares would be designed to be sold through a registered investment_advisor in a wrap or fee based account these shares would be offered at dollar_figurea per share and would not be subject_to an upfront commission or an upfront dealer manager fee class c-2 shares would be subject_to a trailing dealer manager fee of up to c percent of the net offering price per share dollar_figurea which would be paid to the dealer manager in arrears the dealer manager would then reallow up to e percent of the trailing dealer manager fee to the participating registered investment_advisor or to a financial intermediary that provides services relating to taxpayers’ shares for clients of the registered investment_advisor class d shares would be designed for employee benefit plans and separate_accounts of insurance_companies supporting variable annuities variable life_insurance products and k plans these shares would be offered at dollar_figurea per share and would not be subject_to an upfront selling commission class d shares would be subject_to a trailing dealer manager fee of up to m percent of the net offering price per share dollar_figurea and would be payable to the dealer manager in arrears these shares would also be subject_to a service fee of up to n percent of the net offering price per share which would be paid to financial intermediary providing services relating to taxpayers’ shares the final class of common_stock class e would be designed to be sold directly to shareholders and would be issued to institutional investors and high net_worth individuals shares of class e would be offered at dollar_figurea per share and would not be subject_to an upfront selling commission however these shares would be subject_to a trailing dealer manager fee of up to o percent of the net offering price per share which would be paid to the dealer manager these shares would also be subject_to a service fee of up to n percent of the net offering price of dollar_figurea the service fee would also be paid to the dealer manager and both fees would be paid in arrears taxpayers’ anticipate that the minimum investment for class e shares would be dollar_figurep shareholders in all of the proposed classes of shares except class a-1 would be eligible to participate in each taxpayer’s drip during taxpayers’ public offering under the drip distributions from each share would be automatically reinvested in the same class of shares at a price equal to the offering price less any upfront fees accordingly all drip shares would be purchased at dollar_figurea per share distributions from shares in one class are not eligible for reinvestment in shares of a different class drip shares of each class would be subject_to the same asset-based fees as other shares of that class taxpayers represent that the drip shares for each class participating in the drip program will not be priced at less than percent of the public offering price for plr-123730-13 that class and will therefore satisfy the requirements in revrul_83_117 1983_2_cb_98 following the termination of taxpayers’ respective public offerings broker dealers that have sold shares of taxpayers’ common_stock would not be permitted to report in their customer account statements an estimated value per share that is developed from data more than months old taxpayers’ respective boards of directors intend to determine the estimated value per share for each class of stock within months after the completion of the public offerings or at such time as required under finra rules as soon as such determination is made the drip price will be based on the estimated value per share per class in addition to the commissions and dealer manager distribution and service fees that vary according to the placement channel each class would be allocated fees and expenses attributable to other distribution expenses or expenses for services relating to or provided to that class none of the fees that vary by class is related to advisory or custodial services provided to taxpayers or to the management of taxpayers’ assets certain other fees and expenses will be allocated by class these include a fee that is termed a subordinated performance fee and certain organizational and offering expense reimbursements upon the occurrence of any of the following alternative events an advisor would receive a subordinated performance fee i if taxpayer’s shares are listed on a national securities exchange an advisor would be entitled to a fee equal to g percent of the amount if any by which the market_value of taxpayer’s outstanding_stock plus distributions paid prior to listing exceeds the sum of the total amount of capital raised from investors and the amount necessary to generate a r percent annual cumulative non-compounded return to investors ii if taxpayers’ company is sold or their assets are liquidated the advisor will be entitled to a fee equal to q percent of the net sale proceeds after investors have received a return of their capital invested and a r annual cumulative non-compounded return or iii upon termination of the advisory agreement the advisor may be entitled to a fee similar to that to which it would have been entitled had the portfolio been liquidated based on an independent appraised value of the portfolio on the date of termination thus the rate of the subordinated performance fee would be the same for each class but the absolute amount of that fee paid_by each class would reflect variations in the performance of each class the advisor may incur or pay a taxpayer’s organization and offering expenses excluding selling commissions and dealer manager fees each taxpayer may then reimburse the applicable advisor for these amounts up to c percent of aggregate net offering proceeds such costs would be allocated to each class based on the number of outstanding shares in each class plr-123730-13 in summary taxpayers represent that distributions payable to holders of the various classes under the proposed multi-class structure will differ only by reason of the special_allocation of the dealer manager fee upfront selling commissions distribution fees stockholder servicing fees and certain class-specific expenses depending on the placement channel or other factors unique to each class the advisory fee acquisition fee the acquisition and offering and expense reimbursement and the disposition fee would be allocated to each class based on the number of outstanding shares of the class in relation to the number of outstanding shares of all classes law and analysis sec_857 of the code requires in part that a reit’s deduction for dividends_paid for a tax_year as defined in sec_561 but determined without regard to capital_gains dividends equals or exceed sec_90 of its reit taxable_income for the tax_year determined without regard to the deduction for dividends_paid and by excluding any net_capital_gain sec_561 defines the deduction for dividends_paid for purposes of sec_857 to include dividends_paid during the taxable_year sec_561 applies the rules of sec_562 for determining which dividends are eligible for the deduction for dividends_paid under sec_561 sec_562 provides that the amount of any distribution will not be considered as a dividend for purposes of computing the dividends_paid deduction under sec_561 unless the distribution is pro_rata the distribution must not prefer any shares of stock of a class over other shares of stock of that same class the distribution must not prefer one class of stock over another class except to the extent that one class is entitled without reference to waivers of their rights by stockholders to that preference sec_1_562-2 of the income_tax regulations provides that a corporation will not be entitled to a deduction for dividends_paid with respect to any distribution upon a class of stock if there is distributed to any shareholder of such class in proportion to the number of shares held by him more or less than his pro_rata part of the distribution as compared with the distribution made to any other shareholder of the same class nor will a corporation be entitled to a deduction for dividends_paid in the case of any distribution upon a class of stock if there is distributed upon such class of stock more or less than the amount to which it is entitled as compared with any other class of stock a preference exists if any rights to preference inherent in any class of stock are violated the disallowance where any preference in fact exists extends to the entire amount of the distribution and not merely to a part of such distribution revproc_99_40 1999_2_cb_565 describes conditions under which distributions made to a shareholder of a regulated_investment_company ric may plr-123730-13 vary and nevertheless be deductible as dividends under sec_562 revproc_99_40 holds in part that variations in distributions to shareholders that exist solely as a result of certain allocations of fees and expenses described in the revenue_procedure do not prevent the distributions from being dividends under sec_562 the requirements of revproc_99_40 are based on similar requirements contained in rule 18f-3 c f_r 18f-3 under the investment_company act of u s c sec_80a-1 et seq act that are meant to ensure the fair and equal treatment of shareholders one requirement of revproc_99_40 is that the advisory fee must not be charged at different rates for different groups of shareholders the groups of shareholders may be allocated and may pay a different advisory fee however to the extent that any difference in amount_paid is the result of the application of the same performance fee provisions in the advisory contract to the different investment performance of each group of shareholders as a reit taxpayer is not within the scope of revproc_99_40 nevertheless congress and the service have acknowledged the similarity between rics and reits in many areas and have afforded them similar treatment in many situations the legislative_history underlying the tax treatment of reits indicates congress generally intended to equate the tax treatment of reits with the treatment accorded rics reits were created to provide an investment vehicle similar to the ric for small investors to invest in real_estate and real_estate mortgages see h_r rep no 86th cong 2d sess consequently the rationale underlying revproc_99_40 is instructive by analogy in determining whether the distribution of fees and expenses to different classes of shareholders results in the fair and equal treatment of those shareholders in revrul_83_117 the service indicated that a percent discount to certain shareholders participating in a dividend_reinvestment_plan drip would not be considered to be a preferential_dividend in that ruling a reit established a drip in which shareholders could elect to receive dividends either in cash or in the reit’s stock at a price equal to percent of the stock’s fair_market_value on the distribution date the drip was intended as a means for the reit to raise capital and the discount approximated the underwriting and other costs that the reit would have incurred in issuing new stock the revenue_ruling notes that the plan treated all shareholders with impartiality by giving them an equal opportunity to invest and that the savings passed along as a discount was relatively small and resulted in only minor differences in distributions accordingly the percent discount for shareholders that elected to participate in the drip did not preclude the reit from qualifying for the dividends_paid deduction as long as the discount did not exceed five percent publicly offered rics are no longer subject_to sec_562 with respect to distributions in tax years beginning after date plr-123730-13 based on the above facts and representations we conclude that taxpayers’ issuance of the class a-1 shares class a-2 shares class b-1 shares class b-2 shares class c-1 shares class c-2 shares class d shares and class e shares as described above will not cause dividends_paid by each respective taxpayer with respect to the class a-1 shares class a-2 shares class b-1 shares class b-2 shares class c-1 shares class c-2 shares class d shares and class e shares to be preferential dividends within the meaning of sec_562 furthermore the issuance of the class a-1 shares class a-2 shares class b-1 shares class b-2 shares class c-1 shares class c-2 shares class d shares and class e shares will not cause either taxpayer to fail to qualify as a reit finally the issuance of shares pursuant to taxpayers’ drips at a price net of upfront fees will not cause dividends_paid by taxpayers with respect to their shares to be preferential under sec_562 except as specifically ruled upon above no opinion is expressed concerning any federal_income_tax consequences relating to the facts herein under any other provision of the code specifically we do not rule whether each taxpayer otherwise qualifies as a reit under part ii of subchapter_m of chapter of the code this ruling is directed only to the taxpayers requesting it sec_6110 of the code provides that it may not be used or cited as precedent sincerely susan thompson baker_______________ susan thompson baker senior technician reviewer branch office of associate chief_counsel financial institutions products


internal_revenue_service number release date index number ------------------------------ ---------------------- ------------------------ ----------------------------------------- ------------------------------- in re -------------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact ----------------------------------------------------- ----------------------------------- telephone number -------------------- refer reply to cc psi b04 plr-115975-16 date date legend settlor spouse son trust a_trust date date date date date date individual individual attorney attorney law firm state statute state statute state court x -------------------------- ------------------------- -------------------------- ------------------------------------------------------------------------------------- -------------------------------------------------------------------- ------------------------------------------------------------------------------------- ----------------------------------- ----------------------- ------------------------ ------------------ --------------------- ---------------- ------------------ --------------------- ---------------- ------------------------ ------------------ ------------------------------------------------ --------------------------------------------------- ----------------------------------------------- ------------------------------------------------------------------------------------- -------------------------- --- plr-115975-16 dear ----------- this letter responds to your authorized representative’s letter dated date requesting gift estate and generation-skipping_transfer gst tax rulings with respect to the proposed modifications of a_trust the facts and representations submitted are summarized as follows on date settlor created trust a on date trust a was amended and restated at which point it became irrevocable date and date are prior to date pursuant to article iii of trust a three separate trusts have been established with identical terms one for each of settlor's three sons one of those separate trusts trust was established for the benefit of son article iii provides that the trustees other than settlor’s spouse spouse may distribute net_income among the son and his issue at the trustees' discretion any net_income not distributed is to be accumulated and added to principal the trustees other than spouse also have the discretion to distribute principal for the son or his issue for their health maintenance support and education or to assist any of them in the purchase of a home or in a business or profession if the son is living at the death of the survivor of settlor and spouse the trustees are directed to distribute to the son one-tenth of the principal of the trust when he reaches thirty years of age and four-ninths when he reaches thirty-five years of age if at the death of the survivor of settlor or spouse the son has already attained these ages the trustees are at that time to make the required distributions to the son the balance of the trust will continue on the same terms for income and principal distributions upon the death of the son the balance of principal and any undistributed_income is to be distributed to the persons specified by the son in the exercise of a limited_power_of_appointment if the power_of_appointment is not exercised the balance of the trust is to be distributed to the son's issue per stirpes if the son is deceased at the death of the survivor of settlor and spouse the balance of the principal and undistributed_income will be distributed to the son's issue per stirpes if the son and all his issue die the entire balance of his trust shall be added to the trusts for the other sons of settlor article vi paragraph b provides in relevant part that all real_estate decisions are to be made during settlor’s lifetime by spouse while she is trustee all other decisions including real_estate decisions made after settlor’s death or while settlor is plr-115975-16 alive and spouse is not serving as trustee are to be made by a majority of trustees entitled to act in any specific instance under article x paragraph a settlor appoints spouse and attorney as the original trustees upon the death resignation or inability of spouse to serve as trustee settlor appoints individual as successor trustee and upon individual 1’s death resignation or inability to serve the vacancy is to be filled by such individual or series of individuals other than settlor as the last to serve of spouse and individual may designate in writing under article x paragraph b upon settlor’s death spouse individual and attorney are to serve as co-trustees upon the death resignation or inability of either individual or spouse to serve as trustee individual is appointed as trustee as each son attains the age of twenty-five he will become a trustee of his trust article x paragraph c provides that upon the death resignation or inability of attorney to serve as co-trustee the vacancy will be filled by a member of law firm that attorney may designate in his will but in the event that he fails to designate or if his designee dies resigns or is unable to serve said vacancy shall be filled and shall continue to be filled by a member of law firm as shall be designated by that firm from time to time article x paragraph d provides that as each trustee attains the age of x he or she shall resign and be succeeded in accordance with paragraphs a b and c article x paragraph e provides in relevant part that a son or other issue of settlor who is serving as a trustee is prohibited from participating in any decision relating to discretionary distributions of income or principal on date the three sons of settlor signed a statement that acknowledges that each individual trustee other than a son of settlor shall have one vote with respect to all business decisions to be made by the trustees the sons of settlor shall collectively have one vote with respect to all business decisions to be made by the trustees the term business decisions is defined to mean any decision that pertains to or affects an interest in a closely held investment including any decision to acquire additional interests in an existing closely held investment on date state court issued a decree that appointed each son as a co-trustee of his separate trust on date attorney was appointed as a co-trustee of each separate trust law firm delivered a letter dated date to spouse stating that i attorney was serving as co-trustee with attorney ii attorney would serve as successor trustee to attorney upon attorney 1’s resignation iii after the termination of service as trustee by both attorney and attorney law firm would designate as successor trustee a partner of law firm who is acceptable to spouse if she is living or the sons of plr-115975-16 spouse if spouse is not living iv such procedure would be repeated each time a partner of law firm terminated his service as trustee v if such procedure to appoint a successor trustee by law firm did not result in the appointment of a trustee who is acceptable to spouse if she is living or the sons of spouse if spouse is not living then law firm would assist and cooperate with any court_proceeding to appoint a trustee who is not related or subordinate to any of the beneficiaries within the meaning of sec_672 of the internal_revenue_code to fill such vacancy attorney and spouse resigned as trustees when they reached the age of x individual was already more than x years old when spouse resigned so individual never served as trustee currently son and attorney are the only co-trustees of trust state statute provides in relevant part that a noncharitable irrevocable_trust may be modified or terminated upon consent of the settlor and all beneficiaries even if the modification or termination is inconsistent with a material purpose of the trust a settlor's power to consent to a trust's modification or termination may be exercised by a guardian an agent under the settlor's general power_of_attorney or an agent under the settlor's limited power_of_attorney that specifically authorizes that action state statute provides in relevant part that all beneficiaries and trustees of a_trust may enter into a binding nonjudicial settlement agreement with respect to any matter involving the trust a nonjudicial settlement agreement is valid only to the extent it does not violate a material purpose of the trust and includes terms and conditions that could be properly approved by the court under this chapter or other applicable law under the authority of state statute the beneficiaries which include son and son’s children and trustees of trust propose to enter into a nonjudicial settlement agreement to amend certain administrative provisions of trust a the settlement agreement will provide for successor trustee provisions in light of the fact that law firm dissolved under the settlement agreement the date statement paragraph b of article vi and article x in its entirety are revoked each son of settlor is to serve as co- trustee of his separate trust with attorney the settlement agreement also provides that a new article x is to be added to trust a the new article x provides in relevant part that at least one independent_trustee is to serve each separate trust each son is to have the right at any time to remove any trustee including an independent_trustee then serving his separate trust and to appoint a substitute trustee who is an independent_trustee each son may appoint an individual or individuals to exercise such powers known as an appointment person to appoint a new independent_trustee in the case of son’s death or disability the settlement further provides that the individual trustees by majority vote may appoint individuals to serve as additional trustees provided that only independent plr-115975-16 trustees are eligible to elect additional trustees who are not independent trustees each individual trustee may appoint one or more individuals to serve concurrently or consecutively as his or her successor if at any time there is no independent_trustee serving the vacancy in the position is to be filled by the son of settlor or if none by a majority of the income beneficiaries of such trust who are of age and able to give or withhold consent no son or other issue of settlor who may at any time be serving as trustee may participate in any decision relating to the discretionary distributions of income or principal an independent_trustee is defined as a trustee who is not a_related_or_subordinate_party as defined in sec_672 to settlor spouse or any of settlor’s issue you have requested the following rulings the proposed modifications to trust will not constitute the grant of a general_power_of_appointment under sec_2041 and sec_2514 and thus the assets of trust will not be includible in son’s gross_estate at death and will not be deemed to be transferred by son for gift_tax purposes the proposed modifications to trust will not constitute a constructive_addition to trust under sec_2601 and will not affect the exempt status of trust for gst tax purposes the proposed modifications to trust will not cause distributions from or the termination of any interest in trust to be subject_to gst tax law and analysis ruling sec_2041 provides that the value of the gross_estate shall include the value of all property to the extent of any property with respect to which the decedent has at the time of his death a general_power_of_appointment created after date or with respect to which the decedent has at any time exercised or released a power_of_appointment by a disposition that is of such nature that if it were a transfer of property owned by the decedent the property would be includible in the decedent's gross_estate under sec_2035 to inclusive sec_2041 provides that a general_power_of_appointment is a power that is exercisable in favor of the decedent the decedent's_estate the decedent's creditors or the creditors of the decedent's_estate however a power to consume invade or appropriate property for the benefit of the decedent that is limited by an ascertainable_standard relating to the health education support or maintenance of the decedent shall not be deemed a general_power_of_appointment sec_20_2041-1 of the estate_tax regulations provides in part that a plr-115975-16 donee may have a power_of_appointment if he has the power to remove or discharge a trustee and appoint himself for example if under the terms of the instrument the trustee or his successor has the power to appoint the principal of the trust for the benefit of individuals including himself and the decedent has the unrestricted power to remove or discharge the trustee at any time and appoint any other person including himself the decedent is considered as having a power_of_appointment however the mere power of management investment custody of assets or the power to allocate receipts and disbursements as between income and principal exercisable in a fiduciary capacity whereby the holder has no power to enlarge or shift any of the beneficial interests therein except as an incidental consequence of the discharge of the fiduciary duties is not a power_of_appointment sec_2514 provides that the exercise or release of a general_power_of_appointment created after date shall be deemed a transfer of property by the individual possessing such power sec_2514 provides that a general_power_of_appointment is a power that is exercisable in favor of the individual possessing the power the possessor his estate his creditors or the creditors of his estate however a power to consume invade or appropriate property for the benefit of the posessor that is limited by an ascertainable_standard relating to the health education support or maintenance of the decedent shall not be deemed a general_power_of_appointment sec_25_2514-1 of the gift_tax regulations provides in part that a donee may have a power_of_appointment if he has the power to remove or discharge a trustee and appoint himself for example if under the terms of the instrument the trustee or his successor has the power to appoint the principal of the trust for the benefit of individuals including himself and a has the unrestricted power to remove or discharge the trustee at any time and appoint any other person including himself a is considered as having a power_of_appointment however the mere power of management investment custody of assets or the power to allocate receipts and disbursements as between income and principal exercisable in a fiduciary capacity whereby the holder has no power to enlarge or shift any of the beneficial interests therein except as an incidental consequence of the discharge of the fiduciary duties is not a power_of_appointment in revrul_95_58 1995_2_cb_191 the service ruled that a decedent grantor's reservation of an unqualified power to remove a trustee and to appoint an individual or corporate successor trustee that is not related or subordinate to the decedent within the meaning of sec_672 is not considered a reservation of the trustee's discretionary powers of distribution over the property transferred by the decedent grantor to the trust accordingly the trust corpus is not included in the decedent's gross_estate under sec_2036 or sec_2038 plr-115975-16 sec_672 defines the term related_or_subordinate_party to mean any nonadverse_party who is the grantor's spouse if living with the grantor or any one of the following the grantor's father mother issue brother or sister an employee of the grantor a corporation or any employee of a corporation in which the stock holdings of the grantor and the trust are significant from the viewpoint of voting control a subordinate employee of a corporation in which the grantor is an executive in this case none of the proposed modifications affect the dispositive provisions of trust at all times both before and after the proposed modifications no son or other issue of settlor who may at any time be serving as trustee may participate in any decision relating to the discretionary distributions of income or principal under the proposed modification at all times there is to be an independent_trustee of each separate trust a son of settlor may remove a trustee and must replace that trustee with an independent_trustee the son of settlor may not participate in any way with the selection of a non-independent trustee furthermore in the case of the son’s death or disability only the appointment person may appoint an independent_trustee son’s power to remove and replace a trustee is equivalent to the power referenced in revrul_95_58 where a replacement trustee may not be related or subordinate to the powerholder within the meaning of sec_672 accordingly based on the facts submitted and the representations made we conclude that the proposed modifications to trust will not constitute the grant of a general_power_of_appointment under sec_2041 and sec_2514 and thus the assets of trust will not be includible in son’s gross_estate at death and will not be deemed to be transferred by son for gift_tax purposes ruling sec_2 and sec_2601 imposes a tax on every gst made after date a gst is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_2612 provides that the term taxable_termination means a termination by death lapse of time release of a power or otherwise of an interest in property held in a_trust unless a immediately after such termination a non-skip_person has an interest in such property or b at no time after such termination may a distribution including distributions on termination be made from such trust to a skip_person sec_2612 provides that the term taxable_distribution means any distribution from a_trust to a skip_person other than a taxable_termination or a direct_skip under a of the tax_reform_act_of_1986 act and sec_26_2601-1 of the gst tax regulations the gst tax is generally applicable to generation-skipping transfers made after date however under b a of the act and sec_26_2601-1 the gst tax does not apply to a transfer under a_trust that was plr-115975-16 irrevocable on date but only to the extent that such transfer is not made out of corpus added to the trust after date or out of income attributable to corpus so added under sec_26_2601-1 any trust in existence on date will be considered irrevocable unless the settlor had a power that would have caused inclusion of the trust in his or her gross_estate under sec_2038 or sec_2042 if the settlor had died on date sec_26_2601-1 provides in relevant part that for purposes of chapter a constructive_addition under sec_26_2601-1 is treated as an addition to a_trust sec_26_2601-1 provides in relevant part that except as provided under sec_26_2601-1 where any portion of a_trust remains in the trust after the post date release exercise or lapse of a power_of_appointment over that portion of the trust and the release exercise or lapse is treated to any extent as a taxable transfer under chapter or chapter the value of the entire portion of the trust subject_to the power that was released exercised or lapsed is treated as if that portion had been withdrawn and immediately retransferred to the trust at the time of the release exercise or lapse sec_26_2601-1 provides in relevant part that the release exercise or lapse of a power_of_appointment other than a general_power_of_appointment as defined in sec_2041 will not be treated as an addition to a_trust if the power_of_appointment was created in an irrevocable_trust that is not subject_to chapter under sec_26_2601-1 sec_26_2601-1 provides rules for determining when a modification judicial construction settlement agreement or trustee action with respect to a_trust that is exempt from the gst tax under paragraph b or of this section hereinafter referred to as an exempt trust will not cause the trust to lose its exempt status in general unless specifically provided otherwise the rules contained in this paragraph are applicable only for purposes of determining whether an exempt trust retains its exempt status for gst tax purposes thus unless specifically noted the rules do not apply in determining for example whether the transaction results in a gift subject_to gift_tax or may cause the trust to be included in the gross_estate of a beneficiary or may result in the realization of gain for purposes of sec_1001 sec_26_2601-1 provides that a modification of the governing instrument of an exempt trust including a trustee distribution settlement or construction that does not satisfy paragraph b i a b or c of this section by judicial reformation or nonjudicial reformation that is valid under applicable state law will not cause an exempt trust to be subject_to the provisions of chapter if the modification does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held plr-115975-16 the beneficial_interest prior to the modification and the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust sec_26_2601-1 provides that for purposes of this section a modification of an exempt trust will result in a shift in beneficial_interest to a lower generation beneficiary if the modification can result in either an increase in the amount of a gst transfer or the creation of a new gst transfer to determine whether a modification of an irrevocable_trust will shift a beneficial_interest in a_trust to a beneficiary who occupies a lower generation the effect of the instrument on the date of the modification is measured against the effect of the instrument in existence immediately before the modification if the effect of the modification cannot be immediately determined it is deemed to shift a beneficial_interest in the trust to a beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification a modification that is administrative in nature that only indirectly increases the amount transferred for example by lowering administrative costs or income taxes will not be considered to shift a beneficial_interest in the trust in sec_26_2601-1 example considers the following situation in settlor established an irrevocable_trust for the benefit of settlor's issue naming a bank and five other individuals as trustees in the appropriate local court approves a modification of the trust that decreases the number of trustees which results in lower administrative costs the modification pertains to the administration of the trust and does not shift a beneficial_interest in the trust to any beneficiary who occupies a lower generation as defined in sec_2651 than the person or persons who held the beneficial_interest prior to the modification in addition the modification does not extend the time for vesting of any beneficial_interest in the trust beyond the period provided for in the original trust therefore the trust will not be subject_to the provisions of chapter in this case trust was created funded and became irrevocable prior to date it is represented that there have been no additions actual or constructive since that date son’s rights under the proposed modification to remove any trustee and to appoint a successor to such trustee provided that any trustee so appointed shall be an independent_trustee should not be considered a constructive_addition to any trust because such rights do not constitute a general_power_of_appointment within the meaning of sec_2041 and sec_2514 the changes are administrative in nature under sec_26_2601-1 and will not be considered to shift a beneficial_interest to a lower generation in the trust see example of sec_26_2601-1 the changes will not result in a shift in any beneficial_interest to a lower generation nor do the changes extend the time for vesting of any beneficial_interest in trust accordingly based upon the facts submitted and the representations made we conclude that the proposed modifications to trust will not constitute a constructive_addition to trust under sec_2601 and will not affect the exempt status of plr-115975-16 trust for gst tax purposes we also conclude that the proposed modifications to trust will not cause distributions from or the termination of any interest in trust to be subject_to gst tax in accordance with the power_of_attorney on file with this office we have sent a copy of this letter to your authorized representatives except as expressly provided herein we neither express nor imply any opinion concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter 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 provides that it may not be used or cited as precedent sincerely lorraine e gardner lorraine e gardner senior counsel branch office of the associate chief_counsel passthroughs and special industries enclosures copy for sec_6110 purposes copy of this letter


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 psi plr-123792-10 date date legend legend taxpayer subsidiary firm date date date state state year year year year ----------------------------------------------------------- ---------------------------------------------------- ---------------------------------------- -------------------------- -------------------------- -------------------------- ------------- ---------- ------- ------- ------- ------- dear ------------------- this letter responds to a letter dated ----------------- from taxpayer’s representative requesting permission pursuant to sec_301_9100-1 and sec_301_9100-3 of the procedure and administration regulations for an extension of time to make an election under sec_59 of the internal_revenue_code code and sec_1_59-1 of the income_tax regulations to amortize intangible_drilling_and_development_costs idcs and exploration_costs ecs for the taxable years ending date date and date taxpayer requests permission on behalf of its wholly owned subsidiary with which taxpayer files a consolidated federal_income_tax return according to the information submitted taxpayer is a public company incorporated in state in year with its principal_place_of_business in state taxpayer designs develops builds owns and operates geothermal power plants and recovered energy-based power plants worldwide subsidiary was founded in year and in year subsidiary began to incur idcs and ecs in its geothermal operations subsidiary did not incur any idcs prior to year plr-123792-10 taxpayer engaged firm to prepare consolidated tax returns for taxable years ending date date and date firm represents that it was unaware that taxpayer or subsidiary incurred any idcs or ecs in its business operations at the time of filing the returns as a result taxpayer did not timely make the election under sec_59 for any of the taxable years ending date date or date firm discovered the existence of idcs and ecs in year during a detailed analysis of taxpayer’s business projects and subsequently advised taxpayer to seek an extension of time to file the sec_59 elections under sec_301_9100-1 and sec_301_9100-3 of the procedure and administration regulations firm represents that if it had all of the documentation and data needed to make an informed recommendation at the time the original returns were prepared firm would have advised taxpayer to make sec_59 elections for tax years ending date date and date taxpayer represents that granting the relief requested will not result in taxpayer having a lower tax_liability in the aggregate for the tax years affected by the election than taxpayer would have had if the election had been timely made taking into account the time_value_of_money taxpayer represents that it acted in good_faith and that granting relief will not result in prejudice to the interests of the government law and analysis sec_59 allows a taxpayer to deduct ratably over a specified period any qualified_expenditure to which an election under sec_59 applies sec_59 includes in the definition of qualified_expenditure any amount which but for an election under sec_59 would have been allowable as a deduction determined without regard to sec_291 for the taxable_year in which paid_or_incurred under sec_263 relating to intangible drilling and development_expenditures and sec_617 relating to mining_exploration_expenditures sec_59 allows the taxpayer to deduct ratably over the year period beginning with the taxable_year in which such expenditure was made or in the case of a qualified_expenditure for intangible drilling and development_expenditures to deduct the expenditure ratably over the month period beginning with the month in which such expenditure was paid_or_incurred sec_59 specifically prohibits the deduction of the qualified_expenditures under any other section of the code if this option is elected sec_59 allows a taxpayer to make an election under sec_59 for any portion of any qualified_expenditure sec_1_59-1 prescribes the time and manner of making the sec_59 election according to sec_1_59-1 an election under sec_59 shall only be plr-123792-10 made by attaching a statement to the taxpayer's income_tax return or amended_return for the taxable_year in which the amortization of the qualified_expenditures subject_to the sec_59 election begins the taxpayer must file the statement no later than the date prescribed by law for filing the taxpayer's original income_tax return including any extensions of time for the taxable_year in which the amortization of the qualified_expenditures subject_to the sec_59 election begins sec_263 allows a taxpayer an election under regulations prescribed by the secretary to deduct idcs the regulations appear under sec_1_612-4 under sec_1 d the taxpayer may exercise the election by claiming idcs as a deduction on the taxpayer's return for the first taxable_year in which the taxpayer pays or incurs such costs no formal statement is necessary but if the taxpayer fails to deduct the idcs the taxpayer is deemed to have elected to recover such costs through depletion to the extent that they are not represented by physical property and through depreciation to the extent that they are represented by physical property sec_617 allows a taxpayer an election to deduct expenditures paid_or_incurred during the taxable_year for the purpose of ascertaining the existence location extent or quality of any deposit of ore or other mineral and paid_or_incurred before the beginning of the development stage of mine under sec_1_617-1 the taxpayer may exercise the election by deducting exploration_expenditures either in the taxpayer’s return for such taxable_year or in an amended_return filed before the expiration of the period for filing a claim for credit or refund of income_tax for such taxable_year sec_1_617-1 requires a taxpayer who makes an election to deduct to state clearly on his income_tax return for each taxable_year for which he deducts exploration_expenditures the amount of the deduction claimed under sec_617 with respect to each property or mine under sec_301_9100-1 of the procedure and administration regulations the commissioner in exercising the commissioner's discretion may grant a reasonable extension of time under the rules set forth in sec_301_9100-2 and sec_301_9100-3 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 code except subtitles e g h and i sec_301_9100-2 and sec_301_9100-3 provide the standards the 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 allows automatic extensions of time for making certain elections sec_301_9100-3 allows extensions of time for making elections that do not meet the requirements of sec_301_9100-2 plr-123792-10 the commissioner will grant requests for relief under sec_301_9100-3 when the taxpayer provides the evidence including affidavits described in sec_301_9100-3 to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and the grant of relief will not prejudice the interests of the government sec_301_9100-3 sec_301_9100-3 provides in part that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer requests relief under sec_301_9100-3 before the failure to make the regulatory election is discovered by the internal_revenue_service and the taxpayer failed to make the election because after exercising reasonable diligence taking into account the taxpayer's experience and the complexity of the return or issue the taxpayer was unaware of the necessity for the election sec_301_9100-3 provides in part that the government's interest is considered prejudiced if granting relief would result in a taxpayer having a lower tax_liability in the aggregate of all taxable years affected by the election than the taxpayer would have had if the election had been timely made taking into account the time_value_of_money based solely on the information submitted and the representations made we conclude that the requirements of sec_301_9100-1 through have been satisfied accordingly the commissioner grants taxpayer an extension of time of days from the date of this letter to make the election under sec_59 on the tax returns for years ending on date date and date with the appropriate service_center the rulings contained in this letter are based upon information and representations submitted by taxpayer and taxpayer’s representative and accompanied by a penalty of perjury statements executed by the appropriate parties 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 specifically set forth above we express no opinion concerning the federal tax consequences of the facts described above under any other provision of the code and the regulations thereunder specifically we express no opinion concerning whether taxpayer satisfies the requirements of sec_263 sec_617 or sec_59 this letter_ruling is directed only to the taxpayer who requested it under sec_6110 a letter_ruling may not be used or cited as precedent in accordance with the power_of_attorney on file with this office we are sending a copy of this ruling letter to your authorized representative we also are sending a copy of this letter to the appropriate industry director lmsb a copy of this ruling must be plr-123792-10 attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling sincerely associate chief_counsel passthroughs special industries by ______________________ jaime c park senior technician reviewer branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy for sec_6110 purposes


internal_revenue_service national_office technical_advice_memorandum date third party communication none date of communication not applicable index uil no case-mis no number release date ------------------------ ------------------------------- 263a 263a tam-146711-05 taxpayer's name taxpayer's address taxpayer's identification no year s involved date of conference legend --------------------------------------------------------------- --------------------------------------------------------------- ---------------------- -------------------------- --------------------------- ---------------- ----------------------------- -------------------------- ------------------------------------------- ----------------------------- ------------------------------------- -------- ---------------- ---------------- ------------------------ ----------------- taxpayer foreign parent subsidiary country a product x product y product z date --------------------------------- tam-146711-05 agreement --------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------------- year year year year ----------------------------------------------- ----------------------------------------------- ----------------------------------------------- ----------------------------------------------- issues whether subsidiary is required to capitalize royalties under sec_263a whether subsidiary’s treatment of royalty expense constitutes capitalization within the meaning of sec_263a whether subsidiary changed its method_of_accounting for royalties when after reporting them as an expense on line of its form_1120 it began to include them as costs of goods sold reflected on schedule a of its form_1120 whether royalties should have been included in additional sec_263a costs allocated to equivalent units under subsidiary’s allocation method whether subsidiary’s equivalent units of production eup method and its partial conversion of unassigned raw material to equivalent units of finished goods is a proper method for allocating costs to property produced if subsidiary’s method of capitalizing costs under sec_263a is improper whether the commissioner may require use of the simplified_production_method conclusions subsidiary is required to capitalize royalties under sec_263a subsidiary’s treatment of royalty expense did not constitute capitalization within the meaning of sec_263a given that subsidiary did not capitalize royalties under sec_263a and it was required to capitalize such royalties under sec_263a we need not address the issue tam-146711-05 of whether or not subsidiary made an unauthorized change in method_of_accounting subsidiary was not required to allocate royalties under its eup allocation method we have insufficient facts to reach a conclusion as to the reasonableness of subsidiary’s eup method since subsidiary’s method of capitalizing costs under sec_263a is improper the commissioner may place subsidiary on any reasonable method including the simplified_production_method facts foreign parent fp a corporation organized and existing under the laws of country a owns of the stock of taxpayer a corporation organized under the laws of the united_states taxpayer owns nearly all of the stock of subsidiary which is also a corporation organized under the laws of the united_states fp and its subsidiaries develop manufacture distribute and provide financing for the sale of fp’s products including product x product y and product z collectively products as well as related parts in connection with this business fp has acquired and developed industrial property rights quality standards and manufacturing and other information and know-how relating to such products fp has granted taxpayer the exclusive right to distribute fp’s products in substantially_all areas of the united_states and the exclusive right and license to use the trademarks of fp therein subsidiary has been established for the purpose of manufacturing producing and assembling products and related parts for sale to taxpayer taxpayer purchases from subsidiary such products bearing the trademarks of fp so as to enable taxpayer more effectively and efficiently to provide products and related parts in the u s market effective date fp and subsidiary entered into the agreement the agreement was in effect during each of the periods under audit under the agreement fp granted to subsidiary an indivisible non-transferable and non-exclusive right and license to manufacture produce and assemble in the united_states or to have manufactured produced and assembled for it in the united_states by parties not otherwise entitled to do so the products and related parts for sale primarily to taxpayer under the intellectual_property rights and by using the technical information in accordance with the agreement tam-146711-05 subsidiary was to pay a royalty as consideration for the rights and licenses granted under the agreement the royalty itself was based on these various rights described above in the agreement however the amount of the royalty was calculated using the number of units of products sold by subsidiary to taxpayer during each calendar month for each unit sold the royalty was increased by an agreed upon amount representing a percentage of the domestic value added the domestic value added for each product was determined yearly and represented the difference between the weighted average of taxpayer’s -------- prices for all types of that item for the year and the weighted average of the planned cost of parts in all types of that product for the year the royalty was payable for sales by subsidiary to taxpayer during each calendar month the intellectual_property rights and technical information were utilized by subsidiary in all units and parts produced including those that remained on hand at the end of each of the taxable years at issue in addition subsidiary used the intellectual rights and technical information in performing production activities for book purposes subsidiary accrues an expense each month for royalties due to fp based on the number of units sold under the rules of sec_267 subsidiary deferred deduction of the royalty for federal_income_tax purposes until payment was made to fp subsidiary identifies its method of capitalizing sec_263a costs to inventory as a facts and circumstances method under sec_1_263a-1 subsidiary deducted all of the royalty fees paid in each period under audit the royalties were reported on line other deductions in the year and year tax returns the royalties were reported on line other costs of the schedule a in the year and year tax returns however no amount of royalty expense was capitalized to any of the items in ending inventory for year or year subsidiary used an equivalent units of production eup method to allocate additional sec_263a costs to ending inventory however it did not include royalty expense as one of the costs allocated under its eup method in addition subsidiary did not under its eup method allocate any additional sec_263a costs to its in-transit raw materials applicable law sec_263a provides that the direct costs and indirect_costs properly allocable to property that is inventory in the hands of the taxpayer must be included in inventory costs tam-146711-05 sec_1_263a-1 of the income_tax regulations provides in part that taxpayers that produce tangible_personal_property must capitalize all direct costs of producing the property and the property’s properly allocable share of indirect_costs sec_1_263a-1 provides that to determine these capitalizable costs taxpayers must allocate or apportion costs to various activities including production activities sec_1_263a-1 further provides that after sec_263a costs are allocated to the appropriate production activities these costs generally are allocated to the items of property produced during the taxable_year and capitalized to the items that remain on hand at the end of the taxable_year as a result costs incurred during the taxable_year are either included in the cost_of_goods_sold during the taxable_year or are capitalized to the items that remain on hand at the end of the taxable_year using a method permitted under sec_1_263a-1 sec_1_263a-1 provides that the amount of any cost required to be capitalized under sec_263a may not be included in inventory or charged to capital accounts or basis any earlier than the taxable_year during which the amount is incurred within the meaning of sec_1_446-1 sec_1_263a-1 provides that capitalize means in the case of property that is inventory in the hands of a taxpayer to include in inventory costs sec_1_263a-1 provides that costs that are capitalized under sec_263a are recovered through depreciation amortization cost_of_goods_sold or by an adjustment to basis at the time the property is used sold placed_in_service or otherwise_disposed_of by the taxpayer sec_1_263a-1 provides in part that indirect_costs are properly allocable to property produced when the costs directly benefit or are incurred by reason of the performance of production activities sec_1_263a-1 provides examples of indirect_costs that must be capitalized to the extent they are properly allocable to property produced indirect_costs required to be capitalized include licensing and franchise costs incurred in securing the contractual right to use a trademark corporate plan manufacturing procedure special recipe or other similar right associated with property produced see sec_1_263a-1 sec_1_263a-1 sets forth various detailed or specific facts-and-circumstances cost allocation_methods that taxpayers may use to allocate direct and indirect_costs to property produced and property acquired for resale in lieu of a facts-and-circumstances allocation method sec_1_263a-1 authorizes taxpayers to use the simplified methods provided in sec_1_263a-2 and sec_1_263a-3 to allocate direct and indirect_costs to eligible_property produced tam-146711-05 sec_1_263a-1 provides that a taxpayer may use a facts-and-circumstances allocation method if it is a reasonable allocation method in addition a taxpayer may use any other reasonable method to allocate direct and indirect_costs among units of property produced or acquired for resale during the taxable_year an allocation method is reasonable if i the total costs actually capitalized during the taxable_year do not differ significantly from the aggregate costs that would be properly capitalized using another permissible method described in sec_1_263a-1 sec_1_263a-2 or sec_1_263a-3 with appropriate consideration given to the volume and value of the taxpayer's production or resale activities the availability of costing information and the time and cost of using various allocation_methods and the accuracy of the allocation method chosen as compared with other allocation_methods ii the allocation method is applied consistently by the taxpayer and iii the allocation method is not used to circumvent the requirements of the simplified methods provided in sec_1_263a-1 sec_1_263a-2 or sec_1_263a-3 or the principles of sec_263a sec_1_263a-2 provides that producers must capitalize direct and indirect_costs properly allocable to property produced under sec_263a without regard to whether those costs are incurred before during or after production sec_1_263a-2 provides the simplified_production_method for allocating the additional sec_263a costs to ending inventories of property produced and other eligible_property on hand at the end of the taxable_year sec_1_263a-2 provides that except as otherwise provided in sec_1 263a- b ii the simplified_production_method if elected for any trade_or_business of a producer must be used for all production and resale activities associated with designated categories of property to which sec_263a applies sec_267 provides generally that a taxpayer may not deduct any amount owed to a related_party as defined in sec_267 until it is includible in the payee’s gross_income sec_267 states that t he secretary shall by regulations apply the matching principle of paragraph in cases in which the person to whom the payment is to be made is not a united_states_person sec_446 provides that if no method_of_accounting has been regularly used by the taxpayer or if the method used does not clearly reflect income the computation of tam-146711-05 taxable_income shall be made under such method as in the opinion of the secretary does clearly reflect income sec_446 requires that a taxpayer obtain the consent of the secretary prior to changing its method_of_accounting from the basis for which taxable_income is regularly computed to a new method analysis whether subsidiary is required to capitalize royalties under sec_263a sec_1_263a-1 generally requires taxpayers to capitalize the direct costs and a properly allocable share of indirect_costs to the property they produce indirect_costs are all costs other than direct_material_costs and direct_labor_costs in the case of property produced indirect_costs are properly allocable to property produced when the costs directly benefit or are incurred by reason of the performance of production activities sec_1_263a-1 sec_1_263a-1 specifically cites licensing and franchise costs as examples of indirect_costs required to be capitalized licensing and franchise costs include fees incurred in securing the contractual right to use a trademark corporate plan manufacturing procedure special recipe or other similar right associated with property produced or property acquired for resale these costs include the otherwise deductible portion eg amortization of the initial fees incurred to obtain the license or franchise and any minimum annual payments and royalties that are incurred by a licensee or franchisee in plastic engineering technical services inc v commissioner t c memo the tax_court dealt directly with the issue of whether under sec_263a the taxpayer was required to capitalize royalties paid for the right to manufacture and sell an assembly system the tax_court in concluding that the royalty payments were required to be capitalized under sec_263a stated u nder the statute and regulations indirect_costs that is costs other than direct materials costs and direct_labor_costs or acquisition costs must be capitalized if properly allocable to property produced sec_1 263a- e ii income_tax regs further the regulations give as an example of an indirect_cost required to be capitalized licensing and franchise costs sec_1_263a-1 income_tax regs the language found in the regulations speaks directly to petitioner’s license of the patented manufacturing process and the royalties incurred in securing that license tam-146711-05 id in this case the agreement grants subsidiary the rights to use fp’s intellectual_property including patents design patents trademarks service marks and copyrights know-how and technical information subsidiary uses the rights granted in the agreements in performing its production activities to produce each product and the related parts the royalties subsidiary pays to fp for the rights under the agreement are licensing and franchise costs as defined by sec_1_263a-1 the rights directly benefit subsidiary’s activities in producing the products as well as the related parts consequently the royalties for subsidiary’s rights under the agreement are indirect_costs that are properly allocable to property produced and must be capitalized under sec_263a whether subsidiary’s treatment of royalty expense constitutes capitalization within the meaning of sec_263a the royalties were reported on line other deductions in the year and year tax returns and on line other costs of the schedule a in the year and year tax returns on its face it would appear that in year sec_1 and subsidiary was deducting royalties as a period expense then in year sec_3 and subsidiary appeared to be capitalizing royalties to inventory but allocating the entire amount to cost_of_goods_sold and none to ending inventory subsidiary claims that it was capitalizing royalties to inventory all along using a specific_identification_method as provided in sec_1_263a-1 that allocated royalties only to products that were sold during the year subsidiary further claims that it had inadvertently made posting errors in year sec_1 and by reporting royalties on its return as a period expense in support of this position subsidiary argues that the change in treatment from year to year was not a change in method_of_accounting since it had no effect on its calculations or on its net_income for the years in question the amount of royalty expense that subsidiary is permitted to take into account for federal_income_tax purposes is determined based upon the vehicles sold during the year thus the computation of the amount of royalty expense incurred for the taxable_year is unaffected by subsidiary’s method_of_accounting further whether that amount is deducted on line or included entirely in cost_of_goods_sold has no bottom line effect on subsidiary’s taxable_income taxable_income is the same either way subsidiary notes that allocation of an inventory cost entirely to cost_of_goods_sold does constitute capitalization under sec_263a subsidiary concludes that because there is no difference in taxable_income between deducting a cost as a period expense and including it in cost_of_goods_sold its method was capitalization under sec_263a capitalize means to include in inventory costs see sec_1 263a- c costs that are included in inventory costs under sec_263a are recovered tam-146711-05 through cost_of_goods_sold see sec_1_263a-1 thus whether a capitalized cost remains in ending inventory or is included in cost_of_goods_sold is determined by the taxpayer’s inventory_accounting method sec_1_263a-1 provides various methods of cost allocation which taxpayers may use to allocate direct and indirect_costs to property produced or held for resale one such permissible method is a specific_identification_method see sec_1_263a-1 whether a method constitutes capitalization is a separate issue from whether a method of capitalization is reasonable and thus permissible thus a taxpayer including a cost in inventory is capitalizing that cost even if the cost is allocated entirely to cost_of_goods_sold such a capitalization method may or may not be reasonable depending upon whether it satisfies the requirements of a reasonable allocation method in sec_1 263a- f given that an allocation of a cost entirely to cost_of_goods_sold does constitute capitalization the next issue is whether subsidiary’s method was in fact to include royalties in inventory costs and to allocate royalties to cost_of_goods_sold in year the first year under examination the question of which accounting_method is used by the taxpayer is one of fact 97_tc_120 citing 243_f2d_466 9th cir peninsula steel products equipment co v commissioner t c pincite the fact that subsidiary labeled royalties as a period expense rather than as an item of inventory cost in year is relevant but not dispositive the supreme court in 282_us_92 dealt with the issue of whether a taxpayer was using an overall accrual_method or the cash_receipts_and_disbursements_method of accounting but whether a return is made on the accrual basis or on that of actual receipts and disbursements is not determined by the label which the taxpayer chooses to place upon it the use of inventories and the inclusion in the returns of accrual items of receipts and disbursements appearing on petitioner's books indicate the general and controlling character of the account and support the finding of the trial_court that books and returns were on the accrual basis id pincite generally a question concerning the identity of an accounting_method used by a taxpayer is resolved by examining the manner in which the method operates and by classifying that manner of operation under the recognized method it most closely resembles hamilton pincite in this case subsidiary’s treatment of royalties could be consistent with a capitalization method however it is also clearly consistent with the method of deducting the item as a period expense subsidiary argues as evidence that it was capitalizing royalties all tam-146711-05 along that the change in treatment from year to year had no effect on its calculations or on its net_income for the years in question however even assuming that to be the case there is also no indication that the calculations or net_income would have changed if subsidiary were originally deducting royalties and then in year began allocating the entire amount to cost_of_goods_sold further while it is possible to have a reasonable capitalization method which allocates the entire amount of a cost to cost_of_goods_sold capitalization in the vast majority of cases involves the allocation of some portion of items of cost to ending inventory subsidiary’s treatment is consistent only with a small minority of cases in which costs are capitalized and the treatment is not consistent with the manner in which capitalization of an item most commonly operates subsidiary’s treatment is however perfectly consistent with the manner in which deduction of an item as a period expense most commonly operates given these facts as well as the label chosen by subsidiary itself for the item its treatment of royalties most closely resembles the method of deduction as a period expense consequently we conclude that subsidiary’s actual method_of_accounting for the royalty expense as of year is deduction as a period expense since subsidiary was deducting it as a period expense as of year subsidiary was not capitalizing royalty expense within the meaning of sec_263a whether taxpayer changed its method_of_accounting for monthly royalties when after including them as royalty expense on line of its form_1120 taxpayer began to include them as costs of goods sold reflected on schedule a of its form_1120 given that subsidiary did not capitalize royalties under sec_263a as of year and it was required to capitalize such royalties under sec_263a we need not address the issue of whether or not subsidiary made an unauthorized change in method_of_accounting whether royalties should have been included in additional 263a costs allocated to equivalent units under taxpayer’s allocation method there is no requirement in sec_263a or the regulations thereunder that a taxpayer using a facts-and-circumstances method of allocating costs must use the same method or cost objective for each cost allocated to inventory under sec_263a in fact the regulations specifically contemplate such differences for example sec_1_263a-1 provides in part that a taxpayer may allocate different indirect_costs on the basis of different burden rates also sec_1_263a-1 provides that a specific_identification_method traces costs to a cost objective such as a function department activity or product on the basis of a cause and effect or other tam-146711-05 reasonable relationship between the costs and the cost objective typically not every cost will be traceable to the exact same function department activity or product as the regulations allow taxpayers to allocate different costs using different cost objectives subsidiary is not required to use the same method of allocating royalties as for other expenses for which it uses an eup method consequently subsidiary was not required to allocate royalties under its eup allocation method whether the equivalent units method and its partial conversion of unassigned raw material to equivalent units of finished goods is a proper method for allocating costs to property produced there are two aspects to this issue the first involves the treatment of in-transit raw materials and the second aspect involves the appropriateness of subsidiary’s eup method in general in regard to the in-transit raw materials both subsidiary and the field agree that subsidiary is not under its eup method allocating any additional sec_263a costs to these materials however it is not clear to what extent if any subsidiary may be allocating some or all of such costs or other costs using a method other than its eup method the field has argued that subsidiary is not allocating any additional sec_263a costs to its in-transit raw materials the taxpayer argues that the in-transit raw materials are not required to be included in the eup computation because the indirect_costs allocable to the in-transit raw materials already are included in the cost of the in-transit raw materials for book and tax purposes while subsidiary is clearly required under sec_263a to allocate an appropriate amount of direct and indirect_costs related to the in-transit raw materials we have insufficient information on the costs involved and the extent if any to which subsidiary is already allocating the costs to make a determination on this aspect of the issue as to subsidiary’s eup in general prior to the enactment of sec_263a the tax_court in 78_tc_705 recognized the equivalent units of production eup method as the service had applied it to the particular facts of that case the method as described in that case was as follows to compute the portion of factory overhead and the allocation of direct labor to the finished goods and work in process respondent examined the costs of operating petitioner's manufacturing facilities then after adding all the production_costs together respondent divided that total by the equivalent units of production the factor was then included in valuing the finished pants and the work-in-process inventory under the full absorption method_of_accounting for all years tam-146711-05 id pincite each completed pair of pants is considered one equivalent unit if a pair of pants is in process and is half completed it is one half of an equivalent unit thus if there are big_number items in process that are 50-percent completed there are big_number equivalent units id pincite n while primo pants predated the enactment of sec_263a such prior methods were contemplated in the enactment of the section and the regulations thereunder the preamble to the temporary regulations under sec_263a discussed how taxpayers producing property must allocate additional costs required to be capitalized under that section to property on hand at the end of the taxable_year taxpayers producing inventory_property may elect a simplified_method of accounting for the costs required to be allocated under the temporary regulations the simplified_production_method absent the election of the simplified_production_method taxpayers are required to allocate additional costs required to be capitalized under sec_263a with the same degree of specificity as was required of inventoriable costs under prior_law t d 1987_1_cb_98 as the eup method was recognized under the prior_law given the specificity requirements in existence at the time such a method of allocating costs may be considered reasonable currently if it meets the requirements of sec_263a and the regulations thereunder any method other than one of the specifically authorized simplified methods must meet the reasonableness requirements of sec_1_263a-1 in order to be permissible sec_1_263a-1 provides in part that one of the requirements for an allocation method to be reasonable is that the allocation method is not used to circumvent the requirements of the simplified methods provided in sec_1_263a-1 sec_1_263a-2 or sec_1_263a-3 or the principles of sec_263a one important factor in determining the appropriateness of an eup method is the similarity of the units of inventory to which the costs are allocated process-costing techniques are used for inventory costing when there is continuous mass production of like units charles t horngren cost accounting a managerial emphasis prentice-hall 3rd ed the similarity of the units produced is significant because if the production of product x incurs significantly more costs than the production of product y it would not be reasonable to allocate the same amount of costs to a percent completed unit of one as to a percent completed unit of the other another important factor is the rate at which costs are incurred over the process of completing a unit a process costing system operates under the rough assumption that all conversion costs are incurred uniformly in proportion to the degree of product completion id it is not expected or required in order to determine that an eup tam-146711-05 method would be reasonable that there be an absolutely uniform rate at which costs are incurred across the production process however the extent to which costs are incurred unevenly throughout the production process is an important consideration in evaluating the reasonableness of a particular eup method products x y and z are significantly different from each other and those differences would seem to lead to considerable differences in the amount of costs attributable to the production of each product and possible differences in the rate at which costs are incurred as well unfortunately we have insufficient facts regarding the similarity of the products produced the relative uniformity of costs incurred during the production process and other factors to make a determination as to the reasonableness of subsidiary’s eup method if taxpayer’s method of capitalizing costs under sec_263a is improper whether the commissioner may require use of the simplified_production_method sec_446 provides that if the taxpayer’s method_of_accounting does not clearly reflect income the computation of taxable_income shall be made under such method as in the commissioner’s opinion does clearly reflect income see also sec_1_446-1 the commissioner has broad powers in determining whether accounting methods used by a taxpayer clearly reflect income 360_us_446 1959_2_cb_460 once the commissioner determines that a taxpayer's method does not clearly reflect income he may select for the taxpayer a method which in his opinion does clearly reflect income sec_446 the taxpayer carries the burden of showing that the method selected by the commissioner is incorrect and such burden is extremely difficult to carry hamilton industries pincite citing 42_tc_926 affd 357_f2d_656 9th cir sec_446 vests the commissioner with wide discretion in determining whether a particular method_of_accounting clearly reflects income and a heavy burden is imposed upon the taxpayer to overcome a determination by the commissioner in this area 88_tc_1500 a method_of_accounting that is plainly inconsistent with valid regulations does not clearly reflect income within the meaning of sec_446 439_us_522 given that subsidiary was not properly capitalizing costs in accordance with the requirements of the code and regulations its method does not clearly reflect income the courts have consistently held that the commissioner's authority under sec_446 permits him to select the method_of_accounting the taxpayer must use once he has determined that a taxpayer's method does not clearly reflect income see thor power 71_f3d_209 6th cir 28_fedclaims_320 aff'd without op 22_f3d_1105 fed cir consequently if subsidiary does not use a permissible method of capitalizing costs under sec_263a commissioner may place subsidiary on any reasonable method_of_accounting including the simplified_production_method caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer s sec_6110 of the code provides that it may not be used or cited as precedent


internal_revenue_service department of the treasury index number washington dc number release date person to contact telephone number refer reply to cc intl br1-plr-112603-98 date date do ty a country b date c date d date e date f date g dear this is in response to a letter dated date submitted by a’s authorized representative requesting a ruling under sec_877 of the internal_revenue_code_of_1986 code that a’s loss of lawful permanent u s resident status did not have for one of its principal purposes the avoidance of u s taxes under subtitle a or subtitle b of the code additional information was submitted in letters dated date and date the information submitted for consideration is substantially as set forth below the ruling contained in this letter is based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination a was born in country b on date c a moved to the united_states in date d a became a lawful permanent resident_of_the_united_states in date e a moved back to country b in date f and has lived there ever since a relinquished his u s lawful plr-112603-98 permanent resident status expatriated on date g a and a’s parents were born in country b on the date of a’s expatriation a’s net_worth exceeded dollar_figure sec_877 generally provides that a citizen who loses u s citizenship or a u s long- term resident who ceases to be taxed as a lawful permanent resident individuals who expatriate within the 10-year period immediately preceding the close of the taxable_year will be taxed on u s source income as modified by sec_877 for such taxable_year unless such loss did not have for one of its principal purposes the avoidance of u s taxes sec_2107 and sec_2501 provide special estate and gift_tax regimes respectively for individuals who expatriate with a principal purpose to avoid u s taxes a former citizen or former long-term_resident will be treated as having expatriated with a principal purpose to avoid u s taxes for purposes of sec_877 sec_2107 and sec_2501 if the individual’s average income_tax_liability or the individual’s net_worth on the date of expatriation exceed certain thresholds see sec_877 sec_2107 and sec_2501 a former u s citizen whose net_worth or average tax_liability exceeds these thresholds however will not be presumed to have a principal purpose of tax_avoidance if that former citizen is described within certain statutory categories and submits a request for a ruling within one year of the date of loss of u s citizenship for the secretary’s determination as to whether such loss had for one of its principal purposes the avoidance of u s taxes see sec_877 sec_2107 and sec_2501 under notice_98_34 1998_27_irb_30 modifying notice_97_19 1997_1_cb_394 a former long-term_resident whose net_worth or average tax_liability exceeds the applicable thresholds will not be presumed to have a principal purpose of tax_avoidance if that former resident is described within certain categories and submits a complete and good_faith request for a ruling as to whether such loss had for one of its principal purposes the avoidance of u s taxes notice_98_34 requires that certain information be submitted with a request for a ruling that an individual’s expatriation did not have for one of its principal purposes the avoidance of u s taxes a is eligible to request a ruling pursuant to notice_97_19 because he is described in two categories of individuals eligible to submit ruling requests first on the date of a’s expatriation a was and continues to be a resident fully liable to income_tax in country b the country where a was born second a is eligible to submit a request because on the date of his expatriation a was and continues to be a resident fully liable to tax in country b the country where his parents were born a submitted all the information required by notice_97_19 as modified by notice_98_34 plr-112603-98 including any additional information requested by the service after review of the submission accordingly based solely on the information submitted and the representations made it is held that a has made a complete and good_faith submission in accordance with sec_877 and notice_98_34 therefore a will not be presumed to have as one of his principal purposes for expatriating the avoidance of u s taxes it is further held that a will not be treated under sec_877 as having as one of his principal purposes of expatriating the avoidance of u s taxes because the information submitted clearly establishes the lack of a principal purpose to avoid taxes under subtitle a or b 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 a copy of this letter must be attached to a’s u s income_tax return for the year in which a obtained the ruling whether or not a is otherwise required to file a return 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 the taxpayer sincerely _______________________ w edward williams senior technical reviewer branch office of the associate chief_counsel international cc plr-112603-98


internal_revenue_service department of the treasury number release date index number washington dc person to contact telephone number refer reply to cc psi b02-plr-103744-03 date date legend x d1 year dear this responds to a letter dated date and subsequent correspondence submitted on behalf of x requesting a ruling under sec_1362 of the internal_revenue_code x was incorporated on d1 of year the sole shareholder of x intended for x to be an s_corporation however no timely form_2553 election to be a small_business_corporation was filed sec_1362 of the code provides that if - a an election under sec_1362 is made for any taxable_year after the date prescribed by sec_1362 for making such election for such taxable_year or no such election is made for any taxable_year and b the secretary determines that there was reasonable_cause for the failure to timely make such election the secretary may treat such an election as timely made for such taxable_year based solely on the facts and the representations submitted we conclude that x has established reasonable_cause for failing to make a timely election to be an s_corporation for x’s first taxable_year accordingly provided that x makes an election to be an s_corporation by filing a completed form_2553 with the appropriate service_center plr-103744-03 effective for its year taxable_year within days following the date of this letter then such election will be treated as timely made for x’s year taxable_year a copy of this letter should be attached to the form_2553 except as specifically ruled upon above no opinion is expressed concerning the federal tax consequences of the facts described above under any other provisions of the code including whether x was or is a small_business_corporation under sec_1361 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 pursuant to the power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representative sincerely yours matthew lay senior technician reviewer branch associate chief_counsel passthroughs and special industries enclosures copy of this letter copy for sec_6110 purposes