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Interests in partnership investing in student loans treated as obligations in registered form

PLR 201614026

In a private letter ruling (PLR), IRS has concluded that interests in a partnership organized to invest in student loans using funds from domestic feeder and foreign feeder partnerships will be treated as being obligations in registered form for purposes of Code Sec. 163(f)(1).

Background. Under Code Sec. 163(f)(1), there’s no deduction for interest on any registration-required obligation unless the obligation is in registered form. A registration-required obligation is an obligation (including any obligation issued by a governmental entity) other than an obligation which (1) is issued by a natural person, (2) is not of a type offered to the public, or (3) has a maturity (at issue) of not more than one year. (Code Sec. 163(f)(2)) The purpose of the registration requirement for certain obligations is to prevent the under-reporting of tax on gains on sales on both taxable and tax-exempt securities. The requirement also ensures that certain securities will be sold (or resold in connection with the original issue) only to non-U. S. persons (see Reg. § 1.163-5(c)(1)(i))

A pass-through or participation certificate evidencing an interest in a pool of mortgage loans, which is treated as a trust of which the grantor is the owner (or similar evidence of interest in a similar pooled fund or pooled trust treated as a grantor trust) (“pass-through certificate”), may be treated as a registration-required obligation. This hold true if the pass-through certificate is described in Code Sec. 163(f)(2)(A) and Reg. § 1.163-5(c)(1) without regard to whether any obligation held by the fund or trust to which the pass-through certificate relates is described in Code Sec. 163(f)(2)(A) and Reg. § 1.163-5(c)(1). (Reg. § 1.163-5T(d)(1))

Under Reg. § 1.871-14, no tax is imposed under Code Sec. 871(a)(1)(A), Code Sec. 871(a)(1)(C), Code Sec. 881(a)(1), or Code Sec. 881(a(3) (relating to tax on nonresident aliens/foreign corporations on income not connected in with U.S. business) on any portfolio interest as defined in Code Sec. 871(h)(2), and Code Sec. 881(c)(2) received by a foreign person. Under Code Sec. 871(h)(2) and Code Sec. 881(c)(2), interest must be paid on an obligation that is in registered form to qualify as portfolio interest. The term “registered form” has the same meaning given the term by Code Sec. 163(f). Under Reg. § 1.871-14(c)(1)(i), the conditions for an obligation to be considered in registered form are identical to the conditions described in Reg. § 5f.103-1.

Under Reg. § 1.871-14(d)(1), interest received on a pass-through certificate qualifies as portfolio interest if the interest satisfies the conditions in Reg. § 1.871-14(c)(1)(i), without regard to whether any obligation held by the fund or trust to which the pass-through certificate relates is described in Reg. § 1.871-14(c)(1)(ii)). This only applies to payments made to the holder of the pass-through certificate from the trustee of the pass-through trust and does not apply to payments made to the trustee of the pass-through trust.

In general, an obligation is in registered form if:

  1. It is registered as to both principal and any stated interest with the issuer (or its agent) and the obligation may be transferred only by surrender of the old instrument and either the reissuance by the issuer of the old instrument to the new holder or the issuance by the issuer of a new instrument to the new holder;
  2. The right to the principal of, and stated interest on, the obligation may be transferred only through a book entry system maintained by the issuer (or its agent) as described in Reg. § 5f.103-1(c)(2); or
  3. The obligation is registered as to both principal and stated interest with the issuer (or its agent) and may be transferred through most of the methods described in (1) and (2) above. (Reg. § 5f.103-1(c)(1))

Under Reg. § 5f.103-1(c)(2), an obligation is considered transferable through a book entry system if the ownership of an interest in the obligation is required to be reflected in a book entry, whether or not physical securities are issued. A book entry is a record of ownership that identifies the owner of an interest in the obligation.

An investment trust with a single class of undivided beneficial interest in the trust assets is classified as a trust if there is no power under the trust agreement to vary the investment of the certificate holders. (Reg. § 301.7701-4(c)(1))

Facts. The PLR deals with a two-tier partnership set up to invest in student loans. It involves Taxpayer, an exempted company organized under Country law and owned directly by a State limited partnership (“Domestic Feeder”), and two exempted companies, each formed under the laws of Country and classified as a partnership for U.S. tax purposes (each a “Foreign Feeder”). The primary activity of Domestic Feeder and Foreign Feeders will be to raise money from U.S. and foreign investors to buy interests in Taxpayer, which will use the amounts it receives as capital contributions from the Feeders to acquire interests in a limited partnership to be organized under State law and treated as a partnership for federal income tax purposes.

Taxpayer will hold an approximately 99% interest in Partnership, which will acquire student loans, accept additional capital contributions and use principal pay-downs on the loans it holds to finance acquisition of additional student loans. As such, Partnership will have the power to vary the investments it holds. Taxpayer won’t operate in a way that will cause Foreign Feeders to be engaged in the conduct of a trade or business in the U.S. within the meaning of Code Sec. 871(b) or Code Sec. 888(a)(1).

Partnership use the capital contributions it receives from Taxpayer and other partners to acquire Student Loans in the secondary market. The Student Loans aren’t in registered form within the meaning of Reg. § 5f.103-1(c). Partnership will buy the Student Loans with the intent to hold them as capital assets for investment until maturity and won’t be a trader or dealer.

Taxpayer’s business purpose in creating this investment structure is to provide investors in the Feeders with the ability to invest in a pool of student loans and to receive a return on their investment that is above-market on a risk-adjusted basis. The investment structure enables investors to buy into a pool of student loans without incurring the significant administrative costs of creating multiple grantor trusts.

Partnership interests will be transferable only under procedures described in Reg. § 5f.103-1(c), and therefore are in registered form within the meaning of that reg. Specifically, the following procedures will be used for transfer of interests in the Partnership:

  • The general partner will be obligated to keep a full and accurate register of the interests in Partnership. Only those persons that are listed as partners on a “schedule of partners” will be entitled to a distributive share of Partnership’s income with respect to the Student Loans. The “schedule of partners” will be a schedule maintained by the general partners containing the following information for each partner in Partnership: name, address, date of admission, amount and date of all capital contributions, and the amount and date of any transfers to which the general partner consents.
  • The Partnership interest will be transferred only with written consent of the general partner, which the latter may withhold at its sole discretion. The transferee will become a member of Partnership only when the general partner enters the transferee’s name on the “schedule of partners.” The ownership of a Partnership interest will be reflected in a book entry that identifies the owner of an interest and will be transferable only through a book system maintained by Partnership and its general partner, in accordance with the requirements of Reg. § 5f.103-1(c). As a result, the right to receive a distributive share of Partnership’s income attributable to principal and interest with respect to the Student Loans will be transferable only through a book entry system maintained by Partnership, in accordance with the requirements of Reg. § 5f.103-1(c)(2).

Favorable ruling. On the facts, IRS ruled that the interests in Partnership are similar evidences of interest in a similar pooled fund within the meaning of Reg. § 1.163-5T(d)(1). If the requirements of Reg. § 5f.103-1(c)(1) are satisfied, the interests in Partnership will be considered obligations in registered form.

In arriving at this conclusion IRS pointed to these factors:

  • The Student Loans are not in registered form. Reg. § 1.163-5T(d)(1) provides that an interest (a “pass-through certificate”) in a trust that is treated as a grantor trust is considered to be an obligation in registered form if the pass-through certificate is in registered form “without regard to whether any obligation held by the fund or trust to which the pass-through certificate relates” is in registered form. Partnership is not as a grantor trust under Reg. § 301.7701-4(c)(1).
  • Partnership will acquire multiple Student Loans, hold the loans as a single pool of assets, and distribute income received on the pool of Student Loans to its partners as an aggregated stream of income, without regard to particular Student Loans in the pool. In this manner, the Student Loans held by Partnership are similar to a pool of mortgage loans.
  • Partnership interests will be transferable only by way of the procedures described in section Reg. § 5f.103-1(c)(1). Furthermore, Partnership will maintain a book entry system (as described in Reg. § 5f.103-1(c)(2), and the right to receive distributions of principal and interest on the Student Loans will be transferable only by this book entry system.

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Meet Paul Raymond

Meet Paul Raymond

Mr. Raymond is a sought after speaker in tax controversy law by many attorney, accountant, and business groups and at the request of the Internal Revenue Service, has presented programs at the IRS Nationwide Tax Forum, attended by tax professionals throughout the United States.

Additionally, he continues to be an active member in the Section of Taxation, American Bar Association, where he was the Past Chair of the Employment Taxes Committee.

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