PLR 8848037, 1988 WL 573718 (IRS PLR)

Internal Revenue Service (I.R.S.)

Private Letter Ruling

Issue: December 2, 1988September 1, 1988

Section 351 -- Transfer to Corporation Controlled by Transferor

351.00-00 Transfer to Corporation Controlled by Transferor

351.01-00 Control v. No Control by Transferor

Section 367 -- Foreign Corporations

367.00-00 Foreign Corporations-Reorganization or Transfer of Property

367.04-00 Exchanges Beginning After December 31, 1977

CC:INTL:Br3-701-87

LEGEND:

P = * * *

X = * * *

Y = * * *

A = * * *

A1 = * * *

A2 = * * *

A3 = * * *

A4 = * * *

B = * * *

State S = * * *

Product T = * * *

a = * * *

b = * * *

c = * * *

d = * * *

e = * * *

f = * * *

g = * * *

h = * * *

i = * * *

Dear

This letter is in reply to a letter dated September 9, 1987, in which rulings were requested as to the federal income tax consequences of a proposed transaction. Additional information was submitted in letters dated February 10 and July 26, 1988. The information submitted for consideration is summarized below.

P is a Kommanditgesellschaft organized under the laws of West Germany. It is considered a partnership under German law. The partners of P (sometimes referred to collectively as the 'Partners') are A(5%), B(10%), and A’s children A1(21.25%), A2(21.25%), A3(21.25%) and A4(21.25%). A3 is a German citizen who resides in State S and is a U.S. resident for federal income tax purposes. As of the end of 1986, P had outstanding loans (undistributed earnings of P are considered loans from the Partners to P) to the Partners in the following amounts: A(a), A1(b), A2(c), A3(d), A4(e) and B(f) (hereinafter, 'Partner Loans '). Under the terms of the partnership agreement, these Partner Loans bear interest at two percentage points above the Bundesbank discount rate. A, A1 and A2 are limited partners and as such are not liable for the debts of P in excess of their respective portions of the paid-in capital. A3, A4 and B are general partners who are liable for the debts of P, including the Partner Loans. Further, a Partner’s interest in P is nontransferable absent the consent of all Partners.

P does not actively engage in commercial business. In order to maintain commercial tax-exempt status under German law, P’s sole activity is the leasing of its land, buildings and equipment to X. P’s assets consist of cash, accounts receivable, land, buildings, machinery and equipment, factory and office equipment, prepayments and construction in process and financial assets.

The accounts receivable on P’s balance sheet consist of account receivable from X and prepaid expenses relating to deposits and prepaid rents in connection with properties to be used by Y in the active conduct of its trade or business outside the U.S. The prepayments and construction in progress item on P’s balance sheet relates to capital expenditures in connection with properties, such as warehouses, to be used by Y in the active conduct of its trade or business outside the U.S. The cash held by P is German marks, which will be the functional currency of Y and will be the functional currency of Y [sic]. The financial assets item consists of 100 percent of the stock of a shell corporation, the value of which is less than P’s basis therein.

Under the terms of the governing instrument and the partnership provisions of the German Commercial Code (Commercial Code), the rights and obligations of and among the parties are as follows:

(1) P was created for an indeterminate period of time. The governing instrument provides that a member may terminate his or her membership in P; that right to terminate is actually a right to withdraw from P and its exercise would not dissolve P.

However, under German law, the commencement of bankruptcy proceedings over the assets of a P general partner would dissolve P. The provisions relating to general partnerships provide that the filing of bankruptcy proceedings against the assets of a partner dissolves the partnership. The provisions pertaining to limited partnerships provide that unless specifically provided otherwise, the rules pertaining to general partnerships are equally applicable to limited partnerships. The limited partnership provisions concerning dissolution provide only that the death of a limited partner does not dissolve the partnership. Thus, the commencement of bankruptcy proceedings, at least against the assets of a general partner, would cause a dissolution of even a limited partnership.

(2) P has members whose liability is limited to the amount of their respective contributions. However, P also has members who are individuals who are jointly and severally liable for P’s debts; those individuals have substantial assets that may be reached by creditors in satisfaction of P’s debts.

X is a Gesellschaft mit beschraenkter organized under the laws of Germany. Its equity holders are A (90%) and B(10%). X is engaged in the manufacture and sale of Product T, primarily in Germany. While X has substantial foreign sales, only a small portion of such sales are to the United States.

The following transaction has been proposed:

(i) X will distribute additional common stock to the present shareholders in proportion to their current holdings in X. X will then convert under German law to Y, an Aktiengesellschaft.

(ii) The Partners will contribute a portion of the Partner Loans to the capital of P in the following amounts: A(g), A1(h), A2(h), A3(h), A4(h) and B(i). The Partners will then transfer their interests in P, and A individually will transfer certain properties to be used by Y in its business, to Y in exchange for Y stock and the assumption by Y of P’s liabilities. Y will issue only one class of stock. P will terminate under German law and Y will succeed to all of its assets and liabilities.

Following he exchange, the stock of Y will be held as follows: A(30%), A1(15%), A2(15%), A3(15%), A4(15%) and B(10%). Y will keep its books on the accrual method and the calendar year.

Under the governing instrument and the applicable law, the rights and obligations of the parties with respect to Y will be as follows:

(1) The death, insanity, bankruptcy, retirement, resignation, or expulsion of any member of Y will not cause a dissolution of Y.

(2) The responsibility for and the exclusive authority to conduct the daily operation of Y’s business will be vested in its Board of Directors, which will consist of less than all of the shareholders; a Supervisory Board has authority over issues and activities not within the scope of Y’s ordinary business operations. The officers and employees of Y will carry out substantial managerial and operational activities. The primary managerial and operations activities of Y will be conducted outside the U.S.

(3) The members of Y will not be liable for the debts of Y, beyond the amount of their respective capital contribution obligations.

The following representations have been made in connection with the proposed transaction:

(a) No stock or securities will be issued for services rendered to or for the benefit of Y in connection with the proposed transaction.

(b) No stock or securities will be issued for indebtedness of Y that is not evidenced by a security or for interest on indebtedness of Y which accrued on or after the beginning of the holding period of the Partners for the debt.

(c) None of the assets to be transferred were received by the Partners as part of a liquidation of another corporation.

(d) The transfer is not a result of the solicitation by a promoter, broker, or investment house.

(e) The Partners will not retain any rights in the property transferred to Y.

(f) No licenses or leases will be granted in exchange for stock or securities.

(g) No property transferred to Y will be leased back to a Partner or a related party.

(h) The adjusted basis and the fair market value of the assets to be transferred by the Partners to Y will, in each instance, be equal to or exceed the sum of the liabilities to be assumed by Y plus any liabilities to which the transferred assets are subject.

(i) The transfers and exchanges will occur under a plan agreed upon before the transaction in which the rights of the parties are defined.

(j) All exchanges will occur on approximately the same date.

(k) No stock will be placed in escrow or issued in the near future.

(l) There are no fixed plans for Y to issue additional stock in the near future.

(m) No rights, warrants, or subscriptions of Y are outstanding or will be issued or offered in the near future.

(n) No Partner had any plan or intention to dispose of any stock to be received from Y.

(o) There is no plan or intention on the part of Y to redeem or otherwise reacquire any stock to be issued in the proposed transaction. (p) Each Partner will receive stock approximately equal in value to the fair market value of the property transferred to Y.

(q) Y will remain in existence and retain and use the property transferred to it in a trade or business in West Germany.

(r) There is no plan or intention by Y to dispose of the transferred property other then in the normal course of business operations.

(s) Each of the parties to the transaction will pay their respective expenses, if any, incurred in connection with the proposed transaction.

(t) Y will not be an investment company within the meaning of section 351(e)(1) of the Code and section 1.351-1(c)(1)(ii) of the regulations and will not be a personal service corporation within the meaning of section 269A of the Code.

(u) The transferors are not under the jurisdiction of a court in a title 11 or similar case (within the meaning of section 368(a)(3)(A)) and the stock or securities received in the exchange will not be used to satisfy the indebtedness of such debtor.

(v) None of P’s depreciable property has been used in the United States or has qualified as section 38 property by virtue of section 48(a)(2)(B) prior to the transfer.

(w) P has no inventory, installment obligations (the principal amount of which has not previously been included in taxable income), or leased property (other than property which has been leased to X and Y).

(x) P holds no patents or patent applications, copyrights, franchises, trade names, trademarks, technical know-how, or other intangibles.

(y) None of the transferred property will be leased to other persons by the transferee.

Based on the information submitted and the representations set forth above, and provided that the transfer of any property described in section 1.367(a)-5T of the temporary regulations by A3 is treated as subject to section 367(a)(1) and branch losses, within the meaning of section 1.367(a)-6T of the temporary regulations, previously deducted by A3, if any, are recaptured to the extent required by section 1.367(a)-6T, it is held as follows:

(1) For purposes of section 7701(a)(2) of the Code, P is classified as a partnership.

(2) For purposes of section 7701(a)(3) of the Code, Y is classified as a corporation.

(3) The transfer by A3 to Y of A3’s partnership interest in P, as described in ruling 7 below, will be treated as a transfer to Y of A3’s pro rata share of the assets of P (section 367(a)(4) of the Code and section 1.367(a)- 1T(c)(3)(ii) of the temporary regulations).

(4) Except as provided in ruling 5 below, the transfer to Y by A3 of A3’s pro rata share of the assets of P will not be subject to section 367(a)(1) of the Code and Y will be a corporation for purposes of determining the extent to which gain will be recognized by A3 of the transfer (section 367(a)(3)(A) of the Code and section 1.367(a)-2T of the temporary regulations).

(5) The transfer by A3 of any accounts receivable and installment obligations (which have not been previously been included in A3’s income), [sic] as well as any inventory, foreign currency or any other property described in section 1.367(a)-5T of the temporary regulations will subject to section 367(a)(1) and Y will not be a corporation for purposes of determining the extent to which gain will be recognized by A3 on the transfer (section 367(a)(3)(B) of the Code and section 1.367(a)-5T of the temporary regulations).

(6) The transfer of 100 percent of the P interests to Y causes the termination of P under section 708(b)(1)(A) of the Code.

(7) Except as provided in ruling (5), no gain or loss will be recognized by A, A1, A2, A3, A4 and B (the Partners) on their transfer of property consisting of their interests in P and other property to Y solely in exchange for Y stock (section 351(a); see Rev. Rul. 84-111, 1984-1 C.B. 88).

(8) The aggregate of Y’s bases in the property received in the liquidating distribution of P’s assets will equal the aggregate of the transferor’s bases in their interests in P. Y’s holding period of those assets includes the period during which the assets were held by P.

(9) A Partner’s basis of the stock received from Y in the exchange will equal the basis of the property transferred to Y in exchange therefore, increased by any gain recognized by the partner resulting from the transaction and reduced by the amount of liabilities assumed by Y (Section 358(a)(1)). The assumption by Y of P’s liabilities will be treated as a payment of money to P (Section 358(d)).

(10) A Partner’s holding period for the Y stock received in the transaction will include the period during which the property exchanged was held, provided that such property was held as a capital asset or a section 1231 asset on the date of the exchange (Section 1223(1)). The holding period for stock that was received in exchange for a Partner’s interest in section 751 assets that are neither capital assets nor section 1231 assets begins on the date of the day following the exchange.

(11) No tax under section 1491 of the Code will be imposed upon effectuation of the transfer (section 1492 of the Code).

Section 6038B(a) of the Code provides that each United States person who transfers property to a foreign corporation in an exchange described in section 351 shall furnish to the Secretary such information with respect to such exchange as the Secretary may require in such regulations. Section 1.6038B-1T of the regulations provides specific instructions to the shareholders concerning the filing of the proper forms. If the reporting requirements and conditions of section 1.6038B-1T are not met, section 1.6038B-lT(f) provides for certain penalties, including a 25 percent penalty, tolling of the statute of limitations, and the application of section 367(a)(1) to the transfer. Whether a failure to comply was due to reasonable cause and not willful neglect will be determined by the district director under all the facts and circumstances.

The fact that P’s undistributed earnings represent pro rata loans to P by its partners raises issues under sections 987 and 988 of the Code. No opinion is expressed as to the federal income tax consequences of the transaction under those sections, including but not limited to the following:

1. Whether the Partner Loans will be treated as bona fide debt for tax purposes;

2. If the Partner Loans are bona fide debt, whether A3 will recognize currencY gain or loss under section 988 on the contribution of Partner Loans to P;

3. Whether A3 will recognize remittance gain or loss under section 987 on the liquidation of P;

4. Assuming A3 recognizes remittance gain or loss under section 987, what is the character and source of such gain or loss; and

5. The affect any remittance gain or loss under section 987 has on the basis of A3’s interest in P or the basis of A3’s pro rata share of P’s assets and the amount of A3’s pro rata share of P’s liabilities.

Also, no opinion is expressed regarding the federal income tax consequences, if any, of the conversion of X to Y under German law. Further, no opinion is expressed about the tax treatment of the transaction under other provisions of the Code and regulations or about the tax treatment of any conditions existing at the time of, or effects resulting from, the transaction that are not specifically covered by the above rulings.

This ruling is directed only to the taxpayer who requested it. Section 6110(j)(3) of the Code provides that it may not be used or cited as precedent.

It is important that a copy of this letter be attached to the federal income tax return of the taxpayers involved for the taxable year in which the transaction covered by this letter is consummated.

Sincerely yours,

Bernard T. Bress

Senior Technician Reviewer

Office of Associate Chief Counsel (International)

This document may not be used or cited as precedent. Section 6110(j)(3) of the Internal Revenue Code.