Investment Trusts, the Power to Vary, and Holding Partnership Interests

Transcription

1 EDITED BY PETER J. CONNORS, LL.M., ROBERT R. CASEY, LL.M., AND LORENCE L. BRAVENC, CPA, LL.M. SPECIAL INDUSTRIES Investment Trsts, the Power to Vary, and Holding Partnership Interests THOMAS GRAY A trst holding a partnership interest shold careflly consider whether investing in sch an asset cold reslt in a power to vary the investment of its certificate holders. 232 J o r n a l o f T a x a T I o n l m a y When most people think abot a legal entity that is managed by a trstee, holds property for one or more beneficiaries, and is commonly referred to as a trst, they simply assme that the entity is a trst for all prposes. In the tax world, however, the classification of that entity is mch more complicated. It may be classified as a trst, a corporation, a partnership or even a disregarded entity. Classification as a trst is dependent on a variety of factors and can lead to some srprising reslts. CLASSIFICATION AS A TRUST What is the benefit of being classified as a trst? A trst and its beneficial owners can be sbject to jst one level of taxation and generally enjoy simpler reporting reqirements than a partnership. The classification for federal income tax prposes can depend on the scope of a trstee s powers, the permitted activities of the trst, and even the property held by the trst. While the Service and the corts have expanded on these concepts, one area where clear gidance is still lacking is the conseqences of a trst holding a partnership interest. As more flly described below, the Service did isse AM , which conclded with limited explanation that as a reslt of its ownership interest in a partnership, a trst was not an investment trst classified as a trst nder Reg (c), bt rather a bsiness entity. 1 If a trst holds interests in a partnership and that partnership engages in a trade or bsiness, shold those activities be attribted to the trst in determining its classification for federal income tax prposes? Generally, the classification of an entity for federal income tax prposes is determined nder the Treasry Reglations. 2 An entity may be classified as an association taxable as a corpo-

2 ration, a partnership disregarded as an entity separate from its owner, or a trst. If an entity is treated as a bsiness entity, it will not be classified as a trst 3 So while an entity may be generally referred to as a trst, it may not be treated as sch for federal income tax prposes. Specifically, an organization referred to as a trst can be classified nder the Reglations in one of three ways, each reslting in different federal income tax treatment: (1) an ordinary trst, (2) a bsiness trst, or (3) an investment trst. 4 Ordinary Trst An ordinary trst is one in which the prpose of the arrangement is to vest in trstees responsibility for the protection and conservation of property for beneficiaries who cannot share in the responsibility and, therefore are not associates in a joint ventre for the condct of bsiness or profit. 5 Bsiness Trst A bsiness trst is called a trst, bt is not considered a trst for federal income tax prposes. This type of trst is generally created by the beneficiaries in order to carry on a profit making bsiness that normally wold have been carried on throgh a corporation or partnership. 6 The contribtor of the corps of the trst is not determinative of whether the trst will be treated as a bsiness trst, bt rather the nderlying sbstance of the entity will gide the classification. In other words, the arrangement is not intended to jst protect and conserve property. Whether an organization has a bsiness prpose is determined by the instrment creating it. 7 Investment Trst Another type of trst, and the focs of this article, is the investment trst. An investment trst with a single class of ownership will be treated as a trst for federal income tax prposes if there is no power nder the trst agreement to vary the investment of the certificate holders. 8 In addition, an investment trst with mltiple classes of ownership interests will be classified as a trst only if there is no power nder the trst agreement to vary the investment of the certificate holders and the trst is formed to facilitate direct investment in the assets of the trst and the existence of mltiple classes of ownership interests is incidental to that prpose. 9 However, what does it mean to vary the investment of the certificate holders? 10 DETERMINING WHAT IS A POWER TO VARY THE INVESTMENT For years, both the corts and the Service have been rling on what constittes a power to vary the investment of a certificate holder. In its seminal case, North American Bond Trst, 122 F.2d 545, 27 AFTR 892 (CA-2, 1941), the Second Circit rled that the Depositor had it in his power in effect to change the investment of certificate holders at his discretion. In this case, the Depositor originally selected a variety of bonds to be held by the trst, and a beneficiary s interest in the trst was represented by a nit. The Depositor generally cold not change the composition of bonds nderlying sch original nits. When new money came into the trst, however, the Depositor, when acqiring bonds for the new nits, was not restricted to the original composition of bonds as he selected for the first nits. Since the bonds of all the nits constitted a single grop of secrities that each certificate holder shared in according to his or her proportion of all certificates issed, Jdge Learned Hand determined that the ability to acqire different bonds reslted in a power to vary the investment and take advantage of changes in the market to enhance the positions of the first investors. The investment trst, therefore, was not fixed. 11 Investment Trsts Taxable as a Trst Per Service Rlings The Service has also examined the power to vary the investment in a variety of pblic and private rlings. In Rev. Rl , CB 424, the depositor deposited with the trstee interest bearing mnicipal obligations, contracts for prchase of sch obligations, and the cash to make sch prchases. In order to preserve the sond investment character of the trst, the depositor cold direct the trstee to sell certain obligations if, for example, there was a defalt of payment or a sbstantial decline in vale. The trstee was to distribte any interest income or principal collected, less a reserve, semiannally. If the obligor of an obligation was to isse new obligations in exchange for the old ones, the trstee cold accept sch replacement nder certain conditions, sch as when the isser was in defalt or likely to defalt 1 See am (Trsts Holding Interests in a Partnership), 6 J. Tax n fin. Prodcts reg (b). Prior to the effective date of these reglations, the determination of whether a bsiness organization was treated as a corporation or partnership was based on the differences nder local law between partnerships and corporations. Prop regs., 5/13/ fed. reg (1996). The preamble to the proposed reglations notes frther that the distinction between trsts and bsiness entities is restated, bt the determination of whether an organization is classified as a trst for federal tax prposes is intended to remain the same as nder prior law. Id. Generally a corporation needs associates that enter into a bsiness ventre. Morrissey, 296.S. 344, 16 aftr 1274 (1935) (rling on whether an entity shold be classified as a trst or a corporation), see also Bedell Trst, 86 TC 1207 (1986) (trst lacked associates and therefore cold not be classified as an association taxable as a corporation). 3 reg (a). 4 reg The reglations also provide for trsts designated as liqidating trsts and environmental remediation trsts. These organizations are classified as trsts nder the Code. 5 reg (a). 6 reg (b). 7 rev. rl , CB 503; see also Morrissey at 361 (the character of an organization is determined by the terms of the trst instrment ); ltr. rl (entity that held a variety of private investments with the possibility of making additional investments was a bsiness trst and classified as a partnership for tax prposes). 8 reg (c)(1). 9 Id. 10 for a more detailed discssion on ordinary and bsiness trsts, see Sanborn,.S. Tax Classification of Trsts: When is a Trst not a Trst?, 31 Est. Planning J. 9 (September 2004). 11 See also Helvering v. Coleman-Gilbert Associates, 296.S. 369, 16 aftr 1270, 374 (1935) ( [t]he parties are not at liberty to say that their prpose was other or narrower than that which they formally set forth in the instrment ). S P E C I a l I n d S T r I E S m a y l J o r n a l o f T a x a T I o n 233

3 on its payment obligations. The Service rled that since there was no possibility of reinvestment, there was no power to vary the investment of the certificate holders and the fixed investment trst qalified as a trst. The Service has also conclded that certain short-term investments do not create a power to vary the investments In Rev. Rl , C.B. 384, an investment bank gathered fnds from investors and trned over the investment fnds to a trstee. 12 The trstee, along with a company specializing in the administration of mortgages, invested the fnds in varios mortgages. The trstee was to make qarterly distribtions of all principal and interest payments. Between distribtions, the trstee was to invest cash on hand in short-term obligations, sch as U.S. Treasry obligations or in certificates of deposit. Sch investments were reqired to terminate prior to the next distribtion date and all proceeds were reqired to be distribted. The trstee did not have the ability to make any other investments. The rling noted that the investments in temporary, short-term obligations generated a retrn similar to a bank accont and eliminated the possibility to profit from market flctations. Becase there was no ability to invest in new mortgage obligations or take advantage of market flctations, the Service conclded that the organization was a trst for federal income tax prposes. The attribtes of an atomatic reinvestment plan were discssed in Rev. Rl , CB 248. There, before each semiannal distribtion date, the sponsor wold create a new fixed investment trst in which the certificate holders of the existing trsts cold invest their distribtions. A bank wold receive the distribtions on behalf of those certificate holders who wish to participate and wold combine sch amonts and prchase certificates in the new trst. The participant was then credited with its share of certificates. There was no reinvestment in the original trst and the investments in the original trst remain fixed. Therefore, the Service conclded, the reinvestment plan did not create a power to vary the investment In Rev. Rl , C.B. 214, the Service addressed the conseqences of the failre by the trst to acqire certain bonds prsant to contracts deposited in the trst. In the rling, the sponsor deposited in the trst certain contracts to acqire bonds. The contracts allowed for the prchase of the bonds when and if issed. Sch bonds had to be transferred to the trst within 90 days of the creation of the trst. If the bonds were not transferred to the trst within the 90-day period de to reasons beyond the sponsor s or trstee s control, the sponsor then had 20 days to Prior to the issance of AM , most practitioners probably wold have determined that a trst holding a partnership interest shold not reslt in a power to vary the investment of the certificate holder. transfer different bonds of sbstantially the same character and qality as those attribtable to the failed contracts. Otherwise, the trstee was reqired to refnd to the certificate holders certain amonts related to the failed contracts. The Service noted that these powers are incidental to the formation of the trst, they exist only dring the first 110 days of the trst, there was no additional investment, THomaS Gray is a partner with drinker Biddle & reath llp in new york City. He thanks Kaitlin a. mckenzie-fimara for her thoghtfl comments. The views expressed in this article are those of the athor and do not necessarily reflect the views or professional advice of drinker Biddle & reath llp. and there was no change to the corps of the trst. Therefore, the Service conclded that neither the trstee nor the sponsor had a power to vary the investment 13 Similarly, in Rev. Rl , CB 262, the Service fond no power to vary the investments of a certificate holder when, dring the 90-day period immediately following the creation of trst, the depositor cold deposit additional secrities in the trst in exchange for additional certificates. The original secrities were debt secrities and the additional secrities had to be sbstantially similar to the original secrities. The rling noted that the depositor maintained the power to deposit additional secrities in order to adjst the size of the trst based on market conditions. The Service conclded that sch power, like in Rev. Rl , was intended only to facilitate the organization of the trst and was limited in time. Becase of the limited time involved, the power restricts the ability of the depositor to take advantage of market flctations, a key conclsion nder North American Bond Trst. In Rev. Rl , C.B. 270, a trst was created to hold certain bonds issed by a mnicipal corporation. The mnicipal corporation then loaned the proceeds from the bond issance to another corporation that wold develop a waste disposal facility. The developer was to provide credit spport for the loan. Prsant to the trst agreement, the trstee, at the mnicipal corporation s reqest, was permitted to consent to a change in the credit spport if the trstee believed that the change was advisable to maintain the vale and credit ratings of the bonds. The Service noted that the trstee cold not alter any of the terms of the bond isse held by 234 J o r n a l o f T a x a T I o n l m a y S P E C I a l I n d S T r I E S

4 the trst and any increase in the vale of the bonds as a reslt in the credit spport wold be incidental to maintaining the vale of the trst property. Therefore, agreeing to change the credit spport was not a power to vary the investment of the certificate holders. Unlike the rlings above dealing with secrities, Rev. Rl , CB 191, dealt with real property contribted to a trst. Here, the depositor had acqired real property and leased it to a lessee prsant to a ten-year net lease, which generally provided that the lessee wold maintain the property and pay the costs associated with the property. The depositor then contribted the property to the trst and the trst assmed the rights and obligations nder the lease and the original acqisition loan. The trst issed a single class of certificates that were freely tradable, and the trst was to terminate at the earlier of ten years or at the disposition of the property. Any cash received, less certain reserves, was to be distribted qarterly to the beneficial owners, while between distribtion dates the trstee cold invest sch cash in certain short-term obligations that wold terminate prior to the next distribtion date. The trstee s powers were otherwise generally limited, bt it cold make minor non-strctral modifications to the property. The Service noted that becase of the distribtion reqirement, no reinvestment of monies was possible. In addition, the trstee cold not exchange the property for other property, acqire new assets, or accept additional assets. The trstee also cold not renegotiate the lease or the debt that encmbered the property. The Service, therefore, conclded that becase of these limitations, the trstee had no power to vary the investment of the certificate holders to benefit from variations in the market. In private rlings, the Service has also examined whether certain powers constitted a power to vary the investment of certificate holders. The Service has held that there was no sch power when trstees established 12 See also ltr. rl (if the trstee can only reinvest income in short-term obligations that matre prior to the next distribtion date and no additional contribtions allowed, there is no power to vary the investments of the certificate holders), ltr. rl (if trstees can invest cash held as a reserve for liabilities or for distribtion at the next distribtion date in government secrities, certificates of deposit a voting trst. 14 In Ltr. Rl , the trst held most of the common stock of a corporation, the trstees cold vote the shares and take part in and consent to any shareholder s action, bt needed approval by vote of 80% of the registered owners of the trst certificates with respect to certain major corporate actions. The trstees wold distribte any cash dividends received, less certain expenses. Withot mch explanation, the Service conclded that there was no power nder the trst agreement to vary the investment of the certificate holders and the voting trst wold be treated as a trst In another private rling, 15 the Service reviewed (1) whether the trstee s power to vote shares in the same manner and in the same proportion as the shares were voted by owners other than the certificate holders concerning a proposed reorganization, and (2) whether the retention of any stock or secrities received in the reorganization, wold prevent the trst from being classified as a trst Relying on Rev. Rl and Rev. Rl , the Service determined that the trstee s limited power to vote was incidental to the maintenance and preservation of the trst property and was not intended to take advantage of market flctations. Frthermore, the receipt of stock or secrities was not a managerial power that allowed the trstee to take advantage of market variations, and therefore there was no power to vary the investment In Ltr. Rl , the Service determined that a trst agreement that provided for a roll over by investors of their investment into a sbseqent new trst following the termination of the original trst did not case the original trst to be treated as a partnership or corporation for federal income tax prposes. 16 Here the certificate holder wold elect to invest in the nits of the sbseqent trst by making an in-kind contribtion to the sbseqent trst. The sbseqent trst wold be similar to the original trst and have its own indentre, registration statement and prospects. In rling that the initial trst wold not be treated as a partnership or corporation, the Service relied on Rev. Rl The Service noted that the sbseqent trst had independent economic sbstance and there was no legal commitment to create the sbseqent trst or invest in the sbseqent trst. For these reasons and also becase there was generally no incentive to choose the sbseqent trst over other investment strategies, the option to invest in the sbseqent trst did not case the trst to be a mere contination of the original trst. Investment Trsts Taxable as a Corporation Per Service Rling The Service has not always rled that a trst qalifies as a fixed investment trst. In Rev. Rl , CB 448, the Service conclded that the trst shold be treated as an association taxable as a corporation. The trst held a portfolio of mnicipal obligations and was to terminate on the matrity, redemption, sale, or other disposition of the last obligation held by the trst, bt no earlier than a specified date. In order to avoid termination prior to that specified date, the trst agreement provided that dring the first 20 years of the trst s existence it cold reinvest fnds received from early redemptions of bonds held in the corps. The newly acqired bonds had to be similarly rated and matre no later than the specified date of the trst termination. If the fnds were not reinvested within 20 days of receipt, the trstee and reprchase agreements secred by government secrities the trsts will be treated as trsts for federal income tax prposes). 13 See also ltr. rl ltr. rl ltr. rl ; see also ltr. rl ltr. rl ; see also ltr. rl S P E C I a l I n d S T r I E S m a y l J o r n a l o f T a x a T I o n 235

5 had to distribte the fnds to the certificate holders. The Service noted that it is not the power to sell an asset that constittes a power to vary, bt rather the ability to reinvest the proceeds that creates a power to vary the investment If cold borrow money, mortgage and lease the property, and generally improve the property. Not srprisingly, the Service conclded that becase of the broad powers of the trstee and the ability for new beneficiaries to join the trst, the trstee was empowered provided sch sbstittion was intended to facilitate the formation of the trst, (4) consent to the change of the credit spport for bonds held in the trst corps, and (5) vote the stock held by the trst in the same manner as other stock holders and have the For years, both the corts and the Service have been rling on what constittes a power to vary the investment of a certificate holder. this reinvestment takes advantage of market variations and improves the position of the certificate holders, the power to vary is there. Here the Service conclded that the ability to reinvest over sch a long period, at the option of the trstee, allowed the trstee to take advantage of variations in the market and therefore constitted a power to vary the investments In Rev. Rl , C.B. 344, the Service again determined that a trst was not a fixed investment trst, bt instead classified it as an association taxable as a corporation. In the rling, varios heirs to continos parcels of land contribted the land to a trst. The land was sbject to a net lease, with the lessee generally responsible for the cost and maintenance of the land. The trstee was to distribte the income qarterly to the beneficiaries. The trst instrment cold be amended with consent of all the beneficiaries and wold otherwise terminate in 30 years. Beneficiaries or members of their families cold contribte to the trst interests in real estate that were adjacent or continos to the property held in trst and then sch contribtors wold become new beneficiaries of the trst. The trstee cold sell real estate held in the trst and cold prchase additional real estate. Any proceeds from sales not reinvested in real estate wold be reinvested only in certificates of deposits, or obligations of federal or state governments. In addition, the trstee 17 ltr. rl to do more than jst protect and conserve the trst s property. Therefore, the arrangement was classified as an association taxable as a corporation Privately the Service has rled that a foreign nit investment trst, which was created so that investors cold earn a retrn that tracked the performance of a particlar index, shold be classified as an association taxable as a corporation, and not a trst. 17 In Ltr. Rl , a stock exchange created an index that wold reflect the performance of certain companies listed on the exchange. The trst wold invest all of its assets in the stock of companies that were inclded in the index, in the same proportion as reflected in the index. Occasionally, the composition of the stocks inclded in the index wold change and the trst wold adjst the stocks it held in the same proportions. The Service held that the trstee s power to acqire new investments enabled the trst to take advantage of variations in the market and improve the position of the investors. Becase of this ability, the trstee had the power to vary the investment of the nit holders. In sm, the Service has provided gidance that an investment trst will be classified as a trst for federal income tax prposes even if the trstee has a power to (1) sell assets, (2) reinvest cash in short-term secre obligations that matre before the next reqired distribtion date and distribte sch amonts on the distribtion date, (3) take sbstitte assets dring a brief period at the formation of the trst trst receive stock and secrities in a reorganization. In addition, an investment trst may qalify as a trst when the certificate holders have the ability to reinvest in a sbseqent trst or have an atomatic reinvestment plan. The reslts, however, may not be so clear when the trst holds interests in an entity treated as a partnership for federal income tax prposes. IMPLICATIONS OF HOLDING A PARTNERSHIP INTEREST Shold holding a partnership interest inflence the stats of a trst for federal income tax classification prposes? Sperficially, it wold seem that the holding of any particlar asset in and of itself shold not determine the federal income tax classification of an entity, bt when that asset is a partnership interest, the reqired deeper analysis incldes whether the entity or aggregate approach is sed with respect to the partnership and then whether the activities of the partnership are deemed attribtable to the trst. If the partnership activities are attribtable to the holder of the partnership interest and the partnership performed activities that wold be treated as varying the investment of trst certificate holders, a trst holding an interest in sch a partnership wold be at risk of being treated as other than a trst Commentators have discssed the appropriateness of sing the aggregate or entity approach to determine whether activities and attribtes of a partnership shold be attribtable to its 236 J o r n a l o f T a x a T I o n l m a y S P E C I a l I n d S T r I E S

6 partners. 18 Generally, withot some stattory athority sch as Section 751(f), 875(1) or 1402, or some other specific gidance, the assmption wold be that the partnership s activities and attribtes shold not be attribtable to its partners. The Service, thogh, has looked at this isse, and the reslting gidance demonstrates that the answer is not so straightforward. GCM 38201, 12/14/79, considered whether the Service shold isse a proposed revene rling involving a fixed investment trst holding a 10% interest in a limited partnership that was engaged in a bsiness enterprise. The GCM covered two scenarios. In the first scenario, an individal created a trst with a bank, which acted as the trstee, and the individal contribted a 10% interest in a partnership to the trst in exchange for certificates of ownership, which the individal sold to the pblic. The partnership was engaged in commercial fishing operations. The second scenario was identical to the first, except that instead of commercial fishing, the partnership s bsiness was investing in commodity ftres. Relying on varios cort decisions regarding limited partnerships, the Service s proposed rling conclded that the partners (i.e., the trst) were engaged in the trade or bsiness of the partnership. In advising that the Service not pblish its proposed rling, the GCM emphasized that: (1) there was no indication in the two specified scenarios that the limited partners were active participants in the partnerships bsinesses, and (2) if there was a general premise of a matter of law that a limited partner was to be treated as engaged in the trade or bsiness of its partnership, Sections 875(1) and 1402(a) wold be sperflos. If it were pblished, the ramifications of the proposed revene rling cold be profond. For example, based on the Service s gidance in this proposed rling, a trst holding a very small limited partnership interest in a very large syndicated partnership wold be an association taxable as a corporation for federal income tax prposes. The GCM advised that the proposed revene rling not be issed and recommended that the Service take the position otlined in the proposed revene rling only in scenarios where there is a clear legal basis for sch a conclsion. The Service also analyzed a trst holding an interest in a limited partnership in Ltr. Rl In this instance, a trst company created a trst for the sole prpose of investing in a limited partnership. The trst company wold be the trstee and the sole initial limited partner. The rling explains that the trst wold be fnded by varios participating acconts at the time of formation or at other times as reqired by the limited partnership agreement. All nits acqired by the trst and all allocations and distribtions with respect to sch nits wold be allocated on the books The Service has not always rled that a trst qalifies as a fixed investment trst. of the trst to the participating accont that contribted the related fnds. The trstee was described as having limited powers. The rling did not examine Reg (c), bt rather Reg (b), and conclded that the participating acconts wold not be associated together to carry on a joint activity and therefore the trst will be treated as a trst for federal income tax prposes. In Ltr. Rl , a trst company created a trst to invest in a limited partnership, which in trn wold invest in oil and gas properties. The two general partners were an individal and a corporation. The trst wold be the sole initial limited partner and the trst company wold be the trstee of the trst. The corporate general partner and the trstee were both sbsidiaries of the same entity. The trstee received fnds in varios fidciary capacities and contribted those fnds to the trst. The acconts for which the trstee made the contribtions on behalf of were referred to as participating acconts. The amonts contribted to the trst were then invested in the limited partnership in two installments six months apart. All amonts allocated to, or received by, the trst from the limited partnership wold be allocated to the participating acconts. The trstee s powers were limited and met the standards set in Rev. Rl This rling did cite Reg (c) and held that the trst wold be classified as a trst In both Ltr. Rls and , the Service refrained from discssing the possibility of attribting the activities of the limited partnership to its members and did not examine the reasons behind why the trst became a limited partner, as opposed to certificate holders investing directly in the limited partnership. Rather, by not addressing the isse, the Service implied that it viewed each limited partnership as an entity that shold be treated by the trst as any other investment. On the other hand, the ndisclosed facts related to the limited partnership cold spport the conclsion that even if the activities of the partnership were attribted to the trst, those activities wold be so limited as to not reslt in a power to vary the investment of the beneficiaries of the trst. In Ltr. Rl , the Service took a deeper look at the activities of a partnership and whether those activities, if attribted to its partners, cold case a trst that was a partner to have an objective of carrying on a bsiness or the power to vary the trst s investment. In this instance, a pblicly traded company was engaged in the exploration for and prodction of oil and gas and other minerals. The company owned varios properties and wanted 18 See mckee, nelson, and Whitmire, Federal Taxation of Partnerships & Partners 4th ed. (WG&l, 2007), 1.02; Willis and Postlewaite, Partnership Taxation, 7th ed., (WG&l, 2011), 1.04; Banoff, When Will an llc s Trade or Bsiness Be Impted to its members 87 JTax 3 (September 1997); Gray, Hedge fnd Capital acconts and revalations: are They Section 704(b) Compliant?, 123 JTax 3 (September 2015). S P E C I a l I n d S T r I E S m a y l J o r n a l o f T a x a T I o n 237

7 to distribte to its shareholders as a dividend certain royalty interests associated with the properties. Since it was impractical to distribte ndivided interests in sch royalties to its shareholders, the company decided to form a trst to indirectly hold the royalties and distribte ot the trst interests to its shareholders, with a bank acting as trstee. To avoid certain probate isses and solve certain acconting isses, the company determined that the trst shold hold the royalties throgh a general partnership, with the trst holding 99% of the partnership interests and the company holding 1%. The company was reqired to operate the properties in accordance with reasonable and prdent bsiness jdgment and good oil and gas field practices. In analyzing the arrangement, the Service noted that the trstee had limited powers, only the trst cold hold the partnership interest, and the trst agreement prohibited the trstee from engaging in any bsiness activities. The partnership also had limited powers, which generally were to hold the royalty interests and to collect and distribte royalty proceeds. The Service frther noted that even if the activities and powers of the partnership were attribted to its partners, the limited natre of the partnership activities were sch that the trst wold not possess an objective to carry on bsiness or the power to vary the trst s investment. Becase of this, the Service conclded that the trst wold be classified as a trst AM A different conclsion was reached in AM There, an LLC, which was treated as a partnership for federal income tax prposes, was organized with the intent to acqire, hold, and manage a portfolio of investments. The LLC was to isse two classes of nits. The common nits wold be held by a trst, and management nits 19 See reg Qery whether the Service cold have challenged the validity of the llc as a partnership nder the partnership anti-abse rles. See reg wold be held by a small grop of investors who wold also manage the LLC. The trst s sole prpose was to hold the common nits. The AM did not spply any factal information from the trst docments that wold indicate that the trstee, who was not identified, had a power to vary the investment The AM noted that the trst was holding the LLC interests to provide investors with the benefits of the managed investments of the LLC. If those investment activities were condcted directly by the trst, the trst wold not qalify as a trst for federal income tax prposes. AM also notes that the prpose of the arrangement was to enable information reporting to be provided to investors nder rles for widely held fixed investment trsts (WHFIT) 19 as opposed to the LLC issing Schedle K-1s to the investors. The Service conclded that becase the natre and prpose of the trst was to vary the investment, the trst was not an investment trst classified as a trst nder Reg (c), bt rather a bsiness entity. There is very little analysis provided for in AM , and its conclsion is based on the premise that it is appropriate to consider the natre and prpose of the Trst. The Service, however, does not cite any specific athority for this position or provide any clear legal basis for its conclsion, as recommended in GCM It is clear, however, that the Service determined that the prpose of the trst was to take advantage of the more favorable WHFIT reporting rles, and therefore the activities of the LLC were attribted to the trst. If this rationale can prevail in this sitation, it wold seem that the Service cold attribte the activities of a partnership to a partner, or perhaps disregard the partnership, in other sitations when the partner is an entity created for tax prposes. Neither the Code nor the Reglations wold seem to provide for this. Shold tax advisors consider AM as demonstrating a stricter view by the Service with respect to trsts holding partnership interests, or does it represent jst an isolated scenario so fact specific that it represents no precedential vale? If it is the former, what are the facts and circmstances nder which a trst holding a partnership interest can prodce a power to vary the investments of the interest holders? Apparently, if (1) the partnership activities wold clearly be treated as a power to vary if the trst performed sch activities itself and (2) the prpose of the trst is to take advantage of more convenient reporting rles, then a trst will not qalify as an investment trst. However, does the fact that the trst owned all the common nits matter? What if the trst had other assets? What if there was a principal prpose for forming the trst other than to avoid more complicated reporting rles? There are a wide range of facts and circmstances where it wold seem appropriate for a fixed investment trst to hold an interest in a partnership withot jeopardizing its classification The Service s gidance crrently available, however, does not clearly indicate what sitations may be treated as acceptable with respect to a trst holding a partnership interest. CONCLUSION Prior to the issance of AM , most practitioners probably wold have determined that a trst holding a partnership interest shold not reslt in a power to vary the investment of the certificate holder. Now, however, the facts and circmstances srronding the creation of the trst and the activities of the partnership that it holds an interest in need to be careflly examined. Previos gidance sggested that a trst wold not be treated as having a power to vary the investment of its certificate holders by virte of holding a partnership interest nless a clear legal basis provided for sch a conclsion. Becase the analysis in AM is very limited, however, practitioners are now left to ponder whether holding a partnership interest cold jeopardize a trst s federal income tax classification. l 238 J o r n a l o f T a x a T I o n l m a y S P E C I a l I n d S T r I E S