26th Annual Health Sciences Tax Conference

Transcription

1 26th Annual Health Sciences Tax Conference Partnerships and joint ventures: M&A, current developments and JVs with exempt organizations December 7, 2016

2 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. This presentation is 2016 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2

3 Presenters Dan Jensen HCA Inc. Nashville, Tennessee David Miller Ernst & Young LLP Dallas, TX Eric Matuszak Ernst & Young LLP Los Angeles, CA Page 3

4 Agenda Recent developments New Section 707 regulations New Section 752 regulations New Section 385 regulations New partnership audit rules Partnership transactions Disguised sales of partnership interests Property contributions Questions? Page 4

5 Recent developments Page 5

6 New Section 707 regulations Page 6

7 New Section 707 regulations Generally Certain transfers of money or other property between a partnership and one or more of its partners will be treated as a sale of property by the partner to the partnership (or vice versa) if, when viewed together, the transfers are more properly characterized as a sale or exchange of property. The regulation is intended to prevent taxpayers from characterizing what were, in substance, sales of property as contributions and distributions. Existing regulations contain a number of presumptions and exceptions. PS units plus $100 A B C Appreciated property PS Page 7

8 New Section 707 regulations Preformation expenditure reimbursements Existing regulations There is an exception for money transferred to reimburse the partner for capital expenditures with respect to the contributed property incurred within two years of the contribution. The exception only applies to the extent the reimbursed capital expenditures do not exceed 20% of the fair market value of the contributed property. The 20% limit does not apply if the fair market value of the contributed property does not exceed 120% of the adjusted basis of the property. The new regulations: Clarify that in the case of a multiproperty contribution, the 20% fair market value limitation and the 120% exception to this limitation are made separately for each contributed property Explain that capital expenditures has the same meaning for purposes of Section 707 as in other Internal Revenue Code sections, except that it also includes capital expenditures taxpayers elect to deduct and does not include deductible expenses taxpayers elect to treat as capital expenditures Clarify that the exception for capex reimbursements does not apply to extent a partner funded the capex though a borrowing then shifted the economic responsibility for that borrowing to another partner Create a step into the shoes rule for assets acquired by the contributing partner in a nonrecognition transaction under Sections 351, 381(a), 721 or 731 Provide guidance in the case of tiered partnership transactions Page 8

9 New Section 707 regulations Qualified liabilities Existing regulations The assumption of a qualified liability by a partnership is generally not considered disguised sale proceeds. Qualified liabilities are: More than two years old and encumber the property Less than two years old (but not incurred in anticipation of the transfer) and encumber the property Traceable to capital expenditures with respect to the property Incurred in the ordinary course of the trade or business in which the property was used, but only if all the assets material to that trade or business are transferred to the partnership The new regulations: Add a fifth class of qualified liability, which are incurred in connection with the conduct of a trade or business (but not in anticipation of the transfer), but only if all of the assets material to that trade or business are transferred to the partnership PS units A B C 50% Appreciated property subject to $100 of debt 25% 25% PS Page 9

10 New Section 707 regulations Debt financed distribution (DFD) Existing regulations There is an exception for money transferred to the contributing partner from proceeds of a recent partnership borrowing to the extent the distributed amount does not exceed the partner s allocable share of that liability. The new regulations: Add an ordering rule that first tests a transfer to a partner under the DFD exception Provide that any amount not excluded under this exception would then be tested under other exceptions to disguised sale treatment Dramatically change the rules for determining a partner s allocable share of partnership liabilities for disguised sale purposes PS units plus $100 A B C 50% Appreciated property 25% 25% PS $100 Lender Page 10

11 New Section 707 regulations Allocable share of liabilities Prior regulations A partner s share of recourse liabilities is determined under the recourse debt allocation rules of Section 752. A partner s share of nonrecourse liabilities is determined under the Tier 3 nonrecourse debt allocation rules of Section 752, subject to certain limitations. New temporary regulations For disguised sale purposes only, a partner s share of a partnership s liability is determined under the Tier 3 nonrecourse debt allocation rules of Section 752, subject to certain limitations, whether or not the liability is recourse or nonrecourse under Section 752. Thus, if the contributing partner has guaranteed the liability, the liability is treated as nonrecourse for disguised sale purposes, even if it is considered recourse under Section 752. However, if the liability is a recourse liability with respect to another partner under Section 752, that liability is allocated solely to that other partner for disguised sale purposes. The Internal Revenue Service (IRS) and the Treasury announced in late October that they intend to modify this rule. Page 11

12 New Section 707 regulations Allocable share of liabilities DFD example Facts: A contributes Property A. B contributes Property B. PS borrows $100 and distributes the proceeds proportionately to A and B. A and B each guaranty $50 of the $100 liability. Analysis: A B For purposes of Section 752, A and B will each be allocated $50 of the liability as a recourse liability. For purposes of Section 707, from A s perspective: A s own guaranty will be ignored and that portion of the liability will be allocated between A and B under the Tier 3 nonrecourse debt allocation rules. A will not, however, share in any portion of the liability guaranteed by B because A cannot share in any liability that is considered recourse to another partner. A s share of the debt will be $25, and $25 of A s distribution will not qualify as a DFD. PS units plus $50 Property A 50% 50% PS PS units plus $50 Property B $100 Lender The same analysis applies for B. Page 12

13 New Section 752 regulations Page 13

14 New Section 752 regulations Introduction Existing regulations A partner s share of a recourse liability equals the portion of the liability, if any, for which the partner or a related person bears the economic risk of loss (EROL). A partner generally bears the EROL to the extent the partner (or a related person) would be obligated to make a payment if the partnership s assets became worthless and the liability became due and payable. It is generally assumed that a partner will satisfy its payment obligation, irrespective of a partner s net worth, but EROL will be reduced to the extent the partner can seek reimbursement from any partner. The new temporary and proposed regulations: Were published on October 5, 2016 Significantly change (and propose to change) the existing Section 752 regulations Reflect a concern by the IRS and the Treasury that partners have entered into non-commercial payment obligations solely to attract an allocation of liabilities Page 14

15 New Section 752 regulations New temporary regulations Bottom dollar guaranties General rule Bottom dollar payment obligations are not recognized for purposes of determining whether a partner bears the EROL with respect to a partnership liability; bottom dollar guarantees don t work. A bottom dollar payment obligation is any payment obligation where the partner (or related person) is not liable up to the full amount of the payment obligation in the event of non-payment by the partnership. Exceptions: If, after taking into account any indemnification or reimbursement rights, the partner would be liable for at least 90% of the stated payment obligation Vertical slice guaranty An obligation to pay a fixed percentage of every dollar if the liability is not otherwise satisfied Right of proportionate contribution between partners or related persons who are coobligors with respect to a payment obligation where there is joint and several liability Capped payment obligation Page 15

16 New Section 752 regulations New temporary regulations Bottom dollar guaranties Transitional rule The new rules generally apply to any liability or any payment obligation entered into after October 5, However, if immediately prior to October 5, 2016, any partner was allocated a share of the partnership s debt under the old rules, then to the extent that partner s share of such liabilities exceeded the partner s outside basis in the partnership as of such time, the partnership may choose not to apply the new rules to such partner and may continue to apply the old rules for a seven-year transitional period. For any such partner that is a partnership, an S corporation or a disregarded entity (DRE), the seven-year transitional period ends immediately upon a 50% or greater change in ownership of the relevant partner. The amount of debt that may be allocated to a partner under the old rules during the transitional period is reduced (but never increased): Upon a sale of property by the partnership, by the excess of (1) the tax gain allocated to the partner over (2) the product of (a) the total amount realized by the partnership from sale multiplied by (b) the partner s percentage interest in the partnership Upon any other decrease in that partner s share of the partnership s liabilities (e.g., upon the partnership s repayment of its liabilities) Page 16

17 New Section 752 regulations New proposed regulations A partner s payment obligation (other than a bottom dollar payment obligation) will generally be respected as causing the partner to bear the EROL with respect to the liability unless the facts and circumstances evidence a plan to circumvent or avoid the obligation. Non-exclusive list of factors that may indicate such a plan: Partner is not subject to commercially reasonable contractual restrictions that protect the likelihood of payment Partner is not required to provide commercially reasonable documentation regarding its financial condition to the benefited party Payment obligation terminates before the term of the liability or is terminable by the partner, if the purpose is to terminate the payment obligation before events occur that increase the risk of loss to the guarantor or benefited party Partnership holds money or other liquid assets in excess of its reasonably foreseeable needs Payment obligation does not permit the creditor to promptly pursue payment following a payment default or otherwise indicates a plan to delay collection Terms of the partnership s liability would be substantially the same without the payment obligation Creditor or other benefited party does not receive executed documents with respect to the payment obligation within a commercially reasonable period after the creation of the obligation Page 17

18 New Section 385 regulations Page 18

19 New Section 385 regulations Introduction Background Code Section 385(a) The Secretary is authorized to prescribe such regulations as may be necessary or appropriate to determine whether an interest in a corporation is to be treated for purposes of this title as stock or indebtedness (or as in part stock and in part indebtedness. Proposed regulations issued in April 2016 radically changed the common law treatment of certain intercompany liability arrangements. Raised a number of significant concerns, including with respect to their effect on debt issued by partnerships and disregarded entities Over 200 comment letters submitted to the IRS and Treasury Final and temporary regulations issued in October 2016 significantly scaled back the scope of the April 2016 proposed regulations. Page 19

20 New Section 385 regulations Introduction Key takeaways Regulations only apply to interests issued by domestic corporations Reserve on interests issued by foreign corporations Interests issued by non-captive real estate investment trusts (REITs) and regulated investment companies (RICs) excluded Do not apply to instruments issued within a US consolidated group Two main elements Documentation rule Requires certain documentation with respect to debt issued by certain entities Recharacterization rule Recharacterizes debt as equity if the debt is issued in connection with certain specified transactions between members of a group subject to these rules Page 20

21 New Section 385 regulations Documentation rule Overview Requires documentation to be prepared and maintained with respect to debt instruments subject to these rules Failure to satisfy any requirement will result in debt being treated as stock for all US federal tax purposes (unless an exception applies) Satisfaction of documentation requirements does not ensure debt treatment Effective for instruments issued on or after January 1, 2018 Documentation must be completed by due date of issuer s federal income tax return (taking into account extensions) Application to partnership issuers Debt issued by a partnership is not subject to the documentation rule. Debt issued by a disregarded entity owned by a corporation otherwise subject to these rules is subject to these rules. If the debt of the DRE is recharacterized as equity under these documentation rules, the debt of the DRE is recharacterized as equity of the corporate owner of the DRE. There are no springing partnerships as a result of the documentation rule. Page 21

22 New Section 385 regulations Recharacterization rule Overview Certain categories of corporate debt issuances will be treated as equity of the issuer, either at the time of issuance or in a subsequent taxable year. Issuances include: Distributions on stock Acquisitions of expanded group stock Acquisitions of expanded group assets in a reorganization Covered instruments are generally those issued to members of the issuer s expanded group. There are a number of exceptions and reductions to the amounts subject to recharacterization. Application to partnership issuers Under temporary regulations, a controlled partnership is treated as an aggregate of its partners. A controlled partnership is a partnership with respect to which at least 80% of the interests in capital or profits are owned by members of an expanded group (i.e., domestic corporations linked by common ownership and subject to these rules). Under the temporary regulations, debt issued by a disregarded entity and owned by a corporation otherwise subject to these rules is effectively treated as issued by the corporate owner. There are no springing partnerships as a result of the recharacterization rule. Page 22

23 New partnership audit rules Page 23

24 New partnership audit rules Overview The Bipartisan Budget Act of 2015 (Budget Act) generally repealed the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) audit regime and replaced it with a new regime that will become effective on January 1, Budget Act partnership rules affect: Audit procedures Who pays tax How much tax is paid The Joint Committee on Taxation (JCT) estimates the provisions will raise almost $10 billion over a 10-year period. The new audit regime is a sea change in the context of partnership taxation insofar as it allows the IRS to collect tax directly from partnerships. Page 24

25 New partnership audit rules Partnerships subject to the rules Budget Act rules are mandatory when a partnership: Has more than 100 partners Or At least one partner is not an individual, C corp, S corp or estate Treatment of flow-through partners (other than S corps) is unclear Tax-exempt organizations are generally considered C corps for these purposes For partnerships eligible to elect out: Default rule is that the Budget Act rules apply Election out of Budget Act rules must be made each year If the Budget Act rules do not apply, each partner would be audited separately in separate proceedings (pre-tefra, partner-level exam) possibly at the partnership level, but the statute of limitations is controlled at the partner level. Page 25

26 New partnership audit rules Default rule Section 6225 Default rule Adjustments that result in an underpayment with respect to a reviewed year Partnership pays the imputed underpayment in the adjustment year Adjustments that do not result in an underpayment with respect to a reviewed year Adjustment taken into account by the partnership in the adjustment year Imputed underpayment The amount of tax owed by the partnership as a result of net unfavorable IRS audit adjustments with respect to a reviewed year Tax owed in the year the audit becomes final (subject to certain limitations) Tax is computed as the net audit adjustment multiplied by the highest tax rate Page 26

27 New partnership audit rules Default rule Example Year 1 Partnership had net income of $500 but only reports $400 of net income Year 5 IRS audit settled, reflecting $100 net income adjustment Partnership pays $40 of tax (assuming 40% is the highest tax rate) Same result would occur if in Year 1, Partnership had allocated $100 too much to one partner and $100 too little to another partner Only the negative allocation adjustments are taken into account in computing Partnership s adjustment under the Budget Act Not entirely clear how, if at all, the Year 5 adjustment impacts partners outside basis, capital accounts or Partnership s asset basis Page 27

28 New partnership audit rules Modification of imputed underpayment Ability to reduce underpayment after notice of proposed partnership adjustment is issued Allows for one or more partners to file amended returns for the reviewed year and intervening years to take into account the audit adjustments and pay any tax due with such return The imputed underpayment is to be reduced by the audit adjustments reported on these amended returns Procedures need to be established to allow for such modifications that take into account partner tax rates for certain specific circumstances Tax-exempt entities Foreign persons and entities C corporations Individuals with respect to an adjustment to capital gain or a qualified dividend Reallocation adjustments have special rules All impacted partners must amend to reduce underpayment Page 28

29 New partnership audit rules Push-out election Rather than having the partnership make an imputed underpayment in the year the audit is resolved, the partnership can elect to have the partners from the reviewed year (i.e., the earlier year) pay additional tax on their allocable share of the adjustment amount. This applies only if there is an adjustment resulting in an underpayment. The partnership must make an election to apply the alternative payment system and issue statements to reviewed year partners. The election is not available until a final notice of partnership adjustment is issued. It is unclear whether the partnership is absolved of liability upon issuing statements to partners. Page 29

30 New partnership audit rules Partnership Representative The Partnership Representative is the sole person with authority to act on behalf of the partnership and its partners. Replaces the tax matters partner (TMP) under TEFRA More powerful than administrative role held by the TMP Authority to bind all partners to audit adjustments Partners have no statutory right to participate in an audit or litigation No partner-level notice requirements in statute The partnership may designate the Partnership Representative. Eligible persons: Any person with a substantial presence in the United States Does not need to be a partner If the partnership does not designate a Partnership Representative, the IRS may select any person to be the Partnership Representative. Page 30

31 New partnership audit rules Considerations for tax-exempt partners Who should pay the tax? Because tax-exempt entities generally don t pay tax, many are considering whether to require their partnerships to make a pushout election. If the income would be unrelated business taxable income (UBTI), tax-exempt entities may prefer to have the partnership pay the tax. Is it a private benefit? Could it be considered a private benefit if the partnership pays tax attributable to an individual partner who left the partnership? Is this treated as if the tax-exempt entity effectively paid someone else s tax liability? Page 31

32 Partnership transaction issues Page 32

33 Disguised sales of partnership interests Page 33

34 Disguised sale of partnership interests Buyer contributes $20 to PS for a 50% interest and PS distributes $10 to LP1 and LP2. Is this a disguised sale of partnership interests by LP1 and LP2 to Buyer? Recognize pro rata share of gain (rather than recovering basis first) Is this a Section 743 adjustment in Buyer s favor? Is it respected according to its form? LP1 and LP2 recover basis first Is this a Section 734 common basis adjustment shared by all partners? What can the Buyer do to increase the likelihood it is treated as purchasing an interest from LP1 and LP2 (assuming it cannot actually purchase that interest for some reason)? $10 $10 Buyer LP1 LP2 2 2 PS units 50% 50% 1 $20 PS Buyer LP1 LP2 50% 25% 25% PS Page 34

35 Disguised sale of partnership interests Buyer contributes $20 to PS for a 50% interest and PS distributes $20 to LP2 in complete redemption of its interest. Is this a disguised sale of partnership interests? LP2 recognizes all gain in any event. Is this a Section 743 adjustment in Buyer s favor? Is it respected according to its form? Is this a Section 734 common basis adjustment shared by Buyer and LP1? What can Buyer do to increase the likelihood it is treated as purchasing an interest from LP2 (assuming it cannot actually purchase that interest for some reason)? Buyer LP1 LP2 PS units 50% 50% 1 $20 PS Buyer LP1 LP2 50% PS 50% $20 2 $20 Page 35

36 Disguised sale of partnership interests Buyer contributes $40 to PS, and PS distributes cash to LP1 and LP2 in complete redemption of their interests. What is it? Is it a disguised sale of partnership interests? If it is a disguised sale of partnership interests, it is presumably recharacterized as an asset purchase to Buyer under Rev. Rul If it is not a disguised sale of partnership interests, then what is it? Is it a disguised sale of property by PS to Buyer? Does the sale of a going concern doctrine then characterize the transaction as a sale of interests (and does Rev. Rul then apply to Buyer)? Is there any reason Buyer, LP1 or LP2 may care? $20 $20 Buyer LP1 LP2 2 2 PS units 50% 50% 1 $40 PS Buyer LP1 LP2 PS $20 $20 Page 36

37 Property contributions Look out for contingent liabilities Page 37

38 Assumption of Treas. Reg liability B contributes a long-term ground lease and a building thereon to PS. Rent due on the ground lease is above market (i.e., annual rental payments are $110 and fair market rental payments are only $100). PS has assumed a net economic liability from B by assuming the ground lease. B s net economic obligation under the lease is treated as a Treas. Reg liability. A -7 liability is not a liability for purposes of Treas. Reg (i.e., it does not increase a partner s tax basis in its interest in the partnership under 752(a)). Allocation of deductions is attributable to a -7 liability. A PS B 50% 50% Property subject to abovemarket ground lease Page 38

39 Assumption of Treas. Reg liability Should PS s assumption of the -7 liability be taken into account for disguised sale purposes? Treasury Decision (TD) 9207 (2005) The intent of the proposed [Treas. Reg ] regulations [ ] was not to override the disguised sale rules under Section 707, which may include liabilities as consideration. Prior disguised sale regulations took into account all liabilities, regardless of whether those liabilities are treated as liabilities under Treas. Reg New temporary regulations completely changed these rules. Old language was removed, and in the case of -7 liabilities, the new temporary regulations simply reserve on the tax treatment. The preamble notes that in many cases, [-7 liabilities] may constitute qualified liabilities but cautions that certain transfers of -7 liabilities could be abusive, so the IRS will continue to study the issue. Is it a liability of a type that would give rise to an amount realized in a taxable asset sale? To whom should the liability be allocated for disguised sale purposes if it is property treated as a liability for this purpose? A PS B 50% 50% Property subject to abovemarket ground lease Page 39

40 Questions? Page 40

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