In PLR 201820013, the IRS ruled that the anti-churning rules of Section 197(f)(9) and Treas. Reg. Section 1.197-2(h) do not apply to limit the amount of amortization otherwise allowable with respect to Section 197 intangibles deemed purchased in a Revenue Ruling 99-5, Situation 1 transaction. The ruling also indicates that relatedness for Section 197(f)(9) purposes is measured after all transactions occurring under a binding commitment, even if the transactions span multiple years.

Facts

Historic structure and pre-acquisition restructuring

C was an S corporation with Operating Entities that were treated as qualified subchapter S subsidiaries.

As a result of the Pre-Acquisition Restructuring, C's historic shareholders owned the stock of B, an S corporation; and B owned interests in C, which became a State2 LLC disregarded as separate from B for US federal income tax purposes. Moreover, after the Pre-Acquisition Restructuring, the Subsidiaries (including the Operating Entities) were owned by C and, for US federal income tax purposes, disregarded as separate from B. The Subsidiaries owned a significant amount of Section 197(f)(9) intangibles.

Member's acquisition of C interests and proposed buyout

In the Purchase, Member purchased interests in C from B for cash and, as a result, C became a partnership (the Partnership) for US federal income tax purposes in a transaction described in Situation 1 of Revenue Ruling 99-5.

Under a binding commitment outstanding at the time of the Purchase and dependent on no contingencies, apart from the passage of time, Member will buy a portion of B's interests in the Partnership (the Buyout). As a result of the Buyout, B will own less than 20% of the Partnership. It appears that the Buyout will occur three years after the Purchase. The ruling states that the passage of time requirement was to allow Member to have the benefit of the industry expertise of the Founders and Management for at least three years following the Purchase.

The Partnership made a number of representations, including that the Purchase was not undertaken to avoid the operation of the anti-churning rules of Section 197(f)(9) and Treas. Reg. Section 1.197-2(h)(11).

Background

Anti-churning rules

In general, Section 197 permits the amortization of certain intangibles acquired after the applicable effective date (August 10, 1993, or July 25, 1991, if a valid retroactive election is made). However, Section 197(f)(9)'s anti-churning rules deny amortization of specified intangibles (goodwill, going concern value, and any intangible that would not be amortizable absent Section 197), even if they are acquired by the taxpayer after the applicable effective date, if the intangible was held or used at any time during the transition period (on or after July 25, 1991 and on or before the applicable effective date) by the taxpayer or a related person.

Treas. Reg. Section 1.197-2(h)(6)(i) defines "related person" for purposes of Section 197(f)(9). A related person is defined: (i) by reference to the definitions in Sections 267(b) and 707(b)(1), except that the 50% standard is replaced with a 20% standard wherever present, and (ii) as two or more persons who are engaged in trades or business under common control within the meaning of Section 41(f)(1)(A) and (B).

The regulations contain a special rule providing the "time for testing relationships." Under Treas. Reg. Section 1.197-2(h)(6)(ii)(B), a person is generally treated as related to another person for purposes of Treas. Reg. Section 1.197-2(h) if the relationship exists "[i]n the case of a series of related transactions (or a series of transitions that together comprise a qualified stock purchase within the meaning of [S]ection 338(d)(3)), immediately before the earliest such transaction or immediately after the last such transaction." Treas. Reg. Section 1.197-2(h)(6)(ii)(B) does not define the term, "series of related transactions." Examples 24 and 25 of Treas. Reg. Section 1.197-2(k) illustrate Treas. Reg. Section 1.197-2(h)(6)(ii)(B) and involve subsequent transactions that occur under binding agreements. Examples 24 and 25 conclude that the subsequent transactions are part of a "series of the related transactions."

Revenue Ruling 99-5, Situation 1

Revenue Ruling 99-5 provides the basic tax constructs for transactions that result in a single-member disregarded LLC becoming a multi-member LLC treated as a partnership for US federal income tax purposes. In Situation 1, the buyer (B) purchases 50% of the LLC's ownership interests from the LLC's sole member (A) for cash. For federal income tax purposes, B is treated as buying a 50% undivided interest in each of the LLC's assets from A, and immediately thereafter, A and B are treated as contributing their respective interests in the LLC's assets to a partnership in exchange for partnership interests. A recognizes taxable gain under Section 1001 on the deemed sale of assets to B, and B obtains a fair market value tax basis in the assets deemed acquired from A. The subsequent contributions by A and B to LLC, the tax partnership, are treated as non-taxable exchanges under Section 721.

It appears that, without taking into account the Buyout, the Partnership's basis in the Section 197(f)(9) intangibles resulting from the Purchase would not have been amortizable by the Partnership under Section 197 because: (i) B was treated as having held or used the Section 197(f)(9) Intangibles during the transition period; and (ii) B and the Partnership would have been related persons for Section 197(f)(9) purposes.

Rulings

Taking into account the parties' binding commitment to consummate the Buyout at the time of the Purchase, the IRS ruled that, assuming the Buyout occurs and based on the representation that B will own less than 20% of the Partnership's interests after the Buyout, the anti-churning rules of Section 197(f)(9) and Treas. Reg. Section 1.197-2(h) do not apply to limit the amount of amortization otherwise allowable with respect to Member's purchased basis in the Section 197(f)(9) intangibles deemed acquired and then deemed contributed to the Partnership under Revenue Ruling 99-5.

The IRS also ruled that, assuming the Buyout occurs and taking into account the Buyout, the Partnership commences amortization of Member's tax basis in the Section 197 intangibles acquired under the Purchase in the month of the Purchase.

Implications

PLR 201820013 is a favorable ruling for taxpayers seeking to amortize Section 197(f)(9) intangibles deemed purchased in a Revenue Ruling 99-5, Situation 1 transaction and for taxpayers seeking to apply Treas. Reg. Section 1.197-2(h)(6)(ii)(B)'s "series of related transactions" standard to transactions spanning multiple years. The ruling is also significant in that the Partnership was allowed to amortize the purchased basis in the Section 197(f)(9) intangibles during a period that the transition period owner of the Section 197(f)(9) intangible held more than 20% of the Partnership interests. The private letter ruling, which may not be used or cited as precedent, is based on a series of specific transactions, related parties, certain ownership percentages, and representations that may or may not apply to other similar purchases. Thus, similarly situated taxpayers should carefully consider their own facts and may want to consider making their own ruling request.

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