PLR 200852005: Buying back your own shares on a fixed schedule is not a secondary market

Plain-English summary

Section 7704 exists to stop partnerships from being traded like corporate stock while still being taxed like partnerships. A partnership whose interests are traded on an established securities market, or are readily tradable on a secondary market or the substantial equivalent of one, is treated as a corporation. That is a heavy consequence, and it can be triggered by arrangements that look nothing like a stock exchange, because the substantial-equivalent language is deliberately broad.

The foreign entity here had a genuine section 7704 problem to worry about. It was originally a per se corporation under section 301.7701-2(b)(8)(i), meaning it had no choice about being taxed as a corporation. It then re-registered under its home country's law in a form that took it off that list, filed a Form 8832 and became a partnership for federal tax purposes as part of a larger restructuring. All of its ordinary shares are held by a single foreign parent. But it also has widely held non-voting preference shares outstanding, and those shares had been listed on a stock exchange until the entity de-listed them.

De-listing solved the first branch of the test but not the second. The preference holders retained a right to sell their shares back to the entity at a fixed price once a year, on roughly the same date each year, through a defined final year. The entity then added a repurchase program letting holders sell back twice a month, again at the same fixed price. The entity holds a call to redeem every preference share in the final year without the holders' consent and says it intends to exercise it.

Twice-monthly liquidity at a known price is, functionally, a market. That is exactly why section 1.7704-1(e)(1)(viii) matters. It says transfers under a closed end redemption plan are disregarded entirely when you ask whether interests are readily tradable. The exclusion is narrow and turns on two conditions in section 1.7704-1(e)(4): the partnership must not issue any interest after the initial offering, and no partner or related person may offer contemporaneous chances to buy into similar or related partnerships representing substantially identical investments.

The logic of those two conditions is the logic of the whole ruling. Together they mean the pool is closed at both ends. Nothing new comes in, so redemptions shrink the entity rather than churning it, and there is no parallel vehicle that would let an exiting holder's economic position be picked up by a new investor elsewhere. Without that second condition, an affiliated family of look-alike partnerships could serve as the market that the redemption plan itself is not.

The entity represented that it fit both. No preference shares had been issued since the initial offering, and it would issue nothing after the election date other than ordinary shares to its sole parent. There were no contemporaneous substantially identical investments on offer. It also represented that nobody makes public bid or offer quotes on its interests and nobody stands ready to buy or sell at quoted prices, which heads off the separate quoted-price concerns in the regulation.

So both the annual put right and the twice-monthly repurchase program qualified as closed end redemption plans, the redemptions under them are disregarded, and with no interests traded on an established market either, the entity is not a publicly traded partnership. What the letter shows is that frequency of liquidity is not what section 7704 measures. A plan can offer holders an exit every two weeks and still fall outside the statute, because the question is whether a market exists, not how often the door opens.

This is a clean digital release rather than a scan, so no OCR correction was needed. Kept as released: "X is not a publicly traded partnership within the within the meaning of § 7704(b)," with the phrase doubled; "Other than these rights described," missing a word; and the citations to section 267(b) or 707(b)(1) rendered without the usual section symbol on the second.

Ruling snapshot

• Question: Do an annual put right and a twice-monthly repurchase program at a fixed price make a partnership's widely held preference shares readily tradable on a secondary market?
• Outcome: approved. Both arrangements are closed end redemption plans under Treas. Reg. section 1.7704-1(e)(4), so redemptions under them are disregarded, and the taxpayer is not a publicly traded partnership within the meaning of section 7704(b).
• Key authorities: Code sections 267(b), 707(b)(1), 7704(a), 7704(b), 7704(c); Treas. Reg. sections 301.7701-2(b)(8)(i), 1.7704-1(e)(1)(viii), 1.7704-1(e)(3), 1.7704-1(e)(4).

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 200852005 Third Party Communication: None
Release Date: 12/26/2008 Date of Communication: Not Applicable Index Number: 7704.01-00 Person To Contact:
------------------------------------ -----------------, ID No. -------------
------------------------------- Telephone Number:

--------------------------------------------------- Refer Reply To: CC:PSI:B01 PLR-111213-08 Date: September 24, 2008

LEGEND

X = ---------------------------------
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A = -------------------.

Country 1 = ---------------------

Country 2 = --------

Date 1 = -------------------

Date 2 = ------------------

Date 3 = ------------------

Date 4 = ------------------

Date 5 = ----------------------

Date 6 = ----------

Year 1 = -------

Year 2 = -------

Entity 1 = -------------------------------

Entity 2 = ----------------------

Stock Exchange = -------------------------------------- y = --------

Dear ----------------:

This letter is in response to a letter dated March 5, 2008, submitted on behalf of X, requesting a ruling that X is not a publicly traded partnership for purposes of § 7704 of the Internal Revenue Code.

FACTS

X was originally organized as an Entity 1 under the laws of Country 1. A, a Country 2 entity, acquired all of the outstanding ordinary shares of X on Date 1 and continues to own all of X’s ordinary shares. Prior to Date 3, X was a per se corporation within the meaning of § 301.7701-2(b)(8)(i) of the Procedure and Administration Regulations. On Date 3, X re-registered as an Entity 2 under the laws of Country 1. Subsequently, X filed an election on Form 8832, Entity Classification Election, to be treated as a partnership for federal tax purposes effective Date 5. The election was part of a larger restructuring undertaken by A and related entities.

In addition to its ordinary shares, X has outstanding B shares, which are non-voting, non-cumulative preference shares that are widely held. Prior to Date 2, the B shares were listed and traded on Stock Exchange. On Date 2, X de-listed its B shares from Stock Exchange. Holders of B shares have the right to sell their shares to X for y per B share on or around Date 6 of each year from Year 1 to Year 2. Additionally, on Date 4, X implemented an off-market repurchase program pursuant to which the owners of the B shares may sell their shares to X twice per month for y per B share. X has the right to repurchase all outstanding B shares without the consent of the B shareholders in Year 2 for y per B share. X intends to exercise this right to redeem all of the B shares in Year

2. Other than these rights described, there is no right or obligation on the part of either
   X or the B shareholders to redeem or sell the B shares.

X represents that no B shares have been issued since the initial offering of B shares, and that X will not issue any interests on or after Date 5 other than ordinary shares issued to A. X further represents that no partner or person related to any partner (within the meaning of § 267(b) or 707(b)(1)) provides contemporaneous opportunities to acquire interests in similar or related partnerships that represent substantially identical investments. Finally, X represents that no person regularly makes available to the public bid or offer quotes with respect to interests in X and no person stands ready to effectuate buy or sell transactions at the quoted prices.

LAW AND ANALYSIS
Section 7704(a) provides that, except as provided in § 7704(c), a publicly traded partnership will be treated as a corporation.

Section 7704(b) provides that, for purposes of § 7704, the term "publicly traded partnership" means any partnership if (1) interests in such partnership are traded on an established securities market, or (2) interests in such partnership are readily tradable on a secondary market (or the substantial equivalent thereof).

Section 1.7704-1(e)(1)(viii) provides that transfers pursuant to a closed end redemption plan are disregarded in determining whether interests in a partnership are readily tradable on a secondary market or the substantial equivalent thereof.

Section 1.7704-1(e)(4) provides that for purposes of § 1.7704-1(e)(1)(viii), a redemption or repurchase agreement (as defined in § 1.7704-1(e)(3)) is a closed end redemption plan only if (i) the partnership does not issue any interest after the initial offering (other than the issuance of additional interests prior to August 5, 1988); and (ii) no partner or person related to any partner (within the meaning of § 267(b) or 707(b)(1)) provides contemporaneous opportunities to acquire interests in similar or related partnerships that represent substantially identical investments.

Section 1.7704-1(e)(3) provides that, for purposes of § 7704(b) and § 1.7704-1, a redemption or repurchase agreement means a plan of redemption or repurchase maintained by a partnership whereby the partners may tender their partnership interests for purchase by the partnership, another partner, or a person related to another partner (within the meaning of § 267(b) or 707(b)(1)).

No interests in X are traded on an established securities market. The repurchase program described above, and the rights of B shareholders to sell their B shares to X on or around Date 6 each year from Year 1 to Year 2, qualify as closed end redemption plans within the meaning of § 1.7704-1(e)(4). Therefore, redemptions of B shares by X pursuant to those plans should be disregarded in determining whether interests in X are readily tradable on a secondary market or the substantial equivalent thereof.

CONCLUSIONS

Based solely on the facts submitted and the representations made, we conclude that X is not a publicly traded partnership within the within the meaning of § 7704(b).

Except as expressly provided herein, no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representatives.

Sincerely,

Dianna K. Miosi

Dianna K. Miosi
Chief, Branch 1
Office of the Associate Chief Counsel
(Passthroughs & Special Industries)

Enclosures (2)
Copy of this letter
Copy for § 6110 purposes