PLR 1224012: IRS rules reorganized funds will not be publicly traded partnerships

Plain-English summary

The IRS ruled that, after a reorganization, each new investment fund that is classified as a partnership for federal tax purposes will not be treated as a publicly traded partnership. The funds will be held by life insurance company separate accounts and other permitted owners, will not be traded on an established securities market, and will not be publicly quoted or readily exchangeable. The ruling supports the funds' intended use as investment vehicles for variable life insurance policies and annuity contracts. The IRS did not rule on whether the new funds are partnerships for federal tax purposes.

Ruling snapshot

• Question: Would the reorganized investment funds be treated as publicly traded partnerships if they were classified as partnerships?
• Outcome: Approved, conditional on the facts and representations described in the ruling.
• Key authorities: IRC §§ 7704, 817, and 851

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201224012 Third Party Communication: None
Release Date: 6/15/2012 Date of Communication: Not Applicable
Person To Contact:
Index Number: 7704.01-00 ---------------------------, ID No. -------------
Telephone Number:
---------------------
--------------------------------------------- Refer Reply To:
----------------------------------------------- CC:PSI:B01
-------------------------------- PLR-137308-11
---------------------------------- Date:
March 07, 2012

LEGEND

X = ---------------------------------------------

Company = -----------------------------------.

State1 = --------------

Trust = ---------------------------

State2 = -------------

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

   This responds to a letter dated September 7, 2011, together with subsequent

correspondence, submitted on behalf of X by X's authorized representative, requesting
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an entity classification ruling under section 7704 of the Internal Revenue Code.

Facts

   The information submitted states that X is a domestic life insurance company. X

currently invests through separate accounts (“Separate Accounts”), and subaccounts
thereof, individually investing in one or more series (or “Funds”) of Company. Company
is a State1 corporation organized under the laws of State1. Company is an open-end
management investment company, registered under the Investment Company Act of
1940 (“the 1940 Act”). Company issues a separate series of stock representing
ownership interest in each of the Funds. Each Fund is treated as a separate
corporation for federal income tax purposes by operation of section 851(g), and each
Fund has elected to be taxed as a separate regulated investment company within the
meaning of section 851(a). The Funds serve as funding vehicles for variable life
insurance policies and variable annuity contracts (collectively, “Variable Contracts”)
issued by X. X is a shareholder of each of the Funds.

   Company proposes to reorganize its business operations into Trust, a State2

statutory trust that will be the successor-in-interest to Company and will adopt
Company’s registration statement as a management investment company under the
1940 Act (the “Reorganization”). Trust will establish several series (“New Funds”)
pursuant to State2 law, and will issue separate shares of beneficial interest (“Shares”)
representing ownership interests in each of the New Funds. For each Fund of
Company, Trust will create a corresponding New Fund for the purpose of acquiring and
carrying on the activities of a corresponding Fund. Trust's declaration of trust provides
that Shares in the New Funds may be held only be segregated asset accounts of life
insurance companies to support Variable Contracts, or other shareholders permitted
under § 1.817-5(f) to have a beneficial interest in a New Fund without causing the loss
of “look-through” treatment under that regulation.

   Each Fund will undergo the following steps to effectuate the Reorganization.

Each Fund will transfer its assets to a New Fund in exchange for Shares in the New
Fund and the New Fund's assumption of the Fund's liabilities. The Fund will distribute in
complete liquidation the Fund's Shares in the New Fund to its shareholders. X, as a
current shareholder of the Funds, will therefore become an owner of Shares in each
New Fund corresponding to a Fund.

    After the Reorganization, each subaccount of the Separate Accounts will invest

solely in one or more New Funds. The holder of a Variable Contract may specify in
which subaccounts of the Separate Accounts the premiums are to be invested. The
benefits that X pays to the contract holder will reflect in part the investment return
associated with, and the market value of, the relevant underlying investment options
supporting the Variable Contract (i.e. Shares in the New Funds). However, the benefits
under the Variable Contracts can vary significantly from the value of the Shares in the
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New Funds, especially where a contract holder dies before his or her life expectancy.
Typically, a Variable Contract cannot be redeemed, within a specified period, without a
penalty, nor sold at face value. Furthermore, the interests in a New Fund will be owned
only by X, other life insurance companies, or other permissible owners of Shares
specified in § 1.817-5(f) (collectively, “Eligible Shareholders”). The contract holder will
only have claims against the Insurance Company issuing the Variable Contract and not
against the income, gains, losses, or distributions of the New Funds.

   X requests a ruling that after the Reorganization each New Fund that is

otherwise classified as a partnership for federal tax purposes will not be treated as a
publicly traded partnership.

   X makes the following representations regarding Company’s current business

operations and the future business operations of Trust after the Reorganization:

  1. Company is registered with the Securities and Exchange Commission under

the 1940 Act as an open-end management investment company. Each Fund also
operates as a separate open-end management investment company and is taxable as a
separate corporation for federal income tax purposes by reason of section 851(g).

   2. Each Fund has elected to be treated, and has qualified, as a regulated

investment company within the meaning of section 851(a) for each taxable year of its
existence and intends to qualify as a regulated investment company for its final short
taxable period ending on the date of the Reorganization.

   3. Pursuant to the Reorganization, Trust, as successor-in-interest to Company,

will adopt the Company’s registration statement as an open-end management
investment company under the 1940 Act.

   4. Each New Fund will be a separate series of Trust created in conformance with

State2 law and its declaration of trust. The certificate of trust filed on behalf of Trust
includes the notice of limitation of liabilities of series, as provided by State2 law.

   5. Neither Trust nor any New Fund has ever held itself out as, or made an

election to be classified as, a corporation.

   6. Each New Fund will consist of a separate pool of assets, liabilities, and stream

of earnings. The owners of Shares of a New Fund may (with respect to said Shares)
share in the income only of that New Fund and, correspondingly, will be limited to the
assets of that New Fund upon the redemption of Shares in, or the liquidation or
termination of, such New Fund. The payment of the expenses, charges and liabilities of
a New Fund will be limited to that New Fund’s assets. The creditors of a New Fund are
limited to the assets of that New Fund for recovery of expenses, charges, and liabilities.
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    7. Each New Fund will have its own investment objectives, policies, and

restrictions, which shall be the same as the objectives, policies, and restrictions of the
corresponding predecessor Fund.

  8. Votes of the owners of Shares of the New Funds may be conducted by each

New Fund separately with respect to matters that affect only that particular New Fund,
except to the extent the 1940 Act requires all Shares to be voted as a single class of
shares.

   9. Other than in the case of persons permitted under § 1.817-5(f)(3) to have a

beneficial interest in a New Fund, all Shares in each New Fund will be held by
subaccounts of separate accounts of one or more life insurance companies. Public
access to each New Fund will be available exclusively through the purchase of a life
insurance policy or annuity contract that qualifies as a variable contract under section
817(d).

   10. Each New Fund will operate as a separate business entity for federal tax

purposes and, as a business entity with more than one member, will file its own federal
tax return. For federal income tax purposes, all interests in each New Fund will be
owned by X, other life insurance companies, and other permissible owners under
§ 1.817-5(f), and not by the variable contract holder.

  11. Following the Reorganization, the Shares of each New Fund will at all times

be held by fewer than 100 life insurance companies.

   12. The Shares of each New Fund are not, and will not be, traded on an

established securities market and, accordingly, no owner of Shares will have the
opportunity to engage in transactions involving the Shares on an established securities
market.

  13. The Shares of each New Fund are not, and will not be, regularly quoted by

any person, such as a broker or dealer making a market in the Shares and, accordingly,
no owner of Shares will have the opportunity to participate in any market in the Shares.

   14. No person regularly makes available, and no person will make available, to

the public (including customers or subscribers) bid or offer quotes with respect to the
Shares in any New Fund, and no person will stand ready to effect buy or sell
transactions at quoted prices for itself or on behalf of others; accordingly, no owner of
Shares will have the opportunity to engage in transactions involving Shares based upon
bid/offer quotes.

   15. No owner of Shares has, or will have, a readily available, regular, and

ongoing opportunity to sell or exchange Shares through a public means of obtaining or
providing information of offers to buy, sell, or exchanges Shares.
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  16. There is no plan or intention for the redemption of Shares by a New Fund to

be combined with the issuance of Shares in the New Fund to a new issuee of Shares.

      17. Other than the right of an owner of a Variable Contract to allocate premiums

or contract value among one or more subaccounts of Separate Accounts, no owner of a
Variable Contract (i) possesses, or will possess, control over the investment options of
any subaccount or of any New Fund, (ii) has, or will have, any authority to make
investment decisions concerning the assets of any subaccount or of any New Fund, or
(iii) is permitted or will be permitted to select or recommend particular investments or
investment strategies with respect to any subaccount or any New Fund.

   18. Following the Reorganization, Trust may in the future establish and designate

one or more additional series. Any such additional Trust series will engage in the same
type of investment activities as are engaged in by, and will satisfy the same
representations as are made with respect to, the New Funds.

    19. Shares of the New Funds are not, and will not be, transferable without first

obtaining the consent of the trustees of Trust. The trustees may withhold consent if the
trustees determine that the transfer may (i) result in a person who is not an Eligible
Shareholder becoming a shareholder, (ii) otherwise cause a New Fund to cease to be
an eligible entity to which the “look-through” rules of § 1.817-5(f) apply, (iii) cause a New
Fund to be treated as a publicly-traded partnership as defined in section 7704(b), or (iv)
result in a violation of the 1940 Act, the Securities Act of 1933, or other applicable law.
Notwithstanding the foregoing, a shareholder will be permitted to transfer Shares of
which it is the record owner without first obtaining the consent of the Trustees if the
transfer is made (i) to a successor that is an Eligible Shareholder and (ii) in connection
with a merger, consolidation, sale of substantially all assets or similar transaction to
which the shareholder is party.

Law and Analysis

   Section 7704(a) provides that except as provided in section 7704(c), a publicly

traded partnership will be treated as a corporation.

   Section 7704(b) provides that the term “publicly traded partnership” means any

partnership if (1) interests in such partnership are traded on an established securities
market and (2) interests in such partnership are readily tradable on a secondary market
(or the substantial equivalent thereof).

   Section 1.7704-1(a)(2)(i) of the Procedure and Administration Regulations

provides that for purposes of section 7704(b) and § 1.7704-1, an interest in a
partnership includes (A) any interest in the capital or profits of the partnership (including
the right to partnership distributions); and (B) any financial instrument or contract the
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value of which is determined in whole or in part by reference to the partnership
(including the amount of partnership distributions, the value of partnership assets, or the
results of partnership operations).

   Section 1.7704-1(a)(3) provides that for purposes of section 7704(b) and §

1.7704-1, a transfer of an interest in a partnership means a transfer in any form,
including a redemption by the partnership or the entering into of a financial instrument or
contract described in § 1.7704-1(a)(2)(i)(B).

   Section 1.7704-1(c)(1) provides that for purposes of section 7704(b) and

§ 1.7704-1, interests in a partnership that are not traded on an established securities
market (within the meaning of section 7704(b) and § 1.7704-1(b)) are readily tradable
on a secondary market or the substantial equivalent thereof if, taking into account all of
the facts and circumstances, the partners are readily able to buy, sell, or exchange their
partnership interests in a manner that is comparable, economically, to trading on an
established securities market.

    Section 1.7704-1(c)(2) provides that for purposes of § 1.7704-1(c)(1), interests in

a partnership are readily tradable on a secondary market or the substantial equivalent
thereof if-- (i) Interests in the partnership are regularly quoted by any person, such as a
broker or dealer, making a market in the interests; (ii) Any person regularly makes
available to the public (including customers or subscribers) bid or offer quotes with
respect to interests in the partnership and stands ready to effect buy or sell transactions
at the quoted prices for itself or on behalf of others; (iii) The holder of an interest in the
partnership has a readily available, regular, and ongoing opportunity to sell or exchange
the interest through a public means of obtaining or providing information of offers to buy,
sell, or exchange interests in the partnership; or (iv) Prospective buyers and sellers
otherwise have the opportunity to buy, sell, or exchange interests in the partnership in a
time frame and with the regularity and continuity that is comparable to that described in
the other provisions of § 1.7704-1(c)(2).

    Section 1.7704-1(d) provides that for purposes of section 7704(b) and § 1.7704-

1, interests in a partnership are not traded on an established securities market within
the meaning of § 1.7704-1(b)(5) and are not readily tradable on a secondary market or
the substantial equivalent thereof within the meaning of § 1.7704-1(c) (even if interests
in the partnership are traded or readily tradable in a manner described in § 1.7704-
1(b)(5) or (c)) unless-- (1) The partnership participates in the establishment of the
market or the inclusion of its interests thereon; or (2) The partnership recognizes any
transfers made on the market by-- (i) Redeeming the transferor partner (in the case of a
redemption or repurchase by the partnership); or (ii) Admitting the transferee as a
partner or otherwise recognizing any rights of the transferee, such as a right of the
transferee to receive partnership distributions (directly or indirectly) or to acquire an
interest in the capital or profits of the partnership.
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   Section 1.7704-1(h)(1) provides that for purposes of section 7704(b) and this

section, except as otherwise provided in § 1.7704-1(h)(2), interests in a partnership are
not readily tradable on a secondary market or the substantial equivalent thereof if (i) all
interests in the partnership were issued in a transaction (or transactions) that was not
required to be registered under the Securities Act of 1933; and (ii) The partnership does
not have more than 100 partners at any time during the taxable year of the partnership.

   Rev. Proc. 2011-3, § 3.01(78), 2011-1 C.B. 111, provides the Service will not

issue a ruling on whether interests in a partnership that are not traded on an established
securities market (within the meaning of section 7704(b) and § 1.7704-1(b)) are readily
tradable on a secondary market or the substantial equivalent thereof under § 1.7704-
1(c)(1). Rulings specifically pertaining to New Funds supporting variable contract
arrangements of life insurance companies do not fall within the intended scope of the no
rule area.

Conclusion

    The Shares in each New Fund are interests in the capital or profits of the New

Funds. Therefore, if the New Funds are partnerships for federal tax purposes, the
Shares would be partnership interests for purposes of section 7704(b). See § 1.7704-
1(a)(2)(i)(A). The sale of Shares to other insurance companies or to the separate
accounts of other insurance companies does not fall within the definition of trading on
an established securities market as defined in section 7704(b)(1) and § 1.7704-1(b).
Additionally, Shares may only be sold to the Separate Accounts of X, the separate
accounts of other life insurance companies, and other persons specified in § 1.817-
5(f)(3), and (i) are not regularly quoted by any person, such as a broker or dealer,
making a market in the interests; (ii) no person regularly makes available to the public
(including customers or subscribers) bid or offer quotes with respect to the Shares and
stands ready to effect buy or sell transactions at the quoted prices for itself or on behalf
of others; (iii) the owners of Shares do not have a readily available, regular, and
ongoing opportunity to sell or exchange the interests through a public means of
obtaining or providing information of offers to buy, sell, or exchange interests in the
partnership; and (iv) prospective buyers and sellers do not otherwise have the
opportunity to buy, sell, or exchange Shares in a time frame and with the regularity and
continuity that is comparable to that described in the other provisions of § 1.7704-
1(c)(2).

  Based solely on the information submitted and the representations made, we

conclude that, following the Reorganization, each New Fund that is classified as a
partnership will not be treated as a publicly traded partnership.

   Except as specifically set forth above, no opinion is expressed or implied

concerning the federal tax consequences of the facts described above under any other
provision of the Code. Specifically, no opinion is expressed or implied whether the New
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Funds are partnerships for federal tax purposes.

  This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)

provides that it may not be used or cited as precedent.

   Pursuant to the power of attorney on file with this office, a copy of this letter is

being sent to X's authorized representative.

                                       Sincerely,



                                       Joy Spies
                                       Joy Spies
                                       Acting Senior Technician Reviewer, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

Enclosures (2)

Copy of this letter
Copy of this letter for § 6110 purposes

cc: