PLR 1337012: Vehicle-leasing trusts receive qualified lease and disregarded-entity treatment

Plain-English summary

A vehicle-leasing corporation asked about a financing structure using a First Tier Trust, a Titling Trust, sub-trusts, a special purpose vehicle, and a securitization trust. The IRS ruled that the Master Lease Agreements, including leases with terminal rental adjustment clauses, would qualify as qualified motor vehicle operating agreements under IRC § 7701(h), subject to stated financing and cash-flow conditions. It also ruled that the First Tier Trust and Titling Trust would be treated as business trusts and disregarded as entities separate from the taxpayer for federal tax purposes. The ruling did not decide whether the agreements were true leases or address nonrecourse financing.

Ruling snapshot

• Question: Do the described vehicle leases qualify under IRC § 7701(h), and are the First Tier Trust and Titling Trust disregarded entities?
• Outcome: Approved, subject to the stated conditions and limitations.
• Key authorities: IRC § 7701(h); Treas. Reg. §§ 301.7701-1, 301.7701-2, 301.7701-3, and 301.7701-4.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201337012 Third Party Communication: None
Release Date: 9/13/2013 Date of Communication: Not Applicable
Index Number: 7701.25-04, 7701.03-09
Person To Contact:
---------------------------------------------- ------------------------------, ID No. ------------
----------------------------- ---------
----------------------------------- Telephone Number:
----------------------------------- ----------------------
Refer Reply To:
CC:ITA:B07
PLR-151296-12
Date:
May 22, 2013

LEGEND

Taxpayer = ---------------------------------

State One = ------------

First Tier Trust = ------------------------------

Titling Trust = ------------------------------

State Two = --------------

Date = ---------------------------------------------------------------------------------

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

  This letter responds to your letter dated November 29, 2012, and additional

submissions, requesting a private letter ruling under section 7701(h) of the Internal
Revenue Code.

                                                 FACTS

General

   Taxpayer is a corporation incorporated under the laws of State One that files its

federal income tax return using an accrual method and based on a fiscal year.

   Taxpayer is in the vehicle leasing business, providing a range of services for

organizations of different types and sizes. Its services include acquiring vehicles for
lease and managing their maintenance, accident repairs, fuel, and sale. Many of the
vehicles acquired by Taxpayer are leased under an “open end” master lease agreement
(the “Master Lease Agreement”) that incorporates a terminal rental adjustment clause
(“TRAC”). Taxpayer also regularly enters into a material amount of non-TRAC leases.

   Currently, each approved customer that leases a motor vehicle executes, as

“Lessee,” a Master Lease Agreement with Taxpayer. The Lessee also executes a
separate written statement certifying, under penalties of perjury, that any vehicle leased
from Taxpayer will be used more than ----% in the Lessee’s trade or business. In the
same statement, the Lessee acknowledges that it has been advised that it will not be
treated as the owner of the leased vehicle for Federal income tax purposes. Each
motor vehicle leased by the customer is identified in a schedule that is added to the
Master Lease Agreement.

     At the end of the lease term, Taxpayer takes possession of the vehicle and sells

it. In the case of an open-end TRAC lease, Taxpayer must pay Lessee, as a rental
adjustment, an amount equal to the excess of the sales proceeds (net of sales and
related costs) over the depreciated value of the motor vehicle. If the net sales proceeds
are less than the depreciated value of the vehicle, the Lessee must pay to Taxpayer, as
a rental adjustment, an amount equal to the deficiency. Taxpayer, however, guarantees
a minimum amount of net resale proceeds equal to the “fair value” of the motor vehicle
at the beginning of the 12-month period in which the lease terminates. Because the
initial lease term equals 12 full months plus any portion of the month in which the
vehicle is delivered, the guaranteed minimum amount of net sales proceeds is
effectively adjusted if the Lessee elects to extend the lease beyond the initial lease
term.

   Initial vehicle purchases are funded internally either through operating cash flow

or recourse loans from a Taxpayer affiliate or unrelated third party.

    Taxpayer now intends to implement a program that will allow it to obtain

collateralized financing with third party financial institutions. For this purpose, Taxpayer
plans to organize a trust structure that will consist of: (1) a special purpose, bankruptcy-
remote trust (“First Tier Trust”); (2) a titling trust (“Titling Trust”), which will also be
formed as a special purpose, bankruptcy-remote trust; and (3) certain sub-trusts (the
“Sub-Trusts”) created within the Titling Trust. Taxpayer is the grantor, beneficiary, and
administrator of, and will own -----% of the interests in, the First Tier Trust. First Tier
Trust is the grantor and beneficiary of, and will own -----% of the beneficial interests in,
the Titling Trust, which will be represented by an undivided trust interest (“UTI”) and one
or more Special Units of Beneficial Interest (individually, “SUBI”) held by the First Tier
Trust. Taxpayer will also own, either directly or indirectly through disregarded entities, --
-----% of a Special Purpose Vehicle and a securitization trust.

   Taxpayer created First Tier Trust, a State Two Statutory Trust, pursuant to a

Trust Agreement dated Date, to hold a beneficial interest in the Titling Trust and the
related Sub-Trusts. Section 2.03 of the Trust Agreement authorizes the First Tier Trust

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to (1) execute, deliver, enter into and perform its obligations under the Trust Documents
and Titling Trust Documents; (2) acquire, own, hold, and, as permitted under the Trust
Documents, dispose of or pledge trust assets or beneficial interests therein, and
distribute trust funds not otherwise allocable to expenses; (3) subject to the Trust
Documents, engage in such other activities as may be required in connection with the
preservation of the trust assets and the making of distributions to or upon the order of
the beneficiary or any related holder; and, (4) engage in any activities described or
authorized by the Trust Agreement and any and all activities necessary, appropriate, or
incidental to accomplishing the foregoing.

   The Trustee has no discretionary duties other than performing ministerial acts

necessary to accomplish the purposes of the Trust Agreement and therefore looks to
and acts at the direction of Taxpayer, as beneficiary, with regard to any non-ministerial
acts otherwise permitted under the Trust Agreement. In addition, section 4.02 of the
Trust Agreement provides that the Trustee must establish and maintain, at the direction
and for the benefit of Taxpayer, trust accounts in which all cash and proceeds from trust
assets shall be deposited. Taxpayer, as beneficiary, may authorize the Trustee to make
deposits into, disbursements from, and investment of funds on deposit in, any trust
account.

   It is anticipated that the Titling Trust will allocate groups of leases and related

vehicles (with each group consisting of both TRAC and non-TRAC leases) to separate
Sub-Trusts. Unless and until leases and related vehicles held by the Titling Trust are
allocated to a Sub-Trust, the beneficial ownership of those assets will be represented by
the UTI.

    If a group of leases and related vehicles are allocated to a Sub-Trust, the Titling

Trust will issue a SUBI with respect to that Sub-Trust. The SUBI will represent, with
respect to each leased vehicle in the Sub-Trust, beneficial ownership of the lease
payments, and beneficial ownership of the proceeds from the sale of the vehicle
increased or decreased, respectively, by any payments due from, or to, the lessee.
Title to the leased vehicles will remain in the Titling Trust and will not be allocated to the
SUBI.

   Acting as the lessor, the Titling Trust will acquire vehicles and execute the

Master Lease Agreement (TRAC and non-TRAC) with the Lessees or will act as the
lessor pursuant to an assignment of the Master Lease Agreement from Taxpayer. To
fund the vehicle purchases, Taxpayer may either make recourse loans to the First Tier
Trust secured by a pledge of the UTI by the First Tier Trust, or make capital
contributions to the First Tier Trust. The First Tier Trust will then contribute those
monies to the Titling Trust.

   In furtherance of its activities, under the Titling Trust’s governing instrument,

Titling Trust will be authorized to: (1) accept the designation as the legal title holder of
the leased automobiles, (2) enter into and perform, or cause to be performed,
obligations and duties under Master Lease Agreements (TRAC and non-TRAC), (3)
appoint Taxpayer (or third party) as its attorney-in-fact and direct Taxpayer to perform
administrative duties on behalf of the Titling Trust, (4) enter into (or accept the

PLR-151296-12 3

assignment of) a servicing agreement under which Taxpayer will act as the servicer of
the leased automobiles, (5) establish accounts and receive, maintain, invest, and
disburse funds in accordance with the Titling Trust’s governing instrument and the
servicing agreement, and (6) as long as Taxpayer has not defaulted in its servicing
duties, and at the direction of the holder of the UTI or the holder of a SUBI, (i) pledge,
transfer or otherwise dispose of any interest in the assets represented by such UTI or
SUBI, (ii) amend or revoke trust terms with respect to all or a portion of the assets
represented by such UTI or SUBI and (iii) enter into any agreement or instruments
affecting all or any portion of the assets represented by such UTI or SUBI.

   From time to time, the First Tier Trust, as the owner of the UTI (or Taxpayer as

owner of the First Tier Trust) will direct the Titling Trust to create a new Sub-Trust and
allocate to the new Sub-Trust the Titling Trust’s beneficial interests in a designated pool
of vehicles and related leases. It is anticipated that the non-TRAC leases allocated to a
Sub-Trust will represent a material amount of the entire pool. In addition, when
selecting the vehicles for any particular Sub-Trust, Taxpayer will have to take into
account the ordinary concerns of creditors such as lessee concentration, lessee credit
ratings, motor vehicle type and location, and lease term.

   Following an allocation of leases and related vehicles to a Sub-Trust, the Titling

Trust will issue to the First Tier Trust as owner of the UTI, the SUBI representing
beneficial ownership of the cash flows related to the assets of the Sub-Trust. The First
Tier Trust, as owner of the UTI, will then convey the SUBI to a separate, special
purpose vehicle (the “SPV”), which in turn will convey the SUBI to a securitization trust
(“Securitization Trust”).

   The Securitization Trust will then issue instruments in the form of debt to

investors, naming the Securitization Trust as the obligor. The instruments issued will
impose no restrictions on which Securitization Trust assets may be used to satisfy the
debt. Under the operative documents, the investors will agree to treat the instruments
as indebtedness for income tax purposes and will acknowledge that they are not entitled
to any depreciation with respect to any leased vehicles.

    Neither the Titling Trust, the First Tier Trust, nor the SPV will pledge to the

Securitization Trust the title to any vehicle to which the SUBI relates. If the
Securitization Trust fails to make its debt payments, the assets acquired by the creditors
will be the SUBI conveyed to the Securitization Trust and not title to any such vehicle.
Vehicles will not be considered for financing before they are acquired from the
manufacturer with Taxpayer’s working capital and are under lease.

   In furtherance of its activities, under the Securitization Trust’s governing

instrument, the Securitization Trust will be authorized to (1) acquire, transfer, finance,
pledge, and otherwise deal with the SUBI conveyed to it, (2) undertake transactions
involving the vehicles and related leases represented by the SUBI, (3) borrow money,
(4) negotiate, execute and perform the obligations under any agreement relating to the
foregoing activities, and (5) engage in any lawful act or activity and exercise any powers
permitted under state law that are related or incidental to and necessary, convenient or
advisable for the accomplishment of the foregoing purposes.

PLR-151296-12 4

   Taxpayer makes the following representations:

  A.    The Titling Trust, as holder of the title to each motor vehicle in a pool will

be recognized as the sole owner of those motor vehicles for State law purposes.

    B.     At the time a Securitization Trust issues debt instruments, (1) Taxpayer

will expect to receive an opinion from qualified tax counsel that such debt instruments
will qualify as indebtedness for U.S. federal income tax purposes, and (2) Taxpayer and
the holders of the debt instruments will expect the cash flows payable on the SUBI held
by the Securitization Trust to be sufficient to make timely and complete payments on the
debt instruments issued by the Securitization Trust.

    C.      Taxpayer will be the sole owner (either directly or through a disregarded

entity or entities) of each of the Titling Trust, the First Tier Trust, the SPV and the
Securitization Trust, none of which elect to be classified as an association under section
301.7701-3 of the Procedure and Administration Regulations (the “Regulations”).

                             RULINGS REQUESTED

    A.     The Master Lease Agreement entered into by, or assigned to, the Titling

Trust will be a “qualified motor vehicle operating agreement” under § 7701(h) and the
qualification of the Master Lease Agreement as a lease for federal income tax purposes
will be determined without regard to the TRAC provision of the Master Lease
Agreement.

  B.     The Titling Trust and the First Tier Trust will be disregarded as an entity

separate from Taxpayer.

                              LAW AND ANALYSIS

   A.      The Master Lease Agreement entered into by, or assigned to, the Titling

Trust will be a qualified motor vehicle operating agreement.

   Section 7701(h)(1) provides that in the case of a qualified motor vehicle

operating agreement that contains a terminal rental adjustment clause, the agreement is
treated as a lease if (but for such terminal rental adjustment clause) the agreement would
be treated as a lease for Federal income tax purposes, and the lessee is not treated as the
owner of the property subject to the agreement during the period the agreement is in
effect.

   Section 7701(h)(2)(A) defines a qualified motor vehicle operating agreement as

any agreement with respect to a motor vehicle (including a trailer) that meets three
requirements, set forth in subparagraphs (B), (C), and (D) of § 7701(h)(2).

   First, § 7701(h)(2)(B) requires that, under the agreement, the sum of the amount

the lessor is personally liable to repay, and the net fair market value of the lessor’s
interest in any property pledged as security for property subject to the agreement,
equals or exceeds all amounts borrowed to finance the acquisition of property subject to
the agreement. Any property pledged that is property subject to the agreement or

PLR-151296-12 5

property directly or indirectly financed by indebtedness secured by property subject to
the agreement is not taken into account.

     Second, pursuant to § 7701(h)(2)(C), the agreement must contain a separate

written statement signed by the lessee that the lessee certifies, under penalty of perjury,
that it intends that more than 50 percent of the use of the property subject to the
agreement is to be in a trade or business of the lessee, and that clearly and legibly
states that the lessee has been advised that it would not be treated as the owner of the
property subject to the agreement for federal income tax purposes.

    Finally, § 7701(h)(2)(D) requires that the lessor must not know that the

certification in § 7701(h)(2)(C) is false.

    Taxpayer has represented that the terms of the Master Lease Agreement

underlying each new TRAC lease will satisfy the requirements of § 7701(h)(2)(C).
Further, Taxpayer will fund the entire acquisition price of the motor vehicle using
operating capital or the proceeds of recourse debt. Thus, in either case, Taxpayer will be
fully at risk on the acquisition price of the motor vehicles from the time of initial
acquisition of the vehicle.

    Based on the facts and representations made by Taxpayer, and provided that :

(1) Securitization Trust borrows funds from lenders on a recourse basis; and (2)
amounts received in lease payments and from the disposition of motor vehicles (using
rental defaults consistent with historical experience) are expected to be sufficient to
satisfy all obligations to lenders, we conclude that the Master Lease Agreement entered
into by, or assigned to, the Titling Trust will meet the definition of a "qualified motor
vehicle operating agreement" under § 7701(h)(2). In addition, qualification of the Master
Lease Agreement as a lease for federal income tax purposes will be determined without
regard to the TRAC provision of the Master Lease Agreement.

  B.     The Titling Trust and the First Tier Trust will be disregarded as an entity

separate from Taxpayer.

  Section 301.7701-1(a)(1) provides that whether an organization is an entity

separate from its owners for federal tax purposes is a matter of federal tax law and does
not depend on whether the organization is recognized as an entity under local law.

   Section 301.7701-2(a) provides that a business entity is any entity recognized for

federal tax purposes that is not properly classified as a trust under § 301.7701-4 or
otherwise subject to special treatment under the Internal Revenue Code.

   Section 301.7701-3(a) provides that a business entity that is not classified as a

corporation under § 301.7701-2(b)(1), (3), (4), (5), (6), (7), or (8) (an "eligible entity")
can elect its classification for federal tax purposes. An eligible entity with a single owner
can elect to be classified as an association or to be disregarded as an entity separate
from its owner.

PLR-151296-12 6

  Section 301.7701-3(b)(1)(ii) provides that a domestic eligible entity with a single

owner is disregarded as an entity separate from its owner for federal tax purposes
unless the entity elects to be treated as a corporation.

    Section 301.7701-4(a) provides that in general, the term "trust" refers to an

arrangement created either by a will or by an inter vivos declaration whereby trustees
take title to property for the purposes of protecting or conserving it for the beneficiaries.
Generally speaking, an arrangement will be treated as a trust under the Internal Revenue
Code if it can be shown that the purpose of the arrangement is to vest in trustees
responsibility for the protection and conservation of property for beneficiaries
who cannot share in the discharge of this responsibility and, therefore, are not
associates in a joint enterprise for the conduct of business for profit.

    Section 301.7701-4(b) addresses "business trusts" and provides that there are

other arrangements which are known as trusts because the legal title to property is
conveyed to trustees for the benefit of beneficiaries, but which are not classified as
trusts for purposes of the Internal Revenue Code because they are not simply
arrangements to protect or conserve the property for the beneficiaries. These trusts,
which are often known as business or commercial trusts, generally are created by the
beneficiaries simply as a device to carry on a profit-making business which normally
would have been carried on through business organizations that are classified as
corporations or partnerships under the Internal Revenue Code. However, the fact that
the corpus of the trust is not supplied by the beneficiaries is not sufficient reason in itself
for classifying the arrangement as an ordinary trust rather than as an association or
partnership. The fact that any organization is technically cast in the trust form, by
conveying title to property to trustees for the benefit of persons designated as
beneficiaries, will not change the real character of the organization if the organization is
more properly classified as a business entity under § 301.7701-2.

    Accordingly, we conclude that First Tier Trust and Titling Trust will be treated as

business trusts as described in § 301.7701-4(b) and not trusts under § 301.7701-4(a)
for federal income tax purposes. We further conclude that under § 301.7701-3(b)(1)(ii),
First Tier Trust and Titling Trust (including the SUBI Sub-trusts) are domestic eligible
entities with a single owner that are disregarded as entities separate from Taxpayer.

                                PROCEDURAL MATTERS

    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. Specifically, we express or imply no opinion concerning: (1)
whether the Master Lease Agreement is a true lease for Federal income tax purposes;
(2) a situation in which Issuer borrows funds from lenders on a nonrecourse basis; and
(3) a situation in which the amounts received in lease payments and from the
disposition of motor vehicles (using rental default consistent with historical experience)
are not expected to be sufficient to satisfy all obligations to lenders.

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

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

PLR-151296-12 8

    Temporary or final regulations pertaining to one or more of the issues addressed

in this ruling have not yet been adopted. Therefore, this ruling will be modified or
revoked by the adoption of temporary or final regulations, to the extent the regulations
are inconsistent with any conclusion in the letter ruling. See section 11.04 of Rev. Proc.
2013-1, 2013-1 I.R.B. 1, 50. However, when the criteria in section 11.06 of Rev. Proc.
2013-1, 2013-1 I.R.B. 1, 50 are satisfied, a ruling is not revoked or modified retroactively
except in rare or unusual circumstances.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

  The rulings contained in this letter are based upon information and

representations submitted by the taxpayer and accompanied by a penalty of perjury
statement executed by an appropriate party. While this office has not verified any of
the material submitted in support of the request for rulings, it is subject to verification on
examination.

                                    Sincerely,



                                    WILLIE E. ARMSTRONG, JR.
                                    Senior Technician Reviewer, Branch 7
                                    (Income Tax & Accounting)