Partnership unit cancellations are not treated as transfers

Plain-English summary

A limited partnership used units of a related publicly traded partnership for employee incentive awards. To maintain a one-to-one relationship between the entities’ outstanding units, the partnerships canceled corresponding units when award units were purchased and later issued matching new units when awards were made. The taxpayer asked whether those cancellations and reissuances counted as transfers for the publicly traded partnership rules. The IRS ruled that the described transactions would not be treated as transfers under Treasury Regulation section 1.7704-1(a)(3). The ruling did not decide either partnership’s federal tax classification or the application of section 409A and employment tax rules.

Ruling snapshot

• Question: Whether canceling and reissuing partnership units under the employee compensation program constituted transfers for section 7704 purposes
• Outcome: Approved, the transactions were not treated as transfers
• Key authorities: I.R.C. § 7704; Treas. Reg. § 1.7704-1(a)(3)

Full text (IRS public release)

Internal Revenue Service                                       Department of the Treasury
                                                               Washington, DC 20224

Number: 201541009                                              Third Party Communication: None
Release Date: 10/9/2015                                        Date of Communication: Not Applicable
Index Number: 7704.00-00
                                                               Person To Contact:
----------------------------------------------                 -----------------------, ID No. -------------------
-------------------------------                                ---------------------------------------------------
----------------------------------------                       Telephone Number:
 ----------------------------------                            ----------------------
                                                               Refer Reply To:
                                                               CC:PSI:01
                                                               PLR-139491-14
                                                               Date:
                                                               June 18, 2015



Legend

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

Y=                ------------------------------------------

State =           ---------------

Date1 =           ---------------------------

Date2 =           ------------------

Date3 =           ------------------------

Month =           ----------------


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

This letter responds to a letter dated October 20, 2014, and subsequent
correspondence, requesting a ruling under section 7704 of the Internal Revenue Code.

                                                      FACTS

X is a limited partnership organized under the laws of State on Date2. -----------------------
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PLR-139491-14                                    2


Y is a limited partnership organized under the laws of State on Date1. The units
representing assignments of beneficial ownership of limited partnership interests in Y
are publicly traded on the New York Stock Exchange (NYSE). Y represents that it is
treated as a partnership for U.S. federal income tax purposes ----------------------------------
-------------------------------------------------------------------------------------. On Date3, Y
contributed its assets to X in a transaction governed by section 721 and, thereafter, the
principal business activity of Y became owning units of limited partnership interest in X.
At the time of the transaction, Y offered its unitholders a one-time opportunity to
exchange their Y units for X units on a one-for-one basis.

X units are not traded on a public exchange and are subject to substantial transfer
restrictions. The X limited partnership agreement prohibits the general partner from
consenting to a transfer of X units that does not comply with the publicly-traded
partnership safe harbors provided in section 1.7704-1. The general partner is further
required to take any and all actions necessary or desirable to prevent a risk of X being
classified as a publicly-traded partnership under section 7704.

X provides long-term incentive compensation awards to certain employees in the form
of Y units (the Compensation Program). X obtains Y units for its Compensation
Program as follows:

   1. X purchases Y units for the Compensation Plan throughout the year in
      accordance with plans disclosed in the SEC documents;
   2. Upon X’s purchase of Y units, Y promptly cancels such units;
   3. X cancels a corresponding number of X units held by Y in order to maintain the
      one-to-one correlation between outstanding X units and outstanding Y units;
   4. In Month of each year, X determines the amount of new awards under the
      Compensation Program and the number of Y units to be awarded to employees;
   5. X and Y issue a corresponding number of new units to each other;
   6. Newly issued Y units are awarded to the employees.

                                     LAW AND ANALYSIS

Section 721 provides that, subject to certain exceptions, no gain or loss shall be recognized
to a partnership or to any of its partners in the case or a contribution of property to the
partnership in exchange for an interest in the partnership.

Section 731(a)(1) provides that in the case of a distribution by a partnership to a partner,
gain will not be recognized to such partner, except to the extent that any money distributed
exceeds the adjusted basis of such partner’s interest in the partnership immediately before
the distribution.

Section 731(b) provides that a partnership does not recognize gain or loss upon a
distribution of property, including money, to a partner.
PLR-139491-14                                  3

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)(3) provides that for purposes of section 7704(b), 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).

                                       CONCLUSION

Based solely on the information submitted and the representations made, we conclude that
the cancellation and reissuance of units of limited partnership interest in X as described
above as part of the Compensation Program will not be treated as a transfer pursuant to §
1.7704-1(a)(3).

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. In particular, we express no opinion concerning the federal tax classification of X or
Y under section 7704 or the application of section 409A. Furthermore, no opinion is
expressed concerning the application of the Self-Employment Contributions Act, the
Federal Insurance Contributions Act, the Federal Unemployment Tax Act, or the
Federal income tax withholding provisions to the Holding Unit Award Program.

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.

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

                                       Sincerely,

                                       David R. Haglund
                                       David R. Haglund
                                       Chief, Branch 1
                                       Office of the Associate Chief Counsel
                                       (Passthroughs & Special Industries)

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