The IRS has finalized, without substantive changes, proposed regulations that were issued in conjunction with temporary regulations in January 2012. The final regulations make permanent four changes to the rules for allocating and apportioning interest expense for partners in partnerships (T.D. 9676).
The first change is to the method for apportioning interest expense for corporate partners whose interest in the partnership is 10% or more. Those partners are required to apportion their share by reference to the partnership’s assets (the aggregate method). Under the final regulations, the corporation must allocate its distributive share of partnership interest and its unrelated interest expense to all of its assets, including its proportionate share of partnership assets. The final regulations permit corporate partners to use the alternative-tax-book-value method in addition to the other methods for this calculation. (The alternative-tax-book-value method is defined in Regs. Sec. 1.861-9(i)).
The regulations also finalize the requirement that, when determining the value of the assets using the tax-book-value or the alternative-tax-book-value methods, 10% or greater corporate partners must use the inside basis of the assets, including any Sec. 734(b) adjustment (adjustment to basis of undistributed partnership property) or Sec. 743(b) adjustment (adjustment to basis of partnership property upon transfer of partnership interest) (Regs. Sec. 1.861-9(e)(2)).
The second change requires individuals who are general partners or limited partners holding an interest of 10% or more using the tax-book-value or the alternative-tax-book-value methods to also include any Sec. 734(b) or Sec. 743(b) adjustments in making those calculations (Regs. Sec. 1.861-9(e)(3)). The third change fixes a problem in the way taxpayers were applying the regulations (prior to the issuance of the 2012 temporary regulations) in determining the fair market value (FMV) of assets. The IRS had determined that taxpayers were interpreting the FMV method, which requires related-party debt to be excluded as an asset as part of the process for determining total intangible asset value, as meaning that the debt also is not treated as an asset in the hands of the taxpayer for the broader purpose of applying the asset method. In addition, for purposes of valuing the stock in related persons, some taxpayers took the position that those rules excluded related-party debt as an asset, but permitted the value of stock in the related-person obligor to be reduced by the amount of the related-party debt as a liability. These regulations also finalize the rule that related-party debt is an asset of the creditor that must be taken into account whether held by the taxpayer or a related person (Regs. Sec. 1.861-9(h)(4)).
The fourth change is the amendment of Regs. Sec. 1.861-11 to reflect a statutory amendment of Sec. 864(e)(5)(A) to provide that a foreign corporation is treated as a member of an affiliated group for interest allocation and apportionment purposes if more than 50% of its gross income is effectively connected income and at least 80% of the vote or value of its stock is owned by the affiliated group. In that case, all of the foreign corporation’s assets and interest expense are taken into account for purposes of applying the interest apportionment rules.
The final regulations apply to tax years beginning on or after July 16, 2014.