Gerald B. Treacy, Jr.

De-UBIT-izing CRTs: Recent Rulings

PLRs 200315028 ff.: CRUTs – Foreign Corporation – US Partnerships

In what is probably the most complicated structure in this UBTI arena it has yet considered, the Service in PLRs 200315028, 200315032, 200315034, and 200315035, ruled favorably on the following fact pattern: four CRUTs created and funded by the same two individuals intend to create a foreign corporation which will use funds contributed by the CRUTs to purchase interests in US partnerships. The foreign corporation will manage the investment of the CRUTs’ contributions, expected to be all cash, and will purchase interests in US partnerships that use debt financing to acquire investment assets. If the CRUTs owned interests directly in the US partnerships, the debt financing would trigger UBTI to the CRUTs, and would deprive them of exempt status for the years in which they recognized such UBTI. The ruling request specified that all corporate formalities would be followed as to the foreign corporation, and that its assets would be separate from the assets of the CRUTs. None of the CRUTs would incur any debt as a result of these transactions, the request noted. The debt-financed income received by the foreign corporation from the partnerships would either be reinvested by the corporation or distributed to the CRUTs as a dividend. Among the business purposes cited for this arrangement were the advantages of pooling the investment assets of the CRUTs (all of which were formed by the same individuals, as noted), to help reduce costs and provide access to more investment opportunities. Each CRUT was expected to contribute from 10% - 20% of its assets’ value to the foreign corporation. The IRS ruled that the CRUTs would not receive UBTI as a result of these investments and payments, as dividend income does not constitute UBTI. The IRS also ruled that, although because of their common founders, the CRUTs were all technically disqualified persons as to one another under Code Section 4946, this status did not present adverse effects, as the investments will not benefit any other disqualified persons.

Conclusions and Applications

Why didn’t the Service simply reject these indirect investments by the CRTs in enterprises using “debt-financing,” under the “step transaction” rules or similar doctrine? In all three rulings, the Service (and sometimes the representatives of the CRTs themselves) openly noted that, if the CRTs had invested directly in the “debt-financing” enterprises, they would have lost their exempt status for the years in which such investments triggered UBTI. A wag might observe that these rulings suggest that the Service imposes the “step transaction doctrine” only if it has to make the effort to “root out” an indirect series of steps, while if the taxpayers themselves openly call the Service’s attention to the transaction, then there is no problem, and the Service simply lets it pass. Perhaps a more satisfying explanation is that the Service just does not see UBTI in the CRT context as a very serious concern, and is therefore willing to let mildly creative UBTI-avoidance plans go unchallenged. Notable in this context is that the (ever-delayed) “CARE” legislation would greatly soften the impact of UBTI on CRTs, which would not lose their exempt status altogether in years in which UBTI is recognized, but rather would simply pay tax on the UBTI component of their income, a much more sensible approach.

While a CRT is certainly not well advised to carry on its own for-profit trade or business, a passive, indirect investment in an enterprise which uses “debt-financing” should no longer cost the CRT its exempt status, so long as the advisors are familiar with these intriguing new rulings.

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