Certain Publicly Traded Partnerships Treated as Corporations

DEPARTMENT OF THE TREASURY

26 CFR Part 1

[TD 8629]

RIN 1545-AL57

Certain Publicly Traded Partnerships Treated as Corporations

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations relating to the

classification of certain publicly traded partnerships as corporations.

These regulations provide guidance needed by taxpayers to comply with

changes to the law made by the Omnibus Budget Reconciliation Act of

1987. The regulations affect the classification of certain partnerships

for federal tax purposes.

DATES: These regulations are effective December 4, 1995.

For dates of applicability of these regulations, see Sec. 1.7704-

1(l).

FOR FURTHER INFORMATION CONTACT: Christopher T. Kelley, (202) 622-3080

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Introduction

This document adds Sec. 1.7704-1 to the Income Tax Regulations (26

CFR part 1) relating to the definition of a publicly traded partnership

under section 7704(b) of the Internal Revenue Code (Code).

Background

Section 7704 was added to the Code by section 10211(a) of the

Omnibus Budget Reconciliation Act of 1987 (Public Law 100-203), as

amended by sections 2004(f)(1)-(5) of the Technical and Miscellaneous

Revenue Act of 1988 (Public Law 100-647). Section 7704(a) provides that

a publicly traded partnership is treated as a corporation for federal

tax purposes unless the partnership meets the 90 percent qualifying

income test of section 7704(c) or qualifies as an existing partnership.

The term existing partnership is defined in Sec. 1.7704-2. Under

section 7704(b), a partnership is a publicly traded partnership if

interests in the partnership are traded on an established securities

market or are readily tradable on a secondary market or the substantial

equivalent thereof. Section 7704 applies to all domestic and foreign

entities treated as partnerships under section 7701, including limited

liability companies and other entities treated as partnerships for

federal tax purposes.

Notice 88-75 (1988-2 C.B. 386) was issued to provide interim

guidance on the definition of a publicly traded partnership under

section 7704(b). Notice 88-75 provides that interests in a partnership

are not treated as readily tradable on a secondary market or the

substantial equivalent thereof for purposes of section 7704(b)(2) if

the interests are: (1) Issued in certain private placements; (2)

transferred pursuant to transfers not involving trading; (3) traded in

amounts that meet the requirements of a 5-percent or 2-percent safe

harbor; (4) transferred through a matching service that meets certain

requirements; or (5) transferred pursuant to a qualifying redemption or

repurchase agreement. Notice 88-75 does not address when partnership

interests are treated as traded on an established securities market for

purposes of section 7704(b)(1).

On May 2, 1995, the IRS published in the Federal Register a notice

of proposed rulemaking (60 FR 21475) to provide guidance regarding

section 7704(b). A number of public comments were received concerning

the proposed regulations, and a public hearing was held on July 31,

1995. After consideration of the comments received, the proposed

regulations are adopted as revised by this Treasury decision.

Summary of Significant Comments and Revisions

The significant comments on the proposed regulations and the

revisions made in the final regulations are discussed below.

Public Trading

Several commentators requested clarification of the definition of

an established securities market, a secondary market, and the

substantial equivalent of a secondary market. The definitions in the

proposed regulations, however, are drawn directly from the legislative

history to section 7704(b) and incorporate the most important elements

of public trading within the meaning of section 7704(b). As a result,

the final regulations generally adopt the definitions in the proposed

regulations.

The final regulations contain two changes to the definition of a

secondary market and the substantial equivalent thereof. The final

regulations clarify that the determination of whether interests in a

partnership are readily tradable on

[[Page 62027]]

a secondary market or the substantial equivalent thereof is based on

all the facts and circumstances. In addition, the final regulations

eliminate the separate definitions of a secondary market and the

substantial equivalent thereof. This distinction is relevant in the

proposed regulations because several of the safe harbors apply only to

the substantial equivalent of a secondary market. As discussed below,

this distinction is eliminated in the safe harbors. As a result, the

separate definitions of a secondary market and the substantial

equivalent thereof are no longer necessary, and they are combined into

one definition in the final regulations.

The proposed regulations provide that the transfer of an interest

in a partnership is taken into account for purposes of section 7704(b)

only if the partnership recognizes the transfer of the interest or the

interest is redeemed by the partnership. The preamble to the proposed

regulations explains that this provision is intended to prevent a

partnership from becoming publicly traded without the knowledge or

participation of the partnership. Several commentators requested a

clarification of this provision because the definition of a secondary

market requires only that the interests be readily tradable, thereby

creating some concern that the partnership could be publicly traded

even if there were no actual transfer of an interest in the

partnership.

The final regulations address this concern by providing more

explicitly that interests in a partnership will not be treated as

readily tradable on a secondary market or the substantial equivalent

thereof unless (i) the partnership participates in the establishment of

the market or the inclusion of its interests thereon, or (ii) the

partnership recognizes transfers made on that market. This rule also

applies to an established securities market that consists of an

interdealer quotation system that regularly disseminates firm buy or

sell quotations. These modifications will prevent a partnership from

being publicly traded without the participation or consent of the

partnership. This rule is not extended to established securities

markets that consist of the exchanges described in the regulation

because these exchanges list interests in the partnership only with the

knowledge and participation of the partnership. In addition, the final

regulations provide that transfers not recognized by the partnership

are treated as private transfers and therefore do not count for

purposes of the two-percent and 10-percent limitations in the safe

harbors described below.

Safe Harbors

Several commentators requested clarification that, as in Notice 88-

75, the failure of a partnership to satisfy the safe harbors does not

establish or give rise to a presumption that the partnership was

publicly traded. In response, the final regulations clarify that the

fact that a partnership does not qualify for a safe harbor or that a

transfer of an interest in the partnership is not within a safe harbor

is disregarded in determining whether interests in the partnership are

readily tradable on a secondary market or the substantial equivalent

thereof. Thus, these transfers are examined under the general facts and

circumstances test in the regulations.

Private Transfers

Several commentators requested that the definition of a block

transfer be expanded to include transfers by a partner or any person

related to the partner within the meaning of section 267(b) or section

707(b)(1). The commentators noted that interests in a partnership are

often held by related persons and that, while the related group as a

whole may hold more than a two-percent interest in the partnership, no

individual partner in the group might hold more than a two-percent

interest. This comment is adopted in the final regulations.

One commentator also suggested that the exception for transfers at

death be clarified to include transfers from an estate or a

testamentary trust. This comment is adopted in the final regulations.

Another commentator suggested that the exception for transfers by

one or more partners of interests representing more than 50 percent of

the total interests be expanded to include transfers of less than 50

percent. This comment is not adopted in the final regulations. The

exception is provided to allow acquisition of control of a partnership

without raising a concern that the transfers pursuant to the

acquisition would result in the partnership being publicly traded. The

exception is, however, amended by reducing the required amount to 50

percent or more of the interests in partnership capital and profits to

coordinate the exception with section 708(b)(1)(B) terminations.

Redemption and Repurchase Agreements

Several commentators suggested that redemptions by an investment

partnership for the net asset value of the redeemed interest should not

be treated as a transfer for purposes of section 7704(b) because these

transfers do not involve a third party broker or a commission or mark-

up. This comment is not adopted in the final regulations. The

redemption of a partnership interest combined with the issuance of an

interest to a new partner can result in the creation of a secondary

market or the substantial equivalent thereof within the meaning of

section 7704(b), even if no third party or commission is present.

Qualified Matching Service

The proposed regulations provide that, to qualify as a matching

service, the selling partner cannot enter into a binding agreement to

sell an interest until the 15th calendar day after the date information

regarding the offering is made available to potential buyers and the

closing cannot occur until the 30th calendar day after the date the

selling partner can enter into a binding agreement. One commentator

suggested a reduction in these fixed time periods. This comment is not

adopted in the final regulations. The time periods are necessary to

ensure that the matching service does not rise to the level of a

secondary market or the substantial equivalent thereof.

Several commentators raised various concerns about the provisions

in the proposed regulations requiring subscribers to make certain

representations and the provisions preventing the operator of the

matching service from quoting certain prices and buying or selling

interests for itself or on behalf of others. These provisions are

deleted in the final regulations because the requirements for a

matching service already provide that the service cannot list quotes

that commit any person to buy or sell an interest. This modification,

however, does not affect the general rule that a secondary market may

exist if anyone, including the operator of a matching service, quotes

prices at which it stands ready to buy or sell partnership interests.

Private Placements

The proposed regulations generally provide that interests in a

partnership are not readily tradable on the substantial equivalent of a

secondary market if (i) all interests in the partnership were issued in

a transaction not required to be registered under the Securities Act of

1933; (ii) the partnership does not have more than 500 partners or the

initial offering price of each unit was at least $20,000; and (iii) if

the partnership has more than 50 partners, no more than 10 percent of

the total interests in capital or profits are transferred during the

year. Several

[[Page 62028]]

commentators suggested expanding this safe harbor to apply to the

determination of a secondary market. Other commentators suggested

eliminating the 10-percent limitation. Several commentators suggested

increasing the 50-partner limit, such as to 100, and modifying the rule

for counting the number of partners that looked through partners that

were partnerships, grantor trusts, or S corporations. In response to

these comments, the final regulations modify the private placement

exception in the following respects.

First, the safe harbor is expanded to apply to a secondary market

as well as the substantial equivalent of a secondary market. As a

result, interests in a partnership that qualifies for the private

placement safe harbor will not be readily tradable on a secondary

market or the substantial equivalent thereof.

Second, the final regulations provide that the safe harbor does not

apply to partnerships subject to Regulation S (17 CFR 230.901 et seq.),

unless the offering and sale of interests in the partnership would not

have been required to be registered if offered and sold within the

United States. Regulation S, adopted after the issuance of Notice 88-

75, provides an exception from registration for any offerings and sales

outside of the United States, even if registration would have been

required if the interests were offered and sold within the United

States. This modification ensures that the private placement exception

applies in a similar manner to offerings within and outside of the

United States.

Third, the 10-percent limitation is not adopted in the final

regulations. Instead, the final regulations provide that the safe

harbor applies only if the partnership has no more than 100 partners at

any time during the taxable year of the partnership.

Finally, the final regulations provide a new rule for determining

the number of partners in a partnership. Under the proposed

regulations, each person owning an interest in a partnership (lower-

tier partnership) through another partnership, an S corporation, or a

grantor trust (flow-through entity) is treated as a partner in the

lower-tier partnership. The final regulations provide that an owner of

a flow-through entity is treated as a partner in the lower-tier

partnership only if (i) substantially all of the value of the flow-

through entity is attributable to the lower-tier partnership interest,

and (ii) a principal purpose for the tiered arrangement is to permit

the partnership to satisfy the 100-partner requirement.

The requirement that substantially all of the value of the flow-

through entity be attributable to the lower-tier partnership is

intended to limit the look-through rule to flow-through entities that

are economically equivalent to an interest in the lower-tier

partnership. For example, if the only asset held by a flow-through

entity is an interest in a lower-tier partnership, an interest in the

flow-through entity is economically equivalent to an interest in the

lower-tier partnership and the members of the flow-through entity

should be counted as partners in the partnership. The requirement that

there be a principal purpose to avoid the 100 partner rule recognizes

that looking through a flow-through entity is not appropriate in all

cases, even if the flow-through entity owns no interest other than an

interest in the lower-tier partnership, but should be limited to

situations in which a principal purpose of the flow-through entity is

to avoid the 100 partner limitation.

Lack of Actual Trading

The proposed regulations provide that interests in a partnership

are not readily tradable on the substantial equivalent of a secondary

market if the sum of the percentage interests transferred during the

taxable year does not exceed two percent. Several commentators

suggested expanding this safe harbor to secondary markets so that

partnerships could be assured that some level of trading would not

result in public trading. This comment is adopted in the final

regulations.

Qualifying Income

Several commentators requested guidance on the definition of

qualifying income and financial business for purposes of the qualifying

income exception of section 7704. These regulations are intended to

address only the definition of public trading and therefore do not

provide guidance on the definition of qualifying income. The IRS and

Treasury, however, are actively considering guidance on the definition

of qualifying income and financial businesses for investment

partnerships and other partnerships engaged in various types of

securities transactions. The IRS and Treasury invite comments on the

scope and form of such guidance.

Transitional Relief

The proposed regulations provide that they will be effective for

taxable years of a partnership beginning on or after the date final

regulations are published. The preamble to the proposed regulations

requests comments on whether transitional relief is necessary for

partnerships that qualified for an exclusion under Notice 88-75. Many

commentators suggested some form of transitional relief, ranging from

180 days to a permanent grandfather provision.

The final regulations provide that, for partnerships that were

actively engaged in an activity before December 4, 1995, the

regulations apply for taxable years beginning after December 31, 2005.

This ten-year grandfather provision is similar to the grandfather rule

provided on the enactment of section 7704. The final regulations

provide that this transitional relief expires if the partnership adds a

substantial new line of business within the meaning of Sec. 1.7704-2.

The transitional relief is not affected by a termination of the

partnership under section 708(b)(1)(B). Finally, partnerships subject

to transitional relief may continue to rely on Notice 88-75 for

guidance.

Special Analyses

It has been determined that this Treasury decision is not a

significant regulatory action as defined in EO 12866. Therefore, a

regulatory assessment is not required. It also has been determined that

section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5)

and the Regulatory Flexibility Act (5 U.S.C. chapter 6) do not apply to

these regulations and, therefore, a Regulatory Flexibility Analysis is

not required. Pursuant to section 7805(f) of the Internal Revenue Code,

the notice of proposed rulemaking preceding these regulations was

submitted to the Small Business Administration for comment on its

impact on small business.

Drafting Information. The principal author of these regulations

is Christopher T. Kelley, Office of Chief Counsel (Passthroughs and

Special Industries). However, other personnel from the IRS and

Treasury Department participated in their development.

List of Subjects in 26 CFR Part 1

Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 continues to read in

part as follows:

Authority: 26 U.S.C. 7805 * * *

Par. 2. Section 1.7704-1 is added to read as follows:

[[Page 62029]]

Sec. 1.7704-1 Publicly traded partnerships.

(a) In general--(1) Publicly traded partnership. A domestic or

foreign partnership is a publicly traded partnership for purposes of

section 7704(b) and this section if--

(i) Interests in the partnership are traded on an established

securities market; or

(ii) Interests in the partnership are readily tradable on a

secondary market or the substantial equivalent thereof.

(2) Partnership interest--(i) In general. For purposes of section

7704(b) and this section, 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 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).

(ii) Exception for non-convertible debt. For purposes of section

7704(b) and this section, an interest in a partnership does not include

any financial instrument or contract that--

(A) Is treated as debt for federal tax purposes; and

(B) Is not convertible into or exchangeable for an interest in the

capital or profits of the partnership and does not provide for a

payment of equivalent value.

(iii) Exception for tiered entities. For purposes of section

7704(b) and this section, an interest in a partnership or a corporation

(including a regulated investment company as defined in section 851 or

a real estate investment trust as defined in section 856) that holds an

interest in a partnership (lower-tier partnership) is not considered an

interest in the lower-tier partnership.

(3) Definition of transfer. For purposes of section 7704(b) and

this section, 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

paragraph (a)(2)(i)(B) of this section.

(b) Established securities market. For purposes of section 7704(b)

and this section, an established securities market includes--

(1) A national securities exchange registered under section 6 of

the Securities Exchange Act of 1934 (15 U.S.C. 78f);

(2) A national securities exchange exempt from registration under

section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f)

because of the limited volume of transactions;

(3) A foreign securities exchange that, under the law of the

jurisdiction where it is organized, satisfies regulatory requirements

that are analogous to the regulatory requirements under the Securities

Exchange Act of 1934 described in paragraph (b) (1) or (2) of this

section (such as the London International Financial Futures Exchange;

the Marche a Terme International de France; the International Stock

Exchange of the United Kingdom and the Republic of Ireland, Limited;

the Frankfurt Stock Exchange; and the Tokyo Stock Exchange);

(4) A regional or local exchange; and

(5) An interdealer quotation system that regularly disseminates

firm buy or sell quotations by identified brokers or dealers by

electronic means or otherwise.

(c) Readily tradable on a secondary market or the substantial

equivalent thereof--(1) In general. For purposes of section 7704(b) and

this section, interests in a partnership that are not traded on an

established securities market (within the meaning of section 7704(b)

and paragraph (b) of this section) 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.

(2) Secondary market or the substantial equivalent thereof. For

purposes of paragraph (c)(1) of this section, 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 this paragraph (c)(2).

(3) Secondary market safe harbors. The fact that a transfer of a

partnership interest is not within one or more of the safe harbors

described in paragraph (e), (f), (g), (h), or (j) of this section is

disregarded in determining whether interests in the partnership are

readily tradable on a secondary market or the substantial equivalent

thereof.

(d) Involvement of the partnership required. For purposes of

section 7704(b) and this section, interests in a partnership are not

traded on an established securities market within the meaning of

paragraph (b)(5) of this section and are not readily tradable on a

secondary market or the substantial equivalent thereof within the

meaning of paragraph (c) of this section (even if interests in the

partnership are traded or readily tradable in a manner described in

paragraph (b)(5) or (c) of this section) 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.

(e) Transfers not involving trading--(1) In general. For purposes

of section 7704(b) and this section, the following transfers (private

transfers) are disregarded in determining whether interests in a

partnership are readily tradable on a secondary market or the

substantial equivalent thereof--

(i) Transfers in which the basis of the partnership interest in the

hands of the transferee is determined, in whole or in part, by

reference to its basis in the hands of the transferor or is determined

under section 732;

(ii) Transfers at death, including transfers from an estate or

testamentary trust;

(iii) Transfers between members of a family (as defined in section

267(c)(4));

(iv) Transfers involving the issuance of interests by (or on behalf

of) the partnership in exchange for cash, property, or services;

(v) Transfers involving distributions from a retirement plan

qualified under section 401(a) or an individual retirement account;

[[Page 62030]]

(vi) Block transfers (as defined in paragraph (e)(2) of this

section);

(vii) Transfers pursuant to a right under a redemption or

repurchase agreement (as defined in paragraph (e)(3) of this section)

that is exercisable only--

(A) Upon the death, disability, or mental incompetence of the

partner; or

(B) Upon the retirement or termination of the performance of

services of an individual who actively participated in the management

of, or performed services on a full-time basis for, the partnership;

(viii) Transfers pursuant to a closed end redemption plan (as

defined in paragraph (e)(4) of this section);

(ix) Transfers by one or more partners of interests representing in

the aggregate 50 percent or more of the total interests in partnership

capital and profits in one transaction or a series of related

transactions; and

(x) Transfers not recognized by the partnership (within the meaning

of paragraph (d)(2) of this section).

(2) Block transfers. For purposes of paragraph (e)(1)(vi) of this

section, a block transfer means the transfer by a partner and any

related persons (within the meaning of section 267(b) or 707(b)(1)) in

one or more transactions during any 30 calendar day period of

partnership interests representing in the aggregate more than 2 percent

of the total interests in partnership capital or profits.

(3) Redemption or repurchase agreement. For purposes of section

7704(b) and this section, a redemption or repurchase agreement means a

plan of redemption or repurchase maintained by a partnership whereby

the partners may tender their partnership interests for purchase by the

partnership, another partner, or a person related to another partner

(within the meaning of section 267(b) or 707(b)(1)).

(4) Closed end redemption plan. For purposes of paragraph

(e)(1)(viii) of this section, a redemption or repurchase agreement (as

defined in paragraph (e)(3) of this section) is a closed end redemption

plan only if--

(i) The partnership does not issue any interest after the initial

offering (other than the issuance of additional interests prior to

August 5, 1988); and

(ii) No partner or person related to any partner (within the

meaning of section 267(b) or 707(b)(1)) provides contemporaneous

opportunities to acquire interests in similar or related partnerships

which represent substantially identical investments.

(f) Redemption and repurchase agreements. For purposes of section

7704(b) and this section, the transfer of an interest in a partnership

pursuant to a redemption or repurchase agreement (as defined in

paragraph (e)(3) of this section) that is not described in paragraph

(e)(1) (vii) or (viii) of this section is disregarded in determining

whether interests in the partnership are readily tradable on a

secondary market or the substantial equivalent thereof only if--

(1) The redemption or repurchase agreement provides that the

redemption or repurchase cannot occur until at least 60 calendar days

after the partner notifies the partnership in writing of the partner's

intention to exercise the redemption or repurchase right;

(2) Either--

(i) The redemption or repurchase agreement requires that the

redemption or repurchase price not be established until at least 60

calendar days after receipt of such notification by the partnership or

the partner; or

(ii) The redemption or repurchase price is established not more

than four times during the partnership's taxable year; and

(3) The sum of the percentage interests in partnership capital or

profits transferred during the taxable year of the partnership (other

than in private transfers described in paragraph (e) of this section)

does not exceed 10 percent of the total interests in partnership

capital or profits.

(g) Qualified matching services--(1) In general. For purposes of

section 7704(b) and this section, the transfer of an interest in a

partnership through a qualified matching service is disregarded in

determining whether interests in the partnership are readily tradable

on a secondary market or the substantial equivalent thereof.

(2) Requirements. A matching service is a qualified matching

service only if--

(i) The matching service consists of a computerized or printed

listing system that lists customers' bid and/or ask quotes in order to

match partners who want to sell their interests in a partnership (the

selling partner) with persons who want to buy those interests;

(ii) Matching occurs either by matching the list of interested

buyers with the list of interested sellers or through a bid and ask

process that allows interested buyers to bid on the listed interest;

(iii) The selling partner cannot enter into a binding agreement to

sell the interest until the 15th calendar day after the date

information regarding the offering of the interest for sale is made

available to potential buyers and such time period is evidenced by

contemporaneous records ordinarily maintained by the operator at a

central location;

(iv) The closing of the sale effected by virtue of the matching

service does not occur prior to the 45th calendar day after the date

information regarding the offering of the interest for sale is made

available to potential buyers and such time period is evidenced by

contemporaneous records ordinarily maintained by the operator at a

central location;

(v) The matching service displays only quotes that do not commit

any person to buy or sell a partnership interest at the quoted price

(nonfirm price quotes) or quotes that express interest in a partnership

interest without an accompanying price (nonbinding indications of

interest) and does not display quotes at which any person is committed

to buy or sell a partnership interest at the quoted price (firm

quotes);

(vi) The selling partner's information is removed from the matching

service within 120 calendar days after the date information regarding

the offering of the interest for sale is made available to potential

buyers and, following any removal (other than removal by reason of a

sale of any part of such interest) of the selling partner's information

from the matching service, no offer to sell an interest in the

partnership is entered into the matching service by the selling partner

for at least 60 calendar days; and

(vii) The sum of the percentage interests in partnership capital or

profits transferred during the taxable year of the partnership (other

than in private transfers described in paragraph (e) of this section)

does not exceed 10 percent of the total interests in partnership

capital or profits.

(3) Closing. For purposes of paragraph (g)(2)(iv) of this section,

the closing of a sale occurs no later than the earlier of--

(i) The passage of title to the partnership interest;

(ii) The payment of the purchase price (which does not include the

delivery of funds to the operator of the matching service or other

closing agent to hold on behalf of the seller pending closing); or

(iii) The date, if any, that the operator of the matching service

(or any person related to the operator within the meaning of section

267(b) or 707(b)(1)) loans, advances, or otherwise arranges for funds

to be available to the seller in anticipation of the payment of the

purchase price.

(4) Optional features. A qualified matching service may be

sponsored or operated by a partner of the partnership (either formally

or informally), the underwriter that handled the issuance

[[Page 62031]]

of the partnership interests, or an unrelated third party. In addition,

a qualified matching service may offer the following features--

(i) The matching service may provide prior pricing information,

including information regarding resales of interests and actual prices

paid for interests; a description of the business of the partnership;

financial and reporting information from the partnership's financial

statements and reports; and information regarding material events

involving the partnership, including special distributions, capital

distributions, and refinancings or sales of significant portions of

partnership assets;

(ii) The operator may assist with the transfer documentation

necessary to transfer the partnership interest;

(iii) The operator may receive and deliver funds for completed

transactions; and

(iv) The operator's fee may consist of a flat fee for use of the

service, a fee or commission based on completed transactions, or any

combination thereof.

(h) Private placements--(1) In general. For purposes of section

7704(b) and this section, except as otherwise provided in paragraph

(h)(2) of this section, 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 (15 U.S.C. 77a et seq.); and

(ii) The partnership does not have more than 100 partners at any

time during the taxable year of the partnership.

(2) Exception for certain offerings outside of the United States.

Paragraph (h)(1) of this section does not apply to the offering and

sale of interests in a partnership that was not required to be

registered under the Securities Act of 1933 by reason of Regulation S

(17 CFR 230.901 through 230.904) unless the offering and sale of the

interests would not have been required to be registered under the

Securities Act of 1933 if the interests had been offered and sold

within the United States.

(3) Anti-avoidance rule. For purposes of determining the number of

partners in the partnership under paragraph (h)(1)(ii) of this section,

a person (beneficial owner) owning an interest in a partnership,

grantor trust, or S corporation (flow-through entity), that owns,

directly or through other flow-through entities, an interest in the

partnership, is treated as a partner in the partnership only if--

(i) Substantially all of the value of the beneficial owner's

interest in the flow-through entity is attributable to the flow-through

entity's interest (direct or indirect) in the partnership; and

(ii) A principal purpose of the use of the tiered arrangement is to

permit the partnership to satisfy the 100-partner limitation in

paragraph (h)(1)(ii) of this section.

(i) [Reserved].

(j) Lack of actual trading--(1) General rule. For purposes of

section 7704(b) and this section, interests in a partnership are not

readily tradable on a secondary market or the substantial equivalent

thereof if the sum of the percentage interests in partnership capital

or profits transferred during the taxable year of the partnership

(other than in transfers described in paragraph (e), (f), or (g) of

this section) does not exceed 2 percent of the total interests in

partnership capital or profits.

(2) Examples. The following examples illustrate the rules of this

paragraph (j):

Example 1. Calculation of percentage interest transferred. (i)

ABC, a calendar year limited partnership formed in 1996, has 9,000

units of limited partnership interests outstanding at all times

during 1997, representing in the aggregate 95 percent of the total

interests in capital and profits of ABC. The remaining 5 percent is

held by the general partner.

(ii) During 1997, the following transactions occur with respect

to the units of ABC's limited partnership interests--

(A) 800 units are sold through the use of a qualified matching

service that meets the requirements of paragraph (g) of this

section;

(B) 50 units are sold through the use of a matching service that

does not meet the requirements of paragraph (g) of this section; and

(C) 500 units are transferred as a result of private transfers

described in paragraph (e) of this section.

(iii) The private transfers of 500 units and the sale of 800

units through a qualified matching service are disregarded under

paragraph (j)(1) of this section for purposes of applying the 2

percent rule. As a result, the total percentage interests in

partnership capital and profits transferred for purposes of the 2

percent rule is .528 percent, determined by--

(A) Dividing the number of units sold through a matching service

that did not meet the requirements of paragraph (g) of this section

(50) by the total number of outstanding limited partnership units

(9,000); and

(B) Multiplying the result by the percentage of total interests

represented by limited partnership units (95 percent)

([50/9,000] x .95=.528 percent).

Example 2. Application of the 2 percent rule. (i) ABC operates a

service consisting of computerized video display screens on which

subscribers view and publish nonfirm price quotes that do not commit

any person to buy or sell a partnership interest and unpriced

indications of interest in a partnership interest without an

accompanying price. The ABC service does not provide firm quotes at

which any person (including the operator of the service) is

committed to buy or sell a partnership interest. The service may

provide prior pricing information, including information regarding

resales of interests and actual prices paid for interests;

transactional volume information; and information on special or

capital distributions by a partnership. The operator's fee may

consist of a flat fee for use of the service; a fee based on

completed transactions, including, for example, the number of

nonfirm quotes or unpriced indications of interest entered by users

of the service; or any combination thereof.

(ii) The ABC service is not an established securities market for

purposes of section 7704(b) and this section. The service is not an

interdealer quotation system as defined in paragraph (b)(5) of this

section because it does not disseminate firm buy or sell quotations.

Therefore, partnerships whose interests are listed and transferred

on the ABC service are not publicly traded for purposes of section

7704(b) and this section as a result of such listing or transfers if

the sum of the percentage interests in partnership capital or

profits transferred during the taxable year of the partnership

(other than in transfers described in paragraph (e), (f), or (g) of

this section) does not exceed 2 percent of the total interests in

partnership capital or profits. In addition, assuming the ABC

service complies with the necessary requirements, the service may

qualify as a matching service described in paragraph (g) of this

section.

(k) Percentage interests in partnership capital or profits--(1)

Interests considered--(i) General rule. Except as otherwise provided in

this paragraph (k), for purposes of this section, the total interests

in partnership capital or profits are determined by reference to all

outstanding interests in the partnership.

(ii) Exceptions--(A) General partner with greater than 10 percent

interest. If the general partners and any person related to the general

partners (within the meaning of section 267(b) or 707(b)(1)) own, in

the aggregate, more than 10 percent of the outstanding interests in

partnership capital or profits at any one time during the taxable year

of the partnership, the total interests in partnership capital or

profits are determined without reference to the interests owned by such

persons.

(B) Derivative interests. Any partnership interests described in

paragraph (a)(2)(i)(B) of this section are taken into account for

purposes of determining the total interests in partnership capital or

profits only if and to the extent that the partnership satisfies

paragraph (d) (1) or (2) of this section.

(2) Monthly determination. For purposes of this section, except in

the

[[Page 62032]]

case of block transfers (as defined in paragraph (e)(2) of this

section), the percentage interests in partnership capital or profits

represented by partnership interests that are transferred during a

taxable year of the partnership is equal to the sum of the percentage

interests transferred for each calendar month during the taxable year

of the partnership in which a transfer of a partnership interest occurs

(other than a private transfer as described in paragraph (e) of this

section). The percentage interests in capital or profits of interests

transferred during a calendar month is determined by reference to the

partnership interests outstanding during that month.

(3) Monthly conventions. For purposes of paragraph (k)(2) of this

section, a partnership may use any reasonable convention in determining

the interests outstanding for a month, provided the convention is

consistently used by the partnership from month to month during a

taxable year and from year to year. Reasonable conventions include, but

are not limited to, a determination by reference to the interests

outstanding at the beginning of the month, on the 15th day of the

month, or at the end of the month.

(4) Block transfers. For purposes of paragraph (e)(2) of this

section (defining block transfers), the partnership must determine the

percentage interests in capital or profits for each transfer of an

interest during the 30 calendar day period by reference to the

partnership interests outstanding immediately prior to such transfer.

(5) Example. The following example illustrates the rules of this

paragraph (k):

Example. Conventions. (i) ABC limited partnership, a calendar

year partnership formed in 1996, has 1,000 units of limited

partnership interests outstanding on January 1, 1997, representing

in the aggregate 95 percent of the total interests in capital and

profits of ABC. The remaining 5 percent is held by the general

partner.

(ii) The following transfers take place during 1997--

(A) On January 15, 10 units of limited partnership interests are

sold in a transaction that is not a private transfer;

(B) On July 10, 1,000 additional units of limited partnership

interests are issued by the partnership (the general partner's

percentage interest is unchanged); and

(C) On July 20, 15 units of limited partnership interests are

sold in a transaction that is not a private transfer.

(iii) For purposes of determining the sum of the percentage

interests in partnership capital or profits transferred, ABC chooses

to use the end of the month convention. The percentage interests in

partnership capital and profits transferred during January is .95

percent, determined by dividing the number of transferred units (10)

by the total number of limited partnership units (1,000) and

multiplying the result by the percentage of total interests

represented by limited partnership units ([10/1,000] x .95). The

percentage interests in partnership capital and profits transferred

during July is .7125 percent ([15/2,000] x .95). ABC is not required

to make determinations for the other months during the year because

no transfers of partnership interests occurred during such months.

ABC may qualify for the 2 percent rule for its 1997 taxable year

because less than 2 percent (.95 percent+.7125 percent=1.6625

percent) of its total interests in partnership capital and profits

was transferred during that year.

(iv) If ABC had chosen to use the beginning of the month

convention, the interests in capital or profits sold during July

would have been 1.425 percent ([15/1,000] x .95) and ABC would not

have satisfied the 2 percent rule for its 1997 taxable year because

2.375 percent (.95 + 1.425) of ABC's interests in partnership

capital and profits was transferred during that year.

(l) Effective date--(1) In general. Except as provided in paragraph

(l)(2) of this section, this section applies to taxable years of a

partnership beginning after December 31, 1995.

(2) Transition period. For partnerships that were actively engaged

in an activity before December 4, 1995, this section applies to taxable

years beginning after December 31, 2005, unless the partnership adds a

substantial new line of business after December 4, 1995, in which case

this section applies to taxable years beginning on or after the

addition of the new line of business. Partnerships that qualify for

this transition period may continue to rely on the provisions of Notice

88-75 (1988-2 C.B. 386) (see Sec. 601.601(d)(2) of this chapter) for

guidance regarding the definition of readily tradable on a secondary

market or the substantial equivalent thereof for purposes of section

7704(b).

(3) Substantial new line of business. For purposes of paragraph

(1)(2) of this section--

(i) Substantial is defined in Sec. 1.7704-2(c); and

(ii) A new line of business is defined in Sec. 1.7704-2(d), except

that the applicable date is ``December 4, 1995'' instead of ``December

17, 1987''.

(4) Termination under section 708(b)(1)(B). The termination of a

partnership under section 708(b)(1)(B) due to the sale or exchange of

50 percent or more of the total interests in partnership capital and

profits is disregarded in determining whether a partnership qualifies

for the transition period provided in paragraph (l)(2) of this section.

Margaret Milner Richardson,

Commissioner of Internal Revenue.

Approved: November 21, 1995.

Leslie Samuels,

Assistant Secretary of the Treasury.

[FR Doc. 95-29282 Filed 11-29-95; 3:02 pm]

BILLING CODE 4830-01-U