Rev. Rul. 86-23

1986-1 C.B. 4, 1986-8 I.R.B. 6.

INVESTMENT CREDIT; RECAPTURE; DISTRIBUTION TO PARENT CORPORATION;

SUBSEQUENT TRANSFER TO PARTNERSHIP

Published: February 24, 1986

Section 47.-Certain Dispositions, Etc., of Section 38 Property, 26 CFR 1.47-3: Exceptions to the application of section 1.47-1

(Also Sections 38, 332, 381, 721, 723; 1.38-1. 1.332-1, 1.381-1, 1.721-1,

1.723-1.)

  Investment credit; recapture; distribution to parent corporation; subsequent transfer to partnership. Recapture of investment credit under section 47 of the Code does not occur where a wholly owned subsidiary corporation distributes section 38 property to its parent corporation in complete liquidation and the parent subsequently contributes the property to a partnership in which the parent holds a 75 percent interest.

ISSUE

  If a wholly owned subsidiary corporation had claimed investment tax credit with respect to certain property and if the property is later distributed to the parent corporation in a complete liquidation of the subsidiary and is then contributed by the parent to a partnership in which the parent corporation holds a 75 percent interest, does section 47(a) of the Internal Revenue Code require any recapture of the investment tax credit?

FACTS

  X and its three subsidiaries were corporations engaged in active businesses. X determined that it would be advantageous to operate the businesses in partnership form in conjunction with corporation Y and Z. Accordingly, X liquidated the three subsidiaries in transactions that qualified under section

332(a) of the Code. Subsequently, in a transaction that qualified under section

721(a), X contributed all of the property it had received in the liquidations to a new partnership it had formed with Y and Z. In return for the contributions of property, X received a 75 percent interest in the partnership. In return for their cash contributions to the partnership, Y and Z received 15 percent and 10 percent partnership interests, respectively.

  The property received by X in the liquidation of its subsidiaries and subsequently transferred to the partnership included section 38 property that had been previously placed in service by the subsidiaries. The liquidations and subsequent transfer occurred before the close of the useful life that was taken into account in computing the investment tax credit under section 38 of the Code.

  The partnership continued to operate the businesses previously operated by X's three subsidiaries. The section 38 property transferred to the partnership was retained as section 38 property in the same businesses.

LAW AND ANALYSIS

  Section 38 of the Code provides for a general business credit that includes for a taxable year the investment tax credit determined under section 46(a). Sections 46(a) and (c) provide that the amount of the investment tax credit for any taxable year is equal to the sum of certain specified percentages of the qualified investment in section 38 property.

  Section 47(a)(1) of the Code provides that if, during any taxable year, any property is disposed of, or otherwise ceases to be section 38 property with respect to the taxpayer, before the close of the useful life that was taken into account in computing the credit under section 38, then the tax under chapter 1 for the taxable year shall be increased by an amount equal to the aggregate decrease in the credits allowed under section 38 for all prior taxable years that would have resulted solely from substituting, in determining qualified investment, for the useful life the period beginning with the time the property was placed in service by the taxpayer and ending with the time the property ceased to be section 38 property.

  Section 47(b) of the Code provides that property shall not be treated as ceasing to be section 38 property with respect to the taxpayer by reason of a mere change in the form of conducting the trade or business as section 38 property and the taxpayer retains a substantial interest in the trade or business.

  Section 1.47-1(a) of the Income Tax Regulations reiterates the substance of section 47(a)(1) of the Code.

  Section 1.47-3(e)(1) of the regulations provides that section 1.47-1(a) shall not apply to a disposition of section 38 property in a transaction to which section 381(a) of the Code (relating to carryovers in certain corporate acquisitions) applies. If the section 38 property described in the preceding sentence is disposed of, or otherwise ceases to be section 38 property with respect to the acquiring corporation, before the close of the estimated useful life that was taken into account in computing the transferor corporation's qualified investment, then section 1.47-1(a) shall apply to the acquiring corporation with respect to the section 38 property.

  Sections 1.47-3(f)(1)(i) and (ii) of the regulations provide that provisions concerning investment tax credit recapture do not apply to section 38 property where the relevant disposition or cessation is by reason of a mere change in the form of conducting the trade or business in which section 38 property is used, provided that the following four conditions are satisfied:

  (a) the section 38 property is retained as section 38 property in the same trade or business;

  (b) the transferor of the section 38 property retains a substantial interest in the trade or business;

  (c) substantially all of the assets (whether or nor section 38 property) necessary to operate the trade or business are transferred to the transferee to whom the section 38 property is transferred; and

  (d) the basis of the section 38 property in the hands of the transferee is determined in whole or in part by reference to the basis of the section 38 property in the hands of the transferor.

  Section 1.47-3(f)(2) of the regulations states that a substantial interest is retained in a trade or business only if, after the change in form, the retained interest in the trade or business is substantial in relation to the total interest of all persons or is equal to or greater than the transferor's interest prior to the change in form.

  Section 332(a) of the Code provides that no gain or loss shall be recognized on the receipt by a corporation of property distributed in complete liquidation

(as determined under section 332(b)) of another corporation.

  Sections 381(a)(1) and 381(c)(26) of the Code provide that, in the case of the acquisition of assets of a corporation by another corporation in a distribution to such other corporation to which section 332 (relating to liquidations of subsidiaries) applies, the acquiring corporation shall take into account the items required to be taken into account for purposes of section 38 in respect of the transferor corporation.

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

  Section 723 of the Code provides that the basis of property contributed to a partnership by a partner shall be the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount

(if any) of gain recognized to the contributing partner at such time.

  In the present situation, because the liquidation of X's subsidiaries are complete liquidations that qualify for nonrecognition treatment under section

332(a) of the Code, section 381(a) is applicable to the liquidation transactions. Section 1.47- 3(e)(1) of the regulations provides that the recapture provisions do not apply to a transaction to which section 381(a) is applicable. Therefore, the liquidation of X's subsidiaries into X does not result in investment tax credit recapture.

  The recapture issue, however, is presented a second time by X's contribution of the businesses to the partnership. Section 1.47- 3(e)(1) of the regulations provides that if section 38 property that was subject to a section 381(a) transaction is later disposed of, or otherwise ceases to be section 38 property with respect to the acquiring corporation, before the close of the estimated useful life which was taken into account in computing the transferor corporation's qualified investment, then the recapture provisions of section

1.47-1(a) apply to the acquiring corporation with respect to the section 38 property.

  X is an acquiring corporation for purposes of section 1.47- 3(e)(1) of the regulations, and X disposed of the section 38 property received from the liquidation transactions when it contributed the property to the partnership. The contributions, however, are not treated as dispositions for investment tax credit recapture purposes if the four conditions set forth in section 1.47-

3(f)(1)(ii) are satisfied.

  The first condition of section 1.47-3(f)(1)(ii) of the regulations is satisfied because, following the transfer by X of the subsidiaries' property to the partnership, the same businesses previously operated by the subsidiaries continued to be operated by the partnership. The third condition is satisfied because all of the assets necessary to operate those businesses were transferred to the partnership. The fourth condition is satisfied because of the application of sections 721(a) and 723 of the Code, which provide that the basis of the section 38 property in the hands of the partnership is determined by reference to X's basis in the property.

  With respect to the second condition of section 1.47- 3(f)(1)(ii) of the regulations, a transfer may result in a decrease in the transferor's interest without triggering disposition treatment provided that a substantial interest in relation to the total interest of all persons is retained by the transferor. See Rev. Rul. 77-361, 1977-2 C.B. 6, 7. In Example (5) of section 1.47- 3(f)(6) a corporation transferred all of the assets it used to its manufacturing business to a partnership in exchange for a 50 percent interest in the partnership. The example concludes that the corporation retained a substantial interest in the business. In the present situation, because X has a 75 percent general partnership interest in the partnership following the contribution of property to the partnership, X has retained a substantial interest in the business for purposes of section 1.47-3(f)(1)(ii).

  Accordingly, the transfer of the property by X to the partnership meets the four conditions of section 1.47-3(f)(1) of the regulations for treatment under section 47(b) of the Code as a mere change in the form of doing business. The transfer, therefore, does not result in investment credit recapture.

HOLDING

  Under the circumstances described above, the complete liquidation by a parent corporation of its subsidiaries followed by the transfer of the subsidiaries' property to a partnership does not result in investment tax credit recapture under section 47(a) of the Code.

Rev. Rul. 86-23, 1986-1 C.B. 4, 1986-8 I.R.B. 6.