The Service invites comments on the proper application of the rules relating to the creation and maintenance of multiple layers of forward and reverse section 704(c) gain or loss to partnerships and tiered partnerships, including in the context of partnership mergers and divisions.

This procedure provides domestic asset/liability percentages and domestic investment yields needed by foreign life insurance companies and foreign property and liability insurance companies to compute their minimum effectively connected net investment income under section 842(b) of the Code for taxable years beginning after December 31, 2007.

Weighted average interest rate update; corporate bond indices; 30-year Treasury securities; segment rates. This notice contains updates for the corporate bond weighted average interest rate for plan years beginning in August 2009; the 24-month average segment rates; the funding transitional segment rates applicable for August 2009; and the minimum present value transitional rates for July 2009.

This notice provides guidance as to the corporate bond weighted average interest rate and the permissible range of interest rates specified under § 412(b)(5)(B)(ii)(II) of the Internal Revenue Code as in effect for plan years beginning before 2008. It also provides guidance on the corporate bond monthly yield curve (and the corresponding spot segment rates), the 24-month average segment rates, and the funding transitional segment rates under § 430(h)(2). In addition, this notice provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008, the 30-year Treasury weighted average rate under § 431(c)(6)(E)(ii)(I), and the minimum present value segment rates under § 417(e)(3)(D) as in effect for plan years beginning after 2007.

Sections 412(b)(5)(B)(ii) and 412(l)(7)(C)(i), as amended by the Pension Funding Equity Act of 2004 and by the Pension Protection Act of 2006 (PPA), provide that the interest rates used to calculate current liability and to determine the required contribution under § 412(l) for plan years beginning in 2004 through 2007 must be within a permissible range based on the weighted average of the rates of interest on amounts invested conservatively in long term investment grade corporate bonds during the 4-year period ending on the last day before the beginning of the plan year.

Notice 2004-34, 2004-1 C.B. 848, provides guidelines for determining the corporate bond weighted average interest rate and the resulting permissible range of interest rates used to calculate current liability. That notice establishes that the corporate bond weighted average is based on the monthly composite corporate bond rate derived from designated corporate bond indices. The methodology for determining the monthly composite corporate bond rate as set forth in Notice 2004-34 continues to apply in determining that rate. See Notice 2006-75, 2006-2 C.B. 366.

The composite corporate bond rate for July 2009 is 6.39 percent. Pursuant to Notice 2004-34, the Service has determined this rate as the average of the monthly yields for the included corporate bond indices for that month.

The following corporate bond weighted average interest rate was determined for plan years beginning in the month shown below.

Generally for plan years beginning after 2007 (except for delayed effective dates for certain plans under sections 104, 105, and 106 of PPA), § 430 of the Code specifies the minimum funding requirements that apply to single employer plans pursuant to § 412. Section 430(h)(2) specifies the interest rates that must be used to determine a plan’s target normal cost and funding target. Under this provision, present value is generally determined using three 24-month average interest rates (“segment rates”), each of which applies to cash flows during specified periods. However, an election may be made under § 430(h)(2)(D)(ii) to use the monthly yield curve in place of the segment rates. For plan years beginning in 2008 and 2009, a transitional rule under § 430(h)(2)(G) provides that the segment rates are blended with the corporate bond weighted average as specified above. An election may be made under § 430(h)(2)(G)(iv) to use the segment rates without applying the transitional rule.

Notice 2007-81, 2007-44 I.R.B. 899, provides guidelines for determining the monthly corporate bond yield curve, the 24-month average corporate bond segment rates, and the funding transitional segment rates used to compute the target normal cost and the funding target. Pursuant to Notice 2007-81, the monthly corporate bond yield curve derived from July 2009 data is in Table I at the end of this notice. The spot first, second, and third segment rates for the month of July 2009 are, respectively, 3.39, 6.28, and 6.47. The three 24-month average corporate bond segment rates applicable for August 2009 under the election of § 430(h)(2)(G)(iv) are as follows:

The transitional segment rates under § 430(h)(2)(G) applicable for August 2009, taking into account the corporate

bond weighted average of 6.48 stated above, are as follows:

Section 417(e)(3)(A)(ii)(II) (prior to amendment by PPA) defines the applicable interest rate, which must be used for purposes of determining the minimum present value of a participant’s benefit under § 417(e)(1) and (2), as the annual rate of interest on 30-year Treasury securities for the month before the date of distribution or such other time as the Secretary may by regulations prescribe. Section 1.417(e)-1(d)(3) of the Income Tax Regulations provides that the applicable interest rate for a month is the annual rate of interest on 30-year Treasury securities as specified by the Commissioner for that month in revenue rulings, notices or other guidance published in the Internal Revenue Bulletin.

The rate of interest on 30-year Treasury securities for July 2009 is 4.41 percent. The Service has determined this rate as the monthly average of the daily determination of yield on the 30-year Treasury bond maturing in May 2039.

Generally for plan years beginning after 2007, § 431 specifies the minimum funding requirements that apply to multiemployer plans pursuant to § 412. Section 431(c)(6)(B) specifies a minimum amount for the full-funding limitation described in section 431(c)(6)(A), based on the plan’s current liability. Section 431(c)(6)(E)(ii)(I) provides that the interest rate used to calculate current liability for this purpose must be no more than 5 percent above and no more than 10 percent below the weighted average of the rates of interest on 30-year Treasury securities during the four-year period ending on the last day before the beginning of the plan year. Notice 88-73, 1988-2 C.B. 383, provides guidelines for determining the weighted average interest rate. The following rates were determined for plan years beginning in the month shown below.

Generally for plan years beginning after December 31, 2007, the applicable interest rates under § 417(e)(3)(D) are segment rates computed without regard to a 24-month average. For plan years beginning in 2008 through 2011, the applicable interest rate is the monthly spot segment rate blended with the applicable rate under § 417(e)(3)(A)(ii)(II) as in effect for plan years beginning in 2007. Notice 2007-81 provides guidelines for determining the minimum present value segment rates. Pursuant to that notice, the minimum present value transitional segment rates determined for July 2009, taking into account the July 2009 30-year Treasury rate of 4.41 stated above, are as follows:

The principal author of this notice is Tony Montanaro of the Employee Plans, Tax Exempt and Government Entities Division. Mr. Montanaro may be e-mailed at RetirementPlanQuestions@irs.gov.

The Internal Revenue Service invites public comments on the proper application of the rules relating to the creation and maintenance of multiple layers of forward and reverse section 704(c) gain and loss to partnerships and tiered partnerships, including in the context of partnership mergers and divisions.

As discussed in greater detail below, the IRS and Treasury Department issued proposed regulations in 2007 addressing the consequences under sections 704(c)(1)(B) and 737 of certain partnership mergers. The IRS and the Treasury Department received a number of comments in response to these proposed regulations expressing concern about the proposed treatment of section 704(c) layers in connection with a partnership merger. In addition, the IRS and the Treasury Department have become aware that practitioners are taking positions based upon different interpretations of the current tiered partnership rules (Treas. Reg. § 1.704-3(a)(9)). A number of practitioners suggest that the tiered partnerships rules may need to be clarified and similar rules be provided with respect to partnership mergers. The IRS and Treasury believe that further study of certain aspects of the application of section 704(c) is necessary before finalizing the Proposed Merger Regulations.

Section 704(c), in relevant part, provides:

(c) CONTRIBUTED PROPERTY.—

(1) IN GENERAL.—Under regulations prescribed by the Secretary—

Section 704(c)(1)(A) was enacted as part of the Tax Reform Act of 1984 (P.L. 98-369). Congress determined that “special rules are needed to prevent an artificial shifting of tax consequences between the partners with respect to pre-contribution gain or loss. This is particularly important since the various partners may have different tax positions.” H.R. Rep. No. 432, Pt. 2, 98^th Cong., 2d Sess., 1209 March 5, 1984. See also, Staff of Joint Committee on Taxation, 98^th Cong., 2d Sess., General Explanation of H.R. 4170, 212, Dec. 31, 1984.

Section 704(c)(1)(B) was enacted as part of the Omnibus Budget Reconciliation Act of 1989 (P.L. 101-239). It was Congress’s view that the prior law made it “possible for partners to circumvent the rule requiring pre-contribution gain on contributed property to be allocated to the contributing partner.” S. Finance Comm. 101^st Cong., Revenue Reconciliation Act of 1989, Explanation of Provisions Approved by the Committee on Oct. 3, 1989, 196 (Comm. Print 1989).

While section 704(c)(1)(B) addresses the recognition of gain by the contributing partner if property contributed by the partner is distributed to another partner, section 737 addresses the tax consequences when a partner who contributed built-in gain or loss property receives a distribution of other property.

Sections 737(a) and (b), in relevant part, provide:

(a) GENERAL RULE. In the case of any distribution by a partnership to a partner, such partner shall be treated as recognizing gain in an amount equal to the lesser of—

(1) the excess (if any) of

(2) the net precontribution gain of the partner.

Gain recognized under the preceding sentence shall be in addition to any gain recognized under section 731. The character of such gain shall be determined by reference to the proportionate character of the net precontribution gain.

(b) NET PRECONTRIBUTION GAIN. For purposes of this section, the term “net precontribution gain” means the net gain (if any) which would have been recognized by the distributee partner under section 704(c)(1)(B) if all property which—

(1) had been contributed to the partnership by the distributee partner within 7 years of the distribution, and

(2) is held by such partnership immediately before the distribution, had been distributed by such partnership to another partner.

Sections 737(a) and (b) were enacted as part of the Energy Policy Act of 1992 (P.L. 102-486) as a result of Congress’s concern that “a partner who contributes appreciated property to a partnership may be able to avoid or defer the recognition of gain with respect to that property through the mechanism of having the partnership distribute other partnership property to him in partial or complete redemption of his interest while the partnership continues to own the contributed property.” H.R. Rep. 102-631, 102^nd Cong., 2d. Sess., 68 (June 30, 1992). See also, S. Finance Comm. Technical Explanation, 138 Cong. Record S11246, S11265, Aug. 3, 1992 (Daily Ed.). Final regulations under sections 704(c)(1)(B) and 737 were issued in T.D. 8642, dated December 22, 1995. Amendments to these provisions were included in T.D. 8717, dated May 8, 1997, T.D. 9193, dated March 21, 2005 and T.D. 9207, dated May 23, 2005.

On August 22, 2007, the IRS and the Treasury Department published in the Federal Register (72 FR 46932) a notice of proposed rulemaking (REG-143397-05) (the Proposed Merger Regulations), consistent with Notice 2005-15, 2005-1 C.B. 527, providing that (1) section 704(c)(1)(B) applies to newly created section 704(c) gain or loss in property contributed by the transferor partnership to the continuing partnership in an assets-over merger, but does not apply to newly created reverse section 704(c) gain or loss resulting from a revaluation of property in the continuing partnership, and (2) for purposes of section 737(b), net precontribution gain includes newly created section 704(c) gain or loss in property contributed by the transferor partnership to the continuing partnership in an assets-over merger, but does not include newly created reverse section 704(c) gain or loss resulting from a revaluation of property in the continuing partnership. On November 6, 2007, corrections to the proposed regulations were published in the Federal Register (72 FR 62608).

The proposed regulations include several examples. Example (3) of the proposed regulations (see Treas. Proposed Reg. § 1.704-4(c)(4)(ii)(F), Example (3)) involves a situation where built-in gain property contributed to the transferor partnership has both a revaluation loss in the transferor partnership and additional gain upon merger with the transferee partnership. The example concludes that the section 704(c) layers are collapsed in the merger and that upon contribution to the transferee partnership the property had only built-in gain and no built-in loss.

Example 3 is as follows.

Example (3). Revaluation loss and merger gain. (i) Facts. On January 1, 2005, A contributes Asset 1, with a basis of $200x and a fair market value of $300x, to partnership PRS1 in exchange for a 50 percent interest. On the same date, B contributes $300x of cash to PRS1 in exchange for a 50 percent interest. Also on January 1, 2005, C contributes Asset 2, with a basis of $100x and a fair market value of $200x, to partnership PRS2 in exchange for a 50 percent interest. On the same date, D contributes $200x of cash to PRS2 in exchange for a 50 percent interest. PRS1 and PRS2 both have provisions in their respective partnership agreements requiring the revaluation of partnership property upon entry of a new partner. PRS2 would not be treated as an investment company (within the meaning of section 351) if it were incorporated. Neither partnership holds any unrealized receivables or inventory for purposes of section 751. In addition, neither partnership has a section 754 election in place. Asset 1 and Asset 2 are nondepreciable capital assets.

Later on in 2005, PRS2 admitted E as a new partner in PRS2 at a time when the fair market value of Asset 2 was $150x and PRS2’s only other asset was cash of $200x. In exchange for a contribution of cash of $175x, E was admitted as a one-third partner in PRS2. In accordance with the terms of PRS2’s partnership agreement, the partnership revalued its assets upon admission of E so that the unrealized loss of $50x attributable to Asset 2 was allocated equally between C and D, or $25x each. On January 1, 2008, PRS 2 merges into PRS1. At the time of the merger, PRS1’s only assets are Asset 1, with a fair market value of $900x, and $300x in cash. PRS2’s only assets are Asset 2, with a fair market value of $600x, and $375x in cash. After the merger, the partners have book capital and profits and loss interests in PRS1 as follows: A, 27.5%; B, 27.5%; C, 15%; D, 15%; and E, 15%.On January 1, 2013, Asset 2 is distributed to A when its value is still $600.

(ii) Analysis. On the date of the merger of PRS2 into PRS1, the fair market value of Asset 2 ($600x) exceeded its adjusted tax basis ($100x). Thus, when Asset 2 was contributed to PRS1 in the merger, it was section 704(c) gain property. The total amount of the section 704(c) gain was $500x ($600x (fair market value) - 100x (adjusted basis)). The amount of the original section 704(c) gain attributable to Asset 2 equals $50x, the difference between its fair market value ($200x) and adjusted tax basis ($100x) upon contribution to PRS2 by C, less the unrealized loss ($50x) attributable to the revaluation of PRS2 on the admission of E as a partner in PRS2. The amount of the new section 704(c) gain attributable to Asset 2 equals $450x, the total section 704(c) gain ($500x) less the amount of the original section 704(c) gain ($50x). The distribution of Asset 2 to A occurs more than seven years after the contribution by C to PRS2. Therefore, pursuant to § 1.704-4(c)(4)(ii)(A), section 704(c)(1)(B) does not apply to the original section 704(c) gain. The distribution of Asset 2 to A, however, occurs within seven years of the contribution of Asset 2 to PRS1 and PRS2. Pursuant to § 1.704-4(c)(4)(ii)(B), section 704(c)(1)(B) applies to the new section 704(c) gain. As the transferees of PRS2’s partnership interest in PRS1, C, D and E each succeed to $150 of new section 704(c) gain. Thus, as a result of the distribution of Asset 2 to A within seven years of the merger, C, D and E are each required to recognize $150 of gain.

A number of rules in existing regulations may be relevant to mergers, divisions and tiered partnerships. In particular Treas. Reg. § 1.704-3(a)(7)-(9) may apply.

Treas. Reg. § 1.704-3(a)(7) provides rules when a partner transfers his partnership interest and provides a “step in the shoes” approach:

Treas. Reg. § 1.704-3(a)(8) provides special rules for certain specific situations, including the disposition of section 704(c) property in a nonrecognition transaction. Treas. Reg. § 1.704-3(a)(8)(i) states, in relevant part:

Guidance on allocations with regard to the contribution of section 704(c) property in a tiered partnership structure is provided in Treas. Reg. § 1.704-3(a)(9):

While no requests for a hearing were received in response to the proposed regulations issued on August 22, 2007, the IRS and the Treasury Department did receive comments relating to the proposed regulations and took notice of a number of articles published in response to the proposed regulations.

Most of the comments and articles address Example (3) which provides that property either has a built-in gain or built-in loss upon merger, not both, and that original section 704(c) gain is reduced by subsequent revaluation losses. Several comments discussed not only the specifics of Example (3), but also the broader implications of the example. In particular, the commentators questioned whether the example implies that a subsequent revaluation loss would reduce prior section 704(c) gains rather than create a new section 704(c) loss layer where there has been no partnership merger. Another comment suggested that the section 704(c) allocations in the example could be different if, for example, the transferor partnership used the remedial method instead of the traditional method. Other commentators expressed concerns that the application of the proposed regulations would result in tax allocations after the merger that are not consistent with the economic arrangement of the partners of the transferor partnership. For example, if layers of reverse section 704(c) built-in gain or built-in loss are collapsed in the merger, then a partner who prior to the merger was allocated a net loss for book purposes with respect to the property would not recognize a corresponding tax loss until liquidation of its interest. They contend that if the transferor partnership had continued in existence instead of liquidating, the section 704(c) layers would have been preserved under the tiered partnership rules of Treas. Reg. § 1.704-3(a)(9). Some practitioners believe the results should be the same in a merger.

The IRS and the Treasury Department have also become aware that there are conflicting views among practitioners about how section 704(c) layers should be maintained with respect to tiered partnerships. One view is that an aggregate approach should apply or be permitted such that a tiered partnership arrangement can be “looked through” and section 704(c) applied as if the partners of the upper-tier partnership directly own a portion of the assets of the lower-tier partnership (the Aggregate Approach). Another view is the entity approach under which the upper-tier partnership is treated as owning an interest in the lower-tier partnership but is not treated as owning any interest in the section 704(c) property of the lower-tier partnership (the Entity Approach). Each approach raises different issues and has unique consequences.

After extensive consideration of the concerns raised, the IRS and the Treasury Department believe that comments would be helpful to the development of guidance concerning section 704(c) layers in tiered partnerships and in mergers and divisions. The IRS and Treasury Department believe that it is appropriate to consider the issues regarding section 704(c) layers in general before finalizing the Proposed Merger Regulations.

The IRS and Treasury Department are seeking comments relating to section 704(c) layers, as well as other section 704(c) issues, with respect to tiered partnerships, mergers and divisions. The IRS and the Treasury Department plan to address these issues as part of a future guidance project. However, the IRS and Treasury Department are not requesting comments on the principles described in Notice 2005-15, 2005-1 C.B. 527.

The IRS and Treasury Department include examples below of the types of comments requested, but comments are requested on all aspect of these issues, not only those matters listed.

The principal author of this notice is Laura Fields of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this notice, contact Ms. Fields at (202) 622-3050 (not a toll-free call).

This revenue procedure provides the domestic asset/liability percentages and domestic investment yields needed by foreign life insurance companies and foreign property and liability insurance companies to compute their minimum effectively connected net investment income under section 842(b) of the Internal Revenue Code for taxable years beginning after December 31, 2007. Instructions are provided for computing foreign insurance companies’ liabilities for the estimated tax and installment payments of estimated tax for taxable years beginning after December 31, 2007. For more specific guidance regarding the computation of the amount of net investment income to be included by a foreign insurance company on its U.S. income tax return, see Notice 89-96, 1989-2 C.B. 417. For the domestic asset/liability percentage and domestic investment yield, as well as instructions for computing foreign insurance companies’ liabilities for estimated tax and installment payments of estimated tax for taxable years beginning after December 31, 2006, see Rev. Proc. 2008-53, 2008-36 I.R.B. 678.

DOMESTIC ASSET/LIABILITY PERCENTAGES FOR 2008. The Secretary determines the domestic asset/liability percentage separately for life insurance companies and property and liability insurance companies. For the first taxable year beginning after December 31, 2007, the relevant domestic asset/liability percentages are:

118.6 percent for foreign life insurance companies, and

183.4 percent for foreign property and liability insurance companies.

.02 DOMESTIC INVESTMENT YIELDS FOR 2008. The Secretary is required to prescribe separate domestic investment yields for foreign life insurance companies and for foreign property and liability insurance companies. For the first taxable year beginning after December 31, 2007, the relevant domestic investment yields are:

5.3 percent for foreign life insurance companies, and

3.6 percent for foreign property and liability insurance companies.

.03 SOURCE OF DATA FOR 2008. The section 842(b) percentages to be used for the 2008 tax year are based on tax return data following the same methodology used for the 2007 year.

To compute estimated tax and the installment payments of estimated tax due for taxable years beginning after December 31, 2007, a foreign insurance company must compute its estimated tax payments by adding to its income other than net investment income the greater of (i) its net investment income as determined under section 842(b)(5), that is actually effectively connected with the conduct of a trade or business within the United States for the relevant period, or (ii) the minimum effectively connected net investment income under section 842(b) that would result from using the most recently available domestic asset/liability percentage and domestic investment yield. Thus, for installment payments due after the publication of this revenue procedure, the domestic asset/liability percentages and the domestic investment yields provided in this revenue procedure must be used to compute the minimum effectively connected net investment income. However, if the due date of an installment is less than 20 days after the date this revenue procedure is published in the Internal Revenue Bulletin, the asset/liability percentages and domestic investment yields provided in Rev. Proc. 2008-53 may be used to compute the minimum effectively connected net investment income for such installment. For further guidance in computing estimated tax, see Notice 89-96.

This revenue procedure is effective for taxable years beginning after December 31, 2007.

The principal author of this revenue procedure is Sheila Ramaswamy of the Office of Associate Chief Counsel (International). For further information regarding this revenue procedure, contact Sheila Ramaswamy at (202) 622-3870 (not a toll-free call).