IRS PROVIDES GUIDANCE ON DEFINITION OF PUBLICLY TRADED PARTNERSHIPS.

Notice 88-75

I. BACKGROUND

The Internal Revenue Service has received many inquiries regarding the sections of the Omnibus Budget Reconciliation Act of 1987 (Pub. L. 100-203) (the "Act") that affect publicly traded partnerships. The purpose of this notice is to provide guidance with respect to several issues that are of immediate concern to taxpayers.

New sections 469(k), 512(c)(2), and 7704 of the Internal Revenue Code of 1986 (the "Code") were added by the Act. Section 469(k)(1) generally provides that the passive loss rules of section 469 shall be applied separately with respect to items attributable to each publicly traded partnership ("PTP") that is not treated as a corporation under section 7704. Section 512(c)(2) provides that, with respect to any tax-exempt organization described in section 511(a)(2), such organization's distributive share (whether or not distributed) of the gross income and deductions of a PTP that is not treated as a corporation under section 7704 shall be treated as gross income and deductions derived from an unrelated trade or business. Section 7704 treats certain PTPs as corporations for Federal tax purposes.

Section 469(k) of the Code applies to taxable years beginning after December 31, 1986. The amendments to section 512 are applicable to partnership interests acquired after December 17, 1987. Section 7704 generally applies to taxable years beginning after December 31, 1987.

II. DEFINITION OF READILY TRADABLE ON A SECONDARY MARKET OR THE SUBSTANTIAL EQUIVALENT THEREOF

For purposes of sections 469, 512, and 7704 of the Code, a PTP is defined as a partnership the interests in which are: (i) traded on an established securities market; or (ii) readily tradable on a secondary market or the substantial equivalent thereof. Sections 469(k)(2) and 7704(b) of the Code. No regulations have been issued under sections 469(k)(2) or 7704(b) to clarify when interests in a partnership that are not traded on an established securities market will be treated as readily tradable on a secondary market or the substantial equivalent thereof. In recognition of the need for certainty in the tax classification of entities, this notice provides limited safe harbors from the definition of a PTP in advance of the issuance of regulations.

The legislative history of the Act discusses the circumstances under which a partnership should be treated as a PTP because the interests in the partnership are readily tradable on a secondary market or the substantial equivalent thereof. See H. R. Conf. Rept. No. 495, 100th Cong., 1st Sess. 947-950 (1987) (the "Conference Report"). The Conference Report indicates that a secondary market or the substantial equivalent thereof exists if investors are readily able to buy, sell, or exchange their partnership interests in a manner that is comparable, economically, to trading on established securities markets.

A secondary market is generally indicated by the existence of a person standing ready to make a market in the interest. An interest is treated as readily tradable if the interest is regularly quoted by persons such as brokers or dealers who are making a market in the partnership interest. The substantial equivalent of a secondary market exists if there is not an identifiable market maker but either: (i) the holder of an interest has a readily available, regular, and ongoing opportunity to sell or exchange such interest through a public means of obtaining or providing information of offers to buy, sell, or exchange interests; or (ii) buyers and sellers have the opportunity to buy, sell, or exchange interests in a time frame and with the regularity and continuity that the existence of a market maker would provide. The Conference Report provides that even if partnership interests can be traded in a market that is publicly available, the interests are not treated as readily tradable on the substantial equivalent of a secondary market if offers to buy or sell interests are normally not accepted in a time frame comparable to that which would be available on a secondary market. The Conference Report further provides that, although occasional purchases of interests by the partnership or the general partner will not constitute public trading, a regular plan of redemptions or repurchases, or similar acquisitions of interests in the partnership may constitute public trading where holders of interests have readily available and ongoing opportunities to dispose of their interests. Finally, the Conference Report indicates that public trading does not occur solely because the underwriter that handled the issuance of the partnership interests or the general partner occasionally arranges transfers between partners without offering to buy or redeem interests or to issue additional interests to such partners.

Regulations under sections 469(k)(2) and 7704(b) of the Code, when issued, will provide that interests in a partnership will not be treated as readily tradable on a secondary market or the substantial equivalent thereof under the circumstances, or by reason of the transactions, described below. No inferences should be drawn from this notice regarding the treatment under sections 469(k)(2) or 7704(b) of transactions not described in this notice. In particular, the failure of a partnership to satisfy the safe harbors described in II.A., II.B., II.C., II.D., and II.E. below is not intended to establish or give rise to a presumption that the interests in the partnership will be treated as readily tradable on a secondary market or the substantial equivalent thereof. Moreover, if the safe harbors described in section II.C. are not satisfied, transactions that satisfy the safe harbors described in sections II.B., II.D., and II.E. will be disregarded for purpose of determining whether interests in a partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b). The Internal Revenue Service will consider requests for rulings on the issue of whether interests in a partnership are treated as readily tradable on a secondary market or the substantial equivalent thereof pending the issuance of regulations. Satisfaction of the safe harbors described in this notice will not be a prerequisite for issuance of a ruling on this issue. Procedures similar to those described in Rev. Proc. 88-18, 1988-20 I.R.B. 32, shall apply.

A. Private Placements

Interests in a partnership will not be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 46g(k)(2), 512(c)(2), and 7704(b) of the Code if: (i) all interests in such partnership were issued in a transaction (or transactions) that was not registered under the Securities Act of 1933; and (ii) either (A) the partnership does not have more than 500 partners, or (B) the initial offering price of each unit of partnership interest is at least $20,000 and the partnership agreement provides that no unit of partnership interest may be subdivided for resale into units smaller than a unit the initial offering price of which would have been at least $20,000. For purposes of determining the number of partners, each person indirectly owning an interest through a partnership, a grantor trust, or an S corporation shall be treated as a partner. In addition, partnerships will be aggregated for purposes of determining the number of partners where such partnerships jointly operate one or more businesses or the operations of the partnerships are interrelated and the principal purpose for the use of multiple partnerships is to permit any of the partnerships to qualify for the safe harbor under this section II.A.

B. Transfers Not Involving Trading

For purposes of determining whether interests in a partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code, the following transfers will be disregarded: (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; (iii) transfers between members of a family (as defined in section 267(c)(4)); (iv) the issuance of interests by or on behalf of the partnership in exchange for cash, property, or services; (v) distributions from a retirement plan qualified under section 401(a); (vi) block transfers; (vii) transfers pursuant to a right under a redemption or repurchase agreement (as defined in section II.E.) that is exercisable only (A) upon the death, complete disability, or mental incompetence of the partner, or (B) upon the retirement or complete termination of the performance of services of an individual who actively participates in the management of or performs services on a full time basis for the partnership; and (viii) transfers that are disregarded for purposes of sections 469(k)(2), 512(c)(2), and 7704(b) pursuant to section II.E.2. For purposes of this section II.B., the term "block transfer" means the transfer[s] by a partner in one or more transactions during any thirty calendar day period of partnership interests representing in the aggregate more than 5 percent of the total interest in partnership capital or profits.

C. Lack of Actual Trading

1. FIVE PERCENT SAFE HARBOR. Interests in a partnership will not be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code for a taxable year of the partnership if the sum of the percentage interests in partnership capital or profits represented by partnership interests that are sold or otherwise disposed of (including purchases by a partnership of its own interests ("redemptions")) during the taxable year does not exceed 5 percent of the total interest in partnership capital or profits (the "Five Percent Safe Harbor").

A transfer will be disregarded for purposes of the Five Percent Safe Harbor if such transfer is disregarded for purposes of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code pursuant to section II.B. above. Except as provided in the preceding sentence, each sale or other disposition of the beneficial ownership in a partnership interest included in the total interest in partnership capital and profits is taken into account for purposes of applying the Five Percent Safe Harbor, regardless of whether such interest has been transferred previously during the taxable year.

For example, assume that ABC limited partnership formed in 1988), a calendar year partnership, has 9,000 units of limited partnership interest outstanding at all times during 1989, representing in the aggregate 95 percent of the total interest in capital and profits of ABC (the remaining 5 percent is held by the general partner). Assume further that during 1989 the following transactions occur with respect to the units of ABC's limited partnership interest: (i) 450 units are sold through the use of a matching service; (ii) 100 units are sold between members of a family (as defined in section 267(c)(4)); and (iii) 800 units are sold by a partner during a thirty day period. The sales described in (ii) and (iii) above are disregarded for purposes of the Five Percent Safe Harbor because such sales are disregarded as a family transfer and a block transfer, respectively, under section II.B. above. ABC qualifies for the Five Percent Safe Harbor for 1989 because the total interest in partnership capital or profits represented by partnership interests that were sold or otherwise disposed of in transactions that are not disregarded is less than 5 percent (450/9,000 x .95 = 4.75%).

2. TWO PERCENT SAFE HARBOR. Interests in a partnership will not be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code for a taxable year of the partnership if the safe harbor described in section II.C.1. above would be satisfied if: (i) transfers that meet the safe harbors described in sections II.D. and II.E.1. below were also disregarded; and (ii) 2 percent were substituted for 5 percent as the maximum permitted sum of interests in partnership capital or profits that may be sold or otherwise disposed of under this safe harbor (the "Two Percent Safe Harbor").

For example, assume that DEF limited partnership (formed in 1988), a calendar year partnership, has 9,000 units of limited partnership interest outstanding at all times during 1989, representing in the aggregate 95 percent of the total interest in capital and profits of DEF (the remaining 5 percent is held by the general partner). Assume further that, during 1989, the following transactions occur with respect to the units of DEF's limited partnership interest: (i) 800 units are sold through the use of a matching service in sales that meet requirements (i)-(v) of section II.D. below; (ii) 50 units are sold through the use of a matching service in a sale that does not meet requirements (i)-(v) of section II.D. below; and (iii) 500 units are transferred as a result of transactions that are disregarded pursuant to section II.B. above (e.g., block transfers or transfers at death). DEF qualifies for the Two Percent Safe Harbor for 1989 because the percentage interest in partnership capital and profits represented by partnership interests that were sold or otherwise disposed of in transactions that are not disregarded is less than 2 percent ([50/9,000] x .95 = .528%).

D. Matching Services

A matching service typically involves the use of a computerized or printed listing system that lists customers' bid and/or ask prices in order to match partners who want to dispose of their interests in a partnership with persons who want to buy such interests. Matching services may be provided by the general partner of the partnership (either formally or informally), the underwriter that handled the issuance of the partnership interests, or an unrelated third party. (The person or persons providing the matching service is referred to below as the "operator".) Typically, a customer desiring to sell an interest in a partnership (the "listing customer") contacts the operator or its agent, and the operator enters the listing customer's information onto the computer or printed lists that are made available to other customers. Following such listing, the operator and its agents attempt to match the listing customer with its customers desiring to buy interests in such partnership. In the course of performing these services, the operator does not regularly quote prices at which the operator stands ready to buy or sell such interests, make such quotes available to the public, or buy or sell interests for its own account. Matching may occur either by simply matching the lists of interested buyers with the list of interested sellers or through a so-called "bid and ask" process. The bid and ask process typically allows interested buyers to bid on the listed interest for some bidding period. During such period, bids are accumulated but no match is made between potential buyers and the listing customer. Following the expiration of such period, the listing customer is informed of the high bid (if any) and a sale of the interest can then take place.

The transfer of a partnership interest through a matching service similar to those described above will be disregarded for purposes of determining whether interests in such partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code only if: (i) at least a 15 calendar day delay occurs between the day the operator receives written confirmation from the listing customer that an interest in a partnership is available for sale (the "contact date") and the earlier of (A) the day information is made available to potential buyers regarding the offering of such interest for sale, or (B) the day information is made available to the listing customer regarding the existence of any outstanding bids to purchase an interest in such partnership at a stated price; (ii) the closing of the sale effected through the matching service does not occur prior to the 45th calendar day after the contact date; (iii) the listing customer's information is removed from the matching service within 120 calendar days after the contact date; (iv) following any removal (other than removal by reason of a sale of any part of such interest) of the listing customer's information from the matching service, no interest in the partnership is entered into the matching service by such listing customer for at least 60 calendar days; and (v) the sum of the percentage interests in partnership capital and profits represented by partnership interests that are sold or otherwise disposed of (including redemptions) other than in transfers described in section II.B. above during the taxable year of the partnership does not exceed 10 percent of the total interest in partnership capital and profits. For this purpose, the closing of a sale occurs on the earlier of the passage of title to the partnership interest or the payment of the purchase price. The contact date must be established by contemporaneous records maintained by the operator at a central location.

For example, assume the same facts as in the example in section II.C.2. above, except that during 1989 1150 units (rather than 800 units) are sold through the use of a matching service in sales that meet requirements (i)-(iv) of this section II.D. These sales are not disregarded for purposes of determining whether interests in the partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) because the sum of the percentage interests in partnership capital and profits represented by partnership interests that were sold other than in transfers described in section II.B. above is more than 10 percent ([(1150 + 50)/9000] x .95 = 12.67%). DEF does not qualify for the Two Percent Safe Harbor for 1989 because the percentage interest in partnership capital and profits represented by partnership interests that were sold or otherwise disposed of in transactions that are not disregarded is more than 2 percent ([1200/9,000] x .95 = 12.67%).

E. Redemption and Repurchase Agreements

Many partnerships maintain plans of redemption or repurchase whereby their limited partners may tender their limited partnership interests for purchase by the partnership, its general partner[s], or a person related to its general partner[s] (within the meaning of either section 267(b) or section 707(b)(1)) (a "redemption or repurchase agreement").

1. OPEN END PARTNERSHIPS. Except as provided below, the transfer of a partnership interest pursuant to a redemption or repurchase agreement will be disregarded for purposes of determining whether interests in such partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code only if: (i) the redemption or repurchase agreement requires receipt of written notification by the partnership or the general partner (or an agent thereof) at least 60 calendar days before the redemption or repurchase date of such limited partner's intention to exercise the redemption or repurchase right; (ii) either (A) 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 general partner (or an agent thereof), or (B) the redemption or repurchase price is established not more than 4 times during the partnership's taxable year; and (iii) the sum of the percentage interests in partnership capital and profits represented by partnership interests that are sold or otherwise disposed of (including redemptions) other than in transfers described in section II.B. above during the taxable year of the partnership does not exceed 10 percent of the total interest in partnership capital or profits.

2. CLOSED END PARTNERSHIPS. The transfer of a partnership interest pursuant to a redemption agreement will be disregarded for purposes of determining whether interests in a partnership are to be considered readily tradable on a secondary market or the substantial equivalent thereof within the meaning of sections 469(k)(2), 512(c)(2), and 7704(b) of the Code if the partnership does not issue any interest after the initial offering, and the general partner or a person related to the general partner (within the meaning of either section 267(b) or section 707(b)(1)) does not provide contemporaneous opportunities to acquire interests in similar or related partnerships which represent substantially identical investments. The issuance of additional interests by a partnership prior to August 5, 1988 shall be disregarded for purposes of this section II.E.2.

F. Definitions and Conventions

For purposes of section II., the total interest in partnership capital and profits shall be determined by reference to all outstanding interests in partnership capital and profits (including interests owned by the general partner[s]). If, however, the general partner[s] of the partnership and any persons related to the general partner[s] (within the meaning of either section 267(b) or section 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 interest in partnership capital and profits shall be determined without reference to interests owned by the general partner[s] and such related persons.

Except in the case of block transfers (as defined in section II.B. above), for purposes of section II., the percentage interest in partnership capital and profits represented by partnership interests that are sold or otherwise disposed of during a taxable year of the partnership is equal to the sum of the percentage interests sold or otherwise disposed of for each calendar month during the taxable year of the partnership in which a sale or other disposition of a partnership interest occurs (other than a transfer that is disregarded under section II.B. above). The partnership shall determine the percentage interest in capital and profits of interests that are sold or otherwise disposed of during a calendar month by reference to the partnership interests that are outstanding during such month. In determining the interests outstanding for a month, a partnership may use any reasonable convention, provided such convention is consistently used by the partnership from month to month during a taxable year and from year to year. Such 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. For purposes of the definition of block transfer, the partnership shall determine the percentage interest in capital and profits for each transfer of an interest during the thirty calendar day period by reference to the partnership interests that are outstanding immediately prior to such transfer.

For example, assume that GHI limited partnership (formed in 1988), a calendar year partnership, has 1,000 units of limited partnership interest outstanding on January 1, 1989, representing in the aggregate 95 percent of the total interest in capital and profits of GHI (the remaining 5 percent is held by the general partner). Also assume that the following transfers take place during 1989: (i) on January 15, 40 units of limited partnership interest are sold in a transaction that is not disregarded for purposes of the Five Percent Safe Harbor; (ii) on July 10, 1,000 additional units of limited partnership interest are issued by the partnership (the general partner's percentage interest is unchanged); and (iii) on July 20, 15 units of limited partner interest are sold in a transaction that is not disregarded for purposes of the Five Percent Safe Harbor. For purposes of determining the sum of the percentage interests in partnership capital and profits represented by partnership interests that are sold or otherwise disposed of, GHI has chosen to use the end of the month convention. The percentage interest in partnership capital and profits transferred during January is 3.8 percent ([40/1,000] x .95) and during July is .7125 percent ([15/2,000] x .95). GHI is not required to make determinations for the other months during the year because no sales or other dispositions of partnership interests occurred during such months. GHl qualifies for the Five Percent Safe Harbor for its 1989 taxable year because less than 5 percent (3.8 + .7125 = 4.5125%) of its total interest in partnership capital and profits was sold or otherwise disposed of during that year. If GHI had chosen to use the beginning of the month convention, the interest in capital and profits sold during July would have been 1.425 percent ([15/1,000] x .95) and thus GHI would not have satisfied the Five Percent Safe Harbor for its 1989 taxable year because 5.225 percent (3.8 + 1.425) of GHI's interest in partnership capital and profits was sold or otherwise disposed of during the year.

G. Transition Rule

For purposes of sections 469, 512, and 7704 of the Code, if, prior to November 2, 1988, all of the steps are taken that are necessary to ensure that an existing matching service or an existing redemption or repurchase agreement satisfies requirements (i)-(iv) provided in section II.D. or requirements (i) and (ii) in section II.E.1., respectively, transfers of partnership interests before November 2, 1988 pursuant to such matching service or redemption or repurchase agreement will be considered to have met such requirements regardless of whether such transfers actually meet such requirements.

III. TREATMENT OF PUBLICLY TRADED PARTNERSHIPS UNDER PASSIVE ACTIVITY LOSS LIMITATIONS

Section 469(a) of the Code provides, in part, that neither the passive activity loss nor the passive activity credit of the taxpayer for the taxable year shall be allowed. The term "passive activity loss" is defined generally in section 1.469-2T(b)(1) of the temporary income tax regulations as the amount (if any) by which the passive activity deductions for the taxable year exceed the passive activity gross income for such year. Under section 469(e)(1)(A)(i)(I), gross income from interest, dividends, annuities, and royalties not derived in the ordinary course of a trade or business ("portfolio income") may not be taken into account in computing the income or loss from any passive activity.

Under section 469(k) of the Code, the passive loss limitations generally must be applied to a taxpayer's items of income, gain, loss, deduction, and credit from the passive activities held through each PTP as if they were the taxpayer's only items from passive activities. Under this rule, a taxpayer's net passive income for a taxable year from a PTP (i.e., the amount by which the taxpayer's passive activity gross income from the PTP for the year exceeds the taxpayer's passive activity deductions from the PTP for the year) cannot be offset by the taxpayer's losses from other passive activities (including losses from passive activities held through other PTPs). This rule is intended to treat an investor's net passive income from a PTP in a manner similar to a corporate shareholder's dividend income, which constitutes portfolio income for purposes of the passive loss limitations and therefore cannot be sheltered by passive activity deductions.

Section 163(d)(4)(B) of the Code generally provides that investment income means the sum of (i) gross income from property held for investment and (ii) any net gain attributable to the disposition of property held for investment. Under sections 163(d)(5)(A) and 46g(e)(1), dividends on corporate stock that are not derived in the ordinary course of a trade or business are treated as gross income from property held for investment and, thus, are investment income for purposes of section 163(d).

Forthcoming regulations will treat the net passive income from a PTP as investment income for purposes of section 163(d) of the Code. Until such regulations are issued, an amount of a taxpayer's gross income for a taxable year from any PTP equal to the taxpayer's net passive income from such PTP for the year shall be treated as investment income for purposes of section 163(d). For this purpose, a taxpayer's net passive income from a PTP for a taxable year shall be computed by applying all of the rules under the regulations that affect the computation of the taxpayer's passive activity gross income and passive activity deductions from any activity held through the PTP. Thus, in determining a taxpayer's net passive income from a PTP for a taxable year, the taxpayer's passive activity deductions from such PTP for the year shall include any passive activity deductions attributable to expenses of the taxpayer that are incurred outside the PTP and are reasonably allocable to the interest in passive activities that the taxpayer holds through such PTP. A deduction for interest expense shall be considered reasonably allocable to passive activities that a taxpayer holds through a PTP if and only if such interest expense is allocable to those activities under section 1.163-8T or under Notice 88-20, 1988-9 I.R.B. 5, and Notice 88-37, 1988-15 I.R.B. 8.

Questions concerning the treatment of the income from a publicly traded partnership for purposes of section 163(d) may be directd to Michael J. Grace of the Legislation and Regulations Division, Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, D.C. 20224, Attention: CC:LR:Br3 (Telephone (202) 566-3288, not a toll-free call).

IV. TREATMENT OF PUBLICLY TRADED PARTNERSHIPS UNDER UNRELATED BUSINESS INCOME RULES

Section 512(c)(2)(A) of the Code provides that, notwithstanding any other provision of section 512, with respect to any tax-exempt organization described in section 511(a)(2), such organization's distributive share of the gross income of a PTP that is not treated as a corporation under section 7704 shall be treated as gross income derived from an unrelated trade or business. Section 512(c)(2)(B) provides that the tax-exempt organization's share of the partnership's deductions shall be allowed in computing unrelated business taxable income. An effect of section 512(c)(2)(A) is to negate the provisions of section 512(b) that would exclude certain items of gross income from the definition of unrelated business income, such as interest, dividends, annuities, and royalties. As a result, gross income from such sources that is earned by a PTP will constitute unrelated business gross income. Section 512(c)(2)(A), however, does not negate the effect of other provisions of section 512(b) that do not relate to the classification of unrelated business gross income. Therefore, section 512(c)(2)(A) does not prohibit exempt organizations from offsetting the $1,000 specific deduction permitted by section 512(b)(12) against their distributive share of PTP gross income.

V. TRANSITION RULE FOR EXISTING PARTNERSHIPS

Section 10211(c) of the Act provides that section 7704 of the Code will apply, in the case of an "existing partnership", to taxable years beginning after December 31, 1997. An "existing partnership" means a partnership that: (i) was publicly traded on December 17, 1987; (ii) had a registration statement filed with the Securities and Exchange Commission (the "SEC") on or before December 17, 1987, indicating that such partnership was to be a PTP; or (iii) had an application filed with a State regulatory commission on or before December 17 1987, seeking permission to restructure a portion of a corporation as a PTP. Section 10211(c)(2)(B) of the Act provides that a partnership that is treated as an existing partnership ceases to be treated as an existing partnership as of the first day after December 17, 1987, on which there has been an addition of a substantial new line of business with respect to such partnership. The forthcoming regulations will provide that, in the situations described below, a partnership will be treated as an existing partnership for purposes of section 10211(c)(2)(B) of the Act. The Internal Revenue Service will consider requests for rulings on the issue of whether a partnership is or continues to be an existing partnership pending the issuance of regulations. Satisfaction of the requirements described in this notice will not be a prerequisite for issuance of a ruling on these issues. Procedures similar to those described in Rev. Proc. 88-18, 1988-20 I.R.B. 32, shall apply.

A. Registration Statements

As described above, the statements in the partnership's registration statement regarding public trading control whether such partnership is considered an existing partnership for purposes of the transition rule. A registration statement may not provide unequivocally that the interests in a partnership are to be publicly traded. Nevertheless, a partnership will be considered to be an existing partnership for purposes of section 10211(c) of the Act if the partnership's registration statement contains a statement that the partnership will or may list its units on an established securities market at some point in the future, notwithstanding that such listing is subject to the discretion of the general partner or other conditions or qualifications.

B. Substantial New Line of Business

As described above, the transition period for an existing partnership ends on the first day after December 17, 1987, on which there has been an addition of a "substantial new line of business" with respect to such partnership. Uncertainty exists regarding the definitions of: (i) a new line of business, and (ii) substantial. Except as described below, no guidance is provided in this notice as to the meaning of "new line of business." Forthcoming regulations, however, will define the circumstances under which a partnership will be considered to have added a new line of business. Pending the issuance of regulations, the Internal Revenue Service will consider requests for rulings on this issue.

SUBSTANTIAL. The regulations will not classify a new line of business as "substantial" if, during any partnership taxable year, the partnership derives no more than 15 percent of its gross income from such line of business and no more than 15 percent of the value of its total assets are directly used in such business.

NEW LINE OF BUSINESS. For purposes of determining whether a PTP has added a substantial new line of business, a new activity of a partnership will not be considered to be a new line of business within the meaning of section 10211(c)(2)(B) of the Act to the extent an activity generates qualifying income as defined in section 7704(d) of the Code.

ACTIVITIES CONDUCTED THROUGH A CORPORATION. For purposes of determining whether a PTP has added a substantial new line of business, the regulations will not consider an activity conducted in a corporation controlled by the PTP to be an activity of the PTP if no more than 10 percent of the gross income of the PTP that is derived from the corporation during the taxable year would be treated as other than qualifying income as defined in section 7704(d) of the Code if rules similar to those in section 512(b)(13) were applied and the definition of control in section 512(b)(13) were defined by reference to section 304(c). For example, assume that JKL limited partnership, a PTP treated as an existing partnership under section 10211(c) of the Act, acquires all of the stock of X Corporation on January 1, 1989. JKL receives dividends of $185x and interest of $15x from X during JKL's 1989 taxable year. Assume further that X's taxable income during that period, determined without regard to interest paid to JKL, is $500x, none of which would be qualifying income within the meaning of section 7704(d) of the Code. Applying rules similar to section 512(b)(13), all $15x of JKL's interest income would be nonqualifying income ($15x X 500x/500x). However, the activities of X will not be considered conducted by JKL for such taxable year because not more than 10 percent of the gross income derived by JKL from X would be treated as other than qualifying income (15x/200x = 7.5%).

The failure of a partnership to satisfy the safe harbor in the immediately preceding paragraph is not intended to establish or give rise to a presumption that an activity conducted in a corporation controlled by a PTP is to be considered an activity of the PTP.

This document serves as an "administrative pronouncement" as that term is described in section 1.6661-3(b)(2) of the Income Tax Regulations and may be relied upon to the same extent as a revenue ruling or a revenue procedure.

DRAFTING INFORMATION

The principal author of this notice is Stuart G. Wessler of the Legislation and Regulations Division of the Office of Chief Counsel, Internal Revenue Service. However, personnel from other offices of the Internal Revenue Service and the Treasury Department participated in developing this notice both on matters of substance and style. For further information regarding this notice contact Stuart G. Wessler on (202) 566-3297 (not a toll-free call).