Rev. Rul. 78-357

Advice has been requested concerning the application of section 1491 of the Internal Revenue Code of 1954 to a transfer of stock by a United States citizen to a foreign partnership, of which such individual is an equal partner, in exchange for a private annuity under the circumstances described below.

Individuals A, a United States citizen, and B are equal partners in AB, a foreign partnership. A and B are not related to each other. In 1974, for the purpose of transferring additional capital to AB while remaining equal partners A and B made the following transfers to the foreign partnership. A transferred stock of T, a domestic corporation, with an adjusted basis of 50x dollars and a fair market value of 101x dollars to AB in exchange for a legally enforceable promise of AB to pay A a life annuity in equal annual installments. The present value of the annuity received by A was 75x dollars. B transferred 26x dollars of cash to AB. A did not request a determination under section 1492(2) of the Code that the transfer was not in pursuance of a plan having as one of its principal purposes the avoidance of federal income taxes.

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

Section 1.721-1(a) of the Income Tax Regulations states that if the transfer of property by a partner to a partnership results in the receipt by the partner of money or other consideration, including a promissory obligation fixed in amount and time for payment, the transaction will be treated as a sale or exchange under section 707 of the Code rather than as a contribution under section 721.

Section 707 of the Code provides, in part, that if a partner engages in a transaction with a partnership other than in his capacity as a member of such partnership, the transaction shall, with exceptions not here relevant, be considered as occurring between the partnership and one who is not a partner.

With respect to transfers made before October 3, 1975, section 1491 of the Code imposes on the transfer of stock or securities by a United States citizen to a foreign corporation as paid-in surplus or as a contribution to capital, or to a foreign trust, or to a foreign partnership, an excise tax equal to 271/2 percent of the excess of the value of the stock or securities so transferred over their adjusted basis (for determining gain) in the hands of the transferor.

Section 1492(2) of the Code and regulations thereunder provide that the tax imposed by section 1491 will not apply if before the transfer it is established to the satisfaction of the Commissioner that such transfer is not in pursuance of a plan having as one of its principal purposes the avoidance of federal income taxes.

Section 1494(b) of the Code provides that the tax imposed by section 1491 of the Code may be abated, remitted, or refunded if after the transfer it is established to the satisfaction of the Commissioner that such transfer was not in pursuance of a plan having as one of its principal purposes the avoidance of federal income taxes.

In exchange for T stock, A received a legally enforceable promise of AB that is fixed as to amount and time for payment. Therefore, pursuant to section 707(a) of the Code, the transaction is considered as occurring between the partnership and one who is not a partner.

Accordingly, under the above circumstances, the exchange by A of the T stock for the annuity of AB is a taxable exchange between a partnership and one who is not acting in the capacity of a partner to the extent the fair market value of the T stock is equal to the present value of the annuity of 75x dollars. The excess of the fair market value of the T stock transferred over the present value of the annuity, or 26x dollars, is a nontaxable contribution of property to AB under section 721 of the Code.

As provided for under section 1491 of the Code with respect to transfers prior to October 3, 1975, a tax equal to 271/2 percent of the excess of the value of the stock transferred (101x dollars) over its adjusted basis in the hands of the transferor (50x dollars) was due and payable by the transferor at the time of the transfer. The tax so calculated was 14.025x dollars. Under section 1494(b) the tax may be abated, remitted, or refunded (in whole or in part), if A establishes to the satisfaction of the Commissioner that the transfer was not made in pursuance of a plan having as one of its principal purposes the avoidance of federal income taxes.

Compare Rev. Rul. 78-356, page 226, this Bulletin, which holds that a transfer of appreciated stock by a United States citizen to an unrelated foreign corporation in exchange for a private annuity is not subject to the excise tax imposed by section 1491 of the Code because it does not represent paid-in surplus or a contribution to capital, and section 1491 is expressly limited to these kinds of transfers to foreign corporations.

No opinion is expressed on the extent to which other provisions of the Code may apply to the transfer or the annuity payments made under A's agreement with AB.