APPRECIATED PROPERTY TRANSFERRED TO FOREIGN TRUST NOT SUBJECT TO EXCISE TAX UNTIL GRANTOR RELINQUISHES CONTROL OVER TRUST PROPERTY.

Rev. Rul. 87-61

ISSUE

If a United States citizen transfers appreciated property to a trust established in a foreign country and if the transferor is the owner of the trust within the meaning of section 671 of the Internal Revenue Code, then is that transfer subject to the tax imposed by section 1491?

FACTS

In 1983, A, a citizen of the United States, established a trust, FT, under the laws of Country X by executing a trust document and transferring appreciated property to TT as trustee. TT is a bank incorporated in, and having its only place of business in, Country X. As a result of the transfer, TT acquired legal title to the appreciated property and that property became located in Country X.

The terms of the trust document require the payment of all trust income to A's adult child B for B's life, with remainder to C, A's grandchild. Both B and C are citizens and residents of Country X.

When A created the trust, A expressly retained certain powers of the kind described in Subpart E of Part I of Subchapter J of the Code (sections 671 through 679). For purposes of Subpart E, A was treated as the owner of the entire trust from its inception in 1983 until December 31, 1984, when A renounced the powers previously retained. A ceased to be treated as owner of any portion of the trust on December 31, 1984.

LAW AND ANALYSIS

Sections 673 through 679 of the Code set forth the rules for determining when a grantor or other taxpayer is treated as the owner of a trust or any portion thereof. If a grantor is treated as the owner of an entire trust, then section 671 and the regulations interpreting that section provide that the grantor must take into account in computing the grantor's tax liability all of the trust's items of income, deduction, and credit as though the trust had not been in existence during the period the grantor is treated as the owner. If the grantor is treated as the owner of a portion of a trust and that portion consists of specific trust property and its income, then all items directly related to that property are to be taken into account in computing the grantor's income tax liability. Section 1.671-3(a) of the Income Tax Regulations.

Section 1491 of the Code imposes an excise tax on transfers of appreciated property by United States citizens or residents to foreign trusts. Section 1492 provides certain exceptions to the imposition of the section 1491 tax.

Section 1494(a) of the Code provides that the tax imposed by section 1491 shall, without assessment or notice and demand, be due and payable by the transferor at the time of the transfer, and shall be assessed, collected, and paid under regulations prescribed by the Secretary. Section 1.1494-1(a) of the regulations provides, among other things, that every person making a transfer to a foreign trust shall make a return to the district director on the day which the transfer is made and, unless the transfer is nontaxable under section 1492, pay the tax due on the transfer.

Section 7701(a)(31) of the Code defines the terms "foreign estate" and "foreign trust" to mean an estate or trust, as the case may be, the income of which, from sources without the United States that is not effectively connected with the conduct of a trade or business within the United States, is not includible in gross income under subtitle A.

Under section 872 of the Code, a nonresident alien individual does not include in gross income items of foreign source income unless that income is effectively connected with the conduct of a trade or business within the United States. A nonresident alien individual is an individual whose residence is not within the United States and who is not a citizen of the United States. Section 1.871- 2(a) of the regulations.

The initial question presented by this case is whether FT is a foreign trust. Section 7701(a)(31) of the Code defines a foreign trust as one whose foreign source income "is not includible in gross income under subtitle A." In so doing, however, section 7701(a)(31) does not specify whose gross income is not includible. The purpose of section 7701(a)(31) is to define a class of foreign trusts that is analogous to the class of nonresident alien individuals. It is therefore reasonable to conclude that section 7701(a)(31) is referring to the gross income of the trust rather than that of the grantor. Furthermore, the legislative history accompanying the part of the Tax Reform Act of 1976 dealing with foreign trusts indicates clearly that Congress did not intend that the status of a trust as a foreign trust be dependent upon whether the grantor is treated as the owner of the trust. See S. Rep. No. 94-938, 94th Cong., 2d Sess. 215 (1976), 1976-3 (Vol. 3) C.B. 49, 253; H.R. Rep. No. 94-658, 94th Cong., 1st Sess. 206 (1975), 1976-3 (Vol. 2) C.B. 695, 898. Rather, the status of a trust as a foreign trust turns upon whether the trust is comparable to a nonresident alien individual. See Rev. Rul. 60-181, 1960-1 C.B. 257, citing B.W. Jones Trust v. Commissioner, 46 B.T.A. 531 (1942), aff'd 132 F.2d 914 (4th Cir. 1943), which held that a trust is a nonresident alien if it is foreign as to both alienage and residency. See also Rev. Rul. 81-112, 1981-1 C.B. 598, which applies the standards set out in B.W. Jones Trust in determining that a decedent's estate was a foreign estate. In the present case, the trust was established in, and is administered under, the laws of a foreign country, and the trustee is a foreign entity. Further, the trust corpus is located in a foreign country. Therefore, FT is like a nonresident alien individual and, as a result, FT is a foreign trust.

Rev. Rul. 77-402, 1977-2 C.B. 222, considers a situation in which a grantor established a trust over which the grantor at first retained certain powers that caused the grantor to be treated as the owner of the entire trust. The grantor funded the trust with a contribution of money, and the trustees used the money to acquire a limited partnership interest in a real estate investment partnership. During the first few years of the trust, the partnership generated losses and the grantor, as owner of the entire trust, deducted the distributive share of partnership losses attributable to the partnership interest held by the trust. When the basis of the partnership interest had been significantly reduced, the grantor renounced the powers that caused the grantor to be treated as the owner of the trust.

Rev. Rul. 77-402 holds that the grantor recognized gain upon the renunciation of powers to the extent that the share of partnership liabilities attributable to the partnership interest exceeded the adjusted basis of that interest. The ruling explains that during the period that the grantor was treated as the owner of the trust, the grantor was considered to be the owner of all the trust property for federal income tax purposes, including the partnership interest. Consequently, when the grantor renounced the powers that caused the grantor to be the owner of the trust, the grantor is considered to have transferred the partnership interest to the trust. Example 5 of section 1.1001-2(c) of the regulations closely parallels the facts and holding of Rev. Rul. 77-402. Furthermore, the conclusions reached in Rev. Rul. 77-402 and Example 5 of section 1.1001-2(c) were sustained in Madorin v. Commissioner, 84 T.C. 667 (1985). See also Rev. Rul. 85- 13, 1985-1 C.B. 184, which holds that a grantor who is treated as the owner of an entire trust is considered to own the trust assets. Rev. Rul. 85-13 holds also that a grantor who is treated as the owner of a portion of a trust represented by specific trust property is considered to be the owner of that property.

In the present case, A was treated as the owner of the entire trust from its inception in 1983 until December 31, 1984. During the period, all of the items of trust income, deduction, and credit were attributed to A, and, in accordance with Rev. Rul. 77-402 and Rev. Rul. 85-13, A was considered to be the owner of the trust assets for federal income tax purposes. Thus, A is viewed as having transferred property to FT only at the time A ceased to be the owner of the trust. Accordingly, the section 1491 tax is imposed, not at the time that A established the trust, but (unless one of the exceptions set out in section 1492 of the Code applies) at the time A ceased to be the owner of the trust. Further, A is subject to the reporting requirements of section 1.194-1(a) of the regulations only at the time A ceased to be the owner of the trust.

Rev. Rul. 69-450, 1969-2 C.B. 168, considers a transfer to a foreign trust. The transfer in that ruling does not differ materially from the one described in this ruling. Rev. Rul. 69-450 holds that the transfer of appreciated stock to a foreign trust is a transfer subject to the provisions of section 1491 of the Code even if the grantor is the owner of the entire trust. Rev. Rul. 69-450 is incorrect because it fails to recognize that a grantor, as the owner of the entire trust, continues to own the trust assets until the grantor ceases to be the owner of the trust. Rev. Rul. 69-450, is therefore, revoked.

HOLDING

The transfer by A of appreciated property to FT is not a transfer subject to the tax imposed by section 1491 of the Code because A is treated as the owner of the entire trust within the meaning of section 671. Rather, unless one of the exceptions set out in section 1492 applies, the section 1491 tax is imposed at the time A, the grantor, ceases to be the owner of the trust, and A must comply at that time with the reporting requirements of section 1494 and the related regulations.

The holding of this ruling would be the same if the grantor, rather than being treated as the owner of the entire trust, were treated as owning only the portion of the trust represented by transferred property. See Section 1.671-3(a)(2) of the regulations. In addition, the holding of this ruling would be the same if the grantor ceased to be treated as the owner of the trust due to the expiration or lapse of powers. Further, the holding would be the same if the grantor was treated as the owner of the trust because of powers exercisable by a party other than the grantor, and the grantor's ownership of the trust ceased due to the release of renunciation of those powers by that other party, or by the expiration or lapse of the powers.

EFFECT ON OTHER DOCUMENTS

Rev. Rul. 69-450 is revoked.

PROSPECTIVE APPLICATION

Pursuant to authority granted by section 7805(b) of the Code, the holding of this ruling will not be applied adversely to a taxpayer if the transfer of appreciated property to a foreign trust occurred before July 13, 1987, and at the time of the transfer of appreciated property in trust, the grantor complied with the requirements of sections 1491 (unless section 1492 applied) as set forth in the holding of Rev. Rul. 69-450.