CORPORATE GENERAL PARTNER IS ENGAGED IN ACTIVE CONDUCT OF A BUSINESS.

Rev. Rul. 92-17

ISSUE

If officers of a corporation that is a general partner in a limited partnership perform active and substantial management functions for the partnership, including the decision-making regarding significant business decisions of the partnership and regular participation in the overall supervision, direction and control of the employees of the partnership in operating the partnership's rental business, is the corporation engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Internal Revenue Code?

FACTS

For more than 5 years, limited partnership LP has owned several commercial office buildings that are leased to unrelated third parties. Corporation D has owned a 20 percent interest in LP for more than 5 years, and throughout that period of time D has been a general partner of LP. The partnership agreement requires that D, as a general partner, provide the managerial services to LP necessary to operate LP's rental business. For more than 5 years, D has owned all the stock of C, a corporation which has been actively engaged for more than 5 years in the conduct of a trade or business that is unrelated to D's activities.

LP continuously seeks additional properties to expand its rental business. When a property is located, LP negotiates its purchase and financing and determines whether renovations or alterations are necessary to make the building suitable for rental. LP periodically repaints and refurbishes its existing properties.

Pursuant to the terms of its leases, LP provides day-to-day upkeep and maintenance services for its office buildings. These services include trash collection, ground maintenance, electrical and plumbing repair, and insect control. Additionally, LP advertises for new tenants, verifies information contained in lease applications, negotiates leases, handles tenant complaints, prepares eviction notices and warnings for delinquent tenants, collects rent, and pays all expenses, including gas, water, sewage, electricity and insurance for the office buildings. LP also maintains financial and accounting records to reflect income and expenses relating to each of its rental properties as well as LP's general expenses.

The above described activities of LP have been conducted for more than five years. D's officers perform active and substantial management functions with respect to LP's activities, including the decision-making regarding significant business decisions of the partnership (e.g., decisions with respect to significant renovations of partnership properties, the purchase and sale of properties, and significant financings and refinancings). In addition, D's officers regularly participate in the overall supervision, direction and control of LP's employees in their performance of LP's operational functions.

For a valid business purpose, D proposes to distribute all its C stock pro rata to D's shareholders in a transaction intended to meet the requirements of section 355 of the Code. Subsequent to the distribution, officers of D will continue to provide the services described above to LP.

Except for the issue of whether the activities performed by D in connection with the operation of LP's rental business constitute an active trade or business, the transaction will otherwise meet all the requirements of section 355 of the Code.

LAW AND ANALYSIS

Section 355(a) of the Code provides that, under certain circumstances, a corporation may distribute stock or securities in a corporation it controls to its shareholders or security holders in a transaction that is nontaxable to such shareholders or security holders. Sections 355(a)(1)(C) and 355(b) of the Code require that both the distributing and controlled corporations be engaged, immediately after the distribution, in the active conduct of a trade or business that has been actively conducted throughout the 5-year period ending on the date of distribution.

Section 1.355-3(b)(2)(ii) of the Income Tax Regulations, in defining "trade or business" for purposes of section 355, provides that a corporation is treated as engaged in a trade or business immediately after the distribution if a specific group of activities are being carried on by the corporation for the purpose of earning income or profit, and the activities included in such group include every operation that forms a part of, or a step in, the process of earning income or profit. Such group of activities ordinarily must include the collection of income and the payment of expenses.

Section 1.355-3(b)(2)(iii) of the regulations provides that the determination whether a trade or business is actively conducted will be made from all the facts and circumstances. Generally, for a trade or business to be actively conducted, the corporation is required itself to perform active and substantial management and operational functions. Generally, activities performed by the corporation itself do not include activities performed by persons outside the corporation, including independent contractors. A corporation may, however, satisfy the active trade or business test through the activities that it performs itself, even though some of its activities are performed by others.

Under section 1.355-3(b)(2)(iv) of the regulations, the active conduct of a trade or business does not include the holding of property for investment purposes. It also does not include the ownership and operation (including leasing) of property used in a trade or business, unless the owner performs significant services with respect to the operation and management of the property.

The fact that a partnership engages in activities that would constitute the active conduct of a trade or business if conducted by a corporation does not mean that each partner in the partnership is considered to engage in the active conduct of a trade or business for purposes of section 355(b). The determination of whether a partner is considered to engage in the active conduct of a trade or business must be made with reference to the activities of the partner as well as the partnership, and must be based on the requirements of section 355 and the regulations thereunder.

Rev. Rul. 79-394, 1979-2 C.B. 141, amplified by Rev. Rul. 80- 181, 1980-2 C.B. 121, considers whether y, a corporation that had no employees other than unsalaried officers, performed activities sufficient in kind and extent to satisfy the active business requirement of section 355(b). P, a corporation, owned all the stock of X and y. y owned commercial and residential real estate that it had rented to unrelated third parties for over five years. Employees of X, under the supervision, control, and direction of y's officers, performed all operational activities connected with y's rental properties.

Rev. Rul. 79-394 holds that y satisfied the section 355(b) active trade or business test, finding that y's conduct of its rental activities through its officers and the employees of X demonstrated considerable day-to-day management and operational activities that distinguished Y's conduct from the holding of real estate for investment purposes. Rev. Rul. 79-394 concludes that y's lack of salaried employees, without more, did not cause y to fail the section 355(b) active trade or business test.

In this revenue ruling, D, like y in Rev. Rul. 79-394, performs through its officers and the employees of LP significant services with respect to the operation and management of LP's rental business. The only factor tending to prove that D has not been engaged in the active conduct of a trade or business is D's lack of employees to perform the operational services necessary to operate LP's office buildings. However, this factor, standing alone, will not cause D to fail the section 355(b) active trade or business test. Accordingly, based on all the facts and circumstances, D is engaged in the active conduct of a trade or business for purposes of section 355(b) of the Code.

HOLDING

If officers of a corporation that is a general partner in a limited partnership perform active and substantial management functions for the partnership, including the decision-making regarding significant business decisions of the partnership and regular participation in the overall supervision, direction and control of the employees of the partnership in operating the partnership's rental business, the corporation is engaged in the active conduct of a trade or business within the meaning of section 355(b) of the Code. Accordingly, because all the other requirements of section 355 of the Code are met, the distribution of the stock of C by D to D's shareholders is tax-free to the D shareholders under section 355.

DRAFTING INFORMATION

The principal author of this revenue ruling is Lesa R. Byrnes of the Office of Assistant Chief Counsel (Corporate). For further information regarding this revenue ruling contact Ms. Byrnes on (202) 566-4551 (not a toll-free call).