In late January, the IRS issued a private letter ruling (P.L.R. 201504004) dealing with whether interests in a non-grantor trust and a partnership are considered to be in registered form, a precursor to qualification for payments thereon to the portfolio interest exemption. Although the ruling answers in the affirmative, it does not ultimately state whether the particular payments addressed in the ruling would be eligible for the portfolio interest exemption.
To qualify for the portfolio interest exemption, and avoid U.S. withholding tax on payments of U.S.-source interest to a foreign person, the obligation must be in “registered form.” §§ 871(h); 881(c). Registered form for purposes of the portfolio interest exemption has the same meaning as in Section 163(f). §§ 871(h)(7); 881(c)(7). Treasury Regulations Section 1.163-5T(d)(1) confers “registered form” status to certain pass-through or participation certificates evidencing an interest in a pool of mortgage loans treated as a grantor trust under the Code. The Regulation also extends this status to “similar evidence of an interest in a similar pooled fund or pooled trust treated as a grantor trust.” These pass-through certificates are eligible for registered form status under the Internal Revenue Code without regard for whether the underlying obligations to which the pass-through certificates relate are also eligible for registered form status. If an obligation or pass-through certificate is eligible, it will be considered in registered form if it is transferrable only pursuant to the procedures described under Treasury Regulations Section 5f.103-1(c).
In the ruling, the taxpayer sought registered form status for interests in a partnership and a non-grantor trust as “interests in similar pooled funds” under Treasury Regulations Section 1.163-5T(d)(1). The taxpayer’s facts involved a typical master-feeder structure with U.S. and foreign feeder entities that each owned interests in a domestic Master Fund treated as a partnership. The Master Fund then purchased and contributed “scratch and dent” mortgages – loans with potentially incurable defects, such as delinquent payments – to a wholly owned domestic Trust. The Trust anticipated engaging independent servicers to negotiate modifications to some of the mortgages, which could result in deemed reissuances of such mortgages under Treasury Regulations Section 1.1001-3(b). The Trust would also maintain the right in the future to acquire and dispose of similar mortgages, potentially causing it to fail to be treated as a grantor trust under the Code if such actions constituted a power to vary the trust’s investments. See Treas. Reg. § 301.7701-4(c)(1). Interests in both the Master Fund and the Trust were transferrable only pursuant to the procedures described under Treasury Regulations Section 5f.103-1(c).
The underlying mortgages were not in registered form and therefore the interest payments therefrom would not qualify for the portfolio interest exemption. The IRS ruled, however, that interests in the pass-through certificates of the Trust that owned the mortgages, as well as the partnership interests in the Master Fund, could themselves qualify for registered form status. Even though the Trust and the Master Fund are not grantor trusts, the ruling holds that the interests in both are “similar pooled funds” within the meaning of Treasury Regulation Section 1.163-5T(d)(1), meaning that the ownership interests in both the Master Fund and the Trust can be in registered form, assuming such interests comply with the procedures set forth in Treasury Regulations Section 5f.103-1(c).
Beyond ruling that interests in a partnership and a non-grantor trust can constitute registered form instruments, the ruling does not state whether payments on such interests will ultimately qualify for the portfolio interest exemption. The ruling also sidesteps a discussion of whether the activities of the Master Fund or the Trust could cause the Master Fund to be engaged in a U.S. trade or business.