Some Brief Comments on the Section 6418 Transfer Credit Proposed Regulations
June 16, 2023
Updated June 19, 2023
Proposed regulations were filed with the Federal Register on June 14 under IRC section 6418. See REG-101610–23.
In brief, I note the following questions/comments that came to mind after first reading the regulations:
1. Grantor Trust Ownership. Is a grantor trust treated as a disregarded entity in determining ownership of credit property under the regs? The proposed regulations only refer to entities disregarded under the IRC. The text of the rule states that “In the case of an eligible credit property held directly by an entity disregarded as separate from a partnership or S corporation for Federal income tax purposes, such eligible credit property will be treated as held directly by the partnership or S corporation for purposes of making a transfer election.”
The quoted language normally does not connote ownership by the grantor through grantor trusts. When intended to be included, it is usually expressly stated; but not always. As stated, for example, in reg. section 1.1061–2(d)(1)(v):
“A trust wholly described in subpart E, part I, subchapter J, chapter 1 of the Internal Revenue Code (that is, a grantor trust), a qualified subchapter S subsidiary described in section 1361(b)(3), and an entity with a single owner that is treated as disregarded as an entity separate from its owner under any provision of the Internal Revenue Code or any part of 26 CFR….are disregarded….”
And so, if the credit property is held through a grantor trust, who makes the credit transfer and registers the property?
2. Antiabuse Rule. Is the antiabuse rule in the proposed regulations intended to be “the principal purpose” or “a principal purpose” of engaging in the prohibited conduct? The preamble to the proposed regulations states:
“[T]he proposed regulations would include an anti-abuse provision. The intent of the anti-abuse provision is to disallow the election and transfer of an eligible credit under section 6418, or otherwise recharacterize a transaction’s income tax consequences, in circumstances where the parties to the transaction have engaged in the transaction or a series of transactions with the principal purpose of avoiding tax liability beyond the intent of section 6418. This could include transactions that are intended to decrease the eligible taxpayer’s gross income or increase a transferee taxpayer’s deductions. For example, a transaction where an eligible taxpayer undercharges or overcharges for services to a customer who is also purchasing credits from the eligible taxpayer as a transferee taxpayer may violate the anti-abuse rule. The proposed regulations include two examples to illustrate application of the anti-abuse rule.” (Emphasis added).
The text of the proposed regulations setting forth the rule is ambiguous on whether the standard is “the principal purpose” or a “principal purpose”. It reads:
“Anti-abuse rule — (i) In general. A transfer election of any specified credit portion, and therefore the transfer of that specified credit portion to a transferee taxpayer, may be disallowed, or the Federal income tax consequences of any transaction(s) effecting such a transfer may be recharacterized, in circumstances where the parties to the transaction have engaged in the transaction or a series of transactions with the principal purpose of avoiding any Federal tax liability beyond the intent of section 6418. An amount of cash paid by a transferee taxpayer will not be considered as paid in connection with the transfer of a specified credit portion under paragraph (e)(1) of this section if a principal purpose of a transaction or series of transactions is to allow an eligible taxpayer to avoid gross income. Conversely, an amount of cash paid by a transferee taxpayer will be considered paid in connection with the transfer of a specified credit portion under paragraph (e)(1) of this section if a principal purpose of a transaction or series of transactions is to increase a Federal income tax deduction of a transferee taxpayer.” (Emphasis added).
The two examples following the regulation are silent on whether the test is “the” or “a”.
The standard of “the principal purpose” is a higher standard for the IRS to meet than is “a principal purpose”. Although it may not make a difference given the two examples illustrating the rule, but what happens in other cases? The section 269 regulations construe “the principal purpose” as the predominant purpose meaning that a good business purpose is likely to cause the rule not to apply to the taxpayer whereas “a principal purpose” test is much easier for the IRS to meet. See and compare Reg. §1.269–3(a)(2) which states in part: “If the purpose to evade or avoid Federal income tax exceeds in importance any other purpose, it is the principal purpose”, with reg. §1.881–3 which states in part: “A tax avoidance plan is a plan one of the principal purposes of which is the avoidance of tax imposed by section 881. Avoidance of the tax imposed by section 881 may be one of the principal purposes for such a plan even though it is outweighed by other purposes (taken together or separately).”].
Thus, it is clear that a single word, “a” or “the” can make a huge difference in result. Which is it under the proposed regulations?
3. Characterization of the relationship between the eligible taxpayer (seller) and the transferee taxpayer (buyer). Is there any relationship between the eligible taxpayer and the transferee taxpayers established by the sale, meaning is this characterized as a specific relationship in some manner, like partners? Or for other transactions the two parties are treated as completely unrelated individuals. For example, if the seller and buyer also want to monetize depreciation and they jointly form a partnership to do so, do the safe harbor revenue procedures for credit monetization partnerships still apply to them or is a revision of those revenue procedures now required?
4. Transfer Election Statement. Can the transfer election statement document be the partnership agreement if there is one?
5. Bargain purchase not gross income. The U.S. Supreme Court in the 1937 case of Palmer (302 U.S. 63) held that the purpose of the bargain purchase determines its tax treatment; i.e., if it is intended as compensation, then it is so treated for federal tax purposes. And so how is it possible that a bargain purchase of a tax credit is not gross income to the purchaser, the transferee taxpayer, as the proposed regulations provide?
The proposed regulation preamble states:
“With respect to a transferee taxpayer, as described herein, the proposed regulations would provide that there is no gross income to a transferee taxpayer when claiming an eligible credit if the amount paid for the eligible credit is less than the amount of the eligible credit transferred and claimed (transferee gross income exclusion rule). Similar to the development of rules for transaction costs of an eligible taxpayer, in developing the rules applicable to transaction costs of a transferee taxpayer, it will be necessary to determine, among other things, whether (1) the no double benefit principle applies and, if so, how it should apply, and (2) the capitalization rules of section 263 and the regulations thereunder apply and, if so, how they interact with the transferee gross income exclusion rule in the proposed regulations….. Under section 6418(a), a transferee taxpayer is treated as the eligible taxpayer for other purposes of the Code with respect to a transferred eligible credit. An eligible taxpayer would not have gross income as a result of claiming an eligible credit. As such, a transferee taxpayer also should not have gross income as a result of claiming a transferred eligible credit.”
This proposed rule is solely a creature of the proposed regulations. It is not mandated by the statute. Although there is clearly logic and symmetry to the proposed exclusion, can proposed regulations not implementing an express statutory rule override U.S. Supreme Court precedent? I thought the answer was and is no.
6. Other Partnership Tax Rules. I thought that the general operating rules relating to both transferor eligible partnerships and transferee partnerships are reasonable operating rules, including but not limited to the exclusion from gross income, treatment as tax exempt income, allocations of the credits and expenditures, distributions of cash flow, application of at risk and passive activity rules, recapture, excessive credit transfers, and related matters. The questions I have relate to the administrability of the proposed rules to the tax credit industry. I am sure there will be comments on that in the coming months.
7. Other Issues. First a note of caution. There is a line of cases (see, e.g., Route 231 v. Comm’r, 810 F. 3d 247 (4th Cir. 2016)), that hold that a partnership can be treated as entering into a disguised sale of tax credits to the money investors under reg. sections 1.707–3 and -6 given the facts and circumstances as in substance a sale of the credits by the partnership to the investors. Therefore, if the transaction is not in form and in substance a sale of the credits structured under section 6418 and its regulations, then a later determination of a disguised sale by the partnership will not qualify under section 6418 and adverse tax consequences could result. This is because of the timing and registration requirements of the proposed regulations. Should relief be granted in these cases?
Second, a section 6418(a) transfer does not require or even consider whether there is an actual transfer under state or federal non-tax law. All there needs to be is a transfer election statement and an effective registration. Does that mean that a taxpayer can transfer a specified tax credit to a partnership or a corporation taxpayer under section 721 or 351? Is there a requirement, then, of whether a tax credit is “property” that can be transferred separately under the tax law? (On this point, the Fourth Circuit held that the tax credit was property; see Virginia Historic Credit Fund v. Comm’ r). Or is all of this muted because the issuance or deemed issuance of a partnership interest or stock in a section 721 or 351 transaction will be treated as a transfer for non-cash consideration and, as a result, precluded from treatment under section 6418 or otherwise? See reg. section 1.6018–5(f):
“An ineffective transfer election means that no transfer of an eligible credit has occurred for purposes of section 6418, including section 6418(b). Section 6418 does not apply to the transaction and the tax consequences are determined under any other relevant provisions of the Code. For example, an ineffective election results if an eligible taxpayer tries to elect to transfer a specified credit portion, but the eligible taxpayer did not register and receive a registration number with respect to the eligible credit property (or otherwise satisfy the requirements for making a transfer election under the section 6418 regulations) with respect to which the specified credit portion was determined.” (Emphasis added).
