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5. S. 1549-Senators Armstrong, Long, Durenberger, Wallop, Grassley, Symms, Bentsen, Baucus, Boren, and Pryor Exemption from Unrelated Business Income Tax for Income from Certain Oil and Gas Property
Under present law, most organizations which generally are exempt from Federal income taxation under Code section 501(a), including any trust that is part of a tax-qualified pension, profit-sharing, or stock bonus plan described in section 401(a), are subject to tax on any unrelated business taxable income (secs. 511-514). In addition, a tax is imposed on the unrelated trade or business income of an individual retirement account or annuity (an IRA).15 The term unrelated trade or business generally means any trade or business the conduct of which is not substantially related (aside from the need of such organization for income or funds or the use it makes of the profits derived) to the exercise or performance by such organization of the activities for which the organization was granted tax exemption.
Under present law, a tax-exempt organization is treated as being engaged in the same activities as any partnership (whether limited or general) in which the organization invests. Accordingly, if a taxexempt organization becomes a limited partner in a partnership that owns a working interest in oil and gas properties and the working interest is not substantially related to the organization's exempt function, the income derived from the working interest is subject to the unrelated trade or business tax.
Present law also provides that the income of an exempt trust or organization, or an IRA, from debt-financed property which is unrelated to its exempt function is subject to the unrelated business income tax in the proportion in which the property is financed by the debt (sec. 514). Debt-financed property means all property (e.g., rental real estate, tangible personal property, and corporate stock) that is held to produce income and with respect to which indebtedness was incurred to acquire or improve the property or an indebtedness would not have been incurred but for the acquisition or improvement of the property.
A special rule applies under present law to real property acquired by a tax-exempt trust forming part of a tax-qualified pension, etc., plan. Under this rule, debt-financed real property ac
15 Sec. 408(e)(1).
quired by an exempt trust is not treated as debt-financed property unless one of the following applies:
(1) the acquisition price is not a fixed amount determined as of the date of acquisition;
(2) the amount of any indebtedness or any other amount payable with respect to such indebtedness, or the time for making any payment with respect to the indebtedness, is partially or wholly dependent upon any revenue, income, or profits derived from the real property;
(3) the real property is at any time after acquisition leased by the trust to the seller or to any person related to the seller (within the meaning of sec. 267(b));
(4) the real property is acquired from or, at any time after acquisition, is leased to any person that bears a certain relationship to the trust; or
(5) the seller or any person related to the seller or the trust (as described in (3) or (4)) provides the trust with nonrecourse financing in connection with the acquisition and the debt is subordinate to any other indebtedness on the property or bears interest at a rate that is significantly lower than the prevailing market interest rate.
Explanation of the Bill
Under the bill, certain exempt organizations would be permitted to invest in working interests in domestic oil and gas properties without incurring tax for unrelated business income. The organizations that would be eligible under this provision include exempt trusts forming a part of tax-qualified pension, etc., plans, IRAs, and tax-exempt educational organizations described in Code sections 170(b)(1)(A)(ii) or 170(b)(1)(A)(iv).
In order to qualify under the special rule, the trust or organization must receive income from the working interest in oil and gas property as a limited partner from a limited partnership. In addition, the limited partnership could not, at any time during the partnership taxable year for which an income allocation is made (i) allocate to the limited partners a share of any item of deduction, loss, or credit that is less than the limited partners' share of income or gain;
(ii) allocate among the limited partners any item of deduction, loss, or credit that differs from the ratio in which they share income or gain;
(iii) allocate cash distributions to partners (limited or general) in a manner that differs from the allocation of income or gain.
However, these restrictions would not apply if the allocations of depreciation, depletion, gain, or loss take account of the variation between the basis of property to the limited partnership and its fair market value at the time of its contribution to the partnership and if the allocations are permissible under Treasury regulations. 16
16 Sec. 704(c)(2).
For purposes of determining whether an exempt trust or organization is a limited partner or a general partner in a limited partnership, the interests of certain related parties would be taken into account. In addition, an exempt trust or organization which is a limited partner would be treated as owning an interest in any general partner held by any other exempt trust or organization (including related persons) that is a partner in the partnership.
The bill authorizes the Treasury Department to prescribe regulations that would deny the special treatment under the bill in any case in which multi-tier partnerships or other arrangements are used for the principal purpose of avoiding the conditions of the bill. Debt-financed property
The bill would provide an exception to the rules relating to debtfinanced property for working interests in domestic oil and gas properties acquired by tax-qualified pension, etc., plans, IRAs, or certain educational organizations, which would be similar to the rules, under present law, that apply to investment by tax-qualified pension, etc., plans in debt-financed real property.
Under these rules, the exemption would only apply if the acquisition price is a fixed amount and payments are not dependent upon the profits from the property (items 1 and 2 under present law, above). However, the limitations relating to leases between related parties, acquisitions from related parties, and nonrecourse financing from related parties (items 3, 4, and 5, above) would not apply to any acquisition, lease, farm-out, or other transfer of a working interest to a person related to the general partner if the terms of the transfer are consistent with the terms of similar transfers in the same geographic area.
The bill would apply for partnership taxable years beginning after 1982.