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Tax News
CCA 201423019 – a Bona Fide Section 475(f) Election Nightmare
June 11, 2014
Administrative Actions
This CCA was released by the IRS a few days ago. Two things caught my eye here. First it dealt with agency issues, something that any offshore trader or lender fund ought to be interested in, and two, it dealt with what appears to be a belated 475(f) election. The facts are not overly elaborate.  What seems to be a domestic Holdco taxpayer had X% interest in a lending business conducted through Partnership X.  Partnership X engaged in originating and purchasing mortgage loans on the open market and also participated in mortgage backed securitization activities. The securities were contributed to a trust that was owned by the partnership, and in turn, the trust issued notes to third party investors.  The trust (or some of its affiliates) entered in subservices agreement with Subservicer, an LLC wholly owned by the partnership. This Subservicer could collect principal and interest payments for the mortgage loans, monitor property taxes and insurance and foreclose on securing properties. Generally, the Subservicer could not modify terms of the loans or extend additional principal amounts or defer payments or reduce or increase outstanding principal balances or extend the final maturity date. However, the Subservicer could modify the terms of the loan to avoid default.  At some point, Partnership X contributed its interest in the Subservicer to Partnership Z and then it transferred that Partnership Z interest to the taxpayer. In the process, Subservicer became a disregarded entity of Partnership Z.

The taxpayer apparently was in need of mark-to-mark accounting under Sec. 475 for year T3. In that regard, Chief Counsel had to resolve three issues, (1) Is the Taxpayer a dealer, (2) Could the Subservicer’s modification and other “dealer” activities be attributed to taxpayer, and (3) whether the taxpayer is a trader in securities and thus whether it can make a 475(f) election.  IRS Counsel answered all three questions against the taxpayer.  What I can glean from the story is the following. The taxpayer decided for some reason that it needs to use the mark-to-market accounting in T3. However, the taxpayer figured this out too late. It already missed the boat on the trader 475(f) election because the election needs to be filed with the prior year tax return.  Post-factum, the taxpayer tried to reason that it was a dealer because some of the activities of its subsidiary entities should be attributed to it. That argument failed because the IRS believed that the facts showed that these entities did not act as agents for the taxpayer. All and all, the taxpayer was left without the desired MTM.

To me, two things should be highlighted from this CCA. Funds should think ahead of time whether they are going to file 475(f) or not. You cannot wake up one day and decide that you need MTM for your current tax year. The election should be filed with the tax return for the previous year, i.e. one year ahead of time.  The IRS appears to be unyielding on this issue.  In this particular ruling it cited Revenue Procedure 99-17, which sets forth the requirements for making the election, and basically said that the taxpayer cannot file a late or retroactive election. The courts repeatedly have upheld the denial of late elections.  Considering that 9100 relief is a tough path to follow in remedying late elections (see PLR 200736018 and Vines v. Commissioner, 126 T.C. 279 (2006)), taxpayers are left with difficult ancillary arguments such as the attribution dealer arguments in this ruling. What is the IRS concerned about when it comes to late 475(f) elections?  The IRS takes an issue with “hindsight,” i.e. the taxpayer has the benefit of over a year of hindsight he would not otherwise have had, to review and consider the results of his securities trading transactions and whether he would benefit by making the election. This apparently prejudices the IRS.

The second thing that is of note about the ruling is that the taxpayer’s attribution argument failed. Assuming the Subservicer conducted dealer activities and those activities were attributable to the taxpayer, then the taxpayer should have been able to MTM as a dealer. In ruling against the taxpayer, however, the IRS was hung up on the National Carbide and Bollinger agent factors. The IRS held that the facts did not support an agency. One reason being that the service agreements among the various parties provided that the Subservicer was an independent contractor and not an agent.  Let me say this here. When it comes to the IRS, the deck is stacked against the taxpayer. This independent contractor language is a standard fare in services and distributor agreements.  When attribution leads to an IRS favorable result, the IRS pays no heed to the language and views it as a mere form not reflecting the true arrangements of the parties.  Conversely, if lack of attribution suits the IRS, the language is flaunted repeatedly.  This may not please taxpayers, but admittedly, is good advocacy on part of the IRS. One can hardly accuse Chief Counsel of interpreting the facts ever so slightly in favorable light to the IRS, even when assessing litigation hazard.  Knowing this, it is counsel’s job to be extra persuasive regarding key facts, such as the one I am talking about here.  Ultimately it might not save the day, but it might cause Chief Counsel to reconsider the importance of a particular fact.
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Tags: 475(f), CCA 201423019, mark to market