1. Baker &McKenzie LLP
a er 300 East Randolph Street,Suite 5000
~ Chicago,IL 60601
~
United States
C ~ ~' Tel: +1 312 861 8000
Fax: +1 312 861 2899
www.bakermckenzie.com
Asia Pacific
Bangkok
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sYa~YOfe CC:PA:LPD:PR(REG-122855-15) By certified main
Taipei
Tokyo Room 5203
Yangon
Internal Revenue Service
Europe, Middle East
P.O.
Box 76048 Africa
Abu Dhabi
Almaty Ben Franklin Station
Antwerpen Washington,D.C.20044
Bahrain
Baku
Barcelona
Berlin Re:Comments on Section 752 Proposed Debt Allocation Regulations
Brussels
Budapest
ca"°
Casablanca Dear Sir/Madam:
Doha
Dubai
Dusseldorf We are writing to you regarding the Final and Proposed Regulations related to Section
FrankfuNMain
Geneva 707 and 752 concernin (1 how the dis uised sale rules under Section 707 o erate,g ` ~ g pIstanbul
including, particularly, how partnership debt is treated for purposes ofthe disguised sale
Johannesburg
rules,and(2)whether debt guaranteed by a partner is treated as a recourse or nonrecourse
London
Luxembourg liability for purposes of Section 752. The portion of these regulations concerning theMadrid
Mos~oW allocation ofdebt under Section 752 are flawed and should be revoked,amended,and re-
Munich
issued only in proposed form.Paris
Prague
Riyadh'
Rome While the final regulations under Section 707 generally follow the outline of the
St. Petersburg
Stockholm favorably-received disguised sale rules under Section 707,the new proposed regulations
Warsaw concerning the allocation of debt ("2016 Proposed Debt Regulations") adopt a new
Zurich
approach to determine whether debt is treated as a recourse or nonrecourse liability for
The Americas
Bogota purposes of Section 752. This creates significant uncertainty in routine partnership
Brasilia"
Buenos Aires transactions.
Caracas
Chicago
Dallas
Guadalajara Specifically,the 2016 Proposed Debt Regulations create substantial ambiguity in whether
Houston
Juarez guarantees result in a successful transfer of the economic risk of loss ("EROL") for
M Cily purposes ofallocating recourse debt. Previously, payment obligations were disregardedxaco
Miami
Monterrey at the outset if the facts and circumstancesevidenced a plan to circumvent or avoid a
PaoAlto payment obligation. The proposed debt allocation regulations issued in 2014(the"2014
Porto Alegre'•
Rlo da Janeiro•' proposed Debt Allocation Regulations") added a list of six requirements which were
S
antagocisco
required to be satisfied for the debt obligation to be treated as recourse to the partner.
Sao Paulo'•
Tijuana Failure to meet all ofthe factors resulted in the obligation being disregarded for purposes
Toronto
Valencia ofdetermining whether a partner bore the EROL when allocating debt basis.
Washington,DC
•Associated Firm
'• The 2014 Pro osed Debt Allocation Re ulations were met with intense criticism due toP gIn cooperation with
Trench, Rossi e Watanabe
the "all-or-nothing" approach ofthe six requirements• however the 2016 Proposed DebtAdvogados > >
Regulations essentially repackage these requirements as factors in a "facts and
Baker &McKenzie LLP is a member of Baker &McKenzie International, a Swiss Verein.

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circumstances" test. The 2016 Proposed Debt Regulations now include a list ofseven
non-exclusive factors which the IRS views as evidencing a plan to circumvent or avoid a
debt obligation. The proposed factors are asfollows:
1. The partner is notsubjectto commercially reasonable contractual restrictions that
protectthe likelihood ofpayment;
2. The partner is not required to provide commercially reasonable documentation
regarding the partner'sfinancial condition;
3. The term ofthe payment obligation ends or is terminable by the partner before
the partnership liability term;
4. There exists a plan where the primary obligor directly or indirectly holds money
or other liquid assets that exceeds the reasonable foreseeable needs of the
primary obligor;
5. The terms of the payment obligation do not permit the creditor to promptly
pursue payment on default or there exist arrangements which otherwise work to
delay payment;
6. In the case ofa guarantee by a partner,the terms ofthe partnership liability do
not differ with or withoutsuch guarantee;and
7. The creditor does not receive executed documents with respect to the partner's
payment obligation.
Herein lies the problem: the factors are drafted to set an obligation up to fail. All
obligations—even those with irrefutable economic substance and reality, e.g. top-dollar
guarantees, vertical slice guarantees, or run-of-the-mill commercial `real-world'
guarantees—are unlikely to satisfy all ofthe proposed factors. Five ofthe seven factors
are identical to five of the requirements found in the 2014 Proposed Debt Allocation
Regulations. The remaining two factors,together, are substantially the same as the sixth
requirement in the 2014 Proposed Debt Allocation Regulations.
Due to the drafting ofthe 2016 Proposed Regulations, a plan to circumvent or avoid an
obligation is, in practice, presumed unless the partner takes steps to affirmatively refute
the so-called factors. Example 1 provided in the 2016 Proposed Regulations illustrates
this. In the example, A,B,and C formed a domestic limited liability company("LLC")
which received a loan from a bank. A,B,and C do not bear the EROL with respect to
the liability and,therefore, it is characterized as nonrecourse under Reg. §1.752-1(a)(2).
In year three,A guaranteed the entire amount ofthe liability, but did so at his own behest
and did not execute any documents with respect to the guarantee with the bank. The
bank also did not require any asset transfer restrictions by A and none existed. The
example concludes that A's guarantee will not be respected because multiple factors
indicate a plan to circumvent or avoid the payment obligation. Specifically, A was not
subject to commercially reasonable contractual restrictions that protected the likelihood
of payment and A was not required to provide commercially reasonable documentation
regarding his financial condition to the benefited party.

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Query, however, if A was a partner with a net worth of $1 billion who made the
guarantee due to business considerations in which it would greatly damage his business
and reputation to default on the guarantee. Despite this additional fact, A would still fail
the first factor. In reality and in practice,then,the proposed factors are much more akin
to hard requirements. Compounding the problem, because the 2016 Proposed Debt
Regulations are drafted as a"facts and circumstances"test,the ability to take inconsistent
positions,as necessary,is also present.
Additionally problematic, many of the factors require partners to provide evidence
demonstrating something inherently difficult to prove or to engage in a speculative
inquiry. The most troubling factor is perhaps factor(6)because it requires a partner to
prove the counter-factual. To satisfy this factor, a partner must show that the terms ofa
partnership liability would have been different in the alternate universe where the partner
made no such guarantee. Nearly all instances of partner guarantees will routinely be
unable to satisfy this factor. Similarly, factor(4) would require the partner to predict
future risk precisely,because any conservatism would be punished.
Ultimately, the 2016 Proposed Debt Regulations disregard any payment obligation and
allocate the debt on a nonrecourse basis, if, under the facts and circumstances,the obligor
could not pay the full amount of the obligation were it to come due. In practice,
frequently an obligor is only able to make debt service payments,and repayment ofthe
full amount ofthe obligation were it to come due would be impractical. This anti-abuse
rule ostensibly dissolves the satisfaction presumption through the utilization ofthe "facts
and circumstances"test.
Most troublesome is the complete uncertainty taxpayers and tax return preparers now
face. Every partnership tax return,and every Schedule K-1 must set forth each partner's
share ofthe debt ofthe partnership and a determination ofwhether the debt is a recourse
or a nonrecourse obligation. This determination has been clear and straightforward for
over 25 years, and the rules are well understood by taxpayers and tax return preparers.
By switching to a "facts and circumstances" test, the 2016 Proposed Debt Regulations
replace certainty with uncertainty.
The impact of the 2016 Proposed Debt Regulations is, effectively, to switch the
presumption in the existing regulations that debt is a recourse obligation when a partner
bears EROL,to a presumption that all debt is nonrecourse—now,a taxpayer must take
active steps to establish that an obligation is truly recourse. Additionally, the seven
factors are an open invitation for manipulation by a taxpayer who desires nonrecourse
debt treatment. Indeed, the special rules for arrangements tantamount to a guarantee—
yet another anti-abuse rule—was meant to remove from the taxpayers' realm any
possibility to elect either recourse or nonrecourse debt treatment simply by addressing or
ignoring the factors set forth in the 2016 Proposed Debt Regulations. This inclusion of
the"heads we win,tails you lose" anti-abuse rule establishes the inconsistency in the tax
policy surrounding the 2016 Proposed Debt Regulations.

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Additionally,treating all partnership liabilities as nonrecourse for disguised sale purposes
creates what we believe to be further unintended results. Under Reg.§1.707-5(a)(1),ifa
partnership assumes or takes property subjectto a nonqualified liability,the partnership is
treated as transferring consideration to the partner to the extentthe amount ofthe liability
exceeds the partner's share ofthat liability immediately after the partnership assumes or
takes subject to the liability. Under Reg. §1.707-5(a)(2)(ii), a partner's share of a
nonrecourse liability is determined by applying the same percentage used to determine
the partner's share of excess nonrecourse liabilities. Given the interplay between the
sections of the disguised sale regulations, a later assumption by a partnership of any
nonqualified liability will always result in the former contribution being presumed to be
treated,in part,as ataxable disguised sale under Section 707—treatment which cannot be
avoided given the 2016 Proposed Debt Regulations.
Moreover, these flawed regulations lie at the heart of subchapter K ofthe Code. The
allocation of debt is not a remote concern for most partnerships — it is a fundamental
determination made by every partnership which has liabilities. The proposed regulations
would replace alogically-consistent set of rules that have functioned well for decades,
which provide certainty to every partnership and the IRS alike, with a new set of rules
that will upset tax compliance for any partnership which has incurred debt which has
been guaranteed by a partner. This is not some obscure provision ofthe Code — 90% of
new businesses in this country are taxable as partnerships, and most ofthem incur debt.
These proposed regulations will cause major compliance problems in many common
situations.
By reversing and replacing the prior rules(an internally-consistent set oftests focused on
EROL)with a"facts and circumstances"test in which the result is uncertain and open to
manipulation, sound tax administration is impeded. These proposed regulations should
not be finalized in their currentforms.
We thank you for your consideration ofour above comments.
Respectfully submitted,
Richard M.Lipton
~~+ ~~
Nicole D.Renchen
i
~2~~i~~i~i~~~/v
Samuel P. Grilli