APPENDIX B TECHNICAL DRAFTING COMMENTS ON "Interests" and "Rights" The The terms "interest" and "right" are used interchangeably throughout the Draft, which is confusing. problem affects the following sections: Section 2701(a)(2)(A) refers to:: "[t]he value of any retained interest which is not a right to receive qualified fixed payments..." This implies that an interest and a right may be the same thing. In 2703(b) "interest or right" is used, which suggests someone may own a right without owning an interest. Section 2703(c)(2) refers to "an interest in such entity" but not to a right in an entity. Section 2703(e)(3) says that any "right" to receive payments from a 10-percent owned entity under any indebtedness or lease shall be "treated" as an interest (suggesting that rights are not interests and are not to be treated as interests without specific statutory authority). The definition for a "specially valued retained interest" in 2703(e)(2) refers to an interest (but not a right) that was valued under 2701(a)(2)(A) or (B). Section 2701(a)(2)(A) deals with the valuation of an "interest," and 2701(a)(2)(B) deals with the valuation of the "right" to receive a QFP. "Interest" is not defined, but "equity interest" is defined in 2701(a)(3)(B)(ii) to mean "stock or any interest as a partner." (Section 2703(e)(1)(A)(ii) contains a more limited reference, to the "capital or profits interest" in a partnership.) "Right" is not defined, but "specially valued fixed payment rights" are defined in 2701(d)(4) as the right to receive qualified fixed payments under a "specially valued retained interest. (We suggest it would be easier to eliminate the reference to a "specially valued retained interest," and simply say that a specially valued fixed payment right is a qualified fixed payment that has been valued under Section 2701(a)(1)(B), thus preserving the idea that the term doesn't apply to a QFP if the transferor elects out of special valuation treatment for that QFP.) "Instrument" is also used as a substitute for "interest" in 2701(a)(2)(C): the lead-in language speaks of "the following retained interests," two of which are called "instruments. In the overall scheme of 2701, it seems clear that an owner of an "interest" in common stock may have several rights, but only one interest in that stock. The same is true of a preferred stockholder, a general partner or a limited partner. However, 2701(a)(2)(A) says that the value of an "interest" that is not a right to receive QFPs shall be valued at zero. What if a preferred stock owner is entitled to receive $100 per share on a fixed date in the future (which is a QFP under 2701(b)(1)(A)(i)), and dividends that are not determined at a fixed rate? The preferred stock is an "interest" (it falls within the definition of "equity interest"), but is it valued at zero because it is not a right to receive a QFP; or will the value of the interest be the special QFP value for the right to receive the $100 plus the zero value for the right to receive dividends that are not QFPS? The answer should be that some "rights" that are part of an "interest" may be valued at zero under 2701(a)(2)(A); some rights that are part of the same interest will be valued under 2701(a)(2)(B) if they are described in that section; those rights that are described in 2701(a)(2)(C) will be valued under pre-Chapter 14 law; and the sum of the values thus determined for all of the "rights" will be the value of the "interest." The distinction between an interest and a right is also important under 2701(d)(1) and (2), which requires that we revalue particular "rights" rather than the interest itself. However, while 2701(d) deals with the revaluation of "rights," 2701(d)(5) provides that the termination of an "interest" is to be treated as a transfer, leaving open the possible interpretation that the termination of one of several "rights" under a particular interest will not be a transfer unless the entire interest terminates at the same time. Trust Interests. We understand that Section 2701 is not intended to apply to a beneficiary's assignment of his interest in the income or principal of a trust, and our discussion of this section leads us to believe that section 2701(a)(4) should be modified to refer to the "transfer of an interest in trust" instead of "in a trust." Unfortunately, including a trust in the definition of a 10-percent owned entity, and having Section 2701 apply to transfers in those entities, means that the references in Chapter 14 to transfers in a 10-percent owned entity become references to transfers in a trust; and the problem is compounded by specific references to transfers in a trust such as the one in 2701(a)(4). The provisions in Section 2703(e) (4) (which deals with "a transfer of an income or remainder interest with respect to a specified portion of the property in a trust") can apply both to a transfer of property to the trust and to a transfer by a beneficiary of his interest in the trust. For this reason, and also because there are special provisions for trusts that are scattered throughout sections 2701 and 2703, we submit that all trust provisions should be placed in a separate section. We have tested the possibility of doing this from a drafting point of view and are convinced that it is possible to segregate the trust provisions without damaging any of the Committee's objectives for Chapter 14. General Drafting Suggestions We suggest that any reference in the Draft to the transfer, retention or valuation of an "interest" should instead refer to a particular kind of interest. In the case of a corporation or a partnership, the term "equity interest" should be used, and the definition of equity interest in 2701(a)(3)(B)(ii) should be expanded to pick up the language in 2703(e)(1)(A)(ii), so that it would read: "The term 'equity interest' means stock in a an If indebtedness remains in the statute as "interest" there should be a separate definition for a "debt interest;" and if an interest as a lessor remains in the statute, there should be a separate definition for a "lessor interest. This distinction is important because, if our understanding is correct, debt and lessor interests are significant only in valuing the transferred equity interest and for deemed transfer and valuation-on-death purposes, and 2701(a) is not intended to apply to the transfer of a debt interest or a lessor interest to determine if there is a gift or the amount of the gift. The Summary of the Discussion Draft states that employment agreements are not to be affected by these rules, but nothing in the Discussion Draft says so. The definition of "equity interest" (and of "debt interest, if there is one) should state that such an interest does not include any contractual right or claim against the entity that arises because the entity employs the transferor or a member of his family. However, any stock acquired as compensation would be treated as an equity interest once it has been reduced to the employee's possession. If the concept of a lessor interest is not eliminated, the definition should make it clear that a lessor/lessee relationship with the related entity is not a "partnership" and thus an "entity" in which an interest may be transferred. A lessee's interest in leased property also comes within the definition of a "term interest" as defined in 2703(d)(3), which could cause all leasehold arrangements to be treated as a transfer of an interest in trust. And the interest of a borrower in the borrowed money is also arguably "an interest in property for a term of years," and thus a term interest. The definitions of a debt interest, a lessor interest or a lessee interest should state that these relationships shall not be treated as a partnership or a trust. Specific Drafting Proposals Related to "Interests" and "Rights" We suggest that the sections that rely on "interest" or "right" be revised to read as follows: (A) If a transferor transfers an equity interest in a 10-percent owned entity to a member of the transferor's family; and (B) If the transferor (or a member of the transferor's family other than the transferee) retains an [equity interest] [equity, debt or lessor interest] under which the owner of the retained interest possesses a right that has preference over any right under the transferred equity interest, then, solely for the purposes of determining whether such a transfer is a gift (and the amount of such gift), the value of each retained interest described in subparagraph (B) shall be determined as provided in paragraph (2)." Comments (1) The suggested language differentiates between an "interest" and a "right". It reflects the notion that an interest is what the transferor owns and either transfers or retains; but that a "right" is something that attaches to the interest and is normally not transferred or retained separate from the transfer or retention of an interest. The only "right" that is sometimes transferred or retained separate from the transfer or retention of an interest is a voting right (as in the case of revocable or irrevocable proxies, stockholder agreements with respect to voting rights, etc.), but the Discussion Draft provides that voting rights are to be disregarded in determining the value of a retained interest to which they attach. (2) The bracketed material in subparagraph (A) indicates a decision that must be made about whether the retained interest that is to be specially valued will be confined to an "equity interest" or will include indebtedness or leases as now provided for in the Draft. (3) Subparagraph (A) speaks in terms of the transfer of an "equity interest" to make it clear that, if a debt interest or a lessor interest remains in the statute, the transfer of the debt interest or the lessor interest is not a transfer that triggers the application of 2701(a). in (4) Subparagraph (B) picks up the concept set forth 2701(a)(2)(C)(iii), which we regard as an indirect definition of a preferred interest, i.e., any "instrument" ("interest") under which its owner possesses at least one right that has a preference over any right possessed by the owner of . the transferred interest. 2701(a)(2) We suggest that the first part of subparagraph (A) be revised to read: "The value of any right under al and that subparagraph (B) on page 2 of the Discussion Draft, lines 22 and 23 (carried over to the top of page 3) be modified as follows: "For purposes of determining the value of and that subparagraph (C) be modified to read as follows: (1) In the Discussion Draft, the caption for 2701(a)(2) is "Valuation of Retained Interests". However 2701(a)(2)(C) refers to "rights" in the caption, "retained interests" in the text, and "any instrument" in (i) and (ii). No definition of these terms tells us if they are equivalent to one another or what the differences are. The approach of the suggested language is that a "right" is possessed by virtue of owning an "interest," and an "instrument" is a document that describes the nature and scope of the right. (2) Section 2701(a)(2)(C)(iii) is probably unnecessary if the suggested language for 2701(a)(1)(B) is used because the concept in (C)(iii). is incorporated in subparagraph (B). A negative inference embedded in 2701(a)(2)(C)(iii) as it appears in the Discussion Draft is that, if the transferor retains an interest in "any instrument" that has one or more rights that are preferences over any right under the transferred interest, the value of such a retained interest shall be determined with regard to 2701. This can be read as a definition of a retained "interest" that would include debt, leases and any other contractual right of any kind, and is one of the reasons for transferring the concept in (C)(iii) to 2701(a)(1)(B). (3) The suggested language omits the provision that subparagraph (C) does not apply to a trust because we would like to see all provisions that apply to trusts in a section separate from the one that deals with corporations and partnerships. 2701(a)(3) We suggest it is not necessary to define "junior equity interest" It is used only once in the substantive provisions of the Draft, in 2701(a)(3)(A), and is defined in 2701(a)(3)(B) only "for the purposes of this paragraph." (However, the term is also used in 2703(f)(1) with no further definition, but that language can be revised.) If the definition is deleted, Section 2701(a)(3)(A) would be changed to say: "The application of paragraph (1) to |