October 19, 2021

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The Health Look

Treasury’s Green Book Provides Details On The Biden Administration’s Tax Plan – Tax

On May 28, 2021, the Biden Administration released the Fiscal
Year 2022 Budget, and the “General Explanations of the
Administration’s Fiscal Year 2022 Revenue Proposals,”
which is commonly referred to as the “Green Book.” The
Green Book summarizes the Administration’s tax proposals
contained in the Budget. The Green Book is not a proposed
legislation and each of the proposals will have to be introduced
and passed by Congress.

The Green Book proposes to:

  • Increase in the corporate tax rate to 28% from 21%. However,
    recent news reports suggest that President Biden may be willing to
    agree to maintain the corporate tax rate at 21%.1

  • Increase in the top individual tax rate to 39.6% from 37%.

  • Substantially change the international tax rules, as previously
    proposed in the Made in America Tax Plan (which was part of the
    American Jobs Plan) and summarized here.

  • Impose a 15% minimum tax on the book earnings of certain large
    corporations.

  • Increase the long-term capital gains rate and qualified
    dividend income rate to 39.6% (43.4% including the net investment
    income tax) from 20% (23.8% including the net investment income tax
    (“NIIT”)) to the extent the taxpayer’s income exceeds
    $1 million, indexed for inflation. This proposal is proposed to be
    effective retroactively for gains
    and income recognized after April 28, 2021.

  • Treat death and gifts of appreciated property as realization
    events that require gain to be recognized as if the underlying
    property was sold, subject to a $1 million lifetime exclusion.
    Gains on gifts or bequests to charity would not be required to be
    recognized, and gains on gifts or bequests to a spouse would not be
    required to be recognized until the spouse dies or disposes of the
    asset, but basis would carry over.

  • Treat all pass-through business income of high-income taxpayers
    as subject either to the 3.8% NIIT or the 3.8% Medicare tax under
    the Self-Employment Contributions Act (“SECA”).
    Accordingly, limited partners who provide services would be subject
    to self-employment tax on their distributive share of the
    partnership’s business income, and S corporation shareholders
    who materially participate in the corporation’s trade or
    business would be subject to SECA taxes on their distributive share
    of the S corporation’s business income to the extent it exceeds
    certain thresholds.

  • Treat income from carried interests as ordinary income that is
    subject to self-employment tax.

  • Impose a $500,000 per person limit ($1 million in the case of
    married individuals filing a joint return) on the aggregate amount
    of section 1031 like-kind exchange gain deferral for each year,
    with any excess recognized in the year of the exchange.

  • Make permanent the excess business loss limitation.

  • Mandate a comprehensive financial account information reporting
    regime beginning in 2023 that would require gross inflow and
    outflow reporting for all bank and other financial accounts with a
    gross flow threshold of $600 or a fair market value of $600.

Increase the Top Marginal Rate for Individuals and the
Corporate Rate

The Green Book would increase the top individual income tax rate
to 39.6% (from 37%) for taxable income over $509,300 for married
individuals filing a joint return, $452,700 for unmarried
individuals (other than surviving spouses), $481,000 for head of
household filers, and $254,650 for married individuals filing a
separate return. For years after 2022, the thresholds would be
indexed for inflation using the C-CPI-U. The proposal would be
effective for taxable years beginning after December 31, 2021.

Consistent with the proposal in the Made in America Tax Plan,
the Green Book would increase the income tax rate for C
corporations from 21% to 28%. The proposal would be effective for
taxable years beginning after December 31, 2021. For taxable years
beginning after January 1, 2021 and before January 1, 2022, only
the portion of the taxable year in 2022 would be subject to the 28%
rate. (However, as noted above, recent news reports suggest that
President Biden may be willing to agree to maintain the corporate
tax rate at 21%.)

Significant Changes to the International Tax Rules

GILTI

The “global intangible low-taxed income”
(“GILTI”) regime generally imposes a 10.5% minimum tax on
10-percent U.S. corporate shareholders of “controlled foreign
corporations” (“CFCs”) based on the CFC’s
“active” income in excess of a threshold equal to 10% of
the CFC’s tax basis in certain depreciable tangible property
(this basis, “qualified business asset investment,” or
“QBAI”).2 GILTI is not determined on a
country-by-country basis, and, therefore, under current law a U.S.
multinational corporation may be able to avoid the GILTI tax with
respect to its CFCs operating in low tax-rate countries by
“blending” income earned in the low tax-rate countries
with income from high tax-rate countries. In addition, income that
is subject to a foreign effective tax rate in excess of 90% of the
U.S. corporate income tax rate generally is excluded from
GILTI.

Effective Tax Rate on GILTI

Under the Green Book (as under the prior Made in America Tax
Plan), the effective tax rate on GILTI for corporate taxpayers
would increase from 10.5% to 21%, which represents an increase in
the effective tax rate on GILTI to 75% of the corporate tax rate
(21%/28%) from 50% of the corporate tax rate under current law
(10.5%/21%).

Country-by-Country Determination

Today, GILTI is applied on a global basis and U.S.
multinationals can avoid the GILTI tax on investments in low-tax
jurisdictions by “blending” the income earned by CFCs in
low-tax jurisdictions with income earned in high-tax jurisdictions.
The Green Book (as the prior Made in America Tax Plan) would
require GILTI to be determined on a country-by-country basis that
would prevent blending. Accordingly, income earned in low tax-rate
countries would be subject to the minimum tax under the GILTI
regime.

Elimination of 10% of QBAI exclusion

The Green Book (as the prior Made in America Tax Plan) proposes
the elimination of the exclusion of 10% of QBAI from the GILTI
calculation. Accordingly, the first dollar of CFC
“active” income would be subject to the GILTI tax.

Repeal of the High-Tax Exception from GILTI

The Green Book (but not the prior Made in America Tax Plan)
proposes to repeal the high-tax exception from GILTI.

FDII

The “foreign-derived intangible income”
(“FDII”) regime provides a lower 13.5% effective tax rate
for certain foreign sales and the provision of certain services to
unrelated foreign parties in excess of 10% of the taxpayer’s
domestic QBAI.

The Green Book (like the prior Made in America Tax Plan), would
repeal FDII.3

BEAT

The “base erosion and anti-abuse tax”
(“BEAT”) generally provides for an add-on minimum tax,
currently at 10%, on certain deductible payments that are made by
very large U.S. corporations to related foreign parties.

The Green Book (as the prior Made in America Tax Plan) would
replace the BEAT regime with the “Stopping Harmful Inversions
and Ending Low-tax Developments” or “SHIELD” regime.
Similar to the BEAT, the SHIELD regime would also deny U.S.
multinationals tax deductions for payments made to related parties,
but only if the related parties receiving the payments are subject
to a low effective rate of tax. The tax rate at which the SHIELD
regime is triggered would initially be equal to the 21% proposed
GILTI rate,4 but would be replaced by an
eventual global minimum tax rate established under OECD BEPS
project’s Pillar Two.5

The SHIELD regime would only apply to financial reporting groups
with greater than $500 million in global annual revenues, and would
be effective for taxable years beginning after December 31,
2022.

Expansion of Anti-Inversion Rules

An inversion transaction is typically a transaction in which the
shareholders of an existing U.S. corporation own that corporation
as a subsidiary of a non-U.S. corporation. Statutory anti-inversion
provisions under section 7874, together with additional guidance
provided in the Treasury regulations, subject the foreign acquirer
and/or the inverting U.S. corporation to a number of potentially
adverse tax consequences. If the continuing ownership stake of the
shareholders of the inverted U.S. corporation is 80% or more, the
foreign acquirer is treated as a U.S. corporation for U.S. federal
income tax purposes. If the continuing ownership stake of the
shareholders of the inverted U.S. corporation is between 60% and
80%, certain rules designed to prevent “earnings
stripping” – or deductible payments by the U.S. corporation to
its foreign parent – apply.

The Green Book would expand the anti-inversion rules in many
significant ways. These proposals were outlined in the Made in
America Tax Plan, but the Green Book contains significantly more
detail. First, the Green Book proposes to replace the 80% threshold
with a 50% threshold, and to eliminate the separate regime that
applies to inverted U.S. corporations with a continuing ownership
level between 60% and 80%. Accordingly, under the Green Book, if a
non-U.S. corporation acquires a U.S. corporation and 50% or more of
the historic shareholders of the U.S. corporation own the non-U.S.
corporation, the non-U.S. corporation would be taxable as a U.S.
corporation.

Furthermore, the Green Book proposes an additional category of
transactions that would be treated as inversion transactions that
cause the acquiror to be treated as a U.S. corporation, without
regard to the level of shareholder continuity: if a non-U.S.
corporation acquires shares in a U.S. corporation and (1)
immediately prior to the acquisition, the fair market value of the
domestic target entity is greater than the fair market value of the
foreign acquiring corporation, (2) after the acquisition, the
“expanded affiliated group” (generally, a group of
corporations related through at least 50% of ownership) is
primarily managed and controlled in the United States, and (3) the
expanded affiliated group does not conduct substantial business
activities in the country in which the non-U.S. acquiring
corporation is created or organized, then the non-U.S. acquiring
corporation would be taxable as a U.S. corporation.

Finally, the Green Book would expand the scope of anti-inversion
rules to cover acquisitions of substantially all of the assets
constituting (i) a trade or business of a U.S. corporation or
partnership, or (ii) a U.S. trade or business of a non-U.S.
partnership and distributions of stock in a foreign corporation by
a domestic corporation or a partnership that represent either
substantially all of the assets or substantially all of the assets
constituting a trade or business of the distributing entity.

15% Minimum Tax on Book Income for Certain Large
Corporations

The Green Book (as the prior Made in America Tax Plan) proposes
a 15% minimum tax on certain large corporations based on their book
income. The Green Book clarifies certain aspects of this 15%
minimum tax. The book income minimum tax would apply only to
corporations with worldwide book income in excess of $2 billion,
and would be reduced by general business credits (including
R&D, clean energy and housing tax credits) and foreign tax
credits. This tax is structured as a minimum tax, and therefore,
would apply only if it exceeds the corporation’s regular income
tax. The 15% minimum book income tax is effective for taxable years
beginning after December 31, 2021.

Taxing Capital Gains at Ordinary Income Rates for High-Income
Earners

The Green Book proposes (as did the earlier American Families
Plan) taxing long-term capital gains and qualified dividends of
taxpayers with adjusted gross income of more than $1 million
(indexed for inflation after 2022) at the applicable ordinary
income tax rates, which generally would be 39.6% (43.4% including
the net investment income tax).

The Green Book proposes that this increase in the long-term
capital gains and qualified dividend income tax rates be
retroactive and be applied to income recognized after “the
date of announcement”, which is April 28, 2021.

If the proposal to increase the tax rate of capital gains is
enacted, we would expect taxpayers to defer sales of appreciated
property and to use cashless collars and prepaid forward contracts
to reduce economic exposure, and to monetize, liquid appreciated
positions. We would also expect an increase in tax-free mergers and
acquisitions.

Gift Transfer and Death as Realization Events

Under current law, transfer by gift or death is not taxable, and
upon death, the decedent’s heirs get a “stepped up
basis” to fair market value at the time of death. Under the
proposal in the Green Book, death and gifts of appreciated property
would be treated as realization events that require gain to be
recognized as if the underlying property was sold, subject to a $1
million ($500,000 for married couples filing separately) lifetime
exclusion, which would be indexed for inflation after 2022. Gains
on gifts or bequests to charity would not be required to be
recognized, and gains on gifts or bequests to a spouse would not be
required to be recognized until the spouse dies or disposes of the
asset. Basis would carry over in each case.

Payment of tax on the appreciation of certain family-owned and
operated businesses would not be due until the interest in the
business is sold or the business ceases to be family-owned and
operated. The Green Book proposal would also allow a 15-year
fixed-rate payment plan for the tax on appreciated assets
transferred at death, other than (i) liquid assets, such as
publicly traded financial assets, and (ii) businesses for which the
deferral election is made.

The proposal would tax transfers of property into, and
distributions in kind from, a trust, partnership or other
non-corporate entity (other than a grantor trust that is deemed to
be wholly owned and revocable by the donor). It is questionable
whether the drafters intended as broad a result as the words of the
proposal suggest because it would effectively prohibit the use of
partnerships for many common business ventures.

Finally, the Green Book proposal would apparently impose tax
without any realization event on the unrealized appreciation of
assets of a trust, partnership or other non-corporate entity if
there has not been a recognition event with respect to the
applicable property within the prior 90 years, beginning on January
1, 1940. Accordingly, these entities would be subject to tax with
respect to this property beginning on December 31, 2030.

The qualified small business stock (“QSBS”) rules of
section 1202 would remain in effect.

The proposed rules would be effective after December 31,
2021.

3.8% Medicare Tax for All Trade or Business Income of
High-Income Taxpayers

Under the current rules, a 3.8% NIIT is imposed on net
investment income (generally, portfolio and passive income) of
individuals above a certain income threshold, and a 3.8% Medicare
tax under SECA is imposed on self-employment earning of certain
high-income taxpayers. Limited partners and S corporation
shareholders generally are not subject to the SECA Medicare tax on
their distributive share of income from the partnership or the S
corporation, respectively.

The Green Book proposes to impose a 3.8% tax (which will be used
to fund Medicare), either through the NIIT or SECA Medicare tax, on
all trade or business income of taxpayers with adjusted gross
income in excess of $400,000.6

In addition, limited partners, LLC members and S corporation
shareholders who traditionally have not been subject to SECA tax on
their distributive share of income from the underlying entity would
be subject to SECA tax if they provide services and/or materially
participate in the underlying trade or business. Material
participation standards appear to be similar to the same standards
for purposes of passive activity rules under section 469, which
require the person to work for the business for at least 500 hours
per year.

The proposal would be effective for taxable years beginning
after December 31, 2021.

Carried Interests Give Rise to Ordinary Income

Under current law, a “carried” or “profits”
interest in a partnership received in exchange for services is
generally not taxable when received and the recipient is taxed on
their share of partnership income based on the character of the
income at the partnership level. Section 1061 requires certain
carried interest holders to satisfy a three-year holding period -
rather than the normal one-year holding period – to be eligible for
the long-term capital gain rate.7

Under the Green Book, a partner’s share of income on an
“investment services partnership interest” (an
“ISPI”) in an investment partnership would generally be
taxable as ordinary income, and gain on the sale of an ISPI would
be taxable as ordinary income if the partner’s taxable income
(from all sources) exceeds $400,000.

The Green Book defines an ISPI as “a profits interest in an
investment partnership that is held by a person who provides
services to the partnership”. This definition is broader than
section 1061, which applies to interests in partnerships in the
business of “raising or returning capital” and investing
or developing certain investment-type assets.8

Under the Green Book, a partnership will be considered an
“investment partnership” if substantially all of its
assets are investment-type assets (which are similar to the
“specified assets” definition of section 1061), but only
if more than 50% of the partnership’s contributed capital is
from partners to whom the interests constitute property not held in
connection with a trade or business.

The purpose and meaning of the exception provided by this 50%
test is unclear. Assume that insurance companies contribute cash
from their reserves to an investment partnership in exchange for
partnership interests, and the general partner of that partnership
receives a carried interest in exchange for managing the assets of
the partnership. The partnership interests received by the
insurance companies would appear to be reserves held in connection
with their trade or business of providing insurance. It appears
that the general partner would not be subject to the Green Book
proposal or, as discussed below, section 1061, and therefore could
receive allocations of long-term capital gain based upon a one-year
holding period.

Under the Green Book, if a partner who holds an ISPI also
contributes “invested capital” (generally money or other
property, but not contributed capital attributable to the proceeds
of any loan or advance made or guaranteed by any partner or the
partnership or a related person) and holds a qualified capital
interest in the partnership, income attributable to the invested
capital, including the portion of gain recognized on the sale of an
ISPI attributable to the invested capital, would not be subject to
recharacterization. “Qualified capital interests”
generally require that (a) the partnership allocations to the
invested capital be made in the same manner as allocations to other
capital interests held by partners who do not hold an ISPI and (b)
the allocations to these non-ISPI holders are significant. The
“same manner” requirement would be a return to the
language used in the section 1061 proposed regulations, which was
ultimately relaxed to a “similar manner” requirement in
the final regulations.9 The Green Book’s requirement
that allocations to non-ISPI holders be “significant” is
also a divergence from the final section 1061 regulations, which
look to whether the capital contributed by “Unrelated
Non-Service Partners” is significant.10

The Green Book would also require partners to pay
self-employment tax on ISPI income.

In addition, under an anti-abuse rule of the proposal, any
person above the income threshold who performs services for any
entity (including entities other than partnerships) and holds a
“disqualified interest” in the entity is subject to tax
at “rates applicable to ordinary income” on any income or
gain received with respect to the interest. A “disqualified
interest” is defined as convertible or contingent debt, an
option, or any derivative instrument with respect to the entity
(but does not include a partnership interest, stock in certain
taxable corporations, or stock in an S corporation). Thus, under
this proposal if an employee received a note as compensation from a
C corporation, any gain on the sale of the note would be taxable at
ordinary income rates (but, apparently, would not be treated as
ordinary income so the gain could be offset by capital losses). The
anti-abuse rule provides that capital gain subject to it is taxable
“at rates applicable to ordinary income,” but does not
provide that the capital gain is ordinary income. It is unclear why
this rule is different than the rule that applies to ISPIs, but it
would allow capital losses of the taxpayer to offset the capital
gains.

The proposal notes that it is not intended to adversely affect
qualification of a REIT owning a profits interest in a real estate
partnership.

The proposal would repeal section 1061 for taxpayers whose
taxable income (from all sources) exceeds $400,000 and would be
effective for taxable years beginning after December 31, 2021.
Taxpayers whose taxable income is $400,000 or less would be subject
only to section 1061. If the proposal were to become law, we expect
that sponsors of funds will be more likely to receive their
compensation in the form of deferred fees rather than as a carried
interest.

The Green Book proposal appears to be based on the Carried
Interest Fairness Act of 2021, the February 2021 House bill (the
“House Bill”) introduced by Bill Pascrell (NJ) and
co-sponsored by Andy Levin (Michigan) and Katie Porter
(California).

Like the Green Book proposal, the House Bill contained
provisions to treat the net capital gain with respect to an
investment services partnership interest as ordinary income, with a
carve out for gain attributable to a partner’s qualified
capital interest.11 The House Bill also subjects
income from an investment services partnership interest to
self-employment taxes.

The House Bill contains a narrower version of the exception from
ISPI contained in the Green Book. Whereas the Green Book proposal
exempts an ISPI if not more than 50% of the partnership’s
contributed capital is from partners to whom the interests
constitute property not held in connection with a trade or
business, the House Bill would require 75% of a partnership’s
capital to be attributable to qualified capital interests
constituting property held in connection with a trade or business
of its owner for the interest to be exempted.

The House Bill would also amend section 83 to currently tax
partnership interests transferred in connection with the
performance of services, would exempt income from investment
services partnership interests from treatment as qualifying income
of a publicly traded partnership,12 would exempt certain family
partnerships from the application of the bill, and would increase
the penalty for tax underpayments resulting from failure to treat
income from an investment services partnership interest as ordinary
income. These provisions do not appear in the Green Book
proposal.

If the Green Book proposal is enacted, we would expect fund
managers increasingly to receive their compensation in the form of
deferred fees rather than carry, and to subject the deferred fees
to a “substantial risk of forfeiture” to avoid
application of sections 409A and 457A.

Repeal of Section 1031 Like-Kind Exchanges

Under section 1031, taxpayers may defer gain on exchange of real
property for other real property without any limitation on the
amount of deferral.13 The Green Book proposes to
impose a $500,000 per person limit ($1 mm in the case of married
individuals filing a joint return) on the aggregate amount gain
deferral for each year, with any excess recognized in the year of
the exchange.

The proposal would be effective in taxable years beginning after
December 31, 2021.

If the proposal is enacted, we would expect an increased use of
“UPREIT” structures for transfers of real property,
whereby a taxpayer with appreciated property contributes that
property to a partnership owned by a real estate investment trust
(a “REIT”) in exchange for an interest in that
partnership that may be converted into an interest in the REIT.

Excess Business Loss Limitation Made Permanent

Section 461(l) generally disallows non-corporate taxpayers from
deducting “excess business losses.” Excess business
losses are losses from business activities in excess of the sum of
gains from business activities and specified threshold amount.
These losses are carried forward to subsequent taxable years as net
operating losses.

The Green Book proposes to make permanent the excess business
loss limitation on non-corporate taxpayers, which otherwise would
have sunset after December 31, 2026.

Comprehensive Financial Account Information Reporting
Regime

The Green Book also proposes a comprehensive financial account
information reporting by financial institutions and other similar
institutions. This proposal calls for reporting of data on
financial accounts, including gross inflows and outflows with a
breakdown for cash, transactions with a foreign account and
transfer to and from another account with the same owner. Payment
settlement entities, custodians and crypto asset exchanges would be
subject to similar reporting requirements. The proposal also
provides for additional reporting requirements for
purchase/transfer of crypto assets. The only exception specified in
the proposal is for de minimis amounts at a $600 threshold.

This proposal is proposed to be in effect for tax years
beginning after December 31, 2022.

Additional Funding To Be Provided for Enforcement and Tax
Administration

The Green Book also proposes an increase in the budget for the
IRS Enforcement and Operations Support accounts by $6.7 billion and
to provide the IRS with $72.5 billion in mandatory funding, a
portion of which would be used for IRS enforcement and compliance.
The proposal would direct that these additional resources be used
only for enforcement against taxpayers with income above
$400,000.

No Repeal of the Cap on Social Security Taxes

Under current law, employers and employees are each subject to a
6.2% social security tax (for a total of 12.4%) and self-employed
individuals are subject to a 12.4% social security tax on their
first $142,800 (in 2021) of wages. It had been reported that the
Biden Administration would lift the cap so that the social security
tax applied to all wages and self-employment income. This proposal
was not in the Green Book (or the American Families Plan).

No Change to the Gift and Estate Taxes

The Green Book (and the American Families Plan) does not propose
any change to the gift and estate taxes.

No Repeal of the SALT Limitation

Currently, only a maximum of $10,000 annually of state and local
taxes (“SALT”) are deductible from federal income. The
Green Book (and the American Families Plan) does not propose to
change the SALT limitation.

Footnotes

1.
Kristina Peterson, Andrew Restuccia and Richard Rubin.
Biden Signals Flexibility on Taxes for
Infrastructure
” Wall Street Journal, June 3, 2021. https://www.wsj.com/articles/bidens-latest-infrastructure-offer-1-trillion-11622725783?page=1

2. Under
section 250, the 10.5% rate is provided through a 50% deduction,
which is generally not available for non-corporate taxpayers unless
an election under section 962 is made. All section references are
to the Internal Revenue Code of 1986, as amended.

3. A
proposal by the Senate Finance Committee would retain FDII, but
make several significant changes to it.

4. The
21% rate would notably treat the U.K. corporate income tax rate
(currently at 19%) as being a low effective tax rate for purposes
of the SHIELD regime.

5. The
Organisation for Economic Co-operation and Development’s
(“OECD’s”) “Pillar Two Blueprint” is a set
of rules that would require large multinationals to pay a minimum
amount of tax, regardless of where they are organized or do
business. On June 5, 2021, the Group of Seven (“G-7”)
nations agreed that businesses should pay a minimum tax rate of at
least 15% in each of the countries in which they operate. Paul
Hannon, Richard Rubin and Sam Schechner. “G-7 Nations Agree on
New Rules for Taxing Global Companies”. Wall Street Journal,
June 5, 2021. https://www.wsj.com/articles/g-7-nations-agree-on-new-rules-for-taxing-global-companies-11622893415?page=1

6. The
Green Book does not include a proposal to remove the cap on Social
Security tax on taxpayers with adjusted gross income in excess of
$400,000, which is one of the proposals President Biden had made
during his presidential campaign.

7.
Section 1061(a).

8.
Section 1061(c).

9. Final
Treas. Reg 1.1061-3(c)(3)(ii).

10.
Final Treas. Reg 1.1061-3(c)(3)(iv). Under the regulations,
Unrelated Non-Service Partners will be treated as having made
significant aggregate capital contributions if they possess 5% or
more of the aggregate capital contributed to the partnership at the
time the allocations are made.

11.
Carried Interest Fairness Act of 2021, H.R. 1068, 117th
Cong. (2021).

12. A
“publicly traded partnership” with less than 90% passive
“qualifying income” is taxable as a corporation for
federal income tax purposes.

13.
Prior to the Tax Cuts and Jobs Act, section 1031 also applied to
like-kind exchanges of personal property. The Tax Cuts and Jobs Act
limited the scope of section 1031 to like-kind exchanges of real
property.

Treasury’s Green Book Provides Details On The
Biden Administration’s Tax Plan

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