Several lines of evidence suggest that neutral ceramidase is involved in the regulation of ceramide-mediated signaling. Recently, the enzymes from mouse and rat were found to be localized at plasma membranes as a type II integral membrane protein, occasionally being detached from the cells after proteolytic processing of the NH(2)-terminal anchoring region (Tani, M., Iida, H., and Ito, M. (2003) J. Biol. Chem. 278, 10523-10530). We report here that conserved hydrophobic amino acid residues in the COOH-terminal tail are indispensable for the correct folding and localization, and enzyme activity of neutral ceramidase. Truncation of four, but not three, amino acid residues from the COOH terminus of rat neutral ceramidase resulted in a complete loss of enzyme activity as well as cell surface expression in HEK293 cells. Point mutation analysis revealed that Ile(758), the 4(th) amino acid residue from the COOH terminus, and Phe(756) are essential for the enzyme to function. The truncated and mutated enzymes were found to be retained in the endoplasmic reticulum (ER) and rapidly degraded without transportation to the Golgi apparatus. Treatment of the cells expressing the aberrant COOH-terminal enzyme with MG-132, a specific inhibitor for the proteasome, increased the accumulation of the enzyme in the ER, indicating that the misfolded enzyme was degraded by the proteasome. It was also found that the COOH-terminal tail was indispensable for the enzyme activity and correct folding of the prokaryote ceramidase from Pseudomonas aeruginosa, indicating that the importance of the COOH-terminal tail of the enzyme has been preserved through evolution.