Page 10 - Acquisitions, Dispositions & Structuring Techniques Corner

ACQUISITIONS, DISPOSITIONS & STRUCTURING TECHNIQUES CORNER
best with an option to repurchase the securi- ties at the end of the term of the purported loan in question); B.E. Welch, CA-9, 2000-1 ustc ¶50,258, 204 F3d 1228; E.M. Kurata, 101 TCM 1291, Dec. 58,575(M), TC Memo. 2011-64; J.S. Landow, 102 TCM 88, Dec. 58,711(M), TC Memo. 2011-177 (transactions involving “loans” in the form of certain oating rate notes (FRNs) which lender loaned to taxpayer on a non-recourse basis an amount equal to 90% of FMV of securities secured by securities as collateral, constituted a sale by taxpayer of the portfolio to lender, and not a loan by lender to taxpayer that was collateralized by that portfolio); C. Shao, 100 TCM 182, Dec. 58,315(M), TC Memo. 2010-189 (followed Calloway, supra, in nding shares of stock collateralized under a non-recourse loan agreement constitute a “sale” rather than a loan). Several of the reported decisions were part of a “ponzi scheme” perpetrated by Derivium Capital which would later fall into bankruptcy. The Company promoted its “stock-loan program” whereby customers transferred stock to the debtor in exchange for three-year non-recourse loans worth 90% of stocks’ market value. The customers of the “stock-loan program” transferred their stocks into the defendants’ brokerage accounts (“Customer Transfers”). The debtor, instead of managing the stocks, directed the defendants to liquidate the stock and used the proceeds to fund its own ventures (“Cash Transfers”). When the loans matured, customers could either repay the principal loan amount with interest or re nance the loan for an additional term. As a result, the debtor could not meet the obligation to return their customers’ stock when the loans matured, forcing the debtor to le for Bankruptcy. It was recognized in Shao, supra, that nearly 70 civil cases were brought as a result of the scheme.
13 See TAM 200604033 (Jan. 27, 2006) (“[s]ection 1058 clearly envisions that the ‘lender’ retain a signi cant amount of risk of loss and op- portunity for gain on the subject property” as well as the ability (at any time) to recoup pos- session of the property. Congress wanted the taxpayer receiving non-recognition treatment under Code Sec. 1058 to retain some ownership characteristics or qualities over the subject shares, despite the fact that a share lending transaction generally results in transfer of ownership of the shares).
14 However, see Reg. §1.1001-2(a)(4)(i), which provides that the sale of property that secures a non-recourse liability discharges the trans- feror from liability. Crane, SCt, 331 US 12 (1947) (amount realized includes any non-recourse liability secured by the property sold).
15 See also Frank Lyon, Co., SCt, 78-1 ustc ¶9370, 435 US 561, 583–583, 98 SCt 1291 (“where ... there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by
tax-avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties”).
16 Rev. Rul. 2003-7, 2003-1 CB 363.
17 The actual facts in the ruling were as follows:
the taxpayer retains the unrestricted right to dispose of the covering shares. In a short sale, in general, the taxpayer borrows shares of stock (or securities) from the lender and is under an obligation to return identical stock or securities to the lender. For federal income tax purposes, a short sale is not a realization event until the covering shares, i.e., those shares used to repay the original loan of stock, is delivered to the seller or until the lender acquires an “equitable interest” in speci c shares. In a “short against the box” transaction, the taxpayer holds a long position in stock and borrows and sells short an equal amount of stock.
20 K. Hope, 55 TC 1020, Dec. 30,685 (1971), aff’d, CA-3, 73-1 ustc ¶9168, 471 F2d 739.
21 H.S. Richardson, CA-2, 41-2 ustc ¶9592, 121 F2d 1, cert. denied, SCt, 314 US 684, 62 SCt 188.
22 Code Sec. 1259 was enacted into law in 1997.
See S. Rep. No. 33, 105th Cong., 1st Sess. 125–126
(1997), 1997-4 (Vol. 2) CB 1067, 1205–1206.
23 Anschutz Co., CA-10, 2012-1 ustc ¶50,117, 664 F3d
“An individual (‘Shareholder’) held shares of
common stock in Y corporation, which is pub-
licly traded. Shareholder’s basis in the shares
of Y corporation is less than $20 per share.
On September 15, 2002 (the ‘Execution Date’),
Shareholder entered into an arm’s length
agreement (the ‘Agreement’) with Investment
Bank, at which time a share of common stock
in Y corporation had a fair market value of $20.
Shareholder received $z of cash upon execu-
tion of the Agreement. In return, Shareholder
became obligated to deliver to Investment
Bank on September 15, 2005 (the ‘Exchange
Date’), a number of shares of common stock
of Y corporation to be determined by a for-
mula. Under the formula, if the market price
of a share of Y corporation common stock is
less than $20 on the Exchange Date, Invest- 313.
ment Bank will receive 100 shares of common stock. If the market price of a share is at least $20 and no more than $25 on the Exchange Date, Investment Bank will receive a number of shares having a total market value equal to $2000. If the market price of a share exceeds $25 on the Exchange Date, Investment Bank will receive 80 shares of common stock. In addition, Shareholder has the right to deliver to Investment Bank on the Exchange Date cash equal to the value of the common stock that Shareholder would otherwise be required to deliver under the formula.
In order to secure Shareholder’s obligations under the Agreement, Shareholder pledged to Investment Bank on the Execution Date 100 shares (that is, the maximum number of shares that Shareholder could be required to deliver under the Agreement). Shareholder effected this pledge by transferring the shares in trust to a third-party trustee, unrelated to Investment Bank. Under the declaration of trust, Shareholder retained the right to vote the pledged shares and to receive dividends.
Under the Agreement, Shareholder had the unrestricted legal right to deliver the pledged shares, cash, or shares other than the pledged shares to satisfy its obligation under the Agreement. Shareholder is not oth- erwise economically compelled to deliver the pledged shares. At the time Shareholder and Investment Bank entered into the Agreement, however, Shareholder intended to deliver the pledged shares to Investment Bank on the Exchange Date in order to satisfy Shareholder’s obligations under the Agreement.”
18 Miami National Bank, 67 TC 793, Dec. 34,251 (1977).
19 With respect to short sales of stock, the courts have also refused to treat covered purchases as resulting in sale treatment where the agreement provides that until actual delivery,
24 See Code Sec. 1361(b)(3)(B)(ii).
25 The Court cited the IRS’s conclusion in Rev. Rul.
2003-7:
Shareholder has neither sold stock currently nor caused a constructive sale of stock if Shareholder receives a xed amount of cash, simultaneously enters into an agreement to deliver on a future date a number of shares of common stock that varies signi cantly depending on the value of the shares on the delivery date, pledges the maximum number of shares for which delivery could be required under the agreement, retains an unrestricted legal right to substitute cash or other shares for the pledged shares, and is not economically compelled to deliver the pledged shares.
26 664 F3d 330.
27 Cottage Savings Association, SCt, 91-1 ustc
¶50,187, 499 US 554, 111 SCt 1503. In Cottage Sav- ings, the taxpayer sold participation interests in 252 mortgages to four savings and loan as- sociations and purchased from them participa- tion interests in 305 other mortgages. All of the loans were secured by single family homes. The FMV of the participation interests exchanged by each side was approximately $4.5 million. The face value of the participation interests re- linquished by Cottage Savings was $6.9 million. For Federal Home Loan Bank Board (“FHLBB”) accounting purposes, Cottage Savings’ mort- gages were treated as having been exchanged for “substantially identical” ones held by the other lenders. On its 1980 federal income tax return, Cottage Savings claimed a deduction for the adjusted difference between the face value of the interests it traded and the fair market value of the interests it received. Fol- lowing the IRS’s disallowance of the deduction, the Tax Court determined the deduction was
16 JOURNAL OF PASSTHROUGH ENTITIES
SEPTEMBER–OCTOBER 2017