Page 4 - Acquisitions, Dispositions & Structuring Techniques Corner

ACQUISITIONS, DISPOSITIONS & STRUCTURING TECHNIQUES CORNER
VPFC on the settlement date. Settlement also may be accomplished by payment of cash or other shares of the same issuer in lieu of the pledged shares.
e bene ts to the investor of entering into a VPFC can take several forms. First, the investor may be able to receive protection against the risk that the pledged shares may fall in value through the up-front cash payment. Moreover, the investor may be able to participate in the growth in value of the same shares in the future until settlement. Additionally, if properly structured, the appreciation in the concentrated stock position is not subject to federal income tax until the transaction is closed out years later on the settlement date. ere is no much guidance or authority on the necessary ingredients that a taxpayer entering into a VPFC must include in the stock purchase and related agreements in order to achieve a deferral in federal income taxation. Conversely, the IRS may take a narrow view on what types of VPFCs qualify for deferral treatment. Still, the IRS has explained its position in this area which is quite fortunate, and the Tax Court, most recently in McKelvey, continues to endorse the merits of the government’s position in this regard.
Rev. Rul. 2003-7
In Rev. Rul. 2003-7,16 the IRS addressed forward contracts and VPFCs in stock or securities loan arrangements as to whether a particular transaction would constitute a “loan” or a “sale” or “constructive sale” under Code Sec. 1259 for federal income tax purposes. Under the particular facts set forth in Rev. Rul. 2003-7, the taxpayer (1) received a xed amount of cash; (2) simultaneously entered 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; (3) the taxpayer-borrower pledged the maximum number of shares for which delivery could be required under the agreement; and (4) had the restricted legal right to deliver the pledged shares or to substitute cash or other shares on the delivery date.17 e IRS concluded that the shareholder had neither sold stock currently nor caused a constructive sale under Code Sec. 1259 under the facts. erefore, the up-front tax payment was non-taxable.
A Closer Look at the IRS’s Analysis
in Rev. Rul. 2003-7: Was the
Transaction a Loan of Shares or
a Taxable Disposition of Shares?
The IRS noted that the arrangement here involved the transfer of securities to a brokerage rm under a
subordination agreement, which permitted the brokerage rm to use the securities to meet its net capital require- ments under the stock exchange rules. Citing three cases in this area, the ruling highlighted Miami National Bank.18 In Miami National Bank, the Tax Court ruled that even though the brokerage rm had the right to sell stock in the subordination account to satisfy its creditors, the ostensible borrower-taxpayer remained the owner of the shares. A critical factor to the court was that the broker- age rm did not become the owner of the stock in the subordination account because at all times the transferor had the right to reacquire the stock in the subordination account by substituting cash or other marketable securi- ties of equivalent value. Miami National Bank and other similar cases indicate that a transfer of actual possession of stock or securities and legal title may not itself be suf- cient to constitute a transfer of bene cial ownership when the transferor retains the unrestricted right and ability to reacquire the securities.19
e government then noted the Tax Court’s decision in K. Hope,20 where sale treatment occurred under the facts, even though the taxpayer attempted to enter into a non-taxable share loan agreement with an investment bank for the receipt of $4M at closing. e IRS noted that the facts before it were more similar to the facts in Miami National Bank, and the Richardson case,21 wherein the shareholder retained the right to receive dividends and exercise voting rights with respect to the pledged shares. Unlike Hope, legal title and actual possession of the shares were transferred to an unrelated trustee rather than to the investment bank. In this case, like Hope, the shareholder was not required to surrender the shares to the investment bank on the exchange date and could further hold an unrestricted right to reacquire the shares on the exchange date by delivering cash or other shares. In such event, a sale was not present on the funding of the loan.
Alternatively, Was the Arrangement a Constructive Sale Under
Code Sec. 1259?
e IRS next addressed the constructive sale of an appreci- ated nancial position rule contained in Code Sec. 1259. Under Code Sec. 1259(a)(1), if there is a constructive sale of an appreciated nancial position, the taxpayer is required to recognize gain as if such position were sold, assigned, or otherwise terminated at its fair market value on the date of such constructive sale. Under Code Sec. 1259(b), the term “appreciated nancial position” means any position with respect to any stock, debt instrument,
10 JOURNAL OF PASSTHROUGH ENTITIES
SEPTEMBER–OCTOBER 2017