Page 6 - Acquisitions, Dispositions & Structuring Techniques Corner

ACQUISITIONS, DISPOSITIONS & STRUCTURING TECHNIQUES CORNER
was held in February 9–10, 2009. e Tax Court held that the MPSA transactions were sales for federal income taxes and that the corporation was also subject to the built-in gains tax under Code Sec. 1374. is resulted in substantial de ciencies in income tax due from Anschutz Corporation for $35,555,065 (2000) and $41,580,239 (2001) and de ciencies in income tax (plus additions in tax) from the taxpayers, as well, in the amounts of $7,151,834 (2000) and $10,190,555 (2001). e indi- vidual taxpayers and Anschutz Corporation appealed to the Tenth Circuit.
e Tenth Circuit a rmed the Tax Court’s decision below that the transactions were sales for federal income tax purposes of under Code Sec. 1001(c). It applied the multiple-factor, bene ts and burdens of ownership test as re ected in the Tax Court’s decision in Grodt & McKay:
1. Legal title to the pledged shares. e counterparty bro-
kerage rm was a orded all incidents of ownership in the pledged and borrowed shares, including the right to transfer them. Indeed, the brokerage rm transferred the shares in order to repay the third par- ties it had borrowed similar shares from to conduct its pre-transaction short sales. is strongly suggests that the transactions were sales.
2. How the parties treated the transactions. While the parties treated the transactions as executory contracts for the sale of TAC’s shares to the broker, the Tenth Circuit stated that it did not assign much weight to this factor.
3. Did the broker acquire an equity interest in the pledged shares? e taxpayer was viewed as e ectively having cashed out its equity in the property in exchange for the upfront cash payment and a contingent contract right to acquire a certain number of shares based on the stock price. In particular, TAC e ectively exchanged its ownership rights in the pledged stock for (a) an upfront cash payment equal to 75% of the pledged stock’s then-existing market value, (b) a 5% prepaid tranche fee, (c) the potential of bene ting to a limited degree if the pledged stock increased in value over the life of the transactions, and (d) the complete elimination of any risk of loss of value in the pledged stock. e brokerage rm, in turn, obtained the right to use the pledged stock as it saw t and indeed used most of the pledged stock to repay the entities from which it borrowed similar shares of stock to conduct its pre-transaction short sales. e court viewed the counterparty as having acquired an equity interest in the pledged shares.
4. Present obligation of the parties. Under the terms of the VPFCs, TAC had an immediate obligation to transfer
the pledged shares to the possession of the escrow agent, WTC. e brokerage (counterparty) rm, in turn, had an obligation to pay TAC an amount equal to 75% of the then-existing market value of the pledged shares. Under the terms of the related share- lending agreements, WTC had an obligation to give the pledged shares to the broker, who in turn had an obligation to pay to TAC the requisite prepaid lend- ing fee. e Tenth Circuit agreed with the trial court below that the set of transactions and contractual obligations of the respective parties bore substantial similarity to a sale of the pledged stock.
5. Risk of loss. TAC was provided full price risk protection from a fall in the market place of the pledged shares. While the Tax Court found that the payo pro le to TAC of the pledged shares was not entirely xed, it was relatively xed within a relatively narrow range and TAC consequently had signi cantly less price risk than it would have had by simply holding the shares and selling them after the 10-year period. Under a risk of loss lens, the court felt the transactions looked like sales.
6. Opportunity for gain. Under the MPSA agreement, if the stock subject to a speci c VPFC increased over the term of the contract, TAC would retain the rst 50% of any resulting appreciation, with any additional appreciation inuring to the counterparty-broker. e facts showed that substantial appreciation had been transferred to the broker with respect to the three tranches, i.e., from 63% to 71%. is again is indicative of sale treatment.
7. Voting rights. Under the terms of the share-lending agreements, the voting rights of the pledged shares were transferred to the lender along with the right to transfer the shares. While TAC did have the right to recall the borrowed shares, it would require TAC to repay a pro rata portion of the entire Prepaid Tranche Fee to the broker, which would obviously come at a high cost. TAC, however, recalled shares on only two occasions: rst, in 2006, during an IRS audit, and again shortly before the trial in the Tax Court. As the Tax Court noted, both of those recalls appear to have been intended solely by TAC to persuade the IRS, and in turn the Tax Court, that the share-lending agreements were legitimate.
8. Dividend rights. Under the share-lending agreements, TAC’s dividend rights as to the pledged shares were signi cantly altered and limited. In summary of the facts on the record on this issue, TAC e ectively trans- ferred to the broker approximately 83% to 88% of both the risks and rewards of the dividend payments associated with the pledged shares.
12 JOURNAL OF PASSTHROUGH ENTITIES
SEPTEMBER–OCTOBER 2017