Page 8 - Acquisitions, Dispositions & Structuring Techniques Corner

ACQUISITIONS, DISPOSITIONS & STRUCTURING TECHNIQUES CORNER
the original VPFCs as open transactions in full reliance on Rev. Rul. 2003-7 and did not report any gain or loss for 2007.
In 2008 and prior to the original agreed settlement dates, decedent paid consideration to each of the investment banks to extend the settlement dates until 2010 (the VPFC extensions). McKelvey died in 2008 after the execution of the VPFC extensions. e estate did not report the gain in 2008, despite the modi cation extending the term of the agreement until 2010. It continued to rely on Rev. Rul. 2003-7.
e IRS issued a notice of de ciency for 2008 based on its view that the extension of the VPFCs in such year constituted taxable dispositions of the original VPFC contracts. is resulted in unreported short-term capital gain of $88M and unreported long-term capital gain of $112.9M, or a total of $200.9M of unreported gain from the constructive sales of Monster shares pledged under the VPFCs. e IRS treated the decedent’s stock basis in 2008 at $0, placing the burden on the taxpayer to produce a higher basis amount. In the interim, since the taxpayer died prior to the settlement dates, as extended, the estate claimed it was entitled to a fair market value basis in the shares under Code Sec. 1014. e estate challenged the IRS’s determinations by ling a petition with the Tax Court claiming that there was no taxable disposition or realization event in 2008 as a result of the decedent enter- ing into the extension agreements.
Tax Court Finds for McKelvey Est.
e Tax Court began its analysis by delving into Rev. Rul. 2003-7. In Rev. Rul. 2003-7, the IRS analyzed the proper tax consequences associated with a VPFC on ve technical grounds. e facts in the ruling involved whether a shareholder either sold stock currently or caused a constructive sale of stock under Code Sec. 1259, where the shareholder (i) receives a xed amount of cash, (ii) 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, (iii) pledges the maximum number of shares for which delivery could be required under the agreement, (iv) has the unrestricted legal right to deliver the pledged shares or to substitute cash or other shares for the pledged shares on the delivery date and (v) is not economically compelled to deliver the pledged shares. e court further considered its prior decisions in Miami National Bank, as well as in Hope.
In a fully reviewed decision, the Tax Court found for the Petitioner. It held (i) decedent’s entering into the
agreement extending the VPFCs in 2008 until 2010 did not constitute sales or exchanges of property under Code Sec. 1001 and the open transaction treatment a orded the original VPFCs under Rev. Rul. 2003-7 continued until the transactions are closed by the future delivery of stock; and (ii) decedent did not, by virtue of the exten- sion agreement, cause a constructive sale to result under Code Sec. 1259.
e Tax Court endorsed the “open transaction” model developed in Rev. Rul. 2003-7, with respect to certain VPFCs as “straightforward,” and the question of rst impression, therefore, was whether the extensions of the two VPFCs resulted in taxable exchanges under general federal income tax principles or, alternatively, as construc- tive sales under Code Sec. 1259.
e estate argued to the court that the extensions merely postponed the settlement and averaging dates of the con- tracts and permitted the original VPFCs, as extended, to be allowed to continue to be reported as “open” transactions until the contracts were settled by delivery of Monster stock (or other consideration) in 2010.
e IRS’s primary argument in support of its notice of de ciency was that the VPFC extensions resulted in a taxable exchange of contract rights that were “materially di erent either in kind or in extent” to fall within the Cottage Savings regulation, Reg. §1.1001-1(a).27 e Tax Court did not agree with the IRS’s position that there was an “exchange of properties” and did not, therefore, have to decide that the properties were “materially di erent either in kind or in extent.”
e IRS also advanced a “bundle of sticks” type argu- ment in asserting that the extension was a taxable exchange of “property.” In particular, it argued that the original VPFCs were an integrated bundle of valuable investment and other contract rights, as well as obligations, and constituted property. Such rights were subject to market forces and contained valuable investment and contractual rights (and obligations). e valuable rights in the original VPFCs were (i) the right to the cash prepayments; (ii) the right to determine how the VPFCs would be settled, i.e., whether with stock or in cash, and if stock, which speci c shares; and (iii) the right to substitute other collateral. Respondent contended that, even if decedent possessed primarily obligations, the original VPFCs still constituted property within the meaning of Code Sec. 1001.
e Tax Court rejected that the decedent’s right to cash prepayments constituted a valuable property right.28 e reason for this conclusion was that there was not a loan or - nancing arrangement involved as was the case in the Federal Home decision, which it felt the IRS inappropriately relied upon on the basis that it was a case involving a nancing
14 JOURNAL OF PASSTHROUGH ENTITIES
SEPTEMBER–OCTOBER 2017