Page 7 - Acquisitions, Dispositions & Structuring Techniques Corner

9. Right to sell or rehypothecate the pledged shares. e broker-counterparty, as mentioned, had the right to possess and dispose of the pledged shares. It used such shares to repay the entities from which it had borrowed similar shares to conduct its pre-transaction short sales.
e Tenth Circuit, having reviewed the multi-factor test applied by the Tax Court below, a rmed the Tax Court’s decision that the MPSA transactions should be treated as sales.
e court rejected the argument the taxpayers made to the Tax Court below, that their case is “substantially identical to the contract in Rev. Rul. 2003-7” and that the transactions should not be treated as sales. While the taxpayers conceded that the ruling did not discuss a bor- rowing of pledged shares, they asserted that the fact that the borrowing occurred here was irrelevant because neither the borrowings nor the return of pledged shares deprived TAC of its unrestricted right to settle the forward contracts at maturity with cash or other shares.
As with the Tax Court, the Tenth Circuit concluded that the facts in this case were distinguishable from those set out in Rev. Rul. 2003-7.25 A portion of the Tenth Circuit’s opinion on this point is instructive:
e problem with petitioners’ reliance on Revenue Ruling 2003-7 is that the transactions at issue in this case, considered as a whole, are di erent from the entirety of the transactions at issue in Revenue Ruling 2003-7. Whereas the circumstances underly- ing Revenue Ruling 2003-7 involved only a VPFC, in the instant case the parties entered into a series of related transactions that included not only a VPFC, but also the MSPA and the Share–Lending Agree- ments. e result of these related transactions was that DLJ obtained possession, and most of the incidents of ownership, of TAC’s pledged shares. TAC, in turn, obtained cash payments and an elimination of any risk of loss in the pledged stock’s value at the end of the term of the transactions. us, we conclude that petitioners’ reliance on Revenue Ruling 2003-7 is misplaced.26
Finally, the taxpayers argued that they were protected under the safe harbor rule in Code Sec. 1058 from im- mediate taxation. Code Sec. 1058(a) provides that where a taxpayer who transfers securities, de ned in Code Sec. 1236(c), pursuant to an agreement that meets the require- ments of Code Sec. 1058(b), no gain or loss is recognized on the exchange of such securities by the taxpayer for an obligation under such agreement, or on the exchange of
rights under such agreement by that taxpayer for securi- ties identical to the securities transferred by that taxpayer. e requirements under Code Sec. 1058(b) state that the operative agreement shall (i) provide for the return to the transferor of securities identical to the securities transferred; (ii) require that payments shall be made to the transferor of amounts equivalent to all interest, dividends, and other distributions that the owner of the securities is entitled to receive during the period beginning with the transfer of the securities by the transferor and ending with the transfer of identical securities back to the transferor; (iii) not reduce the risk of loss or opportunity for gain of the transferor of the securities in the securities transferred; and (iv) meet such other requirements as the Secretary
may by regulation prescribe.
e Tenth Circuit held that the taxpayers cannot meet
the dividend and risk of loss and opportunity of gain requirements under Code Sec. 1058(b). Accordingly, the proposed de ciencies in federal corporate and individual income taxes against the corporation and the shareholders were upheld.
McKelvey Est.
e Tax Court was again asked to address the federal income tax consequences of a VPFC in McKelvey Est. e Decedent (McKelvey) entered into two VPFCs with two investment banks in 2007 with respect to 1,765,188 shares of Monster class B common stock owned by the decedent. Pursuant to the terms of the original VPFCs, the investment banks made prepaid cash payments to the decedent of $50.1M in September 2007. Under the agree- ment, decedent was obligated to deliver variable quantities of stock to the investment banks on 10 speci ed future settlement dates in September 2008 (original settlement dates) in accordance with a detailed formula. e actual number of Monster shares (or cash equivalent) required for delivery on each settlement date would vary according to the stock market closing price of Monster shares on each speci c settlement date.
Also in September 2007, decedent entered into a second VPFC for 4,762,000 shares of Monster common stock with a second investment bank. Pursuant to the terms of this second VPFC, McKelvey received an up-front cash prepayment of $142.6M in exchange for his agreeing to deliver to the bank one year later up to 4,762,000 shares of Monster common stock or the cash equivalent, again in accordance with the average closing price of Monster stock on the speci ed settlement dates. e formula used was the same as that used with the other investment bank under the rst VPFC. Decedent treated the execution of
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