May 17, 2011
As we’ve reported in the last few months, several securities lending cases are percolating in the appellate courts (see here and here). On April 29, 2011, Anschutz Company filed the opening brief in its appeal of the Tax Court’s decision for the government (opinion and brief linked below).
At issue in Anschutz is the appropriate tax treatment of a set of transactions between the taxpayer and Donaldson, Lufkin & Jenrette Securities Corp. (“DLJ”). The taxpayer sought to leverage long-held shares in publicly-traded railroad companies to obtain financing for other endeavors. In the taxpayer’s hands, the shares had a low basis relative to their fair market value at the time of the transactions in question. The transactions involved the use of prepaid variable forward contracts (“PVFCs”) and concurrent share lending agreements (“SLAs”). Under the PVFCs, DLJ paid the taxpayer a percentage of the current market value of the shares in exchange for the right to receive a number of shares or their cash equivalent at a point in the future. The number of shares to be delivered (or their cash equivalent) was to be determined by a formula agreed upon at the outset. In order to secure its obligation, the taxpayer pledged a number of shares sufficient to ensure consummation of the deal at maturity. In parallel, DLJ entered into an SLA with the taxpayer under which DLJ would take possession of the pledged shares to use them in short sale transactions. Although each of the two transactions, viewed in isolation, would have passed muster under relevant authorities as non-taxable open transactions, the government challenged the arrangement as constituting in substance a taxable sale of the shares at the inception of the deal. After a two-day trial, the Tax Court agreed.
On appeal, Anschutz argues that the Tax Court’s decision to view the transactions as two legs of one overall arrangement was error. Rather, the taxpayer contends that the two transactions should be respected as stand-alone occurrences to be analyzed separately. Under the taxpayer’s view, the PVFCs are non-taxable open transactions under Rev. Rul. 2003-7, and the SLAs fall within the ambit of I.R.C. section 1058 (stock loans not taxable provided certain conditions are met). For the Tax Court, the crux of the case was that the PVFCs had the effect of shifting to DLJ all risk of loss and most of the opportunity for gain on the shares. Under section 1058, a stock lending arrangement cannot reduce the risk of loss or opportunity for gain if it is to be considered non-taxable. The taxpayer contends, however, that in spite of a master agreement governing both legs of the arrangement, the facts properly construed require the two transactions to be analyzed separately as independent deals, each with their own tax consequences.
The government’s response is now due on June 24, 2011. We’ll keep you posted on this and other developments in the securities lending cases.