December 27, 2011
As we have previously reported (see here, here, and here), in Anschutz the Tax Court collapsed two transactions and held that they amounted to a taxable sale of stock. The Tenth Circuit was unmoved by the taxpayer’s appeal and has now affirmed, barely five weeks after hearing oral argument. In its decision, the court of appeals analyzes the transaction through the lens of the eight factors for determining a sale listed in Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237 (1981). With respect to the factor that assesses whether an equity interest was acquired in the property, the court quotes at length from the IRS’s Feb. 6, 2008, Coordinated Issues Paper on the topic, finding its analysis “compelling and applicable to the case before us.”
The court also rejects the taxpayer’s efforts to analogize its transactions to other approved transactions. The court explains that the transaction addressed in Rev. Rul. 2003-7 is distinguishable, in part because there was no borrowing of pledged shares. And the court holds that the taxpayers’ transactions in this case did not fall within the “safe harbor” of Code section 1058 because they “effectively eliminated [the] risk of loss and substantially reduced [the] opportunity for gain.”
November 17, 2011
On November 16, the Tenth Circuit heard oral argument in the Anschutz case, involving the taxpayers’ appeal from the Tax Court’s decision to collapse two transactions involving the use of prepaid variable forward contracts (“PVFCs”) and concurrent share lending agreements (“SLAs”), and treat them as a taxable sale of stock. A fuller description of the case and the parties’ briefs can be found in our prior reports here and here.
The panel hearing oral argument was Chief Judge Briscoe (a Clinton appointee and former Kansas state court judge and Assistant U.S. Attorney), Senior Judge McKay (a Carter appointee who was previously in private practice), and Judge O’Brien (a Bush II appointee who served for many years as a Wyoming state judge).
There is no specific date by which the court must decide the case, but a decision is most likely in the spring of 2012.
June 29, 2011
The government filed its response brief in Anschutz Co., et al. v. Commissioner, Nos. 11-9001 & 11-9002 (10th Cir.), on June 22, 2011 (linked below). See our prior coverage here. Not surprisingly, the government argues that the Tax Court got it right in viewing the putatively separate variable prepaid forward contracts and stock loans as two parts of one overall arrangement, designed to monetize the value of the taxpayer’s low-basis stock at the outset of the deal. The Tax Court held that, in substance, the overall arrangement was a sale for tax purposes because the benefits and burdens of owning the stock had been passed to Anschutz’s counterparty. Based on the briefing, it appears that the key question in the case will be whether the IRS and the Tax Court were correct in viewing the transactions as an integrated whole, or whether they must be analyzed separately under the technical provisions applicable to stock loans and variable prepaid forwards.
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.
March 21, 2011
A while ago we reported on a spate of IRS successes in cases involving purported securities loans (here). The Samueli case is fully briefed in the Ninth Circuit and is expected to be argued in the next couple of months. As we anticipated, two more of those cases, Anschutz and Calloway, have been appealed to the Tenth and Eleventh Circuits, respectively. The taxpayer in Calloway filed his opening brief on March 15, 2011 (linked below). Briefing has not yet begun in Anschutz.
In Calloway, the taxpayer was an IBM employee of many years who had acquired IBM stock during his employment. By the time of the transaction in question, the stock’s value was five times the taxpayer’s basis. Desiring to monetize the stock, and by his own admission, seeking to maximize his after-tax return, the taxpayer entered into an arrangement whereby he transferred his stock to a counterparty in return for a loan equal to 90% of the stock’s fair market value. This resulted in a 10% higher return than a straight sale subject to long-term capital gains tax. Under the arrangement, the taxpayer had no right to any dividends, no ability to reap any gains from appreciation of the stock, and no right to recall the stock during the loan period. The counterparty had the right to sell or otherwise dispose of the stock it purportedly held as collateral. At the close of the three-year loan period, the taxpayer had the option of repaying the principal with interest to redeem his collateral, refinancing the transaction for an additional term, or surrendering his collateral in exchange for extinguishment of the debt. As the stock had depreciated significantly, the taxpayer chose to surrender his collateral. Notably, not only did the taxpayer not report the transaction as a sale, he also did not report any cancellation of indebtedness income upon extinguishing the purported debt.
The IRS challenged the taxpayer’s treatment of the transaction as a loan, asserting that in substance the arrangement was a sale of the taxpayer’s securities. In a reviewed decision, the Tax Court agreed with the IRS that the transaction was indeed a sale, primarily because the benefits and burdens of ownership of the stock had in fact passed to the counterparty (under an application of the test articulated in Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221 (1981)). Of course, it didn’t help the taxpayer that the counterparty had been sued successfully for promoter penalties and for an injunction to cease all further shelter promotion activities.
On appeal, the taxpayer’s position centers around the arguments that (1) the Tax Court’s finding that the counterparty had the right to sell the stock immediately was clear error, and (2) the finding that the taxpayer could not demand the return of his stock during the three-year period was also clear error. These arguments apparently are based on the position that the counterparty did not have the right to sell the stock until a “legitimate” loan was already in place, and because the counterparty used the stock sale to finance the purported loan, no such right ever accrued. Thus, according to the taxpayer, he remained in control of the stock under the terms of the arrangement, and therefore the transaction is subject to the safe harbors under I.R.C. § 1058 and Rev. Rul. 57-451, and furthermore should not be deemed a sale under the applicable common law securities-loan authorities.
We’ll provide an update when the government files its response, and we’ll post on Anschutz when the briefing gets under way (the opening brief is due May 2). On a related note, the Tax Court recently held for the government in a case involving a transaction materially identical to the one in Calloway. See Kurata v. Commissioner, T.C. Memo 2011-64 (March 16, 2011).