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Monday, March 5, 2012
No transferee liability found in sale of all company's assets followed by sale of all its stock
In consolidated cases, the Tax Court has refused to apply the substance over form doctrine to recast the sale of a company's stock, following a sale of all its assets, as a liquidating distribution. The Court further found that the taxpayers weren't liable as transferees under Code Sec. 6901 for tax liabilities arising from the asset sale.
Background.Code Sec. 6901(a) provides that the liability of a transferee of a taxpayer's property may be “assessed, paid, and collected in the same manner and subject to the same provisions and limitations as in the case of the taxes with respect to which the liabilities were incurred.” It doesn't create or define a substantive liability, but merely provides IRS a procedure to assess and collect from the transferee of property the transferor's existing liability. The existence and extent of the transferee's liability are determined by the law of the State in which the transfer occurred.
Facts. On July 2, 2001, Citadel, a large company engaged in the broadcasting business, finalized a deal in which it purchased for $45 million all the assets of the radio stations owned and operated by Slone Broadcasting, a family-run business, that operated several radio stations in Tucson, Arizona. At one point, James and Norma Slone owned all the stock of Slone Broadcasting. In 2001 Slone Broadcasting had two shareholders: Slone Revocable Trust and Slone GST Trust. Slone Broadcasting's adjusted basis in the sold assets was $6,401,074, resulting in a gain of $38,598,926 and an estimated combined Federal and State income tax liability of approximately $15,314,000. In the sale transaction, no tax strategies were utilized by Slone Broadcasting's legal and accounting advisers to reduce the Federal and State income taxes impact.
Slone Broadcasting didn't conduct any business after the asset sale. There were no plans to either liquidate the corporation or make distributions to its shareholders (and no distributions were made). On Oct. 15, 2001, Slone Broadcasting made its first estimated Federal income tax payment of $3,100,000 to IRS for its tax year ending June 30, 2002.
After the asset sale, Slone Broadcasting was contacted by Fortrend International, LLC (Fortrend) and Midcoast Credit Corp (Midcoast). They expressed an interest in purchasing Slone Broadcasting's stock. Slone Broadcasting's legal and accounting advisers knew that Fortrend had a strategy to reduce the income tax due from the asset sale. Fortrend stated that its tax-saving strategy was “proprietary” and couldn't be disclosed. However, Fortrend represented that it wasn't engaging in any transaction that would be deemed a “listed transaction” under Notice 2001-51, 2001-2 CB 190 (i.e., transactions that have been specifically identified by IRS as tax avoidance transactions). In negotiating for the stock sale, Slone Broadcasting received an increase in the purchase price for the stock based on the tax savings anticipated by the buyer.
Legal advisors of both Slone Broadcasting and Slone GST Trust independently analyzed the transferee liability considerations in the stock sale, and concluded that there was no liability. The advisors believed Fortrend planned to offset the gains from the asset sale by contributing high basis/low value assets in a nontaxable Code Sec. 351 transaction and selling those assets at a loss. There was no reason to think that Fortrend planned to use an illegitimate scheme to offset the gains from the asset sale. On Dec. 10, 2001, Fortrend purchased Slone Broadcasting's stock through an affiliate, Berlinetta, Inc. (Berlinetta). Slone Broadcasting's shareholders Slone Revocable Trust and Slone GST Trust received $30,819,544 and $2,550,456 in cash, respectively.
Slone Broadcasting merged with Berlinetta, with Slone Broadcasting surviving and renamed as Arizona Media. Its sole shareholder contributed Treasury bills to Arizona Media with a purported basis of $38,148,304, which Arizona Media sold for $108,731. On July 7, 2002, Arizona Media filed its return, reporting a $37,885,260 gain from the asset sale and an offsetting $38,039,573 loss from the sale of the Treasury bills. On Aug. 6, 2002, IRS refunded Arizona Media the $3,100,000 estimated tax payment previously made by Slone Broadcasting. On audit, IRS determined a deficiency of $13,494,884, a Code Sec. 6662 penalty of $2,698,997, and interest of $7,277,395.
On their joint return, James and Norma Slone reported a basis in their Slone Broadcasting stock of $106,679, resulting in $32,765,826 of gain from the stock sale. On its return, the Slone GST Trust reported a basis of $8,277 in its Slone Broadcasting stock, resulting in $2,542,179 of gain. The Slone Revocable Trust, as a disregarded entity, did not file a return.
On Dec. 22, 2009—after IRS failed to collect the assessed tax, penalty, and interest from Arizona Media—IRS issued transferee notices to the Slone Revocable Trust and Slone GST Trust, determining that the trusts were liable for $16,193,881 and $2,550,832, respectively, plus interest, as transferees of assets for the unpaid liability of Arizona Media for the tax year ending June 30, 2002. IRS also issued separate transferee notices to James and Norma Slone individually, determining each liable under a transferee theory for $16,193,881, plus interest, for the unpaid liability of Arizona Media.
IRS's position. IRS's initially contended that the stock sale shouldn't be respected for Federal tax purposes because it was substantially similar to an “intermediary transaction” tax shelter described in Notice 2001-16. IRS sought to collapse the asset sale and the stock sale to recharacterize the transactions as an asset sale followed by a liquidating distribution.
IRS abandoned this position and acknowledged that the asset sale was independent from the stock sale. Instead, IRS argued that the substance over form doctrine applied to recast the stock sale alone as a liquidating distribution. IRS conceded that the taxpayers' transferee liability under Code Sec. 6901 relied on an underlying substance over form argument. Accordingly, if it was determined that the stock sale must be respected for Federal tax purposes, IRS's transferee liability argument must fail.
Court's findings. The Tax Court concluded that neither the substance over form doctrine nor any related doctrines applied to recast the stock sale as a liquidating distribution. The form of the transaction had to be respected for Federal tax purposes. The Court also found that IRS's concession resolved the transferee liability issue in the taxpayers' favor, and so it didn't need to analyze any liability under State law.
The Tax Court noted that IRS had conceded that the asset sale was independent from the stock sale. The asset sale closed more than five months before the stock sale. The asset sale was negotiated by a media broker with legal and accounting advisors and involved no tax strategies to offset the potential gain. There was no evidence that Fortrend, Midcoast, or Berlinetta were involved in any way in the asset sale, or that a sale of stock was anticipated at that time. In fact, Slone Broadcasting paid its first installment of $3,100,000 of Federal income tax attributable to the asset.
As to the stock sale, Fortrend initiated contact with Slone Broadcasting after the asset sale closed. Attorneys having no involvement in the asset sale were retained to negotiate the stock sale. Due diligence confirmed that Fortrend and Midcoast were legitimate corporations, with reputable law and accounting firms representing them and a bank funding them.
The Tax Court rejected IRS's contention that the taxpayers knew that Fortrend planned to offset the gain from the asset sale and that this was enough information for the taxpayers to know of Fortrend's illegitimate scheme. There are legitimate tax planning strategies to defer or avoid paying taxes, so it wasn't unreasonable to believe that Fortrend had a legitimate method of doing so. When the taxpayers' advisors asked Fortrend for more information about how Berlinetta planned to offset the gains from the asset sale, they were told that Fortrend's methods were “proprietary.” The taxpayers didn't have a duty to inquire further and weren't responsible for any tax strategies Berlinetta used after the stock sale closed.