Sandra K. Shockley v. Commissioner of Internal Revenue

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[PUBLISH]
IN THE UNITED STATES COURT OF APPEALS
FOR THE ELEVENTH CIRCUIT
________________________
No. 16-13473
________________________
U.S. Tax Court Docket Nos. 28207-08, 28208-08, 28210-08
SANDRA K. SHOCKLEY, et al.,
Petitioners-Appellants,
versus
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee.
________________________
Appeal from the United States Tax Court
________________________
(October 3, 2017)
Before TJOFLAT and WILSON, Circuit Judges, and ROBRENO, * District Judge.
*
Honorable Eduardo C. Robreno, United States District Judge for the Eastern District of
Pennsylvania, sitting by designation.
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ROBRENO, District Judge:
Terry and Sandra Shockley, a husband and wife duo, formerly owned a
television and radio company called Shockley Communications Corporation
(“SCC”). In conjunction with their retirement, the Shockleys sold SCC and
reported their gains from this sale on timely federal income tax returns for calendar
year 2001. In September 2007, the Commissioner of the Internal Revenue Service
(“IRS”) assessed additional tax liabilities against SCC for its tax year ending May
31, 2001, and subsequently asserted transferee liability under I.R.C. § 6901 against
each of eight of the largest selling shareholders, including Terry and Sandra
Shockley.
The Tax Court upheld the Commissioner’s transferee liability assessment.
The Shockleys, along with another former SCC shareholder, Shockley Holdings,
L.P. (collectively, “Petitioners”), now appeal this ruling, arguing that the Tax
Court erred in assessing tax liabilities against them as transferees under both
federal and state laws. For the reasons that follow, we will affirm the decisions of
the Tax Court.
I.
The facts giving rise to this appeal—some of which are stipulated, and none
of which are disputed—are lengthy and complex. Drawing largely on the Tax
Court’s recitation in the opinion below, we organize this tortuous series of
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transactions into the following broad categories: the decision to sell, negotiations,
structuring the transaction, the agreements, closing and results, and the tax
consequences of all the foregoing.
A.
Decision to Sell
After purchasing a radio station in Madison, Wisconsin, in early 1985, Terry
and Sandra Shockley incorporated SCC, a closely held corporation, under the laws
of Wisconsin. Between 1985 and 2000, SCC grew to own five television stations,
a radio station, and a video production company in Wisconsin, as well as a
television station and several radio stations in Minnesota. SCC brought in
additional investors during this time to fund its significant business expansion.
SCC eventually came to be owned by 29 separate shareholders, including
Petitioners, several other individuals, a number of investment funds, and the State
of Wisconsin Investment Board (collectively, “SCC shareholders”). Terry and
Sandra, who each separately owned 10.18879% of SCC’s common stock, served as
members of the SCC Board of Directors (“SCC Board”). Terry also served as
SCC’s president and treasurer, and Sandra served as SCC’s vice president and
secretary. Shockley Holdings L.P.—an entity owned by the Shockleys, as general
partners, and their adult children, as limited partners—owned 3.52508% of SCC’s
common stock.
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The Shockleys began considering their retirement options in 1999. On
January 21, 2000, they met with Stephen A. Schmidt (“Schmidt”), a managing
director and tax partner of a professional audit, tax, and consulting services firm
called RSM McGladrey, Inc. (“RSM”). During this meeting and through later
communications, the Shockleys, other members of the SCC Board, and RSM
discussed the following six potential alternative futures for SCC: (1) a sale of
assets by SCC followed by its liquidation; (2) a sale of SCC stock; (3) tax-free
reorganizations under I.R.C. § 368; (4) a “spin-off” of the SCC’s radio assets under
I.R.C. § 355, followed by a sale of SCC stock; (5) redemption of SCC stock from
the SCC shareholders; and (6) a sale of SCC stock using an employee ownership
plan. Schmidt also introduced the Shockleys to Integrated Capital Associates
(“ICA”), a firm that facilitated stock sales of companies.
In February 2000, the Shockleys met with media broker Kalil & Co., Inc.
(“Kalil”) to further discuss potential alternatives for the future of SCC. On April 5,
2000, Terry signed an agreement authorizing Kalil “to act as exclusive broker in
the sale of all of [SCC’s] assets.” Appellee’s Corrected Suppl. App. Tab 5 (Ex. 23-
J). After this exclusive brokerage agreement was in place, Kalil began seeking
potential buyers for SCC. Around the same time, in April 2000, the Shockleys met
with Eric Sullivan, a principal of ICA, to learn more about his company’s services.
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Over the next several months, the Shockleys continued to seek and receive
advice from RSM and communicate regularly with Kalil regarding efforts to sell
SCC. RSM presented the Shockleys with analyses that compared the projected
impacts on both buyers and sellers of a stock sale versus an asset sale. One such
analysis, which assumed a value of $190 million for SCC’s radio and television
assets, showed net after-tax liquidation proceeds to SCC shareholders of $94
million for a hypothetical stock sale, but only $75 million for the correlating
proceeds of a hypothetical asset sale. After reviewing this analysis, and out of
concern that a piecemeal sale of SCC’s assets over time might negatively impact
employee retention and decrease productivity, the SCC Board initially decided to
pursue a stock sale.
This decision notwithstanding, Terry subsequently discovered that the
general preference of buyers in the broadcasting industry was an asset sale.
Further, although Kalil was able to find potential buyers interested in SCC’s assets,
the Shockleys learned it was unlikely that a broadcasting business would be
interested in buying the stock of a company, like SCC, that had both television
stations and radio stations; buyers who were interested in small-sized-market radio
stations generally were not interested in medium-sized-market television stations,
and vice versa.
5
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B.
Negotiations
In May 2000, a purchase offer for SCC’s television assets was made by an
Illinois-based media company named Quincy Newspapers, Inc. (“QNI”).
Structured as an asset sale, QNI’s offer tendered a purchase price of $160 million
for SCC’s television stations and production company. These items comprised
approximately 95% of SCC’s total radio and television assets. No agreement was
reached immediately, but negotiations continued throughout the summer of 2000.
Meanwhile, in a letter dated June 7, 2000, Kalil made Terry aware of two
separate companies—Fortrend International, LLC (“Fortrend”), and Diversified
Group (“Diversified”)—that had each expressed willingness to buy the stock of
SCC and then sell its assets to third-party buyers. As Kalil explained in the letter,
this “buy stock/sell assets” transaction would, with either Fortrend or Diversified,
proceed as follows:
It looks like they negotiate a fee of somewhere between 5-7% on the
gain. You would sell them the stock and they would sell the assets to
a buyer. Both applications would be filed with the [Federal
Communications Commission (“FCC”)] concurrently and they would
“own” [SCC] for about one hour. They feel confident that their tax
attorneys can explain this in such detail as to give both buyer and
seller total comfort.
Appellee’s Corrected Suppl. App. Tab 7 (Ex. 27-J).
In late August 2000, Schmidt arranged a conference call for the Shockleys
and several others to speak with David Kelley, who worked at ICA. The agenda
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for the call included an overview of ICA, the possible use of a “Midco” transaction
for the stock sale of SCC, 1 and a discussion as to why ICA should be selected over
Fortrend or Diversified. During this conference, the Shockleys and other attendees
were informed of a risk that the IRS might recharacterize the transaction as an
asset sale. ICA, however, represented that none of the similarly structured
transactions it had facilitated over an 18-year period had been successfully
challenged or unwound.
In September 2000, QNI indicated that it was willing to consider structuring
the transaction as a purchase of SCC’s stock instead of assets, and it asked Kalil to
provide SCC’s asking price for the stock. In response, Terry drafted a letter to
QNI that (1) showed SCC’s projected purchase prices for a stock sale and,
alternatively, for an asset sale; (2) indicated that SCC could proceed with a
transaction structured either way; (3) provided an analysis comparing an asset
purchase with a stock purchase; and (4) explained that the cash savings to SCC of a
stock sale, rather than an asset sale, would be $11 million. See Appellee’s
Corrected Suppl. App. Tab 58 (Ex. 349-J). He noted in this letter that SCC had a
1
“Midco,” which stands for “middle company,” generally refers to a transaction in which
“the seller engages in a stock sale (thus avoiding the triggering of built-in gain in appreciated
assets) while the buyer engages in an asset purchase (thus allowing a purchase price basis in the
assets), through use of an intermediary company.” The Growing Threat of Transferee Liability
in Midco Deals, Law360, July 5, 2016, available at https://www.law360.com/articles/813956/
the-growing-threat-of-transferee-liability-in-midco-deals.
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“‘Midco’ company arrangement standing by to proceed.”2 See id. QNI did not
agree to the terms presented in that letter and never agreed to buy the stock of
SCC, but it remained interested in the television assets nonetheless. Kalil therefore
continued to negotiate with QNI, on behalf of an ICA affiliate, regarding the price
and terms of a potential sale of SCC’s assets.
The SCC shareholders represented on the SCC Board finally decided in the
fall of 2000 that they would sell SCC’s stock to an affiliate of ICA. 3 Terry
informed Kalil that this was their intention.
C.
Structuring the Transaction
On October 6, 2000, ICA organized Northern Communications Acquisition,
LLC (“NCA LLC”), a Delaware limited liability company. On October 13, 2000,
NCA LLC executed a trust agreement with Roger Ohlrich, an agent of ICA,
forming Northern Communications Statutory Trust (“NCS Trust”) under the laws
of Connecticut. According to the trust instrument, for which NCA LLC acted as
2
The letter further provided that “[i]n discussions with . . . our FCC Counsel, we have
been assured both that the Midco purchase of SCC stock and the Midco sale of the TV assets to
QNI can proceed simultaneously with the FCC and should not significantly delay a Closing.” Id.
3
Although SCC had 29 total shareholders at that time, a provision in its shareholders’
agreement provided that if shareholders owning 65% or more of the shares “determine[d] to sell
or otherwise dispose of all or substantially all of the assets of [SCC] or all of the capital stock of
[SCC],” they could compel the remaining shareholders to vote in favor of the asset sale or
participate in the stock sale. Appellee’s App. Tab 55 (Ex. 328-J, § 3.4(a)). At the time this
decision was made, the largest shareholders were the State of Wisconsin Investment Board
(24.57%), Allsop Venture Partners III, L.P. (21.87%), and Petitioners (collectively, about
23.9%).
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trustor and beneficiary and Ohlrich acted as trustee, NCS Trust was established for
the sole purpose of acquiring the stock of SCC. 4
Also on October 6, 2000, QNI faxed a nonbinding letter of intent to ICA
regarding QNI’s purchase of the television assets from an undisclosed client of
ICA. 5 Kalil negotiated with QNI regarding the final price of the potential
purchase, and on October 27, 2000, QNI sent Kalil—who was working on behalf
of the still-undisclosed client of ICA that would ultimately sell QNI the television
assets—a revised draft of the nonbinding letter of intent. On October 31, 2000,
Kalil, on behalf of this seller, sent QNI a letter accepting its offer to purchase the
television assets.
Although the intent was for QNI to purchase all of SCC’s television assets,
FCC regulations prohibited QNI from purchasing the Minnesota television station
because of market conflict. QNI, however, still desired an economic benefit from
its relationship with the Minnesota television station, as well as an option to buy it
later, if possible. To accommodate QNI, the Shockleys organized a company
called TSTT, LLC (“TSTT”), a Wisconsin entity that would purchase the
4
Frank Taboada, counsel for ICA, NCS Trust, and the affiliated entities of NCS Trust,
explained at trial that it is customary to create entities specifically for a particular transaction.
5
This client was later identified as NCS Trust, the ICA affiliate established on October 13,
2000.
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Minnesota television station from NCAC. At some point prior to January 23,
2001, TSTT was renamed Shockley Broadcasting, LLC (“SB LLC”).
On December 1, 2000, counsel for ICA incorporated Northern
Communications Acquisition Corp. (“NCAC”), a Delaware corporation and
wholly-owned subsidiary of NCS Trust. NCAC was created to serve as the entity
that would purchase the SCC stock. Ohlrich became the president of NCAC, as
well as the chairman and sole member of its board of directors.
Terry did not conduct any in-depth background investigation of NCS Trust
or NCAC, and the SCC shareholders voiced concerns during stock purchase
negotiations about the creditworthiness of NCAC. ICA responded to these
concerns by forming Northern Communications Fund, LLC (“NC Fund”), which
was wholly owned by ICA-related entity Integrated Acquisitions Group, LLC
(“IAG”). NC Fund and another entity, Slabfork LLC, then became the 85% and
15% owner-members, respectively, of the already-established NCA LLC. In a
letter dated December 28, 2000, written to Terry in his capacity as shareholder
representative, IAG represented that it would cause NCAC to be capitalized using
either cash or technology interests via NC Fund, NCA LLC, and NCS Trust.
D.
The Agreements
By the end of December 2000, NCAC had entered into the following three
separate purchase agreements:
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(1) A stock purchase agreement with the SCC shareholders (“SCC
SPA”) dated December 28, 2000, providing that the SCC
shareholders would sell to NCAC all the SCC stock for a
purchase price of $117 million, subject to certain adjustments.
(2) An asset purchase agreement with QNI (“QNI APA”) dated
December 29, 2000, providing that NCAC would sell SCC’s
Wisconsin television stations and production company to QNI
for $168 million, subject to certain adjustments.
(3) An asset purchase agreement with TSTT (“TSTT APA”) dated
December 29, 2000, providing that NCAC would sell the
Minnesota television station to TSTT for $3 million.
In the course of negotiating these agreements, SCC and NCAC counsel remained
wary of “minimiz[ing]” and “eliminat[ing]” any “linkage issues” between the SCC
SPA and the APAs with other entities. See, e.g., Appellee’s Corrected Suppl. App.
Tab 17 (Ex. 78-J) (suggesting edits to the proposed QNI APA “to eliminate linkage
issues with respect to the SPA and APA,” and further suggesting that the parties
“consider how many references are appropriate to SCC if we are attempting to
draft an APA that minimizes linkage issues with SCC”); id. Tab 56 (Ex. 331-J)
(requesting to receive comments “orally, so as to not create too much of a
connection between this document and your client”).
On January 19, 2001, the IRS released Notice 2001–16, 2001–1 C.B. 730,
clarified by Notice 2008–111, 2008–51 I.R.B. 1299, which identified and
described certain transactions as types of an “intermediary transactions tax shelter”
and advised that direct or indirect participants of the same or substantially similar
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transactions would be required to disclose their participation in accordance with 26
C.F.R. § 1.6011–4T(b)(2). 6 Schmidt sent copies of Notice 2001–16 to the
Shockleys and their legal counsel because he believed that the proposed transaction
with ICA bore some similarities to the transactions described in the notice.
In early 2001, Ohlrich toured the stations that SCC owned and was
introduced to SCC employees as the president of the company that was purchasing
6
Specifically, Notice 2001-16 provided in relevant part as follows:
The Internal Revenue Service and the Treasury Department have become
aware of certain types of transactions, described below, that are being marketed to
taxpayers for the avoidance of federal income taxes. The Service and Treasury are
issuing this notice to alert taxpayers and their representatives of certain
responsibilities that may arise from participation in these transactions.
These transactions generally involve four parties: seller (X) who desires to
sell stock of a corporation (T), an intermediary corporation (M), and buyer (Y)
who desires to purchase the assets (and not the stock) of T. Pursuant to a plan, the
parties undertake the following steps. X purports to sell the stock of T to M. T
then purports to sell some or all of its assets to Y. Y claims a basis in the T assets
equal to Y’s purchase price. Under one version of this transaction, T is included
as a member of the affiliated group that includes M, which files a consolidated
return, and the group reports losses (or credits) to offset the gain (or tax) resulting
from T’s sale of assets. In another form of the transaction, M may be an entity that
is not subject to tax, and M liquidates T (in a transaction that is not covered by §
337(b)(2) of the Internal Revenue Code or § 1.337(d)–4) of the Income Tax
Regulations, resulting in no reported gain on M’s sale of T’s assets.
Depending on the facts of the particular case, the Service may challenge
the purported tax results of these transactions on several grounds, including but
not limited to one of the following: (1) M is an agent for X, and consequently for
tax purposes T has sold assets while T is still owned by X, (2) M is an agent for
Y, and consequently for tax purposes Y has purchased the stock of T from X, or
(3) the transaction is otherwise properly recharacterized (e.g., to treat X as having
sold assets or to treat T as having sold assets while T is still owned by X).
Alternatively, the Service may examine M’s consolidated group to determine
whether it may properly offset losses (or credits) against the gain (or tax) from the
sale of assets.
Notice 2001–16, 2001–1 C.B. 730.
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SCC. In addition, NCS Trust applied for a loan of $175 million from Ultrecht–
America Finance Co. (“UAFC”), a subsidiary of Coöperatieve Centrale
Raiffeisen–Boerenleenbank, B.A. (“Rabobank”), in contemplation of purchasing
the SCC stock. On or around January 23, 2001, NCAC, SCC, QNI, and the newly
renamed SB LLC filed applications with the FCC seeking consent for the SCC
stock sale, transfer of the television stations, and assignment of broadcast station
licenses as required by the parties’ respective agreements with one another.
In a letter dated March 29, 2001, Midwest Communications, Inc.
(“Midwest”), a Wisconsin corporation, made an offer to purchase the SCC radio
assets from NCAC for $7.5 million. NCAC, through Ohlrich, accepted the offer
on March 31, 2001.
On April 5, 2001, ICA’s counsel incorporated Shockley Delaware Corp.
(“SDC”), which was wholly owned by NCAC. SDC was created, in part, to hold
SCC’s assets after the acquisition. At some point on or after April 27, 2001, ICA’s
agents formed Northern Communications Holdings Co. (“NC Holdings”), which
had the same officer and director as NCAC: Ohlrich. ICA instructed that NC
Holdings was to be created to serve as an intermediate company so that NC
Holdings would wholly own NCAC while being wholly owned by NCS Trust.
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In the midst of this activity, the president of Kalil sent a business letter to
Terry, SCC, QNI, and Midwest dated April 16, 2001, referencing a discussion that
he had had with Terry regarding Kalil’s fee schedule:
Also, we discussed waiving the fee on the midco expense of $9
million to which I have agreed.
In other words, our exclusive agreement fee schedule is applicable for
$162 million on the television station sale and dollar-for-dollar on the
radio station sale or a combined $178.5 million less $9 million
equaling $169.5 million.
Appellee’s Corrected Suppl. App. Tab 57 (Ex. 334-R). Subsequently, in a business
letter to Kalil drafted on May 1, 2001, Terry referenced an attached exhibit A,
which showed a “Stock Transaction Fee - ICA ($9,000,000).”7 Appellee’s
Corrected Suppl. App. Tab 37 (Ex. 179-J).
On May 15, 2001, UAFC, which had financed other acquisitions by ICA,
approved the loan request made by NCS Trust. This loan was to take the form of a
promissory note up to $175 million made by NCS Trust in favor of Rabobank.
Purportedly, the proceeds of the note would be used to fund NCAC’s purchase of
SCC’s stock. Besides pledges to be made by NCS Trust, the note would at all
times be fully secured by an amount in excess of the borrowed funds as provided
by QNI and to be held in an escrow account (“Escrow I”)—or, alternatively, QNI
7
It is unclear whether ICA ever actually received any fee. See Shockley v. Comm’r, 109
T.C.M. (CCH) 1579, 2015 WL 3827570, at *17 (2015) (noting that “there are some gaps in the
record,” including “whether ICA actually received a fee and in what amount”).
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would provide Rabobank with irrevocable payment instructions for cash held at
First Union National Bank (“First Union”). Rabobank expected the loan to be
repaid within two days of its being made from the proceeds of the QNI APA, and it
expected to receive a transaction fee.
On May 25, 2000, Midwest and NCAC entered into an asset purchase
agreement (“Midwest APA”) with respect to SCC’s radio assets. NCAC, SCC,
QNI, and SB LLC received the FCC consents for their broadcast license
applications on May 30, 2001. Also on that date, UAFC, NCS Trust, NCAC, the
SCC shareholders, and Rabobank entered into an agreement regarding a second
escrow account (“Escrow II”), for which Rabobank would serve as the escrow
agent. According to the agreement, NCAC would use NCS Trust’s loan proceeds
to deposit an amount equal to the SPA purchase price into Escrow II, from which
the SCC shareholders would subsequently be paid for their stock.
E.
Closing and Results
On May 31, 2001, all closings of the sale of SCC stock and sales of SCC
assets took place within a span of less than three hours at one of the law firms
representing ICA and NCS Trust.8 These closings were as follows:
8
Leading up to and throughout the closing, all parties, including Petitioners, engaged
experienced professionals and attorneys to handle complicated portions of the transactions,
including negotiations, FCC regulations, and taxation. SCC and the SCC Shareholders were
represented in the sale of the SCC stock by three different law firms.
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(1) Ohlrich, as trustee of NCS Trust and with respect to its
promissory note, instructed UAFC to draw down $130 million
and to credit the funds to NCS Trust’s Rabobank account. At
the same time, Ohlrich authorized UAFC to debit from the
same account Rabobank’s transaction fee of $750,000. He
transferred the remaining $129,250,000 of loan proceeds to NC
Holdings in exchange for 100 shares of NC Holdings’ preferred
stock given to NCS Trust, and he then pledged both NC
Holdings’ common and preferred stock (held by NCS Trust) to
UAFC as additional security for repayment of the loan.
(2) NC Holdings then gave its $129,250,000 in loan proceeds to
NCAC as a contribution to capital. From that contribution,
NCAC deposited $96,113,235.68 into Escrow II. In accordance
with the SCC SPA and the Escrow II agreement, the SCC
shareholders sold all their shares of SCC to NCAC. SCC then
became a wholly-owned subsidiary of NCAC, and the
Shockleys resigned from their positions in SCC.
(3) Immediately following the sale of this stock, $94,713,235.68
from Escrow II was transferred to a third escrow account
created for the purposes of making disbursements to the (now
former) SCC shareholders.
(4) Next, QNI, NCAC, UAFC, and First Union entered into an
agreement with respect to Escrow I, for which First Union
served as the escrow agent and QNI and several of its
subsidiaries were the guarantors. In accordance with this
agreement, QNI caused to be deposited in escrow at least the
sum required under the QNI APA for the purchase of the
agreed-upon television assets. The agreement further provided
that all amounts paid from Escrow I were to be applied to the
satisfaction of QNI’s obligation to pay the QNI APA purchase
price and the obligation to repay the UAFC loan. Finally, the
agreement provided that UAFC would be repaid that day,
absent any unusual circumstances.
(5) Thereafter, Ohlrich—who was at that point president of both
SDC and SCC—caused SCC to merge with and into SDC.
Effectively at the same time, Ohlrich authorized SDC to convert
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from a corporation to a limited liability company, and thus he
formed a new limited liability company under Delaware law
named Shockley Communications Acquisition, LLC (“SCA
LLC”). SCA LLC immediately admitted an additional
member, Hare Street Trading, L.P., an Isle of Man limited
partnership, which acquired a 1% membership interest. SCA
LLC then purchased the preferred stock subject to the UAFC
loan obligation of NCS Trust. As soon as SCA LLC assumed
this repayment obligation, UAFC released NCS Trust from its
loan obligation. NCAC then merged into NC Holdings, and
although NC Holdings was the surviving entity, its name was
nevertheless changed to “Northern Communications
Acquisition Corp.” (“NCAC II”).
(6) Following its formation, SCA LLC sold its newly acquired
television assets to QNI and SB LLC in accordance with the
QNI APA and the TSTT APA, respectively. A portion of the
proceeds from these asset sales was disbursed to UAFC in
repayment of the loan, and SCA LLC’s obligation under the
loan was thus fully discharged.
(7) Ohlrich, as president of NCAC II, instructed Rabobank to
transfer the remaining $33,136,764.32 of the NCAC
contribution to capital/loan proceeds to an account for SCA
LLC. The FCC broadcast licenses for the radio stations were
assigned from SCC to SCA LLC effective May 31, 2001.
Finally, on September 21, 2001, NCAC II/SCA LLC sold the radio assets to
Midwest in accordance with the Midwest APA. 9
9
From May 31, 2001, through September 20, 2001, SCA LLC remained responsible for
controlling the programming, the employees, and the financial expenditures of the radio stations.
SCA LLC was also the FCC licensee at risk for any violations of FCC rules.
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As a result of all the foregoing transactions, SCC’s appreciated assets were
sold without generating any correlating tax liability to SCC, SDC, SCA LLC,
NCAC II, ICA, the SCC shareholders, or anyone else.10
In exchange for their SCC shares, Terry, Sandra, and Shockley Holdings
ultimately received $10,975,059.03, $11,244,084.42, and $4,053,709.13,
respectively. Petitioners timely filed federal income tax returns for calendar year
2001 reporting gains from the May 31, 2001, sale of SCC stock.
F.
Tax Consequences
On or about February 24, 2002, the IRS received SCC’s Form 1120, U.S.
Corporation Income Tax Return, for its short tax year of January 1 through May
31, 2001. This form, which was prepared by ICA’s Chief Financial Officer,
reported that SCC had zero assets by the end of its 2001 tax year and zero tax due.
It further reported that, on May 31, 2001, SCC had merged into SDC, and
immediately thereafter, SDC converted into a Delaware limited liability company.
This merger and conversion resulted in SCC’s liquidation and tax-free distribution
under I.R.C. § 332.
10
This was the basic bottom line of an opinion letter issued on May 31, 2001, describing
the events that transpired that day and their expected tax consequences. See Shockley, 2015 WL
3827570, at *8-9 (quoting the relevant text of the opinion letter). This letter was prepared by a
law firm representing NCS Trust at the requests of NCS Trust, NC Holdings, NCAC II, SCC,
SDC, and SCA LLC.
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On February 18, 2005, the IRS issued multiple notices of deficiency relating
to SCC’s short tax year ended May 31, 2001. 11 On September 6, 2007, the IRS
assessed the following amounts against SCC for the tax year ending May 31, 2001:
(1) corporate income tax of $41,566,515; (2) an addition to tax under I.R.C.
§ 6651(a)(1) of $2,078,276; (3) an accuracy-related penalty under I.R.C. § 6662 of
$8,313,303; and (4) interest of $26,953,309.60. Thereafter, the IRS undertook
transferee examinations of eight of the largest SCC shareholders who sold their
SCC shares to NCAC on May 31, 2001, including Petitioners. The IRS sent
Petitioners notice of transferee liability statements on August 21, 2008.
On November 19, 2008, Petitioners each filed separate Tax Court petitions
contesting the IRS’s determination that they were liable as transferees for SCC’s
corporate income tax liabilities. The Tax Court consolidated all three cases and
tried them from January 19, 2010, through January 22, 2010. Initially, the Tax
11
On May 25, 2005, the Shockleys filed a petition at docket no. 9700-05 in the United
States Tax Court in response to a deficiency notice they received at what was then their home
address in Madison, Wisconsin. This notice determined a deficiency of $9,868,051 and a
penalty of $1,973,610.20 with respect to the Shockleys’ jointly filed 2001 individual income tax
return. The parties ultimately agreed to settle the case with no deficiency or penalty due, and a
stipulated decision to this effect was entered in docket no. 9700-05 on August 23, 2007.
Also on May 25, 2005, a petition was filed at docket no. 9699-05 in the United States Tax
Court. This petition stated that it was “filed on behalf of Petitioner subject to the invalidity of
the Notice of Deficiency and the failure to properly serve the corporation as required by statute.
Without conceding the jurisdiction of this Court, the Petitioner hereby submits this Limited and
Special Petition.” This case was dismissed for lack of jurisdiction on April 26, 2007, on the
basis that SCC lacked legal capacity to proceed through the Shockleys. The order of dismissal
stated that the parties had agreed that the case should be dismissed on this ground, and therefore
the Court did not need to determine the validity of the notice of deficiency.
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Court held that the limitations period for the IRS to assess transferee liability had
expired, and it entered decisions in favor of the Shockleys on that basis on May 2,
2011. See Shockley v. Comm’r, 101 T.C.M. (CCH) 1451, 2011 WL 1641884, at *9
(2011). The Commissioner appealed, however, and the Eleventh Circuit reversed
and remanded to the Tax Court. See Shockley v. Comm’r, 686 F.3d 1228, 1239
(11th Cir. 2012). The Tax Court then issued a supplemental opinion on June 22,
2015, holding the Shockleys liable as transferees of SCC. See Shockley v.
Comm’r, 109 T.C.M. (CCH) 1579, 2015 WL 3827570, at *20 (2015).12
On March 18, 2016, the Tax Court entered its final decisions in the three
consolidated cases, holding Petitioners liable as transferees of SCC. Terry was
held liable for $10,975,059.00, plus interest. Sandra was held liable for
$11,244,084.00, plus interest. Shockley Holdings was held liable for
$4,053,709.00, plus interest. Petitioners timely appealed.
II.
Whether the Tax Court properly characterized a particular transaction for
federal tax purposes is a question of law subject to de novo review. See Frank
Lyon Co. v. United States, 435 U.S. 561, 581 n.16 (1978); Winn-Dixie Stores, Inc.
12
On August 6, 2015, Petitioners filed a motion for reconsideration, and on January 11,
2016, following additional briefing by the parties, the Tax Court issued a second supplemental
opinion to clarify that Petitioners were liable for pre-notice interest (i.e., for periods prior to the
issuance of the notices of transferee liability) as determined by Wisconsin law, and also for post-
notice interest as determined by the Internal Revenue Code. See Shockley v. Comm’r, 111
T.C.M. (CCH) 1038, 2016 WL 145818, at *6 (2016). The Tax Court’s second supplemental
opinion does not address any of the issues raised in the present appeal.
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v. Comm’r, 254 F.3d 1313, 1315 (11th Cir. 2001). The Tax Court’s application of
state law is also subject to de novo review. L.V. Castle Inv. Grp., Inc. v. Comm’r,
465 F.3d 1243, 1245 (11th Cir. 2006); see also Pugh v. Comm’r, 213 F.3d 1324,
1325 (11th Cir. 2000) (“We have jurisdiction to review the decisions of the Tax
Court ‘in the same manner and to the same extent as decisions of the district courts
in civil actions tried without a jury.’” (quoting 26 U.S.C. § 7482(a)(1))).
A.
Applicable Law
Generally, taxpayers have the right to minimize or avoid their taxes by any
means permitted by law. See Gregory v. Helvering, 293 U.S. 465, 469 (1935).
This right, however, “does not bestow upon the taxpayer the right to structure a
paper entity to avoid tax when that entity does not stand on the solid foundation of
economic reality.” Markosian v. Comm’r, 73 T.C. 1235, 1241 (1980). Although
courts typically “respect the form of a transaction,” they will, when warranted,
“use substance over form and its related judicial doctrines to determine the true
nature of a transaction disguised by formalisms that exist solely to alter tax
liabilities.” John Hancock Life Ins. Co. (U.S.A.) v. Comm’r, 141 T.C. 1, 57 (2013);
see also Markosian, 73 T.C. at 1241 (“When the form of the transaction has not, in
fact, altered any cognizable economic relationships, we will look[ ] through that
form and apply the tax law according to the substance of the transaction.”).
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To determine the true nature of a transaction under federal tax principles,
courts rely primarily on three distinct but similar doctrines. The first of these,
known as the “substance over form” doctrine, allows courts to “look to the
objective economic realities of a transaction rather than to the particular form the
parties employed” in deciding how to treat a particular transaction for tax purposes.
Frank Lyon Co., 435 U.S. at 573. The “business purpose” doctrine applies when
“an operation [had] no business or corporate purpose,” but was “a mere device
which put on the form of a corporate reorganization as a disguise for concealing its
real character.” Gregory, 293 U.S. at 469. Finally, the “economic substance”
doctrine asks whether a transaction “changes in a meaningful way . . . the
taxpayer’s economic position,” and whether “the taxpayer has a substantial
purpose (apart from Federal income tax effects)” for entering into it. I.R.C.
§ 7701(o).
Once a transaction has been recast under any of these principles, a party may
qualify as a transferee under § 6901 of the Internal Revenue Code. Section 6901
provides that the liability of a transferee of property of a taxpayer owing federal
income tax “shall . . . 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.” I.R.C. § 6901(a). “Transferee” is
defined broadly to include any “donee, heir, legatee, devisee, and distributee, and
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with respect to estate taxes, also includes any person who, under section
6324(a)(2), is personally liable for any part of such tax.” I.R.C. § 6901(h).
Importantly, § 6901 does not independently impose tax liability on a
transferee; instead, it provides only a procedure by which the IRS may collect
unpaid taxes owed by a transferor of assets from the transferee who received those
assets. See Comm’r v. Stern, 357 U.S. 39, 43-45 (1958) (“[Section 6901] neither
creates nor defines a substantive liability but provides merely a new procedure by
which the Government may collect taxes. . . . [W]e hold that, until Congress speaks
to the contrary, the existence and extent of liability should be determined by state
law.”). Accordingly, the Commissioner must have an independent basis for
liability before collecting taxes under § 6901—or, in other words, transferee status
under federal law must be determined independently of substantive liability for
fraudulent transfer under state law. See id.; see also Feldman v. Comm’r, 779 F.3d
448, 459 (7th Cir. 2015) (collecting cases supporting the proposition that “[e]very
circuit that has addressed [the] question has . . . required independent
determinations of transferee status under federal law and substantive liability under
state law”). 13
13
Regarding the order in which these inquiries are undertaken, the parties do not dispute on
this appeal that a court “can start with either part, and the Commissioner must pass both to win.”
Buckrey v. Comm’r, 114 T.C.M. (CCH) 45, 2017 WL 2964716, at *8 (2017) (citing Slone v.
Comm’r, 810 F.3d 599, 608 (9th Cir. 2015); Diebold Found., Inc. v. Comm’r, 736 F.3d 172,
185–86 (2d Cir. 2013); Starnes v. Comm’r, 680 F.3d 417, 427 (4th Cir. 2012)).
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The parties do not dispute that the applicable state fraudulent transfer law
that could provide a basis for substantive liability in this case is the Wisconsin
Uniform Fraudulent Transfer Act (“WIUFTA”). 14 This statute provides in relevant
part as follows:
A transfer made or obligation incurred by a debtor is fraudulent as to a
creditor whose claim arose before the transfer was made or the
obligation was incurred if the debtor made the transfer or incurred the
obligation without receiving a reasonably equivalent value in
exchange for the transfer or obligation and the debtor was insolvent at
that time or the debtor became insolvent as a result of the transfer or
obligation.
Wis. Stat. Ann. § 242.05(1). The WIUFTA defines “transfer” broadly as “every
mode, direct or indirect, absolute or conditional, voluntary or involuntary, of
disposing of or parting with an asset or an interest in an asset, and includes
payment of money, release, lease and creation of a lien or other encumbrance.” Id.§ 242.01(12).
The highest state court in Wisconsin has characterized Wis. Stat. Ann.
§ 242.05(1) as comprising three elements of fraudulent transfer: “(1) the creditor’s
claim arose before the transfer was made; (2) the debtor made the transfer without
receiving a reasonably equivalent value in exchange for the transfer; and (3) the
debtor either was insolvent at the time of the transfer or became insolvent as a
14
Wisconsin law applies because the transactions in question took place in Wisconsin. This
Court has jurisdiction to review the Tax Court’s decision under I.R.C. § 7481, and venue is
appropriate for this appeal under I.R.C. § 7482 because the Shockleys resided in Florida and
Shockley Holdings had its principal place of business in Florida at the time the parties filed their
Tax Court petitions.
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result of the transfer.” Badger State Bank v. Taylor, 688 N.W.2d 439, 442 (Wis.
2004). Creditors, including the Commissioner, have the burden to prove all three
elements of transferee liability under the WIUFTA “by clear and convincing
evidence.” In re Loyal Cheese Co., 969 F.2d 515, 518 (7th Cir. 1992) (citing
Kerbet v. Behling, 61 N.W.2d 205, 207 (Wis. 1953)).
Further, the Wisconsin Supreme Court has explained that the WIUFTA is a
creditor-protection statute, and any transfer therefore must be viewed from the
perspective of a creditor. See Badger State Bank, 688 N.W.2d at 449. Moreover,
Wis. Stat. Ann. § 242.05(1) is a “‘constructive fraud’ provision” constituting a “per
se rule” under which good faith (or lack thereof) is irrelevant. See id. at 447. For
these reasons, “[a] transferee’s subjective state of mind does not play a role in
resolving [a] case under Wis. Stat. Ann. § 242.05(1).” Id. at 449.
Prior to the remand in this case, the Court of Appeals for the Seventh Circuit
issued the first decision in any court—state or federal—directly addressing
transferee liability under the WIUFTA. See Feldman, 779 F.3d at 450. 15 The facts
of Feldman involved the former shareholders of a closely held Wisconsin
corporation that had operated a dude ranch in northwestern Wisconsin for several
decades. Id. Following the sale of the dude ranch, the former shareholders of the
corporation engaged in “an intricate tax-avoidance transaction” involving an
15
Knowing that this decision was pending, the Tax Court specifically deferred issuing its
opinion in the instant case until after the Seventh Circuit issued its opinion in Feldman.
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intermediary company called MidCoast that served to “effectively liquidat[e] the
corporation without absorbing the financial consequences of the tax liability.” Id.
The IRS later sought to hold the former shareholders liable for the unpaid taxes as
transferees under § 6901 and the WIUFTA. See id.
On appeal, the Seventh Circuit agreed with the Tax Court’s conclusion that
the shareholders’ transaction bore “the hallmarks of a de facto liquidation,” and it
therefore disregarded the form of the transaction to hold the shareholders liable as
transferees under § 6901. Id. at 457. The Seventh Circuit then proceeded to make
the following holdings:
(1) “[S]tate fraudulent-transfer law is . . . flexible and looks to
equitable principles like ‘substance over form,’ just like the
federal tax doctrines,” id. at 459;
(2) “[T]he independent state-law inquiry will make a difference in
outcome only when there is a conflict between the applicable
federal tax doctrine and the state law that determines
substantive liability”—and “no such conflict” exists between
the WIUFTA and § 6901, id. at 458; and
(3) The shareholders’ “due diligence and lack of knowledge of
illegality is simply beside the point” because “subjective intent
and good faith play no role in the application of the
constructive-fraud provisions of Wisconsin’s UFTA,” id. at
459–60.
Applying these holdings, the Seventh Circuit deemed the shareholders transferees
under both state and federal laws, and affirmed the Tax Court’s decision upholding
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the Commissioner’s assessment of transferee liability against the shareholders for
the dissolved corporation’s unpaid taxes and penalties. Id. at 459-61.
B.
Decision Below
At the outset of its analysis, the Tax Court characterized the transaction at
issue as a Midco transaction that “allow[ed] the parties to have it both ways” by
“letting the seller engage in a stock sale and the buyer engage in an asset sale”:16
While the Shockleys testified that neither they nor SCC ever hired
ICA, the SCC board nevertheless made a decision in September 2000
to sell SCC’s stock to an affiliate of ICA. No ICA “affiliate” existed
to hire ICA at that time; thus the SCC board agreed, tacitly or
otherwise, to permit ICA to act as an intermediary of a “buy SCC
stock/sell SCC assets” transaction. The SCC board wanted ICA’s
services because the SCC shareholders could avoid the unwanted tax
results of an appreciated asset sale and enjoy the sought-after tax
savings of a stock sale—something it was unable to obtain before
16
The Tax Court relied on the definition of this type of transaction provided in the leading
Second Circuit case interpreting New York’s fraudulent conveyance statute:
In such a transaction, the selling shareholders sell their C Corp stock to an
intermediary entity (or “Midco”) at a purchase price that does not discount for the
built-in gain tax liability, as a stock sale to the ultimate purchaser would. The
Midco then sells the assets of the C Corp to the buyer, who gets a purchase price
basis in the assets. The Midco keeps the difference between the asset sale price
and the stock purchase price as its fee. The Midco’s willingness to allow both
buyer and seller to avoid the tax consequences inherent in holding appreciated
assets in a C Corp is based on a claimed tax-exempt status or supposed tax
attributes, such as losses, that allow it to absorb the built-in gain tax liability. If
these tax attributes of the Midco prove to be artificial, then the tax liability created
by the built-in gain on the sold assets still needs to be paid. In many instances,
the Midco is a newly formed entity created for the sole purpose of facilitating
such a transaction, without other income or assets and thus likely to be judgment-
proof. The IRS must then seek payment from the other parties involved in the
transaction in order to satisfy the tax liability the transaction was created to avoid.
Diebold Found., Inc. v. Comm’r, 736 F.3d 172, 175-76 (2d Cir. 2013) (citation omitted).
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working with ICA. Over two months after the SCC board’s decision,
ICA created the stock purchaser, NCAC, which appears to have had
no initial assets or any income-producing purpose of its own and was
capitalized by ICA only when its lack of finances was questioned by
the SCC board.
ICA also generated other shell entities: NCA LLC, NCS Trust, NC
Holdings, SDC, and SCA LLC, as well as NC Fund to fund the
unfunded NCAC. ICA then used this labyrinthine array to bring about
a three-hour program of reorganizations, name changes, and
restructurings, all for the ultimate result of a two-member LLC (one
member being an Isle of Man entity) that was created for no other
explained reason than to avoid the tax consequences of the sales of
SCC’s assets.
Shockley, 2015 WL 3827570, at *14-15 (quoting Diebold Found., 736 F.3d at
175). Following an extensive analysis of this scheme, the Tax Court ultimately
concluded that, “looking to the objective economic realities of the transaction, the
evidence and reasonable inferences therefrom sufficiently establish that the true
substance of the transaction is different from its form—that the only purpose of the
ICA Midco transaction was tax avoidance.” Id. at *17 (citing Frank Lyon Co., 435
U.S. at 573; Harris v. Comm’r, 61 T.C. 770, 783 (1974)). On the basis that “the
overall Midco transaction was a sham because it was not a true multiple-party
transaction, lacked economic substance, had no business purpose, and was only
entered to avoid tax,” the Tax Court disregarded the form of the transaction and
held Petitioners liable as transferees under § 6901. Id. at *20.
The Tax Court then found separately that the transaction was fraudulent
under the WIUFTA. Although the sale of SCC’s stock occurred “an hour or two”
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before the sale of its assets, the Tax Court nevertheless deemed the sale of SCC’s
television and radio assets “taxable events that fall within the definition of a claim
under WIUFTA” because “[l]ogically, these deemed sales would have had to occur
before SCC’s being theoretically able to distribute/transfer the resulting proceeds
to [P]etitioners.” Id. Further, the Tax Court found as a matter of fact that SCC did
not receive “reasonably equivalent value” within the meaning of the WIUFTA
because Petitioners “received distributions of approximately $26 million (not
including loan repayments) from the proceeds of the sales of SCC’s assets while
SCC received nothing (or, at best, received petitioners’ shares of SCC stock,
which—because of the distributions essentially liquidating SCC—were
worthless).” Id. at *21. Finally, with regard to insolvency, the Tax Court
concluded as follows:
[T]he tax on the sales of the assets was a debt to SCC as of the date of
sale, May 31, 2001. That tax debt would have been approximately
$39,488,189. (We arrive at this amount by attributing 95% of the
deficiency of $41,566,515 to the television assets that accounted for
approximately 95% of SCC’s total assets. While $39,488,189 may
not be the actual amount of tax owed on the sales of the televis[i]on
assets, it is close enough to illustrate SCC’s economic status.) For our
purposes, the approximate fair market value of SCC’s remaining
assets after the May 31, 2001, sales, i.e., the radio assets, is considered
to be their purchase price of $7.5 million. As a result, SCC’s tax debt
was significantly greater than its remaining assets as of May 31, 2001.
When SCC sold its remaining assets in September 2001, it would have
continued to be insolvent pursuant to section 242.02(2) of the
Wisconsin Statutes.
Id. at *22.
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C.
Discussion
On appeal, Petitioners argue that “the Tax Court misapplied the substance
over form doctrine in five key ways”:
(1) By “disregarding the economic effects of the stock sale on the
parties to the transaction and instead requiring that the stock
sale provide an economic benefit to the corporation whose
stock was sold”;
(2) By “finding that the shareholders’ legitimate non-tax business
purposes for selling their stock were irrelevant because there
was insufficient evidence that the corporation shared those
purposes”;
(3) By “refusing to acknowledge as legitimate any business
purpose that was not free of tax considerations”;
(4) By “attributing a tax-avoidance purpose to the stock sale based
solely on subsequent transactions conducted by the stock
purchaser without the selling shareholders’ involvement or
knowledge”; and
(5) By “determining that a transaction in which numerous unrelated
shareholders sold their stock to an unrelated purchaser using
funds borrowed from an independent banking institution was
not a bona fide multiple party transaction.”
Appellants’ Br. 21. Petitioners argue further that Wisconsin law does not allow a
litigant to use substance-over-form theories to “invent every element required by
the constructive fraud provisions of the WIUFTA, including both the transfer to the
alleged transferee and the claim at the heart of the debtor/creditor relationship,
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regardless of the alleged transferees’ good faith and lack of knowledge that there
would be an unpaid liability.” Id. at 22.
1.
Transferee Liability Under § 6901
Whether couched in terms of “substance over form,” the “business purpose”
doctrine, or the “economic effects” test, we are unpersuaded by Petitioners’
arguments that the Tax Court improperly chose to recast the SCC stock sale as an
asset sale followed by a liquidating distribution. Had Petitioners simply chosen to
sell their stock in a straightforward fashion, they could not be faulted for that
choice even if it had been based solely on superior tax efficiency. Instead,
however, the Shockleys chose an extraordinarily abstruse route. Nowhere does the
record reflect any legitimate business purpose or economic effects that
satisfactorily explain why Petitioners undertook the Midco transaction that
occurred in this case, nor why the substance of this transaction should be
disregarded in favor of its perplexing form.
Petitioners admit that “avoiding corporate tax on built-in gains was certainly
a factor in the decision not to sell SCC’s assets.” Appellants’ Br. 37–38. Aside
from this tax avoidance purpose, we see no convincing justification for the
Petitioners having entered a “buy stock/sell assets” transaction of precisely the sort
described in Notice 2001-16. Insofar as Petitioners seek to characterize SCC as a
“going concern” at the time of the stock sale, we agree with the Tax Court that “the
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overall transaction nullified SCC as a ‘going concern’ by having it merged out of
existence.” Shockley, 2015 WL 3827570, at *19. Similarly, to the extent that
Petitioners claim their non-tax reason for undertaking a Midco transaction was the
desire to avoid a piecemeal sale of SCC, we agree with the Tax Court that the
Midco transaction produced precisely this result: the sale of SCC’s radio assets did
not occur until nearly four months after the sale of its television assets, and SCC’s
collective television and radio assets were ultimately distributed to three different
buyers. See id. (“If the SCC board was concerned about the ‘breaking up’ of SCC,
however, it nevertheless submitted to the overall transaction with the knowledge
that this exact result would occur.”).
Moreover, Petitioners’ contention that they “engaged in one transaction—the
sale of their SCC stock to NCAC for cash” is disingenuous at best. See
Appellants’ Br. 33. In direct contravention of Petitioners’ claim that NCAC
undertook all actions subsequent to the stock sale “without the Shockleys’
involvement or knowledge,” the record plainly reveals the Shockleys’ awareness
that the SCC stock sale was only one piece of a very intricate puzzle. As early as
August 2000, the Shockleys were informed of the risk that the IRS might
recharacterize the transaction as an asset sale—and this is a warning they
presumably would have understood, given Kalil’s earlier written communication
encouraging Terry to consider not a straightforward stock sale, but instead a “buy
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stock/sell assets” involving an intermediary company’s “ownership” of SCC “for
about one hour.” Appellee’s Corrected Suppl. App. Tab 7 (Ex. 27-J).
Additionally, communications among counsel in the fall of 2000 explicitly express
a desire to “minimize[]” or “eliminate” any “linkage issues” between the stock
purchase agreement and the asset purchase agreements, thereby suggesting that
these agreements were, in fact, linked. Id. at Tab 17 (Ex. 78-J).
Even if all of this went over the Shockleys’ heads, they must have
understood that they were undertaking more than a straightforward stock sale by
the time Terry told QNI in writing that SCC had a “‘Midco’ company arrangement
standing by to proceed,” and that “the Midco purchase of SCC stock and the Midco
sale of the TV assets to QNI can proceed simultaneously . . . .” Appellee’s
Corrected Suppl. App. Tab 58 (Ex. 349-J). And, of course, the closing of the asset
sales to QNI and TSTT took place not only within the same three-hour span as the
stock sale to NCAC, but also at one of the law firms representing ICA and NCS
Trust. These uncontested facts wholly undermine Petitioners’ claim that they
knew nothing about the transaction other than that NCAC would purchase SCC
stock for cash.
Similarly, although Petitioners argue that the Tax Court made no finding that
“ICA, NCAC, Roger Ohlrich or any of the other individuals or entities affiliated
with the stock purchaser were related in any way to any of the 29 selling
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shareholders or to the bank that made the loan for the purchase price,” the parties
do not dispute the Tax Court’s findings that the stock purchaser, NCAC, (1) had no
initial assets or any income-producing purpose of its own, (2) was not created until
the SCC Board decided to pursue a stock sale, and (3) was not capitalized by ICA
until the SCC Board questioned its lack of financing. See Shockley, 2015 WL
3827570, at *15. Nor do the parties dispute that Ohlrich held all of the following
positions (and many of them simultaneously): (1) agent of ICA; (2) president,
chairman, and sole member of the board of directors of NCAC; (3) trustee of NCS
Trust; (4) sole officer and director of NC Holdings; and (5) president of NCAC II.
None of these undisputed facts accord with Petitioners’ claim that “the stock sale
was an arms-length transaction between unrelated parties.” Appellants’ Br. 35.
At bottom, we agree with the Tax Court that Petitioners entered into the
overall transaction solely for tax avoidance purposes. Although we “cannot ignore
the reality that the tax laws affect the shape of nearly every business transaction,”
Frank Lyon Co., 435 U.S. at 580, we nevertheless apply tax law according to the
substance of the transaction when its form “has not, in fact, altered any cognizable
economic relationships,” Markosian, 73 T.C. at 1241. Seeing no adequate non-tax
justification for the “labyrinthine array” of transactions between numerous shell
entities immediately following the sale of SCC stock to NCAC, and given that the
ultimate result of these transactions was nothing more than a two-member LLC
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(one member of which was an Isle of Man entity), we find that the Tax Court
appropriately “use[d] substance over form and its related judicial doctrines to
determine the true nature of a transaction disguised by formalisms that exist solely
to alter tax liabilities.” John Hancock Life Ins. Co., 141 T.C. at 57.
2.
Liability Under State Fraudulent Transfer Law
With respect to substantive liability under state law, Petitioners argue that
the Tax Court erroneously conflated “two separate and distinct tests” by applying
state fraudulent transfer law to a transaction already recast under federal law.
Appellants’ Br. 40. Petitioners take the position that Wisconsin courts have not yet
determined “whether or under what circumstances a court could recast a
transaction to create a transfer that did not actually occur for purposes of the
WIUFTA,” and the only available guidance “strongly indicates that Wisconsin law
would respect corporate form and not recast a stock sale as an asset sale before
applying the WIUFTA.” Id. at 43. In particular, Petitioners rely on Badger State
Bank to argue that “[i]f creditors were given license to recast a transaction to create
the requirements of Section 242.05(1), the statutorily defined class of transfers
would expand exponentially beyond the intent of the drafters and would no longer
constitute an objective per se rule.” Id. at 45–46.
The Commissioner agrees that “no Wisconsin court has addressed this issue
in the context of WIUFTA.” Appellee’s Br 33. Like the Tax Court, however, the
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Commissioner relies on the Seventh Circuit’s recent decision in Feldman to
support the conclusion that Wisconsin courts would apply substance-over-form
principles to cases involving the WIUFTA.
We agree with the Commissioner, the Tax Court, and the Seventh Circuit
that substance-over-form analysis is appropriate in context of the WIUFTA. The
Wisconsin Supreme Court recognized in Badger State Bank that “[t]he Uniform
Fraudulent Transfer Act reflects a strong desire to protect creditors,” and “[b]oth
the language of [WIUFTA] and the policies motivating the Uniform Fraudulent
Transfer Act are couched in terms of creditor protection.” Badger State Bank, 688
N.W.2d at 448. Without the power to look through the form of a transaction to its
substance, this statutory purpose would be severely impeded. Furthermore, and as
the Seventh Circuit noted in Feldman, the Wisconsin state courts are no strangers
to the substance-over-form doctrine. See Feldman, 779 F.3d at 459 (collecting
cases in which the Wisconsin courts have employed a substance-over-form
analysis in “a variety of contexts, most notably including tax cases”).
More importantly, we disagree with Petitioners’ assertion that the Tax Court
“rel[ied] on the federal tax substance over form doctrines to recast the Shockley’s
sale of their SCC stock as an asset sale followed by a liquidating distribution for
purposes of applying state fraudulent transfer law.” Appellants’ Br. 41. Such an
action would, as Petitioners suggest, inappropriately conflate the independent
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inquiries regarding transferee status under § 6901 and substantive liability under
state law. See Stern, 357 U.S. at 43–45. Instead, we agree with the Commissioner
that the Tax Court in this case “simply followed Feldman’s teaching that the
substance-over-form analysis under Wisconsin fraudulent-transfer law is
substantially the same as the substance-over-form analysis under federal tax law.”
Appellee’s Br. 46; see also Feldman, 779 F.3d at 458 (holding that “the
independent state-law inquiry will make a difference in the outcome only when
there is a conflict between the applicable federal tax doctrine and the state law that
determines substantive liability”—and “no such conflict” exists between the
WIUFTA and § 6901). Given the similarly broad definitions of “transfer” under
§ 6901 and the WIUFTA, the creditor-protection goals motivating the WIUFTA,
and a dearth of case law suggesting any meaningful difference between substance-
over-form analysis under federal law and substance-over-form analysis under
Wisconsin state law, the Tax Court was not wrong to have followed this teaching.17
17
In a slightly different twist, Petitioners argue that it was error for the Tax Court to have
recast the transaction at issue without proof that the alleged transferees entered into the
transaction in bad faith. The gist of their argument is that, insofar as a Wisconsin court might
recast a transaction at all, it would not interpret its UFTA contrary to analogous laws in other
states that have adopted the UFTA or UFCA. Citing cases from the First, Second, Fourth, and
Ninth Circuits, Petitioners argue that nearly all circuits to have considered the question have held
that, “in order to recast a transaction or series of transactions under UFTA or UFCA, the
Commissioner must prove that the selling shareholders acted in bad faith, knew or should have
known of the entire scheme implemented by the purchaser, or knew or should have known that
the corporation would have a tax liability that would go unpaid.” Appellants’ Br. 49.
In response, the Commissioner directs our attention to Weintraut v. Commissioner, 112
T.C.M. (CCH) 122, 2016 WL 4040793 (2016), a recent decision in which the Tax Court noted
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Moving to the Tax Court’s application of the substance-over-form doctrine
to impose substantive liability under the WIUFTA, the primary issue in dispute on
appeal is the third requirement outlined in Badger State Bank—that is, the
insolvency requirement.18 See Badger State Bank, 688 N.W.2d at 442 (requiring,
to establish liability for fraudulent transfer under the WIUFTA, that “the debtor
either was insolvent at the time of the transfer or became insolvent as a result of
the transfer.”). With respect to this requirement, Petitioners argue that, even
assuming the transaction is recast under both federal and state laws, the Tax Court
that, although certain courts have imposed a knowledge requirement under their respective
versions of the UFTA, “none of the cases imposing the knowledge requirement involved the
Indiana UFTA,” nor have they “involve[d] the Wisconsin UFTA.” Id. at *65 & n.129. Citing
Feldman and Badger State Bank with approval, the Tax Court in Weintraut concluded that “the
Indiana Supreme Court will not impose, and . . . the Court of Appeals for the Seventh Circuit
will hold that the Indiana Supreme Court will not impose[] the knowledge requirement before
using Indiana substance over form principles” to determine transferee liability under the Indiana
UFTA. Id. at *72.
We need not decide here whether the Seventh Circuit in Feldman properly eschewed any
knowledge requirement from the WIUFTA, or whether the Tax Court properly interpreted
Feldman in Weintraut. Even assuming for the sake of argument that the statute does contain a
knowledge requirement, we find ample support on this record supporting an inference that
Petitioners were aware of both the nature and risks of the Midco transaction they pursued.
18
Petitioners do not dispute that a corporation making liquidating distributions to its
shareholders receives nothing of value in exchange for those distributions, thereby satisfying the
second requirement of Badger State Bank that “the debtor made the transfer without receiving a
reasonably equivalent value in exchange for the transfer.” Badger State Bank, 688 N.W.2d at
442. Furthermore, Petitioners do not dispute that, insofar as the IRS’s tax claims against SCC
relate back to the asset sales that are deemed to have preceded the corresponding liquidating
distributions, the requirement that “the creditor’s claim arose before the transfer was made” is
also satisfied. Id. Any arguments Petitioners raise to the contrary—particularly, that the IRS
was “not a creditor of SCC at the time the Shockleys sold their stock”—depend on respecting the
form of the transaction rather than its substance, which we decline to do for reasons we have
already explained.
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“misapplied the insolvency tests to the debtor in the transactions it invented.” 19
Appellants’ Br. 64.
Petitioners approach their insolvency argument from two angles: they first
focus on what came in to SCC/SCA on the May 31, 2001, closing date, and then
they shift to what allegedly remained in SCC/SCA by the end of that day. Their
basic argument as to what came in to SCC/SCA is as follows:
(1) On May 31, 2001, SCC sold its television assets for $171
million and transferred $94,713,235.68 into escrow for
distribution to the SCC shareholders.
(2) This transaction left $83,786,764.00 in cash plus approximately
$7.5 million in radio assets in SCC, totaling $91,286,764.00.
(3) SCC did not have debts in excess of $91,286,764.00 as of May
31, 2001, and therefore it could not have been insolvent.
See Appellants’ Br. 67.
The Commissioner identifies certain flaws in this argument, including
double-counting the $7.5 million in radio assets and the critical omission of a
$45,564,539.73 debt that SCC owed to Finova Capital Corporation as of May 31,
2001. Accounting for these facts, the Commissioner contends that SCC/SCA had
only $83,786,764.00 following the May 31, 2001 closings (i.e., $171 million +
$7.5 million - $94,713,236)—which is less than the $85,052,728.73 sum of its
19
At the threshold, we note that Petitioners waived their right to pursue this argument on
appeal by failing to raise it until they filed their motion for reconsideration in the Tax Court. See
Thomas v. Bryant, 614 F.3d 1288, 1305 (11th Cir. 2010). In any event, however, the argument
has no merit.
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debts as of that date (i.e., $45,564,539.73 owed to Finova Capital Corporation +
$39,488,189 in federal income tax liability arising from the television-assets sale).
From the perspective of what remained in SCC/SCA by the end of May 31,
2001, Petitioners claim that SCC/SCA had total assets valuing $40,636,764 (i.e.,
$33,136,764 from Rabobank loan proceeds + $7.5 million in radio assets), but tax
liability of only $39,488,189.20 See Appellants’ Br. 69. The Commissioner, on the
other hand, points to exhibits revealing that SCA made at least ten post-closing
disbursements totaling $7,450,366.45. See Appellee’s Br. 56 (citing Exs. 270-J
through 273-J). Additionally, the Commissioner disputes the $33,136,764 cash
figure on the basis that “the parties stipulated that SCA wired a total of
$2,870,723.11 out of [the relevant] account on May 31.” Id. at 57 (citing Doc. 24
¶ 362; Ex. 264-J). Accordingly—and even ignoring the fact that “a large portion
of the remaining $30,266,041 in the SCA account ($33,136,764 - $2,870,723) was
used to repay the Rabobank loan, also on May 31”—SCA’s assets were less than
its estimated tax liability of $39,488,189.
20
This estimate of SCC’s federal income tax liability comes from the Tax Court, see
Shockley, 2015 WL 3827570, at *22 (arriving at this amount “by attributing 95% of the
deficiency of $41,566,515 to the television assets that accounted for approximately 95% of
SCC’s total assets”), and is used by both parties in the respective calculations they advance on
appeal. Although Petitioners complain that “[t]he Tax Court simply had no evidence from which
it could accurately determine the amount of the tax liability that allegedly arose as a result of the
sale of SCC’s television assets on May 31, 2001,” Reply Br. 31, they bear the burden of proving
that the Commissioner incorrectly calculated or assessed SCC’s tax liability and have offered no
arguments or alternative figures in this regard. See I.R.C. § 6902(a); Tax Court Rule 142.
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We see no error in the Commissioner’s reasoning or in the Tax Court’s
insolvency assessment, and thus we find that the record supports the Tax Court’s
conclusion that Petitioners qualify as transferees under section 242.05(1) of the
Wisconsin Statutes. SCC received nothing of “reasonably equivalent value” in
exchange for the proceeds from the sale of its assets, given that the distributions
essentially liquidating the company rendered its stock worthless. The
Commissioner’s claims against Petitioners arose before the transfers were made.
See Swinks v. Comm’r, 51 T.C. 13, 17 (1968) (“A transferee is liable retroactively
for the transferor’s taxes and additions to the tax in the year of the transferor to the
extent of assets received from the transferor, even though the tax liability of the
transferor was unknown at the time of the transfer.”). Finally, the transfers caused
SCC to become insolvent, meaning that its liabilities exceeded its assets. In light
of ample evidence supporting these findings, we uphold the Tax Court’s
determination that Petitioners are substantively liable for fraudulent transfer under
applicable state law.
III.
In summary, we find that the Tax Court appropriately disregarded the Midco
transaction and therefore deemed SCC to have transferred the proceeds of its
highly appreciated assets to its shareholders, including Petitioners. Recasting the
transaction in this manner renders Petitioners liable as transferees pursuant to
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federal tax principles, and it also renders them substantively liable under
Wisconsin state fraudulent transfer law for the taxes generated by the built-in gain
on the appreciated assets that SCC sold. Under these circumstances, the
Commissioner was permitted to assess transferee liability for these unpaid taxes
against Petitioners by applying the procedural device supplied by I.R.C. § 6901.
For these reasons, the decisions of the United States Tax Court are AFFIRMED.
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