Qinetiq US Holdings, Inc. & Subsidiaries v. Commissioner of Internal Revenue

PUBLISHED
UNITED STATES COURT OF APPEALS
FOR THE FOURTH CIRCUIT
No. 15-2192
QINETIQ US HOLDINGS, INC. & SUBSIDIARIES,
Petitioner - Appellant,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent - Appellee.
Appeal from the United States Tax Court.
(Tax Ct. No. 14122-13)
Argued: October 26, 2016 Decided: January 6, 2017
Before KING, KEENAN, and DIAZ, Circuit Judges.
Affirmed by published opinion. Judge Keenan wrote the opinion,
in which Judge King and Judge Diaz joined.
ARGUED: Gregory G. Garre, LATHAM & WATKINS LLP, Washington,
D.C., for Appellant. Ellen Page DelSole, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee. ON
BRIEF: Gerald A. Kafka, Benjamin W. Snyder, Nicolle Nonken
Gibbs, LATHAM & WATKINS LLP, Washington, D.C., for Appellant.
Caroline D. Ciraolo, Acting Assistant Attorney General, Diana L.
Erbsen, Deputy Assistant Attorney General, Gilbert S.
Rothenberg, Teresa E. McLaughlin, Tax Division, UNITED STATES
DEPARTMENT OF JUSTICE, Washington, D.C., for Appellee.
BARBARA MILANO KEENAN, Circuit Judge:
This appeal from a decision of the United States Tax Court
(the tax court) involves the federal income tax treatment of
shares of stock issued to an executive employee of Dominion
Technology Resources, Inc. (DTRI), around the time of DTRI’s
founding. The company’s successor in interest, QinetiQ U.S.
Holdings, Inc. & Subsidiaries (QinetiQ), contends that the stock
was issued in connection with the executive’s employment and was
subject to a substantial risk of forfeiture until 2008. On this
basis, QinetiQ argues that it is entitled to a tax deduction for
the value of the stock as a trade or business expense in the tax
year ending March 31, 2009.
After reviewing QinetiQ’s tax return, the Internal Revenue
Service (IRS) issued a Notice of Deficiency concluding that
QinetiQ had not shown its entitlement to the claimed deduction.
QinetiQ later filed suit in the tax court, raising both a
procedural and a substantive argument. QinetiQ argued that the
IRS failed to give a reasoned explanation in the Notice of
Deficiency for denying the tax deduction. QinetiQ also argued
that the stock qualified as a deductible trade or business
expense in tax year 2008, because the stock was issued in
connection with services and was subject to a substantial risk
of forfeiture until that year. The tax court rejected the
procedural argument, holding that the Notice of Deficiency
2
provided sufficient explanation. The tax court also held that
QinetiQ failed to show that the stock was issued in connection
with services and was subject to a substantial risk of
forfeiture. Accordingly, the tax court entered judgment in
favor of the IRS.
Upon our review, we conclude that the IRS complied with all
applicable procedural requirements in issuing the Notice of
Deficiency to QinetiQ. We further hold that the tax court did
not err in concluding that the stock failed to qualify as a
deductible expense for the tax year ending March 31, 2009,
because the stock was not issued subject to a substantial risk
of forfeiture. We therefore affirm the tax court’s judgment.
I.
In March 2002, Thomas G. Hume (Hume) formed “Thomas G.
Hume, Inc.” as a corporation organized under the laws of
Virginia. Hume was the sole shareholder, and served with his
wife, Karyn Hume, as the initial directors of the corporation.
Hume filed federal tax forms electing for the corporation to be
treated as an “S corporation,” in order to permit the
corporation’s profits and losses to be passed through to him
individually. See 26 U.S.C. § 1366(b). Thomas G. Hume, Inc.
appears not to have engaged in any business before November
2002.
3
In November 2002, Hume and Julian Chin took certain actions
to facilitate Chin’s joining the business enterprise. On
December 6, 2002, Hume and Karyn Hume, as directors, filed
articles of amendment with the Commonwealth of Virginia changing
the name of the corporation to Dominion Technology Resources,
Inc. and creating two classes of shares, class A voting stock
and class B nonvoting stock. The next day, Karyn Hume resigned
from DTRI’s board of directors, leaving Hume as the sole
director. On December 9, 2002, Hume paid a par value 1 of $450 in
exchange for 4,500 shares of DTRI class A voting stock, and Chin
paid the same par value in exchange for 4,455 shares of DTRI
class A voting stock and 45 shares of DTRI class B nonvoting
stock.
On December 12, 2002, Hume executed a “Consent in Lieu of
the Organizational Meeting of the Board of Directors of [DTRI]”
(December Consent), which offered for sale and issuance 4,500
shares of class A stock to Hume, and 4,455 shares of class A and
45 shares of class B stock to Chin. Attached to the December
Consent were letters signed by Hume and Chin acknowledging their
intent to subscribe to the stated stock shares. Also included
in the December Consent was authorization for DTRI to enter into
1
Par value is an “arbitrary dollar amount assigned to a
stock share by the corporate charter.” Par Value, Black’s Law
Dictionary 1298 (10th ed. 2014).
4
a Shareholders Agreement and employment agreements with Hume and
Chin. In a separate paragraph, the December Consent further
authorized DTRI to enter into individual employment agreements
and restrictive stock agreements with other employees.
The Shareholders Agreement entered into by DTRI, Hume, and
Chin stated that the parties
believe that it is in their mutual best interest to
make provisions for the future disposition of all of
the shares of common stock of the Corporation to the
end that continuity of harmonious management is
assured, and a fair process is established by which
said shares of common stock may be transferred,
conveyed, assigned or sold[.]
To that end, the Shareholders Agreement prescribed provisions
for restricting the sale or transfer of stock and for returning
stock to the corporation in the event of either Hume’s or Chin’s
death, disability, or termination of employment with DTRI.
The Shareholders Agreement contained provisions for
calculating the “Agreement Value” of the shares upon the
occurrence of any of these events, and gave the corporation the
option of repurchasing Hume’s or Chin’s shares at the calculated
value in the event of such death, disability, or termination
without cause. Additionally, in the event of voluntary
resignation by the employee, the Shareholders Agreement provided
DTRI the option of purchasing the shares at 5% of the Agreement
Value for every year of the departing employee’s employment, up
to a maximum of 100% after twenty years. However, in the event
5
that the employee voluntarily resigned and engaged in
competition with DTRI, or that DTRI terminated the employee for
cause, the corporation would have the option to purchase the
shares at 5% of the Agreement Value for every year of
employment, up to a maximum of 25% of the Agreement Value.
Also in December 2002, DTRI entered into stock agreements
with other employees that were far more restrictive than the
terms of the Shareholders Agreement executed by Hume and Chin.
The stock agreements with the other employees contained greater
limitations on the transfer of stock and a less generous method
for calculating stock value for purposes of DTRI’s repurchase of
a departing employee’s stock. Also, unlike Hume and Chin, the
other employees did not receive any voting rights in the stock
they received.
DTRI entered into employment agreements with Hume, Chin,
and other employees in December 2002. The employment agreements
with Hume and Chin bore no reference to stock issued as
compensation. In contrast, the employment agreements for the
other employees who received stock in December 2002 explicitly
referenced, under a contract section labeled “Compensation,”
nonvoting stock that was issued subject to restrictions.
DTRI, Hume, and Chin filed yearly tax documents treating
DTRI as a pass-through entity between tax years 2002 and 2006,
with Hume and Chin identified as the shareholders. In DTRI’s
6
tax filings from 2002 to 2006, DTRI allocated its net income or
loss to Hume and Chin, based on their respective percentage of
stock ownership in DTRI in each taxable year. In December 2006,
DTRI revoked its S corporation election, effective January 1,
2007. From 2002 through 2007, DTRI did not report the stock
issued in 2002 to Hume and Chin as employment compensation, and
therefore did not withhold federal payroll taxes on the issued
stock. In contrast, DTRI, Hume, and Chin reported as employment
compensation shares later granted to Hume and Chin.
In 2008, QinetiQ entered into negotiations to purchase
DTRI. On August 4, 2008, QinetiQ, Project Black Acquisition
Corp., DTRI, Hume, and Chin entered into a final agreement and
plan of merger, with QinetiQ paying $123 million in exchange for
all outstanding stock in DTRI. Immediately before the
transaction closed, Hume and Chin executed consent agreements
waiving DTRI’s rights with respect to stock transfer
restrictions or partially vested stock. The merger transaction
closed in October 2008.
For the tax year ending on March 31, 2009, QinetiQ withheld
payroll taxes in accordance with the value of the stock received
by Hume and Chin in 2002, and claimed deductions under 26 U.S.C.
§ 83(h), as wages paid to Hume and Chin for the fair market
value of the shares originally issued to them in December 2002.
Hume and Chin filed personal income tax returns for tax year
7
2008 claiming as wage income the 2008 value of their respective
shares issued in December 2002.
The IRS transmitted to QinetiQ a Notice of Deficiency
stating that the IRS had determined that QinetiQ “ha[d] not
established that [it was] entitled” to a deduction “under the
provisions of [26 U.S.C.] § 83,” and that QinetiQ’s taxable
income for the year thereby was increased by “$117,777,501.”
The IRS did not give a further explanation of its decision in
its Notice of Deficiency.
QinetiQ filed a petition in the tax court challenging the
sufficiency of the Notice of Deficiency, as well as the IRS’s
substantive determination with respect to Chin’s shares. 2 The
tax court ruled that QinetiQ had not demonstrated entitlement to
the deduction on two independent bases, namely, that the stock
was not property “transferred in connection with the performance
of services” and was not “subject to a substantial risk of
forfeiture” at the time Chin acquired the shares. QinetiQ
appeals from the tax court’s judgment.
2Originally, QinetiQ challenged the classification of the
shares issued to both Hume and Chin but, during the pendency of
the tax court case, QinetiQ conceded that the stock shares
issued to Hume did not qualify as Section 83 property.
8
II.
We first address QinetiQ’s argument that the Notice of
Deficiency is invalid because it failed to provide a reasoned
explanation for the agency’s final decision, as required by the
Administrative Procedure Act (APA), 5 U.S.C. §§ 701–06. This
issue presents a question of law that we consider de novo.
Starnes v. Comm’r, 680 F.3d 417, 425 (4th Cir. 2012).
A.
The APA authorizes district courts to review agency actions
with a “focal point” on the “administrative record already in
existence.” Camp v. Pitts, 411 U.S. 138, 142 (1973) (per
curiam). The Supreme Court has held that a required component
of this administrative record is a “reasoned explanation for
[the agency] action.” FCC v. Fox Television Stations, Inc., 556
U.S. 502, 515–16 (2009). QinetiQ anchors its argument on this
principle, maintaining that this requirement of a reasoned
explanation necessarily applies to a Notice of Deficiency,
because that notice is a final agency action within the meaning
of the APA. Thus, according to QinetiQ, failure by the IRS to
comply with this APA requirement rendered the Notice of
Deficiency invalid.
We disagree with QinetiQ’s argument, which fails to
consider the unique system of judicial review provided by the
Internal Revenue Code for adjudication of the merits of a Notice
9
of Deficiency. It is that specific body of law, rather than the
more general provisions for judicial review authorized by the
APA, that governs the content requirements of a Notice of
Deficiency.
Under the APA, the “task of the reviewing court is to apply
the appropriate APA standard of review . . . to the agency
decision based on the record the agency presents to the
reviewing court.” Fla. Power & Light Co. v. Lorion, 470 U.S.
729, 743–44 (1985) (internal citation omitted). The reviewing
court in such a case generally is not authorized to conduct a de
novo evaluation of the record or to “reach its own conclusions”
regarding the subject matter before the agency. Id. at 744.
Some agency-specific statutes, however, provide materially
different procedures for judicial review that predate the APA’s
enactment. One such example is the Internal Revenue Code (the
Code), which authorizes de novo review in the tax court of a
Notice of Deficiency. See 26 U.S.C. § 6214; Eren v. Comm’r, 180
F.3d 594, 597 (4th Cir. 1999). We discussed this unique system
of judicial review in our decision in O’Dwyer v. Commissioner,
266 F.2d 575 (4th Cir. 1959). We explained that because the
Code’s provisions for de novo review in the tax court permit
consideration of new evidence and new issues not presented at
the agency level, those provisions are incompatible with the
10
limited judicial review of final agency actions allowed under
the APA. 3 Id. at 580; see also 26 U.S.C. § 6214(a).
Additionally, we observe that for an agency action to be
deemed “final” within the meaning of the APA and, thus, subject
to the APA’s requirement of a reasoned explanation, the agency
“action must be one by which rights or obligations have been
determined, or from which legal consequences will flow.”
Bennett v. Spear, 520 U.S. 154, 178 (1997) (internal citation
and quotation marks omitted). “[L]egal consequences” include
agency determinations that restrict the government’s power to
take contrary litigation positions in subsequent proceedings.
See U.S. Army Corps of Eng’rs. v. Hawkes Co., 136 S. Ct. 1807,
1814 (2016) (holding that agency determinations effectively
giving a five-year “safe harbor” from government suits create
“legal consequences” within the meaning of the Bennett test).
3
QinetiQ argues that this Court’s opinion in O’Dwyer no
longer is “good law” because O’Dwyer relied on an outmoded line
of reasoning that the APA’s procedures for judicial review apply
only to formal adjudications, to the exclusion of informal
agency actions. Although the APA’s judicial review procedures
have since been held to apply to informal agency actions, as
well as to formal adjudications, see Fla. Power & Light Co., 470
U.S. at 744, we observe that the central holding of O’Dwyer
remains valid, namely, that the de novo review procedures
provided by the Internal Revenue Code, rather than the judicial
review procedures under the APA, govern judicial review of
deficiency proceedings.
11
After issuing a Notice of Deficiency, however, the IRS may
later assert in the tax court new legal theories and allege
additional deficiencies. See 26 U.S.C. § 6214(a); Tax Ct. R.
142(a)(1). Likewise, a taxpayer may raise new matters before
the tax court not previously considered during the
administrative process. 26 U.S.C. § 6214(a). In contrast to
these fluid procedures, the APA’s “arbitrary” and “capricious”
standard requires that judicial review of an agency action be
confined to the static administrative record with deference
accorded to the agency’s decision, and that the agency action be
final in all respects before judicial review commences. See 5
U.S.C. §§ 704, 706(2)(A); Pitts, 411 U.S. at 142.
Given these significant variations in the scope of judicial
review under the two statutory schemes, we conclude that the
APA’s general procedures for judicial review, including the
requirement of a reasoned explanation in a final agency
decision, were not intended by Congress to be superimposed on
the Internal Revenue Code’s specific procedures for de novo
judicial review of the merits of a Notice of Deficiency. As the
Supreme Court has emphasized, Congress did not intend for the
APA “to duplicate the previously established special statutory
procedures relating to specific agencies.” Bowen v.
Massachusetts, 487 U.S. 879, 903 (1988); see also Hinck v.
United States, 550 U.S. 501, 506 (2007) (“[I]n most contexts, a
12
precisely drawn, detailed statute pre-empts more general
remedies.”) (internal citation and quotation marks omitted).
Accordingly, we hold that the APA’s requirement of a reasoned
explanation in support of a final agency action does not apply
to a Notice of Deficiency issued by the IRS and that, therefore,
the Notice of Deficiency issued to QinetiQ in this case was not
subject to that APA requirement. 4
B.
We next consider whether the Notice of Deficiency in this
case was insufficient to satisfy the requirement of Section
7522(a) of the Code that the IRS “describe [in the Notice] the
basis for, and identify the amounts (if any) of, the tax due,
interest, additional amounts, additions to the tax, and
assessable penalties.” 26 U.S.C. § 7522(a). The statute
further provides that “an inadequate description under the
preceding sentence shall not invalidate such notice.” Id.
However, the statute is silent regarding the circumstances, if
any, that will cause a Notice of Deficiency to be invalidated.
Id.
4
We acknowledge that the APA anticipates that “de novo”
determination of facts by the reviewing court may sometimes be
appropriate. 5 U.S.C. § 706(2)(F). However, this is not such a
case, because application of the APA would simply “duplicate the
previously established special statutory procedures” of the
Internal Revenue Code. Bowen, 487 U.S. at 903.
13
Some federal courts of appeal have held that a Notice of
Deficiency may be invalidated for the failure to include certain
information. For example, before the 1988 enactment of Section
7522, 5 we held that a Notice of Deficiency must contain a
statement that the IRS has examined a return and has determined
a deficiency in an “exact amount.” Abrams v. Comm’r, 787 F.2d
939, 941 (4th Cir. 1986). And, after the enactment of Section
7522, the Ninth Circuit implicitly has endorsed application of a
rule that major errors in a Notice of Deficiency causing
prejudice to a taxpayer will render that determination invalid.
See Elings v. Comm’r, 324 F.3d 1110, 1113 (9th Cir. 2003).
Also, the Tenth Circuit has held that a Notice of Deficiency may
not be used to implicitly deny without explanation a taxpayer’s
request for discretionary relief. 6 See Fisher v. Comm’r, 45 F.3d
5The language now codified at 26 U.S.C. § 7522 was
originally codified at Section 7521 in 1988 and renumbered as
Section 7522 in 1990. See Omnibus Taxpayer Bill of Rights, Pub.
L. No. 100-647, § 6233, 102 Stat. 3342, 3735 (1988); Revenue
Reconciliation Act of 1990, Pub. L. No. 101-508, § 11704, 104
Stat. 1388, 1388-519 (1990).
6
We do not read Fisher, as QinetiQ urges, as requiring a
reasoned explanation in all Notices of Deficiency. The court in
Fisher was asked to review the Commissioner’s implicit denial,
through inaction, of a discretionary waiver of a tax penalty.
See Fisher, 45 F.3d at 396–97 (citing 26 U.S.C. § 6661(c)). The
court in Fisher held that without an explicit agency ruling to
review, the tax court “had no basis for determining what reasons
the Commissioner may have relied upon,” and that, therefore, the
Commissioner “failed to demonstrate that she had exercised her
discretion.” Id. at 397. The rationale of Fisher thus applies
(Continued)
14
396, 397 (10th Cir. 1995). In contrast, some of our sister
circuits have held that minor, nonprejudicial flaws in a Notice
of Deficiency will not cause such notice to be invalidated.
Elings, 324 F.3d at 1113; Smith v. Comm’r, 275 F.3d 912, 915 &
n.2 (10th Cir. 2001).
Upon consideration of this authority, we hold that the
Notice of Deficiency issued to QinetiQ satisfied the basic
requirements of the Internal Revenue Code. The Notice of
Deficiency informed QinetiQ that the IRS had determined a
deficiency in an exact amount for a particular tax year, and
incorporated by reference an enclosed statement that “the
deduction you claimed for Salaries and Wages in the amount of
$117,777,501 under the provisions of [Code] § 83 is disallowed
in full as you have not established that you are entitled to
such a deduction.” The Notice of Deficiency further informed
QinetiQ that it had the right to contest this deficiency
determination in the tax court. In light of the taxpayer’s
burden to show entitlement to a particular deduction, INDOPCO,
Inc. v. Comm’r, 503 U.S. 79, 84 (1992), we discern no prejudice
to QinetiQ due to the absence of additional information in the
only to cases in which courts review agency action for abuse of
discretion, rather than cases in which the tax court applies a
de novo standard of review. See id.
15
Notice of Deficiency. Accordingly, we hold that its content was
sufficient to satisfy the requirements of the Internal Revenue
Code.
III.
Finally, we turn to the merits of QinetiQ’s claim that
QinetiQ was entitled to a tax deduction in tax year 2008 for the
stock Chin acquired from DTRI in 2002. In addressing this
issue, we apply an established standard of review. Decisions of
the tax court are subject on appeal to the same standard we
apply to civil bench trials on appeal from the district courts.
Estate of Waters v. Comm’r, 48 F.3d 838, 841–42 (4th Cir. 1995).
Under this standard, we review factual findings for clear error,
legal questions de novo, and mixed questions of law and fact de
novo. Waterman v. Comm’r, 179 F.3d 123, 126 (4th Cir. 1999);
Waters, 48 F.3d at 842.
QinetiQ argues that the stock Chin acquired from DTRI in
2002 qualified as a trade or business expense in 2008, because
the stock was transferred “in connection with” Chin’s employment
with DTRI, and was “subject to a substantial risk of forfeiture”
until Chin sold the shares in 2008 as part of DTRI’s merger with
QinetiQ. See 26 U.S.C. §§ 83(h), 162. The IRS responds that
the tax court properly rejected QinetiQ’s claim because the
evidence showed that Chin subscribed to the stock for
16
investment, rather than in connection with his employment with
DTRI, and that the stock was not issued subject to a substantial
risk of forfeiture.
We agree with the IRS that the tax court did not err in
rejecting QinetiQ’s claimed deduction. Section 83(a) of the
Code, in relevant part, generally treats property transferred
“in connection with the performance of services” as “gross
income of the person who performed such services.” 26 U.S.C.
§ 83(a). Because a transfer of this nature is treated as gross
income of the individual providing such services, the employer
ordinarily is entitled to a deduction for the equivalent value
as a trade or business expense. 26 U.S.C. §§ 83(h), 162(a).
This rule is modified, however, when property transferred
“in connection with the performance of services” is “subject to
a substantial risk of forfeiture.” 26 U.S.C. § 83(a). Property
transferred under such circumstances is not treated as gross
income of the individual providing services until the first
taxable year in which the property was no longer subject to a
substantial risk of forfeiture. Id. Therefore, an employer
seeking to establish entitlement to a deduction for property
transferred to an employee in a prior tax year must show both:
(1) that the property was transferred “in connection with the
performance of services”; and (2) that the property was “subject
to a substantial risk of forfeiture” from the time the property
17
was transferred until the tax year for which the deduction is
claimed. Id.; see also Strom v. United States, 641 F.3d 1051,
1055–56 (9th Cir. 2011); United States v. Bergbauer, 602 F.3d
569, 580 (4th Cir. 2010). Thus, if the employer fails to
establish either of these two required elements, the employer is
not entitled to claim the property transferred in an earlier tax
year as a trade or business expense. See 26 U.S.C. §§ 83(a),
83(h), 162(a).
In the present case, the tax court found that QinetiQ had
failed to prove either requirement for establishing its claimed
deduction. We conclude that the record supports the tax court’s
determination that the stock transferred to Chin in 2002 was not
issued subject to a substantial risk of forfeiture. Because
this factor is a required element of proof for establishing
entitlement to the claimed deduction in the tax year in dispute,
we limit our analysis to this single element and do not address
the other statutorily required element that the stock have been
transferred in connection with the performance of services.
Under Treasury regulations implementing Section 83(a), the
term “substantial risk of forfeiture” is applied in the context
of the “facts and circumstances” of each individual case. 26
C.F.R. § 1.83-3(c)(1). The relevant regulation further
clarifies that property is not “subject to a substantial risk of
forfeiture to the extent that the employer is required to pay
18
the fair market value of such property to the employee upon the
return of such property.” Id. In addition, property is not
subject to a substantial risk of forfeiture if “at the time of
the transfer the facts and circumstances demonstrate that the
forfeiture condition is unlikely to be enforced.” Id. § 1.83-
3(c)(1), (3). Likewise, conditions imposed at the time of
transfer that require the return of property “if the employee is
discharged for cause or for committing a crime,” or “if the
employee accepts a job with a competing firm,” will not be
sufficient to constitute a substantial risk of forfeiture. Id.
§ 1.83-3(c)(2).
Here, the terms of the Shareholders Agreement between DTRI,
Hume, and Chin recited certain conditions that would require
Chin to return the stock to DTRI. In the event of Chin’s death,
disability, or termination without cause, the Shareholders
Agreement provided a formula for DTRI to repurchase Chin’s stock
that corresponded with “one hundred percent (100%) [of] the
Agreement Value.” 7 Given this requirement of fair market value,
the repurchase of Chin’s stock under those circumstances would
7
The Shareholders Agreement prescribed an objective method
for calculating the value of the corporation, based on four
times the earnings of the corporation in the fiscal year
immediately preceding the event requiring valuation. Nothing in
the record indicates that this formula would not result in the
fair market value of the stock.
19
not be considered a “forfeiture” within the meaning of the
relevant regulation. 26 C.F.R. § 1.83-3(c)(1).
In the event of Chin’s voluntary resignation, the
Shareholders Agreement would have provided for DTRI to
repurchase the stock at “five percent (5%) [of the Agreement
Value] for every full year of service” by Chin, up to the full
Agreement Value after 20 years of service. However, if Chin
were terminated for cause or voluntarily resigned and engaged in
competition with DTRI, the stock repurchase price would be 5% of
the Agreement Value for each year of service, up to a maximum of
25% of the Agreement Value.
Read together, these additional provisions of the
Shareholders Agreement indicate that the only circumstances in
which Chin would be required to forfeit his stock at a below-
market price would be if Chin voluntarily resigned before 20
years of employment, if Chin voluntarily resigned and entered
into competition with DTRI, or if Chin were terminated for
cause. Because the regulation provides that forfeiture
provisions triggered by termination for cause or by engaging in
competition do not constitute a “substantial risk of
forfeiture,” 26 C.F.R. § 1.83-3(c)(2), the only remaining
ground for forfeiture would be the circumstance of Chin’s
voluntary resignation.
20
With respect to this sole remaining ground for forfeiture,
the tax court concluded that the likelihood of forfeiture due to
Chin’s voluntary resignation did not amount to a “substantial
risk.” The tax court made a factual determination that Hume
would have been unlikely to enforce the shareholder restrictions
on the stock in the event of Chin’s voluntary departure. In
concluding that Chin’s stock was not subject to a substantial
risk of forfeiture but was intended to be treated as “fully
vested and outstanding stock” without restrictions, the tax
court cited Chin’s role as an initial investor in DTRI, Chin’s
“very close work relationship” with Hume, and Chin’s “vital role
within DTRI as the executive vice president, COO, and a 49.75%
shareholder in voting stock.”
Based on our review, we conclude that the tax court’s
factual conclusion, that Chin’s significant ownership position
in DTRI and his strong relationship with Hume demonstrated that
the stock was not transferred in 2002 subject to a “substantial
risk of forfeiture,” is not clearly erroneous and was supported
by the record. We therefore hold that the tax court did not err
in concluding that QinetiQ failed to establish its entitlement
to the claimed deduction.
21
IV.
For these reasons, we affirm the tax court’s judgment.
AFFIRMED
22