Norma Slone v. Cir

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
NORMA L. SLONE, Transferee, No. 16-73349
Petitioner-Appellee,
Tax Ct. No.
v. 6629-10
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
SLONE FAMILY GST TRUST, UA No. 16-73351
Dated, August 6, 1998, Transferee,
D. Jack Roberts, Trustee,
Petitioner-Appellee, Tax Ct. No.
6630-10
v.
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
2 SLONE V. CIR
JAMES C. SLONE, Transferee, No. 16-73354
Petitioner-Appellee,
Tax Ct.
v. No. 6631-10
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
SLONE REVOCABLE TRUST, UA No. 16-73356
Dated September 20, 1994,
Transferee, James C. Slone and Tax Ct. No.
Norma L. Slone, Trustees, 6632-10
Petitioner-Appellee,
v. OPINION
COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellant.
Appeal from a Decision of the
United States Tax Court
Argued and Submitted February 13, 2018
San Francisco, California
Filed July 24, 2018
SLONE V. CIR 3
Before: Mary M. Schroeder and Paul J. Watford, Circuit
Judges, and William K. Sessions III,* District Judge.
Opinion by Judge Schroeder
SUMMARY**
Tax
The panel reversed a decision of the Tax Court, and
remanded with instructions to enter judgment in favor of the
Commissioner of Internal Revenue, on a petition for
redetermination of federal income tax deficiency challenging
Petitioners’ liability for taxes in connection with an asset and
stock sale.
Slone Broadcasting Co. sold its assets to Citadel
Broadcasting Co. and its shares to Berlinetta, Inc. The stock
sale to Berlinetta involved the payment of funds obtained
through a loan, plus the assumption of a tax liability
generated by the asset sale. Slone Broadcasting and Berlinetta
then merged into a company called Arizona Media Holdings,
Inc. After paying off the loan used to buy the stock, Arizona
Media had no assets with which to pay the tax liability from
the asset sale. The Internal Revenue Service then sent notices
of tax liability to Petitioners, the former shareholders of Slone
*
The Honorable William K. Sessions III, United States District Judge
for the District of Vermont, sitting by designation.
**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
4 SLONE V. CIR
Broadcasting, claiming that they were liable as “transferees”
for taxes owed on the asset sale, under 26 U.S.C. § 6901.
In an earlier appeal, this court considered the Tax Court’s
original ruling in favor of Petitioners, and remanded to the
Tax Court because it had not applied the correct test to
determine whether Petitioners were transferees under section
6901. On remand, the Tax Court again ruled for Petitioners.
In this appeal, applying Arizona’s Uniform Fraudulent
Transfer Act, the panel held that the transaction was
constructively fraudulent as to the creditor (the IRS) because
the debtor (Slone Broadcasting) did not receive a reasonably
equivalent value in exchange for the transfer to the
shareholders and was left unable to satisfy its tax obligation.
The panel explained that the sale to Berlinetta was a cash-for-
cash exchange lacking independent economic substance
beyond tax avoidance, and that reasonable actors in
Petitioners’ position would have been on notice that
Berlinetta never intended to pay Slone Broadcasting’s tax
obligation.
Because the transaction lacked independent economic
substance apart from tax avoidance, and because Petitioners
were liable for the tax obligation under applicable state law,
the panel held Petitioners liable for Slone Broadcasting’s
federal tax obligation as “transferees” under 26 U.S.C.
§ 6901.
COUNSEL
Arthur T. Catterall (argued), Francesca Ugolini, and Gilbert
S. Rothenberg, Attorneys; David A. Hubbert, Acting
SLONE V. CIR 5
Assistant Attorney General; Tax Division, United States
Department of Justice, Washington, D.C.; for Respondent-
Appellant.
Stephen E. Silver (argued) and Jason M. Silver, Silver Law
PLC, Scottsdale, Arizona, for Petitioners-Appellees.
OPINION
SCHROEDER, Circuit Judge:
These consolidated appeals by the Commissioner of
Internal Revenue from the Tax Court involve the
Commissioner’s efforts to hold Petitioners, the former
shareholders of a close corporation, Slone Broadcasting Co.
(“Slone Broadcasting”), responsible for taxes owed on the
proceeds of its 2001 sale of assets to another broadcasting
company, Citadel Broadcasting Co. (“Citadel”), for
$45 million. This generated an estimated tax liability of
$15.3 million. This is the second time the Commissioner has
appealed to this Court. The background is described in more
detail in our first opinion, Slone v. C.I.R., 810 F.3d 599 (9th
Cir. 2015). We only summarize here.
The Petitioners followed up the asset sale to Citadel by
selling Slone Broadcasting’s stock to another company,
Berlinetta, Inc. (“Berlinetta”), an affiliate of Fortrend
International, LLC (“Fortrend”). See id. at 602. Berlinetta
assumed Slone Broadcasting’s income tax liability. Id.Berlinetta, using borrowed funds, paid the Petitioners an
amount representing the net value of the company after the
asset sale plus a premium representing almost two-thirds of
the amount of Slone Broadcasting’s tax liability. The
6 SLONE V. CIR
Petitioners thus received two-thirds of the amount Slone
Broadcasting should have paid in taxes after the asset sale.
Berlinetta and Slone Broadcasting then merged into a new
company called Arizona Media Holdings, Inc. (“Arizona
Media”), id. at 603, purportedly engaged in the business of
debt collection. After the newly formed entity repaid the loan
Berlinetta had used to purchase Petitioners’ stock, however,
the new company had no assets with which to pay the taxes
due from the original asset sale. So the Commissioner went
after the Petitioners as the ultimate transferees of the proceeds
of the original sale of assets. The Commissioner seeks to
establish that the Petitioners are liable for the Slone
Broadcasting tax liability that Berlinetta assumed but never
paid.
In the first appeal we considered the Tax Court’s original
ruling in favor of the Petitioners. We remanded to the Tax
Court because it had not applied the correct test to determine
whether the Petitioners were “transferees” under 26 U.S.C.
§ 6901. See Slone, 810 F.3d at 606–08. Under that section,
the Commissioner can, under certain circumstances, assess
tax liability against a taxpayer who is “‘the transferee of
assets of a taxpayer who owes income tax,’” and such
liability is assessed as if the transferee were the original
taxpayer. Id. at 604 (quoting Salus Mundi Found. v. Comm’r,
776 F.3d 1010, 1017 (9th Cir. 2014)). We held that the
Petitioners would be subject to transferee liability if two
conditions were satisfied: first, the relevant objective and
subjective factors must show that under federal law the
transaction with Berlinetta lacked independent economic
substance apart from tax avoidance; and second, we
explained Petitioners must be liable for the tax obligation
under applicable state law. See id. at 604–08. The Tax Court
SLONE V. CIR 7
erred in its first decision in failing to look behind the form of
this transaction to determine its economic substance under
federal law. In the first appeal, we emphasized that both
federal and state law issues must be satisfied to create
liability. See id. at 608.
On remand to the Tax Court, the Commissioner argued
that the Petitioners received, in substance, a liquidating
distribution from Slone Broadcasting, and that the form of the
stock sale to Berlinetta should be disregarded. Petitioners
emphasized that the proceeds they received came from
Berlinetta, not Slone Broadcasting. The Tax Court chose to
address only state law issues. It correctly looked to the
Uniform Fraudulent Transfer Act (“UFTA”) that Arizona has
adopted, but the Tax Court concluded it could disregard the
form of the stock sale to Berlinetta and look to the entire
transactional scheme only if Petitioners knew that the scheme
was intended to avoid taxes. The Tax Court concluded
Petitioners had no such knowledge and ruled once again for
the Petitioners.
On appeal the Commissioner argues that the Tax Court
misinterpreted the Arizona statute to require actual or
constructive knowledge, but that even if the statute requires
such a showing, the Commissioner satisfied its burden. We
do not reach the issue of statutory interpretation because the
record contains ample evidence that Petitioners were at the
very least on constructive notice that the entire scheme had no
purpose other than tax avoidance.
This record, as described in our earlier opinion and in the
Tax Court’s opinion below, shows that the purpose of
Petitioners’ transaction with Berlinetta was tax avoidance,
and that reasonable actors in Petitioners’ position would have
8 SLONE V. CIR
been on notice that Berlinetta never intended to pay Slone
Broadcasting’s tax obligation. It is not disputed that Slone
Broadcasting, following its asset sale to Citadel, was not
engaged in any business activities. It held only the cash
proceeds of the sale and receivables, plus the accompanying
$15 million tax liability. When Petitioners sold the stock to
Berlinetta, along with that tax liability, Petitioners received,
in substance, an ostensibly tax-free liquidating distribution
from Slone Broadcasting. There was no legitimate economic
purpose other than to avoid paying the taxes that would
normally accompany a liquidating asset sale and distribution
to shareholders. See Diebold Found., Inc. v. Comm’r,
736 F.3d 172, 175 (2d Cir. 2013).
The financing transactions further demonstrate that the
deal was only about tax avoidance. Berlinetta borrowed the
funds to make the purchase. After the merger with Slone
Broadcasting into Arizona Media, that entity, had it been
intended to be a legitimate business enterprise, could have
repaid the loan over time and retained sufficient capital to
sustain its purported debt collection enterprise and cover the
tax obligation. Instead, the financing was structured so that,
after the merger, Slone Broadcasting’s significant cash
holdings went immediately out the door to repay the loan
Berlinetta used to finance its purchase of the Slone
Broadcasting stock and tax liability. In the first appeal, Judge
Noonan observed that this case bears a striking resemblance
to Owens v. Commissioner, 568 F.2d 1233 (6th Cir. 1977), in
which a similar cash-for-cash purchase was held to be a
liquidating distribution to the shareholder. See Slone,
810 F.3d at 608–09 (Noonan, J., concurring in part and
dissenting in part). The analogy is apt.
While the majority of the panel in the first appeal
SLONE V. CIR 9
declined to reach the issue of economic substance under
federal law, it is appropriate to do so now. The Petitioners’
sale to Berlinetta was a cash-for-cash exchange lacking
independent economic substance beyond tax avoidance. See
Feldman v. C.I.R., 779 F.3d 448, 455–57 (7th Cir. 2015).
Indeed Petitioners’ own advisors expressed surprise over this
transaction; one of Petitioners’ lawyers testified that in his
nearly twenty years of private practice he “had never seen a
transaction like this.”
We therefore turn to whether, under Arizona law, the
Petitioners are liable to the government for Slone
Broadcasting/Arizona Media’s tax liability. See Slone,
810 F.3d at 604–05. As the Tax Court recognized, this
question must be resolved under Arizona’s Uniform
Fraudulent Transfer Act. The Commissioner argues in this
appeal that Petitioners are liable under that statute’s
constructive fraud provisions. See Ariz. Rev. Stat. §§ 44-
1004(A)(2), 44-1005. The Arizona UFTA’s constructive
fraud provisions protect a creditor in the event a debtor
engages in a transfer of assets that leaves the debtor insolvent,
i.e., unable to pay its outstanding obligations to the creditor.
See Hullett v. Cousin, 63 P.3d 1029, 1032–33 (Ariz. 2003).
Specifically, the UFTA provides that a transaction is
constructively fraudulent as to a creditor (here, the IRS), if
the debtor (here, Slone Broadcasting), did not “receiv[e] a
reasonably equivalent value in exchange for the transfer or
obligation, and the debtor either:
(a) Was engaged or was about to engage in a
business or a transaction for which the
remaining assets of the debtor were
unreasonably small in relation to the business
or transaction.
10 SLONE V. CIR
(b) Intended to incur, or believed or
reasonably should have believed that he
would incur, debts beyond his ability to pay as
they became due.”
Ariz. Rev. Stat. § 44-1004(A)(2); see id. § 44-1005 (debtor’s
transfer fraudulent as to creditor when “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”).
Our review of the record confirms that Petitioners’ sale of
Slone Broadcasting stock to Berlinetta, and Berlinetta’s
assumption of Slone Broadcasting’s tax liability, was, in
substance, a liquidating distribution to Petitioners, which left
neither Slone Broadcasting nor Berlinetta able to satisfy
Slone Broadcasting’s $15.3 million tax liability. Such a
transfer, in which the debtor, Slone Broadcasting, received no
reasonably equivalent value in return for its transfer to its
shareholders and was left unable to satisfy its tax obligation,
falls squarely within the constructive fraud provisions of the
Arizona UFTA.
The Tax Court held that Petitioners had no actual or
constructive knowledge of Berlinetta’s tax avoidance scheme,
and thus concluded it had to consider merely the rigid form
of the deal. According to the Tax Court, because the
Petitioners received their money from Berlinetta, and not
formally from Slone Broadcasting/Arizona Media, there was
no transfer from the “debtor” for purposes of sections 44-
1004(A)(2) and 44-1005 of the UFTA.
SLONE V. CIR 11
In this appeal, the Commissioner contends that we should
look to the substance of the transactional scheme to see that
Berlinetta was merely the entity through which Slone
Broadcasting passed its liquidating distribution to Petitioners.
We agree, because the Tax Court, without adequate
explanation, viewed itself bound by the form of the
transactions rather than looking to their substance. Its
concern was apparently that the Commissioner had not
established the requisite knowledge on the part of the
participants in the scheme to render Petitioners accountable.
This, however, is belied by the record.
Reasonable actors in Petitioners’ position would have
been on notice that Berlinetta intended to avoid paying Slone
Broadcasting’s tax obligation. Berlinetta communicated its
intention to eliminate that tax obligation, and Slone’s leaders
and advisors, despite their suspicions surrounding the
transaction, asked no pertinent questions. In Berlinetta’s
earliest solicitations to Slone Broadcasting, Berlinetta
marketed its ability to pay the shareholders a premium on
account of its ability to eliminate the company’s tax
liabilities. Berlinetta’s affiliate company, Fortrend, wrote in
a letter to Jack Roberts, Petitioners’ longtime accountant, that
Fortrend could pay a premium purchase price because of its
ability to “resolve liabilities at the corporate level.” This
proposal raised justified suspicions in Slone Broadcasting’s
leadership. Mr. Slone, the company’s president, testified that
upon learning that an entity wanted to purchase Sloan
Broadcasting, after it had already been effectively sold to
Citadel, he asked Jack Roberts, “can that be done?” Unsure,
Roberts replied, “well, I’m going to find out.”
That Berlinetta provided little information regarding how
it would eliminate Slone Broadcasting’s tax liability, coupled
12 SLONE V. CIR
with the structuring of the transactions, provided indications
that would have been hard to miss. Slone Broadcasting’s
advisors understood that the transaction made sense from
Berlinetta’s perspective only if Slone Broadcasting’s tax
liability were eliminated. This deal was, after all, an uneven
cash-for-cash exchange in which Berlinetta paid Petitioners
most of what Slone Broadcasting should have paid in taxes.
Yet Petitioners’ retained counsel testified that when he and
Jack Roberts asked for details, Berlinetta told them “it was
proprietary, it was a secret, and it was theirs, and we weren’t
going to be a party to it, and I said fine.” And in a lengthy
memo retained counsel prepared in November of 2001
analyzing the subject of potential transferee liability, counsel
wrote that Berlinetta would distribute almost all of Slone
Broadcasting’s cash to repay the loan used to finance the
deal. The memo never analyzed how Berlinetta could legally
offset Slone Broadcasting’s taxable gain from the asset sale.
The memo merely concluded that Petitioners would not be
liable as transferees of the proceeds of Slone Broascasting’s
asset sale if the Commissioner successfully challenged the
entity’s attempt to offset the tax liability.
The Tax Court misinterpreted Petitioners’ suspicions and
Berlinetta’s reassurances to mean Petitioners lacked actual or
constructive knowledge of the tax avoidance purpose of the
scheme. This record establishes that the Petitioners were, at
the very least, on constructive notice of such a purpose. In
reaching a contrary conclusion, the Tax Court confused actual
and constructive notice, in effect allowing Petitioners to
shield themselves through “the willful blindness the
constructive knowledge test was designed to root out.”
Diebold, 736 F.3d at 189–90; see Salus Mundi, 776 F.3d at
1020. It is clear that Petitioners’ stock sale to Berlinetta, in
which Berlinetta assumed Slone Broadcasting’s tax liability,
SLONE V. CIR 13
and Berlinetta paid Petitioners an amount representing the net
value of the company after the asset sale and most of the
amount that should have been paid in taxes on that asset sale,
operated in substance as a liquidating distribution by Slone
Broadcasting to Petitioners, but in a form that was designed
to avoid tax liability. Slone Broadcasting’s distribution to
Petitioners was thus a constructively fraudulent transfer under
the Arizona UFTA. Petitioners are liable to the government
for Slone Broadcasting’s federal tax obligation as
“transferees” under 26 U.S.C. § 6901.
REVERSED and REMANDED for entry of judgment
in favor of the Commissioner.