Merrill Lynch & Co., Inc. & Subsidiaries v. Commissioner

120 T.C. No. 3UNITED STATES TAX COURT
MERRILL LYNCH & CO., INC. & SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 18170-98. Filed January 15, 2003.
MP is the parent of an affiliated group (P) that
filed consolidated income tax returns for the taxable
years at issue.
1986 Transactions: In 1986, P decided to sell the
principal investments business of MLL, a second tier
subsidiary. Because P wanted to retain certain assets
of MLL, consisting of its lease advisory business and
certain other assets (the 1986 retained assets) within
the consolidated group while minimizing or eliminating
gain on the sale of MLL outside the consolidated group,
P adopted and implemented a plan consisting of the
following steps: (1) MLL distributed the 1986 retained
assets to its subsidiary, Merlease; (2) MLL then sold
Merlease cross-chain to a sister corporation (MLAM) in
a transaction that qualified as a sec. 304, I.R.C.,
deemed redemption; (3) MLL then distributed a dividend
of the gross sale proceeds to its parent, MLCR, a
wholly owned subsidiary of MP; (4) P then completed the
sale of MLL to a third party. Under the consolidated
- 2 -
return regulations then in effect, the cross-chain sale
and the related dividend generated an increase in
MLCR’s basis in MLL’s stock, enabling P to sell MLL
outside the consolidated group at a loss.
On the date of the 1986 cross-chain sale, P had
identified the prospective purchaser of MLL, had
negotiated a tentative purchase price for MLL, and
clearly intended to sell MLL outside the consolidated
group, thereby terminating MLL’s constructive ownership
under sec. 318, I.R.C., of Merlease, the issuing
corporation.
On its consolidated tax return for TYE Dec. 26,
1986, P claimed a loss from the sale of MLL after
treating the gross sale proceeds as a dividend and
increasing its basis in MLL’s stock by that amount.
1987 Transactions: P decided to sell the leased
properties business of MLCR, its wholly owned
subsidiary. Because P wanted to retain MLCR’s
nonleasing assets (the 1987 retained assets) while
minimizing or eliminating gain on the sale of MLCR
outside the consolidated group, P adopted and
implemented a plan consisting of the following steps:
(1) MLCR identified the subsidiaries holding the 1987
retained assets (MLBFS, MLPC, MLVC, MLEI, MLRDM, MLI,
MLLE); (2) MLCR then sold the seven subsidiaries to
three sister corporations (MLRI, MLPFS, MLAM) within
the consolidated group in transactions that qualified
as sec. 304, I.R.C., deemed redemptions; (3) MLCR then
distributed dividends of the gross sales proceeds to
its parent, MLCMH, a wholly owned subsidiary of MP; (4)
P then completed the sale of MLCR to a third party.
Under the consolidated return regulations then in
effect, the cross-chain sales and related dividends
generated increases in MLCMH’s basis in MLCR’s stock,
enabling P to sell MLCR outside the consolidated group
at a loss.
On the dates of the first seven of the 1987 cross-
chain sales, P had identified the purchaser of MLCR,
had prepared a draft acquisition agreement, and clearly
intended to sell MLCR outside the consolidated group,
thereby terminating MLCR’s constructive ownership under
sec. 318, I.R.C., of the subsidiaries sold cross-chain
(the issuing corporations).
- 3 -
After the first seven of the 1987 cross-chain
sales had closed and shortly before the sale of MLCR
was scheduled to close, the purchaser of MLCR notified
P that it could not own VL, one of MLCR’s subsidiaries
because of Federal law restrictions. Approximately 2
weeks before the sale of MLCR closed, MLCR sold the
stock of VL to MLAM, a sister corporation, in a
transaction that qualified as a deemed sec. 304,
I.R.C., redemption.
On its consolidated income tax return for TYE
Dec. 26, 1987, P claimed a loss of $466,985,176 from
the sale of MLCR after treating the gross sales
proceeds from the 1987 cross-chain sales as a dividend
and increasing its basis in MLCR’s stock by that
amount.
Respondent determined that the nine cross-chain
sales of Merlease, MLBFS, MLPC, MLVC, MLEI, MLRDM, MLI,
MLLE, and VL (the subsidiaries) and the sales of MLL
and MLCR outside the consolidated group were parts of a
firm, fixed, and clearly integrated plan to completely
terminate MLL’s and MLCR’s actual and constructive
ownership of the subsidiaries. Petitioner contends
that each cross-chain sale resulted in the receipt of a
dividend by the selling corporation under secs. 302(d)
and 301, I.R.C., equal to the gross sale proceeds and
that it was entitled, under the consolidated return
regulations, to increase its basis in MLL’s and MLCR’s
stock as a result of the cross-chain sales.
Held: The cross-chain sales qualified as
redemptions in complete termination of MLL’s and MLCR’s
interest in the subsidiaries sold cross-chain under
sec. 302(b)(3), I.R.C., and must be taxed as
distributions in exchange for stock under sec. 302(a),
I.R.C., rather than as dividends under sec. 301, I.R.C.
- 4 -
David J. Curtin, Sheri Dillon, Peter J. Genz, William F.
Nelson, Kimberly S. Piar and Cornelia J. Schnyder, for
petitioner.
Carmen M. Baerga, Jill A. Frisch, Lyle B. Press, and Jody S.
Rubinstein, for respondent.
MARVEL, Judge: Respondent determined the following
deficiencies in the Federal income tax of Merrill Lynch & Co.,
Inc. (Merrill Parent) and subsidiaries (collectively, the
consolidated group or petitioner):
TYE Deficiency
Dec. 26, 1986 $7,704,908
Dec. 25, 1987 12,141,242
Dec. 30, 1988 12,928,981
The ultimate issue in this case involves the proper
computation of petitioner’s basis in the stock of two
consolidated group members (the target corporations) that it sold
in 1986 and 1987. In order to resolve that issue, we must decide
the tax effect of nine cross-chain sales1 of stock of certain
subsidiaries (the issuing corporations) owned by the target
corporations. These sales were structured by petitioner to
transfer certain assets from the target corporations to other
members of the consolidated group (the acquiring corporations)
1
For purposes of this opinion, a cross-chain sale means a
sale by one brother-sister corporation to another brother-sister
corporation in the same ownership chain.
- 5 -
before the target corporations were sold outside the consolidated
group. The parties agree that the cross-chain sales qualified as
section 3042 redemptions that must be tested for dividend
equivalency under section 302(b). The parties disagree, however,
regarding the result of that testing.
Respondent contends that each cross-chain sale by a target
corporation and the later sale of that target corporation outside
the consolidated group were parts of a firm, fixed, and clearly
integrated plan to completely terminate the target corporation’s
actual and constructive ownership of the issuing corporations.
Respondent argues, therefore, that the cross-chain sales
qualified as redemptions in complete termination of the target
corporations’ interest in the issuing corporations under section
302(b)(3), and must be taxed as a distribution in exchange for
stock under section 302(a). Petitioner contends that each cross-
chain sale resulted in the receipt of a dividend by the selling
corporation under sections 302(d) and 301 equal to the gross sale
proceeds and that it was entitled, under the consolidated return
regulations, to increase its basis in the target corporations’
stock by the amount of the dividend.3 Petitioner’s claim to
2
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Monetary amounts are
rounded to the nearest dollar.
3
Under the consolidated return investment adjustment
(continued...)
- 6 -
increased bases in the stock of the target corporations when the
target corporations are sold to unrelated third-party purchasers
in 1986 and 1987 depends for its success upon dividend treatment
for the gross proceeds of the nine cross-chain sales. See secs.
1.1502-32(a) and 1.1502-33, Income Tax Regs.
Following concessions,4 therefore, we must decide:
3
(...continued)
regulations, see secs. 1.1502-32(a) and 1.1502-33, Income Tax
Regs. as in effect for the years at issue, a consolidated group
member’s basis in a subsidiary was increased or decreased, dollar
for dollar, by changes in the earnings and profits of the
subsidiary. The Commissioner subsequently amended the
consolidated return investment adjustment regulations generally
for determinations and tax years beginning on or after Jan. 1,
1995. T.D. 8560, 1994-2 C.B. 200.
4
In its petition, petitioner asserted (1) that respondent
failed to use the Becker “separate return limitation year” net
operating loss of $85,164,319 in computing petitioner’s group
taxable income for the 1987 taxable year; (2) respondent failed
to take into account the recalculated amount of environmental tax
deductions for the 1987 and 1988 taxable years; (3) respondent
failed to allow a separate fuel tax credit and instead included
such credit in petitioner’s general business credits for the 1986
taxable year; (4) respondent failed to include petitioner’s
available general business tax credits in determining
petitioner’s alternative minimum tax for the 1988 taxable year;
and (5) respondent failed to take into account $98,505 of Federal
income tax withheld by Newmont Mining on dividends paid to a
Canadian subsidiary of petitioner during the 1987 taxable year.
In its petition, petitioner also stated that respondent agreed
with petitioner’s position regarding adjustments (1)-(4). In the
answer to the petition, respondent conceded adjustments (1), (2),
and (4). Respondent also conceded that the disagreements
regarding adjustments (1)-(4) would be resolved in computing any
final deficiencies in this case. With respect to adjustment (5),
respondent denied the adjustment in the answer but did not raise
the issue on brief or at trial. Adjustment (5) is, therefore,
deemed conceded. See Rule 151(e)(4) and (5); Petzoldt v.
(continued...)
- 7 -
(1) Whether a deemed section 304 redemption in the form of
a 1986 cross-chain stock sale between brother-sister corporations
in a consolidated group must be integrated with the later sale of
the cross-chain seller outside the consolidated group and treated
as a redemption in complete termination under section 302(a) and
(b)(3) as respondent contends, or whether the deemed section 304
redemption qualified as a distribution of property taxable as a
dividend under section 301 as petitioner contends; and
(2) whether deemed section 304 redemptions in the form of
eight 1987 cross-chain stock sales between brother-sister
corporations in a consolidated group must be integrated with the
later sale of the cross-chain seller outside the consolidated
group and treated as a redemption in complete termination under
section 302(a) and (b)(3) as respondent contends, or whether the
deemed section 304 redemptions were distributions of property
taxable as dividends under section 301 as petitioner contends.
FINDINGS OF FACT
Some of the facts have been stipulated. We incorporate the
stipulated facts into our findings by this reference.
Merrill Parent is a corporation organized under Delaware law
and is the parent corporation of an affiliated group of
corporations that filed consolidated Federal income tax returns
4
(...continued)
Commissioner, 92 T.C. 661, 683 (1989); Money v. Commissioner, 89
T.C. 46, 48 (1987).
- 8 -
during the years at issue. Merrill Parent, through its
subsidiaries and affiliates, provides investment, financing,
insurance, leasing, and related services to clients.
I. 1986 Sale of ML Leasing
Before it was sold outside the consolidated group, Merrill
Lynch Leasing, Inc. (ML Leasing or MLL), was a wholly owned
subsidiary of Merrill Lynch Capital Resources, Inc. (ML Capital
Resources or MLCR), which in turn was wholly owned by Merrill
Parent. ML Leasing was engaged in the business of arranging
leasing transactions between third parties (lease advisory
business). ML Leasing also was engaged in the business of
leasing its own real and tangible personal property to third
parties in the capacity of lessor (principal investments
business). Immediately before the years at issue, the principal
investments business leases were generating substantial positive
cashflow but had “turned around” for income tax purposes, meaning
that if ML Leasing continued to hold the leases, the principal
investments business would generate taxable income in excess of
pretax cashflow. ML Leasing also owned, directly or through
single-purpose subsidiary corporations, general and limited
partnership interests in limited partnerships that held property
subject to operating and leveraged leases.
A. Preliminary Discussions
As early as August 22, 1985, Douglas E. Kroeger, a member of
- 9 -
the corporate tax department at Merrill Parent, sent an
interoffice memorandum to David K. Downes, corporate controller
at Merrill Parent, recommending the sale of ML Leasing’s stock,
after “stripping out” certain assets Merrill Parent did not wish
to sell, as part of a tax strategy that could result in an
increase in after-tax earnings of more than $60 million.5 On
September 16, 1985, Mr. Downes presented this tax strategy to
Jerome P. Kenny, president and chief executive officer of Merrill
Lynch Capital Markets (ML Capital Markets or MLCM),6 and Stephen
L. Hammerman, Merrill Parent’s general counsel, and arranged a
meeting to explain more fully the proposed tax strategy. The
proposed tax strategy at that time consisted of at least two
steps–-the distribution of certain assets of ML Leasing that
Merrill Parent wanted to retain within the consolidated group and
the sale of ML Leasing to a third party following the
distribution.
5
The tax strategy contemplated by Mr. Kroeger was intended
to increase after-tax earnings by taking advantage of a provision
in the consolidated return regulations requiring the addback of
accelerated depreciation over straight-line depreciation when
calculating earnings and profits. See Woods Inv. Co. v.
Commissioner, 85 T.C. 274 (1985). This tax strategy is not at
issue in this case.
6
Although it is unclear from the record, it appears that
Merrill Parent retained Merrill Lynch Capital Markets (ML Capital
Markets) to sell the stock of ML Leasing in 1986 and ML Capital
Resources in 1987.
- 10 -
At some point thereafter, Merrill Parent decided it wanted
to sell only the principal investments business of ML Leasing as
part of its tax strategy. Merrill Parent did not want ML
Leasing’s lease advisory business and certain other assets that
were not part of the principal investments business (collectively
referred to as the 1986 retained assets) to leave the
consolidated group. Merrill Parent decided to transfer the 1986
retained assets to other corporations within the consolidated
group in preparation for the sale of ML Leasing, leaving only the
principal investments business remaining in ML Leasing, including
the operating and leveraged lease assets.
On March 26, 1986, participants at an internal meeting of
petitioner discussed the possible sale of ML Leasing’s stock.
At the meeting, the participants discussed the estimated tax
basis of ML Leasing as of the end of 1985, the approximate value
of ML Leasing, whether the sale would be prohibited because of
various restrictions in the lease documents, the intangible
effects of the sale of ML Leasing, the possibility of tax reform
being passed prior to late August 1986, the estimated after-tax
economic benefit of the sale of ML Leasing, and the estimated
after-tax book gain that would result from the sale of ML
Leasing. At the meeting, Jeffrey Martin, a member of
petitioner’s Mergers & Acquisitions Group, was asked “to feel out
the market on a no-name basis inquiring if there are any
- 11 -
interested parties for such a transaction.” Upon conclusion of
the meeting, it was decided that petitioner “would await Mr.
Martin’s findings before any additional work takes place”
regarding the sale of ML Leasing. In approximately April 1986,
petitioner decided to pursue a sale of ML Leasing and appointed
Theodore D. Sands, managing director of the Investment Banking
Division at Merrill Parent, to serve as the chief negotiator with
respect to the sale.7 Mr. Sands suggested that petitioner “clean
up” ML Leasing by removing any assets the company did not want to
sell (i.e., the 1986 retained assets).8 Mr. Sands, however, did
not suggest the manner in which the 1986 retained assets should
be transferred from ML Leasing, and he did not suggest
implementing the 1986 cross-chain sale at issue in this case.
B. Petitioner Seeks a Purchaser
Mr. Sands was asked to develop a profile of a likely
prospective purchaser for ML Leasing and a list of prospective
purchasers. Mr. Sands established three criteria for a potential
purchaser of ML Leasing: (1) A purchaser should be financially
7
On July 28, 1986, petitioner officially appointed a five-
person project team to conduct the divestiture of ML Leasing,
which included Mr. Sands as chief negotiator.
8
The 1986 retained assets consisted of assets leased under
operating, finance, and leveraged leases, subject to the
liabilities associated with such assets, and the shares of 34
corporate subsidiaries that owned leased equipment and leased
real property. The decision as to which assets would be sold and
which would be retained was made by the head of investment
banking at Merrill Parent.
- 12 -
sophisticated to handle the lease portfolio; (2) a purchaser
should be able to finance the transaction; and (3) a purchaser
should have a net operating loss (NOL) carryforward and,
therefore, should be indifferent to the fact that the lease
portfolio was about to turn for tax purposes.
In or around April 1986, Mr. Sands contacted Inspiration
Resources Corp. (Inspiration). Inspiration was a diversified
natural resources company whose stock was publicly traded on the
New York and Toronto stock exchanges. Inspiration was controlled
by Minerals & Resources Corp., Ltd. (MINORCO), a Bermuda
corporation headquartered in London, England. Mr. Sands had
worked with Inspiration on other matters before 1986 and was
aware that Inspiration had a significant NOL.
Petitioner provided to Inspiration a document entitled
“MERRILL LYNCH LEASING INC. Proposed Sale of Equity Investment
Assets” dated April 1986 (ML Leasing offering memorandum). The
ML Leasing offering memorandum described the assets that would be
owned by ML Leasing at the time of the sale and the pretax
cashflows expected to be derived from the portfolio of leases.
The ML Leasing offering memorandum described the proposed
transaction as follows:
Prior to the sale of Leasing’s stock, any of Leasing’s
assets which are not to be sold will be dividended to
MLCR. Assets remaining in Leasing will be the equity
investments in real estate and equipment net leased to
major corporations, tax benefits purchased under the
1981 Tax Act, unused ITC carryover, and any state net
- 13 -
operating losses (“NOL’s”) not used in the various
ML&Co. 1986 unitary returns. The remaining liabilities
in Leasing would consist solely of deferred taxes.
MLCR will then sell the stock of Leasing. * * *
The 1986 retained assets were not included in the description of
ML Leasing’s portfolio.
On June 19, 1986, Mr. Sands prepared a memorandum entitled
“Status of ML Leasing Sales Effort”. The memorandum reported on
a telephone call Mr. Sands received from Mr. Smith, the Vice
President-Finance for Inspiration. As summarized in the
memorandum, Mr. Smith “expressed strong interest” in purchasing
ML Leasing and reported that he had prepared a detailed analysis
for consideration by Inspiration’s executive committee. Although
Mr. Smith had expressed reservations about the status of
Inspiration’s NOLs and about the lack of certainty regarding the
lease residual values, Mr. Sands reported that Mr. Smith’s
concern regarding Inspiration’s NOLs was not a serious problem
and that Mr. Smith’s concern regarding the residual values would
be addressed in a meeting on June 23 when Mr. Smith and his staff
would meet with a representative of ML Leasing to review the
residuals on a lease-by-lease basis. Mr. Sands reported that, if
Mr. Smith were satisfied after the June 23 meeting, Inspiration
“will make a go - no go decision on buying Leasing at the $80
million asking price based on the assumption that the residual
values can be confirmed by an outside appraiser.”
- 14 -
On July 3, 1986, a written “Presentation to Inspiration
Resources Corporation” prepared by ML Capital Markets was
submitted to Inspiration. The presentation again described the
assets proposed to be owned by ML Leasing at the time of sale of
the ML Leasing stock to Inspiration and the pretax net cashflows
expected to be derived from the portfolio of leases. The 1986
retained assets were not included in those assets. The
presentation proposed a purchase price of $98 million and a
closing date at the end of 1986.
C. The Tax Plan and the Section 304 Cross-Chain Sale
Sometime between 1985 when the possible sale of ML Leasing
was first discussed and July 21, 1986, when ML Leasing
contributed the 1986 retained assets to Merlease Leasing Corp.
(Merlease), petitioner finalized a plan9 to strip ML Leasing of
the 1986 retained assets and to sell ML Leasing outside the
consolidated group using planning techniques designed to increase
petitioner’s tax basis in ML Leasing and thereby eliminate gain
on the sale of ML Leasing. The plan consisted of the following
steps:
9
It appears from the ML Leasing offering memorandum that
petitioner originally intended to have MLL distribute the 1986
retained assets to MLCR as a dividend. We infer from this fact
that petitioner finalized its plan to engage in sec. 304 cross-
chain sales after the ML Leasing offering memorandum had been
prepared.
- 15 -
1. ML Leasing would contribute the 1986 retained assets to
Merlease, a direct wholly owned subsidiary of ML Leasing, in
anticipation of ML Leasing’s sale outside the consolidated group.
2. ML Leasing would then sell Merlease cross-chain to a
sister corporation within the consolidated group.
3. ML Leasing would declare a dividend to ML Capital
Resources of designated assets and the gross sales proceeds from
the cross-chain sale of Merlease to the acquiring corporation.
4. After each of the steps outlined above had occurred,
petitioner would then sell ML Leasing to a third-party purchaser.
In accordance with the plan and pursuant to a resolution
dated July 21, 1986, ML Leasing contributed the 1986 retained
assets to the capital of Merlease.10
In accordance with the plan and pursuant to resolutions
adopted on July 22, 1986, the respective boards of directors of
ML Leasing and Merrill Lynch Asset Management, Inc. (ML Asset
Management or MLAM), a direct wholly owned subsidiary of Merrill
Parent, approved the sale of the stock of Merlease to ML Asset
Management for a purchase price equal to the fair market value of
such stock as of July 22, 1986. Two days later, ML Leasing and
ML Asset Management entered into a stock purchase agreement dated
10
Some of the same assets identified in the July 21, 1986,
consent to corporate action as having been contributed to
Merlease’s capital were included as part of a dividend declared
and paid to ML Capital Resources, ML Leasing’s sole shareholder
as of July 18, 1986.
- 16 -
July 24, 1986, pursuant to which ML Asset Management agreed to
purchase all of ML Leasing’s Merlease stock for a purchase price
of $73,320,471. The sale closed on July 24, 1986. Immediately
before ML Asset Management purchased the stock of Merlease, ML
Asset Management’s accumulated earnings and profits exceeded the
price it paid for the Merlease stock. The parties agree that the
sale of Merlease to ML Asset Management was a section 304
transaction.
D. Presentation to Merrill Parent’s Board of Directors
On July 28, 1986, only 4 days after the cross-chain sale of
Merlease, a formal presentation was made to Merrill Parent’s
board of directors regarding the sale of ML Leasing.11 The
presentation included the distribution of a written summary and
slides illustrating the details of the plan for the sale of ML
Leasing, including key calculations. The written summary began
as follows:
We have identified a significant economic benefit,
based on an opportunity in the tax law, in selling
Merrill Lynch’s proprietary lease business. This
economic benefit can be achieved by structuring a
transaction to sell the stock of our primary leasing
subsidiary, Merrill Lynch Leasing. We believe that
such a sale could realistically result in an after-tax
financial statement gain of approximately $104 million.
The presentation laid out the various steps of the plan to
11
Petitioner was unable to locate the minutes of the meeting
of the board of directors on July 28, 1986, the date the
presentation was made.
- 17 -
dispose of Merrill Lynch’s proprietary lease business culminating
in the sale of ML Leasing’s stock.
The stated purpose of the presentation was to secure the
board’s approval to enter into a letter of intent with the
purchaser12 and to secure the board’s authorization for:
the Executive Committee to approve the final details of
the proposed transaction in accordance with the letter
of intent, subject to closing adjustments and unforseen
contingencies arising from negotiating a final
agreement in early October, up to a maximum reduction
of $20 million.
The written summary informed the board of directors that
“due to the exhaustion of tax benefits, many of * * * [ML
Leasing’s] leases begin to produce taxable income in 1987, with
the remainder ‘turning around’ in 1988. Accordingly, it is an
opportune time to sell our Principal Investments line of business
to an appropriate purchaser.” The summary also informed the
board of directors that because it was not Merrill Parent’s
intent to withdraw from all aspects of the leasing business,
Merrill Parent was removing the 1986 retained assets from ML
Leasing before ML Leasing’s stock was sold in two steps: (1) The
1986 retained assets had been sold to ML Asset Management for
approximately $57 million; and (2) ML Leasing will declare a $115
12
The presentation represented to the board of directors
that “Once both parties have signed the letter of intent, the
sales price will be firmly established subject only to changes in
the residual value by the appraisers. Moreover, even the impact
of residual value appraisals will be limited to $14 million.”
- 18 -
million dividend to ML Capital Resources consisting of cash
received from ML Asset Management, plus other cash, receivables,
and certain liabilities. After removal of the 1986 retained
assets, the summary represented that Merrill Parent would then be
in a position to sell the principal investments business portion
of ML Leasing.
The summary unequivocally identified Inspiration as the
purchaser of ML Leasing’s stock, described Inspiration, and
stated that “In return for the stock of ML Leasing, we will
receive $126 million in cash (subject to adjustments for residual
value appraisals) from the purchaser, Inspiration Resources
Corporation.” The summary also explained how the sale price was
determined,13 quantified the after-tax income and the tax benefit
that would result from the sale, explained the tax risks of the
transaction, and recommended the creation of a $37 million tax
13
The sale price was determined by calculating the present
value of the cashflow stream generated by ML Leasing’s assets
($42 million), discounting the pretax cashflow to reflect the
value of the cashflow to Inspiration ($143 million), calculating
the value of Inspiration’s NOLs ($101 million), and adding to the
present value of the cashflow stream a premium of $53 million
(representing a split of the benefits arising from Inspiration’s
NOLs). The resulting base sale price ($95 million) was then
increased by the amount of cash to be left in ML Leasing
(estimated to be $31 million) to arrive at a total sale price of
$126 million (subject to adjustment for residual value
appraisals).
- 19 -
reserve for the transaction.14 In calculating the recommended
reserve, the summary stated the following:
The first item of tax reserve concerns the sale to
Merrill Lynch Asset Management of the leasing
subsidiaries we wish to retain. The IRS could maintain
that the form of this transaction should be disregarded
and in substance, a distribution with a reduction in
tax basis should be deemed to have occurred. The $16
million reserve amount is the $57 million I noted
previously multiplied by the 28% capital gains tax
rate.
Following the presentation, Merrill Parent’s board of directors
approved the plan, including the sale of Merrill Leasing to
Inspiration.
E. Nonbinding Letter of Intent
On July 29, 1986, 1 day after the presentation to its board
of directors, Merrill Parent entered into a nonbinding letter of
intent with Inspiration for the sale of the stock of ML Leasing
to Inspiration. The letter of intent provided a “period of
exclusivity” during which Merrill Parent would negotiate
exclusively with Inspiration to reach an agreement for the sale
of ML Leasing. Upon executing the letter of intent, the parties
agreed that “if such sale agreement is not executed on or prior
to August 31, 1986, neither of us intends to proceed with the
transactions contemplated herein.” The letter of intent provided
14
The $37 million tax reserve consisted of a $16 million
reserve for the possible disallowance of the deemed dividend
resulting from the cross-chain sale and a $21 million reserve for
lost tax benefits if certain income projections were not
realized.
- 20 -
that “If the conditions to reaching an agreement are satisfied,
the aggregate purchase price will be $95,000,000”, subject to
adjustment for cash left in ML Leasing, for the value of
residuals as determined by independent appraisers, and for other
specified adjustments. The letter of intent also stated:
It is understood that this letter of intent merely
constitutes a statement of our mutual intentions with
respect to the proposed acquisition and does not
contain all matters upon which agreement must be
reached in order for the proposed acquisition to be
consummated. A binding commitment with respect to the
proposed acquisition will result only from execution of
definitive agreements, subject to the conditions
expressed therein.
Following execution of the nonbinding letter of intent, both
Inspiration and Merrill Parent hired outside appraisers to value
the lease portfolio.15
On July 29, 1986, Merrill Parent issued a news release to
its employees announcing that it had entered into a letter of
intent for the sale of a portion of its leasing operations to
Inspiration. Merrill Parent announced that the sale, if
consummated, would result in a realization of after-tax gain of
at least $70 million and was scheduled to close at the end of
15
During July and August 1986, petitioner also executed
various transfers within the consolidated group to remove assets
from ML Leasing before its sale to Inspiration. By resolutions
dated July 31 and Aug. 1, 1986, ML Leasing’s board of directors
authorized payment of a dividend to ML Capital Resources
consisting of all the capital stock of five subsidiaries of ML
Leasing, intercompany receivables, cash, and other assets. These
distributions are not at issue in this case.
- 21 -
1986, “subject to negotiation of definitive documentation and
normal conditions to closing.”
On August 5, 1986, Inspiration’s board of directors ratified
and retroactively approved the nonbinding letter of intent
between Inspiration and Merrill Parent. The board of directors
authorized the executive committee of the board of directors to
“take any and all necessary or desirable actions in connection
with the proposed acquisition of” ML Leasing.
F. Further Negotiations Between Petitioner and Inspiration
On August 19, 1986, Inspiration wrote a letter to Mr. Sands
explaining that “Several problems have arisen over the past few
weeks” regarding the purchase of ML Leasing. In the letter,
Inspiration advised that it was unable “to finance this
transaction on a secured basis within the timeframe and terms of
our agreement.” Inspiration stated that it had started to review
alternative means of financing, including both unsecured
financing and the sale of specific leases from the ML Leasing
portfolio as a means of financing the transaction and suggested
that the increased cost of the unsecured financing “may justify a
downward adjustment in the purchase price.” In the letter,
Inspiration requested that the terms of the draft stock purchase
agreement be altered to accommodate alternative means of
financing; i.e., by eliminating a provision in the draft stock
agreement that prohibited Inspiration from selling significant
- 22 -
assets from ML Leasing for a period of 5 years. In addition,
Inspiration suggested that “Merrill Lynch may have to arrange
with the lessee and the secured noteholders to waive certain
restrictions on transfer of ownership” in order to accommodate
its request. Inspiration also pointed out that the existing
draft purchase agreement did not contain a representation from
petitioner that the cashflows as presented to Inspiration were
correct. Inspiration advised that in order for a lender or a
purchaser to make financing decisions based on “these cash flows,
a legal due diligence review will be insufficient and it will be
essential for Merrill Lynch to represent that the cash flows [of
the leases] are accurate.” Inspiration concluded its letter by
expressing its continued interest in completing the transaction.
In order to give the parties to the letter of intent
additional time to finalize their deal, the parties on August 29,
1986, agreed to extend the term of the nonbinding letter of
intent to September 19, 1986, and negotiations and discussions
continued with Inspiration after August 29, 1986.16
Shortly after August 29, 1986, petitioner’s appraiser and
Inspiration’s appraiser completed their analysis of residual
values. Both appraisers valued the residual values of the leases
16
A Sept. 8, 1986, interoffice memorandum from Mr. Sands
stated that although Inspiration still had not secured financing
to purchase ML Leasing, Inspiration was optimistic that it would
do so. Mr. Sands also indicated that Inspiration’s financing
efforts were going very well.
- 23 -
in ML Leasing’s portfolio higher than petitioner and Inspiration
had expected. As a result, the chief financial officer for
Merrill Parent instructed Mr. Sands to negotiate an increase in
the purchase price from $126.6 million to $131.4 million. In
accordance with those instructions, Mr. Sands attempted to
negotiate an adjustment to the purchase price. Although his
efforts apparently were not initially well received,17 the
parties ultimately agreed to increase the purchase price by $3
million.
In approximately August or early September 1986, petitioner
provided Inspiration with a draft stock purchase agreement dated
September 11, 1986.18 On September 16, 1986, the executive
committee of Inspiration’s board of directors met to discuss the
acquisition of ML Leasing. After discussion, the executive
committee approved the September 11, 1986, stock purchase
agreement substantially in the form presented. The executive
committee also authorized Inspiration’s management to finalize
the necessary bank financing.
17
Mr. Sands was asked by Inspiration’s representatives to
leave the meeting, and, for at least a day after the meeting,
Inspiration refused to return phone calls from either Mr. Sands
or petitioner’s attorneys.
18
The Aug. 19, 1986, letter from Inspiration to Mr. Sands
indicates there was a previous version of the Sept. 11, 1986,
draft stock purchase agreement. The record is unclear, however,
as to when the first stock purchase agreement was drafted and
circulated.
- 24 -
G. ML Leasing Stock Purchase Agreement
Effective September 19, 1986, Merrill Parent, ML Capital
Resources, ML Leasing, and Inspiration executed an agreement for
the purchase and sale of the stock of ML Leasing (ML Leasing
stock purchase agreement). The ML Leasing stock purchase
agreement was amended as of October 31, 1986, to reflect further
negotiations on certain matters. The purchase price was
$129,445,843, payable in cash at closing, subject to certain
postclosing adjustments. Pursuant to the ML Leasing stock
purchase agreement, the purchase price subsequently was adjusted
based on residual value appraisals for certain leases. The sale
of ML Leasing closed on October 31, 1986.
II. 1987 Sale of ML Capital Resources
At the beginning of petitioner’s TYE 1987, ML Capital
Resources was a wholly owned subsidiary of Merrill Parent.19 ML
Capital Resources was engaged in the business of arranging
equipment leasing transactions between third parties and also
owned various types of equipment and other tangible personal
property, which it leased to third parties. ML Capital
Resources’ business focused on small business leases. It was
also a partner in certain limited partnerships that held
19
By resolution dated Apr. 8, 1987, the board of directors
of Merrill Parent approved the formation of a newly organized
corporation, Merrill Lynch Consumer Markets Holdings, Inc.
(Consumer Markets or MLCMH), and the contribution of all the
capital stock of ML Capital Resources to Consumer Markets.
- 25 -
computers leased to IBM and had been active in other types of
financing for medium-sized businesses. ML Capital Resources also
owned the stock of a number of subsidiary corporations that were
engaged in the business of arranging equity and debt financing
for middle- and small-sized companies.
Merrill Parent decided to sell that portion of ML Capital
Resources’ business consisting of the ownership of leased
property. In the aggregate, the leases were generating
substantial positive cashflow but had “turned around” for income
tax purposes so that if ML Capital Resources continued to hold
them, the leases would generate taxable income in excess of
pretax cashflow. Because Merrill Parent did not want ML Capital
Resources’ nonleasing assets to leave the consolidated group, it
decided that ML Capital Resources would sell to other affiliated
corporations the stock of certain subsidiary corporations that
were engaged in lending and financing activities or that owned
other assets and businesses that were not related to its core
consumer leasing operations (collectively referred to as the 1987
retained assets).20
A. Petitioner Seeks a Purchaser
Merrill Parent decided to conduct the sale of ML Capital
Resources utilizing a bidding process. By February 17, 1987, a
20
Senior management decided which assets to sell and which
assets to retain within the consolidated group.
- 26 -
draft preliminary offering memorandum regarding the sale of the
stock of ML Capital Resources (preliminary offering memorandum)
had been prepared, as well as a list of prospective buyers and a
projection of an estimated sale price for ML Capital Resources of
between $70 and $80 million, on which was calculated a potential
after-tax gain of between $43.5 and $88 million. At some point
between February 17, 1987, and March 1987, the preliminary
offering memorandum was finalized.
If a potential purchaser was interested after reviewing the
preliminary offering memorandum, Merrill Parent required that the
potential purchaser sign a confidentiality letter, at which point
the potential purchaser could request a confidential 3-volume
detailed offering memorandum dated March 1987 regarding the
specific leases in ML Capital Resources’ portfolio (3-volume
offering memorandum). Under the bidding procedure established by
Merrill Parent and set forth in the 3-volume offering memorandum,
interested purchasers were required to submit “preliminary
indications of interest”, including a proposed cash purchase
price, by March 27, 1987. Immediately thereafter, ML Capital
Markets and ML Capital Resources would select a limited number of
potential purchasers that would be given the opportunity to
perform detailed due diligence. At that time, prospective
purchasers would be given proposed forms for a stock purchase
agreement. Prospective purchasers were required to submit bids
- 27 -
as to price and terms by April 10, 1987. The 3-volume offering
memorandum indicated that ML Capital Resources “does not intend
to engage in substantial negotiations with respect to the terms
of the Stock Purchase Agreement” and proposed an April 30, 1987,
closing date.
On March 13, 1987, the chairman of the board of ML Capital
Resources authorized a five-person team to pursue the divestiture
of ML Capital Resources, four of whom had been involved in the
sale of ML Leasing. Mr. Sands again was appointed as chief
negotiator.
In and around March 1987, Merrill Parent contacted various
potential purchasers regarding the sale of ML Capital Resources.
The ultimate purchaser, GATX Leasing Corp. (GATX), on behalf of
itself and BCE Development, Inc. (BCE), a majority-owned
subsidiary of Bell Canada Enterprises (collectively referred to
as GATX/BCE unless otherwise indicated), apparently received the
preliminary offering memorandum sometime during March 1987
because ML Capital Markets sent GATX/BCE a confidentiality
agreement dated March 23, 1987.
B. Section 304 Cross-Chain Sales
1. Five Subsidiaries
Effective March 28 and March 30, 1987, respectively, the
boards of directors of ML Capital Resources and Merrill Lynch
Realty, Inc. (ML Realty or MLRI), a wholly owned subsidiary of
- 28 -
Merrill Parent, approved the sale of all the stock of five
subsidiaries wholly owned by ML Capital Resources to ML Realty:
Merrill Lynch Business Financial Services, Inc. (Financial
Services or MLBFS);21 Merrill Lynch Private Capital, Inc.
(Private Capital or MLPC);22 Merrill Lynch Venture Capital, Inc.
(Venture Capital or MLVC); Merrill Lynch Energy Investments, Inc.
(Energy Investments or MLEI); and Merrill Lynch R&D Management,
Inc. (MLRDM) (collectively referred to as the five subsidiaries).
ML Capital Resources and ML Realty entered into a stock
purchase agreement dated March 30, 1987, for the sale of stock of
the five subsidiaries to ML Realty. The purchase price of the
stock of the five subsidiaries was $53,972,607 (which was
allocated to each subsidiary based on their respective book
values). The sale closed on March 30, 1987. Immediately before
its purchase of the five subsidiaries, ML Realty had accumulated
earnings and profits that exceeded the purchase price. The sales
of the five subsidiaries were five of the eight cross-chain sales
21
Before the sale of Financial Services, effective Mar. 30,
1987, ML Capital Resources contributed certain loan receivables
and other assets and liabilities with a net book value of $10
million to Financial Services. These assets and liabilities were
part of the 1987 retained assets and thus were not intended to be
included in the assets of ML Capital Resources at the time of the
sale of its stock.
22
Private Capital had a substantial negative book net worth
as of Mar. 29, 1987. Before the sale of Private Capital,
effective Mar. 30, 1987, ML Capital Resources contributed $32
million in cash to the capital of Private Capital and thereby
created a positive book net worth in Private Capital.
- 29 -
at issue for the taxable year ended December 25, 1987. The
parties agree that these sales were section 304 transactions.
2. ML Interfunding
Merrill Lynch Interfunding, Inc. (ML Interfunding or MLI),
was a wholly owned subsidiary of ML Capital Resources. By
resolutions dated March 27, 28, and 30, 1987, the boards of
directors of ML Capital Resources and ML Asset Management
approved the sale of all the stock of ML Interfunding to ML Asset
Management.23 ML Capital Resources and ML Asset Management
entered into a stock purchase agreement dated March 30, 1987,
which provided for an initial purchase price of $160 million to
be paid at closing with the purchase price to be adjusted as soon
as practicable by subsequent agreement of ML Asset Management and
ML Capital Resources so as to equal the fair market value of the
shares as of March 30, 1987. The sale closed on March 30,
1987.24 Immediately before its purchase of ML Interfunding, ML
23
By resolution dated Mar. 27, 1987, the board of directors
of ML Interfunding declared and paid a dividend having a total
value of $100 million to ML Capital Resources of certain
preferred stock that it owned in Gelco Corporation (Gelco) plus
the shares of certain unaffiliated corporations (portfolio
stock), which it had acquired as a dividend from its wholly owned
subsidiary, ML Portfolio Management, by resolution dated Mar. 26,
1987. By resolution dated Mar. 28, 1987, ML Capital Resources
contributed the portfolio stock and the Gelco shares to Merrill
Lynch Property Holdings, Inc., a direct wholly owned subsidiary
of ML Capital Resources.
24
In a valuation report dated Apr. 18, 1988, Deloitte
Haskins-Sells determined that the fair market value of the stock
(continued...)
- 30 -
Asset Management had accumulated earnings and profits that
exceeded the purchase price. This is the sixth cross-chain sale
at issue for the taxable year ended December 25, 1987. The
parties agree that this cross-chain sale was a section 304
transaction.
3. Leasing Equipment
By resolutions dated April 3, 1987, the respective boards of
ML Capital Resources and Merrill Lynch, Pierce, Fenner & Smith,
Inc. (MLPFS), a first-tier wholly owned subsidiary of Merrill
Parent, approved the sale of all the stock of ML Leasing
Equipment Corp. (Leasing Equipment or MLLE), a wholly owned
subsidiary of ML Capital Resources, to MLPFS.25 ML Capital
Resources and MLPFS entered into a stock purchase agreement dated
April 3, 1987. The purchase price for Leasing Equipment’s stock
was $119,819,690. The sale closed on April 3, 1987. Immediately
before its purchase of Leasing Equipment, MLPFS had accumulated
24
(...continued)
of ML Interfunding as of Mar. 30, 1987, was $181,080,000. Based
on such appraisal, ML Asset Management and Consumer Markets, as
assignee of ML Capital Resources’ rights under the ML
Interfunding stock purchase agreement, agreed that ML Asset
Management would pay Consumer Markets $26,413,365 as the final
payment of the purchase price for the ML Interfunding stock,
which was the difference between $181,080,000 and the net
consideration paid at closing of $154,666,635.
25
On Apr. 2, 1987, ML Capital Resources contributed the
stock of MLL Corporate Partners, Inc., a subsidiary of ML Capital
Resources engaged in nonleasing activities, to Leasing Equipment.
- 31 -
earnings and profits that exceeded the purchase price. This is
the seventh cross-chain sale at issue for the taxable year ended
December 25, 1987. The parties agree that this cross-chain sale
was a section 304 transaction.
C. The Sale of ML Capital Resources
Pursuant to the bidding procedure governing the sale of ML
Capital Resources, petitioner received five or six bids,
including one from GATX/BCE. The bid from GATX/BCE, dated April
21, 1987, contained the principal terms upon which GATX/BCE was
prepared to purchase all the outstanding shares of ML Capital
Resources (April 21, 1987, bid proposal).26 GATX/BCE proposed a
base purchase price of $63 million, plus 70 percent of certain
residual payments in excess of $27 million. GATX/BCE’s April 21,
1987, bid proposal specifically provided, among other things, the
following conditions precedent: (1) GATX/BCE would enter into a
purchase agreement only upon the receipt of all requisite
corporate approvals, including approvals by the boards of GATX
and BCE, and (2) satisfactory completion of further due
diligence. The further due diligence included, but was not
limited to, review of the basic and related documentation, review
of audited financials of the IBM partnerships and ML Capital
26
Although the bidding procedure required each prospective
purchaser to submit by Mar. 27, 1987, preliminary indications of
interest outlining a proposed purchase price, the record contains
no information regarding what, if anything, GATX/BCE submitted.
- 32 -
Resources, and review of a report prepared by IBM Credit
Corporation for the partners of the IBM partnerships.
On April 23, 1987, a formal presentation regarding the sale
of ML Capital Resources was made to Merrill Parent’s board of
directors at its regular meeting. The presentation was made by
Courtney F. Jones. The substance of the presentation was
summarized in a written summary and slides illustrating the
details of the plan for the sale of ML Capital Resources. The
written summary began as follows:
We have identified a significant economic benefit,
based on an opportunity in the tax law, in selling
Merrill Lynch’s proprietary middle market lease
business. This economic benefit can be achieved by
structuring a transaction to sell the stock of one of
our leasing subsidiaries, Merrill Lynch Capital
Resources. We believe that such a sale could
realistically result in an after-tax financial
statement gain of approximately $73 million.
In conjunction with Merrill Lynch Capital Markets we
have identified a purchaser. The purpose of this
presentation is to secure your approval for the
Executive Committee to approve the final details of the
transaction and sign the definitive agreement.
The written summary laid out the various steps of the plan to
dispose of Merrill Lynch’s proprietary middle-market lease
business culminating in the sale of ML Capital Resources’ stock.
The written summary informed the board of directors that--
due to the exhaustion of tax benefits, many of * * *
[ML Capital Resources’] leases have begun to produce
taxable income in 1987. The projected cash flow from
the leases will in most years not be sufficient to
service the debt and the tax liability generated by the
- 33 -
leases. Accordingly, it is an opportune time to sell
this business to an appropriate purchaser.
The written summary also informed the board of directors that
because Merrill Parent did not intend to withdraw from the
“Lending Activities” aspect of the business, Merrill Parent “will
first remove the assets and operations related to the businesses
we wish to retain” and will “transfer all of the subsidiaries of
ML Capital Resources elsewhere within our Corporate structure” in
three steps before ML Capital Resources’ stock was sold: (1) ML
Capital Resources had already sold ML Interfunding’s stock to ML
Asset Management for its net book value of approximately $160
million; (2) ML Capital Resources had already sold the stock of
certain of its subsidiaries to ML Realty Inc. for approximately
$50 million; and (3) ML Capital Resources will declare a $459
million dividend to its parent company, Merrill Lynch Consumer
Markets Holdings, Inc. (Consumer Markets), consisting of cash
received from ML Asset Management and ML Realty, existing cash
balances, the stock of the remaining subsidiaries, receivables,
and liabilities. The board was informed that after these
transfers were completed, ML Capital Resources “will have equity
of approximately $40 million” and “we will be in a position to
sell” ML Capital Resources’ stock.
The presentation identified “a joint venture between BCE
Development, Inc., a wholly owned U.S. subsidiary of Bell Canada
and GATX Leasing Corporation, a wholly owned subsidiary of GATX
- 34 -
Corporation” as the likely purchaser and estimated a sales price
of $70 million, consisting of $62 million in cash plus the
assumption of $8 million in liabilities. The presentation also
explained how the sale price was determined, quantified the
after-tax income and the tax benefit that would result from the
sale, explained the tax risks of the transaction, and recommended
the creation of a $35 million tax reserve for the transaction.27
In calculating the recommended reserve, the presentation stated
the following:
As you can imagine, it is the tax aspects that make
this sale especially attractive. The Tax Department,
in conceiving this transaction, has creatively applied
two different tax concepts to maximize the calculation
of Merrill Lynch’s tax basis in ML Capital Resources.
* * * * *
The second tax concept deals with the creation of
approximately $210 million in tax basis. This basis is
created by selling the stock of certain ML Capital
Resources subsidiaries to MLAM and ML Realty Inc. for
$210 million, rather than distributing this value to ML
Consumer Markets Holdings Inc. Under the tax rules the
sale is recharacterized as two separate transactions; a
dividend by MLAM and MLRI to MLCR of $210 million and a
contribution to the capital of MLAM and MLRI by MLCR of
approximately the same amount. The dividend received
by MLCR increases Merrill Lynch’s tax basis in MLCR by
$210 million. MLCR’s contribution to the capital of
MLAM and MLRI has no effect on tax basis.
27
The $35 million tax reserve consisted of a $14 million
reserve for the possible disallowance of the deemed dividend
resulting from the cross-chain sale and a $21 million reserve for
lost tax benefits if certain income projections were not
realized.
- 35 -
The final step is for MLCR to declare a dividend of
cash, certain subsidiaries, and receivables to ML
Consumer Markets Holdings Inc. This intercompany
dividend triggers a taxable gain that also increases
our tax basis in MLCR. What remains is our tax basis
at the time of sale, $340 million.
As our basis in the stock is greater than the sales
price, the sale results in a $278 million long term
capital loss. This capital loss will offset other long
term capital gains, resulting in a tax benefit of $94
million.
The intercompany dividend to ML Consumer Markets
Holdings triggers a tax liability of $8 million, which
reduces the maximum potential tax benefit to $86
million.
The summary represented that Merrill Parent’s corporate law
department and outside counsel had already prepared a proposed
definitive sales agreement and that the purchaser had submitted
its desired contract changes, which were being negotiated.
Although the summary requested the board of directors to
authorize the executive committee to approve the final details of
the transaction and to sign the definitive agreement for a
minimum sales price of $70 million, the board authorized the
proper officers to finalize the sale of all the capital stock of
ML Capital Resources for not less than $60 million, subject to
adjustments based on the valuation of certain assets.
D. GATX/BCE Modifies Its Initial Bid
In a letter addressed to Mr. Sands dated April 27, 1987,
GATX modified its April 21, 1987, bid proposal (April 27, 1987,
- 36 -
bid proposal).28 GATX reconfigured its April 21, 1987, bid
proposal from $63 million, plus 70 percent of the discounted
value of the residual payments in excess of $27 million, to $66
million, plus 40 percent of the discounted value of residual
payments in excess of $29.5 million. The April 27, 1987, bid
proposal stated that, except for the replacement of the original
paragraphs in the April 21, 1987, bid proposal concerning the
purchase price, “all other terms and conditions remain
unchanged.” As of April 27, 1987, GATX/BCE had not evaluated the
lease portfolio of ML Capital Resources, and the proposed
purchase price was based on the representations made in the
offering memorandum.
E. Nonbinding Letter of Intent
On May 22, 1987, Merrill Parent entered into a nonbinding
letter of intent with GATX/BCE for the sale of the stock of ML
Capital Resources (nonbinding letter of intent). The nonbinding
letter of intent confirmed that Merrill Parent had provided
GATX/BCE with a draft sale agreement containing a description of
the assets in which ML Capital Resources had an equity interest
as of the proposed closing date. The nonbinding letter of intent
set forth pricing terms identical to those set forth in GATX’s
April 27, 1987, bid proposal; i.e, $66 million plus 40 percent of
28
The record is unclear as to whether a second round of bids
was conducted or whether petitioner merely asked GATX/BCE to
modify its original bid.
- 37 -
the discounted value of residual payments in excess of
$29,500,000. The nonbinding letter of intent specifically stated
that the parties were bound by the terms of their March 23, 1987,
confidentiality agreement. The nonbinding letter of intent also
stated:
The consummation of the acquisition contemplated
herein is subject to (i) negotiation and execution of
definitive agreements acceptable in form and substance
to * * * [GATX/BCE] and * * * [petitioner], (ii) no
change having occurred in the federal income tax laws
or the regulations of the U.S. Treasury promulgated
thereunder that would materially adversely alter the
economic effect of the transactions contemplated
herein, (iii) approval of the transactions contemplated
herein by * * * [petitioner’s] Executive Committee and
by the appropriate corporate authorities for * * *
[GATX/BCE], (iv) consummation of satisfactory secured
financing by * * * [GATX/BCE] and (v) other customary
and appropriate closing conditions.
F. GATX Finance Committee Approval
On or about May 29, 1987, the GATX Finance Committee met to
consider the proposed acquisition of ML Capital Resources. A
written proposal presented at that meeting stated that GATX was
“awarded the transaction” based on its initial and modified bid
proposals and was “invited to perform a due diligence
investigation.” The written proposal also stated that, upon
completion of the due diligence process, GATX/BCE reserved the
right to adjust the purchase price based on its due diligence
findings in the event that any information in the 3-volume
offering memorandum was incorrect. The written proposal also
recommended that the base purchase price be reduced to $63.3
- 38 -
million as a result of an increase in the reserve for losses and
a net reduction in expected future residual values.
On June 1, 1987, the GATX Finance Committee approved the
proposal to acquire the capital stock of ML Capital Resources for
a purchase price of $63.3 million, subject to certain specified
conditions. The GATX Finance Committee recommended that the
proposed transaction be forwarded to the GATX board of directors.
G. Continued Negotiations
After executing the nonbinding letter of intent, petitioner
and GATX/BCE continued their negotiations. In conjunction with
GATX/BCE’s due diligence review of the lease portfolio,
petitioner and GATX/BCE agreed that it was impractical to examine
each lease separately because the lease portfolio consisted of
such a large number of relatively small leases. Therefore, they
agreed to use a “statistical sampling technique”, whereby the
parties would jointly pick a certain number of leases at random
to examine in significant detail and compare them to the
representations made by Merrill Parent in the 3-volume offering
memorandum. The results of the “statistical sample” were not
satisfactory to GATX/BCE; i.e., a larger than expected portion of
the leases did not coincide with Merrill Parent’s representations
in the 3-volume offering memorandum.
From May 22 through June 25, 1987, negotiations continued in
order to accommodate the adjustments revealed by the due
- 39 -
diligence review. Among other concessions, petitioner
represented to GATX that to the best of petitioner’s knowledge,
as of the date of the closing, the schedules in the contract were
the actual status of the individual leases and, to the extent
they were not, there would be a postclosing adjustment to
accurately reflect the discrepancies.
During the negotiations, GATX requested that ML Vessel
Leasing Corporation (Vessel Leasing), a wholly owned subsidiary
of ML Capital Resources, not be included in the ML Capital
Resources portfolio because GATX/BCE could not own the assets in
Vessel Leasing due to restrictions under Federal laws.29 By
resolution dated June 10, 1987, the respective boards of ML
Capital Resources and ML Asset Management approved the sale of
all the stock of Vessel Leasing to ML Asset Management. On that
same date, ML Capital Resources and ML Asset Management entered
into a stock purchase agreement with respect to Vessel Leasing’s
stock. The purchase price for the stock was $367,481. The sale
closed on June 10, 1987. Immediately before its purchase of
Vessel Leasing, ML Asset Management had accumulated earnings and
profits that exceeded the purchase price. This is the eighth
cross-chain sale at issue for the taxable year ended December 25,
29
BCE was a Canadian corporation and could not legally own a
vessel that had been financed by the U.S. Government.
- 40 -
1987. The parties agree that this cross-chain sale was a section
304 transaction.
H. Sale of ML Capital Resources Is Finalized
By resolution dated June 18, 1987, ML Capital Resources’
board of directors authorized the sale of its stock to GATX/BCE.
As of June 25, 1987, Merrill Parent, Consumer Markets, ML Capital
Resources, and GATX/BCE entered into an agreement for the
purchase and sale of stock of ML Capital Resources for a fixed
cash consideration of $50,447,996, payable at closing (subject to
adjustments for working capital and certain residual proceeds),
and a contingent cash payment based on the realization of certain
residual values due on or before January 1, 1995, but not to
exceed $15 million. The sale closed on June 26, 1987. Merrill
Parent represented to GATX/BCE that, to the best of its records
and knowledge, as of the date of the closing the schedules
attached to the contract would contain accurate information about
each of the individual leases. To the extent that the schedules
did not contain accurate information, there would be postclosing
adjustments. With one exception, Merrill Parent did not
guarantee the obligations of the lessees. Merrill Parent also
did not guarantee the residual values of any leases.
On its consolidated Federal income tax return for the
taxable year ended December 25, 1987, petitioner claimed a long-
term capital loss in the amount of $466,985,176 from the sale of
- 41 -
ML Capital Resources’ stock, computed as follows:
Sale price $49,581,304
Less: basis in ML Capital Resources 516,566,480
Capital loss (466,985,176)
III. Notice of Deficiency
Respondent mailed a timely notice of deficiency to
petitioner on August 20, 1998, which set forth a number of
adjustments to petitioner’s taxable income for the years at
issue. The only adjustments in dispute are respondent’s
determinations (i) decreasing the long-term capital loss reported
by ML Capital Resources on the 1986 sale of the stock of ML
Leasing to Inspiration on the ground that ML Capital Resources’
basis in the stock was overstated by $73,320,471, and to (ii)
decreasing the long-term capital loss reported by Consumer
Markets on the 1987 sale of the stock of ML Capital Resources to
GATX/BCE on the ground that Consumer Markets’ basis in the stock
was overstated by $328,826,143.30
OPINION
I. Applicable Statutes
The parties agree that section 304 applies to the nine
cross-chain sales and that section 304 treats the cross-chain
30
The $328,826,143 adjustment to the basis of the stock of
Capital Resources in respondent’s notice equals the sum of (i)
the $53,972,607 aggregate purchase price for the five
subsidiaries, (ii) the $154,666,365 initial purchase price for ML
Interfunding, (iii) the $119,819,690 final purchase price for
Leasing Equipment, and (iv) the $367,481 purchase price of Vessel
Leasing.
- 42 -
sales as redemptions. The parties disagree, however, as to
whether the redemptions must be taxed as distributions in
exchange for stock under section 302(a) or as distributions of
property under section 301.
Before section 304 was enacted, a parent corporation could
extract earnings from its related corporations while avoiding
ordinary dividend treatment by selling the stock of one of its
controlled corporations to another of its controlled
corporations. See, e.g., Wanamaker Trust v. Commissioner, 11
T.C. 365 (1948), affd. per curiam 178 F.2d 10 (3d Cir. 1949). In
1950, section 304 was enacted to prevent the bailout of corporate
earnings and profits through sales involving subsidiary
corporations. See Revenue Act of 1950, ch. 994, 64 Stat.906; see
also H. Rept. 2319, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 380,
420; S. Rept. 2375, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 483,
514. In 1954, section 304 was amended to prevent the bailout of
corporate earnings and profits using brother-sister corporations.
See H. Rept. 1337, 83d Cong., 2d Sess. A79 (1954); S. Rept. 1622,
83d Cong., 2d Sess. 239 (1954). This antibailout provision
provides the analytical framework for both parties’ arguments in
this case.
The pertinent part of section 304(a)(1) provides that, for
purposes of section 302, if one or more persons are in control of
each of two corporations, and in return for property, one of the
- 43 -
corporations acquires stock in the other corporation from the
person so in control, then such property shall be treated as a
distribution in redemption of the stock of the corporation
acquiring such stock. See also Rev. Rul. 70-496, 1970-2 C.B. 74.
If a stock acquisition is governed by section 304(a), any
determination as to whether the stock acquisition is to be
treated as a distribution in part or full payment in exchange for
the stock must be made by reference to the stock of the issuing
corporation.31 Sec. 304(b)(1). Section 318, as modified by
section 304(b)(1), applies in determining whether the requisite
control under section 304(a) exists.
Section 304(a)(1) recharacterizes what appears to be a sale
as a redemption by treating the sale proceeds as a distribution
in redemption of the acquiring corporation’s stock and requiring
that the tax consequences of the distribution be determined under
sections 301 and 302. Section 302(a) provides that if a
corporation redeems its stock, the redemption shall be treated as
a distribution in part or full payment in exchange for the stock
if the redemption qualifies as one of four types of redemptions
listed in section 302(b)-–a redemption that is not essentially
equivalent to a dividend (section 302(b)(1)), a substantially
disproportionate redemption of stock (section 302(b)(2)), a
31
In this case, the issuing corporations are Merlease, the
five subsidiaries, ML Interfunding, Leasing Equipment, and Vessel
Leasing. See sec. 304(b)(1).
- 44 -
redemption in complete termination of a shareholder’s interest
(section 302(b)(3)), or a redemption from a noncorporate
shareholder in partial liquidation (section 302(b)(4)). If the
deemed redemption does not qualify under section 302(b), then the
distribution is governed by section 301.32
In this case, respondent relies only upon section 302(b)(3),
claiming that the deemed section 304 redemptions, when integrated
with the sales of the target corporations, completely terminated
the target corporations’ ownership of the issuing corporations.
Section 302(b)(3) provides that “Subsection(a) shall apply if the
redemption is in complete redemption of all of the stock of the
corporation owned by the shareholder.” See Bleily & Collishaw,
Inc. v. Commissioner, 72 T.C. 751, 756 (1979), affd. without
published opinion 647 F.2d 169 (9th Cir. 1981). The attribution
rules under section 318(a) apply in determining ownership of
stock for purposes of section 302. See sec. 302(c)(1).
II. The Parties’ Arguments Regarding the Applicable Legal
Standard
Ordinarily, whether a redemption results in the complete
termination of a shareholder’s interest in a corporation under
section 302 is determined immediately after the redemption. Sec.
32
Sec. 301(a) provides: “Except as otherwise provided in
this chapter, a distribution of property (as defined in section
317(a)) made by a corporation to a shareholder with respect to
its stock shall be treated in the manner provided in subsection
(c).”
- 45 -
302(b)(3) and (c)(2)(A). In some circumstances, however, both
taxpayers and the Commissioner have argued that a redemption
should not be tested under section 302(b) immediately after the
redemption but only after another related transaction has
occurred. See, e.g., Bleily & Collishaw, Inc. v. Commissioner,
supra; Niedermeyer v. Commissioner, 62 T.C. 280 (1974), affd. 535
F.2d 500 (9th Cir. 1976).
In this case, petitioner contends that the deemed section
304 redemptions, i.e., the nine cross-chain sales, should be
tested under section 302(b)(3) without integrating them with the
later sales of the target corporations. Petitioner asserts that
the deemed section 304 redemptions, standing alone, did not
completely terminate the target corporations’ actual and
constructive ownership interest in the issuing corporations
because, under the attribution rules of section 318, the target
corporations continued to hold an ownership interest in those
corporations following the redemptions. Respondent contends,
however, that the section 304 redemptions at issue in this case,
i.e., the nine cross-chain sales, must be integrated with the
later sales of the target corporations in order to decide under
section 302(b)(3) whether the target corporations’ constructive
ownership of the transferred stock under section 318 was
completely terminated. The parties rely on different legal
standards in support of their respective positions.
- 46 -
Petitioner relies on a test articulated by this Court in
Niedermeyer v. Commissioner, supra at 291. Petitioner claims
that this Court has consistently used the Niedermeyer test to
decide whether a redemption should be integrated with other
allegedly related transactions in order to ascertain the tax
consequences of the redemption. In Niedermeyer, we held that, if
a redemption, standing alone, fails to qualify under section
302(b)(3), the redemption will nevertheless be subject to sale or
exchange treatment “Where there is a plan which is comprised of
several steps, one involving the redemption of stock that results
in a complete termination of the taxpayer’s interest in a
corporation”. Id. at 291. However, we required that “the
redemption must occur as part of a plan which is firm and fixed
and in which the steps are clearly integrated.” Id. Petitioner
describes the Niedermeyer test as a “variation of the step
transaction doctrine” and asserts that “While the test permits
amalgamation of steps that are not subject to an ‘absolutely’
binding contract, it leaves little room for contingency”.
Petitioner relies on this Court’s opinions in Monson v.
Commissioner, 79 T.C. 827, 837 (1982), Roebling v. Commissioner,
77 T.C. 30 (1981), and Bleily & Collishaw, Inc. v. Commissioner,
supra at 756, to support its position. According to petitioner,
each of the three above-cited cases had the following facts in
common: (1) Each case involved a partial redemption that was
- 47 -
held to be part of a firm and fixed plan; (2) in each case, the
complete termination of the shareholder’s interest required a
party not controlled by the taxpayer to acquire the remaining
shares; and (3) at the time of the redemption, the third-party
purchaser had already negotiated for and made a firm commitment
to acquire the remaining shares. Petitioner extracts from the
cases the conclusions that, where an alleged plan to completely
terminate a shareholder’s ownership requires the participation of
a third party, the third party must have committed to the plan at
least in substance on or before the redemption date in order for
Niedermeyer’s “firm and fixed plan” requirement to be satisfied
and that a taxpayer’s unilateral plan can never be a firm and
fixed plan. Petitioner’s analysis and arguments, therefore,
focus primarily on whether there was an agreement in substance
with the third-party purchasers of the target corporations’ stock
on the dates of the deemed section 304 redemptions; i.e., the
nine cross-chain sales.
Respondent rejects petitioner’s attempt to focus the Court’s
eye primarily on the third-party purchasers who acquired the
target corporations’ stock and argues for the application of an
intent-based test drawn from the decision of the U.S. Court of
Appeals for the Sixth Circuit in Zenz v. Quinlivan, 213 F.2d 914(6th Cir. 1954) and pertinent opinions of this Court, including
but not limited to, Niedermeyer v. Commissioner, supra. Citing
- 48 -
Zenz, respondent argues that a partial redemption, which is one
of a series of transactions intended to terminate completely a
shareholder’s ownership interest in a corporation, must be
integrated with the related transactions for purposes of section
302(b)(3) and treated as a sale or exchange. Under respondent’s
articulation of the relevant legal standard:
As a result of the decision in Zenz, other
transactions must be taken into account in testing
whether a redemption is a distribution under § 301 or a
sale or exchange under § 302(a) where the redemption is
part of a firm and fixed plan to terminate a
shareholder’s interest in a corporation. Niedermeyer
v. Commissioner, 62 T.C. 280 (1974), aff’d 535 F.2d 500(9th Cir. 1976) (articulating a Zenz-like standard).
As subsequent applications of the Zenz doctrine make
clear, the sequence of planned transactions is
irrelevant where the overall result is the complete
termination of a shareholder’s interest. United States
v. Carey, 289 F.2d 531 (8th Cir. 1961) (holding that
Zenz applies when the redemption precedes the stock
sale pursuant to a plan); see also B. Bittker and J.
Eustice, Federal Income Taxation of Corporations and
Shareholders, ¶9.06[3] at 9-42 (6th ed. 1994)(“[I]f the
form of the distribution is cast as a redemption, its
treatment as a sale under Zenz is highly likely unless
the preliminary redemption transaction can be separated
from the later sale.”) [Fn. ref. omitted.]
In its reply brief,33 petitioner dismisses respondent’s reliance
33
In their reply briefs, both parties argue alternatively
that the applicable standard is derived from the step transaction
doctrine and that one of three tests for deciding whether the
step transaction doctrine should be applied, but not all three
tests, must be used in this case to analyze the sec. 304
redemptions and the later sales. Petitioner contends that only
the binding commitment test should be used, and respondent
contends that only the end result test should be used. For a
detailed description of the three tests, see Andantech L.L.C. v.
Commissioner, T.C. Memo. 2002-97. We decline to apply any of the
(continued...)
- 49 -
on Zenz, claiming that “its relevance to this case is at best
tangential.” Petitioner notes that Zenz involved both a tax year
prior to the enactment of section 302 and a different factual
situation. In Zenz, the sole shareholder of a corporation sold
some of her stock first, and a short time later, the issuing
corporation redeemed the remainder of her stock. Petitioner
distinguishes Zenz from the instant case because “The order of
sale and subsequent redemption was chosen to reduce taxes--that
is, to avoid dividend treatment from the redemption leg”, the
redemption completely terminated the taxpayer’s interest in the
corporation, and the Commissioner was attempting to reorder the
transactions in order to obtain dividend treatment for the
redemption proceeds. Petitioner urges this Court to limit the
application of the Zenz intent-based test to cases where the form
of the transactions and the intent of the taxpayer coincide as it
did in Zenz and to decline to apply the test in cases such as
this where the issue to be decided is “whether a redemption that
does not terminate the shareholder’s interest and a later sale
that does terminate that interest are sufficiently related to
justify treating a non-terminating redemption as part of the
later sale transaction.”
33
(...continued)
three tests because the applicable legal standard is that
identified elsewhere in this Opinion.
- 50 -
III. Analysis of the Nine Cross-Chain Sales
A. In General
Each party claims that the applicable legal standard is
clear and that the legal standard, when applied to the facts,
supports a decision in that party’s favor. The parties rely on
many of the same cases to support their respective positions.
The parties’ arguments, however, are so diametrically opposite
regarding their interpretation of the cases that we must turn to
an examination of the principal cases on which both parties
rely.34 A careful examination of the pertinent facts and
holdings of these cases is necessary to respond adequately to the
parties’ detailed and often tortured parsing of these cases in
support of their respective arguments.
34
Petitioner also relies on several anticipatory dividend
cases to bolster its arguments regarding the cross-chain sales.
See TSN Liquidating Corp., Inc. v. United States, 624 F.2d 1328(5th Cir. 1980); Litton Indus., Inc. v. Commissioner, 89 T.C.
1086 (1987); Gilmore v. Commissioner, 25 T.C. 1321 (1956); Coffey
v. Commissioner, 14 T.C. 1410 (1950); Rosenbloom Fin. Corp. v.
Commissioner, 24 B.T.A. 763 (1931). In each of the anticipatory
dividend cases decided by this Court, we held that a
corporation’s distribution of a dividend to a shareholder before
the shareholder sold his stock was taxable as a dividend and not
as part of the later stock sale. The dividend transactions did
not involve the exchange of stock for consideration. We agree
with respondent that the anticipatory dividend cases are
distinguishable from this case, and we do not consider them
further. See Bittker & Eustice, Federal Income Taxation of
Corporations and Shareholders, par. 8.07[2][a], at 8-66 (7th ed.
2002) (“In order to obtain the hoped-for dividend result, it is
important that the selling shareholder not surrender any of its
target stock to the corporation because use of the redemption
format will likely trigger sale treatment.”)
- 51 -
1. Zenz v. Quinlivan
In Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954), the sole
shareholder of a corporation decided to sell the corporation to a
competitor. Because the competitor did not want to assume the
tax liabilities associated with the corporation’s accumulated
earnings and profits, the competitor purchased only part of the
shareholder’s stock. Three weeks later, after a corporate
reorganization and corporate action, the corporation redeemed the
balance of the shareholder’s stock. On her tax return, the
redeemed shareholder reported the transaction as a redemption of
all of her stock under section 115(c) of the Internal Revenue
Code of 1939 and claimed that the transaction must be treated as
a sale or exchange of stock. The Commissioner determined that
the redemption was essentially equivalent to the distribution of
a taxable dividend and recharacterized the redemption proceeds as
dividend income.
The Court of Appeals for the Sixth Circuit reversed the
decision of the lower court, which had upheld the Commissioner’s
determination. The Court of Appeals acknowledged the “general
principle” that “a taxpayer has the legal right to decrease the
amount of what otherwise would be his taxes or altogether avoid
them, by means which the law permits.” Zenz v. Quinlivan, supra
at 916. The Court of Appeals refused to decide the issue
presented based on the taxpayer’s motivation to avoid taxes.
- 52 -
Instead, it examined the nature of the transaction in order to
decide if it was, in substance, a dividend distribution or a
sale. The Court of Appeals held that the redemption was not
essentially equivalent to the distribution of a dividend because
the taxpayer intended “to bring about a complete liquidation of
her holdings and to become separated from all interest in the
corporation”, and the redemption completely terminated her
interest in the corporation. Id. at 917.
2. Niedermeyer v. Commissioner
Twenty years after Zenz v. Quinlivan, supra, was decided,
this Court decided the tax effect of a sale in the context of
section 304. In Niedermeyer v. Commissioner, 62 T.C. 280 (1974),
the relevant issues were whether the taxpayers’ sale of all of
their common stock in American Timber & Trading Co., Inc. (AT&T)
to Lents Industries, Inc. (Lents) was a redemption involving a
related corporation under section 304(a)(1) of the Internal
Revenue Code of 1954 and, if so, whether the redemption should be
treated as a distribution in exchange for the redeemed stock
under section 302(a) or as a distribution to which section 301
applies. The taxpayers in Niedermeyer sold all of their common
stock but not their preferred stock in AT&T to Lents on September
8, 1966. On the date of the sale, the majority of Lents’ stock
was owned by the taxpayers’ sons. On December 28, 1966, the
taxpayers contributed their AT&T preferred stock to the
- 53 -
Niedermeyer Foundation, a tax-exempt organization. The taxpayers
alleged that the distribution by Lents to them was in exchange
for their AT&T stock. The Commissioner alleged that the sale was
a section 304 transaction between related corporations and that
the distribution was a taxable dividend under sections 301 and
302.
This Court first considered whether the sale was a deemed
redemption under section 304(a)(1). After applying the
constructive ownership rules of section 318(a) as required by
section 304(c), this Court concluded that the taxpayers were in
control of both AT&T and Lents immediately prior to the sale and
that the transaction in which Lents acquired the taxpayers’ AT&T
common stock must be treated as a redemption under section
304(a)(1).
This Court then addressed the taxpayers’ contention that,
even if the sale were treated as a deemed redemption under
section 304(a)(1), the taxpayers nevertheless were entitled to
treat the distribution from Lents as full payment in exchange for
their AT&T stock under section 302(a) by meeting one of the
conditions of section 302(b). After rejecting the taxpayers’
argument under section 302(b)(1), the Court turned to their
arguments under section 302(b)(3). Among other things, the
taxpayers argued that the distribution was in complete
termination of their ownership interest in AT&T, contending that
- 54 -
the distribution and their subsequent gift of their AT&T
preferred stock were parts of a single plan to completely
terminate their actual and constructive ownership of AT&T before
the end of 1966.
In Niedermeyer, this Court acknowledged that, where there is
a plan consisting of a redemption and one or more other steps
that results in a complete termination of the taxpayer’s interest
in a corporation, section 302(b)(3) may apply. Niedermeyer v.
Commissioner, supra at 291 (citing in support Leleux v.
Commissioner, 54 T.C. 408 (1970); Estate of Mathis v.
Commissioner, 47 T.C. 248 (1966)). The Court emphasized,
however, that the redemption “must occur as part of a plan which
is firm and fixed and in which the steps are clearly integrated.”
Id.After searching the record for evidence in support of the
taxpayers’ alleged plan, the Court concluded that the evidence
presented was “too insubstantial to prove the existence of such a
plan.” Id. Among the facts on which the Court relied were the
following:
(1) The alleged plan was not in writing, and there was no
indication that the taxpayers communicated their donative
intention to the charity or to anyone.
(2) The taxpayers’ son who testified at trial about the
Lents stock acquisition did not mention any desire on the
- 55 -
taxpayers’ part to completely terminate their ownership interest
in AT&T.
(3) The taxpayers could easily have changed their minds
regarding their avowed intention to donate their preferred stock.
(4) The taxpayers failed to show that their alleged decision
to donate the preferred stock was in any way fixed or binding.
This Court emphasized that a plan sufficient to pass muster under
section 302(b)(3) did not need to be “in writing, absolutely
binding, or communicated to others” but that “the above-mentioned
factors, all of which are lacking here, tend to show a plan which
is fixed and firm.” Id. at 291-292.
Although the Court in Niedermeyer did not expressly state
that the plan to which it was referring was a plan of the
taxpayers, such a conclusion is warranted. The Court rejected
the taxpayers’ self-serving testimony regarding their intention
to donate and searched instead for objective evidence that the
deemed section 304 redemption and the later gift were integrated
parts of a firm and fixed plan on the part of the taxpayers to
completely terminate their ownership interest; i.e., a plan
consisting of clearly integrated steps to which the taxpayers
were firmly committed.
3. Benjamin v. Commissioner
In Benjamin v. Commissioner, 66 T.C. 1084 (1976), affd. 592
F.2d 1259 (5th Cir. 1979), the issue presented was whether the
- 56 -
redemption of the taxpayer’s class A preferred voting stock by a
family-held corporation was essentially equivalent to a dividend
under section 302(b)(1) of the Internal Revenue Code of 1954. In
deciding the tax effect of the redemption, this Court addressed
the taxpayer’s argument that the redemption was pursuant to a
plan of redemption that, when fully implemented, would completely
terminate the taxpayer’s ownership interest. The evidence at
trial failed to disclose any common understanding among the
shareholders or the redeeming corporation as to the timing of, or
procedure for, the alleged redemption plan, nor was there any
evidence of a concrete plan involving the shareholders or the
corporation. After examining the record, this Court concluded
there was no credible evidence of any firm plan to redeem, noting
that “vague anticipation” was not enough to constitute a plan.
Id. at 1114.
4. Paparo v. Commissioner
In Paparo v. Commissioner, 71 T.C. 692 (1979), the taxpayers
were shareholders of Nashville Textile Corp. (Nashville) and
Jasper Textile Corp. (Jasper), two women’s apparel manufacturers,
and House of Ronnie, Inc. (Ronnie), the corporation that designed
and marketed the clothing made by Nashville and Jasper. In order
to improve their sales development effort, the taxpayers
approached I. Amsterdam, a successful sales organization. The
shareholders of I. Amsterdam also owned Denise Lingerie Co., a
- 57 -
women’s apparel manufacturer. The taxpayers concluded that if
Ronnie could acquire Denise in exchange for Ronnie’s stock,
Ronnie would acquire not only Denise’s manufacturing facilities
but also the sales relationship with I. Amsterdam. In the early
part of 1969, negotiations began. Denise’s shareholders were
interested in the taxpayer’s acquisition proposal but would not
consider accepting stock in a privately held corporation.
In conjunction with the proposed acquisition of Denise, the
taxpayers began to explore taking Ronnie public. The underwriter
they had selected recommended that Nashville and Jasper be
combined with Ronnie before the public offering. In January
1970, the taxpayers and another shareholder of Nashville and
Jasper agreed to sell all of their stock to Ronnie for $800,000.
The taxpayers contemplated that the purchase price would be paid
from the proceeds of one or more public offerings of Ronnie’s
stock.
On March 30, 1970, the first public offering of Ronnie’s
stock was made. A portion of the sales proceeds was used to make
the downpayment to the Nashville and Jasper shareholders.
On October 30, 1970, Ronnie entered into an agreement with
Denise’s shareholders to acquire all of Denise’s outstanding
stock in exchange for Ronnie’s stock.
On April 20, 1972, a second public offering of Ronnie’s
stock was made. A portion of the proceeds was used to pay the
- 58 -
balance of the purchase price owed to the Nashville and Jasper
shareholders.
The sole issue for decision was whether the amounts received
by the taxpayers in 1970 and 1971 from Ronnie in exchange for
their stock in Nashville and Jasper were taxable as capital gains
under section 302,35 or as dividends under section 301. The
parties agreed that section 304 applied to the stock acquisitions
in question and that, therefore, the transfer of Nashville and
Jasper stock to Ronnie must be characterized as a redemption
through the use of related corporations. The parties disagreed
only with respect to the application of section 302. The
taxpayers contended that the redemptions qualified as sales under
section 302(a) because they met the requirements of either
section 302(b)(1) or (2). The taxpayers argued that the 1970
redemption was but one step in an overall plan to redeem their
interest in Nashville and Jasper that ended in 1972 with the
second public offering, and it was not the essential equivalent
of a dividend.
This Court rejected the taxpayers’ argument, concluding that
the record did not contain any compelling evidence of an overall
financial plan covering both the first and the second public
offerings. No formal written plan for the funding of the
35
Relevant Code provisions were from the Internal Revenue
Code of 1954.
- 59 -
redemption through subsequent public offerings of Ronnie’s stock
existed, and no corporate minutes were offered into evidence to
substantiate such a plan. In addition, funding the redemption
through subsequent public offerings of Ronnie’s stock was beyond
the control of the taxpayers. Although this Court acknowledged
the taxpayers’ apparent intent that subsequent public offerings
be made, the taxpayers had made no promise to the underwriter,
nor was there any evidence of an agreement to make another public
offering.
5. Bleily & Collishaw, Inc. v. Commissioner
In Bleily & Collishaw, Inc. v. Commissioner, 72 T.C. 751(1979), the taxpayer owned 30 percent of a corporation. The
majority shareholder wanted sole control over the corporation,
and the taxpayer was willing to sell all of its shares to the
majority shareholder. However, because the majority shareholder
did not have sufficient funds to purchase all of the taxpayer’s
shares at that time, the majority shareholder purchased only a
portion of the taxpayer’s stock. Thereafter, over a period of
approximately 23 weeks, the corporation redeemed the balance of
the taxpayer’s stock in increments tied to the availability of
money to fund the redemptions. Although the taxpayer was under
no contractual or other legal obligation to sell the rest of its
shares or have them redeemed if and when money became available
to fund additional acquisitions, this Court found that the
- 60 -
taxpayer intended to sell its shares whenever the money needed to
fund the acquisitions became available.
In Bleily & Collishaw, Inc., the issue before the Court was
whether the redemptions met the requirements of section 302(b)(3)
of the Internal Revenue Code of 1954. We described the
applicable legal standard as follows:
Where several redemptions have been executed pursuant
to a plan to terminate a shareholder’s interest, the
individual redemptions constitute, in substance, the
component parts of a single sale or exchange of the
entire stock interest. We have refused, however, to
treat a series of redemptions as a single plan unless
the redemptions are pursuant to a firm and fixed plan
to eliminate the stockholder from the corporation.
Generally, a gentleman’s agreement lacking written
embodiment, communication, and contractual obligations
will not suffice to show a fixed and firm plan. On the
other hand, a plan need not be in writing, absolutely
binding, or communicated to others to be fixed and firm
although these factors all tend to indicate that such
is the case. [Id. at 756; citations omitted.]
Noting that whether a firm and fixed plan existed in a given case
is necessarily a fact issue, we held that the requirements of
section 302(b)(3) were met because the redemptions were part of a
firm and fixed plan to eliminate the stockholder from the
corporation. The record established that the corporation planned
to eliminate the taxpayer as a shareholder and that the taxpayer
had agreed to the sale of all its shares and to the purchase
price, even though there was no binding obligation on either
party to consummate additional stock sales.
- 61 -
6. Roebling v. Commissioner
In Roebling v. Commissioner, 77 T.C. 30 (1981), a taxpayer
owned approximately 90 percent of the class B preferred stock and
approximately 45 percent of the common stock of Trenton Trust Co.
(Trenton Trust). In 1958, Trenton Trust adopted a plan of
recapitalization to simplify and strengthen its capital structure
which, among other things, called for the redemption of a
specified amount of the class B preferred stock each year and
required Trenton Trust to establish a sinking fund for that
purpose. During each of the years 1965-69, part of the
taxpayer’s class B preferred stock was redeemed, and in 1965 and
1966, the taxpayer sold some shares. Among the issues presented
to this Court was whether the redemption of the taxpayer’s class
B preferred shares was not essentially equivalent to a dividend
within the meaning of section 302(b)(1) of the Internal Revenue
Code of 1954.
Each year, Trenton Trust set aside funds and decided how
much of those funds it would use to retire the class B preferred
shares. Each retirement of shares required action of Trenton
Trust’s board of directors and the consent and approval of the
FDIC and the Department of Banking and Insurance of the State of
New Jersey. Each year, Trenton Trust’s board of directors
adopted a resolution to apply for the necessary regulatory
approvals, and Trenton Trust then filed its applications. For
- 62 -
most of the relevant years, the applications were granted at
least in part, but on one occasion the application was denied.
Although the taxpayer in Roebling relied only upon section
302(b)(1) to support her contention that each of the redemptions
qualified as a sale or exchange under section 302(a), she argued
that the redemptions were integrated steps in a firm and fixed
plan to redeem all of the preferred stock and that the
redemptions in the aggregate resulted in a meaningful reduction
of the taxpayer’s interest in Trenton Trust. Applying the same
analysis used in cases involving section 302(b)(3), this Court
held that the redemptions were integrated steps in a firm and
fixed plan even though there was no binding commitment on the
part of Trenton Trust to acquire the taxpayer’s shares or on the
taxpayer’s part to tender her shares. The Court acknowledged
that each redemption was subject to the financial condition of
the bank and required regulatory approval, but emphasized that
“this was about as firm and fixed a plan as a bank could have
under the circumstances.” Roebling v. Commissioner, supra at 55.
7. Monson v. Commissioner
In Monson v. Commissioner, 79 T.C. 827 (1982), a closely
held corporation owned by the taxpayer and his children redeemed
all of the children’s stock and a portion of the taxpayer’s stock
on July 30, 1976. Immediately following the redemption, the
taxpayer was the corporation’s sole shareholder. On August 2,
- 63 -
1976, the taxpayer sold all of his shares to a third party for
cash and a promissory note. Minutes of a board of directors
meeting held on July 30, 1976, described the redemption and the
subsequent sale of taxpayer’s remaining stock to a third party as
steps in the sale. The taxpayer reported the redemption proceeds
as income from the sale or exchange of stock under section
302(a).
Citing Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954), this
Court examined the record to determine whether the intent of the
taxpayer was to bring about a complete liquidation of his
ownership interest in his corporation. Monson v. Commissioner,
supra at 835-836. Because the record clearly established that
the redemption of the taxpayer’s stock was part of an overall
plan to terminate his entire interest in his closely held
corporation, this Court held that the redemption was either a
complete termination of the taxpayer’s interest under section
302(b)(3) or was not essentially equivalent to a dividend under
section 302(b)(1). Id. at 837. In either event, section 302(a)
required the redemption to be treated as a sale. Id.
8. Applicable Legal Principles
The above-cited cases decided by this Court confirm that
this Court has not integrated a redemption with one or more other
transactions to decide whether the requirements of section 302(b)
are met unless the redemption was part of a firm and fixed plan
- 64 -
to satisfy one of the conditions of section 302(b) (such as, in
the case of section 302(b)(3), the complete termination of the
taxpayer’s ownership in the issuing corporation), and the steps
of the plan were clearly integrated. Bleily & Collishaw, Inc. v.
Commissioner, 72 T.C. at 756; Niedermeyer v. Commissioner, 62
T.C. at 291. Whether or not a plan existed is an issue of fact
that must be resolved on the basis of all of the relevant facts
and circumstances of a particular case. Bleily & Collishaw, Inc.
v. Commissioner, supra at 756. The taxpayer has the burden of
proving that the Commissioner’s position regarding the existence
or nonexistence of a plan is erroneous. Rule 142(a).36
An analysis of whether or not a firm and fixed plan existed
necessarily entails an examination of the taxpayer’s intent. See
Monson v. Commissioner, supra at 835-836 (citing Zenz v.
Quinlivan, supra, with approval); Niedermeyer v. Commissioner,
supra at 291 (“there was no evidence of communication of
petitioners’ asserted donative intention to the charity or to
anyone”). It is the taxpayer’s intention, as manifested by the
taxpayer’s participation in and agreement to the plan, that the
search for a plan is designed to reveal. However, a taxpayer’s
self-serving statement regarding its intent or regarding the
36
Petitioner has not argued that the burden of proof should
be placed on respondent, and we infer from the record that sec.
7491 does not apply because the examination in this case began
before its effective date.
- 65 -
existence of a plan is given very little weight in the absence of
supporting evidence tending to show that the Commissioner’s
position is erroneous. Niedermeyer v. Commissioner, supra at
291. Instead, this Court has relied primarily on objective
evidence, such as a written plan, corporate minutes confirming
the existence of a plan, or a writing or other communication from
an involved third party, or the lack thereof, as the most
compelling evidence of the existence of a firm and fixed plan
evidencing a taxpayer’s intention regarding the redemption of its
stock. Id.; see also Monson v. Commissioner, supra; Roebling v.
Commissioner, 77 T.C. 30 (1981); Bleily & Collishaw, Inc. v.
Commissioner, supra. By focusing on the intent of the redeeming
corporation and the redeemed shareholder on the date of the
redemption, both this Court and the Court of Appeals for the
Sixth Circuit in Zenz have attempted to cull after-the-fact
attempts on the part of taxpayers to link unrelated transactions
in order to achieve favorable tax treatment, see Niedermeyer v.
Commissioner, supra, from those situations where the taxpayer
intentionally structures two or more transactions as part of a
plan to terminate the taxpayer’s ownership interest in a
corporation, see Zenz v. Quinlivan, supra.An analysis of whether or not a firm and fixed plan existed
also entails an examination of any uncertainty in consummating
the alleged plan. Although a binding commitment to the plan is
- 66 -
not required, whether the redeeming corporation and the redeemed
shareholder have demonstrated their intention to consummate the
alleged plan in some meaningful way is an important factor.
Bleily & Collishaw, Inc. v. Commissioner, supra at 757
(“Collishaw had agreed to the sale of all its shares and to the
purchase price. As noted before, the fact that the agreement was
not binding is not dispositive.”); Niedermeyer v. Commissioner,
supra at 291 (“Petitioners could easily have changed their minds
with regard to any intent to donate the preferred stock. Clearly
petitioners’ decision to donate the preferred stock has not been
shown to be in any way fixed or binding.”). If the taxpayer is
the sole shareholder of a closely held corporation and could
easily change his mind regarding the implementation of the
alleged plan, this Court has demanded compelling evidence of the
taxpayer’s commitment to the plan before it will find that a firm
and fixed plan existed. Niedermeyer v. Commissioner, supra at
291. If, however, the taxpayer is a shareholder of a more
broadly held close corporation or a publicly held corporation,
this Court’s analysis has focused primarily on the redeeming
corporation’s commitment to the plan. For example, in Roebling
v. Commissioner, supra at 55, a case involving the periodic
redemption of a banking institution’s preferred shareholders, we
stated that--
While we realize that this redemption plan was
subject to the financial condition of the bank and the
- 67 -
approval each time of the banking authorities, we think
this was about as firm and fixed a plan as a bank could
have under the circumstances. See Bleily & Collishaw,
Inc. v. Commissioner, supra. We do not believe the
requirement of a firm and fixed plan for redemption
need be as rigid under the circumstances here involved
as would be required in a closely held family
corporation situation where the plan could be changed
at any time by the actions of one or two shareholders.
Compare Niedermeyer v. Commissioner, supra, and
McDonald v. Commissioner, 52 T.C. 82 (1969).
As this Court’s opinion in Roebling confirms, the existence of
conditions, contingencies, or other uncertainties will not
necessarily preclude a finding that a firm and fixed plan exists
but is one factor that the Court must consider in reaching its
decision.
B. The Section 304 Redemptions
The foregoing cases and the principles we have extracted
from them require that we examine the facts in order to decide
whether petitioner engaged in the cross-chain sales and the later
sales of the target corporations as part of a firm and fixed plan
to completely terminate the target corporations’ actual and
constructive ownership of the issuing corporations.
1. The 1986 Cross-Chain Sale of Merlease
Petitioner’s evidence at trial focused almost exclusively on
the lack of any binding commitment or even an agreement in
principle between petitioner and Inspiration, the ultimate
purchaser of ML Leasing, on the date of ML Leasing’s cross-chain
sale of its Merlease stock to ML Asset Management. On the date
- 68 -
of the cross-chain sale, Inspiration had not yet completed its
due diligence, contractually committed itself to buy the stock of
ML Leasing, or finalized its financing arrangements. Moreover,
on the date of the cross-chain sale, the board of directors of
Merrill Parent had not yet authorized the sale of ML Leasing’s
stock, and Inspiration had not yet approved the purchase. The
existence of these uncertainties according to petitioner
precludes any finding that the cross-chain sale was part of a
firm and fixed plan to terminate ML Leasing’s actual and
constructive ownership of Merlease. We disagree.
Whether a redemption and later sale are integrated steps in
a firm and fixed plan is a factual determination that necessarily
focuses on the actions of the redeemed shareholder and the
redeeming corporation. See Roebling v. Commissioner, supra;
Niedermeyer v. Commissioner, 62 T.C. 280 (1974). If the actions
of the redeemed shareholder and the redeeming corporation
evidence a firm and fixed plan to participate in two or more
related transactions that, individually or collectively, qualify
as a redemption under section 302(b), then the redemption
executed pursuant to the plan will qualify as a sale or exchange
under section 302(a). Niedermeyer v. Commissioner, supra.
After examining the actions of the redeemed shareholder (ML
Leasing), the redeeming corporation (ML Asset Management), and
Merrill Parent, we are convinced that the deemed redemption under
- 69 -
section 304, i.e., the cross-chain sale, and the later sale of ML
Leasing outside the consolidated group were two steps in a firm
and fixed plan to terminate ML Leasing’s actual and constructive
ownership of Merlease, the issuing corporation.
The principal, and most compelling, evidence on which we
rely is the formal presentation of the plan to Merrill Parent’s
board of directors, which took place on July 28, 1986, only 4
days after the cross-chain sale of Merlease. The formal
presentation included the distribution of a written summary and
slides illustrating the details of the plan to dispose of
petitioner’s proprietary lease business culminating in the sale
of ML Leasing. The written summary laid out each step of the
plan. Among the steps identified were (1) the cross-chain sale
of Merlease, which the summary acknowledged had already occurred,
(2) the distribution of a dividend by ML Leasing to ML Capital
Resources consisting of the cash received in the cross-chain sale
by ML Leasing from ML Asset Management and other assets, and (3)
the imminent sale of ML Leasing to Inspiration. The written
summary described the tax benefits of the plan, which were
predicated on an increase in Merrill Parent’s basis in ML Leasing
under the consolidated return regulations for the proceeds of the
cross-chain sale. The written summary confirmed that the plan
included the sale of ML Leasing and unequivocally identified
Inspiration as the purchaser.
- 70 -
The written summary also confirmed that, although the sale
of ML Leasing had not yet been finalized, the sale was
sufficiently mature that the establishment of a tax reserve for
the transaction was warranted. In fact, the written summary
included a recommendation to the board of directors that a tax
reserve specifically geared, in part, to the extraordinary basis
adjustment resulting from the section 304 redemption be approved.
Petitioner seeks to minimize the impact of the written
summary by pointing out that the summary was prepared for a board
of directors meeting that occurred 4 days after the cross-chain
sale. Although petitioner is correct regarding the chronology,
petitioner offered us no proof that the plan suddenly sprang to
life after the cross-chain sale had occurred, or that the cross-
chain sale and the later sale of ML Leasing were unrelated. In
fact, petitioner introduced very little evidence regarding the
development, review, and approval of the plan reflected in the
written summary, even though the plan was the product of
petitioner’s own internal planning.
The July 28, 1986, board of directors meeting was a regular
board of directors meeting. Ordinarily, a corporation is
required by its bylaws and/or by State law to provide reasonable
advance notice to its directors of a regular board meeting. We
believe that it is reasonable to infer from this record that the
plan outlined in the written summary and presented to Merrill
- 71 -
Parent’s board of directors on July 28, 1986, had been carefully
constructed, vetted, finalized, and approved by the appropriate
corporate officers by at least July 24, 1986, the date of the
1986 cross-chain sale, and in sufficient time before the July 28,
1986, board of directors meeting to enable the notice of meeting
to be given and the meeting materials to be collated and
distributed to the directors.
We also note that, on the date of the cross-chain sale,
petitioner had identified Inspiration as the purchaser of ML
Leasing and had already engaged in substantial negotiations with
Inspiration. In fact, petitioner and Inspiration had agreed in
principle to a purchase price that was used to calculate the
estimated tax benefits in the written summary presented to the
board of directors. An inference can also be drawn from the
record that, after a meeting on June 23, 1986, Inspiration
confirmed informally that it was prepared to purchase ML
Leasing’s stock, subject to verification of the residual lease
values by an outside appraiser. It was only after such
confirmation was presumably received that petitioner proceeded
with the cross-chain sale.
A firm and fixed plan does not exist for purposes of section
302 when there is only “vague anticipation” that a particular
step in an alleged plan will occur. Benjamin v. Commissioner, 66
T.C. at 1114. The facts in this case, however, establish much
- 72 -
more than vague anticipation that the sale of ML Leasing’s stock
would occur. The facts establish the existence of a firm and
fixed plan on the part of Merrill Parent, ML Leasing, ML Asset
Management, and Merlease to engage in a multistep transaction
specifically designed to dispose of petitioner’s proprietary
leasing business outside of the consolidated group while
eliminating gain on the transaction through basis adjustments
resulting from the interplay of section 304 with the consolidated
return regulations.
We find that a firm and fixed plan to dispose of ML Leasing
outside the consolidated group existed on the date of the 1986
cross-chain sale, and that the 1986 cross-chain sale, the
distribution of a dividend of the gross sale proceeds, and the
sale of ML Leasing were integrated steps in that plan. Because
the 1986 cross-chain sale (the deemed section 304 redemption),
when integrated with the sale of ML Leasing’s stock, resulted in
the complete termination of ML Leasing’s actual and constructive
ownership interest in Merlease (the issuing corporation), see
sec. 304(b), we hold that the redemption qualified under section
302(b)(3), and that, therefore, the redemption shall be treated
as a payment in exchange for stock under section 302(a) and not
as a dividend under section 301.
- 73 -
2. The 1987 Cross-Chain Sales of the Five
Subsidiaries, ML Interfunding, and Leasing
Equipment
Petitioner makes similar factual and legal arguments with
respect to the 1987 cross-chain sales. Because the factual and
legal arguments are virtually identical for all of the 1987
cross-chain sales except the one involving Vessel Leasing, we
shall consider them together, excluding only Vessel Leasing.
Like petitioner’s evidence regarding the 1986 cross-chain
sale, petitioner’s evidence regarding the 1987 cross-chain sales
focused almost exclusively on the lack of any binding commitment
or even an agreement in principle between petitioner and
GATX/BCE, the ultimate purchaser of ML Capital Resources, on the
dates of the 1987 cross-chain sales. Seven of the eight 1987
cross-chain sales occurred on March 30, 1987 (the five
subsidiaries and ML Interfunding), and April 3, 1987 (Leasing
Equipment). On those dates, GATX/BCE had not had any meaningful
opportunity to review the 3-volume offering memorandum or to
conduct its due diligence investigation, and had not
contractually committed itself to buy ML Capital Resources’
stock. Neither the board of directors of Merrill Parent nor the
board of directors of GATX/BCE had approved the transaction.
Petitioner argued that the existence of these uncertainties
precludes any finding that the cross-chain sale was part of a
firm and fixed plan to terminate ML Capital Resources’ actual and
- 74 -
constructive ownership of the issuing corporations. Again, we
disagree.
After examining petitioner’s actions including those of the
redeemed shareholder (ML Capital Resources), the redeeming
corporations (ML Realty, ML Asset Management, and MLPFS), and
Merrill Parent, we are convinced that the section 304 deemed
redemptions, i.e., the 1987 cross-chain sales, and the later sale
of ML Capital Resources to GATX/BCE were steps in a firm and
fixed plan to terminate ML Capital Resources’ actual and
constructive ownership of the issuing corporations.
As with the 1986 cross-chain sale, the most compelling
evidence of a firm and fixed plan with respect to the 1987 cross-
chain sales is the formal presentation of the plan to Merrill
Parent’s board of directors, which took place on April 23, 1987,
2 days after receipt of GATX/BCE’s bid and approximately 3 weeks
after seven of the eight 1987 cross-chain sales closed. The
formal presentation included the distribution of a written
summary and slides illustrating the details of the plan to
dispose of ML Capital Resources using much of the same language,
format, and reasoning as that used in the 1986 written summary.
The written summary laid out each step of the plan. Among the
steps identified were (1) the cross-chain sales of the seven
subsidiaries, which the summary acknowledged had already
occurred, (2) the distribution of a dividend by ML Capital
- 75 -
Resources to its sole shareholder, ML Consumer Markets Holdings,
Inc., of the consideration received in the cross-chain sales, and
(3) the imminent sale of ML Capital Resources to GATX/BCE. The
written summary described the tax benefits of the plan, which
were predicated on an increase in petitioner’s basis in ML
Capital Resources under the consolidated return regulations for
the proceeds of the cross-chain sales. The written summary
confirmed that the plan included the sale of ML Capital Resources
and described GATX/BCE as the “likely purchaser”.
The written summary confirmed that, although the sale of ML
Capital Resources had not yet been finalized and the sale
negotiations were not as far along as those in 1986, the
negotiations were sufficiently mature and the sale sufficiently
likely to occur that the establishment of a tax reserve for the
transaction was warranted. The written summary included a
recommendation to the board of directors that a tax reserve
specifically geared, in part, to the basis adjustment resulting
from the section 304 redemptions be approved. In response to the
presentation regarding the plan, Merrill Parent’s board of
directors approved the plan, ratified the cross-chain sales, and
authorized the appropriate officers to finalize the sale of ML
Capital Resources.
Petitioner attempts to minimize the impact of the written
summary by pointing out that the summary was prepared for a board
- 76 -
of directors meeting that occurred approximately 3 weeks after
the 1987 cross-chain sales. Although petitioner is correct
regarding the chronology, petitioner offered us no proof that the
plan suddenly sprang to life after the 1987 cross-chain sales had
closed or that the 1987 cross-chain sales and the later sale of
ML Capital Resources were unrelated. In fact, petitioner
introduced very little evidence regarding the development,
review, and approval of the plan reflected in the 1987 written
summary, even though the plan was the product of petitioner’s own
internal planning and closely resembled the 1986 plan.
Petitioner correctly points out that, as of the dates of the
1987 cross-chain sales, there was no contractual obligation
between petitioner and GATX/BCE to consummate the sale of ML
Capital Resources. We note, however, that petitioner had
structured the “playing field” in order to expedite and simplify
the sale of ML Capital Resources by (1) structuring the proposed
sale as an auction designed to encourage the submission of bids
acceptable to petitioner, (2) preparing and distributing a
proposed Stock Purchase Agreement in conjunction with the 3-
volume offering memorandum and advising prospective purchasers
that petitioner “does not intend to engage in substantial
negotiations” with respect to its terms, (3) securing at least
one appraisal of residual value in anticipation of the sale, and
(4) offering the prospective purchaser administrative resources
- 77 -
to facilitate the uninterrupted management of ML Capital
Resources’ lease portfolio after the sale closed. In addition,
on the date of the earliest 1987 cross-chain sale, petitioner had
already had substantial contacts with prospective purchasers
including GATX/BCE. GATX/BCE had apparently already submitted a
preliminary indication of interest (including a cash purchase
price), and GATX/BCE had been selected by petitioner to perform
detailed due diligence regarding the proposed sale. Two days
before Merrill Parent’s board of directors approved the sale of
ML Capital Resources and authorized appropriate officers to
finalize the deal, GATX/BCE had submitted its formal bid to
purchase ML Capital Resources’ stock. Merrill Parent had
received and reviewed the bid prior to the board meeting and, in
the written summary distributed at the meeting, described
GATX/BCE to the board of directors as the “likely purchaser”.
We reject petitioner’s argument that any uncertainty
regarding the terms of the proposed sale of ML Capital Resources
at the time of the cross-chain sales prevents integration of the
transactions for purposes of section 302(b). A binding
commitment or even an agreement in principle that each step of a
plan will occur is not a prerequisite for finding that a firm and
fixed plan existed, although uncertainty regarding one or more
steps of the plan is a factor we must consider. Roebling v.
Commissioner, 77 T.C. at 55; Niedermeyer v. Commissioner, 62 T.C.
- 78 -
at 292. While there was some uncertainty regarding the details
of the sale of ML Capital Resources on the dates of the cross-
chain sales, there was no uncertainty that petitioner intended to
sell ML Capital Resources as part of the plan. The totality of
the facts and circumstances convinces us that petitioner had a
firm and fixed plan to dispose of ML Capital Resources in a
carefully orchestrated sequence of steps designed to avoid
corporate-level tax on the transaction. The facts also convince
us that petitioner was prepared to do everything reasonably
possible to facilitate the implementation of that plan.
We find that a firm and fixed plan to dispose of ML Capital
Resources outside the consolidated group existed on the dates of
the cross-chain sales, and that the cross-chain sales, the
distribution of a dividend of the gross sale proceeds, and the
sale of ML Capital Resources were integrated steps in that plan.
3. The 1987 Cross-Chain Sale of Vessel Leasing
Because much of what was said regarding the other 1987
cross-chain sales applies with respect to the cross-chain sale of
Vessel Leasing, we incorporate the foregoing analysis here. What
differentiates the Vessel Leasing sale from the other 1987 cross-
chain sales, however, is a chronology that makes it even easier
to conclude that the Vessel Leasing sale must be integrated with
the sale of ML Capital Resources outside the consolidated group.
- 79 -
The Vessel Leasing cross-chain sale closed on June 10, 1987.
On that date, GATX/BCE had already submitted its initial and
modified bids (April 21, 1987, and April 27, 1987, respectively)
and had been “awarded the transaction”, Merrill Parent’s board of
directors had met and authorized the consummation of the sale of
ML Capital Resources’ stock to GATX/BCE (April 24, 1987),
GATX/BCE had entered into a nonbinding letter of intent (May 22,
1987), GATX’s Finance Committee had approved the proposal to
acquire ML Capital Resources’ stock (June 1, 1987), and GATX/BCE
had completed its due diligence review. During final
negotiations, GATX had requested that ML Capital Resources
dispose of its Vessel Leasing stock prior to closing because
GATX/BCE could not own Vessel Leasing due to Federal law
restrictions. Immediately thereafter the respective boards of ML
Capital Resources and ML Asset Management approved the sale of
Vessel Leasing’s stock to ML Asset Management, and the final 1987
cross-chain sale closed.
It is apparent that the cross-chain sale of Vessel Leasing’s
stock to ML Asset Management was arranged in anticipation of the
imminent sale of ML Capital Resources to GATX/BCE and was part of
a seamless net of transactions culminating in the complete
termination of ML Capital Resources’ ownership interest in the
issuing corporations, whose stock was sold cross-chain in
transactions that qualified as section 304 redemptions. We find,
- 80 -
therefore, that a firm and fixed plan to dispose of ML Capital
Resources outside the consolidated group existed on the date of
the Vessel Leasing cross-chain sale and that the Vessel Leasing
cross-chain sale, like the other 1987 cross-chain sales, was an
integrated step in that plan.
Because the eight 1987 cross-chain sales (the deemed section
304 redemptions), when integrated with the sale of ML Capital
Resources’ stock, resulted in the complete termination of ML
Capital Resources’ actual and constructive ownership interest in
the issuing corporations, see sec. 304(b), we hold that the
redemptions qualified under section 302(b)(3) and that,
therefore, the redemptions shall be treated as a payment in
exchange for the stock under section 302(a) and not as a dividend
under section 301.
IV. Conclusion
The record establishes that on the dates of the cross-chain
sales, petitioner had agreed upon, and had begun to implement, a
firm and fixed plan to completely terminate the target
corporations’ ownership interests in the issuing corporations
(the subsidiaries whose stock was sold cross-chain). The plan
was carefully structured to achieve very favorable tax basis
adjustments resulting from the interplay of section 304 and the
consolidated return regulations, and the steps of the plan were
described in detail in written summaries prepared for meetings of
- 81 -
Merrill Parent’s board of directors. As described in those
written summaries, the cross-chain sales of the issuing
corporations’ stock and the sales of the target corporations were
part of the same seamless web of corporate activity intended by
petitioner to culminate in the sale of the target corporations
outside the consolidated group. Under the test prescribed by
this Court in Niedermeyer v. Commissioner, 62 T.C. 280 (1974),
and other cases discussed herein, respondent properly integrated
the cross-chain sales with the related sales of the target
corporations to ascertain the tax consequences of the
transactions, and we sustain respondent’s determination.
We have considered the other arguments of the parties, and,
to the extent not discussed herein, we conclude that the
arguments are irrelevant, moot, or without merit.
To reflect the foregoing,
Decision will be entered
under Rule 155.