Stock "Loans" Ruled Sales

In three cases this summer, the Court ruled against purported stock loans that it said were sales. One case involved millions of dollars in built-in gain and IRS-asserted deficiencies totaling $30 million for Denver multibillionaire Philip Anschutz. Two other cases involved participants in the Derivium stock abusive shelter, both with similar findings on tax liability but opposite conclusions on the taxpayers' liability for an accuracy-related penalty. Anschutz was the sole owner of the Anschutz Co., an S corporation subject to built-in gains tax. Through a qualified subchapter S subsidiary, the Anschutz Corp. (TAC), Anschutz wanted to convert appreciated securities to cash to fund his real estate and entertainment companies, which included several sports teams and arenas. TAC engaged in a prepaid variable forward contract with Donaldson, Lufkin and Jenrette (DLJ), an investment bank. The company transferred title to the stock to a trustee for cash from DLJ equal to 75% of the current fair market value of the stock. TAC had to repay the loan in 10 years either in cash or with a percentage of the transferred stock based on its fair market value. If the value declined below the cash received, the company could settle the loan by giving DLJ all the stock. The company could retain up to 50% of any appreciation of the stock, with DLJ receiving any additional appreciation. The forward contract also required the company to enter into a share-lending agreement under which DLJ could sell the shares and the company would receive 5% of their value. The company received nearly $351 million from the forward contract and nearly $23.4 million from the share-lending agreement. The IRS audited these transactions and reclassified them as either a current sale or a constructive sale under IRC [section] 1259. It determined built-in gains resulted in deficiencies for the Anschutz Co. of nearly $50 million and $63.8 million for 2000 and 2001, with adjustments to Anschutz's distributive share causing deficiencies on his returns of $12 million and nearly $18 million. The Court treated the forward contract and the lending contract as a single transaction for tax purposes and said it was a sale and not a loan because DLJ received not only the title to the stock but also the benefits and detriments of ownership. The court noted that the company received the full value of the transferred shares and that DLJ would suffer all declines in value and would benefit from almost all of the potential appreciation. It was highly unlikely that the stock would be returned, the court said. The court also denied the taxpayer's arguments that the safe harbor rule of section 1058 applied. Section 1058 provides nonrecognition of gain in securities transfer agreements that require the return of identical securities and that don't reduce the risk of loss or opportunity for gain by the initial owner. The Court also denied stock loan treatment to participants in a scheme by Derivium Capital LLC that had been initially promoted as providing a strategy for small investors that had usually been reserved for the wealthy For background, see U.S. v. Cathcart, docket no. 07-4762 PJH (N.D. Cal. 3/5/2010), and Nagy v. U.S., docket no. 08-2555-DCN (D.S.C. 12/22/2009). See also Tax Matters: Stock Loan Treated as Sale, JofA, Jan. 2009, page 66. Between 1998 and 2002 Derivium engaged in approximately 1,700 transactions in which taxpayers transferred marketable securities to it in exchange for cash equal to 90% of their fair market value. …