Shareholders Liable as Transferees; Stock Sale Was Sham (Shockley, CA-11)

The Tax Court properly assessed transferee tax liabilities against the shareholders of a communications company. The stock sale was properly recast as an asset sale followed by a liquidating distribution.

Sham Transaction

The shareholders sold the company’s assets using an intermediary transactions tax shelter of the kind described in Notice 2001-16. The notice advised that participants in substantially similar transactions would be required to disclose their participation.

No Economic Substance

There was no evidence of any legitimate business purpose that satisfactorily explained why the shareholders undertook the transaction. In addition, the shareholders failed to show why the transaction’s substance should be disregarded in favor of its perplexing form.

The shareholders admitted that avoiding corporate tax on built-in gains factored into their decision not to sell the company’s assets. Moreover, there was no convincing justification for the shareholders’ “buy stock/sell assets” transaction. Further, the shareholders argument that the company was a “going concern” was rejected. The company was merged out of existence by the transaction; thus, it was no longer a going concern.

Furthermore, the shareholders’ nontax reason for the transaction, the desire to avoid a piecemeal sale of the company, was undercut because the transaction produced precisely that result. Moreover, their claim that they engaged in one transaction, the sale of their stock in the company for cash was also undercut because the record plainly revealed their awareness that the stock sale was only one piece of an intricate puzzle.

Finally, the shareholders were informed of the risk that the IRS might recharacterize the transaction as an asset sale. Consequently, the shareholders tried to minimize or eliminate any linkage issues between the stock purchase agreement and the asset purchase agreements.

Tax Avoidance Purpose

It was clear that the shareholders entered into the overall transaction solely for tax avoidance purposes. There was no adequate nontax justification for the labyrinthine array of transactions between numerous shell entities immediately following the initial stock sale. In addition, the ultimate results of these transactions was nothing more than a two-member LLC (of which one was an Isle of Man entity). Therefore, use of the substance over form was appropriate.

Transferee Liability

The record supported the Tax Court’s conclusion that the shareholders qualified as transferees under state law. Recasting the transaction rendered the shareholders liable as transferees under federal tax law. In addition, they were liable under state (Wisconsin) fraudulent transfer law for the taxes generated by the built-in gain on the appreciated assets sold by the company. The transaction left the company insolvent. In addition, the company did not receive anything of reasonably equivalent value in exchange for the proceeds from the asset sale, given the distributions rendered its stock worthless. Thus, the IRS could assess transferee liability for the unpaid taxes using the procedural device in Code Sec. 6901.

R. Feldman, CA-7, 2015-1 ustc ¶50,210, followed. Another case about transferee liability can be found here

Affirming the Tax Court 109 TCM 1579, Dec. 60,329(M), TC Memo. 2015-113.

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CCHTaxGroup

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