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Controversies – Federal

STARS Transaction Rejected

On Feb. 11, 2013, a regular Tax Court opinion was issued in a case that the opinion said was of first impression, ruling against Bank of New York Mellon (BNY). 140 T.C. No. 2. BNY had engaged in a cross-border transaction called STARS that KPMG created around 2000 in cooperation with the foreign bank Barclays. Barclays desired to obtain UK tax credits and deductions that required making an investment in a UK trust in conjunction with investments by a U.S. bank. The benefit for the U.S. bank was to be receipt as a loan of Barclays’ investment of $1.5 billion in the trust, with a very reduced interest rate.

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The Worthless Subsidiary Problem

LPCiminelli Interests, Inc. v. United States, 110 AFTR 2d 2012-6631 (W.D. N.Y. 2012) ruled that a consolidated group did not have to amend its returns to assert that a subsidiary became worthless before the year the IRS claimed it was worthless. This ruling confirms the general rule that taxpayers have no obligation to amend a previously filed return. It also illustrates the pitfalls of dealing with broken subsidiaries, and the wisdom of sometimes doing nothing.

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Global Banks Being Audited

All global banks currently being audited by the IRS, which have engaged in cross-border withholding planning for clients, should take careful notice of AM 2012-009.

This GLAM explains to IRS LB&I how to assess foreign affiliates of domestic banks that did not withhold tax on foreign stock borrowing and back-to-back swaps, in reliance on Notice 97-66. The basic advice is to assert the economic substance doctrine. Fortunately, the advice applies only to transactions prior to the partial codification of the doctrine in 2010, which happened to coincide with legislation fixing the Notice 97-66 problem.

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Non-355 Ruling

Sometimes, a corporation wants to distribute stock of a subsidiary to its shareholders in a taxable transaction and does not want Section 355 to apply to prevent income recognition to both the corporation and the shareholders. Perhaps the corporation has expiring losses it can use to offset any Section 311 gain, and perhaps the shareholders wanted to enjoy the waning moments of the 15 percent tax rate on dividends in 2012.

Of course, Section 355 is not elective. Therefore, the corporation may have to do something to avoid the application of Section 355. One thing to do is to state that it is distributing the stock so that its shareholders can sell it, or sell the stock of the distributing corporation, or both. This appears to have been the plan of the taxpayer in LTR 201252014.

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Rare Taxpayer Debt-Equity Win

Pepsico, Inc., and Pepsico Puerto Rico, Inc. v. Commissioner, T.C. Memo 2012-269, ruled that the U.S. holder of an ambiguous security issued by its foreign affiliate did not have to treat the periodic payments received as interest, even though the affiliate was deducting interest paid under Dutch tax law.

Keys to taxpayer victory. The keys to the taxpayer victory were the following: (1) the issuer was a corporation and not a partnership; taxpayers have lost all recent debt-equity disputes with the IRS in the partnership context; (2) the hybrid security was carefully crafted to have equity-like characteristics in some factual circumstances; (3) the court was unwilling to ignore the possibility that those circumstances would not arise because the holder effectively controlled the issuer; and (4) the tax benefit achieved by the taxpayer was not in one of the hot button areas like foreign tax credit generators or “sale” of historic rehabilitation tax credits.

Two features of the opinion are out of the ordinary: (1) the taxpayer actually got credit for carefully negotiating different treatment of debt and equity in the United States and Holland, and (2) the relatedness of the parties did not count against the taxpayer.

Excess Loss Account Avoided

November 15, 2012 | Posted by Jasper L. (Jack) Cummings | Topic(s): Consolidated Returns, Controversies – Federal

LPCiminelli Interests Inc. v. United States (W.D.N.Y. Nov. 13, 2012) ruled for the taxpayer on an IRS assertion of excess loss account liability. The facts involve a common situation of delay in writing off a worthless consolidated subsidiary that might produce discharge of indebtedness liability and/or recognition of an excess loss account.

Facts: The taxpayer owned a subsidiary that was formed to do construction in a particular area. The subsidiary ran up a lot of debts, ceased operations and in 2004, was reported on the consolidated return as abandoned and removed from the consolidated group. For 2000-2003, the return reported it as inactive.

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CERT Regulation Proposed

Twenty-three years after it was enacted in 1989, the Treasury issued proposed regulations interpreting section 172(h), the corporate equity reduction transaction (CERT) loss carryback disallowance rule dating from the heyday of the leveraged buyouts. Most of us have tried to remember this rule as one aimed at preventing carrying back a loss generated by large interest deductions, and obtaining a refund, when the loan causing the interest deductions was incurred to make a large equity purchase—hence a “corporate equity reduction.”

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Beware of IRS Closing Agreements

United States v. ConocoPhillips, 2012 WL 3646809 (WD Okla) provides a good illustration on how closing agreements with the IRS are like any other contracts, only moreso, because the IRS is likely to be a particularly unbending contract partner if interpretive issues arise.

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Federal Tax Advisory - Short Sales and CFCs

Short sales are either everyday events or mysterious to most people. This advisory discusses the tax implications of short sales in the corporate world, as featured in a recent transaction in which a controlled foreign corporation bought its parent’s publicly traded stock and used the stock as part of the acquisition currency to buy a domestic subsidiary.

The advisory is provided in PDF on the Alston & Bird website:

Reverse Acquisitions and Tax Insurance

LTR 201228002 involves a plain vanilla group structure change in a consolidated group owned by a foreign parent. The ruling is so obvious that one wonders why the taxpayer sought it. The explanation likely lies in the substantial tax savings that can be facilitated by the reverse acquisition. It is likely that someone at the taxpayers’ office said “this is too good to be true, no matter how clear my tax director says the results are, I don’t mind paying to get an IRS seal of approval on the transaction, no matter how many caveats it carries.”

The following example, with made up numbers, shows how tax benefits might be facilitated.

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Tax Equal Protection

Armour v. City of Indianapolis, 132 S. Ct. 2073 (2012) ruled that a city did not violate the Equal Protection Clause of the Fourteenth Amendment when it chose to forgive remaining unpaid installments of a special assessment for sewage improvements but not to refund those taxpayers who had paid in full without choosing to pay in installments.

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Hewlett-Packard Decision on Preferred Stock

Hewlett-Packard Co. et al. v. Commissioner, T.C. Memo. 2012-135, ruled that a special purpose corporation could not issue equity when the interest in the corporation was puttable by the holder to the other shareholder seven years after issuance, and the board of the issuer had to declare dividends annually to the extent of available cash profits. The opinion rested on the twin grounds of the put, which it treated as a put to the issuer, and the relative security of the investment, said to be insured by the limitations on the issuer’s ability to incur debt and make investments other than one secure loan.

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Home Concrete Decided: Taxpayer Wins

On April 25, 2012 the Supreme Court ruled that the overstatement of the basis of property sold, resulting in a substantial understatement of gain, is not an omission from gross income, and so the three year and not the six year statute of limitations applied to the taxpayer’s assessment, meaning the assessment came too late. United States v. Home Concrete & Supply, LLP, 2012 U.S. LEXIS 3274, affirming, 634 F.3d 249 (4th Cir. 2011).

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Economic Substance Doctrine Notice

IRS Notice CC-2012-008 announces new Chief Counsel coordination procedures for assertion of the economic substance doctrine, which incorporate the LB&I Directives previously issued.

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Reorganization and Consolidated Rulings Issued

The usual Friday release of a large number of letter rulings by the IRS included several rulings of interest on reorganizations and consolidated return issues.

Bankruptcy Reorganization: LTR 201208036 addresses the use of qualified settlement funds, disputed ownership funds and liquidating trusts (all referred to as trusts) to hold both some of the assets of the debtor and the securities of Newco, the corporation into which the debtor was reorganized. This debtor evidently was brought down in part by environmental liabilities. It is not clear what assets the debtor transferred to Newco in exchange for securities, but the debtor also transferred plant and equipment to one trust, other assets to another trust and Newco securities to two other trusts.

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Anschutz Company

Just before New Year’s Eve 2011 the Tenth Circuit affirmed the Tax Court’s ruling against the taxpayer Anschutz Company in a case involving a variable prepaid forward contract. Anschutz Co. v. CIR (10th Cir. 2011). The ruling required the taxpayer to recognize immediately the gain on the stock to be sold under the prepaid forward, rather than postponing gain recognition to the future closing of the sale. The court’s reasoning reflected an unfortunate tendency of courts to default to a “benefits and burdens” analysis of ownership of property rather than grappling with the details of the transactions and the code sections at issue.

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LB&I Directive Softens Economic Substance Doctrine

The new LB&I Directive on the economic subject doctrine (ESD) (dated July 15, 2011) probably could not be much better for taxpayers.

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Air Cargo Tax and Corporate Groups

ILM 201123027 gives a big win to an air carrier and rules that for purposes of the federal excise tax on transportation of property by air (section 4271) the Carrier is the member of a corporate group that actually operates the planes, and the taxpayer is the sister corporation called Organizer that legally contracts with the Carrier to deliver the property that is accepted for transport by a third affiliate, the Retailer (owned by Organizer).

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First Time Home Buyer Credit Economic Substance?

June 3, 2011 | Posted by Jasper L. (Jack) Cummings | Topic(s): Controversies – Federal, Penalties

Rodriguez v. CIR, T.C. Memo 2011-122 (June 2, 2011) shows that (1) the IRS is on the case, and (2) the economic substance doctrine is not reserved to high flying taxpayers.

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Chevron Deference and the Salman Ranch

Salman Ranch LLC (partnership) won a refund action for the 1999 year on a Son of Boss transaction in which an allegedly overstated basis facilitated a huge loss. Salman Ranch II, 573 F. 3d 1362 (Fed. Cir. 2009).

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