The Ninth Circuit vacated and remanded a Tax Court decision that held that shareholders were not liable as transferees under Sec. 6901 for tax liabilities arising from a sale of all company assets followed by a sale of all company stock.
Facts: In 2000, Slone Broadcasting Corp. (SBC), a Tucson, Ariz.-based, family-owned and -operated C corporation, sold its radio station assets to a larger competitor. In 2001, Slone sold its stock to an affiliate of Fortrend International LLC, which had approached SBC with a strategy to offset taxable income from the asset sale with a loss on high-basis, low-value Treasury notes. Although the advisers to SBC knew of the existence of the strategy, they were not told its details, with Fortrend saying only that they were "proprietary." As part of the sale, the affiliate assumed liability for $15 million in federal income taxes owed on the asset sale. Then Fortrend contributed the Treasury notes to the affiliate, with which SBC merged.
The IRS audited the successor corporation, Arizona Media, and determined an income tax deficiency ($13.5 million) and penalties and interest ($10 million). The IRS levied the amount, but Arizona Media made no payments and was administratively dissolved by the state of Arizona for failing to file an annual report.
The IRS issued transferee notices for the unpaid liability to SBC's shareholders, James and Norma Slone and family trusts. The notices stated that the stock sale was substantially similar to an "intermediary transaction" tax shelter as described in Notice 2001-16 and recharacterized the asset and stock sales as an asset sale followed by a liquidating transaction. The Slones and the trusts petitioned the Tax Court.
Before trial, the IRS conceded that the stock sale was separate from the assets sale but argued it was still a liquidating distribution under the substance-over-form doctrine. However, the taxpayers successfully argued in Tax Court that the sales were distinct, that no tax strategies to offset potential gains were discussed, that due diligence was employed to investigate and negotiate the stock sale, and that they were not responsible for any tax strategies used after the closing of the stock sale. Consequently, the Tax Court refused to apply the substance-over-form doctrine (see "Tax Matters: Tax Court Respects Stock Sale, Denies Transferee Liability," JofA, May 2012, page 62).
Issues: Sec. 6901(a) provides a procedure through which the IRS may collect from a transferee unpaid taxes owed by the transferor of assets if applicable state law or equity principles provide an independent basis for holding the transferee liable for the transferor's debts.
To impose tax liability on a transferee, a court must engage in the test formulated by the Supreme Court in Stern, 357 U.S. 39 (1958), a two-pronged inquiry in which the first prong asks whether the party is a transferee under Sec. 6901 and other federal tax law, and the second prong questions whether the party is substantially liable for the transferor's unpaid taxes under state law.
Underlying the Ninth Circuit's decision was the Tax Court's incorrect application of substance over form. Substance over form and its related judicial doctrines are used to determine the true meaning of a transaction disguised by formalisms that exist solely to alter tax liabilities. In such instances, the substance of a transaction, rather than its form, will be given effect. Courts generally respect the form of a transaction but will apply the substance-over-form principles when warranted. The Ninth Circuit stated that a holistic approach to transaction analysis is more useful in considering the substance of the events rather than a rigid two-step analysis of the subjective and objective factors.
Holding: The Ninth Circuit ruled the Tax Court had not applied the correct legal standard for characterizing the stock sale transaction for purposes of federal transferee liability and therefore could not resolve the dispute. The Ninth Circuit held that the Tax Court did not address either the subjective or objective factors in characterizing the transaction for tax purposes: whether the shareholders had a business purpose for entering into the stock purchase transaction other than tax avoidance and whether the transaction had economic substance other than shielding shareholders from tax liability. Instead, the Tax Court focused its factual inquiry and analysis on factors that might be relevant to the second prong of the Stern test for assessing transferee liability but did not use its factual findings to analyze the shareholders' liability under the applicable state law (Stern test, second prong), the Ninth Circuit said. Instead, the Tax Court had concluded, based on its findings, that the form of the stock sale should be respected for the shareholders' transferee status (Stern test, first prong).
A separate opinion, concurring and dissenting in part, found that the record was sufficient to hold that the transaction had no economic substance, the shareholders were transferees under Sec. 6901, and the only question to be remanded to the Tax Court was on state-law substantive liability.
- Slone, No. 12-72464 (9th Cir. 6/8/15)
—By Laura Jean Kreissl, Ph.D., associate professor of accounting, the School of Business Economics, Thompson Rivers University, Kamloops, British Columbia, Canada, and Darlene Pulliam, CPA, Ph.D., Regents Professor and McCray Professor of Accounting, the College of Business, West Texas A&M University, Canyon, Texas.