Controlled Corporations Sale of Warrants to Subsidiary Was Not a Bargain Sale

In TAM 200334001, the IRS National Office determined that a controlled corporations sale of warrants to its parents (Taxpayers) affiliate, in connection with Taxpayers spinoff of the controlled corporation, was not a bargain sale, because the sale was at arms length. The controlled corporation sold the warrants to finance a cash dividend to its shareholders under the terms of the spinoff. (In Letter Ruling 8908075, the IRS had determined that, among other things, the distributing corporations retention of an interest in the controlled corporation was not for tax-avoidance purposes.)

Following the spinoffs announcement, an independent investment banker valued the warrants. By the time the warrants were transferred to Taxpayers affiliate, their value had increased substantially; nevertheless, the controlled corporation sold the warrants at the price the investment banker had determined.

Taxpayers Argument

Acting under the assumption that the controlled corporations sale of the warrants was a bargain sale, Taxpayer argued that the transaction should be recast under Sec. 482 in accord with Rev. Rul. 69-630. Relying on Rev. Rul. 69-630, Taxpayer contended the transaction should result in treating: (1) the affiliate as paying the appreciated price for the warrants and receiving a commensurate step-up in basis; (2) the controlled corporation as having distributed to Taxpayer the difference between what it was deemed to have received (i.e., the appreciated price) and what it actually received (i.e., the appraised price) as a cash distribution as to its controlled corporation stock; and (3) Taxpayer as making a capital contribution to its affiliate in that amount.

Analysis

The National Office rejected Taxpayers position. It pointed out that the application of recast principles of Rev. Rul. 69-630 requires, initially, a bargain sale; because the controlled corporations sale of the warrants was not a bargain sale, the ruling did not apply. The warrant sale was not a bargain sale, for two reasons. First, when the warrants were written, the parties agreed on their price (as determined by an independent third-party investment banker); thus, there was no bargain element to the warrants acquisition. Second, the warrant agreement did not contain a provision for adjusting their purchase price between the time of the agreement and the time of sale; thus, Taxpayer had no authority to recalculate the purchase price based on fair market value at the time of sale. In addition, the National Office noted: [E]ven if the form of the transaction does not reflect its substance, the taxpayer is generally precluded from attempting to recharacterize its own transactionThus, even if the taxpayer is correct that the acquisition of the warrants was a bargain sale, taxpayer is precluded from making this argument.

Implications

The National Offices determination in TAM 200334001 that the sale of the warrants constituted an arms-length sale, rather than a bargain sale, has ramifications in certain corporate reorganization contexts. For example, when the value of an acquiring corporations stock decreases between the date a merger agreement is executed and the date the agreement is closed, this TAM supports the proposition that the decrease in stock value does not affect the reorganizations tax-free nature.

In The 20032004 Priority Guidance Plan for Chief Counsel (Corporate), 2003 TNT 179-72, Jasper Cummings, Jr., points out that TAM 200334001s determination, that the form of the warrant purchase was its substance, thereby precluding a recast of the sale, relates to the IRSs 2004 business plan. In particular, Cummings notes that the TAM is relevant to the portion of the business plan dealing with how to determine if continuity of proprietary interest exists for reorganization purposes when the value of the stock the target shareholders will receive changes between the agreement date and the closing date. According to Cummings, the TAM suggests that if the continuity is satisfactory at the time of the agreement, it is satisfactory at closing, unless some evidence of abuse exists.

From Gregory S. Martinelli, Washington, DC