Taxpayer Victory in Partnership Case
By Steven B. Gorin, Esq.
Thompson Coburn LLP, St. Louis, MO
Cox Enterprises, Inc. Subsidiaries v. Comr., T.C. Memo
2009-134, held that a corporation's contribution of a television
station to a partnership did not constitute a dividend even though the
partnership interest it received was originally worth $60.5 million
less than the assets it contributed. The partners in the partnership
were the remaindermen of certain trusts. These trusts, indirectly and
collectively, owned 98% of the corporation's stock. The IRS argued
that the transfer to the partnership should be deemed an indirect
distribution to the remaindermen of the trusts and therefore a
distribution to the trusts.
Judge Halpern rejected the IRS’ contention. First, he held
that the corporation's transfer to the partnership “was not
intended to provide a gratuitous economic benefit to the other
partners….” Second, he held that, even if the corporation
had made such a gratuitous transfer, the transfer did not benefit the
shareholder trusts.
Several factors demonstrated that the corporation's directors did
not intend a gratuitous transfer:
1.
The partnership's formation had nontax business reasons. As
recommended by independent consultants, the corporation tried to sell
these operating assets but was unable to do so. The partnership's
formation allowed the corporation to retain, for use in other areas,
the working capital it had previously needed for the television
station.
2.
The corporation's board's executive committee adopted a resolution
that the other partners be required to make cash contributions to the
partnership “in an amount corresponding to the fair market value
of the partnership interests acquired by” those other partners.
Furthermore, the other partners' acquisition of partnership interest
was to “be on terms and conditions no less favorable to”
the corporation “than the terms and conditions that would apply
in a similar transaction with persons who are not affiliated
with” the corporation.
3.
The corporation retained an outside accounting firm “to render
an opinion of appropriate marketability and minority interest
discounts applicable to a minority interest” in the partnership
as of the date of formation. The partners made contributions based on
the appraised amount. Three years later, the corporation's management
discovered errors in computing the other partners' interests in the
partnership and obtained a new appraisal. The other partners made
additional contributions to bring their contributions up to the
appraised value.
4.
The court relied on U.S. v. Byrum, 408 U.S. 135, 137-138
(1972), to find that the controlling shareholders were subject to
fiduciary duties to the minority shareholders. In the Cox case,
two percent of the stock was owned by people who were not members of
the controlling family; these minority shareholders were principally
employees of the corporation. Judge Halpern pointed out that the
minority shareholders did not own interests in the other partners and
“would not be made financially whole for the likely shortfall in
income and liquidation (or sale) proceeds” if the corporation's
contribution to the partnership constituted a transfer to the other
partners.
The court also found that any gratuitous transfer to the other
partners would not have benefitted the shareholder trusts. The
remaindermen of the trusts held significant interests in the partners,
so a transfer to the other partners would have accelerated the
remaindermen's interests in violation of the trust agreements. Because
the trusts were the controlling shareholders (and the court assumed
for the sake of argument that the trustees also controlled the actions
of the other board members), the trustees would have violated their
fiduciary duties by accelerating the interests of the remaindermen.
Thus, a gratuitous transfer to the other partners would have been
detrimental to the shareholder trusts as entities and would have
violated the trustees' fiduciary duties.
The court concluded that any gratuitous transfer of an interest
from the corporation to the other partners did not constitute a
distribution to the shareholder trusts subject to §311.
Other issues relating to these parties were still before the court
when Judge Halpern wrote this opinion, some of which involved the
trusts themselves. Subject to any light shed by those cases, one may
draw some planning tips from this case:
1.
As usual, documenting a transaction very well is always advisable,
particularly documentation demonstrating an intent to deal at
arms-length.
2.
Although the Tax Court seems to place little weight on the
Byrum case in family limited partnership cases under
§2036, having nonfamily member employees hold 2% of the stock
might do the trick.
3.
Practitioners often wonder whether parties must contribute assets with
fair market value to obtain capital accounts proportionate to their
interests in profits when all partners are making their initial
contributions on formation of the partnership. In this case, the
majority partner (the corporation) contributed assets with value
significantly in excess of the value of its partnership interest.
However, the minority partners contributed assets equal to the value
of their interests in the partnership. Thus, the majority partners
received capital accounts that were higher relative to their interests
in profits compared with the minority partners' capital accounts
relative to their respective interests in profits. Judge Halpern did
not seem to recognize this issue; if he did, he did not mention it in
analyzing the dividend issue. It will be interesting to see whether
the companion cases consider this issue to be of consequence.
For more information, in the Tax Management Portfolios, see
Frias, 764 T.M., Dividends -- Cash and Property, and in Tax
Practice Series, see ¶1220, Dividends.
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