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by Steven B. Gorin, Esq.
Thompson Coburn LLP
St. Louis, Missouri
Cox Enterprises, Inc. & Subsidiaries v. Comr., T.C. Memo 2009-134 (6/9/09), 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's 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 interests 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 Internal Revenue Code §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 the resolution of those issues, 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 arm's-length.
2. Although the Tax Court seems to place little weight on the Byrum case in family limited partnership cases under Internal Revenue Code §2036, having non-family-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.
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