January 12, 2006
MEMORANDUM FOR INDUSTRY DIRECTORS, LMSB DIRECTOR, FIELD SPECIALISTS, LMSB DIRECTOR, PREFILING AND TECHNICAL GUIDANCE, LMSB DIVISION COUNSEL, LMSB AREA DIRECTORS, SBSE
FROM: Barry B. Shott, /s/ Barry B. Shott
Acting Industry Director
Communications, Technology and Media, LMSB
Issue Champion for Notice 2001-16
SUBJECT: Examination of Multiple Parties in Intermediary Transaction Tax Shelters as described in Notice 2001-16, 2001-09 I.R.B. 730
To safeguard the Service’s ability to assess deficiencies against one or more parties in intermediary transaction tax shelters, the Large and Mid-Size Business Division (LMSB) announces a directive emphasizing to examiners that the original shareholders of target corporations, the promoters that facilitate these transactions, the intermediaries, and the ultimate buyers of the assets must all be thoroughly considered for any tax liability, including, if case-specific facts call for it, transferee liability.
This Directive reflects a management decision to re-focus attention on the potential liability of parties other than just the intermediary entities, which will almost certainly be inadequate sources of collection. This Directive is not an official pronouncement of law, and cannot be used, cited, or relied upon as precedent.
Intermediary transaction tax shelters as described in Notice 2001-16 generally involve four parties: a seller (X), who desires to sell the stock of a target corporation (T), a promoter-controlled intermediary entity (M), and a buyer (Y) who desires to purchase the assets, but not the stock, of T. Pursuant to a pre-arranged plan, X purports to sell the stock of T to M. M has arranged financing for this sale through a bridge loan, which is secured by the assets of T. Contemporaneous with or shortly after the stock sale, M purports to sell T's assets to Y. The bridge loan is then repaid from the proceeds and any excess proceeds are retained by M, effectively as a fee. Y claims a basis in the assets equal to Y's purchase price. On occasion, the assets are sold before the stock, meaning that M then purchases the stock of a corporation consisting only of cash.
The primary tax motivation for X to engage in the transaction is the lesser gain recognized due to its high basis in the stock of T, as opposed to T's low inside basis in the assets. The primary tax motivation for Y is larger depreciation and amortization deductions based on the fair market value of the assets, rather than on a carryover basis. Payment of the tax on the gain resulting from the asset sale is often avoided by M offsetting the gain with losses from the sale of inflated-basis assets.
Determining a Liability and Recasting the Transaction
A thorough examination of an intermediary transaction tax shelter requires scrutiny into each aspect of the transaction, including contacting each of the parties involved, to determine the true nature of the transaction. Based on the results of the examination, it may be appropriate to treat M as a mere conduit, thus enabling the Service to either (1) recast the transaction as an asset sale by T to Y, followed by a distribution of the sale proceeds to X, or (2) recast the transaction as a purchase by Y of T’s stock followed by a liquidation of T into Y. See the Intermediary Transaction Tax Shelter Coordinated Issue Paper, December 19, 2002, for further recommendations as to case development.
Examiners should examine the return of the intermediary entity as part of any determination of the proper tax treatment of the overall transaction, as well as any determination of the correct tax liability of the target corporation as a result of the transaction. Examiners should bear in mind, however, that the intermediary itself is unlikely to serve as a source of collection for any tax liability. Experience with these transactions has shown that the intermediary usually has little or no collectible assets. The returns of the original shareholders of target corporations and the ultimate purchasers of the assets should also be thoroughly examined consistent with any recast of the transaction in each particular case.
After an intermediary transaction has been thoroughly examined, consistent with any appropriate recast of the transaction, and determinations of tax liability have been made, examiners should consider transferee liability if it appears that transferee liability may be the only possible way to obtain collection. Transferee liability is secondary liability for another’s unpaid taxes. Transferee liability does not stand on its own because although an assessment against a transferor (who has primary liability) is not always necessary, transferee liability always requires that the Service have first determined the transferor’s liability, including the amount. As a secondary collection tool, transferee liability should not be at the forefront of an examination of an intermediary transaction tax shelter. The potential for transferee liability, however, should not be ignored—ultimately transferee liability may be the only way for the Service to recover a determined tax liability that is otherwise uncollectible. Nevertheless, until the Service has determined the tax treatment of a transaction, including any recast, and determined that one or more transaction participants has a tax liability and has transferred assets to a transferee, a transferee examination is premature. When examiners reach that point and are considering transferee liability, they should be guided in a transferee liability examination by IRM 4.11.52, Transferee Liability Cases. See also IRM 5.17.14, Fraudulent Conveyances and Transferee Liability. Consistent with IRM 18.104.22.168, examiners should also coordinate their transferee liability examination with their Area Transferee Liability Coordinators and Area Counsel, as appropriate.
The elements of transferee liability are: (1) a transfer was made from a taxpayer to a transferee; (2) the taxpayer has a tax liability; (3) the transfer occurred during or after the taxable period in which the taxpayer’s liability accrued; (4) the transferee is liable either at law or in equity for the taxpayer’s unpaid liability; and (5) efforts to collect from the taxpayer have been exhausted or would be futile. As stated in IRM 22.214.171.124, the Service has the burden of proving these elements. Whether transferee liability is present will depend on all of the facts of an intermediary transaction, as well as the Service’s treatment of the transaction, the taxability of gains from the transaction, and the allowance of claimed losses. “Transferee liability cases can be very complex in nature [and must be the product] of independent research predicated upon the facts of the specific case.” IRM 126.96.36.199. For transferee liability, there must be both an underlying factual and legal basis (see the “Types of Transferee Liability” described in IRM 188.8.131.52 and the discussion of federal and state law in IRM 5.17.14).
As an example, assume that after examining an intermediary transaction, an examiner concludes that a sale of target stock to an intermediary was in substance a sale of the target corporation’s assets to a third-party buyer, with the intermediary acting as an accommodation party. Moreover, the payment to the shareholders in the purported sale of the target stock was a disguised distribution (transfer) to the shareholders of the proceeds of the asset sale. Additionally, the examiner also determines that the target corporation incurred a tax liability on the re-characterized asset sale, and the target corporation and the intermediary are unlikely to have assets with which to pay the liability. The examiner should consider whether a basis exists for the liability of the shareholders as transferees of a fraudulent transfer under applicable state or federal law if the transaction was actually intended to be fraudulent or rendered the target corporation and/or intermediary insolvent and fair consideration was not exchanged for the transfer.
As the example demonstrates, at the point where transferee liability is a consideration in an examination, it is important to follow all transfers of the target corporation’s assets (sometimes through the intermediary) to the other participants in the transaction in order to identify potential transferees. A party to the transaction that has received a transfer of cash or other property of the target corporation is potentially liable as a transferee. In intermediary transaction tax shelters, each of the central players may be a potential transferee: (1) the original shareholders of the target corporation who, when the transaction is recast as an asset sale, may be deemed to have received the bulk of the proceeds from the sale of the target corporation’s assets; (2) the buyer (Y), to the extent, for example, Y has paid less than reasonably equivalent value for the target’s assets, or in a stock sale recast if the target incurs a tax liability on its distribution of assets to Y; (3) the promoter to the extent that it has been paid a fee to set up the tax avoidance transaction; and (4) those persons or entities paid a fee for facilitating the transaction, such as consultants, accommodation parties, attorneys, and accountants, inasmuch as the fees paid to them were for non-existent services or were disproportionate to the generally accepted commercial rates for any services actually performed.
If the examiner develops a case which, on its face, supports the assertion of transferee liability against a party or participant, a decision to proceed with the assertion of transferee liability should be based on any preexisting position the Service has taken with regard to the transaction and the transferor’s liability. As a result, the Service’s characterization of the facts and their significance for purposes of transferee liability should be consistent with and not contrary to the Service’s position on the primary liability, especially if the position has been advanced in a notice of deficiency or in litigation. If the position changes or is rejected in litigation, then any transferee liability case may have to be changed accordingly (such as when the Service position shifts to an alternative theory) or even abandoned. Examiners should always coordinate and consult with Counsel anytime the assertion of transferee liability is contemplated in connection with an intermediary transaction.
If you have any questions, please contact Vincent Papallo, Leasing Industry Technical Advisor, at (203) 792-3688.