Flextronics America, LLC v. Commissioner of Internal Revenue, 110810 FEDTAX, 9543-07

Docket Nº:9543-07.
Opinion Judge:FOLEY, Judge
Party Name:FLEXTRONICS AMERICA, LLC, AS ALTERNATIVE AGENT PURSUANT TO TREAS.REG.
Attorney:William A. Schmalzl, Joel V. Williamson, Jongjit Wongsrikasem, Jeffrey A. Goldman, C. Cabell Chinnis, Jr., Matthew C. Houchens, and Erin G. Gladney, for petitioner. James P. Thurston, Bryce A. Kranzthor, Cameron M. McKesson, Rachel L. Hester, Christopher B. Sterner, Barbara M. Leonard, and Mary E...
Case Date:November 08, 2010
Court:United States Tax Court
 
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T.C. Memo. 2010-245

FLEXTRONICS AMERICA, LLC, AS ALTERNATIVE AGENT PURSUANT TO TREAS.REG. § 1.1502-77A(e)(4)(ii) FOR C-MAC HOLDINGS, INC., & SUBSIDIARIES CONSOLIDATED GROUP, Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 9543-07.

United States Tax Court

November 8, 2010

William A. Schmalzl, Joel V. Williamson, Jongjit Wongsrikasem, Jeffrey A. Goldman, C. Cabell Chinnis, Jr., Matthew C. Houchens, and Erin G. Gladney, for petitioner.

James P. Thurston, Bryce A. Kranzthor, Cameron M. McKesson, Rachel L. Hester, Christopher B. Sterner, Barbara M. Leonard, and Mary E. Wynne, for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

FOLEY, Judge

After concessions, the issue for decision is whether transactions relating to inventory should be disregarded and the step-up in basis relating to such assets disallowed.

FINDINGS OF FACT

Petitioner, Flextronics America, LLC, is a Delaware limited liability company with its principal place of business in Milpitas, California. Petitioner is the agent for C-MAC Holdings, Inc. (C-MAC Holdings), & Subsidiaries Consolidated Group (collectively, C-MAC). In 1998 C-MAC was wholly owned by C-MAC Industries, Inc. (Canadian Parent), 1 a Canadian company and parent company of all C-MAC entities. Canadian Parent and all its direct and indirect subsidiaries are hereafter referred to as C-MAC Worldwide Group (C-MACW).

C-MACW, a leading international manufacturer of electronic components, owned and operated manufacturing plants. During the years in issue, Northern Telecom, Inc. (Nortel) was one of the largest purchasers of C-MACW's products. Nortel manufactured telecommunications networking and switching equipment that routed wireless telephone calls. This equipment was housed in large metal boxes which were fabricated in Nortel's mechanical and test facility in Creedmoor, North Carolina (Creedmoor). Each box contained a circuit board which provided power and connectivity for networking and switching equipment. C-MACW manufactured the circuit boards and other component parts and supplied them to Nortel.

I. The Creedmoor Sale

In late 1997, Nortel determined that because it was not operating Creedmoor at full capacity it would be more cost effective to sell Creedmoor and enter into a long-term supply agreement with Creedmoor's purchaser. Nortel solicited, and in March 1998 C-MACW and at least three other electronic components suppliers submitted, bids to purchase Creedmoor. C-MACW's $60 million offer was the winning bid. The acquisition was an integral part of C-MACW's plan to become a full-service provider of telecommunications equipment. Purchasing Creedmoor was also important to C-MACW because sales to Creedmoor had typically accounted for 50 percent of C-MACW's U.S. revenues and more than 15 percent of its worldwide revenues. On May 6, 1998, Nortel faxed proposed asset purchase and supply agreements to Canadian Parent.2 On May 13, 1998, Canadian Parent, in response to Nortel's proposals, submitted its terms for the asset purchase and supply agreements.

II. The Asset Purchase Agreement

After Canadian Parent submitted its bid and offer to purchase Creedmoor, C-MACW contacted KPMG, its accountant. KPMG, in May 1998, advised C-MACW of possible tax planning options relating to the Creedmoor acquisition. Those options included a proposed advance purchase of Creedmoor's inventory assets (the plan). KPMG advised C-MACW's senior management that successful execution of the plan would require a business purpose and would allow petitioner to deduct a significant loss relating to the Creedmoor purchase. Pursuant to the plan C-MAC, on May 28, 1998, would enter into an agreement with Nortel to purchase Creedmoor's inventory. Ten to fifteen days later, Nortel and C-MAC Interconnect Products, Inc. (C-MAC Interconnect), one of Canadian Parent's Canadian subsidiaries, would enter into an agreement to transfer, before closing, ownership of the inventory from Nortel to C-MAC Interconnect, with the remaining assets to be transferred at a later date. Once C-MAC Interconnect acquired the inventory, C-MAC Interconnect would pledge the inventory as security to C-MACW's lenders. Pursuant to the plan, C-MAC Holdings would incorporate a new U.S. corporation, C-MAC Network Systems, to acquire the remaining Creedmoor assets. KPMG referred to the inventory as "Bump Assets" because the series of transactions was designed to trigger sections 357(c)3 and 362(a) and thereby increase, or "bump up", the inventory's basis to equal the total amount of liabilities secured by the inventory.4

Through numerous years of acquiring manufacturing facilities, Dennis Wood, the chief executive officer of C-MACW, expanded C-MACW from a small Canadian company into a large international corporation. During a meeting with senior management regarding the acquisition of Creedmoor, Mr. Wood was informed about the plan and its accompanying tax considerations. Mr. Wood agreed to the plan because he believed that C-MACW could use the inventory in several of its worldwide facilities and that the plan would not hinder C-MACW's ultimate objective--to purchase Creedmoor.

On May 28, 1998, Canadian Parent and Nortel executed the Asset Purchase Agreement (APA). Pursuant to the APA, the purchase price (i.e., which included inventory assets with a December 31, 1997, estimated book value of $17.94 million) would be adjusted in accordance with the physical inventory on the closing date. On June 22, 1998, Canadian Parent sent a letter to Nortel proposing to purchase the inventory before the APA closing date. Nortel ultimately agreed.

III. The Inventory Purchase

From July 1 through 10, 1998, C-MACW entered into several transactions involving the inventory (the inventory transactions). On July 1, 1998, Nortel, Canadian Parent, and C-MAC Interconnect executed the First Amendment to Asset Purchase Agreement (amendment to APA). Pursuant to the amendment to APA, C-MAC Interconnect was authorized to purchase Creedmoor's inventory. C-MAC Interconnect and Nortel, on July 1...

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