ACM Partnership v. C.I.R.

• Decision Date: 13 October 1998
• Docket Number: Nos. 97-7484,No. 97-7484,No. 97-7527,97-7527,97-7484,s. 97-7484
• Citation: 157 F.3d 231
• Parties: -6682, 98-2 USTC P 50,790 ACM PARTNERSHIP, Southampton-Hamilton Company, Tax Matters Partner, Appellant inv. COMMISSIONER OF INTERNAL REVENUE ACM PARTNERSHIP, Southampton-Hamilton Company, Tax Matters Partner, v. COMMISSIONER OF INTERNAL REVENUE, Appellant in
• Court: U.S. Court of Appeals — Third Circuit

Page 231

157 F.3d 231

82 A.F.T.R.2d 98-6682, 98-2 USTC P 50,790

ACM PARTNERSHIP, Southampton-Hamilton Company, Tax Matters Partner, Appellant in No. 97-7484 v. COMMISSIONER OF INTERNAL REVENUE

ACM PARTNERSHIP, Southampton-Hamilton Company, Tax Matters Partner, v. COMMISSIONER OF INTERNAL REVENUE, Appellant in No. 97-7527.

Nos. 97-7484, 97-7527.

United States Court of Appeals, Third Circuit.

Argued June 23, 1998.

Decided Oct. 13, 1998.

Albert H. Turkus (argued), Fred T. Goldberg, Jr., Pamela F. Olson, Skadden, Arps, Slate, Meagher & Flom, LLP, Washington, DC; William L. Goldman, Christopher Kliefoth McDermott, Will & Emery, Washington, DC, for Appellant and Cross Appellee ACM Partnership, Southampton-Hamilton Company, Tax Matters Partner.

Loretta C. Argrett, Assistant Attorney General, Richard Farber, Edward T. Perelmuter (argued), Tax Division Department of Justice, Washington, DC, for Appellee and Cross Appellant Commissioner of Internal Revenue.

BEFORE: GREENBERG, ALITO, and McKEE, Circuit Judges

OPINION OF THE COURT

GREENBERG, Circuit Judge.

I. INTRODUCTION

Appellant ACM Partnership ("ACM"), through its tax matters partner Southampton-Hamilton Company ("Southampton"), appeals from a decision of the United States Tax Court dated June 12, 1997. The Tax Court's jurisdiction rested on I.R.C. §§ 7442, 6213 and 6226 based on appellant's timely filing of a petition seeking redetermination of a deficiency and review of a Final Partnership Administrative Adjustment. Appellate jurisdiction rests on I.R.C. § 7482(a)(1). Venue is proper pursuant to I.R.C. § 7482(b)(1)(A) as Southampton maintained its principal place of business within this circuit at the time it filed its petition. For the reasons that follow, we will affirm in part, reverse in part, dismiss the Commissioner of Internal Revenue's cross appeal, and remand for further proceedings.

II. FACTUAL AND PROCEDURAL HISTORY

This appeal concerns the tax consequences of a series of transactions executed between November 1989 and December 1991 by appellant ACM, a partnership formed on October 27, 1989, with its principal place of business in Curacao, Netherlands Antilles. Each of ACM's three partners was created as a subsidiary of a larger entity several days before ACM's formation. Southampton was incorporated under Delaware law on October 24, 1989, as a wholly-owned subsidiary of Colgate-Palmolive Company ("Colgate"), an international consumer products company. Kannex Corporation N.V. ("Kannex") was incorporated under Netherlands Antilles law on October 25, 1989, as an entity controlled by Algemene Bank Nederland N.V. ("ABN"), a major Dutch bank. ACM's third partner, Merrill Lynch MLCS, Inc. ("MLCS"), was incorporated under Delaware law on October 27, 1989, as a wholly owned subsidiary of Merrill Lynch Capital Services, an affiliate of the financial services holding company Merrill Lynch & Co., Inc. ("Merrill Lynch"). See ACM Partnership v. Commissioner, 73 T.C.M. (CCH) 2189, 2190, 2197 (1997); app. at 81-84, 89-91.

A. The Proposed Partnership

The concept behind the ACM partnership originated in a proposal which Merrill Lynch presented to Colgate in May 1989. During the previous year, Colgate had reported $104,743,250 in long-term capital gains which were attributable in significant part to the sale of its wholly owned subsidiary The Kendall Company ("Kendall"). See app. at 74-75. Colgate had considered and rejected several proposals to reduce the tax liability arising from those 1988 capital gains, see app. at 664, when Merrill Lynch representative Macauley Taylor approached Colgate's Assistant Treasurer Hans Pohlschroeder in May 1989 and proposed an investment partnership that would generate capital losses which Colgate could use to offset some of its 1988 capital gains. App. at 674-76, 784, 965. ¹ Pohlschroeder related the plan to Colgate's Vice President of Taxation Steven Belasco, who expressed reservations because the plan entailed substantial costs, might not be recognized for tax purposes, and did not seem to serve Colgate's non-tax business purposes, and thus might not be well-received by Colgate's legal, financial, and accounting departments who would be required to participate in the plan. See 73 T.C.M. at 2191; app. at 1234-36. Colgate consulted a law firm for advice on the proposed transaction, which the law firm summarized as follows:

A (a foreign entity), B, and C form the ABC Partnership (ABC) on June 30, 1989 with respective cash contributions of $75, $24 and $1. Immediately thereafter, ABC invests $100 in short-term securities which it sells on December 30, 1989, to an unrelated party. The fair market value and face amount of the short-term securities at the time of the sale is still $100. In consideration for the sale, ABC receives $70 cash and an installment note that provides for six semiannual payments ... Each payment equals the sum of a notional principal amount multiplied by the London Interbank Offering Rate (LIBOR) at the start of the semiannual period. ² ABC uses the $70 cash and the first payment on the installment note to liquidate A's interest in ABC and uses the subsequent interest payments to purchase long-term securities.

73 T.C.M. at 2191.

The law firm advised that the sale of the short-term securities would be reported as a contingent installment sale under the installment method which governs "dispositions[s] of property where at least 1 payment is to be received after the close of the taxable year in which the disposition occurs," I.R.C. § 453, and the ratable basis recovery rule which provides that,

[w]hen a stated maximum selling price cannot be determined as of the close of the taxable year in which the sale or other disposition occurs, but the maximum period over which payments may be received under the contingent sale price agreement is fixed, the taxpayer's basis (inclusive of selling expenses) shall be allocated to the taxable years in which payment may be received under the agreement in equal annual increments.

Temp. Treas. Reg. § 15a.453-1(c)(3)(i). ³ Thus, the law firm advised, ABC would recover $25 of its basis in each of the 4 taxable years from 1989 through 1992, and ABC would recognize gain to the extent that the payments received in any year exceeded the $25 or loss to the extent that the payments fell below the $25, but only if the loss were carried over to a year with sufficient reported gains against which to offset that loss. See 73 T.C.M. at 2191.

On July 18, Pohlschroeder and Taylor, who had presented Merrill Lynch's proposal to Pohlschroeder's colleagues in Colgate's treasury department, discussed Colgate's concerns about the proposed partnership transaction, including its costs and its potential to serve Colgate's business purposes. Pohlschroeder's handwritten notes of the conversation read as follows:

... Based on bus. purpose Economic profit Is this partnership profitable? Every single step to be substantiated invest in your own debt Consolidation of effective control but not majority ownership.

App. at 634, 791.

Colgate was interested in the concept of using the proposed partnership to invest in its own debt because of recent developments which had weighted Colgate's debt portfolio toward fixed-rate long-term debt, leaving Colgate vulnerable to a decline in interest rates. ⁴ Moreover, persistent rumors that Colgate was a likely target for a hostile takeover or leveraged buyout had decreased the value of Colgate's debt issues due to the risk that Colgate's credit rating would be downgraded if Colgate became more highly leveraged. Because of these factors, Colgate perceived an opportunity to rebalance its debt profile, thus decreasing its exposure to falling interest rates, by acquiring its long-term debt issues at their presently discounted prices. See app. at 666-68, 880-82, 2762-63, 2765, 2769-70; 73 T.C.M. at 2192.

Colgate and Merrill Lynch discussed the possibility of using the proposed partnership to achieve these objectives. The acquisition of its own debt issues would decrease Colgate's exposure to falling interest rates because by acquiring those debt issues as an asset, Colgate effectively would reap the benefits of receiving the above-market interest payments due on those issues, thus hedging against the burdens associated with owing those payments. See 73 T.C.M. at 2193. Acquiring the debt through the partnership instead of directly would keep the acquisitions off Colgate's books, thus permitting Colgate to carry out its debt acquisition strategy without alerting potential acquirors to the internal accumulation of debt issues which, by increasing the capacity for internal leverage, would increase Colgate's vulnerability to a hostile takeover bid. See 73 T.C.M. at 2192-93; app. at 101, 3249-50, 1921-26, 2793-99, 2810, 2819-20, 3255-61. Thus, the acquisition of Colgate debt through the partnership would allow Colgate to use partnership capital to acquire its debt issues immediately at advantageous prices, then to retire and reissue the debt when market conditions were more favorable. In the interim, the debt effectively would be retired because Colgate would not owe the obligations thereon to third parties, yet the debt would remain outstanding for accounting purposes, reducing Colgate's vulnerability to potential acquirors. See app. at 673; 73 T.C.M. at 2193.

On July 28, 1989, Merrill Lynch presented a proposed partnership transaction summary which incorporated Colgate's debt acquisition objectives into the tax reduction proposal involving the contingent installment sale which Merrill Lynch had presented to Colgate in May 1989. See app. at 678-79. Merrill Lynch revised its proposals throughout the summer and approached ABN about participating in the partnership with Colgate and Merrill Lynch. Merrill Lynch explained to ABN that the partnership would invest in Colgate long-term debt to serve Colgate's debt management objectives, would engage in a contingent...