Comput. Scis. Corp. v. Comm'r of Internal Revenue
| Docket Number | 4823-21 |
| Decision Date | 24 July 2023 |
| Parties | COMPUTER SCIENCES CORPORATION, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
With respect to petitioner's Federal income tax for its fiscal year ending March 29, 2013 (FY2013), the Internal Revenue Service (IRS or respondent) determined a deficiency of $276,535,161 and an accuracy-related penalty of $45,584,0001] The adjustment giving rise to the bulk of this deficiency was the disallowance of a $651,200,000 capital loss (capital loss issue). On June 17 2022, petitioner filed a Motion for Partial Summary Judgment urging the Court to hold as a matter of law that, for FY2013 it "is entitled to a capital loss under section 1001 in the amount of $651,200,000."
By Order served November 22, 2022, this case was assigned to the undersigned for trial or other disposition. We agree with respondent that there exist numerous genuine disputes of material fact that preclude summary adjudication of the capital loss issue. We will accordingly deny the Motion.
The following facts are derived from the pleadings, the parties' Motion papers, and the Exhibits and Declarations attached thereto. They are stated solely for purposes of deciding petitioner's Motion and not as findings of fact in this case. See Sundstrand Corp. v. Commissioner 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). In deciding whether to grant summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to respondent as the nonmoving party. Sundstrand Corp., 98 T.C. at 520.
At all relevant times, petitioner Computer Sciences Corporation (CSC) was the U.S. parent of a group of corporations that joined in the filing of a consolidated Federal income tax return. See § 1501. CSC and its subsidiaries engaged in various aspects of the information technology (IT) business. CSC had its principal place of business in Virginia when its petition was timely filed. Absent stipulation to the contrary, appeal of this case would apparently lie to the U.S. Court of Appeals for the Fourth Circuit. See § 7482(b)(3). We thus follow its precedent. See Golsen v. Commissioner, 54 T.C. 742, 756-57 (1970) aff'd, F.2d 985 (10th Cir. 1971).
In July 2007 CSC acquired all the stock of Covansys Corp. (Covansys), which specialized in offering "industry-specific" IT solutions to companies in particular economic sectors (e.g., healthcare or financial services). Petitioner alleges that its purchase price for the Covansys stock (net of cash acquired) was roughly $1.3 billion. Petitioner alleges that Covansys did not perform as well as expected and that, as of March 2013, it had realized an economic loss on its investment in Covansys. Houlihan Lokey, an appraisal firm retained by petitioner, determined on the basis of various financial projections that the fair market value (FMV) of a 100% interest in Co-vansys, as of March 12, 2013, was $473,800,000.
During FY2013 CSC engaged in a series of restructuring activities. One motivation for this restructuring, respondent alleges, was that petitioner expected to realize (and did realize during FY2013) a large capital gain on the sale of its consumer reporting business to Equifax, Inc. That sale generated cash proceeds of roughly $1 billion and a long-term capital gain of $751,567,314. As the last quarter of FY2013 began, petitioner did not have meaningful capital losses to offset against that gain.
Having allegedly realized an economic loss on its Covansys investment, petitioner could have recognized that loss by selling its Covansys stock (or the Covansys assets) to a third party. But petitioner evidently did not wish to have Covansys- together with its assets, manpower, and expertise-leave the CSC consolidated group. So petitioner executed a series of transactions that it hoped would generate a large capital loss, while maintaining its investment in (and control over) Covansys. Petitioner acknowledges that it expected the FY2013 restructuring to "facilitate (among other things) recognition of a portion of [the] economic loss" it had allegedly incurred on Covansys.
As the principal vehicle for implementing these transactions, petitioner chose another of its wholly-owned subsidiaries, CSC Consulting, Inc. (Consulting). Consulting offered a variety of IT services to customers. It also owned roughly 8% of CSC Computer Services International, Inc., a Nevada company, and roughly 8% of CSC Computer Sciences Holdings S.a.r.l. (CSC Lux), a Luxembourg company that owned interests in more than 100 subsidiaries worldwide. Consulting was historically unprofitable, having incurred substantial annual losses (for book and tax purposes) during 2008-2012. At the start of FY2013, Consulting had unappropriated retained earnings in a negative amount, i.e., ($766,261,594). It had never paid a dividend to CSC, its sole shareholder.
On December 1, 2012, the day on which CSC and Equifax executed their asset purchase agreement, CSC's board of directors was briefed on a structured financing transaction dubbed "Project Trinity." After interviewing several major banks, CSC settled on the Bank of Tokyo-Mitsubishi UFJ (BTMU) as the financing entity for this project. BTMU regularly supplied banking services to CSC, including the extension of a $1.5 billion unsecured line of credit.
According to a March 5, 2013, board presentation, implementation of Project Trinity was expected to involve two steps: (1) CSC would contribute its Covansys stock to Consulting in exchange for three classes of securities, i.e., "senior notes," "senior participating preferred stock," and "junior preferred stock"; and (2) CSC would resell the senior notes and senior preferred stock to BTMU for cash. The bulk of CSC's basis in its Covansys stock would be reallocated to the senior preferred stock, and CSC would recognize a large capital loss on that sale.
On March 22, 2013, CSC agreed to pay BTMU a "debt structuring fee" of $3,437,500 for its services in implementing Project Trinity. That same day CSC transferred all of its Covansys stock to Consulting in exchange for (1) 625 shares of "Participating Class A Stock" of Consulting, each share having a face value of $100,000; (2) 3,488 shares of "Class B Stock" of Consulting, each share having a face value of $100,000; and (3) an alleged Loan to CSC from Consulting with a principal amount of £41,100,000 (roughly equivalent to $62,600,000 at that time). Assuming that each security received by CSC had an FMV equal to its face value, those securities in the aggregate were worth $473,900,000, roughly equal to $473,800,000 value Houlihan Lokey had determined for the Covansys stock as of March 12, 2013. Four days later, on March 26, 2013, CSC sold the Loan and the Class A Stock to BTMU for $62,600,000 and $62,500,000, respectively.
The aggregate voting percentage of BTMU, as the holder of Consulting's Class A Stock, never exceeded 4.9% of the total voting power. CSC, which owned 100% of Consulting's common stock, thus retained complete control over Consulting. And Consulting, at all relevant times, continued to own 100% of Covansys2]
The Class A Stock required Consulting to declare and pay to BTMU quarterly amounts denominated "scheduled dividends." These amounts were calculated at a rate of 3.48% per annum on the stated value of the Class A Stock ($62,500,000). If Consulting failed to pay these amounts on any two consecutive payment dates, BTMU had the right to elect a majority of the directors to Consulting's board for the sole purpose of securing payment of the amounts due. Consulting had the option, beginning in March 2018, to redeem all of the Class A Stock. Consulting was required to redeem all of the Class A Stock in March 2023.
BTMU insisted on a mandatory "repricing" of the Class A Stock after five years. To accommodate that demand, Consulting and BTMU executed, on March 26, 2013, a "remarketing agreement" requiring that certain actions occur in March 2018. In March 2018, rather than pursue those actions, Consulting and BTMU agreed to increase the "scheduled dividend" rate on the Class A Stock from 3.48% to 6.00% per annum.
As a condition of BTMU's purchase of the Class A Stock, Consulting was required to maintain, while that stock remained outstanding, at least $332 million in "qualified assets." "Qualified assets" were defined to include "qualified intercompany receivables," so long as CSC maintained a specified credit rating. A $332 million receivable owed to Consulting by CSC under a promissory note executed in February 2013 was included as a "qualified intercompany receivable." Respondent alleges that this $332 million note served, in effect, to "secure[]" Consulting's obligations to BTMU.
Throughout the period during which BTMU held the Class A Stock, CSC treated that stock as long-term debt for financial accounting purposes and for SEC reporting purposes. However, this security had two features that allegedly made it "participating," i.e., that assertedly gave BTMU the opportunity to participate in Con-sulting's future earnings and growth. First, if Consulting ever paid a dividend to CSC-the sole shareholder of its common stock and the parent of its consolidated group-Consulting was required to pay BTMU a "participating dividend" equal to 3.8% of the dividend paid to CSC. Second, upon redemption of the Class A Stock, BTMU could be entitled to receive, in addition to $62,500,000 (the stock's stated value), a "participating redemption premium."
The "participating redemption premium" was payable only if the value of Con-sulting's common stock, determined by a "valid appraisal," exceeded $782,200,000 on the redemption date. The premium would be calculated as 3.8% of...
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