Seagate Technology, Inc. v. Commissioner
| Decision Date | 27 November 2000 |
| Docket Number | Docket No. 15086-98. |
| Citation | 80 T.C.M. 759 |
| Parties | Seagate Technology, Inc., Successor In Interest To Seagate Peripherals, Inc., f/k/a Conner Peripherals, Inc. v. Commissioner. |
| Court | U.S. Tax Court |
Mark A. Oates, Thomas V.M. Linguanti, John M. Peterson, Jr., Mary E. Wynne, and Andrew P. Crousore, for the petitioner. Debra K. Estrem, Michael J. Cooper, Bryce A. Kranzthor, Jeffrey L. Heinkel, Lavonne D. Lawson, Ewan D. Purkiss, and Mark S. Heroux, for the respondent.
Pursuant to Rule 121,1 this matter is before the Court on the parties' cross-motions for partial summary judgment.2 The parties seek to determine, as a matter of law, whether the "relation-back doctrine" established in Arrowsmith v. Commissioner [52-2 USTC ¶ 9527], 344 U.S. 6 (1952), applies in characterizing petitioner's gain on the sale of stock for purposes of section 954.
Summary judgment may be granted if the pleadings and other materials demonstrate that no genuine issue exists as to any material fact and that a decision may be entered as a matter of law. See Rule 121(b); Sundstrand Corp. v. Commissioner [Dec. 48,191], 98 T.C. 518, 520 (1992), affd. [94-1 USTC ¶ 50,092] 17 F.3d 965 (7th Cir. 1994). There is no genuine issue as to any material fact with respect to the specific legal issue before us, and, accordingly, this matter is ripe for judgment on the contested issue as a matter of law.3 See Rule 121(b).
Petitioner is the successor-in-interest to Conner Peripherals, Inc., (Conner U.S.), a Delaware corporation. Conner U.S. developed and manufactured hard disk drives for sale to personal computer manufacturers and other customers. Conner Malaysia, a third-tier, wholly owned Malaysian manufacturing subsidiary of Conner U.S. manufactured hard disk drives and head-stack assemblies for hard disk drives in Malaysia.
An Asset Purchase Agreement between Conner Malaysia, Read-Rite Corp. (Read-Rite) and Conner U.S. was executed on August 30, 1991. Pursuant to the Asset Purchase Agreement, Conner Malaysia sold its head-stack assembly operating assets (the "assets") to Read-Rite, an unrelated third party. The deal negotiated between Conner Malaysia and Read-Rite called for Conner Malaysia to sell its assets in exchange principally for Read-Rite stock. At the time the sale was negotiated, Read-Rite was preparing to make its initial public offering of stock (IPO).
Pursuant to the Asset Purchase Agreement, the consideration for the assets consisted of the following:
2.1 Read-Rite Shares. On the Delivery Date (as defined in Section 3.2) Read-Rite shall deliver to Conner shares of capital stock of Read-Rite (the "Shares") determined as follows:
(a) In the event of an initial public offering of Read-Rite Common Stock pursuant to a registration statement on Form S-1 (an "Initial Public Offering") which closes within sixty (60) days of the Closing Date, Read-Rite shall issue to Conner that number of shares of Common Stock $.0001 par value of Read-Rite determined by dividing $27,500,000 (subject to adjustment as provided in Section 2.2) by the per share price to the public in the Initial Public Offering. Any fractional share shall be rounded to the nearest whole share.
The Asset Purchase Agreement also provided for an adjustment to the purchase price as follows:
2.2 Adjustment to Purchase Price. The $27,500,000 aggregate consideration described in Section 2.1 shall be subject to adjustment, on a dollar for dollar basis, to the extent that the aggregate net value of the Inventory and Fixed Assets at the Closing, as determined in accordance with this Section 2.2, is greater than or less than $14,000,000. Notwithstanding the foregoing, no adjustment shall be made for an aggregate deviation from $14,000,000 less than or equal to $500,000, and any adjustment shall be made only to the extent that such aggregate net value exceeds $14,500,000 or is less than $13,500,000. To the extent that the Purchase Price after such adjustment exceeds $27,500,000, Read-Rite shall pay such excess amount to Conner in cash on the Closing Date. To the extent that the Purchase Price after such adjustment is less than 27,500,000, the number of shares delivered to Conner shall be appropriately reduced.
Ernst and Young appraised the inventory and fixed assets in the amount of $5,266,237. As a result, there was a net downward adjustment to the purchase price from $27,500,000 to $19,266,237. Thus, while it was originally contemplated that Conner Malaysia would exchange its assets for 2,391,304 shares of Read-Rite stock, representing approximately 8.9 percent of Read-Rite's outstanding shares after the IPO, the actual number of Read-Rite shares that were delivered to Conner Malaysia was 1,675,325. Read-Rite's underwriter, Hambrecht & Quist, announced the purchase price adjustment in its Read-Rite company report as follows:
The original purchase price for the Conner HSA operation was $27.5 million in stock at the IPO price of $11.50. Read-Rite, however, was able to dramatically lower the inventory levels of its own heads at the Conner HSA location before the transaction closed, resulting in a reduction in the actual purchase price to less than $20 million, and thus fewer shares. * * * [Emphasis omitted.]
In order to prevent Conner Malaysia from selling its shares into the market immediately following the IPO, Read-Rite required Conner Malaysia as part of the deal to agree to restrictions upon how soon Conner Malaysia could sell the Read-Rite shares. Specifically, Read-Rite and Conner Malaysia agreed that the Read-Rite shares that Conner Malaysia was to receive would be freely tradeable at the closing of the IPO, subject to a lockup agreement that prevented Conner Malaysia from selling: (1) Any of the Read-Rite shares for 180 days following the closing of the IPO; (2) two-thirds of the shares for 270 days following the closing of the IPO; and (3) one-third of the shares 1 year following the closing of the IPO.
These restrictions on the sale of the Read-Rite stock were expressly included in the Asset Purchase Agreement. In order to prevent Read-Rite from amending the Asset Purchase Agreement to allow a waiver or release of the sale restrictions, Read-Rite's underwriters entered into separate agreements with Read-Rite. These underwriting agreements prevented Read-Rite from unilaterally releasing Conner Malaysia from the restrictions on sale without the underwriters' express written consent.
On October 18, 1991, Read-Rite launched its IPO, and on October 26, 1991, the asset sale between Read-Rite and Conner Malaysia closed. The delivery date of the shares under the Asset Purchase Agreement was November 14, 1991.
Conner Malaysia obtained a valuation by Unterberg Harris, an investment banking firm, of the appropriate discount applicable to the Read-Rite shares based upon the restrictions on sale. The discount applied to the Read-Rite shares took into account the lockup provisions applied to the shares. The discounted value or book "cost" of the Read-Rite shares was calculated to be $16,648,542. For financial reporting purposes, Conner Malaysia calculated the gain realized on the sale of the its assets to be $11,282,490. This figure was derived by subtracting the book value of the assets from the discounted value of the Read-Rite stock.
Pursuant to the Asset Purchase Agreement, the restrictions on Conner Malaysia's sale of the Read-Rite stock lapsed 180 days, 270 days and 1 year following the closing of the date of the Read-Rite IPO. Once the restrictions lapsed, Conner Malaysia was free to keep or sell the shares as it wished.
On April 22, 1992, 180 days after the closing of the IPO, the sale restriction on the first one-third of Conner Malaysia's Read-Rite shares lapsed. On this date, the closing price of Read-Rite shares was $21-1/4 per share. On June 1,1992, Conner Malaysia sold the first third of its Read-Rite shares (558,442 shares) at an average price of $20.31, yielding total proceeds of $11,341,147.65.
The price of Read-Rite shares fell by $.50 from April 22, 1992, the date the first restriction on the sale of shares lapsed, to June 1, 1992, the date Conner Malaysia sold the first one-third of its shares. Thus, by holding the 558,442 shares beyond April 22, 1992, Conner Malaysia lost $279,221 in proceeds that it would have received had it sold the shares on April 22, 1992.
On July 21, 1992, 270 days following the closing date of the IPO, the second restriction on sale lapsed. On this day, the closing price of Read-Rite shares was $23-1/8 per shares. On this day, Conner Malaysia sold 500,000 shares out of the 558,442 shares that it was then entitled to sell. Conner Malaysia sold the 500,000 shares for an average price of $23 per share, yielding proceeds of $11,500,000. Conner Malaysia sold the remaining 58,442 shares from the second one-third of its shares on November 11, 1992, at an average price of $26-1/2 per share, yielding proceeds of $1,548,713.
Between July 21, 1992, the date the second restriction lapsed, and November 11, 1992, the price at which Conner Malaysia sold the Read-Rite shares increased by $3-1/2 per share. Thus, by holding the 58,442 shares beyond the date the second sale restriction lapsed, Conner Malaysia earned an additional $204,547 over the amount it would have earned if it had sold the 58,442 shares on the date the restrictions lapsed.
On October 25, 1992, 1 year following the IPO closing date, the final restriction on sale lapsed. The closing price of Read-Rite shares at this time was $28-3/8. On November 11, 1992, Conner Malaysia sold all of its remaining Read-Rite shares (558,441 shares) at an average price of $26-1/2 per share. This sale yielded proceeds of $14,798,686.50.
Between October 26, 1992 and November 11, 1992, the price of Read-Rite shares fell by $1-7/8 per share. Thus, by holding the 558,441 Read-Rite shares beyond the date of the lapse of the...
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