Trust U/W/O BH & MW Namm v. Commissioner of Internal Revenue, 102918 FEDTAX, 8485-17

Docket Nº:8485-17, 8487-17, 8488-17, 8490-17, 8496-17, 8498-17, 8499-17, 8500-17, 8501-17
Opinion Judge:LAUBER, Judge.
Attorney:Jenny L. Johnson Ware, Guinevere M. Moore, and Shay-Ann Heiser Singh, for petitioners. Carina J. Campobasso and Janet F. Appel, for respondent.
Case Date:October 29, 2018
Court:United States Tax Court

T.C. Memo. 2018-182




Nos. 8485-17, 8487-17, 8488-17, 8490-17, 8496-17, 8498-17, 8499-17, 8500-17, 8501-17

United States Tax Court

October 29, 2018

Jenny L. Johnson Ware, Guinevere M. Moore, and Shay-Ann Heiser Singh, for petitioners.

Carina J. Campobasso and Janet F. Appel, for respondent.


LAUBER, Judge.

These consolidated cases involve the assertion by the Internal Revenue Service (IRS or respondent) of transferee liability against petitioners, former shareholders of a corporation that was the subject of a "Midco" transaction. Currently before the Court are cross-motions for summary judgment on the question whether the IRS mailed notices of transferee liability to petitioners within the period of limitations specified in section 6901(c).[2] Answering that question in respondent's favor, we will grant his motion for partial summary judgment and deny petitioners' cross-motions.


The following facts are derived from the pleadings, the parties' motion papers, and the exhibits attached thereto. They are stated solely for purposes of deciding the motions and not as findings of fact in these cases. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994).

Petitioners are former shareholders of Arebec Corp. (Arebec), a C corporation whose assets consisted chiefly of appreciated marketable securities. At the time petitioners were shareholders, Arebec was subject to Federal income tax as a "personal holding company" under section 542. This tax classification was disadvantageous: Section 541 imposes, in addition to applicable income taxes, "a personal holding company tax equal to 20 percent" of undistributed personal holding company income.

Petitioners desired to liquidate Arebec's assets and have the proceeds distributed to them. But this approach would have had the consequence of requiring that Federal and State income tax be paid both at the corporate and at the shareholder level. Petitioner Andrew Namm, a member of Arebec's board of directors, informed his fellow shareholders that Arebec had explored ways to avoid this "double taxation" problem but had found no "credible solutions."

During the late 1990s and early 2000s tax shelter promoters offered purported solutions to this perceived problem. In one common strategy shareholders would sell their stock to a transient intermediary company, which would plan to offset the built-in gain with a prepackaged tax shelter, often a Son-of-BOSS scheme.3 These transactions took a variety of forms and are commonly called "intermediary company" or "Midco" transactions. See Notice 2001-16, 2001-1 C.B. 730, clarified by Notice 2008-111, 2008-51 I.R.B. 1299. These transactions are well summarized in Diebold Found. Inc. v. Commissioner, 736 F.3d 172, 175-176 (2d Cir. 2013), vacating and remanding T.C. Memo. 2010-238.

A. The Acquisition

In July 2000 a partner at Grant Thornton approached Arebec's management and suggested that Arebec might be a good candidate for sale. He indicated that he had found a suitable buyer, Diversified Group, Inc. (Diversified). Diversified and its president, James Haber, were leading promoters of Midco transactions, and several of their transactions have previously been scrutinized by this Court.[4]

Diversified stated that it would be willing to purchase 100% of Arebec's stock for a price equal to the fair market value of Arebec's assets, less approximately 7% of the capital gain embedded in those assets. This 7% "haircut" was substantially smaller than the effective rate of Federal tax that would apply to the gain if the securities were sold, which (as Mr. Namm informed his fellow shareholders) was "currently 35%." Diversified's offering price for the stock thus represented a significant premium over Arebec's net liquidation value.

On August 24, 2000, Mr. Namm and petitioner James Doran, also a member of Arebec's board, met with Diversified's representatives to discuss the proposal. From August through October the finer points of the deal were negotiated. On September 22, 2000, AC Acquisition, LLC (AC Acquisition), was formed as a subsidiary of Diversified to act as the buyer. On October 16, 2000, Arebec's board approved the transaction and AC Acquisition paid $25, 170, 000 for 100% of Arebec's stock. The proceeds were placed in a trust for petitioners, and 95.7% of the proceeds was distributed to them the following day.

B. Events Surrounding the Acquisition

The following facts are affirmatively alleged by respondent in his answer. In their reply to answer petitioners deny most of these allegations "for lack of sufficient knowledge or information."

AC Acquisition, which had negligible assets, financed its purchase of the Arebec stock with a purported loan of $29 million from a subsidiary of Rabobank, a Dutch bank that has played a similar fleeting role in other Midco transactions.5The loan was dated October 16, 2000, and was explicitly made contingent on an agreement by Paine Webber, a brokerage firm, to purchase all of Arebec's assets immediately after AC Acquisition purchased all of Arebec's stock. Paine Webber duly purchased Arebec's assets.

On October 17, 2000, the day after the purported stock acquisition and asset sale closed, the proceeds from the asset sale, totaling about $26 million, were withdrawn from Arebec's Paine Webber account and deposited into Arebec's Rabobank account. Later that day $25, 500, 000 was withdrawn from Arebec's Rabobank account and deposited into AC Acquisition's Rabobank account. AC Acquisition immediately used those funds to repay the Rabobank loan in full. This set of transactions left Arebec, now wholly owned by AC Acquisition, with negligible assets and a very large tax liability.

On October 23, 2000, Arebec formed and became the sole member of AC Trading, LLC (AC Trading), making a modest capital contribution. Four days later AC Trading purchased offsetting long- and short-option positions on the Japanese yen. Given the offsetting nature of these options and the lack of other assets, AC Trading had negligible economic value. But Arebec claimed a basis in excess of $20 million in AC Trading, valuing the long option at its cost and failing to offset against that value the contingent liability represented by the short option.

Two weeks later Arebec contributed its 100% interest in AC Trading in exchange for an 85% membership interest in AD Equity Investment Fund, LLC (AD Equity), a partnership of which Diversified was the tax matters partner (TMP). Arebec's purported basis in AD Equity was inflated because of the artificially high basis it claimed in AC Trading. On December 11, 2000, AD Equity redeemed Arebec's interest for cash and securities of little value. Arebec's inflated outside basis in AD Equity was transferred to the securities. Arebec claimed it suffered a short-term loss of $20, 986, 503 when it sold those securities on December 26, 2000.

C. Tax Reporting

On December 14, 2001, AD Equity filed Form 1065, U.S. Return of Partnership Income, for the calendar tax year 2000, the year in which it redeemed Arebec's 85% interest.[6] On January 17, 2002, Arebec filed Form 1120, U.S. Corporation Income Tax Return, for its fiscal year ending (FYE) January 31, 2001. On that return Arebec reported long-term capital gain of $20, 187, 206, largely from the sale of its appreciated securities portfolio to Paine Webber, and it reported a short-term capital loss of $21, 109, 722, largely from the sale of the low-value securities received from AD Equity. It reported negative taxable income and claimed a refund.

On December 14, 2004, the IRS issued a notice of final partnership administrative adjustment (FPAA) to Diversified, AD Equity's TMP. The FPAA determined that AD Equity had never existed (or had existed solely for tax avoidance purposes) and that its transactions lacked economic substance. On March 4, 2005, Diversified filed suit on behalf of AD Equity in the U.S. District Court for the Southern District of New York to contest the FPAA adjustments. On June 25, 2014, the District Court dismissed the case with prejudice, which had the effect of sustaining the FPAA. See sec. 6226(h) ("[T]he decision of the Court dismissing the action shall be considered as its decision that the notice of final partnership administrative adjustment is correct.").

Following conclusion of the lengthy partnership proceeding, the IRS issued, on May 12, 2015, a statutory notice of deficiency to Arebec. The IRS disallowed $19, 972, 484 of Arebec's reported capital losses, determining a tax deficiency of $6, 957...

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