Times Mirror - a reflection of the past.

In Tribune Co., 125 TC No. 8 (2005) (Times Mirror), the Tax Court held that a corporate reorganization was not tax flee under Sec. 368(a)(1)(A) and (B) and (a)(2)(E). Rather, the transaction was characterized as a sale for Federal tax purposes. While the decision led to a great deal of discussion and analysis within corporate tax circles, the court's holding is in fact nothing more than the continuous application of the economic-substance, business-purpose and sham-transaction doctrines to corporate reorganizations.

Times Mirror Decision

At a time of major changes in the legal publishing industry, Times Mirror Co., Inc., decided to divest itself of Matthew Bender & Co., Inc., a legal publisher, to restructure its business to focus on newspaper publishing. The transaction at issue in Times Minor was the disposition of Matthew Bender by its parent, Times Mirror, to Reed Elsevier, also a legal publishing company. The transaction was structured as a "corporate joint venture" as follows:

1. Creation of a special purpose corporation (MB Parent) owned partly by Times Mirror and partly by Reed;

2. Stock ownership by MB Parent of stock in an acquisition subsidiary that would eventually merge with Matthew Bender;

3. Ownership by MB Parent of a single-member limited liability company (SMLLC);

4. Control by Times Mirror Of the SMLLC;

5. Control by Reed of Matthew Bender; and

6. A merger of Matthew Bender into the acquisition subsidiary.

In holding that the transaction was not a tax-flee reorganization, the court determined that the economic substance of Times Mirror's management of the SMLLC's assets represented boot; thus, Times Mirror did not receive stock of the requisite 80% value, as required by Sec. 368(a)(2)(E). Similarly, the existence of boot meant that the restructuring could not qualify as a reorganization under Sec. 368(a)(1)(B). In determining that control over the SMLLC represented boot, the Tax Court needed to look no further than Times Mirror's legal and tax advisers, as well as the company's own internal communications, which clearly established the significant value placed on controlling the SMLLC.

While the Tax Court held that it did not need to apply the business-purpose, economic-substance or sham-transaction doctrine to determine whether the reorganization failed to qualify under Sec. 368, the final four pages of the opinion (perhaps contemplating the expected appeal) address how each applies. In citing the fact that the economics of the transaction resulted in Times Mirror's control over $1.375 billion in cash, and Reed's control of the Matthew Bender legal publishing operations, the court stated, "from any perspective, the 'true economic effect'... of the Bender transaction was a sale" by Times Mirror to Reed. Further, in citing Frank Lyon, 435 US 561 (1978), the Tax Court stated, "'the simple expedient of drawing up papers' is not controlling for tax purposes when 'the objective economic realities are to the contrary'" (Times Mirror, 125TC at 131, quoting Frank Lyon, at 573).

The Doctrines

Although economic substance, business purpose and sham transaction represent three separate judicial doctrines, courts often meld them into a single theory when analyzing a particular transaction.

Beginning where all business-purpose analyses do, tax advisers generally look to Gregory v. Helvering, 293 US 465 (1935), aff'g 69 F2d 809 (2d Cir. 1934), in which the Supreme Court addressed a transaction purporting to be a tax-flee reorganization. The transaction was held to be a sham because it lacked a business purpose. In the underlying appellate case, the Second Circuit stated, "because the transactions were no part of the conduct of the business of either or both companies ... they were a sham ..."; the Supreme Court agreed.

Twenty-five years after Gregory v. Helvering, the Supreme Court considered the application of the economic-substance doctrine in Knetsch, 364 US 361 (1960), aff'g 272 F2d 200 (9th Cir. 1959), a transaction involving the purchase of an annuity with mainly nonrecourse notes. It stated,"[f]or it is patent that there was nothing of substance to be realized by Knetsch from this transaction beyond a tax deduction."

In Frank Lyon Co., 435 US 561 (1978), rev'g 536 F2d 746 (8th Cir. 1976), the Supreme Court once again ruled on economic substance, sham transaction and business purpose. Reversing the Eighth Circuit, which disallowed deductions in a sale-leaseback arrangement, the Court held that multiple-party transactions entered into with true nontax business significance should be respected despite the tax consequences.

Seven years after that ruling, the Fourth Circuit, in Rice's Toyota World, Inc., 752 F2d 89 (4th Cir. 1985), aff'g 81 TC 184 (1984), interpreted. Frank Lyon as establishing a two-part test. It held that a transaction is a sham if the transaction has no nontax business purpose and lacks economic substance in the form of a potential profit.

In ACM Partnership, 157 F3d 231 (3rd Cir. 1998), aff'g in part and rev'g in part 73TCM 2189 (1997), the Third Circuit applied the same analysis as the Fourth Circuit, in determining that a transaction will only be disregarded if it lacks both economic substance and business purpose.

More recently, in two cases addressing contingent liability transactions under Secs. 351 and 357, the courts applied the Rice's Toyota two-part test. In Black & Decker Corp., 94 AFTR2d 6437 (D MD 2004); the court, after acknowledging the taxpayer's concession that its sole motivation for the transaction was to avoid taxes, nevertheless respected the transaction because the transaction had a real economic burden, which satisfied one element of the two-prong test. Likewise, in Coltec Industries, Inc., 62 Fed. Cl. 716 (2004), after finding compliance with Secs. 351 and 357, the court noted that the economic-substance doctrine had nonetheless been satisfied "since that doctrine requires proof of at least one of these tests."

Effect of Times Mirror on Historical Cases

When viewed in light of the line of cases that preceded it, the Times Mirror decision is not surprising, nor is it a change in the courts' analyses or reasoning with respect to corporate transactions, specifically reorganizations. Rather, Times Mirror once again shows that innovative structuring without economic substance or a nontax business purpose will be scrutinized by the courts. In addition, for legislators who are considering codification of economic substance, Times Mirror serves as proof that historical judicial precedent continues to operate effectively, For tax advisers, the case serves as a reminder that economic substance and business purpose are not a speed bump in the road to transaction structuring, but rather the keys to the ignition.

FROM KELLY WHITE, J.D., LL.M., IRVINE, CA, AND NICK GRUIDL, CPA, MINNEAPOLIS, MN