Valuation of assets transferred to entity in determining gain.
In 1985, Pope & Talbot, Inc. (P&T), a public company, transferred appreciated real estate and certain new and existing liabilities to a newly formed limited partnership. Immediately after the transfer and under an overall plan, the managing general partner of the partnership, who was a controlling shareholder of P&T, issued the limited partnership units pro rata to the P&T shareholders. The units thereafter were traded publicly.
Although P&T and the IRS agreed that the transaction was a taxable distribution of property under Sec. 311, they disagreed as to the methodology for calculating the gain. Sec. 311 provides for gain recognition to a corporation that distributes appreciated property (other than an obligation of the distributing corporation) determined "as if such property were sold to the distributee at its fair market value." (Although the statute has been modified somewhat since 1985, this language has not changed.) P&T calculated its gain by using the aggregate value of the limited partnership units received by its shareholders. The Service's position was that the gain recognized by P&T under Sec. 311 should be based on the value of the underlying assets transferred by P&T to the partnership.
The Tax Court held for the IRS, and a divided Ninth Circuit affirmed. The majority opinion cited the "plain meaning" of Sec. 311, as well as the legislative history leading to repeal of the General Utilities doctrine. The Ninth Circuit rejected P&T's assertion that "symmetry" required Sec. 311 to be read consistently with Secs. 301 and 302, which measure gain to shareholder recipients of distributions based on the value of the property received.
In addition, the majority rejected P&T's argument that the market price of publicly traded securities equaled the value of the underlying assets held by an entity. The majority determined that a court should choose a valuation method that best fits the circumstances of a particular case. In this situation, the Ninth Circuit noted several reasons why the partnership units did not accurately reflect the value of the underlying assets, specifically concluding that the value of underlying property is generally greater than the aggregate interests representing the property. The court also emphasized that the partnership units were newly issued units with certain restrictions attached that made valuation more tenuous.
Given these limitations, the Ninth Circuit concluded that it would be more appropriate to rely on the testimony of valuation experts to determine the value of the properties transferred to the partnership on the distribution date. The dissenting opinion argued that the majority's interpretation of the "plain meaning" of the statute leads to an anomaly in which the value of property received by shareholders differs from the value of property distributed by the corporation.
Decision's Potential Applicability
The Ninth Circuit's Pope & Talbot analysis (which considers the value of the underlying assets transferred to an entity, rather than the value of the aggregate interests in the entity, in determining the corporate-level gain) may have implications for several other subchapter C areas. For example, Sec. 361 (c)(2), which deals with distributions of appreciated property by a corporation in reorganization transactions, employs the same statutory language as Sec. 311(b) in determining a corporation's gain on a distribution. Therefore, the same analysis as that used by the court in Pope & Talbot might be applied when a corporation transfers assets to a partnership and, as part of the reorganization transaction, the shareholders receive partnership interests (rather than the transferred assets) as a "boot" distribution. One example of such a transaction would be when a corporation acquired in a C reorganization transfers "unwanted assets" to a partnership and, as part of the reorganization, the partnership interests (rather than the actual assets) are distributed to the shareholders. If it followed the Pope & Talbot analysis, the Service might treat the distribution of the partnership interests to the shareholders as a direct sale of such assets by the corporation for their fair market value (FMV) and tax the corporation accordingly.
The Pope & Talbot decision also might be followed by the IRS for failed spinoffs under Sec. 355 when an existing corporation (P) transfers assets to a newly created corporation (N) and distributes the N stock to the P shareholders. If the requirements of Sec. 355 are satisfied, P's distribution of the N stock generally is a nonrecognition event for both P and its shareholders. However, if the Sec. 355 requirements are not satisfied (including the anti-Morris Trust legislation embodied in Sec. 355(e)), P must recognize gain on the distribution. If the Pope & Talbot analysis were applied to this transaction, P might have to recognize gain based on the value of the assets contributed to N rather than on the aggregate trading value of the N stock immediately after the distribution under Sec. 311(b) (in the case of a failed spinoff) or Sec. 361(c)(2) (in the case of a transaction taxable at the corporate level because of Sec. 355(e)).
Similarly, the Pope & Talbot analysis might be applied by the Service to taxable liquidations under Sec. 336. Sec. 336(a) provides that a liquidating corporation recognizes gain or loss on a liquidating distribution "as if such property were sold to the distributee at its fair market value." As with Secs. 311 (b) and 361(c)(2), Sec. 336(a) uses a sale model in determining corporate-level gain. Therefore, a corporation's transfer of its assets to a partnership (or any other entity), immediately followed by a distribution of the partnership interests to the corporation's shareholders in complete liquidation of the corporation, might be viewed by the IRS as a sale of the corporation's assets (rather than the partnership interests) at their FMV. This approach would be similar to that in Rev. Rul. 77-321, which recasts a corporation's transfer of all its assets to a partnership followed by the corporation's complete liquidation of the corporation followed by a transfer of the corporate assets by the shareholders to the partnership.
A final possible example relating to the Pope & Talbot analysis might be a taxable stock purchase followed by an independent transaction in which a target corporation is liquidated under Sec. 336. The Pope & Talbot case might suggest that a valuation of the target assets based on a deemed sale is required for measuring the Sec. 336 tax liability, while a valuation based solely on the stock purchase price might be subject to IRS challenge.
FROM JOSEPH M. CALIANNO, CPA, MBA, J.D., LL.M., AND RICHARD F. MCMANUS, J.D., LL.M., WASHINGTON, DC
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|Author:||McManus, Richard F.|
|Publication:||The Tax Adviser|
|Date:||Jul 1, 1999|
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