The IRS can have a long memory when it comes to rulings and decisions against taxpayers. Even with the seemingly all-purpose economic substance doctrine in its utility belt, the IRS sometimes dusts off old precedents to attack transactions. Revenue Ruling 80-239, 1980-2 C.B. 103, and Basic, Inc. v. United States, 549 F.2d 740 (Ct. Cl. 1977) are two anti-taxpayer authorities that targeted perceived abuses that are now largely obsolete. Nevertheless, the IRS may still invoke these precedents for support in totally different situations. Taxpayers should be aware of how the IRS might use such decisions to attack different transactions.
Rev. Rul. 80-239
The ruling involved a shareholder of a corporation, X, which had never paid a dividend. For good business reasons, the shareholder contributed X to a new holding company, Y, and sought to get cash out of the two corporations. After the contribution of X, Y borrowed cash and distributed it to the shareholder along with all the Y stock. The loan was secured by the stock of X, which guaranteed the loan, and cash from X was paid to Y to repay the loan. The IRS ruled that the shareholder received a dividend from X through Y as a conduit.
In a sense, Rev. Rul. 80-239 is obsolete. It was the IRS’ attempt to resolve two statutory ambiguities at the time: (1) the overlap of a Section 351 exchange with boot and Section 304 and (2) the limitation of a brother-sister Section 304 dividend to the earnings and profits of the acquiring corporation. Section 304 has been amended to address both issues, yet the IRS has not withdrawn the ruling. Its continued existence suggests that the IRS may apply its basic theory where the cash for a distribution in fact comes from the subsidiary. The IRS could also assert, in similar transactions, that the holding company loan is really equity in the holding company or perhaps the subsidiary’s debt.
Basic owned Falls, which owned Carbon. Carborundum wanted to buy the assets of Falls and Carbon, but they refused to sell, so Carborundum offered to buy their stock. The parties agreed that Falls would distribute the stock of Carbon to Basic, and Basic would then sell both corporations to Carborundum. Basic treated the distribution as a dividend. The court ignored the distribution of the Carbon stock to Basic and treated Falls as having sold Carbon.
The pre-sale distribution seems to have been a response to an issue under the predecessor to Section 338, which allowed a buyer a basis step up for target assets without tax if the purchaser bought the target stock directly. However, there was no ability to make similar elections for lower-tier subsidiaries of the target. Notwithstanding updates to the Section 338 rules, the case has been cited favorably in some relatively recent “tax shelter” decisions outside that setting.
Jack Cummings discusses the cited precedents more fully in the recent Federal Tax Advisory.
Note: quoted language in post title from E. E. Cummings’ poem, “nobody loses all the time.”