Chicago Baseball Holdings, LLC, Northside Entertainment Holdings, LLC, F.K.A. Ricketts Acquisition, LLC, Tax Matters Partner
This text of Chicago Baseball Holdings, LLC, Northside Entertainment Holdings, LLC, F.K.A. Ricketts Acquisition, LLC, Tax Matters Partner (Chicago Baseball Holdings, LLC, Northside Entertainment Holdings, LLC, F.K.A. Ricketts Acquisition, LLC, Tax Matters Partner) is published on Counsel Stack Legal Research, covering United States Tax Court primary law. Counsel Stack provides free access to over 12 million legal documents including statutes, case law, regulations, and constitutions.
Opinion
T.C. Memo. 2021-122
UNITED STATES TAX COURT
TRIBUNE MEDIA COMPANY f.k.a. TRIBUNE COMPANY & AFFILLIATES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CHICAGO BASEBALL HOLDINGS, LLC, NORTHSIDE ENTERTAINMENT HOLDINGS, LLC, f.k.a. RICKETTS ACQUISITION, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20940-16, 20941-16. Filed October 26, 2021.
Joel V. Williamson, Thomas Lee Kittle-Kamp, Peter M. Price, Anthony D.
Pastore, Daniel S. Emas, James B. Kelly, Scott M. Stewart, John W. Horne,
Elizabeth P. Mazzocco, and Phillip M. Goldberg, for petitioners.
Justin D. Scheid, Thomas F. Harriman, William Benjamin McClendon,
James M. Cascino, Grubert R. Markley, Rogelio A. Villageliu, and Brandon S.
Cline, for respondent.
Served 10/26/21 -2-
[*2] MEMORANDUM FINDINGS OF FACT AND OPINION
BUCH, Judge: In 2009, Tribune Media Co. f.k.a. Tribune Co. & Affiliates
(Tribune) formed Chicago Baseball Holdings, LLC (CBH), with the Ricketts
family, with Tribune contributing the Chicago Cubs Major League Baseball team
(Chicago Cubs or Cubs) (and related assets) and the Ricketts family contributing
cash. CBH then distributed cash to Tribune. This type of transaction is a
“disguised sale,” which neither party disputes. Although the name “disguised sale”
might seem pejorative, disguised sales are well recognized, and they are taxable. 1
CBH entered into two tranches of debt, one funded by a commercial lender
and the other funded by the Ricketts family. Tribune guaranteed collection of the
debt. To the extent Tribune is deemed ultimately responsible for the debt, the
distribution would be considered debt financed and would not be taxable.
The Commissioner issued a notice of deficiency to Tribune and a notice of
final partnership administrative adjustment (FPAA) as to CBH for 2009. In those
notices, the Commissioner determined that the series of transactions was taxable.
1 See sec. 707(a)(2)(B); see also sec. 1.707-3, Income Tax Regs. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. -3-
[*3] In support of those notices, the Commissioner argues that the debt funded by
the Ricketts family is not bona fide debt and thus should be disregarded for
purposes of the debt-financed distribution rule. The Commissioner further argues
that the likelihood that Tribune would ever be called upon to satisfy its guaranty is
so remote that the guaranty should be disregarded.
Tribune entered into a bona fide guaranty of the debt, and the fact that
having to fulfill that guaranty is remote is not sufficient to disregard it. The debt
funded by the Ricketts family, however, is not bona fide debt for tax purposes and
will be disregarded.
Introduction
President Ronald Reagan has often been referred to as “the Gipper.” This
nickname came about from his role as an actor in “Knute Rockne: All American”,
a 1940 Warner Brothers movie about the legendary football coach from Notre
Dame. Reagan played George Gipp, an all-American football player who died
prematurely. Legend has it that, from his hospital bed, Gipp implored his coach to
tell the team to “win just one for the Gipper.” 2 Reagan delivered that poignant line
2 H.W. Brands, Reagan: The Life 41 (2015). -4-
[*4] in the movie, and from then on, he was associated with both football and the
Gipper.
President Reagan arguably had much closer ties to baseball, and one could
credibly argue that it was his involvement with the Chicago Cubs that launched his
acting career. After graduating from college, Reagan sought to enter the field of
sports broadcasting. 3 His first job landed him in Davenport, Iowa, and later Des
Moines, Iowa, where he did play-by-play announcing of a wide variety of sports. 4
One of the sports he called was baseball, more specifically, Chicago Cubs baseball.
Announcing a Chicago Cubs game was particularly challenging because
Reagan was sitting in a studio in Des Moines while the Cubs were playing in
Chicago. And in the 1930s, there was no broadcast television for Reagan to watch.
In fact, Reagan wasn’t watching the games at all. The studio would receive reports
of what was happening in the game by Morse code via a ticker. 5 Aided by a
telegraph operator, Reagan would turn the dots and dashes into an enthralling play-
3 Ronald Reagan, An American Life 60 (1990). 4 Lou Cannon, Governor Reagan: His Rise To Power 35, 43 (2003). 5 Bob Spitz, Reagan: An American Journey 127 (2018); Cannon, supra note 4, at 43. -5-
[*5] by-play that had many people believing he was reporting live from the game. 6
For effect, he would add recorded crowd applause from a record turntable. 7 He
became “‘the voice of Chicago baseball’ throughout the prairie states.” 8
One game was uniquely challenging to call. As the story goes, it was in the
mid-1930s when the Cubs were playing their arch 9 rival, the St. Louis Cardinals.
It was 0-0 in the ninth inning, and Billy Jurges was batting against Dizzy Dean,
who was pitching for the Cardinals. And the ticker went out. 10
But the young announcer didn’t miss a beat. If he told the listeners the
ticker stopped working, he would have lost his audience. If he announced a hit or
an out, the actual game result might be different from what he announced. So
instead, Reagan improvised foul ball after foul ball, the inaccuracy of which would
be immaterial to the outcome of the game. His improvised play-by-play included a
6 Reagan, supra note 3, at 72; Cannon, supra note 4, at 43; Brands, supra note 2, at 30; Spitz, supra note 5, at 127. 7 Spitz, supra note 5, at 127. 8 Spitz, supra note 5, at 128. 9 Pun intended, although it wasn’t until two decades later that construction began on St. Louis’ Gateway Arch. 10 Reagan, supra note 3, at 72-73; Cannon, supra note 4, at 44; Brands, supra note 2, at 30; Spitz, supra note 5, at 133. -6-
[*6] would-be home run that went foul by a foot and a scuffle in the stands as two
kids fought over another foul ball. When the ticker began working again, it turned
out that Jurges had popped out on the first pitch. 11 Reagan’s listeners were none
the wiser.
By all appearances, Reagan called a live baseball game. 12 It’s only by
digging into what really happened that the appearances give way to reality. 13 So
with that in mind, we dig into what really happened with the sale of the Cubs. 14
11 Reagan, supra note 3, at 73; Cannon, supra note 4, at 44; Brands, supra note 2, at 30; Spitz, supra note 5, at 133. 12 Reagan’s telling was so believable that the unprecedented number of foul balls may have been reported to Ripley’s Believe It Or Not. Reagan, supra note 3, at 73. 13 As for how a Des Moines radio announcer wound up in California, in 1937, Reagan accompanied the Cubs to spring training on Catalina Island, off the coast of Los Angeles. While in California, he did a screen test that landed him a contract with Warner Brothers, the eventual distributor of “Knute Rockne: All American.” Reagan, supra note 3, at 77-81; Cannon, supra note 4, at 48-49; Brands, supra note 2, at 35-37, 41. 14 Coincidentally, it was President Reagan who signed into law the amendments to section 707 that give us the disguised sale rule found in section 707(a)(2)(B) that applies to these cases.
Free access — add to your briefcase to read the full text and ask questions with AI
T.C. Memo. 2021-122
UNITED STATES TAX COURT
TRIBUNE MEDIA COMPANY f.k.a. TRIBUNE COMPANY & AFFILLIATES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
CHICAGO BASEBALL HOLDINGS, LLC, NORTHSIDE ENTERTAINMENT HOLDINGS, LLC, f.k.a. RICKETTS ACQUISITION, LLC, TAX MATTERS PARTNER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 20940-16, 20941-16. Filed October 26, 2021.
Joel V. Williamson, Thomas Lee Kittle-Kamp, Peter M. Price, Anthony D.
Pastore, Daniel S. Emas, James B. Kelly, Scott M. Stewart, John W. Horne,
Elizabeth P. Mazzocco, and Phillip M. Goldberg, for petitioners.
Justin D. Scheid, Thomas F. Harriman, William Benjamin McClendon,
James M. Cascino, Grubert R. Markley, Rogelio A. Villageliu, and Brandon S.
Cline, for respondent.
Served 10/26/21 -2-
[*2] MEMORANDUM FINDINGS OF FACT AND OPINION
BUCH, Judge: In 2009, Tribune Media Co. f.k.a. Tribune Co. & Affiliates
(Tribune) formed Chicago Baseball Holdings, LLC (CBH), with the Ricketts
family, with Tribune contributing the Chicago Cubs Major League Baseball team
(Chicago Cubs or Cubs) (and related assets) and the Ricketts family contributing
cash. CBH then distributed cash to Tribune. This type of transaction is a
“disguised sale,” which neither party disputes. Although the name “disguised sale”
might seem pejorative, disguised sales are well recognized, and they are taxable. 1
CBH entered into two tranches of debt, one funded by a commercial lender
and the other funded by the Ricketts family. Tribune guaranteed collection of the
debt. To the extent Tribune is deemed ultimately responsible for the debt, the
distribution would be considered debt financed and would not be taxable.
The Commissioner issued a notice of deficiency to Tribune and a notice of
final partnership administrative adjustment (FPAA) as to CBH for 2009. In those
notices, the Commissioner determined that the series of transactions was taxable.
1 See sec. 707(a)(2)(B); see also sec. 1.707-3, Income Tax Regs. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code) in effect at all relevant times, and all Rule references are to the Tax Court Rules of Practice and Procedure. All monetary amounts are rounded to the nearest dollar. -3-
[*3] In support of those notices, the Commissioner argues that the debt funded by
the Ricketts family is not bona fide debt and thus should be disregarded for
purposes of the debt-financed distribution rule. The Commissioner further argues
that the likelihood that Tribune would ever be called upon to satisfy its guaranty is
so remote that the guaranty should be disregarded.
Tribune entered into a bona fide guaranty of the debt, and the fact that
having to fulfill that guaranty is remote is not sufficient to disregard it. The debt
funded by the Ricketts family, however, is not bona fide debt for tax purposes and
will be disregarded.
Introduction
President Ronald Reagan has often been referred to as “the Gipper.” This
nickname came about from his role as an actor in “Knute Rockne: All American”,
a 1940 Warner Brothers movie about the legendary football coach from Notre
Dame. Reagan played George Gipp, an all-American football player who died
prematurely. Legend has it that, from his hospital bed, Gipp implored his coach to
tell the team to “win just one for the Gipper.” 2 Reagan delivered that poignant line
2 H.W. Brands, Reagan: The Life 41 (2015). -4-
[*4] in the movie, and from then on, he was associated with both football and the
Gipper.
President Reagan arguably had much closer ties to baseball, and one could
credibly argue that it was his involvement with the Chicago Cubs that launched his
acting career. After graduating from college, Reagan sought to enter the field of
sports broadcasting. 3 His first job landed him in Davenport, Iowa, and later Des
Moines, Iowa, where he did play-by-play announcing of a wide variety of sports. 4
One of the sports he called was baseball, more specifically, Chicago Cubs baseball.
Announcing a Chicago Cubs game was particularly challenging because
Reagan was sitting in a studio in Des Moines while the Cubs were playing in
Chicago. And in the 1930s, there was no broadcast television for Reagan to watch.
In fact, Reagan wasn’t watching the games at all. The studio would receive reports
of what was happening in the game by Morse code via a ticker. 5 Aided by a
telegraph operator, Reagan would turn the dots and dashes into an enthralling play-
3 Ronald Reagan, An American Life 60 (1990). 4 Lou Cannon, Governor Reagan: His Rise To Power 35, 43 (2003). 5 Bob Spitz, Reagan: An American Journey 127 (2018); Cannon, supra note 4, at 43. -5-
[*5] by-play that had many people believing he was reporting live from the game. 6
For effect, he would add recorded crowd applause from a record turntable. 7 He
became “‘the voice of Chicago baseball’ throughout the prairie states.” 8
One game was uniquely challenging to call. As the story goes, it was in the
mid-1930s when the Cubs were playing their arch 9 rival, the St. Louis Cardinals.
It was 0-0 in the ninth inning, and Billy Jurges was batting against Dizzy Dean,
who was pitching for the Cardinals. And the ticker went out. 10
But the young announcer didn’t miss a beat. If he told the listeners the
ticker stopped working, he would have lost his audience. If he announced a hit or
an out, the actual game result might be different from what he announced. So
instead, Reagan improvised foul ball after foul ball, the inaccuracy of which would
be immaterial to the outcome of the game. His improvised play-by-play included a
6 Reagan, supra note 3, at 72; Cannon, supra note 4, at 43; Brands, supra note 2, at 30; Spitz, supra note 5, at 127. 7 Spitz, supra note 5, at 127. 8 Spitz, supra note 5, at 128. 9 Pun intended, although it wasn’t until two decades later that construction began on St. Louis’ Gateway Arch. 10 Reagan, supra note 3, at 72-73; Cannon, supra note 4, at 44; Brands, supra note 2, at 30; Spitz, supra note 5, at 133. -6-
[*6] would-be home run that went foul by a foot and a scuffle in the stands as two
kids fought over another foul ball. When the ticker began working again, it turned
out that Jurges had popped out on the first pitch. 11 Reagan’s listeners were none
the wiser.
By all appearances, Reagan called a live baseball game. 12 It’s only by
digging into what really happened that the appearances give way to reality. 13 So
with that in mind, we dig into what really happened with the sale of the Cubs. 14
11 Reagan, supra note 3, at 73; Cannon, supra note 4, at 44; Brands, supra note 2, at 30; Spitz, supra note 5, at 133. 12 Reagan’s telling was so believable that the unprecedented number of foul balls may have been reported to Ripley’s Believe It Or Not. Reagan, supra note 3, at 73. 13 As for how a Des Moines radio announcer wound up in California, in 1937, Reagan accompanied the Cubs to spring training on Catalina Island, off the coast of Los Angeles. While in California, he did a screen test that landed him a contract with Warner Brothers, the eventual distributor of “Knute Rockne: All American.” Reagan, supra note 3, at 77-81; Cannon, supra note 4, at 48-49; Brands, supra note 2, at 35-37, 41. 14 Coincidentally, it was President Reagan who signed into law the amendments to section 707 that give us the disguised sale rule found in section 707(a)(2)(B) that applies to these cases. Deficit Reduction Act of 1984, Pub. L. No. 98-369, sec. 73, 98 Stat. at 591-592. -7-
[*7] FINDINGS OF FACT
Tribune Background and Purchase of Chicago Cubs
In 1847, Tribune began publishing the Chicago Tribune newspaper. Tribune
went public in 1983. During the year at issue, Tribune was organized as a
corporation under the laws of Delaware and filed its Federal income tax return as a
consolidated group with Tribune as the parent company. When it filed its petition,
Tribune’s principal place of business was Chicago, Illinois.
In 1981, Tribune bought the Chicago Cubs baseball team from the Wrigley
family for $21.1 million; it also purchased Wrigley Field for $600,000. Tribune
held the Cubs in its wholly owned subsidiary, Chicago National League Ball Club,
LLC (CNLBC).
Tribune’s Leveraged Buyout
In September 2006, the Tribune board of directors explored “strategic
alternatives” to Tribune’s existing business model. In April 2007, Tribune
accepted an investment proposal from Sam Zell. Under this proposal, Tribune’s
Employee Stock Ownership Plan (ESOP) would buy Tribune’s outstanding stock
for $34 a share. Tribune had to borrow the funds to repurchase its shares as part of
the ESOP transaction, and when the transaction closed in late 2007, Tribune was
$12.8 billion in debt. -8-
[*8] Mr. Zell invested $315 million during the ESOP transaction; in exchange he
received a warrant to acquire 40% of Tribune’s common stock and became
Tribune’s president and chairman. As part of the ESOP transaction, Tribune
converted from a C corporation to an S corporation effective December 31, 2007.
The Ricketts Family
The Ricketts family has considerable wealth. Joe Ricketts started TD
Ameritrade, a discount brokerage firm, which grew significantly before it merged
with Toronto-Dominion Bank. The family’s primary source of wealth stems from
TD Ameritrade and their ongoing partial ownership of the company.
Along with their significant wherewithal, the Ricketts family has an
enduring love of Cubs baseball. In the mid-2000s, Thomas Ricketts, Joe Ricketts’
son, noticed Tribune’s financial troubles and convinced his family that if Tribune
ever put the Cubs up for sale, they should compete to buy the team. Thomas
Ricketts lined up a bank to support the family in such a transaction and identified
an appropriate family trust that could finance an acquisition. When Tribune
announced the sale of the Cubs, the Ricketts family was already prepared.
Initial Phases of the Cubs Transaction
Tribune’s plan to sell the Cubs was announced at the same time as the
company’s leveraged buyout. The announcement stated that Tribune would use -9-
[*9] the proceeds from the sale to pay down the debt it incurred for the leveraged
buyout. During its financial troubles, Tribune decided to focus on its “core assets,”
which did not include the Cubs; so Tribune chose to sell the team. At the time,
Tribune considered itself a media company. Although the Cubs are a legacy team
in the Major League Baseball (MLB) organization, the team was not a significant
source of cashflow for Tribune.
Tribune began to solicit interested buyers in April 2007. In May 2007,
Tribune hired J.P. Morgan Securities, Inc. (J.P. Morgan), to assist with selling the
Chicago Cubs and related assets (collectively, Cubs assets). The Cubs assets
included the Chicago Cubs, its Dominican baseball operations, Wrigley Field,
Tribune’s interest in Comcast SportsNet Chicago, LLC (CSN Chicago), and its
interests in other related partnerships.
J.P. Morgan gauged buyers’ interest in two kinds of ownership structures:
(1) a single partnership owning all Cubs assets and (2) two separate partnerships,
one holding the Chicago Cubs and the other holding Wrigley Field. Over 100
parties expressed interest in the single partnership structure and 60 expressed
interest in the dual partnership structure.
Bidding on the Cubs assets went through three phases. The first phase
began in the latter half of 2007 when MLB reviewed the financial information and - 10 -
[*10] initial applications of interested buyers. MLB cleared 10 bidding groups.
Tribune provided these 10 groups a descriptive memorandum that outlined
Tribune’s desire to sell a 95% interest in the Cubs with an option for the 95%
interest holder to buy the remaining 5% interest after 12 years. Tribune prepared
the descriptive memorandum before the bidding process.
The second bidding phase occurred in mid to late 2008. The 10 bidding
groups submitted preliminary, nonbinding proposals, which Tribune, J.P. Morgan,
and other advisers evaluated. From that evaluation, they narrowed the number of
bidding groups to five. After another due diligence phase, Tribune narrowed the
group to three potential buyers: (1) the Ricketts family, led by Thomas Ricketts;
(2) a group led by Marc Utay; and (3) a group led by Hersh Klaff.
The third bidding phase began in late 2008. Tribune and CNLBC evaluated
the bids from the three remaining bidders. After reviewing the revised bids from
the groups, Tribune chose to pursue a transaction with the Ricketts family.
Tribune and the Ricketts family began more detailed negotiations. Thomas
Ricketts viewed a 95% stake in the Cubs as a risky investment because expenses
are fixed and income fluctuates with ticket sales, making profitability
unpredictable. From his perspective, the negotiations with Tribune were
“contentious.” Nevertheless, the Ricketts family abided by Tribune’s required - 11 -
[*11] transaction structure: a leveraged partnership with 95% owned by the
Ricketts family and 5% owned by Tribune along with a debt-financed distribution
to Tribune (Cubs transaction). The Cubs transaction structure was dictated by
Tribune and nonnegotiable.
In the spring of 2009, after negotiations between the two sides slowed,
Tribune asked Mr. Utay to reengage in the bidding process. Mr. Utay believed that
Tribune asked his group to reengage because Tribune was motivated to sell the
Cubs but might not get a deal done with the Ricketts family and hoped it could sell
the Cubs to either his group or the Ricketts family. Mr. Utay believed his group
had “some chance of winning” but hesitated to reengage because Tribune and the
Ricketts family were in the midst of negotiations. To alleviate this hesitation, Mr.
Utay asked Tribune to cover all of his group’s historic and projected bidding
expenses. After negotiations, Tribune agreed to pay $2.5 million of the group’s
expenses. These expenses consisted primarily of legal fees. - 12 -
[*12] Ultimately, Tribune proceeded with the Ricketts family. In August 2009,
Tribune and the Ricketts family, operating through Ricketts Acquisition LLC
(RAC), signed the formation agreement for the Cubs transaction. 15
Tribune’s Bankruptcy
During negotiations for the Cubs transaction, Tribune and some of its
subsidiaries filed for chapter 11 bankruptcy. The bankruptcy arose from Tribune’s
inability to service its debts following the leveraged buyout. Chandler Bigelow,
Tribune’s senior vice president and chief financial officer during the Cubs
transaction, believed Tribune’s bankruptcy stemmed from losing advertising
revenue during the 2008 financial crisis, which had a significant effect on
Tribune’s cashflow. According to Mr. Bigelow, the cashflow decreased to a
significant enough extent that the company’s interest expenses relative to income
caused the board of directors to file for bankruptcy. It is Mr. Bigelow’s view that
“there’s a big difference between filing for bankruptcy and being bankrupt.”
According to him, at the time of the bankruptcy filing, Tribune had $300 million in
cash on the balance sheet.
15 RAC later changed its name to Northside Entertainment Holdings, LLC, which is the tax matters partner of Chicago Baseball Holdings, LLC, and petitioner in docket No. 20941-16. - 13 -
[*13] Tribune’s bankruptcy proceeding lasted four years. During this time, its
cash position grew to almost $3 billion.
In August 2009, Tribune moved the bankruptcy court to approve and
authorize the sale of the Cubs to the Ricketts family. In September, the bankruptcy
court authorized the sale and ordered that Tribune’s financial obligations under the
Cubs transaction be entitled to administrative expense priority. In July 2012, the
bankruptcy court confirmed Tribune’s reorganization plan.
MLB Approval Process and Sale Oversight
Before an owner of an MLB team sells or disposes of a team, MLB must
approve the transaction. Any proposed sale or disposition of an MLB team must
be voted on and approved by 75% of MLB teams.
Tribune’s sale of 95% of its interest to the Ricketts family had to be
approved through this process. When considering the disposition, MLB viewed
the continuity of ownership resulting from Tribune’s retention of a 5% interest as a
positive factor.
A significant aspect of MLB approval is an internal debt service rule that
limits the level of debt a team may maintain. The rule aims to ensure a team’s debt
does not impede its economic stability and ability to perform. Related-party debt
that is not secured by team assets is not treated as debt under this rule. MLB - 14 -
[*14] reviewed and approved the Cubs’ ability to finance its operations and service
its debt under the debt service rule.
Creation and Management of CBH
On October 27, 2009 (closing date), Tribune and RAC closed the Cubs
transaction and formed CBH, with Tribune and RAC as partners. On formation,
Tribune contributed the Cubs assets to CBH and RAC contributed $150 million.
At the time, the Cubs assets had a fair market value of $769,976,627. CBH also
assumed $35,241,562 in Cubs liabilities, bringing the net fair market value of the
contribution to $734,735,065. On the closing date, CBH made a special
distribution to Tribune of $704,872,594 (special distribution) as required by the
formation agreement.
CBH was managed by a board of directors, which could have between 2 and
20 members. RAC could appoint up to 19 members and Tribune could appoint 1.
The initial board consisted of one Tribune appointee and four members of the
Ricketts family.
Percentage Shares and Common Capital
The following table shows the ownership percentages and common capital
of CBH’s members upon formation of CBH. Tribune held its interests through
Cubs, LLC, Tribune Sports, Premium Tickets, LLC, and DQ, LLC. - 15 -
[*15] Member Percentage share Common capital
RAC 95.0000% $150,000,000
Cubs, LLC 3.5978% 15,101,181
Tribune Sports 1.3688% 5,745,359
Premium Tickets, LLC 0.0011% 4,522
DQ, LLC 0.0323% 135,781
Total 100% 170,986,843
Despite the interest percentages amounting to 95% for RAC and 5% for Tribune,
common capital shows a different ownership scheme. Of the total common
capital, $150 million is attributable to RAC and $20,986,843 is attributable to
Tribune. This translates to RAC’s owning 87.726% of common capital and
Tribune’s owning 12.274%. At trial, Thomas Ricketts did not know why, and he
appeared surprised to learn that the common capital percentages did not match the
ownership interest percentages.
Operating Support Agreement
On the closing date, Chicago Cubs Baseball Club LLC, RAC, Thomas
Ricketts, Ricketts Educational Trust, RAC Education Trust OSA, LLC (RAC
OSA), CBH, and the Office of the Commissioner of Baseball executed the - 16 -
[*16] operating support agreement. The operating support agreement specified
that RAC OSA would provide unsecured subordinated loans to the Cubs as
requested by the MLB Commissioner. The operating support agreement provided
a financial safety net for the Cubs to ensure the team could pay its players in the
event of financial collapse. The agreement provided MLB with assurance that the
team had operating revenue even amidst economic uncertainty.
Pursuant to the agreement, RAC, Thomas Ricketts, the Joe and Marlene
Ricketts Grandchildren’s Trust (trust), and RAC OSA all committed to providing
this financial safety net. These parties also agreed that RAC OSA would maintain
cash or cash equivalents of at least $35 million. But the operating support
agreement expressly prohibited the use of RAC OSA funds to pay any debts of
CBH or the Cubs.
Every party to the agreement that committed to provide backup funds to
CBH was either a Ricketts family member or an entity owned by (or for the benefit
of) Ricketts family members. RAC wholly owned RAC OSA. The trust was an
intergenerational Ricketts family trust established to pay the secondary education
expenses for Ricketts family members. - 17 -
[*17] Financing the Cubs Transaction
The Ricketts family and Tribune financed the Cubs transaction with a
combination of equity and debt. The Ricketts family contributed the equity
through the trust, which wholly owned RAC. The trust transferred $191,985,182
to RAC, which then transferred $150 million to CBH as an equity investment.
RAC used the remainder of the transferred cash to fund the operating support
agreement, to fund a small portion of the subordinated debt (sub debt), and to pay
various transaction costs. The Ricketts family decided to use the trust to fund the
Cubs purchase because the family viewed the team as a long-term family
investment. Thomas Ricketts preferred for the trust to be the only source of equity
in the transaction and did not want any outside sources of equity.
From the beginning of the bidding process, Tribune intended the sale of the
Cubs to include as much debt as possible; the leveraged partnership structure was
nonnegotiable. The leveraged financing came from two tranches of debt: senior
debt and sub debt. CBH was funded with $425 million of senior debt from
unrelated third parties and $248,750,000 of sub debt from RAC Finance, an entity
closely related to RAC and owned by the Ricketts family. CBH is a limited
liability company (LLC), and neither Tribune nor RAC had an obligation to - 18 -
[*18] contribute capital to CBH. Further, the members of CBH were not liable for
the debts and obligations of CBH.
The Senior Debt
Several banks lent CBH a total of $425 million.16 Under the terms of the
senior credit agreement governing these loans, CBH could use the senior debt only
to (1) pay transaction costs, (2) fund a debt service reserve account, and (3) make
the special distribution to Tribune.
On the closing date, CBH issued and sold $250 million of the senior debt
secured notes to third parties. The notes were issued in three series, set to mature
in 2018, 2020, and 2022. An agreement executed by CBH and the buyers of the
notes required CBH to use the proceeds to pay down $250 million of the senior
debt, bringing the senior debt down to $175 million.
16 These loans totaling $425 million were term loans. Banks also lent $50 million in revolving loans to CBH, but those loans are not part of the senior debt at issue. This financing was effectively bridge financing, a short-term loan that provides financing for a transaction. It is meant to be repaid after the borrower closes the transaction. See Container Corp. v. Commissioner, 134 T.C. 122, 124 (2010), aff’d per curiam without published opinion, 107 A.F.T.R.2d (RIA) 2011- 1831 (5th Cir. 2011). - 19 -
[*19] The parties to these cases stipulated that the senior debt is bona fide debt for
Federal income tax purposes. But they disagree as to whether the senior debt
should be characterized as recourse or nonrecourse to Tribune.
The Sub Debt
Sub debt was also used to fund CBH. RAC and Tribune chose to use sub
debt after a failing financial market left the parties with few options. RAC pulled
as much debt funding as possible from third-party lenders as senior debt.
The largest source of the sub debt was Marlene Ricketts, mother of Thomas
Ricketts, through MMR Financing, LLC. Thomas Ricketts considered the MMR
Financing to be Marlene Ricketts’ “private funds.” Marlene Ricketts was never
asked to purchase an equity interest. The family’s strategy was to fund the equity
part of its investment only from the trust because it existed outside the family’s
estate.
MMR Financing and RAC created a separate entity from which to fund the
sub debt and to hold the corresponding promissory note: RAC Education Trust
Finance, LLC (RAC Finance). MMR Financing contributed $250,750,000 to RAC
Finance, and RAC contributed $18 million. RAC was the sole manager of RAC
Finance. Thomas Ricketts was executive vice president of RAC and had the
authority to make decisions for RAC Finance. Neither MMR Financing nor RAC - 20 -
[*20] Finance was a member of CBH, and neither entity had participation or voting
rights in CBH.
On the closing date, RAC Finance transferred $248,750,000 to CBH in
exchange for the subordinate promissory note (sub debt note). Although the
ultimate transfer came from RAC Finance, Marlene Ricketts funded most of the
sub debt with her private funds from MMR Financing.
The parties in these cases dispute whether the sub debt is debt or equity for
Federal income tax purposes.
1. Subordination
The sub debt was subordinated to the senior debt under the subordination
agreement. The subordination agreement makes payment of the sub debt
conditional on full payment of the senior debt. The agreement provides that CBH
must pay the senior debt in full before making payments other than “permitted
payments” on the sub debt. To be considered “permitted payments,” the payments
must be for regularly scheduled interest payments made if no default occurred, the
payments must be permitted under the cash waterfall, see infra pp. 21-22, and the
interest rate must not exceed 6.5%.
The agreement also prioritizes the senior debt in the event of a dissolution or
reorganization. It provides that in the case of dissolution, winding up, - 21 -
[*21] reorganization, or liquidation, the sub debt holders will transfer and assign to
the senior debt lenders any claims or demands that arise. The subordination
agreement also grants J.P. Morgan, as collateral agent of the senior debt lenders, a
power of attorney over the sub debt holders during any default. If a dissolution or
reorganization event occurs, any payments made toward the sub debt must be
applied instead to the senior debt. In the event that any payments are made to the
sub debt creditors, those payments will be placed in a trust for the benefit of the
senior debt lenders to apply to payment or prepayment of the senior debt.
Additionally, the sub debt creditors covenant not to commence or participate
in any enforcement proceedings for collection of the sub debt until the senior debt
is paid in full.
2. The Cash Waterfall
As part of the Cubs transaction, J.P. Morgan, as collateral agent, and CBH
entered into a cash collateral agreement. This agreement governed the flow of
cash entering into CBH to create the cash waterfall.
Generally, a “cash waterfall” is an agreement between a creditor and a
borrower dictating the order in which the borrower will apply incoming cash to its
obligations. The “waterfall” in the analogy refers to cash coming into the - 22 -
[*22] borrower’s organization at the top of the revenue stream and its descending
“flow” through payment obligations.
In CBH’s cash waterfall, revenues related to certain Cubs assets, such as
gate receipts, local media revenue, and MLB Central Fund distributions,17 would
be deposited into the cash waterfall revenue account. Under the cash collateral
agreement, after revenues in excess of roughly $50 million are transferred to a
separate account to pay the Cubs’ operating expenses, the remaining funds are to
be applied to the cash waterfall in the following order: First and second to
accounts to service the senior debt; third to accounts to pay fees and other
obligations; and fourth to the distribution account. Funds in the distribution
account are then applied in the following order: First for specified capital
contributions; second to pay principal and interest on operating support agreement
loans; third to discretionary capital expenditures; and fourth (and last) to pay the
sub debt. The sub debt is only paid if revenue remains after every previous
obligation is met through the cash waterfall.
17 MLB Central Fund distributions are distributions MLB teams receive from national television revenues. - 23 -
[*23] 3. Benefits to the Sub Debt Holders
The sub debt note conferred benefits on the lender. One benefit was the
right of first refusal to purchase equity in CBH. This right did not apply to the
Ricketts family who could purchase equity in CBH as a matter of course.
The sub debt lender also received 17 specified privileges under the sub debt
note. These privileges include the right to use Wrigley Field for private functions,
clubhouse access, complimentary premium seating, season ticket options,
hospitality benefits, premier parking, and the right to participate in postseason
award ceremonies. These privileges are not transferable to any person who was
not a sub debt holder.
4. Maturity of the Sub Debt
The sub debt had a 15-year maturity and was set to mature on October 27,
2024.18 That maturity date, however, is not as fixed as it might appear. The 15-
year maturity was not actually fixed because its maturity depended on the maturity
The sub debt note provides that CBH promises to repay the debt “fifteen 18
(15) years following the Consummation Date (as defined in the Subscription Agreement) (the ‘Maturity Date’).” The subscription agreement defines the consummation date as “the date of the consummation of the transactions * * * contemplated by the Formation Agreement.” The Cubs transaction closed on October 27, 2009, so the maturity date is 15 years later, on October 27, 2024. - 24 -
[*24] of the senior debt, a fact noted by one of the Commissioner’s experts,
Howard Gellis. As previously discussed, the sub debt principal could not be repaid
until the senior debt was paid in full. Because the senior debt holders could extend
or change the manner, terms, and times of payment, 19 the sub debt maturity date
could also change. This potential extension meant that the maturity date of the sub
debt was not fixed. As explained by Mr. Gellis, the senior debt holder could, in
effect, extend the maturity date of the sub debt indefinitely:
So the subordinated debt has a maturity of 15 years, but even that isn’t even protected here, because in the subordination--in the subordination agreement, the senior lenders are allowed to extend the maturity of their debt, including the notes * * * So if the senior debt extends their maturity beyond the original maturity of the sub-debt, the sub-debt has no ability to say anything about that or to collect, even at its own original maturity.[20]
19 The subordination agreement provides: Without notice to or the consent of the SDF Agent or the Subordinated Creditors, the Collateral Agent and/or the applicable Senior Lenders may, at any time and from time to time and without impairing or releasing the subordination herein made, do any one or more of the following: (a) (i) change the manner, place or terms of payment, or change or extend the time of payment, of the Senior debt *** 20 One of Tribune’s experts, Douglas Skinner, contends that this 15-year maturity date is fixed. His contention, however, fails to take into account the interplay between the payment of the senior debt and the maturity of the sub debt. - 25 -
[*25] 5. Repayment of the Sub Debt
CBH was not obligated to repay the sub debt principal until the sub debt
note reached maturity. At CBH’s discretion, CBH may pay the total principal
amount after five years from the closing date of the Cubs transaction.
6. Interest
a. Interest Terms
The sub debt had a stated interest rate of 6.5%. The sub debt note obligated
CBH to pay the annual accumulated interest on the sub debt on the last business
day in December.
But CBH may pay the interest due only to the extent permitted by the
subordination agreement and the amount of income flowing through the cash
waterfall. Under the subordination agreement, CBH may make a payment only if
“there is cash available for such payment pursuant to the terms and conditions of
the Cash Collateral Agreement” and “such payment is permitted under the Cash
Collateral Agreement and the Subordination Agreement.” Any interest that
remains unpaid because the payment is not permitted under the cash collateral
agreement (the agreement governing the cash waterfall) is added to the principal
amount of the loan. - 26 -
[*26] If CBH does not have sufficient income to pay the interest in full, and the
lender makes an election, CBH must make the remaining payment in kind (PIK).
This PIK feature provides that if CBH could not pay the interest due, RAC
Finance, the lender, could elect to receive up to 39.5% of the interest due in cash.
The remaining interest due would be added to the principal of the note and be
treated as principal instead of accrued and unpaid interest. If RAC Finance
exercised the PIK feature, it could exchange the sub debt note for a new note
reflecting the historic principal plus the PIK-ed interest added to the principal.
On the closing date, RAC Finance elected to trigger the PIK “until such
election is revoked in accordance with * * * the Subordination Note.” For the
duration of the sub debt, Tribune was required to pay only 39.5% of the annual
interest in cash.
b. CBH’s Interest Payments
CBH timely made all required interest payments, whether in cash or in kind.
7. Default and Enforcement
The sub debt lender had limited enforcement rights. RAC Finance could not
demand payment on the sub debt except in the case of default or other limited - 27 -
[*27] circumstances. 21 Default occurs if (1) CBH fails to pay any principal or
interest when due; (2) the total outstanding principal (excluding any PIK interest
added to the principal) of the senior and sub debts exceeds $750 million; and
(3) payment of the entire principal amount of the senior debt is accelerated. These
limited enforcement rights meant that RAC Finance had no power to compel CBH
to make its sub debt interest payments.
The subordination agreement further weakened RAC Finance’s ability to
enforce repayment. The subordination agreement overrode the sub debt note until
the senior debt was paid in full. While the senior debt was still outstanding, the
subordination agreement precluded holders of the sub debt from enforcing any
rights or remedies granted to them under the sub debt note, including their right to
payments. The subordination agreement overrode any rights granted to RAC
Finance by other loan documents. As Mr. Gellis explained, the subordination
agreement created a “complete and utter standstill” of RAC Finance’s ability to
pursue remedies while the senior debt remained outstanding.
21 These limited circumstances include death of the lender and a three-month period in 2022. - 28 -
[*28] 8. Priority of the Sub Debt
The sub debt ranked higher than equity but lower than the senior debt at
CBH. The parties do not appear to dispute this fact, but they disagree on whether
the sub debt was debt or equity for Federal income tax purposes. At trial, both
parties presented experts on the issue.
CBH’s Capitalization
CBH was expected to meet its financial obligations. Although the parties
agree that CBH had sufficient cashflow to make timely interest payments on the
sub debt, the parties differ in their views on the sufficiency of CBH’s
capitalization. CBH’s debt-to-equity ratio was just below 4:1. We accept the
calculation of Israel Shaked, petitioners’ expert, who calculated this ratio by
finding CBH had $673,750,000 of debt (combining the senior and sub debts) and
$171 million in equity.
Marketing and Potential Sale of the Sub Debt
The Ricketts family contemplated selling sub debt notes issued by CBH to
bring in additional investors. The family considered selling up to $75 million of
the sub debt to 8 to 10 investors. The Ricketts family was serious enough about
selling some of the sub debt that they created marketing materials targeting
individual investors. - 29 -
[*29] The Ricketts family marketed the sub debt to private investors through a
private placement memorandum and an investor presentation. The private
placement memorandum marketed the sub debt as an investment and
acknowledged its inherent risk. The memorandum referred to the buying
opportunity as “debt” and as an “investment.” The memorandum referred to
potential buyers as “investors.” It also required any potential investors to represent
that they were purchasing the notes for investment purposes only.
The placement memorandum stated a variety of risks involved in investing
in the subordinated notes. One of these stated risks is the partnership’s ability to
repay. The memorandum explains that the partnership’s ability to repay is
dependent upon the financial performance of the assets, including attendance at
Cubs games, broadcast revenues, player development and contracts, and
competition for entertainment revenue. Another enumerated risk was the
subordinated nature of the notes. The memorandum mentions that the sub debt
notes are illiquid and without an established market. It further warns that the
subordination agreement restricts repayment until the senior debt is fully paid and
includes a PIK feature that would defer expected annual interest payments. The
memorandum concludes with a final warning: “Investors should have the financial
ability to sustain a complete loss of their investment.” - 30 -
[*30] The marketing materials also stated that investors could receive privileges
associated with the sub debt if they chose to invest. These privileges included the
same benefits granted to the sub debt holders, such as private use of Wrigley Field,
use of the “Investors Club” suite, preferred ticketing options, VIP treatment, and
the opportunity to travel with the team. It also granted any note holders the right of
first refusal equity offering in the Cubs.
The Ricketts family ultimately did not sell interests in the sub debt.
Although there was some effort to market the debt, the record does not establish
that anyone was genuinely interested in acquiring any of the sub debt. Ultimately,
Marlene Ricketts funded the entire sub debt.
The Guaranties
On the closing date, Tribune executed two guaranties, the senior debt
guaranty and the sub debt guaranty (collectively, guaranties). The guaranties were
at all times part of the proposed Cubs transaction. When Tribune executed the
guaranties, it had no credit rating due to its pending bankruptcy proceedings.
The guaranties were guaranties of collection of principal and interest; they
were not guaranties of payment. A payment guaranty obligates the guarantor to
pay the loan during a specified period following the borrower’s default. In
contrast, the timeframe within which a guarantor must make good on a collection - 31 -
[*31] guaranty is uncertain. A lender may enforce a collection guaranty only after
the lender has obtained a judgment against the borrower and the judgment is
unsatisfied, or the borrower is insolvent, or could not be compelled to pay.
Both guaranties include similar terms. Neither guaranty may be enforced
until: (1) CBH fails to make a payment and the debt is accelerated; (2) the lenders
have exhausted all creditor remedies against CBH; and (3) the lenders have not
collected the full amount of the principal and interest guaranteed by Tribune. But
the guaranties differ on some key issues. The sub debt guaranty adds an additional
hurdle to enforcement: The senior debt must be paid in full before Tribune’s sub
debt guaranty obligations can be triggered. And the senior debt guaranty provides
that, upon written request from the senior lenders, Tribune must assign the
guaranty to any person who acquires all or substantially all of Tribune. Tribune
may not otherwise assign or transfer the guaranty.
The parties to the senior debt haggled over the terms of the guaranties.
Numerous drafts of the senior debt guaranty were exchanged by the parties,
resulting in a final guaranty that was twice the length of the draft initially proposed
by Tribune. The sub debt guaranty was largely replicated from the senior debt
guaranty. The parties to the sub debt guaranty exchanged multiple drafts of the
document before finalizing the agreement. Although there were several drafts, the - 32 -
[*32] Ricketts family did not negotiate the terms of the guaranties. As Thomas
Rickets testified, they would not have negotiated a guaranty that would shield
Tribune from payment if the guaranties were called.
In an internal accounting memo, Tribune discussed the financial details of
the Cubs transaction. In this memo, Mr. Chakiris, Tribune’s corporate assistance
controller during the Cub’s transaction, analyzed whether the guaranties were
contingent or noncontingent obligations under Generally Accepted Accounting
Principles (GAAP). A contingent obligation is one where payment is probable and
dependent on a future event to occur. A noncontingent obligation is an obligation
that it not dependent on a future event.
The memo concluded that RAC received “no perceived benefit” from the
sub debt guaranty because RAC and the sub debt are “economically aligned.” The
memo found that the senior debt guaranty did not improve RAC’s ability to obtain
debt from third parties and stated that “it is not currently likely that the * * *
[guaranties] will have a material impact on * * * [Tribune’s] operations, cash flows
or liquidity.” It concluded that the possibility of the guaranties’ being called was
“remote.” Consequently, it placed “no value” on the guaranties’ contingent and
noncontingent liabilities. - 33 -
[*33] Tribune thus did not report the value of the guaranties on its financial
statements. It did, however, disclose the guaranties in footnotes within those
statements.
The Special Distribution
In the final step of the Cubs transaction, CBH transferred cash to Tribune.
On the closing date, CBH received the proceeds from the senior debt and sub debt.
That day, CBH made a special distribution of $704,872,594 to Tribune. As a result
of arbitration between the parties to the Cubs transaction, that amount was later
adjusted to $705,672,725.
The Financial Outcome and Expenses of the Cubs Transaction
Tribune received a total final partnership distribution of $714,350,538. 22
CBH assumed $35,241,562 in liabilities associated with the Cubs assets. On the
Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc., that CBH
22 The amount of the distribution was subject to several adjustments, and the final amount was not determined until arbitration between the parties to the Cubs transaction in 2011. The initial transfer consisted of $704,872,594 in cash, $8,577,023 in expenses paid by CBH on behalf of Tribune, $197,806 in expected future transfers, and $100,800 in expected future income from the lease and sale of certain real property. CBH and Tribune reported a special distribution of $713,748,223 on their 2009 tax returns. As a result of arbitration, this number was later adjusted to $714,350,538. - 34 -
[*34] issued to Tribune for 2009, CBH reported Tribune’s basis in the transferred
assets at the time of transfer as $146,010,336. Petitioners argue, but failed to
establish, that its true basis at the time of contribution was $148,544,336 (before
taking into account Tribune’s transaction expenses). 23
Tribune incurred $15,293,748 of expenses to form CBH in 2009. This
amount consists of (1) $8,577,023 in Cubs expenses, including professional fees
and transaction expenses incurred by Tribune and paid by CBH; plus
(2) $6,716,725 in additional transaction expenses. Because the Cubs’ expenses
had been Tribune’s expenses, Tribune is deemed to have received a distribution of
$8,577,023.
Tribune also paid Mr. Utay $2.5 million to reimburse him for bidding
expenses as part of the renegotiation for the Cubs.
Options
Embedded in the Cubs transaction was an option for Tribune to sell its entire
interest in the Cubs. The operating agreement provides an option to Tribune to sell
23 The discrepancy relates to Tribune’s basis in CSN Chicago. Petitioners argue that Tribune’s basis should be adjusted to take into account the final Schedule K-1 it received from CSN Chicago. If that Schedule K-1 is in the record, they do not cite it, and their internal workpapers are not sufficient to establish their basis. - 35 -
[*35] and an option to RAC to buy Tribune’s remaining 5% interest in the Cubs.
The agreement allows RAC to call Tribune’s 5% interest any time during 2018 or
2024 and Tribune to put its 5% interest any time during 2021 or 2027. In 2018,
RAC exercised its call option. The parties agreed to CBH’s fair market value.
After determining the net equity value by reducing the gross fair market value by
the outstanding debt, RAC paid Tribune $107 million for its 5% interest.
Standard & Poor’s (S&P) Credit Rating
S&P did not rate Tribune while it was in bankruptcy, but it issued a
preliminary credit rating for Tribune in 2012, shortly before it emerged from
bankruptcy. S&P continued issuing credit ratings for Tribune from 2012 through
2016. In each of its credit rating reports, S&P considered the guaranties and
concluded that they were a “significant financial risk” or a “financial risk” to
Tribune. S&P assessed Tribune’s overall financial risk profile to be “aggressive.”
In S&P’s 2016 credit rating report of Tribune, it recharacterized “roughly
$100 million” of CBH’s debt as debt attributable to Tribune as a result of the
guaranties. It arrived at $100 million by subtracting the “hypothetical distressed
emergence value of the partnership” and the “potential tax benefits” from CBH’s
“actual debt.” The reclassified debt increased S&P’s assessment of Tribune’s - 36 -
[*36] financial risk, a point explained by Jeanne Shoesmith, who worked on the
credit rating report at S&P.
Tax Reporting of the Cubs Transaction
Tribune timely filed its 2009 Form 1120S, U.S. Income Tax Return for an
S Corporation. On its Form 1120S, Tribune reported the Cubs transaction as a
disguised sale. It reported a loss of $190,685,361 and a net long-term capital gain
of $33,542,275. It reported a net built-in gain of $33,830,135 attributable to the
Cubs transaction. And Tribune deducted the $2.5 million it paid to Mr. Utay.
CBH timely filed its Form 1065, U.S. Return of Partnership Income. CBH
reported that its partners contributed $150 million of cash and $730,879,891 of
property during the 2009 taxable year. It also reported that it made a $704,872,594
cash distribution.
On RAC’s Schedule K-1, CBH reported that RAC owned a 95% interest in
profits and losses and a 93.727294% interest in capital. The Schedule K-1 showed
RAC was allocated nonrecourse liabilities of $116,734,376 and no recourse
liabilities. On Tribune’s Schedule K-1, CBH reported a 5% profits and losses
interest and a 6.272420% capital interest. It showed Tribune’s allocation of
liabilities as nonrecourse liabilities of $6,143,915 and recourse liabilities of - 37 -
[*37] $673,750,000. The Schedules K-1 show that in 2009, RAC contributed
$165,376,486 of capital and Tribune contributed $715,503,405.
Examination, Petition, and Trial
The Commissioner examined Tribune’s and CBH’s 2009 tax returns. On
June 28, 2016, the Commissioner sent Tribune a notice of deficiency for 2009. In
the notice, the Commissioner determined an increased tax liability of $181,661,831
attributable to built-in gains under section 1374 and denied Tribune’s $2.5 million
deduction of Mr. Utay’s negotiation expenses on the basis that these costs should
instead be capitalized.
Citing the anti-abuse rules under section 701 and the substance-over-form
doctrine, the Commissioner determined that Tribune’s guaranties were not valid
and that the disguised sale of the Cubs was taxable. The Commissioner calculated
that Tribune realized $739,509,665 of built-in gain on the sale of the Cubs,
$705,679,530 more than Tribune reported on its return.
The notice also set forth adjustments to items reported by CBH to Tribune.
It reduced Tribune’s reported capital contribution from $715,503,405 to
$20 million. It also reduced Tribune’s reported allocable share of recourse
liabilities from $673,750,000 to zero. It then increased Tribune’s share of
nonrecourse liabilities from $6,143,915 to $27,393,915. - 38 -
[*38] The Commissioner also determined a 40% gross valuation misstatement
penalty of $72,664,732 under section 6662(h) and a 20% accuracy-related penalty
under section 6662(a), (b)(1), (2), and (3), (c), (d), and I in the alternative.
On June 28, 2016, the Commissioner sent Northside Entertainment
Holdings, LLC (formerly RAC), an FPAA for 2009. Through the FPAA, the
Commissioner determined partnership items of CBH, namely, adjustments to
income, capital contributions, and disguised sale proceeds. The FPAA also set
forth the Commissioner’s determinations regarding the nature of CBH’s liabilities,
reclassifying CBH’s sub debt as equity and its senior debt as nonrecourse. The
Commissioner then adjusted CBH’s recourse liabilities down from $673,750,000
to zero and adjusted its nonrecourse liabilities from $122,878,291 to $547,878,291.
The Commissioner also adjusted capital contributions to CBH. The FPAA also set
forth a decrease in Tribune’s capital contribution from $715,503,405 to $20 million
and an increase in RAC’s capital contribution from $165,376,486 to $414,176,486.
The Commissioner also determined a 40% gross valuation misstatement penalty.
Tribune and Northside Entertainment Holdings, LLC, as tax matters partner
of CBH, filed timely petitions with this Court. At that time, the principal place of
business of both entities was Chicago, Illinois. The cases were consolidated and
set for trial. On December 21, 2018, both sides filed motions for partial summary - 39 -
[*39] judgment on the penalty-related issues. In their motions, the parties disputed
whether the penalties were properly approved under section 6751(b). At the time
of trial, the Court had not yet ruled on those motions, and factual issues relating to
the penalties were not tried. For the reasons stated in Tribune Media Co. v.
Commissioner, T.C. Memo. 2020-2, we granted the Commissioner’s motion for
partial summary judgment in part, holding that the section 6662(h) penalty was
timely approved but that factual questions remained as to whether the remainder
were timely approved. We denied petitioners’ cross-motion.
Trial began on October 28, 2019, in Washington, DC. The Court heard
closing arguments on December 11, 2019.
Both sides presented several expert witnesses at trial. Among petitioners’
experts was Ron Kahn, managing director at Lincoln International, LLC, and head
of its debt advisory group. For these cases, Mr. Kahn prepared a rebuttal report to
findings of Howard Gellis, an expert hired by the Commissioner. Mr. Kahn
testified that the sub debt’s terms were commercially reasonable and that the
guaranties served a valid business purpose and had value. Likewise, William
Chambers, an associate professor of finance at Boston University’s Metropolitan
College, testified that the terms of the sub debt were reasonable. Professor Shaked
also testified on petitioners’ behalf. Professor Shaked is a professor of finance and - 40 -
[*40] economics at Boston University’s Questrom School of Business and the
managing director of the Michel-Shaked Group, a firm that provides corporate
finance and business consulting to private and public entities. In his report,
Professor Shaked analyzed CBH’s financial position and concluded that the
company was creditworthy and adequately capitalized. Merle Erickson also
testified for petitioners. An accounting professor at the University of Chicago
Booth School of Business, Professor Erickson provided testimony on the
differences between GAAP accounting and tax accounting, specifically regarding
Tribune’s financial reporting of the guaranties.
The Commissioner also relied on several experts in presenting his case.
Among those experts was Mr. Gellis, the former senior managing director of the
Blackstone Group. Mr. Gellis analyzed the commercial reasonableness of the sub
debt and the guaranties, concluding that neither the guaranties nor the sub debt was
commercially reasonable. Dr. Skinner, an accounting professor and faculty dean at
the University of Chicago Booth School of Business, also opined on the guaranties
and whether they created a material risk for Tribune.
OPINION
Before entering into the Cubs transaction, Tribune elected subchapter S
treatment for Federal income tax purposes. Ordinarily, S corporations are - 41 -
[*41] passthrough entities, which generally are not subject to Federal income tax. 24
Instead, tax is imposed at the shareholder level. 25 However, there are exceptions to
this rule, one of which applies here.
When a C corporation converts to an S corporation, a corporate-level tax
applies to any net recognized built-in gain during the recognition period. 26 The
recognition period generally extends for 10 years from the date of conversion.27
This corporate-level tax applies to transactions treated as completed sales for
Federal income tax purposes. 28
These subchapter S rules are not in dispute. The Cubs transaction occurred
within 10 years of when Tribune converted from a C corporation to an
S corporation in 2007. Thus, when Tribune completed the Cubs transaction in
2009, it could be taxed on built-in gain at the corporate level. What is in dispute is
24 Sec. 1363(a). 25 Sec. 1366(a). 26 Sec. 1374(a). 27 Sec. 1374(d)(7).
Anschutz Co. v. Commissioner, 135 T.C. 78, 97-98 (2010), aff’d, 664 F.3d 28
313 (10th Cir. 2011). - 42 -
[*42] the extent to which Tribune had net recognized built-in gain. The answer to
this question turns on the disguised sale rules in subchapter K.
Petitioners argue that the Cubs transaction is a disguised sale but that the
distribution to Tribune is not taxable because it was a debt-financed distribution.
They claim that the Commissioner erred when he invalidated the guaranties,
recharacterized the liabilities, and designated the sub debt as equity.
The Commissioner agrees that the Cubs transaction was structured as a
disguised sale, but he argues that the distribution to Tribune is taxable. He claims
the guaranties promise repayment in name only, the senior debt is nonrecourse, and
the sub debt is not bona fide debt. He argues in the alternative that various
doctrines should be applied to recast the Cubs transaction as an outright sale.
We take each issue in turn. First, we discuss whether the sub debt is bona
fide debt or equity for Federal income tax purposes. Second, we address whether
the senior debt guaranty is sufficient to render the senior debt recourse as to
Tribune. Lastly, we consider the applicability of various nonstatutory rules to
determine whether the guaranties should be disregarded for Federal income tax
purposes. - 43 -
[*43] Jurisdiction and Burden of Proof
Tribune asks us to determine that no deficiency or addition to tax is due.
CBH asks us to determine that the Commissioner erred in making the adjustments
set forth in the FPAA. The Commissioner asks that we uphold his deficiency
determination as to Tribune and his adjustments as to CBH.
We are a court of limited jurisdiction, which we may exercise only over the
matters Congress has expressly authorized us to consider. 29 We have jurisdiction
to redetermine a deficiency and any addition to tax when the Commissioner mails a
valid notice of deficiency and the taxpayer timely files a petition with our court. 30
We have jurisdiction to determine all partnership items and the applicability of any
penalty when, as here, the tax matters partner files a petition for readjustment of
such items within 90 days of the mailing of a valid FPAA by the Commissioner. 31
We have jurisdiction over this matter.
Generally, the Commissioner’s determinations in a notice of deficiency or an
FPAA are presumed correct, and the taxpayer bears the burden of showing
29 Sec. 7442; Estate of Young v. Commissioner, 81 T.C. 879, 880-881 (1983). 30 Secs. 6212, 6213, and 6214; Rule 13. 31 Sec. 6226(a)(1), (f). - 44 -
[*44] otherwise. 32 Neither party alleges that we should shift the burden of proof,
nor do the facts support shifting it. Therefore, the burden is on petitioners.
The principal place of business of both Tribune and CBH was Chicago,
Illinois, when they filed their respective petitions. Thus, these cases are appealable
to the U.S. Court of Appeals for the Seventh Circuit. 33 When it is controlling, we
follow precedent set by the Seventh Circuit. 34
Disguised Sale Overview
Before embarking on a technical discussion of the disguised sale rules, it
would perhaps be helpful to discuss them conceptually.
A starting point is to understand how a person might monetize a piece of
property. If a person sells property for cash, that person must recognize gain to the
extent the sale price exceeds the basis in the property. 35 Instead, that same person
32 Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). 33 Sec. 7482(b)(1). 34 Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971). 35 Secs. 61(a)(3), 1001(a), (c). - 45 -
[*45] could monetize that same piece of property by taking out a loan, perhaps
secured by the property. The loan proceeds would not be taxed. 36
Suppose instead of selling property for cash, a person contributes the
property to a partnership in exchange for a partnership interest. The contribution is
not a taxable event, and the contributing partner’s basis in the partnership interest
is generally equal to the basis in the property at the time of contribution. 37 Under
normative rules, if that partner receives a distribution of cash from the partnership
in excess of the basis of the property at the time of contribution, that excess
distribution would be income. 38 But economically, the transaction looks a lot like
a sale: Property is transferred and cash is received. This is a disguised sale, and
the Code and the regulations set forth rules on how to calculate the gain, if any. 39
We can apply these same basic principles to a situation in which a person
borrows against property before contributing it. We’ve already established that a
person can borrow against property and the loan proceeds are generally not
36 Commissioner v. Tufts, 461 U.S. 300, 307 (1983). 37 Secs. 721(a), 722. 38 Sec. 731(a)(1). 39 Sec. 707(a)(2)(B); sec. 1.707-3, Income Tax Regs. - 46 -
[*46] taxable. And we’ve already established that contributing property to a
partnership is not a taxable event. If we combine those two transactions, a person
could borrow against the property and then contribute the property to the
partnership while retaining the loan proceeds and remaining liable on the loan.
There would be no tax on that series of transactions. The contributing partner
would have the loan proceeds in hand, be liable for repayment of the loan, and own
a partnership interest with a basis equal to the basis of the property at the time of
contribution.
Suppose instead of borrowing before contributing the property to the
partnership, the person contributes the property and the partnership takes out the
loan. The tax results follow the same basic rules we’ve already outlined. The
person contributes the property, taking a basis in the partnership interest equal to
the basis in the property at the time of contribution. The partnership takes out a
loan, and the partnership distributes cash to the contributing partner. As discussed
above, this is a disguised sale, and the contributing partner will be taxed on the
distribution under the disguised sale rules.
But what if the contributing partner is personally liable on that loan?
Assuming responsibility for that liability would result in an increase to the - 47 -
[*47] contributing partner’s basis. 40 As a result, that partner could receive a
greater tax-free distribution because the partner’s basis includes the combination of
the basis in the property at the time of contribution plus the amount of the liability
assumed by the contributing partner. This relatively straightforward example is the
debt-financed distribution exception to the disguised sale rule. 41
But for the debt-financed distribution exception to apply, the debt must be
bona fide debt, and the contributing partner must, in fact, have assumed or
guaranteed the liability. Those are the issues we are asked to address in these
cases.
The Cubs Transaction: A Disguised Sale
The Cubs transaction arose from Tribune’s desire to dispose of the Cubs
assets, to focus on its core businesses, and to obtain cash to pay off other debts.
However, the Cubs assets had significantly appreciated, and an outright sale would
have generated considerable gain recognition. 42 To maximize its after-tax
40 Sec. 752(a). 41 See sec. 1.707-5(b)(1), Income Tax Regs. 42 See secs. 61(a)(3), 1001. - 48 -
[*48] proceeds, Tribune sought to structure the disposition of the Cubs assets in a
tax-favored way.
Tribune intentionally structured the disposition of the Cubs assets to fit into
an exception to the disguised sale rule that would allow for nonrecognition of gain
from the special distribution. Tribune contributed the Cubs assets to a newly
formed partnership, CBH, in exchange for a 5% interest. CBH borrowed money
and Tribune guaranteed collection of the debt. Then, CBH made the special
distribution to Tribune as part of the transaction. Finally, Tribune reported the
transaction on its 2009 return as a disguised sale. Tribune intended to limit its
recognized gain to the proceeds that exceeded the debt-financed distribution. The
Commissioner does not dispute that the Cubs transaction was structured as a
disguised sale; rather, he takes issue with the debt-financed distribution portion of
the transaction. He argues that the sub debt and the guaranties were not bona fide.
A transaction structure driven by tax planning is not an inherently dubious
structure. As Judge Learned Hand famously explained: “Any one may so arrange
his affairs that his taxes shall be as low as possible; he is not bound to choose that
pattern which will best pay the Treasury; there is not even a patriotic duty to - 49 -
[*49] increase one’s taxes.” 43 Consistent with Judge Hand’s adage, Tribune sought
to arrange its transaction as to minimize its taxes.
Disguised Sales Rules
A disguised sale occurs when a partner transfers property into a partnership
and that partner receives cash or property in return in such a way to render the
transaction a sale. Section 707(a)(2)(B) provides:
If--
(i) there is a direct or indirect transfer of money or other property by a partner to a partnership,
(ii) there is a related direct or indirect transfer of money or other property by the partnership to such partner (or another partner), and
(iii) the transfers described in clauses (i) and (ii), when viewed together, are properly characterized as a sale or exchange of property, such transfers shall be treated * * * [as between the partner acting other than in his capacity as a member of such partnership and the partnership.]
The result of this provision is to revoke the nonrecognition treatment for
transactions between a partner and a partnership and to treat the transaction as a
taxable sale of property between unrelated parties. Congress passed section 707
43 Helvering v. Gregory, 69 F.2d 809, 810 (2d Cir. 1934), aff’d, 293 U.S. 465 (1935). - 50 -
[*50] out of concern that taxpayers were inappropriately deferring gain on
transactions that were actually sales of property by structuring the transactions as
partnership contributions and distributions. 44
The disguised sale rules distinguish between taxable and nontaxable
dispositions of property involving a partnership. When a taxpayer disposes of
property through a sale, the sale may generate taxable income, especially in the
case of appreciated property. 45 However, if instead of selling the property, the
taxpayer disposes of the same property by contributing it to a partnership in
exchange for an interest in the partnership, the transaction is generally tax-free. 46
The potential for abuse occurs when a partner assumes the role of a third-party
seller, allowing the “de facto sales of property to a partnership or another partner”
44 H.R. Rept. No. 98-432 (Part 2), at 1218 (1984), 1984 U.S.C.C.A.N. 697, 884; see also Staff of J. Comm. on Taxation, General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (General Explanation), at 226 (J. Comm. Print 1985). 45 Sec. 1001. 46 See sec. 721(a). - 51 -
[*51] by structuring the transaction as “a contribution to the partnership, followed
(or preceded) by a tax-free distribution from the partnership.” 47
Generally, a partner who contributes property to a partnership will receive
nonrecognition treatment, while a partner who sells property to a partnership must
recognize any gain on that sale. Congress provides nonrecognition of gains on
contributions to and distributions from a partnership to promote the free flow of
capital between a partner and the partnership; these transfers reflect a mere change
in the form of the investment, rather than a cashing-out and realization of the
income from that investment. 48 However, when a transaction is in reality the
cashing out of an investment, the policy rationale behind tax-free treatment no
longer applies.
The regulations promulgated under section 707(a)(2)(B) attempt to clarify
when a transfer between a partnership and its partner more closely reflects a sale
47 General Explanation, supra note 44, at 225; see also H.R. Rept. No. 98-432 (Part 2), supra at 1218, 1984 U.S.C.C.A.N. at 883. Generally, a partner does not recognize gain when the partnership distributes property to the partner except to the extent such distribution exceeds their basis in their partnership interest. Sec. 731(a)(1). 48 See, e.g., Eisner v. Macomber, 252 U.S. 189, 212-213 (1920); General Explanation at 242; Thomas W. Henning, “Partnership Exit Strategies and the Failure of the Substantiality Test”, 63 Tax Law. 43, 97 (2009). - 52 -
[*52] rather than a contribution and distribution. Congress specifically instructed
that the Secretary “should be mindful that the Committee is concerned with
transactions that attempt to disguise a sale of property and not with non-abusive
transactions that reflect the various economic contributions of the partners.” 49 The
regulations state that whether a transaction is treated as a disguised sale depends on
whether:
based on all the facts and circumstances--
(i) The transfer of money or other consideration would not have been made but for the transfer of property; and
(ii) In cases in which the transfers are not made simultaneously, the subsequent transfer is not dependent on the entrepreneurial risks of partnership operations.[50]
The regulations list factors that may assist in making the determination. 51
The Debt-Financed Distribution Exception
There are exceptions to the disguised sale rules, including the debt-financed
distribution rule. The debt-financed distribution rule permits a partner to receive a
49 H.R. Rept. No. 98-432 (Part 2), supra at 1220, 1984 U.S.C.C.A.N. at 886; see also General Explanation at 231. 50 Sec. 1.707-3(b)(1), Income Tax Regs. 51 Sec. 1.707-3(b)(2), Income Tax Regs. - 53 -
[*53] debt-financed distribution of property from a partnership as part of a
disguised sale tax free up to the amount of debt allocated to that partner. 52 To
invoke the debt-financed distribution rule, the partner must “retain substantive
liability for repayment” of the debt, meaning it must be allocated the partnership
liability. 53 Tribune argues that it should be allocated the debt because it bears the
economic risk of loss on account of its guaranties. The Commissioner says the
possibility of Tribune’s being called on to fulfill the guaranties is so remote that
they should be disregarded.
Section 1.707-5(b)(1), Income Tax Regs., sets forth the rule Tribune relies
on to exclude the amount of debt-financed gain:
[I]f a partner transfers property to a partnership, and the partnership incurs a liability and all or a portion of the proceeds of that liability are allocable * * * to a transfer of money or other consideration to the partner made within 90 days of incurring the liability, the transfer of money or other consideration to the partner is taken into account only
52 Sec. 1.707-5(b)(1), Income Tax Regs. 53 General Explanation at 232. Notably, the same Act instructed the Secretary to prescribe regulations relating to the treatment of guaranties. Deficit Reduction Act of 1984, Pub. L. No. 98-369, sec. 79, 98 Stat. at 597. And in its conference report, Congress instructed that those regulations should “take into account, where possible, the manner in which the partners share the economic risk of loss with respect to the borrowed amounts.” H.R. Conf. Rept. No. 98-861, at 868 (1984), 1984-3 C.B. (Vol. 2) 1, 122. - 54 - [*54] to the extent that the amount of money * * * transferred exceeds that partner’s allocable share of the partnership liability.
Under the debt-financed distribution rule, a partner’s allocable share of a
partnership liability is its share of the liability under normal rules for allocation of
partnership liabilities, multiplied by the percentage of the liability used to fund the
distribution. 54 The allocation of partnership liabilities among partners depends on
whether the liability is a recourse liability or a nonrecourse liability. 55 A recourse
liability is a liability for which “any partner or related person bears the economic
risk of loss.” 56 A nonrecourse liability is one for which “no partner or related
person bears the economic risk of loss.” 57
Whether a transaction is abusive can depend on whether a partner bears the
economic risk of loss. In attempting to distinguish between abusive and
nonabusive transactions, Congress recognized that debt frequently plays a valid
role in both sale and business formation transactions and thus did not intend to
54 Sec. 1.707-5(b)(2), Income Tax Regs. 55 Sec. 1.707-5(a)(2), Income Tax Regs. 56 Sec. 1.752-1(a)(1), Income Tax Regs. 57 Sec. 1.752-1(a)(2), Income Tax Regs. - 55 -
[*55] limit its legitimate use. The report of the Joint Committee on Taxation
explains that a nonabusive use of debt occurs when
a partner contributes property to a partnership and that property is borrowed against, pledged as collateral for a loan, or otherwise refinanced, and the proceeds of the loan are distributed to the contributing partner, there is not a disguised sale to the extent the distributed proceeds are attributable to indebtedness properly allocable to the contributing partner under the rules of section 752 (i.e., to the extent the contributing partner is considered to retain substantive liability for repayment of the borrowed amounts), since, in effect, the partner in this case has simply borrowed through the partnership. * * * [58]
In contrast, an abusive situation occurs when:
the transferor partner receives the proceeds of a loan related to the property and responsibility for the repayment of the loan rests, directly or indirectly, with the partnership (or its assets) or the other partners.[59]
Essentially, the distinction is whether the contributing partner is still economically
liable for the debt.
The parties do not dispute that the special distribution was a debt-financed
distribution; but they dispute how much debt is properly allocated to Tribune for
the purpose of applying this rule. Tribune argues it is entitled to offset any gain
58 General Explanation at 232. 59 General Explanation at 232. - 56 -
[*56] recognized on the Cubs transaction by $673,750,000, the amount of the
senior debt and sub debt combined. It says it bore the economic risk of loss for
those debts through the guaranties. The Commissioner disagrees. First, he argues
that the sub debt was not bona fide debt; he argues it was a disguised equity
contribution. Second, he argues that Tribune’s guaranties of the senior debt and
sub debt did not have economic substance such that Tribune was responsible for
repayment of the debts.
The Sub Debt: Bona Fide Debt or Equity
The parties dispute whether the $248,750,000 of sub debt CBH borrowed
from RAC Finance was bona fide debt. Petitioners argue that the sub debt was
bona fide debt and therefore a partnership liability of CBH. The Commissioner
disagrees, saying the sub debt was actually additional equity invested by the
Ricketts family. If the sub debt is not bona fide debt, then it could not be allocated
to Tribune to increase its basis in CBH. And Tribune’s recognized gain from the
Cubs transaction could not be reduced by its share of the sub debt liability.
Factors To Determine Debt or Equity
In determining whether an advance is debt or equity we consider 13 factors
outlined in Dixie Dairies Corp.:
the names given to the certificates evidencing the indebtedness; presence or absence of a fixed maturity date; source of payments; - 57 -
[*57] right to enforce payments; participation in management as a result of the advances; status of the advances in relation to regular corporate creditors; intent of the parties; identity of interest between creditor and stockholder; “thinness” of capital structure in relation to debt; ability of corporation to obtain credit from outside sources; use to which advances were put; failure of debtor to repay; and risk involved in making advances.[60]
We do not weight the factors equally but consider each of them in the context of
the cases before us. 61 They are intended to help us answer “whether the
investment, analyzed in terms of its economic reality, constitutes risk capital
entirely subject to the fortunes of the * * * [business] venture or represents a strict
debtor-creditor relationship.” 62
The Court of Appeals for the Seventh Circuit has not yet reviewed,
approved, or modified our use of the Dixie Dairies factors. However, it has
reviewed questions of whether advances were debt or equity; and when doing so it
has cited with approval many of the cases we relied upon to develop the Dixie
60 Dixie Dairies Corp. v. Commissioner, 74 T.C. 476, 493 (1980). 61 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493-494. 62 Fin Hay Realty Co. v. United States, 398 F.2d 694, 697 (3d Cir. 1968). - 58 -
[*58] Dairies factors. 63 In that Court of Appeals, whether an advance is debt or
equity is a question of fact. 64
Evaluation of the Dixie Dairies Factors
1. The Names Given to the Certificates Evidencing the Indebtedness
The first factor asks us to consider “the names given to the certificates
evidencing the indebtedness.” 65 If the parties use a stock certificate, this factor
weighs towards equity, but the use of a bond, debenture, or note indicates debt. 66
When the instrument is a promissory note, this factor suggests debt. 67 However,
the label placed on an advance is less informative when the same parties control
63 See, e.g., Burr Oaks Corp. v. Commissioner, 365 F.2d 24, 27 (7th Cir. 1966), aff’g 43 T.C. 635 (1965); Sherwood Mem’l Gardens, Inc. v. Commissioner, 350 F.2d 225, 228-229 (7th Cir. 1965), aff’g 42 T.C. 211 (1964); Milwaukee & Suburban Transp. Corp. v. Commissioner, 283 F.2d 279, 282 (7th Cir. 1960), rev’g in part on other grounds T.C. Memo 1959-216, vacated and remanded, 367 U.S. 906 (1961). 64 Portage Plastics Co. v. United States, 470 F.2d 308, 312 (7th Cir. 1972). 65 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 66 Estate of Mixon v. United States, 464 F.2d 394, 403 (5th Cir. 1972).
See Estate of Mixon, 464 F.2d. at 403; NA Gen. P’ship & Subs. v. 67
Commissioner, T.C. Memo. 2012-172, 103 T.C.M. (CCH) 1916, 1919 (2012); Am. Underwriters, Inc. v. Commissioner, T.C. Memo. 1996-548, 72 T.C.M. (CCH) 1511, 1515 (1996). - 59 -
[*59] both sides of a transaction because “the parties may mold it at their will” and
the “[l]abels * * * thus lose their meaningfulness.” 68
The sub debt was evidenced by a sub debt note. Petitioners argue this factor
weighs in favor of debt because the sub debt was evidenced by a note. They also
observe that the sub debt was consistently called debt in transaction documents, in
the private placement memorandum, and in various investor presentations.
The Commissioner concedes that the sub debt was consistently labeled debt.
But he argues that this factor has low probative value in our overall analysis
because the parties to the sub debt are related.
This factor favors debt but has low probative value. The advance was
labeled debt. The parties involved in the transaction consistently called the sub
debt “debt.” However, the Ricketts family controlled both the lender and borrower
and did not negotiate at arm’s length. They could label the advance as they
desired.
68 Fin Hay Realty Co., 398 F.2d at 697. - 60 -
[*60] 2. The Presence or Absence of a Fixed Maturity Date
The second factor is the “presence or absence of a fixed maturity date.” 69
“The presence of a fixed maturity date indicates a fixed obligation to repay, a
characteristic of a debt obligation. The absence of the same on the other hand
would indicate that repayment was in some way tied to the fortunes of the
business, indicative of an equity advance.” 70 A fixed maturity date is one “without
reservation or condition.” 71 This factor weighs heavily in our analysis; without a
provision that “the holder may unconditionally demand his advance at a fixed
time” the advance cannot be a debt. 72
The parties dispute whether the sub debt had a fixed maturity. Petitioners
observe that the sub debt had a stated maturity of 15 years. But the Commissioner
counters that the subordination agreement allowed the senior debt lenders to
effectively extend the maturity date of the sub debt indefinitely.
69 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 70 Estate of Mixon, 464 F.2d at 404. 71 Monon R.R. v. Commissioner, 55 T.C. 345, 359 (1970).
PepsiCo P.R., Inc. v. Commissioner, T.C. Memo. 2012-269, at *58 (citing 72
Jewel Tea Co. v. United States, 90 F.2d 451, 453 (2d Cir. 1937)). - 61 -
[*61] The maturity of the sub debt, according to the note evidencing it, is 15 years.
But the sub debt is subject to the provisions of several other agreements that could
override the maturity date. At trial, Mr. Gellis opined that this 15-year maturity
was not really fixed. He explained that because the sub debt could not be repaid
before the senior debt, the actual maturity date hinged on payment of the senior
debt. And because the senior debt lenders could extend the maturity of the senior
debt, the senior debt holders effectively could extend the maturity of the sub debt
indefinitely. The subordination agreement supports Mr. Gellis’ interpretation.
If a genuine possibility exists that the stated maturity date is flexible, then
the date is not fixed. We considered the fixed maturity date factor in detail in
PepsiCo P.R., Inc. 73 The advances in that case matured in 40 years with a
unilateral option for the holders to extend that date for 15 years. 74 Additionally, if
a related party defaulted on loans owed to the taxpayers in that case, the terms of
the advances became perpetual. 75 The taxpayers argued, in part, that the possibility
73 PepsiCo P.R., Inc. v. Commissioner, T.C. Memo. 2012-269. 74 PepsiCo P.R., Inc. v. Commissioner, at *58. 75 PepsiCo P.R., Inc. v. Commissioner, at *58. - 62 -
[*62] of the advances’ terms becoming perpetual rendered them equity. 76 The
Commissioner disagreed saying the advances had a fixed maturity date indicative
of debt and dismissed the possibility that the maturity would become perpetual,
arguing that the taxpayers would never allow its related entities to default on their
notes. 77 We held that the notes lacked a fixed maturity date, noting in part, that the
related-party default could occur, making the terms perpetual. 78 We therefore held
that the factor favored equity. 79
It is clear that the maturity date here is subject to reservations and
conditions. The maturity date can be deferred if CBH fails to timely pay the senior
debt. It can also be deferred if the senior debt lenders choose to alter the payment
date or other conditions of the senior debt, which they may do “at any time.”
Similar conditions tying maturity of the subject loan to repayment of other loans
indicated equity in PepsiCo. As in PepsiCo, the condition that must be met before
the subject loan reaches maturity is not certain to occur. Whether CBH would pay
76 PepsiCo P.R., Inc. v. Commissioner, at *58. 77 PepsiCo P.R., Inc. v. Commissioner, at *59. 78 PepsiCo P.R., Inc. v. Commissioner, at *65-*66. 79 PepsiCo P.R., Inc. v. Commissioner, at *66. - 63 -
[*63] the senior debt in full within 15 years of the sub debt closing date was
unknown when the note was signed. Therefore, the maturity date was subject to
reservations and conditions that render it not fixed. The lack of a fixed maturity
date indicates equity.
3. The Source of the Payments
The third factor is the “source of payments.” 80 If repayment does not
depend on corporate earnings, this factor leans toward debt. 81 However, the
advance is likely equity if “repayment depends on earnings or is to come from a
restricted source.” 82
Repayment of the sub debt came from the cash waterfall. The sub debt note
provides that the borrower is only permitted to pay interest if there is cash
available in the cash waterfall and the payment is allowed under the requisite
agreements. If enough cash did not flow through the waterfall to fund the interest
payments, the payments would not be made and the unpaid interest would be
added to principal.
80 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 81 Estate of Mixon, 464 F.2d at 405. 82 NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1920. - 64 -
[*64] Petitioners, citing NA Gen. P’ship & Subs., describe this factor as a
consideration of “whether the borrower’s cash flows were reasonably anticipated
to be sufficient to service the debt.” 83 Petitioners argue this factor supports a
finding of debt because both petitioners’ and the Commissioner’s experts
concluded that CBH’s cashflow would most likely enable it to pay its debts as they
came due. The Commissioner argues that the test is not whether CBH could pay
the interest but from which funds it would make the payments. He says that
because CBH can pay only if specific funds are available, repayment is tied to the
success of the business and this factor favors equity.
It is clear that the making of interest payments depended on CBH’s earnings.
Both parties’ experts concluded that CBH had sufficient cashflow to timely service
its debts, including interest payments on the sub debt. But this factor tests whether
repayment depends on the business’ earnings or comes from a restricted source,
not whether that source is expected to have sufficient funds to make repayment.
Through the cash waterfall, CBH’s revenue streams were carefully controlled to
limit what revenue could be used to pay which expenses. Furthermore, although
83 See NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1920. - 65 -
[*65] repayment was likely, it was not certain. Risks existed that could cause the
revenue stream to dry up. For example, revenue is highly dependent on actual
attendance at baseball games. If the Cubs did not perform well during a season, or
other conditions caused a significant drop in attendance, revenue could diminish to
the point that payments on the sub debt could not be made. This is especially true
because the sub debt interest was the last payment obligation in the cash waterfall.
So if revenue sufficiently decreased, the sub debt interest payments would be the
first payment to stop flowing.
Although the making of interest payments depended on earnings, the
ultimate repayment of principal did not. If the debtor’s repayment is contingent
upon earnings or is from a restricted source, such as a judgment recovery,
dividends, or profits, the advance resembles equity. 84 “When circumstances make
it impossible to estimate when an advance will be repaid because repayment is
contingent upon future profits or repayment is subject to a condition precedent, or
Flint Indus., Inc. & Subs. v. Commissioner, T.C. Memo. 2001-276, 82 84
T.C.M. (CCH) 778, 787 (2001). - 66 -
[*66] where a condition may terminate or suspend the obligation to repay, an
equity investment is indicated.” 85
The sub debt note does not require CBH to repay principal out of profits or
otherwise designate a source of payment. Neither does it provide CBH the option
of delaying repayment until it has sufficient profits to pay in full. CBH was
expected to repay the sub debt when it came due, regardless of its revenue. This
indicates that the source of repayment of the principal was not limited to profits or
another specified source and the obligation to repay was not tied to the profitability
of CBH. The Commissioner argues that because repayment of the sub debt
principal was conditioned on repayment of the senior debt, the payments showed
“unusual flexibility.” While it is true that repayment of the sub debt is contingent
on repayment of the senior debt, this lower status is an inherent feature of
subordinated debt. And we will not conclude subordinate debt is equity merely
because of its subordination.
The required payments here are bifurcated. Tribune must pay interest
payments out of whatever profits remain in the cash waterfall, but ultimately its
85 Flint Indus., Inc. & Subs. v. Commissioner, 82 T.C.M. (CCH) at 787. - 67 -
[*67] repayment of the sub debt is not restricted or tied to the profitability of CBH.
We therefore find this factor to be neutral.
4. The Right To Enforce Payment
The fourth factor is the “right to enforce payments.” 86 A definite obligation
to repay indicates debt, 87 but an instrument that does not “provide its holder with
any means to ensure payment” indicates equity. 88 This factor is critical, as “[t]he
right to enforce the payment of interest is one of the requisites of a genuine
indebtedness.” 89
Petitioners assert that RAC Finance had the right to enforce payment of the
sub debt upon maturity or default, so this factor supports debt treatment. They
explain that “consistent with the purpose of a subordination agreement” RAC
Finance can enforce payment of the sub debt after CBH has paid the senior debt.
They concede that these enforcement rights exist only after payment of the senior
86 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 87 NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1920. 88 PepsiCo P.R., Inc. v. Commissioner, at *77.
Gokey Props., Inc. v. Commissioner, 34 T.C. 829, 835 (1960), aff’d, 290 89
F.2d 870 (2d Cir. 1961). - 68 -
[*68] debt, but petitioners ultimately argue that these subordination provisions are
common debt terms.
The Commissioner argues that the subordination provisions are so extensive
that they render any stated enforcement rights as meaningless. He concludes that
this factor favors equity.
This factor weighs strongly toward equity. The right of a holder to enforce
timely payment of amounts due is an essential characteristic of debt. RAC Finance
has no meaningful right to enforce interest payments as they come due. Its ability
to enforce payments of the sub debt is limited both by the sub debt note and the
subordination agreement. RAC Finance has no mechanism to require or enforce
CBH’s interest payments if the cash waterfall lacks sufficient funds. And while
the sub debt note itself prevents enforcement of interest payments, the
subordination agreement provides additional restrictions on the holder of the sub
debt, even when the principal is due. Furthermore, the right to enforce repayment
of principal can become meaningful only after full payment of the senior debt.
RAC Finance’s right of enforcement is not present here. - 69 -
[*69] Petitioners cite Green Bay Structural Steel, Inc. for the proposition that this
Court does not condemn subordination. 90 But the holders of the Green Bay
subordinated debt had rights not available to RAC Finance. In Green Bay, we held
that the subordinated debt was bona fide. 91 But that debt instrument included
provisions “to assure investors a means to enforce payment should a default
occur.” 92 Nonpayment of interest that continued for 30 days was an event of
default. 93 While lenders of the more senior debts could accelerate payment upon
default of the subordinated debt, the subordinated debt holders also could exercise
remedies and trigger acceleration. 94 That is not the case with CBH’s sub debt.
Further, while not every subordinated instrument is equity, subordination
generally favors equity. 95 Petitioners’ argument that these subordination
90 Green Bay Structural Steel, Inc. v. Commissioner, 53 T.C. 451 (1969). 91 Green Bay Structural Steel, Inc. v. Commissioner, 53 T.C. at 458. 92 Green Bay Structural Steel, Inc. v. Commissioner, 53 T.C. at 455. 93 Green Bay Structural Steel, Inc. v. Commissioner, 53 T.C. at 454. 94 Green Bay Structural Steel, Inc. v. Commissioner, 53 T.C. at 453. 95 Am. Underwriters, Inc. v. Commissioner, 72 T.C.M. (CCH) at 1516-1517 (“Subordination of purported debt to the claims of other creditors points towards equity. * * * The fact that an obligation to repay is subordinate to claims of other - 70 -
[*70] provisions are common does not change the underlying principle that the
more repayment is subordinated, the more it looks like equity. And in this regard,
CBH’s sub debt looks very much like equity.
5. Participation Rights
The fifth factor is whether the holder of the instrument enjoys “participation
in management as a result of the advances.” 96 When an instrument does not confer
voting rights or other management rights on the holder, it suggests debt. 97 But
when as a result of the advance the holder gets increased participation rights,
equity is indicated. 98 If the holder’s rights to manage cannot increase because
management is already consolidated, we treat the factor as neutral. 99
creditors, however, does not necessarily mean that the purported debt is really equity.”). 96 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 97 Monon R.R. v. Commissioner, 55 T.C. at 359. 98 Am. Offshore, Inc. v. Commissioner, 97 T.C. 579, 603 (1991). 99 Am. Offshore, Inc. v. Commissioner, 97 T.C. at 603; PepsiCo P.R., Inc. v. Commissioner, at *84; NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1920. Compare Am. Underwriters, Inc. v. Commissioner, 72 T.C.M. (CCH) at 1516 (holding the factor favors debt because the entities were commonly controlled), with Slappey Drive Indus. Park v. United States, 561 F.2d 572, 585 n.23 (5th Cir. 1977) (“The lenders already controlled corporate management; that they derived no more control as a result of the ostensible loans does not cut against the equity classification.”). - 71 -
[*71] Petitioners argue that because RAC Finance lacks voting rights or
management rights in CBH, this factor favors debt. The Commissioner argues that
the sub debt grants management rights because the lender is the mother of the
borrower and “[i]t is hard to envision a situation where Marlene Ricketts takes a
position that is contrary to her son, Thomas Ricketts.” Another reason the
Commissioner argues the sub debt carries management rights is that the sub debt is
“stapled” to the Ricketts family’s controlling equity interest. The Commissioner
cites Mr. Gellis’ testimony, in which Mr. Gellis opined that the sub debt was
“stapled equity, just a piece of paper stapled onto the common equity as a
bifurcated strip of equity.”
The sub debt note provides no management rights to the holder and does not
otherwise affect CBH’s management provisions. Both before and immediately
after the issuance of the sub debt, the board of CBH consisted of one director
appointed by Tribune, and four appointed by RAC. While RAC Finance never had
an ownership interest or management rights in CBH, it was managed by RAC,
which already had management and participation rights in CBH. The terms of the
sub debt also conferred upon its holders privileges, such as private access to
Wrigley Field, priority parking, hospitality benefits, and complimentary premium
seating, which are typically granted to equity owners. - 72 -
[*72] This factor is neutral, indicating neither debt nor equity, because control of
CBH and RAC Finance was common and unchanged by the issuance of the sub
debt. RAC controlled management of CBH and RAC Finance both before and
after issuance of the sub debt. That the parties chose to lend the money through
RAC Finance, a company managed by RAC, does not lead to a management result
different from that if the money had come from RAC.
6. Status Compared to Other Creditors
The sixth factor is the “status of the advances in relation to regular corporate
creditors.” 100 Subordinating repayment of the advance to other creditors generally
suggests equity.101 But the fact that an advance is subordinate to other debts does
not necessarily mean it is equity, especially if the advance has a claim superior to
those of shareholders. 102 This factor is of “some import.” 103
100 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 101 NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1920. 102 Estate of Mixon, 464 F.2d at 406. 103 Estate of Mixon, 464 F.2d at 406. - 73 -
[*73] Petitioners argue that this factor favors debt simply because the sub debt
ranks pari passu (on equal footing) with CBH’s obligations to other unsecured
creditors and superior to its obligations to its equity holders.
The Commissioner argues the factor favors equity because the sub debt was
“far below” the senior debt. He reiterates that the subordination agreement limits
the rights of the sub debt holders and concludes it looks like equity. An expert
hired by the Commissioner expanded on this. Mr. Gellis testified that, although
the sub debt began as pari passu with the trade creditors, if CBH were ever in
default, the trade creditors would require the sub debt to be ranked below their
debt. He explained that this request would stem from the Ricketts family’s
ownership of both the sub debt and equity. Mr. Gellis believed that the
relationship with the trade creditors’ debt and the weak position of the sub debt
holders under the subordination agreement rendered the sub debt “even closer to
the equity than it looked to be on its face initially.”
This factor is neutral. We are not persuaded by either party’s arguments.
The sub debt is positioned so closely between debt and equity that its position is
not illuminating. - 74 -
[*74] 7. Intent of the Parties
The seventh factor is the “intent of the parties.” 104 The intent of the parties
gets at the larger question of the Dixie Dairies factors: “Was there a genuine
intention to create a debt, with a reasonable expectation of repayment, and did that
intention comport with the economic reality of creating a debtor-creditor
relationship?” 105 To discover the intention to create debt or equity, we look at the
“parties’ mutual intent to create a debtor-creditor relationship.” 106 Intent is
reflected by the actions of the parties to the advance and how they treat the relevant
documents and agreements. 107 This is an important factor. 108
Petitioners argue that the parties to the advance intended for the sub debt to
be debt. They point to their consistent labeling of the sub debt as debt on financial
statements, tax returns, correspondence, and representations to third parties.
Petitioners make significant note of Tribune’s and RAC’s treatment of the sub debt
104 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 105 Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. 367, 377 (1973). 106 Yaryan v. Commissioner, T.C. Memo. 2018-129, at *38-*39. 107 PepsiCo P.R., Inc. v. Commissioner, at *88.
Laidlaw Transp., Inc. v. Commissioner, T.C. Memo. 1998-232, 75 T.C.M. 108
(CCH) 2598, 2620 (1998). - 75 -
[*75] as debt during their contentious negotiations over Tribune’s sale to RAC of
its 5% interest.
The Commissioner claims that this factor clearly favors equity. He observes
that there is a disparity between the partners’ stated percentage interests in CBH
and their capital interests. He further argues that the sub debt was treated as
equity. He also points out that the sub debt was not universally viewed as debt,
claiming that both the senior debt lenders and the MLB considered the sub debt
equity.
This factor indicates equity. While the parties wanted the sub debt to have
the appearance of debt for tax purposes, they intended the sub debt to function
economically as equity. The sub debt needed to give the impression of debt for
Tribune to achieve its desired tax outcome. And it is clear that Tribune made
consistent payments according to the terms of the sub debt. But despite
petitioners’ contentions otherwise, the true function of the sub debt was that of an
equity investment.
The sub debt’s actual economic purpose is reflected in the private placement
memorandum. The memorandum labeled the sub debt “debt” but described it as
equity. It emphasized the inherent risks involved in buying pieces of the sub debt,
including CBH’s “ability” to pay (rather than its obligation) and the possibility that - 76 -
[*76] investors could suffer a “complete loss on their investment.” The
memorandum also underscored that investors could avail themselves of
privileges--priority parking, box seats, private use of Wrigley Field--typically
afforded to team owners, and it offered the potential buyers a right of first refusal
on any future sales of Cubs equity. So while the Ricketts family was ostensibly
selling debt, it marketed the opportunity as an equity investment.
The parties structured CBH so that the sub debt functioned economically as
equity. At first glance, it appears that CBH included separate profits and capital
interests. The percentage interests granted to the partners do not match the capital
initially allocated to the partners. Under CBH’s operating agreement, RAC held a
95% interest and Tribune held a 5% interest. However, the partners’ capital
contributions of $150 million for RAC and $20,986,843 for Tribune amount to
87.726% and 12.274% respective ownership interests. But if the sub debt is
included as capital, the ownership interests actually amount to 95% for RAC and
5% for Tribune. - 77 -
[*77] Percent Capital interest Percentage Capital Capital allocated including Member interest allocated interest with sub debt sub debt
RAC 95% $150,000,000 87.726% $398,750,000 94.999%
Tribune 5% 20,986,843 12.274% 20,986,843 5.000%
Total 100% 170,986,843 100% 419,736,843 100%
It is clear that when the $248,750,000 of sub debt was treated economically as
equity, the stated interest and the capital interest align at 95% and 5%.
Further evidence of the partners’ intent lies in RAC’s exercise of its call
option. When RAC exercised the option to buy out Tribune, Tribune and RAC
negotiated a gross enterprise value, less the senior and sub debts, and multiplied by
5%, to determine the purchase price.
If Tribune had truly held a 12.274% interest in the capital of CBH,
presumably it would have been entitled to 12.274% of the value of CBH’s capital
interest, instead of just 5%.
Petitioners make much ado about a partner’s right to negotiate an ownership
interest in an LLC that does not correspond to its economic contributions. But
petitioners miss the point. The parties’ “equity” contributions amounting to a
different split from the 95% and 5% allocated interest is not a concern. But when - 78 -
[*78] the sub debt is added as equity to RAC’s contribution, creating the 95% and
5% split, it appears that the partners treated the sub debt economically as equity.
This alignment is not a coincidence; it reflects the parties’ mutual intent to create
8. Identity of Interest
The eighth factor is the “identity of interest between creditor and
stockholder.” 109 When the creditor and stockholder are the same, we scrutinize the
advance more closely; but an identity of interest does not preclude debt
treatment. 110 When shareholders advance funds to a corporation and the value of
the amounts advanced align pro rata with their ownership interests, an inference
arises that the funds should be characterized as capital contributions rather than
debt. 111 When the shareholder holds debt in a ratio different from equity, the
advance looks like bona fide debt. 112
109 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 110 Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. at 381. 111 Ill. Tool Works Inc. & Subs. v. Commissioner, T.C. Memo. 2018-121, at *48. 112 Slappey Drive Indus. Park, 561 F.2d at 583-584. - 79 -
[*79] The sub debt was issued by an entity held entirely by the Ricketts family to
an entity held entirely by the Ricketts family. CBH issued the sub debt to RAC
Finance. RAC--an entity held entirely by the Ricketts family--owned 95% of
CBH. RAC Finance is owned by RAC and MMR Investments and is managed by
RAC. Marlene Ricketts owns MMR Investments, which is managed by Thomas
Ricketts. The Ricketts family controlled both borrowing and issuing entities.
The Commissioner argues that because of the Ricketts family’s overlapping
interests in CBH and RAC Finance, it is possible that RAC Finance would not
enforce the terms of payment. He cites Gooding Amusement Co. for the
proposition that where identity of interest exists, the creditors will not enforce
payment. 113 The Commissioner essentially argues that it is highly unlikely that
Marlene Ricketts would sue her son, Thomas Ricketts, to enforce the debt. And
this relationship is further entwined because Thomas Ricketts was a
“decisionmaker” for both the equity holder and the sub debt lender. Because of the
overlapping relationship between the lender and borrower of the sub debt, the
Commissioner contends that this factor favors equity.
113 Gooding Amusement Co. v. Commissioner, 23 T.C. 408, 419 (1954), aff’d, 236 F.2d 159 (6th Cir. 1956). - 80 -
[*80] Petitioners disagree with the Commissioner’s outlook and claim that RAC
Finance would enforce repayment despite the interrelatedness of the lender and the
borrower. Petitioners state that while this factor may invite closer scrutiny, it does
not favor equity because the parties took all required steps to formalize the debt.
Petitioners argue that this factor is neutral.
This factor favors equity. The interrelatedness of the lender and borrower is
clear. Petitioners’ arguments that RAC Finance would enforce payment and that
the debt was properly formalized falls short of neutralizing this factor. These
arguments about enforcement and formalities are considered under other factors.
In finding that this factor indicates equity, we do not find or intend to imply that
related parties such as family members cannot enforce debts against other family
members. Rather, we look to the intertwined interests of the lender and borrower
case-by-case. And with regard to RAC Finance and CBH, their interests are
significantly intertwined.
9. Thinness of Capital Structure
The ninth factor is the “‘thinness’ of capital structure in relation to debt.” 114
We examine the debt-to-equity ratio of an entity to determine whether the entity is
114 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. - 81 -
[*81] so thinly capitalized it is unlikely to make repayments. 115 If the borrower
entity is too thinly capitalized, an advance may be better characterized as an equity
investment. 116 Likewise, strong capitalization supports debt treatment. 117 No set
ratio determines adequacy, 118 and capitalization requirements vary by industry. 119
A company in a low risk industry may appropriately be more leveraged than a
company in a highly volatile or risky industry. 120
CBH had a debt-to-equity ratio of 4:1. The Commissioner argues that the
debt-to-equity ratio is closer to 1:1 if the sub debt is calculated as equity instead of
debt. But the purpose of this factor is to consider whether the advance under
consideration would leave the corporation undercapitalized. To evaluate that, we
must consider the advance as debt. The Commissioner has incorrectly
recharacterized the advance before applying the test.
115 PepsiCo P.R., Inc. v. Commissioner, at *91. 116 Ill. Tool Works Inc. & Subs. v. Commissioner, at *46. 117 Ill. Tool Works Inc. & Subs. v. Commissioner, at *46-*47.
Delta Plastics, Inc. v. Commissioner, T.C. Memo. 2003-54, 85 T.C.M. 118
(CCH) 940, 943 (2003). 119 NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1922. 120 NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1922. - 82 -
[*82] We must consider whether a 4:1 debt-to-equity ratio is sufficient
capitalization for CBH. In the past, we have explicitly declined to adopt a specific
ratio to determine adequate capitalization, and we will not do so here. 121 The debt
or equity analysis is a facts and circumstances test, and a 4:1 capitalization ratio
may suggest debt in one case and equity in another.
CBH was adequately capitalized, and this factor supports debt treatment.
Professor Shaked concluded that CBH was adequately capitalized, and we find his
reasoning persuasive. He considered the debt-to-equity ratios of other MLB
franchises and found CBH’s 4:1 ratio to be within the range of ratios of other
teams. His analysis refutes the Commissioner’s argument that CBH was
undercapitalized for an MLB team. The Commissioner argues that the sub debt
would have pushed CBH over the allowable debt limit under the MLB debt service
rule because the rule would not treat the sub debt as debt. But the MLB debt
service rule is not controlling. CBH was sufficiently capitalized with a debt-to-
equity ratio of 4:1.
121 Delta Plastics, Inc. v. Commissioner, 85 T.C.M. (CCH) at 943. - 83 -
[*83] 10. Ability To Obtain Outside Credit
The tenth factor is the “ability of [the] corporation to obtain credit from
outside sources.” 122 If the borrower could have obtained funds from an unrelated
party on substantially the same terms, the factor supports debt characterization. 123
An advance that could not have been obtained from an unrelated borrower is more
likely equity. 124 We recognize that the lender in a related-party transaction may
offer more flexible terms than an unrelated party, so we consider whether the terms
of the related-party loan are a “patent distortion of what would normally have been
available.” 125
Petitioners argue that the terms of the sub debt were not a patent distortion
and that the debt could have been sold to a third party. They claim that the loan
carried a reasonable interest rate, a reasonable maturity date, and adequate lender
protections. Petitioners argue that the PIK feature does not make the sub debt look
like equity and that third parties showed interest in purchasing the debt. Finally,
122 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 123 Ill. Tool Works Inc. & Subs. v. Commissioner, at *48. 124 NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1923.
NA Gen. P’ship & Subs. v. Commissioner, 103 T.C.M. (CCH) at 1923 125
(quoting Litton Bus. Sys., Inc. v. Commissioner, 61 T.C. at 379). - 84 -
[*84] they cite the testimony of Professors Shaked and Chambers and Mr. Kahn
who all found the terms reasonable.
The Commissioner argues the terms of the sub debt were not commercially
reasonable. He claims that the interest rate was too low, that petitioners’ experts
overvalued the privileges, and that the subordination made it undesirable. And he
notes that the attempts of the Ricketts family to sell a portion of the sub debt failed.
The parties and their experts dispute that the PIK feature was commercially
reasonable. Both sides’ experts agree that PIK features are not uncommon in
subordinated debt agreements. But they disagree on the degree of risk associated
with the PIK feature. The Commissioner’s expert, Mr. Gellis, opined that PIK
features carry more risk for the lender because the lender is not paid interest as it
comes due; rather, the lender must wait until maturity to recoup the accumulated
interest added to the principal. Mr. Kahn, an expert for petitioners, testified that
the “PIK feature does not make the security any more equity like.”
Both sides also contested the commercial reasonableness of the interest rate,
particularly considering the privileges granted to the sub debt note holders.
Petitioners argue that, while the stated interest rate was 6.5%, the effective rate was
even higher. Professor Shaked, petitioners’ expert, estimated that the sub debt rate
of return was, in fact, over 8% because the value of the benefits granted to the - 85 -
[*85] holder of the sub debt note increases the effective interest rate well above the
stated 6.5%. But the Commissioner insists that this was not a commercially
reasonable interest rate. He cites Mr. Gellis’ report explaining that the interest
should be 11%-16% to account for the inherent risk of the PIK feature and the
private nature of the loans.
When considering the potential sale of the sub debt, the parties’ experts
disagree about whether an outside investor would have offered terms substantially
similar to those of the sub debt. Professor Shaked, petitioners’ expert, concluded
that a third-party investor would have provided debt financing with terms similar
to those of the sub debt, including the PIK feature and interest rate. Mr. Gellis, the
Commissioner’s expert, disagrees with this analysis. He opined that the
subordinated notes were “issued on terms which would not have been available
from unaffiliated third parties.” He elaborated that the notes “served merely as a
proxy for additional equity.” And the subordination terms made the sub debt so
toothless as to “render[] them no threat to the priority interests of the senior
lenders.”
Interestingly, in these cases, we have real world insight into whether the sub
debt was commercially reasonable because the Ricketts family marketed the sub
debt to potential buyers. In doing so, the Ricketts family offered certain privileges - 86 -
[*86] such as priority parking, ticketing benefits, and private use of Wrigley Field.
The parties disagree on why the sub debt was never sold. The Commissioner says
the Ricketts family did not pursue the sale any further because no one was
interested. Petitioners say the Ricketts family decided against outside
participation. Both arguments are credible, but the fact remains that the notes were
not sold. And even in marketing the debt, the Ricketts family felt the need to
sweeten the deal in various ways including a right of first refusal on acquiring
equity. We are not persuaded that the sub debt terms would have been attractive to
third-party investors.
Petitioners have not met their burden of persuading us that CBH could have
obtained similar debt from an unrelated third party or that the terms of this debt
instrument were not patently unreasonable. The debt was marketed but never sold,
and petitioners did not show that any third party expressed genuine interest in
buying the sub debt. This factor favors equity.
11. Use of the Advance
The eleventh factor is the “use to which [the] advances were put.” 126 If the
borrower uses the advance to fund an acquisition of capital assets, the advance is
126 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. - 87 -
[*87] more likely equity. 127 Use of the funds to meet operating needs of the
business indicates debt. 128
Petitioners at times argue both that this factor is neutral and that it indicates
debt. Petitioners say that use of the sub debt proceeds to fund the special
distribution was neither an acquisition of capital assets nor funding of operating
expenses, and we should therefore disregard the factor. But later, petitioners
argued that the factor should favor debt because the special distribution was part of
the formation of a partnership that would “operate a well-established business.”
The Commissioner argues the factor strongly favors equity. He argues that
the sub debt accounted for a portion of Tribune’s proceeds from the sale of the
Cubs. He adds that the Ricketts family used the funds to acquire their 95% interest
in CBH.
This factor strongly favors equity. The sub debt proceeds were used to fund
the special distribution. The special distribution was an integral part of a
transaction that resulted in a change of ownership. This was not an everyday
operating transaction; it was a significant change in the ownership of assets.
127 PepsiCo P.R., Inc. v. Commissioner, at *96. 128 PepsiCo P.R., Inc. v. Commissioner, at *96. - 88 -
[*88] 12. Failure To Repay
The twelfth factor is the “failure of [the] debtor to repay.” 129 Timely
repayment of an advance may support debt treatment. 130 Conversely, failure to
repay the advance when due suggests equity. 131 This is a significant factor. 132
Petitioners argue that this factor favors debt since CBH made all required
payments on the sub debt. Although the Commissioner cannot dispute that CBH
timely met its obligations on the sub debt, he correctly observes that CBH made its
interest payments in kind, to the maximum extent permitted under the terms of the
sub debt.
This factor favors debt. CBH made all payments when required, whether in
cash or in kind.
129 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 130 PepsiCo P.R., Inc. v. Commissioner, at *97. 131 See Estate of Mixon, 464 F.2d at 410-411. 132 Delta Plastics, Inc. v. Commissioner, 85 T.C.M. (CCH) at 944. - 89 -
[*89] 13. Risk
The thirteenth factor is the “risk involved in making advances.” 133 If
repayment was expected regardless of the success or failure of the business, the
factor favors debt. 134 But if the funds were advanced for a risky purpose, we may
infer that the parties did not expect repayment in all circumstances, and we should
treat the advance as equity. 135
Petitioners argue that the parties expected repayment, and the factor favors
debt. The Commissioner insists that RAC Finance had limited remedies, leaving
any lender exposed to risk. He adds that this factor indicates equity because the
sub debt was held by the same family that controlled CBH’s equity.
This factor favors equity. The risk borne by the Ricketts family was that of
an equity holder, not of a debt holder. If a lender of bona fide debt does not
receive payment on its loan, it can sue to force a liquidation of the borrower’s
assets or exercise other collection mechanisms. An equity holder in the same
position is unlikely to force its business to liquidate to pay itself back uncollected
133 Dixie Dairies Corp. v. Commissioner, 74 T.C. at 493. 134 Ill. Tool Works Inc. & Subs. v. Commissioner, at *47. 135 Ill. Tool Works Inc. & Subs. v. Commissioner, at *47. - 90 -
[*90] debts. An equity holder bears the risk of loss if the borrower defaults. The
Ricketts family bore this risk. If CBH defaulted on its obligations, RAC Finance
had no real tool to enforce payment under the subordination agreement or the sub
debt note. Payment of the sub debt was so relegated that it was the obligation of
last priority in the company. Even if enforcement measures existed, the Ricketts
family (as sub debt holders) would have to enforce their rights by causing the
liquidation of CBH, the company they owned. This is beyond unlikely.
Conclusion: Equity
The sub debt was equity, not bona fide debt, for tax purposes. Although the
sub debt had the superficial appearance of bona fide debt, it more closely
resembles equity. Most of the factors we addressed signaled equity. Many of
these factors--intent of the parties, right to enforce payment, risk, identity of the
interest, and use of the advance--weigh significantly toward equity.
Because the sub debt is equity, it cannot be allocated to Tribune as recourse
debt. The portion of the special distribution funded by the sub debt thus does not
qualify under the debt-financed distribution exception of the disguised sale rules. - 91 -
[*91] Section 752: Allocation of CBH’s Partnership Liabilities
The next issue we must address is whether CBH’s bona fide debt, the senior
debt, should be allocated to Tribune, thereby allowing Tribune to offset a portion
of the gain on the special distribution.
General Rules on Allocating Partnership Liabilities
Section 752 and its regulations govern the allocation of partnership
liabilities. Under section 752(a), when a partner’s share of a partnership liability
increases, the amount of that increase is treated as a cash contribution or increased
investment in the partnership by that partner. Conversely, under section 752(b), a
decrease in a partner’s share of liabilities is treated as a distribution of cash. The
partner receiving an increase or decrease of partnership liabilities also increases or
decreases their basis in their partnership interest, reflecting their changing
investment in the partnership. 136
These subchapter K rules mirror those of debt-financed property acquisitions
by individuals. 137 When an individual taxpayer uses debt financing to acquire
property, the amount of borrowed funds is treated as additional cash invested in the
136 Secs. 705(a), 722, 733, 752.
Laura E. Cunningham & Noël B. Cunningham, The Logic of Subchapter 137
K: A Conceptual Guide to the Taxation of Partnerships 161 (6th ed. 2020). - 92 -
[*92] acquired property and therefore increases the taxpayer’s basis in the
property. 138 This treatment is appropriate because it is assumed that the taxpayer
will pay the debt, thereby actually investing the amount of cash that has been
credited toward basis. 139 And if the debt is not repaid, the borrower may have
income as a result of the cancelation of that debt. 140 The same treatment is
appropriate in a partnership situation because, in the case of recourse debt, we
assume the liable partners will pay the debt if the partnership cannot. 141
It is not always clear which partner should receive the allocation of a
liability. If the venture is successful, the partnership itself will pay the liability and
no partner will bear responsibility. Therefore, to allocate a liability to a partner we
must consider the worst-case scenario: Which partner will have to pay the debt if
the partnership is unable to do so? 142 If a partner would be obligated to pay the
138 Crane v. Commissioner, 331 U.S. 1, 10-11 (1947). 139 Crane v. Commissioner, 331 U.S. at 13-14. 140 Secs. 61(a)(12), 108(a). 141 Stephen Schwarz & Daniel J. Lathrope, Fundamentals of Business Enterprise Taxation 55 (5th ed. 2012). 142 See William S. McKee et al., Federal Taxation of Partnerships & Partners, para. 8.02[2] (4th ed. 2007). - 93 -
[*93] liability in this worst-case scenario, the liability is recourse and is allocated
to the partner who “bears the economic risk of loss” for the debt. 143
Which partner is allocated a liability depends on whether the partners are
general or limited partners and whether the liability is recourse or nonrecourse. 144
In a general partnership, the general partner is allocated liabilities. 145 CBH is an
LLC and has no general partners.
Although Tribune is not a general partner, Tribune guaranteed collection of
the debt. We have held that a partner’s “guarantee of an otherwise nonrecourse
note places each guaranteeing partner in an economic position indistinguishable
from that of a general partner with liability under a recourse note--except that the
guaranteeing partner’s liability is limited to the amount guaranteed.” 146
If Tribune’s senior debt guaranty is valid, the senior debt is a recourse
liability allocated to Tribune. If not, it is a nonrecourse liability. Tribune argues
that it is allocated the entire liability because it bears the economic risk of loss
143 Cunningham & Cunningham, supra note 137, at 166. 144 Schwarz & Lathrope, supra note 141, at 55. 145 See McKee et al., supra note 142, para. 8.02[4][c]. 146 Abramson v. Commissioner, 86 T.C. 360, 374 (1986). - 94 -
[*94] through its senior debt guaranty. The Commissioner disagrees, arguing that
the senior debt guaranty does not sufficiently obligate Tribune under the
constructive liquidation test. He further argues that the principal purpose of the
senior debt guaranty was to create an illusion of economic risk for Tribune without
creating any real risk for Tribune.
Section 1.752-2(b)(1), Income Tax Regs.--the Constructive Liquidation Test
We first look at whether the senior debt guaranty sufficiently binds Tribune
to the senior debt so that it bears the risk of loss in a default. If the debt is recourse
to Tribune, it bears the risk of loss. A partner bears the risk of economic loss for a
partnership liability if the partner would be obligated to make payment to the
creditor if the partnership were constructively liquidated. 147
In a constructive liquidation, all of the following events are deemed to occur
simultaneously: (1) all of the partnership’s liabilities become payable in full;
(2) all of the partnership’s assets (except property contributed to secure a
partnership liability), including cash, become worthless; (3) the partnership
disposes of all of its property in a fully taxable transaction for no consideration;
147 Sec. 1.752-2(a) and (b)(1), Income Tax Regs. - 95 -
[*95] (4) all items of income, gain, loss, or deduction are allocated among the
partners as of the date of the constructive liquidation; and (5) the partnership
liquidates. 148
A partner’s obligation to make a payment on the debt is based on the facts
and circumstances and includes any statutory or contractual obligations. 149
Contractual obligations are not limited to the partnership agreement and include
“guarantees, indemnifications, reimbursement agreements, and other obligations
running directly to creditors.” 150 Further, the regulations assume that partners who
have obligations will actually perform those obligations, “unless the facts and
circumstances indicate a plan to circumvent or avoid the obligation.” 151
The Commissioner argues that Tribune does not bear the risk of economic
loss under the constructive liquidation test because the senior debt guaranty is not
due and payable upon the constructive liquidation of CBH. He argues that
Tribune’s obligation to pay was “insulated by requiring a series of complex
148 Sec. 1.752-2(b)(1), Income Tax Regs. 149 Sec. 1.752-2(b)(3), Income Tax Regs. 150 Sec. 1.752-2(b)(3)(i), Income Tax Regs. 151 Sec. 1.752-2(b)(6), Income Tax Regs. - 96 -
[*96] lawsuits to exhaust all remedies in law and in equity, after which Tribune
could have sued CBH’s lenders for not fully exhausting those remedies.”
Petitioners respond that the Commissioner is not properly applying the
constructive liquidation test.
We agree with petitioners. Under the constructive liquidation test, Tribune
bears the risk of economic loss for the senior debt. According to the terms of
Tribune’s guaranty of the senior debt, Tribune is obligated to pay when CBH fails
to make a payment and the debt is accelerated, the creditors have exhausted their
remedies, and the creditors have failed to collect the full amount of the debt. In a
constructive liquidation, as contemplated by the test set forth in the regulations, the
partnership fails to pay the debt, the debt comes due, the partnership assets are
depleted, and the debt remains outstanding. Under the senior debt guaranty,
Tribune would be required to pay in this circumstance.
The test here is whether Tribune must repay the senior debt creditors in a
worst-case scenario. No other party was liable for the debt, no partnership assets
secured the loans, and if the debt were due in full in the world of a constructive
liquidation, the senior debt creditors would seek repayment from Tribune and no
other party. - 97 -
[*97] The Commissioner also argues that the senior debt guaranty does not pass
the constructive liquidation test because it creates a contingent obligation for
Tribune. A contingent obligation is an obligation that “is subject to contingencies
that make it unlikely that the obligation will ever be discharged.” 152 The
Commissioner claims that the requirement that creditors exhaust legal remedies
before seeking repayment from Tribune make it “unlikely the obligation will ever
be discharged,” and that it is “far from clear” that the creditors would be capable of
exhausting these legal remedies, making Tribune’s collection obligation
contingent.
The fact that the senior debt guaranty is a collection guaranty does not
negate Tribune’s ultimate obligation. And the requirements in the senior debt
guaranty that lenders exhaust their remedies is not a contingency under section
1.752-2(b)(4), Income Tax Regs. If it were, most if not all collection guaranties
would be disregarded as conferring an obligation under the constructive liquidation
test, when the regulations clearly intend to treat guaranties--including collection
152 Sec. 1.752-2(b)(4), Income Tax Regs. - 98 -
[*98] guaranties--as obligations.153 The requirement that the creditors exhaust
other legal remedies before turning to Tribune does not vitiate Tribune’s ultimate
obligation to pay.
Section 1.752-2(j), Income Tax Regs.--the Specific Anti-Abuse Rule
The constructive liquidation test is subject to an anti-abuse rule. The anti-
abuse rule disregards the payment obligation or treats it as the obligation of another
person if it creates an illusion of the partner’s economic risk of loss without
actually subjecting the partner to real financial risk. Section 1.752-2(j)(1), Income
Tax Regs., provides that the obligation may be disregarded if “facts and
circumstances indicate that a principal purpose of the arrangement between the
parties is to eliminate the partner’s economic risk of loss with respect to that
obligation or create the appearance of the partner or related person bearing the
economic risk of loss when, in fact, the substance of the arrangement is otherwise.”
The regulation articulates two situations and an example that illustrate the
rule. The first situation does not apply here. The second states that an obligation
153 See sec. 1.752-2(b)(3)(i), Income Tax Regs. (listing “guarantees” as a possible contract that could confer a payment obligation, and thus recourse liability status, upon a partner); see also sec. 1.752-2(f), Example (7), Income Tax Regs. (stating the guaranteeing partner bears the risk of economic loss for a loan). - 99 -
[*99] is not recognized if “the facts and circumstances evidence a plan to
circumvent or avoid the obligation.” 154 The example indicates that a partner with a
deficit restoration obligation did not bear the economic risk of loss when that
partner was a subsidiary with severely limited capital such that it could not be
exposed to losses likely to be incurred by the partnership.155
The Commissioner seeks to apply the anti-abuse rule. He believes that the
possibility that the senior debt guaranty would ever be called was so remote that
Tribune did not bear the risk of economic loss. The Commissioner claims
numerous “buffers” made it unlikely the senior debt guaranty would be called.
One of these buffers is that Tribune did not bear the risk of loss because the
Ricketts family “was the true guarantor.” The Commissioner focuses on the
Ricketts family’s ownership of the Cubs as an intergenerational trophy asset,
stating that because the Ricketts family committed to the Cubs as a long-term
investment, the family was the “real guarantor.” However, he does not address the
fact that in a constructive liquidation, the Cubs would be deemed worthless and the
Ricketts family would lack an incentive to preserve its investment. Further, the
154 Sec. 1.752-2(j)(3), Income Tax Regs. 155 Sec. 1.752-2(j)(4), Income Tax Regs. - 100 -
[*100] Ricketts family was not a partner in CBH, and no transaction documents
obligated RAC to pay the senior debt in a constructive liquidation. A recourse debt
must be allocated to a partner, and there is no evidence that RAC was that partner.
Another buffer cited by the Commissioner is the operating support
agreement. The Commissioner argues that the operating support agreement, which
memorialized the Ricketts’ family’s agreement to place $35 million in an escrow
account to fund Cubs operating expenses as needed, is the “real guarantee.” But
CBH could not use these escrowed funds to pay its debt. Instead, the escrow
account was established so that the Cubs could continue to operate if its cashflow
decreased significantly. This was a genuine concern because anything that stopped
games from being played, such as a players’ strike, would dramatically decrease
the team’s cashflow. The Commissioner presented no persuasive evidence that the
operating support agreement served the alternative purpose of guaranteeing the
senior debt, particularly when the agreement already served a crucial function. In a
constructive liquidation where CBH could pay neither its debts nor its operating
expenses, CBH’s creditors would not look to the Ricketts family for payment
under the operating support agreement, they would look to Tribune for payment of
the debt. - 101 -
[*101] We decline to address the remaining buffers argued by the Commissioner.
Many of the Commissioner’s “buffers” resemble common lender protections. The
existence of oversight and protections to prevent a doomsday scenario does not
render the senior debt guaranty illusory. Furthermore, the Commissioner’s
argument that the senior debt guaranty is unlikely to be called is without merit. By
relying on the unlikeliness, he concedes the possibility. The constructive
liquidation test does not posit an expected occurrence; rather, it tests the worst-case
scenario, going so far as to assume that even cash is rendered worthless.
Therefore, the probability of Tribune’s fulfillment of its promise in the senior debt
guaranty is irrelevant. It is clear that if CBH could not pay its senior debt, Tribune
would have to do so. The anti-abuse rule does not apply here.
Canal Corp.
The anti-abuse rule and the example provided by section 1.752-2(j), Income
Tax Regs., were applied by this Court in Canal Corp. 156 To date, that is the only
other case that has considered the anti-abuse rule of section 1.752-2(j), Income Tax
Regs. Unsurprisingly, both petitioners and the Commissioner argue that it supports
their positions. As here, Canal Corp. dealt with a transaction intentionally
156 Canal Corp. v. Commissioner, 135 T.C. 199 (2010). - 102 -
[*102] structured to fit within the debt-financed distribution rules. In that case, we
applied the anti-abuse rule to invalidate an indemnification, noting that the facts
and circumstances were analogous to an example in the regulations.
In Canal Corp., Chesapeake Corp. sought to sell its commercial tissue
business, but it had a low tax basis in the asset. 157 Chesapeake’s commercial tissue
business was held in its wholly owned subsidiary, Wisconsin Tissue Mills, Inc.
(WISCO). 158 Georgia Pacific, a commercial lumber and paper products company,
wished to purchase WISCO, but Chesapeake’s low tax basis in WISCO led the
company to disfavor an outright sale. 159
To increase after-tax proceeds to Chesapeake and lower the purchase price
paid by Georgia Pacific, the parties agreed to a leveraged partnership structure. 160
WISCO contributed its commercial tissue assets to a new partnership in exchange
for a minority interest, and Georgia Pacific contributed its relevant assets to the
157 Chesapeake Corp. changed its name to Canal Corp. after the relevant tax years but before we issued the Opinion in Canal Corp. Canal Corp. v. Commissioner, 135 T.C. at 200 n.2. The Opinion refers to the taxpayer as Chesapeake, and we will do the same. 158 Canal Corp. v. Commissioner, 135 T.C. at 201. 159 Canal Corp. v. Commissioner, 135 T.C. at 203. 160 Canal Corp. v. Commissioner, 135 T.C. at 203. - 103 -
[*103] new partnership in exchange for the majority interest. 161 That partnership
then borrowed from a third party and distributed the debt proceeds to WISCO who
then distributed the proceeds to Chesapeake. 162
Georgia Pacific guaranteed the debt, and WISCO indemnified Georgia
Pacific. 163 Chesapeake opted against indemnifying Georgia Pacific to protect its
assets in case payment became due. WISCO attempted to limit its risk of being
called to pay the indemnity. The indemnity covered only the debt principal,
required the partnership’s assets to be exhausted before WISCO paid, and provided
that if WISCO made a payment it would receive an increased interest in the
partnership. WISCO was not required to maintain any net worth and had almost
no assets other than its interest in the joint venture. 164
In Canal Corp., the Commissioner successfully argued that WISCO did not
bear the economic risk of loss and that the anti-abuse rule applied to disregard the
161 Canal Corp. v. Commissioner, 135 T.C. at 207. 162 Canal Corp. v. Commissioner, 135 T.C. at 207-208. 163 Canal Corp. v. Commissioner, 135 T.C. at 204-205. 164 Canal Corp. v. Commissioner, 135 T.C. at 205. - 104 -
[*104] obligation. 165 We found that the indemnity was structured to insulate
WISCO from liability and that WISCO lacked sufficient assets to pay the
indemnity. 166 And in the unlikely event that WISCO would have to pay, it would
receive an increased interest in the partnership as compensation. 167 We held that
the indemnity limited WISCO’s economic exposure and Georgia Pacific, not
WISCO, was truly the partner at risk if the partnership could not pay the debt. 168
WISCO’s indemnity is not analogous to the senior debt guaranty. At no
point did WISCO have the assets to pay the amount of the indemnity; in contrast,
Tribune likely had sufficient assets to fulfill its obligations under the senior debt
guaranty. Further, the likelihood that WISCO would ultimately pay the indemnity
was more attenuated than Tribune’s potential obligation to satisfy the senior debt
guaranty. In a constructive liquidation scenario, Georgia Pacific would have had
to honor its guaranty to the third-party lenders, then seek repayment first from the
partnership, and then seek indemnification from an undercapitalized WISCO,
165 Canal Corp. v. Commissioner, 135 T.C. at 210, 212-213. 166 Canal Corp. v. Commissioner, 135 T.C. at 213-214. 167 Canal Corp. v. Commissioner, 135 T.C. at 213. 168 Canal Corp. v. Commissioner, 135 T.C. at 213. - 105 -
[*105] which because it was undercapitalized, would have left Georgia Pacific
with the liability. Under Tribune’s senior debt guaranty, the third-party lenders
would seek payment from Tribune after first exhausting other legal avenues--a
common term in collection guaranties. Further, the indemnity in Canal Corp.
granted WISCO an increased interest in the partnership if exercised. This is a
significant distinguishing fact. If Tribune had to honor the senior debt guaranty, its
interest in CBH would not increase; it would simply be out that amount. WISCO’s
increased interest would have granted it a benefit for honoring the indemnity
agreement. Tribune would receive no such compensation.
But the Commissioner sees a greater connection between WISCO and
Tribune. He argues that Tribune was undercapitalized like WISCO because
Tribune was in bankruptcy when it executed the senior debt guaranty. But WISCO
lacked the assets to pay the indemnity at the time of the transaction, and its assets
were not expected to increase. While Tribune was bankrupt when it executed the
senior debt guaranty, it had sufficient assets to pay the senior debt guaranty upon
execution and, unlike WISCO, expected its net worth to increase.
General Anti-Abuse Rule and Substance Over Form
The Commissioner argues that section 1.701-2(b), Income Tax Regs., and
the common law doctrine of substance over form apply to invalidate the Cubs - 106 -
[*106] transaction and the nontax treatment of the special distribution. Section
1.701-2(b), Income Tax Regs., which establishes a general anti-abuse rule for
partnerships, and the doctrine of substance over form are coextensive and function
together when necessary. 169 But neither the general anti-abuse rule nor the
substance over form doctrine applies to the Cubs transaction.
Section 1.701-2, Income Tax Regs.: The Subchapter K Anti-Abuse Rule
In addition to the specific anti-abuse rule provided by section 1.752-2(j),
Income Tax Regs., regulations under subchapter K include a general anti-abuse
rule. Section 1.701-2(a), Income Tax Regs., provides that the intent of subchapter
K is to allow taxpayers to conduct business jointly, with flexibility as to the
economic arrangements between partners, without incurring an entity level tax.
For a taxpayer to take advantage of subchapter K, it must first meet three
requirements:
169 The general anti-abuse rule overlaps significantly with several common law doctrines. When the Secretary proposed the partnership general anti-abuse regulation, commentators questioned whether it simply codified existing common law doctrines, especially the substance over form and business purpose doctrines. T.D. 8588, 1995-1 C.B. 109, 112. The preamble to the final regulation explained that “[w]hile the fundamental principles reflected in the regulation are consistent with the established legal doctrines, those doctrines will also continue to apply.” Id. at 112. - 107 - [*107] (1) The partnership must be bona fide and each partnership transaction or series of related transactions (individually or collectively, the transaction) must be entered into for a substantial business purpose.
(2) The form of each partnership transaction must be respected under substance over form principles.
(3) Except as otherwise provided in this paragraph (a)(3), the tax consequences under subchapter K to each partner of partnership operations and of transactions between the partner and the partnership must accurately reflect the partners’ economic agreement and clearly reflect the partner’s income (collectively, proper reflection of income). * * *[170]
If a taxpayer does not meet these requirements, it fails the anti-abuse rule under
section 1.701-2, Income Tax Regs.
The Commissioner argues that the anti-abuse rule of section 1.701-2,
Income Tax Regs., applies to invalidate the senior debt guaranty. 171 He argues that
the regulation “requires that each component of a partnership transaction have a
substantial business purpose.” The Commissioner claims that the senior debt
guaranty lacks a substantial business purpose and therefore violates the general
170 Sec. 1.701-2(a), Income Tax Regs. 171 The Commissioner argues that the general anti-abuse rule and the doctrine of substance over form apply to invalidate both the sub debt guaranty and the senior debt guaranty. However, because we held that the sub debt is not bona fide debt, we focus our discussion here on the senior debt guaranty. - 108 -
[*108] anti-abuse rule. To support this assertion, the Commissioner points to the
benefits lacking in the senior debt guaranty: It did not improve Tribune’s credit or
decrease interest rates on the loans; Tribune did not receive payment to issue the
senior debt guaranty; and the senior creditors did not request that Tribune
guarantee the loans. As further evidence of the senior debt guaranty’s lack of
business purpose, the Commissioner claims that the credit rating agencies “gave
little or no credence” to the senior debt guaranty. And Tribune itself did not
recognize the senior debt guaranty in its financial statements under the GAAP
requirements. Because the senior debt guaranty lacked a business purpose, argues
the Commissioner, it served only to lessen Tribune’s tax liability and fails the
general anti-abuse rule.
Petitioners dispute the Commissioner’s interpretation of section 1.701-2,
Income Tax Regs. Petitioners argue that the Commissioner inaccurately construes
the regulation to require a business purpose for “each component” of a transaction
instead of the transaction as a whole. They point to the examples in the regulation
and courts’ application of the regulation to support their contention.
We agree with petitioners. The examples in the regulation establish that a
partnership must have a genuine business purpose for forming the partnership, not
that every component of the partnership’s formation have a separate business - 109 -
[*109] purpose. The examples find that a partnership passes the anti-abuse rule
when it is formed to “conduct a bona fide business,” 172 such as real estate
management, making joint investments, and owning and operating a building. 173 A
partnership does not have a business purpose when the partners lack the intent to
genuinely pursue a venture under the partnership. In such a situation, the
transactions did not have a business purpose because “any purported business
purpose for the transaction is insignificant in comparison to the tax benefits”
enjoyed by the partners if the partnership form were respected. 174 Accordingly, the
transactions lacked a business purpose and should be disregarded. 175
This business purpose requirement is thus a broad provision applying to the
function of the partnership as a whole. It is not intended to apply to every
agreement into which the partnership or its partners enter. That level of minutiae
was not contemplated by the general anti-abuse rule. The courts have interpreted
business purpose requirements to apply to whether the entities engaged in the
172 Sec. 1.701-2(d), Examples (1) and (2), Income Tax Regs. 173 Sec. 1.701-2(d), Examples (4)-(6), Income Tax Regs. 174 Sec. 1.701-2(d), Examples (7) and (8), Income Tax Regs. 175 Sec. 1.701-2(d), Examples (7) and (8), Income Tax Regs. - 110 -
[*110] transaction are genuine and profit-motivated or whether the ultimate intent
of the transaction had a nontax purpose. 176 In determining whether a transaction
has a nontax motive, we assess whether the transaction alters the taxpayer’s
economic position. 177 CBH, without a doubt, had a bona fide business purpose.
Tribune and RAC created CBH to hold and operate the Cubs, an endeavor which
CBH certainly pursued. The transaction was not a sham and resulted in significant
economic outcomes to Tribune and RAC. No evidence shows that CBH lacked a
business purpose.
Even if the business purpose requirement did not apply to the Cubs
transaction as a whole, the Commissioner’s attempt to discredit the senior debt
176 See, e.g., Kraft Foods Co. v. Commissioner, 232 F.2d 118, 128 (1956) (holding that because the parties that entered into the transaction had “separate and real corporate personality” and “engaged in certain objective acts with the intent of creating legal rights and duties” the transaction had a business purpose); DTDV, LLC v. Commissioner, T.C. Memo. 2018-32, at *39 (“[T]he relevant substantive question is whether the taxpayer had a purpose other than obtaining tax benefits manifestly inconsistent with congressional intent.”); Countryside Ltd. P’ship v. Commissioner, T.C. Memo. 2008-3, 95 T.C.M. (CCH) 1006, 1018 (2008) (stating that the “ultimate transaction * * * accomplish[ed] a legitimate economic or business purpose”). 177 See Countryside Ltd. P’ship v. Commissioner, 95 T.C.M. (CCH) at 1018 (stating that the transaction had business purpose because it changed the economic positions of those involved). - 111 -
[*111] guaranty is unpersuasive. The purpose of a guaranty is to provide an
ultimate payor on a loan if the original obligor is unable to pay. A valid guaranty
ensures that the guarantor will shoulder the ultimate economic burden of a debt.
Because a guaranty certifies that a debt will be paid, it may convey additional
benefits to the parties, such as a favorable interest rate, an improved credit
standing, and a payment from the creditor to the guarantor. The Commissioner
cites these benefits as proof of a guaranty’s “business purpose,” and insists that
because the senior debt guaranty lacked these enhancements, it is not a valid
guaranty. But a guaranty does not require a separate purpose other than pledging
ultimate payment for a loan; additional perks may be desired but are not the
purpose of the guaranty. Conditioning the validity of a guaranty on its provision of
additional extrinsic benefits overlooks its essential function. The Commissioner’s
position is an incorrect analysis of the circumstances under which we will honor a
guaranty. We honor a guaranty if the guarantor has ultimate economic
responsibility for the loan. As we discussed at length, Tribune bore ultimate
responsibility for the senior debt.
The Commissioner’s claim that the senior debt guaranty had no real-world
consequences is similarly false. He argues that the senior debt guaranty lacked
substance because Tribune did not report it on its financial statements per GAAP - 112 -
[*112] guidelines. 178 As Mr. Erickson, an expert for petitioners, credibly testified,
Tribune properly followed these guidelines when it reported the guaranties had no
contingent or noncontingent value but disclosed its economic exposure from the
guaranties. Dr. Skinner, expert for the Commissioner, affirmed that Tribune
accurately represented the guaranties on its financial statements. Mr. Erickson also
credibly testified that the “GAAP value does not equate to the economic value”
because the GAAP calculation measures the likelihood of payment, not the
economic value of a guaranty. Dr. Skinner seemed to agree when he calculated the
economic value of the guaranties at $6,120,000 to $18,860,000. The
Commissioner’s claim that Tribune’s GAAP reporting reflects the guaranties’ true
lack of substance is thus inaccurate. The reporting indicates Tribune’s assessment
that the likelihood it would be called to service the guaranties was remote. As
discussed above, a remote possibility that a guaranty will be called is still a
178 The GAAP guidance relevant to Tribune’s guaranties was the Financial Accounting Standards Board’s Interpretation No. 45 (FIN No. 45), “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others.” FIN No. 45 specified that entities must recognize the fair value of guarantees as liabilities on their balance sheet for contingent and noncontingent components of the guarantees. If a guarantee does not have value, GAAP does not require the entity to report its value. But even if an entity’s guarantees lack value, it must still disclose its guarantees on financial statements. - 113 -
[*113] possibility and does not invalidate a guaranty. Furthermore, the guaranties
had economic value, and the senior debt guaranty is not a sham or an illusory
agreement created solely for tax purposes.
The guaranties affected Tribune’s credit rating. The Commissioner claims
that the credit agencies gave the guaranties “little or no credence,” but that is not
true. In its credit rating analyses of Tribune, S&P accounted for the guaranties
when calculating Tribune’s leverage and risk. In its 2016 credit report, it attributed
$100 million of CBH’s debt to Tribune as a result of the guaranties. According to
Ms. Shoesmith, who worked on Tribune’s credit report at S&P, this additional
$100 million of attributable debt affected Tribune’s credit rating by increasing its
debt to earnings ratio by 0.4. Not only did S&P give more than “a little” credence
to the guaranties, but the guaranties had a real-world effect on Tribune’s credit
rating. The senior debt guaranty had genuine consequences outside of its tax
benefits.
The Commissioner makes two other arguments as to why the senior debt
guaranty fails the general anti-abuse rule. First is the Commissioner’s claim that
the senior debt guaranty was a phony guaranty that was “trumped by the cash-
backed competing guarantee of the Ricketts family,” the operating support
agreement. But the operating support agreement did not guarantee the senior debt - 114 -
[*114] and was established to fund necessary Cubs operating costs. In fact, the
operating support agreement expressly prohibited CBH from using the operating
support agreement funds to satisfy debts. This argument is not persuasive.
Second, the Commissioner states that the senior debt guaranty’s status as a
collection guaranty makes the likelihood of Tribune’s ultimate payment too
attenuated. He cites the protections embedded in the senior debt guaranty
requiring the lenders to exhaust other legal remedies before seeking payment from
Tribune and the protections in the debt structure that minimized the risk of the
senior debt guaranty’s being called. Collection guaranties are valid guaranties.
The regulations in fact provide an example where the partner who has a guaranty
of collection is allocated the debt as a recourse liability. 179 We will not invalidate a
collection guaranty simply because the lenders must seek payment from other
potential sources before turning to the guarantor. Similarly, we will not invalidate
a guaranty because the borrowing entity structured its debt to mitigate the risk of
default. An entity may (and is perhaps encouraged to) create a debt structure that
maximizes its ability to satisfy the terms of its debt agreements. Tribune’s
foresight on this issue does not invalidate the senior debt guaranty.
179 Sec. 1.752-2(j)(4), Income Tax Regs. - 115 -
[*115] Application of the Substance Over Form Doctrine
The doctrine of substance over form embodies the concept that the
economics of a transaction, not just the formal paper steps, should determine its tax
treatment. As described by the Joint Committee on Taxation:
The concept of the substance over form doctrine is that the tax results of an arrangement are better determined based on the underlying substance rather than an evaluation of the mere formal steps by which the arrangement was undertaken. For instance, two transactions that achieve the same underlying result should not be taxed differently simply because they are achieved through different legal steps. The Supreme Court has found that a “given result at the end of a straight path is not made a different result because reached by following a devious path.” * * *[180]
The doctrine arose in Gregory v. Helvering where the Supreme Court considered a
transaction that complied with the text of the Code, but not its intended purpose:
The whole undertaking, though conducted according to the terms of subdivision (B), was in fact an elaborate and devious form of conveyance masquerading as a corporate reorganization, and nothing else. The rule which excludes from consideration the motive of tax avoidance is not pertinent to the situation, because the transaction upon its face lies outside the plain intent of the statute. To hold
Staff of J. Comm. on Taxation, Study of Present-Law Penalty and Interest 180
Provisions as Required by Section 3801 of the Internal Revenue Service Restructuring and Reform Act of 1998 (Including Provisions Relating to Corporate Tax Shelters) (Vol. I), at 195 (J. Comm. Print 1999) (quoting Minn. Tea Co. v. Helvering, 302 U.S. 609, 613 (1938). - 116 -
[*116] otherwise would be to exalt artifice above reality and to deprive the statutory provision in question of all serious purpose.[181]
The Supreme Court also stated the test as “whether what was done, apart from the
tax motive, was the thing which the statute intended.” 182 We use the doctrine of
substance over form to “determine the true nature of a transaction and
appropriately recast it for Federal income tax purposes.” 183 But we apply these
principles “only when warranted and generally respect the form of a
transaction.” 184
When form and substance align--even when the form provides additional tax
benefits to the taxpayer--the form will be respected. But when form and substance
do not align, it is assumed that tax consequences inappropriately drove that
decision. A leading treatise has explained:
If a transaction is consummated in a form that fairly reflects its substance, it ordinarily passes muster despite the conscious pursuit of tax benefits; in this case, the choice of form resembles an election provided by statute. On the other hand, if the form does not coincide with the transaction’s substance, the fact that it was negotiated at
181 Gregory v. Helvering, 293 U.S. at 470. 182 Gregory v. Helvering, 293 U.S. at 469.
Exelon Corp. v. Commissioner, 147 T.C. 230, 299 (2016), aff’d, 906 F.3d 183
513 (7th Cir. 2018). 184 Exelon Corp. v. Commissioner, 147 T.C. at 299. - 117 -
[*117] arm’s length by unrelated taxpayers does not protect it against attack, because the assumption of opposing tax interests is inapplicable.[185]
Petitioners argue that substance over form should not apply because they
complied with the disguised sale rules. They assert that the question posed by the
doctrine of substance over form is whether the steps of the transaction
substantively took place. And they argue the doctrine does not apply “where a
taxpayer has dutifully structured a transaction in compliance with a detailed
regulatory regime that implements Congress’s intent.” Petitioners claim that
Tribune may reap the tax benefits of the disguised sales rules if:
(a) the parties actually contributed their respective assets to form a bona fide partnership,
(b) the partnership in fact borrowed the Senior and Subordinated Debt;
(c) the Subordinated Debt in fact constitutes true debt for tax purposes, and
(d) Tribune provided guarantees of the Senior and Subordinated Debt that qualify as valid guarantees under section 752.
Petitioners claim that because Tribune followed--in substance as well as form--the
prescribed steps of a disguised sale, the transaction should be respected.
Boris I. Bittker & Lawrence Lokken, Federal Taxation of Income, Estates 185
and Gifts, para. 4.3.3, at 4-40 (3d ed. 1999). - 118 -
[*118] The Commissioner argues in the alternative that we should recast the Cubs
transaction as an outright sale under the substance over form doctrine. He argues
that in substance the Cubs transaction was a sale of 95% of the team’s assets and
was “orchestrated as a partnership contribution in form solely to avoid the payment
of income tax.” He further alleges that “[f]rom the outset, all parties knew the
transaction was in substance a sale, that Tribune wanted to part with the Cubs, that
the transaction had to be structured in a certain manner, and that the structure
existed to provided Tribune tax benefits.”
What the Commissioner is describing is a disguised sale. Petitioners
reported this disguised sale as such on their tax returns and have consistently
identified the Cubs transaction as a disguised sale. Respondent acknowledged the
same on the FPAA he issued with respect to CBH and the notice of deficiency he
issued to Tribune.
The Cubs transaction was a disguised sale in both form and substance. The
economic reality of this transaction lies squarely within the intent of the disguised
sale statute. The parties to the transaction formed a bona fide partnership that
operates the Cubs franchise with assets contributed by Tribune. And the
partnership in fact distributed cash to Tribune. This transaction also substantively
fits into the debt-financed distribution exception for a disguised sale, receiving the - 119 -
[*119] distribution tax free up to the amount of the senior debt guaranteed by
Tribune. CBH borrowed the senior debt, and Tribune guaranteed the senior debt.
When such a transaction is explicitly provided for by Congress and followed by a
taxpayer in both substance and form, we will not recharacterize it. 186 The doctrine
of substance over form is applied to prevent taxpayers from mislabeling
transactions to achieve a desired tax consequence. 187 Petitioners did not mislabel
the transaction here; the economic substance of the Cubs transaction is a disguised
sale with a debt-financed distribution, a structure contemplated by both the statute
and the regulations.
The Utay Expenses
The final issue we address is whether Tribune must capitalize the Utay
expenses. Tribune paid Mr. Utay’s group $2.5 million to reengage in the bidding
process for the Cubs after negotiations with the Ricketts family stalled. This $2.5
million covered bidding expenses--mostly legal fees--incurred by the group.
Tribune deducted this expense.
Esmark, Inc. v. Commissioner, 90 T.C. 171, 200 (1988), aff’d, 886 F.2d 186
1318 (7th Cir. 1989).
See Benenson v. Commissioner, 910 F.3d 690, 699 (2d Cir. 2018), rev’g 187
and remanding T.C. Memo 2015-119. - 120 -
[*120] The Commissioner denied the deduction in Tribune’s notice of deficiency.
He argues that the $2.5 million should be capitalized under section 263 because
Tribune incurred the expense to facilitate an acquisition of a trade or business or a
change in its capital structure. Section 263 denies deductions for any
improvements or betterments to the taxpayer’s property. 188 Taxpayers must
instead capitalize costs paid to facilitate the acquisition of assets or ownership in a
trade or business. 189
Petitioners argue that Tribune correctly deducted the expense under section
165(a) as an abandonment loss. They claim that the Utay expenses are deductible
as expenses related to an abandoned transaction because Mr. Utay’s group did not
prevail in the bidding process.
For Federal income tax purposes, whether a payment is a deductible expense
or a capital expenditure concerns the timing of the taxpayer’s recovery of the cost.
A business expense is deductible for the year it is incurred; a capital expenditure is
amortized or depreciated over the life of the relevant asset. 190 Whether an expense
188 Sec. 263(a)(1). 189 Sec. 1.263(a)-5(a), Income Tax Regs. 190 INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 83-84 (1992). - 121 -
[*121] should be capitalized or deducted turns on whether the “payment serves to
create or enhance * * * a separate and distinct additional asset.” 191 When an
expense does not create such an asset, the question hinges on whether the expense
will generate significant benefits for the taxpayer extending beyond the taxable
year. 192
Petitioners cite two cases in support of their argument: A.E. Staley Mfg. Co.
& Subs. 193 and Santa Fe Pac. Gold Co. 194
In A.E. Staley Mfg. Co. & Subs., the taxpayer feared a potential hostile
takeover. To defend itself, the taxpayer hired investment bankers to prepare for a
takeover, advise it, and assist it in the event a takeover occurred. 195 The
investment bankers suggested that the taxpayer find a friendly “white knight”
investor to waylay an adversarial one, which the taxpayer proceeded to do. 196 But
191 Commissioner v. Lincoln Sav. & Loan Ass’n, 403 U.S. 345, 354 (1971). 192 Metrocorp, Inc. v. Commissioner, 116 T.C. 211, 221-222 (2001).
A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d 482 (7th Cir. 193
1997), rev’g 105 T.C. 166 (1995). 194 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. 240 (2009). 195 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 484. 196 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 484. - 122 -
[*122] the taxpayer’s “white knight” was an enemy in disguise and began buying
additional shares against the taxpayer’s wishes. 197 During this takeover, the
investment bankers discussed with the taxpayer alternatives to the hostile tender
offer, but the tender offer was ultimately accepted by the taxpayer’s board. 198 The
taxpayer deducted the fees it paid to the investment bankers for their services in
response to the hostile takeover. 199
The Commissioner argued that the taxpayer should have capitalized those
expenses under section 263. 200 The Court of Appeals for the Seventh Circuit
explained that capitalized costs are those expended to better an entity or “produce
future benefits”; in contrast, the taxpayer was “engaged in the process of defending
its business from attack” and thus trying to maintain the status quo. 201 It incurred
the expenses in an attempt to prevent the transaction that ultimately occurred. 202
197 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 484-485. 198 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 485. 199 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 485. 200 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 487. 201 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 489. 202 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 489-490. - 123 -
[*123] The Court of Appeals held that the expenses the taxpayer incurred to defend
itself from the takeover were deductible under section 162 and those incurred to
find alternative transactions to the takeover were deductible under section
165(a). 203
Petitioners also cite Santa Fe Pac. Gold Co. 204 As in A.E. Staley Mfg. Co.
& Subs., the taxpayer in Santa Fe Pac. Gold Co. fell victim to a hostile takeover.
The taxpayer became vulnerable to a takeover, and a hostile firm began its pursuit
to form a merger against the taxpayer’s wishes. 205 To avoid a takeover from the
hostile firm, the taxpayer entered into a merger agreement with a “white knight”
firm; the agreement included a termination fee clause. 206 Ultimately, the hostile
firm succeeded in its takeover, forcing the taxpayer to pay the termination fee to
203 A.E. Staley Mfg. Co. & Subs. v. Commissioner, 119 F.3d at 491. 204 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. 240. 205 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 245-250. 206 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 252. - 124 -
[*124] the “white knight.” 207 The taxpayer deducted the termination fee, and the
Commissioner denied its deduction. 208
We held that the taxpayer properly deducted the termination fee under
sections 162 and 165. 209 We found that the “termination fee was intended to * * *
deter competing bids” and reimburse the “white knight” if the deal fell through. 210
The fee was deductible under section 162 because it was paid in pursuit of
defending the taxpayer and did not “produce[] any long-term benefit.” 211 We
emphasized that the termination fee was not part of the ultimate merger because
“[t]he two transactions were separate: (1) A white knight transaction; and (2) a
hostile takeover.” 212 In finding that the taxpayer could also deduct the fee under
section 165(a), we rejected the Commissioner’s argument that the “white knight”
merger and hostile takeover represented two separate alternatives to achieve the
207 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 258-259. 208 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 259-260. 209 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 276-279. 210 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 272. 211 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 272. 212 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 273-274. - 125 -
[*125] same goal. 213 We stated that the facts showed that the taxpayer’s goal was
to avoid restructuring and it was forced into a new capital structure. Again, we
emphasized that the two plans were “separate and distinct” and “[t]he two possible
combinations were not part of an overall plan by * * * [the taxpayer] to change its
capital structure.” 214
The Utay expenses should be capitalized. Tribune paid $2.5 million to Mr.
Utay’s group to facilitate the Cubs transaction that actually closed. Tribune had a
specific partnership structure and transaction it wished to execute. It initiated this
transaction and deliberately chose its bidders through a careful process before
selecting the Ricketts family as the final bidder. When negotiations with the
Ricketts family stalled, Tribune approached Mr. Utay to reengage. Mr. Utay
213 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 277-278. 214 Santa Fe Pac. Gold Co. v. Commissioner, 132 T.C. at 278. In coming to this conclusion, we cited two cases that allowed taxpayers’ deductions under sec. 165(a). The first was Sibley, Lindsay & Curr Co. v. Commissioner, 15 T.C. 106 (1950), where the taxpayer’s bankers created three separate restructuring plans and deducted the costs of the two plans it did not pursue. We allowed the deductions for the costs of the two plans because they were distinct from the plan the taxpayer pursued. Id. at 110. The second was United States v. Federated Dept. Stores, Inc. (In re Federated Dep’t Stores, Inc.), 171 B.R. 603, 612-613 (Bankr. S.D. Ohio 1994), where the court allowed the taxpayer to deduct termination fees related to a failed “white knight” transaction because the successful hostile takeover and the “white knight” merger were two mutually exclusive transactions. - 126 -
[*126] believed that Tribune reached out because it was intent on finding a buyer
for the Cubs. Tribune thus paid Mr. Utay’s group to facilitate the Cubs transaction.
Under these facts, it is clear that the payment was made to close the
transaction that was ultimately consummated. Tribune paid the Utay expenses in
an effort to achieve one of two binary results, to close the transaction with either
the Ricketts family or the Utay group. Had the Utay group succeeded in getting to
the closing table, the Utay expenses would have been capitalized into that
transaction under section 263. But the evidence is clear that Tribune paid the
amount principally to push the Ricketts family to the closing table. The expenses
were incurred to facilitate the transaction that actually closed and thus must be
capitalized into that transaction under section 263.
Petitioners’ argument that the expense is a loss from an abandoned
transaction is not supported. Both A.E. Staley Mfg. Co. & Subs. and Santa Fe Pac.
Gold Co. allowed deductions for sums paid in an attempt to avert a hostile
takeover. In each case, the transaction that created the capital asset was one the
taxpayer paid to avoid. There were two “separate and distinct” plans in the cited
cases: the transaction that occurred and a plan to avert that transaction. In both
cases, the plan to avert the transaction was thus abandoned. That is not the
situation here. Tribune was focused on creating the transaction that ultimately - 127 -
[*127] occurred. It did not attempt to find alternatives to the Cubs transaction but
to facilitate it. When the Ricketts family hesitated, Tribune opened up the
possibility of proceeding with Mr. Utay’s group and paid to do so. Whether
Tribune moved forward with the Ricketts family or Mr. Utay’s group, the overall
plan to create a new capital asset was the same. Tribune paid the expenses in
pursuit of this plan. Thus, no plan was ever abandoned, and Tribune did not suffer
abandonment losses. The Utay expenses must be capitalized.
Conclusion
Tribune’s 2009 disposition of the Chicago Cubs was a disguised sale to the
newly formed partnership CBH. The advance characterized as sub debt was equity
for tax purposes, and the portion of the distribution attributable to the sub debt
cannot offset Tribune’s recognized gains from the disguised sale. The senior debt
guaranty was bona fide, and the portion of the distribution attributable to the senior
debt guaranty is a nontaxable debt-financed distribution. Finally, the $2.5 million
Utay expenses must be capitalized. The issue of penalties will be addressed in
further proceedings.
Appropriate decisions will be entered
following further proceedings regarding
penalties.
Related
Cite This Page — Counsel Stack
Chicago Baseball Holdings, LLC, Northside Entertainment Holdings, LLC, F.K.A. Ricketts Acquisition, LLC, Tax Matters Partner, Counsel Stack Legal Research, https://law.counselstack.com/opinion/chicago-baseball-holdings-llc-northside-entertainment-holdings-llc-tax-2021.