131 T.C. No. 19
UNITED STATES TAX COURT
MERRILL LYNCH & CO., INC. & SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent*
Docket No. 18170-98. Filed December 30, 2008.
MP decided to sell its wholly owned subsidiary, MLCR but wanted to retain a portion of MLCR’s assets within MP’s affiliated group. Before its sale, MLCR sold the stock in certain of its subsidiaries (issuing corporations) to brother-sister corporations in MP’s affiliated group (acquiring corporations). We held that these cross-chain sales, along with the subsequent sale of MLCR outside the affiliated group, were made pursuant to a firm and fixed plan to completely terminate MLCR’s ownership interests in the issuing corporations. Applying sec. 304, I.R.C., we held that the cross-chain sales qualified as redemptions in complete termination of MLCR’s interest in the issuing corporations under sec. 302, I.R.C., and, as such, must
* This Opinion supplements our previous Opinion, Merrill Lynch & Co. & Subs. v. Commissioner, 120 T.C. 12 (2003), affd. in part and remanded 386 F.3d 464 (2d Cir. 2004). - 2 -
be taxed as distributions in exchange for stock instead of as dividends under sec. 301, I.R.C. The Court of Appeals for the Second Circuit affirmed our holding in part but remanded for us to consider P’s argument, made for the first time on appeal, that the sec. 302(b)(3), I.R.C., test for complete termination required consideration of MP’s ownership interest in the issuing corporations. MP asserts that it is entitled to dividend treatment because neither the cross-chain sales nor the later sale of MLCR reduced the 100- percent constructive ownership interest attributed to MP in the issuing corporations. Held: Under sec. 304, I.R.C., MLCR is the only shareholder whose interest in the issuing corporations must be tested pursuant to sec. 302, I.R.C. Because MLCR’s interest was completely terminated, the redemption was properly treated as a distribution in exchange for stock under sec. 302(a), I.R.C.
Kenneth W. Gideon and Martin D. Ginsburg, for petitioner.
Carmen M. Baerga, Jill A. Frisch, and Lyle Press, for
respondent.
SUPPLEMENTAL OPINION
MARVEL, Judge: This case is before the Court on remand from
the Court of Appeals for the Second Circuit. Merrill Lynch & Co.
& Subs. v. Commissioner, 386 F.3d 464 (2d Cir. 2004), affg. in
part and remanding 120 T.C. 12 (2003). In our prior Opinion, we
found that the cross-chain sales of subsidiary stock between
brother-sister corporations in an affiliated group1 were made
1 The affiliated group filed a consolidated Federal income tax return for each of the years at issue. - 3 -
pursuant to a firm and fixed plan to completely terminate the
cross-chain selling corporation’s actual and constructive
ownership of the subsidiaries and that the cross-chain sales must
be integrated with the later sale of the cross-chain seller
outside the affiliated group. Applying section 304,2 we held
that the cross-chain sales qualified as redemptions in complete
termination of the selling shareholder corporation’s interest in
the subsidiaries and must be taxed as distributions in exchange
for stock under section 302(a) and (b)(3) rather than as
dividends under section 301. The Court of Appeals affirmed our
decision in part but remanded the case for our consideration of
an argument petitioner advanced for the first time on appeal.3
Background
We adopt the findings of fact in Merrill Lynch & Co. & Subs.
v. Commissioner, 120 T.C. 12 (2003) (Merrill Lynch I), as
modified by the Court of Appeals. For convenience and clarity,
we repeat below the previously found facts necessary for the
disposition of this case.
Merrill Lynch & Co., Inc. (Merrill Parent), is a corporation
organized under Delaware law and is the parent corporation of an
affiliated group of corporations that filed consolidated Federal
2 All section references are to the Internal Revenue Code. 3 Petitioner did not appeal our decision with respect to the 1986 cross-chain sale of Merlease Leasing Corp. and the 1987 cross-chain sale of Merrill Lynch Vessel Leasing Corp. - 4 -
income tax returns for the taxable years at issue. Merrill
Parent, through its subsidiaries and affiliates, provides
investment, financing, insurance, leasing, and related services
to clients. Merrill Parent’s wholly owned subsidiaries included
Merrill Lynch Capital Resources, Inc. (ML Capital Resources),
Merrill Lynch Realty, Inc. (ML Realty), Merrill Lynch Asset
Management, Inc. (ML Asset Management), and Merrill, Lynch,
Pierce, Fenner & Smith, Inc. (MLPFS).
ML Capital Resources was engaged in the business of
arranging equipment leasing transactions between third parties
and also owned various types of equipment and other tangible
personal property, which it leased to third parties. In
addition, ML Capital Resources owned the stock of several
subsidiary corporations that were engaged in the business of
arranging equity and debt financing for small and midsize
companies. Merrill Parent wanted to sell a portion of ML Capital
Resources’ business but did not want certain of ML Capital
Resources’ nonleasing assets to leave the affiliated group. As a
result, Merrill Parent decided that before it sold ML Capital
Resources, ML Capital Resources would sell to other corporations
in the affiliated group the stock of its subsidiary corporations
that were engaged in lending and financing activities or that
owned other assets and businesses that were not related to its
consumer leasing operations. - 5 -
During February and March 1987 Merrill Parent prepared a
preliminary offering memorandum regarding the sale of ML Capital
Resources, contacted various prospective buyers, and established
the procedures for bidding on ML Capital Resources. On March 30,
1987, ML Capital Resources sold all of the stock in five of its
wholly owned subsidiaries to ML Realty for $53,972,607 and sold
all of the stock in another of its wholly owned subsidiaries to
ML Asset Management for an initial purchase price of $160
million.4 On April 3, 1987, ML Capital Resources sold all of its
stock in a seventh wholly owned subsidiary to MLPFS for
$119,819,690.5 These stock sales between the brother-sister
corporations constitute the cross-chain sales at issue in this
case. The parties agree that these sales were section 304
transactions.
On June 25, 1987, Merrill Parent, Merrill Lynch Consumer
Markets Holdings, Inc. (Consumer Markets), and ML Capital
Resources entered into an agreement with GATX Leasing Corp.,
acting on behalf of itself and BCE Development, Inc.
(collectively GATX/BCE), for the purchase and sale of the stock
4 The purchase price was to be adjusted as soon as practicable by a subsequent agreement reflecting the actual fair market value of the shares as of Mar. 30, 1987. 5 In addition, by resolution dated Apr. 8, 1987, Merrill Parent’s board of directors approved the formation of Merrill Lynch Consumer Markets Holdings, Inc. (Consumer Markets), and the contribution of all of ML Capital Resources’ capital stock to Consumer Markets. - 6 -
of ML Capital Resources. The purchase price of the ML Capital
Resources stock was $57,363,817.6
On its consolidated Federal income tax return for the
taxable year ended December 25, 1987, petitioner claimed a long-
term capital loss of $466,985,176 from the sale of ML Capital
Resources stock. On the basis of its interpretation of sections
302 and 304, petitioner treated the proceeds of the cross-chain
stock sales as dividend payments to ML Capital Resources, which
increased ML Capital Resources’ earnings and profits. Petitioner
took the position that under the consolidated return regulations
then in effect, the increase in ML Capital Resources’ earnings
and profits generated a corresponding increase in the basis of
the ML Capital Resources stock held by Consumer Markets. See
secs. 1.1502-32(a) and 1.1502-33, Income Tax Regs. As a result
of this asserted increase, petitioner claimed that it recognized
a loss on the sale of the stock of ML Capital Resources outside
the affiliated group.
Respondent mailed a timely notice of deficiency to
petitioner in which respondent, among other things, decreased the
long-term capital loss petitioner reported on the 1987 sale of
the stock of ML Capital Resources to GATX/BCE on the ground that
6 In Merrill Lynch I we did not make a finding regarding the total purchase price of the ML Capital Resources stock. The purchase price shown above is derived from the opinion of the Court of Appeals. See Merrill Lynch & Co. & Subs. v. Commissioner, 386 F.3d at 467. - 7 -
Consumer Markets’ basis in the ML Capital Resources stock was
overstated by $328,826,143, which represents the aggregate
purchase price of the eight subsidiaries sold in the 1987 cross-
chain sales.7
The issue for decision in Merrill Lynch I was whether the
deemed section 304 redemptions in the form of the cross-chain
stock sales must be integrated with the later sale of the cross-
chain seller, ML Capital Resources, outside the affiliated group
and treated as a redemption in complete termination under section
302(a) and (b)(3) or whether the deemed section 304 redemptions
were distributions of property taxable as dividends under section
301. We found that on the dates of the cross-chain sales,
petitioner had agreed upon and had begun to implement a firm and
fixed plan to completely terminate the ownership interest of ML
Capital Resources in the subsidiary corporations whose stock was
sold cross-chain. Consequently, we held that the cross-chain
sales, when integrated with the sale of ML Capital Resources’
stock, resulted in a complete termination under section 302(b)(3)
of the actual and constructive ownership interest of ML Capital
Resources in the subsidiaries purchased in the cross-chain sales.
Accordingly, we concluded that the proceeds of the cross-chain
7 The proper tax treatment of one of the eight 1987 cross- chain sales is not at issue in this remand because petitioner did not appeal it. - 8 -
sales must be treated as a payment in exchange for stock under
section 302(a) rather than as a dividend under section 301.
The Court of Appeals adopted the firm and fixed plan test as
the appropriate method for determining whether two transactions
conducted at different times may be integrated for the purposes
of section 302(b)(3) and affirmed our application of that test to
the cross-chain sales and subsequent sale of ML Capital
Resources. However, the Court of Appeals remanded the case for
consideration of an alternative argument petitioner advanced for
the first time on appeal. Merrill Lynch & Co. & Subs. v.
Commissioner, 386 F.3d at 475.
On appeal petitioner argued that the proceeds of the cross-
chain sales must be treated as a dividend under section 301, even
if it is found that the actual and constructive ownership
interest of ML Capital Resources in the purchased subsidiary
corporations was completely terminated when it was sold outside
the affiliated group, because Merrill Parent retained a
constructive ownership interest in the purchased subsidiaries
after the sale of ML Capital Resources for purposes of section
302(b)(3). Id. at 474-475.
Discussion
Section 304(a)(1) recharacterizes the sale proceeds of
subsidiary stock sold by one corporation to another of its
commonly controlled corporations as a distribution in redemption - 9 -
of the acquiring corporation’s stock and requires that the tax
consequences of the distribution be determined under sections 301
and 302. Under section 302(a), a redemption of stock is treated
as a distribution in exchange for stock if it meets any of the
tests provided in section 302(b). If none of the section 302(b)
tests is met, the redemption is treated as a dividend under
section 301. Sec. 302(d). The termination of interest test of
section 302(b)(3) mandates exchange treatment “if the redemption
is in complete redemption of all of the stock of the corporation
owned by the shareholder.” In the application of this and all
other tests under section 302(b), section 304(b)(1) requires that
any determination as to whether the acquisition is to be treated
as a distribution in exchange for stock must be made by reference
to the stock of the issuing corporation.8
The parties disagree on whether for purposes of section 304
Merrill Parent as well as ML Capital Resources is considered a
shareholder whose continuing interest in the issuing corporations
must be tested under section 302(b)(3). On appeal petitioner
contended for the first time that because Merrill Parent’s
ownership interest in the issuing corporations was not completely
terminated within the meaning of section 302(b)(3) by the sale of
8 For purposes of sec. 304 in this case, the subsidiaries whose stock was sold cross-chain are considered the issuing corporations, and the purchasing corporations, ML Realty, ML Asset Management, and MLPFS, are considered the acquiring corporations. - 10 -
ML Capital Resources’ stock outside the affiliated group,
petitioner has properly reported the proceeds of the sale as
dividends. Petitioner makes the same argument on remand.
Petitioner’s argument rests on the following: (1) Immediately
before the cross-chain sales, the acquiring corporations were
wholly owned subsidiaries of Merrill Parent; (2) under the
attribution rules of section 318, ownership of the issuing
corporations was also attributed to Merrill Parent through its
ownership of ML Capital Resources; and (3) after the sale of ML
Capital Resources, Merrill Parent continued constructively to own
100 percent of the stock of the issuing corporations through its
ownership of the acquiring corporations.
Petitioner relies on section 304(a)(1) to support its
position that the section 302(b)(3) termination of interest test
applies to Merrill Parent’s constructive ownership of the issuing
corporations’ stock. According to petitioner, the specific
reference in section 304(a)(1)(B) to “person (or persons) so in
control” requires the interests of all persons in control to be
considered in applying section 302(b)(3). Petitioner asserts
that under section 318, Merrill Parent constructively owned 100
percent of the stock of the issuing corporations both before and
after the cross-chain sales. Sec. 304(c)(3). Petitioner
concludes that because the sale of ML Capital Resources did not
affect Merrill Parent’s constructive ownership of the stock of - 11 -
the issuing corporations, the complete termination required under
section 302(b)(3) did not occur, and the proceeds of the cross-
chain sales were properly characterized as dividends.
Respondent contends that ML Capital Resources is the
shareholder whose interest in the issuing corporations must be
tested under section 302(b)(3) and that because Merrill Parent’s
sale of the stock of ML Capital Resources must be integrated with
the cross-chain sales of the stock of the issuing corporations,
the interest of ML Capital Resources in the issuing corporations
was completely terminated under section 302(b)(3). To support
his position, respondent argues that section 304(a)(1) explicitly
refers to the corporation that receives property in exchange for
its stock in the issuing corporation. Respondent also asserts
that the regulations promulgated under section 304 clearly
identify the interest of the transferor-shareholder as the
relevant interest to be examined under the section 302(b)(3)
test.
We must decide, therefore, whether Merrill Parent’s
continuing constructive ownership interest in the issuing
corporations after the cross-chain sales must be taken into
account in analyzing the tax consequences under sections
304(a)(1) and 302(b)(3) of ML Capital Resources’ 1987 sale of
stock in the issuing corporations to the acquiring corporations.
In making this determination, we start by interpreting section - 12 -
304(a)(1). In interpreting a statute, we begin with the language
of the statute itself. Consumer Prod. Safety Commn. v. GTE
Sylvania, Inc., 447 U.S. 102, 108 (1980); Fed. Home Loan Mortgage
Corp. v. Commissioner, 121 T.C. 129, 134 (2003). If the language
of the statute is plain and unambiguous, we generally apply the
statute in accordance with its terms. Fed. Home Loan Mortgage
Corp. v. Commissioner, supra at 134; Wells Fargo & Co. v.
Commissioner, 120 T.C. 69, 89 (2003). Whether the statute is
ambiguous is determined by reference to the language of the
statute, the specific context in which that language is used, and
the broader context of the statute as a whole. Wells Fargo & Co.
v. Commissioner, supra at 89. If the statute is ambiguous or
silent, we may look to the statute’s legislative history to
determine congressional intent and to resolve any ambiguity.
Fed. Home Loan Mortgage Corp. v. Commissioner, supra at 134;
Wells Fargo & Co. v. Commissioner, supra at 89.
Section 304 provides in relevant part as follows:
SEC. 304. REDEMPTION THROUGH USE OF RELATED CORPORATIONS.
(a) Treatment of Certain Stock Purchases.--
(1) Acquisition by related corporation (other than subsidiary).--For purposes of sections 302 and 303, if--
(A) one or more persons are in control of each of two corporations, and
(B) in return for property, one of the corporations acquires stock in the other - 13 -
corporation from the person (or persons) so in control,
then (unless paragraph (2) applies) such property shall be treated as a distribution in redemption of the stock of the corporation acquiring such stock. To the extent that such distribution is treated as a distribution to which section 301 applies, the stock so acquired shall be treated as having been transferred by the person from whom acquired and as having been received by the corporation acquiring it, as a contribution to the capital of such corporation.
* * * * * * *
(c) Control.--
(1) In general.--For purposes of this section, control means the ownership of stock possessing at least 50 percent of the total combined voting power of all classes of stock entitled to vote, or at least 50 percent of the total value of shares of all classes of stock. If a person (or persons) is in control (within the meaning of the preceding sentence) of a corporation which in turn owns at least 50 percent of the total combined voting power of all stock entitled to vote of another corporation, or owns at least 50 percent of the total value of the shares of all classes of stock of another corporation, then such person (or persons) shall be treated as in control of such other corporation.
(3) Constructive ownership.--
(A) In general.--Section 318(a) (relating to constructive ownership of stock) shall apply for purposes of determining control under this section.
While section 304(a)(1)(A) refers to “one or more persons” and
section 304(a)(1)(B) refers to “person (or persons) so in - 14 -
control”, section 304(a)(1) makes clear that the person or
persons in control must also be transferors of issuing
corporation stock who receive property in exchange for their
transferred stock. Accordingly, under section 304, the persons
in control must actually receive property in exchange for the
transfer of their issuing corporation stock to warrant the
redemption analysis in section 302. The references to “persons”
in section 304(a), when read in conjunction with section
304(c)(1) and (3), merely indicate that the interests of more
than one person may be combined through attribution of stock
ownership in order to meet the requisite control required for the
application of section 304(a)(1).9 The constructive ownership
rules of section 318 are thus independent of the transfer and
receipt requirements of section 304(a).
Because sections 302 and 304 operate to determine the tax
consequences to the recipient of a corporate distribution,10 it
necessarily follows that the rules set forth in sections 302 and
304 apply only to the shareholder who, in exchange for stock,
actually receives the proceeds of a cross-chain sale. The
position that the section 302(b) tests may be applied to a
9 For purposes of the Internal Revenue Code, unless otherwise indicated, “The term ‘person’ shall be construed to mean and include an individual, a trust, estate, partnership, association, company or corporation.” Sec. 7701(a)(1). 10 Secs. 302 and 304 are in subpt. A, entitled “Effects on Recipients”, of subch. C, pt. I. - 15 -
shareholder who indirectly or constructively holds stock but has
neither transferred any stock nor received the proceeds of the
stock sale cannot be reconciled with the language and structure
of section 304(a)(1).
The regulations promulgated under section 304 also confirm
that the section 302(b) tests apply only to the person or persons
who actually transfer stock in the issuing corporation to the
acquiring corporation in consideration for property.11 Section
1.304-2(a), Income Tax Regs., provides as follows:
(a) If a corporation, in return for property, acquires stock of another corporation from one or more persons, and the person or persons from whom the stock was acquired were in control of both such corporations before the acquisition, then such property shall be treated as received in redemption of stock of the acquiring corporation. * * * As to each person transferring stock, the amount received shall be treated as a distribution of property under section 302(d), unless as to such person such amount is to be treated as received in exchange for the stock under the terms of section 302(a) or section 303. * * * [Emphasis added.]
Although the regulation acknowledges that more than one person
may be in control of both corporations within the meaning of
section 304, it clearly recognizes that the person or persons in
control must also have transferred stock in exchange for
property. According to the regulation, only a person who has
transferred stock in exchange for property is subject to the
provisions of section 302. Section 1.304-2(c), Example (4),
11 In this context property includes cash. Sec. 317(a). - 16 -
Income Tax Regs., illustrates this distinction as follows:
Corporation X and corporation Y each have outstanding 100 shares of common stock. H, an individual, W, his wife, S, his son, and G, his grandson, each own 25 shares of stock of each corporation. H sells all of his 25 shares of stock of corporation X to corporation Y. Since both before and after the transaction H owned directly and constructively 100 percent of the stock of corporation X, and assuming that section 302(b)(1) is not applicable, the amount received by him for his stock of corporation X is treated as a dividend to him to the extent of the earnings and profits of corporation Y.
In the example more than one person was considered to be in
control of each corporation and their interests were aggregated
to determine control for purposes of section 304, but the section
302(b) tests were applied only to the shareholder who actually
transferred stock to the commonly controlled corporation in
exchange for property. Nothing in the statute or the regulations
“commands” that the interests of all persons in control be tested
under sections 304(a)(1) and 302(b), as petitioner contends.
ML Capital Resources owned 100 percent of the stock of the
issuing corporations before the cross-chain sales, thereby
satisfying the control requirement set forth in section
304(a)(1). As a result, we need not look beyond ML Capital
Resources’ ownership of the issuing corporations to consider any
additional persons who may have an indirect interest in the
issuing corporations under the section 318 attribution rules. ML
Capital Resources was the only “person” who transferred any stock
to the acquiring corporations in the cross-chain sales, and ML - 17 -
Capital Resources was the only shareholder that received property
from the acquiring corporations in exchange for stock in the
issuing corporations. Consequently, ML Capital Resources is the
only shareholder whose interest in the issuing corporations must
be tested under the provisions of section 302(b)(3). Because the
interest of ML Capital Resources in the issuing corporations was
completely terminated upon its sale outside of the affiliated
group, the redemption shall be treated as a distribution in
exchange for stock. Secs. 304(a)(1), 302(b)(3).
Petitioner presents various hypothetical situations to
demonstrate the unintended results that the adoption of
respondent’s position might have produced under earlier versions
of section 304. These examples, however, assume facts that are
not present in this case and rely on statutory provisions that
are no longer in effect. Consequently, we do not address the
hypothetical situations discussed in petitioner’s brief.
Moreover, we have recognized that “a statute cannot be drafted
with sufficient particularity to fully accomplish its purposes
while avoiding every potential abuse”. Van Raden v.
Commissioner, 71 T.C. 1083, 1116 (1979) (Wilbur J., dissenting),
affd. 650 F.2d 1046 (9th Cir. 1981). We are required to review
and interpret sections 304 and 302 as in effect for 1987, the
year of the contested cross-chain sales. Hypotheticals aside, we
are satisfied that the language and structure of sections 304 and
302 mandate our holding herein. - 18 -
To reflect the foregoing,
Decision will be entered in
accordance with the mandate of the
Court of Appeals for the Second
Circuit.