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April 12, 2010
An issue settled more than 30 years ago undoubtedly informed the manner in which Comcast and General Electric structured their joint venture arrangement regarding the "sale" of NBC Universal.
Announced in December of 2009, NBC Universal is valued at about $30 billion, and the agreement between the two companies aims to create a joint venture in which Comcast owns 51% of the television network, while its former owner, GE, owns the remaining 49%.
The deal harkens back to a 1978 tax case involving Penn Dixie Steel Corporation that, among other things, addressed the general benefits and burdens of ownership, as well the concept that that a collar on shares may act to transfer ownership of those shares. At issue, according to the Internal Revenue Service, is that the taxpayer sought to treat a collar transaction as a sale, in part, because the possibility that a put and call would not be exercised was so remote that it should be ignored.
The original transaction began in the following manner: C Corporation and U Corporation entered into a joint venture agreement on July 1, 1968, which closed on July 31, 1968. U transferred so-called old Phoenix (the "wanted" business) to newly-created Phoenix Corporationm in exchange for 50% of the stock of Phoenix and a debenture issued by Phoenix.
In addition, C made a (cash) capital contribution to Phoenix and received in exchange the remaining 50% of Phoenix's stock.
During the period August 1, 1970 to July 31, 1971, U could "put" to C its Phoenix stock for $8.5 million, plus 125% of half of the "undistributed profits" of Phoenix. C, in turn, could "call" U's stock in Phoenix on the same terms during the following year, beginning August 1, 1971 and ending July 31, 1972.
Sometime after July 31, 1968, Penn-Dixie Corporation acquired control of C. Because U was concerned that Penn-Dixie was in "poor financial condition," its treasurer forced Phoenix to invest (the funds that C had contributed to Phoenix) in a debenture issued by U.
U exercised its put option effective July 31, 1971, and C purchased the stock by the following series of transactions: C executed an interest-free promissory note payable to Phoenix, and Phoenix agreed to accept the promissory note in full satisfaction of the U debenture in which it had invested.
The issue was whether the 1968 transaction between U and C constituted a sale to C of U's entire interest in old Phoenix. Consider that the payment of half the purchase price was deferred for two or three years. So, if the transaction constituted a sale, C would be entitled to an "imputed interest" deduction under Section 483 of the Internal Revenue. The court, however, ruled that the 1968 transaction did not constitute such a sale. (See Penn-Dixie Steel Corporation v. Commissioner, 69 T.C. 837 (1978).)
Benefits and Burdens of Ownership
In form, the transaction did not constitute a sale. The taxpayer, the court said, would have us "telescope" the transaction and consider that C acquired all of the assets and liabilities of old Phoenix from U in 1968 — which it then transferred to new Phoenix in exchange for all the stock of Phoenix, and paid U in two installments. The taxpayer, the court observed, seeks to have us hold that the "benefits and burdens of ownership" passed to C in 1968.
The facts, however, belied this contention. The court noted that: (1) the documentation is replete with references to the existence of a joint venture; (2) U and C shared stock ownership of Phoenix; (3) U and C had equal representation on the Phoenix board of directors; and (4) U and C shared in Phoenix's earnings until C acquired full ownership of Phoenix in 1971.
Certainty of Exercise
The taxpayer also sought to buttress its position by arguing that the possibility that the put or call would not be exercised "was so remote" that it should be ignored. The court, however, stated that "...we are not convinced that there was a sufficient certainty that the put or call would be exercised even if we were to consider such a certainty sufficient to find a sale..."
Here, a one-year period would elapse from the date U's put expired to the date when C's call expired. Further, more than three years could elapse from the time the joint venture agreement was signed to the date U's put expired — and more than four years until C's call expired.1
We consider it, the court observed, more than a "remote possibility" that Phoenix may so prosper in the first three years that U would forego the exercise of its put, and that the economic outlook for the steel industry could then change sufficiently in the following year to lead C to decide not to exercise its call.
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