Stock Loan Treated as Sale

July 23, 2010

The Tax Court has sided with the IRS in a case where they sought to collect over $100 million in taxes from billionaire Philip Anschutz. At issue was a complicated arrangement known as a variable prepaid forward contract, in which Anschutz received cash up front for a sale to occur later. Anschutz loaned the shares that were covered by this contract to the firm providing the up front payment, permitting that firm to sell the shares. The court found that the prepaid contract and the lending arrangement had to be seen as part of a single deal, with the result being that the sale is viewed as taking place at the time of the up front payment rather than later as Anschutz intended.

Anschutz, estimated by Forbes to be worth $6 billion, wanted to raise money for some business ventures, which included ownership of sports teams and the Staples Center in Los Angeles. He held some highly appreciated shares of stock that could be sold for this purpose, but wanted to postpone paying tax on the sale. A forward sale is a transaction in which the sale is to occur later. When the sale involves stock that is publicly traded, to avoid being taxed at the outset the amount to be received per share must not be fixed in advance, making it a variable forward sale. And to produce cash up front it must be a prepaid variable forward sale.

By itself, this arrangement can be structured so that it is not treated as a current sale of the shares. The investment firm providing the transaction cannot simply take the risk that the shares will decline in value, however, so they need to borrow shares they can sell in the stock market. The borrowing increases the cost of the prepaid variable forward sale transaction — unless the investment firm can borrow the shares from the same person who is entering into the forward sale. That is what happened here: Anschutz loaned the same shares that were subject to the forward sale.

Viewed as separate transactions, neither the forward sale nor the share lending arrangement would be treated as a sale at the outset. The court said they had to be viewed together, with the result being that Anschutz was treated as having sold the stock at the time he received the up front payment — precisely the result he was trying to avoid.

The decision comes on the heels of another where the Tax Court ruled in favor of the IRS in a superficially similar arrangement structured by Derivium Capital. The earlier case involved a less sophisticated structure, however — and a lot less money.


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