Tax News

CCH (cch.taxgroup.com) reports:

  A parent corporation, part of a consolidated group of corporations, was denied a loss and other deductions arising out of the sale of stock owned by an affiliate of its sole operating subsidiary. The loss was generated through a basis leveraged investment swap spread (BLISS) transaction, which lacked economic substance.

  In a series of interconnected transactions, the operating subsidiary sold substantially all of its assets at a sizeable gain. It arranged to concurrently purchase and sell a long and a short option in foreign currency, known as a digital option spread, which it then contributed to a partnership wholly owned by the subsidiary and its president. At the same time, the partnership purchased shares of stock. As a result of the capital contribution of the digital option spread, the subsidiary significantly increased its outside basis in the partnership interest. The partnership liquidated shortly thereafter, resulting in a distribution of the stock to the subsidiary, which it received with a basis equal to its outside basis in the partnership. The subsidiary immediately sold the stock at a loss, which offset the gain from the prior sale of its assets.

  The transaction was found to lack economic substance and, therefore, was a sham, because the odds of the subsidiary making a profit from the digital option spread were infinitesimally small, apart from generating significant tax losses. Moreover, the BLISS transaction served no business purpose; it was developed as a mechanism for tax avoidance and not as an investment strategy. There was no true economic loss with respect to the sale of the stock, but instead only a tax loss generated by the stepped-up basis in the stock.

  The consolidated group was also denied a deduction for its legal fees incurred in implementing the BLISS transaction because it lacked economic substance and the fees were not incurred to generate income. The Code Sec. 6662 accuracy-related penalty was imposed for gross valuation misstatements, negligence and substantial understatement of tax attributable to the transaction. The partnership's reported basis in the stock was more than 400 percent of its actual basis, the consolidated group substantially understated its income, and the participants knew that its reporting position was contrary to Notice 2000-44, 2000-2 CB 255. Although the consolidated group claimed to have relied on written advice of counsel, which concluded that the consolidated group would more likely than not prevail in the event of an IRS challenge to the BLISS transaction, it was not reasonable to have relied on such advice, particularly because the attorneys were the promoters of the transaction.

New Phoenix Sunrise Corporation and Subsidiaries, 132 TC No. 9, Dec. 57,785

Other References:

 
Code Sec. 752

  CCH Reference - 2009FED ¶25,526.17

 
Code Sec. 6662

  CCH Reference - 2009FED ¶39,651G.17

  CCH Reference - 2009FED ¶39,654.60

 
Code Sec. 6664

  CCH Reference - 2009FED ¶39,661.65

  Tax Research Consultant

  CCH Reference - TRC PART: 36,150
CCH Reference -
TRC SALES: 3,154
CCH Reference - TRC PENALTY:3,100