Anschutz Co. v. Commissioner

ANSCHUTZ COMPANY, PETITIONER v. COMMISSIONER OF

INTERNAL REVENUE, RESPONDENT

PHILIP F. AND NANCY P. ANSCHUTZ, PETITIONERS

v. COMMISSIONER OF INTERNAL REVENUE,

RESPONDENT

Docket Nos. 18942–07, 19083–07. Filed July 22, 2010.

P–PA, an individual, owned P–AC, an S corporation. TAC

is a wholly owned qualified subch. S subsidiary of P–AC, and

its items of income and gain are reported on P–AC’s Federal

tax return. P–PA used TAC as an investment vehicle. TAC

held the stock of companies that P–PA decided to invest in.

TAC entered into a master stock purchase agreement (MSPA)

for the sale of some of those corporate stocks in 2000 and

2001 to DLJ, an investment bank. The MSPA consisted of for-

ward contracts and share-lending agreements. The forward

contracts were prepaid in cash and would be settled with vari-

able numbers of shares of stock. The share-lending agree-

ments called for TAC to lend the shares of stock subject to the

forward contracts to DLJ. P–PA and P–AC treated the MSPA

as an open transaction and did not report any gain or loss on

the transfers of stock. R determined that the MSPA was a

sale of stock and that P–AC was liable for built-in gains tax

pursuant to sec. 1374, I.R.C., as a result of TAC’s income and

gain being reported on P–AC’s return. R also determined that

there were deficiencies in the personal income tax of P–PA,

the sole shareholder of P–AC, as a result of adjustments

including in his income a distributive share of the built-in

gain. Under sec. 1058, I.R.C., no gain or loss is recognized by

a taxpayer who transfers securities pursuant to an agreement

that meets the requirements of sec. 1058(b), I.R.C. Sec. 1259,

I.R.C., provides for constructive sale treatment if a taxpayer

enters into a transaction listed in sec. 1259(c)(1), I.R.C. Held:

The MSPA constituted a sale and TAC and P–AC must recog-

nize gain to the extent of the upfront cash payments received

in 2000 and 2001; the MSPA called for the lending of shares

but did not meet the requirements of sec. 1058(b), I.R.C.,

because it limited TAC’s risk of loss. Held, further, TAC did

not engage in constructive sales of stock in 2000 and 2001

pursuant to sec. 1259, I.R.C.

Robert A. Rudnick, Jonathan R. DeFosse, Richard J.

Gagnon, Jr., and Thomas S. Martin, for petitioners.

Dennis M. Kelly, Michael Cooper, and Jennifer

Auchterlonie, for respondent.

78

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(78) ANSCHUTZ CO. v. COMMISSIONER 79

GOEKE, Judge: This deficiency case turns on the treatment

of stock transactions entered into by the Anschutz Corp.

(TAC), a qualified subchapter S subsidiary of the Anschutz

Co., during 2000 and 2001. TAC entered into a master stock

purchase agreement (MSPA) to sell shares of stock to an

investment bank. The MSPA also called for TAC to lend those

same shares to the bank. The issue is whether this sale

agreement with concurrent share lending requires TAC, and

its parent, Anschutz Co., to recognize built-in gain upon

entering into the transaction. For the reasons stated herein,

we conclude that TAC and Anschutz Co. must recognize gain

to the extent of the upfront cash payments received in 2000

and 2001 exceed TAC’s basis in the stock.

FINDINGS OF FACT

1. General Background

Some of the facts have been stipulated, and the stipula-

tions of fact and the attached the exhibits are incorporated

herein by this reference.

Philip F. Anschutz (Mr. Anschutz) resided in Colorado at

the time he filed his petition. 1 Mr. Anschutz was the sole

shareholder of Anschutz Co. and is a calendar year taxpayer.

Anschutz Co. was incorporated in Delaware on July 25, 1991.

At the time it filed its petition, Anschutz Co.’s principal place

of business was Denver, Colorado. Anschutz Co. elected,

effective August 1, 1999, to be treated as an S corporation

under section 1362. 2

TAC was incorporated in Kansas on December 17, 1959,

and its principal place of business was in Denver, Colorado.

At all times during 2000 and 2001 Anschutz Co. owned all

of the outstanding stock of TAC.

Anschutz Co. elected to treat TAC as a qualified subchapter

S subsidiary under section 1361(b)(3)(B)(ii). As a result, all

assets, liabilities, income, deductions, and credits of TAC were

treated as those of Anschutz Co. on the latter’s Federal

income tax returns for 2000 and 2001.

1 Nancy P. Anschutz is a party because she and Mr. Anschutz filed joint Federal income tax

returns.

2 Unless otherwise indicated, all section references are to the Internal Revenue Code in effect

for the years in issue, and all Rule references are to the Tax Court Rules of Practice and Proce-

dure.

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80 135 UNITED STATES TAX COURT REPORTS (78)

The stock transactions at issue were entered into by TAC.

We refer to Mr. Anschutz and Anschutz Co. collectively as

petitioners.

Respondent determined that TAC’s stock transaction should

have been treated as a closed sale. Because TAC is a qualified

subchapter S subsidiary, its income would be reported on

Anschutz Co.’s tax return. As a result, respondent deter-

mined that Anschutz Co. was liable for deficiencies in built-

in gains tax under section 1374 of $49,724,005 and

$63,856,385 for 2000 and 2001, respectively. Because

Anschutz Co. is an S corporation and thus a flow-through

entity, these determinations caused adjustments to Mr.

Anschutz’s distributive share of Anschutz Co.’s income and

gain. As a result of these adjustments, respondent deter-

mined correlative deficiencies of $12,081,726 and $17,941,239

in Mr. Anschutz’s income tax for 2000 and 2001, respectively.

2. Background of the Transactions at Issue

Beginning in the 1960s, Mr. Anschutz invested in and

operated companies engaged in oil exploration and devel-

oping natural resources. During the past two decades Mr.

Anschutz invested in and operated railroad companies.

Mr. Anschutz’s decision to invest in a particular company

typically left him holding large blocks of its stock. Mr.

Anschutz used TAC as an investment vehicle to hold these

stocks.

Over the past decade Mr. Anschutz began investing in real

estate and entertainment companies. These activities

included ownership of the Staples Center in Los Angeles,

California, the Los Angeles Kings of the National Hockey

League, and the Los Angeles Galaxy of Major League Soccer.

In the late 1990s and early 2000s Mr. Anschutz needed

substantial amounts of cash to fund the acquisition, develop-

ment, and expansion of these new business ventures.

In the course of researching various financing vehicles to

fund its expanding real estate and entertainment enter-

prises, Mr. Anschutz and executives at Anschutz Co. con-

sulted with Donaldson, Lufkin & Jenrette Securities Corp.

(DLJ). 3 Mr. Anschutz and Anschutz Co. decided to raise funds

3 The principal party to the stock transactions with TAC was DLJ Cayman Islands, LDC. DLJ

Cayman Islands and Donaldson, Lufkin & Jenrette Securities Corp. were subsidiaries of Donald-

son, Lufkin & Jenrette, a U.S. investment bank. On Nov. 3, 2000, DLJ was acquired by Credit

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(78) ANSCHUTZ CO. v. COMMISSIONER 81

by causing TAC to enter into transactions with DLJ involving

the appreciated stock owned by TAC. Mr. Anschutz believed

that these transactions would allow TAC to receive cash,

using the appreciated stock as collateral, without having

caused a sale for Federal income tax purposes.

TAC entered into long-term sale and lending agreements

with regard to the stock at issue. The sale agreements were

memorialized by a master stock purchase agreement (MSPA)

and various accompanying documents but were referred to by

petitioners as ‘‘Prepaid Variable Forward Contracts’’ (PVFCs).

These PVFCs were accompanied by share-lending agreements

(SLAs) with respect to the shares subject to the PVFCs.

TAC and DLJ negotiated the structure, basic provisions, and

terms of all of the memorializing documents for the PVFCs

and the SLAs used in implementing the stock transactions

over the course of a year. The parties disagree whether the

PVFCs should be viewed separately from the SLAs or as part

of an integrated transaction.

3. The Transactions

a. PVFCs

A forward contract is an executory contract calling for the

delivery of property at a future date in exchange for a pay-

ment at that time. A PVFC is a variation of a standard for-

ward contract. In a typical PVFC, a securities owner (the

forward seller) holding an appreciated equity position enters

into a forward contract to sell a variable number of shares

of that equity position. The purchaser prepays its obligation

under the PVFC to purchase a variable number of shares on

a future date. At the maturity date of the contract, the for-

ward seller will settle the contract by delivering either: (1)

Shares of stock that had been pledged as collateral at incep-

tion of the contract; (2) identical shares of the stock; 4 or (3)

cash. Typically the number of shares or the amount of cash

to be delivered at maturity is determined at or near the con-

Suisse First Boston, Inc. (CSFB). This acquisition did not materially affect the terms of the

stock transactions. We will refer to Donaldson, Lufkin & Jenrette, its subsidiaries, and CSFB

as DLJ for simplicity.

4 ‘‘Identical’’ in this context does not mean the exact shares pledged at inception, but shares

of stock of the same corporation and class as those pledged at inception. This allows the seller

to retain the original shares but acquire additional shares in the open market at or around the

contract’s maturity and deliver those shares instead.

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82 135 UNITED STATES TAX COURT REPORTS (78)

tract maturity date according to the market price of the stock

at issue.

Consider a taxpayer holding 100 shares of Corporation X

stock, trading at $10 per share. The taxpayer enters into a

PVFC to deliver a number of shares in 1 year and receives a

$1,000 upfront cash payment. If the stock is trading at $10

or below, the taxpayer must deliver all 100 shares. If the

stock is trading at $20, the taxpayer must deliver 50 shares

or $1,000 cash.

b. Share-Lending Agreements

Share-lending agreements are often entered into by equity

holders who have taken a long position with respect to a

stock and plan on holding it for an extended period. The

equity owner can agree to lend the stock to a counterparty,

who can then use the borrowed shares to increase market

liquidity and facilitate stock sales. For example, the equity

owner can lend shares to an investment bank, which could

then use the lent shares to execute short sales on behalf of

its clients.

The borrower will normally pledge cash collateral, and the

lender will derive a profit lending the shares by retaining a

portion of the interest earned by this cash collateral. At the

end of the lending period, the counterparty will return the

borrowed shares to the equity owner/lender.

4. TAC’s Transactions

a. Transaction Terms

Mr. Anschutz caused TAC to enter into the MSPA. Both the

PVFCs and the SLAs were governed by the same transaction

documents. DLJ was the counterparty, and Wilmington Trust

Co. (WTC) served as the collateral agent.

The PVFCs required DLJ to make an upfront payment to

TAC in exchange for a promise by TAC to deliver a variable

number of shares to DLJ 10 years in the future. TAC and DLJ

negotiated two issues: (1) The amount of DLJ’s upfront pay-

ment in relation to the fair market value of the shares; and

(2) the amount of appreciation TAC would be entitled to

retain over the term of the PVFCs.

TAC and DLJ decided that DLJ would make an upfront pay-

ment equal to 75 percent of the fair market value of the

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(78) ANSCHUTZ CO. v. COMMISSIONER 83

shares subject to the PVFCs. The parties also agreed that

there would be a ceiling on TAC’s entitlement to any appre-

ciation in the stock over the term of the PVFC. If the fair

market value of the stock at issue in the PVFC were to

increase over the term of the contract, TAC was entitled to

retain the first 50 percent of this appreciation. Any addi-

tional appreciation above the first 50 percent would accrue to

DLJ.

The MSPA also required TAC to pledge collateral in

exchange for the upfront cash payment under the PVFC and

required TAC and DLJ to execute pledge agreements for each

transaction schedule. TAC pledged the shares of stock at issue

in the PVFCs as collateral for the upfront payment and to

guarantee TAC’s performance under the PVFC. The pledged

shares were delivered to WTC as trustee. The pledge agree-

ments further required WTC to enter into SLAs with DLJ. WTC

held title to the stock pursuant to the pledge agreements and

acted as TAC’s agent in entering into the SLAs. TAC received

a prepaid lending fee calculated by reference to the value of

the lent shares (discussed in detail below); the fee was gen-

erally equal to 5 percent of the fair market value of the

shares lent under the SLAs.

The diagram below illustrates the general outline of the

transaction.

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84 135 UNITED STATES TAX COURT REPORTS (78)

b. Transaction Documents

The stock transactions were memorialized in the MSPA. The

MSPA required the execution of a transaction schedule for

each stock at issue. TAC and DLJ executed three transaction

schedules.

The MSPA also required that for each transaction schedule

the parties execute a pledge agreement establishing collat-

eral accounts with WTC. Pledge agreements were executed,

corresponding to the three transaction schedules. Each

pledge agreement required WTC as collateral agent and DLJ

to execute an SLA that would allow WTC to lend shares of

stock to DLJ. Three SLAs were executed corresponding to the

three pledge agreements.

Although each transaction schedule governed a certain

number of shares of stock, these base numbers of shares

were further divided into smaller segments for each PVFC,

called ‘‘tranches’’. A tranche is a number of related securities

that are part of a larger securities transaction. The MSPA

required that each PVFC and each instance of share lending

be memorialized by a pricing schedule and notice of bor-

223501.eps

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(78) ANSCHUTZ CO. v. COMMISSIONER 85

rowing, respectively. Each pricing schedule and notice

of borrowing caused the establishment of a tranche.

There were a total of 10 pricing schedules and notices of

borrowing executed pursuant to the 3 transaction schedules

and 3 SLAs. Transaction 1 was made up of six tranches;

transaction 2 was made up of three tranches; and transaction

3 was made up of one tranche.

The amounts of the upfront payments and the numbers of

shares to be delivered were decided by reference to formulas

and definitions contained in the MSPA, discussed in more

detail below.

i. MSPA

The MSPA between TAC as seller and DLJ as buyer was

entered into on May 9, 2000. The MSPA provided the basic

framework for the stock transactions and defined certain

terms and requirements that applied to all of the stock trans-

actions. The MSPA also included terms that would apply dif-

ferently depending on the specific transaction schedule or

pricing schedule at issue. These terms would be defined in

greater detail in the transaction schedule or pricing schedule

as each was executed.

ii. Transaction Schedules

As stated previously, TAC and DLJ executed three trans-

action schedules pursuant to the MSPA. Each corresponded to

a different corporate security.

Each transaction schedule identified the issuer, the type of

security at issue, and the maximum number of shares that

would be subject to the transaction. The transaction schedule

further defined certain terms, initially defined and contained

in the MSPA, as they would apply to all of the shares gov-

erned by that specific transaction schedule. These terms

included the effective date and maturity dates of the trans-

action, the ‘‘Minimum Average Hedge Price’’, the ‘‘Hedging

Termination Date’’, the ‘‘Threshold Appreciation Price Multi-

plier’’, the ‘‘Purchase Price Multiplier’’, and the ‘‘Maximum

Borrow Cost Spread Trigger’’.

The effective date of a transaction schedule was the date

on which TAC and DLJ executed the transaction schedule.

Each transaction schedule had a range of maturity dates

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86 135 UNITED STATES TAX COURT REPORTS (78)

beginning on the 10th and ending on the 11th anniversary

of the effective date of the transaction.

Each stock transaction between TAC and DLJ was preceded

by DLJ’s executing short sales of that stock in the open

market. These short sales had to be executed between the

effective date of a transaction schedule and the hedging

termination date. The hedging termination date was the final

date for DLJ to execute short sales to determine the ‘‘average

hedge price’’.

iii. Pricing Schedules

Each individual stock transfer made pursuant to a trans-

action schedule was memorialized by a pricing schedule. The

execution of a pricing schedule established a tranche for that

transaction. 5 The sum of the base shares in each tranche

equaled the number of shares subject to the transaction

schedule.

These terms included: (1) The average hedge price; (2) the

downside protection threshold price; (3) the threshold appre-

ciation price; (4) the purchase price; (5) the payment

schedule (within 5 days of execution of the pricing schedule);

(6) the tranche notice date; and (7) the maturity dates.

The information in each pricing schedule was generated by

DLJ’s executing short sales of the stock that would be in the

tranche. These short sales in effect hedged DLJ’s risk on the

forward contract, because the short sales protected DLJ from

a decrease in stock value during the term of the PVFC.

The average hedge price was the average price DLJ

received on its short sales. The average hedge price and the

downside protection threshold price were equal. The down-

side protection threshold price is so named because it rep-

resents the lowest value that TAC could receive for its shares

on the settlement date. This in effect locked in a value per

share that TAC would get credit for when the PVFCs were set-

tled.

TAC’s entitlement to the first 50 percent of any apprecia-

tion of the shares was represented in the transaction

5 Each individual tranche had both a transaction number and a tranche number. Thus, a

tranche could be identified as T1T1, where the first number was the number of the transaction

and the second was the number of the tranche within that transaction. Thus, the six tranches

under transaction 1 can be represented as T1T1 through T1T6, the three tranches under trans-

action 2 as T2T1 through T2T3, and the tranche under transaction 3 as T3T1.

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(78) ANSCHUTZ CO. v. COMMISSIONER 87

schedule by the threshold appreciation price multiplier and

in the pricing schedule by the initial threshold appreciation

price multiplier of 1.50. The initial threshold appreci-

ation price multiplier was applied to the average hedge price

to calculate the threshold appreciation price. The threshold

appreciation price was the maximum amount per share that

TAC would retain.

In sum, TAC was entitled to retain any stock value above

the downside protection threshold price and below or equal

to the threshold appreciation price. Any value per share

above the threshold appreciation price accrued to DLJ.

The short sales and accompanying information were used

to determine the upfront payment TAC was entitled to receive

under each tranche. This upfront payment was equal to 75

percent and was represented in the transaction schedule by

a purchase price multiplier of .75. The amount of the upfront

payment was calculated in each pricing schedule. The base

number of shares in a tranche was multiplied by the average

hedge price and the purchase price multiplier of .75. The

resulting amount was the upfront payment made to TAC

under the PVFCs.

iv. Pledge Agreements

The MSPA required TAC and DLJ to establish collateral

accounts to hold shares subject to the MSPA, the transaction

schedule, and the pricing schedule. TAC and DLJ entered into

three pledge agreements, each corresponding to one of the

three transaction schedules.

WTC served as collateral agent. Each pledge agreement pro-

vided for the establishment of collateral accounts with WTC,

delivery to WTC of the number of shares initially subject to

the applicable transaction and tranche, the creation of secu-

rity interests in the pledged shares, and release of these

pledged shares to WTC. The pledge agreement also dealt with

the treatment of income and distributions related to the

pledged shares.

v. SLAs

The MSPA and the pledge agreements required WTC to enter

into SLAs with DLJ that allowed DLJ to borrow from WTC the

shares pledged as collateral.

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88 135 UNITED STATES TAX COURT REPORTS (78)

Three SLAs were executed, corresponding to the three

transaction schedules and pledge agreements entered into

under the MSPA. Individual acts of borrowing were initiated

by DLJ. The separate SLAs, like the transaction schedules,

were divided into separate tranches. Each tranche was estab-

lished by the filing of a notice of borrowing with WTC.

The tranche establishment notice assigned a tranche

number and identified the number of shares subject to the

SLA tranche. Each notice of borrowing corresponded to a spe-

cific tranche established under one of the three transaction

schedules. Thus, for each pricing schedule tranche T1T1

through T3T1, there is a corresponding share-lending

tranche.

The SLAs further provided procedures for the transfer of

shares, periodic payments of dividends and distributions with

respect to the shares at issue, payment of fees, guaranties,

and the recall of shares lent under the agreement. The SLAs

provided that TAC could recall the pledged shares by noti-

fying WTC, which would then inform DLJ of the recall. Upon

receiving notice, DLJ would return the number of borrowed

shares subject to that specific recall to TAC’s collateral

accounts at WTC. If TAC recalled shares from DLJ, it would

have to return a pro rata portion of the prepaid lending fee

it received upon the initial share lending.

c. Acceleration Provisions

Each PVFC had a maturity date of 10 to 11 years after

execution. However, DLJ could, pursuant to the MSPA, accel-

erate the settlement date of a PVFC if certain events occurred.

If DLJ accelerated a transaction, TAC would have to deliver a

number of shares that would vary with the parties’ relative

economic positions at the time of acceleration.

DLJ could accelerate a PVFC only if certain events occurred,

including TAC’s filing for bankruptcy or a material change in

TAC’s economic position such that it was unclear whether TAC

would be able to satisfy its obligations under the PVFC.

Lastly, DLJ could accelerate the settlement of a PVFC if it was

unable to hedge its position with respect to the stock at issue

in the PVFC.

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(78) ANSCHUTZ CO. v. COMMISSIONER 89

d. Execution of PVFCs and SLAs

Each individual PVFC was executed according to the same

steps. DLJ, upon receiving notice that TAC wanted to execute

a PVFC, would borrow shares of the stock at issue 6 in the

pricing schedule from an unrelated third party and sell those

shares in the open market as part of a short sale. These

short sales would be used to generate the information in the

pricing schedule and to determine TAC’s upfront payment.

These short sales were executed between the execution date

of the pricing schedule and the hedging termination date,

and the results of the short sales were compiled in the

pricing schedule. The short sale proceeds were used to fund

the upfront payment made as part of the PVFC and left DLJ

with an obligation to close out the short sale by transferring

identical shares to the original third-party lender. The PVFCs

and the short sales worked to cancel out DLJ’s risk of loss on

the stock purchases. If the fair market value of stock subject

to the PVFCs dropped over the course of the contract, the

short sales would earn a profit; if the fair market value

increased, the PVFCs would earn a profit.

DLJ would not execute one short sale for the entire amount

of stock at issue in the pricing schedule. Instead, DLJ would

split the number of shares over a number of different short

sales as part of the process for establishing each tranche.

The various prices received on these short sales were then

averaged to determine the average hedge price for the

tranche.

The other terms of the various pricing schedules memori-

alizing each tranche under the MSPA were determined on the

basis of these initial short sales. As stated previously, the

average hedge price equaled the downside threshold protec-

tion price. The base number of shares was multiplied by the

average hedge price and the purchase price multiplier to

determine TAC’s upfront payment. The downside protection

threshold price was multiplied by the initial threshold appre-

ciation price multiplier to determine the maximum amount of

value per share that TAC would be entitled to keep if the

stock appreciated.

6 The corporate stocks at issue in the transactions are all widely traded and available, so the

borrowing of shares to execute a short sale was not difficult.

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90 135 UNITED STATES TAX COURT REPORTS (78)

The cash proceeds of the short sales were used to fund the

upfront payment of the PVFCs. Payment was made within 5

days of delivery of the pricing schedule to TAC.

5. TAC’s Three Transactions

a. Transaction 1

On May 9, 2000, TAC and DLJ executed a transaction

schedule pursuant to the MSPA for transaction 1. Transaction

1 implemented a stock transaction with respect to a max-

imum of 10 million shares of Union Pacific Resources Group,

Inc. (UPR) common stock.

The transaction schedule for transaction 1 provided an

effective date of May 9, 2000, and a range of maturity dates

from the 10th to the 11th anniversary of the effective date.

The transaction schedule further provided a hedging termi-

nation date of December 31, 2000, an initial threshold appre-

ciation price multiplier of 1.50, and a purchase price multi-

plier of .75. Although the MSPA allowed TAC to settle with

either cash or securities, the transaction schedule deleted the

cash settlement option.

On May 9, 2000, TAC, DLJ, and WTC entered into a pledge

agreement with respect to the stock subject to transaction 1.

As stated previously, transaction 1 was divided into six

tranches, corresponding to six pricing schedules. Three of the

six pricing schedules were for a total of 4 million shares of

UPR common stock. The other three were for a total of

2,217,903 shares of Anadarko Petroleum Corp. (APC) common

stock.

The pricing schedule for T1T1 was dated May 12, 2000,

and was for 1.5 million shares of UPR common stock. T1T1

had an average hedge price of $21.49. 7 TAC received an

upfront cash payment of $24,181,087 for T1T1. DLJ executed

a share-lending notice, establishing a borrowing tranche cor-

responding to T1T1. The borrowing tranche was for 1.5 mil-

lion shares of stock. DLJ actually borrowed 1,449,000. TAC

received a prepaid lending fee of $1,640,143 for these shares.

The pricing schedule for T1T2 was dated May 12, 2000,

and was for 1.5 million shares of UPR common stock. T1T2

had an average hedge price of $21.49. TAC received an

7 All prices are rounded to two decimal places.

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(78) ANSCHUTZ CO. v. COMMISSIONER 91

upfront cash payment of $24,181,087 for T1T2. DLJ executed

a share-lending notice, establishing a borrowing tranche cor-

responding to T1T2. The borrowing tranche was for 1.5 mil-

lion shares of stock. DLJ actually borrowed 1,449,000. TAC

received a prepaid lending fee of $1,640,143 for these shares.

The pricing schedule for T1T3 was dated June 9, 2000, and

was for 1 million shares of UPR common stock. T1T3 had an

average hedge price of $23.76. TAC received an upfront cash

payment of $17,818,725 for T1T3. DLJ executed a share-

lending notice, establishing a borrowing tranche cor-

responding to T1T3. The borrowing tranche was for 1 million

shares of stock. DLJ actually borrowed 1 million. TAC received

a prepaid lending fee of $1,131,914 for these shares.

On July 14, 2000, UPR merged with APC. As a result, the

4 million shares at issue in tranches T1T1 through T1T3

were converted to 1,820,000 shares of APC common stock. The

3,898,000 shares actually lent pursuant to lending tranches

established under T1T1 through T1T3 were converted to

1,773,590 shares of APC common stock. Further, tranches 4–

6, discussed below, dealt with shares of APC common stock,

not UPR common stock.

The pricing schedule for T1T4 was dated August 8, 2000,

and was for 951,117 shares of APC common stock. T1T4 had

an average hedge price of $49.85. TAC received an upfront

cash payment of $35,559,530 for T1T4. DLJ executed a share-

lending notice, establishing a borrowing tranche cor-

responding to T1T4. The borrowing tranche was for 951,117

shares of stock. DLJ actually borrowed 747,182. TAC received

a prepaid lending fee of $2,370,635 for these shares.

The pricing schedule for T1T5 was dated August 10, 2000,

and was for 633,393 shares of APC common stock. T1T5 had

an average hedge price of $52.49. TAC received an upfront

cash payment of $24,937,189 for T1T5. DLJ executed a share-

lending notice, establishing a borrowing tranche cor-

responding to T1T5. The borrowing tranche was for 633,393

shares of stock. DLJ actually borrowed 523,984. TAC received

a prepaid lending fee of $1,662,479 for these shares.

The pricing schedule for T1T6 was dated August 10, 2000,

and was for 633,393 shares of APC common stock. T1T6 had

an average hedge price of $52.49. TAC received an upfront

cash payment of $24,937,189 for T1T6. DLJ executed a share-

lending notice, establishing a borrowing tranche cor-

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92 135 UNITED STATES TAX COURT REPORTS (78)

responding to T1T6. The borrowing tranche was for 633,393

shares of stock. DLJ actually borrowed 523,984. TAC received

a prepaid lending fee of $1,662,479 for these shares.

b. Transaction 2

On December 5, 2000, TAC and DLJ executed a transaction

schedule for transaction 2 for 2 million shares of Union

Pacific Corp. (UPC) common stock. It was later amended to

allow for a maximum of 3 million shares of UPC common

stock. The transaction schedule for transaction 2 stated an

effective date of December 5, 2000, a range of maturity dates,

a hedging termination date of January 30, 2001, an initial

threshold appreciation price multiplier of 1.50, and a pur-

chase price multiplier of .75. The transaction schedule fur-

ther stated that transaction 2 could not be settled in cash.

On December 5, 2000, TAC and DLJ executed a pledge

agreement for the shares subject to transaction 2. On Feb-

ruary 9, 2001, DLJ and WTC, as agent for TAC, entered into

an SLA with respect to the shares at issue in transaction 2.

Transaction 2 was executed through three pricing sched-

ules. The pricing schedule for T2T1 was dated January 4,

2001, and was for 750,000 shares of UPC common stock. T2T1

had an average hedge price of $50.56. TAC received an

upfront cash payment of $28,440,562 for T2T1. DLJ executed

a share-lending notice, establishing a borrowing tranche cor-

responding to T2T1. The borrowing tranche was for 750,000

shares of stock. DLJ actually borrowed 750,000. TAC received

a prepaid lending fee of $1,896,037 for these shares.

The pricing schedule for T2T2 was dated January 4, 2001,

and was for 750,000 shares of UPC common stock. T2T2 had

an average hedge price of $51.09. TAC received an upfront

cash payment of $28,742,681 for T2T2. DLJ executed a share-

lending notice, establishing a borrowing tranche cor-

responding to T2T2. The borrowing tranche was for 750,000

shares of stock. DLJ actually borrowed 750,000. TAC received

a prepaid lending fee of $1,916,178 for these shares.

The pricing schedule for T2T3 was dated January 16, 2001,

and was for 1.5 million shares of UPC common stock. T2T3

had an average hedge price of $51.61. TAC received an

upfront cash payment of $58,061,250 for T2T3. DLJ executed

a share-lending notice, establishing a borrowing tranche cor-

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(78) ANSCHUTZ CO. v. COMMISSIONER 93

responding to T2T3. The borrowing tranche was for 1.5 mil-

lion shares of stock. DLJ actually borrowed 1.5 million shares.

TAC received a prepaid lending fee of $3,870,750 for these

shares.

c. Transaction 3

On April 5, 2001, TAC and DLJ executed a transaction

schedule for transaction 3 to execute a stock transaction with

respect to a maximum of 2 million shares of UPC common

stock.

On April 5, 2001, TAC, DLJ, and WTC entered into a pledge

agreement with respect to the shares subject to transaction

3. WTC, as agent for TAC, and DLJ entered into an SLA with

respect to the shares of transaction 3.

Transaction 3 consisted of only one pricing schedule for all

2 million shares at issue. The pricing schedule for T3T1 was

dated April 25, 2001, and had an average hedge price per

share of $56.07. TAC received an upfront cash payment of

$84,109,350 for T3T1. DLJ executed a share-lending notice,

establishing a borrowing tranche corresponding to T3T1. The

borrowing tranche was for 2 million shares of stock. DLJ actu-

ally borrowed 2 million shares. TAC received a prepaid

lending fee of $5,607,290 for these shares.

d. Total Payments Received

received upfront payments under the PVFCs totaling

TAC

$350,968,652 and $23,398,050 in prepaid lending fees under

the SLAs.

6. Later Years

a. Amendments to Documentation

The parties to the MSPA have continued to monitor the

transactions with regard to their business goals. DLJ, for

instance, has continued to adjust its hedges under the PVFCs.

The MSPA, pledge agreements, and SLAs were amended on

June 13, 2003, to reflect DLJ’s being acquired by CSFB and to

introduce the concept of ‘‘share reduction cash payments’’.

This amendment dealt with cash dividends or dividend

equivalent payments received by TAC with respect to the

stocks subject to the transactions at issue. The share reduc-

tion program gave TAC two options: (1) It would pay DLJ cash

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94 135 UNITED STATES TAX COURT REPORTS (78)

equal to any cash dividends or dividend equivalent pay-

ments; or (2) use the payments to acquire additional shares

of the particular stock at issue and pledge those additional

shares as collateral under the pledge agreements.

b. Share Recalls

In 2006, during respondent’s audit of petitioners, TAC

recalled a portion of the shares pursuant to its authority

under the SLAs. The decision to recall shares was an attempt

by petitioners to show respondent that the SLAs were valid.

Shortly before trial, petitioners recalled the remaining

shares lent under the SLAs. The shares of stock were recalled

to again show the legitimacy of the SLAs and TAC’s right of

recall. In both instances, TAC paid DLJ a pro rata portion of

the prepaid lending fee, as required by the SLAs.

7. Settling the PVFCs at Maturity

The PVFCs will be settled at their maturity dates when it

will be determined how many shares, or the cash equivalent,

must be delivered to DLJ (the settlement shares). The MSPA

sets out the process for calculating the settlement shares or

amount of cash that TAC must deliver.

The number of settlement shares required to be delivered

at a PVFC’s maturity date is determined by multiplying the

base number of shares in each tranche by the average settle-

ment ratio. The average settlement ratio will be calculated

before the maturity date and is determined by reference to

the adjusted settlement price.

The adjusted settlement price will be the New York Stock

Exchange trading value multiplied by the distribution adjust-

ment factor. The distribution adjustment factor is applied in

order to account for any distributions made with respect to

the stock at issue at or near the maturity date.

Once the adjusted settlement price is calculated, it will be

compared to the downside protection threshold price and the

threshold appreciation price, which, as discussed above, pro-

vided the range of values in which TAC would keep some

appreciation of the stock.

If the adjusted settlement price was less than or equal to

the downside protection threshold price, the average settle-

ment ratio will be 1. Applying a ratio of 1 to the base number

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(78) ANSCHUTZ CO. v. COMMISSIONER 95

of shares means that TAC will be required to deliver at most

the base number of shares and will not have to return any

additional value to DLJ. In effect, if the adjusted settlement

price was less than or equal to the downside protection

threshold price, then TAC just had to deliver the number of

shares at issue in the tranche. No matter how far the value

of the stock fell, TAC would not have to return any portion

of the upfront cash payment. Thus, the downside threshold

protection price locked in a minimum value that TAC was

guaranteed to receive credit for.

If the adjusted settlement price was between the downside

protection threshold price and the threshold appreciation

price, the average settlement ratio was a ratio that when

applied to the base number of shares in each tranche would

reduce TAC’s ultimate delivery obligation by a certain number

of shares. The shares TAC was entitled to keep would be

equal in value to any appreciation of the stock that TAC was

entitled to retain.

If the adjusted settlement price was greater than the

threshold appreciation price, the average settlement ratio

was a fraction that when applied to the base number of

shares in each tranche would allow TAC to keep the first 50

percent of appreciation and allow any excess appreciation to

go to DLJ as previously explained.

Once the average settlement ratio was determined, it was

multiplied by the base number of shares in each tranche. TAC

was then required to deliver that number of shares to DLJ to

satisfy its obligation under the PVFCs. The shares used to

settle the PVFCs could be those in TAC’s collateral accounts at

WTC (to which the lent shares were returned) or similar

shares. Alternatively, cash could be used to make the settle-

ment payment.

8. Procedural Posture

Mr. Anschutz and Anschutz Co. treated the PVFC portions

of the MSPA as open transactions and not as closed sales of

stock. Neither reported gain or loss from the stock trans-

actions on his or its Federal income tax returns.

TAC had bases during 2000 of $0.87 and $1.91, respectively,

in the UPR and APC shares subject to transaction 1. TAC had

a basis of $1.51 during 2001 in the UPC shares subject to

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96 135 UNITED STATES TAX COURT REPORTS (78)

transactions 2 and 3. On August 22, 2007, respondent issued

a notice of deficiency to Anschutz Co. for tax years 2000 and

2001. The notice of deficiency determined that TAC had

entered into closed sales of stock, had received 100 percent

of the fair market value for the stock, and thus was liable

for section 1374 built-in gains tax in 2000 and 2001 to the

extent the value received exceeded Anschutz Co.’s basis in

the stock. The built-in gains tax was calculated by reference

to the shares of stock that were pledged to WTC, then bor-

rowed by DLJ. The deficiencies do not include shares pledged

as collateral by TAC but not borrowed by DLJ.

Because S corporations are flow-through entities, the built-

in gain respondent determined on Anschutz Co.’s returns,

less the tax on that gain, then flowed to Mr. Anschutz. On

August 22, 2007, respondent issued a notice of deficiency to

Mr. Anschutz for 2000 and 2001. The notice of deficiency

determined deficiencies in Mr. Anschutz’s income tax with

respect to the adjustments to Anschutz Co.’s tax liabilities.

On August 21, 2007, Anschutz Co. filed its petition in

docket No. 18942–07. On August 23, 2007, Mr. Anschutz

filed his petition in docket No. 19083–07. A trial in these

consolidated cases was held on February 9–10, 2009, in

Washington, D.C.

Respondent submitted an expert report in support of his

position that closed sales of stock occurred in 2000 and 2001.

Petitioners submitted a report in rebuttal.

OPINION

The Commissioner’s determinations in the notice of defi-

ciency are presumed correct, and the taxpayer bears the bur-

den of proving, by a preponderance of the evidence, that

these determinations are incorrect. Rule 142(a)(1); Welch v.

Helvering, 290 U.S. 111, 115 (1933). Under section 7491(a),

if the taxpayer produces credible evidence with respect to

any factual issue relevant to ascertaining the taxpayer’s

liability and meets other requirements, the burden of proof

shifts from the taxpayer to the Commissioner as to that fac-

tual issue. Neither party addressed the burden of proof.

Because we decide this case on the basis of the preponder-

ance of the evidence, we need not decide upon which party

the burden rests.

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(78) ANSCHUTZ CO. v. COMMISSIONER 97

Section 61(a)(3) provides that gross income includes gains

derived from dealings in property. Section 1001(a) provides

that the gain from the sale or other disposition of property

shall be the excess of the amount realized over the adjusted

basis, as calculated by reference to section 1011.

The stocks at issue were owned by TAC, a qualified sub-

chapter S subsidiary. Normally, an S corporation is not

subject to Federal income taxes. Sec. 1363(a). Like a partner-

ship, it is a conduit through which income and loss flow to

its shareholders. Normally, if an S corporation disposes of

stock, any gain on the disposition will flow to the corpora-

tion’s owners.

Anschutz Co. elected S corporation status on August 1,

1999. Anschutz Co. also elected to treat TAC as a qualified

subchapter S subsidiary under section 1361(b)(3)(B). As a

result, all income, deductions, and credits of TAC were includ-

able in Anschutz Co.’s Federal income tax returns for 2000

and 2001.

Section 1374(a) provides an exception to the general rule

of flow-through treatment. Section 1374(a) imposes a cor-

porate-level tax on the net recognized built-in gain of an S

corporation that has converted from C corporation to S cor-

poration status. The tax generally applies to built-in gain

recognized during the 10-year period beginning with the first

taxable year for which the corporation is an S corporation.

See sec. 1374(d)(7). Built-in gain is measured by the appre-

ciation of any asset over its adjusted basis at the time the

corporation converts from C corporation to S corporation

status. N.Y. Football Giants, Inc. v. Commissioner, 117 T.C.

152, 155 (2001); see sec. 1374(d)(3). An S corporation gen-

erally is not liable for the built-in gains tax on the disposi-

tion of any asset if it establishes that it did not own the asset

on the day it converted from C to S status, or that the fair

market value of the asset was less than its adjusted basis on

the first day of the first taxable year for which it was an S

corporation. N.Y. Football Giants, Inc. v. Commissioner,

supra at 155.

TAC owned the stock at issue and entered into the stock

transactions with DLJ. Because the fair market value of the

stock exceeded its adjusted basis on the first day TAC became

a qualified subchapter S subsidiary, the built-in gains tax

will be triggered if the stock transactions are treated as com-

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98 135 UNITED STATES TAX COURT REPORTS (78)

pleted sales for Federal income tax purposes. Because TAC is

treated as a qualifying subchapter S subsidiary, its assets,

liabilities, and items of income and deductions are attributed

to its parent, Anschutz Co. Petitioners concede that if we find

the PVFCs and the SLAs constitute sales for Federal tax pur-

poses, then the built-in gains tax will apply.

Because Anschutz Co. is an S corporation, Mr. Anschutz

would normally have to report Anschutz Co.’s income on his

own return. Section 1366(f)(2) provides that any section 1374

tax paid by an S corporation is treated as a loss sustained

by that corporation. N.Y. Football Giants, Inc. v. Commis-

sioner, supra at 157 & n.5. If we find that Anschutz Co. was

required to report gain upon TAC’s entering into the MSPA,

Anschutz Co. will be required to pay built-in gains tax. This

tax will then be treated as a loss for Anschutz Co. See sec.

1366(f)(2). Treating the stock transactions as closed sales will

have an impact on Mr. Anschutz’s distributive share of

Anschutz Co.’s income and loss, consisting of an increase in

his income to the extent the gain from sale treatment

exceeds the built-in gains tax. Accordingly, respondent deter-

mined deficiencies in Mr. Anschutz’s income tax as a result

of determining that built-in gain from the stock transactions

was attributable to Anschutz Co.

Respondent puts forth two arguments in support of his

determinations: (1) That the MSPA triggered a sale under sec-

tion 1001; and (2) that there was a constructive sale under

either section 1259(c)(1)(A) or (C). We will address each in

turn.

I. Section 1001 Sale of Stock

A. Respondent’s Argument

Respondent argues that TAC’s transfers of stock during

2000 and 2001 should be treated as closed transactions for

Federal tax purposes. His argument comprises three parts:

(1) TAC transferred legal title and the benefits and burdens

of ownership; (2) the SLAs are not true lending arrangements,

but a way for TAC to deliver the shares of stock to DLJ; and

(3) TAC transferred the shares to DLJ in exchange for an

ascertainable amount of consideration equal to 100 percent of

the fair market value of the stock.

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(78) ANSCHUTZ CO. v. COMMISSIONER 99

To determine whether an agreement transfers substan-

tially all of the incidents of ownership, we look at all of the

facts and circumstances surrounding the transfer, relying on

objective evidence of the parties’ intentions provided by their

overt acts. Ragghianti v. Commissioner, 71 T.C. 346, 349–350

(1978); Pac. Coast Music Jobbers, Inc. v. Commissioner, 55

T.C. 866, 874 (1971), affd. 457 F.2d 1165 (5th Cir. 1972);

Dunne v. Commissioner, T.C. Memo. 2008–63.

In Dunne v. Commissioner, supra, we compiled the fol-

lowing nonexclusive factors that are evaluated in deter-

mining whether a transaction transfers the accoutrements of

stock ownership:

(1) Whether the taxpayer has legal title or a contractual

right to obtain legal title in the future;

(2) whether the taxpayer has the right to receive consider-

ation from a transferee of the stock;

(3) whether the taxpayer enjoys the economic benefits and

burdens of being a shareholder;

(4) whether the taxpayer has the power to control the com-

pany;

(5) whether the taxpayer has the right to attend share-

holder meetings;

(6) whether the taxpayer has the ability to vote the shares;

(7) whether the stock certificates are in the taxpayer’s

possession or are being held in escrow for the benefit of that

taxpayer;

(8) whether the corporation lists the taxpayer as a share-

holder on its tax return;

(9) whether the taxpayer lists himself as a shareholder on

his individual tax return;

(10) whether the taxpayer has been compensated for the

amount of income taxes due by reason of shareholder status;

(11) whether the taxpayer has access to the corporate

books; and

(12) whether the taxpayer shows by his overt acts that he

believes he is the owner of the stock.

No one factor is necessarily determinative, and the weight of

a factor in each case depends on the surrounding facts and

circumstances. Id.

Respondent argues that in determining whether a sale

occurred, we must look at all relevant documents to deter-

mine whether TAC has transferred the indicia of ownership.

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100 135 UNITED STATES TAX COURT REPORTS (78)

Respondent contends that this includes the MSPA, all trans-

action schedules, all pledge agreements, and all SLAs.

Respondent argues that all of these documents must be ana-

lyzed because they are interrelated and the parties treated

the PVFCs and the SLAs as one transaction.

1. Did TAC Transfer Legal Title and the Benefits and Bur-

dens of Ownership?

Respondent points out that TAC transferred legal title to

the stock but concedes that transfer of title without transfer

of the benefits and burdens of the stock might not qualify as

a sale for Federal tax purposes. Respondent further argues

that TAC transferred the benefits and burdens of ownership

upon entering into the MSPA, including: (1) The right to vote

the pledged shares as a shareholder; (2) control and the right

to dispose of the pledged shares; and (3) substantially all of

TAC’s economic rights in the pledged shares. TAC received

substantial upfront cash payments for the shares.

2. Were the SLAs Legitimate Share-Lending Agreements?

Although respondent next argues that TAC transferred a

number of indicia of ownership to DLJ, were we to give effect

to the SLAs according to their terms, TAC’s ability to recall

the shares would accordingly return those rights and indicia

of ownership to TAC. To that end, respondent argues that the

SLAs were not true share-lending agreements but merely a

means of delivering the shares to DLJ pursuant to stock

sales. If we agree with respondent that the SLAs were not

true share-lending agreements and the shares of stock could

not actually be recalled, it would support respondent’s argu-

ments that the benefits and burdens of stock ownership were

transferred to DLJ along with legal title to the pledged stock.

Respondent’s argument concerning the SLAs is based on his

contention that the SLAs do not conform with industry stand-

ards governing typical share-lending agreements. Respondent

contends that TAC’s SLAs lack the following attributes nor-

mally found in a share-lending agreement: (1) A pledge of

liquid collateral; (2) a securities lending fee payable by the

borrower; (3) a right exercisable by the lender to receive dis-

tributions payable on the securities; and (4) a right exer-

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(78) ANSCHUTZ CO. v. COMMISSIONER 101

cisable by the lender to demand return of the lent shares

without substantial conditions or restrictions.

3. TAC Received 100 Percent Value in 2000 and 2001

Respondent argues that TAC received 100 percent of the

fair market value of the pledged shares in 2000 and 2001,

not only the cash payments equal to 80 percent of the fair

market value of the stock at that time.

As discussed above, TAC is entitled to retain any stock

value above the downside protection threshold price and

below or equal to the threshold appreciation price.

Respondent argues that this right can be valued as an equity

option. Respondent also argues that TAC’s right to any divi-

dends can also be valued as an equity option. Respondent

relies on his expert report in calculating the fair market

values of these options.

Respondent contends that because the SLAs are not legiti-

mate, any additional value that TAC is entitled to keep at the

PVFC maturity dates is more properly viewed as a payment

from DLJ to TAC than as TAC’s retaining shares of stock. In

accordance with this view, respondent contends that TAC,

instead of being able to retain shares, was given equity

options that would pay out should the stock appreciate or

any dividends be paid out on the stocks.

Respondent’s valuation of this equity option and the divi-

dend option and DLJ’s fees for entering into the transactions

make up the difference between the 80 percent of the fair

market value of the shares received as cash and 100 percent

of the fair market value of the stock at the time TAC and DLJ

entered into the transaction.

Respondent contends that TAC received the 100 percent as

follows: (1) 75 percent of the fair market value as the upfront

cash payment under the pricing schedules; (2) 5 percent of

the fair market value as the prepaid lending fee; (3) an

equity option equal in value to the present value of any

appreciation in the pledged shares above the downside

protection threshold and not in excess of the threshold appre-

ciation price; (4) a dividend option equal in value to the

present value of any dividend rights over the term of the

PVFCs; and (5) the remainder as DLJ’s fees for entering into

and structuring the transaction.

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102 135 UNITED STATES TAX COURT REPORTS (78)

B. Petitioners’ Argument

Petitioners argue that TAC executed two separate trans-

actions—PVFCs and SLAs—and neither constitutes a current

sale for Federal tax purposes.

Petitioners argue that the PVFCs are not current sales

because the identity and quantity of stock being sold will not

be determinable until the PVFC maturity dates. Petitioners

contend that the taxpayer’s basis, the holding period, and the

number of securities to be sold cannot be known until the

future delivery date, and it is therefore impossible for the

parties to know how many shares will be sold and whether

TAC will ultimately realize a gain or loss on the transaction.

Petitioners rely heavily on Rev. Rul. 2003–7, 2003–1 C.B.

363, and argue that the PVFCs at issue are substantially

identical to those addressed in the revenue ruling. In Rev.

Rul. 2003–7, supra, the taxpayer entered into a forward con-

tract with an investment bank to deliver a variable number

of shares of stock, depending on the fair market value of the

stock on the delivery date.

The sale agreement required the taxpayer to pledge as

collateral the maximum number of shares that might have to

be delivered at maturity. Rev. Rul. 2003–7, supra, states that

the taxpayer informed his counterparty bank that he

intended to use the shares pledged as collateral to satisfy his

ultimate delivery obligation.

The taxpayer received an upfront payment in exchange for

his obligation to deliver stock at a later date and had the

unrestricted right to deliver the pledged shares, cash, or

identical shares to satisfy his delivery obligation. The rev-

enue ruling held that the taxpayer had not caused a sale

under section 1001.

Petitioners assert that any differences between the instant

case and the PVFCs in Rev. Rul. 2003–7, supra, are immate-

rial, including the fact that the transaction schedules for

transactions 1 and 2 deleted the cash settlement option. Peti-

tioners point to testimony by DLJ employees that TAC could

settle in cash, rather than in shares, because it made no dif-

ference to the bank. Petitioners further contend that their

position is stronger than that of the taxpayer in Rev. Rul.

2003–7, supra, because, unlike the taxpayer in the ruling,

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(78) ANSCHUTZ CO. v. COMMISSIONER 103

TAC never stated to DLJ that it intended to cover the PVFCs

with the shares pledged as collateral.

Petitioners concurrently argue that the SLAs are not cur-

rent sales. Petitioners point to longstanding caselaw that has

held share lending not to be current sales and contend that

Congress’ enactment of section 1058 in 1997 reaffirms the

tax-free nature of share-lending transactions.

Petitioners contend that the SLAs at issue satisfy the

requirements of section 1058, which provides a special rule

for determining taxation under agreements that call for the

lending of shares of stock. Section 1058(a) provides that if a

taxpayer transfers securities subject to an agreement that

meets the requirements of section 1058(b), no gain or loss

shall be recognized on the transfer in exchange for a promise

to return identical shares at the end of the agreement period.

Section 1058(b) imposes four requirements that must be met

in order to satisfy that subsection.

(1) The agreement must provide for the return of identical

securities. Sec. 1058(b)(1).

(2) If dividends, interest, or equivalent payments are made

between the initial transfer by the transferor and the return

of identical securities by the transferee with respect to the

transferred shares, the agreement must provide for the pay-

ment of those amounts to the transferor. Sec. 1058(b)(2).

(3) The agreement must not reduce the risk of loss or

opportunity for gain of the transferor in the securities trans-

ferred. Sec. 1058(b)(3).

(4) The agreement must meet any further requirements

that the Secretary has prescribed by regulation. Sec.

1058(b)(4).

Petitioners argue that the SLAs do not violate section

1058(b) because: (1) DLJ is required to return shares to TAC

of the same issuer, class, and quantity as those borrowed; (2)

while the share loans are outstanding, DLJ is required to pay

TAC amounts equal to all interest, dividends, and other pay-

ments with respect to the lent shares; (3) the SLAs do not

reduce TAC’s risk of loss or opportunity for gain in the bor-

rowed shares.

Petitioners dispute respondent’s contention that the SLAs

are illusory and violate section 1058(b) because the PVFCs

limit TAC’s risk of loss. Petitioners argue that we should look

only at the documents connected with the SLAs themselves,

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104 135 UNITED STATES TAX COURT REPORTS (78)

not those connected with the PVFCs. Petitioners point to

Samueli v. Commissioner, 132 T.C. 37, 48–49 (2009), and

contend that this Court has rejected the idea that section

1058 allows looking beyond the lending agreement itself to

simultaneously executed hedging transactions. In Samueli v.

Commissioner, supra at 47, this Court held that a share-

lending did not meet the requirements of section 1058(b)

because it strictly limited the transferor’s ability to recall the

shares, thus reducing the transferor’s opportunity for gain.

Petitioners point to proposed but never finalized regula-

tions issued under section 1058 and contend that the deter-

mination of whether a share-lending agreement limits a

lender’s risk of loss is made by reference to the lender’s

ability to recall the lent shares. The proposed regulations

indicate that an agreement to lend shares that allows the

lender to terminate the loan upon notice of not more than 5

business days does not limit the lender’s risk of loss. Peti-

tioners argue that because the SLAs can be terminated upon

TAC’s demand and because the SLAs are separate and distinct

from the PVFCs, they do not limit TAC’s risk of loss and there-

fore satisfy the requirements of section 1058.

Petitioners conclude that because the PVFCs and the SLAs

do not require petitioners to recognize gain, respondent’s

determinations should not be upheld.

C. Analysis

1. Was There a Sale?

We agree with respondent that the shares subject to the

VPFCs and lent pursuant to the SLAs were sold for Federal

income tax purposes. TAC transferred the benefits and bur-

dens of ownership to DLJ in exchange for valuable consider-

ation. Petitioners must recognize gain in an amount equal to

the upfront cash payments received upon entering into the

transactions.

TAC entered into an integrated transaction comprising two

legs, one of which called for share lending. The transaction

comprised PVFCs and SLAs. The two legs were clearly related

and interdependent, and both were governed by the MSPA.

The MSPA required TAC to enter into a pledge agreement

upon execution of a transaction schedule, and the pledge

agreement required WTC to enter into an SLA with DLJ upon

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(78) ANSCHUTZ CO. v. COMMISSIONER 105

execution of a pledge agreement. Further, if DLJ could not

maintain its hedges (hedges based on TAC’s lending shares to

DLJ), DLJ could accelerate the PVFCs.

Lending the shares subject to the PVFCs was a vital part

of the transaction and was contemplated during the parties’

negotiations. While evaluating DLJ’s potential as a source of

financing, TAC and its executives viewed presentations by DLJ

as to how the transactions at issue would occur. The presen-

tation provided an overview of a transaction as a whole and

stated that DLJ would borrow shares from TAC pursuant to

the SLAs to cover its initial short sale obligation.

This is in line with testimony of TAC and DLJ executives

involved in the planning and negotiating of the transactions.

Scott Carpenter, a managing director of the Anschutz Invest-

ment Co., who was involved in the negotiations of the stock

transactions, testified that the MSPA required execution of

the pledge agreements, and the pledge agreements required

execution of the SLAs. Philip Turbin, employed by DLJ during

the negotiations with TAC, testified that the borrowed shares

were used to close out the initial short sales. This is in line

with the overall structure of the transaction as initially pre-

sented to TAC.

Petitioners argue that our decision in Samueli supports

their contention that the SLAs were separate and distinct

from the PVFCs. We disagree. The taxpayers in Samueli

argued that the reduction of their opportunity for gain

should not be determinative because they could have entered

into a separate hypothetical transaction. Samueli v. Commis-

sioner, supra at 48–49. This Court rejected the taxpayers’

argument and analyzed the parties’ actual agreement under

section 1058. Id.

Petitioners mischaracterize the Court’s ruling in Samueli

when they argue that the PVFCs are outside the lending

agreement. We have held that the agreement consists of both

the SLAs and the PVFCs.

If we analyze the MSPA as a whole, it is clear that TAC

transferred the benefits and burdens of ownership, including:

(1) Legal title to the shares; (2) all risk of loss; (3) a major

portion of the opportunity for gain; (4) the right to vote the

stock; and (5) possession of the stock.

Neither petitioner nor respondent disputes that TAC trans-

ferred legal title to the stock. Likewise, neither party dis-

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106 135 UNITED STATES TAX COURT REPORTS (78)

putes that TAC did not possess the stock or have the oppor-

tunity to vote the stock.

Analyzing the MSPA makes clear that TAC transferred all

risk of loss and most of the opportunity for gain with regard

to the stock subject to the PVFCs and lent to DLJ. TAC received

75 percent of the cash value of the stock up front. Even if the

stock value fell over the term of the PVFCs, TAC would

not have to pay any of this amount back. DLJ could do with

the lent stock whatever it wanted and in fact disposed of the

stock almost immediately to close out its original short sales.

The parties focus on the validity of TAC’s right to recall the

stock lent to DLJ. Petitioners argue that the ability to recall

the shares means that TAC only temporarily transferred the

benefits and burdens of ownership but could recall the stock

at any time. Thus, in petitioners’ view, although TAC trans-

ferred legal title, possession, the right to vote, risk of loss,

and most opportunity for gain, the transfer was only tem-

porary and could be rescinded at any time upon notice to

WTC and DLJ.

Respondent argues that the recalls should be ignored

because they were shams meant to influence the result of

this case. In respondent’s view, if we ignore the recalls, peti-

tioner could not recall the benefits and burdens of ownership.

Although we agree with petitioners that TAC could recall

the shares, the recalls were accomplished only to influence

the tax analysis. The recalls were not a foreseeable economi-

cally motivated event when the transactions at issue were

structured. They were rather an after-the-fact effort to

change the earlier tax effect which was fixed in 2000 and

2001.

Once TAC lent shares to DLJ, DLJ used them to close out its

original short sales. For all intents and purposes, those lent

shares were gone and could not be recovered.

The transaction documents support a finding that the

share recalls were really TAC borrowing shares from DLJ.

Because DLJ closed out its original short sales with the lent

shares, the shares later transferred to TAC were in substance

DLJ borrowing shares from third parties and delivering them

to TAC. Pursuant to the MSPA, TAC was required to pay back

the prepaid lending fee plus an additional amount if DLJ’s

borrowing costs exceeded the amount of the prepaid lending

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(78) ANSCHUTZ CO. v. COMMISSIONER 107

fee. With regard to the 2009 share recalls, TAC was required

to bear any additional borrowing costs of DLJ.

Accordingly, we find that TAC transferred the benefits and

burdens of ownership to DLJ in 2000 and 2001, and the later

recalls were in substance a separate event akin to TAC bor-

rowing shares.

Petitioners cannot avail themselves of section 1058. The

MSPA violates the requirement of section 1058(b)(3) that the

agreement not limit the lender’s risk of loss or opportunity

for gain. The MSPA eliminated TAC’s risk of loss with regard

to the lent shares.

The crux of petitioners’ argument with regard to section

1058 is that the PVFCs are separate from the SLAs and that

none of the transactions conducted pursuant to the PVFCs

and the SLAs are taxable events. Petitioners’ argument might

hold true if the SLAs were separate and distinct from the

PVFCs. However, the two are linked, and we cannot turn a

blind eye to one aspect of the transaction in evaluating

another.

TAC entered into one agreement that called for the lending

of shares and limited its risk of loss. Once the PVFCs and the

SLAs are viewed together, it is clear that the MSPA violates

section 1058(b)(3) because the MSPA limited TAC’s risk of loss

under the agreement through its use of the downside protec-

tion threshold. The downside protection threshold guaran-

teed that no part of the payment, equal to 75 percent of the

fair market value of the stock, received by TAC at initiation

of the agreement would have to be paid back when the PVFCs

were ultimately settled. At settlement, if the adjusted stock

price was at or below the downside protection threshold, the

average settlement ratio was 1. This meant that the max-

imum TAC had to deliver was the base number of shares in

each tranche without any regard to the fair market value of

those shares.

We can look to tranche T1T1 as an example. That tranche

had an average hedge price of $21.49 and was for 1.5 million

shares of UPR stock. TAC received an upfront payment of

$24,181,087 for agreeing to deliver a variable number of

shares 10 to 11 years in the future. Because of the loss

limitation, TAC would never have to return that upfront pay-

ment. Even if the stock dropped to $1 a share, TAC would not

have to account for this devaluation by giving back any por-

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108 135 UNITED STATES TAX COURT REPORTS (78)

tion of their upfront payment. Petitioners could not lose any

value per share if the fair market value dropped below the

downward protection threshold price. This limitation of the

risk of loss under the agreement violates section 1058(b)(3).

Petitioners contend that TAC’s risk of loss was not limited

because TAC could recall the shares. This argument is not

convincing because it ignores the impact of the PVFCs. We

cannot ignore that the SLAs were coupled with the PVFCs.

Petitioners argue that the transactions are in no way related;

but as discussed above, this is not credible.

The parties entered into an agreement to sell and lend

shares by integrated transactions. The PVFCs and the SLAs

were clearly related. One could not occur without the other.

To the extent that petitioners argue TAC and DLJ could have

entered into the PVFCs without corresponding share-lending

agreements, that hypothetical transaction is not before the

Court. The transaction before the Court transferred the bene-

fits and burdens of ownership of the lent shares, and peti-

tioners do not satisfy the section 1058 safe harbor.

2. What Must Petitioners Recognize?

We next determine the amount of gain petitioners must

recognize on the MSPA. Respondent argues that TAC received

value equal to 100 percent of the fair market value of the

shares that were subject to the PVFCs and were lent pursuant

to the SLAs. We disagree. Petitioners are required to recog-

nize gain only to the extent TAC received cash payments in

2000 and 2001.

Respondent relies on his expert report in arguing that TAC

received 100 percent of the fair market value. Respondent’s

argument in support of his contention that TAC received 100

percent of the fair market value upfront is that the SLAs

were not legitimate and that TAC would never have posses-

sion of the shares after initially lending them to DLJ. Thus,

the PVFCs would never actually be settled within the terms

of the MSPA because TAC would never regain possession of the

shares and never have to calculate and return shares to DLJ.

Because TAC would never regain possession of the shares at

issue, any gain TAC might receive upon appreciation of the

stock was not really a retention of shares but could be viewed

as a payment from DLJ to TAC equal in value to any stock

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(78) ANSCHUTZ CO. v. COMMISSIONER 109

appreciation. Respondent’s expert testified that this payment

profile could be priced as the payout of equity options

received in 2000 and 2001.

Although certain portions of TAC’s contracts can be valued

as equity options representing TAC’s entitlement to some

appreciation in price and future dividends, whether peti-

tioners will ever receive that value will not be determined

until the contracts are settled. Further, as respondent’s

expert testified, the probability of the stock price’s being

above the downward protection threshold price is only 43 to

48 percent for TAC’s three transactions.

Respondent’s determinations, to the extent they treat peti-

tioners as having received additional value in excess of the

cash received, are incorrect. Accordingly, petitioners must

recognize gain to the extent TAC received cash upfront pay-

ments in 2000 and 2001, which would include the 75-percent

payment based upon the fair market value of shares and the

5-percent prepaid lending fee.

II. Section 1259 Constructive Sale

A. Respondent’s Arguments

Respondent argues in the alternative that TAC caused

constructive sales of the stock at issue. Respondent asserts

two alternative grounds for finding a constructive sale under

section 1259: A constructive short sale by TAC under section

1259(c)(1)(A) and a constructive forward contract sale under

section 1259(c)(1)(C).

Congress enacted section 1259 because it was concerned

that taxpayers holding appreciated equity positions were

entering into certain complex financial transactions in order

to sell their positions without paying any tax. Section

1259(a)(1) provides that if there is a constructive sale of an

appreciated financial position, the taxpayer shall recognize

gain as if such appreciated position were sold at its fair

market value on the date of such constructive sale. Any gain

shall be taken into account for the taxable year during which

the constructive sale occurred. Sec. 1259(a)(1). Section

1259(b)(1) provides in pertinent part that the term ‘‘appre-

ciated financial position’’ means any position with respect to

stock if there would be gain were such a position sold at its

fair market value.

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110 135 UNITED STATES TAX COURT REPORTS (78)

If a constructive sale of an appreciated financial position

occurs, section 1259(a)(2) provides rules for adjusting the

financial product’s basis and holding period. Section

1259(a)(2)(A) provides that the owner of the appreciated

financial position will increase his or her basis in that posi-

tion to account for the gain recognized on the constructive

sale. Further, the owner’s holding period for the financial

position will reset as of the date of the constructive sale.

These rules are intended to prevent an owner of an appre-

ciated financial position from having to recognize gain

twice—once as of the date of the constructive sale, and again

when the financial transaction leading to the constructive

sale treatment eventually closes.

Section 1259(c)(1) lists certain transactions that are

treated as constructive sales if entered into with respect to

an appreciated financial position. Three of the enumerated

transactions are relevant. Section 1259(c)(1)(A) provides that

a taxpayer shall be treated as having made a constructive

sale of an appreciated financial position if the taxpayer

enters into a short sale of the same or substantially identical

property. Section 1259(c)(1)(C) provides that a taxpayer is

treated as having made a constructive sale with respect to an

appreciated financial position if the taxpayer enters into a

futures or forward contract to deliver the same or substan-

tially identical property. Lastly, section 1259(c)(1)(E) allows

the Secretary to prescribe regulations describing transactions

that will be treated as constructive sales if they are substan-

tially similar in effect to those listed in section 1259(c)(1)(A)–

(D). Section 1259(d)(1) defines a forward contract as a con-

tract to deliver a substantially fixed amount of property

(including cash) for a substantially fixed price.

Respondent argues first that DLJ acted as an agent for TAC

and executed a short sale on TAC’s behalf for the stocks at

issue in the PVFCs. Respondent argues that the constructive

sale occurred as follows: (1) TAC informs DLJ that it intends

to sell shares of stock pursuant to a transaction schedule; (2)

DLJ, acting as TAC’s agent, engages in the short sales used to

generate the terms of a pricing schedule; (3) DLJ borrows

shares pursuant to an SLA; and (4) DLJ uses the borrowed

shares to close out the initial short sale.

Respondent argues in the alternative that the PVFCs

trigger a constructive sale under section 1259(c)(1)(C)

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(78) ANSCHUTZ CO. v. COMMISSIONER 111

because the MSPA is a forward contract to deliver ‘‘the same

or substantially identical property’’ as TAC’s appreciated

financial positions in the stock at issue.

B. Petitioners’ Arguments

Petitioners dispute respondent’s characterization of the

transaction as a constructive sale under either section

1259(c)(1)(A) or (C).

Petitioners argue that there could be no constructive short

sale under section 1259(c)(1)(A) because TAC did not cause

any short sales to occur. Petitioners argue that DLJ was not

acting as TAC’s agent but rather was a counterparty to the

transaction, and the decision to execute short sales was DLJ’s

alone.

Petitioners next argue that TAC did not cause a forward

contract constructive sale under section 1259(c)(1)(C) because

the PVFCs were not forward contracts: the number of shares

to be delivered is not a substantially fixed amount of prop-

erty. Petitioners again point to Rev. Rul. 2003–7, supra, and

argue that because the revenue ruling found 20 percent to be

a substantial variance, then 33.3 percent must be a substan-

tial variance.

C. Analysis

TACdid not cause constructive sales during 2000 and 2001.

TAC did not cause short sales of substantially similar prop-

erty or enter into forward contracts for a substantially fixed

amount of property. DLJ was not acting as an agent for TAC;

DLJ executed short sales in order to meet its contractual

obligations to TAC. Further, use of the short sales was DLJ’s

hedging transaction, a means for DLJ to limit its losses on its

purchase of TAC’s stocks should they decrease in value. The

constructive short sale provisions are intended to force a tax-

payer to recognize gain upon entering into short sales that

limit the taxpayer’s loss. TAC did not limit its loss through

short sales; DLJ did.

TAC’s transactions were likewise not constructive forward

contracts. As discussed above, a forward contract is treated

as a constructive sale if it is for a substantially fixed amount

of property for a substantially fixed price. Sec. 1259(c)(1)(C),

(d)(1). Section 1259 does not define the terms ‘‘substantially

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112 135 UNITED STATES TAX COURT REPORTS (78)

fixed amount of property’’ or ‘‘substantially fixed price’’. Sec-

tion 1259 gives the Secretary two sources of authority for

issuing regulations to carry out Congress’ intent—section

1259(c)(1)(E) and (f)—but no regulations have been issued

defining either phrase.

The legislative history provides some guidance as to deter-

mining whether a transaction is treated as a constructive

sale under section 1259. The Senate Finance Committee

report, S. Rept. 105–33, at 125–126 (1997), 1997–4 C.B. (Vol.

2) 1067, 1205–1206, in stating that a forward contract results

in a constructive sale only if it provides for delivery of a

substantially fixed amount of property at a substantially

fixed price, goes on to say that ‘‘a forward contract providing

for delivery of an amount of property, such as shares of

stock, that is subject to significant variation under the con-

tract terms does not result in a constructive sale.’’ The report

does not define or provide any guidance relative to the term

‘‘significant variation’’, and the Secretary has not issued any

regulations interpreting this term.

The Senate Finance Committee report provides more

detailed guidance when discussing the Secretary’s regulatory

authority under section 1259(c)(1)(E) to issue regulations to

carry out the purpose of section 1259. Id. at 126, 1997–4 C.B.

(Vol. 2) at 1206. Congress anticipated that the Secretary

would use his authority to issue regulations treating as

constructive sales financial transactions which, like those

listed in section 1259(c)(1), have the effect of eliminating

‘‘substantially all of the taxpayer’s risk of loss and oppor-

tunity for income or gain’’ with respect to the appreciated

financial position. Id. However, transactions in which the

taxpayer eliminated his risk of loss, or opportunity for

income or gain, but not both, were not to be treated as

constructive sales under section 1259. Id.

The report goes on to state that it is not intended that risk

of loss and opportunity for gain be considered separately. If

a transaction has the effect of eliminating substantially all of

the taxpayer’s risk of loss and substantially all of the tax-

payer’s opportunity for gain with respect to an appreciated

financial position, it is intended that the Secretary’s regula-

tions would treat the transaction as a constructive sale. Id.

Again, however, section 1259 and the legislative history do

not define ‘‘substantially all’’.

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(78) ANSCHUTZ CO. v. COMMISSIONER 113

Rev. Rul. 2003–7, supra, provides some limited guidance in

evaluating whether TAC’s PVFCs trigger constructive sale

treatment. In that revenue ruling the taxpayer entered into

a forward contract to deliver a variable number of shares of

stock, depending on the fair market value of the stock on the

delivery date. The taxpayer received an upfront payment in

exchange for his obligation to deliver stock at a later date.

The taxpayer’s delivery obligation varied by 20 shares: the

taxpayer would have to deliver no fewer than 80, and no

more than 100, shares of the stock at issue. The revenue

ruling held that the taxpayer had not entered into a

constructive sale under section 1259(c)(1)(C) because the

variation in the number of shares deliverable, 20, was signifi-

cant, and the agreement was not a contract to deliver a

substantially fixed amount of property for purposes of section

1259(d)(1).

TAC’s stock transactions were not forward contract

constructive sales because they were not forward contracts as

defined in section 1259(d)(1)—they did not provide for

delivery of a substantially fixed amount of property for a

substantially fixed price. Section 1259 does not define the

term ‘‘substantial’’, and the Secretary has not issued regula-

tions providing any additional guidance. TAC’s ultimate

delivery obligation may vary by as much as 33.3 percent; this

is in excess of the variance in Rev. Rul. 2003–7, supra. TAC

may ultimately deliver between 6,025,261 and 9,037,903

shares of stock to settle the PVFCs. We find this variance in

TAC’s delivery obligation to be substantial. TAC did not cause

a constructive sale under section 1259(c)(1)(C).

III. Conclusion

Petitioners must recognize gain on the MSPA to the extent

of cash received in 2000 and 2001. Petitioners did not cause

a constructive sale under section 1259(c)(1)(C).

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114 135 UNITED STATES TAX COURT REPORTS (78)

To reflect the foregoing,

Decisions will be entered under Rule 155.

f

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