Shareholder Seeks Supreme Court Review of Transferee Liability

MICHAEL A. TRICARICHI, TRANSFEREE,
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

In the
Supreme Court of the United States

On Petition for a Writ of Certiorari to the United
States Court of Appeals for the Ninth Circuit

PETITION FOR A WRIT OF CERTIORARI

Jonathan E. Strouse
Counsel of Record
Harrison & Held, LLP
333 West Wacker Drive, Suite 1700
Chicago, Illinois 60606
(312) 332-1111
jstrouse@harrisonheld.com

Counsel for Petitioner

QUESTION PRESENTED

Whether a tax court in applying fraudulent transfer principles for imposing transferee liability with respect to a taxpayer must utilize the fraudulent transfer law in the state where the taxpayer lived, or whether the tax court is free to apply fraudulent transfer law from any state in which the tax court may arbitrarily choose. Likewise, whether, after properly planning his affairs to minimize his overall federal income tax liability, and in light of the tax court and Ninth Circuit applying the wrong body of law, a taxpayer may be liable pursuant to I.R.C. § 6901 of the Internal Revenue Code for, inter alia, the conduct of third parties who purchased the taxpayer's business when the taxpayer had no involvement with, or actual knowledge of, the wrongful conduct of the third party and where that third party's conduct occurred months after the transaction closed.

PARTIES TO THE PROCEEDINGS

The Petitioner is Michael A. Tricarichi, Transferee. The Respondent is the Commissioner of Internal Revenue.

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TABLE OF CONTENTS

QUESTION PRESENTED

PARTIES TO THE PROCEEDINGS

TABLE OF CONTENTS

TABLE OF APPENDICES

TABLE OF CITED AUTHORITIES

OPINIONS BELOW

JURISDICTION

STATEMENT

REASONS FOR GRANTING THE PETITION

CONCLUSION

TABLE OF APPENDICES

APPENDIX A — OPINION OF THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT, DATED NOVEMBER 13, 2018

APPENDIX B — MEMORANDUM OF THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT, FILED NOVEMBER 13, 2018

APPENDIX C — DECISION OF THE UNITED STATES TAX COURT, DATED JULY 29, 2016.

APPENDIX D — SUPPLEMENTAL MEMORANDUM OPINION OF THE UNITED STATES TAX COURT, FILED JULY 18, 2016

APPENDIX E — MEMORANDUM FINDINGS OF FACT AND OPINION OF THE UNITED STATES TA X COURT, FILED OCTOBER 14, 2015

APPENDIX F — ORDER DENYING PETITION FOR PANEL REHEARING OF THE UNITED STATES COURT OF APPEALS FOR THE NINTH CIRCUIT, FILED JANUARY 7, 2019

APPENDIX G — STATUTES AND REGULATIONS

TABLE OF CITED AUTHORITIES

CASES:

Coltec v. United States, 454 F.3d 1340 (Fed. Cir. 2006)

Commissioner v. Stern, 357 U.S. 39 (1958)

Comm'r v. Court Holding Co., 324 U.S. 331 (1945)

Cont'l Cas. Co. v. Symons, 817 F.3d 979 (7th Cir. 2016)

Diebold Found., Inc. v. Comm'r, 736 F.3d 172 (2d Cir. 2013)

Frank Lyon Co. v. United States, 435 U.S. 561 (1978)

Gregory v. Helvering, 293 U.S. 465, 55 S. Ct. 266 (1935)

HBE Leasing Corp. v. Frank, 48 F.3d 623 (2d Cir. 1995)

Hunt v. Comm'r, T.C. Memo 1990-248

Kraft Foods Co. v. Comm'r, 232 F.2d 118 (2d Cir. 1956)

Lynch v. United States, 192 F.2d 718 (9th Cir. 1951)

Masonic Health Care, Inc. v. Finley, 892 N.E.2d 942 (Ohio Ct. App. 2008)

Michael A. Tricarichi v. Comm'r, T.C. Memo. 2015-201

Michael A. Tricarichi v. Comm'r, T.C. Memo. 2016-132

Peter Pan Seafoods, Inc. v. United States, 417 F.2d 670 (9th Cir. 1969)

Premier Therapy, LLC v. Childs, 2016 Ohio 7934, 2016 Ohio App. LEXIS 4813 (Ohio Ct. App. 2016)

Reddam v. Comm'r, 755 F.3d 1051 (9th Cir. 2014)

Rosenfeld v. Comm'r, 706 F.2d 1277 (2d Cir. 1983)

S&M Plumbing Co. v. Comm'r, 55 T.C. 702 (1971)

Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995)

Salus Mundi Foundation v. Comm'r, 776 F.3d 1010 (9th Cir. 2014)

Slone v. Commissioner, 810 F.3d 599 (9th Cir. 2015)

Slone v. Commissioner, 896 F. 3d 1083 (9th Cir. 2018)

United States v. General Geophysical Co., 296 F.2d 86 (5th Cir. 1961)

Williams v. Aetna Fin. Co., 83 Ohio St. 3d, 700 N.E.2d 859 (1998)

STATUTES AND REGULATIONS

26 U.S.C. § 7482(a)(1)

28 U.S.C. § 1254(1)

I.R.C. § 6901

Ohio Uniform Fraudulent Transfer Act § 1336.01-.10

Ohio Rev. Code § 1701.08

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OPINIONS BELOW

One of the opinions of the court of appeals is unpublished, but available at 752 Fed. Appx. 455. (App1a-11a). The other opinion is a memorandum of the court of appeals (App. 12a-14a) and is reported at 908 F.3d 588. The memorandum findings of fact and opinion and supplemental memorandum opinion of the tax court (App. 32a-95a; 17a-31a) are reported at T.C. Memo 2015-201 and 2016-132 respectively and are available on Lexis at 2015 Tax Ct. Memo LEXIS 2010 (U.S. T.C. Oct. 14, 2015) and 2016 Tax Ct. Memo LEXIS 131 (U.S. T.C. July 18, 2016) respectively. A decision by the tax court was entered on July 29, 2016 (App. 15a-16a).

JURISDICTION

The judgment of the court of appeals was entered on November 13, 2018. A petition for panel rehearing was denied on January 7, 2019. App. 96a. On March 22, 2019, Justice Kagan extended the time within which to file a petition for writ of certiorari to and including June 6, 2019. The jurisdiction of this Court is invoked pursuant to 28 U.S.C. § 1254(1).

STATEMENT

This case concerns whether Petitioner Michael A. Tricarichi (“Petitioner”) properly and legally planned a transaction to minimize his overall federal income tax liability and, in determining whether such tax planning was proper, whether the tax court and Ninth Circuit applied the proper law in determining that Petitioner was liable for the conduct of unrelated third-party purchasers months after the sale of Petitioner's stock in Westside Celular, Inc. (“Westside”).

In 2012, the Commissioner of Internal Revenue sought to hold Petitioner responsible as a transferee pursuant to I.R.C. § 6901 of the Internal Revenue Code of 1986, as amended (“I.R.C.”) for an estimated $15.1 million in taxes that were not paid by the purchaser of Petitioner's Westside stock. The tax court ruled in Commissioner's favor and held that Petitioner was liable as a transferee. App. 15a-16a, 95a. The court of appeals had jurisdiction pursuant to 26 U.S.C. § 7482(a)(1). In relying upon Slone v. Commissioner, 810 F.3d. 599, 604-606 (9th Cir. 2015) (“Slone I ”) and Slone v. Commissioner, 896 F.3d. 1083, 1086 (9th Cir. 2018) (“Slone II”), and further referencing the two separate and independent federal and state law prongs under Commissioner v. Stern, 357 U.S. 39 (1958), the Ninth Circuit affirmed the tax court in a memorandum and held that a recast of Petitioner's sale of stock in Westside resulted in a “transfer” pursuant to Ohio fraudulent transfer law which, in turn, triggered transferee liability pursuant to I.R.C. § 6901. The tax court further held, and the Ninth Circuit affirmed, that Petitioner was liable as a result of actions taken by the purchaser of the Westside stock, including the borrowing of money under a loan, even though Petitioner had no involvement in, or actual knowledge of, the post-closing actions taken by the buyer. Likewise, the tax court held, and the Ninth Circuit affirmed, that a loan procured by the buyer, with no involvement by the Petitioner, and the speed at which such loan was repaid by the buyer, could be used as proof in an action against Petitioner even though Petitioner had no ability to affect the speed of such repayment. Lastly, the tax court held, and the Ninth Circuit affirmed that, in determining whether there was transferee liability pursuant to I.R.C. § 6901, it was unnecessary to use the controlling state's fraudulent transfer statute (i.e., Ohio), but rather “any” state's uniform fraudulent transfer statute, such as Arizona, could be used.

Westside Cellular

• Westside was incorporated in Ohio on March 4, 1988. (ER259 ¶ 2).

• In 2003, Westside received a large cash distribution as the settlement for a lawsuit which had been brought by Westside against one of its suppliers ten years prior. (ER197 lines 10-19).

• While considering options for the future of Westside, Petitioner was approached to sell Westside by MidCoast Credit Corp. (“MidCoast”) and Fortrend International LLC (“Fortrend”), companies that Petitioner understood to be in the debt collection business. (ER25-26; ER265 ¶ 36; ER199 line 21 to ER200 line 8; ER187 line 20 to ER188 line 10).

• To evaluate the competing proposals, Petitioner retained the Ohio law firm of Hahn Loeser & Parks LLP (“Hahn Loeser”), which had represented Westside before an administrative agency in its protracted dispute with various wholesale providers. (ER4-25; ER264 ¶ 32).

• Petitioner also retained the nationally known accounting firm of PricewaterhouseCoopers LLP (“PwC”) to advise Petitioner on the federal income tax consequences of the stock purchase proposals. (ER27; ER266 ¶ 43).

• Because it offered a greater purchase price for his stock, Petitioner ultimately decided to pursue the offer made by Fortrend to maximize the return on his investment in what would be a fully taxable stock sale. (ER27; ER265 ¶¶ 38; 41).

• Over the course of several months, Petitioner's advisors vetted Fortrend's stock purchase offer and negotiated it to closure in a Stock Purchase Agreement dated September 9, 2003. (ER41).

• Nob Hill, Inc. (“Nob Hill”), an affiliate of Fortrend, was the acquisition vehicle which ultimately purchased Petitioner's Westside stock. (ER41; ER267 ¶ 52).

Fortrend's Distressed Debt Strategy

• During the vetting process, Petitioner and his advisors became aware that the pricing of Fortrend's offer was based, in part, on Fortrend's belief that it could reduce Westside's contingent income tax liability (thereby increasing the value of the company) by implementing a distressed debt strategy to produce tax deductions which would offset the income arising from the wholesale provider settlements. (ER42-43; ER117 line 20 to ER120 line 15).

• This strategy was consistent with Petitioner's understanding that Fortrend was in the debt collection business. (ER199 line 21 to ER200 line 8; ER171 line 20 to ER172 line 4; ER187 line 20 to ER188 line 10).

• At the time, Fortrend's distressed debt strategy was only a hypothetical; it was not made part of, or in any way referenced in, the Stock Purchase Agreement and, whether it was implemented, the buyer was contractually obligated to “satisfy fully” any Westside income tax liability. (ER35; ER426 §5.2(a)).

• The distressed debt strategy was not actually implemented by Fortrend until almost two months after the stock sale closed when, on November 6, 2003, an affiliate of Fortrend purported to contribute high basis, low value debt to Westside. (ER43; ER395).

• Petitioner had no involvement whatsoever in Westside after the sale nor did Petitioner have any actual knowledge of the details of the distressed debt transaction employed by Westside. App. 75a. (ER387).

• Early in the following year, the new owners of Westside caused the company to file its 2003 corporate income tax return reporting a bad debt deduction arising from the contributed debt. (ER43; ER387 line 15).

• This reporting, and the later disallowance of the bad debt deduction by the Internal Revenue Service (“IRS”), gave rise to the tax liability of Westside, which the government now seeks to collect from Petitioner. (ER44-45; ER279 ¶ 110; ER281-82 ¶¶ 118-19, 120-21; ER358-67).

• PwC, Petitioner's tax advisor, evaluated Fortrend's distressed debt strategy at a conceptual level and concluded that the strategy was neither illegal nor improper. (ER266 ¶¶ 45-47; ER501-05; ER119 line 5 to ER120 line 15).

• PwC also determined that there was no issue of transferee liability for Petitioner pursuant to I.R.C. § 6901 and that Petitioner should proceed with the stock sale. App. 43a. (ER504; ER169 line 20 to ER170 line 9; ER145 line 25 to ER146 line 8; ER117 line 20 to ER131 line 5).

• Hahn Loeser similarly determined that Fortrend's stock purchase offer should be negotiated to closure, with terms included in the Stock Purchase Agreement that would help to ensure that Petitioner was paid for his stock and that the purchaser would honor its contractual obligation to “satisfy fully” any Westside income tax liability. (ER173 line 24 to ER175 line 3; ER464 § 5.2(a)).

Third Party Financing for the Stock Purchase

• Petitioner and his advisors were aware of, and relied upon, the condition that the stock purchase would, in large part, be financed by a loan to the buyer from Coöperatieve Centrale Raiffeisen-Boerenleenbank, B.A. (“Rabobank”), a global financial institution. (ER38; ER161 lines 4-8).

• To implement the transaction, Nob Hill obtained a 30-day, approximate $29 million variable rate loan from Rabobank and obtained a $5 million demand loan from Moffatt International (“Moffat”). (ER440-49; ER496-99).

• On September 9, 2003, $29,900,000 in Rabobank loan proceeds and $5,000,000 in Moffatt loan proceeds were credited to Nob Hill's Rabobank account. (ER272 ¶ 71; ER272-73 ¶ 73).

• Neither Westside nor Petitioner were a party to the loan agreements between or among Nob Hill, Rabobank, and Moffatt. (ER440-49; ER496-99).

Closing the Stock Sale

• On September 9, 2003, the stock purchase price was transferred from Nob Hill's account at Rabobank to Petitioner's account and, at that moment, Petitioner lost all interest in and control of Westside. (ER275 ¶ 86; ER400).

• Petitioner reported receipt of the purchase price on his 2003 income tax return, paying more than $5 million in income tax on the resulting long-term capital gain. (ER46; ER288 ¶ 163; ER369 line 54; ER376 line 8).

• As a result, Petitioner was paid for his stock with Rabobank and Moffatt loan proceeds that were unencumbered by a security interest in Westside's assets. (ER271-72 ¶ 70; ER232-33; ER277 ¶¶ 97, 98).

• Petitioner had no involvement or impact in any aspect of the loan or its speed of repayment, both of which, according to the tax court, formed the basis of Petitioner's transferee liability. App. 50a-53a; 70a-73a.

Post-Closing Events

• Immediately after the closing, and again with no involvement of Petitioner, the purchaser [of the Westside stock] repaid the Moffat and Rabobank loans. App. 53a-54a.

• Thereafter, on November 6, 2003, nearly two months after the stock sale closed, the purchaser caused Westside to engage in a distressed debt transaction previously contemplated by Fortrend. (ER43; ER395).

• Westside's new owners then determined that, without the actual knowledge or involvement of Petitioner, the transaction gave rise to a write-off of “high basis/low value” debt that the new owners had caused to be contributed to Westside; the resulting bad debt deduction was reported on Westside's 2003 federal income tax return. App. 54a-57a. (ER387 line 15).

• The IRS later examined Westside's income tax return, disallowed the bad debt deduction, and assessed against Westside the tax, interest, and penalties which the IRS now seeks to collect from Petitioner pursuant to I.R.C. § 6901. (ER45; ER358-67).

Procedural History

• On September 21, 2012, Petitioner filed a petition in tax court challenging the IRS's notice of transferee liability. (ER41-57).

• After trial, the tax court issued a memorandum opinion in March, 2015 in favor of the IRS, holding that under both Ohio and federal law, in substance, Petitioner received Westside's cash rather than any third party loan proceeds, subjecting Petitioner to transferee liability pursuant to I.R.C. § 6901. App. 32a-95a (ER19-87).

• After further proceedings and issuance of a supplemental memorandum opinion addressing the computation of interest, a final decision was entered by the tax court on July 29, 2016. App.15a-16a.

• In a summary memorandum, with no analysis or rationale of Petitioner's claims or arguments, the Ninth Circuit affirmed the decision of the tax court in November, 2018 in a memorandum, and denied Petitioner's petition for panel rehearing on January 7, 2019. App 12a-14a, 96a.

REASONS FOR GRANTING THE PETITION

This case raises fundamental and important issues of law: (1) whether both the tax court and the Ninth Circuit under Stern — the landmark Supreme Court case which promulgated a two-part federal and state law test — used the proper law in applying the facts to the law; (2) whether a taxpayer can plan a transaction to properly minimize his federal income tax liability; and (3) whether one person can be held liable for the conduct of another when the first party had no ability to impact any wrongful conduct and where such alleged wrongful conduct occurred after the relationship between the parties had ended.

This case is of vital importance to the business community in the United States. It is sometimes the case that, in a corporate merger or acquisition, the acquiring company is worth less than the seller. It is equally common that a purchaser assumes debt to accomplish such a transaction. It is commonplace that the purchaser sells part of the acquired business after the acquisition. In that case, the purchaser may use the proceeds from the sale to decrease or extinguish the debt which the buyer has assumed. The decision in this case by the tax court, and subsequent affirmance by the Ninth Circuit, will have a chilling effect on such acquisitions. There is essentially no finality to a sale because a seller can always be held accountable for the actions of a buyer, regardless of the time that passes subsequent to the transaction, and without regard to whether the seller has any ability to control the actions of the buyer.

A. The tax court and the Ninth Circuit applied the wrong body of law by holding that constructive fraud principles did not require actual fraud as required under applicable Ohio law. This court should grant this petition to determine whether, in a tax case, the tax court and Ninth Circuit must apply the proper state law.

1. The Ninth Circuit failed to state the legal basis for its affirmance of the tax court's finding under the state law prong of the two-part Stern test.

I.R.C. § 6901 does not impose substantive tax liability on a transferee but simply gives the Commissioner a remedy or procedure for collecting an existing liability of the transferor. Commissioner v. Stern, 357 U.S. 39, 42 (1958). To take advantage of this procedure, the Commissioner must establish an independent basis under applicable state law for holding the transferee liable for the transferor's debts. I.R.C. § 6901; Commissioner v. Stern, 357 U.S. at 45.

As stated infra, the Ninth Circuit memorandum opinion here is notable for its lack of specificity or rationale relating to the affirmance of the tax court's conclusion that Petitioner was liable to the Commissioner pursuant to I.R.C. § 6901 and, more specifically, under the Ohio Uniform Fraudulent Transfer Act (“OUFTA”). On this particular issue, the memorandum opinion is entirely limited to the following statement:

“Under the state-law prong, the tax court properly determined that Westside's cash was 'transferred' to Tricarichi under Ohio UFTA.” See Ohio Rev. Code Ann § 1336.01(L) (defining “transfer” as “every direct or indirect . . . method of disposing of or parting with an asset”).”

App. 14a.

This sparse holding by the Ninth Circuit fails to articulate (i) the principles pursuant to Ohio law that were relied upon by the tax court in its determination that Petitioner was liable under OUFTA, or (ii) any legal basis for the tax court's determination that Petitioner was liable under OUFTA. Under these circumstances, Petitioner is entitled to assume that the Ninth Circuit adopted the tax court's legal analysis relating to Petitioner's liability under OUFTA. Since the determination of liability under OUFTA is a question of law, the tax court's finding on the OUFTA issue is subject to de novo review by the Ninth Circuit. Diebold Found., Inc. v. Comm'r, 736 F.3d 172, 183 (2d Cir. 2013). The tax court's determination of legal issues relating to Petitioner's liability under OUFTA is entitled to no deference.

2. The Ninth Circuit's decisions in Sloan I and Sloan II are not determinative of Petitioner's liability under OUFTA.

The only cases cited in the Ninth Circuit's memorandum opinion under OUFTA and relating to the substantive issue of Petitioner's liability for Westside's tax liabilities are Slone I and Slone II. App. 14a. However, these cases are of marginal relevance for the second prong of this Court's two-part test under Stern (i.e., state law issues) because Slone I and Slone II were decided by the Ninth Circuit under Arizona law, rather than Ohio law. In relying heavily and exclusively on the two Slone cases, the Ninth Circuit completely overlooked material distinctions between Ohio law and Arizona law – particularly on the issue of when distinct transactions may be collapsed and treated as a single transaction for purposes of determining fraudulent transfer liability.

In addition, the basis for the Ninth Circuit's decision in Slone II was fundamentally different from the tax court's basis for its conclusion in this case that Petitioner had liability under OUFTA. In Slone II, the Commissioner argued that the petitioners were liable under Arizona law on a substance over form theory – that the Court “. . . should look to the substance of the transactional scheme to see that Berlinetta was merely the entity through which Slone Broadcasting passed its liquidating distributions to Petitioners.” 896 F.3d at 1087. The Ninth Circuit, in Slone II, agreed that the holding by the tax court erroneously “. . . viewed itself as being bound by the form of the transactions rather than looking to their substance.” Id.

In contrast, the tax court in this case specifically declined to address the substance over form theory of liability under OUFTA. (ER59; 62). Rather, the tax court determined that Petitioner had liability under OUFTA for two reasons: (i) because the loans from Rabobank and Moffat that produced the funds to acquire Petitioner's Westside shares were “shams,” and (ii) because the stock sale transaction would be recharacterized under Ohio law as a de facto liquidation of Westside. App. 68a-73a, 81a-83a. The substance over form analysis utilized in Slone II was not addressed by the tax court in this case. Thus, the Ninth Circuit in affirming the tax court decision, relied almost exclusively on both Slone cases, which solely applied Arizona law.

3. Both the Ninth Circuit and the tax court misapprehended Ohio law pertaining to the collapsing doctrine.

The tax court's decision, affirmed by the Ninth Circuit, was predicated upon its finding that it was required to collapse the various transactions between or among Petitioner, Westside, Nob Hill, and the lenders that funded the acquisition of the Westside stock, into a single transaction because Petitioner had “constructive knowledge” of Fortrend's entire fraudulent scheme. In rejecting Petitioner's argument that he was not aware of Fortrend's plan as a whole to avoid Westside's taxes, the tax court opined as follows:

“If this is true, it is irrelevant. Finding that a person had constructive knowledge does not require that he has actual knowledge of the plan's minute details. It is sufficient if, under the totality of the surrounding circumstances, he 'should have known' about the tax-avoidance scheme.”

App. 75a.

The tax court's embrace of this constructive knowledge test was based upon various decisions applying the substantive law of a state or states other than Ohio. HBE Leasing Corp. v. Frank, 48 F.3d 623, 636 (2d Cir. 1995) (applying New York law); Diebold Foundation, Inc. v. Comm'r, 736 F.3d 172, 186 (2d Cir. 2013) (holding under New York law that multiple transactions could be collapsed if the ultimate transferee had “actual or constructive knowledge of the entire scheme”); Salus Mundi Foundation v. Comm'r, 776 F.3d 1010, 1020 (9th Cir. 2014) (adopting the Diebold rationale that under New York law, collapsing was proper where the transferee had constructive knowledge of a tax avoidance scheme).

Further, the tax court failed to cite a single Ohio case which permitted the collapsing of multiple transactions into a single transaction based solely upon constructive knowledge. On the contrary, the tax court acknowledged that “. . . Ohio courts have not addressed this precise scenario. . . .” App. 73a. Nevertheless, in the absence of supporting Ohio authority, the tax court adopted the constructive knowledge test expressed in “. . . judicial interpretations of fraudulent transfer provisions similar to Ohio's. . . .” Id.

In reaching its legal conclusion that collapsing was required because Petitioner had constructive knowledge of Fortrend's tax avoidance scheme, the tax court misapprehended Ohio law as clearly and squarely discussed in Premier Therapy, LLC v. Childs, 2016 Ohio 7934, 2016 Ohio App. LEXIS 4813 (Ohio Ct. App. 2016). The holding in Premier Therapy that “[m]ultiple transactions designed to perpetuate a fraud can be considered a single transaction,” is properly and solely limited to cases involving actual rather than constructive fraud. This is clear from the court's citation to Masonic Health Care, Inc. v. Finley, 892 N.E.2d 942 (Ohio Ct.App. 2008), a case that involved actual fraud, and its citation to Williams v. Aetna Fin. Co., 700 N.E.2d 859 (Ohio 1998), which held that the acts of a co-conspirator can be attributed to each participant in the conspiracy. Premier Therapy itself involved a determination of liability under both the OUFTA and a “dependent civil conspiracy claim” that was based on a finding of malicious intent. Premier Therapy, 2016 Ohio App. Lexis 4813, at *57; see also Williams, 700 N.E.2d at 868 (providing the elements of a civil conspiracy claim under Ohio law); Cont'l Cas. Co. v. Symons, 817 F.3d 979, 989, 992-93 (7th Cir. 2016) (upholding application of substance over form principles under Indiana fraudulent transfer law where the trial court concluded that assets were transferred with actual intent to hinder, delay or defraud).

The tax court acknowledged, and the Ninth Circuit affirmed, that collapsing the various transactions in this case into a single transaction was a necessary prerequisite for establishing Petitioner's liability under OUFTA. App. 81a, 83a. By declaring that Petitioner's lack of actual knowledge of Fortrend's alleged entire tax avoidance plan or scheme was “irrelevant” and imposing liability based solely upon Petitioner's purported constructive knowledge (i.e., he should have known), the tax court clearly misapplied substantive Ohio law in deciding the state law prong of the two-part Stern test for imposing transferee liability pursuant to I.R.C. § 6901. App. 75a.

B. The tax court and the Ninth Circuit have denied Petitioner his right to properly plan his affairs in order to minimize his federal income tax liability.

In the landmark case of Gregory v. Helvering, 293 U.S. 465 (1935), this Court held that:

“[i]t is quite true that if a reorganization in reality was effected within the meaning of subdivision (B), the ulterior purpose mentioned will be disregarded. The legal right of a taxpayer to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits, cannot be doubted. United States v. Isham, 84 U.S. (17 Wall.) 496, 506 (1873); Superior Oil Co. v. Mississippi, 280 U.S. 390, 395, 396, 50 S.Ct. 169, 74 L.Ed. 504; Jones v. Helvering, 63 App.D.C. 204, 71 F.(2d) 214, 217.”

Id. at 469. (Emphasis added).

The tax court and Ninth Circuit have now clearly stated that, in fact, Petitioner had no legal right to decrease the amount of what otherwise would be his taxes, or altogether avoid them, by means which the law permits. Id. This position explicitly runs counter to this Court's decision in Gregory v. Helvering.

Here, Petitioner had a clear “non-tax” purpose for completing the transaction. The tax court itself found such fact to be true, but then completely ignored its own finding by stating that the transaction “was entered into solely to evade Westside's federal and Ohio tax liabilities.” App. 92a-93a. If the Ninth Circuit had actually performed a proper de novo review, it would have addressed the tax court's failure to consider the legal precedent cited above and the proper application of the facts to such law. Precedent states that even assuming arguendo that Petitioner did not have a non-tax motive for the transaction (which is clearly rebutted by the tax court's own statement), the fact is that such a motive is entirely permissible and not grounds to therefore impose transferee liability, as was done here.

In applying economic substance principles, it is the subjective purpose of the taxpayer against whom those principles are being applied that should be the focus of the inquiry. See, e.g., Reddam v. Commissioner, 755 F.3d 1051, 1057-58 (9th Cir. 2014) (“[T]he Ninth Circuit generally applies a two-prong inquiry addressing . . . the subjective motivation of the taxpayer (whether the taxpayer had a non-tax business purpose for the transaction).”) (emphasis added). While it is not disputed that taxes were taken into account by Fortrend in setting the price it offered for the Westside stock, from Petitioner's perspective, acceptance of that offer resulted in a fully taxable economic return of greater than $34 million. Accordingly, because Petitioner paid more than $5 million in tax, it cannot be seriously argued that Petitioner “intended to do anything other than acquire tax deductions.” Sacks v. Commissioner, 69 F.3d 982, 987 (9th Cir. 1995). Completely independent of any tax considerations, Petitioner intended to make a $34 million return on his investment, consistent with his overall federal income tax planning.

In examining the characteristics of Petitioner's non-tax business purpose for selling his Westside stock, the fact that a lower economic return (and, in turn, lower tax liability on the stock sale) might have been realized had Petitioner, rather than selling his stock to Fortrend, chosen to use Westside as a vehicle for making other investments, does nothing to negate the overriding purpose of realizing a non-tax economic return. As this Court has held, choosing between different forms for a transaction in order to maximize the after-tax economic return does not eliminate the underlying business purpose for the transaction. Frank Lyon Co. v. United States, 435 U.S. 561, 579 (1978) (noting that because “the tax laws affect the shape of nearly every business transaction,” the fact that favorable tax consequences were taken into account does not negate the business purpose for a transaction); Coltec v. United States, 454 F.3d 1340, 1357 (Fed. Cir. 2006) (“[T]here is a material difference between structuring a real transaction in a particular way to provide a tax benefit (which is legitimate) and creating a transaction, without a business purpose, in order to create a tax benefit (which is illegitimate).”).

Further, in its conclusory analysis of the federal prong of the two-part test under Stern, for purposes of I.R.C. § 6901, the tax court not only failed to give proper recognition to Petitioner's non-tax business purpose for selling his stock, but also the tax court summarily and erroneously concluded that “the transaction by which Nob Hill 'purchased' Westside stock . . . had no economic substance. . . .” App. 92a. In making the objective inquiry under the economic substance test, “the question is whether a reasonable investor would enter into [the] transaction for its possible investment gains.” Reddam, 755 F.3d at 1060. Neither the tax court nor the Ninth Circuit ever addressed this question. This issue was clearly raised in briefing to both the tax court and the Ninth Circuit.

The importance of this issue cannot be overstated. In Frank Lyon, this Court held that:

“[W]here, as here, there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties.”

435 U.S. at 583-84.

Applying objective economic substance principles in a context similar to this case, the Ninth Circuit reversed the district court in Peter Pan Seafoods, Inc. v. United States, 417 F.2d 670 (9th Cir. 1969) and held that the acquisition by a new company (Ajax) of debt issued by a corporation (New Harris) should not, in substance, be treated as the corporation acquiring its own debt in a taxable transaction. In doing so, the Ninth Circuit noted that “[w]e accept the [district court's] findings of fact, but we hold that the court drew improper legal conclusions from them.” Id. at 672.

Ajax was established as a new company to acquire New Harris's debt primarily to avoid the income tax that would otherwise have been due if New Harris had purchased it directly. Id. at 672. Ajax was established by the president of New Harris for this tax avoidance purpose and over 85 percent of Ajax's stock was owned by the president and other New Harris shareholders. Id. at 671-72. The New Harris debt was, in large part, acquired with proceeds from a third party loan that Ajax pledged the soon-to-be-acquired debt to secure. Id. at 671. Ajax's lender was also assured that New Harris would prepay the debt promptly after Ajax purchased it and that Ajax would use those funds to repay the loan. Id. at 672. Notwithstanding the primary tax motive for the transaction, the fact that financing was to be secured by the New Harris debt, and assurances from New Harris that the debt would promptly be repaid with corporate funds, the Court held that that transaction had independent economic significance and should be recognized for tax purposes. Id. at 672-73. Irrespective of common control over the companies, the role of Ajax and a third party lender distinguished the facts in Peter Pan from cases where the form of a transaction was disregarded. Id. at 673-74 (distinguishing Comm'r v. Court Holding Co., 324 U.S. 331 (1945), United States v. General Geophysical Co., 296 F.2d 86 (5th Cir. 1961) and Lynch v. United States, 192 F.2d 718 (9th Cir. 1951) and holding that a transaction entered into for tax purposes will be regarded when it “was not done by the taxpayer, but by others, both in form and in substance”).

The facts in this case follow those in Peter Pan although here — unlike Ajax — Nob Hill had no relationship to or with Petitioner and was in no way controlled by Petitioner. In this case, more than $34 million in cash changed hands between at least three unrelated parties in a transaction which generated more than $5 million in federal tax liability for Petitioner. As in Peter Pan, the involvement of unrelated third parties — including Rabobank — and the insertion of third-party loan proceeds gives the stock sale independent economic substance, requiring that it be recognized for federal income tax purposes. As in Peter Pan, the fact that Rabobank had a springing interest in the purchased stock and was given assurances (by Nob Hill, not Petitioner) that its loan would be quickly repaid does nothing to change the analysis. As in Frank Lyon, Rabobank had a “'real and substantial risk' such that 'should anything go awry'” with Fortrend's post-closing plan to use Westside's assets to cover Nob Hill's obligation on its note, Rabobank's capital and assets were exposed. Sacks, 69 F.3d at 987 (quoting Frank Lyon, 435 U.S. at 580).¹ Although the terms of the stock sale were, in part, formed by Fortrend's tax considerations, as in Peter Pan where the transaction was chosen “because of the tax that would be incurred,” the stock sale here “was not done by the taxpayer, but by others, in form and in substance,” and it is properly regarded as a genuine multi-party transaction encouraged by business realities and not shaped solely by tax-avoidance features. Peter Pan, 417 F.2d at 674.

Moreover, in contrast to the economic substance cases where courts disregard a transaction by applying a “pre-tax profit” test to measure “whether a reasonable investor would enter into [the] transaction for its possible investment gains,” Reddam, 755 F.3d at 1060, it cannot be disputed that regardless of how the transaction was planned and irrespective of Fortrend's tax-motivated pricing considerations, the stock sale would necessarily have generated a multi-million dollar gain for Petitioner, wholly independent of any tax considerations.

Finally, structuring the transaction as a stock sale was far from a meaningless gesture. To the contrary, it had the effect of transferring meaningful rights and responsibilities from Petitioner to Nob Hill under Ohio law,² and — at the insistence and direction of the new owners — creating a “springing” security interest in favor of Rabobank. Kraft Foods Co. v. Comm'r, 232 F.2d 118, 128 (2d Cir. 1956) (“Since the acts were real and the taxable entities cannot be characterized as sham entities, the transactions should not be disregarded merely because the transaction was entered into in response to a change in the governing tax law”); Rosenfeld v. Comm'r, 706 F.2d 1277, 1281 (2d Cir. 1983) (“[W]e believe our inquiry should focus on whether there has been a change in the economic interests of the parties. If their legal rights and beneficial interests have changed, there is no basis for labeling a transaction a 'sham' and ignoring it for tax purposes.”).

This Court should take this case to address whether a taxpayer may take actions to properly reduce his federal income taxes and whether the conduct of third parties, without involvement from or actual knowledge by a Taxpayer, can act to eliminate the tax minimization principles found by this Court in Gregory v. Helvering, 293 U.S. 465, 55 S.Ct. 266 (1935) and its progeny.

C. The tax court, with the Ninth Circuit affirming, imposed liability on Petitioner for the actions of unrelated third-party purchasers based on a finding that the purchaser obtained a “sham” loan from Rabobank evidenced by the speed with which the purchaser repaid Rabobank. The Court should grant this petition to determine whether a litigant is responsible for the conduct of a third party over which he had no control.

The tax court committed clear error with respect to its factual findings that Petitioner was subject to the purchaser's “sham” loan where Petitioner was in no way a party to the loan. App. 70a-73a. Here, Petitioner could not have anticipated being asked to answer for the conduct of others who entered into a loan without Petitioner's involvement or consent. Petitioner had no ability to defend the conduct of those entities. Thus, the legal constraints detailed above prevent the imposition of penalties for the conduct of others.

The tax court and Ninth Circuit necessarily found that Petitioner was liable as a transferee even though: (1) Petitioner was not a party to the loan disallowed by the IRS, and (2) the speed of repayment for the loan was a factor in Petitioner's tax court ruling even though Petitioner could not impact the speed. In the stock sale as planned, Petitioner received funds borrowed by Nob Hill from Rabobank and John Moffatt. In this case, however, there was no relationship whatsoever between or among Petitioner and Nob Hill, Rabobank, and Moffatt and any conduct between or among those third parties in entering into “sham loan” arrangements cannot, under Ohio law, be held against Petitioner. While Ohio law may allow a court to look through the form to the substance of a transaction that a party entered into, a sham determination made with respect to a transaction between unrelated third parties who are not before the court cannot be held against a litigant who was not a party to the sham.

Here, Petitioner was not a party to, or in any way related to, a party to the Rabobank and Moffatt loans which the tax court found to be shams. App. 70a-73a. Accordingly, there is no Ohio law which supports applying the third-party sham loan finding against Petitioner in order to hold Petitioner liable for Westside's tax debt. Thus, even accepting the lower courts' conclusion that the arrangements between or among Nob Hill, Rabobank, and Moffatt were shams, that conclusion cannot be used to deem that the stock sale gave rise to a voidable Ohio law “transfer.”³

In fact, in addition to the “loan,” the entire transaction at issue here, as it related to Petitioner, occurred in September 2003, after which date Petitioner had no involvement whatsoever in Westside or the preparation of its tax returns and no actual knowledge of what was ultimately contained therein.

Between the September closing and the end of the tax year, the purchaser began purchasing “bad debt.” Petitioner had no involvement or actual knowledge of those purchases.

It was not until after the purchaser filed Westside's 2003 income tax return in April 2004 and such tax return was audited by the IRS that the IRS disallowed the “bad debt” as a deduction to offset Westside's 2003 income. Ultimately, it was determined that the purchaser had engaged in fraud in connection with such purchases.

Here, however, the tax court, with the Ninth Circuit affirming, admits that Petitioner had no actual knowledge of those purchases and was not involved therein, yet the tax court assumed that Petitioner was complicit in such fraud. App. 75a, 80a-83a. Neither the tax court nor the Ninth Circuit has cited any evidence which supports the tax court's finding that Petitioner himself engaged in fraud under applicable Ohio law.

Finding that Petitioner engaged in fraud without any evidence and on facts showing that the fraud occurred after the Petitioner was no longer in control of Westside is clear error. Otherwise, there would be no situation in which a seller of a business could ever be free from liability, because it would always be the case that later conduct by the purchaser could occur and, by necessity, that conduct would be outside the ambit of control by the selling party.

CONCLUSION

The petition for writ of certiorari should be granted to ensure that: (i) the correct body of law is applied (i.e., Ohio and not Arizona) under the Supreme Court's two-part test in Commissioner v. Stern when interpreting I.R.C. § 6901; (ii) that proper tax planning and tax minimization efforts of a taxpayer are respected; and (iii) that a taxpayer cannot be held accountable for the actions of unrelated third-party purchasers months after a legitimate business transaction has closed.

June 6, 2019

Respectively submitted,

Jonathan E. Strouse
Counsel of Record
Harrison & Held, LLP
333 West Wacker Drive, Suite 1700
Chicago, Illinois 60606
(312) 332-1111
jstrouse@harrisonheld.com

Counsel for Petitioner