Justice Argues Publisher's Reorganization Was Not Tax-Free

2. Alternatively, whether the transaction was, in substance, a sale.

After a trial, the Tax Court (Honorable Mary Ann Cohen) issued an opinion (published at 125 T.C. 110) finding that taxpayer's Bender transaction did not satisfy the Code's requirements for tax-free treatment. Based on the parties' stipulation that the Bender opinion governed the outcome of the Mosby transaction, the court issued a supplemental memorandum opinion making similar findings regarding Mosby. (A136-140.) The Tax Court then adopted the parties' agreed- upon computations. (A141.)

Taxpayer appealed, filing a brief that focuses on the Bender transaction, but stating (Br. 3) that its arguments also apply to the Mosby transaction. This brief similarly focuses on the Bender transaction.²

This case concerns whether taxpayer's July 31, 1998 divestiture of Bender was taxable. Before that time, taxpayer engaged in the legal publishing business through Bender, which was wholly owned by one of taxpayer's subsidiaries (TMD). In late 1997, taxpayer "decided to get out" of that business and "monetize" Bender. (A6-10; Supp37.) Because taxpayer's basis in Bender was much lower than Bender's fair market value, taxpayer was concerned that a sale of Bender for cash would generate a large tax liability. Accordingly, taxpayer investigated "tax-efficient disposition methods." (A9; Supp72.) Taxpayer's financial advisor, Goldman Sachs, proposed several structures for the transaction. Taxpayer rejected proposals that involved "payment over time." (A8; SA54; Supp2-3, 33, 35-36, 73-74.)

Taxpayer was eager to have the significant cash proceeds of its Bender divestiture for use in repurchasing its own stock. (A111.) Since 1995 (and key to its ongoing strategic planning), taxpayer had been pursuing "an active share repurchase plan," and it hoped to use any Bender proceeds to accelerate its share-repurchase program. (A11- 14; Supp71, 74, 131.)

B. Price Waterhouse's proprietary structure

In March 1998, Goldman informed taxpayer about a tax-advantaged method for divesting Bender that was confidential and "proprietary" to Price Waterhouse (PW). (A15, 24; Supp3.) The structure was designed to be a merger that would qualify for tax-free treatment under §§ 368(a)(1)(A) and (a)(2)(E). Pursuant to those sections, reorganization treatment is permitted when a controlled subsidiary merges into a target company (which will emerge as the surviving corporation) and shareholders of the target exchange their stock for stock of the controlled subsidiary's parent company. As pertinent here, the Code requires that the parent stock received in the exchange equals at least 80 percent of the value of the target company. If the former target shareholders receive any consideration other than parent company stock in the exchange, they must establish that the non-qualifying consideration is no more than 20 percent of the total consideration for the transaction to qualify as tax-free.

Under PW's plan, the transaction would resemble a merger, but would function as a sale, with the seller controlling cash in an amount equal to the value of the target company, and the buyer controlling the target. To facilitate that scheme, a special purpose corporation (MB Parent), and a controlled subsidiary (MergerSub), would be created. The buyer would transfer cash to MB Parent that would equal the value of Bender. That cash would be deposited in a limited liability company (LLC), with MB Parent as the only member. Bender and MergerSub would merge, with Bender emerging as the surviving corporation. Both taxpayer and the buyer would receive MB Parent stock (thus giving the appearance of a merger). Taxpayer would be appointed the manager of LLC, and would receive the irrevocable contractual right to control the cash deposited there. The buyer's MB Parent stock would have voting control, thus giving the buyer control of Bender. (Supp75-82, 92-101, 119-126.)

When PW's plan was presented to taxpayer, taxpayer was assured that it would not share control with the buyer, but would be "the sole manager of LLC in perpetuity, with no fiduciary obligations to the holders of the [MB Parent] preferred stock." (Supp84.) As described to taxpayer's Board of Directors, the PW structure "separates ownership and control so that the acquiring company controls [Bender] and [taxpayer] controls an amount of cash equivalent to [Bender's] value, but without having paid a tax for the shift in control." (A24-25; Supp93.) The Board was assured that, although the MB Parent stock that taxpayer would receive in the transaction would not have voting control, taxpayer "will control the [LLC] holding all of the cash by virtue of being the sole (nonequity) manager of the LLC." (Id.) The Board report summarizes the results of the PW structure as follows:

• [Taxpayer] will control the LLC, thereby controlling the cash in it and any assets or businesses acquired with such cash.

• [Taxpayer] and the LLC will be consolidated for financial reporting purposes.

• The acquiring company will control [Bender] and will be able to consolidate for financial reporting purposes.

• At some later date and upon mutual agreement, the [Bender] and MB Parent preferred stock can be redeemed at face value and the nonvoting [stock] can be redeemed at a formula price, which would leave the acquiring company as the sole owner of [Bender] and [taxpayer] as the sole, and controlling owner of MB Parent, with the ability to liquidate MB Parent and the LLC without a tax cost.

The PW structure was presented to potential bidders, who were advised that the structure (ostensibly designed to last 20 years) could be unwound when the expected IRS audit was complete. See Supp81 (handwritten note states "structure stay in place through close of TM audit for 1998"); Supp157 (handwritten note states "after audit TMC no reason to be in this structure").

C. Reed acquiesces in proprietary PW plan

After taxpayer announced that Bender was for sale, two of the largest legal publishing companies, Reed Elsevier and Wolters Kluwer, expressed interest. (A16-17.) In its preliminary interest letter, Reed advised taxpayer that it was prepared to purchase Bender through a transaction that provided Reed no tax benefits, but that the consideration it would pay "would be substantially higher" if Reed did obtain those tax benefits. (Supp85.) To provide Reed those tax benefits, the parties would have to elect to treat a stock sale as an asset sale.

A week later, taxpayer informed potential bidders that it would "be willing to accept bids if they bid based on [the proprietary PW] structure," and advised that any "substantive changes" to the proposed structure "will be viewed as disadvantaging [the bidder's] final offer." (A17-18; Supp34, 135.) Eager to acquire Bender (one of the few remaining legal companies available for acquisition), and having learned that its rival bidder had accepted the PW structure, Reed submitted an offer accepting that structure. (A6, 23.) In formulating the amount of cash it was willing to pay for Bender, Reed (consistent with its preliminary interest letter) accounted for the fact that the PW structure would not provide it certain tax benefits. (A16-17, 23, 111; Supp85, 221-222.) Accordingly, Reed offered to "purchase" Bender for "cash consideration" of $1.375 billion, and "accepted [taxpayer's] preferred structure for the purchase of [Bender]." (A23; Supp6, 90.)

After taxpayer's Board approved Reed's offer, taxpayer and Reed spent two days negotiating the details necessary to implement the PW structure, and on April 27, 1998, taxpayer (and its affiliates, collectively referred to as "taxpayer") and Reed (and its affiliates, collectively referred to as "Reed") entered into the Bender "plan of merger" agreement. (A24-34; Supp64-69, 102-103.) The agreement was expressly conditioned on Reed's "funding" $1,375,000,000, which would be transferred to an LLC controlled by taxpayer through a contract the enforceability of which Reed agreed not to contest. (A31, 34; Supp105, 109, 112.)

D. LLC agreement

To facilitate the PW structure, the parties had to enter into an LLC agreement that gave taxpayer control of the cash. Pursuant to that agreement, taxpayer (i) would be the sole manager of LLC, (ii) could not be removed from that position, even for cause, (iii) would have no fiduciary obligation to the holders of MB Parent's preferred stock, i.e., Reed, and (iv) would not be liable to any party for a breach of any duty. (A44-45,47-48; SA242-243, 249.) LLC's stated purpose was to invest its assets in accordance with what taxpayer determined was the best interests of LLC. (A44; SA242.) The manager had the "sole discretion" regarding distributing LLC's assets. (A46; SA247.) As taxpayer's expert testified at trial, the LLC agreement provided taxpayer "extraordinary control power." (Supp48.)

Before submitting its offer, Reed inquired as to whether the LLC agreement would "contain some restrictions on the use of the cash." (A21; Supp88.) In response, taxpayer made clear to Reed that the "LLC Agreement will not contain any restrictions on the use of the cash," but that LLC would make cash distributions to MB Parent sufficient to pay tax liabilities, dividends on the MB Parent preferred stock, and other general expenses. (A22; Supp89.)

E. The Bender transaction

The mechanics of the Bender transaction (which closed on July 31, 1998) are not in dispute and are merely summarized here. (A42- 76.) A chart setting out the results of the Bender transaction appears at page 13, infra.

Before the closing, Reed created two new corporations, MB Parent and MergerSub. Taxpayer formed a single-member LLC, into which Reed's "cash consideration" of $1.375 billion would be deposited. Then, taxpayer, Reed, and MB Parent executed the LLC agreement, which made taxpayer the manager of LLC immediately after the effective time of the "merger" (i.e., July 31, 1998). (A23, 38, 42-72; SA240- 258; Supp9.)

On July 31, 1998, the parties took the remaining steps to implement PW's plan. Reed contributed $775 million to MergerSub in exchange for (i) MergerSub common stock (with 20 percent voting power), (ii) MergerSub participating preferred stock, and (iii) MergerSub voting preferred stock (with 80 percent voting power). Reed also lent $600 million to MergerSub. Reed then transferred the two classes of MergerSub preferred stock to MB Parent in exchange for all of MB Parent's voting preferred stock (with 80 percent voting power). MB Parent then issued MergerSub all of the MB Parent common stock (with 20 percent voting power) in exchange for MergerSub's $1.375 billion. MergerSub then merged with and into Bender under New York law, with Bender continuing as the surviving corporation. Through that merger, all MergerSub stock was converted into Bender stock. Then, as prearranged, MB Parent contributed the $1.375 billion to LLC, of which taxpayer was the manager. (A72-76; Supp10-12, 15-26.)

After the transaction, (i) Reed owned all of the Bender common stock and the MB Parent preferred stock; (ii) taxpayer (through TMD) owned all of the MB Parent common stock, and was the manager of LLC, which held $1.375 billion; and (iii) MB Parent owned two classes of Bender preferred stock (voting and participating). (A74-75; Supp24- 26.) Reed controlled MB Parent through its MB Parent preferred stock. (Id.) By controlling MB Parent (which held 80 percent of Bender's voting power), and owning Bender common stock (which had the other 20 percent of Bender's voting power), Reed had 100 percent of Bender's voting power. (Id.) Taxpayer, in turn, controlled the cash through the LLC agreement. (A25-26, 35; SA240-252.)

 

Ownership of Bender, MB Parent, and LLC

 

after Bender Transaction

 

 

 

The Bender "merger" agreement recited that the "Merger Consideration" was the MB Parent common stock that taxpayer received in the Bender transaction, but did not value that stock. (A32; Supp106.) Taxpayer's Board was told that the consideration for Bender (and Mosby) was "over $2.0 billion in cash," $1.375 billion of which was attributed to the Bender sale. (A40; Supp129-131.) The Board was further informed that the $2 billion "will be deposited into our accounts," giving taxpayer "a very substantial level of resources for redeployment over time in operating assets and for recapitalization." (A39-40; Supp128, 130.) Similarly, in its accounting records, taxpayer characterized the consideration for Bender as $1.375 billion in "[c]ash received from Reed." (Supp139.)

When Goldman prepared the "Fairness Package" for taxpayer's shareholders, it represented that the "consideration" for selling Bender and a Bender subsidiary (Shepard's) was "$1.65 billion in cash." (A34-35; Supp114.) Similarly, taxpayer's management told its shareholders that taxpayer had sold Bender and Shepard's "for $1.65 billion." (A37, 93; Supp150-151, 154-155.) Taxpayer boasted that the Bender sale provided it "considerable cash resources" and "significant financial flexibility." (A93-94.)

Taxpayer's independent auditors also concluded that taxpayer received (through the LLC agreement) control over "$1,375 million proceeds from the sale." (A35-36; Supp116-118.) They concluded that, although the "sale" was structured as a "reorganization," taxpayer actually had "total control over the assets and operations of the LLC and Reed [ ] has total control over the assets and operations of [ ] Bender." (Id.) The auditors emphasized that, pursuant to the express terms of the LLC agreement, taxpayer "has no fiduciary duty to the holder of [MB Parent] and may use its discretion as to the use of the [LLC's] assets," including having the "LLC buy its own debt instruments or [taxpayer] stock, make business acquisitions or any other transaction to the benefit of [taxpayer]. The only limitation is that [taxpayer] may not upstream LLC assets to itself." (Id.) Although the MB Parent common stock did not give taxpayer control of LLC (and the Bender proceeds therein), the separate LLC agreement provided taxpayer control of LLC, thus permitting taxpayer (consistent with GAAP) to consolidate LLC in its financial reporting and report a gain exceeding $1 billion on the Bender sale. (Supp168-173.)

In its public filings with the Securities and Exchange Commission (SEC), taxpayer reported that, in a transaction designed to be a tax-free reorganization, it had received both MB Parent stock (to which it assigned no value) and "control" of $1.375 billion deposited in LLC, which would be included in taxpayer's consolidated financial statements. (A89-90, 95-99; Supp27-28, 55-59, 169-171, 174-179.) The balance sheet provided to the SEC indicated that taxpayer's "cash and cash equivalents" had increased by over $1.6 billion. (A92; Supp28.)

Taxpayer's public and private statements about the Bender proceeds were consistent with Reed's understanding of the transaction. At trial, Reed's primary negotiator (Bruggink) testified that he had "[n]o concerns" about what taxpayer did with the Bender proceeds, because he did not "expect to see it again." (Supp226-227.) See also SA125 (Reed's tax counsel testified that Reed has "no interest" in LLC's profits). Because Reed had no real interest in the Bender proceeds, it consented in 1999 to taxpayer's proposal that $21 million be paid to taxpayer as dividends on its MB Parent common stock. (A84.)

G. Taxpayer's lack of interest in Bender

Taxpayer informed the Board that, in divesting Bender (and Mosby), it was "completely exiting the legal and health sciences publishing business." (Supp128.) Taxpayer made similar representations to its shareholders. (A37; Supp150-155.) In its 1998 financial statements, taxpayer reported Bender's operating results as a "discontinued operation," and in subsequent financial reporting did not include any financial information related to Bender. (A96; Supp173.)

Those representations were consistent with taxpayer's no longer having an economic interest in Bender. Reed directly owned all of Bender's common stock. Although taxpayer owned MB Parent, which, in turn, owned two classes of Bender preferred stock, any value that MB Parent could receive from Bender on that stock would be negated by MB Parent's obligations to Reed on the MB Parent preferred stock. (A120, 128.) The stated values of the various preferred stock were as follows: MB Parent preferred stock held by Reed -- $68,750,000; Bender voting preferred stock held by MB Parent -- $61,616,163. (Supp13-14.) The formula-price value of the Bender participating preferred stock held by MB Parent was estimated by taxpayer to be worth approximately $7 million. (A66-67; Supp31, 126, 134, 144.) Thus, the expected cash flows upon redemption of the preferred stock were as follows:

 Bender --> --> $S68 million --> --> MBParent --> --> $68 million --> --> Reed

Taxpayer's public and private representations were consistent with Reed's understanding. As Bruggink testified, Reed obtained "all" of the value of Bender in the transaction. (Supp223.) The Bender preferred stock retained by taxpayer (through MB Parent) was merely -- in his view -- "formalities and paperwork" to support the tax structure. (Supp226-227.) Reed witnesses also testified that Reed had "100 percent" control of Bender (Supp38, 223-226), notwithstanding the fact that, in purchasing Bender, Reed agreed to certain restrictions on corporate actions (such as liquidation) that otherwise could weaken taxpayer's tax position (Supp111).

H. Taxpayer's use of the Bender proceeds

After the Bender transaction closed, taxpayer immediately began to use the Bender proceeds. Within four months of the Bender closing, taxpayer had used over half of the proceeds to purchase its own stock. (A81.) Within a year, taxpayer had used almost all of the Bender proceeds, spending 80 percent to purchase its own stock, 10 percent in a joint venture with taxpayer's largest shareholders (which further reduced taxpayer's outstanding stock), and the remaining 10 percent in smaller investments that complemented taxpayer's business. (A87, 100; SA134.) After Tribune and Times Mirror merged in 2000, LLC continued the share-repurchasing program. (Supp147, 219.) By repurchasing its own shares, taxpayer used the Bender proceeds to pay its own shareholders and enhance earnings per share. (A92; Supp185-189.) As taxpayer asserted in its public filings, "[e]arnings per share for 1998 benefitted principally from the net gain on divestitures as well as a reduction in the average number of common shares outstanding." (A96.)

I. The proceedings below

In 2002, the Commissioner sent taxpayer a notice of deficiency, determining that taxpayer should have recognized a capital gain of approximately $1.3 billion in 1998 based on the Bender transaction, which the Commissioner maintained did not qualify as a tax-free reorganization. At trial, taxpayer argued that the transaction qualified for tax-free treatment under either (i) § 368(a)(1)(B), arguing that taxpayer received only MB Parent common stock in the Bender transaction, or, alternatively, (ii) § 368(a)(1)(A), arguing that the MB Parent common stock was worth at least $1.1 billion (i.e., 80 percent of the total consideration). (A104- 106.)

After a lengthy trial, the Tax Court held that the Bender transaction was a taxable sale. The court found that the consideration that taxpayer received for the Bender stock disqualified the transaction from tax-free treatment under §§ 368(a)(1)(A) or (B). (A133.) The transaction did not qualify under § 368(a)(1)(B) because, as the court found, the MB Parent common stock was not the sole consideration for the transaction. (A121, 125.) That determination was based in part on taxpayer's concession that the LLC agreement was part of the "deal," and that the Bender transaction would not have occurred unless taxpayer received both stock and control of LLC. (A119-120.)

Nor did the transaction qualify under § 368(a)(1)(A), because taxpayer failed to prove that the common stock was worth 80 percent of the total consideration. Based on its extensive "factual analysis of the transaction," as well as "common sense," the court concluded that the management authority over the cash in LLC had "far more value" to taxpayer than the MB Parent common stock, and thus represented the "bulk" of the consideration. (A121, 125.) The court noted that the statute does not require exact valuations for each item received in the transaction, only proportionate valuations for the qualifying and non-qualifying consideration. (A125.)

In support of its valuation determination, the court found that the LLC agreement gave taxpayer "control" of the cash in LLC, and thereby provided taxpayer "the significant proceeds of its divestiture of Bender to spend on repurchasing its own stock." (A111- 112, 121.) The court noted that the LLC agreement did "not contain any restrictions on the use of the cash" -- as taxpayer had emphasized to Reed -- and expressly provided that taxpayer's only fiduciary obligation was to itself. (A115-116.) The court further noted that taxpayer had similarly represented to its Board, shareholders, and the SEC that it controlled the cash proceeds of the Bender divestiture. (A118.) In any event, the court found, "cash is fungible," so if there were (contrary to taxpayer's contemporaneous representations) restrictions on taxpayer's use of the cash, taxpayer's concededly permissible use of the cash to fuel its stock repurchase program obviously freed up taxpayer's other resources to be used for working capital. (A116-117.)

The court rejected taxpayer's argument that the Bender transaction should be characterized as a tax-free merger because the parties had labeled it as such in the "merger" agreement. The court explained that the "form of the transaction includes the totality of the contractual arrangements" as interpreted by the parties, and is "not limited to the design, characterization, and labels put on the arrangements by [taxpayer's] tax advisors." (A111.) The court also rejected the testimony of Bradley, taxpayer's expert, valuing the MB Parent common stock at $1.375 billion. Bradley's valuation assumed (among other things) that MB Parent was immediately liquidated after the merger. The Commissioner argued, and the court agreed, that Bradley's assumptions were inconsistent with the facts. (A122, 125; Docket 67 at 149.) The Commissioner also submitted expert testimony, which the court did not adopt.

Although the court based its decision on its finding that taxpayer failed to satisfy the statutory requirements for a tax-free reorganization, it also addressed the Commissioner's alternative substance-over-form argument. (A125-133.) The court found that taxpayer had monetized its Bender investment, and that, therefore, the "true economic effect" of the Bender transaction was a sale. (A133.) The court further found that taxpayer's purported continuing interest in Bender's operations was "negated" by the evidence, which showed that Bender's preferred stock obligations to MB Parent were canceled out by MB Parent's preferred stock obligations to Reed. (A120, 128.) Viewing the transaction as a whole, the court concluded that MB Parent "serves no [non-tax] purpose" and lacked "substantive economic effect." (A130-131.)

1. The Bender transaction does not satisfy the Code's requirements for a tax-free reorganization. To qualify for tax-free treatment under § 368, taxpayer had to prove that the MB Parent stock constituted at least 80 percent of the total consideration received for Bender. Taxpayer received both stock and the contractual right to control $1.375 billion, and the contractual right was (as the Tax Court found) more valuable to taxpayer than the stock. That factual finding is supported by the transaction documents, the parties' representations, expert testimony, and common sense.

2. Alternatively, the Bender transaction was, in substance, a sale. Transactions that satisfy "the literal terms of the reorganization provisions" are nevertheless taxable if taxpayer receives "essentially the equivalent of cash," or fails to maintain a "substantial" interest in the transferred corporation. Paulsen v. Commissioner, 469 U.S. 131, 136-137 (1985) (citation omitted). Here, taxpayer was able to "cash out" its Bender investment, and quickly used almost all of the Bender proceeds to purchase its own stock, disbursing over $1 billion to its shareholders. Moreover, taxpayer failed to maintain a continuing economic interest in Bender. Although it argues to the contrary, based on MB Parent's holding Bender preferred stock worth $68 million, that limited connection (i) is insufficient to satisfy the continuity-of-interest requirement, and (ii) is negated by MB Parent's $68 million obligation to Reed on Reed's MB Parent preferred stock.

A. Introduction

The tax treatment of exchanges of stock of corporations that are parties to a reorganization is prescribed by § 354(a)(1), which provides that "[n]o gain or loss shall be recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the plan of reorganization, exchanged solely for stock or securities in such corporation or in another corporation a party to the reorganization." As pertinent here, the Code permits tax-free treatment when a controlled subsidiary merges into a target company (which will emerge as the surviving corporation), and shareholders of the target exchange their stock for stock of the parent. Such a transaction can qualify as an "A" (merger) reorganization, and is referred to as a "reverse triangular merger." §§ 368(a)(1)(A) and (a)(2)(E); 11 Mertens, Law of Federal Income Taxation at 43-123 (1999) (Mertens).

A reverse triangular merger can qualify as an "A" reorganization if (among other things) the former shareholders of the surviving corporation exchange at least 80 percent of its stock for voting stock of the parent corporation; the other 20 percent can be acquired for any other type of consideration. § 368(a)(2)(E). (If the former shareholders receive only voting stock of the parent corporation, the acquisition also may qualify as a "B" reorganization under § 368(a)(1)(B).) As we asserted below (and taxpayer has never challenged), taxpayer bears the burden of proving that its transaction qualifies for tax-free treatment, including demonstrating that the MB Parent common stock was worth at least 80 percent of the consideration it received for its Bender stock. See Tax Ct. R. 142(a); Kikalos v. Commissioner, 434 F.3d 977, 982 (7th Cir. 2006); Goldstein Brothers, Inc. v. Commissioner, 232 F.2d 566 (7th Cir. 1956).

Here, the Tax Court correctly found that taxpayer failed to prove that it satisfied the statutory requirements for a tax-free reorganization. The Bender transaction was not a "B" reorganization, because taxpayer failed to prove that it received only voting stock for Bender. And the transaction was not an "A" reorganization, because taxpayer failed to prove that the MB Parent stock it received was worth 80 percent of the Bender stock it gave up. Part I of our Argument demonstrates that the court's determination that taxpayer failed to satisfy the statutory requirements is fully supported by the record. Part II demonstrates that (assuming the Bender transaction satisfied the Code's formal requirements), taxpayer failed to prove that the transaction's substance matched its form. See Bittker & Eustice, Federal Income Taxation of Corporations & Shareholders 12-19 (7th ed. 2006) (Bittker) (noting well-settled principle that "literal compliance with the reorganization provisions is not enough").³

First, however, we address several overarching errors in taxpayer's brief. Initially, the Tax Court did not (as taxpayer repeatedly charges (e.g., Br. 22, 43)) disregard MB Parent and the "form" of the transaction. Rather, the court gave due regard to all the formal aspects of the transaction, not just those relied on by taxpayer. E.g., Alumax Inc. v. Commissioner, 165 F.3d 822 (11th Cir. 1999) (taxpayer failed to satisfy § 1504's 80 percent voting-power requirement, based on court's review of all the corporate governing documents, not just taxpayer's label on stock). The only item disregarded in the court's statutory analysis was taxpayer's self-serving label (and testimony) that the transaction was intended to be a "tax-free reorganization," when all of the transactional documents -- read as a whole -- indicated otherwise. See Bittker at 12-20 & 12-21 ("If the acquisition is found to be a taxable sale, the fact that the parties label it as a tax-free reorganization will not control.").

Second, taxpayer's repeated references to the Tax Court's analysis as "subjective" could not be further from the truth. As the court's extensive factual analysis makes clear, the court's holding was based on the objective evidence of taxpayer's (i) contractual arrangements, (ii) the parties' understanding of those arrangements, and (iii) representations made by taxpayer to its auditors, management, shareholders, and the SEC. Indeed, much of the opinion consists of lengthy quotations from the documentary evidence. Craig Friedrich, Control Over Purchaser's Cash Makes Reverse Triangular Merger a Sale for Tax Purposes, 33 Corp. Tax'n 36, 38 (2006) (noting the "extremely detailed" and "persuasive fact finding" in Tribune that largely consists of "lengthy, detailed quotes from a wide range of sources"). The court's detailed analysis is hardly a "subjective 'I know it when I see it' approach," as taxpayer wrongly contends (Br. 42). As the court explained (A132), it dealt "only with what actually transpired and [gave] effect to the legal documentation of the Bender transaction, with key points emphasized by the terms of the documents and the statements made by [taxpayer] representatives about what was accomplished in the Bender transaction." Although taxpayer may find the documentary evidence -- which is overwhelming -- an inconvenient obstacle to its effort to obscure the realities of the transaction, such evidence is hardly "subjective," and properly was considered by the court below.

Finally, taxpayer's suggestion (Br. 66) that its transaction was "routine[ ]," and the Tax Court's opinion "unprecedented," has matters exactly backwards. Hoping to avoid over $500 million in federal income tax, taxpayer entered into a proprietary tax scheme that even Reed's tax counsel conceded was "[v]ery nontypical." (SA118.) See Lee Sheppard, Corporate Sales: Ignore that LLC Behind the Curtain, 1999 Tax Notes Today 1-1 (Jan. 4, 1999) (describing the "peculiar" nature of taxpayer's deal, and the large tax reserve set aside to cover the probable "tax exposure on the deal"); Supp180-183 (analyzing taxpayer's tax reserve). The Tax Court, following well-settled precedent, correctly required taxpayer to establish that its highly unusual deal complied with the Code's requirements.

B. Taxpayer failed to prove that it received only MB Parent common stock or, alternatively, that the MB Parent common stock was worth 80 percent of the Bender consideration

The parties agreed that to satisfy the statute's 80 percent test, taxpayer had to prove that the MB Parent common stock constituted at least 80 percent of the consideration that taxpayer received in the Bender transaction. (Br. 37; A108.) After reviewing the record as a whole, the Tax Court found that, accepting the form of the deal, (i) taxpayer received both the common stock and control over the cash in LLC as consideration for Bender, and (ii) the control over the cash constituted more than 20 percent of the total consideration. (A106, 111, 120-121.) Taxpayer has shown no error (let alone clear error) in those findings.

Consistent with the documents, taxpayer reported to its Board that it was exchanging Bender for both common stock and the control rights. (A112.) Similarly, in its SEC filings, taxpayer reported both the MB Parent common stock it received (without any particular value attributed to it) and the control rights it acquired in the Bender transaction. (A90; SA260; Supp27-28.) Taxpayer's own experts testified that the contractual right to control the cash was a valuable "asset." E.g., SA179 (referring to contractual right to manage LLC as one of taxpayer's "Assets"); Supp48-51 (conceding that taxpayer received "extraordinary control power" under the LLC agreement that it did not possess by merely holding the common stock). Thus, "all the transactional documents, public filings, and trial testimony" did not (as taxpayer claims (Br. 9)) provide that MB Parent stock was the "sole consideration."

Taxpayer's argument (Br. 65 (emphasis in original)) that the "LLC Agreement is nothing more than an uncompensated management obligation that [taxpayer] assumed in order to preserve its ultimate interest in the MB Parent common stock" rings particularly hollow. Without the LLC agreement, Reed (and not taxpayer) would have controlled the cash, as taxpayer concedes (Br. 57). Simply owning all of the MB Parent common stock (which lacked voting control) did not give taxpayer control over -- and immediate use of -- the Bender proceeds. (A25.) Taxpayer's accountants concurred, noting that taxpayer "controls the assets of the LLC through the management agreement," not through the stock. (A113 (emphasis added).)

Indeed, the LLC agreement is critical to the proprietary PW structure, and is what permits -- as a practical matter -- the transaction to take place. Both taxpayer and Reed wanted control over their newly acquired assets (cash for taxpayer, Bender for Reed). Simply jointly holding stock in MB Parent (required to satisfy the statutory requirements for a reverse triangular merger) could not satisfy both parties; only one could have control over its new asset via the MB Parent stock. To remedy that situation -- but thereby turning a merger into a sale -- the parties gave taxpayer contractual control over the cash, and Reed voting stock control over Bender. Although taxpayer's tax lawyer testified that the control rights were "never contemplated as separate consideration" (Br. 67), taxpayer's CFO conceded that the LLC control rights were a valuable asset because they were "a way of assuring that the cash would be invested in a manner that was parallel of [taxpayer's] interests at all times" (A119 (quoting SA73-74)).

In an analogous situation, the Supreme Court has valued the equity and debt aspects of stock separately to determine whether a transaction qualified as a tax-free reorganization under § 368(a)(1)(A). Paulsen, 469 U.S. 131. There, the Court held that the transaction was taxable because the "debt aspect" of the exchanged shares greatly outweighed the value of the equity aspects of those shares. Id. at 140-142. The Court rejected the taxpayer's argument that the two aspects could not be valued "separately." Id. at 141.

Treating the control rights as separate consideration is not (as taxpayer claims (Br. 64)) inconsistent with Estate of Curry v. United States, 706 F.2d 1424 (7th Cir. 1983), an estate-tax valuation case. There, the decedent owned both a controlling voting stock interest and nonvoting stock, and the Court held that the value of the nonvoting stock could not be less than the value of the voting stock. In so holding, the Court did not rule (as taxpayer suggests) that both stock interests could not be assigned a discrete value. Rather, the Court held that a value could be assigned to both classes of stock, so long as both were deemed to have been sold to the same buyer. Id. at 1430. Similarly, here, both the control rights and the stock can -- and, pursuant to § 368(a)(2)(E)(ii), must -- be valued.

Finally, the fact that the control rights here are contractual does not (as taxpayer suggests (Br. 65)) mean that they are not valuable property. Almost 70 years ago, the Supreme Court determined that, in the context of a corporate reorganization, a contractual assumption of liabilities was a valuable asset that could not simply be ignored, even though the assumption was economically inseparable from the transfer of stock. United States v. Hendler, 303 U.S. 564, 566-567 (1938). And Revenue Ruling 2003-97 is not to the contrary, but simply addresses the issue whether a note linked to a purchase contract qualified as debt for purposes of deducting interest under § 163(a).

Every contemporaneous statement (both internal and public) in which taxpayer described the Bender transaction touted the value of the control rights, which gave taxpayer immediate control over $1.375 billion -- not the value of the common stock, which gave taxpayer only a residual and eventual interest in LLC's investments. In reports to the Board regarding Reed's offer for Bender, taxpayer's management highlighted the control rights (not the common stock). (A24-25.) The Board was assured that taxpayer would "have a very substantial level of resources for redeployment over time in operating assets and for recapitalization." (A38-39; Supp128-130.) Those resources were available because taxpayer controlled the LLC, not because it owned the common stock. Six months after the transaction, the Board was informed that those control rights permitted taxpayer to "return[ ] $1.1 billion to our shareholders through share purchases and dividends." (Supp137-138.) Shareholders, too, were told that the Bender transaction permitted taxpayer to "redeploy" "considerable cash resources" "in a way that will enhance [its] earnings power" -- a redeployment permitted by the control rights, not the common stock. (A93-94; Supp62-63.)

In deciding to divest Bender, taxpayer wanted immediate access to the divestiture proceeds so that it could fund its ongoing share-repurchase program. It had rejected proposed structures for the Bender transaction that would involve a "payment over time." (SA54; Supp33, 35-36.) The control rights gave taxpayer immediate access to $1.375 billion, almost all of which it quickly used. The common stock merely gave taxpayer a residual interest that (according to taxpayer) would not be liquidated for at least 20 years, and could not generate dividend payments without Reed's assent.⁴

Not only did the control rights permit taxpayer to return over $1 billion to its (not Reed's) shareholders, that control also allowed taxpayer to greatly enhance its economic picture for potential investors and current shareholders. As the Commissioner's financial-reporting expert explained, the "primary benefit" of the Bender transaction to taxpayer "is to report the assets of [LLC] in its consolidated financial statements along with a significant gain from the sale of Bender," boosting taxpayer's reported consolidated net income for 1998 from approximately $300 million to $1.4 billion. (Supp184-185.) Given the structure of the transaction, and taxpayer's own statements, the Tax Court correctly determined that, as a matter of common sense, the control rights were extremely valuable to taxpayer, which did not prove that those rights were not worth more than 20 percent of the consideration. See Allan Sloan, Washington Post at C3 (October 13, 1998) (analyzing taxpayer's SEC filings, and concluding that it was '"an affront to common sense'" to call the "Bender sale a reorganization," because taxpayer "has full control" of the "cash" and "uses it for purposes such as buying back stock") (citation omitted).

In an effort to minimize the record evidence demonstrating the enormous value that taxpayer placed on the control rights, taxpayer denigrates (Br. 67) the Tax Court's reliance (A125) on "common sense." Taxpayer's criticism is misplaced. In Curry, this Court expressly relied on "common sense" in its valuation determination. 706 F.2d at 1427, 1428. Taxpayer's valuation -- which treats the control rights as an "obligation" (Br. 65) rather than a valuable asset -- itself defies common sense (as well as the record evidence), and was correctly rejected by the Tax Court.

Not only is the Tax Court's valuation determination supported by a common-sense analysis of the factual record, it also is supported by expert testimony. One of the Commissioner's experts (Barclay) testified that a seller who owned both the common stock and the control rights would value the control rights as "at least [at] 40- percent of the $1.375 billion deal." (Supp164-166.) That opinion was based on numerous control-premium studies estimating "the value of control at 40% or more of the value of the company." (Supp165.)

Barclay's opinion in this regard is consistent with case law addressing control premiums. E.g., Eateries, Inc. v. J.R. Simplot, Co., 346 F.3d 1225, 1233 (10th Cir. 2003) (holding that the "district court's finding of a 35 percent control premium" was not clearly erroneous); Estate of Trenchard v. Commissioner, 69 T.C.M. (CCH) 2164, 2174 (1995) (holding that "control is worth 40 percent of the value"). Although control in those cases was obtained through the stock itself (i.e., through the stock's voting rights), whereas here control was obtained through a separate contract, the principle from the case law that control of an asset is worth a large percentage of that asset applies, regardless of the source of that control. Here, the control premium (as a percentage of total consideration) is properly allocated to the contractual rights, not the MB Parent common stock. Barclay's testimony that a party who held both the common stock and the contractual control rights would value the control rights at almost half of the total value supports the Tax Court's conclusion that the MB Parent common stock was not 80 percent of the total consideration.

In reaching his conclusion regarding control premiums, Barclay did not (as taxpayer contends (Br. 68)) value the control rights as if they were held by a party unrelated to the holder of the MB Parent common stock. See Supp44-46 (Barclay expressly denied that his valuation was based on taxpayer's "separat[ing] its control rights from [its] residual ownership over the assets"); Supp47 (Barclay explained that, in forming his opinion, he "thought about what would the value of this control right be to the person who actually owned it at the time, [taxpayer]," and that he was "not hypothesizing a transaction that says [taxpayer was] going to separate these rights and destroy value"). Similarly, another Commissioner expert (Jensen) -- whom taxpayer refers to as "a leading theorist on corporate control" (Br. 70) -- opined that the "control rights are very valuable" to someone holding both control rights and common stock. (Supp40, 218.)

It is true that the Commissioner instructed his experts "to assume that the holder of either the MB Parent common stock or the Control Rights was a truly hypothetical party who was not necessarily related to the other." (Docket 80 at 16 (emphasis added)). See Eyler, 88 F.3d at 451 (in applying the fair- market-value standard, the buyer and seller must be "hypothetical"). Accordingly, some of the expert testimony submitted by the Commissioner valued the common stock and the control rights as if one of those assets were sold to an unrelated party. E.g., Supp41-43 (Shapiro opined that the MB Parent common stock was worth between zero and $206 million if sold to an unrelated party).

Taxpayer argues (Br. 67-71) that such a valuation (which taxpayer refers to as "the bifurcation premise") is contrary to Curry, which held that "to permit the hypothetical bifurcation of an otherwise integrated bundle of property for valuation purposes would severely undermine the estate tax system and permit abusive manipulation." 706 F.2d at 1428. Taxpayer's argument is overbroad; as noted above, in Curry, the Court addressed valuation of two different classes of stock for estate tax purposes, in contrast to the inquiry mandated by § 368(a)(2)(E)(ii) as to the proportionate values of the separate consideration components received in an acquisition. And, of course, in the reorganization context that finding of proportionate value is outcome determinative. But in any event, this Court need not decide whether some of the Commissioner's expert testimony is inconsistent with Curry, because (i) the Tax Court did not rely on the testimony, and (ii) other record evidence overwhelmingly supports the court's valuation determination.

The Tax Court properly discredited the parties' self-serving testimony that the MB Parent common stock was worth $1.375 billion. (A121.) As Reed conceded at trial, the parties had a common "interest" in ensuring "that the merger qualified as a tax-free merger."⁵ (SA113.) To facilitate that characterization, both parties could be expected to testify that the common stock was worth $1.375 billion. The parties did not -- as taxpayer suggests (Br. 30) -- "negotiate[ ]" a "value" for the MB Parent common stock. Rather, the parties negotiated how much "funding" Reed had to contribute to obtain Bender (i.e., $1.375 billion) using the proprietary PW structure. (Supp109.)

But even if the parties had actually negotiated the value of the common stock (and there is no evidence establishing that they did), arm's-length negotiations are not "conclusive" evidence of fair market value. In re MDL-731, 989 F.2d 1290, 1297-1298 (2d Cir. 1993); see Commissioner v. Chatsworth Stations, Inc., 282 F.2d 132, 135 (2d Cir. 1960) ("Although the parties to the sale of a going business may expressly provide for the allocation of the purchase price among the various assets sold, the Commissioner is not bound to accept the parties' allocation."). Even if taxpayer and Reed had assigned the common stock a value of $1.375 billion in the "merger" agreement (which they did not), this would not be dispositive, as the Tax Court noted (A121).

Bradley's testimony does not assist (let alone satisfy) taxpayer's burden of proof on the valuation question. Bradley hypothesized an immediate dissolution of MB Parent, LLC, and Bender, and then calculated that (upon that July 31, 1998 dissolution) $1.375 billion would flow to the holder of the MB Parent common stock. (Supp159.) Based on this hypothetical scenario -- which essentially reduces the merger to a sale -- Bradley concluded that the MB Parent common stock was worth $1.375 billion. (Supp161.) The Tax Court rejected Bradley's opinion because (i) he failed to consider the contractual aspects of the Bender transaction, and (ii) based his valuation on assumptions contrary to the record. (A122, 125.) Taxpayer has not -- and cannot -- demonstrate any error in that ruling. Instead, taxpayer erroneously asserts (Br. 70-71) that Bradley's opinion was (i) "consistent with the facts," which ignores the court's contrary ruling, and (ii) "uncontested," which distorts the record.

The Tax Court properly disregarded Bradley's opinion. The parties did not contemplate the immediate dissolution and liquidation of LLC and MB Parent, as taxpayer concedes in arguing (Br. 12-13) that the structure "was expected to operate for at least twenty years," and that taxpayer could not unilaterally terminate the structure. Obviously, liquidating LLC and MB Parent eradicates the need for (and thus the value of) the control rights (which Bradley recognized was an "asset" (SA179)). But so long as the structure stands, taxpayer needs (and therefore values) the control rights to use the Bender proceeds.

Bradley further undervalued the control rights by assuming that taxpayer was given only the authority to manage (but not control) the cash. That assumption is belied by the LLC agreement (SA242, 249), was directly challenged by the Commissioner's experts (Supp195-218), and was contradicted by taxpayer's other experts (Supp190-192). Indeed, one of taxpayer's experts opined that the LLC agreement "empowered the holder of the Control Rights to, for all intents and purposes, steal the entirety of the value of [LLC] for private gain." (Supp194.)

Finally, if this Court were to determine that there is insufficient evidence in the record to determine the proportionate values of the consideration, taxpayer (which had the burden of proof on the issue) should bear the consequences. As a general rule, the "party with the burden of proof' in tax cases should "lose" where all valuations are "manifestly erroneous." Kohler Co. v. United States, 468 F.3d 1032, 1035 (7th Cir. 2006), petition for rehearing en banc pending. In Kohler, the Court disregarded that rule because (in its view) the Commissioner had set up an "extravagant evaluation" for the taxpayer to disprove, id. at 1037, a situation not present here. Both parties agree that the total consideration received by taxpayer was worth $1.375 billion, and the Code -- not the Commissioner -- sets the valuation for the taxpayer to prove (i.e., 80 percent of that total consideration).

C. Taxpayer's remaining arguments lack merit

Unable to shake the factual foundation for the Tax Court's holding that it failed to prove that the MB Parent common stock was worth at least $1.1 billion (as required by statute), taxpayer seeks to inject "legal" issues (Br. 21-22, 41) where there are none, claiming that the court (i) relied on financial accounting rules in contravention of Thor Power Tool v. Commissioner, 439 U.S. 522 (1979), (ii) ignored Treasury Regulation § 1.368-1(e)(1), and (iii) did not apply this Court's rules for determining whether a corporation has economic substance set out in Northern Indiana Public Service Co. v. Commissioner, 115 F.3d 506 (7th Cir. 1997) ("MPSCO"). Taxpayer's arguments miss the mark.

The Tax Court's opinion does not conflict with Thor Power, which simply holds that a taxpayer's financial accounting treatment is not "dispositive" of the proper tax treatment. JP Morgan Chase Co. v. Commissioner, 458 F.3d 564, 569 (7th Cir. 2006). Here, the court did not (as taxpayer erroneously suggests (Br. 40-41)) conclude that taxpayer's financial accounting treatment of the transaction was dispositive of the proper tax treatment. Rather, the court relied on taxpayer's SEC filings and other contemporaneous representations, in addition to its financial accounting, as evidence that it controlled the cash and used it for its own strategic purposes (A118). Taxpayer does not address this other evidence.

Treasury Regulation § 1.368-1(e)(1) is not pertinent to the Tax Court's holding that taxpayer failed to satisfy certain statutory requirements for tax-free reorganization. That regulation addresses an additional reorganization requirement, developed by the courts and codified in the regulation, referred to as the continuity-of-interest requirement. As the regulation's preamble makes clear, however, the regulation "appl[ies] solely for purposes of determining whether the [continuity-of-interest] requirement is satisfied," and not "as to whether other reorganization requirements are satisfied." 63 Fed. Reg. 4174, 4176 (1998). Although the Commissioner argued below that taxpayer's transaction also failed the continuity-of-interest requirement, the Tax Court decided the case on different, statutory grounds, and therefore had no occasion to cite Treasury Regulation § 1.368-1(e)(1). Moreover, as demonstrated infra, II.C, taxpayer cannot satisfy that regulation.

NIPSCO is similarly irrelevant to the Tax Court's statutory holding, which did not (as taxpayer wrongly asserts (Br. 44)) "turn[ ] on whether MB Parent's separate corporate existence and the form of the parties' transaction can be disregarded." The Tax Court's opinion makes clear that the court's statutory holding was wholly separate from the court's discussion of the Commissioner's alternative substance-over-form arguments (A125-126), including any arguments premised on disregarding MB Parent (A127). It was in the context of that discussion that the court addressed taxpayer's cases that purportedly limit applying substance-over-form analysis to recast a transaction. (A128 (citing the case relied on by taxpayer below, Esmark, Inc. v. Commissioner, 90 T.C. 171 (1988), aff'd without published opinion, 886 F.2d 1318 (7th Cir. 1989)).) Moreover, as demonstrated infra, II.D, NIPSCO does not support taxpayer's argument that the substance of the transaction properly can be ignored.

Finally, taxpayer's suggestion (Br. 31) that the Commissioner is seeking to "whipsaw" Reed and taxpayer is both unfounded and irrelevant. "Whipsaw" is an inapt term, because the Commissioner is not characterizing the transaction differently for different taxpayers; for both taxpayer and Reed, this transaction is a taxable sale of stock. Although Reed had offered to pay more for Bender, had taxpayer been willing to structure the transaction to provide Reed tax benefits related to the basis of Bender's assets, the parties chose to structure the transaction as a reorganization (with no tax benefits for Reed), and Reed paid less accordingly. Whether or not this transaction is judicially determined to be a tax-free reorganization, Reed will get what it paid for, viz., (i) no stepped-up basis in Bender's assets, and (ii) a basis in Bender's stock equal to the amount of cash it contributed to MergerSub, under either § 358(a)(1) or § 1012.

Taxpayer's "whipsaw" argument also should not divert attention from the fact that taxpayer failed to satisfy the statutory requirements for a tax-free reorganization that it entered into in the hope of forever avoiding -- not just deferring -- tax on almost $1.3 billion in gain. (A26; Supp94.) In point of fact, taxpayer -- and not the Commissioner -- is attempting to whipsaw here. It represents to the Commissioner and the courts (for purposes of decreasing its taxes) that it has not monetized its gain from Bender, while at the same time representing to the investing public (for purposes of increasing its earnings) that it has monetized that gain. Tax-free monitization, however, is wholly incompatible with the purpose of the reorganization provisions.

A. Introduction

If this Court were to determine that taxpayer satisfied the literal requirements for a tax-free reorganization under either §§ 368(a)(1)(A) or (B), it nevertheless should deny tax-free treatment to the Bender transaction based on long-standing judicial precedent that courts must look to the substance of transactions in deciding tax cases, including (as here) reorganization cases. As the Supreme Court has emphasized time and again, "[s]atisfying the literal terms of the reorganization provisions, however is not sufficient to qualify for nonrecognition of gain or loss." Paulsen, 469 U.S. at 136 (collecting cases); accord McDonald's Restaurants of Illinois, Inc. v. Commissioner, 688 F.2d 520, 523-525 (7th Cir. 1982) (holding that a merger was, in "substance," a cash sale). The purpose of §§ 354(a) and 368(a)(1) is to "postpone tax liability" for taxpayers who have merely "continued an investment rather than liquidating one." Id. at 523. Here, the transaction fails to qualify for tax- free treatment because taxpayer (i) was able to monetize its more than $1 billion gain in Bender, and (ii) failed to maintain a continuing economic interest in Bender. The objective evidence in the record overwhelmingly supports the Tax Court's finding (A133) that the Bender transaction was, both in form and in substance, a sale.

B. Taxpayer monetized its $1.3 billion gain from its Bender investment

Taxpayer "cashed out" the gain inherent in Bender, making nonrecognition treatment inappropriate under § 354. The purpose of the reorganization provisions, and the tax deferral treatment they permit, is "to free from the imposition of an income tax purely 'paper profits or losses' wherein there is no realization of gain or loss in the business sense but merely the recasting of the same interests in a different form." Paulsen, 469 U.S. at 136 (citation omitted); Treas. Reg. § 1.368-1(b). The nonrecognition provisions were never intended to apply where a taxpayer disposes of its stock or assets for cash or cash equivalents. Mertens at § 43:18. For example, in Paulsen, the Court recharacterized a "formal" equity interest as "essentially the equivalent of cash," and rejected taxpayer's claim for tax-free treatment under §§ 354(a)(1) and 368(a)(1)(A). 469 U.S. at 137. Similarly, this Court has determined that where the owner of the target company has, in "substance" (although not in form), "cash[ed] out" its investment, then the purported reorganization is properly treated as a "taxable transaction." McDonald's, 688 F.2d at 524-525.

Here, the objective evidence clearly demonstrates that taxpayer has realized a gain "in the business sense," and has "cashed out" its Bender investment. The stock interest received by taxpayer in the Bender transaction, coupled with the control rights, was essentially effective ownership of cash equal to the value of Bender. As detailed above, every contemporaneous statement by taxpayer extols the enormous cash resources that taxpayer gained from the Bender transaction. Moreover, taxpayer captured the full economic and accounting value of a cash sale. As soon as the transaction closed, taxpayer began to use the $1.375 billion Bender proceeds to expand its share repurchase program, and within months had spent most of the Bender proceeds to reduce its outstanding shares (thus increasing dramatically its earnings per share). Taxpayer was also able to report "a gain of $1.35 billion." (A92-93.)

Taxpayer's treatment of the cash is consistent with Reed's contemporaneous understanding. Reed was informed by taxpayer that the "LLC agreement will not contain any restrictions on the use of the cash." (A22.) As Reed's chairman and chief negotiator in the transaction (Bruggink) testified, Reed had "[n]o concerns" about the $1.375 billion after the transaction, because Reed did not expect to see the cash again, and did not "expect to have any say in how [taxpayer] invested, what [taxpayer] did with the $1.375 billion." (Supp226-227.)

Utterly ignoring the undisputed facts that it used the vast majority of the Bender proceeds to accomplish its share-repurchase program, and that it padded its consolidated balance sheet with those proceeds (A95), taxpayer argues (Br. 16, 58-59) that it "did not receive the proceeds of the Bender divestiture" because it did not have "the right to use those assets for any purpose it desired." That assertion is both irrelevant and inaccurate.

The undisputed facts demonstrate that taxpayer used the proceeds for the very purpose it most desired (to repurchase its shares in its ongoing share-repurchase initiative) and, therefore, whether it could have used the proceeds for other purposes is purely academic. Taxpayer never has claimed that using the proceeds to purchase its stock somehow was foreclosed by the LLC agreement. Therefore, even if the agreement did not give taxpayer the right to directly "divert" the cash to itself, but instead limited taxpayer to using the cash to repurchase its own stock, such a distinction is meaningless in this context. As taxpayer's CFO conceded (and as the Tax Court found (A116)), "cash is fungible." Because it was able to use the cash in LLC to implement its share-repurchase program, and thus generate "significant free cash flow" (A78), taxpayer did not need to "divert" the Bender proceeds directly to itself in order to serve "its own corporate purposes" (Br. 63-64). In this regard, we note that the Tax Court did not find (as taxpayer claims (Br. 64 (citing A132)) that taxpayer "receive[d] the proceeds of sale." On the contrary, the court found that taxpayer "receive[d] the proceeds of sale for use in its strategic plans" (A132 (emphasis added)), which is indisputably true.

Indeed, a variation of taxpayer's argument was rejected by the Supreme Court nearly 70 years ago in a corporate reorganization case in which the taxpayer's debts were discharged by another. In Hendler, the taxpayer argued that the payment of its debts could not be treated as income, because it "did not actually receive the money." 303 U.S. at 566. The Court disagreed, holding that the taxpayer's "gain was as real and substantial as if the money had been paid it and then paid over by it to its creditors." Id. The cases cited by taxpayer (Br. 58-59) are not to the contrary, and do not alter the inescapable conclusion that taxpayer (through the PW plan) utilized a reorganization facade to monetize its prior stock interest in Bender, and has disbursed the proceeds to its shareholders.

In addition to being irrelevant, taxpayer's argument regarding the purported restrictions is factually inaccurate. The LLC agreement itself does not (as taxpayer asserts (Br. 60)) place "any restrictions" on taxpayer's use of the cash, a fact that taxpayer emphasized to Reed. See A22 ("The LLC agreement will not contain any restrictions on the use of the cash."). The agreement's stated purpose in no way limits the manager's discretion (as taxpayer now argues (Br. 59)), but merely provides, in a circular fashion, that the LLC's purposes are whatever "the Manager [ i.e., taxpayer] determines is in the best interests of [LLC]" (SA242). The agreement also expressly provides that if taxpayer, as manager of LLC, has any fiduciary duties, they "shall be owed solely" to taxpayer and not to Reed. (A116; SA243.) And taxpayer's reliance (Br. 61) on Delaware law is misplaced -- the parties agreed that the LLC agreement overrode any contrary provisions in law, including Delaware law (SA249; Supp209-214).

Moreover, taxpayer's argument is belied by its contemporaneous public statements regarding the Bender proceeds, which taxpayer claimed to control without restrictions. (E.g., A94.) Indeed, taxpayer's accountants relied on the absence of any restrictions in the LLC agreement in approving consolidation of LLC's assets in taxpayer's financial results. (A113-114.) Analyzing the LLC agreement, taxpayer's auditors concluded that taxpayer (i) has "total control over [LLC's] assets and operations," (ii) has "no fiduciary duty to the holder of [MB Parent] and may use its discretion as to the use of the assets," and (iii) "is the beneficiary of all of the ownership risks and rewards of the LLC." (A113-114.) Those conclusions were seconded by Jensen, the Commissioner's corporate-control expert. (Supp209-214.)

Ignoring the fact that it has already used almost all of the cash to repurchase its own stock, taxpayer argues (Br. 23) that it cannot obtain the cash in the form of MB Parent dividends without the approval of Reed (which has voting control of MB Parent). Taxpayer's argument misses the mark. Although (as taxpayer argues (Br. 57)) Reed controls "the purse strings" for any funds that LLC distributes to MB Parent, taxpayer controls the purse strings to the funds that remained in LLC. Taxpayer simply did not need to transfer funds from LLC to MB Parent to itself -- it could (and did) freely use the funds in LLC without ever having to move the funds to Reed's area of control. Taxpayer was able to fully use the Bender proceeds (except for a relatively small dividend issued in 1999) without such a diversion (and therefore without Reed's approval). In addition, using the funds through LLC, instead of through dividend payments, made tax sense; as taxpayer concedes (Br. 17), any dividends issued by MB Parent to taxpayer would have been "taxable" to taxpayer, whereas taxpayer could use the funds in LLC at no tax cost.

The Tax Court's conclusion that taxpayer had "unfettered control over $1.375 billion in cash" (A133) is fully supported by the record. Through the PW plan, taxpayer utilized a scheme whereby it was able to liquidate its Bender interest (by controlling over $1 billion) without technically receiving cash. To permit taxpayer to receive such control from Reed in exchange for control over Bender without (in taxpayer's words) "a tax for the shift in control" (A112; Supp93) would completely undermine the purpose of the reorganization provisions, which is to free purely paper gains or losses from the current imposition of tax. This case thus is unlike those cited by taxpayer (Br. 38-39) where a substantial portion of the proceeds remained in illiquid, corporate form. Here, taxpayer's gain was immediately liquid and under its control.

C. Taxpayer has no continuing economic interest in Bender

Not only did taxpayer receive the functional equivalent of $1.375 billion in cash, it also essentially disposed of Bender, thus failing to maintain the required post-transaction continuity of interest. To satisfy that requirement, taxpayer's "ownership interest in the prior organization must continue in a meaningful fashion in the reorganized enterprise." Paulsen, 469 U.S. at 136. That "interest must be definite and material; it must represent a substantial part of the value of the thing transferred." Id. (citation omitted); accord Treas. Reg. § 1.368-1(e)(1)(i) (continuity-of-interest "requires that in substance a substantial part of the value of the proprietary interests in the target corporation be preserved in the reorganization"). As the regulation emphasizes, "[a]ll facts and circumstances must be considered in determining whether, in substance, a proprietary interest in the target corporation is preserved." Id. Viewing the transaction as a whole, taxpayer failed to maintain any (let alone "substantial") continuing interest in the Bender operations.

MB Parent's ownership interest in Bender was extremely limited, and disappears when the entire transaction is taken into account. (A120, 128.) Under the formal agreements in the Bender transaction, Reed -- independent of MB Parent -- owned all of the Bender common stock. Thus, the bulk of Bender's value was owned directly by Reed, not through MB Parent. Although MB Parent nominally held two classes of Bender's preferred stock, the redemption value of that stock was no more than $68 million (i.e., $61 million from the Bender preferred stock and $7 million from the Bender participating preferred stock), or approximately 5 percent of Bender's value. (A61, 90; Supp134, 144.) Therefore, even viewing the Bender preferred stock in isolation, taxpayer failed to maintain a stake in a "substantial" part of the value transferred, as the case law requires.

Further, the Bender stock retained by MB Parent must be analyzed in the context of the entire transaction. It is apparent that even the limited value of the Bender preferred vanishes in light of MB Parent's financial obligations to Reed via Reed's MB Parent preferred stock. As designed in the original transaction, MB Parent owes Reed $68 million on the MB Parent preferred stock owned by Reed (A90) -- the exact amount that MB Parent expects to receive from Bender. (Supp126.) In 1999, the stated values of the MB Parent preferred and the Bender preferred increased when Reed contributed its Lexis assets to Bender. This increase did not (as taxpayer claims (Br. 18)) change the overall economics of the PW structure, because the proportionate values remained the same.⁶

Similarly, the dividend provisions in the various preferred stocks demonstrate that any Bender funds received by MB Parent would be directed to Reed, not taxpayer. MB Parent owes Reed more in dividends on the MB Parent preferred than Bender owes MB Parent in dividends on the Bender preferred, although the difference is minimal (A86), and was considered by taxpayer to be a "net cost of the structure" (Supp141). Here, the parties have eliminated the value of MB Parent's purported continuing interest in Bender by literally rerouting (using the same Reed bank account (Supp146)) the economic value of that interest to Reed through the MB Parent preferred held by Reed. Given the offsetting obligations of the preferred stock redemptions and dividends, taxpayer could expect to receive no economic benefit from MB Parent's Bender stock. Thus, viewed as a whole, the transaction documents demonstrate that taxpayer had no continuing economic interest in Bender, as the Tax Court found (A120, 128).

Taxpayer's contemporaneous statements regarding the Bender transaction further confirm that it had no ongoing economic interest in Bender. Taxpayer told management that "we are completely exiting the legal and health sciences publishing business." (Supp128.) Similarly, taxpayer informed its shareholders that it was "selling" Bender because it "didn't make sense for [taxpayer] strategically to keep these businesses." (Supp151-155.) After the Bender transaction, taxpayer reported Bender's operating results as a "discontinued operation" and, in subsequent financial reporting, did not include any financial information related to Bender. (Supp53, 173.) Taxpayer's statements are consistent with Reed's understanding. (Supp223-226.)

In arguing that it maintained the required continuing interest in Bender, taxpayer narrowly focuses (Br. 14-16) on the fact that MB Parent holds two classes of preferred stock in Bender, with a combined value that taxpayer conceded during the trial was no more than $70 million (Supp31). This argument ignores the fact that the value of MB Parent's interest in Bender was completely wiped out by MB Parent's obligations to Reed on the MB Parent preferred stock. See Associated Wholesale Grocers, Inc. v. United States, 927 F.2d 1517, 1528-1529 (10th Cir. 1991) (in applying "substance over form," the court "ignore[s] acts taken in intermediate steps which the taxpayer has itself undone with subsequent steps"); BB&T Corp. v. United States, 2007 WL 37798 (M.D.N.C. Jan. 4, 2007) (recharacterizing offsetting obligations) (a copy of the slip opinion is included in this briefs addendum). Given MB Parent's obligations to Reed, taxpayer will not (as it argues (Br. 53-54)) "share in [Bender's] economic fortunes." And, contrary to taxpayer's suggestion (Br. 55-56), it will not share in Bender's economic misfortunes, given Bender's enormous value. But even if Bender somehow were unable to pay its preferred stockholder $61 million, that unexpected outcome would be merely another "transaction cost" of the PW tax scheme.

Finally, the purported restrictions on Reed's control of Bender (relied on by taxpayer (Br. 55-57)) are irrelevant. In an acquisitive reorganization (as this purports to be), the required continuity of interest relates to the continued interest in "value" not control. Treas. Reg. § 1.368-1(e)(1) (emphasis added). Similarly, the relevant legal determination is whether taxpayer has a continuing economic interest in Bender, not whether Reed has a continuing economic interest in the cash. Moreover, Reed's interest in the cash is de minimis -- originally less than $200,000 a quarter to pay the differential in dividends owed on the preferred stock. (A86; Supp140.) That limited interest was of no significance to Reed, as demonstrated by Bruggink's testimony that Reed had "no concerns" about the Bender proceeds. (Supp226-227.)

D. Taxpayer's request for a mechanical and narrowly focused test is inconsistent with binding precedent as well as with Treasury Regulation § 1.368-1(e)(1)

Taxpayer contends (Br. 35, 39) that the Bender transaction should be evaluated by a "mechanical" test "focusing exclusively upon the form of the consideration received," and that the Tax Court erred by analyzing the "totality of the Bender transaction." Taxpayer's argument is inconsistent with binding precedent as well as with the Treasury Regulation upon which it purportedly relies.

The Supreme Court has made it clear that, in determining whether transactions satisfy the continuity-of-interest requirement, courts must not '"exalt artifice above reality,'" and should "disregard[ ] the formal terms of the instruments in question and look[ ] to their economic substance." Paulsen, 469 U.S. at 141-143 (quoting Gregory v. Helvering, 293 U.S. 465 (1935)). Following that mandate, courts uniformly recognize that "literal," mechanical compliance with the reorganization provisions is insufficient, and that in judging the "substance" of a transaction, "each case" is "controlled by its own peculiar facts," Southwest Natural Gas Co. v. Commissioner, 189 F.2d 332, 334 (5th Cir. 1951), and "all the facts and circumstances" must be considered, Utley v. Commissioner, 906 F.2d 1033, 1037 (5th Cir. 1990).

Indeed, this Court has soundly rejected the argument -- urged by taxpayer here -- that the continuity-of-interest test should be applied in a "myopic," formalistic manner. McDonald's, 688 F.2d at 524-525. There, the Court held that, under a "pragmatic view" of all the surrounding facts and circumstances, the transaction was a taxable sale (not a reorganization), because it failed to satisfy the "continuity-of-interest requirement" -- even though the seller received stock in the merged enterprise. Id. at 525. In so holding, the Court emphasized that "[s]ubstance over form is the key" and the "comprehensive deal" must be examined, not just some narrow, formal aspect of the transaction. Id.

As this Court has explained, although "in tax law form often is substance," that form will not be respected if the surrounding circumstances and "expectations of the parties" undermine the parties' "paper" arrangements. Levin, 832 F.2d at 406 (citing United States v. Howell, 775 F.2d 887, 890 (7th Cir. 1985)). See Rexnord, Inc. v. United States, 940 F.2d 1094, 1097-1098 (7th Cir. 1991) (rejecting taxpayer's narrow focus on "the language of the agreements," and holding that "[a]lthough these transactions had the trappings of a 'bona fide sale,' the economic reality was quite different").

Ignoring this precedent, taxpayer cites (Br. 33-35) Treasury Regulation § 1.368-1(e)(1) for the proposition that the continuity-of-interest test is "mechanical." Taxpayer's characterization of the regulation is overbroad; in fact, the regulation provides that "[a]ll facts and circumstances must be considered in determining whether, in substance, a proprietary interest in the target corporation is preserved." Treas. Reg. § 1.368-1(e)(1)(i) (emphasis added). That language belies taxpayer's claim (Br. 34) that the regulation establishes a "bright-line rule" for all continuity-of-interest determinations.

E. Taxpayer's reliance on NIPSCO is misplaced

Taxpayer argues (Br. 22, 42-44) that, under the "economic substance" doctrine set out in NIPSCO, MB Parent cannot be disregarded. There, the Court considered whether a foreign subsidiary corporation (Finance) had sufficient economic substance to entitle its parent corporation to tax benefits under a treaty. The Court affirmed the lower court's factual finding that Finance was not a mere "conduit," and was recognizable for tax purposes, because Finance engaged in "substantive business activity," and the form of the transaction resulted in "actual, non-tax-related changes in economic position." NIPSCO, 115 F.3d at 511-512. Taxpayer's reliance on NIPSCO is misplaced.

First, it is not necessary to disregard MB Parent in order to conclude that the Bender transaction was in substance a sale. Neither the determination that taxpayer cashed out its Bender investment nor the determination that taxpayer failed to maintain a real economic interest in Bender is dependent on disregarding MB Parent. On the contrary, the existence of a sale rests on the fact that taxpayer controls the Bender proceeds through the LLC agreement, to which MB Parent is a party. And the lack-of-continuing-economic-interest determination is based on the fact that MB Parent owes Reed more on the MB Parent preferred stock than Bender owes MB Parent on the Bender preferred stocks. In other words, we are not asking this Court to disregard MB Parent but, rather, to give due regard to the entire structure, including the LLC agreement and the interlocking preferred stock interests, that together negate any real economic connection between taxpayer and Bender.

As cases like Rexnord and McDonald's demonstrate, this Court (like other courts) characterizes a transaction according to its substance, without first determining that one of the transaction participants lacks economic substance. See also Rogers v. United States, 281 F.3d 1108, 1114-1118 (10th Cir. 2002) (distinguishing NIPSCO, and explaining that even a transaction that had "economic substance" could be recharacterized "as one thing rather than another" under the substance-over-form doctrine); TIFD III-E, Inc. v. United States, 459 F.3d 220, 231 (2d Cir. 2006) (holding that "even when [a taxpayer's] interest has economic substance," the Commissioner may "reject[ ] a taxpayer's characterization" of that interest). Accordingly, it is unnecessary to address NIPSCO.

Second, and assuming arguendo that disregarding MB Parent is essential to recharacterizing the transaction as a sale (which it is not), NIPSCO does not further taxpayer's case. There, the Court concluded that Finance must be respected because it (and not the taxpayer) had "control" over Finance's investments. 115 F.3d at 513-514. In contrast here, taxpayer -- not MB Parent -- controls the cash and investments in LLC. (A112-114; SA260.) MB Parent has no access to the cash (other than the required distributions for taxes and dividends). (SA247; Supp212-213.)

As the Tax Court noted (A130), this case is analogous to West Coast Mkt'g Corp. v. Commissioner, 46 T.C. 32 (1966), where the court recharacterized a purported tax-free reorganization as a taxable sale, after finding that the intermediate corporation was created solely to be a conduit for transferring property without tax cost. Like the intermediary corporation in West Coast, MB Parent (i) serves no business purpose other than providing the form necessary to support a claim for a tax-free reorganization (A127), and (ii) has no meaningful economic effect (A130), as the Tax Court determined.

The Tax Court's determinations are consistent with NIPSCO's legal standard, and thus taxpayer's claim (Br. 47) that the court committed "legal error" is incorrect. Taxpayer's related complaint (Br. 44) that the court "inexplicably failed to address" NIPSCO also is baseless. Taxpayer did not cite this Court's NIPSCO opinion in its post-trial briefs, and only briefly cited (in its reply brief) the lower court opinion in NIPSCO. (Docket 81 at 44.) Instead, and as the Tax Court noted (A128), taxpayer relied on Esmark, a case that holds that the transaction's form will be disregarded if (as here) it "failed to reflect the substance of the transaction," 90 T.C. at 183. See Docket 66 at 67-72; Docket 81 at 44-45.

Taxpayer has not shown that the Tax Court's findings regarding MB Parent are clearly erroneous. See NIPSCO, 115 F.3d at 512 (determining whether a corporation carried on sufficient business activity to be respected was a "question of fact," upon which taxpayers bear the "burden of proof') (citation omitted). As the record establishes, MB Parent (i) has no employees or offices of its own (Supp39), (ii) does not conduct any of its own business (Supp132), and (iii) was created as a special purpose corporation to support taxpayer's claim for a tax-free reorganization (Supp93, 225-227). Indeed, before closing, taxpayer informed Reed that "MB Parent will have little or no business activity except with respect to the receipt of distributions from [LLC]" (Supp132), and taxpayer's contrary claim on appeal (Br. 52) is baseless. Given taxpayer's own contemporaneous statement, the Tax Court's finding that MB Parent "had no business" (A127) is neither "baffling" nor "false," as taxpayer contends (Br. 49).

Similarly lacking in merit is taxpayer's claim (Br. 51) that "MB Parent has retained its assets, not passed them on to another party." MB Parent (controlled by Reed) has irrevocably passed its assets to LLC (controlled by taxpayer), leaving MB Parent in control of essentially nothing. See SA150 (taxpayer's agent testifies that MB Parent's only assets are the Bender preferred stocks). And although MB Parent pays the taxes on income generated by LLC, LLC is an independent entity. The fact that MB Parent has existed in corporate form since 1998 does not (as taxpayer suggests (Br. 52)) lend it substance, just as the passage of time in West Coast did not give meaning to the conduit corporation there.

In sum, the proprietary PW scheme is no more than an elaborate veneer to mask a taxable sale. It violates both the letter and the spirit of the Code. To bless this device invites an infinite variety of corporate tax avoidance schemes. In particular, taxpayers with appreciated property could dispose of it without paying a tax on the gain simply by constructing an elaborate "merger," where one party enjoys the use of the property and the other party enjoys the use of the cash. Such an attack on the federal fisc should not be countenanced.

Code of 1986 (26 U.S.C.):

Sec. 368. Definitions relating to corporate reorganizations

(e) Continuity of interest -- (1) General rule. (i) The purpose of the continuity of interest requirement is to prevent transactions that resemble sales from qualifying for nonrecognition of gain or loss available to corporate reorganizations. Continuity of interest requires that in substance a substantial part of the value of the proprietary interests in the target corporation be preserved in the reorganization. A proprietary interest in the target corporation is preserved if, in a potential reorganization, it is exchanged for a proprietary interest in the issuing corporation (as defined in paragraph (b) of this section), it is exchanged by the acquiring corporation for a direct interest in the target corporation enterprise, or it otherwise continues as a proprietary interest in the target corporation. However, a proprietary interest in the target corporation is not preserved if, in connection with the potential reorganization, it is acquired by the issuing corporation for consideration other than stock of the issuing corporation, or stock of the issuing corporation furnished in exchange for a proprietary interest in the target corporation in the potential reorganization is redeemed. All facts and circumstances must be considered in determining whether, in substance, a proprietary interest in the target corporation is preserved. For purposes of the continuity of interest requirement, a mere disposition of stock of the target corporation prior to a potential reorganization to persons not related (as defined in paragraph (e)(3)) of this section determined without regard to paragraph (e)(3)(i)(A) of this section) to the target corporation or to persons not related (as defined in paragraph (e)(3) of this section) to the issuing corporation is disregarded and a mere disposition of stock of the issuing corporation received in a potential reorganization to persons not related (as defined in paragraph (e)(3) of this section) to the issuing corporation is disregarded.

² If this Court were to determine that the Bender transaction qualifies for tax-free treatment, a remand would be necessary to address the Commissioner's alternative, statutory argument related to the Mosby transaction (A138; Supp30), as well as the Commissioner's alternative argument that § 269 dictates that taxpayer must recognize gain on the Bender and Mosby transactions (A135).

³ Taxpayer cites to "Bittker and Eustice's" observations about the Tax Court's opinion (e.g., Br. 40), but it bears noting that Mr. Bittker died before the court issued its opinion, and Mr. Eustice is "of counsel" to the law firm litigating another taxpayer's case that (according to public filings) involves a similar transaction. Tax Ct. No. 20742-04.

⁴ The bulk of the Bender proceeds is now gone. Ninety percent of LLC's "investments" are in taxpayer's own stock, which -- according to LLC's financial statements -- is "restricted from sale because [LLC] is considered an affiliate of [taxpayer]." (A103.) Even without that restriction, reselling the stock is inconsistent with taxpayer's stock-repurchase program.

⁵ Unlike taxpayer, Reed had no economic interest in the value of the MB Parent common stock, because that value did not affect Reed's tax position. Reed's basis in its Bender common stock equaled the amount of cash it contributed to MergerSub in exchange for what would become the Bender stock, whether the transaction was taxable (§ 1012) or tax free (§ 358(a)). Thus, whether the MB Parent common stock was valued at $1.3 billion or $1.30 would not change Reed's basis in its Bender stock.

⁶ After the Lexis contribution, the MB Parent preferred was valued at $109 million, the Bender preferred at $102 million, and the Bender participating at $7 million. (Supp144.)