Opinion
11832-20
07-05-2024
AVENTIS, INC., AND SUBSIDIARIES, Petitioner v. COMMISSIONEROF INTERNAL REVENUE, Respondent
ORDER
David Gustafson Judge
This is a deficiency case involving the years 2008-2011, brought under 26 U.S.C. § 6213(a), that is set for trial at a special session of the Tax Court in Washington, D.C., beginning February 3, 2025. Petitioner Aventis, Inc. ("Aventis") and Subsidiaries filed a motion for summary judgment (Doc. 37). The motion asks us to hold that stock issued by Aventis pursuant to an alleged Financial Asset Securitization Investment Trust ("FASIT") agreement is debt, rather than equity, regardless of whether the agreement actually qualifies as a FASIT agreement under § 860L. Because of the presence of genuine issues of material fact, we will deny the motion.
Unless otherwise indicated, statutory references are to the Internal Revenue Code (Title 26 of the United States Code) as in effect at the relevant times; references to regulations are to Title 26 of the Code of Federal Regulations ("Treas. Reg.") as in effect at the relevant times; and references to Rules are to the Tax Court Rules of Practice and Procedure. Some dollar amounts are rounded.
Background
The following background is drawn from the parties' pleadings, stipulation of facts, and motion papers. This narrative is stated solely for the purpose of ruling on the pending motion and not as findings of fact.
Aventis and Affiliates
Aventis is a Pennsylvania corporation. Bridgewater, New Jersey, was its principal place of business at the time the petition was filed. Aventis is an indirect subsidiary of Sanofi. Rhone-Poulenc Rorer International (Holdings), Inc. ("RPRIH"), was a Delaware corporation and also, like Aventis, an indirect subsidiary of Sanofi, and was merged into Aventis on December 31, 2001. Rhone-Poulenc Investissement S.A. ("RPI") was a French corporation also indirectly owned by Sanofi. RPI's parent, Sanofi-Aventis Amerique du Nord S.A. ("SAAN"), dissolved RPI without liquidation in 2006. RPR (UK) Holdings Limited ("RPRUK"), was a UK affiliate of petitioner.
Prior to June 20, 2002, petitioner was known as Rhone-Poulenc Rorer, Inc. ("RPR"). Sanofi has undergone several name changes. It was known as Rhone-Poulenc prior to August 20, 2004, and then Sanofi-Aventis S.A. until May 6, 2011, when its name changed to Sanofi. We sometimes refer to these entities by their eventual names, Aventis and Sanofi, even in describing events that took place before they got those names.
FASIT Agreement
Debt existed among Aventis and its affiliates. RPRUK owed £641,000,000 to RPRIH; and on January 1, 1998, that debt was divided into two separate debts (memorialized in interest-bearing promissory notes) consisting of £545 million in "long-term" debt and £96 million in "short-term" debt.
In July 2000 RPRIH entered into an agreement with two unrelated companies-Dynamo Investments, Inc. ("Dynamo"), and Chase Manhattan Bank, ("Chase")- and with its affiliate RPI. Under that agreement, those two notes (then held by RPRIH) were transferred into a FASIT. (For simplicity we refer to it as a FASIT even though the Commissioner contends that it did not qualify as a FASIT. Aventis's motion that we now address presents an alternative theory under which it is assumed that it did not qualify.)
Originally RPRIH was the asset manager of the FASIT, and did not own an interest in it. Rather, under the agreement, interests in the FASIT were owned by the other three entities: In exchange for $500,000, Dynamo held the "ownership interest" reflected in an interest-bearing "Class I Note". In exchange for $11,500,000, Chase held a "regular interest" reflected in an interest-bearing "Class II Note". In exchange for $559,500,000, RPI held a "regular interest" reflected in stock issued by RPRIH ("Series A/E Stock"). While the Notes issued pursuant to the agreement were traditional debt instruments in the form of interest-bearing notes, the Series A/E Stock was different: As its name implies, it was stock that required payments to RPI not of interest but of dividends, which were to be calculated based on the performance of the other assets in the agreement.
The stock issued by RPRIH was originally Series A Stock. However, after RPRIH merged with RPR (later Aventis) on December 31, 2001, the Series A Stock was reissued as Series E Stock of RPR (later Aventis). We refer to this as the "Series A/E Stock".
Terms of Series A/E Stock
Resolving doubts in favor of the non-moving party (for the reasons stated below in Part I.A), we assume, for purposes of Aventis's motion, that the Series A/E Stock had the following characteristics:
• The Series A/E Stock was characterized as "stock" by Aventis and the other parties to the agreement.
• The Series A/E Stock is described as "preferred stock" on Aventis's tax return balance sheet.
• No "principal" of the Series A/E Stock was provided in the terms of the agreement.
• A third-party lender would not have made a loan similar to that which RPRIH received under the terms of the Stock.
• The Series A/E Stock was thinly capitalized.
• The investor risk under the terms of the Series A/E Stock was high because repayment would be limited to the value of the assets of the FASIT.
• Repayment of the Series A/E Stock was subordinate to the other FASIT interest owners and creditors of Aventis.
• The Series A/E Stock provided voting rights to RPI.
• Payments on the Series A/E Stock were dependent on the performance of the assets in the FASIT.
• Any payments made to RPI had to be approved by the Board of Directors of Aventis.
• Any amount not distributed as dividends would have been included in the holder's liquidation preference.
• There was no fixed rate of interest on the Series A/E Stock.
• The funds paid to Aventis were not used for business operations but to acquire capital.
• Payments made to RPI after the exit of Chase were profits from the FASIT assets and not interest.
• There is no provision for redemption of the Series A/E Stock prior to the maturity date.
Subsequent changes
The assets and interests provided for in the agreement changed during the life of the agreement. Chase withdrew entirely from the agreement in 2003 after full satisfaction of the Class II Note, and the Class I Note held by Dynamo reduced in principal to just $100,000. RPRIH (original holder of RPRUK's notes and asset manager of the FASIT) merged with RPR in December 2001, and RPR became Aventis in June 2002.
Summary of the situation
The situation that the parties intended to exist under the FASIT regime was, in a simplified description, as follows: Aventis was the legal owner of the assets in the FASIT. However, Dynamo (not a party to this case) was the holder of the "ownership interest", and therefore Dynamo was the entity that was to be treated as owner of the FASIT assets for U.S. tax purposes. That is, Dynamo would report the income earned on those assets and would deduct the interest payments made on the Class I and Class II notes. Importantly, Dynamo would also-as permitted by the FASIT rules (if they applied)-deduct, as interest, the dividends to be paid on the Series A/E stock.
However, the FASIT rules govern only U.S. taxation. "[T]he Series A/E Instrument in the hands of the French parent was treated as preferred stock for French tax purposes." (Doc. 59 at 24.)
Audit and litigation
On audit the IRS determined that the intended FASIT did not actually qualify for FASIT treatment. Consequently, the IRS disregarded Dynamo's artificial designation as owner under the FASIT rules and instead, consistent with the legal and economic realities, treated Aventis as the owner (and as the entity that must recognize income). Moreover, in the absence of the special FASIT rules, the IRS determined that Aventis was not entitled to deduct, as interest, the dividends paid on the Series A/E Stock. Rather, those dividends would be treated as dividends, not deductible by the payor.
Aventis filed its petition to challenge the IRS's determinations. Aventis's principal position is that its FASIT was valid under the rules of section 860L. That principal position is not the subject of the pending motion. Rather, paragraph 5(n) the petition states, as an alternative position: "[I]f the FASIT Arrangement did not qualify as a FASIT and Petitioner must report the interest income earned on the FASIT Assets, Petitioner (and not Dynamo) is also entitled to a deduction for the interest expense payments made on the Series A/E Instrument, as the Series A/E Instrument is treated as debt under general tax principles."
This alternative position is the subject of Aventis's motion for summary judgment, which asks us to hold that, under general principles of debt-vs.-equity, the Series A/E Stock should be treated as debt, not equity, and the payments made pursuant to it should therefore be treated as deductible interest and not as non-deductible dividends. The parties filed their memoranda (Docs. 38, 50, 59) and, in response to our orders (Docs. 62, 64), the Commissioner filed a supplemental memorandum (Doc. 71).
Discussion
I. Legal principles
A. Summary Judgment Standard
The purpose of summary judgment is to expedite litigation and avoid unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). Under Rule 121(a)(2), we may grant summary judgment when there is no genuine dispute as to any material fact and a decision may be rendered as a matter of law. Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992) aff'd, 17 F.3d 965 (7th Cir. 1994). The burden is on the moving party to demonstrate that no genuine dispute as to any material fact remains. FPL Grp., Inc. & Subs. v. Commissioner, 11 T.C. 73, 74-75 (2001). In deciding whether to grant summary judgment, we construe factual materials and inferences drawn from them in the light most favorable to the non-moving party. Sundstrand, 98 T.C. at 520 (citing Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255 (1986)). However, the non-moving party may not rest upon the mere allegations or denials in its pleadings but instead must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); Sundstrand, 98 T.C. at 520.
B. Debt vs. equity
A bona fide debt is one that "arises from a debtor-creditor relationship based upon a valid and enforceable obligation to pay a fixed or determinable sum of money." Treas. Reg. § 1.166-1(c) (bad debt provision): see also Kean v. Commissioner, 91 T.C. 575, 594 (1988). The Court determines the characterization of an investment as debt or equity by weighing multiple factors. The U.S. Court of Appeals for the Third Circuit (the presumptive venue for appeal of this case, under section 7482(b)(1)(B)) has identified 16 such factors:
(I) the intent of the parties; (2) the identity between creditors and shareholders; (3) the extent of participation in management by the holder of the instrument; (4) the ability of the corporation to obtain funds from outside sources; (5) the 'thinness' of the capital structure in relation to debt; (6) the risk involved; (7) the formal indicia of the arrangement; (8) the relative position of the obligees as to other creditors regarding the payment of interest and principal; (9) the voting power of the holder of the instrument; (10) the provision of a fixed rate of interest;
(II) a contingency on the obligation to repay; (12) the source of the interest payments; (13) the presence or absence of a fixed maturity date; (14) a provision for redemption by the corporation; (15) a provision for
redemption at the option of the holder; and (16) the timing of the advance with reference to the organization of the corporation.Fin Hay Realty Co. v. U.S., 398 F.2d 694, 696 (3d Cir. 1968). These factors are fact-intensive and require weighing by the Court.
C. FASIT Rules
A FASIT is a type of investment vehicle authorized by Congress in 1996 to allow for the securitization of revolving, non-mortgage debt obligations. All interests in a FASIT must be either regular interests or the ownership interest. § 860L(a)(1)(B). Section 860L(b)(1)(A) provides:
Congress later repealed the FASIT rules in 2004 due to concerns that FASITs were highly susceptible to abuse by corporations with international affiliates. Namely, Congress had not intended to allow corporations to enter into agreements by which an asset is considered debt for tax purposes in the United States but equity for tax purposes abroad.
(A) In General.- The term "regular interest" means any interest which is issued by a FASIT on or after the startup date with fixed terms and which is designated as a regular interest if-
(i) such interests unconditionally entitles the holder to receive a specified principal amount (or other similar amount),
(ii) interest payments (or other similar amounts), if any, with respect to such interest are determined based on a fixed rate, or, except as otherwise provided by the Secretary, at a variable rate permitted under section 860G(a)(1)(B)(i),
(iii) such interest does not have a stated maturity (including options to renew) greater than 30 years (or such longer period as may be permitted by regulations),
(iv) the issue price of such interest does not exceed 125 percent of its stated principal amount, and
(v) the yield to maturity on such interest is less than the sum determined under section 163(i)(1)(B) with respect to such interest.
An interest shall not fail to meet the requirements of clause (i) merely because the timing (but not the amount) of the principal payments (or other similar amounts) may be contingent on the extent that payments on debt instruments held by the FASIT are made in advance of anticipated payments and on the amount of income from permitted assets.
Under these provisions, a regular interest that is not otherwise a debt instrument is nonetheless treated as a debt instrument for federal tax purposes. § 860H(c)(1). There must be one, and only one, ownership interest and it must be held by an eligible corporation. § 860L(a)(1)(C).
Whether the corporations involved in the agreement are eligible corporations in this case is not at issue and therefore we do not discuss it further.
In the event that an arrangement ceases to be a FASIT, Proposed Regulation section 1.860H-3(1)(c) provides that "holders of regular interests are treated as exchanging their regular interests for interests in the underlying arrangement", and "interests in the underlying arrangement are classified . . . under general principles of Federal income tax law."
For the purposes of this motion, petitioner asks that the Court focus solely on the characterization of the Series A/E Stock for U.S. tax purposes, assuming arguendo that the arrangement between petitioner, Dynamo, Chase, and RPI does not qualify as a FASIT. Petitioner argues that, under general principles of Federal income tax law, the Series A/E Stock is debt for U.S. tax purposes.
II. Analysis
We analyze the character of the Series A/E Stock in light of the factors set out above in Part II. For the reasons set forth in respondent's memoranda (Doc. 43 at 98-119; Doc. 71 at 20-35), we will deny petitioner's motion.
A. Intent of the parties
Aventis stresses the first of the 16 Fin Hay factors-"intent of the parties"-in arguing that the parties clearly and unequivocally intended to invoke the FASIT rules in order to obtain treatment as debt, not equity. Thay did indeed. However, the parties' mere desire that an instrument obtain U.S. tax treatment as debt does not evidence an intent to create a bona fide debt in fact. (Nor would a desire that the instrument obtain French tax treatment as preferred stock necessarily evidence an intent to create equity.) The "intent of the parties" factor looks for an intent to create real debt. The FASIT rules allowed debt treatment in circumstances where the parties intended to and did create an interest that, under the law, would otherwise be equity; so intending to create a FASIT (and thereby to obtain debt treatment) did not show an intent to create debt. (See Doc. 71 at 24-30.)
B. Other factors
Rather, as respondent states in his memo at page 100, intent is "assessed from the objective facts of the transaction, rather than self-serving statements." (Doc. 43 at p. 100, citing Ellinger v. U.S., 470 F.3d 1325, 1335 (11th Cir. 2006) and Roth Steel Tube Co. v. Commissioner, 800 F.2d 625, 630 (6th Cir. 1986).)
As discussed at length by respondent, there are many objective facts which the parties have not stipulated and for which the evidence before us precludes our holding the absence of disputes of material fact. Rather, there are genuine disputes of material fact concerning at least the matters set out above in "Terms of Series A/E Stock".
It is therefore
ORDERED that petitioner's motion (Doc. 37) for summary judgment is denied, and that this case will proceed to trial.