Opinion
20860-18
02-01-2022
WILLIAM A. HAMMOND & IRMA HAMMOND, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
ORDER
Travis A. Greaves Judge
This case is before the Court on petitioners' motion for partial summary judgment (motion) filed on January 21, 2021, under Rule 121. For the reasons explained below, we deny petitioners' motion.
Petitioners characterize the motion as a motion for summary judgment, however, the motion does not address all of the issues petitioners raised in the pleadings. Therefore we will recharacterize the motion as a motion for partial summary judgment.
Unless otherwise noted, all Rule references are to the Tax Court Rules of Practice and Procedure, all section references are to the Internal Revenue Code in effect at all relevant times, and all dollar amounts are rounded to the nearest dollar.
I. Background
The following facts are based on the parties' motion papers and attached exhibits, unless otherwise stated, and are not disputed. Petitioners resided in Texas when they filed the petition.
A. 2007 Transactions
On or about January 22, 2007, co-petitioner William Hammond (Mr. Hammond) entered into stock-to-cash programs with Alexander Capital Markets, LLC (ACM). The ACM stock-to-cash programs worked as follows: ACM loaned funds to customers who in turn posted collateral with ACM in the form of securities. The amount of the loans typically equaled 85 percent to 90 percent of the securities' value. Under the terms of these loans, ACM had the right to sell the customers' securities upon receipt. After a period of time, normally between two and seven years, the customer would have the right to (1) receive back his securities (or the equivalent cash value) if he repaid the balance of the loan plus accrued interest, or alternatively (2) "walk away" from the nonrecourse obligation at the end of the redemption period having already received up to 90 percent of the value of his securities. Although customers were assured that ACM engaged in "hedging" transactions designed to protect against adverse market movements and that ACM would be able to return either the full value of the customers' securities or cash equivalent at the end of the contract period, ACM normally sold the customers' securities upon receipt, remitted up to 90 percent of the sales proceeds to the customers as the "loan", paid commissions to third-parties who marketed the stock-to-cash program on behalf of ACM, and retained the remaining proceeds for its own benefit.
Use of terms like "loan", "collateral", "lend", "hedge", "principal", "interest", "maturity", etc., are for convenience only. We do not intend for our use of those terms to imply that ACM's stock-to-cash program or the 2007 transactions (defined below) constituted loans for Federal tax purposes.
Whenever a loan term matured and the client directed ACM to remit his shares or cash profits, ACM generally used funds generated from newer client transactions to repay the maturing client obligations. Although ACM did not have enough funds to cover its outstanding liabilities beginning as early as 2007, ACM nevertheless continued to market its stock-to-cash program, which was later determined to be a fraudulent Ponzi scheme. See Sec. and Exch. Comm'n v. Chapman, No. CV 13-5648, 2021 WL 199539 (E.D. Pa. Jan. 20, 2021).
Mr. Hammond and a representative from ACM signed a "Stock to Cash Master Loan Agreement for Non-Recourse Structured Financing" and an addendum (collectively, master agreement). As part of this agreement, Mr. Hammond agreed to transfer to ACM 50, 000 shares of Complete Production Services, Inc. (CPS) stock worth approximately $889,500 (as of the date Mr. Hammond entered into the master agreement) in exchange for an estimated loan amount of $800,550 with an interest rate around 12 percent. On or about March 28, 2007, Mr. Hammond signed an addendum to the master agreement to transfer to ACM another 75, 474 shares of CPS stock worth approximately $1,504,952 (as of the date Mr. Hammond entered into the addendum) in exchange for another estimated loan amount of $1,354,456 with an interest rate around 12 percent.
References to the master agreement include all addendums thereto.
CPS merged into Superior Energy Services, Inc. in 2012. Superior Energy Services, Inc. filed for bankruptcy in 2020 and was subsequently removed from the New York Stock Exchange.
The master agreement provided that these two loans (2007 transactions) were for a term of 36 months and carried the following conditions: (1) title of the CPS stock was transferred to ACM whereby ACM obtained voting rights with respect to the stock and received any dividends issued on them; (2) no prepayments of the loans were permissible by Mr. Hammond during the term of the loans; (3) ACM had the "absolute right to pledge, transfer, assign, hypothecate, lend, encumber, sell short, or sell outright" the CPS stock and the exclusive right to receive and retain any benefits from such transactions; and (4) ACM's ability to provide financing to Mr. Hammond, including the final loan amounts, was contingent on ACM's ability to "hedge" the CPS stock. On January 26, 2007, ACM "hedged" the first 50, 000 shares of CPS stock for $945,000, with approximately 90 percent of that amount remitted to Mr. Hammond on or around January 31, 2007. On April 2, 2007, ACM "hedged" the additional 75, 474 shares of CPS stock for $1,497,404, with approximately 90 percent of that amount also remitted to Mr. Hammond on or around April 6, 2007.
Upon the loans' maturity, the master agreement provided Mr. Hammond with four options: (1) pay off the loan balances with accrued interest in cash and receive back the same number of shares of CPS stock Mr. Hammond transferred to ACM in 2007; (2) instruct ACM to liquidate the CPS stock, pay off the loans' balance, and remit the balance to Mr. Hammond; (3) inform ACM of his intent to not repay the loans, "choosing instead to forfeit securities to ACM with no contingent liability"; or (4) renew the master agreement (for up to 20 years). ACM had no right under the master agreement to require repayment of the loans and Mr. Hammond was not personally liable for the loans; ACM's remedy in the event of default by Mr. Hammond was limited to Mr. Hammond's surrender of the CPS stock. Mr. Hammond ultimately chose the third option by not repaying the loans and forfeiting the CPS stock upon maturity in 2010 because the value of the securities at that time was lower than the unpaid loans' balance and accrued interest.
CPS stock closed at $17.82 and $14.04 per share on January 22, 2007, and January 22, 2010, respectively.
B. Alleged Deficiency
Following an examination of petitioners' 2007 return, respondent issued petitioners a notice of deficiency and determined a deficiency in petitioners' income tax for tax year 2007 in the amount of $15,464 and an accuracy-related penalty under section 6662(a). Respondent attributed petitioners' alleged deficiency to an adjustment increasing the amount of petitioners' capital gain income by reason of the 2007 transactions after determining that the loans were actually disguised sales of the CPS stock and that petitioners did not report the advancements as income on their return.
Respondent conceded the accuracy-related penalty.
In response to the notice of deficiency, petitioners timely filed a petition with this Court challenging, among other things, respondent's determination with respect to the 2007 transactions.
II. Discussion
A. Burden of Proof
The Commissioner's determinations set forth in a notice of deficiency are generally presumed correct, and the taxpayer bears the burden of proving that the determinations are in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). A limited exception may apply where the Commissioner alleges unreported income but introduces no substantive evidence and relies solely on the presumption of correctness. See Sealy Power, Ltd. v. Commissioner, 46 F.3d 382, 386 (5th Cir. 1995), aff'g in part rev'g in part T.C. Memo. 1992-168; Jackson v. Commissioner, 73 T.C. 394, 401 (1979). The burden of proof can also shift to the Commissioner as to certain factual issues where a taxpayer presents credible evidence in support of that issue. Sec. 7491(a); see also Higbee v. Commissioner, 116 T.C. 438, 440-441 (2001). Petitioners do not suggest, and the record does not support, a finding that the burden of proof should shift to respondent with respect to any issue under petitioners' motion.
B. Summary Judgment
The purpose of summary judgment is to expedite litigation and avoid costly, unnecessary, and time-consuming trials. See FPL Grp., Inc. & Subs. V. Commissioner, 116 T.C. 73, 74 (2001). We may grant summary judgment where there is no genuine dispute of material fact and a decision may be rendered as a matter of law. Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118 T.C. 226, 238 (2002). The moving party bears this burden. Rauenhorst v. Commissioner, 119 T.C. 157, 162 (2002). Furthermore, we construe the facts and draw all inferences in the light most favorable to the nonmoving party to decide whether summary judgment is appropriate. Bond v. Commissioner, 100 T.C. 32, 36 (1993). In so doing the nonmoving party may not rest upon the mere allegations or denials of his pleading, but must set forth specific facts showing that there is a genuine dispute for trial. Rule 121(d); Bond v. Commissioner, 100 T.C. at 36.
C. Analysis
The parties dispute whether the 2007 transactions were loans or sales. "Courts have defined a loan as an express or implied agreement where one person advances money to the other and the other agrees to repay it upon such terms as time and rate of interest." Sollberger v. Commissioner, T.C. Memo. 2011-78, 2011 WL 1235366, at *3, aff'd, 691 F.3d 1119 (9th Cir. 2012); Black's Law Dictionary (11th ed. 2019) (defining a loan as "a sum of money lent at interest"). For disbursements to constitute a loan for federal income tax purposes, "there must have been, at the time the funds were transferred, an unconditional obligation on the part of the transferee to repay the money, and an unconditional intention on the part of the transferor to secure repayment." Haag v. Commissioner, 88 T.C. 604, 615-616 (1987) (citing Haber v. Commissioner, 52 T.C. 255, 266 (1969)), aff'd without published opinion 855 F.2d 855 (8th Cir. 1988); accord Sollberger, supra. Accordingly, a bona fide debtor-creditor relationship must have existed between Mr. Hammond and ACM in 2007 for the 2007 transactions to be properly characterized as loans.
To assist us in making this determination we look to a series of decisions by this Court involving similar stock-to-cash programs in which we consistently characterized such transactions as disguised sales. See Calloway v. Commissioner, 135 T.C. 26, 33 (2010), aff'd, 691 F.3d 1315 (11th Cir. 2012); SWF Real Estate LLC v. Commissioner, T.C. Memo. 2015-63; Raifman v. Commissioner, T.C. Memo. 2012-228; Sollberger, supra; Landow v. Commissioner, T.C. Memo. 2011-177; Kurata v. Commissioner, T.C. Memo. 2011-64; Shao v. Commissioner, T.C. Memo. 2010-189. The 2007 transactions factually mirror in almost all material respects the stock-to-cash programs at issue in those case.
In 2007 Mr. Hammond transferred legal title and possession of the CPS stock to ACM, who then had the unconditional right to sell the stock outright. The parties do not dispute that ACM sold the CPS stock as part of the 2007 transactions. Cf. Calloway, supra at 34. The value of the "loans" was not determined until after the 2007 "hedges" of the CPS stock by ACM, with the financing itself wholly contingent on ACM's ability to execute these "hedges". Cf. id. at 35. In contrast to the ordinary risk assumed by a lender-that a borrower might not repay a loan-ACM faced the opposite risk in that if Mr. Hammond repaid the loans in 2010 and requested ACM deliver the CPS shares back to him, ACM would have been forced to buy the stock from the financial marketplace in 2010 (assuming it sold some or all of the stock during the course of either "loan") and likely realize a loss on the transactions based on the decreased value of the CPS stock between 2007 and 2010. Cf. id. at 39. Mr. Hammond bore no risk of loss in the event the CPS stock decreased in value and was entitled to retain all the funds transferred to him regardless of the performance of the CPS stock in the financial marketplace. Cf. id. at 36. Lastly, Mr. Hammond had no personal liability to pay principal or interest to ACM on the loans, and it would not have made sense for him to do so unless the value of the CPS stock had substantially appreciated. Cf. id. at 38. The only right Mr. Hammond retained regarding the CPS stock was an option, exercisable in 2010, requiring ACM to deliver the CPS stock (after presumably first reacquiring from the marketplace any shares sold by ACM during the course of the "loans") to him at that time. Id. We therefore find that the benefits and burdens of the CPS stock passed from Mr. Hammond to ACM in 2007 such that Mr. Hammond is considered to have sold the CPS stock to ACM and recognized capital gain income from the 2007 transactions. See Grodt & McKay Realty, Inc. v. Commissioner, 77 T.C. 1221, 1237 (1981) (holding a sale occurs on the date the benefits and burdens of ownership are transferred between parties).
Respondent asserts that ACM sold the stock immediately after receiving it from Mr. Hammond, a point that petitioners do not dispute. Accordingly, we construe this fact in the light most favorable to respondent, the nonmoving party.
In reaching the above conclusion we apply, just as we did in Calloway and its progeny, the "substance over form" doctrine. See Calloway, supra at 33-38; Raifman, supra at *15. The Supreme Court first articulated this doctrine in Gregory v. Helvering, 293 U.S. 465, 469-470 (1935), and it has become a well-settled principle that the incidence of taxation depends on the substance rather than form of the transaction. Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945) ("To permit the true nature of a transaction to be disguised by mere formalisms, which exist solely to alter tax liabilities, would seriously impair the effective administration of the tax policies of Congress.").
Petitioners' argue, however, that respondent has improperly applied this doctrine with respect to the 2007 transactions. Petitioners contend that this doctrine applies only if both of the following requirements are met: (1) the form adopted in a transaction differs from its economic substance; and (2) that form results in a measurable tax benefit that would not otherwise be allowed to the taxpayer if the transaction were characterized according to that substance. Petitioners further posit that this second condition was not met in that "they did not receive a tax benefit" by entering into the 2007 transactions because if the 2007 transactions are respected according to their alleged form, then the master agreements would "give rise to the exact same tax consequences" in that both characterizations-either a sale or loan- would result in taxable long-term capital gains.
As with the taxpayers in Calloway and subsequent cases involving similar stock-to-cash programs, we recognize the inherent tax advantage behind petitioners' attempt to characterize the transactions as "loans". Petitioners could either outright sell the CPS stock and, depending on their basis in the stock and relevant tax attributes for the year, net less than 90 percent of the value of the stock after payment of tax on the gain, or alternatively realize approximately 90 percent of the value of the transferred CPS stock through the arrangement with ACM by attempting to label the transactions as loans.
In an attempt to support their allegations, petitioners specifically claim that if the 2007 transactions are respected according to their form then they would have had to recognize capital gain income on their 2010 return in the form of discharge of indebtedness and that respondent "should have assessed tax against [p]etitioner in year 2010 (not in 2007) when [p]etitioner earned capital gains by voluntarily surrendering the CPS [s]tock in satisfaction of the [l]oan[s]." Petitioners, however, did not even abide by their own position in that they did not factually demonstrate that they reported any such discharge of indebtedness income on their 2010 return (or in any other tax year). See Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946) ("The rule is well established that the failure of a party to introduce evidence within his possession and which, if true, would be favorable to him, gives rise to the presumption that if produced it would be unfavorable."). More importantly, none of our prior decisions, including Calloway¸ which consistently applied the substance over form doctrine to invalidate other materially indistinguishable stock-to-cash programs, held for the proposition that petitioners are asking us to accept now. Thus, to find for petitioners' position would be to essentially override this precedent, which we are not inclined to do based on the legal arguments and facts presented before us.
We likewise find no basis in fact to support petitioners' related contention that they did not receive or derive a time value of money tax benefit arising from the 2007 transactions by not reporting until 2010 any gain that they may have been required to recognize in 2007 based on their failure to demonstrate recognition of this gain in any taxable year.
Upon due consideration, it is
ORDERED that petitioners' motion for summary judgment, filed January 21, 2021, is recharacterized as petitioners' motion for partial summary judgment and that motion is denied. It is further
ORDERED that, on or before March 2, 2022, the parties shall, jointly or separately, file a status report with the Court as to the then-present status of the case.