Merrill Lynch & Co., Inc. & Subsidiaries v. Commissioner

120 T.C. No. 3

UNITED STATES TAX COURT

MERRILL LYNCH & CO., INC. & SUBSIDIARIES, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 18170-98. Filed January 15, 2003.

MP is the parent of an affiliated group (P) that
filed consolidated income tax returns for the taxable
years at issue.

1986 Transactions: In 1986, P decided to sell the
principal investments business of MLL, a second tier
subsidiary. Because P wanted to retain certain assets
of MLL, consisting of its lease advisory business and
certain other assets (the 1986 retained assets) within
the consolidated group while minimizing or eliminating
gain on the sale of MLL outside the consolidated group,
P adopted and implemented a plan consisting of the
following steps: (1) MLL distributed the 1986 retained
assets to its subsidiary, Merlease; (2) MLL then sold
Merlease cross-chain to a sister corporation (MLAM) in
a transaction that qualified as a sec. 304, I.R.C.,
deemed redemption; (3) MLL then distributed a dividend
of the gross sale proceeds to its parent, MLCR, a
wholly owned subsidiary of MP; (4) P then completed the
sale of MLL to a third party. Under the consolidated
 - 2 -

return regulations then in effect, the cross-chain sale
and the related dividend generated an increase in
MLCR’s basis in MLL’s stock, enabling P to sell MLL
outside the consolidated group at a loss.

On the date of the 1986 cross-chain sale, P had
identified the prospective purchaser of MLL, had
negotiated a tentative purchase price for MLL, and
clearly intended to sell MLL outside the consolidated
group, thereby terminating MLL’s constructive ownership
under sec. 318, I.R.C., of Merlease, the issuing
corporation.

On its consolidated tax return for TYE Dec. 26,
1986, P claimed a loss from the sale of MLL after
treating the gross sale proceeds as a dividend and
increasing its basis in MLL’s stock by that amount.

1987 Transactions: P decided to sell the leased
properties business of MLCR, its wholly owned
subsidiary. Because P wanted to retain MLCR’s
nonleasing assets (the 1987 retained assets) while
minimizing or eliminating gain on the sale of MLCR
outside the consolidated group, P adopted and
implemented a plan consisting of the following steps:
(1) MLCR identified the subsidiaries holding the 1987
retained assets (MLBFS, MLPC, MLVC, MLEI, MLRDM, MLI,
MLLE); (2) MLCR then sold the seven subsidiaries to
three sister corporations (MLRI, MLPFS, MLAM) within
the consolidated group in transactions that qualified
as sec. 304, I.R.C., deemed redemptions; (3) MLCR then
distributed dividends of the gross sales proceeds to
its parent, MLCMH, a wholly owned subsidiary of MP; (4)
P then completed the sale of MLCR to a third party.
Under the consolidated return regulations then in
effect, the cross-chain sales and related dividends
generated increases in MLCMH’s basis in MLCR’s stock,
enabling P to sell MLCR outside the consolidated group
at a loss.

On the dates of the first seven of the 1987 cross-
chain sales, P had identified the purchaser of MLCR,
had prepared a draft acquisition agreement, and clearly
intended to sell MLCR outside the consolidated group,
thereby terminating MLCR’s constructive ownership under
sec. 318, I.R.C., of the subsidiaries sold cross-chain
(the issuing corporations).
 - 3 -

After the first seven of the 1987 cross-chain
sales had closed and shortly before the sale of MLCR
was scheduled to close, the purchaser of MLCR notified
P that it could not own VL, one of MLCR’s subsidiaries
because of Federal law restrictions. Approximately 2
weeks before the sale of MLCR closed, MLCR sold the
stock of VL to MLAM, a sister corporation, in a
transaction that qualified as a deemed sec. 304,
I.R.C., redemption.

On its consolidated income tax return for TYE
Dec. 26, 1987, P claimed a loss of $466,985,176 from
the sale of MLCR after treating the gross sales
proceeds from the 1987 cross-chain sales as a dividend
and increasing its basis in MLCR’s stock by that
amount.

Respondent determined that the nine cross-chain
sales of Merlease, MLBFS, MLPC, MLVC, MLEI, MLRDM, MLI,
MLLE, and VL (the subsidiaries) and the sales of MLL
and MLCR outside the consolidated group were parts of a
firm, fixed, and clearly integrated plan to completely
terminate MLL’s and MLCR’s actual and constructive
ownership of the subsidiaries. Petitioner contends
that each cross-chain sale resulted in the receipt of a
dividend by the selling corporation under secs. 302(d)
and 301, I.R.C., equal to the gross sale proceeds and
that it was entitled, under the consolidated return
regulations, to increase its basis in MLL’s and MLCR’s
stock as a result of the cross-chain sales.

Held: The cross-chain sales qualified as
redemptions in complete termination of MLL’s and MLCR’s
interest in the subsidiaries sold cross-chain under
sec. 302(b)(3), I.R.C., and must be taxed as
distributions in exchange for stock under sec. 302(a),
I.R.C., rather than as dividends under sec. 301, I.R.C.
 - 4 -

David J. Curtin, Sheri Dillon, Peter J. Genz, William F.

Nelson, Kimberly S. Piar and Cornelia J. Schnyder, for

petitioner.

Carmen M. Baerga, Jill A. Frisch, Lyle B. Press, and Jody S.

Rubinstein, for respondent.

MARVEL, Judge: Respondent determined the following

deficiencies in the Federal income tax of Merrill Lynch & Co.,

Inc. (Merrill Parent) and subsidiaries (collectively, the

consolidated group or petitioner):

TYE Deficiency

Dec. 26, 1986 $7,704,908
Dec. 25, 1987 12,141,242
Dec. 30, 1988 12,928,981

The ultimate issue in this case involves the proper

computation of petitioner’s basis in the stock of two

consolidated group members (the target corporations) that it sold

in 1986 and 1987. In order to resolve that issue, we must decide

the tax effect of nine cross-chain sales1 of stock of certain

subsidiaries (the issuing corporations) owned by the target

corporations. These sales were structured by petitioner to

transfer certain assets from the target corporations to other

members of the consolidated group (the acquiring corporations)

1
For purposes of this opinion, a cross-chain sale means a
sale by one brother-sister corporation to another brother-sister
corporation in the same ownership chain.
 - 5 -

before the target corporations were sold outside the consolidated

group. The parties agree that the cross-chain sales qualified as

section 3042 redemptions that must be tested for dividend

equivalency under section 302(b). The parties disagree, however,

regarding the result of that testing.

Respondent contends that each cross-chain sale by a target

corporation and the later sale of that target corporation outside

the consolidated group were parts of a firm, fixed, and clearly

integrated plan to completely terminate the target corporation’s

actual and constructive ownership of the issuing corporations.

Respondent argues, therefore, that the cross-chain sales

qualified as redemptions in complete termination of the target

corporations’ interest in the issuing corporations under section

302(b)(3), and must be taxed as a distribution in exchange for

stock under section 302(a). Petitioner contends that each cross-

chain sale resulted in the receipt of a dividend by the selling

corporation under sections 302(d) and 301 equal to the gross sale

proceeds and that it was entitled, under the consolidated return

regulations, to increase its basis in the target corporations’

stock by the amount of the dividend.3 Petitioner’s claim to

2
All section references are to the Internal Revenue Code in
effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure. Monetary amounts are
rounded to the nearest dollar.
3
Under the consolidated return investment adjustment
(continued...)
 - 6 -

increased bases in the stock of the target corporations when the

target corporations are sold to unrelated third-party purchasers

in 1986 and 1987 depends for its success upon dividend treatment

for the gross proceeds of the nine cross-chain sales. See secs.

1.1502-32(a) and 1.1502-33, Income Tax Regs.

Following concessions,4 therefore, we must decide:

3
(...continued)
regulations, see secs. 1.1502-32(a) and 1.1502-33, Income Tax
Regs. as in effect for the years at issue, a consolidated group
member’s basis in a subsidiary was increased or decreased, dollar
for dollar, by changes in the earnings and profits of the
subsidiary. The Commissioner subsequently amended the
consolidated return investment adjustment regulations generally
for determinations and tax years beginning on or after Jan. 1,
1995. T.D. 8560, 1994-2 C.B. 200.
4
In its petition, petitioner asserted (1) that respondent
failed to use the Becker “separate return limitation year” net
operating loss of $85,164,319 in computing petitioner’s group
taxable income for the 1987 taxable year; (2) respondent failed
to take into account the recalculated amount of environmental tax
deductions for the 1987 and 1988 taxable years; (3) respondent
failed to allow a separate fuel tax credit and instead included
such credit in petitioner’s general business credits for the 1986
taxable year; (4) respondent failed to include petitioner’s
available general business tax credits in determining
petitioner’s alternative minimum tax for the 1988 taxable year;
and (5) respondent failed to take into account $98,505 of Federal
income tax withheld by Newmont Mining on dividends paid to a
Canadian subsidiary of petitioner during the 1987 taxable year.
In its petition, petitioner also stated that respondent agreed
with petitioner’s position regarding adjustments (1)-(4). In the
answer to the petition, respondent conceded adjustments (1), (2),
and (4). Respondent also conceded that the disagreements
regarding adjustments (1)-(4) would be resolved in computing any
final deficiencies in this case. With respect to adjustment (5),
respondent denied the adjustment in the answer but did not raise
the issue on brief or at trial. Adjustment (5) is, therefore,
deemed conceded. See Rule 151(e)(4) and (5); Petzoldt v.
(continued...)
 - 7 -

(1) Whether a deemed section 304 redemption in the form of

a 1986 cross-chain stock sale between brother-sister corporations

in a consolidated group must be integrated with the later sale of

the cross-chain seller outside the consolidated group and treated

as a redemption in complete termination under section 302(a) and

(b)(3) as respondent contends, or whether the deemed section 304

redemption qualified as a distribution of property taxable as a

dividend under section 301 as petitioner contends; and

(2) whether deemed section 304 redemptions in the form of

eight 1987 cross-chain stock sales between brother-sister

corporations in a consolidated group must be integrated with the

later sale of the cross-chain seller outside the consolidated

group and treated as a redemption in complete termination under

section 302(a) and (b)(3) as respondent contends, or whether the

deemed section 304 redemptions were distributions of property

taxable as dividends under section 301 as petitioner contends.

FINDINGS OF FACT

Some of the facts have been stipulated. We incorporate the

stipulated facts into our findings by this reference.

Merrill Parent is a corporation organized under Delaware law

and is the parent corporation of an affiliated group of

corporations that filed consolidated Federal income tax returns

4
(...continued)
Commissioner, 92 T.C. 661, 683 (1989); Money v. Commissioner, 89
T.C. 46, 48 (1987).
 - 8 -

during the years at issue. Merrill Parent, through its

subsidiaries and affiliates, provides investment, financing,

insurance, leasing, and related services to clients.

I. 1986 Sale of ML Leasing

Before it was sold outside the consolidated group, Merrill

Lynch Leasing, Inc. (ML Leasing or MLL), was a wholly owned

subsidiary of Merrill Lynch Capital Resources, Inc. (ML Capital

Resources or MLCR), which in turn was wholly owned by Merrill

Parent. ML Leasing was engaged in the business of arranging

leasing transactions between third parties (lease advisory

business). ML Leasing also was engaged in the business of

leasing its own real and tangible personal property to third

parties in the capacity of lessor (principal investments

business). Immediately before the years at issue, the principal

investments business leases were generating substantial positive

cashflow but had “turned around” for income tax purposes, meaning

that if ML Leasing continued to hold the leases, the principal

investments business would generate taxable income in excess of

pretax cashflow. ML Leasing also owned, directly or through

single-purpose subsidiary corporations, general and limited

partnership interests in limited partnerships that held property

subject to operating and leveraged leases.

A. Preliminary Discussions

As early as August 22, 1985, Douglas E. Kroeger, a member of
 - 9 -

the corporate tax department at Merrill Parent, sent an

interoffice memorandum to David K. Downes, corporate controller

at Merrill Parent, recommending the sale of ML Leasing’s stock,

after “stripping out” certain assets Merrill Parent did not wish

to sell, as part of a tax strategy that could result in an

increase in after-tax earnings of more than $60 million.5 On

September 16, 1985, Mr. Downes presented this tax strategy to

Jerome P. Kenny, president and chief executive officer of Merrill

Lynch Capital Markets (ML Capital Markets or MLCM),6 and Stephen

L. Hammerman, Merrill Parent’s general counsel, and arranged a

meeting to explain more fully the proposed tax strategy. The

proposed tax strategy at that time consisted of at least two

steps–-the distribution of certain assets of ML Leasing that

Merrill Parent wanted to retain within the consolidated group and

the sale of ML Leasing to a third party following the

distribution.

5
The tax strategy contemplated by Mr. Kroeger was intended
to increase after-tax earnings by taking advantage of a provision
in the consolidated return regulations requiring the addback of
accelerated depreciation over straight-line depreciation when
calculating earnings and profits. See Woods Inv. Co. v.
Commissioner, 85 T.C. 274 (1985). This tax strategy is not at
issue in this case.
6
Although it is unclear from the record, it appears that
Merrill Parent retained Merrill Lynch Capital Markets (ML Capital
Markets) to sell the stock of ML Leasing in 1986 and ML Capital
Resources in 1987.
 - 10 -

At some point thereafter, Merrill Parent decided it wanted

to sell only the principal investments business of ML Leasing as

part of its tax strategy. Merrill Parent did not want ML

Leasing’s lease advisory business and certain other assets that

were not part of the principal investments business (collectively

referred to as the 1986 retained assets) to leave the

consolidated group. Merrill Parent decided to transfer the 1986

retained assets to other corporations within the consolidated

group in preparation for the sale of ML Leasing, leaving only the

principal investments business remaining in ML Leasing, including

the operating and leveraged lease assets.

On March 26, 1986, participants at an internal meeting of

petitioner discussed the possible sale of ML Leasing’s stock.

At the meeting, the participants discussed the estimated tax

basis of ML Leasing as of the end of 1985, the approximate value

of ML Leasing, whether the sale would be prohibited because of

various restrictions in the lease documents, the intangible

effects of the sale of ML Leasing, the possibility of tax reform

being passed prior to late August 1986, the estimated after-tax

economic benefit of the sale of ML Leasing, and the estimated

after-tax book gain that would result from the sale of ML

Leasing. At the meeting, Jeffrey Martin, a member of

petitioner’s Mergers & Acquisitions Group, was asked “to feel out

the market on a no-name basis inquiring if there are any
 - 11 -

interested parties for such a transaction.” Upon conclusion of

the meeting, it was decided that petitioner “would await Mr.

Martin’s findings before any additional work takes place”

regarding the sale of ML Leasing. In approximately April 1986,

petitioner decided to pursue a sale of ML Leasing and appointed

Theodore D. Sands, managing director of the Investment Banking

Division at Merrill Parent, to serve as the chief negotiator with

respect to the sale.7 Mr. Sands suggested that petitioner “clean

up” ML Leasing by removing any assets the company did not want to

sell (i.e., the 1986 retained assets).8 Mr. Sands, however, did

not suggest the manner in which the 1986 retained assets should

be transferred from ML Leasing, and he did not suggest

implementing the 1986 cross-chain sale at issue in this case.

B. Petitioner Seeks a Purchaser

Mr. Sands was asked to develop a profile of a likely

prospective purchaser for ML Leasing and a list of prospective

purchasers. Mr. Sands established three criteria for a potential

purchaser of ML Leasing: (1) A purchaser should be financially

7
On July 28, 1986, petitioner officially appointed a five-
person project team to conduct the divestiture of ML Leasing,
which included Mr. Sands as chief negotiator.
8
The 1986 retained assets consisted of assets leased under
operating, finance, and leveraged leases, subject to the
liabilities associated with such assets, and the shares of 34
corporate subsidiaries that owned leased equipment and leased
real property. The decision as to which assets would be sold and
which would be retained was made by the head of investment
banking at Merrill Parent.
 - 12 -

sophisticated to handle the lease portfolio; (2) a purchaser

should be able to finance the transaction; and (3) a purchaser

should have a net operating loss (NOL) carryforward and,

therefore, should be indifferent to the fact that the lease

portfolio was about to turn for tax purposes.

In or around April 1986, Mr. Sands contacted Inspiration

Resources Corp. (Inspiration). Inspiration was a diversified

natural resources company whose stock was publicly traded on the

New York and Toronto stock exchanges. Inspiration was controlled

by Minerals & Resources Corp., Ltd. (MINORCO), a Bermuda

corporation headquartered in London, England. Mr. Sands had

worked with Inspiration on other matters before 1986 and was

aware that Inspiration had a significant NOL.

Petitioner provided to Inspiration a document entitled

“MERRILL LYNCH LEASING INC. Proposed Sale of Equity Investment

Assets” dated April 1986 (ML Leasing offering memorandum). The

ML Leasing offering memorandum described the assets that would be

owned by ML Leasing at the time of the sale and the pretax

cashflows expected to be derived from the portfolio of leases.

The ML Leasing offering memorandum described the proposed

transaction as follows:

Prior to the sale of Leasing’s stock, any of Leasing’s
assets which are not to be sold will be dividended to
MLCR. Assets remaining in Leasing will be the equity
investments in real estate and equipment net leased to
major corporations, tax benefits purchased under the
1981 Tax Act, unused ITC carryover, and any state net
 - 13 -

operating losses (“NOL’s”) not used in the various
ML&Co. 1986 unitary returns. The remaining liabilities
in Leasing would consist solely of deferred taxes.

MLCR will then sell the stock of Leasing. * * *

The 1986 retained assets were not included in the description of

ML Leasing’s portfolio.

On June 19, 1986, Mr. Sands prepared a memorandum entitled

“Status of ML Leasing Sales Effort”. The memorandum reported on

a telephone call Mr. Sands received from Mr. Smith, the Vice

President-Finance for Inspiration. As summarized in the

memorandum, Mr. Smith “expressed strong interest” in purchasing

ML Leasing and reported that he had prepared a detailed analysis

for consideration by Inspiration’s executive committee. Although

Mr. Smith had expressed reservations about the status of

Inspiration’s NOLs and about the lack of certainty regarding the

lease residual values, Mr. Sands reported that Mr. Smith’s

concern regarding Inspiration’s NOLs was not a serious problem

and that Mr. Smith’s concern regarding the residual values would

be addressed in a meeting on June 23 when Mr. Smith and his staff

would meet with a representative of ML Leasing to review the

residuals on a lease-by-lease basis. Mr. Sands reported that, if

Mr. Smith were satisfied after the June 23 meeting, Inspiration

“will make a go - no go decision on buying Leasing at the $80

million asking price based on the assumption that the residual

values can be confirmed by an outside appraiser.”
 - 14 -

On July 3, 1986, a written “Presentation to Inspiration

Resources Corporation” prepared by ML Capital Markets was

submitted to Inspiration. The presentation again described the

assets proposed to be owned by ML Leasing at the time of sale of

the ML Leasing stock to Inspiration and the pretax net cashflows

expected to be derived from the portfolio of leases. The 1986

retained assets were not included in those assets. The

presentation proposed a purchase price of $98 million and a

closing date at the end of 1986.

C. The Tax Plan and the Section 304 Cross-Chain Sale

Sometime between 1985 when the possible sale of ML Leasing

was first discussed and July 21, 1986, when ML Leasing

contributed the 1986 retained assets to Merlease Leasing Corp.

(Merlease), petitioner finalized a plan9 to strip ML Leasing of

the 1986 retained assets and to sell ML Leasing outside the

consolidated group using planning techniques designed to increase

petitioner’s tax basis in ML Leasing and thereby eliminate gain

on the sale of ML Leasing. The plan consisted of the following

steps:

9
It appears from the ML Leasing offering memorandum that
petitioner originally intended to have MLL distribute the 1986
retained assets to MLCR as a dividend. We infer from this fact
that petitioner finalized its plan to engage in sec. 304 cross-
chain sales after the ML Leasing offering memorandum had been
prepared.
 - 15 -

1. ML Leasing would contribute the 1986 retained assets to

Merlease, a direct wholly owned subsidiary of ML Leasing, in

anticipation of ML Leasing’s sale outside the consolidated group.

2. ML Leasing would then sell Merlease cross-chain to a

sister corporation within the consolidated group.

3. ML Leasing would declare a dividend to ML Capital

Resources of designated assets and the gross sales proceeds from

the cross-chain sale of Merlease to the acquiring corporation.

4. After each of the steps outlined above had occurred,

petitioner would then sell ML Leasing to a third-party purchaser.

In accordance with the plan and pursuant to a resolution

dated July 21, 1986, ML Leasing contributed the 1986 retained

assets to the capital of Merlease.10

In accordance with the plan and pursuant to resolutions

adopted on July 22, 1986, the respective boards of directors of

ML Leasing and Merrill Lynch Asset Management, Inc. (ML Asset

Management or MLAM), a direct wholly owned subsidiary of Merrill

Parent, approved the sale of the stock of Merlease to ML Asset

Management for a purchase price equal to the fair market value of

such stock as of July 22, 1986. Two days later, ML Leasing and

ML Asset Management entered into a stock purchase agreement dated

10
Some of the same assets identified in the July 21, 1986,
consent to corporate action as having been contributed to
Merlease’s capital were included as part of a dividend declared
and paid to ML Capital Resources, ML Leasing’s sole shareholder
as of July 18, 1986.
 - 16 -

July 24, 1986, pursuant to which ML Asset Management agreed to

purchase all of ML Leasing’s Merlease stock for a purchase price

of $73,320,471. The sale closed on July 24, 1986. Immediately

before ML Asset Management purchased the stock of Merlease, ML

Asset Management’s accumulated earnings and profits exceeded the

price it paid for the Merlease stock. The parties agree that the

sale of Merlease to ML Asset Management was a section 304

transaction.

D. Presentation to Merrill Parent’s Board of Directors

On July 28, 1986, only 4 days after the cross-chain sale of

Merlease, a formal presentation was made to Merrill Parent’s

board of directors regarding the sale of ML Leasing.11 The

presentation included the distribution of a written summary and

slides illustrating the details of the plan for the sale of ML

Leasing, including key calculations. The written summary began

as follows:

We have identified a significant economic benefit,
based on an opportunity in the tax law, in selling
Merrill Lynch’s proprietary lease business. This
economic benefit can be achieved by structuring a
transaction to sell the stock of our primary leasing
subsidiary, Merrill Lynch Leasing. We believe that
such a sale could realistically result in an after-tax
financial statement gain of approximately $104 million.

The presentation laid out the various steps of the plan to

11
Petitioner was unable to locate the minutes of the meeting
of the board of directors on July 28, 1986, the date the
presentation was made.
 - 17 -

dispose of Merrill Lynch’s proprietary lease business culminating

in the sale of ML Leasing’s stock.

The stated purpose of the presentation was to secure the

board’s approval to enter into a letter of intent with the

purchaser12 and to secure the board’s authorization for:

the Executive Committee to approve the final details of
the proposed transaction in accordance with the letter
of intent, subject to closing adjustments and unforseen
contingencies arising from negotiating a final
agreement in early October, up to a maximum reduction
of $20 million.

The written summary informed the board of directors that

“due to the exhaustion of tax benefits, many of * * * [ML

Leasing’s] leases begin to produce taxable income in 1987, with

the remainder ‘turning around’ in 1988. Accordingly, it is an

opportune time to sell our Principal Investments line of business

to an appropriate purchaser.” The summary also informed the

board of directors that because it was not Merrill Parent’s

intent to withdraw from all aspects of the leasing business,

Merrill Parent was removing the 1986 retained assets from ML

Leasing before ML Leasing’s stock was sold in two steps: (1) The

1986 retained assets had been sold to ML Asset Management for

approximately $57 million; and (2) ML Leasing will declare a $115

12
The presentation represented to the board of directors
that “Once both parties have signed the letter of intent, the
sales price will be firmly established subject only to changes in
the residual value by the appraisers. Moreover, even the impact
of residual value appraisals will be limited to $14 million.”
 - 18 -

million dividend to ML Capital Resources consisting of cash

received from ML Asset Management, plus other cash, receivables,

and certain liabilities. After removal of the 1986 retained

assets, the summary represented that Merrill Parent would then be

in a position to sell the principal investments business portion

of ML Leasing.

The summary unequivocally identified Inspiration as the

purchaser of ML Leasing’s stock, described Inspiration, and

stated that “In return for the stock of ML Leasing, we will

receive $126 million in cash (subject to adjustments for residual

value appraisals) from the purchaser, Inspiration Resources

Corporation.” The summary also explained how the sale price was

determined,13 quantified the after-tax income and the tax benefit

that would result from the sale, explained the tax risks of the

transaction, and recommended the creation of a $37 million tax

13
The sale price was determined by calculating the present
value of the cashflow stream generated by ML Leasing’s assets
($42 million), discounting the pretax cashflow to reflect the
value of the cashflow to Inspiration ($143 million), calculating
the value of Inspiration’s NOLs ($101 million), and adding to the
present value of the cashflow stream a premium of $53 million
(representing a split of the benefits arising from Inspiration’s
NOLs). The resulting base sale price ($95 million) was then
increased by the amount of cash to be left in ML Leasing
(estimated to be $31 million) to arrive at a total sale price of
$126 million (subject to adjustment for residual value
appraisals).
 - 19 -

reserve for the transaction.14 In calculating the recommended

reserve, the summary stated the following:

The first item of tax reserve concerns the sale to
Merrill Lynch Asset Management of the leasing
subsidiaries we wish to retain. The IRS could maintain
that the form of this transaction should be disregarded
and in substance, a distribution with a reduction in
tax basis should be deemed to have occurred. The $16
million reserve amount is the $57 million I noted
previously multiplied by the 28% capital gains tax
rate.

Following the presentation, Merrill Parent’s board of directors

approved the plan, including the sale of Merrill Leasing to

Inspiration.

E. Nonbinding Letter of Intent

On July 29, 1986, 1 day after the presentation to its board

of directors, Merrill Parent entered into a nonbinding letter of

intent with Inspiration for the sale of the stock of ML Leasing

to Inspiration. The letter of intent provided a “period of

exclusivity” during which Merrill Parent would negotiate

exclusively with Inspiration to reach an agreement for the sale

of ML Leasing. Upon executing the letter of intent, the parties

agreed that “if such sale agreement is not executed on or prior

to August 31, 1986, neither of us intends to proceed with the

transactions contemplated herein.” The letter of intent provided

14
The $37 million tax reserve consisted of a $16 million
reserve for the possible disallowance of the deemed dividend
resulting from the cross-chain sale and a $21 million reserve for
lost tax benefits if certain income projections were not
realized.
 - 20 -

that “If the conditions to reaching an agreement are satisfied,

the aggregate purchase price will be $95,000,000”, subject to

adjustment for cash left in ML Leasing, for the value of

residuals as determined by independent appraisers, and for other

specified adjustments. The letter of intent also stated:

It is understood that this letter of intent merely
constitutes a statement of our mutual intentions with
respect to the proposed acquisition and does not
contain all matters upon which agreement must be
reached in order for the proposed acquisition to be
consummated. A binding commitment with respect to the
proposed acquisition will result only from execution of
definitive agreements, subject to the conditions
expressed therein.

Following execution of the nonbinding letter of intent, both

Inspiration and Merrill Parent hired outside appraisers to value

the lease portfolio.15

On July 29, 1986, Merrill Parent issued a news release to

its employees announcing that it had entered into a letter of

intent for the sale of a portion of its leasing operations to

Inspiration. Merrill Parent announced that the sale, if

consummated, would result in a realization of after-tax gain of

at least $70 million and was scheduled to close at the end of

15
During July and August 1986, petitioner also executed
various transfers within the consolidated group to remove assets
from ML Leasing before its sale to Inspiration. By resolutions
dated July 31 and Aug. 1, 1986, ML Leasing’s board of directors
authorized payment of a dividend to ML Capital Resources
consisting of all the capital stock of five subsidiaries of ML
Leasing, intercompany receivables, cash, and other assets. These
distributions are not at issue in this case.
 - 21 -

1986, “subject to negotiation of definitive documentation and

normal conditions to closing.”

On August 5, 1986, Inspiration’s board of directors ratified

and retroactively approved the nonbinding letter of intent

between Inspiration and Merrill Parent. The board of directors

authorized the executive committee of the board of directors to

“take any and all necessary or desirable actions in connection

with the proposed acquisition of” ML Leasing.

F. Further Negotiations Between Petitioner and Inspiration

On August 19, 1986, Inspiration wrote a letter to Mr. Sands

explaining that “Several problems have arisen over the past few

weeks” regarding the purchase of ML Leasing. In the letter,

Inspiration advised that it was unable “to finance this

transaction on a secured basis within the timeframe and terms of

our agreement.” Inspiration stated that it had started to review

alternative means of financing, including both unsecured

financing and the sale of specific leases from the ML Leasing

portfolio as a means of financing the transaction and suggested

that the increased cost of the unsecured financing “may justify a

downward adjustment in the purchase price.” In the letter,

Inspiration requested that the terms of the draft stock purchase

agreement be altered to accommodate alternative means of

financing; i.e., by eliminating a provision in the draft stock

agreement that prohibited Inspiration from selling significant
 - 22 -

assets from ML Leasing for a period of 5 years. In addition,

Inspiration suggested that “Merrill Lynch may have to arrange

with the lessee and the secured noteholders to waive certain

restrictions on transfer of ownership” in order to accommodate

its request. Inspiration also pointed out that the existing

draft purchase agreement did not contain a representation from

petitioner that the cashflows as presented to Inspiration were

correct. Inspiration advised that in order for a lender or a

purchaser to make financing decisions based on “these cash flows,

a legal due diligence review will be insufficient and it will be

essential for Merrill Lynch to represent that the cash flows [of

the leases] are accurate.” Inspiration concluded its letter by

expressing its continued interest in completing the transaction.

In order to give the parties to the letter of intent

additional time to finalize their deal, the parties on August 29,

1986, agreed to extend the term of the nonbinding letter of

intent to September 19, 1986, and negotiations and discussions

continued with Inspiration after August 29, 1986.16

Shortly after August 29, 1986, petitioner’s appraiser and

Inspiration’s appraiser completed their analysis of residual

values. Both appraisers valued the residual values of the leases

16
A Sept. 8, 1986, interoffice memorandum from Mr. Sands
stated that although Inspiration still had not secured financing
to purchase ML Leasing, Inspiration was optimistic that it would
do so. Mr. Sands also indicated that Inspiration’s financing
efforts were going very well.
 - 23 -

in ML Leasing’s portfolio higher than petitioner and Inspiration

had expected. As a result, the chief financial officer for

Merrill Parent instructed Mr. Sands to negotiate an increase in

the purchase price from $126.6 million to $131.4 million. In

accordance with those instructions, Mr. Sands attempted to

negotiate an adjustment to the purchase price. Although his

efforts apparently were not initially well received,17 the

parties ultimately agreed to increase the purchase price by $3

million.

In approximately August or early September 1986, petitioner

provided Inspiration with a draft stock purchase agreement dated

September 11, 1986.18 On September 16, 1986, the executive

committee of Inspiration’s board of directors met to discuss the

acquisition of ML Leasing. After discussion, the executive

committee approved the September 11, 1986, stock purchase

agreement substantially in the form presented. The executive

committee also authorized Inspiration’s management to finalize

the necessary bank financing.

17
Mr. Sands was asked by Inspiration’s representatives to
leave the meeting, and, for at least a day after the meeting,
Inspiration refused to return phone calls from either Mr. Sands
or petitioner’s attorneys.
18
The Aug. 19, 1986, letter from Inspiration to Mr. Sands
indicates there was a previous version of the Sept. 11, 1986,
draft stock purchase agreement. The record is unclear, however,
as to when the first stock purchase agreement was drafted and
circulated.
 - 24 -

G. ML Leasing Stock Purchase Agreement

Effective September 19, 1986, Merrill Parent, ML Capital

Resources, ML Leasing, and Inspiration executed an agreement for

the purchase and sale of the stock of ML Leasing (ML Leasing

stock purchase agreement). The ML Leasing stock purchase

agreement was amended as of October 31, 1986, to reflect further

negotiations on certain matters. The purchase price was

$129,445,843, payable in cash at closing, subject to certain

postclosing adjustments. Pursuant to the ML Leasing stock

purchase agreement, the purchase price subsequently was adjusted

based on residual value appraisals for certain leases. The sale

of ML Leasing closed on October 31, 1986.

II. 1987 Sale of ML Capital Resources

At the beginning of petitioner’s TYE 1987, ML Capital

Resources was a wholly owned subsidiary of Merrill Parent.19 ML

Capital Resources was engaged in the business of arranging

equipment leasing transactions between third parties and also

owned various types of equipment and other tangible personal

property, which it leased to third parties. ML Capital

Resources’ business focused on small business leases. It was

also a partner in certain limited partnerships that held

19
By resolution dated Apr. 8, 1987, the board of directors
of Merrill Parent approved the formation of a newly organized
corporation, Merrill Lynch Consumer Markets Holdings, Inc.
(Consumer Markets or MLCMH), and the contribution of all the
capital stock of ML Capital Resources to Consumer Markets.
 - 25 -

computers leased to IBM and had been active in other types of

financing for medium-sized businesses. ML Capital Resources also

owned the stock of a number of subsidiary corporations that were

engaged in the business of arranging equity and debt financing

for middle- and small-sized companies.

Merrill Parent decided to sell that portion of ML Capital

Resources’ business consisting of the ownership of leased

property. In the aggregate, the leases were generating

substantial positive cashflow but had “turned around” for income

tax purposes so that if ML Capital Resources continued to hold

them, the leases would generate taxable income in excess of

pretax cashflow. Because Merrill Parent did not want ML Capital

Resources’ nonleasing assets to leave the consolidated group, it

decided that ML Capital Resources would sell to other affiliated

corporations the stock of certain subsidiary corporations that

were engaged in lending and financing activities or that owned

other assets and businesses that were not related to its core

consumer leasing operations (collectively referred to as the 1987

retained assets).20

A. Petitioner Seeks a Purchaser

Merrill Parent decided to conduct the sale of ML Capital

Resources utilizing a bidding process. By February 17, 1987, a

20
Senior management decided which assets to sell and which
assets to retain within the consolidated group.
 - 26 -

draft preliminary offering memorandum regarding the sale of the

stock of ML Capital Resources (preliminary offering memorandum)

had been prepared, as well as a list of prospective buyers and a

projection of an estimated sale price for ML Capital Resources of

between $70 and $80 million, on which was calculated a potential

after-tax gain of between $43.5 and $88 million. At some point

between February 17, 1987, and March 1987, the preliminary

offering memorandum was finalized.

If a potential purchaser was interested after reviewing the

preliminary offering memorandum, Merrill Parent required that the

potential purchaser sign a confidentiality letter, at which point

the potential purchaser could request a confidential 3-volume

detailed offering memorandum dated March 1987 regarding the

specific leases in ML Capital Resources’ portfolio (3-volume

offering memorandum). Under the bidding procedure established by

Merrill Parent and set forth in the 3-volume offering memorandum,

interested purchasers were required to submit “preliminary

indications of interest”, including a proposed cash purchase

price, by March 27, 1987. Immediately thereafter, ML Capital

Markets and ML Capital Resources would select a limited number of

potential purchasers that would be given the opportunity to

perform detailed due diligence. At that time, prospective

purchasers would be given proposed forms for a stock purchase

agreement. Prospective purchasers were required to submit bids
 - 27 -

as to price and terms by April 10, 1987. The 3-volume offering

memorandum indicated that ML Capital Resources “does not intend

to engage in substantial negotiations with respect to the terms

of the Stock Purchase Agreement” and proposed an April 30, 1987,

closing date.

On March 13, 1987, the chairman of the board of ML Capital

Resources authorized a five-person team to pursue the divestiture

of ML Capital Resources, four of whom had been involved in the

sale of ML Leasing. Mr. Sands again was appointed as chief

negotiator.

In and around March 1987, Merrill Parent contacted various

potential purchasers regarding the sale of ML Capital Resources.

The ultimate purchaser, GATX Leasing Corp. (GATX), on behalf of

itself and BCE Development, Inc. (BCE), a majority-owned

subsidiary of Bell Canada Enterprises (collectively referred to

as GATX/BCE unless otherwise indicated), apparently received the

preliminary offering memorandum sometime during March 1987

because ML Capital Markets sent GATX/BCE a confidentiality

agreement dated March 23, 1987.

B. Section 304 Cross-Chain Sales

1. Five Subsidiaries

Effective March 28 and March 30, 1987, respectively, the

boards of directors of ML Capital Resources and Merrill Lynch

Realty, Inc. (ML Realty or MLRI), a wholly owned subsidiary of
 - 28 -

Merrill Parent, approved the sale of all the stock of five

subsidiaries wholly owned by ML Capital Resources to ML Realty:

Merrill Lynch Business Financial Services, Inc. (Financial

Services or MLBFS);21 Merrill Lynch Private Capital, Inc.

(Private Capital or MLPC);22 Merrill Lynch Venture Capital, Inc.

(Venture Capital or MLVC); Merrill Lynch Energy Investments, Inc.

(Energy Investments or MLEI); and Merrill Lynch R&D Management,

Inc. (MLRDM) (collectively referred to as the five subsidiaries).

ML Capital Resources and ML Realty entered into a stock

purchase agreement dated March 30, 1987, for the sale of stock of

the five subsidiaries to ML Realty. The purchase price of the

stock of the five subsidiaries was $53,972,607 (which was

allocated to each subsidiary based on their respective book

values). The sale closed on March 30, 1987. Immediately before

its purchase of the five subsidiaries, ML Realty had accumulated

earnings and profits that exceeded the purchase price. The sales

of the five subsidiaries were five of the eight cross-chain sales

21
Before the sale of Financial Services, effective Mar. 30,
1987, ML Capital Resources contributed certain loan receivables
and other assets and liabilities with a net book value of $10
million to Financial Services. These assets and liabilities were
part of the 1987 retained assets and thus were not intended to be
included in the assets of ML Capital Resources at the time of the
sale of its stock.
22
Private Capital had a substantial negative book net worth
as of Mar. 29, 1987. Before the sale of Private Capital,
effective Mar. 30, 1987, ML Capital Resources contributed $32
million in cash to the capital of Private Capital and thereby
created a positive book net worth in Private Capital.
 - 29 -

at issue for the taxable year ended December 25, 1987. The

parties agree that these sales were section 304 transactions.

2. ML Interfunding

Merrill Lynch Interfunding, Inc. (ML Interfunding or MLI),

was a wholly owned subsidiary of ML Capital Resources. By

resolutions dated March 27, 28, and 30, 1987, the boards of

directors of ML Capital Resources and ML Asset Management

approved the sale of all the stock of ML Interfunding to ML Asset

Management.23 ML Capital Resources and ML Asset Management

entered into a stock purchase agreement dated March 30, 1987,

which provided for an initial purchase price of $160 million to

be paid at closing with the purchase price to be adjusted as soon

as practicable by subsequent agreement of ML Asset Management and

ML Capital Resources so as to equal the fair market value of the

shares as of March 30, 1987. The sale closed on March 30,

1987.24 Immediately before its purchase of ML Interfunding, ML

23
By resolution dated Mar. 27, 1987, the board of directors
of ML Interfunding declared and paid a dividend having a total
value of $100 million to ML Capital Resources of certain
preferred stock that it owned in Gelco Corporation (Gelco) plus
the shares of certain unaffiliated corporations (portfolio
stock), which it had acquired as a dividend from its wholly owned
subsidiary, ML Portfolio Management, by resolution dated Mar. 26,
1987. By resolution dated Mar. 28, 1987, ML Capital Resources
contributed the portfolio stock and the Gelco shares to Merrill
Lynch Property Holdings, Inc., a direct wholly owned subsidiary
of ML Capital Resources.
24
In a valuation report dated Apr. 18, 1988, Deloitte
Haskins-Sells determined that the fair market value of the stock
(continued...)
 - 30 -

Asset Management had accumulated earnings and profits that

exceeded the purchase price. This is the sixth cross-chain sale

at issue for the taxable year ended December 25, 1987. The

parties agree that this cross-chain sale was a section 304

transaction.

3. Leasing Equipment

By resolutions dated April 3, 1987, the respective boards of

ML Capital Resources and Merrill Lynch, Pierce, Fenner & Smith,

Inc. (MLPFS), a first-tier wholly owned subsidiary of Merrill

Parent, approved the sale of all the stock of ML Leasing

Equipment Corp. (Leasing Equipment or MLLE), a wholly owned

subsidiary of ML Capital Resources, to MLPFS.25 ML Capital

Resources and MLPFS entered into a stock purchase agreement dated

April 3, 1987. The purchase price for Leasing Equipment’s stock

was $119,819,690. The sale closed on April 3, 1987. Immediately

before its purchase of Leasing Equipment, MLPFS had accumulated

24
(...continued)
of ML Interfunding as of Mar. 30, 1987, was $181,080,000. Based
on such appraisal, ML Asset Management and Consumer Markets, as
assignee of ML Capital Resources’ rights under the ML
Interfunding stock purchase agreement, agreed that ML Asset
Management would pay Consumer Markets $26,413,365 as the final
payment of the purchase price for the ML Interfunding stock,
which was the difference between $181,080,000 and the net
consideration paid at closing of $154,666,635.
25
On Apr. 2, 1987, ML Capital Resources contributed the
stock of MLL Corporate Partners, Inc., a subsidiary of ML Capital
Resources engaged in nonleasing activities, to Leasing Equipment.
 - 31 -

earnings and profits that exceeded the purchase price. This is

the seventh cross-chain sale at issue for the taxable year ended

December 25, 1987. The parties agree that this cross-chain sale

was a section 304 transaction.

C. The Sale of ML Capital Resources

Pursuant to the bidding procedure governing the sale of ML

Capital Resources, petitioner received five or six bids,

including one from GATX/BCE. The bid from GATX/BCE, dated April

21, 1987, contained the principal terms upon which GATX/BCE was

prepared to purchase all the outstanding shares of ML Capital

Resources (April 21, 1987, bid proposal).26 GATX/BCE proposed a

base purchase price of $63 million, plus 70 percent of certain

residual payments in excess of $27 million. GATX/BCE’s April 21,

1987, bid proposal specifically provided, among other things, the

following conditions precedent: (1) GATX/BCE would enter into a

purchase agreement only upon the receipt of all requisite

corporate approvals, including approvals by the boards of GATX

and BCE, and (2) satisfactory completion of further due

diligence. The further due diligence included, but was not

limited to, review of the basic and related documentation, review

of audited financials of the IBM partnerships and ML Capital

26
Although the bidding procedure required each prospective
purchaser to submit by Mar. 27, 1987, preliminary indications of
interest outlining a proposed purchase price, the record contains
no information regarding what, if anything, GATX/BCE submitted.
 - 32 -

Resources, and review of a report prepared by IBM Credit

Corporation for the partners of the IBM partnerships.

On April 23, 1987, a formal presentation regarding the sale

of ML Capital Resources was made to Merrill Parent’s board of

directors at its regular meeting. The presentation was made by

Courtney F. Jones. The substance of the presentation was

summarized in a written summary and slides illustrating the

details of the plan for the sale of ML Capital Resources. The

written summary began as follows:

We have identified a significant economic benefit,
based on an opportunity in the tax law, in selling
Merrill Lynch’s proprietary middle market lease
business. This economic benefit can be achieved by
structuring a transaction to sell the stock of one of
our leasing subsidiaries, Merrill Lynch Capital
Resources. We believe that such a sale could
realistically result in an after-tax financial
statement gain of approximately $73 million.

In conjunction with Merrill Lynch Capital Markets we
have identified a purchaser. The purpose of this
presentation is to secure your approval for the
Executive Committee to approve the final details of the
transaction and sign the definitive agreement.

The written summary laid out the various steps of the plan to

dispose of Merrill Lynch’s proprietary middle-market lease

business culminating in the sale of ML Capital Resources’ stock.

The written summary informed the board of directors that--

due to the exhaustion of tax benefits, many of * * *
[ML Capital Resources’] leases have begun to produce
taxable income in 1987. The projected cash flow from
the leases will in most years not be sufficient to
service the debt and the tax liability generated by the
 - 33 -

leases. Accordingly, it is an opportune time to sell
this business to an appropriate purchaser.

The written summary also informed the board of directors that

because Merrill Parent did not intend to withdraw from the

“Lending Activities” aspect of the business, Merrill Parent “will

first remove the assets and operations related to the businesses

we wish to retain” and will “transfer all of the subsidiaries of

ML Capital Resources elsewhere within our Corporate structure” in

three steps before ML Capital Resources’ stock was sold: (1) ML

Capital Resources had already sold ML Interfunding’s stock to ML

Asset Management for its net book value of approximately $160

million; (2) ML Capital Resources had already sold the stock of

certain of its subsidiaries to ML Realty Inc. for approximately

$50 million; and (3) ML Capital Resources will declare a $459

million dividend to its parent company, Merrill Lynch Consumer

Markets Holdings, Inc. (Consumer Markets), consisting of cash

received from ML Asset Management and ML Realty, existing cash

balances, the stock of the remaining subsidiaries, receivables,

and liabilities. The board was informed that after these

transfers were completed, ML Capital Resources “will have equity

of approximately $40 million” and “we will be in a position to

sell” ML Capital Resources’ stock.

The presentation identified “a joint venture between BCE

Development, Inc., a wholly owned U.S. subsidiary of Bell Canada

and GATX Leasing Corporation, a wholly owned subsidiary of GATX
 - 34 -

Corporation” as the likely purchaser and estimated a sales price

of $70 million, consisting of $62 million in cash plus the

assumption of $8 million in liabilities. The presentation also

explained how the sale price was determined, quantified the

after-tax income and the tax benefit that would result from the

sale, explained the tax risks of the transaction, and recommended

the creation of a $35 million tax reserve for the transaction.27

In calculating the recommended reserve, the presentation stated

the following:

As you can imagine, it is the tax aspects that make
this sale especially attractive. The Tax Department,
in conceiving this transaction, has creatively applied
two different tax concepts to maximize the calculation
of Merrill Lynch’s tax basis in ML Capital Resources.

* * * * *

The second tax concept deals with the creation of
approximately $210 million in tax basis. This basis is
created by selling the stock of certain ML Capital
Resources subsidiaries to MLAM and ML Realty Inc. for
$210 million, rather than distributing this value to ML
Consumer Markets Holdings Inc. Under the tax rules the
sale is recharacterized as two separate transactions; a
dividend by MLAM and MLRI to MLCR of $210 million and a
contribution to the capital of MLAM and MLRI by MLCR of
approximately the same amount. The dividend received
by MLCR increases Merrill Lynch’s tax basis in MLCR by
$210 million. MLCR’s contribution to the capital of
MLAM and MLRI has no effect on tax basis.

27
The $35 million tax reserve consisted of a $14 million
reserve for the possible disallowance of the deemed dividend
resulting from the cross-chain sale and a $21 million reserve for
lost tax benefits if certain income projections were not
realized.
 - 35 -

The final step is for MLCR to declare a dividend of
cash, certain subsidiaries, and receivables to ML
Consumer Markets Holdings Inc. This intercompany
dividend triggers a taxable gain that also increases
our tax basis in MLCR. What remains is our tax basis
at the time of sale, $340 million.

As our basis in the stock is greater than the sales
price, the sale results in a $278 million long term
capital loss. This capital loss will offset other long
term capital gains, resulting in a tax benefit of $94
million.

The intercompany dividend to ML Consumer Markets
Holdings triggers a tax liability of $8 million, which
reduces the maximum potential tax benefit to $86
million.

The summary represented that Merrill Parent’s corporate law

department and outside counsel had already prepared a proposed

definitive sales agreement and that the purchaser had submitted

its desired contract changes, which were being negotiated.

Although the summary requested the board of directors to

authorize the executive committee to approve the final details of

the transaction and to sign the definitive agreement for a

minimum sales price of $70 million, the board authorized the

proper officers to finalize the sale of all the capital stock of

ML Capital Resources for not less than $60 million, subject to

adjustments based on the valuation of certain assets.

D. GATX/BCE Modifies Its Initial Bid

In a letter addressed to Mr. Sands dated April 27, 1987,

GATX modified its April 21, 1987, bid proposal (April 27, 1987,
 - 36 -

bid proposal).28 GATX reconfigured its April 21, 1987, bid

proposal from $63 million, plus 70 percent of the discounted

value of the residual payments in excess of $27 million, to $66

million, plus 40 percent of the discounted value of residual

payments in excess of $29.5 million. The April 27, 1987, bid

proposal stated that, except for the replacement of the original

paragraphs in the April 21, 1987, bid proposal concerning the

purchase price, “all other terms and conditions remain

unchanged.” As of April 27, 1987, GATX/BCE had not evaluated the

lease portfolio of ML Capital Resources, and the proposed

purchase price was based on the representations made in the

offering memorandum.

E. Nonbinding Letter of Intent

On May 22, 1987, Merrill Parent entered into a nonbinding

letter of intent with GATX/BCE for the sale of the stock of ML

Capital Resources (nonbinding letter of intent). The nonbinding

letter of intent confirmed that Merrill Parent had provided

GATX/BCE with a draft sale agreement containing a description of

the assets in which ML Capital Resources had an equity interest

as of the proposed closing date. The nonbinding letter of intent

set forth pricing terms identical to those set forth in GATX’s

April 27, 1987, bid proposal; i.e, $66 million plus 40 percent of

28
The record is unclear as to whether a second round of bids
was conducted or whether petitioner merely asked GATX/BCE to
modify its original bid.
 - 37 -

the discounted value of residual payments in excess of

$29,500,000. The nonbinding letter of intent specifically stated

that the parties were bound by the terms of their March 23, 1987,

confidentiality agreement. The nonbinding letter of intent also

stated:

The consummation of the acquisition contemplated
herein is subject to (i) negotiation and execution of
definitive agreements acceptable in form and substance
to * * * [GATX/BCE] and * * * [petitioner], (ii) no
change having occurred in the federal income tax laws
or the regulations of the U.S. Treasury promulgated
thereunder that would materially adversely alter the
economic effect of the transactions contemplated
herein, (iii) approval of the transactions contemplated
herein by * * * [petitioner’s] Executive Committee and
by the appropriate corporate authorities for * * *
[GATX/BCE], (iv) consummation of satisfactory secured
financing by * * * [GATX/BCE] and (v) other customary
and appropriate closing conditions.

F. GATX Finance Committee Approval

On or about May 29, 1987, the GATX Finance Committee met to

consider the proposed acquisition of ML Capital Resources. A

written proposal presented at that meeting stated that GATX was

“awarded the transaction” based on its initial and modified bid

proposals and was “invited to perform a due diligence

investigation.” The written proposal also stated that, upon

completion of the due diligence process, GATX/BCE reserved the

right to adjust the purchase price based on its due diligence

findings in the event that any information in the 3-volume

offering memorandum was incorrect. The written proposal also

recommended that the base purchase price be reduced to $63.3
 - 38 -

million as a result of an increase in the reserve for losses and

a net reduction in expected future residual values.

On June 1, 1987, the GATX Finance Committee approved the

proposal to acquire the capital stock of ML Capital Resources for

a purchase price of $63.3 million, subject to certain specified

conditions. The GATX Finance Committee recommended that the

proposed transaction be forwarded to the GATX board of directors.

G. Continued Negotiations

After executing the nonbinding letter of intent, petitioner

and GATX/BCE continued their negotiations. In conjunction with

GATX/BCE’s due diligence review of the lease portfolio,

petitioner and GATX/BCE agreed that it was impractical to examine

each lease separately because the lease portfolio consisted of

such a large number of relatively small leases. Therefore, they

agreed to use a “statistical sampling technique”, whereby the

parties would jointly pick a certain number of leases at random

to examine in significant detail and compare them to the

representations made by Merrill Parent in the 3-volume offering

memorandum. The results of the “statistical sample” were not

satisfactory to GATX/BCE; i.e., a larger than expected portion of

the leases did not coincide with Merrill Parent’s representations

in the 3-volume offering memorandum.

From May 22 through June 25, 1987, negotiations continued in

order to accommodate the adjustments revealed by the due
 - 39 -

diligence review. Among other concessions, petitioner

represented to GATX that to the best of petitioner’s knowledge,

as of the date of the closing, the schedules in the contract were

the actual status of the individual leases and, to the extent

they were not, there would be a postclosing adjustment to

accurately reflect the discrepancies.

During the negotiations, GATX requested that ML Vessel

Leasing Corporation (Vessel Leasing), a wholly owned subsidiary

of ML Capital Resources, not be included in the ML Capital

Resources portfolio because GATX/BCE could not own the assets in

Vessel Leasing due to restrictions under Federal laws.29 By

resolution dated June 10, 1987, the respective boards of ML

Capital Resources and ML Asset Management approved the sale of

all the stock of Vessel Leasing to ML Asset Management. On that

same date, ML Capital Resources and ML Asset Management entered

into a stock purchase agreement with respect to Vessel Leasing’s

stock. The purchase price for the stock was $367,481. The sale

closed on June 10, 1987. Immediately before its purchase of

Vessel Leasing, ML Asset Management had accumulated earnings and

profits that exceeded the purchase price. This is the eighth

cross-chain sale at issue for the taxable year ended December 25,

29
BCE was a Canadian corporation and could not legally own a
vessel that had been financed by the U.S. Government.
 - 40 -

1987. The parties agree that this cross-chain sale was a section

304 transaction.

H. Sale of ML Capital Resources Is Finalized

By resolution dated June 18, 1987, ML Capital Resources’

board of directors authorized the sale of its stock to GATX/BCE.

As of June 25, 1987, Merrill Parent, Consumer Markets, ML Capital

Resources, and GATX/BCE entered into an agreement for the

purchase and sale of stock of ML Capital Resources for a fixed

cash consideration of $50,447,996, payable at closing (subject to

adjustments for working capital and certain residual proceeds),

and a contingent cash payment based on the realization of certain

residual values due on or before January 1, 1995, but not to

exceed $15 million. The sale closed on June 26, 1987. Merrill

Parent represented to GATX/BCE that, to the best of its records

and knowledge, as of the date of the closing the schedules

attached to the contract would contain accurate information about

each of the individual leases. To the extent that the schedules

did not contain accurate information, there would be postclosing

adjustments. With one exception, Merrill Parent did not

guarantee the obligations of the lessees. Merrill Parent also

did not guarantee the residual values of any leases.

On its consolidated Federal income tax return for the

taxable year ended December 25, 1987, petitioner claimed a long-

term capital loss in the amount of $466,985,176 from the sale of
 - 41 -

ML Capital Resources’ stock, computed as follows:

Sale price $49,581,304
Less: basis in ML Capital Resources 516,566,480
Capital loss (466,985,176)

III. Notice of Deficiency

Respondent mailed a timely notice of deficiency to

petitioner on August 20, 1998, which set forth a number of

adjustments to petitioner’s taxable income for the years at

issue. The only adjustments in dispute are respondent’s

determinations (i) decreasing the long-term capital loss reported

by ML Capital Resources on the 1986 sale of the stock of ML

Leasing to Inspiration on the ground that ML Capital Resources’

basis in the stock was overstated by $73,320,471, and to (ii)

decreasing the long-term capital loss reported by Consumer

Markets on the 1987 sale of the stock of ML Capital Resources to

GATX/BCE on the ground that Consumer Markets’ basis in the stock

was overstated by $328,826,143.30

OPINION

I. Applicable Statutes

The parties agree that section 304 applies to the nine

cross-chain sales and that section 304 treats the cross-chain

30
The $328,826,143 adjustment to the basis of the stock of
Capital Resources in respondent’s notice equals the sum of (i)
the $53,972,607 aggregate purchase price for the five
subsidiaries, (ii) the $154,666,365 initial purchase price for ML
Interfunding, (iii) the $119,819,690 final purchase price for
Leasing Equipment, and (iv) the $367,481 purchase price of Vessel
Leasing.
 - 42 -

sales as redemptions. The parties disagree, however, as to

whether the redemptions must be taxed as distributions in

exchange for stock under section 302(a) or as distributions of

property under section 301.

Before section 304 was enacted, a parent corporation could

extract earnings from its related corporations while avoiding

ordinary dividend treatment by selling the stock of one of its

controlled corporations to another of its controlled

corporations. See, e.g., Wanamaker Trust v. Commissioner, 11

T.C. 365 (1948), affd. per curiam 178 F.2d 10 (3d Cir. 1949). In

1950, section 304 was enacted to prevent the bailout of corporate

earnings and profits through sales involving subsidiary

corporations. See Revenue Act of 1950, ch. 994, 64 Stat.906; see

also H. Rept. 2319, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 380,

420; S. Rept. 2375, 81st Cong., 2d Sess. (1950), 1950-2 C.B. 483,

514. In 1954, section 304 was amended to prevent the bailout of

corporate earnings and profits using brother-sister corporations.

See H. Rept. 1337, 83d Cong., 2d Sess. A79 (1954); S. Rept. 1622,

83d Cong., 2d Sess. 239 (1954). This antibailout provision

provides the analytical framework for both parties’ arguments in

this case.

The pertinent part of section 304(a)(1) provides that, for

purposes of section 302, if one or more persons are in control of

each of two corporations, and in return for property, one of the
 - 43 -

corporations acquires stock in the other corporation from the

person so in control, then such property shall be treated as a

distribution in redemption of the stock of the corporation

acquiring such stock. See also Rev. Rul. 70-496, 1970-2 C.B. 74.

If a stock acquisition is governed by section 304(a), any

determination as to whether the stock acquisition is to be

treated as a distribution in part or full payment in exchange for

the stock must be made by reference to the stock of the issuing

corporation.31 Sec. 304(b)(1). Section 318, as modified by

section 304(b)(1), applies in determining whether the requisite

control under section 304(a) exists.

Section 304(a)(1) recharacterizes what appears to be a sale

as a redemption by treating the sale proceeds as a distribution

in redemption of the acquiring corporation’s stock and requiring

that the tax consequences of the distribution be determined under

sections 301 and 302. Section 302(a) provides that if a

corporation redeems its stock, the redemption shall be treated as

a distribution in part or full payment in exchange for the stock

if the redemption qualifies as one of four types of redemptions

listed in section 302(b)-–a redemption that is not essentially

equivalent to a dividend (section 302(b)(1)), a substantially

disproportionate redemption of stock (section 302(b)(2)), a

31
In this case, the issuing corporations are Merlease, the
five subsidiaries, ML Interfunding, Leasing Equipment, and Vessel
Leasing. See sec. 304(b)(1).
 - 44 -

redemption in complete termination of a shareholder’s interest

(section 302(b)(3)), or a redemption from a noncorporate

shareholder in partial liquidation (section 302(b)(4)). If the

deemed redemption does not qualify under section 302(b), then the

distribution is governed by section 301.32

In this case, respondent relies only upon section 302(b)(3),

claiming that the deemed section 304 redemptions, when integrated

with the sales of the target corporations, completely terminated

the target corporations’ ownership of the issuing corporations.

Section 302(b)(3) provides that “Subsection(a) shall apply if the

redemption is in complete redemption of all of the stock of the

corporation owned by the shareholder.” See Bleily & Collishaw,

Inc. v. Commissioner, 72 T.C. 751, 756 (1979), affd. without

published opinion 647 F.2d 169 (9th Cir. 1981). The attribution

rules under section 318(a) apply in determining ownership of

stock for purposes of section 302. See sec. 302(c)(1).

II. The Parties’ Arguments Regarding the Applicable Legal
Standard

Ordinarily, whether a redemption results in the complete

termination of a shareholder’s interest in a corporation under

section 302 is determined immediately after the redemption. Sec.

32
Sec. 301(a) provides: “Except as otherwise provided in
this chapter, a distribution of property (as defined in section
317(a)) made by a corporation to a shareholder with respect to
its stock shall be treated in the manner provided in subsection
(c).”
 - 45 -

302(b)(3) and (c)(2)(A). In some circumstances, however, both

taxpayers and the Commissioner have argued that a redemption

should not be tested under section 302(b) immediately after the

redemption but only after another related transaction has

occurred. See, e.g., Bleily & Collishaw, Inc. v. Commissioner,

supra; Niedermeyer v. Commissioner, 62 T.C. 280 (1974), affd. 535

F.2d 500 (9th Cir. 1976).

In this case, petitioner contends that the deemed section

304 redemptions, i.e., the nine cross-chain sales, should be

tested under section 302(b)(3) without integrating them with the

later sales of the target corporations. Petitioner asserts that

the deemed section 304 redemptions, standing alone, did not

completely terminate the target corporations’ actual and

constructive ownership interest in the issuing corporations

because, under the attribution rules of section 318, the target

corporations continued to hold an ownership interest in those

corporations following the redemptions. Respondent contends,

however, that the section 304 redemptions at issue in this case,

i.e., the nine cross-chain sales, must be integrated with the

later sales of the target corporations in order to decide under

section 302(b)(3) whether the target corporations’ constructive

ownership of the transferred stock under section 318 was

completely terminated. The parties rely on different legal

standards in support of their respective positions.
 - 46 -

Petitioner relies on a test articulated by this Court in

Niedermeyer v. Commissioner, supra at 291. Petitioner claims

that this Court has consistently used the Niedermeyer test to

decide whether a redemption should be integrated with other

allegedly related transactions in order to ascertain the tax

consequences of the redemption. In Niedermeyer, we held that, if

a redemption, standing alone, fails to qualify under section

302(b)(3), the redemption will nevertheless be subject to sale or

exchange treatment “Where there is a plan which is comprised of

several steps, one involving the redemption of stock that results

in a complete termination of the taxpayer’s interest in a

corporation”. Id. at 291. However, we required that “the

redemption must occur as part of a plan which is firm and fixed

and in which the steps are clearly integrated.” Id. Petitioner

describes the Niedermeyer test as a “variation of the step

transaction doctrine” and asserts that “While the test permits

amalgamation of steps that are not subject to an ‘absolutely’

binding contract, it leaves little room for contingency”.

Petitioner relies on this Court’s opinions in Monson v.

Commissioner, 79 T.C. 827, 837 (1982), Roebling v. Commissioner,

77 T.C. 30 (1981), and Bleily & Collishaw, Inc. v. Commissioner,

supra at 756, to support its position. According to petitioner,

each of the three above-cited cases had the following facts in

common: (1) Each case involved a partial redemption that was
 - 47 -

held to be part of a firm and fixed plan; (2) in each case, the

complete termination of the shareholder’s interest required a

party not controlled by the taxpayer to acquire the remaining

shares; and (3) at the time of the redemption, the third-party

purchaser had already negotiated for and made a firm commitment

to acquire the remaining shares. Petitioner extracts from the

cases the conclusions that, where an alleged plan to completely

terminate a shareholder’s ownership requires the participation of

a third party, the third party must have committed to the plan at

least in substance on or before the redemption date in order for

Niedermeyer’s “firm and fixed plan” requirement to be satisfied

and that a taxpayer’s unilateral plan can never be a firm and

fixed plan. Petitioner’s analysis and arguments, therefore,

focus primarily on whether there was an agreement in substance

with the third-party purchasers of the target corporations’ stock

on the dates of the deemed section 304 redemptions; i.e., the

nine cross-chain sales.

Respondent rejects petitioner’s attempt to focus the Court’s

eye primarily on the third-party purchasers who acquired the

target corporations’ stock and argues for the application of an

intent-based test drawn from the decision of the U.S. Court of

Appeals for the Sixth Circuit in Zenz v. Quinlivan, 213 F.2d 914

(6th Cir. 1954) and pertinent opinions of this Court, including

but not limited to, Niedermeyer v. Commissioner, supra. Citing
 - 48 -

Zenz, respondent argues that a partial redemption, which is one

of a series of transactions intended to terminate completely a

shareholder’s ownership interest in a corporation, must be

integrated with the related transactions for purposes of section

302(b)(3) and treated as a sale or exchange. Under respondent’s

articulation of the relevant legal standard:

As a result of the decision in Zenz, other
transactions must be taken into account in testing
whether a redemption is a distribution under § 301 or a
sale or exchange under § 302(a) where the redemption is
part of a firm and fixed plan to terminate a
shareholder’s interest in a corporation. Niedermeyer
v. Commissioner, 62 T.C. 280 (1974), aff’d 535 F.2d 500
(9th Cir. 1976) (articulating a Zenz-like standard).
As subsequent applications of the Zenz doctrine make
clear, the sequence of planned transactions is
irrelevant where the overall result is the complete
termination of a shareholder’s interest. United States
v. Carey, 289 F.2d 531 (8th Cir. 1961) (holding that
Zenz applies when the redemption precedes the stock
sale pursuant to a plan); see also B. Bittker and J.
Eustice, Federal Income Taxation of Corporations and
Shareholders, ¶9.06[3] at 9-42 (6th ed. 1994)(“[I]f the
form of the distribution is cast as a redemption, its
treatment as a sale under Zenz is highly likely unless
the preliminary redemption transaction can be separated
from the later sale.”) [Fn. ref. omitted.]

In its reply brief,33 petitioner dismisses respondent’s reliance

33
In their reply briefs, both parties argue alternatively
that the applicable standard is derived from the step transaction
doctrine and that one of three tests for deciding whether the
step transaction doctrine should be applied, but not all three
tests, must be used in this case to analyze the sec. 304
redemptions and the later sales. Petitioner contends that only
the binding commitment test should be used, and respondent
contends that only the end result test should be used. For a
detailed description of the three tests, see Andantech L.L.C. v.
Commissioner, T.C. Memo. 2002-97. We decline to apply any of the
(continued...)
 - 49 -

on Zenz, claiming that “its relevance to this case is at best

tangential.” Petitioner notes that Zenz involved both a tax year

prior to the enactment of section 302 and a different factual

situation. In Zenz, the sole shareholder of a corporation sold

some of her stock first, and a short time later, the issuing

corporation redeemed the remainder of her stock. Petitioner

distinguishes Zenz from the instant case because “The order of

sale and subsequent redemption was chosen to reduce taxes--that

is, to avoid dividend treatment from the redemption leg”, the

redemption completely terminated the taxpayer’s interest in the

corporation, and the Commissioner was attempting to reorder the

transactions in order to obtain dividend treatment for the

redemption proceeds. Petitioner urges this Court to limit the

application of the Zenz intent-based test to cases where the form

of the transactions and the intent of the taxpayer coincide as it

did in Zenz and to decline to apply the test in cases such as

this where the issue to be decided is “whether a redemption that

does not terminate the shareholder’s interest and a later sale

that does terminate that interest are sufficiently related to

justify treating a non-terminating redemption as part of the

later sale transaction.”

33
(...continued)
three tests because the applicable legal standard is that
identified elsewhere in this Opinion.
 - 50 -

III. Analysis of the Nine Cross-Chain Sales

A. In General

Each party claims that the applicable legal standard is

clear and that the legal standard, when applied to the facts,

supports a decision in that party’s favor. The parties rely on

many of the same cases to support their respective positions.

The parties’ arguments, however, are so diametrically opposite

regarding their interpretation of the cases that we must turn to

an examination of the principal cases on which both parties

rely.34 A careful examination of the pertinent facts and

holdings of these cases is necessary to respond adequately to the

parties’ detailed and often tortured parsing of these cases in

support of their respective arguments.

34
Petitioner also relies on several anticipatory dividend
cases to bolster its arguments regarding the cross-chain sales.
See TSN Liquidating Corp., Inc. v. United States, 624 F.2d 1328
(5th Cir. 1980); Litton Indus., Inc. v. Commissioner, 89 T.C.
1086 (1987); Gilmore v. Commissioner, 25 T.C. 1321 (1956); Coffey
v. Commissioner, 14 T.C. 1410 (1950); Rosenbloom Fin. Corp. v.
Commissioner, 24 B.T.A. 763 (1931). In each of the anticipatory
dividend cases decided by this Court, we held that a
corporation’s distribution of a dividend to a shareholder before
the shareholder sold his stock was taxable as a dividend and not
as part of the later stock sale. The dividend transactions did
not involve the exchange of stock for consideration. We agree
with respondent that the anticipatory dividend cases are
distinguishable from this case, and we do not consider them
further. See Bittker & Eustice, Federal Income Taxation of
Corporations and Shareholders, par. 8.07[2][a], at 8-66 (7th ed.
2002) (“In order to obtain the hoped-for dividend result, it is
important that the selling shareholder not surrender any of its
target stock to the corporation because use of the redemption
format will likely trigger sale treatment.”)
 - 51 -

1. Zenz v. Quinlivan

In Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954), the sole

shareholder of a corporation decided to sell the corporation to a

competitor. Because the competitor did not want to assume the

tax liabilities associated with the corporation’s accumulated

earnings and profits, the competitor purchased only part of the

shareholder’s stock. Three weeks later, after a corporate

reorganization and corporate action, the corporation redeemed the

balance of the shareholder’s stock. On her tax return, the

redeemed shareholder reported the transaction as a redemption of

all of her stock under section 115(c) of the Internal Revenue

Code of 1939 and claimed that the transaction must be treated as

a sale or exchange of stock. The Commissioner determined that

the redemption was essentially equivalent to the distribution of

a taxable dividend and recharacterized the redemption proceeds as

dividend income.

The Court of Appeals for the Sixth Circuit reversed the

decision of the lower court, which had upheld the Commissioner’s

determination. The Court of Appeals acknowledged the “general

principle” that “a taxpayer has the legal right to decrease the

amount of what otherwise would be his taxes or altogether avoid

them, by means which the law permits.” Zenz v. Quinlivan, supra

at 916. The Court of Appeals refused to decide the issue

presented based on the taxpayer’s motivation to avoid taxes.
 - 52 -

Instead, it examined the nature of the transaction in order to

decide if it was, in substance, a dividend distribution or a

sale. The Court of Appeals held that the redemption was not

essentially equivalent to the distribution of a dividend because

the taxpayer intended “to bring about a complete liquidation of

her holdings and to become separated from all interest in the

corporation”, and the redemption completely terminated her

interest in the corporation. Id. at 917.

2. Niedermeyer v. Commissioner

Twenty years after Zenz v. Quinlivan, supra, was decided,

this Court decided the tax effect of a sale in the context of

section 304. In Niedermeyer v. Commissioner, 62 T.C. 280 (1974),

the relevant issues were whether the taxpayers’ sale of all of

their common stock in American Timber & Trading Co., Inc. (AT&T)

to Lents Industries, Inc. (Lents) was a redemption involving a

related corporation under section 304(a)(1) of the Internal

Revenue Code of 1954 and, if so, whether the redemption should be

treated as a distribution in exchange for the redeemed stock

under section 302(a) or as a distribution to which section 301

applies. The taxpayers in Niedermeyer sold all of their common

stock but not their preferred stock in AT&T to Lents on September

8, 1966. On the date of the sale, the majority of Lents’ stock

was owned by the taxpayers’ sons. On December 28, 1966, the

taxpayers contributed their AT&T preferred stock to the
 - 53 -

Niedermeyer Foundation, a tax-exempt organization. The taxpayers

alleged that the distribution by Lents to them was in exchange

for their AT&T stock. The Commissioner alleged that the sale was

a section 304 transaction between related corporations and that

the distribution was a taxable dividend under sections 301 and

302.

This Court first considered whether the sale was a deemed

redemption under section 304(a)(1). After applying the

constructive ownership rules of section 318(a) as required by

section 304(c), this Court concluded that the taxpayers were in

control of both AT&T and Lents immediately prior to the sale and

that the transaction in which Lents acquired the taxpayers’ AT&T

common stock must be treated as a redemption under section

304(a)(1).

This Court then addressed the taxpayers’ contention that,

even if the sale were treated as a deemed redemption under

section 304(a)(1), the taxpayers nevertheless were entitled to

treat the distribution from Lents as full payment in exchange for

their AT&T stock under section 302(a) by meeting one of the

conditions of section 302(b). After rejecting the taxpayers’

argument under section 302(b)(1), the Court turned to their

arguments under section 302(b)(3). Among other things, the

taxpayers argued that the distribution was in complete

termination of their ownership interest in AT&T, contending that
 - 54 -

the distribution and their subsequent gift of their AT&T

preferred stock were parts of a single plan to completely

terminate their actual and constructive ownership of AT&T before

the end of 1966.

In Niedermeyer, this Court acknowledged that, where there is

a plan consisting of a redemption and one or more other steps

that results in a complete termination of the taxpayer’s interest

in a corporation, section 302(b)(3) may apply. Niedermeyer v.

Commissioner, supra at 291 (citing in support Leleux v.

Commissioner, 54 T.C. 408 (1970); Estate of Mathis v.

Commissioner, 47 T.C. 248 (1966)). The Court emphasized,

however, that the redemption “must occur as part of a plan which

is firm and fixed and in which the steps are clearly integrated.”

Id.

After searching the record for evidence in support of the

taxpayers’ alleged plan, the Court concluded that the evidence

presented was “too insubstantial to prove the existence of such a

plan.” Id. Among the facts on which the Court relied were the

following:

(1) The alleged plan was not in writing, and there was no

indication that the taxpayers communicated their donative

intention to the charity or to anyone.

(2) The taxpayers’ son who testified at trial about the

Lents stock acquisition did not mention any desire on the
 - 55 -

taxpayers’ part to completely terminate their ownership interest

in AT&T.

(3) The taxpayers could easily have changed their minds

regarding their avowed intention to donate their preferred stock.

(4) The taxpayers failed to show that their alleged decision

to donate the preferred stock was in any way fixed or binding.

This Court emphasized that a plan sufficient to pass muster under

section 302(b)(3) did not need to be “in writing, absolutely

binding, or communicated to others” but that “the above-mentioned

factors, all of which are lacking here, tend to show a plan which

is fixed and firm.” Id. at 291-292.

Although the Court in Niedermeyer did not expressly state

that the plan to which it was referring was a plan of the

taxpayers, such a conclusion is warranted. The Court rejected

the taxpayers’ self-serving testimony regarding their intention

to donate and searched instead for objective evidence that the

deemed section 304 redemption and the later gift were integrated

parts of a firm and fixed plan on the part of the taxpayers to

completely terminate their ownership interest; i.e., a plan

consisting of clearly integrated steps to which the taxpayers

were firmly committed.

3. Benjamin v. Commissioner

In Benjamin v. Commissioner, 66 T.C. 1084 (1976), affd. 592

F.2d 1259 (5th Cir. 1979), the issue presented was whether the
 - 56 -

redemption of the taxpayer’s class A preferred voting stock by a

family-held corporation was essentially equivalent to a dividend

under section 302(b)(1) of the Internal Revenue Code of 1954. In

deciding the tax effect of the redemption, this Court addressed

the taxpayer’s argument that the redemption was pursuant to a

plan of redemption that, when fully implemented, would completely

terminate the taxpayer’s ownership interest. The evidence at

trial failed to disclose any common understanding among the

shareholders or the redeeming corporation as to the timing of, or

procedure for, the alleged redemption plan, nor was there any

evidence of a concrete plan involving the shareholders or the

corporation. After examining the record, this Court concluded

there was no credible evidence of any firm plan to redeem, noting

that “vague anticipation” was not enough to constitute a plan.

Id. at 1114.

4. Paparo v. Commissioner

In Paparo v. Commissioner, 71 T.C. 692 (1979), the taxpayers

were shareholders of Nashville Textile Corp. (Nashville) and

Jasper Textile Corp. (Jasper), two women’s apparel manufacturers,

and House of Ronnie, Inc. (Ronnie), the corporation that designed

and marketed the clothing made by Nashville and Jasper. In order

to improve their sales development effort, the taxpayers

approached I. Amsterdam, a successful sales organization. The

shareholders of I. Amsterdam also owned Denise Lingerie Co., a
 - 57 -

women’s apparel manufacturer. The taxpayers concluded that if

Ronnie could acquire Denise in exchange for Ronnie’s stock,

Ronnie would acquire not only Denise’s manufacturing facilities

but also the sales relationship with I. Amsterdam. In the early

part of 1969, negotiations began. Denise’s shareholders were

interested in the taxpayer’s acquisition proposal but would not

consider accepting stock in a privately held corporation.

In conjunction with the proposed acquisition of Denise, the

taxpayers began to explore taking Ronnie public. The underwriter

they had selected recommended that Nashville and Jasper be

combined with Ronnie before the public offering. In January

1970, the taxpayers and another shareholder of Nashville and

Jasper agreed to sell all of their stock to Ronnie for $800,000.

The taxpayers contemplated that the purchase price would be paid

from the proceeds of one or more public offerings of Ronnie’s

stock.

On March 30, 1970, the first public offering of Ronnie’s

stock was made. A portion of the sales proceeds was used to make

the downpayment to the Nashville and Jasper shareholders.

On October 30, 1970, Ronnie entered into an agreement with

Denise’s shareholders to acquire all of Denise’s outstanding

stock in exchange for Ronnie’s stock.

On April 20, 1972, a second public offering of Ronnie’s

stock was made. A portion of the proceeds was used to pay the
 - 58 -

balance of the purchase price owed to the Nashville and Jasper

shareholders.

The sole issue for decision was whether the amounts received

by the taxpayers in 1970 and 1971 from Ronnie in exchange for

their stock in Nashville and Jasper were taxable as capital gains

under section 302,35 or as dividends under section 301. The

parties agreed that section 304 applied to the stock acquisitions

in question and that, therefore, the transfer of Nashville and

Jasper stock to Ronnie must be characterized as a redemption

through the use of related corporations. The parties disagreed

only with respect to the application of section 302. The

taxpayers contended that the redemptions qualified as sales under

section 302(a) because they met the requirements of either

section 302(b)(1) or (2). The taxpayers argued that the 1970

redemption was but one step in an overall plan to redeem their

interest in Nashville and Jasper that ended in 1972 with the

second public offering, and it was not the essential equivalent

of a dividend.

This Court rejected the taxpayers’ argument, concluding that

the record did not contain any compelling evidence of an overall

financial plan covering both the first and the second public

offerings. No formal written plan for the funding of the

35
Relevant Code provisions were from the Internal Revenue
Code of 1954.
 - 59 -

redemption through subsequent public offerings of Ronnie’s stock

existed, and no corporate minutes were offered into evidence to

substantiate such a plan. In addition, funding the redemption

through subsequent public offerings of Ronnie’s stock was beyond

the control of the taxpayers. Although this Court acknowledged

the taxpayers’ apparent intent that subsequent public offerings

be made, the taxpayers had made no promise to the underwriter,

nor was there any evidence of an agreement to make another public

offering.

5. Bleily & Collishaw, Inc. v. Commissioner

In Bleily & Collishaw, Inc. v. Commissioner, 72 T.C. 751

(1979), the taxpayer owned 30 percent of a corporation. The

majority shareholder wanted sole control over the corporation,

and the taxpayer was willing to sell all of its shares to the

majority shareholder. However, because the majority shareholder

did not have sufficient funds to purchase all of the taxpayer’s

shares at that time, the majority shareholder purchased only a

portion of the taxpayer’s stock. Thereafter, over a period of

approximately 23 weeks, the corporation redeemed the balance of

the taxpayer’s stock in increments tied to the availability of

money to fund the redemptions. Although the taxpayer was under

no contractual or other legal obligation to sell the rest of its

shares or have them redeemed if and when money became available

to fund additional acquisitions, this Court found that the
 - 60 -

taxpayer intended to sell its shares whenever the money needed to

fund the acquisitions became available.

In Bleily & Collishaw, Inc., the issue before the Court was

whether the redemptions met the requirements of section 302(b)(3)

of the Internal Revenue Code of 1954. We described the

applicable legal standard as follows:

Where several redemptions have been executed pursuant
to a plan to terminate a shareholder’s interest, the
individual redemptions constitute, in substance, the
component parts of a single sale or exchange of the
entire stock interest. We have refused, however, to
treat a series of redemptions as a single plan unless
the redemptions are pursuant to a firm and fixed plan
to eliminate the stockholder from the corporation.
Generally, a gentleman’s agreement lacking written
embodiment, communication, and contractual obligations
will not suffice to show a fixed and firm plan. On the
other hand, a plan need not be in writing, absolutely
binding, or communicated to others to be fixed and firm
although these factors all tend to indicate that such
is the case. [Id. at 756; citations omitted.]

Noting that whether a firm and fixed plan existed in a given case

is necessarily a fact issue, we held that the requirements of

section 302(b)(3) were met because the redemptions were part of a

firm and fixed plan to eliminate the stockholder from the

corporation. The record established that the corporation planned

to eliminate the taxpayer as a shareholder and that the taxpayer

had agreed to the sale of all its shares and to the purchase

price, even though there was no binding obligation on either

party to consummate additional stock sales.
 - 61 -

6. Roebling v. Commissioner

In Roebling v. Commissioner, 77 T.C. 30 (1981), a taxpayer

owned approximately 90 percent of the class B preferred stock and

approximately 45 percent of the common stock of Trenton Trust Co.

(Trenton Trust). In 1958, Trenton Trust adopted a plan of

recapitalization to simplify and strengthen its capital structure

which, among other things, called for the redemption of a

specified amount of the class B preferred stock each year and

required Trenton Trust to establish a sinking fund for that

purpose. During each of the years 1965-69, part of the

taxpayer’s class B preferred stock was redeemed, and in 1965 and

1966, the taxpayer sold some shares. Among the issues presented

to this Court was whether the redemption of the taxpayer’s class

B preferred shares was not essentially equivalent to a dividend

within the meaning of section 302(b)(1) of the Internal Revenue

Code of 1954.

Each year, Trenton Trust set aside funds and decided how

much of those funds it would use to retire the class B preferred

shares. Each retirement of shares required action of Trenton

Trust’s board of directors and the consent and approval of the

FDIC and the Department of Banking and Insurance of the State of

New Jersey. Each year, Trenton Trust’s board of directors

adopted a resolution to apply for the necessary regulatory

approvals, and Trenton Trust then filed its applications. For
 - 62 -

most of the relevant years, the applications were granted at

least in part, but on one occasion the application was denied.

Although the taxpayer in Roebling relied only upon section

302(b)(1) to support her contention that each of the redemptions

qualified as a sale or exchange under section 302(a), she argued

that the redemptions were integrated steps in a firm and fixed

plan to redeem all of the preferred stock and that the

redemptions in the aggregate resulted in a meaningful reduction

of the taxpayer’s interest in Trenton Trust. Applying the same

analysis used in cases involving section 302(b)(3), this Court

held that the redemptions were integrated steps in a firm and

fixed plan even though there was no binding commitment on the

part of Trenton Trust to acquire the taxpayer’s shares or on the

taxpayer’s part to tender her shares. The Court acknowledged

that each redemption was subject to the financial condition of

the bank and required regulatory approval, but emphasized that

“this was about as firm and fixed a plan as a bank could have

under the circumstances.” Roebling v. Commissioner, supra at 55.

7. Monson v. Commissioner

In Monson v. Commissioner, 79 T.C. 827 (1982), a closely

held corporation owned by the taxpayer and his children redeemed

all of the children’s stock and a portion of the taxpayer’s stock

on July 30, 1976. Immediately following the redemption, the

taxpayer was the corporation’s sole shareholder. On August 2,
 - 63 -

1976, the taxpayer sold all of his shares to a third party for

cash and a promissory note. Minutes of a board of directors

meeting held on July 30, 1976, described the redemption and the

subsequent sale of taxpayer’s remaining stock to a third party as

steps in the sale. The taxpayer reported the redemption proceeds

as income from the sale or exchange of stock under section

302(a).

Citing Zenz v. Quinlivan, 213 F.2d 914 (6th Cir. 1954), this

Court examined the record to determine whether the intent of the

taxpayer was to bring about a complete liquidation of his

ownership interest in his corporation. Monson v. Commissioner,

supra at 835-836. Because the record clearly established that

the redemption of the taxpayer’s stock was part of an overall

plan to terminate his entire interest in his closely held

corporation, this Court held that the redemption was either a

complete termination of the taxpayer’s interest under section

302(b)(3) or was not essentially equivalent to a dividend under

section 302(b)(1). Id. at 837. In either event, section 302(a)

required the redemption to be treated as a sale. Id.

8. Applicable Legal Principles

The above-cited cases decided by this Court confirm that

this Court has not integrated a redemption with one or more other

transactions to decide whether the requirements of section 302(b)

are met unless the redemption was part of a firm and fixed plan
 - 64 -

to satisfy one of the conditions of section 302(b) (such as, in

the case of section 302(b)(3), the complete termination of the

taxpayer’s ownership in the issuing corporation), and the steps

of the plan were clearly integrated. Bleily & Collishaw, Inc. v.

Commissioner, 72 T.C. at 756; Niedermeyer v. Commissioner, 62

T.C. at 291. Whether or not a plan existed is an issue of fact

that must be resolved on the basis of all of the relevant facts

and circumstances of a particular case. Bleily & Collishaw, Inc.

v. Commissioner, supra at 756. The taxpayer has the burden of

proving that the Commissioner’s position regarding the existence

or nonexistence of a plan is erroneous. Rule 142(a).36

An analysis of whether or not a firm and fixed plan existed

necessarily entails an examination of the taxpayer’s intent. See

Monson v. Commissioner, supra at 835-836 (citing Zenz v.

Quinlivan, supra, with approval); Niedermeyer v. Commissioner,

supra at 291 (“there was no evidence of communication of

petitioners’ asserted donative intention to the charity or to

anyone”). It is the taxpayer’s intention, as manifested by the

taxpayer’s participation in and agreement to the plan, that the

search for a plan is designed to reveal. However, a taxpayer’s

self-serving statement regarding its intent or regarding the

36
Petitioner has not argued that the burden of proof should
be placed on respondent, and we infer from the record that sec.
7491 does not apply because the examination in this case began
before its effective date.
 - 65 -

existence of a plan is given very little weight in the absence of

supporting evidence tending to show that the Commissioner’s

position is erroneous. Niedermeyer v. Commissioner, supra at

291. Instead, this Court has relied primarily on objective

evidence, such as a written plan, corporate minutes confirming

the existence of a plan, or a writing or other communication from

an involved third party, or the lack thereof, as the most

compelling evidence of the existence of a firm and fixed plan

evidencing a taxpayer’s intention regarding the redemption of its

stock. Id.; see also Monson v. Commissioner, supra; Roebling v.

Commissioner, 77 T.C. 30 (1981); Bleily & Collishaw, Inc. v.

Commissioner, supra. By focusing on the intent of the redeeming

corporation and the redeemed shareholder on the date of the

redemption, both this Court and the Court of Appeals for the

Sixth Circuit in Zenz have attempted to cull after-the-fact

attempts on the part of taxpayers to link unrelated transactions

in order to achieve favorable tax treatment, see Niedermeyer v.

Commissioner, supra, from those situations where the taxpayer

intentionally structures two or more transactions as part of a

plan to terminate the taxpayer’s ownership interest in a

corporation, see Zenz v. Quinlivan, supra.

An analysis of whether or not a firm and fixed plan existed

also entails an examination of any uncertainty in consummating

the alleged plan. Although a binding commitment to the plan is
 - 66 -

not required, whether the redeeming corporation and the redeemed

shareholder have demonstrated their intention to consummate the

alleged plan in some meaningful way is an important factor.

Bleily & Collishaw, Inc. v. Commissioner, supra at 757

(“Collishaw had agreed to the sale of all its shares and to the

purchase price. As noted before, the fact that the agreement was

not binding is not dispositive.”); Niedermeyer v. Commissioner,

supra at 291 (“Petitioners could easily have changed their minds

with regard to any intent to donate the preferred stock. Clearly

petitioners’ decision to donate the preferred stock has not been

shown to be in any way fixed or binding.”). If the taxpayer is

the sole shareholder of a closely held corporation and could

easily change his mind regarding the implementation of the

alleged plan, this Court has demanded compelling evidence of the

taxpayer’s commitment to the plan before it will find that a firm

and fixed plan existed. Niedermeyer v. Commissioner, supra at

291. If, however, the taxpayer is a shareholder of a more

broadly held close corporation or a publicly held corporation,

this Court’s analysis has focused primarily on the redeeming

corporation’s commitment to the plan. For example, in Roebling

v. Commissioner, supra at 55, a case involving the periodic

redemption of a banking institution’s preferred shareholders, we

stated that--

While we realize that this redemption plan was
subject to the financial condition of the bank and the
 - 67 -

approval each time of the banking authorities, we think
this was about as firm and fixed a plan as a bank could
have under the circumstances. See Bleily & Collishaw,
Inc. v. Commissioner, supra. We do not believe the
requirement of a firm and fixed plan for redemption
need be as rigid under the circumstances here involved
as would be required in a closely held family
corporation situation where the plan could be changed
at any time by the actions of one or two shareholders.
Compare Niedermeyer v. Commissioner, supra, and
McDonald v. Commissioner, 52 T.C. 82 (1969).

As this Court’s opinion in Roebling confirms, the existence of

conditions, contingencies, or other uncertainties will not

necessarily preclude a finding that a firm and fixed plan exists

but is one factor that the Court must consider in reaching its

decision.

B. The Section 304 Redemptions

The foregoing cases and the principles we have extracted

from them require that we examine the facts in order to decide

whether petitioner engaged in the cross-chain sales and the later

sales of the target corporations as part of a firm and fixed plan

to completely terminate the target corporations’ actual and

constructive ownership of the issuing corporations.

1. The 1986 Cross-Chain Sale of Merlease

Petitioner’s evidence at trial focused almost exclusively on

the lack of any binding commitment or even an agreement in

principle between petitioner and Inspiration, the ultimate

purchaser of ML Leasing, on the date of ML Leasing’s cross-chain

sale of its Merlease stock to ML Asset Management. On the date
 - 68 -

of the cross-chain sale, Inspiration had not yet completed its

due diligence, contractually committed itself to buy the stock of

ML Leasing, or finalized its financing arrangements. Moreover,

on the date of the cross-chain sale, the board of directors of

Merrill Parent had not yet authorized the sale of ML Leasing’s

stock, and Inspiration had not yet approved the purchase. The

existence of these uncertainties according to petitioner

precludes any finding that the cross-chain sale was part of a

firm and fixed plan to terminate ML Leasing’s actual and

constructive ownership of Merlease. We disagree.

Whether a redemption and later sale are integrated steps in

a firm and fixed plan is a factual determination that necessarily

focuses on the actions of the redeemed shareholder and the

redeeming corporation. See Roebling v. Commissioner, supra;

Niedermeyer v. Commissioner, 62 T.C. 280 (1974). If the actions

of the redeemed shareholder and the redeeming corporation

evidence a firm and fixed plan to participate in two or more

related transactions that, individually or collectively, qualify

as a redemption under section 302(b), then the redemption

executed pursuant to the plan will qualify as a sale or exchange

under section 302(a). Niedermeyer v. Commissioner, supra.

After examining the actions of the redeemed shareholder (ML

Leasing), the redeeming corporation (ML Asset Management), and

Merrill Parent, we are convinced that the deemed redemption under
 - 69 -

section 304, i.e., the cross-chain sale, and the later sale of ML

Leasing outside the consolidated group were two steps in a firm

and fixed plan to terminate ML Leasing’s actual and constructive

ownership of Merlease, the issuing corporation.

The principal, and most compelling, evidence on which we

rely is the formal presentation of the plan to Merrill Parent’s

board of directors, which took place on July 28, 1986, only 4

days after the cross-chain sale of Merlease. The formal

presentation included the distribution of a written summary and

slides illustrating the details of the plan to dispose of

petitioner’s proprietary lease business culminating in the sale

of ML Leasing. The written summary laid out each step of the

plan. Among the steps identified were (1) the cross-chain sale

of Merlease, which the summary acknowledged had already occurred,

(2) the distribution of a dividend by ML Leasing to ML Capital

Resources consisting of the cash received in the cross-chain sale

by ML Leasing from ML Asset Management and other assets, and (3)

the imminent sale of ML Leasing to Inspiration. The written

summary described the tax benefits of the plan, which were

predicated on an increase in Merrill Parent’s basis in ML Leasing

under the consolidated return regulations for the proceeds of the

cross-chain sale. The written summary confirmed that the plan

included the sale of ML Leasing and unequivocally identified

Inspiration as the purchaser.
 - 70 -

The written summary also confirmed that, although the sale

of ML Leasing had not yet been finalized, the sale was

sufficiently mature that the establishment of a tax reserve for

the transaction was warranted. In fact, the written summary

included a recommendation to the board of directors that a tax

reserve specifically geared, in part, to the extraordinary basis

adjustment resulting from the section 304 redemption be approved.

Petitioner seeks to minimize the impact of the written

summary by pointing out that the summary was prepared for a board

of directors meeting that occurred 4 days after the cross-chain

sale. Although petitioner is correct regarding the chronology,

petitioner offered us no proof that the plan suddenly sprang to

life after the cross-chain sale had occurred, or that the cross-

chain sale and the later sale of ML Leasing were unrelated. In

fact, petitioner introduced very little evidence regarding the

development, review, and approval of the plan reflected in the

written summary, even though the plan was the product of

petitioner’s own internal planning.

The July 28, 1986, board of directors meeting was a regular

board of directors meeting. Ordinarily, a corporation is

required by its bylaws and/or by State law to provide reasonable

advance notice to its directors of a regular board meeting. We

believe that it is reasonable to infer from this record that the

plan outlined in the written summary and presented to Merrill
 - 71 -

Parent’s board of directors on July 28, 1986, had been carefully

constructed, vetted, finalized, and approved by the appropriate

corporate officers by at least July 24, 1986, the date of the

1986 cross-chain sale, and in sufficient time before the July 28,

1986, board of directors meeting to enable the notice of meeting

to be given and the meeting materials to be collated and

distributed to the directors.

We also note that, on the date of the cross-chain sale,

petitioner had identified Inspiration as the purchaser of ML

Leasing and had already engaged in substantial negotiations with

Inspiration. In fact, petitioner and Inspiration had agreed in

principle to a purchase price that was used to calculate the

estimated tax benefits in the written summary presented to the

board of directors. An inference can also be drawn from the

record that, after a meeting on June 23, 1986, Inspiration

confirmed informally that it was prepared to purchase ML

Leasing’s stock, subject to verification of the residual lease

values by an outside appraiser. It was only after such

confirmation was presumably received that petitioner proceeded

with the cross-chain sale.

A firm and fixed plan does not exist for purposes of section

302 when there is only “vague anticipation” that a particular

step in an alleged plan will occur. Benjamin v. Commissioner, 66

T.C. at 1114. The facts in this case, however, establish much
 - 72 -

more than vague anticipation that the sale of ML Leasing’s stock

would occur. The facts establish the existence of a firm and

fixed plan on the part of Merrill Parent, ML Leasing, ML Asset

Management, and Merlease to engage in a multistep transaction

specifically designed to dispose of petitioner’s proprietary

leasing business outside of the consolidated group while

eliminating gain on the transaction through basis adjustments

resulting from the interplay of section 304 with the consolidated

return regulations.

We find that a firm and fixed plan to dispose of ML Leasing

outside the consolidated group existed on the date of the 1986

cross-chain sale, and that the 1986 cross-chain sale, the

distribution of a dividend of the gross sale proceeds, and the

sale of ML Leasing were integrated steps in that plan. Because

the 1986 cross-chain sale (the deemed section 304 redemption),

when integrated with the sale of ML Leasing’s stock, resulted in

the complete termination of ML Leasing’s actual and constructive

ownership interest in Merlease (the issuing corporation), see

sec. 304(b), we hold that the redemption qualified under section

302(b)(3), and that, therefore, the redemption shall be treated

as a payment in exchange for stock under section 302(a) and not

as a dividend under section 301.
 - 73 -

2. The 1987 Cross-Chain Sales of the Five
Subsidiaries, ML Interfunding, and Leasing
Equipment

Petitioner makes similar factual and legal arguments with

respect to the 1987 cross-chain sales. Because the factual and

legal arguments are virtually identical for all of the 1987

cross-chain sales except the one involving Vessel Leasing, we

shall consider them together, excluding only Vessel Leasing.

Like petitioner’s evidence regarding the 1986 cross-chain

sale, petitioner’s evidence regarding the 1987 cross-chain sales

focused almost exclusively on the lack of any binding commitment

or even an agreement in principle between petitioner and

GATX/BCE, the ultimate purchaser of ML Capital Resources, on the

dates of the 1987 cross-chain sales. Seven of the eight 1987

cross-chain sales occurred on March 30, 1987 (the five

subsidiaries and ML Interfunding), and April 3, 1987 (Leasing

Equipment). On those dates, GATX/BCE had not had any meaningful

opportunity to review the 3-volume offering memorandum or to

conduct its due diligence investigation, and had not

contractually committed itself to buy ML Capital Resources’

stock. Neither the board of directors of Merrill Parent nor the

board of directors of GATX/BCE had approved the transaction.

Petitioner argued that the existence of these uncertainties

precludes any finding that the cross-chain sale was part of a

firm and fixed plan to terminate ML Capital Resources’ actual and
 - 74 -

constructive ownership of the issuing corporations. Again, we

disagree.

After examining petitioner’s actions including those of the

redeemed shareholder (ML Capital Resources), the redeeming

corporations (ML Realty, ML Asset Management, and MLPFS), and

Merrill Parent, we are convinced that the section 304 deemed

redemptions, i.e., the 1987 cross-chain sales, and the later sale

of ML Capital Resources to GATX/BCE were steps in a firm and

fixed plan to terminate ML Capital Resources’ actual and

constructive ownership of the issuing corporations.

As with the 1986 cross-chain sale, the most compelling

evidence of a firm and fixed plan with respect to the 1987 cross-

chain sales is the formal presentation of the plan to Merrill

Parent’s board of directors, which took place on April 23, 1987,

2 days after receipt of GATX/BCE’s bid and approximately 3 weeks

after seven of the eight 1987 cross-chain sales closed. The

formal presentation included the distribution of a written

summary and slides illustrating the details of the plan to

dispose of ML Capital Resources using much of the same language,

format, and reasoning as that used in the 1986 written summary.

The written summary laid out each step of the plan. Among the

steps identified were (1) the cross-chain sales of the seven

subsidiaries, which the summary acknowledged had already

occurred, (2) the distribution of a dividend by ML Capital
 - 75 -

Resources to its sole shareholder, ML Consumer Markets Holdings,

Inc., of the consideration received in the cross-chain sales, and

(3) the imminent sale of ML Capital Resources to GATX/BCE. The

written summary described the tax benefits of the plan, which

were predicated on an increase in petitioner’s basis in ML

Capital Resources under the consolidated return regulations for

the proceeds of the cross-chain sales. The written summary

confirmed that the plan included the sale of ML Capital Resources

and described GATX/BCE as the “likely purchaser”.

The written summary confirmed that, although the sale of ML

Capital Resources had not yet been finalized and the sale

negotiations were not as far along as those in 1986, the

negotiations were sufficiently mature and the sale sufficiently

likely to occur that the establishment of a tax reserve for the

transaction was warranted. The written summary included a

recommendation to the board of directors that a tax reserve

specifically geared, in part, to the basis adjustment resulting

from the section 304 redemptions be approved. In response to the

presentation regarding the plan, Merrill Parent’s board of

directors approved the plan, ratified the cross-chain sales, and

authorized the appropriate officers to finalize the sale of ML

Capital Resources.

Petitioner attempts to minimize the impact of the written

summary by pointing out that the summary was prepared for a board
 - 76 -

of directors meeting that occurred approximately 3 weeks after

the 1987 cross-chain sales. Although petitioner is correct

regarding the chronology, petitioner offered us no proof that the

plan suddenly sprang to life after the 1987 cross-chain sales had

closed or that the 1987 cross-chain sales and the later sale of

ML Capital Resources were unrelated. In fact, petitioner

introduced very little evidence regarding the development,

review, and approval of the plan reflected in the 1987 written

summary, even though the plan was the product of petitioner’s own

internal planning and closely resembled the 1986 plan.

Petitioner correctly points out that, as of the dates of the

1987 cross-chain sales, there was no contractual obligation

between petitioner and GATX/BCE to consummate the sale of ML

Capital Resources. We note, however, that petitioner had

structured the “playing field” in order to expedite and simplify

the sale of ML Capital Resources by (1) structuring the proposed

sale as an auction designed to encourage the submission of bids

acceptable to petitioner, (2) preparing and distributing a

proposed Stock Purchase Agreement in conjunction with the 3-

volume offering memorandum and advising prospective purchasers

that petitioner “does not intend to engage in substantial

negotiations” with respect to its terms, (3) securing at least

one appraisal of residual value in anticipation of the sale, and

(4) offering the prospective purchaser administrative resources
 - 77 -

to facilitate the uninterrupted management of ML Capital

Resources’ lease portfolio after the sale closed. In addition,

on the date of the earliest 1987 cross-chain sale, petitioner had

already had substantial contacts with prospective purchasers

including GATX/BCE. GATX/BCE had apparently already submitted a

preliminary indication of interest (including a cash purchase

price), and GATX/BCE had been selected by petitioner to perform

detailed due diligence regarding the proposed sale. Two days

before Merrill Parent’s board of directors approved the sale of

ML Capital Resources and authorized appropriate officers to

finalize the deal, GATX/BCE had submitted its formal bid to

purchase ML Capital Resources’ stock. Merrill Parent had

received and reviewed the bid prior to the board meeting and, in

the written summary distributed at the meeting, described

GATX/BCE to the board of directors as the “likely purchaser”.

We reject petitioner’s argument that any uncertainty

regarding the terms of the proposed sale of ML Capital Resources

at the time of the cross-chain sales prevents integration of the

transactions for purposes of section 302(b). A binding

commitment or even an agreement in principle that each step of a

plan will occur is not a prerequisite for finding that a firm and

fixed plan existed, although uncertainty regarding one or more

steps of the plan is a factor we must consider. Roebling v.

Commissioner, 77 T.C. at 55; Niedermeyer v. Commissioner, 62 T.C.
 - 78 -

at 292. While there was some uncertainty regarding the details

of the sale of ML Capital Resources on the dates of the cross-

chain sales, there was no uncertainty that petitioner intended to

sell ML Capital Resources as part of the plan. The totality of

the facts and circumstances convinces us that petitioner had a

firm and fixed plan to dispose of ML Capital Resources in a

carefully orchestrated sequence of steps designed to avoid

corporate-level tax on the transaction. The facts also convince

us that petitioner was prepared to do everything reasonably

possible to facilitate the implementation of that plan.

We find that a firm and fixed plan to dispose of ML Capital

Resources outside the consolidated group existed on the dates of

the cross-chain sales, and that the cross-chain sales, the

distribution of a dividend of the gross sale proceeds, and the

sale of ML Capital Resources were integrated steps in that plan.

3. The 1987 Cross-Chain Sale of Vessel Leasing

Because much of what was said regarding the other 1987

cross-chain sales applies with respect to the cross-chain sale of

Vessel Leasing, we incorporate the foregoing analysis here. What

differentiates the Vessel Leasing sale from the other 1987 cross-

chain sales, however, is a chronology that makes it even easier

to conclude that the Vessel Leasing sale must be integrated with

the sale of ML Capital Resources outside the consolidated group.
 - 79 -

The Vessel Leasing cross-chain sale closed on June 10, 1987.

On that date, GATX/BCE had already submitted its initial and

modified bids (April 21, 1987, and April 27, 1987, respectively)

and had been “awarded the transaction”, Merrill Parent’s board of

directors had met and authorized the consummation of the sale of

ML Capital Resources’ stock to GATX/BCE (April 24, 1987),

GATX/BCE had entered into a nonbinding letter of intent (May 22,

1987), GATX’s Finance Committee had approved the proposal to

acquire ML Capital Resources’ stock (June 1, 1987), and GATX/BCE

had completed its due diligence review. During final

negotiations, GATX had requested that ML Capital Resources

dispose of its Vessel Leasing stock prior to closing because

GATX/BCE could not own Vessel Leasing due to Federal law

restrictions. Immediately thereafter the respective boards of ML

Capital Resources and ML Asset Management approved the sale of

Vessel Leasing’s stock to ML Asset Management, and the final 1987

cross-chain sale closed.

It is apparent that the cross-chain sale of Vessel Leasing’s

stock to ML Asset Management was arranged in anticipation of the

imminent sale of ML Capital Resources to GATX/BCE and was part of

a seamless net of transactions culminating in the complete

termination of ML Capital Resources’ ownership interest in the

issuing corporations, whose stock was sold cross-chain in

transactions that qualified as section 304 redemptions. We find,
 - 80 -

therefore, that a firm and fixed plan to dispose of ML Capital

Resources outside the consolidated group existed on the date of

the Vessel Leasing cross-chain sale and that the Vessel Leasing

cross-chain sale, like the other 1987 cross-chain sales, was an

integrated step in that plan.

Because the eight 1987 cross-chain sales (the deemed section

304 redemptions), when integrated with the sale of ML Capital

Resources’ stock, resulted in the complete termination of ML

Capital Resources’ actual and constructive ownership interest in

the issuing corporations, see sec. 304(b), we hold that the

redemptions qualified under section 302(b)(3) and that,

therefore, the redemptions shall be treated as a payment in

exchange for the stock under section 302(a) and not as a dividend

under section 301.

IV. Conclusion

The record establishes that on the dates of the cross-chain

sales, petitioner had agreed upon, and had begun to implement, a

firm and fixed plan to completely terminate the target

corporations’ ownership interests in the issuing corporations

(the subsidiaries whose stock was sold cross-chain). The plan

was carefully structured to achieve very favorable tax basis

adjustments resulting from the interplay of section 304 and the

consolidated return regulations, and the steps of the plan were

described in detail in written summaries prepared for meetings of
 - 81 -

Merrill Parent’s board of directors. As described in those

written summaries, the cross-chain sales of the issuing

corporations’ stock and the sales of the target corporations were

part of the same seamless web of corporate activity intended by

petitioner to culminate in the sale of the target corporations

outside the consolidated group. Under the test prescribed by

this Court in Niedermeyer v. Commissioner, 62 T.C. 280 (1974),

and other cases discussed herein, respondent properly integrated

the cross-chain sales with the related sales of the target

corporations to ascertain the tax consequences of the

transactions, and we sustain respondent’s determination.

We have considered the other arguments of the parties, and,

to the extent not discussed herein, we conclude that the

arguments are irrelevant, moot, or without merit.

To reflect the foregoing,

Decision will be entered

under Rule 155.