IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT
No. 94-50291
IN THE MATTER OF: INSILCO CORPORATION,
Debtor.
INSILCO CORPORATION,
Appellant,
versus
UNITED STATES OF AMERICA and
AMPHENOL CORPORATION,
Appellees.
Appeal from the United States District Court
for the Western District of Texas
(May 15, 1995)
Before HIGGINBOTHAM, SMITH, and STEWART, Circuit Judges.
PATRICK E. HIGGINBOTHAM, Circuit Judge:
During the pendency of its voluntary bankruptcy proceedings,
Insilco Corporation filed an amended return with the Internal
Revenue Service, claiming a $14.4 million refund. The bankruptcy
court adjudicated Insilco's claim and granted summary judgment in
favor of the government. Insilco appealed, and the district court
affirmed. We hold that Insilco is not entitled to a refund and,
accordingly, affirm.
I.
In 1985, Insilco Corporation owned sixty-six percent of the
shares of Times Fiber Communication, Inc. and the public owned the
remainder. LPL Investment Group, Inc.,1 a newly formed corporation
with no significant assets, sought to acquire Times Fiber. LPL
initially proposed to pay Insilco cash and LPL stock in exchange
for Insilco's Times Fiber stock. Later, the parties structured the
deal as the following individual transactions rather than a single
exchange:
1. Public Offer: Times Fiber made a self-tender to purchase
the Times Fiber shares held by the public for $15.25 per
share.
2. Times Fiber Sale: Insilco sold all of its Times Fiber
shares to LPL in exchange for $15.25 per share, or
approximately $96 million in cash.
3. LPL Preferred Stock Purchase: Insilco paid $20 million
to LPL to purchase 200,000 shares of LPL preferred stock.
4. LPL Common Stock Purchase: Insilco and five other
investors paid $8 million to acquire LPL common stock.
Insilco paid $897,068 for 953,135 shares of class A stock.
5. Merger: LPL acquired the remaining shares of Times Fiber
stock held by the public for $15.25 per share by means of a
merger.
A separate document was prepared for each of these transactions:
for the public offer, an Offer to Purchase for Cash by Times Fiber
Communications, Inc. Any and All Outstanding Shares of its Common
Stock, dated December 4, 1985; for Insilco's sale of Times Fiber
Stock to LPL, a Stock Purchase Agreement, dated November 17, 1985
and amended December 2, 1985; for Insilco's purchase of LPL
1
LPL is the predecessor corporation to the current
intervenor-appellee, Amphenol Corporation.
2
preferred stock, a Preferred Stock Subscription Agreement, dated
December 31, 1985; for purchase of LPL common stock by Insilco and
other investors, six Common Stock Subscription Agreements, each
dated December 31, 1985; and for the merger of the remaining Times
Fiber shares of stock held by the public, an Agreement and Plan of
Merger, dated November 22, 1985. The public offer expired on
December 26, 1985, and the other transactions closed on December
31, 1985. In 1989, LPL redeemed all of Insilco's LPL stock, both
common and preferred.
On its original 1985 tax return, Insilco reported that it sold
the Times Fiber stock for $96 million, recognizing a gain of
approximately $75 million from a basis of $21 million. It also
treated the LPL preferred and common stock as purchased for $20
million and $897,068, respectively. LPL reported the Times Fiber
stock as a purchase for cash and elected to have I.R.C. § 3382
apply to the transaction.
Availability of the § 338 election was critical to the success
of the negotiations between LPL and Insilco. Under § 338, a
corporation that purchases eighty percent of the stock of another
corporation within a twelve-month period and satisfies certain
other conditions may elect to have the transaction treated as
though it were a purchase of the assets (rather than the stock) of
the acquired corporation, thus allowing the basis of those assets
to be stepped up to the amount paid for the stock. This, in turn,
2
All citations to the Internal Revenue Code are as of
1985, when the events relevant to the issues in this case took
place.
3
has the effect of increasing the amount of the depreciation or
amortization deductions available to the acquired corporation, and,
accordingly, its post-tax cash flow. Lawrence DeGeorge, chief
executive officer of LPL, stated in his affidavit that he would not
have pursued the transaction had he believed that an election under
§ 338 would not be available. Insilco was aware that LPL intended
to make and did actually make the § 338 election.
In 1991, during the pendency of its voluntary bankruptcy
proceedings, Insilco amended its 1985 federal income tax return and
claimed a refund of approximately $14.4 million. In the amended
return, Insilco took the position that under substance-over-form
principles, the transaction should be treated as an exchange of
Times Fiber stock for cash and LPL stock. In effect, Insilco
sought to collapse the separate purchase and sale transactions into
the following single transaction: Insilco sold all of its stock in
Times Fiber and in exchange received LPL common and preferred stock
and approximately $75 million in cash ($96 million for the sale of
Times Fiber stock $20 million for the purchase of the
preferred shares $897,068 for the purchase of the common
shares). By characterizing the transaction in this manner, Insilco
would be entitled to a refund under §§ 304 and 351 and LPL would
not be entitled to the § 338 election.
A few days after filing its amended return, Insilco sought
adjudication of its refund claim in the bankruptcy court. Insilco
and the government each filed a motion for summary judgment. The
bankruptcy court denied Insilco's motion and granted summary
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judgment in favor of the government. The district court affirmed.
Insilco filed an appeal in this court, which was dismissed when the
court determined that the order from which the appeal was taken was
not an appealable final order. The case was remanded to the
bankruptcy court, which disposed of the remaining issues between
the parties. The district court essentially re-entered its
judgment affirming the summary judgment decision, and Insilco filed
this appeal.
II.
A.
The bankruptcy court correctly held that the rule of
Commissioner v. Danielson, 378 F.2d 771 (3d Cir.) (en banc), cert.
denied, 389 U.S. 858 (1967) (adopted by this court in Spector v.
Commissioner, 641 F.2d 376 (5th Cir. Unit A), cert. denied, 454
U.S. 868 (1981)), applies to preclude Insilco from recharacterizing
its transaction and reaping favorable tax benefits. In Danielson,
shareholders of the Butler County Loan Company sold their interest
in the company to the Thrift Investment Corporation. Each
shareholder received $374 per share, which was allocated $222 to
the share and $152 to a covenant not to compete. Under applicable
tax laws, such allocation would mean that the $222 would be
entitled to favorable capital gains treatment while the $152 had to
be treated as ordinary income. When the shareholders claimed the
full amount as capital gain, the IRS filed suit for the deficiency.
5
The court found in favor of the IRS and adopted the following
rule: "[A] party can challenge the tax consequences of his
agreement as construed by the Commissioner only by adducing proof
which in an action between the parties to the agreement would be
admissible to alter that construction or to show its
unenforceability because of mistake, undue influence, fraud,
duress, etc." 378 F.2d at 775. The court distinguished the case
in which the taxpayer seeks to raise a substance-over-form argument
from cases in which the IRS resorts to such argument. The court
found that "to allow the Commissioner alone to pierce formal
arrangements does not involve any disparity of treatment because
taxpayers have it within their own control to choose in the first
place whatever arrangements they care to make." Id.; accord
Spector, 641 F.2d at 381 ("Just as the Commissioner in determining
income tax liabilities may look through the form of a transaction
to its substance, so, as a general rule, may he bind a taxpayer to
the form in which the taxpayer has cast a transaction.") (citations
omitted). The court also addressed the issue of taxpayers who,
claiming to be unaware of the tax consequences of their agreement,
argue that they could not have consciously entered into the
agreement. The court held that even when "'[i]t is reasonably
clear that the sellers failed to give consideration to the tax
consequences of the provision, . . . where parties enter into an
agreement with a clear understanding of its substance and content,
they cannot be heard to say later that they overlooked possible tax
6
consequences.'" Danielson, 378 F.2d at 778 (quoting Hamlin's Trust
v. Commissioner, 209 F.2d 761, 765 (10th Cir. 1954)).
Finally, the court raised sound policy reasons to hold parties
to their agreements. First, it noted that the tax consequences of
a transaction are often taken into account in determining the
purchase price. Danielson, 378 F.2d at 775. To allow one party to
recharacterize a transaction at a later date to achieve favorable
tax advantages would be tantamount to granting that party "a
unilateral reformation of the contract with a resulting unjust
enrichment." Id. Second, the court concluded that sanctioning
such recharacterization would "nullify the reasonably predictable
tax consequences of the agreement." Id. Third, the court found
that to permit this type of attack "would cause the Commissioner
considerable problems in the collection of taxes[, because] [t]he
Commissioner would not be able to accept taxpayers' agreements at
face value." Id.
This court faced a similar recharacterization issue in
Spector. There the court had to determine "whether a transaction
in which taxpayer surrendered his partnership interest in an
accounting firm in exchange for a specified sum constitutes a
'sale' of his partnership interest, thus creating long term capital
gain under [I.R.C. §] 741 . . ., or whether the transaction was a
'liquidation' of taxpayer's interest under section 707(c), thus
producing ordinary income gain under section 736(a)(2)." 641 F.2d
at 377-78. The parties to the transaction had structured it as a
liquidation, and the evidence revealed that the amount of the
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withdrawing partner's settlement was calculated with the
expectation that the parties would elect to treat the transaction
as a liquidation. Reviewing the taxpayer's decision to treat the
transaction as a sale producing a capital gain, the Tax Court
concluded that the taxpayer could disavow the form of the
transaction on a showing that, as structured, it did not comport
with economic reality. This court, however, adopted the Danielson
rule and reversed and remanded. Id. at 386.
Utley v. Commissioner, 906 F.2d 1033 (5th Cir. 1990) (per
curiam), reached the same result. In that case, the taxpayers sold
property to a corporation in which they were the sole shareholders.
As an installment sale, the taxpayers were required to report
capital gains. However, had the parties characterized the
transaction as a contribution to capital, the transfer would have
been a non-recognition event under I.R.C. § 351. This court
rejected the taxpayers' attempt to claim that the transfer was not
really a sale but a contribution and concluded that despite the
lack of evidence indicating that the transaction was in reality an
installment sale, the taxpayers were held to the form of
transaction originally chosen. Id. at 1038-39.
Danielson, Spector, and Utley stand for the proposition that
a taxpayer cannot recast its transaction and reap the resulting
benefits. This principle and the policies that underlie it apply
in this case. Insilco could have structured the transaction as a
sale of stock in exchange for cash and stock; indeed, that is how
the parties originally structured the transaction. Nonetheless,
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the parties ultimately chose to structure the transaction as
separate purchases and sales. Some six years later, now that it
has no remaining financial interest in LPL, Insilco cannot change
its mind. LPL anticipated that § 338 would apply to step up the
basis in Times Fiber's assets. To allow recharacterization would
effectively permit Insilco to unilaterally reform the contract,
contrary to the teachings of Danielson.
B.
Insilco argues that the Danielson rule does not apply in this
case because §§ 304 and 351 are mandatory. In other words, Insilco
claims that it made a mistake of law that it is now seeking to
correct and that it is not seeking to recast the facts of its
transaction. This argument is without merit.
1.
Section 304 provides that when a person who is in control of
two corporations sells the stock of one corporation to the other
corporation, the proceeds of the sale shall be considered a
distribution and the acquired stock shall be considered a
contribution to capital. In order for § 304 to apply, the
transferor (Insilco) must be in control of both corporations (Times
Fiber and LPL) before the stock transfer. See Treas. Reg. § 1.304-
2(a). Insilco was in control of Times Fiber before the transfer.
See I.R.C. § 304(c)(1). It argues that it also had actual control
of LPL before the transfer pursuant to § 304(c)(2)(A), which
provides that
[w]here 1 or more persons in control of the issuing
corporation [Times Fiber] transfer stock of such corporation
9
in exchange for stock of the acquiring corporation [LPL], the
stock of the acquiring corporation received shall be taken
into account in determining whether such person or persons are
in control of the acquiring corporation.
As LPL and Insilco structured the transaction, Insilco received $96
million when it transferred the Times Fiber stock to LPL; it did
not receive any LPL stock. Nor did Insilco acquire LPL shares of
stock by transferring its shares of Times Fiber. In short, the
transaction was structured as purchases and sales of stock for
cash, not as an exchange of stock for stock. To achieve a result
that fits within § 304 requires that we recharacterize the
transaction, which is precluded by Danielson.
Insilco attempts to avoid recharacterization arguments by
claiming that it had constructive ownership of LPL before the
transactions. A person constructively owns stock if that person
has an option to acquire the stock. I.R.C. § 318(a)(4). "[T]o
qualify as an option, the holder must have the right to obtain the
stock at his election. . . . [with] no contingencies with respect
to such election." Rev. Rul. 68-601, 1968-2 C.B. 124 (defining
when a warrant is an option). Insilco claims that it had an option
to purchase a controlling portion of LPL stock because on December
31, 1985, it had the unconditional right to acquire one hundred
percent of the LPL preferred stock, the aggregate value of which
represented over fifty percent of the total value of all classes of
LPL stock.
Insilco did not make this argument to the bankruptcy court,
and we need not consider it. Insilco claims its failure to make
the specific constructive ownership argument to the bankruptcy
10
court should not preclude this court from considering the issue
because it has always maintained that § 304 applied and § 304(c)
refers to § 318, the constructive ownership provision. However,
Insilco had to advance its option argument before the bankruptcy
court. Instead, the first time Insilco raised this argument was in
its reply brief to the district court on appeal from the bankruptcy
court's order. The district court did not mention the issue in its
affirmance, and we need not consider issues raised for the first
time on appeal. See First Colonial Corp. of Am. v. American
Benefit Life Ins. Co. (In re First Colonial Corp. of Am.), 693 F.2d
447, 449-50 n.5 (5th Cir. 1982), cert. denied, 461 U.S. 915 (1983);
see also Texas v. United States, 730 F.2d 339, 358 n.35 (5th Cir.)
(stating that the determination of whether to consider an issue not
raised below is within the discretion of the court and should be
decided on a case-by-case basis), cert. denied, 469 U.S. 892
(1984). In any event, the contract to purchase the preferred
shares cannot be considered an unconditional option because
Insilco's agreement to purchase $20 million worth of LPL preferred
shares was conditioned on other transactions, most notably
Insilco's agreement to sell its Times Fiber shares to LPL and the
merger of Times Fiber into LPL.
2.
Insilco also argues that § 351 is mandatory and, therefore,
applicable to the LPL transaction. Section 351(a) provides that
"[n]o gain or loss shall be recognized if property is transferred
to a corporation by one or more persons solely in exchange for
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stock or securities in such corporation and immediately after the
exchange such person or persons are in control . . . of the
corporation." As with § 304, Insilco's argument hinges on its
characterization of the transaction as an exchange of Times Fiber
stock for LPL stock and cash. While surely related, the distinct
transactions involving Insilco, LPL, Times Fiber's shareholders,
and other investors were simply not structured as an exchange.
Insilco's attempt to say otherwise is not permitted. See
Danielson, 378 F.2d at 775.
III.
For the foregoing reasons, the judgment of the district court
is AFFIRMED.
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