Judgment summary
The United States Tax Court considered whether an arrangement among Aventis, Inc. (petitioner), its French affiliate Sanofi-Aventis Amerique du Nord S.A. (SAAN), Dynamo Investments, Inc. (Dynamo), and Chase Manhattan Bank (Chase) qualified as a valid financial asset securitization investment trust (FASIT) under sections 860H to 860L of the Internal Revenue Code for the 2008 to 2011 tax years.
The court held that the Series A/E Stock issued to SAAN was not a valid regular interest of a FASIT. It did not unconditionally entitle SAAN to a specified principal amount and it did not entitle SAAN to interest payments based on a fixed rate or permitted variable rate.
The court held that even if the stock had been a valid regular interest at inception, it would have ceased to be one in the latter half of 2000 because of the allocation of money market account income, and in 2003 because of Chase's withdrawal. Aventis also failed to meet the grandfather provision enacted when the FASIT rules were repealed in 2004.
The court held that the substantial compliance doctrine did not apply because the statutory requirements were essential rather than procedural or directory. It also held that Aventis was the beneficial owner of the assets and had to recognise the interest income generated by them. Finally, the court held that the Series A/E Stock was in substance equity, so the amounts paid to SAAN as dividends were not deductible as business interest.
Decision was entered for respondent.
Background
Aventis, Inc. was during the years in issue a Pennsylvania corporation and an indirect subsidiary of its French parent Sanofi, S.A. It was the common U.S. parent of an affiliated group carrying out Sanofi's North American operations and filed consolidated federal income tax returns. Its principal place of business was New Jersey when it filed its Petition.
Sanofi sought to expand its North American operations in the late 1990s and 2000s and needed liquid financing. In April 1999 Babcock & Brown, Inc., an investment banking firm, presented petitioner with a proposal to use a FASIT to securitize certain intercompany loans, which would allow petitioner to meet financing needs and obtain tax benefits from differing tax treatment between the United States and foreign jurisdictions. Petitioner paid Babcock & Brown an upfront fee of $970,000 to implement the arrangement.
On 21 July 2000 the FASIT was created when RPR (petitioner), SAAN, BBH, Chase, and Dynamo entered into an Amended and Restated Asset Management Agreement (2000 AMA). Petitioner designated a segregated pool of $571 million in intercompany loans as the initial FASIT assets. Petitioner issued three FASIT interests: a Class I Note to Dynamo for $500,000 designated the ownership interest, a Class II Note to Chase for $11.5 million designated a regular interest, and Series A/E Stock to SAAN for $559,500,000 designated a regular interest.
The FASIT rules of sections 860H to 860L were repealed by the American Jobs Creation Act of 2004, effective 1 January 2005, subject to a grandfather provision for FASITs in existence on 22 October 2004 whose regular interests remained outstanding in accordance with their original terms. Petitioner's purported FASIT remained in place through 2015.
Core dispute
Respondent determined deficiencies in petitioner's federal income tax for the 2008 to 2011 tax years. Respondent disregarded the FASIT because the requirement that all interests be either the ownership interest or a regular interest was not met, and allocated the income generated by the FASIT assets to petitioner.
The issues for consideration were whether the arrangement qualified as a valid FASIT under sections 860H to 860L, and, if it was not a FASIT, whether petitioner substantially complied with the FASIT rules, whether petitioner should be treated as the beneficial owner of the assets, and whether the interest held by SAAN was debt or equity.
Petitioner contended the arrangement was a valid FASIT for the years in issue. Respondent contended it was invalid from its inception in 2000.
Court findings
The court found the Series A/E Stock was not a valid regular interest from inception. It had no principal amount, and the liquidation preference was contingent on the fair market value of the FASIT assets and the fees and expenses of managing them, so it did not unconditionally entitle SAAN to receive the original issue price of $1,998,214 per share or a specified amount [Opinion Part II.A.2].
The court found the Series A/E Stock did not entitle its holder to payments based on a fixed rate or a permitted variable rate. Dividends were payable at the discretion of petitioner's board of directors, were cumulative, and were not calculated using a fixed rate, and the holder had no mechanism to enforce declaration of a dividend [Opinion Part II.A.3].
The court found that even if the stock had been valid at inception, it ceased to be a valid regular interest in the latter half of 2000 because petitioner used a pro rata approach to allocate money market account income, giving the Series A/E Stock more than the weighted average, and in 2003 because after Chase's withdrawal the Additional Interest formula was not updated in writing, resulting in payments to the Series A/E Stock that were not based on a weighted average rate [Opinion Part II.B].
The court found petitioner failed to meet the grandfather provision. The parties did not provide the required written notice of extension by 15 October 2004 and instead waived the 90-day notice requirement by letter agreement dated 14 January 2005, so the regular interests were no longer outstanding in accordance with their original terms [Opinion Part II.B.3].
The court found the substantial compliance doctrine did not apply because the FASIT requirements were essential statutory requirements, in the conjunctive, rather than procedural or directory requirements [Opinion Part III].
The court found petitioner failed to show that it was not the beneficial owner of the assets. Petitioner held legal title to the intercompany receivables, could replace the assets without investor consent, and had legal recourse against debtors. Applying the relevant factors, the court concluded petitioner was the beneficial owner [Opinion Part IV].
The court found the Series A/E Stock was in substance equity. Reviewing the sixteen Fin Hay factors, 11 factors favoured equity and the intent of the parties clearly favoured equity [Opinion Part V].
Outcome
The court held that petitioner had not established that the arrangement was a valid FASIT for the years in issue, that the substantial compliance doctrine did not apply to section 860L(b)(1), and that petitioner had not shown it was not the beneficial owner of the FASIT assets. Petitioner had to recognise the interest income generated by the FASIT assets. The Series A/E Stock was in substance equity, so petitioner could not deduct amounts paid as dividends to SAAN as interest payments. Decision was entered for respondent.
The deficiencies determined were $10,469,002 for 2008, $9,331,096 for 2009, $9,338,611 for 2010, and $9,330,260 for 2011.
Major issues / areas of contention
- Whether the arrangement among petitioner, SAAN, Dynamo, and Chase qualified as a valid FASIT under sections 860H to 860L.
- Whether the Series A/E Stock met the statutory requirements of a regular interest, in particular unconditional entitlement to a specified principal amount and payments based on a fixed or permitted variable rate.
- Whether the allocation of money market account income and the changes following Chase's withdrawal caused the arrangement to cease to be a valid FASIT.
- Whether petitioner met the requirements of the grandfather provision enacted on repeal of the FASIT rules in 2004.
- Whether the substantial compliance doctrine could excuse petitioner's failure to strictly comply with the FASIT statutory requirements.
- Whether petitioner was the beneficial owner of the FASIT assets and had to recognise the interest income they generated.
- Whether the Series A/E Stock held by SAAN was debt or equity for federal income tax purposes.