Another Leveraged Partnership
Another leveraged partnership has come under attack.
Such transactions are sometimes used by sellers of assets to defer a tax on gain. Rather than make a direct sale, the seller and buyer both contribute assets to a partnership. The seller contributes the assets it intends to sell. In this particular case, the buyer contributed notes and cash for the purchase price. The partnership then borrowed the amount of the notes from a bank and distributed the amount to the seller.
The seller does not have to pay tax on the cash distribution as long as the distribution is not recast by the IRS as purchase price for a disguised sale of the assets to the partnership. It should not be as long as the seller is ultimately liable for the partnership-level debt.
Two special-purpose subsidiaries through which the buyer held its interest in the partnership guaranteed repayment of the loan. The seller agreed to indemnify the buyer’s subsidiaries if they had to pay on the guarantee. However, there was no requirement in the indemnity for the seller to maintain any particular net worth.
The IRS has challenged the transaction on audit. The IRS national office rejected the idea in an internal memo that the seller is ultimately on the hook for the partnership-level debt because no payments have to be made on the indemnity unless the buyer has had first to pay out on the guarantee. If the transaction runs into trouble, then the buyer would default on the guarantee, and the seller would not have to make a payment, the IRS said.
The IRS also does not believe that the seller should get a pass as a policy matter on re-characterization of the transaction as a disguised sale. Congress intended that these sorts of transactions would not be recast as disguised sales, the IRS said, only where a partner contributes to a partnership property that is already subject to debt and then receives a cash distribution or else the partnership borrows against the assets after the contribution to make the cash distribution. The IRS said the borrowing in this case is nothing more than an advance against the notes from the buyer.
The national office suggested that if its technical arguments fail, then the audit team should attack the transaction head on, either by recasting it as a borrowing by the buyer to buy the assets followed by formation of the partnership or by arguing that the transaction is in reality a sale.
The facts appear to match a transaction that the Tribune Co. did when it sold Newsday in 2008 in the hope of deferring tax on the gain for 10 years. It did a similar transaction in 2009 when it sold the Chicago Cubs. The IRS wants $190 million in back taxes on the Newsday sale plus a $38 million penalty and $17 million in interest through December 2012. The Tribune Co. said in a financial filing that it plans to take the case to IRS appeals. It is currently under audit in the Cubs transaction. The company warned that it could be liable for another $225 million in federal and state income taxes on the Cubs deal before penalties and interest.
The internal IRS memo is Chief Counsel Advice 201304013. The IRS released a redacted version in June.
The US Tax Court treated a similar transaction as a sale in 2010 after Chesapeake Corporation — now called Canal Corporation — conveyed the assets of a subsidiary that made paper products to Georgia Pacific using a leveraged partnership. See earlier coverage about the structure in the September 2010 NewsWire starting on page 17 and a “Special Update: Tax Issues in Project Sales” in June 2004.