The following article is adapted from reprinted from the M&A Tax Report, Vol. 8, No. 1, August 1999, Panel Publishers, New York, NY.
POPE & TALBOT'S LAST GASP
By Robert W. Wood, San Francisco
M&A Tax Report readers may well recall that we have covered the issue in the Pope & Talbot case a few times before. Our coverage goes way back to April of 1997, and even before that, to June of 1995. See Wood, "Investment Banker Bees Held Deductible in Pope & Talbot," 5 M&A Tax Report (April 1997), p. 1; and Wood, "Taxable Spinoffs May Now Carry Greater Tax Liabilities," Vol. 3, No. 11, M&A Tax Report (June 1995), p. 6. There have been a smattering of articles about it and related cases since.
In the first iteration of the Pope & Talbot case, 104 T.C. 574 (1995), the facts unfolded. The taxpayer was a publicly held corporation in the timber, land development and resort businesses in Washington state. In October of 1995, the board directors and shareholders adopted a plan of distribution calling for the transfer of assets of certain businesses to Pope Resources, a newly formed limited partnership. The partnership had two Delaware corporations as managing general partner and standby general partner, respectively.
These two corporate partners were initially owned equally by two of the principal shareholders. Under the plan, one corporation was to receive partnership units when Pope & Talbot transferred the Washington properties to the partnership. This corporate general partner was then to make a pro rata distribution of partnership units to the Pope & Talbot shareholders.
Like most tax cases, the actual transactions examined go far back into the mid-1980s. In late 1985, pursuant to the plan, Pope & Talbot transferred its Washington timberlands to the partnership subject to a substantial and newly-acquired loan. Also transferred were the land development and resort businesses, and $1.5 million in cash. Pursuant to the plan, the general partner issued partnership units to each record holder of Pope & Talbot stock, with each shareholder receiving one partnership unit for every five shares of common stock held.
The big issue was how to value the property that was distributed. The distribution was clearly taxable, since the common shareholders of Pope & Talbot wound up receiving partnership interests in a partnership holding some of the assets that were previously held by the company. The question was how much the partnership units were worth.
The taxpayer argued that the fair market value of the property should be determined by reference to the value of the partnership units received by each shareholder. In contrast, the IRS argued that Section 311(d) required the fair market value of the property that was distributed to be determined as if the property had been sold in its entirety. (For full discussion on this issue, see Wood, "Taxable Spinoffs May Now Carry Greater Tax Liabilities," Vol. 3, No. 11 M&A Tax Report (June 1995), p. 6.)
After weighing the statutory language of Section 311(d)—which was relied on by both parties—and reviewing the legislative history, the Tax Court concluded that the corporation could not avoid tax on any inherent gain by distributing property to its shareholders. After a lengthy diatribe about the meaning of the legislative history, the court held that the taxpayer's gain on the distribution of the properties had to be determined as if the taxpayer had sold its interest in the properties at their fair market value on the date of the distributions.
The Tax Court next rendered its decision in Pope & Talbot, Inc., et al. v. Commissioner, T.C. Memo 1997-116 (1997). This Pope & Talbot case considers primarily our old friend, INDOPCO, and the cost of an investment banker hired to render advice concerning potential hostile takeovers. No such takeover was ever consummated—or even threatened. In fact, the costs in question related to the usual items: legal, accounting, investment banking, and other fees relating to the formation of the partnership, the transfer of the Washington properties, and the distribution of the partnership units. The taxpayer agreed that these expenses were capital in nature, and were therefore not deductible under Section 162. However, the taxpayer argued that these were sales expenses and could therefore be used to offset its gain on the taxable distribution. The court found that the sales were capital expenditures and could not be used to offset them.
In addition, reverting back to the first case, the Tax Court calculated the fair market value of the distributed property by determining what a willing buyer would pay in a hypothetical sale of the property on the date of the distribution. See T.C. Memo 1997-116 (1997).
On appeal in the Ninth Circuit, the taxpayer challenged the methodology by which the Tax Court valued the distribution of properties, and challenged the value placed on those properties as well (valuation methodology and value being at least technically distinct). See Pope & Talbot, Inc. v. Commissioner, 162 F.3d 1256 (9th Cir. 1999). The Ninth Circuit disagreed with all of the taxpayer's arguments, concluding that the property distributed by the corporation had to be valued as if the taxpayer had sold the property at the time of the distribution.
Turning to the actual valuation of the distributed properties, the Ninth Circuit made a prescient finding in rejecting the notion that the market price of securities (here, limited partnership units) accurately reflected the value of the underlying assets. The court noted that the partnership units received by the shareholders were fractional parts of a whole, and that a reduction equivalent to a fractional interest discount was appropriate in valuing them. The limited partnership interests here were newly minted, and thus difficult to value.
Plus, the Ninth Circuit expressly stated that sales of individual limited partnership units would not accurately reflect the value of the underlying properties. The Ninth Circuit ruled that the Tax Court properly relied on expert appraisals and other valuation evidence (other than the partnership unit prices set by market forces). The Ninth Circuit thus upheld the Tax Court's valuation methods.
Form & Substance
The Pope & Talbot case may be just another decision to wend its way through the Tax Court (twice) and the Court of Appeals. Yet, for those few of us still interested in the pre-General Utilities repeal version of Subchapter C, it could be an important case. Even for all the rest of us, it is an important case about valuation, one that both corporate planners and estate planners alike may be able to employ.
Indeed, by clever interposition of a partnership, Pope & Talbot, Inc. managed to "distribute" a parcel of appreciated property (timberland) to its shareholders. Those shareholders received a distribution, not of timberland, but of partnership interests. In form, Pope & Talbot transferred the timberland to a partnership controlled by Pope & Talbot shareholders, and the partnership simultaneously issued partnership units pro-rata to the Pope & Talbot shareholders. No one disputed that the transaction amounted to the distribution of a dividend to the Pope & Talbot shareholders. The issue was the proper computation of Pope & Talbot's section 311(b) gain.
The IRS argued that Pope & Talbot distributed timberland. Pope & Talbot argued that it must have distributed partnership interests, because that was unquestionably what the shareholders received. Thus at odds, the IRS set about valuing the timberland, while the taxpayer argued that it merely had to multiply the number of publicly traded partnership interests received by the shareholders by the price per unit set by the market on which they were trading. Valuation details aside, the Ninth Circuit confirmed the IRS's position that Pope & Talbot distributed timberland, which was received by the distributee shareholders as partnership units.
Even in a losing case, it would seem that there may be a grain (or in this instance, perhaps a toothpick) of wisdom.
Pope & Talbot's Last Gasp, Vol. 8, No. 1, M&A Tax Report (August 1999), p. 1.