Third Circuit: Share Redemption Payment Had Unstated Interest Under Sec. 483

(Parker Tax Publishing December 2025)

The Third Circuit affirmed the Tax Court and held that a $191 million payment to a trust for its shares in a corporation, which merged with another corporation to extinguish the trust's interest, had unstated interest taxable as ordinary income under Code Sec. 483. The court found that the payment, which was made in 2002 after a lawsuit brought by the trust was settled, had no stated interest and was paid "under" the merger agreement executed in 1999, and the merger agreement was a contract for the sale or exchange of the trust's shares. Berwind v. Comm'r, 2025 PTC 362 (3d Cir. 2025).

Background

Founded in 1883, the Berwind Corporation was a closely held coal mining business owned by Charles G. Berwind, Sr. In 1963, Charles established trusts for each of his four children, including Graham and David. Over time, Graham Berwind sought to consolidate the ownership of Berwind Corporation. By 1976, only two of the trusts continued to hold interests in the Berwind Corporation: the Graham Berwind Trust ("GB Trust") and the Charles G. Berwind Trust for David M. Berwind (the DB Trust).

In 1978, the Berwind Corporation acquired a separate company, Colorcon, Inc., which specialized in pharmaceutical coatings. The Berwind Corporation formed Berwind Pharmaceutical Services, Inc. (BPSI) as a vehicle to own Colorcon's common stock. From that point forward, many actions affecting corporate structure were taken, including (1) the elimination of the DB Trust's ownership interest in the Berwind Corporation and (2) the transfer of part of the GB Trust's BPSI interests to trusts held by Graham Berwind's children. In 1990, the GB Trust and the trusts held by his children contributed their interests in the Berwind Corporation and BPSI to a separate corporate entity, Berwind Group Partners. The DB Trust held no interest in Berwind Group Partners but continued to have an ownership interest in BPSI.

Beginning in the 1990s, Berwind Group Partners sought to acquire or redeem the DB Trust's ownership interest in BPSI. After the DB Trust rejected multiple offers, the effort to eliminate the DB Trust's shares escalated. Under Pennsylvania law, a parent corporation can merge with its 80-percent owned subsidiary without a vote by the subsidiary's shareholders (i.e., a short-form merger). In August 1999, the President of Berwind Corporation sent a letter to the DB Trust stating that BPSI hoped to negotiate a mutually satisfactory purchase but, if not, it was prepared to execute a short-form merger that would result in Berwind Group Partners' ownership of 100 percent of BPSI.

In November 1999, concerned that the DB Trust would be deprived of its stake in BPSI, four of its trustees filed a lawsuit against the Berwind Corporation, Berwind Group Partners, BPSI's directors and Graham Berwind (the Warden litigation). On December 15, 1999, despite the Warden lawsuit, Berwind Group Partners and the Berwind Corporation effectuated a short-form merger between BPSI and a newly created parent company, BPSI Acquisition. The Merger Agreement provided that at the time of the merger, (1) each share of BPSI Acquisition common stock would be converted into one share of BPSI common stock; (2) shares of BPSI common stock owned by BPSI would be cancelled; and (3) any remaining shares of BPSI common (i.e., those held by DB Trust) would be converted into the right to receive a promissory note valued at $82,820,000, due in a single payment two years later, on December 15, 2001, with interest accruing at 10 percent.

The Merger Agreement was executed by one officer from BPSI Acquisition and one officer from BPSI. As a minority shareholder of BPSI, the DB Trust was not entitled to vote on the Merger Agreement. On December 16, 1999, BPSI filed the articles of merger and the Merger Agreement with the Pennsylvania Secretary of State. After several months of negotiation, the Warden litigation was settled in November 2002 (the Settlement Agreement). The Settlement Agreement required the DB Trust to deliver in escrow, among other items, its BPSI stock certificates and a stipulation of dismissal for the Warden litigation. In exchange, BPSI agreed to pay the DB Trust $191,000,000 (the Settlement Amount), also held in escrow and later released on December 31, 2002.

A tax dispute remained following the settlement. Code Sec. 483 imputes interest to a payment when, among other things, the payment is "under [a] contract for the sale or exchange of any property," and when the contract provides for deferred payments, as to which there is "unstated interest." In BPSI's view, the Settlement Amount was a deferred payment for the purchase of the DB Trust's shares in BPSI "under" the Merger Agreement in 1999 for purposes of Code Sec. 483(a)(1). According to BPSI, the 2002 Settlement Agreement only had the effect of determining the share price for purposes of that agreement. This position meant that the DB Trust would be stuck with characterizing part of the Settlement Amount as interest, and thus, income to the DB Trust for tax purposes. The DB Trust unsurprisingly took the position that the Settlement Amount was a payment "under" the 2002 Settlement Agreement and that its shares were sold at that time. This position meant that no portion of the Settlement Amount would be characterized as interest, and hence, it would be wholly taxed as capital gains earned by the DB Trust. This tax dispute was foreseen by the parties at the time of settlement and the parties prepared their taxes for 2002 according to their respective positions.

The IRS audited both returns and issued deficiency notices to both BPSI and the DB Trust. The deficiency notices sent to the DB Trust and its beneficiaries determined that part of the Settlement Amount represented unstated interest income and under Code Sec. 483 was taxable as ordinary income. The DB Trust took its case to the Tax Court. In Berwind v. Comm'r, T.C. Memo. 2023-146, the Tax Court ruled for the IRS and held that the December 16, 1999 merger constituted a sale of the DB Trust' shares for purposes of Code Sec. 483. The court held that DB Trust was liable for taxes owed on approximately $31 million of ordinary income that the court deemed was the interest portion of the $191 million Settlement Amount. The DB Trust and its beneficiaries appealed to the Third Circuit.

The government contended that the $191 million payment, made in 2002, was made "under" the 1999 Merger Agreement because that instrument extinguished the DB Trust's shares and obligated BPSI to pay a redemption price for those shares. The DB Trust disagreed, making two arguments in response. First, it asserted that BPSI made the $191 million payment "under" the 2002 Settlement Agreement because that was the instrument "that expressly provided for the payment in redemption of the Trust's BPSI stock." This was in essence an argument that the sale took place in 2002. Second, DB Trust contended that even if the Settlement Amount were a deferred payment made for a 1999 sale or exchange, the 1999 Merger Agreement was not a "contract" capable of triggering Code Sec. 483 because DB Trust did not assent to the merger.

Analysis

The Third Circuit affirmed the Tax Court and held that Code Sec. 483 applied to the $191 million payment. In sum, the court found that the payment had no stated interest and was (1) paid in 2002 "under" the 1999 Merger Agreement, which (2) was a contract for the sale or exchange of the DB Trust's shares in 1999.

The court found that under Pennsylvania law, the merger of BPSI with BPSI was effective on December 16, 1999, when the articles of merger were filed with the Pennsylvania Secretary of State. The merger agreement, the court observed, stated that the DB Trust's preferential shares would be redeemed for $1 per share. The court rejected DB Trust's assertion that the Merger Agreement was not a contract, finding that the agreement was executed by BPSI Acquisition and BPSI and was approved by both corporations' boards of directors. Accordingly, the court concluded that there were two assenting parties to the merger. The court said that on December 16, 1999, the Merger Agreement effected the sale of the DB Trust's shares and mandated a payment in exchange for that redemption. The court said that this enforceable agreement - assented to by two parties and recognized by law - constituted a contract and the DB Trust's common shares were sold pursuant to that contract.

Next, the court found that the $191 million settlement amount was made "under" the 1999 Merger Agreement. Code Sec. 483(c) states, in part, that it applies "to any payment on account of the sale or exchange of property." This language, the court found, signals that Code Sec. 483 applies when the payment is "on account of the [contracted] sale." The court thus held that, for purposes of Code Sec. 483, a payment is "under" a contract when the contract serves as the basis for, or authorizes, the sale of property. The court reasoned that the Merger Agreement served as the basis for the payment of the DB Trust's shares because it was the instrument that effected the sale of the shares and mandated payment for those shares. The court also found that the 2002 Settlement Amount paid "for" the DB Trust's shares because it fulfilled BPSI's obligation to compensate the DB Trust for its shares.

For a discussion of the unstated interest rule, see Parker Tax ¶244,575.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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