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Owner of Fast Food Restaurants Can't Revise Merger Transaction After Deal Closes

(Parker Tax Publishing October 2017)

The Third Circuit affirmed the Tax Court and held that the owner of a number of fast food restaurants that entered into a merger deal could not restructure the transaction to obtain better tax results after the deal closed. The court cited the Danielson rule in holding that, absent proof of mistake, fraud, undue influence, duress, or the like, which would be recognizable under local law in a dispute between the parties to an agreement, a taxpayer generally will be held to the terms or form of an agreement entered into. Tseytin v. Comm'r, 2017 PTC 387 (3d Cir. 2017).


Michael Tseytin was the primary shareholder in a New Jersey corporation, U.S. Strategies, Inc. (USSI), whose business involved owning and operating two Russian LLCs that in turn owned and operated most of Russia's Kentucky Fried Chicken (KFC) and Pizza Hut restaurants. Tseytin owned 75 percent of USSI's shares. The remaining 25 percent was owned by a company named Archer Consulting Corporation.

The two corporations wanted to enter into a merger with AmRest Holdings, NV, a Netherlands corporation also involved in the fast-food business. It owned KFCs, Pizza Huts, and other fast-food restaurants in Eastern Europe, Central Europe, Germany, France, and Spain. In May 2007, all the relevant players substantively agreed to the merger in two separate written agreements. The first agreement was between Tseytin and Archer, wherein Tseytin agreed to purchase for his own account Archer's 25 percent stake in USSI. At closing on June 14 at Archer's offices in Moscow, Archer was to transfer the shares to Tseytin and then, at some time in the next month, Tseytin would make a "deferred" purchase payment to Archer, prior to July 31st.

The second agreement (the Merger Agreement), was signed by Tseytin, USSI, and AmRest - but not Archer - and stated that at closing in Warsaw the following would occur: (1) Tseytin would ensure that he was the "record" owner of 100 percent of the USSI stock, "free and clear of any restrictions"; (2) Tseytin would transfer 100 percent of USSI's shares to AmRest; and (3) AmRest would transfer cash and AmRest stock to Tseytin as compensation.

The transaction went through as planned. On June 14, Tseytin and Archer closed on their agreement and Archer transferred its USSI stock to Tseytin. On July 2, the USSI - AmRest merger closed, and Tseytin transferred all the USSI stock to AmRest. On July 3, AmRest sent Tseytin $23,099,420 in cash and $30,791,390 in AmRest stock, for a total of nearly $54 million for all USSI shares. Then on July 5, Tseytin paid Archer $14 million for its 25 percent stake in USSI.

In two tax filings for the 2007 tax year, Tseytin took two different approaches to the transaction. In his original return, Tseytin reported tax liability of approximately $3,781,000 and paid that amount to the IRS. But, in 2009, he amended his return and reported a lower amount of liability, approximately $2,577,000, and requested a refund for the difference.

On audit and in a notice of deficiency, the IRS treated the Archer and non-Archer shares of USSI stock as owned by Tseytin and as separate blocks of stock with identifiable and different cost bases (as did Tseytin on his amended return). The IRS calculated the taxable amount or portion of the $23,099,420 total cash received on the merger using the total $54 million merger consideration - not just the $23,099,420 total cash received (as Tseytin had done on his amended return). As a result of the IRS's calculations, the amount of Tseytin's long-term capital gain realized on the transfer of the non-Archer shares increased to approximately $40,418,000 and the entire $17,324,565 (i.e., 75% of the total cash received allocable to the non-Archer shares ($23,099,420)) was charged or taxed to Tseytin as long-term capital gain.

Relying on the loss disallowance rule of Code Sec. 356(c), the IRS did not allow a $527,297 short-term capital loss realized on the Archer shares to reduce or to be netted against the $40,418,000 long-term capital gain realized on the non-Archer shares or to reduce the $17,324,565 portion of the cash boot to be recognized and taxed. Code Sec. 356 (c) provides that if (1) Code Sec. 354 would apply to an exchange or Code Sec. 355 would apply to an exchange or distribution, but for the fact that (2) the property received in the exchange or distribution consists not only of property permitted by Code Sec. 354 or Code Sec. 355 to be received without the recognition of gain or loss, but also of other property or money, then no loss from the exchange or distribution is recognized. As a result of the IRS calculations, the IRS determined that Tseytin had a total 2007 federal income tax liability of $3,811,000 - a deficiency of $30,478 and a $6,095 accuracy-related penalty under Code Sec. 6662(a). Tseytin disagreed with these calculations and petitioned the Tax Court.

Tax Court's Decision

Before the Tax Court, Tseytin acknowledged that on his original 2007 federal income tax return the 1,000 shares of USSI stock were incorrectly treated as a single block of stock, and he agreed that (as reflected on his amended return) those shares of stock consisted of two separate blocks of stock.

With regard to the Archer shares, Tseytin made two arguments. First, in transferring the Archer shares to AmRest, Tseytin said he acted only as a nominee or agent for Archer, that he never owned the Archer shares, and that the Tax Court should treat the Archer shares as either sold directly by Archer to AmRest or as redeemed by USSI or by AmRest from Archer. According to his argument, Tseytin would treat $14 million (the amount paid to Archer for the Archer shares) of the $23,099,420 total cash consideration received from AmRest as not received by him, but rather as received by and taxable to Archer.

Second, in the alternative and if he was to be treated as the owner of the Archer shares on their transfer to AmRest, Tseytin argued that he should be allowed to subtract the $527,297 short-term capital loss realized on the transfer of the Archer shares from the $17,324,565 long-term gain to be recognized and taxed as cash boot.

The Tax Court rejected Tseytin's argument and held for the IRS. In so doing, the court invoked the Danielson rule (Comm'r v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965)), which stands for the proposition that, absent proof of mistake, fraud, undue influence, duress, or the like, which would be recognizable under local law in a dispute between the parties to an agreement, a taxpayer generally will be held to the terms or form of an agreement entered into.

Tseytin appealed to the Third Circuit, raising two main issues with respect to his tax liability: (1) whether he owed tax for income he allegedly derived from Archer's shares, and (2) whether his "losses" could be subtracted from his overall gains.

Third Circuit Finds No Exception to Danielson Rule

The Third Circuit, also citing the Danielson rule, affirmed the Tax Court's decision and upheld the deficiency assessment by the IRS. The court noted that none of the Danielson exceptions applied. Tseytin was not arguing that he was defrauded into the transaction, for example. The contracts signed by the parties, the court observed, stated in explicit terms that Tseytin acquired ownership of Archer's stock (i.e., he purchased it for his own account before selling it to AmRest), and even though the shares were in his hands for only a brief period of time, he was the "record" owner, "free and clear of any restrictions." These terms, the court said, could hardly be clearer and, under Danielson, that was the end of the matter; no exception applied, the general rule governed, and, the court stated, Tseytin must bear the tax liability associated with owning all the USSI shares.

The court noted that Tseytin could have hypothetically structured the deal so that he never acquired formal ownership of Archer's shares. But because he did not, he can not benefit from an alternative route after the transaction. According to the court, Tseytin must bear the tax consequences of his business decisions, and his two blocks of stock were required to be analyzed as separate units and Code Sec. 356 applied.

For a discussion of the Danielson rule as it relates to the sale of a business, see Parker Tax ¶118,110.

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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