taxation research paper

TSEYTIN v. COMM., 120 AFTR 2d 2017-5539 (698 Fed. Appx. 720), Code Sec(s) 354; 356; 6662;

7491, (CA3), 08/18/2017

American Federal Tax Reports (Prior Years) (RIA)

American Federal Tax Reports

TSEYTIN v. COMM., Cite as 120 AFTR 2d 2017-5539 (698 Fed. Appx. 720), Code Sec(s) 356; 354; 6662; 7491, (CA3), 08/18/2017

Michael TSEYTIN; Ella TSEYTIN, APPELLANTS v. COMMISSIONER of Internal Revenue.

Case Information:

[pg. 2017-5539]

Code Sec(s): 356; 354, 6662; 7491

Court Name: U.S. Court of Appeals, Third Circuit,

Docket No.: No. 16-1674,

Date Decided: 08/18/2017.

Prior History: Tax Court, (2015) TC Memo 2015-247, RIA TC Memo ¶2015-247

(opinion by Swift, J.), affirmed in part and remanded in part.

Tax Year(s): Year 2007.

Disposition: Decision against Taxpayers in part.

Cites: 698 Fed. Appx. 720, 2017-2 USTC P 50,317.

HEADNOTE

1. Corp. reorgs.-cash boot- closely held corps.-share ownership; different blocks of stock; gain

and loss; basis-computations and allocation-married taxpayers. Tax Court properly determined that

pursuant to Danielson rule, taxpayer who originally owned 75% of shares in his Russian-operating fast

food co., was taxable on entire amount of proceeds of sale of co. that he made to outside party in

merger transaction after first acquiring other shareholder's 25% stake, so as to be able to sell entire

100% to outside party. Even though taxpayer remitted portion of proceeds to other/former shareholder,

since taxpayer was record owner of all shares free and clear of any restrictions at time of sale, he was

clearly taxable on entirety of same. Arguments about his lack of substantive ownership or that he didn't

benefit from effectively serving as go-between for other shareholder, such that Danielson rule wasn't

implicated in 1st place, were rejected accordingly. Alternative arguments that agency principles or New

York contract law otherwise meant taxpayer couldn't be held liable for other shareholder's tax burden,

and/or to treat all shares as single block of stock to which loss-recognition rule applied, were also

rejected. However, case was remanded for limited purpose of addressing issues relating to taxpayer's

wife, who, as parties agreed, had been erroneously held liable for taxpayer's deficiencies.

Reference(s): ¶ 3565.02(5) Code Sec. 356 ; Code Sec. 354

2. Accuracy-related negligence penalties-burden of proof and production-reasonable cause;

good faith. These issues weren't discussed on appeal.

Reference(s): ¶ 66,625.01(20) ; ¶ 74,915.03(5) Code Sec. 6662 ; Code Sec. 7491

OPINION

Frank Agostino, Esq. Lawrence A. Sannicandro, Jr., Esq. Agostino & Associates 14 Washington Place

The Bank House Hackensack, NJ 07601 Counsel for Appellants

David A. Hubbert, Acting Assistant Attorney General Regina S. Moriarty, Esq. Bridget M. Rowan, Esq.

United States Department of Justice Tax Division 950 Pennsylvania Avenue, N.W. P.O. Box 502

Washington, D.C. 20044 Counsel for Appellee

UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT,

Before: VANASKIE, KRAUSE, and RESTREPO, Circuit Judges

OPINION *

Judge: VANASKIE, Circuit Judge.

NOT PRECEDENTIAL

On Petition for Review of Order of the United States Tax Court (T.C. No. 354-12)

Tax Court Judge: Hon. Stephen J. Swift [pg. 2017-5540]

This tax appeal raises the classic tax issue of form versus substance. Appellant Michael Tseytin was the

primary shareholder in a company that owned most of Russia's Pizza Huts and KFCs. To sell the

company, he bought out his minority shareholder and then transferred all the company's

shares-including what he just purchased-to the buyer, an Eastern and Central European fast-food peer.

In effect, the deal meant Tseytin sold his majority stake and also acted as the go-between in the minority

shareholder's sale of its shares. But the IRS took the formalities of the deal literally, and taxed Tseytin on

the gain attributable to all the shares, even the gain on the shares purchased from the minority

shareholder.

Tseytin now argues he should not be taxed on stock he bought from the minority shareholder because

he never owned it and acted merely as an agent, and alternatively, if he must be taxed, he should be

permitted to recognize losses. We find neither argument meritorious because Tseytin must bear the tax

consequences of his business decisions, and Tseytin's two blocks of stock must be analyzed as

separate units to give content to I.R.C. § 356. A limited remand, however, is warranted, because the

parties agree that Appellant Ella Tseytin-Michael's wife-was held liable for her husband's tax bill in error.

We will remand so that the error with respect to Ella may be corrected, but otherwise affirm.

I.

This case centers on a two-company merger. The first company was Appellant Michael Tseytin's 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 KFC and Pizza Hut restaurants. Tseytin

owned 75% of USSI's shares. The remaining 25% were owned by a company named Archer Consulting

Corporation.

On the other side of the merger was 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% stake in USSI. (App. 123, 125.) 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. (App. 123.)

The second agreement, the Merger Agreement, was signed by Tseytin, USSI, and AmRest-but not

Archer-and stated that at closing in Warsaw (1) Tseytin would ensure that he was the "record" owner of

100% of the USSI stock, "free and clear of any restrictions"; (2) Tseytin would transfer 100% of USSI's

shares to AmRest; and (3) AmRest would transfer cash and AmRest stock to Tseytin as compensation.

(App. 152.)

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% 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 $3,780,522 and paid that amount to the IRS. But in 2009

he amended his return and reported a lower amount of liability, $2,577,182, and requested a refund for

the difference. The Commissioner audited Tseytin and found the original amount to be closer to correct.

The Commissioner denied Tseytin's request for a refund and ordered Tseytin to pay $30,478 in back

taxes and a $6,096 penalty. Tseytin then petitioned the Tax Court for a redetermination. The Tax Court

held for the Commissioner, and Tseytin timely appealed.

II.

The Tax Court had jurisdiction pursuant to 26 U.S.C. ("I.R.C.") § 6213 and § 7442. We have

jurisdiction to review decisions of the Tax Court under I.R.C. § 7482(a)(1). We review the Tax

Court's legal conclusions de novo and its factual findings for clear error. Crispin v. Comm'r, 708 F.3d

507, 514 [111 AFTR 2d 2013-829] (3d Cir. 2013).

III.

Tseytin raises two main issues as to his tax liability: (1) whether he owes tax for income he allegedly

derived from Archer's shares, and (2) whether his "losses" can be subtracted from his overall gains. [pg.

2017-5541]

A.

[1] First, Tseytin challenges the Commissioner's determination that he must pay tax on the $14 million

that he received from AmRest and remitted to Archer. The question is whether the form of the

transaction makes Tseytin liable for a gain on the 25% share of USSI stock that had been held by

Archer.

"[W]hile a taxpayer is free to organize his affairs as he chooses, ... once having done so, he must accept

the tax consequences of his choice, whether contemplated or not, and may not enjoy the benefit of

some other route he might have chosen to follow but did not." Comm'r v. Nat'l Alfalfa Dehydrating &

Milling Co. , 417 U.S. 134, 149 [33 AFTR 2d 74-1347] (1974) (citations omitted). A taxpayer who

falls within the scope of this rule-the "Danielson rule"-is stuck with the form of his business transaction,

and can make an argument that substance should prevail over that form only if a limited class of

exceptions applies, for example, if the taxpayer was fraudulently induced into the deal, or there has been

a material breach. Comm'r v. Danielson, 378 F.2d 771, 775 [19 AFTR 2d 1356] (3d Cir. 1967) (en

banc).

Here, Tseytin argues he was never the substantive owner of the Archer block of stock and therefore

should not be taxed on the $14 million portion of AmRest's payment that he passed to Archer. But none

of the Danielson exceptions apply-Tseytin does not argue he was defrauded into the transaction, for

example-and the contracts signed by the parties state in explicit terms that Tseytin acquired ownership

of Archer's stock: he "purchase[d]" it for his "own account" prior to 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." (App. 123, 125, 152.) These terms could hardly be clearer. Under Danielson, that is the

end of the matter; no exception applies, the general rule governs, and Tseytin must bear the tax liability

for owning all the USSI shares. Tseytin could have hypothetically structured the deal so that he never

acquired formal ownership of Archer's shares. But he did not, and may not benefit from an alternative

route now.

Tseytin puts forward four arguments in an attempt to escape this conclusion. First, he believes his

argument about substantive ownership falls outside the scope of the Danielson rule because he is

merely disputing how the contracts should be interpreted, and is not seeking to recharacterize the form

of the exchange. Tseytin is correct that Danielson's scope does not extend to a taxpayer's challenge to

the Commissioner's interpretation of a contract. Amerada Hess Corp. v. Comm'r , 517 F.2d 75,

85-86 [35 AFTR 2d 75-1536] (3d Cir. 1975). In Hess, for example, the Danielson rule did not prohibit a

taxpayer from challenging how a stock's fair-market value should be calculated under the terms of a

particular contract. Id. But even if Tseytin's argument could be characterized as involving contract

interpretation, the contracts here are unambiguous: Tseytin bought Archer's stock for his own account,

free and clear of any restrictions, and owned it prior to the sale to AmRest.

Second, Tseytin argues the Danielson rule should not apply because its background policies are not

implicated. According to Tseytin, the Danielson rule's purpose is to prevent a taxpayer from having her

cake and eating it too: a taxpayer must accept the bitter with the sweet and a deal's tax consequences

with its business benefits. Tseytin sees this tax-fairness policy not implicated here because in his view

he incurred no benefit from serving as Archer and AmRest's go-between-he never received any cake at

all. This argument has at least two fatal flaws. For one, Tseytin likely did benefit. By structuring the

merger so that he purchased Archer's stock for his own account prior to the sale to AmRest, Tseytin

made the overall merger simpler by ensuring that AmRest could deal with only one party. Greater

simplicity likely reduced the deal's transaction costs and litigation risk, increased the likelihood of the

deal actually closing, and perhaps caused AmRest to pay a higher price than it otherwise may have.

Second, even if Tseytin is right that the Danielson rule's background policies are not implicated here,

that is of no consequence, because rules must generally be enforced independently of their underlying

policies. That is after all the point of a bright-line rule like Danielson's: its clear-cut nature requires that

judges enforce it without wading into policy analysis, ensuring that the rule's application will be easy and

predictable. See Kathleen M. Sullivan, The Supreme Court, 1991 Term-Foreword: The Justices of Rules

and Standards, 106 Harv. L. Rev. 22, 58-59 (1992) (comparing the relative advantages and

disadvantages of bright-line rules and broader standards). Here, the Danielson rule's predictability would

be eviscerated if we held, as Tseytin would have us hold, that its application actually depends on

background tax-fairness policies. That would turn Danielson's bright-line rule into something other than a

bright-line rule. Tseytin also argues the Hess case supports the proposition that the Danielson rule is

already not enforced when it diverges [pg. 2017-5542] from its underlying purposes. That is not what the

Hess case held-as mentioned above, Hess did not purport to create new exceptions within Danielson 's

scope; it held that the Danielson rule does not "determine[] the appellants' burdens" when the appellant

"attack[s]" the Commissioner's interpretation of particular terms in a contract. Hess, 517 F.2d at 85-86,

n.38.

Third, Tseytin makes an agency argument: he was nothing more than Archer's agent in selling Archer's

block of stock, and agents are not liable for the tax burden of their principals. An agency relationship is

created through "manifestation by the principal to the agent that the agent may act on his account" and

the agent's "consent" to the undertaking. Restatement (Second) of Agency § 15 (Am. Law. Inst. 1958);

cf. Comm'r v. Bollinger, 485 U.S. 340, 349 [61 AFTR 2d 88-793] (1988) (citing the Restatement as

persuasive authority for agency principles in a tax case). Here, Tseytin argues he and Archer had an

agency relationship whereby his undertaking was to transfer Archer's shares to AmRest and remit to

Archer the $14 million payment. The problem is that the best available evidence-the written agreement

between Archer and Tseytin-strongly suggests there was no agency relation. The agreement states in

straightforward terms that Tseytin purchased Archer's shares for his own account. A gaping silence in

the agreement says even more: the contract does not mention an agency relationship in form or

substance, and none of the terms suggest Tseytin ever had an obligation to sell his newly-acquired

shares to AmRest or anyone else; for all the contract cared, Tseytin could have kept the stock for as

long as he wanted, as long as he paid Archer its $14 million. Tseytin did of course encumber himself

with an obligation to sell the Archer shares, but that obligation was to USSI and AmRest, not Archer, and

arose out of the separate Merger Agreement to which Archer was not a party. Tseytin's response is that

a principal-agent relationship can be inferred by the parties' conduct, and more specifically Archer and

Tseytin's informal agreement, made prior to the enactment of the two written agreements, to sell USSI

through Tseytin. See Nat'l Carbide Corp. v. Comm'r, 336 U.S. 433, [sic, 422] 436-38 [37 AFTR 834]

(1949) (examining the conduct of two companies, using six factors, to determine the existence of a

principal-agent relationship). But for us to rely on that pre-written-agreement conduct, we would have to

ignore the fact that Tseytin and Archer integrated their agreements. Their written agreement, wholly

lacking in any indication of an agency relation, states that it is "the entire agreement" and "supersedes

all prior and contemporaneous oral or written agreements with regard to such subject matter." (App.

126); see also Restatement (Second) of Contracts § 209, cmt. a (Am. Law Inst. 1981) ("An integrated

agreement supersedes contrary prior statements").

Finally, Tseytin argues his case can be saved by New York contract law. In New York, a party may

rescind a contract if (a) the party was induced to participate by fraud, or (b) there was a material breach.

Strand Bldg. Corp. v. Russell & Saxe, Inc., 232 N.Y.S.2d 384, 386 (N.Y. Super. Ct. 1962). Tseytin,

however, cites this line of case law to go much further, arguing that at the time Tseytin transferred

Archer's block of USSI shares to AmRest, Archer could have still hypothetically tried to rescind its

contract with Tseytin, because Tseytin had not yet paid Archer the $14 million. Tseytin says this

possibility of rescission means he only ever held "bare legal title" to Archer's shares, a property interest

insufficient to bear the burden of taxation on the $14 million portion of AmRest's payment. Keeping in

mind that nothing in the record indicates that Archer had a reason to justify a rescission, New York law

does not go nearly as far as Tseytin would like it to: nothing in the Strand case discusses the property

interest a person in Tseytin's shoes holds in his stock, whether it be "bare legal title" or something else,

and Strand does not address any tax issues, federal or otherwise. The New York rescission issue is little

more than a red herring.

In sum, Tseytin owned 100% of USSI's shares when he sold the company to AmRest for $54 million in

aggregate compensation. He must shoulder the tax burden for the entire payment-even the portion

associated with the $14 million he remitted to Archer.

B.

Tseytin next makes an argument in the alternative that if he must be taxed on the full $54 million from

AmRest, he should be permitted to subtract from his gains on his original shares what he says he "lost"

on the sale of the Archer shares.

The Tax Code imposes a general rule prohibiting the recognition of gains and losses incurred in a

stock-for-stock corporate merger transaction. I.R.C. § 354(a); see also Comm'r v. Clark, 489

U.S. 726, 729 [63 AFTR 2d 89-860] (1985) (stating the Tax Code "imposes no current tax on certain

stock-for-stock ex[pg. 2017-5543] changes"). 1 But this general rule has an exception for instances

when a corporate reorganization involves a transfer of stock in exchange for both stock and other

property or money. I.R.C. § 356. In those transactions, losses still fall within the scope of the general

rule-they may not be recognized-but gains must be recognized, unlike in the context of a typical

stock-for-stock transaction. Id. § 356(a), (c). 2

To give content to § 354 and § 356, the Commissioner analyzes multifaceted transactions

according to their separate units, so that a taxpayer may not end-run the no-recognition-of-losses rule by

tucking one unit's unrecognizable loss under the transaction's broader recognizable gain. For example,

in Lakeside Irrigation Co. v. Commissioner, an irrigation company sold four blocks of stock in return for

certain business debts being forgiven. 128 F.2d 418, 418 [29 AFTR 521] (5th Cir. 1942). The

company realized gains on two of the blocks of stock, losses on the other two, and an overall gain when

all of the gains and losses on the four blocks were netted. Id. at 419. This four-block sale raised the

specter of a statute similar to § 356(c) that would require recognition of the two gains and prohibit

recognition of the two losses. The company attempted to avoid the non-recognition problem by

characterizing the four-block transfer as one big exchange, thereby allowing the company to subtract the

two-block loss from the larger two-block gain and report to the IRS one smaller gain. Id. The

Commissioner, the Tax Court's predecessor, and the Fifth Circuit all found this arrangement

impermissible, holding that when a transaction involves "separate unit[s]" each unit must be analyzed

separately. Id .

Here, Tseytin tries to do what Lakeside prohibits. He asks the Court to treat the two blocks of USSI

stock-his block and Archer's-as one unit, sold in one exchange. If we did so, Tseytin believes he could

subtract a loss of more than $500,000 on the Archer shares from a gain of more than $17 million on his

original shares. The Commissioner disputes whether Tseytin's math is correct, 3 but even assuming it is,

at least two undisputed factors support the Tax Court's finding that Tseytin's USSI stock holdings were

composed of two units: Tseytin acquired one block of USSI stock approximately three years before the

second block, and he held a vastly different basis in the two blocks. Given that the blocks are indeed

separate, § 356 prohibits recognition of any loss in the Archer block, as the Tax Court correctly held.

Tseytin argues we should depart from Lakeside's rule at least in cases like this one, where a taxpayer

seeks to recognize only a small loss alongside a much larger gain. That argument has been twice

considered and rejected, or at least deferred, by the Department of the Treasury. The Department

issued notices of proposed rulemaking in 2006 and 2009 stating that it was considering the issue and

soliciting comments on the matter. 74 Fed. Reg. 3509, 3509-3511 (Jan. 21, 2009); 71 Fed. Reg. 4264,

4266 (Jan. 26, 2006). Neither of those notices were followed by the promulgation of a rule or any other

agency action. Also, neither of the notices provide an argument or explanation (or even a recitation of

someone else's argument or explanation) as to why what Tseytin proposes could be advantageous.

From our perspective, Lakeside 's approach is better: separate units must be treated separately to

prevent § 356's exception from swallowing § 354(a)'s rule. Perhaps a later case or agency rule

will further explore what it means for an exchange to be composed of "separate" units. But given the [pg.

2017-5544] current landscape, the Tax Court did not err with regard to the loss-recognition issue.

IV.

One final matter remains: Michael Tseytin's wife, Ella Tseytin, is also an appellant and a party to this

appeal. Both the Commissioner and the Appellants agree that she was inadvertently and erroneously

held liable in the Tax Court for her husband's tax deficiencies. We will remand the case to the Tax Court

to provide it an opportunity to address the issue.

V.

The Tax Court's decision was correct, and we will therefore affirm with a limited remand on the issue of

Appellant Ella Tseytin's liability.

* This disposition is not an opinion of the full Court and pursuant to I.O.P. 5.7 does not constitute

binding precedent.

1 Pertinent here is the general rule provided in I.R.C. § 354(a)(1): "No gain or loss shall be

recognized if stock or securities in a corporation a party to a reorganization are, in pursuance of the

plan or reorganization, exchanged solely for stock or securities in such corporation or in another

corporation a party to the reorganization."

2 Section 356(a) states in pertinent part:

Recognition of gain: If-

((A)) section 354 or 355 would apply to an exchange but for the fact

that

((B)) the property received in the exchange consists not only of property

permitted by section 354 or 355 to be received without the

recognition of gain but also of other property or money,

then the gain, if any, to the recipient shall be recognized, but in an amount not in

excess of the sum of such money and the fair market value of such other property.

I.R.C. § 356(a)(1).

Section 356(c) states,

Loss: If-

((1)) section 354 would apply to an exchange or section 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 section 354 or 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 shall be recognized.

I.R.C. § 356(c).

3 Indeed, according to the Commissioner Tseytin's netting argument would hurt him rather than help.

The I.R.S. found Tseytin liable for a $17.3 million gain, but under the Commissioner's math netting the

Archer shares with Tseytin's original shares would result in a much higher gain of more than $23.1

million, not the $16.8 million that Tseytin claims. We need not decide whose calculation is correct,

however, because a netting approach is not available here.

© 2020 Thomson Reuters/Tax & Accounting. All Rights Reserved.