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Midco a no-go

November 12, 2009

When a C corporation is up for sale, the tax law pits the interests of the buyer against the seller. The buyer wants to buy assets to get a fresh new basis for depreciation, maximizing future deductions. The seller doesn't like that so much because much of the income from asset sales is often ordinary, and because the seller pays tax both on the asset sale and on the subsequent distribution of the proceeds from the corporation.

During the tax shelter frenzy of the late 90's, big-firm tax scientists tried to square the circle on stock sales with the "Midco" shelter. It was a simple structure as these things go. A tax-indifferent entity -- maybe an offshore shell company -- would buy the target company stock, and then turn around and sell the assets to the real buyer. If it works, the seller gets the benefits of a stock sale and the buyer gets the benefits of an asset sale.

A District Court last year said it doesn't work. Now the Fifth Circuit agrees with the Tax Court, reports the TaxProf.

Accounting firm PriceWaterhouse Coopers (PWC) arranged for a tax-indifferent "Midco" named "K-Pipe" to buy the stock of Bishop Group Ltd. and sell the assets to Midcoast Energy Resources. The appeals court said the IRS could ignore K-Pipe:

Accordingly, the uncontroverted facts support the district court’s determination that the IRS was entitled to disregard the form of the transaction and treat it as a direct sale of stock. Given that the transaction was designed solely for the purpose of avoiding taxes, and Midcoast has offered no adequate non-tax reasons for using a conduit entity, the district court did not err in finding the IRS appropriately disregarded the form of the transaction.

So far there doesn't seem to be a single mass-marketed big firm shelter that actually worked reliably when challenged.

Cite: Enbridge Energy Co. v. United States, No. 08-20261 (5th Cir. Nov. 10, 2009).

Tags: tax shelters.TaxProf.