Controlled corporation's sale of warrants to subsidiary was not a bargain sale.

• Author: Martinelli, Gregory S.

In TAM 200334001, the IRS National Office determined that a controlled corporation's sale of warrants to its parent's (Taxpayers) affiliate, in connection with Taxpayer's spinoff of the controlled corporation, was not a bargain sale, because the sale was at ann's length. The controlled corporation sold the warrants to finance a cash dividend to its shareholders under the terms of the spinoff. (In Letter Ruling 8908075, the IRS had determined that, among other things, the distributing corporation's retention of an interest in the controlled corporation was not for tax-avoidance purposes.)

Following the spinoff's announcement, an independent investment banker valued the warrants. By the time the warrants were transferred to Taxpayer's affiliate, their value had increased substantially; nevertheless, the controlled corporation sold the warrants at the price the investment hanker had determined.

Taxpayer's Argument

Acting under the assumption that the controlled corporation's sale of the warrants was a bargain sale, Taxpayer argued that the transaction should be recast under Sec. 482 in accord with Rev. Rul. 69-630. Relying on Rev. Rul. 69-630, Taxpayer contended the transaction should result in treating: (1) the affiliate as paying the appreciated price for the warrants and receiving a commensurate step-up in basis; (2) the controlled corporation as having distributed to Taxpayer the difference between what it was deemed to have received (i.e., the appreciated price) and what it actually received (i.e., the appraised price) as a cash distribution as to its controlled corporation stock; and (3) Taxpayer as making a capital contribution to its affiliate in that amount.

Analysis

The National Office rejected Taxpayer's position. It pointed out that the application of recast principles of Rev. Rul. 69-630 requires, initially, a bargain sale; because the controlled corporation's sale of the warrants was not a bargain sale, the ruling did not apply. The warrant sale was not a bargain sale, for two reasons. First, when the warrants were written, the parties agreed on their price (as determined by an independent third-party investment banker); thus, there was no bargain element to the warrants' acquisition. Second, the warrant agreement...