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September 23, 2011

Now that another tax filing deadline is behind us, many organizations will begin to shift their focus from tax return compliance to tax planning for current and future operations. Some of these areas may include transferring assets or entering into financing arrangements with related and/or unrelated parties to improve cash flow positions. These opportunities often entail an analysis and determination of a property's “tax ownership,” one of the most fundamental yet seemingly complicated concepts in tax law. The Internal Revenue Service has wrestled with taxpayers in this area in the past, and there is no apparent end in sight. Although a plethora of tax precedent exists to navigate through the complexities, many argue that the established principles are too often misunderstood and misapplied across the spectrum of potential transactions and industries. Even more troubling, there is often confusion over the conclusions reached for financial statement and/or legal purposes and how these conclusions impact the tax analysis. To be sure, the tax ownership analysis is a separate and distinct analysis that should be based on tax law, even where it is tempting to use standards developed for the other purposes as a guide to the right answer. All of this unfortunately leads to inconsistent positions taken by the government, results in unexpected conclusions reached by the courts, and impedes tax planning.

To illustrate this point, determining tax ownership may prove difficult if the taxpayer retains an interest in, or obligation with regard to, property that has been legally transferred to another party. Such a taxpayer may be surprised to find the Service seeking to recharacterize the transaction based on its view of the “economics of the transaction” — a view that may not reflect the form of the transaction, the legal structure of the transaction, the financial accounting treatment of the transaction, or the intent of the contracting parties. Tax ownership rules can also sneak up on taxpayers in connection with secured financing transactions where the taxpayer may be viewed as inadvertently “disposing of” the underlying collateral for tax purposes. Accordingly, to increase the likelihood that the Service will respect the chosen form of a transaction and the intent of the contracting parties — whether “sale” or “secured financing” — taxpayers should carefully examine the appropriate tax ownership factors and structure the transaction with these in mind.

The complexity plaguing the tax ownership rules arises from the fact that the various multifactor tests have evolved over many years from judicial decisions in which courts have been called upon to answer the same question (whether a “sale or exchange” has taken place for tax purposes) in connection with different types of property (e.g., marketable securities, mortgage loans, real property, tangible personal property, etc.). The courts have created and expanded upon a multifactor test that aims to prescribe tax consequences based on the underlying economics of the transaction. The relevant factors that a court will examine may vary in connection with the nature of the property under consideration. The difficulty arises in:

• Identifying the relevant judicial opinions;

• Parsing through the cases to ascertain the factors relevant to the current transaction; and

• Weighing the application of these factors to a particular set of facts that may or may not be consistent with the court cases from which the ownership factors were drawn.

In short, many would argue that we lack a comprehensive analytical framework that can be used to effectively analyze tax ownership.

The uncertainty and confusion that can result is clearly evident in the Tax Court’s fairly recent opinion in Calloway v. Commissioner. In Calloway, the transaction in question entailed a short-term loan for which the taxpayer pledged stock as collateral. The Service challenged the taxpayer’s loan characterization and asserted that the transaction comprised a sale of the pledged securities for tax purposes. The Tax Court reached its conclusion by applying the eight-factor test established in Grodt & McKay Realty, Inc. v. Commissioner, which many regard as a seminal case in the tax ownership area. These factors include (in no particular order of priority and no particular factor being dispositive):

1) Whether legal title passes;

2) How the parties treat the transaction;

3) Whether an equity interest in the property is acquired;

4) Whether the contract creates a present obligation on the seller to execute and deliver a deed and a present obligation on the purchaser to make payments;

5) Whether the right of possession is vested in the purchaser;

6) Which party pays the property taxes;

7) Which party bears the risk of loss or damage to the property; and

8) Which party receives the profits from the operation and sale of the property.

After applying these factors, the Tax Court agreed with the Service and held that the benefits and burdens of ownership of the collateral had shifted from the taxpayer to the lender. Consequently, the transaction was recharacterized as a sale or exchange of the collateral. The actual application of the above-stated factors is not what distinguishes Calloway from other cases involving the multifactor test, but rather that the Tax Court chose to apply the test in the first place. The Calloway decision raises two important questions:

• Whether a multifactor ownership test should apply to determine tax ownership with regard to a particular transaction; and, if so,

• Which multifactor test should apply.

In Calloway, Judge Holmes in his concurring opinion answered the “whether” question by berating the majority for “going off on a frolic and detour through an inappropriate multifactor test” when the court could have been reached the same conclusion without its complexities. Judge Holmes was concerned that the Tax Court’s holding was broader than necessary and thus could have an adverse impact in other areas of law. This concern was echoed by the tax community following the Calloway decision and prompted the New York State Bar Association to publish a report urging the Treasury and Service to issue guidance that would limit the potential for Calloway and similar decisions to undermine the existing rules under IRC Section 1058, Transfers of Securities Under Certain Agreements, with regard to stock lending transactions.

Following the Calloway decision, the Tax Court held in Landow v. Commissioner that a taxpayer’s participation in a stock loan program where the taxpayer obtained a loan equal to 90 percent of the stock’s face value constituted a sale of the pledged stock. The Tax Court analyzed the Landow transaction using the same factors as in Calloway. Whether these Tax Court decisions reflect an effort to shut down what the Service perceives as an abusive transaction or whether they entail a change in the tax law having broader implications for financial transactions is yet to be determined.

In answering the “which” question, Judge Holmes asserted that even if a multifactor test were to apply, the multifactor test in Grodt was the wrong test for the Calloway transaction because the Grodt test was aimed at transactions involving non-fungible property. According to Judge Holmes, the actual facts of Grodt (involving the purported sale of cattle) and Calloway (secured borrowing) were too diverse to make the Grodt multifactor test relevant to Calloway (i.e., the ownership factors relevant to transactions involving fungible/intangible property differ from those relevant to dealings in non-fungible/tangible property). Putting aside the potential broader implications of Calloway, the case highlights the difficulty in determining whether a multifactor test applies and, if so, in identifying which factors should be considered.

Taxpayers seeking to monetize receivables via a sale or secured borrowing also face this conundrum and need to carefully consider which ownership factors will apply to the chosen transaction. For example, a financial institution that enters into a loan participation transaction to sell a portion of a pool of mortgage loans may need to consider the following eight factors:

1) Whether the transaction was treated as a sale for tax purposes;

2) Whether the obligors on the debt instruments were notified of the transfer of the debt instruments;

3) Which party serviced the debt instruments;

4) Whether the payments to the transferee corresponded to collections on the debt instruments;

5) Whether the transferee imposed restrictions on the operations of the transferor that are consistent with a lender-borrower relationship;

6) Which party had the power of disposition;

7) Which party bore the risk of loss;

8) Which party had the potential for gain.

In contrast, a financial institution that aims to monetize a portfolio of mortgage loans via a securitization may need to consider the rules laid out in Rev. Rul. 70-544 and Rev. Rul. 70-545, known as the Government National Mortgage Association or GNMA Rulings, and the administrative guidance that have flowed from these rulings. The GNMA Rulings establish that a sponsor of a mortgage securitization transaction, that uses a grantor trust as the securitization vehicle, will be treated as a sale of an undivided interest in the mortgages to a buyer(s) of the trust certificate(s). The key characteristics of the transactions addressed in the GNMA Rulings include (a) the limited ability of the issuer or trustee to reacquire and/or substitute the mortgages once transferred to the trust, and (b) the economic relationship (or lack thereof) of the principal and interest payments made by the obligor to those remitted from the trust to the trust certificate holders (the owners of the trust). One would reasonably expect that a loan securitization transaction fitting within the parameters of the GNMA Rulings should result in the transfer of tax ownership from the originator/trust sponsor to the certificate holders. However, as in the case of other tax ownership situations, whether the tax authorities will ultimately agree is not free of doubt.

Although the chosen transaction form and type of property under consideration vary, the questions remain the same when it comes to tax ownership. Initially, taxpayers should determine whether specific tax rules govern the particular form of transaction (i.e., does a multifactor test apply), such as the GNMA Rulings for securitizations. If not, the next step is to consider the relevant ownership factors that should apply to the particular transaction under consideration. The taxpayer should meticulously review the potentially relevant authority to ensure the proper factors are identified in order to mitigate the risk of the Service treating the transaction differently than what the parties intended. Finally, the taxpayer should analyze the transaction under the ownership factors that were identified and consider the potential impact of each factor, since no one factor should be dispositive of the outcome (regardless of how much one tries to make it so).

Having said this, there are a few practical pointers that taxpayers should consider.

• Although it is a well-established tax principle that no one factor is dispositive, the Service has been known to narrowly focus on which party bears the risk of loss to the point that it equates tax ownership with that sole factor (even if other factors exist to support a different conclusion). Accordingly, taxpayers that wish to engage in a sale for tax purposes and provide the buyer with recourse or a customary guarantee with regard to the property sold should ensure that as many of the other ownership factors as possible support sale treatment.

• Taxpayers should also maintain all relevant documentation that supports the intent of the parties and form of the transaction (e.g., documentation of the transaction's business purpose, proof that the flow of payments reflects the flow on the transaction agreements, etc.). Maintaining documentation can be particularly critical for transactions that can impact tax years well beyond the year in which the transaction originated, since the Service may come “knocking” long after the employees who undertook the transaction are no longer with the contracting organization(s).

• Of all the tax ownership factors commonly cited, those that are based on the relative economic exposure of the parties (e.g., risk of loss, power to dispose, the ability to profit) have generally carried the most weight in the eyes of the tax authorities. Therefore, taxpayers seeking a particular tax treatment when structuring the form and substance of a transaction should be careful not to place too much reliance on the other factors.

Alvarez & Marsal Taxand Says:

The tax ownership rules applicable to a particular transaction — whether it is a purported sale, a secured borrowing, a leasing transaction or the licensing of intellectual property — can be a minefield to navigate. Taxpayers need to consider the relevant rules in order to mitigate the likelihood that the Service will seek to recharacterize the taxpayer's chosen form for a transaction. The consequences could be significant: the loss of cost recovery deductions, recognition of gain, responsibility to withhold U.S. taxes in cross-border deals — all which could have an unexpected and unwelcomed impact on a company’s financial statements and cash flow. Although these rules have a rich history, their application continues to evolve, as can be seen in Calloway. A taxpayer’s best defense is to be prepared by making tax ownership a part of every analysis.


Calloway v. Commissioner, 135 T.C. 26 (July 8, 2010).
77 T.C. 1221 (1981).
2011 TNT 112-22, NYSBA Tax Section Report Addresses Treatment of Securities Loans.
Jonathan S. Landow, et ux. v. Commissioner, T.C. Memo 2011-177 (July 25, 2011).
United Surgical Steel Co., Inc. v. Comm’r, 54 T.C. 1215, 1229-30, 1231 (1970), acq., 1971-2 C.B. 3.
Id.; Town & Country Food Co., Inc. v. Comm’r, 51 T.C. 1049, 1057 (1969), acq., 1969-2 C.B. xxv.
United Surgical Steel at 1229-30, 1231; Town & Country at 1057.
United Surgical Steel at 1230; Yancey Bros. Co. v. United States, 319 F. Supp. 441, 446 (N.D. Ga. 1970).
American Nat'l Bank of Austin v. United States, 421 F.2d 442, 452 (5th Cir.), cert. denied, 400 U.S. 819 (1970).
Union Planters Nat'l Bank of Memphis v. United States, 426 F.2d 115, 118 (6th Cir.), cert. denied, 400 U.S. 827 (1970); Elmer v. Comm’r, 65 F.2d 568, 569 (2d Cir. 1933).
United Surgical Steel at 1229; Town & Country at 1057. Revenue Ruling 70-544, 1970-2 C.B. 6;
Revenue Ruling 70-545, 1970-2 C.B. 7.


Sean Menendez 
Managing Director, Miami

Jennifer Palacios, Senior Director, contributed to this article.

For More Information on This Topic, Contact:

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