Dot-Com Mogul Not Entitled to $112 Million Capital Loss from CARDS Transaction

(Parker Tax Publishing December 2016)

The Tax Court determined that a taxpayer, who had made his fortune before the tech bubble burst in early 2000, was not entitled to $112 million in capital losses from his redemption of a note used to secure a loan as part of a Custom Adjustable Rate Debt Structure (CARDS) transaction. The court determined that the taxpayer had insufficient basis in the note to claim the loss, as a large portion of the loan was secured by a CD and his liability for the entire value of the loan was contingent on the entire value of the CD being drawn down after 30 years, which the court determined was not the likely term of the loan. Putanec v. Comm'r, T.C. Memo. 2016-221.

Background

In 1996, Boris Putanec and six of his business colleagues formed Ariba Technologies, Inc., a company at the forefront of business-to-business ecommerce. In 1999, Ariba went public, giving the company a value of $6 billion. Ariba followed this opening with $274 million in sales for its fourth year, and its market cap soared to nearly $40 billion.

In March 2000, the tech bubble burst, and by October 2002, $5 trillion in paper wealth had been wiped off the NASDAQ. Ariba was one of the few survivors standing after the March 2000 NASDAQ crash and, believing that the stock price would rebound and that selling his shares would hurt his future net worth, Putanec sought other ways to monetize his Ariba stock.

In early 2000, Putanec retained myCFO, Inc. for tax-preparation services. MyCFO also began to provide him with wealth-management services and urged him to diversify his holdings in Ariba. Putanec put a bit of his wealth into real estate and several limited partnership investments, but he was concerned that the investments required cash on hand, something that was hard to come by when so much of his wealth was in one company's stock. Putanec raised this concern with myCFO, which told him about the Custom Adjustable Rate Debt Structure (CARDS) transaction. The CARDS transaction was developed and marketed by Chenery Associates, Inc. (Chenery).

Around February 2000, Putanec signed an engagement letter with Chenery in which he agreed to pay $3 million for the CARDS transaction. The planners structured the CARDS transaction to give Putanec a potential capital loss of $100 million to offset any gains from selling his Ariba stock. The transaction involved setting up a new company that entered into an agreement with Deutsche Bank and involved a complicated 30-year term $100 million loan arrangement, with the loan being secured by a CD, whereby Putanec received a note with an allegedly high basis in connection with the loan arrangement. Because the note was denominated in euros, Putanec had to convert the euros to dollars, and Deutsche Bank required Putanec to agree to foreign-currency exchange contracts to convert the euros. These redemptions had a beneficial tax effect. They produced a reported loss of more than $100 million, which more than offset the gains Putanec realized from the sale of about 3 million Ariba shares throughout 2001.

On his returns for 2000 and 2001, Putanec took the position that his basis in the note was the full value of the loan, and thus when he redeemed it and received a total amount equal to its face value rather than its much higher alleged basis, there was a large capital loss (approximately $112 million). He also took deductions for foreign currency exchange losses. The IRS denied the deductions.

Analysis

The Tax Court noted that as a general matter, consideration paid usually determines a taxpayer's basis in a capital asset such as a note. Under Code Sec. 1011, the basis to be used to determine gain or loss from a sale or other disposition of property should be determined under Code Sec. 1012, which equates basis with the cost of the property. A liability that an asset's buyer assumes, the court stated, is included in the total cost of acquiring property.

Putanec argued that, because he assumed liability on the entire loan as a cost of receiving the note, his basis in the note must equal the entire amount of the loan. The court noted that one problem with that argument was that the new company that had been set up was also liable on the entire loan. In the end, the court said, Putanec's own interest in the deal was to realize a paper loss on the subsequent disposition of the note. There was nothing in the record that showed the court that Putanec had any interest in being on the hook 30 years later for more than $100 million. Thus, the court found that when Putanec acquired the note, he was not likely to repay the large portion of the loan secured by the CD, because it was so extremely unlikely that the loan would continue for very long at all. The portion of the loan secured by the CD, the court noted, was "contingent." Citing its decision in Albany Car Wheel Co. v. Comm'r, 40 T.C. 831 (1963), the court said that the general rule is that a contingent liability assumed as a part of an acquisition may not be added to the basis of the acquired property.

With regard to Putanec's claim for the foreign currency contract losses, the court stated that under Code Sec. 1256, a foreign currency contract is "marked to market" at the end of every year, and the taxpayer recognizes gain or loss as if the contract had been sold for its fair market value. The court determined the contracts at issue qualified under the definition of "foreign currency contract" in Code Sec. 1256(g)(2)(A): Putanec entered into them at arm's length with Deutsche Bank (a commercial bank), and the euro was traded through regulated futures contracts during 2000 and 2001 (the years in which the contracts were in effect). Because the contracts fell under the mark-to-market rules, the court held Putanec was entitled to the losses, and stated they would be treated as 40 percent short-term capital losses and 60 percent long-term capital losses.

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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