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The 11th Circuit Court in Lizzie W. Calloway et vir v.
Commissioner (No. 11-103965 (11th Cir., (2012)) affirmed the
Tax Court's decision (135 T.C. 3 (2010) that a taxpayer sold
his stock upon entering into an agreement that purported to be a
nonrecourse loan.
In Calloway, an individual (Calloway) had purchased 990
common shares of IBM (the shares) while employed at IBM. The shares
had appreciated in value since being acquired by Calloway. In early
August 2001, Calloway entered into an agreement with Derivium
Capital LLC (Derivium), which provided that Derivium would lend an
amount of cash to Calloway equal to 90 percent of the market value
of the shares (the loan). The terms provided that the loan (i)
accrued interest equal to 10.5 percent, which compounded annually;
(ii) was nonrecourse and (iii) had a three-year maturity term.
On Aug. 16, 2001, Calloway transferred the shares to Derivium as
collateral for the loan and agreed that Derivium had the right to
sell some or all of the shares without providing notice to
Calloway. Calloway did not have to maintain margin requirements
other than transferring the shares. Dividends that Derivium
received from the shares would be applied against the interest due
from Calloway.
On Aug. 17, 2001, Derivium sold the shares on the open market
and subsequently transferred the loan to Calloway based on the
amount it received from the sale (i.e., 90 percent of the market
value of the shares). Thus, the amount of the loan was not
determined until after Derivium sold the shares. Calloway could not
prepay the loan, and Derivium could not require Calloway to repay
the loan prior to maturity.
At the end of the three-year maturity term of the loan, Calloway
had the option to (i) pay cash equal to the outstanding principal
and interest related to the loan and receive the shares, (ii)
extend the term of the loan in exchange for a fee equal to a
percentage of the balance due or (iii) surrender the shares with no
additional obligation.
On July 27, 2004, immediately prior to the loan's maturity,
Calloway stated that he relinquished his right to the shares in
satisfaction of the loan, and he never made any payments of
principal or interest on the loan.
The primary issue in Calloway was whether the loan
constituted a sale of the shares in 2001 or a nonrecourse debt
Calloway owed to Derivium.
The Tax Court held that the loan constituted a sale of the
shares by Calloway in 2001 rather than a nonrecourse debt Calloway
owed to Derivium; some of the Tax Court judges, however, had
divergent rationales. The Tax Court's analyses are summarized
as follows:
The court's majority analyzed the loan under the factors
provided in Grodt & McKay Realty, Inc. v. Commissioner
(77. T.C. 1221 (1981)) relating to the benefits and burdens of
ownership (the majority opinion).
Judge James S. Halpern asserted that Derivium's possession
of the shares, coupled with its ability to sell the shares, was
most relevant in determining that the loan constituted a sale of
the shares (the Halpern opinion).
Judge Mark V. Holmes cited Treas. Reg. Sec. 1.1001-2(a)(4)(i)
and Commissioner v. Tufts (461 U.S. 300 (1983)) to support
that Calloway sold the shares to Derivium upon Derivium's sale
of the shares on the open market (the Holmes opinion).
The 11th Circuit held that the loan constituted a sale of the
shares by Calloway in 2001 rather than a nonrecourse debt Calloway
owed to Derivium. The court, however, disputed the Halpern and
Holmes opinions, and adopted the rationale set forth in the
majority opinion.
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