On April 4th the Tax Court decided another Derivium Capital case: Solleberger v. Comm’r, T.C. Memo 2011-78. Earlier we reported on Calloway,15 the first Derivium case decided by the Tax Court.16 Derivium offered a taxpayer with appreciated securities a non-recourse loan for 90% of their value. The notion was that the taxpayer could extract money from its stock position, hedge the downside risk (through the non-recourse feature) and not create a recognition event for federal income tax purposes. Why would the lender do this? The lender would (i) loan money to the taxpayer on the 90% basis and (ii) buy a put on the stock with a $90 strike to hedge its risk. It would charge the taxpayer interest equal to the cost of money plus the cost of the put. Both charges would be part of the loan interest. Unfortunately, it turned out that Derivium did not have any money to lend, instead it sold the taxpayer’s stock to get the money to lend. The IRS has been successful in the various Derivium cases in arguing that the loans were shams and that the taxpayer recognized gain on the transactions in question. Note that in Solleberger, instead of stock the taxpayer borrowed against bank notes. The taxpayer had sold its business to an ESOP and rolled over the gain into socalled ESOP notes under Section 1042.
It borrowed against the ESOP notes, however, the Tax Court granted summary judgment for the government on the grounds that all benefits and burdens had passed to the lender, a Derivium affiliate. Therefore, the notes had been sold rather than pledged; this in turn triggered gain under Section 1042.