Opinion
23373-18
08-11-2021
Peak Potentials Training International, Petitioner v. Commissioner of Internal Revenue, Respondent
ORDER
David Gustafson, Judge
In this deficiency case brought pursuant to section 6213, the Commissioner of the Internal Revenue Service ("the Commissioner") determined in a statutory notice of deficiency that the gross receipts of petitioner, Peak Potentials Training International ("Peak"), should be increased by $6,594,610 for the tax year 2011. Peak has moved for partial summary judgment and submitted declarations and exhibits in support thereof (Docs. 16-19), to which the Commissioner has filed an opposition and supporting documents (Docs. 22-24, 35). Peak has filed a reply (Doc. 37) and accompanying declarations (Docs. 38-39), and the Commissioner has filed a sur-reply (Doc. 42). The central contention in Peak's motion is that the undisputed facts show that it should be permitted a deduction against gross income under section 162 for all but a very small amount of the $6,594,610 for its 2011 tax year (and as to the remaining amount, it concedes a factual dispute). We will deny Peak's motion.
Unless otherwise noted, all section references are to the Internal Revenue Code of 1986 as in effect at all relevant times (codified in 26 U.S.C.), and all Rule references are to the Tax Court Rules of Practice and Procedure.
Background
Except where noted, the following facts are not in dispute.
Peak's organization and business
Peak is a corporation organized in 2002 under the laws of the State of Washington. Its business activities were undertaken in various locations throughout the United States, but Peak's declarant asserts that it was "headquartered in Washington", which we infer to mean that its "principal office", for purposes of section 7482(b)(1) was in Washington. Peak is wholly owned by a Canadian parent company, Peak Potentials Training, Inc. ("PPT(CAN)"). (Doc. 18 at 4, para. 8.) At all relevant times, Peak was taxed as a corporation, reporting its income tax on Form 1120, "U.S. Corporation Income Tax Return". (Doc. 35 at 13-34.)
PPT(CAN) was founded by Harvey Eker, a bestselling author and motivational speaker, and its business consisted of providing seminars based on Mr. Eker's teachings. PPT(CAN) formed its U.S. subsidiary, Peak, in order "to provide logistical and fulfillment services to customers for seminar courses provided in the United States. These services included interfacing with customers, taking orders, receiving deposits, making arrangements with third-party event spaces, and contracting with trained speakers (including * * * [Mr. Eker]) to handle the seminar presentations." (Doc. 18 at 3-4.) Peak regularly sold its seminars to customers in bundles; and customers would pay in advance to attend multiple seminars over a given period, which could span two or more years. (Doc. 18 at 4.) Peak refers to these payments as "customer advance deposits" or simply "customer deposits" and retained on its books a "customer deposit account" tracking this item of income. (Doc. 18 at 4, 8, 35-36.)
Peak's method of accounting
In paragraph 5 of its petition (Doc. 1 at 4), Peak alleges:
f. In 2007 and 2008, Petitioner reported customer advance deposits in full as income in the year of receipt. In 2009 and 2010, Petitioner reported one half of the deposits as income in the year of receipt and the other half as income in the following year, as allowed by Rev. Proc. 2004-34.
g. Prior to 2007, Petitioner had improperly deferred the customer deposit revenue relating to the prepaid seminar contracts until the associated seminar services were performed. But, upon realizing its mistake in 2007, Petitioner self-reported the error in its method of accounting and included more than $27 million of deferred revenue (customer deposits) in income over a four-year period between 2007 and 2010 pursuant to section 481 of the Internal Revenue Code.
h. Between the section 481 inclusion of the pre-2007 deferred revenues and the customer deposits included in income between 2007 and 2010, Petitioner reported almost $54 million in income during the 2007 to 2010 time period.
Rev. Proc. 2004-34 permits an accrual method taxpayer to use the so-called "deferral method" of accounting for advance payments for certain items such as (relevant here), payments for the provision of services. Under the "deferral method" of accounting, an advance payment would be taken into account upon the first to occur of (1) the recognition of the income in revenue for financial accounting purposes or (2) the year next succeeding the year in which payment is received.
In the declaration of Sudeep Goyal, an accountant for a Canada-based accounting firm who assisted with the income-tax-related services for Peak, this figure is estimated to be $26.7 million. (Doc. 9, para. 11.)
The Commissioner has denied the specific allegations in these paragraphs but admitted that "in 2008 petitioner submitted a Form 3115, Application for Change in Accounting Method, reflecting a section 481(a) adjustment in the amount of $27,165,723, which would be recognized in income in equal parts over a four-year period from 2007 to 2010." (Doc. 7 at 2-3.) The Commissioner does not dispute that Peak uses an accrual method of accounting. (Doc.22 at 14.)
In support of its motion for partial summary judgment, Peak elaborates on the timing of how it recognized income and deductions as follows:
As pre-paid contracts were serviced, * * * [Peak] would take into account as deductions the costs incurred in connection with providing
the seminars to customers (e.g., event space bookings, costs of seminar speakers, etc.) as the costs were paid.
* * * When the pre-paid contracts were serviced and income was recognized for accounting purposes (although it had already been recognized as income at an earlier point for tax purposes), the "customer deposit" account was debited, and "revenue" was credited.(Doc. 19, para. 12, 13). Peak contends that by the end of 2010, it had approximately $7 million in its "customer deposits" account, and that "all but approximately $80,000 (i.e., half of the $159,108 in advance deposits received in 2010) of this amount had already been taken into income for tax purposes" but constituted payments for services that had not yet been performed. (Id. para. 14).
Sale of Peak
In 2011 PPT(CAN) and Peak sold their seminar business to a newly-formed limited liability company organized under the laws of Delaware called "NewPeaks, LLC" ("the Purchaser"). (Doc. 18:4, 7, 88-89). The transaction was structured as an asset sale and purchase, which included all the business assets of Peak, PPT(CAN), and several smaller affiliated entities ("the Sellers"). (Doc. 18 at 4, para. 14.)
The Asset Purchase Agreement ("the Agreement") setting forth the terms of the sale (Doc. 18 at 7-84) was executed by all of the essential parties to the Agreement, and the Commissioner does not raise a challenge as to the authenticity of the document. Under the terms of the Agreement, the parties arranged for two separate closings. Payment of consideration associated with the "First Closing" (the "First Closing Purchase Price") and delivery of specified "First Closing Assets" was to be made October 27, 2011; and payment of consideration associated with the "Second Closing" (the "Second Closing Purchase Price") and delivery of specified "Second Closing Assets" was to be made on or before January 31, 2012.
First Closing Assets
Paragraph 1.1 of the Agreement provides that on October 27, 2011, the Sellers were to deliver to the Purchaser the assets set forth on Schedule 1.1, which is a 9-page exhibit to the Agreement that lists numerous tangible and intangible assets located in various office locations in the United States and Canada, including telephone, fax, email and internet accounts, off-the-shelf software licenses, laptops, desktops, servers, printers and other equipment, cell phones and their associated accounts, and other office assets. In addition to these items, the following assets are listed on Schedule 1.1 as due to be delivered to Purchaser in October 2011:
Accounts Receiveable. [sic] Incoming monies and related documents include the following, as reflected in the Infusionsoft and z-admin databases:
• Client contracts
• Payment plans
• Fulfillment obligations
Contracts, Leases, and Permits - per schedule 14.5(a), 14.5(b), and 14.5(c)
Business operational goodwill and contractual rights to Multi Speaker Events after closing
Although listed as assets, these "Fulfillment obligations" were Peak's obligations to customers and thus were evidently liabilities, not assets. Under the Agreement, Purchaser assumed these liabilities of Peak.
No Schedules 14.5(a) through (c) appear to be appended to the Agreement. Schedules 10.5a ("Contracts"), 10.5b ("Leases"), and 10.5c ("Permits") are attached to the Agreement, and for purposes of this order we assume that the intended reference in Schedule 1.1 was to Schedules 10.5a-c. (Doc. 18 at 42-44.)
The Agreement also specifically excludes certain assets from those to be delivered upon the First Closing, which include, in relevant part, "[a]ny of Seller's cash, cash equivalents, and any amounts held on deposit in Seller's (or its affiliates) savings, checking, money market, investment accounts or other similar accounts. This also includes checks or other monetary instruments that have been received but not yet processed"; "[m]onies paid after Closing from multispeaker event speaker sales for courses that were completed prior to closing"; and the "Second Closing Assets". Additional excluded assets are set forth in Paragraph 1.2 and Schedule 1.2 of the Agreement.
First Closing Purchase Price
In exchange for these "First Closing Assets", the Purchaser agreed to pay a "First Closing Purchase Price" as specified in paragraph 1.4, and to assume certain liabilities as specified in paragraph 1.3 (discussed below).
1.4 First Closing Purchase Price for the First Closing Assets. Purchaser shall pay to Sellers, and Sellers shall accept as the total purchase price for the First Closing Assets (the "First Closing Purchase Price"), the sum of (i) Two Million Dollars (US$2,000,000.00) (the "First Closing Cash Payment"), (ii) Two Hundred Seventy Three Thousand Seven Hundred Ninety Seven and 43/100 Dollars (US$273,797.43) (the "Additional Purchase Price"), (iii) the License Fee (as hereinafter defined), (iv) the Restrictive Covenant Payment (as hereinafter defined), and (v) the goodwill associated with the Unfulfilled Courses (as hereinafter defined). The goodwill associated with the Unfilled Courses will equal the amount of all customer deposits for pre-sold and unfulfilled courses (the "Unfulfilled Courses") set forth on Schedule 1.4 [i.e., $7,740,559, as explained below] as of the date of the First Closing (the "Customer Deposits"), less the amount of merchant deposits transferred to Purchaser. Purchaser shall receive a credit against the payment contemplated by clause (v) of this Section 1.4 relating to the First Closing Purchase Price equal to the amount of the Customer Deposits for the Unfulfilled Courses less the amount of the merchant deposits transferred to Purchaser. The First Closing Cash Payment, together with the License Fee and the Restrictive Covenant Payment, all totaling Two Million Five Hundred Thousand U.S. Dollars (US$2,500,000.00), shall be paid in full by Purchaser to * * * [PPT(CAN)] at the First Closing. * * * The Additional Purchase Price shall be paid by Purchaser to * * * [PPT(CAN)] in three (3) equal monthly installments of Ninety One Thousand Two Hundred Sixty Five and 81/100 U.S. Dollars (US$91,265.81) each. Payments of the Additional Purchase Price shall be paid on November 1, 2011, December 1, 2011, and January 2, 2012.
The term "merchant deposits" is not a defined term in the Agreement, and it only appears twice--both times in paragraph 1.4.
In summary, the agreement appears to provide for a total First Closing Purchase Price (before accounting for any assumed liabilities) of $2,500,000 (clauses (i), (iii), and (iv)), plus $273,797 (clause (ii)), plus $7,740,559 "less the amount of the merchant deposits transferred to Purchaser" (which Peak urges is zero, because "no funds actually changed hands"). Under petitioner's interpretation of the Agreement, the First Closing Purchase Price (before accounting for any assumed liabilities) would be $10,514,356. Petitioner asserts that Purchaser received a credit against the First Closing Purchase Price of $7,740,559, "less the amount of the merchant deposits transferred to Purchaser" ($0, per Peak's assertions). Peak explains the operation of this term of paragraph 1.4 by stating that "NewPeaks was treated as paying the selling group $7.7 million as part of the First Closing, even though no funds actually changed hands". (Doc. 17:9.) This characterization suggests that in Peak's view, the First Closing Purchase Price was $10,514,356; i.e., application of the purported credit against the payment due in respect of clause (v) did not operate as a reduction to the First Closing Purchase Price.
The record does not show the amount of any funds that were in fact paid or to whom such payments were made. And Peak's assertion that "NewPeaks was treated as paying the selling group $7.7 million as part of the First Closing, even though no funds actually changed hands" is ambiguous as to which selling party or parties received the purported "credit" for the payment due in respect of clause (v) (emphasis added). (The Agreement does not contain the term "selling group" employed by Peak in its pleadings.) We further observe that the payments under paragraph 1.4 that specifically prescribe when and among whom they will "change hands" are payments (totaling the remaining $2,773,797) to be made from the Purchaser to PPT(CAN).
In the Declaration of Sudeep Goyal, an accountant who assisted his employer, a Canadian accounting firm, with Peak's income tax returns (but was not the primary person responsible for preparing the returns), (Doc.19, para. 3) Mr. Goyal asserts the following:
As a part of the "First Closing," the sales price was increased by "goodwill" in an amount representing the total of all of the customer deposit accounts held by the selling group(less the amount of any merchant deposits transferred). However, NewPeaks also received credits towards payment of the purchase price in the amounts of the selfsame customer deposit accounts, which was $6,594,610 with respect to [Peak]'s customer deposit accounts (and $7,740,559 in total across all of the selling entities) as of October 26, 2011 (the date of sale). (Doc. 19, para. 19). The Commissioner disputes this characterization, raises hearsay objections, and argues that Mr. Goyal does not have sufficient personal knowledge of these facts to establish them for purposes of Peak's motion for partial summary judgment, and further asserts that the facts in the declaration are inconsistent with the documentary evidence submitted with Peak's motion. (Doc. 22 at 5-6.) Rather than dispute individual assertions, the Commissioner advances these objections to the entire content of Mr. Goyal's declaration, and we address these objections below in part I. For purposes of Peak's motion, we assume the term "selling group" means Peak, PPT(CAN), and the other smaller affiliated entities defined as the "Sellers" in the Agreement.
First Closing Liabilities
The liabilities assumed by Purchaser at the First Closing are described as follows:
1.3 First Closing Liabilities Assumed and Unassumed. Purchaser is not assuming or agreeing to pay any of Sellers' debts or obligations in connection with the First Closing except (i) those liabilities specified in Schedule 1.3, (ii) all obligations related to the Unfulfilled Courses (as hereinafter defined), and (iii) all trade payables of Sellers as of the First Closing (collectively, the "First Closing Assumed Liabilities"). Purchaser is not assuming any liabilities in connection with the First Closing other than the First Closing Assumed Liabilities and all obligations related to the Unfulfilled Courses. Purchaser shall fully perform and discharge all obligations and duties of the First Closing Assumed Liabilities.Schedule 1.3, "Assumed Liabilities" lists the following items:
Customer Deposits - Schedule 1.4 [which contains the statement "The customer deposit account as of 26 Oct 2011 is $7,740,559"]
Liabilities created by fulfillment of contracts in Schedule 10.5(a)
Employee accrued vacation and sick leave
Any commission payments that become due as a result of revenue earned by the purchaser
Any contractual liability for any contracts that are assumed
"Unfulfilled courses" were thereafter defined as "pre-sold and unfulfilled courses", see paragraph 1.4 of the Agreement, supra. (Though this definition contains the term it purports to define, we assume that "unfulfilled courses" is intended to be shorthand for "pre-sold and unfulfilled courses".)
The first line of Schedule 1.4 "Customer Deposits" states that "Customer Deposits reflect product (including courses, workshops, and camps) for which cash has been received, but the product has not yet been delivered." Nothing in paragraph 1.4 or Schedule 1.4 specifies to which party(ies) the deposits belong. For purposes of Peak's motion, we assume that at least $6,594,610 of the customer deposits belonged to Peak.
The "Assumed Liabilities" items on Schedule 1.3 are followed by a chart that lists 17 different "Events" in one column, scheduled "Date[s]" from October 28, 2011 through August 31, 2012 in the next column, and the "Venue" locations corresponding therewith in the final column. The chart appears to be cross-referenced in Schedule 10.5(a) "Contracts", where it is described as the list of "Venues" for which existing contracts are listed on that schedule.
We note that the "Assumed Liabilities" on Schedule 1.3 include both "Customer Deposits" listed on Schedule 1.4 (which constitute previous payments for obligations not yet fulfilled) and, as a separate item, the "Liabilities created by fulfillment of contracts in Schedule 10.5(a)". In addition to the contracts for event "Venues" described above, Schedule 10.5(a) also lists contracts for "Trainers (active)", "Leases", and "Operational". Twenty-three "Operational" contracts are listed on Schedule 10.5(a), including, for example, contracts titled "Third Party Event Speakers", "ROR coaching program coaches", "PSOM program expert consultant", and "CORE team event support staff"--i.e., existing contracts that appear necessary to perform services in Peak's line of business.
Second Closing Assets
The Second Closing Assets, set forth on Schedule 2.1, include only the following:
• Permanent Rights for usage of trade name "Peak Potentials" (need right language here) [parenthetical in the original]
• All websites and domain names associated with "www.peakpotentials.com"
Second Closing Purchase Price
Paragraph 2.4 of the Agreement provides that the Second Closing Purchase Price is $7,500,000, structured as one cash payment of $2,500,000 to be paid at closing by Purchaser (to whom, the Agreement does not specify), followed by the delivery of two negotiable secured promissory notes to be executed by the Purchaser in favor of PPT(CAN), "for the benefit of Sellers" thereafter. The Agreement states that the Purchaser does not assume any liabilities in connection with the Second Closing. It also provides the Sellers with a choice of remedies for an instance in which the Purchaser "fails to consummate the Second Closing", including a liquidated damages clause in the amount of $7,500,000.
Performance of the Agreement
The record does not reveal whether, how, or when the parties to the Agreement consummated its terms.
Peak's 2011 income tax return
Peak filed with its 2011 Form 1120 a Form 4797, "Sale of Business Property", reporting the sale of one item, described as "Goodwill", for which it listed no acquisition date and a date of sale of December 31, 2011. (Doc. 35 at 26.) For this item Peak reported a gross sales price of $1,000,000 and listed no depreciation and no cost basis, for a total gain of $1,000,000. This capital gain of $1,000,000 was the only item of capital gain/loss Peak reported for 2011. Id. at 19. On Schedule M-3, "Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More", filed with its 2011 Form 1120, Peak reported on line 20 that its "unearned/deferred revenue" was reduced by $6,777,092 during the 2011 calendar year, which resulted in an annual gross profit of ($5,623,053). Id. at 22. Peak reported total taxable income (a loss) of ($4,944,157) for 2011. Id. at 13.
Form 8594, "Asset Acquisition Statement Under Section 1060" is not among the forms Peak filed with its 2011 income tax return.
Schedule L, "Balance Sheets per Books", of Peaks' 2011 Form 1120 shows assets described on line 9 as "other investments" and further described on statement 5 as follows:
Description
Beginning of tax year
End of tax year
Due from related party
$19,932,374
$12,359,699
Long Term Investments
450, 000
450, 000
Total to Schedule L, line 9
20, 382, 374
12, 809, 699
On line 18 of schedule L, Peak reported "other current liabilities", further described on statement 6 as follows:
(Doc. 35 at 17, 33.) Thus if we were to assume that the amount "due from related party" is Peak's reporting of loans due to Peak only from PPT(CAN), and further assume that the amount "due to affiliate" represents only amounts due from Peak to PPT(CAN), and further assume that there were no other adjustments made to the intercompany loans running between Peak and PPT(CAN), we would conclude that netting these two obligations would result in a "beginning of tax year balance" of $6,420,532 due from PPT(CAN) to Peak, and an "end of tax year balance" of $3,913,656 due from PPT(CAN) to Peak. In other words, the net change in the intercompany loans would be an overall reduction of the amount PPT(CAN) owed to Peak of only $2,506,876 (not an amount that is greater than or equal to $6,594,610).
Description
Beginning of tax year
End of tax year
Advance customer deposits
$7,015752
[-0-]
Due to affiliate
13, 511, 842
$8,446,043
Total to Schedule L, line 9
20, 527, 594
8, 446, 043
As we explain below in part IV, the facts regarding the amount of the purported inter company loans are in dispute. Viewing these disputed facts in the light most favorable to the Commissioner, we conclude that Peak cannot show that it reduced PPT(CAN)'s debt to it by 6, 594, 610.
Peak also filed with its 2011 Form 1120 a Form 5472, "Information Return of a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation Engaged in a U.S. Trade or Business". (Doc. 35 at 28-29.) On Form 5472 Peak identified PPT(CAN) as a "foreign person" holding at least 25% of its stock. In Part IV of the Form 5472 Peak (as the "reporting corporation") was prompted to provide information regarding "monetary transactions between reporting corporations and foreign related party". On line 18 of Part IV, Peak identified that the "amounts loaned" to PPT(CAN) had a "beginning balance" of $8,914,821 and an "ending balance or monthly average" of $4,555,193. On line 7 of part IV, Form 5472 prompts the reporting corporation to report the same information with respect to any "amounts borrowed" from the foreign related party. Peak reported nothing on line 7.
Statutory notice of deficiency and Tax Court petition
On August 24, 2018, the Commissioner sent Peak a statutory notice of deficiency ("SNOD") determining income tax deficiencies for Peak's tax years ending December 31, 2009, 2010, and 2011. The Form 886-A, "Explanation of Adjustments", attached to the SNOD stated with respect to the adjustment for tax year 2011:
It is determined that the Taxpayer is not entitled to the $6,594,610.00 deduction on its asset sale because economic performance regarding the assumed liability had not occurred prior to the sale.
Alternatively, if it is determined that the Taxpayer is entitled to a $6,594,610.00 deduction, it must include the $6,594,610.00 liability assumption in its amount realized, and correspondingly the gain realized and recognized as income on its asset sale.
The Commissioner's adjustments for 2010 and 2009 resulted from the 2011 adjustment made to increase Peak's gross receipts by $6,594,610, resulting in the determination that Peak was not entitled to the net operating loss carryback deductions it took for 2010 and 2009 that it claimed were derived from the loss claimed in 2011.
Peak timely petitioned the Tax Court for a redetermination of the deficiencies resulting from the Commissioner's adjustments for tax years 2009, 2010, and 2011.
Peak's motion for summary judgment
The subject of Peak's motion for partial summary judgment is the tax treatment of $6,435,502 of customer deposits in its possession before the sale to NewPeaks. Peak contends this amount is fully deductible against its gross receipts for 2011 because "it cannot be disputed * * * that Petitioner held fulfillment obligations related to at least $6,435,502 worth of prepaid customer deposits". That is, Peak alleges that, but for the asset sale and purchase, Peak was bound to spend $6.4 million to fulfill the service obligations it had incurred under prior sales; but because under the Agreement the Purchaser assumed those obligations, Peak would not need to perform those services or incur the expense of doing so.Peak argues that it should be entitled to deduct this amount because NewPeaks assumed the obligation to provide the services corresponding with the deposits in the asset sale.
Peak concedes that there may be a dispute of fact with respect to whether Peak was still obligated to perform services associated with the remaining $159,108 of deposits made in 2010 and 2011.
Peak maintains that "no funds actually changed hands" between Peak and NewPeaks. Instead, Peak asserts that NewPeaks was treated as paying the "selling group" $6,594,610 (because NewPeaks assumed the obligation) even though it actually received none of the customer deposits, and that "in conjunction with the [deemed] transfer, Petitioner eliminated its customer deposit accounts and reduced the amounts owed to Petitioner by PPT(CAN) in the amount reflected in the customer deposit accounts at the time of sale ($6,594,610)". PPT(CAN), in turn, reported the $6,594,610 associated with the customer deposit accounts "as additional income from the sale of their business goodwill to NewPeaks". (Doc. 17 at 10.) Thus, Peak maintains that the economics of the transaction resulted in Peak becoming "more than $6.5 million poorer" by reducing the intra-company receivable due to it from PPT(CAN). That is, as between NewPeaks and the selling group, NewPeaks in effect paid $6.4 million by assuming the obligation, and the selling group was enriched to the extent of $6.4 million and received income in that amount; but within the selling group, it was PPT(CAN) and not Peak that was enriched (and should recognize income), because the effect of the inter-company account adjustments was to allocate the income to PPT(CAN).
Peak argues that because it had already included the customer deposits in income for tax purposes, it was entitled to deduct "at least $6,425,502" because it had not yet had an occasion to deduct from its income the costs of rendering those services (because under its method of accounting such costs were not yet deductible). (Doc. 17 at 12-13.) In support of this argument Peak relies on James M. Pierce Corp. v. Commissioner, 326 F.2d 67, 72 (8th Cir. 1964), rev'g 38 T.C. 643; Revenue Ruling 68-112, 1968-1 C.B. 62, and Commercial Security Bank v. Commissioner, 77 T.C. 145 (1981). Peak cites these cases for the rule that the seller of business assets is entitled to a deduction for the amount of the liabilities running with those assets which are assumed by the buyer in the sale. Id. at 15. However, Peak argues that because it had already taken the deposit amounts into income for tax purposes, it was entitled to deduct the amount of the deposits without first including them in its amount realized on the sale of the assets. Id. at 16-23. Peak further argues that it fulfilled the "economic performance" requirement for deductibility under the section 461 regulations either because it already recognized those amounts as taxable income, or because the "selling group (including both PPT(CAN) and petitioner)" recognized those amounts in income at the time of the sale. Id. at 26.
Peak's assertions regarding its income tax reporting for 2011
In the declaration of Harvey Eker (Doc. 18, para. 19), Peak explains its reporting of only $1 million of capital gain from the sale of the business assets as follows:
The Commissioner disputes the purported facts recited in Mr. Eker's declaration, raising objections based on hearsay, lack of personal knowledge, and credibility (ie, the statements are" self-serving"), and further pointing out that the declaration is contracted by the documentary evidence that Peak submitted in support of its motion. (Doc. 22 at 6-8). These arguments are addressed below in part I.
When allocating the total purchase price between PPT(CAN), [Peak], and the smaller affiliate entities, it was determined that only a portion ($1 million) of the total purchase price could be allocated to [Peak] as sale of its goodwill. This allocation made sense because [Peak]'s role was that of a mere logistics and fulfillment agent--the bulk of the value lay in the intellectual property rights and goodwill held by PPT(CAN).
Mr. Goyal further explained (Doc. 19, para. 22) how this amount was derived as follows:
The Commissioner also disputes these assertions by Mr. Goyal, see n. 7, supra. We assume for purposes of this motion that Peak did not include $6,594,610 (the amount of its customer deposits) in its amount realized when Peak calculated its gain on the sale of its business assets--attributable to goodwill or otherwise.
[Peak] reflected $1 million as proceeds from the sale of "goodwill" on its 2011 federal income tax return (via Form 4797), the amount of which was arrived at by estimating the average profit [Peak] historically realized on its net revenue (which was approximately 15%), and multiplying that by the amount of outstanding customer deposits. This computation reflected the value [Peak] brought to the selling group by providing logistics services.
Peak's assertions regarding PPT(CAN)'s 2011 income tax return
Peak further contends that "[t]he 'goodwill' amount, which was calculated by reference to the approximately $7.7 million worth of advanced deposits, was included in full by PPT(CAN) as income from the sale of "goodwill" on its Canadian income tax return." (Doc. 19 at para. 21). The Commissioner has filed with his response a copy of PPT(CAN)'s Canadian "T2 Corporation Income Tax Return" for 2011, and it is yet unclear which items reported on the return (if any) correspond with the "approximately $7.7 million worth of advanced deposits". We note that the Commissioner has outstanding discovery requests with respect to these items, but we also conclude, as explained below in part III.C., that PPT(CAN)'s income tax reporting to the Canadian tax authorities has little bearing on Peak's reporting to the IRS of Peak's gain on the sale of substantially all of its business assets. (Doc.35 at 109-110).
Payment toward purported loan from Peak to PPT(CAN)
In the declaration of Sudeep Goyal (Doc. 19) filed with its motion, Peak explained the purported economics of the non-transfer of $6,594,610 in customer deposits and the alleged impact it had on an inter-company loan receivable due to it from PPT(CAN) as follows:
The Commissioner disputes this characterization and advances the same objections to the Declaration of Sudeep Goyal that we explained at note 7, supra.
23. While NewPeaks was treated as having received the amounts reflected in [Peak]'s customer deposit account in order to make its payment for "goodwill" to the selling entities, no funds were actually transferred from [Peak] to NewPeaks. Instead, in conjunction with the transfer, [Peak] eliminated its customer deposit accounts and reduced the amounts PPT(CAN) owed [Peak] by the amount reflected in the customer deposit accounts at the time of sale, which was $6,594,610. [Emphasis added].
24. Rather than have [Peak] (and others) transfer millions of dollars (i.e., the amount of the customer deposit accounts) to NewPeaks, and then have NewPeaks transfer an equivalent amount of money back to the selling entities (principally, PPT(CAN)), the transactional lawyers recommended that the offsetting obligations between [Peak] and PPT(CAN) (on one hand) and [Peak] and NewPeaks (on the other) be simply netted.
25. This re-arrangement of rights resulted in [Peak] becoming $6.5 million poorer, as it reduced the intra-company receivables. However, this did not change the economics or tax treatment of the deal because [Peak] no longer held customer deposit accounts and held approximately $6.5 million less in an asset account (i.e., the amount owed to it by PPT(CAN) was reduced), and PPT(CAN) reported the amounts related to [Peak]'s customer deposit accounts as additional income from the sale of their business good will to NewPeaks. [Emphasis added].
At the time that Peak filed its motion, it represented (in Mr. Goyal's declaration, para. 15) that the opening balance of the loan that PPT(CAN) owed to Peak as of the beginning of tax year 2011 was "in excess of $12 million dollars". In its motion Peak did not mention or account for any debt obligation that Peak owed to PPT(CAN).
The Commissioner's response to Peak's motion
The Commissioner filed an objection to Peak's motion arguing that summary judgment is not appropriate because material facts remain in dispute, and further objecting to the sufficiency of the declarations that Peak submitted to establish such facts in support of its motion. The Commissioner lists the material facts in dispute as follows (Doc. 24 at 4-5):
(1) Whether the Asset Purchase Agreement * * * treated petitioner as being obligated to pay NewPeaks $6,594,610 related to customer deposits.
(2) Whether the Agreement obligated NewPeaks to pay PPT Canada $6,594,610 related to customer deposits.
(3) How PPT Canada and petitioner actually reported the sales transaction on their respective 2011 tax returns.
(4) Whether petitioner was $6,594,610 "poorer" as a result of the sale.
(5) Whether there was a loan or receivable that PPT Canada owed petitioner.
(6) Whether the $1 million of "goodwill" reported on petitioner's 2011 Form 4797, Sales of Business Property, was in connection with the sale to NewPeaks.
The Commissioner responds to Peak's legal arguments regarding the deductibility of the approximately $6.5 million in customer deposits by arguing that Peak is not entitled to a deduction because it did not satisfy the economic performance requirement of section 461(h) , asserting that Peak "had not incurred any costs with respect to the deferred service liability prior to the asset sale", and citing in support section 461(h)(2)(B) and 26 C.F.R. section 1.461-4(d)(4)(i). More pertinent is the Commissioner's argument that section 1.461-4(d)(5)--not section 1.461-4(d)(4)(i)--applies where the deduction the taxpayer seeks occurs with the sale of a trade or business. Section 1.461-4(d)(5) expressly requires the taxpayer (i.e., Peak, not PPT(CAN)) to include the liability in its amount realized in order to be entitled to the corresponding deduction, which the Commissioner contends that Peak did not do. (Doc. 15 at 20.)
"For purposes of this title, in determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs * * * If the liability of the taxpayer requires the taxpayer to provide property or services, economic performance occurs as the taxpayer provides such property or services." Sec. 461(h)(1), (2)(b).
Peak's reply
Peak reiterates many of its arguments in its reply and contends that the material facts upon which its motion is based are not in dispute. In particular, Peak asserts that the Commissioner "does not dispute that Petitioner's intercompany amount receivable from PPT(CAN) was reduced by $6,594,610" (though the Commissioner's enumeration of disputed facts includes the existence of the loan itself). Further, Peak revises the amount of the outstanding receivable at the start of 2011, saying that $8.9 million was the outstanding balance on the loan amount due to it from PPT(CAN), which "is still in excess of the $6,594,610 reduction" it says it made later that year "in connection with the sale" (Doc. 37 at 10-11). Peak now contends that the transfer of customer deposit account balances (accomplished by reducing the loan owed to it by PPT(CAN)) occurred "prior to the sale of assets to New Peaks, LLC", and offers in support unaudited financial statements of PPT(CAN) and what appears to be an excerpt of its internal (and unaudited) journal entries in support of this contention. Peak argues that "[t]his transfer of the customer deposits account by means of an adjustment to an inter-company loan account constitutes 'economic performance'" for purposes of the all events test of section 461, and cites 26 C.F.R. sec. 1.461-4(g)(1)(ii)(A) and 1.461-4(c)(2) for the proposition that "economic performance can be accomplished by a netting of offsetting accounts." Peak argues that their "purpose in making this adjustment * * * was to ensure that its customer obligations would be taken care of by in effect giving PPT(CAN) almost $6.6 million." (Doc. 37 at 15-16.) In effect, Peak argues that it paid PPT(CAN) to assume the obligation to deliver services associated with the customer deposit account before the sale of its business assets to NewPeaks.
Additional documentation of intercompany loans
Peak submitted with its reply an "excerpt from Petitioner's internal financial statements for 2011 reflecting transactions in an intercompany account with PPT(CAN)", which describes the credit of the $6,594,610 as made "[t]o record the transfer of customer deposits to PPT prior to sale of assets to NewPeaks LLC". Also of note on the excerpt is a debit against the balance of the loan in the amount of $1,000,000 described as made "[t]o record the sale of assets to NewPeaks LLC" (Doc. 39 at 15.) The dates on each of these journal entries is December 31, 2011. Accounting for additional items, the net change to the outstanding loan amount of $12,794,721 during the year was ($4,823,668), resulting in a balance remaining at year-end of $7,971,052.
Peak also submitted a second declaration of Mr. Goyal (Doc. 38) to "explain and elaborate" on his prior statement regarding the amount of the outstanding loan that PPT(CAN) owed to Peak at the beginning of 2011:
2. My earlier statement was based on the PPT(CAN) loan receivable account from [Peak]'s financial statement, which reflected an amount of $12,886,693.19 of outstanding loan receivables as of the end of the 2010 year. My statement did not take into account amounts payable from [Peak] to PPT(CAN) reflected elsewhere on the financial statement in the amount of $3,971,872.21. While Peak in fact had in excess of $12 million of loan receivables from PPT(CAN) as of the end of 2010, PPT(CAN)'s net obligation to [Peak] was only $8,914,820.98. [Peak] reported $8,914,820.98 as the amount of inter-company debt between it and PPT(CAN) as of the start of the year on its 2011 Form 5472.
Attached as an Exhibit to Mr. Goyal's second declaration is a copy of an unaudited financial statement of PPT(CAN) containing a balance sheet for the company as of December 31, 2011. PPT(CAN)'s unaudited balance sheet shows that the opening balance(s) on outstanding loan(s) from PPT(CAN) to related parties at the beginning of 2011 were $12,134,100, which increased to $19,625,123 by the end of 2011 (for a net increase in the amount of money owed to PPT(CAN) that was "due from related parties" of $7,491,023). It also showed that the opening balance(s) on amounts "due to related parties" from PPT(CAN) at the beginning of 2011 were $9,491,836, which decreased to $9,084,555 by the end of 2011 (for a net decrease of $407,281). In addition to the balance sheet, the Exhibit contains an income statement and numerous pages of journal entries for the calendar year of 2011. No individual item in any of these documents shows $6,594,610 of liability relief from Peak at any time, let alone prior to the sale of business assets. We are unable to reconstruct from these documents Mr. Goyal's calculations as expressed in his second (or first) declaration.
Nor is it necessary to parse this information; even if it supports the unaudited financial statement, it presents a factual conflict-i.e., a "genuine dispute of material fact"--with Peak's own prior account of the facts supporting the loans running between it and PPT(CAN).
The Commissioner's sur-reply
The Commissioner argues that Peak has raised a new theory in its reply by arguing that it transferred the approximately $6.5 million in customer deposits (and the obligation to deliver the services associated with those deposits) to PPT(CAN) prior to the sale, and points out that Peak stated in its petition and motion that those customer deposits were in its own account at the time of the sale--i.e., Peak's previous position was that it transferred the deposits and the "obligations" associated therewith to NewPeaks at the time of the sale, not to PPT(CAN) before the sale. (Doc. 42 at 3-4.) The Commissioner asserts that the regulation upon which Peak now relies in its response, section 1.461-4(d)(5), no longer applies in the context of Peak's new theory, and moreover that the new theory is based on facts that are in conflict with the facts Peak recited in its motion. However, the Commissioner maintains his position that section 1.461-4(d)(5) applies in this instance, and therefore Peak's failure to include the amount of customer deposits in its amount realized precludes it from taking a deduction in that amount.
Discussion
I. Summary judgment
The purpose of summary judgment is to expedite litigation and avoid unnecessary trials. Fla. Peach Corp. v. Commissioner, 90 T.C. 678, 681 (1988). The Court may grant summary judgment when there is no genuine dispute as to any material fact and that a decision may be rendered as a matter of law. Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff'd, 17 F.3d 965 (7th Cir. 1994). Under Rule 121(b), we evaluate "the pleadings, answers to interrogatories, depositions, admissions, and any other acceptable materials, together with the affidavits or declarations" to determine if a genuine dispute of material fact exists.
Supporting and opposing affidavits or declarations shall be made on personal knowledge, shall set forth such facts as would be admissible in evidence, and shall show affirmatively that the affiant or declarant is competent to testify to the matters stated therein. Sworn or certified copies of all papers or parts thereof referred to in an affidavit or a declaration shall be attached thereto or filed therewith.Rule 121(d). Conclusory, nonspecific statements in affidavits are not sufficient, and missing facts will not be presumed. Lujan v. Nat'l Wildlife Fed'n, 497 U.S. 871, 888-889 (1990).
We hold that the declarations Sudeep Goyal do not show that they are made on personal knowledge, so Peak cannot rely on that declaration in its motion for partial summary judgment. See Celanese Corp. & Consol. Subsidiaries v. United States, 9 Cl. Ct. 45, 48-49 (1985) (The requirement that an affidavit submitted in support of summary judgment "'shall show affirmatively' that the affiant is competent to testify as to the matters stated therein" is not met by the affiant's mere conclusory statement asserting personal knowledge). We hold that Mr. Goyal's assertion that he was an employee of the accounting firm who assisted with Peak's account, but that he was "not directly responsible for [Peak's] account", is insufficient to show personal knowledge of many of the factual assertions in his declarations (Docs. 19 and 38), particularly those that describe and characterize the intercompany relations between Peak and PPT(CAN). Insofar as his declaration characterizes Peak's tax reporting for 2011, we find that the 2011 tax return speaks for itself. We nevertheless address below Mr. Goyal's declarations, not because we adopt the facts asserted therein, but for the purpose of illustrating manifest disputes of material fact.
As to the declaration of Harvey Eker, the founder of PPT(CAN) and sole director of Peak, we hold that, to the extent his declaration seeks to characterize or recast the transaction memorialized in the Agreement, such characterizations are mere evidence of his subjective perspective or intent. At best, and only if relevant, such characterizations may create an issue of fact necessitating a trial. See Charlotte Aircraft v. Commissioner, T.C. Memo 1997-124 at *4 (citing Preece v. Commissioner, 95 T.C. 594 (1990)). But Mr. Eker's characterizations of the transaction cannot correct or Overcome the Agreement so as to support Peak's motion for summary judgment.
In deciding whether to grant summary judgment, Rule 121 requires that we draw factual inferences in the light most favorable to the non-moving party, Sundstrand Corp. v. Commissioner, 98 T.C. at 520--in this instance, the Commissioner. For Peak to prevail on its motion for partial summary judgment, it would need to show that there is no genuine dispute as to the material facts that would be necessary to its demonstrating, as a matter of law, that Peak is entitled to the deduction of almost $6.5 million of liabilities associated with the customer deposit account.
II. Deductibility of liabilities for an accrual-method taxpayer
Section 461(a) provides that "[t]he amount of any deduction or credit allowed by this subtitle [A, "Income Taxes"] shall be taken for the taxable year which is the proper taxable year under the method of accounting used in computing taxable income." For a taxpayer (like Peak) that uses the accrual method of accounting, an otherwise allowable expense is generally allowed as a deduction for the year the taxpayer incurred the expense, irrespective of the date of payment. Whether a business expense (e.g., a deduction under section 162 for an ordinary and necessary expense of carrying on a trade or business) has been "incurred" is determined by the "all events test" as set forth in 26 C.F.R. section 1.461-1(a)(2)(i), which provides:
The parties agree that Peak uses an accrual method of accounting, and the Commissioner does not dispute Peak's assertion that the approximately $6.5 million in customer deposits at issue "had already been taken into income for [federal] tax purposes" (Doc. 17 at 6); rather, he argues that this is irrelevant to the issue of the tax consequences of the sale of business assets at issue. (Doc. 22 at 30.)
Under an accrual method * * * a liability * * * is incurred, and generally is taken into account for Federal income tax purposes, in the taxable year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and economic performance has occurred with respect to the liability. * * *See Caltex Oil Venture v. Comm'r, 138 T.C. 18, 23 (2012) (citing United States v. Gen. Dynamics Corp., 481 U.S. 239, 242-243 (1987)). The Commissioner concedes the first two elements of this test (Doc. 22 at 15) but disputes that Peak has met the requirement of economic performance.
For purposes of satisfying the economic performance requirement, "[i]f the liability of the taxpayer requires the taxpayer to provide property or services, economic performance occurs as the taxpayer provides such property or services." Sec. 461(h)(2)(B). Moreover, economic performance occurs "as the taxpayer incurs costs (within the meaning of § 1.446-1(c)(1)(ii)) in connection with the satisfaction of the liability." 26 C.F.R. sec. 1.461-4(d)(4)(i), Income Tax Regs. For these purposes, "liability" is a broad term that "includes any item allowable as a deduction, cost, or expense for Federal income tax purposes--including "any amount otherwise allowable as a capitalized cost, as a cost taken into account in computing cost of goods sold, as a cost allocable to a long-term contract, or as any other [otherwise allowable] cost or expense." 26 C.F.R. sec. 1.446-1(c)(1)(ii)(B).
Peak argues that the customer deposits are "liabilities" because they correspond to obligations to customers for future services--indeed, the Agreement for the purchase of Peak's business assets listed the customer deposit account (deposits totaling $7,740,559) on the schedule of "First Closing Assumed Liabilities". But this characterization does not make it so. The record establishes that the customer deposits are just that--deposits. If anything, the $6.5 million in deposits demonstrates the amount of payments that Peak had received from its customers (part of the gross receipts of the business), but there are no values in the record associated with the costs of delivering the services for which Peak's customers had paid. Peak acknowledges this much in its motion in its explanation of how it arrived at the $1 million of capital gain it reported for the sale of "goodwill" (based on the amount of customer deposits) in 2011: "The $1 million reported by Petitioner as income from the sale was calculated by estimating the average profit Petitioner historically realized on its net revenue, which was approximately 15%, and multiplying that by the amount of customer deposits outstanding." (Doc. 17at 9, n.5.) An estimation of average profit is not evidence supporting the amount of the costs of delivering the services for which Peak's customers had prepaid that remained outstanding at the time of the sale. (And even if this estimate were accurate, it would support a deduction of $5.525 million (i.e., $6.5 million less 15% of $6.5 million), which is not what Peak reported on its return.)
Alternatively, it would appear under Peak's theory that it deducted costs associated with the customer deposits twice: first against its amount realized on the sale of "goodwill" of $6.5 million (estimating such costs at 85% thereof), which resulted in Peak reporting capital gain of only $1 million, and again when it reduced its gross receipts for 2011 by an additional $6.5 million.
The Commissioner responds to Peak's legal arguments regarding the deductibility of the approximately $6.5 million in customer deposits by arguing that Peak is not entitled to a deduction because it did not satisfy the economic performance requirement of section 461(h), asserting that Peak "had not incurred any costs with respect to the deferred service liability prior to the asset sale", and citing in support section 461(h)(2)(B) and 26 C.F.R. section 1.461-4(d)(4)(i). We agree that viewing the evidence in the light most favorable to the Commissioner yields the conclusion that Peak has not met its burden on summary judgment to show that it incurred costs associated with the deferred service liability. As we explain below, we agree with the Commissioner that section 1.461-4(d)(5) applies to determine the tax consequences to Peak of the sale of its business assets, and that the facts necessary to support a deduction under this regulation are in dispute.
"For purposes of this title, in determining whether an amount has been incurred with respect to any item during any taxable year, the all events test shall not be treated as met any earlier than when economic performance with respect to such item occurs * * * If the liability of the taxpayer requires the taxpayer to provide property or services, economic performance occurs as the taxpayer provides such property or services." Sec. 461(h)(2)(b).
III. Deductibility of liabilities in connection with the sale of a business by an accrual method taxpayer
A. General rule
Generally "if, in connection with the sale or exchange of a trade or business by a taxpayer, the purchaser expressly assumes a liability arising out of the trade or business that the taxpayer but for the economic performance requirement would have been entitled to incur as of the date of the sale, economic performance with respect to that liability occurs as the amount of the liability is properly included in the amount realized on the transaction by the taxpayer". 26 C.F.R. sec. 1.461-4(d)(5)(i). According to Peak (and undisputed by the Commissioner), the assets sold under the Agreement "included all of the business assets of PPT(CAN) and Petitioner [Peak], as well as the assets owned by several smaller affiliated entities." (Doc. 17 at 6.) Peak does not contend that it did not sell a "trade or business" within the meaning of section 1.461-4(d)(5)(ii). Rather, it argues that the "liabilities" at issue need not be included in Peak's amount realized on the sale of the business assets because the prepayments had already been subject to income tax in previous years under its method of accounting.
B. Capital vs. income transaction
Peak relies primarily on James M. Pierce Corp. v. Commissioner, 326 F.2d 67, 69 (8th Cir.1964), in which the taxpayer, upon a sale of substantially all of its business assets, was required to accelerate income recognition of previously untaxed amounts held in a reserve account corresponding with its obligations to deliver permanent newspaper subscriptions to its customers. Rather than pay the purchaser of the business assets to assume the liability associated with the deferred revenue, the purchase price was reduced by a corresponding amount. Id. at 69-70. The court held that the taxpayer should be treated as if it paid the purchaser an equivalent amount as compensation for assuming the obligation to perform the services (thus generating a deduction to the taxpayer under Section 162). Id. at 72. Critical to the court's analysis is the fact that the income component of the transaction was separate from the consequences of the capital transaction (which constituted a tax-free liquidation under the version of section 337 then in effect). See id. at 71-72. Accordingly, the Pierce court did not reach the question of whether, in a taxable capital transaction such as the sale of business assets at issue here, the liability relief should be included in the seller's amount realized.
Though the tax consequences to the purchaser were not at issue, the Pierce court did note that this treatment would likely result in the purchaser realizing income in an amount corresponding with this deemed payment (against which it would later deduct the liabilities it assumed from the seller). James M. Pierce Corp. v. Commissioner, 326 F.2d at 72; see also Rev. Rul. 71-450.
The other case upon which Peak relies, Commercial Security Bank v. Commissioner, 77 T.C. 45 (1981), reaches a similar result regarding a taxpayer using a cash method of accounting who sold its business assets in connection with a section 337 (tax-free) liquidation. However, in doing so the Tax Court noted:
* * * there can be no question but that the "accrued interest receivables" were properly included in * * * [the seller]'s income for its last taxable year * * * It is also beyond question (and petitioner does not argue otherwise) that the amount of the "accrued business liabilities" would, but for the impact of section 337, have been taken into account in computing * * * [the seller]'s gain or loss from the sale. Crane v. Commissioner, 331 U.S. 1 (1947). But it does not necessarily follow that those liabilities are deductible. That, as we see it, is a separate issue.Commercial Security Bank v. Commissioner, 77 T.C. at 148-149. While the Tax Court did go on to hold that the liabilities were deductible in that case, its analysis of the capital transaction at issue contemplates that in a taxable transaction (like Peak's), the seller's liability relief would have to be taken into account as an increase in its amount realized for purposes of computing gain or loss on the transaction. This result is consistent with 26 C.F.R. section 1.461-4(d)(5).
Moreover, Peak does not contend that under the Agreement, the purchase price was reduced to account for the purchaser's assumption of the obligation to deliver services associated with the customer deposits (as it was in Pierce and Commercial Security Bank). Rather, the purchaser in the Agreement was given a "credit" toward the purchase price, and Peak contends that the amount of the credit (which was equivalent to the amount of the customer deposits) was included in the amount realized of the "selling group". Peak has failed to successfully show that Peak (rather than another member of the "selling group") included the amount corresponding with the deduction it claimed in its amount realized on the sale.
C. Anticipatory assignment of income doctrine
We have assumed for purposes of Peak's motion that "selling group" means Peak, PPT(CAN), and the other smaller affiliated entities who are all, collectively, the "Seller" under the Agreement. Moreover, Peak argues that it did not have to recognize the $6.5 million associated with its customer deposits because PPT(CAN), and not Peak, included the amount of the customer deposits in its amount realized under the Agreement. But the tax consequence to PPT(CAN) on the sale of business assets is not controlling where Peak, an entirely separate taxpayer, seeks to claim the deduction associated with the credit that PPT(CAN) reported to an entirely separate taxing authority. As the Commissioner points out, PPT(CAN) is a foreign corporation that, for 2011, had no income effectively connected with a trade or business in the United States, and therefore PPT(CAN) is not a taxpayer subject to U.S. income tax, see 882(b); 7701(a)(14). (Doc. 22 at 20.) The Commissioner accordingly argues that PPT(CAN)'s inclusion of the deposits in its amount realized would not satisfy the requirement of 26 C.F.R. section 1.461-4(d)(5)(i) that "the liability is properly included in the amount realized on the transaction by the taxpayer". We agree.
The undisputed facts show that PPT(CAN) filed a Canadian income tax return for 2011 reporting all of the gain on the sale of its business assets, and that any business that the "selling group" conducted in the United States was performed by Peak, a C corporation. Because we draw all inferences in favor of the Commissioner, and because no facts support the assertion that PPT(CAN) was subject to United States income tax for 2011 (nor does any party contend that it was), we must assume that PPT(CAN) was not a "taxpayer" within the meaning of 7701(a)(14) for 2011.
But more to the point, Peak has made no argument or explanation as to why it should be permitted to, in effect, assign its income to PPT(CAN) with the consequence of Peak's avoiding the tax associated with that income when the "credit" for the "liability relief" was unambiguously consideration exchanged for specific customer deposits, $6.5 million of which belonged to Peak. "A person cannot escape taxation by anticipatory assignments, however skillfully devised, where the right to receive income has vested." Rauenhorst v. Commissioner, 119 T.C. 157, 163-164 (2002) (quoting Harrison v. Schaffner, 312 U.S. 579, 582 (1941)). The anticipatory assignment of income doctrine ensures that income is taxed "to those who earn or otherwise create the right to receive it and enjoy the benefit of it when paid." Helvering v. Horst, 311 U.S. 112, 119 (1940). Further, "the mere assignment of the right to receive income is not enough to insulate the assignor from income tax liability" where "the assignor actually earns the income or is otherwise the source of the right to receive and enjoy the income". Commissioner v. Sunnen, 333 U.S. 591, 604 (1948), quoted in Rauenhorst v. Commissioner, 119 T.C. at 163. A taxpayer "cannot avoid taxation by entering into a contractual arrangement whereby that income is diverted to some other person or entity." United States v. Basye, 410 U.S. 441, 449 (1973).
Peak does not deny that it collected the customer deposits for services that Peak was contractually obligated to render (and that it paid income tax on the deposits under its method of accounting); it cannot therefore contractually foist onto PPT(CAN) the amount realized that was associated with the relief of that liability, particularly when it seeks to claim the corresponding deduction under the relevant regulations. We accordingly find meritless Peak's argument that PPT(CAN)'s alleged inclusion on its Canadian tax return of the $6.5 million in customer deposits in PPT(CAN)'s amount realized is sufficient to meet the requirements of section 1.461-4(d)(5)(i).
D. Allocation of amount realized
Generally when a taxpayer engages in an "applicable asset acquisition" in which it sells all of its assets constituting a trade or business, and the purchaser's basis in those assets "is determined wholly by reference to the consideration paid for such assets", sec. 1060(c), then:
for purposes of determining both-
(1) the transferee's basis in such assets, and
(2) the gain or loss of the transferor with respect to such acquisition,
the consideration received for such assets shall be allocated among such assets acquired in such acquisition in the same manner as amounts are allocated to assets under section 338(b)(5).Section 1060(a). "A group of assets constitutes a trade or business if * * * [i]ts character is such that goodwill or going concern value could under any circumstances attach to such group." 26 C.F.R. section 1.1060-1(b)(2), Income Tax Regs. For any such applicable asset acquisition, "sellers and purchasers must allocate the consideration under the residual method as described in §§1.338-6 and 1.338-7 in order to determine, respectively, the amount realized from, and the basis in, each of the transferred assets." Id. at sec. 1.1060-1(a).
The residual method described in the section 338 regulations breaks down the assets sold into seven classes (I through VII) and provides that the consideration exchanged in the transaction is first reduced by the amount of Class I assets (consisting of cash and general deposit accounts) before being allocated among Classes II through VI in proportion to the fair market value of the assets in those respective classes, and then finally, if any unallocated consideration remains, to Class VII. 26 C.F.R. sec. 1.338-6(b)(1), (2). Class VII consists of "goodwill and going concern value" (all other section 197 intangibles make up class VI). Id. at sec. 1.338-6(b)(2)(vi), (vii). The residual method helps to ensure that a sale of an asset classified as business goodwill is not actually based on the value of some other business asset(s) sold; the purchaser generally desires goodwill over assets in other classes because of its often shorter amortization period; and a purchaser may prefer that a section 197 intangible be classified as goodwill to achieve capital gain over ordinary income treatment. See Complex Media, Inc. v. Commissioner, T.C. Memo. 2021-14, at *89-*91, n.28 (and authorities cited therein); Kennedy v. Commissioner, T.C. Memo. 2010-206 (holding that payments purportedly allocated to goodwill by contract and therefore claimed as capital gains were in fact consideration paid for services includable in the selling taxpayer's ordinary income).
The Agreement defined the portion of the First Closing Purchase Price corresponding with the amount of the customer deposits as "goodwill". The only gain on the sale ($1 million) that Peak reported on its 2011 return was for "goodwill" in which Peak reported no tax basis. The terms of the Agreement do not clearly allocate the purchase price between the selling entities, nor does the record contain any additional information as to whether Peak (not PPT(CAN)) allocated any portion of the consideration it received in the sale to anything other than a purported $1 million item of self-created goodwill. It appears that under the Agreement Peak sold multiple assets of its own which would be classifiable as assets other than goodwill. Because goodwill is the residual class to which consideration is allocated last under section 1060, Peak's characterization of the sale proceeds on its tax return appears inaccurate or incomplete. (At a minimum, it appears to be at odds with the transaction as set forth in the Agreement.)
Accordingly, we hold that a genuine dispute exists regarding the facts concerning Peak's amount realized on the sale generally, and with regard to whether Peak's amount realized on the sale included the amount of the liabilities corresponding with the obligation to perform services related to the customer deposits in Peak's customer deposit account.
IV. Impact of intercompany liabilities running between Peak and PPT(CAN)
In its reply, Peak pivots from focusing on whether it either met, or should legally be relieved of, the obligation to include the amount of the customer deposit liabilities in its amount realized in order to be entitled to a section 162 deduction for those liabilities at the time of the sale, to arguing that it satisfied economic performance in any event by transferring those liabilities to PPT(CAN) prior to the sale. Even if we were to entertain Peak's argument that the reduction of an intercompany loan that PPT(CAN) owed to it in the amount of the customer deposit account constituted economic performance, the facts regarding the amount of the loan and the implications of any offset amounts of intercompany loans running from Peak to PPT(CAN) are not adequately demonstrated. As the Commissioner points out, bookkeeping entries "are no more than evidential, being neither indispensable nor conclusive." Doyle v. Mitchell Brothers Co., 247 U.S. 179, 187 (1918). The substance of a transaction must be determined from the facts surrounding the transaction rather than from bookkeeping entries. See, e.g., Southern Pacific Transportation Co. v. Commissioner, 75 T.C. 497, 832-833 (1980). Peak's internal documents are thus insufficient to establish these facts, and even those documents contain material contradictions that we cannot resolve on summary judgment.
For the reasons we expressed in part III.C above, we find this economic performance argument to be of doubtful merit.
Finally, we observe that Peak's argument with respect to forgiveness of PPT(CAN)'s debt prior to the sale--newly raised in its reply--appears to be an effort to recast the substance of the transaction despite its chosen form. "[I]t is ultimately up to the taxpayer and not the courts to structure transactions in a manner eligible for favorable tax treatment". See Lomas Santa Fe, Inc. v. Commissioner, 693 F.2d 71, 73 (9th Cir. 1982) (citing Commissioner v. National Alfalfa Dehydrating & Milling Co., 417 U.S. 134, 148-149 (1974)).
In conclusion, we find that material facts are in dispute regarding: (1) the amount of the liabilities accrued in respect of the customer deposits at the time of the sale; (2) Peak's amount realized in the sale; and (3) the existence of any inter- company loans that would have impacted the analysis of the tax consequences of the sale.
In consideration of the foregoing, it is
ORDERED that petitioner's motion for partial summary judgment is denied. It is further
ORDERED that the parties shall file a joint status report (or separate reports, if expedient) on or before September 10, 2021, setting forth the issues remaining for trial.