Pending Merger Required to be Considered in Valuing Stock

In Chief Counsel Advice, the IRS concluded that in valuing a gift of publicly traded stock to a grantor retained annuity trust, the announcement of a merger shortly thereafter after the gift must be factored into the valuation.

FACTS: A taxpayer who was a co-founder and Chairman of the Board of a publicly traded corporation gifted shares of stock of the company to a newly-formed grantor retained annuity trust. After the transfer date, the corporation announced its merger with another corporation. Prior to the gift date, the corporation had undergone negotiations with multiple parties and on the gift date had been engaged in exclusive negotiations with the corporation that was the subject of the merger announcement. The IRS determined that the pending merger should have been considered in arriving at the value of the gifted stock.

COMMENTS:

A common issue in income and transfer tax planning is whether post-transaction events should impact the value of the subject asset. Oftentimes, there are subsequent events that in hindsight appear appropriate to the valuation, such as a post-transaction sale, merger, or business announcement. The planner and appraiser have the difficult task to determine the necessity of inclusion of such on-the-horizon events in valuation, and what weight to give them.

In determining that the merger announcement should be considered, the IRS relied on several valuation maxims, interpretations and precedents that practitioners should give consideration to. These include:

     (a) In applying the willing buyer and willing standard for valuation (here, as provided in Treas. Regs. § 25.25.12-1), a willing buyer and seller are presumed to have reasonable knowledge of relevant facts affecting the value of the property at issue, even if the facts are unknown to the actual owner.

     (b) Both parties are presumed to have made a reasonable investigation of the relevant facts. Thus, in addition to facts that are publicly available, reasonable knowledge includes those facts that a reasonable buyer or seller would uncover during the course of negotiations over the purchase price of the property. Moreover, a hypothetical willing buyer is presumed to be “reasonably informed” and “prudent” and to have asked the hypothetical willing seller for information that is not publicly available.

     (c) While publicly traded stock is generally valued based on the average of the highest and lowest selling price on the day of the transfer, if such prices do not represent the fair market value then a modification of the value is required. Treas. Regs. § 25.2512-2(e).

     (d) In Silverman v. Commissioner, T.C. Memo. 1974-285, aff'd, 538 F.2d 927 (2d Cir. 1976), cert. denied, 431 U.S. 938 (1977), the petitioners gifted shares of preferred stock while in the process of reorganizing with the intent to go public. The Tax Court rejected the expert testimony presented by the petitioners because the expert failed to take into account the circumstances of the future public sale.

     (e) In Ferguson v. Commissioner, 174 F.3d 997 (9th Cir. 1999), aff'g 108 T.C. 244 (1997), an assignment of income case, a transfer of shares was undertaken in stock of a corporation after an investment firm had located a purchaser for the corporation, a merger agreement had been entered into, and a tender offer was underway. The court concluded that the shares were transferred after the shares had ripened from an interest in a viable corporation into a fixed right to receive cash and the merger was “practically certain” to go through, and therefore applied the assignment of income doctrine to tax the transferor on the gain from the tender offer exchange that occurred after the transfer.

Various rules of thumb and factual inquiries are employed by taxpayers and the IRS in determining how to apply post-transfer events. One important element is time – how long after the subject transfer did the post-transfer event occur. Unfortunately, in the subject CCA, the date information that would advise of the time period between the gift and the merger announcement was redacted. Another factor is whether the subsequent event was contractually committed – again, the facts here do not disclose whether the merger was irrevocably committed to occur at the time of the gift. The CCA also demonstrates the similarity of inquiry that can exist between transfer tax valuations, and whether an assignment of income occurs as to a sale event that occurs after property is transferred.

Just because a subsequent event should be considered does not mean a tender or purchase price should be fully substituted for other measures of value. Case law typically requires that such events be considered in the valuation, but what weight should be given is always a facts and circumstances test. Of course, one important factor in such valuation should be the likelihood that the post-transfer event will occur, as measured on the date of transfer. This circles back to questions including whether the post-transfer event is the subject of a binding contract or agreement, and even then questions of whether the contract will close due to contractual contingencies and other applicable facts should be considered.

Chief Counsel Advice 201939002, September 27, 2019