An interesting article by Steven M. Davidoff appeared in today's NYT discussing a First Circuit Court of Appeals case here, is worth a serious read and some serious thought for those Kossacks who are discussing making all, or some, capital gains taxable as income, and a terrible loss for venture capitalists like Bain, which is not the company in the case but whose internal activities are familiar to readers of diaries here during the 2012 campaign as to the mechanics of how vulture capitalists operate.
This possible loss, since the case is not over, is of two sorts, one the one which was litigated. The other is a peculiarity of the law that precisely the same statutory language as was used to sink the vulture capitalist over against the Teamsters and Trucking Pension Fund also appears in the Internal Revenue Code, to determine whether the income or benefits to certain sorts of companies or individuals, the kind we know as vulture capitalists, are taxable as INCOME! not capital gains only.
The case is also a victory for the New England Teamsters and Trucking Industry Pension Fund against a vulture capitalist company whose specialty is distressed companies, and who was trying, in a bankruptcy case, to avoid itself having to pay sums due for workers of a company the vulture capitalists got themselves involved in, and which went into bankruptcy, in part to get rid of pension fund liablity to the Teamsters and PBGIC, the governmental insurors of pension funds of bankrupt companies. Sound familiar?
For those here who have cursed long and harshly the venture capital firms which prey on companies in difficulty, and then crow when they fire employees, close plants, kill benefit plans, collect large management and consultancy fees owed by the victim while doing it, and then the company so butchered heads back out into the market free of all of those burdens, and then the vulture claims capital gains treatment for everything it got out of the process, this is a wonderful case.
It does not hurt that the vulture made the argument that structuring and taxing deals of this kind in the way it claims as correct is good for the economy, because it cleans up troubled companies and makes the economy stronger. That argument died very quickly, squashed by the Court.
The case is from the First Circuilt Court of Appeals, feds, in Boston, which means it's not going away any time soon, and the text of the case indicates that the decision here is an outgrowth of at least a Seventh Circuit decision and other cases, rather than a unique oddball. The decision is also unusually clear in its writing which gives the ordinary Kossack a clearer than usual picture of the situation.
The issue presented is whether the vulture capital company was a 'passive investor' in the company which was tanked, or whether it was more, whether it got benefits that passive investors did not get, an 'investor plus' theory in the terms of these sort of litigations, and whether that meant it was in a 'trade or business' although it used affiliates between itself and the soon to be bankrupt company, and it itself had no officers, employees or offices. The object of the litigation was for the vulture to avoid having to pay withdrawal fees for the Teamsters Pension Fund as it tried to eliminate the pension plan for its target. The Teamsters and PBGIC fought back. The vulture lost on that point and was held a 'trade or business.'
The test the court was using was whether the vulture was a trade or business, rather than simply a passive investor and whether it and the soon to be bankrupt company were under common control. If those two points were met, the court said that the vulture itself was responsible for making the withdrawal payments.
In deciding the case, the vulture capitalist company was not aided by having one or more layers of independent affiliates between itself and the victim company, and found itself subject to liability because it obtained benefits that passive investors did not out of management fees paid by the vic which it could use as credits against sums otherwise due to the general partner of the investment vehicle it used to do the deal. : "it was them, not me" did not work in this case at all.
The case itself has been sent back to the district court to examine the issue of 'common control' which is something passive investors by definition don't have the power to do to any degree and which the district court did not look at sufficiently, that is, whether the vulture used the relationship it created with the victim company to make business decisions for the victim company, hirings and firings, asset sales, plant closings, elimination of pension liabilities and that sort of decisions, apparently the sort that vultures often do make for distressed companies to 'clean them up' and get them ready for relaunch of one sort or another. Payment of sums denominated 'management fees' and appearing and taking action at board meetings on internal business issues of the victim company are now going to be highly problematic for the vulture, it seems. At least in the Bankruptcy Courts and the First Circuit.
It ain't done, but the Teamsters won a biggie in this. Yay Teamsters.
The second issue, about whether this applies as well under the Internal Revenue Code is a more interesting one, as the legal problem there is slightly different. Although the language is the same, what the First Circuit case appears to say is that there is no SCOTUS decision setting a' one definition fits all' for 'trade or business' and it is not entirely clear as to whether this definition for pension and bankruptcy provisions would also be applied in IRS litigations. This is especially interesting as a number of the cases cited by the court discussing the language were IRS litigations.
Part of the issue presented was that PBGIC had adopted this language but did not do it by a rulemaking procedure but by an appeal letter, sort of like a supposedly private tax ruling of the sort IRS followers look at and rely upon, but without the public comment period and such which accompanies and legitimates full rulemaking, and which to the court's mind eliminates the notion of unfair surprise, also a problem in this case.
The author of the NYT article is described as a professor of Law and Finance at Ohio State, and he points out that it might well be possible for the Obama Administration to move forward on the distinction created in this case, to create IRS regulations of the sort subject to public comment and adoption, in order to incorporate this decision into the interpretive nexus of IRS decisions as to how to distinguish between passive and therefor capital gains treatment funds, and treatment and taxation as regular income, if it is willing to do so. Doing so might evade the screaming opposition of Rs in Congress, and make the benefits now all treated as capital gains when the vultures file, into income for IRS purposes.
If this were done, and the author seems to have his doubts as to the will of the Obama Administration to do so, that would be a result which is halfway between the current mess and the taxation of all capital gains as income, passive or not, that some Kossacks here have urged.
This case could either be appealed to SCOTUS at this point on the 'trade or business' branch of the decision, or the appeal could wait until the district court acts on the 'common control' portion of the decision which managed not to get decided there the first time, when the entire decision would come back to the First Circuit, and thence possibly further. The behind-the-scenes lobbying on that must be breathtaking.
Comments invited.