Acqis Technology Inc. v. Comm., TCM 2024-21
This post is part of our series on recent important tax cases that may be of interest to accounting, tax, and finance professionals. For more like this, see our Federal Tax Update and California Federal Tax Update, which offer a comprehensive analysis of the year’s most pivotal tax developments.
Debit Cash, Credit Equity or Income? Settlements from Patent Infringement Lawsuits are Income (Acqis Technology Inc. v. Comm., TCM 2024-21)
Acqis Technology’s business model was to acquire patents and engage law firms on a contingency basis to sue for patent infringement and failure to pay royalties. Defendants in some of the lawsuits entered into settlements that included licensing agreements and share purchase agreements (SPAs). The licensing agreements were generally free of additional costs to the defendants. Acqis sold Settlement Shares to the defendants. The Settlement Shares had limited dividend and distribution rights, limited liquidation rights, were nonvoting, and could not be sold or transferred. Some of the defendants did not purchase Settlement Shares but designated a charity to receive those shares.
On the books, a stock issuance is recorded with a debit to cash and credit to equity. There is no taxable income from the issuance of stock. “In the case of a corporation, gross income does not include any contribution to the capital of the taxpayer.” (§118)
At trial Acqis’ expert testified that the value of the Settlement Shares was $18.40 and was no different than any other class of shares. The IRS valuation expert determined that the value of the Settlement Shares was zero. The zero valuation was due to the fact that the Settlement Shares “could not generate income for the Settlement Shareholders and likewise precluded them from modifying the rights of their shares to generate income in the future, depriving the shares of any value.”
The Tax Court concluded that the SPAs were shams. “If a commonsense review of a particular transaction leads to the conclusion that the transaction does not have a nontax business purpose or any economic substance other than the creation of tax benefits, the form of that transaction may be disregarded, and the Commissioner may rely on its underlying economic substance for tax purposes.
Tax practitioner planning. Don’t take significant client documents at face value. Just because a document has a particular title does not mean that it automatically qualifies a transaction for a specific type of tax treatment.