Robert H. Scarborough (Freshfields Bruckhaus Deringer, New York) has published Property Purchase or Payment in Kind? The Oxford Paper Conundrum, 62 Tax Law. 823 (2009). Here is the abstract:
If a taxpayer undertakes an obligation or assumes a liability in exchange for property, how is the transaction characterized? Did the taxpayer buy the property, paying with its promise? Or did the taxpayer receive the property as payment for its undertaking or assumption?
To anyone other than a tax lawyer, the question may seem semantic, but the tax consequences of the two ways of seeing the same facts are quite different. Under the first characterization (the Purchase Model), the taxpayer can have no income from receiving the property, since a purchase (even at a bargain) is not a taxable event. The taxpayer's costs are treated as purchase price and are generally capitalized as incurred, except to the extent treated as interest on a deferred payment obligation. Under the second characterization (the Fee Model), the taxpayer is deemed to receive a payment equal to the value of the property as consideration for what it has agreed to do, and then takes that as its basis in the property. This deemed payment may or may not produce current income, depending on whether the obligation is treated as debt, or if not, on the rules governing advance payments for the kind of obligation undertaken. The taxpayer then takes its costs into account as costs of performing its obligation, the timing of recognition of which depends on the kind of obligation, rather than as purchase price of property.
Whether to apply the Fee Model or the Purchase Model is a persistent issue, and it has arisen repeatedly since the early days of the income tax. This question was presented squarely by the 1936 transaction considered in the three Oxford Paper decisions, which are discussed in detail in this paper. It was hotly debated by the Justice Department and the IRS in 1970, and was faced again recently by the Treasury Department and the Service in drafting 2006 regulations on application of section 338 to taxable acquisitions of insurance companies.
The Oxford Paper issue is also a pervasive one, arising in a variety of contexts. Commentators have discussed extensively the law's general adoption of the Purchase Model in one setting: taxable acquisition of the assets of a business subject to its liabilities, and some have considered in detail arguments for and against adopting the Fee Model in that setting. But the same issue can arise in other settings where, as in Oxford Paper, only one obligation and one asset are involved and the obligation is not related to the asset.
This paper illustrates the choice between the Purchase Model and the Fee Model with a series of examples showing how it can arise in a variety of settings. This paper then surveys the judicial decisions and IRS rulings that have faced this issue, showing that — with a few notable exceptions — they have adopted the Purchase Model. Finally, this paper considers whether there is a right answer, from a tax policy standpoint, as to which of these two models should apply and concludes that there is not.
