internal_revenue_service national_office technical_advice_memorandum date number release date index uil no case mis no tam-105212-00 cc ita b3 district_director taxpayer’s name taxpayer’s address taxpayer’s identification no years involved date of conference legend taxpayer utility power marketer company state year date date date date date x units y units a b c d issue what is the character of proceeds received in return for the transfer to a power marketer of a long-term power supply contract with a utility as part of a larger transaction in which the original contract is cancelled and a new contract entered into between the power marketer and the utility tam-105212-00 conclusion on these particular facts the consideration received qualifies as gain from the sale_or_exchange of property within the meaning of sec_1221 sec_1222 and sec_1231 facts taxpayer a partnership was formed to construct and operate a power plant for the generation of electricity taxpayer had a lease to operate a power plant owned by company the power plant was a qualifying small power production facility a qf under the public_utility regulatory policies act of purpa p l 92_stat_3117 under purpa public_utilities are required to purchase excess power generated by qf's in their area at a price equal to the utility's avoided cost that is the cost avoided by the utility by substituting power generated by the qf in general at the time the contract at issue was entered into the amounts paid to qf's for power under these statutorily-mandated contracts consisted of energy payments and capacity payments energy payments are based on the costs of producing electricity such as fuel costs and operating and maintenance_expenses that are avoided by substituting power generated by a qf capacity payments are based on generating plant construction costs that are avoided by relying on a qf's generating plant capacity payments are made regardless of whether the qf delivers electricity to the utility the implementation of purpa created a new class of non-utility generating companies and a significant market for electric power produced by non-utilities taxpayer sold electricity to utility pursuant to a purpa power purchase agreement ppa dated date under the terms of ppa utility was obligated to purchase the total output of electric energy and capacity of the power plant the capacity of the power plant is x units utility was to pay taxpayer monthly for dispatched power in an amount made up of an energy payment and a capacity payment ppa was terminable by utility on date resulting in an original term of approximately years ppa was assignable with utility's written consent which could not be unreasonably withheld after the enactment of purpa the cost of fuel in the united_states declined which led to a reduction in utilities’ costs of producing electric power in addition since the early 1990's the electric utility industry has been undergoing deregulation which has led to increased competition in the industry and a reduction in the price of electricity as a consequence of these and other factors many purpa contracts including the ppa in the present case contained rates that were significantly above market for several years utility paid taxpayer shutdown fees under a suspension agreement pursuant to which taxpayer agreed not to operate the plant however early in year tam-105212-00 taxpayer notified utility that it intended to resume operation and deliveries to utility under ppa under deregulation legislation enacted by state in year utility was required to pursuant to this policy and in an attempt to reduce its costs utility terminated or restructured a number of above-market contracts with qf’s utility entered into negotiations with taxpayer to terminate ppa but could not reach mutually agreeable terms power marketers generally are intermediaries engaged in the business of buying electricity from traditional utilities and other sources and reselling electricity at wholesale prices power marketer was able to buy and resell power at a rate that was lower than the rate contained in ppa in year power marketer entered into negotiations with taxpayer and utility power marketer negotiated with taxpayer for the purchase of taxpayer’s interests in ppa power marketer also negotiated with utility either to supply power to utility under the ppa to be purchased from taxpayer or to purchase and terminate ppa and enter into a replacement agreement with utility on date the negotiations between power marketer and utility resulted in the signing of a memorandum of agreement moa under the moa power marketer would purchase taxpayer’s interests in ppa immediately terminate ppa and enter into a replacement ppa with utility ppa making an additional payment to utility of dollar_figurea taxpayer would retain the power plant free of the financing_lease with company and could operate it as a merchant power plant under the moa taxpayer's approval of the restructuring was a condition_precedent to the execution of ppa ppa as described in the moa and subsequently entered into between power marketer and utility provided that power marketer would deliver to utility an amount of electric energy equal to the deliveries expected under ppa based on historical averages for the term remaining under ppa approximately years ppa also obligated power marketer to deliver x plus y units of capacity to utility more than the capacity provided for in ppa the rates under ppa while still above market tam-105212-00 were lower than those set forth in ppa under both ppa and ppa rates were subject_to an adjustment for inflation unlike ppa which contained constant rates for electricity and for capacity throughout a given year the rates in ppa differentiated between on-peak and off-peak periods for each year the following day utility filed a petition with the state public_utilities commission puc requesting approval of ppa state’s statutes generally prohibited electric utilities from entering into a supply contract for a period longer than three years for more than a stated amount of electrical capacity without obtaining a certificate of public convenience and necessity from the puc although contracts with qf’s such as ppa were exempt from this requirement approval of ppa was required because power marketer is not a qf in its petition utility stated utility subsequently entered into a stipulation with state’s public advocate approving the proposed transaction which was described as follows the stipulation also recited that on date the state puc entered an order approving the stipulation on the ground that the restructuring would result in significant cost savings to utility and its customers as compared to the projected costs of purchasing energy and capacity from taxpayer under ppa through date the order also approved utility's request that on date several agreements were signed consistent with the moa and the puc order taxpayer and power marketer executed a purchase agreement pursuant to which power marketer purchased taxpayer’s interests in ppa for dollar_figured dollar_figureb of which was paid to taxpayer and dollar_figurec of which was paid on behalf of taxpayer to company as payment for company’s interests in the power plant taxpayer and company executed tam-105212-00 a purchase agreement and facility lease termination pursuant to which taxpayer acquired ownership in the power plant ppa was terminated and power marketer and utility executed ppa the agreements signed on date were interrelated the purchase agreement between taxpayer and power marketer referenced but did not discuss ppa among the conditions precedent to the execution of ppa were that taxpayer and power marketer had to have entered into an agreement transferring ownership in ppa to power marketer and power marketer and utility had to have entered into an agreement terminating ppa another condition_precedent was that taxpayer had to approve the restructuring defined to include the consummation by utility power marketer taxpayer company and certain other parties of the termination of ppa and the execution and delivery of ppa incorporated as an exhibit to ppa was a mutual release executed by taxpayer and utility which referenced power marketer’s agreement to purchase ppa and utility’s agreement to terminate ppa and enter into ppa the release provided among other things that utility and taxpayer released each other from any and all claims arising out of or in connection with the execution performance or nonperformance of ppa according to taxpayer’s submission all aspects of the transaction were coordinated and orchestrated with respect to when each leg of the transaction was executed and at the time these documents were executed taxpayer power marketer and utility knew that power marketer was not going to perform under the terms of ppa however according to taxpayer each party negotiated independently and had opposing interests taxpayer subsequently entered into a new power supply contract with another utility taxpayer reported the receipt of the dollar_figured from power marketer as long-term_capital_gain the revenue_agent maintains that this amount is ordinary_income law and analysis in order for proceeds from the disposition of an asset to qualify as long-term_capital_gain the asset must be a capital_asset as defined by sec_1221 the disposition must be a sale_or_exchange and the asset must have been held for more than one year sec_1222 under sec_1231 capital_gain also may result from the sale_or_exchange of real or depreciable_property used in the taxpayer’s trade_or_business and held for more than one year if sec_1231 gains exceed sec_1231 losses for the year in the present case ppa was an asset held by taxpayer for more than one year whether the dollar_figured received from power marketer was long-term_capital_gain therefore depends on two factors the nature of the asset and the nature of the transaction tam-105212-00 nature of the asset ppa as property sec_1221 defines the term capital_asset as property held by the taxpayer regardless of whether it is connected with the taxpayer's trade_or_business unless the property meets one of five listed exceptions inventory property of a character which is subject_to the allowance for depreciation provided in sec_167 or real_property used in a trade_or_business certain intangible_property accounts_receivable acquired in the ordinary course of a trade_or_business and certain publications of the united_states government the term sec_1231 gain includes the sale_or_exchange of property used in a taxpayer's trade_or_business of a character which is subject_to the allowance for depreciation under sec_167 and that does not fall within certain exceptions generally equivalent to the exceptions in sec_1221 in the present case ppa was an asset used in the taxpayer’s trade_or_business that does not fall within any of the listed exceptions to capital_gain treatment in sec_1221 or sec_1231 we do not decide whether it was a capital_asset or a sec_1231 asset because in either case gain from the sale_or_exchange of such an asset would be capital_gain for taxpayer in order for either sec_1221 or sec_1231 to apply however the asset sold must constitute property although sec_1221 appears to give broad meaning to this term the supreme court has found it evident that not everything which can be called property in the ordinary sense and which is outside the statutory exclusions of sec_1221 qualifies as a capital_asset rather the term capital_asset is to be construed narrowly in accordance with the purpose of congress to afford capital-gains treatment only in situations typically involving the realization of appreciation in value accrued over a substantial period of time 364_us_130 compensation_for temporary seizure of business facilities is ordinary_income similarly in 356_us_260 the court denied capital_gain treatment on the disposition of certain mineral payments carved out of established oil_and_gas working interests observing the lump-sum consideration seems essentially a substitute for what would otherwise be received at a future time as ordinary_income in short consideration was paid for the right to receive future income not for an increase in the value of the income-producing property on this basis capital_gain or loss treatment has been denied for transactions involving payments in return for interests carved out of or related to an interest retained by the taxpayer see eg gillette and p g lake interests related to compensation_for all references are to the statutes and regulations as in effect for the year at issue the term has the same meaning under sec_1221 as it has under sec_1231 see 423_f2d_494 9th cir cert_denied 400_us_848 tam-105212-00 personal services rendered or to be rendered in the future see eg 303_f2d_687 9th cir interest in films to be produced by taxpayer 454_f2d_1120 8th cir agency contract with insurance_company 81_tc_930 tenure rights and interests relating to income already earned or about to be earned see eg 131_f2d_50 6th cir right to dividend that was already declared on the other hand as the courts have noted simply because the property transferred will produce ordinary_income and such income is a major factor in determining the value of the property does not necessarily mean that the amount received for the property is essentially a lump-sum substitute_for_ordinary_income in guggenheim the court focused on whether substantial investment risks involved in holding the asset that was the source of the income were transferred see t c pincite in dresser the court distinguished between proceeds from the present sale of the future right to earn income capital_gain and the present sale of the future right to earned_income ordinary_income f 2d pincite in ferrer the court distinguished between cases involving an ‘estate’ in or an ‘encumbrance’ on or an option to acquire an interest in property which if itself held would be a capital_asset and an opportunity afforded by contract to obtain periodic receipts of income by dealing with another or by rendering services or by virtue of ownership of a larger ‘estate’ f 2d pincite cited cases omitted see generally 84_tc_50 capital_gain on transfer of franchise rights summary of factors in estate of shea a case particularly analogous to the present case the court held that the transfer by the taxpayers’ s_corporation to a third party of a shipping charter a contract to provide cargo space on the corporation’s ships was a sale of property under sec_1231 resulting in capital_gain the corporation had originally acquired the shipping charter along with the ship to which it was subject later substituted a different ship and eventually sold the charter as a separate asset in its holding the court stressed that the shipping charter was not a contract to perform personal services that the taxpayer had been required to capitalize the acquisition_cost of the charter and that the value of the charter was primarily determined by its rate as compared to prevailing market rates thus the court observed the difference between the amount_paid for the charter and the amount received upon his disposition represented appreciation in value over time due purely to the action of market forces this according to the court was precisely the type of profit for which capital_gain treatment is intended citing gillette see t c pincite 46_tc_559 acq 1967_2_cb_2 sale of syndicated interests in a racehorse see also 324_f2d_56 5th cir transfer of exclusive feature of a patent contract 304_f2d_125 2d cir various rights in a literary work 57_tc_15 acq 1973_2_cb_3 shipping charter tam-105212-00 based on the above we conclude that the bundle of contract rights and obligations represented by ppa in the present case was property within the meaning of sec_1221 and sec_1231 the ppa did not represent a right to compensation_for_personal_services rendered or to be rendered rather it involved the sale of a product-electricity nor was it a right to collect income already earned as in rhodes' estate instead like the exclusive feature of the right to practice the license at issue in dresser the ppa was itself an income-producing asset a right to earn income in the future as made clear by dresser and guggenheim it is not dispositive that the income to be produced by the ppa would have been ordinary nor that the value of the ppa was largely determined by the present_value of that expected future income stream moreover the ppa was not simply in the words of the ferrer court an opportunity afforded by contract to obtain periodic receipts of income by dealing with another first as a purpa contract mandated by federal and state statutes and regulations the ppa reflected to some extent benefits created by governmental action similar to other rights that have been treated as capital assets see eg revrul_66_58 1966_1_cb_186 cotton acreage allotments revrul_70_644 1970_2_cb_167 milk allocation rights second like the shipping charter at issue in estate of shea the value of the ppa was largely determined by prevailing market rates and was subject_to market fluctuations outside of the control of taxpayer based on projections of economic factors over a significant period of time4 as stated in gillette and estate of shea such appreciation in value over time resulting from market fluctuations is the type of profit for which capital_gain treatment is intended we reach the conclusion that taxpayer sold property within the meaning of sec_1221 and sec_1231 regardless of whether taxpayer had any ownership_interest in the generating facility prior to the sale of ppa and therefore might be viewed as transferring the contract while retaining an underlying related income-producing asset cf gillette p g lake as discussed above while the ppa was clearly related to the power plant it was transferable separate from the plant and in the context of the regulatory environment in which the transaction occurred was an income-producing asset in its own right one that had a value independent of taxpayer’s plant in this respect it was similar to the shipping charter in estate of shea which-while it was clearly related to a ship in a generic sense-was not linked to any specific ship it could be and was transferred from ship to ship and sold as a separate asset as noted above unlike the charter in estate of shea taxpayer had not acquired ppa through purchase and had no basis in the contract however the contract was certainly an asset as to which costs would have to be capitalized in appropriate circumstances separate from the source of in this connection note the length of the contract-approximately years with remaining at the time of the present transaction unlike the corporation in estate of shea taxpayer had no investment in ppa in the sense that taxpayer had no basis in the ppa at the time of the transfer however this is only one factor in the determination see foy t c pincite-one which in our view does not outweigh the other factors in this case with respect to whether investment risks in the property were transferred-a factor cited in guggenheim foy and other cases-see p below tam-105212-00 the electricity that was the subject of the contract taxpayer transferred its entire_interest in ppa and after the transaction the operation of the power plant had no economic_effect on ppa or vice versa in fact taxpayer subsequently entered into a new contract to sell the output of the power plant to a different utility nature of the transaction sale_or_exchange the sale_or_exchange doctrine in general even though we conclude that ppa was property within the meaning of sec_1221 and sec_1231 in order for the proceeds received by taxpayer to be capital_gain they must result from the sale_or_exchange of ppa within the meaning of sec_1222 and sec_1231 the transaction was clearly a disposition of property within the meaning of sec_1001 since taxpayer parted with all substantial rights and obligations in the contract in return for a cash payment6 however under long-established case precedent not all dispositions are a sale_or_exchange for purposes of the capital_gains provisions in 306_us_436 for example the supreme court applied the commonly accepted meaning of the term sale_or_exchange in holding that the redemption by a corporation of its bond did not fall within the meaning of that term and thus resulted in ordinary_income to the bondholder similarly in 313_us_247 the court held that insurance received as compensation_for the loss of business_assets was not capital_gain reasoning that neither the term sale nor exchange was appropriate to characterize the demolition of property and subsequent compensation_for its loss by an insurance_company u s pincite over the years congress has enacted numerous statutory_sale or exchange provisions which override this general doctrine and provide for capital_gain or loss in many situations7 however none of these statutory provisions covers the present case contract rights and the extinguishment doctrine one branch of the sale_or_exchange doctrine holds that in certain circumstances amounts received for the cancellation or termination of contractual or similar rights or claims do not qualify for capital_gain or loss treatment because the rights are not sold to or exchanged with the payor instead they simply cease to exist this doctrine-variously termed the extinguishment disappearing asset or vanishing see 90_tc_558 aff’d in part and vacated in part on a different issue 912_f2d_44 2d cir cf 77_tc_1221 see eg sec_165 sec_166 worthless securities foreclosures a involuntary_conversions overruling flaccus leather short_sales option expirations 1234a certain contract cancellations leases and certain distributorships debt retirements overruling fairbanks tam-105212-00 asset doctrine-is normally applied in two-party situations however there is precedent for applying it in a three-party situation such as the present case if the substance of the transaction is found to constitute a cancellation rather than a sale some explanation of the historical development of the doctrine is useful in order to elucidate its current status and the factors that determine its application especially in three-party situations the development of the doctrine can be traced in a series of rulings and court opinions many of which were issued by the court_of_appeals for the second circuit in an early case 204_f2d_673 the second circuit held that payment to a distributor for terminating its exclusive contract with a manufacturer was ordinary_income drawing an analogy to a situation in which the holder of the note surrenders it to the maker for a payment the court found that the payment and release not only ended the promisor’s previously existing duty but also destroyed the promisee’s rights they were not transferred to the promisor they merely came to an end and vanished f 2d pincite another early case 205_f2d_360 2d cir aff'g 17_tc_1517 cert_denied 346_us_866 dealt with a three- party situation in general artists the taxpayer a booking agent had entered into contracts with frank sinatra entitling the taxpayer to represent sinatra exclusively and receive a percentage of sinatra's earnings the taxpayer purported to sell the contracts to another booking agent mca under an agreement endorsed by sinatra that provided that mca would enter into new contracts with sinatra shortly after the new contracts were signed and general artists later received a payment from mca which it treated as capital_gain although the tax_court relied in part on a finding that the taxpayer had not parted with property the sole basis of the second circuit’s affirming opinion was that while the transaction was a sale in form in substance it was a cancellation it might be suggested that the instant case differs from that of starr bros because the latter involved a release of a binding negative covenant to the obligor whereas here there was a transfer to a third person of the rights under the covenant but we think the correct view is that here there was a release to the obligor ie sinatra the counterparty of a negative covenant in order to allow a new covenant to be made with the third party mca the agreement provided that such new contracts should be made and be deemed to supersede cancel and take the place of taxpayer’s contracts with the singer f 2d pincite during the same period the courts also distinguished between cancellations of such so- called naked contract rights and cancellations of another class of rights-primarily rights connected with real_estate or other more traditional forms of property-that were viewed as sufficiently substantial to survive termination or cancellation thereby tam-105212-00 resulting in capital_gain or loss8 in revrul_56_531 1956_2_cb_983 clarified revrul_72_85 1972_1_cb_234 the service recognized this distinction and acquiesced in these cases now largely governed by sec_1241 a statutory_sale or exchange provision enacted in however citing starr and general artists the ruling made clear that the service will continue to regard the relinquishment of simple contract rights as not involving the sale_or_exchange of a capital_asset and will treat amounts received in consideration of such relinquishment as constituting ordinary_income c b pincite two influential cases decided in are significant for present purposes because they involve long-term supply contracts in 252_f2d_344 2d cir rev’g 26_tc_967 nonacq 1957_2_cb_8 cert_denied 357_us_919 the taxpayer a coal company received a lump-sum payment in return for cancellation of its exclusive contract to purchase the output of a coal mine upholding the commissioner’s determination that the payment was ordinary_income the second circuit rejected the tax court’s rationale-that the counterparty to the contract by making the cancellation payment had reacquired the right to sell its coal to whomsoever it chose at whatever terms it could arrange t c pincite according to the second circuit it would be more in accord with common understanding to say that the payment is solely for the termination of the right-duty relationship between the two parties to the agreement f 2d pincite in the second case 260_f2d_489 9th cir aff’g 27_tc_892 a corporation that held a long-term requirements contract with a supplier for the purchase of petroleum products entered into a similar arrangement with the taxpayer’s partnership reselling the products to the partnership at a slightly higher price subsequently because of a shortage in the supply of gasoline the partnership’s contract right had substantial value see t c pincite and the partnership accepted a payment from the counterparty in termination of the contract the tax_court held that the contract was property_used_in_the_trade_or_business in the partnership’s hands and the circuit_court accepted this finding however both courts rejected the taxpayer’s argument that the effect of the termination agreement was to resell the contract rights to the counterparty rather relying on the line of authority represented by starr pittston and general artists both courts held that the payment was ordinary_income in the words of the circuit_court the principal object result and ‘effect’ of the termination agreement was to terminate rights not continue them nor transfer them-nor sell them-nor exchange them f 2d pincite see eg 19_tc_667 acq 1956_2_cb_7 aff’d 210_f2d_752 2d cir cert_denied 348_us_829 lease termination 18_tc_438 acq c b aff’d 210_f2d_390 5th cir cert_denied 348_us_829 lease restriction 16_tc_1450 acq 1956_2_cb_6 aff’d 200_f2d_72 3d cir cert_denied 345_us_939 lease termination see also 157_f2d_235 2d cir cert_denied 330_us_826 payment to life_tenant for transfer of life interest in trust to remainderman was capital_gain tam-105212-00 in the second circuit despite its role in developing the extinguishment doctrine cast doubt on its continuing validity in a often-cited case 304_f2d_125 rev’g in part and remanding 35_tc_617 acq 1961_2_cb_4 in that case the taxpayer actor jose ferrer had acquired from pierre lamure the author of a novel certain rights connected with the novel including the stage rights and the right to prevent disposition of the movie rights after the director john huston expressed an interest in producing a movie based on the novel and starring ferrer a series of agreements were signed pursuant to which ferrer surrendered his rights huston acquired the movie rights and the taxpayer received a series of payments from huston’s company moulin some of which ferrer reported as capital_gain analyzing prior case law the ferrer court decided that more recent cases had moved away from the distinction relied upon to some extent in starr brothers and general artists between a sale to a third person that keeps the ‘estate’ or ‘encumbrance’ alive and a release that results in its extinguishment f 2d pincite footnotes omitted describing this as a formalistic distinction the court continued in the instant case we can see no sensible business basis for drawing a line between a release of ferrer’s rights to lamure for a consideration paid_by moulin and a sale of them with lamure’s consent to moulin or to a stranger who would then release them tax law is concerned with the substance here the voluntary passing of property rights allegedly constituting capital assets not with whether they are passed to a stranger or to a person already having a larger estate focusing instead on the nature of the asset the court concluded that the holdings in cases such as starr general artists pittston and leh could be justified as involving assets that weren’t property rather than on the basis of the extinguishment doctrine f 2d pincite following this approach the court unbundling the various rights given up by ferrer held that ferrer received capital_gain upon surrender of his right to produce a play and his negative rights to prevent disposition of film rights because they represented equitable interests but ordinary_income with respect to termination of his rights to receive a stated percentage of film proceeds two cases one decided shortly before and one shortly after ferrer demonstrate opposite approaches to the application of the extinguishment doctrine in a three-party situation in the first 37_tc_223 the taxpayer held several agency contracts with a movie actor it assigned the contracts with the actor’s agreement to another company in return for a lump-sum payment without ruling on the nature of the assets which could have been viewed as contracts for personal services the court held that there was no sale_or_exchange relying on general artists in substance what was accomplished in each case was the substitution of one agent for another and we do not think that the form of the transaction ie whether the old tam-105212-00 contracts were to be canceled and new ones entered into or whether the new agent simply stepped into the shoes of the old with the artist’s consent should lead to a result here different from that reached in general artists t c pincite by contrast in 320_f2d_929 5th cir the court employed a substance over form analysis to convert a two-party cancellation into a three-party sale effectively reversing the approach in general artists and paul small artists in bisbee-baldwin the taxpayer assigned mortgages to investors who then employed the taxpayer to service those mortgages some of the investors later cancelled their contracts with the taxpayer and gave the business to other agents over the taxpayer’s objection the investors paid the taxpayer a standard percentage termination fee for which they were reimbursed by the new agents the court following ferrer’s unbundling approach determined that a portion of each fee was allocable to capital assets with respect to these amounts the court held that in substance the rights had been sold to the new agents the investors were conduits bisbee-baldwin received the payments the transferee’s paid through the investors something was transferred what bisbee-baldwin transferred was a bundle of rights under its contracts to service certain mortgages for a price the transferees stepped into bisbee-baldwin’s shoes it is irrelevant that the investors’ approval was required and that instead of assignment the transfer was effected by termination of the old contracts and execution of new contracts f 2d pincite after the issuance of ferrer language in the opinion led some observers and courts to conclude that the extinguishment doctrine was dead-that is if one followed ferrer then cases such as starr general artists pittston and leh were correct if at all only because the assets in those cases were not property not because of the extinguishment doctrine9 however subsequent events have made clear that the extinguishment doctrine survived ferrer and has been applied by both the service and the courts-including the second circuit in revrul_75_527 1975_1_cb_30 for example the service reaffirmed the position it had taken in revrul_56_531 with respect to the extinguishment doctrine and contract rights in revrul_75_527 the taxpayer owned a building that was heated by a central hot water distribution plant owned by a supplier who had a contract to furnish heat to the building because of the expense of maintaining the system the supplier desired to see eg 324_f2d_56 5th cir starr bros has been repudiated by the second circuit in ferrer b bittker l lokken federal taxation of income estates and gifts 2d ed two-party three-party distinction criticized in ferrer fast becoming a footnote to history but see id 3d ed may have become a footnote to history tam-105212-00 terminate the contract the taxpayer accepted the supplier’s offer to reimburse the taxpayer for the cost of converting to an individual heating system in termination of the supply contract revrul_75_527 holds that the amount received by the taxpayer for conversion of the system is ordinary_income because there was no sale_or_exchange in that the taxpayer’s right to have the building heated by the central heating plant was extinguished and did not pass to the supplier the ruling cites revrul_56_531 pittston and leh for the proposition that in general the mutual relinquishment of simple contract rights and obligations does not give rise to a capital_transaction and the cancellation or release of a contract right does not transfer the right to the transferee-payor and is therefore not a sale similarly in in 448_f2d_549 the second circuit held that a payment to a lessor for the cancellation of its right to have leased property restored was not a sale_or_other_disposition within the meaning of sec_453 in so holding the court stated that the second circuit has long held that cancellation or release of a contract right does not transfer the rights to the transferee- payor and thus is not a ‘sale’ f 2d pincite the court then went on to state we do not agree that ferrer overruled the general artists and starr bros cases ferrer is to be distinguished on the ground that it involved the release of motion picture production rights which could have been sold to any third person id pincite following billy rose there was some question whether its holding was restricted to the sec_453 context see eg 509_f2d_1220 2d cir in addition in and again in the scope of the extinguishment doctrine was significantly restricted with the enactment and expansion of sec_1234a the committee report accompanying the changes severely criticized the extinguishment doctrine which it characterized as present law citing among other cases starr general artists and pittston see s rep no 105th cong 1st sess dollar_figure however in 148_f3d_186 rev’g and remanding 108_tc_208 the second circuit made clear that outside of statutory_sale or exchange provisions such as sec_1234a the extinguishment doctrine still applies-not just under sec_453 but in its original sec_1222 sec_1231 context as well accepting the taxpayer’s position-based on cases like starr general artists and pittston see f 3d pincite-and citing the passage from billy rose quoted above id pincite the court held that fees paid in connection with the cancellation of legs of commodity forward contracts prior to the effective date of current sec_1234a were ordinary losses for lack of a sale_or_exchange under 1222-despite the fact that the sec_1234a provides that gain_or_loss attributable to the cancellation lapse expiration or other termination of a right or obligation with respect to property which is or on acquisition would be a capital_asset in the hands of the taxpayer is treated as gain_or_loss from the sale of a capital_asset note that the statute does not cover contracts related to sec_1231 assets or as in the present case ordinary assets tam-105212-00 economic result achieved by cancellation was identical to that achieved by offsetting such contracts a transaction resulting in capital_gain or loss with respect to ferrer the wolff court quoted from an earlier opinion 994_f2d_855 aff’g in part and rev’g in part tcmemo_1990_659 in which the court_of_appeals for the d c circuit had applied the same analysis to the same transactions as in wolff after the cancellation of ferrer’s contract there was still an extant contract for the movie rights with essentially the same terms but a different signatory therefore the court held the substance_over_form_doctrine applied see also bisbee-baldwin because the consideration for the cancellation in ferrer came from a third party it was in substance a sale here however the underlying contracts were cancelled in substance as well as in form when a contract was cancelled it did not merely change hands it ceased to exist altogether f 2d pincite see wolff f 3d pincite note the emphasis in the quoted passage on the fact that in ferrer the rights were not merely transferable rather they were actually transferred to a third party for consideration from the third party although in both wolff and stoller the tax_court was reversed the disagreement concerned the interpretation of ferrer’s substance over form approach the tax_court did not challenge the extinguishment doctrine itself see estate of israel t c pincite distinguishing between unexpected and true cancellations of commercial contracts as in pittston and leh and expected cancellations of commodity-type contracts consistent with this position in a more recent case 111_tc_256 aff’d 196_f3d_866 7th cir possibly on another ground petition for cert filed u s l w u s date no the tax_court based its decision on the extinguishment doctrine citing leh among other authorities the court held that an s corporation’s proceeds from the settlement of a purchased legal claim were ordinary_income due to lack of a sale_or_exchange because the s corporations’ rights in the lawsuit vanished both in form and substance upon the receipt of the settlement proceeds t c pincite summarizing this often conflicting precedent the extinguishment doctrine has faced considerable criticism over its half-century history yet it remains a feature of the tax law congress has reduced the scope of the doctrine but has not as yet eliminated it altogether when contract rights involve the provision of personal services the doctrine in both wolff and stoller the courts’ holdings were not affected by the fact that congress had enacted specific_legislation covering post-effective-date transactions similar to those at issue see wolff f 3d pincite stoller f 2d pincite in this respect although courts have occasionally cited the existence of statutory_sale or exchange provisions as evidence of congressional disapproval of the sale_or_exchange doctrine in general or the extinguishment doctrine in particular see eg ferrer f 2d pincite more often such provisions have been construed as confined to their stated scope see eg 313_us_247 tam-105212-00 is no longer relevant payment for the termination of such rights is now viewed as ordinary_income on the ground that they are not property regardless of the nature of the transaction at the other extreme the cancellation of certain rights traditionally viewed as substantial -such as leases and life estates-will always be treated as a sale_or_exchange whether or not they are covered by statute and whether or not they are actually re-transferred to third parties revrul_56_531 with respect to other contract rights and interests the ferrer case while undoubtedly influential has led to varying interpretations some courts and commentators regard ferrer as having eliminated the extinguishment doctrine altogether-leaving the nature of the asset as the only relevant inquiry however this does not appear to be the majority view nor is it the position of the service the extinguishment doctrine in general and cases such as pittston and leh in particular continue to be cited as valid precedent even by the court that decided ferrer see eg revrul_75_527 stoller f 2d pincite taxpayer’s prevailing argument wolff f 3d pincite same estate of israel t c pincite doctrine distinguished by court nahey t c pincite although ferrer did not eliminate the extinguishment doctrine altogether it has ameliorated its impact to some extent first the case clearly shifted the primary thrust of the analysis away from the nature of the transaction and towards the nature of the asset second and related to the first point the ferrer case has come to stand for a substance over form approach to the sale_or_exchange determination-exemplified by the bisbee-baldwin case-in which rights are more likely to be viewed as having in substance survived a transaction even though the transaction took the form of a cancellation or terminationdollar_figure this substance over form aspect of ferrer is sometimes applied in two-party situations in which the fact that the rights in question could be transferred to a third party coupled with other factors is viewed as sufficient to regard the rights as surviving as separate assets in the counterparty’s hands13 under this view situations such as those in revrul_75_527 right to centralized hot water heat and sirbo holdings right to restoration of property on leased premises are distinguishable because they involve the cancellation of rights that are not valuable assets capable of transfer to a third party this interpretation is difficult to reconcile with cases like pittston and leh however since there is no indication that the contract rights in those cases were not for a similar example of the evolution of the sale_or_exchange doctrine see the line of cases represented by 737_f2d_479 5th cir cert_denied 469_us_1189 in which the courts found a sale_or_exchange resulting in capital_loss in certain transactions traditionally viewed as lacking that element such as abandonments of mortgaged properties see eg dresser f 2d pincite 468_fsupp_1085 d minn aff’d without written opinion 624_f2d_1109 8th cir release of right_of_first_refusal regarding motel franchise is a sale_or_exchange where release added to rights of grantor by removing obstacle to franchise operation by grantor or others tam-105212-00 valuable potentially transferable assets however ferrer’s substance over form approach is often applied more narrowly in three-party situations in which-as in bisbee-baldwin and in ferrer itself-the consideration for the release of the contract rights comes from a third party directly or indirectly and the rights are not merely transferable to third parties in the abstract but are in fact transferred and survive in some form in the hands of the third party in such three-party situations the question then becomes whether there is a sufficient nexus and similarity-between the rights given up by the taxpayer and the rights acquired by a third party-to permit the conclusion that the rights survived in substance in the hands of the third party the d c circuit in stoller acknowledged this aspect of ferrer however it took a restrictive view of the circumstances in which it could be applied interpreting ferrer as involving an extant contract for the movie rights with essentially the same terms but a different signatory f 2d pincite this was a questionable reading of ferrer-the terms of the agreement between huston moulin and lamure were significantly different from those in the ferrer-lamure agreement see f 2d pincite t c pincite moreover other courts as well as the service have recognized that the rights acquired by the third party or parties need not be identical to those given up in order to be viewed as surviving the transaction see for example the service’s position in stoller-accepted by the tax_court but not the d c circuit-to the effect that contract rights were not extinguished when in part they were replaced by contracts between the same parties for the same commodities albeit with new prices and delivery dates f 2d pincite see also estate of israel t c pincite 112_tc_209 n water rights did not vanish where they reverted to the government survived and were reallocated to other users in this respect the extinguishment doctrine has evolved since when the general artists opinion was issued and-while general artists may still represent valid precedent for the general proposition that the extinguishment of simple contract rights is not a sale or exchange-after ferrer cases like general artists and paul small artists might well be decided differently on their actual factsdollar_figure application to the present case taxpayer points to certain formal aspects of the transaction-chiefly the purchase agreement whereby power marketer purported to purchase taxpayer’s entire_interest in ppa in return for a cash payment-as evidence that the transaction was a sale of ppa for capital_gains purposes taxpayer also argues that its tax treatment should not depend on what power marketer chose to do as a result of separate negotiations after power marketer acquired ppa however as discussed above there is ample we express no opinion as to whether cases similar to pittston and leh-or perhaps the present case-might be decided differently under the new rules covering hedging_transactions see sec_1221 - b generally effective for transactions entered into on or after date in the present case ppa was not identified as a hedging_transaction and is not otherwise covered by the current hedging regulations see sec_1_1221-2 of the income_tax regulations tam-105212-00 precedent in this context for looking beyond the form of the transaction this is especially true when as in the present case the separate steps of the transaction are so clearly interrelated whether or not there were separate negotiations leading up to the transactions that were executed on date it is clear that on that date each step of the transaction was dependent on taxpayer’s approval and that taxpayer knew that power marketer had no intention of performing under ppa and would terminate ppa simultaneously with-not after -its acquisition from taxpayer by the same token however neither the execution of mutual releases as between taxpayer and utility-a common precaution in a complex legal transaction-nor the fact that the transaction was referred to in some contexts as a buyout of ppa by utility necessarily establish that the transaction was a cancellation rather than a sale see eg leh f 2d pincite n 346_f2d_884 6th cir the tax consequences turn on the substance of the transaction accordingly the question to be decided is whether under ferrer’s substance over form approach as applied in three-party cases such as bisbee-baldwin the present transaction was in substance a sale of taxpayer’s rights in ppa to power marketer on these particular facts we conclude that it was first as discussed above the transaction was in form a sale of taxpayer’s interest in ppa to a third party as a matter of non-tax law at least power marketer succeeded to taxpayer’s rights and obligations in ppa if only momentarily and under tax or non-tax law the fact that a purchaser of an asset is under a pre-existing_obligation to sell or otherwise dispose_of the asset upon acquisition does not necessarily mean that the asset was not in fact purchased or that the transaction must be recharacterized second although as part of the integrated transaction ppa was terminated and ceased to exist this was not done as in leh or revrul_75_527 because the payor-in this case power marketer-simply wished to eliminate what had become a burdensome contract nor did power marketer once it had acquired ppa terminate ppa in return for cash or debt from utility-which might lead to the conclusion that in substance the transaction was an indirect means for utility to eliminate the contract rather the consideration for the acquisition of ppa came from power marketer not utility and power marketer acquired ppa 1-and paid an additional dollar_figurea to utility-because by doing so it was able to satisfy the requirements set by both utility and the regulatory authorities for entering into ppa a long-term power supply contract moreover while ppa was not identical to ppa the two contracts were similar in several respects first the remaining term of ppa was the same as that under ppa second while the source of the electricity differed the amount of energy to be furnished under ppa was based on the historical amounts furnished under ppa and the amount of capacity was similar finally-although power marketer was not a qf and the price terms under ppa were not as favorable to the supplier as under ppa 1-ppa was accepted by both utility and the regulatory authorities as a substitute for ppa because ppa while still a long-term_contract at above-market rates was more favorable to utility and the ratepaying public than ppa this was reflected not only in the fact of approval itself but also in the manner in which tam-105212-00 in this way some of the statutory benefits of a purpa contract like ppa were effectively preserved and reflected in ppa similarly to a significant extent the investment risks of such a contract-see the discussion of this factor in cases like guggenheim and foy above-were not eliminated but were effectively transferred from taxpayer to power marketer in substance therefore power marketer’s payment to taxpayer was intended to and did in fact result in the acquisition of valuable rights by power marketer in the form of a long-term above-market power supply contract of a type no longer favored in the new deregulated environment and similar in many significant respects to the rights given up by taxpayer in the transaction in this sense power marketer stepped into the shoes of taxpayer under the more liberal interpretation of the sale_or_exchange doctrine represented in ferrer bisbee-baldwin and subsequent cases-as opposed to earlier cases such as general artists or paul small artists-and taking into account all the factors discussed above we conclude that the substance of taxpayer’s rights in ppa survived the transaction accordingly the transaction was a sale_or_exchange of property within the meaning of sec_1221 sec_1222 and sec_1231


internal_revenue_service number release date index number ------------------------- ------------------------------------------------- ----------------------------------------------- -------------------------------- -------------------------------------------------- -------------------------------- department of the treasury washington dc third party communication none date of communication not applicable_person to contact -------------------- telephone number --------------------- refer reply to cc tege eb ec plr-144008-07 date date legend legend date x date y corporation business a business b distributing controlled distributing llc controlled llc ---------------------- -------------------------- -------------------------------- ------------------------- ---------------------------- -------------------------------- ----------------------- ------------------- --------------------- stock_option plan ------------------------------------------------------------- ------------------------------------------------------------------------ stock incentive plan ---------------------------------------------------------------- ------------------------------------------------------------------------ dear --------------- this letter responds to a letter dated date and subsequent correspondence submitted by your authorized representatives requesting rulings under various sections of the internal_revenue_code code this letter addresses your requested rulings under sec_83 and sec_424 of the code a related letter was issued plr-144008-07 on date x the facts as represented in your original and supplemental submissions are set forth below the transaction transaction described in the submissions was completed on date y as described in the submissions corporation was a publicly-held company and the common parent of an affiliated_group_of_corporations filing a consolidated federal_income_tax return corporation was directly engaged in business a and business b corporation had one class of common_stock outstanding the purpose of the transaction was to separate for valid business reasons the two business lines in a spin-off transaction distributing controlled distributing llc and controlled llc were newly formed for purposes of the transaction distributing had one class of common_stock all of which was held by corporation controlled had one class of common_stock all of which was held by distributing all of the membership interests of distributing llc were held by corporation and all of the membership interests of controlled llc were held by distributing distributing llc and controlled llc were disregarded as entities separate from their owners for federal_income_tax purposes pursuant to the transaction corporation merged with and into controlled llc with controlled llc surviving the merger in the merger each share of corporation common_stock was exchanged for one share of distributing common_stock following the merger controlled llc contributed business a to distributing llc and distributed all of its interests in distributing llc to distributing distributing then transferred all of its interests in controlled llc to controlled following such transfers of interests distributing llc incurred certain indebtedness from third party sources and contributed a portion of the proceeds to distributing distributing contributed a portion of such proceeds to controlled then distributed pro_rata all of the common_stock of controlled to holders of record of distributing common_stock share distribution after the forgoing distributing owned business a and controlled owned business b with employees of business a being employees of distributing and employees of business b being employees of controlled with one exception each director of corporation became a director of either distributing or controlled one director of corporation became a director of both corporations prior to the transaction corporation maintained the stock_option plan and the stock incentive plan pursuant to the stock_option plan and the stock incentive plan corporation granted certain of its employees and directors options to purchase shares of corporation’s common_stock as a result of the transaction each incentive_stock_option corporation iso and non-statutory option corporation non-statutory option held by an employee or director immediately before the share distribution was converted into a corresponding incentive_stock_option or non-statutory stock_option to acquire either distributing common_stock distributing isos or non-statutory stock_options as applicable or controlled common_stock controlled isos or non-statutory plr-144008-07 stock_options as applicable consequently employees and directors of distributing received distributing isos or non-statutory options collectively distributing options and employees and directors of controlled received controlled isos or non-statutory options collectively controlled options each distributing or controlled option received as a result of the transaction had the same terms and conditions as the corresponding corporation isos and non-statutory options collectively corporation options except that appropriate adjustments were made by reason of the transaction corporation makes the following representations none of the corporation non- statutory options had a readily_ascertainable_fair_market_value within the meaning of sec_1_83-7 of the income_tax regulations regulations at the time the options were granted none of the distributing or controlled non-statutory options had a readily_ascertainable_fair_market_value within the meaning of sec_1_83-7 of the regulations at the time the options were granted the conversion of corporation isos to distributing and controlled isos as described above was consistent with sec_424 of the code and regulations issued thereunder and corporation specifically represents that the requirements of sec_1_424-1 of the regulations are satisfied pursuant to a tax_allocation_agreement distributing and controlled will each only claim a deduction for compensation income recognized by its own employees and directors sec_83 of the code provides that if in_connection_with_the_performance_of_services property is transferred to any person other than the person for whom such services are performed the excess of the fair_market_value of such property determined without regard to any restriction other than a restriction that by its terms will never lapse at the first time the rights of the person having the beneficial_interest in such property are transferable or are not subject_to a substantial_risk_of_forfeiture whichever occurs earlier over the amount if any paid for such property shall be included in the gross_income of the person who performed such services in the first taxable_year in which the rights of the person having the beneficial_interest in such property are transferable or are not subject_to a substantial_risk_of_forfeiture whichever is applicable sec_83 of the code provides that if property to which sec_83 applies is exchanged for property subject_to restrictions and conditions substantially_similar to those to which the property given in such exchange was subject and if sec_354 sec_355 sec_356 or sec_1036 or so much of sec_1031 as relates to sec_1036 applied to such exchange or if such exchange was pursuant to the exercise of a conversion privilege such exchange shall be disregarded for purposes of sec_83 and the property received shall be treated as property to which subsection a applies sec_83 of the code provides that in the case of a transfer of property to which sec_83 applies there shall be allowed as a deduction under sec_162 to the person for whom were performed the services in connection with which such property was transferred an amount equal to the amount included under subsection a plr-144008-07 b or d in the gross_income of the person who performed such services such deduction shall be allowed for the taxable_year of such person in which or with which ends the taxable_year in which such amount is included in the gross_income of the person who performed such services sec_3 of revproc_2007_3 provides that the internal_revenue_service will not issue a letter_ruling regarding which corporation is entitled to the deduction under sec_83 of the code in cases where a corporation undergoes a corporate_division if the facts are not similar to those described in revrul_2002_1 2002_2_irb_268 sec_1_83-1 of the regulations provides that if substantially nonvested property is subsequently sold or otherwise_disposed_of to a third party in an arm’s length transaction while still substantially nonvested the person who performed the such services shall realize compensation in an amount equal to the excess of the amount_realized on such sale_or_other_disposition over the amount if any paid for such property under sec_1_83-1 of the regulations sec_1_83-1 shall not apply to and no gain shall be recognized on any sale forfeiture or other_disposition to the extent that any property received in exchange therefore is substantially nonvested instead sec_83 of the code and sec_1_83-1 of the regulations shall apply with respect to such property received as if it were substituted for the property disposed of sec_1_83-7 of the regulations provides that if there is granted to an employee or independent_contractor in_connection_with_the_performance_of_services an option to which sec_421 of the code does not apply sec_83 of the code shall apply to such grant if the option has a readily_ascertainable_fair_market_value at the time the option is granted the person who performed such services realizes compensation upon such grant at the time and in the amount determined under sec_83 of the code if sec_83 of the code does not apply to the grant of such an option because the option does not have a readily_ascertainable_fair_market_value at the time of grant sec_83 and b of the code shall apply at the time the option is exercised or otherwise_disposed_of even though the fair_market_value of such option may have become readily ascertainable before such time if the option is exercised sec_83 and b of the code apply to the transfer of property pursuant to such exercise and the employee or independent_contractor realizes compensation upon such transfer at the time and in the amount determined under sec_83 and b of the code if the option is sold or otherwise_disposed_of in an arm’s length transaction sec_83 and b of the code apply to the transfer of money or other_property received in the same manner as those sections would have applied to the transfer of property pursuant to an exercise of the option sec_424 of the code provides that the term issuing or assuming a stock_option in a transaction to which sec_424 applies means a substitution of a new option for the old option or an assumption of the old option by an employer_corporation or a parent or subsidiary of such corporation by reason of a corporate merger consolidation acquisition of property or stock separation reorganization or plr-144008-07 liquidation if the excess of the aggregate fair_market_value of the shares subject_to the option immediately after the substitution or assumption over the aggregate option_price of such shares is not more than the excess of the aggregate fair_market_value of all shares subject_to the option immediately before such substitution or assumption over the aggregate option_price of such shares and the new option or the assumption of the old option does not give the employee additional benefits which he did not have under the old option sec_424 of the code provides that if the terms of any option to purchase stock are modified extended or renewed such modification extension or renewal shall be considered the granting of a new option sec_424 of the code provides in part that the term modification means any change in the terms of the option that gives the employee additional benefits under the option but such terms shall not include a change in the terms of the option attributable to the issuance or assumption of an option under sec_424 sec_1_424-1 of the regulations provides rules under which an eligible_corporation may by reason of a corporate transaction substitute a new statutory option new option for an outstanding statutory option old option or assume an old option without such substitution or assumption being considered a modification of the old option under sec_1_424-1 of the regulations the term eligible_corporation means a corporation that is the employer of the optionee or a related corporation of such corporation the determination of whether a corporation is the employer of the optionee or a related corporation of such corporation is based upon all of the relevant facts and circumstances existing immediately after the corporate transaction under sec_1_424-1 of the regulations the term corporate transaction includes i a corporate merger consolidation acquisition of property or stock separation reorganization or liquidation ii a distribution excluding an ordinary dividend or a stock split or stock_dividend described in sec_1_424-1 of the regulations or change in the terms or number of outstanding shares of such corporation and iii such other corporate events prescribed by the commissioner in published guidance sec_1_424-1 of the regulations provides that for a change in an option or issuance of a new option to qualify as a substitution or assumption the change must be made by an eligible_corporation and occur by reason of a corporate transaction sec_1_424-1 of the regulations further provides that generally a change in an option or issuance of a new option is considered to be by reason of a corporate transaction unless the relevant facts and circumstances demonstrate that such change or issuance is made for reasons unrelated to such corporate transaction plr-144008-07 pursuant to sec_1_424-1 of the regulations for a change in an option or issuance of a new option to qualify as a substitution or assumption the following requirements must be met i in the case of an issuance of a new option or portion thereof in exchange for an old option or portion thereof the optionee's rights under the old option or portion thereof must be canceled and the optionee must lose all rights under the old option or portion thereof there cannot be a substitution of a new option for an old option within the meaning of sec_1_424-1 of the regulations if the optionee may exercise both the old option and the new option it is not necessary to have a complete substitution of a new option for the old option however any portion of such option which is not substituted or assumed in a transaction to which sec_1_424-1 of the regulations applies is an outstanding option to purchase stock or to the extent sec_1_424-1 of the regulations applies a modified option ii the excess of the aggregate fair_market_value of the shares subject_to the new or assumed option immediately after the change in the option or issuance of a new option over the aggregate option_price of such shares must not exceed the excess of the aggregate fair_market_value of all shares subject_to the old option or portion thereof immediately before the change in the option or issuance of a new option over the aggregate option_price of such shares iii on a share by share comparison the ratio of the option_price to the fair_market_value of the shares subject_to the option immediately after the change in the option or issuance of a new option must not be more favorable to the optionee than the ratio of the option_price to the fair_market_value of the stock subject_to the old option or portion thereof immediately before the change in the option or issuance of a new option the number of shares subject_to the new or assumed option may be adjusted to compensate for any change in the aggregate spread between the aggregate option_price and the aggregate fair_market_value of the shares subject_to the option immediately after the change in the option or issuance of the new option as compared to the aggregate spread between the option_price and the aggregate fair_market_value of the shares subject_to the option immediately before the change in the option or issuance of the new option iv the new or assumed option must contain all terms of the old option except to the extent such terms are rendered inoperative by reason of the corporate transaction v the new option or assumed option must not give the optionee additional benefits that the optionee did not have under the old option based on the information submitted we rule that plr-144008-07 sec_83 of the code does not apply to the distributing or controlled non- statutory options that the holders of corporation non-statutory options received pursuant to the share distribution because those options did not have a readily_ascertainable_fair_market_value on the date the share distribution occurred sec_83 will apply when those options are exercised or otherwise_disposed_of the exchange of corporation isos for distributing or controlled isos pursuant to the share distribution will not constitute a modification extension or renewal of these incentive stock_options within the meaning of sec_424 of the code and therefore will not constitute the grant of new options for purposes of sec_424 of the code provided the requirements of sec_162 of the code are satisfied in the event that amounts are includible in the gross_income of a holder of distributing or controlled options under sec_83 of the code as a result of the exercise of such options distributing will be entitled to a corresponding deduction pursuant to sec_83 of the code if the employee was employed by or the director was a director of distributing or a subsidiary of distributing from the date the option was granted through the date of exercise or any earlier termination of employment where applicable and controlled will be entitled to a corresponding deduction pursuant to sec_83 of the code if the employee was employed by or the director was a director of controlled or a subsidiary of controlled from the date the option was granted through the date of exercise or any earlier termination of employment where applicable except as specifically ruled on above no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter in particular no opinion is expressed or implied regarding the qualification of the options under sec_422 of the code further no opinion is expressed or implied regarding sec_409a of the code this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides that it may not be used or cited as precedent a copy of this letter must be attached to any income_tax return to which it is relevant the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination plr-144008-07 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representatives sincerely ___________________________________ kenneth m griffin senior technician reviewer executive compensation branch office of the division counsel associate chief_counsel tax exempt and government entities