                       T.C. Memo. 2000-361



                    UNITED STATES TAX COURT



    SEAGATE TECHNOLOGY, INC., SUCCESSOR IN INTEREST TO SEAGATE
PERIPHERALS, INC., f.k.a. CONNER PERIPHERALS, INC., Petitioner v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket No. 15086-98.                Filed November 27, 2000.



         P’s controlled foreign corporation, S, sold its
    operating assets to an unrelated corporation, C, in
    exchange for stock of C. The parties to the asset sale
    executed a lockup agreement prohibiting S from selling
    the C stock during a restricted period because C was in
    the process of making its initial public offering.
    During the restricted period, the price of the C stock
    increased. When the sale restrictions lapsed, S sold
    the C stock and realized a gain. Under secs. 951 and
    954, I.R.C., P must include in its U.S. income its pro
    rata portion of S’ foreign personal holding company
    income (FPHCI). Under sec. 1.954-2T(e)(3)(iv),
    Temporary Income Tax Regs., 53 Fed. Reg. 27505 (July
    21, 1988), gain from the sale of operating assets used
    in S’ trade or business does not give rise to foreign
    personal holding company income (FPHCI). Under sec.
    954(c)(1)(B)(i), I.R.C., gain from the sale of a
    passive investment in stock does give rise to FPHCI.
                               - 2 -

          The parties seek to determine, as a matter of law,
     whether the relation-back doctrine, established in
     Arrowsmith v. Commissioner, 344 U.S. 6 (1952), applies
     for purposes of sec. 954, I.R.C., in characterizing S’
     portion of the gain relating to the increase in the
     value of the C stock during the period in which S was
     prohibited from selling the stock. P contends that,
     under the relation-back doctrine, the sale of the C
     stock was integrally related to the sale of the
     operating assets due to the lockup agreement and the
     restrictions on re-sale of the C stock, and that the
     gain on the sale of the stock must take its character
     from the sale of the assets and does not constitute
     FPHCI. R contends that the relation-back doctrine does
     not apply and S’ gain on the sale of C stock
     constitutes gain from a separate investment in stock
     giving rise to FPHCI taxable to P.

          Held: The relation-back doctrine established in
     Arrowsmith does not apply based on the facts of this
     case to characterize S’ gain on the sale of C stock for
     purposes of sec. 954, I.R.C., and accordingly the gain
     on the sale of the C stock constitutes FPHCI.



     Mark A. Oates, Thomas V.M. Linguanti, John M. Peterson, Jr.,

Mary E. Wynne, and Andrew P. Crousore, for petitioner.

     Debra K. Estrem, Michael J. Cooper, Bryce A. Kranzthor,

Jeffrey L. Heinkel, Lavonne D. Lawson, Ewan D. Purkiss, and Mark

S. Heroux, for respondent.


                        MEMORANDUM OPINION

     GERBER, Judge:   Pursuant to Rule 121,1 this matter is before

the Court on the parties’ cross-motions for partial summary


     1
       Unless otherwise indicated, all Rule references are to the
Tax Court Rules of Practice and Procedure, and all section
references are to the Internal Revenue Code in effect for the
taxable years at issue.
                                  - 3 -

judgment.2     The parties seek to determine, as a matter of law,

whether the “relation-back doctrine” established in Arrowsmith v.

Commissioner, 344 U.S. 6 (1952), applies in characterizing

petitioner’s gain on the sale of stock for purposes of section

954.

        Summary judgment may be granted if the pleadings and other

materials demonstrate that no genuine issue exists as to any

material fact and that a decision may be entered as a matter of

law.       See Rule 121(b); Sundstrand Corp. v. Commissioner, 98 T.C.

518, 520 (1992), affd. 17 F.3d 965 (7th Cir. 1994).      There is no

genuine issue as to any material fact with respect to the

specific legal issue before us, and, accordingly, this matter is

ripe for judgment on the contested issue as a matter of law.3

See Rule 121(b).




       2
       Petitioner has filed two motions for partial summary
judgment. This opinion considers what has been denominated in
one of those motions as the section 954 “Read-Rite issue”. The
other motion for partial summary judgment concerns what has been
denominated as the “section 482 cost-sharing issue”, which
involves the question of whether the cost, if any, of employee
stock options should be included as part of petitioner’s cost-
sharing agreement with its foreign subsidiaries.
       3
       While respondent originally believed and argued in his
brief that material facts were in dispute, respondent later
conceded that the parties’ disagreements over the facts focused
on interpretations and conclusions drawn from the underlying
facts and not on the facts themselves.
                              - 4 -

                            Background

     Petitioner is the successor-in-interest to Conner

Peripherals, Inc., (Conner U.S.), a Delaware corporation.

Conner U.S. developed and manufactured hard disk drives for sale

to personal computer manufacturers and other customers.   Conner

Malaysia, a third-tier, wholly owned Malaysian manufacturing

subsidiary of Conner U.S. manufactured hard disk drives and

head-stack assemblies for hard disk drives in Malaysia.

     An Asset Purchase Agreement between Conner Malaysia, Read-

Rite Corp. (Read-Rite) and Conner U.S. was executed on August

30, 1991.   Pursuant to the Asset Purchase Agreement, Conner

Malaysia sold its head-stack assembly operating assets (the

“assets”) to Read-Rite, an unrelated third party.   The deal

negotiated between Conner Malaysia and Read-Rite called for

Conner Malaysia to sell its assets in exchange principally for

Read-Rite stock.   At the time the sale was negotiated, Read-Rite

was preparing to make its initial public offering of stock

(IPO).

     Pursuant to the Asset Purchase Agreement, the consideration

for the assets consisted of the following:

         2.1 Read-Rite Shares. On the Delivery Date (as
    defined in Section 3.2) Read-Rite shall deliver to
    Conner shares of capital stock of Read-Rite (the
    “Shares”) determined as follows:

              (a) In the event of an initial public
    offering of Read-Rite Common Stock pursuant to a
    registration statement on Form S-1 (an “Initial Public
                              - 5 -

    Offering”) which closes within sixty (60) days of the
    Closing Date, Read-Rite shall issue to Conner that
    number of shares of Common Stock $.0001 par value of
    Read-Rite determined by dividing $27,500,000 (subject
    to adjustment as provided in Section 2.2) by the per
    share price to the public in the Initial Public
    Offering. Any fractional share shall be rounded to the
    nearest whole share.

     The Asset Purchase Agreement also provided for an

adjustment to the purchase price as follows:

         2.2 Adjustment to Purchase Price. The
    $27,500,000 aggregate consideration described in
    Section 2.1 shall be subject to adjustment, on a dollar
    for dollar basis, to the extent that the aggregate net
    value of the Inventory and Fixed Assets at the Closing,
    as determined in accordance with this Section 2.2, is
    greater than or less than $14,000,000. Notwithstanding
    the foregoing, no adjustment shall be made for an
    aggregate deviation from $14,000,000 less than or equal
    to $500,000, and any adjustment shall be made only to
    the extent that such aggregate net value exceeds
    $14,500,000 or is less than $13,500,000. To the extent
    that the Purchase Price after such adjustment exceeds
    $27,500,000, Read-Rite shall pay such excess amount to
    Conner in cash on the Closing Date. To the extent that
    the Purchase Price after such adjustment is less than
    27,500,000, the number of shares delivered to Conner
    shall be appropriately reduced.

     Ernst and Young appraised the inventory and fixed assets in

the amount of $5,266,237.   As a result, there was a net downward

adjustment to the purchase price from $27,500,000 to

$19,266,237.   Thus, while it was originally contemplated that

Conner Malaysia would exchange its assets for 2,391,304 shares

of Read-Rite stock, representing approximately 8.9 percent of

Read-Rite’s outstanding shares after the IPO, the actual number

of Read-Rite shares that were delivered to Conner Malaysia was
                              - 6 -

1,675,325.   Read-Rite’s underwriter, Hambrecht & Quist,

announced the purchase price adjustment in its Read-Rite company

report as follows:

    The original purchase price for the Conner HSA
    operation was $27.5 million in stock at the IPO price
    of $11.50. Read-Rite, however, was able to
    dramatically lower the inventory levels of its own
    heads at the Conner HSA location before the transaction
    closed, resulting in a reduction in the actual purchase
    price to less than $20 million, and thus fewer shares.
    * * * [Emphasis omitted.]

     In order to prevent Conner Malaysia from selling its shares

into the market immediately following the IPO, Read-Rite

required Conner Malaysia as part of the deal to agree to

restrictions upon how soon Conner Malaysia could sell the Read-

Rite shares.   Specifically, Read-Rite and Conner Malaysia agreed

that the Read-Rite shares that Conner Malaysia was to receive

would be freely tradeable at the closing of the IPO, subject to

a lockup agreement that prevented Conner Malaysia from selling:

(1) Any of the Read-Rite shares for 180 days following the

closing of the IPO; (2) two-thirds of the shares for 270 days

following the closing of the IPO; and (3) one-third of the

shares 1 year following the closing of the IPO.

     These restrictions on the sale of the Read-Rite stock were

expressly included in the Asset Purchase Agreement.   In order to

prevent Read-Rite from amending the Asset Purchase Agreement to

allow a waiver or release of the sale restrictions, Read-Rite’s

underwriters entered into separate agreements with Read-Rite.
                                - 7 -

These underwriting agreements prevented Read-Rite from

unilaterally releasing Conner Malaysia from the restrictions on

sale without the underwriters’ express written consent.

     On October 18, 1991, Read-Rite launched its IPO, and on

October 26, 1991, the asset sale between Read-Rite and Conner

Malaysia closed.   The delivery date of the shares under the

Asset Purchase Agreement was November 14, 1991.

     Conner Malaysia obtained a valuation by Unterberg Harris,

an investment banking firm, of the appropriate discount

applicable to the Read-Rite shares based upon the restrictions

on sale.   The discount applied to the Read-Rite shares took into

account the lockup provisions applied to the shares.    The

discounted value or book “cost” of the Read-Rite shares was

calculated to be $16,648,542.    For financial reporting purposes,

Conner Malaysia calculated the gain realized on the sale of the

its assets to be $11,282,490.    This figure was derived by

subtracting the book value of the assets from the discounted

value of the Read-Rite stock.

     Pursuant to the Asset Purchase Agreement, the restrictions

on Conner Malaysia’s sale of the Read-Rite stock lapsed 180

days, 270 days and 1 year following the closing of the date of

the Read-Rite IPO.   Once the restrictions lapsed, Conner

Malaysia was free to keep or sell the shares as it wished.
                              - 8 -

     On April 22, 1992, 180 days after the closing of the IPO,

the sale restriction on the first one-third of Conner Malaysia’s

Read-Rite shares lapsed.   On this date, the closing price of

Read-Rite shares was $21-1/4 per share.    On June 1, 1992, Conner

Malaysia sold the first third of its Read-Rite shares (558,442

shares) at an average price of $20.31, yielding total proceeds

of $11,341,147.65.

     The price of Read-Rite shares fell by $.50 from April 22,

1992, the date the first restriction on the sale of shares

lapsed, to June 1, 1992, the date Conner Malaysia sold the first

one-third of its shares.   Thus, by holding the 558,442 shares

beyond April 22, 1992, Conner Malaysia lost $279,221 in proceeds

that it would have received had it sold the shares on April 22,

1992.

     On July 21, 1992, 270 days following the closing date of

the IPO, the second restriction on sale lapsed.   On this day,

the closing price of Read-Rite shares was $23-1/8 per shares.

On this day, Conner Malaysia sold 500,000 shares out of the

558,442 shares that it was then entitled to sell.   Conner

Malaysia sold the 500,000 shares for an average price of $23 per

share, yielding proceeds of $11,500,000.   Conner Malaysia sold

the remaining 58,442 shares from the second one-third of its

shares on November 11, 1992, at an average price of $26-1/2 per

share, yielding proceeds of $1,548,713.
                              - 9 -

     Between July 21, 1992, the date the second restriction

lapsed, and November 11, 1992, the price at which Conner

Malaysia sold the Read-Rite shares increased by $3-1/2 per

share.   Thus, by holding the 58,442 shares beyond the date the

second sale restriction lapsed, Conner Malaysia earned an

additional $204,547 over the amount it would have earned if it

had sold the 58,442 shares on the date the restrictions lapsed.

     On October 25, 1992, 1 year following the IPO closing date,

the final restriction on sale lapsed.   The closing price of

Read-Rite shares at this time was $28-3/8.   On November 11,

1992, Conner Malaysia sold all of its remaining Read-Rite shares

(558,441 shares) at an average price of $26-1/2 per share.     This

sale yielded proceeds of $14,798,686.50.

     Between October 26, 1992 and November 11, 1992, the price

of Read-Rite shares fell by $1-7/8 per share.   Thus, by holding

the 558,441 Read-Rite shares beyond the date of the lapse of the

third sales restriction, Conner Malaysia lost $1.05 million in

proceeds that it would have received had it sold the shares on

October 26, 1992.

     In 1992, Conner Malaysia received gross proceeds of

$39,188,546 from the sale of the Read-Rite shares.   Conner

Malaysia subtracted $16,648,542 (the discounted value of the

Read-Rite Shares) from the gross proceeds of sale and reported a
                                   - 10 -

book gain from the sale of the Read-Rite shares in the amount of

$22,540,004.

                                 Discussion

        The subpart F provisions (sections 951 through 964) require

U.S. shareholders of a controlled foreign corporation (CFC) to

recognize certain income (subpart F income) at the time the CFC

earns that income, rather than later when such earnings are

distributed as a dividend.4       Subpart F income includes foreign

base company income as determined under section 954.        See sec.

952(a)(2).        Under section 954(a)(1), foreign base company income

includes foreign personal holding company income (FPHCI).

       Current taxation of FPHCI under the subpart F regime is

intended to tax “income which is passive in character.”         S.

Rept. 1881, 87th Cong., 2d Sess. (1962), 1962-3 C.B. 707, 788.

In enacting the FPHCI subpart F provisions, Congress intended to

tax income that arose from “portfolio types of investments” or

“where the company [was] merely passively receiving investment

income.”        Id. at 789.

           Accordingly, gains arising from a CFC’s passive or

portfolio investments typically create FPHCI under section 954.

See, e.g., sec. 954(c)(1)(A) (treating dividends, interest,

rents and annuities as FPHCI) and (B)(i) (treating the proceeds



       4
           The parties agree that Conner Malaysia is a CFC of Conner
U.S.
                              - 11 -

on the sale of property that gives rise to dividends, interest,

rents and annuities as FPHCI).

     Consistent with the general congressional scheme of not

including a CFC’s income from conduct of an active trade or

business within the definition of subpart F income, the

regulations specifically exclude from the FPHCI definition gain

from the sale of the operating assets of a CFC’s active trade or

business.   See sec. 954(c)(1)(B)(iii); sec. 1.954-2T(e)(3)(iv),

(v), and (vi), Temporary Income Tax Regs., 53 Fed. Reg. 27505

(July 21, 1988).   Thus, under the subpart F income regime and

the definition of FPHCI, a CFC’s gain on the sale or exchange of

property used in its trade or business does not constitute

FPHCI.

     The parties in this case agree that any gain from Conner

Malaysia’s sale of the assets constitutes gain from the sale of

operating assets used in its trade or business and that,

therefore, such gain does not constitute FPHCI.   The issue

before us is whether the portion of the gain relating to the

increase in the value of the Read-Rite shares during the period

in which Conner Malaysia was prohibited from selling the stock

should be characterized by reference to the sale of the assets
                                 - 12 -

or characterized as arising from a passive investment in the

Read-Rite shares unrelated to the sale of the assets.5

         Petitioner contends that Conner Malaysia’s receipt and sale

of the restricted Read-Rite shares were part and parcel of, and

integrally related to, its sale of the assets.     Therefore,

petitioner argues that under the relation-back doctrine, the

gain on the sale of the shares was inexorably tied to the gain

on the sale of the assets and does not constitute foreign

personal holding company income.      Respondent contends that the

facts in this case do not support the application of the

relation-back doctrine and the gain on the sale of the stock

cannot be characterized by reference to the earlier asset sale.

         Generally, the relation-back doctrine, established by the

Supreme Court in Arrowsmith v. Commissioner, 344 U.S. 6 (1952),

stands for the principle that a subsequent event which is so

integrally related to a prior event that the two events are in

effect part and parcel of the same transaction, should be

treated as having the same character as the prior event.     The

doctrine is premised on the idea that the tax consequences




     5
       Petitioner admits that any net gain resulting from an
increase in stock price after the lapsing of the sales
restriction should constitute FPHCI.
                                - 13 -

should be the same as if the subsequent event had occurred at

the time of the prior event.6

     In Arrowsmith v. Commissioner, supra at 7, the taxpayers

liquidated a corporation in which they had equal stock

ownership.   Partial distributions were made from 1937 to 1940,

and the taxpayers classified and reported these distributions as

capital gains in each year.     In 1944, 4 years after the last

distribution, a judgment was entered against the taxpayers as

the corporation’s transferees.     Each taxpayer paid his or her

share of the judgment and deducted his or her payment as an

ordinary business expense.    The Commissioner characterized the

taxpayers’ payments made pursuant to the judgment in 1944 as

capital losses, not ordinary expenses, that arose out of the

original 1940 liquidation.    The Commissioner maintained that

“the payment of the judgment ‘grew out of, was related to, and

took its character from a capital transaction’” and that the

judgment payments could not be disassociated in their ultimate



     6
       The relation-back doctrine is commonly employed to
distinguish between capital and ordinary treatment of a
transaction. The problem usually arises when a court must
distinguish between capital and ordinary treatment in determining
the character of a subsequent gain or loss which is directly
related to an earlier transaction. To that end, courts routinely
hold that if there has been an “adjustment”, “renegotiation”, or
“revision” of the original selling price of the asset, the
character of the subsequent transaction follows the character of
the initial transaction. The relation-back doctrine has also
been used to prevent taxpayers from receiving what is effectively
a double benefit.
                                - 14 -

character from the distributions in liquidation which such

payments would have served to diminish.     Bauer v. Commissioner,

15 T.C. 876, 878-79 (1950), revd. sub nom. Commissioner v.

Arrowsmith, 193 F.2d 734 (2d Cir. 1952), affd. 344 U.S. 6

(1952).     The Supreme Court agreed with the Commissioner’s

position and held that the payments by the taxpayers were

allowable only as capital losses because they arose from the

earlier capital transaction.

        Courts have applied the Arrowsmith v. Commissioner, supra,

relation-back doctrine in favor of both the taxpayer and the

Government in a myriad of factual settings.7    The relation-back

doctrine has also been invoked under different labels, such as

the “tax benefit rule” of United States v. Skelly Oil, 394 U.S.

678 (1969) or the “origin of claim” rule established in cases

such as Clay v. Commissioner, T.C. Memo. 1981-375.     Regardless

of the label given to the principle, this Court has consistently

framed it as follows:

    the most appropriate tax treatment of the transaction
    in the later year is obtained by examining the


    7
       For example, the relation-back doctrine has been utilized
not only in the context of corporate liquidations, but also in
the context of: (1) Settling lawsuits or paying attorneys’ fees
in connection with a previous disposition of property, Kimbell v.
United States, 490 F.2d 203 (5th Cir. 1974); (2) refunding or
adjusting purchase prices, United States v. Skelly Oil Co., 394
U.S. 678 (1969); and (3) cases dealing with section 16(b) of the
Securities and Exchange Act of 1934 (currently codified at 15
U.S.C. sec. 78p(b)), Brown v. Commissioner, 529 F.2d 609 (10th
Cir. 1976), revg. T.C. Memo. 1973-275.
                             - 15 -

    circumstances surrounding the related transaction in
    the earlier year, because of the relationship between
    the transactions, and it is immaterial whether such a
    result favors the taxpayer or the Government.

Bresler v. Commissioner, 65 T.C. 182, 186-187 (1975).    In

Bresler, the taxpayers sold their small business corporation’s

section 1231 property at a significant loss in 1964.    The

taxpayers reported their share of the loss on their own returns

as a net operating loss that reduced their ordinary income.    In

the same year, they commenced a lawsuit against a competitor for

alleged antitrust violations, claiming damages that included the

full amount of their loss from the sale of assets.   In 1967, the

case was settled.   On the 1967 income tax return, the taxpayers

claimed that the majority of the settlement proceeds was to

reimburse them for the loss they realized upon the sale of their

corporation’s assets and that those proceeds were taxable as

capital gain and not as ordinary income.   The Commissioner

maintained that the proceeds should be treated as ordinary

income.   The Tax Court, agreeing with the Commissioner and

treating the proceeds as ordinary income, stated:

    If * * * [taxpayers’ corporation] had received the
    antitrust settlement in * * * [1964], any portion
    representing compensation for the loss on the sale of
    its section 1231 property would have merely reduced its
    ordinary loss * * *. Arrowsmith requires that the gain
    realized in 1967 be treated in the same manner as if it
    had been received in 1964.

    Since the gain, if received in 1964, would have
    resulted in an increase in ordinary income, it is not
    transformed into capital gain by a mere delay in
                             - 16 -

    receipt. The subsequent gain is part and parcel of the
    original loss transaction and cannot be segregated for
    tax purposes. The gain in 1967 is merely an adjustment
    of the prior sale price; it is not a new and
    independent sale or exchange of section 1231 property.
    The receipt of the payment in 1967 was merely the
    completion of a prior transaction. Arrowsmith requires
    us to treat both events as a unified transaction. * * *
    [Id. at 187; citations omitted; emphasis supplied.]

     Simply stated, the doctrine set forth in Arrowsmith v.

Commissioner, supra, is that the tax treatment of a transaction

occurring in 1 year may control the tax treatment afforded a

second transaction in a subsequent year where both transactions

are integrally related.   This doctrine does not breach the

principle of the annual accounting period because no attempt is

made to reopen and readjust the treatment of the original

transaction.   See id. at 8, 9.   In order for Arrowsmith v.

Commissioner, supra, to apply, however, there must be a

relationship between two transactions which is sufficient to

require the conclusion that both transactions are parts of a

unified whole.

     In Arrowsmith, the Supreme Court found such relationship in

part because the payment at issue would have been offset against

the capital gain had both transactions occurred in the same

year.   Likewise in Bresler v. Commissioner, supra, a sufficient

relationship was found because the settlement proceeds paid in a

subsequent year would have been offset against the original loss

transaction had both events occurred in the same year.
                               - 17 -

     The question we must ask, then, is whether the two

transactions in this case were “part and parcel of one”.     Wener

v. Commissioner, 24 T.C. 529, 532 (1955), affd. 242 F.2d 938

(9th Cir. 1957).    If so, then the gain or loss in the subsequent

year must take its character from the transaction in the earlier

year.   See Bresler v. Commissioner, 65 T.C. at 187; Arrowsmith

v. Commissioner, 344 U.S. 6, 8 (1952).

     We addressed an analogous situation in Slater v.

Commissioner, 64 T.C. 571 (1975), and concluded that the

relation-back doctrine did not apply.    In Slater the taxpayer

was granted an option to purchase restricted shares of his

employer’s stock.   The taxpayer exercised his option in June

1968 and, when the restrictions lapsed in July 1969, recognized

the difference between the stock’s exercise price and its fair

market value as ordinary income.   The following year, in

December 1970, the shares were sold at a loss.   The taxpayer

attempted to argue that, under the relation-back doctrine, the

loss should be characterized as an ordinary loss by reference to

the character of the gain that had been recognized when the

restrictions lapsed.   The taxpayer argued that because he had

received the options as part of his employment, the loss on the

shares should relate back to his employment.

     We rejected the taxpayer’s argument, finding instead that

no relationship existed between the taxpayer’s employment and
                                 - 18 -

the loss on the sale of the shares.       We concluded that when the

taxpayer purchased the stock, he became an investor in the

stock, and any subsequent gain or loss is due to the fortunes of

the company.     Accordingly, his loss was not found to be

integrally related to the circumstances under which he acquired

the stock, and we declined to apply the Arrowsmith v.

Commissioner, supra, doctrine.

         Petitioner argues that Slater v. Commissioner, supra, is

inapposite because the sale giving rise to the recognition of

the entire loss at issue in that case occurred 17 months after

the restrictions on the stock lapsed.      Petitioner contends that

no one, including the Commissioner, doubted that the

restrictions on the shares of stock linked the taxpayer’s

exercise of the options in 1968 to his income from the shares in

1969.8

      It is true that the taxpayer sold the stock 17 months after

the restrictions lapsed and no argument was ever made that a

portion of the loss was attributable to the restricted period.

Indeed, the restricted period was addressed in Slater v.

Commissioner, supra, only to the extent that the taxpayers


     8
       The reporting of the bargain element as ordinary income by
the taxpayers in 1969 when the restrictions lapsed was not
governed by the relation-back doctrine. As such, we do not view
petitioner’s statement regarding the link between the exercise of
the option and the reporting of the bargain element as
instructive in determining whether the relation-back doctrine
applies to the facts of this case.
                              - 19 -

reported additional ordinary income for the bargain element of

the stock when the restricted period ended.    What is important

about Slater, however, is our statement that “When * * * [the

taxpayer] purchased the stock at a bargain, it was as if he had

been paid additional compensation which was used to purchase the

stock; thereby, he became an investor in the stock, and any

subsequent gain or loss is due to the fortunes of the company.”

Id. at 575. Thus, we considered the taxpayer in Slater v.

Commissioner, supra, to have become an investor in the stock in

June 1968, and we did not view the restricted period as altering

when the taxpayer became an investor.

     Similarly in the present case, we view petitioner as an

investor in Read-Rite at the time the shares were received.     We

do not find the gain on the sale of the Read-Rite stock to be

integrally related to the circumstances under which petitioner

acquired the stock.   After receiving the Read-Rite shares as

consideration for the assets, Conner Malaysia became an investor

in the stock, and any subsequent gain or loss was due to the

fortunes of Read-Rite in the marketplace.

     In addition, the value of the Read-Rite shares was

independently determined upon sale by investors in the stock

market, and was not integrally related to Conner Malaysia’s

former sale of assets to Read-Rite.    Further, any gain or loss

on the Read-Rite shares during the restricted period had no
                                - 20 -

impact on the agreed upon sales price of the assets.       The Asset

Purchase Agreement did not provide for an adjustment or revision

of the purchase price at the end of the restricted period.          As

such, the first transaction terminated when the assets were

sold, and the subsequent sale of the Read-Rite stock was a new

transaction that should be considered entirely separate and

independent for tax purposes.    Accordingly, the facts of this

case provide no basis for applying the relation-back doctrine of

Arrowsmith v. Commissioner, supra.

     Petitioner makes several contrary arguments.      First,

petitioner contends that the lockup agreement and restrictions

on the Read-Rite shares were the integral links tying Conner

Malaysia’s sale of the Read-Rite shares to its receipt of the

shares in exchange for the assets.       According to petitioner,

both the receipt of the Read-Rite shares and the sale

restrictions imposed on Conner Malaysia by Read-Rite and its

underwriters was an integral part of Conner Malaysia’s sale of

the assets.   Thus, petitioner argues that the sale of the Read-

Rite shares upon lapse of the sale restrictions arose out of and

was part and parcel of the same transaction.

     The fact that restricted stock was used as consideration

for the asset sale does not integrally tie the two transactions

together.   Regardless of when Conner Malaysia could sell the

Read-Rite shares, the subsequent sale of those shares did not
                               - 21 -

involve any adjustment, renegotiation, or revision of the

original selling price of the assets.   The restrictions simply

prevented Conner Malaysia from selling the shares during the

lockup period.   The restrictions did not in any way change the

value of the assets, or the aggregate consideration as stated in

the Asset Purchase Agreement, that the parties agreed upon.

Once the assets were sold, any fluctuations in the Read-Rite

stock during the restricted period were due to the fortunes of

Read-Rite and market forces and had nothing to do with the value

of the assets sold.   The two transactions were not tied

together.   For example, if the Read-Rite shares became worthless

during the restricted period, it would not then follow that the

assets became worthless as well.   The assets had an agreed upon

value, and any subsequent gain or loss on the Read-Rite shares

had no effect on such value.   As such, the fact that the

consideration for the assets was restricted stock does not

provide the requisite link for the application of the relation-

back doctrine.

     Petitioner also contends that the fact that the assets were

purchased for stock, rather than cash, also provides the

requisite link to apply the relation-back doctrine.   While it is

true that Read-Rite shares were ultimately received in exchange

for the assets, it is also true that a purchase price was agreed

upon and then paid in stock.   The parties initially agreed to
                             - 22 -

sell the assets for $27,500,000, payable in Read-Rite shares.    A

subsequent adjustment based on an appraisal of the inventory and

fixed assets reduced the aggregate consideration to $19,266,237.

This amount represented the fixed, noncontingent purchase price

for which Conner Malaysia agreed to sell its assets.    The number

of Read-Rite shares to be delivered to Conner Malaysia as

consideration for the assets was determined by dividing this

amount by the IPO per share price of Read Rite stock.

     Nothing in the Asset Purchase Agreement gave any indication

that the sales price for the assets could not be determined

until the restrictions on the Read-Rite stock lapsed.   There is

also no indication in the Asset Purchase Agreement that any

subsequent gain on Conner Malaysia’s sale of the Read-Rite

shares merely represented an adjustment or additional portion of

the purchase price of the assets.   Thus, the fact that the

consideration for the assets was Read-Rite stock does not, by

itself, provide an integral link between the two transactions.

     Petitioner also cites several cases that were decided under

the open transaction doctrine.9   These cases, however, are



    9
       Under the open transaction doctrine, the original
transaction is held open and the resulting tax consequences are
suspended, while under the relation-back doctrine, the original
transaction is closed, and the subsequent taxable transaction
receives its character based on the original transaction. Unlike
the relation-back doctrine, the touchstone for use of the open
transaction doctrine is the inability to value what was received
in the original transaction.
                                - 23 -

irrelevant to our analysis since neither party is advocating for

the application of the open transaction doctrine in the present

case.     Indeed, the fact that Conner Malaysia discounted and

valued the restricted shares in 1991 indicates that they treated

the asset sale as a closed transaction in 1991.     Petitioner

nevertheless argues that the logic and analysis used in Likins-

Foster Honolulu Corp. v. Commissioner, 840 F.2d 642 (9th Cir.

1988), affg. T.C. Memo. 1985-572 and Dimond v. United States (In

re Steen), 509 F.2d 1398 (9th Cir. 1975), are controlling in the

instant case, even though those cases did not cite Arrowsmith v.

Commissioner, supra, and were decided using the open transaction

doctrine.    We disagree.   While similarities may exist between

relation-back cases and open transaction cases, they nonetheless

involve different principles, and we simply cannot rely on cases

that were decided based on the open transaction doctrine in

order to decide a case that, neither party disputes, involved a

closed transaction.

     Petitioner acquired the Read-Rite shares at a set price

which was not at all dependent on what it subsequently obtained

from unrelated third parties upon the sale of the restricted

shares.    Petitioner did not introduce any evidence that Conner

Malaysia and Read-Rite intended the asset price to be determined

after the Read-Rite shares were sold or the restrictions lapsed.

The fact that Conner Malaysia assumed the risk that it was
                              - 24 -

selling its assets in exchange for stock that could be worthless

by the time Conner Malaysia was free to dispose of it does not

change the fact that any such decrease in the value of the

shares was unrelated to the asset sale.   Furthermore, the

restrictions addressed the ability of Conner Malaysia to trade

the Read-Rite shares and did not specifically prohibit Conner

Malaysia from pledging the shares as collateral or borrowing

against the shares during the lockup period.   Thus, despite the

restrictions, it was possible for Conner Malaysia to realize

value from the Read-Rite shares during the restricted period,

and any such value would be separate and independent from the

asset sale.

      In short, Conner Malaysia’s receipt of the Read-Rite shares

in exchange for its assets represents a transaction that is not

part and parcel of Conner Malaysia’s subsequent sale of such

shares.   The facts simply do not demonstrate the requisite link

between the receipt of the Read-Rite shares and the subsequent

sale of those shares necessary to apply the relation-back

doctrine.10




     10
       Respondent stresses that the relation-back doctrine has
never been applied in the subpart F setting. We note that our
conclusion that the relation-back doctrine is not applicable in
the instant case does not necessarily bar the use of the
relation-back doctrine in other situations within the subpart F
arena.
                              - 25 -

     In light of the foregoing and considering the facts of this

case, we hold that the relation-back doctrine established in

Arrowsmith v. Commissioner, supra, does not apply for purposes

of characterizing Conner Malaysia’s gain on the sale of the

Read-Rite stock.   Accordingly, petitioner’s gain on the sale of

the Read-Rite stock constitutes FPHCI.

     We have considered the parties’ remaining arguments and

find them either irrelevant or unnecessary for resolving the

parties’ controversy.   To reflect the foregoing,

                               An order will be issued denying

                          petitioner’s motion for partial summary

                          judgment and granting respondent’s

                          motion for partial summary judgment.
