The CARDS Shelter. Although the patched together CARDS transactions have nuances, here is the broad overview by the Third Circuit:
A CARDS transaction is a tax-avoidance scheme that was widely marketed to wealthy individuals during the 1990's and early 2000's. It purports to generate, through a series of pre-arranged steps, large "paper" losses deductible from ordinary income. First, a tax-indifferent party, such as a foreign entity not subject to United States taxation, borrows foreign currency from a foreign bank (a "CARDS Loan"). Then, a United States taxpayer purchases a small amount, such as 15 percent, of the borrowed foreign currency by assuming liability for a an equal amount of the CARDS Loan. The taxpayer also agrees to be jointly liable with the foreign borrower for the remainder of the CARDS Loan and so the taxpayer purports to establish a basis equal to the entire borrowed amount. n3 Finally, the taxpayer exchanges the foreign currency he purchased for United States dollars. That exchange is a taxable event, and the taxpayer claims a loss equal to the full amount of his supposed basis in the CARDS Loan, less the proceeds of the relatively small amount of currency actually exchanged. The taxpayer uses that loss to shelter unrelated income. n4The following is the gravamen of the smack down on the merits -- actually lack of merits (footnote omitted):
n3 The Commissioner contends that that step in the CARDS transaction "is predicated on an invalid application of the ... basis provisions of the Internal Revenue Code." (Appellee's Br. at 4.) Specifically, I.R.C. § 1012 provides that a taxpayer's basis in property is generally equal to the purchase price paid by the taxpayer. That purchase price includes the amount of the seller's liabilities assumed by the taxpayer as part of the purchase, on the assumption that the taxpayer will eventually repay those liabilities. See Comm'r v. Tufts, 461 U.S. 300, 308-09 (1983) (noting that a loan must be recourse to the taxpayer to be included in basis). But in a CARDS transaction, the Commissioner argues, the taxpayer and the foreign borrower agree that the taxpayer will repay only the portion of the loan equal to the amount of currency the taxpayer actually purchases.
n4 The general structure of a CARDS transaction is well and thoroughly set forth in Gustashaw v. Commissioner, 696 F.3d 1124, 1127-28, 1130-31 (11th Cir. 2012).
The Tax Court found that Crispin's CARDS transaction failed both the objective and subjective tests for economic substance. The Court noted that Crispin experienced only a paper loss of $7.6 million,16 and that, after the CARDS Loan was repaid, Crispin experienced no consequences other than receiving the tax deduction. As a result, the Court concluded that "[t]he ordinary loss claimed from the CARDS transaction was fictional" (App. at 27), which it noted was "the hallmark of a transaction lacking economic substance." (Id. at 28.)
As to Crispin's stated business purpose, the Tax Court determined that both the structure of the CARDS transaction and the record belie Crispin's contention that he engaged in the transaction to obtain long-term financing for use in his aircraft leasing business. Although the Zurich loan had a stated 30-year maturity, the proceeds remained in Zurich's complete possession and control as collateral for the loan, and Zurich had the ability to call the loan at any time after the first year, which it in fact did. Also, Crispin never took any action to obtain and use the proceeds of the loan, knowing that he would have to post an offsetting amount of cash collateral. Nor did he ever take any steps to secure Zurich's approval to substitute aircraft for cash as collateral for the loan. Finally, there was no potential for profit, because the interest rate charged on the CARDS Loan was greater than the interest paid on the proceeds deposited as collateral at Zurich. Based on the foregoing, all of which is well-supported by the record, we see no error, let alone clear error, in the Tax Court's ultimate finding that Crispin's CARDS transaction lacked economic substance.
Crispin objects to the Tax Court's conclusion that much of his testimony on the business purpose of his CARDS transaction was not credible. In particular, the Court discounted his testimony that he had approached Zurich about substituting aircraft for cash as collateral for the CARDS Loan, and that he had received assurances from Zurich that it would consider such a change. Evidently that testimony — as well as expert testimony regarding the potential profit that could be generated by using the CARDS Loan proceeds to purchase aircraft — were unimpressive, because the Court found that Crispin did not actually plan to pursue the substitution of collateral. Crispin's protestations of unfairness in that finding ring hollow. Assessing whether "taxpayers' fact witnesses testified incredibly with regard to material aspects of th[e] case, and that their testimony ... was self-serving, vague, elusive, uncorroborated, and/or inconsistent with documentary and other reliable evidence" constitutes the kind of "credibility determinations ... ensconced firmly within the province of a trial court, afforded broad deference on appeal." Neonatology Assocs., 299 F.3d at 229 n.9 (internal quotation marks omitted). In this case, there was ample documentary and testimonial evidence that contradicted Crispin's account of the business purpose of his CARDS transaction, and the Tax Court did not abuse its discretion in deciding not to credit Crispin's evidence.The Tax Court held, in essence, that not only was the shelter bullshit, but the taxpayer's claim of so-called "business purpose" was bullshit. As described euphemistically by the Third Circuit, that claim was "unimpressive."
The Thrid Circuit then turned to the penalty and sustained Tax Court's imposition of the gross valuation misstatement penalty in § 6662(h). In the following footnote, the Third Circuit did note the current division among the Circuits on this issue:
n18 Our sister circuits are divided as to whether the valuation misstatement penalty applies to tax deductions that have been totally disallowed under the economic substance doctrine. Compare Fidelity Int'l Currency Advisor A Fund, LLC v. United States, 661 F.3d 667, 671-75 (1st Cir. 2011) (holding that the penalty is applicable), Zfass v. Comm'r, 118 F.3d 184, 190 (4th Cir. 1997) (same), Gilman v. Comm'r, 933 F.2d 143, 151 (2d Cir. 1991) (same), and Massengill v. Comm'r, 876 F.2d 616, 619-20 (8th Cir. 1989) (same), with Heasley v. Comm'r, 902 F.2d 380, 383 (5th Cir. 1990) (holding that when the IRS totally disallows a deduction, the underpayment is "not attributable to a valuation overstatement" but rather to claiming an improper deduction), Gainer v. Comm'r, 893 F.2d 225, 228 (9th Cir. 1990) (same), and Todd v. Comm'r, 862 F.2d 540, 543 (5th Cir. 1988) (holding that the penalty was inapplicable when the deficiency was not due to overstated basis but to a failure to place property into service). However, Crispin's reliance on Todd and Gainer is misplaced because they do not state the law of this Circuit. See Merino v. Comm'r, 196 F.3d 147, 157-159 (3d Cir. 1999) (holding that the valuation misstatement penalty applies to property acquired in a transaction found to lack economic substance and expressly declining to follow Todd and Heasley).Finally, to tie this into a criminal tax blog, of course, the shelter itself was bullshit and the taxpayer's representation required as usual in bullshit tax shelters in order to get the legal opinion that he had a legitimate business purpose and independent profit motive was false. Hence, one would have thought that a criminal case might be made or at least a civil fraud penalty imposed. Here is what the Third Circuit said (footnote omitted and emphasis supplied):
Our reasoning as to the applicability of the valuation misstatement penalty finds support in the recent decision of the United States Court of Appeals for the Eleventh Circuit in Gustashaw, supra. In that case, the taxpayer conceded the tax deficiency that the Commissioner had assessed as a result of the disallowance of a CARDS Loan loss, so the economic substance issue was not before the Court, but the taxpayer contested the penalties. Applying the "majority rule," the Eleventh Circuit held that the 40 percent penalty applies "even if the deduction is totally disallowed because the underlying transaction, which is intertwined with the overvaluation misstatement, lacked economic substance." 696 F.3d at 1136. Also, the Fifth and Ninth Circuits "have questioned the wisdom of their positions" in Todd, Heasley, and Gainer because those positions create the "anomalous result" of relieving a taxpayer of the penalty when a deduction is disallowed because it is so egregious that it is improper for a reason other than valuation, such as a lack of economic substance, See Bemont Investments, L.L.C. ex rel. Tax Matters Partner v. United States, 679 F.3d 339, 355 (5th Cir. 2012) (Prado, J., concurring) (noting that the "Todd/Heasley rule," by "[a]mplifying the egregiousness of the scheme — to the point where the transaction is an utter sham — could ... , perversely, shield the taxpayer from liability for overvaluation"); Keller v. Comm'r., 556 F.3d 1056, 1061 (9th Cir. 2009) (recognizing that the rule as expressed in most Circuits, including Merino, is a "sensible method of resolving overvaluation cases" because it "cuts off at the pass what might seem to be an anomalous result — allowing a party to avoid tax penalties by engaging in behavior one might suppose would implicate more tax penalties, not fewer[,]" but acknowledging that, "[n]onetheless, in this circuit we are constrained by Gainer").
For example, Crispin represented to Pullman that the business purpose of the transaction was to reduce borrowing costs and to afford Crispin "the ability to have access to large amounts of capital on a long-term basis to operate the business of Murus." (Supplemental App. at 87.) However, Crispin knew or should have known that that representation was false, given that aircraft were not approved as collateral, which would have been necessary for Murus to make use of the CARDS Loan, and further given that the loan was in essence a one-year revolving credit facility callable at any time after the first year. Crispin also represented to Pullman that "[n]either Chenery nor any other party provided any tax related promotional material to [him] prior to [his] entering into" the CARDS transaction. (Supplemental App. at 79.) But Chenery founder Hahn had presented a CARDS transaction proposal to Crispin that included promotional materials describing the associated tax benefits, as well as a sample tax opinion. When a taxpayer relies on advice that is based on the taxpayer's own misrepresentations, that reliance is neither reasonable nor in good faith. See Treas. Reg. § 1.6664-4(b)(1) ("Reliance ... on the advice of a professional tax advisor or an appraiser does not necessarily demonstrate reasonable cause and good faith.").Even though the 40% penalty may seem significant, I think the IRS has been altogether too lenient with taxpayers attempting to raid the fisc and steal from their fellow citizens (in the aggregate) through these bullshit tax shelters. Why shouldn't false representations made by the taxpayer himself draw the civil fraud penalty?
JAT Note: This is a blog entry originally posted on my Federal Tax Crimes Blog here.