The first tip-off as to the Court's (Judge Allegra's) view of the shelter is in its opening quote:
“When does a taxpayer cross the fault line between the cheering fields of tax planning and the forbidding elevations of form over substance, far enough, at least, to require a transaction to be recharacterized for tax purposes? No map – statutory, regulatory or otherwise – precisely reveals this point of no return. Rather, . . . the judicial traveler [is] guided only by multi-factored analyses, balancing tests and other forms of ad hocery, which, if properly employed, serve hope that the terrain’s true character will be revealed.”The quote, by the way, is from Principal Life Ins. Co. v. United States, 70 Fed. Cl. 144, 145 (2006). As an aside, Judge Allegra penned a subsequent Principal Life opinion that, in my view is fantastic and, hence I assign it to my Tax Procedure class to read. Principal Life Insurance Co. v. United States, 95 Fed. Cl. 786 (2010) Readers wishing to read this opinion can download my class materials here. Judge Allegra's Wikipedia page is here.
The Court continues:
This case is about LILOs and, relatedly, SILOs. No, not the Disney character, mind you, nor anything remotely agricultural or martial. Rather, the LILOs and SILOs at play here are acronyms, given to so-called “lease in/lease out” and “sale in/lease out” transactions, respectively. In the world of Federal taxation, LILOs and SILOs are labyrinthine, leveraged-lease transactions in which United States taxpayers seek the tax benefits associated with the ownership of properties that the actual owners – owing to their tax-exempt status – cannot enjoy. Before such transactions were banned by Congress, a variety of prodigious assets owned by foreign corporations and government agencies were so leased – rail cars, hydroelectric plants, locomotives, public transit lines, cellular telecommunications equipment, sewer systems, to name a few – all with the same objective, namely, to take advantage of deductions that would otherwise be “wasted.”We have this saying in parts of the South that a day without grits is a day wasted. I guess the same notion that potential deductions captured in tax indifferent entities are deductions wasted.
I won't get into the labyrinth of the details of the shelter -- all of these are wrapped with detailed to make their substance less visible. I will give some key snippets penned in Judge Allegra's inimitable way:
The rent deductions taken here presuppose that UBC, via the Head Lease, possessed an ownership interest in the Pond. But is this so? To be sure, “[t]here is no simple device available to peel away the form of this transaction and to reveal its substance.” Frank Lyon, 435 U.S. at 576. On the other hand, as Burke once said, “[t]hough no man can draw a stroke between the confines of night and day still light and darkness are on the whole tolerably distinguishable.” And this is neither a hard case nor one of first impression.Stripping the inquiry to essentials (footnotes omitted):
Indeed, in a phalanx of recent cases, courts considering analogous LILO/SILO transactions have readily concluded that, despite the form of those transactions, the taxpayers, in substance, never obtained the benefits and burden of ownership – that viewed in their totality, the circumstances of the lease/sublease transactions did not permit the taxpayers to be viewed, for tax purposes, as possessing an interest in the property upon which their deductions hinged. [String citations omitted] In each of these cases, the court found that the structure of the LILO/SILO prevented the taxpayer from obtaining a genuine ownership interest in the property. And in each instance, the key inquiry was the same – whether the taxpayer involved bore the benefits and burdens associated with the leased asset.
While these cases cite a variety of considerations, the central question in each case came down to whether the original property holder – the “tax indifferent” entity – could be expected to exercise its purchase option at the end of the sublease. That issue proved determinative because if that option was to be exercised, the transactions would become off-setting leases, leaving the property essentially in the hands of the original owner, at least for tax purposes. This was especially so because, under each of the transactions, the tax indifferent entity was to maintain uninterrupted use of the subject property without any involvement of the taxpayer. Moreover, via the offsetting nature of the obligations established in the transaction, the taxpayer was insulated from meaningful economic risk of loss or potential gain, and thus obtained none of the benefits or burdens associated with its leasehold interest.
Hotly-debated in these cases was how to evaluate the purchase options in terms of their impact on who, in substance, should be viewed as owning the subject properties. The taxpayers in all these case argued – as UBC originally did here – that the purchase option factored into the substance-over-form calculus only if it was “certain” to be exercised. Each of the courts made short shrift of that assertion, finding instead that the relevant standard was whether a prudent investor in the taxpayer’s position would have “reasonably expected” that the tax indifferent entity would exercise the purchase option.As the Federal Circuit well-explained in Wells Fargo –
We have never held that the likelihood of a particular outcome in a business transaction must be absolutely certain before determining whether the transaction constitutes an abuse of the tax system. The appropriate inquiry is whether a prudent investor in the taxpayer’s position would have reasonably expected that outcome. Characterization of a tax transaction based on a highly probable outcome may be appropriate, particularly where the structure of the transaction is designed to strongly discourage alternative outcomes.
641 F.3d at 1325-26. Commenting on this passage in Consolidated Edison, the Federal Circuit more recently stated that “[t]his language makes clear that a ‘reasonable expectation’ standard, rather than a ‘certainty’ standard, governs the recharacterization of transactions under the substance-over-form doctrine.” 703 F.3d at 1376. “In our view, and consistent with Wells Fargo,” the court concluded, “‘the critical inquiry’ is whether [the taxpayer] ‘could have reasonably expected that the tax-indifferent entity would exercise its repurchase option.”’ Id. (quoting Wells Fargo, 641 F.3d at 1327).
* * * * *
[Distinguishing Frank Lyon, the case that breathed false hope into the bullshit tax shelter industry]
This case is fundamentally different for a host of reasons. First, unlike the bank in Frank Lyon, the tax-indifferent entity here lacked control over the funds that were churned in the transaction. As the Federal Circuit noted in Wells Fargo, “[t]he only flow of funds between the parties to the transaction was the initial lump sum given to the tax-exempt entity as compensation for its participation in the transaction,” adding that “from the tax-exempt entity’s point of view, the transaction effectively ended as soon as it began.” 641 F.3d at 1330.52 Further, unlike in Frank Lyon, the taxpayer here, UBC, retained neither a significant upside potential for economic gain nor a downside risk of economic loss. See BB&T, 523 F.3d at 474; Wells Fargo, 91 Fed. Cl. at 78; John Hancock Life Ins., 141 T.C. at 83 (finding that the circumstances of the LILO there “are very different from those of a traditional leveraged lease, and certainly far different from the transaction in Frank Lyon”). In Frank Lyon, Lyon’s capital was committed to the building – “[i]ts financial position was affected substantially by the presence of this long-term debt.” Frank Lyon, 435 U.S. at 577. Such is not the case here. Finally, UBC seeks to enjoy, via the form carefully given the transaction, deductions that would not be available to Anaheim. And the Supreme Court emphasized that was not true of the three-party transaction in Frank Lyon. Accordingly, Frank Lyon avails plaintiff naught.In its conclusion (footnote omitted):
The court need go no further. Unlike the nobles in Hans Christian Andersen’s famous fable, the court will not pretend to see something that is not there. In that story’s denouement, a little child witnessing the Emperor’s parade cries out to his father: “But he has nothing on!” Viewed through the prism of Consolidated Edison and Wells Fargo, the transaction here is likewise revealed to be naked of the requisite substance. Despite plaintiff’s valiant attempt to weave cloth out of diamonds, it has not shown otherwise.
Based on the foregoing, the court concludes that plaintiff is not entitled to the refunds requested. The Clerk is directed to enter judgment dismissing plaintiff’s complaint.JAT Comment: This is a quick posting. As I reflect more, I may add to, change, etc. this blog entry.