Pursuant to 5 T H C IR . R. 47.5, the court has determined that thi s opinion should not * be publishe d and is not precedent except under the limited circu mstance s set forth in 5 T H C IR . R. 47.5 .4. 

### INTHE UNITED S TATESCOU RT OFAPPEALS

FORTHEFIFTH CIRCU IT

N o. 08- 20261

ENB RI DGE E NER GYC OMPA NYI NC; E NBR I DGE MI DC OA S T E NER GY LP , f or m er l y know n as E nbri dge M i dco as tE ner gy I nc, f or m er l y know n as M i dcoast E n ergy R esources I n c P l ai n t i f fs - A pp el l an t s v. UN I TE D S TA TE S OF AM ERI CA D efen da n t- A pp el l ee

A p p ea lf

rom the U n i tedS tates D i stri ct C ou rt f or th e Sou t h ern D i st ri ctof T exas U SD C N o. 4: 06- C V

- 657

B ef ore B A R K S D A L E , D E N N IS, an d E L R O D , C i rcui tJu dg es . P E R C U R IA M: * Pl ai nt i f fs- A ppel l ant s E nbri dge E ner gy Com pany, I nc. and E nbri dge M i dcoast E n ergy, L
. P
. (coll ect ivel y, “M i dcoast” ) broug h tt h i s s u i tf or a r ef u n d of t axes an d p en al t i es asses sed by the Inter n alR e v en u e Servi ce (“ IR S ” or

“ Com m i s s i o ne r” )

. I n 1 99 9, M i dc o as ta c quir e d the c o nt r o lo f t he Bi s ho p Gr o up (“ B i shop ” ) , w h i ch operated va ri ou s energy-r e l ated pi pel i n es. Th e chan ge of United States Court of App eals

Fifth Circuit 

### F I L E D November

10, 2009 Cha rl es R. F ulb ru g e II I ClerkN o. 08- 20261

2 controlt ook the f

orm of a cond uitt ran sact i on , w h ereby B i shop ’ s s ol e shareh ol der sol d h i s s t ock t o a t h i rd- pa rt y i n t erm edi ary (t h e K

- P i pe M erger C orporati on , or “K -P i p e”), w h i ch the n i m m ed i a tel y so l dthe f orm erly B i sh op ass ets to M i d coa st. The I RS, a pplyi ng t he “ s ubs t anc e o ve rf o r m ” do c t r i ne , di s r e ga r de d the us e o f t he
c ondui ti n t he tr ansac t i on, tr eat i ng t he tr ansac t i on as a dir ec ts t oc k s al e f ort ax pur po s e s - - r e s ul t i ng i n l e s s fav o r ab l e t axt r e at m e ntf o rM i dc o as t
. Af

t e rpa yi ng d u e ta x e s a n dp e n a ltie s u n d e rp r o te s t, M id c o a s t b r o u g h t t h e in s ta n t s u it
c l ai m i ng t he I RS er r o ne o us l y t r e at e d the t r ans ac t i o n a s adir e c ts t o c k s al e a nd
erroneou sly assessed a 20% pen al t y . T h e di st ri ctcourtgran t ed su m m ary ju d g m e n t t o th e IR S o n b o th cla im s . F o rth e fo llo w in gre a s o n s , w e a ffir m . I . B A CK GRO UND T h e m a te r ia l fa c ts o f th is ca s e a r e u n d is p u te d , a n dt h e d is tr ic t c o u r t a b ly
a n d a ccu ra tel y recit ed th em i n i ts m em ora n d u m op i n i on a n d ord e r . S ee E n bri dge E n ergy Co. v. Un i t ed S t ate s , 5 5 3 F . S u p p . 2 d7 1 6 (S .D . T e x . 2 0 0 8 ). W e h ig h lig h t t h e m o s t s a lie n t fa c ts h e r e . M i dc oast andBi s ho p wer e i n t he b us i ne s s o f o w ni ng ando pe r at i ng nat ur alg as pi pe l i ne s . D e nni s Lang l e y w as Bi s ho p’ s s o l e s har e ho l de r , a nd thus controll ed B i shop ’ s asset s, w h i ch consi st ed p ri m ari l y of na t u ralgas pi pel i n es. Beg i nni ng i n 1 99 9, Langl e y de c i de d t o s e l l Bi s ho p. Spe c i f i c all y, Lang l e y s o ugh t to s e ll h is s t o c k i n B is h o p b e c a u s e ad ir e c t s to c k -s a le w o u ldb e s u b s ta n tia lly
m o r e b e n e fi c ia l t o h im fr o m ata xp e r s p e c t iv e th a n as a le o f o n lyth e e n t it y ’s asset s. L an gl ey arran ged w i t h C h ase S ecuri t i es, Inc. t o soli citpotenti albu yers o f th e B is h o p s to c k

. M id co a st w a s a n in te re ste db u y e r, b u t p re fer re dto p u rc h a se B ish o p ’s
as s e t s r athe rt han Lang l e y’ s s t o c k. M i dc o as t ’ s p r e fe r e nc e f o rpur c has i ng t he B is h o p ’ s a s s e ts s te m m e df r o m ad e s ir e to a v o idth e ta xliab ilityth a t w o u ldre s u lt f rom pu rchasi n g L an gl ey’ s s t ock. M i dcoast n on et h el e ss s u b m i t t ed a seri es of
n on -bi n d i n g, con d i ti on a l b i d s for th e pu rch a se of th e st ock , n on e of w h i ch l edtoN o. 08- 20261

3 a f i nals al e a gr e e m e nt
. I n Sept e m be r1 99 9, a f t e rc o nduc t i ng f

ur t he rdue di l i ge nc e , M i dc o as tr e duc e d it s b i d p r i c e f o rt he s t o c k t o $ 16 3 m i l l i o n, apr i ce bel ow w hatLangl ey had so ught f ort he s t oc k. A s M i dco as t ’ s gener alc ounse lhas
aver r ed, t hi s bi d “r es ul t ed i n a s i gni f i c antgap bet w ee n t he pr i c e M i dco as tw as
w i l l i n g to p a y a n dthe pr i ce L a n gleyi n d i ca tedh e w a s w i l l i n g to a ccep t. ” A tappr oxi m at ely t hi s sa m e t i m e, M i dco as tc ons ul t ed w i t h an out si de t ax ad vi sor , Pr i c e w at e r ho us e Coo pe r s , LLP ( “ PW C” ) , c o nc e r ni ng t he t r ans ac t i o n. P W C f i rstsugg est ed the i dea of u si n g a “ m i dco t ran sact i on , ” i n w h i ch L an gl ey
w ou l d sel lhi s B i shop st ock t o a th ird party, an d the t h i rd pa rt y w ou l d i n t u rn s e l lt h e B is h o p a s s e ts to M id c o a s t. T h is a r r a n g e m e n t, P W C a d v is e d , w o u ld pro v i d e t a x b e ne f

i t s f o r b o t h M i d c o a s t a nd La ngl e y . PW C s ug g e s t e d t hat M i d coa st u se F ortren d In tern a ti on a l L L C (“ F ortren d”) , a n i n ve stm en t b a n k , to fa ci l i tate th e tran sa cti on . T h om a s J. P a l m i sa n o, th en a se n i or m a n a ge r w i th P W C , t e stified t h at hi s f i rm contact ed F ort rendt o faci l i t ate th e M i dco tr a n s a c tio n s p e c ific a llys o t h a t “M id c o a s t [w o u ld ] r e c e iv e as te p p e d -u p b a s is in th e [B i sh op ] a sse ts. A n dbydo i n g so , it w ou l dgive [M i d coa st] an ab ilityto i n crea se th e a m ou n t of con sider a ti on f

or th e a sse ts. ” R eco gn i zing th e b en efits of t he For t r end- fac i l i t at ed m i d co t r ansac t i on, M i dco as tagr ee d bec ause , as M i dc o as t ’ s C F O test i f i e d, “t hi s w as t he o nly t hi ng t hatw e fe l tc o ul d c l o s e ” t he g a p b e tw e e n L a n g le y ’ s re q u e s te dp r ic e a n dM id c o a s t’s o ffe r . F ortren dbe ga n n eg oti a ti n g w i thL a n gleyto a cq u i re his B i sh op stock , w i th M id c o a s t a n dP W C p a r tic ip a tin ginth e n e g o tia tio n s a n do fte n d e a lin gd ir e c tly
w i t h Langl e y. Fo r t r e nd c r e at e d a n e nt i t y, K

- P i pe , s pe c i f i c all y f o rt he tra n sa ctio n . K

- P i pe h adno assets of it s ow n , nor ha d i tcondu ct ed an y pri or b u sine ss. O n S ep tem b er 3 0 , 19 9 9 , K -P i p e su b m i tted a l et te ro f in ten t t o L a n gleycont ai ni ng i t s of fert o pur c hase t he B i sho p s t oc k. The f oll ow i ng day, O ctob er 1 , 19 9 9 , M i d coa st su b m i tted a l etter of i n ten t t o K -P i p e con tain i n g it s o f fe rt o pur c has e t he Bi s ho p a s s e t s . Appr o xi m at e l y o ne w e e k l at e r , f o l l o w i ng t heN o. 08- 20261

4 l et t er s of

i nt ent , K

- Pi pe pur c hase d al lof Lan gley ’ s B i sho p s t oc k; t he nextday, K

- P i pe sol d allof

B ish op’ s asset s t o M i dcoast, save f or a r oyalty i n t erest ( describedas t h e B u t cher I n t erest) hel d byB i shop t h at K

- P i pe sol d to a pa rt n ershi p consi st i n g of K

- P i pe an d M i dcoast. K

- P i pe f i n an ced i t s pu rchase of Lang l e y’ s s t o c k wi t h a l o an o bt ai ne d f r o m R ab o ba nk N e de r l and , a D ut c h b ank kno w n f

o rf i nanc i ng m i dc o t r ans ac t i o ns , w hi ch w ase nt i r e l y s e c ur e d b y f unds t o t a l i n g$ 1 9 1
. 1 mi l l i o n t h a tMi d c o a s td e p o s i t e di n e s c r o w w i t hR a b o b a n k

. K

P i pe tr an sferred app roxi m ately $12 2. 5 m i l l i on t o L an gl ey i n con si derati on f or t he s t o c k; M i dc o as t t r ans fe r r e d $1 22
. 6 m i l l i o n t o K

- Pi pe i n c o ns i de r at i o n f o rt he
as s e t s , a nd a n a ddit i o nal$ 79 m i l l i on d i r e c t l y t o Bi s ho p’ s c r e dit o r s . The di f fer enc e i n pri c e b et w ee n t he s t oc k purc hase pr i c e a nd t he as se t sa l e pric e w as $ 6 .4 m illio n , re p r e s e n tin gK -P ip e ’ s (a n dth e r e fo r e F o r tr e n d ’ s ) c o m m is s io n . K

- P i pe ret ai n ed tit l e i n t erestt o t h e B i shop st ock, equ i t y i n t h e B u t cher I nt e r e s t , a nd c e r t ai n c aus e s o f a c t i o n a ga i ns tt hi r d p ar t i e s ( as w e l la s t he d iff e re n ce b e tw e e n th e p u rc h a se p rice of th e sto ck a n dsa le p rice of th e a ss e ts). K

- Pi pe c on ti n u ed in ex i st enc e thro ugh atl eas t2002, t hough i t s annu alt ax f i l i ngs s h o w t h a titc o n d u c t e dv i r t u a l l yn o b u s i n e s s . S u b s e q u e n tt o t h e s t o c ka sse t sale, i n N ov em b er 2 0 0 0 , M i d coa st p a i d K -P i p e $2 4 4 , 7 5 0 f or K -P i p e’ s eq u i ty i n the B u t cher In t erestb y exerci si n g an eff ect ivel y m an da t ory pu rchase opti on i tr e t ai ne d f

r o m t he o r i gi nalt r ans ac t i o n. M i dc o as ts ubs e que nt l y t e r m i nat e d the B u t cher I n t erestan d d edu ct ed an al l egedl oss on it s 2001 corporate tax ret u rn o f a ppr o xi m at e l y $5

. 7 m i l l i o n. M i dco as tc l ai m ed an adj ust ed bas i s i n t he f or m erB i sho p as se t s i n t ax ye ar 199 9 equ alt o t h e $19 2 m i l l i on itpaid f or t h em . In sub sequ en t years, M i dcoast b e g a n c l a i m i n gd e d u c t i o n s b a s e do n t h e d e pr e c i a t i o n o f t h o s e a s s e t s . T h e I RS i nst i t ut ed an audi tand par t i al l y di sa l l ow ed thos e de duct i ons , f i ndi ng t hat M i dc o as ts ho ul d ha vepa i d t ax e s a s t ho ughitpur c has e d th e s t o c k o f Bi s ho p. A ccor di n gl y, t h e I R S di sregarded the f orm of t h e condu i tt ran sact i on an d tr eatedN o. 08- 20261

5 i tas t h ou gh M i dcoast di rect l y pu rchased t h e stoc k of B i shop

. T h e IR S perm i t t ed M i dc o a s tt o c l a i m ac a r r y o v e rb a s i s o f $ 3 5 m i l l i o n i n t hea s s e t s (t heb a s i s t hat Bi s ho p c o ul d ha vec l ai m e d) a nd m ak e de duc t i o ns b as e d o n t hata m o unt
. The IR S al so asses sed a 20 % pen al t y du e t o the sub st an t i alun derpa ym en tof t axes. M i dcoast pa i d ap proxi m ately $5. 4 m i l l i on t o t h e IR S u n der protes t
. Th ereaf t er, M i dc o as ts o u g h tar e f u n do f t h a tp a y m e n t
. W h e n t h e I RS d e n i e dt h e r e f u n d, M id c o a s t b r o u g h t t h e in s ta n t s u it t o o b ta in th e re fu n d

. O n t h e parti es’cr oss -m ot i on s f or s u m m ary j u dg m en t , t h e di st ri ctcourt gran t ed su m m ary j u dg m en tt o t h e U n ited S t ates, concl u di n g t h at M i dcoast fai l ed to m eetit s burd en t o prove t h at th e I R S erroneou sly di sregarded the f orm of t h e con d ui tt r ansac t i on. The di st r i c tc our tal sohel d t hatt he I R S w as p e r m itt e dto a s s e s s th e 2 0 % p e n a lty

. M id c o a s t t im e lya p p e a le d

. I I . S TA NDARD OF RE VI EW

“ T h e gen eralcharacter i zati on of a tr a n sa ct i on f

or t ax p u rposes i s a q u estion of l a w su bj ect to rev i ew . ” Fran k Lyon Co v. Un i t ed S t ate s , 435 U
. S. 561, 5 8 1 n . 1 6 ( 1 9 7 8 ). W e rev i ew the distri ct cou rt’ s gra n t of su m m a ryj u d gm en t de
novo . Tu rner v. B aylorR i cha rdson Med. C t r. , 4 7 6 F .3d3 3 7 , 3 4 3 (5t h C ir. 2 0 0 7 ). Aparty i s entit l ed to sum m ary j u dg m en tonl y i f “t h e pl ead i n gs, t h e di scovery anddi s c l o s ur e m at e r i al s o n f i l e , and any af

f i da vit s s ho w t hat t he r e i s no g e nui ne i ssue as t o an ym a te ria l factan d that t h e m ovan ti s entit l ed to j u dg m en tas a
m at t e ro f

l aw. ” Fed

. R. Civ. P. 56 (c )

. O n a m o t i o n f o r s um m ary j udg m e nt , t he
cou rt m u st view the fa cts i n the l i gh t m ost fav ora b l e to th e n on -m ov i n g p a rty
a n dd r a w a ll re a s o n a b le in fe r e n c e s init s fa v o r . S ee Hockm an v. W est w ard Co m m c ’ ns , LLC , 407 F
. 3d 317 , 325 ( 5th C i r. 200 4)

. In revi ew i n g t h e evi den ce, t he c o ur tm us t“r e f

r ai n f r o m m ak i ng c r e dibil i t y de t e r m i nat i o ns o rw e i ghi ng t he
ev i d en ce.” Tu rner , 476 F. 3d at343.N o. 08- 20261

6 I I I . DI S CU S S I ON A . Su bst an ce O ver F orm The Supr e m e Cour the l d i n Com m i ssi on er v. Cou rt Hol d i ng Co. , 32 4 U
. S. 331 ( 1945) , t hatthe I R S m ay as se ss t axes bas ed on t he s ubst ance , r at hert han t he f o r m , o f ac o nduitt r ans ac t i o n. The Cour te xp l ai ne d: T h e in cid e n ce o f t a x a tion d e p e n d s u p o n th e su b sta n ce of a t r a n s a c t i o n . T h e t a xc o n s e q u e n c e s wh i c h a r i s e f r o m g a i n s f

r o m a s al e o f pr o pe r t y ar e no tf

i nall y t o be det e r m i ne d s o l e l y byt he m e ans em pl oye d t o tr ansf

erl egalt i t l e. Rathe r , t he t r ansac t i on m ustbe vi e w e d a s a w ho l e , a nd e ac h s t e p, f r o m t he c o m m e nc e m e nto f t he negot i at i ons t o the c ons um m at i on o f t he s al e, i s r el evant
. Asal e b y one per so n ca nnotbe t r ansf or m ed f ort ax p u r pos es i nt o as al e b y an ot h er by usi n g t h e l att er as a cond u i t t h rough w h i ch t o pa ss t i t l e. T o perm i tt h e t rue n ature of a t ran sact i on t o be di sgu i sed by m ere fo r m a lis m s , w h ichex i st sole lyto a lte rta xlia b ilitie s , w o u lds e r io u s ly i m pa i r th e ef

fect ive ad m i n i st rat i on of t h e t ax p ol i ci es of

C on gress. I d. a t3 34
. The Cour tr e af f i r m e d thi s ho l di ng i n Uni t e dS t a t e sv . Cu m be r land P u bl i c Servi ce Co. , 3 38 U
. S. 4 51 ( 19 50 ) , a n d obse rve d thati n a pplyi ng t he
s ubs t anc e - o ve r - f

o r m pr i nc i pl e , t h e cour t“ c an c o ns i de rm o t ive s , i nt e nt , a nd
con d u ct i n ad d i ti on to w h a t ap p ea rs in w ri tteni n stru m en ts u sed bypa rti es to
con trol ri gh ts as a m on g th em selve s. ” Se ei d. at455 n. 3. The Suprem e Courthas al s o c aut i o ne d, ho w e ve r , a ga i ns tdi s r e ga r di ng l e git i m at e t r ans ac t i o ns , s t at i ng th a t “ w h e r e . . . th e r e is ag e n u in e m u ltip le -p a r tytr a n s a c tio n w ith e c o n o m ic sub st an ce w h i ch i s c om pel l ed or encou ragedby bu si n ess or r egu l ator y real i t i es, i s i m bued w i t h t ax- i ndependentc ons i der at i ons , and i s nots haped s ol ely by t axav o i da nc e fe at ur e s t hatha vem e ani ngl e s s l ab e l s a t t ac he d, t he G o ve r nm e nt
s h o u ldh o n o rt h e a llo c a tio n o f r ig h ts a n dd u tie s e ffe c tu a te db yth e p a r tie s .” Fr a n kLy o n , 435 U
. S. at583- 84. W e ha v e a p p li e dth e su b sta n ce -ov e r-fo rm d o ctr in e on n u m e ro u s o cc asi on s, be gi nni ng w i t h o urde c i s i o n i n D ava n tv. Com m i ssi on er , 366 F
. 2d874 ( 5th C i r. 196 6) , t o concl u de that t h e sal e of a cor porati on ’ s asset s t h rough an i n t erm edi aryN o. 08- 20261

The intermediary receive d $1 5,58 3.30for his roleinthe transaction . The entire sale 1 wa s f orapp roxim ately$ 1 millionincon si deration . See Davant , 36 6 F .2d at 8 78. 7 t o a vo i d c ap i t algai ns t ax at i o n co ul d be t r e at e d as a di r e c tsa l e , t hus t r i gg e r i ng ah ig h e rr a te o f ta x a tio n . D av ant i nvo lve d t ax pa ye r s w ho s o l d the i rs t o c k i n a c o r p o r a t i o n a nda t t e m p t e dt o c l a i m al o werc a p i t a lg a i ns rat e fort hes a l e . To
a c c o m p li s h th is , th e ta x p a y e r s s o ldth e irs to c kto a n in te r m e d ia r yw h o w o u ld

“ m ak e a re as o nab l e pr o f i t” fo rhi s ro l e , and the n t he i nt e r m e di ary w o ul d s e l lt he 1
c o r porati on ’ s a s s e t s t o ab uye r(i n t hi s c as e , a no t he rc o r po r at i o n o w ne d b y t he ta x p a y e r s ) a n dliq u id a te th e ta r g e t c o r p o r a tio n . Se ei d. at 878
. Th e ta x p a y er ar gue d t hatt he t r ans ac t i o n w as a bon a f i de sa l e o f

hi s s t o c k i n t he c o r po r at i o n,
w h i l e t h e I R S argu ed that t h e t ran saction shou l d h ave been t reat ed as a
c o r p o r a te r e o r g a n iz a tio n a n dta x e da t a h ig h e ro r d in a r yin c o m e ra te
. Se ei d. at 879. W e a gr ee d w i t h t he I R S’ s det er m i na ti on , s tat i ng t hatt he “ c our t s have
n ever been shack l ed to m ere pap er s u bter f u ges. I tis h a rd t o i m agine a t r ans ac t i o n m ore d evo i d o f s ubs t anc e t han t he pur po r t e d ‘ s al e ’t o [t he i n term ed i a ry]. ” I

d. at 880
. Th i s court specif i cal l y n ot ed that t h e i n t erm edi ary

“ served no fun ct i on ot h er th an t o divertour att en t i on t o avoi d tax. Stat ed
an ot h er w ay, hi s presence servedno l egi t i m ate non t ax-avoid a n ce bu si n ess p u rp ose . ” I

d. at 881. Th er e w as t hus no m er i ti n t he t axpaye r s’ar gum entt hat
a s t o c k s al e co ul d notbe t r e at e d as a sa l e of as s e t s : “ [W ] e se e t hatt he t r e at m e nt
o f s to c k s a s a s s e ts , o r a s s e ts a s s to c k , h a s a lw a y s b e e n u tiliz e db yth e co u r ts in h arm o n i zi n g t h e st atutor y l an gu age w i t h t h e si n gl e rat i on alpl an e of t axa t i on en visi on edbyC on gr ess . ” I d. at887. Si m i l arl y, i n B l u eberr y L an dCo. v. Com m i ssi on er , 361 F
. 2d93 ( 5th C i r. 19 6 6 ) , t he t a x p a y e r s s o ught t o s e l l t he i r c o r p o r a t i o ns ’ a s s e t s . Af t e r f i ndi ng a buyer , t he t axpaye r s and t he buyerbe gan nego t i at i ng t he s al e a nd re ac hed an agr ee m ent , butt he dea lfellapar tbe c ause of t he per c eived adver set ax c o n s e q u e n c e s . I

d. at 94-96. A tt h at t i m e, an i n t erm edi ary agreed t o est abli shN o. 08- 20261

8 a ho l di ng c o m pa ny t h at w ou l d b uy t he t ax pa ye r s ’s t o c k, s e l lt he a s s e t s t o t he b u y e r , a n dliq u id a te th e co r p o r a tio n s . I d. at 96-9 7
. Th e i n t erm edi ary es t abl i she d t he hol di ng c om pany and ac c om pl i she d t he t r ansac t i on, r et ai ni ng a
m o d e s t fe e fo r h is s e rv ic e s . Se ei d. The I R S so ught t o t r eatt he t r ansac t i on as a s ham , and w e agr ee d, spec i f i c al l y re l yi ng on the fac tt hatt he t r ansac t i on had be e n ne go t i at e d b y t he t axp ayerw i t h t he e ve nt ualb uye r- - a nd thatt he in te r m e d ia ry“serv edn o re a l o ru s e fu l e c o n o m icp u r p o s e a p a r t fr o m ta xs a v in g s .” I d. at102. “ N ot hi ng her e sai d i s i nt ended t o pre ventor i n any w ay di sc our age a r e aland bo na f

i desa l e of

st o c k byst o c kho l de r s of one co r po r at i o n t o as e c o nd
c o r p o r a t i o n , a n d l i q u i d a t i o n o f t h e f i r s t b y t h e a c q u i r i n g c o r p o r a t i o n . . . . But
m i s s i ng he r e i s t hata l l

- i m po r t ante l e m e nt- - t he t r ans ac t i o n m us tb e r e ala nd b on af i d e.” I d. W e a l s o a gr e e d wi t h t he I RS’ s s ubs t anc e - o ve r - f o r m de t e r m i nat i o n i n R eef Corp. v Com m i ssi on er , 368 F
. 2d125 ( 5th C i r. 196 6)

. Th e t axp ayer i n tha tcase
w as ac o r po r at i o n o w e d b y t w o g r o ups o f sha r e ho l de r s . O ne gr o up s o ugh tt o b uy th e o th e r ’ s in te r e s t in th e c o r p o r a tio n . T h e in itia l p la n fo ra c c o m p lis h in gth is go alw as r ej e c t e d byt he se l l e r s be c aus e of t he adv e r s e t axc o ns e que nc e s , s o t he p a rti es d eve l ope d a new pl an f orusi ng a new c or por at e e nt i t y and an in te r m e d ia r yto e n g a g e inas to c k/a s s e t s w a p in o r d e r to o b ta in am o r e fa v o r a b le ta xb a s is fo rth e p u r c h a s e da s s e ts
. I d. a t1 28

- 29
. W e e xp l ai ne d: [The i nt e r m e di ary] w as am e r e c o nduiti n apr e c o nc e ive d a nd p r e a r r a n g e d u n ifie dp la n to re d e e m th e s to c ko f th e [s e lle r s ]. H is act ivi t y w as bu ta st ep i n t h e pl an . H e carri ed out a sal es c on t ract alr e ad y e nt e r e d i nt o be t w e e n t he c o r po r at i o ns . H e as s um e d nor i s k, in c u r r e dn o p e r s o n a l lia b ility , p a idn o e x p e n s e s a n do b ta in e do n ly bare l egal title to t h e st ock. Th ere w as an i n suff i ci en tshi f

t i n g of econom i c i n t erest s t o [t h e i n t erm edi ary]
. I ti s s e ttled t h at un der such circum st an ces sub st an ce m u stbe given ef fectover f

orm f or federalt ax p u rposes. I d. at130.N o. 08- 20261

9 H o w e ve r , w e ha veno ta l w ay s a gr e e d w i t h the I RS’ s a ppli c at i o n o f t he
s ubs t anc e ov e rf

o r m do c t r i ne . I n Compa q Compu t er Corp. v Com m i ssi on er , 277 F. 3d 778 ( 5t h C i r . 2001) , t he t axpaye r ( C om paq) purc hase d shar es of a f or ei gn c o r po r at i o n us i ng an i nt e r m e di ary. The e vi de nc e e s t ab l i s he d thatt he i nt e r m e di ary ap pr o ac he d Co m pa q ab o utb uyi ng t he s t o c k and thatt he i n t erm edi ary “ [w ] i t h ou ti n volvi n g C om pa q . . . chose both the si zes andpri ces of th e trad es a n dthe i d en tity of t h e com p a n y th a t w o u ldsellthe [ sh a res] to C om p a q . ” I

d. at779- 80. The I R S arg ued t hatt he t r ansacti on s houl d be di s r e g a r d e d , whi c h wou l d p r e v e nt Co m p a q f r o m c l a i m i ng fa v o r a b l e t ax t r e at m e nto n it s c ap i t all o s s e s a nd d ivi de nds

. W e di s ag r e e d, c o nc l udi ng t hatt he t r ansac ti on w as m ot ivat ed bya bus i nes s purpos e unr el at ed t o o bt ai ni ng t ax b en efits a n d “econ om i c su b stan ce.” I d. at781

- 82
. Spe c i f

i c all y, w e not e d t hatt he t ran sact i on s “h adb ot h a reasonab l e possibi l i t y of prof i tatt en dedby a realri sk of l oss an dan ad eq u a te n on -t a x b u sine ss p u rp o s e . T h e tran sa cti on w a s n ot a
m ere f orm a l i ty or a rtifice b u t occu rred i n a rea l m a rk et su bj ect to rea lri sk s. ” I d. at788. B . A p p l i ca ti o n to the In stan t C a se Th e unc ont r ove r t ed e vi denc e s upport s t he di st r i c tc our t ’ s c onc l usi on t hat th is w a s as h a m co n d u it tr a n s a c tio n , a n d th a t M id c o a s t is n o t e n tit le dto cla im a st epp ed-up b asi s f

or the asset s i tpu rchased. L an gl ey soug h tt o sellhi s s t ock i n B i sho p, know i ng t hata dir ec tas se ts al e w ou l d have negat ive t ax conse que nc e s f

o rhi m . As M i dc o as tc o nc e de s , Bi s ho p’ s a s s e t s ha d a ppr e c i at ed consi derab l y an d the corporat i on w ou l d h ave to p a ys i gn i f i can tt axes on t h ose gai ns, and Lan gl ey i n t urn w oul d have t o payt axes on di st r ibut i ons he t oo k as
a s har e ho l de rf

r o m Bi s ho p. M i dc o as tw as o ne o f m anyi nt e r e s t e d b uye r s a nd
su b m i tted a bid o f $1 5 7 m i l l i on for th e stock , w h i ch it su b seq u en tly in crea sed to $1 84
. 2 m i l l i o n, b utt he n - - upo n f ur t he rr ef

l ect i o n - - l o w e r e d t o $ 16 3 m i l l i o n. L a n g le yfo u n dth is o ffe ru n a c c e p ta b le

.N o. 08- 20261

10 W hen Lan gl ey r ej ec t ed M i dco as t ’ s r educ ed of fer , M i dco as t as ked i t s t ax ad vi s o r , PW C, f

o rs ugg e s t i o ns a bo uti m pr o vi ng i t s bi d. PW C s ugg e s t e d thatt he pa rt i es use a t h i rd- pa rt y i n t erm edi ary f or th e t ran sact i o n a n d su ggested Fo r t r e nd , ac o r p o r a t i o n t ha tha s do nea nu m b e rof c o nd uitt r a ns a c t i o ns . PW C th en bro u gh t F ortren din to th e fol d

. T h e ev i d en ce sh ow s th a t th i s w a s d on e to “b r id g e th e g a p ” in th e tr a n s a c tio n -- r e fe r r in gt o t h e a g r e e dd is p u te o v e rth e s a le pri ce. M i dcoast u n derst ood th at Fortr en d w ou l d bu y L an gl ey’ s s t ock an d then
s e ll th e B is h o p a s s e ts to M id c o a s t. F o r t r e n d , ra th e r th a n b u y in gth e sto ck a n dse llin gth e a ss e ts itse lf, f o r m e d as pe c i alv e hi c l e s o l e l y f o rt hi s pur po s e : K

- Pi pe . K

- Pi pe exi s t e d f o rno ot herpurpo set han t o a c c om pl i sh thi s t r ansac t i on , a n d d i d no s ubst ant ive bus i n ess b e f

o r e o ra f

t e ritf i ni s he d the t r ans ac t i o n he r e . Al t ho ughK

- Pi pe o b ta in e dfin a n c in gfo rits p u r c h a s e o f L a n g le y ’ s s to c k , th a t fin a n c in gw a s w h o lly secured by M i dco ast’ s f u n ds equ alt o t h e l oan dep osit ed i n esc row accoun t s. Thus , w hi l e t e c hni c all y a l o an, itw as e f fe c t ive l y n od if

fe r e ntt han pur c has i ng t he st oc k w i t h M i dco as t ’ s f und s. T h a t fi nanci ng w as ob t ai ned t hro ugh a f or ei gn ban k k n ow n t o f

i n an ce th ese typ es of m i dco t ran sact i on s. K

- P i pe d i d n otexi st pr i o rt o t he t r ans ac t i o n’ s o c c ur r e nc e ; itw as c r e at e d s o l e l y t o buy t he st o c k a nd sel lt h e B i shop asset s. Th e evi den ce s h ow s th at La n gl ey an d M i dcoast w ere d iscu ss in gth e p u rc h a se p rio r to K -P ip e ’ s in v o lve m e n t, th a t th e ym e t to g e th e r -- al o ng w i t h PW C - - t o di s c us s t he de al , a nd thatt he s e l l/buyt r ans ac t i o ns o c c ur r e d wi t hi n 2 4 ho ur s . Thi s e vi de nc e s upp o r t s o nly t he i nfe r e nc e t hatK

- Pi pe
w a s m e r e lya n in te r m e d ia r yw ith o u t a b o n afid e ro le inth e tr a n s a c tio n . Indeed , M i dcoast concedes that “M i dcoast w an t ed to a cq u ir e t h e B i shop pi peli ne as se t s. B utt he o nl y w ay M i dco as tc oul d ac qui r e the B i sho p as se t s at a pri ce M i dcoast w as w il li n gto p ay w as if a t h i rd pa rt y ( K

- P i pe) acqu i red B i shop ’ s s t ock f

rom L an gl ey an d then sol d the asse t s t o M i dcoast. ” M i dcoast
a r tic u la te s o n lyt h r e e p u r p o r te db u s in e s s re a s o n s w h yit u s e daco n d u itN o. 08- 20261

11 t r a n s a c t i o n r a t h e rt h a n ad i r e c ta s s e t p u r c h a s e . F i r s t , Mi d c o a s ts t a t e s t h a tKPi pe s o ugh tt o e ar n a“ pr o f i t
. ” B utt hi s doe s notans w e rt he que s t i o n of w hy any pa rt y w as w i l l i n g to p a yK -P ip e t o be an i n t erm edi ary. M oreover, as our case l aw show s, t h e m ere paym en tof a fee or prof

i tby the i n t erm edi ary does n ot pre ventf

i ndi ng t hatt he tr ansac t i on w as a sham

. Sec ond, M i dco as tst at es t hat i tuse d t he m i dc o t r ans ac t i o n f o r m b e c aus e it“w ant e d t o a c quir e a nd o pe r at e t he B is h o p p ip e lin e a s s e ts a t a p r ic e it w a s w illin g a n d c o u ld a ffo r d to p a y .” T h is is nota t ax- i ndependentbusi nes s c ons i der at i on; t he m on ey M i dco as ts aved by le s s e n in gits ta xb u r d e n a llo w e dit to p a ym o r e fo rth e a s s e ts
. M i d coa st f

u rth e rc o n te n d s th a t th i s tran sa cti on l i m i tedits exp osu re to litig a tio n b e c a u s e , h a dit p u r c h a s e dth e B is h o p s to c k , it w o u ld h a v e b e e n lia b le fo rcla im s a g a in s t B is h o p . B yp u r c h a s in go n lyt h e a s s e ts , M id c o a s t c o n te n d s , it coul d av oi d l i abili t y on kn ow n an d u n kn ow n cl ai m s that m i gh tbe assert ed agai nstt he B i sho p c or por at e e nt i t y. Bu tt hi s i n no w ay e xpl ai ns w hy an in te r m e d ia r yw a s n e c e s s a r y : T h e p a r tie s c o u ld h a v e a c h ie v e dth e s a m e re s u lt hadM i dc o as tb o ugh tt he a s s e t s dir e c t l y f r o m Langl e y andBi s ho p w i t ho utus i ng a n in te r m e d ia r y . S ee Pol i u s v. C lark E qu i p. Co. , 802 F. 2d 75, 77 ( 3d C i r . 1986) (“ Li ab i l i t y c o nt i nue s [i n t he c o nt e xto f a st o c k s al e ] be c aus e t he c o r po r at e b o dy i t s e l f s urvive s . A dif

fe r e ntr ul e a ppl i e s w he n o ne c o r po r at i o n pu r c has e s t he
as s e t s o f

a no t he r . U nde rt he w e l l

- s e t t l e d r ul e o f c o r porate l aw , w he r e o ne com pa n y sel l s ortransfers al lof it s asset s t o an ot h er, t h e sec on d en t i t y does n ot b e c o m e lia b le fo rth e d e b ts a n dlia b ilitie s , in c lu d in gto r ts , o f th e tr a n s fe r o r .”). A c c o r d in g ly , t h e u n c o n t r o v e r t e dfa c t s s u p p o r tt h e d is t r ic tc o u r t ’s determ i n ati on t h at th e I R S w as en t i t l ed t o di sregard t h e f orm of t h e t ran sact i on an d tr eat itas a di rectsal e of st ock. G iven t h at th e transacti on w as desi gn ed solely f or th e p u rp ose of a vo i d i n g ta xe s, an dM i d coa st h a s off ere dn o a d eq u a te
n o n -ta xre a s o n s fo ru s in gaco n d u it e n tit y , th e d i s tr ic t c o u r t d idn o t e r rin f i ndi ng t he I RS app r o pr i at e l y di s r e ga r de d the f o r m o f t he t r ans ac t i o n.N o. 08- 20261

12 C . P enal t y D et er m i nat i on I n a ddit i o n t o c hall e ngi ng t he I RS’ s t r e at m e nto f t he c o nduitt r ans ac t i o n, M i dco as t ’ s suital so c hal l enges t he i m pos i t i on of a 20% underpay m entpenal t y. W e revi e w th e di st ri ctcourt ’ s deci si on on the pen al t y i ssue f or abu se of d is c r e tio n . S ee Pan A m er. L if e I n s. Co. v. Un i t ed S t ate s , 1 7 4 F
. 3 d69 4 , 69 6 ( 5 th C ir. 1 9 9 9 ). M i dc o as tm ak e s t w o a r gum e nt s aga i ns tt he di s t r i c tco ur t ’ s r ul i ng t hatt he I R S w as per m i t t ed to a sse ss t he 20% penal t y. Fi r st , M i dco as tar gues t hat be c aus e it di d no t unde r pa y, t he n no pe nalt y c o ul d b e a s s e s s e d. Thi s a r gum e nt
n ece ssa ri l y fail s i n l i gh t o f o u r d ecisi on ab ov e th a t M i d coa st u n d ersta tedits i n com e taxl i a b i l i ty for this t ra n sa cti on . A l tern a tive l y, M i d c o a s t a rg u es th a t,
e ve n if t he I RS i s e nt i t l e d t o di s r e ga r d the f o r m o f t he c o nduitt r ans ac t i o n, t he I R S co ul d notas se ss t he penalt y be c ause M i dco as th ad “ subs t ant i alaut hor i t y” t o sup port i t s act i on s. The I nt e r nalRev e nue Cod e g e ne r all y pr o vi de s for a2 0% pe nalt y f o rt he

“ sub st an t i alun derst atem en tof i n com e t ax. ” 26 U
. S

. C

. § 666 2( a) & (b)

. H ow ever, atax p a ye r i s n ot su bj ect to the pe n a l ty i f th e u n d ersta tem en t i s attrib u tab l e to

“ t he t ax t r eat m entof any it em by t he t axpaye rif t her e i s orw as s ubst ant i al
a u th ority f

or su ch treatm en t. ” I d. § 6662( d) ( 2) ( B ) (i)

. E ven i f t her e i s subs t ant i al
au t h orit y sup porti n g t h e t axp ayer’ s t ax tr eatm en t , t h ou gh , a t axp ayer can n ot
a v o idth e p e n a ltyinth e ca s e o f ta xs h e lte r s . I d. § 666 2( d) ( 2) ( C)

. The Cod e d e fin e s ata xs h e lte ra s , in tera lia , a n e n tity o r p la n o r ar ra n g e m e n t “if a s i gnif i c antpur po s e o f

s uc h pa r t ne r s hi p, en t i t y, pl an, o ra r r ang e m e nti s t he
a vo i d a n ce orev a sionof F ed era li n com e tax
. ” I d. T h e di st ri ct court rul ed th at t h ere w as n o sub st an t i al au t h orityfor M id c o a s t’s ta xtr e a tm e n t of th e tr a n s a c tio n a n d th a t, in a n y e v e n t, th e co n d u it tran sa cti on co n sti tu teda “taxsh elt er,”m a k i n g th e su b stan ti a lau th ority
e xc e pt i o n i nap pl i c ab l e . Thi s w as no ta bus e o f di s c r e t i o n. Fir s t , a l lo f t heN o. 08- 20261

13 ava i l ab l e a ut ho r i t y i ndi c at e d thatt hi s t r ans ac t i o n - - m o t iva t e d s o l e l y byt he avoi dance of

t axes - - w oul d be di sr egar ded and t hatM i dco ast w ou l d notbe
en t i t l ed t o cl ai m a st epp ed-up basi s f or t h e B i shop asset s. Th i s authori t y t ook t he f o r m o f b o t h Sup r e m e Cour ta nd F i f t h Ci r c ui tpr e c e de nt
. Se c o nd, t he uncont r ove r t ed evi denc e sho w s t hat t he ar r angem ent at i ss ue i n t hi s c as e had th e s o le p u r p o s e o f a v o id in gfe d e r a l in c o m e ta x . T h u s , i tfa l l s s q u a r e lyw ith in th e C od e’ s d efi n i ti on of a “tax sh elt er.” It i s cl ea r th a t tax a vo i d a n ce w a s, a t a
m i n i m u m , a “ si gn i f

i can tpu rpose” of

t h e arrang em en t as requir ed byt h e st atute. A ccord i n gly, w e a ff

i rm the distri ct cou rt’ s ru l i n g t h a t th e I R S w a s p erm i tted to
as se ss a pe nal t y aga i nstM i dco as tpurs uant t o § 6662. IV . C ONC L US I ON F or th e foreg oin g re a son s, w e A F F IR M the ju d gm en t of th e d i stri ct cou rt.