T.C. Memo. 2009-251

UNITED STATES TAX COURT

COUNTRY PINE FINANCE, LLC, RICHARD A. PHILLIPS, TAX MATTERS

PARTNER, Petitioner v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 1399-07. Filed November 5, 2009.

Christopher Kliefoth and Karla L. Palmer, for petitioner.

Elizabeth R. Edberg, John W. Stevens, and Robert D.

Heitmeyer, for respondent.

MEMORANDUM OPINION

GOEKE, Judge: During 2001 the members of Country Pine

Finance, L.L.C. (Country Pine Finance), sold an unrelated

insurance business, generating gain and leaving them facing a

contingent tax liability. The members entered into a Custom

Adjustable Rate Debt Structure (CARDS) transaction in order to
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reduce their tax liabilities. The CARDS transaction generated a

loss on Country Pine Finance’s 2001 Form 1065, U.S. Return of

Partnership Income. The issue for decision is whether Country

Pine Finance is entitled to this loss. For the reasons stated

herein, we find that Country Pine Finance is not entitled to the

claimed loss.

The stipulations of fact and the attached exhibits are

incorporated herein by this reference. Charles C. Burnham, Terry

L. Stewart, Wayne R. Sharp, Jan P. Blick, Thomas E. Kolassa,

Edward M. Burnham, David L. Burnham, James M. Burnham, James L.

Harvin III, Thomas A. Reitan, John S. Avery, Richard A. Phillips

(petitioner), John R. Bromley, and Stephen C. Adams were the

members of Country Pine Finance during its existence

(collectively, the members).

Background

1. The Burnhams

Charles C. Burnham, Edward M. Burnham, David L. Burnham, and

James M. Burnham are brothers. The four were involved in two

business ventures: (1) Blue Marlin, a real estate business; and

(2) Burnham Insurance Group (BIG), an insurance broker.

A. Burnham Insurance Group

Charles Burnham and his brothers formed BIG in 1978. BIG

existed until its sale in 2001. Between 1978 and 2001 BIG merged

with or acquired 12 other entities, usually smaller insurance
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brokerages. Typically the owner of the merged or acquired entity

would become a BIG stockholder. Most of the members other than

the Burnhams became BIG shareholders through these mergers and

acquisitions.

B. Blue Marlin

The Burnham brothers and two unrelated individuals, Al Ivany

(Mr. Ivany), and George Markham (Mr. Markham), formed Blue Marlin 

in the 1980s to develop a corporate office park on Country Pine

Lane in Calhoun, Michigan. The corporate park was made up of

three buildings: (1) 100 Country Pine Lane; (2) 300 Country Pine

Lane; and (3) 500 Country Pine Lane. Blue Marlin built the 100

and 500 Country Pine Lane buildings.

Later, Blue Marlin divested itself of its holdings. The 500

Country Pine Lane building was sold to three individuals, Thomas

Kolassa (Mr. Kolassa), Don Karsten (Mr. Karsten), and Mills Mayo

(Mr. Mayo). The 100 Country Pine Lane building was sold to Mr.

Ivany. The 300 Country Pine Lane building was sold to BIG. 

2. Sale to HUB

Sometime before 2001 the BIG stockholders decided to sell

the company. At that time the members and four unrelated

individuals owned 84 percent of the shares outstanding, with the

remaining 16 percent owned by an employee stock ownership plan. 

The BIG stockholders decided to sell the company to HUB

International (HUB). The stockholders of BIG and HUB entered
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into an agreement and plan of merger whereby BIG was merged into

a wholly owned subsidiary of HUB. The stockholders of BIG

received shares of HUB stock and cash in exchange for their BIG

shares. 

BIG was valued by an appraiser before the stockholders

entered into the merger agreement. However, one of BIG’s

business lines could not be valued accurately at that time. The

parties to the merger agreement agreed that they would value that

business line 2 years later, in 2003, and that if the results of

that future valuation showed this business line to be worth more

than originally thought, HUB might make additional payments to

the BIG stockholders in 2003.

A. Requirements of Sale

During negotiations HUB informed the BIG stockholders that

it was not interested in owning any real estate and would not

purchase the 300 Country Pine Lane building. The stockholders

decided to sell the 300 Country Pine Lane building to Country

Pine Enterprises, L.L.C. (Country Pine Enterprises). 

B. Country Pine Enterprises

Country Pine Enterprises was formed to hold the 300 Country

Pine Lane building, which was conveyed to Country Pine

Enterprises on June 29, 2001. Country Pine Enterprises then

leased the 300 Country Pine Lane building to HUB. As a result,

the BIG offices remained in the 300 Country Pine Lane building
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after the merger. Country Pine Enterprises later acquired the

500 Country Pine Lane building and some adjacent land.

C. Results of Sale

On June 18, 2001, HUB and BIG executed a letter of intent

whereby the stockholders of BIG agreed to sell their shares to

HUB. The merger was put into effect on July 20, 2001, through a

subsidiary of HUB. The stockholders of BIG received HUB stock

and cash in exchange for their shares in BIG. The BIG

shareholders all recognized gain on the exchange of their stock

and reported it on their individual Forms 1040, U.S. Individual

Income Tax Return, for tax year 2001. Facing large contingent

tax liabilities as a result of this gain, the members sought ways

to offset their gains. One possible solution was a CARDS

transaction.

3. Introduction to CARDS

The members participated in a CARDS transaction in 2001. 

The transaction was developed by Chenery Associates, Inc.

(Chenery). The members decided to participate after viewing two

presentations by Chenery.

A. Chenery Associates, Inc.

Chenery was incorporated in 1993. Roy Hahn (Mr. Hahn) was a

principal at Chenery. Chenery developed and marketed tax

shelters and worked with different investment banks in New York

to implement its transactions. Chenery developed and implemented
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numerous CARDS transactions, including the CARDS transaction at

issue, and received fees for each. A portion of the fees was

used to pay the third parties involved in the specific CARDS

transaction and their counsel. 

B. Bob Baker

Bob Baker (Mr. Baker) was an insurance executive who later

founded his own wealth management company, Asset Strategies. Mr.

Baker met Mr. Hahn in the mid-1990s, and they remained in contact

during their careers. Mr. Hahn introduced Mr. Baker to the CARDS

transaction.

Mr. Baker also met Mr. Kolassa during the mid-1990s. Mr.

Baker became acquainted with BIG and the other BIG stockholders

through Mr. Kolassa after Mr. Kolassa joined BIG. Later, Mr.

Baker and David Burnham discussed tax planning before the BIG-HUB

merger was consummated. Mr. Baker referred the members to Mr.

Hahn.

C. Miller Canfield

Miller, Canfield, Paddock & Stone, P.L.C. (Miller Canfield),

was a law firm located in Michigan. John Campbell was an

attorney at Miller Canfield who provided legal advice to the

members and Country Pine Finance on implementing the CARDS

transaction. Mr. Campbell and Miller Canfield did not provide

any advice to the members or Country Pine Finance other than in

connection with the CARDS transaction.
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D. Decision To Enter Into a CARDS Transaction

On August 30, 2001, petitioner told Mr. Hahn that the

members wanted to enter into a CARDS transaction. The three

parties involved were: (1) Zurich Bank; (2) Fairlop Financial

Trading, L.L.C. (Fairlop Trading); and (3) Country Pine Finance.

4. The CARDS Transaction in General

A CARDS transaction has three phases: (1) The loan

origination phase; (2) the loan assumption phase; and (3) the

operational phase. In general, three parties are required to

carry out a CARDS transaction: (1) A bank; (2) a borrower; and

(3) an assuming party. 

A. Loan Origination

During the loan origination phase, the bank agrees to lend

funds to the borrower. The borrower is a Delaware limited

liability company with two members, both of whom are United

Kingdom citizens to ensure that there are no U.S. income tax

effects at the borrower level. The bank requires the borrower to

be capitalized in an amount equal to 3 percent of the funds to be

borrowed. 

The loan is typically for 30 years, with principal due after

30 years but interest due annually. The credit agreement

memorializing the loan imposes restrictions on what the loan

proceeds can be used for. Collateralization requirements imposed

by the bank require the borrower to use the loan proceeds to
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1Suppose the amount of the original loan from the bank to

the borrower was $10 million. The assuming party would assume a

portion, $1 million, of the loan. The $1 million would be

transferred from the borrower to the assuming party, and in

exchange the assuming party would become jointly and severally

liable for the entire $10 million loan.

acquire highly stable items such as Government bonds or highly

rated commercial paper. After initially collateralizing the loan

with high-value, stable assets, such as Treasury bonds or

promissory notes from the bank, the borrower can substitute

collateral and gain access to the loan proceeds. In effect, the

loan proceeds are initially used to purchase high-value items to

serve as collateral for the loan until an equally high-value item

can be swapped for the purchased items. This swapping of

collateral purportedly frees some of the loan proceeds to be used

for investment purposes as the borrowers see fit. However, the

decision to swap collateral is not left to the discretion of the

borrower. The bank ultimately decides whether and on what terms

a certain asset or security can be used as collateral.

B. Loan Assumption

The second phase is the loan assumption phase--when the

assuming party would assume a portion of the loan on behalf of

the borrower. The assuming party would receive only a portion of

the loan proceeds but would agree to become jointly and severally

liable for the entire amount of the original loan to the

borrower.1 The assuming party would assume a portion of the loan
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equal to the present value of the principal amount due in 30

years.

C. Operational Phase

The operational phase consists of periodic “reset dates”. 

Each reset date allows the borrower to exchange collateral, with

corresponding adjustments of the interest rate, and of the term

until the next reset date. The decision to swap collateral or

adjust the interest rate at a reset date is left to the

discretion of the bank. If new collateral is proposed, it often

results in a change of loan terms to reflect any adjustments to

the amount of risk the parties face.

The purported purpose behind a CARDS transaction was to

provide investment financing. A CARDS participant would enter

into the CARDS transaction and use the assumed portion of the

loan proceeds to make an investment. The investment property

would then be swapped as collateral. In theory, the investment

would be successful if the rate of return on the investment

property exceeded the costs of entering into the CARDS

transaction.

5. Country Pine Finance and Third Parties

A. Zurich Bank

Zurich Bank acted as the lender in the CARDS transaction at

issue. Chenery had previously engaged Deutsche Bank in its

transactions, but Mr. Hahn’s contact at Deutsche Bank had moved
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2We refer to Zurich Bank and ZCM Matched Funding Corp. as

Zurich Bank for simplicity. 

to Zurich Bank. Shortly thereafter Zurich Bank was engaged. ZCM

Matched Funding Corp. acted as Zurich Bank’s agent for purposes

of the CARDS transaction.2

B. Fairlop Trading

Fairlop Trading, the borrower, was organized as a Delaware

limited liability company on July 13, 2001, with Elizabeth A. D.

Sylvester and Michael Sherry, citizens and residents of the

United Kingdom, the members.

The Fairlop Trading members contributed $444,182 to Fairlop

Trading. Cash of $6,296 was contributed with the remaining

$437,885 due pursuant to notes payable. Fairlop Trading was set

up solely to take part in this CARDS transaction. 

C. Country Pine Finance

Articles of incorporation for Country Pine Finance were

filed on November 14, 2001. A certificate of dissolution for

Country Pine Finance was filed 1 year later, on November 14,

2002. Petitioner served as Country Pine Finance’s tax matters

partner at all relevant times.

The members made capital contributions to Country Pine

Finance on November 21, 2001, and February 27, 2002, as follows:

Member 11/21/01 2/27/02

Charles C. Burnham $145,497 $42,010

Terry L. Stewart 132,425 38,235
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Wayne R. Sharp 76,335 22,040

Jan P. Blick 48,720 14,067

Thomas E. Kolassa 61,761 17,832

Edward M. Burnham 41,087 11,863

David L. Burnham 36,063 10,413

James M. Burnham 32,862 9,488

James L. Harvin, III 31,483 9,090

Thomas A. Reitan 22,144 6,394

John S. Avery 21,651 6,251

Richard A. Phillips 24,550 7,088

John R. Bromley 17,807 5,141

Stephen C. Adams 17,613 5,085

 Total (rounded) 710,000 205,000

Country Pine Finance was formed specifically to carry out the

CARDS transaction. The amounts contributed were based on the

amount of the fees to be paid to Chenery. A portion of the fees

paid to Chenery was used to pay the third parties for their

participation in the transaction.

6. The CARDS Transaction at Issue

A. Origination

On November 9, 2001, Zurich Bank and Fairlop Trading entered

into a credit agreement. Fairlop Trading was required to pledge

collateral in order to borrow funds. Fairlop Trading entered

into a master pledge and security agreement on November 9, 2001,

in order to satisfy the collateral requirement. 

Zurich Bank applied a “haircut” to any pledged collateral. 

The haircut varied depending on the type of collateral pledged. 

For example, promissory notes from Zurich Bank or cash would not

be subject to a haircut, while long-term commercial paper might

receive a 10-percent haircut. The effect of the haircut would be
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to require the borrower to contribute or acquire additional

assets to serve as collateral to make up for the haircut applied.

On December 4, 2001, Fairlop Trading informed Zurich Bank

that it intended to borrow 16,613,000. The notice of intent to

borrow indicated that the 16,613,000 would be used to purchase

assets from Zurich Bank to collateralize the loan.

On December 4, 2001, 16,613,000 was deposited into Fairlop

Trading’s Zurich Bank account. The 16,613,000 was used to

purchase two promissory notes from Zurich Bank, one for

13,662,660, the other for 2,990,340. Both promissory notes

matured on December 4, 2002, and were used to collateralize the

16,613,000 loan from Zurich Bank to Fairlop Trading.

Fairlop Trading borrowed 16,613,000 from Zurich Bank, then

exchanged the 16,613,000 for Zurich Bank promissory notes worth

16,613,000. This left Fairlop Trading owing Zurich Bank

16,613,000, and Zurich Bank owing Fairlop Trading 16,613,000. 

The 13,662,660 and 2,990,340 promissory notes were pledged as

collateral for the loan. If Fairlop Trading defaulted on the

loan, Zurich Bank could use the promissory notes to satisfy the

debt. 

Zurich Bank did not apply a haircut to promissory notes

issued by Zurich Bank pledged as collateral, so no haircut was

applied and Fairlop Trading did not have to contribute additional

collateral. The terms of the loan from Zurich Bank to Fairlop
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3The 6,824 difference between the value of the original

note, 2,990,340, and the value of the new note and euro,

2,997,164, was due to interest received on the 2,990,340

promissory note.

Trading matched the terms of the promissory notes except that

Fairlop Trading was required to pay 50 additional basis points of

interest. This 50-basis-point spread served as a portion of the

fees paid to Zurich Bank for entering into the CARDS transaction.

The 13,662,660 note remained with Fairlop Trading. The

2,990,340 note was later exchanged for a new note from Zurich

Bank and 1,015,493.60. The note had a principal amount of

1,981,671.3 Fairlop Trading immediately pledged the 1,981,671

note and the euro as collateral.

B. Assumption by the Members

On December 26, 2001, the members entered into a purchase

agreement to purchase the 1,981,671 promissory note and

1,015,493.60 from Fairlop Trading. In exchange for the note and

euro, the members agreed to become jointly and severally liable

for the entire 16,613,000 loan from Zurich Bank to Fairlop

Trading and waived any right of contribution against Fairlop

Trading. The purported purpose of the waiver was to make the

members fully liable for the entire 16,613,000 even if Fairlop

Trading still maintained control over any portion of the

proceeds. The members immediately pledged the promissory note

and euro as collateral for the loan.
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The members contributed the 1,981,671 note and

1,015,493.60 to Country Pine Finance. In exchange, Country Pine

Finance guaranteed the loan. Country Pine Finance claimed bases

in the 1,981,671 promissory note and the 1,015,493.60 of

$9,658,146 and $4,938,036, respectively. Country Pine Finance’s

claimed bases were based on the members’ purportedly becoming

jointly and severally liable for the entire 16,613,000. 

Shortly thereafter Country Pine Finance pledged the

1,981,671 note and the 1,015,493.60 as collateral for the loan. 

Again all amounts lent by Zurich Bank were guaranteed by

collateral purchased from Zurich Bank with those loan proceeds. 

None of the “liable” parties ever contributed any additional

collateral. If Country Pine Finance had wanted to substitute

collateral for the note and euro, Zurich Bank would have had to

consent.

On December 28, 2001, Country Pine Finance and Zurich Bank

entered into a cross-currency swap. Section 1.988-2(e)(2)(ii),

Income Tax Regs., defines a currency swap contract as a contract

involving different currencies between two or more parties to

exchange periodic interim payments on or before maturity of the

contract and exchange the swap principal amount upon maturity of

the contract. The exchange of periodic interim payments is the

exchange of a payment in one currency for a payment in another

currency, with both payments being determined by reference to an
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4Euro Interbank Offered Rate refers to the short-term rate

of interest paid by one euro zone bank to another.

5London Interbank Offered Rate refers to the rate of

interest paid when one bank borrows from another in the London

interbank lending market.

interest index applied to the swap principal amount. Sec. 1.988-

2(e)(2)(ii)(C), Income Tax Regs.

The cross-currency swap was a combination of an interestrate swap and a foreign exchange forward contract. Initially

Country Pine Finance transferred the 2,997,640 to Zurich Bank,

and Zurich Bank transferred $2,633,308 to Country Pine Finance. 

These were the notional amounts of the swap. 

On December 28, 2001, the $2,633,308 Country Pine Finance

received from Zurich Bank was used to purchase a promissory note

with a principal amount of $2,633,308 from the bank. The

promissory note was then pledged as collateral. 

The interest portion of the currency swap required Zurich

Bank to pay to Country Pine Finance annual interest on the

2,997,162 at the euro Interbank Offered Rate (EURIBOR),4 and 

Country Pine Finance to make monthly interest payments at the

U.S. dollar London Interbank Offered Rate (LIBOR)5 to Zurich Bank

on the $2,633,308. 

The interest-rate swap allowed petitioner to receive

interest payments equal to the amount of interest it would

eventually owe on the 1,981,671 note and the 1,015,493.60.
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The foreign exchange forward contract allowed Country Pine

Finance to convert the $2,633,308 value of the promissory note

purchased from Zurich Bank back into euro on December 4, 2002, at

the same rate used to convert the euro into dollars on December

28, 2001. This in effect would allow Country Pine Finance to end

up in the same economic position upon the closing of the crosscurrency swap as it was on the day it entered into the swap. The

cross-currency swap was closed out less than 1 year later on

December 4, 2002.

C. Operational Phase

The members asserted that the purpose for entering into the

CARDS transaction was to finance a real estate investment. 

According to the members, they would purchase real estate and use

the real estate as collateral. If the members’ investment was

profitable, earnings from the real estate would exceed the costs

of the CARDS transaction. 

Zurich Bank told the members at the initiation of the CARDS

transaction at issue that they would not be able to use real

estate as collateral. On October 30, 2001, Mr. Hahn sent

petitioner an email informing him that Zurich Bank would not

allow the members to swap commercial real estate as collateral

for the loan at that time because Zurich Bank could not properly

evaluate any possible real estate before the initiation of the

CARDS transaction. The members decided to enter into the CARDS
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transaction even though it would be some time before real estate

could possibly be used as collateral. The members decided to

enter into the CARDS transaction in 2001 anyway because the tax

loss was needed in 2001.

Real estate was never substituted as collateral, and neither

the members nor Country Pine Finance ever attempted to substitute

any specific piece of real estate as collateral. During 2002

petitioner made attempts to determine whether real estate in a

general sense could be substituted, but the members never

attempted to purchase or use a specific piece of real estate as

collateral. Nor did the members have any specific piece of real

estate evaluated by Zurich Bank for collateralization purposes. 

Likewise the members never attempted to substitute any type of

collateral other than real estate for the promissory notes. 

On August 15, 2002, Zurich Bank informed Fairlop Trading and

the members that Zurich Bank was no longer willing to maintain

the loan. All of the borrowed funds were paid back with the

pledged collateral, and no additional capital contributions were

ever made. Country Pine Finance was dissolved on November 14,

2002, by unanimous vote of the members. 

7. Country Pine Finance’s and Members’ Returns

Country Pine Finance filed a Form 1065 for tax year 2001 on

September 16, 2002, claiming a $7,917,051 net short-term capital

loss on a “Euro Promissory Note” and a $4,045,820 loss on the
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6Unless otherwise indicated, all section references are to

the Internal Revenue Code (Code), and all Rule references are to

the Tax Court Rules of Practice and Procedure. 

sale of business property. The $4,045,820 loss was reported on a

Form 4797, Sales of Business Property, as an ordinary loss on a

“Euro Deposit”. 

The losses resulted from Country Pine Finance’s swapping the

note and euro for U.S. dollars as part of the cross-currency

swap. Country Pine Finance claimed a basis of $14,596,182 in the

euro. This was the U.S. dollar value of the initial loan from

Zurich Bank to Fairlop Trading, 16,613,000. The members claimed

this high basis in the euro because of the members’ agreeing to

be liable for the amount of the entire loan from Zurich Bank to

Fairlop Trading. 

The euro were a nonfunctional currency within the definition

of section 988.6 See sec. 1.988-1(c), Income Tax Regs. When

Country Pine Finance exchanged the 2,997,640 for $2,633,308, it

claimed a loss on the disposition of the euro equal to the

difference between $14,596,182 and $2,633,308. Section 1.988-

1(a)(1), Income Tax Regs., provides that disposition of a

nonfunctional currency is a section 988 transaction. Thus the

members’ transfer of the euro was treated as a section 988

transaction. The loss was split between the promissory note and

the euro. This resulted in a $7,917,051 net short-term capital

loss on the promissory note and a $4,045,820 loss on the euro.
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Country Pine Finance filed a document titled “Disclosure

Statement For Reportable Transaction Under Reg. 1.6011-4T” (the

disclosure statement). The disclosure statement stated that

Country Pine Finance had entered into a “Custom Adjustable Rate

Debt Program” and that the principal tax benefits were the

$7,917,000 short-term capital loss and the $4,045,000 ordinary

loss. The disclosure statement further indicated that Country

Pine Finance estimated a reduction in Federal income tax

liability of its members for 2001 of $3,120,000 as a result. 

Attached to the Form 1065 were Schedules K-1, Partner’s

Share of Income, Credits, Deductions, etc., for all of the

members. Each Schedule K-1 reported a member’s share of the net

short-term capital loss and the ordinary loss. 

Each member filed his own Form 1040 reporting both his gains

from the exchange of BIG stock and the claimed flow-through

losses from Country Pine Finance. The losses from Country Pine

Finance were used to offset the members’ various gains on the

disposition of BIG stock. However, some of the members decided

not to claim all of the losses available to them, on the advice

of their personal return preparers who had determined that the

transaction might be challenged by the Internal Revenue Service

(IRS). The percentage of the loss claimed by each member who did

not claim the entire loss available to him was based on his
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return preparer’s estimation of a hypothetical future settlement

with the IRS should the IRS challenge the transaction.

On October 17, 2006, respondent issued a notice of final

partnership administrative adjustment (FPAA) to Country Pine

Finance for taxable year 2001. The FPAA disallowed the claimed

net short-term capital loss and the ordinary loss. The FPAA did

not assert any penalties against Country Pine Finance or its

members. 

The FPAA included a document titled “Explanation of

Adjustments” which provided numerous alternative arguments in

support of the adjustments made in the FPAA, including that:

(1) The CARDS transaction lacked economic substance, was

entered into primarily for tax-avoidance purposes, and was

prearranged or predetermined;

(2) application of the substance-over-form or steptransaction doctrine would disallow the loss; or

(3) neither Country Pine Finance nor any member was

entitled to a deduction under section 165, 465, or 988.

On January 17, 2007, petitioner filed his petition

contesting the determinations in the FPAA. A trial was held on

January 26-30 and February 5-6, 2009, at a special session of the

Court in Chicago, Illinois. Both petitioner and respondent

presented fact witnesses and expert witnesses.
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Respondent submitted two expert reports prepared by Dr. A.

Lawrence Kolbe (Dr. Kolbe) and Dennis Logue (Mr. Logue). Dr.

Kolbe’s report focused on a financial analysis of the CARDS

transaction and the lack of rationality of entering into the

CARDS transaction versus standard mortgage-based real estate

financing. Mr. Logue’s report evaluated the relationships among

Zurich Bank, Fairlop Trading, and Country Pine Finance in the

context of the banking industry and the bona fides of the

purported loans. Mr. Logue concluded that the loan transactions

to which Zurich Bank, Fairlop Trading, and Country Pine Finance

were parties were not carried out in accordance with industry

norms.

Petitioner submitted expert reports by Gordon L. Klein (Mr.

Klein) and Frank A. De Lisi (Mr. De Lisi). Mr. Klein focused on

Country Pine Finance’s business purpose for entering into a CARDS

transaction and whether Country Pine Finance could have generated

a nontax economic profit from the CARDS transaction. Mr. De Lisi

studied the documents memorializing the various stages of the

CARDS transaction and concluded that it would have been

reasonable for Zurich Bank to allow Country Pine Finance to

substitute commercial real estate as collateral for the loan.
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Discussion

I. TEFRA in General

Partnerships do not pay Federal income taxes, but they are

required to file annual information returns reporting the

partners’ distributive shares of tax items. Secs. 701, 6031. 

The individual partners then report their distributive shares of

the tax items on their Federal income tax returns. Secs. 701-

704. Upon formation a limited liability company with two or more

members is treated as a partnership unless it elects to be

treated as a corporation. Sec. 301.7701-3(b)(1)(i), Proced. &

Admin. Regs. Country Pine Finance did not elect to be treated as

a corporation and thus is treated as a partnership for Federal

income tax purposes.

To remove the substantial administrative burden occasioned

by duplicative audits and litigation and to provide consistent

treatment of partnership tax items among partners in the same

partnership, Congress enacted the unified audit and litigation

procedures of the Tax Equity and Fiscal Responsibility Act of

1982 (TEFRA), Pub. L. 97-248, sec. 402, 96 Stat. 648. See

Randell v. United States, 64 F.3d 101, 103 (2d Cir. 1995); H.

Conf. Rept. 97-760, at 599-600 (1982), 1982-2 C.B. 600, 662-663. 

Under TEFRA, all partnership items are determined in a

single partnership-level proceeding. Sec. 6226; see also Randell

v. United States, supra at 103. The determination of partnership
- 23 -

items in a partnership-level proceeding is binding on the

partners and may not be challenged in a subsequent partner-level

proceeding. See secs. 6230(c)(4), 7422(h). This precludes the

Government from relitigating the same issues with each of the

partners.

In partnership-level proceedings such as the case before us,

the Court’s jurisdiction is limited by section 6226(f) to a

redetermination of partnership items and penalties on those

partnership items. Section 6231(a)(3) defines the term

“partnership item” as any item required to be taken into account

for the partnership’s taxable year under any provision of

subtitle A of the Code to the extent the regulations provide that

such item is more appropriately determined at the partnership

level than at the partner level. The loss claimed on Country

Pine Finance’s Form 1065 is a partnership item properly

determined at a partnership-level proceeding. Sec.

301.6231(a)(3)-1(a)(1)(i), Proced. & Admin. Regs.

II. Burden of Proof

Tax deductions are a matter of legislative grace, and a

taxpayer has the burden of proving that he is entitled to the

deductions claimed. Rule 142(a)(1); INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992); New Colonial Ice Co. v.

Helvering, 292 U.S. 435, 440 (1934). The burden of proof on

factual issues that affect a taxpayer’s liability for tax may be
- 24 -

shifted to the Commissioner where the “taxpayer introduces

credible evidence with respect to * * * such issue.” Sec.

7491(a)(1). Petitioner does not claim that the burden shifts to

respondent under section 7491(a). In any event, petitioner has

failed to establish that he has satisfied the requirements of

section 7491(a)(2). On the record before us, we find that the

burden of proof does not shift to respondent under section

7491(a). 

III. Economic Substance Doctrine

“The legal right of a taxpayer to decrease the amount of

what otherwise would be his taxes, or altogether avoid them, by

means which the law permits, cannot be doubted.” Gregory v.

Helvering, 293 U.S. 465, 469 (1935). However, even if a

transaction is in formal compliance with Code provisions, a

deduction will be disallowed if the transaction is an economic

sham. Am. Elec. Power Co. v. United States, 326 F.3d 737, 741

(6th Cir. 2003). 

The parties have not formally stipulated where an appeal of

this case will lie. At trial counsel for both petitioner and

respondent indicated that appeal would likely lie with the Court

of Appeals for the Sixth Circuit, and both petitioner and

respondent focus on caselaw of that circuit in their posttrial

briefs. However, absent stipulation to the contrary, appeal may

lie in the Court of Appeals for the District of Columbia Circuit
- 25 -

because Country Pine Finance was dissolved. See sec. 7482(b)(1)

(flush language). Whether appeal lies in the Court of Appeals

for the Sixth Circuit or the District of Columbia Circuit does

not affect our decision. 

The Court of Appeals for the Sixth Circuit has stated that

“‘The proper standard in determining if a transaction is a sham

is whether the transaction has any practicable economic effects

other than the creation of income tax losses.’” Dow Chem. Co. v.

United States, 435 F.3d 594, 599 (6th Cir. 2006) (quoting Rose v.

Commissioner, 868 F.2d 851, 853 (6th Cir. 1989), affg. 88 T.C.

386 (1987)). “[W]hen ‘it is patent that there [is] nothing of

substance to be realized by [the taxpayer] from [a] transaction

beyond a tax deduction,’ the deduction is not allowed despite the

transaction’s formal compliance with Code provisions.” Am. Elec.

Power Co. v. United States, supra at 741 (quoting Knetsch v.

United States, 364 U.S. 361, 366 (1960)). “If the transaction

has economic substance, ‘the question becomes whether the

taxpayer was motivated by profit to participate in the

transaction.’” Dow Chem. Co. v. United States, supra at 599

(quoting Illes v. Commissioner, 982 F.2d 163, 165 (6th Cir.

1992), affg. T.C. Memo. 1991-449). “‘If, however, the court

determines that the transaction is a sham, the entire transaction

is disallowed for federal tax purposes,’” id., and no subjective

inquiry into the taxpayer’s motivation is made, id. at 599. A
- 26 -

court “will not inquire into whether a transaction’s primary

objective was for the production of income or to make a profit,

until it determines that the transaction is bona fide and not a

sham.” Rose v. Commissioner, supra at 853. 

In Horn v. Commissioner, 968 F.2d 1229, 1239 (D.C. Cir.

1992), revg. Fox v. Commissioner, T.C. Memo. 1988-570, the Court

of Appeals for the D.C. Circuit stated that a transaction lacked

economic substance if: (1) The taxpayer had no business purpose

other than obtaining tax benefits in entering the transaction;

and (2) the transaction lacks any reasonable possibility of

earning a profit. See also Andantech L.L.C. v. Commissioner,

T.C. Memo. 2002-97, affd. in part and remanded in part 331 F.3d

972 (D.C. Cir. 2003). The test in Horn is disjunctive;

satisfaction of either prong satisfies the conditions for a

determination that the subject transaction has economic

substance. Countryside Ltd. Pship. v. Commissioner, T.C. Memo.

2008-3 n.20.

IV. Petitioner’s Arguments

Petitioner argues that the CARDS transaction had economic

substance and was entered into to permit Country Pine Finance to

finance real estate investments on the members’ behalf. 

Petitioner contends that the CARDS transaction satisfies both the

objective and subjective requirements of the economic substance

test and that the claimed loss should be allowed.
- 27 -

Petitioner argues that the CARDS transaction had legal

significance to Country Pine Finance and the members because the

loans were bona fide and the members were jointly and severally

liable for the entire 16,613,000. Petitioner also argues that

Fairlop Trading, the members, and Country Pine Finance were all

at risk for the loan proceeds.

Petitioner focuses on the profit potential of the CARDS

transaction as if real estate had been substituted for collateral

and points to his expert reports in support of this contention. 

Petitioner argues that if real estate had been allowed as

collateral, the members would have used the proceeds to invest in

real estate and attempt to earn a profit.

V. Respondent’s Arguments

Respondent argues that the claimed loss should be disallowed

because the CARDS transaction lacked economic substance and that

the members did not have a nontax reason for entering into the

transaction. 

Respondent first argues that the CARDS transaction lacked

economic substance and had no practical effect other than the

creation of income tax losses because: (1) The initial loan, (2)

the members’ assumption of the loan and contribution to the

capital of Country Pine Finance, and (3) the members’ entering

into the cross-currency swap served no purpose other than the

creation of tax losses. Respondent argues that none of the
- 28 -

parties were ever at risk because the various credit agreements

required Fairlop Trading and Country Pine Finance to pledge highvalue collateral and it was in Zurich Bank’s discretion to allow

any collateral to be swapped. Respondent argues that Zurich Bank

would not allow collateral to be swapped because it would be

against Zurich Bank’s financial interest to do so, as it would

expose the bank to unnecessary risk.

Respondent disagrees that we should evaluate the CARDS

transaction as if Country Pine Finance had been able to

substitute real estate as collateral. Respondent contends that

this would be inappropriate because any potential profit from an

investment in real estate that the members could earn would be

profit from a separate transaction, not the transaction that gave

rise to the tax loss at issue. Respondent further contends that

whatever profit Country Pine Finance may or may not have been

able to earn from substituting collateral, the artificial tax

losses at issue would remain. Respondent contends that even if

we were to assume that real estate could be substituted, the

substitution would result in an entirely new loan between Zurich

Bank and Country Pine Finance because it would require the

parties to negotiate new loan terms. Respondent concludes that

because substitution of real estate would lead to an entirely new

loan, the initial CARDS transaction that was consummated and
- 29 -

carried out would have been irrelevant to the real estate

financing but for the tax losses generated.

Respondent next argues that even if we were to accept that

the initial loan and assumption were necessary and that real

estate could be substituted as collateral, the new loan would

still be a sham designed solely to achieve tax benefits because

Country Pine Finance and its members had no chance of making a

profit on any future real estate investment. Respondent points

to his expert witness reports and argues that Country Pine

Finance would still not earn a profit because Zurich Bank would

require onerous loan terms requiring payments that would far

exceed any potential profit. Respondent contends that in order

for Country Pine Finance to make a profit, Zurich Bank would have

to both allow real estate as collateral and agree to loan terms

that would be contrary to its own financial interests.

In the alternative respondent argues that even if we find

that the CARDS transaction had economic substance, the loss

should be disallowed because the members participated in the

CARDS transaction only in order to create an artificial tax loss. 

Respondent contends that Country Pine Finance fails the

subjective prong because testimony of the members shows that they

had no knowledge or understanding of the CARDS transaction, did

not read, review, or remember the CARDS transaction documents,

and decided to enter into the transaction for the tax loss. 
- 30 -

Respondent points to the members’ failure to research or obtain

any assurance of the availability of real estate as collateral

both before and after they entered into the CARDS transaction as

evidence that the members were just after the tax loss and not

truly interested in financing a real estate investment.

VI. Analysis

A. Objective Analysis

We begin by analyzing the objective profit potential of the

transaction giving rise to the claimed tax loss. The transaction

giving rise to the loss was the swap of 2,997,164 for $2,633,308

as part of the cross-currency swap. Country Pine Finance claimed

a basis totaling $14,596,182 in the euro and the promissory note. 

As a result of this inflated basis, Country Pine Finance claimed

losses totaling $11,962,871 when it received the $2,633,308 from

Zurich Bank as part of the cross-currency swap. 

There were no third parties in this transaction. Country

Pine Finance, Fairlop Trading, and Zurich Bank were involved

specifically to enter into this CARDS transaction. Fairlop

Trading’s operating agreement indicates that its only purpose was

the CARDS transaction, it could not enter into any other business

transactions, and it was never able to access the loan proceeds. 

The CARDS transaction consisted of prearranged steps entered into

to generate a tax loss; the loan proceeds were never at risk and
- 31 -

the transaction giving rise to the tax loss was cashflow

negative. 

None of the loan proceeds ever left Zurich Bank’s control,

as both Fairlop Trading and Country Pine Finance used Zurich Bank

accounts. Although Country Pine Finance and the members

purportedly became liable for the loan proceeds, the various loan

agreements required Fairlop Trading, the members, and Country

Pine Finance to immediately pledge trustworthy collateral for

those loan amounts. The proceeds of the initial loan from Zurich

Bank to Fairlop Trading were used to purchase promissory notes

from Zurich Bank that were then used to collateralize the initial

loan. The members immediately pledged the 1,981,671 note and

the 1,015,493 as collateral after assuming the loan. Later,

Country Pine Finance immediately pledged the euro contributed by

the members as collateral for the loan that it now guaranteed. 

After the euro were swapped for dollars as part of the crosscurrency swap, the $2,633,108 received was used to purchase a

promissory note from Zurich Bank as collateral for that amount. 

There was no chance that Zurich Bank, Fairlop Trading, or the

members would ever lose any money on the CARDS transaction other

than fees. See Am. Elec. Power Co. v. United States, 326 F.3d at

743 (holding that in corporate-owned life insurance plan,

although individual parts of transaction represented actual

transfers of risk among parties, overall structure of 
- 32 -

transaction ensured that no risk existed for taxpayer at overall

plan level).

The members knew in October 2001 that they would not be able

at that time to substitute real estate as collateral. Because

the parties knew that they would not be able to substitute real

estate as collateral and that the only collateral that would be

accepted by Zurich Bank without the bank’s imposing a haircut was

Zurich Bank promissory notes, the members knew that they would

have to purchase Zurich Bank promissory notes and pledge them as

collateral. Because the members knew that they would be using

Zurich Bank promissory notes as collateral, they knew that they

would never truly be at risk for any of the loan proceeds. 

After entering into the CARDS transaction, none of the

parties ever made any additional contributions to capital or ever

attempted to use the loan proceeds. Once the loans came due, the

various promissory notes were used to pay back the loans. The

terms and interest rates of the currency swap and the forward

contract allowed Country Pine Finance to back out of the

transactions without paying any amounts other than the fees

required as part of the transaction.

If we look past the predetermined steps, the CARDS

transaction lacks economic substance because it was cashflow

negative. Respondent’s expert Dr. Kolbe testified that the CARDS

transaction had a negative net present value and rate of return
- 33 -

7This figure is the EURIBOR on that date plus 50 basis

points, as required by the loan terms.

relative to the capital invested. Both calculations indicate

that the CARDS transaction was cashflow negative. 

Dr. Kolbe calculated the net present value and rate of

return relative to capital by reference to the amounts Country

Pine Finance received and paid out as part of the CARDS

transaction. After taking into account fees and interest, Dr.

Kolbe calculated that Country Pine Finance received about 2.2

million on December 28, 2001, and paid back 3.1 million on

December 4, 2002. Applying the relevant cost of capital at the

time the members decided to enter into the transaction, 3.806

percent,7 resulted in the transaction’s having a negative net

present value of 771,042. Dr. Kolbe also calculated that

Country Pine Finance paid nearly 36 percent interest on the loan,

significantly higher than the relevant cost of capital, 3.806

percent. Dr. Kolbe concluded that Country Pine Finance had no

possibility of profit and that any use of the loan proceeds would

create a material and unnecessary drag on that investment.

We find this testimony accurate. Country Pine Finance paid

more than $700,000 in order to borrow 2,997,164 for 1 year. 

Those funds were then used to purchase investments that would

never earn a profit. Because the restrictions imposed by Zurich

Bank meant that Country Pine Finance would never be able to
- 34 -

substitute collateral that could earn a profit, the transaction

would always be cashflow negative. The CARDS transaction was

always a losing proposition from a nontax perspective because for

Country Pine Finance to earn a profit, Zurich Bank would have to

allow the substitution of collateral that would earn more than

the cost of the initial loans without imposing any more onerous

terms than the ones in place when the transaction was initiated. 

This would have been against Zurich Bank’s economic interests

because it would have exposed Zurich Bank to increased risk

without a corresponding economic benefit. See Mahoney v.

Commissioner, 808 F.2d 1219, 1220 (6th Cir. 1987) (in

commodities-trading-based tax shelter, grant of complete

discretion over transaction in one party is curious in face of

alleged risk involved and lack of experience of taxpayers), affg.

85 T.C. 127 (1985); New Phoenix Sunrise Corp. & Subs. v.

Commissioner, 132 T.C. at ___ (slip op. at 33). As it was

initially structured, the CARDS transaction resulted in interest

payments to Zurich Bank without the bank’s facing any economic

risk because the loans were guaranteed with Zurich Bank

promissory notes. Zurich Bank had no reason to allow Country

Pine Finance to substitute collateral because it would have

exposed the bank to increased risk without a corresponding

financial benefit. Although Zurich Bank could have adjusted the

loan terms to account for this increased risk, for example by
- 35 -

increasing the interest rate, the adjustment in loan terms would

have negatively affected Country Pine Finance. Country Pine

Finance would have had to either provide additional capital for

collateral purposes or pay higher interest on the loan. This

would have resulted in higher costs and an increased negative

cashflow.

Country Pine Finance argues that we should look at the CARDS

transaction as if real estate could have been substituted, but we

must look at the transaction that gave rise to the tax loss. See

Am. Elec. Power Co. v. United States, 326 F.3d at 744. As

respondent points out, the substitution of real estate would have

been a separate transaction from the one giving rise to the tax

benefit. That transaction is separate from any hypothetical

future swap of real estate as collateral, and any profit from the

real estate investment would not be a profit from the CARDS

transaction. See id. (“Money generated by means of abusive tax

deductions can always be applied to beneficial causes, but the

eventual use of the money thus generated is not part of the

economic-sham analysis.”). Even if we were to find that the

CARDS transaction had a profit potential if real estate were

substituted, the claimed loss generated by the currency swap

would remain. 

The substitution of real estate would have created a new

transaction with new terms. Each reset date allowed Country Pine
- 36 -

Finance to swap collateral, but this would require Zurich Bank to

evaluate the new collateral and determine whether any haircut

would apply. Further, the parties would also have to negotiate

new terms, including the applicable interest rate and term until

the next reset date. 

Petitioner’s arguments overlook the fact that the members

entered into the transaction having reason to believe that real

estate could not be used as collateral. The possibility of real

estate as collateral was never explored before the decision to

enter into the CARDS transaction, and the record indicates that

petitioner knew in October 2001 that real estate could not be

substituted. The members and Country Pine Finance never received

confirmation from Zurich Bank that real estate could be

substituted. The members likewise did not determine whether real

estate had been allowed as collateral in any of the other

Chenery-implemented CARDS transactions. Further, if Zurich Bank

was applying a haircut to highly stable corporate and U.S.

Treasury bonds, it is not credible that a long-term real estate

investment would be allowed without a substantial haircut that

would require the members to contribute additional collateral or

pay substantially higher fees.

As of October 2001, before the initiation of the CARDS

transaction, petitioner knew that any potential real estate could

not be evaluated, and thus could not used as collateral. 
- 37 -

However, the members decided to forge ahead with the CARDS

transaction even though there was no real estate investment to

finance. The members entered into the CARDS transaction in 2001

in order to generate losses that could be used to offset the gain

on the exchange of the BIG stock. Petitioner testified that the

reason the members decided to enter into the transaction in 2001

was the tax benefit even though Zurich Bank could not evaluate

real estate. 

Further, Mr. Miller testified that the members had hoped to

revisit the CARDS transaction in 2003 in regard to the second BIG

business line. The members were interested in revisiting the

CARDS transaction to generate additional losses in 2003 if the

subsequent valuation of BIG’s second business line, discussed

supra page 4, had resulted in additional payments from HUB to the

BIG shareholders, resulting in additional gains.

Country Pine Finance and the members engaged in a

transaction in order to create a tax loss. The transaction had

no profit potential and was cashflow negative. Even if we accept

that real estate could be substituted as collateral and that

Country Pine Finance would earn a profit on that real estate, the

artificial loss would remain. This artificial loss would be

unrelated to the hypothetical real estate financing arrangement. 

See Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1358

(Fed. Cir. 2006); see also Kornman & Associates, Inc. v. United
- 38 -

States, 527 F.3d 443, 456 (5th Cir. 2008) (“The Trust

acknowledges that it only suffered a $200,000 economic loss in

connection with these transactions, yet it claimed a $102.6

Million tax loss on its return.”); Cemco Investors, LLC v. United

States, 515 F.3d 749, 750-751 (7th Cir. 2008); New Phoenix

Sunrise Corp. & Subs. v. Commissioner, 132 T.C. ___ (slip op. at

33); Maguire Partners-Master Invs., LLC v. United States, 103

AFTR 2d 2009-763, at 2009-772, 2009-1 USTC par. 50,215, at 87,444

(C.D. Cal. 2009) (“First, the claimed basis is fictional, because

* * * [taxpayers] paid only $1.5 million and $675,000, * * * but

gained an increased basis of $101,500,000 and $45,675,000,

respectively.”); Klamath Strategic Inv. Fund, LLC v. United

States, 472 F. Supp. 2d 885, 894 (E.D. Tex. 2007), affd. in part

and vacated in part 568 F.3d 537 (5th Cir. 2009). This is not

the case of a business decision with only two possible outcomes,

gain or loss, having resulted in a loss. Rather, a real estate

investment would not make legitimate the loss incurred on the

CARDS transaction. Although petitioner asks us to evaluate the

transaction as if real estate could have been substituted as

collateral we must look at the transaction giving rise to the tax

loss at issue; an illegitimate loss cannot be grafted onto a

hypothetical legitimate transaction.
- 39 -

B. Subjective Analysis

The claimed loss is also disallowed because the members did

not have a nontax business purpose for entering into the CARDS

transaction. Although the members testified that the decision

was made to secure financing for future real estate investments,

that testimony is not credible. There is substantial evidence

that the decision to enter into the CARDS transaction was solely

tax motivated. 

The members knew or had reason to know in October 2001 that

real estate could not be substituted at that time but decided to

enter into the CARDS transaction anyway. The decision to go

ahead even without real estate as viable collateral was driven by

the desire for a tax loss. Petitioner testified that the

decision to enter into the transaction in 2001 was to take

advantage of the tax benefits. Notes taken by the members during

the Chenery presentations focused on the tax benefits, and the

members never researched or evaluated an investment in real

estate.

The members repeatedly testified that they did not read any

of the relevant documents but only signed the signature pages. 

Jan Blick, Stephen Adams, Thomas Reitan, Edward, James, and David

Burnham, John Bromley, Thomas Kolassa, John Avery, and James

Harvin all testified that they did not remember and in any event

would not have bothered to read any of the transaction documents. 
- 40 -

Further, most of the members testified that they had no knowledge

of Zurich Bank, Fairlop Trading, or CARDS in general. The

members’ lack of due diligence in researching the CARDS

transaction indicates that they knew they were doing nothing more

than purchasing a tax loss and not entering into a legitimate

business or financing transaction with any nontax objectives. 

See Pasternak v. Commissioner, 990 F.2d 893, 901 (6th Cir. 1993),

affg. Donahue v. Commissioner, T.C. Memo. 1991-181.

The members’ claim to have a nontax motive for Country Pine

Finance’s serving as a financing vehicle and their becoming

jointly and severally liable for 16,613,000 in exchange for only

2,997,640 is undercut by the fact that none of the members

performed any research into the CARDS transaction, performed any

economic analysis of a possible real estate investment, or read

any of the documents memorializing the transaction. The members

all had business backgrounds and had owned or coowned their own

businesses before joining BIG. In spite of these backgrounds,

the members entered into the transaction without bothering to

read any of the documents they signed, even though they were

purportedly becoming liable for 16,613,000. It is not credible

that the members would voluntarily make themselves liable for

that amount without reading any of the memorializing documents. 

The fact that the members never bothered to verify that real

estate could be substituted as collateral for the loan proceeds
- 41 -

undercuts the claimed reason for the CARDS transaction in the

first place. 

Most of the members were involved in the purchase of the 300

Country Pine Lane building by Country Pine Enterprises. Had the

members really been interested in financing possible real estate

purposes, their collective business experiences should have shown

how contrived the CARDS transaction was. Wayne Sharp testified

that he entered into the CARDS transaction even though he was not

interested in financing real estate. The other members testified

in only the most general terms that the purpose behind Country

Pine Finance was to finance real estate. However, none of the

members ever truly investigated how such financing would work. 

The record shows that the members entered into the CARDS

transaction solely for the tax loss and did not have a legitimate

business purpose. Accordingly, Country Pine Finance likewise

fails the subjective requirement of Rose v. Commissioner, 868

F.2d 851 (6th Cir. 1989).

C. Conclusion

The CARDS transaction lacked economic substance and stood no

chance of earning a profit. The members did not have a nontax

business purpose for entering into the CARDS transaction. 

Because we find that the CARDS transaction lacked economic

substance, it is disregarded for tax purposes and Country Pine

Finance’s claimed loss is disallowed.
- 42 -

To reflect the foregoing,

Decision will be entered

for respondent.