NOT PRECEDENTIAL
UNITED STATES COURT OF APPEALS FOR THE THIRD CIRCUIT

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No. 12-1779

____________ ROVAKAT, LLC, A Partne rship, Shant S. Hovnanian, Tax Matters Partner, Appellant

v. COMMISSIONER OF INTERNAL REVENUE

___________ On Appeal from the Un ited States Tax Court (Docket No. 3251-09) United States Tax Court Judg e: Honorable David Laro

___________ Submitted Under Third Circuit L.A.R. 34.1(a) October 25, 2012 Before: HARDIMAN, GREENAWAY, JR., and VANASKIE, Circuit Judges (Opinion Filed: June 17, 2013)

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OPINION

___________ VANASKIE, Circuit Judge. Rovakat, LLC, a partnership for tax pu rposes, by its tax matters partner, Shant S. Hovnanian, appeals the Decem ber 21, 2011 decision of the United States Tax Court that substantially upheld notices of Fin al Partnership Administrat ive Adjustments (“FPAAs”) issued by the Commissioner of Internal Revenue (the “Commissioner”) for tax years2 2002, 2003, and 2004. The FPAAs, in pertin ent part, disallowed more than $5 million in losses that Rovakat claimed from a “distressed asset/debt” (“DAD”) tax shelter, and imposed accuracy-related penalties under §6662(h) of the Internal Revenue Code, 26 U.S.C. § 6662(h). Having carefully considered the Tax Court opinion , the record, and the parties’ contentions, we will affirm.
I. The parties are completely familiar with the complex transactions that provide the context for this dispute, and we will not recount here the facts that are so comprehensively presented in the Tax Court opinion. Instead, for purposes of our decision, the following summary of the parties’ transactions suffices: 1. On June 7, 2001, Credicom Asia redeemed its worthless class A common stock fr om its parent corporation, Credicom NV (“CNV”), for 1,718,116 Swiss francs and $303,375. CNV’s claimed “b asis” in the class A common stock, i.e., the amount it ha d invested in Credicom Asia’s class A common stock, approximated $184,000,000. 2. The next day, CNV transferred the 1,718,116 Swiss francs and $303,375 to Inter national Capital Partners, LP (“ICP”), in exchange for a partnership interest in ICP. 1 3. On November 6, 2002, ICP transferred 50,000 of the Swiss francs, having a fair market value of $34,185, to Rovakat in exchange for a part nership interest in Rovakat.

1 ICP was a Cayman Islands limited partnership and founding part ner of Rovakat. ICP was controlled by Lance O. Valdez, a tax attorney and financial advisor who put together DAD tax shelters. Valdez was also president of Cr edicom Asia, and directed the transactions that formed th e basis for the DAD tax shelter at issue in this case.3 4. On December 26, 2002 , ICP transferred 90% of its partnership interest in Rova kat to Mr. Hovnanian for $30,776. 2 5. On December 27, 2002 , Rovakat sold the 50,000 Swiss francs to a third party fo r their fair market value of $35,468. 3
6. Rovakat incurred almo st $400,000 in costs related to these transactions, including f ees of more than $380,000 to Valdez, and $13,000 for a tax opinion from a law firm recommended by Valdez. 7. On its tax returns fo r 2002, 2003, and 2004, Rovakat claimed that its basis in the 50,000 Swiss francs was $5,805,000, so that its transfer of the Swiss francs for $35,468 generated a loss of mo re than $5,700,000. 4
In FPAAs issued for Rovakat’s 20 02, 2003, and 2004 tax returns, the Commissioner determined that Rovakat ha d not established th e claimed basis of $5,805,000 in the 50,000 Swiss francs, a nd thus was not entitled to deductions from

2 Mr. Hovnanian has a degree in economics from the U niversity of Pennsylvania, and is a sophisticated investor as well as an entrepreneur in the information technology and medical devices fields.

3 The Tax Court opinion was in consistent with regard to th e fair market value of the Swiss francs. The Tax Court first stated that the francs were valu ed at $35,268, (App. 21), but later stated that they were valued at $35,468 (A pp. 30.) We use the latter number—$35,468—which is the value the parties stipu lated to before the Tax Court. (Supplemental App. 52.)

4 As a general rule, property received in exchange for a partnership interest assumes the basis of the partner’ s interest in the property. See 26 U.S.C. § 721(a). In this case, Rovakat treated Credicom Asia as a part nership and CNV as one of its partners, notwithstanding their corporate structures. Asserting that CNV liquidated its partnership interest in Credicom Asia for “p roperty” in the form of Swiss francs, Rovakat claimed that CNV’s basis in the class A common stock , totaling approximately $184,000,000, attached to the Swiss francs. Rovakat claims a pro rata share of the purported basis in the Swiss francs.4 ordinary income for the purported “loss” incurre d when the Swiss francs were sold for $35,468. The Commissioner found in the alternative that the d eductions should be disallowed because the Swiss francs transaction lacked ec onomic substance. The Commissioner’s FPAAs also imposed a 40 % gross valuation misstatement penalty pursuant to 26 U.S.C. § 6662 (h)(1) with respect to tax un derpayments resulting from the wrongfully claimed losses attribu ted to the Swiss francs transaction. Rovakat challenged the disallowances for th e deductions attributed to the Swiss francs transaction in the Tax Court. In rejecting Rovakat’s challenges, the Tax Court applied the “substance-over -form” doctrine, and found that Credicom Asia’s redemption of its class A stock from CNV, a corporation, c ould not be regarded as a transfer of a partnership interest. Conse quently, CNV’s basis in the class A stock did not attach to the Swiss francs received by CNV in exchange for the class A st ock. Alternatively, the Tax Court held that Rovakat could not claim a basis of more than $5,800,000 in Swiss francs having a market value of only approxim ately $35,000 because the transactions at issue lacked “sufficient economic substan ce to be respected for federal tax purposes.” (App. 47.) Specifically, the Tax Court found that “[ t]he francs transaction as a whole, when viewed in the light of its i ndividual steps, had no econom ic significance other than to serve as a means for Mr. Hovnanian’s attempt to purchase and use CNV’s built-in-loss.” ( Id. at 48.) Observing that “[b]ecause a tran saction that lacks econom ic substance is not recognized for Federal tax purposes, and ‘can not be the basis for a deductible loss,’” the Tax Court ruled that Rovakat could no t claim losses from that transaction. ( Id. at 64.) Finally, the Tax Court sustain ed the 40% accuracy-related pe nalties, rejecting Rovakat’s5 assertion that it had acted in good faith and with reasonable cause on th e basis of opinions from tax attorneys.
II. Rovakat timely appealed the Tax Cour t decision, challenging the disallowances for the losses it attributed to the Swiss francs transaction as well as the 40% accuracyrelated penalties. 5

A. The Disallowance of the Claimed Loss The Tax Court had jurisdiction ov er this matter pursuant to 26 U.S.C. §§ 6226(f) and 7442. We have jurisdiction pursuant to 26 U.S.C. § 7482.

“[W]hile we conduct plenary review of the Tax Court's legal conclusions, we review its factual findings, including its ultim ate finding as to the economic substance of a transaction, for clear error.” ACM P’ship v. Comm’r , 157 F.3d 231, 245 (3d Cir. 1998). In this case, the Tax Court characterized the in itial transaction in th e series of transactions that culminated with Rovak at’s sale of Swiss francs, i.e. , the redemption of Credicom Asia stock from CNV for Swiss francs and $303,375, to be a sale of common stock as opposed to a transfer of partnership interest s as asserted by Rova kat. It is firmly established that the substan ce of a transaction, and not its fo rm, governs its tax treatment. See Comm’r v. Court Holding Co. , 324 U.S. 331, 334 (1945) (“The incidence of taxation depends upon the subs tance of a transaction.”). The Ta x Court had ample justification for characterizing the redemption of Credicom Asia’s stock from its parent, CNV, as a

5 The Tax Court also sustained other adjustments made by the Commissioner in the FPAAs as well as the Commissioner’s 20% accur acy related penalty attributable to the underpayment of taxes resulting from the ot her adjustments to income and deductions made by the Commissioner in the FPAAs. Rovakat does not challenge on appeal these aspects of the Tax Court’s decision.6 sale. In this regard, it is i rrefutable that both CNV and Cred icom Asia were corporations. Because CNV could not have transferred a partnership interest in exchange for dollars and Swiss francs, it could not carry over its basis in Credicom A sia class A stock to the Swiss francs that ultimately were transferred to Rovakat and sold for $35,468. For this and all the other reasons articulat ed by the Tax Court in its exceedingly thor ough opinion, the Tax Court did not err in rejecting the more than $5 million loss claimed by Rovakat. 6
B. We review the Tax Court’s findings w ith respect to the asses sment of accuracyrelated penalties for clear error. See Stobie Creek Invs. LLC v. United States , 608 F.3d 1366, 1381 (Fed. Cir. 2010). In this case, there is no dispu te that Rovakat asserted a basis in the Swiss francs that exceed ed 400% of the correct amount , triggering a 40% penalty for a “gross valuation misstatement[].” See 26 U.S.C. § 6662(h). Rovakat could avoid

6 Although we need not r each the alternative ground ar ticulated by the Tax Court for sustaining the disallowance of the claimed loss—the Swiss francs transaction lacked economic substance—we note that we discern no error in the Tax Court’s application of the economic substance do ctrine as explicated in ACM Partnership . Under this doctrine, “a transaction that is ‘devo id of economic substance’ mu st be disregarded for tax purposes and ‘cannot be the b asis for a deductible loss.’” ACM P’ship , 157 F.3d at 247 (quoting Lerman v. Comm’r , 939 F.2d 44, 45 (3d Cir. 1991 )). The Tax Court faithfully adhered to the requireme nts that both the “‘objective economic substance of the transactions’ and the ‘subjective business mo tivation’ behind them” be examined. Id. (quoting Casebeer v. Comm’r , 909 F.2d 1360, 1363 (9th Ci r. 1990)). Its findings on both prongs of the inquiry are well supported. For example, on the objective component, the Tax Court properly considered that the nearly $400,000 in fees paid by Rovakat to obtain Swiss francs having a value of approxim ately $35,000 did not make economic sense independent of claiming a loss premised upon an artificially inflated basis in the Swiss francs. As to the subjective component , the Tax Court likewise had substantial reasons for finding that “the economic reality of the francs tran saction is not consistent with a bona fide profit objective.” (App. 64.) The Tax Court’s correct application of the “economic substance” doctrin e provides an alternative basis for sustaining the disallowance of the claimed loss.7 the penalty only by demonstr ating both reasonable cause fo r its gross misstatement and good faith. 26 U.S.C. § 6664(c)(1). Rova kat asserts that it satisfied its “heavy burden” of showing reasonable cause, Richardson v. Comm’r , 125 F.3d 551, 557 (7th Cir. 1997), because it had relied upon opinions issued by law firms regarding the transaction. The Tax Court rejected Rovakat’s argument becau se one opinion was ob tained from a law firm recommended to Rovak at by Valdez, the person that prom oted and profited from the transaction, and the other opini on was not given to Rovakat’ s partner on tax matters, Mr. Hovnanian, until years after the transactions were consummated. Moreover, both opinions were found to be based upon unsupported assump tions. Given these factual findings, we discern no error in the Tax Court’s conclusions that Rovakat lacked reasonable cause and did not act in good faith. Accordingly, Rova kat cannot avoid the gross misstatement penalties.
III. Consistent with the foregoi ng and for substantially the same reasons articulated by the Tax Court in its comprehensive opinion, we will affirm the Tax Court’s December 21, 2011 decision in this case.