FOR PUBLICATION

UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

JOHN PAUL REDDAM,

Petitioner-Appellant,

v.

COMMISSIONER OF INTERNAL

REVENUE,

Respondent-Appellee.

No. 12-72135

Tax Ct. No.

22557-08

OPINION

Appeal from a Decision of the United States Tax Court

Argued and Submitted

April 10, 2014—Pasadena, California

Filed June 13, 2014

Before: Jerome Farris and Andrew D. Hurwitz, Circuit

Judges, and Paul L. Friedman, District Judge.*

Opinion by Judge Hurwitz

 

*

 The Honorable Paul L. Friedman, District Judge for the U.S. District

Court for the District of Columbia, sitting by designation.
2 REDDAM V. CIR

SUMMARY**

Tax

The panel affirmed the Tax Court’s decision affirming a

decision by the Commissioner of Internal Revenue

disallowing a capital loss deduction because it lacked

economic substance and was intended to create capital losses.

Taxpayer pursued a tax and investment program

marketed by KPMG, the Offshore Portfolio Investment

Strategy (OPIS), to reduce the tax liability associated with

either taking his company public or selling it. Applying the

economic substance doctrine, the panel held that the record

supported the Tax Court’s conclusion that taxpayer pursued

the OPIS product solely for its tax benefits, as well as the

conclusion that the product had no practical economic effects

other than the creation of income tax losses.

COUNSEL

David W. Wiechert (argued) and Jessica C. Munk, Law

Office of David W. Wiechert, San Clemente, California, for

Petitioner-Appellant.

Kathryn Keneally, Assistant Attorney General, Tamara W.

Ashford, Deputy Assistant Attorney General, Gilbert S.

Rothenberg, Richard Farber, and Judith A. Hagley (argued),

 

** This summary constitutes no part of the opinion of the court. It has

been prepared by court staff for the convenience of the reader.
REDDAM V. CIR 3

Attorneys, Tax Division, Department of Justice, Washington,

D.C., for Respondent-Appellee.

OPINION

HURWITZ, Circuit Judge:

John Paul Reddam claimed a deduction on his 1999 tax

return of $50,164,421 for a capital loss purportedly generated

by several Cayman Islands entities. The Commissioner of

Internal Revenue disallowed the deduction, finding that the

transaction lacked economic substance. After a bench trial,

the Tax Court affirmed. Reddam v. Comm’r, No. 22557-08,

2012 WL 1215220 (T.C. Apr. 11, 2012). We have

jurisdiction over Reddam’s appeal under 26 U.S.C.

§ 7482(a)(1) and affirm.

I. Factual Background

A. Reddam’s $48,500,000 capital tax gain and

search for tax reduction strategies

In 1995, Reddam founded several companies (collectively

“DiTech”) that originated, purchased, and serviced residential

home loans. Reddam was the sole shareholder, chief

executive officer, and chairman of the board of each entity. 

Between 1995 and 1997, DiTech grew significantly.

Reddam used KPMG1 for his personal taxes and DiTech’s

corporate returns. KPMG also served as DiTech’s auditor. 

 

1

 The firm was named KPMG Peat Marwick until 1999.
4 REDDAM V. CIR

In 1998, Reddam hired a KPMG partner, Scott Carnahan, as

the president of DiTech.

In 1998, Reddam considered either taking DiTech public

or selling it; he also investigated ways to reduce the tax

liability associated with those strategies. Carnahan therefore

introduced Reddam to a KPMG tax partner, Carl Hastings. 

Hastings recommended that Reddam pursue a tax and

investment program marketed by KPMG: the Offshore

Portfolio Investment Strategy (“OPIS”).

According to KPMG’s marketing materials, OPIS utilized

“100% leverage offshore” to allow investors “to avoid U.S.

regulatory rules that limit the amount of financing

permissible in securities transactions.” The materials stated

that the strategy “[m]aximizes U.S. investor’s basis in foreign

bank stock and thereby minimizes gain, or maximizes loss, on

the disposition of such stock,” something that would only be

desirable to a U.S. investor with other significant gains to

offset.2 KPMG emphasized that the costs of investing in

OPIS were not based on potential investment gains, but were

instead tied to the amount of “capital gain [tax] exposure” to

be eliminated.

After several meetings with KPMG tax partners, Reddam

understood OPIS to be a “complicated, technical” investment

strategy that involved “some kind of basis shift,” whose

“details were all very, very complicated.” He understood that

OPIS employed “hedging,” so that any potential upside relied

 

2

 The tax code defines the basis of property as “the cost of such

property.” 26 U.S.C. § 1012(a). As a general matter, the greater the basis

a taxpayer has in an asset, the lower the gain on the disposition of that

asset and, hence, the lower the taxes owed.
REDDAM V. CIR 5

entirely on a rise in an underlying foreign bank stock. 

However, in general, Reddam did not “understand how

[OPIS] works.”

Reddam knew that OPIS might “make money,” but

chiefly was drawn to its potential “to be successful relative to

generating a tax loss.” He sought the advice of KPMG tax

partners because he was “looking to make sure that I paid the

lowest tax rate that I could.”

Before investing, Reddam had Carnahan contact KPMG’s

competitors to inquire if they were offering similar “tax

elimination” products. He was informed that several were,

but Ernst & Young was not, because it did not think such a

product “worked.” Carnahan advised Reddam to seek

independent advice because he was “a little concerned that

the same people pitching the transaction and receiving a fee

for that transaction would also be giving the [tax] opinion on

that transaction.” Nonetheless, Reddam never sought

independent investment or legal advice.

In April 1999, GMAC Mortgage Corporation purchased

DiTech, making an initial payment of $70,000,000. Reddam

incurred a $48,500,000 capital tax gain and decided to “enter

the OPIS transaction.”

In early May 1999, Reddam hired KPMG as his “tax

advisor” with respect to OPIS. KPMG again

“recommend[ed] that [Reddam] seek independent advice

concerning the investment aspects of the proposed

transaction.” Reddam never did.
6 REDDAM V. CIR

B. Simplified overview of Reddam’s OPIS

transaction

The Tax Court opinion thoroughly explains the byzantine

OPIS transaction.3 Reddam, 2012 WL 1215220, at *3–12. 

 

3

 A professor at the University of Texas at Austin who has testified on

behalf of plaintiffs seeking recovery of costs from KPMG explains OPIS

transactions this way:

The FLIP/OPIS shelter depends technically on the cost

basis of a Cayman Islands entity shifting over to a

related U.S. taxpayer after the Cayman Islands entity

was redeemed out. For each purchaser, a shell Cayman

Islands corporation or partnership was set up that was

related, within the constructive ownership rules of

[26 U.S.C.] section 318, to the U.S. taxpayer who

purchased the shelter. The Cayman Islands entity

bought stock of a foreign bank, either Deutsche Bank or

UBS, with funds borrowed on a nonrecourse basis from

the same bank, in the amount of the artificial loss to be

generated. A few weeks later, the same bank redeemed

all the stock, and the Cayman Islands entity repaid the

bank with the redemption proceeds. The redemption,

however, purported to fail to qualify as a redemption

under U.S. tax law. [See 26 U.S.C. § 302(b)(1).] A

shareholder giving up shares in a failed redemption has

a dividend rather than a sale or exchange and cannot

use its basis in the redeemed shares against the

redemption proceeds. [See id.] FLIP/OPIS rests on the

claim that the basis of the Cayman Islands entity that

could not be used in the redemption transferred over to

bank stock owned by the related U.S. taxpayer who had

purchased the shelter. [See id. § 302(c); 26 C.F.R.

§ 1.302-2(c).] The U.S. taxpayer thus purportedly had

an excess, built-in loss on his bank stock by the amount
REDDAM V. CIR 7

Given the transaction’s complexity, we detail only those

aspects necessary to explain our holding, and append

KPMG’s graphical description of an OPIS transaction to this

opinion.4

of the original borrowed cost basis of the Cayman

Islands entity. The U.S. taxpayer reported the excess

loss on the sale of his bank stock.

Calvin H. Johnson, Tales from the KPMG Skunk Works: The Basis-Shift

or Defective-Redemption Shelter, 108 Tax Notes 431, 434 (July 25, 2005). 

The parties’ joint stipulation of facts explains the steps in OPIS as follows:

KPMG’s OPIS generally involved the following

structured transactions: (i) KPMG client’s purchase of

foreign bank’s stock; (ii) KPMG client’s agreement to

a “swap” transaction with a foreign owned limited

liability company that owned partnership interests in an

off-shore partnership; (iii) KPMG client’s purchase of

a call option to acquire a fifty percent interest in the

general partner of the off-shore partnership; (iv) offshore partnership’s purchase of stock in foreign bank

using proceeds from a loan from that bank; (v) offshore

partnership’s purchase of options from foreign bank;

(vi) foreign bank’s purchase of options from off-shore

partnership; (vii) foreign bank’s redemption of the

stock acquired by offshore partnership; and

(viii) client’s purchase of an option to acquire foreign

bank’s stock in an amount equal to the foreign bank

stock redeemed.

 

4

 KPMG planned OPIS transactions to be carried out in a specific

sequence. Although Reddam’s transactions did not occur in the precise

order envisioned by KPMG, the Commissioner does not argue that this

altered the Internal Revenue Code’s treatment of Reddam’s transaction

vis-a-vis a “properly” enacted OPIS transaction.
8 REDDAM V. CIR

First, Reddam5 entered into an Investment Advisory

Agreement with Presidio, a firm owned and operated by

former KPMG partners. Several entities were then created: 

(i) a domestic limited liability company owned by a foreign

person (that therefore owed no U.S. taxes, see 26 U.S.C.

§§ 881–85), Clara Street, LLC; (ii) a Cayman Islands

corporation, Clara Street Ltd. (owned by Clara Street, LLC);

and (iii) a Cayman Islands limited partnership, Cormorant LP

(“Cormorant”), whose limited partner was Clara Street LLC

and general partner was Clara Street Ltd. Presidio also

created investment accounts at Deutsche Bank for Reddam

and the entities.

Second, Reddam deposited $6,000,0006 into his Deutsche

Bank account, of which $2,500,000 was used to purchase

Deutsche Bank common stock. The remaining funds were

used to (a) enter into a “rate swap transaction” under which

Reddam made two fixed rate payments to Clara Street LLC

in exchange for the LLC’s agreement to make payments to

Reddam based on the average price of Deutsche Bank stock

during the timeframe of the OPIS transaction (May to July

1999), and (b) buy a call option (the “first call option”) from

Clara Street LLC for $150,000 that permitted Reddam to

either (i) purchase fifty percent of Clara Street Ltd., or

(ii) receive the value of Clara Street Ltd. in cash.

 

5

 On KPMG’s advice, Reddam formed the J. Paul Reddam Trust to

implement the OPIS transaction. Because a grantor trust is disregarded as

an entity for income tax purposes, see 26 U.S.C. § 671, we refer to

Reddam and the trust collectively as “Reddam.”

 

6

 Much of the transaction was carried out in euros. To minimize

complexity, we describe the transaction in approximate U.S. dollar

amounts.
REDDAM V. CIR 9

Third, Cormorant borrowed approximately $42,000,000

from Deutsche Bank to purchase Bank stock. The stock was

pledged as collateral for the loan, and Deutsche Bank retained

significant control over the stock. Deutsche Bank was also

given a security interest in Clara Street LLC and Clara Street

Ltd., the companies that owned Cormorant.

Fourth, Cormorant and Deutsche Bank engaged in several

options transactions. Cormorant purchased options

exercisable from May to July 1999 that had strike prices

within a narrow range, most of which were tied to the price

of Deutsche Bank stock during that time period.7 The options

permitted Deutsche Bank to purchase a portion of the Bank

stock owned by Cormorant if the price was within a certain

narrow range during May to July 1999.

Fifth, Cormorant sold all the Deutsche Bank stock it held

back to the Bank, using the proceeds to pay off the loan

originally used to purchase the shares. Although the value of

Deutsche Bank stock had risen in the interim, Cormorant

made virtually no profit because the purchase agreement

required Cormorant to sell ninety percent of the stock at a

price below its purchase price.

Sixth, Reddam purchased call options from Deutsche

Bank that permitted him to purchase Deutsche Bank stock in

July or August, 1999 (the “back end options”).

Seventh, Reddam exercised the first call option, opting to

have Clara Street LLC pay him a cash settlement, rather than

sell him the shares in Clara Street Ltd.

 

7

 Cormorant bought a put option, European-style Asian call options, and

European-style fade-in options.
10 REDDAM V. CIR

Eighth, Reddam sold his back end call options to

Deutsche Bank for a profit of approximately $200,000.

Finally, Reddam sold the $2,500,000 of Deutsche Bank

stock he purchased directly for approximately $2,900,000.

C. Simplified overview of Reddam’s calculation of

basis in underlying securities from OPIS

transaction

The purported tax benefits of OPIS hinge on transferring

basis from an off-shore entity to a U.S. taxpayer. 

Consequently, we set forth Reddam’s position on how his

bases in the securities underlying his OPIS transaction should

have been calculated.

Reddam paid approximately $2,500,000 for shares in

Deutsche Bank. Cormorant purchased approximately

$42,000,000 of Deutsche Bank stock, using the proceeds of

the loan it obtained from Deutsche Bank. Cormorant and

Reddam were related parties. See 26 U.S.C. § 318. Reddam

therefore took the position that, for tax purposes, he

constructively owned Cormorant’s Deutsche Bank stock. See

§ 318(a)(2)(A), (a)(2)(C), (a)(4), (a)(5). Similarly, Reddam

took the position that Cormorant constructively owned the

$2,500,000 worth of shares that he purchased directly. Thus,

on his 1999 tax returns, Reddam calculated his total basis in

the Deutsche Bank stock, including the purchase prices and

the various brokerage fees, as approximately $43,800,000.

When Cormorant sold its shares in Deutsche Bank back

to the Bank for $42,000,000, Cormorant ordinarily would be

treated as having been completely redeemed under 26 U.S.C.

§ 302(b)(3). But, Reddam took the position that because
REDDAM V. CIR 11

Cormorant also constructively owned Reddam’s $2,500,000

worth of Deutsche Bank shares, Cormorant’s sale was neither

a complete redemption under § 302(b)(3), nor a substantially

disproportionate redemption under § 302(b)(2). Rather,

Reddam contended that after the sale, there was no

“meaningful reduction” in Cormorant’s ownership of

Deutsche Bank. United States v. Davis, 397 U.S. 301, 313

(1970) (“[T]o qualify for preferred treatment under

[§ 302(b)(1)], a redemption must result in a meaningful

reduction of the shareholder’s proportionate interest in the

corporation.”). Reddam took the position that Cormorant’s

sale of the $42,000,000 of stock to Deutsche Bank was

actually a dividend Cormorant was required to include in

gross income under 26 U.S.C. § 301(c)(1); as a result,

Cormorant now had $42,000,000 in basis it could not use to

offset its gain from the sale of that stock.8 Applying the

constructive ownership rules of § 318, Reddam treated

Cormorant’s unused basis as available to him. See § 302(a);

26 C.F.R. § 1.302-2(c). Hence, after fees and divisions

between the various entities, Reddam claimed a basis of

$43,800,000 in his Deutsche Bank shares, despite having

directly purchased only $2,500,000 worth of shares.

Using essentially the same analysis, Reddam contended

that his bases in (1) the first call option, (2) the rate swap

transaction, and (3) the back-end call options were,

respectively, $9,400,000, $3,650,000, and $164,000.

 

8

 Because Cormorant was a Cayman Islands partnership, it was

indifferent to the U.S. tax consequences of this treatment. See 26 U.S.C.

§§ 881–85.
12 REDDAM V. CIR

D. Reddam’s reported gains and losses on his

1999 tax returns

On his 1999 returns, Reddam reported $48,500,000 of

capital gains from his sale of DiTech, and an offsetting loss

of $50,200,000 from the OPIS transaction. The $50,200,000

loss was based on the following calculations:

Sale Price Cost Basis Gain/Loss

Deutsche Bank

Stock

$2,900,000 $43,800,000 -$40,900,000

First Call

Option

$800,000 $9,400,000 -$8,600,000

Swap

Transaction

$3,000,000 $3,650,000 -$650,000

Back-end Call

Options

$98,000 $164,000 -$66,000

Total $6,800,000 $57,000,000 -$50,200,000

II. Procedural Background

In 2001, the IRS announced it would not recognize

alleged tax benefits attributable to OPIS transactions. I.R.S.

Notice 2001-45, 2001-2 C.B. 129. In 2003, the IRS offered

a settlement under which OPIS “participants would give up

80 percent of their tax losses and would still face appropriate

penalties.” Johnson, supra, at 434. The IRS later

“announced that 92 percent of the taxpayers it identified as

buying the shelter have taken the IRS settlement offer.” Id.

Reddam did not accept the offer. The Commissioner

disallowed all of Reddam’s claimed capital losses from the

OPIS transaction and determined a deficiency of $8,000,000
REDDAM V. CIR 13

on his 1999 returns. Reddam timely challenged the

deficiency in the Tax Court, which conducted a bench trial.

In the Tax Court, the Commissioner urged five different

grounds in support of the deficiency determination. Reddam,

2012 WL 1215220, at *15 & n.12. The court, however,

upheld the deficiency on a single ground, finding that the

OPIS transaction “lacked economic substance.” Id. at

*15–20.

As the Tax Court correctly noted, the

economic substance doctrine is a judicial

mechanism which allows a court to disregard

a transaction for Federal income tax purposes

if it finds that the taxpayer did not enter into

the transaction for a valid business purpose

but rather sought to claim tax benefits not

contemplated by a reasonable application of

the language and purpose of the Code or the

regulations.

Id. at *15. And the Tax Court also recognized, in

determining whether a transaction lacks economic substance,

that the Ninth Circuit generally applies a two-pronged inquiry

addressing the objective nature of the transaction (whether it

has economic substance beyond tax benefits) and the

subjective motivation of the taxpayer (whether the taxpayer

had a non-tax business purpose for the transaction). Id. at

*16–17 (citing Bail Bonds by Marvin Nelson, Inc. v. Comm’r,

820 F.2d 1543, 1549 (9th Cir. 1987)). The Tax Court also

recognized, however, that we have “rejected the notion” that

this is a “‘rigid two-step analysis,’” but rather a single inquiry

into “whether the transaction had ‘any practical economic
14 REDDAM V. CIR

effects’ other than tax benefits.” Id. at *17 (quoting Sacks v.

Comm’r, 69 F.3d 982, 988 (9th Cir. 1995)).

A. Subjective inquiry

The Tax Court appropriately framed the inquiry as

“whether the taxpayer was induced to commit capital for

reasons relating only to tax considerations or whether a

nontax or legitimate profit motive was involved.” Id. at *19

(citing Shriver v. Comm’r, 899 F.2d 724, 726 (8th Cir.

1990)).

After considering the evidence, the court concluded that

Reddam’s “overriding purpose” was tax avoidance. Id.

Reddam became interested in OPIS only after learning it

would “eliminate” his gain from the sale of DiTech, and the

court held that the “economic reality of [the] investment”

belied any profit motive. Id. Reddam’s lack of

understanding of the OPIS transaction, coupled with his “lack

of due diligence” and reliance on opinion letters only from

marketers of the deal also indicated that “he knew he was

purchasing a tax loss rather than entering into a legitimate

investment.” Id. at *20. The Tax Court could not “excuse his

willful indifference as to the profit potential of the transaction

and accept that his uninformed position was sufficient to

satisfy [the] business purpose inquiry.” Id. Rather,

Reddam’s “refusal” to “fully investigate the transaction, by

. . . hiring outside counsel to analyze the transaction . . .

underscore[d] that [he] was entirely unconcerned with the

profitability of the investment.” Id.
REDDAM V. CIR 15

B. Objective inquiry

The Tax Court acknowledged that a transaction satisfies

the economic substance doctrine if it has “‘any practical

economic effects’ other than tax benefits.” Id. at *16

(quoting Sacks, 69 F.3d at 988). The court therefore

addressed the experts’ reports on the OPIS transaction, to

determine whether “the transaction was likely to produce

benefits aside from tax deductions.” Id. (citing, inter alia,

Bail Bonds, 820 F.2d at 1549). The Commissioner’s expert

(Dr. Kolbe) calculated the OPIS transactions’ net present

value (“NPV”) and the expected rate of return of each

component relative to its individual cost of capital, while

Reddam’s expert (Dr. Miller) performed an expected rate of

return analysis “‘functionally equivalent’ to the NPV

analysis” performed by Dr. Kolbe. Id. at *17. The Tax

Court, however, “ascribe[d] little value” to either of these

calculations because they “do little to aid in our determination

of whether a profit was reasonably likely in the OPIS

transaction.” Id. (internal quotation marks and citations

omitted).

The court did find useful Dr. Kolbe’s “additional

comparison of the ‘values’ of the discrete elements of the

OPIS transaction to their purchase price” because it “does,

partially, illuminate the economics of petitioner’s

investment.” Id. According to Dr. Kolbe, Reddam “overpaid

$2,289,650 for the entire OPIS transaction” because, other

than his direct purchase of Deutsche Bank stock, “each

distinct aspect of the transaction was materially mispriced to

[his] disadvantage.” Id. Although this mispricing was not

“dispositive,” the Tax Court noted, it “signals to this Court

that the transaction was devoid of economic substance.” Id.
16 REDDAM V. CIR

Reddam’s expert, Dr. Miller, claimed that in twenty-three

to twenty-five percent of the possible future price paths the

OPIS transaction could have taken (based on possible

trajectories of the underlying Deutsche Bank stock) a profit

net of tax benefits would result. Id. at *18. Dr. Kolbe argued

that Dr. Miller used an improper measure of volatility and

that these transactions would have resulted in a profit no more

than ten to twelve percent of the time. Id. Without expressly

adopting either analysis, the Tax Court concluded that the

pretax profit potential of OPIS was “so remote as to render

disingenuous any suggestion that the transaction was

economically viable.” Id.

When the “allegedly purposeful mispricing” of the

options and swap agreement were also considered, the court

concluded “it is clear that petitioner remained in an

economically untenable position with little hope of profit

before taking into account the investment’s tax benefits.” Id.

The court was “unconvinced that the mere hint of future

profitability, be it at 10 or 25% likelihood . . . requires this

Court to conclude that the investment was ‘likely’ to produce

benefits aside from substantial capital losses.” Id. (citing Bail

Bonds, 820 F.2d at 1549).

The Tax Court also rejected Reddam’s argument that, had

“the transaction been entered into a few months later, he

would have made several million dollars” because Reddam

suffered a “significant economic loss of approximately

$342,507 on his OPIS transaction.” Id. Rather, the

undisputed facts indicated that “a pretax profit on the

investment was highly unlikely” and Reddam’s own expert

agreed that “on average, and at the median, the transaction

generates a substantial loss.” Id. (internal quotation marks

omitted). Thus, the Tax Court found that “the evidence
REDDAM V. CIR 17

reveals the OPIS transaction to be clearly lacking in

economic substance,” id., and held that “accordingly, [it]

should be disregarded for tax purposes,” id. at *20.

III. Discussion

A. Standard of Review

The Tax Court’s factual determinations about a

transaction’s economic substance are reviewed for clear error,

but the legal standards it applies and the application of those

standards to the facts are reviewed de novo. Frank Lyon Co.

v. United States, 435 U.S. 561, 581 n.16 (1978); Sacks,

69 F.3d at 986. “In addition, the Commissioner’s

determination that the transaction is a sham is presumptively

correct, and Taxpayers have the burden of producing

evidence to rebut the deficiency determination and [the]

burden of persuasion to substantiate the deduction.” Sochin

v. Comm’r, 843 F.2d 351, 355 n.9 (9th Cir. 1988), abrogated

on other grounds by Landreth v. Comm’r, 859 F.2d 643,

648–49 (9th Cir.1988); see also Welch v. Helvering, 290 U.S.

111, 115 (1933) (stating that Commissioner’s determination

that expenses were not deductible is a “ruling [that] has the

support of a presumption of correctness, and the petitioner

has the burden of proving it to be wrong”).

B. Economic Substance Doctrine

The economic substance doctrine focuses both “on the

subjective aspect of whether the taxpayer intended to do

anything other than acquire tax deductions, and the objective

aspect of whether the transaction had any economic substance

other than creation of tax benefits.” Sacks, 69 F.3d at 987;

see also Casebeer v. Comm’r, 909 F.2d 1360, 1365 (9th Cir.
18 REDDAM V. CIR

1990) (“The economic substance factor involves a broader

examination of whether the substance of a transaction reflects

its form, and whether from an objective standpoint the

transaction was likely to produce economic benefits aside

from a tax deduction.”) (quotation marks and citation

omitted). “[T]he consideration of business purpose and

economic substance are simply more precise factors to

consider in the application of this court’s traditional sham

analysis; that is, whether the transaction had any practical

economic effects other than the creation of income tax

losses.” Sochin, 843 F.2d at 354.

1. Subjective Inquiry

Reddam argues that the Ninth Circuit requires only that

a taxpayer have “a business purpose and not be motivated

solely by tax benefits,” and that the Tax Court improperly

looked only at “whether taxes were the most important

purpose.” This court, however, has “repeatedly and carefully

noted that” the economic substance doctrine is not a “‘rigid

two-step analysis,’” Sacks, 69 F.3d at 988 (quoting Casebeer,

909 F.2d at 1363), but instead focuses holistically on whether

“‘the transaction had any practical economic effects other

than the creation of income tax losses,’” id. (emphasis added)

(quoting Sochin, 843 F.2d at 354).

Reddam argues that the Tax Court failed to properly

credit his testimony which acknowledged his tax motivation,

but also claimed that he entered into the OPIS transaction

hoping to “make money.” But, on the record before it, the

Tax Court was entitled to find that Reddam’s efforts “to

reduce his tax liabilities which prefaced the investment

evidenc[ed] his true motives for engaging in the transaction.” 

Reddam, 2012 WL 1215220, at *19. The timing of the OPIS
REDDAM V. CIR 19

transaction provided compelling evidence of Reddam’s

purpose—to offset the enormous taxable gains accumulated

from his sale of DiTech.

Reddam also argues that his “investment diligence”

distinguishes his case from another OPIS case relied upon by

the Tax Court, Blum v. Commissioner, in which the taxpayer

conceded that he had “no understanding” of many key aspects

of the transaction. No. 2679-06, 2012 WL 129801 (T.C. Jan.

17, 2012), aff’d, 737 F.3d 1303 (10th Cir. 2013). But, even

if Reddam’s due diligence exceeded Blum’s, the Tax Court

properly noted that Reddam nonetheless ignored both

KPMG’s and Carnahan’s recommendations that he seek

independent advice regarding the investment portions of

OPIS. The court was therefore entitled to find, as a matter of

fact, that Reddam was motivated to invest millions of dollars

in OPIS solely because of the anticipated tax benefits of the

transaction. Given the complicated structure of the OPIS

transaction, Reddam’s failure to investigate the scheme

(which he paid KPMG hundreds of thousands of dollars to

implement), belies a profit-making motive.

The KPMG marketing materials also undercut Reddam’s

argument that he entered into the OPIS transaction for its

profit potential. Those materials forthrightly state that the

OPIS transaction “minimizes gain, or maximizes loss,” an

anathema to a profit-seeking investor.9

 The record amply

 

9

 Moreover, in calculating the costs of the OPIS transaction, the KPMG

materials list the underlying Deutsche Bank stock and the back-end

options as investments, but list the swap transaction and the first call

option as out-and-out costs of the transactions, not investments capable of

earning a profit.
20 REDDAM V. CIR

supports the Tax Court’s factual conclusion that Reddam

pursued the OPIS product solely for its tax benefits.

2. Objective Inquiry

As noted above, although our cases have analyzed the

question of economic substance in two parts, objective and

subjective, the fundamental question remains whether the

transaction at issue “‘had any practical economic effects other

than the creation of income tax losses.’” Sacks, 69 F.3d at

988 (quoting Sochin, 843 F.2d at 354). Put differently, the

question is whether a reasonable investor would enter into an

OPIS transaction for its possible investment gains. In

addressing this question, we look to the “overall structure” of

the transaction. Keane, 865 F.2d at 1092. Even if a

transaction could “as a theoretical matter . . . result in

economic gains,” it nonetheless lacks substance if it was

“executed in such a manner as to insure that the net result . . .

would be tax deductible losses.” Id. at 1091; see also

Gregory v. Helvering, 293 U.S. 465, 467–70 (1935)

(reviewing the “whole undertaking” and affirming

Commissioner’s disregard of corporate reorganization as

being “without substance” because “[t]o hold otherwise

would be to exalt artifice above reality and to deprive the

statutory provision in question of all serious purpose”).

Reddam argues that, because the Tax Court did not

expressly adopt either expert’s calculation, it implicitly

credited Dr. Miller’s conclusion that the OPIS transaction

could have generated a profit twenty-three percent of the

time, and thus erred as a matter of law in holding that there

“was not a reasonable opportunity for profit under the

economic substance doctrine.” He contends that it “cannot be
REDDAM V. CIR 21

said that a 23–25% chance of profit is not meaningful and has

no substance whatsoever or is remote.”

In response, the Commissioner argues that Reddam’s

subjective motivation in seeking tax avoidance alone is

sufficient to sustain the Tax Court’s ruling. The

Commissioner also focuses on the fact that the “$50 million

tax loss was wholly artificial” and argues that any transaction

which creates an artificial tax loss is an economic sham. See

Sala v. United States, 613 F.3d 1249, 1253 (10th Cir. 2010).

We decline the parties’ invitations, however, to apply a

one-size-fits-all test. We do not address these issues in

isolation; rather, they are part of a pragmatic total inquiry. 

The application of the economic substance doctrine turns not

only on the percentage of possible profit or loss underlying

Reddam’s OPIS transaction, but also on the likely

corresponding magnitude of those possible profits or losses

and how would they be reported for tax purposes. See, e.g.,

Sacks, 69 F.3d at 987–88 (holding that a transaction was not

a sham because it had a purpose of making money after taxes

and shifted risk of non-payment to taxpayer); Casebeer,

909 F.2d at 1361 (holding that a transaction was a sham

because investors had nothing at risk and nothing to gain

except tax benefits); Sochin, 843 F.2d at 354 (holding that a

transaction was a sham because it had no “practical effects

other than the creation of income tax losses”). There was

some theoretical possibility that Reddam’s OPIS transaction

would create a net economic gain. But the magnitude of even

the most optimistic gain is dwarfed by the magnitude of the

tax loss it was designed to generate and the strong probability

of a pretax loss.
22 REDDAM V. CIR

Put differently, the small percentage chance that

Reddam’s OPIS transaction could have created a sizeable

economic gain in return for his multi-million dollar

investment10 pales in comparison to the expectation that it

would always create a tax loss of $42,000,000 to

$50,000,000. No matter how the underlying Deutsche Bank

stock performed, the OPIS transaction was designed

inevitably to produce a tax loss: the $42,000,000 shift of

basis from Cormorant to Reddam would always (even under

Reddam’s expert’s calculations) have overshadowed any

possible gain. On this record, the Tax Court was correct in

concluding that the percentage of likely potential gain did not

infuse economic substance into what was clearly a tax loss

scheme.

Unlike Reddam, we do not read the Tax Court as holding

that a transaction with a ten to twenty-five percent chance of

generating a profit always lacks economic substance. Instead,

we read the Tax Court as properly holding that, in this case,

the evidence is overwhelming that no objective investor or

taxpayer would enter into the OPIS transaction for its profit

making potential. Rather, the overall structure of the OPIS

transaction compels the conclusion that it would be purchased

solely for its ability to create capital losses. See Keane,

865 F.2d at 1091 (affirming the Tax Court’s conclusion that

 

10 Dr. Miller’s report states that only in highly uncommon circumstances

would the OPIS transaction make any kind of profit, but that five percent

of the time it could make between $3,450,000 and $6,300,000. It defies

belief that an objective investor would risk $6,000,000 on a transaction

that was designed to lose money at least seventy-five percent of the time,

could make a nominal profit twenty percent of the time, but might, only

five percent of the time, have generated profits in that range for any reason

other than to garner the eight-figure tax loss the transaction was designed

to generate.
REDDAM V. CIR 23

it was the taxpayer’s “entire tax straddle scheme . . . which

taints the deductibility of the . . . losses”) (internal quotation

marks omitted). The Tax Court had ample record support for

its factual conclusion that the OPIS transaction has “‘no

practical economic effects other than the creation of income

tax losses.’” Sacks, 69 F.3d at 987 (quoting Sochin, 843 F.2d

at 354).11

IV. Conclusion

For the reasons above, the judgment of the Tax Court is

AFFIRMED.

 

11 Like the Tax Court, we therefore find it unnecessary to reach the

Commissioner’s other arguments in support of the deficiency

determination.
24 REDDAM V. CIR

APPENDIX
REDDAM V. CIR 25