department of the treasury internal_revenue_service washington d c date number release date uilc tl-n-6722-98 cc dom fs p si internal_revenue_service national_office field_service_advice memorandum for north central district_counsel from assistant chief_counsel field service cc dom fs subject lease_stripping transaction this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be cited as precedent legend t b c d e f g h j k l m n a b c d e f g h dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure i j k l m n o p q r s t u v w x y z aa bb cc dd ee ff gg hh ii jj kk ll a b c d e f g h i j year year year dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure year year year year issues whether the lease_stripping transactions lack economic_substance whether the partnership form should be respected whether the purported sale_and_leaseback of the computer equipment and store equipment are properly characterized for federal_income_tax purposes whether the step_transaction_doctrine can be applied to collapse the lease_stripping transactions whether sec_482 applies to the lease-stripping transactions at issue and if so the consequences of applying sec_482 conclusions the lease_stripping transactions lack economic_substance because the transactions had no objective economic_substance there was no business_purpose for the transactions and the parties entered into the transactions for tax_avoidance purposes there are insufficient facts to determine if the partnership form should be respected it appears that the purported sale_and_leaseback of the computer equipment and store equipment are not properly characterized for federal_income_tax purposes we recommend further factual development it appears that the step_transaction_doctrine may apply to collapse the lease_stripping transactions we recommend further factual development sec_482 applies to a portion of the lease-stripping transactions at issue facts introduction this case involves a lease-stripping transaction with one party realizing rental income from property and another party or parties claiming deductions for rental expenses and or depreciation on the equipment the service has defined and described forms of lease-stripping transactions and the code sections and doctrines that are applicable to such transactions notice_95_53 1995_2_cb_334 depending upon the facts of the case the service may apply the following provisions to the transaction sec_269 sec_382 sec_446 sec_482 sec_701 or sec_704 sec_7701 and the underlying regulations it may also recharacterize certain assignments or accelerations of future payments as financings or apply the assignment-of-income principles the business-purpose doctrine or the substance-over-form doctrines including the step transaction and sham doctrines notice_95_53 t entered into two different purported sale_and_leaseback transactions in the first transaction t sold and leased back computer equipment utilized in its business in the second transaction t sold and leased back retail store equipment of one of its divisions purported sale_and_leaseback of computer equipment t utilized computer equipment in its business on october year t purportedly sold the computer equipment to b for dollar_figurea in payment of the purchase_price b executed in favor of t three non-recourse notes totaling dollar_figureb and three recourse notes totaling dollar_figurec the notes were secured_by a purchase money security_interest in the equipment on the same day t leased back the computer equipment from b for an a year period with an option to extend the lease for another b months t also acquired an option to purchase the equipment upon the end of either the lease or the lease extension period the payments due from t to b under the lease-back agreement equaled the principal and interests payments due from b to t under the notes issued for the purchase of the computer equipment on the same day b sold the computer equipment to c for dollar_figured in payment of the purchase_price c assumed b’s non-recourse notes to t totaling dollar_figureb and executed two notes one note in the amount of dollar_figuree and one note in the amount of dollar_figuref c is a partnership with three partners two partners are individuals and the third the the terms sale_and_leaseback are used for convenience only t one of its division and a wholly-owned subsidiary individually sold the equipment in three different transactions because the terms of each of the agreements are similar we shall refer to the three sales as one sale of computer equipment majority partner d is an indian nation believed to be not subject_to u s federal tax on the same day c sold the computer equipment to e for dollar_figureg in payment of the purchase_price e executed in favor of c two nonrecourse notes one note in the amount of dollar_figuree and one note in the amount of dollar_figureh on the same day c leased back the computer equipment from e for a c-year period with an option to extend the lease for another b months pursuant to the terms of the master lease c agreed to pay rent as follows one payment of dollar_figurei payable on january year eight semiannual payments of dollar_figurej payable on january and july of each year beginning on july year and ending on january year and one final payment in the amount of dollar_figurek payable on april year on november year c sold its rights to receive the lease payments from t to f for dollar_figurel on december year t executed an agreement under which it would unconditionally make lease payments to f g was a wholly owned subsidiary of t on december year t contributed dollar_figurem to g in exchange for d shares of g common_stock simultaneously and in conjunction with this transfer c contribute the two nonrecourse notes executed by e the lease between c and e and the note executed by c to b to g in exchange for e shares of series a preferred_stock the payments due under e’s note and the lease payments due under the lease between c and e are the same and therefore offsetting t booked the residual rights under the master lease as an asset with a value of dollar_figuren in contrast to an appraisal which placed a future value on the equipment of over dollar_figureo on december year g entered into an agreement with h under which g agreed to pay a portfolio acquisition fee of dollar_figurep to h for assisting g in arranging the assignment and assumption_agreement pursuant to which c contributed certain equipment to g in exchange for series a preferred_stock and for related matters g also entered into a tax_matters_agreement with h under which h agreed to refund a portion of the portfolio acquisition fee if c failed to report the proceeds of the sale of lease payments as income in the year_of_sale or if g’s basis in the notes from e was less than that agreed upon on december year g paid the note to b it had assumed from c at the same time pursuant to the direction of h g paid to b a dollar_figureq portion of the portfolio acquisition fee it owed to h the sum of those two payments to b equaled the dollar_figurec recourse notes due from b to t b thus satisfied that note directly from payments made by g the b nonrecourse notes due to t were satisfied by the sale of the rents due under the leases to f in october year at the end of the initial term under the user leases t renewed the leases with g for an additional b months for a total additional cost of dollar_figurer this is in contrast to the residual_value booked as part of a sec_351 transfer of dollar_figuren and an appraisal estimate of almost dollar_figures at the end of the master lease period which coincided with the extended user leases t repurchased the equipment from e for approximately dollar_figuret the estimated value of the computer equipment at the end of the master lease_term was dollar_figureu purported sale_and_leaseback of store equipment on december year t purportedly sold retail store equipment including wall fixtures wood fixtures metal gondola wall standards stockroom shelving garment rack cubes fixture accessories shoe fixtures pharmacy fixtures lawn and garden fixtures errors and omissions and field order modifications and display items from one of its store divisions to b for dollar_figurev t’s cost_basis in the equipment was dollar_figurew and it had claimed dollar_figurex in depreciation_deductions on the same day t leased back the store equipment from b for a term of f years with an option to extend for another g years t had an option to purchase the store equipment at the end of the initial lease_term or at the end of the renewal_period on the same day b sold the store equipment to j a partnership for dollar_figurey and leased the equipment back from j the majority partner of j k is an indian nation believed to be not subject_to u s federal tax on the same day j sold the store equipment to m for dollar_figurey and j leased back the store equipment from m for a term of h years j’s rental obligations are as follows one installment of dollar_figurez payable on january year thirteen equal semiannual installments of dollar_figureaa on january and july of each year commencing on july year and ending july year and one final installment of dollar_figurebb payable on december year on january year j sold its right to receive the lease payments to m for dollar_figurecc on january year t contributed dollar_figuredd cash to g in exchange for i shares of g common_stock simultaneously and in conjunction with this transfer j transferred its rights and obligations under the notes and equipment in exchange for j shares of series b preferred_stock in g on september year m sold the rights to the rent receivables to n according to t’s counsel g could have reasonably anticipated a profit in excess of dollar_figureee on its out of pocket investment of dollar_figureff on a pre-tax non-discounted basis t deducted rental expense payments relating to this transaction totaling dollar_figuregg in excess of related_income in the tax years ending january year and february year in a proposal dated december year the projected total pretax income impact for the year through year years was dollar_figurehh the projected taxes saved for lease positions was dollar_figureii in this document the risks to the transaction included the following if the second transaction doesn’t occur we are stuck with a market rate sale leaseback - we’d prefer to own this second transaction was described as follows in a second transaction a month later our subsidiary g obtains the rights to use the fixtures for another years years this partnership transfers its favorable tax positions to us for a fee after years we have the option to purchase the fixtures at fair_market_value law and analysi sec_1 lack of economic_substance a transaction that is entered into solely for the purpose of tax reduction and that has no economic or commercial objective to support it is a sham and is without effect for federal_income_tax purposes estate of franklin v commissioner t c 752_f2d_89 4th cir 435_us_561 when a transaction is treated as a sham the form of the transaction is disregarded and the proper tax treatment of the parties to the transaction is determined to be respected a transaction must have economic_substance separate and distinct from the economic benefit achieved solely by tax reduction if a taxpayer seeks to claim tax benefits which were not intended by congress by means of transactions that serve no economic purpose other than tax savings the doctrine_of economic_substance is applicable 31_f3d_117 3d cir 861_f2d_494 7th cir aff’g 87_tc_1087 364_f2d_734 2d cir aff’g 44_tc_284 31_tc_33 aff’d 270_f2d_294 3d cir acm partnership v commissioner tcmemo_1997_115 aff’d in part and rev’d in part 157_f3d_231 3d cir whether a transaction has economic_substance is a factual determination 338_us_451 this determination turns on whether the transaction is rationally related to a useful nontax purpose that is plausible in light of the taxpayer’s conduct and useful in light of the taxpayer’s economic situation and intentions the utility of the stated purpose and the rationality of the means chosen to effectuate it must be evaluated in accordance with commercial practices in the relevant industry 89_tc_986 acm partnership supra a rational relationship between purpose and means ordinarily will not be found unless there was a reasonable expectation that the nontax benefits would be at least commensurate with the transaction costs yosha v commissioner 87_tc_1087 acm partnership supra in determining whether a transaction has economic_substance so as to be respected for tax purposes both the objective economic_substance of the transaction and the subjective business motivation must be determined acm partnership f 3d pincite 968_f2d_1229 d c cir 909_f2d_1360 9th cir 81_tc_184 aff'd in part and rev'd in part 752_f2d_89 4th cir the two inquiries are not separate prongs but are interrelated factors used to analyze whether the transaction had sufficient substance apart from its tax consequences to be respected for tax purposes acm partnership f 3d pincite casebeer f 2d pincite see also notice_95_53 1995_2_cb_334 all of the facts and circumstances surrounding the transactions must be considered no single factor will be determinative courts will respect the taxpayer’s characterization of the transactions if there is a bona_fide transaction with economic_substance compelled or encouraged by business or regulatory realities imbued with tax-independent considerations and not shaped solely by tax_avoidance features that have meaningless labels attached see 435_us_561 909_f2d_1360 9th cir recently the service was successful in showing that a series of prearranged transactions involving the purchase and sale of debt instruments in an attempt to shift accelerated installment_sale gain to a tax-neutral partner and manufacture a loss for another partner lacked economic_substance acm partnership v commissioner tcmemo_1997_115 aff’d in relevant part rev’d in part remanded 157_f3d_231 3d cir cert_denied u s lexis u s date in acm partnership the commissioner argued that the purchase and sale of debt instruments were prearranged and predetermined devoid of economic_substance and lacking in economic reality the court found that the taxpayer desired to take advantage of a loss that was not economically inherent in the object of the sale but which the taxpayer created artificially through the manipulation and abuse of the tax laws the court also stated that the tax law requires that the intended transactions have economic_substance separate and distinct from economic benefit achieved solely by tax reduction it held that the transaction lacked economic_substance and therefore that the taxpayer was not entitled to the claimed deductions the opinion demonstrates that the court will disregard a series of otherwise legitimate transactions where the commissioner is able to show that the facts when viewed as a whole have no economic_substance see also rev_rul 1999_13_irb_3 because lease-in lease-out transactions have no economic_substance a u s taxpayer could not take deductions for rent or interest_paid or incurred in connection with the transaction while the profit potential or economic risk relative to the expected tax_benefit necessary to meet the objective economic_substance test has not been quantified a reasonable prospect or possibility for profit is required see horn f 2d pincite n rice’s toyota world inc t c pincite nominal or de_minimis profit potential does not imbue a transaction with economic_substance 364_us_361 912_f2d_736 4th cir rev’g ustc cch e d n c 103_tc_29 94_tc_738 84_tc_412 there was no objective economic_substance or business_purpose for the formation of the sale and lease backs and subsequent sale of the right to receive lease payments rather the sole purpose of the transaction was the creation of tax benefits to the extent the transactions at issue lack economic_substance the expenses and deductions from the sale-leaseback are disallowed formation of partnership in order for a federal tax law partnership to exist the parties must in good_faith and with a business_purpose intend to join together in the present conduct of an enterprise and share in the profits or losses of the enterprise the entity’s status under state law is not determinative for federal_income_tax purposes 327_us_280 42_tc_1067 the existence of a valid partnership depends on whether considering all of the facts-the agreement of the parties the conduct of the parties in execution of its provisions their statements the testimony of disinterested persons the relationship of the parties their respective abilities and capital contributions the actual control of income and the purposes for which it is used and any other facts throwing light on their true intent-the parties in good_faith and action with a business_purpose intended to join together for the present conduct of an undertaking or enterprise 337_us_733 asa investering partnership v commissioner tcmemo_1998_305 appeal filed no d c cir date revrul_82_61 1982_1_cb_13 recently the service was successful in making this argument in asa investering partnership in that case the primary issue considered by the tax_court was whether allied signal allied signal investment corporation asic barber corporation n v and dominguito corporation n v formed a valid partnership for federal_income_tax purposes the court held that the corporations did not the court disregarded the existence of barber and dominguito because the facts demonstrated that those entities were agents for abn the lender see 485_us_340 the court pointed out several relevant facts first both barber and dominguito were thinly capitalized shell_corporations established for the sole purpose of engaging in the venture second the parties treated abn as the real participant in the venture and disregarded barber’s and dominguito’s respective corporate forms as an example allliedsigned paid abn directly for barber’s and dominguito’s participation in the venture third barber and dominguito were mere conduits abn lent barber and dominguito the funds for their respective capital contributions and retained options that allowed abn to purchase barber’s and dominguito’s shares for a de_minimis amount all of barber’s and dominguito’s profit from the transactions came back to abn the court also concluded that because asic was alliedsignal’s wholly-owned subsidiary alliedsignal not asic was the relevant party so for purposes of deciding the issue the court also ignored the existence of asic the court then considered whether alliedsignal and abn intended to join together in the present conduct of an enterprise the court pointed out the following facts as relevant to reaching its conclusion that alliedsignal and abm did not intend to join together in the present conduct of an enterprise first alliedsignal and abn had divergent business goals alliedsignal entered into the venture for the sole purpose of generating capital losses to shelter an anticipated capital_gain in pursuing this goal alliedsignal chose to ignore transaction costs profit potential and other fundamental business considerations alliedsignal focused solely on the potential tax benefits in contrast abn entered into the venture for the sole purpose of receiving its specified return this return was independent of the performance of asa’s investments eg the profitability of the libor notes and the success of the venture ie whether alliedsignal succeeded in generating capital losses further abn did not have any profit potential beyond its specified return and did not have any intention of being alliedsignal’s partner in essence the arrangement did not put all of the parties in the same business boat therefore they cannot get into the same boat merely to seek tax benefits culbertson u s pincite the taxpayer argued that asa investerings partnership should be respected as a bona_fide partnership because the purported partners carefully followed partnership formalities the court stated that such formalities may have created a partnership facade but the conduct of alliedsignal and abn demonstrated that the bermuda agreement not the partnership_agreement governed their affairs the court concluded that the characteristics of alliedsignal and abn’s relationship were contrary to the characteristics of a bona_fide partnership alliedsignal and abn had divergent rather than common interests moreover they did not share in the venture’s profit and losses and did not comply with their partnership_agreement when it conflicted with the another agreement in conclusion the court stated that alliedsignal asic and abn’s agents barber and dominguito did not have the requisite intent to join together for the purpose of carrying on a partnership and sharing in the profits and losses therefrom instead further analysis revealed that alliedsignal and abn had a debtor-creditor relationship having concluded that abn was in substance a lender the court held that barber and dominguito were not partners in asa investerings partnership and that the appropriate amount of gain relating to the sale of the ppns and loss relating to the sale of the libor notes should be allocated between alliedsignal and asic proper characterization of sale_and_leaseback whether the purported sale_and_leaseback of the computer equipment and the store equipment are properly characterized for federal_income_tax purposes depends upon the substance of the transaction 91_tc_838 a transaction may be considered a sale for federal_income_tax purposes if the benefits_and_burdens_of_ownership have passed to the purchaser of the assets levy t c pincite the taxpayer in levy entered into sale- leaseback transactions involving computer equipment in determining that the taxpayer’s purchase of the equipment should be respected for federal_income_tax purposes the court stated that the factors relevant to this determination are the purchaser’s equity_interest in the computer equipment as a percentage of the purchase_price a useful_life of the property that extends beyond the lease_term lease renewal or purchase options at the end of the lease_term based on fair_market_value of the equipment at that time whether the projected residual_value of the equipment plus the cash_flow generated by the rental of the equipment allows the investors to recoup at least their initial cash investment whether a turnaround point is reached at some point whereby depreciation and interest_deduction are less than income received from the lease whether the net tax savings for the investors are less than their initial the potential for realizing a profit or loss on the sale or release of the cash investment and equipment levy t c pincite see also 89_tc_1229 aff’d in part rev’d in part 909_f2d_1360 9th cir additional factors to consider in determining the correct characterization include whether an equity_interest was acquired in the property whether the contract created a present obligation on the seller to execute and deliver a deed and on the purchaser to make payments and whether the right of possession is vested in the purchaser 77_tc_1221 in 84_tc_412 ndollar_figure the court stated that a lessee acquires an equity when he acquires something of value in relation to the overall transaction other than the mere use of the property the lessor of the computer equipment being leased retained its ownership in the equipment because it did not lease the equipment for its entire economic life to the lessee and the lessor had the potential for receiving a high residual_value of the equipment an equity_interest in property is acquired when the lessee has the use of the equipment for its entire useful_life in revrul_55_541 1955_2_cb_19 the purported lessee corporation m had the use of the equipment for substantially its entire useful_life though corporation m may have never acquired legal_title to the equipment because corporation m was to enjoy all of the benefits of ownership of the equipment the service determined that corporation m was transferred an equitable interest in the equipment in larsen supra the court determined that the taxpayer acquired the benefits_and_burdens_of_ownership of the computer equipment used in the sale_and_leaseback transaction however the court also determined that the transactions were not motivated by a business_purpose were devoid of economic_substance and were disregarded for federal_income_tax purposes factors that the court deemed to be neutral in determining whether a taxpayer should be respected as the owner of the equipment include the following the existence of a net_lease the absence of significant positive net_cash_flow during the leaseback term or rent geared to interest and mortgage amortization and the use of nonrecourse_liability larsen t c pincite citing 84_tc_412 see also 435_us_561 an assignment of future revenues is not a bona_fide sale but rather a lending transaction secured_by the right to future revenue when the assignee has the right to repayment 556_f2d_1107 ct_cl this certainty is characteristic of a loan mapco inc f 2d pincite in mapco inc the court determined that amounts deposited in the bank by the taxpayer indirectly guaranteed repayment which was also a characteristic of a loan mapco inc supra limited_use_property is property that is not expected to be useful to or useable by the lessor at the end of the lease_term except for purposes of continued leasing or transfer to a member of the lessee group revrul_82_61 1982_1_cb_13 it is the service’s position that- if because of the nature of the property or its location the property is expected not to be useful or usable by the purported lessor at the end of the lease_term except for purposes of transfer or continued leasing to the purported lessee or a related_party then future passage of title to the purported lessee is also likely and consistently the transaction should be treated as a purchase g_c_m see also revproc_76_30 1976_2_cb_647 the service will not issue advance rulings on whether a transaction is a lease for u s federal_income_tax purposes pursuant to revproc_75_21 1975_1_cb_715 and revproc_75_28 1975_1_cb_752 in transactions involving limited_use_property g repurchased the computer equipment for approximately dollar_figuret pursuant to the sec_351 transaction the residual_value of the equipment was estimated to be over dollar_figureu the purchase option and the actual purchase_price do not appear to have been at the fair_market_value of the equipment facts that support recharacterizing the sale_and_leaseback as a financing t had the option to lease the computer equipment for up to c years and had the option to repurchase the equipment upon the expiration of the leases g repurchased the computer equipment for approximately dollar_figuret approximately two months after t sold the equipment to b it appears that t retained its equity_interest in the equipment as defined in revrul_55_541 because t retained the benefits of ownership of the equipment for substantially the entire useful economic life of the equipment moreover t retained the right to repurchase the equipment which is indicative of t’s intent never to sell the computer equipment t received a payment for its equipment at the beginning of the transaction and was to make rent payments that equaled the purchase_price of the equipment thus t was able to recover its rental payments up-front a fact which supports recharacterizing the sale_and_leaseback as a financing it appears that t’s expected profit in this case was locked-in because the amounts to be paid for the computer equipment were predetermined and not market-driven the expected profits were based on residual valuations that were inflated these facts support recharacterizing the sale_and_leaseback as a financing e purchased and leased back the computer equipment to c this is inconsistent with t’s sale lease back and repurchase of the equipment which further underscores the conclusion that t did not sell lease back and repurchase the computer equipment if the purported sale by and leaseback to t of computer equipment is properly characterized as a financing_arrangement and not as a sale and a leaseback then the dollar_figurea that t received from b as payment would be properly characterized as a loan and would not be included in t’ s gross_income 499_us_573 furthermore if the transaction is not properly characterized as a sale and a leaseback the rental income to b would then be properly characterized as repayment of the loan principal which would not be taxable as income and interest which would be taxable as income in the second above-described transaction t retained an option to purchase the store equipment at the end of the initial lease_term or at the end of the renewal_period t through its subsidiary g repurchased the store equipment furthermore t expressed its lack of interest in leasing the equipment in the proposal as follows risks if the second transaction doesn’t occur we are stuck with a market rate sale leaseback - we’d prefer to own it appears that t wanted and intended to retain the benefits of ownership of the store equipment even after the expiration of the lease these facts suggest that t retained the benefits of ownership of the equipment and therefore retained an equity_interest in the property pursuant to revrul_55_541 these facts support recharacterizing the sale_and_leaseback as a financing additionally t purportedly expected a profit from the sale of the store equipment this profit however was predetermined and locked-in and based upon the expected residual_value of the equipment which was never realized this fact supports recharacterizing the sale_and_leaseback as a financing upon the termination of the lease after either f or h years the store division was required to return the equipment to b the lessor essentially the division would have been required to remove the fixtures that had been mounted to the walls and bolted to the floors had t not repurchased the store equipment while we do not know the quality of the store equipment or its expected useful_life we question the likelihood that the equipment could be removed without damaging it we also question the likelihood that the store equipment could be resold to a third party arguably the store equipment is limited_use_property and the division’s store is the only lessee that could use the equipment upon the expiration of the lease this fact would support recharacterizing the sale_and_leaseback as a financing if the purported sale_and_leaseback of the division’s store equipment was not a sale and a leaseback but rather a financing_arrangement then any amount that t received from b as payment would be properly characterized as a loan and would not be included in t’s gross_income centennial savings bank fsb u s pincite furthermore if the transaction is not a sale and a leaseback the rental income to b would then be properly characterized as repayment of principal and would not be taxable as income application of step_transaction_doctrine courts have applied alternative tests in deciding whether to invoke the step_transaction_doctrine in a particular transaction one of the tests is the end result test 88_tc_1415 the end result test of the step_transaction_doctrine is a rule_of substance over form that treats a series of formally separate but related steps as a single transaction if the steps are in substance integrated interdependent and focused towards a particular result penrod supra the end result test is based upon the intent of the taxpayer the step_transaction_doctrine allows the service to argue that certain economically meaningless steps of a transaction can be collapsed or ignored thus the issue is whether the step_transaction_doctrine can be applied in this case to eliminate economically meaningless steps of c and possibly b and therefore treat c and possibly b as conduits application of sec_482 the transaction is analyzed as being composed of two legs first there was a sale leaseback_transaction t sale_and_leaseback in which t sold computers to b and leased back the equipment from b the term of this lease t lease was a years with a b month option to renew b then sold the equipment subject_to t’s lease to c a partnership the majority of which was owned by a tax exempt entity c then sold the computers to e and leased back the equipment from e c sale leaseback the term of this lease c lease was c months with a b month option to renew the second leg of the transaction which occurred on november year involves c assigning its rights to the lease payments paid_by t which were assigned to c as a result of the c lease to f for dollar_figurel c recognized the receipt of the dollar_figurel as income on the assignment of its rights to the lease payments of course since c’s majority partner was tax exempt tax was not paid on that portion of the income on december year as part of a sec_351 transaction c then contributed its interest in the c lease ie both its right to use the property for the period following the t lease and the obligation to make lease payments to e to g a subsidiary of t in which t owned all the common_stock in exchange for preferred_stock of g as part of this sec_351 transaction c also transferred the installment note that e gave it in consideration for the sale of the computers the payments g was to receive pursuant to the installment note were exactly equal to the payments it was required to make under the c lease it is not clear whether in the second transaction the rent payments g was obligated to make to m exactly equaled the installment payments on the nonrecourse loan that g was to receive from k this fact needs further development we separately analyze whether sec_482 can be applied to each leg of the transaction sec_482 emphasis added provides the following in any case of two or more organizations trades_or_businesses owned or controlled directly or indirectly by the same interests the secretary may distribute apportion or allocate gross_income deductions between or among such organizations if he determines that such distribution apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations thus in order for sec_482 to apply to a transaction the transaction must be between two or more entities owned or controlled by the same interests as there is no common ownership among the participants to the transaction other than t’s ownership of g and possibly b being affiliated with c the primary question under sec_482 becomes whether any of the participants particularly t g and c are controlled by the same interests the sec_482 regulations define control to include any kind of control direct or indirect whether legally enforceable and however exercisable or exercised sec_1_482-1 1968_1_cb_218 sec_1_482-1t 1993_1_cb_90 sec_1_482-1 1994_2_cb_93 see also 1_bta_624 acq 1925_1_cb_2 c ontrol not arising or flowing from legally enforceable means may be just as effective in evading taxation as if found on the most formal and readily enforceable legal instrument the regulations also state that i t is the reality of control that is decisive rather than a rigid focus on record ownership of the entities at issue id accord 372_f2d_415 4th cir aff’g tcmemo_1966_015 cert_denied 389_us_841 42_tc_114 aff’d 358_f2d_342 6th cir cert_denied 385_us_899 17_tc_231 aff’d 202_f2d_873 5th cir cert_denied 346_us_819 acq in part and nonacq in part 1952_2_cb_2 revrul_65_142 1965_1_cb_223 moreover the regulations provide that a presumption of control arises if income or deductions have been arbitrarily shifted sec_1_482-1 see 598_f2d_1382 5th cir rev’g a f t r 2d ria n d tex holding that based on sec_1_482-1 the service properly argued that proof of income_shifting between two corporations establishes a presumption of common_control accord 294_f2d_82 5th cir aff’g 32_tc_390 acq 1959_2_cb_4 referring to reg sec_29 the and regulations also contain this presumption and add that control may exist as a result of the actions of two or more taxpayers acting in concert with a common goal or purpose sec_1_482-1t sec_1_482-1 the taxable years at issue are year year and year accordingly there are three sets of sec_482 regulations that potentially apply to the years at issue the regulations apply to taxable years beginning on or before date the regulations apply to taxable years beginning after date and the regulations apply to taxable years beginning after date unless an election is made to apply them to all prior open years sec_1_482-1t sec_1_482-1 we are uncertain whether t is a calendar or fiscal_year taxpayer or whether an election to apply the regulations retroactively has been made consequently we will distinguish between the regulations by referring to their year of promulgation in parenthesis when each set of regulations is referred to accord dhl corp v commissioner tcmemo_1998_461 w hen the interests controlling one entity and those controlling another have a common interest in shifting income from the former to the latter entities may be considered commonly controlled in determining whether the control requirement under the regulations is satisfied thus under the regulations joint legal ownership or overlapping ownership is not required for unrelated corporations to come within the purview of sec_482 if income_or_deduction shifting is present or if there is common goal to shift income or deductions 54_tc_912 rev’d in relevant part 453_f2d_1144 2d cir nonacq 1975_2_cb_3 nonacquiescence relates to tax_court opinion only as the second circuit adopted an interpretation of control that is consistent with and sec_482 regulations 5_tc_558 acq c b acq withdrawn and substituted for nonacq revrul_65_142 1965_1_cb_223 nevertheless it is our opinion that sec_482 cannot be applied to the first leg of the transaction the t sale leaseback_transaction since there was no arbitrary shifting_of_income or deductions in the first leg of the transaction the necessary shifting of deductions related_income is not present in the t sale leaseback in that t is enjoying the use of the property while deducting the lease payments the only apparent shifting_of_income is the fact that c the recipient of the lease payments is a partnership the majority partner of which is a tax exempt party therefore we do not believe that sec_482 should be applied to the first leg of the transaction it is our opinion however that the control requirement is met when analyzing the second leg of the transaction through the stripping of income from the leases to c an entity whose majority partner is exempt from u s tax and the reporting of the deductions relating to that income by g see notice_95_53 1995_2_cb_334 t he parties to a stripping transaction are controlled by the same interests because among other factors they act in concert with a common goal of arbitrarily shifting income and deductions between a transferor and a transferee it should be noted that the temporary regulations and the current regulations to the extent they apply to the transactions at issue lend greater support to this conclusion since they refer to parties acting in concert or with a common goal and purpose see sec_1_482-1t a presumption of control arises if income or deductions have been arbitrarily shifted as a result of the actions of two or more taxpayers acting in concert or with a common goal and purpose sec_1_482-1 controlled includes any kind of control including control resulting from the actions of two or more taxpayers acting in concert or with a common goal and purpose if control is found to exist the service may allocate income and deductions among members of the controlled_group sec_1_482-1 sec_1_482-1t sec_1_482-1 a controlled_group or controlled_taxpayer is defined to mean the entities owned or controlled by the same interests and includes the taxpayer that owns or controls other taxpayers sec_1_482-1 sec_1_482-1t sec_1_482-1 unlike the term control the phrase same interests is not defined in the sec_482 regulations case law as well as the legislative_history of sec_482 provide guidance sec_482 was enacted to prevent the artificial shifting_of_income between controlled taxpayers to avoid federal taxes and thereby milk a taxable entity ie placing deductions in one entity and income related to those deductions in another entity 598_f2d_1375 5th cir citing h rept no 70th cong 1st sess c b part s rept no 70th cong 1st sess c b part see also h rept no and s rept no 67th cong 1st sess in using the term same interests congress intended to include more than the same persons or the same individuals brittingham f 2d pincite 366_f2d_890 5th cir aff’g 43_tc_540 cert_denied 386_us_1016 2_bta_229 see also lxi-part cong rec statement of sen king referring to the same forces controlling a number of corporations different persons with a common goal or purpose for artificially shifting income can constitute the same interests for the purposes of the statute south texas rice warehouse co f 2d pincite see also brittingham f 2d pincite citing ach t c pincite the phrase same interests should not be narrowly construed to frustrate the intent of sec_482 appeal of rishell phonograph co b t a pincite if the same interests’ was intended to mean only the same persons ’ it would have been easy for congress by using the latter term to have avoided all ambiguity accord grenada indus inc supra thus it is not necessary that the same person or persons own or control each controlled business before sec_482 can be applied but there must be a common design for the shifting_of_income in order for different entities to constitute the same interests indeed this definition of same interest is identical to the definition of control and the presumption relating thereto in the regulations and case law thus if there is a common design for shifting income or deductions then the requirements for control and same interests will be met see hall t c pincite an arbitrary shifting_of_income coupled with the ability to direct the actions of an entity establishes control for the purposes of sec_482 -- whether or not ownership exists accordingly we believe the requirement that control be held by the same interests was met in the second leg of the transaction the lease_strip since we assume that there was a common design to separate the rental income from the related deductions by having the income recognized by a partnership the majority partner of which was a tax exempt entity and the related deductions recognized by t’s subsidiary g assuming that the threshold requirements of sec_482 ie control by the same interests are met the service may allocate income and deductions among members of the controlled_group generally we have considered applying sec_482 to lease-stripping transactions under three alternative analyses under the first sec_482 analysis the economic_substance of a transaction subject_to sec_482 is analyzed by focusing on the parties’ actual conduct the economic risks purported transferred and whether from a business perspective the transaction makes objective business sense or under the language of some cases would have been entered into by a hard-headed business person see generally sec_1_482-1 sec_1_482-1t sec_1_482-1 where the economic_substance of a transaction is inconsistent with the parties’ purported characterization the service may disregard the contractual terms underlying the transaction and treat the transaction consistent with its economic_substance this treatment may result in a denial of deductions arising from the transaction at issue see eg forman f 2d pincite medieval attractions n v v commissioner tcmemo_1996_455 royalty payments to a related foreign_entity that was not the owner or developer of an intangible were disallowed as deductions the payments had no economic_substance under sec_482 because the foreign_entity was not the creator developer or in substance have the ability to transfer the intangibles the second sec_482 analysis that may be applied to the transactions relates to sec_482's role in nonrecognition transactions such as sec_351 transactions specifically sec_482 may apply in nonrecognition transactions to allocate income and deductions attributable to an entity’s disposition of built-in-loss and gain property which it acquired in a nonrecognition_transaction to the contributing shareholder or partner see sec_1_482-1 sec_1_482-1t sec_1_482-1 811_f2d_543 10th cir aff'g 82_tc_830 643_f2d_747 cl_ct on remand cl_ct aff'd without opinion 732_f2d_168 fed cir 556_f2d_889 8th cir aff'g a f t r 2d d minn national securities corp v commissioner forman v commissioner 453_f2d_1144 2d cir sec_482 may overlap with sec_162 and result in the denial of deductions where the lack of arm’s-length dealings results in payments between parties with a close relationship in an attempt to avoid taxes 137_f2d_600 3rd cir aff’g 46_bta_562 cert_denied 320_us_794 80_tc_34 aff'd in relevant part 756_f2d_1430 9th cir cert_denied 474_us_1055 see also 84_tc_996 aff'd in part rev'd in part 856_f2d_855 7th cir restricting sec_482's application to nonrecognition transactions in cases of tax_avoidance in the lease-stripping context this analysis applies by likening the contribution in a nonrecognition_transaction of the obligation to pay rent after the income has been stripped-off to a contribution of built-in-loss property this is because once the income is stripped off and the obligation to pay rent remains the combined right to receive tax-free rent and the obligation to pay deductible rent will generate a tax loss this is in spite of the fact that the transferee in the nonrecognition_transaction will pay little if any out-of-pocket cash because the tax-free inflows of rent or in this case consideration for the sale of the property will offset the deductible outflows accordingly if a tax_avoidance motive is present which is often the case in lease-stripping transactions it is appropriate to allocate the built- in loss to the tax exempt contributing shareholder and prevent the evasion of taxes by the investor on the facts relating to this leg of the transaction the sale-leaseback transaction between c and e effectively converted future rental payments into an interest- bearing installment note when this note is considered in conjunction with g’s assumption of c’s obligation to pay rent to e the net effect is akin to a contribution of built-in_loss_property by c to g the tax loss was assured by g’s receipt of a section-362 a -transferred basis in the installment note e issued to c thus the repayment of principal by e to g -- which accounted for the vast majority of payments to g -- was a tax-free recovery_of basis while g was able to take substantial tax deductions for the deemed payment of rent to e importantly these deductions were realized without g having to make cash disbursements as the payment streams on the e note and the c lease offset g also apparently accrued a nominal amount of interest_income because there appears to have been a tax-avoidance purpose underlying the sec_351 transaction between g and c the built-in_loss ie the rental deductions may be allocated to c this has the result of allocating the rental deductions of g arising from the e lease to c a pass-through entity substantially_all of whose interests are owned by persons not subject_to the united states’ taxing jurisdiction the third theory under which a lease-stripping transaction may be analyzed relates to the service’s ability to allocate income and deductions in order to clearly reflect income and or prevent the evasion of taxes sec_482 sec_1 b and d sec_1_482-1t sec_1_482-1 specifically lease-stripping transactions are often effected by a creating an artificial separation of the rental income from the associated deductions by accelerating the rental income in the hands of an entity not subject_to the unites states’ taxing jurisdiction and b by placing the deductions associated with the rental income in an entity subject_to united_states tax see notice_95_53 in such an instance the service may prevent this artificial shifting_of_income and deductions by a allocating the rental deductions from u s taxpayer to the tax-exempt_entity or b allocating the rental income from tax-exempt_entity to the u s taxpayer see eg 372_f2d_415 4th cir aff’g tcmemo_1966_015 cert_denied 389_us_841 361_f2d_607 4th cir aff’g sub nom 240_fsupp_378 e d n c 305_f2d_681 9th cir 198_f2d_214 2n cir rev’g 16_tc_882 cert_denied 344_us_874 196_f2d_1006 2d cir cert_denied 344_us_835 such an allocation would match the income and the deductions associated with the income and thereby constitute a clearer reflection of income than that which is represented by a lease- stripping transaction concomitantly in the lease-stripping context the evasion of taxes is prevented application of this sec_482 analysis to the g - c sec_351 transaction could result in an allocation from g to c of the income and deductions attributable to the items c contributed to g ie the e note and the c lease obligations in this manner the second theory under which sec_482 may be applied to lease- stripping transactions sec_482's role in nonrecognition transactions is similar to the third theory the clear_reflection_of_income and tax_evasion standards where the rental deductions are allocated to c case development hazards and other considerations please call if you have any further questions deborah a butler by william c sabin jr senior technician reviewer passthroughs and special industries branch field service division


internal_revenue_service number release date index number ----------------------------- ------------------------------------------- --------------------- ------------------------------- department of the treasury washington dc third party communication date of communication month dd yyyy person to contact ---------------------- id no ----------- telephone number -------------------- refer reply to cc psi b06 plr-128569-14 date date legend taxpayer parent corp a corp b corp c corp d corp e state facility power plant location date date a a b c d e process process a process b ---------------------------------------------- ---------------------------------------------------------- ---------------------- --------------------------------------------------------------- ------------------ -------------------------------------------- --------------------------------------------------------- ------------------------------- ------------ ---------------------------------------- --------------------------------- ----------------------- --------------------- -------------------------- ----------------------------------- --- --- --- --- ----- ----------- -------------- -------------- plr-128569-14 dear ------------- this is in response to your request submitted by your authorized representative on date to supplement ruling plr-141119-11 dated date concerning the federal_income_tax consequences of the transaction described below facts taxpayer information taxpayer is a state limited_liability_company that is a wholly owned subsidiary of corp a taxpayer was formed to lease and operate two facilities including the facility because taxpayer has not elected to be classified as an association_taxable_as_a_corporation for federal_income_tax purposes it is disregarded as an entity separate from corp a for such purposes corp a a state corporation is wholly owned by parent a state corporation that is the common parent of a consolidated_group of companies whose members include corp a parent uses the accrual_method of accounting and has adopted the calendar_year as its annual_accounting_period the refined_coal production process taxpayer has entered into an agreement to lease the facility from corp b for a term ending on date corp b is owned by corp c the facility was designed and constructed by corp c to produce a refined_coal product that reduces emissions of nitrous oxide nox and mercury hg when burned as fuel in a coal-fired power plant the facility was placed_in_service in date and it is currently located at the power plant located in location on land owned by corp d the power plant is a coal-fired and steam-producing power plant in regular commercial operation taxpayer has entered into a contract with corp d for the sale of refined_coal produced by the facility to corp d for use as feedstock in the power plant the facility can be moved and reassembled at other power plant locations the process the technology employed to produce refined_coal in the facility is known as the process a proprietary process which is designed to reduce nox and hg emissions in cyclone coal-fired boilers the rights to the technology are licensed by corp e to corp c and have been sublicensed from corp c to taxpayer for the full term of the lease of the facility from corp b plr-128569-14 the process involves the use of two separate inorganic chemicals chemical reagents which are applied to feedstock consisting of percent e coal the first chemical reagent referred to as process a is a solid material that mixes evenly with coal’s native ash in power plant boilers and affects the melting properties of coal’s native ash during combustion in power plant boilers this allows adjustment of the air- fuel ratio in the boiler which reduces oxygen in the boiler and provides more favorable conditions for reduction of nox emissions the second chemical reagent referred to as process b is an inorganic liquid solution which reacts with the mercury in coal resulting in changes to the chemical form of the mercury oxidizing more of it as a result more of the mercury is captured with the fly-ash in the particulate control equipment resulting in a higher degree of removal the facility’s equipment transports the chemical reagents to a coal conveyor belt where they are applied evenly to the coal feedstock the chemical reagents are combined with the coal at a rate proportional to the coal flow rate the application of each chemical reagent is controlled separately by computer equipment which determines the rate of application based on the flow rate of the coal on the conveyor belt the minimum proportion of each chemical reagent to be applied per ton of feedstock coal is set based on previously verified emissions test results the amount of each chemical reagent applied per ton of feedstock coal may be increased above but will not be decreased below the per-ton amounts used to produce the refined_coal used in the most recent emissions testing cems field testing on date corp c conducted full-scale emissions tests using continuous emission monitoring cems field testing at the power plant using a coal feedstock and refined_coal produced in the facility from the a coal since the date emissions tests taxpayer has conducted periodic emissions tests using cems field testing at the power plant using refined_coal produced in the facility from a coal the emissions tests were conducted in the following manner to establish a baseline for nox and mercury emissions one unit of the power plant was operated for a three-hour period at or above a of full load using a coal feedstock the same power plant unit was operated for a second three-hour period under the same operating conditions except for adjustments to primary or secondary air in accordance with good air pollution control practices using refined_coal produced in the facility using the process from a coal feedstock and the chemical reagents applied at a predetermined proportion during both the baseline tests and the tests using refined_coal nox and mercury emissions were measured using cems equipment that conforms to applicable united_states epa standards the nox cems device was located upstream of the post- plr-128569-14 combustion nox emission controls the mercury cems device is located in the stack downstream of hg and nox emission controls each cems field test indicated that burning refined_coal produced using the process in the boilers at the power plant results in a reduction of nox emissions in excess of b and a reduction of mercury emissions in excess of c excluding dilution caused by materials combined or added during the production process when compared to emissions resulting from burning prb coal feedstock to produce the same amount of useful thermal energy the emission reductions demonstrated in each cems field test have been verified by an independent in combustion and environmental engineering as required by notice_2010_54 2010_40_irb_403 notice including verification that any post-combustion hg controls were operated under the same conditions throughout the test period licensed professional engineer experienced additional emissions testing taxpayer will conduct additional emissions tests on or before the first to occur of i a change in the process used to produce refined_coal at the facility ii a change in the source or rank of the feedstock coal used to produce refined_coal or iii the expiration of six months since the most recent redetermination test if additional testing is conducted due to a change in the process taxpayer will conduct a cems field test or other test permitted by section dollar_figure of the notice taxpayer anticipates that where there has been no change in the process it will ordinarily conduct redetermination testing using laboratory analysis establishing that the sulfur and mercury content of both the feedstock coal and the refined_coal on average do not vary by more than percent below the bottom nor by more than percent above the top of the range of the sulfur content and range of the mercury content of the feedstock coal and refined_coal used in the most recent section dollar_figure test period taxpayer plans to use the following protocol to collect samples for laboratory analysis during the cems field test taxpayer will collect coal samples from the moving conveyor belt during the period that refined_coal for the cems test is being fed to the coal bunkers in the power plant and will collect refined_coal samples from the moving conveyor belt during the same period a minimum of d samples will be collected taxpayer will submit the samples to an independent laboratory which will conduct a separate analysis of the sulfur and hg content of each sample using standard laboratory techniques this analysis will establish a range of sulfur content and hg content for the coal and refined_coal burned during the cems field test during each six-month redetermination period samples of both feedstock coal and refined_coal will be collected on a regular basis from a moving conveyor belt both before and after the facility using this protocol it is expected that during normal operation of the facility at least e samples of feedstock coal and at least e samples of plr-128569-14 refined_coal will be collected each day after a specified number of samples of feedstock coal and refined_coal have been collected those samples will be sent to an independent laboratory which will combine each set of samples into a single gross sample for preparation and analysis of sulfur and hg content the testing results for sulfur and hg content for the gross samples of feedstock coal and refined_coal respectively collected during the six-month redetermination period will then be averaged the average sulfur and mercury content of the coal and refined_coal will be acceptable if it does not vary by more than percent below the bottom nor by more than percent above the top of the range of sulfur and hg content of the samples taken during the cems test period ruling requested based on the foregoing taxpayer has requested that we that the redetermination requirement of section dollar_figure of the notice may be satisfied by laboratory analysis establishing that the sulfur and mercury content of both the feedstock coal and the refined_coal on average do not vary by more than percent below the bottom or by more than percent above the top of the range of the sulfur content and the range of mercury content of the feedstock coal and the refined_coal used in the most recent test conducted in accordance with section dollar_figure of the notice law and analysis sec_45 of the code generally provides a credit against federal_income_tax for_the_use_of renewable or alternative resources to produce electricity or fuel for the generation of steam sec_45 provides that in the case of a producer of refined_coal the credit available under sec_45 for any taxable_year shall be increased by an amount equal to dollar_figure5 per ton of qualified refined_coal i produced_by_the_taxpayer at a refined_coal_production_facility during the 10-year period beginning on the date that the facility was originally placed_in_service and which is ii sold by the taxpayer to an unrelated_person during such 10-year period and such taxable_year for purposes of sec_45 section dollar_figure of the notice provides that the term refined_coal means a fuel which - i is a liquid gaseous or solid fuel including feedstock coal mixed with an additive or additives produced from coal including lignite or high carbon fly ash including such fuel used as a feedstock ii is sold by the taxpayer with the reasonable expectation that it will be used for the purpose of producing steam and iii is certified by the taxpayer as resulting when used in the production of steam in a qualified_emission_reduction sec_45 and section dollar_figure of the notice provide that the term qualified_emission_reduction means in the case of refined_coal produced at a facility placed_in_service after date a reduction of at least twenty percent of the emissions of nitrogen oxide and at least forty percent of the emissions of either sulfur dioxide so2 or hg released when burning the refined_coal excluding any dilution caused by materials combined or added during the production process as compared to the emissions released when burning the plr-128569-14 feedstock coal or comparable coal predominantly available in the marketplace as of date and in the case of production at a facility placed_in_service before date a reduction of at least percent of the emissions of nox and at least percent of the emissions of either so2 or hg released when burning the refined_coal excluding any dilution caused by materials combined or added during the production process as compared to the emissions released when burning the feedstock coal or comparable coal predominantly available in the marketplace as of date sec_45 generally provides that the term refined_coal_production_facility means a facility which is placed_in_service after date and before date section dollar_figure of the notice provides that the refined_coal credit is allowed for qualified refined_coal produced and sold to an unrelated_person by the taxpayer without regard to whether the taxpayer owns the refined_coal_production_facility in which the refined_coal is produced accordingly a taxpayer that leases or operates a facility owned by another person may claim the credit for refined_coal that the taxpayer produces in the facility section dollar_figure of the notice provides that a refined_coal_production_facility will not be considered to have been placed_in_service after date if more than percent of the total fair_market_value of the facility the cost of the new property plus the value of the used_property is attributable to property that was placed_in_service on or before date section dollar_figure of the notice generally provides that a qualified emissions reduction does not include any reduction attributable to mining processes or processes that would be treated as mining as defined in sec_613 a c or i if performed by the mine owner or operator accordingly in determining whether a qualified_emission_reduction has been achieved the emissions released when burning the refined_coal must be compared to the emissions that would be released when burning the feedstock coal feedstock coal is the product resulting from processes that are treated as mining and are actually applied by a taxpayer in any part of the taxpayer’s process of producing refined_coal from coal sec_613 describes treatment processes that are not considered as mining unless they are provided for in sec_613 or any necessary or incidental to a process provided for in sec_613 any cleaning process such as a process that uses ash separation dewatering scrubbing through a centrifugal pump spiral concentration gravity concentration flotation application of liquid hydrocarbons or alcohol to the surface of the fuel particles or to feed slurry provided such cleaning does not change the physical or chemical structure of the coal and drying to remove free water provided such drying does not change the physical or chemical identity of the coal will be considered as mining plr-128569-14 section of the notice provides in part that emissions reduction may be determined using continuous emission monitoring system cems field testing section a provides in part that cems field testing is testing that meets all the following requirements i the boiler used to conduct the test is coal-fired and steam-producing and is of a size and type commonly used in commercial operations ii emissions are measured using a cems iii if epa has promulgated a performance standard that applies at the time of the test to the pollutant emission being measured the cems must conform to that standard iv emissions for both the feedstock coal and the refined_coal are measured at the same operating conditions and over a period of at least hours during which the boiler is operating at a steady state at least percent of full load v a qualified_individual verifies the test results in a manner that satisfies the requirements of section b section of the notice provides that methods other than cems field testing may be used to determine the emissions reduction if a method other than cems field testing is used the service may require the taxpayer to provide additional proof that the emission reduction has been achieved the permissible methods include a testing using a demonstration pilot-scale combustion furnace if it established that the method accurately measures the emission reduction that would be achieved in a boiler described in section a a i and a qualified_individual verifies the test results in a manner that satisfies the requirements of sections c i ii v and vi of the notice and b a laboratory analysis of the feedstock coal and the refined_coal that complies with a currently applicable epa or astm standard and is permitted under section b i or ii of the notice section of the notice provides that a taxpayer may establish that a qualified_emission_reduction determined under section dollar_figure applies to production from a facility by a determination or redetermination that is valid at the time the production occurs a determination or redetermination is valid for the period beginning on the date of the determination or redetermination and ending with the occurrence of the earliest of the following events i the lapse of six months from the date of such determination or redetermination ii a change in the source or rank of feedstock coal that occurs after the date of such determination or iii a change in the process of producing refined_coal from the feedstock coal that occurs after the date of such determination or redetermination section of the notice provides that in the case of a redetermination required because of a change in the process of producing refined_coal from the feedstock coal the redetermination required under section dollar_figure must use a method that meets the requirements of section in any other case the redetermination requirement may be satisfied by laboratory analysis establishing that - a the sulfur s or mercury hg content of the amount of refined_coal necessary to produce an amount of useful energy has been reduced by at least percent percent in the case of facilities placed_in_service after date in comparison to the s or hg plr-128569-14 content of the amount of feedstock coal necessary to produce the same amount of useful energy excluding any dilution caused by materials combined or added during the production process or b the s or hg content of both the feedstock coal and the refined_coal do not vary by more than percent from the s and hg content of the feedstock coal and refined_coal used in the most recent determination that meets the requirements of section dollar_figure of the notice section dollar_figure of the notice provides that the certification requirement of sec_3 c is satisfied with respect to fuel for which the refined_coal credit is claimed only if the taxpayer attached to its tax_return on which the credit is claimed a certification that contains the following a statement that the fuel will result in a qualified emissions reduction when used in the production of steam a statement indicating whether cems field testing was used to determine the emissions reduction if cems field testing was not used to determine the emissions reduction a description of the method used a statement that the emissions reduction was determined or redetermined within the six months preceding the production of the fuel and that there have been no changes in the source or rank of feedstock coal used or in the process of producing refined_coal from the feedstock coal since the emissions reduction was determined or was most recently determined and a declaration signed by the taxpayer in the following form under penalties of perjury i declare that i have examined this certification and to the best of my knowledge and belief it is true correct and complete section of the notice provides in part that in the case of a redetermination required because of a change in the process of producing refined_coal from the feedstock coal the redetermination required under section dollar_figure must use a method that meets the requirements of section in any other case the redetermination requirement may be satisfied by laboratory analysis establishing that the sulfur and mercury content of both the feedstock coal and the refined_coal do not vary by more than percent from the sulfur and mercury content of the feedstock coal and refined_coal used in the most recent redetermination that meets the requirements of the notice accordingly we conclude the redetermination requirement of section dollar_figure of the notice may be satisfied by laboratory analysis establishing that the sulfur and mercury content of both the feedstock coal and the refined_coal on average do not vary by more than percent below the bottom of nor more than ten percent above the top of the range of the sulfur and mercury content of the feedstock coal and refined_coal used in the most recent determination test that meets the requirements of section dollar_figure of the notice plr-128569-14 this ruling expresses no opinion regarding any issue not specifically addressed in this ruling letter including whether any person has sold refined_coal to an unrelated_person or when the facility was placed_in_service in particular we express or imply no opinion that taxpayer has sufficient risk or rewards of the production activity to qualify as the producer of the refined_coal the service may challenge an attempt to transfer the credit to a taxpayer who does not qualify as a producer including transfers structured as partnerships sales or leases that do not also transfer sufficient risks and rewards of the production activity in accordance with the power_of_attorney on file with this office we are sending a copy of this letter to your authorized representative a copy of this ruling must be attached to any income_tax return to which it is relevant alternatively taxpayers filing their returns electronically may satisfy this requirement by attaching a statement to their return that provides the date and control number of the letter_ruling this ruling is directed only to the taxpayer who requested it sec_6110 of the code provides it may not be used or cited as precedent we are sending a copy of this letter_ruling to the industry director sincerely peter c friedman senior technician reviewer branch office of associate chief_counsel passthroughs special industries cc


t c memo united_states tax_court david and amy s martin petitioners v commissioner of internal revenue respondent david martin inc petitioner v commissioner of internal revenue respondent docket nos filed date david and amy s martin pro_se david k martin an officer for petitioner in docket no caroline r krivacka for respondent memorandum findings_of_fact and opinion dawson judge in these consolidated cases respondent determined that petitioners david and amy martin the martins are liable for a dollar_figure deficiency in federal_income_tax for and that petitioner david martin inc the corporation is liable for a dollar_figure deficiency in federal_income_tax for its taxable_year ending date the issues to be decided are whether david martin mr martin an officer of the corporation who performs services for the corporation is an employee of the corporation whether mr martin is entitled to additional deductions for employee business_expenses and whether additional employment_taxes accrued to the corporation pursuant to sec_461 and are deductible by the corporation during the taxable_year in which the wages giving rise to the employment_taxes were paid to mr martin findings_of_fact some of the facts have been stipulated and are so found the stipulation of facts and the exhibits attached thereto are incorporated herein by this reference when the petitions in these cases were filed the martins resided in tennessee and the corporation’s principal_place_of_business was in tennessee mr martin is the president and sole shareholder of the corporation 1unless otherwise indicated all section references are to the internal_revenue_code code in effect for taxable years at issue mr martin is a real_estate agent who works for re max preferred properties re max re max pays mr martin a commission on completed sales before mr martin reported his commission income and expenses on schedule c profit or loss from business james clark mr clark is a tax_return_preparer in knoxville tennessee he is not an attorney an accountant or an enrolled_agent authorized to represent taxpayers before the internal_revenue_service irs he is not admitted to practice before the tax_court mr clark has been a tax_return_preparer since and has prepared petitioners’ individual and corporate_income_tax returns since or before starting his business as a return preparer mr clark had been employed by the irs for years primarily matching forms w-2 wage and tax statement and with individual returns he prepares returns for approximately corporate clients and prepares approximately returns for individual clients every year mr clark advised mr martin to conduct his business through a corporation mr clark thought that a c_corporation if he mr martin is accumulating equity pays taxes pincite cents on the dollar it doesn’t have a self-employment_tax obligation a sole_proprietorship has both income_tax obligation and self- employment_tax obligations mr martin did not consult an attorney or anyone other than mr clark regarding the advisability or consequences of conducting his business through a c_corporation mr clark set up the corporation and its accounts for mr martin the corporation conducts no business apart from mr martin’s real_estate activity with re max mr martin deposits his commission checks into the corporation’s bank account the corporation pays a large portion of mr martin’s business_expenses and many of the martins’ personal expenses mr martin keeps the records for the corporation he gives all his records to mr clark for preparation of petitioners’ returns mr clark did not treat mr martin as an employee of the corporation he did not prepare or file any employment_tax returns for the corporation for any taxable quarter he explained that licensed real_estate companies treat their brokers and agents as independent contractors rather than employees because the companies do not usually pay their brokers and agents a set weekly or monthly amount--real estate brokers may earn commissions for four sales in one month and none for or months the martins’ returns for and the corporation’s returns for taxable years ending date and were selected for audit mr clark represented the martins during the audit of petitioners’ returns and provided petitioners’ receipts and canceled checks to the examination officer mr clark took the position that re max should have issued the forms to the corporation rather than to mr martin the examination officer determined that mr martin was an employee of the corporation and that the corporation was liable for employment_taxes the corporation appealed the examination officer’s determination regarding the employment_taxes to respondent’s appeals_office and had not paid the employment_taxes as of the time of the trial respondent issued the corporation and the martins separate notices of deficiency treating the corporation’s payment of mr martin’s business_expenses and the martins’ personal expenses as mr martin’s wages petitioners timely filed petitions in this court challenging the deficiencies mr clark drafted the substantially identical petitions filed by the martins in their case and the corporation in its case opinion a the martins’ position the petition mr clark drafted and filed in the martins’ case alleges 2where the commissioner seeks to reclassify an individual as an employee for purposes of imposing employment_taxes on the employer under subtit c of the code he may issue the employer a notice_of_determination concerning worker classification sec_7436 an employer who receives such notice_of_determination may petition this court for review of the employee classification as well as the proper amount of employment_tax owing as a result of classifying the worker as an employee sec_7436 and b in irs audited david and amy martin and their corporation david martin inc for and on irs issued a letter proposing changes to david martin inc ’ sec_941 and obligations including periods in and as an adjustment to payroll tax obligations that document falls outside the u s tax court’s jurisdiction on date irs issued a notice_of_deficiency to david amy martin cursory examination suggests that the proposed changes to david martin inc ’s payroll tax obligations also affect david and amy martin’s federal tax obligations the notice_of_deficiency does not reflect the adjustment caused by the payroll tax adjustments david and amy martin ask that the court require that the irs reconcile the discrepancies between its contradictory positions and require that irs make david and amy martin whole in all tax periods if irs claims the increased payroll and attendant tax obligation then it should make appropriate adjustments to david and amy martin’s income and expenses in all periods in their pretrial memorandum the martins assert that respondent was incorrect in determining that mr martin was an employee of the corporation and that many of the disbursements respondent considers wages are deductible expense reimbursements deductible basis in capital_transactions or otherwise deductible items b the corporation’s position the petition mr clark drafted and filed in the corporation’s case is substantially identical to that filed in the martins’ case except that it also asserts that the irs should also account for the appropriate accruals of payroll tax_liability in its pretrial memorandum the corporation asserts that respondent’s reclassification of mr martin as its employee subjects it to liability for payroll_taxes for both the employer’s and employee’s portions and if irs wishes to accrue payroll liability to david martin inc for the periods in question it must also accrue the accompanying payroll tax expense to david martin inc proper inclusion will correctly eliminate any corporate tax obligation to the petitioner and support irs’ claim for increased payroll_taxes in the u s court of federal claims except for the corporation’s claim that it is entitled to deduct the payroll_taxes the examination officer determined it was obligated to pay the martins and the corporation have not identified specified an amount of or provided any substantiation for any additional deductions to which they might be entitled for the years at issue neither petitioners nor respondent have taken the position that mr martin was an independent_contractor or employee of re max or that all income paid_by re max is his and not the corporation’s cf 104_tc_140 c jurisdiction to decide mr martin’s employee classification petitioners each received a notice_of_deficiency and they invoked our jurisdiction by filing petitions for redetermination of a deficiency under sec_6213 sec_6214 grants us jurisdiction to redetermine the correct amount of a deficiency and to determine whether any additional_amounts or any additions to tax should be assessed pursuant to sec_7436 the tax_court has jurisdiction to review certain determinations made by the commissioner regarding worker classification and the proper amount of employment_tax under such determinations 121_tc_89 affd 425_f3d_1203 9th cir 117_tc_263 however our jurisdiction under sec_7436 depends upon and arises only after a determination of worker classification by the secretary charlotte’s office 3pursuant to sec_6512 the tax_court has jurisdiction to determine the amount of an overpayment_of_tax our jurisdiction to determine whether there has been an overpayment is limited to the same taxable_year or years for which the commissioner has issued a notice_of_deficiency and with regard to which the taxpayer has timely filed a petition for redetermination of the deficiency id in addition our overpayment jurisdiction is limited to determining an overpayment of income gift estate or excise_taxes and related interest imposed by ch or sec_6512 and if we have determined that there is no deficiency but that the taxpayer has made an overpayment_of_tax or that there is a deficiency but the taxpayer has made an overpayment of the tax we have jurisdiction to determine the amount of the overpayment and order a refund of the overpayment or to credit the overpayment against the deficiency if the requirements of sec_6512 are satisfied sec_6512 and 4before the enactment of sec_7436 judicial review of an assessment of employment_taxes or related penalties was available only if a taxpayer paid a divisible part of the assessment filed a claim_for_refund and filed a refund_suit in a federal district_court or the court of federal claims to recover amounts paid see sec_7422 u s c sec_1346 and sec_1491 boutique inc v commissioner supra pincite respondent has not made such a determination and therefore we do not have original jurisdiction under sec_7436 over petitioners’ claims that mr martin was not an employee of the corporation for employment_tax purposes however in a deficiency proceeding such as this where the existence and amount of the deficiency depends on whether the taxpayer is classified as an employee or an independent_contractor we have jurisdiction to decide the proper status see eg 49_f3d_713 11th cir tax_court properly held taxpayers were independent contractors rather than employees of insurance_company affg tcmemo_1993_478 and smithwick v commissioner tcmemo_1993_582 123_tc_219 taxpayer was self-employed under sec_3121 when he worked as a captain or crew member of the fishing boats affd 137_fedappx_373 1st cir weber v commissioner 103_tc_378 minister was employee not an independent_contractor and his business_expenses were not properly reported on schedule c but were allowable as miscellaneous_itemized_deductions on schedule a itemized_deductions subject_to the 2-percent floor affd 60_f3d_1104 4th cir similarly where the existence and amount of an employer- taxpayer’s deficiency depends on the taxpayer’s deduction for employment_taxes this court has jurisdiction to decide whether the employer is entitled to a deduction and if so the amount of the deduction d mr martin’s employment status sec_3111 and sec_3301 impose fica social_security and futa unemployment taxes on employers for wages paid to their employees for federal employment_tax purposes sec_3121 defines an employee in part as any officer of a corporation however there is an exception to employee status for an officer who does not perform any services or performs only minor services and who neither receives nor is entitled to receive remuneration sec_31_3121_d_-1 employment_tax regs for federal employment_tax purposes the term wages is defined as all remuneration for employment sec_3121 sec_3306 the form of payment is immaterial the only relevant factor being whether the payments were actually received as compensation_for employment sec_31_3121_a_-1 sec_31_3306_b_-1 employment_tax regs consequently an officer who performs substantial services for a corporation and who receives remuneration in any form for those services is considered an employee whose wages are subject_to federal employment_taxes veterinary surgical consultants p c v commissioner 1l7 t c affd sub nom 54_fedappx_100 3d cir mr martin is an officer of the corporation and therefore he is an employee of the corporation under the general_rule of sec_3121 additionally mr martin performed substantial services for the corporation indeed he was the only individual working for the corporation and the corporation’s income was generated from the real_estate sales services mr martin provided therefore we hold that mr martin was an employee of the corporation e additional deductions mr martin testified that he kept business records and receipts which he presented to the examination officer during the audit he asserted that some of the expenses the corporation paid that respondent treated as his wages were in fact expenses of the corporation mr martin alluded to a cashier’s check paid to a title company but did not state the amount of the check or provide any facts regarding the transaction except for the payroll_taxes the examination officer determined the corporation was obligated to pay the martins and the corporation have not identified specified an amount or provided any substantiation for any additional deductions to which they might be entitled for the years at issue except for the corporation’s assertion that it is entitled to an additional deduction for the payroll_taxes petitioners have failed to identify or substantiate any errors in the deficiencies respondent determined in the notices of deficiency a contested tax_liability is not deductible because it has not accrued 320_us_516 119_tc_8 affd 376_f3d_1015 9th cir 73_tc_71 sec_1_461-2 income_tax regs defines a contest as a contest arises when there is a bona_fide dispute as to the proper evaluation of the law or the facts necessary to determine the existence or correctness of the amount of an asserted_liability it is not necessary to institute suit in a court of law in order to contest an asserted_liability an affirmative act denying the validity or accuracy or both of an asserted_liability to the person who is asserting such liability such as including a written protest with payment of the asserted_liability is sufficient to commence a contest thus lodging a protest in accordance with local law is sufficient to contest an asserted_liability for taxes thus the employment_tax disputed by the corporation is a contested tax see dixie pine prods co v commissioner supra doug-long inc v commissioner supra pincite citing 5_tc_150 a liability is not fixed if a taxpayer disputes such liability sec_461 provides that under specified circumstances not applicable in this case a contested liability can be deducted unless an accrual_method taxpayer satisfies the conditions of sec_461 he generally may not claim a deduction for a contested tax_liability before the year the contest is ended by compromise or settlement or through a final disposition wadsworth v commissioner tcmemo_2008_171 the corporation has contested the employment_taxes therefore they did not accrue in the year the wages were paid to mr martin and the corporation may not deduct them for its tax_year here in issue sec_461 provides sec_461 contested_liabilities --if-- the taxpayer contests an asserted_liability the taxpayer transfers money or other_property to provide for the satisfaction of the asserted_liability the contest with respect to the asserted_liability exists after the time of the transfer and but for the fact that the asserted_liability is contested a deduction would be allowed for the taxable_year of the transfer or for an earlier taxable_year determined after application of subsection h then the deduction shall be allowed for the taxable_year of the transfer this subsection shall not apply in respect of the deduction for income_war_profits_and_excess_profits_taxes imposed by the authority of any foreign_country or possession_of_the_united_states f reliance on advice of return preparer petitioners relied on mr clark in reporting their income expenses and taxes on their federal_income_tax returns when respondent’s counsel asked mr martin whether he blindly followed mr clark’s advice without understanding the ramifications mr martin responded well the way that i looked at it is you know it’s kind of like a doctor or a physician you know i certainly don’t go to the doctor and tell him what i’m going to do i certainly heed his advice if i have confidence in him or her you know because that’s what they do--that’s their profession and i have a great physician and i do exactly everything that she tells me to do because my health is important to me i met mr clark years ago he was somebody that i felt like i trusted somebody that i felt like i could have confidence in and even after today no matter what happens here today unless something dramatically changes if he gives me advice that i feel is good advice i’m going to take his advice in that venture because that’s out of my area that’s out of my league and my dad kind of taught me if you don’t know anything about it then don’t do it just stay with what you know so-- unfortunately mr martin’s confidence in mr clark appears to have been misplaced mr clark testified that he is not an attorney an accountant or an enrolled_agent his 6-year employment with the irs primarily matching forms w-2 and with the individuals’ returns does not necessarily qualify him to prepare tax returns let alone advise clients regarding business planning business accounting or various complicated problems involving federal taxation mr clark testified that he advised mr martin to incorporate his real_estate sales business actually set up the corporation set up the bookkeeping procedures and prepared the corporation’s and the martins’ federal_income_tax returns he knew that mr martin was an officer of the corporation who provided substantial services for the corporation re max clearly considered mr martin to be its agent entitled to commissions on his sales and issued annual forms to him mr clark knew this and yet he advised mr martin to deposit the commission checks into the corporation’s bank account and to treat the income as income of the corporation cf 104_tc_140 he knew that the corporation paid mr martin’s business_expenses as well as some of the martins’ personal expenses he apparently did not report any of those payments as either wages reportable on form_w-2 or commissions reportable on form_1099 he did not know that an officer of a corporation who performs services for the corporation is an employee of the corporation for employment_tax purposes mr martin obtained no tax_benefit by incorporating his business instead of mr martin’s paying self-employment_tax on his commission income and claiming a deduction for half the tax the corporation pays and deducts the employer’s portion half of the employment_taxes the other half is withheld from mr martin’s wages and he does not get a tax deduction for his portion of the taxes additionally when mr clark set up the recordkeeping procedures he did not create an accountable_plan for reimbursement of mr martin’s employee_expenses or advise mr martin to do so consequently the corporation’s payment of those expenses is included in computing mr martin’s wages and he must deduct them on schedule a subject_to the 2-percent floor rather than schedule c during the audit mr clark advised mr martin to appeal the issue of mr martin’s status as an employee to respondent’s appeals_office thereby precluding the corporation from deducting the employment_taxes in the year the wages were paid mr clark prepared the unusually obscure petitions filed in these cases during the trial mr martin relied almost entirely on mr clark’s testimony to explain petitioners’ positions in their cases that testimony for the most part is void of relevant content we note that other corporate and individual clients of mr clark similarly relied on him in presenting their cases to the court during the same trial session as these cases see eg rosemann v commissioner tcmemo_2009_185 rosser v commissioner docket no rosser enters inc v commissioner docket no g conclusion mr martin is an employee of the corporation and the payments made to him are wages the corporation may not deduct the employment_taxes until the contest has been resolved and petitioners have failed to identify or substantiate any deductions not allowed by respondent to reflect the foregoing decisions will be entered for respondent