superior trading llc jetstream business limited tax_matters_partner et al petitioners v commissioner of internal revenue respondent filed date docket nos r denied losses claimed by ps tax matters or other partici- pating partners on behalf of purported partnerships relating to distressed consumer receivables acquired from a brazilian retailer in bankruptcy reorganization r adjusted partnership items attributing a zero basis to the receivables in lieu of the claimed carryover_basis in the full face_amount of the receiv- ables r determined accuracy-related_penalties under sec_6662 i r c for gross_valuation_misstatements of inside bases held ps failed to establish that the distressed con- sumer receivables had any_tax basis upon transfer from the brazilian company held further the purported contribution of the receivables by the brazilian company to a nominal part- nership and the subsequent redemption of the brazilian com- cases of the following petitioners are consolidated herewith nero trading llc jet- stream business limited tax_matters_partner docket no pawn trading llc jetstream business limited tax_matters_partner docket no howa trading llc jetstream business limited tax_matters_partner docket no queen trad- ing llc jetstream business limited tax_matters_partner docket no rook trading llc jetstream business limited tax_matters_partner docket no galba trading llc jetstream business limited tax_matters_partner docket no tiberius trading llc jetstream business limited tax_matters_partner docket no tiffany trading llc walnut fund llc tax_matters_partner docket no blue ash trad- ing llc jetstream business limited tax_matters_partner docket no lyons trading llc jetstream business limited tax_matters_partner docket no lonsway trading llc bengley fund llc tax_matters_partner docket no ster- ling trading llc jetstream business limited tax_matters_partner docket no good karma trading llc jetstream business limited tax_matters_partner docket no and warwick trading llc jetstream business limited a partner other than the tax_matters_partner docket no verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner pany’s partnership_interest are properly treated as a single transaction and recharacterized as a sale of the receivables held further ps did not substantiate the amount_paid for the receivables and therefore the receivables have a zero basis for federal tax purposes following their transfer held further ps were unable to demonstrate good_faith and reasonable_cause and therefore the accuracy-related_penalties are sus- tained paul j kozacky john n rapp jeffrey g brooks john a cochran and ralph minto jr for petitioners lawrence c letkewicz and laurie a nasky respondent for wherry judge each of these consolidated cases con- stitutes a partnership-level proceeding under the unified_audit and litigation provisions of the tax equity and fiscal responsibility act of publaw_97_248 96_stat_648 commonly referred to as tefra the issues for decision are whether a bona_fide partnership was formed for federal tax purposes between a brazilian retailer and a british virgin islands company for purposes of servicing and collecting distressed consumer receivables owed to the retailer whether this brazilian retailer made a valid con- tribution of the consumer receivables to the purported part- nership under sec_721 whether these receivables should receive carryover_basis treatment under sec_723 whether the brazilian retailer’s claimed contribution and subsequent redemption from the purported partnership should be collapsed into a single transaction and recharacter- ized as a sale of the receivables and whether the sec_6662 accuracy-related_penalties apply background the alphabet soup of tax-motivated structured transactions has acquired yet another flavor- dad dad is an acronym for distressed asset debt the essential transaction at the core of these consolidated partnership-level proceedings see the commissioner’s distressed asset debt tax_shelters coordi- nated issue paper lmsb-04-0407-031 date it unless otherwise indicated all section references are to the internal_revenue_code_of_1986 as amended and in effect for the years at issue and all rule references are to the tax_court rules_of_practice and procedure verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports seems only fitting that after devoting countless hours in the last decade to adjudicating son-of-boss transactions we have now progressed to deciding the fate of dad deals and true to the poet’s sentiment that the child is father of the man the dad deal seems to be considerably more attenuated in its scope and far less brazen in its reach than the son-of-boss transaction a son-of-boss transaction seeks to exploit the narrow defi- nition of a partnership_liability under sec_752 to conjure up a tax loss for a detailed description of the contours of a prototypical son-of-boss transaction see 128_tc_192 in a nutshell the son- of-boss stratagem pairs a contingent_liability that evades the reach of sec_752 with an asset and contemplates a con- tribution of the liability-ridden asset to a purported partner- ship the euphemistically termed taxpayer then claims an artificially inflated basis as a consequence of the contribu- tion upon subsequently unwinding the contribution and set- tling the matching liability the alleged partner contends that he has suffered a loss recognizable for tax purposes see id by contrast a dad deal is more subtle instead of a claimed permanent tax loss manufactured out of whole cloth a dad deal synthesizes an evanescent one the loss is pro- claimed under authority of sec_723 and sec_704 from an alleged contribution of a built-in_loss asset by a tax indif- ferent party to a purported partnership with a tax sen- sitive one however this loss is preordained to be nullified by a matching gain upon the dissolution of the venture con- sequently the tax benefits sought by the tax sensitive party are absent other factors confined to timing gains moreover claiming these benefits requires sufficient outside_basis which in turn entails an investment of real assets because of a dad deal’s comparatively modest grab and highly stylized garb we can safely address its sought-after tax characterization without resorting to sweeping economic_substance arguments those arguments have underpinned the judicial resolution of statutory provisions that have pro- tected the public fisc against the attacks of son-of-boss opportunists see eg 515_f3d_749 7th cir 132_tc_161 affd 408_fedappx_908 6th cir jade trading llc v united verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner states 80_fedclaims_11 revd on other grounds 598_f3d_1372 fed cir unlike the stilted single-entity son-of-boss transaction a dad deal requires a minimum of two parties with one willing to give up something of sub- stantive value in an arm’s-length world this would happen only if adequate compensation changed hands consequently we need only look at the substance lurking behind the pos- ited form and where appropriate step together artificially separated transactions to get to the proper tax characteriza- tion but we are getting ahead of ourselves findings_of_fact i introduction all of the consolidated cases involve directly or indirectly warwick trading llc warwick an illinois limited_liability_company our narrative begins on date when war- wick entered into a contribution agreement contribution agreement with lojas arapua s a arapua a brazilian retailer in bankruptcy reorganization arapua a public company headquartered in sao paulo brazil was at one time the largest retailer of household appliances and consumer electronics in brazil arapua’s growth had been driven in large part by its consumer credit program arapua had been the first company in brazil to grant credit directly to its retail customers in order to increase sales many of arapua’s credit customers had become delinquent in their payments and some of these delinquent accounts constituting arapua’s past due receivables were the subject of the contribution agreement pursuant to this agreement arapua purported to contribute to warwick certain past due consumer receivables in exchange for percent of the mem- bership interests in warwick at different times during the latter half of warwick in turn claims to have contrib- uted varying portions of the brazilian consumer receivables acquired from arapua in exchange for a 99-percent member- arapua had filed a petition on or about date under the bankruptcy laws of brazil arapua’s petition initiated a proceeding termed concordata which is the rough equivalent of a ch bankruptcy reorganization under the u s bankruptcy code arapua became a public reporting company in and at all times relevant here filed quarterly and annual audited financial statements with comissao de valores mobiliarios cvm the brazilian version of the u s securities_and_exchange_commission sec verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports ship interest in each of different limited_liability compa- nies trading companies individual u s investors acquired membership interests in the various trading companies through yet another set of limited_liability companies holding_companies to accom- plish this warwick contributed virtually all of its member- ship interests in each given trading company to the cor- responding holding_company during the years at issue jet- stream business limited jetstream then a british virgin islands company was the managing member of warwick and of each of the trading companies and holding_companies the tax matters or other participating partners of warwick and the trading companies have brought these consolidated actions on behalf of their respective entities all of these entities elected to be treated as partnerships for federal_income_tax purposes and claimed a carryover_basis in the brazilian consumer receivables that were the subject of the contribution agreement during and each of the trading companies wrote off almost the entire basis in its share of the brazilian consumer receivables ostensibly resulting in business_bad_debt deductions and in one instance a capital_loss unified individual u s investors holding membership interests in a given trading company through the corresponding holding_company claimed the benefits of these deductions on their respective federal_income_tax returns warwick also claimed losses on the sale of membership interests in the holding_companies to the individual u s investors pursuant to tefra’s provisions respondent issued notices of final_partnership_administrative_adjustment fpaas denying these deductions and attacking the characterization of the transactions engaged in by war- wick and the trading companies on several grounds including lack of economic_substance the partnership antiabuse rules of sec_1_701-2 income_tax regs the disguised sale rules of sec_707 and the transfer_pricing rules of sec_482 further the fpaas adjusted the partnerships’ partnership-level audit these trading companies all of whose claimed deductions are at issue in these consolidated cases are blue ash trading llc galba trading llc good karma trading llc howa trading llc lonsway trading llc lyons trading llc nero trading llc pawn trading llc queen trading llc rook trading llc sterling trading llc superior trading llc tiberius trading llc and tiffany trading llc respondent has since conceded the transfer_pricing argument and declared that he does not verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner bases in the receivables to zero and determined accuracy- related penalties for gross_valuation_misstatements under sec_6662 petitioners timely petitioned the court challenging the fpaas a trial was conducted the week of date in chicago illinois ii mr rogers’ neighborhood the common thread that runs through these consolidated cases is a tax lawyer whose credentials and claimed expertise extend beyond tax law mr john e rogers rogers has a b a in mathematics and physics from the university of notre dame a j d from harvard law school and an m b a from the university of chicago with a concentration in inter- national finance and econometrics rogers started his professional career in at the now- dissolved accounting firm arthur andersen where he rose through the ranks to eventually become an equity partner rogers left arthur andersen in and went to work for a startup medical device company called reddy laboratories the venture failed after the food and drug administration denied the company’s application_for a license in rogers joined fmc corp a dollar_figure billion company with oper- ations in over countries rogers served as fmc corp ’s director of taxes and assistant treasurer through in rogers became an equity partner in altheimer gray a full-service law firm headquartered in chicago illinois with offices in eastern europe altheimer gray dissolved in and rogers joined the seyfarth shaw llp seyfarth shaw law firm in july of that year rogers began as an income partner at seyfarth shaw but had become an equity partner in a little over a year rogers left seyfarth shaw at the end of date when he opened his own firm rogers associates seek to reallocate the losses of warwick or the trading companies to arapua under sec_482 rogers is admitted to practice in the states of illinois and pennsylvania he is also admitted to practice before the united_states tax_court the court_of_appeals for the seventh circuit the court_of_appeals_for_the_federal_circuit the court of international trade and the inter- national trade commission rogers is a member of the international_fiscal_association an international tax group he has also been a trustee of the tax foundation a publicly supported foundation that researches tax policy issues and publishes papers rogers has worked with the governments of puerto rico and romania in developing programs implementing their industrial taxation programs rogers continued verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports seeking to capitalize on his credentials as an international finance expert rogers asserts that he has developed a unique business model for simultaneously exploiting pricing inefficiencies in the retail and foreign exchange markets the model consisted of servicing offshore consumer receivables and remitting the proceeds to the united_states rogers claims that his expertise at analyzing probabilistic yield pat- terns enabled him to uncover hidden value in asset pools such as consumer receivables further his keen under- standing of macroeconomic factors underlying exchange rate movements supposedly allowed him to opportunistically time the acquisition and disposition of offshore assets both of these abilities came together in his project that entailed investing in and managing distressed retail consumer receiv- ables overseas which underlies this litigation after allegedly researching and testing several different countries rogers decided to begin with brazil in rogers attributes this choice to the then-underdeveloped nature of the brazilian collections industry and the rapidly appreciating brazilian currency he settled on arapua receiv- ables for his initial foray again after prospecting several large retail chains and their respective accounts receivables of varying vintage he set up a tiered_partnership structure for acquiring the arapua receivables consisting largely of postdated checks rogers contends that the tiered partner- ship structure was optimal given his envisaged exit strategy-a roll_up followed by an initial_public_offering iii dad’s army the deal began with the formation of warwick and the transfer of distressed receivables from arapua to warwick at the same time rogers formed a set of trading companies and a set of holding_companies as individual u s investors were found warwick transferred a portion of the receivables it had acquired from arapua to a trading company in exchange for a supermajority interest in the trading com- pany concurrently warwick exchanged most of its interest has written a number of publications primarily on international tax matters transfers of tech- nology the use of low-tax jurisdictions and the compensation of executives outside the united_states in rogers was invited to testify before the house ways_and_means_committee on fundamental international tax reform rogers has taught courses on international finance as an adjunct instructor at the illinois institute of technology verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner in the trading company for a supermajority interest in a holding_company which it then sold to the individual u s investor after a brief period the trading companies claimed par- tially worthless_debt deductions and in one instance a cap- ital loss with respect to the receivables in which they held interests the trading companies also claimed miscellaneous deductions for amortization and collection expenses all deductions that the trading companies claimed flowed to the individual investors through the holding_companies war- wick itself claimed losses on the sales of interests in the holding_companies and deductions for amortization rogers and petitioners describe the venture as one in which arapua partnered with the following for servicing and collection of its distressed but semi-performing receiv- ables in the first instance arapua ostensibly partnered with warwick and through warwick with the trading companies and subsequently through the trading companies with the respective holding_companies and through the holding_companies with the ultimate individual u s taxpayers as a consequence of this tiered_partnership arrangement rogers and petitioners argue that pursuant to sec_723 arapua’s tax basis in its receivables carried over to warwick rogers and petitioners claim this basis equals the receiv- ables’ face_amount without any downward adjustment to account for their distressed quality at some point shortly after transferring its receivables arapua was redeemed out of its purported partnership with warwick however because warwick had not made a sec_754 election the sec_743 adjustment to the basis of partnership property did not apply thus according to rogers and petitioners the basis of arapua’s receivables in the hands of warwick remained unchanged at the receivables’ face_amount even after arapua’s redemption soon thereafter warwick contributed the distressed receiv- ables to various trading companies under sec_723 warwick claimed a basis in its partnership_interest in each trading company in the amount of warwick’s basis in the contributed receivables this in turn equaled the receiv- see supra note listing the trading companies whose claimed deductions are at issue in these consolidated cases these include the companies listed supra note verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports ables’ face_amount also under sec_723 the trading com- pany took a basis in the receivables equal to warwick’s basis in these receivables-again the receivables’ face_amount finally the various trading companies sold exchanged or otherwise liquidated the distressed receivables through an accommodating party for the receivables’ fair_market_value the resulting loss equal to the spread between the face_amount and the fair_market_value of the receivables alleg- edly tiered up and was allocated proportionately to the indi- vidual u s taxpayers holding membership interests in the holding_companies under authority of sec_704 and sec_1_704-3 income_tax regs for a u s taxpayer to be able to report his allocable share of the loss on his individual tax_return he must have had pursuant to sec_704 adequate adjusted outside_basis in his partnership_interest in his or her holding_company therefore the individual u s taxpayers were required to contribute a substantial amount of cash or other significant assets such as an investment portfolio to the holding compa- nies to generate the required outside bases for sec_704 purposes each individual u s taxpayer’s outside_basis was subsequently reduced in the amount of the allowed loss from the sale_or_exchange of the distressed receivables con- sequently the individual u s taxpayer was absent actual unintended and unsought partnership economic losses des- tined to later have gain upon the redemption of his partner- ship interest thus any_tax savings afforded by rogers’ tax strategy would be limited to deferral benefits nonetheless these timing gains can be substantial and build quickly i shutting the barn door opinion as noted the dad deal delineated above entails a tax indif- ferent party purportedly contributing a built-in_loss asset to a partnership followed by a recognition of the built-in_loss and its allocation to one or more tax sensitive parties with- out commenting upon whether tax characterization of this deal could ever have materialized under prior_law we note that recent legislation has limited the ability to transfer losses among partners santa monica pictures llc v commissioner tcmemo_2005_104 n the sought-after verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner the american_jobs_creation_act_of_2004 ajca publaw_108_357 118_stat_1589 amended sec_704 sec_734 and sec_743 effective for transactions entered into after date the amendments to sec_704 provide that in the case of contributions of built-in_loss_property to a partnership the built-in_loss may be taken into account only by the contributing_partner and cannot be allocated to any other partners the amendments to sec_734 make the basis_adjustment rules of that section mandatory to any distribution where there is a substantial_basis_reduction similarly the basis_adjustment rules of sec_743 are made mandatory to a transfer of a partnership_interest with a substantial_built-in_loss together these statutory changes are intended inter alia to prevent shifting a built-in_loss from a tax indifferent foreign_entity to a u s taxpayer through the use of a partnership see h conf rept pincite because the transactions that are the subject of these consolidated cases took place before date none of the changes made by the ajca to sec_704 sec_734 and sec_743 apply to them our discussion therefore will be based upon the prior state of the law ii competing characterizations petitioners contend that in congress sic enacted u s c sec_704 which calls for the tax result which the irs challenges at trial petitioners point to sec_1_704-3 promulgated in which states that a if changes made by the american_jobs_creation_act_of_2004 ajca publaw_108_357 118_stat_1589 were to apply to a transaction similar to the one devised and marketed by rogers and described above then any amount of the loss attributable to the spread between the face_amount and the fair_market_value of the distressed receivables that exists upon con- tribution will not be allocable to the u s taxpayer under amended sec_704 the entire amount of this built-in_loss would be reserved for allocation to the tax indifferent foreign_entity as the contributing_partner if the tax indifferent foreign_entity leaves the partnership before the re- ceivables are sold then either amended sec_734 or amended sec_743 will apply to prevent the built-in_loss from ever being recognized the tax indifferent foreign_entity could leave the part- nership by a sale or transfer of its partnership_interest or by means of a liquidating cash dis- tribution upon a sale or transfer of the tax indifferent foreign entity’s partnership_interest amended sec_743 would require a downward adjustment to the u s taxpayer’s share of the in- side basis in the receivables for a liquidating cash distribution amended sec_734 would require a similar downward adjustment to the partnership’s inside_basis in these receivables con- sequently whether the tax indifferent foreign_entity leaves via a sale or transfer of its partner- ship interest or by means of a liquidating cash distribution the built-in_loss in the receivables would be eliminated and could no longer become available for allocation to the u s taxpayer verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports taxpayer ‘must’ allocate ‘built-in’ losses as petitioners did here petitioners cite two seminal cases 331_us_1 and 461_us_300 to establish the fundamental proposition that taxpayers get basis in assets purchased with borrowed money and may claim depreciation deductions-tax losses- on that basis consequently petitioners find nothing illogical or unnatural in a result where tax losses exceed a taxpayer’s economic losses petitioners refer us to 435_us_561 where the supreme court approved depreciation_deductions for a taxpayer who bor- rowed virtually the entire purchase_price to acquire a building petitioners assert that the supreme court approved an outcome in which the taxpayer leased the building back to its original owner for virtually its entire life leading to deductions-also known as tax losses-that vastly exceeded the taxpayer’s cash investment respondent counters that the deductions and losses claimed in the years and should be disallowed for several reasons among the grounds that respondent advances is the argument that the transactions engaged in by the trading companies had no independent economic sub- stance length that we agree with petitioners that the mere fact that tax losses from a transaction exceed the accompanying economic losses does not render the transaction devoid of economic_substance respondent contends at even assuming the most optimistic of revenue projections advanced by petitioners the evidence is clear that the trading companies had no chance let alone a realistic chance of earning a single dollar of pre-tax profit we are not so easily convinced petitioners introduced considerable evidence at trial some of it quite credible that servicing of distressed brazilian consumer receivables was attracting the interest and investment dollars of legitimate and sophisti- cated u s investors during and moreover the actual receivables that the purported partnerships acquired had in fact generated nontrivial revenues though it wa sec_11 petitioner’s expert mr henry dunphy dunphy testified credibly about protesto a par- verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner not immediately apparent whether such revenues were large enough to justify the cash outlays however we need not resolve these fact-intensive issues in order to rule on warwick’s and the trading companies’ claimed losses and decide these cases iii validity of contribution two necessary conditions for the allocation of the built-in losses in the arapua receivables away from arapua and to the holding_companies are that arapua be deemed to have formed a partnership with jetstream and that arapua made a contribution rather than a sale of the receivables to that partnership whether a valid partnership exists for purposes of federal tax law is governed by federal_law see 337_us_733 327_us_280 88_tc_1405 labels applied to a transaction for purposes of local law are not binding for purposes of federal tax law see 387_us_456 for warwick to have constituted a partnership between arapua and jetstream for federal tax law purposes at the time that arapua transferred its receivables arapua and jetstream should have had a common intention to collec- tively pursue a joint economic outcome the so-called check- the-box regulation sec_301_7701-3 proced admin regs certainly allows an eligible_entity with at least two members to elect to be classified as a partner- ship however we remain far from persuaded that arapua and jetstream ever came together to constitute an entity for this purpose respondent contends that jetstream and arapua did not intend to join together as partners in the conduct of ticularly effective method for collecting on unpaid checks in brazil the method consists of issuing to the check-writer a notice from a semiofficial agency providing a final opportunity to make an acceptable payment of the check if no acceptable often a negotiated reduced_amount payment is received in response the check-writer’s name is placed on a consolidated blacklist shared by all major brazilian credit bureaus adversely affecting the check-writer’s ability to buy anything on credit or open a bank account dunphy who was engaged by petitioners as collections manager employed the protesto method on the arapua receivables with a great deal of success in his expert report and trial testimony dunphy indicated on the basis of his prior experience and subjective analysis of comparables that the collection yield on some selected tranches of the receivables could have been as high a sec_12 percent of the face_amount verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports a business we agree as respondent points out arapua and rogers the sole owner and director of jetstream each had different agendas arapua’s sole motivation appeared to be to derive cash for its receivables in order to avert or delay a forced liquidation by comparison among other things rogers wanted the receivables because of their pur- ported built-in losses which he could use to generate large tax deductions along the same lines and for similar reasons we are unconvinced that arapua ever made a bona_fide contribution of the receivables under sec_721 the basis_of_property contributed to a partnership is preserved so that unrecog- nized gain_or_loss is deferred until realized by the partner- ship however sec_721 applies only to a contribution of property in exchange for an interest in the partnership arapua was not seeking to partner with jetstream in serv- icing and extracting value from the receivables instead it was looking for ready cash if arapua never considered itself a partner in a joint enterprise with jetstream it could not have contributed the receivables within the meaning of sec_721 see eg 49_tc_4 we cannot believe that a hurriedly organized tour through sec_721 and sec_731 could yield such an absurd result the objective evidence regarding the stark divergence in the respective interests of arapua and jetstream with respect to the transfer of the receivables undermines peti- tioners’ cause even more troubling is petitioners’ failure to definitively account for arapua’s so-called redemption from the purported partnership petitioners failed to establish exactly when and how arapua was paid to give up its claimed partnership_interest in warwick while insisting that arapua did not sell the receivables to warwick peti- tioners nonetheless acknowledge that arapua received cash petitioners claim that in or about march arapua was redeemed out of warwick further they insist that rogers believes that arapua was paid fair value for its redemption which is a discount from what it wanted however petitioners concede that rogers was unable to verify whether arapua’s redemption occurred in dollars or brazilian currency moreover petitioners are unable to quantify this amount in either currency petitioners argue in their posttrial brief that the weight of evidence suggests that arapua was eventually redeemed out of the partnership for approximately of historical notional value of the receivables em- phasis supplied rogers himself admitted at trial that my belief at this-and continues at this point it was about percent verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner for its interest in warwick within a year after entering into the contribution agreement under sec_707 partner contributions may be recharacterized as sales if the contributing_partner receives distributions from the partnership that are in effect consid- eration for the contributed_property the accompanying regu- lations establish a 2-year sale harbor presumption on either side of the purported contribution see sec_1_707-3 income_tax regs stating that if within a two-year period a partner transfers property to a partnership and the part- nership transfers money or other consideration to the partner without regard to the order of the transfers the transfers are presumed to be a sale of the property to the partnership unless the facts and circumstances clearly establish that the transfers do not constitute a sale petitioners have given us no reason to challenge respondent’s assertion that as a result of arapua’s receipt of money within years of transferring the receivables the transaction between arapua and war- wick is presumed to be a sale under sec_707 and the regulations promulgated thereunder we may conclude from petitioners’ failure to rebut this presumption that arapua sold its receivables to warwick rather than contributed them for a partnership_interest con- sequently the receivables’ basis in warwick’s hands was their fair_market_value on the date of transfer instead of their historical basis in arapua’s hands with a fair_market_value basis on the date of transfer the receivables could yield few or no losses that warwick or any of the trading companies may claim in addition to these foundational concerns that go to the very substance of whether a partnership was ever formed and whether a contribution was ever made there remain questions regarding whether even the requirements of form were properly satisfied petitioners’ posttrial brief states that arapua remained a partner in warwick throughout and until march when it was redeemed out of warwick and though petitioners characterize arapua’s redemption as occurring much later than its contribution the fact re- mains that by petitioners’ own admission arapua received cash for its warwick partnership in- terest on date less than months after transferring the receivables under the date contribution agreement verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports iv foot faults respondent introduced credible_evidence at trial chal- lenging compliance with numerous requirements of brazilian law such as obtaining the approval of the trustee and the judge overseeing arapua’s bankruptcy pro- ceeding having the contribution agreement with a complete list of receiv- ables translated into portuguese and registered with a public registry of deeds and notifying the debtors of the assignments of their debts petitioners countered with expert testimony of their own questioning the applicability of some of these requirements and suggesting that customary business practice in brazil often diverges from formal requirements of the letter of the law we need not and therefore do not parse such conflicting testimony to decide definitively whether each applicable_requirement of brazilian law governing a transfer of title in the arapua receivables was satisfied it suffices for our pur- poses to note that petitioners carry the burden of estab- lishing by a preponderance_of_the_evidence that arapua made a valid contribution of the receivables to a partnership within the meaning of sec_721 see rule a 290_us_111 by failing to credibly rebut respondent’s evidence on this issue petitioners have failed to carry their burden and consequently have not established a valid sec_721 contribution respondent’s expert on brazilian law mr sergio tostes tostes who has been a practicing lawyer in brazil for over years and is currently a senior partner in a well-respected firm opined that the contribution agreements between warwick and the trading companies are for- eign documents that are unenforceable in brazil unless translated into portuguese and reg- istered with a public registry of deeds in the absence of such registration the assignments of the receivables are not valid against third parties including the debtors petitioners’ brazilian law expert ms maria helena ortiz bragaglia bragaglia a partner in what tostes acknowledged was one of brazil’s leading firms was of the opinion that the fail- ure to render a portugese translation and obtain registration did not affect the contribution agreement’s validity per se she conceded however that these requirements would have to be satisfied before bringing suit to enforce the agreement in brazilian courts and therefore for the agreement to be effective against third parties bragaglia insisted that such third parties do not include the debtors whose accounts were the subject of the contribution agreement in her expert testimony bragaglia pointed to and out- lined the legal research that supported her view tostes claimed that the majority of brazilian scholars led by the highly respected jurist caio mario are of the view that a third party is anyone who is not a party to the agreement in this case that would include the debtors since they are not parties to the contribution agreements we need not and do not resolve the competing claims by tostes and bragaglia on this issue instead we merely note that bragaglia’s testimony fails to conclusively determine the weight of brazilian legal authority bearing upon this question therefore by relying exclusively on her expert opinion petitioners have failed to adequately establish that the contribution agreement verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner v arapua’s financial reporting finally even assuming arguendo that arapua validly contributed the receivables to a bona_fide partnership so that warwick would inherit arapua’s basis in the receivables we are not convinced that that basis would equal the receivables’ face_amount in fact respondent offered compelling and unrebutted evidence suggesting that even a carryover_basis for the receivables would be closer to zero than to their face_amount respondent showed that the receivables which arapua transferred to warwick had previously been contrib- uted to and returned by another limited_liability_company mpatrn llc in before the purported contribution of the same receivables to warwick moreover as respondent argues after the receivables were returned to arapua arapua removed the receivables from its balance_sheet would be enforceable against the debtors in the absence of such enforceability we cannot con- clude that the contribution agreement effected a contribution of the receivables from arapua to warwick recognizable for u s tax purposes there was a similar difference in opinion between these two brazilian law experts regarding any requirement for obtaining prior approval of the contribution agreement from arapua’s creditors and the trustee and the judge overseeing the concordata tostes asserted that these parties had a right to challenge the contribution agreement and would have done so if it had been brought to their attention directly prior to its execution bragaglia contended that mention of the contribution agreement in arapua’s quarterly and annual financial reports which were placed in the files of the concordata proceeding sufficed again we refrain from choosing be- tween these differing opinions regarding brazilian law and instead focus on the commonality between them reconciling the two expert testimonies we conclude that prior approval of the contribution agreement would not have been required if the agreement constituted arapua’s or- dinary course of business during its bankruptcy reorganization petitioners have not convinced us that the contribution agreement in fact comprised routine and normal operations for arapua during that time to the contrary rogers indicated in his trial testimony that he had deter- mined that arapua’s receivables were strategically valuable to the company and arapua viewed the contribution agreement with warwick as a strategic partnering arrangement we take that testimony to mean that arapua was as to a material asset venturing out into hitherto unex- plored territory a premise inconsistent with ordinary course of dealings respondent has presented credible circumstantial evidence that supports this finding re- spondent has shown that on date arapua transferred defaulted receivables which were more than days past due to mpatrn llc by date arapua had received of the face_amount and mpatrn llc had returned the remainder of the receivables to arapua sometime before date rogers obtained a copy of the audited financial statement which arapua had submitted to the cvm the brazilian version of the u s sec see supra note for the period ended date as a consequence rogers was aware that arapua had transferred receivables to mpatrn llc and rogers subse- quently negotiated for a putative contribution of these receivables to warwick petitioners counter this carefully reconstructed and plausible narration of likely facts with a blanket denial stating that respondent has presented no evidence that the defaulted receivables purportedly transferred by arapua to mpatrn are the same similar or related to the arapua receivables contributed to warwick petitioners have failed to convince us that the arapua receivables that were the subject of the contribution agreement had not been previously transferred and reac- quired by arapua verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports raising a serious question whether arapua had any basis in the receivables which could carry over to warwick petitioners counter by arguing that a zeroing out of the receivables from arapua’s accounting statements prepared for financial reporting purposes is not determinative of their proper tax treatment for federal tax purposes we acknowledge the vastly different objectives that financial and tax_accounting have the primary goal of financial_accounting is to provide useful information to management shareholders creditors and others properly interested the major responsibility of the accountant is to protect these parties from being misled consistently with its goals and responsibilities financial_accounting has as its foundation the principle of conservatism 439_us_522 regardless we shall not simply ignore the fact that arapua’s management believed albeit conservatively that the receiv- ables were close to worthless the primary goal of the income_tax system is the equitable collection of rev- enue the major responsibility of the internal_revenue_service is to protect the public fisc id in pursuit of that goal we may properly consider arapua’s internal assessment of the receivables’ intrinsic value and its implied unre- covered cost of the assets in imputing a basis to the receiv- ables for sec_721 purposes after all the purpose of sec_721 is to facilitate the flow of property from individuals to partnerships that will use the property productively by preventing the mere change in form from precipitating taxation 727_f2d_1043 11th cir since the arapua receivables were never within the pur- view of federal taxation before their transfer to warwick we see no reason why at least in this instance we may not derive these receivables’ proper federal tax basis from their reported value on arapua’s financial statements at the time petitioners acknowledge a large accounts_receivable balance in and then a smaller number in accompanied by a similar decline in the provision for doubtful debts over the same period though petitioners concede that a large part of the receivables were no longer there they counter that rogers does not know if in fact the arapua receivables were previously transferred to mpatrn petitioners emphasize that the losses with respect to the eliminated receivables were not used for the reduction of taxes charged- off they claim that arapua’s financial_accounting disclosure of a decline in receivables did not tell rogers whether the arapua receivables were written off for u s tax purposes rogers’ inference is that the receivables were not written off for u s tax purposes but that a tax re-contribution to capital of a partnership was made verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner of transfer again petitioners have failed to persuade us otherwise the grounds we have discussed thus far viz failure to establish a bona_fide partnership and a valid contribution and contravention of applicable local law requirements are sufficient to sustain respondent’s fpaas and deny warwick and the trading companies the claimed losses yet we choose not to stop here we persevere for two related reasons first we wish to underscore that petitioners’ failings are not merely those that could have been remedied with proper execution of the contemplated transaction the transaction here is inherently flawed and will not deliver the sought- after tax consequences rogers’ knowledge of tax law and experience with tax practice should have put him on notice of this obvious flaw his failure to take such notice and the issues analyzed above support the application of the sec_6662 accuracy-related_penalty that respondent has deter- mined vi stepping stones rogers arranged for a sequence of convoluted and inter- related steps to proceed with the acquisition and servicing of the arapua receivables other than the tax outcome he sought there was no logical reason for the many inter- mediate exercises arapua’s purported membership in war- wick was engineered solely to obtain a carryover_basis for the receivables and retain their built-in_loss further arapua’s subsequent redemption was apparently contrived to complete a disguised purchase of the receivables and remove arapua respondent’s brazilian law expert tostes opined that arapua had certainly written off the receivables for both financial and tax reporting purposes by date when it transferred them to warwick petitioners contend that independent auditors viewed the arapua financials and concluded that the receivables were recorded as credits in arapua’s balance_sheet as taxable_income in the end of the year income statement thus proving rogers’ belief that arapua did not ‘charge-off ’ the receivables for reduction of taxes in any year since rogers was not admit- ted as an expert in brazilian law his beliefs are irrelevant for the purpose of determining the receivables’ prior brazilian tax treatment petitioners counter tostes’ expert opinion by claiming that according to mr tostes examination of the arapua financial statements does not allow a definitive conclusion that the arapua receivables were written off however the burden of establishing that the receivables had a carryover_basis is on petitioners and they fail to meet that burden by merely suggesting that respondent’s expert allows for a possibility that the re- ceivables might have had some tax basis under brazilian law finally petitioners point to rog- ers’ conclusion that the receivables had not been charged off in any way pursuant to u s in- come tax law other than revealing petitioners’ keen grasp of the obvious this contention has little probative value since the receivables were never within the purview of federal taxation before their transfer to warwick verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports from the picture when the built-in_loss was recognized the recognized loss could then be allocated away from arapua and entirely to the holding_companies in other words arapua’s entry and exit were timed to maneuver in between the constraints of partnership tax_accounting rules to pre- serve and bring to fruition an alleged tax loss are we at liberty to collapse or step together the trans- action’s intermediate points and in effect trace a direct path in answering this question we begin with the general proposition that a transaction’s true substance rather than its nominal form governs its federal tax treatment see gen- erally 324_us_331 293_us_465 before we can recast this or any transaction in a manner that makes its underlying substance obvious and relegates its overt form to the background we subject the transaction’s many twists and turns to a searching analysis of the facts to see whether the true substance of the transaction is dif- ferent from its form or whether the form reflects what actu- ally happened 61_tc_770 see also 85_tc_309 holding that formally separate steps in an integrated and interdependent series that is focused on a particular end result will not be afforded independent significance in situa- tions in which an isolated examination of the steps will not lead to a determination reflecting the actual overall result of the series of steps 78_tc_350 applying the step_transaction_doctrine in cases where a taxpayer seeks to get from point a to point d and does so stopping in between at points b and c in such a situation courts are not bound by the twisted path taken by the taxpayer and the intervening stops may be dis- regarded or rearranged courts generally apply one of three alternative tests in deciding whether to invoke the step_transaction_doctrine and disregard a transaction’s intervening steps these tests in increasing degrees of permissiveness are the binding_commitment_test the end result test and the interdepend- ence test the least permissive of the three tests the binding_commitment_test considers whether at the time of taking the first step there was a binding commitment to undertake verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner the subsequent steps see 391_us_83 holding that if one transaction is to be characterized as a ‘first step’ there must be a binding commitment to take the later steps in applying this test we ask whether at the time of arapua’s supposed contribu- tion of the receivables it was assured of being subsequently redeemed out of warwick though there has been no specific finding of fact on this issue we observe that in the absence of any such redemption of arapua’s so-called partnership_interest the tax losses would have remained arapua’s and could not have been allo- cated to the holding_companies thus the very design of the transaction contemplated a subsequent redemption of arapua from warwick however the binding_commitment_test is seldom used and is applicable only where a substantial period of time has passed between the steps that are subject_to scrutiny andantech llc v commissioner tcmemo_2002_97 affd in part 331_f3d_972 d c cir less than a year elapsed between arapua’s entering into the contribution agreement and its claimed redemption from warwick it is unclear whether the binding_commitment_test is appropriate in these circumstances see id see also 927_f2d_1517 n 10th cir declining to apply the binding_commitment_test because the case did not involve a series of transactions spanning several years the end result test focuses on the parties’ subjective intent at the time of structuring the transaction see 190_f3d_1165 10th cir holding that what matters is not whether the parties intended to avoid taxes but if they intended to reach a particular result by structuring a series of transactions in a certain way the test examines whether the formally separate steps are pre- arranged components of a composite transaction intended from the outset to arrive at a specific end result we have no hesitation in concluding that under the end result test we can safely invoke the step_transaction_doctrine here by peti- tioners’ own admission the tax benefits were a legitimate inducement for individual u s investors to invest in the ven- see supra note sec_12 and and accompanying text verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports ture but arranging for these tax benefits required the care- fully choreographed entry and exit of arapua such entry and exit could not but have been previously arranged to reach the desired end result-allocation of the recognized tax loss away from arapua the third and least rigorous of the tests is the inter- dependence test this test analyzes whether the intervening steps are so interdependent that the legal relations created by one step would have been fruitless without completion of the later series of steps see 88_tc_1415 if however intermediate steps accomplished valid and independent economic or business purposes courts respect their independent significance see 13_f3d_577 2d cir 702_f2d_1234 5th cir in applying the interdependence test we ask whether any economic or business_purpose was served by arapua’s entry to and exit from warwick alternatively we question whether an outright sale of the arapua receivables would have been just as effective in transferring title and facili- tating their subsequent servicing in either formulation the test is satisfied and we are free to invoke the step trans- action doctrine and collapse the formal steps into a single transaction note that the three tests we outline above are not mutu- ally exclusive arguably the requirements of all and cer- tainly of two of the three tests have been met here more- over a transaction need only satisfy one of the tests to allow for the step_transaction_doctrine to be invoked see associ- ated wholesale grocers inc v united_states supra pincite- finding the end result test inappropriate but applying the step_transaction_doctrine using the interdependence test we conclude that the various intermediate steps of the transaction structured and put into operation by rogers are properly collapsed into a single transaction this transaction consisted of arapua’s selling its receivables to warwick for the amount of cash payments that were eventually made to arapua by and on behalf of warwick consequently war- wick’s basis in the arapua receivables was no higher than the sum of these payments-but petitioners have failed to verdate 0ct date jkt po frm fmt sfmt v files super sheila superior trading llc v commissioner substantiate these payments any subsequent losses are therefore properly measured against a basis of zero vii accuracy-related_penalty respondent determined that there is a gross_valuation_misstatement within the meaning of sec_6662 in all the consolidated cases under sec_6662 and h a i a gross_valuation_misstatement would arise if the adjusted_basis of any property claimed on any return of tax_imposed_by_chapter_1 is percent or more of the amount deter- mined to be correct if the correct adjusted_basis is found to be zero any positive amount claimed on the return would constitute a gross_valuation_misstatement respondent contends that the correct basis of the receiv- ables in the hands of both warwick and the trading compa- nies is zero because petitioners have failed to substantiate the amount of payments warwick made to arapua for the receivables and more importantly that they were contrib- uted we agree with respondent therefore we conclude that there are gross_valuation_misstatements on the respective returns of warwick and the trading companies con- sequently the applicable accuracy-related_penalty i sec_40 per- cent in each of the consolidated cases under sec_6664 an accuracy-related_penalty will not be imposed if we find that warwick and the trading companies acted with reasonable_cause and in good_faith we make this determination at the partnership level taking into account the state of mind of the general_partner see 131_tc_275 see supra note and accompanying text each partnership’s basis in the receivables is part of that partnership’s inside_basis and is therefore a partnership_item within the meaning of sec_6231 and sec_301_6231_a_3_-1 income_tax regs consequently we do have jurisdiction over the penalty in this partnership- level case 136_tc_67 since the overvalued asset was a partnership_item the outside_basis of individual partners is of no consequence id pincite thus our assertion of jurisdiction over penalties here is not affected by and is distinguish- able from the respective opinions of two courts of appeals which have held that a trial_court lacks jurisdiction to determine partners’ outside bases in partnership-level proceedings see 591_f3d_649 d c cir affg in part revg in part vacating in part and remanding on penalty issues 131_tc_84 598_f3d_1372 fed cir further a portion of any underpayment by the individual u s investors is attributable to the gross valu- ation misstatement of the receivables within the meaning of sec_6662 verdate 0ct date jkt po frm fmt sfmt v files super sheila united_states tax_court reports for warwick and each of the trading companies jetstream was the managing member at the time the transactions at issue transpired rogers was the sole owner and director of jetstream at all such times consequently he was the only individual with the authority to act on behalf of petitioners it is therefore rogers’ conduct that is relevant for the pur- pose of determining whether we should sustain the asserted accuracy-related_penalties there has been no showing of reasonable_cause or good_faith on rogers’ part in conceptualizing designing and exe- cuting the transactions to the contrary as we have detailed above rogers’ knowledge and experience should have put him on notice that the tax benefits sought by the form of the transactions would not be forthcoming and that these trans- actions would be recharacterized and stepped together to reveal their true substance viii conclusion we uphold respondent’s fpaas we conclude that the arapua receivables had zero basis in warwick’s hands we further sustain respondent’s determination regarding the sec_6662 accuracy-related_penalty we find that peti- tioners have failed to establish reasonable_cause or good_faith under sec_6664 we have considered all the other arguments made by peti- tioners and to the extent not discussed above we conclude those arguments are irrelevant moot or without merit to reflect the foregoing decisions will be entered for respondent f since none of the partnerships relied upon external professional advice within the mean- ing of 115_tc_43 affd 299_f3d_221 3d cir the three-factor test developed there is irrelevant for establishing reasonable_cause and good_faith in these partnership-level proceedings verdate 0ct date jkt po frm fmt sfmt v files super sheila