department of the treasury int ernal revenue service washington d c o f f i c e o f c h i e f c o u n s e l date number release date cc corp b06 tl-n-7420-00 uilc internal_revenue_service national_office field_service_advice memorandum for jody s tancer associate area_counsel financial services and healthcare cc lm fsh brk attention andrew j mandell from jasper l cummings jr associate chief_counsel cc corp subject lease_stripping transaction this chief_counsel_advice responds to your memorandum dated date in accordance with sec_6110 this chief_counsel_advice should not be cited as precedent legend taxpayer partnership a partnership c limited_partnership b entity a entity b entity c entity q entity r tl-n-7420-00 tax exempt entity type a foreign_corporation t foreign_entity v corporation p corporation s_corporation w corporation x corporation y financial_institution a financial_institution b individual a individual b individual c individual d individual e individual f statement x executive position a consultant city a city b country a country b country c article a article b tl-n-7420-00 paragraph a a b c d e f g h j k l m n p a b c d e f asset a asset b asset c asset a business tl-n-7420-00 dollar_figurea dollar_figureb dollar_figurec dollar_figured dollar_figuree dollar_figuref dollar_figureg dollar_figureh dollar_figurej dollar_figurek dollar_figurel dollar_figurem dollar_figuren dollar_figurep dollar_figureq dollar_figurer dollar_figures dollar_figuret dollar_figureu dollar_figurev dollar_figurew dollar_figurex dollar_figurey dollar_figurez dollar_figureaa dollar_figurebb tl-n-7420-00 dollar_figurecc dollar_figuredd dollar_figureee dollar_figureff dollar_figuregg dollar_figurehh dollar_figurejj dollar_figurekk agreement a year a year b year c year d year e month a month b month c date a date b date c date d date e date f date g date h date j tl-n-7420-00 issues you have requested written advice on a number of issues relating to a large loss taken by taxpayer in year c you have indicated that this loss arose from a tax abusive transaction as we informed you orally the facts have not been fully developed which are necessary to fully evaluate most of these issues nevertheless we will comment on each of the following issues as best we can issue whether a series of prearranged transactions culminating in a dollar_figurebb capital_loss on the sale of stock received by the taxpayer in a sec_351 transaction should be disallowed on the following grounds a that the taxpayer failed to substantiate its entitlement to the capital_loss b that the series of transactions in which the taxpayer obtained and sold the assets lacked economic_substance and whether the carryover_basis in the stock received from limited_partnership b was derived from lease_stripping transactions that lacked economic_substance c that the capital_loss may be allocated from taxpayer to limited_partnership b under the authority of sec_482 d that sec_351 does not apply to the exchanges so that limited_partnership b would recognize gain_or_loss on the exchange and taxpayer would take a basis in the stock equal to their fair_market_value e that the basis in the inflated basis stock acquired in the original sec_351 transaction in the underlying lease_strip is overstated issue whether the foreign shareholders of taxpayer a domestic_corporation may be held liable as transferees for taxpayer's tax_liability resulting from the corporation's long-term_capital_gain on the sale of the appreciated assets issue whether the service can take the position that the accuracy related penalty provided by sec_6662 applies to deficiencies that result from adjustments to the capital losses reported by taxpayer conclusions issue with respect to a series of prearranged transactions culminating in a dollar_figurebb capital_loss on the sale of stock received by taxpayer in a sec_351 transaction a the taxpayer failed to substantiate its entitlement to the capital_loss tl-n-7420-00 b further factual development is required both as to the taxpayer’s subjective and objective motives for the transfers of the stock and as to the underlying lease_strip transactions in order to assert that the transactions lacked economic_substance and that the taxpayer cannot claim a carryover_basis in the assets from those transactions c the capital_loss may be allocated from taxpayer to limited_partnership b under the authority of sec_482 from the facts provided we conclude that sec_482 is potentially applicable to taxpayer and the other parties to this transaction to reallocate the loss from the sale of the corporation p stock from taxpayer to limited_partnership b because the participants acted in concert pursuant to a common plan to shift deductions to taxpayer they are part of the same controlled_group for purposes of applying sec_482 sec_482 may be applied under two alternative theories to prevent the evasion of taxes and clearly reflect the income of the participants i under the first theory under sec_482 the economic_substance tax_evasion standards of sec_482 the service would potentially disregard the purported sec_351 transfer between taxpayer partnership a and limited_partnership b due to a lack of economic_substance so that limited_partnership b is treated as never having transferred the corporation p stock to taxpayer as a result the loss that taxpayer claimed on the sale of the stock to corporation s will be disallowed and reallocated to limited_partnership b more facts will need to be developed to determine if this is a viable theory under which to reallocate the stock loss ii under the second theory under sec_482 the clear_reflection_of_income standard of sec_482 the service would allocate taxpayer’s deduction for the built-in_loss stock it received back to limited_partnership b on the basis that sec_482 may be applied to allocate deductions attributable to property received in a sec_351 transfer from the transferee corporation back to the contributor to clearly reflect income it is our understanding that the facts as currently developed suggest that this is a viable theory the service may use to reallocate the stock loss back to limited_partnership b d sec_351 does not apply to the exchanges so that limited_partnership b would recognize gain_or_loss on the exchange and taxpayer would take a basis in the stock equal to their fair_market_value e depending on the facts that may be developed the basis in the inflated basis stock acquired in the original sec_351 transaction in the underlying lease_strip is overstated tl-n-7420-00 issue the foreign shareholders of taxpayer may be held liable as transferees for taxpayer's tax_liability as a result of the taxpayer’s long-term_capital_gain on the sale of the appreciated assets issue depending on the facts that develop there is support for the view that the accuracy-related_penalty attributable to negligence potentially applies to the deficiency that results from the disallowance of the built-in losses from the inflated basis assets because taxpayer appears to have disregarded the economic_substance of the transactions from which the losses were claimed and has failed to offer evidence that there was reasonable_cause for its return position for the losses or that it acted in good_faith in claiming them facts you have indicated that the facts so far developed are as follows a background taxpayer formerly entity b was incorporated in month a year a in month b year a taxpayer purchased the asset a in city b for dollar_figuret the company financed another dollar_figureu to renovate asset a which was completed in month c year b thereafter taxpayer entered into a contract with entity a to operate the asset a business from month a year a through date e taxpayer was owned by individual a c foreign_corporation t c and foreign_entity v j individual a is a country a citizen he is the former executive position a of entity b which operates at least a city a asset a business es individual a is also believed to be involved in all facets of the operation of entity a foreign_corporation t is a country a company foreign_entity v is a country b country a joint_venture to date taxpayer has failed to adequately comply with the examiner's request for information in this case taxpayer’s year c schedule d statement x specifies date j as the date when the corporation acquired the asset a business according to taxpayer’s year b and year c forms the corporation paid management fees in those years of dollar_figured and dollar_figurep respectively tl-n-7420-00 b taxpayer’s year c sale of the asset a business on date a taxpayer sold the asset a business and asset c to entity c for dollar_figurekk although taxpayer realized net_capital_gain on the transaction of dollar_figureee it reported the sale on its year c form_1120 as separate transactions involving the physical assets and goodwill on its year c schedule d taxpayer reported gain on the sale of goodwill of dollar_figureff computed as follows gross_sales price dollar_figuregg basis gain dollar_figureq dollar_figureff the corporation also reported a loss in year c on the sale of the physical assets of dollar_figurec computed as follows gross_sales price depreciation basis loss dollar_figurehh dollar_figures dollar_figurejj dollar_figurec according to statement x the dollar_figurehh represents the sale price of asset a asset b and asset c it is unknown how or on what basis taxpayer allocated the sale price between goodwill and tangible_property according to the examiner the corporation has not responded to her questions regarding the allocation c resignation of taxpayer’s officers and directors on date d all officers and directors of taxpayer either resigned or were terminated by letter dated date e individual a also resigned as an officer and director of taxpayer by corporate resolution dated date e the resignations of all existing directors were accepted by that same resolution individual f was named as taxpayer’s sole director by separate resolution individual f was also elected vice president treasurer and secretary individual e was elected president and both individual f and individual tl-n-7420-00 b3 were given sole signature_authority over the corporation’s funds the relationship if any between individual a and the new officers of taxpayer is unknown individual d was subsequently added as a director d the shareholders’ sale of their taxpayer stock on date e taxpayer’s shareholders sold their entire stock interests in the corporation to partnership a for dollar_figurev partnership a is a domestic_partnership formed on date b between entity r the general_partner and entity q the limited_partner according to irs records the partnership has never filed a form_1065 from date b to date c partnership a’s partners were entity r d and entity q k a country c_corporation as of date c entity r’s and entity q’s partnership interests were reduced to a and f respectively with the introduction of two additional limited partners corporation w n and corporation x e thereafter on date e partnership a’s partners were corporation w g and corporation x e to finance the purchase of the taxpayer stock partnership a borrowed dollar_figurew from the financial_institution a this loan was guaranteed by taxpayer which also pledged as collateral its interest in funds on deposit at the financial_institution b pursuant to agreement a and its stock pursuant to a stock pledge agreement the examiner believes that the deposited funds represent the proceeds from the month b year c sale of the asset a business e the sec_351 transaction on date e taxpayer entered into a transaction intended to qualify for nonrecognition treatment under sec_351 in this transaction taxpayer received dollar_figuren in cash from partnership a which received nothing in return taxpayer also contributed c shares of taxpayer stock to limited_partnership b for which it taxpayer received d shares of corporation p stock in return partnership a did not assume any of taxpayer's liabilities individual b consultant prepared partnership a’s unfiled year c form_1065 as discussed in section d of the facts to date taxpayer has not furnished the examiner with the purchase agreement limited_partnership b is a partnership whose m limited_partner is the tax-neutral tax exempt entity type a tl-n-7420-00 the corporation p stock is allegedly valued at dollar_figureg and has a basis in limited_partnership b’s hands of dollar_figurecc to date taxpayer has refused to provide any information regarding the corporation p stock following the purported sec_351 transaction partnership a owned l of taxpayer the balance b was owned by limited_partnership b f taxpayer’s corporate_distributions to partnership a on date e taxpayer declared dividends payable to partnership a totaling dollar_figurey according to the corporate resolution dollar_figurer of this amount was required to be paid prior to the sec_351 transaction by separate resolution taxpayer was required to distribute an additional dollar_figurex as a dividend after the sec_351 transaction because taxpayer did not have any earnings_and_profits as of date h the distributions were treated as returns of capital to date the funds have not been traced according to some of the documentation provided these funds may have been used to pay off partnership a's dollar_figurew note and the required dollar_figuree arrangement fee to the financial_institution a following the sec_351 transaction taxpayer held d shares of corporation p stock with a fair_market_value of dollar_figureg and an alleged adjusted_basis of dollar_figurecc in addition to the above distributions it also appears that taxpayer made additional distributions to partnership a of dollar_figurel and dollar_figuref in year c as reflected on schedule l of taxpayer's year d form_1120 its notes receivable went from dollar_figurem to dollar_figureh7 in that year this dollar_figurel reduction was apparently later recharacterized as a year c distribution there was also an additional distribution in year c of dollar_figuref resulting in total distributions to partnership a in that year of dollar_figureaa this figure does not however reconcile with the dollar_figurez appearing on partnership a's unfiled year c form_1065 schedule d g taxpayer’s sale of the corporation p stock on date g taxpayer sold the d shares of corporation p stock it received in the sec_351 transaction to corporation s for dollar_figureg8 the alleged fair_market_value on date e presently the examiner is unaware of the identity of the principals of corporation s the absence of earnings_and_profits is attributable to the capital_loss discussed in section g of the facts this figure includes the dollar_figureg corporation s note discussed in section g of the facts and a miscellaneous note for dollar_figurea in the purchase and sale agreement the purchase_price of the stock was listed at dollar_figurej the reason for the difference is unknown tl-n-7420-00 the purchase_price was paid with a promissory note dated date g in the face_amount of dollar_figureg on schedule d of its year c form_1120 the corporation reported a long-term_capital_loss of dollar_figurebb computed as follows gross_sales price dollar_figureg basis loss dollar_figurecc dollar_figurebb taxpayer used this loss to offset the gain realized on the month b year c sale of the asset a business as noted above taxpayer’s basis in the corporation p stock received from the tax-neutral limited_partnership b has not been substantiated to date h subsequent taxpayer returns on its year d form_1120 taxpayer reported only interest_income of dollar_figureb from the dollar_figureh note receivable from corporation s according to the corporation’s balance_sheet it had total assets for that year of dollar_figurek representing the face value of the note plus accrued interest of dollar_figureb it appears that corporation s satisfied the dollar_figureg note sometime in year e although actual payment has not been demonstrated taxpayer’s year e form_1120 reflects that it had no income and cash of only dollar_figurek i relationships between the parties according to the various transactional documents the parties appear to be related for example individual c signed a consent of shareholders as president of corporation w the general_partner of partnership a and is also the signing authority for partnership c the general_partner for limited_partnership b additionally individual d is involved with three entities individual d is a director of taxpayer evidenced by individual d’s signature on the date f consent of stockholders individual d also signed the stock subscription on behalf of limited_partnership b with title omitted and the purchase agreement on behalf of corporation s title also omitted finally as noted above individual b prepared partnership a's unfiled year c form_1065 individual b is also the vice president of corporation y entity r's general_partner and a signatory for taxpayer tl-n-7420-00 j taxpayer’s lack of cooperation to date taxpayer has provided only selected transactional documents additionally taxpayer has yet to respond to the examiner’s questions regarding the circumstances and or business_purpose for the sec_351 transaction furthermore it is unknown whether the foreign shareholders have any other_property interests in the united_states consequently the examiner intends to issue third-party summonses to further develop the facts in this case law and analysis issue whether a series of prearranged transactions culminating in a capital_loss on the sale of stock received by taxpayer in a sec_351 transaction should be disallowed on the following grounds a that taxpayer failed to substantiate its entitlement to the capital_loss as set forth above although the corporation p stock is valued at dollar_figureg and had an alleged basis in limited_partnership b's hands of dollar_figurecc to date taxpayer has refused to provide any information regarding the corporation p stock it has long been recognized that when taxpayers claim bases carried over from other parties they are required to prove the carryover bases 153_f2d_708 8th cir 33_bta_420 james manufacturing co v commissioner 17_bta_205 the books of the party from whom the basis is carried over do not prove the basis of the assets reflected on them fairmont aluminum co v commissioner 7_tcm_783 aff’d 180_f2d_832 4th cir reasoning that the balance_sheet of the predecessor_corporation without more cannot logically be viewed as proof of basis a taxpayer is not entitled to basis it cannot substantiate stock yards national bank v commissioner 6_tcm_478 citing 283_us_223 aff’d 169_f2d_39 8th cir therefore the claimed loss should not be allowed without taxpayer providing evidence of its claimed dollar_figurecc basis if taxpayer does provide you with substantiation of this loss then you may wish to seek our advice again on how this affects taxpayer’s entitlement to the loss b economic_substance lease strips and inflated basis transactions a transaction that is entered into primarily to reduce taxes and that has no economic or commercial objective to support it is a sham and is without effect for federal_income_tax purposes 64_tc_752 752_f2d_89 4th cir 435_us_561 to be respected a tl-n-7420-00 transaction must have economic_substance separate and distinct from the economic benefit achieved by tax reduction if a taxpayer seeks to claim tax benefits that congress did not intend by means of transactions that serve no economic purpose other than tax savings the doctrine_of economic_substance applies 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 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 primarily by tax_avoidance features that have meaningless labels attached see 435_us_561 909_f2d_1360 9th cir the service was successful recently 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 157_f3d_231 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 primarily by tax reduction it held that the transaction tl-n-7420-00 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 revrul_99_14 1999_13_irb_3 because lease-in lease-out transactions have no economic_substance a u s taxpayer may not take deductions for rent or interest_paid or incurred in connection with a transaction see also 113_tc_214 113_tc_254 aff’d 11th cir date 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 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 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 taxpayer has not provided any information regarding its business_purpose for getting and disposing of the corporation p stock resulting in a dollar_figurebb capital_loss in the same taxable_year in which it had an approximate unrelated dollar_figuredd gain taxpayer should be made to demonstrate not only its reasons for entering into these transactions but also that it performed due diligence in its pursuit of that business_purpose as you note if the taxpayer had a valid business_purpose for this transaction it is likely that an explanation would have already been provided we understand that the credibility of any possible explanations for the investment in and sale of the stock will be investigated further by you through discovery and other means tl-n-7420-00 the inflated basis stock was received by taxpayer in a purported transaction on date e in exchange for c shares of its own stockdollar_figure taxpayer sold the stock on date g for dollar_figureg which resulted in the dollar_figurebb lossdollar_figure there must be a reasonable expectation that the nontax benefits would be at least commensurate with the transaction costsdollar_figure yosha v commissioner 87_tc_1087 acm partnership v commissioner f 2d pincite no evidence has been presented by taxpayer as to how it expected to make a profit from the ownership of the stock pending further factual development the transfers of the stock may lack economic_substance in order to make the argument that the basis should be reduced because it stemmed from a lease_stripping transaction further development of the facts surrounding that lease_strip itself is required in particular it must be shown that the transaction giving rise to the inflated basis property was one in which income was inappropriately separated from related deductions in a prearranged manner if taxpayer provides additional information that bears on the objective economic_substance and non tax business_purpose of these transactions you may wish to again seek our advice on this issue c the service may allocate the capital_loss claimed by taxpayer to limited_partnership b under the authority granted by sec_482 it is our opinion that a valid sec_351 transaction did not occur in this case if a bona_fide sec_351 transaction did not take place taxpayer will not be entitled to take a carryover_basis in the corporation p stock of dollar_figurecc instead taxpayer will be obligated to take a fair_market_value basis in the stock of dollar_figureg the following sec_482 analysis will only have consequence in this case if the sec_351 transaction is ultimately found to be valid if the transaction is ultimately determined to meet the requirements of sec_351 sec_482 can be applied to allocate the capital_loss attributable to the corporation p stock back to its contributor limited_partnership b i discussion of sec_482's requirements a 482-generally sec_482 was designed to prevent the artificial shifting milking or distorting of the true net incomes of commonly controlled enterprises 405_us_394 barford v commissioner you state that you do not know the value of the c shares of taxpayer stock the alleged basis in the stock was dollar_figurecc you state that you do not know all of the transaction costs involved in the transaction tl-n-7420-00 194_f3d_782 7th cir 372_f2d_415 4th cir cert_denied 389_us_841 42_tc_114 aff’d 358_f2d_342 6th cir cert_denied 385_us_899 cf h_r rep no 70th cong 1st sess sec_482 provides in relevant part in any case of two or more organizations trades_or_businesses whether or not incorporated whether or not organized in the united_states and whether or not affiliated owned or controlled directly or indirectly by the same interests the secretary may distribute apportion or allocate gross_income deductions credits or allowances between or among such organizations trades_or_businesses if he determines that such distribution apportionment or allocation is necessary in order to prevent evasion of taxes or to clearly reflect the income of any of such organizations trades_or_businesses emphasis added for the reallocation rule_of sec_482 to apply to a transaction the transaction must involve at least two entities owned or controlled by the same interests sec_482 imposes two additional requirements regarding the entities ownership or control must exist in some manner among the participants and the same interests must possess the control regarding the first requirement because partnership a and limited_partnership b were unrelated to taxpayer the mutual ownership provision of sec_482 will not apply therefore taxpayer and limited_partnership b must be found to be controlled by the same interests if we are to apply sec_482 to the transaction that took place between them b legal standard for determining control under sec_482 definition of control a court decisions the regulations under sec_482 define control to include any kind of control regardless of whether such control is direct or indirect or legally enforceable sec_1_482-1 case law supports the regulation’s definition of control indicating that it is actual and practical control which counts in the application of sec_482 rather than record ownership or legally enforceable control ach t c pincite 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 1972_2_cb_2 see also 1_bta_624 acq 1925_1_cb_2 control not arising or flowing from means legally enforceable may be just as effective in evading taxation as if founded on the most formal and readily enforceable legal instrument dhl corp v commissioner t c memo holding that foreign investors did not have sec_482 control_over a corporation despite their ability to appoint a majority of its board_of directors because domestic shareholders retained the ability to control day-to-day tl-n-7420-00 operations and major events charles town f 2d pincite holding that two shareholders were in control of a corporation in which they only owned two percent of the outstanding_stock because of their possession of effective and practical control_over the corporation consequently according to both the sec_482 regulations and the applicable case law none of the participants in this transaction is required to have legal control of another participant through majority ownership of that other participant’s voting_stock for control to exist as defined under sec_482 the service has the authority to determine whether control exists by considering the reality of the control situation and examining whether the same interests effectively control the participants to the transaction rather than basing the control determination solely on the taxpayer’s percentage of ownership of voting_stock or legal right to direct the participant’s actions b sec_1_482-1 acting in concert or with a common goal or purpose and the presumption of control current final regulations which govern the years covered by this case provide that when control does not exist through a taxpayer’s majority ownership of a participant’s voting_stock or a legally enforceable agreement delegating the power to direct an entity’s actions alternatively control results from the actions of two or more taxpayers acting in concert or with a common goal or purpose sec_1_482-1 see also dhl corp t c memo pincite when 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 by its terms the regulation does not require taxpayers to be related to each other by overlapping ownership to effect sec_482 control by acting in concert alternatively a presumption of control arises under the regulations if income and deductions have been arbitrarily shifted id case law is in accord with the regulation’s presumption of control through the arbitrary shifting_of_income or deductions see 598_f2d_1382 5th cir holding that the government correctly argued that proof of a shifting_of_income between two corporations establishes a presumption of common_control under sec_1_482-1 -predecessor to current sec_482 regulations 294_f2d_82 5th cir finding presumption of control under sec_29 of regulation 111-predecessor to current sec_482 regulations however by its terms the existence of control by acting in concert or with a common goal or purpose may be found separately under the regulations whether or not a presumption of control is found through an arbitrary shifting existence of control among taxpayer partnership a and limited_partnership b tl-n-7420-00 under sec_1_482-1 and the relevant case law none of the participants to this transaction are required to own interests in each other majority or otherwise for the requisite control to exist under sec_482 instead the service may consider whether effective_control existed among the parties even in the absence of a legal or contractual right to direct the actions of the entities a common officers in determining the existence of control among taxpayer partnership a and limited_partnership b the fact that the entities shared some common directors and officers must be taken into account individual c the president of the general_partner of partnership a was also the signing authority for the general_partner of limited_partnership b on date d all of the officers and directors of partnership a either resigned or were terminated individual f was elected the sole director vice president treasurer and secretary of taxpayer individual f signed the stock subscription agreement with limited_partnership b as well as the purchase agreement with corporation s on behalf of taxpayer individual d one of the a directors of taxpayer signed the stock subscription agreement on behalf of limited_partnership b and the purchase agreement on behalf of corporation s more facts must be developed to determine the extent of the above-mentioned officers and directors’ authority over their respective entities when making the control determination it is the reality of how control was actually exercised among the parties that must be considered for purposes of sec_482 for instance if individual d had the unilateral authority to bind taxpayer limited_partnership b and corporation s to the corporation p stock transfer and sale or if he effectively controlled the operation of the entities despite the existence of other directors or officers this would be indicative that the three entities were under common_control similarly individual d could have been acting in conjunction with individual f to control the business decisions of the entities individual f’s involvement in other lease_stripping transactions is also relevant in that the resignations of taxpayer’s board and officers and his subsequent assumption of the roles of director vice president treasurer and secretary may have occurred solely to make use of his knowledge and experience to effectuate the shifting of the corporation p stock basis to taxpayer b the existence of control through the parties’ acting in concert and with a common goal or purpose the corporation p stock contributed by limited_partnership b in the sec_351 transaction had a substantial_built-in_loss of -dollar_figurebb the difference between its purported fair_market_value of dollar_figureg and its purported basis of dollar_figurecc by contributing the corporation p stock to taxpayer on date e only approximately a months subsequent to the date taxpayer sold its asset a business at a substantial capital_gain limited_partnership b acted in concert with taxpayer to shift the potential capital_loss deduction inherent in the stock from it to taxpayer partnership a’s ownership of l of taxpayer’s stock was the result of an attempt to make the high tl-n-7420-00 basis corporation p stock transfer by limited_partnership b to taxpayer appear to be a valid sec_351 transactiondollar_figure thus partnership a acted in concert with taxpayer and limited_partnership b to ensure that taxpayer would be permitted to claim the benefits of a nonrecognition transfer including taking a carryover_basis in the corporation p stock it also appears as though a common goal may have existed among the parties to shift the loss deduction inherent in the corporation p stock to taxpayer partnership a’s participation in this transaction allowed it to receive prearranged distributions of dollar_figurer and dollar_figurew as well as distributions in the amounts of dollar_figurel and dollar_figuref these distributions were treated as returns of capital to partnership a due to taxpayer’s lack of earnings_and_profits for the year c taxable_year although partnership a may have used the dollar_figurew distribution to pay off its note to the financial_institution a partnership a would have received the remaining distributions as tax- free returns of capital therefore partnership a benefitted from aiding taxpayer in achieving the goal of shifting the loss deduction it is not clear from the facts what benefit limited_partnership b received from its participation in the transaction this fact must be developed to provide support for the position that the parties had a common goal to shift the loss deduction to taxpayer since limited_partnership b would have had no reason to aid taxpayer in achieving this goal through the stock transfer if it received nothing of value in return additionally the service should develop facts relating to whether the partners of limited_partnership b had the ability to use the capital_loss deduction shifted to taxpayer if the partners could not have claimed the loss on their returns had it been passed through to them the service’s argument that limited_partnership b had a common interest with taxpayer in shifting the deduction to taxpayer will be stronger because the transfer of a loss deduction to a u s taxpayer would have been worth more to them c the presumption of control among the parties in making the sec_482 control determination the service may apply the presumption of control provided for in sec_1_482-1 and in the applicable case law the regulations do not require the service to also establish that the parties acted in concert or with a common goal or purpose for the presumption to be applicable the service must only establish that income or deductions have been arbitrarily shifted between the parties for the presumption of control to arise from the facts provided to us and in addition to the acting in concert control theory discussed above it appears as though a loss deduction has also been arbitrarily shifted from limited_partnership b to taxpayer to allow it to offset the majority of the long-term_capital_gain attributable to the asset a business sale no plausible 13as previously discussed it is our primary position that the transaction whereby the high basis low fair_market_value corporation p stock was transferred to taxpayer was not a valid sec_351 transaction tl-n-7420-00 reason has been offered as to why taxpayer would accept stock with such a low value in exchange for its own stock especially when considered in light of the fact that taxpayer had recently received gross_income from the asset a business sale in the amount of dollar_figurekk the lack of a credible non-tax reason as to why taxpayer would want the corporation p stock makes the shifting of the deduction attributable to the stock appear to have occurred in an arbitrary manner because an arbitrary shifting of the built-in_loss inherent in the corporation p stock appears to have occurred between taxpayer limited_partnership b and partnership a control is presumed to exist among the entities for the purposes of sec_482 pursuant to sec_1_482-1 and the applicable case law as stated though it is sufficient under the final_regulation to show independently that the parties acted in concert or with a common goal or purpose without having to argue a rebuttable_presumption of control was created through an arbitrary shifting once it has been determined that control exists among the participants sec_482 next requires that the same interests possess the requisite control to permit the commissioner to make a reallocation c legal standard for determining the same interests under sec_482 the regulations do not define what the term the same interests means under sec_482 case law indicates that in using the term the same interests congress intended to include more than the same persons or the same individuals 598_f2d_1375 5th cir holding that different persons with a common goal or purpose for arbitrarily shifting income can constitute the same interests for purposes of sec_482 see also 453_f2d_1144 2d cir cert_denied 407_us_934 reversing tax court’s holding that two independently owned corporations acting in concert together to make interest-free loans to a jointly owned corporation did not constitute the same interests within the meaning of sec_482 366_f2d_890 5th cir cert_denied 386_us_1016 cf 2_bta_229 but see the 5_tc_558 acq c b acq withdrawn 1965_1_cb_5 case law indicates that the legal standard for determining whether the same interests control an entity is identical to the standard applied to determine whether control of an entity exists under this approach if different entities are found to have a common goal to shift income or deductions among each other not only will control of the entities exist but the entities will also constitute the same interests for the purpose of sec_482 as previously discussed facts show the apparent existence of a common plan among taxpayer partnership a and limited_partnership b to shift deductions to taxpayer in the year c year consequently we conclude that taxpayer partnership a and limited_partnership b constitute the same interests under sec_482 and thus establish the necessary control group for tl-n-7420-00 purposes of this section in making such an allocation if taxpayer is able to substantiate the requirements for a sec_351 transaction then independent grounds exist under sec_482 to reallocate the loss deduction claimed by taxpayer to prevent the evasion of taxes or to clearly reflect income ii application of sec_482 to this transaction generally there are two alternative bases to apply sec_482 to a transaction prevention of the evasion of tax and the clear_reflection_of_income a economic_substance tax_evasion standards of sec_482 the application of sec_482 has been upheld where the challenged transaction was arranged without a valid business_purpose and solely in order to avoid taxes 84_tc_996 aff’d in part and rev’d in part 856_f2d_855 7th cir when analyzing potential tax_avoidance aspects of a transaction the commissioner will respect the transaction’s contractual terms if consistent with the true economic_substance of the transaction sec_1_482-1 the economic_substance standard of the regulations overlaps with the economic_substance and sham_transaction doctrines developed in case law which allow the service to consider the economic realities of a transaction and disregard transactions lacking a business_purpose and entered into solely for tax_avoidance motivesdollar_figure however the sec_482 regulations expand upon case law and provide the following specific guidance the contractual terms including the consequent allocation of risks that are agreed to in writing before the transactions are entered into will be respected if such terms are consistent with the economic_substance of the underlying transactions in evaluating economic_substance great weight will be given to the actual conduct of the parties and the respective legal rights of the parties if the contractual terms are inconsistent with the economic_substance of the underlying transaction the district_director may disregard see 293_us_465 364_us_361 interest deductions disallowed where nothing of substance could be realized from the transaction other than a tax deduction 435_us_561 the simple expedient of drawing up papers is not controlling for tax purposes when the objective economic realities of a situation are to the contrary 752_f2d_89 4th cir transaction is a sham where taxpayer is motivated by no business_purpose other than obtaining tax benefits in entering a transaction and where transaction has no economic_substance because no reasonable possibility of profitability exists 157_f3d_231 3d cir cert_denied 526_us_1017 transaction devoid of economic_substance cannot be the basis for a deductible loss tl-n-7420-00 such terms and impute terms that are consistent with the economic_substance of the transaction sec_1_482-1 thus sec_482 provides an alternative approach it provides additional criteria under which to apply the economic_substance and sham inquiries to the parties’ conduct and terms adopted and does not restrict the service’s authority to make allocations in instances of colorable or sham transactions we note that in the context of this transaction and similar tax_shelter transactions this allocation authority would exist only where there is a common tax_avoidance scheme among the participants to shift income and or deductions arbitrarily note that the prior sentence does not apply to the alternative theory discussed above for establishing control the ability to direct the actions of certain participants under the first sec_482 analysis the economic_substance of a transaction is analyzed by focusing on the parties’ actual conduct the economic risks purportedly transferred and whether from a business perspective the transaction makes objective business sense see 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 b forman f 2d pincite applying the regulation’s economic_substance standard to this transaction the facts show an indicia of a lack of economic_substance the corporation p stock had a purported value of only dollar_figureg taxpayer sold the stock only b months after receiving it in the sec_351 transfer the facts appear to show that the purpose of the sec_351 transaction was to trigger the loss in the high basis low value stock as evidenced by the quick sale the large carryover_basis of the stock compared to its low purported fair_market_value ensured the generation of a substantial loss deduction to offset the gain from taxpayer’s asset a business sale upon taxpayer’s sale of the stock no facts have been provided concerning taxpayer’s business_purpose for entering into the sec_351 transaction however considering that the stock had a minimal fair_market_value in relation to its basis it also appears unlikely that taxpayer could have generated even any economic profit from stock which was essentially worthless see 94_tc_738 given the stock’s low value the corporation p stock would have had to increase in value over f times its received value of dollar_figureg for taxpayer to simply break even with the purported dollar_figurecc million basis p growth in value was required by disposing of the stock only a few months after its receipt taxpayer did not even attempt to realize a profit from the stock by affording the stock enough time to appreciate in value nor does the possibility of a future profit over a long-term seem even feasible under realistic business considerations even under extraordinary industry expectations tl-n-7420-00 no projection or due diligence of any anticipated profit has been shown see 113_tc_214 the tax_court found significant that neither the taxpayer nor any other representative conducted an analysis of the risks associated with trading transactions in concluding that the transactions lacked economic_substance and were entered into solely for the attendant tax benefits despite the indicia of a lack of economic_substance which are present in this case further facts must be developed to determine if under all reasonable expectations this is a valid approach under which to make a sec_482 allocation further this transaction appears to be a back-end part of a lease_stripping transaction as described in part a of notice_95_53 1995_2_cb_334 in which the service indicated that lease_stripping transactions effected through a transferred_basis transaction would result in the exercise of the service’s authority to reallocate gross_income deductions credits or allowances between the participants in the transaction if the facts once fully developed indicate that the contribution and sale of the stock appear to be part of a prearranged transaction to avoid taxation of the gain from the asset a business sale which took place during the year c taxable_year the transaction should be recharacterized pursuant to sec_1 d ii b in conformity with its true economic reality recharacterization of the transaction in this case would result in the commissioner’s disregarding limited_partnership b’s transfer of its high basis low value corporation p stock which would consequently result in the reallocation of the capital_loss claimed by taxpayer on the sale of the stock back to limited_partnership b such a reallocation made pursuant to the commissioner’s authority under the economic_substance tax_evasion standards of sec_482 would serve to prevent taxpayer from evading substantial taxes on an unrelated capital_gain b clear_reflection_of_income standard of even in the absence of tax_avoidance motives the commissioner may make a sec_482 allocation if necessary to clearly reflect income when a transfer is involved the commissioner may disregard the nonrecognition provisions of sec_351 to make a sec_482 allocation to clearly reflect income among the controlled taxpayers sec_1_482-1 to clearly reflect income or prevent the avoidance of taxes the commissioner may make an allocation under sec_482 with respect to transactions that would otherwise qualify for nonrecognition_of_gain_or_loss under sec_351 additional authority exists through case law in support of the service’s position allowing the disregard of nonrecognition provisions if necessary to clearly reflect income one such case in accord with the service’s position is 137_f2d_600 3rd cir cert_denied 320_us_794 in which a parent_corporation transferred stock with a substantial_built-in_loss to a tl-n-7420-00 wholly-owned subsidiary in a transaction which qualified as a nonrecognition_transaction under the predecessor to sec_351 the subsidiary in form sold the stock and claimed a loss deduction id pincite the commissioner disregarded the nonrecognition_transaction and treated the amount of the pre-contribution loss as sustained instead by the parent of the subsidiary under sec_45 of the revenue act of the predecessor to sec_482 id the taxpayer claimed that the subsidiary was entitled under the nonrecognition and basis provisions of the code to claim a loss deduction by virtue of the carryover_basis it received in the stock transfer id pincite the court rejected the taxpayer’s argument stating that in every case in which sec_45 was applied its application would result in a conflict with the literal provisions of some other provision id the court held the section could still be applied to clearly reflect income despite a conflict with the literal provisions of another section of the code id other cases are in accord with national securities corp that sec_482 may be applied to clearly reflect income despite apparent conflict with the provisions of another section of the code see 198_f2d_214 2nd cir cert_denied 344_us_874 commissioner properly applied sec_482 to reallocate deductions associated with property acquired in a reorganization to transferee to clearly reflect income 811_f2d_543 10th cir commissioner has broad discretion under sec_482 to correct distortion_of_income occurring through the strict application of other provisions of the code and may invoke sec_482 to reallocate income derived from the disposition of property previously acquired in a nonrecognition_transaction 281_f2d_7 4th cir 756_f2d_1430 9th cir cert_denied 474_us_1055 commissioner may invoke sec_482 to reallocate income derived from the disposition of property previously acquired in a nonrecognition_transaction see also 305_f2d_681 9th cir sec_482 will control when it conflicts with sec_351 eli lilly t c pincite8 sec_482 may be applied in circumstances involving sec_351 transactions if necessary to clearly reflect income or prevent the avoidance of tax 88_tc_252 in the instant case we conclude that taxpayer primarily engaged in the sec_351 transaction to further tax_avoidance motives and that the subsequent disposition of the corporation p stock taxpayer acquired in the transfer resulted in a distortion_of_income by disposing of the high basis low value corporation p stock received in the sec_351 transfer at a substantial loss taxpayer was able to shelter significant capital_gains income for the cost of eight shares of its stock given the short_period of time taxpayer held the stock and that the stock was likely sold prior to the close of the year c taxable_year to trigger the substantial loss inherent in the stock it is apparent that the pre-contribution loss attributable to the stock properly belongs to limited_partnership b accordingly under the analysis adopted in national securities corp and its progeny the service may disregard the sec_351 tl-n-7420-00 transfer and allocate the losses taxpayer claimed on the sale of the corporation p stock back to the transferor entity limited_partnership b to clearly reflect income a sec_482 allocation may be made despite the fact that its application would result in a conflict with the literal provisions of sec_351 which would treat the transferee corporation taxpayer as the true owner of the corporation p stock and allow it to claim the loss as set forth in national securities corp this conflict is inevitable and is not sufficient reason to prevent the application of sec_482 to the instant transaction iii potential application of sec_1_897-6t as mentioned previously and discussed below our primary argument is that the requirements of sec_351 were not met we note that if taxpayer is ultimately determined to have met the requirements of sec_351 sec_1_897-6t may potentially apply to this transaction under sec_1_897-6t if a foreign_person transfers property that is not a u s real_property interest to a domestic_corporation in a nonrecognition exchange which has an adjusted_basis in excess of its fair_market_value on the date of transfer which will not be used in or held for use in a trade_or_business of the_domestic_corporation and which is sold at a loss within two years of the transfer by the_domestic_corporation the_domestic_corporation may not use the loss to offset the gain recognized from the sale of a u s real_property interest the facts indicate that the regulation may potentially be applicable to this transaction the adjusted_basis of the corporation p stock exceeded its fair_market_value on the date of its transfer to taxpayer no facts have been provided indicating that taxpayer ever had the intention to hold the stock for use in its trade_or_business additionally taxpayer sold the corporation p stock within b months of its transfer it is not clear whether a foreign_person transferred the stock to taxpayer further facts should be developed to determine whether limited_partnership b is a foreign_partnership however regardless of whether sec_1_897-6t is applicable sec_482 may still be applied to reallocate the stock loss back to limited_partnership b d the service may challenge the capital_loss reported by taxpayer on the ground that sec_351 does not apply to the property exchanges so that limited_partnership b would recognize gain_or_loss on the exchange and taxpayer would take a basis in the stock equal to fair_market_value based on the facts as currently developed it is our position that the transaction in which limited_partnership b contributed corporation p stock to taxpayer in exchange for its stock did not satisfy the requirements of sec_351 a control requirement sec_351 provides nonrecognition treatment for transfers of property by one or more persons solely in exchange for stock in such corporation and immediately tl-n-7420-00 after the exchange such person or persons are in control as defined in sec_368 of the corporation to which the property was transferred see sec_351 transferors who contribute property to a corporation at different times may be considered part of a single control group if their rights have been previously defined and the execution of the agreement proceeds with an expedition consistent with orderly procedure sec_1_351-1 for example two transferors were treated as a group where their transfers of property were made days apart pursuant to a non-binding mutual understanding see 109_f2d_479 1st cir cert_denied 310_us_650 an existing shareholder will not be considered part of a transferor group if the property it transfers is of relatively small value in comparison to the value of the stock and securities already owned by the transferor and if the primary purpose of the transfer is to qualify under sec_351 the exchanges of property by other persons transferring property sec_1_351-1 it is generally contemplated that where a transferor in a sec_351 transaction transfers property to a controlled_corporation the transferee corporation must exchange its stock for the property contributed there is an exception whereby stock of the transferee corporation would not have to be received by the transferor as part of the exchange additional stock of the transferee subsidiary_corporation does not have to be given to the transferor as part of a sec_351 transaction in a situation for example where a parent_corporation owned all of the stock of a subsidiary_corporation and the parent_corporation transferred property in the sec_351 transaction to that subsidiary_corporation this is because the transferor in the sec_351 transaction would be a owner of the subsidiary both before and after the sec_351 transaction for the transferee to issue additional stock to the transferor under such circumstances would be meaningless see revrul_64_155 1964_1_cb_138 exchange of stock in a sec_351 transfer is not necessary where the transferor’s receipt of additional stock would not change the level of ownership_interest in the wholly owned transferee subsidiary see also 85_tc_824 rev’d on other grounds 872_f2d_519 2d cir the tax_court held that the requirements of sec_351 were met in a transfer to a wholly owned subsidiary even though no additional stock was issued prior to the purported sec_351 transaction in the facts before us partnership a owned all of the stock of taxpayer in the purported transaction taxpayer as transferee received dollar_figuren in cash from partnership a and received d shares of corporation p stock from limited_partnership b and contributed c shares of its stock to limited_partnership b partnership a also received a dollar_figurex distribution from taxpayer as part of the transaction that dwarfed the dollar_figuren transferred in form from partnership a to taxpayer partnership a got no actual stock back for its transfer in form of dollar_figuren to taxpayer following the purported sec_351 transaction partnership a owned l of taxpayer and limited_partnership b owned the remaining b tl-n-7420-00 partnership a received no taxpayer stock- where limited_partnership b is a taxpayer shareholder as a result of the purported sec_351 transaction there can be no meaningless gesture with respect to partnership a not having received taxpayer stock back in exchange for partnership a’s purported contribution of dollar_figuren in other words with limited_partnership b as a shareholder after the purported sec_351 transaction partnership a was required in the sec_351 transaction to have received taxpayer stock back in exchange for its purported transfer of dollar_figuren to taxpayer therefore the transaction appears to fail the control requirement of sec_351 because partnership a owns such a large part of taxpayer stock as part of the transaction partnership a needs to be a qualified transferordollar_figure here there was no qualified_transfer of property for stock by partnership a the facts of this case reflect that this purported sec_351 transaction was not a transaction for which failure for partnership a to receive stock in taxpayer the transferee corporation could be a meaningless gesture failure on the part of partnership a to receive taxpayer’s stock means that partnership a is not a qualified transferor under sec_351 required transfer of property under sec_351 partnership a transferred dollar_figuren to taxpayer it was contemplated as part of the purported sec_351 transaction that partnership a would receive significantly more in cash dollar_figurex from taxpayer than the dollar_figuren the dollar_figurex dividend from taxpayer to partnership a was over e times greater than the original transfer from partnership a to taxpayer therefore there was no net transfer of property by partnership a to taxpayer since partnership a did not transfer property to taxpayer partnership a was not a transferor in this transaction therefore the transaction does not meet sec_351's control requirement failure to qualify under sec_351 since the only transferor for purposes of sec_351 was limited_partnership b and limited_partnership b did not have actual control the transaction fails the sec_351 control test and results in giving taxpayer a fair_market_value basis in the corporation p stock it got from limited_partnership b so that taxpayer will not have a large loss on the sale of that stock b business_purpose requirement courts have held that a transaction meeting the statutory elements of sec_351 does not qualify for nonrecognition if it lacks a non-tax business_purpose caruth v 15limited partnership b was only a b shareholder after the purported sec_351 transaction tl-n-7420-00 united_states 688_fsupp_1129 n d tex aff’d on other issues 865_f2d_644 5th cir 714_f2d_977 9th cir in caruth the taxpayer transferred stock in a closely_held_corporation to his wholly owned corporation four days before the closely_held_corporation declared a large dividend the government argued that the dividend should be recognized by the taxpayer because his transfer of the closely held stock to his wholly owned corporation had no business_purpose the taxpayer argued that sec_351 did not require a business_purpose the court's opinion traced the development of sec_351 and concluded that the provision is tied very closely to the corporate_reorganization provisions on that basis the court reasoned that the principles applicable to reorganizations were equally valid for transfers of property to a controlled_corporation under sec_351 in kluener v commissioner tcmemo_1996_519 aff'd 154_f3d_630 6th cir the taxpayer sold his thoroughbred horses to raise funds to meet loan obligations he first transferred the horses to his wholly owned corporation which then sold the horses at auction the corporation reported the sale of the horses on its tax_return but offset the gain with a loss carryover rather than use the proceeds for its own purposes the corporation held the funds in a separate_account for several months and then distributed the entire amount to the taxpayer who used part of the funds to pay loans and loaned part back to the corporation the tax_court held that in substance the taxpayer sold the horses using the corporation as a conduit on appeal the sixth circuit affirmed in discussing sec_351 the court summarized the application of the business_purpose requirement by noting that a shareholder's transfer of property to his closely_held_corporation is not taxed if the transfer occurred for a valid non-tax business_purpose but that the code will tax a shareholder who transfers property solely to avoid taxes the court in kluener identified the standards used to determine whether there is a business_purpose for a transfer these factors include whether the transfer fulfilled its stated purpose the extent to which the transferor rather than the transferee benefitted from the transfer the extent to which the transferee needed the property the length of time between the transfer and subsequent events the number of such transfers the taxpayer's expertise in tax matters and the transactions' form courts also examine any explicit indicators of a taxpayer's intent such as documents or negotiations that confirm or belie the existence of a prearranged plan f 2d pincite tl-n-7420-00 you have indicated that the facts as currently developed do not suggest a plausible business_purpose for the transactions you state that the taxpayer has not as of yet even attempted to argue that it had a valid business_purpose if sec_351 does not apply to the transactions the transfers would be taxable exchanges under sec_1001 taxpayer's basis in the corporation p stock would be determined under sec_1012 if the taxpayer does provide a purported business_purpose for this transaction you should attempt to get as many details as possible and address any defects in that explanation after this occurs you may wish to seek our further advice on that matter at that time e whether the basis in the inflated basis stock acquired in the original sec_351 transaction in the underlying lease stip is overstated depending on the facts that may be developed with regard to the lease_strip transactions additional arguments might be made that the application of sec_358 will reduce the basis by the amount of any liability usually the obligation to pay rent that is assumed in the underlying transaction that created the inflated basisdollar_figure the assumption of the liability would be within the scope of sec_357 and under sec_357 sec_358 and sec_358 the basis of the stock received must be reduced by the amount of the liability assumed the service should reject any argument that the obligation to pay rent is a liability described in sec_357 and that therefore the assumption of the liability does not reduce the stock basis by reason of sec_358 additional arguments should be considered even if the assumption of the lease obligations would otherwise be within the scope of sec_357 and sec_358 you should consider whether the assumption should be treated as a distribution of money under sec_357 and therefore should reduce the stock basis under sec_358 in general sec_357 provides that if taking into consideration the nature of the liability and the circumstances in the light of which the arrangement for the assumption was made it appears that the principal purpose of the taxpayer with respect to the assumption described in sec_357 was either a purpose to avoid federal_income_tax on the exchange or if not such purpose was not a bona_fide business_purpose then such assumption shall for purposes of sec_351 be considered as money received by the taxpayer on the exchange sec_357 16these transactions occurred before date and therefore sec_358 would not be applicable tl-n-7420-00 this will require consideration of whether the facts show that taxpayer assumed the indebtedness without a proper business_purpose once you have determined these facts you may wish to seek additional field_service_advice in addition you should consider whether an argument can be made that the transaction does not provide a bona_fide loss under sec_165 this will also require a consideration of whether the facts show an economic loss see notice_99_59 1999_2_cb_761 once you have determined these facts you may wish to seek additional field_service_advice on that issue the foreign shareholders of taxpayer a domestic_corporation may be held liable as transferees for taxpayer's tax_liability resulting from the corporation's long term capital_gain on the sale of the appreciated assets although taxpayer is a domestic_corporation the original shareholders consist of a country a nonresident_alien a country a company and a country b country a joint_venture on date e taxpayer's shareholders sold their entire interests to partnership a partnership a's partners ultimately were corporation w and corporation xdollar_figure if it is possible to hold the original shareholders liable as transferees then the dollar_figurev transfer to the shareholders in exchange for their stock could be characterized in two ways on the one hand it could be characterized as a redemption distribution and hence a transfer to the original shareholders since the payments had their source in taxpayer because they were derived from an obligation taken on and satisfied by taxpayer dollar_figure see 217_f3d_1117 9th cir alternatively the transfer could be characterized as a liquidation ie a de_facto_liquidation distribution and hence a transfer by taxpayer to its original shareholders since taxpayer did not have the ability to satisfy its liabilities after it paid the dividends to partnership a which partnership a apparently used to pay off the loan to the financial_institution a see sec_1_332-2 redina v commissioner tcmemo_1996_392 more specifically if the shareholders and not taxpayer are to be held liable for the tax it must be determined whether transferee_liability can be asserted 17the examiner believes that partnership a is either the promoter of this transaction or an entity created by the promoter 18partnership a borrowed the money to purchase the stock from the financial_institution a on date e taxpayer declared dividends payable to partnership a totaling dollar_figurey according to a corporate resolutions dollar_figurer was required to be paid prior to the transaction and dollar_figurex was required to be paid after the transaction although the funds have not yet been traced it is likely that the funds were used to pay off partnership a’s dollar_figurew note and the dollar_figuree arrangement fee to the financial_institution a tl-n-7420-00 transferee_liability sec_6901 of the internal_revenue_code provides a procedure through which the service may collect from a transferee of assets unpaid taxes owed by the transferor of the assets if a basis exists under applicable federal or state law for holding the transferee liable 111_tc_172 aff’d 213_f3d_1173 9th cir a transferee’s liability may be established either at law or in equity 37_tc_945 sec_6901 of the code does not create the liability of a transferee but is a secondary method for enforcement of the existing liability of the transferor 57_tc_680 although sec_6901 provides a method by which to collect the tax federal or state law determines the existence and extent of the liability of a transferee 93_tc_475 in the case of a shareholder under the facts before us transferee_liability can arise in equity under state law in the form of uniform fraudulent transfer act ufta as adopted by the district of columbia in furthermore transferee_liability can arise under the federal debt collection procedure act fdcpa because we can assert liability under the dcufta or the fdcpa we need not address whether transferee_liability arises under the equitable trust_fund_theory or whether transferee_liability at law can be asserted dcufta and fdcpa state law has traditionally governed transferee_liability in both equity and law see 357_us_39 the court held that until congress speaks to the contrary the existence and extent of transferee_liability should be determined by state law however transferee_liability can be based either on the federal or state statutes such as the uniform fraudulent transfer act ufta or the federal debt collection procedure act fdcpa in the instant case both the ufta as enacted by the district of columbia in hereafter dcufta and the fdcpa govern the transaction dcufta in particular d c code a provides that a transfer made or obligation incurred by a debtor is fraudulent as to a creditor whether the creditor’s claim arose before or after the transfer was made or the obligation was incurred if the debtor made the transfer or incurred the obligation with actual intent to hinder delay or defraud any creditor of the debtor or without receiving a reasonably equivalent value in exchange for the transfer or obligation and the debtor was engaged or was about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction or intended to incur or believed or reasonably should have 19d c code to tl-n-7420-00 believed that the debtor would incur debts beyond the debtor’s ability to pay as they became due the dcufta defines a creditor as anyone having a claim d c code a claim is defined as a right to payment whether or not the right is reduced to judgment liquidated unliquidated fixed contingent matured unmatured disputed undisputed legal equitable secured or unsecured d c code under the dcufta a transaction may be voided whether it involves constructive or actual fraud in the case of constructive fraud the transfer is fraudulent without regard to actual intent if the conveyance is made without fair consideration and the debtor is either insolvent at the time or is rendered insolvent by the transfer a transfer made by a debtor is fraudulent whether the creditor’s claim arose before or after the transfer was made if the debtor made the transfer without receiving a reasonably equivalent value in exchange for the transfer in the case of actual fraud there is no need to show that the conveyance was made for inadequate consideration however unlike constructive fraud the irs would be required to show actual intent by the transferor to defraud delay or hinder creditors this is normally achieved through circumstantial evidence known as the badges_of_fraud which are listed in d c code b as in the case of constructive fraud the transfer need not be made before the creditor’s claim arises fdcpa the federal debt collection procedure act fdcpa is an additional law at the federal level for which the service can use to provide for transferee liabilitydollar_figure the fdcpa describes five potential grounds in sec_3304 for setting aside transfers that are fraudulent as to debts owed the united_states including tax debtsdollar_figure three of these fdcpa provisions for setting aside transfers fraudulent as to the united_states involve variants of constructive fraud sub sec_3304 20the fdcpa u s c et seq was enacted in and basically parallels the provisions of the ufta u s c b provides that this chapter shall not be construed to curtail or limit the right of the united_states under any other federal_law or any state law to collect taxes or to collect any other amount collectible in the same manner as a tax see u s c b defining debt as including an amount owing to the united_states on account of a tax see also 224_br_435 bankr d al and united_states v sawaf f 3d 6th cir tl-n-7420-00 b b i and b b ii a fourth fdcpa provision addresses actual fraud sub sec_3304dollar_figure a fifth fdcpa provision sub sec_3304 involves transfers to insiders of the transferor for even bona_fide antecedent debts if the insider had reasonable_cause to believe the transferor was insolvent in addition to the dcufta fraudulent transfer provisions described above the service can consider alternative reliance on any of the five fdcpa provisions as potential grounds in this case for imposing personal transferee_liability under sec_6901 or for filing a federal district_court action to set_aside a fraudulent transfer with respect to the transfers to the taxpayer shareholders see 111_tc_172 n aff’d 213_f3d_1173 9th cir sub sec_3304 describes eleven non-exclusive factors badges_of_fraud to be considered in determining the transferor’s actual intent to hinder delay or defraud a creditor for purposes of the fdcpa including that the transfer was to an insider the transfer was of substantially_all the debtor’s assets the value of the consideration received by the debtor was not reasonably equivalent the debtor was insolvent or became insolvent shortly after the transfer was made and or the transfer occurred shortly before or shortly after a substantial debt was incurred the five potential fdcpa grounds described in u s c sec_3304 that are available to the service for setting aside a transfer that is fraudulent as to a tax debt owed the united_states are as follows sec_3304 transfer fraudulent as to a debt to the united_states a debt arising before transfer - except as provided in sec_3307 a transfer made or obligation incurred by a debtor is fraudulent as to a debt to the united_states which arises before the transfer is made or the obligation is incurred if - a the debtor makes the transfer or incurs the obligation without receiving a reasonably equivalent value in exchange for the transfer or obligation and b the debtor is insolvent at that time or the debtor becomes insolvent as a result of the transfer or obligation or a the transfer was made to an insider for an antecedent debt the debtor was insolvent at the time and b the insider had reasonable_cause to believe that the debtor was insolvent according to united_states v maryans aftr2d n d ind a transfer made with intent to defraud a creditor under u s c sec_3304 is fraudulent as to a debt to the united_states regardless of when such debt arose in relation to the transfer see also 991_fsupp_678 s d n y tl-n-7420-00 b transfers without regard to date of judgment - except as provided in sec_3307 a transfer made or obligation incurred by a debtor is fraudulent as to a debt to the united_states whether such debt arises before or after the transfer is made or the obligation is incurred if the debtor makes the transfer or incurs the obligation - a with actual intent to hinder delay or defraud a creditor or b without receiving a reasonably equivalent value in exchange for the transfer or obligation if the debtor - i was engaged or about to engage in a business or a transaction for which the remaining assets of the debtor were unreasonably small in relation to the business or transaction or ii intended to incur or believed or reasonably should have believed that he would incur debts beyond his ability to pay as they became due in the instant case we understand that your office intends to recast the transaction as a redemption or alternatively as a liquidation the facts submitted disclose that the transfer to the shareholders rendered taxpayer insolvent a transfer to a shareholder whether in the context of a redemption or liquidation is considered to be in exchange for an inadequate consideration because the stock of a shareholder is simply a certificate representing the assets of the corporation based on the facts submitted the transaction as recast in this case is a constructive fraud on the creditors under the dcufta or the fdcpa you question whether the dcufta or fdcpa will apply here since there is no indication that the amount_paid the shareholders for the stock by partnership a was not reasonable as indicated above a recharacterized transaction is considered to be the actual transaction for all purposes of the code since the form of the recasted transaction reflects the true nature of the transaction in light of your recharacterization of the transaction the shareholders will be treated as having received their consideration from taxpayer rather than partnership a as a consequence the distribution to the shareholders will be considered either as a redemption or as a liquidating dividend in either case the distribution will be deemed to lack adequate_consideration furthermore it has been questioned whether the service can impose transferee_liability where a transfer is made during as opposed to after the taxable_year of the transferor the question arises because it might be argued that the tax_liability of the transferor did not accrue until a tax was due at the end of the year however it is our position that dcufta and fdcpa both provide that transferee_liability can be established by demonstrating that the transfer occurred either during or after the period for which the tax_liability of the transferor accrued since the shareholder transferees are liable under both dcufta and fdcpa we need not address whether they are liable under the trust fund doctrine or transferee_liability at law tl-n-7420-00 guidance as to collection from foreign shareholders it is a well established principle of common_law that no country has an obligation to further the governmental interests of a foreign sovereign by assisting in the collection_of_taxes owed the latter known as the revenue rule the doctrine is traced to an opinion by lord mansfield in holman v johnson eng rep k b although courts have sometimes questioned the soundness of the revenue rule it has long been accepted and prevails both in international and united_states practice see restatement third of foreign relations sec_483 and note1 see also 376_us_398 the revenue rule is overcome in modern times by bilateral tax_treaties that provide for mutual assistance in collection in most of the tax_treaties signed by the united_states the collection_assistance_provision is generally directed only against persons who improperly claim the treaty benefits but the u s tax_treaties with canada denmark france netherlands and sweden each has more comprehensive provisions for collection23 each of these countries and the united_states have by a separate bilateral tax_treaty mutually agreed to assist each other in collecting the taxes owed the treaty partner subject_to certain conditions in the only domestic case on the subject 955_fsupp_795 n d ohio the u s district_court upheld an irs treaty collection request to the dutch government which resulted in the seizure of taxpayer’s assets held in a bank safe deposit box in baarn the netherlands in the present case assuming that the original shareholders of taxpayer are liable as transferees any collection_of_taxes from them would depend on the provisions of the tax_treaties the united_states has with the respective countries where the transferees or their assets are located individual a is a country a citizen foreign_corporation t is a country a corporation and foreign_entity v is a country b country a joint_venture article a of the u s -country a income_tax treaty provides for mutual assistance in collection of income taxes but paragraph a of this article states that assistance shall not be accorded with respect to citizens companies and other entities of the contracting state to which application is made the country a tax authorities would therefore refrain from assisting the service in collecting taxes owed by individual a foreign_corporation t and foreign_entity v the country b authorities would be equally disinclined to assist in collection with respect to taxes owed by foreign_entity v because of a nearly identical provision in article b of the u s -country b income_tax treaty convention with respect to taxes on income and on capital date u s - can tias income_tax convention date u s -den tias convention for the avoidance of double_taxation date u s -fr kav convention for the avoidance of double_taxation date u s -nether kav convention for the avoidance of double_taxation date u s -swe kav tl-n-7420-00 in these instances the bar against providing assistance in collection applies only with respect to the citizens and residents of each requested state we interpret this to mean that neither requested state is prohibited from assisting in collection of u s taxes from out of property or assets of noncitizens and nonresidents located within its boundaries we can therefore request the u s competent_authority to see if her counterpart in country b would assist in collection_of_taxes owed by individual a and foreign_corporation t likewise we may also ask the u s competent_authority to request her counterparts in both country a and the country b to assist in collecting from assets owned by the noncitizen or nonresident component of the joint_venture foreign_entity v and located in each country in the event collection efforts using the country b and country a treaties are unsuccessful there is another avenue worth exploring the service may initiate a suit for appointment of a receiver as authorized by sec_7403 d such an action needs to be coordinated with the office of procedure and administration collection bankruptcy and summons for appointment of a receiver the service need only make a prima facie showing that a substantial tax_liability probably exists and that collection of the tax may be jeopardized if a receiver is not appointed 291_f2d_520 2d cir if a u s district_court could assert personal jurisdiction over any of the former shareholders of taxpayer based on their physical presence in the united_states it can order the appointment of a receiver and repatriation of assets to the united_states 196_fsupp_243 s d n y aff’d 302_f2d_821 2d cir see also united_states v clough a f t r 2d n d calif it would not be appropriate or practicable under any other theories or remedies to hold the foreign shareholders liable as transferees of domestic stock in taxpayer or on its subsequent disposition the accuracy-related_penalty provided by code sec_6662 applies to deficiencies that result from adjustments to the losses reported by taxpayer from its disposition of the stock received in the purported sec_351 transaction code sec_6662 imposes a penalty in an amount equal to percent of the underpayment_of_tax attributable to one or more of the items set forth in code sec_6662 the items set forth in code sec_6662 include as is relevant here negligence substantial understatements of income_tax and substantial valuation misstatements under chapter also sec_6662 imposes a penalty equal to percent of the underpayment_of_tax attributable to a gross_valuation_misstatement as defined in sec_6662 for detailed discussions on these subjects see litigation_guideline_memorandum entitled appointment of receivers for foreign assets intl-3 and the related lgm writs of ne_exeat_republica intl-2 gl-7 tl-n-7420-00 negligence - negligence includes a failure to make a reasonable attempt to comply with provisions of the internal revenue laws or failure to do what a reasonable and ordinarily prudent person would do under the same circumstances see sec_6662 martello v commissioner 380_f2d_499 5th cir aff'g on this issue 43_tc_168 sec_1_6662-3 a return position that has a reasonable basis is not attributable to negligence but negligence is strongly indicated where a taxpayer fails to make a reasonable attempt to ascertain the correctness of a reported_item which would seem to a reasonable and prudent person to be 'too good to be true' under the circumstances sec_1_6662-3 the accuracy-related_penalty does not apply with respect to any portion of an underpayment if it is shown that there was reasonable_cause for such portion of an underpayment and that the taxpayer acted in good_faith with respect to such portion see sec_6664 the determination of whether the taxpayer acted with reasonable_cause and in good_faith depends upon the pertinent facts and circumstances see sec_1_6664-4 the most important factor is the extent of the taxpayer’s effort to assess the proper tax_liability for the year see id the negligence_penalty can be applied to deficiencies resulting from the application of the economic_substance_doctrine 113_tc_214 here the facts developed seem to support the view that the accuracy-related_penalty attributable to negligence applies to the deficiency that results from the disallowance of the built-in losses from the inflated basis assets because taxpayer appears to have disregarded the economic_substance of the transactions from which the losses were claimed and has failed to offer evidence that there was reasonable_cause for its return position for the losses or that it acted in good_faith in claiming them many of the players involved in the transactions were individuals with a history of involvement in lease_stripping transactions and either knew or should have known that the service had issued notice_95_53 stating that it intended to challenge lease_stripping transactions such as those from which the inflated bases of the stock were derived there is no evidence that they thoroughly investigated the bona_fide economic aspects of the lease_stripping transactions or reasonably relied on professional advice that the losses are allowable see 904_f2d_1011 5th cir sec_1_6664-4 we accordingly conclude that the facts as currently developed may well support the conclusion that taxpayer was negligent and that the penalty provided by code sec_6662 should therefore be considered substantial_valuation_misstatement - a percent accuracy related penalty is imposed on the portion of any underpayment caused by a substantial_valuation_misstatement the penalty is increased to percent in the case of a gross_valuation_misstatement a substantial_valuation_misstatement exists if the adjusted_basis of any property claimed on a return is percent or more of the amount determined to be the correct amount of such adjusted_basis sec_6662 a gross_valuation_misstatement occurs where the value or adjusted_basis of any property claimed on any return is or more of the tl-n-7420-00 amount determined to be the correct valuation or adjusted_basis sec_6662 the circumstances in which a valuation misstatement exists include the circumstance when a taxpayer's claimed basis is disallowed for lack of economic_substance 933_f2d_143 2d cir cert_denied 502_us_1031 here if the service prevails on its challenge to the basis reported by taxpayer in the stock it received in the purported sec_351 transaction we believe the penalty provided by code sec_6662 would apply on the grounds that a substantial_valuation_misstatement would exist if the basis taxpayer claimed was percent or more of the amount determined to be the correct basis we believe the penalty would be percent of the underpayment see sec_6662 substantial_understatement_of_income_tax - a substantial_understatement_of_income_tax exists for a taxable_year if the amount of understatement exceeds the greater of percent of the tax required to be shown on the return or dollar_figure dollar_figure in case of a corporation other than an s_corporation or personal_holding_company as defined in sec_542 sec_6662 understatements are generally reduced by the portion of the understatement attributable to the tax treatment of items for which there was substantial_authority for such treatment and any item if the relevant facts affecting the item's tax treatment were adequately disclosed in the return or an attached statement and there is a reasonable basis for the taxpayer's tax treatment of the item sec_6662 however those reductions do not apply to items of corporations attributable to tax_shelters sec_6662 tax_shelter means as is relevant here any plan or arrangement a significant purpose of which is the avoidance or evasion of federal_income_tax sec_6662 however for transactions entered into on or before date a principal purpose rather than a significant purpose test applies in determining whether a tax_shelter is present we believe that the facts currently developed support the position that the series of transactions in which taxpayer acquired and sold the inflated basis stock to recognize the built-in losses was potentially a tax_shelter the facts suggest that the purpose of the transactions was to generate losses to offset gains from the sale of the asset a business by taxpayer and do not suggest a business_purpose for the transactions in these circumstances we believe that any understatement that resulted from the disallowance of the loss claimed from the preferred_stock if substantial may well be subject_to the penalty provided by code sec_6662 due to a substantial_understatement unless the taxpayer meets the reasonable_cause exception to sec_6664 with respect to reasonable_cause for the substantial_understatement_penalty attributable to tax_shelter items of a corporation special rules apply see sec_6662 for the definition of a tax_shelter the determination of whether a corporation acted with reasonable_cause and good_faith in its treatment of a tax_shelter_item is based on all pertinent facts and circumstances sec_1_6664-4 a corporation's legal justification may be taken into account as tl-n-7420-00 appropriate in establishing that the corporation acted with reasonable_cause and in good_faith in its treatment of a tax_shelter_item but only if there is substantial_authority within the meaning of sec_1_6662-4 for the treatment of the item and the corporation reasonably believed at the time the return was filed that such treatment was more_likely_than_not the proper treatment sec_1_6664-4 the regulations provide that in meeting the requirement of reasonably believing that the treatment of the tax_shelter_item was more_likely_than_not the proper treatment the corporation may reasonably rely in good_faith on the opinion of a professional tax advisor if the opinion is based on the tax advisor's analysis of the pertinent facts and authorities in the manner described in sec_1_6662-4 and the opinion unambiguously states that the tax advisor concludes that there is a greater than 50-percent likelihood that the tax treatment of the item will be upheld if challenged by the service sec_1_6664-4 in addition the requirements of sec_1_6664-4 must also be met with respect to the opinion of the tax advisor in particular the opinion must be based on all the pertinent facts and circumstances and the taxpayer’s purposes and their relative weight for entering into the transaction and structuring it in a particular manner also the advice cannot be based on unreasonable factual or legal assumptions and must not unreasonably rely on the representations or statements of the taxpayer or any other person therefore if possible the tax advisor's opinion should be obtained to determine whether these requirements are met although satisfaction of the substantial_authority and belief requirements is necessary to a reasonable_cause finding this may not be sufficient for example reasonable_cause may not exist if the taxpayer's participation in the tax_shelter lacked significant business_purpose if the taxpayer claimed benefits that were unreasonable in comparison to the initial investment in the tax_shelter or if the taxpayer agreed with the shelter promoter that the taxpayer would protect the confidentiality of the tax aspects of the structure of the tax_shelter sec_1_6664-4 you have indicated that the facts as currently developed do not satisfy the reasonable basis standard that applies for purposes of determining negligence therefore the more stringent substantial_authority standard would also not be satisfied see sec_1_6662-4 and sec_1_6662-3 also assuming the underpayment is due to negligence ie a failure to make a reasonable attempt to comply with the tax laws or to exercise ordinary and reasonable care in the preparation of the return then the reasonable_cause exception of sec_6664 would not apply the most important factor in determining whether the taxpayer acted with reasonable_cause and in good_faith is the extent of the taxpayer’s effort to assess the taxpayer’s proper tax_liability sec_1_6664-4 a finding of negligence would be consistent with a conclusion that the taxpayer made only minimal efforts to assess the proper tax_liability tl-n-7420-00 moreover we believe that any understatement that resulted from the disallowance of the loss claimed from the inflated basis assets may well if substantial be subject_to the substantial_understatement_penalty provided by code sec_6662 even if the series of transactions in which taxpayer acquired and sold the inflated basis assets to recognize the built-in losses was not a tax_shelter if the transactions were not a tax_shelter the understatement would be reduced by the portion of the understatement attributable to the tax treatment of items for which there was substantial_authority for such treatment and any item if the relevant facts affecting the item’s tax treatment were adequately disclosed in the return or an attached statement and there is a reasonable basis for the taxpayer’s tax treatment of the item sec_6662 neither of those exceptions appears to apply the substantial_authority standard is higher than the reasonable basis standard sec_1_6662-4 you have indicated that the facts as currently developed do not support a conclusion that taxpayer had even a reasonable basis for claiming the inflated basis in addition you have indicated that the relevant facts affecting the items' tax treatment were not disclosed in the return of taxpayer or in attached statements case development hazards and other considerations tl-n-7420-00 this writing may contain privileged information any unauthorized disclosure of this writing may have an adverse effect on privileges such as the attorney client privilege if disclosure becomes necessary please contact this office for our views please call if you have any further questions jasper l cummings jr associate chief_counsel corporate alfred c bishop jr branch chief cc corp br by