department of the treasury internal_revenue_service washington d c date dom fs i uilc number release date internal_revenue_service national_office field_service_advice memorandum for from assistant chief_counsel field service cc dom fs subject this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be cited as precedent legend taxpayer b c d e f g h law firm law firm nationality country period period period period period period period date date date date date date date date date year w year x year y year z amount amount amount amount amount amount amount amount amount amount amount dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure amount amount amount amount amount amount amount amount amount amount amount percentage percentage percentage percentage percentage months x months y months z credit rating forms issues dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure dollar_figure whether the lease_stripping transactions at issue are sham transactions lacking business_purpose and economic_substance whether the step_transaction_doctrine applies to the lease_stripping transactions at issue what is the proper characterization of d’s purchase of the lease receivables whether the service should challenge the depreciation_deductions attributable to the lease_stripping transactions under sec_167 whether sec_482 applies to the taxpayer and other parties to the lease- stripping transactions at issue and if so what are the consequences of applying sec_482 conclusions the service should apply the sham_transaction theory to support the disallowance of the taxpayer’s claimed deductions for rental expenses in the years at issue on the grounds that the lease-stripping transaction lacks economic_substance the parties did not have any business_purpose for carrying out the transaction and the parties entered into the transaction for tax_avoidance purposes the service should not assert the step transaction more facts need to be developed before a determination may be made regarding how to characterize the transaction and whether the sale vs financing argument applies in this case from the facts provided we conclude that sec_482 may apply to taxpayer and the other parties collectively the participants to the transaction because the participants acted in concert pursuant to a common plan to arbitrarily shift income and deductions the participants will be treated as members of the same controlled_group for purposes of sec_482 facts this case involves a lease-stripping transaction where one party realizes rental income from property and another party or parties to the transaction claim deductions for rental expenses and or depreciation on the equipment in notice_95_53 1995_2_cb_334 the service defined and described forms of lease-stripping transactions and the i r c sections and doctrines that are applicable to such transactions notice_95_53 states that depending upon the facts of the case the service may apply the following authorities to the transaction sec_269 sec_382 sec_446 sec_482 sec_701 or sec_704 sec_7701 and the regulations of each section and authorities that recharacterize certain assignments or accelerations of future payments as financings assignment-of-income principles the business-purpose doctrine or the substance-over-form doctrines including the step transaction and sham doctrines we understand that taxpayer entered into two lease-stripping transactions and that the two transactions are factually very close based on the information provided to us the following is a summary of the first transaction which is described more fully in the request for field_service_advice these are the facts that taxpayer’s purport happened and are reported as such without validating the facts the initial participants to the transaction were c a u s_corporation engaged in the business of computer equipment_leasing and b we understand that b is a resident and citizen of country had spent fewer than days each year in the united_states did not conduct any business in the united_states and did not have a permanent_establishment in the united_states b was apparently experienced in computer leasing and operated a consulting company focusing on cross-border tax structures step purchase of the equipment on date b purchased computer equipment from c for amount the equipment was subject_to pre-existing user leases between third parties and c as well as liens of financial institutions securing nonrecourse loans entered into by c the third-party lessees paid rent directly to the financial institutions holding the liens c did not transfer any rights with respect to these user leases eg the right to receive third-party rents to b also during the terms of the third-party leases the third parties were permitted to sublease or relocate the equipment without b’s consent to finance the purchase b borrowed amount from the e and borrowed the remainder of the purchase_price from c in the form of amount of recourse installment notes and amount of nonrecourse balloon notes the e loan was secured_by the equipment if b defaulted e’ recourse was limited to the equipment and to third-party rents the loan and was payable approximately ½ years after the purchase however any transfer of b’s interest in the equipment prior to the loan’s due_date would accelerate the payment of principal and interest under the loan unless b obtained c’s consent he was prohibited from selling or assigning his interest in the equipment and from leasing the equipment to any party except c although he was permitted to sell his right to receive rents under a lease if such sale occurred prior to the maturity of the installment notes the notes would be accelerated and all principal and interest would become immediately payable additionally all proceeds from such a sale were required to first be used as prepayment of principal and accrued interest on the installment notes step leaseback of the equipment on date simultaneously with the purchase b leased back the equipment to c for a maximum term of approximately four years the terms of the lease and we assume the sales documents were expressly conditioned on b’s anticipated ability to sell or assign his right to receive rent under the lease the lease terms provided that c had the option of purchasing the equipment at the end of the lease for its fair_market_value at such time he also had the option of terminating the lease between period period the early termination_date and reacquiring the equipment for the greater of its fair_market_value or the balance outstanding on the balloon note plus an early termination fee because the equipment was subject_to pre-existing user leases neither c nor b actually used the equipment and c’s rights under the sale_and_leaseback agreements were subject_to the rights of the third-party lessees b could not interrupt the third-party lessees’ use of the equipment unless c and the third parties obligated to pay rent to c both defaulted c which had managed the third-party leases prior to the sale to b continued to do so after the sale under the terms of the lease b was not responsible to c for the maintenance repair or servicing of the equipment further as required by the lease c promised to indemnify him for any claims or losses from any_action by c or third-party lessee step sale of the lease receivable two weeks after the sale-leaseback on date b sold the right to receive certain rents in lump sum to d a u s bank for amount the lease receivable under the terms of the sale agreement c would pay rent directly to d instead of b until one day before the early termination_date period or when c prepaid all rent due whichever occurred earlier after such time d agreed to reconvey to b its right to receive rent from c d was solely responsible for demanding and collecting these payments b was under no obligation to take such action d had no security_interest in the equipment and no recourse against b d’s recourse was limited to c the sale of the lease receivable triggered the acceleration of the installment notes and b was required to use the amount sale proceeds to pay off the amount installment notes as required by the terms of the notes and the security_agreement d directly wired the proceeds to c’s account the purchase agreement provides pincite that purchase and sale of undivided lease interests subject_to the terms of this agreement on the closing date seller hereby sells assigns transfers and conveys to purchaser and purchaser hereby purchases and acquires from seller an undivided_interest of percentage1 in the purchased lease the ‘undivided lease interest’ for the purchase_price subject_to the provisions contained in sec_3 and below such sale shall be absolute and without_recourse against seller except for the warranties and agreements on the part of seller expressly set forth hereunder thus the purchase agreement purports to be a sale of the interests in the leases the purchase agreement pincite states that agreement to reconvey purchaser and seller hereby agree that upon a prepayment of rent or one business_day prior to the early termination_date purchaser shall reconvey transfer and assign to seller all of purchaser’s right title and interest in and to the undivided lease interest with respect to the applicable category of equipment except for the designated rights and identified payments free and clear of all leases and liens other than permitted liens and ii if any amounts become due and payable by the lessee other than amounts constituting designated rights or identified payments in consideration of the mutual covenants contained herein purchaser shall immediately reconvey transfer and assign to seller all of purchaser’s right title and interest in and to the right to receive any such amount free and clear of all leases and liens other than permitted liens such rights title and interests to be reconveyed being hereinafter collectively referred to as the reconveyed rights c was the lessee on the leases the designated rights defined in the purchase agreement pincite mean the right to demand collect sue for receive and retain including without limitation all rights of seller to require prepayment of the percentage of rent upon an event of default the percentage of payments of rent and any prepayments thereof together with interest on overdue payments thereof as provided in the lease and ii all rights of seller to receive the casualty value with respect to each unit of equipment but shall not include any interest in the equipment of any other rights under the lease d agreed that it would have no claim or recourse against b with respect to certain designated rights or identified payments or such failure of lessee to pay rent or any other_amounts pursuant to the terms of the lease purchase agreement pincite the parties also agreed in the purchase agreement pincite that there are or there may be from time to time other purchasers of undivided percentage interests in the purchased lease other than the undivided lease interest notwithstanding the foregoing purchaser shall have the right subject_to sec_4 hereof to exercise individually all power rights and remedies under this agreement_against seller as if there were no other purchasers and purchaser acknowledges and agrees that each other purchaser may from time to time be granted by seller the same right under its agreement with respect to such other purchaser’s purchase of its undivided percentage interest in the purchased lease the parties agreed that the purchaser would bear the risk of loss on non-payment of the rents in the purchase agreement pincite as follows b seller will do and perform any and all acts and execute any and all documents in order to effect the purposes of this agreement and the sale of the undivided lease interest hereunder and to perfect and evidence purchaser’s ownership of the undivided lease interest c purchaser and seller shall direct lessee to make to purchaser i payments of rent including any prepayments of rent representing the percentage of the purchased lease together with interest on overdue payments which rents are payable pursuant to sec_2 and c of the lease after the date hereof but before the early termination dates and ii payments of casualty value payable pursuant to the lease purchaser shall have the sole responsibility for demanding collecting and receiving the identified payments and seller shall take no action with respect thereto it appears from the facts that d did not receive a security_interest in the underlying leased equipment or the leases furthermore in the purchase agreement pincite the parties agreed that except pursuant to sec_3 purchaser agrees not to sell assign or participate any of its interest in this agreement or the undivided lease interest other than purchaser’s interest in the designated rights and the identified payments subject_to the final proviso of this clause f and any attempted assignment in violation of this provision shall be void provided that purchaser may sell or assign any of its interest the transferred interest in this agreement or the undivided lease interest to one or more purchasers so long as any such purchaser agrees that such purchaser shall be bound by the terms of this agreement with respect to such transferred interest such purchaser shall become a purchaser for all purposes hereunder with respect to such transferred interest and such purchaser shall properly execute and deliver internal_revenue_service forms upon the sale of such transferred interest to such purchaser if requested by seller or lessee provided further that any sale assignment participation or transfer by purchaser of its interest in this agreement or the undivided lease interest shall not be made without seller’s prior written consent if the same i would increase any obligations or costs or diminish any rights of seller hereunder or in connection herewith or ii is to be made to a person other than a u s banking institution or a u s branch or a foreign banking institution in exhibit a the intercreditor agreement of the purchase agreement pincite sec_2 reads in relevant part as follows if on or prior to date the seller has not fully discharged its obligations toward the bank under the bank note and the bank e security_agreement the purchaser agrees to promptly deliver to the bank the lease marked original in which case the bank shall hold such lease as successor agent in accordance with sec_2 otherwise the purchaser shall immediately deliver the same to the seller unless as of such date the seller has not fully discharged its obligations toward the nonrecourse lender thus d the purchaser was required to deliver to either e or to b the seller the original lease and d therefore was required to keep the lease for approximately months y from period in the purchase agreement pincite the parties agreed that purchaser further agrees that it shall have no claim or recourse against seller with respect to such designated rights or identified payments or such failure of lessee to pay rent or any other_amounts pursuant to the terms of the lease d subsequently assigned the lease receivables to g and h see letter dated date from law firm to f in other documents relating to this transaction the transaction is discussed as a sale of the lease receivables see letter of date from law firm to f discussing the transaction as a sale step transfer of b’s interest in exchange for stock in f on date b and taxpayer which owned all of the stock of f engaged in a transaction they intended to qualify as a sec_351 transaction we assume that f files a consolidated_return with taxpayer taxpayer contributed to f amount of cash in exchange for additional shares of f common_stock b contributed to f his interest in the equipment and lease in exchange for f preferred_stock his interest essentially consisted only of legal_title to the equipment and a contingent rental stream associated with the lease after the period as the rental stream associated with the first months y had already been sold to d the future rental stream was not guaranteed because c had the option of terminating the lease by the period thus f’ remaining economic_interest appears to be based on the equipment’s residual_value and a contingent rental stream beginning in two years according to the exchange_agreement dividends on b’s preferred_stock would accrue at an annual rate of percentage of the amount liquidation value payable in cash on the earlier of date or the date of redemption after date the annual dividend rate dropped to percentage b was granted the right to redeem his stock but only between period after date f had the option to redeem the stock because the terms of the e loan required b to prepay the outstanding balance of the loan upon the transfer of his interest in the equipment and lease part of the amount cash contribution from taxpayer was used by f to pay off the outstanding amount balance of the loan step appraisals of the equipment and early termination of the lease on the date b purchased the equipment date two appraisal companies were hired by b and or c to estimate the residual_value of the equipment taxpayer also obtained appraisals at the time it entered the transaction the appraisers had uniformly estimated the equipment's fair_market_value at the early termination_date to be amount and the residual fair_market_value at the regular termination_date to be amount between period c exercised its early termination option because c asserted that the amount due on the balloon notes and accrued interest exceeded the actual fair_market_value at the early termination_date it sought to reacquire the equipment from f by paying the principal and accrued interest on the balloon notes which was amount in any event the amount offered by c and apparently accepted by taxpayer required nothing more than cancellation of f’ balloon note obligation to c the reacquisition resulted in a amount loss for f reported tax consequences for its tax years period f claimed a total of amount of depreciation expense and a amount sec_1231 loss it is unclear whether f claimed additional deductions for interest_expense the request for field_service_advice only specified depreciation_deductions and a sec_1231 loss f did not report any rental income in connection with the equipment although b’s sale of the lease receivable to d was a recognition event for u s tax purposes no u s tax was imposed on the gain from the sale because b was not subject_to u s taxation from f’ perspective it was not required to recognize this gain because it was not yet the legal owner of the equipment and lease when the gain was required to be taken into account for u s tax purposes thus f claimed it was not liable for any_tax on the gain on the sale of the lease receivable issue whether the lease_stripping transactions at issue are sham transactions lacking business_purpose and economic_substance conclusion we concur with district_counsel and recommend asserting the sham_transaction theory to attack the sales leasebacks in this case law and analysis district_counsel has indicated it believes that the sham_transaction theory is the strongest argument for challenging the transactions if the service prevails on this ground the taxpayer’s claimed depreciation_deductions and sec_1231 losses will be entirely disallowed in notice_95_53 1995_2_cb_334 the service discusses lease strips or stripping transactions and the tax consequences of these transactions in this notice the service announced that it may apply the substance-over-form-doctrines including the sham_transaction theory and the step transaction theory as to the sham_transaction theory generally where there is a genuine multiple-party transaction with economic_substance which is compelled or encouraged by business or regulatory realities is imbued with tax-independent considerations and is not shaped solely by tax-avoidance features that have meaningless labels attached the transaction is not a sham and the service should honor the allocation of rights and duties effectuated by the parties to provide guidance in determining whether a transaction is a sham for tax purposes courts have looked to whether the taxpayer had a business purposes for engaging in the transaction other than tax_avoidance and whether the transaction had economic_substance beyond the creation of tax benefits thus both the taxpayer’s subjective business motivation and the objective economic_substance of the transactions are examined from the facts presented by district_counsel we concur that the service has a viable argument that the transactions are sham transactions while it is impossible to have a simple test or checklist for determining whether a particular transaction is a sham we see no reason not to assert the sham_transaction theory in this case this theory is the service’s primary weapon in virtually all sale leaseback cases development of this theory is especially important here in light of the fact that this case does not involve a partnership and therefore the sales leasebacks cannot be attacked on the various grounds generally asserted in partnership cases a transaction that is entered into solely for the purpose of tax reduction and that has no economic or commercial objective to support it is a sham and is without effect for federal_income_tax purposes 752_f2d_89 4th cir 435_us_561 when a transaction is treated as a sham the form of the transaction is disregarded in determining the proper tax treatment of the parties to the transaction the service must show that the taxpayer was motivated by no substantial business_purpose other than obtaining tax benefits and that the transaction did not have any economic_substance all of the facts and circumstances surrounding the transactions must be considered no single factor will be determinative courts will respect the taxpayer’s characterization of the transactions if there is a bona_fide transaction with economic_substance compelled or encouraged by business or regulatory realities imbued with tax-independent considerations and not shaped solely by tax_avoidance features that have meaningless labels attached see 435_us_561 909_f2d_1360 9th cir recently the service was successful in showing that a series of prearranged transactions involving the purchase and sale of debt instruments in an attempt to shift accelerated installment_sale gain to a tax-neutral partner and manufacture a loss for another partner was a sham acm partnership v commissioner tcmemo_1997_115 appeal docketed no 3rd cir date in acm partnership the service argued that the purchase and sale of debt instruments were prearranged and predetermined devoid of economic_substance and lacking in economic reality in its opinion the tax_court said 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 tax_court also stated that the tax law requires that the intended transactions have economic_substance separate and distinct from economic benefit achieved solely by tax reduction it held that the transaction lacked economic_substance and therefore the taxpayer was not entitled to the claimed deductions the opinion demonstrates that the tax_court will disregard a series of otherwise legitimate transactions where the service is able to show that the facts when viewed as a whole have no economic_substance even if the entire transaction is not a sham that is if the debts created were genuine the transaction could still be rejected by the court in 364_f2d_734 2d cir the court disallowed petitioner’s deductions for interest_paid in connection with a loan on the grounds that the transaction lacked any expectation of profit and was entered into by petitioner without any purpose except to obtain an interest_deduction see also 31_f3d_117 3d cir and lee v commissioner ---f 3d- wl a f t r 2d 2nd cir date no the sham_transaction theory should be applied in this case to disallow income expenses and deductions from the sale-leaseback the transaction at issue in this case involves a series of sale-leasebacks each of which may have some business_purpose but when taken as a whole have no business_purpose independent of tax considerations as in acm partnership the taxpayer entered into the transaction for the sole purposes of avoiding taxes case development hazards and other considerations while there is no case on point that involves a lease-stripping transaction of the nature in this case there are many cases involving transactions in which courts have applied the sham_transaction doctrine resolution of the issue will depend on the facts in the case we anticipate the taxpayer will argue that the transaction was entered into for a profit and had economic reality apart from the tax benefits it obtained to counter this argument the service should argue that the transactions at issue were prearranged and predetermined devoid of economic_substance and lacking in economic reality in this regard the more facts that can be developed that show the relationships between the parties and the prearrangements between them the more likely the victory in this case issue whether the step_transaction_doctrine applies to the lease_stripping transactions at issue conclusion based on the facts presented we believe that the service should not assert the application of the step_transaction_doctrine facts the following facts briefly and generally summarize the facts set forth by district_counsel in its request for field_service_advice taxpayer entered into two lease_stripping transactions structured by c using foreign citizens as intermediaries as a result of the transactions profitable taxpayer subsidiaries took large depreciation_deductions while nontaxable foreign citizens realized the rental income the following facts briefly recount the steps of the first transaction1 sometime prior to date c inc purchased computer equipment which it then leased to end-users on date c sold some of its computer equipment to b a nationality citizen and resident taking cash nonrecourse balloon promissory notes and recourse installment notes b obtained the cash from loans as evidenced by senior recourse notes also on date b leased the equipment back to c on date b sold a portion of the rents due under the leases to d b used the sales’ proceeds to satisfy the recourse installments notes owed to c the second transaction is substantially_similar to the first district_counsel did not relate the facts of the second transaction in its request for fsa on date f a subsidiary of taxpayer entered into an agreement with b to exchange shares of f stock for b’s interest in the computer equipment and leases subject_to the nonrecourse balloon promissory notes and the senior recourse notes simultaneous with this agreement taxpayer transferred cash to f in exchange for additional f stock shortly after the date exchanges f satisfied the senior recourse notes sometime between period c exercised an early termination option under the leases although taxpayer and c differed on the amount due to taxpayer under the early termination option it does not appear any final resolution was ever reached based upon the above transactions b a non-taxable foreign_citizen accelerated the realization of rental income prior to his exchange of computer equipment with taxpayer taxpayer in turn reported significant depreciation_deductions and losses law and analysis the field asks whether the equipment_leasing transaction can be challenged under the step_transaction_doctrine the step_transaction_doctrine is a subset of the substance_over_form_doctrine and treats a series of formally separate but related steps as a single transaction if the steps are in substance integrated interdependent and focused towards a particular result 88_tc_1415 the step_transaction_doctrine as described above allows the service to argue that certain economically meaningless steps of a transaction can be collapsed or ignored the field asks whether the step_transaction_doctrine can be applied in this case to eliminate economically meaningless steps case development hazards and other considerations as explained elsewhere we believe that there is an argument that the series of transactions can be recast to reflect the substance as explained elsewhere we believe that there is an argument for ignoring b’s role thus the transaction between c and b and the transaction between b and d is reduced to a transaction between c and d in other words at this point the service ha sec_2 after the date exchanges c continued to be obligated to make rent payments under the leases eliminated one step in the series of transactions which would support asserting the application of the step_transaction_doctrine since b is no longer a party to the transaction he is not deemed to have transferred property to f in the purported sec_351 exchange instead c would be treated as having transferred such property to f thus the recast still has one less step as described in the previous paragraph however b received f preferred_stock any proposed recast must account for this issue what is the proper characterization of d’s purchase of the lease receivables conclusion we conclude that the additional factual development is required in order to determine the proper characterization law and analysis it has been proposed that the acceleration of the future rental income to b may be challenged by recharacterizing the assignment of the lease receivables to d as a financing rather than as a sale the effect of characterizing this transaction as a sale instead of a financing would be that b must recognize any gain_or_loss from the sale of the lease receivables for federal_income_tax purposes under sec_1001 if subject_to taxation in the u s alternatively if the transaction is a financing or a secured financing then b does not include the borrowed amounts in gross_income 499_us_573 1991_2_cb_30 thus when he transferred the leasehold interests to f on date b would have also transferred to f the right to receive the lease payments accordingly b and subsequently f would then recognize the income from the lease payments over the period of the payments from period instead of accelerating the income in year w in general federal_income_tax consequences are governed by the substance of a transaction 293_us_465 xiv-1 c b a transaction is a sale if the benefits_and_burdens_of_ownership have passed to the purported purchaser 106_tc_237 generally courts examine a number of factors to determine whether a transaction is a sale or something else such as a financing or a lease e g 91_tc_838 89_tc_1229 aff’d in part and rev’d in part 909_f2d_1360 9th cir 77_tc_1221 the tax_court in grodt mckay t c pincite enumerated eight factors to consider when making the determination of whether the transaction is a sale or a financing whether legal_title has passed how the parties treated the transaction whether an equity_interest was acquired in the property whether the seller was obligated to execute and deliver a deed and the buyer was obligated to make payments whether the purchaser had a vested right to possession which party paid property taxes which party bore the risk of loss or damage and which party received profits from the operation and sale the courts have generally focused on the risk of loss and treated a transaction as a sale when the assignee bears the risk that the anticipated income will not be paid where the assignment involves the right to receive future income in exchange for consideration e g 472_f2d_867 6th cir conversely when the assignee is certain that it will be fully repaid that certainty is characteristic of a loan 556_f2d_1107 ct_cl e g watts copy systems v commissioner tcmemo_1994_124 concluding assignment was a loan because the assignee received a security_interest in the property generating the income and the assignor guaranteed that the income would be paid to establish that an assignment is a secured financing it is necessary to show that the assignee received a security_interest in the leased equipment the assignor expressly guaranteed the payment of the future income or the assignor implicitly guaranteed the payment of the future income watts copy systems inc v commissioner tcmemo_1994_124 an implicit guarantee can be found where the assignor agrees to repurchase a lease in default or where the assignor provided the assignee with indirect collateral see eg mapco f 2d pincite concluding that certificates of deposits issued by a bank and held by the taxpayer were indirect guarantees intended to protect the bank against default even though the taxpayer was not personally liable to the bank for the borrower’s loan 485_f2d_1236 5th cir upon an analysis of the sale or financing factors applied to the facts of this case many of the facts indicate that it will be difficult to recharacterize the sale of the lease receivables into a financing and additional factual development is required d was obligated to pay b for its acquired rights although d had a right to physically possess the underlying leases d and its assignees g and h were obligated to return the original leases to b in date these facts fail to support a recharacterization d bore the risk of loss or nonpayment of the underlying rents d however had the right to seek payments from the lessee of the equipment c d’s ability to profit from the transaction appears to have been limited to the rents that it received from the underlying leases which were already contractually predetermined d could have assigned or sold its interests in the leases at a price in excess of the price that it paid nevertheless the sale or financing argument should be used as an alternative to the substance-over-form argument and a denial of the depreciation_deductions under sec_167 taken by f which we conclude are the better arguments with these facts a successful application of the substance-over-form arguments will accomplish the goal of matching the income with the deductions the depreciation_deductions could be denied if the computer equipment or leases were neither used in f’s trade_or_business nor held_for_the_production_of_income case development hazards and other considerations issue whether the service can challenge the depreciation_deductions attributable to the lease_stripping transactions under sec_167 conclusion we conclude that it is unnecessary to designate sec_167 as a separate and alternative theory in this case as long as service pursues the sham_transaction theory law and analysis district_counsel asserts that as an alternative theory the service may be able to challenge the depreciation_deductions taken by the taxpayer under sec_167 of the code f is entitled to its claimed depreciation_deductions on the computer equipment under sec_167 only if the equipment was used_in_the_trade_or_business or held_for_the_production_of_income as district_counsel acknowledges the facts relevant to the sham_transaction theory would control the disallowance of the depreciation_deductions under sec_167 we conclude that it is unnecessary to designate sec_167 as a separate and alternative theory in this case as long as service pursues the sham_transaction theory if f’s investments in the computer equipment were sham transactions then it necessarily follows that the equipment was not used_in_the_trade_or_business or held_for_the_production_of_income accordingly the sec_167 argument should be included with the sham_transaction theory issue whether sec_482 applies to the taxpayer and other parties to the lease- stripping transaction at issue and if so what are the consequences of applying sec_482 conclusion from the facts provided we conclude that sec_482 may apply to taxpayer and the other parties collectively the participants to the transaction because the participants acted in concert pursuant to a common plan to arbitrarily shift income and deductions the participants will be treated as members of the same controlled_group for purposes of sec_482 sec_482 may be applied to reflect clearly the income and deductions arising from the transaction under the following alternative theories law and analysis economic_substance standards of sec_482 recharacterize the sale-leaseback between c and b and the subsequent sale of the lease receivable from b to d as a loan from d to c or ii disregard the sec_351 transaction due to a lack of economic_substance so that f a wholly owned subsidiary of taxpayer is treated as never having acquired ownership of the equipment thus taxpayer’s deductions relating to the equipment would be disallowed and reallocated to c or clear_reflection_of_income and tax_evasion standards of sec_482 these standards may be applied under two alternatives allocate f’ deductions to b during the period b owned the preferred_stock of f so that income and deductions attributable to the sale-leaseback and sale of the lease receivable are not artificially separated or allocate to f the proportionate amount of the proceeds from the sale of the lease receivable for the period of f’ participation in the transaction application of sec_482 to nonrecognition transactions allocate f’ deductions to b on the basis that sec_482 may allocate income or deductions attributable to property acquired by a transferee corporation f in a sec_351 transaction back to the contributing shareholder b overview in order for sec_482 to apply to a transaction the transaction must be between two or more entities owned or controlled by the same interests sec_482 the next section sec_2 of this memorandum discusses the meaning of control and same interests we conclude that to the extent it can be shown that the transaction was carried out pursuant to a common design that was intended to include all of the parties to the transaction and effect an arbitrary shifting_of_income and deductions the parties may be treated for purposes of this transaction as controlled by the same interests within the sec_482 meaning of control consequently under such conditions the participants would be part of the same controlled_group evidenced by their acting in concert with a common goal to shift deductions to f and income to b see sec_1_482-1t sec_1_482-1 accordingly sec_482 applies to the transaction sec_3 of this memorandum discusses the application of sec_482 to the transaction under three alternative theories under the assumption that the requisite control has been established through the existence of a common design pursuant to which the participants acted sec_3 a analyzes the transaction under the economic_substance standards in the sec_482 regulations and sec_482 caselaw we conclude that the terms of the sale-leaseback and the sale of the lease receivable appear to be inconsistent with the economic_substance of the transaction see sec_1_482-1t sec_1_482-1 by either recharacterizing the sale- leaseback and the sale of the lease receivable as a loan from d to c or disregarding the sec_351 transaction due to a lack of economic_substance f is treated as never having acquired ownership of the equipment and its deductions should be disallowed accordingly sec_3 b discusses the artificial separation of the rental income purportedly attributable to b from the deductions to which f is purportedly entitled through b’s transfer to f of his interest in the equipment and lease see notice_95_53 1995_2_cb_334 consequently two alternative allocations under sec_482 may be appropriate allocate f’ deductions to b during the period he owned f preferred_stock or allocate to f the proportionate amount of proceeds from the sale of the lease receivable for the period of f’ participation in the transaction see sec_482 sec_1 1t a sec_1_482-1 sec_3 c discusses the role of sec_482 in nonrecognition transactions and the ability of the service to allocate income and deductions attributable to an entity’s disposition of built-in-loss and gain property which it acquired in a nonrecognition the final regulations under sec_482 apply to the years at issue unless taxpayer’s tax_year begins on or before date in that case the temporary regulations may apply unless taxpayer makes an election to apply the final transfer_pricing regulations retroactively sec_1_482-1t sec_1_482-1 consequently we will distinguish between the two regulations by referring to their year of promulgation in parenthesis when each set of regulations is referred to transaction to the contributing shareholder we conclude that b’s contribution of his interest in the equipment and lease after the income was stripped appears to be akin to such a situation consequently an allocation of f’ deductions to b also may be appropriate under this theory meaning of controlled same interests statutory language of sec_482 sec_482 provides the following in any case of two or more organizations trades_or_businesses owned or controlled directly or indirectly by the same interests the secretary may distribute apportion or allocate gross_income deductions between or among such organizations if he determines that such distribution apportionment or allocation is necessary in order to prevent evasion of taxes or clearly to reflect the income of any of such organizations sec_482 emphasis added thus in order for sec_482 to apply to a transaction the transaction must be between two or more organizations trades_or_businesses owned or controlled by the same interests as there is no common ownership among the participants to the transaction other than b’s receipt of preferred_stock in the sec_351 transaction the question is whether any of the participants -- c b and taxpayer f in particular -- are controlled by the same interests and may be said to be members of the same controlled_group legal standard for control the sec_482 regulations define control to include any kind of control direct or indirect whether legally enforceable and however exercisable or exercised sec_1_482-1t 1993_1_cb_90 sec_1_482-1 1994_2_cb_93 see also 1_bta_624 acq 1925_1_cb_2 c ontrol not arising or flowing from legally enforceable means may be just as effective in evading taxation as if found on the most formal and readily enforceable legal instrument the regulations also state that i t is the reality of control that is decisive rather than a rigid focus on record ownership of the entities at issue id accord 42_tc_114 aff’d 358_f2d_342 6th cir cert_denied 385_us_899 17_tc_231 aff’d 202_f2d_873 5th cir cert_denied 346_us_819 acq in part and nonacq in part 1952_2_cb_2 revrul_65_142 1965_1_cb_223 372_f2d_415 4th cir aff’g tcmemo_1996_15 cert_denied 389_us_841 moreover the regulations provide that a presumption of control arises if income or deductions have been arbitrarily shifted as a result of the actions of two or more taxpayers acting in concert with a common goal or purpose sec_1 1t g sec_1_482-1 see 598_f2d_1382 5th cir rev’g a f t r 2d ria n d tex holding that based on sec_1_482-1 the service properly argued that proof of income_shifting between two corporations establishes a presumption of common_control thus under the regulations joint legal ownership or overlapping ownership is not required for unrelated corporations to fall within the purview of sec_482 if there is a common goal to shift income or deductions but see 5_tc_558 acq c b acq withdrawn and substituted for nonacq revrul_65_142 1965_1_cb_223 54_tc_912 rev’d in relevant part 453_f2d_1144 2d cir cert_denied 407_us_934 reh’g denied 409_us_899 nonacq 1975_2_cb_3 nonacquiescence related to tax_court opinion only as the second circuit adopted an interpretation of control that is consistent with the and sec_482 regulations where the service seeks to establish common_control due to the presence of an artificial shifting_of_income and deductions it is the service’s burden to prove the applicability of sec_482 by establishing a shifting_of_income and deductions dallas ceramic tile f 2d pincite we believe that this burden may be met by the stripping of income from the leases to b an entity outside of the united states’ taxing jurisdiction and the reporting of the deductions relating to that income by f see notice_95_53 1995_2_cb_334 t he parties to a stripping transaction are controlled by the same interests because among other factors they act in concert with a common goal of arbitrarily shifting income and deductions between a transferor and a transferee legal standard for same interests if control is found to exist the service may allocate income and deductions among members of the controlled_group sec_1_482-1t sec_1_482-1 a controlled_group or controlled_taxpayer is defined as the entities owned or controlled by the same interests and includes the taxpayer that owns or controls other taxpayers sec_1_482-1t sec_1_482-1 unlike the term control the phrase same interests is not defined in the sec_482 regulations case law as well as the legislative_history of sec_482 provide guidance sec_482 was enacted to prevent the artificial shifting_of_income between controlled taxpayers to avoid federal income taxes and thereby milk a taxable entity ie placing deductions in one entity and income related to those deductions in another entity 598_f2d_1375 5th cir citing h_rep_no 70th cong 1st sess c b part s rep no 70th cong 1st sess c b part in using the term same interests congress intended to include more than the same persons or the same individuals brittingham f 2d pincite 366_f2d_890 5th cir aff’g 43_tc_540 cert_denied 386_us_1016 2_bta_229 see also lxi-part cong rec statement of sen king referring to the same forces controlling a number of corporations different persons with a common goal or purpose for artificially shifting income can constitute the same interests for the purposes of the statute see south texas rice warehouse f 2d pincite see also brittingham f 2d pincite citing ach t c pincite the phrase same interests should not be narrowly construed to frustrate the intent of sec_482 appeal of rishell phonograph co pincite if ‘the same interests’ was intended to mean only ‘the same persons ’ it would have been easy for congress by using the latter term to have avoided all ambiguity accord grenada indus supra thus it is not necessary that the same person or persons own or control each controlled business before sec_482 can be applied but there must be a common design for the shifting_of_income in order for different entities to constitute the same interests indeed this definition of same interests is identical to the definition of control and the presumption relating thereto in the regulations and case law thus if there is a common design for shifting income or deductions then the requirements for control and same interests will be met see hall v commissioner t c pincite arbitrary shifting_of_income coupled with ability to direct actions of entity establishes control for sec_482 purposes regardless of whether ownership exists the common design of the transaction at issue based on the facts provided the transaction has the hallmarks of a prearranged structured transaction marketed by a promoter where the participants in the transaction appear to have acted in concert pursuant to a common design to shift income and deductions for tax purposes indeed this common design provides an explanation for why the participants engaged in the several uneconomic transactions and circular flows of cash that when bound together constituted the stripping transaction when b purchased the equipment from c the equipment was subject_to pre-existing third-party leases from which b did not have the right to receive rental income b and c then immediately entered into a leaseback agreement under which c was obligated to pay rent to b but c itself did not actually use the equipment as it had already leased the equipment to the third parties but for the creation of c’s obligation to pay rent to b there would have been no opportunity to accelerate recognition of income for u s tax purposes and leave the corresponding deductible obligation to pay c outstanding and available for transfer to f the income acceleration was achieved through the sale of the lease receivable c could have achieved the same acceleration effect by prepaying all rent due directly to b but through the sale of the lease receivable c effectively obtained a loan from d thus avoiding using its own funds and the potentially adverse effect of carrying an amount liability on its books which could have raised c’s borrowing costs vis-a-vis other creditors absent this recognition event the transaction would have been unmarketable to taxpayer or any other taxable u s party because if taxpayer had been required to recognize the income it would result in an economic loss except in the unlikely event that the highly inflated estimated residual_value of the equipment was realized d was fully aware of the purpose of and its role in the lease- stripping transaction and was informed of each step of the transaction it knew that the purchase of the lease receivable would accelerate taxable_income to b after which b could sell his interest to a u s company with a tax appetite see d’s transaction description the bank knew that the transaction would allow a u s company to subsequently purchase the tax benefits of depreciation on the equipment without incurring the income acceleration associated with the lease receivable purchase id the existence of a common design is further evidenced by the restrictions imposed by c on b under the sale leaseback and security agreements c not b controlled the funds associated with the transaction at all times this is because b nominally possessed the right to the rent due under the leaseback prior to selling this right to d but this right was substantially limited in that the rent payments were equal to amounts due on the installment notes similarly b had nominal rights to the proceeds from the sale of the lease receivable but he was required to use these proceeds to pay off the installment notes additionally at the termination of the lease when c reacquired the equipment b was required to first use the proceeds to pay off the balloon notes thus b did not have any right to the rent or sale proceeds other than to have the sale proceeds applied to its obligations to c f as transferee of b’s interest similarly had no control_over the funds similarly the fact that the leaseback terms and we assume the sale document’s terms were made expressly conditioned on b’s ability to sell the right to receive rent under the b - c lease further demonstrates the existence of a common design to effectuate a lease_strip indeed if the sale - leaseback would have been void without b’s ability sell the stream of c’s rent payments b’s presence in the entire transaction appears solely to provide an accommodation person to absorb tax-free the rent from the sale of the rental rights under the leaseback this is because there is no net economic difference in effect between c entering into the sale - leaseback with either b or d where b had to find a purchaser of c’s rental stream in order to give the c - b sale leaseback effect b’s participation in the transaction depended on the future entry of a taxpayer who could utilize depreciation and interest deductions absent the fully anticipated entry of a u s taxpayer such as taxpayer we question whether b would have participated in this transaction he was not entitled to use the proceeds from the sale of the lease receivable since the terms of the equipment sale required the proceeds to be applied to pay off c’s installment notes there appears to be no source_of_income from this transaction except amount plus dividends accruing at a rate of approximately percentage which b would receive if he redeemed his f preferred_stock per the exchange_agreement five years from the date he transferred his interest in the equipment and lease to f between period we do not know what compensation b has been paid up to this point further indicia of the existence of a common design to shifting income and deductions is that all of the participants in the transaction received substantial benefits that were contingent on their coordinated activity under the common plan these benefits as described below were to be realized only if each participant performed its specific role under the common plan benefits to taxpayer and its subsidiary f for an investment of approximately amount taxpayer received amount of deductions over three years which at a percentage federal tax_rate resulted in more than amount of tax benefits moreover while taxpayer through its consolidated_return with f received a substantial tax_benefit for engaging in the transaction it neither had a reasonable possibility of economic profit nor realized an actual economic profit f’ economic_interest and its pre-tax economic profit were based solely on the residual_value of the equipment and the potential stream of rental payments after the termination_date since b had sold its right to all pre-termination rents to d according to the terms of the lease if c exercised its option to terminate the lease early it could reacquire the equipment for the greater of its fair_market_value or the balance outstanding on the installment notes if c opted to lease the equipment for the regular term it could reacquire the equipment for its fair_market_value at that time when c exercised its early termination option the amount outstanding balance on the balloon notes exceeded the equipment’s fair_market_value as appears to have been anticipated by the common plan thus f having to use the proceeds to pay off the balloon notes earned no profit benefits to c c received amount of cash paid up-front on the sale of the equipment it also earned a return on the amount from d assuming that it invested the amount payment in an interest bearing asset that yielded more than libor plu sec_75 basis points which was the amount that had to be paid back to d which c probably did not repay through a rent prepayment until several months later according to d c’s other_benefits from the equipment sale included off-balance sheet financing and minimization of the risk associated with the equipment’s residual_value also as the likely promoter of the tax_shelter c possibly earned additional fees the amounts of which we do not know although c had sold and leased back the equipment from b c still maintained the third- party leases collected rents and performed other lessor duties neither b nor f performed any of these duties benefits to b we do not know what up-front compensation b received in consideration for his participation in the transaction nor the source of this compensation ie from which participants in the transaction it is likely that he received a fee from c if c was the promoter of this transaction we do not know however the amount of this fee nor when it was paid f was obligated to pay b amount and accrued dividends upon the redemption of b’s stock but this was not likely to occur until period considering that his costs were likely relatively minimal b stood to receive a generous return on a minimal up-front investment assuming this amount was paid however it is important to note that b’s anticipated amount was contingent on the success of the transaction as a lease_strip this is because of b’s agreement to indemnify f up to the value of his preferred_stock in the event of any u s tax_liability of f arising as a result of b’s participation in the sec_351 transaction thus if the transaction failed its goal as a lease_strip b stood to loose any benefit that he might have received as a result of the sec_351 transaction further as indicated above b’s primary purpose was to serve as an accommodation party for the benefit of f b’s profit appears to be limited to the cash associated with the stock_redemption and dividends and a possible a fee from c and or f although the proceeds from the sale of the lease receivable were recognized during b’s period of ownership he did not have any right to use these proceeds other than to apply the amounts to pay off the installment note for this reason we assume and recommend factual development of the point that b was not subject_to tax in belgium on this u s recognition event as insulation against the risk of tax exposure c promised to indemnify b for any u s taxes arising from the sale purchase or subleasing of the equipment and rent or any other proceeds payable to b benefits to d d earned an interest rate spread on amount at a rate of libor plu sec_75 basis points for assuming a short-term unsecured credit position with c which had a credit rating of rating and amount in fees paid_by c benefits to e e earned interest at an unspecified rate on its amount18 loan to b and probably some fees in sum for the same reasons that c b taxpayer f and d appear to constitute the same interests -- the common design to shift income and deductions -- they are all members of the same control group notice_95_53 supra sec_1_482-1t - sec_1_482-1 - the participants also satisfy the control requirement because it is likely that the actions and roles of the accommodation parties b in particular were hand crafted by c and taxpayer so as to effectuate the desired lease_strip see hall v commissioner supra t c pincite an arbitrary shifting_of_income coupled with the ability to direct the actions of an entity establishes control for the purposes of sec_482 whether or not ownership exists although sec_482 applies to organizations trades_or_businesses sec_482 may apply to b as an individual because of his putative leasing activities of c's assets and participation for a profit in the lease-stripping scheme see 77_tc_1014 6th cir aff'd 723_f2d_58 10th cir sec_1_482-1t sec_1_482-1 we recommend factual development as to whether b engaged in this lease-stripping transaction as an individual or through his trade_or_business thus sec_482 may be applied to scrutinize the equipment sale from c to b the subsequent leaseback to c the sale of the lease receivable to d the purported sec_351 transaction between taxpayer f and b and the separation of the income and deductions arising under the entire transaction our conclusion that sec_482 may apply to the transaction at-issue is bolstered by the fifth circuit’s decision in south texas rice warehouse supra in which the tax_court and the fifth circuit applied sec_482 to a lease-stripping transaction involving a corporation and a partnership owned by four unrelated families the court upheld the service’s application of sec_482 to prevent the stripping of the income to one entity for the purposes of allowing the other entity to realize losses from depreciation_deductions notwithstanding the fact that the two entities were owned by approximately individuals in varying percentages like south texas rice warehouse for the reasons outlined below we believe that the transaction may be viewed as a common design among the participants to create tax deductions for f without corresponding income inclusions application of sec_482 to the transaction we believe sec_482 may be applied under three alternative approaches set forth below under the first approach discussed in sec_3 a the terms of the sale leaseback and the sale of the lease receivable are inconsistent with the economic_substance of the transaction under the second approach discussed in sec_3 b the separation of income and deductions arising from the transaction does not clearly reflect income for tax purposes the third approach discussed in sec_3 c addresses sec_482’s role in nonrecognition transactions and in the sec_351 transaction between taxpayer and b in particular economic_substance analysis relationship of case law standard to sec_482 standards sec_482 overlaps with the case law4 relating to economic_substance and sham doctrines by allowing the service in certain instances to disregard contractual terms and agreements and to recharacterize a transaction see sec_1 2t a ii b -2t a sec_1_482-1 -1 d ii c ex -1 f ii -2 a ii b -2 a -4 f ii a however the sec_482 regulations expand upon case law principles and provide additional guidance in specific areas specifically the regulations provide the following 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 economic_substance of the underlying transaction the district_director may disregard such terms and impute terms that are consistent with the economic_substance of the transaction see acm partnership v commissioner 73_tcm_2189 aff’d in relevant part 157_f3d_231 3d cir 31_f3d_117 3d cir transaction is a sham if it has no substance other than to create deductions 752_f2d_89 4th cir transaction is a sham if the taxpayer was motivated by no business purposes other than obtaining tax benefits in entering the transaction and the transaction has no economic_substance because no reasonable possibility of a profit exists 868_f2d_851 6th cir standard for sham is whether the transaction has any practicable economic effects other than the creation of income_tax losses a taxpayer's subjective business_purpose and the transaction's objective economic_substance may be relevant to this inquiry 765_f2d_643 7th cir the freedom to arrange one's affairs to minimize taxes does not include the right to engage in financial fantasies with the expectation that the internal_revenue_service and the courts will play along 843_f2d_351 9th cir cert_denied 488_us_824 sham analysis consists of examination of whether the transaction had any practical economic effects other than generating tax benefits citations omitted 857_f2d_1383 9th cir transaction related to gold mining venture had no non-tax economic_effect 862_f2d_1486 11th cir transactions whose sole function is to produce tax deductions are substantive shams regardless of the motive of the taxpayer citations omitted 94_tc_738 same 89_tc_986 deductions denied due to lack of economic_substance chapman v commissioner 73_tcm_2405 sec_1_482-1 sec_1_482-1t the regulations further provide in making allocations under sec_482 the district_director is not restricted to the case of improper accounting to the case of a fraudulent colorable or sham_transaction or to the case of a device designed to reduce or avoid tax by shifting or distorting income deductions credits or allowances sec_1_482-1 sec_1_482-1t thus sec_482 provides an alternative approach to challenging the transaction at issue by providing additional criteria under which to apply the economic_substance and sham inquiries to the parties’ conduct and not restricting the service’s allocation authority to instances of colorable or sham transactions see 88_tc_252 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 arbitrarily shift income and or deductions economic_substance of the sale - leaseback_transaction sale of the lease receivable the economic_substance of the sale-leaseback between c and b appears to be other than its purported form specifically for the reasons set forth below the sale-leaseback may be disregarded as an interim step with no economic_substance that when considered in conjunction with the sale of the lease receivable constitutes a amount loan by d to c such a consideration of both transactions in conjunction with one another is appropriate as both were intended to be part of the same common plan and the validity of the sale-leaseback was conditioned on the sale of the lease receivable see 116_fsupp_721 cl_ct the following points support this conclusion in a bona_fide sale the buyer assumes the risk that it may not realize income from property purchased see estate of stranahan v commissioner 472_f2d_857 6th cir watts copy systems inc v commissioner tcmemo_1994_124 however as the putative buyer of the equipment from c b assumed no such risk nor did it assume any risk vis-á-vis the transaction first b ostensibly purchased the property for amount -- amount of which came from a e loan and the remaining amount coming from loans of c ie purchase money notes although the e loan to b was recourse in name by its own terms it was not recourse to b e’s recourse was limited to third-party rents and the equipment which were already assigned to other financiers who already had security interests in the equipment see corbin west partnership v commissioner 56_tcm_153 tcmemo_1988_436 recourse loan made to undercapitalized obligor that is not likely to be paid may be disregarded as an economic sham concerning the remaining amount in loans these were to be paid from rents from c under the sale-leaseback in sum there were simply circular flows of funds with no economic_effect see 820_f2d_1543 9th cir transactions which constitute a circular flow of funds between entities pursuant to a common plan that are motivated and shaped by tax_avoidance concerns may be considered shams accord 46_f3d_1470 9th cir 73_tc_1163 aff’d 673_f2d_1962 9th cir marine v commissioner 921_f2d_280 9th cir estate of nazarian v commissioner t c memo cch gurdin v commissioner thus like the e loan b was not at risk on the c notes as any loan payment obligation to c could be offset against rents to be received from it nor was b subject_to any of the risks normally indicative of a purchase of property see also sec_1 1t c ii b and sec_1_482-1 discussing the non- exclusive three-prong tests that apply when members of the same controlled_group seek to allocate risks between them b sold the lease receivable to d for amount as required by the sale - leaseback agreement the sale of the lease receivable accelerated the installment note that b owed to c accordingly d paid the amount directly to c rather than to the putative seller of the lease receivable b thus b’s presence in the transaction was essentially reduced to that of an accommodation party in order to facilitate the transfer of tax benefits to taxpayer see allied signal inc v commissioner t c memo cch it is appropriate to disregard thinly capitalized entities utilized for the sole purpose of engaging in a transaction designed to secure tax benefits where the parties disregarded the entities in the transaction and treated them as mere conduits the only economic_interest b and later f had as owner and lessor of the equipment was based on the residual_value of the equipment at the time c terminated the lease indeed because we have reason to believe that this residual_value was in reality anticipated to be less than the balance of the balloon note this economic_interest was illusory see 435_us_561 and stacom v commissioner 61_tcm_2691 aff'd per curiam 987_f2d_774 11th cir in the sale-leaseback context a sale-leaseback transaction will be recognized for tax purposes where it is multiparty possesses economic_substance compelled or encouraged by business or regulatory realities and is imbued with tax-independent considerations and is not shaped solely by tax-avoidance features that have meaningless labels attached this economic_substance analysis of the sale leaseback_transaction should be further developed in light of the following authorities smoot v commissioner t c memo cch stacom v commissioner 61_tcm_2691 aff'd per curiam 987_f2d_774 11th cir 73_tc_1163 aff’d 673_f2d_1062 9th cir 410_f2d_615 6th cir unger v united_states u s t c 77_tc_1221 w b lasher co v commissioner 51_tcm_1234 74_tc_305 aff’d 671_f2d_316 9th cir pursuant to the common plan b was never intended nor did he ever receive a positive cash_flow from the combined sale - leaseback and sale of the lease receivable further also per the common plan he never had to pay off the installment note balloon notes or the e loan this is because the proceeds from the sale of the lease receivable fully satisfied the installment note cash from taxpayer paid off the outstanding balance of the e loan and c’s amount payment to reacquire the equipment paid off the balloon notes accordingly any ostensible payments by c to b and or d do not constitute rent under income_tax principles see eg sec_543 sec_1 c ii b rent under income_tax principles is compensation_for use of or the right to use property rather as intended by the common plan the combination of a rent due under the leaseback to b by c b b’s offsetting payments due to c under the installment notes and c the sale of the lease receivable by b to d effectively converted any compensation due to b or d for_the_use_of the equipment to a loan from d to c thus the actual conduct of the participants and the legal and economic_substance of the rights and obligations assumed and assigned were inconsistent with their purported form the combination of the sale - leaseback and sale of the lease receivable was economically and legally structured to constitute a loan by d to c it would be inappropriate to treat the combination of these transactions in any other fashion that would exalt form over substance other economic_substance considerations in re f also relevant to an economic-substance analysis is whether from a business perspective the transaction makes objective business sense or under the language of some cases would have been entered into by a hard-headed business person 453_f2d_1144 2nd cir see id sec_482 may overlap with sec_162 and result in the denial of deductions where the lack of arm’s length dealings results in payments between parties with a close relationship in an attempt to avoid taxes medieval attractions n v v commissioner tcmemo_1996_455 ria royalty payments to a related foreign_entity that was not the owner or developer of an intangible were disallowed as deductions the payments had no economic_substance under sec_482 because the foreign_entity was not the creator developer or in substance have the ability to transfer the intangibles considering this economic_substance factor it appears that the sec_351 transaction may be said to be devoid of economic_substance note this argument is distinct from the analysis found later in sec_3 c of this memorandum relating to sec_482's role in allocating to a contributing shareholder losses arising from the disposition of built-in- loss property contributed to a corporation first f could not have had any reasonable expectation of profit from the sale of the lease receivable since the proceeds from the sale were recognized for tax purposes by b prior to f' entry into the transaction even after f bought b’s interest in the equipment and lease f did not have any right to the proceeds as all the proceeds were used to pay off the installment note second because f had no right to the proceeds from the sale of the lease receivable f' only opportunity to realize an economic benefit was contingent on the residual fair_market_value of the equipment at the termination of the lease exceeding the principal and accrued interest on the outstanding balloon note f in fact never earned any income from the transaction because at the time c opted to terminate the lease early the amount due on the balloon note exceeded the equipment's fair_market_value several appraisers had uniformly estimated that the equipment’s fair_market_value was amount on the early termination_date and amount on the regular termination_date however it appears that when c reacquired the equipment on the early termination_date the amount outstanding balance on the balloon note exceeded the equipment’s fair_market_value see also 688_fsupp_1129 d c tex aff’d 865_f2d_644 5th cir sec_351 transactions must be supported by a business_purpose in sum it appears that the sale leaseback sale of the lease receivable and the sec_351 transaction are devoid of economic_substance and may be disregarded the effect of disregarding either the sale_and_leaseback and the sale of the lease receivable as a necessary consequence the lease receivable or the sec_351 transaction is to break the chain of transactions that give rise to f’ claim that it is entitled to depreciation and interest deductions application of sec_482's clear_reflection_of_income tax_evasion standards sec_3 a of this memorandum discussed applying sec_482 to disregard the individual steps in the transaction under sec_482's economic_substance standards as an alternative to disallowing deductions by disregarding the steps sec_482 may effectively disallow deductions of a taxpayer by allocating them to another entity pursuant to the service’s authority to allocate income and deductions to clearly reflect income and prevent the evasion of taxes see sec_482 sec_1 1t a sec_1_482-1 this analysis and the case law affirming the service’s exercise of this allocation authority is not based upon an economic-substance analysis rather it focuses on the distortions in taxable_income caused by the separation of income from deductions see 198_f2d_214 2d cir rev’g 16_tc_882 cert_denied 344_us_874 305_f2d_681 9th cir as stated in notice_95_53 the separation of income from deductions in lease-stripping transactions does not clearly reflect income particularly where they are achieved through a transaction structured to evade taxes accordingly to prevent the evasion of taxes and to effect a clear_reflection_of_income two alternative allocations may be appropriate either f’ deductions could be allocated to b during the period b owned f preferred_stock or income ie a portion of d’s amount payment could be allocated to f in proportion to the period it owned the interest in the equipment and lease see eg 372_f2d_415 4th cir aff’g tcmemo_1966_015 cert_denied 389_us_841 361_f2d_607 4th cir aff’g sub nom 240_fsupp_378 e d n c 198_f2d_214 2nd cir rev’g 16_tc_882 cert_denied 344_us_874 305_f2d_681 9th cir 196_f2d_1006 2d cir cert_denied 344_us_835 sec_482's application in nonrecognition transactions another approach which may be used to challenge f’ depreciation and interest deductions focuses on the sec_351 transaction between f and b sec_482 may be applied to allocate income or losses from the disposition of property acquired in a nonrecognition_transaction such as a sec_351 transaction where the property was contributed to the corporation for tax_avoidance purposes see sec_1 1t d iii sec_1_482-1 the seminal case illustrating sec_482's role in sec_351 transactions is 137_f2d_600 3rd cir aff’g 46_bta_562 cert_denied 320_us_794 in national securities a parent_corporation contributed_property with a basis of dollar_figure and a value of dollar_figure to the capital of its subsidiary the property was stock of an unrelated corporation which had declined substantially in value from the time the parent_corporation purchased the stock approximately months after receiving the stock from its parent the subsidiary sold the stock for dollar_figure and claimed a dollar_figure loss id pincite the service disallowed the loss stating that the subsidiary was only entitled to the loss realized from the decline in value during the months it held the stock and not the loss attributable to the decline in value when the parent held the stock the service allocated the remaining loss to the parent under sec_45 of the internal_revenue_code of the predecessor to sec_482 reasoning that the allocation of the pre- contribution built-in-loss to the parent was necessary to reflect income clearly the court agreed with the service's determination and reasoned sec_45 is directed to the correction of particular situations in which the strict application of the other provisions of the code will result in a distortion of the income of affiliated organizations the parent made the investment in standard stock in and held on to the stock as an investment until when it was contributed to the capital of the subsidiary and sold months later it seems most reasonable to treat the loss as one which had in fact been sustained by the parent rather than by its subsidiary the shifting of the loss to the subsidiary gives an artificial picture of its true_taxable_income and one which it was unnecessary for the commissioner to accept id pincite numerous other cases have followed national securities in allocating pre- contribution or pre-distribution before the repeal of the general_utilities_doctrine gain_or_loss to the transferor or transferee on the subsequent disposition of contributed or distributed property by the transferee see eg 643_f2d_747 cl_ct on remand cl_ct aff'd without op 732_f2d_168 fed cir 556_f2d_889 8th cir aff'g a f t r 2d d minn 811_f2d_543 10th cir aff'g 82_tc_830 80_tc_34 aff’d in relevant part 756_f2d_1430 9th cir cert_denied 474_us_1055 the tax_court has recently interpreted the national securities line of cases to apply in instances where there is a tax_avoidance purpose 84_tc_996 aff’d in part rev’d in part 856_f2d_855 7th cir thus given the substantial amount of evidence indicating the tax_avoidance purpose of the transaction at issue we believe that sec_482 may apply to the sec_351 transaction involving f b and taxpayer focusing on the sec_351 transaction the proper allocation under sec_482 would be to allocate the deductions from f to b during b’s ownership of f stock our rationale is that from a tax perspective the depreciation and interest_expenses of f could only result in a tax loss to f after b had stripped off all of the gross taxable_income regardless of any realistic residual_value of the leases thus in effect b contributed built-in-loss property to f like the shareholder in national securities pursuant to a tax_avoidance plan to allow f the transferee corporation to recognize the tax losses case development hazards and other considerations we believe that the service’s ability to apply sec_482 is enhanced significantly in this case by the close proximity in time approximately three months during which all participants entered the transaction at issue for purposes of applying sec_482 we believe that it is crucial to obtain promotional materials as well as any correspondence and internal documents relating thereto in order to support the proposition that the participants acted pursuant to a common plan we believe that if promotional materials were to be obtained they would contain a description and or diagrams outlining the entire scheme and the roles of each participant possibly identifying several or all of the participants it will also be important to determine whether this transaction was a registered tax_shelter as it would further evince the common plan to evade taxes if you have any questions please contact william c sabin jr senior technician reviewer passthroughs and special industries branch field service division


t c summary opinion united_states tax_court thomas g henk jr petitioner v commissioner of internal revenue respondent docket no 7120-10s filed date thomas g henk jr pro_se scott w forbord and mark j miller for respondent cohen judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect when the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case subsequent section references are to the internal_revenue_code in effect for the year in issue respondent determined a deficiency of dollar_figure in petitioner’s federal_income_tax for that was based on income reported to the internal_revenue_service on form 1099-misc miscellaneous income but not reported on petitioner’s return the deficiency determined included self-employment_tax that is now conceded by respondent the recomputed deficiency in issue is dollar_figure background some of the facts have been stipulated and the stipulated facts are incorporated in our findings by this reference petitioner resided in wisconsin when he filed his petition during petitioner was employed by dealer financial systems and earned wages that were paid weekly on date petitioner’s employment was terminated and he was given severance_pay by a franklin financial corp check for dollar_figure franklin financial corp was a sister corporation of dealer financial systems a form 1099-misc given to petitioner and sent to the internal_revenue_service reported the severance_pay dealer financial systems reported petitioner’s wages of dollar_figure on a form_w-2 wage and tax statement petitioner did not report the severance_pay on his tax_return for respondent determined that the unreported amount was nonemployee compensation subject_to income and self- employment_tax discussion petitioner denied ever working for franklin financial corp and initially disputed receipt of the severance_pay reflected in the form 1099-misc however by the time of trial he stipulated that he had received a check for dollar_figure from that entity he contends that his former employer paid the severance from a different entity and reported it on form 1099-misc to avoid employment_taxes and to shift the burden of such taxes to him the record does not contain any explanation of why petitioner’s severance_pay was paid_by an entity other than the one that paid his wages nonetheless there is no dispute as to the purpose of the payment and it is income that petitioner should have reported on his return for see sec_61 gross_income means all income from whatever source derived and includes compensation_for services including fees commissions fringe_benefits and similar items petitioner’s suspicions concerning the motivation of his former employer are irrelevant to the taxability of the amount that he received neither the employer’s liability for employment_taxes nor petitioner’s share is before the court see mcwhorter v commissioner tcmemo_2008_263 lucas v commissioner tcmemo_2000_14 n grooms v commissioner tcmemo_1992_291 to reflect respondent’s concession decision will be entered for respondent for a deficiency of dollar_figure


t c memo united_states tax_court gary cummings petitioner v commissioner of internal revenue respondent docket no 21650-06l filed date gary cummings pro_se nancy p klingshirn for respondent memorandum opinion vasquez judge this case is before the court on respondent’s motion for summary_judgment petitioner failed to file federal_income_tax returns for and respondent issued statutory notices of deficiency to petitioner determining deficiencies and additions to tax for and petitioner received the notices of deficiency but did not petition the court for a redetermination of the tax deficiencies and additions to tax determined in the notices of deficiency for and notices of deficiency after the period for timely filing a petition with the court regarding the notices of deficiency elapsed respondent assessed against petitioner the amounts shown on the notices of deficiency respondent mailed petitioner letter final notice_of_intent_to_levy and notice of your right to a hearing levy notice the levy notice advised petitioner that respondent intended to levy on petitioner’s property to secure payment of his outstanding tax_liabilities for and the levy notice also explained that petitioner had a right to request a hearing with respondent’s office of appeals appeals to appeal the proposed collection action and to discuss payment method options by submitting a form request for a collection_due_process_hearing with respect to the proposed levy respondent mailed petitioner letter notice_of_federal_tax_lien filing and your right to a hearing under sec_6320 lien notice the lien notice advised petitioner that respondent had filed a notice_of_federal_tax_lien nftl with respect to petitioner’s unpaid tax_liabilities for and the lien notice also explained that petitioner had a right to request a hearing with appeals to appeal the proposed collection action and to discuss payment method options by submitting a form with respect to respondent’s nftl petitioner timely filed two forms 12153--one regarding the levy notice and one regarding the lien notice petitioner’s explanations of disagreement on both forms were identical inappropriate collection activity and invalid administrative record petitioner did not explain on the form or attach any statement to the form explaining what inappropriate collection activity had taken place or why the administrative record was invalid appeals acknowledged receipt of petitioner’s requests for a hearing with respect to the levy notice and the lien notice for and by letter appeals advised petitioner that appeals would not provide a face-to-face hearing if the only items he wished to discuss were those determined by the courts to be frivolous or groundless that he could receive a face-to- face hearing on any relevant nonfrivolous issues if he informed appeals in writing or by phone of such nonfrivolous issues that appeals scheduled a telephone conference for date and that appeals would not consider alternative collection methods unless petitioner filed his and income_tax returns and completed collection information statements the letter further advised petitioner before you decide whether to petition a notice_of_determination you should know that the tax_court is empowered to impose monetary sanctions up to dollar_figure for instituting or maintaining an action before it primarily for delay or for taking a position that is frivolous or groundless 115_tc_576 forbes v commissioner tcmemo_2006_10 dollar_figure penalty imposed aston v commissioner tcmemo_2003_128 dollar_figure penalty imposed petitioner responded to appeals by letter and requested a face-to-face hearing petitioner wrote that the issues that he intended to raise at the hearing included challenging the validity of the allegations as to amounts allegedly owed due to the failure by the irs to follow its own administrative procedures including without limitation violations of sec_6065 pursuant to usc d and the administrative procedures act challenging whether or not a valid and properly completed assessment and deficiency exist as petitioner requested appeals provided him with a copy of his administrative file for appeals did not send petitioner a copy of his administrative file for as he had already obtained a copy through a freedom_of_information_act_request appeals offered to reschedule a telephone conference with petitioner to discuss any relevant nonfrivolous issues regarding the dollar_figure he owed as of date in tax penalties and interest for and petitioner replied that appeals’ assertion that the issues he raised were frivolous was a lie and you should know it additionally petitioner wrote raising issues of irs failure to follow its own administrative procedures is absolutely a valid reason and evokes a requirement for a face-to-face hearing be advised that i refuse to accept your offer of a telephone hearing and if you continue to fail or refuse to grant me a face-to-face hearing and should you attempt to proceed with collection of a disputed assessment without providing me a face-to-face hearing to discuss your failure to follow your own administrative procedures then i will bring a lawsuit against you in u s district_court under current law you can be fired for your failure to perform your duties in accordance with internal revenue laws subsequently appeals issued petitioner a notice_of_determination concerning collection action s under sec_6320 and or with respect to petitioner’ sec_2002 and taxable years notice_of_determination appeals determined that the proposed levy and the nftl were appropriate collection actions in petitioner’s case petitioner filed a petition challenging the notice_of_determination at the time he filed the petition petitioner resided in ohio petitioner claimed inter alia irs has other irregular and interesting preconditions such as filling out forms and submitting a payment schedule these requirements are impossible since petitioner does not know what the irs wants until he meets with it petitioner is not required to do these and did not the irs illegally and wrongfully withheld a hearing and has violated his statutory rights and administrative due process rights to appear at a hearing irs was notified that petitioner challenged the validity of this alleged debt of a related procedural deficiency lack of required certification per sec_6065 and of petitioner’s demand for proper certification of lawful assessment the irs refused to acknowledge petitioner’s demand nor did it offer any evidence of lawful verification of their assessment at any time petitioner requested a face to face hearing within the legal time period and therefore is entitled to an in-person hearing under sec_6330 petitioner is entitled to a cdph at a location convenient to them sic taxpayer was not given the opportunity to raise any relevant issue relating to the unpaid tax or the proposed levy at a hearing in accordance with sec_6330 and that the internal_revenue_service violated petitioner’s fifth and fourteenth amendment rights motion for summary_judgment rule a provides that either party may move for summary_judgment upon all or any part of the legal issues in controversy summary_judgment may be granted if it is demonstrated that no genuine issue exists as to any material fact and a decision may be rendered as a matter of law rule b 98_tc_518 affd 17_f3d_965 7th cir we conclude that there is no genuine issue as to any all rule references are to the tax_court rules_of_practice and procedure and all section references are to the internal_revenue_code material fact and that a decision may be rendered as a matter of law determination to proceed with collection sec_6320 provides that the secretary shall furnish the person described in sec_6321 with written notice ie the hearing notice of the filing of a notice of lien under sec_6323 sec_6320 and b further provides that the taxpayer may request administrative review of the matter in the form of a hearing within a 30-day period the hearing generally shall be conducted consistent with the procedures set forth in sec_6330 d and e sec_6320 sec_6330 provides that the secretary shall furnish taxpayers with written notice of their right to a hearing before any property is levied upon sec_6330 further provides that the taxpayer may request administrative review of the matter in the form of a hearing within a prescribed 30-day period sec_6330 and b pursuant to sec_6330 a taxpayer may raise at the sec_6330 hearing any relevant issue with regard to the commissioner’s collection activities including spousal defenses challenges to the appropriateness of the commissioner’s intended collection action s and alternative means of collection 114_tc_604 114_tc_176 if a taxpayer received a statutory_notice_of_deficiency for the years in issue or otherwise had the opportunity to dispute the underlying tax_liability the taxpayer is precluded from challenging the existence or amount of the underlying tax_liability sec_6330 sego v commissioner supra pincite goza v commissioner supra pincite petitioner received the notices of deficiency for and accordingly he cannot challenge his underlying liabilities see sec_6330 sego v commissioner supra pincite goza v commissioner supra pincite therefore we review respondent’s determination for an abuse_of_discretion see sego v commissioner supra pincite petitioner claims that appeals did not verify the assessments petitioner is wrong appeals verified the assessment of petitioner’s taxes for and and petitioner received a copy of his administrative file for and petitioner also argues that he was not required to file collection information statements with appeals that he was entitled to a face-to-face hearing that appeals illegally and wrongfully withheld a hearing and violated his statutory rights and administrative due process rights and that the internal_revenue_service violated his fifth and fourteenth amendment rights these are shopworn arguments characteristic of tax- protester rhetoric that has been universally rejected by this and other courts see 848_f2d_1007 9th cir affg tcmemo_1987_225 784_f2d_1006 9th cir we will not painstakingly address these assertions with somber reasoning and copious citation of precedent to do so might suggest that these arguments have some colorable merit 737_f2d_1417 5th cir at the hearing petitioner stated i don’t have collection alternatives petitioner has failed to raise a spousal defense or make a valid challenge to the appropriateness of respondent’s intended collection actions these issues are now deemed conceded see rule b accordingly we conclude that respondent did not abuse his discretion and we will grant respondent’s motion for summary_judgment sustaining respondent’s determination to proceed with collection sec_6673 sec_6673 authorizes this court to require a taxpayer to pay to the united_states a penalty not to exceed dollar_figure if the taxpayer took frivolous or groundless positions in the proceedings or instituted the proceedings primarily for delay a position maintained by the taxpayer is frivolous where it is contrary to established law and unsupported by a reasoned colorable argument for change in the law 791_f2d_68 7th cir see also 820_f2d_1464 9th cir sec_6673 penalty upheld because taxpayer should have known claim was frivolous petitioner’s objection to respondent’s motion for summary_judgment petition forms and correspondence with respondent contain frivolous and groundless statements and arguments petitioner’s answers to the court’s questions at the hearing on respondent’s motion for summary_judgment were evasive and or nonresponsive at the hearing the court inquired as to what issues petitioner wanted to raise in his sec_6330 case petitioner stated that he wanted a face-to-face hearing additionally the following colloquy took place the court the court asked you what nonfrivolous arguments you had -- mr cummings i’m not prepared at this court for such a thing the court you’re not offering waht sic those arguments were mr cummings i’m offering my nonfrivolous issues and that’s -- the court i’m sorry mr cummings i’m offering my nonfrivolous issues the court i’m asking you what are they mr cummings inappropriate collection activity the court like what mr cummings i’m not prepared for that right now the court and what else mr cummings and invalid administrative record the court and what’s your argument on that any specifics mr cummings i want it on the record at a collection_due_process_hearing i’m not prepared to argue these matters before the court today additionally the court asked petitioner what collection alternatives he wanted to raise petitioner tried to avoid answering the question but eventually stated that he had none in the notice_of_determination petitioner was warned that the court is empowered to impose monetary sanctions up to dollar_figure for instituting or maintaining an action before us that is primarily for delay frivolous or groundless respondent cited 115_tc_576 forbes v commissioner tcmemo_2006_10 dollar_figure penalty imposed and aston v commissioner tcmemo_2003_128 dollar_figure penalty imposed to petitioner warning him of the consequences he could face for taking frivolous or groundless positions in these proceedings or instituting the proceedings primarily for delay we conclude petitioner’s position was frivolous and groundless and that he instituted and maintained these proceedings primarily for delay appeals and the court gave petitioner multiple opportunities to state any nonfrivolous issues he wished to raise at a sec_6330 hearing petitioner repeatedly refused to state any nonfrivolous issues he would assert via raising frivolous and groundless arguments and petitioning this court petitioner has sought to delay the collection of a total of approximately dollar_figure of deficiencies and penalties for and by date this amount including interest totaled almost dollar_figure accordingly pursuant to sec_6673 we hold petitioner is liable for a dollar_figure penalty to reflect the foregoing an appropriate order and decision will be entered