Opinion ID: 902846
Heading Depth: 3
Heading Rank: 1

Heading: On June 7, 2001, Credicom Asia redeemed its

Text: worthless class A common stock from its parent corporation, Credicom NV (“CNV”), for 1,718,116 Swiss francs and $303,375. CNV’s claimed “basis” in the class A common stock, i.e., the amount it had invested in Credicom Asia’s class A common stock, approximated $184,000,000. 2. The next day, CNV transferred the 1,718,116 Swiss francs and $303,375 to International Capital Partners, LP (“ICP”), in exchange for a partnership interest in ICP. 1 3. On November 6, 2002, ICP transferred 50,000 of the Swiss francs, having a fair market value of $34,185, to Rovakat in exchange for a partnership interest in Rovakat. 1 ICP was a Cayman Islands limited partnership and founding partner of Rovakat. ICP was controlled by Lance O. Valdez, a tax attorney and financial advisor who put together DAD tax shelters. Valdez was also president of Credicom Asia, and directed the transactions that formed the basis for the DAD tax shelter at issue in this case. 2 4. On December 26, 2002, ICP transferred 90% of its partnership interest in Rovakat to Mr. Hovnanian for $30,776. 2 5. On December 27, 2002, Rovakat sold the 50,000 Swiss francs to a third party for their fair market value of $35,468. 3 6. Rovakat incurred almost $400,000 in costs related to these transactions, including fees of more than $380,000 to Valdez, and $13,000 for a tax opinion from a law firm recommended by Valdez. 7. On its tax returns for 2002, 2003, and 2004, Rovakat claimed that its basis in the 50,000 Swiss francs was $5,805,000, so that its transfer of the Swiss francs for $35,468 generated a loss of more than $5,700,000. 4 In FPAAs issued for Rovakat’s 2002, 2003, and 2004 tax returns, the Commissioner determined that Rovakat had not established the claimed basis of $5,805,000 in the 50,000 Swiss francs, and thus was not entitled to deductions from 2 Mr. Hovnanian has a degree in economics from the University of Pennsylvania, and is a sophisticated investor as well as an entrepreneur in the information technology and medical devices fields. 3 The Tax Court opinion was inconsistent with regard to the fair market value of the Swiss francs. The Tax Court first stated that the francs were valued at $35,268, (App. 21), but later stated that they were valued at $35,468 (App. 30.) We use the latter number—$35,468—which is the value the parties stipulated to before the Tax Court. (Supplemental App. 52.) 4 As a general rule, property received in exchange for a partnership interest assumes the basis of the partner’s interest in the property. See 26 U.S.C. § 721(a). In this case, Rovakat treated Credicom Asia as a partnership and CNV as one of its partners, notwithstanding their corporate structures. Asserting that CNV liquidated its partnership interest in Credicom Asia for “property” in the form of Swiss francs, Rovakat claimed that CNV’s basis in the class A common stock, totaling approximately $184,000,000, attached to the Swiss francs. Rovakat claims a pro rata share of the purported basis in the Swiss francs. 3 ordinary income for the purported “loss” incurred when the Swiss francs were sold for $35,468. The Commissioner found in the alternative that the deductions should be disallowed because the Swiss francs transaction lacked economic substance. The Commissioner’s FPAAs also imposed a 40% gross valuation misstatement penalty pursuant to 26 U.S.C. § 6662(h)(1) with respect to tax underpayments resulting from the wrongfully claimed losses attributed to the Swiss francs transaction. Rovakat challenged the disallowances for the deductions attributed to the Swiss francs transaction in the Tax Court. In rejecting Rovakat’s challenges, the Tax Court applied the “substance-over-form” doctrine, and found that Credicom Asia’s redemption of its class A stock from CNV, a corporation, could not be regarded as a transfer of a partnership interest. Consequently, CNV’s basis in the class A stock did not attach to the Swiss francs received by CNV in exchange for the class A stock. Alternatively, the Tax Court held that Rovakat could not claim a basis of more than $5,800,000 in Swiss francs having a market value of only approximately $35,000 because the transactions at issue lacked “sufficient economic substance to be respected for federal tax purposes.” (App. 47.) Specifically, the Tax Court found that “[t]he francs transaction as a whole, when viewed in the light of its individual steps, had no economic significance other than to serve as a means for Mr. Hovnanian’s attempt to purchase and use CNV’s built-in-loss.” (Id. at 48.) Observing that “[b]ecause a transaction that lacks economic substance is not recognized for Federal tax purposes, and ‘cannot be the basis for a deductible loss,’” the Tax Court ruled that Rovakat could not claim losses from that transaction. (Id. at 64.) Finally, the Tax Court sustained the 40% accuracy-related penalties, rejecting Rovakat’s 4 assertion that it had acted in good faith and with reasonable cause on the basis of opinions from tax attorneys.