Court Opinion

ID: 4485411
Source: CourtListenerOpinion
Date Created: 2020-01-16 21:17:24.414014+00
Date Added: 2024-06-11T15:04:10.382647
License: Public Domain

Hamblen, J., dissenting: I respectfully dissent. The Court majority, in my opinion, makes an errant approach to the problem presented. Section 465 was enacted to prevent loss deductions in excess of economic investment arising from certain tax shelter activities. The arrangement petitioners entered into appears to have substance, although the at risk value of the Fairfield note is problematical. If so, as Judge Simpson’s concurring opinion relates, then we should limit the at risk value of the Fairfield note rather than extend the at risk provisions to situations where cash call requirements within the partnership agreement present additional economic risk to limited partners. Furthermore, I share Judge Simpson’s view, and that of Judge Cohen, that the Court’s "at risk” analysis, as applied here, should be firmly focused on and limited to Fairfield’s role in the transaction as a person having an interest in the activity other than that of a creditor. Sec. 465(b)(3). The majority approach which focuses on the partnership agreement cash call requirements Creates a bad precedent for genuine business transactions structured through limited partnership arrangements. See 1 W. McKee, W. Nelson & R. Whitmire, Federal Taxation of Partnerships and Partners, par. 8.03, at 8-11 to 8-12 and par. 10.11 [2][b], at 10-78 to 10-79 (1977). It is my view that the limited partners here were on par with general partners as far as liability on the Fairfield note is concerned. I, therefore, concur with Judge Cohen’s dissent. Nims, Whitaker, Cohen, and Wright, JJ, agree with this dissent. Cohen, J., dissenting: I respectfully dissent. As Judge Whitaker states, the issue is one of Federal tax law. Although we may look to State law to determine the substantive rights and liabilities of the various parties to the transactions, in my view the majority focuses excessively upon the purported uncertainty of creditors’ remedies under California law. The result reached by the majority may indeed be correct on the facts. I share Judge Simpson’s impression that Fairfield appears to be a person having an interest in the activity, other than that of a creditor, under section 465(b)(3), and that the absence of a provision for interest on the notes adds an element of economic unreality to the transactions. This should be explored further by the finder of facts. I cannot, however, join the majority’s reasoning that the liability of the limited partners on the notes to Fairfield is "contingent” for the purpose of the "at risk” rules. The majority cites two reasons for its conclusion at page 588: the requirement [to make an additional capital contribution] was merely a contingency since it was not known in 1976 or 1977 (a) whether there would or would not be sufficient partnership revenues to satisfy the Fairfield note prior to or on maturity of the note, or in the event the Fairfield note was not satisfied in full on maturity, the amount of the capital contributions needed to cover the deficiency, or (b) if the general partners would in fact exercise their discretion to make the cash call if an unpaid balance on the Fairfield note were to exist on December 31, 1992. * ■* * I agree that the second contingency, if it existed, might ultimately negate the liability of the limited partners to make the cash call; in that event, they would not be at risk on the liability to Fairfield. Nowhere does the majority find, however, that the general partners had the unilateral discretion to waive the express undertaking of the limited partners to make the additional contributions if the notes were not satisfied through partnership operations by the maturity date. Such a result would indeed be anomalous as a matter of State law. The references to State law in the majority opinion strongly suggest, and indeed the entire opinion implies, that Fairfield could, at maturity, force the limited partners to make the additional contributions to satisfy the notes. Thus the determinative "contingency” found by the majority can only be that the partnerships might generate sufficient revenues to satisfy, in full or in part, the notes to Fairfield prior to their maturity date. Whether this possibility renders petitioners’ liability "contingent” can best be examined by assuming for a moment that such "contingency” did not exist, i.e., that the notes to Fairfield merely required a single balloon payment on the maturity date and that cash from partnership operations was currently distributable to the partners. Under this assumed scenario, the limited partners’ obligations to contribute the additional funds and thereby satisfy the notes on maturity would be certain: the possibility that interim partnership revenues could discharge that liability would not exist. The "contingency” relied upon by the majority is thus merely the acceleration of payment on the notes, as compared with the posited scenario. If the limited partners are not considered at risk solely because of such "contingency,” it is doubtful that any liability could pass muster under section 465. Any indebtedness might be satisfied through cash generated by the leveraged activity or asset. Bona fide investors incurring valid, recourse debt typically hope such will be the case. Section 465(b)(2), however, specifically contemplates that certain borrowed amounts are to be included as amounts at risk. In enacting the rules under examination, Congress intended to prevent a taxpayer from deducting an amount for which he is not at economic risk. S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 85. The paradigm situation to which the "at risk” rules apply is where the investor incurs nonrecourse debt, on which he has no personal liability and will suffer no economic detriment if the activity generates insufficient revenues to satisfy the debt. S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 87-88. The majority thus distorts and unduly extends the "at risk” rules. Instead of limiting the taxpayer’s deduction where the liability is payable only out of revenues generated by or assets used in the activity, the majority extends section 465 to situations where the liability may be so paid. As the term is used by Congress, whether an investor is at risk depends upon the nature of the taxpayer’s obligation if the activity is an economic failure, not if it is a success. The majority apparently attributes significance to the general partners’ discretion over distributions to the limited partners. (See note 14.) Because the partnership agreements prescribed specific ratios for partnership distributions, however, the discretion of the general partners merely related to the timing of the distributions. It is incongruous that the possibility that funds would remain in the partnership and not be distributed immediately to the limited partners could render the limited partners not at risk. Distributions from a partnership reduce a partner’s initial amount at risk. Sec. 7.465-2, -5, Income Tax'Regs.; S. Rept. 94-938 (1976), 1976-3 C.B. (Vol. 3) 49, 89. The majority states that the limited partners were not liable on the Fairfield notes as of the years in issue because "Fairfield had no established recourse on its notes against petitioners.” (Page 589.) This statement confuses the existence of liability with the timing of payment thereon and the means of enforcing such payment. A taxpayer who must make payments on a debt on or before the maturity date has personal liability, and hence is at risk, even though the creditor cannot enforce payment before maturity. Congress could have prescribed the result reached by the majority by prohibiting deductions with respect to all indebtedness, recourse and nonrecourse alike, or by dealing with various types of debt in greater detail. As we have so frequently said, however, it is not for us to rewrite the statute as enacted. Wilbur, Nims, Whitaker, Kórner, and Hamblen, JJ, agree with this dissent.