Court Opinion

ID: 9940267
Source: CourtListenerOpinion
Date Created: 2024-02-13 20:01:41.997705+00
Date Added: 2024-06-11T13:44:42.115536
License: Public Domain

United States Tax Court

                         T.C. Memo. 2024-21

ACQIS TECHNOLOGY, INC. AND CONSOLIDATED SUBSIDIARY,
                      Petitioner

                                   v.

            COMMISSIONER OF INTERNAL REVENUE,
                        Respondent

                              —————

Docket No. 9261-17.                            Filed February 13, 2024.

                              —————

Nathan E. Honson, Theresa M. Bevilacqua, and Nicholas K. Tygesson,
for petitioner.

Jeannine A. Zabrenski, Robert J. Braxton, Kathleen K. Raup, and
Laurel B. Stout, for respondent.

       MEMORANDUM FINDINGS OF FACT AND OPINION

        MARSHALL, Judge: By statutory notice of deficiency dated
February 1, 2017, the Internal Revenue Service (IRS or respondent)
determined deficiencies in petitioner’s federal income tax and penalties
as follows:

                           Served 02/13/24
                                             2

[*2]                  TYE Nov. 30 1     Deficiency
                                                         Penalty
                                                        § 6662(a)
                           2010        $5,003,457        $1,000,691
                           2011          2,960,097          592,019
                           2012          4,777,425          955,485
                           2015           235,301             47,060

Petitioner timely petitioned this court. After concessions, the issues
before us are whether payments petitioner received upon settlement of
certain patent infringement litigation are includible in gross income or
are nontaxable contributions to capital, whether the six-year limitations
period under section 6501 applies, and whether penalties under section
6662(a) apply. 2 As explained below, we resolve these issues in favor of
respondent.

                               FINDINGS OF FACT

        Some of the facts have been stipulated and are so found. The First
Stipulation of Facts, the Second Stipulation of Facts, and the attached
Exhibits are incorporated herein by this reference. Acqis Technology,
Inc., is a Delaware corporation with its principal place of business in
California. During all relevant times, Acqis Technology, Inc., was the
parent corporation of ACQIS, LLC, a wholly owned subsidiary
(collectively, petitioner or Acqis).

       Petitioner was founded by Dr. William Chu (Chu) in 1998 and
originally incorporated in California. The Acqis board of directors
(BOD) was formed thereafter. The BOD controls the issuance of
dividends and distributions and exercises other corporate powers. From
2004 through November 2010, the members of the BOD were Acqis’s
largest shareholders. From the point of incorporation, petitioner issued
both common stock and preferred stock (Series A Preferred Stock and
Series B Preferred Stock).

       Acqis initially operated as a computer hardware developing and
licensing business. In 2004 Acqis sold its hardware business and

        1 Petitioner’s taxable yearend is November 30.    The deficiency and penalty
amounts stated for each year refer to amounts petitioner received from December 1 of
the preceding year through November 30 of the stated year.
        2 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are
to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,
and Rule references are to the Tax Court Rules of Practice and Procedure.
                                    3

[*3] transitioned into a nonpracticing patent licensing entity. Acqis
acquired seven U.S. patents related to modular computer systems and
set about seeking royalties from entities that infringed on those patents.
In April 2004 petitioner retained Townsend, Townsend & Crew, LLP
(Townsend) to send “notice letters” to companies Acqis viewed as
potentially infringing on its patents. Petitioner provided Townsend with
a list of patents and potential royalty estimates, and Townsend began
issuing notice letters in May 2004. In September 2004 petitioner
retained Ronald Schultz, Esq., of Robins, Kaplan, Miller & Ciresi on a
contingency fee basis to represent petitioner with respect to patent
licensing and enforcement litigation.

       From 2004 through 2009 petitioner strengthened its patent
portfolio and prepared lawsuits against large technology companies
selling blade server products. Petitioner continued seeking additional
patents related to blade server technology and obtained three such
patents between February and May 2008. Petitioner owned a total of
eight blade server patents, issued to it between 2001 and 2008, at the
time it began preparing for patent infringement lawsuits.

       In September 2008 petitioner engaged Cooley Godward Kronish,
LLP (Cooley), to enforce its patents on a full contingency fee basis.
Cooley’s fee to license and enforce the blade server patents was equal to
33-1/3% to 45% of net revenues (i.e. gross revenues less Cooley’s
expenses) generated from patent infringement enforcement, subsequent
licensing transactions, or court awards. Cooley was not entitled to a
contingency fee from amounts paid by persons purchasing petitioner’s
stock.

       Cooley and Acqis spent September 2008 through April 2009
preparing to enforce Acqis’s patent portfolio through litigation. As of the
filing of the Petition, all companies that have entered into licensing
agreements with petitioner were first sued by petitioner for patent
infringement.

I.    Acqis’s Share Structure

       Petitioner began issuing common stock and Series A Preferred
Stock upon its incorporation in 1998 and began issuing Series B
Preferred Stock in 2000 (the three classes of stock are hereafter
collectively, Investment Shares). Between July 13, 1998, and December
24, 2009, petitioner issued common stock shares at the price of $0.06 or
$0.10 per share by way of sales, stock option exercises, or warrant
                                    4

[*4] exercises. Between October 31, 2000, and July 15, 2010, petitioner
sold Series B Preferred Stock at the price of $1.00 per share.
Shareholders of the Investment Shares (Investment Shareholders) are
Chu’s family, friends, business associates, and angel investors. When
soliciting investment in Investment Shares, petitioner provided
potential investors with confidential information regarding its finances,
patent portfolio, targeted companies and projected returns. Petitioner
never distributed proceeds from the sales of Investment Shares to
existing shareholders as a dividend or distribution. Petitioner hired a
law firm on an hourly basis to assist with the sale of Investment Shares,
and upon purchase, Investment Shareholders would send funds directly
to petitioner.

       As of November 17, 2010, petitioner had issued and authorized
the following shares and classes of stock:

            Type of Stock     Shares Issued    Shares Authorized
         Common Stock              8,326,550           18,000,000
         Series A Preferred        1,900,005            2,000,000
         Series B Preferred        4,616,675            5,500,000

On November 18, 2010, the BOD authorized, and petitioner created a
new class of stock, Class B Common Stock (Settlement Shares), while
the existing common stock was converted to Class A Common Stock. On
January 19, 2011, Acqis converted the Series A Preferred shares and the
Series B Preferred shares into Class A Common Stock.

        On December 16, 2011, Acqis reincorporated in Delaware. In a
letter to investors petitioner explained the reincorporation as allowing
greater flexibility in declaring dividends and establishing liquidation
preference among the different classes of stock. The reincorporation also
facilitated the creation of Class C Common Stock, which petitioner
anticipated it might issue in connection with future litigation. As of the
time of trial, however, petitioner had not yet issued any shares of
Class C Common Stock.

       As part of the reincorporation in Delaware, Acqis made changes
to dividend and distribution rights, liquidation preference, and voting
rights held by the different classes of stock.          Following the
reincorporation, the BOD may prefer Investment Shareholders over
Class B Common Stock shareholders (Settlement Shareholders) and any
potential Class C Common Stock shareholders with respect to the
issuance of dividends or distributions, permitting the payment of a
dividend to Investment Shareholders but not to Settlement
                                         5

[*5] Shareholders or Class C Common Stock shareholders. With respect
to liquidation rights preferences among the share classes, Settlement
Shares were not entitled to receive any payment upon liquidation until
Investment Shares had first been paid ratably out of the legally
distributable assets of the company an amount equal to any proceeds
received by, or capital contributions to, petitioner in respect of the First
Patent Litigation (defined below), including any settlements or
judgments related to it. As of November 30, 2012, petitioner reported
current assets of $5,745,200. With respect to voting and BOD election
and removal rights, Investment Shares were entitled to one vote per
share, whereas Settlement Shares and Class C Common Stock were
nonvoting.

II.    First Patent Litigation

       On April 2, 2009, petitioner filed a single lawsuit (First Patent
Litigation) against 11 companies: Defendant 1 (D1), a corporation
subsequently acquired by Defendant 2 (D2), Defendant 3 (D3),
Defendant 4 (D4), Defendant 5 (D5), Defendant 6 (D6), Defendant 7
(D7), Defendant 8 (D8), Defendant 9 (D9), Defendant 10 (D10), and
Defendant 11 (D11) (collectively, First Patent Litigation Defendants). 3
Cooley, as counsel for Acqis for the First Patent Litigation, hired experts
to assist with valuation and expert testimony, and opened trust accounts
to receive settlement payments (collectively, Lawyer Trust Account).

       Acqis and Cooley succeeded in pursuing patent infringement
damages and licensing fees from each of the First Patent Litigation
Defendants in the form of negotiated settlements. The First Patent
Litigation Defendants each paid cash amounts to the Lawyer Trust
Account. 4 Cooley’s contingent legal fee due from petitioner for
settlement of the First Patent Litigation was based on the amounts paid
into the Lawyer Trust Account.

       3 The identity of and amount paid by any patent litigation defendant will not

be disclosed pursuant to the Court’s Orders dated April 16 and May 4, 2021.
       4 The settlement amounts paid by each of the remaining First Patent Litigation

Defendants to petitioner were each less than the settlement amounts that D1, D2, D3,
and D4 ultimately agreed to pay petitioner.
                                    6

[*6] III.   Settlements with D1, D2, D3, and D4

       A.    Negotiations and Settlement with D1

       Petitioner demanded damages exceeding the amount ultimately
paid by D1 ($D1); the amount initially demanded for patent
infringement was determined by experts hired by Cooley. Petitioner and
D1 engaged in mediation in connection with the First Patent Litigation
in November 2010. As part of these settlement negotiations, petitioner
requested that D1 become a shareholder of petitioner by purchasing
shares in petitioner, in exchange for a reduced settlement amount.
D1 had never previously sought to become a shareholder of petitioner
but agreed to the settlement structure to save money. Petitioner did not
provide future patent enforcement plans or financial information, other
than relevant incorporation documents, as part of the share purchase
proposal.

       Acqis and D1 reached a settlement on November 3, 2010, and
signed a memorandum of understanding (MOU), a settlement and
patent license agreement (SA), and a share purchase agreement (SPA).
The parties agreed that, contingent upon the payment of $D1 to Acqis,
Acqis and D1 would dismiss all pending litigation against each other,
and D1 would purchase Settlement Shares at $Z per share and a license
to use Acqis’s patents. Chu chose the $Z share price based on his
estimate of Acqis’s portfolio success in four or five years, but he did not
have the shares valued. The SA required D1 to cease any assistance to
remaining parties to the First Patent Litigation and granted D1 a
perpetual license to use any current or future intellectual property (IP)
held by Acqis at no additional expense beyond $D1. D1 deposited $D1
in the Lawyer Trust Account on November 24, 2010. Cooley received its
contingent legal fee calculated on the full payment amount made by D1
in accordance with Cooley’s agreement with Acqis for settlements
resulting from the First Patent Litigation. D1 would have paid the
settlement amount with or without the SPA.

       B.    Negotiations and Settlement with D2

       Petitioner also demanded damages exceeding the amount
ultimately paid by D2 ($D2); the amount initially demanded for patent
infringement was determined by experts hired by Cooley. Petitioner and
D2 engaged in mediation in connection with the First Patent Litigation
in December 2010. As part of these settlement negotiations, petitioner
requested that D2 become a shareholder of petitioner by purchasing
                                   7

[*7] shares in petitioner in exchange for a reduced settlement amount.
Petitioner did not provide future patent enforcement plans or financial
information, other than relevant incorporation documents, as part of the
share purchase proposal. Neither Acqis nor D2 engaged in discussions
regarding the per-share price of Acqis shares. They instead negotiated
only the overall settlement amount to be paid.

       Acqis and D2 reached a settlement on December 30, 2010, and
signed an MOU, an SA, and an SPA. The parties agreed that, contingent
upon the payment of $D2 to Acqis, Acqis and D2 would dismiss all
pending litigation against each other, D2 would cease any assistance to
remaining First Patent Litigation Defendants, and D2 would receive
Settlement Shares at $Z per share and a license to use Acqis’s patents.
Chu again chose the $Z share price based on his estimate of Acqis’s
portfolio success in four or five years, but he did not have the shares
valued. D2 designated Susan G. Komen for the Cure® (Komen) as the
recipient of the Settlement Shares; D2 never possessed any Acqis
shares. As of the filing of the Petition, petitioner has never provided
Komen with any financial information.

       The SA granted D2 a perpetual license to use any current or
future IP held by Acqis at no additional expense beyond $D2, despite D2
never becoming a shareholder of Acqis. D2 deposited $D2 in the Lawyer
Trust Account on or about December 30, 2010. Cooley received its
contingent legal fee calculated on the full payment amount made by D2
in accordance with Cooley’s agreement with Acqis for settlements
resulting from the First Patent Litigation. D2 had never previously
sought to become a shareholder of Acqis, and its primary reason for
agreeing to the SPA was to settle the litigation and obtain a license.

      C.     Negotiations and Settlement with D3

       Petitioner also demanded damages exceeding the amount
ultimately paid by D3 ($D3); the amount initially demanded for patent
infringement was determined by experts hired by Cooley. Petitioner and
D3 engaged in mediation in connection with the First Patent Litigation,
during which petitioner requested that D3 become a shareholder of
petitioner by purchasing shares in petitioner in exchange for a reduced
settlement amount.      Petitioner did not provide future patent
enforcement plans or financial information, other than relevant
incorporation documents, as part of the share purchase proposal.
Neither Acqis nor D3 engaged in discussions regarding the per-share
                                       8

[*8] price of Acqis shares. They instead negotiated only the overall
settlement amount to be paid.

       Acqis and D3 reached a settlement on December 23, 2011, and
signed an MOU, an SA, and an SPA. The parties agreed that, contingent
upon the payment of $D3 to Acqis, Acqis and D3 would dismiss all
pending litigation against each other and D3 would receive Settlement
Shares at $Z per share and a license to use Acqis’s patents. 5 Chu again
chose the $Z share price despite the fact that a year had passed since
the settlements with D1 and D2. The $Z share price was again
purportedly based on Chu’s estimation of Acqis’s portfolio success in four
or five years, and again he did not have the shares valued. Like D2, D3
designated Komen as the recipient of the Settlement Shares; D3 never
possessed any Acqis shares. As of the filing of the petition, petitioner
has never provided Komen with any financial information.

       The SA granted D3 a perpetual license to use any current or
future IP held by Acqis at no additional expense beyond $D3, despite D3
never becoming a shareholder of Acqis. D3 deposited $D3 in the Lawyer
Trust Account on or about December 23, 2011. Cooley received its
contingent legal fee calculated on the full payment amount made by D3
in accordance with Cooley’s agreement with Acqis for settlements
resulting from the First Patent Litigation. D3 had never previously
sought to become a shareholder of Acqis, and its primary reason for
agreeing to the SPA was to settle the litigation and obtain a license.

      D.     Negotiations and Settlement with D4

      Petitioner demanded from D4 damages exceeding the amount
ultimately paid by D4 ($D4). Petitioner and D4 engaged in negotiations
in connection with the First Patent Litigation, during which petitioner
requested that D4 become a shareholder of petitioner by purchasing
shares in petitioner. D4 had never previously sought to become a
shareholder of Acqis. D4 ultimately paid a higher settlement amount to
Acqis because it declined to structure the settlement as a share
purchase.

      Acqis and D4 reached a settlement on December 2, 2010, agreeing
that D4 would pay Acqis an amount less than $D4 ($D4Z) in exchange
for Acqis and D4 dismissing all pending litigation against each other
and Acqis granting D4 a perpetual license to use any current or future

      5 The MOU mistakenly listed an incorrect price per share of $Y.
                                          9

[*9] IP held by Acqis. D4 deposited $D4Z in the Lawyer Trust Account
on December 17, 2010. Cooley received its contingent legal fee
calculated on the full payment amount made by D4 in accordance with
Cooley’s agreement with Acqis for settlements resulting from the First
Patent Litigation.

       E.      Rights of First Refusal

       Investment Shareholders had a right of first refusal to protect
their investment from dilution if petitioner sold additional shares.
Nevertheless, Acqis never offered any Investment Shareholders the
opportunity to purchase Settlement Shares alongside D1, D2, or D3.
Chu opined that Investment Shareholders were not interested in
Settlement Shares because Investment Shareholders had “better
shares.”

       F.      Settlement Terms

        By December 31, 2011, all activities related to the First Patent
Litigation had concluded, and all First Patent Litigation defendants had
settled with Acqis.      Ultimately, the primary difference in the
agreements signed by D1, D2, and D3 and the other First Patent
Litigation Defendants was the inclusion of SPAs. 6 None of the
agreements executed by D1, D2, and D3 in connection with the First
Patent Litigation allocated the settlement payment amounts to taxable
gross income or to nontaxable stock purchases. Instead, the SAs provide
that each party must determine and be responsible for its tax treatment
of the transaction. D2 and D3 treated the settlement payments as made
for licenses and claimed business deductions for the payments. 7 D2 and
D3 did not treat the payments as made for investments and did not
claim a charitable contribution deduction for their assignment of Acqis
shares to Komen.

       In seeking settlements with D1, D2, D3, and D4, petitioner
offered discounted settlement amounts for structuring settlements to

       6 As part of the settlements, D1, D2, D3, D4, D8, and D11 received a perpetual

license to use petitioner’s existing and future patents. D5, D7, and D9 received a
perpetual license to use petitioner’s existing and future patents related to the
underlying patents in the First Patent Litigation. D10 received a perpetual license to
use petitioner’s existing patents related to the underlying patents in the First Patent
Litigation. Finally, D6 did not receive a license to use any of petitioner’s patents.
       7 As of the time of trial D1 no longer had any record of its treatment of the

settlement payment.
                                     10

[*10] include SPAs, such that D1, D2, D3, and D4 would each pay less
to receive a settlement, shares, and a license than they would pay for
just a settlement and a license. D1, D2, D3, and D4, were the only First
Patent Litigation Defendants to receive SPA offers, and ultimately they
were the defendants that paid the most into the Lawyer Trust Account.
Chu testified that he proposed the idea to change the dynamic of the
lawsuits and Acqis accepted less money in settlement because having
large technology companies as shareholders would validate Acqis,
granting it credibility. Although Chu testified that Acqis settled with
D2 and D3 at discounted rates on account of the credibility Chu expected
D2 and D3 could grant to Acqis as shareholders, D2 and D3 never
became shareholders, having designated Komen as the recipient of the
Settlement Shares. Furthermore, the SPAs precluded Acqis from
disclosing the identities of D1, D2, and D3. 8

       D1, D2, and D3 essentially obtained “free licenses” because they
became shareholders. When discussing the license component of the
settlement with D1, Chu stated:

      In the business deal, in the business transaction that we
      did, by inviting them to become a major owner in this case,
      of our patent, I certainly felt that for that – for being a
      major shareholder of our patent, I would not ask them for
      a license fee, which is a business call . . . . For them, it’s a
      free license. And if we can recoup the number or the price
      of what they pay for or the amount that they pay for, then
      they got it for free. So to me, it’s a free license.

D2 and D3 received “free licenses” but, as stated, never became
shareholders of Acqis. D1 is the only Acqis shareholder who has been
granted a license, free or otherwise.

       At the time of the First Patent Litigation, Chu was aware that,
by structuring the settlement payments as stock sales, petitioner would
report the transactions as capital contributions and therefore no taxable
income. Chu stated that structuring smaller settlement amounts as
SPAs was not worth the legal cost associated with the process, despite
having a stated goal of enlisting large technology companies as

       8 On one occasion in 2018 petitioner disclosed the identity of D1 as a

shareholder without being granted permission by D1.
                                   11

[*11] shareholders with value coming from the size of the company, not
the size of the investment.

IV.   Second and Third Patent Litigation
       In September 2013 petitioner filed four patent infringement
lawsuits (Second Patent Litigation) against Defendant 12 (D12),
Defendant 13 (D13), Defendant 14 (D14), and Defendant 15 (D15)
(collectively, Second Patent Litigation Defendants). Cooley again
represented petitioner for the Second Patent Litigation on a contingent
fee basis under the same terms as for the First Patent Litigation. The
Second Patent Litigation involved blade server and serial peripheral
component interconnect (PCI) patents. Petitioner alleged infringement
of 11 patents that were issued to petitioner between 2005 and 2009.
Petitioner demanded damages from each of the Second Patent Litigation
Defendants and entered into SAs in December 2014, January 2015, and
September 2015. The settlement amounts paid by D12, D14, and D15
to petitioner were each substantially smaller than the settlement
amount that D1, D2, or D3 agreed to pay petitioner. Petitioner did not
offer any of these large technology companies in the Second Patent
Litigation the opportunity to structure their settlements to include
SPAs because the settlement amounts were “very small” and it would
not be “worth the legal cost to go through that process.” The Second
Patent Litigation Defendants wired their settlement payments to the
Lawyer Trust Account. Cooley received its contingent legal fee
calculated on the full payments made by the Second Patent Litigation
Defendants. Petitioner exhausted its ability to obtain licensing fees
from the blade server market upon settlement of the Second Patent
Litigation.

       Petitioner’s litigation against D13 was still pending and had not
yet been concluded as of the filing of the Petition in this case. D13, in
performing discovery in their case with Acqis, moved to compel
production of documents relating to petitioner’s valuation of the license
given to D3. D13’s counsel argued that D13 was entitled to statements
petitioner made regarding the valuation of the D1, D2, and D3
settlement amounts, especially to the extent that petitioner argued that
the licenses had no value. Petitioner’s counsel, Cooley, argued that
disclosure to D13 of petitioner’s valuations of the “free licenses,” per
Chu’s words, was inappropriate because “[t]hese are valuations [and]
allocations that are made for different purposes under California tax
law, under federal tax law, and not economic analysis.”
                                         12

[*12] In September and October 2020 petitioner filed patent
infringement lawsuits (Third Patent Litigation) against Defendant 16,
Defendant 17, Defendant 18, Defendant 19, Defendant 20, and
Defendant 21. The Third Patent Litigation involved products using
serial PCI and Universal Serial Bus 3.0 that allegedly infringed upon
patents issued to petitioner between 2015 and 2018. Chu testified that,
at the time of the settlements with D1, D2, and D3, Acqis had not yet
applied for the patents pursuant to which Acqis initiated the Third
Patent Litigation, and they were only in Chu’s head. All Third Patent
Litigation cases were still pending at the time of trial.

V.     Financial and Tax Reporting

       Petitioner’s taxable yearend is November 30. From 1998 through
2009, petitioner did not earn a profit. For each of the taxable years
during the First Patent Litigation, petitioner submitted into evidence
profit and loss statements reporting settlement income for each year
from 2008 to 2012. 9

       Petitioner filed its Forms 1120, U.S. Corporation Income Tax
Return, for tax years ending November 30, 2010 (2009 Form 1120),
November 30, 2011 (2010 Form 1120), November 30, 2012 (2011 Form
1120), and November 30, 2015 (2014 Form 1120), on February 15, 2011,
February 15, 2012, August 14, 2013, and February 15, 2016,
respectively. On its 2009 Form 1120 petitioner listed its business
activity as “Sales & Development” and its product or service as
“Computer.” On its 2010 and 2011 Forms 1120 petitioner listed its
business activity as “Patent” and its product or service as “Royalties.”

       Petitioner did not report payments from D1, D2, and D3 as gross
receipts on the 2009, 2010, or 2011 Form 1120. Petitioner instead
reported increases in shareholder equity in common stock on line 22b of
Schedule L, Balance Sheet per Books, of each Form 1120. The increases
to shareholder equity for each year roughly corresponded to, but did not
match, the settlement amounts received from D1, D2, and D3. On the
Forms 1120 petitioner reported as “Cost of Goods Sold” the contingent
legal fee amounts paid to Cooley in connection with the First Patent

        9 Despite receiving settlement amounts for each of 2008 through 2012,

petitioner’s profit and loss statements for these years showed losses for 2008, 2009,
2010, and 2012.
                                         13

[*13] Litigation settlements, describing the amounts                     as   “legal
settlement fees” in a statement attached to each return.

       On the 2009 Form 1120 petitioner reported $W in gross receipts
from the First Patent Litigation settlement payments 10 from D5, D6,
D7, D9, D10, and D11. See supra note 3. On the 2010 Form 1120
petitioner reported $V as gross receipts from the First Patent Litigation
settlement payments from D4, D5, and D11. On the 2011 Form 1120
petitioner reported $U in gross receipts from the First Patent Litigation
but reported $T of royalty income from D5 and D9.

       Gary Price of the accounting firm Sensiba San Filippo, LLP
(Sensiba), prepared and signed the 2009, 2010, 2011, and 2014 Forms
1120. Petitioner informed Sensiba that D1, D2, and D3 had each paid
petitioner to purchase Settlement Shares and that in the cases of D2
and D3, the shares were being issued to Komen. Petitioner did not
provide Sensiba with copies of the SAs or the SPAs with respect to D1,
D2, or D3. Petitioner did not provide Sensiba a copy of the fee agreement
with Cooley, which sets forth that the contingent legal fees are
calculated on net revenues generated from enforcement for licenses or
recoveries owed to petitioner pursuant to licensing transactions.
Neither Sensiba nor Cooley provided petitioner with opinions regarding
the proper tax treatment of the payments by D1, D2, and D3 in
settlement of the First Patent Litigation. Chu reviewed and approved
the 2009, 2010, 2011, and 2014 Forms 1120.

       On February 1, 2017, the IRS issued a notice of deficiency (Notice)
with respect to petitioner’s tax years ending November 30, 2010, 2011,
2012, and 2015. The Notice determined that the payments from D1, D2,
and D3 are not contributions to capital but rather are includible in
income as gross receipts, resulting in deficiencies for taxable years
ending November 30, 2010, 2011, and 2012. The adjustments to taxable
years ending November 30, 2010, 2011, and 2012 resulted in
computational adjustments to petitioner’s net operating loss (NOL)
carryovers and carrybacks, resulting in a deficiency for the taxable year
ending November 30, 2015. The Notice also determined a penalty under
section 6662(a) for each taxable year.

        10 We note that D8 entered into an SA with petitioner on October 2, 2009, and

made a settlement payment to petitioner on October 14, 2009. Because petitioner’s tax
yearend is November 30, D8’s settlement payment would have been reported on
petitioner’s 2008 Form 1120.
                                   14

[*14] VI.   Acqis’s Shareholder Relations

      Petitioner reserved funds received from the settlement payments
by D1, D2, D3, and D4 for distributions to Investment Shareholders.
Chu testified that the payments from D1, D2, and D3 allowed Acqis to
continue the business and “reward” Investment Shareholders.

       As of the time of trial, D1 and Komen owned 13% of petitioner but
continued to lack voting rights or BOD representation. They had
minimal interaction with petitioner since the First Patent Litigation
settlements. D1 and Komen, the third- and second-largest shareholders,
respectively, never regularly received financial reporting information
from Acqis. D1 and Komen were required to hold the Settlement Shares
indefinitely unless petitioner registered its shares under the Securities
Act of 1933. In 2010 and 2011 Komen sought to sell or liquidate the
Settlement Shares it held, but petitioner denied the request, stating that
it permitted no sales or transfers of Acqis shares among shareholders.

       As of May 2, 2013, the BOD consisted solely of shareholders
directly or indirectly owning shares of Class A Common Stock. From
2004 through 2022, the members of the BOD did not change except for
the retirement of one member. Petitioner has never made any
distribution or paid any dividends to Settlement Shareholders.

VII.   Expert Testimony on Fair Market Value

       Both petitioner and respondent presented expert testimony with
respect to the fair market value (FMV) of the Settlement Shares and
license agreements at the time D1, D2, and D3 reached settlements with
petitioner. There is no dispute about the qualifications of the experts.

      Michael Pellegrino (Pellegrino) testified as an expert in IP
valuation on behalf of petitioner. Pellegrino approached the stock
valuation by first determining a value for Acqis’s patent portfolio and
then allocating that value across the outstanding shares. Ultimately,
Pellegrino determined that Acqis’s patent portfolio had a value between
$175,666,458 and $462,209,323, with a median value of $318,851,038.
By dividing the $318,851,038 value equally across the 17,322,729 total
outstanding common stock shares and options, Pellegrino arrived at a
Settlement Share price of $18.40 per share. Pellegrino’s model valued
Class A Common Stock and Settlement Shares equally, ascribing no
economic impact to voting rights, distribution rights, BOD
representation, or liquidation preference.
                                           15

[*15] Pellegrino determined the Acqis patent portfolio valuation using
the patents Acqis owned and projected incomes from each as asserted by
Acqis representatives. In his model Pellegrino included 34 patents in
Acqis’s patent portfolio. As of November 3, 2010, the date that Acqis
and D1 reached an SA, petitioner had been granted approval for 18 of
those patents, had 5 patents pending approval, and had yet to apply for
11 of the patents. Pellegrino had met with Chu and other Acqis
representatives in 2015 to gather additional information on Acqis. At
those meetings Chu and the other Acqis representatives provided
Pellegrino with market sizes for products potentially infringing on
Acqis’s patent portfolio, Acqis’s expected royalty rates for various
products, and an assumed royalty base of 100%. 11 With that information
gathered in 2015, Pellegrino then created a valuation model.

       Jeff Anderson (Anderson) testified as an expert in IP valuation
and business valuation on behalf of respondent. Anderson approached
the stock valuation by determining what value, if any, the Settlement
Shareholders could derive from owning the Settlement Shares.
Ultimately, Anderson determined that the shares have no value.
Alternatively, Anderson determined a range of values between $0.032
and $0.146 per share based on Acqis’s historical results, drawing on
prior income and expenses.

       Anderson determined Acqis’s enterprise value using Acqis’s
projected income using a discounted cashflow analysis based on the net
present values of the cashflows from the licenses. Anderson then
applied discounts to the value for lack of marketability to account for the
Settlement Shareholders’ inability to sell or transfer shares and their
lack of voting rights, and petitioner’s lack of economic motivation to pay
dividends or distributions and the Settlement Shareholders’ inability to
force such a change. Anderson determined that the Settlement Shares

         11 “A reasonable royalty is calculated by identifying a royalty ‘base’ (i.e., the

amount of infringing sales against which damages are assessed) and applying a royalty
‘rate’ to that base (i.e., a percentage to which a willing licensor and willing licensee
would have agreed in a hypothetical negotiation before infringement began, reflecting
the proportional value of the patented technology to the base).” MediaTek, Inc. v.
Freescale Semiconductor, Inc., 2014 WL 2854890, at *2 (N.D. Cal. June 20, 2014)
(citing VirnetX Inc. v. Apple Inc., 925 F. Supp. 2d 816, 835 (E.D. Tex. 2013), aff’d in
part, rev’d in part, vacated in part, and remanded sub nom. VirtnetX, Inc. v. Cisco Sys.,
Inc., 767 F.3d 1308 (Fed. Cir. 2014)). In other words, the royalty base is the revenue
pool that was implicated by the infringement. “The royalty base generally is
determined based upon the ‘smallest salable patent-practicing unit.’” Id. (quoting
LaserDynamics, Inc. v. Quanta Computer, Inc., 694 F.3d 51, 67 (Fed. Cir. 2012)).
                                         16

[*16] could not generate income for the Settlement Shareholders and
likewise precluded them from modifying the rights of their shares to
generate income in the future, depriving the shares of any value.

                                    OPINION

I.     The SPAs Were Shams.

       Taxpayers generally bear the burden of proof in this Court. Rule
142(a)(1). The Commissioner’s determination that a transaction is a
sham is generally presumptively correct. Sochin v. Commissioner, 843
F.2d 351, 355 n.9 (9th Cir. 1988), aff’g Brown v. Commissioner, 85 T.C.
968 (1985), abrogated on other grounds by Landreth v. Commissioner,
859 F.2d 643 (9th Cir. 1988); see also Welch v. Helvering, 290 U.S. 111,
115 (1933). The taxpayer has the burden of proof to show the nontaxable
nature of payments received when the taxpayer does not dispute receipt
of the payments in issue. 12 Tokarski v. Commissioner, 87 T.C. 74, 75–77
(1986).

       The sham transaction doctrine requires courts and the
Commissioner to look beyond the form of a transaction and to consider
its substance. Slone v. Commissioner, 810 F.3d 599, 605 (9th Cir. 2015),
vacating and remanding T.C. Memo. 2012-57. The sham transaction
doctrine emerged from Gregory v. Helvering, 293 U.S. 465 (1935), in
which the Supreme Court affirmed the Commissioner in denying
deductions claimed by taxpayers in a corporate reorganization that had
followed each step required by the Code. The Supreme Court held that
this transaction was a “mere device” for the “consummation of a
preconceived plan” and not a reorganization within the intent of the
Code as it then existed. Id. at 469. Since then, the U.S. Courts of
Appeals have expanded upon the sham transaction doctrine, creating
generally analogous yet not identical standards. See, e.g., Rose v.
Commissioner, 868 F.2d 851, 853 (6th Cir. 1989), aff’g 88 T.C. 386
(1987); Kirchman v. Commissioner, 862 F.2d 1486, 1490–92 (11th Cir.
1989), aff’g Glass v. Commissioner, 87 T.C. 1087 (1986); Rice’s Toyota
World, Inc. v. Commissioner, 752 F.2d 89, 91 (4th Cir. 1985), aff’g in
part, rev’g in part, and remanding 81 T.C. 184 (1983).

      Two relevant forms of sham transactions exist: factual shams and
economic shams. Krumhorn v. Commissioner, 103 T.C. 29, 38 (1994).

        12 Petitioner has not argued or otherwise established that the burden shifting

provision of section 7491(a)(1) applies.
                                          17

[*17] Factual shams are purported transactions that never took place,
while economic shams are transactions that lack economic substance.
Id. In examining economic shams the U.S. Court of Appeals for the
Ninth Circuit focuses on (1) the subjective inquiry of whether the
taxpayer intended anything other than acquiring tax benefits (business
purpose) and (2) the objective inquiry of whether the transaction had
any practical economic effects beyond avoiding taxation (economic
substance). 13 Reddam v. Commissioner, 755 F.3d 1051, 1059 (9th Cir.
2014), aff’g T.C. Memo. 2012-106. While not a rigid two-part test, the
business purpose and economic substance prongs allow for a more
holistic approach in determining a sham transaction.           Slone v.
Commissioner, 810 F.3d at 606; Casebeer v. Commissioner, 909 F.2d
1360, 1363 (9th Cir. 1990), aff’g T.C. Memo. 1987-628, aff’g Moore v.
Commissioner, T.C. Memo. 1987-626, aff’g Sturm v. Commissioner, T.C.
Memo. 1987-625, and aff’g in part, rev’g in part Larsen v. Commissioner,
89 T.C. 1229 (1987).

       If a commonsense review of a particular transaction leads to the
conclusion that the transaction does not have a nontax business purpose
or any economic substance other than the creation of tax benefits, the
form of that transaction may be disregarded, and the Commissioner may
rely on its underlying economic substance for tax purposes. 14 Slone v.
Commissioner, 810 F.3d at 606; Reddam v. Commissioner, 755 F.3d
at 1061–62. Respondent contends that the SPAs were economic shams.
As discussed in detail below, we agree.

       A.      Business Purpose and Tax Motivation

      We look first to the business purpose prong, a subjective inquiry
assessing whether petitioner had a business purpose for engaging in the

       13 Absent a stipulation to the contrary, this case is appealable to the Ninth

Circuit. § 7482(b). We follow the precedent of that court that is squarely on point.
Golsen v. Commissioner, 54 T.C. 742, 757 (1970), aff’d, 445 F.2d 985 (10th Cir. 1971).
       14
          We acknowledge that the economic substance doctrine was codified in section
7701(o), effective for transactions entered into after March 30, 2010. See Health Care
and Education Reconciliation Act of 2010, Pub. L. No. 111-152, § 1409(e)(1), 124 Stat.
1029, 1070. Respondent, however, has not invoked section 7701(o) in this case and has
instead pointed us to the approach taken by the Ninth Circuit in characterizing
transactions for tax purposes. Petitioner has similarly focused on the law of the Ninth
Circuit, making no argument that section 7701(o) would dictate a different result but
instead citing that section in support of the Ninth Circuit’s approach. See also Slone
v. Commissioner, 810 F.3d at 606 (describing section 7701(o) as having “codified a
similar approach” to that of the Ninth Circuit). Consequently, we address section
7701(o) no further.
                                           18

[*18] transaction, other than tax avoidance. Reddam v. Commissioner,
755 F.3d at 1060. “The business purpose factor often involves an
examination of the subjective factors which motivated a taxpayer to
make the transaction at issue.” Bail Bonds by Marvin Nelson, Inc. v.
Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987), aff’g T.C. Memo.
1986-23.

       The business purpose examination can be framed as whether the
taxpayer was motivated by reasons solely connected to tax savings, or if
the taxpayer had a nontax profit motive. Reddam v. Commissioner, 755
F.3d at 1060. A taxpayer’s self-interested declarations are not accepted
without question; rather, the Court considers all objective facts known
to the taxpayer at the time, or the facts discoverable by the basic inquiry
of a profit-motivated party. Skeen v. Commissioner, 864 F.2d 93, 95 (9th
Cir. 1989), aff’g Patin v. Commissioner, 88 T.C. 1086 (1987). Regardless
of the taxpayer’s motives, however, a transaction with the sole function
of the production of tax deductions is a sham.               Kirchman v.
Commissioner, 862 F.2d at 1492.

       Before we can apply the sham transaction doctrine, we must
define the transaction that must be tested. One approach is to broadly
define the transaction, i.e., whether petitioner’s settlements with D1,
D2, and D3 were sham transactions when taking the broader context of
the IP litigation and petitioner’s business objectives into consideration.
Conversely, another approach is to narrowly define the transaction, i.e.,
whether the SPAs, by themselves, were collectively, a sham transaction.
We think it is appropriate to apply the latter approach because the
parties’ execution of the SPAs (transaction) is the operative transaction
from which this dispute arises. 15 Below, we consider whether the SPAs
had a business purpose and economic substance.

      During settlement negotiations, petitioner offered D1, D2, D3,
and D4 discounts to structure the settlements as stock purchases rather
than as licensing agreements. Chu testified that he understood at the

         15 We note that, on brief, petitioner also appears to narrowly define the relevant

transaction. Petitioner’s opening and reply briefs focus on the validity of the SPAs and
petitioner’s business motivations behind them. See Pet’r’s Pretrial Mem. (No. 160);
Pet’r’s Opening Br. (No. 177); Pet’r’s Answering Br. (No. 182). Petitioner’s arguments
focus on its assertion that the payments made by D1, D2, and D3, were bona fide stock
purchases and therefore the payments were properly characterized as capital
contributions. Petitioner supports this assertion with several arguments that again
focus on the characteristics and value of the Settlement Shares and the settling parties’
allocation of the payments to the Settlement Shares.
                                   19

[*19] time that petitioner would not have to pay taxes on the payments
if structured as stock purchases. Petitioner, however, asserts that the
financial incentive to have defendants settle through stock purchases
was to enlist the large technology firms as “partners.” Per petitioner, it
expected that the defendants, as shareholders, would provide the
company with credibility and validity, while retaining a passive interest
in Acqis’s future success.

       We find these asserted motivations unconvincing.          While
partnering with large technology firms may have served to amplify
Acqis’s stature and legitimacy, the terms of the SPAs barred Acqis from
publicizing their new arrangements or disclosing the names of D1, D2,
and D3.

       We also find it noteworthy that petitioner offered the stock
purchase structuring discount only to D1, D2, D3, and D4. Chu
explained that he did not offer the stock purchase structuring discount
to any of the other litigation defendants because the settlement amounts
were “very small” and it would not be “worth the legal cost to go through
that process.” This explanation conflicts with petitioner’s previously
stated motivations. Chu testified that Acqis was seeking legitimacy and
stature by partnering with large technology firms, while imbuing the
firms with an interest in Acqis’s ongoing success. The degree of success
Acqis achieved with each of these goals would depend on the size of the
firm with which it partnered and the firm’s ability to amplify Acqis’s
legitimacy, not the size of the firm’s investment. Gaining validity and
credibility through partnerships would depend on the validity and
credibility of Acqis’s potential partner, a factor Chu did not mention as
relevant to his decision regarding which firms would be offered an SPA
structure.

       A factor Chu did consider when structuring settlement payments,
i.e., the size of the settlement payment itself, strikes us as
counterintuitive as well. If large technology firm partners would grant
Acqis credibility, validity, and passive support for future success such
that Acqis was willing to pay (through a discounted settlement payment)
the partners in pursuit of the alliance, surely the partnership itself was
worth the legal cost to implement? Indeed, smaller settlement amounts
would have benefited Acqis by costing the company a smaller discount
while providing the same partnership value.
                                   20

[*20] Our review of petitioner’s motivations leads us to conclude that
Acqis did not have a business purpose for engaging in the transaction
beyond the acquisition of tax benefits.

      B.     Economic Substance

       We next turn to the economic substance prong which “involves a
broader examination of whether the substance of a transaction reflects
its form, and whether from an objective standpoint the transaction was
likely to produce economic benefits aside from a tax deduction.” Bail
Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d at 1549. The
economic substance of a transaction, not its form, is controlling. Gregory
v. Helvering, 293 U.S. at 470. Our task is to determine whether
petitioner and D1, D2, and D3 have actually done what the
documentation purports to do. See Falsetti v. Commissioner, 85 T.C.
332, 347 (1985). Looking to the totality of the facts and circumstances,
factors we may consider in deciding whether a transaction has economic
substance include (1) the FMV of the property involved; (2) the presence
or absence of arm’s-length price negotiations; (3) the relationship
between sale price and FMV; (4) the financing structure; (5) whether the
burdens of ownership shifted; and (6) whether the parties adhered to the
terms of their contract. See Rose, 88 T.C. at 410–11; Helba v.
Commissioner, 87 T.C. 983, 1004 (1986), supplemented by T.C. Memo.
1987-529, aff’d, 860 F.2d 1075 (3d Cir. 1988) (unpublished table
decision); Falsetti, 85 T.C. at 348–53; see also Sacks v. Commissioner,
69 F.3d 982, 988–92 (9th Cir. 1995), rev’g T.C. Memo. 1992-596.

       Petitioner asserts that the structure of the payments by D1, D2,
and D3 has economic substance. The burden rests upon petitioner to
prove this assertion. See Rule 142(a); Welch v. Helvering, 290 U.S. 111.
Petitioner must demonstrate that the payments here in issue were in
fact made to purchase Acqis stock and that the sales were likely to
produce economic benefits aside from shielding Acqis from tax liability.
See Slone v. Commissioner, 810 F.3d at 607; Bail Bonds by Marvin
Nelson, Inc. v. Commissioner, 820 F.2d at 1549.

             1.     FMV

      The FMV of an asset is the price at which the property would
change hands between a willing buyer and a willing seller, neither being
under any compulsion to buy or to sell and both having reasonable
knowledge of relevant facts. United States v. Cartwright, 411 U.S. 546,
550–51 (1973); Treas. Reg. § 20.2031-1(b).
                                   21

[*21] Section 2031 and regulations thereunder provide general rules for
property valuation for estate tax purposes, though the same valuation
rules apply to income tax cases such as this. See Philip Morris, Inc. &
Consol. Subs. v. Commissioner, 96 T.C. 606, 628 (1991), aff’d, 970 F.2d
897 (2d Cir. 1992). When a market valuation is unavailable, as is often
the case with closely held corporations, the FMV is determined by
considering “the company’s net worth, prospective earning power and
dividend-paying capacity, and other relevant factors.” Treas. Reg.
§ 20.2031-2(f). Such factors include the economic outlook of the
industry, the company’s position in the industry, and the degree of
control of the business represented by the group of shares being valued.
Id. Furthermore, the valuation must also consider the “rights,
restrictions, and limitations of the various classes of stock.” Estate of
Newhouse v. Commissioner, 94 T.C. 193, 218 (1990).

       In general, “property is valued as of the valuation date on the
basis of market conditions and facts available on that date without
regard to hindsight.” Estate of Gilford v. Commissioner, 88 T.C. 38, 52
(1987). Subsequent events are not considered in fixing FMV, except to
the extent that they were reasonably foreseeable on the valuation date.
Id. at 52–53. Generally, valuations based on subsequent events that
were not foreseeable on the valuation date are not helpful. Messing v.
Commissioner, 48 T.C. 502, 509 (1967).

       The determination of the FMV of property is a question of fact.
Sammons v. Commissioner, 838 F.2d 330, 333 (9th Cir. 1988), aff’g in
part, rev’g in part T.C. Memo. 1986-318. At trial we received opinion
evidence from two expert witnesses, and we weigh their testimony in
light of their qualifications as well as all other relevant evidence of
value. See Estate of Christ v. Commissioner, 480 F.2d 171, 174 (9th Cir.
1973), aff’g 54 T.C. 493 (1970); Estate of Gilford, 88 T.C. at 56. The
Court has broad discretion to evaluate “the overall cogency of each
expert’s analysis” but is not bound by the opinion of any expert witness
and will accept or reject expert testimony in the exercise of sound
judgment. Helvering v. Nat’l Grocery Co., 304 U.S. 282, 295 (1938);
Sammons v. Commissioner, 838 F.2d at 333–34 (quoting Ebben v.
Commissioner, 783 F.2d 906, 909 (9th Cir. 1986), aff’g in part, rev’g in
part T.C. Memo. 1983-200); Estate of Hall v. Commissioner, 92 T.C. 312,
338 (1989). In addition, we may be selective in deciding what parts (if
any) of their opinions to accept. See Gerdau Macsteel, Inc. v.
Commissioner, 139 T.C. 67, 158 (2012). As discussed herein, we
generally find Anderson’s conclusions to be more persuasive than those
of Pellegrino.
                                   22

[*22] Petitioner’s expert, Pellegrino, asserts that the value of the
Settlement Shares at the time of settlement was $18.40 per share;
respondent’s expert, Anderson, asserts that the shares had a value of
zero per share. The experts took different approaches to the valuation.
Anderson set out to determine the value of the shares based on Acqis’s
projected income using a discounted cashflow analysis. Using Acqis’s
income between 2008 and 2012, Anderson determined a present value
for Acqis’s projected income for future years, including the discount rate
to account for uncertainty regarding future income. Anderson also
accounted for prior sales of Acqis stock and the market rate at which
those sales occurred. Anderson then determined three different share
values after adjusting for (1) the lack of rights, (2) the historical
operating results, or (3) the adjusted operating results. Essentially,
Anderson set out to determine the value that Acqis could extract from
its operations, and what value the Settlement Shareholders could
extract from Acqis by owning the Settlement Shares.

       Petitioner’s expert set out to determine the value of the
Settlement Shares based on the value of Acqis’s patent portfolio at the
time of settlement. Pellegrino valued the patent portfolio using the
number of patents held, the projected market sizes for the patents, and
projected litigation success, while discounting for risk. The valuation
did not adjust for the lack of liquidation, voting, guaranteed dividends,
marketability, or transfer rights, deeming any such distinctions to have
negligible impact on the value of the shares. Pellegrino essentially
determined the potential future value of Acqis’s assets and allocated
that value to all shares while presuming equal access to it.

       The Court has been presented with multiple potential values for
the Settlement Shares: $Z per the SPAs, $18.40 per Pellegrino, and zero
per Anderson. Investment Shareholders had also been paying between
$0.06 and $0.10 per share of common stock as recently as 2009—one
year before the first Settlement Shares were issued. In assessing the
validity of each of these values as applied to the Settlement Shares, we
return to a point first raised by Anderson: What value can the
shareholders extract from Acqis through their ownership of the
Settlement Shares?

       In assessing the value of these shares, we are guided by factors
that seek to value the company and its potential growth, as well as the
potential for the shares to derive value for the shareholders from the
company and its growth.            As the Settlement Shares were
nontransferrable and Acqis did not permit their sale, the Settlement
                                     23

[*23] Shareholders were denied the opportunity to derive capital gains
through appreciation in their shares by way of Acqis’s growth. If Acqis
were to successfully litigate all future patents, securing large
settlements and overflowing coffers, the Settlement Shares, locked to
their current owners, would not be able to convert this success into
currency.

       As the settlement shareholders have been denied the opportunity
to realize income from disposing of the Settlement Shares, we turn to
their eligibility to derive income from share ownership. See Treas. Reg.
§ 20.2031-2(f). Where bid and ask prices are unavailable, we determine
this through the specific facts of the case, including the “degree of control
of the business represented by the block of stock to be valued,” and
dividend-paying capacity. Id.; see Estate of Newhouse, 94 T.C. at 218.

       Pellegrino asserts as a foundation of his analysis that Investment
Shares and Settlement Shares have “identical value economically,”
attributing no valuation impact to restrictions on voting rights, dividend
or distribution rights, or liquidation preference. We disagree. The Court
has previously held that valuation must account for the rights,
restrictions, and limitations of the classes of stock. Estate of Newhouse,
94 T.C. at 218. If the rights and powers of one class of stock are
sufficient to significantly limit the ability of another class of stock to
control the company and its assets, then the value of that other class of
stock will be significantly less than if it enjoyed full and unrestricted
control over corporate affairs. Id. The Court considers eligibility for
redemption, liquidation rights, voting power, eligibility for dividends,
and the power of shareholders to obtain eligibility for dividends in
determining share value. Id. at 219–22.

       Our review of the factors above leads us to determine that the
Settlement Shares did not have economic value at the time of the
settlements. The SPAs dictate petitioner’s expectation and intention
that the Settlement Shares will not receive dividends, do not have
liquidation preference, are not transferrable or redeemable, and have no
voting rights or other means to effect a change with respect to those
absent rights. Acqis has created an instrument that looks like an equity
share with none of its substance. In searching for words to describe
Acqis’s creation, we find ourselves comparing it to a ceremonial “Key to
the City”: It bears the appearance of an item we know well, but opens
no doors, bestows no ownership or function, and is instead merely
representational. Likewise, the Settlement Shares resemble shares in
                                   24

[*24] form, but in function they grant no real benefits of ownership or
income. We conclude that the Settlement Shares are worthless.

             2.     Arm’s-Length Negotiations

      Likewise relevant to our inquiry is whether the parties conducted
arm’s-length negotiations in establishing the price of the Settlement
Shares. See Falsetti, 85 T.C. at 349. The Court has previously reviewed
for reasonable sale prices, evidence of attempts to negotiate, and
evidence of investigation into a financial return by the purchasing party.
Helba, 87 T.C. at 1005–07; Falsetti, 85 T.C. at 348–50.

        As discussed infra, the sale prices grossly exceeded the FMV of
the shares. D1, D2, and D3 did not negotiate with petitioner in setting
the share price but only over the settlement amount needed to end the
litigation. We see no indication that the parties conducted arm’s-length
negotiations in establishing the price of the Settlement Shares

             3.     Relationship Between FMV and Sales Price

       We next turn to the relationship between the FMV and the sale
price of the Settlement Shares. See Falsetti, 85 T.C. at 351. We have
previously determined the FMV to be zero, while the ostensible sale
price for Settlement Shares was $Z per share. Even when looking at
values asserted by Acqis, a value of $18.40 per share and a sale price of
$Z do not align and are supplied with no explanation as to the disparity.
The stark difference between these values militates against petitioner’s
contention that the stock purchases had economic substance.

             4.     Financing Structure of the Transaction

       We next consider the financing structure used by the
participants. Levy v. Commissioner, 91 T.C. 838, 857–58 (1988); Helba,
87 T.C. at 1007–11. The financing structure for the settlements with
D1, D2, and D3 was essentially the same. Each of D1, D2, and D3
entered into an MOU, an SA, and an SPA. The parties agreed that Acqis
and the settling defendant would dismiss all pending litigation against
each other, and the settling defendant would pay a specified sum to
receive Settlement Shares (at $Z per share) and a perpetual
nonexclusive license to use Acqis’s patents. Chu chose the $Z share price
on the basis of his estimate of Acqis’s portfolio success in four or five
years but did not have the shares valued. Both D2 and D3 designated
Komen as the recipient of the Settlement Shares, and neither ever
possessed any Acqis shares. The SA required the settling defendant to
                                          25

[*25] cease any assistance to remaining parties to the First Patent
Litigation and granted the settling defendant a perpetual license to use
any current or future IP held by Acqis at no additional expense beyond
the settlement payment.

       Although the other First Patent Litigation Defendants did not
receive shares or a right to acquire shares, the essential components of
Acqis’s settlements with D1, D2, and D3 generally match the other
patent infringement litigation settlements and licensing fee payments
from all other First Patent Litigation Defendants except for D6, which
did not receive any license as part of its settlement. Aside from D6, each
of the other defendants received a license to use petitioner’s existing
and/or future patents as an essential component of the settlement. 16
Payments from D1, D2, and D3 were paid into the Lawyer Trust
Account. Cooley was paid a contingent fee out of the funds paid into
that account, consistent with the agreement between Acqis and Cooley
that Cooley would receive payment with respect to patent infringement
enforcement, subsequent licensing transactions, or court awards (i.e.,
not stock sales). The remainder was then transferred to Acqis. This
process did not align with Acqis’s approach to prior stock purchases, for
which Acqis hired a law firm on an hourly basis and directly traded
shares for payment with shareholders.

        The structure of the transactions with D1, D2, and D3 does not
resemble that used with respect to other Acqis stock purchases. Instead,
it is functionally equivalent to the process employed with respect to the
other First Patent Litigation Defendants in pursuing patent
infringement damages and licensing fees.

                5.      Burdens and Benefits of Ownership

      In contemplating whether this transaction constitutes a stock
sale, we must also consider whether the burdens and benefits of
ownership have passed from seller to buyer. See Falsetti, 85 T.C. at 348.

        16 As discussed supra, as part of the settlements, D1, D2, D3, D4, D8, and D11

received a perpetual license to use petitioner’s existing and future patents. Petitioner
negotiated a narrower licensing arrangement with the other defendants that received
licenses. D5, D7, and D9 received a perpetual license to use petitioner’s existing and
future patents related to the underlying patents in the First Patent Litigation while
D10 received only a perpetual license to use petitioner’s existing patents related to the
underlying patents in the First Patent Litigation. The differences in the breadth of
the license agreements received by the various defendants does not change our
analysis.
                                   26

[*26] In the context of stock ownership, the “[b]enefits and burdens of
stock ownership generally include sharing in the successes and failures
of the corporation and receiving dividends.” Dunne v. Commissioner,
T.C. Memo. 2008-63, 95 T.C.M. (CCH) 1236, 1243 (first citing Pac. Coast
Music Jobbers, Inc. v. Commissioner, 55 T.C. 866, 875–76 (1971), aff’d,
457 F.2d 1165 (5th Cir. 1972); and then citing Yelencsics v.
Commissioner, 74 T.C. 1513, 1528 (1980)); see also Anschutz Co. v.
Commissioner, 135 T.C. 78, 99 (2010) (citing the factors evaluated in
Dunne to determine whether a transaction validly transferred stock
ownership), aff’d, 664 F.3d 313 (10th Cir. 2011). This again is a question
of fact that must be ascertained from the intention of the parties as
evidenced by the written agreements. Falsetti, 85 T.C. at 349. As
concluded supra, we see no evidence of any benefits of ownership
transferring to D1 or to Komen, as they were unable to receive any
financial gain from the ownership. Because of the restrictions on the
Settlement Shares, they were unable to share in the success of the
corporation and were not expected to receive dividends. It likewise
appears no burdens of ownership shifted. Despite D1 and Komen
collectively owning 13% of Acqis shares, the shareholders had no right
to receive financial information, elect BOD members, or vote.
Conversely, Acqis did provide such financial information and rights to
smaller Investment Shareholders.

             6.     Adherence to Contract Terms

       Finally, we look to see whether the parties conducted the
transaction with a “complete disregard of contractual terms.” Helba, 87
T.C. at 1004. Our review of the record reveals one instance we can
identify where petitioner did not honor the terms of the contracts. The
SPAs contained NDAs that barred Acqis from disclosing the defendants
as shareholders. On one occasion in 2018 Chu disclosed D1’s status as
a shareholder of Acqis without D1’s permission. This one instance,
though likely contrary to the terms of the contract, does not amount to
its “complete disregard.”

      C.     Conclusion

        In all, the record convincingly shows that the parties sought to
settle the patent infringement litigation, but the transaction (as defined
above) served no purpose toward that goal and had no nontax effect.
Instead, the SPAs were added as a legal fiction to achieve a desired
result with respect to Acqis’s tax liability. We find no evidence that
petitioner was concerned with the real value of its shares or passing the
                                   27

[*27] benefits and burdens of their ownership to D1, D2, or D3. The
shares D1 acquired and that D2 and D3 transferred to Komen bore no
value, in stark contrast to the price paid, with no attention paid to the
price per share by D1, D2, or D3 during negotiations. Except for tax
purposes, Acqis and Cooley treated the settlement payments from D1,
D2, and D3 the same as the patent infringement damages and licensing
fees resulting from the First Patent Litigation.

      The SPAs were executed with the sole purpose of obtaining a tax
benefit for Acqis and lacked any economic substance beyond that goal.
What pretended to be a purchase of Acqis shares was really a settlement
payment for patent infringement damages and a licensing fee. The
transaction before us lacks both business purpose and economic
substance and is a sham. Accordingly, the transaction will be
disregarded.

II.   The Payments from D1, D2, and D3 Are Taxable Gross Receipts.

       After holding that the SPAs are disregarded as a sham
transaction, we now must examine the remaining component of the
settlements, the SAs, to determine the payor’s intent with respect to the
settlement payments. The determination of the payor’s intent will, in
turn, dictate the tax consequences of the settlement payments to
petitioner.

       When a taxpayer receives damages from a settlement, “the tax
consequences of the settlement depend on the nature of the claim that
was the basis for the settlement, rather than the validity of the claim.”
Cung v. Commissioner, T.C. Memo. 2013-81, at *10 (quoting
Healthpoint, Ltd. v. Commissioner, T.C. Memo. 2011-241, 102 T.C.M.
(CCH) 379, 382); see also United States v. Burke, 504 U.S. 229, 237
(1992). The amounts paid in settlement should receive the same tax
treatment as if the dispute had been litigated and reduced to judgment.
Freda v. Commissioner, 656 F.3d 570, 574 (7th Cir. 2011), aff’g T.C.
Memo. 2009-191. When a claim is resolved by settlement, the relevant
question for determining the tax treatment of the settlement is: “In lieu
of what were the damages awarded?” Tribune Publ’g Co. v. United
States, 836 F.2d 1176, 1178 (9th Cir. 1988) (quoting Raytheon Prod.
Corp. v. Commissioner, 144 F.2d 110, 113 (1st Cir. 1944), aff’g 1 T.C. 952
(1943)).

       In determining in lieu of what the damages were awarded, the
critical inquiry is the payor’s intent at the time of settlement. See
                                   28

[*28] Metzger v. Commissioner, 88 T.C. 834, 847–48 (1987), aff’d, 845
F.2d 1013 (3d Cir. 1988) (unpublished table decision); Fono v.
Commissioner, 79 T.C. 680, 694, 696–98 (1982), aff’d, 749 F.2d 37 (9th
Cir. 1984) (unpublished table decision). In making this inquiry we first
look to the terms of the settlement agreement itself for indicia of the
payor’s intent as to the payment’s purpose. See Greer v. United States,
207 F.3d 322, 329 (6th Cir. 2000); Dulanto v. Commissioner, T.C. Memo.
2016-34, at *6, aff’d, 703 F. App’x 527 (9th Cir. 2017); Allum v.
Commissioner, T.C. Memo. 2005-177, 90 T.C.M. (CCH) 74, 77–78, aff’d,
231 F. App’x 550 (9th Cir. 2007). Where the agreement lacks express
terms of purpose, the Court looks beyond the agreement to other
evidence that may shed light on the payor’s intent, Greer, 207 F.3d
at 329; Dulanto, T.C. Memo. 2016-34, at *6–7; Allum, 90 T.C.M. (CCH)
at 77–78, such as to the amount paid, the circumstances that led to the
agreement, and any other facts that may reveal the payor’s intent, see,
e.g., Green v. Commissioner, 507 F.3d 857, 868 (5th Cir. 2007), aff’g T.C.
Memo. 2005-250; Pipitone v. United States, 180 F.3d 859, 864–65 (7th
Cir. 1999); Allum, 90 T.C.M. (CCH) at 77–78. Ultimately, the character
of the payment hinges on the payor’s dominant reason for making the
payment. See Green v. Commissioner, 507 F.3d at 868; Allum, 90 T.C.M.
(CCH) at 77–78. Thus, even if the settlement documents do clearly
allocate a payment, the Court may ignore such allocation when there is
evidence that the payment represented something else. Milenbach v.
Commissioner, 318 F.3d 924, 933–34 (9th Cir. 2003), aff’g in part, rev’g
in part on other grounds 106 T.C. 184 (1996). As it has been aptly stated,
“[w]hen assessing the tax implications of a settlement agreement, courts
should neither engage in speculation nor blind themselves to a
settlement’s realities.” Id. at 933 (quoting Bagley v. Commissioner, 121
F.3d 393, 395 (8th Cir. 1997)).

       As direct proof of the payor’s intent may not be available, the
Court reviews the facts and circumstances surrounding the payment.
Bent v. Commissioner, 87 T.C. 236, 245 (1986), aff’d, 835 F.2d 67 (3d Cir.
1987); Allum, 90 T.C.M. (CCH) at 77–78 (citing Knuckles v.
Commissioner, 349 F.2d 610, 613 (10th Cir. 1965), aff’g T.C. Memo.
1964-33). Thus, absent express terms of the purpose of the payment in
a settlement agreement, we consider other provisions in the settlement
agreement documents as an element of the inquiry of the facts and
circumstances of the payment. Allum, 90 T.C.M. (CCH) at 77–78 (citing
Knuckles v. Commissioner, 349 F.2d at 613). We will review the
agreement to interpret the intent of the parties, which is inferred from
the four corners of the agreement if the contract is unambiguous.
U.S. Cellular Inv. Co. of L.A. v. GTE Mobilnet, Inc., 281 F.3d 929, 934
                                    29

[*29] (9th Cir. 2002). A contract is ambiguous if it is capable of two
different reasonable interpretations. CNH Indus. N.V. v. Reese, 583
U.S. 133, 138 (2018); Smith v. Commissioner, 82 T.C. 705 (1984). Where
a contract is ambiguous, the Court is free to consult extrinsic evidence
to the contract, and the burden of proof falls to the taxpayer to prove
that its interpretation is correct. CNH Indus. N.V., 583 U.S. at 138;
Rink v. Commissioner, 100 T.C. 319, 325–26 (1993), aff’d, 47 F.3d 168
(6th Cir. 1995).

       In addition to considering settlement agreement documents to
determine the intent of a payment, the Court has considered several
factors in determining whether a payor intended a capital contribution.
These factors include whether (1) the fee in question is earmarked for
application to a capital acquisition or expenditure, (2) the payors are the
equity owners of the corporation and there is an increase in the equity
capital of the organization by virtue of the payment, and (3) the payors
have an opportunity to profit from their investment in the corporation.
Bd. of Trade of City of Chicago & Subs. v. Commissioner, 106 T.C. 369,
386 (1996). Payments for shares have been held not to be capital
contributions where the shares lacked the attributes of stock, such as
rights to pro rata dividends or growth in the corporation during its life
and where payors were not informed of their right to vote for
management and share in the assets of the corporation upon liquidation.
See Affiliated Gov’t Emps.’ Distrib. Co. v. Commissioner, 322 F.2d 872,
877 (9th Cir. 1963), aff’g 37 T.C. 909 (1962); see also, e.g., Commissioner
v. Scatena, 85 F.2d 729, 732 (9th Cir. 1936) (characterizing stock as an
“interest or right which the owner has in the management, profits and
assets of a corporation”), aff’g 32 B.T.A. 675 (1935).

        As discussed, because the SPAs are disregarded, we are left to
analyze the SAs to determine the defendants’ intent for making the
settlement payments. The SAs state that petitioner sued each
defendant for patent infringement and that the parties desired to settle
the patent infringement litigation. As part of the settlement of the
patent infringement litigation, petitioner and each defendant agreed
that the defendant would acquire a perpetual nonexclusive license and
would purchase the Settlement Shares pursuant to an SPA. The parties
also agreed to mutual releases, and petitioner agreed to dismiss the
patent infringement litigation against each defendant. Although it is
clear from the SAs that each defendant executed the SA to generally
settle the patent infringement claims that petitioner asserted against it,
the SAs do not state the allocation of such payments and, except for D3’s
SA, do not state the total consideration to be paid.
                                   30

[*30] Each SA provided that the consideration paid in exchange for the
settlement was for a license and an investment in petitioner (through
the SPA). The SA, however, does not allocate the consideration as
between these two items. A clear allocation in the SA of the settlement
consideration as between these two items would have been an indication
of the payor’s intent in making the settlement payment. Absent a
statement of the total consideration to be paid and an allocation of the
consideration, the SA is ambiguous as to the payor’s intent in making
the settlement payment. Thus, we examine indirect evidence of payor
intent by applying the circumstantial factors in Board of Trade, which
we view as illuminating the intent of D1, D2, and D3 in making the
settlement payments.

       Of the circumstantial factors raised as indirect evidence of payor
intent in Board of Trade, we have already concluded that the Settlement
Shareholders are not equity owners of Acqis and that the payors do not
have an opportunity to profit from the corporation. See supra Opinion
Part I.C. As for earmarking the payments, Acqis instead distributed
most of the funds received as a “reward” for Investment Shareholders,
retaining part for daily operating expenses. We see no evidence that
Acqis applied the funds to a capital acquisition or expenditure.

       We likewise find no evidence that D1, D2, and D3 intended for
their payments to buy shares or serve as capital contributions. The
record reflects that the payments were for damages for petitioner’s
patent infringement claims and to buy perpetual nonexclusive licenses
for petitioner’s patents. As part of the MOU, the SA, and the SPA,
petitioner and each of D1, D2, and D3 agreed that Acqis and the settling
defendant would dismiss all pending litigation against each other and
the settling defendant would receive Settlement Shares at $Z per share
and a license to use Acqis’s patents. D2 and D3 never accepted the
shares offered by Acqis, receiving only licenses, and donated the shares
to charity. Nor did D2 and D3 claim charitable contribution deductions
for assigning the shares to Komen. Instead, D2 and D3 allocated their
settlement payments to licensing fees for their own financial reporting
and claimed business deductions. D1, D2, and D3 have provided
statements to the effect that they never sought to become shareholders
of Acqis and would have made the settlement payments with or without
the SPA component. These considerations leave little doubt that D1,
D2, and D3 intended the settlement payments (1) as damages to settle
petitioner’s patent infringement claims and (2) to buy perpetual
nonexclusive licenses, not shares. The settlement payments are
therefore taxable gross receipts to petitioner. See § 61(a)(6); Schmitt v.
                                    31

[*31] Commissioner, 271 F.2d 301, 303–05 (9th Cir. 1959), aff’g 30 T.C.
322 (1958); Raytheon Prod. Corp., 1 T.C. at 960–62.
III.   The Six-Year Period of Limitations Applies.

       Generally, any tax imposed by the Code must be assessed within
three years after the return was filed. § 6501(a). However, a six-year
period of limitations applies if a taxpayer omits from gross income an
amount properly includible therein which exceeds 25% of the amount of
gross income stated in the return. § 6501(e). For a trade or business,
gross income is defined for this purpose as the total amount received
from the sale of goods or services, without taking into account the
decrease for any cost of sales or services. § 6501(e)(1)(B)(i). “Gross
income” is thus equated with gross receipts. Insulglass Corp. v.
Commissioner, 84 T.C. 203, 210 (1985). In interpreting the predecessor
to section 6501(e), the Supreme Court has stated that Congress intended
the section to grant the Commissioner additional time where a
taxpayer’s omission on the return puts the Commissioner at a special
disadvantage in detecting errors. Colony, Inc. v. Commissioner, 357 U.S.
28, 36 (1958).

       Having established that the settlement payments from D1, D2,
and D3 were income to petitioner, we turn to see whether that income
exceeds the threshold set forth in section 6501(e). Initially, we note that
the period of limitations in section 6501(e) is in issue only for tax years
ending November 30, 2010 through 2012 and not for the tax year ending
November 30, 2015. The record in this case supports a determination
that the relevant amounts of gross receipts omitted for petitioner’s tax
years ending in November 2010, 2011, and 2012, respectively, exceed
25% of the gross receipts reported on the Forms 1120 for those years.
See supra note 3. Accordingly, the requirements of section 6501(e) are
met and the six-year limitations period applies.

      Petitioner asserts that the three-year limitations period applies
and that the proposed adjustments with respect to the tax years ending
November 30, 2010, 2011, and 2012 are time barred because it
adequately disclosed the omitted income on its returns. “In determining
the amount omitted from gross income . . . , there shall not be taken into
account any amount which is omitted from gross income stated in the
return if such amount is disclosed in the return, or in a statement
attached to the return, in a manner adequate to apprise the Secretary
of the nature and amount of such item.” § 6501(e)(1)(B)(iii). Thus,
“adequate disclosure” of the nature and amount of the transaction
                                    32

[*32] protects the taxpayer from the application of the six-year
limitations period. CNT Invs., LLC v. Commissioner, 144 T.C. 161, 214
(2015); Estate of Fry v. Commissioner, 88 T.C. 1020, 1022 (1987). The
disclosure must be made in the original return or an attachment to it.
§ 6501(e)(1)(B)(iii); Houston v. Commissioner, 38 T.C. 486 (1962).
Adequacy of the disclosure is determined using a reasonable person
standard and is not based on the expertise of the reviewer. Univ.
Country Club, Inc. v. Commissioner, 64 T.C. 460, 469–71 (1975).

       The Court has long addressed what degree of disclosure is
required. The taxpayer need not recite every aspect of the transaction,
but the disclosure must be more substantial than simply providing a
clue “sufficient to intrigue a Sherlock Holmes.” George Edward Quick
Tr. v. Commissioner, 54 T.C. 1336, 1347 (1970), aff’d per curiam, 444
F.2d 90 (8th Cir. 1971). Disclosure must therefore provide enough
information so as to allow selection of the return for audit to be a
reasonably informed process. Estate of Fry, 88 T.C. at 1023. Where the
Commissioner must thoroughly scrutinize the return to determine
whether income was omitted or the return was misleading, disclosure is
inadequate. Highwood Partners v. Commissioner, 133 T.C. 1, 22 (2009).
The question of adequate disclosure is one of fact, and the burden of
proving adequacy in both nature and amount of omitted income falls to
the taxpayer. Whitesell v. Commissioner, 90 T.C. 702, 707–08 (1988);
Univ. Country Club, Inc., 64 T.C. at 468.

        Petitioner made two relevant disclosures on its returns for the
years in question. On line 22b of Schedule L, Acqis reported increases
to common stock shareholder equity. Petitioner also reported “Legal
Settlement Fees” under the cost of goods sold on Statement 5 attached
to its Schedule A on its 2009 and 2010 Forms 1120 and on Statement 12
attached to its Form 1125-A, Cost of Goods Sold, that was attached to
its 2011 Form 1120. The disclosures end there. Petitioner’s returns do
not connect the increases in shareholder equity to the legal settlement
fees, nor do they connect petitioner’s business model with legal
settlements. Instead, the returns state that petitioner’s business
activity was computer sales and development on the 2009 Form 1120,
and patent royalties on the 2010 and 2011 Forms 1120.

       These clues are insufficient to “apprise the Secretary of the nature
and amount” of the omitted income. See § 6501(e)(1)(B)(iii). While
petitioner did disclose increases to common stock shareholder equity,
the values did not match amounts received from D1, D2, and D3 during
the respective years as settlement payments, further obfuscating any
                                    33

[*33] disclosure. Petitioner also reported “Legal Settlement Fees” as
costs of goods sold on their returns but did not disclose their business
model as a nonpracticing patent licensing entity. While there are clues,
mere disclosure of expenses related to an activity does not provide an
adequate clue that the taxpayer omitted income from that activity.
Hines v. Commissioner, T.C. Memo. 1989-17, 56 T.C.M. (CCH) 1050,
1053, aff’d, 893 F.2d 1330 (3d Cir. 1989) (unpublished table decision).

       Moreover, these disclosures were misleading. Disclosures may
provide a clue to omitted income, but misleading disclosures do not
adequately apprise the Commissioner of the nature and amount of an
item. Benson v. Commissioner, T.C. Memo. 2006-55, 91 T.C.M. (CCH)
925, 928, supplementing T.C. Memo. 2004-272, aff’d, 560 F.3d 1133 (9th
Cir. 2009). The Court in Estate of Whitlock summed up the issue
succinctly in concluding that there are “too many missing fact links in
the logical chain connecting the items actually disclosed to the ultimate
disclosure that [the taxpayers] had omitted amounts from the gross
income stated on their return.” Estate of Whitlock v. Commissioner, 59
T.C. 490, 511 (1972), aff’d in part, rev’d in part on other grounds, 494
F.2d 1297 (10th Cir. 1974). The factual gaps between reporting an
increase in shareholder equity and legal fees paid, and payments
received for patent infringement damages and licensing agreements
disguised as sales of stock, are substantial.

       Looking to analogous cases confirms the inadequacy of
petitioner’s disclosures. The Court has previously found that the
reporting of a stock redemption transaction by a closely held corporation
as a cash sale to a presumably unrelated party was an inadequate
disclosure. Estate of Fry, 88 T.C. at 1023. Likewise, the Court has held
that a nondetailed listing of assets as of yearend was insufficient
disclosure to enable the Commissioner to determine whether a
corporation had any earnings invested in U.S. property or increases in
such earnings. Estate of Whitlock, 59 T.C. at 510–11. At a more
granular level, the Court has held that the disclosure of gold mining
development expenses for the operator of a gold mine was not adequate
disclosure of omitted income from mining gold and that, in fact, the
taxpayers had made no disclosure at all. Hines, 56 T.C.M. (CCH) at
1053. In contrast the Court has also held that incorrect treatment of a
transaction, while still accurately reflecting the transaction, was an
adequate disclosure. Walker v. Commissioner, 46 T.C. 630, 639–40
(1966). Petitioner’s disclosure of clues failed to disclose the true nature
of the transaction and lies firmly among cases where the six-year period
of limitations has applied.
                                         34

[*34] In contending that the extended period does not apply, petitioner
asserts that adequate disclosure does not require the taxpayer to
abandon its position that an amount received is not includible in gross
income. See id. at 640 n.8. While petitioner’s assertion is true, achieving
an adequate disclosure need not be viewed in such absolutes; petitioner
could have adequately disclosed the nature of the transaction and the
amount of omitted income, but it did not. Chu’s testimony on the history
of the patent litigation, settlement negotiation, and decision to structure
the settlements as SPAs certainly shows petitioner’s ability to disclose
the nature of the transaction and amounts omitted while standing by
Acqis’s original position. We conclude that the disclosure is inadequate.

IV.    Respondent’s Determination of Accuracy-Related Penalties Is
       Sustained.

       Pursuant to section 6662(a), a taxpayer may be liable for a
penalty of 20% on the portion of an underpayment of tax attributable to
a substantial understatement of income tax. § 6662(b). In the case of a
corporation, a substantial understatement of income tax is defined as an
understatement of tax that exceeds the lesser of (i) 10% of the tax
required to be shown (or, if greater, $10,000) on the tax return or (ii) $10
million. See § 6662(d)(1)(B). In general, the term “understatement”
means the excess of the tax required to be shown on a return for the tax
year over the tax shown on the return. § 6662(d)(2)(A). Generally,
pursuant to section 7491(c), the Commissioner must provide sufficient
evidence indicating the imposition of the accuracy-related penalty is
appropriate and that the taxpayer’s underpayment was attributable to
a substantial understatement. Higbee v. Commissioner, 116 T.C. 438,
446–47 (2001). However, section 7491(c) applies only to individual
taxpayers and does not apply to corporate taxpayers, such as petitioner.
See NT, Inc. v. Commissioner, 126 T.C. 191, 195 (2006). Accordingly,
respondent does not have any burden of production under section
7491(c), and petitioner has the burden of proving the accuracy-related
penalties do not apply. 17

        17 Although respondent bears no burden of production here, including with

respect to the section 6751(b) supervisory approval requirement, see Dynamo Holdings
v. Commissioner, 150 T.C. 224, 237 (2018), we note that petitioner has stipulated that
the section 6751(b) requirement has been satisfied.
                                          35

[*35] For the tax years ended in November 2010, 2011, 2012, and
2015, 18 respondent determined that petitioner is liable for accuracy-
related penalties attributable to substantial understatements of income
tax. 19 On the basis of the updated amounts includible in gross income
as established above, petitioner’s understatements for the years in
question are as follows:

                                                                    10% of Tax
          Tax Shown    Tax Required to Be      Understatement
                                                                   Required to be
          on Return    Shown on Returns           of Tax
                                                                  Shown on Return
 2010        -0-            $5,003,457           $5,003,457         $500,345.70
 2011     $16,138            2,976,235            2,960,097          297,623.50
 2012        -0-             4,777,425            4,777,425          477,742.50
 2015       6,210              241,511              235,301           24,151.10

       In the event of a substantial understatement, however, the
taxpayer may escape the penalty under certain circumstances. First, a
taxpayer does not owe a penalty where the taxpayer can identify
“substantial authority” supporting its treatment of an item of income.
§ 6662(d)(2)(B)(i). Second, a taxpayer does not owe a penalty where the
taxpayer can demonstrate that the relevant facts affecting the item’s tax
treatment are adequately disclosed in the return or an attachment to
the return and there was a reasonable basis for the tax treatment of the
item by the taxpayer. § 6662(d)(2)(B)(ii). Finally, to the extent that the
taxpayer had reasonable cause for its position and acted in good faith,
the penalty also does not apply. § 6664(c)(1). As discussed below,
petitioner argues that the accuracy-related penalties should not apply
because (1) it had substantial authority for its position and (2) it
demonstrated reasonable cause for its position and acted in good faith.

      First, petitioner asserts that it had substantial authority to
support its position that the proceeds from the Settlement Share
purchases were not taxable. Petitioner argues that section 118, which

        18 Respondent determined penalties for tax year ending November 30, 2015, as

a computational adjustment related to the deficiencies from tax years ending
November 30, 2010 through 2012.
         19 Respondent states that the accuracy-related penalties under section 6662(a)

for the tax years ending November 30, 2011 and 2012, were understated because they
were calculated after the application of NOL carrybacks from the tax years ending
November 30, 2013 and 2014, which were not available at the time the returns for the
tax years ending November 30, 2011 and 2012, were filed. Resp’t’s Opening Br. 1 n.*
(No. 176). However, respondent is not seeking to increase the amounts of those
accuracy-related penalties. The amounts in the table reflect the amounts from the
notice of deficiency without excluding the NOL carrybacks.
                                   36

[*36] provides that the gross income of a corporation does not include
any contribution to capital, and section 1032, which provides that a
corporation recognizes no gain or loss on the receipt of money in
exchange for stock, and their related regulations support its position. In
particular, petitioner quotes Treasury Regulation § 1.1032-1(a) as
support.     That regulation provides that “[t]he disposition by a
corporation of shares of its own stock . . . for money or other property
does not give rise to taxable gain or deductible loss to the corporation
regardless of the nature of the transaction or the facts and
circumstances involved.” Petitioner’s argument seems to be elevating
form over the actual substance. Nonetheless, we have already held that
the structured stock sales lacked economic substance and are
disregarded. The record shows that the parties sought to settle the
patent infringement litigation and provide patent licenses, with the
transaction (as defined above) added as a legal fiction to achieve a
desired result with respect to Acqis’s tax liabilities. We reject
petitioner’s reliance on Treasury Regulation § 1.1032-1(a) as support for
its position in the light of our analysis that the transaction lacked
economic substance and is disregarded. Cf. Affiliated Gov’t Emps.’
Distrib. Co., 37 T.C. at 918 (evaluating the “real nature” of amounts paid
to taxpayer to determine whether section 1032 applied to those
amounts). Petitioner does not make any other argument that it had
substantial authority to support its reporting, or lack thereof, with
respect to the settlement proceeds it received from D1, D2, and D3.
Accordingly, petitioner has not demonstrated that it had substantial
authority for its treatment of those proceeds.

       In addition petitioner asserts that it had reasonable cause for its
position and that it acted in good faith. Specifically, Acqis had its
returns for the years in question prepared by an accounting firm.
Reliance on the advice of a professional tax adviser may, but does not
necessarily, establish reasonable cause and good faith. Treas. Reg.
§ 1.6664-4(b)(1), (c). A taxpayer must prove by a preponderance of the
evidence three elements in order to show that reliance on advice was
reasonable: “(1) The adviser was a competent professional who had
sufficient expertise to justify reliance, (2) the taxpayer provided
necessary and accurate information to the adviser, and (3) the taxpayer
actually relied in good faith on the adviser’s judgment.” DJB Holding
Corp. v. Commissioner, 803 F.3d 1014, 1030 (9th Cir. 2015) (quoting
Neonatology Assocs., P.A. v. Commissioner, 115 T.C. 43, 99 (2000), aff’d,
299 F.3d 221 (3d Cir. 2002)), aff’g WB Acquisition, Inc. v. Commissioner,
T.C. Memo. 2011-36. However, “[t]he mere fact that a certified public
accountant has prepared a tax return does not mean that he or she has
                                    37

[*37] opined on any or all of the items reported therein.” Neonatology
Assocs., 115 T.C. at 100.

       Acqis has not demonstrated by a preponderance of the evidence
that the three-prong test in Neonatology Associates has been satisfied.
First, nothing in the record indicates the accounting firm knew Acqis’s
reasons for engaging in the transaction or for structuring it as a sale of
stock. See Treas. Reg. § 1.6664-4(c)(1)(i) (listing the taxpayer’s purposes,
and the relative weight of such purposes, for entering into a transaction
and structuring it in a particular manner as information the adviser
must consider). More importantly, Acqis concedes never having asked
the accounting firm for an opinion on the validity of the transaction. See
DJB Holding Corp. v. Commissioner, 803 F.3d at 1030. Instead, the
record reveals only that the accountant prepared tax returns for the
transaction on the basis of how Acqis portrayed the transaction and
provided information. Petitioner has not met its burden of showing
reasonable reliance on the accounting firm’s advice. See Higbee, 116
T.C. at 449; Treas. Reg. § 1.6664-4(b)(1); Higbee, 116 T.C. at 449.

       Petitioner also asserts that it acted in good faith. The decision as
to whether the taxpayer acted with reasonable cause and in good faith
depends upon all the pertinent facts and circumstances. See Treas. Reg.
§ 1.6664-4(b)(1). Relevant factors include the taxpayer’s efforts to assess
his proper tax liability, including the taxpayer’s reasonable and good
faith reliance on the advice of a professional such as an accountant. See
id. Further, an honest misunderstanding of fact or law that is
reasonable in light of the experience, knowledge, and education of the
taxpayer may indicate reasonable cause and good faith. Higbee, 116
T.C. at 449 (citing Remy v. Commissioner, T.C. Memo. 1997-72).

      Petitioner structured stock sales that lacked economic substance
in order to characterize its receipt of payments for the settlement of
patent infringement litigation and licenses as nontaxable contributions
to capital. See supra Opinion Part I.C. Petitioner has provided
explanations for the stock sale structure that are counterintuitive and
contrary to both the economic reality of the transaction and the contract
terms agreed therein. See supra Opinion Part I.A. These are not actions
taken with reasonable cause in good faith.

      Citing Rolfs v. Commissioner, 135 T.C. 471, 495-96 (2010), aff’d,
668 F.3d 888 (7th Cir. 2012), petitioner counters that, whether Acqis’s
treatment of the transaction is correct, it is not unreasonable as they
have shown that a reasonable argument can be made in support of their
                                          38

[*38] position. We disagree. The Court in Rolfs was called upon to rule
on an area of law that was unsettled at the time. Id. at 496. The Court
has consistently acknowledged unsettled law to be a factor in favor of
reasonableness for taxpayers trying to navigate their own liability.
Patel v. Commissioner, 138 T.C. 395, 417 (2012); Rolfs, 135 T.C. at 496.
The law regarding sham transactions, however, emerged from Gregory
v. Helvering in 1935. Although the law regarding sham transactions is
complex, it was hardly unsettled when petitioner filed its returns. See
supra Opinion Part I.A; see DJB Holding Corp. v. Commissioner,
803 F.3d at 1030–31.

       Because petitioner has not met its burden of proving that it had
substantial authority or reasonable cause for the position that the
settlement payments were nontaxable contributions to capital, we
sustain respondent’s imposition of the accuracy-related penalties for
petitioner’s taxable years ending November 30, 2010, 2011, 2012, and
2015, under section 6662(a) and (b)(2). 20

      We have considered the parties’ other arguments and, to the
extent they are not discussed herein, find them to be irrelevant, moot,
or without merit.

        To reflect the foregoing,

        Decision will be entered under Rule 155.

        20 Respondent, on brief, argued that petitioner could not assert any defenses to

the accuracy-related penalties because the income was attributable to a “tax shelter”
as defined in section 6662(d)(2)(C)(ii). Because we find that no defenses apply to the
imposition of the accuracy-related penalties, we do not address whether the
transaction at issue constituted a tax shelter.