June 30, 2010
On March 5, 2010, the government filed its reply brief in its appeal from the Tax Court’s decision in Sunoco Inc. v. Commissioner, 122 T.C. 88 (2004), thus completing the appellate briefing. The case raises a novel issue concerning the Tax Court’s jurisdiction to determine overpayment interest. Sunoco filed a petition seeking redetermination of deficiencies for its 1979, 1981, and 1983 tax years. In an amended petition, Sunoco reported that certain issues had settled but argued that the IRS had committed errors in calculating the interest on underpayments and overpayments arising out of those issues because it used incorrect starting and ending dates. The IRS moved to dismiss Sunoco’s claims for additional overpayment interest on the ground that Code section 6512 does not give the Tax Court jurisdiction to make a determination of overpayment interest with respect to overpayments not at issue in the case. The Tax Court denied the motion, holding that it had jurisdiction over Sunoco’s claims because the court would be resolving the same issues regarding starting and ending dates in connection with disputes over underpayment interest that were unquestionably before the court.
The Tax Court’s decision is a narrow one, finding that the settled principles of Estate of Baumgardner v. Commissioner, 85 T.C. 445 (1995), apply in Sunoco’s unusual circumstances because the date issues necessarily affect both underpayment interest and overpayment interest. The government, however, objects that Baumgardner is limited to underpayment interest and that Sunoco opens a Pandora’s box with broad implications by holding that section 6512 can give the Tax Court jurisdiction to resolve a dispute over overpayment interest. In the government’s view, there are no circumstances in which the overpayment jurisdiction of section 6512 can cover a claim for overpayment interest.
Because the appeal of Sunoco was delayed for years while a motion for reconsideration was pending, actual events cast some doubt on the government’s claim of broad implications. The case was decided in 2004 and in the past six years, the Tax Court has had little occasion even to cite it, much less to use it to open the gates to all sorts of taxpayer claims for overpayment interest. Nonetheless, the case has finally reached the Third Circuit, and that court will now decide whether the Tax Court overstepped its bounds in applying the principles of Baumgardner to overpayment interest in this context.
The key documents in the case are here:
June 28, 2010
As many if not most tax practitioners are aware, Castle Harbour is the nickname of a partnership taxation case that has been the subject of a great deal of attention in recent years. See TIFD III-E Inc. v. United States, 342 F. Supp. 2d 94 (D.Conn. 2004), rev’d, 459 F.3d 220 (2d Cir. 2006). The case involved a partnership arrangement that allocated 98% of the taxable income derived from fully depreciated aircraft leases to two foreign banks, even though the banks received only a relatively meager debt-like return on their partnership interests. The IRS attacked the structure on two basic grounds: (1) that the overall arrangement was a sham, and (2) that the foreign banks were not bona fide equity partners, but rather held interests economically in the nature of secured loans.
The district court decided the case in the taxpayer’s favor, holding that the partnership arrangement was not a sham because there were legitimate business purposes for the deal, and the arrangement did have appreciable economic effects, even though the partners had tax avoidance motives in entering into the deal. The Second Circuit reversed the district court on the IRS’ second argument, namely that the banks were not bona fide partners because they had no meaningful stake in the entrepreneurial success or failure of the venture. The court’s holding was based on an application of the Supreme Court’s facts and circumstances test for bona fide partner status set forth in Commissioner v. Culbertson, 337 U.S. 733 (1949). The Second Circuit remanded the case for further consideration of an alternative argument by the taxpayer—that the partnership was a “family partnership” under I.R.C. section 704(e).
In a somewhat surprising turn, the district court held that the banks were partners in a partnership under section 704(e), irrespective of the Second Circuit’s ruling applying Culbertson. The government, of course, has appealed to the Second CIrcuit, No. 10-70. The government’s brief is linked below. The taxapayer’s brief is due September 14, 2010.
June 22, 2010
The Supreme Court’s recent denial of certiorari left intact the First Circuit’s en banc decision in United States v. Textron, Inc., 577 F.3d 21 (1st Cir. 2009), holding that Textron’s tax accrual workpapers had not been created “in anticipation of litigation” and therefore were not entitled to work product protection. The Supreme Court’s decision, of course, does not make Textron the law of the land, but rather leaves considerable uncertainty over whether other circuits will follow the First Circuit’s lead or instead place greater weight on a company’s interest in protecting from the IRS the company’s lawyers’ assessments of the strength of its tax positions.
The next insight into these issues could come soon from the D.C. Circuit in United States v. Deloitte & Touche USA LLP, 623 F. Supp. 2d 39 (D.D.C. 2009), appeal pending, No. 09-5171 (argued Feb. 26, 2010). The dispute in Deloitte arises in a different context from Textron, but it touches on similar issues. In the course of tax litigation with a partnership owned by Dow Chemical, the government sought discovery from Deloitte of three documents that contained opinions of Dow lawyers concerning the merits of the tax issues. The government agrees that two of these documents (a tax opinion prepared by Dow’s outside counsel and a legal analysis prepared by Dow’s in-house counsel) are attorney work product, but it argues that Dow waived the work product protection when it disclosed the documents to Deloitte. The third document is an analysis prepared by Deloitte that contains opinions of Dow attorneys that had been conveyed orally to Deloitte. The government argues that this document, prepared by accountants, is not work product.
The district court denied the government’s motion to compel in a brief opinion. It ruled that the Deloitte memo was work product because it recorded the thoughts of Dow’s counsel concerning the prospects in litigation. And it ruled that Dow did not waive the privilege by sharing its legal analysis with its auditors. The government’s appeal potentially could lead the D.C. Circuit to address several recurring issues.
The threshold issue of whether the Deloitte memo is work product presents the Textron issue, and the D.C. Circuit thus could directly address whether it agrees with the First Circuit’s view on tax accrual workpapers. The government repeats its winning argument in Textron that work product protection does not attach to tax accrual workpapers or similar documents that are prepared for the business purpose of preparing accurate financial statements. Dow, which has intervened as the real party in interest to oppose the government’s document request aimed at Deloitte, argues that work product protection attaches because of the documents’ content — namely, lawyers’ opinions of the prospects of litigation.
Both parties, however, have advanced arguments for distinguishing Textron that could allow the D.C. Circuit to avoid directly addressing the Textron reasoning. Dow argues that, whatever merit the Textron analysis has in the summons context where the IRS is examining a return and seeking to identify issues, it has no merit in the discovery context where the government has identified the issue and is just looking to enhance its litigation prospects by peeking through a window into the other side’s thought processes. The government, for its part, argues that the work product claim fails at the outset because, in contrast to Textron, the information is contained in a document prepared by accountants.
These issues concerning the definition of work product apply only to the Deloitte memo. Because the government does not dispute that the other two documents contain work product, the D.C. Circuit can also be expected to address the important issue of whether work product protection is waived by disclosing the information to a company’s auditor. This issue was decided in favor of Textron in the original First Circuit panel decision, but that decision was vacated and became irrelevant once the en banc court determined that the tax accrual workpapers were not work product in the first place.
The appeal was argued on February 26 before a relatively conservative panel — Judges Sentelle, Brown, and Griffith. It will be interesting to see how deeply the D.C. Circuit decides to delve into these issues and how directly it decides to address the Textron decision.
[Disclosure: Miller & Chevalier filed amicus briefs on behalf of Financial Executives International in support of Textron’s claim of work product protection in both the First Circuit and the Supreme Court.]
June 20, 2010
The Tax Court and the U.S. District Court in New Jersey recently issued the first two opinions construing I.R.C. section 707(a)(2)(B), which is somewhat remarkable given that the partnership disguised sale rules have been on the books since 1984. See Va. Historic Tax Credit Fund 2001 LP v. Comm’r, T.C. Memo 2009-295; United States v. G-I Holdings Inc. (In re: G-I Holdings, Inc.), 2009 U.S. Dist. LEXIS 115850 (D.N.J. Dec. 14, 2009). The Government has appealed the Tax Court’s decision in Virginia Historic to the Fourth Circuit.
In Virginia Historic, the Tax Court rejected the IRS’s challenge to the use of partnerships as marketing vehicles for state tax credits. Under Virginia law, taxpayers can receive tax credits for investment in historical renovation projects. The tax credits are made available to stimulate investment in such projects because they are often unprofitable, and as a result, financing for the projects is often difficult to obtain. Because of restrictions on the direct transfer of the tax credits, the taxpayers in this case set up several investment partnerships that pooled funds from many investors and then contributed the funds to several lower-tier developer-partnerships. In exchange for investment in the developer-partnerships the upper-tier partnerships received partnership interests that entitled them to tax credits generated by specific projects. The tax credits would then be pooled by the upper-tier partnerships and distributed to the investors. The IRS took the position that the scheme was a disguised sale of tax credits in exchange for the investors’ cash.
In a memorandum opinion by Judge Kroupa, the Tax Court rejected the IRS’s disguised-sale contention largely on the basis that the investments were subject to the entrepreneurial risks of the enterprise. There was a possibility that developers would not complete the projects on time or in a manner acceptable to the state agency overseeing the projects, which placed receipt of the tax credits at risk. There was also the possibility that the upper-tier partnerships would not be able to pool sufficient credits to be able to make all of the promised distributions. Although distribution of the credits was guaranteed by the partnerships, there was no guarantee that the partnerships would have sufficient resources to make the investors whole. Accordingly, the court held that the investors’ capital was sufficiently at risk in order to avoid disguised sale treatment. Significantly, the degree of risk associated with the acquisition of state tax credits was relatively small, especially given that the investment partnerships spread risk through the pooling of resources and the dispersion of those resources over many developer-partnership projects.
The government has filed its opening brief. The taxpayer’s brief in response is due July 26, 2010. We will continue to monitor the case and post the briefs as soon as they are available.
The district court in GI-Holdings, by contrast, did apply the disguised-sale rule of Code section 707(b). The unpublished decision, linked below, contains a detailed discussion of the issue, but it is not yet an appealable order. Proceedings in the district court have been stayed until September 2010, but there is a strong possibility that the case will be appealed to the Third Circuit after the remaining issues are resolved in the district court.