October 22, 2010
On October 15, 2010, the government filed its reply brief in TIFD III-E Inc. v. United States, No. 10-70 (2d Cir.) (“Castle Harbour”). The brief is linked below. For our prior coverage of the case, see here and here.
In its reply, the government contends that I.R.C. section 704(e)(1) is inapplicable to the facts of the case, and that the provision only applies in the family partnership context, where parties are related. The government asserts that section 704(e)(1) was not intended to apply, and indeed has never before been applied (and upheld) to an arm’s length transaction between two or more corporate entities.
Even assuming section 704(e)(1) applies, the government argues that the Dutch banks did not possess “capital interests” under the statute, because “capital interests” are legally equivalent to bona fide partnership interests, which the Second Circuit has already determined the Dutch banks did not possess. In essence, the government argues that the test under section 704(e)(1) is the same as the test under Commissioner v. Culbertson, 337 U.S. 733 (1949), and the Second Circuit having made its determination under that test, it is now law of the case that the Dutch banks did not have “capital interests.”
On a similar tack, the government also argues that under the facts of the case, the banks did not possess capital interests in the purported partnership. The government attempts to rebut the taxpayer’s fact arguments by arguing that a number of these fact issues were previously considered by the Second Circuit, with the court rejecting them as support for the conclusion that the banks had a meaningful equity participation in the partnership.
With respect to section 704(b), the government asserts that the taxpayer’s discussion of 704(c) is a red herring, and that the section 704(b) substantial economic effect test requires that tax results follow economic results; i.e., tax benefits and burdens must coincide with the related economic benefits and burdens. The government argues that the transaction at issue plainly fails that test: the taxpayer received $288 million of the partnership’s actual income, but only paid tax on $6 million. Meanwhile, the Dutch banks received $28 million of the partnership’s actual income, but were allocated $310 million of it.
The government also reiterates its position regarding penalties: the District Court’s misconstruction of the facts and misapplication of the law do nothing to abrogate asserted penalties, and that the taxpayer really did not have substantial authority for its return position.