DocketNumber: No. 6492-06
Citation Numbers: 98 T.C.M. 128, 2009 Tax Ct. Memo LEXIS 194, 2009 T.C. Memo. 192
Judges: "Marvel, L. Paige"
Filed Date: 8/25/2009
Status: Non-Precedential
Modified Date: 11/20/2020
MEMORANDUM OPINION
MARVEL,
This matter is before the Court on the parties' motions for summary judgment under
For the reasons discussed below, we shall deny petitioner's motion for summary judgment and grant respondent's motion for summary judgment.
The parties stipulated the relevant facts for purposes of our ruling on the motions. We incorporate their stipulations herein by this reference. No facts material to the disposition of the cross-motions remain in dispute.
On or before September 26, 2001, Laurence K. Fishman (Mr. Fishman) engaged the law firm of Cantley and Sedacca, L.L.P. *196 (Cantley), to prepare and file all documents necessary for the formation of LKF and LKF CC. Between September 26 and October 17, 2001, Cantley prepared and sent Mr. Fishman documents to enable Mr. Fishman to participate in market-linked deposit transactions (MLD transactions) Cantley promoted. *197 The operating agreement identified Venice, California, as LKF's principal office and place of business.
On September 26, 2001, LKF CC was incorporated under the laws of Delaware; the certificate of incorporation identified Edward Sedacca as the incorporator. On September 27, 2001, in his capacity as the sole shareholder of LKF CC, *198 was deposited into LKF's account.
On October 17, 2001, LKF and Deutsche Bank AG New York (Deutsche Bank) *199 bonus coupon if the strike price was greater than or equal to 125.15 Japanese yen to a U.S. dollar (long option). With respect to the deposit by Deutsche Bank, LKF was to pay Deutsche Bank a Euro 3,477,802 bonus coupon if the strike price was greater than or equal to 125.17 Japanese yen to a U.S. dollar (short option).
Under the terms of the MLD transactions, LKF was to pay Deutsche Bank a premium of Euro 2,197,802, or $ 2 million at a spot rate of 0.91, and Deutsche Bank was to pay LKF a premium of Euro 2,173,626, or $ 1,978,000 at a spot rate of 0.91. The terms of the long and short options provisions of the MLD transactions are summarized below:
Strike price | |||
Option | Premium | per U.S. dollar | Bonus coupon |
Long | [euro] 2,197,802 | [yen] 125.15 | [euro] 3,516,484 |
Short | 2,173,626 | 125.17 | 3,477,802 |
Net | 24,176 n.1 | 38,682 | |
*4*n.1 The U.S. dollar equivalent of the net premium was | |||
*4*$22,000 at the exchange rate of 0.91 U.S. dollar per euro. |
The parties agreed to pay the premiums on October 19, 2001, *200 deposit amounts or the premiums to the other party. On October 25, 2001, LKF wired a $ 22,000 net premium to Deutsche Bank.
Under the bonus coupon provisions of the MLD transactions, three scenarios were possible. If on the bonus coupon fixing date the exchange rate was below 125.15 Japanese yen to a U.S. dollar, neither LKF nor Deutsche Bank would be entitled to a premium interest payment. If the exchange rate was 125.15 or 125.16 Japanese yen to a U.S. dollar, LKF would be entitled to a Euro 3,516,484 Events *201 After October 17, 2001 On October 18, 2001, Mr. Fishman entered into an agreement with CF Advisors XVI, L.L.C. (CF Advisors), On October 29, 2001, CF Advisors became a member of LKF when LKF CC and CF Advisors executed an amended and restated operating agreement of LKF X Investments, L.L.C. (amended agreement). In the amended agreement LKF CC and CF Advisors acknowledged that LKF CC contributed $ 130,000 The amended agreement also provided that CF Advisors would provide services as an investment adviser and foreign currency and foreign currency derivatives specialist. The amended agreement provided for quarterly compensation of CF Advisors for such services calculated on the basis of LKF's net asset value and all income and gains. With respect to 2001, however, the parties agreed CF Advisors *204 would receive a one-time $ 8,000 service fee. *205 a purchase of Canadian dollars for $ 1,000 (Canadian currency position) at the spot rate. On December 18, 2001, the MLD transactions matured. Neither LKF nor Deutsche Bank repaid each other the principal or fixed interest. LKF's Deemed Liquidation On December 20, 2001, CF Advisors withdrew as a member of LKF by selling its interest to LKF CC for $ 2,000; LKF CC became LKF's sole member after the sale. Because LKF had elected to be treated as a partnership for Federal tax purposes, the sale of CF Advisors' interest resulted in a deemed liquidation of LKF for Federal income tax purposes. See On or about December 24, 2001, LKF sold the Canadian currency position for $ 878.07. Federal Income Tax Reporting In January 2002 Cantley mailed Mr. Fishman a 100-page opinion letter regarding the MLD transactions. The opinion concluded, inter alia, that it was more likely than not that: (1) The obligations under the short option would not be treated as liabilities for purposes of LKF timely filed its Form 1065. On Schedules K-1, Partner's Share of Income, Credits, Deductions, etc., LKF reported capital contributions by LKF CC of $ 2,130,000, consisting of $ 130,000 cash and $ 2 million of MLD transactions, and contributions by CF Advisors of $ 2,000. LKF CC's contribution of $ 2 million represented a Euro 2,197,802 premium, converted to U.S. dollars at the spot rate of 0.91, that LKF was required to pay Deutsche Bank under the terms of the long option. LKF CC and LKF did not treat the obligations under the short option as liabilities under *208 On the Form 1065 LKF reported the following separately stated partnership items: All separately stated partnership items were allocated to LKF CC. LKF also reported distributions to its partners of $ 132,873 cash and the Canadian currency position to LKF CC and $ 2,000 to CF Advisors. On his 2001 Form 1040 Mr. Fishman included LKF CC as an S corporation. Mr. Fishman reported a nonpassive loss from LKF's Schedule K-1 of $ 2,001,809. The loss *209 represented LKF CC's loss on the sale of the Canadian currency position that LKF CC received in a deemed distribution in the LKF liquidation; the Canadian currency position was sold for $ 878.07, with the substituted basis of $ 2,001,000. Mr. Fishman combined this nonpassive loss from LKF with other income of $ 2,042,730, primarily related to Mr. Fishman's business, Trident Labs, Inc., and reported total partnership and S corporation income of $ 23,606. Respondent examined LKF's 2001 Form 1065 and on December 28, 2005, mailed an FPAA to LKF CC as tax matters partner. In Exhibit A, Explanation of Items (explanation *210 of items), attached to the FPAA, Although the FPAA did not adjust the partners' outside bases to zero, in the explanation of items respondent determined that the partners failed to establish that the partners' bases in the long option were greater than zero and, accordingly, *211 the partners failed to establish that the adjusted bases in their respective partnership interests were greater than zero. In paragraph 9 of the explanation of items respondent determined that penalties under LKF CC, as LKF's tax matters partner, timely filed a petition contesting respondent's determinations. On June 25, 2008, the parties filed a stipulation of settled issues (stipulation). The parties stipulated that all of the disputed partnership items should be adjusted in accordance with the FPAA, (except the partnership item "Distributions -- property other than money"). *212 Petitioner also stipulated: 2. If the Court determines that it has jurisdiction in this case, petitioner stipulates that he does not intend to call any witnesses or offer any evidence in this proceeding, or otherwise contest the determinations made in the FPAA other than the determination that the valuation misstatement penalty imposed by I.R.C. In the recitals part of the stipulation petitioner contends that the Court lacks jurisdiction over certain issues addressed in the FPAA and that any underpayment attributable to the adjustments in the FPAA would not be subject to the valuation misstatement prong of the accuracy-related penalty under Whereas, if the Court determines that it has jurisdiction in this case, petitioner does not intend to contest any of the issues raised in the FPAA other than the issue of whether the valuation misstatement penalty would apply in this case, and whether respondent has the burden of production for any I.R.C. Whereas, aside from the Stipulation of Facts to be prepared and submitted, the petitioner does not intend to offer any witnesses or further evidence on the valuation misstatement penalty issue * * * Respondent asserts that summary judgment is appropriate because petitioner stipulated the adjustments in the FPAA and does not contest the determinations made in the FPAA, other than the *213 determination that the valuation misstatement prong of the accuracy-related penalty under Petitioner filed a motion for summary judgment asserting that it had stipulated the numerical adjustments in the FPAA and that the Court lacks jurisdiction over nonnumerical determinations in the explanation of items because such determinations purport to eliminate LKF's partners' outside bases in LKF. Petitioner argues the Court lacks jurisdiction over outside basis adjustments. Petitioner also argues that respondent's determinations of sham, economic substance, and tax avoidance are not partnership items and cannot be litigated in a partnership-level proceeding. This case is ripe for summary judgment because the parties do not dispute the facts and we may render a decision as a matter of law. Summary *214 judgment is designed to expedite litigation and avoid unnecessary, time-consuming, and expensive trials. For Federal income tax purposes partnerships are not taxable entities, but they are required to file annual information returns reporting items of gross income and deductions and other information as the Secretary may prescribe. A partnership item is any item the Secretary has determined is more appropriately determined at the partnership level than at the partner level. After a final partnership-level adjustment has been made to a partnership item in a unified partnership proceeding, the Commissioner may assess a corresponding computational adjustment to a partner's tax liability without issuing a notice of deficiency. Petitioner contends the term "partnership item" includes only accounting items and does not refer to judicial doctrines of sham or lack of economic substance. Petitioner argues that we lack jurisdiction in this partnership-level proceeding to consider such issues as well as the question of outside basis, which is an affected item. *218 This Court is a court of limited jurisdiction, and we may exercise our jurisdiction only to the extent provided by Congress. See The determinations in the explanation of items in this case are similar to those contained in exhibit A to the FPAA in Like the partner in Respondent stated in paragraph 9 of the explanation of items that the adjustments in the FPAA were attributable to a tax shelter, for which LKF had no substantial authority or reasonable cause. Respondent determined that the entire underpayment of tax resulting from those adjustments is attributable to *221 (1) gross or substantial valuation misstatement under Petitioner stipulated that it is contesting only the applicability of the valuation misstatement prong of the accuracy-related penalty (valuation misstatement penalty). We treat this stipulation as conclusive and binding on petitioner and deem issues with respect to the negligence and substantial understatement prongs of the Petitioner *224 argues that the Court does not have jurisdiction to determine a penalty with respect to an adjustment to an affected item, such as outside basis. We held in Respondent argues that the partners' collective basis in LKF should be zero instead of the amount claimed. Respondent also contends the valuation misstatement penalty applies because the inflated basis in the Canadian currency position originates in the partnership's misstatement of Mr. Fishman's contribution amount and his resulting basis in the partnership interest. Petitioner argues the valuation misstatement penalty is inappropriate because the record does not support a factual determination of sham or lack of economic substance. Petitioner believes that *226 by carving out the right to contest the valuation misstatement penalty it preserved the right to argue that the transactions had a business purpose. We disagree. The parties' stipulation clearly states that if the Court finds it has jurisdiction, petitioner does not intend to contest the determinations made in the FPAA other than the valuation misstatement penalty. Stipulations are conclusive and binding on the parties unless otherwise permitted by the Court. Petitioner argues the valuation misstatement penalty is inapplicable as a matter of law because the underpayment *227 of tax is not attributable to erroneous valuation but rather to disregard of a partnership. In support petitioner relies on, among other cases, Relying on In Respondent argues that when the petition was filed, LKF had no principal place of business. Petitioner states in its petition that LKF's legal residence was California when it filed the petition. However, petitioner then stipulated that LKF filed its 2001 Form 1065 as a final return, in December 2001 LKF distributed its assets to the partners, and the partnership was deemed liquidated for Federal income tax purposes. Accordingly, we conclude that LKF did not have a principal place of business when the petition was filed, and this case may be appealable to the Court of Appeals for the District of Columbia Circuit. See In When considering penalties at the partnership level, we may consider defenses of the partnership, such as the reasonable cause exception. See In its petition, petitioner claimed that "assuming some or all of the Commissioner's *233 adjustments are correct, there was reasonable cause for Petitioner's positions and the Petitioner acted in good faith." In the stipulation of settled issues petitioner stipulated that it did not intend to offer any witnesses or further evidence on the valuation misstatement issue. On the basis of the foregoing, we shall deny petitioner's motion for summary judgment and grant respondent's motion for summary judgment. We have considered the parties' *234 remaining arguments, and to the extent not discussed above, we conclude those arguments are irrelevant, moot, or without merit. To reflect the foregoing, APPENDIX Exhibit A -- Explanation of Items 1. It is determined that neither LKF X Investments, L.L.C. nor its purported partners have established the existence of LKF X Investments, L.L.C. as a partnership as a matter of fact. 2. Even if LKF X Investments, L.L.C. existed as a partnership, the purported partnership was formed and availed of solely for purposes of tax avoidance by artificially overstating basis in the partnership interests of its purported partners. The formation of LKF X Investments, L.L.C., the acquisition of any interest in the purported partnership by the purported partner, the purchase of offsetting positions on market-linked deposits, the transfer of offsetting positions held by LKF X Investments, L.L.C. to LKF Capital X Corp., the purchase of assets by the partnership, and the distribution of those assets to the purported partners in complete liquidation of the partnership interests, and the subsequent sale of those assets to generate a loss, all within a period *235 of less than 4 months, had no business purpose other than tax avoidance, lacked economic substance, and, in fact and substance, constitutes an economic sham for Federal income tax purposes. Accordingly, the partnership and the transactions described above shall be disregarded in full and any purported losses resulting from these transactions are not allowable as deductions for Federal income tax purposes. 3. It is determined that LKF X Investments, L.L.C. was a sham, lacked economic substance and, under a. LKF X Investments, L.L.C. is disregarded and all transactions engaged in by LKF X Investments, L.L.C. are treated as engaged in directly by its purported partners. This includes the determination that the assets purportedly acquired by LKF X Investments, L.L.C., including but not limited to *236 foreign currency options, were acquired directly by the purported partners. b. The positions in market-linked deports [sic] purportedly acquired by or assumed by LKF X Investments, L.L.C. are treated as never having been acquired by or assumed by said partnership and any gains or losses purportedly realized by LKF X Investments, L.L.C. on the positions in market-linked deposits are treated as having been realized by its partners. c. The purported partners of LKF X Investments, L.L.C. should be treated as not being partners in LKF X Investments, L.L.C. d. Acquisitions by LKF X Investments, L.L.C. will be adjusted to reflect clearly the partnership's or purported partners' income. 4. It is determined that the obligations under the short positions on market-linked deposits sold are liabilities within the meaning of 5. It is determined that neither LKF X Investments, L.L.C. nor its purported partners *237 entered into the positions on market-linked deposits or purchased the foreign currency or stock with a profit motive for purposes of 6. It is determined that, even if the positions on market-linked deposits are treated as having been contributed to LKF Investments, L.L.C., the amount treated as contributed by the partners under 7. It is determined that the adjusted bases of the long position(s) on market-linked deposits and *238 other contributions purportedly acquired by the LKF X Investments, L.L.C. and contributed to LKF X Capital Corp. has not been established under 8. It is further determined that, in the case of a sale, exchange, or liquidation of LKF X Investments, L.L.C. partners' partnership interests, neither the purported partnership nor its purported partners have established that the bases of the partners' partnership interests were greater than zero for purposes of determining gain or loss to such partners from the sale, exchange, or liquidation of such partnership interest. 9. Accuracy-Related Penalties: It is determined that the adjustments of partnership items of LKF X Investments, L.L.C. are attributable to a tax shelter for which no substantial authority has been established for the position taken, and for which there was no showing of reasonable belief by the partnership or its partners that the position taken was more likely than not the correct treatment of the tax *239 shelter and related transactions. In addition, all of the underpayments of tax resulting from those adjustments of partnership items are attributable to, at a minimum, (1) substantial understatements of income tax, (2) gross valuation misstatement(s), or (3) negligence or disregarded rules or regulations. There has not been a showing by the partnership or any of its partners that there was reasonable cause for any of the resulting underpayments, that the partnership or any of its partners acted in good faith, or that any other exceptions to the penalty apply. It is therefore determined that, at a minimum, the Accuracy-Related Penalty under A. A 40 percent penalty shall be imposed on the portion of any underpayment attributable to the gross valuation misstatement as provided by B. A 20 percent penalty shall be imposed on the portion of the underpayment attributable to negligence *240 or disregard of rules and regulations as provided by C. A 20 percent penalty shall be imposed on the underpayment attributable to the substantial understatement of income tax as provided by D. A 20 percent penalty shall be imposed on the underpayment attributable to the substantial valuation misstatement as provided by It should not be inferred by the determination of the Accuracy-Related Penalty in this notice that fraud penalties will not be sought on any portion of an underpayment subsequently determined to be attributable to fraud or that prosecution for criminal offenses will not be sought under Item Amount Interest income $ 1,316,000 Interest expense (1,302,800) Dividend income 405 Net loss on digital options (1,687) Guaranteed payments to CF Advisors (8,000) Wire fees (30) Nondeductible expenses (15) Total 3,873 Item As Reported AsCorrected Portfolio income interest $ 1,316,000 -0- Portfolio income dividends 405 -0- Other portfolio income (loss) (1,687) -0- Guaranteed payments to partner 8,000 $ 8,000 Deductions related to portfolio income 8,030 -0- Interestexpense 1,302,800 -0- Investment income 1,314,718 -0- Investment expenses 8,030 -0- Net earnings from self-employment 8,000 8,000 Nondeductible expenses 15 -0- Distributions--money 134,873 134,873 Distributions--property other than money 2,001,000 -0-
1. Unless otherwise indicated, all section references are to the Internal Revenue Code (Code), and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. Respondent determined in the FPAA that LKF was a sham, lacked economic substance, and should be disregarded for Federal income tax purposes. Our references to LKF as a partnership and to its members as partners are for convenience only.
LKF is not a small partnership within the meaning of the small partnership exception, see
3. Cantley instructed Mr. Fishman to sign the documents but not date them. Mr. Fishman signed the documents as instructed and returned them to Cantley in September 2001.↩
4. On Sept. 26, 2001, LKF filed a Form SS-4, Application for Employer Identification Number, identifying LKF as a multiple member limited liability company and Mr. Fishman as its manager. The Form SS-4 showed that Los Angeles County, California, was LKF's principal business location.
5. The record indicates that as of Sept. 27, 2001, Mr. Fishman had not transferred any property to LKF CC in exchange for its stock. The record is not clear whether any LKF CC shares nevertheless had been issued to Mr. Fishman at that point that would have allowed Mr. Fishman to properly elect LKF CC's directors on Sept. 27, 2001. See
6. The parties stipulated that Deutsche Bank was the counterparty to the transactions. Although Deutsche Bank sent the confirmations of the transactions, the confirmations also indicate that Deutsche Bank London was the counterparty. In any case, for purposes of the parties' motions it is irrelevant which Deutsche Bank entity entered into the transactions.↩
7. For both MLD transactions Deutsche Bank was the calculation agent that would determine and notify the parties of the exchange rate on the bonus coupon fixing date.↩
8. The parties incorrectly stipulated that the premium for the long option was payable on Oct. 16, 2001, instead of Oct. 19, 2001.↩
9. The parties' stipulation of fact 24 incorrectly shows this amount as Euro 3,156,484.↩
10. The potential net bonus coupon is calculated as the difference between the bonus coupons payable, or Euro 3,516,484 minus Euro 3,477,802.↩
11. The parties incorrectly stipulated the name of the CF Advisors entity; we disregard the stipulation on this point as being inconsistent with the record.↩
12. Although the parties stipulated that Mr. Fishman received 1,000 LKF CC shares in exchange for interest in LKF, a document entitled "
13. The long option and $ 130,000 were assets LKF held when it was a single-member limited liability company, and therefore technically LKF CC contributed both cash and the long option to the newly created partnership with CF Advisors, as stipulation 79 states (and as reported on LKF's Form 1065, U.S. Return of Partnership Income). However, for reasons that are not explained in the record, the amended agreement does not mention the long option as a capital contribution by LKF CC.↩
14. The stipulation of facts contains conflicting information regarding the amount of the service fee. On the one hand, stipulated Exhibit 21-J states that the fee was $ 8,000, and we so find. On the other hand, the parties stipulated in par. 39(g) that the fee was $ 20,000. In any event, the amount of the fee is not determinative.↩
15. The record does not reflect what exchange rate the calculation agent reported on the bonus coupon fixing date, but the parties stipulated that the New York Federal Reserve Bank reported the exchange rate of 127.38 Japanese yen per U.S. dollar. The record does not reflect that the parties paid each other bonus coupons or that Deutsche Bank paid a net bonus coupon to LKF.↩
16. The parties stipulated that LKF sold the Canadian currency position.↩
17. The parties incorrectly stipulated the amount of distribution to CF Advisors, but the exact amount is irrelevant for purposes of deciding the parties' motions.↩
18. Although on its Form 1065 LKF checked off that it is not subject to
19. The explanation of items is attached hereto as an appendix.↩
20. For "Distributions--property other than money" the parties stipulated $ 8,000, instead of $ 2,001,000 as LKF reported on the Form 1065, or zero, as respondent determined in the FPAA.
21. Petitioner also points out that in the stipulation of settled issues respondent allowed three partnership items (guaranteed payments, net earnings from self-employment, and distributions of money). Although petitioner argues that those allowances are inconsistent with allegations of sham and disregarding partnership, we do not believe that the settlement of adjustments between parties operates to prevent the parties or this Court from addressing and resolving other issues that have not been settled and are properly before the Court.
22.
23. The Commissioner may not stack or compound parts of the accuracy-related penalty to impose a penalty in excess of 20 percent on any given portion of an underpayment, or 40 percent, if such portion is attributable to a gross valuation misstatement.
24. Petitioner cites
25. Although the parties stipulated the Cantley opinion as a joint exhibit, petitioner is not arguing in its briefs that LKF relied on an opinion of a professional tax adviser.↩
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