District Court Holds that Santander's Arguments to Avoid Penalty for Bullshit Tax Shelter (No Substance) Lack Substance (7/24/18)

In Santander Holdings USA, Inc. v. United States (D. Mass. Dkt. 09-11043-GAO Dkt Entry 344 7/17/18), here, Santander previously lost the merits of its bullshit tax shelter on appeal, with the Court of Appeals holding that the shelter lacked economic substance.  Santander Holdings USA, Inc. v. United States, 844 F.3d 15 (1st Cir. 2016), here, cert. denied sub nom. Santander Holdings USA, Inc., & Subsidiaries v. United States, 137 S. Ct. 2295 (2017).  See my discussion of the Court of Appeals decision, First Circuit, Reversing the District Court, Rejects Santander's Bullshit Tax Shelter (Federal Tax Crimes Blog 12/17/16), here.

Santander argued that, although its tax shelter lacked economic substance -- i.e., was bullshit -- it should be able to avoid the accuracy related penalty.  Well, basically, the district court held that that argument too lacked substance -- was bullshit.  The opinion is short and, I think, predictable, so I forego addressing it further.

However, the district court did include a quote from the Court of Appeals' decision that I had included in my prior write up but was in a larger quote so that I had not focused on it.  The district court did focus on it as follows.  This is the quote (cleaned up):

When a transaction is one designed to produce tax gains not real gains—such as when the challenged transaction has no prospect for pre-tax profit—then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

The district corut did not quote the whole paragraph from the Court of Appeals which includes "tax evasion" twice, so I offer the whole paragraph (cleaned up):

The economic substance doctrine is centered on discerning whether the challenged transaction objectively lies outside the plain intent of the relevant statutory regime. A transaction fails the economic substance test if, though it actually occurred and technically complied with the tax code, it was merely a device to avoid tax liability. Courts may disregard the form of transactions that have no business purpose or economic substance beyond tax evasion. In other words, when a transaction is one designed to produce tax gains not real gains -- such as when the challenged transaction has no prospect for pre-tax profit -- then it is an act of tax evasion that, even if technically compliant, lies outside of the intent of the Tax Code and so lacks economic substance.

Readers of this blog will recognize the term "tax evasion."  At least in this blog and in other authorities on criminal tax matters, tax evasion is a term of art.  Narrowly, it means the specific tax evasion crime in § 7201, but is often used to cover the panoply of tax crimes where tax was evaded (e.g., the Sentencing Guidelines require that for a tax loss as the first step in the sentencing calculation).  But, the term usually does connote conduct that is criminal.  See e.g., the Wikipedia entry for Tax Evasion, here.

First Circuit, Reversing the District Court, Rejects Santander's Bullshit Tax Shelter (12/17/16)

I previously have written about Santander Bank's version (through a predecessor, Sovereign) of its version of a bullshit tax shelter (a foreign tax credit generator), a version which was blessed at the trial level.  See Attacks on Indicted Tax Court Judge Kroupa's Decisions (8/26/16), here, (where, on appeal, Santander attacked an adverse precedent in the Tax Court based on the indictment of Tax Court Judge Kroupa).  We now have the decision on the appeal from the First Circuit -- Santander loses. Santander Holdings United States v. United States, ___ F.3d ___, 2016 U.S. App. LEXIS 22400 (1st Cir. 2016), here.

The bullshit tax shelter does not work, just as it failed to work for other taxpayers in the other courts of appeals.  Bank of New York Mellon Corp. v. Commissioner (BNY), 801 F.3d 104 (2d Cir. 2015), here; and Salem Financial, Inc. v. United States, 786 F.3d 932, 951 (Fed. Cir. 2015), here.

The Court offers the following as an introduction to the economic substance doctrine in the tax law, the reason it called the bullshit out:

B. The Economic Substance Doctrine 

The federal income tax is, and always has been, based on statute. The economic substance doctrine, n7 like other common law tax doctrines, can thus perhaps best be thought of as a tool of statutory interpretation, n8 as then-Judge Breyer characterized it in his opinion for this court in Dewees v. Commissioner, 870 F.2d 21, 35-36 (1st Cir. 1989).
   n7 Sovereign argues that the foreign tax credit area is so heavily populated with IRS regulation that there is no need for any further regulation by the courts under the guise of the economic substance doctrine. On these facts, we reject the proposition. In practical terms, it takes time for the government to analyze a new problem, come up with a solution, and promulgate regulations. "The endless ingenuity of taxpayers in attempting to avoid taxes means that there will be a first time for everything," Wells Fargo, 143 F. Supp. 3d at 838, and the economic substance test guards against abuse of loopholes that Congress and the IRS have not anticipated.
   n8 As one commentator says:
A related . . . claim is that the legislature assumes that long-standing common law doctrines such as economic substance will be used to interpret the statutes it enacts. Under this claim, the doctrines have been implicitly adopted as part of the statute -- at least where the statute does not indicate otherwise.
Joseph Bankman, The Economic Substance Doctrine, 74 S. Cal. L. Rev. 5, 11 (2000). 

The common law economic substance doctrine traces back to the Supreme Court's decision in Gregory v. Helvering, 293 U.S. 465 (1935).   n9 The Court there looked beyond the fact that a corporate reorganization technically complied with the statutory requirement and found that it lacked economic substance. Id. at 468-70. It found as such because the reorganization was:
   n9  In 2010, Congress enacted a statutory economic substance test. See 26 U.S.C. § 7701(o). The statutory test was not made retroactive. Our analysis, however, is not in conflict with that test, as Congress specified that the 2010 codification would be applied as courts have previously and consistently applied the economic substance doctrine. Id. § 7701(o)(5)(C). If the codification reveals anything about congressional intent as to pre-2010 STARS transactions, it supports our conclusion. 

an operation having no business or corporate purpose —- a mere device which put on the form of a corporate reorganization as a disguise for concealing its real character, and the sole object and accomplishment of which was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner. 

Id. at 469. The Court reached this conclusion from the fact that "the transaction upon its face lies outside the plain intent of the statute." Id. at 470. 

UK Supreme Deploys Economic Concepts Similar to US Doctrines for Attacking Tax Shelters (4/4/16)

The UK Supreme Court has nixed a sham tax scheme.  New Judgment: UBS AG v HMRC; DB Group Services (UK) Ltd v HMRC [2016] UKSC 13 (UKSC Blog), here (with link to the opinion, here). Jane Croft and Vanessa Houlder, UBS and Deutsche avoided tax on bonuses, rules Supreme Court (FT 3/9/16), here.  A reader sometime back advised me of this development; apologies to readers for not getting around to it earlier.)

To me, the interesting point was the discussion of statutory interpretation, with incident of taxation based on the reality of the transaction, ignoring the insertion of meaningless steps solely to affect taxation, etc..  I direct readers to  the Supreme Court opinion, here:¶¶ 61, p. 20 -  32, p. 33).   Here is the conclusion:

98. The error of the Court of Appeal in these cases lies, in my opinion, in adopting a literal construction of Chapter 2, and applying it to a correspondingly formal analysis of the facts. Adopting a purposive construction of Chapter 2, the conditions relied upon in order to bring the shares in question within the scope of the exemption conferred by section 425(2) failed to make provision of the kind required by section 423(1)(a): that is to say, provision having a business or commercial purpose, as distinct from provision whose only purpose was the obtaining of the exemption. That does not however mean that the conditions are to be disregarded for all fiscal purposes. Income tax is payable on the value of the shares as at the date of their acquisition in accordance with Abbott v Philbin, account being taken of any effect which the conditions may have had.

Excerpts From the FT article:

UBS and Deutsche Bank have lost a legal challenge brought by HM Revenue & Customs over two offshore schemes designed to avoid paying tax on bankers’ bonuses. 

The Supreme Court on Wednesday overturned two earlier court decisions over the controversial schemes that operated in 2003 and 2004.

HMRC had argued throughout the 12-year dispute that the schemes were designed to exploit tax avoidance loopholes and the banks should pay back about £50m each. 

The tax schemes centred on bankers receiving shares in specially created companies, meaning they escaped income tax. 

The banks then paid banker bonuses into the schemes without having to account to HMRC for income tax or national insurance contributions for the staff or their own liabilities on earnings. 

Some 426 staff agreed to take part in the scheme and it was argued in court papers that UBS devised schemes in 2003 and 2004 to avoid paying £36.9m of tax and £12.7m in national insurance on £92m of bankers’ bonuses.\ 

Deutsche’s scheme revolved around £91m of bonuses and share awards to individual bankers above £2m. 

The Supreme Court found the restrictive conditions attached to the shares in the UBS scheme “had no business or commercial rationale beyond tax avoidance”. In the Deutsche scheme, the conditions were “simpler but equally artificial”. 

Lord Robert Reed, the Supreme Court justice, noted in his ruling: “In our society, a great deal of intellectual effort is devoted to tax avoidance.” 

He added it was “difficult to accept” arguments that parliament when passing the law had intended to encourage tax exemptions for restricted share awards where this “has no purpose whatsoever other than the obtaining of an exemption itself”. 

* * * *

Another BullShit Tax Shelter Bites the Dust (9/12/15)

We have yet another great opinion attacking bullshit tax shelters for what they are -- bullshit.  See Bank of N.Y. Mellon Corp. v. Commissioner, ___ F.3d ___, 2015 U.S. App. LEXIS 15993 (2d Cir. 2015), here.  The opinion is by Denny Chin (Wikipedia, here), a truly outstanding judge.

First, here is the unofficial summary:

Appeals and cross‐appeal heard in tandem from a judgment of the United States Tax Court (Kroupa, J.) and an opinion and order of the United States District Court for the Southern District of New York (Stanton, J.) applying the ʺeconomic substance doctrineʺ to transactions involving foreign tax credits.   The Tax Court considered the effect of foreign taxes in its pre‐tax analysis and denied the claimed foreign tax credits as lacking economic substance, but allowed interest expense deductions for the loan associated with the transactions.   The district court held that the economic substance doctrine applies to transactions involving foreign tax credits generally and that foreign taxes are to be included in calculating pre‐tax profit.  
    AFFIRMED.

Well, that's pretty cryptic.  I won't try to summarize the complex facts whereby the parties involved tried to exploit the tax regimes of the countries involved.  The Court summarizes its holdings in the Conclusion as follows:

The Court summarizes all of its holdings in the conclusion:

CONCLUSION 

Accordingly, the decisions of the district court and Tax Court are AFFIRMED. To summarize: 

(1) We reject AIG's contention that foreign tax credits, by their nature, are not reviewable for economic substance. The purpose of the "economic substance" doctrine is to ensure that a taxpayer's use of a tax benefit complies with Congress's purpose in creating that benefit. Accordingly, we hold that the "economic substance" doctrine can be applied to disallow a claim for foreign tax credits. 

(2) In determining whether a transaction lacks economic substance, we consider: (a) whether the taxpayer had an objectively reasonable expectation of profit, apart from tax benefits, from the transaction; and (b) whether the taxpayer had a subjective non-tax business purpose in entering the transaction. Gilman, 933 F.2d at 147-48. In our Circuit, we employ a "flexible" analysis where both prongs are factors to consider in the overall inquiry into a transaction's economic substance. 

(3) The focus of the objective inquiry is whether the transaction "offers a reasonable opportunity for economic profit, that is, profit exclusive of tax benefits." Gilman, 933 F.2d at 146 (internal quotation marks omitted). We conclude, as a matter of first impression in this Circuit, that foreign taxes are economic costs and should thus be deducted when calculating pre-tax profit. We also conclude that it is appropriate, in calculating pre-tax profit, for a court both to include the foreign taxes paid and to exclude the foreign tax credits claimed. In so holding, we agree with the Federal Circuit in Salem and disagree with decisions of the Fifth and Eighth Circuits (Compaq and IES, respectively). 

(4) Under the subjective prong, a court asks whether the taxpayer has a legitimate, non-tax business purpose for entering into the transaction. 

(5) As to AIG's transactions, we hold that there are unresolved material questions of fact regarding the objective factors -- i.e., the economic effects of the cross-border transactions and the reasonableness of AIG's expectation of non-tax benefits. There are also material questions of fact regarding AIG's subjective business purpose for entering the cross-border transactions. Because a reasonable factfinder could resolve these questions in favor of the government and conclude therefrom that the cross-border transactions lacked economic substance, the district court did not err in denying AIG's motion for partial summary judgment. 

(6) As to BNY's transactions, we hold that the Tax Court correctly concluded that the STARS trust transaction lacked economic substance. We also hold that the Tax Court did not err in concluding that the $1.5 billion loan from Barclays had independent economic substance, and that BNY was therefore entitled to deduct the associated interest expenses. Accordingly, we affirm the Tax Court's judgment in its entirety.

I now want to focus on the economic substance holding related to the the foreign tax credit manipulation that the Fifth Circuit and the Eighth Circuit had blessed in Compaq Comput. Corp. v. Commissioner, 277 F.3d 778 (5th Cir. 2001); and IES Indus., Inc. v. United States, 253 F.3d 350 (8th Cir. 2001).  Essentially, in calling the tax shelters in the instant cases bullshit, the Court was, in kinder judicial language, calling Compaq and IES bullshit as well.  So, let's see how it did that:

Another Bullshit Shelter Bites the Dust (12/19/13)

We have yet another of the genre out of the Tenth Circuit, this time proving Michael Graetz's famous observation that an abusive tax shelter is “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  The new case is Blum v. Commissioner, 737 F.3d 1303 (10th Cir. 2013), here.

Before discussing the case, I offer this description of tax shelters from my Federal Tax Procedure Book (footnotes omitted):

Abusive tax shelters are many and varied.  Some are outright fraudulent, usually wrapped in a shroud of paper work designed to present the shelter as a real deal.  The more sophisticated are often without substance but do have some at least attenuated, if superficial, claim to legality.  Some of the characteristics that I have observed for tax shelters that the Government might perceive as abusive are that (i) the transaction is outside the mainstream activity of the taxpayer, (ii) the transaction is incredibly complex in its structure and steps so that not many (including specifically IRS auditors) will have the ability, tenacity, time and resources to trace it out to its illogical conclusion (this feature is often included to increase the taxpayer’s odds of winning the audit lottery); (iii) the transaction costs of the arrangement and risks involved, even where large relative to the deal, still have a favorable cost benefit/ratio only because of the tax benefits to be offered by the audit lottery, (iv) the promoters of the adventure make a lot more than even an hourly rate even at the high end for professionals (the so-called value added fee, which is often insurance type compensation to mediate shift potential penalty risks to the tax professional or the netherworld between the taxpayer and the tax professional) and (v) the objective indications as to the taxpayer's purpose for entering the transaction are a tax savings motive rather than any type of purposive business or investment motive.  More succinctly, Michael Graetz, a Yale Law Professor, has described an abusive tax shelter as “[a] deal done by very smart people that, absent tax considerations, would be very stupid.”  Other thoughtful observers vary the theme, e.g. a tax shelter “is a deal done by very smart people who are pretending to be rather stupid themselves for financial gain.”

Blum fits the pattern.

Mr. Blum was a very successful businessman.  He was apparently very capable in assessing risks and rewards of financial ventures.  Mr. Blum retained KPMG who sold him one of its tax shelter products which it marketed in the 1990s and early 2000s.  This particular product was OPIS, a basis enhancement strategy. The abusive basis enhancement strategies claimed to create large amounts of basis without the taxpayer having to incur a cost for the basis.  The taxpayer would then use the artificial basis to offset otherwise taxable gain, thereby artificially reducing the tax liability.  Mr. Blum got into the deal when he had a large gain that would otherwise be taxed.

When KPMG's representative made the pitch, Mr. Blum "claims he saw an investment opportunity; the Commissioner claims Mr. Blum saw a tax evasion opportunity."  (Emphasis supplied.) Mr. Blum bought the pitch and made a representation to KPMG that he was doing the deal for a legitimate nontax business or investment purpose.  (That representation was essential to KPMG's participation in implementing the transaction.)  Bottom-line, the Tax Court concluded and the Tenth Circuit concluded that the representation was false.

Economic Substance Uncertainty in Civil Cases (12/5/13)

In past entries on this blog, I have expressed concern about deploying the economic substance doctrine in criminal cases.  Here is yet another reason for concern.

In American International Group v. United States (SDNY 1:09-cv-01871), in a civil tax case, the IRS has raised economic substance to defeat AIG's tax sheltering activities. (This activities appear to have the earmarks of bullshit tax shelters, but I suppose that is the issue in the case.) Keep in mind that this is a civil case and the scope and application of the economic substance doctrine apparently is uncertain (yet in criminal cases, it is supposed to set a known and knowable line to meet the willfulness element).

On November 4, 2013, Judge Louis L. Stanton (Wikipedia here) entered an the following order (caption omitted):

CERTIFICATION UNDER 28 U.S.C. § 1292(b)

On the letter-application of Plaintiff American International Group, Inc. ("AIG"), and over the opposition by defendant, I hereby certify my March 29, 2013 Opinion and Order denying AIG's motion for partial summary judgment for interlocutory appeal under 28 U.S.C. § 1292(b). 

I am well aware that "Only exceptional circumstances will justify a departure from the basic policy of postponing appellate review until after the entry of a final judgment", Klinghoffer v. S.N.C. Achille Lauro Ed Altri-Gestione Motonave Achille Lauro in Amministrazione Straordinaria, 921 F.2d 21, 25 (2d Cir. 1990), but this case presents the exceptional circumstances which warrant interlocutory appeal. My ruling turned on two related questions of law which together are controlling, and there are substantial grounds for difference of opinion as to each of them. 

A reversal on either ground would produce judgment for AIG on the most significant of its claims in this complex (by any standard) action. 

In each transaction, AIG's subsidiary sold preferred shares in its foreign affiliate (the "Special Purpose Vehicle" or "SPV") to a foreign lender bank and committed to repurchase these shares in the future. The SPV invested the money from the sales, paid taxes on the investment income to its foreign government, and made payments to the lender bank ("dividend"), which paid little, if any, tax on them because the local law treated the dividend as a tax-exempt intracorporate return of capital, since it regarded the bank as an owner, not a lender. AIG in effect shared the bank's tax benefit with it, by negotiating a "dividend" rate well below the return on the SPV's investments. It claims credits for the SPV's foreign tax payments, but will not obtain those credits if the application of the economic substance doctrine bars the transactions.

Daugerdas Retrial Jury Instructions - Part 07 Tax Evasion Instructions Part 3 Economic Substance (11/27/13; 11/29/13)

I address in this blog the relationship to the defendants served as enablers and the taxpayers whose taxes were allegedly evaded.  In the prior cases, as I recall it, the Government conceded that the taxpayers themselves were innocent.  That would mean that the enabler defendants could not have aided and abetted the taxpayers' tax evasion.  It is not clear to me that the Government made that concession in this Daugerdas retrial.  So, I suppose, the jury could have applied an aiding and abetting construct to say that the enabler defendants aided and abetted some or all guilty taxpayers, but I think on the instructions given which did not develop the aiding and abetting concept, they would have had to find the defendants directly guilty of the crime of tax evasion which they could do because tax evasion can apply to enablers directly without the help of derivative liability provisions.

But, I want to focus on the taxpayers because it was their taxes that had to be evaded in all events for the crime of tax evasion as charged in Daugerdas.  What would it require for their taxes to have been evaded via the tax shelters promoted by the enabler defendants?  In the Tax Due and Owing instruction, Judge Pauley explained that the critical issue as to whether there was a tax due and owing was whether the shelters lacked economic substance.  (I have previously written on what I perceive as major difficulties in presenting the concept of economic substance to juries; they can be reviewed via the "Economic Substance" link.)  One uncertainty is whether the two component tests commonly applied to determine economic substance are in the disjunctive or the conjunctive.  That uncertainty has existed for a long time.  So, Judge Pauley asked the jury to apply the test in the conjunctive -- the most defendant-friendly application of the economic substance test.

Judge Pauley explained in explaining Tax Due and Owing:

The Government claims that the reason the taxpayers * * * * owed more taxes than they reported is that the losses they claimed on their tax returns as a result of the Short Sale, SOS, Swap, or HOMER tax shelters were not allowable. The Government contends that these losses were not allowable because they stemmed from transactions that lacked “economic substance.” 

A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss allegedly sustained in such a transaction is not properly claimed on a tax return. 

In order to establish that a transaction lacks economic substance, the Government must prove, beyond a reasonable doubt, two components. 

The first component is that the relevant taxpayer had no genuine business purpose for engaging in the transaction in question apart from the creation of the tax deduction.  

The second component is that there was no reasonable possibility that the transaction would result in a profit.

A Self-Proclaimed "Simple Man," "Utterly Uneducated" in Tax and Finance, but Still a Self-Made Multi-Millionaire Loses his Bullshit Tax Shelter Case (4/13/13)

In Kerman v. Commissioner, ___ F.3d ___, 2013 U.S. App. LEXIS 7032 (6th Cir. 2013), here, the Sixth Circuit rejected the Kerman's claim for tax benefits or, at least, relief from penalties from a bullshit tax shelter, this one of the Cards variety that has met with uniform rejection from the courts.  I just gave you the final result.  But the opinion starts this way (usually you can tell the result from the opening):

A tax shelter can be legitimate — if the reported transaction has economic substance. But the shelter Mark Kerman participated in lacked such substance. The transaction had no purpose other than the creation of an income tax benefit. After Kerman claimed the benefit on his tax return, the IRS disallowed the deduction and imposed a valuation misstatement penalty pursuant to 26 U.S.C. § 6662(e), which was increased to 40 percent of the unpaid tax pursuant to § 6662(h). The tax court affirmed the IRS's decision. Kerman appeals, contending that the shelter was legitimate and that, even if it was not, the penalty should not be imposed. Because the transaction lacked economic substance and Kerman lacked reasonable cause or good faith to believe that it did, we AFFIRM.
I
A
Mark Kerman is a college-educated multi-millionaire.

Toward the end of the opinion another key signal dot is connected as follows:

Finally, Kerman argues, the tax court gave him too much credit. He's just a simple man, "utterly uneducated in the complex tax arena — let alone the more byzantine tax-shelter realm." Appellant's Br. 48. Consequently, he was forced to rely on personal advisors. And, he argues, his reliance was reasonable even if his advisors had conflicts of interest.

So, what should I say about the opinion?  Prudence and respect for my readers time counsels that I should not say anything except the bullet points from the case.  So, I won't.

Mr. Cummings' Defense of Aggressive Tax Shelter Professionals (2/28/13)

I write to offer readers the following article:  Jasper L. Cummings, Jr., DOJ Criminal Tax Overreach, 138 Tax Notes 745 (Feb. 11, 2013), here, permitted with the permission of Tax Analysts.  I also offer below a brief summary and my comments.

Mr. Cummings, a frequent commentator on the tax law and its ripples (including criminal tax law), advises right up front that his principal points are:

This article makes the following principal points: 

•  The tax bar should have been somewhat more concerned about the way the Department of Justice Tax Division has prosecuted selected major law and accounting firm tax professionals who participated in the planning of, opinions on, or audit defense of some structured transactions during the most recent tax shelter boom that ended in the early 21st century. 

•  The type of arguments that the DOJ pursued against defendants like those in the Coplan case, recently affirmed in part and reversed in part by the Second Circuit, n1 might produce numerous convicted felons if applied to activities in which many readers have participated in.
   n1 United States v. Coplan, No. 10-583 (2d Cir. 2012), Doc 2012-24490, 2012 TNT 231-17 . [JAT Note:  the citation for Coplan is 703 F.3d 46 (2d Cir. 20122) and the opinion is here.]

•  The most troubling aspect of the Coplan and other prosecutions is that they follow a trend to criminalize advising, and even defending, a transaction that the DOJ believes does not produce the desired tax results under the (civil) economic substance doctrine.

Mr. Cummings uses the Coplan case as a point of departure.  (For my prior blogs on Coplan, see Major CA2 Decision on E&Y Tax Shelter Convictions (11/29/12), here, with links to the 8 other blogs on aspects of the Second Circuit's decision in Coplan.) He laments that the tax bar has just rolled over to prosecutions and convictions in tax shelter cases as a way to do damage control for their franchise in the aggressive tax planning area.  (Let a few be prosecuted so that the others can continue to play with relatively minor risk because only a few can be prosecuted).  He says (footnote omitted):

Another Bullshit Tax Shelter Bites the Dust (2/12/13)

In Bank of New York Mellon Corp. v. Commissioner, 140 T.C. No. 2 (2013), here, the Tax Court knocked down yet another another bullshit tax shelter.  It is a complex case, and for purposes of this blog, I will not get into the weeds (this genre of tax shelter usually has many weeds designed to obscure the big picture what is really going on -- i.e., pretty much nothing except paper and money shuffling and re-shuffling, with net effect mostly to the promoters).  I will just summarize the gravamen of the opinion:

The Court opens the opinion (after finding the bullshit facts) as follows (emphasis supplied):

This complex transaction presents a case of first impression in this Court. We are asked to decide whether petitioner is entitled to foreign tax credits and certain expense deductions from the STARS transaction and also whether petitioner is entitled to report income generated from the STARS assets as foreign source income. Respondent argues that the STARS transaction lacked economic substance. Respondent asserts consequently that the foreign tax credits and expenses attributable to STARS should be disallowed and the income from the STARS assets should be characterized as U.S. source. n7 Petitioner, in contrast, contends the STARS transaction had economic substance. In this regard, petitioner asserts that BNY entered into STARS to obtain low-cost funding for its banking business and that it reasonably expected to earn a pre-tax profit from STARS. Additionally, petitioner contends that the U.S. foreign tax credit was intended for transactions like STARS.
   n7 Respondent also argues that the foreign tax credits BNY claimed are disallowed under substance over form doctrines (including the step transaction doctrine) and under the statutory anti-abuse rule in sec. 269(a). We need not decide these arguments because of our other holdings.

The Court  then concludes that, on the facts, there was no economic substance.  That holding seems solid.

Article on Importance of Jury Instructions in White Collar, including Tax, Crime Cases (1/29/13)

I write today to direct readers to a recent very good article by Susan E. Brune and Laurie Edelstein titled Jury Instructions: Key Topics in Federal White Collar Cases, 36 Champion 26 (2012), here.  The authors' web site is here and their bios are here (Brune) and here (Edelstein).

The introduction:  "The right jury charge can make the difference between conviction and acquittal. "  The article then explores some contexts in which instructions can be particularly helpful in white collar crime cases.  As most readers will know (and as I remind my Tax Fraud class), tax crimes are a subject of white collar crimes, hence it is not surprising that the authors deal with instructions in tax crimes cases.

The six areas discussed are (1) Reasonable Doubt, (2) Willful Blindness, (3) Venue, (4) Securities Fraud, (5) Tax Evasion: Economic Substance, and (6) Antitrust.  I will focus on the comments on (1) Reasonable Doubt, (2) Willful Blindness and (3) Tax Evasion: Economic Substance.

Reasonable Doubt

The authors clearly summarize the courts' continuing inability to formulate instructions to explain reasonable doubt to a jury in a way that we can have confidence that the jurors understand the concept.  None of the various circuit courts' formulations is perfect, but the suggest that (footnotes omitted):

Defense counsel might consider proposing the Federal Judicial Center's (FJC) pattern instruction on reasonable doubt, which Justice Ginsburg highlighted in Victor. This instruction does away with the "hesitate to act" analogy and instead focuses on whether the government has met its burden of proof: "Proof beyond a reasonable doubt is proof that leaves you firmly convinced of the defendant's guilt." The "firmly convinced" standard, which certain circuits have approved, more accurately reflects the state of certainty required to find a defendant guilty.  

* * * * 

Because the Supreme Court's decision in Victor effectively held that problematic words or definitions in a reasonable doubt charge can be neutralized by words or phrases that preclude the jury from requiring more than a reasonable doubt to acquit, it is unlikely that a reasonable doubt charge will provide grounds for reversal of a guilty verdict on appeal. Advocating for a charge that focuses on the government's burden and instructs the jury that it cannot convict unless it is firmly convinced of the defendant's guilt thus can be critical. It may help secure an acquittal in the first instance.

Coplan # 6 - Court Approves the Economic Substance Instruction (12/5/12)

I continue discussion of the issues in United States v. Coplan, et al., 703 F.3d 46 (2d Cir. 11/29/12), here and here.

The Court affirmed the economic substance instruction.  Economic substance is not a clearly defined concept in the tax law, and there are various interpretations of it.  Hence, in my view, it is a difficult concept to convey to a jury.  [Remember the black box nature of the jury I discussed in an earlier blog on Coplan, Coplan #2 - The Sufficiency Challenge for the Conspiracy Counts (Federal Tax Crimes Blog 12/2/12), here. Nevertheless, in a criminal tax case, the courts seem to adopt the most taxpayer friendly version of the economic substance concept (except to the extent they are bound by Circuit precedent) and instruct the jury accordingly.  I think that is what happened in Coplan (subject to Circuit precedent) and the other principal tax shelter criminal tax cases.  I am not saying that is right, because even as thus interpreted, the concept is a difficult one for a lay jury to understand.

Let's see what the Court said about the instruction.  I enclose at the end of this blog the complete economic substance instruction that was given.  The portion that the Court deemed relevant is included in a footnote to the opinion, so I cut and paste here the entire discussion on economic substance (including the footnote with the relevant excerpts from the instructions but excluding another footnote dealing with the codified economic substance doctrine in 26 USC § 7701(o), here):  I present first the excerpted portion of the Economic Substance instruction and then include the text of the discussion without footnotes:

THE EXCERPTED INSTRUCTION (from footnote 40):

   fn40 With respect to the economic substance test, the District Court instructed the jury as follows:
In order to establish that a transaction lacks economic substance, the government must prove two elements beyond a reasonable doubt: The first element is that there was no reasonable possibility that the transaction would result in a profit. The second element is that the relevant taxpayer had no business purpose for engaging in the transaction in question apart from the creation of the tax deduction.
. . . .
Now, let me say a few words about your determination as to whether or not there was a reasonable possibility that the shelter would result in a profit. This element requires you to reach an objective judgment about whether the government has proved that there was no reasonable possibility that the shelter would result in a profit. In other words, this does not depend upon what the taxpayer believed about the profit potential. It requires you to consider all of the evidence and reach a conclusion about whether the government has proved beyond a reasonable doubt that there was no reasonable possibility of a profit on the tax shelter after the fees and other costs were paid. If you find that the government has proved beyond a reasonable doubt that there was no reasonable possibility of a profit, then you move on to the second element, whether the relevant taxpayer had no business purpose for engaging in the tax shelter. If you find that the government has not proved the lack of a reasonable possibility of a profit, then you must reject the government's theory and find the defendants not guilty.
A VI: 424/6176-77 (paragraph breaks omitted).

Further Comments on the Briefing in the Larson, Pfaff and Ruble Cert Petitions (6/21/11)

I have just received the Government's Brief in Opposition to Certiorari in the Larson and Pfaff cases (Sup. Ct. Dkt No. 10-1049) and Brief in Opposition to Certiorar in the Ruble Case (Sup. Ct. Dkt No. 10-1061). I have previously blogged on the Petitions for Certiorai in those cases in the following blog entries: Petitions for Cert in US v. Pfaff, Ruble & Larson and The Conduct Too Remote Is Not Evasion Argument in the Larson & Pfaff Petition for Certiorari . I have just a few points that I wish to make on the documents documents I just received:

1. The issue that I think is worthy of certiorari is whether the economic substance doctrine draws a sufficiently knowable criminal line. (I have previously blogged on facets of this issue here.)  The problem, in my mind, is that the Supreme Court itself has botched the analysis and approved civilly transactions that lack economic substance relative to the taxpayer's participation in the shelters / arrangements. Charles Kingson, are respected observer in this area, has said pungently:

More on the Daugerdas Case - The Role of Nonpromoter Enablers (6/5/11)

The Chicago Tribune reports on the consequences of BDO Seidman's love affair with the Daugerdas shelters. See Ameet Sachdev, Tax shelters put BDO Seidman in middle of firestorm with federal prosecutors, Chicago Tribune, Business (6/4/11). It is interesting to consider what additional retribution, if any, the Government may visit on BDO now that its former chief executive, Denis Field, has been convicted and others down the BDO food chain have pled. For all of the firms participating in this genre of shelters, one has to ask where the gatekeeper was or the gatekeepers were. Was anyone concerned about the well-being of the firm?

Someone has asked that question about Jenkens & Gilchrist, the Dallas based firm with national ambitions that drove it to expand, inter alia, into Chicago and pick up the now disgraced and convicted tax shelter promoter par excellence, Paul Daugerdas. I have written about Daugerdas before and want to discuss here a variation of the Jenkens & Gilchrist story recounted in a recent article, Milton C. Regan, Jr., Taxes and Death: The Rise and Demise of an American Law Firm, STUDIES IN LAW, POLITICS AND SOCIETY: LAW FIRMS, LEGAL CULTURE, AND LEGAL PRACTICE, Vol. 52, pp. 107-144, Austin Sarat, ed., JAI Press 2010; Georgetown Law and Economics Research Paper No. 11-08.

Economic Substance Doctrine Tax Felonies (6/1/11)

I write today to provide viewers access to Jasper Cummings' article, Jasper L. Cummings, Jr., Economic Substance Doctrine Felonies, 131 Tax Notes 977 (May 30, 2011) and 2011 TNT 104-10 (5/31/11). (This article is provided with the permission of Tax Analysts.)  Mr. Cummings writes on the use of the economic substance doctrine in criminal tax cases. Most particularly, he writes about Mr. R. J. Ruble who was convicted in the first round of Son-of-Boss criminal prosecutions. In that case, Ruble, a tax lawyer, was convicted along with John Larson and Bob Pfaff who provided financial services in the conceptualization and implementation of the shelters. Two prominent subsequent shelter prosecutions have also used the economic substance doctrine in the charges to the jury.

First, let me disclose that I represented one of the dismissed defendants in the sprawling prosecution that ended up in the conviction of Messrs. Ruble, Larson and Pfaff. Once my client was dismissed along with 12 others before trial, I no longer had an immediate interest in the case but I did observe the progress of the proceedings through conviction and appeal and now pending petition for certiorari in the Supreme Court. I was particularly interested in whether and how the economic substance doctrine would be presented to the jury.

Petitions for Cert in US v. Pfaff, Ruble & Larson

Petitions for certiorari have been filed in the criminal convictions of John Larson, Robert Pfaff and R.J. Ruble in the massive KPMG-related criminal case which drew fame in an earlier iteration (United States v. Stein before 13 defendants were dismissed for prosecutorial abuse). The Second Circuit summary affirmance of the convictions of Larson, Pfaff and Ruble is here. The petition for John Larson and Robert Pfaff is here. The petition for R. J. Ruble is here..

Another Set Back for the Remaining Daugerdas Defendants - Economic Substance is Sufficiently Malleable to Establish a Line a Citizen Could Know (12/29/10)

Judge Pauley, USDC SDNY, served up a loss for the Daugerdas defendants just before Christmas. The opinion in United States v. Daugerdas, 759 F. Supp. 2d 461 (SD NY 2010) is here. The defendants made the now standard argument in complex tax shelters, particularly those based on extrapolations of Helmer, that, given Helmer, the law was not sufficiently clear to establish a legal duty that the defendants could know. I have previously blogged on facets of this issue before. See here.

As occurs frequently, Judge Pauley conflates two distinct -- albeit related -- concepts. The threshold issue is whether the duty was knowable -- a legal inquiry that is separate from what the defendants might have known or intended. James and its progeny establish that the duty must be sufficiently clear that a citizen (not necessarily the actual defendant in the dock) could know the duty. Only if that question is answered in the affirmative is the Cheek issue reached -- did the defendant know the knowable legal duty? That is an issue for the jury to determine after trial so long as the prosecutors have enough evidence to survive a motion for acquittal.

Without citing James or its progeny, Judge Pauley does address the James threshold issue. Bottom line, he holds that the economic interest concept as a bar to claimed benefits and as interpreted by the courts (it is a judicial doctrine, after all) was sufficiently certain to give the hypothetical citizen a line that could be crossed (aka was knowable), leaving the issue for trial of whether these particular defendants knew the line they allegedly crossed. Could have known is not sufficient for a criminal conviction. The Government will have to prove that the did know. But that is another chapter.

Justice Stevens Announces Retirement (4/9/10)

The papers announce today Justice John Paul Stevens' long expected retirement. He is a great judge and will be missed on the Supreme Court and throughout the country. 

I had first encountered Judge Stevens in arguments in the 7th Circuit Court of Appeals long ago.  I found him exceptionally sharp and willing to mix it up intellectually.  I eschew war stories here, however interesting they may be to me.  Being a tax lawyer and being concerned about the development of the tax law for the good of society as a whole, I can point to one particular matter in which his voice, spoken in dissent, should have been heeded.  That was in Frank Lyon Co. v. United States, 435 U.S. 561 (1978), a case that, in my opinion (I am not alone) was wrongly decided by the majority and has had disastrous consequences to the orderly development of the tax law over the years.  Therefore, I quote Judge Stevens' dissent in Frank Lyon in its entirety.  Although it would help to have read the majority opinion to knew the target he is shooting at, it is not critical.  If you have been more than casually involved in or observing the tax shelter industry over the years, you will understand why he is right:  The doctrine of economic substance developed on the shoulders of his dissent would have been a lot more coherent.

Altria #2 - Economic Substance and Juries (3/22/10)

In Altria (see blog here for introduction), Judge Holwell submitted the issues to the jury as follows:

The Court instructed the jury to analyze the transactions under the two common law disallowance methods relied on by the Government: the "substance over form" doctrine, and the "economic substance" doctrine. With respect to substance-over-form, the Court instructed the jury to put aside the labels used or names given to the documents and transactions, and decide whether Altria actually acquired and retained a genuine ownership interest in the Seminole, Oglethorpe, and Vallei facilities, and a genuine leasehold interest in the MTA facility. The jury was to consider "all the relevant facts and circumstances surrounding the transactions," including eight non-exclusive factors identified by the Court. 4 (Charge to the Jury, at 33-34 (Docket No. 146).) At the same time, the Court cautioned the jury that its analysis should turn on the facts as it found them, including its understanding of how the transactions were designed to unfold: "You must consider and give the appropriate weight to all the relevant facts and circumstances. In the end, the question is whether Altria retained significant and genuine attributes of traditional owner (or lessor) status." (Id. at 34.)

Economic Substance Jury Instruction in Larson/Pfaff/Ruble (3/22/10)

I previously attached deep in a blog Judge Kaplan’s economic substance charge to the jury in United States v. Larson (S.D. N.Y. No. 05 CR 888 (LAK)), dated 12/11/08, pp. 5225- 5232.  I have decided that, because of the ongoing discussion I should lift it up into a separate blog for those who might have missed it.

In order to prove that element in this case, we focus on the doctrine of economic substance. In this case, the government contends that the taxpayers whose tax returns are the subject of each count of tax evasion, owed more federal income tax then they reported on the returns for one reason only, in each case the taxpayer took a deduction from his taxable income due to a loss that the tax return attributed to one of the four tax strategies at issue in this case. You remember them, FLIP, OPIS, BLIPS and SOS.

The government argues that every one of those tax strategies lacked economic substance. That the tax deduction each one of those taxpayers took was improper, for that reason, and, therefore, that each taxpayer owed more federal income tax than was declared on the tax return. The defendants dispute that. They contend, among other things, that the tax strategies did not lack economic substance, that the deductions were proper, and that the tax returns, therefore, accurately stated the amounts of tax that were due and owing.

This means that your task here, with respect to the first element, is to decide for each count, whether the tax strategy that gave rise to the loss claimed as a deduction on that tax return, lacked economic substance in order to decide whether the relevant taxpayer owed more federal tax, income tax, than was shown that was due on the tax return. So I am now going to instruct you with respect to your consideration of the economic substance issue.

A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss that allegedly was sustained in such a transaction, therefore, is not properly claimed on a tax return.

In order to establish that a transaction lacks economic substance, the government must prove beyond a reasonable doubt both of two factors. The first factor is that the relevant taxpayer had no business purpose for engaging in the transaction apart from creating the tax deduction.

The second factor is that there was no reasonable possibility that the transaction would result in a profit.

Now, let me define one term and say a few things about each one of these factors.

First the definition. The word profit, as I use it in this context, means a return in excess of the cost of the investment, disregarding entirely any tax benefits. Let me give you an example. If somebody puts a million dollars into a deal, he would have to get a return of more than a million dollars without considering any tax benefits in order for the transaction to be profitable. Common sense. A return of $750,000 on a million dollar investment results in a loss of $250,000, not a profit. That's what I mean by profit. Forget the tax benefits, look at the investment and the return.

Now, let me discuss the first element that I mentioned, whether the taxpayer had any business purpose for entering into the deal. In deciding that question, you, of course, may consider any direct evidence of the taxpayer's motive. But you are not limited to direct evidence in deciding why a taxpayer did a transaction. You can consider circumstantial evidence as well.

I am going to talk to you later about what circumstantial evidence means. But for purposes of the present, think of it just as common sense, and then I will explain it later on.

For example, you may consider the manner in which the transaction was sold to the taxpayer. In other words, you are entitled to consider whether and to what extent it was sold to the taxpayer as a way to create a tax deduction to offset other taxable income, and/or as a way to generate a return, a profit, exclusive of tax benefits on the investment. You are entitled to consider that.

You may consider also whether a reasonable taxpayer would have paid the fees necessary to do the transaction in order to gain the chance of whatever profit potential existed if the transaction did not also carry with it tax benefits.

Now, let me try to put this into plain English. What helped me think about it, maybe it will help you, I am going to give you a couple of examples, so bear with me on the examples. Let's take an example in which a taxpayer has to put up $2 million to enter into some deal or strategy. Suppose further that the strategy in question offers a five percent chance, that's one chance out of 20, resulting in a payout, when all is said and done of $2,050,000. In other words, it's a one in 20 chance of making $50,000 on a $2 million investment.

Assume also that the taxpayer has a huge amount of income, and that there is a very big tax benefit to the strategy, maybe a $10 million tax loss or deduction.

Now, common sense will tell you that few, if any, people, no matter how rich they are, would put up $2 million for a five percent chance, a one out of 20 chance, of making $50,000. So on those facts you might conclude that there must have been only one reason for the taxpayer to have paid the $2 million. And that the $10 million tax loss or deduction probably was the only reason.

Let me give you another example, also an example in which the same taxpayer has to put up the same $2 million.

What's different in this example is this, assume there is a 33 percent chance, now it's one out of three we are talking about, of getting a payout of $3 million. And thus a profit of a million dollars within a year. Now, a 33 percent chance, a one out of three chance of making a profit, is not bad odds, it's pretty good odds. And a million dollars is nothing to sneeze at, even if you are very rich.

In this second example, the high likelihood, relatively high likelihood, and the large size of the potential profit, would be circumstances that might tend to show that the taxpayer had a nontax reason for doing the deal.

Many people might consider it a very good investment opportunity, without regard whether there was any tax benefit.

In the end, what you would do, is to consider all the evidence, direct, if there is any, and circumstantial, to decide whether the government had proved that the tax benefits were the only reason for doing the deal.

Those are my examples.

So let me come back to this case. If you find that the government has proved that the tax benefits were the only reason for doing the deal involved in any particular count, you will go on to consider the second part of the economic substance test that I gave you a moment ago. And that I am going to talk about more in a minute.

If you find, however, that the government has not proved that the tax benefits were the only reason for doing the deal, you must reject the government's economic substance argument. And you, therefore, must reject its contention that there was additional tax due and owing. That in turn would require you to find the defendant or defendants in question, not guilty on the particular tax evasion count that related to the particular taxpayer and year in question.

Now, let me say a word about the second fact in the economic substance test, which is whether there was a reasonable possibility that the strategy involved on the count you are considering would result in a profit.

Now, at one level this is largely self-explanatory, but I want to emphasize to you that this factor requires you to come to an objective judgment about whether the government has proved that there was no reasonable possibility that the strategy would result in a profit. In other words, this doesn't depend on what the taxpayer believed about the tax potential -- excuse me, the profit potential -- it requires you to consider all the evidence that you have, and reach a conclusion about whether the government has proved beyond a reasonable doubt, that there was no reasonable possibility of a profit.

In doing this, you are going to have to consider the evidence concerning investment aspects of each of the four tax strategies at issue in this case. For example, the transactions involving the Argentine peso and the Hong Kong dollar that were involved in the BLIPS strategy, and the foreign currency options that were involved in the SOS strategy. Of course, you have to consider the particulars of the other two strategies, as well, I mentioned those because they come immediately to mind.

Now, in considering whether the government has met its burden on the second factor, you should take into account whether the taxpayer, considering all the aspects of the strategy, had any reasonable chance of making a profit or suffering a loss as a result of changes in the market.

To take one example, if you are considering a BLIPS deal, you should consider whether the taxpayer had any reasonable chance of making a profit or suffering a loss as a result of changes in the value of the Argentine peso and the Hong Kong dollar, given the terms of the deal. If you find that the government has proved beyond a reasonable doubt both prongs of the economic substance test, in other words, both that the taxpayer had no nontax reason for doing the deals on the count in question, and that there was no reasonable possibility of making a profit, you may find that the requirement of additional tax due and owing will have been satisfied, and you will go on to consider whether the government has proved that the additional tax due and owing was substantial.