Saturday, October 6, 2018

Court Orders Disgorgement of $50 Million Gross Receipts for Bullshit Tax Shelter (10/6/18)

I wrote yesterday on the bullshit tax shelter of the Exelon Corporation, a major corporation.  Today, I write on another, less sophisticated, genre of bullshit tax shelter -- those promoted to the less sophisticated.  I say less sophisticated because it was not wrapped in a smog of paper like Exelon and others of its genre and, at the end of the day, relies on less sophisticated techniques, principally overvaluation, that has been the problem in abusive tax shelters for years.

DOJ announced here that, in United States v. RaPower-3, LLC, et. al. (D. Utah 10/4/18), here, the Court (i) ordered abusive tax shelter promoters "to disgorge over $50 million in gross receipts" from the abusive tax shelter and "barred defendants from promoting and marketing the scheme and ordered them to take steps to ensure that the public is not further harmed by their actions." 

Key excerpts from the announcement:
Based upon evidence the government submitted to the court during a 12-day bench trial, the court found that the defendants engaged in a “massive fraud.” The court stated that the defendants “each knew, or had reason to know, that their statements about the tax benefits purportedly related to buying solar lenses were false or fraudulent.” 
The court stated that “[b]ecause of the manner in which Defendants promoted the scheme, the court concludes that $50,025,480 in gross receipts from the solar energy scheme came from money that rightfully belonged to the U.S. Treasury.” The court found that the defendants “obstructed discovery about their gross receipts and other topics involving their finances.” 
The court stated that the United States showed a “reasonable approximation” of the total gross receipts from lens sales. In addition, the court held that defendants would not be allowed any credit of operating expenses because such credits “are not consistent with principles of equitable disgorgement.” 
According to the opinion, defendant Neldon Johnson claimed to have invented purported solar energy technology involving solar thermal lenses placed in arrays on towers. The court found that to “make money from this purported solar energy technology, Johnson decided to sell a component of the purported technology: the solar lenses.” 
Under the proper circumstances, the Internal Revenue Code allows a taxpayer engaged in a trade or business certain tax deductions for expenses the taxpayer incurs while generating income. Likewise, if all of the requirements are met, the tax law allows an “energy credit” for certain “energy property.” 
However, in this case, the court concluded that the defendants “knew, or had reason to know, that their customers were not in a trade or business of leasing out solar lenses and, therefore, that their customers were not allowed the depreciation deduction or solar energy tax credit.” 
The opinion also concluded that the defendants made “gross valuation overstatements” when they sold lenses to customers. The court found that the defendants sold each lens for a total purported price of $3,500. The court stated that the evidence showed that the raw cost of each supposed “lens” was very low and found that “[d]efendants’ technology does not work, and is not likely to work to produce commercially viable electricity or solar process heat. Therefore, each ‘lens’ is just one component of an inoperable system. It is not a piece of sophisticated technology such that premium pricing is appropriate for it.” 
The court also barred defendants from promoting and marketing the scheme. The court stated that the defendants sold lenses using a multi-level marketing approach, and encouraged distributors to “bring still more people in to the multi-level marketing system and build an extensive ‘downline.’” The court concluded that, in this case, “[t]he toxic combination of multi-level marketing and misleading information creates an urgent need [for] an injunction.”  
The injunction requires, among other things, that the defendants stop making statements that a person who buys a lens is in a trade or business with respect to that lens; may lawfully claim a depreciation deduction or any other business expense deduction related to a solar lens; and may lawfully claim a solar energy credit related to a lens. 
Further, the court ordered that the defendants disclose, in their marketing materials for lenses that the court “has determined that the solar energy technology of RaPower-3 in place from 2005 to 2018 is without scientific validation or substance and ineligible for tax credits or depreciation by individual purchasers of lenses.” 
* * * * 
In the past decade, the Tax Division has obtained injunctions against hundreds of unscrupulous tax preparers and tax scheme promoters. Information about these cases is available on the Justice Department’s website. An alphabetical listing of persons enjoined from preparing returns and promoting tax schemes can be found here. If you believe that one of the enjoined persons or businesses may be violating an injunction, please contact the Tax Division with details (link sends e-mail).
JAT comments:

1.  The Court opens its 144 page opinion with the following (footnotes omitted) which projects where the opinion is going:
This case was tried over 12 days in April and June 2018. The United States presented testimony from 25 witnesses, both live and via deposition designation. Defendants rested their case without calling a single witness, but they thoroughly examined each witness called by the United States, including Defendants Neldon Johnson and R. Gregory Shepard. Defendants’ thorough cross examination of Shepard and Johnson did not lend any credibility to their case.  More than 650 exhibits were received into evidence. On June 22, 2018, immediately after closing arguments, partial findings of fact were delivered from the bench, concluding that Defendants engaged in a “massive fraud” for which they would be enjoined and disgorgement would be ordered.  * * * *  After careful consideration of all this testimony, evidence, ] submissions and materials, these final Findings of Fact and Conclusions of Law are filed.
2.  I did not read the opinion closely but did page through it to catch key items.  The court meticulously deconstructs the promoter's claims about the technology involved and the implementation of the tax shelter scheme.  The key findings relate to overvaluation, technology that could not work, a business plan that could not work, and marketing of the tax benefits rather than the business opportunity.

3.  The Government seems to be seeking disgorgement in these cases.  The disgorgement amount here is of the gross receipts, apparently because that is a substitute for the false tax benefits claimed by the taxpayers supposedly "investing" in the scheme.  Here are excerpts related to disgorgement (pp. 125-130, footnotes omitted):
To show entitlement to disgorgement, the United States has the burden of “producing evidence permitting at least a reasonable approximation of the amount of [Defendants’] wrongful gain.” Defendants bear the “risk of uncertainty in calculating net profit.” “‘Reasonable approximation’ will suffice to establish the disgorgement liability of a conscious wrongdoer, when the evidence allows no greater precision, because the conscious wrongdoer bears the risk of uncertainty arising from the wrong. The allocation of risk of uncertainty to the wrongdoer yields the rule that ‘when damages are at some unascertainable amount below an upper limit and when the uncertainty arises from the defendant's wrong, the upper limit will be taken as the proper amount.’” In other words, if “the true measure of unjust enrichment is an indeterminable amount not less than 50 and not more than 100, liability in disgorgement will be fixed at 100.” 
Defendants obstructed discovery about their gross receipts and other topics involving their finances. They did not produce relevant documents and information to the United States on these issues. Nonetheless, the United States showed that Defendants “sold” at least 49,415 lenses. If all customers paid the $1,050 down payment required under the terms of Defendants’ own transaction documents, Defendants’ gross receipts were $51,885,750. There was testimony that not all of Defendants’ customers have paid the down payment amount for all of the lenses they purportedly bought, but Defendants offered no credible evidence of the amount of any missing down payments. But this is the likely explanation for why Defendants’ own customer database shows that (even if Defendants “sold” 82,365 lenses) customers actually paid in $50,025,480 as of February 28, 2018. It is reasonable, based on the facts of this case and Defendants’ extensive promotion of the solar energy scheme, to conclude that customers have used their “purchases” of all, or nearly all, of those lenses to claim a depreciation deduction and a solar energy credit. Because of the manner in which Defendants promoted the scheme, the Court concludes that $50,025,480 in gross receipts from the solar energy scheme came from money that rightfully belonged to the U.S. Treasury. Defendants – who are the ones in possession of the best evidence of a reasonable approximation of their gross receipts – failed to rebut the United States’ evidence of this reasonable approximation, and introduced no credible evidence of their own on the point. 
On the facts of this case, it is appropriate to hold Johnson liable for the gross receipts shown in the RaPower-3 database. An individual may be held liable for what is, on its face, an entity’s debt, when 1) there was “such unity of interest and lack of respect given to the separate identity of the corporation by its shareholders that the personalities and assets of the corporation and the individual are indistinct” and 2) “adherence to the corporate fiction [would] sanction a fraud, promote injustice, or lead to an evasion of legal obligations.”  
* * * * 
Disgorgement will be ordered, pursuant to § 7402(a), in these amounts. Defendants will not be allowed any credit of operating expenses to “carry[] on the business that is the source of the profit subject to disgorgement.” When a defendant defrauds the claimant, as the United States has shown Defendants have done, such credits are not consistent with principles of equitable disgorgement. 
In addition to this direct harm to the Treasury, Defendants’ misconduct has caused the government to devote substantial resources to investigating the solar energy scheme, which Defendants promoted widely; investigating Defendants’ conduct in particular; examining the tax returns of Defendants’ customers; litigating nearly 200 petitions filed by Defendants’ customers in Tax Court; and litigating this case for nearly three years.Further, the government has suffered irreparable harm from Defendants’ misconduct, which “undermine[d] public confidence in the administration of the federal tax system and encourage[d] noncompliance with the internal revenue laws.”
4.  This is the first time I paid attention to the DOJ web page with an Alphabetical List of Injunctions obtained by DOJ Tax.  That list is here.  The list includes the name and, where available, the press release.  The list is quite long.  I think most of the list involves tax return preparers, but does include significant numbers of persons promoting abusive schemes of one sort or another.

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