D.C. Circuit Swats Down Bullshit Tax Shelter (11/29/19)

In Endeavor Partners, LLC v. Commissioner, ___ F.3d ___ (D.C. Cir. 2019), here, the Court affirmed the Tax Court’s strike-down of yet another bullshit tax shelter, Endeavor Partners, LLC v. Commissioner, T.C. Memo. 2018-96, here.  In broad overview without getting into the weeds, these shelters do very large highly leveraged offsetting trades with relatively little cash outlay and no real economic risk.  The resulting transactions produce very large nominal gains with offsetting nominal losses, with in net no material risk and no material gain.  The nominal gains are allocated to tax indifferent parties, and the nominal losses are allocated to wealthy taxpayers with high taxable income to offset their income and thus avoid (or, in many cases, evade) tax on their income.

I start with the marvelous Tax Court opinion by Judge Lauber because he does get into the weeds.  Here is the overview from p. 3 of the Slip Op.:

Finding that the transactions lacked any economic substance whatsoever, we will sustain respondent’s disallowance of the loss deductions in question. But we are unable to sustain the accuracy-related penalties determined under section 6662(a). Although the partnerships’ conduct is plainly deserving of penalty, respondent has conceded that the IRS did not secure, prior to the issuance of the FPAAs, written supervisory approval of the penalties as required by section 6751(b)(1). 

Basically, the principal behind one of the promoters was Andrew D. Beer, but he had many enablers, including prominent accounting firms (Arthur Andersen and Ernst & Young), at least one prominent law firm (Arnold & Porter, whose more likely than not opinion was highly marketable), and Deutsche Bank ("DB", which implemented the illusory financial transactions and made the purported loans backing them).  Arnold & Porter alone was paid about $10 million for something.  I started to call them legal fees, but that gives them a dignity they do not deserve.  A better description is that they were insurance premiums sold to wealthy participants in the shelter to protect them (they hoped) from criminal and civil penalties for claiming tax shelter benefits that any reasonable and half-way intelligent person would have known were too good to be true.

So, the Tax Court in 66 pages lays bare the perfidy of these actors, albeit dressed in tax lingo that somehow detracts from the fact that these bullshit shelters, and this one specifically, were simply fraudulent raids on the U.S. Treasury.

So, how does one defend such nonsense?  I have not looked through the Tax Court briefs, but the Tax Court did find Mr. Beer and the expert witnesses not credible on any issue in the case.  So, further obfuscation was the defense.  It did not work at the trial level.

To their credit, the attorneys for the bullshit shelter in their appellate brief opened as follows:

Delta and its affiliates (collectively the “Delta Group”) were involved with certain so-called “tax shelters” that we recognize this Court has viewed with disfavor. At issue here, however, is not whether any transaction was a “tax shelter” or whether any “tax shelter” was valid. Rather, the issues on this appeal are principled ones of evidence and fundamental procedural fairness. We respectfully urge the Court to focus on how the Tax Court applied the rules of evidence rather than on the subject matter to which it applied them.

Just as the shelter dodged the bullet on the accuracy related penalty because of the IRS’s footfault on the § 6751(b) written manager approval requirement, it tried to avoid the consequence of its bullshit because, it alleged, the Tax Court treated it unfairly from a procedural perspective.

The Tax Court (Judge Lauber) had specifically determined that his fact findings were not based on the allocation of the burden of persuasion (although the shelter surely had the burden of persuasion and thus the risk as to any fact as to which the court was in equipoise) because the Tax Court said (Slip Op. 49), it found facts by a preponderance of the evidence, thus avoiding any issue as to allocation of the burden of persuasion.  The Court of Appeals agreed (Slip Op. 5)

The partnerships argue that the Commissioner bore the burden of proof at trial. But the Tax Court correctly ruled that “the allocation of the burden of proof in these cases is immaterial” because the governing standard was the preponderance of the evidence. Endeavor Partners Fund, LLC, 2018 WL 3203127, at *17; see Blodgett v. Comm’r, 394 F.3d 1030, 1039 (8th Cir. 2005). Under a preponderance standard, once both parties have produced their respective evidence, the side with the more persuasive case prevails. See Blodgett, 394 F.3d at 1039. 

So the shelter’s attorney was left to try to pull a procedural rabbit out of the hat to overcome the stench of what it created.  They tried to rely upon the testimony of Beer, but the Tax Court found his testimony not credible.  The Court of Appeals held that finding to be within the Tax Court’s province and entitled to deference as the trier of fact observing the witness.  (Slip Op. 6.)

The Court of Appeals then rejected the next procedural argument, one of evidence and the so-called negative inference from a party’s failure to call a witness.  In this case, the parties failed to call DB witnesses, the party implementing the offsetting financial positions.  Either side could have called one or more DB witnesses.  In its most common iteration, the missing witness negative inference is deployed when the witness is controlled by one of the party’s to the litigation.  In that case, the presumption is that, if the missing witness’s testimony were helpful to that party that party could and would have produced the witness, so that the failure to call the witness permits an inference that the witness' testimony would have been negative and that negative inference can be considered in deciding the case.

In this case, DB who could have explained the relationship between the offsetting financial transactions was, in one sense, equally available to both parties, in the sense that both could have subpoenaed DB witnesses to explain the transactions (and key spreadsheets).  But, in addition, in DB’s nonprosecution agreement with DOJ, DB had agreed to cooperate and produce witnesses.  So, the IRS had that additional leverage over DB that could have been used if it thought the DB witness’s testimony would have been helpful.  I don’t know why the IRS did not call the DB witnesses, but I suspect that the reason was that their testimony would have been redundant from the reasonable and fairly compelled inferences from the documentary evidence and from reasonable inferences from not credible attempts to explain those inferences away by witnesses such as Beer and the shelter's proffered experts.

At any rate, without getting into the weeds on that evidence issue as to inferences from missing witnesses, I commend readers to the Court’s discussion.

JAT Comments on the Penalty:

As noted above, the Tax Court rejected the penalty because the written approval required by § 6751(b) had not been obtained when it was first asserted.  The Tax Court said (Slip Op. 65):

In the instant cases, the initial penalty determinations were set forth in the FPAAs, and respondent has conceded that the IRS did not secure written supervisory approval of the penalties before those notices were issued to petitioners. In light of petitioners’ having properly raised this issue and respondent’s concession, we find that the IRS did not comply with section 6751(b).

The Tax Court held that the IRS could not cure that initial problem by re-asserting with management approval the accuracy related penalty in the Tax Court proceeding.

The question I ask is whether the IRS could have (should have) asserted the civil fraud penalty in the Tax Court proceeding.  There should be little doubt that the penalty could have applied in this case or at least, on the evidence, the IRS could have made a respectable showing that it applied.  My gut tells me that the Court held the way it did solely with respect to the accuracy related penalty.  As to the civil fraud penalty, it had never been asserted as a bargaining chip and, I think, might have been asserted in the Tax Court proceeding with appropriate management approval.