Tuesday, July 3, 2007

Tax Help: The Tax Court considered “substance over form” standards in determining whether a tax shelter was “tax motivated” in River City Ranches , Jeffry Bergamyer, Tax Matters Partner, et al., v. Commissioner, TC Memo. 2007-171, July 2, 2007. The Tax Court also determined that there was fraud for purposes of applying the 6-year statute of limitations

The Tax Court noted:

Section 6621(c) provides for an increased rate of interest with respect to any substantial underpayment of tax in any taxable year attributable to a tax-motivated transaction. Section 6621(c)(3)(A) generally lists the types of transactions which are considered "tax-motivated transactions". A tax-motivated transaction includes any valuation overstatement within the meaning of section 6659(c), and such a valuation overstatement exists, among other situations, if the adjusted basis of property claimed on any return exceeds 150 percent of the correct amount of basis. Secs. 6621(c)(3)(A)(i), 6659(c). A tax-motivated transaction further includes "any sham or fraudulent transaction." Sec. 6621(c)(3)(A)(v).

It is well established that the tax consequences of transactions are governed by substance rather than form. Frank Lyon Co. v. United States, 435 U.S. 561, 573 (1978). When taxpayers resort to the expedient of drafting documents to characterize transactions in a manner which is contrary to objective economic realities and which has no significance beyond expected tax benefits, the particular forms they employ are disregarded for tax purposes. Id. at 572-573; Helvering v. F. & R. Lazarus & Co., 308 U.S. 252, 255 (1939). If a transaction is devoid of economic substance, it is not recognized for Federal taxation purposes. Gregory v. Helvering, 293 U.S. 465 (1935).

Determining the economic substance of a transaction requires an analysis of several objective factors: (1) Whether the stated price for the property was within reasonable range of its value; (2) whether there was any intent that the purchase price would be paid; (3) the extent of the taxpayer's control over the property; (4) whether the taxpayer would receive any benefit from the disposition of the property; (5) whether the benefits and burdens of ownership passed; (6) the presence or absence of arm's-length negotiations; (7) the structure of the financing; (8) the degree of adherence to contractual terms; and (9) the reasonableness of the income and residual value projections. Levy v. Commissioner, 91 T.C. 838, 854 (1988); Rose v. Commissioner, 88 T.C. 386, 410 (1987), affd. 868 F.2d 851 (6th Cir. 1989).

Our findings reflect the consideration of these objective factors. The partnerships had no business purpose beyond generating tax benefits. The facts show that the partnerships themselves were shams and lacked economic substance. They were merely a facade used by Hoyt to provide the tax benefits he promised in his promotional materials. They had no independent economic substance beyond the purported sheep breeding transactions which were also illusory and had no economic effect.

It is also significant in these cases that for section 6621(c) penalty-interest purposes the partnerships overvalued their assets and overstated their bases therein. The parties have stipulated facts that support findings of partnership asset overvaluations and basis overstatements. For example, they stipulated that: (1) The purchase prices exceeded the value of each partnership's flock because many of the sheep purportedly sold did not exist; (2) sheep sold to the partnerships for average prices ranging from $1,135 to $2,126 were nowhere near the quality of breeding sheep Barnes Ranches sold for $400 or more; (3) the partnerships never acquired the benefits and burdens of ownership; and (4) the promissory notes used to purchase the sheep did not represent valid indebtedness. Because we have determined that the partnership transactions lacked economic substance and are shams and that the partnerships never acquired the benefits and burdens of ownership, it follows that the adjusted bases in the sheep are zero. Clayden v. Commissioner, 90 T.C. 656, 677-678 (1988); Rose v. Commissioner, supra at 426; Zirker v. Commissioner, 87 T.C. 970, 978-979 (1986).

We conclude that the partnerships' activities are tax-motivated transactions within the meaning of section 6621(c).

Issue 2. Whether the Period of Limitations on Assessment Had Expired When the FPAAs Were Issued

The period for making assessments of tax attributable to a partnership item or affected item is set forth in section 6229. Section 6229 provides in pertinent part:


(a) General Rule. --Except as otherwise provided in this section, the period for assessing any tax imposed by subtitle A with respect to any person which is attributable to any partnership item (or affected item) for a partnership taxable year shall not expire before the date which is 3 years after the later of --

(1) the date on which the partnership return for such taxable year was filed, or

(2) the last day for filing such return for such year (determined without regard to extensions).

(b) Extension by Agreement. --

(1) In general. --The period described in subsection (a) (including an extension period under this subsection) may be extended --


(B) with respect to all partners, by an agreement entered into by the Secretary and the tax matters partner (or any other person authorized by the partnership in writing to enter into such an agreement),

before the expiration of such period.


(c) Special Rule in Case of Fraud, Etc. --

(1) False return. --If any partner has, with the intent to evade tax, signed or participated directly or indirectly in the preparation of a partnership return which includes a false or fraudulent item --

(A) in the case of partners so signing or participating in the preparation of the return, any tax imposed by subtitle A which is attributable to any partnership item (or affected item) for the partnership taxable year to which the return relates may be assessed at any time, and

(B) in the case of all other partners, subsection (a) shall be applied with respect to such return by substituting "6 years" for "3 years."

Respondent issued the FPAAs at issue after the normal 3-year periods for assessment had expired. With regard to these FPAAs, however, Hoyt, as TMP, had executed consents extending the limitations periods. The partnerships argue that the extensions are invalid because Hoyt executed them while disabled by conflicts between his own interests and those of his partners. Respondent argues that the consents were valid and, alternatively, if the waivers are invalid, the 6-year limitations period under section 6229(c)(1) applies.

The 6-year limitations period applies if four requirements are met: (1) The entity is a partnership; (2) the partnership return includes a false or fraudulent item; (3) a partner signed or participated directly or indirectly in the preparation of the return; and (4) the partner signed or participated with the intent to evade tax. Sec. 6229(c)(1); Transpac Drilling Venture, 1983-2 v. United States, 83 F.3d 1410, 1414 (Fed. Cir. 1996), affg. 32 Fed. Cl. 810 (1995); cf. Allen v. Commissioner, 128 T.C. 37 (2007). There is no requirement that the signer of the partnership return intend to evade his own taxes. The 6-year statute is applicable to each partner if, in signing a false or fraudulent partnership return, the signer intended to evade the taxes of the other partners. Transpac Drilling Venture, 1983-2 v. United States, supra at 1414-1415. There is also no requirement that the other partners have knowledge of the false or fraudulent deductions claimed on a partnership return. The intent of the signer of the partnership return to evade the taxes of the other partners satisfies the intent element of the 6-year statute of limitations for making additional assessments under section 6229(c)(1), which applies when the partnership return containing false or fraudulent items is signed with intent to evade tax.Id. It is the fraudulent nature of the return that extends the limitations period. Allen v. Commissioner, supra at 42.

Through participation in the Hoyt partnerships, the partners received the benefits of the false and fraudulent partnership deductions. A partnership is required to file an annual information tax return even though it is not a taxable entity for Federal income tax purposes. Secs. 701, 6031; sec. 1.701-1, Income Tax Regs. Each partner is liable for income tax in his or her individual capacity with respect to his or her share of partnership items of income, loss, deduction, and credit. Sec. 701; sec. 1.702-1, Income Tax Regs. Thus, through such participation in the Hoyt partnerships, each partner received flowthrough partnership deductions that were false and fraudulent and which reduced or eliminated the partner's tax liability.

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