Wednesday, February 27, 2008

Economic Substance

A taxpayer is not entitled to loss deductions pursuant to §165(c)(2) if his claimed losses stem from transactions that lack economic substance. See Iles v. C.I.R [ 93-2 USTC ¶50,525], 982 F.2d 163, 165 (6th Cir. 1992). Moreover, "when a taxpayer claims a deduction, it is the taxpayer who bears the burden of proving that the transaction has economic substance." Coltec Industries, Inc. v. United States [ 2006-2 USTC ¶50,389], 454 F.3d 1340, 1355 (Fed. Cir. 2006).

Richard M. Nault v. United States of America.

U.S. District Court, Dist. N.H.; Civ. 04-cv-479-PB, February 9, 2007.

[ Code Sec. 165]

Sham transactions: Economic substance. --


BARBADORO, District Judge: Richard Nault brings this action against the United States to recover income tax refunds for several tax years. Nault's claims stem from investments he made in several agriculture-based limited partnerships (collectively the "AMCOR Partnerships"). In 2001, the tax court entered orders resolving a claim by the United States that the AMCOR Partnerships were sham transactions lacking economic substance. The parties agree that Nault's entitlement to the refunds he now seeks depends upon the meaning and legal effect of the tax court orders.

The matter is before me on cross motions for summary judgment.


This case falls within the purview of the Tax Equity and Fiscal Responsibility Act of 1982 ("TEFRA"). Accordingly, I begin by explaining TEFRA's legal framework. I then describe Nault's investments in the AMCOR Partnerships and the tax court litigation challenging the legitimacy of the partnerships' tax returns.

A. The TEFRA Framework 1

TEFRA establishes a "single unified procedure for determining the tax treatment of all partnership items at the partnership level, rather than separately at the partner level." Callaway [ 2000-2 USTC ¶50,744], 231 F.3d at 108. Whether an item is a partnership item or a nonpartnership item is the threshold inquiry under TEFRA. Id. Partnership items are "subject to TEFRA's centralized audit procedures," while "the treatment of nonpartnership items is determined at the level of the individual partner's return...." Id. Under TEFRA, taxpayers are not "permitted to raise nonpartnership items in the course of a partnership proceeding." Id. Correlatively, taxpayers cannot raise partnership items at partner level proceedings. Id.

TEFRA further mandates that a partner file "an income tax return that is consistent with the partnership return." Id. "The partner's distributive share of any partnership item must be reported in the same manner as on the partnership's information return ( i.e., it must have the same amount, the same characterization, the same timing)." Id. at 108-09 (citations omitted).

"The [Internal Revenue Service ("IRS")] may adjust partnership items only at the partnership level and only after following TEFRA procedures." Id. at 109. Specifically, "[t]o audit a partnership return, the IRS must send notice of the beginning of an administrative proceeding ('NBAP') to the partners entitled to notice (the 'notice partners')." 2 Id. "[A]ny partner has the right to participate in any administrative proceeding relating to the determination of partnership items at the partnership level." Id. (citing I.R.C. §6224(a)). "[I]f after completing its audit the IRS adjusts the partnership return, it must send the notice partners a notice of final partnership administrative adjustment ('FPAA')." Id. (citing I.R.C. §6223(a)(2), (d)(2)).

"Within 90 days of the date the IRS mails the FPAA notice, the partnership's 'tax matters partner' (TMP) 3 may contest the FPAA by filing a petition for readjustment in Tax Court, the Court of Federal Claims or the appropriate federal district court." Id. (citing I.R.C. §6226(a)). "If the TMP does not file a petition within this period, then any notice partner may file a petition for readjustment within the next 60 days. Id. (citing I.R.C. §6226(b)(1)). "Regardless whether the petition for judicial readjustment is filed by the TMP or by a notice partner, all other partners are treated as parties to the suit, provided that they have an ongoing interest in the outcome of the proceedings. Id. (citing I.R.C. §6226(c), (d)). "In this manner TEFRA allows all partners, if they choose, to litigate a dispute with the IRS in a single proceeding that binds all." Id.

"After the FPAA adjustments become final ( i.e., after they go unchallenged for 150 days or are judicially resolved in a section 6226 [tax court, district court, or Court of Federal Claims proceeding]), the IRS may assess partners with the tax which properly accounts for their distributive share of the adjusted partnership items, without notice, as a computational adjustment." Id. at 109-10 (citing I.R.C. §§6225(a), 6230(a) (1), 6231(a)(6)). "In certain cases, where no further factual determinations are necessary at the partner level, an assessment attributable to an 'affected item' may also be made by computational adjustment." Id. at 110. An "affected item" is "any item to the extent such item is affected by a partnership item. Id. In the event of an unfavorable court decision, the TMP, a notice partner, or a 5-percent group make seek appellate review in the appropriate forum. I.R.C. §6226(g).

B. Tax Treatment of Nault's Investments 4

Nault invested in the AMCOR Partnerships between 1984 and 1986. Each partnership reported significant losses in its first year of existence and comparatively smaller amounts of income in subsequent years. Nault took deductions based on his distributive share of partnership losses and paid taxes on his share of partnership income disbursements throughout the course of his investments. 5

In 1987, the IRS examined the AMCOR Partnerships' tax returns and issued FPAA notices disallowing deductions claimed by each partnership. In the FPAA notices, the IRS explained that the adjustments resulted from, inter alia, an IRS determination that the AMCOR Partnerships' activities constituted a series of sham transactions lacking economic substance.

Following the issuance of the FPAA notices, certain AMCOR partners --not including the TMP --filed Petitions for Readjustment of Partnership Items in the United States Tax Court pursuant to I.R.C. §6226. In July 1999, the TMP for each AMCOR Partnership intervened in each AMCOR tax court proceeding.

In 2001, after years of litigation, the IRS and the TMP entered into an agreement providing that the IRS would disallow approximately 72 percent of the AMCOR Partnerships' losses but allow the partnerships to retain all of their claimed Investment Tax Credits. The agreement also provided that the AMCOR partners would not file amended returns restating any reported income from the AMCOR Partnerships on which they had already paid income taxes.

The IRS ultimately filed Motions for Entry of Decision in the tax court, and the tax court entered decisions with respect to each AMCOR Partnership reflecting the terms of the settlement agreement. Each of the tax court decisions contained the following language:
ORDERED AND DECIDED:...[t]hat the foregoing adjustments to partnership income and expenses are attributable to transactions which lacked economic substance, as described in former I.R.C. §6621(c)(3)(A)(v), so as to result in a substantial distortion of income and expenses....

After the tax court litigation was resolved, the IRS issued adjustments to Nault's 1984, 1985, and 1986 income tax returns based on the disallowed deductions. Nault then paid the additional taxes resulting from the adjustments.

While the tax court litigation was ongoing, each of the AMCOR Partnerships terminated. Nault had no remaining basis in his partnership interests when the partnerships terminated apart from any "restored" basis he might be entitled to claim based upon the tax court's disallowance of his prior deductions.

In September 2002, Nault sought tax refunds by filing amended federal income tax returns for 1995, 1996, 1998, 1999, 2000, and 2001. In the amended returns, Nault claimed an ordinary loss deduction in the year each partnership terminated as well as carryover adjustments for other years affected by the termination year losses. Along with his refund claims, Nault attached statements explaining why he was entitled to the refunds. Specifically, Nault asserted that the Tax Court's 2001 disallowance of 72 percent of the AMCOR Partnership deductions --and derivatively, his share of the deductions --resulted in a restoration of his basis in those partnerships by corresponding amounts. As a result of this adjustment to his basis, he argued, he was entitled to loss deductions in the exact amount of his previously disallowed deductions because the partnerships became worthless upon termination.

On December 18, 2002, the IRS denied Nault's refund claims. Nault timely filed this action on December 17, 2004.


Summary judgment is appropriate "if the pleadings, depositions, answers to interrogatories, and admissions on file, together with the affidavits, if any, show that there is no genuine issue as to any material fact and that the moving party is entitled to a judgment as a matter of law." Fed. R. Civ. P. 56(c). "Cross-motions for summary judgment do not alter the basic Rule 56 standard, but rather simply require [the court] to determine whether either of the parties deserves judgment as a matter of law on facts that are not disputed." Adria Int'l Group, Inc. v. Ferre Dev., Inc., 241 F.3d 103, 107 (1st Cir. 2001) (citation omitted).


In claiming a loss deduction, Nault relies upon 26 U.S.C. §165(a), which permits individuals to take tax deductions for losses "not compensated for by insurance or otherwise." Another statutory provision --26 U.S.C. §165(c) --adds important limitations to such deductions. It provides:
In the case of an individual, the deduction under subsection (a) shall be limited to --

(1) losses incurred in a trade or business;

(2) losses incurred in any transaction entered into for profit, though not connected with a trade or business; and

(3) except as provided in subsection (h), losses of property not connected with a trade or business or a transaction entered into for profit, if such losses arise from fire, storm, shipwreck, or other casualty, or from theft.

Nault does not allege that he was involved in a trade or business in connection with the AMCOR Partnerships. Nor does he allege that his losses arose from fire, storm, shipwreck, or other casualty. Thus, Nault's claimed loss deductions can only be grounded in §165(c)(2): "a loss incurred in a transaction entered into for profit."

A taxpayer is not entitled to loss deductions pursuant to §165(c)(2) if his claimed losses stem from transactions that lack economic substance. See Iles v. C.I.R [ 93-2 USTC ¶50,525], 982 F.2d 163, 165 (6th Cir. 1992). Moreover, "when a taxpayer claims a deduction, it is the taxpayer who bears the burden of proving that the transaction has economic substance." Coltec Industries, Inc. v. United States [ 2006-2 USTC ¶50,389], 454 F.3d 1340, 1355 (Fed. Cir. 2006). The government relies on these accepted principles in contending that Nault is not entitled to the deductions he seeks because, it argues, the tax court determined that the transactions on which Nault's deductions are based lacked economic substance.

Nault recognizes that he is not entitled to take deductions pursuant to §165(c)(2) unless he can establish that his claimed losses are attributable to transactions that had economic substance. He also agrees that the tax court orders are determinative on this issue. Thus, this case turns on how the tax court orders are construed.

The government offers a straightforward interpretation of the tax court orders. Its position is that the parties to the tax court proceeding settled their dispute by agreeing to the entry of court orders recognizing that the losses disallowed pursuant to the orders were "attributable to transactions which lacked economic substance." Because the orders clearly provide that the transactions on which Nault's claims are based lacked economic substance, the government argues, Nault cannot rely on the disallowed losses to "restore" his basis in his investments.

Nault focuses on the effect of the court orders rather than their specific terms in arguing that the tax court actually determined that the AMCOR Partnerships had economic substance. In making this argument, Nault relies primarily on the basic principle that "a transaction that lacks economic substance simply is not recognized for federal taxation purposes, for better or worse...." ACM P'ships v. Comm'r of Internal Revenue [ 98-2 USTC ¶50,790], 157 F.3d 231, 261 (3d Cir. 1998) (citation and internal quotation marks omitted). He then reasons that if the tax court acted consistently with this principle, it must have determined that the AMCOR Partnerships had economic substance because the court allowed partners to retain their Investment Tax Credits and a portion of their partnership's losses and because the settlement agreement that gave rise to the orders barred partners from filing amended returns restating any reported income generated by the partnerships.

I am not convinced that courts are required to apply the economic substance doctrine in quite so inflexible a manner as Nault suggests. However, I need not delve into this complex issue to resolve this case because Nault fails to appreciate the significance of the fact that the orders on which his claims depend were issued pursuant to a settlement. The government argued in the tax court proceeding that the AMCOR Partnerships were sham transactions that were completely lacking in economic substance. The TMP disagreed. After extensive litigation, the parties compromised their claims by settlement and, in so doing, they agreed to the precise language that was used in the court orders that resolved the parties' dispute. That language plainly provides that the disallowed losses on which Nault's current claims are based were attributable to transactions that lacked economic substance. It is unsurprising and ultimately insignificant for our purposes that the settlement also represented something less than a complete victory for either side. All that matters here is that the settlement resulted in the issuance of court orders that plainly resolved the issue that is now before the court.

Accordingly, I hold that the tax court decisions determined that the disallowed deductions were attributable to transactions that lacked economic substance. Those decisions are binding on Nault in this proceeding. Thus, Nault has no claim to loss deductions resulting from a restored basis because transactions lacking economic substance cannot give rise to losses under §165(c).


For the reasons set forth herein, I grant the government's motion for summary judgment (Doc. No. 34) and deny Nault's crossmotion for summary judgment (Doc. No. 43). The clerk is instructed to enter judgment accordingly.


1 In Callaway v. Comm'r, the Second Circuit provided a thorough and enlightening explanation of TEFRA. See [ 2000-2 USTC ¶50,744] 231 F.3d 106, 107-12 (2d Cir. 2000). I rely heavily on Callaway in explaining TEFRA's legal framework.

2 A notice partner is "a partner entitled to notice under section 6223(a)." Id. (citing I.R.C. §6231(a)(8)). "When a partnership has 100 or more partners, a notice partner is generally one who owns at least a one percent interest in the partnership." Id. (citing I.R.C. §6223(b)(1)). It is unclear from the record whether Nault was a notice partner in any of the AMCOR Partnerships.

3 The TMP is "the general partner designated in the partnership agreement to handle tax matters." Id. (citing I.R.C. §6231(a)(7)).

4 The facts in this section are drawn from the parties' Joint Statement of Background Facts and Background Discussion of Law Regarding Taxation of Partnership Interests (Doc. No. 31) and certain exhibits in the summary judgment record. The record is construed in the light most favorable to Nault.

5 Nault's reported income and loss amounts for the AMCOR Partnerships are represented in a chart appended to the parties' Joint Statement of Background Facts. A copy of the chart is included with this Memorandum and Order as Appendix A.

Richard M. Nault, Plaintiff, Appellant v. United States, Defendant, Appellee.

U.S. Court of Appeals, 1st Circuit; 07-1455, February 15, 2008.

Affirming a DC N.H. decision, 2007-1 USTC ¶50,326.

[ Code Sec. 165]

Loss deductions: Sham transactions: Economic substance. --

Before: Torruella and Lynch, Circuit Judges, and Stahl, Senior Circuit Judge.

STAHL, Senior Circuit Judge: Plaintiff-appellant Richard M. Nault appeals the district court's decision denying his motion for summary judgment and granting summary judgment in favor of the United States. Nault argues that the district court erred in its interpretation of several agreed judgments entered by the Tax Court ("the Tax Court decisions"), embodying the terms of a settlement between the Internal Revenue Service ("IRS") and Frederick H. Behrens, as Tax Matters Partner ("TMP"), regarding the proper tax treatment of several agriculture-related limited partnerships organized by American Agri-Corp., Inc. ("AMCOR") 1 a California corporation (collectively the "AMCOR Partnerships" or "Partnerships"). For the reasons discussed below, we affirm.


Nault allegedly invested approximately $1,230,000.00 in five AMCOR Partnerships between 1984 and 1986. In 1987, the IRS began scrutinizing the AMCOR Partnerships' tax returns and issued Final Partnership Administrative Adjustment Notices disallowing certain deductions on the basis that the Partnerships' activities constituted a series of sham transactions lacking economic substance. After years of litigation, the IRS and the TMP reached a settlement in which 72% of the Partnerships' deductions were disallowed, the government agreed not to disallow investment tax credits claimed by the partners, and the partners agreed not to file amended returns modifying any reported income from the Partnerships on which the partners had paid income taxes. Upon motion of the IRS, the Tax Court entered decisions with respect to each Partnership reflecting the terms of the settlement agreement.

Based upon the Tax Court decisions, the IRS issued adjustments to Nault's 1984, 1985, and 1986 income tax returns, and Nault paid the additional taxes resulting from the adjustments. Each of the Partnerships terminated during the lengthy Tax Court litigation, leaving Nault without any remaining basis in his partnership interests. In September 2002, Nault filed amended income tax returns for 1995, 1996, 1998, 1999, 2000, and 2001, asserting that his basis in the Partnerships should be "restored" to a level inversely proportionate to the Tax Court decisions' disallowance of 72% of the Partnerships' loss deductions. Nault claimed that he was entitled to an ordinary loss deduction for the taxable basis that was "restored" to his then-worthless partnership interests.

On December 18, 2002, the IRS denied Nault's request for a refund. Nault filed a complaint in federal district court on December 17, 2004, seeking to recover his purported overpayment of income tax pursuant to 26 U.S.C. §7422 and 28 U.S.C. §1346(a)(1). On February 9, 2007, the district court ruled on the parties' cross motions for summary judgment, granting summary judgment in favor of the government and denying summary judgment to Nault. See Nault v. United States, Civil No. 04-cv-479, 2007 WL 465310 (D.N.H. Feb. 9, 2007). This appeal ensued.


We review de novo a district court's grant of summary judgment based on contract interpretation. See John Hancock Life Ins. Co. v. Abbott Labs., 478 F.3d 1, 7 (1st Cir. 2006). Summary judgment is appropriate where the evidence shows that "there is no genuine issue as to any material fact and that the moving party is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(c).

The parties agree that tax deductions are not permitted for transactions that lack economic substance and that the inquiry at hand --whether the Partnerships or transactions relevant to this appeal lacked economic substance --is confined to interpretation of the Tax Court decisions implementing the settlement between the IRS and the TMP. Thus, a detailed recitation of the substantive law underlying the parties' dispute is unnecessary. See United States v. ITT Cont'l Baking Co., 420 U.S. 223, 233, 236-37 (1975) (explaining that settlements incorporated into judicial decisions are self-contained within their four corners and, consequently, are detached from the substantive law giving rise to the litigation).

In construing a settlement subsequently adopted by a court, we apply the same basic rules that govern the interpretation of ordinary contracts. See id. at 235-37; Rodi v. Ventetuolo, 941 F.2d 22, 28 (1st Cir. 1991); see also Smart v. Gillette Co. Long-Term Disability Plan, 70 F.3d 173, 178 (1st Cir. 1995) (explaining that federal common law requires us to be "guided by common-sense canons of contract interpretation" (citation omitted)). Interpretation of the terms of an unambiguous contract is a matter of law, subject to judicial resolution. See id. Quite simply, "[a]n unambiguous contract must be enforced according to its terms...." Senior v. NSTAR Elec. & Gas Corp., 449 F.3d 206, 219 (1st Cir. 2006). Moreover, terms within a contract are accorded their "plain, ordinary, and natural meaning." Filiatrault v. Comverse Tech., Inc., 275 F.3d 131, 135 (1st Cir. 2001).

A contract is ambiguous where the disputed terms are facially inconsistent or reasonably susceptible to multiple, plausible interpretations. See Smart, 70 F.3d at 178. If a contract is ambiguous, we will consider extrinsic evidence to give effect to the parties' intent in forming the contract. Id. "The question of whether a contract is ambiguous is generally a question of law for the judge...." Senior, 449 F.3d at 219.

Nault contends that the Tax Court decisions should not be interpreted to mean that the Partnerships or the underlying transactions lacked economic substance. In support, he asserts that the disputed language of the Tax Court decisions is ambiguous, that principles of construction favor his suggested interpretation, and that extrinsic evidence conclusively establishes that the parties intended to effectuate his interpretation. These arguments are not well-founded.

First, the plain language of the Tax Court decisions unambiguously favors the government's interpretation. Section II of each Tax Court decision states:
That the foregoing adjustments to partnership income and expense are attributable to transactions which lacked economic substance, as described in former I.R.C. §6621(c)(3)(A)(v), so as to result in a substantial distortion of income and expense, as described in I.R.C. §6621(c) (3)(A)(iv), when computed under the partnership's cash receipts and disbursements method of accounting; and

That liabilities [in varying amounts] lack economic substance.

The district court held that this language unmistakably signaled that the adjustments of the loss deductions were made because the underlying transactions lacked economic substance, thus preventing Nault from now claiming tax deductions. 2

To escape this seemingly inexorable conclusion, Nault asserts that the presence of the phrase "so as to result in a substantial distortion of income and expenses" generates ambiguity. He argues that this phrase indicates that the underlying transactions may not have entirely lacked in economic substance, but merely distorted the Partnerships' balance sheet. To buttress this conclusion, he points out that the very next sentence simply declares that "liabilities" in varying amounts lacked economic substance without any such qualifying language. Thus, Nault argues, the district court violated the time-honored maxim that variances in language should not be treated as superfluous.

Nault is mistaken. The reference to former 26 U.S.C. §6621(c)(v) (1988), which helps to define "tax motivated transactions," confirms that the transactions were "sham[s] or fraudulent transaction[s]," and therefore lacked economic substance. See, e.g., Durrett v. Comm'r, 71 F.3d 515, 517 (5th Cir. 1996). The phrase "so as to result in a substantial distortion of income and expense" simply tracks the language of the former 26 U.S.C. §6621(c)(3)(iv) (1988), which likewise helps to define "tax motivated transactions." Thus, each phrase independently establishes that the adjustments were attributable to the Partnerships' tax-motivated activities. Admittedly, Nault is correct that transactions that lack economic substance are treated differently from those that merely result in a substantial distortion of income. Compare Dewees v. Comm'r, 870 F.2d 21, 30-31 (1st Cir. 1989) (refusing to permit deductions for sham transactions), with Mantell v. Comm'r, 66 T.C.M. (CCH) 697, 1993 WL 347409, at *10 (T.C. Sept. 13, 1993) (approving adjustments based on accounting methods that created a substantial distortion of income).

Nevertheless, the plain language of the Tax Court decisions still firmly establishes that the underlying transactions lacked economic substance. 3 Here, the greater implies the lesser --because the underlying transactions lacked economic substance, they necessarily resulted in a substantial distortion of income. Thus, the government's interpretation --that "[t]he decisions . .. state that the transactions resulted in a substantial distortion of income and expense because they lacked economic substance" --is by far the most natural reading of the disputed language. At the very least, it is logically consistent; Nault's proposed construction eviscerates the entire sentence. Under Nault's interpretation, the "substantial distortion" language must be read to modify the "lacked economic substance" language. We decline the invitation to mangle the English language by adopting an approach that defies basic rules of syntax and diction; the Tax Court clearly stated that the lack of economic substance "result[ed] in" the distortion of income, not the other way around.

Nault seeks additional support from the fact that the distortion language was not used in the next paragraph, which concerned the Partnerships' liabilities. The most obvious explanation for why this language was not used in reference to the Partnerships' liabilities is simply that the first paragraph referred to the underlying transactions themselves, while the second paragraph referred to the liabilities claimed by the Partnerships. Naturally, the erroneous liabilities themselves did not "result in a substantial distortion of income or expense." They simply lacked economic substance. Moreover, we will not declare perfectly clear language ambiguous merely because the Tax Court did not reiterate it verbatim in the very next sentence in dealing with a related, but not identical, matter.

Next, Nault argues that because the settlement "did not treat the Partnerships as lacking economic substance," the Tax Court decisions are ambiguous. 4 Nault's contention is based on a fundamentally erroneous conception of the Tax Court decisions, which approved a settlement. See Miller Tabak Hirsch & Co. v. Comm'r, 101 F.3d 7, 10 (2d Cir. 1996) (explaining that in a judicially-approved settlement parties are "free to settle the case in any manner not violative of law or public policy, regardless of what the result might have been had the parties gone to trial"). Parties to a settlement, almost by definition, eschew the possibility of obtaining some portion of what they would like in exchange for certain terms with which they can live. See Rodi, 941 F.2d at 27 (stating that a settlement "`normally embodies a compromise,' within the limits of which the litigants...must be prepared to live" (quoting United States v. Armour & Co., 402 U.S. 673, 681 (1971))). The fact that the IRS chose to settle rather than risk the hazards of litigation is no more a concession that the transactions at hand possessed economic substance than a defendant's decision to settle a dubious lawsuit for pennies on the dollar is a concession that the suit had merit. Indeed, there is little doubt that parties occasionally settle claims simply to avoid the hassle, uncertainty, and expense of litigation even where a favorable outcome seems all but certain.

Here, it was perfectly permissible for the IRS to insist upon language that declared the transactions to lack economic substance --perhaps anticipating claims plaintiffs such as Nault might make --while simultaneously making certain concessions to the taxpayers. It was incumbent upon the TMP to dispute any language that he did not wish included in the Tax Court decisions. See Rodi, 941 F.2d at 27 (admonishing that litigants must abide by terms of a settlement even where they prove more onerous than originally anticipated). In the end, therefore, Nault remains confined to the language agreed to in the settlement. See In re New Seabury Co. Ltd. P'ship, 450 F.3d 24, 31, 39 (1st Cir. 2006) (rejecting the district court's "functional analysis" of the parties' stipulation in favor of the bankruptcy court's analysis of its plain language).

Finally, Nault argues that, even if the plain language of the Tax Court decisions is unambiguous, the district court nevertheless erred by failing to consider extrinsic evidence. First, it is elementary that we do not ordinarily examine extrinsic evidence to alter or clarify the terms of an otherwise unambiguous contract. See Smart, 70 F.3d at 179. Nevertheless, "in the exceptional case, a latent ambiguity in seemingly clear contract language may require us to consider extrinsic evidence to determine the actual object of the parties' agreement." Coffin v. Bowater Inc., 501 F.3d 80, 97 (1st Cir. 2007).

This is not such a case. Nault's proposed interpretation of the Tax Court decisions is not merely strained, but flatly contradictory to the plain meaning of its terms. In essence, he "argue[s] that the [disputed] language does not mean what it says."Id. at 98. If the language of the Tax Court decisions does not comport with what the parties intended, then the TMP should have insisted upon different language.

Finally, we note that Nault dramatically overstates the persuasive force of the extrinsic evidence that he has proffered. It is by no means so conclusive as he suggests. 5 He directs our attention to a written summary regarding the settlement, prepared by the IRS, stating, inter alia, that each partner "may have a capital gain or loss upon his termination from the partnership" (emphasis added). This summary, however, was nonbinding, the specific section in question was designated as informational, the clause was permissive, and the provision referred only to the partner's capital contribution. Nault also points to a letter he received from the IRS indicating that the Service had made "[a] determination...that allow[ed] for capital treatment of these losses." This statement is certainly peculiar --and inconsistent with the IRS's current position. This letter, however, cannot serve as a definitive guide for our interpretation of Tax Court decisions executed more than a year previously. Additionally, the court notes that the same letter notified Nault of the IRS's rejection of his claims for a deduction for an ordinary loss related to his "restored" basis in the Partnerships.

In summary, Nault's arguments obfuscate what is, in reality, a very simple case. The plain language of the Tax Court decisions indicates that the disallowed loss deductions were based on transactions that lacked economic substance. We have no jurisdiction to determine whether the relevant transactions actually did have economic substance --the sole matter within our purview is determining what the Tax Court meant by its decisions. The Tax Court's determination, that the transactions lacked economic substance, is unambiguous.


The judgment of the district court is affirmed.

1 For a partial history of AMCOR and the related litigation, see Crop Assocs.-1986 v. Comm'r, 80 T.C.M. (CCH) 56, 2000 WL 976792, at *1-7 (T.C. July 17, 2000).

2 Nault argues that the government has waived the position that the underlying transactions lacked economic substance, in favor of the position that the Partnerships themselves lacked economic substance. This contention is irrelevant. The district court unequivocally held that "the disallowed deductions were attributable to transactions that lacked economic substance." Nault, 2007 WL 465310, at *5 (emphasis added). We are not limited in our review by the fact that the district court rendered its decision on grounds that the government may or may not have urged below. Nault's position, if accepted, would confine the lower court to choosing between the rationales submitted by the parties. This is not the law. See Kamen v. Kemper Fin. Servs., Inc., 500 U.S. 90, 99 (1991) (holding that a "court is not limited to the particular legal theories advanced by the parties").

3 Albeit in dicta, the Court of Federal Claims has reached a similar conclusion about these decisions. See Keener v. United States, 76 Fed. Cl. 455, 457 & n.2 (Fed. Cl. 2007) (stating that the Tax Court found "the various partnership transactions to be sham transactions"); see also Howell v. Comm'r, 94 T.C.M. (CCH) 104, 2007 WL 2126593, at *1 (T.C. July 25, 2007) (stating that the IRS and TMP "stipulated that the partnerships entered into transactions that lacked economic substance and created substantial distortions of partnership income") (emphasis added).

4 Nault cites the Eleventh Circuit's decision in Fickling v. United States, 507 F.3d 1302 (11th Cir. 2007), as authority for this proposition. Nault, however, ignores a crucial factual distinction between the two cases. There is no indication that the disputed settlement discussed in Fickling contained any language labeling the transaction in question as lacking economic substance. Indeed, the Eleventh Circuit characterized the settlement in question as "noncommittal" concerning whether the underlying transaction was a sham. Id. at 1305.

5 In addition to noting the limited probative value of Nault's extrinsic evidence, we observe that the government likewise adduced extrinsic evidence --an affidavit from Margaret K. Hebert, an IRS attorney responsible for the AMCOR litigation --to buttress its own position. We need not discuss this evidence further, however, because it is unnecessary to our conclusion.

Transactions Entered Into for Profit: Economic substance

Despite the fact that the venture was rather risky and that tax savings were a critical element in investing in the venture, limited partners in a partnership formed to exploit a synthetic fuel process were able to claim their share of partnership losses. There was a business purpose behind the venture, investors had a reasonable possibility of realizing profit, and the venture "had practicable income effects other than the creation of tax losses."

D.B. Smith, CA-6, 91-2 USTC ¶50,326.

To the contrary.

A partnership that was to develop the market for a new way of harnessing energy was a sham devised to bring tax benefits to its investors, and deductions for a partner's share of partnership losses were denied.

J. Karr, CA-11, 91-1 USTC ¶50,113, 924 F2d 1018.

A partnership allegedly created to pursue production of an alternative energy source was not entitled to deductions for licensing fees and research and development fees. The partnership's activity lacked economic substance because of the amount and structure of the fees paid, the inexperience of the promoters, conflicts of interest among the promoters and the heavy emphasis placed on the tax benefits that would be gained by the partners.

Peat Oil and Gas Assoc., 100 TC 271, Dec. 48,944. Aff'd, sub nom. R. Ferguson, CA-2, 94-2 USTC ¶50,357.

Summary judgment against an investor was reversed because a material issue of fact existed concerning the economic substance of investment trades.

C.P. Brown, CA-7, 92-2 USTC ¶50,564, 976 F2d 1104.

Loss deductions claimed by investors in a corporation involved in the cattle business were disallowed. Regardless of whether the taxpayers had a profit motive, their expenditures to enter and stay in the cattle program, as well as their additional costs for the purchase of embryos and calves, were nondeductible because the program lacked economic substance. Even assuming that the investment constituted a bona fide business transaction, no showing was made that an investment loss or a theft loss was sustained during the tax years at issue.

R.E. Daoust, 67 TCM 2914, Dec. 49,832(M), TC Memo. 1994-203.

An individual was denied loss deductions relating to an alleged diamond mining venture because he did not own any rights in the venture.

G.M. Osserman, 71 TCM 2892, Dec. 51,319(M), TC Memo. 1996-205.

Investors in a limited partnership involved in oil and gas recovery were denied a loss deduction for their cash investment because the entity's activities and transactions lacked economic substance. They had agreed to be bound by the ruling in G.E. Krause, Dec. 48,383, affirmed sub nom. R.A. Hildebrand, CA-10, 94-2 USTC ¶50,305, a test case involving identical partnership transactions. Pursuant to that decision, loss deductions were disallowed because the entity did not engage in for-profit business transactions. Although the investors conceded that no profit objective existed at the partnership level, they contended that the profit-objective test should be measured only at the individual partner level. However, because the partnership's transactions lacked economic substance, their loss deduction was disallowed despite their individual profit objective in making the investment.

M.L. Marinovich, 77 TCM 2075, Dec. 53,399(M), TC Memo. 1999-179.

As to deductions claimed with respect to transactions lacking economic substance and a profit motive, see ¶12,177.59.

Corporations that acquired two debt instruments structured so that the value of one was expected to increase significantly at the same time that the value of the other one decreased significantly, could not recognize a current loss on the sale of the debt instrument that that decreased in value while not recognizing the gain on the other debt instrument.

Rev. Rul. 2000-12, 2000-1 CB 734.

The profit objectives of individuals who invested in enhanced oil recovery limited partnerships had to be measured at the partnership level because the parties' stipulation that the activities of the partnerships were not entered into with a profit objective did not affect the status of the partnerships for federal tax purposes. The finding that the partnerships' activities lacked profit motives was not tantamount to a holding that the investors intended to create entities other than partnerships. Rather, the partnerships entered into transactions, formed joint ventures, operated gas wells, and conducted themselves as partnerships.

A.C. Copeland, CA-5, 2002-1 USTC ¶50,420, 290 F3d 326.

A corporation's transfer of interests in multilayered leases of computer equipment and related trusts lacked economic substance and expense deductions claimed in relation to the transaction were denied. The transaction was solely motivated by tax considerations. There was no real obligation on behalf of the taxpayer or profit potential in connection with the transaction and the taxpayer's expert testimony as to the credibility of the transaction was inaccurate and unconvincing.

Nicole Rose Corp., 117 TC 328, Dec. 54,578.

Losses generated by claiming an inflated basis as the result of a transfer of assets in which the taxpayer becomes joint and severally liable for the transferor's indebtedness on the assets in excess of the fair market value of the assets lack economic substance. Although the basis of an asset is its fair market value or cost, including the amount of the transferor's liability assumed by the taxpayer-transferee, the inclusion of such liabilities into the basis of the asset is predicated on the assumption that the liabilities will be paid in full by the transferee.

Notice 2002-21, 2002-1 CB 730.

An equipment lease-financing company did not have a legitimate nontax business purpose for engaging in a lease-stripping transaction in which it claimed large rental expense deductions in exchange for an investment of less than one percent of the anticipated deductions. The taxpayer did not have a business reason for the transaction apart from tax consequences and there was no possibility of economic profit from the transaction. Deductions and losses claimed in connection with the transaction were disallowed.

CMA Consolidated, Inc., 89 TCM 701, Dec. 55,917(M), TC Memo. 2005-16.

An investor in several limited partnerships was not entitled to claim loss deductions because the disallowed deductions on which his claim was based lacked economic substance. The Tax Court's orders were binding on the individual because the government and the partnership's tax matters partners (TMP) compromised their claims by settlement and, in so doing, agreed to the precise language used in the court orders. Although the Tax Court disallowed a portion of the partnership deductions and allowed partners to retain their investment tax credits, the individual could not rely on the disallowed losses to restore his basis in his investments.

R.M. Nault, DC N.H., 2007-1 USTC ¶50,326.

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