Wednesday, January 20, 2010

WELLS FARGO & COMPANY AND SUBSIDIARIES v. U.S., Cite as 105 AFTR 2d 2010-XXXX, 01/08/2010
Case Information:
Code Sec(s):
Court Name: In the United States Court of Federal Claims,
Docket No.: No. 06-628T,
Date Decided: 01/08/2010.
In the United States Court of Federal Claims,
Judge: WHEELER, Judge.
In this tax refund suit, Plaintiff Wells Fargo & Company (“Wells Fargo”) claims $115,174,203.00 in depreciation, interest and transaction cost deductions for the tax year 2002. The deductions stem from Wells Fargo's participation in 26 leveraged lease transactions, seventeen with domestic transit agencies, and nine involving qualified technological equipment (“QTE”). Although the tax treatment of all 26 transactions is at issue in this case, the parties limited their trial presentation to five agreed transactions, allowing the Court's ruling on these five to guide the resolution of the remainder. Of the five trial transactions, four involve public transit agencies, and one is a QTE lease involving cellular telecommunications equipment. The four transit lessees are: the New Jersey Transit Corporation (“NJT”), the State of California Department of Transportation (“Caltrans”), the Metropolitan Transit Authority of Harris County, Texas (“Houston Metro”), and the Washington Metropolitan Area Transit Authority (“WMATA”). The lessee in the QTE lease is a Belgian entity, Belgacom Mobile, S.A. (“Belgacom”).
The leveraged leases in this case sometimes are referred to as “SILO” (“sale in/lease out”) tax shelters, where a tax-exempt entity such as a public transit agency transfers tax benefits for a fee to a United States taxpayer such as Wells Fargo. The transactions involve depreciable assets such as rail cars, locomotives, or buses in the transit leases, or telecommunications equipment in the Belgacom lease. The documentation for each transaction is extensive, but the objective is for the taxpayer, Wells Fargo, to take advantage of significant tax deductions acquired from tax-exempt entities to offset taxable income and thereby reduce overall tax liability to the United States.
In assessing Wells Fargo's claimed deductions, the Court must examine the “substance over form” doctrine to determine whether Wells Fargo acquired a depreciable ownership interest in the property, and whether Wells Fargo bears the property's burdens and benefits. In simplest terms, the agreements comprising a SILO transaction are set up to suggest that a “sale” of property has taken place, that the property has been “leased back” to the original owner, and that a “loan” has been created to finance the transaction. Defendant contends that the “substance” of the transactions merely is a transfer of tax benefits to avoid federal taxes. The Court also must examine whether the circular flow of loan proceeds in these transactions creates any allowable interest deductions. Part of this inquiry is to determine whether any genuine indebtedness has occurred, and whether the loaned funds actually were available for use by Wells Fargo to finance the “sale.” A third inquiry is whether there is any economic substance to these transactions, other than the transfer of tax benefits, that would warrant depreciation and transaction cost deductions under the Internal Revenue Code (“IRC”) §§ 167 and 168, or interest deductions under IRC § 163. 1
The Court conducted a 20-day trial in Washington, D.C. during April 6 through May 1, 2009. The Court heard the testimony of 33 witnesses, thirteen of whom were experts. The fact witnesses included representatives from Wells Fargo and each of the four transit agencies, as well as appraisers and consultants who participated in, or assisted in arranging, the transactions. The expert witnesses testified in the areas of finance, economics, accounting, leveraged leases, and transit industry practices. The Court also heard fact and expert testimony on the Belgacom transaction. The evidentiary record consists of 5,150 pages of trial transcript, and 1,157 documentary exhibits. The parties submitted post-trial briefs on August 3, 2009, and reply briefs on September 17, 2009. The Court heard closing arguments on October 22, 2009. The Court allowed the parties to submit supplemental briefs on November 13, 2009 addressing new case law issued since the post-trial reply briefs.
Other courts have considered the tax treatment of SILO transactions, or the similar “LILO” (“lease in/lease out”) transactions and, with one exception, have concluded that the taxpayer who participated in the transaction is not entitled to any of the claimed tax benefits. AWG Leasing Trust v. United States, 592 F.Supp.2d 953 [101 AFTR 2d 2008-2397] (N.D. Ohio 2008); BB&T Corp. v. United States, 2007 WL 37798 [99 AFTR 2d 2007-376], at 1 (M.D.N.C., Jan. 4, 2007), aff'd, 523 F.3d 461 [101 AFTR 2d 2008-1933] (4th Cir. 2008). Two of the SILO and LILO cases have been tried to juries, and in both of those cases, the jury returned a verdict disallowing the tax deductions. Altria Group, Inc. v. United States, No. 1:06-cv-09430, 2009 WL 874207, at 1 (S.D.N.Y. July 9, 2009); Fifth Third Bancorp & Subs. v. United States, No. 1:05-cv-350 (S.D. Ohio, April 18, 2008). The one exception to date is Consolidated Edison Company of New York, Inc. v. United States, No. 06-305T, 2009 WL 3418533 [104 AFTR 2d 2009-6966], at 1 (Fed. Cl. Oct. 21, 2009) (Horn, J.), where our Court concluded after lengthy analysis that a LILO transaction had legitimate business purposes, and allowed the claimed tax deductions. The Court rightly observed in Consolidated Edison that each transaction “must be evaluated on its own merits.” Id.
Another SILO tax shelter case, although not a tax refund suit, is Hoosier Energy Rural Electric Cooperative, Inc. v. John Hancock Life Insurance Company, 588 F.Supp.2d 919 (S.D. Ind. 2008), aff'd 582 F.3d 721 (7th Cir. 2009). This case arose from the 2007–2008 economic downturn, where one of the insurance entities in the transaction, Ambac Assurance Corporation, had its credit rating reduced. The lessor, John Hancock, exercised its right to demand that Hoosier Energy find a replacement for Ambac, even though Ambac had not missed any payments. The case involves Hoosier Energy's request for injunctive relief to maintain the status quo while Hoosier Energy seeks a replacement for Ambac. In granting injunctive relief, the district court described the SILO transaction as a “blatantly abusive tax shelter” that is “rotten to the core.” 588 F.Supp.2d at 921, 928. The Court of Appeals affirmed the district court's grant of injunctive relief, but clarified that the agreements comprising the SILO transaction were legally enforceable under New York law, even if not an approved tax shelter under the Internal Revenue Code. The Court of Appeals gave Hoosier Energy until the end of 2009, approximately 3-1/2 months, to find a replacement for Ambac. 582 F.3d at 730.
The Court has reviewed carefully the applicable case law and all of the evidence of record. In brief summary, the Court finds that Wells Fargo is not entitled to the claimed tax deductions on the five trial transactions. The SILO transactions did not grant to Wells Fargo the burdens and benefits of property ownership. The transactions lack economic substance, and were intended only to reduce Wells Fargo's federal taxes by millions of dollars. Although well disguised in a sea of paper and complexity, the SILO transactions essentially amount to Wells Fargo's purchase of tax benefits for a fee from a tax-exempt entity that cannot use the deductions. The transactions are designed to minimize risk and assure a desired outcome to Wells Fargo, regardless of how the value of the property may fluctuate during the term of the transactions. Indeed, nothing of any substance changes in the tax-exempt entity's operation and ownership of the assets. The only money that changes hands is Wells Fargo's up-front fee to the tax-exempt entity, and Wells Fargo's payments to those who have participated in or created the intricate agreements. The equity and debt “loop” transactions simply are offsetting accounting entries not involving actual payments, or pools of money eventually returned to the original holder. If the Court were to approve of these SILO schemes, the big losers would be the Internal Revenue Service (“IRS”), deprived of millions in taxes rightfully due from a financial giant, and the taxpaying public, forced to bear the burden of the taxes avoided by Wells Fargo.
On the issue of economic substance, the Court has considered whether there is any likelihood of profit from the five trial transactions, aside from the tax benefits. In each transaction, the parties employed equity and debt “defeasance accounts,” which are types of escrow accounts intended to minimize the risks of non-payment. During the lease-back period, a return is generated from the equity defeasance account investments. The value of the equity defeasance account is expected to grow so that the tax-exempt entity can exercise the buy-out option at the end of the lease-back period without using any of its own funds. However, the equity defeasance account return is more than offset by the other costs of the transaction, including Wells Fargo's cost of funds to engage in the transaction. The end result is that the trial transactions produce an overall loss without the tax benefits, and no rational person would engage in these transactions absent the tax benefits. This conclusion is borne out by Wells Fargo's cessation of SILO transactions after the IRS began disallowing SILO tax deductions. Moreover, the profitable portion of the transactions could be realized simply by investing in the same portfolio as the equity defeasance account. The only reason to create the elaborate array of agreements comprising a SILO transaction is for Wells Fargo to obtain the tax benefits at minimal risk, and with complete assurance of the desired long-term outcome.
The SILO transactions here are offensive to the Court on many levels. A cadre of company executives, in concert with teams of well known legal and accounting firms and other consultants, regularly constructed and participated in these tax schemes for Wells Fargo, apparently blind to professional standards of care. Representatives from the Federal Transit Administration (“FTA”) encouraged transit agencies to participate in SILO transactions as a way to raise additional funds, without seriously considering the probable adverse tax treatment of the transactions. Even when the IRS issued a 1999 Revenue Ruling disallowing tax deductions from LILO transactions, 2 the participants continued on with only slight adjustments to create the SILO transactions. The Court has little sympathy for those who have lost out as a result of this decision.
The Court will set a conference with counsel during the next 45 days to determine whether any further proceedings are necessary to address the remaining 21 transactions at issue in this case. With respect to the five trial transactions, and for the reasons explained in more detail below, the Court finds for Defendant. If the parties agree that additional proceedings are not needed for the other 21 transactions, the Court will direct the Clerk to enter final judgment for Defendant, and to dismiss Plaintiff's complaint with prejudice. Further action by the Court therefore must await guidance from the parties.
I. Findings of Fact 3
A. Overview of SILO Transactions
In a SILO transaction, a United States taxpayer such as Wells Fargo enters into various agreements with an entity that is not subject to federal income tax, and with financing institutions. The agreements are described as “leases,” “subleases,” and “loans,” among others, but they are all part of a single, integrated “sale in, lease out” transaction. One witness described the agreements as a “stack [that] was almost a foot high.” (Britton, Tr. 1228.) 4 In the package of agreements, each part is precisely interwoven with, and dependent upon, the others. The substance of the SILO transaction can be seen only from the entire package of agreements, not from examining the individual agreements separately. A “participation agreement” defines all of the participants and documents comprising the overall SILO transaction. (Johnson, Tr. 1650.) Each of the five trial transactions employed a participation agreement. (PX903, NJT; PX1076, Caltrans; PX1319, Houston Metro; PX1515, WMATA; PX678, Belgacom.)
When considered as a whole, the SILO transaction is designed to provide the taxpayer, Wells Fargo, with: (1) a purported basis to claim large depreciation deductions as the alleged owner of rail cars, locomotives, buses, or other capital assets; and (2) interest expense deductions based upon non-recourse “loop debt” arranged with a financing institution. “Rental” payments and “interest” payments are not actually made among the SILO participants, but are recorded as offsetting accounting entries at the affiliated entities managing the debt accounts.
The tax-exempt entity already has acquired and owns the capital assets used for a SILO transaction. Thus, financing the tax-exempt entity's acquisition of the capital assets is not one of the transaction's objectives. (Lys, Tr. 4567; DX701 at 20240.) The tax-exempt entity continues to hold legal title to the capital assets, and is responsible for the operation and maintenance of the assets. (DX701 at 20240.) Nevertheless, the taxpayer claims that ownership of the assets for tax purposes has shifted to it pursuant to one of the leases, and that it is incurring interest expense on a non-recourse loan. The tax benefits acquired by the taxpayer did not previously hold any value, because the tax-exempt entity does not pay federal income taxes, and cannot use the deductions. The right to claim the deductions has value only in the hands of a taxpaying entity. The tax-exempt entity receives an up-front payment from the taxpayer as consideration for the transfer of the tax benefits. (McCalley, Tr. 672–73; Pohl, Tr. 927–30.) The up-front payment, often expressed as a percentage of the transaction size, provides the incentive for the tax-exempt entity to participate in the transaction. (McCalley, Tr. 633, 672–74; Webb, Tr. 1002–03; Britton, Tr. 1206; DX329 at 623–26; PX808 at 7636.)
The tax-exempt entity has the right to terminate the SILO transaction at a future date through exercise of a “purchase option.” However, the tax-exempt entity does not actually contribute any of its own money to pay the purchase option price. Instead, “equity funds” from the taxpayer are set aside at the inception of the transaction, invested in securities in a collateral account, and then later used to fund the purchase option price. In this way, equity funds advanced by the taxpayer at the outset ultimately are returned to it. The tax-exempt entity pays nothing to exercise the purchase option.
The following hypothetical diagram shows the “Equity Loop” and “Debt Loop” segments of a SILO transaction. The Debt Loop side shows an $8.00 non-recourse loan that passes through the tax-exempt entity on the closing date, and is deposited in an account with an affiliate of the lender. On the Equity Loop side, the taxpayer makes a $2.00 payment to the tax-exempt entity on the closing date, of which the tax-exempt entity keeps $0.50 as its incentive fee for transferring the tax benefits to the taxpayer. The remaining $1.50 is deposited in an account with another affiliate of the lender, to be invested for later funding of the purchase option.
B. The Components and Mechanics of a SILO Transaction
In a typical SILO transaction, the taxpayer, Wells Fargo, purports to lease capital assets from a tax-exempt entity under an agreement called a “head lease.” The length of the head lease is set to be longer than the remaining economic useful life of the assets, so the taxpayer can assert that the head lease should be treated as a sale for federal tax purposes and claim depreciation deductions as the purported new owner. (D. Ellis, Tr. 2623, 2629; Pohl, Tr. 900.) The tax-exempt entity concurrently enters into another agreement, usually called a “sublease,” where it purports to lease the assets back from the taxpayer for a shorter period of time than the head lease. After executing these documents, the tax-exempt entity continues to use the assets, just as it did before the SILO transaction. The tax-exempt entity retains all maintenance, insurance, and other obligations associated with ownership of the property.
As payment of the “head lease rent,” the taxpayer makes a single payment to the tax-exempt entity at closing. The funds for the head lease rent come from two sources: (1) the proceeds of a purported non-recourse loan, called the “debt funds;” and (2) a cash payment from the taxpayer, called the “equity funds.” The tax-exempt entity, however, does not retain the head lease payment. All of the debt funds are paid immediately to an affiliate of the lender, called a “debt payment undertaker,” as part of a debt defeasance arrangement. “Defeasance” is a means of reducing risk on a debt by having a third party hold the necessary funds or securities and make payments when due during the course of a transaction. See Charles J. Woelfel, The Fitzroy Dearborn Encyclopedia of Banking & Finance, 285 (10th ed. 1994); (Rupprecht, Tr. 155–56; Grossman, Tr. 2013.) The debt payment undertaker then is obligated to make the tax-exempt entity's “rent payments” on the sublease to the taxpayer. The rent payments, however, are not actually made to the taxpayer, but are made instead to the lender (the debt payment undertaker's affiliate), to satisfy the taxpayer's debt service obligations on the non-recourse loan.
The debt service obligations on the non-recourse loan are set to match, in timing and amount, the tax-exempt entity's rent payments under the sublease. (DX701 at 20241.) Thus, the debt funds given to the debt payment undertaker are sufficient to satisfy both the tax-exempt entity's sublease rental obligations and the taxpayer's debt service obligations throughout the sublease, without any additional payments by either the taxpayer or the tax-exempt entity. Id. In this loop debt structure, the debt funds flow in a circle from the lender, to the taxpayer, to the tax-exempt entity, and then back to an affiliate of the lender, all in accordance with terms agreed to by the parties at the closing of the SILO transaction. (Whitman, Tr. 1380–82, 1385; Lys, Tr. 4575–76.) The taxpayer, however, claims interest deductions for tax purposes throughout the sublease term.
Like the debt funds, most of the equity funds contributed by the taxpayer, and nominally paid to the tax-exempt party as part of the head lease payment, are immediately paid as a fee to the “equity payment undertaker” at closing, as part of an equity defeasance arrangement. (Whitman, Tr. 1382–83.) The remaining portion of the equity funds is retained by the tax-exempt entity as its inducement fee for entering into the SILO transaction. (Lys, Tr. 4567–68.) The funds paid to the equity payment undertaker typically are invested in government bonds or other high-grade debt securities, and are referred to as the “equity collateral.” As with the debt defeasance arrangement, the tax-exempt entity does not have access to these funds during the term of the sublease. At the end of the sublease, when the tax-exempt entity can exercise the “purchase option,” the funds held by the equity payment undertaker provide exactly the amount due from the tax-exempt entity to terminate the transaction.
The tax-exempt entity thus does not need to use any of its own funds to exercise the purchase option. The equity payment undertaker simply repays the taxpayer's equity funds with a predetermined return, in a second circular flow of funds. From the date of closing, the taxpayer claims to be the owner of the capital assets, with the right to assert depreciation deductions on its taxes, even though the tax-exempt entity continues to use and maintain the assets, just as it had done before the SILO transaction. (McCalley, Tr. 653.)
C. The Two Types of SILOs
1. Lease to Service Contract SILO Transactions
At the end of the sublease period, the tax-exempt entity has the unilateral right to exercise a pre-funded purchase option, and terminate the SILO transaction. In a “lease-to-service contract” SILO transaction, if the tax-exempt entity does not exercise its purchase option, the taxpayer then can select between one of two options: (1) it can require the tax-exempt entity to transfer the assets to the taxpayer, described as “the return option” in the transaction documents; or (2) it can require the tax-exempt entity to arrange a so-called service contract for the operation of the assets, described as “the service contract option.” (Shuman, Tr. 2378–79; Shinderman, Tr. 3753–55.)
If the tax-exempt entity does not exercise the purchase option, and the taxpayer then elects the service contract option, the tax-exempt entity becomes obligated to arrange for the service contract, many of the terms for which are specified in the SILO closing documents. If the taxpayer chooses, the tax-exempt entity also becomes obligated to locate an “operator” for the assets, which must be an entity other than the “service recipient,” the entity for whom the assets are operated. The tax-exempt entity typically is required to arrange for refinancing of the original non-recourse loan. (Lys, Tr. 4524.) Like the original loan, the refinancing loan must be non-recourse.
For the service contract option, the SILO documents specify the amount and timing of the payments, even though the beginning of the hypothetical service contract would not begin until at least twenty years in the future. These terms are set in advance so that the service contract will provide the necessary funds to repay any non-recourse refinancing loan, if one could be obtained, without the taxpayer having to contribute any of its own funds. The intent is for the taxpayer to receive its original equity contribution, along with the same or similar return that it would receive if the tax-exempt entity had exercised the purchase option. From the inception of the SILO transaction, the taxpayer is guaranteed to receive back its equity contribution with the specified return. The taxpayer also is insulated from any meaningful risk exposure associated with “ownership” of the assets.
Alternatively, if the taxpayer elects the return option, the tax-exempt entity likely would be required to find replacement equipment within an eleven or twelve-month period. Such a short period for this purpose would pose a significant challenge for transit agencies. The typical procurement cycle for new vehicles in the bus and rail industry ranges from two to six years, depending on the number of railcars or buses to be procured and the transit agencies' total fleet and operating needs. (Wilson, Tr. 4266–68; Salci, Tr. 3442–46, 3450–51; Britton, Tr. 1196; Weinman, Tr. 4121–29.) While the actual construction of new railcars, for example, could take approximately two years, the procurement process also would include substantial planning, engineering, and testing before acceptance and revenue operation could occur. This process would require a minimum of five years before new railcars could be placed into service. (Weinman, Tr. 4124–25.) The transit agencies thus would need to consider a possible new procurement well in advance of deciding whether to exercise the fixed purchase option. (Wilson, Tr. 3450–51; Salci, Tr. 4267–68.) If they decline the fixed purchase option, the transit agencies would not know whether Wells Fargo would elect the return option or the service contract option until eleven or twelve months prior to the termination date. Thus, the structure of the end of sublease choices strongly encourages the tax-exempt entity to exercise the fixed purchase option.
2. QTE SILO Transactions
A QTE SILO differs from a lease-to-service contract SILO in some respects. First, the tax-exempt entity's purchase option typically is earlier than the end of the sublease period, and is often called an “early buyout option” or “EBO.” Second, the taxpayer usually does not have the option to force the tax-exempt entity to enter into a service contract at the end of the sublease if the tax-exempt entity does not exercise the EBO. In general, the participants executed QTE SILOs before the SILO “industry” developed the service contract feature. Third, the QTE SILOs typically impose strict conditions on the tax-exempt entity if it declines the EBO and must transfer the equipment to the taxpayer. The so-called “return conditions” typically require the tax-exempt entity to return the equipment in “as new” condition, with the most recent hardware and software releases from the equipment manufacturer included. Due to these onerous conditions, the tax-exempt entity is motivated to exercise the EBO and terminate the SILO.
D. Safe-Harbor Leases and LILO Transactions — Predecessors to SILOs
In 1981, Congress enacted laws that permitted leasing transactions with tax-exempt entities, often referred to as “safe-harbor leasing rules.” See Economic Recovery Tax Act, Pub. L. No. 97-34, 95 Stat. 172 (1981); see also Staff of the Joint Committee on Taxation, 97th Cong., General Explanation of the Revenue Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, at 45–62 (Dec. 31, 1982) (“TEFRA Bluebook”). Under the safe-harbor leasing rules, a transaction could qualify as a sale and lease-back for tax purposes if it met the safe-harbor criteria, regardless of whether the lessor could only obtain a profit on the transaction by taking tax benefits into account, and regardless of whether the lessor obtained the substantive benefits and burdens of ownership of the property as a result of the transaction. TEFRA Bluebook at 50–51. Safe-harbor leasing criteria permitted a sale-leaseback transaction even if it was nothing more than a “tax benefit transfer.” Id. at 51–52. Safe-harbor leases in many respects were similar to SILO transactions. The enactment of the safe-harbor leasing rules led to a proliferation of leasing transactions whose sole purpose was tax avoidance. Id.
Just one year later, in 1982, Congress shut down safe-harbor leasing transactions. Congress enacted laws that limited the tax benefits available for safe-harbor leases entered into between July 1, 1982 and January 1, 1984, and repealed the safe-harbor leasing rules thereafter. Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, 96 Stat. 324 (1982); TEFRA Bluebook at 54. Congress took this action because of “the tax avoidance opportunities that safe-harbor leasing had created,” and “adverse public reaction to the sale of tax benefits.” TEFRA Bluebook at 53.
In 1984, Congress enacted what is known as the “Pickle Rule.” By this rule, Congress intended to limit the tax benefits associated with leasing transactions involving tax-exempt entities by requiring the taxpayer to depreciate the value of the leased assets over a longer time period than otherwise would be required. Deficit Reduction Act, Pub. L. No. 98-369, 98 Stat. 494 (1984). The Pickle Rule required any leased tax-exempt property to be depreciated on a straight-line basis over an assigned asset class, or 125 percent of the lease term, whichever was longer. Deficit Reduction Act, § 31; Shinderman, Tr. 2781; DX704A at 7–8. Congress added IRC § 7701(e), which requires arrangements denominated as “service contracts” to be treated as leases if they are “properly treated” as such, and the arrangement meets other relevant factors. (DX704A at 8.)
After the repeal of safe-harbor leasing and the enactment of the Pickle Rule, some taxpaying entities sought ways to structure transactions that would allow the purchase of tax benefits from tax-exempt entities, but would not run afoul of the Pickle Rule. One of these was the LILO transaction.
The typical LILO transaction is similar to the SILO transaction, described above. The taxpayer purports to lease assets from a tax-exempt entity, and then immediately lease them back to the tax-exempt entity for a shorter period. See Rev. Rul. 2002-69; Maxim Shvedov, CRS Report of Congress: Tax Implications of SILOs, QTEs and Other Leasing Transactions with Tax Exempt Entities, pp. 8–9 (Nov. 30, 2004) (“CRS Report”). As in a SILO, the tax-exempt entity continues to use the property just as it did before the LILO transaction, and remains responsible for the maintenance and operation of the asset during the lease-back period. A portion of the head lease is prepaid, and is funded largely with a purported non-recourse loan that is defeased in a loop debt structure. The timing and amount of the tax-exempt entity's sublease rental payments and the taxpayer's debt service payments on the non-recourse loan match exactly, so neither party makes any out-of-pocket payments during the lease-back period.
Also, as in a SILO, the taxpayer makes an “equity investment” with its own funds, most of which is paid as an “equity undertaking fee” to an equity undertaker. The remainder is paid to the tax-exempt entity as its inducement fee for transferring the tax benefits. The funds paid to the equity undertaker are used to purchase securities that pay a fixed rate of return, which matches the amount needed for the tax-exempt entity to exercise the purchase option at the end of the sublease term.
There are two principal differences between LILO and SILO transactions. In a LILO tax shelter, the head lease term is structured to span less than 80 percent of the remaining useful life of the assets, so the taxpayer can assert the head lease isnot equivalent to a sale for tax purposes. See CRS Report at 12. Instead, the taxpayer claims to have a leasehold interest in the assets for tax purposes, and claims deductions for its purported rental obligations, not depreciation deductions associated with an ownership interest, thereby avoiding the Pickle Rule. The LILO transaction is structured so that the rental deductions are claimed more quickly than taxable income is realized on the sublease, thereby creating a tax benefit for the taxpayer.
The second difference between LILO and SILO transactions is the description of the options available to the taxpayer at the end of the lease-back period if the tax-exempt entity does not exercise the purchase option. In a LILO transaction, the taxpayer can (1) require the tax-exempt entity to surrender the assets to the taxpayer for its own use; (2) lease the assets to a third party (“the replacement lease option”); or (3) compel the tax-exempt entity to lease the property under a renewal lease. See Rev. Rul. 2002-69. If the taxpayer elects either of the latter two options, it would be obligated to make a second “deferred rent” payment at the end of the sublease period. Id. However, because of offsetting rents under the renewal or replacement lease, the taxpayer never needs its own funds to satisfy the deferred rent payment. Similar to the service contract option in a SILO transaction, the renewal and replacement lease options in a LILO transaction are structured so that the taxpayer obtains a return of its equity and has an expected after-tax return as if the tax-exempt entity had exercised the purchase option. See BB&T, 523 F.3d at 464–65 (LILO structured “in a way that essentially eliminates any risk of economic loss”).
E. Regulatory and Legislative Responses to LILO and SILO Transactions
In 1999, the Treasury Department issued amendments to IRC § 467 that effectively eliminated the market for LILO transactions. Under these amendments, the taxpayer in a LILO transaction had to treat the prepayment of the head lease rent as a loan for tax purposes, and the rental income as interest on that loan, thereby eliminating the tax benefit generated by the prepayment of the head lease. See Treas. Reg. § 1.467-4 (1999). Also in 1999, the IRS issued Revenue Ruling 1999-14, holding that taxpayers could not take rental payment or interest deductions in LILO transactions because they lack economic substance. Later, in Revenue Ruling 2002-69, the IRS held that LILO transactions did not satisfy the substance-over-form doctrine. See Rev. Rul. 2002-69. In light of these IRS actions, taxpayers and tax-exempt entities, including public transit agencies, stopped engaging in LILOs. (McCalley, Tr. 629; Pohl, Tr. 898–99; Webb, Tr. 1054–55; Whitman, Tr. 1342; D. Ellis, Tr. 2742; Shinderman, Tr. 3782; DX722, Schroeder Dep., at 39.)
These new rulings and regulations, however, did not end the attempts of taxpayers to create tax benefits from leases involving tax-exempt entities. The lawyers, promoters, and arrangers involved with LILOs next developed the SILO structure. (McCalley, Tr. 626–27, 630; Whitman, Tr. 1339; Hackett, Tr. 3569; Shinderman, Tr. 3783–84; DX722, Schroeder Dep., at 39–40.) Since the target of the new IRS provisions was the rental and interest payments involved in LILO transactions, the provisions did not apply to depreciation deductions derived from the taxpayer's purported ownership of assets in SILO transactions. The issuance of the final regulations under IRC § 467 led to the creation of SILO transactions with lease-to-service contract options. Under the Pickle Rule, the lease term over which the taxpayer must depreciate property does not include service contracts that satisfy the requirements of IRC § 7701(e). In a lease-to-service contract SILO, the taxpayer asserts that the service contract period tacked on at the end of the sublease is not included in the lease term for purposes of the Pickle Rule. On this basis, the taxpayer claims the depreciation deduction over a shorter time period, thus increasing its value to the taxpayer because of the time-value of money.
The promoters and arrangers proposed the SILO transaction to taxpayers and tax-exempt entities as a replacement to the LILO structure. (Webb, Tr. 999–1003; DX200; DX722, Schroeder Dep., at 33–35.) Arrangers, such as Allco Financial Corporation (“Allco”), typically were paid a percentage of the transaction size on a contingent fee basis. If the parties did not complete the transaction, the arrangers did not receive any payment. (Whitman, Tr. 1299–301, 1333–34; Hackett, Tr. 3577–79.)
The market for SILO transactions continued until 2004, when Congress enacted the American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418 (2004) (“AJCA”), amending the IRC to eliminate the purported tax benefits associated with LILO and SILO transactions. See also IRS Notice 2005-13, 2005-1 C.B. 630. Congress made these Code amendments to “curtail[] the ability of a tax-exempt entity to transfer ... tax benefits to a taxable entity.” Staff of the Joint Committee on Taxation, 108th Congress, General Explanation of Tax Legislation Enacted in the 108th Congress, at 420 (May 2005). Congress was concerned that taxpayers were “attempting to circumvent” the Pickle Rule “through the creative use of service contracts with ... tax-exempt entities,” and were thereby frustrating the purpose of the Pickle Rule to “prevent tax-exempt entities from using leasing arrangements to transfer the tax benefits of accelerated depreciation on property they used to a taxable entity.” Id. Although the AJCA provisions relating to LILO and SILO transactions applied prospectively, the AJCA's legislative history states that the amendments to the Code were “not intended to affect the scope of any other present-law tax rules or doctrines applicable to purported leasing transactions,” and that “[n]o inference is intended regarding the appropriate present-law tax treatment of transactions entered into prior to the effective date.” H.R. No. 108-755 at 660 (2004).
The AJCA created an exemption for SILO transactions involving public transit agency purchases of transportation equipment using federal subsidies administered by the FTA, where the transit agency had submitted an application to the FTA, permitting the use of the federally subsidized transportation equipment in the SILO transaction. AJCA, § 849(b). The AJCA exemption applies to “qualified transportation property,” defined as property where an application: (1) had been submitted to the FTA after June 30, 2003 and before March 14, 2004; (2) had been approved by the FTA before January 1, 2006; and (3) included a description of and value of the property. Id. None of the public transit agency transactions at issue in this case fall within these established time frames.
F. Wells Fargo's Leasing History
Wells Fargo began in business in 1852 as a provider of stagecoach service, mail delivery, banking services, freight delivery, and passenger transportation. Over the years, Wells Fargo evolved into a diversified financial services company. In 1998, Norwest Corporation acquired Wells Fargo and changed its name to Wells Fargo & Company. After this merger, Wells Fargo continued Norwest's historical leasing business, which had existed since the 1970s. (Rupprecht, Tr. 79–80, 88–89.) Norwest's equipment finance company became known as Wells Fargo Equipment Finance, Inc., or “WFEFI.” (Rupprecht, Tr. 78.) In 2000, Wells Fargo acquired First Security Bank Corporation, which also had a leasing business. (Johnson, Tr. 1488–89.)
Wells Fargo has engaged in many leasing transactions, including leveraged leases, involving rail cars, buses, and a variety of other assets. In this respect, Wells Fargo is similar to other large banks that maintain significant leasing portfolios. See AWG, 592 F.Supp.2d at 962. For a short time, however, Wells Fargo engaged in the transactions at issue, which differed from those it had done previously, and from those it has done since. Wells Fargo still engages in traditional leveraged lease transactions. (Johnson, Tr. 1791.)
Following the enactment of the AJCA in 2004, Wells Fargo and others stopped entering into new leveraged lease-to-service contract transactions because the market for them ceased to exist. (McCalley, Tr. 632; Webb, Tr. 1063–64; Britton, Tr. 1204–05; Johnson, Tr. 1790–91.) Many of the LILO and SILO arrangers went out of business, or stopped promoting SILOs, after enactment of the AJCA. (Whitman, Tr. 1348–50; Hackett, Tr. 3573.) Wells Fargo had closed lease-to-service contract transactions in 2003 that involved buses, and which were approved by the IRS because of the AJCA exemption regarding FTA approval. These bus transactions were with the Chicago Transit Authority, PACE (a suburban bus service in Chicago), and AC Transit (a San Francisco-Oakland area bus service). (Johnson, Tr. 1528–29.)
For all of its leveraged lease transactions, Wells Fargo typically engaged in an extensive due diligence and approval process. The due diligence included a careful credit review by the Credit Department, and an equipment review by the Equipment Department. (Johnson, Tr. 1555–57; Grossman, Tr. 1985.) Wells Fargo employed the guidelines from a “Front End Guidance” document developed by Phyllis Grossman in evaluating whether to go forward with a proposed transaction. (Grossman, Tr. 1978–79; PX34; PX73; DX529.) Ms. Grossman was a Vice President of Norwest Equipment Finance, Inc. from 1990 to 1998, and was responsible for overseeing the leveraged lease portfolio. (Grossman, Tr. 1974–76.) She originated the Belgacom transaction. (Grossman, Tr. 1984–85.) The “Front End Guidance” document described requirements relating to lessee credit quality, equipment, service contracts, yield/return requirements, and concentration limitations. (PX34; PX73; PX451.) Wells Fargo's analysis always involved a tax capacity review, designed to assure that sufficient taxable revenue existed against which to offset the expected tax deductions from the transaction. (Rupprecht, Tr. 161–62; Grossman, Tr. 2046–47.)
Investors in leveraged leases such as Wells Fargo are motivated in part by the pattern of earnings available under accepted accounting procedures. (J. Ellis, Tr. 3113–16.) The Financial Accounting Standards Board (“FASB”) is responsible for promulgating accounting rules, known as Generally Accepted Accounting Principles (“GAAP”), pursuant to authorization from the Securities and Exchange Commission. (J. Ellis, Tr. 3082–83.) One of the accounting rules is FAS 13, Accounting for Leveraged Leases. (J. Ellis, Tr. 3083–3085; PX2.) FAS 13 contains criteria for determining whether a transaction qualifies as a leveraged lease. (PX1663A at 14–15; PX2.) If FAS 13 applies, the lessor is required to allocate its expected income from the transaction to the periods when it has a positive investment. (J. Ellis, Tr. 3112–14.) The pattern of earnings often is referred to as “frontloaded earnings.” (Shinderman, Tr. 3947–48.)
Under FAS 13, a leveraged lease has three separate phases of investment: (1) a positive investment phase in the early years when the investor's cumulative cash outflows exceed its inflows; (2) a negative investment phase when the cumulative cash flows exceed the cumulative cash outflows; and (3) a positive investment phase in the later years when cumulative cash flows again are positive. (PX1663A at 7; PDX 9, J. Ellis.) FAS 13 does not alter the total income attributed to the transaction, but simply changes the timing of the income under GAAP. (J. Ellis, Tr. 3130–32, 3143–44; PX1663A at 19; PDX 20, J. Ellis.)
G. Wells Fargo's Trial Transactions
All of the domestic transit SILOs differed from traditional leveraged leases by including a service contract option at the end of the sublease period. (Oram, Tr. 499–500; DX626 at 20088.) The transactions were unusual in providing the lessor, Wells Fargo, with a choice at the end of the sublease period to impose a service contract or any sort of forced renewal. Wells Fargo's representative testified that “[u]sually, all choices are given to the lessee.” (Oram, Tr. 554–55.)
The negative amortization, or interest roll-up, of the non-recourse debt in the SILO transaction also was an unusual feature that had the effect of increasing Wells Fargo's claimed interest deductions. (D. Ellis, Tr. 2724–25; Gould, Tr. 2892–93; DX626 at 20089.)
Wells Fargo made its equity investment in the five trial transactions through trusts. On behalf of Wells Fargo, each trust entered into various transaction agreements. (Johnson, Tr. 1650–51; Stip. 1.1.2, NJT; Stip. 1.2.2, Caltrans; Stip. 1.3.2, WMATA; Stip. 1.4.2, Houston Metro; Stip., Belgacom.) The following are the names and dates of the Wells Fargo trusts for each trial transaction: (1) NJT — January 31, 2001 trust with State Street Bank (Stip. 1.1.2); (2) Caltrans — December 18, 2001 trust with State Street Bank (Stip. 1.2.2); (3) WMATA — September 10, 2002 trust with Wilmington Trust Company (Stip. 1.3.2); (4) Houston Metro — April 15, 2002 trust with Wells Fargo Bank Northwest (Stip. 1.4.2); and (5) Belgacom — December 19, 1997 trust with First Security Bank (Stip. Wells Fargo reported each trust's income and expenses as its own.
Although SILOs were different from traditional leveraged leasing transactions, Wells Fargo nevertheless prepared credit approval presentations (“CAPs”) just as it did for other transactions. In these CAPs, Wells Fargo representatives described the transactions to obtain internal approval. A CAP exists for each of the five trial transactions. (DX44, Belgacom; PX1000, Caltrans; PX821, NJT; PX1229, Houston Metro; PX1430, WMATA.)
Each CAP identifies the parties involved, the arranger promoting the transaction, and describes the structure of the transaction. (See, e.g., PX1000 at 11247; PX821 at 35882.) In particular, the CAP summarizes the defeasance arrangements, the service contract option (or other options in Belgacom), the mechanisms in place to remove any risk, and the expected yield, with tax benefits, to Wells Fargo. For the transit SILOs, the transaction is described both in narrative and schematic form. For example, an exhibit to the Caltrans CAP depicts an overview of the transaction: Caltrans receives an “up-front benefit,” the nonrecourse loop debt amounts are immediately returned through the debt defeasance arrangement to the American International Group (“AIG”), and Wells Fargo's equity investment is placed in the equity defeasance arrangement, pledged to Wells Fargo, and then eventually returned to it. (PX1000 at 11306; see also PX821 at 35886, NJT; PX1229 at 252721, Houston Metro; PX1430 at 233394, WMATA; DX15 at 1299, Belgacom.)
After review, Wells Fargo executives approved the transactions by signing the CAP. Wells Fargo's tax department performed the final review, certifying that Wells Fargo had enough “tax capacity” to use the tax benefits it expected to claim from each transaction. (DX44 at 222361, Belgacom; PX1000 at 11249, Caltrans; PX821 at 35883, NJT; DX829 at 26162, Houston Metro; PX1430 at 233352, WMATA.) Having sufficient “tax capacity,” i.e., other taxable income against which to apply the expected depreciation and interest deductions, was a necessary condition for Wells Fargo to enter into each SILO transaction. (Rupprecht, Tr. 161–62; Johnson, Tr. 1892–93; Shinderman, Tr. 3811–13; PX73 at 43088; DX455.)
“Tax capacity” was important to Wells Fargo because the reduction in taxes, resulting from the depreciation and interest it intended to claim, provided the source of Wells Fargo's return on the transaction. (Rupprecht, Tr. 176–77.) In the Caltrans transaction, for example, the CAP states “the yield in this transaction is dependent upon Wells Fargo's ability to depreciate the equipment over 125% of the base Lease Term (33.75 years) using the Pickle method and to deduct the interest expense on the non-recourse debt.” (PX1000 at 11280.) According to the CAP, Wells Fargo expected a yield, including the tax benefits, of 11.45% in Caltrans. (PX1000 at 11246, 11280; Johnson, Tr. 1851.) Recognizing that tax benefits might be disallowed, however, Wells Fargo also calculated a return without tax benefits. According to the CAP, this return would be only 2.6%, which is less than Wells Fargo's cost of funds for the transaction. (PX1000 at 11280; Johnson, Tr. 1846–47, 1854.) Wells Fargo's reliance on tax benefits for the return also is present in each of the other trial transactions. (PX821 at 35881, 35912, NJT; PX1229 at 252648, 252681, Houston Metro; PX1430 at 233350, 233382, WMATA; DX44 at 222361, 222363, Belgacom.)
The SILO trial transactions were facilitated by so-called “arrangers,” such as Allco Finance, Capstar Partners LLC (“Capstar”), or ABN AMRO Bank Lease Advisory (Belgacom) (“ABN AMRO”), who worked on behalf of the tax-exempt entities. (McCalley, Tr. 624.) The arrangers identified the equipment owned by the tax-exempt entity that would be suitable for use in a SILO transaction. (McCalley, Tr. 591–92, 640–41; Whitman, Tr. 1271–73.) Using preliminary appraisals of value and remaining economic useful life, the arrangers estimated the tax benefits that could be generated from a SILO transaction. (McCalley, Tr. 640–41.) Once the arranger and the tax-exempt entity decided to go forward, the arranger began to solicit bids from prospective U.S. taxpayers to enter into a SILO transaction utilizing the identified equipment. (McCalley, Tr. 592; Whitman, Tr. 1274.) The arranger sometimes lined up the entities that would act as loop debt provider and equity payment undertaker, or solicited separate bids to fill these roles. (Whitman, Tr. 1353–55.) The competitive bids received from prospective equity investors contained specific information about the structure of the proposed SILO, including “pricing runs” that show the inducement fee to the tax-exempt entity.
Wells Fargo also retained its own “arrangers,” such as Trinity Advisors, Cornerstone Financial, Macquarie Corporate Finance, or Fleet Capital Leasing (“Fleet”), to provide assistance. Wells Fargo's arrangers developed the various schedules and numerical terms to be included in the SILOs, with a view to maximizing the “after tax yield” to Wells Fargo from the SILOs. The arrangers calculated the schedules and reports, called “ABC reports,” using a proprietary software program. (Whitman, Tr. 1366–67; Hackett, Tr. 3587.) The ABC reports took into account the value of the equipment, the term of the head lease, the closing date of the transaction, Wells Fargo's combined state and federal income tax rate, the interest rate on the non-recourse loan, and the rate of return on the equity collateral. Applying complex mathematical formulas, the ABC reports produced Wells Fargo's equity investment, the sublease rent schedules, the non-recourse loan repayment schedules, the loan amortization schedules, the purchase option price and payment schedule, the stipulated loss and termination value schedules, and the service contract basic fee schedule. (Whitman, Tr. 1372; Hackett, Tr. 3586–92.) In the transit SILOs, the arrangers used the software to assure that Wells Fargo's after-tax yield would be the same regardless of whether the fixed purchase option or the service contract option was selected.
As noted, all of the trial transactions employed a loop debt structure. A lender purportedly lends funds on a non-recourse basis to Wells Fargo, and on the closing date, the funds are paid to a debt payment undertaker, which in all cases is an affiliate of the lender. (Lynch, Tr. 3671–72.) The debt payment undertaker uses the funds to repay the non-recourse loan. The corporate parents whose affiliates served as lenders and debt payment undertakers were AIG, Financial Security Assurance (“FSA”), and Rabobank (for Belgacom). The debt defeasance structure permitted the loop debt providers to avoid having to include the nonrecourse loans on their balance sheets. The lenders and debt payment undertakers entered into arrangements that obviated the need for the debt payment undertaker to make actual payments to the lender.
For each transaction, Wells Fargo received an appraisal of the property that would be the subject of the SILO. (Rivello, Tr. 2137–39; PX717; PX842; PX1015; PX1255; PX1448.) As part of their promotion of the transactions, the arrangers typically hired the appraisers, before any taxpayer had committed to the transaction. In Caltrans and WMATA, for example, the arranger Allco retained Ernst & Young to appraise the railcars. (Whitman, Tr. 1298–1301; Rivello, Tr. 2170–71, 2201–02; PX983; PX1413.) If a transaction failed to close, Allco paid the appraiser's fees. If the transaction did close, Wells Fargo paid a fee to Allco, and a portion of this fee went to the appraiser. (Whitman, Tr. 1299–1301, 1403–04.)
The purported reason for the appraisal was to determine the “fair market value” of the property that would be subject to the SILO. In fact, however, the arrangers and appraisers worked together to increase the valuation of the SILO property, and thereby increase the “price” to be paid for the property. (McCalley, Tr. 643–44; Whitman, Tr. 1334–35.) Lessee advisors also worked to increase the property's appraised valuation. (Hackett, Tr. 3604–05.) The appraisals included “soft costs,” such as interest during a construction phase, managing the build process, and the creation of training manuals, among others. (Whitman, Tr. 1352–53; Rivello, Tr. 2204–06.) With all parties to the transaction working to inflate the property's value, since a higher value would result in the greatest benefit to all, there were no negotiations of terms as would occur in a typical sale of property. A higher value of the property benefitted all parties. (McCalley, Tr. 643–644; Webb, Tr. 1022–24.) Even though the appraiser was assessing the value of property owned by the tax-exempt entities, the appraisal report, with one exception, was not shared with them. (McCalley, Tr. 645–47, 688; Pohl, Tr. 911–12; Webb, Tr. 1024; Britton, Tr. 1213–14; Hackett, Tr. 3601.) WMATA received a brief summary of the fair market value and useful life of its property on the day of closing. (Pohl, Tr. 913–14; DX423.)
Donald Oram of Wells Fargo's Equipment Management Division reviewed the draft appraisals and related documents prior to closing. Mr. Oram recorded his conclusions about the appraisals in short memoranda or in the CAP. (PX822; PX999; PX1226; PX1426; DX44; Oram, Tr. 505–08.) Mr. Oram did not review the final appraisals before preparing his memoranda because they were unavailable. (Oram, Tr. 509–14.) Mr. Oram often thought the appraisers' valuations were too high. (Oram, Tr. 514–23; PX999; PX1226; DX223.) Nevertheless, Mr. Oram approved the appraisal for each trial transaction based upon the protections provided in the financial structure, not based on the value of the equipment. In the Caltrans SILO, for example, Mr. Oram wrote:
This transaction relies on structure, not collateral support, to mitigate our booked residual risk. This risk is effectively mitigated through the use of Service Contracts, Cash Defeasance accounts, and a requirement to purchase Residual Value Insurance.
(PX999 at 164632.) In his WMATA and Houston Metro memoranda, Mr. Oram explained that the service contract option and cash defeasance accounts provided “leverage” to Wells Fargo, and the means to ensure payment of its expected return. (PX1226 at 165085; PX1426 at 60831.)
Wells Fargo retained outside law firms, such as Winston & Strawn, King & Spalding, or Watson, Farley & Williams, as tax counsel in all of the SILO transactions. The law firms worked with Wells Fargo's arrangers to develop the particular SILO structures reflected in Wells Fargo's bids, and prepared the transactional documents, often using previous SILO deals as “precedent documentation.” The law firms also were involved in the generation of the appraisal reports and the “service contract opinion reports,” which addressed the commercial feasability of the service contract. (Rivello, Tr. 2199; Shuman, Tr. 2409–12.)
The parties stipulated to the documents comprising each of the five trial transactions. (Joint Stip., April 2, 2009.) Each of the SILOs included a participation agreement listing the operative documents, and providing that execution of all of the operative documents was a condition precedent to the transaction. (PX678, PX757, Belgacom; PX833–34, NJT; PX1076–77, Caltrans; PX1319–20, Houston Metro; PX1515, WMATA.)
H. Other SILO Characteristics
1. Tax-Exempt Entity's Use and Possession of the Assets
In each SILO transaction, the tax-exempt entity had acquired and was using the property before it entered into the transaction. (Pohl, Tr. 915; Webb, Tr. 989; Bronte, Tr. 1116–17; Britton, Tr. 1212; DX15 at 1294, 1304; DX44 at 222362.) The WMATA rail cars had been in operation for up to seventeen years prior to the SILO transaction. (Pohl, Tr. 915.) Despite the execution of the lease documents, the SILO transaction did not alter the tax-exempt entity's continuing use of the SILO property. Also, the transit agencies did not segregate or treat the SILO rail cars or buses any differently than their other equipment. (Pohl, Tr. 921–22; Webb, Tr. 985, 999; Bronte, Tr. 1119; Britton, Tr. 1219–20.) Caltrans, for example, has spent millions of dollars of its own money to overhaul the rail cars subject to the SILO transaction. (Bronte, Tr. 1121–23; DX252 at 54–56.) There is no evidence that the transit agencies entered into SILOs as a way to dispose of the rail cars or buses. The transit agencies needed their rail cars and buses at the time of entering into the SILO transactions, and they expected to continue using these assets in service. (Pohl, Tr. 921–22; Webb, Tr. 1071; Bronte, Tr. 1118; Britton, Tr. 1198.)
Similarly, Belgacom did not alter its use of the cellular telecommunications equipment in any way as a result of the SILO transaction. Just as before the SILO, Belgacom continued as the legal owner of the property, and claimed tax ownership and depreciation deductions under Belgian law. (DX186 at 002-03; DX703.) Thus, Wells Fargo and Belgacom were both claiming tax ownership and depreciation deductions in their respective countries for the same equipment.
2. Termination of the SILO Through a Pre-funded “Purchase Option”
Each SILO transaction, like a LILO, contains a mechanism for the tax-exempt entity to terminate the transaction, the pre-funded “purchase option.” In the transit SILOs, the “fixed purchase option” (“FPO”) arises at the end of the lease-back terms. (PX908 at 180367, NJT; PX1081 at 10325, Caltrans; PX1324 at 24857, Houston Metro; PX1518 at 59767, WMATA.) In the Belgacom SILO, “early buy-out options” (“EBOs”) arise 3-1/2 years before the end of the lease-back terms. (PX757 at 9187; PX758 at 9237.) In each transaction, the tax-exempt entity can exercise its option simply by giving notice to Wells Fargo. Exercise of the option then terminates the SILO, including the head leases or equipment agreements, and the SILO ends. The SILO property has never left the possession or control of the tax-exempt entity.
The tax-exempt entities do not use any of their own funds to exercise the FPO or EBO and terminate the transaction. The options are fully funded with money supplied by Wells Fargo at closing. The “books are cleared” by offsetting accounting entries and the return to Wells Fargo of the money it put into the transaction. This money had been set aside in a secure account for Wells Fargo's benefit until the FPO or EBO date. (McCalley, Tr. 634; Shinderman, Tr. 3771–72; PX821 at 35910; PX1229 at 252680; PX1430 at 233381; PX1000 at 11278; DX44 at 222363.)
Wells Fargo required the tax-exempt entities to state in Tax Indemnity Agreements that they had not, at the time of closing, made any determination on whether to exercise the FPOs or EBOs. (PX912 at 180248.) Wells Fargo required these statements to support its claim for tax benefits. The evidence, however, strongly supports a conclusion that the FPOs and EBOs would almost certainly be exercised to terminate the transactions. Id. For example, William Bassett of Caltrans testified “the probabilities were very high that we would exercise that ....” (Bassett, Tr. 4077.) Capstar's John Hackett wrote to Houston Metro that “we fully anticipate that you will buy the buses back with the defeasance proceeds ....” (DX276 at 180.) In the NJT transaction, the request for board approval of the SILO described the projected completion date as “approximately 26 years” from approval, which is the FPO date at the end of the lease-back. (DX345 at 4500; Webb, Tr. 1060–61.) NJT has engaged in other similar transactions with purchase option dates that have already passed, and in every case, NJT has exercised the option to terminate the transaction at that point. (Webb, Tr. 1066–68.) The EBO dates in the Belgacom SILO also have passed, and in both lots, Belgacom exercised the EBOs. (PX653, PX658.) Defendant's expert, Dr. Thomas Lys, confirmed that the FPO was nearly certain to be exercised. (Lys, Tr. 4506.)
3. Wells Fargo's Options if the FPOs Were Not Exercised
In the transit SILOs, if the transit agency failed to terminate the transaction through exercise of the purchase option, Wells Fargo then would have two choices: (a) to demand the delivery of some or all of the rail cars or buses to Wells Fargo for resale; or (b) to require the transit agency to arrange a “service contract” at the transit agency's expense. Wells Fargo also could combine these choices by electing the delivery of some vehicles, and a service contract as to other vehicles. Under the service contract procedure, the transit agency, or another entity which the transit agency must find and propose for Wells Fargo's approval, would have to use the vehicles for a defined multi-year term after the end of the lease-back period. (PX908 at 180368–70, NJT; PX1081 at 10326–29, Caltrans; PX1324 at 24858–60, Houston Metro; PX1518 at 59769–71, WMATA.) The service contract term varied from seven to fourteen years among the four transit SILOs. (PX904 at 180481, NJT; PX1077 at 10252, Caltrans; PX1320 at 24777, Houston Metro; PX1515 at 59651, WMATA.) The transit agency would not know which choice Wells Fargo would make until only eleven or twelve months before losing its equipment, or being required to use it under a new service contract. (See, e.g., DX706 at 22–25.)
If Wells Fargo elected to impose a service contract, the transit agency would not only need to arrange a service contract, but also fulfill other requirements: (a) find an “operator” acceptable to Wells Fargo to run the transit service, and negotiate an operating agreement; (b) arrange for refinancing of the outstanding non-recourse debt; (c) in Caltrans and WMATA, obtain and pay for a letter of credit for the benefit of the refinancing lender; (d) in Caltrans, WMATA, and Houston Metro, procure and pay for residual value insurance in coverage amounts specified at closing, for the benefit of Wells Fargo; (e) satisfy the equipment's physical “return conditions;” and (f) at Wells Fargo's request, enter into new defeasance arrangements for the benefit of Wells Fargo, to secure payment of amounts owed to Wells Fargo under the service contract. (PX904 at 180469, 180476; PX908 at 180368–71, NJT; PX1077 at 10246, 10252; PX1081 at 10326–29, Caltrans; PX1320 at 24777; PX1324 at 24858–59, Houston Metro; PX1515 at 59651; PX1518 at 59769–72, WMATA; DX706A at 7–20; PX821 at 35882; PX1000 at 11252, 11256, 11278; PX1229 at 252653, 252680; PX1430 at 233356–57, 233381; Johnson, Tr. 1765–66.)
Other service contract requirements in each SILO are: (i) arrange for the purchase of additional equipment by the service recipient, if necessary; (ii) arrange for the service recipient to have rights to land and infrastructure, if necessary; (iii) satisfy Wells Fargo's credit policies by the service recipient; and (iv) provide an “opinion of independent tax counsel” selected by Wells Fargo stating that entry into the service contract by the transit agency, or anyone related to it under IRC § 168(h)(4) will not “result in any material adverse federal income tax consequences” to Wells Fargo, if the transit agency wants to be the service recipient, and continue to use its equipment. (See, e.g., PX1515 at 59643; PX1518 at 59769.)
The transit agency must meet all of the above requirements in the eleven to twelve months after Wells Fargo provides notice that it intends to impose a service contract. If the transit agency fails to meet all of the service contract conditions and requirements, the transaction effectively would revert to the FPO. (See, e.g., PX908 at 180377, §§ 16(h)(A), 17(i)–(j); PX1518 at 59772.)
4. Belgacom's Exercise of the EBOs
The Belgacom SILO did not contain the service contract option. Instead, the agreement provided that if Belgacom did not terminate the SILO at the EBO dates, the leasebacks would continue for another 3-1/2 years until the end of their original terms. At that point, Belgacom would need to comply with significant “return conditions.” (Rupprecht, Tr. 168; PX679 at 8252; PX758 at 9236–37.) Belgacom would be required to purchase the equipment, renew the lease-back for up to four one-year terms, or surrender the equipment to Wells Fargo. (PX679 at 8252–53; PX758 at 9236–37.) Any renewals or purchase would be at specially defined “fair market rental value” or “fair market sales value,” which assumed that the return conditions had been satisfied. (PX678 at 8210; PX757 at 9193.)
Upon entering into the Belgacom SILO, Wells Fargo expected Belgacom to terminate the transaction at the EBO point. (Rupprecht, Tr. 160–61, 167, 173–74.) Wells Fargo stated in its CAP that “[t]he EBO is expected to be exercised.” (DX44 at 222364.) Wells Fargo described the return conditions as “strict and onerous,” and one of the reasons that Belgacom would exercise the pre-funded EBO. Id. In annual reviews of the Belgacom SILO, Wells Fargo stated:
The lease provides an early buyout option to the Sublessee in the 10th year and [Wells Fargo] is expecting Belgacom to exercise this option. The original return provisions of the lease were written with the intention of being overly onerous to make the lease-end return of any equipment an unattractive option.
(PX622 at 241813; see also PX199, PX626–27, PX635, DX702 at 20408–09.) As expected, Belgacom terminated both the 1997-3 and 1997-4 SILOs in 2007 and 2008 by exercising the EBOs. (PX653, PX658, PX741; Rupprecht, Tr. 204.)
I. The SILO's Financial Structure
The financial structure of the SILOs, though composed of multiple components, effectively consists of two circular flows of money, a debt loop and an equity loop. In the debt loop, the SILO's head lease seemingly provides for a large payment at closing from Wells Fargo to the tax-exempt entity. Each payment is funded by the proceeds of a nonrecourse loan made to Wells Fargo, and from a smaller investment by Wells Fargo. In each SILO, however, all the proceeds of the non-recourse loan are given immediately to a debt payment undertaker, which is an affiliate of the lender. Also, most of Wells Fargo's contribution is transferred to an equity payment undertaker, which is intended to fund the FPO or EBO at a later date. The tax-exempt entity receives only a modest incentive payment at closing.
The sublease in each SILO seemingly provides for rent payments by the tax-exempt entity to Wells Fargo during the lease-back period. However, the tax-exempt entity does not supply any of its own funds to pay rent. Instead, the debt payment undertaker agrees to make the rent payments from the proceeds it received from its affiliate at closing. Wells Fargo does not receive rent payments because it has assigned its rights to the lender as collateral for the non-recourse loan. The rent payments are set to match in timing and amount the payments due on the non-recourse loan. (Lynch, Tr. 3700.) Thus, during the lease-back period, the rental and debt service obligations are satisfied by offsetting book-keeping entries within the lender and debt payment undertaker group, and no cash changes hands between the parties to the leases. 6
At the FPO and EBO dates, the “purchase” by the tax-exempt entity terminating the transaction is funded by a combination of (a) the money supplied by Wells Fargo and set aside in the equity payment undertaking arrangement, and (b) the termination of the outstanding debt by either a final payment from the debt payment undertaker to the lender, or the offset of a “prepaid rent loan,” payable to the tax-exempt entity at that time against the purchase price. In all cases, the tax-exempt entity does not supply any funds to exercise the FPO or EBO, and the original non-recourse debt is paid without Wells Fargo having to supply any funds. The money set aside in the equity payment undertaking arrangement is returned to Wells Fargo. This “equity loop” may be extended past the FPO or EBO dates if the transaction is not terminated at this point. If so, the SILO structure still provides for the return of Wells Fargo's entire investment to it.
II. Discussion
A. Standards for Decision
The Court conducts a de novo review in tax refund suits. See George E. Warren Corp. v. United States, 135 Ct. Cl. 305, 314 [49 AFTR 1617], 141 F.Supp. 935, 940 (1956) (“[t]he tax laws contemplate a trial de novo”); Gingerich v. United States, 77 Fed. Cl. 231, 240 [99 AFTR 2d 2007-3430] (2007) (“[a] tax refund suit is a de novo proceeding.”). Thus, a tax refund suit “is not an appellate review of the administrative decision that was made by the IRS; instead, the Court must make an independent decision as to whether the taxpayer is due a refund.” D'Avanzo v. United States, 54 Fed. Cl. 183, 186 [90 AFTR 2d 2002-7023] (2002) (citing Int'l Paper Co. v. United States, 36 Fed. Cl. 313, 322 [78 AFTR 2d 96-6075] (1996)). In conducting a de novo review, the Court must give “no weight ... to subsidiary factual findings made by the [IRS] in its internal administrative proceedings.” Id. (quoting Cook v. United States, 46 Fed. Cl. 110, 113 [85 AFTR 2d 2000-1017] (2000)).
In a tax refund suit, the plaintiff bears the burden of proving that it has overpaid its taxes for the year in question in the exact amount of the refund sought. See Helvering v. Taylor, 293 U.S. 507, 515 [14 AFTR 1194] (1935); Lewis v. Reynolds, 284 U.S. 281 [10 AFTR 773] (1932); Dysart v. United States, 169 Ct. Cl. 276, 340 [15 AFTR 2d 205] F.2d 624 (1965). The burden of proof includes “both the burden of going forward and the burden of persuasion.” Gingerich, 77 Fed. Cl. at 240 (quoting Sara Lee Corp. v. United States, 29 Fed. Cl. 330, 334 [72 AFTR 2d 93-6421] (1993)). In meeting its burden, the plaintiff must prove its case by a preponderance of the evidence. Ebert v. United States, 66 Fed. Cl. 287, 291 [96 AFTR 2d 2005-5163] (2005). To prevail in this suit, Wells Fargo must carry its burden of proving that it is entitled to the deductions it has claimed for depreciation, interest, and transaction costs in connection with the SILO tax shelters.
B. The Substance of the Transactions Determines Their Tax Treatment.
A primary guiding principle of tax law is that the substance, not the form, of a transaction determines its tax consequences. Gregory v. Helvering, 293 U.S. 465, 469–70 [14 AFTR 1191] (1935). In applying this principle, courts look to the “objective economic realities of a transaction rather than to the particular form the parties employed.” Frank Lyon Co. v. United States, 435 U.S. 561, 573 [41 AFTR 2d 78-1142] (1978). The forms, titles, or labels on the parties' various agreements are not controlling. Id.; see also, Comm'r v. Court Holding Co., 324 U.S. 331, 333 [33 AFTR 593] (1945) (courts should not “permit the true nature of a transaction to be disguised by mere formalisms.”); BB&T Corp. v. United States, 523 F.3d 461, 471 [101 AFTR 2d 2008-1933] (4th Cir. 2008) (taxpayer may not “claim tax benefits ... by affixing labels to its transactions that do not accurately reflect their true nature.”); Halle v. Comm'r, 83 F.3d 649, 655 [77 AFTR 2d 96-2125] (4th Cir. 1996) (“surrounding circumstances and economic realities” will overcome any “presumption” generated by the transaction's form.).
In the present case, Wells Fargo asserts that it was the owner for tax purposes of the equipment used in the WMATA, Houston Metro, NJT, Caltrans, and Belgacom SILO transactions, and therefore is entitled to claim depreciation deductions for the equipment under IRC §§ 167 and 168. Wells Fargo's burden is to show that, in substance, it became the owner of the SILO equipment, not merely that it intended to become the owner, or that the transactional documents label it the owner. See Frank Lyon, 435 U.S. at 572–73.
1. No Benefits and Burdens of Ownership
A taxpayer's claim of property ownership will not be respected unless the taxpaying entity actually bears the current “benefits and burdens of ownership.” Coleman v. Comm'r, 16 F.3d 821, 826 [73 AFTR 2d 94-1209] (7th Cir. 1994) (citing Frank Lyon, 435 U.S. at 582–84). The possibility of future ownership is not sufficient. Rather, the issue is whether the “transaction, as it stands at the time in question, sufficiently shifts the benefits and burdens of ownership such that the transaction should, for tax purposes, be treated as if it were a sale.” Kwiat v. Comm'r, 64 T.C.M. (CCH) 327, 1992 [1992 RIA TC Memo ¶92,433] WL 178603, at 8 (1992). Wells Fargo thus must prove that it acquired the benefits and burdens of ownership when it entered into the SILO transactions during 1997–2002.
Determining the attributes of ownership in any particular case largely is a factual inquiry. The “critical fact,” however, is whether the taxpayer has undertaken “substantial financial risk” of loss of its investment, based on the value of the underlying property. Coleman, 16 F.3d at 826. As the Supreme Court explained in Frank Lyon, the important inquiry is “whose capital was committed to the [property] ... [and therefore, who is] entitled to claim depreciation for the consumption of that capital.” 435 U.S. at 581. In the Frank Lyon case, the Supreme Court respected a sale/leaseback transaction because the taxpayer was, in fact, exposed to a “real and substantial risk” of whether it could repay a recourse loan and whether it could “recoup its investment.” Id. at 576–77, 579. In contrast, in Swift Dodge v. Comm'r, 692 F.2d 651 [51 AFTR 2d 83-333] (9th Cir. 1982), the court held that an agreement purporting to be a lease was not a genuine lease because the user of the property, and not the lessor, bore the burdens of ownership. The user was responsible for insurance, expenses, and taxes, and most “importantly,” the user also “assumed the risk of depreciation.” Id. at 654; see also Aderholt Specialty Co. v. Comm'r, 50 T.C.M. (CCH) 1101, 1985 [¶85,491 PH Memo TC] WL 15115, at 1 (1985) (recharacterizing lease because the purported lessor had no risk of loss); cf. Estate of Thomas v. Comm'r, 84 T.C. 412, 435 (1985) (respecting sale/leaseback because taxpayer “bore risk” that it could not “recoup its cash outlay.”).
Other courts have addressed the tax treatment of LILO and SILO transactions similar to Wells Fargo's, and have applied the above principles. With one exception, the court disallowed the claimed tax deductions. AWG Leasing Trust v. United States, 592 F.Supp.2d 953 [101 AFTR 2d 2008-2397] (N.D. Ohio 2008); BB&T Corp. v. United States, 2007 WL 37798 [99 AFTR 2d 2007-376], at 1 (M.D.N.C., Jan. 4, 2007), aff'd, 523 F.3d 461 [101 AFTR 2d 2008-1933] (4th Cir. 2008). In the AWG and BB&T cases, the court concluded that the taxpayer lacked a substantial risk of loss to its initial cash outlay in the transaction. In the cases involving jury trials, the jury returned a verdict each time disallowing the claimed tax benefits. Altria Group, Inc. v. United States, No. 1:06-cv-09430 (S.D.N.Y. July 9, 2009); Fifth Third Bancorp & Subs. v. United States, No. 1:05-cv-350 (S.D. Ohio, April 18, 2008). The one exception to date is Consolidated Edison Company of New York, Inc. v. United States, 2009 WL 3418533 [104 AFTR 2d 2009-6966], at 1 (Fed. Cl. Oct. 21, 2009), to be discussed below.
In AWG, the taxpayer entered into a SILO transaction like those at issue here, with a head lease, lease, and purchase option. Debt and equity undertaking payment arrangements funded the loop debt, rent and purchase option. Just as in the Wells Fargo SILOs, if the tax-exempt entity did not elect the purchase option, the taxpayer could impose a service contract. AWG, 592 F. Supp.2d at 966–72.
In summarizing its reasons for concluding that the SILO transaction did not transfer a depreciable ownership interest to plaintiffs, the district court observed that:
(i) no substantive benefits or burdens of ownership are transferred between the parties during the Initial Leaseback Period; (ii) no significant cash flows between the parties exist during the Initial Leaseback Period; (iii) the AWG transaction creates little, if any, risk for the Plaintiffs throughout the Head Lease; and (iv), most importantly, it is nearly certain that AWG will exercise the Fixed Purchase Option in 2024, thus ensuring that Plaintiffs never actually acquire economic ownership of the Facility.
Id. at 981–82. The court further noted that “[t]he Plaintiffs did not take legal title of the Facility,” and that “[s]imply described, the Plaintiffs enjoyed almost none of the attributes of ownership during the sublease term to 2024.” Id. at 982–83. In holding that the taxpayer did not acquire any of the benefits and burdens of ownership, the court stated that “the structure ... effectively protects the Plaintiffs from any possible risk of financial loss, including the loss of its initial [] equity investment,” whether or not the purchase option is exercised. Id. at 983.
In BB&T, the taxpayer entered into a LILO transaction. There was a lease and leaseback with different lengths. There was a fully funded purchase option that the tax-exempt entity could exercise to terminate the transaction. There were debt and equity payment undertaking arrangements that funded the loop debt, sublease rent and purchase option. BB&T, 523 F.3d at 466–70. The taxpayer could impose a renewal lease if the purchase option were not exercised. In upholding summary judgment, and determining that the taxpayer did not retain significant and genuine attributes of a lessor, the court held:
First, each right and obligation BB&T obtained under the Head Lease it simultaneously returned to [the lessee] via the Sublease for the duration of the Basic Lease Term, leaving BB&T only a right to make an annual inspection of the Equipment. Second, although the transaction ostensibly provides for the exchange of tens of millions of dollars in rental payments during the Basic Lease Term, the only money that has (and that may ever) change hands between BB&T and [the lessee] is the $6,228,702 BB&T provided as [the lessee's] “incentive for doing the deal.” (J.A. at 325.) [The lessee] has therefore not only continued to use the Equipment just as it had before the transaction, it has done so without paying anything to BB&T. Third, [the lessee], through the purchase option, can unwind the transaction without ever losing dominion and control over the Equipment or having surrendered any of its own funds to BB&T, and has no economic incentive to do otherwise. BB&T therefore does not expect [the lessee] to “walk away” from the Equipment. (J.A. at 85.) Finally, regardless of whether [the lessee] bucks this expectation, the structure of the transaction insulates BB&T from any risk of losing its initial $12,833,846 investment in the government bonds or incurring the obligation to invest additional funds.
Id. at 473.
Like the transaction structures in AWG and BB&T, the Court concludes here that Wells Fargo does not have any funds at risk. In each of the five trial transactions, Wells Fargo employed 100 percent loop debt, where the debt payment undertaker and the nonrecourse lender were affiliates, and the entire loan proceeds immediately were transferred back to the lender group at closing. The equity defeasance account also was deposited with an affiliate of the lender. In three of the five trial transactions (WMATA, NJT, Caltrans), AIG was the lender, meaning that at closing, all of the transaction funds were deposited with an AIG affiliate, except for the inducement fee paid to the tax-exempt entity. The loan proceeds were not invested in the property or equipment, or retained by either the tax-exempt entity or Wells Fargo. Moreover, the debt and equity undertaking payment arrangements eliminated the need for the tax-exempt entity to actually pay rent under the lease-backs, or for Wells Fargo to actually make any debt service payments. The “rent” and “debt” payments in each SILO simply are accounted for as offsetting entries within the lender group. The debt will be completely paid without Wells Fargo having to supply any funds, whether the FPOs and EBOs are exercised or not. In contrast, in Frank Lyon, the taxpayer alone was liable for repayment of recourse debt, “to which it exposed its very business well-being.” Frank Lyon, 435 U.S. at 576–77, 582. The taxpayer also was dependent upon the lessee for payment of rent to service the debt. Id.
The Court also must examine as an element of property ownership whether Wells Fargo assumed any risk that the property would decline in value. In each of the five trial transactions, Wells Fargo's investment was immediately placed in an equity defeasance arrangement, in which it had a security interest, and to which the lender had no recourse. Upon any early termination of a SILO, Wells Fargo would receive the equity portion of the Termination Value or Stipulated Loss Value payments. These payments are funded by the proceeds of the equity defeasance arrangements and a strip surety policy so that Wells Fargo recovers its initial investment plus the interest earned on the equity collateral, regardless of any decline in value of the SILO equipment. Upon exercise of the FPOs and EBOs, Wells Fargo receives a return on its investment as if it had invested directly in a portfolio established in the equity defeasance arrangement, without regard to the value of the SILO equipment. Wells Fargo's “Net Economic Return” is guaranteed simply by the SILO transaction structure. See AWG, 592 F.Supp.2d at 983–84 (termination value payments protect taxpayer's investment); BB&T, 523 F.3d at 470 (letter of credit provided to support early termination payments).
Even if the FPOs were not exercised in the transit SILOs, a decline in the value of the SILO property would not prevent Wells Fargo from recouping its entire investment in each transaction. The ability of Wells Fargo to put a service contract in place assures recovery of its initial investment plus the desired yield through the service contract's Basic Fees and the residual value insurance that must be purchased for its benefit. Wells Fargo's Richard Johnson testified that “[t]he service contract was, as I have noted before, designed to protect our residual value.” (Johnson, Tr. 1775.) The renewal lease in BB&T and the service contract in AWG served the same function. BB&T, 523 F.3d 468–69; AWG, 592 F.Supp.2d at 971–72, 984.
In the Belgacom transaction, the service contract is not necessary for Wells Fargo to recover its investment. The remainder of the Lease automatically is continued after the EBO, if the EBO is not exercised, and Wells Fargo recoups its investment from the post-EBO Lease payments alone.
This case is very different from Frank Lyon, where the lessee had renewal options, but the exercise of the options was at the lessee's unconstrained choice, and the taxpayer did not have the ability to impose a renewal upon the lessee. In Frank Lyon, the taxpayer's investment return was dependent upon the property's value, and its initial investment was at risk if the property declined in value. As the Supreme Court observed, the lessee in Frank Lyon could choose not to exercise its renewal options and “walk away” from the property at the end of the lease-back. Frank Lyon, 435 U.S. at 583. The taxpayer thus was “gambling” that the rents it might otherwise obtain after the lease-back would be sufficient to “recoup its investment.” Id. at 579.
Here, Wells Fargo is not gambling at all. Its minimum return is fixed from the start, and if necessary, Wells Fargo can force the tax-exempt entities to stay in the game, with the predetermined results, to recoup its initial investment. The elimination of any risk from the taxpayer's initial investment and return is a distinguishing feature of both SILOs and LILOs. (Shinderman, Tr. 3752–53, 3783, 3797–98, 4017–19; DX1664, Ex. 16.)
2. No Transfer of Rights and Duties of Ownership at Closing
The Court must consider whether any rights and duties of ownership of the SILO equipment transferred to Wells Fargo at closing. See BB&T, 523 F.3d at 473; AWG, 592 F.Supp.2d at 982–83. Here, the Court finds that WMATA, NJT, Caltrans, Houston Metro, and Belgacom all retained legal title, as well as the right to exclusive possession, use and quiet enjoyment of the SILO property throughout the lease-back term. The tax-exempt entity also remained responsible for all maintenance and insurance. They retained the right to all profits, and were responsible for all losses, resulting from the operation of the equipment. In substance, nothing changed for the tax-exempt entities from before the SILO transaction, except they had given up tax deductions that they could not use in the first place.
In the Belgacom transaction, Belgacom continued to claim tax ownership and tax deductions for the equipment under Belgian law, (DX186, DX703), while Wells Fargo claimed tax ownership and tax deductions under U.S. law. Thus, Belgacom sold to Wells Fargo, for a fee, only the right to claim tax deductions under U.S. law. Although the interpretation of Belgian tax law is beyond the purview of the Court, the Belgacom SILO transaction created a “double dip” where one party claims tax ownership under Belgian law, and another party claims tax ownership under U.S. law.
3. No Payments During the Lease-back Period
The Court has examined the evidence to determine the extent to which payments, if any, occurred between the lessee and lessor during the SILO lease-back period. In the five trial transactions, the Court has identified only a circular flow of funds between the lender's affiliated entities, and no payments at all between the lessee and lessor, except for the incentive fee to the lessee at the time of closing. See BB&T, 523 F.3d at 473; AWG, 592 F.Supp.2d at 982–83. Although the Head Leases and Equipment Agreements seemingly provide payments of millions of dollars, all of those funds, other than the incentive fee payment, were immediately diverted to debt payment undertakers, as part of the loop debt, or to equity undertaking arrangements, where the funds were invested in securities and pledged to Wells Fargo until the FPO date. Due to the offsetting rent and debt schedules, no other money changes hands after closing, and the tax-exempt entities continue to use their property as before the SILO transaction, without paying anything to Wells Fargo.
Not a single dollar of the SILO funds was used to purchase or build the SILO equipment. Rather, the circular flow of funds results in the lender and Wells Fargo receiving all of their cash back at a later date. The five trial transactions thus are significantly different from the sale/leaseback in Frank Lyon, where the sale proceeds actually were used to construct the lessee's new building. 435 U.S. at 565–66. There, the transaction had a commercial purpose. In this case, however, the tax-exempt entities sold their tax benefits to Wells Fargo for relatively modest incentive fees, and Wells Fargo invested in the equity undertaker's portfolio of securities. As the Fourth Circuit explained in BB&T:
[We,] like the district court, conclude that in substance, the transaction is a financing arrangement, not a genuine lease and sublease. All that BB&T has done is paid [the lessee] approximately $6 million dollars to sign documents meeting the formal requirements of a lease and sublease, arranged a circular transfer of funds from and then back to ABN [the lender/debt payment undertaker], and invested approximately $12 million in government securities.
BB&T, 523 F.3d at 475.
This Court agrees with the Fourth Circuit's description of the SILO transactions, except that the Fourth Circuit perhaps has been too charitable. The heart of these transactions is that Wells Fargo paid a fee to tax-exempt entities to acquire valuable tax deductions that the tax-exempt entities could not use. Wells Fargo also invested an amount with an equity undertaker that it could have done directly, without involving any tax-exempt entities or their equipment. Aside from these two elements, the circular flow of funds adds nothing to the transaction, except to eliminate any risk to Wells Fargo and to produce more claimed tax deductions. The involvement of lenders like AIG, appraisers like Ernst & Young, and law firms like King & Spalding is “window dressing” serving only to generate fees and lengthy documents to give the SILOs an appearance of validity. The Indiana district court hit the mark when it described the SILO as a “blatantly abusive tax shelter” that is “rotten to the core.” Hoosier Energy Rural Elec. Coop., Inc. v. John Hancock Life Ins. Co., 588 F.Supp.2d 919, 921, 928 (S.D. Ind. 2008), aff'd 582 F.3d 721 (7th Cir. 2009).
Certainly, taxpayers are entitled to structure their affairs with an eye on the tax consequences, and to minimize the taxes they might legally owe. Superior Oil Co. v. Mississippi, 280 U.S. 390, 395–96 (1930); BB&T, 523 F.3d at 471. In Helvering v. Gregory, 69 F.2d 809, 810 [13 AFTR 806] (2d Cir. 1934), aff'd 293 U.S. 465 [14 AFTR 1191] (1935), Judge Learned Hand observed that “[a]ny one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.” Id. The Court, however, agrees with the district court in Hoosier Energy that this principle must yield when an abusive SILO tax shelter is involved:
That principle does not apply to the [Hoosier Energy] SILO transaction, at least based on the record before the court at this point. For the reasons stated, the transaction appears to have had one motivating force: abusive and fraudulent use of tax deductions by a party who had no significant benefits or burdens of ownership of the property in question. The volume of paper used to dress up this central purpose does not affect its core illegality.
Hoosier Energy, 588 F.Supp.2d at 930.
The IRS was entitled to view these SILO transactions for what they are, not what they purport to be. As the Fourth Circuit observed in BB&T, citing an Abraham Lincoln riddle from Rogers v. United States, 281 F.3d 1108, 1118 [89 AFTR 2d 2002-1115] (10th Cir. 2002), “How many legs does a dog have if you call a tail a leg?”
The answer is “four,” because “calling a tail a leg does not make it one.” Id. Here, BB&T styled the LILO as a lease financed by a loan, but did not in substance acquire a genuine leasehold interest or incur genuine indebtedness. Accordingly, ... whether it has “reached the point where the tax tail began to wag the dog,” Hines, 912 F.2d at 741, we conclude that the Government was entitled to recognize that tail for what it was, not what BB&T professed it to be.
BB&T, 523 F.3d at 477. The Court agrees fully with the Fourth Circuit's analysis in BB&T, and concludes that, looking at the substance of the SILO transactions, Wells Fargo did not become the owner for tax purposes of the SILO equipment, and is not entitled to the depreciation amounts claimed.
C. Whether Wells Fargo is Entitled to Interest Deductions
IRC § 163(a) provides a deduction for “interest paid or accrued within the taxable year on indebtedness.” To claim this deduction, a taxpayer must prove that the payment is “compensation for the use or forbearance of money.” Deputy v. du Pont, 308 U.S. 488, 498 [23 AFTR 808] (1940). The indebtedness also must be genuine and serve a useful purpose. Knetsch v. United States, 364 U.S. 361, 365–66 [6 AFTR 2d 5851] (1960). The indebtedness must be in substance, and not merely in form. BB&T, 523 F.3d at 475. The fact that a purported borrower may sign a loan document providing for a legal obligation to repay the loan does not alone give the debt any substance. Id. at 476.
In the present case, the Court concludes that Wells Fargo cannot claim an interest deduction from the non-recourse loop debt. All of the loan proceeds in each SILO transaction were immediately returned to an affiliate of the lender, acting as debt payment undertaker, and then to the common parent, the original source of the funds. (Lynch, Tr. 3675.) On the day of closing, the loan funds were routed through the accounts shown on the cash flow memos, and the lenders did not relinquish the use of the money except for the brief one-day loop. Neither Wells Fargo nor the tax-exempt entity ever had the use of the funds. The full proceeds were paid to the debt payment undertaker as a non-refundable fee, and became an asset solely of the debt payment undertaker. (See, e.g., PX1088 at 10415; DX243.) The debt payment undertaker then agreed to make the debt service payments on the loop debt. Thus, Wells Fargo did not need to pay any principle or interest on the loan, and the loan proceeds effectively were used to repay the loan. The economic reality of the non-recourse loan was reflected in the lender's own internal accounting for the loop debt. In three of the trial transactions, AIG eliminated the loan from its books through offsetting entries, and in Belgacom, Rabobank assigned the loan a “zero solvency rating.” (Lynch, Tr. 3700; DX187 at 19820.)
The Fourth Circuit stated with regard to similar loop debt, it is “difficult to see how the “interest” [] paid could represent “compensation for the use or forbearance of money.”” BB&T, 523 F.3d at 476 (citing Halle, 83 F.3d at 652). The district court in AWG reached the same conclusion, finding that the “loans at issue lack any substantive business purpose other than creating this “loop debt” between the Plaintiffs, AWG, and the German banks to generate tax benefits for the Plaintiffs.” AWG, 592 F.Supp.2d at 993. In Belgacom, ABN AMRO acknowledged that, while the “cash flow is circular,” there is a “tax benefit” to the purported borrower. (DX12 at 1120.)
Except for Consolidated Edison, all of the SILO and LILO transaction cases that have considered a tax deduction for loop debt interest have denied the claim. BB&T, 523 F.3d at 475–77; AWG, 592 F.Supp.2d at 990–94; Fifth Third, No. 1:05-cv-350 (S.D. Ohio, April 18, 2008) (jury verdict); Altria, No. 1:06-cv-09430 (S.D.N.Y. July 9, 2009) (jury verdict); see also, Hines v. United States, 912 F.2d 736, 741 [66 AFTR 2d 90-5483] (4th Cir. 1990) (interest expense in sale/leaseback disallowed where “the lease and debt payments between the three parties [lessor, bank, lessee] were structured to be offsetting. The circularity meant that the transaction became self-sustaining after the payments at closing with virtually no further financial input necessary from any of the parties.”); Flecyn v. United States, 691 F.Supp. 205, 212 [62 AFTR 2d 88-5026] (C.D.Cal. 1988) (interest deductions disallowed because the loan and interest payments “were simply parts of a circularization of funds.”). The Court agrees that Wells Fargo is not entitled to an interest deduction attributable to the loop debt on the non-recourse loan.
D. Whether the Transactions Have Any Economic Substance
Wells Fargo is not entitled to its depreciation, transaction cost, and interest deductions if the SILO transactions lack economic substance. The Federal Circuit has held that “the economic substance doctrine require[s] disregarding, for tax purposes, transactions that comply with the literal terms of the tax code but lack economic reality.” Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1352 [98 AFTR 2d 2006-5249] (Fed. Cir. 2006), cert. denied 549 U.S. 1206 (2007). Under the economic substance doctrine, Wells Fargo must prove that the SILO transactions had (1) objective economic substance, and (2) a non-tax business purpose. Coltec, 454 F.3d at 1355–56; H.J. Heinz Co. v. United States, 76 Fed. Cl. 570, 583–85 [99 AFTR 2d 2007-2940] (2007). If Wells Fargo fails to meet either requirement, the claimed deductions should be disallowed.
In Coltec, the taxpayer sold one of its businesses in 1996 for a gain of $240.9 million. The taxpayer then met with its tax advisors from Arthur Andersen to discuss a strategy for offsetting the gain. Arthur Andersen proposed a tax avoidance transaction that involved three steps. First, the parent company would reorganize a dormant subsidiary into a special purpose entity. Second, the parent would transfer property and contingent liabilities to the newly reorganized subsidiary in exchange for stock in that subsidiary. Third, the subsidiary would sell the stock to a third party for a nominal sum, creating a significant loss because the sale price of the stock would be drastically lower than its basis. Using this form of transaction, the taxpayer generated a $378.7 million capital loss that could be offset against the aforementioned $240.9 million capital gain. Coltec, 454 F.3d at 1343.
Although Coltec is not a SILO or LILO tax shelter case, the creation of a transaction for the purpose of avoiding taxes is the same in Coltec as it is here. The Federal Circuit held that the transaction employed “had no meaningful economic purpose, save the tax benefits to Coltec,” and that the “transaction must be ignored for tax purposes.” Id. at 1347. Citing Rothschild v. United States, 407 F.2d 404 [23 AFTR 2d 69-637] (Ct. Cl. 1969) and Gregory v. Helvering, 293 U.S. 465 [14 AFTR 1191] (1935), the Federal Circuit observed:
[O]ur predecessor court inRothschild stated, “Gregory v. Helvering requires that a taxpayer carry an unusually heavy burden when he attempts to demonstrate that Congress intended to give favorable tax treatment to the kind of transaction that would never occur absent the motive of tax avoidance.” 407 F.2d at 411 (quotingDiggs v. Comm'r of Internal Revenue , 281 F.2d 326, 330 [6 AFTR 2d 5095] (2d Cir. 1960)). Other circuits have similarly held that “[e]conomic substance is a prerequisite to the application of any Code provision allowing deductions [and therefore that] ... [t]he taxpayer has the burden of showing that the form of the transaction accurately reflects its substance, and the deductions are permissible.” In re CM Holdings, Inc., 301 F.3d at 102.
Coltec, 454 F.3d at 1355–56; see also Frank Lyon, 435 U.S. at 584 (Noting that a transaction must not be “shaped solely by tax avoidance features”); Jade Trading, LLC v. United States, 80 Fed. Cl. 11, 48 [100 AFTR 2d 2007-7123] (2007) (“The objective economic substance test requires that a taxpayer prove that a transaction had a “realistic financial benefit” beyond tax avoidance.” (quoting Coltec, 454 F.3d at 1356 n.16.))
1. Reasonable Possibility of Any Non-tax Profit
In examining objective economic substance, the taxpayer's subjective motivation is not relevant or determinative. Coltec, 454 F.3d at 1356. Instead, each transaction must be examined objectively, and a determination must be made whether the transaction provided a reasonable possibility of profit, exclusive of tax benefits. Id.; see also Black & Decker Corp. v. United States, 436 F.3d 431, 441–42 [97 AFTR 2d 2006-841] (4th Cir. 2006); Gilman v. Comm'r, 933 F.2d 143, 146–47 [67 AFTR 2d 91-1016] (2d Cir. 1991); Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 91 [55 AFTR 2d 85-580] (4th Cir. 1985); Stobie Creek Invs., LLC v. United States, 82 Fed. Cl. 636, 672–73 [102 AFTR 2d 2008-5442] (2008); Jade Trading, 80 Fed. Cl. at 48. Further, where the non-tax benefits are deferred over multiple years, present value adjustments to the future benefits are appropriate to assess the transaction's “actual and anticipated economic effects.” ACM P'ship v. Comm'r, 157 F.3d 231, 259 [82 AFTR 2d 98-6682] (3rd Cir. 1998); see also United States v. Broderson, 67 F.3d 452, 457 (2d Cir. 1995) (“[S]um of payments in a lease stream does not accurately represent the value of the lease stream because it fails to account for the time value of money.”).
Applying these principles here, the Wells Fargo SILO transactions lack objective economic substance. The source of the non-tax, economic benefit to Wells Fargo, when the SILOs terminate at the FPOs and EBOs, is simply the return of its investment from the equity defeasance arrangements in 15–25 years, plus the interest earned. Wells Fargo could have realized this same return simply by investing in the portfolio of the equity defeasance arrangement, without involving the transit agencies, or Belgacom, or their equipment, in any way. Moreover, as Defendant's expert, Professor Lys, demonstrated, the net present value of these non-tax investment proceeds is less than the total cost to Wells Fargo of participating in the transactions. On a net present value basis, each SILO is a losing proposition without the tax benefits. (DX701.) The net loss of each SILO is due to: (a) the significant transaction costs that Wells Fargo paid to arrangers, law firms, appraisers, insurers and lenders to create the intricate agreements that it hoped would provide millions in tax deductions, and insulate it from any risks; (b) the incentive payment that Wells Fargo had to pay to the tax-exempt entities to purchase their tax deductions and gain their participation in the SILO; and (c) the cost of funds to Wells Fargo to engage in the transactions. Though the mountains of paper defy comprehension without careful study, the bottom line is that the SILOs provide no reasonable possibility of profit at all, absent a claim for the tax deductions.
Wells Fargo's cost of funds alone turns the SILOs into a losing proposition. Wells Fargo's witness, Richard Johnson, agreed that the cash-on-cash, non-tax return calculated is less than Wells Fargo's cost of funds for its leasing business. (Johnson, Tr. 1854, 1966–67; see also, PX1000 at 11280.) Thus, aside from the net present value analysis and the lengthy deferral of payments until the FPO and EBO dates, there was no reasonable possibility of profit from the SILOs simply because the expected non-tax investment return was less than Wells Fargo's cost of funds.
The district court in AWG held that the SILO did have economic substance because the internal rate of return, absent tax benefits, was approximately 3.4 percent. AWG, 592 F.Supp.2d at 980. The court found that the taxpayer could have “expected to make a small, but guaranteed, pre-tax profit” sufficient to establish economic substance. Id. In the present case, when all transactional and funding costs are considered, the non-tax return is negative. Thus, if not for the tax deductions, no rational business entity would seriously contemplate a SILO transaction. See Stobie Creek, 82 Fed. Cl. at 691 (“[A] reasonable investor would take into account the costs and fees associated with entering and completing a transaction in evaluating whether an investment had a reasonable possibility of making a profit.”). The Court concludes that, absent the claimed tax benefits, the five SILO transactions presented at trial lack objective economic substance.
2. Existence of Any Non-tax Business Purpose
Wells Fargo's SILO transactions lack subjective economic substance because there was no non-tax business purpose. See Coltec, 454 F.3d at 1355. Without the claimed tax benefits, and without the company's tax capacity to use the claimed tax benefits, Wells Fargo would not have entered into the SILO transactions. (Johnson, Tr. 1892.) As noted, “tax capacity” refers to the company having other revenue from business operations against which the SILO tax deductions could be applied and thereby reduce taxes. The motivating reason for the Wells Fargo SILOs was the desire to reduce the company's taxes as much as possible. There were no non-tax reasons that would justify Wells Fargo's entering into these transactions.
The lack of any arms' length negotiations of many substantive terms is a further indication of a questionable transaction. The key terms of the SILOs were determined by tax considerations, and Wells Fargo's constraints to eliminate risk. The transaction terms were more the product of a software model, than any negotiations or commercial realities. (Webb, Tr. 1055–56; Britton, Tr. 1227; Whitman, Tr. 1372; Hackett, Tr. 3587–92.) There is precious little evidence of the parties negotiating a rent schedule, an interest rate on the non-recourse loan, or amortization schedules of the loan based upon any commercial realities. As Defendant's expert, Morris Shinderman, observed, and Plaintiff's Mr. Gould agreed, the enormous negative amortization of the non-recourse loan schedules is unusual, and not what would be seen in a normal commercial leasing transaction. (Shinderman, Tr. 3760–61, 3766; Gould, Tr. 2892–93.) The effect of the “interest roll-up” simply is to increase claimed interest deductions. (Shinderman, Tr. 3780–81; D. Ellis, Tr. 2724–25.) The large rent prepayments, on paper, in the WMATA and Caltrans SILOs also are very unusual. (Shinderman, Tr. 3769.) In Belgacom, the equipment selected for the transaction was based entirely upon tax considerations. The parties were intent upon using equipment that was “qualified technological equipment” under the U.S. tax code. (DX15 at 1304.)
Similarly, the Court found the appraisals of the fair market value and the remaining useful life of the SILO equipment to be suspect in all five trial transactions. As an example, the 45 NJT light-rail vehicles had an acquisition cost of $144 million, but Marshall & Stevens appraised them at $160 million. (Webb, Tr. 1020–22; PX808; PX824.) Some of the fair market value appraisals of the Belgacom equipment also were “far too high.” (Chastain, Tr. 4395.) All parties to the SILO transactions would benefit from higher appraisals pushed to the limits of reality. A higher fair market value and longer useful life would make the value of the transaction larger, increasing the available tax deductions to Wells Fargo, and also increasing the transaction fees to the other participants. From the vantage point of the tax-exempt entities, they received cash at closing in exchange for tax deductions that they could not use, but otherwise nothing changed. The reference in Senator Grassley's November 17, 2003 letter to the statement of a knowledgeable municipal manager is most telling: “People giving him money which he never had to pay back, for doing something that he was already doing.” (PX223.)
Wells Fargo asserts that it structured the SILO transactions to comply with FAS 13, and to take advantage of the “front-loading” of income required under FAS 13. Wells Fargo argues that the desire to recognize “front-loading” under FAS 13 is a legitimate non-tax business objective that gives the SILO transactions economic substance. However, the Court concludes that the financial benefits of improper tax deductions cannot provide a non-tax business purpose for the transaction. Such a bootstrap argument has been rejected in other cases:
[The taxpayer's] intended use of the cash flows generated by the [transaction] is irrelevant to the subjective prong of the economic substance analysis. If a legitimate business purpose for the use of the tax savings “were sufficient to breathe substance into a transaction whose only purpose is to reduce taxes, [then] every sham tax-shelter device might succeed.”
Am. Elec. Power, Inc. v. United States, 136 F.Supp.2d 762, 791–92 [87 AFTR 2d 2001-917] (S.D. Ohio 2001), aff'd, 326 F.3d 737 [91 AFTR 2d 2003-2060] (6th Cir. 2003) (quoting Winn-Dixie Stores, Inc. v. Comm'r, 113 T.C. 254, 287 (1999), aff'd, 254 F.3d 1313 [87 AFTR 2d 2001-2626] (11th Cir. 2001)).
Finally, while it is true that “the tax laws affect the shape of nearly every business transaction,” Frank Lyon, 435 U.S. at 580, it is also true that “there is a material difference between structuring a real transaction in a particular way to provide a tax benefit (which is legitimate), and creating a transaction, without a business purpose, in order to create a tax benefit (which is illegitimate).” Coltec, 454 F.3d at 1357. Here, the SILO was nothing more than a sequel to the LILO structure that the IRS determined was without any economic substance. See Rev. Rule 1999-14. Once the SILO structure came to the attention of the IRS, and the tax benefits again became unavailable, taxpayers immediately stopped entering into SILOs, just as happened with LILOs. The SILO transaction simply was another way to transfer tax deductions from tax-exempt entities that could not use them.
E. The Consolidated Edison Case is Distinguishable.
In the recent decision in Consolidated Edison Company of New York, our Court allowed the taxpayer's 1997 tax year deductions in a LILO transaction. In that case, a utility, Con Ed, entered into a transaction with a Dutch utility known as Electriciteitsbedrijf Zuid-Holland, N.V. (“EZH”). The facility subject to the transaction was a “gas-fired, combined cycle cogeneration plant” located in the Netherlands, known as “RoCa3.” Con Ed, 2009 WL 3418533 [104 AFTR 2d 2009-6966], at 1. In the 1990s, Con Ed provided electricity to over eight million people in New York City and Westchester County, New York. The New York Public Service Commission (“PSC”) regulated all of Con Ed's operations prior to the mid-1990s, when the PSC deregulated New York State electric companies to encourage competition. The PSC ordered Con Ed and other utilities to submit plans describing how they would restructure their operations to create a more competitive market. The plans were to include proposed corporate structures, including unregulated subsidiaries, that would achieve the PSC's restructuring goals. Id. at 2.
The PSC authorized Con Ed to invest in unregulated subsidiaries that would later participate in energy infrastructure projects and market technical services worldwide. In pursuit of these company objectives, Con Ed sought to enter into one or more LILO investments to offset losses it expected to sustain as a result of deregulation in New York State, including losses from divestiture of some of its assets. Id. at 3. Against this background, Con Ed invested in the Dutch utility plant as a way to expand its international investments, diversify its assets, and develop strategic alliances abroad. Id.
The Court found a legitimate business purpose in Con Ed's LILO investment, and ruled that the transaction was not made simply to achieve tax avoidance. Specifically, the Court noted the following non-tax reasons for Con Ed to engage in this venture:
[T]he ability to pursue new opportunities and alternatives in a deregulated market; the expectation of making a pretax profit through the RoCa3 Transaction; plaintiff's entry into Western European energy markets; the potential for benefits from the output of the RoCa3 Facility due to the life of the plant beyond the Sublease Basic Term; technical benefits to Con Ed of operating a state of the art plant in its own field of expertise; the ability to further develop and share Con Ed's own cutting edge technology; and environmental benefits, including gaining expertise, while involved with a world-class, environmentally friendly plant and improving plaintiff's environmental public image.
Id. at 89.
Con Ed is a distinctly unique case, easily distinguishable from Wells Fargo's SILO transactions. The fact that a New York utility would want to invest in a Dutch utility for all of the reasons mentioned above presents a materially different set of circumstances than are presented here. In the course of its 159-page slip opinion, the Court in Con Ed repeatedly emphasized the fact-dependent basis for the outcome, stating:
• “[E]ach transaction ... must be evaluated on its own merits,” id. at 1;
• “The conclusions of the court offered in this opinion are based on the specific and unique facts which led to, and were part of, the RoCa3 Transaction,” id.;
• “The [expert] reports in the record before the court ... are specific to the RoCa3 Transaction and Facility and should be reviewed on their own merits, and not compared to separate, unrelated transactions, which do not even invoke electric generating facilities,” id. at 5;
• “[E]ach LILO transaction is developed and formed differently, based on specific relationships, the chronology, the financial relationships, the nature of the property involved, and any number of other variables,” id. at 38;
• Determining whether the taxpayer has acquired a true leasehold interest in the property “is a question of fact which must be ascertained from the intention of the parties as evidenced by the written agreements read in light of the attending facts and circumstances,” id. at 43 (citing Grodt & McKay Realty, Inc. v. Comm'r, 77 T.C. 1221, 1237 (1981);
• In critiquing the position of a key Government expert, the Court noted “[f]or the most part, his testimony failed to address the unique characteristics of the RoCa3 Transaction,” id. at 52;
• “[T]he parties have presented volumes of exhibits and testimony, including expert testimony, unique to the RoCa3 Transaction, id. at 122;
• “After presiding over the lengthy trial, examining and reexamining the trial transcripts and exhibits entered into the record and reviewing the written submissions of the parties, the court is persuaded, as is evident throughout this opinion, that the plaintiff has established, through its witnesses and the exhibits, that the RoCa3 Transaction was a unique LILO transaction, which provided tax and bookkeeping advantages to the plaintiff; was, in form, a true lease; possessed economic substance; and, therefore, should be respected as qualifying for the tax deductions claimed.” Id. at 128.
The Court in Con Ed distinguished AWG and BB&T by observing that “considerations of economic substance are factually specific to the transaction involved.” Id. at 115. Applying that same test here, which this Court agrees is correct, the present case is much more like AWG and BB&T. The five Wells Fargo trial transactions lack economic substance, and therefore the claimed deductions must be denied.
III. Conclusion
Based upon the foregoing, the Court denies Plaintiff's claim for a tax refund as to the WMATA, NJT, Caltrans, Houston Metro, and Belgacom transactions presented at trial. The Court will schedule a status conference with counsel for the parties during the next 45 days to address the need for further proceedings, if any, regarding the remaining transactions at issue. If further proceedings are not necessary, the Court will enter a final judgment in favor of Defendant, and dismiss Plaintiff's complaint with prejudice. Pursuant to RCFC 54(d), the Court finds that Defendant is the prevailing party, and awards costs to Defendant.
The cited sections of the Internal Revenue Code are found in 26 U.S.C. §§ 163, 167, and 168 (2006). For convenience, the Court will refer to Internal Revenue Code provisions as “IRC § ___.”
Rev. Rul. 99-14, 99-1 C.B. 835, modified and superseded by Rev. Rul. 2002-69, 2002-2 C.B. 760.
This statement of the facts constitutes the Court's principal findings of fact under Rule 52(a) of the Court of Federal Claims (“RCFC”). Other findings of fact and rulings on mixed questions of fact and law are set forth in the later analysis.
In this opinion, the Court will refer to the trial transcript by witness and page as “Name, Tr. ___,” and to trial exhibits as “PX___” for Plaintiff's exhibits, and “DX ___” for Defendant's exhibits. The parties' pretrial stipulations of fact, filed on April 2, 2009, are referred to as “Stip. ___.” For lengthy exhibits, page citations include the numerical portion of Bates numbers. Demonstrative exhibits from Plaintiff and Defendant are referred to as “PDX ___” and “DDX ___” respectively.
“GSM” is a popular Global System for Mobile communications, used throughout the world.
An exception exists in the Belgacom transaction, where Merrill Lynch, the equity payment undertaker, makes a few payments to Wells Fargo during the lease-back period.
The FTA designated Richard Steinmann as its deponent at the FTA's Rule 30(b)(6) deposition. (PX366.) The deposition testimony of Mr. Steinmann is found in PX365 and PX375.

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