Tax refund suit filed by WF claiming over $115M in depreciation, interest and expenses for 2002 in connection with participating in 26 leveraged lease transactions, 17 with domestic transit agencies and 9 pertaining to qualified technological equipment ("QTE") Five of the 26 were selected for trial by agreement of the parties who agreed to allow the principles from these transactions to govern the balance. Of the five trial transactions, four involved public transit agencies, and one a QTE lease involving cellular telecommunications equipment. The lessees were public authorities or governmental agencies. A sale in/lease out or SILO tax shelter is where a tax-exempt entity transfers tax benefits for a fee to a United States taxpayer, e.g., WF. The transactions involving depreciable property ranging from buses to trains to telecommunications equipment. The object for each transaction is for the purchaser-lessor to obtain substantial tax deductions from an otherwise tax-exempt entity (seller-leaseback lessee).
The government’s attacks on such arrangements generally involve: (i) applying the substance over form doctrine to determine whether WF really acquired ownership with respect to the purchased assets or whether in substance, the seller really retained ownership and all that is involved is an artificial shifting of tax benefits; (ii) does the financing aspects associated with such sale and lease back, which involves a loan to the original owner to finance the transaction should be respected and allow interest deductions on the loan repayments; and (iii) whether there is any economic substance to these transactions, other than the transfer of tax benefits, that would warrant depreciation and transaction cost deductions.
The Claims Court conducted a 20 day trial in Spring 2009 at which time 33 witnesses, including 13 experts testified. The evidentiary record was voluminous consisting of over 5,000 pages of trial transcript and over 1,100 exhibits. The Court conducted a 20-day trial in Washington, D.C. during April 6 through May 1, 2009.
Other courts have been asked to rule on SILOs or "lease in/lease out" or "LILO" transaction. With one exception, the courts have ruled against the taxpayers claiming the desired tax benefits. See AWG Leasing Trust v. United States, 592 F.Supp.2d 953 (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 (4th Cir. 2008); Altria Group, Inc. v. United States, 2009 WL 874207, at 1 (S.D.N.Y. July 9, 2009). The taxpayer was successful in Consolidated Edison Company of New York, Inc. v. United States, 2009 WL 3418533 (Fed. Cl. Oct. 21, 2009) (Horn, J.), also a Claims Court case which found that the particular LILO transaction involved had legitimate business purposes and allowed the claimed dedutions.
In Hoosier Energy Rural Electric Cooperative, Inc. v. John Hancock Life Ins. Co., 588 F. Supp. 2d 919 (S.D. Ind. 2008), aff’d 582 F.3d 721 (7th Cir. 2009), involved an insurance company which had its credit rating reduced as part of the economic downturn. The lessor of the property, John Hancock, exercised its right to demand that Hoosier Energy find a replacement for the tenant even though it 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 the tenant. In granting injunctive relief, the district court described the SILO transaction as a "blatantly abusive tax shelter" that is "rotten to the core." 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 user. 582 F.3d at 730.
After reviewing the record, the Claims Court found that WF is not entitled to the claimed tax deductions on the 5 trial transactions. WF never acquired the burdens and benefits of ownership. Moreover, the transactions lack economic substance, and were intended only to reduce WF’s federal taxes by millions of dollars. Although well disguised in "a sea of paper and complexity", the SILO transactions essentially amount to WF’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 WF, 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. If the Court were to approve of these SILO schemes, the big losers would be the IRS through the loss of millions of taxes.
On the issue of economic substance, the Court examined if there was any likelihood of profit aside from the tax benefits. After going through the detailed paperwork the Court concluded that 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. The Court announced that it 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.