One September 30, 2011, three US federal courts held in favor of the United States in separate cases involving abusive tax shelters. Though all three opinions invoke the economic substance doctrine, the transactions at issue pre-date the codifi cation of the doctrine.
In Pritired 1, LLC, Principal Life Ins. Co., Tax Matters Partner and Principal Life Ins. Co. v. US, the US District Court for the Southern District of Iowa disallowed a refund claimed of $21.2 million attributable to foreign tax credits. The Court concluded that the US taxpayer’s investment through an in-form partnership with French banks was in substance a loan to the French banks and not a partnership, based on factual fi ndings that without the foreign tax credits the US taxpayers received through partnership allocations and distributions, the US taxpayers would not have made a profi t on the transaction or had a business purpose for entering the transaction.
In WFC Holdings Co. v. US, the US District Court for the District of Minnesota disallowed a tax refund claim for more than $80 million fi led by a subsidiary of Wells Fargo & Co. The refund claim was based on an alleged capital loss deduction of more than $420 million stemming from a transaction involving the transfer of “underwater” commercial leases to a Wells Fargo subsidiary in exchange for preferred stock, followed by a related sale of such subsidiary’s preferred stock to Lehman Brothers, Inc. The US District Court concluded that WFC satisfi ed the technical requirements of the Internal Revenue Code, however, the transaction as a whole, lacked a business purpose and economic substance.
In Southgate Master Fund LLC v US, the Fifth Circuit Court of Appeals affi rmed the District Court’s disallowance of over $200 million in partnership losses to the deducting partner, stating that although the acquisition of certain foreign investments had economic substance, the formal partnership structure through which that acquisition took place was a sham. The Court applied the sham partnership and substance-overform doctrines to disregard the acquisition through the partnership and recharacterize the transaction as a direct purchase and sale of the underlying partnership investments.