One of the "son of BOSS" tax shelters popular at the turn of the century and marketed by KPMG-- involving foreign currency straddles and tiered partnerships used to create a loss that could purportedly be shifted to the taxpayer purchasing the partnership interest to offset preexisting capital gains--bit the dust in Mississippi district court. The case is Nevada Partners Fund, CIVIL ACTION NO. 3:06cv379-HTW-MTP, available on BNA, here.
The taxpayers must have hoped a trial judge would be more sympathetic on this 2001 partnership shelter than a jury, since the case was decided without one. The IRS in these cases argued the partnership anti-abuse rule set out in Reg. 1.701-2, which indicates that the complex partnership regulations are to be applied in a manner "consistent with the intent of subchapter K" (subchapter K, of course, being the tax code provisions applicable especially to partnerships). If a transaction is undertaken with a principal purpose of reducing the present value of tax, then it may be recast and the tax determinations based on the recast transaction. James Williams had an $18 million capital gain, and KPMG suggested he use a marketed tax shelter by which phantom losses would purportedly shelter the gain from tax. A hedge fund named Bricolage developed the "Family Options Customize (FOCus) shelter and sold the LLC interests to Williams that were needed to implement the deal.
The marketing strategy was standard. The judge here footnotes the Chew v. KPMG case, in which Judge Barbour noted that
KPMG marketed these forms of tax strategies to its long-term wealthy clients. The strategy involved using the services of an investment advisor [who] provided the design and rhetoric to recast the tax strategies as investment strategies. A global bank then would provide financing and nominal investment transactions that provided the investment “cover” to disguise the tax driven motives. A law firm would provide the purportedly “independent” opinion letters blessing the proposed strategy and supposedly insulating the clients from IRS penalties in the event of an audit.
Like the similar BDO-Seidman COBRA ("currency options bring reward alternatives") or the BLIPs and OPIS deals, the FOCus deal involved a carefully calculated series of purchases and sales taking place over a short time period, designed to allow the shelter buyer to take into account losses not suffered economically by the taxpayer. But the marketing discussions advised that after the deal was done, the buyer would retain the interests in the remaining entities purchased and be able to actually engage in investment strategies. As the judge notes, no mention was made of investment until this post-shelter phase of the transaction entities was discussed.
The judge notes that there was ample notice that these kinds of transactions dealing in noneconomic losses would not withstand scrutiny, citing Notices 99-59 and 2000-44 and, of course, the seminal case in partnership phantom loss tax shelters, ACM Partnership. The FOCus strategy was tweaked so that KPMG hoped that it would not fall prey to the same result as the original son of Boss shelters, but the marketers all knew it might. Yet Notice 2002-50 was released just a few months after Williams entered the deal (and before he had made a final decision on how to report the losses) and that notice dealt directly with these types of partnership shelters. Arnold & Porter nonetheless provided an opinion letter to the taxpayer in October 2002 that the deal was "more likely than not" to receive the tax treatment stated (allowance of the loss to Williams).
The partners argued that this was an integrated investment strategy (that happened to also have a nice tax kicker) that should not be broken apart into a tax strategy and an investment strategy. Williams made about $23 million through investments, with the advice of Bricolage, the creater of the tax shelter, between 2002 and 2007.
The judge didn't buy it. He noted that the tax shelter and the legitimate investments were separate deals that could have taken place without any connection between them, and that the origination of the deal lay in the tax planning.
The central point in 2001 of following the strategy being promoted by KPMG was to ameliorate Williams’ tax situation, regardless of Williams’ investment activity.
[Later in the opinion, the judge notes that an economic study of the investment strategy made no mention of the FOCus strategy or its tax advantages. He concludes] "The FOCus steps through the three-tiered partnership simply was not a factor in the investment strategy to be pursued through Bricolage."
Interestingly, the judge points out a communication between KPMG and the taxpayer that was revealing about the marketer's assessment of the shelter. A draft of the engagement letter noted that this was "an aggressive strategy." Counsel for the buyer noted that he recognized it was aggressive and okayed striking the phrase from the final letter.