The Federal Claims Court December 21, 2007 decision in Jade Tradeing LLC vs United States Download jade_trading. 122107.pdf will likely reverberate across the tax shelter/economic substance debate.
Jade Trading was a purported partnership set up to make it possible for clients of BDO Seidman to generate an artificially high basis in a low value asset that would create a loss on exit from the partnership, which loss could be used against other, unrelated gains. The "Son of BOSS" shelter required the clients to purchase offsetting currency options, ostensibly priced at about $15 million. The clients only paid the difference, a scant $150,000 or so. The option counterparty, AIG, took care to be sure that the options wouldn't be separated (if they were, AIG would be under considerably different and substantial counterparty risk, among other things). Each client's (there were three brothers in this deal) total upside potential (ignoring the fees paid for the transaction) was about $140,000, and total loss potential was only the actual investment of $150,000. But each client paid consulting and legal fees of more than $934,000 (not including the fees to set up LLCS and other transaction costs). So there was a negative 80% rate of return on their "investment", which existed to generate tax losses and really added nothing to their ability to trade in options. In fact, one expert quoted in the case sounds almost bemused as he notes that there simply was no reason for contributing the options to a partnership.
The Court does a superb job of separating the grain from the chaff. It notes that the partnership scheme relied on an anomaly in the tax law--the fact that a pair of purchased and sold options might create an artificially high partnership interest basis because the law, at the time of the deal based on the 1975 Helmer case, disregarded contingent liabilities for purposes of section 752 (the provision that ulimately results in basis adjustments in respect of liabilities of a partner assumed by a partnership). But the court moves right on to economic substance, giving short shrift to the partnership's argument that no shelter could be found if it was in literal compliance with the tax code. The court specifically states that the economic substance doctrine disregards transactions despite their literal compliance with tax laws, if the particular transaction that generates the tax benefit lacks objective economic substance.
And the court minces no words in pointing out the ways that the Jade Trading deals lacked economic substance. Citing Coltec, it looks to objective evidence and finds a long list, including fictional losses, huge fees that make a reasonable profit expectation impossible, minimal investments that are parked in a partnership that has no business purpose, all according to the structure of a deal that was marketed as a tax avoidance transaction by the BDO Seidman "wolf pack" tax shelter team. In discussing the appropriate penalties, the court notes that this was "an elaborate fictional construct with no economic consequences other than tax benefits."
This is a good decision, well written, and supported by ample evidence from depositions, tax opinion letters, and marketing materials. It will likely be quoted frequently as the courts continue to use economic substance to hold taxpayers accountable for their tax evasion schemes.
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