141 T.C. 1 (T.C. 2013), 6404-09, John Hancock Life Ins. Co. (U.S.A.) v. Commissioner of Internal Revenue

Docket Nº:6404-09, 7083-10, 7084-10
Citation:141 T.C. 1
Party Name:John Hancock Life Insurance Company (U.S.A.), as Successor in Interest to John Hancock Life Insurance Company (f.k.a. John Hancock Mutual Life Insurance Company) and Subsidiaries, et al.,[1] Petitioners v. Commissioner of Internal Revenue, Respondent
Attorney:Arthur L. Bailey, Jean A. Pawlow, James W. Johnson, Kevin J. Cloherty, Alexis A. Maclvor, Thomas K. Spencer,and Nathaniel J. Dorfman, for petitioners. Daniel A. Rosen, Lyle B. Press, Steven N. Balahtsis, Allison Ickovic, and Abigail F. Dunnigan, for respondent.
Case Date:August 05, 2013
Court:United States Tax Court
 
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141 T.C. 1 (T.C. 2013)

John Hancock Life Insurance Company (U.S.A.), as Successor in Interest to John Hancock Life Insurance Company (f.k.a. John Hancock Mutual Life Insurance Company) and Subsidiaries, et al.,[1] Petitioners

v.

Commissioner of Internal Revenue, Respondent

Nos. 6404-09, 7083-10, 7084-10

United States Tax Court

August 5, 2013

JH is primarily in the business of selling life insurance poli­cies, annuities, long-term care insurance, and other retire­ment services. To fulfill its contractual obligations under these services JH invests the premiums it receives. In 1979 JH began investing in leveraged leases. A leveraged lease is a lease in which the equity investor borrows money from a third-party lender to finance a portion of the purchase price of the asset involved and leases the asset to its ultimate user. In 1997 JH began investing in lease-in-lease-out (LILO) trans­actions and in 1999 began investing in sale-in-lease-out (SILO) transactions. JH participated in 19 LILO transactions and 8 SILO transactions between 1997 and 2001. With respect to the LILO transactions, JH claimed deductions for rental expenses for the prepaid rent paid to the tax-indifferent entities and interest expenses related to the repayment of the nonrecourse loans. JH also amortized transaction costs related

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to the LILO transactions. With respect to the SILO trans­actions, JH claimed deductions for depreciation and interest expenses and amortized the related transaction costs. R dis­allowed these deductions for the years at issue and deter­mined that JH had OID income with respect to the LILO and SILO transactions. The parties agreed to litigate three LILO transactions and four SILO transactions and use them as test transactions for the remaining LILO and SILO transactions at issue. A transaction will be respected for Federal income tax purposes if it has economic substance and the substance of the transaction is consistent with its form. P argues that the LILO and SILO test transactions have economic sub­stance because JH derived a pretax profit from each trans­action and entered into the transactions with the primary purpose of making a profit. P also argues that the substance of each LILO and SILO transaction is consistent with its form because JH held a true leasehold interest in each of the LILO assets and obtained an ownership interest in each of the SILO assets. R argues that the LILO and SILO test transactions lack economic substance and the substance of the transactions is not consistent with their form. Specifically, R argues that JH failed to acquire a substantive leasehold interest in the LILO assets and failed to acquire a substantive ownership interest in the SILO assets. Thus, R argues the true sub­stance of the LILO and SILO transactions is a loan from JH to the tax-indifferent entities. R argues in the alternative with respect to the LILO and SILO transactions that at most P acquired a future interest in the LILO and SILO assets. The parties also dispute the location of JH's principal place of business. Held: JH's principal place of business is Boston, Massachusetts. Held, further, R failed to prove that the three LILO and four SILO test transactions lack economic sub­stance. Held, further, the substance of the three LILO test transactions is not consistent with their form. The LILO test transactions resemble financial arrangements, and JH is therefore denied its claimed rental expense, interest expense, and transaction cost deductions with respect to them. Held, further, the substance of three of the SILO test transactions is consistent with their form; however, JH did not acquire a present interest in the SILO test transaction properties and is therefore denied its claimed depreciation and interest expense deductions. Held, further, the substance of the fourth SILO test transaction is not consistent with its form. That SILO test transaction resembles a financial arrangement, and JH is therefore denied its claimed depreciation expense, interest expense, and transaction cost deductions with respect to that transaction. Held, further, JH had OID income with respect to the three LILO test transactions and the fourth SILO test transaction but not with respect to the first three

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SILO test transactions, in which it failed to acquire a present interest.

Arthur L. Bailey, Jean A. Pawlow, James W. Johnson, Kevin J. Cloherty, Alexis A. Maclvor, Thomas K. Spencer,and Nathaniel J. Dorfman, for petitioners.

Daniel A. Rosen, Lyle B. Press, Steven N. Balahtsis, Allison Ickovic, and Abigail F. Dunnigan, for respondent.

CONTENTS FINDINGS OF FACT ............................................................................. 8

Background .......................................................................................... 8

I. John Hancock's History ............................................................ 8

II. Investment Process and Review ............................................. 9

III. Leasing .................................................................................... 10

IV. LILO and SILO Transactions ................................................ 10

A. Basic Structure ..................................................................... 10

B. History ................................................................................... 15

C. Due Diligence ........................................................................ 17

D. The Hoosier Transaction ...................................................... 18

The LILO Test Transactions .............................................................. 19

I. OBB LILO .................................................................................. 20

A. Lease and Sublease .............................................................. 20

1. The Asset ............................................................................ 20

2. Terms .................................................................................. 21

3. Rent and Financing ........................................................... 21

a. Initial Lease .................................................................... 21

b. Sublease and Defeasance ............................................... 21

4. Property Rights and Obligations ...................................... 22

5. Default ................................................................................ 23

B. End of Sublease Term .......................................................... 23

1. OBB's Purchase Option ..................................................... 23

2. John Hancock's Options .................................................... 24

a. Renewal Option .............................................................. 24

b. Replacement Option ....................................................... 25

c. Retention Option ............................................................ 25

II. SNCB 2 and SNCB 5 Lot 1 LILO Transactions .................... 25

A. Lease and Sublease .............................................................. 25

1. The Assets .......................................................................... 25

2. Terms .................................................................................. 26

3. Rent and Financing ........................................................... 27

a. Initial Lease .................................................................... 27

b. Sublease and Defeasance ............................................... 27

4. Property and Default Rights and Obligations ................. 28

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B. End of Sublease Term .......................................................... 28

The SILO Test Transactions .............................................................. 28

I. TIWAG ....................................................................................... 29

A. Lease and Sublease .............................................................. 29

1. The Assets .......................................................................... 29

2. Terms .................................................................................. 29

3. Rent and Financing ........................................................... 30

a. Initial Lease .................................................................... 30

b. Sublease and Defeasance ............................................... 30

4. Property Rights and Obligations ...................................... 32

5. Default ................................................................................ 33

B. End of Sublease Term .......................................................... 33

1. TIWAG's Purchase Option ................................................ 33

2. John Hancock's Options .................................................... 33

II. Two Dortmund Transactions .................................................. 35

A. Lease and Sublease .............................................................. 35

1. The Asset ............................................................................ 35

2. Terms .................................................................................. 36

3. Rent and Financing ........................................................... 37

a. Initial Lease .................................................................... 37

b. Sublease and Defeasance ............................................... 37

4. Property and Default Rights and Obligations ................. 38

B. End of Sublease Term .......................................................... 38

III. SNCB SILO...

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