AD Global FX Fund, LLC v. United States, Consol. 05 Civ. 00223 (RKE)
Decision Date | 31 March 2014 |
Docket Number | Consol. 05 Civ. 00223 (RKE) |
Parties | AD GLOBAL FX FUND, LLC, AD EQUITY INVESTMENT FUND LLC, and AD GLOBAL 2001 FUND LLC, Plaintiffs, v. UNITED STATES, Defendant. |
Court | U.S. District Court — Southern District of New York |
Before: Richard K. Eaton, Judge*
This is a consolidated action brought by three related limited liability companies, AD Global FX Fund, LLC ("AD FX"), AD Equity Investment Fund LLC ("AD Equity"), and AD Global 2001 Fund LLC ("AD 2001"), formed by Alpha Consultants Inc. ("Alpha") and The Diversified Group Inc. ("Diversified") (the source of the "AD" in the name of each fund) (collectively, "plaintiffs"), challenging the Internal Revenue Service's ("IRS" or "defendant") Notice of Final Partnership Administrative Adjustments ("FPAA") issued to each plaintiff. In each company's respective FPAA, the IRS determined that the entities were formed as tax shelters intended to create artificial tax losses to offset the individual fund's corporate partners' unrelated taxable gains and, thus, the entities were to be disregarded as shams for tax purposes. These consolidated actions were commenced by plaintiffs pursuant to 26 U.S.C. § 6226(a)(2000), which allows a partnership to seek a readjustment of determinations made in a FPAA. Plaintiffs have moved for partial summary judgment. For the reasons stated below, the motion is granted in part.
BACKGROUND1
This case involves the alleged organization of limited liability companies as tax shelters in order to produce large, artificial tax losses for the companies' corporate partners.2 In each case, the individual partners took the following steps to create a putative loss for tax purposes. First, the partner simultaneously purchased from and sold to Lehman Brothers Commercial Corporation ("Lehman") paired options on foreign currency, giving the partner the right to purchase or "call" the currency (the "long option") and the obligation to sell or "put" the currency (the "short option") at some point in the future for a pre-determined price in U.S. Dollars. Pls.' Local Rule 56.1 Statement ¶¶ 3, 19, 32 (ECF Dkt. No. 50) () . In each case, the strike price3 for both the long and short options was nearly identical, such that the partner would neither gain nor lose any appreciable amount upon the exercising of the pair of options. See Pls.' 56.1 ¶¶ 3, 19, 32. In all cases, the purchase price of the long option was higher than the purchase price of the short option. Pls.' 56.1 ¶¶ 3, 19, 32. As a result, the onlyamount actually paid by each partner to Lehman was equal to the difference in the purchase price of the options. Pls.' 56.1 ¶¶ 3, 19, 32.
For example, Moxon Corp. ("Moxon"), a partner in AD FX, simultaneously purchased a long option on the Canadian Dollar for $40 million USD, and sold a short option on the Canadian Dollar to Lehman for $39.8 million USD. Pls.' 56.1 ¶ 3. "The net result was that Moxon paid Lehman $200,000." Pls.' 56.1 ¶ 3.
Second, each partner contributed the option pairs in exchange for partnership interests in their respective limited liability companies. Pls.' 56.1 ¶¶ 4, 20, 33. The percentage interest received by the contributing partner was determined by the partnership based on the value of the long options, without consideration of the partner's obligation under the short option. Pls.' 56.1 ¶¶ 4, 20, 33. Presumably, this was because the value of the short option was sufficiently speculative that it might be ignored when computing basis. Accordingly, each partner's capital account reflected an initial contribution of property valued at the gross purchase price of the long option, without netting the offsetting liability incurred under the paired short option. Thus, each partner's capital account valued the contributed long option at an amount far in excess of the amount actually expended to acquire that option. For example, Moxon's capital account in AD FX reflected an initial contribution of approximately $40 million, the purchase price of the long option. This was notwithstanding that Moxon only paid approximately $200,000 to acquire the option because of the contemporaneous sale of the short option to Lehman for approximately $39.8 million. Pls.' 56.1 ¶¶ 3, 4.
Third, the partnership liquidated its assets and each partner withdrew from the partnership. Pls.' 56.1 ¶¶ 9, 23, 36. Upon withdrawal, each partner received the value of its share of the partnership's assets, which was a relatively small amount, especially when comparedto the value of the partner's initial contribution, as reflected in the partnership's capital account. See Pls.' 56.1 ¶¶ 9, 12, 23, 25, 36, 39.
Finally, on its federal income tax return, each plaintiff partnership took the position that it had received the options from its partners as contributions to a partnership within the meaning of 26 U.S.C. § 721, with a carryover basis determined under 26 U.S.C. § 723. Pls.' 56.1 ¶¶ 10, 24, 37. In each case, the partnership claimed that each partner's initial contribution was equal to the value of the long option, without considering the partnership's assumption of the partner's offsetting liability under the short option.4 Pls.' 56.1 ¶¶ 10, 24, 37. Likewise, upon withdrawal, each partner claimed an outside basis in its partnership interest equal to the gross price of the long option, without a setoff for the partnership's assumption of the obligations under the short option. Pls.' 56.1 ¶¶ 12, 25, 39.
For example, upon withdrawal, Moxon received approximately $60,000 as the value of its investment in AD FX. When subtracted from the $40 million value of the long option contributed as its initial capital investment in AD FX, this resulted in a claimed tax loss in excess of $39 million. Pls.' 56.1 ¶ 12. In other words, Moxon's claimed basis in its partnership interest was approximately $40 million, and its claimed partnership interest upon withdrawal was approximately $60,000. Moxon then claimed a tax loss equal to the difference in its alleged basis ($40 million) and its alleged share of assets on liquidation ($60,000). Pls.' 56.1 ¶ 12.
For each partnership, the IRS issued an FPAA challenging these reported losses.5 Pls.' 56.1 ¶¶ 13, 26, 40. According to the government, these transactions were merely "son of theBOSS"6 tax shelters orchestrated to create losses to offset taxable gains. United States of America's Mem. of Law in Opp'n to Pls.' Mot. For Partial Summ. J. 4 (ECF Dkt. No. 38) ("Def.'s Br."). The IRS determined that these partnerships were mere shams intended to create tax losses, as the transactions at issue had no economic substance. Accordingly, the IRS determined that the partnership form and the claimed losses resulting from the foregoing transaction would be disregarded in determining the tax liability of the partners.
The FPAA issued for AD 2001 ("AD 2001 FPAA"), which was virtually identical in substance to the FPAAs for AD FX and AD Equity, made the following findings:
To continue reading
Request your trial