Bemont Invs., L.L.C. v. United States

• Decision Date: 26 April 2012
• Docket Number: No. 10–41132.,10–41132.
• Citation: 109 A.F.T.R.2d 2012,679 F.3d 339
• Parties: BEMONT INVESTMENTS, L.L.C., by and through its TAX MATTERS PARTNER, Plaintiff–Appellee—Cross–Appellant, v. UNITED STATES of America, Defendant–Appellant—Cross–Appellee. BPB Investments, L.C., by and through its Tax Matters Partner, Daniel Beal, BPB Investments, L.L.C. Tax Matters Partner, Plaintiffs–Appellees—Cross–Appellants, v. United States of America, Defendant–Appellant—Cross–Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

679 F.3d 339

109 A.F.T.R.2d 2012-1922

BEMONT INVESTMENTS, L.L.C., by and through its TAX MATTERS PARTNER, Plaintiff–Appellee—Cross–Appellant,

v.UNITED STATES of America, Defendant–Appellant—Cross–Appellee.

BPB Investments, L.C., by and through its Tax Matters Partner, Daniel Beal, BPB Investments, L.L.C. Tax Matters Partner, Plaintiffs–Appellees—Cross–Appellants,

v.United States of America, Defendant–Appellant—Cross–Appellee.

No. 10–41132.

United States Court of Appeals,Fifth Circuit.

April 26, 2012.

Roy Theodore Englert, Jr. (argued), Gary A. Orseck, Robbins, Russell, Englert, Orseck, Untereiner & Sauber, L.L.P., Washington, DC, Michael Todd Welty, Laura L. Gavioli, Lezlie Brooke Willis, SNR Denton US, L.L.P., Dallas, TX, Steven Merouse, SNR Denton US, L.L.P., Chicago, IL, for Plaintiffs–Appellees Cross–Appellants.

Judith Ann Hagley (argued), Richard Bradshaw Farber, Supervisory Atty., Gilbert Steven Rothenberg, Dep. Asst. Atty. Gen., U.S. Dept. of Justice, Tax Div., App. Section, Washington, DC, Jonathan Lee Blacker, Holly Michele Church, U.S. Dept. of Justice, Tax Div., Dallas, TX, for Defendant–Appellant Cross–Appellee.

Appeals from the United States District Court for the Eastern District of Texas.

Before REAVLEY, DAVIS and PRADO, Circuit Judges.

W. EUGENE DAVIS, Circuit Judge:

These consolidated cases sought judicial review of notices of final partnership administrative adjustment (FPAA) issued to Bemont Investments, L.L.C. (Bemont) and BPB Investments, L.C. (BPB). Following that review in the district court, the government appeals two aspects of the district court's judgment: (1) the ruling on the partnerships' motion for partial summary judgment disallowing the 40% valuation misstatement penalty, and (2) the ruling post trial holding that the FPAA issued to Bemont for the 2001 tax year was time-barred. The partnerships appeal the district court's judgment upholding the imposition of the 20% substantial understatement and negligence penalties. We affirm in part and reverse in part.

I.

On October 13, 2006, the Commissioner of the Internal Revenue issued FPAAs to Bemont and BPB for tax years 2001 and 2002. An FPAA is the partnership equivalent of a statutory notice of deficiency to an individual or non-partnership entity. The FPAAs disallowed losses from a foreign currency hedging transaction claimed on Bemont's 2001 partnership return and BPB's 2002 return. Both FPAAs also imposed four, alternative, non-cumulative penalties: (1) a 40% penalty for underpayment attributable to a gross valuation misstatement, (2) a 20% penalty for underpayment attributable to negligence, (3) a 20% penalty for underpayment attributable to a substantial understatement of income tax, and (4) a 20% penalty for underpayment attributable to a substantial valuation misstatement, all under 26 U.S.C. § 6662. The partnerships timely commenced actions for readjustment of partnership items by filing petitions in the district court. The actions were consolidated and referred by consent to a magistrate judge for all purposes.

Before trial, the court granted the partnerships' motion for partial summary judgment, holding that the government was foreclosed from imposing the valuation misstatement penalties (items (1) and (4) above). The remainder of the case proceeded to trial. After a bench trial, the court determined that the FPAA issued to Bemont for 2001 was time-barred, precluding the tax assessment and penalties related to that tax year. The court upheld the disallowance of losses reported by the partnerships and the imposition of penalties against them (items (2) and (3) above) for 2002. Both sides appeal.

The transaction underlying this dispute is described by the IRS as a classic Son of BOSS tax shelter. This type of shelter creates tax benefits in the form of deductible losses or reduced gains by creating an artificially high basis in partnership interests. Ordinarily under the Internal Revenue Code, when a partner contributes property to a partnership, the partner's basis in his partnership interest increases. 26 U.S.C. § 722. When a partnership assumes a partner's liability, the partner's basis decreases. 26 U.S.C. §§ 722, 752. A Son of BOSS shelter recognizes the increased basis resulting from the partnership's acquisition of the partner's asset, but ignores the effect on that basis created by the partnership's assumption of the partner's liability. A higher basis can lead to the recognition of a loss or a reduced amount of gain when the asset is sold. The IRS classified such schemes as abusive tax shelters. Notice 2000–44, 2000–2 C.B. 255. The notice designated such shelters as “listed transactions” for purposes of Treasury Regulation §§ 1.6011–4T(b)(2) and 301.6111–2T(b)(2). A listed transaction is one the IRS has determined to be a tax avoidance transaction. Treas. Reg. § 1.6011–4T, as amended by T.D. 92000, 2002–2 C.B. 87.

Taxpayers who purchase and entities who promote listed transactions have certain disclosure requirements to the IRS. In general, the taxpayer must file a disclosure statement with any tax return that includes gains or losses from a listed transaction. 26 U.S.C. § 6011. Promoters of listed transactions, who are also called material advisors, must keep lists identifying persons who engage in such transactions and report that information to the IRS upon request. 26 U.S.C. § 6112.

To combat the problem of taxpayers and promoters who fail to comply with the disclosure requirements, Congress extended the usual three-year statute of limitations for issuance of a deficiency notice or FPAA in cases involving undisclosed listed transactions until one year after the taxpayer or his tax-shelter advisor has complied with the notice requirements. 26 U.S.C. § 6501(c)(10).

The particular shelter in this case took the following form. Andrew Beal formed BPB and contributed to BPB $5 million in cash and stock with a cost basis of $4 million in Solution 6, an Australian company. Beal's purported plan was to takeover Solution 6 in a transaction requiring substantial sums of Australian dollars. To hedge the risk that the Australian dollar would appreciate (relative to the U.S. dollar) prior to closing on a takeover bid for Solution 6, BPB entered into a digital currency swap transaction with Deutsche Bank. The swaps included two long positions that required BPB to pay Deutsche Bank a fee of $202.5 million. Two short positions required Deutsche Bank to pay BPB a fee of $197.5 million. BPB only paid Deutsche Bank the net difference between the long and short positions, i.e. $5 million. In addition, the swaps required BPB and Deutsche Bank to make offsetting fixed payments to each other—under which term Deutsche Bank paid BPB approximately $2.5 million. Thus, BPB's net cost of these transactions was $2.5 million.

Shortly after Beal formed BPB, BPB formed a partnership called Bemont with Montgomery. BPB contributed the swaps contracts and Solution 6 stock to Bemont. The partnerships reported that the tax basis of the swaps contributed was $202.5 million, ignoring the $197.5 million offset represented by the short swaps.

After the swaps terminated in November 2001, Montgomery left the Bemont partnership with BPB, causing Bemont to terminate for tax purposes. Once Montgomery exited, Bemont's only asset was the Australian currency, which was deemed distributed to BPB. In late 2001, Beal and Montgomery decided not to pursue the takeover of Solution 6 and BPB sold most of the Australian currency at its fair market value. Using the inflated basis of $202.5 million, Bemont reported a $151 million foreign-currency loss on its 2001 return, which was allocated to Beal. In 2002, after the deemed distribution from Bemont, BPB sold the remainder of the Australian currency and reported a $46 million foreign-currency loss on its 2002 return, which was allocated to Beal.

In adopting this tax treatment, Beal and Montgomery relied on the advice of tax accountant, Matt Coscia, that the tax treatment using the inflated tax bases was likely correct. Neither Beal nor the partnerships filed the disclosure statements required by Notice 2000–44 and 26 U.S.C. § 6011 with their tax returns affected by participation in the transactions.

In April 2005, the IRS audited Beal's 2002 tax return and inquired about the $46 million loss allocated from BPB. Beth Montgomery, the accountant who had prepared Beal's return, gave the IRS agent a copy of the agreement assigning BPB's rights under the swaps to Bemont. The agreement listed all four swaps—two long and two short. She also provided copies of the confirmation letters for the long swaps but did not provide further detail on the short swaps. No adjustments were made by the IRS to Beal's return for that year.

On October 13, 2006, after the ordinary three-year statute of limitations for examining Beal's and the partnerships' 2001 returns had expired, the IRS issued FPAAs to BPB and Bemont. The FPAA the IRS issued to Bemont covered the 2001 tax year, disallowing the losses from the swaps and determining that Bemont's partners had no basis in the partnership. The FPAA the IRS issued to BPB dealt with the 2002 tax year, and disallowed the losses from the swaps and determined that the BPB partners had no basis. Thus this case deals with the 2001 losses reported by Bemont and the 2002 losses reported by BPB.

II.

The district court's findings of fact are reviewed for clear error and legal conclusions are reviewed de novo. Klamath Strategic Inv. Fund v. United States, 568 F.3d 537, 543 (5th Cir.2009).

III.

Ordinarily, the IRS must assess taxes within three years after a taxpayer files his return. 26 U.S.C. § 6501. Because the IRS issued the FPAA for Bemont's 2001 tax year more than three years after the return was filed, the district court had to determine whether the statute of limitations had run as to Bemont's 2001 return. The Internal Revenue Code allows an exception to the three year limitations period...