Boca Investerings Partnership v. U.S.

• Decision Date: 05 October 2001
• Docket Number: Civ. A. No. 97-0602 (PLF).
• Parties: BOCA INVESTERINGS PARTNERSHIP, et al., Plaintiffs, v. The UNITED STATES of America, Defendant.
• Court: U.S. District Court — District of Columbia

Page 298

167 F.Supp.2d 298

BOCA INVESTERINGS PARTNERSHIP, et al., Plaintiffs, v. The UNITED STATES of America, Defendant.

Civ. A. No. 97-0602 (PLF).

United States District Court, District of Columbia.

October 5, 2001.

Melvin White, Diane L. Cafritz, Christopher Kliefoth, William L. Goldman, Karla Palmer, McDermott Will & Emery, Washington, DC, for plaintiffs.

Darren D. Farfante, Michael J. Salem, Samuel Alvin Mitchell, Thomas P. Holderness, U.S. Dept. of Justice, Washington, DC, Richard L. Gilman, Papermaster & Weltmann, Landover, MD, for defendant.

OPINION, FINDINGS OF FACT AND CONCLUSIONS OF LAW

PAUL L. FRIEDMAN, District Judge.

                                            TABLE OF CONTENTS
                INTRODUCTION ................................................................302
                

                I. FINDINGS OF FACT .......................................................303
                   A. American Home Products ..............................................303
                      1. AHP Generally.....................................................303
                      2. HP General Business Goals ........................................305
                      3. AHP General Treasury Function ....................................305
                      4. AHP General Tax Function .........................................307
                   B. American Home Products' Sale of Boyle-Midway ........................308
                   C. Proposal of Boca Investerings Partnership ...........................308
                      1. Merrill Lynch Proposal ...........................................308
                         a. Nature of Investments .........................................312
                         b. Potential Partners ............................................313
                         c. Merrill Lynch's Fee ...........................................314
                         d. Risks Associated With and Timing and Review of Potential
                              Subsequent Transactions .....................................314
                      2. AHP Internal Evaluation and Approval of Proposal .................315
                      3. Foreign Partners' Decision to Invest in Partnership ..............318
                   D. Organization of Boca ................................................319
                      1. Formation of the Partnership in Bermuda ..........................319
                      2. The Partnership Agreement ........................................323
                      3. The Organizational Meeting in Bermuda ............................326
                   E. Boca's Investments and Transactions .................................328
                      1. Purchases of PPNs ................................................328
                      2. Sale of the PPNs for Cash and LIBOR Notes ........................331
                         a.  May 18, 1990 Partnership Meeting .............................331
                         b.  AHP Approval .................................................332
                         c.  Sale of PPNs for Cash and LIBOR Notes ........................333
                         d.  Negotiability of LIBOR Notes .................................335
                         e.  Results as of May 31, 1990 ...................................335
                         f.  Merrill Valuations and the Loss on the LIBOR Notes............336
                         g.  Transaction Costs.............................................337
                      3. Purchase of Portion of Syringa's Partnership Interest in Boca ....337
                         a.  Syringa's Request and Partnership Meeting ....................337
                         b.  Effect of Purchase ...........................................339
                      4. Distribution of LIBOR Notes to AHP and AHP 10 and Cash to
                           Addiscombe and Syringa .........................................339
                      5. Further Reductions In Syringa's Interest .........................342
                      6. Sale of LIBOR Notes ..............................................344
                      7. Withdrawal Of Syringa from Boca ..................................345
                      8. Purchase of Addiscombe's Partnership Interest ....................346
                         a.  AHP's Request ................................................346
                         b.  Effect of Buy-Out ............................................346
                

                F. Economic Relationship Among the Partners .................................. 348
                    G. Economic Substance of Plaintiffs' Transactions ............................ 349
                       1. The Expert Witnesses ....................................................... 349
                       2. Boca's Ownership of the PPNs ............................................... 351
                          a. Benefits of Ownership ................................................... 351
                          b. Risks of Ownership ...................................................... 351
                       3. Boca's Ownership of the LIBOR Notes ........................................ 352
                       4. Prospects for Profit on Investments ........................................ 354
                       5. Addiscombe's and Syringa's Profits ......................................... 358
                       6. Absence of Debtor/Creditor Relationship .................................... 358
                       7. The Partners' Capital Accounts and Installment Sale Gain ................... 359
                    H. Activities Outside of the Partnership ..................................... 360
                       1. Addiscombe and Syringa Swaps with ABN Bank ................................. 360
                       2. ABN Bank-MLCS Swaps ........................................................ 361
                       3. MLCS Swaps with LIBOR Note Issuers ......................................... 361
                       4. Effect of Swaps on the Partnership ......................................... 362
                    I. Boca's Tax Reporting ...................................................... 362
                II. CONCLUSIONS OF LAW ............................................................... 363
                    A. The Burden of Proof ....................................................... 365
                    B. Relevant Statutory and Legal Background ................................... 365
                    C. The Boca Partnership ...................................................... 367
                       1. Formation and Operation of the Partnership ................................. 368
                          a. AHP's Approval of the Partnership ....................................... 368
                          b. The Agreement to Enter a Partnership .................................... 369
                          c. The Partnership Agreement ............................................... 370
                          d. Operation as a Partnership .............................................. 370
                          e. Each Partner's Interest in the Partnership .............................. 371
                       2. Conclusions of Law Regarding the Boca Partnership .......................... 372
                    D. The Boca Transactions ..................................................... 374
                       1. Boca's Investments and Transactions ........................................ 377
                          a. Initial Investment in Boca and Purchase of PPNs ......................... 377
                          b. Sale of PPNs and Purchase of LIBOR Notes ................................ 378
                          c. Purchase of Syringa's Interest in Boca and Acquisition of LIBOR
                              Notes .................................................................. 379
                          d. Sale of LIBOR Notes and Purchase of Addiscombe's Interest in
                              Boca ................................................................... 379
                       2. Conclusions of Law Regarding the Boca Transactions ......................... 380
                    E. Alternative Determinations ................................................ 380
                       1. Debtor/Creditor Relationship ............................................... 381
                       2. Step Transaction Doctrine .................................................. 383
                       3. Creation of Market for LIBOR Notes ......................................... 384
                

                       4. Allocation of Installment Sale Gain under Section 704(b) ................... 386
                       5. Conclusions of Law Regarding the Commissioner's Alternative Determinations
                            .......................................................................... 387
                III. CONCLUSION ...................................................................... 388
                

INTRODUCTION

Plaintiff's Boca Investerings Partnership ("Boca" or the "Partnership") and its tax matters partner, American Home Products Corporation ("AHP" or the "Company"), brought this action under Section 6226(a) of the Internal Revenue Code of 1986, as amended, 26 U.S.C. § 6226(a) (1994), seeking a judicial readjustment of certain partnership items affected by the Commissioner of Internal Revenue's Notice of Final Partnership Administrative Adjustment ("FPAA"), dated December 30, 1996. As a result of financial transactions entered by the Boca partnership, AHP — one of the partners — enjoyed a significant tax benefit: the ability to declare substantial capital losses on its tax returns for fiscal years ending May 31, 1990, 1991, 1992 and 1993, which in turn would offset a large capital gain it incurred in 1990.

In the FPAA the Commissioner reallocated to AHP much of the capital gain accrued by Boca through the transactions after finding that Boca was a sham partnership created by AHP for the sole purpose of creating the capital loss. Plaintiffs argue that the adjustments made by the Commissioner should be readjusted to the amounts originally reported by Boca on its partnership federal income tax returns because Boca was a bona fide partnership for federal income tax purposes and because the financial transactions entered by Boca that created the capital loss had sufficient economic substance to be recognized for federal income tax purposes. Defendant asserts that the Commissioner's determination must be upheld and judgment must be entered for defendant because plaintiffs failed at trial to show by a preponderance of the evidence that the Commissioner's findings were erroneous.

The case was tried before the Court without a jury over a period of 17 days in June, September and November 2000, and in January and April 2001. At trial, plaintiffs called as witnesses Thomas M. Nee, AHP Vice President, Taxes; Milan Kofol, AHP Deputy Treasurer; Richard...