Pritired 1, LLC v. United States

• Decision Date: 30 September 2011
• Docket Number: No. 4:08–cv–00082–JAJ–TJS.,4:08–cv–00082–JAJ–TJS.
• Citation: 816 F.Supp.2d 693,108 A.F.T.R.2d 2011,2011 USTC P 50654
• Parties: PRITIRED 1, LLC, Principal Life Insurance Company, Tax Matters Partner, and Principal Life Insurance Company, Plaintiffs, v. UNITED STATES of America, Defendant.
• Court: U.S. District Court — Southern District of Iowa

108 A.F.T.R.2d 2011-6605

2011-2 USTC P 50,654

816 F.Supp.2d 693

PRITIRED 1, LLC, Principal Life Insurance Company, Tax Matters Partner, and Principal Life Insurance Company, Plaintiffs,

v.UNITED STATES of America, Defendant.

No. 4:08–cv–00082–JAJ–TJS.

United States District Court,S.D. Iowa,Central Division.

Sept. 30, 2011.

Harold N. Schneebeck, Jr., Varun Bhat, William C. Brown, Bruce B. Graves, Brown Winick Graves Gross Baskerville & Schoenebaum PLC, Des Moines, IA, for Plaintiffs.

James C. Strong, Stuart D. Gibson, Department of Justice, Washington, DC, for Defendant.

MEMORANDUM OPINION AND ORDER

JOHN A. JARVEY, District Judge.

+----------------------------------------------------------------------------+
                ¦I. ¦Nature of the Case                                              ¦696    ¦
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                ¦   ¦                                                                ¦       ¦
                +---+----------------------------------------------------------------+-------¦
                ¦II.¦Findings of Fact                                                ¦697    ¦
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    A.   Background and Notice of FPAA                                  697
                

         1.  Principal Companies                                        697
                         2.  Citibank                                                   697
                         3.  Pritired 1, LLC                                            698
                         4.  French Banks                                               698
                         5.  Notice of FPAA                                             698
                

    B.   Negotiations Forming Pritired Transaction                      699
                    C.   Basic Structure and Performance of Pritired Transaction        703
                

         1.  Basic Structure                                            703
                             Voting Rights and Expected Duration of the Pritired
                         2.  Transaction                                                705
                         3.  Calculation of Interest Rate                               707
                         4.  Cash Flows, PC Swaps, and B Share Swaps                    707
                         5.  Pritired Model Projections                                 710
                         6.  Actual Performance of Pritired Transaction                 712
                

    D.   Debt and Equity Attributes of Pritired Transaction             716
                

         1.  Expert                                                     716
                

             a.  Andrew S. Carron                                       716
                             b.  Joel Finard                                            717
                             c.  Michael Cragg                                          719
                

         2.  Analysis of the Debt and Equity Characteristics            720
                

             a.  Characterization                                       722
                             b.  Market Risk                                            723
                             c.  Credit Risk                                            724
                             d.  Voting Rights                                          725
                

         3.  Expected Economic Benefit of the Pritired Transaction      725
                

                III. Background of Relevant Law                                         728
                

    A.   Partnerships and Foreign Tax Credits                           728
                    B.   Notice 98–5                                                    728
                    C.   TEFRA                                                          729
                    D.   Burden of Proof                                                731
                

                IV. Analysis of the FPAA                                                732
                

    A.   Whether the Pritired Transaction Should Be Characterized as a  732
                         Loan
                

         1.  Intent to Form a Partnership                               732
                         2.  Debt and Equity Characteristics                            733
                

    B.   Whether the Pritired Transaction Lacks Economic Substance      735
                    C.   Whether the Pritired Transaction Violates the Anti–Abuse Rule  741
                    D.   Whether the Pritired Transaction Lacks Substantial Economic    741
                         Effect
                

                V.  Conclusion                                                          744
                

This matter comes before the Court pursuant to a bench trial held December 8–9, 13–15, and 17, 2010. The plaintiffs Pritired 1, LLC (“Pritired”) and Principal Life Insurance Company (“Principal”) were represented by Harold Schneebeck, Bruce Graves, and Varun Bhat. Defendant United States Government was represented by Stuart Gibson and James Strong. At the conclusion of the trial, the case was taken under advisement. The Court finds in favor of the United States.

The facts of this case are exceedingly complex. At the risk of oversimplification, the transaction at issue can be summarized as follows. American companies sent three hundred million dollars to French banks who combined the three hundred million dollars with nine hundred million dollars of their own. The money was used to earn income from low risk financial instruments. French income taxes were paid on the income from this approximately 1.2 billion dollar investment. The American companies received some cash from the income on the securities but, more importantly, were given the ability to claim foreign tax credits on the taxes paid on the entire 1.2 billion dollar pool. Through this transaction, the French banks were able to borrow three hundred million dollars at below market rates. The American companies received a very high return on an almost risk free investment. Only one thing could make such a transaction so favorable to everyone involved. United States taxpayers made it work.

I. Nature of the Case

This case is a dispute surrounding a complex set of transactions involving two United States companies and two French banks. It was commenced pursuant to a petition for readjustment of partnership item based on a Notice of Final Partnership Administrative Adjustment (“FPAA”) the Internal Revenue Service (“IRS”) issued to Principal on December 20, 2007. I.R.C. § 6226(a)(2) (“tax matters partner may file a petition for readjustment of the partnership items for such taxable year with ... the district court of the United States for the district in which the partnership's principal place of business is located”). The partnership tax provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”), Pub.L. No. 970248, 96 Stat. 324 (1982) (codified as amended at 26 U.S.C. § 6221, et seq. (1997)), enable the IRS to examine income tax returns filed by partnerships and make adjustments through issuance of a FPAA pursuant to 26 U.S.C. § 6223(a)(2). Section 6226 of the Internal Revenue Code permits this Court to conduct judicial review of the FPAA. I.R.C. § 6226(f).

Principal is the Tax Matters Partner for a partnership known as Pritired 1, LLC (“Pritired”). Pritired entered into a transaction with two French Banks, Bred Banque Populaire (“Bred”) and Natexis Banque Populaire (“NBP”) (collectively, “French Banks”). Citibank North America (“Citibank”) designed the transaction. In this transaction, Pritired received $291 million of Perpetual Certificates (“PCs”) and $9 million in “B Shares” from entities of the French Banks, LFI 4 SAS ¹ and VAL A SAS (collectively “SAS”) in exchange for $300 million in cash. The parties executed the transaction on October 27, 2000, and exited (unwound) it on December 31, 2005. As a result of the transaction, Principal claimed approximately $21 million in foreign tax credits against its taxable income for the years 2002 and 2003.

The IRS alleges that the Pritired transaction was structured to accrue foreign tax credits for its partners, but earn little to no cash return from its French investments. In the FPAA, the IRS determined that Principal was not entitled to claim Pritired's share of French foreign taxes paid or accrued for the years 2002 and 2003. Thus, the foreign tax credits for the partners of Pritired, including Principal were disallowed.

Principal disputes the FPAA's adjustments to the partnership income and filed this action to obtain a refund of the taxes resulting from the FPAA adjustments. Principal deposited the funds allegedly due and owing by reason of such adjustments, approximately $21.2 million. This action is to obtain a refund of that deposit. In accordance with Federal Rule of Civil Procedure 52(a)(1), the Court makes the following findings of fact and conclusions of law.

II. Findings of Fact

A. Background and Notice of FPAA

1. Principal Companies

Principal Financial Group is a multi-national insurance company that primarily engages in asset management and accumulation, including issuing insurance and annuity policies and guaranteed interest contracts. Principal Financial Group is a Delaware corporation with its principal place of business in Des Moines, Iowa. Final Pretrial Conference Order, Undisputed Facts ¶ A, Dkt. No. 57–1 (hereinafter “Undisputed Facts”).

Plaintiff Principal Life Insurance Company ² (“Principal”) is an Iowa insurance company with its primary office in Des Moines, Iowa. Id. ¶ A. Principal is a wholly-owned second-tier subsidiary of Principal Financial Group, Inc. Id. Principal sells, among other things, insurance, annuity, and guaranteed interest contracts. In order to meet the liabilities from these contracts, it invests the premiums and other consideration received in a variety of assets, including stocks, bonds, notes, and other assets. Principal is a “spread lender” because it generates income based on the difference (or “spread”) between what it pays out for capital and what it can earn by investing that capital.

Principal Capital Management, LLC, is a wholly-owned subsidiary of Principal Financial Group, Inc., and engages in asset management services. It provides investment management expertise and advice, and assists Principal in screening and exploring investment opportunities. Id. at 4, 15.

2. Citibank

Citibank is also a multi-national United States...