Unionbancal Corp. & Subsidiaries v. United States

• Decision Date: 23 October 2013
• Docket Number: No. 06-587T,06-587T
• Court: U.S. Claims Court
• Parties: UNIONBANCAL CORPORATION & SUBSIDIARIES, Plaintiff, v. THE UNITED STATES, Defendant.

UNIONBANCAL CORPORATION & SUBSIDIARIES, Plaintiff, v. THE UNITED STATES, Defendant.

No. 06-587T

United States Court of Federal Claims

Filed Under Seal: October 4, 2013

Reissued: October 23, 2013¹

Tax refund suit; Trial; Lease-in/lease out

(LILO) transaction involving public arena;

Substance-over-form doctrine; Consolidated

Edison and Wells Fargo examined; "Rent"

payments not deductible under section

162(a)(3) of the Code; Purchase option

likely to be exercised; "Interest" payments

not deductible under section 163 of the

Code; Circular obligations yielded no

genuine indebtedness.

OPINION

David Farrington Abbott, Mayer, Brown, Rowe, & Maw, LLP, New York, NY, for plaintiff.

Joseph Andrew Sergi, Tax Division, United States Department of Justice, Washington, D.C., with whom was Assistant Attorney General Kathryn M. Keneally, for defendant.

"When does a taxpayer cross the fault line between the cheering fields of tax planning and the forbidding elevations of form over substance, far enough, at least, to require a transaction to be recharacterized for tax purposes? No map - statutory, regulatory or otherwise - precisely reveals this point of no return. Rather, . . . the judicial traveler [is] guided only by multi-factored analyses, balancing tests and other forms of ad hocery, which, if properly employed, serve hope that the terrain's true character will be revealed."²

ALLEGRA, Judge:

This case is about LILOs and, relatedly, SILOs. No, not the Disney character, mind you, nor anything remotely agricultural or martial. Rather, the LILOs and SILOs at play here are acronyms, given to so-called "lease in/lease out" and "sale in/lease out" transactions, respectively. In the world of Federal taxation, LILOs and SILOs are labyrinthine, leveraged-lease transactions in which United States taxpayers seek the tax benefits associated with the ownership of properties that the actual owners - owing to their tax-exempt status - cannot enjoy. Before such transactions were banned by Congress, a variety of prodigious assets owned by foreign corporations and government agencies were so leased - rail cars, hydroelectric plants, locomotives, public transit lines, cellular telecommunications equipment, sewer systems, to name a few - all with the same objective, namely, to take advantage of deductions that would otherwise be "wasted."

This case is before the court following a trial in Washington, D.C. It involves the tax treatment of the Pond Transaction - a leveraged lease between a subsidiary of UnionBanCal Corporation (UBC) and the City of Anaheim, California (Anaheim or the City). Anaheim is a so-called "tax indifferent" entity because it is not subject to Federal income taxation. The Pond Transaction centers around the lease and simultaneous sublease of a sports and entertainment facility located in Anaheim, California, previously known as the Arrowhead Pond of Anaheim (the Pond).³ Anaheim controlled the operation of the Pond before and after the transaction. Notwithstanding this, at issue is whether, via this LILO, UBC obtained what Anaheim could not have enjoyed - the tax benefits of ownership and indebtedness, reflected in various deductions UBC claimed under the Internal Revenue Code of 1986⁴ for its 1999 through 2002 tax years. First, the facts.

I.

Based on the record, including the parties' stipulations, the court finds as follows:

UBC is a financial services company, headquartered in San Francisco, California. Though its subsidiaries, UBC offers a variety of banking and financial services to a broad spectrum of domestic and international customers. At the time of the Pond Transaction, Bankers Commercial Corporation (BCC), UNBC Leasing Inc., and UnionBanCal Leasing Corporation were all subsidiaries of UBC engaged in equipment leasing and other lease-related financing. UBC entered into direct financing and leveraged leases through its Equipment Leasing Division (the ELD), which managed the operations of BCC, UNBC Leasing, Inc., and UnionBanCalLeasing Corporation.⁵ Prior to the years in question, very few of the leases ELD entered into involved property in California; most had been with Japanese corporations and involved foreign-based property.

Prior to April 1996, The Bank of Tokyo, Ltd. was the parent company of Union Bank and The Mitsubishi Bank Ltd. was the parent company of the Bank of California. In April 1996, The Bank of Tokyo, Ltd., and The Mitsubishi Bank Ltd. merged to form The Bank of Tokyo-Mitsubishi, Ltd. (BTM). As part of the merger, the Bank of California and Union Bank consolidated into UBC, with its primary operating subsidiary being Union Bank of California, N.A. As of August 10, 1998, BTM owned 82 percent of UBC. As of March 3, 1999, BTM owned 64 percent of UBC, following a secondary offering of UBC stock and a stock repurchase. On January 1, 2006, BTM and UFJ Bank Ltd. combined to form the Bank of Tokyo-Mitsubishi UFJ, Ltd. (BTMU). On November 4, 2008, BTMU acquired the remainder of the outstanding stock of UBC, leaving UBC as a wholly-owned subsidiary of BTMU.

As of late 1998, Anaheim owned the Pond, an arena located in Anaheim, Orange County, California, about 28 miles southeast of downtown Los Angeles. On June 26, 1990, Anaheim and Ogden Facility Management Corporation of Anaheim (Ogden), a subsidiary of Ogden Corporation, entered into an agreement pursuant to which Anaheim agreed to construct and Ogden agreed to manage and operate the Pond. Construction of the Pond commenced in 1991. To finance that construction Anaheim issued Certificates of Participation (1990 COPS) in the amount of $103.6 million.⁶ By letter dated February 24, 1993, Disney Sports Enterprises, Inc. and Ogden reached an agreement whereby the Anaheim Mighty Ducks, a National Hockey League (NHL) franchise, agreed to play all of its regular season and playoff games at the Pond (the Mighty Ducks Agreement). The Mighty Ducks Agreement expires on February 23, 2023, unless terminated earlier. The grand opening of the Pond occurred on June 18, 1993. In November 1993, Anaheim issued $126.5 million in Certificates of Participation (COPS) in order to refinance its obligations with respect to the 1990 COPS, as well as to provide additional financing for improvements required by the Mighty Ducks Agreement, on-site and off-site parking improvements, and various administrative office and club improvements.

On December 1, 1993, the management agreement between Anaheim and Ogden was amended and restated in a Second Amended and Restated Management Agreement (the Management Agreement). The Management Agreement was for a term of thirty years, commencing on June 15, 1993, and ending on June 14, 2023. Pursuant to the Management Agreement, Anaheim granted Ogden the exclusive right to occupy, use, manage, operate, market, and promote the Pond, or to arrange for the use, management, operation, marketing, or promotion of the Pond. Ogden assumed responsibility for paying the Pond's operating expenses, including all interest principal, premium, fees, amounts, costs, and expenses required on the COPS. Neither the full faith and credit nor the taxing power of the City was pledged to the payment of the debt related to the COPS.⁷

In late 1998, Babcock & Brown, acting on behalf of Anaheim and Ogden Corporation, advanced the prospect of UBC doing the Pond Transaction with Lance Markowitz, Senior Vice President and head of the ELD.⁸ Babcock & Brown was the financial and leasing advisor both to Anaheim and Ogden, and advised those parties on how to structure and negotiate the terms of the Pond Transaction.⁹ For its part, UBC engaged BTM Capital Corporation (BTM), a sister corporation, as its leasing and financial advisor in reviewing and closing the Pond Transaction. Under Markowitz's direction, the ELD prepared a Credit Recommendation Summary and attached memorandum urging UBC's Senior Loan Committee to approve a proposal under which UBC would acquire an "equity portion of a leasehold interest" in the Pond. The Credit Recommendation Summary was signed "Recommended" by Markowitz and Joni LeSage of the ELD on December 22, 1998. The memorandum touted that the Pond Transaction was designedto protect UBC's investment from risk of loss.¹⁰ On December 24, 1998, UBC's Senior Loan Committee approved UBC's participation in the Pond Transaction.

The memorandum attached to the Credit Recommendation Summary strongly suggests that UBC's main purpose in entering into the LILO transaction was to achieve the tax benefits associated with rent and interest deductions. It stated that "[t]hough the tax benefit is not essential to a return of the investment, it is essential to obtaining an acceptable return on the investment." The memorandum noted that while the cash yield on the proposed investment was only approximately 3.0 percent pre-tax, "[t]he net after-tax yield of the proposed investment is approximately 10.0%," a "yield [that] compares very favorably to those available in other leverage lease transactions." (By comparison, at the time of the Pond Transaction, Treasury bonds and municipal bonds were yielding, on average, 4.5 percent and 3.47 percent, respectively.) Other UBC internal documents revealed that the tax benefits drove the transaction. A memorandum from UBC's files, for example, explained that "[f]rom the investor's perspective, the leasehold allows for very large write-offs in the first few years of the transaction." And at trial, Markowitz agreed that "[t]he tax benefits were essential to obtaining an acceptable return for BCC," adding that UBC "would not have pursued the transaction without the tax attributes."¹¹

While UBC was working its way through the approval process, so was Anaheim. In a January 22, 1999, memorandum to the City Manager and City Council of Anaheim, William Sweeney, then the Finance Director, recommended that the City Council approve the Pond Transaction. In this memorandum, he stated that "in terms of allocation of net proceeds, the agreement with [Ogden] provides...