Uviado Llc v. U.S.

Citation755 F.Supp.2d 767
Decision Date02 August 2010
Docket NumberCivil Action Nos. H–09–0052, H–09–0065.
PartiesUVIADO, LLC, by and through Shahid R. KHAN a partner other than the Tax Matters Partner, Plaintiff,v.UNITED STATES of America, by and through the INTERNAL REVENUE SERVICE, Defendant.Leman, LLC, by and through Jonction LLC a partner other than the Tax Matters Partner, Plaintiff,v.United States of America, by and through the Internal Revenue Service, Defendant.
CourtU.S. District Court — Southern District of Texas

OPINION TEXT STARTS HERE

Linda Schulze Paine, Lawrence W. Sherlock, Chamberlain Hrdlicka et al., Houston, TX, for Plaintiff.Grover Hartt, III, Department of Justice, Dallas, TX, Jonathan L. Blacker, Attorney at Law, Dallas, TX, Joshua David Smeltzer, Dallas, TX, for Defendant.

MEMORANDUM AND OPINION

LEE H. ROSENTHAL, District Judge.

In January 2009, two investment partnerships, Uviado, LLC and Leman, LLC, filed these lawsuits against the United States, seeking readjustment of partnership items proposed in two notices of Final Partnership Administrative Adjustment (“FPAA”) issued in August 2008 by the Commissioner of the Internal Revenue Service. The issue addressed in this opinion is venue, which turns on the partnerships' principal place of business.

The plaintiffs contend that in late 2008, they moved the principal place of their business to Houston, Texas. The United States argues that Uviado and Leman attempted to “manufacture venue” in Houston shortly before filing these lawsuits in order to take advantage of Fifth Circuit case law relating to penalties that is more favorable to Khan than the law in the alternative available venues. Those alternatives are the Tax Court, the Court of Federal Claims, the Central District of Illinois, or the District of Connecticut. (Uviado Docket Entry No. 16–1 at 9–13). According to the United States, even disregarding the plaintiffs' motivation to “manufacture” venue in Texas, their efforts to do so were ineffective under the applicable law. That law includes the Supreme Court's recent clarification of the iconic phrase “principal place of business” in 28 U.S.C. § 1332(c) to mean, for a corporation, its “nerve center,” the “actual center of direction, control, and coordination” by the officers. Hertz Corporation v. Friend, ––– U.S. ––––, 130 S.Ct. 1181, 1192, 175 L.Ed.2d 1029 (2010).

The United States has moved to transfer venue to the Central District of Illinois under 28 U.S.C. § 1406(a), asserting that venue is improper in Houston, Texas. The parties conducted discovery limited to the venue issue and exchanged briefs. Based on the motion, response, reply, and surreply; 1 the record; and the applicable law, this court concludes that the principal place of business for Uviado, LLC, and Leman, LLC at the relevant time was not Houston, Texas, but rather Champaign–Urbana, Illinois. Accordingly, the motions to transfer are granted and these cases are transferred to the Central District of Illinois, Urbana Division.

The reasons are explained below.

I. Background

In early January 2009, Uviado, LLC, through its partner, Shahid R. Khan, and Leman, LLC, through its partner, Jonction, LLC (of which Khan was a partner and sole manager), sued the United States seeking readjustment of partnership items proposed in two notices of Final Partnership Administrative Adjustment (“FPAA”) issued by the IRS. The United States asserts that through these and three other earlier partnerships, Shahid Khan, who lives and has a business in Illinois, engaged in a series of transactions to shelter “virtually all of his income”—approximately $250,000,000—from taxation. Both partnerships claim that venue is proper under 26 U.S.C. § 6226 and 28 U.S.C. § 1402 in the Southern District of Texas, Houston Division, because their principal places of business are in Houston. The only issue litigated so far has been whether venue is proper in Houston, Texas or Urbana, Illinois.

A. The Underlying Tax Issues: The Tax Equity and Fiscal Responsibility Act of 1982 (“TEFRA”)

TEFRA was enacted “to improve the auditing and adjustments of income tax items attributable to partnerships.” Kornman & Assocs., Inc. v. United States, 527 F.3d 443, 446 n. 1 (5th Cir.2008) (citing Alexander v. United States, 44 F.3d 328, 330 (5th Cir.1995)). TEFRA established “a single unified procedure for determining the tax treatment of all partnership items at the partnership level, rather than separately at the partner level.” Id. (citing Callaway v. Comm'r, 231 F.3d 106, 108 (2d Cir.2000)). Partnerships are not subject to federal income taxes. 26 U.S.C. § 701. “Instead, a partnership is treated as a conduit through which income passes to its partners, who are responsible for reporting their pro rata share of tax on their individual income tax returns.” Duffie v. United States, 600 F.3d 362, 365 (5th Cir.2010). While not subject to tax, the partnerships file informational tax returns. Id. The Act “consolidated the partnership-level audit and adjustment procedures by requiring that ‘the tax treatment of any partnership item shall be determined at the partnership level.’ Id. (quoting 26 U.S.C. § 6221). After TEFRA, rather than conducting individual partner-level proceedings, the IRS can collectively adjust partnership items in a single proceeding and assess the partners separately based on the adjustments. Id. (citing Prati v. United States, 81 Fed.Cl. 422, 427 (2008)).

The IRS notifies the individual partners of an adjustment by issuing an FPAA. 26 U.S.C. § 6223. The FPAA sets out the IRS's adjustments and provides the grounds for the adjustment. Duffie, 600 F.3d at 366. The tax matters partner—the partner “designated to act as a liaison between the partnership and the IRS in administrative proceedings and as the representative of the partnership in judicial proceedings”—has the exclusive right to challenge the proposed adjustments for ninety days following issuance of the FPAA. Id. at 365 n. 1; see 26 U.S.C. § 6226(a). If the tax matters partner does not file suit challenging the FPAA within ninety days, the other partners have sixty days to file a petition for readjustment. 26 U.S.C. § 6226(b)(1); Duffie, 600 F.3d at 366. “If a partnership level challenge is filed, each partner in the partnership is deemed a party to the case.” Duffie, 600 F.3d at 367 (citing 26 U.S.C. § 6226(c)(1)).

B. The Venue Provisions

The Internal Revenue Code requires a partner to file a petition challenging the FPAA in one of three places: (1) the Tax Court, (2) the district court of the United States for the district in which the partnership's principal place of business is located, or (3) the Court of Federal Claims.” 26 U.S.C. § 6226(a). As to the second option, the Treasury Regulations state: “The principal place of a partnership's business for purposes of determining the appropriate district court in which a petition for a readjustment of partnership items may be filed is its principal place of business as of the date the petition is filed.” 26 C.F.R. § 301.6226(a)–1. The regulations give an example of a partnership that moves its principal place of business after the date the IRS issues an FPAA but before the complaint seeking judicial review of that adjustment is filed. Id. § 301.6226(a)–1(b). The term “principal place of business” is not defined in the Internal Revenue Code. No cases interpret the meaning of “principal place of business” in the specific context of 26 U.S.C. § 6226 nor cite 26 C.F.R. § 301.6226(a)–1.

The United States argues that the partnerships' primary place of business was not in the Southern District of Texas when the petitions were filed and seeks to transfer the case to the Central District of Illinois under 28 U.S.C. § 1406(a). The parties agree that a partnership can have only one principal place of business.

C. The Facts Relevant to Venue

The relevant facts are largely undisputed.2 The legal significance of those facts is vigorously contested. A chronological summary of the relevant facts is set out below.

The tax years at issue are 2002 and 2003. The taxpayers at issue are Shahid Khan and his wife. Shahid Khan is a businessman who for over forty years has lived and worked in Champaign–Urbana, Illinois. Khan is the president of Flex–N–Gate Corporation (“FNG”), which is headquartered in Urbana, Illinois. Khan lives at 1102 Wilshire Court in Champaign, Illinois. In 2002, Khan reported $68,420,913 in wages and non-passive and passive income from FNG. (Uviado Docket Entry No. 15–3, Smeltzer Decl., Ex. A). In 2003, Khan reported $55,149,740 in wages and non-passive and passive income from FNG. ( Id., Ex. B). The transaction involving Uviado occurred in 2002 and Leman in 2003. Both transactions were promoted by an entity affiliated with Gramercy, “a boutique investment management firm” specializing in distressed debt investments. (Uviado Docket Entry No. 1 at 3). Gramercy is a limited liability company organized under Delaware law with its principal office in Greenwich, Connecticut.3

1. 2002

Uviado was formed in Delaware in 2002. According to Uviado's complaint in this case, Gramercy formed the investment partnership “to actively invest in U.S. and non-U.S. denominated distressed debt instruments.” ( Id. at 4). In 2002, Uviado had five members. Khan had an 85.63 percent interest in Uviado. The remaining interest was held by entities related to Gramercy. (Docket Entry No. 15–9, Exhibit 5 at 40). The initial operating agreement for Uviado stated that its “principal office” was in Greenwich, Connecticut “or at such other address as the Sole Manager shall determine in its sole discretion.” ( Id. at 6).

The United States explains that in the 2002 tax year, Uviado was a “Distressed Asset/Debt” or “DAD” tax shelter. (Uviado Docket Entry No. 16–1 at 4). The United States alleges that Uviado bought “worthless Brazilian debts through transactions designed to disguise the true economics of the transaction.” ( Id.). According to the plaintiff, in 2002 Uviado sold...

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