Ya Global Investments, LP F.K.A. Cornell Capital Partners, LP, Yorkville Advisors, GP LLC, Tax Matters Partner and Ya Global Investments, LP F.K.A. Cornell Capital Partners, LP, Yorkville Advisors, LLC, Tax Matters Partner

United States Tax Court

T.C. Memo. 2024-78

YA GLOBAL INVESTMENTS, LP f.k.a. CORNELL CAPITAL

PARTNERS, LP, YORKVILLE ADVISORS, GP LLC, TAX MATTERS

PARTNER AND YA GLOBAL INVESTMENTS, LP f.k.a. CORNELL

CAPITAL PARTNERS, LP, YORKVILLE ADVISORS, LLC, TAX

MATTERS PARTNER,

Petitioners

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

YA GLOBAL INVESTMENTS, LP, YORKVILLE ADVISORS GP, LLC,

TAX MATTERS PARTNER,

Petitioner

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent

—————

Docket Nos. 14546-15, 28751-15. Filed August 8, 2024.

—————

PS, a partnership, provided funding to portfolio

companies in exchange for stock, convertible debentures,

promissory notes, and warrants. Under its established

accounting policies, PS stopped accruing interest on

debentures and promissory notes when, in the opinion of

its general partner, reasonable doubt existed as to the

collectibility of the interest. PS wrote off previously

accrued interest when it determined that payment by the

debtor was unlikely. During 2009, PS accrued $17,137,938

of interest that it ended up writing off as an expense for the

year. Also during that year, PS’s general partner

established foreign special purpose vehicles (Foreign SPVs)

Served 08/08/24

2

[*2] to facilitate the redemption of indirect interests in PS.

Each Foreign SPV held participation interests entitling it

to receive cash distributions as PS sold specified securities.

On December 31, 2009, PS held stock, warrants, and

convertible debentures issued by C, an Australian

corporation in voluntary administration. On its financial

statements, PS reported that its C convertible debentures

were worth $148,269,798 on December 31, 2009. In an

amended petition, Ps made the affirmative claim that PS

was not required to have accrued for 2009 the $17,137,938

of interest that it later wrote off.

Held: PS was engaged in a U.S. trade or business

during 2009.

Held, further, PS is required by I.R.C. § 475(a)(2) to

recognize gain or loss as if each security it held on

December 31, 2009, had been “sold for its fair market

value” on that date.

Held, further, Ps have not established that any

portion of the $148,269,798 value that PS assigned to its C

convertible debentures was attributable to one or more

assets that were not “securities” within the meaning of

I.R.C. § 475(c)(2).

Held, further, if the participation interests held by

the Foreign SPVs were contract rights to shares of the

proceeds from the sale of specified securities owned by PS,

those interests were capital interests in PS. See Treas.

Reg. § 1.704-1(e)(1)(v).

Held, further, I.R.C. § 704(e)(1), as in effect for 2009,

required that the owner of a capital interest in a

partnership be recognized as a partner regardless of that

person’s subjective intent to participate in the

partnership’s business.

Held, further, because the record does not establish

whether the participation interests held by the Foreign

SPVs gave them undivided ownership interests in specified

securities or instead were contractual rights to receive

proceeds upon PS’s sale of those securities, Ps have not met

their burden of establishing that the Foreign SPVs were

3

[*3] not partners in PS during 2009. Therefore, PS’s

withholding tax liability under I.R.C. § 1446 for 2009 must

take into account the items of partnership income, gain,

loss, and deduction allocable to the Foreign SPVs.

Held, further, Ps have not established that, when PS

accrued the $17,137,938 of interest it later wrote off for

2009, there was no reasonable expectation that the interest

would ultimately be paid. PS’s accrual of the interest

indicates that, at the time of accrual, its general partner

had not determined that reasonable doubt existed as to the

collectibility of the interest. Ps have not identified any

evidence unavailable to PS’s general partner during 2009

that establishes that PS should have had no reasonable

expectation of ultimately receiving the interest.

__________

Ellis L. Reemer, Henry C. Cheng, Tamara L. Shepard, and Caryn G.

Schechtman, for petitioners.

Gretchen A. Kindel, Robert T. Bennett, Rebecca J. Kalmus, Charles E.

Buxbaum, Shawna A. Early, Kelly M. Davidson, and Travis Vance III,

for respondent.

MEMORANDUM FINDINGS OF FACT AND OPINION

HALPERN, Judge: In these cases, we review notices of final

partnership administrative adjustment (FPAAs) in which respondent

adjusted various partnership items reported by YA Global Investments,

LP, a limited partnership (YA Global or the partnership) for the taxable

years ended December 31, 2006, 2007, 2008, and 2009.1 The FPAAs

reflect respondent’s determination that the partnership was engaged in

a U.S. trade or business during those years and that, consequently, it

was liable for withholding tax under section 14462 on the portion of its

1 Respondent also issued FPAAs for the partnership’s 2010 and 2011 taxable

years but made no adjustment to its partnership items for those years.

2 Unless otherwise indicated, statutory references are to the Internal Revenue

Code, Title 26 U.S.C., in effect for the years in issue, regulation references are to the

Code of Federal Regulations, Title 26 (Treas. Reg.), in effect for those years, and Rule

4

[*4] taxable income effectively connected with that trade or business

that was allocated to foreign partners. The FPAAs also determined that

the partnership was liable for additions to tax under sections 6651(a)(1)

and (2) and 6655 for its failure to file Forms 8804, Annual Return for

Partnership Withholding Tax, and its failure to pay estimated taxes and

section 1446 withholding tax.

In addition to assigning error to respondent’s determination that

YA Global was engaged in a U.S. trade or business during the years in

issue, petitioners raised various issues regarding the manner in which

respondent computed the partnership’s section 1446 withholding tax

liability. And petitioners challenged respondent’s determinations of the

additions to tax. Petitioners also alleged that the applicable statute of

limitations barred respondent from assessing the tax and additions to

tax in issue for 2006 and 2007.

In YA Global Investments, LP v. Commissioner, Nos. 14546-15

and 28751-15, 161 T.C. (Nov. 15, 2023), we addressed the issues that

affected YA Global’s taxable years ended December 31, 2006, 2007, and

2008. For the reasons explained in that opinion, we concluded that

(1) the activities of Yorkville Advisors, the manager of YA Global’s

assets, were attributable to the partnership, (2) YA Global was engaged,

through Yorkville Advisors, in the conduct of a U.S. trade or business

during 2006, 2007, and 2008, (3) YA Global was required to recognize

gain under the “mark-to-market” rule of section 475(a)(2) for each of

2006, 2007, and 2008, (4) all of YA Global’s taxable income for 2006,

2007, and 2008 was effectively connected with its U.S. trade or business,

(5) YA Global’s liability for section 1446 withholding tax for 2007 and

2008 could not be “adjusted” under section 1464 to reflect stipulated

expenses of YA Offshore Global Investments, Ltd. (YA Offshore), beyond

its distributive share of partnership deductions, (6) YA Global’s filing of

Form 1065, U.S. Return of Partnership Income, for each of 2006, 2007,

and 2008 did not commence the period of limitation on the assessment

of section 1446 withholding tax for the year, and (7) YA Global is liable

for additions to tax under section 6651(a)(1) and (2) for its failure to file

Forms 8804 and pay section 1446 withholding tax.

references are to the Tax Court Rules of Practice and Procedure in effect for the

relevant times.

5

[*5] Conference calls held with the parties’ counsel on November 29,

2023, and February 22, 2024, identified the following issues that remain

to be decided for YA Global’s taxable year ended December 31, 2009:

1. Whether the increase in the value of YA Global’s interest

in Compass Resources, Ltd. (Compass), during 2009 was

attributable to securities subject to section 475’s mark-to-

market rules;

2. Whether any of the items effectively connected with YA

Global’s U.S. trade or business for 2009 are properly

allocated to foreign special purpose vehicles to which the

partnership issued Schedules K‒1, Partner’s Share of

Income, Deductions, Credits, etc., for that year;

3. The value of accrued interest on convertible debentures

held by YA Global on December 31, 2009, for the purpose

of determining the partnership’s mark-to-market gain or

loss for the year under section 475(a)(2); and

4. Whether YA Global was required to accrue for 2009

$17,137,938 of interest that it wrote off on its books.3

FINDINGS OF FACT

YA Global’s Activities

YA Global provided funding to portfolio companies in the form of

convertible debentures, standby equity distribution agreements

(SEDAs), and other securities. In a SEDA, YA Global committed to

purchasing up to a specified dollar value of a portfolio company’s stock

over a fixed period, typically two years. The portfolio companies to

3 In an Order issued December 1, 2023 (December 1 Order), we identified an

additional issue related to YA Global’s liability for additions to tax. The Supplemental

Briefs that the parties submitted in response to that Order indicated that the parties’

only disagreements regarding the additions to tax respondent determined were

derivative of other issues. In regard to YA Global’s 2010 and 2011 taxable years,

shortly after trial, the parties stipulated:

To the extent that YA Global is found to be engaged in a U.S. trade or

business in 2006 through 2009, YA Global was also engaged in such

U.S. trade or business in 2010 and 2011; in such case, YA Global’s

income and losses for 2010 and 2011 will be computed using the same

methodology used to make adjustments to YA Global’s Forms 1065 for

2006 through 2009 as shown in the FPAAs for those years.

6

[*6] which YA provided funds were generally small, microcap companies

that would have been unable to receive funds from conventional sources

such as commercial banks.

Compass

In November 2007, YA Global entered into a Series A Convertible

Loan Agreement with Compass, an Australian company. Compass

initially borrowed $25 million under that agreement and, in May 2008,

borrowed an additional $11 million. Between April and December of

2008, Compass repaid about $13 million. On January 29, 2009,

Compass entered into voluntary administration, and its stock was

suspended from trading. In 2009, YA Global held Compass stock and

warrants, in addition to convertible debt. On April 22, 2009, the

administrator appointed in connection with Compass’s voluntary

administration prepared a 94-page “Circular to Creditors.”

At a meeting of Compass shareholders held on June 17, 2010, YA

Global, as one of the corporation’s creditors, submitted a proposal to

recapitalize the corporation. Under the proposal, YA Global would have

received 2,263,267,330 new Compass shares in exchange for the debt

Compass owed to YA Global on January 29, 2009, which was stated at

approximately $35,538,068. The plan also called for YA Global to make

additional advances of up to about $50 million. Another creditor, Coffee

House, would have received 422,101,919 shares in exchange for the debt

Compass owed to it, which was stated at approximately $37,798,404.

The issuance of new stock to YA Global and Coffee House would have

diluted the interests of existing Compass shareholders to about 5%.

Compass’s administrators asked DMR Corporate Pty Ltd. (DMR)

to prepare an independent expert’s report evaluating YA Global’s

proposed recapitalization of Compass. DMR concluded that Compass

“ha[d] a nil value” before the proposed recapitalization because “a

substantial deficiency of net assets will result from both an orderly

realisation of assets and from a liquidation of the assets.”

According to the DMR report, “[u]nder the liquidation of assets

valuation methodology, the Administrators estimate that [Compass]

would have a deficiency of assets of $66,647,967.” Compass’s pro forma,

postrecapitalization, balance sheet showed total liabilities of

$42,421,199. As noted in the text, in the recapitalization, about

$35,538,068 of debt held by YA Global and about $37,798,404 of debt

held by Coffee House would be exchanged for newly issued Compass

7

[*7] stock. Therefore, Compass apparently had total liabilities before

the recapitalization of about $115,757,671 ($42,421,199 + $35,538,068 +

$37,798,404). The administrators thus determined that a sale of

Compass’s assets in liquidation would generate proceeds of about

$49,109,704 ($115,757,671 − $66,647,967).

Neither the “orderly realisation” scenario nor the liquidation

scenario valued Compass as a going concern. According to the DMR

report: “The orderly realisation of assets method estimates the fair

market value by determining the amount that would be distributed to

shareholders, after payment of all liabilities including realisation costs

and taxation charges that arise, assuming the company is wound up in

an orderly manner.” “The liquidation method,” the report explained, “is

similar to the orderly realisation of assets method except the liquidation

method assumes that the assets are sold in a short time frame.”

In evaluating the fairness of the proposed recapitalization,

however, DMR valued Compass as a going concern. It accepted that, if

Compass were valued as a going concern, its gross assets would be worth

$113,250,000, substantially more than the $49,109,704 of proceeds that

could be raised from a liquidating sale. Thus, Compass’s net assets, after

the proposed recapitalization, would be $70,828,801 ($113,250,000 total

assets less $42,421,199 remaining liabilities).4 DMR valued the existing

shareholders’ interests in Compass at $3,541,000 (roughly 5% of

$70,829,000). In other words, DMR determined that the same stock that

would have been worthless in an “orderly realisation” or liquidation

scenario would be worth about $3.5 million if Compass were maintained

as a going concern, recapitalized in accordance with YA Global’s

proposal. For that reason, DMR judged the proposed recapitalization to

be fair.

YA Global’s initial recapitalization proposal was approved by

Compass’s creditors but not by its shareholders. YA Global then

submitted a revised proposal that was approved by both Compass’s

creditors and shareholders.

Special Purpose Vehicles

Most investors in YA Global participated in the partnership

through one of two “feeder” funds: YA Offshore and YA Global

4 DMR viewed a net asset value of $70,829,000 as a “conservative estimate,”

and opined that, “in a best-case scenario,” Compass’s equity value “could be up to

$20,000,000 higher.”

8

[*8] Investments (U.S.), LP (YA Onshore). U.S. investors owned their

interests in YA Global through YA Onshore, and foreign investors held

their interests in YA Global through YA Offshore.

YA Global’s general partner established two special purpose

vehicles (SPVs) at the end of each quarter during 2009, one for the

benefit of investors in YA Onshore and another for the benefit of

investors in YA Offshore. The SPVs facilitated redemption requests

made by the investors. Each investor who sought redemption (of either

its partnership interest in YA Onshore or its stock in YA Offshore) was

given the option of receiving an in-kind distribution of securities or an

ownership interest in one of the SPVs, which held “pro rata participation

interests” in YA Global’s securities. The SPVs would receive cash

distributions as YA Global liquidated its securities in the ordinary

course of its business.

At trial, Oren Franks, YA Global’s controller, explained that the

SPVs gave withdrawing investors “a slice—their pro rata slice” of YA

Global’s existing securities. The withdrawing investors, he said, “would

no longer participate in new investments done by YA Global.”

Financial Reporting

YA Global issued its 2009 financial statements in August 2010.

(The auditor’s report on those financial statements is dated August 13,

2010.)

YA Global’s Consolidated Statement of Financial Condition as of

December 31, 2009, reported the partnership’s investments at fair

value. An explanatory note accompanying the partnership’s financial

statements includes an extensive discussion of how the partnership

determined the fair value of its investments. According to that note,

convertible debentures, promissory notes, and other assets “for which no

. . . market prices [were] available [were] valued at fair value as [YA

Global’s] General Partner . . . reasonably determine[d] in good faith.”

YA Global accounted separately for accrued interest on

debentures and promissory notes and the underlying instruments. Its

Consolidated Statement of Financial Condition as of December 31, 2009,

lists “Investments” (including Convertible Notes and Debentures and

9

[*9] Promissory Notes) and “Interest Receivable” as separate assets.5

The explanatory note describes the partnership’s accounting for accrued

interest: “The accrual of interest is discontinued when, in the opinion of

the General Partner, there is reasonable doubt as to collectability. The

Partnership also records a charge to operations for interest receivable

that is written-off when management determines that payment by the

debtor is unlikely.”

The Schedule of Investments included in YA Global’s financial

statements for 2009 lists convertible debentures of Compass at a value

of $148,269,798. That amount is the midpoint of a range of values for

YA Global’s interest in Compass as of September 30, 2009, determined

by the financial advisory firm Valuation Research Corp. (VRC). In

valuing YA Global’s interest in Compass, VRC estimated Compass’s

enterprise value at $250.9 million to $306.9 million.

YA Global’s Consolidated Statement of Financial Condition for

2009 reports a liability of $316,254,804 described as “Due to Special

Purpose Vehicles.” An explanatory note describes that amount as “[t]he

fair value of the participating interests in the Partnership held by the

SPVs . . . as of December 31, 2009.” The partnership’s 2009 Consolidated

Statement of Changes in Partners’ Capital reports withdrawals of

$329,120,453. A footnote explains that that figure “[i]ncludes

$277,044,686 of in-kind distributions . . . of participating interests in

Special Purpose Vehicles.”

YA Global’s Consolidated Statement of Operations for 2009

reports an investment loss of $10,839,690, the excess of expenses of

$56,716,169 over income of $45,876,479. The reported expenses include

a $46,506,023 “[w]rite-off of interest receivable deemed uncollectible.”

Tax Reporting

The Form 1065 that YA Global filed for 2009 reported a taxable

loss of $125,568,354, consisting of $42,617,464 of interest, a short-term

capital loss of $18,792,337, a long-term capital loss of $96,771,203, other

income of $4,042,912, and other deductions of $56,665,190. By contrast,

the partnership’s loss per income statement for the year, as reported on

line 26(a) of Schedule M‒3, Net Income (Loss) Reconciliation for Certain

Partnerships, Part II, was only $21,715,680. The partnership’s loss per

5 YA Global reported $34,581,418 of interest receivable as of December 31,

2009. By contrast, it reported $66,237,160 of interest receivable as of December 31,

2008.

10

[*10] income statement reflected other income of $103,852,672 not

taken into account for tax purposes. An explanatory statement

identifies the other income as “Change in Unrealized Appreciation.”

The “other deductions” of $56,665,190 that YA Global reported on

line 13d of Schedule K, Partners’ Distributive Share Items, of its 2009

Form 1065 include the same writeoff of interest receivable reported on

YA Global’s 2009 financial statements ($46,506,023), legal fees of

$7,521,049, other professional fees of $1,602,188, and other investment

expenses of $1,035,930.

YA Global issued Schedules K–1 for 2009 to, among others, YA

Offshore and the following four SPVs: YA Offshore Global Investments

SPV, Ltd., YA Offshore SPV 309, Ltd., YA Offshore SPV 609, Ltd., and

YA Offshore SPV 909, Ltd. (collectively, Foreign SPVs). The Schedule

K–1 issued to each Foreign SPV identified it as a foreign corporation.6

The Schedules K–1 issued to the Foreign SPVs reported

allocations to them of each item of income, loss, and deduction shown on

YA Global’s Schedule K. Those schedules also reported the Foreign

SPVs as having substantial capital accounts in YA Global at the end of

2009: YA Offshore Global Investments SPV, Ltd. had a capital account

of $47,615,923, YA Offshore SPV 309, Ltd.’s capital account was

$114,757,093, YA Offshore SPV 609 Ltd.’s capital account was

$35,106,274, and YA Offshore SPV 909’s capital account was $8,709,758.

Writeoff of Accrued Interest

Petitioners provided a schedule to respondent (included in the

record as Exhibit 1290-P) “to show information used to compute YA

Global’s interest write off for 2009.”7 Exhibit 1290-P shows interest

accrued and written off on 98 debentures and promissory notes issued

by 34 different issuers. Those issuers are Access Beverage, Inc. (Access

Beverage), BlueCreek Energy, Inc., Cobalis Corp. (Cobalis), Compass,

Corporate Strat, CSI Business, Earth Biofuels, Inc. (Earth Biofuels),

EYI Ind., Falcon Natural Gas Corp. (Falcon), Futuremedia PLC

6 YA Global also issued a Schedule K–1 to an entity named YA Offshore SPV

1209, Ltd., which the schedule identifies, perhaps erroneously, as a domestic

corporation. But the Schedule K–1 issued to YA Offshore SPV 1209, Ltd., lists that

entity’s share of each item of YA Global’s income, loss, and deduction as zero.

7 The amount shown on Exhibit 1290-P as interest written off is $99 less than

the $46,506,023 that YA Global reported on its financial statements and on its tax

return.

11

[*11] (Futuremedia), Handheld Entertainment, Inc. (Handheld), Ignis

Petroleum Group, Inc. (Ignis Petroleum), Innova Holdings, Inc., Isonics

Corp. (Isonics), iVoice Technology, Inc. (iVoice), KD Resources, Macmin

Silver Limited, MM2 Group, Inc. (MM2), Natural Nutrition, Inc.,

Newgen Tech., NS8 Corp., Pacific Gold Corp. (Pacific Gold), Poseidis,

Inc. (Poseidis), PNG Ventures, Inc., Renewable Fuels, Inc., Speech

Switch, Inc., Techlabs Inc., Teleplus World Corp. (Teleplus), Terminal 1,

Titan Global Holdings, Inc. (Titan), TXP Corp., United Fiber Systems,

U.S. Helicopter Corp. (US Helicopter), and Wherify Wireless, Inc.

(Wherify). The interest that YA Global both accrued and wrote off for

2009 did not include interest on any debenture or promissory note issued

by McKenzie Bay International, Ltd., Savi Media Group, Inc., or the

Certo Group Corp.

Respondent stipulated that petitioners provided him with Exhibit

1290-P but did not stipulate the amounts shown on the schedule. The

amounts in the “2009 Write Off” column of Exhibit 1290-P sum to

$46,505,924. Another column purports to identify the portion of the

amount written off that accrued in 2009. The amounts in that column

sum to $17,137,938.

Cobalis

YA Global accrued and wrote off interest for 2009 on two

debentures issued by Cobalis. It accrued interest on each debenture in

January and then wrote off all accrued interest in February.

An order issued by the Securities and Exchange Commission on

July 26, 2011, revoked the registration of Cobalis’s securities. The order

notes that the auditors’ report included with the registration statement

filed by Cobalis’s predecessor in 2002 expressed doubt about the

company’s ability to continue as a going concern. The auditors also

included going concern qualifications in the financial statements of

Cobalis and its predecessor for 2004 through 2007.

On August 1, 2007, YA Global filed an involuntary bankruptcy

proceeding against Cobalis. On August 31, 2009, Cobalis filed a

bankruptcy plan in which it proposed to repay its debt using revenue

from product sales and the sale of its common stock.

Compass

YA Global accrued and wrote off interest for 2009 on two

debentures issued by Compass. On one of those debentures, the

12

[*12] partnership accrued interest for each month from January

through May, accrued no interest for June or July, wrote off most of the

accrued interest in August, and wrote off the remainder of the accrued

interest in November. On the other debenture, the partnership again

accrued interest each month from January through May, accrued no

interest for June, July, or August, wrote off most of the accrued interest

in September, and wrote off the remainder of the accrued interest in

November.

Isonics

YA Global both accrued and wrote off interest for 2009 on three

debentures and three promissory notes issued by Isonics. YA Global

accrued interest on each instrument for each month from January

through November. On one of the debentures, it received a $600,000

payment of interest in March.

A Form 10–Q (the quarterly report under Section 13 or 15(a) of

the Securities and Exchange Act of 1934) filed by Isonics for the quarter

ended October 31, 2008, noted that Isonics had working capital and

stockholders’ deficits at the end of the quarter. It noted that the

company might not be in compliance with covenants made in connection

with its issuance of convertible debentures and term notes. Those

conditions, the company reported, “raise[d] substantial doubt about [its]

ability to continue operations as a going concern.” In fact, the auditors’

report on the company’s financial statements for the year ended April

30, 2008, included a going concern qualification. Isonics’s cashflow from

operating activities was −$815,000 for the six months ended October 31,

2007, and −$1,211,000 for the six months ended October 31, 2008.

iVoice

YA Global both accrued and wrote off for 2009 interest on a

debenture issued by iVoice.8 The partnership accrued interest on that

debenture for each month from January through May 2009. It accrued

no interest from June through October. It then wrote off the accrued

interest in November.

According to Form 10–K (the Annual Report Pursuant to Section

13 or 15(d) of the Securities and Exchange Act of 1934) for the year

8 The partnership also wrote off in November 2009 interest that had accrued

as of December 31, 2008, on another iVoice debenture. The partnership did not accrue

any interest on that other debenture for 2009.

13

[*13] ended December 31, 2008, filed by iVoice Technology, Inc. (iVoice

Technology), a subsidiary of iVoice, iVoice Technology’s auditors

included a going concern qualification in its reports on the company’s

financial statements for both 2007 and 2008. The going concern

qualification included in the company’s 2007 financial statements was

attributed to, among other things, its “historical negative cash flow.”

The going concern qualification for 2008 was based, among other things,

on the company’s negative cashflow from operations and negative

working capital.

A Form 10–Q filed by iVoice for the quarter ended September 30,

2009, also refers to “substantial doubt about the Company’s ability to

continue as a going concern.” That doubt was attributed to the

company’s “substantial accumulated deficits,” its “obligation to deliver

an indeterminable amount of common stock due on derivative

liabilities,” and its completion of “the process of spinning out . . . five

operating subsidiaries.” The company had spun off three of the five

operating subsidiaries in 2005 and, since then, had “transitioned itself

into a company focused on the development and licensing of proprietary

technologies.”

A Form 10–K for the year ended December 31, 2009, filed by

B Green Innovations, Inc. (B Green), the successor to iVoice Technology,

states that the company’s auditors had, again, included a going concern

qualification in their report on the company’s financial statements for

the year. The issues cited by the auditors for their 2009 going concern

qualification were the company’s “net loss,” its “negative cash flow from

operations,” and its “negative working capital.”

MM2

YA Global accrued and wrote off interest for 2009 on two

debentures issued by MM2. For each debenture, the partnership

accrued interest each month from January through November and then

wrote off all accrued interest in December.

The statements of cashflow included in the Form 10–Q filed by

MM2 for the quarter ended March 31, 2009, report that the company’s

cashflow from operations was −$298,826 for the nine months ended

March 31, 2008, and −$89,233 for the nine months ended March 31,

2009. The Form 10–Q also notes that the company was “in default of

the repayment terms” of a convertible debenture it issued to YA Global

in 2006. As of the date of the filing of the Form 10–Q, YA Global had

14

[*14] “not demanded payment” on the debenture and MM2’s

“management [was] in negotiations to restructure the debt.” The Form

10–Q also stated that the company’s “recurring losses” and “deficiencies

in cash flow from operations . . . raise[d] substantial doubt about [its]

ability to continue as a going concern.”

Titan

YA Global accrued and wrote off interest for 2009 on a debenture

issued by Titan. The partnership accrued interest on the debenture for

each month from January through November of 2009 and then wrote off

the accrued interest in December.

The Consolidated Statements of Cash Flows included in a Form

10–Q that Titan filed for the quarter ended November 30, 2008, report

that Titan’s cashflow from operations was −$8,758,000 for the three

months ended November 30, 2007, but was $5,744,000 for the

three months ended November 30, 2008.

November 24, 2009, Meeting of Yorkville Advisors’ Investment

Committee

At a meeting of Yorkville Advisors’ Investment Committee held

on November 24, 2009, the committee reviewed positions held by YA

Global and agreed to write down specified positions as of December 31,

2009. Among other things, the committee agreed to write down 50% of

YA Global’s position in Access Beverage, 20% of YA Global’s position in

Cobalis, 25% of its position in Isonics, 50% of its position in MM2, 25%

of its position in Poseidis (in addition to a 20% writedown previously

taken), 50% of its position in Speech Switch, 50% of its position in Titan,

and 30% of its position in US Helicopter.

FPAA

The 2009 FPAA determined that YA Global had ordinary

business income of $24,790,341. That amount is the partnership’s

overall loss for the year computed without regard to the interest writeoff

and increased by the change in unrealized appreciation reported on line

26(d) of Part II of the partnership’s Schedule M–3 (−$125,568,354 +

$46,506,023 + $103,852,672 = $24,790,341). The FPAA describes the

15

[*15] interest writeoff deduction as having been disallowed because it

had “not been substantiated or shown to be allowed under I.R.C. § 166.”9

The 2009 FPAA determined that YA Global owed section 1446

withholding tax for the year of $6,748,616. In computing that amount,

respondent determined that all of the partnership’s ordinary business

income was effectively connected taxable income (ECTI). In

determining YA Global’s section 1446 liability for 2009, respondent took

into account the portion of YA Global’s ECTI allocable to YA Offshore

and the Foreign SPVs.10

OPINION

I. Treatment Under Section 475 of YA Global’s Interest in Compass

Resources

Section 475(a) provides rules regarding the treatment of

“securities” held by a “dealer in securities.” Section 475(a)(1) requires

that securities included in the dealer’s inventory be valued at their fair

market value. Section 475(a)(2) provides:

In the case of any security which is not inventory in the

hands of the dealer and which is held at the close of any

taxable year—

(A) the dealer shall recognize gain or loss as

if such security were sold for its fair market value on

the last business day of such taxable year, and

(B) any gain or loss shall be taken into

account for such taxable year.

For purposes of section 475, the term “security” includes “any . . . share

of stock in a corporation,” § 475(c)(2)(A), any “note, bond, debenture, or

other evidence of indebtedness,” § 475(c)(2)(C), and any warrant to

acquire stock, § 475(c)(2)(E).

9 Section 166(a)(1) allows a deduction for “any debt which becomes worthless

within the taxable year.” Section 165(a) allows a deduction for “any loss sustained

during the taxable year and not compensated for by insurance or otherwise.”

Deductions in respect of debt instruments that are evidenced by securities are

governed by section 165 rather than section 166. See § 166(e). Petitioners contend

that YA Global’s convertible debentures were “securities” within the meaning of

section 165(g)(2).

10 Respondent concedes that “YA Global is not liable for any section 1446 tax

with respect to [YA Offshore] SPV 1209, Ltd.”

16

[*16] In our prior opinion, we concluded that YA Global was a “dealer

in securities,” as defined by section 475(c)(1), and thus was subject to

the mark-to-market rule provided in section 475(a)(2). We also

concluded that petitioners had not demonstrated that any of the

securities YA Global held at the end of 2006, 2007, or 2008 qualified for

an exception from the mark-to-market rules for securities identified as

being held for investment. See § 475(b)(1)(A), (2). Petitioners offer us

no reason why those conclusions do not apply equally to the

partnership’s 2009 taxable year. It follows that, under section 475(a)(2),

YA Global is required to recognize gain or loss as if each security it held

on December 31, 2009, had been “sold for its fair market value” on that

date.

Petitioners contend that the $103,852,672 Change in Unrealized

Appreciation reported on Schedule M–3 of YA Global’s 2009 Form 1065

includes “an unrealized gain of over $116,308,517 that was associated

with YA Global’s investment of [sic] Compass Resources, Ltd.” “But for

the inclusion of [that] unrealized gain,” petitioners allege, “the total

unrealized amount for 2009 would have been a comparatively modest

loss . . . rather than a gain.” Petitioners argue:

Respondent’s inclusion of the $116.3 million unrealized

gain associated with Compass was in error because . . . that

unrealized gain was not attributable to any security that

YA Global held. Rather, it was an amount recorded on YA

Global’s books to account for the value associated with the

likelihood that YA Global would be entitled to enter into a

new funding arrangement with Compass that would render

the Fund [that is, YA Global] a controlling shareholder in

the company.

Petitioners’ argument rests on DMR’s determination that

Compass had a nil value before the proposed recapitalization. If the

Compass stock was worthless, petitioners reason, the warrants YA

Global held to acquire Compass stock “were also worthless.” And the

partnership’s right to convert its Compass debentures into stock “was

also worth zero.” If the conversion privilege were worthless, “[t]he debt

could not possibly be worth more than its face value.” Petitioners

conclude: “The value of the interest that the Fund held in Compass was

therefore not attributable to any security at all. Rather, the interest

that VRC valued was merely the potential that the Fund would be

entitled to acquire stock of Compass as part of the recapitalization of the

company if that transaction were approved.”

17

[*17] Respondent argues that “[n]othing in the record . . . establishes

how YA Global calculated the [$103,852,672] shown on the 2009

Schedule M–3 or whether the unrealized gain of $116,308,517

attributable to Compass Resources was included in this calculation.”

Moreover, even assuming arguendo that “petitioners could show that

the Section 475 Adjustment took into account an unrealized gain of

approximately $116 million with respect to Compass Resources,”

respondent disputes petitioners’ claim that the gain was not attributable

to a security. Respondent observes that petitioners’ position is

“inconsistent with YA Global’s own financial reporting.” He argues that

petitioners “have not provided evidence to establish that the unrealized

gain attributable to Compass Resources was for anything other than”

the convertible debentures that YA Global reported on its 2009 financial

statements.

Petitioners’ argument rests on an invalid premise. DMR

concluded that Compass’s equity would have “a nil value” if Compass

were valued on either an “orderly realisation” or liquidation method.

But the DMR report, in judging the proposed recapitalization as fair,

established that Compass was worth more as a going concern than as a

pool of assets to be liquidated either in a “short time frame” or “an

orderly manner.” The conclusion petitioners draw from the DMR report,

that the Compass stock was worthless, would be valid only if an orderly

realization of assets or prompt liquidation would produce more value for

stakeholders than continuing Compass as a going concern. The DMR

report itself establishes the invalidity of that premise.11

We understand that petitioners might be reluctant to accept the

possibility that YA Global overstated the value of its interest in

Compass on the partnership’s 2009 financial statements. With their

insistence that the partnership’s interest in Compass was worth no less

than the $148,269,798 that YA Global reported as the value of its

Compass convertible debentures, however, petitioners have backed

themselves into a corner. The simultaneous acceptance that (1) YA

Global held an interest in Compass as of December 31, 2009, worth

$148,269,798, and (2) only $31,961,281 of that value ($148,269,798 −

11 If Compass’s assets were worth $113,250,000, a value that the DMR report

accepted as a conservative estimate, Compass would have been insolvent before the

recapitalization even if the company were valued as a going concern. The value of

Compass’s assets would have been less than its $115,757,671 of liabilities. But DMR

determined that Compass’s assets could have been worth up to $20 million more than

$113,250,000. If so, Compass would not have been insolvent and its stock would have

had positive value before the recapitalization.

18

[*18] $116,308,517) was attributable to securities reflects a logical

contradiction. The proposed recapitalization would have entitled YA

Global to receive new Compass stock in exchange for its pre-

recapitalization interest in Compass. If that interest consisted of

securities worth $31,961,281 and some other asset worth $116,308,517,

what happened to that other asset? If it simply disappeared in the

recapitalization, it cannot have been a real asset. And viewing YA

Global as having received new Compass stock in exchange for the

expectation of receiving new Compass stock would be tautological: The

mere expectation of receiving something cannot be consideration for its

receipt.

In sum, the differences between the VRC and DMR reports do not

identify any nonsecurity interests in Compass that YA Global held at

the end of 2009. Instead, the differences reflect different judgments as

to Compass’s enterprise value.12 But petitioners have not asked us to

resolve that difference. Instead, consistent with YA Global’s financial

reporting, petitioners accept that the partnership’s interest in Compass

was worth $148,269,798 as of December 31, 2009. The question for us

to resolve is whether petitioners have met their burden of proving that

any portion of that value was attributable to one or more assets that

were not “securities” within the meaning of section 475(c)(2).13 For the

reasons explained above, petitioners have not met that burden.

12 The valuation assumptions underlying the DMR report indicate that the

value of YA Global’s interest in Compass at the end of 2009 could not have been more

than about $72.6 million. The issuance of new stock to YA Global under the proposed

recapitalization would have given it an 80% interest in Compass. If, as DMR

determined, Compass’s net assets in a “best-case scenario” were worth no more than

$90,829,000, then YA Global’s interest in Compass, post recapitalization, would have

been worth no more than about $72.6 million ($90,829,000 × .8). We assume that YA

Global would not have proposed a recapitalization of Compass that reduced the value

of its interest in the company. Petitioners, however, do not argue that YA Global’s

interest in Compass as of December 31, 2009, was worth less than the $148,269,798 it

reported on its financial statements as the value of its Compass convertible

debentures. Instead, petitioners argue that most of that value was attributable to one

or more assets that were not “securities” within the meaning of section 475(c)(2).

13 Rule 142(a)(1) provides: “The burden of proof shall be upon the petitioner,

except as otherwise provided by statute or determined by the Court; and except that,

in respect of any new matter, increases in deficiency, and affirmative defenses, pleaded

in the answer, it shall be upon the respondent.” None of the exceptions applies to the

issues addressed in this Opinion.

19

[*19] II. Allocation of ECTI to Foreign Special Purpose Vehicles

A. Background

Section 1446(a) requires a partnership to pay a withholding tax

on any ECTI allocable to a foreign partner. Section 1446(b)(1) provides

that “[t]he amount of the withholding tax payable by any partnership

under [section 1446(a)] shall be equal to the applicable percentage of the

effectively connected taxable income of the partnership which is

allocable under section 704 to foreign partners.” The “applicable

percentage,” in respect of any foreign partner, is the highest rate of tax

specified in either section 1 or section 11(b)(1), depending on whether

the foreign partner is a corporation. § 1446(b)(2). The term “effectively

connected taxable income” generally refers to “the taxable income of the

partnership which is effectively connected (or treated as effectively

connected) with the conduct of a trade or business in the United States.”

§ 1446(c).

In our prior opinion, we concluded that petitioners had failed to

meet their burden of proving that YA Global was not engaged in a U.S.

trade or business during 2006, 2007, and 2008. Again, petitioners offer

us no reason why that conclusion does not apply equally for the

partnership’s 2009 taxable year.

Under section 1461, withholding agents are personally liable for

the tax they are required to deduct and withhold under chapter 3

(sections 1441 through 1464). If the recipient of the income subject to

withholding pays the tax against which the withholding tax could be

credited, however, the withholding agent is relieved of liability for

withholding tax but not “for interest or any penalties or additions to the

tax otherwise applicable in respect of [the withholding agent’s] failure

to deduct and withhold.” § 1463.

Treasury Regulation § 1.1446-3(e)(1) applies the principle of

section 1463 to the specific case of partnership withholding under

section 1446:

[A] partnership that is required to pay 1446 tax but fails to

do so, or pays less than the amount required under this

section, is liable under section 1461 for the payment of the

tax required to be withheld under chapter 3 of the Internal

Revenue Code and the regulations thereunder unless, and

to the extent, the partnership can demonstrate pursuant to

paragraph (e)(2) of this section, to the satisfaction of the

20

[*20] Commissioner or his delegate, that a foreign partner has

paid the full amount of tax required to be paid by such

partner to the Internal Revenue Service.

A partnership seeking to rely on the exemption from liability must

“provide sufficient information to the IRS [Internal Revenue Service] to

determine that the partner’s tax liability was satisfied or established to

be zero.” Treas. Reg. § 1.1446-3(e)(2).

In his Reply Brief, respondent conceded that YA Offshore had

nonpartnership expenses for 2009 sufficient to offset its share of YA

Global’s ECTI. Accordingly, respondent conceded that, under Treasury

Regulation § 1.1446-3(e), YA Global had no section 1446 withholding tax

liability for 2009 in respect of YA Offshore. In that Brief, however,

respondent observed that petitioners had “made no arguments asserting

that any foreign partner, other than YA Offshore, paid its income tax

liability or had zero tax liability.” Respondent viewed petitioners as

having “conceded, therefore, that YA Global is liable for the section 1446

withholding tax attributable to YA Global’s other foreign partners for

2009.”

In an Order issued August 12, 2022, we posed questions to the

parties that we expected them to be prepared to address at a remote

Special Session scheduled for August 31, 2022. Among our questions for

petitioners were the following:

Do petitioners agree that, during 2009, YA Global had

partners other than YA Offshore who were either foreign

or from whom the partnership did not receive withholding

certificates under Treasury Regulation § 1.1446-1(c)(2)? If

so, do petitioners concede that, should the Court determine

that YA Global was engaged in a U.S. trade or business

during 2009, the partnership would be liable for

withholding tax under section 1446 on the portion of its

ECTI allocable to those other foreign (or deemed foreign)

partners?

Because we did not have sufficient time at the August 31 Special

Session to address all the questions we had for the parties, we scheduled

another remote Special Session for September 16, 2022. At the

September 16 Special Session, we asked petitioners’ counsel whether, “if

we determine that YA Global was [in] a U.S. trade or business in 2009,

the partnership would owe some withholding tax liability in regard to

21

[*21] those foreign partners other than YA Offshore.” Petitioners’

counsel responded: “Technically, I think it is correct. . . . I think

technically [the Foreign SPVs] were partners, and I can’t think of any

good reason around it. So I’m going to say yes.”

Following the September 16 Special Session, we issued an Order

(September 20 Order), directing the parties to submit written reports

addressing the questions discussed during that session. In the report

petitioners submitted in response to the September 20 Order (November

16 Report), petitioners asserted that the Foreign SPVs “were not

partners in any ongoing business of the Fund, and even if they were

technically members of the partnership, they would not have had

effectively connected taxable income . . . allocable to them under section

704.” “[B]y their very nature,” petitioners argued, the Foreign SPVs

“were not in a continuing partnership with the other investors in YA

Global.” They were “merely co-owners of illiquid assets, not partners in

any continuing venture.” “Even if the [Foreign] SPVs could somehow be

viewed as partners in [YA Global],” petitioners added, “any allocations

of income to them were not distributive shares under section 704 but

were, instead, made to them ‘other than in [their] capacity] as . . .

member[s] of [the] partnership.’” On the premise that “[a]ny allocations

to the [Foreign] SPVs were attributable to withdrawn capital,”

petitioners concluded that those allocations could not have been made

under section 704(b).

In a Response to petitioners’ November 16 Report, respondent

argued that we should not allow petitioners to raise the Foreign SPVs’

status as partners in YA Global because petitioners had not pleaded the

issue. Respondent claimed to be “unduly surprised and prejudiced.” He

continued:

Whether the [Foreign] SPVs were partners of YA Global

raises factual and legal questions quite unlike those that

were presented at trial with respect to YA Global’s lending,

underwriting, and financing activities. Had respondent

known that petitioners did not consider the SPVs to be

partners of YA Global, respondent would have sought to

discover additional information before trial and would have

sought to present additional evidence or elicit additional

testimony at trial. Respondent would face extreme

prejudice if he were required to mount a challenge to

petitioners’ new argument and factual assertions at this

stage, two years post-trial. The Court, therefore, in its

22

[*22] sound discretion, should decline to consider petitioners’

new argument.

On the merits of the issue, respondent argued, in essence, that

petitioners should be bound by YA Global’s tax reporting. As respondent

observed: “YA Global treated the SPVs like partners, maintaining

capital accounts on their behalf and allocating YA Global’s income and

loss to them.” Respondent dismissed as “immaterial” YA Global’s

reporting of a liability to the SPVs on its 2009 financial statements. “[A]

partnership,” he observed, “can owe a liability to a partner.”

In an Order issued January 12, 2023 (January 12 Order), we

noted that petitioners had “offered no explanation of why they had failed

to raise in either their opening or answering brief their argument that

no ECTI of YA Global for 2009 would be properly allocable to the foreign

SPVs.” “Before deciding whether to consider petitioners’ argument,” we

resolved to “give them the opportunity to explain why we should not

treat them as having conceded the argument and why raising the

argument for the first time more than two years after trial [would] not

[be] untimely.”

In a Supplemental Brief they filed in response to the January 12

Order, petitioners contended that the record was sufficient for us to

resolve the legal question of the Foreign SPVs’ status as partners of YA

Global. On that premise, petitioners argued that respondent would “not

be prejudiced by [our] consideration of th[eir] argument.” “The evidence

in the record,” in their view, “demonstrates that the Foreign SPVs were

not partners in YA Global.”

Petitioners’ Supplemental Brief also elaborated on their

substantive argument on the Foreign SPVs’ status and their entitlement

to allocations of YA Global’s ECTI. Petitioners claimed that the Foreign

SPVs had no intent to join in any business conducted by YA Global and

share in the profits or losses of that business. On that premise,

petitioners reasoned, the Foreign SPVs were not partners in YA Global

under the test enunciated in Commissioner v. Culbertson, 337 U.S. 733

(1949). As explained in more detail below, the Culbertson Court rejected

this Court’s view that “essential to membership in a family partnership

for tax purposes [is] the contribution of either ‘vital services’ or ‘original

capital.’” Id. at 741. It noted that its prior opinion in Commissioner v.

Tower, 327 U.S. 280 (1946), “provide[d] no support for such an

approach.” Commissioner v. Culbertson, 337 U.S. at 741. It added:

23

[*23] The question is not whether the services or capital

contributed by a partner are of sufficient importance to

meet some objective standard supposedly established by

the Tower case, but whether, considering all the facts . . .

the parties in good faith and acting with a business purpose

intended to join together in the present conduct of the

enterprise.

Id. at 742. (Although Culbertson, like Tower, addressed a family

partnership, courts have since used the Culbertson test to determine

whether partnerships involving unrelated persons should be recognized

for tax purposes. E.g., Bussing v. Commissioner, 88 T.C. 449, 460

(1987).)

Petitioners acknowledge that section 704(e)(1), as in effect for

2009, required that the owner of a capital interest in a partnership be

recognized as a partner if capital is a material factor in the production

of a partnership’s income. Petitioners argue, however, that “[f]ormer

section 704(e) was not intended to create an additional or alternative

test to Culbertson.” They claim support for that argument from a report

of the Staff of the Joint Committee on Taxation prepared in connection

with the 2015 repeal of section 704(e). Staff of J. Comm. on Tax’n, 114th

Cong., General Explanation of Tax Legislation Enacted in 2015, JCS-1-

16 (2015 Bluebook), at 83–84 (J. Comm. Print 2016). The 2015 Bluebook

explains that Congress repealed section 704(e)(1) “to eliminate any

argument that the provision applies an alternative test as to whether

the holder of a capital interest is a partner with respect to that interest,

or whether the interest constitutes a capital interest in a partnership.”

2015 Bluebook at 84.14

In a Response to petitioners’ Supplemental Brief, respondent

argued, among other things, that (1) the record is insufficient to support

a conclusion that the Foreign SPVs were not partners in YA Global, and

(2) the weight of the evidence that is in the record supports a contrary

conclusion. Respondent observed that any shareholders who wanted to

promptly terminate their indirect participation in YA Global could have

elected to receive in-kind distributions. “By not taking that option,”

respondent continued, “the ultimate investors through the Foreign SPVs

chose to remain in business with YA Onshore, YA Offshore, and the

14 By “alternative test,” the Joint Committee staff apparently meant an

alternative to the Culbertson test. In its description of pre-2015 law, the staff cited

Culbertson as having provided “the test of a partnership.” 2015 Bluebook at 83.

24

[*24] other SPVs.” Respondent infers that “[t]he Foreign SPVs wanted

YA Global to hold, sell, exchange, transfer, or otherwise manage and

deal with the securities YA Global held in 2009 and maximize the profits

on those securities before the Foreign SPVs’ interests were redeemed.”

Respondent dismisses as “immaterial” the Foreign SPVs’ lack of

participation in “new investments.” He contends:

The Foreign SPVs remained in partnership with YA

Onshore, YA Offshore, and the other SPVs for the ongoing

management of the currently held securities and profited

or lost on those investments accordingly. They depended

on YA Global’s hired investment manager to oversee the

securities and dispose of them in the partners’ best

interests. . . . As a consequence, the Foreign SPVs

continued to bear the risk of loss and enjoy the fruits of YA

Global’s activities.

B. Analysis

As we suggested in our January 12 Order, we do not view

petitioners as seeking to raise a new, unpleaded issue “but instead

raising for the first time after their submission of multiple briefs a new

argument in regard to an issue that has been in the case from the

outset.” In both their initial and amended Petitions, petitioners alleged

that “the Commissioner erred in determining that . . . the partnership

is liable for withholding tax [for 2009] in the amount of $6,748,616.”

Thus, as we observed in the January 12 Order, “[t]he assignments of

error in petitioners’ petitions are sufficiently broad to encompass the

question of whether any liability for 2009 withholding tax ultimately

determined should include amounts attributable to the [F]oreign SPVs.”

We also noted that “Rule 151(e)(5) . . . requires a party’s brief to contain

a statement of the party’s argument, setting forth and discussing ‘the

points of law involved and any disputed questions of fact.’” Citing

Gregory v. Commissioner, T.C. Memo. 2018-192, at *10–11, and Remuzzi

v. Commissioner, T.C. Memo. 1988-8, aff’d on other grounds, 867 F.2d

609 (4th Cir. 1989) (unpublished table decision), we warned that

“[a]rguments not made on brief may be treated as having been

conceded.”

Petitioners have failed to offer us a valid reason not to treat them

as having conceded that the Foreign SPVs were partners in YA Global

during 2009 and, as such, were entitled to receive allocations of ECTI.

Petitioners allege that the record is sufficient to allow us to resolve the

25

[*25] issue and that, consequently, respondent would not be prejudiced

by our allowing petitioners to raise the issue. The reason we treat

arguments not made on brief as conceded, however, is not to avoid

prejudice to the opposing party. Instead, treating an argument not

made on brief as conceded is a sanction for noncompliance with Rule

151(e).

Moreover, we do not agree that the record is sufficient for us to

determine whether the Foreign SPVs were partners in YA Global.

According to YA Global’s 2009 financial statements, the SPVs held “pro

rata participation interests” in securities. Petitioners point to no

evidence in the record that details the terms of the participation

interests or identifies how title to the securities covered by those

interests was held. Did the participation interests give the Foreign

SPVs undivided ownership interests in specified securities? Or were

they instead simply contractual rights to receive proceeds upon the sale

of those securities? The record does not say.

It does not follow, however, that respondent would be prejudiced

were we to address on the merits the question of the Foreign SPVs’

status. Because petitioners bear the burden of proof under Rule 142(a),

they bear the consequences of the record’s inadequacy. Therefore,

whether we treat petitioners as having conceded that the Foreign SPVs

were partners entitled to allocations of ECTI or instead address the

issue on the merits, we would reach the same result: YA Global’s

liability for section 1446 withholding tax for 2009 should take into

account the Foreign SPVs’ shares of the partnership’s ECTI for the year.

1. The Importance of the Terms of the Participation

Interests

We agree with petitioners that, if the participation interests the

Foreign SPVs held gave them undivided ownership interests in the

subject securities, the Foreign SPVs would not have been partners in YA

Global. But they may well have been more than “mere” co-owners.

While the Foreign SPVs, if co-owners, would not have been partners in

YA Global, they might have been (indeed, probably would have been)

partners with YA Global.15 Even if the participation interests gave the

15 Although petitioners argue that “the SPVs were merely co-owners of illiquid

assets,” they do not identify the other co-owner(s). We take it as a given, however, that

the Foreign SPVs were not co-owners with YA Onshore and YA Offshore. The parties

do not dispute that YA Global was a partnership or that YA Onshore and YA Offshore

were partners in that partnership. Therefore, YA Onshore and YA Offshore were, inter

26

[*26] Foreign SPVs title to portions of the securities, the Foreign SPVs’

interests apparently went beyond co-ownership of some of the securities

managed by the partnership. The Schedules K–1 issued to the Foreign

SPVs reported allocations to them of each item of income, loss, and

deduction shown on YA Global’s Schedule K. While the Schedules K–1

are not dispositive, they are evidence of the economic arrangement

between YA Global and the Foreign SPVs. Petitioners do not identify

any evidence that calls into question the accuracy of the Schedules K-1

in reflecting that economic arrangement. We can think of no economic

justification for allocating to the Foreign SPVs a share of each item of

income, loss, and deduction (including, for example, legal and other

professional fees) if the Foreign SPVs were merely co-owners, with YA

Global, of specified securities. If they were, indeed, co-owners, they also

shared economically in the results of activities that we have concluded

constitute a trade or business. See, e.g., Cusick v. Commissioner, T.C.

Memo. 1998-286, 1998 WL 440881, at *4 (“[T]he distinction between

mere coowners and coowners who are engaged in a partnership lies in

the degree of business activity of the coowners or their agents.”).

If the Foreign SPVs were partners with YA Global in a lower tier

partnership engaged in a U.S. trade or business, the Foreign SPVs

would have been allocated a share of the ECTI of that lower tier

partnership. Section 1446 withholding tax would have been owed in

respect to the Foreign SPVs’ share of that ECTI. But that section 1446

withholding tax would have been a partnership item of the lower tier

partnership. Our jurisdiction in the present cases allows us to

determine only YA Global’s partnership items. It does not extend to the

determination of any section 1446 withholding tax liability, or any other

partnership items, of any partnership that might have existed between

YA Global and the Foreign SPVs. In short, if the record established that

the participation interests distributed to the Foreign SPVs gave them

undivided ownership interests in the subject securities, YA Global’s

section 1446 withholding tax liability would not include any amounts

attributable to the Foreign SPVs. And we could not determine in these

cases any section 1446 withholding tax owed by any lower tier

partnership between YA Global and the Foreign SPVs.

But the record does not establish that the participation interests

distributed to the Foreign SPVs gave them undivided ownership

interests in the subject securities. We must therefore consider the

se, partners and not co-owners. If the Foreign SPVs were co-owners, they must have

been co-owners with YA Global itself.

27

[*27] consequences that would ensue if the participation interests

instead were contract rights that entitled the Foreign SPVs to share in

the proceeds received by YA Global from the sale of securities that it

owned outright. In that event, as explained below, the Foreign SPVs

would have been partners in YA Global, and the partnership’s section

1446 withholding tax liability for 2009 would have included tax on the

Foreign SPVs’ shares of the partnership’s ECTI. If the participation

interests were contract rights to shares of the proceeds from the sale of

specified securities owned by YA Global, then the Foreign SPVs owned

capital interests in YA Global and section 704(e)(1), as in effect for 2009,

would have required the Foreign SPVs to be recognized as partners in

YA Global. Moreover, even if petitioners were correct that section

704(e)(1) did not require recognition as a partner of a capital interest

owner who would not have been treated as a partner under the

Culbertson test, we would still conclude that petitioners have not met

their burden of proof. The record does not allow us to conclude that the

Foreign SPVs were not partners in YA Global under Culbertson.

2. The Foreign SPVs as Partners Under Section

704(e)(1)

If the participation interests distributed to the Foreign SPVs

provided them with contractual rights to proceeds from the sale of

securities owned entirely by YA Global, rather than direct ownership

interests in those securities, then the Foreign SPVs owned capital

interests in YA Global. Treasury Regulation § 1.704-1(e)(1)(v) provides:

“For purposes of section 704(e), a capital interest in a partnership means

an interest in the assets of the partnership, which is distributable to the

owner of the capital interest upon his withdrawal from the partnership

or upon liquidation of the partnership.”

If the Foreign SPVs owned capital interests in YA Global, the

plain terms of section 704(e)(1) would require that they be recognized as

partners. Before its repeal in 2015, section 704(e)(1) provided: “A person

shall be recognized as a partner for purposes of this subtitle if he owns

a capital interest in a partnership in which capital is a material income-

producing factor, whether or not such interest was derived by purchase

or gift from any other person.” Petitioners make no argument that

capital was not a material factor in producing YA Global’s income.

But petitioners would have us interpret section 704(e)(1) so that

it did not require recognition of the owner of a capital interest as a

partner in a partnership if the capital interest owner did not intend to

28

[*28] join in the conduct of the partnership’s business. Petitioners’

proposed interpretation would add a condition absent from the statutory

test for the recognition of a capital interest owner as a partner. Under

the plain terms of section 704(e)(1), the owner of a capital interest in a

partnership in which capital is a material income-producing factor must

be recognized as a partner regardless of the capital interest owner’s

subjective intent to participate in the partnership’s business. Moreover,

petitioners’ proposed interpretation of section 704(e)(1) is not only

contrary to the statute’s plain text; its adoption could also frustrate

Congress’s purpose in enacting the rule.

Congress enacted the predecessor of section 704(e)(1) in 1951, in

response to the Supreme Court’s opinions in Tower and Culbertson. As

noted, both cases addressed family partnerships, which the Tower Court

described as an “acute problem.” Commissioner v. Tower, 327 U.S. at

284. (In particular, the problem the Court saw was the use of family

partnerships to try “to escape surtaxes by dividing one earned income

into two or more.” Id.)

In a typical family partnership arrangement, a family’s primary

income-earner would make gifts to other family members. The donees

would then contribute the proceeds of the gift to a partnership with the

donor. If the arrangement were respected, income that would otherwise

have been taxed to the donor would instead be taxed (usually at lower

rates) to the donees. The Court in Tower and Culbertson sought to apply

to family partnerships fundamental concepts of the assignment of

income—in particular, the principle that income from property should

be taxed to its owner.

Tower involved a husband and wife who had been majority

shareholders in a corporation. (The husband had owned 445 out of 500

shares, the wife only 5 shares.) The husband transferred 190 shares to

his wife. The corporation then liquidated, and its assets were

contributed to a new partnership. The question before the Court was

whether the income attributable to the wife’s interest in the partnership

was taxable to her or to her husband. The Court wrote:

We are of the opinion that the . . . facts were

sufficient to support the Tax Court’s finding that the wife

was not a partner in the business. A partnership is

generally said to be created when persons join together

their money, goods, labor, or skill for the purpose of

carrying on a trade, profession, or business and when there

29

[*29] is community of interest in the profits and losses. When

the existence of an alleged partnership arrangement is

challenged by outsiders, the question arises whether the

partners really and truly intended to join together for the

purpose of carrying on business and sharing in the profits

or losses or both. . . . Here the Tax Court, acting pursuant

to its authority in connection with the enforcement of

federal laws, has found from testimony before it that [the

husband] and his wife did not intend to carry on business

as a partnership. This finding of fact, since supported by

evidence, is final.

Commissioner v. Tower, 327 U.S. at 286–87 (footnotes omitted). The

Court acknowledged the possibility that a husband and wife could form

a valid tax partnership. If, for example, the wife “either invests capital

originating with her or substantially contributes to the control and

management of the business, or otherwise performs vital additional

services, or does all of these things,” the Court accepted, “she may by a

partner.” Id. at 290. The Court added that, when the wife

does not share in the management and control of the

business, contributes no vital additional service, and where

the husband purports in some way to have given her a

partnership interest, the Tax Court may properly take

these circumstances into consideration in determining

whether the partnership is real within the meaning of the

federal revenue laws.

Id.

Culbertson involved a ranching business allegedly conducted by a

partnership among a father and his four sons. The business had

previously been operated by a partnership between the father and an

unrelated individual. After buying out his former partner, the father

sold interests in the cattle to his sons in exchange for notes that were

ultimately either forgiven or repaid from profits of the business. The

older son received a salary for serving as foreman on the ranch before

entering the Army. The second son also served in the Army. The two

younger sons were in school and worked on the ranch only in the

summer.

This Court declined to recognize a tax partnership among the

father and his sons. Culbertson v. Commissioner, 6 T.C.M. (CCH) 692

30

[*30] (1947), rev’d, 168 F.2d 979 (5th Cir. 1948), rev’d and remanded,

337 U.S. 733 (1949). We reasoned that the father was the source of all

capital in the business and the sons had not contributed sufficient

services to justify recognition as partners. (The oldest son, having been

paid for his services, made no contribution at all.)

The Supreme Court, on hearing the case, judged that we had been

too rigid in applying Tower. The contribution of either vital services or

original capital, the Court explained, is not essential for one to be

recognized as a partner. Instead, they are simply factors to consider.

The Court then described the governing inquiry as follows:

The question [of whether a family partnership is real for

income tax purposes] is not whether the services or capital

contributed by a partner are of sufficient importance to

meet some objective standard supposedly established by

the Tower case, but whether, considering all the facts—the

agreement, the conduct of the parties in execution of its

provisions, their statements, the testimony of disinterested

persons, the relationship of the parties, their respective

abilities and capital contributions, the actual control of

income and the purposes for which it is used, and any other

facts throwing light on their true intent—the parties in

good faith and acting with a business purpose intended to

join together in the present conduct of the enterprise.

Commissioner v. Culbertson, 337 U.S. at 742. The Supreme Court thus

remanded the case to this Court. It directed us to consider, as to each of

the sons, whether “there [was] a bona fide intent that they be partners

in the conduct of the cattle business, either because of services to be

performed during th[e] years [in issue], or because of contributions of

capital of which they were the true owners.” Id. at 748.

In response to Tower and Culbertson, Congress determined that

basic assignment of income principles should be applied in the context

of partnerships in the same way that they apply in other contexts. See

generally H.R. Rep. No. 82-586, at 32‒34 (1951), reprinted in 1951

U.S.C.C.A.N. 1781, 1815‒13; S. Rep. No. 82-781, at 38‒41 (1951),

reprinted in 1951 U.S.C.C.A.N 1968, 2008‒10. In other contexts, bona

fide gifts of property, such as real estate or corporate stock, shift to the

donee the incidence of taxation on the income produced by the property.

The same should be true, Congress determined, of a bona gift of a

partnership interest or capital used to acquire a partnership interest.

31

[*31] The committee reports accompanying the Revenue Act of 1951 do

not explicitly state an intent to overrule Tower or Culbertson. Instead,

they describe Congress as addressing “confusion” that arose from those

cases, “[w]hether or not the [Court’s] opinion[s] . . . afford any

justification for the confusion.” H.R. Rep. No. 82-586, at 33, reprinted in

1951 U.S.C.C.A.N. at 1814; S. Rep. No. 82-781, at 39, reprinted in 1951

U.S.C.C.A.N. at 2009.

Notwithstanding Congress’s deference to the Supreme Court, in

enacting the predecessor of section 704(e)(1) Congress called for a

different focus in the analysis of family limited partnerships. While

Tower and Culbertson focused on the parties’ subjective intent, Congress

focused the inquiry on the reality of capital ownership. Tower and

Culbertson left open the possibility that a taxpayer like Mrs. Tower, who

contributes no substantial services to a family partnership and whose

only contribution of capital to the partnership was funded by an

intrafamily gift, might not be recognized as a partner. Congress

intended that, as long as the gift was real, the donee partner should be

recognized as a partner. If section 704(e)(1) were interpreted to allow

withholding recognition of the donee as a partner unless the donee and

others involved really intended to carry on business as a partnership,

the statute would not have achieved Congress’s purpose of

“harmoniz[ing] the rules governing interests in the so-called family

partnership with those generally applicable to other forms of property

or business.” H.R. Rep. No. 82-586, at 32, reprinted in 1951

U.S.C.C.A.N. at 1813; S. Rep. No. 82-781, at 38, reprinted in 1951

U.S.C.C.A.N. at 2008. Dividends, for example, are taxed to the owner of

the stock on which the dividends are paid. If partnership income may

be taxed to someone other than the owner of the interest in the capital

that produced the income, depending on the parties’ subjective

intentions, basic assignment of income principles would not apply

uniformly to partnerships and “other forms of property or business.”

The 2015 Bluebook does not establish petitioners’ proposition

that, when Congress enacted section 704(e)(1)’s predecessor in 1951, it

did not intend to provide an alternative or additional test to that

articulated in Culbertson. The Joint Committee staff can speak with

some authority in 2016 on the reasons Congress repealed section

32

[*32] 704(e)(1) the previous year.16 It has little or no authority to

explain why Congress first enacted that statutory rule 65 years earlier.17

Moreover, the Joint Committee staff recognized that, before

2016,18 an argument could have been made that section 704(e)(1)

“provides an alternative test as to whether the holder of a capital

interest is a partner.” 2015 Bluebook at 84. Had that not been a

potentially valid argument, Congress would not have needed to take

action to “eliminate” the argument. Id.

The 2015 Bluebook indicates that Congress repealed section

704(e)(1) in response to TIFD III-E Inc. v. United States, 660 F. Supp.

2d 367, 394 (D. Conn. 2009), rev’d, 666 F.3d 836 (2d Cir. 2012), in which

the District Court for the District of Connecticut accepted the possibility

that an entity might not “qualify as a partner under Culbertson and still

. . . qualify as a partner in a partnership under section 704(e)(1).” The

case involved a partnership known as Castle Harbour, formed by

subsidiaries of General Electric Capital Corp. and two Dutch banks. In

its initial opinion in the case, the district court concluded that the

formation of Castle Harbour was not a sham transaction, the Dutch

banks were partners in Castle Harbour, and the allocations of

partnership income to them satisfied the substantial economic effect

16 In Redlark v. Commissioner, 106 T.C. 31, 45 (1996), rev’d, 141 F.3d 936 (9th

Cir. 1998), we wrote that, although a “Joint Committee Staff Explanation . . . is not

part of the legislative history,” it is nonetheless “entitled to respect.” We added,

however, that, “[w]here there is no corroboration in the actual legislative history, we

[would] not hesitate to disregard [a] General Explanation as far as congressional intent

is concerned.” Id. The Court of Appeals for the Ninth Circuit, in reversing our decision,

agreed that “post-enactment explanations,” such as those often provided by the Staff

of the Joint Committee on Taxation, “cannot properly be described as ‘legislative

history’” but accepted that “they are at least instructive as to the reasonableness of an

agency’s interpretation of a facially ambiguous statute.” Redlark v. Commissioner, 141

F.3d at 941. The “Bluebook” considered in Redlark, however, was prepared shortly

after and in connection with the legislation that enacted the statute in issue.

17 In Mars, Inc. v. Commissioner, 88 T.C. 428, 435 (1987) (quoting United States

v. Southwestern Cable Co., 392 U.S. 157, 170 (1968)), we wrote: “[I]t is well settled that

‘the views of one Congress as to the construction of a statute adopted many years before

by another Congress have “very little, if any, significance.”’” In Mars, we addressed

official legislative history: a report of the Senate Finance Committee. If postenactment

legislative history should be given little, if any, weight, even less weight should be

given to unofficial sources, such as Joint Committee staff explanations, purporting to

interpret legislation enacted “many years before.”

18 The Bipartisan Budget Act of 2015, Pub. L. No. 114-74, § 1102(b)(1) and (c),

129 Stat. 584, 639, repealed section 704(e)(1), effective for partnership taxable years

beginning after December 31, 2015.

33

[*33] requirement of section 704(b). TIFD III-E Inc. v. United States,

342 F. Supp. 2d 94, 109 (D. Conn. 2004), rev’d, 459 F.3d 220 (2d Cir.

2006). The U.S. Court of Appeals for the Second Circuit reversed on the

ground that the Dutch banks “were not bona fide equity partners in

Castle Harbour.” TIFD III-E, Inc., 459 F.3d at 240. The appellate court

nonetheless remanded the case to allow the district court to determine,

among other things, whether “the partnership was a family partnership

under the provisions of I.R.C. § 704(e).”19 Id. at 241 n.19. On remand,

the district court accepted that the Second Circuit’s opinion established

that “the Dutch Banks were not partners in Castle Harbour under

Culbertson.” 660 F. Supp. 2d at 395. Nonetheless, the court concluded

that section 704(e)(1) required the recognition of the Dutch banks as

partners. The Second Circuit then reversed the district court’s judgment

a second time. TIFD III-E Inc., 666 F.3d 836. The appellate court did

not reject the notion that section 704(e)(1) requires that the owner of a

capital interest be recognized as a partner regardless of that person’s

subjective intent to participate in the partnership’s business.20 Instead,

the court concluded that section 704(e)(1) did not apply. Because the

Dutch banks’ interests in Castle Harbour were overwhelmingly in the

nature of debt, if not outright debt, those interests, in the Second

Circuit’s view, were not capital interests within the meaning of section

704(e)(1).

We agree with the District Court for the District of Connecticut

that section 704(e)(1), interpreted in accordance with its plain terms and

consistent with the intent expressed by the Congress that enacted the

provision’s predecessor, may require the recognition as a partner of one

who holds a capital interest in a partnership but would not be recognized

as a partner under Culbertson’s intent test. We doubt, however, that

that situation would often arise. (Given the ultimate disposition of the

Castle Harbour litigation, it did not arise in that case.) It would be

unusual for a person to put capital at risk in a business in which the

person had no intention of participating. Putting capital at risk is itself

a form of participation. The cases before us, however, involve unusual

circumstances. While the Foreign SPVs may, depending on the terms of

19 Although section 704(e) was captioned “Family partnerships,” that caption

did not limit the provision’s scope. See, e.g., Carriage Square, Inc. v. Commissioner, 69

T.C. 119, 126 n.4 (1977); Evans v. Commissioner, 54 T.C. 40, 51 (1970), aff’d, 447 F.2d

547 (7th Cir. 1971).

20 In fact, the Second Circuit was willing to assume “that there may be

circumstances in which the application of Culbertson and § 704(e)(1) yields different

results as to whether the purported holder of a partnership interest qualifies as a

partner.” TIFD III-E, Inc., 666 F.3d at 847 n.8.

34

[*34] their participation interests, have owned capital interests in YA

Global, the Foreign SPVs’ owners had initiated a process that would

eventually lead to the liquidation of their indirect interests in YA Global.

It is that scenario that raises the prospect that section 704(e)(1) and

Culbertson might lead to different results.

For the reasons explained above, we conclude that, if the

participation interests held by the Foreign SPVs provided them with

contractual rights to proceeds from the sale of securities owned by YA

Global, so that the Foreign SPVs held capital interests in the

partnership, section 704(e)(1), as in effect for 2009, would have required

recognition of the Foreign SPVs as partners regardless of the extent to

which they intended to join YA Onshore and YA Offshore in the conduct

of YA Global’s business.

3. The Foreign SPVs as Partners Under Culbertson

Moreover, even if we were to accept petitioners’ claim that the

Foreign SPVs cannot be recognized as partners in YA Global unless they

satisfied the Culbertson test, we would conclude that petitioners have

not established that Culbertson precludes recognition of the Foreign

SPVs as partners in YA Global. The record establishes that the Foreign

SPVs were created for the benefit of investors in YA Offshore who sought

redemption of their indirect interests in YA Global but declined the

option of having their interests redeemed immediately by in-kind

distributions of securities. Instead, each investor chose to receive an

interest in a Foreign SPV so that the securities the investor would

otherwise have received in redemption would continue to be managed

by Yorkville Advisors on behalf of YA Global. As YA Global sold

securities in the ordinary course of what we have concluded to be a trade

or business, each Foreign SPV would receive a share of the proceeds

from the sale of those securities in which it held participation interests.

The Foreign SPV, we assume, would then distribute proceeds to the

ultimate investors. Once all the securities in which a Foreign SPV held

participation interests had been sold, the indirect interests in YA Global

of those investors who declined immediate in-kind distributions would

be fully liquidated. Petitioners would apparently impute to the Foreign

SPVs the intentions of their owners. Because the owners had initiated

a process that would eventually result in the complete liquidation of the

owners’ indirect interests in YA Global, petitioners argue that the

Foreign SPVs did not intend to join YA Onshore and YA Offshore in the

conduct of YA Global’s business.

35

[*35] If the owners of the Foreign SPVs had wanted to cease their

indirect participation in YA Global’s business, they would have chosen

to be redeemed by means of in-kind distributions. As respondent

observes, that the Foreign SPVs’ owners rejected that choice indicates

that they saw a benefit in allowing the continued joint management of

YA Global’s securities. They specifically chose to continue their

participation in YA Global’s business until all the securities in which

they held indirect interests had been liquidated in the course of that

business. Therefore, the evidence in the record does not establish that

the subjective intentions of the Foreign SPVs would preclude their

recognition as partners of YA Global under Culbertson.

Petitioners’ position, as we understand it, ultimately rests on a

false premise. A partner does not cease being a partner simply by

announcing an intention to withdraw from the partnership. Even if the

partner goes further and surrenders his partnership interest in

exchange for a right to share in the proceeds from sales of specified

assets, the partner still remains a partner until he receives the final

payment. That is the mandate of section 736, which provides rules

governing the treatment of withdrawing partners. Under that section,

a withdrawing partner remains a partner until his interest in the

partnership is completely liquidated.

Brennan v. Commissioner, T.C. Memo. 2012-209, 2012 WL

3000336, aff’d, 621 F. App’x 408 (9th Cir. 2015), illustrates the effect of

section 736 in a situation closely analogous to that of the owners of the

Foreign SPVs. The taxpayer in Brennan had been a partner in a

partnership that managed asset portfolios for wealthy individuals and

institutional investors. As part of a restructuring of the partnership in

2002, the taxpayer surrendered his membership interest. Thereafter,

his only interest in the partnership was a right to share in the proceeds

of the partnership’s sale of specified assets. The partnership reported

capital gains from that sale in 2003 and 2004. The taxpayer argued that

he should not have been allocated any shares of those gains because his

status as a partner terminated in 2002. We disagreed. Relying on

section 736, we concluded that the taxpayer remained a partner for tax

purposes in 2003 and 2004 and had to take into account his distributive

shares of the partnership’s capital gains in those years, along with

various other items. If the owners of the Foreign SPVs had held their

interests in YA Global directly, rather than through YA Offshore, they

would have been in the same situation as the taxpayer in Brennan. The

present facts are distinguishable from those of Brennan in that the

Foreign SPVs apparently had no interest in YA Global before they

36

[*36] received their participation interests. Nonetheless, Brennan

shows that the fundamental assumption that seems to underlie

petitioners’ position is contrary to the treatment of withdrawing

partners under section 736.

4. Allocations to Foreign SPVs as Distributive Shares

Petitioners thus have not met their burden of establishing that

the Foreign SPVs were not partners in YA Global. Petitioners argue,

however, that, even if the Foreign SPVs were partners, the allocations

they received were not distributive shares of partnership income.

Instead, petitioners claim, the Foreign SPVs received those allocations

in a capacity other than that of partners. They rely on section 707(a),

which provides rules that govern transactions between a partnership

and a partner in which the partner acts in a nonpartner capacity. For

example, if a partner leases property to the partnership, the

compensation for the use of the property is deductible by the partnership

and rental income to the partner rather than a distributive share of the

partnership’s income. If the partnership makes a purported distributive

share allocation to the partner as compensation for its use of the

property, the allocation will not be respected. Treas. Reg. § 1.704-

1(b)(1)(v). Petitioners fail to identify any transactions between YA

Global and the Foreign SPVs in which the latter acted in capacities other

than as partners. Petitioners appear to claim that none of the

allocations made to the Foreign SPVs can be distributive shares of YA

Global’s ECTI. They base that claim not on the Foreign SPVs’ role in

any particular transaction but on the Foreign SPVs’ status in relation

to YA Global. In short, their section 707(a) argument repeats, in a

different guise, their argument that the Foreign SPVs should not be

recognized as partners in YA Global. We have already concluded that

the record does not support that argument. Section 707(a) does not

provide grounds to treat allocations to the Foreign SPVs as other than

ECTI if those entities are recognized as partners of YA Global.21

Finally, petitioners rely on YA Global’s financial statements for

the proposition that “[a]ny allocations to the SPVs were attributable to

withdrawn capital . . . and therefore could not be allocations [of

distributive shares of partnership income] under section 704(b).” Our

21 A partnership’s income cannot be ECTI as to some partners but not others.

For the purpose of determining a partnership’s section 1446 withholding tax liability,

“[t]he calculation of partnership ECTI allocable to foreign partners . . . and the

partnership’s withholding tax obligation are partnership-level computations.” Treas.

Reg. § 1.1446-2(a).

37

[*37] response to that argument is simple: Financial statements do not

determine tax consequences.22

5. Conclusion

We thus conclude that YA Global’s section 1446 withholding tax

liability for 2009 includes the product of (1) the items of partnership

income, gain, loss, and deduction allocable to the Foreign SPVs,23 and

(2) the highest marginal tax rate specified in section 11(b)(1). Each

Foreign SPV’s shares of partnership income, gain, loss, and deduction

include (1) those items reported on the Schedule K–1 issued to it other

than the writeoff of interest receivable deemed uncollectible included in

the other deductions reported on line 13d,24 and (2) the Foreign SPV’s

share of YA Global’s mark-to-market gain for 2009 under section

475(a)(2).

III. Value of Accrued Interest on Debentures as of December 31, 2009

An Order issued August 10, 2022 (August 10 Order), listed the

initial questions to be discussed at the August 31, 2022, remote hearing.

Among other things, we asked whether “respondent agree[d] with

petitioners that the accrual of interest on a debenture held by [YA

Global] created an asset separate from the underlying debenture.” We

also asked about the interrelationship of sections 165, 166, and 475. In

particular, we asked whether, if YA Global’s convertible debentures

were subject to the mark-to-market rule of section 475(a)(2), as

respondent alleged, accrued interest on the debentures “would be taken

into account in determining the [debenture’s] basis and fair market

value for the purpose of determining the gain or loss that the

partnership would recognize under section 475(a)(2).” We noted that

22 Financial statements can, of course, be evidence of facts relevant to the

determination of tax consequences. That YA Global’s financial statements report the

distribution of participation interests to the Foreign SPVs as withdrawals of capital

may indicate that the participation interests provided the Foreign SPVs with

undivided ownership interests in the subject securities. The Schedules K‒1 issued to

the Foreign SPVs, however, point in the opposite direction, reporting substantial

capital accounts.

23 In our prior opinion, we concluded that petitioners had not established that

any portion of YA Global’s taxable income was not effectively connected with its U.S.

trade or business. YA Glob. Invs., LP, 161 T.C., slip op. at 62.

24 As explained infra Part III, to the extent that doubts about collectibility

reduce the value of the accrued interest on the debentures YA Global held on December

31, 2009, they should be taken into account in valuing the debentures for the purpose

of determining YA Global’s mark-to-market gain under section 475(a)(2).

38

[*38] respondent seemed to have “accepted the values at which the

partnership stated its debentures,” by using those values in computing

his mark-to-market adjustment, “but disregarded the partnership’s

write-off of accrued interest.” We asked whether respondent could

explain what we suggested may have been “inconsistent reliance on the

partnership’s financial reporting.” We also asked whether petitioners

would “hold to their contention that accrued interest is an asset separate

from the underlying debenture should we decide that the partnership’s

debentures are securities subject to the mark-to-market rule of section

475(a)(2).”

In a report submitted after the hearing, respondent advised us

that he “does not agree with petitioners that the accrual of interest on a

debenture held by the partnership created an asset separate from the

underlying debenture for purposes of section 475.” Respondent simply

chose not to contest the partnership’s treatment of accrued interest as a

separate asset. Instead, he “evaluated the accrued, but unpaid, interest

as a separate asset for purposes of disallowing the deduction claimed . . .

and not as part of the debentures for purposes of determining the

adjustment under section 475.”

Respondent rejected the notion that the write-off of allegedly

uncollectable accrued interest would be “subsumed within the mark-to-

market accounting” for the debentures. He argued for an approach

reflected in regulations proposed in 1995, but not yet adopted, under

which section 165 or 166, as applicable, would be applied before section

475(a)(2)’s mark-to-market rule. Prop. Treas. Reg. § 1.475(a)-1(f), 60

Fed. Reg. 397, 403 (Jan. 4, 1995). Under that approach, the basis of a

wholly worthless debt would be reduced to zero under the applicable

deduction provision and no gain or loss would be recognized under

section 475(a)(2).

Respondent denied that he had been inconsistent in his reliance

on YA Global’s financial reporting. According to his posthearing Report:

[R]espondent accepted, in the interest of sound tax

administration, values from the partnership’s financial

reports when the information provided to respondent

established that such values were sufficiently consistent

with tax principles but did not accept amounts from the

partnership’s financial reports when neither the financial

reports nor any other information provided to respondent

substantiated that the amounts in the partnership’s

39

[*39] financial reports were sufficiently consistent with tax

principles.

Respondent claims that “the partnership’s own description of its

accounting for its interest income is fundamentally inconsistent with

any assertion that its interest income is reported in its financial reports

at fair value.” While YA Global stated its debentures at fair value, it

stated accrued interest at either its full, nominal amount or zero.

“Because the partnership’s financial reports use different methods for

treatment and valuation of the debentures and the amount of the

interest accruals,” respondent argues, he “was not inconsistent in

accepting the valuation of the debentures while rejecting the amounts

reported for the interest accruals.”

In their posthearing Report, petitioners agreed with the

proposition that “if the Fund were a dealer in securities within the

meaning of section 475 and if the debentures it purchased were not held

for investment—then the plain language of section 475 and the

regulations thereunder would require that the loss in value of the

securities be treated as a reduction in the Fund’s income.” Regarding

respondent’s reliance on Proposed Treasury Regulation § 1.475(a)-1(f),

petitioners argue that “[p]roposed regulations . . . have no legal effect

unless and until they are adopted.”

Petitioners acknowledge that “[t]here were many times when the

Fund wrote off interest with respect to underlying debentures that were

reported at values below par.” Petitioners apparently mean that the

debentures were reported at values that, while below par, were greater

than zero. For example, YA Global wrote off all the interest that had

accrued on the debentures and promissory notes issued by Access

Beverage, Cobalis, Isonics, MM2, Poseidis, Speech Switch, Titan, and

US Helicopter. Even after the writedowns agreed to at the November

24, 2009, meeting of Yorkville Advisors’ Investment Committee,

however, the partnership continued to state those notes and debentures

at a substantial portion (50% to 80%) of their face value. Nonetheless,

petitioners characterize as “untenable” “[r]espondent’s willingness to

accept the determinations made by the Fund’s management and its

auditors with respect to the valuation of investments generally—but not

with respect to the valuation of interest receivable.”

Petitioners argue that “accrued interest receivable [can be

viewed] as an asset separate from its underlying debenture when doing

so is necessary to clearly reflect a taxpayer’s income.” Petitioners reason

40

[*40] that, if YA Global’s debentures were not subject to section 475(a),

treating the accrued interest and the underlying principal as separate

assets would have been necessary because the former would be an

ordinary income asset while the latter would be a capital asset.

Petitioners allow, however, that, “[i]f the debentures were subject to the

mark-to-market rules of section 475, it would not matter whether the

accrued interest were viewed as an asset separate from the underlying

debentures because any loss from the worthlessness of the interest or

the underlying principal invested would be ordinary in character.”

As noted supra Part I, our prior opinion establishes that, under

section 475(a)(2), YA Global is required to recognize gain or loss as if

each security it held on December 31, 2009, had been “sold for its fair

market value” on that date. The parties agree that, given that

conclusion, no grounds exist to treat interest accrued on a debenture and

the underlying debenture itself as separate assets. Respondent argues

that accrued interest and the underlying debenture can never be treated

as separate assets. Petitioners argue that accrued interest can be

treated as a separate asset if the underlying debenture is a capital asset.

Under section 475(d)(3), however, any gain or loss recognized by YA

Global under section 475(a)(2) is ordinary income or loss. Petitioners

accept that, under those circumstances, accrued interest need not be

treated as an asset separate from the debenture on which it accrued.

Each debenture and the interest accrued on the debenture can

appropriately be treated as a unitary asset for the purpose of

determining YA Global’s mark-to-market gain or loss under section

475(a)(2).

Under the circumstances, we also need not decide whether section

165 or 166 must be applied before section 475(a)(2). Respondent argues

that the basis of a worthless security should first be reduced to zero

under section 165 or 166, as applicable, before applying section

475(a)(2). Petitioners disagree. But respondent also argues that

petitioners have not established YA Global’s entitlement to a deduction

under section 165 or 166.25

25 As noted in the text, petitioners take the position that, if YA Global’s

debentures are subject to section 475(a)(2), neither section 165 nor section 166 would

be applied before applying section 475(a)(2). Instead, petitioners accept that any

decline in value of accrued interest because of doubts about collectibility would be

taken into account in computing the partnership’s mark-to-market gain or loss.

Because we have concluded that YA Global’s debentures are securities subject to

41

[*41] We thus face the factual question of the value of the debentures

YA Global held on December 31, 2009. In the December 1 Order, we

identified that question as one of the issues in regard to YA Global’s

2009 taxable year not resolved by our initial opinion. That Order invited

the parties to submit supplemental briefs on that and the other

remaining issues. Respondent, in his Supplemental Brief, pointed to

various discrepancies and incongruities in the record, contending that it

“does not include sufficient information to estimate the value of the

accrued interest YA Global claimed as a writeoff or to assess whether,

and to what extent, YA Global’s mark-to-market gains for 2009 should

be adjusted to account for any loss in value of its accrued interest.”

By contrast, petitioners’ Supplemental Brief directs us to four

pages of the Report they submitted after the August 31, 2022, remote

hearing. In that Report, petitioners maintained their positions (rejected

in our prior opinion) that YA Global was not engaged in a U.S. trade or

business, that it was not a “dealer in securities,” within the meaning of

section 475(c)(1), and that, even if it were, its securities would be

exempted from section 475(a)(2)’s mark-to-market rule by the exception

provided in section 475(b)(1)(A) for securities held for investment. As

noted above, petitioners allowed that, if the partnership were a dealer

and its securities subject to section 475(a)(2), doubts about the

collectibility of accrued interest on a debenture would be taken into

account in determining the partnership’s mark-to-market gain or loss.

And they agreed that, in that event, there would be no reason to treat

as separate assets accrued interest on a debenture and the debenture

itself. Given the procedural status of the cases, however, petitioners did

not specifically address the question of the value that should be ascribed

to the debentures if principal and accrued interest on each debenture

were treated as elements of a unitary asset.

Our December 1 Order gave each party the opportunity to submit

a reply to the other’s Supplemental Brief. Neither party did so.

Petitioners have thus left unchallenged respondent’s claim that the

record is insufficient to determine the extent to which the mark-to-

market gain that respondent determined for YA Global’s 2009 taxable

year should be adjusted to reflect doubts about the collectibility of

accrued interest on some of the debentures the partnership held on

December 31, 2009.

section 475(a)(2), we treat petitioners as having conceded respondent’s denial of the

partnership’s $46,506,023 deduction for allegedly uncollectible accrued interest.

42

[*42] Both parties’ positions have logical flaws grounded in YA Global’s

separate accounting for accrued interest on debentures and the

debentures themselves. Respondent would treat all accrued interest as

worth its full nominal amount, even if the underlying debenture were

determined to be worth less than face value. By contrast, petitioners

would have us accept that a debenture’s principal could be worth a

substantial portion of its face amount (e.g., 50% to 80%) while accrued

interest on the debenture was worthless.26

Even though respondent’s position, like petitioners’, is logically

flawed, we will nonetheless uphold the FPAA’s determination that YA

Global had mark-to-market gain under section 475(a)(2) of

$103,852,672. Petitioners have made no argument grounded in the

record about the extent of any adjustment to the mark-to-market gain

determined in the FPAA necessary to reflect doubts about the

collectibility of accrued interest on YA Global’s convertible debentures

and promissory notes.

IV. Requirement to Accrue Interest

In an amended Petition filed in June 2020, petitioners made an

affirmative claim that YA Global’s 2009 income “must be reduced by

$17,137,938,” which, they claim, “represents interest income that the

Partnership erroneously accrued in 2009 despite the fact that the

collection of such interest income was doubtful, and it was reasonably

certain that such interest income would never be paid.”

Treasury Regulation § 1.451-1(a) provides: “Under an accrual

method of accounting, income is includible in gross income when all the

events have occurred which fix the right to receive such income and the

amount thereof can be determined with reasonable accuracy” (all events

test). As the Supreme Court explained in Spring City Foundry Co. v.

Commissioner, 292 U.S. 182, 184 (1934), for taxpayers “[k]eeping

accounts and making returns on the accrual basis . . . it is the right to

receive and not the actual receipt that determines the inclusion of the

amount in gross income.”

26 Under its established accounting policies, YA Global writes off accrued

interest “when management determines that payment by the debtor is unlikely.” Even

if the payment of accrued interest is less likely than not, it would not follow that the

accrued interest adds nothing to the value of the underlying promissory note or

debenture.

43

[*43] Under an exception to the all events test, a taxpayer need not

accrue income whose receipt is sufficiently doubtful. The courts have

articulated the governing standard in various ways. According to the

Court of Appeals for the Second Circuit, income need not be accrued if

“it is of doubtful collectability or it is reasonably certain it will not be

collected.” Corn Exch. Bank v. United States, 37 F.2d 34, 34 (2d Cir.

1930). In the same opinion, however, the court wrote that income should

be accrued only if it is “likely to be paid or can be collected.” Id.

In Georgia School-Book Depository, Inc. v. Commissioner, 1 T.C.

463, 469 (1943), this Court identified two circumstances in which

accrual under the all events test would not be required. “To allow the

exception,” we wrote, “there must be a definite showing that an

unresolved and allegedly intervening legal right makes receipt

contingent or that the insolvency of his debtor makes it improbable.” On

the facts before us, we concluded that “there was no reasonable

expectation that [the amounts in issue] would not ultimately be paid.”

Id. at 471. We applied the “no reasonable expectation” standard again

in Chicago & North Western Railway Co. v. Commissioner, 29 T.C. 989,

996 (1958), concluding that the taxpayer before us was not required to

accrue interest on debt owed to it by a subsidiary we described as

“hopelessly insolvent.”

The reasonable expectancy of payment exception to the all events

test must be “strictly construed.” Eur. Am. Bank & Tr. Co. v. United

States, 20 Cl. Ct. 594, 605 (1990), aff’d, 940 F.2d 677 (Fed. Cir. 1991)

(unpublished table decision). Like any exception, it “must not be allowed

to swallow up the [general] rule.” Ga. School-Book Depository, Inc., 1

T.C. at 469. Applying the exception too broadly could allow a taxpayer

“at his own will [to] shift the receipt of income from one year to another

as should suit his fancy.” Id.

To our knowledge, the characterization of the caselaw offered by

the U.S. Court of Appeals for the Sixth Circuit in 1968 remains accurate:

“In all of the cases . . . which have held an item non-accruable because

of doubtful collectibility, substantial evidence had been presented as to

the financial instability or even the insolvency of the debtor.” Jones

Lumber Co. v. Commissioner, 404 F.2d 764, 766 (6th Cir. 1968), aff’g

T.C. Memo. 1967-81. Financial difficulties of a debtor that merely delay

payment are not sufficient to avoid accrual. See Hoffman v.

Commissioner, T.C. Memo. 1989-154; Koehring Co. v. United States, 190

Ct. Cl. 898, 910 (1970).

44

[*44] YA Global’s reporting of accrued interest demonstrates that it had

a reasonable expectation of receiving the interest accrued when it

recorded that interest. Under its established accounting policies, YA

Global stopped accruing interest when its general partner determined

that “there [was] reasonable doubt as to collectibility.” When

“management determine[d] that payment by the debtor [was] unlikely,”

the partnership wrote off accrued interest. In the August 10 Order, we

asked: “Given the description of YA Global’s accounting policies

included in its financial statements, does [the accrual of interest] not

indicate that the General Partner determined that there was no

‘reasonable doubt as to collectibility’ when the interest accrued and that

any doubts arose only thereafter?”

At the August 31, 2022, remote hearing, petitioners’ counsel

advised us: “[T]he way the accruals worked is that the fund

administrator just churned out this report every month. So it wasn’t

like they were making decisions on a monthly basis, accrue or don’t

accrue.” She added: “It was just was [sic] completely immaterial until

their financial reports. They had to do financial statements, and that’s

when they had to decide.”

In their posthearing Report, petitioners wrote:

[T]he Fund’s managers were not necessarily aware of

events demonstrating a portfolio company’s financial

distress the moment those events occurred, and the

financial statements do not suggest they would (or could)

be. It would not be reasonable for the Fund’s managers to

review the likelihood of collectability for every debenture

in the Fund’s portfolio every month. Thus, the fact that

management did not make the determination that interest

should be written off (or not accrued) with regard to a

particular debenture in a particular month did not reflect

any determination that there was no reasonable doubt as

to its collectability.

Exhibit 1290-P refutes petitioners’ claims. It shows that YA

Global did decide on a monthly basis whether to accrue interest on its

debentures or promissory notes.27

27 Respondent contends that Exhibit 1290-P is “unreliable and should not be

given any credence or weight.” Among other discrepancies, he observes that the

amount shown on Exhibit 1290-P as interest written off is $99 less than the

45

[*45] Given the clear implications of YA Global’s accounting policies,

petitioners can prevail on their affirmative claim only by presenting

evidence unavailable to YA Global’s general partner during 2009 as the

partnership accrued interest that establishes that the partnership

should have had no reasonable expectation, when the interest accrued,

of ultimately receiving it. In the report they submitted after the August

31, 2022, remote hearing, petitioners claim to “have presented objective

evidence of identifiable events demonstrating the worthlessness of the

interest receivables.” They refer us to proposed finding 232 in their

Opening Brief. That proposed finding lists four “identifiable events”

petitioners claim to be indicative of a portfolio company’s financial

distress:

(1) the financial statement auditor had expressed

substantial doubt as to whether the particular portfolio

company could continue as a going concern, (2) the portfolio

company was in bankruptcy or similar proceedings, (3) the

portfolio company was in default on its current obligations,

(4) the portfolio company suffered substantive negative

cash flows in its operations.[28]

Petitioners’ proposed finding 232 includes a table that lists 19 of

the issuers of debentures or promissory notes on which YA Global both

accrued and wrote off interest for 2009: Cobalis, Compass, Earth

Biofuels, Falcon, Futuremedia, Handheld, Ignis Petroleum, Innova

Holdings, Inc., Isonics, iVoice, MM2, Pacific Gold, Poseidis, Tech

Laboratories, Inc., Teleplus, Titan, TXP Corp., US Helicopter, and

Wherify.29 The table cites exhibits in the record that purportedly show

$46,506,023 that YA Global reported in its financial statements and on its tax return.

The $99 difference may indicate a transposition error. Regardless, for the reasons

explained in the text below, even if we were to accept the accuracy of Exhibit 1290-P,

we would conclude that petitioners have not met their burden of establishing that YA

Global overstated its 2009 interest income by $17,137,938.

28 We are unsure what it means for a company to have “substantive” negative

cashflow from operations. Perhaps petitioners meant to refer to a company’s operating

cashflow being substantially negative.

29 The table also includes McKenzie Bay International, Ltd., Savi Media Group,

Inc., and the Certo Group Corp. Of the 34 portfolio companies that issued debentures

or promissory notes on which YA Global accrued and wrote off interest for 2009,

petitioners make no mention in their briefs of 9 of them: Access Beverage, Corporate

Strat., EYI Ind., Macmin Silver Ltd., Natural Nutrition, Inc., PNG Ventures, Inc.,

Renewable Fuels, Inc., Speech Switch, Inc., and United Fiber Systems. Another six

issuers, BlueCreek Energy, Inc., CSI Business, KD Resources, Newgen Tech., NS8

Corp., and Terminal 1 receive only passing mention in petitioners’ briefs. Petitioners

46

[*46] that each portfolio company had suffered from one or more of

petitioners’ four “identifiable events.”

In their posthearing Report, petitioners argue:

It is clear from these identifiable events that these portfolio

companies were not in a financial position to make any

interest payments that became due in 2009. These

portfolio companies’ history of nonpayment of interest also

justified not accruing additional interest income in 2009.

By the end of 2008, the interest in arrears under each

debenture was already substantial . . . and the history of

nonpayment continued through 2009. . . . When the

substantial prior nonpayment of interest is viewed

together with the evidence of financial distress experienced

by these portfolio companies, there can be little doubt,

much less reasonable doubt, that the interest payables

were not collectible when each became due throughout

2009.

Most of the exhibits petitioners cite in their proposed finding 232

are filings made by the portfolio company under the federal securities

laws. And most of those filings cover periods ended on or before

September 30, 2008.30 We assume that YA Global’s general partner had

access to the information reported in those filings when it chose to

continue into 2009 the accrual of interest on debentures or promissory

notes issued by those portfolio companies. It follows that the

information reported in those filings did not prevent YA Global from

do not direct us to any evidence in the record as to the financial condition of any of

those six portfolio companies.

30 Petitioners refer us to a Form 10–Q filed by Earth Biofuels for the quarter

ended September 30, 2008, a Form 10–QSB filed by Falcon for the quarter ended

September 30, 2006, a Form 20–F filed by Futuremedia for the year ended June 30,

2007, a Form 10–Q filed by ZVUE Corp. (successor to Handheld) for the quarter ended

September 30, 2008, a Form 10–KSB filed by Ignis Petroleum for the year ended

January 30, 2008, a Form 10–QSB filed by Innova Robotics & Automation, Inc., for the

quarter ended September 30, 2007, a Form 10–Q filed by Pacific Gold for the quarter

ended September 30, 2008, a Form 10–QSB/A filed by Poseidis for the quarter ended

May 31, 2006, a Form 10–QSB filed by Techlabs, Inc. for the quarter ended March 31,

2007, a Form 10–Q filed by Teleplus for the quarter ended September 30, 2008, a Form

10–KSB/A filed by TXP Corp. for the year ended December 31, 2007, a Form 10–Q filed

by US Helicopter for the quarter ended September 30, 2008, and the following forms

filed by Wherify: a Form 10–KSB for the year ended June 30, 2006, a Form 10–KSB

for the year ended June 30, 2007, and a Form 10–QSB for the quarter ended March

31, 2008.

47

[*47] having a reasonable expectation, at the time of accrual, that it

would ultimately receive the interest accrued.

We have yet to address 6 of the 34 portfolio companies that issued

debentures or promissory notes on which YA Global both accrued and

wrote off interest for 2009: Cobalis, Compass, Isonics, iVoice, MM2, and

Titan. We address those remaining 6 portfolio companies below.

A. Cobalis

YA Global’s actions in accruing interest on its Cobalis debentures

in January 2009 and writing off all accrued interest the following month

show that, contrary to the claims of petitioners and their counsel, the

accrual of interest during a year was not automatic and that evaluations

of collectibility were made during the year. In particular, those actions

show that YA Global had no reasonable doubt in January about the

collectibility of the interest accrued on its Cobalis debentures but that,

in the next month, it determined that payment of that interest was

unlikely.

Petitioners’ proposed finding 232 lists for Cobalis both the “going

concern” and the “bankrupty/receivership” identifiable events. The

evidence of those circumstances to which petitioners point us does not

call into question the judgments reflected in YA Global’s treatment of

the interest accrued on its Cobalis debentures. Concerns about Cobalis’s

ability to continue as a going concern long predated January 2009. Yet

those concerns did not prevent YA Global from accruing interest on its

Cobalis debentures in that month. The bankruptcy proceedings

involving Cobalis also predated January 2009. Petitioners point to no

information about Cobalis’s financial condition in January 2009 that,

had it been available to YA Global’s general partner, would have caused

the general partner to conclude that there was reasonable doubt as to

the collectibility of the interest that accrued on the Cobalis debentures

in that month.

B. Compass

Petitioners’ proposed finding 232 lists for Compass only the

“bankruptcy/receivership” identifiable event. To demonstrate that

Compass was in “bankruptcy or similar proceedings,” petitioners cite the

April 22, 2009, “Circular to Creditors” prepared by Compass’s

administrator. We infer that YA Global, as a major creditor of Compass,

was well aware of the commencement of Compass’s voluntary

administration proceedings on January 29, 2009. Nonetheless, the

48

[*48] partnership continued to accrue interest on its Compass

debentures through May 2009, demonstrating that the partnership’s

general partner judged that, at that time, no reasonable doubt existed

as to the collectibility of the accrued interest. Petitioners do not claim

that any of the information provided to creditors in the April 22, 2009,

circular was unknown to YA Global but, had it been known, would have

affected its general partner’s decision to continue the accrual of interest

on the partnership’s Compass debentures through May 2009.

(Petitioners’ proposed finding 232 does not cite any specific page or

pages of the circular. They thus appear to cite the circular only to

establish that Compass entered voluntary administration on January

29, 2009.)

C. Isonics

Petitioners’ proposed finding 232 lists for Isonics the “going

concern” and “cash flow” identifiable events. The evidence of those

circumstances to which petitioners direct us does not call into question

the judgments reflected in YA Global’s treatment of the interest accrued

on its Isonics debentures and promissory notes. Given the going concern

qualification included in the report of the company’s auditors on its

financial statements for the year ended April 30, 2008, YA Global’s

general partner had reason to know, in January 2009, of doubts about

Isonics’s ability to continue operations as a going concern. It also had

reason to know of Isonics’s cashflow problems. Those problems seem to

have worsened between October 31, 2007, and October 31, 2008. But

those worsening cashflow problems did not prevent YA Global from

continuing to accrue interest on its Isonics debentures and promissory

notes through November 2009. Petitioners point to no information

about Isonics’s financial condition between January and November 2009

that, had it been available to YA Global’s general partner, would have

caused the general partner to conclude that reasonable doubt existed as

to the collectibility of the interest on the Isonics debentures and

promissory notes that accrued during those months.

D. iVoice

The partnership’s reporting of interest on its iVoice debenture,

accruing interest from January through May 2009, ceasing accrual

between June and October, and then writing off accrued interest in

November, shows the partnership had no reasonable doubt about the

collectibility of the accrued interest until June 2009.

49

[*49] Petitioners’ proposed finding 232 lists for iVoice the “going

concern” and “cash flow” identifiable events. The evidence of those

circumstances to which petitioners direct us does not call into question

the judgments reflected in YA Global’s treatment of the interest accrued

on its iVoice debenture. Although iVoice Technology’s 2008 Form 10–K,

iVoice’s September 30, 2009, Form 10–Q, and B Green’s 2009 Form 10–K

reported doubts about the company’s ability to continue as a going

concern, those doubts were not new. They dated back at least to 2007.

In the face of those doubts about the ability of iVoice and iVoice

Technology to continue as going concerns, and in the face of their

“historical negative cash flow,” YA Global continued to accrue interest

on its iVoice debenture through May 2009. We are not convinced that

the judgment reflected in that accounting was based on incomplete

information about iVoice’s financial condition between January and

May of 2009.

E. MM2

The partnership’s reporting of accrued interest on its MM2

debentures shows that it had no reasonable doubt about the collectibility

of the interest accrued on its MM2 debentures until December 2009.

Petitioners’ proposed finding 232 lists for MM2 the “going

concern,” “default,” and “cash flow” identifiable events. The evidence of

those circumstances to which petitioners direct us does not call into

question the judgments reflected in YA Global’s accrual of interest on its

MM2 debentures through November 2009. The factors cited in MM2’s

Form 10–Q for the quarter ended March 31, 2009, that led to doubt

about the company’s ability to continue as a going concern—losses and

deficiencies in cashflow—did not arise for the first time during that

quarter. Moreover, even after YA Global would have had access to the

information disclosed in MM2’s March 31, 2009, Form 10–Q, the

partnership continued to accrue interest on its MM2 debentures. And,

of course, YA Global would have been well aware of MM2’s default on

the repayment terms of one of those debentures. We are thus not

convinced that the judgment reflected in YA Global’s accrual of interest

on its MM2 debentures between January and November 2009 was based

on incomplete information about MM2’s financial condition during those

months.

50

[*50] F. Titan

Petitioners’ proposed finding 232 lists for Titan only the “cash

flow” identifiable event. Petitioners cite the Consolidated Statements of

Cash Flows included in Titan’s Form 10–Q for the quarter ended

November 30, 2008. Those statements report that Titan had negative

cashflow from operations for the three months ended November 30,

2007, but positive cashflow for the three months ended November 30,

2008. We fail to see how those statements call into question the

determination made by YA Global’s general partner that no reasonable

doubt existed as to the collectibility of interest on the partnership’s Titan

debenture through November 2009.

Petitioners have not presented evidence unavailable to YA

Global’s general partner during 2009 as the partnership accrued

interest that establishes that the partnership should have had no

reasonable expectation, when the interest accrued, of ultimately

receiving it. Of the 34 portfolio companies that issued debentures or

promissory notes on which YA Global accrued and wrote off interest for

2009, 9 receive no mention in petitioners’ Briefs. Petitioners mention

another 6 of those 34 portfolio companies only in passing and do not call

to our attention any evidence in the record of the financial condition of

those companies. Petitioners do refer us to evidence of the financial

condition of 19 of the portfolio companies that issued debentures or

promissory notes on which YA Global accrued and wrote off interest for

2009. For 13 of those 19 portfolio companies, that evidence consists of

one or more securities law filings that cover periods ended on or before

September 30, 2008. Again, we assume that any information reported

in those filings about the financial condition of those 13 portfolio

companies was known to YA Global’s general partner when it decided to

accrue interest in 2009 on the debentures and promissory notes issued

by those portfolio companies. As to the remaining 6 portfolio companies,

the evidence to which petitioners point does not call into question YA

Global’s reporting of interest accrued on debentures or promissory notes

issued by those companies. Therefore, we conclude that YA Global did

not overstate its interest income for 2009 by $17,137,938. Instead, the

partnership’s interest income was $42,617,464, as stated on its 2009

Schedule K. That interest income should be included as an element of

the partnership’s ordinary business income for the year.

It follows from our resolution of the issues remaining that YA

Global had ordinary business income for 2009 of $24,790,341, as

determined in the FPAA. Under the analysis described in our prior

51

[*51] opinion, all of that ordinary business income was effectively

connected with YA Global’s U.S. trade or business. YA Global owed

section 1446 withholding tax, in an amount to be determined by the

parties under Rule 155, on that portion of its 2009 ECTI allocable to the

Foreign SPVs. Our resolution of the issues addressed in Parts I through

IV should allow the parties to compute under Rule 155 YA Global’s

liabilities for additions to tax for 2009 under sections 6651(a)(1) and (2)

and 6655.

Decisions will be entered under Rule 155 for the taxable years 2009

through 2011.