“If interest rates rise above the agreed maximum yield, [the taxpayer] is required to purchase the mortgage on terms less favorable than they would have been at current rates.”
How later courts described this case
- “If interest rates rise above the agreed maximum yield, [the taxpayer] is required to purchase the mortgage on terms less favorable than they would have been at current rates.”
Written by the judges who cited it.
The opinion
United States Tax Court
161 T.C. No. 11
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 November 15, 2023.
—————
PS, a partnership, provided funding to portfolio
companies in exchange for stock, convertible debentures,
promissory notes, and warrants. Because PS had no
employees, it hired YA to manage its assets. PS could
impose restrictions from time to time on the management
of its assets with appropriate notice to YA. As part of the
transactions in which PS acquired securities from portfolio
companies, those companies paid fees to both PS and YA.
For each of 2006, 2007, and 2008, PS filed Form
1065, U.S. Return of Partnership Income, but did not file
Form 8804, Annual Return for Partnership Withholding
Served 11/15/23
2
Tax (Section 1446). PS was advised by the accounting firm
that prepared its returns that it was not engaged in a U.S.
trade or business. PS later filed suit against the
accounting firm for professional malpractice and
negligence.
By execution of a series of Forms 872–P, Consent to
Extend the Time to Assess Tax Attributable to Partnership
Items, R and PS agreed to extend until March 31, 2015, for
each of the years in issue, the period of limitation on the
assessment of “any federal income tax attributable to the
partnership items of the partnership . . . against any
partner.”
On March 6, 2015, R issued notices of final
partnership administrative adjustment (FPAAs) for
taxable years that included 2006 through 2008. The
FPAAs reflected R’s determination that PS was engaged in
the conduct of a trade or business in the United States
during those years, that all of PS’s taxable income was
effectively connected with that trade or business, and that
PS was liable for withholding tax under I.R.C. § 1446 on
the portion of PS’s effectively connected taxable income
allocable to its foreign partners. R also determined that PS
was a “dealer in securities” subject to the mark-to-market
accounting rules provided in I.R.C. § 475.
Held: Because Ps (PS’s tax matters partners) accept
that the activities of an agent can be attributed to the
agent’s principal for the purpose of determining whether
the principal is engaged in the conduct of a U.S. trade or
business, and because Ps have not established that the
relationship between PS and YA was other than agency,
YA’s activities can be attributed to PS. PS’s ability to give
interim instructions to YA regarding the management of
PS’s account demonstrates a relationship of agent and
principal rather than service provider and recipient.
Held, further, Ps have not established that, during
2006, 2007, and 2008, PS was not engaged in a U.S. trade
or business, as defined by I.R.C. § 864(b), Commissioner v.
Groetzinger, 480 U.S. 23 (1987), and Higgins v.
Commissioner, 312 U.S. 212 (1941). The activities that YA
3
conducted on PS’s behalf were continuous, regular, and
engaged in for the primary purpose of income or profit.
And Ps have not established that the fees paid by portfolio
companies were additional payments for the use of capital.
Therefore, they have not established that the activities
that YA conducted on PS’s behalf were limited to either the
management of investments or trading in stocks or
securities.
Held, further, because PS “regularly [held] itself out
as being willing and able to” purchase stock and
debentures, the portfolio companies from which it made
those purchases were its “customers,” within the meaning
of I.R.C. § 475(c)(1)(A). Cf. Treas. Reg. § 1.475(c)-1(a)(2).
Held, further, because PS “regularly purchase[d]
securities from . . . customers in the ordinary course of a
trade or business,” it was a “dealer in securities,” within
the meaning of I.R.C. § 475(c)(1)(A), and thus subject to the
mark-to-market rule provided in I.R.C. § 475(a)(2).
Held, further, to satisfy the identification
requirement provided in I.R.C. § 475(b)(2), under which
securities can be excepted from the mark-to-market rules
of I.R.C. § 475(a), a dealer’s records must explicitly state
that the security in question is described in either I.R.C.
§ 475(b)(1)(A) or (B) or I.R.C. § 475(b)(1)(C); identification
of a security in general terms as “held for investment” is
insufficient to meet the requirement.
Held, further, Ps have not established that any
portion of PS’s taxable income was not effectively
connected with its U.S. trade or business.
Held, further, a partnership’s liability for
withholding tax under I.R.C. § 1446 can be reduced by
nonpartnership deductions of a foreign partner only if the
foreign partner certifies those deductions under Treas.
Reg. § 1.1446-6.
Held, further, a partnership’s payment of
withholding tax under I.R.C. § 1446 results in an
overpayment for purposes of I.R.C. § 1464 only if the
withholding tax paid exceeds the withholding tax properly
4
due. Jones v. Liberty Glass Co., 332 U.S. 524 (1947). An
overpayment does not result merely because the
withholding tax paid in respect of a foreign partner exceeds
the foreign partner’s income tax liability for the year under
I.R.C. § 871(b) or 882.
Held, further, PS’s filing of Form 1065 for each of
2006, 2007, and 2008 did not commence the period of
limitation on the assessment of I.R.C. § 1446 withholding
tax because the return did not advise R of PS’s potential
liability for that tax. Commissioner v. Lane-Wells Co., 321
U.S. 219 (1944); Springfield v. United States, 88 F.3d 750
(9th Cir. 1996); Paschall v. Commissioner, 137 T.C. 8
(2011).
Held, further, because the tax imposed by I.R.C.
§ 1446 is an income tax, PS is a “partner” within the
meaning of I.R.C. § 6231(a)(2). Consequently, even if the
periods of limitation on the assessment of I.R.C. § 1446
withholding tax commenced with PS’s filing of Forms 1065,
the Forms 872–P executed for 2006 and 2007 extended the
period of limitation for the assessment of that tax for each
of those years so that it remained open when R issued the
FPAAs.
Held, further, PS’s filing of Forms 1065 did not
shield it from additions to tax under I.R.C. § 6651(a)(1) for
its failure to file Forms 8804. Even if a Form 1065 required
to be filed by I.R.C. § 6031(a) can, in some circumstances,
serve as a “return” whose filing can prevent the imposition
of an addition to tax under I.R.C. § 6651(a)(1), PS’s Forms
1065 cannot be accepted as defective Forms 8804 because
they fail at least three of the four elements of the test
prescribed in Beard v. Commissioner, 82 T.C. 766 (1984),
aff’d, 793 F.2d 139 (6th Cir. 1986). Although R apparently
accepts that the Forms 1065 that PS filed for 2006, 2007,
and 2008 were signed under penalties of perjury, those
returns did not disclose the facts relevant to the
determination that PS was engaged in a U.S. trade or
business, they did not purport to be Forms 8804, and they
were not filed on the basis of an honest and reasonable
belief that they would satisfy PS’s obligations to file Forms
8804.
5
Held, further, Ps have not met their burden of
proving that PS’s failure to file Forms 8804 and pay I.R.C.
§ 1446 withholding tax was due to reasonable cause and
not willful neglect.
—————
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.
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 1446 on the portion of its
taxable income effectively connected with that trade or business that
was allocated to foreign partners. 2 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. 3 As described in more detail below, in
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, 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
references are to the Tax Court Rules of Practice and Procedure in effect at the relevant
times.
3 In addition, each FPAA determined that the “I.R.C. § 6662 accuracy-related
penalty is applicable.” Petitioners advise us that “[r]espondent has acknowledged . . .
that he does not have sufficient evidence establishing his compliance with I.R.C.
6
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 4 also raise various issues regarding the manner in which
respondent computed the partnership’s section 1446 withholding tax
liability. And petitioners challenge respondent’s determinations of
additions to tax. Petitioners also allege that the applicable statute of
limitations bars respondent from assessing the tax and additions to tax
in issue for 2006 and 2007. In this Opinion, we address those issues
raised by YA Global’s taxable years ended December 31, 2006, 2007, and
2008. The partnership’s 2009 taxable year raises additional issues that
we will address in a subsequent Opinion after giving the parties the
opportunity to submit supplemental briefs that take into account our
resolution in this Opinion of those issues common to all four taxable
years. In this Opinion, we address the following issues:
1. Can the activities of Yorkville Advisors, the
manager of YA Global’s assets, be attributed to the
partnership?
2. If so, was YA Global engaged, through Yorkville
Advisors, in the conduct of a U.S. trade or business during
2006, 2007, and 2008?
3. Was YA Global required to recognize gain under
the “mark-to-market” rule of section 475(a)(2) for each of
2006, 2007, and 2008?
4. If YA Global was engaged in the conduct of a U.S.
trade or business during 2006, 2007, and 2008, how much
of YA Global’s taxable income for each year was effectively
connected with that trade or business?
§ 6751(b), and he has therefore conceded these penalties.” Because respondent does
not dispute petitioners’ assertion, we treat him as having conceded the accuracy-
related penalties determined in the FPAAs. Similarly, because petitioners make no
argument on brief challenging the determination in the 2006 FPAA that YA Global
had $23,483,852 of net earnings from self-employment, we treat them as having
conceded that issue. See Gregory v. Commissioner, T.C. Memo. 2018-192, at *10–11;
Remuzzi v. Commissioner, T.C. Memo. 1988-8, aff’d on other grounds, 867 F.2d 609
(4th Cir. 1989).
4 The consolidated cases before us involve two petitioners. Yorkville Advisors,
LLC, a Delaware limited liability company (Yorkville Advisors), was YA Global’s tax
matters partner during 2006. Another entity, Yorkville Advisors GP, LLC (Yorkville
GP), was YA Global’s tax matters partner during the remaining years in issue.
7
5. If YA Offshore Global Investments, Ltd. (YA
Offshore) was allocated effectively connected taxable
income for 2007 and 2008, can YA Global’s liability for
section 1446 withholding tax for each year be “adjusted”
under I.R.C. § 1464 to reflect stipulated expenses of YA
Offshore beyond its distributive share of partnership
deductions?
6. Did YA Global’s filing of Form 1065 for each of
2006, 2007, and 2008 commence the period of limitation on
the assessment of I.R.C. § 1446 withholding tax for the year
and, if so, was that period extended by the execution of
Forms 872–P, Consent to Extend the Time to Assess Tax
Attributable to Partnership Items?
7. Is YA Global liable for additions to tax under
I.R.C. § 6651(a)(1) and (2) for its failure to file Forms 8804
and pay I.R.C. § 1446 withholding tax?
For readers’ convenience, we will present our findings of those
facts relevant to each issue together with our analysis of the issue.
I. Attribution of Yorkville Advisors’ Activities to YA Global
A. Introduction
The principal issue in the cases before us is whether YA Global
engaged in a trade or business in the United States during the taxable
years ended December 31, 2006, 2007, 2008, and 2009. If the
partnership was so engaged, it was required by section 1446 to withhold
and pay tax on that portion of its income effectively connected with its
U.S. trade or business that was allocable to any foreign partners.
The cases present as a threshold issue the question of whether
Yorkville Advisors’ activities can be attributed to YA Global.
Respondent acknowledges that “[a]s it had no employees, YA Global
itself could not perform any activities.” Therefore, respondent’s
conclusion that the partnership engaged in a U.S. trade or business
necessarily rests on the premise that the activities of Yorkville Advisors,
as the manager of the partnership’s assets, can be attributed to the
partnership.
8
B. Findings of Fact
YA Global was formed as a Delaware limited partnership on
January 2, 2001. In early 2007, YA Global registered under the laws of
the Cayman Islands. From YA Global’s formation until January 14,
2007, Yorkville Advisors was YA Global’s sole general partner. From
January 15, 2007, through December 31, 2011, Yorkville GP was YA
Global’s sole general partner. When petitioners filed their Petitions in
these cases, YA Global’s mailing address was in George Town, Grand
Cayman.
In an Amended and Restated Investment Management
Agreement entered into as of December 1, 2005 (2005 Agreement), YA
Global retained Yorkville Advisors “to render investment management
services and manage [YA Global’s] securities investment account.” 5
Yorkville Advisors maintained its headquarters in New Jersey. In the
2005 Agreement, YA Global “constitute[d] and appoint[ed]” Yorkville
Advisors “as the Partnership’s Agent and attorney-in-fact with full
power and authority to buy, sell, or otherwise deal with the
[Partnership’s] account.” 2005 Agreement § 2. The agreement further
states that the “power of attorney” granted to Yorkville Advisors “is
coupled with an interest and is irrevocable.” Id.
Section 3 of the 2005 Agreement provided: “The Partnership shall
promptly advise the Investment Manager of any specific investment
restrictions relating to the Account. In the absence of such notice, the
Investment Manager shall operate the Account without any agreed-
upon restrictions with the Partnership.” By its terms, the 2005
Agreement could be “terminated by either party with or without cause
by the giving of not less than 30 days’ written notice to the other party.”
2005 Agreement § 10(a).
As of August 1, 2007, YA Global and Yorkville Advisors entered
into a new agreement (2007 Agreement) that amended and restated the
2005 Agreement. The 2007 Agreement includes provisions that are
substantively identical to those of the 2005 Agreement described above.
(The termination provision of the 2007 Agreement appears as section
14(a).) In addition, section 9 of the 2007 Agreement states: “The
5 YA Global entered into the 2005 Agreement under its former name, Cornell
Capital Partners, LP. For convenience, we will refer to the partnership throughout as
YA Global. Similarly, we will refer to YA Offshore Global Investments, Ltd.
throughout as YA Offshore, even in regard to periods in which it was known as Cornell
Capital Partners Offshore, Ltd.
9
activities engaged in by the Investment Manager on behalf of [YA
Global] shall be subject to the policies of and control” of YA Global’s
general partner. 6
Yorkville Advisors was compensated for its services by a
management fee equal to a specified percentage (generally 2%) of the
partnership’s assets and a 20% incentive fee based on the partnership’s
profits.
YA Global filed a Form 1065 for each of the years in issue. The
partnership’s 2007 Form 1065 includes a Schedule K–1, Partner’s Share
of Income, Deductions, Credits, etc., for Yorkville Advisors that shows
an ending capital account balance of zero. The partnership’s 2008
return does not include a Schedule K–1 for Yorkville Advisors.
C. The Parties’ Arguments
Petitioners argue that the activities of one person cannot be
attributed to another for the purpose of determining whether the second
person is engaged in a U.S. trade or business unless the first person is
an agent of the other under agency law. 7 They contend that, “[u]nder
established agency law, both in general and as applied in tax cases, the
key to determining whether a principal-agency relationship exists is the
degree to which the principal has the right to control the putative
agent.” “The element of control,” they assert, “is critical for attribution.”
Petitioners allege that “the investors who pooled their funds and gave
them over to be managed by Yorkville and Yorkville GP did not exercise
the requisite control to create an agency relationship.”
Petitioners offer two alternative characterizations of the
relationship between YA Global and Yorkville Advisors. First, they
contend that the parties’ relationship “was one of service recipient and
service provider, not one of agency.” In their Answering Brief, they
suggest an alternative characterization, arguing that Yorkville
Advisors’ authority to act on YA Global’s behalf was “coupled with an
interest,” in which case it would follow that Yorkville Advisors was not
6 The record does not include an investment management agreement
subsequent to the 2007 Agreement. Therefore, we infer that the 2007 Agreement
remained in effect at least through the end of 2008.
7 Petitioners argue that Congress should be “presumed to have incorporated”
common law agency principles into the relevant statutory provisions “to determine
when the actions of one party may be attributable to another.”
10
a “true agent” because it acted to protect its own interests rather than
to advance those of YA Global.
Respondent first contends that Federal tax law governs the
question of when a foreign person can be treated as engaged in a U.S.
trade or business by reason of the attribution to that person of activities
conducted by another. In his view, attribution turns on “whether the
putative agent was acting on behalf of or for the benefit of” the foreign
person.
Next, respondent argues that, even if attribution of activities for
tax purposes turns on agency law, the activities of Yorkville Advisors
would still be attributed to YA Global. He contends that Yorkville
Advisors was the partnership’s agent “throughout the years at issue.”
He elaborates: “Yorkville Advisors’ [sic] acted as YA Global’s agent
because YA Global and Yorkville Advisors agreed that Yorkville
Advisors’ [sic] would act on YA Global’s behalf and YA Global had the
right to control Yorkville Advisors’ conduct.”
Respondent rejects petitioners’ claim that Yorkville Advisors was
a service provider. He points to section 3 of each of the 2005 Agreement
and the 2007 Agreement, which, in his description, allowed YA Global
to “impose[] specific investment restrictions relating to [its] Account.”
Respondent concludes that “YA Global had the power to give interim
instructions or directions.” See Restatement (Third) of Agency (Third
Restatement) § 1.01 cmt. f (Am. L. Inst., 2006) (“The power to give
interim instructions distinguishes principals in agency relationships
from those who contract to receive services provided by persons who are
not agents.”).
D. Analysis
Both the 2005 Agreement and the 2007 Agreement refer to
Yorkville Advisors as YA Global’s “Agent.” While that description is not,
by itself, determinative, petitioners have not established that the
relationship between Yorkville Advisors and YA Global was other than
one of agency. Petitioners accept that the activities of an agent can be
attributed to the agent’s principal for the purpose of determining
whether the principal is engaged in a U.S. trade or business. Therefore,
we need not decide whether, as respondent suggests, activities can be
11
attributed for tax purposes even in the absence of an agency
relationship. 8
The distinction between an agency relationship and one of service
provider and recipient turns not on the ability to provide direction but
instead on when that direction may be provided. Service recipients need
not accept whatever might strike a service provider’s fancy. In a
relationship of service provider and recipient, however, any instructions
that limit the provider’s discretion must be given at the outset: The
recipient cannot vary the instructions midstream. By contrast, the
principal in an agency relationship can give interim instructions.
Section 1.01 of the Third Restatement defines “agency” as “the fiduciary
relationship that arises when one person (a ‘principal’) manifests assent
to another person (an ‘agent’) that the agent shall act on the principal’s
behalf and subject to the principal’s control, and the agent manifests
assent or otherwise consents so to act.” As that definition suggests, “the
principal’s right to control the agent’s actions” is “[a]n essential element
of agency.” Id. cmt. f. Not only can the principal “initially state[] what
the agent shall and shall not do”; the principal also “has the right to give
interim instructions or directions to the agent once their relationship is
established.” Id. It is “[t]he power to give interim instructions [that]
distinguishes principals in agency relationships from those who contract
to receive services provided by persons who are not agents.” Id.
We agree with respondent that each of the investment
management agreements allowed YA Global to give interim instructions
to Yorkville Advisors regarding the management of the partnership’s
account. As noted above, section 3 of each agreement requires the
partnership to “promptly advise” Yorkville Advisors “of any specific
investment restrictions relating to the Account.” The requirement of
prompt notice of any investment restrictions obviously presupposes that
the partnership could impose restrictions on the manner in which
Yorkville Advisors managed the partnership’s accounts. And those
restrictions could be changed from time to time as long as the
partnership provided Yorkville Advisors with the requisite notice. The
limits on Yorkville Advisors’ discretion were not set once and for all at
8 Respondent’s proposed test, under which attribution would turn on “whether
the putative agent was acting on behalf of or for the benefit of” a foreign person is
almost certainly too broad. Courts have declined to attribute to a foreign person
activities of another that benefit the foreign person. E.g., Amalgamated Dental Co.,
Ltd. v. Commissioner, 6 T.C. 1009 (1949). Thus, more than mere benefit to the foreign
person would be required to attribute to that person the activities of another even if
the tax law provides a test separate from agency law.
12
the outset of the parties’ relationship. It follows that Yorkville Advisors
was not, as petitioner contends, a service provider.
As petitioners observe, “[a] power given as security does not
create a relationship of agency.” Third Restatement § 3.12 cmt b.
Whether a power is given as security to protect rights of the holder
affects the power’s duration. As a general matter, a principal can
terminate an agent’s actual authority at any time, regardless of any
agreement between them. Id. § 3.10(1). When a power is given as
security, however, “[a] principal’s manifestation of revocation is, unless
otherwise agreed, ineffective to terminate [the] power.” Id. § 3.10(2). A
power given as security does not create an agency relationship “because
it is neither given for, nor exercised for, the benefit of the person who
creates it.” Id. § 3.12 cmt. b. The holder of a power given as security “is
not subject to the creator’s control and the holder does not owe fiduciary
duties to the creator.” Id. Because the power is given to protect rights
of the holder, it would defeat the power’s purpose to allow the creator to
control the holder or to terminate the power at will.
As noted above, section 2 of each investment management
agreement provides that the “power of attorney” granted to Yorkville
Advisors “is coupled with an interest and is irrevocable.” But that
characterization, like the contrary designation of Yorkville Advisors as
YA Global’s “Agent,” is not itself dispositive. The investment
management agreements do not identify the “interest” with which
Yorkville Advisors’ power of attorney is “coupled.” Nor do petitioners in
their briefs.
The coupling of Yorkville Advisors’ power of attorney with its
“interest” in serving as YA Global’s investment manager cannot render
its power irrevocable. A power given as security “is given to protect a
legal or equitable title or to secure the performance of a duty apart from
any duties owed the holder of the power by its creator that are incident
to the relationship of agency.” Third Restatement § 3.12. The authority
granted to Yorkville Advisors under the investment management
agreements cannot be viewed as having been granted to secure Yorkville
Advisors’ right to compensation for its services as YA Global’s
investment manager. As comment b to section 3.12 of the Third
Restatement explains, “An agent’s interest in being paid a commission
is an ordinary incident of agency and its presence does not convert the
agent’s authority into a power held for the agent’s benefit.” If, however,
Yorkville Advisors had “a distinct interest” in YA Global, separate from
its status as the partnership’s investment manager, “a power given to
13
protect that [other] interest [would be] a power given as security.” See
Third Restatement § 3.12 cmt. b.
The only interest disclosed in the record that Yorkville Advisors
had in YA Global apart from its role as the partnership’s investment
manager was the general partner interest it held in the partnership
until January 14, 2007. But Yorkville Advisors’ authority as investment
manager cannot be viewed as having been granted to secure its general
partner interest in YA Global because the authority and the interest
were not coterminous. A power given to secure legal or equitable title
must be given “upon the creation of the . . . title,” Third Restatement
§ 3.12, and necessarily terminates with the termination of “the interest
secured,” id. § 3.13(1)(a). The authority to manage YA Global’s assets
granted to Yorkville Advisors in the investment management
agreements continued after the termination of Yorkville Advisors’
interest as the partnership’s general partner.
Moreover, the same ability of YA Global to control Yorkville
Advisors that precludes the latter from being viewed as a service
provider rather than an agent also demonstrates that Yorkville Advisors
did not have a power coupled with an interest. As noted above, the
holder of a power given as security cannot be subject to the creator’s
control. As also noted above, however, section 9 of the 2007 Agreement
expressly subjects Yorkville Advisors’ activities as investment manager
to the control of Yorkville GP, YA Global’s general partner. And under
both the 2007 Agreement and the 2005 Agreement, YA Global could
impose “restrictions” on Yorkville Advisors’ decisions in managing the
partnership’s assets. The degree of control retained by YA Global is
antithetical to the proposition that the partnership granted authority to
Yorkville Advisors to protect some interest independent of the latter’s
role as the partnership’s investment manager.
To sum up, both of the investment management agreements in
effect during the years in issue expressly appoint Yorkville Advisors as
YA Global’s “Agent” in managing the partnership’s assets. Petitioners
have not established that that characterization was incorrect. YA
Global’s ability under each agreement to give interim instructions that
would restrict Yorkville Advisors’ discretion in managing the
partnership’s assets prevents the parties’ relationship from being
viewed as one of service provider and recipient. And in each agreement,
YA Global retained a degree of control over Yorkville Advisors that
prevents viewing the latter’s powers as having been given to secure some
unidentified interest in the partnership or its assets apart from
14
Yorkville Advisors’ role as the partnership’s investment manager.
Instead, in each of the 2005 Agreement and the 2007 Agreement, YA
Global manifested its assent to Yorkville Advisors’ acting on the
partnership’s behalf and subject to the partnership’s control in
managing its assets. And Yorkville Advisors consented to act in that
capacity. It follows that the relationship between the parties was one of
“agency,” as defined by section 1.01 of the Third Restatement and that,
consequently, the activities Yorkville Advisors conducted pursuant to
the 2005 Agreement and the 2007 Agreement can be attributed to the
partnership for the purpose of determining whether the partnership was
engaged in a U.S. trade or business during the years in issue. We now
turn to the question of whether those activities rose to the level of a U.S.
trade or business.
II. YA Global’s Conduct of a U.S. Trade or Business
A. Findings of Fact
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 number of shares that YA Global would receive in exchange
for a given dollar amount advanced under a SEDA was typically
determined using a discounted price. For example, in the SEDA that
YA Global entered into on February 22, 2006, with Face Print Global
Solutions, Inc. (Face Print), the “Purchase Price” used to determine the
number of shares the partnership would receive from Face Print was
stated as “97% of the Market Price during the Pricing Period.” 9 The
Pricing Period included the five Trading Days immediately preceding
the date of the Advance (Advance Date). The “Market Price” was “the
lowest VWAP [volume weighted adjusted price] of the Common Stock
during the Pricing Period.” 10 Respondent’s expert, Roberts W.
9 The parties stipulated that, “[w]hile specific terms may vary from transaction
to transaction, the documents . . . with respect to [the] SEDA transaction between YA
Global and Face Print Global Solutions, Inc. and the provisions contained in the
documents are typical of SEDA transactions in which YA Global entered.”
10 Other SEDAs apparently provided for greater discounts. Petitioners did not
object to respondent’s proposed finding that, “[c]ommonly, the Purchase Price [used to
determine the number of shares to be issued for an advance under a SEDA] was 95–
15
Brokaw III, a former investment banker and adjunct professor of
finance at New York University, testified that he did not consider the
discounts in SEDA pricing to be blockage discounts, which he defined as
discounts “applied to securities because of some form of illiquidity.”
In addition to granting YA Global the right to purchase stock at
a discounted price, SEDAs typically required the portfolio company to
pay to Yorkville Advisors and YA Global various fees upon the execution
of the SEDA and additional fees upon each advance of funds. The Face
Print SEDA, for example, required the company to pay Yorkville
Advisors an initial structuring fee of $20,000 and an additional $500
structuring fee for each advance. Face Print also had to pay the
partnership commitment fees in the form of (i) $200,000 worth of its
common stock upon execution of the SEDA, (ii) 6% of each advance,
withdrawn from the proceeds of the SEDA, and (iii) warrants allowing
the partnership to purchase 26,325,000 shares of Face Print’s common
stock over five years at prices ranging from $0.15 to $0.35 per share.
The terms of at least some convertible debentures also allowed
YA Global to acquire the stock of the issuer, upon conversion, at a
discount. For example, section 3(a) of the convertible debenture issued
to the partnership by Neomedia Technologies, Inc., on August 28, 2008,
provided, subject to specified limitations: “This Debenture shall be
convertible into shares of Common Stock at the option of the Holder, in
whole or in part at any time and from time to time, after the Original
Issue Date.” That section further provided: “The number of shares of
Common Stock issuable upon a conversion hereunder equals the
quotient obtained by dividing (x) the outstanding amount of this
Debenture to be converted by (y) the Conversion Price (as defined in
Section 3(c)(i)).” Section 3.(c)(i) provided:
The conversion price in effect on any Conversion Date shall
be, at the sole option of the Holder, equal to either (a)
Fifteen Cents ($0.15) (the “Fixed Conversion Price”) or (b)
ninety percent (90%) of the lowest closing Bid Price of the
Common Stock during the thirty (30) trading days
immediately preceding the Conversion Date as quoted by
Bloomberg, LP (the “Market Conversion Price”).
97% of the lowest ‘Volume Weighted Average [Price]’ (‘VWAP’) of the common stock
during the Pricing Period.”
16
The Neomedia Technologies convertible debenture, however, may
not have been representative. The parties stipulated that “[w]hile
specific terms may vary from transaction to transaction, the documents
. . . with respect to a convertible debenture transaction between YA
Global and LocatePLUS Holdings Corporation and the provisions
contained in the documents are typical of convertible debenture
transactions in which YA Global entered.” Under the terms of the
convertible debenture that LocatePLUS Holdings Corporation
(LocatePLUS) issued to the partnership, if the partnership had elected
to convert the debenture into stock, the number of shares that it would
have been entitled to receive would have been determined by a fixed
conversion price. 11
The portfolio companies also paid fees in connection with at least
some convertible debenture transactions. 12 For example, Kevin
Kreisler, the former chief executive officer of a company called
GreenShift, testified that when his company issued convertible
debentures to YA Global, it paid transactional and structuring fees. 13
And a slide deck used for a presentation to prospective investors in the
partnership describes convertible debentures as involving, in addition
to “[w]arrant coverage” and interest, a “[o]ne time, non-recurring”
“banker’s fee.” Although petitioners repeatedly question the reliability
of marketing materials, the slide referring to fees paid in convertible
debenture transactions was supported by testimony from Edward
Schinik, Yorkville Advisors’ chief financial officer. When asked about
the slide, Mr. Schinik said he was not familiar with the specific term
“banker’s fee,” but he agreed that “the fees, the interest rate, [and] the
warrant coverage were all part of the economics” of a convertible
debenture transaction.
11 Petitioners cite the LocatePLUS convertible debenture in support of a
proposed finding that “YA Global had the right to convert portions of the debt into
common stock of the company, and [the] number of shares issued upon conversion was
determined using a conversion price that was the lower of (i) a fixed price or (ii) a
discount to an average market price computed over a specific period preceding the
installment date.” In support of that finding, petitioners cite section 17(i) of the
debenture. That section defines “Company Conversion Price,” which determined the
number of shares LocatePLUS had to issue if it had elected to pay interest in stock.
12 The LocatePLUS convertible debenture, which the parties have designated
as representative, does not appear to have provided for the payment of fees.
13 Mr. Kreisler did not specify whether GreenShift paid the fees to YA Global
or to Yorkville Advisors. The convertible debenture that GreenShift issued to YA
Global does not appear to be in the record.
17
Mr. Kreisler, the GreenShift CEO, shared Mr. Schinik’s
understanding. Mr. Kreisler was indifferent to the specific names given
to required fees. When asked why GreenShift paid them, he responded:
“I saw them as part of the embedded economics in the deal.”
Similarly, when Jay Wright, the CEO of a company called Mobile
Pro, was asked whether the fee his company paid in connection with its
issuance of convertible debentures to YA Global was for services, he
replied: “No. This was part of the overall economics of the transaction.”
He said the focus during the negotiations was on “the total cost [of]
capital.” He alluded to a tradeoff between fees and interest rates, with
higher fees, for example, being a quid pro quo for a lower interest rate.
YA Global would typically exercise a conversion feature on a
convertible note only when it was ready to sell the stock it would receive
on conversion. According to Mark Angelo, the founder and president of
YA Global and Yorkville Advisors, it would not “make sense” to convert
a debenture and then hold the stock received. 14 When asked how long
YA Global would typically hold a security in its portfolio, Mr. Angelo
responded: “We targeted a 12-to-24 month investment horizon.”
According to a private placement memorandum dated December
1, 2005 (December 2005 PPM), prepared in connection with the issuance
of limited partnership interests in the partnership, the fees that
Yorkville Advisors received from portfolio companies were “[t]ypically
. . . generated by the Investment Manager for due diligence, structuring
and commitment fees. Those fees “were intended to cover the Fund’s
and the Investment Manager’s expenses and overhead.” In 2004,
however, the fees that Yorkville Advisors had received from portfolio
companies “exceeded the Fund’s and Investment Manager’s expenses
and overhead by a significant margin.” Therefore, Yorkville Advisors
planned, going forward, “to remit to the [partnership] any excess funds
realized from these fees after the payment of all expenses and overhead.”
Consistent with those plans, the partnership agreements governing YA
Global, as amended in 2007, provide that, if Yorkville Advisors received
cash fees in excess of its expenses, it could remit the excess fees to YA
Global or apply them in satisfaction of the management fee owed to
Yorkville Advisors by the partnership.
The fees that Yorkville Advisors received from portfolio
companies apparently did not continue to cover its expenses and
14 Respondent’s expert, Mr. Brokaw, agreed.
18
overhead throughout the years in issue. According to the partnership’s
financial statements, the cash fees that Yorkville Advisors was entitled
to or did receive were approximately $33,400,000 in 2006, approximately
$25,300,000 in 2007, and $10,047,387 in 2008. By contrast, Yorkville
Advisors reported total deductions on its tax returns of about $29 million
for 2006, $33 million for 2007, and $29.6 million for 2008. 15 Yorkville
Advisors remitted to the partnership $7.4 million in fees in 2006 and
$1,600,617 in 2007. The partnership’s financial statements for 2008
make no mention of any remission of fees by Yorkville Advisors.
During the period from 2006 to 2008, the volume of transactions
that Yorkville Advisors executed on behalf of YA Global declined. YA
Global entered into 25 SEDA transactions in 2006, 19 in 2007, and only
9 in 2008. The partnership acquired 202 convertible debentures in 2006,
116 in 2007, and 111 in 2008.
In a letter to investors, Yorkville Advisors stated: “We have
always said that part of what sets Yorkville apart is the way that it
manages the transactions from start to finish. Part of our edge is that
we identify, source, negotiate, conduct due diligence, structure the
transactions, fund, and manage the majority of our deals.” Yorkville
Advisors employed in-house attorneys to structure transactions and
draft deal documents.
Yorkville Advisors had more than 50 employees during 2006,
2007, and 2008. It had 56 employees in 2006. In February 2007, it had
51 employees. And it had 54 employees in 2008.
Yorkville Advisors paid substantial salaries, wages, and payroll
taxes. On its 2006 tax return, Yorkville Advisors reported salaries and
wages of over $15 million and payroll taxes of more than $750,000. On
its 2007 return, Yorkville Advisors reported salaries and wages of
almost $16.5 million and payroll taxes of almost $600,000. On its 2008
return, Yorkville Advisors reported salaries and wages of over $11
million and payroll taxes of more than $450,000.
Yorkville Advisors devoted most of its activities to YA Global
during the years in issue. In 2005, Yorkville Advisors managed three
other funds: Cornell Rx, Highgate House, and Montgomery Equity
Partners. The assets of the other three funds, however, were
15 The reported total deductions included office expense of $199,645 for 2006,
$178,276 for 2007, and $252,003 for 2008.
19
considerably smaller than those of YA Global, whose assets constituted
more than 72% of Yorkville Advisors’ total assets under management.
Cornell Rx was terminated in 2006. And Highgate House and
Montgomery Equity Partners were restructured and effectively merged
with YA Global on May 1 and July 1, 2006, respectively. Therefore,
between July 1, 2006, and April 1, 2009, YA Global was the only fund
that Yorkville Advisors managed. 16
The December 2005 PPM describes the partnership’s “investment
objective” as “achiev[ing] superior risk-adjusted returns through capital
appreciation primarily by making directly managed private equity and
equity-related investments and, to a lesser extent, debt investments in
public and private companies.” Consistent with that objective, the
partnership reported substantial net income on its financial statements
for each of 2006, 2007, and 2008. 17
Petitioners’ expert, Josh Lerner, a professor of investment
banking at Harvard Business School, prepared a report in which he
compared YA Global “to the array of institutions that provide financing
to companies.” Among other things, he “conduct[ed] quantitative
analyses of YA Global’s fund performance and that of its investee firms.”
Dr. Lerner found that “the pattern of [the partnership’s] returns closely
matches those of [venture capital] funds, with a few very strong
performers (more than 100 percent) that offset a large number of losses.”
The FPAA for 2006 states: “It is determined that Cornell Capital
Partners LP was engaged in a trade or business within the United
States during the partnership taxable year ended December 31, 2006.”
The FPAAs for 2007 and 2008, while referring to YA Global, include
substantially identical statements.
B. Applicable Law
Section 1446(a) requires a partnership to pay a withholding tax
on the portion of any “effectively connected taxable income” allocable to
a foreign partner. 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
16 On April 1, 2009, Yorkville Advisors launched YA Global Investments II,
Ltd.
17 The partnership reported more than $101 million of net income for 2006,
more than $122 million for 2007, and more than $61 million for 2008.
20
conduct of a trade or business in the United States.” § 1446(c). Although
the question of when activities rise to the level of a U.S. trade or business
frequently arises in determining the U.S. tax liability of foreign persons,
neither the Code nor the regulations provide a comprehensive definition
of what it means to be engaged in a U.S. trade or business.
Section 864(b) provides that “the term ‘trade or business within
the United States’ includes the performance of personal services within
the United States at any time within the taxable year.” 18 That section
goes on to list activities not within the definition of “trade or business
within the United States,” including trading in securities or
commodities. See § 864(b)(2).
For the most part, courts have addressed on a case-by-case basis
activities not within the per se rule for personal services and not covered
by the trading safe harbors. Perhaps the closest any court has come to
articulating a general definition of trade or business was when the
Supreme Court stated, in Commissioner v. Groetzinger, 480 U.S. 23, 35
(1987): “[N]ot every income-producing and profit-making endeavor
constitutes a trade or business. . . . We accept the fact that to be engaged
in a trade or business, the taxpayer must be involved in the activity with
continuity and regularity and that the taxpayer’s primary purpose for
engaging in the activity must be for income or profit.”
But the courts have also recognized an exception to the general
principle that continuous and regular activities directed at income or
profit amount to a trade or business. A taxpayer whose activities are
limited to investment—regardless of how continuous and regular those
activities—is not engaged in a U.S. trade or business.
Although the investment exception is widely recognized, its
rationale is unclear. And the absence of a clear rationale for the
investment exception makes it difficult to define its parameters.
The investment exception traces its roots back to Higgins v.
Commissioner, 312 U.S. 212 (1941). Higgins involved a Paris resident
who maintained a New York office where employees managed his
“extensive investments in real estate, bonds and stocks.” Id. at 213. In
computing his U.S. tax liability, he sought to deduct his investment
18 The definition of “trade or business within the United States” provided in
section 864(b) applies for purposes of parts I and II of subchapter N of chapter 1
(sections 861–898) and chapter 3 (the withholding rules provided in sections 1441
through 1464).
21
management expenses as ordinary and necessary business expenses
under the predecessor of section 162. The Commissioner accepted that
the expenses were ordinary and necessary. He also accepted that the
taxpayer’s real estate activities constituted a trade or business. But he
disallowed that portion of the expenses allocable to the taxpayer’s
dealings in securities. While the taxpayer conceded that small investors
were not engaged in a trade or business, he argued that his activities
were different. Because his activities were much more extensive than
those typical of small investors, he argued, his activities amounted to a
trade or business. The Commissioner countered that personal
investment activities, however extensive, cannot be a trade or business.
The Court wrote that the determination of “whether the activities of a
taxpayer are ‘carrying on a business’ requires an examination of the
facts in each case.” Id. at 217. It added:
The Bureau of Internal Revenue has this duty of
determining what is carrying on a business, subject to
reexamination of the facts by the Board of Tax Appeals and
ultimately to review on the law by the courts on which
jurisdiction is conferred. The Commissioner and the Board
appraised the evidence here as insufficient to establish [the
taxpayer’s] activities as those of carrying on a business.
The [taxpayer] merely kept records and collected interest
and dividends from his securities, through managerial
attention for his investment. No matter how large the
estate or how continuous or extended the work required
may be, such facts are not sufficient as a matter of law to
permit the courts to reverse the decision of the Board.
Id. at 217–18. 19
The Higgins opinion, as the Court later described it in
Commissioner v. Groetzinger, 480 U.S. at 29-30, was “bare and brief”
and “devoid of analysis.” With “its stress on the facts of each case,”
Higgins “affords no readily helpful standard” for determining when a
taxpayer is or is not engaged in a trade or business. Id. at 32. The Court
in Groetzinger accepted that Higgins “must stand for the proposition
19 Under the law in effect for the years at issue in Higgins, the taxpayer could
have deducted the expenses in question only as trade or business expenses under the
predecessor of section 162. Section 212 now allows a deduction for expenses incurred
in income-producing activities that do not rise to the level of a trade or business, but
Congress did not enact the predecessor of that section until 1942, in response to the
Court’s opinion in Higgins.
22
that full-time market activity in managing and preserving one’s own
estate is not embraced within the phrase ‘carrying on a business,’ and
that salaries and other expenses incident to the operation are not
deductible as having been paid or incurred in a trade or business.” Id.
at 30. But Higgins offers little or no guidance on how far the investment
exception extends and whether it encompasses a taxpayer whose
activities include anything beyond earning returns on invested capital.
C. The Parties’ Arguments
1. Respondent
Though respondent asserts that “[t]he U.S. trade or business
standard under section 864(b) does not hinge on labels,” he nonetheless
rests his argument on them. “During the Relevant Period,” 20 respondent
asserts, “YA Global performed various lending, underwriting, and other
financing activities and generally behaved like a lender and
underwriter.” Regarding YA Global’s purported lending business,
respondent asserts that, “[d]uring the Relevant Period, YA Global made
hundreds of loans directly to companies in exchange for promissory
notes and convertible debentures.” 21 Respondent concludes that “YA
Global’s lending activities far exceeded the number of loans needed to
establish a trade or business.”
Respondent describes YA Global’s role in a SEDA as that of an
“intermediary,” acquiring stock in exchange for advances and later
reselling that stock in the market. The partnership, he says, “essentially
perform[ed] the function of an underwriter.” And underwriting services,
respondent contends, “are a service provided to an issuer.”
Respondent suggests that YA Global’s transactions in convertible
debentures, in addition to being part of a lending business, were also
20 Respondent uses the term “Relevant Period” to refer to 2006 through 2011.
21 Respondent bases his assertion in part on a proposed factual finding
concerning the number of “promissory notes” issued to YA Global by portfolio
companies during the years in issue. In response to that proposed finding, petitioners
object to any suggestion that “YA Global received promissory notes as standalone
securities.” Petitioners contend that YA Global acquired promissory notes “only in
limited contexts, primarily as part of equity-related investment packages.” Because
our analysis does not turn on whether any trade or business conducted by YA Global
could be properly characterized as being, in particular, a lending business, we need not
resolve the factual question of the extent to which YA Global acquired promissory notes
other than as part of an “equity-related investment package.”
23
part of an underwriting business. “Like SEDAs,” respondent argues,
“convertible debentures were targeted to the ultimate issuance of equity
to the public markets.” Respondent observes that YA Global would
typically convert a debenture into stock (and thereby surrender the
downside protection afforded by its creditor’s rights) only when it was
prepared to sell the stock received upon conversion. This practice, in
respondent’s view, “shows that equity acquired with respect to the
convertible debentures was not held as an investment” but that “instead,
YA Global made efforts to distribute the stock in a manner consistent
with its underwriting or dealing activities.”
Through its use of “SEDAs, convertible debentures, and
promissory notes,” respondent argues, “YA Global provided financial
services to companies seeking funding.” And “[t]he performance of
services in the United States,” respondent reminds us, “is (with limited
exceptions) treated as a trade or business under the express language of
section 864(b).” The fees paid by portfolio companies, in respondent’s
view, reinforce the conclusion that YA Global, through Yorkville
Advisors, “was engaged in a services business.” The receipt of fee
income, respondent alleges, distinguishes YA Global from “[t]axpayers
engaged merely in trading and investment.”
Respondent denies petitioners’ claim that he is raising a new
issue in arguing that YA Global engaged in a trade or business because
it provided services. Referring to a Chief Counsel Advice issued in 2014
regarding YA Global, 22 respondent asserts that he “has always
contended that YA Global provided services for compensation.”
Respondent also points to references to the performance of services
included in a stipulation the parties filed on August 28, 2020 (August 28
stipulation), and in respondent’s Pretrial Memorandum.
Paragraph 1 of the August 28 stipulation states the parties’
agreement as to respondent’s contentions concerning YA Global’s
alleged U.S. trade or business and precludes respondent from “tak[ing]
. . . the position that YA Global was engaged in a U.S. trade or business
other than as stated in this paragraph.” Paragraph 1(d) and (e) lists as
examples of the activities involved in YA Global’s alleged business
“lending, underwriting, and stock distribution and any associated
22 The parties agree that YA Global was the subject of Chief Counsel Advice
201501013 (Sept. 5, 2014).
24
services” and “services performed by YA Global and others on YA
Global’s behalf.”
Respondent’s Pretrial Memorandum stated: “During the years at
issue, YA Global was engaged in a U.S. financing business, conducting,
among other activities, lending and underwriting activities and services
through its agent Yorkville Advisors.” Two sentences later, respondent
asserted: “In addition, as part of this business activity, YA Global,
through its agent Yorkville Advisors, performed services in the United
States for fees, which itself demonstrates that the activity constitutes a
U.S. trade or business.” Later, respondent argued that YA Global is
ineligible for the trading safe harbor because it “did not seek to profit
solely from a change in value of the securities it received from issuers
and borrowers.” Rather, respondent contended, “in exchange for
performing its activities and services, YA Global received compensation
in the form of fees, discounted property, interest, and spreads.” “The
receipt of compensation,” respondent argued, “evidences the
performance of services, which, if performed in the United States, is per
se the conduct of a trade or business in the United States, under section
864(b).”
Respondent suggests that his references to the performance of
services are not part of an additional argument, separate from his
contention that YA Global engaged in underwriting and lending.
According to respondent, “lending and underwriting themselves
constitute services.” Respondent denies “argu[ing] that services are
involved apart from YA Global’s lending and underwriting activities.”
He says his Pretrial Memorandum “makes plain that the fees-for-
services argument is associated with, not independent of, respondent’s
argument that YA Global was in the lending and underwriting
business.” YA Global’s receipt of fees for services, in respondent’s view,
simply establishes that it was engaged in the business of underwriting
and lending.
Respondent reasons that the FPAAs’ determinations that YA
Global “was engaged in a trade or business in the United States” “were
sufficient to put petitioners on notice of the issues in this case.”
Respondent concludes that he “has not raised a new issue or argued any
theories beyond what [he] outlined at the start of the trial and well
before.”
Respondent argues that YA Global did not qualify for the section
864(b)(2) safe harbor because “financing activities” other than trading,
25
“such as lending and underwriting . . . are not covered by the safe
harbors.” The distinction between lending and underwriting, on the one
hand, and trading, on the other, respondent explains, “is based on the
nature and extent of the activities, including direct involvement with
the issuer.”
2. Petitioners
Petitioners argue: “Even if Yorkville’s activities were attributable
to YA Global, . . . those activities would not have given rise to a trade or
business because the activities—had YA Global undertaken them
directly—would have been in furtherance of investing YA Global’s own
funds and managing its own portfolio.” Petitioners observe that
continuous and regular activities directed toward profit do not
necessarily constitute a trade or business. In support of that
observation, petitioners cite Higgins, which they characterize as
“seminal.” Petitioners assert that YA Global’s profits did not arise from
the actions the partnership undertook through Yorkville Advisors.
Instead, those profits “arose as a result of YA Global putting its capital
at risk in the ventures of its portfolio companies.”
Petitioners rely on Dr. Lerner’s testimony that YA Global’s
variable returns are more like those of venture capital funds than of
banks. They assert: “It is clear when looking at YA Global’s returns as
a whole that it generated profits and losses from putting its capital at
risk. That is the hallmark of investment.”
Petitioners allow that “[i]t is possible for a taxpayer to have a
trade or business that is derived from providing capital to others” but
only “if that trade or business is lending.” Petitioners claim that “YA
Global was not in the lending business” because the convertible
debentures that YA Global received from portfolio companies “were not
true loans.” 23
Petitioners also dispute respondent’s analogy of YA Global’s
activities to those of an underwriter: “YA Global did not earn
guaranteed returns or fee income for providing underwriting services.
To the contrary, its returns were far from guaranteed, and they were
23 Respondent asserts that petitioners cannot disavow the form of the
convertible debentures and that, in any event, the form should be respected because it
resulted from arm’s-length relationships.
26
earned as a result of putting its own capital at risk, not from connecting
companies with other investors.”
Petitioners claim that, because respondent did not allege in his
pleadings that YA Global’s activities were subject to the per se rule that
treats the performance of personal services as a U.S. trade or business,
that issue is not before us. In addition to asserting that respondent’s
services argument is untimely, petitioners contend that that argument
is “outside the scope of the stipulation filed by the parties on August 28,
2020.” In the alternative, petitioners ask that, if we do consider the
issue, we place the burden of proof on respondent. 24
Regarding the merits of the “services” issue, petitioners deny that
Yorkville Management or YA Global “provided any services to portfolio
companies.” They contend that “[t]he agreements requiring that
portfolio companies pay fees to Yorkville made no mention of any
services that Yorkville was to provide.” “If the various ‘fees’ paid by
portfolio companies were truly in exchange for services,” petitioners
reason, “then the amounts of those fees would have varied based on the
amount of time Yorkville had to spend providing such services.” But,
they say, “[t]here is no evidence, . . . that that was the case.” “In fact,”
petitioners observe, “the fees varied, both in name and in amount, on a
deal-by-deal basis.” Further, petitioners contend, “neither the Fund nor
Yorkville ever got any fees unless the Fund closed a deal and put its
capital at risk.”
In petitioners’ view, “[p]ortfolio companies looked to YA Global for
capital, not for advice, consultation, or anything else particular to the
knowledge and skills of Yorkville employees.” “The ‘fees’ paid by
portfolio companies,” petitioners conclude, “were simply part of the cost
they paid to gain access to YA Global’s capital.”
Petitioners liken the commitment fees in SEDAs to premiums
paid for put options. “Because the SEDA gave the portfolio company the
right, but not the obligation, to sell its stock to YA Global during a fixed
period,” petitioners reason, “it was a purchase by the company (and a
sale by YA Global) of a put option.” Petitioners assert: “The Code makes
clear that transactions in options are capital transactions, not fees for
24 Rule 142(a)(1) provides as a general rule that “[t]he burden of proof shall be
upon the petitioner.” But that general rule is subject to exceptions. Under one of those
exceptions, respondent bears the burden of proof “in respect of any new matter.” Id.
27
services.” 25 They conclude: “It is clear, then, that any commitment fees
that portfolio companies paid to YA Global when they entered into a
SEDA were not compensation for services. Rather, they were income
from capital assets, namely YA Global’s investments in the portfolio
companies.”
Petitioners also deny that the pricing terms in SEDAs were
evidence of the provision of underwriting services. “The fact that YA
Global may have purchased stock in SEDA transactions at a discount to
market,” they argue, “is . . . not evidence that it provided underwriting
services to anyone.” They observe that the price of the portfolio
company’s stock on the date of an advance “could have been more or less
than the purchase price determined using data from” the preceding five-
day pricing period. “Therefore,” petitioners conclude, “even if YA Global
were able to sell all of the portfolio company’s stock on any particular
day, there would be no guarantee that the price at which it purchased
the stock would be set at a discount to the price at which it sold.” By
contrast, petitioners contend, “in a typical underwriting arrangement
. . . the underwriter is, in effect, guaranteed a specific percentage of the
gross sales of a company’s stock.”
Consistent with their claim that YA Global’s activities were
limited to managing its investments, petitioners observe that the
partnership “frequently held long positions in its companies’ stock for
long periods of time.” “In any case,” petitioners argue, “to the extent YA
Global generated its profits from acquiring and disposing of stock
quickly, those activities render it a trader.” And petitioners seem to
view the safe harbor for trading in stocks and securities provided in
section 864(b)(2) as encompassing the judicially created safe harbor for
investment. Under what petitioners describe as the “broad definitions”
of “securities” and “trading” provided in the regulations, “all of YA
Global’s transactions, including purchases of convertible debentures,
converting them to stock, entering into SEDAs, purchasing stock
25 Petitioners refer to section 1234(b)(1), which provides: “In the case of the
grantor of [an] option, gain or loss from any closing transaction with respect to, and
gain on the lapse of, an option in property shall be treated as a gain or loss from the
sale or exchange of a capital asset held not more than one year.”
28
pursuant to SEDAs and selling stock, all [sic] fall within the definition
of ‘trading in stocks or securities.’” 26
D. Analysis
The issue of whether YA Global engaged in a U.S. trade or
business through Yorkville Advisors during the years in issue turns on
three questions. First, were the activities Yorkville Advisors conducted
on behalf of YA Global continuous, regular, and engaged in for the
primary purpose of income or profit? Second, were those activities
limited to the management of investments? And third, were they
covered by the safe harbor provided in section 864(b)(2)(A) for trading in
stocks or securities? If the activities that Yorkville Advisors conducted
on behalf of YA Global were continuous, regular, and directed at income
or profit, went beyond the management of investments, and were not
within the statutory safe harbor for securities trading, then YA Global
was engaged in a U.S. trade or business as defined by section 864(b),
Groetzinger, and Higgins. The appropriate label for that business would
be of no moment. Regular and continuous activities directed at income
or profit are, by definition, activities of a trade or business. If those
activities are conducted in the United States and are outside the
26 Although the statutory safe harbors refer to “[t]rading in stocks or
securities,” see § 864(b)(2)(A)(i) and (ii), the regulations implementing those safe
harbors refer to “[t]he effecting of transactions in the United States in stocks or
securities,” see Treas. Reg. § 1.864-2(c)(1) and (2). Treasury Regulation § 1.864-
2(c)(2)(i)(c) provides:
For purposes of this paragraph, the term “securities” means any note,
bond, debenture or other evidence of indebtedness, or any evidence of
an interest in or right to subscribe to or purchase any of the foregoing;
and the effecting of transactions in stocks or securities includes buying,
selling (whether or not by entering into short sales), or trading in
stocks, securities, or contracts or options to buy or sell stocks or
securities, on margin or otherwise, for the account and risk of the
taxpayer, and any other activity closely related thereto (such as
obtaining credit for the purpose of effectuating such buying, selling, or
trading). The volume of stock or security transactions effected during
the taxable year shall not be taken into account in determining under
this paragraph whether the taxpayer is engaged in a trade or business
in the United States.
Thus, as petitioners read the regulation, any buying or selling of stocks or
securities, whether or not that buying or selling goes beyond investing and constitutes
“trading,” would be covered by the trading safe harbor.
29
judicially created exception for investment and the statutory safe harbor
for trading, then the activities are those of a U.S. trade or business.
1. Continuous, Regular, and Engaged in for Profit?
Petitioners make no argument that Yorkville Advisors’ activities
were not regular, continuous, and directed at profit. Given the number
of Yorkville Advisors’ employees who devoted themselves to YA Global’s
affairs during the years in issue, petitioners have no apparent basis for
denying that those activities were regular and continuous. And the
record leaves no room for doubt that Yorkville Advisors sought to
generate profits for the limited partners who invested in YA Global. 27
2. Limited to the Management of Investments?
Petitioners’ primary argument regarding the trade or business
issue is that YA Global was simply an investor. That argument stands
or falls on whether, as petitioners claim, the only returns YA Global and
Yorkville Advisors earned from portfolio companies were returns on
capital invested in those companies.
The record does not support petitioners’ claim that the fees paid
by the portfolio companies were simply additional payments for the use
of capital. Petitioners assert that “YA Global/Yorkville never got any
fees unless the Fund closed a deal and put its capital at risk.” While it
may be true that a portfolio company had no obligation to pay fees to
either Yorkville Advisors or YA Global unless a transaction was
consummated, the payment of fees did not depend on the partnership’s
putting its capital at risk. Some of the commitment fees required under
the terms of a SEDA were payable upon execution of the relevant
agreements, before the portfolio company sought any advances.
If the fees that portfolio companies paid were simply additional
compensation for capital, those fees should have been paid entirely to
YA Global. The funds provided to portfolio companies came from the
partnership. The record discloses no instance in which Yorkville
27 The December 2005 PPM confirms YA Global’s profit-making intent in
describing the partnership’s “investment objective” as achieving “superior-risk
adjusted returns.” The PPM’s use of the terms “investment” and “investments” does
not, of course, establish that the activities that Yorkville Advisors conducted on behalf
of YA Global were limited to the management of investments. But the PPM does
confirm the obvious point that the partnership sought to earn positive returns for its
limited partners.
30
Advisors provided capital to a portfolio company. And yet, Yorkville
Advisors received cash fees from portfolio companies. The form of the
transactions thus indicates that the portfolio companies received
something of value from Yorkville Advisors above and beyond the capital
they received from YA Global.
In objecting to proposed findings by respondent about specific
types of fees, petitioners claim repeatedly that “the fees associated with
transactions varied, both in name and amount.” Petitioners thereby
suggest that the labels applied to different fees had no real consequence.
They seem to want us to believe, for example, that describing as a
“structuring fee” an amount paid to Yorkville Advisors does not indicate
that the fee was compensation for Yorkville Advisors’ efforts in
structuring the transaction. As another example, petitioners suggest
that “‘monitoring’ fees were paid in cases where it was clear there would
be nothing to monitor.” Petitioners’ position seems to rest on the
premise that the fees Yorkville Advisors charged portfolio companies
were at least misleading, if not downright deceptive.
The testimony of Messrs. Kreisler and Wright suggests that
portfolio companies were relatively indifferent to whether the payments
they made went to Yorkville Advisors or YA Global or whether the costs
of the transaction to the companies took the form of interest, discounts,
or fees given one label or another. But the characterization of fees
should not have been a matter of indifference to Yorkville Advisors and
YA Global’s limited partners. For them, the labels given to the various
fees had real economic consequences: Those designations affected
whether the fees would go directly to the partnership (and thus
necessarily shared among its limited partners) or instead were paid, in
the first instance, to Yorkville Advisors, leaving to the latter’s discretion
the extent to which it would remit to the partnership any fees beyond
those necessary to cover expenses.
In addition to paying at least market rates for the capital
provided by YA Global, 28 the portfolio companies paid fees intended to
28 The record provides no grounds for concluding that the terms on which YA
Global provided capital to portfolio companies failed to provide the partnership with
at least market-based returns. Petitioners suggest, contrary to Mr. Brokaw’s
testimony, that the discounts at which YA Global could acquire portfolio company stock
under a SEDA were “blockage” discounts, reflecting thin trading in the stock of the
portfolio companies and compensating the partnership for the risk that it would be
unable to sell its shares into the market without depressing the market price. We need
31
cover the costs of the activities that Yorkville Advisors conducted on the
partnership’s behalf—that is, identifying, sourcing and negotiating
transactions, conducting due diligence, and structuring and managing
the transactions. 29 As indicated by the testimony of Messrs. Kreisler
and Wright, the portfolio companies would not have entered into a
transaction whose overall economics were unattractive. If the portfolio
companies were willing to cover both the cost of Yorkville Advisors’
activities and the cost of the capital they received, it follows that
Yorkville Advisors’ activities had value to the portfolio companies. If, as
petitioners argue, Yorkville Advisors’ activities were limited to
managing YA Global’s investments, the portfolio companies should have
been unwilling to cover any of the costs of those activities. 30
Concluding that the fees paid by portfolio companies were for
benefits other than their receipt of capital does not depend on identifying
specific services that the relevant agreements required Yorkville
Advisors to provide. There would have been no apparent need for an
agreement to impose on Yorkville Advisors the obligation to negotiate,
structure, and document the transaction to which the agreement
related. By the time the parties executed the agreement, the negotiating
and structuring of the transaction would have been complete.
not resolve the dispute about whether the SEDA discounts were blockage discounts.
Even if the discounts precisely compensated YA Global for the risk of being unable to
sell the shares acquired without depressing their market price, the partnership would
still have been paying an arm’s-length price for the stock. The absence of market
benchmarks for evaluating the terms of the convertible debentures makes it difficult
to assess the adequacy of the stated interest rates. Those rates were presumably lower
than what would have been provided in the absence of the conversion feature. But the
record provides no evidence that any discount in interest rates was more than what
would have been necessary to cover the value of the conversion right.
29 While the fees that Yorkville Advisors was entitled to receive were intended
to cover its expenses—and did so for 2004, and apparently for 2005 and 2006 as well—
they seem not to have covered all of Yorkville Advisors’ expenses for 2007 or 2008. As
shown in our findings of fact, Yorkville Advisors’ expenses did not decline at the same
rate as the fees it received, perhaps because some of its expenses, such as office rent
and at least some salaries, did not vary directly with transaction volume. Even so, the
fees that Yorkville Advisors received, or was entitled to receive, covered 76.7% of
expenses (as reported on Yorkville Advisors’ tax return) for 2007 and 33.9% for 2008.
30 Comparing YA Global’s situation to that of the taxpayer in the “seminal” but
“devoid of analysis” case on which petitioners rely, we doubt that the portfolio
companies in which Mr. Higgins invested would have been favorably disposed to a
request that they pay him fees sufficient to cover the costs of his New York office.
32
Nor is it of any moment that the fees that portfolio companies
paid to Yorkville Advisors were not measured by the hours that
Yorkville Advisors’ employees devoted to a particular transaction.
While charging a set amount per hour spent may be a common way to
bill for legal and other services, parties can also agree to the provision
of services in exchange for fixed fees.
More generally, the fees charged to portfolio companies were
intended to cover Yorkville Advisors’ variable costs and overhead.
Yorkville Advisors was allowed, at its discretion, to remit to YA Global
only that portion of the fees that exceeded the expenses incurred. We
can thus infer that the amounts of the fees were set with an eye to the
transaction costs incurred even if the fees were not determined by a
strict hourly rate.
It makes sense that the portfolio companies saw value in
Yorkville Advisors’ activities. The transactions in which they received
needed capital would not have occurred but for Yorkville Advisors’
efforts. YA Global’s mere showing up on a portfolio company’s doorstep
with capital in hand would not have allowed the company to use that
capital in its business. More had to be done. And that something more—
the source of its professed competitive “edge”—was done by Yorkville
Advisors. 31
In that respect, the activities that Yorkville Advisors conducted
on behalf of YA Global can be meaningfully distinguished from those of
a typical investor. Investors who purchase securities on the open
market do not deal directly with the companies in which they invest.
Any benefit to the issuer from the investor’s purchase is negligible. The
issuer receives no additional capital at that time. A given investor’s
market purchase increases the demand for the issuer’s security and,
together with other purchases, may increase the security’s market
price—an eventuality presumably favored by the issuer’s management.
But the issuer itself realizes no immediate benefit from any increase in
the price at which its securities trade in the market. Even an investor
who buys securities upon initial issuance provides no benefit to the
issuer other than the capital provided. By contrast, when the purchaser
of a security goes beyond simply deciding whether to purchase a security
on the terms offered and arranges and structures the transaction in
31 As noted above, petitioners acknowledge that “[t]he ‘fees’ paid by portfolio
companies were . . . part of the cost they paid to gain access to YA Global’s capital.”
Precisely. Paying to gain access to capital is not the same as paying for capital.
33
which the security is issued, the issuer realizes a benefit beyond the
receipt of capital. In that circumstance, the issuer would have reason to
pay for that additional benefit, as YA Global’s portfolio companies
apparently did in paying fees intended to cover the costs of Yorkville
Advisors’ activities. 32
Petitioners’ reliance on section 1234(b)—the provision regarding
the termination of options—is misplaced. As noted above, petitioners
cite the provision in support of their claim that SEDA commitment fees
were income from capital assets rather than compensation for services.
As respondent reminds us, however, that section, by its terms, does not
apply “to any option granted in the ordinary course of the taxpayer’s
trade or business of granting options.” § 1234(b)(3). Claiming as
authority for the proposition that the partnership was not engaged in a
U.S. trade or business a provision that would apply only if the SEDA
transactions were not part of a trade or business assumes the point in
issue.
Moreover, SEDA commitment fees can be readily distinguished
from premiums paid in a typical put option. The premium paid for a put
option generally compensates the writer for the risk that it will be called
upon to purchase the subject property at a price that proves to be more
than the property is worth when the option is exercised. As we
explained in Federal Home Loan Mortgage Corp. v. Commissioner
(Freddie Mac), 125 T.C. 248, 263–64 (2005):
[I]n a typical put option, the optionee is willing to pay a
premium to the optionor for the right to sell a security to
the optionor at an agreed price sometime in the future. If
the market value of the security falls below the exercise
price, the optionee can sell the security to the optionor at a
price greater than its value on the exercise date. That
potential opportunity is what the optionee paid for.
Likewise, the premium received by the optionor is
compensation for accepting the potential risk of having to
purchase at an unfavorable price. If the market value of
the security rises above the exercise price, the option will
not be exercised, and the optionor keeps the option
32 In Commissioner v. Groetzinger, 480 U.S. at 30, the Court interpreted
Higgins as “stand[ing] for the propositions that full-time market activity in managing
and preserving one’s own estate is not embraced within the phrase ‘carrying on a
business.’” (Emphasis added.)
34
premium for having accepted the risk associated with
uncertainty.
By contrast, the price YA Global would pay for stock issued for a SEDA
advance would almost certainly (and by apparent design) be at a
discount to the market price. A SEDA would seldom, if ever, require the
partnership to purchase stock for a price in excess of its value at the
time of purchase.
Petitioners refer us to a definition of “put option” provided in
Investopedia.com, an online financial reference guide. According to
Investopedia:
A put option . . . is a contract giving the option buyer the
right, but not the obligation, to sell—or sell short—a
specified amount of an underlying security at a
predetermined price within a specified time frame. This
predetermined price at which the buyer of the put option
can sell the underlying security is called the strike price.
James Chen, Put Option: What It Is, How It Works, and How to Trade
Them, Investopedia, https://www.investopedia.com/terms/p/
putoption.asp (last updated Mar. 2, 2022). “An option’s value is
informed by the difference between the fixed strike price and the market
price of the underlying security.” Jason Fernando, Option Strike Prices:
How It Works, Definition, and Example, Investopedia,
https://www.investopedia.com/terms/s/strikeprice.asp (last updated
Apr. 24, 2023).
In a SEDA, however, neither the number of shares to be sold nor
the price to be paid for those shares is set upon execution of the contract.
Under the definition provided in the very authority petitioners cite,
therefore, a SEDA is not a put option.
Referring to Freddie Mac, petitioners remind us that “[t]his Court
has specifically recognized that a ‘commitment fee,’ when it is paid in
exchange for the right, but not the obligation, to enter into an agreement
with predefined terms, is effectively a premium for a put option.” In
Freddie Mac, we treated as option premiums commitment fees that
originators of mortgages paid to the taxpayer for the option of selling it
mortgages. Although the agreement between the taxpayer and
originators provided a formula for determining the price the taxpayer
would pay for a mortgage if an originator chose to sell it, the exact price
could not be determined when the parties executed the agreement.
35
Instead, that price would depend on the movement of interest rates
between the execution of the agreement and any sale of the mortgage.
But the formula had the effect of requiring the taxpayer to pay a
minimum price. The taxpayer’s yield from a mortgage could not exceed
a stated maximum. Therefore, the agreement protected the originator
from declines in the value of the subject mortgage due to increases in
interest rates beyond the specified yield. See Freddie Mac, 125 T.C. at
264 (“If interest rates rise above the agreed maximum yield, [the
taxpayer] is required to purchase the mortgage on terms less favorable
than they would have been at current rates.”). In that respect, the
agreements at issue in Freddie Mac are distinguishable from SEDAs.
As respondent observes, “when YA Global entered into a SEDA, it did
not have any exposure to price fluctuations prior to the time of ‘exercise’
(when it acquired stock from the issuer), because it always bought stock
at a discount to the prevailing market price.” Conversely, “[u]nlike a
put option, SEDAs did not protect issuers against the risk of a decline
in their stock price (due to the floating purchase price).”
The record provides no evidence that YA Global treated SEDA
commitment fees as put option premiums. Options generally receive
open transaction treatment. The tax treatment of the premium paid for
the option will depend on whether it is exercised. In the case of a put
option, the premium is treated as a reduction in the purchase price of
the property if the option is exercised. E.g., Rev. Rul. 58-234, 1958-1
C.B. 279, 285. Otherwise, the grantor of the option recognizes ordinary
income upon the option’s lapse, id. at 284, unless section 1234(b)(1)
applies to treat the amount as short-term capital gain.
Petitioners fail to explain how the prescribed treatment of option
premiums could have applied to SEDA commitment fees. Suppose a
portfolio company elected to receive an advance of less than the
maximum amount allowed under a SEDA. What portion of the
commitment fee would be applied to reduce YA Global’s purchase price
for the stock issued in that advance? In theory, the commitment fee, if
treated as an option premium, would have to be prorated among all of
the shares YA Global purchases under the SEDA. But the number of
shares that YA Global would ultimately purchase could not be
determined until all possible advances had been made.
3. Trading Safe Harbor
Just as the activities that Yorkville Advisors conducted on behalf
of YA Global were not limited to the management of the partnership’s
36
investments, those activities were not limited to trading in stocks or
securities. The reason that YA Global was not an investor during the
years in issue was not that its portfolio turned over too rapidly. Instead,
YA Global fails to qualify for the investment safe harbor because the
income the partnership earned from portfolio companies went beyond
returns on invested capital. In that respect, YA Global can be
distinguished from both investors and traders. Traders, like investors,
simply earn returns on the capital they invest. Because the portfolio
companies compensated Yorkville Advisors and the partnership for
benefits that went beyond the use of invested capital, YA Global was
neither an investor nor a trader. 33 The activities that Yorkville Advisors
conducted on the partnership’s behalf during the years in issue were not
covered by either the judicially created safe harbor for the managing of
investments or the statutory safe harbor for trading in securities
provided in section 864(b)(2)(A).
4. Conclusion: Petitioners’ Failure to Meet Their
Burden of Proof
To sum up, the record establishes that the activities that
Yorkville Advisors conducted on behalf of YA Global were continuous,
regular, and directed at income or profit, went beyond the management
of investments, and were not within the statutory safe harbor for
securities trading. It follows that petitioners have not met their burden
of proving that YA Global was not engaged in a U.S. trade or business—
as defined by section 864(b), Groetzinger, and Higgins—during the years
in issue.
33 YA Global would not fall within the trading safe harbor even if we were to
accept that, under Treasury Regulation § 1.864-2(c)(2)(i)(c), the safe harbor covers any
buying and selling of stocks or securities. The activities that Yorkville Advisors
conducted on behalf of YA Global went beyond buying and selling socks or securities.
Petitioners make no argument that the activities that Yorkville Advisors conducted in
identifying, sourcing, and negotiating transactions—activities for which Yorkville
Advisors was compensated by portfolio companies—were “closely related” to buying,
selling, or trading in stocks or securities. Yorkville Advisors’ activities can be readily
distinguished from obtaining credit to buy, sell, or trade in stocks or securities.
Yorkville Advisors’ work in arranging for the issuance of stock or convertible
debentures by a portfolio company could be viewed as a precondition to its purchase of
that stock or those debentures. In that limited sense, Yorkville Advisors’ activities
could be likened to a taxpayer’s obtaining the credit necessary to purchase stock or
securities. But the taxpayer’s obtaining of credit would not provide a benefit to the
issuer of the stock or securities for which the issuer could be expected to compensate
the taxpayer. As respondent observes, “Taxpayers engaged merely in trading and
investment simply do not earn income designated as fees.”
37
Petitioners’ burden is not limited to establishing that YA Global
was not in a trade or business of underwriting or lending. The issue
before us is not so narrowly circumscribed. The FPAAs reflect
respondent’s determination that YA Global “was engaged in a trade or
business within the United States.” The petition assigns error to
respondent’s determinations that the partnership was engaged in a U.S.
trade or business during the years in issue. Respondent’s answer denies
that he erred as alleged.
Therefore, the issue defined by the pleadings is whether YA
Global was engaged in a trade or business—of any sort—during the
taxable years in issue. Petitioners seem to have viewed their task as
limited to refuting the specific arguments respondent advanced. The
August 28 stipulation may reflect petitioners’ mistaken assumption
that, in circumscribing respondent’s arguments, they would be limiting
their factual burden.
The August 28 stipulation had no effect on the burden of proof.
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.” 34 While petitioners amended their Petitions
before trial to raise affirmative issues, respondent did not amend his
Answer until April 2023, more than two years after the initial round of
posttrial briefs. As explained infra Part V.A, the amended Answer
respondent ultimately filed does not address the question of whether YA
Global was engaged in a U.S. trade or business but only the amount of
withholding tax that would be due should we to determine (as we have)
that the partnership was so engaged. Moreover, even an amended
answer does not shift the burden of proof if it “assert[s] . . . a new theory
which merely clarifies or develops the original determination without
being inconsistent or increasing the amount of the deficiency.” Achiro
v. Commissioner, 77 T.C. 881, 890 (1981). The arguments respondent
has advanced about why YA Global was engaged in a U.S. trade or
business are not inconsistent with the FPAAs’ determinations that YA
Global was engaged in a U.S. trade or business. Consequently,
34 Petitioners’ petition, as amended, asserts that respondent has the burden of
proof in regard to the adjustments set forth in the FPAAs because “[t]he FPAAs fail to
identify the factual basis for any of the adjustments.” Petitioners make no argument
on brief, however, concerning the applicability of section 7491, which, in specified
circumstances, can shift the burden of proof to the Commissioner.
38
respondent has not raised a “new matter” for which Rule 142(a) would
assign him the burden of proof.
Petitioners had the burden of proving that YA Global was not
engaged in a U.S. trade or business during the years in issue. They have
not met that burden. Therefore, we conclude that YA Global was
engaged in a U.S. trade or business during the years in issue.
YA Global’s conduct of a trade or business in the United States,
however, does not, by itself, establish that the partnership is liable for
section 1446 withholding tax in any particular amounts. The
partnership’s liability under section 1446 depends on that portion of its
taxable income that is both (1) effectively connected with its U.S. trade
or business and (2) allocable to foreign partners. As explained in more
detail infra Part IV, respondent contends that all of the taxable income
YA Global reported was effectively connected with its U.S. trade or
business. But respondent also argues that, in one respect, the
partnership’s taxable income for each of 2006, 2007, and 2008 differs
from what it reported on its Form 1065 for the year. According to
respondent, the partnership’s reported taxable income must be adjusted
to reflect the application of section 475’s mark-to-market rules.
Therefore, before considering the extent to which the partnership’s
taxable income is effectively connected with its U.S. trade or business,
we must consider whether the amount of the partnership’s taxable
income for each year depends in part on the rules provided in section
475.
III. Applicability of Section 475’s Mark-to-Market Rules
A. Findings of Fact
Yorkville Advisors and YA Global used slide decks to make
presentations to prospective investors or portfolio companies. One of
those slide decks describes the partnership’s “competitive edge” in “deal
origination.” It notes that “[c]ompanies seeking capital contact the Firm
directly.” The slide deck also refers to introductions provided by
investment bankers, referrals from securities attorneys and accounting
firms, YA Global’s sponsorship of industry conferences, and the
consistent quotation in the press of Yorkville Advisors’ “Principals and
Bankers” “as authorities on structured finance.” Another slide deck, for
a presentation by Yorkville Advisors, states: “Strong reputation leads
many issuers to contact us directly.”
39
Mr. Angelo confirmed that “industry professionals . . . came to us.”
“Investment banks [and] placement agents,” he said, “would call us and
show us potential investment opportunities.” In addition, “law firms
[and] accounting firms . . . would show [Yorkville Advisors] potential
investment opportunities.” Mr. Angelo also confirmed that Yorkville
Advisors’ personnel “went out and . . . attended a lot of conferences” in
industries in which they sought to source transactions and “would look
to speak to management” of potential portfolio companies.
Section 3.4 of the Face Print SEDA included the following among
representations and warranties that the partnership (as “Investor”)
made to Face Print (the “Company”):
The securities are being purchased by the Investor
for its own account, for investment purposes. The Investor
agrees not to assign or in any way transfer the Investor’s
rights to the securities or any interest therein and
acknowledges that the Company will not recognize any
purported assignment or transfer except in accordance
with applicable Federal and state securities laws. No other
person has or will have a direct or indirect beneficial
interest in the securities. The Investor agrees not to sell,
hypothecate, or otherwise transfer the Investor’s securities
unless the securities are registered under Federal and
applicable state securities laws or unless, in the opinion of
counsel satisfactory to the Company, an exemption from
such laws is available.
Similarly, section 2(a) of the Securities Purchase Agreement that
the partnership entered into with LocatePLUS (also included among the
partnership’s representations and warranties) states:
Each Buyer[35] is acquiring the Securities for its own
account for investment only and not with a view towards,
or for resale in connection with, the public sale or
distribution thereof, except pursuant to sales registered or
exempted under the Securities Act [of 1933]; provided,
however, that by making the representations herein, such
Buyer reserves the right to dispose of the Securities at any
time in accordance with or pursuant to an effective
35 A schedule attached to the agreement identifies the partnership as the only
“Buyer.”
40
registration statement covering such Securities or an
available exemption under the Securities Act. Such Buyer
does not presently have any agreement or understanding,
directly or indirectly, with any Person to distribute any of
the Securities.
The partnership’s Form 1065 for 2006 reported total taxable
income of $99,272,114, consisting of $27,557,943 of interest, $1,212,281
of ordinary dividends, $66,353,835 of short-term capital gain,
$1,756,027 of long-term capital gain, $9,797,190 of other income, and
$7,405,162 of other deductions. The sum of those amounts appears on
line 26(d) of Part II of Schedule M–3, Net Income (Loss) Reconciliation
for Certain Partnerships. Line 22(b) of that same schedule shows a
temporary difference between financial statement income and taxable
income of $3,588,938, which an explanatory statement identifies as
“change in unrealized appreciation.”
The partnership’s 2007 Form 1065 reported total taxable income
of $124,781,391, consisting of $45,083,015 of interest, $739,568 of
ordinary dividends, $72,034,012 of short-term capital gain, $540,186 of
long-term capital loss, $9,056,334 of other income, and $1,591,352 of
other deductions. The return also reported foreign taxes paid of $38,208.
The total taxable income shown on line 26(d) of Schedule M–3 Part II
($124,743,183) is the difference between the partnership’s total taxable
income and the foreign taxes paid. Line 22(b) of that schedule shows a
temporary difference of $2,337,280, which an explanatory statement
describes as a change in unrealized appreciation or deprecation. (The
$2,337,280 temporary difference reduced the partnership’s financial
statement net income but was added back to arrive at taxable income.)
The partnership’s 2008 Form 1065 reported total taxable income
of $48,542,819, consisting of $50,148,704 of interest, $557,181 of
ordinary dividends, $17,074,059 of short-term capital gain, $22,498,796
of long-term capital loss, $5,186,508 of other income and $1,924,837 of
other deductions. Line 26(d) of Schedule M–3, Part II shows the sum of
those amounts. Line 22(b) of that same schedule shows a temporary
difference of $13,393,454, which an explanatory statement identifies as
a change in unrealized depreciation. (The temporary difference was
included in financial statement income but not taxable income.) The
temporary difference YA Global reported on line 22(b) of Schedule M–3,
Part II of its 2008 Form 1065 is the net of two amounts shown on the
partnership’s 2008 income statement: a $13,813,194 “[i]ncrease in
unrealized appreciation of investments and forward currency contracts
41
for the year” and a $419,740 “[u]nrealized loss in securities distributed
to Partners.” The partnership’s 2008 return also reports “other credits”
of $249,917, identified as “U.S. tax withheld.”
The Form 1065 that YA Global filed for each of 2006, 2007, and
2008 reported no ordinary business income on line 22.
The 2006 FPAA states respondent’s determination that the
partnership “was a dealer in securities within the meaning of I.R.C.
§ 475 during the 2006 tax year.” Consequently, the partnership “was
required to apply the ‘mark to market’ accounting rules described
therein and all gains or losses are treated as ordinary income or loss.”
The FPAAs for 2007 and 2008 state similar determinations for those
years.
The 2006 FPAA determined that the partnership had “[n]et
ordinary business income for the 2006 tax year [of] $102,861,052.00,”
which the FPAA describes as “Form 1065 Schedule M–3 Part II line
26(d) less line 22(b), treated as ordinary.” ($102,861,052 is the sum of
the $99,272,114 total taxable income reported by the partnership and
the $3,588,938 change in unrealized appreciation included in financial
statement income but not taxable income.) The 2007 and 2008 FPAAs
determined net ordinary business income for those years of
$122,405,903 and $61,936,273, respectively. Respondent derived those
amounts in the same manner he employed for 2006, using the amounts
shown on lines 26(d) and 22(b) of the Schedule M–3 Part II of the
partnership’s return for the year. 36 The 2008 FPAA also disallowed the
$249,917 of other credits reported by the partnership on the ground that
those credits “have not been substantiated.” 37
36 The $122,405,903 net ordinary business income determined in the 2007
FPAA is the difference between the $124,743,183 reported on line 26(d) of Schedule
M–3, Part II and the $2,337,280 temporary difference reported on line 22(b). Because
the amount reported on line 26(d) was reduced by the foreign taxes YA Global
purported to have paid, the ordinary business income respondent determined for 2007
was also reduced by that amount. The 2007 FPAA, however, redetermined the
partnership’s foreign taxes paid to be zero, on the ground that the partnership had not
substantiated the reported amount. Although the Petitions assigned error to
respondent’s disallowance of the foreign taxes claimed by the partnership for 2007,
petitioners make no argument on brief in support of that assignment of error.
37 Although the Petitions assign error to respondent’s disallowance of the credit
for U.S. tax withheld that YA Global reported for 2008, petitioners make no argument
on brief to support the claim in the Petitions that “[t]he Partnership substantiated
42
B. Applicable Law
Section 475(a) provides rules regarding the treatment of
“securities” held by a “dealer in securities.” Section 475(a)(1) requires
the securities included in the dealer’s inventory to 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.
Any gain or loss recognized under section 475(a)(2) is “treated as
ordinary income or loss.” § 475(d)(3)(A)(i).
Section 475(c)(1) defines “dealer in securities” as “a taxpayer
who—(A) regularly purchases securities from or sells securities to
customers in the ordinary course of a trade or business; or (B) regularly
offers to enter into, assume, offset, assign or otherwise terminate
positions in securities with customers in the ordinary course of a trade
or business.” 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). 38 Treasury Regulation
§ 1.475(c)-1(a) provides: “Whether a taxpayer is transacting business
with customers is determined on the basis of all of the facts and
circumstances.”
Section 475(b)(1) lists securities to which the mark-to-market
rules of section 475(a) do not apply. Among the listed exceptions are
(A) any security held for investment, [and]
Other credits as reflected on Form 1065 . . . [for] taxable year 2008, and therefore the
Partnership is entitled to a $249,917 credit in taxable year 2008.” We therefore uphold
respondent’s determination that the partnership’s other credits for 2008 were zero.
38 Section 475(c)(2)(E) includes within the definition of “security” any “evidence
of an interest in, or a derivative financial instrument in, any security described in
[section 475(c)(2)(A), (B), (C), or (D)] . . . including any option, forward contract, short
position, and any similar financial instrument in such a security.”
43
(B)(i) any security described in subsection (c)(2)(C)
[that is, a note, bond, debenture, or other evidence of
indebtedness] which is acquired (including originated) by
the taxpayer in the ordinary course of a trade or business
of the taxpayer and which is not held for sale . . .
§ 475(b)(1). Treasury Regulation § 1.475(b)-1(a) provides: “[A] security
is held for investment (within the meaning of section 475(b)(1)(A)) or not
held for sale (within the meaning of section 475(b)(1)(B)) if it is not held
by the taxpayer primarily for sale to customers in the ordinary course of
the taxpayer’s trade or business.”
To qualify a security for one of the exceptions listed in section
475(b)(1), a taxpayer must identify it as such. Section 475(b)(2)
provides:
A security shall not be treated as described in
subparagraph (A), (B), or (C) of paragraph (1), as the case
may be, unless such security is clearly identified in the
dealer’s records as being described in such subparagraph
before the close of the day on which it was acquired,
originated, or entered into (or such other time as the
Secretary may by regulations prescribe).
Treasury Regulation § 1.475(b)-2(a) elaborates:
An identification of a security as exempt from mark to
market does not satisfy section 475(b)(2) if it fails to state
whether the security is described in—
(1) Either of the first two subparagraphs of
section 475(b)(1) (identifying a security as held for
investment or not held for sale); or
(2) The third subparagraph thereof
(identifying a security as a hedge).
Revenue Ruling 97-39, 1997-2 C.B. 62, 62, addresses several
issues “to enable taxpayers to comply with the mark-to-market
requirements of § 475.” Issue 6 asks: “Is a dealer in securities required
to use a special procedure to comply with the identification requirements
under § 475?” Id. at 63. The ruling answers that question in the
negative, explaining:
Unless the Commissioner otherwise prescribes, a dealer
may comply with the identification requirements under
44
§ 475 using any reasonable method . . . . The identification,
however, must be made on, and retained as part of, the
dealer’s books and records. The dealer’s books and records
must clearly indicate . . . that it is being made for purposes
of § 475. . . . Under § 1.475(b)-2(a), an identification need
not distinguish between an exception under § 475(b)(1)(A)
(concerning certain securities held for investment) and one
under § 475(b)(1)(B) (concerning securities not held for
sale). Exceptions under either of these provisions,
however, must be distinguished from exceptions under
§ 475(b)(1)(C) (concerning securities held as hedges).
Id. at 63–64.
C. The Parties’ Arguments
1. Petitioners
Petitioners assert that YA Global was not a dealer in securities,
within the meaning of section 475(c)(1), because the partnership’s
“portfolio companies were not its ‘customers,’ nor were the anonymous
investors who purchased the companies’ stock on public exchanges.”
Petitioners also seem to argue that all of the securities YA Global held
at the end of any of the taxable years in issue were exempt from section
475(a) by reason of the exception provided in section 475(b)(1)(A) for
“securit[ies] held for investment.”
Petitioners claim that statements in the SEDA agreements and
securities purchase agreements under which YA Global purchased
stock, warrants, and convertible debentures satisfy section 475(b)(2)’s
identification requirement. In particular, they point to the partnership’s
representation in section 3.4 of the Face Print SEDA that the
partnership was purchasing Face Print stock “for investment purposes”
and section 2(a) of the Securities Purchase Agreement with LocatePLUS
that the partnership was acquiring the LocatePLUS convertible
debentures “for investment.”
Petitioners find “nothing in the statute or regulations that
requires a taxpayer to identify a security by specifically writing the
words ‘section 475.’” In petitioners’ reading of the Code and regulations,
a taxpayer need only “describe the security as being either (1) held for
investment or not held for sale or (2) a hedge (that otherwise meets the
requirements of section 475(b)(1)(C), which is not relevant here).”
45
2. Respondent
Regarding YA Global’s status as a dealer in securities,
respondent, as we understand him, does not claim that the partnership
regularly sold securities to customers but contends that the portfolio
companies from whom the partnership purchased securities were its
customers. Respondent concedes that “[t]here is . . . no case law under
section 475 that specifically addresses the relevant facts and
circumstances necessary for finding customers.”
Finding a dearth of specific authority under section 475,
respondent looks to caselaw under section 1221(a), which excludes from
the definition of “capital asset” “property held by the taxpayer primarily
for sale to customers in the ordinary course of his trade or business.”
That caselaw, as respondent describes it, focuses on whether the
taxpayer acts as a middleman and profits from marking up the property
it buys and sells.
Respondent contends that “[t]he language in the various
instruments . . . providing that the securities were acquired for
investment purposes, is not sufficient for purposes of [the identification
requirement of] section 475.” To comply with section 475(b)(2),
respondent suggests, the identification must be “specific to section 475.”
By that, respondent means that the identification must state “that the
security is described in section 475(b)(1)(A), (B), or (C).” Respondent
observes that the text on which petitioners rely included in the Face
Print SEDA and the LocatePLUS Securities Purchase Agreement “does
not state that the security is described in one of the subsections of
section 475(b)(1).” Moreover, that text “does not specify that [it] is even
applicable for federal tax purposes.” Respondent surmises that “[t]his
language was most likely added for securities law purposes.”
D. Analysis
1. YA Global’s Status as a “Dealer in Securities”
The threshold issue raised by respondent’s determination that YA
Global was subject to the mark-to-market rules of section 475 is whether
the partnership was a “dealer in securities” for each of the years in issue.
Petitioners do not contest that the stock, debt instruments, and
warrants the partnership held were “securities” within the meaning of
section 475(c)(2). Nor do they dispute that YA Global regularly
purchased those securities from portfolio companies. We have already
concluded that those purchases occurred in the ordinary course of a
46
trade or business. Therefore, YA Global was a dealer in securities if the
portfolio companies from which it regularly purchased stock, warrants,
and debt instruments were the partnership’s “customers.”
To determine whether YA Global was a dealer in securities within
the meaning of section 475(c)(1), we need not resort to analogous
authorities such as caselaw under section 1221(a). Instead, we can
make that determination on the basis of section 475 and its
accompanying regulations. Treasury Regulation § 1.475(c)-1(a)(2)
provides: “For purposes of section 475(c)(1)(B), the term dealer in
securities includes, but is not limited to, a taxpayer that, in the ordinary
course of the taxpayer’s trade or business, regularly holds itself out as
being willing and able to enter into either side of a transaction
enumerated in section 475(c)(1)(B).” Section 475(c)(1)(B), again, treats
as a dealer in securities a taxpayer who regularly offers to deal in
positions in securities with customers in the ordinary course of its trade
or business. Treasury Regulation § 1.475(c)-1(a)(2), in contrast to the
statute it interprets, does not use the term “customers.” In place of that
term, the regulation refers to the taxpayer’s “regularly hold[ing] itself
out as being willing and able to enter into” specified positions. The
regulation thus establishes that a taxpayer’s “customers,” for purposes
of section 475(c)(1)(B), are those with whom the taxpayer does what it
“regularly holds itself out” to do. And we see no grounds for giving the
term “customers” a different meaning for purposes of section
475(c)(1)(A) than for section 475(c)(1)(B).
The record leaves no doubt that YA Global held itself out as being
willing and able to provide capital to portfolio companies. 39 Yorkville
Advisors cultivated a reputation that led portfolio companies to contact
it directly. The introductions and referrals received and the recognition
it garnered in the press attest to the breadth of its and YA Global’s
reputations. Those reputations could not have developed if Yorkville
Advisors and YA Global had not held themselves out as standing ready
to enter into transactions involving the partnership’s purchase of debt
securities and stock issued by portfolio companies.
Because YA Global “regularly [held] itself out as being willing and
able to” purchase stock and debentures, the portfolio companies from
39 As previously noted, petitioners repeatedly question the reliability of
marketing materials as evidence. Regardless of their reliability for other purposes, we
accept those materials as evidence of how Yorkville Advisors and YA Global held
themselves out to, and were perceived by, potential investors and portfolio companies.
47
which it made those purchases were its “customers,” within the meaning
of section 475(c)(1)(A). Treas. Reg. § 1.475(c)-1(a)(2). Because YA Global
“regularly purchase[d] securities from . . . customers in the ordinary
course of a trade or business,” it was a “dealer in securities,” within the
meaning of section 475(c)(1)(A). Consequently, the partnership was
subject to the mark-to-market rule provided in section 475(a)(2).
2. The Section 475(b)(1)(A) Exception for Securities
Held for Investment
The parties’ dispute concerning the “held for investment”
exception provided in section 475(b)(1)(A) centers on the identification
requirement of section 475(b)(2). Again, respondent makes no argument
that the purchasers to whom YA Global sold its securities on the market
were its “customers.” It follows that the securities held by YA Global
would be covered by the investment exception if the partnership
properly identified them as such. (For the same reason, the debentures
the partnership held would qualify for the exception provided in section
475(b)(1)(B)(i) if properly identified, but petitioners do not argue that
YA Global identified the debentures as covered by that exception.)
Although the record does not support petitioners’ assertion that
“YA Global’s SEDAs and securities purchase agreements consistently
stated that the securities it purchased were held for investment,” we
take respondent to have conceded the point. As petitioners remind us,
the parties stipulated that the documents executed in connection with
the Face Print SEDA and the LocatePLUS convertible debentures were
“typical.” But that stipulation does not establish that the agreements
under which YA Global purchased any securities it held at the end of
any of the years in issue had identical terms. The very stipulations on
which petitioners rely acknowledge the possibility that “specific terms
may vary from transaction to transaction.”
Nonetheless, respondent appears to accept that every SEDA and
every securities purchase agreement had a statement regarding YA
Global’s investment purpose materially identical to that included in the
Face Print SEDA and the LocatePLUS securities purchase agreement.
In their Opening Brief, petitioners, citing the Face Print SEDA and the
parties’ stipulation about its typicality, proposed a finding of fact that
“SEDA agreements contained a statement that YA Global was
purchasing the securities for its own account, and for investment
purpose.” Respondent could have objected to petitioners’ proposed
finding because the record does not support it (specifically, because the
48
record does not establish that all SEDA agreements had statements as
to investment purpose materially identical to that included in the Face
Print SEDA). While respondent did object to petitioners’ proposed
finding, his objection was narrower. He objected only “[t]o the extent
the finding implies that the inclusion of this language satisfies the
identification requirement in section 475(b)(2).” To that extent,
respondent observes, the finding states a legal conclusion that he judges
to be “inaccurate.” But respondent did not question the factual accuracy
of the finding as to the statement included in SEDA agreements other
than the Face Print SEDA.
Similarly, petitioners proposed a finding that “[t]he securities
purchase agreements pursuant to which YA Global purchased
convertible debentures contained a provision stating that the Fund was
buying the securities for its own account and for investment only.” In
support of their proposed finding, petitioners cite the LocatePLUS
securities purchase agreement and the parties’ stipulation as to that
agreement’s typicality. Again, while respondent could have objected
that the record does not support the proposed finding, he instead
objected on more limited grounds, stating that, “[t]o the extent the
finding implies that the inclusion of this language satisfies the
identification requirement in section 475(b)(2),” the finding draws an
“inaccurate” legal conclusion.
Even accepting that all agreements had materially identical
descriptions of YA Global’s investment purpose in acquiring the
securities in question, we agree with respondent that those descriptions
do not satisfy section 475(b)(2)’s identification requirement. Petitioners,
again, assert: “All that is required under [the statute and regulations]
is that a taxpayer describe the security as being either (1) held for
investment or not held for sale or (2) a hedge.” Petitioners’ paraphrase
of Treasury Regulation § 1.475(b)-2(a) is inaccurate. The regulation
does not require mere description of the purpose for which a dealer holds
a security. Instead, to meet the requirement of section 475(b)(2), the
description of a security in the dealer’s books and records must “state
whether the security is described in—(1) Either of the first two
subparagraphs of section 475(b)(1) (identifying a security as held for
investment or not held for sale); or (2) [t]he third subparagraph thereof
(identifying the security as a hedge).” Treas. Reg. § 1.475(b)-2(a)
(emphasis added).
As we read Treasury Regulation § 1.475(b)-2(a), it does require
“writing the words ‘section 475.’” An identification cannot “state” that
49
the security is described in either section 475(b)(1)(A) or (B) or instead
in section 475(b)(1)(C) without referring to the section in which those
subparagraphs appear. (“State” is not synonymous with “demonstrate”
or “indicate.”) 40
Requiring an explicit statement that a security is described in
either section 475(b)(1)(A) or (B) or section 475(b)(1)(C) is consistent
with the apparent purpose of section 475(b)(2)’s temporal condition. The
statute requires that a security be “clearly identified in the dealer’s
records as being described in [section 475(b)(1)(A), (B), or (C)] before the
close of the day on which it was acquired, originated, or entered into.”
§ 475(b)(2) (emphasis added). The temporal requirement prevents
taxpayers from gaining the benefit of hindsight, choosing the rules that
will govern the timing and character of the income they recognize from
a security only after seeing whether the security’s value increases or
decreases. Ambiguous identifications could allow dealers to get the
benefit of hindsight, claiming that an identification was sufficient if
circumstances develop under which exception from the mark-to-market
rule would be advantageous or, alternatively, claiming that an
identification was inadequate if application of the mark-to-market rule
would be preferable. Requiring an explicit statement that a security is
described in either section 475(b)(1)(A) or (B) or in section 475(b)(1)(C)
prevents ambiguity and thus ensures that dealers cannot benefit from
hindsight.
The statements of YA Global’s investment purpose in the Face
Print SEDA and the securities purchase agreement executed in
connection with the LocatePLUS convertible debentures do not satisfy
the identification requirement of section 475(b)(2), as interpreted by
Treasury Regulation § 1.475(b)-2(a). Neither agreement “states” that
the securities purchased thereunder are described in section
475(b)(1)(A) (or in either section 475(b)(1)(A) or (B)). Therefore,
petitioners have not established that any of the securities it held at the
40 Therefore, we do not accept petitioners’ suggestion that Revenue Ruling 97-
39 “goes beyond what is required by the statute and the Regulations.” Instead,
Treasury Regulation § 1.475(b)-2(a) supports the ruling’s conclusion that “[t]he dealer’s
books and records must clearly indicate . . . that [the identification] is being made for
purposes of § 475.” An identification that “states” that a security is described either in
section 475(b)(1)(A) or (B) or in section 475(b)(1)(C) will necessarily be “made for
purposes of § 475.”
50
end of any of the years in issue were described in section 475(b)(1)(A)
and thus excepted from the mark-to-market rules of section 475(a). 41
3. Conclusion
For the reasons explained above, we conclude that YA Global was
a “dealer in securities,” within the meaning of section 475(c)(1)(A), and
thus subject to the mark-to-market rule provided in section 475(a)(2).
Petitioners have not demonstrated that the partnership identified, in
accordance with section 475(b)(2), any of the securities it held at the end
of 2006, 2007, or 2008 as having been “held for investment” within the
meaning of section 475(b)(1)(A). Nor have petitioners demonstrated
that any of the amounts reported on line 22(b) of Schedule M–3 Part II
of the partnership’s returns were attributable to assets that were not
securities, within the meaning of section 475(c)(2). Therefore, with one
qualification, we uphold respondent’s inclusion in the partnership’s
ordinary business income for each of 2006, 2007, and 2008 of the
amounts reported on line 22(b) of part II of the partnership’s Schedule
M–3 for the year. We do not agree with respondent that the mark-to-
market adjustment for 2008 should be reduced by the $419,740
described in the partnership’s 2008 financial statements as
“[u]nrealized loss in securities distributed to Partners.” Any securities
distributed by the partnership during 2008 would not have been “held
[by the partnership] at the close of [the] taxable year” and thus would
not have been subject to section 475(a)(2). 42 Therefore, we conclude that
41 Even if we were to accept that every SEDA and every securities purchase
agreement issued in connection with a portfolio company’s issuance of convertible
debentures included a statement that satisfied the identification requirement of
section 475(b)(2), petitioners have not established the portion of the changes in
unrealized appreciation or depreciation included in its financial statement income for
each year that was attributable to SEDAs or convertible debentures.
42 In addition, we do not uphold in full respondent’s determinations of YA
Global’s ordinary business income. For each of 2006, 2007, and 2008, respondent
reclassified as ordinary business income each item of income, gain, deduction, or loss
reported by the partnership. To the extent that the amounts of capital gain or loss
reported by the partnership were attributable to securities, within the meaning of
section 475(c)(2), those amounts would be treated as ordinary income or loss under
section 475(d)(3)(A). And petitioners have not established that any of the amounts
reported as capital gain or loss were attributable to assets of YA Global other than
securities. Nor have petitioners established that any of the amounts reported as other
income or other deductions were required to be separately stated under section 702(a).
But section 702(a)(5) requires the separate statement of dividends, and respondent has
offered no justification for including in ordinary business income the amounts the
51
the partnership was required to recognize mark-to-market gain under
section 475(a)(2) for 2008 of $13,813,194—the amount identified on the
partnership’s financial statements as “[i]ncrease in unrealized
appreciation of investments and foreign currency contracts for the year.”
Having established YA Global’s taxable income for 2006, 2007,
2008, the next step in the determination of the partnership’s liability for
section 1446 withholding tax is to consider the extent to which the
partnership’s taxable income was effectively connected with the
partnership’s U.S. trade or business and allocable to foreign partners.
IV. YA Global’s Effectively Connected Taxable Income
A. Findings of Fact
YA Global invested primarily in microcap and low-priced public
companies traded in the over-the-counter public markets.
Although the FPAAs for 2006, 2007, and 2008 determined that
YA Global owed withholding tax of $15,900,807, $27,800,851, and
$16,882,544, respectively, they provided no details of how respondent
computed the partnership’s alleged liability. In response to an informal
discovery request, however, respondent’s counsel provided supporting
details to petitioners in October 2018. But respondent did not share
those details with the Court in his posttrial briefs. Therefore, in an
order issued on February 28, 2023 (February 28 Order), we directed
respondent to “submit a report explaining in detail the calculations
underlying his determination of [YA Global’s] section 1446 withholding
tax liability for each of the years in issue.” Our February 28 Order also
stated:
[I]f the calculations that respondent provides in response
to this order differ from those previously provided to
petitioners’ counsel, or if petitioners object to those
calculations for reasons beyond those raised in their
posttrial briefs, petitioners may advise the Court by filing
partnership reported as dividends. In addition, respondent’s reduction of ordinary
business income for 2007 by the foreign taxes reportedly paid by the partnership is
obviously in error. Even leaving aside that respondent disallowed the foreign taxes as
unsubstantiated and petitioners do not contest that disallowance on brief, foreign taxes
are not deductible by a partnership. Instead, each partner is treated as having paid
the partner’s proportionate share of foreign taxes paid by the partnership. See
§ 901(b)(5). Each partner then chooses to either deduct or credit the taxes. Treas. Reg.
§ 1.702-1(a)(6).
52
a motion for leave to respond to respondent’s report,
provided that any such motion is filed within one week
after respondent submits his report.
Respondent timely filed his Report on March 14, 2013. Petitioners did
not move for leave to respond to respondent’s Report.
B. Applicable Law
To review, section 1446 applies to a partnership if (1) the
“partnership has effectively connected taxable income for any taxable
year” and (2) “any portion of such income is allocable under section
704[43] to a foreign partner.” § 1446(a).
In general, section 1446(c) defines “effectively connected taxable
income” to mean “the taxable income of the partnership which is
effectively connected (or is treated as effectively connected) with the
conduct of a trade or business in the United States.” When the two
conditions specified in section 1446(a) are met, that section provides that
the partnership must “pay a withholding tax . . . at such time and in
such manner as the Secretary shall by regulations prescribe.”
The rules for determining whether income is effectively connected
with a U.S. trade or business differ depending on the nature and source
of the income. Section 864(c)(2) addresses U.S.-source fixed or
determinable annual or periodical income and gain or loss from sources
within the United States from the sale or exchange of capital assets.
The determination of whether income, gain, or loss within the scope of
section 864(c)(2) is effectively connected with a U.S. trade or business is
generally made taking into account such factors as “whether—(A) the
income, gain, or loss is derived from assets used or held for use in the
conduct of such trade or business, or (B) the activities of such trade or
business were a material factor in the realization of the income, gain, or
loss.”
43 Under section 704, a partner’s distributive share of the partnership’s income,
gain, loss, deduction, or credit is generally determined by the partnership agreement.
§ 704(a). If, however, the partnership agreement does not include allocation
provisions, or if the allocations provided for in the agreement lack substantial economic
effect, then each partner’s distributive share of the partnership’s income, gain, loss,
deduction, or credit is determined “in accordance with the partner’s interest in the
partnership (determined by taking into account all facts and circumstances).” § 704(b).
53
Special rules apply, however, to
any dividends or interest from stocks or securities, or any
gain or loss from the sale or exchange of stocks or securities
which are capital assets, which is from sources within the
United States and derived by a nonresident alien
individual[44] or a foreign corporation in the active conduct
during the taxable year of a banking, financing, or similar
business in the United States.
Treas. Reg. § 1.864-4(c)(5)(ii). Income, gain, or loss within the scope of
Treasury Regulation § 1.864-4(c)(5)(ii) is treated as effectively connected
only in specified circumstances. For example, interest or dividends are
effectively connected if (1) the securities that gave rise to the income are
attributable to the U.S. office through which the taxpayer carries on its
banking, financing, or similar business and (2) the taxpayer acquired
the securities (a) “[a]s a result of, or in the course of making loans to the
public,” or (b) in the case of dividends, the taxpayer acquired the stock
on which the dividends were paid “[i]n the course of distributing such
stocks . . . to the public.” Treas. Reg. § 1.864-4(c)(5)(ii)(a)(1) and (2).
Treasury Regulation § 1.864-4(c)(5)(i) provides:
A nonresident alien individual or a foreign corporation
shall be considered for purposes of this section . . . to be
engaged in the active conduct of a banking, financing, or
similar business in the United States if at some time
during the taxable year the taxpayer is engaged in
business in the United States and the activities of such
business consist of any one or more of the following
activities carried on, in whole or in part, in the United
States in transactions with persons situated within or
without the United States:
(a) Receiving deposits of funds from the
public,
(b) Making personal, mortgage, industrial, or
other loans to the public,
(c) Purchasing, selling, discounting, or
negotiating for the public on a regular basis, notes,
44 Section 703(a) provides, subject to specified exceptions, that “[t]he taxable
income of a partnership shall be computed in the same manner as in the case of an
individual.” None of the specified exceptions would prevent treating YA Global as an
individual for purposes of Treasury Regulation § 1.864-4(c)(5)(ii).
54
drafts, checks, bills of exchange, acceptances, or
other evidences of indebtedness,
(d) Issuing letters of credit to the public and
negotiating drafts drawn thereunder,
(e) Providing trust services for the public, or
(f) Financing foreign exchange transactions
for the public.
Any U.S.-source income, gain, or loss not covered by section
864(c)(2) is treated as effectively connected with the taxpayer’s U.S.
trade or business regardless of the factual connection between the
specific item and the taxpayer’s business. § 864(c)(3).
As a general rule, “no income, gain, or loss from sources without
the United States shall be treated as effectively connected with the
conduct of a trade or business within the United States.” § 864(c)(4)(A).
Foreign-source dividends or interest, however, are effectively connected
if they are attributable to “an office or other fixed place of business
within the United States” and “derived in the active conduct of a
banking, financing, or similar business within the United States.”
§ 864(c)(4)(B). Section 864(c)(5)(A) provides that, for purposes of section
864(c)(4)(B),
in determining whether a nonresident alien individual or a
foreign corporation has an office or other fixed place of
business, an office or other fixed place of business of an
agent shall be disregarded unless such agent (i) has the
authority to negotiate and conclude contracts in the name
of the nonresident alien individual or foreign corporation
and regularly exercises that authority or has a stock of
merchandise from which he regularly fills orders on behalf
of such individual or foreign corporation, and (ii) is not a
general commission agent, broker, or other agent of
independent status acting in the ordinary course of his
business[.]
An agent can be an independent agent even if the agent is related
to the principal and even, in some circumstances, if the agent acts
“exclusively, or almost exclusively” for that principal. See Treas. Reg.
§ 1.864-7(d)(3)(ii) and (iii). Treasury Regulation § 1.864-7(d)(3)(ii)
provides: “The determination of whether an agent is an independent
agent . . . shall be made without regard to facts indicating that either
the agent or the principal owns or controls directly or indirectly the other
55
or that a third person or persons own or control directly or indirectly
both.” And Treasury Regulation § 1.864-7(d)(3)(iii) provides:
Where an agent who is otherwise an independent agent
. . . acts in such capacity exclusively, or almost exclusively,
for one principal who is a nonresident alien individual or a
foreign corporation, the facts and circumstances of a
particular case shall be taken into account in determining
whether the agent, while acting in that capacity, may be
classified as an independent agent.
In InverWorld, Inc. v. Commissioner, T.C. Memo. 1996-301, 1996
WL 352998, we concluded that a U.S. subsidiary of a foreign parent was
not an independent agent of its parent. The subsidiary “had few clients”
other than its parent and the parent’s clients. Id., 1996 WL 352998,
at *27. We found that “the services that [the subsidiary] performed were
almost exclusively for” its parent. Id. And the record did “not establish
that [the subsidiary] marketed its services to clients on its own.” Id. On
the basis of the record, we concluded that the subsidiary “was not an
‘independent agent’ within the meaning of section 1.864-7(d)(3), Income
Tax Regs.” Id. The exclusivity of the parties’ relationship, though not
dispositive under the applicable regulations, seems to have weighed
heavily in our conclusion. The only other factor we noted in the course
of our analysis is that the subsidiary did not market its services to
others.
Rules provided in sections 861 through 865 determine the source
of various types of income. Interest is generally U.S. source if it is paid
on an obligation of the United States, the District of Columbia, a
noncorporate resident, or a domestic corporation. § 861(a)(1).
Otherwise, the interest is foreign source. § 862(a)(1). Dividends paid by
a domestic corporation are generally U.S. source while those paid by
most foreign corporations are foreign source. §§ 861(a)(2), 862(a)(2).
Gains on sales of personal property are generally sourced by reference
to the seller’s residence. § 865(a). Section 865(e)(2)(A), however,
provides: “Notwithstanding any other provisions of this part, if a
nonresident maintains an office or other fixed place of business in the
United States, income from any sale of personal property . . .
attributable to such office or other fixed place of business shall be
sourced in the United States.” Section 865(e)(3) provides that “[t]he
principles of section 864(c)(5) shall apply in determining whether a
taxpayer has an office or other fixed place of business and whether a sale
is attributable to such an office or other fixed place of business.” In
56
determining the source of gains from sales of personal property by a
partnership, the rules of section 865 shall, “except as provided in
regulations . . . be applied at the partner level.” § 865(i)(5).
C. The Parties’ Arguments
1. Respondent
Respondent contends that all of YA Global’s income “is effectively
connected with the conduct of [the partnership’s] lending and
underwriting business.” He notes that any U.S.-source income other
than capital gains or fixed or determinable annual or periodical income
would be effectively connected under section 864(c)(3). Respondent
would include in that category YA Global’s gain or loss from the sale or
deemed sale of securities. 45
Respondent accepts that the determination of whether YA
Global’s U.S.-source dividends, interest, and capital gain or loss are
effectively connected with its U.S. trade or business is governed by the
special rules provided in Treasury Regulation § 1.864-4(c)(5)(ii) rather
than the generally applicable asset use and business activities tests
provided in section 864(c)(2). He asserts: “YA Global’s lending business
fits squarely within the definition of the ‘active conduct of a banking,
financing, or similar business’” provided in Treasury Regulation § 1.864-
4(c)(5)(i). “Throughout the years at issue,” he reasons, “YA Global
regularly and continuously negotiated and received convertible debt
instruments and promissory notes, which amounted to making loans to
the public, and purchasing, selling, discounting, or negotiating for the
public on a regular basis, notes, drafts, checks, bills of exchange,
acceptances, or other evidences of indebtedness.” Respondent thus
concludes that, “for the purposes of section 864(c), YA Global was
engaged in the active conduct of a banking, financing, or similar
business in the United States.”
Respondent argues that “[t]he stock and securities giving rise to”
YA Global’s interest and dividend income “were acquired through the
45 Because we have concluded that YA Global was a dealer in securities and
did not properly identify its securities as held for investment, its gains and losses from
sales of securities (including deemed sales under section 475(a)(2)) would be “treated
as ordinary income or loss” under section 475(d)(3). In respondent’s view, “it does not
necessarily follow that the underlying assets are not capital assets.” Respondent
argues, however, that “[i]t would seem appropriate” to treat as “ordinary assets”
securities not identified as having been held for investment.
57
active financing business carried on in a U.S. office, including the office
located [in] Jersey City, New Jersey” that was “simultaneously the office
of YA Global, Yorkville Advisors . . . and Yorkville GP.” He notes that,
“[i]n the course of carrying on this business, YA Global received interest-
bearing promissory notes and convertible debt instruments,” “may have
received warrants from the issuers as consideration for making loans,
and frequently converted debt instruments into stock.” He argues that
“all U.S.-source interest and dividends generated by the convertible
debt, warrats [sic], stock, and other securities acquired in connection
with YA Global’s financing business, and U.S.-source gain from capital
assets (if any), are treated as effectively connected with the conduct of a
U.S. trade or business.” In reaching that conclusion, respondent
implicitly equates the portfolio companies to which YA Global provided
financing and “the public.” And he argues that “[d]ividends qualify [as
effectively connected income] as they are received on stock in the course
of distributing it to the public.”
Respondent contends that, “[i]f some portion of YA Global’s U.S.
source income is not effectively connected under Treas. Reg. § 1.864-
4(c)(5), it would be tested under the general effectively connected income
rules for U.S.-source income.” He reasons that YA Global’s U.S.-source
interest and fee income would be effectively connected under the
business activities test because “the origination of loans is clearly a
material factor in the interest and fees.” The same would be true, he
argues, of dividends or gains from stock received upon the conversion of
a convertible debenture or in connection with a SEDA.
Although respondent flatly asserts that “[m]ost, if not all, of [YA
Global’s] income comes from sources within the United States,” he also
contends that, to the extent that the partnership received “foreign-
source interest, dividends, and gain or loss from sales of stocks or
securities generated by the convertible debt, warrants, stock and other
securities acquired in connection with YA Global’s lending and
underwriting business,” those items of income, gain, or loss “were
effectively connected with the conduct of a U.S. trade or business.” He
rests that conclusion in part on the premise that “[t]he office of Yorkville
Advisors is attributable to YA Global for purposes of section
864(c)(4)([B]) because Yorkville Advisors is a dependent agent of YA
Global and Yorkville Advisors negotiated hundreds of contracts on
behalf of YA Global during the years in issue.”
58
2. Petitioners
Petitioners have not directly addressed the question of the extent
to which YA Global’s income, gain, or loss would be effectively connected
with any U.S. business in which we determine the partnership to have
been engaged. In the list of issues included in both his Pretrial
Memorandum and his Opening Brief, respondent included the following:
“Was the income YA Global received from the trade or business
effectively connected with the conduct of such trade or business
pursuant to section 864(c)?” Petitioners included no similar question in
the list of issues included in either their Pretrial Memorandum or their
Opening Brief. Apparently as a consequence, neither of petitioners’
briefs explicitly addresses the question of how much of YA Global’s
income would be effectively connected taxable income (ECTI) in the
event that we determine that the partnership was engaged in a U.S.
trade or business.
Nonetheless, some of the arguments petitioners advance in
regard to other issues would, if accepted, affect the amount of YA
Global’s ECTI. For example, in arguing that the transactions in stocks
or securities that Yorkville Advisors conducted on behalf of YA Global
were covered by the safe harbor for securities trading provided in section
864(b)(2)(A)(i), petitioners refer to Yorkville Advisors as “an
independent agent.” Petitioners appear to ground that characterization
on the premise that Yorkville Advisors “managed multiple funds,” so
that the transactions it entered into that involved YA Global were in
furtherance of its own business. If petitioners were correct that
Yorkville Advisors was an independent agent, then, under section
864(c)(5)(A), Yorkville Advisors’ office could not be attributed to YA
Global. Consequently, section 864(c)(4)(B) would not apply to treat any
of YA Global’s foreign-source income, gain, or loss as effectively
connected with its U.S. trade or business. Instead, under section
864(c)(4)(A)’s general rule, none of YA Global’s foreign-source income,
gain, or loss could be treated as effectively connected.
Petitioners also steadfastly deny that YA Global was involved in
the distribution of stock and thus was (or was analogous to) an
underwriter. The partnership, they insist, “did not connect buyers and
sellers of stock.” They continue: “It did not advertise its holdings as
inventory, nor did it provide price quotes to potential purchasers. It did
not engage in merchandising functions at all.” “[W]hen YA Global
wanted to sell stock,” petitioners observe, “it had to engage the services
of third-party broker-dealers.” If, as respondent accepts, any U.S.-
59
source dividends that YA Global received on stock acquired under a
SEDA were derived by the partnership “in the active conduct . . . of a
banking, financing, or similar business in the United States,” Treas.
Reg. § 1.864-4(c)(5)(ii), and if, as petitioners contend, YA Global did not
acquire that stock “in the course of distributing [it] . . . to the public,”
Treas. Reg. § 1.864-4(c)(5)(ii)(a)(2), then those dividends would not be
effectively connected with YA Global’s U.S. trade or business.
D. Analysis
The record does not support petitioners’ argument (again, made
in a different context) that Yorkville Advisors was an independent agent
of YA Global. As noted above, petitioners base that argument on the
premise that Yorkville Advisors was engaged in an investment
management business independent of any business conducted by YA
Global, in pursuance of which Yorkville Advisors managed funds other
than YA Global. We have found, however, that Yorkville Advisors
devoted most of its activities to YA Global during the years in issue.
Between June 1, 2006, and April 1, 2009, YA Global was the only fund
that Yorkville Advisors managed. See supra Part II.A. While Treasury
Regulation § 1.864-7(d)(3)(iii) contemplates the possibility that,
depending other facts and circumstances, an agent who acts exclusively
for one principal can nonetheless be classified as an independent agent,
petitioners point to no other facts or circumstances that would support
that classification of Yorkville Advisors’ relationship with YA Global.
The record provides no evidence, for example, that Yorkville Advisors
marketed its investment management services to unrelated funds. See
InverWorld, Inc. v. Commissioner, 1996 WL 352998, at *27. We
therefore accept respondent’s claim that “YA Global is considered to
have had a U.S. office within the meaning of section 864(c)(5), as
referenced in section 865(e)(3), throughout the Relevant Period.”
Before accepting respondent’s claim that all of YA Global’s income
from personal property was U.S. source and effectively connected,
however, we must consider section 865(i)(5). That section, again,
provides that, subject to any regulatory exceptions, the sourcing rules
for personal property sales provided in section 865 “shall apply at the
partner level.” In the absence of an applicable exception to section
865(i)(5)’s mandate, the relevant question in determining the source of
a foreign partner’s share of gain or loss from YA Global’s sale of
securities or other personal property would be whether the partner
“maintains an office or other fixed place of business in the United States”
to which that gain or loss is attributable. § 865(e)(2)(A). We might
60
assume that YA Global’s U.S. office “should be deemed to have been [a]
U.S. office” of each of its foreign partners. Grecian Magnesite Mining,
Indus. & Shipping Co., SA v. Commissioner, 149 T.C. 63, 85 (2017), aff’d,
926 F.3d 819 (D.C. Cir. 2019). Because we are here concerned, however,
not with the foreign partners’ substantive tax liability but instead YA
Global’s liability for withholding tax under section 1446, we need not
rest our analysis on such an assumption, however reasonable it might
be.
In the context of section 1446 withholding tax, Treasury
Regulation § 1.1446-2(a) provides an exception to section 865(i)(5)’s
mandate of partner-level source determinations. Treasury Regulation
§ 1.1446-2(a) provides: “The calculation of partnership ECTI allocable
to foreign partners . . . and the partnership’s withholding tax obligation
are partnership-level computations solely for purposes of determining
the 1446 tax.” A partnership’s section 1446 tax liability depends on the
ECTI allocable to foreign partners. Whether the partnership’s income
from sales of personal property is effectively connected under section
864(c) depends in part on the source of that income. And the income’s
source depends on the nexus between the income and a U.S. office or
other fixed place of business. § 865(e)(2)(A). We thus conclude that,
“solely for purposes of determining the 1446 tax,” section 865(e)(2)(A)
treats income from sales of personal property as U.S.-source income if
that income is attributable to a U.S. office or other fixed place of business
maintained (or attributable to) the partnership. Treas. Reg. § 1.1446-
2(a). At least for that purpose, it is of no moment whether the
partnership’s office or fixed place of business can be attributed to the
partnership’s foreign partners (or whether a foreign partner otherwise
maintains a U.S. office or fixed place of business to which the income
might be attributable).
We have no doubt that YA Global’s income from sales of personal
property was attributable to Yorkville Advisors’ U.S. office, which we
have already concluded was also YA Global’s U.S. office. Yorkville
Advisors’ U.S. office was “a material factor” in the production of that
income, and “activities of the type from which such income” was derived
were “regularly carrie[d] on” at that office. See §§ 864(c)(5)(B), 865(e)(3).
Therefore, at least for purposes of determining YA Global’s
section 1446 withholding tax liability, the partnership’s income from
sales of personal property is U.S.-source income under section
865(e)(2)(A). To the extent that that income arises from sales of personal
property other than capital assets, the income is effectively connected
61
under section 864(c)(3) without regard to the specific factual connection
between the income and the partnership’s business.
We agree with respondent that it is “appropriate” to treat YA
Global’s securities as assets other than capital assets. We disagree with
respondent, however, that that classification “does not necessarily
follow” from section 475(d)(3)(A)(i)’s treatment as ordinary income or
loss of the partnership’s gains or losses with respect to securities.
Respondent overlooks sections 64 and 65. Section 64 provides: “Any gain
from the sale or exchange of property which is treated or considered,
under other provisions of this subtitle, as ‘ordinary income’ shall be
treated as gain from the sale or exchange of property which is neither a
capital asset nor property described in section 1231(b).” Section 65
provides a corresponding rule for losses: “Any loss from the sale or
exchange of property which is treated or considered, under other
provisions of this subtitle, as ‘ordinary loss’ shall be treated as loss from
the sale or exchange of property which is not a capital asset.”
To review, we have established that any gain or loss recognized
by YA Global with respect to securities is treated, by reason of section
475(d)(3)(A) and section 64 or 65, as gain or loss from the sale or
exchange of property which is not a capital asset. And we have also
established that any such gain or loss would be U.S. source under section
865(e)(2)(A). It follows, then, that the determination of the effectively
connected status of that gain or loss is governed by section 864(c)(3).
Under section 864(c)(3)’s per se rule, any gain or loss recognized by YA
Global with respect to securities was effectively connected with its U.S.
trade or business.
We now turn to petitioners’ denial that YA Global engaged in the
distribution of stock. Whether YA Global’s business included the
distribution of stock would be irrelevant to the determination of the
partnership’s ECTI unless, as respondent claims, the partnership was
engaged “in the active conduct during [2006, 2007, and 2008] of a
banking, financing, or similar business in the United States.” Treas.
Reg. § 1.864-4(c)(5)(ii).
Whether the partnership’s U.S. trade or business was, in
particular, “a banking, financing, or similar business,” within the
meaning of Treasury Regulation § 1.864-4(c)(5)(i), turns on whether the
portfolio companies to which the partnership provided financing were a
broad enough class to constitute “the public.” The regulatory definition
of a banking, financing, or similar business, with its repeated references
62
to “the public,” seems to contemplate retail operations. But YA Global
did not hold itself out to any and all potential customers who sought
financing. Instead, it targeted what might be referred to as a niche
market. The portfolio companies with which the partnership dealt made
up a small slice of potential recipients of the types of services described
in Treasury Regulation § 1.864-4(c)(5)(i).
Even if we were to accept that YA Global made loans to the public,
and thus was engaged in the active conduct of a banking, financing, or
similar business, U.S.-source dividends on stock acquired under a SEDA
would not be effectively connected unless the partnership acquired that
stock in the course of distributing it to the public. Treas. Reg. § 1.864-
4(c)(5)(ii)(a)(1) and (2).
Under the circumstances, we need not decide whether the
portfolio companies to which YA Global made loans were a broad enough
group to constitute “the public” or whether the partnership acquired any
dividend-paying stock under a SEDA in the course of distributing that
stock to the public. The record does not allow us to determine the source
of the dividends and interest YA Global received, much less the extent
to which the partnership’s U.S.-source dividends were paid in respect of
stock acquired in a SEDA.
In short, petitioners have not met their burden of establishing
that any portion of the partnership’s taxable income was not effectively
connected with its U.S. trade or business. Indeed, petitioners advance
no explicit argument at all on the question of the extent to which the
partnership’s income is effectively connected. And they did not move for
leave to respond to the Report respondent submitted in response to the
February 28 Order. Petitioners’ inaction indicates that they generally
accept the premise reflected in that Report that all of the items of
income, gain, loss, or deduction YA Global reported on its return for each
of 2006, 2007, and 2008 were effectively connected with the
partnership’s U.S. trade or business. Therefore, we uphold respondent’s
determination to that effect. 4
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