# UNITED STATES TAX COURT > Briefs, arguments, decisions, and more. URL: https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A72198034959ccd04 ## Record - **Collection:** Agency decision - **Document type:** Agency decision ## Text DRB 141 T.C. No. 1 UNITED STATES TAX COURT JOHN HANCOCK LIFE INSURANCE COMPANY (U.S.A.), AS SUCCESSOR IN INTEREST TO JOHN HANCOCK LIFE INSURANCE COMPANY (f.k.a. JOHN HANCOCK MUTUAL LIFE INSURANCE COMPANY) AND SUBSIDIARIES, ET AL.,' Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent Docket Nos. 6404-09, 7083-10, 7084-10. Filed August 5, 2013. JH is primarily in the business of selling life insurance policies, annuities, long-term care insurance, and other retirement services. To fulfill its contractual obligations under these services JH invests the premiums it receives. In 1979 JH began investing in leveraged leases. A leveraged lease is a lease in which the equity investor iCases of the following petitioners are consolidated herewith: The Manufacturers Investment Corporation and Subsidiaries, as successor in interest to John Hancock Financial Services, Inc., and Subsidiaries, docket No. 7083-10; and John Hancock Life Insurance Company (U.S.A.) and Subsidiaries, as successor in interest to John Hancock Life Insurance Company (f.k.a. John Hancock Mutual Life), docket No. 7084-10. SERVED Aug 05 2013 -2borrows money from a third-party lender to finance a portion of the purchase price of the asset involved and leases the asset to its ultimate user. In 1997 JH began investing in lease-in-lease-out (LILO) transactions and in 1999 began investing in sale-in-lease-out (SILO) transactions. JH participated in 19 LILO transactions and 8 SILO transactions between 1997 and 2001. With respect to the LILO transactions, JH claimed deductions for rental expenses for the prepaid rent paid to the tax-indifferent entities and interest expenses related to the repayment of the nonrecourse loans. JH also amortized transaction costs related to the LILO transactions. With respect to the SILO transactions, JH claimed deductions for depreciation and interest expenses and amortized the related transaction costs. R disallowed these deductions for the years at issue and determined that JH had OID income with respect to the LILO and SILO transactions. The parties agreed to litigate three LILO transactions and four SILO transactions and use them as test transactions for the remaining LILO and SILO transactions at issue. A transaction will be respected for Federal income tax purposes if it has economic substance and the substance of the transaction is consistent with its form. P argues that the LILO and SILO test transactions have economic substance because JH derived a pretax profit from each transaction and entered into the transactions with the primary purpose of making a profit. P also argues that the substance of each LILO and SILO transaction is consistent with its form because JH held a true leasehold interest in each of the LILO assets and obtained an ownership interest in each of the SILO assets. R argues that the LILO and SILO test transactions lack economic substance and the substance of the transactions is not consistent with their form. Specifically, R argues that JH failed to acquire a substantive leasehold interest in the LILO assets and failed to acquire a substantive ownership interest in the SILO assets. Thus, R argues -3the true substance of the LILO and SILO transactions is a loan from JH to the tax-indifferent entities. R argues in the alternative with respect to the LILO and SILO transactions that at most P acquired a future interest in the LILO and SILO assets. The parties also dispute the location of JH's principal place of business. Held: JH's principal place of business is Boston, Massachusetts. Held, further, R failed to prove that the three LILO and four SILO test transactions lack economic substance. Held, further, the substance of the three LILO test transactions is not consistent with their form. The LILO test transactions resemble financial arrangements, and JH is therefore denied its claimed rental expense, interest expense, and transaction cost deductions with respect to them. Held, further, the substance of three of the SILO test transactions is consistent with their form; however, JH did not acquire a present interest in the SILO test transaction properties and is therefore denied its claimed depreciation and interest expense deductions. Held, further, the substance of the fourth SILO test transaction is not consistent with its form. That SILO test transaction resembles a financial arrangement, and JH is therefore denied its claimed depreciation expense, interest expense, and transaction cost deductions with respect to that transaction. Held, further, JH had OID income with respect to the three LILO test transactions and the fourth SILO test transaction but not with respect to the first three SILO test transactions, in which it failed to acquire a present interest. -4Arthur L. Bailey, Jean A. Pawlow, James W. Johnson, Kevin J. Cloherty, Alexis A. Maclvor, Thomas K. Spencer, and Nathaniel J. Dorfman, for petitioners. Daniel A. Rosen, Lyle B. Press, Steven N. Balahtsis, Allison Ickovic, and Abigail F. Dunnigan, for respondent. CONTENTS FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12 Background ................................................. 12 I. John Hancock'sHistory ............................. 12 II. InvestmentProcess andReview ....................... 14 III. Leasing .......................................... 16 IV. LILOand SILOTransactions ......................... 16 A. Basic Structure ............................... 16 B. History ..................................... 24 C. DueDiligence................................ 26 D. The Hoosier Transaction ....................... 28 TheLILOTest Transactions .................................... 30 I. OBBLILO ....................................... 31 -5- A. LeaseandSublease ........................... 31 1. TheAsset .............................. 31 2. Terms .................................33 3. RentandFinancing ...................... 33 a. b. 4. 5. B. Property Rights and Obligations . . . . . . . . . . . . 35 Default ................................36 EndofSubleaseTerm .........................37 1. 2. II. InitialLease ....................... 33 Sublease and Defeasance . . . . . . . . . . . . . 33 OBB'sPurchaseOption................... 37 JohnHancock'sOptions .................. 38 a. RenewalOption .................... 38 b. c. ReplacementOption ................ 39 RetentionOption ................... 40 SNCB 2 and SNCB 5 Lot 1 LILO Transactions . . . . . . . . . . 40 A. B. Lease and Sublease . .. .... . . ............... ... 40 1. The Assets ............................. 40 2. 3. Terms .................................42 RentandFinancing ...................... 42 a. InitialLease ....................... 42 b. Sublease and Defeasance . . . . . . . . . . . . . 43 4. Property and Default Rights and Obligations . . 44 End of Sublease Term . .. . . . . . . .. . . . . . ... .. . .. . 44 The SILOTestTransactions .................................... 45 I. TIWAG .......................................... 46 A. LeaseandSublease ........................... 46 1. The Assets ............................. 46 2. Terms ................................. 47 3. RentandFinancing ...................... 47 a. InitialLease ....................... 47 -6- B. II. 4. b. Sublease and Defeasance . . . . . . . . . . . . . 48 Property Rights and Obligations . . . . . . . . . . . . 51 5. Default ................................52 EndofSubleaseTerm .........................53 1. TIWAG'sPurchaseOption ................ 53 2. John Hancock'sOptions .................. 53 TwoDortmundTransactions ......................... 56 A. LeaseandSublease ........................... 56 1. TheAsset .............................. 56 2. Terms ................................. 58 3. Rent and Financing ...................... 59 a. InitialLease ....................... 59 b. Sublease and Defeasance . . . . . . . . . . . . . 59 4. B. III. Property and Default Rights and Obligations . . 61 EndofSubleaseTerm ......................... 61 SNCB SILO ...................................... 63 A. GrantandSubgrant ........................... 63 1. The Asset .............................. 63 2. Terms ................................. 64 3. Rent and Financing ..... ...... . ..... ..... 64 a. Grant ..... .. .... .. .... . . ......... 64 4. B. b. Subgrant and Defeasance . . . . . . . . . . . . 65 Property and Default Rights and Obligations . . 67 EndofSubgrantTerm ......................... 67 Tax Returns, Notices of Deficiency, and Trial . . . . . . . . . . . . . . . . . . . . . . 68 I. Procedural History ................................. 68 A. Notice of Deficiency (Docket No. 6404-09) . . . . . . . . 69 -7- II. B. Notice of Deficiency (Docket No. 7084-10) . . . . . . . . 70 C. Notice of Deficiency (Docket No. 7083-10) . . . . . . . . 72 D. PretrialMotions .............................. 76 Trial............................................. 76 A. B. Petitioners' Expert Witnesses (Alphabetical Order) . . 77 1. Mr.JohnDolan ......................... 77 2. Dr. Paul Doralt . . .. .. .. . . . . . .. . . . . . . . .. . . 77 3. Mr.Hans Haider......................... 78 4. Dr.Friedrich Hey ........................ 78 5. Dr.FriedrichPopp ....................... 79 6. 7. 8. Dr. Thomas Schurrle . . . . . . . . . . . . . . . . . . . . . 79 Dr. Norbert Stoeck . . . . . . . . . . . . . . . . . . . . . . . 80 Dr. Frederik Vandendriessche . . . . . . . . . . . . . . 80 Respondent's Expert Witnesses (Alphabetical Order) 81 1. Dr. IgnaasBehaeghe ..................... 81 2. Dr. StefanDiemer ....................... 81 3. Dr.MatthiasHeisse ...................... 81 4. 5. 6. 7. 8. Dr. Thomas Lys ......................... 82 Dr.F.H. RolfSeringhaus .................. 83 Mag. Alexander Stolitzka . . . . . . . . . . . . . . . . . 83 Dr. Vukan Vuchic .................. ..... 84 Dr.PeterWundsam ......................84 OPINION ........................................................ 85 Burden ofProof..............................................85 PrincipalPlace ofBusiness ..................................... 86 LeveragedLease Transactions .................................. 87 I. FrankLyon ....................................... 87 -8 - II. A. Economic Substance .......................... 90 B. SubstanceOverForm.......................... 92 LILOandSILOLitigation ........................... 93 A. BB&T ..................................... 96 B. AWG...................................... 100 C. WellsFargo ................................ 106 D. Altria...................................... 113 E. Consolidated Edison ......................... 119 The Test Transactions ........................................ 125 I. II. Economic Substance ............................... 126 A. ObjectiveInquiry ............................ 127 B. SubjectiveInquiry ........................... 143 Substance OverForm ............................. 144 A. OBB and SNCB LILO Transactions . . . . . . . . . . . . . 147 1. B. OBB Purchase Option Decision . . . . . . . . . . . 153 a. Financial Considerations . . . . . . . . . . . . 159 b. RetentionOption .................. 161 2. c. Renewal and Replacement Options . . . . 161 SNCB Purchase Option Decision . . . . . . . . . . 168 3. Conclusion ............................ 176 SILOTest Transactions ....................... 177 1. TIWAG and Dortmund Transactions . . . . . . . 179 a. Sublease Term .................... 179 b. PurchaseOptions .................. 183 -9I. 2. TIWAG Transaction . . . . . . . . . . 184 c. ii. Dortmund Transactions . . . . . . . . 199 Service Contract Benefits and Burdens 213 d. FutureInterest .................... 219 SNCB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222 a. Purchase Option Decision . . . . . . . . . . . 223 b. SubgrantTerm .................... 232 c. Conclusion ....................... 235 InterestDeductions ..........................................236 Original Issue Discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238 TransactionExpenses ........................................ 241 Conclusion................................................. 242 HAINES, Judge: These cases are consolidated for purposes of trial, briefing, and opinion. Respondent determined the following deficiencies in petitioners' Federal income tax for 19942 and 1997-2001 (years at issue):3 2Petitioners' 1994 deficiency arises from the denial of a claimed NOL carryback. 3All section references are to the Internal Revenue Code (Code), as amended and in effect for the years at issue, and all Rule references are to the Tax Court Rules of Practice and Procedure, unless otherwise indicated. Amounts are rounded to the nearest dollar. -10Year Deficiency 1994 1997 1998 1999 2000 2001 $8,860,564 65,746,621 173,497,367 59,899,141 108,046,947 143,516,079 These deficiencies stem from 27 leveraged lease transactions (leveraged leases) that petitioners participated in between 1997 and 2001. For purposes of resolving this action expeditiously, the parties agreed to try seven of the leveraged leases (test transactions) and apply a formula to determine the deficiency, if any, with respect to the remaining leveraged leases. The test transactions comprise three lease-in-lease-out (LILO) transactions and four sales-in-lease-out (SILO) transactions.4 The test transactions were identified at trial and are referred to herein by the lease counterparty to each transaction. The counterparties for the LILO test transactions are: (1) Osterreichische Bundesbahnen (OBB), a Government-owned Austrian corporation that operates the Austrian Federal railway system, and (2) Societe Nationale des Chemins de Fer Belges (SNCB), a Belgian company that 4Petitioners have referred to the SILO transactions as "service contract" transactions throughout the pleadings and at trial and have emphasized this distinction from a LILO. For simplicity and without prejudice, we refer to these transactions as SILO transactions. - 11 owns and operates the national rail system of Belgium.5 The counterparties for the SILO test transactions are: (1) Tiwag-Tiroler Wasserkraft AG (TIWAG), an Austrian corporation that is owned by the Austrian Province of Tyrol and is in the business of generating, transmitting, and distributing electrical power to commercial and residential consumers in Tyrol; (2) the City of Dortmund, Germany (Dortmund);6 and (3) SNCB. The issues for decision are: (1) whether the principal place of business for petitioner in docket No. 7083-10 was in Massachusetts or Michigan; (2) whether the test transactions lacked economic substance resulting in disallowance of petitioners' claimed deductions for rent, depreciation, interest, and transaction expenses; (3) whether under the substance over form doctrine, the substance of the 5SNCB is the counterparty to two LILO test transactions. At trial and on brief these LILO transactions were referred to as SNCB 2 and SNCB 5 lot 1. For purposes of this Opinion, we refer to them individually in the same manner and collectively as the SNCB LILO transactions. 6Dortmund is the counterparty to two SILO test transactions, referred to at trial and on brief as the Dortmund 1 and Dortmund 2 transactions. The assets subject to the Dortmund 1 transaction are Halls 1, 2, and 3A of the Westfalenhallen Dortmund Trade Fair, Event, and Congress Center Complex and the associated facility sites. The assets subject to the Dortmund 2 transaction are Halls 4-8 of the Westfalenhallen Dortmund Trade Fair, Event, and Congress Center Complex and the associated facility sites. In all other material respects, Dortmund 1 and Dortmund 2 are identical. Therefore, for purposes of this Opinion, we refer to them individually as Dortmund 1 and Dortmund 2, and collectively as the Dortmund transactions. - 12 test transactions was a purchase of a future interest, inconsistent with its form, resulting in disallowance of petitioners' claimed deductions for rent, depreciation, interest, and transaction expenses; or (4) alternatively, whether under the substance over form doctrine, the substance of the test transactions was a financing arrangement, inconsistent with its form, resulting in generation of original issue discount (OID) income and the disallowance of petitioners' claimed deductions for rent, depreciation, and interest expenses. FlNDINGS OF FACT Some of the facts have been stipulated and are so found. The stipulations of fact, together with those attached exhibits which were found relevant and admissible, are incorporated herein by this reference. At the time they filed their petitions, the principal place of business of petitioners in docket Nos. 6404-09 and 7084-10 was in Massachusetts. There is a dispute among the parties as to whether the principal place of business of petitioner in docket No. 7083-10 was in Massachusetts or Michigan. Background I. John Hancock's History John Hancock Mutual Life Insurance Co. (JH Mutual) was incorporated in Massachusetts in 1862. In February 2000 JH Mutual converted from a mutual life - 13 insurance company to a publicly traded company. At that time it was renamed John Hancock Life Insurance Co. (JHLIC) and became a wholly owned subsidiary of John Hancock Financial Services, Inc. (JHFS). In April 2004 Manulife Financial Corp., a Canadian company (Manulife), acquired JHFS and all of its subsidiary corporations. Pursuant to a restructuring, on December 31, 2009, John Hancock Life Insurance Co. (U.S.A.) (JHUSA) succeeded JHLIC. A subsidiary of Manulife, the Manufacturer's Investment Co., a Michigan general business corporation (MIC), succeeded JHFS. Unless otherwise indicated, for purposes of this Opinion we refer to JH Mutual, JHLIC, JHFS, JHUSA, MIC, and their subsidiaries collectively as John Hancock. Throughout its history John Hancock's primary business has been the sale of life insurance policies, annuities, long-term care insurance, and other retirement services. To fulfill its contractual obligations under these services, John Hancock invests the premiums it receives. Because of the varying lengths of John Hancock's contractual obligations to its policyholders, it seeks to invest in opportunities that match its long- and short-term cashflow needs and provide an appropriate return or yield for its assessed risk levels. John Hancock's financial needs require it to invest in a diversified set of domestic and international assets. Between 1997 and 2001 John Hancock invested - 14 between $6.8 and $10 billion annually and managed a portfolio of investments valued between $38.9 and $46.6 billion. II. Investment Process and Review Between 1997 and 2001 John Hancock's committee of finance oversaw its investments. The committee of finance comprised members of John Hancock's board of directors as well as its chairman, vice chairman, and president. Committee of finance approval was required for all investments of a designated s1Ze. John Hancock's bond and corporate finance group managed the day-to-day responsibilities with respect to a significant portion of the company's investments, including bond portfolios, private equity, and alternative asset investments. The bond and corporate finance group was divided into teams. For instance, the "industrial" team was charged with managing investments in transportation, timber, industrial equipment, mining, metal and communications assets. The "energy" team managed investments in power plants, power companies, and other energy assets. The "international" team managed cross-border investments. The work of each team was connected to the "portfolio management" department, which determined the types of investments and yields that John Hancock needed to support its contractual obligations to its policyholders. The division of - 15 responsibility within the bond and corporate finance group allowed each team to specialize and develop an expertise in its designated industries. Each of John Hancock's investments went through a thorough review process. Typically, a bond and corporate finance group team was charged with drafting an investment recommendation, known within John Hancock as a "yellow report". A yellow report analyzes a proposed investment in numerous ways, including an analysis of the expected return, risk profile, collateral support, credit rating of the relevant parties to the transaction, term of the transaction, and any special aspects of the investment. The yellow report was used as an approval request for many of John Hancock's investments. John Hancock's bond investment committee reviewed the yellow reports. The bond investment committee held bimonthly meetings and comprised leaders from each of the bond and corporate finance group's industry teams. At each bond investment committee meeting, the credit analyst responsible for analyzing the investment featured in the yellow report presented the opportunity, discussed the risks and rewards of the investment, and fielded questions from the committee. After review and consideration, the bond investment committee's members voted to approve or deny an investment. If an investment was approved, it moved to the committee of finance for further review and approval. - 16 Generally, a committee of finance meeting was held once a month. However, in certain circumstances the bond investment committee was granted "between meeting authority" to enter into an investment normally requiring further approval. "Between meeting authority" was necessary in cases where John Hancock has to proceed with a time-sensitive investment. III. Leasing In 1979 John Hancock formed a leasing company. Leasing transactions were attractive to John Hancock because they offered a higher after-tax return than traditional investments. A leveraged lease is a lease in which the equity investor borrows money from a third-party lender to finance a portion of the purchase price of the asset involved and leases the asset to its ultimate user. John Hancock participated in leveraged leases as both equity investor and lender. A variety of assets were involved, including aircraft, medical equipment, tractors, irrigation systems, barges, trailers, grain silos, natural gas compressors, manufacturing equipment, automobiles, and railcars. IV. LILO and SILO Transactions A. Basic Structure John Hancock participated in 19 LILO transactions and 8 SILO transactions between 1997 and 2001. LILO and SILO transactions are types of leveraged - 17 leases. In a typical LILO transaction, a U.S. taxpayer, acting through a grantor trust,7 leases assets from a foreign or domestic tax-exempt entity and simultaneously leases that property back to the lessee 8 The U.S. taxpayer prepays the initial lease's rent, which is funded through a nonrecourse loan from a thirdparty lender and an equity contribution from the U.S. taxpayer. The equity ordinarily ranges from 10% to 20% of the value of the initial lease. Because the loan funding the debt portion of the investment is nonrecourse, the U.S. taxpayer is entitled to favorable accounting treatment on its financial statements pursuant to Statement of Financial Accounting Standards No. 13 (FAS 13).9 The sublease has a shorter term than the initial lease. At the end of the sublease term the tax-exempt entity has the option to purchase the remainder of the U.S. taxpayer's leasehold interest in the initial lease. If the tax-exempt entity 7The grantor trust is generally disregarded for Federal income tax purposes. 8Each lessee counterparty to the test transactions is a foreign entity. These foreign entities are so called tax-indifferent entities because they are not subject to U.S. taxation. For convenience we shall refer to these entities as tax-exempt entities. 9FAS 13 addresses lease accounting for lessors and lessees taking part in leveraged leases. FAS 13 enables earlier recognition of income relative to other transactions with similar cashflows. Additionally, FAS 13 allows nonrecourse debt used in a leveraged lease to be excluded from the liabilities side of a balance sheet. - 18 - chooses not to exercise this purchase option, the U.S. taxpayer may elect to: (1) compel the tax-exempt entity to renew the sublease; (2) take possession of the asset; or (3) enter into a replacement sublease with a third party. Most LILO and SILO transactions impose requirements upon a tax-exempt entity that chooses not to exercise its purchase option, such as refinancing the U.S. taxpayer's nonrecourse loan. If the tax-exempt entity cannot meet these requirements, it must ordinarily exercise the purchase option. A typical SILO transaction is similar, except that the term of the initial lease extends beyond the remaining useful life of the asset. Therefore, the U.S. taxpayer takes the position that the initial lease is a sale for U.S. Federal tax purposes. Also, if the tax-exempt entity chooses not to purchase the asset at the end of the sublease term, the U.S. taxpayer's options differ slightly. The U.S. taxpayer may (1) compel the lessee to arrange for a service contract for the asset for a predetermined term or (2) take possession of the asset. "Defeasance" is a common characteristic in most LILO and SILO transactions. Defeasance is a way to minimize risk. The forin of the defeasance in a particular LILO or SILO transaction will vary, but it is ordinarily accomplished through one or more deposits with third-party financial institutions, known as payment undertakers. In most LILO and SILO transactions the U.S. taxpayer will - 19 require a debt payment undertaking agreement (DPUA) as part of the transaction, and often will require an equity payment undertaking agreement (EPUA) as well. In a DPUA, the tax-exempt entity deposits a portion of prepaid rent received from the U.S. taxpayer funded by the nonrecourse loan with the debt payment undertaker (DPU), sometimes related to the lender, and in return the DPU agrees to make rent payments on behalf of the tax-exempt entity under the sublease. The timing and amount of the tax-exempt entity's rent under the sublease usually matches the U.S. taxpayer's debt service payments on the nonrecourse loan. As a result, the DPU will often pay the lender directly and neither the U.S. taxpayer nor the tax-exempt entity make any out-of-pocket payments during the initial lease term. In an EPUA, the tax-exempt entity deposits a portion of the U.S. taxpayer's equity investment with an equity payment undertaker (EPU). This deposit is designed to pay the tax-exempt entity's equity portion of rent payments, to grow to cover the sublease termination value in case of a sublessee default, and to fund the tax-exempt entity's purchase option at the end of the initial lease. As a result, the tax-exempt entity is not forced to incur any additional out of pocket expenses if it chooses to exercise its purchase option. - 20 In addition to a DPUA and an EPUA, the U.S. taxpayer in a LILO or SILO transaction may require additional protection, such as a pledge of the amounts deposited pursuant to the DPUA or EPUA, or residual value insurance. If an amount deposited with a payment undertaker is not pledged to the U.S. taxpayer, the tax-exempt entity may have the right to withdraw the deposit for its own use if it replaces the deposit with approved substitute collateral, such as a letter of credit. The tax-exempt entity retains the portion of the equity contribution that is not deposited pursuant to an EPUA. This amount is known as the tax-exempt entity's "net present value benefit" from the transaction. The following graphics display the closing day and sublease lease term cashflowsl° and the operating structure of a basic single-lender LILO with debt and equity defeasance during the sublease lease term. For purposes of this graphic, the U.S. taxpayer's grantor trust is the lessor and the tax-exempt entity is the lessee during the sublease lease term. 1°The graphic ignores transaction expenses that the U.S. taxpayer ordinarily pays on the closing date. - 21 - Illustrative Hypothetical Closing Day Cashflows US Taxpayer Equity Contribution ($20) Grantor Trust Nonrecourse Loan ($80) Lender Equity Contribution+ Debt Contribution= Prepaid Rent on Inital Lease ($100) Equity Equity Payment Undertaker Contribution - Fee Tax Exempt Nonrecourse Loan Debt ($80) Payment Undertaker Entity ($17) Fee ($3) The tax-exempt entity receives a fee for entering into the transaction with the grantor trust. The equity contribution (minus the fee) will then be invested by the equity payment undertaker and will be used to pay a portion of the sublease rent payments and fund the purchase option at the end of the sublease term. The debt contribution will be invested by the debt payment undertaker and will be used to pay a portion of the sublease rent payments and eventually returned to the lender as debt service payments on the nonrecourse loan. Typically the lender and the debt payment undertaker are related parties, and often the equity payment undertaker is also related to the lender. - 22 - Sublease Term Cashflows Retum of U.S. Equity Taxpayer 4 --- - - -- Grantor Trust Debt Service Payment - - -- -- , Return of Equity Sublease Rent Contribution through Sublease (Funded by Debt Portion and Equity Portion) Lender Sublease Rent Sublease Equity Tax Exempt Rent Debt Payment - -- - -- V Entity 4 - - - - Payment Undertaker (Fee) Undertaker The dashed lines represent the theoretical flow of cash from the payment undertakers to the tax-exempt entity, the tax-exempt entity to the grantor trust, and the grantor trust to the U.S. taxpayer and the lender. However, because the timing and amount of the lessee's sublease rent payments and the lessor's debt service payments match exactly, the debt payment undertaker often pays the lender directly, satisfying both the sublease rent and the debt service payment. Similarly, the equity payment undertaker's sublease rent ends up in the hands of the U.S. taxpayer as a return of equity. - 23 - Closing Day Cashflows and Sublease Term Cashflows Equity Loop US Taxpayer Equity Contribution Debt Loop . . Grantor Trust Portion of equiíy contribution : : . returned to U.S. Taxpayer as sublease rent Equity Payment Undertaker Equity Contribution Fee . Lender Equity Contribution+ Nonrecourse loan = Prepaid Rent on Inital : Lease Tax Exempt. Entit . Fee .· Nonrecourse Loan Nonrecourse Loan Nonrecourse loan returned to Lender through sublease rent payments Debf Payntent Undertaker - Above is a combination of the closing day cashflows and the sublease term cashflows. Together the two cashflows create what is known as loop debt. -24B. History In 1975 the Internal Revenue Service (IRS) issued guidelines for advance ruling purposes in determining whether leveraged lease transactions may be treated as leases for Federal tax purposes. Rev. Proc. 75-21, 1975-1 C.B. 715. In 1981 Congress enacted safe harbor leasing rules for sale and leaseback transactions that allowed taxpayers to lease property from tax-exempt entities. Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, 95 Stat. 172. These safe harbor rules were repealed in 1982 because of adverse public reaction and reduced tax revenues. Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97248, 96 Stat. 324. In 1984 Congress enacted what has become known as the "Pickle rule", which subjected property leased to a tax-exempt entity to unfavorable depreciation rules. Deficit Reduction Act of 1984, Pub. L. No. 98- 369, 98 Stat. 494. John Hancock began investing in LILO transactions in 1997. LILO transactions were designed to work around the Pickle rule because the taxable party leased the property involved, rather than purchasing it, and then immediately subleased the property back to the tax-exempt entity. LILO transactions became popular means of raising funds for tax-exempt entities. In fact, the Federal Transit Administration (FTA) promoted and approved LILO and SILO transactions - 25 between 1997 and 2001 as a means of providing cash infusions for financially troubled public transit agencies. In 1999 John Hancock and other similar investors ceased to invest in LILO transactions because of a change to the regulations under section 467, requiring that prepayment of the initial lease rent be treated as a loan for tax purposes. See sec. 1.467-4, Income Tax Regs." In 2002 the IRS issued Rev. Rul. 2002-69, 2002-2 C.B. 760, which determined that a LILO transaction is more properly characterized as a future interest in property and a taxpayer may not deduct rent or interest paid or incurred in connection with such a transaction. The IRS further stated that it would disallow tax benefits claimed in connection with LILO transactions on other grounds, including the substance over form and economic substance doctrines. Id. Unable to continue investing in LILO transactions, John Hancock and other similar investors began investing in SILO transactions. SILO transactions also avoided the pitfalls of the Pickle rule because the service contract was arguably not included in the lease term as long as it complied with section 7701(e). As a "The IRS proposed regulations that largely eliminated the tax benefits associated with LILO transactions in 1996; these regulations became effective in 1999. - 26 result, SILO transactions were designed to allow the lessor to claim depreciation deductions over a shorter term, increasing the transaction's tax value. In 2004 Congress enacted the American Jobs Creation Act of 2004, Pub. L. No. 108-357, 118 Stat. 1418, eliminating the benefits associated with LILO and SILO transactions. This legislation was prospective in effect and was not designed to alter the general principles of tax law that apply to determine the legitimacy of transactions designed to generate tax deductions. See H.R. Conf. Rept. No. 108-755, at 660 (2004), 2004 U.S.C.C.A.N. 1341, 1720-1721. C. Due Diligence John Hancock learned of opportunities to invest in LILO or SILO transactions from promoters such as D'Accord Financial Services and Citigroup. A promoter acted as an adviser to the counterparties in these transactions, drafted offering memoranda, and solicited offers or bids from potential investors. After receiving an offering memorandum, John Hancock would prepare an offer that was contingent on participation of the lenders at agreeable terms, completion of internal and external due diligence, and the receipt of approved expert opinions and reports. If John Hancock was chosen to participate in the transaction, it engaged experts and attorneys to help negotiate a term sheet. John Hancock set limitations for its total investments in LILO and SILO transactions between 1997 - 27 and 2001 that were based on its "tax capacity", which was determined on the basis of its ability to offset its taxable income with losses. As part of John Hancock's internal assessment of a LILO or SILO transaction, the bond and corporate finance group drafted a yellow report. Each transaction had to receive the approval of John Hancock's bond investment committee and committee of finance. John Hancock generally chose to participate in LILO and SILO transactions where its specialty groups had a familiarity with the assets involved. Team members of the bond and corporate finance group performed site visits and inspected many of the subject assets of the leveraged leases. John Hancock also engaged a team of independent specialists and consultants as part of its due diligence process. These specialists and consultants were relied upon to provide appraisals, accounting advice, insurance advice, legal opinions, engineering opinions, and market analysis with respect to the relevant industries. John Hancock also relied upon a financial modeling tool within the leasing industry known as the ABC reports. Among other things, the ABC reports projected John Hancock's pretax and after-tax financial consequences for each transaction. The ABC reports provided alternative simulations based on the assumption that the counterparty to each LILO or SILO transaction exercised its - 28 purchase option and on the assumption that the counterparty did not exercise its purchase option. As part of John Hancock's internal risk assessment, John Hancock gave each LILO and SILO transaction a credit rating based on the credit ratings of the counterparties, the relevant defeasance, and the external specialty reports and opinions. John Hancock's internal credit rating for each LILO transaction was AA1, one grade below John Hancock's highest credit rating of AAA. John Hancock's internal credit rating for each SILO transactions was AA3, a grade slightly lower than AA1. John Hancock categorized its investments in LILO and SILO transactions as bonds. The securities valuation office of the National Association of Insurance Commissioners (NAIC) evaluates and rates investments held by insurance companies. Its highest rating is NAIC 1, which is given to transactions that require the least amount of regulatory capital. Each of John Hancock's LILO and SILO transactions was rated NAIC 1. D. The Hoosier Transaction In 2008 the financial sector experienced a credit crisis. This crisis resulted in widespread credit downgrades of financial institutions throughout the world, including downgrades to the credit ratings of some of the payment undertakers and - 29 insurance entities involved in John Hancock's LILO and SILO transactions. In one such case, John Hancock was forced to litigate with an Indiana cooperative, Hoosier Energy, over a SILO transaction involving a coal-fired power plant. Hoosier Energy Rural Elec. Coop., Inc. v. John Hancock Life Ins. Co., 588 F. Supp. 2d 919 (S.D. Ind. 2008), aff'd, 582 F.3d 721 (7th Cir. 2009). In 2002 John Hancock entered into a SILO transaction with Hoosier in which John Hancock leased a coal-fired power plant for 63 years and subleased it back to Hoosier for 30 years. John Hancock's equity investment in the transaction was $56,772,812. John Hancock also spent $12,830,640 in transaction expenses. As part of John Hancock's security package, Hoosier obtained a credit default swap from Ambac Assurance Corp. (Ambac). In 2008 Ambac's credit rating was downgraded, and John Hancock exercised its right upon a credit downgrade under the transaction documents to require Hoosier to replace Ambac. When Hoosier was unable to replace Ambac within the specified period, John Hancock tried to enforce its default rights. Hoosier sought injunctive relief to prevent John Hancock from enforcing its default rights while it continued to look for a replacement for Ambac. The District Court for the Southern District of Indiana granted Hoosier's request for injunctive relief, and the Court of Appeals for the Seventh Circuit affirmed, giving Hoosier - 30 approximately 3½ months to find a replacement. During this period, John Hancock and Hoosier settled their dispute. In this settlement, Hoosier agreed to pay John Hancock $68 million. The LILO Test Transactions In connection with each of the test transactions John Hancock entered into numerous agreements covering thousands of pages and conferring various rights and obligations upon the parties involved." The general rights and obligations created as part of each test transaction are similar. However, the details of those rights and obligations vary from transaction to transaction. In each case, a "participation agreement" governs the interaction of the agreements to the transaction and provides, among other things, a general framework for the transaction's structure. Each transaction includes numerous agreements, including an initial lease and sublease, known as the "head lease" and the "lease" in some cases. For simplicity and consistency, we refer to the head lease in each John Hancock did not directly participate in any of the test transactions. Rather, John Hancock established a grantor trust through which it participated. These grantor trust are generally disregarded for Federal income tax purposes and thus do not affect our analysis. Therefore, they are disregarded for purposes of this Opinion. - 31 transaction as the initial lease and the lease as the sublease." Our reference to the transaction in this way is for convenience and is not dispositive of the status of a transaction or the determination of the benefits and burdens of ownership. The basic structures and relevant details of each of the LILO test transactions are described below. I. OBB LILO A. Lease and Sublease 1. The Asset The OBB transaction closed on June 18, 1998. The asset subject to the OBB transaction is the Vienna Kledering Marshalling Yard (VK marshalling yard), which opened in 1996. Its primary function is "shunting", or the splitting up of freight cars from incoming trains, sorting them, and attaching them to outbound trains headed to their final destinations in Europe. The VK marshalling yard has the capacity to process over 6,100 freight cars daily and is one of the largest marshalling yards in eastern Europe. "Each test transaction includes a tax indemnity agreement. The tax indemnity agreements provide that the lessee counterparty will indemnify John Hancock should John Hancock lose its rights to claim the expected tax benefits from the test transactions because of certain enumerated reasons. Unlike the taxpayer in Historic Boardwalk Hall, LLC v. Commissioner, 694 F.3d 425 (3d Cir. 2012), rev'g 136 T.C. 1 (2011), John Hancock is not protected if its tax benefits are reduced as a result of an IRS challenge. - 32 Deloitte & Touche (Deloitte) appraised the VK marshalling yard for the OBB transaction at a fair market value, as of the closing date, of $352,711,000. This value served as the basis for determining John Hancock's investment in the initial lease. John Hancock and OBB did not further negotiate this investment amount. The appraisal further determined that as of the closing date, the VK marshalling yard had a remaining economic useful life of approximately 48 years. The appraisal used both the cost method of valuation and the discounted cashflow method in reaching its fair market value determination but based its conclusion on the cost method because of a lack of reliable data with respect to expected revenues and expenses from the VK marshalling yard. Deloitte also estimated the residual value of John Hancock's remaining leasehold interest in the VK marshalling yard at the end of the sublease term to be $105,107,878. The appraisal relied upon the discounted cashflow method to reach this residual value determination, stating that the cost approach was inapplicable and that the residual value of John Hancock's remaining leasehold interest would depend upon the cashflows the VK marshalling yard would generate during the remainder of the initial lease term. -332. Terms On the closing date, OBB leased the VK marshalling yard to John Hancock for a term of approximately 38 years. Simultaneously, John Hancock subleased the VK marshalling yard back to OBB for a term of approximately 18 years. At the end of the sublease term OBB was given the option of purchasing John Hancock's leasehold interest in the VK marshaling yard. 3. Rent and Financing a. Initial Lease The initial lease required John Hancock to make an up-front payment to OBB of $309,375,024 and a deferred rent payment of $2,295,340,042 on November 12, 2041, five years after the end of the initial lease term. To fund the up-front payment, John Hancock contributed $65,980,517 and borrowed $243,394,507 from Creditanstalt AG (Credit AG) on a nonrecourse basis. John Hancock also paid $8,817,775 of transaction expenses. b. Sublease and Defeasance Pursuant to the sublease, OBB agreed to pay rent to John Hancock. In order to fund the sublease rent payments OBB entered into a number of defeasance agreements. Pursuant to a DPUA, on the closing date OBB deposited the $243,394,507 John Hancock borrowed from Credit AG and paid to OBB as an up- - 34 front rent payment with CA-Leasing GmbH (CA Leasing), an affiliate of Credit AG. In return, CA Leasing agreed to make a series of payments on behalf of OBB which exactly match John Hancock's debt service payments to Credit AG in amounts and timing. As a result, pursuant to the transaction documents, CA Leasing pays Credit AG directly to satisfy John Hancock's debt service and OBB's sublease rent. Credit AG guaranteed CA Leasing's payments under the DPUA. The DPUA and guaranty do not eliminate OBB's legal obligation to pay rent under the sublease. In certain circumstances, OBB is entitled to replace the DPUA with substitute collateral, including a qualified letter of credit. On June 19, 1998, one day after the closing date, OBB entered into a swap agreement with Merrill Lynch Capital Services, Inc. (Merrill Lynch). Pursuant to this agreement, OBB paid Merrill Lynch $45,380,000 from John Hancock's $65.,980,517 of equity contribution in exchange for Merrill Lynch's agreement to make payments to OBB in accordance with a specified schedule, including payments to fund OBB's purchase option if exercised. Further, an affiliate of Merrill Lynch guaranteed Merrill Lynch's obligations pursuant to the swap agreement. OBB pledged a first-priority security interest in the swap agreement to John Hancock as collateral for its obligations under the sublease. OBB retained - 35 the excess of the up-front rent payment from John Hancock to OBB pursuant to the initial lease over the amounts OBB deposited with CA Leasing and Merrill Lynch under the DPUA and swap agreement, respectively. This amount is OBB's cash takeaway from the transaction, or what the parties refer to as OBB's "net present value benefit". On the closing date, OBB also provided John Hancock with a letter of credit issued from Bank Austria Aktiengesellschaft (Bank Austria). Under the letter of credit, Bank Austria is required to pay John Hancock a specified amount in the event OBB defaults on its obligations pursuant to the sublease. This potential payment eliminated any of John Hancock's risk of exposure that was not covered under the DPUA and the swap agreement. The DPUA, swap agreement, guaranties, pledge, and letter of credit were all required in the OBB transaction under the participation agreement. As a result of the structure in place, the OBB LILO transaction is fully defeased. 4. Property Rights and Obligations The initial lease grants John Hancock the right to "possession, use and quiet enjoyment" of the VK marshalling yard. The initial lease is a net lease, meaning that it requires John Hancock to insure, maintain, and repair the VK marshalling yard. John Hancock may satisfy these requirements through its participation in the - 36 sublease. John Hancock's participation in the sublease is required under the participation agreement. OBB's rights and obligations under the sublease with respect to possession and use of the VK marshalling yard are nearly identical to John Hancock's rights and obligations under the initial lease, including the right to "quiet enjoyment" of the VK marshalling yard. The sublease grants OBB the right to modify the VK marshalling yard, subject to certain restrictions. OBB is further restricted, with certain exceptions, from subleasing the VK marshalling yard or creating or permitting a lien on the VK marshalling yard. John Hancock has the right to visit and inspect the VK marshalling yard. 5. Default If John Hancock defaults on its obligations under the initial lease, OBB may require John Hancock to return the VK marshalling yard, terminate the lease, and demand liquidated damages. In the "Event of Loss", the lease terminates and John Hancock is required to pay a stipulated value to OBB. An "Event of Loss" is defined to include, among other things, actual loss of the VK marshalling yard due to damage or governmental seizure. John Hancock's rights against OBB in the case of a lessee default under the sublease are similar. John Hancock is entitled to collect on the "Termination - 37 Value" of the sublease, take possession of the VK marshalling yard, sell the VK marshalling yard, and terminate the sublease. The sublease termination value is predetermined and is designed to provide John Hancock with a return on its equity investment. In the case of an "Event of Loss" under the sublease, which is the equivalent to the event of loss under the initial lease, the initial lease ends and OBB must pay John Hancock the termination value. Additionally, all rents are due from OBB to John Hancock, and OBB must pay John Hancock an additional amount to offset the stipulated value John Hancock is required to pay OBB under the initial lease. B. End of Sublease Term 1. OBB's Purchase Option At the end of the sublease term OBB has the option to purchase John Hancock's leasehold interest in the VK marshalling yard for $153,817,825, payable in predetermined installments. The payments due to OBB from CA Leasing and Merrill Lynch match exactly the purchase option price and timing. If OBB exercises its purchase option, all agreements executed pursuant to the OBB LILO transaction will terminate and John Hancock will no longer be required to pay OBB the deferred rent payment under the initial lease. - 38 2. John Hancock's Options If OBB does not exercise its purchase option, John Hancock may choose among three alternatives. John Hancock may elect to: (1) renew the sublease; (2) replace OBB and lease the VK marshalling yard to another lessee; or (3) take possession of the VK marshalling yard. In all three scenarios John Hancock must provide OBB with acceptable collateral to secure John Hancock's obligations to pay the deferred rent payment under the initial lease. a. Renewal Option The renewal option extends John Hancock's sublease with OBB for approximately 13 years and includes a set of prenegotiated rent payments during the renewal term totaling $642,175,362. These rent payments have two components. First, the current portion of renewal rent is equal to $213,241,461 and is payable throughout the renewal term. The remainder, or $428,933,901, is deferred and payable at the end of the renewal term. Combined, these rent payments ensure John Hancock's return on its equity investment. At the end of the renewal term John Hancock would take possession of the VK marshalling yard for the remainder of the initial lease term. If John Hancock elects to renew the sublease, OBB must arrange for either an extension of the nonrecourse loan from Credit AG to John Hancock or for - 39 another lender to replace Credit AG as the lender under substantially the same terms as the original loan. If OBB is unable to do so, it must purchase up to 49% of the principal outstanding on the loan from Credit AG and attempt to again extend the remaining loan or find a replacement lender. If OBB is still unable to extend the loan or find a replacement lender, it again has the option of choosing to exercise the purchase option. If OBB elects the renewal option, it must also arrange for collateral substantially identical to the swap agreement and letter of credit to secure the equity portion of rent during the renewal term. OBB may also be required to provide collateral to secure the debt portion of rent during the renewal term if the replacement lender deems it necessary for the loan extension. b. Replacement Option Under the replacement option, OBB must cooperate with John Hancock in the negotiation, execution, and delivery of a replacement lease. However, John Hancock bears the costs incurred in connection with the replacement lease. The replacement lease does not have to mirror the renewal lease. John Hancock, and not OBB, must arrange for a loan extension for its nonrecourse loan from Credit AG or find a replacement lender. If John Hancock is unable to do so, it must purchase the remaining principal of the loan from Credit AG. Further, if John - 40 Hancock is unable to find a replacement lessee within 30 days of the end of the sublease term, it will be deemed to have selected the renewal option. c. Retention Option Under the retention option, John Hancock must arrange for payments in satisfaction of the principal of its nonrecourse loan from Credit AG. If John Hancock is unable to do so within 30 days of the end of the sublease term, it will be deemed to have selected the renewal option. II. SNCB 2 and SNCB 5 Lot 1 LILO Transactions A. Lease and Sublease 1. The Assets The SNCB 2 and SNCB 5 lot 1 transactions closed on September 29 and December 15, 1997, respectively. The Kingdom of Belgium owns 99.9% of SNCB, which was reorganized as a limited liability company under Belgian public law in 1991." SNCB operates and maintains domestic and international passenger trains and freight rolling stock in Belgium. The asset subject to the SNCB 2 transaction is the Thalys highspeed trainset (Thalys trainset), which consists of "In 2005 SNCB again reorganized with SNCB being renamed SNCB Holding. Under the reorganization SNCB formed two subsidiaries, SNCB and Infrabel, both public limited liability companies. For purposes of this analysis, we refer to SNCB Holding and its subsidiaries as SNCB. - 41 two power units and eight passenger cars, holds approximately 400 people, and is used for highspeed international travel. The assets subject to the SNCB 5 lot 1 transaction are eight electric motive units (EMUs). The EMUs are three-car trainsets consisting of a driving car and two trailer cars and are used predominantly for intercity service. Deloitte appraised the Thalys trainset at a fair market value of $34,267,200 on the closing date of the SNCB 2 transaction. Deloitte separately appraised the EMUs at a fair market value of $61,371,200 on the closing date of the SNCB 5 lot 1 transaction. As in the OBB transaction, these values served as the basis for determining John Hancock's investments in the transactions, and the parties did not further negotiate the investment amounts. Deloitte concluded that as of the closing dates of the SNCB 2 and SNCB 5 lot 1 transactions, the Thalys trainset and the EMUs had remaining economic useful lives of 42 and 45 years, respectively. The appraisals used both the cost method and the discounted cashflow method in their fair market value determinations but chose to rely on the cost method because of a lack of reliable data with respect to expected revenues and expenses in connection with the assets. Deloitte also appraised John Hancock's remaining leasehold interests in the Thalys trainset and EMUs at the - 42 end of the subleases, estimating the residual values to be $7,774,387 and $14,483,603,respectively. 2. Terms As part of the SNCB 2 transaction John Hancock leased the Thalys trainset from SNCB for a term of approximately 34 years. Simultaneously, John Hancock subleased the Thalys trainset back to SNCB for a term of approximately 15 years. In the SNCB 5 lot 1 transaction John Hancock leased the EMUs from SNCB for a term of approximately 34 years. Simultaneously, John Hancock subleased the EMUs back to SNCB for a term of approximately 16 years. SNCB has the option of purchasing John Hancock's leasehold interests in the Thalys trainset and EMUs at the end of each transaction's sublease term. 3. Rent and Financing a. Initial Lease Similar to the OBB transaction, the initial lease in each of the SNCB LILO transactions required John Hancock to make an up-front rent payment on the closing date and a deferred rent payment five years after the end of each initial lease term. John Hancock contributed $6,314,390 and $12,164,454 to the SNCB 2 and SNCB 5 lot 1 transactions, respectively, and borrowed $23,957,351 and $42,725,648 to fund the remainder of the up-front payments on a nonrecourse - 43 basis from Eurofima European Co. for the Financing of Railroad Rolling Stock (Eurofima). John Hancock also paid transaction expenses of $733,318 and $797,826 as part of the SNCB 2 and SNCB 5 lot 1 transactions, respectively. b. Sublease and Defeasance Pursuant to the subleases, SNCB agreed to pay rent to John Hancock. Similar to the OBB LILO, in order to fund its sublease rent payments SNCB entered into a number of defeasance agreements. The debt defeasance in each transaction is accomplished through a prepaid currency swap whereby SNCB and Eurofima agreed to swap specified amounts of U.S. dollars for Belgian francs on specified dates. Similar to the DPUA in the OBB transaction, the payments due from Eurofima to SNCB exactly match John Hancock's debt service payments to Eurofima in amount and timing. The equity defeasance in each SNCB LILO transaction is governed by a pledged collateral account agreement (PCAA) with Merrill Lynch. Pursuant to the PCAAs, SNCB deposited a specified amount with Merrill Lynch to secure the equity portion of sublease rent, sublease termination value, and the amount required for SNCB's purchase options. John Hancock was granted a first-priority security interest in each of the PCAAs. SNCB's net present value benefit in the SNCB LILO transactions is the difference between John Hancock's up-front - 44 payments under the initial leases and the respective amounts deposited and paid pursuant to the currency swaps and PCAAs. As a result of the structure in place, the SNCB LILO transactions are fully defeased. 4. Property and Default Rights and Obligations John Hancock's and SNCB's property and default rights and obligations pursuant to the initial leases and subleases of the SNCB LILO transactions are substantially similar to those conferred under the initial lease and sublease of the OBB transaction. The most significant difference between the OBB transaction and the SNCB LILO transactions is that in each of the SNCB LILO transactions the counterparty, SNCB, has limited right under the subleases to replace the subject assets. B. End of Sublease Term According to the appraisals, the fixed purchase option price in each of the SNCB LILO transactions is greater than the expected fair market values of the respective assets on the purchase option dates. If SNCB exercises its purchase options with respect to the SNCB LILO transactions, all agreements executed pursuant to the transactions would terminate and John Hancock would no longer be required to pay the deferred rent payments under the initial leases. - 45 If SNCB does not exercise its purchase options, John Hancock may renew the subleases, replace SNCB with a different lessee, or take possession of the assets. The rights and obligations conferred upon John Hancock under each option are substantially similar to those described with respect to the OBB transaction. The SILO Test Transactions Several characteristics distinguish John Hancock's SILO transactions from its LILO transactions. First, because the length of the initial lease exceeds the estimated economic useful life of the asset, John Hancock treated each SILO transaction as a sale for U.S. Federal tax purposes. Next, a service contract option replaces the renewal and replacement leases if the lessee forgoes its purchase option. And finally, pursuant to section 467 the sublease rent payments are treated as a loan from the lessee counterparty to the U.S. taxpayer (section 467 loan). Section 467 imputes a loan and adds an interest component to a lease in certain cases where the allocation of rent payments does not match the dates when actual payments are due. In the case of John Hancock's SILO transactions, the lessee counterparties prepay their sublease rent payments, creating a section 467 loan from the lessee counterparty to John Hancock. -46- I. TIWAG A. Lease and Sublease 1. The Assets The TIWAG transaction closed on December 21, 2001. TIWAG is a regional energy utility in the Province of Tyrol, Austria. The asset subject to the TIWAG transaction is a 21.6% undivided interest in the Sellrain-Silz hydropower facility (Sellrain-Silz). Sellrain-Silz is a pumped storage, hydroelectric generating facility. The water powering the facility comes from an area covering 139 square kilometers in the northern Stubai Alps. Sellrain-Silz is an important component in TIWAG's power supply. According to the most recent public data, in 2008 Sellrain-Silz produced 21% of TIWAG's total power generation and 4% of TIWAG's total power sold. Deloitte appraised the 21.6% undivided interest in Sallrain-Silz as of the closing date of the TIWAG transaction at a fair market value of $323,136,000, with a remaining economic useful life of 75 years. This appraised fair market value served as the basis for determining John Hancock's investment in the transaction, and the parties did not further negotiate the investment amount. Further, Deloitte estimated that as of the end of the sublease and service contract terms the fair market value of the 21.6% undivided interest in Sellrain-Silz would - 47 be $648,210,816 and $778,757,760, respectively. Deloitte used the discounted cashflow method in its fair market value determinations. 2. Terms On the closing date John Hancock leased the 21.6% undivided interest in Sellrain-Silz from TIWAG for a term of approximately 94 years. Simultaneously, John Hancock subleased the 21.6% undivided interest in Sellrain-Silz to TIWAG for a term of approximately 35 years. Because the term of the initial lease exceeded its estimated remaining economic useful life, the parties treated it as a sale for U.S. tax purposes. TIWAG has the option of purchasing John Hancock's leasehold interest in Sellrain-Silz at the end of the sublease term. 3. Rent and Financing a. Initial Lease On the closing date John Hancock paid TIWAG $323 million pursuant to the initial lease. To fund this payment, John Hancock contributed $49,427,050 in equity and borrowed a total of $273,572,950 from two lenders on a nonrecourse basis: $246,215,655 from Mercantile Leasing Co. (Mercantile) (series A loan) and $27,357,295 from Bank Fur Tiroler Und Vorarlberg (BTV) (series B loan). John Hancock paid $4,037,500 of transaction expenses. - 48 b. Sublease and Defeasance Pursuant to the sublease, TIWAG agreed to pay rent to John Hancock. The sublease required many of these payments to be made before the period to which they were allocated. The prepayment of rent is treated as a loan from TIWAG to John Hancock under section 467. At the end of the sublease term the section 467 loan balance is expected to be $636,037,102. In order to fund the sublease rent payments, TIWAG entered into a number of defeasance agreements. Unlike John Hancock's LILO transactions, the SILO transactions do not require full defeasance. Rather, the transaction documents only require the proceeds of the series A loan to be set aside pursuant to a DPUA. In the TIWAG transaction, pursuant to the series A DPUA, TIWAG paid $246,215,655 to Barclays Bank PLC (Barclays) on the closing date. In return, Barclays agreed to make a series of payments on behalf of TIWAG which exactly match John Hancock's debt service payments to Mercantile under the series A loan. As a result, the transaction documents allow for payments directly from Barclays to the series A lender, Mercantile, to satisfy John Hancock's series A debt service and a portion of TIWAG's sublease rent. The series A DPUA is a three-party agreement that includes John Hancock, providing John Hancock with a priority interest in the deposit in the event TIWAG defaults on its sublease rent obligations. - 49 Barclays is an affiliate of the series A lender, Mercantile. However, Mercantile did not guarantee Barclay's payments under the series A DPUA. TIWAG remains legally responsible for all rent and other obligations under the sublease. In certain circumstances TIWAG may replace the series A DPUA with substitute collateral, including a qualified letter of credit. In addition to the series A DPUA, TIWAG entered into a series B DPUA and an EPUA on the closing date. TIWAG's series B DPUA and EPUA were arranged and agreed upon outside of the SILO transaction. The documents governing the TIWAG transaction do not require these agreements. John Hancock is not a party to either agreement, and neither is pledged to John Hancock. Pursuant to the series B DPUA, TIWAG deposited $29,585,454 with Dexia Credit Local (Dexia). In return Dexia agreed to make a series of payments on behalf of TIWAG which exactly match John Hancock's debt service payments to BTV under the series B loan. The payments from the series A DPUA and the series B DPUA exactly satisfy TIWAG's debt portion of sublease rent." Dexia is not an affiliate of BTV, the series B lender. "Throughout the sublease term, TIWAG's sublease rent payments exceed John Hancock's debt service payments by approximately $10 million. This $10 million is known as the "equity portion" of sublease rent. - 50 Pursuant to the EPUA, TIWAG deposited $23.1 million with UBS AG (UBS). In return UBS agreed to make a series of payments on behalf of TIWAG pursuant to a specified schedule covering the equity portion of sublease rent and funding a portion of TIWAG's purchase option if exercised. TIWAG's net present value benefit in the transaction is approximately $24.1 million, equaling the difference between John Hancock's investment in the initial leases, $323 million, and the amounts paid to Barclays, Dexia, and UBS pursuant to the series A DPUA, series B DPUA, and EPUA. Although the series B DPUA and the EPUA were not required pursuant to the TIWAG transaction documents, John Hancock knew of TIWAG's intention to enter into such agreements because the defeasance agreements allowed TIWAG to receive beneficial accounting treatment under European accounting principles (European GAAP). Even if TIWAG decided not to enter into a series B DPUA and EPUA on the closing date, the transaction documents required such agreements or other similar qualifying collateral upon the occurrence of certain trigger events such as a credit downgrade or majority ownership change in TIWAG. As a precaution John Hancock preapproved a "form" of the series B DPUA and the EPUA as well as Dexia and UBS as qualified payment undertakers. - 51 The "form" series B DPUA and EPUA are identical to TIWAG's actual agreements absent the information specific to the timing and participating parties. 4. Property Rights and Obligations The initial lease grants John Hancock the right to use, operate, maintain or possess the 21.6% undivided interest in Sellrain-Silz. During the initial lease term TIWAG cannot sell, dispose of, or create a security interest in the property without John Hancock's consent. The initial lease also restricts TIWAG's rights to consolidate or merge with another company or spin off, convey, transfer, or lease substantially all of its assets to another party. TIWAG's rights and obligations under the sublease with respect to possession and use of the 21.6% undivided interest in Sellrain-Silz are nearly identical to John Hancock's rights and obligations under the initial lease. The sublease is a net lease, meaning that TIWAG is responsible for maintenance, insurance, and operational costs. During the sublease term TIWAG generally cannot create or permit any lien on the 21.6% undivided interest in Sellrain-Silz. John Hancock has the right to visit and inspect Sellrain-Silz twice a year. On the closing date John Hancock and TIWAG also entered into an "Agreement of Servitude" pursuant to which TIWAG granted John Hancock a right-of-way to specified land parcels at Sellrain-Silz (ROW agreement). The - 52 ROW agreement provides John Hancock access to the road that leads from the public.road to the upper dam of Sellrain-Silz. This right-of-way was registered with the land registry at the district court in Silz, Austria. Upon the occurrence of a "Trigger Event", John Hancock has the right to purchase certain parcels of land related to Sellrain-Silz. A trigger event includes, among other things, TIWAG's selling or imposing a mortgage or pledge on specified land connected with Sellrain-Silz. 5. Default Neither John Hancock nor TIWAG has the right to declare the initial lease in default and pursue remedies. However, under the sublease, John Hancock has certain remedies against TIWAG in the case of a "Lessee Event of Default". In such a case, John Hancock is entitled to collect on the "Termination Value" of the sublease. John Hancock may also take possession of, sell, or sublease the 21.6% undivided interest in Sellrain-Silz. . Just as in John Hancock's LILO transactions, termination value is predetermined on the closing date and ensures John Hancock's return on its equity investment. TIWAG must also pay John Hancock the termination value in the case of a "Lease Event of Loss", which includes actual loss or seizure of Sellrain-Silz. - 53 B. End of Sublease Term 1. TIWAG's Purchase Option At the end of the sublease term TIWAG has the option of purchasing John Hancock's leasehold interest in Sellrain-Silz for $795,135,940. If TIWAG exercises the purchase option, John Hancock must pay TIWAG the amount due under the section 467 loan, and all agreements executed pursuant to the TIWAG transaction would terminate. The section 467 loan balance exactly matches the first installment of the purchase option. Therefore, if TIWAG exercises its purchase option, these amounts offset each other. The remaining installments of the purchase option price are f'manced through TIWAG's EPUA, meaning that if TIWAG exercises the purchase option, it does not have to contribute or borrow any additional cash. 2. John Hancock's Options If TIWAG does not exercise its purchase option, John Hancock has two choices. First, it may elect to require TIWAG to arrange for a service contract between John Hancock and one or more power purchasers. Second, it may elect to take possession of the 21.6% undivided interest in Sellrain-Silz. In either case, TIWAG must ensure at its own expense that Sellrain-Silz is in satisfactory condition in accordance with all regulatory and other requirements. - 54 Similar to the LILO test transactions, neither party has advanced a compelling reason John Hancock would select the retention option in any of the SILO test transactions. Therefore, as the parties have, we focus our discussion for each SILO test transaction on the service contract option. Under the service contract option, TIWAG must procure one or more "Qualified Bidders" to enter into one or more power purchase agreements with John Hancock and arrange for an operator of the 21.6% undivided interest in Sellrain-Silz during the service contract term. TIWAG must also find a bank to refinance the section 467 loan. A qualified bidder cannot be the operator or be related to the operator of Sellrain-Silz. TIWAG may be the power purchaser or the operator but not both. The power purchase agreements must match the service contract term which is prearranged on the closing date to be approximately 25 years. Any power purchaser must agree to make a series of predetennined payments throughout this term, known as the "Capacity Charges". These payments total $1,316,013,696. A power purchaser is also required to pay for John Hancock's fixed and variable cost of operating the 21.6% undivided interest in Sellrain-Silz. The capacity charges are set at amounts that reflect the future fair market value of the asset and cover John Hancock's cost of servicing the - 55 refinanced section 467 loan while paying John Hancock a specified return. If John Hancock fails to make the required capacity available to the service purchaser for any reason, including force majeure, the capacity charges will be reduced in a manner consistent with the service contract. The power purchase agreements do not require credit support to secure the power purchaser's payments during the service contract term. However, if at any point during the service contract term a power purchaser's credit rating were to fall below A or A2 under S&P's and Moody's credit rating systems, respectively, that power purchaser would be required to procure credit support in the form of a letter of credit or guaranty from a bank or guarantor with the requisite credit rating. John Hancock may also request that TIWAG acquire residual value insurance to protect a portion of the value of the 21.6% undivided interest in Sellrain-Silz at the end of the service contract term. The amount of the residual value insurance is the lesser of: (1) $205,422,256 or (2) 35% of the appraised fair market value of the 21.6% undivided interest in Sellrain-Silz at the end of the service contract term as determined at or near the purchase option date. From the end of the service contract term to the end of the initial lease John Hancock would take possession of the 21.6% undivided interest in Sellrain-Silz to use as it pleases. - 56 If TIWAG fails to find qualified bidders to enter into the power purchase agreements or fails to procure a bank to refinance the section 467 loan, it may cure this failure through the exercise of its purchase option. If TIWAG is able to satisfy all the required conditions and a power purchase agreement is in place, it will receive the proceeds of the section 467 loan from John Hancock as well as the balance of the EPUA. II. Two Dortmund Transactions A. Lease and Sublease 1. The Asset The Dortmund transactions closed on December 20, 2001. The assets subject to the Dortmund transactions are halls 1, 2, 3A, and 4-8 of the Westfalenhallen Dortmund Trade Fair, Event, and Congress Center Complex (trade fair facility). Dortmund is in the State of North Rhine-Westphalia, Germany. Westfalenhallen Dortmund GmbH (Westfalenhallen), a German limited liability company, operates the trade fair facility through its subsidiaries, and Dortmund is the sole owner of Westfalenhallen. The trade fair facility presents more than 30 national and international trade fairs each year. In 2000, the year before John Hancock entered into the Dortmund transactions, more than 7,000 exhibitors and more than 1 million visitors came to Dortmund for events hosted in - 57 the trade fair facility. In 2004 Dortmund constructed hall 3B as an addition to the trade fair facility, which is not and was never made part of the Dortmund transactions. John Hancock and Dortmund executed servitude consent agreements so that the new hall would not adversely affect John Hancock's interest in the trade fair facility. Deloitte appraised the trade fair facility. As of the closing date of the Dortmund transactions, the appraisalsl6 concluded that the halls subject to the transactions had the following fair market values and remaining economic useful lives: Hall Fair market value Remaining useful life in years 1 2 3A 4 5 6 7 8 $31,661,000 10,295,000 4,588,000 23,249,000 13,910,000 22,330,000 17,835,000 15,160,000 60 55 55 60 55 62 62 68 The appraisals were used to determine John Hancock's investment in the transactions, and the parties did not further negotiate the investment amounts. 16Deloitte issued one appraisal for halls 1, 2, and 3A of the trade fair facility and a second appraisal for halls 4-8. - 58 According to the appraisals, as of the purchase option date the expected fair market value of the trade fair facility was determined to be $242,882,556. The methodology used in the appraisals attributed 80% of the fair market value determinations to the discounted cashflow method and 20% to the cost method. 2. Terms On the closing date John Hancock leased the trade fair facility from Dortmund for a term of 99 years. Simultaneously, John Hancock subleased the trade fair facility to Dortmund for a term of approximately 30 years. This arrangement required multiple agreements to incorporate the entire trade fair facility. In each transaction, an initial lease and sublease govern the parties' rights and obligations with respect to the halls. With respect to the facility sites associated with each hall, the parties entered into a "Facility Site Lease Agreement" for each transaction. Unless otherwise stated, there are no material rights and obligations conferred, pursuant to each facility site lease, that distinguish the Dortmund transactions from John Hancock's other SILO test transactions for purposes of this Opinion. Dortmund has the option of purchasing John Hancock's leasehold interests in the trade fair facility at the end of the sublease term. - 59 3. Rent and Financing a. Initial Lease On the closing date of the Dortmund transactions John Hancock made payments to Dortmund of $46,544,000 and $92,484,000 pursuant to the initial lease agreements and facility lease agreements of the Dortmund 1 and Dortmund 2 transactions, respectively. To fund these payments, John Hancock contributed $7,379,928 for the Dortmund 1 transaction and $14,652,452 for the Dortmund 2 transaction. John Hancock also borrowed approximately 90% of the debt from Mercantile, equal to $35,247,665 and $70,048,393 for the respective transactions (series A loans). The remaining 10% was borrowed from Westdeutsche Landesbank Girozentrale (series B loans). John Hancock also paid transaction expenses of $1,373,048 and $2,728,730 as part of the Dortmund 1 and Dortmund 2 transactions, respectively. b. Sublease and Defeasance Pursuant to the sublease agreements, Dortmund agreed to pay rent to John Hancock. As in the TIWAG transaction, the sublease agreements require that many of these payments be made before the period to which they are allocated, resulting in section 467 loans to John Hancock in each transaction. On the purchase option date, the total balance of the section 467 loans is expected to be - 60 approximately $221,835,000. In order to fund the sublease rent payments Dortmund entered into a number of defeasance agreements. On the closing date Dortmund entered into a series A DPUA with Barclays for each of the Dortmund transactions. The series A DPUAs are substantialvly similar to the series A DPUA in the TIWAG transaction. With respect to the series B loan and equity, just as in the TIWAG transaction, the Dortmund transactions do not require Dortmund to enter into a series B DPUA or an EPUA. John Hancock is not a party to a series B DPUA or EPUA, and John Hancock is not the beneficiary of a pledge of a series B DPUA or EPUA. Nonetheless, Dortmund defeased the series B loans and equity in agreements executed outside of the Dortmund transactions. Dortmund's net present value benefit in each transaction is equal to its up-front payments under the initial leases less the amount that was deposited pursuant to the series A DPUAs, series B DPUAs, and EPUAs. Dortmund entered into a series B DPUA with Hypo-und Vereinsbank AG for each of the Dortmund transactions. Dortmund also entered into numerous EPUAs with Bank Austria. As in the TIWAG transaction, the series B DPUAs and EPUAs entitle Dortmund to beneficial accounting treatment under European GAAP. John Hancock knew that Dortmund intended on entering into such - 61 agreements because John Hancock preapproved a "form" of the EPUAs as well as Bank Austria as the EPUA undertaker. The EPUAs were required under the participation agreement upon the occurrence of certain trigger events. There are no trigger events that would require Dortmund to enter into the series B DPUAs. Nonetheless, John Hancock approved a "form" for the series B DPUAs. 4. Property and Default Rights and Obligations John Hancock and Dortmund's property and default rights and obligations, pursuant to the Dortmund transactions' initial leases, facility site leases, and sublease agreements, are substantially similar to those conferred under the initial lease and sublease in the TIWAG transaction. B. End of Sublease Term Dortmund has a purchase option at the end of each transaction's sublease term which is designed in a manner consistent with the TIWAG transaction. If Dortmund does not exercise its purchase options, John Hancock must choose between requiring Dortmund to arrange for a service contract or take possession of the trade fair facility itself. Under the service contract option Dortmund must procure one or more service purchasers for the trade fair facility. The service purchasers must agree to pay service fees that consist of: (1) the annual capacity availability charges that - 62 - are designed to cover John Hancock's debt service on the refinanced section 467 loan and ensure a predetermined economic return on its investment and (2) the trade fair facility operating and maintenance expenses. Dortmund may remain the operator of the trade fair facility or must find a qualified replacement operator. Unlike the TIWAG transaction, Dortmund may be both the service purchaser and the operator. If John Hancock fails to make the trade fair capacity and management services available to the service purchasers for any reason, including force majeure, the capacity availability charges will be reduced in a manner consistent with the service contract. The service contract does not require credit support to secure a service purchaser's payments during the service contract term. However, . if at any point during the service contract term a service purchaser's credit rating were to fall below BBB+ or Baal under S&P's and Moody's credit rating systems, respectively, the service purchaser is required to procure acceptable credit support. In all other ways, the design, structure, and economics of John Hancock's service contract options and retention options in the Dortmund transactions are substantially similar to those of the TIWAG transaction. - 63 III. SNCB SILO A. Grant and Subgrant 1. The Asset The SNCB SILO closed on November 14, 2001. The asset subject to the SNCB SILO is a 50% undivided interest in the high-speed rail line that runs from the Belgian-French border to Lembeek, Belgium, and the railway station known as "Brussels South" that is dedicated to that high-speed line (together the HSL). The HSL is integrated with the main east-west rail line in Belgium. SNCB considers the HSL to be its "crown jewel" as it enables high-speed rail services between the United Kingdom, France, the Netherlands, and Germany. Deloitte appraised the HSL and concluded that as of the closing date, a 50% undivided interest in the HSL had a fair market value of $426,900,500 and a remaining economic useful life of 78 years. This value served as the basis for determining John Hancock's investment in the SNCB SILO, and the parties did not further negotiate the investment amount. Deloitte further appraised the 50% undivided interest in HSL as of the purchase option date at $890,941,344. The appraisal used the discounted cashflow method in its fair market value determinations. -642. Terms On the closing date John Hancock entered into a grant of rights agreement with SNCB with respect to the 50% undivided interest in HSL for a term of approximately 99 years (grant). Simultaneously, John Hancock and SNCB entered into a subgrant of rights agreement for a term of approximately 29 years (subgrant) whereby John Hancock granted a set of nearly identical rights in the 50% undivided interest in HSL back to SNCB.4 SNCB has the option of purchasing John Hancock's interest in the HSL at the end of the subgrant term. 3. Rent and Financing a. Grant On the closing date John Hancock paid $426,900,500 to SNCB pursuant to the grant. To fund this payment John Hancock contributed $61,177,535 in equity and borrowed a total of $365,722,965 from two lenders on a nonrecourse basis, $329,150,668 from Mercantile (series A loan) and $36,572,297 from Barclays (series B loan). John Hancock also paid $3,799,414 of transaction expenses. "For purposes of this analysis, there are no material differences between the function of the grant of rights and the subgrant used in the SNCB SILO and the leases and subleases used in John Hancock's other SILO test transactions. - 65 b. Subgrant and Defeasance Pursuant to the subgrant SNCB agreed to make subgrant rent payments to John Hancock in the amounts and on the dates specified in the sublease agreement. The sublease requires that many of these payments be made before the period to which they are allocated. As in John Hancock's other SILO test transactions, this prepayment creates a section 467 loan. At the end of the sublease term the section 467 loan balance is expected to be $780,056,766. In order to fund the subgrant rent payments SNCB entered into a number of defeasance agreements. On the closing date, SNCB entered into a series A DPUA with Barclays. The series A DPUA is substantially similar to those in John Hancock's other SILO test transactions. Also as in John Hancock's other SILO test transactions, the SNCB SILO transaction does not require SNCB to enter into a series B DPUA or an EPUA. John Hancock is not a party to a series B DPUA or an EPUA, and John Hancock is not the beneficiary of a pledge of a series B DPUA or EPUA. On November 19, 2001, SNCB entered into a currency swap transaction (CST) with Bank of America, NA (BofA). Pursuant to the currency swap transaction, SNCB agreed to pay BofA U.S.-dollar-denominated payments on certain specified dates in exchange for euro-denominated payments. The payments made to SNCB under the currency swap transaction match the debt - 66 service payments on the series B loan. Unlike the currency swap transactions in the SNCB LILO transactions, SNCB did not prepay this currency swap. Also on November 19, 2001, SNCB entered into a USD Credit Linked Deposit Agreement with UBS (CLDA). Similar to the EPUAs in John Hancock's other SILO test transactions, SNCB placed a deposit with UBS in exchange for a series of payments exactly matching the timing and amount of the equity subgrant payments and the purchase option price. SNCB may not freely terminate the CLDA.18 However, the CLDA permits SNCB to direct the payments due from UBS to the recipient of its choosing. As in John Hancock's other SILO test transactions, the CLDA entitled SNCB to beneficial accounting treatment under European GAAP, and John Hancock knew that SNCB intended on executing such an agreement. SNCB calculated its net present value benefit from the transaction as the difference between the $426,900,500 received from John Hancock pursuant to the grant and the amounts paid upon the execution of the series A DPUA, the CLDA, and the CST. '8Petitioners argue that SNCB may terminate the CLDA at any time to free up cash for its general business purposes. To support this argument, petitioners rely solely on the testimony of an SNCB executive. This testimony is not consistent with the terms of the CLDA. - 67 4. Property and Default Rights and Obligations For purposes of this analysis the property and default rights and obligations of John Hancock and SNCB, with respect to the grant and subgrant, are substantially similar to those conferred under the initial leases and subleases in John Hancock's other SILO test transactions. The primary difference in the SNCB . SILO transaction is that HSL is part of the Belgian public domain. Consequently, the parties included provisions in the transaction documents providing that if HSL ceases to be an asset in the public domain, the parties intend for all of the transaction documents to survive and the rights and obligations of the parties to constitute an independent contractual relationship. B. End of Subgrant Term SNCB has a purchase option at the end of the subgrant term under substantially the same terms and conditions as in John Hancock's other SILO test transactions. Further, as in those transactions, if SNCB does not exercise its purchase option, John Hancock must choose between requiring SNCB to arrange for a service contract or taking possession of the 50% undivided interest in HSL. Under the service contract option SNCB must procure a "Service Purchaser" under the service contract, which cannot be SNCB, and arrange for the section 467 loan to be refinanced. John Hancock must find an operator for the - 68 50% undivided interest in HSL; but if it cannot find a suitable operator, SNCB is required to assume the position. Under the service contract the service purchaser must agree to pay John Hancock: (1) the base service fees, which are designed to cover John Hancock's debt service on the refinanced section 467 loan and ensure a predetermined economic return on its investment and (2) the monthly additional fees that cover the fixed and variable costs of operating the 50% undivided interest in HSL. The service purchaser has the right to terminate the service contract if John Hancock fails to make the asset available for the negotiated services for any reason, except for force majeure, and fails to cure within 60 days of notification. In the case of force majeure, the service purchaser may terminate the service contract if John Hancock fails to cure within 180 days. In all other ways, the design, structure, and economics of John Hancock's service contract option and retention option are substantially similar to those of John Hancock's other SILO test transactions. Tax Returns, Notices of Deficiency, and Trial I. Procedural History John Hancock filed a consolidated Federal income tax return for each of the years at issue. - 69 A. Notice of Deficiency (Docket No. 6404-09) On December 17, 2008, respondent issued a notice of deficiency to John Hancock which determined Federal income tax deficiencies for 1994, 1997, and 1998 of $8,860,564, $65,746,621, and $173,497,367, respectively, based upon the disallowance of various deductions and adjustments to gross income from John Hancock's LILO transactions and the denial of a capital loss carry back to 1994. On March 16, 2009, John Hancock filed the petition with this Court at docket No. 6404-09, disputing the 1994, 1997, and 1998 determined deficiencies. The notice of deficiency for docket No. 6404-09 included three of the test transactions litigated in these cases, the OBB LILO and the two SNCB LILOs.1° With respect to the OBB LILO, respondent determined that the LILO transaction was in substance the purchase of a future interest by John Hancock and therefore denied John Hancock's deductions of $66,899,067 for a rental expense, $15,946,722 for an interest expense, and $298,054 for amortized transaction costs for 1998. Additionally, respondent reduced John Hancock's taxable rental income by $19,169,206 for 1998. Alternatively, respondent determined that in substance the OBB LILO transaction was a financing arrangement and therefore increased John Hancock's taxable income by $1,040,159 for OID income for 1998. Under 19The nOtiCe Of defiCiency Combined the two SNCB LILO transactions. - 70 this alternative argument, respondent concedes John Hancock's deduction for amortized transaction costs. With respect to the two SNCB LILOs, respondent determined that the LILO transactions were in substance purchases of future interests by John Hancock and therefore denied John Hancock's deductions of $6,849,494 and $39,408,434 for rental expenses, $1,737,691 and $10,030,464 for interest expenses, and $23,787 and $127,220 for amortized transaction costs for 1997 and 1998, respectively. Additionally, respondent reduced John Hancock's taxable rental income by $2,265,498 and $13,298,535 for 1997 and 1998, respectively. Alternatively, respondent determined that in substance the two SNCB LILO transactions were a financing arrangement and therefore increased John Hancock's taxable income by $229,736 and $1,929,488 for OID income for 1997 and 1998, respectively. Under this alternative argument, respondent concedes John Hancock's deduction for amortized transaction costs.20 B. Notice of Deficiency (Docket No. 7084-10) On December 24, 2009, respondent issued a notice of deficiency to John Hancock which determined a Federal income tax deficiency for 1999 of 20Respondent made similar determinations and denied similar deductions for the six other LILO transactions listed in the notice of deficiency. - 71 $59,899,141 based upon the disallowance of various deductions and adjustments to gross income from John Hancock's LILO transactions. On March 23, 2010, John Hancock filed the petition with this Court at docket No. 7084-10, disputing the 1999 determined deficiency. The notice of deficiency for docket No. 7084-10 included three of the test transactions litigated in these cases, the OBB LILO and the two SNCB LILOs." With respect to the OBB LILO, respondent determined that the LILO transaction was in substance the purchase of a future interest by John Hancock and therefore denied John Hancock's deductions of $124,785,824 for a rental expense, $29,516,300 for an interest expense, and $555,956 for amortized transaction costs for 1999. Additionally, respondent reduced John Hancock's taxable rental income by $35,739,244 for 1999. Alternatively, respondent determined that in substance the OBB LILO transaction was a financing arrangement and therefore increased John Hancock's taxable income by $4,746,135 for OID for 1999. Under this alternative argument, respondent concedes John Hancock's deduction for amortized transaction costs. With respect to the two SNCB LILO transactions, respondent determined that the LILO transactions were in substance the purchase of a future interest by The notice of deficiency combined the two SNCB LILO transactions. - 72 John Hancock and therefore denied John Hancock's deductions of $39,408,436 for a rental expense, $9,787,937 for an interest expense, and $127,220 for amortized transaction costs for 1999. Additionally, respondent reduced John Hancock's taxable rental income by $13,298,535 for 1999. Alternatively, respondent determined that in substance the two SNCB LILO transactions were financing arrangements and therefore increased John Hancock's taxable income by $2,055,293 for OID income for 1999. Under this alternative argument, respondent concedes John Hancock's deductions for amortized transaction costs.22 C. Notice of Deficiency (Docket No. 7083-10) On December 24, 2009, respondent issued a notice of deficiency to John Hancock which determined Federal income tax deficiencies for 2000 and 2001 of $108,046,947 and $143,516,079, respectively, based upon the disallowance of various deductions and adjustments to gross income from John Hancock's LILO and SILO transactions and the denial of worthless stock losses for 2000.23 On March 23, 2010, John Hancock filed the petition with this Court at docket No. 7083-10, disputing the 2000 and 2001 determined deficiencies. 22Respondent made similar determinations and denied similar deductions for the six other LILO transactions listed in the notice of deficiency. 23The parties filed a stipulation of settled issues with the Court on June 7, 2011, resolving the worthless stock loss issue for 2000. - 73 The notice of deficiency for the case at docket No. 7083-10 included all seven of the test transactions litigated in these cases, the OBB LILO, the two SNCB LILOs," the TIWAG SILO, the two Dortmund SILOs," and the SNCB SILO. With respect to the OBB LILO, respondent determined that the LILO transaction was in substance the purchase of a future interest by John Hancock and therefore denied John Hancock's deductions of $124,785,824 and $124,785,724 for rental expenses, $29,073,071 and $28,598,273 for interest expenses, and $555,956 and $555,956 for amortized transaction costs for 2000 and 2001, respectively. Additionally, respondent reduced John Hancock's taxable rental income by $35,739,244 and $35,739,244 for 2000 and 2001, respectively. Alternatively, respondent determined that in substance the OBB LILO transaction was a financing arrangement and therefore increased John Hancock's taxable income by $4,044,640 and $5,361,948 for OID income for 2000 and 2001, respectively. Under this alternative argument, respondent concedes John Hancock's deduction for amortized transaction costs. With respect to the two SNCB LILO transactions, respondent determined that the LILO transactions were in substance purchases of future interests by John "The notice of deficiency combined the two SNCB LILO transactions. "The notice of deficiency combined the two Dortmund SILO transactions. - 74 Hancock and therefore denied John Hancock's deductions of $39,408,436 and $38,940,891 for rental expenses, $9,527,327 and $9,068,703 for interest expenses, and $127,220 and $127,220 for amortized transaction costs for 2000 and 2001, respectively. Additionally, respondent reduced John Hancock's taxable rental income by $13,298,535 and $13,297,807 for 2000 and 2001, respectively. Alternatively, respondent determined that in substance the two SNCB LILO transactions were a financing arrangement and therefore increased John Hancock's taxable income by $2,189,343 and $2,332,181 for OID income for 2000 and 2001, respectively. Urider this alternative argument, respondent concedes John Hancock's deductions for amortized transaction costs. With respect to the TIWAG SILO, respondent determined that John Hancock had not acquired the benefits and burdens of ownership of the property subject to the SILO transaction and therefore denied John Hancock's deductions of $807,500 for a depreciatiön expense, $535,234 for an interest expense, and $2,802 for amortized transaction costs for 2001. Additionally, respondent determined that in substance the John Hancock made a loan to TIWAG and failed to report interest income on that loan. Therefore, respondent increased John Hancock's taxable income by $78,302 for OID income for 2001. - 75 With respect to the two Dortmund SILO transactions, respondent determined that John Hancock had not acquired the benefits and burdens of ownership of the property subject to the SILO transactions and therefore denied John Hancock's deductions of $115,170 for depreciation expenses, $240,614 for interest expenses, and $21,259 for amortized transaction costs for 2001. Additionally, respondent determined that in substance John Hancock made a loan to Dortmund and failed to report interest income on that loan. Therefore, respondent increased John Hancock's taxable income by $24,985 for OID income for 2001. With respect to the SNCB SILO, respondent determined that John Hancock had not acquired the benefits and burdens of ownership of the property subject to the SILO transaction and therefore denied John Hancock's deductions of $5,032,552 for a depreciation expense, $2,594,278 for an interest expense, and $15,898 for amortized transaction costs for 2001. Additionally, respondent determined that in substance the John Hancock made a loan to SNCB and failed to report interest income on that loan. Therefore, respondent increased John Hancock's taxable income by $627,439 for OID income for 2001.26 26Respondent made similar determinations and denied similar deductions for the six other LILO transactions and one other SILO transaction listed in the notice (continued...) - 76 D. Pretrial Motions Respondent failed to timely raise the economic substance theory in the pleadings, instead raising the issue for the first time in his pretrial memorandum, dated September 16, 2011. Petitioners filed a motion in limine for exclusion of respondent's argument based on the economic substance theory on September 23, 2011, and respondent filed an objection to petitioners' motion on October 6, 2011. On October 11, 2011, the parties presented oral arguments to the Court with respect to petitioners' motion. By order of the Court dated October 12, 2011, we denied petitioners' motion in limine for exclusion of the economic substance theory but placed the burden of proof with respect to the economic substance theory on respondent. II. Trial The Court held a five-week special trial session in Boston, Massachusetts. The record in these cases includes the testimony of 53 witnesses, over 3,600 exhibits, over 4,000 pages of trial transcripts, and over 1,000 pages of briefing. Both parties rely heavily on expert opinions to support their arguments. The parties' expert witnesses, their qualifications, and their Court-recognized 26(...continued) of deficiency. - 77 expertises are listed below. We evaluate expert opinions in the light of all of the evidence in the record, and we are not bound by the opinion of any expert witness. Helvering v. Nat'l Grocery Co., 304 U.S. 282, 295 (1938); Shepherd v. Commissioner, 115 T.C. 376 (2000), aff'd, 283 F.3d 1258 (1 lth Cir. 2002). We may reject, in whole or in part, any expert opinion. Estate of Davis v. Commissioner, 110 T.C. 530, 538 (1998). A. Petitioners' Expert Witnesses (Alphabetical Order) 1. Mr. John Dolan The Court recognized Mr. Dolan as an expert in the field of European railways and railway assets. .Mr. Dolan is a chartered civil engineer, a member of the Institution of Civil Engineers, and a holder of the title European engineer. He is also a chartered member of the Institute of Logistics and Transport. Mr. Dolan has worked in the European railway industry since 1972 and currently works as a consultant for InterFleet Technology Ltd. where he advises on a range of railway safety, infrastructure, and operational issues. He previously worked in advisory roles for Haliburton, Her Majesty's Railway Inspectorate, and British Rail. 2. Dr. Paul Doralt The Court recognized Dr. Doralt as an expert in the field of Austrian tax law. Dr. Doralt is admitted to the Austrian Chamber of Accountants as a certified - 78 tax adviser and to the Austrian bar as an attorney. He is currently a partner at Dorda Brugger Jordis GmbH, with his practice focus in tax law. Mr. Doralt is a board member of the International Tax Committee of the International Bar Association. 3. Mr. Hans Haider The Court recognized Mr. Haider as an expert in the field of Austrian and European electricity. Mr. Haider is currently the managing partner of Hans Haider Consulting. He has over 40 years of experience, having served as a member of the management board of Siemens AG Austria and chairman of the management board and CEO of Verbund AG, Austria's largest utility. He has previously served as president of the Austrian National Committee to the World Energy Counsel and president of the European Union of the Electricity Industry. Mr. Haider is currently a member of Ernst & Young's Energy Advisory Board. 4. Dr. Friedrich Hey The Court recognized Dr. Hey as an expert in the field of German tax law. Dr. Hey received a doctorate in law from the University of Hamburg/Germany and is admitted as a certified tax adviser and a German attorney. He is currently a partner at Debevoise & Plimpton LLP (Debevoise & Plimpton) and the chair of the German American Lawyers Association. Dr. Hey's work has been published - 79 numerous times, and he has been recognized as a leading German tax expert by publications such as Chambers, Legal 500 EMEA, PLC Which Lawyer?, and Who's Who-Legal. 5. Dr. Friedrich Popp The Court recognized Dr. Popp as an expert in the field of Austrian corporate law and creditor rights law. Dr. Popp received a doctorate in law from the University of Vienna/Austria with a thesis in civil law. He is currently an associate at Debevoise & Plimpton. Dr. Popp has published numerous articles in various journals and is a frequent contributor to the Austrian Journal of Banking and Financial Research. 6. Dr. Thomas Schurrle The Court recognized Dr. Schurrle as an expert in the field of German administrative and public law. Mr. Schurrle received a doctorate in law from the University of Heidelberg. He is currently the managing partner of the Frankfurt office of Debevoise & Plimpton. His experience has focused on advising municipalities and companies on the financial, economic, and regulatory aspects of cross-border leasing. Mr. Schurrle teaches a law class at the Institute of Law and Finance at the Johann-Wolfgang-Goethe-University in Frankfurt. - 80 7. Dr. Norbert Stoeck The Court recognized Dr. Stoeck as an expert in the field of trade fair industry including the ownership and operation of trade fairs in Germany. Dr. Stoeck received a Ph.D. in marketing from the University of Rostock. Since 1983 he has worked at Roland Berger Strategy Consultants and currently serves as the head of the "International Trade Shows, Tourism and Mega-Events" practice group. In this role Dr. Stoeck has managed over 100 trade fair projects internationally and advised on countless others including trade fairs in German municipalities. He has written numerous books and articles discussing the management of trade fairs, trade fair strategies, and all other aspects of the trade fair industry. 8. Dr. Frederik Vandendriessche The Court recognized Dr. Vandendriessche as an expert in the field of Belgian administrative and public law. Dr. Vandendriessche received a doctorate in law at the University of Ghent with a focus in public and private legal entities. He is currently a partner in the Brussels office of Stibbe where he focuses his practice in administrative law. Dr. Vandendriessche is a professor of public law at the University of Ghent and the University of Antwerp. He has written a wide - 81 range of articles about public law that have been published in Belgian journals and magazmes. B. Respondent's Expert Witnesses (Alphabetical Order) 1. Dr. Ignaas Behaeghe The Court recognized Dr. Behaeghe as an expert in Belgian law. Dr. Behaeghe received a doctorate in law and economic sciences from the University of Antwerp and a master's in tax law from the Fiscale Hogeschool in Brussels. He is currently an equity partner at Eversheds Brussels. 2. Dr. Stefan Diemer The Court recognized Dr. Diemer as an expert in the field of German tax law. Dr. Diemer received his doctorate in law from the University of Regensburg. He is currently a partner at Heisse Kursawe Eversheds and practices in the area of corporate and tax law. Dr. Diemer is a certified tax lawyer and is a member of the International Transaction Support Team of Eversheds, a unit specializing in international transactions. The JUVE Handbuch 2009/2010 lists Dr. Diemer as a frequently recommended lawyer in the field of corporate law. 3. Dr. Matthias Heisse The Court recognized Dr. Heisse as an expert in the field of German law, except for German criminal law. Dr. Heisse received his doctorate in law from the - 82 University of Munich. He is currently the managing partner of Heisse Kursawe Eversheds and focuses his practice in mergers and acquisitions, corporate, and tax law. Dr. Heisse lectures on corporate law topics at the University of Turin, the University of Munich, and the University of Augsburg. He is recognized in numerous publications such as Chambers Europe, Legal 500 Europe, and the JUVE Handbook 2010/2011 as a leading attorney in the field of corporate law. 4. Dr. Thomas Lys The Court recognized Dr. Lys as an expert in the field of financial economics. Dr. Lys received his Ph.D. in accounting and finance from the University of Rochester. He presently holds the Eric L. Kohler chair in accounting and professor of accounting and information management at the Northwestern University Kellogg School of Professional Management. Dr. Lys teaches classes in financial reporting, security analysis, and mergers and acquisitions. Dr. Lys' research has been published in prominent academic journals including the Journal of Accounting and Economics, the Journal of Financial Economics, the Journal of Business, and the Accounting Review. Dr. Lys has previously testified for the Government in other Federal leasing cases. - 83 5. Dr. F.H. Rolf Seringhaus The Court recognized Dr. Seringhaus as an expert in the field of trade fair exhibiting and marketing. Dr. Seringhaus earned his doctorate in administrative studies from York University. He is a professor emeritus in global marketing at the Wilfred Laurier University School of Business and Economics. Dr. Seringhaus has worked in academics since 1981 teaching courses and researching international marketing. He has written countless journal articles discussing topics such as international trade fairs and marketing, as well as three books on global marketing management. 6. Mag. Alexander Stolitzka The Court recognized Mag. Stolitzka as an expert in the field of Austrian law. Mag. Stolitzka received a doctorate in law from Vienna University. He is currently the managing partner of Eversheds Austria, focusing his practice in real estate, insurance, and corporate law. He is also a member of the board of directors of Eversheds International, Ltd., London. Mag. Stolitzka is a member of the German Chamber of Commerce in Austria and is also a legal adviser to the Swiss embassy in Vienna. - 84 7. Dr. Vukan Vuchic The Court recognized Dr. Vuchic as an expert in the field of transportation systems. Dr. Vuchic received a Ph.D. in civil engineering and transportation from the University of California at Berkeley. He is an emeritus professor of transportation systems engineering at the University of Pennsylvania where he taught and performed research in various areas of transportation from 1967-2010. Dr. Vuchic has written over 150 papers and reports discussing rail systems and has lectured at approximately 90 universities. He has also published three books on urban public transportation systems and another book on relationship of transportation and cities. Dr. Vuchic is also the recipient of numerous honors and awards from transportation organizations around the world for his contributions to the field of transportation systems. 8. Dr. Peter Wundsam The Court recognized Dr. Wundsam as an expert in the field of Austrian taxation and accounting. Dr. Wundsam is a partner at Moore Stephens in Vienna and has been working as an auditor and tax consultant for 15 years. He is a certified public accountant and certified tax adviser in Austria. He is also a member of the executive board of the Chamber of Accountants and a member of the committee on commercial law and auditing within the Austrian Chamber of - 85 Accountants. Further, Dr. Windsam is the head of the working committee public sector of the Austrian Institute of Auditors and an editor of the publication Public Sector Bulletin. OPINION Burden of Proof The burden is upon petitioners to prove that respondent's determinations in the notices of deficiency are incorrect. See Rule 142(a)(1). However, in respect of any new matter, respondent bears the burden of proof. Id. Respondent failed to timely raise his economic substance argument in the pleadings. As a result, on October 12, 2011, the Court issued an order placing the burden in these cases on respondent to prove that the economic substance doctrine applies to the leveraged leases. Petitioners do not argue that the burden of proof shifts to respondent pursuant to section 7491(a) for any other issue or year, nor have they shown that the threshold requirements of section 7491(a) have been met for any of the other determinations at issue. Accordingly, the burden remains on petitioners with respect to all other issues to prove that respondent's determinations of deficiencies in income tax are incorrect. - 86 Principal Place of Business In the case at docket No. 7083-10 the parties disagree as to whether an appeal would come before the U.S. Court of Appeals for the First or Sixth Circuit. In the case of a corporation seeking redetermination of a tax liability, section 7482(b)(1)(B) provides that a decision of the Tax Court "may be reviewed by the United States court of appeals for the circuit in which is located * * * the principal place of business or principal office or agency of the corporation". This determination is made as of the time the petition is filed. Thus, the crux of the parties' dispute is the location of MIC's "principal place of business". The Supreme Court has recently determined that a corporation's "principal place of business" is "best read as referring to the place where a corporation's officers direct, control, and coordinate the corporation's activities." Hertz Corp. v. Friend, 559 U.S. 77, 92-93 (2010). This is often referred to as the "nerve center" test, and it normally refers to where a corporation maintains its headquarters, provided that the headquarters is the actual center of direction, control and coordination. Id. Respondent argues that MIC's principal place of business is and always has been in Michigan because MIC was incorporated there and has represented in correspondence to the IRS and the Michigan Department of Consumer & Industry Services that its principal place of business is in Michigan. - 87 Petitioners argue, on the other hand, that MIC's principal place of business is in Massachusetts because six of its nine corporate officers" and all three of its directors work in Massachusetts, its corporate books and records are kept in Massachusetts, and its significant business decisions have been and continue to be made in Massachusetts. Further, MIC does not maintain offices in Michigan. It is clear to us that MIC's "nerve center" is in Massachusetts. Respondent has not presented any evidence to dispute that MIC's office in Massachusetts is the center of its direction, control, and coordination. Therefore, we conclude that Massachusetts was MIC's principal place of business when its petition was filed. Leveraged Lease Transactions I. Frank Lyon Co. v. United States The seminal case for leveraged lease transactions is Frank Lyon Co. v. United States, 435 U.S. 561 (1978), where the Supreme Court set forth the circumstances under which the Commissioner must respect such a transaction for Federal tax purposes. The Supreme Court stated: where * * * there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, that is imbued with tax-independent considerations, and that is not shaped solely by tax-avoidance The remaining three officers work in Toronto, Canada. - 88 features * * * [to which] meaningless labels [are] attached, the Government should honor the allocation of rights and duties effectuated by the parties. Expressed another way, so long as the lessor retains significant and genuine attributes of the traditional lessor status, the form of the transaction adopted by the parties governs for tax purposes. What those attributes are in any particular case will necessarily depend upon its facts. * * * [Id. at 583-584; fn. ref. omitted.] In Frank Lyon, Worthen Bank (Worthen) sought to construct a new bank building. State and Federal regulations prohibited Worthen from financing the construction through conventional methods. As a result, Worthen was forced to find alternative financing, and eventually came to an agreement with the taxpayer, Frank Lyon Co. (Frank Lyon). Pursuant to this agreement, Frank Lyon purchased the building from Worthen during its construction for a total of $7,640,000, and leased it back to Worthen for an initial term of 25 years. Frank Lyon invested $500,000 and financed the remainder with a third-party lender. A mortgage secured the loan on the building, as well as Frank Lyon's promise to assume personal responsibility for the loan's repayment and an assignment to the lender of the rental payments under the lease. Worthen retained options to repurchase the building at the end of the 11th, 15th, 20th, and 25th years of the initial lease. Alternatively, Worthen could opt to renew the lease for eight additional five-year terms. Worthen's rent payments - 89 equaled the amounts of Frank Lyon's debt service in amount and timing. Further, the prices of Worthen's purchase options matched Frank Lyon's then-outstanding loan balance, plus Frank Lyon's initial $500,000 investment, with 6% compounded interest. The lease was a net lease with Worthen remaining obligated to pay taxes, insurance, and utilities. The Supreme Court held that the form of a sale-leaseback transaction will be respected for Federal tax purposes as long as the taxpayer retains significant and genuine attributes of a traditional lessor. Id. at 584. An important inquiry is "whose capital was committed to the * * * [property] * * * [and therefore, who is] entitled to claim depreciation for the consumption of that capital." Id. at 581. Frank Lyon was liable as principal for the repayment of the $7,640,000 loan, had invested $500,000 in the transaction, and its return on the transaction was guaranteed only if Worthen exercised its extension options, which was speculative. The Supreme Court also determined the following factors, among others, to favor Frank Lyon: (1) Worthen's rent and purchase option prices were reasonable; (2) Frank Lyon assumed the credit risk of Worthen's defaulting on its rent payments; (3) there was a real possibility that Worthen could walk away from the transaction at the end of the initial lease; (4) the transaction was negotiated in - 90 good faith between independent parties; and (5) Worthen and Frank Lyon paid the same tax rates, making the transaction tax neutral for the fisc. Accordingly, the Supreme Court held for Frank Lyon, concluding that "a sale-and-leaseback, in and of itself, does not necessarily operate to deny a taxpayer's claim for deductions." Frank Lyon, 435 U.S. at 584. A. Economic Substance After the Supreme Court issued its opinion in Frank Lyon, several Courts of Appeals reduced the Supreme Court's economic substance formulation to a twopart test: (1) whether the transaction had economic substance beyond tax benefits (objective test); and (2) whether the taxpayer had shown a nontax business purpose for entering the disputed transaction (subjective test). See, e.g., ACM P'ship v. Commissioner, 157 F.3d 231, 247-248 (3d Cir. 1998), aff'g in part, rev'a in part T.C. Memo. 1997-115; Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987), aff'g T.C. Memo. 1986-23; Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89, 91-92 (4th Cir. 1985), aff'g in part, rev'g in part 81 T.C. 184 (1983). However, the various Courts of - 91 Appeals disagree as to the appropriate relationship between the objective and subjective tests.28 The Court of Appeals for the Fourth Circuit has adopted a disjunctive approach, treating a transaction as having economic substance if the transaction has either a business purpose or economic substance. See, e.g., Rice's Toyota World, Inc. v. Commissioner, 752 F.2d at 91-92. The Courts of Appeals for the Ninth and Eleventh Circuits view the objective and subjective prongs as elements of one comprehensive inquiry. See, e.g., Sacks v. Commissioner, 69 F.3d 982, 988 (9th Cir. 1995), rev'g T.C. Memo.1992-596; Kirchman v. Commissioner, 862 F.2d 1486, 1492 (11th Cir.1989), affg Glass v. Commissioner, 87 T.C. 1087 (1986). Finally, the Court of Appeals for the Federal Circuit adheres to a multifactor test which provides that a lack of economic substance may be sufficient to invalidate a transaction regardless of whether the taxpayer has motives other than tax avoidance. Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1355 (Fed. Cir. 2006). 28Congress codified the economic substance doctrine in the Code by the Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, sec. 1409, 124 Stat. at 1067. See also H.R. Rept. No. [Text truncated at 120,000 characters. The full text is on the page linked above.] --- Source: Frix Law Library, https://www.frixlaw.com/law-library/documents/agency%3Atax-court%3A72198034959ccd04. Public record. Not legal advice.