UNITED STATES TAX COURT
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T.C. Memo 2002-97
UNITED STATES TAX COURT
ANDANTECH L.L.C., WELLS FARGO EQUIPMENT FINANCE, INC. (f.k.a.
NORWEST EQUIPMENT FINANCE, INC.), TAX MATTERS PARTNER, AND WELLS
FARGO & COMPANY (f.k.a. NORWEST CORPORATION), A PARTNER OTHER
THAN THE TAX MATTERS PARTNER, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket Nos. 15532-98, 4277-00,
6348-00.
Filed April 9, 2002.
On Sept. 28, 1993, A, a limited liability Wyoming
company, composed of two Belgian citizens, BP and FBE,
purchased a portfolio of 40 IBM mainframe computers (the
equipment) from C, for $122,415,762, which was paid: (1)
$14,995,931 in cash (which A borrowed from UBS, a Swiss
bank), and (2) $107,419,831 by A’s notes to C. At the
time of sale, the equipment was under existing leases to
end users and subject to existing liens; the equipment
was sold to A subject to the existing leases and liens.
Simultaneously with its purchase of the equipment,
A leased the equipment back to C.
1
Cases of the following petitioners are consolidated
herewith: Andantech L.L.C., Equipment Investors Co., Inc., A
Partner Other Than The Tax Matters Partner, docket Nos. 4277-00
and 6348-00.
- 2 On Oct. 29, 1993, A sold a portion of the rents due
from C to NationsBank for $87,805,802. The sale of the
rents caused a portion ($87,805,802) of A’s note to C to
accelerate, and the proceeds A received from the sale
were paid to C.
On Dec. 9, 1993, FBE entered into an agreement with
EICI pursuant to which FBE assigned his 2-percent
interest in A to EICI.
On Dec. 10, 1993, BP entered into an agreement with
RDL, a subsidiary of NEFI, pursuant to which (1) BP
exchanged his 98-percent interest in A for 6,150 shares
of preferred stock in RDL, and (2) NEFI agreed to
contribute $14,817,382 in cash to RDL in exchange for 100
shares of RDL common stock.
BP’s transfer of his 98-percent interest in A caused
an acceleration of A’s note to UBS. As a result, RDL and
EICI contributed $14,817,382 and $302,396, respectively,
to the capital of A.
A used these amounts (totaling
$15,119,778) to pay the principal and interest due under
its note to UBS.
On its Federal income tax return for the short
period from Sept. 28 to Dec. 10, 1993 (the 12/10/93 short
period), A reported net income of $86,930,096 that was
allocated to BP, FPE, and EICI. On its Federal income
tax return for the short period from Dec. 11 to Dec. 31,
1993 (the 12/31/93 short period), A reported a $2,143,937
loss (consisting of depreciation deductions and interest
expense). A reported a $50,069,397 loss for 1994 (also
consisting of depreciation deductions and interest
expense).
Respondent determined that the sale-leaseback
transaction described above was a prearranged transaction
that lacked business purpose as well as economic
substance.
Consequently, in FPAAs issued to A,
respondent determined that the losses claimed by A
($2,143,937 for the 12/31/93 short period and $50,069,397
for 1994) should be disallowed. Additionally, respondent
determined that A should have reported $87,805,801 of
income for the 12/31/93 short period.
Held: A is disregarded because BP and FPE did not
intend to join together for the purpose of carrying on a
business as partners or sharing in the profits and losses
from an equipment leasing activity.
- 3 Held, further, alternatively, participation of BP,
FBE, and EICI in the sale-leaseback transaction described
above is disregarded under the step transaction doctrine.
Held, further, the sale-leaseback transaction
described above lacked a valid business purpose, as well
as economic substance, and thus is not to be respected
for Federal tax purposes. Consequently, (1) A is not
required to include the sale of the rents ($87,805,801)
as income for the 12/31/93 short period, (2) A is not
entitled to deduct $2,143,937 as expenses from “other
rental activities” for the 12/31/93 short period, and (3)
A is not entitled to deduct $50,069,397 of similar
expenses for 1994.
Mark Alan Hager, Walter A. Pickhardt, John R. Kalligher,
William K. Wilcox, and Myron L. Frans, for petitioners in
docket No. 15532-98.
Walter A. Pickhardt, Mark Alan Hager, and William K.
Wilcox, for petitioner in docket No. 4277-00.
Walter A. Pickhardt, for petitioner in docket No. 6348-00.
Robert M. Ratchford, Donna C. Hansberry, John C. Schmittdiel,
and Robert J. Burbank, for respondent.
- 4 CONTENTS
FINDINGS OF FACT
. . . . . . . . . . . . . . . . . . . . . . . 7
I.
Norwest and Its Affiliated Group . . . . . . . . . . . . . 7
A.
Norwest . . . . . . . . . . . . . . . . . . . . . . . 7
B.
NEFI . . . . . . . . . . . . . . . . . . . . . . . . 8
II.
Comdisco and CIG . . . . . . . . . . . . . . . . . . . . . 8
III. Negotiations . . . . . . . . . . . . . . . . . . . . . .
A.
CIG’s Initial Discussions With Norwest and NEFI . .
B.
NEFI’s Credit Approval Presentation . . . . . . . .
C.
Financial Projections and Appraisals . . . . . . .
D.
The Foreign Investors . . . . . . . . . . . . . . .
IV.
12
12
14
16
25
Formation of Andantech and the Sale-Leaseback (Appendixes
A, B, and C) . . . . . . . . . . . . . . . . . . . . . .
A.
The Purchase Price . . . . . . . . . . . . . . . .
B.
The Equipment Lease . . . . . . . . . . . . . . . .
C.
The Bank Loan . . . . . . . . . . . . . . . . . . .
28
30
31
37
V.
Sale of Comdisco Rents (Appendix D)
39
VI.
Mr. de la Barre d’Erquelinnes’s and Mr. Parmentier’s
Withdrawal From Andantech . . . . . . . . . . . . . . .
A.
Mr.
de
la
Barre
d’Erquelinnes’s
and
Mr.
Parmentier’s Withdrawal of Capital Contributed to
Andantech . . . . . . . . . . . . . . . . . . . . .
B.
Transfer of Mr. de la Barre d’Erquelinnes’s
Membership Interest in Andantech to EICI (Appendix
E) . . . . . . . . . . . . . . . . . . . . . . . .
C.
Transfer of Mr. Parmentier’s Membership Interest to
RD Leasing in Exchange for Preferred Stock
(Appendix F) . . . . . . . . . . . . . . . . . . .
. . . . . . . . . .
VII. Repayment of Bank Loan (Appendixes F and G)
41
41
41
42
. . . . . .
43
. . . . . . . . . . . . .
44
IX.
Comdisco’s Exercise of Early Termination Options . . . .
45
X.
Dissolution of RD Leasing and Andantech
. . . . . . . .
50
XI.
Andantech’s Federal Income Tax Returns . . . . . . . . .
50
XII. Respondent’s Determinations . . . . . . . . . . . . . .
A.
FPAAs for the 1993 Short Years . . . . . . . . . .
B.
FPAA for the 1994 Taxable Year . . . . . . . . . .
52
52
53
VIII. Sale of Computer to End User
- 5 OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . .
53
I.
Procedural Issues
53
II.
Whether the Sale-Leaseback Transaction Should Be
Respected . . . . . . . . . . . . . . . . . . . . . . . 55
A.
Overview
of
Statutory
Framework
for
the
Transactions . . . . . . . . . . . . . . . . . . . 56
B.
Positions of the Parties . . . . . . . . . . . . . 61
C.
Analysis . . . . . . . . . . . . . . . . . . . . . 62
1.
Andantech Is Not a Valid Partnership and Is
Not Recognized for Federal Tax Purposes . . . 64
a.
Andantech-Foreign Should Be Disregarded
Because Messrs. Parmentier and de la
Barre d’Erquelinnes Did Not Intend To
Join Together for the Purpose of Carrying
On a Business and Sharing in the Profits
or Losses From the Equipment Leasing
Activity . . . . . . . . . . . . . . . . 65
b.
Andantech-US
Should
Be
Disregarded
Because EICI Did Not Intend To Join With
RD Leasing for the Purpose of Carrying On
Partnership Business and Sharing in the
Profits or Losses From the Partnership’s
Equipment Leasing Activity . . . . . . . 68
2.
Andantech Acted as a Mere Shell or Conduit To
Strip the Income From the Transaction and
Avoid Income Taxation and, Under the Step
Transaction Doctrine, Should Be Disregarded . 69
a.
Binding Commitment Test . . . . . . . . . 71
b.
End Result Test . . . . . . . . . . . . . 72
c.
Interdependence Test . . . . . . . . . . 75
3.
The Sale-Leaseback Transaction Lacked Business
Purpose and Economic Substance . . . . . . . . 82
a.
The Experts . . . . . . . . . . . . . . . 84
b.
No Reasonable Possibility for Profit
Existed . . . . . . . . . . . . . . . . . 89
c.
RD Leasing/Norwest Was Not Motivated by
Any Business Purpose Other Than Obtaining
Tax Benefits . . . . . . . . . . . . . . 95
i.
Presence or Absence of Arm’s-Length
Price Negotiations . . . . . . . . . 97
ii. The Relationship Between the Selling
Price and the Fair Market Value . . 99
iii. The Structure of the Financing . . . 99
iv. The
Degree
of
Adherence
to
Contractual Terms . . . . . . . . . 102
v.
The Reasonableness of the Income and
. . . . . . . . . . . . . . . . . . .
- 6 -
D.
Residual Value Projections . . . . . 104
vi. Insertion of Other Entities . . . . 106
4.
The Transaction Was Not a Sale and the
Financing Did Not Constitute Genuine Debt . . 108
Conclusion . . . . . . . . . . . . . . . . . . . . 112
APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . 114
MEMORANDUM FINDINGS OF FACT AND OPINION
JACOBS,
Judge:
Respondent
issued
Andantech,
L.L.C.
(Andantech), a limited liability Wyoming company, notices of final
partnership
administrative
adjustment
(FPAAs)
that
reflected
adjustments to Andantech’s partnership returns for taxable years
which ended on December 10, 1993 (the 12/10/93 FPAA), December 31,
1993 (the 12/31/93 FPAA), and December 31, 1994 (the 12/31/94
FPAA).
These consolidated cases involve an equipment sale-leaseback
transaction that is described in flow chart form, in attached
appendixes A through G. The transaction is designed to produce tax
benefits
to
RD
Leasing,
Inc.
(RD
Leasing),
a
member
of
an
affiliated group in which Norwest Corp. (Norwest) is the common
parent, through RD Leasing’s membership in Andantech.
The substantive issue to be resolved is whether the saleleaseback transaction involved herein should be respected for
Federal tax purposes.
All section references are to the Internal Revenue Code as in
effect for the years in issue.
- 7 FINDINGS OF FACT
Some
of
accordingly.
the
facts
have
been
stipulated
and
are
found
The stipulations of facts and the attached exhibits
are incorporated herein by this reference.
I.
Norwest and Its Affiliated Group
A.
Norwest
At all relevant times, Norwest was a Delaware corporation,
maintaining
Minnesota.
its
principal
place
of
business
in
Minneapolis,
In 1998, Norwest merged with Wells Fargo & Co.
Norwest
was the surviving corporation, but it subsequently changed its name
to Wells Fargo & Co.
Norwest is a bank holding company registered with the Federal
Reserve Bank under the Bank Holding Company Act of 1956.
Norwest’s
affiliates provide banking and other financial services. From 1993
through
1996,
Norwest
and
its
affiliated
consolidated Federal income tax returns.
corporations
filed
Norwest is a publicly
held company whose stock is traded on the New York Stock Exchange
and on the Midwest Stock Exchange.
J. Daniel Vandermark was Norwest’s senior vice president of
tax; he reported to John Thornton, Norwest’s chief financial
officer. All sale-leasebacks had to be approved by Mr. Vandermark.
B.
NEFI
Norwest Equipment Finance, Inc. (NEFI), now known as Wells
Fargo Equipment Finance, Inc., is a Minnesota corporation engaged
in the business of equipment leasing.
At all relevant times, NEFI
- 8 was a wholly owned subsidiary of Norwest Bank Minnesota, N.A.
(NBM), which in turn was a wholly owned subsidiary of Norwest.
NEFI was actively involved in leasing transactions involving
“middle market” equipment (i.e., equipment having a market value
between $25,000 and $2 million). NEFI was also involved, albeit to
a lesser extent, in leasing transactions involving higher end
equipment.
Within the Norwest group, sale-leasebacks were usually taken
in the name of NEFI’s parent, NBM.
NEFI.
James Renner was president of
Phyllis Grossman was vice president of sale-leaseback
transactions for NEFI. She was primarily responsible for reviewing
the structure of, and overseeing the completion of, all proposed
sale-leaseback transactions.
NEFI employed the law firm of Faegre & Benson (and used the
services of David Beadie and John Steffen) to render legal advice
with respect to the sale-leaseback transaction involved herein.
II.
Comdisco and CIG
Comdisco, Inc. (Comdisco), is a Delaware corporation with its
principal place of business in Rosemont, Illinois.
Comdisco is a
publicly held corporation whose stock is traded on the New York
Stock Exchange.
Comdisco is a lessor, dealer, and remarketer of
computer equipment.
In 1993, it was the largest independent
computer leasing company in the United States.
Comdisco purchases computers primarily through debt financing.
After entering into a lease with a customer (existing lease),
- 9 Comdisco borrows, on a nonrecourse basis, an amount equal to the
present value of the rental payments due under the lease (existing
financing) from a financial institution or insurance company. Such
borrowing is secured by an assignment of the rents and a lien on
the equipment (existing lien).
Comdisco rarely obtains sufficient
proceeds from the existing financing to fund the total cost of the
equipment.
(The balance of the equipment cost is referred to as
the equity portion.
The equity portion ranges from 10 to 25
percent of the cost of the equipment, depending on the length of
the lease and the type of equipment.)
Comdisco recovers a portion
of the equity portion by entering into sale-leaseback transactions
with third parties.
In a sale-leaseback transaction, the third party purchases the
equipment (subject to the existing lease and existing lien) and
leases it back to Comdisco.
Generally, the present value of rent
paid by Comdisco to the third party is less than the purchase price
paid by the third party.
The third party obtains the depreciation
deductions associated with the equipment and is entitled to the
residual value of the equipment at the end of the lease.
Ideally,
the transaction is structured so that the third party can recover
most of his investment from the residual value and profits from the
tax savings he receives from depreciation and interest deductions.
Comdisco also obtains a tax benefit from the transaction; the saleleaseback transaction allows Comdisco a deduction for the rent it
pays to the third party (instead of a deduction for depreciation of
- 10 the equipment), thereby reducing Comdisco’s alternative minimum
tax.
Between 1993 and 1996, Comdisco had a wholly owned subsidiary,
Comdisco Investment Group, Inc. (CIG).
CIG’s executives included:
Frank Trznadel-–president; Robert Snyder--executive vice president;
and Paula Ortmann–vice president.
CIG
assisted
Comdisco
in
structuring
sale-leaseback
transactions of computers involving foreign investors and U.S.
corporations (domestic corporations), referred to by Comdisco as
cross-border equipment leasing transactions.
CIG presented to
domestic corporations proposals for cross-border equipment leasing
transactions between Comdisco, partnerships made up of the foreign
investors, and the domestic corporations.2 The proposals stated in
relevant part:
COMDISCO EQUIPMENT LEASING CONCEPT
Comdisco has developed a cross-border equipment
leasing transaction that produces permanent U.S. tax
savings through the advantageous use of U.S. tax rules
concerning the acceleration of taxable income from rents.
Unlike most Western countries, the United States
treats as taxable income any amounts received as prepaid
rent or as proceeds from a sale, without recourse, of a
stream of rental payments. These amounts are income even
though they are unearned and are attributable to future
years.
2
Comdisco had entered into transactions similar to the
transaction at issue in these cases. Prior transactions involved
the participation of the following four partnerships: Fillupar
Leasing (1991); Astropar Leasing (1991); Compupar Leasing (I)
(1992); and Compupar Leasing (II) (1992).
- 11 As will be shown below, the unusual U.S. treatment
of these income amounts creates an opportunity for an
“arbitrage” between the U.S. tax system and that of
another country (such as Belgium) which does not treat
the amounts as currently taxable income.
The essential elements of the transaction are as
follows:
1.
Two Belgian individuals, with experience in all
aspects of the leasing business, purchase a portfolio of
U.S. computer equipment from Comdisco, Inc. (“Comdisco”).
The purchase is made through an entity that is treated as
a partnership for U.S. tax purposes (the “Partnership”).
The equipment is immediately leased back to Comdisco,
which in turn subleases the equipment to its customers,
the users of the equipment. Neither the Partnership nor
its partners are subject to U.S. tax.
2.
Subsequently, the Partnership sells to a bank
the right to receive the rents payable by Comdisco under
the lease.
The sale of the Comdisco rent stream is
without recourse to either the Partnership or to the
equipment. Accordingly, from a U.S. point of view, all
of the rental income from the Comdisco lease is deemed to
have been accelerated. Stated another way, the sale of
the rent stream removes or “strips” the rental income
from the leased equipment.
3.
At a later date, but without any prior
commitment (formal or informal) to do so, a U.S. company
may acquire a 98% interest in the Partnership, utilizing
certain provisions of the U.S. tax code under which tax
attributes carry over to the new owner.
4.
The U.S. company, as 98% partner, would be
entitled to depreciation with respect to 98% of the cost
of the equipment. No rental income would be reportable
by the U.S. company, that income having been accelerated
into the tax period prior to the U.S. company’s becoming
a partner.
5.
The resulting U.S. tax savings from the
depreciation would be permanent tax savings, not mere
deferrals. They would be reflected in reported earnings.
The law firm of Baker & McKenzie provided Comdisco with legal
services related to the sale-leaseback transactions.
- 12 III. Negotiations
A.
CIG’s Initial Discussions With Norwest and NEFI
In June 1993, representatives from CIG (Mr. Trznadel, Mr.
Snyder, and Ms. Ortmann), Norwest (Mr. Vandermark), NEFI (Ms.
Grossman), and Peat Marwick met to discuss a cross-border equipment
leasing transaction involving a portfolio of IBM computer equipment
(ultimately, the sale-leaseback transaction involved herein).
At
this meeting, representatives of CIG made a presentation from a
paper (entitled “Equipment Leasing Proposal” (the Proposal)), and
various flowcharts that outlined the elements and tax benefits of
a proposed cross-border equipment leasing transaction.
Following the June presentation by CIG, Ms. Grossman requested
additional information from Comdisco. On July 6, 1993, Ms. Ortmann
sent Ms. Grossman an economic analysis of a hypothetical saleleaseback transaction involving a $75 million portfolio of computer
equipment.3
On August 3, 1993, Ms. Ortmann provided Ms. Grossman
with sample documents (including a contract for sale of equipment,
lease, notes, security agreements, and a contract for sale of the
lease receivable) which could be used in connection with a proposed
cross-border equipment leasing transaction.
Ms. Grossman gave
these documents to NEFI’s attorneys for their review. Ms. Grossman
also
requested,
3
by
interoffice
memo,
that
the
articles
of
The economic analysis of a $75 million portfolio shows
a cash investment by the 98-percent shareholder of $9,252,693 and
a pretax profit of 6.1 percent using an estimated residual value
on the lease termination date of $22,754,717.
- 13 incorporation of a then-dormant corporation, known as Radio Dealers
Leasing, Inc.,4
be
amended
so
as
to
change
corporation to RD Leasing, Inc. (RD Leasing).5
the
name
of
the
RD Leasing was to
become the U.S. company involved in the sale-leaseback transaction
which is the subject of this litigation.
On August 6, 1993, Ms. Ortmann provided Ms. Grossman with a
portfolio of computers owned by Comdisco valued at $94 million
which could be the subject of a cross-border equipment leasing
transaction.
The
equipment
Comdisco
proposed
to
sell
and
simultaneously lease back was subject to existing leases between
Comdisco (as lessor) and others (i.e., large corporations and
institutions) as end users.
The equipment was also subject to
existing liens securing nonrecourse loans.
Some of the existing
leases required the consent of the end user to any sale of the
equipment by Comdisco.
A draft of a letter to one of the end
users, dated August 30, 1993, requested written consent to a sale
of the equipment to Norwest Bank Corp. and assured that the
“transfers are subject, subordinate to and in no way alter your
rights under the Lease.
Comdisco remains responsible for all of
its obligations as Lessor of the Equipment to the same extent as if
the transfers had not occurred.”
Letters dated September 7, 1993,
4
Radio Dealers Leasing, Inc., was organized as a
corporation under Minnesota law on Apr. 20, 1988.
5
NEFI owned all the common stock of RD Leasing during
the years in issue and through the dissolution of RD Leasing in
1997.
- 14 to two end users requested written consent for a sale to “a bank
with a combined capital and surplus of at least $50,000,000”.
A
letter to another end user stated that the sale was to a Wyoming
limited liability company.
The letters to the end users also
stated that Comdisco had the option to repurchase the equipment at
the end of the lease and “expect[ed] to do so”.
On August 30, 1993, Ms. Grossman faxed CIG Norwest’s credit
standards for end users of the equipment.6
B.
NEFI’s Credit Approval Presentation
Mark Valentine, assistant vice president of credit for NEFI,
managed a staff of credit analysts and officers.
His role in the
sale-leaseback transaction involved herein was limited to reviewing
Comdisco’s creditworthiness and ability to service any acquired
portfolio of leased computers.
On September 2, 1993, having received information regarding
the proposed sale-leaseback transaction from Ms. Grossman, Mr.
Valentine authorized a “Transaction Credit Analysis”, referred to
within NEFI as a “Credit Approval Presentation” (CAP).
The stated
purpose of the CAP was to review “Comdisco’s ability to service an
acquired portfolio and, in the event of a sub-leasee default,
replace equipment leases.” The CAP emphasized that the risk of the
6
The creditworthiness of the end user was important
because the computers sold (as well as the rents due Comdisco
from the end users) had been used by Comdisco as collateral to
secure its own loans and were subject to the existing liens.
Ms. Grossman, however, did not inquire into the amounts of the
existing liens, and that information was not provided to her.
- 15 transaction was rated “purely on the credit of Comdisco and not on
the risks inherent in this tax advantaged lease transaction”.
The CAP stated in relevant part: “All credit and tax risks
will be assumed by Norwest Tax Department”; NEFI’s role would be
“that of consultant”; and NEFI would be paid a fee for its
services.
The
CAP
also
contained
a
“Collateral”
section,
reflecting that “Limited value is placed upon the collateral with
the transaction’s purpose being tax driven and subject to Norwest
Tax Department approval.
However, there is upside potential for
the benefit of Norwest Corporation.”
The CAP further stated that
“Credit risk is considered remote based upon Comdisco’s credit,
substantial underlying lessees and short 36 month term.”7
Because Mr. Vandermark was head of the Norwest tax department,
his signature was required on all CAPs involving sale-leaseback
transactions.
Mr. Vandermark had to verify that Norwest had
taxable income sufficient to use the desired tax benefits.
Various Norwest and NEFI officers signed the CAP; the last
signature
7
was
dated
September
21,
1993.
The
CAP
approved
According to Mr. Vandermark and Mr. Renner, president
of NEFI, all sale-leaseback transactions have substantial tax
benefits; the “upside potential” (as referred to in the CAP) was
“in the residuals”. According to Ms. Grossman, the CAP’s
reference to “tax driven” meant that there were tax benefits
associated with the proposed sale-leaseback transaction and that
there was “residual upside”, meaning that the residual value of
the computers could produce a substantial economic profit.
- 16 Comdisco’s credit rating but did not commit Norwest, NEFI, or RD
Leasing to enter into the sale-leaseback transaction involved
herein.
C.
Financial Projections and Appraisals
CIG had a contract with Marshall & Stevens (M&S) pursuant to
which M&S agreed to provide appraisal reports for the computer
equipment in Comdisco’s portfolio. M&S agreed to perform quarterly
appraisals for $1,500 per quarter and to submit to CIG reports
derived from these quarterly appraisals at $300 per report.
sent the reports to James Hastings, a CIG executive.
prepared
financial
analyses
(including
the
M&S
Mr. Hastings
modeling
of
the
economics of transactions CIG proposed), handled various accounting
issues, and worked with appraisers.
When
the
sale-leaseback
transaction
involved
herein
was
proposed, Mr. Hastings used the M&S report to interpolate the
values stated therein to arrive at values relevant to the specific
dates in
the
proposed
transaction.
He
then
presented
these
interpolated numbers to Greg Barwick, one of M&S’s appraisers.8
CIG had a letter, dated September 25, 1993, delivered by
messenger to Ms. Grossman, as well as Messrs. Beadie and Steffen.
That letter included red-lined drafts of the documents for the
8
Mr. Hastings prepared an equipment schedule with
current and projected residual values to verify that the numbers
were still “in force as of the date of the transaction in case
the transaction date fell between a couple of quarters”. Mr.
Barwick used Mr. Hastings’ equipment schedule to write his
appraisal report.
- 17 proposed
sale-leaseback
transaction,
as
well
as
a
financial
analysis (the September Projections), which consisted of economic
projections relating to the transaction:
one projection was
premised upon the assumption that Comdisco would exercise an early
termination
option,9
while
the
other
assumption that Comdisco would not.
was
premised
upon
the
The assumptions as to the
residual values were identical to the forecasts set forth in the
appraisal of the equipment dated September 28, 1993, provided by
M&S.
The following charts set forth the economic projections with
respect to the proposed purchasing partnership (charts 1-8) and to
the proposed U.S. company partner (charts 9-12):
9
Early termination dates and final termination dates
were specified in the documents.
- 18 Chart 1
Computation of Partnership Taxable Income With Estimated Residual Value Proceeds
(Assumes Full Term)
Interest Expense
Year
Sale Rent
Additional
Depreciation
Install.
Ending
Receivable
Fixed Rent
Deduction
Bank Loan
Note
11/28/93
$87,793,608
-0-
-0-
($106,409)
($364,289)
12/31/93
-0-
-0-
($6,120,788)
-0-
12/31/94
-0-
-0-
(46,517,990)
-0-
12/31/95
-0-
-0-
(27,910,794)
-0-
12/31/96
12/31/97
-0-0-
$19,385,022
(16,746,476)
6,003,302
(25,119,714)
Total
87,793,608
(106,409)
25,388,324 (122,415,762)
Balloon
Residual
Taxable
Note
Income
Income(Loss)
($300,982)
-0-
$87,021,928
-0-
(305,514)
-0-
(6,426,302)
-0-
(1,932,141)
-0-
(48,450,131)
-0-
(2,113,390)
-0-
(30,024,183)
-0-
-0-
(2,158,409)
-0-
480,136
-0-
-0-
(335,666)
$25,418,982
5,966,904
(364,289)
(7,146,103)
25,418,982
8,568,352
Chart 2
Computation of Partnership Cash Flow With Estimated Residual Value Proceeds
(Assumes Full Term)
Debt Service
Year
Ending
11/28/93
Equipment
Purchase
Bank Loan
($122,415,762) $14,995,931
Install.
Balloon
Note
Note
($364,289) $19,990,512
Sale Rent
Additional
Residual
Pretax
Receivable
Fixed Rent
Income
Cash Flow
$87,793,608
-0-
-0-
-0-
12/31/93
-0-
(15,102,340)
-0-
-0-
-0-
-0-
-0-
($15,102,340)
12/31/94
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
12/31/95
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
12/31/96
-0-
-0-
-0-
(4,819,668)
-0-
$19,385,022
-0-
14,565,354
12/31/97
Total
-0(122,415,762)
-087,793,608
6,003,302
25,388,324
$25,418,982
25,418,982
9,105,338
8,568,352
0(106,409)
-0(22,316,947)
(364,289) (7,146,103)
- 19 Chart 3
Computation of Partnership Taxable Income Without Estimated Residual Value Proceeds
(Assumes Full Term)
Interest Expense
Year
Sale Rent
Additional
Depreciation
Install.
Ending
Receivable
Fixed Rent
Deduction
Bank Loan
Note
11/28/93
$87,793,608
-0-
-0-
($106,409)
($364,289)
12/31/93
-0-
-0-
($6,120,788)
-0-
12/31/94
-0-
-0-
(46,517,990)
-0-
12/31/95
-0-
-0-
(27,910,794)
-0-
12/31/96
12/31/97
-0-0-
$19,385,022
(16,746,476)
6,003,302
(25,119,714)
Total
87,793,608
(106,409)
25,388,324 (122,415,762)
Balloon
Balloon Note
Taxable
Note
COD Income
Income(Loss)
($300,982)
-0-
$87,021,928
-0-
(305,514)
-0-
(6,426,302)
-0-
(1,932,141)
-0-
(48,450,131)
-0-
(2,113,390)
-0-
(30,024,183)
-0-
-0-
(2,158,409)
-0-
480,136
-0-
-0-
(335,666)
$20,335,186
883,108
(364,289)
(7,146,103)
20,335,186
3,484,555
Chart 4
Computation of Partnership Cash Flow Without Estimated Residual Value Proceeds
(Assumes Full Term)
Debt Service
Year
Ending
11/28/93
Equipment
Purchase
Bank Loan
($122,415,762) $14,995,931
Install.
Balloon
Note
Note
($364,289) $19,990,512
Sale Rent
Additional
Residual
Pretax
Receivable
Fixed Rent
Income
Cash Flow
$87,793,608
-0-
-0-
-0-
12/31/93
-0-
(15,102,340)
-0-
-0-
-0-
-0-
-0-
($15,102,340)
12/31/94
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
12/31/95
-0-
-0-
-0-
-0-
-0-
-0-
-0-
-0-
12/31/96
-0-
-0-
-0-
(4,819,668)
-0-
$19,385,022
-0-
14,565,354
12/31/97
Total
-0(122,415,762)
-0(364,289)
(1,981,761)
13,189,083
-087,793,608
6,003,302
25,388,324
-0-0-
4,021,541
3,484,555
0(106,409)
- 20 Chart 5
Computation of Partnership Taxable Income With Estimated Residual Value Proceeds
(Assumes Early Termination)
Interest Expense
Year
Sale Rent
Depreciation
Ending
11/28/93
Receivable
$87,793,608
Deduction
-0-
Bank Loan
($106,409)
Residual &
Install.
Balloon
Early Term.
Taxable
Note
($364,289)
Note
($300,982)
Penalty
-0-
Income (Loss)
$87,021,928
12/31/93
-0-
($6,120,788)
-0-
-0-
(305,514)
-0-
(6,426,302)
12/31/94
-0-
(46,517,990)
-0-
-0-
(1,932,141)
-0-
(48,450,131)
12/31/95
-0-
(27,910,794)
-0-
-0-
(2,113,390)
-0-
(30,024,183)
12/31/96
-0-
(41,866,191)
-0-
-0-
(940,072)
$44,619,804
1,813,541
Total
87,793,608
122,415,762
(106,409)
(364,289)
(5,592,099)
44,619,804
3,934,853
Chart 6
Computation of Partnership Cash Flow With Estimated Residual Value Proceeds
(Assumes Early Termination)
Debt Service
Year
Equipment
Install.
Balloon
Sale Rent
Early Term.
Pretax
Ending
11/28/93
Purchase
($122,415,762)
Bank Loan
$14,995,931
Note
($364,289)
Note
$19,990,512
Receivable
$87,793,608
Penalty
-0-
Cash Flow
-0-
12/31/93
-0-
(15,102,340)
-0-
-0-
-0-
-0-
($15,102,340)
12/31/94
12/31/95
-0-0-
-0-0-
-0-0-
-0-0-
-0-0-
-0-0-
-0-0-
12/31/96
Total
-0(122,415,762)
-0(364,289)
(25,582,611)
(5,592,099)
-087,793,608
$44,619,804
44,619,804
19,037,193
3,934,853
-0(106,409)
- 21 Chart 7
Computation of Partnership Taxable Income Without Estimated Residual Value Proceeds
(Assumes Early Termination)
Interest Expense
Year
Sale Rent
Depreciation
Ending
Receivable
$87,793,608
Deduction
-0-
Bank Loan
($106,409)
11/28/93
Install.
Balloon
Early Term.
Taxable
Note
($364,289)
Note
($300,982)
Penalty
-0-
Income (Loss)
$87,021,928
12/31/93
-0-
($6,120,788)
-0-
-0-
(305,514)
-0-
(6,426,302)
12/31/94
-0-
(46,517,990)
-0-
-0-
(1,932,141)
-0-
(48,450,131)
12/31/95
-0-
(27,910,794)
-0-
-0-
(2,113,390)
-0-
(30,024,183)
12/31/96
-0-
(41,866,191)
-0-
-0-
(940,072)
$25,926,467
(16,879,796)
Total
87,793,608
122,415,762
(106,409)
(364,289)
(5,592,099)
25,926,467
(14,758,484)
Chart 8
Computation of Partnership Cash Flow Without Estimated Residual Value Proceeds
(Assumes Early Termination)
Debt Service
Year
Equipment
Install.
Balloon
Sale Rent
Early Term.
Pretax
Ending
11/28/93
Purchase
($122,415,762)
Bank Loan
$14,995,931
Note
($364,289)
Note
$19,990,512
Receivable
$87,793,608
Penalty
-0-
Cash Flow
-0-
12/31/93
-0-
(15,102,340)
-0-
-0-
-0-
-0-
($15,102,340)
12/31/94
12/31/95
-0-0-
-0-0-
-0-0-
-0-0-
-0-0-
-0-0-
-0-0-
12/31/96
Total
-0(122,415,762)
-0(364,289)
(25,582,611)
(5,592,099)
-087,793,608
$25,926,467
25,926,467
343,856
(14,758,484)
-0(106,409)
- 22 Chart 9
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow With Estimated Residual Value Proceeds
(Assumes Full Term)
Cash Flow
Taxable Income
Share of
Preferred Stock
Year
From
Taxes
Partnership
Dividend/
Pre-Tax
Taxes
After-Tax
Ending
Partnership
(Paid) Saved
Cash Flow
Redemption
Cash Flow
(Paid) Saved
Cash Flow
12/31/93
($6,297,776)
$2,376,151
($14,800,293)
-0-
($14,800,293)
$2,376,151
($12,424,142)
12/31/94
(47,481,128)
17,914,630
-0-
($48,966)
(48,966)
17,914,630
17,865,663
12/31/95
(29,423,700)
11,101,562
-0-
(48,966)
(48,966)
11,101,562
11,052,596
12/31/96
12/31/97
470,533
5,847,566
(177,532)
(2,206,287)
14,274,047
8,923,231
(48,966)
(48,966)
14,225,081
8,874,265
(177,532)
(2,206,287)
14,047,549
6,667,978
12/31/98
-0-
-0-
-0-
(661,045)
(661,045)
-0-
Total
(76,884,505)
29,008,524
8,396,985
(856,910)
7,540,074
29,008,524
(661,045)
36,548,598
Chart 10
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow Without Estimated Residual Value Proceeds
(Assumes Full Term)
Cash Flow
Share of
Preferred Stock
Year
Taxable Income
From
Taxes
Partnership
Dividend/
Pre-Tax
Taxes
After-Tax
Ending
Partnership
(Paid) Saved
Cash Flow
Redemption
Cash Flow
(Paid) Saved
Cash Flow
12/31/93
($6,297,776)
$2,376,151
($14,800,293)
-0-
($14,800,293)
$2,376,151
($12,424,142)
12/31/94
(47,481,128)
17,914,630
-0-
($48,966)
(48,966)
17,914,630
17,865,663
12/31/95
(29,423,700)
11,101,562
-0-
(48,966)
(48,966)
11,101,562
11,052,596
12/31/96
12/31/97
470,533
865,445
(177,532)
(326,533)
14,274,047
3,941,110
(48,966)
(48,966)
14,225,081
3,892,144
(177,532)
(326,533)
14,047,549
3,565,611
12/31/98
-0-
-0-
-0-
(661,045)
(661,045)
-0-
Total
(81,866,625)
30,888,278
3,414,864
(856,910)
2,557,954
30,888,278
(661,045)
33,446,232
- 23 Chart 11
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow With Estimated Residual Value Proceeds
(Assumes Early Termination)
Cash Flow
Taxable Income
Share of
Preferred Stock
Year
From
Taxes
Partnership
Dividend/
Pre-Tax
Taxes
After-Tax
Ending
Partnership
(Paid) Saved
Cash Flow
Redemption
Cash Flow
(Paid) Saved
Cash Flow
12/31/93
($6,297,776)
$2,376,151
($14,800,293)
-0-
($14,800,293)
$2,376,151
($12,424,142)
12/31/94
(47,481,128)
17,914,630
-0-
($48,966)
(48,966)
17,914,630
17,865,663
12/31/95
(29,423,700)
11,101,562
-0-
(48,966)
(48,966)
11,101,562
11,052,596
12/31/96
12/31/97
1,440,292
-0-
(543,422)
-0-
18,319,471
-0-
(48,966)
(48,966)
18,270,504
(48,966)
(543,422)
-0-
17,727,082
(48,966)
12/31/98
-0-
-0-
-0-
(661,045)
(661,045)
-0-
Total
(81,762,312)
30,848,920
3,519,177
(856,910)
2,662,267
30,848,920
(661,045)
33,511,187
Chart 12
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow Without Estimated Residual Value Proceeds
(Assumes Early Termination)
Cash Flow
Share of
Preferred Stock
Year
Taxable Income
From
Taxes
Partnership
Dividend/
Pre-Tax
Taxes
After-Tax
Ending
Partnership
(Paid) Saved
Cash Flow
Redemption
Cash Flow
(Paid) Saved
Cash Flow
12/31/93
($6,297,776)
$2,376,151
($14,800,293)
-0-
($14,800,293)
$2,376,151
($12,424,142)
12/31/94
(47,481,128)
17,914,630
-0-
($48,966)
(48,966)
17,914,630
17,865,663
12/31/95
(29,423,700)
11,101,562
-0-
(48,966)
(48,966)
11,101,562
11,052,596
12/31/96
12/31/97
(16,879,179)
-0-
6,368,514
-0-
-0-0-
(48,966)
(48,966)
(48,966)
(48,966)
6,368,514
-0-
6,319,548
(48,966)
12/31/98
-0-
-0-
-0-
(661,045)
(661,045)
-0-
(661,045)
Total
(100,081,783)
37,760,857
(14,800,293)
(856,910)
(15,657,204)
37,760,857
22,103,653
- 24 Ms.
September
Grossman
reviewed
Projections
the
September
specifically
Projections.
forecasted
that:
The
(1)
If
Comdisco exercised an early termination option under the lease, the
partnership would get a pretax return of 9.0 percent, and RD
Leasing would get a pretax return of 6.6 percent and an after-tax
return of 101.5 percent; and (2) if Comdisco exercised a final
termination option under the lease, the partnership would get a
pretax return of 15.1 percent, and RD Leasing would get a pretax
return of 14.0 percent and an after-tax return of 99.5 percent.
A copy of the M&S appraisal report dated September 28, 1993,
was given to Ms. Grossman.
CIG provided two additional appraisal
reports, also dated September 28, 1993, one from Manufacturers’
Appraisal
Co.
(MAC)
and
the
other
from
Appraisal
Resources
International (ARI).
CIG paid for the M&S, MAC, and ARI appraisals.10
Ms. Grossman
was aware that the residual value forecasts of the IBM mainframe
computers in the M&S, MAC, and ARI appraisal reports were higher
than those of industry publishers, such as Daley Marketing Corp.
(DMC), International Data Corp. (IDC), and the Gartner Group.
the basis
of
her
own
experience,
Ms.
forecasts
of
IDC
and
the
Group
Gartner
Grossman
tended
believed
to
be
On
that
overly
conservative.
10
According to Ms. Grossman, Ms. Ortmann, Mr. Renner, and
petitioners’ expert Thompson Ryan, it is common for the packager
of a leasing transaction (here, CIG) to pay the appraisal fees.
- 25 The following reflects the projected residual values of the
equipment at the early and final termination dates, as set forth in
the M&S, MAC, and ARI appraisal reports:
Early termination
Final termination
M&S
MAC
ARI
$44,275,948
25,418,982
$48,442,600
34,257,000
$45,334,670
26,769,965
Ms. Grossman provided copies of the three appraisal reports to
NEFI’s attorneys, Messrs. Beadie and Steffen.
Ms. Grossman discussed the proposed returns of the transaction
with Mr. Vandermark, who in turn discussed them with Mr. Thornton
(Norwest’s chief financial officer).
Mr. Thornton subsequently
approved the transaction.
D.
The Foreign Investors
As outlined in the materials provided to Norwest in June 1993,
CIG had discussions with potential Swiss investors, Hans Humbel and
Egon Riesterer, regarding the possibility of their involvement in
a
sale-leaseback
transaction.
Messrs.
Humbel
and
Riesterer
proposed to form an entity called Intared for this purpose.
On
September 14, 1993, Comdisco sent Ms. Grossman and Faegre & Benson
copies
of
“Articles
Liability Company”.
and
Riesterer,
of
Organization
for
Intared
I,
Limited
Comdisco’s negotiations with Messrs. Humbel
however,
terminated
in
September
1993
because
Comdisco was unwilling to sign the tax indemnity agreement they
had proposed.
Immediately thereafter, CIG sought other foreign
investors to complete the transaction.
- 26 Richard Temko is an American attorney with an office in
Brussels, Belgium. CIG’s executive vice president (Mr. Snyder) was
acquainted with Mr. Temko.
Baudouin Parmentier and Frederic de la
Barre d’Erquelinnes are citizens and residents of Belgium.11
Mr.
Temko introduced Mr. Parmentier to Mr. Snyder, and Mr. Parmentier
engaged Mr. Temko as his legal adviser to represent him in the
transactions at issue in this case.
On September 15, 1993, Mr. Snyder sent a memorandum (by
facsimile)
to
Mr.
Temko
describing
a
possible
cross-border
equipment leasing transaction, along with flowcharts, in which Mr.
Parmentier would exchange an interest in a limited liability
company (ultimately, Andantech) for preferred stock to be issued by
a “U.S. Company” (ultimately, the preferred stock of RD Leasing).
The next day, although negotiations were ongoing with NEFI, Mr.
Snyder sent a second memorandum and summary sheet to Mr. Temko,
which stated that “No U.S. company has made any commitment to enter
into the exchange * * * and there can be no assurance any such U.S.
11
Neither Mr. Parmentier nor Mr. de la Barre
d’Erquelinnes was subject to our jurisdiction, and neither
appeared at trial. However, Mr. Parmentier agreed to be deposed
on May 4, 2000 (and to be interviewed on May 5, 2000), in
Brussels. The parties stipulated that had Mr. Parmentier
testified at trial, his testimony would be as set forth in the
transcript (including exhibits) of his May 4, 2000, deposition,
and the transcript (including exhibits) of his May 5, 2000,
interview.
We have examined the transcripts of Mr. Parmentier’s
deposition and interview and find many of his statements are
unsupported by other evidence in the record.
Mr. de la Barre d’Erquelinnes was neither deposed nor
interviewed.
- 27 company
will
be
found.”
Mr.
Parmentier
was
interested
in
participating in the transaction but was concerned about his
potential tax liability, as well as the financial risk.
On September 17, 1993, Mr. Temko sent a letter (by facsimile)
from Mr. Parmentier to Comdisco “confirming the terms upon which he
and his co-investor are prepared to participate in the proposed
transaction.”
letter.
Mr. Temko requested that Comdisco countersign the
Mr. Parmentier’s conditions included assurances from
Comdisco that if the transaction did not proceed as reflected in
the flowcharts, then Mr. Parmentier and his partner could (1)
promptly recover their $200,000 investment, (2) withdraw from
Andantech at no expense, (3) incur no potential liability for
Andantech debts, and (4) incur no potential liability in connection
with managing Andantech. Further, Mr. Parmentier asked Comdisco to
provide assurances that he would be able to exchange his interest
for preferred stock on the basis described in the flowcharts and
realize
the
full
value
of
the
preferred
stock
“without
any
significant risk of impairment”. Mr. Snyder advised Mr. Parmentier
that Comdisco could not make the requested assurances. However, by
letter dated September 24, 1993, Mr. Snyder confirmed to Mr.
Parmentier:
there will be no impediment to the sale of the preferred
shares at any time such a sale should be desired. (It
would be appreciated, from a tax point of view, if no
sale were arranged for one year, but no such legal
restriction would exist.)
Let me also confirm that, if the U.S. Company
- 28 defaulted on dividends (or redemption), the preferred
shareholder(s) would take over voting control of U.S.
Company. This, in turn, would trigger the “excess loss
account” of U.S. Company (that is, the excess of tax
losses previously claimed from this transaction over the
parent company's investment in the U.S. Company) as
immediate taxable income of the parent. (This would be
a disaster since it plans to never have to trigger the
excess loss account). * * *
On September 25, 1993, Barbara Spudis with Baker & McKenzie
faxed to the firm’s Amsterdam office an urgent request for answers
to questions posed by Mr. Temko.
The fax stated in part:
The client [Comdisco] is planning to close the
transaction involving the LLC on Tuesday, September 28,
1993. At the last minute, the two original investors
(Swiss individuals) in the transaction appear to have
backed out, and now the client is attempting to replace
them with two Belgian individuals. In order to do so, we
are attempting to describe the entire transaction and
satisfy their counsel as to the minimal risks associated
with the transaction on a rush basis. * * *
*
*
*
*
*
*
*
To give you more information about the transaction
I am attaching a description of the facts which was
prepared when Swiss involvement was contemplated. * * *
The
entire
transaction
is
expected
to
involve
approximately $120 million. Basically, the individuals
forming the company are involved for two months during
which the income allocation occurs and then the interest
is transferred to the U.S. corporate investor who reaps
the benefit of ongoing depreciation deductions.
IV.
Formation of Andantech and the Sale-Leaseback (Appendixes A,
B, and C)
Andantech’s articles of organization were signed on September
25, 1993, by Ms. Spudis and Regina Howell, also of the Baker &
McKenzie law firm, and the certificate of organization was issued
by the Wyoming secretary of state on September 27, 1993.
- 29 On September 27, 1993, Mr. Snyder, Ms. Ortmann, and Mr.
Trznadel flew to Minneapolis to meet with Messrs. Beadie and
Steffen (NEFI’s attorneys) to discuss the “red-lined drafts” of the
documents. During the meeting, Messrs. Beadie and Steffen provided
CIG with their changes to the drafts.
On September 27, 1993, Mr. Parmentier contributed $196,000 to
the capital of Andantech (Mr. Parmentier borrowed the entire amount
from Banque Internationale de Luxembourg), and Mr. de la Barre
d’Erquelinnes contributed $4,000 to the capital of Andantech (the
source of
funds
for
Mr.
de
la
Barre
d’Erquelinnes’s
contribution is not reflected in the record).
capital
Andantech retained
N.V.O. Computerleasing B.V. (NVO), a Dutch corporation directed by
Nicholas van Onselen, as its first manager.12
A Dutch corporation
was chosen to avoid conducting any business activity in the United
States or Belgium.
The operating agreement of Andantech, dated September 28,
1993,
provided
for
a
priority
return
for
d’Erquelinnes (or his successor in interest).
Mr.
de
la
Barre
Specifically, the
agreement provided that if, at the time of a distribution from the
partnership,
Mr.
de
la
Barre
d’Erquelinnes
had
made
capital
contribution other than his initial capital contribution of $4,000,
then distributions were to be made first to him in an amount equal
to
his
12
priority
return
(6
percent
of
his
unreturned
capital
In subsequent years, its managers were James Fetzer and
Andrew Rupprecht, NEFI employees.
- 30 compounded monthly) plus his unreturned capital.
would
then
be
made
unreturned capital.
to
Mr.
Parmentier
to
the
Distributions
extent
of
his
Any remaining amount would be distributed
among the members in proportion to their percentage interests.
Mr. Snyder did not disclose the identity of the foreign
investors to Ms. Grossman or to other NEFI representatives, nor did
he disclose the identity of the U.S. company to Mr. Parmentier.
In
October or November 1993, Ms. Grossman learned that Mr. Parmentier
was a partner in Andantech; in November 1993, Messrs. Steffen and
Beadie learned Mr. Parmentier’s identity.
On September 28, 1993, Andantech and Comdisco executed an
“Equipment
Purchase
Agreement”
(the
purchase
agreement),
an
“Equipment Lease” (the equipment lease), and other documents, which
memorialized the sale-leaseback of 40 IBM mainframe computers (the
equipment) then owned by Comdisco.
At the time the purchase
agreement was executed, the equipment was under lease to various
end users.
Pursuant to the purchase agreement, the equipment was
sold subject to the user leases and liens in favor of different
Comdisco lenders.
A.
The Purchase Price
The purchase price for the equipment was $122,415,762; the
purchase price was paid: (1) $14,995,931 in cash, which Union Bank
of Switzerland (UBS) lent to Andantech (the bank loan); and (2) the
$107,419,831 balance, by Andantech’s notes, consisting of (i) a
series of nine junior nonrecourse balloon notes (junior promissory
- 31 notes
2a-2i,
referred
to
as
the
balloon
notes)
aggregating
$19,990,51213 (the balloon notes, documenting the balloon loan), and
(ii) a junior recourse note in the amount of $87,429,31914 (the term
note, documenting the term loan). The bank loan, the balloon loan,
and the term loan all were tied to the equipment lease.
B.
The Equipment Lease
Immediately after purchasing the equipment, Andantech leased
such equipment to Comdisco pursuant to the equipment lease; this
was a net lease.
The equipment consisted of 40 IBM mainframe
computers and associated ancillary equipment.
There were nine
different models–-four were IBM 9121s and five were IBM 9021s (the
IBM 9021s were larger and more powerful than the IBM 9121s).
The
equipment lease separated the equipment into nine categories (A
through I) by model type.
Equipment in categories A through D
included the IBM 9121s and equipment in categories E through I
included the IBM 9021s.
The term of the equipment lease varied
from 41 to 47 months, depending upon the category of equipment.
During the term of the lease, Comdisco could, at its expense,
add or install upgrades on the equipment.
Any upgrade did not
13
Interest accrued on the principal at 9 percent per
annum, compounded monthly. Accrued interest was payable at
maturity.
14
Principal and interest were payable in monthly
installments equal to the monthly rent due from Comdisco before
the early termination date under the lease. Interest was payable
on the principal at 5 percent per annum, compounded monthly,
subject to any increase in rent as provided in the lease.
- 32 become an accession to the equipment and did not become the
property of Andantech.
Comdisco had an option (the final termination option) to
purchase the equipment at the end of the term of the equipment
lease at market value (as defined in the equipment lease).
If
Comdisco installed any upgrades and did not exercise the final
termination option, Comdisco was required to either remove the
upgrade or consent to Andantech’s sale or re-lease of the equipment
with
the
upgrade.
If,
after
termination
of
the
lease,
the
equipment with one or more upgrades was sold or re-leased to a
party other than Comdisco, Andantech would receive the portion of
the proceeds determined by multiplying the amount of the proceeds
by a fraction, the numerator of which would be the fair market
value of the equipment without the upgrades as of the date of the
sale or re-lease and the denominator of which would be the fair
market value of the equipment with the upgrades as of such date.
Comdisco was limited in its ability to selectively exercise
the final termination option.
If Comdisco elected to exercise the
final termination option for any of the equipment in categories A
through D, it had to do so for all equipment in those categories.
Similarly, if Comdisco elected to exercise the final termination
option for any of the equipment in categories E through I, it had
to do so for all equipment in those categories.
Comdisco also had an option (the early termination option) to
terminate the equipment lease with respect to each category of
- 33 equipment
(and
to
purchase
the
equipment)
on
certain
early
termination dates by paying to Andantech an amount equal to an
“early termination supplement” specified in the equipment lease for
that category of equipment plus the greater of (i) the then value
of the equipment in that category or (ii) the principal and accrued
interest
on
the
balloon
note
for
that
category.
The
early
termination option was limited in a manner identical to the final
termination option; i.e., if Comdisco elected to exercise the early
termination option for any of the equipment in categories A through
D, it had to do so for all such equipment.
Similarly, if Comdisco
elected to exercise the early termination option for any of the
equipment in categories E through I, it had to do so for all such
equipment.
Comdisco’s early termination option was subject to a further
restriction in that, unless the UBS bank loan (secured in part by
the rent
due
after
the
early
termination
date)
was
prepaid,
Comdisco could not exercise the early termination option without
Andantech's approval.
The purchase price, termination date, early
termination
date,
termination
supplement
follows:
early
of
termination
the
stated
equipment
by
value,
and
category
early
were
as
- 34 Computation of Fair Market Value Sales Price and Early Termination Values & Supplements
Lease
Type/Model/
List
FMV
Early Termination
Sale
Stated Value
Category
(LP)
% of LP
(SP)
Date
Mos.
Date
% of SP
Amount
% of SP
Amount
9021/720/E
$35,412,247
18%
$6,374,205
2/27/97
41
5/27/96
21.59%
$1,376,191
0.28%
$17,848
9021/740/F
12,336,045
36
4,440,976
2/27/97
41
5/27/96
20.00
888,195
0.28
12,435
9021/820/G
68,624,690
36
24,704,888
2/27/97
41
5/27/96
20.00
4,940,978
0.28
69,174
9021/860/H
40,808,478
36
14,691,052
2/27/97
41
5/27/96
20.00
2,938,210
0.28
41,135
9021/900/I
139,926,914
36
50,373,689
2/27/97
41
5/27/96
20.00
10,074,738
0.28
Total 9021
297,108,375
100,584,810
20,218,312
141,046
281,638
9121/260/A
4,637,115
53
2,457,672
7/27/97
46
9/27/96
23.23
570,917
0.28
6,881
9121/320/B
18,186,545
49
8,911,407
8/27/97
47
10/27/96
24.72
2,202,900
0.29
25,843
9121/440/C
6,923,363
49
3,392,448
8/27/97
47
10/27/96
24.72
838,613
0.29
9,838
9121/480/D
14,427,399
49
7,069,425
8/27/97
47
10/27/96
24.72
1,747,562
0.29
20,501
Total 9121
44,174,422
21,830,952
5,359,992
63,063
Total all models
341,282,796
122,415,762
$25,578,304
344,701
- 35 Rents payable under the equipment lease before the early
termination dates were subject to periodic adjustments to the
extent that prevailing market rates during the equipment lease term
increased or decreased from time to time above or below the rates
that were reflected in the original rent schedule.
Comdisco had
the right, on any rent payment date that occurred more than 5
months after the commencement of the equipment lease, to prepay (on
a present value basis) certain of the then-remaining installments
of rent.
Pursuant to the terms of the equipment lease and the term
loan, for each category of the equipment, rents due to Andantech
from Comdisco were equal to the payments under the term loan due
from Andantech to Comdisco before the early termination date.
The leases with the end users were unaffected by the equipment
lease.
When the initial subleases with the end users expired,
Comdisco had the right to re-lease the equipment.
Comdisco
agreed
to
indemnify
Andantech
from
and
against
certain taxes imposed on Andantech (or its members) as a result of
the sale, purchase, or ownership of the equipment, the payment of
rents, and other factors.
The indemnified taxes included State
sales and property taxes but did not include any Federal taxes.
Comdisco also agreed to indemnify Andantech against Federal
withholding taxes on rents or on income from the sale of any right
to receive rents; the indemnity was transferable to the benefit of
any
purchaser,
lender,
or
other
assignee
of
Andantech.
- 36 Additionally, Comdisco agreed to indemnify Messrs. Parmentier and
de la Barre d’Erquelinnes from Federal income taxes with respect to
the rents, proceeds from the sales of rents, or proceeds from the
sale of the equipment, provided (1) they did not engage in any
activities in the United States, and (2) Andantech, Mr. Parmentier,
and Mr. de la Barre d’Erquelinnes did not maintain a permanent
establishment in the United States.
Comdisco had the right to substitute a replacement computer
(replacement equipment) for a leased computer, but only if the
sublease (to an end user) of the computer terminated and a person
unrelated to Comdisco (such as an end user) made a bona fide offer
to purchase the computer. In that event, Andantech (as lessor) had
the right to request reasonable documentation from Comdisco before
transferring title pursuant to a bill of sale.
equipment
did
not
have
the
same
model
If the replacement
number
as
the
leased
computer, then the replacement equipment had to have a then value
and an estimated residual value (supported by appraisals provided
by Comdisco), as well as a remaining useful life, at least as great
as those of the substituted computer.
C.
The Bank Loan
UBS made a $14,995,931 bank loan to Andantech for the cash
portion of the purchase price. Denis Campbell, the account manager
at UBS who managed Comdisco’s account, worked on the bank loan.
UBS had been the lender in four prior Comdisco leveraged saleleaseback transactions, and Mr. Campbell had worked on all of those
- 37 loans.
Initially, the transaction which is the subject of this
litigation was to involve Intared I (the entity formed by potential
Swiss investors Hans Humbel and Egon Riesterer).
As of September
23, 1993, Mr. Campbell was evaluating the transaction with Intared
I.
By September 25, 1993, however, the Swiss investors had pulled
out of the deal, and thereafter, Andantech, with Mr. Parmentier as
the member holding the largest interest, was to be the borrower.
On September 28, 1993 (at the time the leveraged sale-leaseback
transaction was scheduled to close), a UBS loan officer in New York
(David Bawden) refused to approve the loan to Andantech.15
Mr.
Bawden requested references as to Mr. Parmentier’s character.
Mr.
Campbell then contacted UBS’s leasing affiliate in Switzerland,
which vouched for Mr. Parmentier’s character.
On September 30,
1993, UBS made the bank loan by wire transferring $14,995,931 to
Comdisco on Andantech’s behalf in payment of the purchase price of
the equipment.
The bank loan was for a term of 47 months; however, the Bank
Note contained a mandatory payment acceleration clause in the event
3 percent or more of the ownership interest in Andantech was
transferred.
within 3
15
UBS anticipated that the bank loan would be repaid
months,
inasmuch
as
previous
loans
made
in
similar
UBS wired $14,995,931 to Comdisco on Sept. 28, 1993,
but the same amount was wired back from Comdisco to UBS on the
same day.
- 38 Comdisco transactions had been prepaid in that timeframe.
V.
Sale of Comdisco Rents (Appendix D)
On September 29, 1993, and October 13, 1993, Ms. Ortmann sent
Mr.
Beadie
agreement”.
drafts
of
a
“corrected
lease
receivable
purchase
Mr. Beadie reviewed and made handwritten notations on
these drafts.
Michael Zehfuss is the manager for NationsBank in charge of
Comdisco’s account.
In October 1993, he began working on the
transaction in which NationsBank was to purchase a portion of the
rents payable under the lease by Comdisco to Andantech.
NationsBank had established a credit limit (i.e., a limitation
on the extension of credit) of $125 million for Comdisco.
The
proposed purchase of rents would have placed NationsBank’s exposure
(without considering demand deposit overdrafts) at $138 million.
Consequently, the transaction required the approval of numerous
NationsBank
officers.
Because
of
logistical
problems,
final
approval for the transaction was not given until October 27, 1993.
NationsBank’s
records
show
that
the
bank
treated
the
transaction as a loan to Comdisco and anticipated prepayment by
March 28, 1994.
The bank’s records describe the transaction as
follows:
Comdisco has approached NationsBank to provide financing
for a sale/leaseback transaction involving a lease
receivable purchase with Comdisco as the obligor. The
proposed structure is identical to two lease receivable
purchases the Bank funded for Comdisco in September 1991
($10MM related to Astropar L.P) and May 1992 ($35MM
related to Compupar L.P.). Each of these transactions *
- 39 * * generated $168,000 in net interest income for
assuming a short-term, unsecured credit position with
Comdisco * * *.
*
*
*
*
*
*
*
Although
Comdisco
has
historically
prepaid
each
receivable purchase transaction that NationsBank has
funded, the company may elect not to prepay the proposed
purchase. In this situation, NationsBank would hold a 36
month, unsecured loan to Comdisco at 75bp. In electing
not to prepay, Comdisco would reduce its ability to fund
future transactions in the bank market.
*
*
*
*
*
*
*
Based on the credit quality of Comdisco * * * , the
adequate yield * * *, and prepayment history we have
experienced in identical transactions, I recommend
approval of the $88MM TML. * * *
On October 29, 1993, NationsBank purchased from Andantech (on
a nonrecourse basis) a portion of the rents due from Comdisco under
the
equipment
receivable
lease
purchase
for
$87,805,802,
agreement.
pursuant
Pursuant
to
thereto,
the
lease
NationsBank
received “designated rights” that included the right to receive the
rents but not the equipment.
The rents purchased by NationsBank (aggregating $94,109,445)
were those payable pursuant to the equipment lease after October
29, 1993, and before the early termination dates.
Pursuant to a
Consent and Agreement, Comdisco agreed to make payment of the rents
to NationsBank.
Under the terms of the term note for the purchase of the
equipment, Andantech’s sale of the rents to NationsBank accelerated
the term note. Andantech directed NationsBank to wire transfer the
- 40 proceeds for the rent sale ($87,805,802) to Comdisco in payment of
Andantech’s
obligations
to
Comdisco
under
the
term
note.
NationsBank did so, and Comdisco canceled the term note.
VI. Mr. de la Barre d’Erquelinnes’s and Mr. Parmentier’s
Withdrawal From Andantech
A.
Mr. de la Barre d’Erquelinnes’s and Mr. Parmentier’s
Withdrawal of Capital Contributed to Andantech
On November 30, 1993, Mr. Parmentier and Mr. de la Barre
d’Erquelinnes withdrew (in the aggregate) $189,882.89 from the
capital of Andantech.
B.
Transfer of Mr. de la Barre d’Erquelinnes’s Membership
Interest in Andantech to EICI (Appendix E)
Equipment
Investors
Co.,
Inc.
(EICI),
was
organized
on
December 6, 1993, and at all relevant times thereafter validly
existed as a corporation, under the laws of Delaware.
Initially,
Mr. de la Barre d’Erquelinnes was EICI’s sole shareholder; Mr.
Parmentier was EICI’s sole director.
Pursuant
to
an
Assignment
and
Assumption
of
Membership
Interest of Andantech L.L.C., dated December 9, 1993, Mr. de la
Barre d’Erquelinnes transferred his 2-percent membership interest
in Andantech to EICI.
Mr. de la Barre d’Erquelinnes thereafter
withdrew as a member of Andantech, and EICI was admitted.
On
December
28,
1993,
Mr.
de
la
Barre
d’Erquelinnes
transferred his EICI stock to a charitable support trust (the
Trust); thereafter, the Trust was at all relevant times the sole
shareholder
of
EICI.
The
Trust
was
established
in
1988
by
- 41 Comdisco, as settlor, and by Robert Kelman, as sole trustee.
The
beneficiaries of the Trust were various charitable organizations,
and the Trust was a tax-exempt organization.
C.
Transfer of Mr. Parmentier’s Membership Interest to RD
Leasing in Exchange for Preferred Stock (Appendix F)
Mr. Parmentier transferred his 98-percent membership interest
in Andantech to RD Leasing pursuant to an Exchange Agreement dated
December 10, 1993.
RD Leasing issued 6,150 shares of series A
preferred stock (the RD Leasing preferred stock) to Mr. Parmentier
in exchange for his 98-percent membership interest. Mr. Parmentier
thereafter withdrew as a member of Andantech, and RD Leasing was
admitted.
The RD Leasing preferred stock provided for a dividend at the
rate of 6.878 percent.
The 6,150 shares of RD Leasing preferred
stock issued to Mr. Parmentier had a liquidation preference of
$615,000 (plus unpaid dividends).
The 6,150 shares of preferred
stock had a value of 0.5 percent of the equipment’s purchase price
(approximately $122 million).
Mr. Parmentier agreed to hold the RD Leasing preferred stock
for 1 year (i.e., through December 10, 1994).
RD Leasing, however,
was required to maintain a portion of its assets in “permitted
investments”
(low-risk
securities)
sufficient
to
satisfy
the
liquidation preference, including all accrued but unpaid dividends.
RD Leasing had the option to redeem the RD Leasing preferred stock
on or after January 1, 2000, at a price equal to the liquidation
- 42 preference (plus unpaid dividends), provided that RD Leasing had
funds legally available for payment.
The holder of the RD Leasing
preferred stock had the option to require RD Leasing to redeem the
RD Leasing preferred stock on or after January 1, 1999, at a price
equal
to
the
liquidation
preference
(plus
unpaid
dividends),
provided RD Leasing had funds legally available for payment.
The holder of the RD Leasing preferred stock did not have
voting rights, except upon the occurrence of certain specified
voting rights events, as defined in the terms of the RD Leasing
preferred stock.
Such events included the failure to make the
required redemption of the RD Leasing Preferred Stock and the
failure to maintain investment assets at specified levels.
Upon
the occurrence of such an event, the holder of the RD Leasing
preferred stock would have a right, voting with the common stock,
to cast in the aggregate 21 percent of the total votes cast by all
stockholders.
VII. Repayment of Bank Loan (Appendixes F and G)
Mr.
Parmentier’s
transfer
of
his
98-percent
membership
interest in Andantech on December 10, 1993, triggered a mandatory
acceleration of the bank loan.
UBS informed Andantech that the payoff amount on the bank loan
was $15,119,777.60 and requested that this amount be wired on
December 10, 1993, to the account of UBS at the Federal Reserve
Bank in New York.
Andantech received the cash needed to repay the bank loan from
- 43 capital contributions made by RD Leasing and EICI.
Pursuant to a
Capital Contribution Agreement, dated December 10, 1993, RD Leasing
and EICI were obligated to make contributions to the capital of
Andantech in amounts proportionate to their respective membership
interests; accordingly, RD Leasing contributed $14,817,382.05, and
EICI contributed $302,395.55 to Andantech.
RD Leasing received from NEFI the $14,817,382.05 it needed to
contribute to the capital of Andantech.
(NEFI had agreed (in the
Exchange Agreement) that it would purchase 100 additional shares of
common stock in RD Leasing for $14,817,382.05.) EICI borrowed from
UBS the $302,395.55 it needed to contribute to the capital of
Andantech.
The bank records show that Comdisco guaranteed the UBS
loan to EICI.
RD Leasing and EICI made their capital contribution by wiring
$14,817,382.05 and $302,395.55, respectively, directly to UBS’
account in payment of the bank loan.
VIII. Sale of Computer to End User
In April 1994, one of the end users opted to purchase the IBM
9021 computer equipment it subleased from Comdisco.
was one that had been sold to Andantech.
any of the proceeds from that sale.
The computer
Andantech did not receive
Instead, Comdisco elected to
substitute replacement equipment. Comdisco neither provided notice
to
Andantech
that
it
was
exercising
its
right
to
substitute
replacement equipment nor invoked the procedures for substitution
required by the equipment lease.
- 44 The equipment lease imposed an obligation upon Comdisco to
provide Andantech with annual reports, which, among other things,
contained information as to the location of the equipment.
CIG
provided Andantech with location reports relating to the equipment
on March 1, 1994, February 27, 1995, and February 28, 1996.
Ms.
Grossman received these reports.
The 40 mainframe computers in Andantech’s portfolio were
identified by serial number in the location reports. The computers
shown in the reports had the same serial numbers as those that were
on the 1993 bill of sale.
The location of the equipment (and the
sublessee) sometimes changed.
In light of the fact that the CIG
location reports reflected no changes in the serial numbers, Ms.
Grossman was unaware that Comdisco had substituted replacement
equipment for one of the 40 computers that Andantech purchased.
IX.
Comdisco’s Exercise of Early Termination Options
On April 25, 1996, Comdisco informed Andantech that it was
exercising its early termination option to purchase the equipment
in categories E through I (i.e., the IBM mainframes in the 9021
series).
On
May
30,
1996,
Comdisco
received
from
Computer
Information Resources (CIR) an appraisal of the equipment in these
five categories, valuing the computers at $11,444,000.
Ms. Grossman asked Don Oram, an NEFI equipment manager, to
independently investigate the value of the equipment.
After
reviewing several reports (Computer Price Watch and the Gartner
Group reports), on May 27, 1996, Mr. Oram informed Ms. Grossman
- 45 that the value of the equipment in categories E through I was
between $11,600,000 and $12,225,000.
The principal amounts of the balloon notes for categories E
through I (junior promissory notes 2e-2i) were:
$1,083,615;
$699,454; $3,891,020; $2,313,841; and $7,933,856, respectively.
The aggregate principal amount was $15,921,786.
interest at 9 percent, compounded monthly.
The notes bore
The total liability on
the early termination date was $20,222,439.
Ms. Grossman and Mr. Vandermark discussed Comdisco’s exercise
of its early termination option, as well as Comdisco’s belief that
the value of the equipment in categories E through I was less than
the liability for principal and interest on the balloon notes. Mr.
Vandermark was disconcerted to learn that there was a good chance
that RD Leasing would receive nothing for its position in the
lease.
(ARI
On May 30, 1996, Ms. Grossman engaged ARI Propertylink Co.
Propertylink)
to
appraise
the
40
mainframe
computers
comprising the Andantech portfolio as of the early termination
dates. Mary O’Connor (who had appraised the equipment in 1993) was
ARI Propertylink’s appraiser.
On June 5, 1996, ARI Propertylink advised Ms. Grossman that
the value of the equipment was $13,465,000.
The appraisal stated
that the equipment had “eroded” in value more rapidly than had been
anticipated in 1993 because of:
strategy
(i.e.,
increased
(1) A change in IBM pricing
discounting);
(2)
an
increase
in
production of mainframes by IBM; (3) the introduction of new
- 46 products by IBM’s competitors (Amdahl Corp. and Hitachi Data
Systems, Inc.); and (4) the introduction of “CMOS based parallel
architecture” on April 5, 1994.
On June 6, 1996, CIG advised
Andantech that the value of the equipment in categories E through
I inclusive did not exceed the principal plus accrued interest due
on junior promissory notes 2e through 2i.
After analyzing the information received from Mr. Oram and the
ARI PropertyLink appraisal, Ms. Grossman concluded that Andantech
was not entitled to consideration from Comdisco for the equipment
in categories E through I, beyond the cancellation of the balloon
notes
relating
thereto.
Thus,
Andantech
accepted
Comdisco’s
determination that the value of the equipment in categories E
through I did not exceed the principal plus accrued interest on
junior promissory notes 2e through 2i.
On July 2, 1996, Andantech executed a bill of sale for the
equipment in categories E through I to Comdisco.
On July 10,
1996, Comdisco canceled the balloon notes relating to the equipment
in categories E through I (i.e., junior promissory notes 2e-2i).
On August 23, 1996, Comdisco advised Andantech that it was
exercising its early termination option to purchase the equipment
in categories A through D (i.e., the 9121 models).
Comdisco
engaged two additional companies to provide appraisals of the
equipment in category A as of the early termination date.
findings included the following:
The
(1) In its September 23, 1996,
appraisal, Computer Merchants, Inc. (CMI), concluded that the value
- 47 of category A of the equipment was $63,000 (as of September 27,
1996, the early termination date); and (2) in its September 24,
1996, appraisal, CIR concluded that the value of category A of the
equipment was $89,000 (as of September 27, 1996).
Accordingly, on
September 25, 1996, Comdisco advised Andantech that the value of
the category A equipment did not exceed the principal plus accrued
interest due on the corresponding junior promissory note 2a.
On October 3, 1996, Mr. Oram advised Ms. Grossman that the IBM
computers corresponding to equipment in category A had a maximum
value of $56,000, as of September 27, 1996.
Andantech accepted
Comdisco’s conclusion that the value of the equipment in category
A did not exceed the principal plus accrued interest on junior
promissory note 2a. Thereafter, Andantech executed an undated bill
of sale of the equipment in category A to Comdisco.
On October 8,
1996, Comdisco canceled junior promissory note 2a.
Comdisco subsequently engaged CIR and CMI to appraise the
equipment in categories B through D.
On October 21, 1996, CMI
informed Comdisco that the value of the equipment in categories B
through D was $52,000, as of October 27, 1996.
On October 25,
1996, CIR advised Comdisco that the value of the equipment in
categories B through D was $62,000, as of October 27, 1996.
Mr.
Oram advised Ms. Grossman of these findings.
In light of these appraisals, Ms. Grossman requested ARI
PropertyLink
to
update
its
June
4,
1996,
appraisal.
ARI
PropertyLink confirmed its earlier opinion as to the September 27,
- 48 1996, value of the equipment in category A, and as to the October
27, 1996, values of the equipment in categories B,
a
result
of
the
appraisal,
Andantech
C, and D.
accepted
As
Comdisco’s
determination that the value of the equipment in categories B
through D did not exceed the principal plus accrued interest on
three of the balloon notes.
Accordingly, on December 5, 1996,
Andantech executed a bill of sale of the equipment in categories B
through D to Comdisco.
On December 12, 1996, Comdisco canceled
three of the balloon notes.
The three bills of sale that Andantech executed in 1996 (the
1996 bills of sale) conveyed to Comdisco the identical computers
that Andantech had acquired pursuant to the 1993 bill of sale.
The
serial numbers on the 1996 bills of sale were identical to those on
the 1993 bill of sale.
Comdisco never
Thus, the 1996 bills of sale reflect that
replaced
any
of
the
computers
(i.e.,
did
not
substitute a different computer for any of the original Equipment).
As
stated
previously,
the
equipment
lease
provided
that
Comdisco would pay an early termination supplement if it elected to
exercise
its
early
termination
option.
Comdisco
paid
early
termination supplements of $289,076, $57,084, and $7,206. Pursuant
to
Andantech’s
operating
agreement,
Andantech
made
an
early
termination distribution of $353,366 to EICI.
X.
Dissolution of RD Leasing and Andantech
On May 1, 1997, RD Leasing was dissolved.
1997, Andantech was dissolved.
On or about May 29,
- 49 XI.
Andantech’s Federal Income Tax Returns
Andantech filed a Form 1065, U.S. Partnership Return of
Income, for the short tax year beginning September 28, 1993, and
ending December 10, 1993 (the 12/10/93 short period).
On Schedule
K, Partners’ Shares of Income, Credits, Deductions, Etc., of the
return, Andantech reported $86,930,528 of income that included
$86,930,096 of net income from other rental activity ($87,805,801
of gross income from other rental activity and $875,705 of expenses
from other rental activity) and $432 of interest income. Andantech
reported on Schedules K-1, Partner’s Share of Income, Credits,
Deductions,
Etc.,
d’Erquelinnes,
allocated
to
and
Mr.
for
Mr.
Parmentier,
Mr.
de
NEFI
that
$85,191,494
of
the
Parmentier,
$1,738,736
to
Mr.
la
Barre
income
de
la
was
Barre
d’Erquelinnes, and $134 to NEFI.
Andantech also filed a Form 1065 for the short tax year
beginning December 11, 1993, and ending December 31, 1993 (the
12/31/93 short period).
On Schedule L, Balance Sheets, of the
return, Andantech reported $20,459,014 as liability on mortgages,
notes, and bonds payable in 1 year or more.
On Schedule K of the
return, Andantech reported a $2,143,937 loss attributed to a
$2,040,263
depreciation
deduction
and
a
$103,674
interest
deduction.
Andantech reported no gross income from other rental
activity.
Andantech reported on Schedules K-1 that 98 percent of
- 50 the loss was allocated to RD Leasing and 2 percent to EICI.
The
loss allocated
1993
to
RD
Leasing
was
included
in
Norwest’s
consolidated return.
Andantech filed a Form 1065 for the tax year ending December
31,
1994.
On
Schedule
L
of
the
return,
Andantech
reported
$22,378,210 as liability on mortgages, notes, and bonds payable in
1 year or more.
On Schedule K of the return, Andantech reported a
$50,069,397 loss attributed to a $48,150,200 depreciation deduction
and $1,919,197 interest deduction.
Andantech reported no gross
income from other rental activity. Andantech reported on Schedules
K-1 that 98 percent of the loss was allocated to RD Leasing and 2
percent to EICI.
The loss allocated to RD Leasing was included in
Norwest’s 1994 consolidated return.
XII. Respondent’s Determinations
A.
FPAAs for the 1993 Short Years
On January 14, 2000, respondent issued a notice of final
partnership administrative adjustments (FPAA) regarding Andantech’s
12/10/93 short period (the 12/10/93 FPAA).
On January 14, 2000,
respondent also issued an FPAA regarding Andantech’s 12/31/93 short
period (the 12/31/93 FPAA).16
Respondent determined that Andantech’s claimed 12/10/93 short
16
As explained hereinafter, respondent contends that
there is only one 1993 taxable period for Andantech and that
there was no termination of the partnership on Dec. 10, 1993.
- 51 period should be disregarded and all income and deductions for that
period should be reported in Andantech’s 12/31/93 short period. In
the 12/10/93 FPAA, respondent determined that the $86,930,096
income reported should be reduced to zero for the 12/10/93 short
period. In the 12/31/93 FPAA, respondent determined that Andantech
should
have
reported
$2,143,937 loss.
income
of
$87,805,801,
rather
than
the
Respondent increased the gross income for the
sale of the receivable and disallowed all the claimed deductions.
Included with each copy of the 12/10/93 FPAA and the 12/31/93
FPAA was a letter advising each person of his or its right to elect
to have partnership items treated as nonpartnership items pursuant
to section 6223(e).
Neither Mr. Parmentier, Mr. de la Barre
d’Erquelinnes, NEFI, RD Leasing, Norwest, nor EICI filed such an
election.
On April 17, 2000, NEFI and Norwest timely filed a petition
for Andantech’s 12/31/93 short period (docket No. 4277-00).
On
June 6, 2000, EICI timely filed a petition for Andantech’s 12/10/93
short period (docket No. 6348-00).
B.
FPAA for the 1994 Taxable Year
On June 19, 1998, respondent issued an FPAA with regard to
Andantech’s 1994 tax year (the 1994 FPAA).
in
the
1994
Andantech
FPAA
should
that
be
$50,069,397
disallowed.
of
Respondent determined
deductions
Alternatively,
claimed
by
respondent
determined in the 1994 FPAA that the “sale” of the lease receivable
- 52 was a “financing arrangement” and consequently Andantech’s income
should be increased by $34,482,268 for rent payable in 1994.
On
September
21,
1998,
NEFI
and
Norwest
timely
filed
a
petition for Andantech’s 1994 taxable year (docket No. 15532-98).
OPINION
I.
Procedural Issues
At the outset, we deal with two procedural matters. First, we
determine whether for purposes of this litigation the statute of
limitations period under section 6501(a) expired with respect to
the
12/10/93
short
period
and/or
the
12/31/93
short
period.
Second, we determine whether the FPAAs for the 12/10/93 short
period and/or the 12/31/93 short period are valid.
First,
we
turn
to
the
period
of
limitations
matter.
Petitioners acknowledge that the period for assessing a deficiency
in tax under section 6501(a) remains open for RD Leasing and EICI.
They assert, however, that section 6501(a) is inapplicable to
partnership items and affected items.
They maintain that the
period for assessing a deficiency related to partnership items and
affected items is controlled by section 6229(a), and that the
periods within which respondent could issue an FPAA with respect to
Andantech’s 12/10/93 short period and its 12/31/93 short period had
expired under section 6229(a) before the mailing of those FPAAs.
Petitioners’ position is contrary to our holding in RhonePoulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C.
533 (2000), interlocutory appeal dismissed (for lack of appellate
- 53 jurisdiction) and remanded to the Tax Court for further proceedings
on the merits 249 F.3d 175 (3d Cir. 2001).
See also
CC & F W.
Operations Ltd. Pship. v. Commissioner, T.C. Memo. 2000-286, affd.
273 F.3d 402 (1st Cir. 2001).
In Rhone-Poulenc, we stated that
section 6501(a) provides a general period of limitations for
assessing and collecting any tax imposed by the Code.
Section
6229(a) sets forth a minimum period for assessing any income tax
with respect to any person that is attributable to any partnership
item or affected item; this minimum period can be greater than, or
Id. at 540-
less than, the period of limitations in section 6501.
543.
Section
6501
contains
no
exception
attributable to partnership items.
Congress
did
not
create
a
for
deficiencies
In drafting section 6229,
completely
separate
statute
of
limitations for assessments attributable to partnership items. Id.
at 545.
Section 6229 merely supplements section 6501.
CC & F W.
Operations Ltd. Pship. v. Commissioner, supra.
Petitioners concede that under the holding of Rhone-Poulenc
Surfactants
&
Specialties,
L.P.
v.
Commissioner,
supra,
the
limitations period has not expired. They, however, request that we
reconsider
Rhone-Poulenc.
We
decline
to
do
so.
We
hold,
therefore, that the period of limitations for issuing the FPAAs for
both 1993 short periods had not expired at the time the FPAAs were
issued.
Second, we rely upon Wind Energy Tech. Associates III v.
- 54 Commissioner, 94 T.C. 787 (1990), to conclude that issuing an FPAA
during the 120-day period set out in section 6223(d)(1) does not
invalidate an FPAA.
Accordingly, we hold that the FPAAs for the
12/10/93 short period and the 12/31/93 short period are valid.
II.
Whether the Sale-Leaseback Transaction Should Be Respected
We now turn to the substantive issue before us; namely,
whether the sale-leaseback transaction involved should be respected
for Federal tax purposes.
In essence, this case involves the stripping of income from
Andantech’s sale of the Comdisco rents (which income, for tax
purposes, passed through untaxed to Belgian citizens and residents)
and the subsequent use by Norwest (on its consolidated returns for
the
years
at
issue)
of
Andantech’s
losses
from
depreciation
deductions and interest expense related to Andantech’s purchase and
lease of the computer equipment.
A.
Overview of Statutory Framework for the Transactions
We begin our analysis with an overview of the transactions
involved herein, and the statutory provisions and caselaw within
which Comdisco planned the series of transactions that petitioners
and Comdisco assert brought into play nonrecognition provisions of
the Code governing partnerships and corporations, as well as
treaties with foreign governments.
This overview presupposes that
the transactions and entities are to be respected for Federal tax
purposes.
1.
Andantech was organized as a limited liability company,
- 55 intending to be taxed as a partnership.
(Pursuant to sections 701
and 702, a partnership is treated as a flow-through entity for
purposes of Federal income taxation.)
As such, if Andantech is
recognized as a partnership, its items of income, gain, loss,
deduction, and credit passed through to its partners.
2.
A taxpayer is permitted to sell its right to future
income.
If a bona fide sale of future income occurs at arm’s
length and for adequate consideration, then the seller of the
future income is taxed in the year of sale on the amount of
consideration he actually receives and the buyer is taxed on any
excess of income received over his purchase price.
Mapco Inc. v.
United States, 214 Ct. Cl. 389, 556 F.2d 1107, 1110 (1977).
Petitioners assert that the sale-leaseback transaction between
Andantech and Comdisco should be respected, and Andantech’s sale of
the Comdisco rents to NationsBank should be considered a bona fide
arm’s-length sale for adequate consideration.
On this premise,
Andantech contends it is deemed to recognize gain from the sale in
1993, the year of the sale, and the income passes through to
Andantech’s partners (i.e., Messrs. Parmentier and de la Barre
d’Erquelinnes/EICI).
3.
Pursuant to section 708(b)(1)(B), a partnership is deemed
terminated (for Federal tax purposes) upon the sale or exchange of
50 percent or more of the total interest in the partnership’s
capital
and
petitioners
profits
assert
within
the
a
12-month
partnership
is
period.
to
be
Here,
if
respected,
as
Mr.
- 56 Parmentier’s contribution of his 98-percent interest in Andantech
to RD Leasing in exchange for RD Leasing’s preferred stock caused
a deemed termination of the partnership. (For convenience, we will
refer to
the
partnership
prior
to
the
deemed
termination
as
Andantech-Foreign.)
If the sale or exchange of a partner’s interest in the
partnership results in the deemed termination of the partnership,
then pursuant to section 708(b)(1)(B), the partnership’s taxable
year is deemed closed upon the triggering sale or exchange.
706(c)(1).
and
the
Sec.
Consequently, if as petitioners assert the partnership
sale
of
the
rent
receivables
are
to
be
respected,
Andantech-Foreign’s taxable year is deemed closed on December 10,
1993, the date Mr. Parmentier exchanged his 98-percent interest in
the partnership for the preferred stock, and Andantech-Foreign is
required to include the income from the sale of the Comdisco rents
on its return for the 12/10/93 short period.
That income would
then
and
pass
through
to
Messrs.
Parmentier
de
la
Barre
d’Erquelinnes/EICI.
4.
Section 894 provides that, to the extent required by any
treaty obligation of the United States, income (of any kind) is
exempt from U.S. taxation and excluded from gross income.
Here,
petitioners assert that any income from the sale of the Comdisco
rents that passes through to Messrs. Parmentier and de la Barre
d’Erquelinnes would be exempt from U.S. taxation pursuant to the
treaty between the United States and Belgium. Further, petitioners
- 57 assert, pursuant to section 351(a), no gain is recognized by Mr.
Parmentier on the exchange of his interest in Andantech for the
preferred stock of RD Leasing.17
Moreover, petitioners assert,
pursuant to section 358(a), Mr. Parmentier’s basis in his RD
Leasing preferred stock is the same as that in his 98-percent
interest in Andantech that was transferred to RD Leasing.
And
pursuant to section 362(a)(1), RD Leasing’s basis in the 98-percent
Andantech interest received from Mr. Parmentier is equal to Mr.
Parmentier’s basis in the partnership interest immediately before
the partnership-interest preferred-stock exchange (approximately
$119 million18).
17
Sec. 351(a) provides:
SEC. 351(a). General Rule.–-No gain or loss shall
be recognized if property is transferred to a
corporation by one or more persons solely in exchange
for stock in such corporation and immediately after the
exchange such person or persons are in control (as
defined in section 368(c)) of the corporation.
Sec. 368(c) defines control as:
SEC. 368(c). Control Defined.–-* * * ownership of
stock possessing at least 80 percent of the total
combined voting power of all classes of stock entitled
to vote and at least 80 percent of the total number of
shares of all other classes of stock of the
corporation.
18
Mr. Parmentier’s basis in his partnership interest, if
computed according to petitioners’ contentions under secs. 705(a)
and 752, would be as follows:
Initial contribution
Plus
Share of UBS loan ($14,995,931 x 98%)
$196,000
14,696,012
(continued...)
- 58 5. Petitioners assert that a termination of Andantech-Foreign
occurred, see supra pp. 57-58, resulting in a deemed distribution
of partnership property to new and continuing partners (i.e., RD
Leasing and EICI) and that there was a deemed recontribution of the
property to a newly formed partnership.
18
Sec. 1.708-1(b)(1)(iv),
(...continued)
Share of balloon notes ($19,990,512 x 98%)
19,590,702
Share of term note ($87,429,319 x 98%)
85,680,733
Share of income
85,191,494
Less
Share of term note Paid ($87,429,319 x 98%) (85,680,733)
Share of withdrawal ($189,883 x 98%)
(186,085)
Basis
119,488,123
- 59 Income Tax Regs.
(For convenience, we will refer to the new
partnership as Andantech-US.)
Continuing,
recontribution
of
petitioners
the
assert
property
to
that,
upon
Andantech-US,
the
deemed
Andantech-US
acquired a substituted basis in the property equal to the adjusted
basis of the property in the hands of the contributing partners, RD
Leasing and EICI.
Secs. 732, 723.
Thus, according to petitioners, the effect of the deemed
termination of Andantech-Foreign is that (1) no gain or loss is
recognized to RD Leasing or EICI under section 731(a) or to
Andantech-US under section 731(b), (2) Andantech-US has a basis in
the computer equipment of $119 million, and (3) RD Leasing has a
basis of $119 million in its 98-percent interest in Andantech-US.
6.
Section 167 provides for a depreciation deduction with
respect to property used in a taxpayer’s trade or business or held
for
the
production
of
income
by
a
taxpayer.
Section
168
establishes the appropriate depreciation method, recovery period,
and convention for tangible property.
(The depreciation deduction
allows a taxpayer to recover the cost of the property used in a
trade or business or for the production of income.
United States
v. Ludey, 274 U.S. 295, 300-301 (1927); Durkin v. Commissioner, 872
F.2d 1271, 1276 (7th Cir. 1989), affg. 87 T.C. 1329 (1986).)
Here,
according to petitioner, Andantech-US’s basis in the computer
equipment was $119 million, and Andantech-US properly reported the
depreciation deduction on its partnership tax returns for the
- 60 10/31/93 short year and for 1994. Additionally, petitioners assert
that Andantech-US properly reported an interest expense deduction
under section 163(a) on its partnership tax returns for those
years.
Ultimately, RD Leasing and EICI claimed these interest and
depreciation deductions as partners of Andantech-US.
B.
Positions of the Parties
Petitioners
assert
that
the
sale-leaseback
transaction
involved herein was a genuine multiple-party transaction, with
economic substance that was compelled or encouraged by business
realities, and was not shaped solely by tax-avoidance features. As
such, petitioners assert that the transaction should be respected
for Federal tax purposes because it satisfies the test of Frank
Lyon Co. v. United States, 435 U.S. 561, 583-584 (1978).
On the other hand, respondent contends that Comdisco devised
a transaction designed to allow foreign parties (not subject to
U.S. tax) to realize tax-free rental income, while allowing a U.S.
company to report significant tax deductions related to that rental
income.
Here, approximately $87.8 million in rental income was
shifted (i.e., stripped) to non-U.S. taxpayers through AndantechForeign, while Norwest, a U.S. taxpayer (for cash and preferred
stock totaling approximately $15.4 million), received, through RD
Leasing and Andantech-US, more than $100 million of depreciation
and interest
rental
deductions
income.
without
Respondent
recognizing
contends
that
any
corresponding
the
“prearranged”
transaction at issue should not be respected for Federal tax
- 61 purposes because it had no nontax business purpose and lacked
economic substance.
C.
Analysis
The focus of each party’s position, in essence, is in terms of
substance over form and related (e.g., sham and step transaction)
judicial doctrines.
Under these judicial doctrines, although the
form of a transaction may literally comply with the provisions of
a Code section, the form will not be given effect where it has no
business purpose and operates simply as a device to conceal the
true character of a transaction.
U.S. 465, 469-470 (1935).
See Gregory v. Helvering, 293
“To permit the true nature of a
transaction to be disguised by mere formalisms, which exist solely
to alter tax liabilities, would seriously impair the effective
administration of the tax policies of Congress.”
Court Holding Co., 324 U.S. 331, 334 (1945).
Commissioner v.
Conversely, if the
substance of a transaction accords with its form, then the form
will be upheld and given effect for Federal tax purposes.
See
Blueberry Land Co. v. Commissioner, 361 F.2d 93, 100-101 (5th Cir.
1966), affg. 42 T.C. 1137 (1964).
A transaction may be treated as a sham where (1) the taxpayer
is motivated by no business purpose other than obtaining tax
benefits, and (2) the transaction has no economic substance because
no reasonable possibility of a profit exists. Rice’s Toyota World,
Inc. v. Commissioner, 752 F.2d 89, 91-95 (4th Cir. 1985), affg. on
this issue 81 T.C. 184 (1983).
But a transaction that has a valid
- 62 business purpose and economic substance may still be recast in
order to reflect its true nature. Packard v. Commissioner, 85 T.C.
397, 419-422 (1985).
Substance over form and related judicial doctrines all require
“a
searching
analysis
of
the
facts
to
see
whether
the
true
substance of the transaction is different from its form or whether
the form reflects what actually happened.” Harris v. Commissioner,
61 T.C. 770, 783 (1974).
The issue of whether any of those
doctrines should be applied involves an intensely factual inquiry.
See Gordon v. Commissioner, 85 T.C. 309, 327 (1985); see also Bowen
v. Commissioner, 78 T.C. 55, 79 (1982), affd. 706 F.2d 1087 (11th
Cir. 1983); Gaw v. Commissioner, T.C. Memo. 1995-531, affd. without
published opinion 111 F.3d 962 (D.C. Cir. 1997).
After a thorough review of the record in these consolidated
cases, we find, and thus hold, alternatively, the following:
(1)
Andantech is not a valid partnership and should not be
recognized for Federal tax purposes; more specifically:
(a)
Andantech-Foreign
should
be
disregarded
because
Messrs. Parmentier and de la Barre d’Erquelinnes did not intend to
join together as partners for the purpose of carrying on a
- 63 business; i.e., they did not join together to share in the profits
or losses from Andantech-Foreign’s equipment leasing activity; and
(b)
Andantech-US should be disregarded because EICI did
not intend to join with RD Leasing for the purpose of carrying on
a business; i.e., they did not join together to share in the
profits or losses from Andantech-US’s equipment leasing activity;
(2)
and
de
alternatively, the participation of Messrs. Parmentier
la
Barre
transactions
d’Erquelinnes,
EICI,
and
Andantech
in
the
involved herein should be disregarded under the step
transaction doctrine;
(3)
additionally,
with
respect
to
Andantech,
its
sale-
leaseback transaction with Comdisco was a sham because it (a) was
not
a
true
substance,
multiple-party
(c)
was
not
transaction,
compelled
or
(b)
lacked
encouraged
by
economic
business
realities, and (d) was shaped solely by tax-avoidance features;
(4)
with respect to Norwest and RD Leasing, Andantech’s
sale-leaseback transaction with Comdisco should not be respected
because it lacked business purpose as well as economic substance.
Our reasons for these findings/holding now follow.
1.
Andantech Is Not a Valid Partnership and Is Not
Recognized for Federal Tax Purposes
“A partnership is generally said to be created when persons
join together their money, goods, labor, or skill for the purpose
of carrying on a trade, profession, or business and when there is
community of interest in the profits and losses.”
Commissioner v.
- 64 Tower, 327 U.S. 280, 286 (1946); see also ASA Investerings Pship.
v. Commissioner, 201 F.3d 505, 513 (D.C. Cir. 2000), affg. T.C.
Memo. 1998-305.
When the existence of an alleged partnership is
challenged, the question arises whether the partners truly intended
to join together for the purpose of carrying on business and
sharing in the profits or losses or both.
Commissioner v. Tower,
supra at 286-287. “Business activity” excludes activity whose sole
purpose is tax avoidance. ASA Investerings Pship. v. Commissioner,
supra at 512.
a.
Andantech-Foreign
Should
Be
Disregarded
Because Messrs. Parmentier and de la Barre
d’Erquelinnes Did Not Intend To Join Together for
the Purpose of Carrying On a Business and Sharing
in the Profits or Losses From the Equipment Leasing
Activity
In these consolidated cases, we are convinced that Messrs.
Parmentier and de la Barre d’Erquelinnes did not intend to join
together in order to share in any profit or loss from the business
activity of Andantech-Foreign; namely, the sale and leaseback of
computer equipment. Rather, to the contrary, we are convinced that
Mr. Parmentier’s true business objective was to profit from the
preferred stock of RD Leasing that he expected to receive.
The correspondence between Mr. Parmentier’s attorney, Mr.
Temko, and Comdisco establishes to us that Mr. Parmentier’s sole
concern was with his potential tax liability and financial risk.
Mr. Parmentier wanted assurances that he and Mr. de la Barre
d’Erquelinnes could (1) promptly recover their $200,000 investment,
- 65 (2) withdraw from Andantech at no expense, (3) incur no potential
liability for Andantech debts, and (4) incur no potential liability
in connection with managing Andantech.
Further, Mr. Parmentier
asked Comdisco to provide assurances that he would be able to
exchange his partnership interest for preferred stock on the basis
described in the flowcharts and realize the full value of the
preferred stock “without any significant risk of impairment”.
Comdisco attempted to satisfy Mr. Parmentier, Mr. de la Barre
d’Erquelinnes, and their counsel as to the minimal risks associated
with the transaction.
Messrs. Parmentier and de la Barre d’Erquelinnes contributed
comparably minimal (and borrowed at that) funds ($200,000 in a
purported $122 million transaction) to Andantech-Foreign, which
they withdrew within 3 months.
We are satisfied that Andantech-
Foreign and Messrs. Parmentier and de la Barre d’Erquelinnes were
but mere conduits used by Comdisco and NEFI.
Neither took part in
any decisions regarding the sale and leaseback of the equipment;
rather, all
Comdisco.
of
the
negotiations
took
place
between
NEFI
and
NEFI set the criteria for the end users, set the $122
million amount of the transaction, reviewed the projected cashflow
(which depended on the $15 million investment from Norwest), and
reviewed the documents and instruments for the various transactions
(including the sale of the rent receivables).
- 66 Mr.
Parmentier
was
rewarded
for
participating
in
the
transaction involved herein through the redemption of the RD
Leasing
preferred
activity.
stock,
Further,
we
not
are
through
the
equipment
convinced
that
Mr.
de
leasing
la
Barre
d’Erquelinnes had no intent to profit, and did not profit, from his
participation in any of the transactions.
After withdrawing the
funds he had contributed to Andantech-Foreign, Mr. de la Barre
d’Erquelinnes transferred his 2-percent membership interest in
Andantech-Foreign to EICI and then transferred his EICI stock to a
charitable support trust established in 1988 by Comdisco.
The purpose underlying Messrs. Parmentier’s and de la Barre
d’Erquelinnes’ participation in the transaction at issue is clearly
stated in a September 25, 1993, fax from Barbara Spudis (of the
Baker & McKenzie law firm) to that firm’s Amsterdam office.
fax stated:
The
“The individuals forming the company are involved for
two months during which the income allocation occurs and then the
interest is transferred to the U.S. corporate investor who reaps
the benefit of ongoing depreciation deductions.”
The record reveals that Andantech-Foreign was not created for
the purpose of carrying on a trade or business but rather to strip
the
income
Consequently,
from
the
transaction
we
will
not
and
recognize
avoid
taxation.
Andantech-Foreign
partnership for Federal income tax purposes.
Pship. v. Commissioner, supra.
U.S.
as
a
See ASA Investerings
- 67 b.
Andantech-US Should Be Disregarded Because
EICI Did Not Intend To Join With RD Leasing for the
Purpose of Carrying On Partnership Business and
Sharing in the Profits or Losses From the
Partnership’s Equipment Leasing Activity
After Mr. de la Barre d’Erquelinnes transferred his 2-percent
membership interest in Andantech-Foreign to EICI, EICI borrowed
from UBS $302,395.55 that it needed to contribute to the capital of
Andantech.
Comdisco guaranteed the loan, and UBS treated the loan
as a loan to Comdisco.
transferred
his
EICI
Mr. de la Barre d’Erquelinnes then
stock
to
a
charitable
support
trust
established in 1988 by Comdisco.
There is no evidence that EICI had assets other than its
interest in Andantech. Moreover, EICI’s only means of repaying the
UBS loan was through its 6-percent priority return distribution in
the event Comdisco exercised its early termination option.
EICI
did
not
participate
in
the
negotiations
of
the
transactions and did not intend to profit, and did not profit, from
the transactions.
EICI did not join with RD Leasing for purposes
of carrying on a trade or business or sharing in profit or loss
from the sale-leaseback transaction.
EICI did not exist before the transactions at issue.
It was
created as a vehicle to dispose of Mr. de la Barre d’Erquelinnes’s
2-percent
interest
and
to
create
the
illusion
of
participant required for partnership classification.
a
second
Under the
principles of Gregory v. Helvering, 293 U.S. 465 (1935), AndantechUS is not recognized as a valid partnership for Federal income tax
- 68 purposes.
2.
Andantech Acted as a Mere Shell or Conduit To Strip
the Income From the Transaction and Avoid Income Taxation
and, Under the Step Transaction Doctrine, Should Be
Disregarded
Even if we believed Andantech should be respected as a valid
partnership (which we do not), it should be disregarded under the
step transaction doctrine.
“Under the step-transaction doctrine,
a particular step in a transaction is disregarded for tax purposes
if the taxpayer could have achieved its objective more directly,
but instead included the step for no other purpose than to avoid
U.S. taxes.” Del Commercial Props., Inc. v. Commissioner, 251 F.3d
210, 213-214 (D.C. Cir. 2001), affg. T.C. Memo. 1999-411; see also
Penrod v.
Commissioner,
88
T.C.
1415,
1428-1430
(1987).
As
described in Smith v. Commissioner, 78 T.C. 350, 389 (1982):
The step transaction doctrine generally applies in
cases where a taxpayer seeks to get from point A to point
D and does so stopping in between at points B and C. The
whole purpose of the unnecessary stops is to achieve tax
consequences differing from those which a direct path
from A to D would have produced. In such a situation,
courts are not bound by the twisted path taken by the
taxpayer, and the intervening stops may be disregarded or
rearranged. [Citation omitted.]
The
relating
existence
of
to
individual
the
business
purposes
steps
in
and
a
economic
complex
effects
series
of
transactions does not preclude application of the step transaction
doctrine.
True v. United States, 190 F.3d 1165, 1176-1177 (10th
Cir. 1999).
To ratify a step transaction that exalts form over
substance merely because the taxpayer can either (1)
- 69 articulate some business purpose allegedly motivating the
indirect nature of the transaction or (2) point to an
economic effect resulting from the series of steps, would
frequently defeat the purpose of the substance over form
principle. Events such as the actual payment of money,
legal transfer of property, adjustment of company books,
and execution of a contract all produce economic effects
and accompany almost any business dealing. Thus, we do
not rely on the occurrence of these events alone to
determine whether the step transaction doctrine applies.
Likewise, a taxpayer may proffer some non-tax business
purpose for engaging in a series of transactional steps
to accomplish a result he could have achieved by more
direct means, but that business purpose by itself does
not preclude application of the step transaction
doctrine. * * *
Id. at 1177.
Under the step transaction doctrine, a series of formally
separate steps may be collapsed and treated as a single transaction
if the steps are in substance integrated and focused toward a
particular result.
Courts have applied three alternative tests in
deciding whether the step transaction doctrine should be invoked in
a particular situation; namely, (1) if at the time the first step
was entered into, there was a binding commitment to undertake the
later
step
(binding
commitment
test),
(2)
if
separate
steps
constitute prearranged parts of a single transaction intended to
reach an end result (end result test), or (3) if separate steps are
so interdependent that the legal relations created by one step
would have been fruitless without a completion of the series of
steps (interdependence test). See Penrod v. Commissioner, supra at
1428-1430. More than one test might be appropriate under any given
set of circumstances; however, the circumstances need satisfy only
- 70 one of the tests in order for the step transaction doctrine to
operate.
Associated Wholesale Grocers, Inc. v. United States, 927
F.2d 1517, 1527-1528 (10th Cir. 1991) (finding end result test
inappropriate but applying the step transaction doctrine using the
interdependence test).
We now turn to the application of these
three tests to the transaction involved herein.
a.
Binding Commitment Test
We first consider the application of the binding commitment
test. Petitioners posit that RD Leasing was not bound to engage in
the transaction until it actually entered the transaction in
December
1993,
d’Erquelinnes
and
that
formed
Messrs.
Parmentier
Andantech-Foreign
commitment by RD Leasing.
and
de
independent
la
Barre
of
any
For the reasons set forth below, we do
not believe it is appropriate to apply the binding commitment test
to our step transaction analysis in this case.
The purpose of the binding commitment test is to promote
certainty in tax planning; it is the most rigorous limitation of
the step transaction doctrine. It is seldom used and is applicable
only where a substantial period of time has passed between the
steps that are subject to scrutiny.
Thus, it is not an appropriate
test to apply to the transactions before us inasmuch as the
transactions were prearranged by Comdisco, completed in 6 months,
and fell entirely within a single tax year.
Wholesale
Grocers,
Inc.
v.
United
See, e.g., Associated
States,
supra
at
1522
n.6
(rejecting use of the binding commitment test because the case did
- 71 not involve a series of transactions spanning several years).
Because the transactions in the present case do not span a long
period of time or involve a binding commitment to pursue successive
steps, we do not analyze them under the binding commitment test.
Thus, in this case, only the end result and interdependence tests
are relevant to our step transaction analysis.
b.
End Result Test
We now turn to the application of the end result test.
The
end result test combines into a single transaction separate events
that appear to be components of something undertaken to reach a
particular result.
Kornfeld v. Commissioner, 137 F.3d 1231, 1235
(10th Cir. 1998), affg. T.C. Memo. 1996-472; Associated Wholesale
Grocers, Inc. v. United States, supra at 1523.
Under the end
result test, if we find that a series of closely related steps in
a transaction is merely the means to reach a particular end result,
we will not separate the steps but instead will treat them as a
single transaction.
King Enters., Inc. v. United States, 189 Ct.
Cl. 466, 418 F.2d 511, 516 (1969); see also Helvering v. Ala.
Asphaltic Limestone Co., 315 U.S. 179 (1942); Morgan Manufacturing
Co v. Commissioner, 124 F.2d 602 (4th Cir. 1941), affg. 44 B.T.A.
691 (1941); Heintz v. Commissioner, 25 T.C. 132 (1955); Ericsson
Screw Mach. Prods. Co. v. Commissioner, 14 T.C. 757 (1950).
The end result test focuses upon the actual intent of the
parties as of the time of the transaction.
It is flexible and
bases tax consequences on the substance of the transaction, not on
- 72 the formalisms chosen by the participants. “The intent we focus on
under the end result test is not whether the taxpayer intended to
avoid taxes. * * * Instead, the end result test focuses on whether
the taxpayer intended to reach a particular result by structuring
a series of transactions in a certain way.”
True v. United States,
190 F.3d at 1175.
Under
the
end
result
test,
there
is
no
independent
tax
recognition of the individual steps unless the taxpayer shows that
at the time the parties engaged in the individual step, its result
was the intended end result in and of itself.
Id.
If this is not
what was intended, then we collapse the series of steps and give
tax consideration only to the intended end result.
Id.
“The
doctrine derives vitality, rather, from its application where the
form of a transaction does not require a particular further step be
taken; but, once taken, the substance of the transaction reveals
that the ultimate result was intended from the outset.” (Emphasis
in original.)
King Enters., Inc. v. United States, supra at 518.
Applying the end result test to the sale-leaseback transaction
at issue, we examine whether Comdisco and Norwest intended from the
outset to transfer the benefits and burdens of the sale-leaseback
of the equipment to RD Leasing.
If the intended end result was for
RD Leasing to have those benefits and burdens, then petitioners
cannot claim a right to favorable tax treatment for the various
intermediate transactions leading up to that intended result.
The record clearly indicates that every step taken by the
- 73 parties (the formation of Andantech, the sale-leaseback of the
equipment between Comdisco and Andantech, the sale of the Comdisco
rents to NationsBank, and the contribution by Mr. Parmentier of his
interest in Andantech to RD Leasing) were but transitory steps.
All
the
legal
documents
relating
to
the
transactions,
including the sale of the Comdisco rents, were negotiated and
reviewed by NEFI; and all profit and cashflow projections were
based on the assumption that a U.S. company would invest $15
million.
We are unable to glean from the record that Messrs.
Parmentier and de la Barre d’Erquelinnes ever contemplated making
(and there is no evidence that they had the means to make) a $15
million investment.
of
its
$15
(On the other hand, NEFI bore the risk of loss
million
investment.)
Moreover,
the
financial
projections never evaluate the transaction on the basis of the
initial contributions made by Messrs. Parmentier and de la Barre
d’Erquelinnes.
Simply put, we are of the opinion that Messrs.
Parmentier and de la Barre d’Erquelinnes never intended to place
their funds at risk.
They withdrew their minimal contributions as
soon as practicable and before transferring their interests to RD
Leasing and EICI.
It is obvious to us that Mr. Parmentier’s only
concerns in entering into the arrangement were to ensure that he
would not be taxed on the sale of the Comdisco rents and that he
would profit from his receipt of the preferred stock.
Neither Mr.
Parmentier nor Mr. de la Barre d’Erquelinnes had any of the
benefits or burdens associated with the sale-leaseback transaction.
- 74 The intended result from the outset was to pass the benefits and
burdens of the sale-leaseback transaction to RD Leasing in order to
allow Norwest to claim large depreciation deductions and for Mr.
Parmentier to make his profit through the value of RD Leasing’s
preferred stock.
Thus, by applying the end result test, we will give tax
consideration only to that intended result.
c.
Interdependence Test
We reach the same conclusion by reviewing the transactions
under the interdependence test. The “interdependence” test focuses
on
whether
“the
steps
are
so
interdependent
that
the
legal
relations created by one transaction would have been fruitless
without a completion of the series.”
Redding v. Commissioner, 630
F.2d 1169, 1177 (7th Cir. 1980), revg. and remanding 71 T.C. 597
(1979); see also Kass v. Commissioner, 60 T.C. 218 (1973), affd.
without published opinion 491 F.2d 749 (3d Cir. 1974); Farr v.
Commissioner,
24
T.C.
Commissioner,
16
T.C.
350
607
(1955);
Am.
(1951);
Wire
Am.
Fabrics
Bantam
Car
Corp.
v.
Co.
v.
Commissioner, 11 T.C. 397 (1948), affd. 177 F.2d 513 (3d Cir.
1949).
This test concentrates on the relationship between the
steps, rather than on their “end result”.
See Sec. Indus. Ins. Co.
v. United States, 702 F.2d 1234, 1245 (5th Cir. 1983).
The interdependence test requires a court to find whether the
individual steps had independent significance or had meaning only
as part of the larger transaction.
Penrod v. Commissioner, 88 T.C.
- 75 at 1429-1430.
If the steps have “reasoned economic justification
standing alone”, then the interdependence test is inappropriate.
Sec. Indus. Ins. Co. v. United States, supra at 1247.
If, however,
the only reasonable conclusion from the evidence is that the steps
have “meaning only as part of the larger transaction”, then the
step transaction doctrine applies as a matter of law.
Id. at 1246.
In order to maintain this objectivity and ensure the steps have
independent significance, it is useful to compare the transactions
in question with those usually expected to occur in otherwise bona
fide business settings.
See Merryman v. Commissioner, 873 F.2d
879, 881 (5th Cir. 1989), affg. T.C. Memo. 1988-72.
Here, the sale-leaseback transaction between Comdisco and
Andantech-Foreign and the sale of the Comdisco rents by AndantechForeign to NationsBank would not have taken place without the
planned participation of RD Leasing.
This point is demonstrated
both by the importance of the preferred stock to Mr. Parmentier in
the negotiations and the certain financial failure of AndantechForeign without a cash infusion from RD Leasing.
Petitioners
assert
that
the
financial
projections
using
forecasts of the residual values made by the appraisers in 1993
show that Andantech had a reasonable opportunity to earn a profit
from the transaction.
All of the financial projections, however,
were made on the basis of the $15 million supplied by RD Leasing
and the avoidance of Federal income tax on the rents payable by
Comdisco.
- 76 Mr. Parmentier’s failure to seriously evaluate the likely
residual
value
arbitrary
purchase
partnership
of
the
(which
equipment,
his
his
price,
and
would
facilitate
willingness
minimal
his
to
pay
an
investment
in
the
abandonment
of
the
transaction in the event RD Leasing failed to take the next step),
collectively persuade us that Mr. Parmentier and Andantech-Foreign
did not have profit motivation for entering into the sale-leaseback
transaction.
Additionally, the loans to Andantech were attributable to a
desire by UBS and NationsBank to accommodate Comdisco.
UBS, which
ultimately provided the approximate $15 million cash needed for the
purchase of the equipment, had provided similar amounts for other
similar Comdisco deals.
UBS made the loan to Andantech on the
basis of Comdisco’s creditworthiness and on the basis that the
earlier loans had been paid off, usually within 3 months.
On the
other hand, Andantech had minimal assets. Its only means of paying
the interest due on the approximate $15 million loan was from the
rents due from Comdisco.
But Andantech had “sold” the Comdisco
rents to NationsBank and was required to use the proceeds received
from NationsBank to pay off the $87 million term note owed to
Comdisco.
Thus,
after
the
sale
of
the
Comdisco
rents
to
NationsBank, Andantech had no means of paying the substantial
interest accruing on the approximate $15 million UBS loan as the
interest became due.
The funds provided by RD Leasing did not just enhance the
- 77 financial condition of the partnership; they were essential to the
solvency of the partnership.
The financial limitations placed on
Andantech
likely
made
it
extremely
that
the
transfer
of
Mr.
Parmentier’s interest to RD Leasing would, as it did, take place
promptly.
Our
review
of
the
entire
record
persuades
us
that
the
transactions did not take the form they did in order to afford
Andantech an opportunity to earn a profit.
To the contrary, we are
convinced that the only purpose for structuring the sale-leaseback
transaction between Comdisco and Andantech, rather than directly
between Comdisco and RD Leasing, was to avoid tax that would have
been paid by NEFI on the acceleration of rental income from the
sale of the Comdisco rents had the transactions been structured as
direct sale-leaseback transactions between Comdisco and RD Leasing.
We find that Andantech acted as a mere shell or conduit to strip
the income from the transaction and avoid income for RD Leasing.
Accordingly, we hold the steps involved in the transactions at
issue lack any reasoned economic justification standing alone.
As
stated, there was no apparent purpose for Messrs. Parmentier and de
la Barre d’Erquelinnes to purchase (through Andantech) and lease
back the equipment other than to facilitate the eventual transfer
of the property into the hands of RD Leasing.
exist before this transaction.
Andantech did not
It was created as a limited
liability company to serve as a passthrough vehicle specifically
for the transaction at issue.
- 78 The exchange of Mr. Parmentier’s partnership interest for the
RD Leasing preferred stock is suspect.
RD Leasing was a shell
corporation and was not involved in equipment leasing.
It was
recapitalized for the purpose of engaging in this transaction. Mr.
Parmentier was not interested in any true investment in RD Leasing.
He wanted cash but agreed to take and hold the RD Leasing preferred
stock only in order to qualify the exchange under section 351.
RD Leasing was required to maintain sufficient funds to pay
the liquidation preference to Mr. Parmentier.
We see no apparent
reasons for the use of an exchange of the preferred stock for Mr.
Parmentier’s interest in Andantech other than to facilitate the
tax-free transfer of the depreciation deductions to Norwest and to
compensate Mr. Parmentier for his services.
Standing
alone,
none
of
the
individual
steps
in
the
transaction at issue is the type of business activity one would
expect to see in a bona fide, arm’s-length business deal between
unrelated parties, and none of them makes any objective sense
standing alone without contemplation of the subsequent steps in the
transaction.
next.
Each step in the transaction leads inexorably to the
Consequently, the interdependence test is satisfied for
application of the step transaction doctrine.
We are of the opinion that NEFI and Comdisco recognized that
a direct transaction with RD Leasing would result in the offset of
depreciation
deductions
Consequently,
they
passed
with
the
ownership
income
from
the
rents.
of
equipment
through
the
- 79 Andantech-Foreign in order to produce a more favorable tax result.
By channeling the sale and leaseback of the equipment through
Andantech-Foreign, and by using a series of unnecessary exchanges
and transfers, RD Leasing through Andantech-US ended up with a high
basis in the equipment.
It would be unreasonable to assume that
the convoluted steps used in this transaction were anything other
than an integrated plan (prearranged by Comdisco and NEFI) to
accomplish tax advantages that could not be accomplished otherwise.
In essence, Comdisco and NEFI changed what would have been the
natural result of a direct purchase of the equipment by engaging in
a series of steps designed from the outset to circumvent the intent
of the Code.
Fundamental principles of taxation dictate that “A
given result at the end of a straight path is not made a different
result because reached by following a devious path.”
v. Helvering, 302 U.S. 609, 613 (1938).
Minn. Tea Co.
Consequently, we (1)
ignore the indirect route of the individual steps, (2) view the
transactions in their entirety, and (3) treat the transaction as
one between Comdisco and NEFI.
Under either the end result test or the interdependence test,
courts will ignore a step in a series of transactions if that step
does not appreciably affect the taxpayer’s beneficial interest
except
to
reduce
his
tax.
Del
Commercial
Commissioner, 251 F.3d 210 (D.C. Cir. 2001).
Props.,
Inc.
v.
There must be a
purpose for each step other than tax avoidance and the purpose
cannot be a “facade”.
Id. at 214.
The absence of a valid nontax
- 80 business purpose is fatal.
Id.
After reviewing Comdisco’s equipment leasing concept, see
supra pp. 10-12, and the economic effect of the transaction, we
conclude that the insertion of Andantech into the sale-leaseback
transaction involved herein served no valid nontax business purpose
and was devoid of any economic substance. Regardless of which test
is used under the step transaction doctrine, the facts in this case
require us to reach the same result.
If the sole purpose of a transaction with a foreign entity “is
to dodge U.S. taxes, the treaty cannot shield the taxpayer from the
fatality of the step-transaction doctrine. For a taxpayer to enjoy
the treaty’s tax benefits, the transaction must have a sufficient
business or economic purpose.”
Del Commercial Props., Inc. v.
Commissioner, supra at 213-214; see also Gaw v. Commissioner, T.C.
Memo. 1995-531, affd. without published opinion 111 F.3d 962 (D.C.
Cir. 1997).
The foreign entity must serve a role with a sufficient
business or economic purpose to overcome the conduit nature of the
transaction.
Del Commercial Prop., Inc. v. Commissioner, supra at
215.
In this case, the creation of Andantech-Foreign did not
appreciably
affect
Norwest’s
interests
in
arrangement, except to reduce its U.S. tax.
the
sale-leaseback
Andantech-Foreign’s
sole purpose was to enable Norwest to obtain the benefits of an
exemption established by treaty for income attributable to the sale
of the Comdisco rents.
And a tax-avoidance motive standing by
- 81 itself is not a business purpose which is sufficient to support a
transaction for tax purposes.
See Knetsch v. United States, 364
U.S. 361 (1960); Higgins v. Smith, 308 U.S. 473 (1940); Gregory v.
Helvering, 293 U.S. at 469.
3.
The Sale-Leaseback Transaction Lacked
Business Purpose and Economic Substance
We also agree with respondent that, even if we did not
disregard Andantech’s participation in the transaction, the saleleaseback transaction should not be respected for Federal income
tax purposes.19
Courts
will
give
effect
to
“a
genuine
multiple-party
transaction with economic substance that is compelled or encouraged
by business or regulatory realities, that is imbued with taxindependent considerations, and that is not shaped solely by taxavoidance features to which meaningless labels are attached”.
Frank Lyon Co. v. United States, 435 U.S. at 562.
In Horn v. Commissioner, 968 F.2d 1229 (D.C. Cir. 1992), the
Court of Appeals for the D.C. Circuit set forth the following test
for determining whether a transaction should be considered a sham
for tax purposes:
“To treat a transaction as a sham, the court must find
19
We note that, if the transaction has economic
substance, then RD Leasing is entitled to the interest and
depreciation deductions but must include the income from the sale
of the Comdisco rents. If, on the other hand, the transaction
lacks economic substance, then RD Leasing is not entitled to the
claimed deductions and is not required to include the income from
the sale of the rents.
- 82 [1] that the taxpayer was motivated by no business
purpose other than obtaining tax benefits in entering the
transaction, and [2] that the transaction has no economic
substance because no reasonable possibility of profit
exists.” * * *
Id. at 1237 (quoting Friedman v. Commissioner, 869 F.2d 785, 792
(4th Cir. 1989)); see also IES Indus., Inc. v. United States, 253
F.3d
350 (8th Cir. 2001); ACM Partnership v. Commissioner, 157
F.3d 231 (3d Cir. 1998), affg. in part, revg. in part, dismissing
in part, and remanding T.C. Memo. 1997-115; Salina Partnership,
L.P. v. Commissioner, T.C. Memo. 2000-352; Shriver v. Commissioner,
T.C. Memo. 1987-627, affd. 899 F.2d 724, 727 (8th Cir. 1990).
Our
inquiry as to the business purpose and economic substance of a
transaction is inherently factual.
See Torres v. Commissioner, 88
T.C. 702, 718 (1987).
In this case, we conclude that the sale-leaseback should not
be respected for tax purposes because (1) no reasonable possibility
for profit existed, and (2) RD Leasing was not motivated by any
business purpose other than obtaining tax benefits.
Petitioners and respondent each retained expert witnesses to
assess the possibility of profit with respect to the sale-leaseback
transaction involved herein.
a.
The Experts
In total, nine experts testified–-five for petitioners and
four for respondent.
Two of the experts (David Fleming for
petitioners and Dr. James Schallheim for respondent) testified as
to the economics of the transaction. In particular, each testified
- 83 as to the pretax returns RD Leasing could expect to receive.
Each
agreed that if the estimated residual values of the computers (as
determined by M&S, MAC, and ARI) were attainable, then the leases
were economically viable (i.e., had economic substance) without
regard to tax considerations.
The two experts differed, however,
on the amount of pretax return attainable.
In
reviewing
the
other’s
report,
Mr.
Fleming
and
Dr.
Schallheim each had one “major” disagreement with respect to the
computation of yield, specifically, the computations of yield with
regard to the scenario where Comdisco does not exercise its early
termination option.
In his rebuttal report, Dr. Schallheim stated
that Mr. Fleming included $2,711,993 as rents to be received by
Andantech, whereas Dr. Schallheim thought those rents had been sold
to NationsBank.
(In addition, Dr. Schallheim found that Mr.
Fleming had understated the interest on the balloon notes in the
full term option by $268,541.)
Dr. Schallheim based his conclusion on his understanding of
the definition of the term “Sale Rents” in the lease receivable
purchase agreement.
That provision, which defined the rents sold
to NationsBank, stated that “Sale Rents” would mean “all payments
of Rent payable under the Lease after the Closing Date but before
the Early-Termination Date as set forth on Schedule I.”
(Schedule
I was captioned “Rents Sold to Purchaser” and provided specific
dollar amounts of the rents that were sold.)
Dr. Schallheim
testified that he treated all rents payable before the early
- 84 termination dates as having been sold, whether or not they were
listed on Schedule I.
Dr. Schallheim also based his conclusion on
the fact that Andantech-U.S. did not receive any rent payments from
Comdisco.
Thompson Ryan, one of petitioners’ experts, testified that had
the projected residual values of the computers been realized, and
had Comdisco exercised its early termination option, then the
pretax return for RD Leasing would have been 6.6 percent, as
reflected
in
the
September
Projections.
John
Deane,
one
of
respondent’s experts, agreed with Mr. Ryan’s calculation; however,
Mr. Deane believed a 6.6-percent return was at, or slightly below,
the low end of what an investor would consider acceptable in 1993.
The other experts (Ralph Page, Mary O’Connor, and Patrick
Callahan for petitioners and Susan Middleton and Peter Daley for
respondent) opined as to the reasonableness of the projected
residual values of the computers.
Petitioners’ experts testified
that the price paid for the computers was fair and that the
projected residual values were attainable.
Not surprisingly,
respondent’s experts believed otherwise.
Mr. Daley was the publisher of two industry reports-–the DMC
End-User Market Value Report and the DMC Residual Value Report.
The information contained in these reports was based on computer
(and related equipment) sales between dealers; hence, the amounts
reflected in the DMC reports were wholesale (marked up by 10
percent),
rather
than
retail,
prices.
On
the
basis
of
the
- 85 information contained in his reports, Mr. Daley opined that the
purchase price of the computers was inflated and that the projected
residual values of the computers were unattainable.
Ms. Middleton, an expert in the field of residual valuation of
mainframe computers at IDC, rebutted the expert opinion of Mr.
Page.
She opined that Mr. Page’s estimated economic life for the
equipment was too long and explained that IDC projected a 6- to 7year life for the equipment as of June/July 1993.
On the basis of
the residual values forecast by IDC in its IBM June/July 1993
Residual Value Report, the residual value of the equipment on the
early termination date was less than $20 million, and on the
termination date it was less than $10 million.
Ms. Middleton
testified that IDC did not take into account (in its residual value
forecasting)
the
value
of
computers
on
lease,
or
the
“lease
premium”.
The experts made their evaluation of residual values on the
basis of a percentage of list price, as did the three September
1993 appraisals.
The following table sets forth the percentages
used in the various appraisals as well as the percentages published
in DMC’s 1993 publication:
- 86 Computation of Residual Value
as Percentage of List Price (LP)
Early Termination Date
I
Type/Model
% of LP
Category
9021/720/E
5/27/96
6.67%
9021/740/F
5/27/96
12.67
9021/820/G
5/27/96
12.67
9021/860/H
5/27/96
12.67
9021/900/I
5/27/96
12.67
9121/260/A
9/27/96
20.66
9121/320/B 10/27/96
19.75
9121/440/C 10/27/96
19.75
9121/480/D 10/27/96
19.75
Value
$44,275,948
II
III
IV
% of LP
8%
14
14
14
14
20
21
20
19
$48,442,600
% of LP
7%
13
13
13
13
20
20
20
20
$45,334,670
% of LP
7.96%
14.83
13.70
14.12
13.63
13.44
11.87
15.14
13.78
$44,702,292
I
RV as
% of LP
3.75%
7.50
7.50
7.50
7.50
11.00
10.00
10.00
10.00
$25,418,962
II
RV as
% of LP
5-6%
10
10
10
10
14
14
13-14
13
$34,257,000
III
RV as
% of LP
4%
8
8
8
8
10
10
10
10
$26,769,965
IV
RV as
% of LP
4.84%
10.95
9.93
10.50
9.88
8.54
7.70
9.08
8.27
$31,607,012
End of Lease Term
Type/Model
Category
9021/720/E
2/27/97
9021/740/F
2/27/97
9021/820/G
2/27/97
9021/860/H
2/27/97
9021/900/I
2/27/97
9121/260/A
7/27/97
9121/320/B
8/27/97
9121/440/C
8/27/97
9121/480/D
8/27/97
Value
I.
II.
III.
IV.
V.
VI.
M&S appraisal
MAC appraisal
ARI appraisal
Mr. Page’s appraisal using 8-year useful life.
DMC Consulting Group (Mr. Daley’s Expert Report)
DMC Residual Value Reports (Third Quarter 1993)
V
8 Years
% of LP
1.81%
5.35
4.81
4.81
4.77
5.27
4.26
4.09
4.29
$16,238,905
VI
% of LP
Retail/Wholesale
2.0/1.8% (4/96)
6.1/5.5 (4/96)
5.5/4.9 (4/96)
5.5/5.0 (4/96)
5.4/4.9 (4/96)
5.2/4.7 (10/96)
4.7/4.2 (10/96)
4.5/4.0 (10/96)
4.7/4.2 (10/96)
V
VI
% of LP
1.01%
2.11
1.85
2.04
1.94
1.37
1.10
1.10
1.10
$6,341,682
Retail/Wholesale
1.2/1.1% (1/97)
2.4/2.2 (1/97)
2.2/1.9 (1/97)
2.3/2.0 (1/97)
2.2/2.0 (1/97)
1.6/1.5 (7/97)
1.6/1.4 (7/97)
1.6/1.4 (7/97)
1.6/1.5 (7/97)
- 87 b.
No
Existed
Petitioners
assert
Reasonable
that
RD
Possibility
Leasing
had
for
a
Profit
reasonable
opportunity to earn a profit from the transaction based upon the
forecasts of residual values made by the appraisers in 1993.
Petitioners insist that the forecasts of residual values of the
equipment were realistic.
For the reasons set forth hereinafter,
we conclude that the sale-leaseback transaction involved herein had
no realistic potential to earn a meaningful profit.
In
order
to
hold
that
tax
avoidance
was
not
the
sole
motivation for the transaction, we must determine that a profit was
reasonably likely.
Estate of Thomas v. Commissioner, 84 T.C. 412,
440 n.52 (1985).
On an objective basis, we conclude that RD
Leasing had no reasonable prospect for pretax profit.
The key to profitability rested in achieving the projected
residual values for the equipment on the early or final termination
Dates.20
The record reveals that forecasting residual values is
inherently difficult in light of the fact that a forecaster’s
predictions
rely
upon
future
economic
events
and
trends.
20
The estimated yields from the perspective of RD Leasing
was as follows:
September projections
December projections
Mr. Fleming’s analysis
Early
Termination
Final
Termination
6.60%
6.70
5.74
14.00%
14.10
12.95
- 88 Reasonable people can differ.
Many of the experts agreed that
“residual value forecasting is more an art than a science” (and
that forecasting computer residual values was similar to predicting
the stock market).
We are not bound by the opinion of any expert witness when
that
opinion
is
contrary
to
our
own
Commissioner, 84 T.C. 722, 734 (1985).
judgment.
Chiu
v.
We may accept or reject
expert testimony as we, in our best judgment, deem appropriate.
Helvering v. Natl. Grocery Co., 304 U.S. 282 (1938); Silverman v.
Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo.
1974-285.
methods of
On the basis of our analysis of the transaction, and the
evaluation
employed
by
each
expert,
we
find
that
petitioners’ experts overvalued the residual value of the equipment
and that respondent’s experts undervalued it.
Petitioners’ experts posit that several unforeseen factors
resulted in RD Leasing’s failure to realize the projected residual
values of the computers: (1) The introduction and commercial
success of a new technology by IBM, called CMOS21 (complementary
metal oxide semiconductor), and IBM’s failure to provide a “path”
by
which
21
existing
mainframes
could
be
upgraded;
(2)
IBM’s
CMOS processors had the following advantages: they
cost less than 25 percent of the list price of IBM’s older
mainframes; they required substantially less floor space; they
did not require dedicated environmental support (i.e., they were
air cooled instead of water cooled); they could be maintained for
50 percent less than older machines; and they could be configured
to process data in less time.
- 89 announcement that it would no longer publish list prices for its
9021 and 9121 computer models, and that it would provide discounts
to purchasers of those models in order to retain its market share;
(3) increased competition from other manufacturers (such as Amdahl
Computer Corp. and Hitachi Data Systems, Inc.); and (4) IBM’s
adoption
of
a
“market
basket
approach”,
whereby
IBM
bundled
hardware, software, and services into a single package, charging a
single price.
Respondent’s experts testified that in 1993 the mainframe
market community was aware that IBM would be introducing new
technology22 which would shorten the lives (and adversely affect the
residual values) of the IBM 9021 and 9121 models; however, they
acknowledged that the specifics of the new technology were unknown.
Ms. Middleton acknowledged that in the fall of 1993, there was some
speculation as to whether IBM could successfully develop CMOS
technology, and if IBM could, when IBM would be able to bring a
product (using that technology) to market.
The September 1993 ARI appraisal claims that the “unusual
pessimism” of the residual value estimates by the Gartner Group,
IDC, and DMC are the result of several assumptions, including the
prediction that “IBM will introduce revolutionary technology in
January 1996 and that the value of * * * [the computers] will
22
A Nov. 10, 1993, New York Times article reported that
IBM had introduced a big new computer to replace its antiquated
mainframe line.
- 90 approach their estimated salvage value of 1% of list within one
year after the announcement.”
Additionally, the DMC Residual Value Report for the third
quarter 1993 forecast commentary for the IBM 9021 models states
that the lack of a list price was bothersome to most users because
of the lack of a reference point to begin negotiations.
The report
indicates that there also was no list price for the IBM 9121
models.
Thus, at the time of the transaction, IBM no longer
provided list prices and the lack of list prices was not an
unforeseeable event.
We think the market forces that resulted in a rapid decline in
the value of the equipment were predictable in 1993 and, at a
minimum, should
not
have
been
ignored
by
the
appraisers
and
petitioners’ experts in estimating the residual values.
The M&S report states that IBM typically introduces a new
series (or family) of mainframes every 3.5 to 5 years.
Mr. Page,
a vice president of M&S, testified as an expert for petitioners in
this case.
His estimate of the residual value of the computers is
based upon a chart from a study he prepared for M&S in spring 1993
using a 10-year useful life.
His age/life depreciation curve was
based upon an annual study that he prepared beginning in 1980 and
continuing through 1992.
The data for this study came from the
January issues of the “Computer Price Guide” (recognized as the
most authoritative source of secondary market information).
In
1993 when he prepared the chart, he was aware of the fact that “the
- 91 rate of technological changes was accelerating.”
He did not
shorten the useful life; instead, he reduced the value by 10
percent for years 1 to 8 and a lesser amount for years 9 and 10.
Petitioners’ experts assert that respondent’s experts failed
to take into account the “foot print” value when estimating the
residual value of the equipment.
The “foot print” value is the
value that accrues to a computer that is on lease.
It includes the
ability to upgrade. Significant profits can be made from upgrades.
The record shows, however, that RD Leasing did not have the benefit
of the foot print.
Rather, Comdisco had the right to that benefit.
All the experts opined that if the residual value estimates of
MAC, M&S, and ARI were valid, then the lease would appear to have
economic
substance
before
taxes.
However,
we
find
that
the
estimated values provided by petitioners’ experts are not reliable
as estimates of residual values of the equipment.
Those estimates
inflate the residual values by including the “foot print” value and
ignoring
predictable
negatively.
market
events
that
affected
the
values
In sum, we do not accept the analyses and conclusions
of petitioners’ experts as to residual values.
Petitioners’ experts assert that residual values for January
1994, as set forth in the October 1992 DMC Residual Value Report,
were extremely low. They assert that the DMC forecasts undervalued
the residual values of the IBM 9021 models by up to 186 percent and
the IBM 9121 models by up to 13 percent.
In our opinion, the
predictions of the earlier DMC Residual Value Report would have
- 92 been less accurate than the report available at the time of the
transaction, in part because they were made shortly after the
computers were first introduced by IBM.
Increasing the residual
values forecast in the DMC Residual Value Report available at the
time of the transaction by the undervaluation percentages provided
by petitioners’ expert Mr. Callahan for each model, a reasonable
estimate of the residual value of the equipment would have been as
follows:
Type/Model/
Category
9021/720/E
9021/740/F
9021/820/G
9021/860/H
9021/900/I
9121/260/A
9121/320/B
9121/440/C
9121/480/D
Total
9021/720/E
9021/740/F
9021/820/G
9021/860/H
9021/900/I
9121/260/A
9121/320/B
9121/440/C
9121/480/D
Total
Computation of Residual Value
Full Term
List Price
(LP)
DMC/(Increase)
$35,412,247
1.2% (2.6)
3.12%
12,336,045
2.4 (1.5)
3.60
68,624,690
2.2 (1.5)
3.30
40,808,478
2.3 (1.5)
3.45
139,926,914
2.2 (1.5)
3.30
4,637,115
1.6 (1.1)
1.76
18,186,545
1.6 (1.1)
1.76
6,923,363
1.6 (1.1)
1.76
14,427,399
1.6 (1.1)
1.76
$35,412,247
12,336,045
68,624,690
40,808,478
139,926,914
4,637,115
18,186,545
6,923,363
14,427,399
Early Termination Date
2.0% (2.6) 5.20%
6.1 (1.5) 9.15
5.5 (1.5) 8.25
5.5 (1.5) 8.25
5.4 (1.5) 8.10
5.2 (1.1) 5.72
4.7 (1.1) 5.17
4.5 (1.1) 4.95
4.7 (1.1) 5.17
Amount
$1,104,862
444,098
2,264,615
1,407,892
4,617,588
81,613
320,083
121,851
253,922
10,616,524
$1,841,437
1,128,748
5,661,537
3,366,699
11,334,080
265,243
940,244
342,706
745,897
25,626,591
We find that at the time of the transaction, the estimated
residual value of the equipment for the final termination dates was
- 93 no greater than $10,616,524 and for the early termination dates was
no greater than $25,626,591.
The projected balance due on the balloon notes at the end of
the full term of the lease was $20,335,186, and at the early
termination
date
the
projected
balance
was
$25,582,611.
Consequently, RD Leasing had no realistic potential to recover its
investment or to earn a pretax profit.
In
sum,
we
conclude
that
under
the
objective
economic
substance test, the leveraged sale-leaseback transaction involved
herein had no reasonable opportunity for economic profit.
We now
turn our attention to whether RD Leasing/Norwest was motivated by
any business purpose apart from obtaining tax benefits.
c.
RD Leasing/Norwest Was Not Motivated by Any
Business Purpose Other Than Obtaining Tax Benefits
The proper inquiry for the business purpose test is “whether
the taxpayer
was
induced
to
commit
capital
for
reasons
only
relating to tax considerations or whether a non-tax motive, or
legitimate profit motive, was involved.”
899 F.2d at 726.
Shriver v. Commissioner,
In other words, the business purpose test is a
subjective economic substance test.
In making a “subjective
analysis of the taxpayer’s intent”, we review such factors as the
depth
and
accuracy
of
the
taxpayer’s
investigation
into
the
investment. Id. To the extent the taxpayer’s subjective intent is
material, we also consider factors that are arguably relevant to
the inquiry.
- 94 Petitioners posit that, on a subjective basis, RD Leasing,
NEFI, and Norwest acted in a businesslike manner and were not
motivated solely by tax considerations.
But we are not satisfied
that Norwest/RD Leasing (through its executive employees) believed
that
the
projected
residual
values
were
both
realistic
and
attainable.
In analyzing whether a taxpayer was induced to commit capital
for reasons relating only to tax considerations or whether a
legitimate profit motive was involved, the following factors are
particularly significant: (1) The presence or absence of arm’slength price negotiations, Helba v. Commissioner, 87 T.C. 983, 1004
(1986), affd. without published opinion 860 F.2d 1075 (3d Cir.
1988); see also Karme v. Commissioner, 73 T.C. 1163, 1186 (1980),
affd. 673 F.2d 1062 (9th Cir. 1982); (2) the relationship between
the
selling
price
and
the
fair
market
value,
Zirker
v.
Commissioner, 87 T.C. 970, 976 (1986); Helba v. Commissioner, supra
at 1005-1007, 1009-1011; (3) the structure of the financing, Helba
v. Commissioner, supra at 1007-1011; (4) the degree of adherence to
contractual terms, id. at 1011; (5) the reasonableness of the
income and residual value projections, Rice’s Toyota World, Inc. v.
Commissioner, 81 T.C. at 204-207; and (6) the insertion of other
entities, Helba v. Commissioner, supra at 1011. Our application of
these factors to the transaction involved herein follows.
i.
Presence or Absence of Arm’s-Length Price
Negotiations
- 95 Arm’s-length
commercially
bargaining
valid
is
an
transactions.
obvious
Id.;
characteristic
see
also
Karme
of
v.
Commissioner, supra. To determine that an arm’s-length transaction
took place, we must find that the buyer was motivated to secure the
lowest purchase price possible and, conversely, that the seller
looked to obtain the highest price.
See Fox v. Commissioner, 80
T.C. 972, 1009 (1983), affd. without published opinion 742 F.2d
1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731
F.2d 230 (4th Cir. 1984), affd. without published opinion 734 F.2d
9 (3d Cir. 1984), affd. without published opinions sub nom. Hook v.
Commissioner,
Kratsa
v.
Commissioner,
Leffel
v.
Commissioner,
Rosenblatt v. Commissioner, Zemel v. Commissioner, 734 F.2d 5, 6-7,
9 (3d Cir. 1984).
Here, it is evident that Ms. Grossman, who reviewed and
recommended the transaction for NEFI, had little interest in
securing the lowest purchase price for the computers.
Indeed, the
opposite was true; the greatest projected profits stemmed from tax
deductions which in turn increased as the purchase price increased.
Cf. Patin v. Commissioner, 88 T.C. 1086, 1122 (1987), affd. without
published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186
(4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93
(9th Cir. 1989), affd. without published opinion 865 F.2d 1264 (5th
Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865
(6th Cir. 1989); Ferrell v. Commissioner, 90 T.C. 1154, 1186
(1988).
- 96 Nothing in any of the papers related to the negotiations
indicate that Ms. Grossman (or for that matter Mr. Parmentier) ever
attempted to negotiate a purchase price for the computers in an
amount less than that set forth in Comdisco’s proposal. Similarly,
there
is
no
evidence
that
Ms.
Grossman
(or
Mr.
Parmentier)
negotiated to increase the amount of the rent payable under the
lease, to reduce the amount of the cash to be invested, or to
reduce the interest rates payable on the notes.
Succinctly stated, there is no evidence of any arm’s-length
negotiations by anyone in the sale-leaseback transaction at issue.
Rather, the participants allowed Comdisco to arrange all aspects of
the transactions.
Moreover, the record is devoid of evidence that
the purchase price was in any way determined with a true regard for
the profitability of the activity.
Brannen v. Commissioner, 78
T.C. 471, 509 (1982), affd. 722 F.2d 695 (11th Cir. 1984); see also
Helba v. Commissioner, supra at 1005-1011.
And the lack of arm’s-
length negotiations indicates that NEFI did not enter into the
transaction for a legitimate profit purpose.
ii. The Relationship Between
Price and the Fair Market Value
the
Selling
In this case, all but $15 million of the selling price was
financed by Comdisco.
The transaction was arranged so that the
payments due on the financing were offset by the rents payable by
Comdisco.
In fact, the rents were determined by reference to the
purchase price.
Therefore, the selling price and the fair market
- 97 value of the equipment at the time of the purchase had little
effect on the pretax profitability of the transaction.
The pretax
profitability was dependent on the residual value at the early
termination
date
or
the
final
termination
date;
profitability was dependent on the tax savings.
the
overall
See Zirker v.
Commissioner, supra at 976; Helba v. Commissioner, supra at 10051007, 1009-1011.
iii. The Structure of the Financing
The structure of the financing is an important factor in
evaluating the claimed economic substance of the sale-leaseback
transactions.
Helba v. Commissioner, supra at 1007-1011.
In this
case, most of the purchase price of the properties was financed by
debt that in reality was functionally identical to nonrecourse
obligations.
On
numerous
occasions,
courts
have
found
that
a
disproportionately large amount of nonrecourse debt included in the
purchase price of a piece of property indicates that a transaction
lacks economic substance. See, e.g., Waddell v. Commissioner, 86
T.C. 848, 902 (1986), affd. per curiam 841 F.2d 264 (9th Cir.
1988); Elliott v. Commissioner, 84 T.C. 227, 238 (1985), affd.
without published opinion 782 F.2d 1027 (3d Cir. 1986); Estate of
Baron v. Commissioner, 83 T.C. 542, 552-553 (1984), affd. 798 F.2d
65 (2d Cir. 1986).
This is especially true when, as a practical
matter, there is little possibility that the debt will ever be
paid.
- 98 RD Leasing was not liable to a third party for the debt.
Unlike the transaction in Frank Lyon Co. v. United States, 435 U.S.
561 (1978), if Comdisco had failed to make its lease payments, RD
Leasing would not have had to provide its own capital to make
mortgage payments to a third party.
If RD Leasing did not make its
final balloon payments on the equipment, Comdisco’s only remedy was
to retake the equipment.
Thus, RD Leasing had the option to
abandon the equipment, leaving Comdisco no recourse against RD
Leasing.23
The transaction did not occur on a public market but rather in
an environment controlled by Comdisco and NEFI.
When the sale-
leaseback transaction involved herein was proposed, Mr. Hastings
used the M&S report to interpolate the values stated therein to
arrive at values relevant to the specific dates in the proposed
transaction.
He then presented these interpolated numbers to Greg
Barwick, one of M&S’s appraisers.
The cost of the computers, the
financing of the purchase price (including the interest rates), and
the rents, as well as the estimated residual values, were easily
manipulated to project a pretax profit.
NationsBank’s
records
show
that
the
bank
treated
the
“purchase” of the rents receivable as a loan to Comdisco and
anticipated prepayment by March 28, 1994.
23
The bank’s records
The equipment was Andantech’s only asset, and the
Andantech interest was RD Leasing’s principal asset (RD Leasing,
however, was required to maintain sufficient investments to
redeem Mr. Parmentier’s preferred stock).
- 99 indicate
that
Comdisco
approached
NationsBank
to
“provide
financing” for a sale/leaseback transaction involving a lease
receivable purchase with Comdisco as the obligor.
NationsBank
expected the transaction to generate “$168,000 in net interest
income for assuming a short-term, unsecured credit position with
Comdisco”.
Although
Comdisco
had
historically
prepaid
each
receivable purchase transaction funded by NationsBank, Comdisco
could elect not to prepay.
“In this situation, NationsBank would
hold a 36 month, unsecured loan to Comdisco at 75bp.”
Under the terms of the term note for the purchase of the
equipment, Andantech’s sale of the rents to NationsBank accelerated
the term note. Andantech directed NationsBank to wire transfer the
proceeds from the rent sale ($87,805,802) to Comdisco in payment of
Andantech’s
obligations
to
Comdisco
under
the
term
note.
NationsBank did so, and Comdisco canceled the term note.
The rents owed by Comdisco before the early termination date
were calculated to equal the amount due on the term note.
The sale
of those rents to NationsBank was in fact a short-term loan to
Comdisco, and Andantech was required to use the proceeds to pay off
the term note.
transaction.
There was no substance to the financing of the
See Mapco Inc. v. United States, 556 F.2d at 1110.
iv. The Degree of Adherence to Contractual
Terms
A transaction having economic substance has as one of its
characteristics an intent by the parties of having their agreements
- 100 enforced.
The
indicates
that
parties’
the
failure
transaction
to
does
enforce
not
their
conform
agreements
to
economic
Helba v. Commissioner, 87 T.C. at 1011; cf. Arrowhead
realities.
Mountain Getaway, Ltd. v. Commissioner, T.C. Memo. 1995-54 (finding
of sham transaction supported by showing that promoter was “notably
careless and unbusinesslike” in documenting and altering legal
relationships of the partnership), affd. 119 F.3d 5 (9th Cir.
1997).
In the instant matter, Comdisco had the right to substitute
replacement equipment if the end user made a bona fide offer to
purchase the computer.
In that event, RD Leasing had the right to
request reasonable documentation from Comdisco before transferring
title pursuant to a bill of sale.
In April 1994, one of the end users purchased the IBM 9021
computer equipment it subleased from Comdisco.
one
that
had
been
sold
to
Andantech.
substitute replacement equipment.
The computer was
Comdisco
elected
to
But Comdisco failed to provide
notice to Andantech that it was exercising its right to substitute
replacement
equipment
and
did
not
follow
the
procedures
for
substitution required by the equipment lease.
We are also mindful that Comdisco provided Ms. Grossman with
location reports relating to the equipment on March 1, 1994,
February 27, 1995, and February 28, 1996.
computers
that
were
the
subject
of
the
The 40 mainframe
sale-leaseback
were
identified by serial number in the location reports. The computers
- 101 shown in the reports had the same serial numbers as those that were
on the 1993 bill of sale.
Ms. Grossman was unaware that Comdisco
had substituted replacement equipment for the equipment purchased
by the end user.
When Comdisco exercised its early termination option, the 1996
bills of sale conveyed back to Comdisco the identical computers
that Andantech had acquired pursuant to the 1993 bill of sale.
The
serial numbers on the 1996 bills of sale were identical to those on
the 1993 bill of sale.
Thus, the 1996 bills of sale inaccurately
reflect that Comdisco never replaced any of the computers (i.e.,
did not substitute a different computer for any of the original
equipment).
Andantech never transferred title to the end user.
Comdisco treated the equipment as its own and transferred ownership
of the equipment to the end user.
We are also mindful that, as Dr. Schallheim points out, under
the schedule of rents, Andantech did not sell all of the rents to
NationsBank.
Andantech.
Comdisco should have paid $2,711,993 of rent to
Petitioners’ expert, Mr. Fleming, included those rents
in his analysis of the profit potential.
Petitioners argue that
those rents should be included in evaluating the profit potential,
but they fail to explain why Andantech never sought to collect the
rents.
The low degree of adherence to the entities’ contractual
terms, particularly those relating to the actual ownership and the
right to transfer ownership to a third party, indicates a lack of
- 102 substance to the transaction.
Rose v. Commissioner, 88 T.C. 386,
410-411 (1987), affd. 868 F.2d 851 (6th Cir. 1989); Helba v.
Commissioner, 87 T.C. at 1009.
v.
The Reasonableness of
Residual Value Projections
the
Income
and
We have examined the reasonableness of projections of income
expected to emanate from a transaction as a means of evaluating its
economic
substance.
See,
e.g.,
Rice’s
Toyota
World,
Inc.
v.
Commissioner, 81 T.C. at 204-207.
We are mindful that it is inappropriate to use hindsight in
determining whether residual projections were correct. However, in
1993, the public was aware that IBM was developing CMOS, which, if
and when brought to market, would affect the normal depreciation
curve.
We find it difficult to believe that NEFI, being actively
involved in the financing and leasing of computers, was unaware of
the potential that such events could occur.
Ms. Grossman received three appraisals from Comdisco.
Ms.
Grossman testified that she did not have “a sufficient level of
comfort” with only one (the M&S) appraisal, and she requested
additional
appraisals.
She
admitted,
however,
that
the
MAC
appraisal provided little information. The ARI appraisal discloses
that
the
appraisal
would
be
used
for
support
of
true
lease
requirement related to Federal taxation and as support in the
investment decision process.
The report clearly states that
industry publications such as Gartner Group, IDC, and DMC forecast
- 103 significantly lower residual values.
Ms. Grossman admitted that
she wanted the file to show that she had looked for as much
information as she could.
by
Comdisco
were
In our opinion, the appraisals provided
nothing
more
transaction with legitimacy.
than
an
attempt
to
color
the
Although NEFI had entered into many
other leveraged sale-leaseback transactions and had expertise in
this area, it failed to use any of its expertise in analyzing the
residual values.
In fact, the CAP places little value on the
collateral (the value of the equipment).
Further, the testimony of Ms. Grossman at trial indicates that
NEFI officials knew that there was a high risk that the transaction
would
result
transaction
in
a
loss.
Ms.
Grossman
testified
that
the
was
too
large
for
NEFI,
that
was
more
appropriate for Norwest.
and
it
That claim is contradicted by the fact
that the transaction was conducted through RD Leasing, at the time
an inactive shell corporation without any other assets.
Ms.
Grossman admitted that if anything went wrong with the deal, NEFI
officials would not receive bonuses.
RD Leasing was used because
the corporate officers did not want any losses from the transaction
to be attributed to NEFI.
Ms. Grossman’s admission leads us to
conclude that she was aware that it was unlikely that any pretax
profit would be made on the transaction.
We are satisfied that at the time Norwest/RD Leasing entered
into
the
sale-leaseback
transaction
involved
herein,
the
Norwest/NEFI executives did not reasonably believe that an economic
- 104 profit, independent of tax benefits, was attainable and knew that
a genuine risk of loss existed.
The projections showed that,
regardless of any pretax profit, Norwest/NEFI would realize an
after-tax profit ranging from 92 to 101 percent.
NEFI never
considered the financial consequences of the transaction without
the
prior
stripping
of
the
rents
from
the
transaction.
A
reasonable person would not believe that there was a basis for
entering into the transaction other than for the acquisition of tax
benefits.
See Helba v. Commissioner, supra at 1012.
vi.
Insertion of Other Entities
In determining a lack of economic substance, the fact the
parties created and/or used intermediate entities for no valid
business purpose is of significance.
See, e.g., id. at 1011.
Here, Comdisco and NEFI created and/or used various entities to
participate in the sale-leaseback transaction in order to strip the
income
from
the
transaction
and
for
no
other
purpose.
Specifically, Comdisco enlisted Messrs. Parmentier and de la Barre
d’Erquelinnes to create Andantech and EICI.
Mr. de la Barre
d’Erquelinnes then used EICI and the Trust, a charitable trust (tax
exempt) previously created by Comdisco, as a depository for his
interest after his participation had served its purpose.
And NEFI
used RD Leasing (previously known as Radio Dealers Leasing, Inc.),
an inactive shell corporation.
Our review of these factors shows that the sale-leaseback
transaction at issue was not compelled or encouraged by business or
- 105 regulatory realities.
Rather, it was “shaped solely by tax
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