UNITED STATES TAX COURT
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136 T.C. No.
1
UNITED STATES TAX COURT
HISTORIC BOARDWALK HALL, LLC, NEW JERSEY SPORTS AND EXPOSITION
AUTHORITY, TAX MATTERS PARTNER, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 11273-07.
Filed January 3, 2011.
New Jersey Sports and Exposition Authority (NJSEA)
and Pitney Bowes (PB) formed Historic Boardwalk Hall,
LLC, to allow PB to invest in the historic
rehabilitation of the East Hall, a popular convention
center in Atlantic City, New Jersey.
The East Hall underwent a significant
rehabilitation during the years at issue. On Forms
1065, U.S. Return of Partnership Income, for 2000,
2001, and 2002, Historic Boardwalk Hall claimed
qualified rehabilitation expenditures and allocated
those expenditures to PB, allowing PB to claim historic
rehabilitation tax credits pursuant to sec. 47, I.R.C.
R issued an FPAA asserting alternative grounds for
denying PB the claimed rehabilitation tax credits. R's
overarching argument is that NJSEA sold the
rehabilitation tax credits to PB for a fee. R also
SERVED JAN -3 2011
- 2 -
argues that the accuracy-related penalty púrsuant to
sec. 6662, IRC, applies
Held:
istoric- Boardwalk Hall was not a sham and s
d d not lack economic substance.Held, further, PB did become a partner in Históric
Boardwalk Hall.
Held, further, NJSEA did transfer the benefits and
urdens of ownership of the East Hall to Historic
Boardwalk Hall.
Held, further, -the sec. 6662, IRC, penalty is not
appl ic able .
Kevin M. Flynn and Michael Serdof f
Daniel Rosen; Kurt Ruben
for petitioner
Molly Donough, and Sashka Koleva,
for respondent.
COEKE,
udge:
Respondent issued a notice o
fina
partnership administrative adjustment (FPAA) to Historic
Boardwalk Hall
LLC (Historic Boardwalk Hall) .
The issues for
decis on are:
(1) Whether Hist oric Boardwalk Hall is a shain;
(2) whether Pitney Bowes was a partner in Historic Boardwalk
Hall;
3) whether New Jersey Sports and, Exposition Aut hority
(NJSE
or petitioner) transferred the benefits and burdens of
ownership of the East Hall to liistoric Boardwalk Hall
and
- 3 (4) whether Historic Boardwalk Hall is liable for section
66621 accuracy-related penalties for years 2000, 2001, and 2002.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulations
of fact and the attached exhibits are incorporated herein by this
reference.
NJSEA was created by the New Jersey State Legislature
in 1971 and is a State instrumentality.
NJSEA was initially
formed to build, own, and- operate.the Meadowlands Sports Complex
in East Rutherford, New Jersey
NJSEA's jurisdiction was expanded by the New Jersey State
Legislature in January 1992 to include the Atlantic City
Convention Center Project.
That project authorized NJSEA to
build, own, and operate a new convention center and to own and
operate the East Hall (the East Hall is also known as Historic
Boardwalk Hall).
To carry out the new Convention Center Project, the Atlantic
County 'Improvement Authority (ACIA) and NJSEA entered into a
lease for the East Hall whereby NJSEA leased the- East Hall for a
term of 35 years at a rent of -$1 per year.
Shortly thereafter,
NJSEA entered into an operating agreement with the Atlantic City
Convention Center Authority (ACCCA). * ACCCA was initially formed
All section references are to the Internal Revenue Code
(Code), and all Rule references are to the Tax Court Rules of
Practice and Procedure.
to. proinote tourism in the Atlantic City region
nd eit would
serve" as day-to-dÁy managet of, the*Êast HÉll.
Läter
NJSEA and ACCCAr entered into a management agreement
with Spectator Managementa,Group (SMG) .
SMGewas well known for
managing, marketing,- and, developing public assembly facilities,
includ ng c'onvention andispecial event centers.
NJSEAucontracted
to have SMG manage the East +Ìall beöause NJSEA felt tihet a
private company would ibehable to promote
oversee, andemanage the
East Hall, the West Hall (a facility adjacept to the. East Hal-l)s
and the -soon-to-be cons'tr cted conventiori ce ter
The management
agreement stated that SMG would piovide opei-ations, marketing,
f inance, employee supervision, adininistrat iñe,; :ahd óther .general
management services .
SMG managed the East Hall day to day
.a -
.
e a
SMG maintained saa
system of accounts for Historic Boardwalk Háll
and Historic
Boardwalk Hall's annual auclitedafinancial statements)wer
based
on this asystem of accounts . NAlthough SMG s initïal agreement pas
for a '3-year term, it has Meen extended.
1
1.
Overview of the T ansaction lat ]!ssue n
* :
Historic Boardwalk Hall was orgànized under the laws of the
State of New Jersey as aglimitedAiabil-ity companyson/June 26,
2000 .
NJSEA was the sole member 6f Historic Boardwalk Hall at
formation.
On September 14, 2000, PB Historic Renovations, LLC
- 5 (Pitney Bowes),2 was admitted as a member of Historic Boardwalk
Hall.
Historic Boardwalk Hall's purpose was to allow Pitney Bowes
to invest in the rehabilitation of the East Hall.
Because the
East Hall was a historic structure, this rehabilitation project
had the potential to earn -section 47 historic rehabilitation
credits.3
Historic Boardwalk Hall's formation would allow Pitney
Bowes, a private party, to earn these historic rehabilitation
credits from the rehabilitation of a public, governmentally
owned, building.
Respondent argues that in substance the
transaction was akin to NJSEA's selling rehabilitation credits to
Pitney Bowes.
To that end, respondent determined alternatively
in the FPAA that Historic Boardwalk Hall is a -sham, that Pitney
Bowes was never a partner in Historic Boardwalk Hall, and that
NJSEA never transferred ownership of the East Hall to Historic
Boardwalk Hall.
A finding for respondent on any of these
theories would prevent the section 47 rehabilitation credits from
flowing to Pitney Bowes; instead they would flow to NJSEA.
2PB Historic Renovations, LLC, was a limited liability
company whose sole member during all relevant periods was Pitney
Bowes Credit Corp.
During all relevant times, Pitney Bowes
Credit Corp. was a wholly owned subsidiary of Pitney Bowes Corp.
For simplicity, we refer to PB Historic Renovations, LLC, Pitney
Bowes Credit Corp., and Pitney Bowes Corp. as Pitney Bowes.
3Sec. 47 allows for a Federal tax credit of 20 percent of
the qualified rehabilitation expenditures with respect to any
certified historic structure.
- 6 -
Petitioner contends instead that transactions like the one at
issue were promoted and supported by Congress and are not shams.
2.
'East-Hall History
-
-
,
,
,
Construction of the East Hall began, in,1,926 and was,
completed in 1929.
It is loca_ted prominently- at the center of
the,At+lanti'c City, New Jersey, Boardwalk and faces the Atlantic
Ocean.a
The East Hall was;a popular event space of exceptionally
large ,dimensions,-featuring an auditorium with a 130-foot ceiling
and over 250,000 square feet of floor space.
After it was completed, the.East Ha_ll hosted ,a-number of
public events, including hockey matches, professional football
games,p and equestrian shows.
The East Hall also hosted trade
shows, conferences, meetings, and musi.cal performances, including
those sof the Beatles and the Rollling Stones.
Beginning in 1933,
the East Hall.hosted the.Miss America pageant.
The East, Hall was listed as a National Histor.ic Landmark by
the U."S. Department of the Interi-or on February 27, 1987.
In -
January 1992 the New Jersey State Legislature authorized NJSEA to
undertake construction of the new convention center and
renovation of the East Hall.
Once the new convention center was
complêted, it'was expected to become the primary locati-on'for
flat-floor conventions like the ones that had until that time
been ßeld in the East Hall. * As a result,'~the East Hall would no
- 7 longer draw those types of events and wouldrhaverno use unless
renovated.
Once construction began on the new convention center,
representatives of NJSEA and other New Jersey State officials
began to study and make plans for the future of the East Hall.
Because it had become run down, the'only way to make the East
Hall usable again was to convert it to a special events facility
that could host concerts, sporting events, family shows, and
other civic events.
This conversion would require thit the East
Hall be substantially rehabilitated."
State officials-in New
Jersey decided to rehabilitate the East Hall and convert it into
a mixed-use space.
Rehabilitation of the East Hall began in December 1998.
was to be completed in four phases:
It
(1) Construction of
scaffolding suspended from the auditorium's ceiling to facilitate
rehabilitation of the ceiling;
(2) removal of auditorium ceiling
tiles and abatement of asbestos;
(3) reconstruction of the
ceiling using glass-fiber reinforced tiles and high-performance
acoustical perforated aluminum tiles; and (4) construction of a
new permanent arena seating bowl, construction of support
services and patron amenities beneath the seating bowl, and
restoration and historically accurate.painting of the Hall's
interior.
To pay for a ,portion of the renovation. costs, on/Juner15,*
1999, NJSEA issued about $49.5 million of State bonds.
In
additi.on, NJSEA received approximately $22 million from the New
Jersey, Casino Reinvestment Development Authority .
In the
absence of- an equity investor, the rehabilitation would have been
funded, entirely by the State.of New:Jersey.
3.
Sovereign Capital Resources , LLC
In late 1998, Paul -Hoffman (Mr. Hoffman) of Sovereign
Capital Resources, LLC , (Sovereign),, contacted, representatives of
NJSEA. , Sovereign was founded by Mr. Hoffman ,and a partner in
1995.
Mr. H,offman contacted NJSEA because he had 1 arned of the
East Hall renovation; one of Sovereign' s business ilines Was
raising, equity for,historicr rehabilitations.
NJSEA engaged the
services of Sovereign.to act as -its financial advisér in finding
an equity investor for the East Hall' s rehabilitatioír. y a
Respondent argues that this was not an investment, but rather
Sovereign was facilitating a sale of the historic tax credits
generated by the East Hall rehabilitation.
, NJSEA engaged several law firms sto review and opine on'
a
11
certain aspects of the transaction:
(1) ; Wol f , BlockdSchorr,
4The New Jersey Casinò Reinvestment 'Developfnent Authority is
a State agency created by the New Jersey State Isegislature that
uses funds generated from governmental charges imposed on the
casino industry for economic development and community projects
throughout the State. The funds given to NJSEA were in tihe form
of a grant .
Solis-Cohen, LLP;
Vecchione
(2) Gibbons, Del Deo, Dolan, Griffinger &
(Gibbons, Del Deo); and (3) Wolf & Sampson,
P.C.
NJSEA
also engaged the accounting firm of Reznick Fedder & Silverman,
P.C.
(Reznick), to provide counsel on the rehabilitation credit
transaction.
4.
Confidential Offering Memorandum
Sovereign prepared a confidential offering memorandum as
part of its services to NJSEA.
The memorandum was prepared using
information provided to Soverign by NJSEA, Reznick, and others
and included financial information for the rehabilitation of the
East Hall and for its operation after the rehabilitation was
completed.
The financial projections in the confidential offering
memorandum were based on certain assumptions, most importantly
that revenue from the East Hall would increase 3 percent per
year.
The financials projected that the eventual partnership
would have positive net operating income from 2002 through^2009.
That net operating income would be zeroed out through lease
payments, an increase in a "replacement reserve", the investor
member's 3-percent priority distribution, and an incentive
management fee, to the extent there was cash to make- those
payments.
T e confidential offering memorandum a]so, informed
prospe tive investors, that-Historic JBoardwalk Halle would hav.e
taxable losses for at, least the years 2002 -through 2009.
The financial projections attached to the amended and
restated operating agreement, discussed moré fully below, are
different from those attached to the confidential offerings
memora dum.
The memorandum was -sent to 19¥ corporations and described Ethe
transaction as, a "sale" of tax credits .
The memorandum indicated
that t e private investor' s equi y investment would bei used to
pay, a development fee to NJSEA, with any surplus remaining with
Historic Boardwalk Hall.
joinin
Four corporations showed interest ,in
the ti-ansaction, and each submitted a bid detailing how
much it would be willing to invest depending on the
rehabilitation credits it would earn. ¿Eventtiallye Pit-ney4Bowes'
offer was accepted and it was selected to invest in Historic
Board alk Hall.
5.
Formatifon of Historic Boardwalk Hall
Historic Boardwalk Hall, organized on June 26, 2000
elected
to bedtreated a,s a, partnership for Fe'deral income tax purposes.
NJSEA was dhe sole member at formationrand executed ari operating
agreenent for the East Hall, as explained above.
When Pitney
Bowes joined Historic Boardwalk Hall on September 14, ,2000, NJSEA
and Historic Boardwalk Hall signed an amended and restated
- 11 -
operating agreement (the AREA).
The AREA identified NJSEA as
managing member and Pitney Bowes as investot member of Historic
Boardwalk Hall.
Pursuant to the terms of the AREA, Pitney Bowes
has a 99.9-percent ownership interest in Historic Boardwalk Hall.
NJSEA owns the remaining 0.1 percent.
Profits, losses, tax
credits, and net cashflow are allocated to Historic Boardwalk
|
Hall's members according to their ownership interests.
The AREA stated that Historic Boardwalk Hall was formed to
acquire, develop, finance, rehabilitate, own, maintain, operate,
license, and sell or otherwise dispose of the East Hall for- use
as a special events facility to hold events, including but not
limited to, spectator sporting events.
The AREA made -clear that
the potential rehabilitation tax credits were an integral part of
the transaction but did not use the term "sale".
It referred to
both Pitney Bowes and NJSEA as members of Historic Boardwalk
Hall.
Article 3.01 of the AREA reiterated the purpose of Historic
Boardwalk Hall and also granted Historic Boardwalk Hall the
authority to take actions nece-ssary to carry out its purpose.
The AREA included an additional set of financial
information.
The most important difference between these
financials and those attached to the confidential offering
mémorandum was the inflation factor applied to the East'Hall''s
revenues.
The financial projections attached to the AREA used a
12 -
3 . 5 -percent inf lator , rather than thes 34. 0 -percent - inf lator in the
confidêntial offe'rlng memorandum.
.Also, the soperating
assumpi-ions underlying the updated financials, assumed higher
servioè income, parking revenue,. and rnovelty revenue in the first
year o
operations
Operating expenses for- -the
nitial years
remained the same .
As a result of higher projected fevenues, the. statement of
projecged cashflows attached to the AREA showed higher payments
to they equity, investor and also payments on the acquisition and constaction loans discussed below.
Chese finanéials, h weëer,
still cesulted in a staxable net loss
6.
Lease and ,Sublease of the East Hall
Äsediscussed above, NJSEA leased the East H 11 from ACIA for
a 35
ear, term. , On September 14, 2000, NJSEA amended its lease
agreegent. to extend the lease termountil Noyember 11,( 2087.
On
that date, NJSEA and Historic Boardwalk Hall entered ;into two
agreenîents.
First, NJSEA ass sublessor and Histo ic Boardwalk
Hall as suble.ssee entered into a sublease of the East Hall
whereby NJSEA subleased the property to Historic Boardwalk Hall.
Second, NJSEA and †Iistoric ;Boardwalk Hall entered. into a lease
agreements which the parties treated as a sale sand putchase for
Federal , S tate , and ,loáal income taxopurposes .
Pursuant3to , the
lease tagreementy Historic Boardwalk Hall purportedly acquired
ownership of Žhe East,Hall.
- 13 -
Historic Boardwalk Hall paid for the East Hall by an
acquisition note in the amount of $53,621,405.
The acquisition
note was secured by a mortgage on the property.
The amount of
the acquisition note represented the total expenditures that
NJSEA had made through that date in renovating the East Hall.
The acquisition note bears interest at 6.09 percent per year and
provides for level annual payments of $3,580,840 through the year
2040, to the exten~t Historic Boardwalk Hall has sufficient cash
to make the-annual payments.
Also on September 14, 2000, NJSEA entered into a
construction loan -agreement with Historic Boardwalk Hall to lend
amoúnts to the partnership from time to time to pay for the
remainder of renovations to the East Hall.
At that time, NJSEA
agreed to lend $57,215,733 to Historic Boardwalk Hall.
NJSEA's
obligation to lend to Historic Boardwalk Hall was evidenced by a
mortgage note and a second mortgage on the property.
7.
Contributions to Historic Boardwalk Hall
Pitney Bowes made capital contributions to Historic
Boardwalk Hall and also lent funds to the partnership.
Pursuant
to the AREA, Pitney Bowes was to make four cap'ital contributions
totaling $18,195,757.
Pitney Bowes made the following contributions to Historic
Boardwalk Hall:
- 14 Date
Amount
/ 9/14/00
$650 , 000
12/19'/00
3 660
1/17/01
3,400,000
10/30/02
10,467,849
2/12/04
21,173 182
The Dec. 19,
2000, and Jan. 17
2001,
65
apital
contributions were together considered Pitney Bowes
sécorid caþital contribution, even though the
coritribûtion was niadd on t wo s'eparatlê datås.
A portion of Pitney Bowes' fourth capital e
contribution was paid and is ourrently being held i
escrow.
Pitney Bowes also nade an investor loan, of. $1 1 nillion to
Historic Boardwalk Hall on September, 14, 2000 .
-
The þrincipal
amount of the investor ldan2 was increased to $1 218.000 on or
around October 30, 2002.
Pitney Bowes wast not required to make the second
third, or
fou th capital contribution if certain requireme ts in the AREA
were not satisfied.
The AREA provided that Pitney Bowes' capit 1 contributions 2
ewere to be úsed to pay down t;he principal on,the acquigition
note. 7 Pitgey Bowes' capital .contributions were in fact used to
ay down the principal on the acquisition note .
Shortly
thereaf ter, a corresponding draw would be made , on the
construction note, and NJSEA would advance those funds to
Historic Boardwalk Hall.
Ultimately, these offåett'ing draws left
- 15 -
Historic Boardwalk Hall with cash in the amount of Pitney Bowes'
capital contributions, a decreased balanch on the acquisition
loan, and an increased balance on the construction loan.
These
funds were then used by Historic Boardwalk Hall to pay assorted
fees related to the transaction and to pay NJSEA a developer's
fee for its work managing and overseeing the East Hall's
rehabilitation.
A portion of Pitney Bowes' second capital contribution was
not returned to Historic Boardwalk Hall but rather was used by
NJSEA to purchase the guaranteed investment contract (GIC).
The
GIC is discussed further below.
Historic Boardwalk Hall paid NJSEA $14 million as a
development fee for its role overseeing the East Hall's
rehabilitation.
This came mainly from Pitney Bowes' third and
fourth capital contributions and was paid pùrsuant to a
development agreement between Historic Boardwalk Hall and NJSEA.
The development agreement reiterated Historic Boardwalk Hall's
purpose and imposed certain obligations on NJSEA as the
developer, in exchange for a $14 million development fee.
The
development agreement obligated NJSEA to obtain all required
Government approvals for the rehabilitation and to-oversee the
completion of the rehabilitation.
This included:
(1) Overseeing
the contractors who were rehabilitating the East Hall;
ensuring that all amenities consistent with the overall
(2)
- 16 -
rehabi itation were pput in place;
phase,
(3) causing the completion of
of the rehabil-itation; and (4) causing the rehabi-1-itation
such that it would earn rehabi-litation tax, credits . - The
déveio månty ägreement further required NJSEA, to obtain4
certif cation -of ·the rehabilitation from atheeU.S. Department of
the Interior and to maintain insurance sover the
ehabilitatiòn as
set fo th in the AREA.
ouid
NJSEA's .development,fee
o
be
earned untial the fehabilitation was completed, and it was payable
immediately upon completion.
8.
Dist!ributions FromsHistoric Boardwalk Hall
The AREA provided for the distribution of H storic Boardwalk
Håll's net cashflow.
First, if certain title insurance or
environmental insurance sproceeds, were paid, 100
PÅtney Bowes.
ercent went to
Second, any;remaining net-cashflow was used to
make interest payments one Pitney.:Bowes' investor loán to ,Históric
Bôardwalk Hall .
Should there be any ,remaining neta c ashf low, 99 . 9 percent was
tò be distributedato «Pitney Bowese until Pitney Bowes had received
its 3-p rcent preferred return.
,The preferred return was equal
to 3 percent ,of ;its adjusted capital contributidn, which was
detarinined fat the .endsofeHistoric Boardwalk Ha]:1 sofisca
year.
Nekt, funds, were 'distributed to Pitney< Bowes: to -coverrany
Federal, State, and elocal- sincome taxes paid on tiaxáble income
allocated to Pitney Bowest.e
Any;remainingenet cashflow gwas athen
- 17 distributed to NJSEA for current and accrued but unpaid debt
service on the acquisition and construction notes, and then to
NJSEA to repay any operating deficit loans.
Lastly, any
remaining net cashflow was paid to Pitney Bowes and NJSEA in
accordance with their membership interests.
9.
Environmental Concerns and Analysis
The parties were concerned that the East Hall's
rehabilitation would lead to certain environmental hazards.
To
that end, Pitney Bowes retained the law ~firm of Kelley:Drye &
Warran, LLP, to assess Historic Boardwalk Hall and- Pitney Bowes'
potential liability for environmental- claims.
In order to determine any potential envir'onmental issues,
Historic Boardwalk Hall obtained -reports that evaluated the East
Hall for potential hazards and also provided remediation plans.
Environmental Partners, Inc., prepared a Phase I
Environmental Site Assessment for Pitney Bowes.
The report
identified certain environmental hazards, including asbestos,
possibly lead-based paint, underground storage tanks, and other
chemical hazards.
The report characterized the East Hall as an
"unknown risk" and concluded that environmental liabilities could
not be estimated at that time without more analysis of the East
Hall.
L. Robert Kimball & Associates, Inc., also prepared a
hazardous materials assessment (the Kimball report) of the East
- 18 -
Hall, focusing on asbestos, lead-based paint, "hazardousdater als
storage,s drainage, roofs deterioration, and certains hazarddus
chemicals+ thatemight «be present or become, exposed by the East i
Hall's rehabilitatione
The Kimball report then wentaon Só
evaluate how potentialahazards should be dealt withiand 4estimated
what remediation would cost .
:The Kimball report estimatpd that
remediation- would scost more than $3 -million
The . AREA contained certain representations by NJSEA to
Pitney: Bowes concerning the East Hal]: and sits rehabilitation witih
regardy to environmental" hazards .
First, NJSEA, warranted to
Pitney Bowes that there were no known environmental haeards other
than those identified inc the environmental assessments.
aNJSEA
also warranted thateif any new'environmental hazards were;
uncovered, NJSEArwould remediate them in its role as managing ,
member.
SecondgNJSEA,warranted that should uit -default in its
role -to remediate any environmental hazards, itaould-hold Pitney
Bowes harmless and indemnify it ;formany ,costs incurredeas a
result of NJSEA' s def ault .
liability insurance .
NJSF2A, also -held environmental
Historic Boardwalk Hall was a named insured
one the insurance policy, and Pitney Bowes was later radded àsaan
additrional insured.
10 ..
Future Transfers of Pitney Bowes' Interest
NJ$EAsand Pitney Bowes contemplated Pitney Bowes' disposing
of its membership interest and leaving -Historic Boardwalk Hall.
- 19 -
To that end, they negotiated a number ,of possible ways to
transfer Pitney Bowes' interest to NJSEA.
A.
Pitney Bowes Repurchase Option
The AREA provided two options.
First, article 5.03 gave
Pitney Bowes the authority to require NJSEA to purchase Pitney
Bowes' interest sin Historic Boardwalk" Hall.
If Pitney Bowes-
exercised its option under this article, NJSEA would have to
purchase its membership interest for a price equal to:
(1)
Pitney Bowes' capital contributions up to that point plus 15percent interest;
(2) Pitney Bowes' reasonable third-party fees
and expenses with regard to the transaction; and (3) $100,000 as
a reimbursement-for Pitney Bowes'. internal expenses with regard
to the transaction.
NJSEA had to make the $100,000 reimbursement
payment only if phase 3 of the rehabilitation5 was not placed in
service for purposes of the rehabilitation-tax credit by December
31, 2000, or if the rehabilitation tax credits were less than
$650,000 for taxsyear 2000 for any reason.,
Pitney Bowes could
exercise its' repurchase option contained in article 5.<03 only
until January 15,
2001.
sPhase 3 involved the rehabilitation of the East Hall's
ceiling. This included replacing the ceiling tiles and the
lighting system and installing a computericontrolled light system
at the base of each ceiling bay that would allow for the
projection of sunsets and other theatrical effects onto the new
ceiling tiles.
- 20 Ba'
NJSEA Management Purchase Opt ion
Article 8 . 02 (a) and (b) of the AREA imposed certain
restrictions on NJSEA's authority as managing member.
Article *
8.02(a)s/preventedUNJSEA from performing any act- in violation of
the lan,, performing any act in vio]:ation ofaany project
documents,adoing any act that .requirede PitneypBowes' consenty or
borrowing ' or commingling any of Historic .Boardwalk Hall' s funds . y
Article 8.02-(b) prevented NJSEA from -selling, refinancing,
or disposingofs Historic Boardwalk. Hall' s assets
modifying Historic Boardwalk Hall' s insurance plan
materially
amending sany
of the/maint transaction documents, borrowing any money other-than
the "acquisition or construction loans, or takingsany -action that
would-àdversely affect Pitney Bowes, either as a member or - a
f inancially .
«
i'These prohibitions were not absolute.
Both article 8 02-(a)
and (b) -gave' NJSEA the option to purchase Pitney. Bowes'
membership interest before taking any "of the prohibited actions.
To exércise its options, NJSEA -would have to giye written notice
of its intent to purchase Pitney Bowes' interest and, would have
to actually purchase the interest within 90 days of ,providing
such not ice .
If it exercised its options, NJSEA would have to pay Pitney
Bowes the piesentgalue of the projected t ax beneZits and t e
prolected cashflow~to be distributed to Pitney BoWes
The
- 21 -
projected cashflows were limited to the projected tax benefits up
until the first date that NJSEA could eiercias'e its purchase'
option (discussed below), and to the extent that Pitney Bowes had
received any tax benefits or cashflows at the time NJSEA decided
to purchase Pitney Bowes' interest".
Thus, if NJSEA exercised its
option under article 8.02(a) or (b), its payment obliñation would
be based on its projected obligations from that date until the
earliest date it could have otherwise opted to purchase Pitney
Bowes' membership interest.
C.
Future Pu'rchåse Options
Lastly, the parties negotiated two'additional agreements
that would allow NJSEA to reacquire Pitney Bowes' membership i
interest in Historic Boardwalk Hall.
On September 14, 2000,
Pitney Bowes and NJSEA entered into two option contracts.
These
were the'3'purchase option agreement" and the "agreement to compel
purchase".
The purchase option agreement gave NJSEA the right to
purchase Pitney Bowes' membership interest in Historic Boardwalk
Hall.
NJSEA could execute the purchase option agreement at any
time during a 12-month 'period beginning 60 months after the
entire East Hall was placed in service for purposes of
determining the historic rehabilitation credits.
Thus, from 60
months to 72 months after the East Hall was placed in service,
- 22 -
NJSEA had the option,to purchase Pitney Bowes' interest
The
option/would expire at thesend of the 12-month periode
If theepurchase option agreement was not executed; the
agreement to compel purchase gave <Pitney Bowes the right to
require NJSEA, to :purchase Pitney Bowes' membership interest in
Historic SBoardwalk ,Hall.
Pitney Bowes may exercise this option
dgring aul25morith period beginning 84 months af ter the East Hall
isgpladed in servicesfor purposes ,of determining; the historic.e
rehabilitation credits.
Like the purchase option agreement, the
agreement to compel purchase was available -only for 12 months ;
Both options.require NJSEA to pay Pitney Bowee theugreater
of:
(1) 99.9 percent of the fair market value of 100 percent sof
the membership interests in Historic Boardwal-k HillG or (2) any
accrued and unpaid preferred return.
At the tïmerof trial, none-of the options had been
exercised, and Historic Boardwalk Hall continued to operate with.
Pitney, Bowe s and- NJSEA - as it s only members .
11.
Guaranteed Investment Contract
In/order to secure NJSEA' s payment if: NJSEA reacquired
Pitne
Bowes' interest in Historic Boardwalk Hall,a the AREA
requi ed NJSEA to purchase a GIC.
As discussed above, Pitney Bowes' capital- contrib tions were
initially used to pay -down the principals on theyacquisition, loan
Shortly thereafter, a corresponding draw would be made on the
- 23 construction -loan, leaving Historic Boardwalk Hall with the
capital contribution.
This did not occur with respect to Pitney
Bowes' entire second capital contribution.
Althodgh the àecond
capital contribution was used to pay down the acquisition loan, a
corresponding draw was not made on the construction loan.
NJSEA,
retaining these funds, used a portion of the capital contribution
to fund the purchase of the GIC.
First Union National Bank (First Union) was appointed escrow
agent for both Pitney Bowes and NJSEA.
NJSEA deposited about
$3.2 million of Pitney Bowes' second capital contribution with
First Union.
First Union then entered into a master repurchase
agreement with Transamerica Occidental Life Insurance Co.
The
master repurchase agreement was then pledged as collateral to
secure NJSEA's payment obligation if,- under eilther the purchase
option or the agreement to compel purchase, it was required to
purchase Pitney Bowes' membership interest in Historic Boardwalk
Hall.
12.
Tax Benefits Guaranty
NJSEA, Pitney Bowes, and Historic Boardwalk Hall foresaw the
possibility that the Internal Revenue -Service (IRS) would
challenge the reporting of the East Hall's rehabilitation.
Consequently, the AREA appointed NJSEA as Historic Boardwalk
Hall's tax matters partner and provided for the appointment of
counsel by NJSEA should the transaction be challenged.
Pitney
- 24 -
Bowes had final approval over the appointment ,of counsel to
repfesent Historic, Boardwa-lk Hall.
Pitney; Bowes and Historic Boardwalk Hall also executede a
"Tax Benefits Guaranty Agreement" by which Historic Boardwalk
Hall guaranteed the projected tax benefitse allocable tonPitney
Bowes .
NJSEA was required to fund any payments made pursuant- to
the tax bene f its guaranty .
Theltax benefits guaranty provides that it was entered into
to induce Pitney Bowes, as investor, to acquire, an interest in
Historic Boardwalk Hall.
Its ultimate purpose was to require
NJSEA to make Pitney Bowes whole should any part of the tax
benefits be successfully challenged by the IRSr.
13
Opinion letters
NJSÈA and Pitney Bowes sought and received opinion letters
concernin
various aspects of the transaction.
c
Wolfe Block sprepared a tax opinion letter (Wolf Block
opinión) analyzing the East Hall transaction.
The Wolf Block
opinion analyzed numerous Federal tax issues and concluded in
pertinent part that Historic Boardwalk Hall was properly
classirfied as a partnership, Historic Boardwalk Hall owned the
East Hall, and the transaction did not violate the economic
substance or sham transaction doctrines .
The Wolf iBlock opinion relied on a number of other legal
opinions in reaching those conclusions .
These other opinion
- 25 letters analyzed various non-tax-related legal questions raised
by the East Hall's rehabilitation and Pitney Bowes' investment.
Gibbons, Del Deo opined that NJSEA had the authori~ty to act on
behalf of the State of New Jersey, that Historic Boardwalk Hall
was a valid LLC, and that Pitney Bowes became a member of
Historic Boardwalk Hall under State law.
Wolf & Samson, P.C.,
issued a letter concerning how New Jersey State law and NJSEA's
being financed by State bonds would affect NJSEA'saobligations
under the AREA to fund any deficits and any additional,
construction costs.
Madison & Sutro, LLP, provided an opinion
letter evaluating the proper classification of the acquisition
note, the construction note, and Pitney Bokes' investor loan as
debt rather than equity.
14.
Rehabilitation and Operation of the East-Hall
Bank accounts were established by SMG as agent for Historic
Boardwalk Hall.
After February of 2001, account statements show
regular activity, including both deposits to and checks written
on the account.
NJSEA had entered into contracts with various third parties
regarding certain aspects of the East Hall's rehabilitation.
These contracts were all assigned to Historic Boardwalk Hall at
or around the time Pitney Bowes- became a member in Historic
Boardwalk Hall.
These contracts dealt mainly with contractors
- 26 -
who were engaged to perform various pieces of the trehabilitation
of sthe East Hall-.
Tþe2 renovation of the East Hall and itssconversion to a
special events arena was a success:
Since its rehabilitátion
the East Hall has held performances by a number of Well-known
entertainers, and its revenues in 2000, 2001, and 2002 exceeded
those in the Reznick projections.
However, the East-Ha l has
operated at a deficit.
15.
Procedural Posture
Historic Boardwalk Hall timely filed Forms
065, U.S. Return
of Partnership Income, for 2000, 2001, and, 2002.
The Forms 1065
showed income,r deductions, and ultimately net losses for all -3«
years.
The deductions included the cost of wages for employees
who were operating the East Hall.
Historic Boardwalk Hall
claimed the following -qualified rehabilitation expenses:
Year
Expenditures
20 0 0
2001
20 02
$38 , 862, 877
68, 865, 639
1, 271, 482
Schedules K-1, Partner' s Share of Income, Credits
Deductions,
etc., were gissued to Pitney Bowes and NJSEAsin accordance with
their membership interests .
On AFebruary 22, 2007, respondent issued the FPAA .covering
the 2000,, 2001,5 and 2002 tax years to Historic Boardwalk Hall.c
The FPAA determined that any items of income or loss or
-- 27 -
separately stated items reported on Historic Boardwalk Hall's
Forms 1065 and allocated to Pitney Bowes were reallocated to
NJSEA.
The FPAA also determined that underpayments of tax
attributable to those adjustments would be subject to the section
6662 penalty.
The FPAA contained an "Explanation of Adjustments" which '
provided alternative arguments in support of the adjustments made
in the FPAA, including that:
(1)
Historic Boardwalk Hall was created for the express
purpose of improperly passing along tax benefits to Pitney Bowes
and is a sham;
(2)
Pitney Bowes' stated partnership interest in Historic
Boardwalk Hall was not bona fide because Pitney Bowes had no
meaningful stake in the success or failure of Historic Boardwalk
Hall;
(3)
the East Hall was not "sold" to Historic Boardwalk Hall
because the benefits and burdens of ownership did not pass to.
Historic Boardwalk Hall.
Accordingly, any items of income or
loss or separately stated items attributable to ownership of the
East Hall were disallowed;
(4)
respondent pursuant to his authority in the antiabuse
provisions of section 1.701-2(b), Income Tax Regs., had
determined that Historic Boardwalk Hall should be disregarded for
Federal income tax purposes; and
- 28 (5)
a 1 or spart of the underpayments, of tax attfibutable to
the adjustments in- the -FPAA were attributable to either
negligence , a asubstantial understatement of incomes tax, or both .
Petitionere filed its petition in response toe the F,PAA on May
21, 2007.
A trial was held from April 13-16, 2009ysin New York
Newdótk .
Respondent submitted an expert report in support of
his (position-.a
OPINION
I.
TEFRA in General
Pattnerships do not pay Federal income -taxes, buts they are
required to file annual information returns reporting the
partners' distributive shares of tax items.
Secs. 701, 6031.
The individual partners then report their distributiver shares of
theetax itemsgone their Federal 'Lncome taX returns.
'704 .
Secs. 7013
A limited liability company with two or more members is
treated as a -partnership unless it elects to bestreated as a
corporation.
*Sec e 301. 7701-3 (b),(1) (I) ,
Proced.
Admin. Regs
HistoricsBciardwalk Hall did not elect to be treated-as a
. corporation and thus is treated as a partnership for Federal
inc ome t ax purpos e s .
né ¿To -remove the substantial administrative!burden occasioned
by -duplicative audits and litigation and to provide consistente
treatment of partnership tax items among .partners singthe same;
partnership, Congress enacted the unified audit and;litigation
- 29 -
procedures of the Tax Equity and Fiscal Responsibility Act of
1982
(TEFRA) ,
Pub. L.
97-248,
sec . 402,
96' Stat .
Randell v. United States, 64 F.3d 101, 103
Conf. Rept. 97-760, at 599-600
648 .
See
(2d Cir. 1995); H.
(1982),.1982 2 C.B. 600,
662-663.
Under TEFRA, all partnershig items are determined in a
single partnership-level proceeding.
v. United States, supra at 103.
Sec. 6226; see also Randell
.The determination of partnership
items in a partnership-level proceeding is binding on the
partners and may not be challenged in a subsequent partner-level
proceeding.
See secs. 6230(c) (4), 7422 (h).
This precludes- the
Government from relitigating the same issues with each of the
partners.
In partnership-level proceedings such as the case before us,
the Court's jurisdiction is limited by section 6226(f) to a
redetermination of partnership items and penalties on those
partnership items.
Section 6231(a) (3) defines the term
"partnership item" as any item required to be taken into account
for the partnership's -taxable year under any provision of
subtitle A of the Code to the extent the regulations provide that
such item is more appropriately determined at the partnership
level than at the partner level.
- The question whether a partnership is a sham is a
partnership item more appropriately determined at the partnership
level.
Petaluma FX Partners, LLC v. Commissioner, 131 T.C. 84,
C
- 30 95
(2008)
af fd. in pertinent part 591 F.3d .649: (D.C. 'Cir. 2010) .
Likewise, whether Pitney Bowes was a partner in»Historic
Boardwalk Hal-l -is also. a partnership item more appropriately
determined atsthe partnership level.
Commissioner, 118 T.C. 541
(2002) .
See, Blonien v.
Further, the determination
whether NJSEA, contributed the East Hall to Histonic Boardwalk
Halls is also a. partnership item.
T.C.
305
41-42
(2007) .
Nussdorf v. Commissioner
129
Lastly, respondent'-s determination±that
the transaction should be recast to carry out the intentlof
subchapter -K is likewise a partnership item.
Neither-party
disputes our, jurisdiction over these items .
II.
Burden of Proof
The Commissioner' s determinations in an FPAA are generally
presumed correct, and a party challenging an FPAA has the ßurden
of proving that the Commissioner's determinations are in error.
Rule 142 (a) ; -Welch v. Helvering,
290 U. S.
111,
115
(1933) ;
Republic Plaza Props. Pship. v.. Commissioner, ,107 T.C. 194, 104
(1996)
The burden of proof on factual issues :that affect a
taxpayer'scliability for tax may be shi-fted to the Commissionér
where, Ethe "taxpayer introduces credible evidence with respect to
* * * such issue."
Sec. 7491(a) (1) .
o
Petitioner argues that the burden shifts to respor).dent under
sectiono74913(a) .
Respondent disagrees and arguesathat peti-tioner
has .not: satisfied the requirements of section 7491.
A shift in
- 31 -
the burden of persuasion "has real significance only in the rare
event of an-evidentiary tie."
1030,
1039
(8th Cir.
2005),
Blodgett v. Commissioner, 394 F.3d
affg. T.C. Memo.
2003-212.
We decide
this case on the preponderance of the evidence, and the burden of
proof is not a factor in our analysis.
We will'address each of
respondent's arguments in turn.
III.
Economic Substance
Respondent first argues that Historic- Boardwalk Hall lacks
economic substance.
Both parties agree-that an appeal in this
case lies in the Court of Appeals for the Third Circuit.
sec. 7482.
See
The Court of Appeals for the Third Circuit has stated
that a court is to "analyze two aspects of a'transaction to
determine if it has economic substance:
its objective economic
substance and the subjective business motivation behind it."
v. CM Holdings,
Inc.,
301.F.3d 96,
102
(3d Cir.
2002).
IJUi
However,
in CM Holdings, Inc. the court went on to state that these
aspects do not constitute discrete prongs of a "'rigid two-step
analysis'" but "'represent related factors both of which inform
the analysis of whether the transaction had sufficient substance,
apart from its tax consequences, to be respected for tax
purposes.'"
231,
247
Id.
(3d Cir.
Memo. 1997-115).
(quoting ACM Pship. v. Commissioner, 157 F.3d
1998), affg.
in part and revg.
in part T.C.
If, however, a transaction "'affects the
taxpayer's net economic position, legal relations, or non-tax
-
32
-
1;>usiness interests-, it will not be disregarded. merely because it
was motivated by tax considerations.'"
Id.
(quot-ing ACM.Pship
v. Commissioner, 157 F-3d at 247) .
Respondent argues that Historic Boardwalk Hall ism a sham
because it lacked; objective economic substance andrthat its
partners lacked any business motivation other than transferring
historic tax credits from NJSEA to Pitney Bowes.
Respondent asks
that we look to- t-he individual partners to determine thet economic
substance of the transaction.
Respondent contends that Historic Boardwalk- Hall lacked
objective. economic substance because the parties, in respondent's
view, negotiated and executed a transaction in anticipation of a
limited number of possible outcomes, none of which would
appreciably-affect Pitney Bowes' economic position- otherethan
through a reduction of its tax liabilities.
Respondent argues that the following are the only, possible
outcomes of Historic Boardwalk Hall' s formation, assuming the
partiest act in an "economically rational manner"
(1)
If the East Hall was profitable, NJSEA wóuld be-
compelled to exercise its repurchase option immediately after the
sectiorra47 recapture. period ended, terminating Pitney Bowes'
intereste in Historic Boardwalk Hall.
Pitney Bowes woulds receive
its 3,percent, annual return until it exited Historic Boardwalk
Hall through preferred net cashflow distributions.s
-
s
- 33 -
(2)
If the East Hall was unprofitable, Pitney Bowes would
exercise its put option, compelling NJSEA to purchase its
interest in Historic Boardwalk Hall for its 3-percent annual
return.
In this case, because East Hall is unprofitable and
there are no preferred net cashflow distributions, Pitney Bowes
receives its payment through the GIC.
Respondent contends that the parties knew that Historic
Boardwalk Hall would not earn a profit and that the Reznick
projections showing a profit were simply window dressing meant to
give the transaction an appearance of legitimacy.
Respondent further argues that Pitney Bowes would never earn
a profit on its investment in Historic Boardwalk Hall.
In
respondent's view, although Pitney Bowes was entitled to its 3percent return either through preferred distributions or the GIC,
Historic Boardwalk Hall still lacked objective business substance
because any return would be less than Pitney Bowes could have
earned had it invested its capital contributions in other
financial instruments.
Taking into account the time value of
money, respondent argues that Pitney Bowes' investment results in
a negative cashflow to Pitney Bowes.
Respondent also a gues that other contractual provisions
ensure that Historic Boardwalk Hall has no economic' effect on its
partners, including the tax benefits guaranty agreement, the
operating-deficit guaranty, the completion guaranty, and the fact
- 34 -
that all. of Historic Boardwalk Hall's debts are.nonrecourse to
Pitney, Bowes .
Respondent concludes that the -parties
econcéic
posi ions were all fixed and unaffected by the return from
Historic Boardwalk Hall in any circumstance.
Moving to the subjective test, respondent argues that
Historic Boardwalk Hall served no subjective business purpose
because it was intended solely to facilitate NJSEA s sale, of
rehabilitation tax credits and other favorable tax attributes to
Pitney Bowes.:
All of respondent's arguments concerning the economic
substance of Historic Boardwalk Hall are made without taking into
account the 3-percent return and the rehabilitation creditse
Respondent argues that the rehabilitation, credits must be ignored
in evaluati.ng, the economic substance of Historic Boardwalk Hall.
Respondent points to Friendship Dairies, Inc.av. Commissionera 90
T.,C ,1054 (1988), and argues that investment tax.credits are
never to be.taken into account in determining the economic
substance of, a transaction.
Petitioners first argues that the economic substance doctrine
is inapplicable to the Historic Boardwalk Hall transaction
båáäuse Congress, in enacting and amending section 47, intended
to use section 47 to spur corporations to invest in historic
rehabilitation projects that otherwise would not be economically
-feasiblea
Petitioner further contends that the point of the
l
--35 credit -wa's to address the reality that most rehabilitation
projects had an inherent lack of profitability-athus it would be
inappropriate to disregard a transaction for aliack of~
profitability when the purpose of section 47 isato make up for
that lack of profitability.
Further, petitioner puts forth alternative arguments in
support of its position that the Historic Boardwalk Hall
transaction has economic substanoe.
First, pëtitioner argues e
that the rehabislitation tax credits at issue' can be taken into
account in determining whether the transaction has economic
substance and provided a net economic benefit to Pitney Bowes.
Petitioner points to Saaks v. Commissioner, 69 F.3d 982
(9th Cir.
1995) , revg . T . C.' Memo . 1992-596,4 and' argues that - we' must take s
the rehabilitation credits into account- in determining ·the
profitability of the transaction.
Second, petitioner argues that even if wer do not take- the
rehabilitation tax credits into account, the Reznick projections
show that the Historic Boardwalk Hall has economic substance
be'cause 'Pitney Bowes land the-Easti Hall Chad a chance of searning a
prof it .
Petitioner also asserts the 3-percent return gives the
transaction economic significance.
In Sacks v..- Commissioner, supra, the Court of Appeals for
the Ninth Circuit evaluated the economic substance of a solar
- 36 -
energyaequipmentesale-leaseback transaction.
The Courtsof
Appeals found that the transaction had economic substance on the
basis of the following factors:
(1)
The taxpayer's personal obligation to payathe price was
genuine;
(2)
the taxpayer paid fair market value for thesequipment;
(3)
.the tak benefits would have existed for someone, and
were not created out of thin air.by the transaction;
(4)
the - business of selling solar energy was, genuine; and
(5) . the business consequences of a rise or fall in energy
prices were: genuinely shifted to the taxpayer.
I_d. at 988. GThe Court of Appeals discussed whether the solar
energy credits should be taken into account in determining the
profitability sof a the transaction.
The Commissioner had argued
successfully in this Court that any financial analysis of the
transalction had to be done without regard to the solar energy
credits:
On the basis of that argument, we found ÷that the e
taxpayer'sytransaction lacked economic substance because itswas
cashflow negative unless the tax credits were taken into account
and" disallowed the claimed credits .
The; Court of Appeals disagreed with that analyáis,asstating
that the taxpayer' s investment "did not become as sham just
because git,s profitability was based on after-tax instead of pretax projections."
Id. at 991.
The Court of Appeals went on to
37 -
state that "Where a transaction has economic - substance, it does
not become a sham merely because it is likely to be unprofitable
on a pre-tax basis", id.,a and that "Absences of pre-tax
profitability doeenot show 'whether the stransaction had economic
sübstance beyond the creation of taxe benefits 'twhere Congress:
has purposely used, tax incentives to= change investors'- conduct",
id.a(citation omitted) .
The- Court; of Appeals rejected. the
Commissioner's argument thatethe tax benefits3should be excluded
from the economic sanalysis, because. "If the government treats taxadvantaged transactions as shams unless they make economic sense
on a pre-tax basis, then it takes away with the executiver hand
what it gives with the legislative."
Id. at 992. - Ultimately,
the Court of Appeals recognized that if the types of transactions
that Congress intehded to encourage had -to be profitable on a
pretax' basis, then Congress would not have needed to provide
incentives -to get taxpayers to invest in them;; in effect, ther
Commissione'r was attempting to use the reason Congress created
the tax benefits as a ground for denying them.
Id.
The Court of Appeals' for the Third Circuit has not directly
addressed whether investment táx credits are to-be taken into
account in determining the economic substance of a transaction.
In IRS v. CM Holdings,o Inc.,
301 F.3d 96
(3d Cir.¯ 200-1),
the 2
taxpayer attempted to rely on the opinion of the Court of Appeals
for the Ninth Circuit in Sacks in arguing that2 a corporate-owned
- 38 life ainsurance-plan had economic substance because Congress had
explicitly sanctioned those types of tax strategies.
Howeverá
the Courts of Appeals for- the Third Circuit distinguished±Sacks
because- the Sacks opinion, in allowing depreciation deductions
and investment credits with respect to a sale and leasebacksof
solar energy equipment, reasoned that both Federal-and:State
legislatures had specifically encouraged investment in solar
energyt and thereby "skewed the neutrality of the <tax system."a
& åt.106
(quoting Sacks v. Commissioner, supra at 991) .
Respondent:argues that Sacks does not control.since, unlike
the tran*saction in Sacks, the East Hall transaction and Historic
Boardwalk, Hall are shams because they had no appreciable effect
on therpartries' economic positions.
As an initial matter, we do not agree with respondent that
Pitney Bo.wes invested in the Historic Boardwalk Hall transaction
solely, to earn rehabilitation tax credits.
We. believe the 3-
percent. return and the expected tax credits should be viewed
together.
Viewed as a whole, the Historic Boardwalk Hal-1 and the
East Hall:transactions did have economic substance.
Pitney
Bowes, NJSEA, and Historic Boardwalk Hall had a legitimate
business purpose--to allow Pitney Bowes to invest in the East
Hall's rehabilitation.
Pitney,Bowes invested in the East Hall rehabilitation. 4 Most
of Pitney-Bowes' capital contributions were used to pay -a
- 39 -
develiopment fee to NJSEA for its.role in manašing the
rehabiilitation of- the East Hall according to the development
agreement between His-tori~c Boardwalk Hall and NJSEA.
Respondent''s contention that Pitney Bowes was unnecessary to the
transaction becaúse NJSEA was going to rehabilitate the East Hall
without a 'corporate investor overlooks the imþact that Pitney
Bowes had ori' the frehabilitation:
no mattert NJSEA' s intentions at
the time it decided to- rehabilitate the East Hal]G Pitney Bowes'
investment provided NJSEA with more'money than it otherwise-would
have had; as a result, the rehabilitation ultimatelyacost the
State of New Jersey less.
Respondent does not allege that a
circular flow of funds resul-ted in Pitney Bowes receiving its 3percent preferred return on its capital contfibutions.
In '
addition, Pitney Bowes received the rehabilitation tax credits.
Historid *Boardwalk Hall and the AREA imposed financial requirements ök both'Pitney Bowes and- NJSEA.
Pitney Bowes was
required to makes capital contributions, and NJSEA was- required to
managë the East Hall'& rehabilitation and assure its completion.
If NJSEA failed in its role as manager and the rehabilitation did
not proceed according to the ÷parties' plan, Pitney Bowes would
not be:required to make additional capital contributions.
This
would -have left NJSEA responsible for a larger portilon of the
East Hall's rehabilitation.
- 40 -
Respondent points to the parties' use of the term "sale of
tax crèdits" and argues that the term "development, feet' and ther
payment of a development fee by Historic Boardwalk flaltleto NJgEA'
is ,merely meant to disguise evidence showing the true nature of
theftransaction to be a sale of tax credits.
We smusta look sto the
substance of the stransaction, rather than the terms «usediby the
parties..
The regulations clearly indicate that a development fee
is a qualified rehabilitation expense.
Income 'I'ax Regs .
Sec. 1.48 12(c) (2),
The opinion letters obtained by NJSEA and
Pitney Bowes alL discuss whether a development fee is the type of
rehabilitation expense that is eligible to earn rehabil-itation
tax credits,, and whether the amount of the development fee at
issueuwas reasonable in this type of rehabilitation
yRespondent
does not argue that any portion of the rehabilitatrion credits
clairned is inappropriate or attempt to disallow -any of Historic.
Boardwälk-Hal-l's claimed credits on the ground that the
developments fee was not a qualified rehabilitation expense
Pitne
Bowes faced risks as a result of joining Hisstoric.
Boardwalk Hall.
First, and most importantly to its goals-, it
faced the risk that the rehabilitation would not be completed.
a In addition, both NJSEA and Pitney Bowes faced pot;ential
liability for environmental hazards from the rehabilitation.
Although Historic Boardwalk Hall and Pitney Bowes were added as
named insured parties to NJSEA' s environmental insurance, there
- 41 -
was no guaranty that:
(1) The insurance payout would cover any
potential liability; and, (2) if NJSEA was required to make up any
difference, it would be financially able to do so.
Overall, respondent's argument that certain agreements e
prevented ther East Hall transaction from affecting the partners'
economic positions is incorrect.
These side agreements and
guaranties must be looked at in context:
attract an equity'investor.
they; were necessary to
These provisions are meantato
protect Pitney Bowes- from any unforeseen circumstances that scould
arise as a result of problems with the rehabilitation.
Respondent does not argue that the'-completion guaranty is.a sham
or is not a legitimate agreement between the parties.
Instead,
respondent argues that because Pitney Bowes.' investment iis
limited to its capital contributions and because Pitney Bowes
cannot be held responsible.for 'additional funds to complete the
East HalTirehabilitation, theeEast Hall transaction as a whole
lacks economic substance.
However, those agreementsi show that
the East Hall and Historic Boardwalk Hal:1 did in facts affect the
parties' economic positions--the agreements'were meant to prevent
the transaction from having as larger impact than ethe parties had
bargained for.
This is not a transaction in'which the parties had-competing
interests that would work against the partneeship's stated purpose.
NJSEA and Pitney Bowes had a common goal:
the
- 42 -
rehabilitation of the East Hall.
NJSEA needed the rehabilitation
to be successful; in order to make the East Hall an attractive,
site for concerts and events after the construction of the new
convention.-center.
Pitney Bowes needed the rehabilitation to be
successfuloso it would earn rehabilitation credits «and its 3-e
percent return.
Both would receive a net economic benefiteif the
rehabilitations was successful.
The legislative history of section 47 indicates that one of
its -purposes is to encourage taxpayers to participaterin what
would otherwise be an unprofitable activity.
Congress enacted
the zrehabilitation tax credit in order to spur private investment
in unprofitable historic rehabilitations.
As respondent notes,
the East Hall "has operated at a deficit.
Without the
a
rehabilitation tax credit, Pitney Bowes would not have invysted
in its jrehabi-litation, because it could not otherwise earn: a sufficient net economic benefit on its investment.
of ethescredit is directed at just this problem:
,The purpose
because the East
Hall·.operates at a deficit, its operations alone would not
a
provide an;adequate 'economic benefit that would attract a sprivate
investor.
eFurther, if not for the rehabilitation stax credit,
NJSEA would not have had access to the nearly $14 millionipaid to
it :as a development fee for its ef forts in rehabilitating the
East Hall.
Considering that the cost of the rehabilitation was
s
- 43 -
about $100 million, Pitney Bowes contributed about 15 percent of
the cost of-the rehabilitation.
Respondent attempts to read Friendship Dairies,- Inc. v.
Commissioner, 90 T.C. 1054 (1988), as holding ethat the investment
tax credit is never taken into account in considering the
economic substance of a transaction.
make such- a broad holding.
Friendship Dairies does not
Although we held in that case that
the investment tax credits at issue could not be taken into
account indevaluating ther economic substance of thats transaction,
we did-not explicitly hold that investment creditst are never
taken into account when applying the economic substance doctrine.
We stated that
-
"We acknowledge that many such tax-motivated
transactions are congressionally approved and
encouraged. * * * The determination whether a transaction is one Congress intended to encourage will
require a broad view of the relevant statutory
framework and some investigation-into legislative
history. The issue of congressional intent is raised
only upon a threshold determination' that a· partitular
transaction was entered into primarily for tax
reasons."
Id. at 1064
(quoting Fox v.
Commissioner,
82 T.C.
1001,
1021
(1984)).
In Friendship Dairies, We disregarded a sale-leaseback
transaction which h'ad no chance sof profitability.,
This case is
distinguishable on its facts.
Ultimately, NJSEA had more money for the rehabilitation than
it would have had if Pitney Bowes had not invested in Historic
- 44 -
Boardwalk Hall.:
Both parties would receive a net economic
benefit from the transaction if the rehabilitation was
successgul.
Pitney Bowes would earn a net economic benefit as a
result of its entering into the East Hall' s rehabilitation,- while
NJSEA ,would see higher revenues from other Atlantic City
properties if the East Hall was a successful loss leader and
began attracting large crowds after the rehabilitation was
.
completed.
,
The rehabilitation of the East Hall was a success .
Historic
Boardwalk Hall has been operating and continues to operate day to
daye with, ther East. Hall being used as a convention facility.
In
conclusion, Historic Boardwalk Hall had objective economic
substance.
IV.
Whether Pitney Bowes Was a Partner in Historic Boardwalk
Hall
Respondent next argues that Pitney Bowes was not a partner
in Historic Boardwalk Hall.
Respondent contends that Pitney
Bowes' partnership interest should be disregarded because:
(1)
Pitney Bowes had no meaningful stake in Historic Boardwal-k Hall' s
success or failure; and (2) Pitney Bowes' interest in Historic
Boardwalk. Hall is more like debt than equity.
Ultimately,
respondent' s two arguments both center on the fact that Pietney
Bovies' return was limited to 3 percent .
- 45 Section 761(a) defines "Partnership" as follows":
SEC., 761'(a). Partnership.--For purposes of this a
subtitle, the term "partnership" includes a syndicate,
group, pool, jointaventure"or other unincorporated
organization through or by means of which any business,
financiale operation, or venture is carried on, and
which is not withinathe meaning of this stitle
[subtitle] , a corþorationt or a trust oi- estate * * *
Both petitioner and -respondent point to Commissioner v.
Culbertson, 337 U.S. 733
(1949), in support of their arguments.
In Culbertson, the Supremë Court had to det'ermine whether a valid
partnership was formed.
The Supreme Court listed several
objective factors that influenáe the determination of whether a
partnershiþ fis valid, including:
parties;
(1) The agreement between the'
(2) the conduct- of the parties in executing.its
provisions;
(3) the patties' statements;
disinterested persons;
(4) the testimony of
(5) the'relationship*of the parties;a (6)
their respective abilities and capital contributions;
(7) the
actual control of income; and (8) the purposes for which the
income is used.
Id. -at 742; see also Va. Histbric Tax Credit
Fund 2001 LP v
Commi.ssioner, T.C. Memo.a 2009-295.
In Va.
Historic Tax Credit, wë applied the Culbertson factors and upheld
a partnership which was formed tx> allow the partners to share and
distribute State tax credits.
In Luna v. Commissioner,
42 T.C.
1067,
1077-1078
(1964),
this Court stated that "while all circumstances are to be
considered
the essential question is whether the parties
- 46 intended tomand did in fact, join together for the present
conduct of an undertaking or enterprise", and cited Commissioner
v. Culbertson, supra at 742, which stated:
e The - question is not whether the servicest or
capital - contributed by a partner are of sufficient
importance to meet some objective standard * * * but
whether, considering all the facts * * * the parties in
good faith and acting with a business purpose intended
tá "join together in the present conduct of the
enterprise . * * *
Petitioner argues that Historic Boardwalk Hall is a valid
partnership and that Pitney Bowes was a partner ein, that
partnership.
Petitioner points to the partnership agreement, the
parties' actions in negotiating that agreement, and ,the part;i.es'
actions, after the agreement was executed.
Petit-ioner contends
that Pitney Bowes' extensive investigation of all aspects of the
transaction and Historic Boardwalk Hall' s business changes made
af ter execution all support a conclusion that Pitney Bowes was a
partner in Historic Boardwalk Hall.
We agree with petitioner.
Pitney Bowes and NJSEA, in good
faith and acting with a business purpose, intended to join
together in the present conduct of a business enterprise .,
As we
held above, Pitney Bowes and NJSEA joined together in a
transaction with economic substance to allow Pitney Bowes yto
invest in sthe East Hall rehabilitation.
Further, as we found
above, the decision to invest provided a net economic benefit to
Pitney Bowes through its 3-percent preferred return and
.-
- 47 -
rehabilitation tax credits.
Combined with our above holding that
Historic Boardwalk Hall had economic substance, it is clear that
Pitney Bowes was a partner in Historic Boardwalk Hall.
The parties' investigations and documentation both support a
finding that the, parties intended to join together in a
rehabilitation of the East Hall.
Although the confidential -
offering memorandum used the term "sale", it was used in the
context of describing an investment transaction.
The
confidential offering memorandum accurately described the
substance of the transaction:
an investment in the East Hall's
rehabilitation.
The parties' investigation likewise.suppoirts a.finding- of an
effort to join together in rehabilitating the East Hall.
The
parties investigated potential environmental hazards and
attémpted to mitigate them:
This included two analyses by
consulting firms- and adding Historic BoardwalkiHall and Pitney
Bowes as named parties to NJSEA's insurance policies.
.NJSEA and
Pitney Bowes sought and received a number of opinion letters;
evaluating various aspect's of thé transaction.
The executed-transaction documents accurately represent the
substance of the transaction.
The AREA is between Pitney Bowes
and NJSEA and provides a detailed description of Historic
Boardwalk Hall's -purpose--to rehabilitate and manage the East a
Hall.
Sinces formationy Historic;Boardwalk -Halls hasacarried out
- 48 -
its goals.
The AREA describes Pitney Bowes and NJSEAzas members e
and alsó provides for transfers of their membership interests in
later years.
The development agreement between Historic
Boardwalk Hall contractually obligates NJSEA to.manage the East
Hall's rehabilitation and accurately represents the ;substance of
the transaction.
Since execution of those agreements, the partiesahave
carried out their responsibilities under the AREA.
NJSEA oversaw
the-Easte Hall's -rehabilitation, and Pitney Bowes made its
required capital contributions.
The East Hall was actually
rehabilitated, did reopen to the public, and has been successful.
This rehabilitation provided benefits to both Pitney Bowes and
NJSEA.
Respondent again asks us to ignore the rehabilitation tax.
creái.its at issue.
Pitney Bowes joined Historic Boardwalk Hall in
exchange for its 3-percent preferred return and the
rehäbilitation itax credits.
The 3-percent preferredereturneand
theirehabilitation tax credits provided a net economic benefit to
Pitney Bowes.
Even if we do ignore the tax credits, Pi-tney
Bowes' interest -is not more like debt than equity because Pitney
Bowes is not guaranteed to receive a 3-percent return every year.
Because the East Hall operated at a loss each year,e Pitney Bowes
was not guaranteed the 3-percent return at the end of argiven
year because there might not be sufficient cashflow to pay it.
- 49 -
In accord with the AREA, Pitney Bowes might not receive its
preferred return until NJSEA purchased Pitney Bowes' membership
interest, if at alla
.
Taking into account the stated purpose behind Historica
Boardwalk Hall' s formation, the parties' investigation of the
transaction
the transaction documents, and the parties'
respective.roles
we hold that Historic Boardwalk Hall was a
e
valid partnership.
V.
Whether- the sEast Hall Was "Sold"- to Historic Boardwalk Hall
Respondent next argues that NJSEA did not transfer the East
Hall to Historic Boardwalck Hall for Federal income tax purposes
because NJSEA did not transfer the benefits and burdens of
ownership.
Whether the benefits and burdens of ownership with respect
to property have passed to the taxpayer is a question of fact
that must be answered from the intentions of the parties as
established by the written agreements read in light of the
attending facts and circumstances.
T.C.
244,
252
(2005),
Arevalo v.1Commissioner, 124
affd. 1469 F.3d 436
(5th Cir.
McKay Rea-lty e Inc . v . Commiss ioner, a 77 T . C .
1221,
2006); Grodt &
1237
(1981),.
We look sto the substance of the agreement and nots just the labels
us ed by the part ies .;
Arevalo V,. Commiss ioner , supra e at· 252a
.The
following-factors aré considered:: - (1) Whether legal title
passes;
(2) how the sparties treat the transaction;
(3) whether
-
50
-
equity was acquired in the property;
(4) whether the contract
creates a present obligation on the seller to execute and deliver
a deed and a present obligation on the purchaser to.make
payments;
(5), whether the right of possession vested in the
purchaser;
(6) which party pays the property taxes;
e
(7) which
party bears the risk of loss or damage to the property; and (8)
which partyareceives the profits from the operation and- sale of
the property.
Id.
Respondent argues that the burdens of ownership remained.
with NJSEA because it bore all of the burdens of the East Hall's
operation and rehabilitation,
including remaining liable for the
East Hall's operating expenses, real estate taxes, workers'
compensation, and property and other insurance coverage and for
completion-of the East Hall rehabilitation.
Respondent contends
that NJSEA also remained responsible for any excess development
costs, interest, taxes, and the costs of any environmental
problems
Respondent concurrently argues that NJSEA maintained
theabenefits of ownership because it had the authority, ,through
its purchase option, to purchase Pitney Bowes' interest in
,
Históric'Bóardwalk Hall at any time.
Respondent points to Sun
Oïl Co.» v. Commissioner,
(3d Cir.
562 F.2d 258
1977) ,
revg. T.C.
Mem6.31976-40, and argues that under the Court of Appeals for the
Third Circuit's authority, a purchase option requires a ,finding
that the benefits and burdens were not passed.
- 51 -
Petistioner argues that the transaction documents clearly
show the-parties' intent to sell the East Hall to Historic
Boardwalk Hall.
Petitioner also argues that NJSEA had a
contractual obligation 'to deliver the East Hall to -Histotic
Boardwalk Hall, - that Historic Boardwalk" Hall shada an obligation to
pay for the East Hall, and tha't Històtic~ Boardwalk Hall had
possession of the East Hall.
-
Some of the factors weigh in'favor of finding a-sale:
The parties treated the t¯ransaction as a sale;
(1)
(2) possession of
the East Hall vested in Historic Boardwalk Hall;
(3), Historic
Boardwalk Hall reported the East Hall's profits and stood to lose
its income if the East Hall stopped operating as an event space.
Others weigh ägainst petitioner:
(1) NJSEA remaine& liable for
the East Hall's property taxes (2) because Historic Boardwalk
Hall operated" atua loss, NJSEAlwas not guaranteed--toirecëive
payments on the acquïsition ,loan each year;
(3-) NJSEA could
reacquire the East H,all by exercising its òpti~on under article
8.02 of the AREA.
We must evaluate whether the.East Hallewas transferred in
the context of this specific rehabilitation transaction.
We look
at all the facts and circumstances surrounding the transaction at
issue.
The East Háll has been öperatinij asaan event space, and all
income and expenses of the East Hall have been reported on
- 52 Historic Boardwalk Hall's Forms 1065.
Bank accounts were opened
in Historic, Boardwalk Hall' s name by SMG as operator sof ,the ~East
Hall.
Respondent argues that the benefits and burdens were not
transferred because NJSEA remained liable for the rehabilitation
and the expense of managing the East Hall.
Respondent points to
statements by NJSEA executives that the East Hall would operate
in thes same manner as it had before Historic Boardwalk Hall was
formed and argues that these statements support- a conclusion- that
the benefits and burdens were not transferred to Historic
eBoardwalk- Hall.
statements .
Respondent misinterprets the context of these
They were made in relation to NJSEA' s decision to
assignesome of its construction contracts to Historic Boardwa]:k
Hall. e The statements appear to have been made to .third parties
and swere meant to assuage the concerns of those third parties
that theirs contracts and dealings with regard to the East Hal]:
would be affected by the contract assignment to Historic
Boardwalk Hall.
6 Respondent' s additional argument in the context of the East
Hall's ownership .concerns the article 8.02 purchase option.
Respondent -points to Sun Oil Co. v. Commissioner, supra, and contends that in the Court of Appeals for the Third Circuit, a
purchase- option such as the one in article 8.02 requires a
- 53 -
finding that the benefits and burdens of- ownership remained with
NJSEA.
We do not believe that Sun Oil- controls.
3
In that case, Sunray DX Oil Co..(Sunray)- sold 320 parcels of
land to'a tax-exempt trust.
back.
Sunray then leased those parcels
The Commissioner challenged Sunray's. dëductions for lease
payments.
This Court found in favor of the taxpayer, but the
Court of Appeals for the Third Circuit reversed our decision.
The Court of Appeals focused on Suhray's ability to-recover
the land "sold" to the tax-exempt trust.
Sunray had:a number of
options if it decided it wanted to recover a specific piece of
land.
First, it could simply swap another piece of land".for that
land, without the trust's being able to reject it.
Second,
Sunray could make an offer- to repurchase a specific piece of
land.
Lastly, Sunray had a right of repurchasing the lands for an
amount equal, to the present value of rent payments due 60 years
-in the future, which would be an almost negligible value.
The Court sof Appeals focused on how these provisions did.not
truly transfer any rights to the trust.
The Court of Appeals,
observed that because Sunray could, without any restrictions,
swap anyapiece of land for one subject* to the sale-leaseback at
issue, the offer provisions in the contracts were rendered moot.
Further, the Courtsof Appeals held that because Sunray could
always repurchase the land for an almost- negligible amount by its
repurchase options,,it ~could always recover the land without
- 54 -
paying the trust fair market value.
The Court of Appeals stated:
"The options to repurchase provide Sunray with a built in latchstring by which it could spring legal title to the properties
whenever it served its convenience without obligating Sunray to
pay fair market value."
Sun Oil Co. v. Commissioner, 562 F.2d at
268.
As an initial matter, we note that Sun Oil is
distinguishable on its facts.
That case dealt with a sale-
leaseback. transaction entered into to generate artificial rent
deductions .
Further, we do not believe that the presence of a
purchase option prevents our finding that the benefits and
burdens of ownership of the East Hall were transferred sto
Historic Boardwalk Hall in the context of the reha.bilitation tax
credit.
A purpose of Historic Boardwalk Hall was to allow Pitney
Bowes to invest in the rehabilitation of the East Hall and= earn
,rehabilitation tax credits.
The purchase option agreement gave
NJSEA the right to purchase Pitney Bowes' membership interest in
Historic: Boardwalk Hall at any time during a 12-month period
beginning 60 months after the entire East Hall was placed in
service for purposes of determining the historic rehabi+litation
credits .
The rehabilitation credits of Pitney Bowes would have
been subject to recapture had it disposed of its partnership
interest. within 60 months after the renovated East Hall was
- 55 -
placed in service.
Regs.
See sec. 50; sec. 1.47-6(a) (1), Income Tax
The statute demonstrates an anticipation of repurchase and
creates a disincentive.
Congress established a means to police
early dispositions and created a deterrent to a premature buyout.
For these reasons, NJSEA's purchase option was not contrary to
-the purpose of the rehabilitation tax credit.
-
In conclusion, we find that NJSEA transferred the benefits
and burdens of ownership of the East Hall--to Historic Boardwalk
Hall.
VI.
Respondent's Recasting of- the Transaction
Respondent alternatively determined in the FPAA that it-was
necessary- to redàst the East Hall transaction to "achieve tax
results that are consistent with the" intent of subchapter K."
Section 1 701-2(b), Income Tax Regs.," gives the Commissioner the
authority to recastotransactions foreFederal income tax purposes
if a partnership is formed or availed of in connection with a
transaction a principal purpose of which is to reduce
substantially the present value of the partners' aggregate
Federal income tax liability in a manner that is inconsistent
with subchapter K.
Section 1.701-2(a), Income Tax Regs.,
provides that the following requirements are implicit in the
intent of subchapter K:
(1)
The partnership -must be bona fide and each
partnership transaction or series of related
transactions * * * must be entered into for a a
substantial business purpose;
-
56
-
(2)
The form of each partnership transaction must
be respected under substance over form principles;
(3)
* * * the tax consequences under subchapter K
to;each partner of partnership operations and of
transactions between the partner and the partnership
must accurately reflect the partners' economic
agreement and clearly reflect the partner's income
* * *
Requirement (3), however, contains an exception in certain
situations.
Some statutory and regulatory requirements imposed
on partnerships by subchapter K may cause tax results that do not
accurately reflect the partners' economic agreement or clearly
reflect the partners' income, thus violating requirement, (3)
above.
Section 1.701-2(a) (3), Income Tax Regs., provides that if
a transaction satisfies requirements (1) and (2), requirement (3)
will be treated as satisfied to the extent that the application
of such a provision to the transaction and the ultimate tax
results, taking into account all the relevant facts and
circumstances, are clearly contemplated by that provision.
The determination of whether a transaction involving a
partnership ought to be recast is made with consideration given
to.ther statutory provision giving rise to the tax benefits and
all pertinent facts and circumstances.
Section 1.701-2(c)
Income Tax -Regs., provides a nonexclusive list of factors to be
considered, including whether:
(1)
The present value of the partners' aggregate
Federal tax liability is substantially less than had
the partners owned the partnership's assets and
conducted the partnership's activities directly;
- 57 -
(2)
The present value of the partners' aggregate
Federal tax liability is substantially less than would
be the case if purportedly separate transactions that
are designed to reach a particular result are
integrated'and treated as steps in a~single transaction
* * *(3)
One or more partners who are necessary to
achieve the claimed tax results either have a nominal
interest in the partnership, are substantially
protected from any risk of loss from the partnership's
activities * * *, or have little or no participation in
the profits from the partnership's activities other
than a preferred return that is in the nature of a
payment for the use of capital;
(4)
Substantially all of the partners * * * are
related (directly or indirectly) to one another;
(5)
Partnership items are allocated in compliance
with the literal language of §§ 1.704-1 and 1.704-2,
but with results that are inconsistent with the purpose
of section 704(b)" and those regulations * * * ;
(6) " Ther benefits andt burdens of ownership of
property nominally contributed to the partnership are
in"substantial part retained. (directly orsindirectly)
by the contributing partner (or a related party); or
(7)
The benefits and burdens of ownership of
partnership prop'erty -are in substantial part shifted
(directly or indirectly) to the distributee partner
before or after the property is actually distributed"to a
the distributee partner (or a related party).
Respondent argues that his decision to recast the East Hall
transaction was correct because Historic Boardwalk Hall's
principal purpose was to substantially reduce the present value
of Pitney Bowes' aggregate tax liability in a manner inconsistent
with the purpose of subchapter K.
Petitioner, however, contends that the East Hall transaction
is wholly consistent with the purpose of subchapter K and further
- 58 -
argues that the East Hall transaction is analogous to examples of
the proper use of partnerships in section 1.701-2, Income Tax
Regse
Section 1.701-2(d), Income Tax Regs., lists various
factual situations involving the use of a partnership and
evaluates whether that use is or is not consistent with the
intent of subchapter K.
Section 1.701-2(d), Example (6), Income Tax Regs., involves
the formation of a partnership by A and B, two high-bracket
taxpayers, and X, a corporation with net-operating loss
carryforwards.
A, B, and X form partnership PRS to own and
operate a building that qualifies for section 42 low-income
housing credits.
PRS is financed with cash contributions by A
and B and nonrecourse indebtedness, and the partnership agreement
provides for special allocations of income and deductions,
including depreciation, to A and B equally.
This allocation is
consistent with the allocation of other economically substantial
partnership items attributable to the building.
The section 42
low-income housing credits are also allocated according to the
partnership agreement.
The partners and partnership comply with
all applicable partnership regulations in their management and
reporting of the partnership.
These include sections 1.704-
1(b) (2) (ii)-(iii), 1.704-2(e), and 1.752-3,
Income Tax Regs.
The ultimate result reached by the Commissioner is that
individuals A and B are allowed to deduct their distributive
- 59 shares of PRS' losses against their nonpartnership income and to
apply the low-income housing credits against their tax
liabilities.
Example (6) goes on to indicate that this
allocation may not accurately reflectithe partners! economic,
agreement or clearly reflect income.
However,2because- the
provisions that lead to' this result, sections 1.704-1(b) (2) (ii") (iii), 1.704-2(ë), and 1.75223,
Income Tax Regs., clearly
contemplated this result, then requirement (3), discussed above,
is treated as having been satisfied.
The use of PRS results in partners A and B's aggregate
Federal income'tax liability being lower than if A and B had
owned the building directly.
This result flows from A and B's,
being able to use corporation X's otherwise allocable credits.
Example 6 concludes that, even though the use of partnership PRS
leads eto this result, 'the PRS transaction ~is not inconsistent
wi-th the intent of subchapter K.
As a result, the Commissioner
cannot invoke section 1.701-2(b), Income' Tax Regs., to recast the
transaction.
Respondent disputes:petitioner's reliance on Example (6) and
argues that it is inapplicable.
Respondent contends that Example
(6) concerns a general partnership, unlike Pitney Bowes, NJSEA,
and Historic Boardwalk Hall, where all partners have personal
liability, none of the entities is tax exempt, section 42-does
- 60 not require a profit motive, and the taxpayers aretat risk if thes
building declines in value.
Respondent argues that Historic Boardwalk Hall violated
section,1r701-2(a)(1), Income Tax Regs., because there was nog
substantial business purpose for its formation.
Respondent
points to certain factors listed in section 1.701-2(c), Income
Tax Regs., and concludes that section 1.701-2(a) (1), Income Tax
Regs;., has been violated.
These factors include Pitney Bowes'
aggregate tax liability's being lower as a result of Historic
Boardwa-lk Hall's creation; thus, Pitney Bowes is substantially
protected from any risk of loss and has little or no
participation in the partnership's profits other than its
preferred return.
Respondent does not argue a breach of
requirement (1) or (2) of section 1.701-2(a), Income Tax Regs:
We have previously rejected respondent's contentions in,the
context of his other arguments.
We agree with petitioner that
respondent's decision to recharacterize the East Hall transaction
pursuant to section 1.701-2 (b), Income Tax Regs., was
inappropriate..
as
NJSEA and Pitney Bowes had the legitimate
business purpose, as discussed above, of allowing Pitney Bowes to
invest in.the East Hall's rehabilitation.
The use of a
partnership was necessary to allow a for-profit corporation,to
invest in the rehabilitation of a government-owned building.
Although Pitney Bowes' aggregate tax liability was reduced as a
- 61 -
result of this transaction, Congress intended to use the
rehabilitation tax credit to draw private investments into public
rehabilitations Further,
the regulations clearly contemplate a situation in
which a partnership is used to transfer valuable tax attributes
from an entity that cannot use them--corporation X--to
individuals who can--taxpayers A and B.
Example (_6_) ,
VII.
See sec. 1.701-2(d),
Income Tax Regs.
Section 6_6_62 Accuracy-Related Penalty
Respondent determined in the FPAA that Historic Boardwalk
Hall should be liable for the accuracy-related penalty pursuant
to section 6662.
Because we find respondent's other
determinations to be incorrect, the section 6662 penalty is
inapplic able .
VIII.
Conclusi-oD
Respondent ' s determinations in the FPAA were incorrect .
To
reflect the foregoing,
An appropriate decision
will be entered.
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