UNITED STATES TAX COURT

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141 T.C. No. 1

UNITED STATES TAX COURT

JOHN HANCOCK LIFE INSURANCE COMPANY (U.S.A.), AS SUCCESSOR

IN INTEREST TO JOHN HANCOCK LIFE INSURANCE COMPANY (f.k.a.

JOHN HANCOCK MUTUAL LIFE INSURANCE COMPANY) AND

SUBSIDIARIES, ET AL.,' Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 6404-09, 7083-10,

7084-10.

Filed August 5, 2013.

JH is primarily in the business of selling life insurance policies,

annuities, long-term care insurance, and other retirement services. To

fulfill its contractual obligations under these services JH invests the

premiums it receives. In 1979 JH began investing in leveraged

leases. A leveraged lease is a lease in which the equity investor

iCases of the following petitioners are consolidated herewith: The

Manufacturers Investment Corporation and Subsidiaries, as successor in interest to

John Hancock Financial Services, Inc., and Subsidiaries, docket No. 7083-10; and

John Hancock Life Insurance Company (U.S.A.) and Subsidiaries, as successor in

interest to John Hancock Life Insurance Company (f.k.a. John Hancock Mutual

Life), docket No. 7084-10.

SERVED Aug 05 2013

-2borrows money from a third-party lender to finance a portion of the

purchase price of the asset involved and leases the asset to its ultimate

user.

In 1997 JH began investing in lease-in-lease-out (LILO)

transactions and in 1999 began investing in sale-in-lease-out (SILO)

transactions. JH participated in 19 LILO transactions and 8 SILO

transactions between 1997 and 2001.

With respect to the LILO transactions, JH claimed deductions

for rental expenses for the prepaid rent paid to the tax-indifferent

entities and interest expenses related to the repayment of the

nonrecourse loans. JH also amortized transaction costs related to the

LILO transactions. With respect to the SILO transactions, JH

claimed deductions for depreciation and interest expenses and

amortized the related transaction costs. R disallowed these

deductions for the years at issue and determined that JH had OID

income with respect to the LILO and SILO transactions.

The parties agreed to litigate three LILO transactions and four

SILO transactions and use them as test transactions for the remaining

LILO and SILO transactions at issue.

A transaction will be respected for Federal income tax purposes

if it has economic substance and the substance of the transaction is

consistent with its form. P argues that the LILO and SILO test

transactions have economic substance because JH derived a pretax

profit from each transaction and entered into the transactions with the

primary purpose of making a profit. P also argues that the substance

of each LILO and SILO transaction is consistent with its form

because JH held a true leasehold interest in each of the LILO assets

and obtained an ownership interest in each of the SILO assets. R

argues that the LILO and SILO test transactions lack economic

substance and the substance of the transactions is not consistent with

their form. Specifically, R argues that JH failed to acquire a

substantive leasehold interest in the LILO assets and failed to acquire

a substantive ownership interest in the SILO assets. Thus, R argues

-3the true substance of the LILO and SILO transactions is a loan from

JH to the tax-indifferent entities. R argues in the alternative with

respect to the LILO and SILO transactions that at most P acquired a

future interest in the LILO and SILO assets.

The parties also dispute the location of JH's principal place of

business.

Held: JH's principal place of business is Boston,

Massachusetts.

Held, further, R failed to prove that the three LILO and four

SILO test transactions lack economic substance.

Held, further, the substance of the three LILO test transactions

is not consistent with their form. The LILO test transactions resemble

financial arrangements, and JH is therefore denied its claimed rental

expense, interest expense, and transaction cost deductions with

respect to them.

Held, further, the substance of three of the SILO test

transactions is consistent with their form; however, JH did not acquire

a present interest in the SILO test transaction properties and is

therefore denied its claimed depreciation and interest expense

deductions.

Held, further, the substance of the fourth SILO test transaction

is not consistent with its form. That SILO test transaction resembles

a financial arrangement, and JH is therefore denied its claimed

depreciation expense, interest expense, and transaction cost

deductions with respect to that transaction.

Held, further, JH had OID income with respect to the three

LILO test transactions and the fourth SILO test transaction but not

with respect to the first three SILO test transactions, in which it failed

to acquire a present interest.

-4Arthur L. Bailey, Jean A. Pawlow, James W. Johnson, Kevin J. Cloherty,

Alexis A. Maclvor, Thomas K. Spencer, and Nathaniel J. Dorfman, for

petitioners.

Daniel A. Rosen, Lyle B. Press, Steven N. Balahtsis, Allison Ickovic, and

Abigail F. Dunnigan, for respondent.

CONTENTS

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

Background ................................................. 12

John Hancock'sHistory ............................. 12

II.

InvestmentProcess andReview ....................... 14

III.

Leasing .......................................... 16

IV.

LILOand SILOTransactions ......................... 16

Basic Structure ............................... 16

History ..................................... 24

DueDiligence................................ 26

The Hoosier Transaction ....................... 28

TheLILOTest Transactions .................................... 30

OBBLILO ....................................... 31

-5-

LeaseandSublease ........................... 31

TheAsset .............................. 31

Terms .................................33

RentandFinancing ...................... 33

Property Rights and Obligations . . . . . . . . . . . . 35

Default ................................36

EndofSubleaseTerm .........................37

II.

InitialLease ....................... 33

Sublease and Defeasance . . . . . . . . . . . . . 33

OBB'sPurchaseOption................... 37

JohnHancock'sOptions .................. 38

RenewalOption .................... 38

ReplacementOption ................ 39

RetentionOption ................... 40

SNCB 2 and SNCB 5 Lot 1 LILO Transactions . . . . . . . . . . 40

Lease and Sublease . .. .... . . ............... ... 40

The Assets ............................. 40

Terms .................................42

RentandFinancing ...................... 42

InitialLease ....................... 42

Sublease and Defeasance . . . . . . . . . . . . . 43

Property and Default Rights and Obligations . . 44

End of Sublease Term . .. . . . . . . .. . . . . . ... .. . .. . 44

The SILOTestTransactions .................................... 45

TIWAG .......................................... 46

LeaseandSublease ........................... 46

The Assets ............................. 46

Terms ................................. 47

RentandFinancing ...................... 47

InitialLease ....................... 47

-6-

II.

Sublease and Defeasance . . . . . . . . . . . . . 48

Property Rights and Obligations . . . . . . . . . . . . 51

Default ................................52

EndofSubleaseTerm .........................53

TIWAG'sPurchaseOption ................ 53

John Hancock'sOptions .................. 53

TwoDortmundTransactions ......................... 56

LeaseandSublease ........................... 56

TheAsset .............................. 56

Terms ................................. 58

Rent and Financing ...................... 59

InitialLease ....................... 59

Sublease and Defeasance . . . . . . . . . . . . . 59

III.

Property and Default Rights and Obligations . . 61

EndofSubleaseTerm ......................... 61

SNCB SILO ...................................... 63

GrantandSubgrant ........................... 63

The Asset .............................. 63

Terms ................................. 64

Rent and Financing ..... ...... . ..... ..... 64

Grant ..... .. .... .. .... . . ......... 64

Subgrant and Defeasance . . . . . . . . . . . . 65

Property and Default Rights and Obligations . . 67

EndofSubgrantTerm ......................... 67

Tax Returns, Notices of Deficiency, and Trial . . . . . . . . . . . . . . . . . . . . . . 68

Procedural History ................................. 68

Notice of Deficiency (Docket No. 6404-09) . . . . . . . . 69

-7-

II.

Notice of Deficiency (Docket No. 7084-10) . . . . . . . . 70

Notice of Deficiency (Docket No. 7083-10) . . . . . . . . 72

PretrialMotions .............................. 76

Trial............................................. 76

Petitioners' Expert Witnesses (Alphabetical Order) . . 77

Mr.JohnDolan ......................... 77

Dr. Paul Doralt . . .. .. .. . . . . . .. . . . . . . . .. . . 77

Mr.Hans Haider......................... 78

Dr.Friedrich Hey ........................ 78

Dr.FriedrichPopp ....................... 79

Dr. Thomas Schurrle . . . . . . . . . . . . . . . . . . . . . 79

Dr. Norbert Stoeck . . . . . . . . . . . . . . . . . . . . . . . 80

Dr. Frederik Vandendriessche . . . . . . . . . . . . . . 80

Respondent's Expert Witnesses (Alphabetical Order) 81

Dr. IgnaasBehaeghe ..................... 81

Dr. StefanDiemer ....................... 81

Dr.MatthiasHeisse ...................... 81

Dr. Thomas Lys ......................... 82

Dr.F.H. RolfSeringhaus .................. 83

Mag. Alexander Stolitzka . . . . . . . . . . . . . . . . . 83

Dr. Vukan Vuchic .................. ..... 84

Dr.PeterWundsam ......................84

OPINION ........................................................ 85

Burden ofProof..............................................85

PrincipalPlace ofBusiness ..................................... 86

LeveragedLease Transactions .................................. 87

FrankLyon ....................................... 87

-8 -

II.

Economic Substance .......................... 90

SubstanceOverForm.......................... 92

LILOandSILOLitigation ........................... 93

BB&T ..................................... 96

AWG...................................... 100

WellsFargo ................................ 106

Altria...................................... 113

Consolidated Edison ......................... 119

The Test Transactions ........................................ 125

II.

Economic Substance ............................... 126

ObjectiveInquiry ............................ 127

SubjectiveInquiry ........................... 143

Substance OverForm ............................. 144

OBB and SNCB LILO Transactions . . . . . . . . . . . . . 147

OBB Purchase Option Decision . . . . . . . . . . . 153

Financial Considerations . . . . . . . . . . . . 159

RetentionOption .................. 161

Renewal and Replacement Options . . . . 161

SNCB Purchase Option Decision . . . . . . . . . . 168

Conclusion ............................ 176

SILOTest Transactions ....................... 177

TIWAG and Dortmund Transactions . . . . . . . 179

Sublease Term .................... 179

PurchaseOptions .................. 183

-9I.

TIWAG Transaction . . . . . . . . . . 184

ii.

Dortmund Transactions . . . . . . . . 199

Service Contract Benefits and Burdens 213

FutureInterest .................... 219

SNCB . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 222

Purchase Option Decision . . . . . . . . . . . 223

SubgrantTerm .................... 232

Conclusion ....................... 235

InterestDeductions ..........................................236

Original Issue Discount . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 238

TransactionExpenses ........................................ 241

Conclusion................................................. 242

HAINES, Judge: These cases are consolidated for purposes of trial,

briefing, and opinion. Respondent determined the following deficiencies in

petitioners' Federal income tax for 19942 and 1997-2001 (years at issue):3

2Petitioners' 1994 deficiency arises from the denial of a claimed NOL

carryback.

3All section references are to the Internal Revenue Code (Code), as amended

and in effect for the years at issue, and all Rule references are to the Tax Court

Rules of Practice and Procedure, unless otherwise indicated. Amounts are

rounded to the nearest dollar.

-10Year

Deficiency

1994

1997

1998

1999

2000

2001

$8,860,564

65,746,621

173,497,367

59,899,141

108,046,947

143,516,079

These deficiencies stem from 27 leveraged lease transactions (leveraged

leases) that petitioners participated in between 1997 and 2001. For purposes of

resolving this action expeditiously, the parties agreed to try seven of the leveraged

leases (test transactions) and apply a formula to determine the deficiency, if any,

with respect to the remaining leveraged leases. The test transactions comprise

three lease-in-lease-out (LILO) transactions and four sales-in-lease-out (SILO)

transactions.4

The test transactions were identified at trial and are referred to herein by the

lease counterparty to each transaction. The counterparties for the LILO test

transactions are: (1) Osterreichische Bundesbahnen (OBB), a Government-owned

Austrian corporation that operates the Austrian Federal railway system, and (2)

Societe Nationale des Chemins de Fer Belges (SNCB), a Belgian company that

4Petitioners have referred to the SILO transactions as "service contract"

transactions throughout the pleadings and at trial and have emphasized this

distinction from a LILO. For simplicity and without prejudice, we refer to these

transactions as SILO transactions.

- 11 owns and operates the national rail system of Belgium.5 The counterparties for the

SILO test transactions are: (1) Tiwag-Tiroler Wasserkraft AG (TIWAG), an

Austrian corporation that is owned by the Austrian Province of Tyrol and is in the

business of generating, transmitting, and distributing electrical power to

commercial and residential consumers in Tyrol; (2) the City of Dortmund,

Germany (Dortmund);6 and (3) SNCB.

The issues for decision are: (1) whether the principal place of business for

petitioner in docket No. 7083-10 was in Massachusetts or Michigan; (2) whether

the test transactions lacked economic substance resulting in disallowance of

petitioners' claimed deductions for rent, depreciation, interest, and transaction

expenses; (3) whether under the substance over form doctrine, the substance of the

5SNCB is the counterparty to two LILO test transactions. At trial and on

brief these LILO transactions were referred to as SNCB 2 and SNCB 5 lot 1. For

purposes of this Opinion, we refer to them individually in the same manner and

collectively as the SNCB LILO transactions.

6Dortmund is the counterparty to two SILO test transactions, referred to at

trial and on brief as the Dortmund 1 and Dortmund 2 transactions. The assets

subject to the Dortmund 1 transaction are Halls 1, 2, and 3A of the

Westfalenhallen Dortmund Trade Fair, Event, and Congress Center Complex and

the associated facility sites. The assets subject to the Dortmund 2 transaction are

Halls 4-8 of the Westfalenhallen Dortmund Trade Fair, Event, and Congress

Center Complex and the associated facility sites. In all other material respects,

Dortmund 1 and Dortmund 2 are identical. Therefore, for purposes of this

Opinion, we refer to them individually as Dortmund 1 and Dortmund 2, and

collectively as the Dortmund transactions.

- 12 test transactions was a purchase of a future interest, inconsistent with its form,

resulting in disallowance of petitioners' claimed deductions for rent, depreciation,

interest, and transaction expenses; or (4) alternatively, whether under the

substance over form doctrine, the substance of the test transactions was a

financing arrangement, inconsistent with its form, resulting in generation of

original issue discount (OID) income and the disallowance of petitioners' claimed

deductions for rent, depreciation, and interest expenses.

FlNDINGS OF FACT

Some of the facts have been stipulated and are so found. The stipulations of

fact, together with those attached exhibits which were found relevant and

admissible, are incorporated herein by this reference. At the time they filed their

petitions, the principal place of business of petitioners in docket Nos. 6404-09 and

7084-10 was in Massachusetts. There is a dispute among the parties as to whether

the principal place of business of petitioner in docket No. 7083-10 was in

Massachusetts or Michigan.

Background

John Hancock's History

John Hancock Mutual Life Insurance Co. (JH Mutual) was incorporated in

Massachusetts in 1862. In February 2000 JH Mutual converted from a mutual life

- 13 insurance company to a publicly traded company. At that time it was renamed

John Hancock Life Insurance Co. (JHLIC) and became a wholly owned subsidiary

of John Hancock Financial Services, Inc. (JHFS). In April 2004 Manulife

Financial Corp., a Canadian company (Manulife), acquired JHFS and all of its

subsidiary corporations. Pursuant to a restructuring, on December 31, 2009, John

Hancock Life Insurance Co. (U.S.A.) (JHUSA) succeeded JHLIC. A subsidiary of

Manulife, the Manufacturer's Investment Co., a Michigan general business

corporation (MIC), succeeded JHFS. Unless otherwise indicated, for purposes of

this Opinion we refer to JH Mutual, JHLIC, JHFS, JHUSA, MIC, and their

subsidiaries collectively as John Hancock.

Throughout its history John Hancock's primary business has been the sale

of life insurance policies, annuities, long-term care insurance, and other retirement

services. To fulfill its contractual obligations under these services, John Hancock

invests the premiums it receives. Because of the varying lengths of John

Hancock's contractual obligations to its policyholders, it seeks to invest in

opportunities that match its long- and short-term cashflow needs and provide an

appropriate return or yield for its assessed risk levels.

John Hancock's financial needs require it to invest in a diversified set of

domestic and international assets. Between 1997 and 2001 John Hancock invested

- 14 between $6.8 and $10 billion annually and managed a portfolio of investments

valued between $38.9 and $46.6 billion.

II.

Investment Process and Review

Between 1997 and 2001 John Hancock's committee of finance oversaw its

investments. The committee of finance comprised members of John Hancock's

board of directors as well as its chairman, vice chairman, and president.

Committee of finance approval was required for all investments of a designated

s1Ze.

John Hancock's bond and corporate finance group managed the day-to-day

responsibilities with respect to a significant portion of the company's investments,

including bond portfolios, private equity, and alternative asset investments. The

bond and corporate finance group was divided into teams. For instance, the

"industrial" team was charged with managing investments in transportation,

timber, industrial equipment, mining, metal and communications assets. The

"energy" team managed investments in power plants, power companies, and other

energy assets. The "international" team managed cross-border investments. The

work of each team was connected to the "portfolio management" department,

which determined the types of investments and yields that John Hancock needed

to support its contractual obligations to its policyholders. The division of

- 15 responsibility within the bond and corporate finance group allowed each team to

specialize and develop an expertise in its designated industries.

Each of John Hancock's investments went through a thorough review

process. Typically, a bond and corporate finance group team was charged with

drafting an investment recommendation, known within John Hancock as a "yellow

report". A yellow report analyzes a proposed investment in numerous ways,

including an analysis of the expected return, risk profile, collateral support, credit

rating of the relevant parties to the transaction, term of the transaction, and any

special aspects of the investment. The yellow report was used as an approval

request for many of John Hancock's investments.

John Hancock's bond investment committee reviewed the yellow reports.

The bond investment committee held bimonthly meetings and comprised leaders

from each of the bond and corporate finance group's industry teams. At each bond

investment committee meeting, the credit analyst responsible for analyzing the

investment featured in the yellow report presented the opportunity, discussed the

risks and rewards of the investment, and fielded questions from the committee.

After review and consideration, the bond investment committee's members voted

to approve or deny an investment. If an investment was approved, it moved to the

committee of finance for further review and approval.

- 16 Generally, a committee of finance meeting was held once a month.

However, in certain circumstances the bond investment committee was granted

"between meeting authority" to enter into an investment normally requiring further

approval. "Between meeting authority" was necessary in cases where John

Hancock has to proceed with a time-sensitive investment.

III.

Leasing

In 1979 John Hancock formed a leasing company. Leasing transactions

were attractive to John Hancock because they offered a higher after-tax return than

traditional investments. A leveraged lease is a lease in which the equity investor

borrows money from a third-party lender to finance a portion of the purchase price

of the asset involved and leases the asset to its ultimate user. John Hancock

participated in leveraged leases as both equity investor and lender. A variety of

assets were involved, including aircraft, medical equipment, tractors, irrigation

systems, barges, trailers, grain silos, natural gas compressors, manufacturing

equipment, automobiles, and railcars.

IV.

LILO and SILO Transactions

Basic Structure

John Hancock participated in 19 LILO transactions and 8 SILO transactions

between 1997 and 2001. LILO and SILO transactions are types of leveraged

- 17 leases. In a typical LILO transaction, a U.S. taxpayer, acting through a grantor

trust,7 leases assets from a foreign or domestic tax-exempt entity and

simultaneously leases that property back to the lessee 8 The U.S. taxpayer prepays

the initial lease's rent, which is funded through a nonrecourse loan from a thirdparty lender and an equity contribution from the U.S. taxpayer. The equity

ordinarily ranges from 10% to 20% of the value of the initial lease. Because the

loan funding the debt portion of the investment is nonrecourse, the U.S. taxpayer

is entitled to favorable accounting treatment on its financial statements pursuant to

Statement of Financial Accounting Standards No. 13 (FAS 13).9

The sublease has a shorter term than the initial lease. At the end of the

sublease term the tax-exempt entity has the option to purchase the remainder of the

U.S. taxpayer's leasehold interest in the initial lease. If the tax-exempt entity

7The grantor trust is generally disregarded for Federal income tax purposes.

8Each lessee counterparty to the test transactions is a foreign entity. These

foreign entities are so called tax-indifferent entities because they are not subject to

U.S. taxation. For convenience we shall refer to these entities as tax-exempt

entities.

9FAS 13 addresses lease accounting for lessors and lessees taking part in

leveraged leases. FAS 13 enables earlier recognition of income relative to other

transactions with similar cashflows. Additionally, FAS 13 allows nonrecourse

debt used in a leveraged lease to be excluded from the liabilities side of a balance

sheet.

- 18 -

chooses not to exercise this purchase option, the U.S. taxpayer may elect to: (1)

compel the tax-exempt entity to renew the sublease; (2) take possession of the

asset; or (3) enter into a replacement sublease with a third party. Most LILO and

SILO transactions impose requirements upon a tax-exempt entity that chooses not

to exercise its purchase option, such as refinancing the U.S. taxpayer's

nonrecourse loan. If the tax-exempt entity cannot meet these requirements, it must

ordinarily exercise the purchase option.

A typical SILO transaction is similar, except that the term of the initial lease

extends beyond the remaining useful life of the asset. Therefore, the U.S. taxpayer

takes the position that the initial lease is a sale for U.S. Federal tax purposes.

Also, if the tax-exempt entity chooses not to purchase the asset at the end of the

sublease term, the U.S. taxpayer's options differ slightly. The U.S. taxpayer may

(1) compel the lessee to arrange for a service contract for the asset for a

predetermined term or (2) take possession of the asset.

"Defeasance" is a common characteristic in most LILO and SILO

transactions. Defeasance is a way to minimize risk. The forin of the defeasance in

a particular LILO or SILO transaction will vary, but it is ordinarily accomplished

through one or more deposits with third-party financial institutions, known as

payment undertakers. In most LILO and SILO transactions the U.S. taxpayer will

- 19 require a debt payment undertaking agreement (DPUA) as part of the transaction,

and often will require an equity payment undertaking agreement (EPUA) as well.

In a DPUA, the tax-exempt entity deposits a portion of prepaid rent received from

the U.S. taxpayer funded by the nonrecourse loan with the debt payment

undertaker (DPU), sometimes related to the lender, and in return the DPU agrees

to make rent payments on behalf of the tax-exempt entity under the sublease. The

timing and amount of the tax-exempt entity's rent under the sublease usually

matches the U.S. taxpayer's debt service payments on the nonrecourse loan. As a

result, the DPU will often pay the lender directly and neither the U.S. taxpayer nor

the tax-exempt entity make any out-of-pocket payments during the initial lease

term.

In an EPUA, the tax-exempt entity deposits a portion of the U.S. taxpayer's

equity investment with an equity payment undertaker (EPU). This deposit is

designed to pay the tax-exempt entity's equity portion of rent payments, to grow to

cover the sublease termination value in case of a sublessee default, and to fund the

tax-exempt entity's purchase option at the end of the initial lease. As a result, the

tax-exempt entity is not forced to incur any additional out of pocket expenses if it

chooses to exercise its purchase option.

- 20 In addition to a DPUA and an EPUA, the U.S. taxpayer in a LILO or SILO

transaction may require additional protection, such as a pledge of the amounts

deposited pursuant to the DPUA or EPUA, or residual value insurance. If an

amount deposited with a payment undertaker is not pledged to the U.S. taxpayer,

the tax-exempt entity may have the right to withdraw the deposit for its own use if

it replaces the deposit with approved substitute collateral, such as a letter of credit.

The tax-exempt entity retains the portion of the equity contribution that is not

deposited pursuant to an EPUA. This amount is known as the tax-exempt entity's

"net present value benefit" from the transaction.

The following graphics display the closing day and sublease lease term

cashflowsl° and the operating structure of a basic single-lender LILO with debt

and equity defeasance during the sublease lease term. For purposes of this

graphic, the U.S. taxpayer's grantor trust is the lessor and the tax-exempt entity is

the lessee during the sublease lease term.

1°The graphic ignores transaction expenses that the U.S. taxpayer ordinarily

pays on the closing date.

- 21 -

Illustrative Hypothetical Closing Day Cashflows

Taxpayer

Equity

Contribution

($20)

Grantor

Trust

Nonrecourse

Loan

($80)

Lender

Equity Contribution+

Debt Contribution=

Prepaid Rent on Inital

Lease

($100)

Equity

Payment

Undertaker

Contribution -

Fee

Tax Exempt

Nonrecourse

Loan

Debt

($80)

Payment

Undertaker

Entity

($17)

Fee

($3)

The tax-exempt entity receives a fee for entering into the transaction with the

grantor trust. The equity contribution (minus the fee) will then be invested by the

equity payment undertaker and will be used to pay a portion of the sublease rent

payments and fund the purchase option at the end of the sublease term. The debt

contribution will be invested by the debt payment undertaker and will be used to

pay a portion of the sublease rent payments and eventually returned to the lender

as debt service payments on the nonrecourse loan. Typically the lender and the

debt payment undertaker are related parties, and often the equity payment

undertaker is also related to the lender.

- 22 -

Sublease Term Cashflows

Retum of

U.S.

Equity

Taxpayer 4 --- - - --

Grantor

Trust

Debt Service

Payment

- - -- -- ,

Return of Equity

Sublease Rent

Contribution

through Sublease

(Funded by Debt

Portion and Equity

Portion)

Lender

Sublease

Rent

Sublease

Equity

Tax Exempt

Rent

Debt

Payment - -- - -- V

Entity 4 - - - - Payment

Undertaker

(Fee)

Undertaker

The dashed lines represent the theoretical flow of cash from the payment

undertakers to the tax-exempt entity, the tax-exempt entity to the grantor trust, and

the grantor trust to the U.S. taxpayer and the lender. However, because the timing

and amount of the lessee's sublease rent payments and the lessor's debt service

payments match exactly, the debt payment undertaker often pays the lender

directly, satisfying both the sublease rent and the debt service payment. Similarly,

the equity payment undertaker's sublease rent ends up in the hands of the U.S.

taxpayer as a return of equity.

- 23 -

Closing Day Cashflows and Sublease Term Cashflows

Equity

Loop

Taxpayer

Equity

Contribution

Debt

Loop

. Grantor

Trust

Portion of equiíy

contribution

returned to U.S.

Taxpayer as

sublease rent

Equity

Payment

Undertaker

Equity

Contribution Fee

Lender

Equity Contribution+

Nonrecourse loan =

Prepaid Rent on Inital

: Lease

Tax Exempt.

Entit

Fee

.· Nonrecourse

Loan

Nonrecourse

Loan

Nonrecourse loan

returned to Lender

through sublease

rent payments

Debf

Payntent

Undertaker

Above is a combination of the closing day cashflows and the sublease term

cashflows. Together the two cashflows create what is known as loop debt.

-24B.

History

In 1975 the Internal Revenue Service (IRS) issued guidelines for advance

ruling purposes in determining whether leveraged lease transactions may be

treated as leases for Federal tax purposes. Rev. Proc. 75-21, 1975-1 C.B. 715. In

1981 Congress enacted safe harbor leasing rules for sale and leaseback

transactions that allowed taxpayers to lease property from tax-exempt entities.

Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, 95 Stat. 172. These safe

harbor rules were repealed in 1982 because of adverse public reaction and reduced

tax revenues. Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97248, 96 Stat. 324. In 1984 Congress enacted what has become known as the

"Pickle rule", which subjected property leased to a tax-exempt entity to

unfavorable depreciation rules. Deficit Reduction Act of 1984, Pub. L. No. 98-

369, 98 Stat. 494.

John Hancock began investing in LILO transactions in 1997. LILO

transactions were designed to work around the Pickle rule because the taxable

party leased the property involved, rather than purchasing it, and then immediately

subleased the property back to the tax-exempt entity. LILO transactions became

popular means of raising funds for tax-exempt entities. In fact, the Federal Transit

Administration (FTA) promoted and approved LILO and SILO transactions

- 25 between 1997 and 2001 as a means of providing cash infusions for financially

troubled public transit agencies.

In 1999 John Hancock and other similar investors ceased to invest in LILO

transactions because of a change to the regulations under section 467, requiring

that prepayment of the initial lease rent be treated as a loan for tax purposes. See

sec. 1.467-4, Income Tax Regs." In 2002 the IRS issued Rev. Rul. 2002-69,

2002-2 C.B. 760, which determined that a LILO transaction is more properly

characterized as a future interest in property and a taxpayer may not deduct rent or

interest paid or incurred in connection with such a transaction. The IRS further

stated that it would disallow tax benefits claimed in connection with LILO

transactions on other grounds, including the substance over form and economic

substance doctrines. Id.

Unable to continue investing in LILO transactions, John Hancock and other

similar investors began investing in SILO transactions. SILO transactions also

avoided the pitfalls of the Pickle rule because the service contract was arguably

not included in the lease term as long as it complied with section 7701(e). As a

"The IRS proposed regulations that largely eliminated the tax benefits

associated with LILO transactions in 1996; these regulations became effective in

1999.

- 26 result, SILO transactions were designed to allow the lessor to claim depreciation

deductions over a shorter term, increasing the transaction's tax value.

In 2004 Congress enacted the American Jobs Creation Act of 2004, Pub. L.

No. 108-357, 118 Stat. 1418, eliminating the benefits associated with LILO and

SILO transactions. This legislation was prospective in effect and was not

designed to alter the general principles of tax law that apply to determine the

legitimacy of transactions designed to generate tax deductions. See H.R. Conf.

Rept. No. 108-755, at 660 (2004), 2004 U.S.C.C.A.N. 1341, 1720-1721.

Due Diligence

John Hancock learned of opportunities to invest in LILO or SILO

transactions from promoters such as D'Accord Financial Services and Citigroup.

A promoter acted as an adviser to the counterparties in these transactions, drafted

offering memoranda, and solicited offers or bids from potential investors. After

receiving an offering memorandum, John Hancock would prepare an offer that

was contingent on participation of the lenders at agreeable terms, completion of

internal and external due diligence, and the receipt of approved expert opinions

and reports. If John Hancock was chosen to participate in the transaction, it

engaged experts and attorneys to help negotiate a term sheet. John Hancock set

limitations for its total investments in LILO and SILO transactions between 1997

- 27 and 2001 that were based on its "tax capacity", which was determined on the basis

of its ability to offset its taxable income with losses.

As part of John Hancock's internal assessment of a LILO or SILO

transaction, the bond and corporate finance group drafted a yellow report. Each

transaction had to receive the approval of John Hancock's bond investment

committee and committee of finance. John Hancock generally chose to participate

in LILO and SILO transactions where its specialty groups had a familiarity with

the assets involved. Team members of the bond and corporate finance group

performed site visits and inspected many of the subject assets of the leveraged

leases.

John Hancock also engaged a team of independent specialists and

consultants as part of its due diligence process. These specialists and consultants

were relied upon to provide appraisals, accounting advice, insurance advice, legal

opinions, engineering opinions, and market analysis with respect to the relevant

industries. John Hancock also relied upon a financial modeling tool within the

leasing industry known as the ABC reports. Among other things, the ABC reports

projected John Hancock's pretax and after-tax financial consequences for each

transaction. The ABC reports provided alternative simulations based on the

assumption that the counterparty to each LILO or SILO transaction exercised its

- 28 purchase option and on the assumption that the counterparty did not exercise its

purchase option.

As part of John Hancock's internal risk assessment, John Hancock gave

each LILO and SILO transaction a credit rating based on the credit ratings of the

counterparties, the relevant defeasance, and the external specialty reports and

opinions. John Hancock's internal credit rating for each LILO transaction was

AA1, one grade below John Hancock's highest credit rating of AAA. John

Hancock's internal credit rating for each SILO transactions was AA3, a grade

slightly lower than AA1. John Hancock categorized its investments in LILO and

SILO transactions as bonds.

The securities valuation office of the National Association of Insurance

Commissioners (NAIC) evaluates and rates investments held by insurance

companies. Its highest rating is NAIC 1, which is given to transactions that

require the least amount of regulatory capital. Each of John Hancock's LILO and

SILO transactions was rated NAIC 1.

The Hoosier Transaction

In 2008 the financial sector experienced a credit crisis. This crisis resulted

in widespread credit downgrades of financial institutions throughout the world,

including downgrades to the credit ratings of some of the payment undertakers and

- 29 insurance entities involved in John Hancock's LILO and SILO transactions. In

one such case, John Hancock was forced to litigate with an Indiana cooperative,

Hoosier Energy, over a SILO transaction involving a coal-fired power plant.

Hoosier Energy Rural Elec. Coop., Inc. v. John Hancock Life Ins. Co., 588 F.

Supp. 2d 919 (S.D. Ind. 2008), aff'd, 582 F.3d 721 (7th Cir. 2009).

In 2002 John Hancock entered into a SILO transaction with Hoosier in

which John Hancock leased a coal-fired power plant for 63 years and subleased it

back to Hoosier for 30 years. John Hancock's equity investment in the transaction

was $56,772,812. John Hancock also spent $12,830,640 in transaction expenses.

As part of John Hancock's security package, Hoosier obtained a credit default

swap from Ambac Assurance Corp. (Ambac). In 2008 Ambac's credit rating was

downgraded, and John Hancock exercised its right upon a credit downgrade under

the transaction documents to require Hoosier to replace Ambac. When Hoosier

was unable to replace Ambac within the specified period, John Hancock tried to

enforce its default rights.

Hoosier sought injunctive relief to prevent John Hancock from enforcing its

default rights while it continued to look for a replacement for Ambac. The District

Court for the Southern District of Indiana granted Hoosier's request for injunctive

relief, and the Court of Appeals for the Seventh Circuit affirmed, giving Hoosier

- 30 approximately 3½ months to find a replacement. During this period, John

Hancock and Hoosier settled their dispute. In this settlement, Hoosier agreed to

pay John Hancock $68 million.

The LILO Test Transactions

In connection with each of the test transactions John Hancock entered into

numerous agreements covering thousands of pages and conferring various rights

and obligations upon the parties involved." The general rights and obligations

created as part of each test transaction are similar. However, the details of those

rights and obligations vary from transaction to transaction. In each case, a

"participation agreement" governs the interaction of the agreements to the

transaction and provides, among other things, a general framework for the

transaction's structure. Each transaction includes numerous agreements, including

an initial lease and sublease, known as the "head lease" and the "lease" in some

cases. For simplicity and consistency, we refer to the head lease in each

John Hancock did not directly participate in any of the test transactions.

Rather, John Hancock established a grantor trust through which it participated.

These grantor trust are generally disregarded for Federal income tax purposes and

thus do not affect our analysis. Therefore, they are disregarded for purposes of

this Opinion.

- 31 transaction as the initial lease and the lease as the sublease." Our reference to the

transaction in this way is for convenience and is not dispositive of the status of a

transaction or the determination of the benefits and burdens of ownership. The

basic structures and relevant details of each of the LILO test transactions are

described below.

OBB LILO

Lease and Sublease

The Asset

The OBB transaction closed on June 18, 1998. The asset subject to the

OBB transaction is the Vienna Kledering Marshalling Yard (VK marshalling

yard), which opened in 1996. Its primary function is "shunting", or the splitting

up of freight cars from incoming trains, sorting them, and attaching them to

outbound trains headed to their final destinations in Europe. The VK marshalling

yard has the capacity to process over 6,100 freight cars daily and is one of the

largest marshalling yards in eastern Europe.

"Each test transaction includes a tax indemnity agreement. The tax

indemnity agreements provide that the lessee counterparty will indemnify John

Hancock should John Hancock lose its rights to claim the expected tax benefits

from the test transactions because of certain enumerated reasons. Unlike the

taxpayer in Historic Boardwalk Hall, LLC v. Commissioner, 694 F.3d 425 (3d Cir.

2012), rev'g 136 T.C. 1 (2011), John Hancock is not protected if its tax benefits

are reduced as a result of an IRS challenge.

- 32 Deloitte & Touche (Deloitte) appraised the VK marshalling yard for the

OBB transaction at a fair market value, as of the closing date, of $352,711,000.

This value served as the basis for determining John Hancock's investment in the

initial lease. John Hancock and OBB did not further negotiate this investment

amount. The appraisal further determined that as of the closing date, the VK

marshalling yard had a remaining economic useful life of approximately 48 years.

The appraisal used both the cost method of valuation and the discounted cashflow

method in reaching its fair market value determination but based its conclusion on

the cost method because of a lack of reliable data with respect to expected

revenues and expenses from the VK marshalling yard. Deloitte also estimated the

residual value of John Hancock's remaining leasehold interest in the VK

marshalling yard at the end of the sublease term to be $105,107,878. The

appraisal relied upon the discounted cashflow method to reach this residual value

determination, stating that the cost approach was inapplicable and that the residual

value of John Hancock's remaining leasehold interest would depend upon the

cashflows the VK marshalling yard would generate during the remainder of the

initial lease term.

-332.

Terms

On the closing date, OBB leased the VK marshalling yard to John Hancock

for a term of approximately 38 years. Simultaneously, John Hancock subleased

the VK marshalling yard back to OBB for a term of approximately 18 years. At

the end of the sublease term OBB was given the option of purchasing John

Hancock's leasehold interest in the VK marshaling yard.

Rent and Financing

Initial Lease

The initial lease required John Hancock to make an up-front payment to

OBB of $309,375,024 and a deferred rent payment of $2,295,340,042 on

November 12, 2041, five years after the end of the initial lease term. To fund the

up-front payment, John Hancock contributed $65,980,517 and borrowed

$243,394,507 from Creditanstalt AG (Credit AG) on a nonrecourse basis. John

Hancock also paid $8,817,775 of transaction expenses.

Sublease and Defeasance

Pursuant to the sublease, OBB agreed to pay rent to John Hancock. In order

to fund the sublease rent payments OBB entered into a number of defeasance

agreements. Pursuant to a DPUA, on the closing date OBB deposited the

$243,394,507 John Hancock borrowed from Credit AG and paid to OBB as an up-

- 34 front rent payment with CA-Leasing GmbH (CA Leasing), an affiliate of Credit

AG. In return, CA Leasing agreed to make a series of payments on behalf of OBB

which exactly match John Hancock's debt service payments to Credit AG in

amounts and timing. As a result, pursuant to the transaction documents, CA

Leasing pays Credit AG directly to satisfy John Hancock's debt service and

OBB's sublease rent.

Credit AG guaranteed CA Leasing's payments under the DPUA. The

DPUA and guaranty do not eliminate OBB's legal obligation to pay rent under the

sublease. In certain circumstances, OBB is entitled to replace the DPUA with

substitute collateral, including a qualified letter of credit.

On June 19, 1998, one day after the closing date, OBB entered into a swap

agreement with Merrill Lynch Capital Services, Inc. (Merrill Lynch). Pursuant to

this agreement, OBB paid Merrill Lynch $45,380,000 from John Hancock's

$65.,980,517 of equity contribution in exchange for Merrill Lynch's agreement to

make payments to OBB in accordance with a specified schedule, including

payments to fund OBB's purchase option if exercised. Further, an affiliate of

Merrill Lynch guaranteed Merrill Lynch's obligations pursuant to the swap

agreement. OBB pledged a first-priority security interest in the swap agreement to

John Hancock as collateral for its obligations under the sublease. OBB retained

- 35 the excess of the up-front rent payment from John Hancock to OBB pursuant to

the initial lease over the amounts OBB deposited with CA Leasing and Merrill

Lynch under the DPUA and swap agreement, respectively. This amount is OBB's

cash takeaway from the transaction, or what the parties refer to as OBB's "net

present value benefit".

On the closing date, OBB also provided John Hancock with a letter of credit

issued from Bank Austria Aktiengesellschaft (Bank Austria). Under the letter of

credit, Bank Austria is required to pay John Hancock a specified amount in the

event OBB defaults on its obligations pursuant to the sublease. This potential

payment eliminated any of John Hancock's risk of exposure that was not covered

under the DPUA and the swap agreement. The DPUA, swap agreement,

guaranties, pledge, and letter of credit were all required in the OBB transaction

under the participation agreement. As a result of the structure in place, the OBB

LILO transaction is fully defeased.

Property Rights and Obligations

The initial lease grants John Hancock the right to "possession, use and quiet

enjoyment" of the VK marshalling yard. The initial lease is a net lease, meaning

that it requires John Hancock to insure, maintain, and repair the VK marshalling

yard. John Hancock may satisfy these requirements through its participation in the

- 36 sublease. John Hancock's participation in the sublease is required under the

participation agreement.

OBB's rights and obligations under the sublease with respect to possession

and use of the VK marshalling yard are nearly identical to John Hancock's rights

and obligations under the initial lease, including the right to "quiet enjoyment" of

the VK marshalling yard. The sublease grants OBB the right to modify the VK

marshalling yard, subject to certain restrictions. OBB is further restricted, with

certain exceptions, from subleasing the VK marshalling yard or creating or

permitting a lien on the VK marshalling yard. John Hancock has the right to visit

and inspect the VK marshalling yard.

Default

If John Hancock defaults on its obligations under the initial lease, OBB may

require John Hancock to return the VK marshalling yard, terminate the lease, and

demand liquidated damages. In the "Event of Loss", the lease terminates and John

Hancock is required to pay a stipulated value to OBB. An "Event of Loss" is

defined to include, among other things, actual loss of the VK marshalling yard due

to damage or governmental seizure.

John Hancock's rights against OBB in the case of a lessee default under the

sublease are similar. John Hancock is entitled to collect on the "Termination

- 37 Value" of the sublease, take possession of the VK marshalling yard, sell the VK

marshalling yard, and terminate the sublease. The sublease termination value is

predetermined and is designed to provide John Hancock with a return on its equity

investment. In the case of an "Event of Loss" under the sublease, which is the

equivalent to the event of loss under the initial lease, the initial lease ends and

OBB must pay John Hancock the termination value. Additionally, all rents are

due from OBB to John Hancock, and OBB must pay John Hancock an additional

amount to offset the stipulated value John Hancock is required to pay OBB under

the initial lease.

End of Sublease Term

OBB's Purchase Option

At the end of the sublease term OBB has the option to purchase John

Hancock's leasehold interest in the VK marshalling yard for $153,817,825,

payable in predetermined installments. The payments due to OBB from CA

Leasing and Merrill Lynch match exactly the purchase option price and timing. If

OBB exercises its purchase option, all agreements executed pursuant to the OBB

LILO transaction will terminate and John Hancock will no longer be required to

pay OBB the deferred rent payment under the initial lease.

- 38 2.

John Hancock's Options

If OBB does not exercise its purchase option, John Hancock may choose

among three alternatives. John Hancock may elect to: (1) renew the sublease; (2)

replace OBB and lease the VK marshalling yard to another lessee; or (3) take

possession of the VK marshalling yard. In all three scenarios John Hancock must

provide OBB with acceptable collateral to secure John Hancock's obligations to

pay the deferred rent payment under the initial lease.

Renewal Option

The renewal option extends John Hancock's sublease with OBB for

approximately 13 years and includes a set of prenegotiated rent payments during

the renewal term totaling $642,175,362. These rent payments have two

components. First, the current portion of renewal rent is equal to $213,241,461

and is payable throughout the renewal term. The remainder, or $428,933,901, is

deferred and payable at the end of the renewal term. Combined, these rent

payments ensure John Hancock's return on its equity investment. At the end of

the renewal term John Hancock would take possession of the VK marshalling yard

for the remainder of the initial lease term.

If John Hancock elects to renew the sublease, OBB must arrange for either

an extension of the nonrecourse loan from Credit AG to John Hancock or for

- 39 another lender to replace Credit AG as the lender under substantially the same

terms as the original loan. If OBB is unable to do so, it must purchase up to 49%

of the principal outstanding on the loan from Credit AG and attempt to again

extend the remaining loan or find a replacement lender. If OBB is still unable to

extend the loan or find a replacement lender, it again has the option of choosing to

exercise the purchase option.

If OBB elects the renewal option, it must also arrange for collateral

substantially identical to the swap agreement and letter of credit to secure the

equity portion of rent during the renewal term. OBB may also be required to

provide collateral to secure the debt portion of rent during the renewal term if the

replacement lender deems it necessary for the loan extension.

Replacement Option

Under the replacement option, OBB must cooperate with John Hancock in

the negotiation, execution, and delivery of a replacement lease. However, John

Hancock bears the costs incurred in connection with the replacement lease. The

replacement lease does not have to mirror the renewal lease. John Hancock, and

not OBB, must arrange for a loan extension for its nonrecourse loan from Credit

AG or find a replacement lender. If John Hancock is unable to do so, it must

purchase the remaining principal of the loan from Credit AG. Further, if John

- 40 Hancock is unable to find a replacement lessee within 30 days of the end of the

sublease term, it will be deemed to have selected the renewal option.

Retention Option

Under the retention option, John Hancock must arrange for payments in

satisfaction of the principal of its nonrecourse loan from Credit AG. If John

Hancock is unable to do so within 30 days of the end of the sublease term, it will

be deemed to have selected the renewal option.

II.

SNCB 2 and SNCB 5 Lot 1 LILO Transactions

Lease and Sublease

The Assets

The SNCB 2 and SNCB 5 lot 1 transactions closed on September 29 and

December 15, 1997, respectively. The Kingdom of Belgium owns 99.9% of

SNCB, which was reorganized as a limited liability company under Belgian public

law in 1991." SNCB operates and maintains domestic and international passenger

trains and freight rolling stock in Belgium. The asset subject to the SNCB 2

transaction is the Thalys highspeed trainset (Thalys trainset), which consists of

"In 2005 SNCB again reorganized with SNCB being renamed SNCB

Holding. Under the reorganization SNCB formed two subsidiaries, SNCB and

Infrabel, both public limited liability companies. For purposes of this analysis, we

refer to SNCB Holding and its subsidiaries as SNCB.

- 41 two power units and eight passenger cars, holds approximately 400 people, and is

used for highspeed international travel. The assets subject to the SNCB 5 lot 1

transaction are eight electric motive units (EMUs). The EMUs are three-car

trainsets consisting of a driving car and two trailer cars and are used

predominantly for intercity service.

Deloitte appraised the Thalys trainset at a fair market value of $34,267,200

on the closing date of the SNCB 2 transaction. Deloitte separately appraised the

EMUs at a fair market value of $61,371,200 on the closing date of the SNCB 5 lot

1 transaction. As in the OBB transaction, these values served as the basis for

determining John Hancock's investments in the transactions, and the parties did

not further negotiate the investment amounts. Deloitte concluded that as of the

closing dates of the SNCB 2 and SNCB 5 lot 1 transactions, the Thalys trainset

and the EMUs had remaining economic useful lives of 42 and 45 years,

respectively. The appraisals used both the cost method and the discounted

cashflow method in their fair market value determinations but chose to rely on the

cost method because of a lack of reliable data with respect to expected revenues

and expenses in connection with the assets. Deloitte also appraised John

Hancock's remaining leasehold interests in the Thalys trainset and EMUs at the

- 42 end of the subleases, estimating the residual values to be $7,774,387 and

$14,483,603,respectively.

Terms

As part of the SNCB 2 transaction John Hancock leased the Thalys trainset

from SNCB for a term of approximately 34 years. Simultaneously, John Hancock

subleased the Thalys trainset back to SNCB for a term of approximately 15 years.

In the SNCB 5 lot 1 transaction John Hancock leased the EMUs from SNCB for a

term of approximately 34 years. Simultaneously, John Hancock subleased the

EMUs back to SNCB for a term of approximately 16 years. SNCB has the option

of purchasing John Hancock's leasehold interests in the Thalys trainset and EMUs

at the end of each transaction's sublease term.

Rent and Financing

Initial Lease

Similar to the OBB transaction, the initial lease in each of the SNCB LILO

transactions required John Hancock to make an up-front rent payment on the

closing date and a deferred rent payment five years after the end of each initial

lease term. John Hancock contributed $6,314,390 and $12,164,454 to the SNCB 2

and SNCB 5 lot 1 transactions, respectively, and borrowed $23,957,351 and

$42,725,648 to fund the remainder of the up-front payments on a nonrecourse

- 43 basis from Eurofima European Co. for the Financing of Railroad Rolling Stock

(Eurofima). John Hancock also paid transaction expenses of $733,318 and

$797,826 as part of the SNCB 2 and SNCB 5 lot 1 transactions, respectively.

Sublease and Defeasance

Pursuant to the subleases, SNCB agreed to pay rent to John Hancock.

Similar to the OBB LILO, in order to fund its sublease rent payments SNCB

entered into a number of defeasance agreements. The debt defeasance in each

transaction is accomplished through a prepaid currency swap whereby SNCB and

Eurofima agreed to swap specified amounts of U.S. dollars for Belgian francs on

specified dates. Similar to the DPUA in the OBB transaction, the payments due

from Eurofima to SNCB exactly match John Hancock's debt service payments to

Eurofima in amount and timing.

The equity defeasance in each SNCB LILO transaction is governed by a

pledged collateral account agreement (PCAA) with Merrill Lynch. Pursuant to the

PCAAs, SNCB deposited a specified amount with Merrill Lynch to secure the

equity portion of sublease rent, sublease termination value, and the amount

required for SNCB's purchase options. John Hancock was granted a first-priority

security interest in each of the PCAAs. SNCB's net present value benefit in the

SNCB LILO transactions is the difference between John Hancock's up-front

- 44 payments under the initial leases and the respective amounts deposited and paid

pursuant to the currency swaps and PCAAs. As a result of the structure in place,

the SNCB LILO transactions are fully defeased.

Property and Default Rights and Obligations

John Hancock's and SNCB's property and default rights and obligations

pursuant to the initial leases and subleases of the SNCB LILO transactions are

substantially similar to those conferred under the initial lease and sublease of the

OBB transaction. The most significant difference between the OBB transaction

and the SNCB LILO transactions is that in each of the SNCB LILO transactions

the counterparty, SNCB, has limited right under the subleases to replace the

subject assets.

End of Sublease Term

According to the appraisals, the fixed purchase option price in each of the

SNCB LILO transactions is greater than the expected fair market values of the

respective assets on the purchase option dates. If SNCB exercises its purchase

options with respect to the SNCB LILO transactions, all agreements executed

pursuant to the transactions would terminate and John Hancock would no longer

be required to pay the deferred rent payments under the initial leases.

- 45 If SNCB does not exercise its purchase options, John Hancock may renew

the subleases, replace SNCB with a different lessee, or take possession of the

assets. The rights and obligations conferred upon John Hancock under each

option are substantially similar to those described with respect to the OBB

transaction.

The SILO Test Transactions

Several characteristics distinguish John Hancock's SILO transactions from

its LILO transactions. First, because the length of the initial lease exceeds the

estimated economic useful life of the asset, John Hancock treated each SILO

transaction as a sale for U.S. Federal tax purposes. Next, a service contract option

replaces the renewal and replacement leases if the lessee forgoes its purchase

option. And finally, pursuant to section 467 the sublease rent payments are treated

as a loan from the lessee counterparty to the U.S. taxpayer (section 467 loan).

Section 467 imputes a loan and adds an interest component to a lease in certain

cases where the allocation of rent payments does not match the dates when actual

payments are due. In the case of John Hancock's SILO transactions, the lessee

counterparties prepay their sublease rent payments, creating a section 467 loan

from the lessee counterparty to John Hancock.

-46-

TIWAG

Lease and Sublease

The Assets

The TIWAG transaction closed on December 21, 2001. TIWAG is a

regional energy utility in the Province of Tyrol, Austria. The asset subject to the

TIWAG transaction is a 21.6% undivided interest in the Sellrain-Silz hydropower

facility (Sellrain-Silz). Sellrain-Silz is a pumped storage, hydroelectric generating

facility. The water powering the facility comes from an area covering 139 square

kilometers in the northern Stubai Alps. Sellrain-Silz is an important component in

TIWAG's power supply. According to the most recent public data, in 2008

Sellrain-Silz produced 21% of TIWAG's total power generation and 4% of

TIWAG's total power sold.

Deloitte appraised the 21.6% undivided interest in Sallrain-Silz as of the

closing date of the TIWAG transaction at a fair market value of $323,136,000,

with a remaining economic useful life of 75 years. This appraised fair market

value served as the basis for determining John Hancock's investment in the

transaction, and the parties did not further negotiate the investment amount.

Further, Deloitte estimated that as of the end of the sublease and service contract

terms the fair market value of the 21.6% undivided interest in Sellrain-Silz would

- 47 be $648,210,816 and $778,757,760, respectively. Deloitte used the discounted

cashflow method in its fair market value determinations.

Terms

On the closing date John Hancock leased the 21.6% undivided interest in

Sellrain-Silz from TIWAG for a term of approximately 94 years. Simultaneously,

John Hancock subleased the 21.6% undivided interest in Sellrain-Silz to TIWAG

for a term of approximately 35 years. Because the term of the initial lease

exceeded its estimated remaining economic useful life, the parties treated it as a

sale for U.S. tax purposes. TIWAG has the option of purchasing John Hancock's

leasehold interest in Sellrain-Silz at the end of the sublease term.

Rent and Financing

Initial Lease

On the closing date John Hancock paid TIWAG $323 million pursuant to

the initial lease. To fund this payment, John Hancock contributed $49,427,050 in

equity and borrowed a total of $273,572,950 from two lenders on a nonrecourse

basis: $246,215,655 from Mercantile Leasing Co. (Mercantile) (series A loan) and

$27,357,295 from Bank Fur Tiroler Und Vorarlberg (BTV) (series B loan). John

Hancock paid $4,037,500 of transaction expenses.

- 48 b.

Sublease and Defeasance

Pursuant to the sublease, TIWAG agreed to pay rent to John Hancock. The

sublease required many of these payments to be made before the period to which

they were allocated. The prepayment of rent is treated as a loan from TIWAG to

John Hancock under section 467. At the end of the sublease term the section 467

loan balance is expected to be $636,037,102. In order to fund the sublease rent

payments, TIWAG entered into a number of defeasance agreements.

Unlike John Hancock's LILO transactions, the SILO transactions do not

require full defeasance. Rather, the transaction documents only require the

proceeds of the series A loan to be set aside pursuant to a DPUA. In the TIWAG

transaction, pursuant to the series A DPUA, TIWAG paid $246,215,655 to

Barclays Bank PLC (Barclays) on the closing date. In return, Barclays agreed to

make a series of payments on behalf of TIWAG which exactly match John

Hancock's debt service payments to Mercantile under the series A loan. As a

result, the transaction documents allow for payments directly from Barclays to the

series A lender, Mercantile, to satisfy John Hancock's series A debt service and a

portion of TIWAG's sublease rent. The series A DPUA is a three-party agreement

that includes John Hancock, providing John Hancock with a priority interest in the

deposit in the event TIWAG defaults on its sublease rent obligations.

- 49 Barclays is an affiliate of the series A lender, Mercantile. However,

Mercantile did not guarantee Barclay's payments under the series A DPUA.

TIWAG remains legally responsible for all rent and other obligations under the

sublease. In certain circumstances TIWAG may replace the series A DPUA with

substitute collateral, including a qualified letter of credit.

In addition to the series A DPUA, TIWAG entered into a series B DPUA

and an EPUA on the closing date. TIWAG's series B DPUA and EPUA were

arranged and agreed upon outside of the SILO transaction. The documents

governing the TIWAG transaction do not require these agreements. John Hancock

is not a party to either agreement, and neither is pledged to John Hancock.

Pursuant to the series B DPUA, TIWAG deposited $29,585,454 with Dexia

Credit Local (Dexia). In return Dexia agreed to make a series of payments on

behalf of TIWAG which exactly match John Hancock's debt service payments to

BTV under the series B loan. The payments from the series A DPUA and the

series B DPUA exactly satisfy TIWAG's debt portion of sublease rent." Dexia is

not an affiliate of BTV, the series B lender.

"Throughout the sublease term, TIWAG's sublease rent payments exceed

John Hancock's debt service payments by approximately $10 million. This $10

million is known as the "equity portion" of sublease rent.

- 50 Pursuant to the EPUA, TIWAG deposited $23.1 million with UBS AG

(UBS). In return UBS agreed to make a series of payments on behalf of TIWAG

pursuant to a specified schedule covering the equity portion of sublease rent and

funding a portion of TIWAG's purchase option if exercised. TIWAG's net present

value benefit in the transaction is approximately $24.1 million, equaling the

difference between John Hancock's investment in the initial leases, $323 million,

and the amounts paid to Barclays, Dexia, and UBS pursuant to the series A DPUA,

series B DPUA, and EPUA.

Although the series B DPUA and the EPUA were not required pursuant to

the TIWAG transaction documents, John Hancock knew of TIWAG's intention to

enter into such agreements because the defeasance agreements allowed TIWAG to

receive beneficial accounting treatment under European accounting principles

(European GAAP). Even if TIWAG decided not to enter into a series B DPUA

and EPUA on the closing date, the transaction documents required such

agreements or other similar qualifying collateral upon the occurrence of certain

trigger events such as a credit downgrade or majority ownership change in

TIWAG. As a precaution John Hancock preapproved a "form" of the series B

DPUA and the EPUA as well as Dexia and UBS as qualified payment undertakers.

- 51 The "form" series B DPUA and EPUA are identical to TIWAG's actual

agreements absent the information specific to the timing and participating parties.

Property Rights and Obligations

The initial lease grants John Hancock the right to use, operate, maintain or

possess the 21.6% undivided interest in Sellrain-Silz. During the initial lease term

TIWAG cannot sell, dispose of, or create a security interest in the property without

John Hancock's consent. The initial lease also restricts TIWAG's rights to

consolidate or merge with another company or spin off, convey, transfer, or lease

substantially all of its assets to another party.

TIWAG's rights and obligations under the sublease with respect to

possession and use of the 21.6% undivided interest in Sellrain-Silz are nearly

identical to John Hancock's rights and obligations under the initial lease. The

sublease is a net lease, meaning that TIWAG is responsible for maintenance,

insurance, and operational costs. During the sublease term TIWAG generally

cannot create or permit any lien on the 21.6% undivided interest in Sellrain-Silz.

John Hancock has the right to visit and inspect Sellrain-Silz twice a year.

On the closing date John Hancock and TIWAG also entered into an

"Agreement of Servitude" pursuant to which TIWAG granted John Hancock a

right-of-way to specified land parcels at Sellrain-Silz (ROW agreement). The

- 52 ROW agreement provides John Hancock access to the road that leads from the

public.road to the upper dam of Sellrain-Silz. This right-of-way was registered

with the land registry at the district court in Silz, Austria. Upon the occurrence of

a "Trigger Event", John Hancock has the right to purchase certain parcels of land

related to Sellrain-Silz. A trigger event includes, among other things, TIWAG's

selling or imposing a mortgage or pledge on specified land connected with

Sellrain-Silz.

Default

Neither John Hancock nor TIWAG has the right to declare the initial lease

in default and pursue remedies. However, under the sublease, John Hancock has

certain remedies against TIWAG in the case of a "Lessee Event of Default". In

such a case, John Hancock is entitled to collect on the "Termination Value" of the

sublease. John Hancock may also take possession of, sell, or sublease the 21.6%

undivided interest in Sellrain-Silz. . Just as in John Hancock's LILO transactions,

termination value is predetermined on the closing date and ensures John

Hancock's return on its equity investment. TIWAG must also pay John Hancock

the termination value in the case of a "Lease Event of Loss", which includes actual

loss or seizure of Sellrain-Silz.

- 53 B.

End of Sublease Term

TIWAG's Purchase Option

At the end of the sublease term TIWAG has the option of purchasing John

Hancock's leasehold interest in Sellrain-Silz for $795,135,940. If TIWAG

exercises the purchase option, John Hancock must pay TIWAG the amount due

under the section 467 loan, and all agreements executed pursuant to the TIWAG

transaction would terminate. The section 467 loan balance exactly matches the

first installment of the purchase option. Therefore, if TIWAG exercises its

purchase option, these amounts offset each other. The remaining installments of

the purchase option price are f'manced through TIWAG's EPUA, meaning that if

TIWAG exercises the purchase option, it does not have to contribute or borrow

any additional cash.

John Hancock's Options

If TIWAG does not exercise its purchase option, John Hancock has two

choices. First, it may elect to require TIWAG to arrange for a service contract

between John Hancock and one or more power purchasers. Second, it may elect to

take possession of the 21.6% undivided interest in Sellrain-Silz. In either case,

TIWAG must ensure at its own expense that Sellrain-Silz is in satisfactory

condition in accordance with all regulatory and other requirements.

- 54 Similar to the LILO test transactions, neither party has advanced a

compelling reason John Hancock would select the retention option in any of the

SILO test transactions. Therefore, as the parties have, we focus our discussion for

each SILO test transaction on the service contract option.

Under the service contract option, TIWAG must procure one or more

"Qualified Bidders" to enter into one or more power purchase agreements with

John Hancock and arrange for an operator of the 21.6% undivided interest in

Sellrain-Silz during the service contract term. TIWAG must also find a bank to

refinance the section 467 loan. A qualified bidder cannot be the operator or be

related to the operator of Sellrain-Silz. TIWAG may be the power purchaser or

the operator but not both. The power purchase agreements must match the service

contract term which is prearranged on the closing date to be approximately 25

years.

Any power purchaser must agree to make a series of predetennined

payments throughout this term, known as the "Capacity Charges". These

payments total $1,316,013,696. A power purchaser is also required to pay for

John Hancock's fixed and variable cost of operating the 21.6% undivided interest

in Sellrain-Silz. The capacity charges are set at amounts that reflect the future fair

market value of the asset and cover John Hancock's cost of servicing the

- 55 refinanced section 467 loan while paying John Hancock a specified return. If John

Hancock fails to make the required capacity available to the service purchaser for

any reason, including force majeure, the capacity charges will be reduced in a

manner consistent with the service contract. The power purchase agreements do

not require credit support to secure the power purchaser's payments during the

service contract term. However, if at any point during the service contract term a

power purchaser's credit rating were to fall below A or A2 under S&P's and

Moody's credit rating systems, respectively, that power purchaser would be

required to procure credit support in the form of a letter of credit or guaranty from

a bank or guarantor with the requisite credit rating.

John Hancock may also request that TIWAG acquire residual value

insurance to protect a portion of the value of the 21.6% undivided interest in

Sellrain-Silz at the end of the service contract term. The amount of the residual

value insurance is the lesser of: (1) $205,422,256 or (2) 35% of the appraised fair

market value of the 21.6% undivided interest in Sellrain-Silz at the end of the

service contract term as determined at or near the purchase option date. From the

end of the service contract term to the end of the initial lease John Hancock would

take possession of the 21.6% undivided interest in Sellrain-Silz to use as it

pleases.

- 56 If TIWAG fails to find qualified bidders to enter into the power purchase

agreements or fails to procure a bank to refinance the section 467 loan, it may cure

this failure through the exercise of its purchase option. If TIWAG is able to

satisfy all the required conditions and a power purchase agreement is in place, it

will receive the proceeds of the section 467 loan from John Hancock as well as the

balance of the EPUA.

II.

Two Dortmund Transactions

Lease and Sublease

The Asset

The Dortmund transactions closed on December 20, 2001. The assets

subject to the Dortmund transactions are halls 1, 2, 3A, and 4-8 of the

Westfalenhallen Dortmund Trade Fair, Event, and Congress Center Complex

(trade fair facility). Dortmund is in the State of North Rhine-Westphalia,

Germany. Westfalenhallen Dortmund GmbH (Westfalenhallen), a German limited

liability company, operates the trade fair facility through its subsidiaries, and

Dortmund is the sole owner of Westfalenhallen. The trade fair facility presents

more than 30 national and international trade fairs each year. In 2000, the year

before John Hancock entered into the Dortmund transactions, more than 7,000

exhibitors and more than 1 million visitors came to Dortmund for events hosted in

- 57 the trade fair facility. In 2004 Dortmund constructed hall 3B as an addition to the

trade fair facility, which is not and was never made part of the Dortmund

transactions. John Hancock and Dortmund executed servitude consent agreements

so that the new hall would not adversely affect John Hancock's interest in the

trade fair facility.

Deloitte appraised the trade fair facility. As of the closing date of the

Dortmund transactions, the appraisalsl6 concluded that the halls subject to the

transactions had the following fair market values and remaining economic useful

lives:

Hall

Fair market value

Remaining useful

life in years

$31,661,000

10,295,000

4,588,000

23,249,000

13,910,000

22,330,000

17,835,000

15,160,000

The appraisals were used to determine John Hancock's investment in the

transactions, and the parties did not further negotiate the investment amounts.

16Deloitte issued one appraisal for halls 1, 2, and 3A of the trade fair facility

and a second appraisal for halls 4-8.

- 58 According to the appraisals, as of the purchase option date the expected fair

market value of the trade fair facility was determined to be $242,882,556. The

methodology used in the appraisals attributed 80% of the fair market value

determinations to the discounted cashflow method and 20% to the cost method.

Terms

On the closing date John Hancock leased the trade fair facility from

Dortmund for a term of 99 years. Simultaneously, John Hancock subleased the

trade fair facility to Dortmund for a term of approximately 30 years. This

arrangement required multiple agreements to incorporate the entire trade fair

facility. In each transaction, an initial lease and sublease govern the parties' rights

and obligations with respect to the halls. With respect to the facility sites

associated with each hall, the parties entered into a "Facility Site Lease

Agreement" for each transaction. Unless otherwise stated, there are no material

rights and obligations conferred, pursuant to each facility site lease, that

distinguish the Dortmund transactions from John Hancock's other SILO test

transactions for purposes of this Opinion. Dortmund has the option of purchasing

John Hancock's leasehold interests in the trade fair facility at the end of the

sublease term.

- 59 3.

Rent and Financing

Initial Lease

On the closing date of the Dortmund transactions John Hancock made

payments to Dortmund of $46,544,000 and $92,484,000 pursuant to the initial

lease agreements and facility lease agreements of the Dortmund 1 and Dortmund 2

transactions, respectively. To fund these payments, John Hancock contributed

$7,379,928 for the Dortmund 1 transaction and $14,652,452 for the Dortmund 2

transaction. John Hancock also borrowed approximately 90% of the debt from

Mercantile, equal to $35,247,665 and $70,048,393 for the respective transactions

(series A loans). The remaining 10% was borrowed from Westdeutsche

Landesbank Girozentrale (series B loans). John Hancock also paid transaction

expenses of $1,373,048 and $2,728,730 as part of the Dortmund 1 and Dortmund

2 transactions, respectively.

Sublease and Defeasance

Pursuant to the sublease agreements, Dortmund agreed to pay rent to John

Hancock. As in the TIWAG transaction, the sublease agreements require that

many of these payments be made before the period to which they are allocated,

resulting in section 467 loans to John Hancock in each transaction. On the

purchase option date, the total balance of the section 467 loans is expected to be

- 60 approximately $221,835,000. In order to fund the sublease rent payments

Dortmund entered into a number of defeasance agreements.

On the closing date Dortmund entered into a series A DPUA with Barclays

for each of the Dortmund transactions. The series A DPUAs are substantialvly

similar to the series A DPUA in the TIWAG transaction. With respect to the

series B loan and equity, just as in the TIWAG transaction, the Dortmund

transactions do not require Dortmund to enter into a series B DPUA or an EPUA.

John Hancock is not a party to a series B DPUA or EPUA, and John Hancock is

not the beneficiary of a pledge of a series B DPUA or EPUA. Nonetheless,

Dortmund defeased the series B loans and equity in agreements executed outside

of the Dortmund transactions. Dortmund's net present value benefit in each

transaction is equal to its up-front payments under the initial leases less the

amount that was deposited pursuant to the series A DPUAs, series B DPUAs, and

EPUAs.

Dortmund entered into a series B DPUA with Hypo-und Vereinsbank AG

for each of the Dortmund transactions. Dortmund also entered into numerous

EPUAs with Bank Austria. As in the TIWAG transaction, the series B DPUAs

and EPUAs entitle Dortmund to beneficial accounting treatment under European

GAAP. John Hancock knew that Dortmund intended on entering into such

- 61 agreements because John Hancock preapproved a "form" of the EPUAs as well as

Bank Austria as the EPUA undertaker. The EPUAs were required under the

participation agreement upon the occurrence of certain trigger events. There are

no trigger events that would require Dortmund to enter into the series B DPUAs.

Nonetheless, John Hancock approved a "form" for the series B DPUAs.

Property and Default Rights and Obligations

John Hancock and Dortmund's property and default rights and obligations,

pursuant to the Dortmund transactions' initial leases, facility site leases, and

sublease agreements, are substantially similar to those conferred under the initial

lease and sublease in the TIWAG transaction.

End of Sublease Term

Dortmund has a purchase option at the end of each transaction's sublease

term which is designed in a manner consistent with the TIWAG transaction. If

Dortmund does not exercise its purchase options, John Hancock must choose

between requiring Dortmund to arrange for a service contract or take possession of

the trade fair facility itself.

Under the service contract option Dortmund must procure one or more

service purchasers for the trade fair facility. The service purchasers must agree to

pay service fees that consist of: (1) the annual capacity availability charges that

- 62 -

are designed to cover John Hancock's debt service on the refinanced section 467

loan and ensure a predetermined economic return on its investment and (2) the

trade fair facility operating and maintenance expenses. Dortmund may remain the

operator of the trade fair facility or must find a qualified replacement operator.

Unlike the TIWAG transaction, Dortmund may be both the service purchaser and

the operator.

If John Hancock fails to make the trade fair capacity and management

services available to the service purchasers for any reason, including force

majeure, the capacity availability charges will be reduced in a manner consistent

with the service contract. The service contract does not require credit support to

secure a service purchaser's payments during the service contract term. However, .

if at any point during the service contract term a service purchaser's credit rating

were to fall below BBB+ or Baal under S&P's and Moody's credit rating systems,

respectively, the service purchaser is required to procure acceptable credit support.

In all other ways, the design, structure, and economics of John Hancock's service

contract options and retention options in the Dortmund transactions are

substantially similar to those of the TIWAG transaction.

- 63 III.

SNCB SILO

Grant and Subgrant

The Asset

The SNCB SILO closed on November 14, 2001. The asset subject to the

SNCB SILO is a 50% undivided interest in the high-speed rail line that runs from

the Belgian-French border to Lembeek, Belgium, and the railway station known as

"Brussels South" that is dedicated to that high-speed line (together the HSL). The

HSL is integrated with the main east-west rail line in Belgium. SNCB considers

the HSL to be its "crown jewel" as it enables high-speed rail services between the

United Kingdom, France, the Netherlands, and Germany.

Deloitte appraised the HSL and concluded that as of the closing date, a 50%

undivided interest in the HSL had a fair market value of $426,900,500 and a

remaining economic useful life of 78 years. This value served as the basis for

determining John Hancock's investment in the SNCB SILO, and the parties did

not further negotiate the investment amount. Deloitte further appraised the 50%

undivided interest in HSL as of the purchase option date at $890,941,344. The

appraisal used the discounted cashflow method in its fair market value

determinations.

-642.

Terms

On the closing date John Hancock entered into a grant of rights agreement

with SNCB with respect to the 50% undivided interest in HSL for a term of

approximately 99 years (grant). Simultaneously, John Hancock and SNCB entered

into a subgrant of rights agreement for a term of approximately 29 years (subgrant)

whereby John Hancock granted a set of nearly identical rights in the 50%

undivided interest in HSL back to SNCB.4 SNCB has the option of purchasing

John Hancock's interest in the HSL at the end of the subgrant term.

Rent and Financing

Grant

On the closing date John Hancock paid $426,900,500 to SNCB pursuant to

the grant. To fund this payment John Hancock contributed $61,177,535 in equity

and borrowed a total of $365,722,965 from two lenders on a nonrecourse basis,

$329,150,668 from Mercantile (series A loan) and $36,572,297 from Barclays

(series B loan). John Hancock also paid $3,799,414 of transaction expenses.

"For purposes of this analysis, there are no material differences between the

function of the grant of rights and the subgrant used in the SNCB SILO and the

leases and subleases used in John Hancock's other SILO test transactions.

- 65 b.

Subgrant and Defeasance

Pursuant to the subgrant SNCB agreed to make subgrant rent payments to

John Hancock in the amounts and on the dates specified in the sublease agreement.

The sublease requires that many of these payments be made before the period to

which they are allocated. As in John Hancock's other SILO test transactions, this

prepayment creates a section 467 loan. At the end of the sublease term the section

467 loan balance is expected to be $780,056,766. In order to fund the subgrant

rent payments SNCB entered into a number of defeasance agreements.

On the closing date, SNCB entered into a series A DPUA with Barclays.

The series A DPUA is substantially similar to those in John Hancock's other SILO

test transactions. Also as in John Hancock's other SILO test transactions, the

SNCB SILO transaction does not require SNCB to enter into a series B DPUA or

an EPUA. John Hancock is not a party to a series B DPUA or an EPUA, and John

Hancock is not the beneficiary of a pledge of a series B DPUA or EPUA.

On November 19, 2001, SNCB entered into a currency swap transaction

(CST) with Bank of America, NA (BofA). Pursuant to the currency swap

transaction, SNCB agreed to pay BofA U.S.-dollar-denominated payments on

certain specified dates in exchange for euro-denominated payments. The

payments made to SNCB under the currency swap transaction match the debt

- 66 service payments on the series B loan. Unlike the currency swap transactions in

the SNCB LILO transactions, SNCB did not prepay this currency swap.

Also on November 19, 2001, SNCB entered into a USD Credit Linked

Deposit Agreement with UBS (CLDA). Similar to the EPUAs in John Hancock's

other SILO test transactions, SNCB placed a deposit with UBS in exchange for a

series of payments exactly matching the timing and amount of the equity subgrant

payments and the purchase option price. SNCB may not freely terminate the

CLDA.18 However, the CLDA permits SNCB to direct the payments due from

UBS to the recipient of its choosing. As in John Hancock's other SILO test

transactions, the CLDA entitled SNCB to beneficial accounting treatment under

European GAAP, and John Hancock knew that SNCB intended on executing such

an agreement. SNCB calculated its net present value benefit from the transaction

as the difference between the $426,900,500 received from John Hancock pursuant

to the grant and the amounts paid upon the execution of the series A DPUA, the

CLDA, and the CST.

'8Petitioners argue that SNCB may terminate the CLDA at any time to free

up cash for its general business purposes. To support this argument, petitioners

rely solely on the testimony of an SNCB executive. This testimony is not

consistent with the terms of the CLDA.

- 67 4.

Property and Default Rights and Obligations

For purposes of this analysis the property and default rights and obligations

of John Hancock and SNCB, with respect to the grant and subgrant, are

substantially similar to those conferred under the initial leases and subleases in

John Hancock's other SILO test transactions. The primary difference in the SNCB

. SILO transaction is that HSL is part of the Belgian public domain. Consequently,

the parties included provisions in the transaction documents providing that if HSL

ceases to be an asset in the public domain, the parties intend for all of the

transaction documents to survive and the rights and obligations of the parties to

constitute an independent contractual relationship.

End of Subgrant Term

SNCB has a purchase option at the end of the subgrant term under

substantially the same terms and conditions as in John Hancock's other SILO test

transactions. Further, as in those transactions, if SNCB does not exercise its

purchase option, John Hancock must choose between requiring SNCB to arrange

for a service contract or taking possession of the 50% undivided interest in HSL.

Under the service contract option SNCB must procure a "Service

Purchaser" under the service contract, which cannot be SNCB, and arrange for the

section 467 loan to be refinanced. John Hancock must find an operator for the

- 68 50% undivided interest in HSL; but if it cannot find a suitable operator, SNCB is

required to assume the position. Under the service contract the service purchaser

must agree to pay John Hancock: (1) the base service fees, which are designed to

cover John Hancock's debt service on the refinanced section 467 loan and ensure a

predetermined economic return on its investment and (2) the monthly additional

fees that cover the fixed and variable costs of operating the 50% undivided interest

in HSL.

The service purchaser has the right to terminate the service contract if John

Hancock fails to make the asset available for the negotiated services for any

reason, except for force majeure, and fails to cure within 60 days of notification.

In the case of force majeure, the service purchaser may terminate the service

contract if John Hancock fails to cure within 180 days. In all other ways, the

design, structure, and economics of John Hancock's service contract option and

retention option are substantially similar to those of John Hancock's other SILO

test transactions.

Tax Returns, Notices of Deficiency, and Trial

Procedural History

John Hancock filed a consolidated Federal income tax return for each of the

years at issue.

- 69 A.

Notice of Deficiency (Docket No. 6404-09)

On December 17, 2008, respondent issued a notice of deficiency to John

Hancock which determined Federal income tax deficiencies for 1994, 1997, and

1998 of $8,860,564, $65,746,621, and $173,497,367, respectively, based upon the

disallowance of various deductions and adjustments to gross income from John

Hancock's LILO transactions and the denial of a capital loss carry back to 1994.

On March 16, 2009, John Hancock filed the petition with this Court at docket No.

6404-09, disputing the 1994, 1997, and 1998 determined deficiencies.

The notice of deficiency for docket No. 6404-09 included three of the test

transactions litigated in these cases, the OBB LILO and the two SNCB LILOs.1°

With respect to the OBB LILO, respondent determined that the LILO transaction

was in substance the purchase of a future interest by John Hancock and therefore

denied John Hancock's deductions of $66,899,067 for a rental expense,

$15,946,722 for an interest expense, and $298,054 for amortized transaction costs

for 1998. Additionally, respondent reduced John Hancock's taxable rental income

by $19,169,206 for 1998. Alternatively, respondent determined that in substance

the OBB LILO transaction was a financing arrangement and therefore increased

John Hancock's taxable income by $1,040,159 for OID income for 1998. Under

19The nOtiCe Of defiCiency Combined the two SNCB LILO transactions.

- 70 this alternative argument, respondent concedes John Hancock's deduction for

amortized transaction costs.

With respect to the two SNCB LILOs, respondent determined that the LILO

transactions were in substance purchases of future interests by John Hancock and

therefore denied John Hancock's deductions of $6,849,494 and $39,408,434 for

rental expenses, $1,737,691 and $10,030,464 for interest expenses, and $23,787

and $127,220 for amortized transaction costs for 1997 and 1998, respectively.

Additionally, respondent reduced John Hancock's taxable rental income by

$2,265,498 and $13,298,535 for 1997 and 1998, respectively. Alternatively,

respondent determined that in substance the two SNCB LILO transactions were a

financing arrangement and therefore increased John Hancock's taxable income by

$229,736 and $1,929,488 for OID income for 1997 and 1998, respectively. Under

this alternative argument, respondent concedes John Hancock's deduction for

amortized transaction costs.20

Notice of Deficiency (Docket No. 7084-10)

On December 24, 2009, respondent issued a notice of deficiency to John

Hancock which determined a Federal income tax deficiency for 1999 of

20Respondent made similar determinations and denied similar deductions for

the six other LILO transactions listed in the notice of deficiency.

- 71 $59,899,141 based upon the disallowance of various deductions and adjustments

to gross income from John Hancock's LILO transactions. On March 23, 2010,

John Hancock filed the petition with this Court at docket No. 7084-10, disputing

the 1999 determined deficiency.

The notice of deficiency for docket No. 7084-10 included three of the test

transactions litigated in these cases, the OBB LILO and the two SNCB LILOs."

With respect to the OBB LILO, respondent determined that the LILO transaction

was in substance the purchase of a future interest by John Hancock and therefore

denied John Hancock's deductions of $124,785,824 for a rental expense,

$29,516,300 for an interest expense, and $555,956 for amortized transaction costs

for 1999. Additionally, respondent reduced John Hancock's taxable rental income

by $35,739,244 for 1999. Alternatively, respondent determined that in substance

the OBB LILO transaction was a financing arrangement and therefore increased

John Hancock's taxable income by $4,746,135 for OID for 1999. Under this

alternative argument, respondent concedes John Hancock's deduction for

amortized transaction costs.

With respect to the two SNCB LILO transactions, respondent determined

that the LILO transactions were in substance the purchase of a future interest by

The notice of deficiency combined the two SNCB LILO transactions.

- 72 John Hancock and therefore denied John Hancock's deductions of $39,408,436 for

a rental expense, $9,787,937 for an interest expense, and $127,220 for amortized

transaction costs for 1999. Additionally, respondent reduced John Hancock's

taxable rental income by $13,298,535 for 1999. Alternatively, respondent

determined that in substance the two SNCB LILO transactions were financing

arrangements and therefore increased John Hancock's taxable income by

$2,055,293 for OID income for 1999. Under this alternative argument, respondent

concedes John Hancock's deductions for amortized transaction costs.22

Notice of Deficiency (Docket No. 7083-10)

On December 24, 2009, respondent issued a notice of deficiency to John

Hancock which determined Federal income tax deficiencies for 2000 and 2001 of

$108,046,947 and $143,516,079, respectively, based upon the disallowance of

various deductions and adjustments to gross income from John Hancock's LILO

and SILO transactions and the denial of worthless stock losses for 2000.23 On

March 23, 2010, John Hancock filed the petition with this Court at docket No.

7083-10, disputing the 2000 and 2001 determined deficiencies.

22Respondent made similar determinations and denied similar deductions for

the six other LILO transactions listed in the notice of deficiency.

23The parties filed a stipulation of settled issues with the Court on June 7,

2011, resolving the worthless stock loss issue for 2000.

- 73 The notice of deficiency for the case at docket No. 7083-10 included all

seven of the test transactions litigated in these cases, the OBB LILO, the two

SNCB LILOs," the TIWAG SILO, the two Dortmund SILOs," and the SNCB

SILO. With respect to the OBB LILO, respondent determined that the LILO

transaction was in substance the purchase of a future interest by John Hancock and

therefore denied John Hancock's deductions of $124,785,824 and $124,785,724

for rental expenses, $29,073,071 and $28,598,273 for interest expenses, and

$555,956 and $555,956 for amortized transaction costs for 2000 and 2001,

respectively. Additionally, respondent reduced John Hancock's taxable rental

income by $35,739,244 and $35,739,244 for 2000 and 2001, respectively.

Alternatively, respondent determined that in substance the OBB LILO transaction

was a financing arrangement and therefore increased John Hancock's taxable

income by $4,044,640 and $5,361,948 for OID income for 2000 and 2001,

respectively. Under this alternative argument, respondent concedes John

Hancock's deduction for amortized transaction costs.

With respect to the two SNCB LILO transactions, respondent determined

that the LILO transactions were in substance purchases of future interests by John

"The notice of deficiency combined the two SNCB LILO transactions.

"The notice of deficiency combined the two Dortmund SILO transactions.

- 74 Hancock and therefore denied John Hancock's deductions of $39,408,436 and

$38,940,891 for rental expenses, $9,527,327 and $9,068,703 for interest

expenses, and $127,220 and $127,220 for amortized transaction costs for 2000 and

2001, respectively. Additionally, respondent reduced John Hancock's taxable

rental income by $13,298,535 and $13,297,807 for 2000 and 2001, respectively.

Alternatively, respondent determined that in substance the two SNCB LILO

transactions were a financing arrangement and therefore increased John Hancock's

taxable income by $2,189,343 and $2,332,181 for OID income for 2000 and 2001,

respectively. Urider this alternative argument, respondent concedes John

Hancock's deductions for amortized transaction costs.

With respect to the TIWAG SILO, respondent determined that John

Hancock had not acquired the benefits and burdens of ownership of the property

subject to the SILO transaction and therefore denied John Hancock's deductions

of $807,500 for a depreciatiön expense, $535,234 for an interest expense, and

$2,802 for amortized transaction costs for 2001. Additionally, respondent

determined that in substance the John Hancock made a loan to TIWAG and failed

to report interest income on that loan. Therefore, respondent increased John

Hancock's taxable income by $78,302 for OID income for 2001.

- 75 With respect to the two Dortmund SILO transactions, respondent

determined that John Hancock had not acquired the benefits and burdens of

ownership of the property subject to the SILO transactions and therefore denied

John Hancock's deductions of $115,170 for depreciation expenses, $240,614 for

interest expenses, and $21,259 for amortized transaction costs for 2001.

Additionally, respondent determined that in substance John Hancock made a loan

to Dortmund and failed to report interest income on that loan. Therefore,

respondent increased John Hancock's taxable income by $24,985 for OID income

for 2001.

With respect to the SNCB SILO, respondent determined that John Hancock

had not acquired the benefits and burdens of ownership of the property subject to

the SILO transaction and therefore denied John Hancock's deductions of

$5,032,552 for a depreciation expense, $2,594,278 for an interest expense, and

$15,898 for amortized transaction costs for 2001. Additionally, respondent

determined that in substance the John Hancock made a loan to SNCB and failed to

report interest income on that loan. Therefore, respondent increased John

Hancock's taxable income by $627,439 for OID income for 2001.26

26Respondent made similar determinations and denied similar deductions for

the six other LILO transactions and one other SILO transaction listed in the notice

(continued...)

- 76 D.

Pretrial Motions

Respondent failed to timely raise the economic substance theory in the

pleadings, instead raising the issue for the first time in his pretrial memorandum,

dated September 16, 2011. Petitioners filed a motion in limine for exclusion of

respondent's argument based on the economic substance theory on September 23,

2011, and respondent filed an objection to petitioners' motion on October 6, 2011.

On October 11, 2011, the parties presented oral arguments to the Court with

respect to petitioners' motion. By order of the Court dated October 12, 2011, we

denied petitioners' motion in limine for exclusion of the economic substance

theory but placed the burden of proof with respect to the economic substance

theory on respondent.

II.

Trial

The Court held a five-week special trial session in Boston, Massachusetts.

The record in these cases includes the testimony of 53 witnesses, over 3,600

exhibits, over 4,000 pages of trial transcripts, and over 1,000 pages of briefing.

Both parties rely heavily on expert opinions to support their arguments. The

parties' expert witnesses, their qualifications, and their Court-recognized

26(...continued)

of deficiency.

- 77 expertises are listed below. We evaluate expert opinions in the light of all of the

evidence in the record, and we are not bound by the opinion of any expert witness.

Helvering v. Nat'l Grocery Co., 304 U.S. 282, 295 (1938); Shepherd v.

Commissioner, 115 T.C. 376 (2000), aff'd, 283 F.3d 1258 (1 lth Cir. 2002). We

may reject, in whole or in part, any expert opinion. Estate of Davis v.

Commissioner, 110 T.C. 530, 538 (1998).

Petitioners' Expert Witnesses (Alphabetical Order)

Mr. John Dolan

The Court recognized Mr. Dolan as an expert in the field of European

railways and railway assets. .Mr. Dolan is a chartered civil engineer, a member of

the Institution of Civil Engineers, and a holder of the title European engineer. He

is also a chartered member of the Institute of Logistics and Transport. Mr. Dolan

has worked in the European railway industry since 1972 and currently works as a

consultant for InterFleet Technology Ltd. where he advises on a range of railway

safety, infrastructure, and operational issues. He previously worked in advisory

roles for Haliburton, Her Majesty's Railway Inspectorate, and British Rail.

Dr. Paul Doralt

The Court recognized Dr. Doralt as an expert in the field of Austrian tax

law. Dr. Doralt is admitted to the Austrian Chamber of Accountants as a certified

- 78 tax adviser and to the Austrian bar as an attorney. He is currently a partner at

Dorda Brugger Jordis GmbH, with his practice focus in tax law. Mr. Doralt is a

board member of the International Tax Committee of the International Bar

Association.

Mr. Hans Haider

The Court recognized Mr. Haider as an expert in the field of Austrian and

European electricity. Mr. Haider is currently the managing partner of Hans Haider

Consulting. He has over 40 years of experience, having served as a member of the

management board of Siemens AG Austria and chairman of the management

board and CEO of Verbund AG, Austria's largest utility. He has previously

served as president of the Austrian National Committee to the World Energy

Counsel and president of the European Union of the Electricity Industry. Mr.

Haider is currently a member of Ernst & Young's Energy Advisory Board.

Dr. Friedrich Hey

The Court recognized Dr. Hey as an expert in the field of German tax law.

Dr. Hey received a doctorate in law from the University of Hamburg/Germany and

is admitted as a certified tax adviser and a German attorney. He is currently a

partner at Debevoise & Plimpton LLP (Debevoise & Plimpton) and the chair of

the German American Lawyers Association. Dr. Hey's work has been published

- 79 numerous times, and he has been recognized as a leading German tax expert by

publications such as Chambers, Legal 500 EMEA, PLC Which Lawyer?, and

Who's Who-Legal.

Dr. Friedrich Popp

The Court recognized Dr. Popp as an expert in the field of Austrian

corporate law and creditor rights law. Dr. Popp received a doctorate in law from

the University of Vienna/Austria with a thesis in civil law. He is currently an

associate at Debevoise & Plimpton. Dr. Popp has published numerous articles in

various journals and is a frequent contributor to the Austrian Journal of Banking

and Financial Research.

Dr. Thomas Schurrle

The Court recognized Dr. Schurrle as an expert in the field of German

administrative and public law. Mr. Schurrle received a doctorate in law from the

University of Heidelberg. He is currently the managing partner of the Frankfurt

office of Debevoise & Plimpton. His experience has focused on advising

municipalities and companies on the financial, economic, and regulatory aspects

of cross-border leasing. Mr. Schurrle teaches a law class at the Institute of Law

and Finance at the Johann-Wolfgang-Goethe-University in Frankfurt.

- 80 7.

Dr. Norbert Stoeck

The Court recognized Dr. Stoeck as an expert in the field of trade fair

industry including the ownership and operation of trade fairs in Germany. Dr.

Stoeck received a Ph.D. in marketing from the University of Rostock. Since 1983

he has worked at Roland Berger Strategy Consultants and currently serves as the

head of the "International Trade Shows, Tourism and Mega-Events" practice

group. In this role Dr. Stoeck has managed over 100 trade fair projects

internationally and advised on countless others including trade fairs in German

municipalities. He has written numerous books and articles discussing the

management of trade fairs, trade fair strategies, and all other aspects of the trade

fair industry.

Dr. Frederik Vandendriessche

The Court recognized Dr. Vandendriessche as an expert in the field of

Belgian administrative and public law. Dr. Vandendriessche received a doctorate

in law at the University of Ghent with a focus in public and private legal entities.

He is currently a partner in the Brussels office of Stibbe where he focuses his

practice in administrative law. Dr. Vandendriessche is a professor of public law at

the University of Ghent and the University of Antwerp. He has written a wide

- 81 range of articles about public law that have been published in Belgian journals and

magazmes.

Respondent's Expert Witnesses (Alphabetical Order)

Dr. Ignaas Behaeghe

The Court recognized Dr. Behaeghe as an expert in Belgian law. Dr.

Behaeghe received a doctorate in law and economic sciences from the University

of Antwerp and a master's in tax law from the Fiscale Hogeschool in Brussels. He

is currently an equity partner at Eversheds Brussels.

Dr. Stefan Diemer

The Court recognized Dr. Diemer as an expert in the field of German tax

law. Dr. Diemer received his doctorate in law from the University of Regensburg.

He is currently a partner at Heisse Kursawe Eversheds and practices in the area of

corporate and tax law. Dr. Diemer is a certified tax lawyer and is a member of the

International Transaction Support Team of Eversheds, a unit specializing in

international transactions. The JUVE Handbuch 2009/2010 lists Dr. Diemer as a

frequently recommended lawyer in the field of corporate law.

Dr. Matthias Heisse

The Court recognized Dr. Heisse as an expert in the field of German law,

except for German criminal law. Dr. Heisse received his doctorate in law from the

- 82 University of Munich. He is currently the managing partner of Heisse Kursawe

Eversheds and focuses his practice in mergers and acquisitions, corporate, and tax

law. Dr. Heisse lectures on corporate law topics at the University of Turin, the

University of Munich, and the University of Augsburg. He is recognized in

numerous publications such as Chambers Europe, Legal 500 Europe, and the

JUVE Handbook 2010/2011 as a leading attorney in the field of corporate law.

Dr. Thomas Lys

The Court recognized Dr. Lys as an expert in the field of financial

economics. Dr. Lys received his Ph.D. in accounting and finance from the

University of Rochester. He presently holds the Eric L. Kohler chair in accounting

and professor of accounting and information management at the Northwestern

University Kellogg School of Professional Management. Dr. Lys teaches classes

in financial reporting, security analysis, and mergers and acquisitions. Dr. Lys'

research has been published in prominent academic journals including the Journal

of Accounting and Economics, the Journal of Financial Economics, the Journal of

Business, and the Accounting Review. Dr. Lys has previously testified for the

Government in other Federal leasing cases.

- 83 5.

Dr. F.H. Rolf Seringhaus

The Court recognized Dr. Seringhaus as an expert in the field of trade fair

exhibiting and marketing. Dr. Seringhaus earned his doctorate in administrative

studies from York University. He is a professor emeritus in global marketing at

the Wilfred Laurier University School of Business and Economics. Dr.

Seringhaus has worked in academics since 1981 teaching courses and researching

international marketing. He has written countless journal articles discussing

topics such as international trade fairs and marketing, as well as three books on

global marketing management.

Mag. Alexander Stolitzka

The Court recognized Mag. Stolitzka as an expert in the field of Austrian

law. Mag. Stolitzka received a doctorate in law from Vienna University. He is

currently the managing partner of Eversheds Austria, focusing his practice in real

estate, insurance, and corporate law. He is also a member of the board of directors

of Eversheds International, Ltd., London. Mag. Stolitzka is a member of the

German Chamber of Commerce in Austria and is also a legal adviser to the Swiss

embassy in Vienna.

- 84 7.

Dr. Vukan Vuchic

The Court recognized Dr. Vuchic as an expert in the field of transportation

systems. Dr. Vuchic received a Ph.D. in civil engineering and transportation from

the University of California at Berkeley. He is an emeritus professor of

transportation systems engineering at the University of Pennsylvania where he

taught and performed research in various areas of transportation from 1967-2010.

Dr. Vuchic has written over 150 papers and reports discussing rail systems and has

lectured at approximately 90 universities. He has also published three books on

urban public transportation systems and another book on relationship of

transportation and cities. Dr. Vuchic is also the recipient of numerous honors and

awards from transportation organizations around the world for his contributions to

the field of transportation systems.

Dr. Peter Wundsam

The Court recognized Dr. Wundsam as an expert in the field of Austrian

taxation and accounting. Dr. Wundsam is a partner at Moore Stephens in Vienna

and has been working as an auditor and tax consultant for 15 years. He is a

certified public accountant and certified tax adviser in Austria. He is also a

member of the executive board of the Chamber of Accountants and a member of

the committee on commercial law and auditing within the Austrian Chamber of

- 85 Accountants. Further, Dr. Windsam is the head of the working committee public

sector of the Austrian Institute of Auditors and an editor of the publication Public

Sector Bulletin.

OPINION

Burden of Proof

The burden is upon petitioners to prove that respondent's determinations in

the notices of deficiency are incorrect. See Rule 142(a)(1). However, in respect

of any new matter, respondent bears the burden of proof. Id. Respondent failed to

timely raise his economic substance argument in the pleadings. As a result, on

October 12, 2011, the Court issued an order placing the burden in these cases on

respondent to prove that the economic substance doctrine applies to the leveraged

leases. Petitioners do not argue that the burden of proof shifts to respondent

pursuant to section 7491(a) for any other issue or year, nor have they shown that

the threshold requirements of section 7491(a) have been met for any of the other

determinations at issue. Accordingly, the burden remains on petitioners with

respect to all other issues to prove that respondent's determinations of deficiencies

in income tax are incorrect.

- 86 Principal Place of Business

In the case at docket No. 7083-10 the parties disagree as to whether an

appeal would come before the U.S. Court of Appeals for the First or Sixth Circuit.

In the case of a corporation seeking redetermination of a tax liability, section

7482(b)(1)(B) provides that a decision of the Tax Court "may be reviewed by the

United States court of appeals for the circuit in which is located * * * the principal

place of business or principal office or agency of the corporation". This

determination is made as of the time the petition is filed. Thus, the crux of the

parties' dispute is the location of MIC's "principal place of business".

The Supreme Court has recently determined that a corporation's "principal

place of business" is "best read as referring to the place where a corporation's

officers direct, control, and coordinate the corporation's activities." Hertz Corp. v.

Friend, 559 U.S. 77, 92-93 (2010). This is often referred to as the "nerve center"

test, and it normally refers to where a corporation maintains its headquarters,

provided that the headquarters is the actual center of direction, control and

coordination. Id. Respondent argues that MIC's principal place of business is and

always has been in Michigan because MIC was incorporated there and has

represented in correspondence to the IRS and the Michigan Department of

Consumer & Industry Services that its principal place of business is in Michigan.

- 87 Petitioners argue, on the other hand, that MIC's principal place of business is in

Massachusetts because six of its nine corporate officers" and all three of its

directors work in Massachusetts, its corporate books and records are kept in

Massachusetts, and its significant business decisions have been and continue to be

made in Massachusetts. Further, MIC does not maintain offices in Michigan.

It is clear to us that MIC's "nerve center" is in Massachusetts. Respondent

has not presented any evidence to dispute that MIC's office in Massachusetts is

the center of its direction, control, and coordination. Therefore, we conclude that

Massachusetts was MIC's principal place of business when its petition was filed.

Leveraged Lease Transactions

Frank Lyon Co. v. United States

The seminal case for leveraged lease transactions is Frank Lyon Co. v.

United States, 435 U.S. 561 (1978), where the Supreme Court set forth the

circumstances under which the Commissioner must respect such a transaction for

Federal tax purposes. The Supreme Court stated:

where * * * there is a genuine multiple-party transaction with

economic substance which is compelled or encouraged by business or

regulatory realities, that is imbued with tax-independent

considerations, and that is not shaped solely by tax-avoidance

The remaining three officers work in Toronto, Canada.

- 88 features * * * [to which] meaningless labels [are] attached, the

Government should honor the allocation of rights and

duties effectuated by the parties. Expressed another way, so long as

the lessor retains significant and genuine attributes of the traditional

lessor status, the form of the transaction adopted by the parties

governs for tax purposes. What those attributes are in any particular

case will necessarily depend upon its facts. * * * [Id. at 583-584; fn.

ref. omitted.]

In Frank Lyon, Worthen Bank (Worthen) sought to construct a new bank

building. State and Federal regulations prohibited Worthen from financing the

construction through conventional methods. As a result, Worthen was forced to

find alternative financing, and eventually came to an agreement with the taxpayer,

Frank Lyon Co. (Frank Lyon). Pursuant to this agreement, Frank Lyon purchased

the building from Worthen during its construction for a total of $7,640,000, and

leased it back to Worthen for an initial term of 25 years. Frank Lyon invested

$500,000 and financed the remainder with a third-party lender. A mortgage

secured the loan on the building, as well as Frank Lyon's promise to assume

personal responsibility for the loan's repayment and an assignment to the lender of

the rental payments under the lease.

Worthen retained options to repurchase the building at the end of the 11th,

15th, 20th, and 25th years of the initial lease. Alternatively, Worthen could opt to

renew the lease for eight additional five-year terms. Worthen's rent payments

- 89 equaled the amounts of Frank Lyon's debt service in amount and timing. Further,

the prices of Worthen's purchase options matched Frank Lyon's then-outstanding

loan balance, plus Frank Lyon's initial $500,000 investment, with 6%

compounded interest. The lease was a net lease with Worthen remaining obligated

to pay taxes, insurance, and utilities.

The Supreme Court held that the form of a sale-leaseback transaction will

be respected for Federal tax purposes as long as the taxpayer retains significant

and genuine attributes of a traditional lessor. Id. at 584. An important inquiry is

"whose capital was committed to the * * * [property] * * * [and therefore, who is]

entitled to claim depreciation for the consumption of that capital." Id. at 581.

Frank Lyon was liable as principal for the repayment of the $7,640,000 loan, had

invested $500,000 in the transaction, and its return on the transaction was

guaranteed only if Worthen exercised its extension options, which was

speculative.

The Supreme Court also determined the following factors, among others, to

favor Frank Lyon: (1) Worthen's rent and purchase option prices were reasonable;

(2) Frank Lyon assumed the credit risk of Worthen's defaulting on its rent

payments; (3) there was a real possibility that Worthen could walk away from the

transaction at the end of the initial lease; (4) the transaction was negotiated in

- 90 good faith between independent parties; and (5) Worthen and Frank Lyon paid the

same tax rates, making the transaction tax neutral for the fisc. Accordingly, the

Supreme Court held for Frank Lyon, concluding that "a sale-and-leaseback, in and

of itself, does not necessarily operate to deny a taxpayer's claim for deductions."

Frank Lyon, 435 U.S. at 584.

Economic Substance

After the Supreme Court issued its opinion in Frank Lyon, several Courts of

Appeals reduced the Supreme Court's economic substance formulation to a twopart test: (1) whether the transaction had economic substance beyond tax benefits

(objective test); and (2) whether the taxpayer had shown a nontax business

purpose for entering the disputed transaction (subjective test). See, e.g., ACM

P'ship v. Commissioner, 157 F.3d 231, 247-248 (3d Cir. 1998), aff'g in part, rev'a

in part T.C. Memo. 1997-115; Bail Bonds by Marvin Nelson, Inc. v.

Commissioner, 820 F.2d 1543, 1549 (9th Cir. 1987), aff'g T.C. Memo. 1986-23;

Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89, 91-92 (4th Cir. 1985),

aff'g in part, rev'g in part 81 T.C. 184 (1983). However, the various Courts of

- 91 Appeals disagree as to the appropriate relationship between the objective and

subjective tests.28

The Court of Appeals for the Fourth Circuit has adopted a disjunctive

approach, treating a transaction as having economic substance if the transaction

has either a business purpose or economic substance. See, e.g., Rice's Toyota

World, Inc. v. Commissioner, 752 F.2d at 91-92. The Courts of Appeals for the

Ninth and Eleventh Circuits view the objective and subjective prongs as elements

of one comprehensive inquiry. See, e.g., Sacks v. Commissioner, 69 F.3d 982,

988 (9th Cir. 1995), rev'g T.C. Memo.1992-596; Kirchman v. Commissioner, 862

F.2d 1486, 1492 (11th Cir.1989), affg Glass v. Commissioner, 87 T.C. 1087

(1986). Finally, the Court of Appeals for the Federal Circuit adheres to a

multifactor test which provides that a lack of economic substance may be

sufficient to invalidate a transaction regardless of whether the taxpayer has

motives other than tax avoidance. Coltec Indus., Inc. v. United States, 454 F.3d

1340, 1355 (Fed. Cir. 2006).

28Congress codified the economic substance doctrine in the Code by the

Health Care and Education Reconciliation Act of 2010, Pub. L. No. 111-152, sec.

1409, 124 Stat. at 1067. See also H.R. Rept. No. 111-443 (I), at 291-299 (2010),

2010 U.S.C.C.A.N. 123, 222-231 (discussing the reasons for codification of the

economic substance doctrine). This codified doctrine does not apply to these

cases because it is effective only for transactions entered into after March 30,

2010.

- 92 B.

Substance Over Form

Courts use substance over form and its related judicial doctrines to

determine the true nature of a transaction disguised by formalisms that exist solely

to alter tax liabilities. See United States v. R.F. Ball Constr. Co., 355 U.S. 587

(1958); Commissioner v. Court Holding Co., 324 U.S. 331 (1945); Stewart v.

Commissioner, 714 F.2d 977, 987-988 (9th Cir. 1983), a_[f'g T.C. Memo.

1982-209; Rose v. Commissioner, T.C. Memo. 1973-207. In such instances, the

substance of a transaction, rather than its form, will be given effect. We generally

respect the form of a transaction, however, and will apply the substance over form

principles only when warranted. See Gregory v. Helvering, 293 U.S. 465 (1935);

Blueberry Land Co. v. Commissioner, 361 F.2d 93, 100-101 (5th Cir. 1966), aff'g

42 T.C. 1137 (1964).

In Frank Lyon, 435 U.S. at 584, the Supreme Court held that the form of a

sale-leaseback transaction will be respected for Federal tax purposes as long as the

lessor retains significant and genuine attributes of a traditional lessor. The

substance over form doctrine requires viewing the transaction as a whole.

Commissioner v. Court Holding Co., 324 U.S. at 334. A "critical fact," however,

is whether the taxpayer has undertaken "substantial financial risk" of loss of its

investment on the basis of the value of the underlying property. Coleman v.

- 93 Commissioner, 16 F.3d 821, 826 (7th Cir. 1994), aff'g T.C. Memo. 1987-195 and

T.C. Memo. 1990-99.

II.

LILO and SILO Litigation

In the case at bar, petitioners assert that the LILO and SILO leveraged

leases are genuine multiple-party transactions, with economic substance, that were

compelled or encouraged by business realities and were not designed as a scheme

to avoid payment of taxes. As such, petitioners assert, the LILO and SILO

leveraged leases should be respected for Federal tax purposes because they satisfy

the requirements set out by the Supreme Court in Frank Lyon Co.

Respondent contends that the LILO and SILO leveraged leases are

"prepackaged, promoted tax products" that "create tax benefits for John Hancock

out of thin air, and share that value with the counterparties, promoters, and

advisors". Therefore, respondent argues that the leveraged leases should not be

respected for Federal tax purposes because John Hancock did not acquire the

benefits and burdens of ownership with respect to the SILO transactions or a true

leasehold interest with respect to the LILO transactions and thus the transactions

lack economic substance.

Taxpayers have lost their fight for claimed tax benefits in SILO and LILO

transactions in all Courts of Appeals in which they have appeared. The Courts of

- 94 -

Appeals for the Second and Fourth Circuits have ruled against taxpayers in Altria

Grp., Inc. v. United States, 658 F.3d 276 (2d Cir. 2011) (denying the taxpayer's

motion for judgment as a matter of law and a new trial after a jury verdict

disallowed the tax benefits derived from three SILO transactions and a LILO

transaction), aff'g 694 F. Supp. 2d 259 (S.D.N.Y.2010), and BB&T Corp. v.

United States, 523 F.3d 461 (4th Cir. 2008) (disallowing the tax benefits derived

from a LILO transaction), a_ffEg 2007 WL 37798 (M.D.N.C. 2007), respectively.

Likewise, the Court of Appeals for the Federal Circuit has ruled against taxpayers

in Wells Fargo & Co. v. United States, 641 F.3d 1319 (Fed. Cir. 2011)

(disallowing the tax benefits derived from 26 SILO transactions), afEg 91 Fed. Cl.

35 (2010), and Consol. Edison Co. of N.Y., Inc. & Subs. v. United States, 703

F.3d 1367, 2013 WL 93110 (Fed. Cir. 2013) (disallowing tax benefits derived

from a LILO transaction because the taxpayer never acquired the benefits and

burdens of ownership), rev'g 90 Fed. Cl. 228 (2009). In AWG Leasing Trust v.

United States, 592 F. Supp. 2d 953 (N.D. Ohio 2008), the District Court for the

Northern District of Ohio disallowed the tax benefits derived from a SILO

transaction. AWG was not appealed.29

29Additionally, in Fifth Third Bancorp v. United States, No. 05-350 (S.D.

Ohio Apr. 18, 2008), a jury verdict without a related published opinion disallowed

(continued...)

- 95 The Tax Court has never ruled upon the income tax consequences of a LILO

or SILO transaction. As an aid to our evaluation of the present case, we will

review the LILO and SILO cases already decided, in chronological order by the

date they were decided. We begin with BB&T, in which the Court of Appeals for

the Fourth Circuit established the basis for a substance over form inquiry with

respect to LILO transactions. We next review AWG, in which the District Court

for the Northern District of Ohio was the first court to review a SILO transaction,

applying both a substance over form inquiry and a two-part economic substance

inquiry. Finally, we review three decisions from the Courts of Appeals for the

Second Circuit3° and the Federal Circuit," which determine whether the substance

of each transaction is consistent with its form, among other inquiries, and set forth

29(...Continued)

the taxpayer's claimed tax benefits derived from a LILO transaction. Further,

beginning on March 12, 2012, the Court of Federal Claims held a 10-day trial in

Unionbancal Co. & Subs. v. United States, No. 1:06-cv-00587 (Fed. Cl. filed Aug.

14, 2006), to determine whether to uphold assessed deficiencies resulting from

two LILO transactions. To date, no opinion has been issued and no decision has

been rendered in that case.

3°Altria Grp., Inc. v. United States, 658 F.3d 276 (2d Cir. 2011), aff'g 694 F.

Supp 2d. 259 (S.D.N.Y. 2010).

Wells Fargo & Co. v. United States, 641 F.3d 1319 (Fed. Cir. 2011), aff'g

91 Fed. Cl. 35 (2010), and Consol. Edison Co. of N.Y., Inc. & Subs. v. United

States, 703 F.3d 1367 (Fed. Cir. 2013), rev'g 90 Fed. Cl. 228 (2009).

- 96 the standard by which to judge whether a purchase option is likely to be exercised

in a LILO or SILO transaction.

BB&T

In the first case of its kind, the Court of Appeals for the Fourth Circuit

affirmed a District Court's decision to grant summary judgment to the

Government, disallowing the taxpayer's claimed deductions in connection with a

LILO transaction. BB&T, 523 F.3d 461. The taxpayer, BB&T Corp. (BB&T),

was a domestic financial service company. In the LILO transaction, BB&T leased

pulp manufacturing equipment from Sodra Cell AB (Sodra), a Swedish

manufacturer of wood pulp, for a term of 36 years and subleased the equipment

back to Sodra for a term of 15.5 years.

BB&T's LILO transaction was very similar to the typical LILO transaction

described above in section IV.A of our findings of fact and depicted in the

associated graphic. The rights and obligations conferred in the initial lease and

sublease were nearly identical, with Sodra continuing to use and possess the

equipment as it did before the transaction. The transaction was fully defeased,

resulting in a series of bookkeeping entries in satisfaction of Sodra's sublease rent

payments and BB&T's debt service which matched in amount and timing. The

defeasance transactions also prefunded Sodra's purchase option at the end of the

- 97 sublease. As in John Hancock's LILO transactions, if Sodra were to decide not to

exercise its purchase option, BB&T would have the choice of: (1) renewing the

sublease; (2) replacing Sodra; or (3) retaining the equipment. Finally, Sodra was

required to procure a long-term letter of credit for the benefit of BB&T in the

event that the transaction was unwound early.

BB&T argued to the District Court that it had acquired a legitimate

leasehold interest in the equipment. The argument was predicated upon certain

new obligations imposed on Sodra as part of the sublease, including Sodra's

obligation to maintain and operate the equipment consistently with certain

standards, hold a specified amount of insurance, and file certain reports not

previously required. The court disagreed, holding that "[i]n substance, Sodra's use

and possession of the [e]quipment was unaltered by the transaction". The court

held that nothing in the record indicated that any alterations to Sodra's rights and

obligations with respect to the equipment were unique to the initial lease, nor was

there any evidence that such obligations were not the responsibility of Sodra

before the LILO transaction.

The District Court further held that even if Sodra were to choose not to

exercise its purchase option, the defeasance structures and obligations imposed on

the parties ensured that BB&T bore no real risk of loss. Despite construing the

- 98 evidence in the light most favorable to BB&T, the court granted the Government's

motion for summary judgment, disregarded the reciprocal and offsetting

obligations of the LILO transaction, and concluded that BB&T acquired no more

than a future interest in the equipment.

On appeal, the Court of Appeals for the Fourth Circuit affirmed the trial

court's decision. Applying the doctrine of substance over form, the Court of

Appeals determined that in order for BB&T to deduct payment on the initial lease

as a rent payment under section 162(a)(3), it had to establish that it acquired a

genuine leasehold interest in the equipment, i.e., that the initial lease was, in

substance, a true lease for tax purposes.

In determining whether the transaction allocated BB&T's and Sodra's

rights, obligations, and risks in a manner that resembles a traditional lease

relationship, the court found that (1) BB&T and Sodra exchanged nearly identical

rights and obligations in the initial lease and sublease, leav.ing BB&T only a right

to make an annual inspection of the equipment; (2) though the transaction

provided for the exchange of tens of millions of dollars in rent payments, there

was a lack of actual cashflow during the term of the transaction aside from the

money BB&T provided Sodra as incentive for the transaction; (3) Sodra, through

its purchase option, could unwind the transaction without ever losing dominion

- 99 and control over the equipment or having surrendered any of its own funds to

BB&T and had no economic incentive to do otherwise; thus, BB&T did not expect

Sodra to walk away from the cashless purchase option at the end of the sublease;

and (4) the structure insulated BB&T from any risk of losing its initial investment.

BB&T, 523 F.3d at 473.

Moreover, the court held that unlike the transaction in Frank Lyon, the

LILO transaction "failed to show any 'business or regulatory realities' that

'compelled or encouraged * * * the structure of the transaction at issue here, nor

has it established that the LILO is 'imbued with tax-independent considerations,

and is not shaped solely by tax avoidance features that have meaningless labels

attached'". Id. Thus, the court held in substance the transaction was a financing

arrangement, not a genuine lease and sublease.

The court did not analyze BB&T's LILO transaction for economic

substance. The court noted that whether a particular transaction lacks economic

substance is a question of fact. Id. at 472. As a result, because the case arose out

of a motion for summary judgment, the District Court and Court of Appeals were

required to view the facts in a light most favorable to BB&T, and both courts

assumed the LILO transaction had economic substance.

- 100 B.

AWG

In AWG, 592 F. Supp. 2d 953, the District Court for the Northern District of

Ohio was the first court to review a SILO transaction. In the transaction at issue,

KeyCorp (Key) and PNC Financial Services Group, Inc. (PNC), two financial

institutions, entered into a grantor trust (Key/PNC). Key/PNC leased a waste-to-

energy disposal and treatment plant (facility) in Wuppertal, Germany, from

Abfallwirtschaftgesellschaft mbH Wuppertal (AWG) for a term of 75 years and

subleased the facility back to AWG for a term of 24 years. A consortium of

German municipalities owned AWG, and they were also some of the facility's

most important customers. Like John Hancock's SILO transactions, because the

initial lease exceeded the expected economic useful life of the leased asset, it was

treated as a sale for U.S. Federal tax purposes.

The sublease was a net lease, with AWG retaining nearly identical rights

and obligations with respect to the facility as it had before the SILO transaction.

Key/PNC through an equity contribution provided approximately 13% of the

prepaid rent to AWG as required by the initial lease. Similar to John Hancock's

SILO transactions, the remainder of the transaction was financed through two

nonrecourse loans, a series A loan accounting for 90% of the debt and a series B

loan accounting for the remaining 10%. Unlike John Hancock's SILO

- 101 transactions, Key/PNC required that the transaction feature full defeasance, with

AWG obligated to enter into separate DPUAs for the series A and series B loans,

as well as an EPUA. These defeasance agreements ensured the payment of

AWG's rental obligation under the sublease, which matched Key/PNC's debt

service in amount and timing, and funded AWG's purchase option. The series A

DPUA was pledged as collateral for repayment of Key/PNC's loans.

The structure of AWG's purchase option was similar to those of the lessee

counterparties in John Hancock's SILO transactions. However, unlike John

Hancock's SILO transactions, if AWG chose not to exercise its purchase option,

Key/PNC was not given options. Rather, the transaction required AWG to enter

into a service contract to purchase solid waste disposal services from Key/PNC for

a specified term. As in John Hancock's SILO transactions, the service contract

option required the lessee counterparty, AWG, to arrange for a refmancing of

Key/PNC's nonrecourse debt.

In order to determine whether Key/PNC was entitled to the claimed tax

deductions, the District Court analyzed the economic substance of the transaction

following Dow Chem. Co. v. United States, 435 F.3d 594, 599 (6th Cir. 2006),

which treats a transaction as having economic substance only if the transaction has

- 102 genuine economic effects other than tax benefits and the taxpayer is truly

motivated by profit to participate in the transaction.

Starting with the assumption that AWG would exercise its purchase option,

the evidence showed that Key/PNC would receive approximately $78 million on

its $55 million equity investment during the sublease term. The court held that

this 3.4% return was consistent with the type of return banks ordinarily receive

from leveraged lease transactions. Further, the court held that although it was

unlikely that AWG would choose the service contract option, if it did so Key/PNC

had the potential to earn between 5% and 8% on its equity investment, depending

on the facility's business production. Accordingly, the District Court held that the

transaction had genuine economic effects other than tax benefits. The court also

held that Key/PNC had a profit motive, relying on the small chance that the

transaction could earn between 5% and 8%.

Having concluded that the SILO transaction had economic substance, the

District Court turned to the substance over form test. Citing Frank Lyon, 453 U.S.

561, the District Court held that in order for Key/PNC to prevail on its claim that

the substance of the transaction was consistent with its form, thus entitling

Key/PNC to tax depreciation and amortization deductions, Key/PNC had to prove

that it both obtained and kept significant and genuine characteristics of ownership

- 103 of the facility. "Such genuine attributes of ownership are generally found only

where the alleged owner bears both the burdens and enjoys the benefits of asset

ownership." AWG, 592 F. Supp. 2d at 981.

Several facts were pivotal to the court's decision. First, the court held that

AWG's rights and obligations with respect to the facility remained virtually the

same before and after the SILO transaction. Notably, under German law, legal

title to the facility remained with AWG, entitling AWG to depreciation deductions

on the facility for German tax purposes. Next, the court pointed to the circular

nature of the SILO transaction's payment structure, holding that the offsetting

payments strongly indicated that the transaction had little substantive purpose.

Third, the court held that Key/PNC did not assume the substantive credit, residual

value, or remarketing risk that is typical of a lessor in a leveraged lease. Aside

from its other protections, the court noted that the SILO transaction included a

guaranty from the municipal members of AWG, backed by the German Federal

Government, to the benefit of Key/PNC.

Finally, the District Court emphasized that AWG was "highly likely" or

"nearly certain"" to exercise its purchase option. If AWG did not exercise the

"The District Court also used terms such as "compelled to" and "virtually

certain" to determine whether AWG would exercise its purchase option. AWG

(continued...)

-104purchase option, it was required to refinance Key/PNC's nonrecourse debt of $383

million. On the purchase option date, the appraisal estimated the fair market value

of the facility to be $390 million. Accordingly, initial refinancing would require a

loan-to-value ratio of over 98%. A provision in the service contract required a $50

million payment from AWG, reducing the amount required to be borrowed to $333

million. Nonetheless, this loan-to-value ratio of approximately 85% was still well

above the typical ratio for a Gennan loan, of no greater than 67%. The District

Court concluded that exercise of the purchase option was the only viable choice .

for AWG.

The court also took into consideration the tax consequence to AWG of

nonexercise under German law. As is the case in John Hancock's SILO

transactions, although the initial lease is treated as a sale for U.S. Federal tax

purposes, under German law AWG remained the owner of the facility. If AWG

were to elect the service contract option, it would receive the cash balance from

"(...continued)

Leasing Trust v. United States, 592 F. Supp. 2d 953, 986 (N.D. Ohio 2008). Later,

Courts of Appeals have discussed in depth the standard to be used to determine

whether a party in a SILO or LILO transaction will exercise its purchase option.

See Wells Fargo, 641 F.3d at 1325-1330; Consol. Edison, 703 F.3d at 1379. The

District Court in AWG lacked the benefit of the Court of Appeals for the Federal

Circuit's in-depth analysis of the issue and creation of a reasonable likelihood

standard.

- 105 the DPUAs and EPUA, or approximately $521 million. The District Court held

that this receipt of cash, combined with AWG's relinquishment of the facility,

would likely be treated as a taxable sale under German law. The transaction's

original appraisal failed to consider this possibility and its impact on AWG's

purchase option decision.

Several other unique facts were important in the District Court's decision.

For instance, the court seemed skeptical about the accuracy of the appraisal,

pointing to the large discrepancy between the facility's original appraised fair

market value of $250 million and the $450 million appraisal used to build the

transaction. The court also noted that no representative from AWG testified at

trial to provide evidence of any reason for AWG to participate in the SILO

transaction outside of its net present value benefit. In sum, the court concluded

that

the AWG transaction is a financing arrangement designed in

significant measure to increase tax deductions available to * * *

[Key/PNC]. The AWG transaction * * * is not a genuine sale and

leaseback. Essentially all that * * * [Key/PNC] did was to pay AWG

a $28.5 million accommodation fee to sign paperwork meeting the

formal requirements of a sale and leaseback and to arrange a circular

and largely meaningless flow of cash from and then back to * * * [the

German lenders]. AWG, meanwhile, continues to have undisturbed

and uninterrupted possession and control of the Facility, continues to

claim the tax benefits of ownership of the Facility under German law,

and has no economic or political motivation to give up control of the

- 106 plant to * * * [Key/PNC] at any time. Because * * * [Key/PNC]

never became the true owners of the Facility, they are not entitled to

deductions for the depreciation or amortization of expenses

associated with the asset. [AWG, 592 F. Supp. 2d at 990.]

Wells Fargo

In Wells Fargo, 641 F.3d 1319, the Court of Appeals for the Federal Circuit

affirmed the Court of Federal Claims' decision to disallow the taxpayer's claimed

tax benefits arising from 26 SILO transactions. The parties agreed to try a set of

test transactions, four of which involved transportation assets with domestic transit

agencies as the counterparties (transit agency transactions) and a fifth involving

qualified technological equipment with a foreign counterparty. The lessee

counterparties and the assets of the Wells Fargo test transactions were as follows:

(1)

New Jersey Transit Corporation--45 light rail vehicles and 650 buses;

(2)

State of California Department of Transportation (Caltrans)--6

locomotives and 12 intercity passenger rail cars;

(3)

Metropolitan Transit Authority of Harris County, Texas (Houston

Metro)--45 commuter buses and 241 transit buses;

(4)

Washington Metropolitan Area Transit Authority (WMATA)--42

subway cars; and

- 107 (5)

Belgacom Mobile, S.A., a Belgian entity (Belgacom)-2 lots of GSM

cellular communications equipment.

Wells Fargo & Co. (Wells Fargo) is a diversified financial services

company. It operates a leasing company, maintains a fairly significant leasing

portfolio, and invests in leases involving a variety of assets. Wells Fargo

conducted extensive due diligence before entering into its SILO transactions,

including credit approvals and tax capacity analyses. It also relied upon the work

of qualified appraisers, accountants, and lawyers who reviewed and provided

support for their SILO transactions.

In each of the transit agency transactions Wells Fargo, through a grantor

trust, made an initial equity contribution of approximately 15% to 20% of the

prepaid rent made to the lessee counterparty and borrowed the remainder on a

nonrecourse basis. Unlike John Hancock's SILO transactions, Wells Fargo did

not divide its borrowing into series A and series B loans. A promoter secured the

appraisals that determined the value of each transaction. The rights and

obligations transferred to Wells Fargo under the initial lease in each of the

transactions were substantially similar to those transferred back to the lessee

counterparties in the respective subleases. The lessee counterparties' rent

payments under the subleases exactly matched Wells Fargo's debt service

- 108 payments in amount and timing. Further, unlike John Hancock's SILO

transactions, which did not require series B debt or equity defeasance, each of

Wells Fargo's transactions required full debt and equity defeasance.

Wells Fargo's SILO transactions featured purchase options for the lessee

counterparties at the end of the sublease terms. The purchase options were

prefunded through the defeasance transactions. If a lessee counterparty were to

decide not to exercise its purchase option, Wells Fargo would have the choice of

either taking possession of the transportation equipment or requiring the lessee to

arrange for a service contract.

The service contract option imposed certain obligations on the lessee

counterparty. These obligations included: (1) finding an acceptable operator for

the transportation equipment and negotiating an operating agreement; (2)

arranging for the refinancing of Wells Fargo's nonrecourse loan; (3) in the

Caltrans and WMATA transactions, obtaining and paying for a letter of credit for

the benefit of the refinancing lender; (4) in the Caltrans, WMATA, and Houston

Metro transactions, procuring and paying for residual value insurance for the

benefit of Wells Fargo; (5) satisfying the equipment's physical return conditions;

and (6) if Wells Fargo requires, entering into new defeasance agreements to secure

amounts owed to Wells Fargo under the service contracts.

- 109 The trial court analyzed Wells Fargo's test transactions under both the

substance over form and economic substance doctrines. In each test transaction,

the court concluded that Wells Fargo was not entitled to its claimed deductions.

Analyzing whether the benefits and burdens of ownership had passed to Wells

Fargo, the court compared each Wells Fargo test transaction with the transaction

in Frank Lyon, finding:

The loan proceeds were not invested in the property or equipment, or

retained by either the tax-exempt entity or Wells Fargo. Moreover,

the debt and equity undertaking payment arrangements eliminated the

need for the tax-exempt entity to actually pay rent under the

lease-backs, or for Wells Fargo to actually make any debt service

payments. The "rent" and "debt" payments in each SILO simply are

accounted for as offsetting entries within the lender group. The debt

will be completely paid without Wells Fargo having to supply any

funds, whether the * * * [purchase options] are exercised or not. In

contrast, in Frank Lyon, the taxpayer alone was liable for repayment

of recourse debt, "to which it exposed its very business well-being."

* * * The taxpayer also was dependent upon the lessee for payment of

rent to service the debt. [Wells Fargo, 91 Fed. Cl. at 77.]

The court also found that Wells Fargo's return on its investment was guaranteed in

each of the SILO transactions, regardless of any decline in the value of the leased

assets.

The court distinguished Wells Fargo's test transactions "from Frank Lyon,

where the lessee had renewal options, but the exercise of the options was at the

lessee's unconstrained choice, and the taxpayer did not have the ability to impose

- 110 a renewal upon the lessee." Id. at 78. The court concluded that despite

convincing evidence that the service contract and return options were viable,

"[t]he near certain exercise of * * * [the purchase options] at the end of the leaseback period renders moot what might or might not happen after the * * *

[purchaser option] date passes." Id. at 74.

Finally, the court determined that Wells Fargo's transactions lacked

economic substance because on a net present value basis each SILO is "a losing

proposition without the tax benefits." Id. at 82. The court also held that there was

no nontax business purpose to the SILO transactions and that the transactions were

not the product of "any negotiations or commercial realities".

On appeal, Wells Fargo challenged the Court of Federal Claims' decision

with respect to both the application of the substance over form doctrine and the

court's determination that there was no economic substance. The Court of

Appeals for the Federal Circuit focused its analysis on the substance over form

inquiry (i.e., whether Wells Fargo acquired the benefits and burdens of ownership

in the leased assets) and the question of whether the lessee counterparties would

exercise their purchase options at the end of the lease term. Wells Fargo, 641 F.3d

at 1325-1330.

-111Wells Fargo argued that (at the time the transactions were entered into) it

could not know for certain whether the lessee counterparties would exercise their

purchase options. The court stated: "We have never held that the likelihood of a

particular outcome in a business transaction must be absolutely certain before

determining whether the transaction constitutes an abuse of the tax system. The

appropriate inquiry is whether a prudent investor in the taxpayer's position would

have reasonably expected * * * [the counterparties to exercise their purchase

option]", not whether the taxpayer was certain of such an outcome. Id. at 1325-

1326.

Wells Fargo challenged the testimony of Dr. Lys, the Government's expert

on financial economics, and defended its own appraisers' analyses. The court

identified the discount rate that the lessee counterparties would apply in

calculating the net present value of its purchase option decision as the "crux of the

disagreement" between Dr. Lys' analysis and those of Wells Fargo's appraisers.

The appraisers analyses used the weighted average cost of capital (WACC) in the

transit industry as the appropriate discount rate. Dr. Lys, on the other hand, used a

lower discount rate in the same way as he has done for John Hancock's

transactions, equal to the rate at which the lessee counterparty could borrow funds.

Using the borrowing rate, Dr. Lys projected that (1) the fair market values of the

- 112 leased assets on the sublease purchase options dates and (2) the cost of the

payments to Wells Fargo under the service contracts were higher than their

appraised values. As a result, Dr. Lys concluded that the service contract provided

the lessee counterparties with less financial benefit than if they simply decided to

exercise the purchase option. Wells Fargo argued that Dr. Lys' deviation from the

use of the WACC rate was inappropriate and produced inaccurate results.

The court adopted Dr. Lys' approach, citing the trial court's acceptance of

his methodology. The court declined to pass judgment on whether a different

discount rate was more appropriate. Rather, the court held that the discount rate

was a "distinctly factual matter" and that Wells Fargo had failed to prove that the

trial court's acceptance of Dr. Lys' methodology was clear error. Further, the

court concluded that the trial court's conclusion that the lessee counterparties

would exercise their purchase options did not depend on Dr. Lys' analysis. Citing

witness testimony and documentary evidence, the court held that the trial court's

findings of fact provided ample evidence that there were substantial difficulties for

the lessee counterparties to comply with the service contract option and that Wells

Fargo reasonably expected the purchase options to be exercised. Any testimony or

evidence to the contrary was "not enough to call into question" the trial court's

conclusions. Therefore, the benefits and burdens of ownership did not pass to

- 113 Wells Fargo and Wells Fargo's SILO transactions could not be respected for

Federal tax purposes under the substance over form doctrine.

Altria

In Altria, 658 F.3d 276, the Court of Appeals for the Second Circuit

affirmed a District Court's decision to deny the taxpayer judgment as a matter of

law following an unfavorable jury verdict. At issue in Altria were three SILO

transactions and a LILO transaction. The taxpayer, Altria Group, Inc. (Altria), is a

financial services company. The lessee counterparties and subject assets of

Altria's test transactions were as follows:

(1)

New York Metropolitan Transportation Agency (MTA)--a rail car

maintenance facility;

(2)

Oglethorpe Power Corp. (Oglethorpe)--a pumped storage

hydroelectric facility;

(3)

Seminole Electrical Cooperative, Inc. (Seminole)--a coal-fired

electrical generating plant; and

(4)

Watershap Vallei en Eem (Vallei), an independent agency of the

Government of the Netherlands--a wastewater treatment facility. Oglethorpe,

Seminole and Vallei were SILO transactions, and MTA was a LILO transaction.

- 114 Each of Altria's transactions featured full defeasance, a lessee purchase

option, and a renewal option or service contract option at the end of the sublease

term. Additionally, in each of the transactions at issue: (1) there was no viable

secondary market for the subject assets; (2) the assets were essential to the lessee

counterparties' businesses; (3) the appraisals did not properly estimate the assets'

expected residual value and useful lives; (4) the transactions shifted tax benefits

from a nontaxable to a taxable entity, rather then transferring benefits among

taxable entities; and (5) the defeasance accounts created a circular flow of money.

Altria's motion for judgment as a matter of law argued that the jury gave

undue weight to evidence that had no bearing on the interests Altria acquired in

the transactions, that the trial court's jury instructions were misleading, and that

Altria proved that the transactions were reasonably expected to generate a non-taxbased profit. Notably, Altria argued that the jury was not instructed to consider

the proper factors in determining whether Altria acquired the benefits and burdens

of a traditional lessor.

The jury instructions asked the jury to consider "all the relevant facts and

circumstances", including the following eight nonexclusive factors: (1) whether

"meaningful" control over the assets was transferred; (2) whether the equity

investment in the facility was "meaningful"; (3) cashflows between the parties; (4)

- 115 whether the transaction was motivated by "legitimate business purposes, or solely

by a desire to create tax benefits"; (5) regulatory realities; (6) whether the assets

had expected useful lives beyond the leaseback that Altria could benefit from; (7)

whether it was reasonable to expect that the assets would have meaningful value at

the end of the leaseback which would benefit Altria; and (8) whether Altria had

the potential to benefit from an increase in the asset's value and suffer a loss of its

equity investment in the facility as a result of a decrease in the facility's value.

Altria, 694 F. Supp. 2d at 271. For factors 6-8, the District Court asked the jury to

consider the "likelihood" that the lessee counterparty would exercise its purchase

option.

Altria argued that these factors were inappropriate, that the controlling

factors with respect to the benefits and burdens of ownership analysis should come

from a series of post-Frank Lyon Tax Court decisions, and that the jury should

have been instructed to evaluate the factors in those cases as the exclusive

determinative indicia of ownership. The District Court disagreed, holding that

[t]o say * * * that the Tax Court's decisions identify the exclusive

criteria for determining which taxpayer is entitled to a depreciation

deduction would be to ignore the essential holding of Frank Lyon,

that whether a taxpayer possesses a depreciable interest in a leased

asset must be determined through a fact-intensive analysis focused on

the "substance and economic realities" of the challenged transaction.

* * * [Id. at 275.]

- 116 Altria further argued that even if the all-encompassing approach of Frank

Lyon is proper, several of the specific factors the court presented to the jury were

inappropriate. The District Court focused its discussion on two particular factors.

First, Altria argued that the court erred in instructing the jury to determine the

"likelihood" that the lessee counterparties would exercise their purchase options,

rather than instructing the jury to determine whether the purchase options were

"certain" or "nearly certain" to be exercised. The District Court held that Altria's

argument was merely one of semantics, since the "likelihood" of exercise includes

the possibility of a determination that it was "certain" or "nearly certain". It stated

that no Court of Appeals supports Altria's proposed standard and none has

addressed exactly "how likely" the exercise of an option must be to support a

conclusion that the taxpayer did not acquire a depreciable interest. Finally, and

most importantly, the District Court held that Altria's proposed instruction

misunderstood the Government's argument, i.e., that it was the cumulative effect

of each of the transactions' possible scenarios, and not just the purchase options,

that determines whether the benefits and burdens have passed.

Second, Altria argued that the District Court should have instructed the jury

to disregard present value in its residual interest analysis. The District Court

disagreed, finding that the present value analysis "properly sought to illuminate

- 117 the transactions' 'substance and economic realities', * * * particularly the relative

importance of the residual values nominally Altria stood to receive". Altria, 694

F. Supp. 2d at 280 (quoting Frank Lyon, 435 U.S. at 582).

Altria also argued against the use of a present value analysis as part of the

second prong of the economic substance test, whether Altria acted with a bona fide

business purpose. Citing rule 401 of the Federal Rules of Evidence, which

provides that "relevant evideríce" is "evidence having any tendency to make the

existence of any fact that is of consequence to the determination of the action more

probable or less probable", the District Court held that the Government's present

value analysis easily satisfied this test, and a reasonable factf'mder might conclude

that it is "less probable" that an investor had a reasonable business purpose for a

transaction with a negative net present value. Id. at 284-285. Altria also argued

that the use of a present value analysis in the business purpose test was

inconsistent with one of the District Court's other jury instructions, which was to

ignore present value in determining whether the transactions had "economic

effect", the first prong of the economic substance test. The District Court

dismissed this argument, holding that it was dependent on a "false dichotomy" and

that realizing transactional profit on a cash-in-cash-out basis is not the only

legitimate objective a business may pursue.

-118On appeal, the Court of Appeals for the Second Circuit addressed three

arguments with respect to substance over form. Altria, 658 F.3d at 286. First,

Altria challenged the District Court's decision that it was appropriate for the jury

to evaluate the "likelihood" that the lessee counterparties would exercise their

purchase options, again arguing that the jury should have been instructed to

evaluate whether exercise was "certain" or "nearly certain". The Court of Appeals

affirmed the District Court's position, holding that the purchase option is just one

factor in determining ownership and that the likelihood of the purchase options'

being exercised is not determinative of the analysis. Further, the court held that

neither the Supreme Court nor the Court of Appeals for the Second Circuit has

ever concluded that the true substance of a transaction is limited to events that are

"certain" or "virtually certain" to occur.

Altria argued that the jury instructions failed to provide any guidance on

what levels of equity investment or residual value are "meaningful" in the leasing

context, leaving the jury without a proper standard to work with. Altria requested

an instruction stating that a 6% equity investment and an expected residual value

of 10% to 20% would satisfy this threshold. The court dismissed this argument,

holding that a precise numerical test would encourage taxpayers to change the

form and not the substance of their transactions. Citing Frank Lyon, the court said

- 119 that the existence of a depreciable interest in an asset depends on the particular

facts of the case.

Finally, Altria argued that two of the factors included in the jury

instructions' nonexclusive list were "neutral" and therefore not relevant to

determining traditional lessor status. The first factor was control over the asset,

which Altria noted is present in all leveraged leases. The court rejected this

argument, holding that Frank Lyon specifically requires such an analysis. The

second factor was cashflows, which the court likewise rejected, citing the

relevance of circular cashflows to the courts in Wells Fargo, BB&T, and AWG.

Accordingly, the court affirmed the jury's findings that Altria did not obtain the

benefits and burdens of ownership with respect to its transactions.

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