Argued and Submitted, Pasadena, California April 10, 2014.
Appeal from a Decision of the United States Tax Court. Tax Ct. No. 22557-08.
The panel affirmed the Tax Court's decision affirming a decision by the Commissioner of Internal Revenue disallowing a capital loss deduction because it lacked economic substance and was intended to create capital losses.
Taxpayer pursued a tax and investment program marketed by KPMG, the Offshore Portfolio Investment Strategy (OPIS), to reduce the tax liability associated with either taking his company public or selling it. Applying the economic substance doctrine, the panel held that the record supported the Tax Court's conclusion that taxpayer pursued the OPIS product solely for its tax benefits, as well as the conclusion that the product had no practical economic effects other than the creation of income tax losses.
David W. Wiechert (argued) and Jessica C. Munk, Law Office of David W. Wiechert, San Clemente, California, for Petitioner-Appellant.
Kathryn Keneally, Assistant Attorney General, Tamara W. Ashford, Deputy Assistant Attorney General, Gilbert S. Rothenberg, Richard Farber, and Judith A. Hagley (argued), Attorneys, Tax Division, Department of Justice, Washington, D.C., for Respondent-Appellee.
Before: Jerome Farris and Andrew D. Hurwitz, Circuit Judges, and Paul L. Friedman, District Judge.[*]
HURWITZ, Circuit Judge:
John Paul Reddam claimed a deduction on his 1999 tax return of $50,164,421 for a capital loss purportedly generated by several Cayman Islands entities. The Commissioner of Internal Revenue disallowed the deduction, finding that the transaction lacked economic substance. After a bench trial, the Tax Court affirmed. Reddam v. Comm'r, T.C. Memo 2012-106, 2012 WL 1215220 (T.C. 2012). We have jurisdiction over Reddam's appeal under 26 U.S.C. § 7482(a)(1) and affirm.
I. Factual Background
A. Reddam's $48,500,000 capital tax gain and search for tax reduction strategies
In 1995, Reddam founded several companies (collectively " DiTech" ) that originated, purchased, and serviced residential home loans. Reddam was the sole shareholder, chief executive officer, and chairman of the board of each entity. Between 1995 and 1997, DiTech grew significantly.
Reddam used KPMG for his personal taxes and DiTech's corporate returns. KPMG also served as DiTech's auditor. In 1998, Reddam hired a KPMG partner, Scott Carnahan, as the president of DiTech.
In 1998, Reddam considered either taking DiTech public or selling it; he also investigated ways to reduce the tax liability associated with those strategies. Carnahan therefore introduced Reddam to a KPMG tax partner, Carl Hastings. Hastings recommended that Reddam pursue a tax and investment program marketed by KPMG: the Offshore Portfolio Investment Strategy (" OPIS" ).
According to KPMG's marketing materials, OPIS utilized " 100% leverage offshore" to allow investors " to avoid U.S. regulatory rules that limit the amount of financing permissible in securities transactions." The materials stated that the strategy " [m]aximizes U.S. investor's basis in foreign bank stock and thereby minimizes gain, or maximizes loss, on the disposition of such stock," something that would only be desirable to a U.S. investor with other significant gains to offset. KPMG emphasized that the costs of investing in OPIS were not based on potential
investment gains, but were instead tied to the amount of " capital gain [tax] exposure" to be eliminated.
After several meetings with KPMG tax partners, Reddam understood OPIS to be a " complicated, technical" investment strategy that involved " some kind of basis shift," whose " details were all very, very complicated." He understood that OPIS employed " hedging," so that any potential upside relied entirely on a rise in an underlying foreign bank stock. However, in general, Reddam did not " understand how [OPIS] works."
Reddam knew that OPIS might " make money," but chiefly was drawn to its potential " to be successful relative to generating a tax loss." He sought the advice of KPMG tax partners because he was " looking to make sure that I paid the lowest tax rate that I could."
Before investing, Reddam had Carnahan contact KPMG's competitors to inquire if they were offering similar " tax elimination" products. He was informed that several were, but Ernst & Young was not, because it did not think such a product " worked." Carnahan advised Reddam to seek independent advice because he was " a little concerned that the same people pitching the transaction and receiving a fee for that transaction would also be giving the [tax] opinion on that transaction." Nonetheless, Reddam never sought independent investment or legal advice.
In April 1999, GMAC Mortgage Corporation purchased DiTech, making an initial payment of $70,000,000. Reddam incurred a $48,500,000 capital tax gain and decided to " enter the OPIS transaction."
In early May 1999, Reddam hired KPMG as his " tax advisor" with respect to OPIS. KPMG again " recommend[ed] that [Reddam] seek independent advice concerning the investment aspects of the proposed transaction." Reddam never did.
B. Simplified overview of Reddam's OPIS transaction
The Tax Court opinion thoroughly explains the byzantine OPIS transaction.Reddam, T.C. Memo 2012-106, ...