                              T.C. Memo. 2013-253



                        UNITED STATES TAX COURT



    BUYUK LLC, BOYALIK LLC, A PARTNER OTHER THAN THE TAX
                 MATTERS PARTNER, Petitioner v.
        COMMISSIONER OF INTERNAL REVENUE, Respondent

BEYAZIT, LLC, RP CAPITAL PARTNERS LLC, A PARTNER OTHER THAN
             THE TAX MATTERS PARTNER, Petitioner v.
       COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket No. 11051-10, 6853-12.                 Filed November 6, 2013.


      Eric E. Kalnins and Gabriel G. Tsui, for petitioners.

      Jennifer N. Brock, Gretchen Ann Kindel, and Jeffrey S. Luechtefeld, for

respondent.
                                        -2-

[*2]        MEMORANDUM FINDINGS OF FACT AND OPINION


       LARO, Judge: These cases are partnership-level proceedings subject to the

unified audit and litigation procedures of the Tax Equity and Fiscal Responsibility

Act of 1982, Pub. L. No. 97-248, sec. 402(a), 96 Stat. at 648. In separate notices

of final partnership administrative adjustment (FPAA), respondent disallowed a

deduction of $4,458,816 that Buyuk LLC (Buyuk) claimed on its 2003 Form 1065,

U.S. Return of Partnership Income, and a deduction of $12,223,174 that Beyazit

LLC (Beyazit) claimed on its 2003 Form 1065. The FPAAs also determined,

among other things, accuracy-related penalties applied to any underpayments of

tax attributable to the disallowances. Respondent’s primary determination in that

respect was that for each partnership the penalty equaled 40% of the

underpayment because of a gross valuation misstatement under section 6662(h).1

Alternatively, respondent determined that the penalty equaled 20% of the

underpayment because of negligence or disregard of rules or regulations under

section 6662(b)(1), a substantial understatement of income tax under section

6662(b)(2), or a substantial valuation misstatement under section 6662(b)(3). As a


       1
       Unless otherwise indicated, section references are to the Internal Revenue
Code in effect for the year in issue (Code), Rule references are to the Tax Court
Rules of Practice and Procedure, and some dollar amounts are rounded.
                                        -3-

[*3] result of our findings today under the concepts of disguised sales under

section 707(a)(2)(B), the substance over form and step transaction doctrines, and

the economic substance doctrine, we sustain respondent’s determinations in the

FPAAs to the extent set out in this opinion.

                              FINDINGS OF FACT

      The parties filed with the Court a stipulation of facts and a supplemental

stipulation of facts, both with accompanying exhibits. Those facts and exhibits are

incorporated herein by this reference. We find the facts accordingly. Buyuk’s and

Beyazit’s principal place of business was Greenwich, Connecticut, when the

petitions were filed.

Gramercy Advisors LLC

      Marc Helie and Robert Koenigsberger founded Gramercy Advisors LLC in

1998 to manage hedge funds investing in emerging market debts. Gramercy

Advisors’ affiliated entities include Gramercy Asset Management LLC, Gramercy

Financial Services LLC (GFS), and Mead Point Capital Management LLC

(collectively, Gramercy).

      From its inception to at least 2004, Gramercy operated its flagship fund, the

Gramercy Emerging Markets Fund (GEMF), using several feeder entities. One

feeder was an LLC for domestic investors, and another was a Cayman Islands
                                         -4-

[*4] company for foreign investors. A domestic investor would purchase a

membership interest in GEMF LLC, and Gramercy itself would not have an equity

interest in that LLC. The GEMF invested primarily in distressed, defaulted, or

undervalued emerging market debt securities issued by a country (sovereign debt)

or a corporation (corporate debt) that were denominated in U.S. dollars.2 The

GEMF did not invest in consumer receivables or accounts receivable.

      The GEMF’s reason to focus on sovereign debt instruments was twofold.

First, the concept of bankruptcy would not apply to a central government issuing

the debt instruments. Further, these types of instruments were susceptible to

positive restructuring outcomes because of a sovereign government’s need to

maintain access to global capital markets. Along the same vein, as to corporate

debt securities the GEMF focused on foreign corporations that were important to

their respective countries’ economies. In such a case, the government of the

foreign country in which the foreign corporation operated would have a vested

interest in ensuring the viability of that corporation and thus favorable

restructuring outcomes for international investors in the securities issued by the

corporation. These foreign corporations the GEMF targeted would also have

      2
      Mr. Helie testified that he might have purchased some distressed debts
denominated in Thai baht around 1997 and 1998. Nothing in the record indicates
GEMF invested in any other debt denominated in local currency.
                                          -5-

[*5] cross-border revenues and multinational assets that could mitigate the impact

of any currency devaluations. Finally, to avoid exposure to foreign exchange

fluctuations and application of unfamiliar foreign laws, the GEMF concentrated on

U.S. dollar denominated instruments issued in the international capital markets

and subject to the laws of either New York or the United Kingdom.

      The GEMF’s investment philosophy did not include buying and holding an

investment to earn interest or otherwise to collect on the debt securities. Instead, it

involved buying a sovereign or corporate debt security early and capitalizing on an

increase in price by selling the security before an impending restructuring of the

debt or after the restructuring. At times, Mr. Helie would take an active role in the

restructuring of the debt instruments. In addition, the GEMF would typically

purchase the debt instrument directly instead of purchasing an interest in an entity

holding the debt instrument. The GEMF’s investors would pay an annual

management fee of 1% of assets under management, a performance fee equal to

20% of return net of management fee and expenses, and a redemption fee of 2% of

the redeemed amount during the first 12 months or off semiannual cycle after the

first 12 months. Gramercy also imposed concentration limits on the GEMF’s

investments intended to diversify the GEMF’s portfolios and to prevent the fund

from investing too heavily in one particular region or specific type of asset.
                                         -6-

[*6] BDO Seidman LLP

      BDO Seidman LLP (BDO) is an accounting firm which from at least 2000

through 2003 promoted and sold a number of “tax solutions” products through its

Tax Solutions Group (TSG). BDO’s management marketed these tax solutions

within the firm by providing incentives to its employees and partners for

participating in the sales of these tax solutions. These incentives included bonuses

and firmwide recognition. One form of recognition was a firmwide email with the

subject line “Tax $ell$” announcing the sale of a tax solution, the employee who

generated the sale, and the fee arising from the sale. The amount of any bonus

paid to an employee was tied to the net fee BDO was able to earn from selling a

tax solution.

      One of these tax solutions BDO promoted to its clients through TSG was a

highly structured distressed debt investment product (BDO distressed debt

structure).

      The BDO distressed debt structure involved an investment in foreign

consumer receivables with high cost basis and low fair market value. BDO

required the consumer receivables be overdue and denominated in a foreign

currency that had suffered significant devaluation relative to the U.S. dollar.

Under the BDO distressed debt structure, the foreign owner of the receivables
                                        -7-

[*7] would transfer and assign the receivables to a U.S. limited liability company

(LLC) under a contribution agreement in exchange for a membership interest in a

“master” LLC solely managed by a Gramercy entity. The master LLC would then

contribute the consumer receivables to a second LLC (level A LLC) in exchange

for a membership interest in the level A LLC; a Gramercy entity would also

acquire and maintain a 1% interest in the same LLC. The client would then

acquire approximately 90% of the master LLC’s membership interest in the level

A LLC in exchange for cash. After the client’s cash purchase of the membership

interest in the level A LLC, the foreign company would redeem its membership

interest in the master LLC for cash. The client would become the sole manager of

the level A LLC and contribute securities or additional cash to the level A LLC.

The level A LLC would then contribute the consumer receivables to a second LLC

(level AA LLC) in exchange for a membership interest in the level AA LLC. The

level A LLC would own 99% of the level AA LLC, and a Gramercy entity would

be the manager and own 1% of the level AA LLC. Following this contribution,

the consumer receivables would be swapped for assets of another Gramercy LLC

to achieve the desired tax effect of recognizing the inherent loss in the consumer

receivables.
                                         -8-

[*8] To sell the tax sheltering product, according to Paul Shanbrom, a BDO

employee from the TSG group, someone from that group would typically first

meet with the potential client with an understanding of the amount of tax loss the

client was looking to generate to shelter the client’s income. The BDO employee

would discuss the distressed debt investment product, the steps and the mechanics

involved in the structured transaction, the types of investments the client would be

making in the overall transaction, and how the transaction would generate the

desired tax loss to offset income.

      In return for its devised structure and a tax opinion supporting the structure,

BDO would receive fees from the client. The fees were based on a percentage of

the tax loss to be generated, which depended on the character of the desired tax

loss: 8% to 10% for ordinary losses and 6% to 7% for capital losses. BDO would

also pay a fee to Gramercy for sourcing the distressed assets.

Gramercy’s Managed Account Business

      Beginning at least by 2000, BDO began to refer clients to Gramercy to

facilitate its clients’ participation in the BDO distressed debt structure. To

increase its client base, Gramercy was willing to accommodate these clients by

expanding its operations to include an element that Gramercy had not considered

before. This additional element involved the clients’ investing in distressed debts
                                        -9-

[*9] meeting BDO’s criteria outlined above (DAD account). In exchange for

implementing the distressed debts transactions through a DAD account, Gramercy

would require the BDO-referred client to make separate, additional investments in

instruments that mirrored Gramercy’s traditional hedge fund business and tracked

the GEMF (managed EMF account), appoint Gramercy as its investment manager

with respect to these accounts, and contribute to these accounts specified amounts

of cash. These two types of investments, a DAD account and a managed EMF

account, together formed what Gramercy has referred to as a “managed account”

for each client BDO referred.

      Each BDO-referred client or group of clients had his, her, or its own

managed account. For one managed account, the BDO-referred client (or a group

of these clients) would invest roughly 15% of the desired tax loss in the managed

account. To facilitate a distressed debt transaction, through a DAD account

meeting the criteria for a BDO distressed debt structure, Gramercy would source

the qualified distressed debts on BDO’s behalf and receive a fee from BDO in

return. For the managed EMF account, Gramercy invested in instruments of the

same type and in the same proportion as those in which the GEMF invested.
                                         -10-

[*10] Sourcing of the Distressed Debts

      Mr. Helie was responsible for sourcing accounts receivable used in the BDO

distressed debt structure and focused his search on receivables from Russian utility

companies with the type of inherent tax loss that BDO had asked for. In that

connection, he solicited help from two individuals with whom he had previously

worked, Rich Straughan and Gregor Short, to identify receivables that had

suffered from ruble devaluation in 1998. When he was able to identify potential

receivables to be acquired, he engaged a Russian law firm, ALM Feldmans, to

provide advice on the particular transaction.

      One such Russian utility company whose accounts receivable were so

identified was OAO Saratovenergo (Saratov). During the relevant times, Saratov,

an open joint stock company organized under the laws of the Russian Federation,

provided energy to consumers in the Saratov region of Russia and was part of the

Unified Energy System, which was a state-owned enterprise overseeing a

consolidated group of 72 electric generation facilities in Russia.

      During the negotiation over the transfer of its receivables, Saratov

expressed concerns that it would not immediately receive cash payment for its

receivables. Mr. Helie understood Saratov wanted cash for the receivables and not

an interest in a U.S. LLC. However, Saratov’s concern was ameliorated once it
                                         -11-

[*11] was told that it would receive cash payments for its receivables as soon as

BDO identified an individual or individuals who would participate in the BDO

distressed debt structure.

      In early 2002 ALM Feldmans, with Mr. Straughan’s assistance, engaged

John Hall, director of Legal and Financial Services Ltd., and provided him a

power of attorney from Saratov (Saratov POA).3 Acting ostensibly under the

Saratov POA, Mr. Hall formed EROSE LLC (EROSE), organized in Delaware, to

hold distressed foreign debt to be used in the BDO distressed debt structure.

Gramercy was the sole manager of EROSE from its inception. Around March 1,

2002, Mr. Hall, again acting ostensibly as “attorney for” Saratov under the Saratov

POA, executed an assignment agreement that purported to assign to EROSE all of

Saratov’s rights to and interests in certain accounts receivable in a total face

amount of RUB 2,195,102,103 that were due from 46 of its commercial customers

(Saratov receivables). The Saratov receivables represented approximately 13% of

Saratov’s total assets in book value. Using RUB/USD exchange rates for 1996,


      3
       We held an evidentiary hearing on March 1, 2013, on respondent’s motion
in limine challenging the authenticity of the Saratov POA. On March 22, 2013,
we denied respondent’s motion, finding that the Saratov POA was authentic.
However, the ruling left open the issue of “whether there was a valid and effective
transfer of the subject accounts receivable.” Our opinion today renders this issue
moot.
                                         -12-

[*12] 1997, and 1998, EROSE’s Form 1065 for 2002 reported this transfer as

“capital contributed” of $368,815,654 by Saratov.4 Gramercy recorded this same

amount as EROSE’s tax basis. Using the RUB/USD exchange rate of 31.027 on

the date of the contribution, the Saratov receivables had an equivalent face value

of $70,748,126 as of the date of contribution.

      The Saratov receivables were different from the type of emerging market

debt securities in which the GEMF would typically deal in that the Saratov

receivables were denominated in a local currency and much less liquid than many

other instruments, making it difficult to find a buyer at the time. The debt

instruments were also highly distressed and remained outstanding when they

appeared to be overdue by at least four years. Moreover, Saratov did not appear to

have any of the cross-border revenues or multinational assets that the GEMF

typically looked for to mitigate the impact of any currency devaluations. Finally,

the managed accounts did not have any concentration limits that Gramercy

imposed on the investments in the GEMF to prohibit the GEMF from investing

too heavily in one particular region or specific type of asset.

      Gramercy assigned a fair market value of $3,931,338 to the Saratov

receivables as of March 1, 2002, around the time when Saratov contributed the

      4
          The average implicit RUB/USD exchange rate would be 5.95176 to 1.
                                       -13-

[*13] receivables to EROSE. The fair market value was determined by applying a

percentage to the face amount of each receivable before converting that amount to

U.S. dollars using the then-applicable RUB/USD exchange rate. On March 2,

2002, Gramercy purportedly became a 1% member of EROSE by contributing to

EROSE promissory notes issued by entities owned by Gramercy’s principals and

with stated values of $39,710.49. The notes were unsecured and payable on

demand and bore annual interest of 3%.

      As contemplated by the overall BDO distressed debt structure, Saratov

(purportedly through Mr. Hall and Gramercy) entered into a collection and

servicing agency agreement on May 1, 2002 (collection agreement). The

collection agreement provided that Saratov would collect, service, and manage the

Saratov receivables for EROSE. Under the collection agreement, Gramercy would

be entitled to receive 10% of the face value of the Saratov receivables, or RUB

219,510,210 (10% deductible), before any payout to Saratov. Any collection in

excess of this 10% deductible would be shared between Gramercy (25%) and

Saratov (75%). In other words, Gramercy could receive up to 32.5% of the face

value of the Saratov receivables if Saratov collected 100% of the receivables at

their face value. Gramercy took no action other than entering into the collection
                                        -14-

[*14] agreement to collect on the Saratov receivables; no money was ever

collected from these receivables.

James A. Cochran and Richard Perlman

      In 2003 James A. Cochran and Richard Perlman worked for PracticeWorks,

Inc. (PracticeWorks), as chief financial officer and chairman of the board,

respectively. With the announcement in July 2003 of Eastman Kodak Co.’s

impending acquisition of PracticeWorks, which was consummated in October

2003, Messrs. Cochran and Perlman expected large payouts from their severance

packages and the sale of PracticeWorks shares and stock options; Mr. Cochran

projected a payout of approximately $5 million, and Mr. Perlman projected

approximately $17 million. In fact, Messrs. Cochran and Perlman reported wages

(including severance and compensation on the sale of PracticeWorks stock

options) of $4,679,610 and $12,049,049, respectively, on their 2003 Federal

individual income tax returns.

      In or around August 2003 BDO met with Messrs. Cochran and Perlman to

discuss investing in entities that managed distressed debt instruments. Mr.

Shanbrom was involved in the sale of the BDO distressed debt structure to Messrs.

Cochran and Perlman. To facilitate Messrs. Cochran’s and Perlman’s

participation in the promoted structure, BDO referred the two to Gramercy to
                                       -15-

[*15] become investors in Gramercy’s managed accounts, each of which would, as

noted above, consist of a DAD account investing in distressed Russian accounts

receivable, such as the Saratov receivables, and a managed EMF account that

mirrored and tracked the GEMF. After meeting with Gramercy in or about

September 2003, Messrs. Cochran and Perlman each entered into an investment

management agreement (IMA) with Gramercy and signed letters of representations

and warranties in connection with the IMA.

Transactions at Issue

      Mr. Cochran, Boyalik LLC, and Buyuk (Buyuk Transaction)

      Under his IMA with Gramercy, Mr. Cochran committed $600,0005 to

Gramercy for investment in instruments tracking those in which the GEMF

invested, i.e., sovereign and corporate debt in emerging markets. To compensate

BDO for its devised structure and introduction to Gramercy, Mr. Cochran, who

was earning an annual salary of $175,000 at PracticeWorks at the time, paid BDO

a $200,000 fee under a consulting agreement dated September 17, 2003, that did

not cover any other services BDO provided. Mr. Cochran paid BDO another


      5
        This amount equals 15% of the ordinary loss Mr. Cochran claimed on his
2003 Federal income tax return, see infra, which corroborates Mr. Shanbrom’s
testimony that a BDO-referred client was asked to invest in cash equal to 15% of
the anticipated tax loss.
                                       -16-

[*16] $5,000 fee under a Tax Audit Representation Agreement (TARA), but he

did not actually receive any services under the TARA. Mr. Cochran also paid

$25,000 for a tax opinion from Kilpatrick Stockton on the Buyuk transaction as

well as $5,000 to Register & Akers to prepare a report on Gramercy.

      Buyuk and Boyalik LLC (Boyalik), which Gramercy formed on May 27,

2003, both LLCs organized in Delaware, would become the LLCs used in

connection Mr. Cochran’s managed account. On September 26, 2003, EROSE

contributed certain portions of three of the Saratov receivables (Buyuk

receivables), with a face value of RUB 27,491,732 and a value of $66,486.64 as of

the date of contribution, to Boyalik in exchange for a 98.9% interest in Boyalik.

The Buyuk receivables were:

                                          Date of            Face value
                 Debtor                 origination           (in RUB)
       OAO Khimvolvokna                   6/30/1998           23,261,150
       AOOT Yershovsky Kam               12/31/1997              433,000
       AO Orashayemoye                   12/31/1997            3,797,582


      As a step of the integrated BDO distressed debt structure that contemplated

the forming of a partnership for Federal income tax purposes, Gramercy

contributed to Boyalik participation interests of 0.1849% in two promissory notes
                                       -17-

[*17] with a face value of $400,000 (Gramercy notes), or $739, in exchange for a

1.1% interest; Gramercy was named manager of Boyalik. For sourcing the Buyuk

receivables in connection with Mr. Cochran’s participation in the BDO distressed

debt structure, Gramercy sought and received fees from BDO of $64,600.

      Using the RUB/USD exchange rates applicable on the alleged dates of

origination, Boyalik recorded the total face value of the Buyuk receivables as

$4,528,047. As noted above, Gramercy assigned the Buyuk receivables a value of

$66,487 as of September 26, 2003. Gramercy arrived at this value first by

determining that the Buyuk receivables were worth 7.38% of their face value and

then by converting this amount to U.S. dollars using the prevailing RUB/USD

exchange rate, 30.5235, on September 26, 2003.

      On October 13, 2003, Mr. Cochran paid EROSE $60,579 for 90% of

EROSE’s 98.9% interest in Boyalik and replaced Gramercy as sole manager. On

the same day, Boyalik contributed the Buyuk receivables to Buyuk for a 98.9%

interest in Buyuk. As an integral step in the BDO distressed debt structure that

contemplated the forming of a partnership for Federal income tax purposes,

Gramercy contributed its participation interests of 0.1872% in the Gramercy notes

to Buyuk, valued at $748, for a 1.1% interest in Buyuk. Gramercy was the

managing member of Buyuk, and Mr. Cochran was not involved in Buyuk’s daily
                                        -18-

[*18] operations. For the investment management services, Gramercy charged

Mr. Cochran an annual fee equal to 3% of the net asset value held in Buyuk--in

contrast to the 1% the GEMF typically charged its clients--and a performance fee

equal to 20% of any net profit--the same percentage the GEMF charged its clients.

Gramercy valued the Buyuk receivables at $67,319 as of October 13, 2003, using

the then-prevailing RUB/USD exchange rate.6

      On November 1, 2003, Mr. Cochran contributed $539,421 in cash to

Boyalik, and Gramercy contributed $6,000 in additional participation interests in

the Gramercy notes. Together with his cash payment for his interest in Boyalik,

Mr. Cochran’s cash contribution on November 1 satisfied his commitment under

the IMA to invest $600,000 with Gramercy. On the same day, Boyalik contributed

the $539,421 in cash received from Mr. Cochran to Buyuk, and Gramercy

contributed additional participation interests in the Gramercy notes to maintain its

1.1% interest. Gramercy invested the cash contribution in the managed EMF

account.




      6
       As noted above, Gramercy decided the Buyuk receivables were worth
7.38% of their face value. Applying the RUB/USD exchange rate of 30.1462
prevailing on October 13, 2002, Gramercy assigned the Buyuk receivables a value
of $67,319.
                                        -19-

[*19] On December 22, 2003, Mr. Cochran contributed to Boyalik his account

held at Goldman Sachs that he and Gramercy valued at $3.4 million. Gramercy

contributed additional participation interests in the Gramercy notes to Boyalik to

maintain its 1.1% interest. By the end of 2003, EROSE had a 0.17% interest in

Boyalik; Mr. Cochran and Gramercy held 98.73% and 1.1% interests, respectively.

      At BDO’s direction, Gramercy, without considering whether it was a good

time to sell the Buyuk receivables, caused Buyuk to sell all of the Buyuk

receivables to GFS (a Gramercy entity) for $69,231 on December 26, 2003. The

face amount of the Buyuk receivables was $937,884 on that date.

      On its 2003 Form 1065, Buyuk reported an ordinary foreign currency gain

of $1,914 on the purported sale of the Buyuk receivables computed as follows:

      Security              Basis               Proceeds             FX Gain
  Khimvolokna              $56,958              $58,578               $1,620
  Yershovsky Kam             9,299                 9,563                 264
  Orashayemoye               1,060                 1,090                    30
      Total                 67,317                69,231               1,914

Buyuk allocated 98.9% of the foreign currency gain ($1,893) to Boyalik and 1.1%

($21) to Gramercy. Boyalik in turn allocated 90% of the foreign currency gain

($1,704) to Mr. Cochran and 10% ($190) to EROSE.
                                          -20-

[*20] On the 2003 Form 1065, Buyuk also claimed an ordinary loss deduction,

identified as “Sale of Debt Instruments - Section 988”, of $4,458,816 on the

purported sale of the Buyuk receivables computed as follows:

               Basis                   Proceeds                    Gain (Loss)
            $4,528,0471                 $69,231                   ($4,458,816)

        1
       The Buyuk receivables took a basis in the amount of the receivables’ face
value using the RUB/USD exchange rate applicable on the alleged dates of
origination.

Buyuk allocated the entire loss deduction claimed to Boyalik, which in turn

allocated 90% of the claimed loss, or $4,012,934, to Mr. Cochran and 10%, or

$445,882, to EROSE. On their 2003 Federal income tax return, Mr. Cochran and

his then wife claimed an ordinary loss deduction from Boyalik of $3,971,000,

which effectively offset approximately 85% of Mr. Cochran’s reported wages for

2003.

        Mr. Perlman, Bekoz LLC / RP Capital Partners LLC, and Beyazit LLC
        (Beyazit Transaction)

        The transaction relating to Mr. Perlman is effectively identical to that

involving Mr. Cochran. We will note only the main differences here.
                                       -21-

[*21] Under his IMA with Gramercy, Mr. Perlman was committed to invest

$1,650,0007 with Gramercy in instruments tracking the GEMF. Mr. Perlman paid

BDO $500,000 with respect to his Consulting Agreement and $20,000 with

respect to his TARA. Mr. Perlman also paid $75,000 to Kilpatrick Stockton for a

written tax opinion on the transaction and $5,000 to Register & Akers to prepare a

report on Gramercy.

      The equivalents of Buyuk and Boyalik are Beyazit LLC (Beyazit) and RP

Capital Partners LLC (RP Capital) (formerly Bekoz LLC),8 respectively, which

Gramercy also formed on the same day it formed Buyuk and Boyalik.

      On September 26, 2003, EROSE transferred certain Saratov receivables to

RP Capital (Beyazit receivables) with a face value of RUB 76,050,650 in

exchange for a 98.9% interest in RP Capital while Gramercy contributed

participation interests of 0.5114% in the Gramercy notes, or $2,046, for a 1.1%

interest; Gramercy was named manager of RP Capital. As was the case with Mr.

Cochran’s managed account, Gramercy’s becoming a member of RP Capital was



      7
      Again, this commitment represents 15% of the ordinary loss Mr. Perlman
claimed on his 2003 Federal income tax return.
      8
       This second-level LLC was first named Bekoz LLC. On November 13,
2003, Bekoz LLC was renamed RP Capital Partners LLC after Mr. Perlman. For
ease, we will refer to this second level LLC as RP Capital throughout the opinion.
                                       -22-

[*22] essential to the BDO distressed debt structure in relation to Mr. Perlman’s

managed account. The Beyazit receivables, which Gramercy valued at $183,917

as of September 26, 2003, included the following:

                                       Date of               Face value
                 Debtor               origination             (in RUB)
          OAO Khimvolokna              6/30/1998            74,850,650
          AOOT
           Saratovsky Kame1            6/30/1998              1,200,000

      1
       The Saratovsky Kame receivable was not listed in the assignment
agreement between Saratov and EROSE or in the contribution agreement between
EROSE and RP Capital; it was rather added as part of the Beyazit receivables in
November 2003. There is nothing in the record showing that an account
receivable due from AOOT Saratovsky Kame was transferred from Saratov to
EROSE or from EROSE to RP Capital or from RP Capital to Beyazit. While we
have reservations over whether the Saratovsky Kame receivable was ever
transferred from Saratov to EROSE and from EROSE to RP Capital, our opinion
today renders this issue moot.

      On October 13, 2003, Mr. Perlman paid EROSE $167,576 for 90% of

EROSE’s interest in RP Capital and replaced Gramercy as the sole manager. On

the same day, RP Capital contributed the Beyazit receivables to Beyazit for a

98.9% interest in Beyazit, and Gramercy contributed participation interests of

0.5178% in the Gramercy notes for a 1.1% interest. Gramercy valued the RP

Capital receivables at $186,220 as of October 13, 2003 using the prevailing

RUB/USD exchange rate on that date. Gramercy was again the managing member
                                       -23-

[*23] of Beyazit and charged Mr. Perlman the same percentage fees that it charged

Mr. Cochran in connection with his respective account; Mr. Perlman was not

involved in the daily operations of Beyazit.

      On November 1, 2003, Mr. Perlman contributed $1,482,424 in cash to RP

Capital, which RP Capital immediately contributed to Beyazit; Gramercy

contributed additional participation interests in the Gramercy notes. Mr.

Perlman’s cash contribution on November 1, 2003, together with his cash payment

for his interest in RP Capital, satisfied his commitment under the IMA to invest

$1,650,000 with Gramercy. On December 22, 2003, Mr. Perlman made an

additional contribution to RP Capital that Mr. Perlman and Gramercy valued at

$13,957,296,9 and Gramercy contributed additional promissory notes. By the end

of 2003, EROSE had a 0.12% interest in RP Capital; Mr. Perlman and Gramercy

had 98.78% and 1.1% interests in RP Capital, respectively.

      In a manner similar to the sale of the Buyuk receivables, Gramercy caused

Beyazit to sell the Beyazit receivables without considering whether it was the right

time to sell but rather did so at BDO’s direction. On November 19, 2003,

approximately one month after Beyazit acquired the Khimvolokna receivable from


      9
       The contribution consisted of Mr. Perlman’s account held at Goldman
Sachs and certain partnership interest in Ovenworks.
                                           -24-

[*24] RP Capital, Beyazit sold the receivable to GFS for $185,422 in cash.

Beyazit also sold the Saratovsky Kame receivable for $2,973 although it is unclear

from the record when Beyazit sold it.10 The face amount of the Beyazit

receivables on November 19, 2003, was $2,552,207.

       On its Form 1065 Beyazit reported an ordinary loss of $12,220,999 from the

sale of the Beyazit receivables as follows:

            Description             Sale price       Basis      Ordinary gain (loss)
 Sale of foreign currency --
  sec. 988                           $2,973          $2,938               $35
 Sale of foreign currency --
  sec. 988                          185,422         183,282              2,140
 Sale of debt instruments -- sec.
  988                               188,395       12,411,569      (12,223,174)
  Total                             376,790       12,597,789      (12,220,999)

Beyazit allocated 98.9% of the section 988 gain ($2,151) to RP Capital and 1.1%

($24) to Gramercy. Beyazit allocated the entire section 988 loss to RP Capital.

RP Capital in turn allocated 90% of the section 988 loss ($10,998,921) to Mr.

Perlman and 10% ($1,222,102) to EROSE. On their 2003 return, Mr. Perlman

and his wife reported a “foreign currency loss from flow-throughs” of




       10
        Beyazit’s 2004 Form 1065 listed December 26, 2003 as the date of the
sales of both receivables.
                                      -25-

[*25] $10,998,921, which effectively offset approximately 91% of their reported

wages for 2003.

Saratov’s Redemption of Its Interest in EROSE

      Throughout 2002 and 2003, Mr. Hall on Saratov’s behalf requested partial

withdrawals of Saratov’s interest in EROSE; Mr. Hall made these requests upon

the instruction of Mr. Straughan and the advice of Gramercy. Saratov’s

withdrawals, which together amounted to approximately 90% of what Gramercy

deemed to be the fair market value of the Saratov receivables ($3,931,338) around

March 1, 2002, are shown in the following table:

                  Request date                        Amount
                   8/21/2002                          $98,420
                   11/6/2002                           65,915
                  11/10/2002                          108,253
                   12/4/2002                          400,390
                    7/7/2003                          749,994
                   8/27/2003                          528,218
                   12/1/2003                          321,368
                  12/10/2003                          991,287
                  12/26/2003                          281,366
                    Total                           3,545,211
                                         -26-

[*26] According to Mr. Cochran’s account statement, $44,329 was expected to be

paid to Saratov in connection with the Buyuk receivables. Gramercy’s internal

accounting spreadsheet also shows $124,577 was expected to be paid to Saratov in

connection with the Beyazit receivables. Messrs. Cochran’s and Perlman’s

payments to EROSE were sufficient to pay these amounts to Saratov.

                                     OPINION

Burden of Proof

      Taxpayers generally bear the burden of proof in a partnership-level

proceedings such as these, see Rule 142(a); Welch v. Helvering, 290 U.S. 111

(1933), and petitioners conceded at trial that they have the burden of proof in these

consolidated cases.

Petitioners’ Tax Positions

      Petitioners, Boyalik and RP Capital, claim that the initial transfer of the

Saratov receivables to EROSE, a purported partnership for Federal income tax

purposes, was a valid transfer effected through the Saratov POA. Petitioners

further claim EROSE’s subsequent transfers of the Saratov receivables to them, as

well as their transfers of their respective receivables to Buyuk and Beyazit, all of

which purported to be partnerships for Federal income tax purposes, were also

valid transfers.
                                        -27-

[*27] Because the valid transfers were contributions of property to the

partnerships subject to the subchapter K nonrecognition rules, petitioners argue,

the partnerships each took a transferred basis of the receivables that they received.

See secs. 721(a) and (b), 723. In other words, petitioners argue that Saratov’s tax

basis in the Buyuk receivables--that is, the receivables’ face amount converted to

U.S. dollars using the prevailing RUB/USD exchange rates on the receivables’

origination dates--eventually became Buyuk’s tax basis in the same receivables,

which were transferred in a series of nonrecognition transactions from Saratov to

EROSE to Boyalik and finally to Buyuk. Similarly, petitioners maintain that

Saratov’s tax basis in the Beyazit receivables became Beyazit’s tax basis in those

receivables, which were transferred also in a series of nonrecognition transactions

from Saratov to EROSE to RP Capital and finally to Beyazit.

      According to petitioners, upon disposition of the receivables, Buyuk and

Beyazit each recognized a loss equal to the difference between the amount of cash

received and its tax basis in the receivables sold. Because the losses recognized

were losses inherent in the receivables in the hands of Saratov, petitioners

contend, any such built-in loss had to be allocated to the contributing partner who

had made the contribution in a nonrecognition transaction. Sec. 704(c). Because

Buyuk had acquired the Buyuk receivables from Boyalik in a nonrecognition
                                         -28-

[*28] transaction, Buyuk had to allocate--and did allocate--the recognized built-in

loss to Boyalik. See sec. 1.704-3(a)(8), (b)(1), Income Tax Regs. Similarly,

Beyzait had to and did allocate the built-in loss recognized from the disposition of

the Beyazit receivables to RP Capital. Id.

      If a partner contributes property with inherent loss to a partnership and

subsequently sells all or a portion of his or her partnership interest, the partnership

must allocate any built-in loss recognized from the disposition of the property to

the successor of the partnership interest in proportion to the partnership interest

transferred. Sec. 1.704-3(a)(7), Income Tax Regs. Consistent with this allocation

rule, Boyalik allocated 90% of the built-in loss flowing from Buyuk to Mr.

Cochran, and RP Capital allocated 90% of the built-in loss from Beyazit to Mr.

Perlman.

Respondent’s Positions

      Respondent does not dispute the manner in which the losses were allocated.

Instead, respondent attacks the entire series of transactions starting with Saratov’s

purported contribution of its receivables to EROSE. Respondent advances several

alternative arguments to support his disallowance of the claimed losses. They
                                        -29-

[*29] include:11 (1) Saratov’s contribution of the receivables to EROSE and

EROSE’s subsequent cash distributions to Saratov in redemption of its interest in

EROSE constituted a disguised sale of the receivables under section 707(a)(2)(B);

(2) Saratov’s contribution of the receivables to EROSE and EROSE’s subsequent

sale of its interests in Boyalik and RP Capital to Messrs. Cochran and Perlman

were in substance sales of the receivables to Messrs. Cochran and Perlman and

prearranged steps designed to improperly shift tax losses to Messrs. Cochran and

Perlman that should be collapsed under the step transaction doctrine; and (3) the

transactions at issue lacked economic substance. On the record before us, we

sustain respondent’s disallowance of the claimed losses under all of the three

alternative grounds.

Expert Reports

      We admitted a total of five expert reports and one expert rebuttal report at

trial, and the experts who wrote these reports testified and were cross-examined by

opposing counsel. See Fed. R. Evid. 702; Rule 143(g). In one instance, we

directed two adverse experts who offered diametrically opposing opinions on the

      11
        Respondent has advanced a number of different arguments in support of
the disallowance of the losses. Because we are able to reach our holding today
solely on the basis of disguised sales, substance over form and step transaction,
and the lack of economic substance, we express no opinions as to other theories
respondent has argued on his brief.
                                        -30-

[*30] same subject matter to testify concurrently in a manner described more fully

below. Our discretion to accept or reject an expert’s analysis in whole or in part is

broad. Crimi v. Commissioner, T.C. Memo. 2013-51, 105 T.C.M. (CCH) 1330,

1340 (2013) (citing cases). “We need not accept an expert’s opinion in its

entirety, * * * and we are not bound by an expert’s opinion that is contrary to our

own judgment”. Id. (citing Parker v. Commissioner, 86 T.C. 547, 562 (1986), and

Chiu v. Commissioner, 84 T.C. 722, 734 (1985)). To the extent that in reaching

our decisions today we have relied on an expert’s opinions submitted to us, we

will summarize those opinions below.

      Burd Report

      We recognize Gene Burd as an expert in Russian law, specifically Russian

currency control law, commercial aspects of the Russian civil law, Russian

corporate law, and Russian business practices.

             Currency Control System in Russia

      The Russian Federation has had a very strict foreign currency control

regime since the disintegration of the Soviet Union in 1991. In 1992 the Russian

Government adopted the Currency Control Law of 1992 establishing the

principles of the currency operation, authority and functions of the agencies of the
                                         -31-

[*31] currency control, rights and obligations of the residents and nonresidents,

and liability for violation of currency control legislation.

      The 1992 law divided transactions into two types: foreign currency

operations in the ordinary course of business and foreign currency operations

involving transfer of capital. The 1992 law required all payments between

residents and nonresidents to be made under the regulations established by the

Central Bank of the Russian Federation (CBRF). All transactions in violation of

the 1992 law were invalid and void.

      The 1992 law also established “authorized banks” to act as the CBRF’s

agents in carrying out certain specific functions under the currency control regime.

These authorized banks were responsible for monitoring and reviewing

compliance with the currency control laws, reviewing the merits of foreign

currency transactions, and supervising the correctness and completeness of

accounting and reporting in connection with transactions involving foreign

currency. The ultimate effect of the currency control regime was that no

transaction involving foreign currency could be legally carried out outside of the

regulatory supervision and control of the CBRF, its regional offices, or the

authorized banks.
                                        -32-

[*32] Mr. Burd opines that the transactions involving the Saratov receivables

would be considered transactions in connection with the movement of capital

subject to the restrictive currency control regime. These include Saratov’s having

a membership interest in EROSE, its redemption of its interest in EROSE, and its

payments to a nonresident that Saratov was required to make under the collection

agreement should it collect from the debtors. Thus, the contemplated transactions

would require special permissions in accordance with procedures established by

the CBRF, which included submission of a long list of documents and obtaining a

positive opinion, i.e., approval, from the Ministry of Economy. Permissions were

granted rarely and only on a discretionary basis.

      Mr. Burd further opines that the collection agreement would be virtually

impossible to implement given the onerous currency control restrictions. Under

the collection agreement, Gramercy was required to open a bank account into

which Saratov would deposit all collections on the receivables. Gramercy had two

options to effect this scheme: (1) establishing a ruble-denominated bank account

in Russia or (2) establishing an account in another currency outside Russia. To

implement the first option, Gramercy would need to obtain special permission in

accordance with Instruction 93-I dated October 12, 2000, On the Procedure for the

Establishment by the Authorized Banks of the Bank Accounts for Non-Residents
                                        -33-

[*33] in the Currency of Russian Federation and Execution of Transactions on

These Accounts (Instruction 93-I). Gramercy would essentially need to open a

branch office in Russia in order to meet the onerous filing requirements and

administrative procedures for doing so. The entire process was time consuming

and required assistance from local counsel to ensure compliance.

      If Gramercy were to open an account outside Russia, the payment scheme

contemplated by the collection agreement would require Saratov’s amending its

contracts with its debtors so that the debtors would transfer any payments directly

to Gramercy’s offshore account since intercompany payments in Russia were

customarily made only by direct bank transfers. It would also require Saratov to

issue notices to its debtors informing them of the change of ownership of the

receivables. Finally, Saratov’s debtors would also need to obtain special

permissions before they could make any direct payments to an account established

outside of Russia.

      The record does not show any of these steps were taken.

             Statute of Limitation

      Mr. Burd also questions whether Gramercy had sufficient information to

confirm that the statutory period of limitation had not run on the receivables and

that the receivables remained collectible. Mr. Burd has reviewed documents that
                                         -34-

[*34] purported to substantiate the claim that the statutory period of limitation had

not run on the assigned debts when Saratov purportedly transferred the accounts

receivable to EROSE. Mr. Burd concludes that the documents would be

insufficient to substantiate such a claim.

      A general period of limitation under the Russian Civil Code is three years.

The period begins to run when the creditor acquires the right to demand

performance, upon the expiration of any extended time for performance, or upon

the debtor’s admission of indebtedness; admission of indebtedness during the

statutory period would also restart the period of limitation. A reconciliation report

may serve as evidence of an admission of indebtedness. Although account

reconciliation reports were provided to substantiate the claim that the receivables

remained collectible when Saratov transferred them to EROSE, these reports, in

Mr. Burd’s opinion, did not provide the required details as to when the purportedly

admitted debts were incurred, when they were due, and whether the entire

obligation or only a portion had been admitted by the debtors. Without the

required information, the reconciliation reports were ineffective under the relevant

Russian laws to restart the period of limitation.
                                          -35-

[*35]          Barter Transactions

         During the mid-1990s when the Saratov receivables arose, there was a

shortage of working capital in Russia, resulting in frequent failure of companies to

meet their current obligations. Many private and state-owned enterprises did not

have sufficient cash in hand to make timely payments for the most necessary

equipment and supplies or to meet payroll obligations. Salary payments were

often delayed for months, and sometimes employees would have to sell or

exchange goods manufactured by their own companies, which had paid these

employees in kind with the manufactured goods, to sustain their livelihood.

         The financial situation facing the electric power industry was rather bleak.

Average salary arrears reached as high as 6 months and in certain regions up to 8

to 12 months. In 1998 only about 20% of any outstanding obligations was met

with cash payments and the rest was met with payments in kind and IOUs. Barter

transactions were time consuming and inefficient and did not always result in

actual cash collections. It was not unusual for parties to structure multiple

transactions to obtain required goods or to convert products to cash. The

prevalence of barter and debt settlement transactions resulted in the creation of

unofficial exchange markets with traders and brokers who connected various

deals.
                                         -36-

[*36]         Devaluation of Russian Ruble

        In 1998 the Russian ruble collapsed. On August 17, 1998, the Russian

Government devalued the ruble, defaulted on domestic debt, and declared a

moratorium on payment to foreign creditors. Within a month, the value of Russian

rubles fell from approximately 6.7 rubles to U.S. dollar to 21 rubles per dollar.

              Customary Business Practice Around 2002

        By 2002 the fiscal situation facing the Russian electric power supply and

distribution system improved significantly, and problems with nonpayment or

bartering in place of cash payments had been practically eliminated. However,

legal and business due diligence remained a crucial part of engaging in any

transactions with businesses in Russia. In the light of complex currency control

regulations, Western companies would conduct extensive due diligence before

doing any business in Russia. As a result, proper documentation of any

transaction was crucial, and transaction documents were verified and reviewed in

excruciating detail. It would thus be highly unusual for there to be a complete

absence of any pretransaction due diligence and failure to address basic

requirements of the currency control regulations in documenting a particular

transaction, as was the case with the Buyuk and Beyazit transactions. Mr. Burd

thus concludes that a Western business, like EROSE or Gramercy, would not
                                        -37-

[*37] engage in a transaction in Russia with the expectation of profit without

putting together a comprehensive document package that would be crucial in the

eventual and successful repatriation of these profits from Russia.

      Bean Report

      We recognize Professor Bruce Bean as an expert in Russian business

practices and business climate between March 1995 and June 2003.

      Generally, Professor Bean and Mr. Burd agree on many points relating to

the general environment in Russia in the 1990s . Their discussions of the

economic environment in Russia, barter transactions, and customary business

practices (e.g., the importance of extensive due diligence and documentation of

any transaction) are largely consistent. They disagree primarily in their

conclusions.

      Professor Bean points out that Saratov had some leverage for collecting

outstanding debts because its customers needed electricity. And since Saratov

provided electricity to a region that was relatively prosperous and well endowed

with oil and gas and productive agricultural land, Professor Bean opines--while

acknowledging he has no knowledge about Saratov’s business itself--that the

Saratov receivables were an attractive investment especially in the light of the

economic recovery and renewed optimism Russia experienced in the early 2000s.
                                          -38-

[*38] Professor Bean then concludes the transactions at issue were consistent with

for-profit business transactions and procedures entered into in Russia during the

relevant period and that the documentation and procedures used in these

transactions were consistent with the usual and customary business practices

prevalent in Russia at that time.

      While we find Professor Bean to be a credible expert witness, the

conclusory nature of his opinions compels us to give them little weight in reaching

our decision today. First, his conclusion that the Saratov receivables would make

an attractive investment was speculative and vague. Professor Bean’s report fails

to discuss with any specificity or detail how the obligors of these receivables

would be able to meet their obligations under the accounts. Professor Bean admits

in his report that he has no information on Saratov’s business and by extension its

debtors; thus we question how Professor Bean was able to conclude the Saratov

receivables would be a good investment without knowing anything about the

specific debtors. Finally, relying generally on the upward outlook of an economy

at the regional or national level is not, at least in these cases, sufficient to show

for-profit motive when, as Mr. Burd and Scott Calahan point out, the

countervailing factors would cause any prudent businessperson to pause before

making the investment.
                                         -39-

[*39] Moreover, Professor Bean fails to identify in his report how the documents

and procedures used in the transactions at issue, and which of these documents

and procedures, were consistent with the usual and customary business practices

in Russia at the time. Without any specifics, it is difficult for us to glean from

Professor Bean’s report what led him to his conclusion, especially when we

consider both Mr. Burd’s and Mr. Calahan’s detailed discussions of the type of

extensive due diligence and documentation required in a transaction similar those

in these cases.

      In sum, we give the Bean report little evidentiary weight.

      Concurrent Expert Witness Testimony--Mr. Burd and Professor Bean

      Following a pretrial conference and on the parties’ agreement, the Court

directed Mr. Burd and Professor Bean to testify concurrently. The procedure was

implemented in substantially the same way as in Rovakat, LLC v. Commissioner,

T.C. Memo. 2011-225, 102 T.C.M. (CCH) 264, 271 (2011), aff’d, ___ Fed. Appx.

___, 2013 WL 2948023 (3d Cir. June 17, 2013). See also Crimi v. Commissioner,

105 T.C. M. (CCH) at 1330. See generally Michael R. Devitt, “A Dip in the Hot

Tub: Concurrent Evidence Techniques for Expert Witnesses in Tax Court Cases”,

117 J. Tax’n 213 (2012) (discussing the concurrent testimony process more fully).

Insofar as the conclusions reached in the Burd report and the Bean report are
                                         -40-

[*40] diametrically opposed to each other, we cannot overstate the importance of

concurrent witness testimony in these cases. Moreover, through Mr. Burd’s and

Professor Bean’s concurrent testimony, we were able to flesh out some of their

reports’ conclusions, reasonably reconcile the experts’ varying conclusions when

possible, and when reconciliation was impossible, understand the basis for their

disagreeing opinions and decide which opinion to rely on.

      Both Professor Bean and Mr. Burd agree that doing business in Russia

would require extensive due diligence and strict compliance with documentation.

Both experts further agree that several steps in the transactions, such as the

payment mechanism under the collection agreement, would implicate the

restrictive currency control laws.

      Calahan Report

      We recognize Scott Calahan as an expert in asset management, including

the performance of due diligence and valuation of distressed debts.

             Saratov Receivables and Due Diligence

      The Calahan report’s observations on the statute of limitation applicable to

the receivables at issue, the Russian economy and commercial culture in the mid

1990s to early 2000s, and the type of due diligence an informed buyer would be

expected to conduct in connection with similar transactions are consistent with
                                         -41-

[*41] those in the Burd report and the Bean report. We will highlight only several

issues the Calahan report is able to supplement.

      Mr. Calahan observes that there was an absence of any credit analysis or

adequate due diligence and documentation of the debtors of the Saratov

receivables. He thus concludes Gramercy and EROSE had made “less than

serious” efforts to understand Saratov’s debtors and how to collect the receivables.

Mr. Calahan further opines this lackluster effort drastically reduced any ability to

resell the Saratov receivables to an informed and independent buyer as well as any

expected market price upon any resale.

      The Calahan report lists over 50 due diligence items that an informed buyer

would expect to review in a similar transaction. However, only a handful of the

due diligence items are found in the record. Having reviewed petitioners’

production during discovery and his own independent research, Mr. Calahan

concludes that there remained the uncertainty, among other uncertainties, as to the

existence of the companies identified as debtors and their ability to repay. Mr.

Calahan also questions whether the small expected return, if any, from the

distressed receivables--assuming all the uncertainties were favorably resolved to

the satisfaction of a fully capable U.S. investor--justified the work required and

the cost to properly evaluate and document the acquisition of the distressed debts.
                                        -42-

[*42] Mr. Calahan also notes that not all uncertainties were likely to be favorably

resolved.

      Finally, Mr. Calahan opines that the collection agreement was commercially

unreasonable and would have likely inhibited any remittances to Gramercy. Mr.

Calahan notes that collection agreements rarely have a deductible before payment

of any servicing fee. Mr. Calahan opines that it would be unlikely for Saratov to

be able to collect 10% or more of the Saratov receivables and that Saratov would

not have expected to often be paid any servicing fee as a result of the 10%

deductible in the collection agreement. Mr. Calahan further notes that Saratov’s

share of the upside on collection (i.e., 75% of any collection after the deductible)

was unreasonable since servicing and collection fees rarely exceed 30% to 40% of

monthly collections.

             Valuation of the Saratov Receivables

      Mr. Calahan has also appraised the Saratov receivables. The Calahan report

provides fair market values of the receivables on March 1, 2002 (i.e., around the

time when Saratov transferred the receivables to EROSE), September 26, 2003

(i.e., when EROSE transferred the Buyuk receivables and Beyazit receivables to

Boyalik and RP Capital, respectively), and October 13, 2003 (i.e., when Mr.

Cochran and Mr. Perlman purchased from EROSE their member interests in
                                         -43-

[*43] Boyalit and RP Capital, respectively). Mr. Calahan defines fair market

value to be the price at which property would change hands between a willing U.S.

buyer and a willing seller, neither being under any compulsion to buy or to sell

and both having reasonable knowledge of relevant facts. For each of the three

dates, Mr. Calahan provides valuations under two alternative assumptions: (1)

Saratov’s transfer of the Saratov receivables was a valid and effective transfer and

none of the uncertainties identified in the Calahan report existed; (2) the

uncertainties identified in the report did exist and had not been resolved, that is,

assuming the transaction as it actually existed.

      In general, the longer the debtor has gone without paying down the debt, the

lower the price buyers of that debt are willing to pay; obligations more than five

years past due are generally regarded as having little to no value. In appraising the

Saratov receivables, Mr. Calahan used the income method of valuation and the

market method of valuation; the valuation methods and the valuations themselves

are unrebutted and were not challenged at trial. Mr. Calahan then reconciled the

results from these two approaches. His reconciled values are approximately the

midpoint between the income method and market method values, subject then to

adjustment on the basis of his professional judgment. The following tables show

the valuation results:
                                           -44-

[*44] INCOME METHOD VALUATION

     1.    Assuming all uncertainties resolved satisfactorily
           Debtor               3/1/2002            9/26/2003   10/13/2003
      OAO
       Khimvolvokna               0.79%               0.29%       0.28%
      AOOT Yershovsky
       Kam                        0.39                0.16        0.15
      AO Orashayemoye             0.60                0.23        0.22
      AOOT Saratovsky
       Kame                       0.79                0.29        0.28

     2.    Assuming uncertainties not resolved
           Debtor               3/1/2002            9/26/2003   10/13/2003
      OAO
       Khimvolvokna               0.0%                0.0%         0.0%
      AOOT Yershovsky
       Kam                        0.0                 0.0          0.0
      AO Orashayemoye             0.0                 0.0          0.0
      AOOT Saratovsky
       Kame                       0.0                 0.0          0.0

MARKET METHOD VALUATION

     1.    Assuming all uncertainties resolved satisfactorily
           Debtor              3/1/2002             9/26/2003    10/13/2003
      OAO
       Khimvolvokna              0.44%                0.15%        0.14%
      AOOT Yershovsky
       Kam                       0.22                 0.07         0.07
      AO Orashayemoye            0.34                 0.11         0.11
      AOOT Saratovsky
       Kame                      0.44                 0.15         0.15
                                         -45-

    [*45] 2.     Assuming uncertainties not resolved
           Debtor             3/1/2002             9/26/2003   10/13/2003
     OAO
      Khimvolvokna               0.0%                 0.0%        0.0%
     AOOT Yershovsky
      Kam                        0.0                  0.0         0.0
     AO Orashayemoye             0.0                  0.0         0.0
     AOOT Saratovsky
      Kame                       0.0                  0.0         0.0

RECONCILED VALUATION

    1.    Assuming all uncertainties resolved satisfactorily
           Debtor             3/1/2002             9/26/2003   10/13/2003
     OAO
      Khimvolvokna              0.60%                0.20%       0.20%
     AOOT Yershovsky
      Kam                       0.30                 0.10        0.10
     AO Orashayemoye            0.45                 0.15        0.15
     AOOT Saratovsky
      Kame                      0.60                 0.20        0.20

    2.    Assuming uncertainties not resolved
           Debtor             3/1/2002             9/26/2003   10/13/2003
     OAO
      Khimvolvokna              0.0%                  0.0%       0.0%
     AOOT Yershovsky
      Kam                       0.0                   0.0        0.0
     AO Orashayemoye            0.0                   0.0        0.0
     AOOT Saratovsky
      Kame                      0.0                   0.0        0.0
                                         -46-

[*46] Cragg Report

      We recognize Michael Cragg as an expert in economics and finance,

specifically economic and financial analysis of cross-border transactions and

international capital markets.

      Dr. Cragg first opines that the transactions at issue were outside the scope of

Gramercy’s normal business. As the record shows, before its dealings with BDO

and in the Saratov receivables, Gramercy invested primarily in sovereign and

corporate securities denominated in U.S. dollars that were issued on the

international capital markets and subject to the laws of New York and the United

Kingdom. In contrast, the Saratov receivables bore none of these earmarks of

Gramercy’s investment philosophy. Dr. Cragg finds the Saratov receivables were

subject to unique risks, such as currency risk and Russian legal risk, that were

outside of Gramercy’s typical focus.

      Dr. Cragg believes Gramercy’s investment in the Saratov receivables failed

to follow its core investment strategies that were event and value driven. In the

context of distressed debt, an event-driven investment adviser would want to know

whether the distressed debt could be either restructured or repaid leading to

significant profits in the future. Event-driven strategy is highly sensitive to timing

relative to market events. However, Gramercy appeared to allow BDO to dictate
                                         -47-

[*47] when it had to sell the Saratov receivables as part of the BDO distressed

debt structure, and the record does not otherwise show the decision to sell the

receivables was prompted by any market events. A value-oriented strategy

involves selecting assets that are undervalued from a fundamental, future cashflow

perspective and require an analysis of the fundamental value of the assets. Dr.

Cragg does not believe Gramercy performed such an analysis, and we note here

Mr. Calahan’s valuation of the receivables based on the income method reveals

the receivables had little to no fundamental value.

      Dr. Cragg further opines that no rational investor could have expected that

collections would improve or produce a positive restructuring outcome as a result

of the BDO distressed debt structure or the collection agreement. Dr. Cragg

observes that credit restructuring normally involves active renegotiation to

influence the way in which a debtor repays its obligations. This may involve

liquidation of a debtor’s assets, renegotiating the specific terms of a credit

agreement, or influencing the credit collection process in other ways. However,

by entering into the collection agreement with Saratov after acquiring the debts,

Gramercy did nothing to further influence the collection process but instead

passed the role of the collector back to Saratov, which had already demonstrated

its inability to collect on the receivables throughout their lives; some of them had
                                         -48-

[*48] been incurred as early as 1997. Indeed, the Calahan report and the Cragg

report are in agreement in that Saratov had little to no economic incentive to

pursue the debtors and collect on the receivables as a result of the 10% deductible

in the collection agreement. The record bolsters Dr. Cragg’s conclusion since

there is no evidence of any collections on or attempts to restructure the Saratov

receivables.

      Dr. Cragg finally opines that no economically rational taxpayer would have

entered into the overall transactions involving the BDO distressed debt structure at

issue but for the tax benefits arising from the transactions. Dr. Cragg finds it

highly improbable that the substantial costs of the transactions could be overcome

by a combination of a large increase in the value of the ruble along with a massive

improvement in collections on the Buyuk receivables or the Beyazit receivables.

On the other hand, the anticipated magnitude of the claimed tax benefits

guaranteed the Buyuk transaction and the Beyazit transaction would be

individually profitable if those tax benefits were realized even if the values of the

receivables dropped to zero. In other words, on an after-tax basis, substantial

profits were guaranteed while on a pretax basis losses were virtually certain.

      At the time of the sales of the Buyuk receivables and the Beyazit

receivables, those receivables had face values of $937,884 and $2,552,207,
                                        -49-

[*49] respectively. Gramercy valued these two sets of receivables at $67,319

(Buyuk receivables) and $186,220 (Beyazit receivables) as of October 13, 2003

(i.e., approximately one to two months before the sales of the receivables);

Gramercy determined both values by applying the same predetermined percentage,

i.e., 7.38%. Taking into account petitioners’ limited upside potential under the

collection agreement (i.e., at the most 32.5% of the collections) and Gramercy’s

performance fee--assuming full collections on the receivables in a short time and

using the highest RUB/USD exchange rate between the exchange rate on October

13, 2003 and the exchange rate on December 26, 2003--the maximum values the

Buyuk receivables and the Beyazit receivables could achieve were $257,313 and

$700,818, respectively.

      On the other hand, the transaction costs in connection with the Buyuk

transaction and the Beyazit transaction were $295,579 and $767,576, respectively,

broken down as follows:
                                        -50-

[*50] Buyuk transaction
                   Payee                       Type               Amount
          EROSE                       Interest in Boyalik         $60,579
          BDO                         Consulting fee              200,000
          BDO                         Tax representation fee           5,000
          Register & Akers            Report on Gramercy               5,000
          Kilpatrick Stockton         Legal opinion                   25,000
                                                                  1
           Total                                                      295,579
      1
       The total transaction cost Dr. Cragg used in his report was $290,579. We
do not see how the lower transaction cost could have materially affected Dr.
Cragg’s eventual opinion.

      Beyazit transaction
                   Payee                       Type               Amount
          EROSE                       Interest in Boyalik        $167,576
          BDO                         Consulting fee               500,000
          BDO                         Tax representation fee           20,000
          Register & Akers            Report on Gramercy                5,000
          Kilpatrick Stockton         Legal opinion                    75,000
                                                                   1
           Total                                                       767,576

      1
        The transaction cost Dr. Cragg used in his report was $787,576. Dr. Cragg
testified that the actual transaction cost being lower did not materially affect his
conclusion. We agree.

In addition, Mr. Cochran and Mr. Perlman each incurred an additional 2% asset

management fee that they would not have incurred but for the BDO distressed debt
                                        -51-

[*51] structure. Dr. Cragg thus opines that without the anticipated tax benefits, it

was virtually impossible for the transactions to break even, even if in the

extremely unlikely event all of the Buyuk receivables or Beyazit receivables, as

the case may be, were fully collected. In contrast, the after-tax profits were

guaranteed. In conclusion, Dr. Cragg finds that a rational investor could not have

reasonably expected to make a nontax profit from either the Buyuk transaction or

the Beyazit transaction given the required increase in receivable recovery rates and

the required large appreciation in the ruble.

      Figure 1 below shows a combination of collection rates and exchange rates

that was necessary for the transactions to be profitable on a pretax basis.
                                       -52-

[*52]




                                     Figure 1

        Spirikhin Report

        We recognize Alexei Spirikhin as an expert in Russian Accounting

generally and specifically in reviewing and analyzing Russian financial

statements.
                                        -53-

[*53] Mr. Spirikhin reviewed and analyzed Saratov’s financial statements for the

years ending December 31, 2001 and 2002. He concludes the financial statements

were prepared in accordance with Russian accounting laws and Russian

Accounting Standards that all Russian companies were required to follow in

preparing financial statements. Under Russian accounting principles, Saratov had

to reflect on its financial statements ownership in all domestic and foreign entities

irrespective of the size of the investment. For 2002 Saratov did not report any

change to its long-term financial investments, including investments in

subsidiaries, affiliates or associate companies, and other organizations. On the

basis of this observation, Mr. Spirikhin opines that Saratov did not make any

capital investments to any overseas subsidiary, or more specifically, Saratov did

not establish EROSE as a subsidiary or invest in it. Mr. Spirikhin further opined

at trial that the financial statements do not reveal any evidence of any return on an

investment, including Saratov’s receiving a distribution in redemption of any

purported interest in EROSE, which would have been reported on Saratov’s

financial statements had it actually occurred.

      Further, the Khimvolokna receivables were specifically listed in the 2002

financial statements as one of the major debtors. However, the Khimvolokna

receivables were not similarly listed in the financial statements for the year ending
                                         -54-

[*54] December 31, 2003. Mr. Spirikhin also notes that in 2003 there was a

sizable bad debt writeoff but is uncertain as to whether the Saratov receivables

were among the debts that were written off. Mr. Spirikhin opines that one

possibility was that Saratov sold the receivables for less than their face value in

2003 and wrote off the losses then.

      Mr. Spirikhin also reviewed at trial Saratov’s account reconciliation reports

dated December 1, 2002, for Khimvolokna, Orashayemoye, and Yershovsky Kam,

which are in evidence. These reports are not invoices, but they are essential to the

preparation of a company’s financial statements in that they represent the amounts

the creditor and the debtor believe to be outstanding at a given time. On the

account reconciliation reports dated December 1, 2002, Saratov recorded

outstanding receivables due from Khimvolokna, Orashayemoye, and Yershovsky

Kam in amounts equal to or greater than the amounts purportedly transferred to

EROSE. On the basis of these observations, Mr. Spirikhin opines that Saratov

would not have created these reports if it had transferred the receivables to

EROSE and thus appeared to own the receivables at the end of 2002.

      Finally, we note that Professor Bean opined during the course of his

concurrent testimony that it was possible that Saratov believed it still owned the

receivables in 2002 and kept them on its books despite having transferred them to
                                           -55-

[*55] another entity for an interest in that entity. Professor Bean speculated that

Saratov might think that because nobody knew about the transaction, it wanted to

wait and see whether the transaction would actually succeed before reporting the

transaction on its financial statements.

Disallowance of the Claimed Loss Deductions

      Disguised Sales Under Section 707(a)(2)(B)

      Generally, a partner may contribute property to a partnership for an interest

in the partnership tax free. Sec. 721(a). Likewise, a partner may receive tax-free

distributions from the partnership of previously taxed capital. Sec. 731(a).

However, the disguised sales rule under section 707(a)(2)(B) treats a contribution

of property and a related distribution from the partnership as a taxable sale when

their combined effect is to allow the contributing partner to dispose of the

contributed property for money or other consideration. See sec. 1.707-3(a)(1),

Income Tax Regs. This is the case when the distribution would not have been

made but for the initial contribution of property and, in cases involving

nonsimultaneous transfers, the distribution is not dependent on the entrepreneurial

risks of partnership operations. Sec. 1.707-3(b)(1), Income Tax Regs. In other

words, with nonsimultaneous transfers, if the contributing partner’s capital is at

risk in the partnership for a sufficient time, the nonrecognition rules apply.
                                         -56-

[*56] Conversely, if contributed capital is not at risk and the subsequent

distribution bears no relationship to the entrepreneurial risks of the partnership’s

operations, the transfers are properly viewed together as a sale.

      Transfers treated as sales under the disguised sales rule are treated as sales

for all purposes under the Code. Sec. 1.707-3(a)(2), Income Tax Regs. The sale is

considered to take place on the date the partnership is considered the owner of the

property under general principles of Federal tax law. Id. For nonsimultaneous

transfers, the contributing partner is deemed to have exchanged the contributed

property for the partnership’s obligation to make a subsequent transfer or transfers

of money or other consideration. Id. See generally secs. 453 (installment sale),

1274 (time value of money rules); sec. 1.707-3(f), Example (2), Income Tax

Regs.12

      Under the regulations, reciprocal transfers between the partner and the

partnership made within two years give rise to a rebuttable presumption that the

transfers constitute a sale of the transferred property to the partnership. Sec.

1.707-3(c), Income Tax Regs. The taxpayer may rebut the presumption by

carrying his or her burden to show facts and circumstances that “clearly establish

      12
         We fully expect the parties to apply during Rule 155 computations the
rules of installment sales under sec. 453 and time value of money under sec. 1274
as is the case in the example in the regulations.
                                        -57-

[*57] that the transfers do not constitute a sale.” Id. (emphasis added); see

Superior Trading, LLC v. Commissioner, T.C. Memo. 2012-110, 103 T.C.M.

(CCH) 1604, 1613 (2012), aff’d, 728 F.3d 676 (7th Cir. 2013). The regulations

further provide 10 such facts and circumstances that may tend to prove the

existence of a sale. Sec. 1.707-3(b)(2), Income Tax Regs.

      In 2002 and 2003, following Saratov’s transfer of the Saratov receivables to

EROSE, Saratov received cash distributions from EROSE of at least $3.5 million,

or approximately 90% of the Saratov receivables’ value determined on the date the

receivables were transferred to EROSE (i.e., March 1, 2002). Following Mr.

Cochran’s and Mr. Perlman’s purchases of EROSE’s interests in Boyalik and RP

Capital, respectively, in October 2003, EROSE made cash distributions to Saratov

of $1,594,021 in December 2003.13 Hence, under the disguised sales regulations,

the presumption of a sale attaches. Unless petitioners can clearly establish the

transfers were not in fact sales of the receivables, EROSE is considered to have

bought the Buyuk and Beyazit receivables from Saratov and taken cost bases in




      13
         The cash distributions were partly funded by Mr. Cochran’s and Mr.
Perlman’s payments for their purchases of EROSE’s interests in the LLCs since
there is nothing in the record showing EROSE had other cash income to otherwise
enable the cash distributions.
                                         -58-

[*58] them of $44,329 and $124,577, respectively, subject to any adjustments

under sections 453 and 1274.14

      The record in these cases also compels the conclusion that the transfers are

properly characterized as a sale under the disguised sales regulations. First, it is

clear that EROSE’s cash distributions to Saratov would not have been made but

for Saratov’s transfer of the receivables. See sec. 1.707-3(b)(1)(i), Income Tax

Regs. Indeed, the cash distributions were entirely funded by money provided by

individuals such as Messrs. Cochran and Perlman who would not have bought into

the LLCs but for the receivables’ having the desired characteristics and tax

attributes. What is more, Saratov was initially concerned about the BDO

distressed debt structure but eventually agreed to participate in it after being

assured that it would receive cash for the receivables sometime after the initial

      14
         These were the amounts EROSE had agreed to pay and paid Saratov for
the receivables. Respondent appears to claim that EROSE took cost bases in the
receivables equal to what Messrs. Cochran and Perlman each paid for their
interests in Boyalik and RP Capital, respectively. But because the partnership is
considered the purchaser of the Saratov receivables under the disguised sales rule,
the reference point is what EROSE paid. In essence, and putting aside any
currency fluctuations between March 2002 and October 2003, Messrs. Cochran
and Perlman paid EROSE more than what EROSE paid Saratov for the Buyuk and
Beyazit receivables -- i.e., EROSE charged Messrs. Cochran and Perlman for the
receivables at 7.38% of the face amount while paid Saratov only 5%--and EROSE
pocketed the difference. But this does not change the fact that EROSE’s tax bases
must be its costs. We expect that during Rule 155 computations, these lower bases
will result in higher gains from the sales of the receivables to GFS.
                                        -59-

[*59] contribution. In other words, the contribution of the receivables and the

subsequent cash distributions were reciprocal transfers.

      Further, the record shows the Saratov receivables were not at risk in

EROSE’s hands and EROSE’s cash transfers to Saratov bore no relationship to the

entrepreneurial risks of the partnership’s operations. See sec. 1.707-3(b)(1)(ii),

Income Tax Regs. Petitioners argue that without Saratov and Gramercy’s joint

efforts to operate EROSE in a manner to monetize the receivables, there would

have been no cash available for distributions. As petitioners see it, there were

three ways for the so-called joint efforts to make a profit on the receivables: (1)

collecting on the receivables; (2) restructuring the receivables for a more favorable

collection outcome; and (3) selling the receivables to someone else. However,

under the BDO distressed debt structure, the Saratov-Gramercy “partnership”

could not have monetized the receivables in any of these three ways.

      Soon after Saratov transferred the receivables to EROSE, Gramercy, as

EROSE’s manager, outsourced the task of collection back to Saratov and did

nothing else to collect on the receivables or influence their collection. Before

entering into the collection agreement, Saratov had never been able to collect from

its debtors. And the arrangement under the collection agreement did nothing to

incentivize Saratov to “work harder” to pursue its debtors. To the contrary, the
                                        -60-

[*60] economic arrangement contemplated by the overall structure ensured that

Saratov would receive less than what it could collect, if anything, on the

receivables. If Saratov could successfully pursue its debtors to collect anything

without Gramercy’s assistance, Saratov, from an economic perspective, would not

have entered into the arrangement and agreed to turn over a part of its collection to

Gramercy, which offered no help at all. But because Saratov did join with

Gramercy in EROSE while retaining its role as the sole collector pursuing the

receivables, the parties could not have legitimately anticipated that Saratov and by

extension EROSE would collect even one ruble from the debtors.

      Indeed, other aspects of the record also support our finding that neither

Saratov nor Gramercy expected successful collection. Gramercy’s lackluster

efforts to document and perform due diligence on the debtors and the collectibility

of the receivables show Gramercy was never serious about collecting. Further,

there is no credible evidence that indicates either Saratov or Gramercy attempted

to comply or documented its compliance with the stringent foreign currency

control regime in Russia. The payment scheme under the collection agreement

likewise made any transfer of funds to EROSE virtually impossible without

overcoming a plethora of regulatory hurdles in Russia. In addition, Mr. Calahan’s

unrefuted valuation of the receivables shows they had little to no value. When
                                        -61-

[*61] viewed in the light of Mr. Calahan’s valuation, the 10% deductible imposed

by the collection agreement eliminated any incentives for Saratov to pursue its

debtors.15 Finally, no collection was ever in fact made. Together, the record

shows Saratov did not join Gramercy to operate EROSE to collect on the

receivables. Thus, any subsequent cash distribution by EROSE cannot be said to

depend on the entrepreneurial risks of the partnership’s operations in the context

of collection.

      The above analysis also informs our next finding, that Saratov and

Gramercy likewise did not expect that their “joint efforts” could effect favorable

restructuring outcomes for the receivables. We first note that Mr. Calahan’s

valuation of the receivables as nearly worthless makes incredible any claim that it

was realistically possible to restructure the debts. Further, as Dr. Cragg points out

in his report, debt restructuring requires active renegotiation to influence how the

debtor may repay its debts: for example, an increased interest rate in exchange for

a longer term of repayment coupled with reduced periodic payments, immediate

payment in satisfaction of the debt in exchange for substantial discount of the


      15
       Even the 7.38% valuation agreed upon by Saratov and Gramercy strongly
suggests that the parties did not believe any collection was likely to surpass the
10% threshold. Thus, we agree with Mr. Calahan and Dr. Cragg that Saratov had
no economic incentive to spend any efforts to collect on the receivables.
                                         -62-

[*62] debt’s balance, or threats of liquidation of debtor’s assets in foreclosure, and

so forth.

      In most cases, the level of pressure and influence the collector may bring to

bear is critical. But here Saratov continued to be the sole collector and had shown

that it could exert little influence on its debtors. Meanwhile, Gramercy did not use

any specialized skills, particular expertise, or commercial or political leverage to

pressure the obligors of the receivables to renegotiate the debts for a more positive

collection outcome. In fact, any skills or expertise Gramercy might have had in

restructuring distressed securities related to restructuring sovereign or corporate

debts, not consumer receivables that lacked the kinds of socioeconomic and

commercial characteristics inherent in sovereign or corporate debts that lent

themselves to restructuring.

      Had Saratov been able to restructure the receivables with its debtors without

Gramercy’s help, it would have been unnecessary for Saratov to enter into the type

of arrangement that it did with Gramercy. But the fact that Saratov did enter into

such an arrangement suggests that neither Saratov nor Gramercy anticipated any

successful restructuring would result from joining together under EROSE. Thus,

in the context of restructuring, EROSE’s cash distributions to Saratov had nothing
                                         -63-

[*63] to do with the entrepreneurial risks of the partnership’s operations since the

partnership never endeavored to restructure the receivables in the first place.

      Petitioners’ claim that EROSE could monetize the receivables by operating

to sell the receivables to someone else is likewise not supported by the record. It

is true that EROSE turned the receivables into cash by contributing the receivables

to a lower tiered LLC and then selling its interest in the LLC to tax-sensitive

individuals like Messrs. Cochran and Perlman. However, it was not EROSE’s

ingenuity or Gramercy’s entrepreneurial acumen that identified the individual

purchasers and facilitated the sales. In fact, it had always been part of the integral

plan, even before Saratov transferred its receivables to EROSE, that BDO would

be responsible for identifying prospective purchasers and referring them to

Gramercy; Gramercy’s sole role was sourcing distressed foreign accounts

receivable that met BDO’s criteria and becoming a “partner” of the LLC to

facilitate the implementation of BDO’s scheme. EROSE and Gramercy simply

had nothing to do with finding buyers of membership interests in LLCs that held

Saratov’s receivables. It is thus clear that BDO was the one that pledged the

funding of the cash distributions to Saratov by promising to find individuals like

Messrs. Cochran and Perlman to buy into the BDO distressed debt structure.
                                        -64-

[*64] Simply put, Saratov’s receipt of cash distributions from EROSE was not

dependent on any entrepreneurial risks of EROSE’s operations.

      Further, the money Saratov received from EROSE had never been subject to

any entrepreneurial risks of EROSE’s operations because BDO and Gramercy had

already agreed before the transfer of the Saratov receivables to pay Saratov about

5% of the face amount of any receivables that BDO was able to sell through the

structure. Upon the transfer of the Saratov receivables, Saratov and Gramercy

agreed Saratov’s interest in EROSE had a value of approximately $3.9 million. As

part of the BDO distressed debt structure, EROSE consistently sold to an

individual or a group of individuals 90% of its interest in an LLC that held some

portion of the Saratov receivables. Thus, in the aggregate, EROSE sold its

membership interests in all of the LLCs involved for approximately $3.5 million

($3.9 million × 90%), which also equaled 5% of the face amount of the Saratov

receivables using the exchange rate on March 1, 2002.16 EROSE in fact made cash

payments of approximately $3.5 million to Saratov within two years. With respect

to each bundle of receivables, Mr. Cochran’s account statement shows that




      16
           RUB 2,195,102,103 divided by 31.027 multiplied by 5% = $3.53 million.
                                       -65-

[*65] $44,329, or 5% of the Buyuk receivables’ face amount,17 was expected to be

paid to Saratov in connection with the Buyuk receivables. Similarly, Gramercy’s

internal accounting spreadsheet shows that $124,577, or 5% of the Beyazit

receivables’ face amount,18 was expected to be paid to Saratov in connection with

the Beyazit receivables. Mr. Cochran’s and Mr. Perlman’s cash payments were

each sufficient to cover the promised payments to Saratov, and EROSE paid

Saratov the agreed amounts. When viewing all these pieces together, we are

convinced that the money Saratov received was a fixed price negotiated between

the parties before Saratov allegedly transferred the accounts receivable to EROSE,

and the cash payments were thus not subject to any entrepreneurial risks of

EROSE’s partnership operations.

      Finally, Saratov’s economic position did not change and thus Saratov did

not bear any risk by transferring the receivables to EROSE. Because the

receivables were almost worthless, Saratov did not actually face any risks by

placing them with EROSE--the worst that could have happened was the highly


      17
        The face amount of the Buyuk receivables was RUB 27,491,732.
Converted to U.S. dollars using the RUB/USD exchange rate of 31.027 on March
1, 2002, the face amount was $886,058.
      18
       The face amounts of the Beyazit receivables was RUB 76,050,650.
Converted to U.S. dollars using the RUB/USD exchange rate of 31.027, it was
$2,451,111.
                                        -66-

[*66] unlikely event that BDO would fail to find buyers and Saratov would be left

with an interest in an LLC holding receivables that had always been worthless.

Moreover, relying on Mr. Spirikhin’s expert opinion and Mr. Bean’s testimony,

we believe that from Saratov’s accounting perspective, it did not actually give up

the receivables until it received cash from EROSE in 2003. This would explain

why the receivables appeared to remain on Saratov’s books for 2002.

      All in all, we find that the cash payments to Saratov did not result from

EROSE’s operations. We further find there was little risk that Saratov would not

receive the promised cash payments because BDO had assured Saratov that it

would make cash payments equal to 5% of the receivables’ face amount, which it

would fund using payments from individuals who agreed to participate in its tax

sheltering scheme. The assurance was virtually certain to materialize because the

potential after-tax profits the structure was expected to generate far exceeded what

BDO promised to pay Saratov, making it highly unlikely that BDO would fail in

finding tax-motivated investors.19


      19
        For Mr. Cochran, the expected return, in the form of an ordinary tax loss
of approximately $4 million, on his cash investment of $600,000 under his IMA
was 666%. For Mr. Perlman, the expected return ($10.99 million) on his cash
investment ($1.65 million) was also 666%. This clever and yet contrived
arithmetic, once unmasked, reveals the intent of BDO’s scheme to lure its
investors with and only with lucrative tax losses.
                                        -67-

[*67] Against the two-year presumption and the overwhelming evidence showing

that the cash payments to Saratov were not dependent on the entrepreneurial risks

of partnership operations, petitioners seek to rebut the presumption and persuade

us the transfers were not a sale by attempting to show that the 10 facts and

circumstances listed in the regulations were clearly absent in these cases.20 See,

e.g., sec. 1.707-3(f), Example (3)(iii), Income Tax Regs. (lack of sources to fund

distribution may be evidence of transfer not part of sale). Petitioners rely heavily

on the fact that Saratov did not have any legally enforceable right to a subsequent

distribution when it transferred the receivables, see sec. 1.707-3(b)(2)(ii), Income

Tax Regs., and that no one at that time was obligated to contribute cash or liquid




      20
         The regulations state that the listed 10 facts and circumstances “may tend
to prove the existence of a sale” but are otherwise silent on whether the converse
is true--namely, whether their absence may prove that reciprocal transfers are not
part of a sale. See sec. 1.707-3(b)(2), Income Tax Regs. Some commentators
have suggested that Example 3 in the regulations appears to indicate that a
taxpayer may rely on the absence of these factors to show a sale has not occurred.
See Laura E. Cunningham & Noël B. Cunningham, The Logic of Subchapter K: A
Conceptual Guide to the Taxation of Partnerships, 232 (4th ed. 2011); 2 William
S. McKee et al., Federal Taxation of Partnerships and Partners, para. 14.02[3][b],
at 19 (4th ed. 2007). This is the argument petitioners make in their brief. Because
we disagree with petitioners’ factual allegation underlying their argument (i.e.,
there is clearly an absence of any of the 10 factors from the transactions at issue),
we need not address the premise of their argument (i.e., a showing of the absence
of any of the 10 factors may tend to prove that related transfers are not part of a
sale).
                                         -68-

[*68] assets to effect any subsequent cash contribution, see sec. 1.707-3(b)(2)(iv),

Income Tax Regs.

      But the crucial and common theme to be gleaned from the 10 facts and

circumstances in the regulations and their examples is that if, at the time of the

earlier transfer, it was reasonably certain that the transferor would receive cash or

other consideration for the property transferred of an amount determinable with

reasonably certainty, the related transfers will be reclassified as a sale. See sec.

1.707-3(b)(2)(i), Income Tax Regs. Our findings today show that Saratov was

promised payments equal to 5% of the face amount of the Saratov receivables--

which were nearly worthless at the time of the transfer--upon BDO’s successfully

finding investors to pay for the receivables to be used in the structure. Neither

Saratov nor BDO showed any doubt that BDO could find such investors,

especially when we consider the fact that Saratov wanted only cash for the

receivables and was willing to part with the receivables for the time being without

being paid at once after BDO provided assurances that it could obtain the cash to

fund the promised distributions. The assurances were backed and secured by the

reasonable certainty that BDO would be able to raise $3.5 million with little

difficulty in a short time from investors who hoped to avail themselves of tens of

millions of dollars of tax losses through BDO’s structure. Thus, we cannot agree
                                           -69-

[*69] with petitioners that the facts and circumstances in these cases clearly

establish the transfers were not a sale.

      In sum, we conclude that Saratov’s transfer of the Saratov receivables to

EROSE and EROSE’s cash payments constituted an installment sale of the

receivables.21 As a result, EROSE’s bases in the Buyuk and Beyazit receivables

were cost bases to be computed under Rule 155. See supra note 12.

      Substance Over Form; Step Transaction

      Our disguised sales analysis naturally suggests the possible application of

the substance over form and step transaction doctrines. “To permit the true nature

of a transaction to be disguised by mere formalisms, which exist solely to alter tax

liabilities, would seriously impair the effective administration of the tax policies of

Congress.” Commissioner v. Court Holding Co., 324 U.S. 331, 334 (1945). For

the reasons outlined in our disguised sales analysis, the true substance of the

overall transaction was Saratov’s disposing of the Saratov receivables for cash

consideration. When negotiating with Saratov, Mr. Helie understood that Saratov

was ultimately interested in cash for its receivables. The amount of cash Saratov


      21
        In reaching our decision today by recharacterizing the purported
contribution and distributions as a sale in disguise, we do not intend to say one
way or another whether EROSE was a bona fide partnership for Federal income
tax purposes.
                                          -70-

[*70] would receive was already determined at the time of the initial transfer. It

was virtually certain from the outset that BDO would be able to collect sufficient

money from buyers interested in the tax attributes of the receivables to fund the

promised consideration to Saratov. Thus, the overall transaction was in substance

an installment sale of the receivables.

      Under the step transaction doctrine, we may collapse a series of formal steps

into a single transaction if: “the intervening steps are so interdependent that the

legal relations created by one step would have been fruitless without completion

of the later series of steps” (interdependence test), Superior Trading, LLC v.

Commissioner, 137 T.C. 70, 90 (2011) (citing Penrod v. Commissioner, 88 T.C.

1415, 1428-1430 (1987)), aff’d, 728 F.3d 676 (7th Cir. 2013); “the formally

separate steps are prearranged components of a composite transaction intended

from the outset to arrive at a specific end result” (end result test), id. at 89 (citing

True v. United States, 190 F.3d 1165, 1175 (10th Cir. 1999)); or “at the time of

taking the first step, there was a binding commitment to undertake the subsequent

steps” (binding commitment test), id. at 88-89 (citing Commissioner v. Gordon,

391 U.S. 83, 96 (1968)).

      The end result test clearly applies here because everyone involved in the

transaction had always expected from the outset of the transaction that Saratov
                                       -71-

[*71] would be paid a predetermined amount once BDO was able to find

individuals like Messrs. Cochran and Perlman to participate in its distressed debt

structure. Our disguised sales analysis supports this conclusion. Indeed, the

record shows many of the steps taken in the overall transaction were steps that the

BDO distressed debt structure deliberately choreographed to produce the promised

tax losses. See Superior Trading, LLC v. Commissioner, 137 T.C. at 90.

      The interdependence test is equally applicable here. In applying this test,

we inquire whether the intermediate steps accomplished valid and independent

economic or business purposes. Id. Petitioners would want us to believe that each

intermediate step had its own economic significance and served valid business

purposes. The record, however, simply does not support such a claim.

      Saratov’s placing the receivables with EROSE served only one purpose: to

facilitate the BDO distressed debt structure in exchange for a predetermined

amount of cash. Saratov did not bear any risks when it transferred the receivables

to EROSE because they were almost worthless.

      As to Messrs. Cochran and Perlman, if their goal was to invest in foreign

distressed debts, they could have purchased the debts directly. Messrs. Cochran

and Perlman claim they wanted to avail themselves of the liability protection

provided by an LLC because they were concerned about exposure to some
                                        -72-

[*72] unspecified risks resulting from their investment in the Russian receivables.

However, they have failed to articulate with particularity the risks to which they

feared they would be exposed. Further, they could enjoy liability protection by

either transferring any distressed debts that they acquired individually to an LLC

or forming a single-member LLC for purposes of acquiring distressed debts--in

either case, BDO’s highly structured scheme involving multitiered partnerships

would not be necessary to achieve the purported business purpose and bore no

independent economic significance.

      Finally, the only purpose for the eventual sales of the Buyuk and Beyazit

receivables to GFS was to trigger the inherent tax losses rather than for any

economic gain because the sales made at BDO’s direction were simply a shuffling

of the distressed receivables among the accounts Gramercy managed for other

individuals. Put another way, the sales made no economic sense because,

depending on the investment manager’s outlook, he or she would inevitably

undermine and harm the position of either the buyer or the seller, both of whom

were his/her clients.

      For these reasons, we can easily conclude that the various intermediate steps

engineered for the BDO distressed debt structure are properly collapsed into a
                                         -73-

[*73] single transaction.22 The transaction is simply Saratov’s sale of the

receivables to EROSE for a portion of what EROSE was then able to package as

membership interests in certain LLCs and to resell to Messrs. Cochran and

Perlman.

      Economic Substance

      As we have indicated earlier, the overall transaction engendered by the

BDO distressed debt structure also lacked economic substance. Although

taxpayers may generally structure their business transactions in a manner to

maximize their after-tax profits (i.e., producing the least amount of tax liability),

see Boulware v. United States, 552 U.S. 421, 430 n.7 (2008) (citing Gregory v.

Helvering, 293 U.S. 465, 469 (1935)), courts may nonetheless disregard

transactions that as a whole do not have economic substance compelled by

business realities and separate and apart from the resulting tax benefits, Frank

Lyon Co. v. United States, 435 U.S. 561, 583-584 (1978); Gilman v.

Commissioner, 933 F.2d 143, 148-149 (2d Cir. 1991), aff’g T.C. Memo. 1989-

684; see also ACM P’ship v. Commissioner, T.C. Memo. 1997-115, 73 T.C.M.

(CCH) 2189, 2214-2215 (1997), aff’d in part, rev’d in part on other grounds, 157

      22
        As to the binding commitment test, we find it inapplicable here because
there was no express binding commitment to undertake the various transactions in
the overall structure.
                                         -74-

[*74] F.3d 231 (3d Cir. 1998). The economic substance doctrine requires a

searching analysis that turns on the “‘objective economic substance of the

transactions’” and the “‘subjective business motivation’” behind them. ACM

P’ship v. Commissioner, 157 F.3d 231 at 247 (quoting Casebeer v. Commissioner,

909 F.2d 1360, 1363 (9th Cir. 1990), aff’g T.C. Memo. 1987-628, and aff’g Moore

v. Commissioner, T.C. Memo. 1987-626, and aff’g Sturm v. Commissioner, T.C.

Memo. 1987-625, and aff’g in part, rev’g in part Larsen v. Commissioner, 89 T.C.

1229 (1987)); Nicole Rose Corp. v. Commissioner, 117 T.C. 328, 336 (2001),

aff’d, 320 F.3d 282 (2d Cir. 2003); see also Rice’s Toyota World, Inc. v.

Commissioner, 752 F.2d 89, 91 (4th Cir. 1985), aff’g in part, rev’g in part 81 T.C.

184 (1983).

      The various Courts of Appeals disagree as to the appropriate relationship

between the objective and subjective prongs of the economic substance inquiry.

See John Hancock Life Ins. Co. (U.S.A.) v. Commissioner, 141 T.C. ___, ___ (slip

op. at 91) (Aug. 5, 2013) (citing cases from different circuits taking different

approaches to objective and subjective tests). Cases from the Court of Appeals for

the Second Circuit, to which these cases are appealable,23 can be construed as


      23
       At trial, the parties stipulated that these cases are appealable to the Court
of Appeals for the Second Circuit.
                                         -75-

[*75] applying the two tests disjunctively, conjunctively, or according to the facts

and circumstances without adhering to a rigid two-step analysis. See generally

United States v. Coplan, 703 F.3d 46, 91-92 (2d Cir. 2012) (noting that issue of

how to apply two tests is not settled in the circuit). But it appears courts in the

Second Circuit tend to apply a flexible and fluid approach. See Altria Grp., Inc. v.

United States, 694 F. Supp. 2d 259, 282 (S.D.N.Y. 2010); Long Term Capital

Holdings v. United States, 330 F. Supp. 2d 122 (D. Conn. 2004), aff’d, 150 Fed.

Appx. 40 (2d Cir. 2005); see also Gilman v. Commissioner, 933 F.2d 143.

Irrespective of how the Court of Appeals treats the relationship between the two

tests, our fluid and unitary analysis of the two prongs shows no economic

substance in the transactions at issue because petitioners have failed to establish

with credible evidence that there was ever any realistic possibility of making a

pretax profit on the Buyuk and Beyazit receivables or that they had any valid

business purpose other than acquiring the large tax benefits by entering into the

transactions. Consequently, we must disregard the transactions for Federal income

tax purposes and sustain respondent’s disallowance of the losses claimed.

             Objective Test

      A transaction generally has economic substance for Federal income tax

purposes if the transaction offers a reasonable opportunity for pretax profit.
                                         -76-

[*76] Gilman v. Commissioner, T.C. Memo. 1989-684 (1989), 58 T.C.M. (CCH)

1075, 1080 (1989), aff’d, 933 F.2d 143 (2d Cir. 1991); Rovakat, LLC v.

Commissioner, 102 T.C.M. (CCH) at 273 (citing Gefen v. Commissioner, 87 T.C.

1471, 1490 (1986)). A reasonable opportunity for pretax profit is present only if

there was a legitimate expectation that the nontax benefits would be at least

commensurate with the transaction costs. ACM P’ship v. Commissioner, 73

T.C.M. (CCH) at 2217. In some instances, tax losses that do not “correspond to

any actual economic losses, do not constitute the type of ‘bona fide’ losses that are

deductible” for Federal tax purposes. ACM P’ship v. Commissioner, 157 F.3d at

252.

       We agree with Dr. Cragg’s conclusion that there was no realistic possibility

for the transactions at issue to break even absent any tax benefits. Dr. Cragg

found the Buyuk and Beyazit receivables to have maximum values of $257,313

and $700,818, respectively. However, the transaction costs associated with the

Buyuk and Beyazit transactions were $295,579 and $767,576, respectively,

without including the 2% asset management fees Gramercy charged in connection

with the BDO distressed debt structure. Thus, it was virtually impossible for the

transactions to turn a profit even in the highly unlikely event the parties could

collect the full face amounts of the receivables.
                                         -77-

[*77] Gramercy valued the receivables at 7.38% of their face amount.24 Thus, this

valuation implicitly acknowledged that either collection within a short time

beyond 7.38% was unrealistic and in fact impossible or collection beyond 7.38%

was possible but costs associated with collection would yield a net value not much

more than 7.38% of the receivables’ face amount. In either case, the parties could

not have contemplated that collection would yield a net value much more than

7.38%. And as we discussed above, the manner in which the collection agreement

was structured provided no incentive for Saratov to expend any efforts to collect

on the receivables. Thus, substantial favorable movement in the RUB/USD

exchange rate was necessary to make up any shortfall in their values resulting

from uncollectibility. Figure 1 shows the combination of short-term collection

rates and exchange rate movement necessary to break even in the transactions.

Over a long period, however, the minimum required collection rates would likely

have to be even higher as a result of increased transaction costs associated with the

time value of money and the market cost of risk.25




      24
           Mr. Calahan’s unrefuted valuations are much lower.
      25
        But absent any extraordinary events, the actual collectibility would likely
be lower as the accounts receivable remained in default and outstanding for a
longer period.
                                         -78-

[*78] To generate collection at those rates in the short term, a rational investor

would expect from an economic perspective that Gramercy would have some

competitive advantage in collecting these types of debts and be aggressively

pursuing the debtors. In fact, Gramercy did not have such a competitive advantage

as its expertise and skills lay in sovereign and corporate debt instruments and not

consumer receivables. Nor had Gramercy expended any efforts, not to mention

extraordinary efforts, to pursue the debtors to improve collection or encourage

positive restructuring outcomes. Indeed, neither Saratov nor Gramercy ever

collected on the receivables. Moreover, substantial appreciation in the ruble was a

necessary condition for the transactions to turn a profit in all cases, but the record

shows no credible evidence that any of the participants in the transactions

expected or even contemplated that this would occur.

      Petitioners argue that there were ways other than collection for the

transactions to be profitable: restructuring the receivables, selling the receivables,

and speculating on the ruble. Petitioners also argue that Mr. Cochran’s and Mr.

Perlman’s investments in the managed EMF accounts (i.e., the second component

the managed account that tracked the GEMF) gave the transactions economic

substance. We disagree.
                                           -79-

[*79] The prospect of any positive restructuring of defaulted debts is inextricably

tied to the debts’ collectibility and the debtors’ business fundamentals. As we

noted, weak collection prospects render any favorable restructuring difficult.

Because the substantial transaction costs exceeded the Buyuk and Beyazit

receivables’ values determined on the basis of full collection, any restructuring

had to do better than what a combination of collection rates and favorable

exchange rate movement could yield in order to cover costs and generate profits.

Generally, as an economic and commercial matter, it is difficult for a holder of

highly distressed, long overdue debts to restructure the debts and to perform better

than collection on a dollar-to-dollar basis; i.e., if current collectibility is $10, the

net present value of the restructured debt, discounted for any market risks, will

unlikely exceed $10 absent strong fundamentals in the debts or the debtor’s

business. Particularly in these cases, we cannot see how a rational investor could

have reasonably expected a favorable restructuring outcome given our conclusion

that the receivables had little value, rendering collection unlikely, and the lack of

any evidence of strong fundamentals in the debts or the debtors. Further, as we

have said elsewhere, no one actually expended efforts to induce the debtors to

negotiate to restructure the accounts receivable, and Gramercy was simply sitting

on the sidelines and failed to be proactively involved in any restructuring process.
                                        -80-

[*80] Thus, we find that a rational investor could not have legitimately expected

positive restructuring outcomes on these facts.

      As to speculation on the ruble, collection would remain in the equation in

most cases. Figure 1 shows that 20% appreciation in the ruble was necessary to

generate any profits assuming 100% collection. Even if the ruble appreciated by

50%, the collection rate would still have to be approximately 50%. And assuming

no collections and relying on the assumption that the net value of 7.38% was

commercially reasonable, there had to be an 83% appreciation in the ruble for the

transactions to break even. There is no credible evidence that there was any

realistic expectation that the ruble would appreciate in that magnitude.

      Because it could not have been reasonably expected that positive economic

outcomes could result from collection, restructuring, or currency speculation, no

economically rational investor would have bought the receivables from the

partnerships unless that investor were also tax motivated. Thus, petitioners cannot

claim as a matter of law that they could have legitimately expected profits from the

transactions by selling the receivables to someone else.

      We must also reject petitioners’ suggestion that our economic substance

analysis should take into account Mr. Cochran’s and Mr. Perlman’s investments in

the managed EMF accounts. The investments in the managed EMF accounts were
                                       -81-

[*81] economically independent from the investments in the DAD accounts--that

is, Messrs. Cochran and Perlman could invest in the GEMF directly without

investing in the DAD accounts;26 nor did the managed EMF accounts have any

impact on the fundamental economics of the Saratov receivables or serve as a

hedge against the DAD accounts when the DAD accounts were on a pretax basis

sure losing investments to begin with. It would be a far cry from the essence of

the doctrine of economic substance if we allowed a taxpayer to instill substance in

an economically nonviable transaction by bundling it with an economically

unrelated transaction bearing some stuff of substance. “[O]ne economically

beneficial component of a much larger, complex transaction * * * does not impart


      26
        Further, Messrs. Cochran and Perlman could have invested directly in the
GEMF without incurring the additional 2% asset management fee that provided no
incremental benefit to them because Gramercy’s investment strategies as to the
managed EMF accounts were identical to those employed on the GEMF. Hence,
the additional fee can only be attributed to the DAD account component, which
our opinion today explains did not bear any valid nontax business purpose or
pretax profit potential.

       As Dr. Cragg correctly points out in his report, we can also ignore Mr.
Cochran’s contribution of his Goldman Sachs account to Boyalik and Mr.
Perlman’s contribution of his Goldman Sachs account and partnership interest in
Ovenworks to RP Capital. These assets were used to increase Mr. Cochran’s and
Mr. Perlman’s outside bases so that they could take the tax losses when Buyuk and
Beyazit sold the receivables and appeared to sit in the higher tiered LLCs walled
off from the managed accounts. Thus, these assets did not affect the fundamental
pretax economics of the transactions.
                                         -82-

[*82] economic substance to the larger * * * transaction.” WFC Holdings Corp. v.

United States, 728 F.3d at 746.

      At the end, the transactions here yielded only nominal economic gains, and

thus the claimed tax losses bore no relationship to the economic reality of the

transactions. There was never a legitimate or reasonable expectation of pretax

profits in these cases. We thus find that the transactions lacked objective

economic substance.

             Subjective Test

      The second part of the economic substance analysis inquires whether a

taxpayer has subjective nontax reasons to enter into a transaction and whether he

or she has a legitimate profit motive for doing so. Rice’s Toyota World, Inc. v.

Commissioner, 752 F.2d at 92. Whether a transaction is conducted with a

subjective business purpose depends on a number of subfactors, including

whether: (1) the taxpayer had a valid nontax business purpose for entering into

the transaction; (2) the transaction was negotiated and entered into at arm’s length;

(3) the taxpayer performed due diligence regarding the commercial viability and

market risks of the transaction; (4) in the case of a partnership, the partners

intended to join together for the present conduct of an undertaking or enterprise;

and (5) the transaction was marketed as a tax shelter in which the purported tax
                                         -83-

[*83] benefit significantly exceeded the taxpayer’s actual investment. Rovakat v.

Commissioner, 102 T.C.M. (CCH) at 274. These subfactors are not exclusive, and

no one subfactor is controlling. Id.

      As we discussed earlier, petitioners claim there were four ways for the

transactions to be profitable. We have already rejected petitioners’ claims, and we

need not repeat them here. It suffices to say that petitioners have not shown any

valid business purpose for engaging in the transactions but for the expected tax

losses inherent in the receivables. No part of the overall transaction was

“rationally related to a useful nontax purpose that is plausible in light of the

taxpayer’s conduct and useful in light of the taxpayer’s economic situation and

intentions * * * [all] evaluated in accordance with commercial practices in the

relevant industry.” ACM P’ship v. Commissioner, 73 T.C.M. (CCH) at 2217.

      Nor was any part of the overall transaction negotiated at arm’s length.

Gramercy and its related entities were on all sides of the transactions. When

Saratov purportedly transferred the Saratov receivables to EROSE, Gramercy

determined the value to be 7.38% of the face amount; Saratov was also promised

5% of the face amount. However, neither of these two valuations came close to

the fair market value of the Saratov receivables. The amounts Messrs. Cochran

and Perlman committed to invest under their respective IMAs were determined
                                        -84-

[*84] solely as percentages of the anticipated tax losses and did not appear

commensurate with their judgment of Gramercy’s competence and track record as

an investment adviser. The eventual sales of the Buyuk and Beyazit receivables

were simply an internal shuffling between Gramercy’s managed accounts that, as

we concluded earlier, had little economic significance. Finally, the collection

agreement was commercially unreasonable. Simply put, the transactions at issue

were highly structured with the only end game of generating tax losses.

      We have noted elsewhere that there is a lack of credible evidence showing

anyone had conducted the level of due diligence commensurate with the

complexity and the magnitude of the transactions at hand. Petitioners’ vague

claim that Mr. Helie and Mr. Shanbrom had gone to Russia to perform due

diligence is simply insufficient given the many uncertainties implicated by the

transactions.

      Our analysis under disguised sales concepts clearly shows Saratov and

Gramercy did not join together for the present conduct of an undertaking or

enterprise. See Rovakat v. Commissioner, 102 T.C.M. (CCH) at 275-276.

EROSE never endeavored to pursue the stated business purpose to collect on the

Saratov receivables, restructure the debts, or seek an independent, third-party

buyer of the receivables. This was also true for Boyalik/Buyuk and RP
                                         -85-

[*85] Capital/Beyazit because the economic arrangements did not change at these

lower level LLCs.

      Further, our opinion also shows that the structure at issue was not necessary

for Messrs. Cochran and Perlman to achieve their stated business objectives;

indeed, Messrs. Cochran and Perlman incurred additional transaction costs as a

result of the BDO distressed debt structure as compared to direct investments in

the GEMF. Mr. Cochran’s and Mr. Perlman’s stated desire to seek liability

protection to explain why they decided to join with Gramercy in the LLCs was

also not supported by the credible evidence in the record. As to Gramercy, its

reason to participate in the undertaking appeared to be to earn fees that it would

not have earned from typical hedge fund accounts and also to acquire new clients.

But these purposes bore no relationship to the stated business purpose of the

enterprise; instead they were merely incentives to induce Gramercy to help

facilitate the tax-motivated transactions.27 Thus, the parties at each step of the

transaction did not intend to join together in the present conduct of an

economically viable enterprise, and the overall structure was not a “genuine

multiple-party transaction”. See Frank Lyon Co., 435 U.S. at 562.

      27
        Moreover, as a sharp departure from its normal business practice with
respect to the GEMF, Gramercy had an equity interest in an LLC involved in the
BDO distressed debt structure that required the forming of a partnership.
                                        -86-

[*86] Finally, the BDO distressed debt structure was marketed as a tax shelter to

Messrs. Cochran and Perlman. Mr. Shanbrom, who was the person pitching the

tax sheltering product to Messrs. Cochran and Perlman, acknowledged that the

BDO structure was always marketed to investors as a tax shelter.

      For these reasons, in the light of the economic and commercial reality

underlying the transactions at issue, we find the transactions also lacked any bona

fide profit objective.

             Conclusion

      In sum, our unitary analysis of the two prongs of the economic substance

doctrine shows an economically rational investor could not have legitimately

expected any pretax profit potential in the Buyuk and Beyazit transactions, which

did not serve any valid nontax business purpose. We thus find the transactions

lacked economic substance.

Accuracy-Related Penalties

      Section 6662(a) and (b)(1), (2), and (3) provides that a taxpayer may be

liable for a 20% accuracy-related penalty on the portion of an underpayment

attributable to, among other things, negligence or disregard of rules or regulations,

a substantial understatement of income tax, or a substantial valuation

misstatement. Section 6662(h)(1) increases the penalty from 20% to 40% to the
                                        -87-

[*87] extent that the underpayment is attributable to a gross valuation

misstatement. A gross valuation misstatement exists where the value or adjusted

basis of the property claimed on a return is 400% or more of the amount

determined to be correct. Sec. 6662(h)(2)(A). If the value or adjusted basis of the

property is determined to be zero, the gross value misstatement penalty is

applicable. Sec. 1.6662-5(g), Income Tax Regs. In the Court of Appeals for the

Second Circuit, a gross valuation misstatement exists and thus the 400% penalty

applies where a claimed tax benefit is disallowed for lack of economic substance.

Gilman v. Commissioner, 933 F.2d at 150-152.

      An accuracy-related penalty under section 6662 does not apply to any

portion of an underpayment, however, for which a taxpayer had reasonable cause

and acted in good faith. Sec. 6664(c)(1). For partnerships, we inquire into a

taxpayer’s reasonable cause and good faith, or lack thereof, at the partnership

level, taking into account the state of mind of the general partner. New

Millennium Trading, LLC v. Commissioner, 131 T.C. 275, 279-280 (2008).

      Under any of the three grounds on which we sustain respondent’s

disallowance of the claimed loss deductions, Buyuk and Beyazit grossly misstated

the values of their bases in the Buyuk and Beyazit receivables. Thus, respondent

has proved his prima facie case to impose the penalties.
                                       -88-

[*88] On brief, petitioners did not advance any arguments or articulate any

reasons as to why the accuracy-related penalties are not warranted. Thus, we find

that petitioners have conceded the issue and sustain respondent’s determination of

the penalties. Zapara v. Commissioner, 124 T.C. 223, 233 (2005), aff’d, 652 F.3d

1042 (9th Cir. 2011); see also Higbee v. Commissioner, 116 T.C. 438, 446-447

(2001).



      Any arguments not discussed in this opinion are irrelevant, moot, or lacking

in merit.

      To reflect the foregoing,


                                                  Decisions will be entered under

                                              Rule 155.
