                                      SUPERIOR TRADING, LLC, JETSTREAM BUSINESS LIMITED, TAX
                                       MATTERS PARTNER, ET AL., 1 PETITIONERS v. COMMISSIONER
                                                OF INTERNAL REVENUE, RESPONDENT

                                               Docket Nos. 20171–07,           20230–07,         Filed September 1, 2011.
                                                           20232–07,           20243–07,
                                                           20337–07,           20338–07,
                                                           20652–07,           20653–07,
                                                           20654–07,           20655–07,
                                                           20867–07,           20870–07,
                                                           20871–07,           20936–07,
                                                           19543–08.

                                                  R denied losses claimed by Ps, tax matters or other partici-
                                               pating partners on behalf of purported partnerships, relating
                                               to distressed consumer receivables acquired from a Brazilian
                                               retailer in bankruptcy reorganization. R adjusted partnership
                                               items, attributing a zero basis to the receivables in lieu of the
                                               claimed carryover basis in the full face amount of the receiv-
                                               ables. R determined accuracy-related penalties under sec.
                                               6662(h), I.R.C., for gross valuation misstatements of inside
                                               bases. Held: Ps failed to establish that the distressed con-
                                               sumer receivables had any tax basis upon transfer from the
                                               Brazilian company. Held, further, the purported contribution
                                               of the receivables by the Brazilian company to a nominal part-
                                               nership and the subsequent redemption of the Brazilian com-

                                         1 Cases of the following petitioners are consolidated herewith: Nero Trading, LLC, Jet-

                                      stream Business Limited, Tax Matters Partner, docket No. 20230–07; Pawn Trading, LLC,
                                      Jetstream Business Limited, Tax Matters Partner, docket No. 20232–07; Howa Trading,
                                      LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20243–07; Queen Trad-
                                      ing, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20337–07; Rook
                                      Trading, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20338–07; Galba
                                      Trading, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20652–07; Tiberius
                                      Trading, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20653–07; Tiffany
                                      Trading, LLC, Walnut Fund, LLC, Tax Matters Partner, docket No. 20654–07; Blue Ash Trad-
                                      ing, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20655–07; Lyons
                                      Trading, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20867–07;
                                      Lonsway Trading, LLC, Bengley Fund, LLC, Tax Matters Partner, docket No. 20870–07; Ster-
                                      ling Trading, LLC, Jetstream Business Limited, Tax Matters Partner, docket No. 20871–07;
                                      Good Karma Trading, LLC, Jetstream Business Limited, Tax Matters Partner, docket No.
                                      20936–07; and Warwick Trading, LLC, Jetstream Business Limited, a Partner Other Than the
                                      Tax Matters Partner, docket No. 19543–08.


                                      70




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                                               pany’s partnership interest are properly treated as a single
                                               transaction and recharacterized as a sale of the receivables.
                                               Held, further, Ps did not substantiate the amount paid for the
                                               receivables, and therefore the receivables have a zero basis for
                                               Federal tax purposes following their transfer. Held, further,
                                               Ps were unable to demonstrate good faith and reasonable
                                               cause, and therefore the accuracy-related penalties are sus-
                                               tained.

                                        Paul J. Kozacky, John N. Rapp, Jeffrey G. Brooks, John A.
                                      Cochran, and Ralph Minto, Jr., for petitioners.
                                        Lawrence C. Letkewicz and Laurie A. Nasky, for
                                      respondent.
                                         WHERRY, Judge: Each of these consolidated cases con-
                                      stitutes a partnership-level proceeding under the unified
                                      audit and litigation provisions of the Tax Equity and Fiscal
                                      Responsibility Act of 1982, Pub. L. 97–248, sec. 402(a), 96
                                      Stat. 648, commonly referred to as TEFRA. The issues for
                                      decision are: (1) Whether a bona fide partnership was formed
                                      for Federal tax purposes between a Brazilian retailer and a
                                      British Virgin Islands company for purposes of servicing and
                                      collecting distressed consumer receivables owed to the
                                      retailer; (2) whether this Brazilian retailer made a valid con-
                                      tribution of the consumer receivables to the purported part-
                                      nership under section 721; 2 (3) whether these receivables
                                      should receive carryover basis treatment under section 723;
                                      (4) whether the Brazilian retailer’s claimed contribution and
                                      subsequent redemption from the purported partnership
                                      should be collapsed into a single transaction and recharacter-
                                      ized as a sale of the receivables; and (5) whether the section
                                      6662 accuracy-related penalties apply.

                                                                               Background
                                        The alphabet soup of tax-motivated structured transactions
                                      has acquired yet another flavor—‘‘DAD’’. DAD is an acronym
                                      for distressed asset/debt, the essential transaction at the core
                                      of these consolidated partnership-level proceedings. See the
                                      Commissioner’s ‘‘Distressed Asset/Debt Tax Shelters/Coordi-
                                      nated Issue Paper’’, LMSB–04–0407–031 (Apr. 18, 2007). It
                                        2 Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986,

                                      as amended and in effect for the years at issue, and all Rule references are to the Tax Court
                                      Rules of Practice and Procedure.




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                                      seems only fitting that after devoting countless hours in the
                                      last decade to adjudicating Son-of-BOSS transactions, we have
                                      now progressed to deciding the fate of DAD deals. And true
                                      to the poet’s sentiment that ‘‘The Child is father of the Man’’,
                                      the DAD deal seems to be considerably more attenuated in its
                                      scope, and far less brazen in its reach, than the Son-of-BOSS
                                      transaction.
                                         A Son-of-BOSS transaction seeks to exploit the narrow defi-
                                      nition of a partnership liability under section 752 to conjure
                                      up a tax loss. For a detailed description of the contours of a
                                      prototypical Son-of-BOSS transaction, see Kligfeld Holdings v.
                                      Commissioner, 128 T.C. 192 (2007). In a nutshell, the Son-
                                      of-BOSS stratagem pairs a contingent liability that evades the
                                      reach of section 752 with an asset and contemplates a con-
                                      tribution of the liability-ridden asset to a purported partner-
                                      ship. The euphemistically termed ‘‘taxpayer’’ then claims an
                                      artificially inflated basis as a consequence of the contribu-
                                      tion. Upon subsequently unwinding the contribution and set-
                                      tling the matching liability, the alleged partner contends that
                                      he has suffered a loss recognizable for tax purposes. See id.
                                         By contrast, a DAD deal is more subtle. Instead of a
                                      claimed permanent tax loss manufactured out of whole cloth,
                                      a DAD deal synthesizes an evanescent one. The loss is pro-
                                      claimed under authority of sections 723 and 704(c) from an
                                      alleged contribution of a built-in loss asset by a ‘‘tax indif-
                                      ferent’’ party to a purported partnership with a ‘‘tax sen-
                                      sitive’’ one. However, this loss is preordained to be nullified
                                      by a matching gain upon the dissolution of the venture. Con-
                                      sequently, the tax benefits sought by the tax sensitive party
                                      are, absent other factors, confined to timing gains. Moreover,
                                      claiming these benefits requires sufficient ‘‘outside basis’’,
                                      which, in turn, entails an investment of real assets.
                                         Because of a DAD deal’s comparatively modest grab and
                                      highly stylized garb, we can safely address its sought-after
                                      tax characterization without resorting to sweeping economic
                                      substance arguments. Those arguments have underpinned
                                      the judicial resolution of statutory provisions that have pro-
                                      tected the public fisc against the attacks of Son-of-BOSS
                                      opportunists. See, e.g., Cemco Investors LLC v. United States,
                                      515 F.3d 749, 752 (7th Cir. 2008); New Phoenix Sunrise Corp.
                                      & Subs. v. Commissioner, 132 T.C. 161, 185 (2009), affd. 408
                                      Fed. Appx. 908 (6th Cir. 2010); Jade Trading, LLC v. United




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                                      States, 80 Fed. Cl. 11 (2007), revd. on other grounds 598 F.3d
                                      1372, 1376 (Fed. Cir. 2010). Unlike the stilted single-entity
                                      Son-of-BOSS transaction, a DAD deal requires a minimum of
                                      two parties, with one willing to give up something of sub-
                                      stantive value. In an arm’s-length world, this would happen
                                      only if adequate compensation changed hands. Consequently,
                                      we need only look at the substance lurking behind the pos-
                                      ited form, and where appropriate, step together artificially
                                      separated transactions, to get to the proper tax characteriza-
                                      tion. But we are getting ahead of ourselves.

                                                                          FINDINGS OF FACT

                                      I. Introduction
                                        All of the consolidated cases involve, directly or indirectly,
                                      Warwick Trading, LLC (Warwick), an Illinois limited liability
                                      company. Our narrative begins on May 7, 2003, when War-
                                      wick entered into a Contribution Agreement (contribution
                                      agreement) with Lojas Arapua, S.A. (Arapua), a Brazilian
                                      retailer in bankruptcy reorganization. 3
                                        Arapua, a public company headquartered in Sao Paulo,
                                      Brazil, was at one time the largest retailer of household
                                      appliances and consumer electronics in Brazil. 4 Arapua’s
                                      growth had been driven, in large part, by its consumer credit
                                      program. Arapua had been the first company in Brazil to
                                      grant credit directly to its retail customers in order to
                                      increase sales.
                                        Many of Arapua’s credit customers had become delinquent
                                      in their payments, and some of these delinquent accounts,
                                      constituting Arapua’s past due receivables, were the subject
                                      of the contribution agreement. Pursuant to this agreement,
                                      Arapua purported to contribute to Warwick certain past due
                                      consumer receivables in exchange for 99 percent of the mem-
                                      bership interests in Warwick. At different times during the
                                      latter half of 2003, Warwick, in turn, claims to have contrib-
                                      uted varying portions of the Brazilian consumer receivables
                                      acquired from Arapua in exchange for a 99-percent member-
                                        3 Arapua had filed a petition on or about June 24, 1998, under the bankruptcy laws of Brazil.

                                      Arapua’s petition initiated a proceeding termed ‘‘concordata’’, which is the rough equivalent of
                                      a ch. 11 bankruptcy reorganization under the U.S. Bankruptcy Code.
                                        4 Arapua became a public reporting company in 1995, and at all times relevant here, filed

                                      quarterly and annual audited financial statements with ‘‘Comissao de Valores Mobiliarios’’
                                      (CVM), the Brazilian version of the U.S. Securities and Exchange Commission (SEC).




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                                      74                 137 UNITED STATES TAX COURT REPORTS                                        (70)


                                      ship interest in each of 14 different limited liability compa-
                                      nies (trading companies). 5
                                         Individual U.S. investors acquired membership interests in
                                      the various trading companies through yet another set of
                                      limited liability companies (holding companies). To accom-
                                      plish this, Warwick contributed virtually all of its member-
                                      ship interests in each given trading company to the cor-
                                      responding holding company. During the years at issue, Jet-
                                      stream Business Limited (Jetstream), then a British Virgin
                                      Islands company, was the managing member of Warwick and
                                      of each of the trading companies and holding companies. The
                                      tax matters or other participating partners of Warwick and
                                      the trading companies have brought these consolidated
                                      actions on behalf of their respective entities.
                                         All of these entities elected to be treated as partnerships
                                      for Federal income tax purposes and claimed a carryover
                                      basis in the Brazilian consumer receivables that were the
                                      subject of the contribution agreement. During 2003 and 2004,
                                      each of the trading companies wrote off almost the entire
                                      basis in its share of the Brazilian consumer receivables
                                      ostensibly resulting in business bad debt deductions and, in
                                      one instance, a capital loss.
                                         Individual U.S. investors holding membership interests in
                                      a given trading company, through the corresponding holding
                                      company, claimed the benefits of these deductions on their
                                      respective Federal income tax returns. Warwick also claimed
                                      losses on the sale of membership interests in the holding
                                      companies to the individual U.S. investors. Pursuant to
                                      TEFRA’s     unified    partnership-level     audit  provisions,
                                      respondent issued notices of final partnership administrative
                                      adjustment (FPAAs) denying these deductions and attacking
                                      the characterization of the transactions engaged in by War-
                                      wick and the trading companies on several grounds including
                                      lack of economic substance, the partnership antiabuse rules
                                      of section 1.701–2, Income Tax Regs., the disguised sale rules
                                      of section 707(a)(2)(B), and the transfer pricing rules of sec-
                                      tion 482. 6 Further, the FPAAs adjusted the partnerships’
                                        5 These trading companies, all of whose claimed deductions are at issue in these consolidated

                                      cases, are: Blue Ash Trading, LLC; Galba Trading, LLC; Good Karma Trading, LLC; Howa
                                      Trading, LLC; Lonsway Trading, LLC; Lyons Trading, LLC; Nero Trading, LLC; Pawn Trading,
                                      LLC; Queen Trading, LLC; Rook Trading, LLC; Sterling Trading, LLC; Superior Trading, LLC;
                                      Tiberius Trading, LLC; and Tiffany Trading, LLC.
                                        6 Respondent has since conceded the transfer pricing argument and declared that he ‘‘does not




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                                      (70)              SUPERIOR TRADING, LLC v. COMMISSIONER                                       75


                                      bases in the receivables to zero and determined accuracy-
                                      related penalties for gross valuation misstatements under
                                      section 6662(h).
                                        Petitioners timely petitioned the Court challenging the
                                      FPAAs. A trial was conducted the week of October 5, 2009, in
                                      Chicago, Illinois.
                                      II. Mr. Rogers’ Neighborhood
                                         The common thread that runs through these consolidated
                                      cases is a tax lawyer whose credentials and claimed expertise
                                      extend beyond tax law. Mr. John E. Rogers (Rogers) has a
                                      B.A. in mathematics and physics from the University of
                                      Notre Dame, a J.D. from Harvard Law School, and an M.B.A.
                                      from the University of Chicago, with a concentration in inter-
                                      national finance and econometrics.
                                         Rogers started his professional career in 1969 at the now-
                                      dissolved accounting firm Arthur Andersen, where he rose
                                      through the ranks to eventually become an equity partner.
                                      Rogers left Arthur Andersen in 1991 and went to work for
                                      a startup medical device company called Reddy Laboratories.
                                      The venture failed after the Food and Drug Administration
                                      denied the company’s application for a license. In 1992
                                      Rogers joined FMC Corp., a $5 billion company with oper-
                                      ations in over 100 countries. Rogers served as FMC Corp.’s
                                      director of taxes and assistant treasurer through 1997.
                                         In 1998 Rogers became an equity partner in Altheimer &
                                      Gray, a full-service law firm headquartered in Chicago,
                                      Illinois, with offices in Eastern Europe. Altheimer & Gray
                                      dissolved in 2003, and Rogers joined the Seyfarth Shaw, LLP
                                      (Seyfarth Shaw), law firm in July of that year. Rogers began
                                      as an income partner at Seyfarth Shaw but had become an
                                      equity partner in a little over a year. Rogers left Seyfarth
                                      Shaw at the end of May 2008, when he opened his own firm,
                                      Rogers & Associates. 7
                                      seek to reallocate the losses of Warwick or the trading companies to Arapua under I.R.C. § 482.’’
                                        7 Rogers is admitted to practice in the States of Illinois and Pennsylvania. He is also admitted

                                      to practice before the United States Tax Court, the Court of Appeals for the Seventh Circuit,
                                      the Court of Appeals for the Federal Circuit, the Court of International Trade, and the Inter-
                                      national Trade Commission.
                                        Rogers is a member of the International Fiscal Association, an international tax group. He
                                      has also been a trustee of the Tax Foundation, a publicly supported foundation that researches
                                      tax policy issues and publishes papers. Rogers has worked with the Governments of Puerto Rico
                                      and Romania in developing programs implementing their industrial taxation programs. Rogers
                                                                                                     Continued




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                                         Seeking to capitalize on his credentials as an international
                                      finance expert, Rogers asserts that he has developed a
                                      unique business model for simultaneously exploiting pricing
                                      inefficiencies in the retail and foreign exchange markets. The
                                      model consisted of servicing offshore consumer receivables
                                      and remitting the proceeds to the United States. Rogers
                                      claims that his expertise at analyzing probabilistic yield pat-
                                      terns enabled him to uncover hidden value in asset pools
                                      such as consumer receivables. Further, his keen under-
                                      standing of macroeconomic factors underlying exchange rate
                                      movements supposedly allowed him to opportunistically time
                                      the acquisition and disposition of offshore assets. Both of
                                      these abilities came together in his project that entailed
                                      investing in and managing distressed retail consumer receiv-
                                      ables overseas, which underlies this litigation.
                                         After allegedly researching and testing several different
                                      countries, Rogers decided to begin with Brazil in 2003.
                                      Rogers attributes this choice to the then-underdeveloped
                                      nature of the Brazilian collections industry and the rapidly
                                      appreciating Brazilian currency. He settled on Arapua receiv-
                                      ables for his initial foray, again after prospecting several
                                      large retail chains and their respective accounts receivables
                                      of varying vintage. He set up a tiered partnership structure
                                      for acquiring the Arapua receivables, consisting largely of
                                      postdated checks. Rogers contends that the tiered partner-
                                      ship structure was optimal given his envisaged exit
                                      strategy—a ‘‘roll up’’ followed by an initial public offering.
                                      III. DAD’s Army
                                        The deal began with the formation of Warwick and the
                                      transfer of distressed receivables from Arapua to Warwick.
                                      At the same time, Rogers formed a set of trading companies
                                      and a set of holding companies. As individual U.S. investors
                                      were found, Warwick transferred a portion of the receivables
                                      it had acquired from Arapua to a trading company, in
                                      exchange for a supermajority interest in the trading com-
                                      pany. Concurrently, Warwick exchanged most of its interest
                                      has written a number of publications, primarily on international tax matters, transfers of tech-
                                      nology, the use of low-tax jurisdictions, and the compensation of executives outside the United
                                      States. In 1997 Rogers was invited to testify before the House Ways and Means Committee on
                                      fundamental international tax reform. Rogers has taught courses on international finance as an
                                      adjunct instructor at the Illinois Institute of Technology.




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                                      in the trading company for a supermajority interest in a
                                      holding company, which it then sold to the individual U.S.
                                      investor.
                                         After a brief period, the trading companies claimed par-
                                      tially worthless debt deductions (and, in one instance, a cap-
                                      ital loss) with respect to the receivables in which they held
                                      interests. The trading companies also claimed miscellaneous
                                      deductions for amortization and collection expenses. All
                                      deductions that the trading companies claimed flowed to the
                                      individual investors through the holding companies. 8 War-
                                      wick itself claimed losses on the sales of interests in the
                                      holding companies and deductions for amortization.
                                         Rogers and petitioners describe the venture as one in
                                      which Arapua partnered with the following for servicing and
                                      collection of its ‘‘distressed’’ but ‘‘semi-performing’’ receiv-
                                      ables. In the first instance, Arapua ostensibly partnered with
                                      Warwick; and through Warwick, with the trading companies;
                                      and subsequently, through the trading companies, with the
                                      respective holding companies; and through the holding
                                      companies, with the ultimate individual U.S. taxpayers.
                                         As a consequence of this tiered partnership arrangement,
                                      Rogers and petitioners argue that pursuant to section 723,
                                      Arapua’s tax basis in its receivables carried over to Warwick.
                                      Rogers and petitioners claim this basis equals the receiv-
                                      ables’ face amount without any downward adjustment to
                                      account for their ‘‘distressed’’ quality. At some point, shortly
                                      after transferring its receivables, Arapua was redeemed out
                                      of its purported partnership with Warwick. However, because
                                      Warwick had not made a section 754 election, the section
                                      743(b) adjustment to the basis of partnership property did
                                      not apply. Thus, according to Rogers and petitioners, the
                                      basis of Arapua’s receivables in the hands of Warwick
                                      remained unchanged at the receivables’ face amount even
                                      after Arapua’s redemption.
                                         Soon thereafter, Warwick contributed the distressed receiv-
                                      ables to various trading companies. 9 Under section 723,
                                      Warwick claimed a basis in its partnership interest in each
                                      trading company in the amount of Warwick’s basis in the
                                      contributed receivables. This, in turn, equaled the receiv-
                                        8 See supra note 5, listing the trading companies whose claimed deductions are at issue in

                                      these consolidated cases.
                                        9 These include the companies listed supra note 5.




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                                      ables’ face amount. Also, under section 723, the trading com-
                                      pany took a basis in the receivables equal to Warwick’s basis
                                      in these receivables—again, the receivables’ face amount.
                                         Finally, the various trading companies sold, exchanged, or
                                      otherwise liquidated the distressed receivables through an
                                      ‘‘accommodating’’ party for the receivables’ fair market value.
                                      The resulting loss, equal to the spread between the face
                                      amount and the fair market value of the receivables, alleg-
                                      edly tiered up, and was allocated proportionately to the indi-
                                      vidual U.S. taxpayers holding membership interests in the
                                      holding companies under authority of section 704(c) and sec-
                                      tion 1.704–3(a)(7), Income Tax Regs.
                                         For a U.S. taxpayer to be able to report his allocable share
                                      of the loss on his individual tax return, he must have had,
                                      pursuant to section 704(d), adequate adjusted outside basis
                                      in his partnership interest in his or her holding company.
                                      Therefore, the individual U.S. taxpayers were required to
                                      contribute a substantial amount of cash or other significant
                                      assets, such as an investment portfolio, to the holding compa-
                                      nies to generate the required outside bases for section 704(d)
                                      purposes. Each individual U.S. taxpayer’s outside basis was
                                      subsequently reduced in the amount of the allowed loss from
                                      the sale or exchange of the distressed receivables. Con-
                                      sequently, the individual U.S. taxpayer was, absent actual
                                      unintended and unsought partnership economic losses, des-
                                      tined to later have gain upon the redemption of his partner-
                                      ship interest. Thus, any tax savings afforded by Rogers’ tax
                                      strategy would be limited to deferral benefits. Nonetheless,
                                      these timing gains can be substantial and build quickly.
                                                                                  OPINION

                                      I. Shutting the Barn Door
                                        As noted, the DAD deal delineated above entails a tax indif-
                                      ferent party purportedly contributing a built-in loss asset to
                                      a partnership, followed by a recognition of the built-in loss
                                      and its allocation to one or more tax sensitive parties. With-
                                      out commenting upon whether the sought-after tax
                                      characterization of this deal could ever have materialized
                                      under prior law, we note that ‘‘Recent legislation has limited
                                      the ability to transfer losses among partners.’’ Santa Monica
                                      Pictures, LLC v. Commissioner, T.C. Memo. 2005–104 n.81.




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                                        The American Jobs Creation Act of 2004 (AJCA), Pub. L.
                                      108–357, sec. 833, 118 Stat. 1589, amended sections 704,
                                      734, and 743 effective for transactions entered into after
                                      October 22, 2004. The amendments to section 704 provide
                                      that in the case of contributions of built-in loss property to
                                      a partnership, the built-in loss may be taken into account
                                      only by the contributing partner and cannot be allocated to
                                      any other partners. The amendments to section 734 make
                                      the basis adjustment rules of that section mandatory to any
                                      distribution where there is a substantial basis reduction.
                                      Similarly, the basis adjustment rules of section 743 are made
                                      mandatory to a transfer of a partnership interest with a
                                      substantial built-in loss. Together, these statutory changes
                                      are intended inter alia to prevent shifting a built-in loss from
                                      a tax indifferent foreign entity to a U.S. taxpayer through
                                      the use of a partnership. See H. Conf. Rept. 108–755, at 627
                                      (2004). 10
                                        Because the transactions that are the subject of these
                                      consolidated cases took place before October 22, 2004, none
                                      of the changes made by the AJCA to sections 704, 734, and
                                      743 apply to them. Our discussion, therefore, will be based
                                      upon the prior state of the law.
                                      II. Competing Characterizations
                                        Petitioners contend that ‘‘In 1954, congress [sic] enacted 26
                                      U.S.C. § 704(c), which calls for the tax result which the IRS
                                      challenges at trial’’. Petitioners point to ‘‘Treasury Regulation
                                      § 1.704–3(a)(7), promulgated in 1993, [which] states that a
                                         10 If changes made by the American Jobs Creation Act of 2004 (AJCA), Pub. L. 108–357, sec.

                                      833, 118 Stat. 1589, were to apply to a transaction similar to the one devised and marketed
                                      by Rogers and described above, then any amount of the loss attributable to the spread between
                                      the face amount and the fair market value of the distressed receivables that exists upon con-
                                      tribution will not be allocable to the U.S. taxpayer. Under amended sec. 704, the entire amount
                                      of this built-in loss would be reserved for allocation to the tax indifferent foreign entity as the
                                      contributing partner. If the tax indifferent foreign entity leaves the partnership before the re-
                                      ceivables are sold, then either amended sec. 734 or amended sec. 743 will apply to prevent the
                                      built-in loss from ever being recognized. The tax indifferent foreign entity could leave the part-
                                      nership by a sale or transfer of its partnership interest or by means of a liquidating cash dis-
                                      tribution. Upon a sale or transfer of the tax indifferent foreign entity’s partnership interest,
                                      amended sec. 743 would require a downward adjustment to the U.S. taxpayer’s share of the in-
                                      side basis in the receivables. For a liquidating cash distribution, amended sec. 734 would require
                                      a similar downward adjustment to the partnership’s inside basis in these receivables. Con-
                                      sequently, whether the tax indifferent foreign entity leaves via a sale or transfer of its partner-
                                      ship interest or by means of a liquidating cash distribution, the built-in loss in the receivables
                                      would be eliminated and could no longer become available for allocation to the U.S. taxpayer.




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                                      taxpayer ‘must’ allocate ‘built-in’ losses as Petitioners did
                                      here.’’
                                         Petitioners cite ‘‘Two seminal cases, Crane v. Commis-
                                      sioner, 331 U.S. 1 (1947), and Commissioner v. Tufts, 461
                                      U.S. 300 (1983), [to] establish the fundamental proposition
                                      that taxpayers get basis in assets purchased with borrowed
                                      money and may claim depreciation deductions—tax losses—
                                      on that basis.’’ Consequently, petitioners find nothing
                                      illogical or unnatural in a result where tax losses exceed a
                                      taxpayer’s economic losses.
                                         Petitioners refer us to ‘‘Frank Lyon Co. v. United States,
                                      435 U.S. 561, 583–84 (1978), [where] the Supreme Court
                                      approved depreciation deductions for a taxpayer who bor-
                                      rowed virtually the entire purchase price to acquire a
                                      building’’. Petitioners assert that the Supreme Court
                                      approved an outcome in which the taxpayer ‘‘leased the
                                      building back to its original owner for virtually its entire life,
                                      leading to deductions—also known as tax losses—that vastly
                                      exceeded the taxpayer’s cash investment.’’
                                         Respondent counters that the ‘‘deductions and losses,
                                      claimed in the years 2003 and 2004, should be disallowed for
                                      * * * [several] reasons.’’ Among the grounds that respondent
                                      advances is the argument that ‘‘The transactions engaged in
                                      by the trading companies had no independent economic sub-
                                      stance.’’
                                         We agree with petitioners that the mere fact that tax
                                      losses from a transaction exceed the accompanying economic
                                      losses does not render the transaction devoid of economic
                                      substance. Respondent contends at length that ‘‘Even
                                      assuming the most optimistic of revenue projections
                                      advanced by petitioners, the evidence is clear that the
                                      trading companies had no chance, let alone a realistic
                                      chance, of earning a single dollar of pre-tax profit.’’ We are
                                      not so easily convinced. Petitioners introduced considerable
                                      evidence at trial, some of it quite credible, that servicing of
                                      distressed Brazilian consumer receivables was attracting the
                                      interest and investment dollars of legitimate and sophisti-
                                      cated U.S. investors during 2003 and 2004. Moreover, the
                                      actual receivables that the purported partnerships acquired
                                      had, in fact, generated nontrivial revenues, 11 though it was
                                           11 Petitioner’s   expert, Mr. Henry Dunphy (Dunphy), testified credibly about ‘‘protesto’’, a par-




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                                      (70)              SUPERIOR TRADING, LLC v. COMMISSIONER                                        81


                                      not immediately apparent whether such revenues were large
                                      enough to justify the cash outlays.
                                        However, we need not resolve these fact-intensive issues in
                                      order to rule on Warwick’s and the trading companies’
                                      claimed losses and decide these cases.
                                      III. Validity of Contribution
                                         Two necessary conditions for the allocation of the built-in
                                      losses, in the Arapua receivables, away from Arapua and to
                                      the holding companies are: that Arapua be deemed to have
                                      formed a partnership with Jetstream; and that Arapua made
                                      a contribution, rather than a sale of the receivables, to that
                                      partnership.
                                         Whether a valid partnership exists for purposes of Federal
                                      tax law is governed by Federal law. See Commissioner v.
                                      Culbertson, 337 U.S. 733, 737 (1949); Commissioner v. Tower,
                                      327 U.S. 280, 287–288 (1946); Frazell v. Commissioner, 88
                                      T.C. 1405, 1412 (1987). Labels applied to a transaction for
                                      purposes of local law are not binding for purposes of Federal
                                      tax law. See Commissioner v. Estate of Bosch, 387 U.S. 456,
                                      457 (1967).
                                         For Warwick to have constituted a partnership between
                                      Arapua and Jetstream for Federal tax law purposes at the
                                      time that Arapua transferred its receivables, Arapua and
                                      Jetstream should have had a common intention to collec-
                                      tively pursue a joint economic outcome. The so-called check-
                                      the-box regulation, section 301.7701–3(a), Proced. & Admin.
                                      Regs., certainly allows ‘‘An eligible entity with at least two
                                      members * * * [to] elect to be classified as * * * a partner-
                                      ship’’. However, we remain far from persuaded that Arapua
                                      and Jetstream ever came together to constitute an ‘‘entity’’
                                      for this purpose.
                                         ‘‘Respondent contends that * * * Jetstream and Arapua
                                      did not intend to join together as partners in the conduct of
                                      ticularly effective method for collecting on unpaid checks in Brazil. The method consists of
                                      issuing to the check-writer a notice from a semiofficial agency, providing a final opportunity to
                                      make an acceptable payment of the check. If no acceptable (often a negotiated reduced amount)
                                      payment is received in response, the check-writer’s name is placed on a consolidated blacklist
                                      shared by all major Brazilian credit bureaus, adversely affecting the check-writer’s ‘‘ability to
                                      buy anything on credit or open a bank account.’’ Dunphy, who was engaged by petitioners as
                                      collections manager, employed the protesto method on the Arapua receivables with ‘‘a great deal
                                      of success’’. In his expert report and trial testimony, Dunphy indicated, on the basis of his prior
                                      experience and subjective analysis of comparables, that the collection yield on some selected
                                      tranches of the receivables could have been as high as 12 percent of the face amount.




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                                      a business.’’ We agree. As respondent points out: ‘‘Arapua
                                      and Rogers, the sole owner and director of Jetstream, each
                                      had different agendas.’’ Arapua’s sole motivation appeared to
                                      be to derive cash for its receivables in order to avert or delay
                                      a forced liquidation. By comparison, among other things,
                                      ‘‘Rogers wanted the receivables * * * because of their pur-
                                      ported built-in losses, which he could use to generate large
                                      tax deductions.’’
                                         Along the same lines, and for similar reasons, we are
                                      unconvinced that Arapua ever made a bona fide contribution
                                      of the receivables. Under section 721(a), the basis of property
                                      contributed to a partnership is preserved so that unrecog-
                                      nized gain or loss is deferred until realized by the partner-
                                      ship. However, section 721(a) applies only to a contribution
                                      of property in exchange for ‘‘an interest in the partnership’’.
                                      Arapua was not seeking to partner with Jetstream in serv-
                                      icing and extracting value from the receivables. Instead, it
                                      was looking for ready cash. If Arapua never considered itself
                                      a partner in a joint enterprise with Jetstream, it could not
                                      have contributed the receivables within the meaning of sec-
                                      tion 721(a). See, e.g., Wilkinson v. Commissioner, 49 T.C. 4,
                                      12 (1967) (‘‘We cannot believe that a hurriedly organized tour
                                      through sections 721 and 731 could yield such an absurd
                                      result.’’).
                                         The objective evidence regarding the stark divergence in
                                      the respective interests of Arapua and Jetstream with
                                      respect to the transfer of the receivables undermines peti-
                                      tioners’ cause. Even more troubling is petitioners’ failure to
                                      definitively account for Arapua’s so-called redemption from
                                      the purported partnership. Petitioners failed to establish
                                      exactly when and how Arapua was paid to give up its
                                      claimed partnership interest in Warwick. 12 While insisting
                                      that ‘‘Arapua did not sell the receivables to Warwick’’, peti-
                                      tioners nonetheless acknowledge that ‘‘Arapua received cash
                                        12 Petitioners claim that ‘‘In or about March, 2004 Arapua was redeemed out of Warwick.’’

                                      Further, they insist that ‘‘Rogers believes that Arapua was paid fair value for its redemption,
                                      which is a discount from what it wanted.’’ However, petitioners concede that ‘‘Rogers was unable
                                      to verify whether Arapua’s redemption occurred in dollars or [Brazilian currency]’’. Moreover,
                                      petitioners are unable to quantify this amount in either currency. Petitioners argue in their
                                      posttrial brief that ‘‘The weight of evidence suggests that Arapua was eventually redeemed out
                                      of the partnership for approximately 1.5% of historical notional value of the receivables.’’ (Em-
                                      phasis supplied.) Rogers himself admitted at trial that ‘‘My belief at this—and continues at this
                                      point, it was about 11⁄2 percent.’’




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                                      (70)              SUPERIOR TRADING, LLC v. COMMISSIONER                                       83


                                      for its interest in Warwick’’ within a year after entering into
                                      the contribution agreement. 13
                                        Under section 707(a)(2)(B), partner contributions may be
                                      recharacterized as sales if the contributing partner receives
                                      distributions from the partnership that are, in effect, consid-
                                      eration for the contributed property. The accompanying regu-
                                      lations establish a 2-year ‘‘sale harbor’’ presumption on
                                      either side of the purported contribution. See sec. 1.707–3(c),
                                      Income Tax Regs. (stating that ‘‘if within a two-year period
                                      a partner transfers property to a partnership and the part-
                                      nership transfers money or other consideration to the partner
                                      (without regard to the order of the transfers), the transfers
                                      are presumed to be a sale of the property to the partnership
                                      unless the facts and circumstances clearly establish that the
                                      transfers do not constitute a sale.’’). Petitioners have given us
                                      no reason to challenge respondent’s assertion that as a result
                                      of Arapua’s receipt of money within 2 years of transferring
                                      the receivables, ‘‘the transaction between Arapua and War-
                                      wick is presumed to be a sale under I.R.C. § 707(a)(2) and
                                      the regulations promulgated thereunder.’’
                                        We may conclude from petitioners’ failure to rebut this
                                      presumption that Arapua sold its receivables to Warwick
                                      rather than contributed them for a partnership interest. Con-
                                      sequently, the receivables’ basis in Warwick’s hands was
                                      their fair market value on the date of transfer instead of
                                      their historical basis in Arapua’s hands. With a fair market
                                      value basis on the date of transfer, the receivables could
                                      yield few or no losses that Warwick or any of the trading
                                      companies may claim.
                                        In addition to these foundational concerns that go to the
                                      very substance of whether a partnership was ever formed
                                      and whether a contribution was ever made, there remain
                                      questions regarding whether even the requirements of form
                                      were properly satisfied.


                                         13 Petitioners’ posttrial brief states that ‘‘Arapua remained a partner in Warwick throughout

                                      2003 and until March, 2004, when it was redeemed out of Warwick.’’ And though petitioners
                                      characterize Arapua’s redemption as occurring ‘‘much later than its contribution’’, the fact re-
                                      mains that by petitioners’ own admission, Arapua received cash for its Warwick partnership in-
                                      terest on Mar. 1, 2004, less than 10 months after transferring the receivables under the May
                                      7, 2003, contribution agreement.




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                                      IV. Foot Faults
                                        Respondent introduced credible evidence at trial chal-
                                      lenging compliance
                                      with numerous requirements of Brazilian law, such as obtaining the
                                      approval of the trustee and the judge overseeing Arapua’s bankruptcy pro-
                                      ceeding, having the Contribution Agreement, with a complete list of receiv-
                                      ables, translated into Portuguese and registered with a Public Registry of
                                      Deeds, and notifying the debtors of the assignments of their debts.

                                      Petitioners countered with expert testimony of their own
                                      questioning the applicability of some of these requirements
                                      and suggesting that customary business practice in Brazil
                                      often diverges from formal requirements of the letter of the
                                      law.
                                         We need not, and therefore do not, parse such conflicting
                                      testimony to decide definitively whether each applicable
                                      requirement of Brazilian law governing a transfer of title in
                                      the Arapua receivables was satisfied. It suffices for our pur-
                                      poses to note that petitioners carry the burden of estab-
                                      lishing by a preponderance of the evidence that Arapua made
                                      a valid contribution of the receivables to a partnership within
                                      the meaning of section 721(a). See Rule 142(a)(1); Welch v.
                                      Helvering, 290 U.S. 111, 115 (1933). By failing to credibly
                                      rebut respondent’s evidence on this issue, petitioners have
                                      failed to carry their burden and, consequently, have not
                                      established a valid section 721(a) contribution. 14
                                         14 Respondent’s expert on Brazilian law, Mr. Sergio Tostes (Tostes), who has been a practicing

                                      lawyer in Brazil for over 35 years and is currently a senior partner in a well-respected firm,
                                      opined that the ‘‘Contribution Agreements between Warwick and the trading companies are for-
                                      eign documents that are unenforceable in Brazil unless translated into Portuguese and reg-
                                      istered with a Public Registry of Deeds. In the absence of such registration, the assignments
                                      of the receivables are not valid against third parties, including the debtors.’’
                                         Petitioners’ Brazilian law expert, Ms. Maria Helena Ortiz Bragaglia (Bragaglia), a partner in
                                      what Tostes acknowledged was one of Brazil’s ‘‘leading firms’’, was of the opinion that the fail-
                                      ure to render a Portugese translation and obtain registration did not affect the contribution
                                      agreement’s validity per se. She conceded, however, that these requirements would have to be
                                      satisfied before bringing suit to enforce the agreement in Brazilian courts and, therefore, for the
                                      agreement to be effective against third parties.
                                         Bragaglia insisted that such third parties do not include the debtors, whose accounts were
                                      the subject of the contribution agreement. In her expert testimony, Bragaglia pointed to and out-
                                      lined the legal research that supported her view. Tostes claimed that ‘‘The majority of Brazilian
                                      scholars, led by the highly respected jurist Caio Mario, are of the view that a third party is
                                      anyone who is not a party to the agreement. In this case, that would include the debtors, since
                                      they are not parties to the Contribution Agreements.’’
                                         We need not, and do not, resolve the competing claims by Tostes and Bragaglia on this issue.
                                      Instead, we merely note that Bragaglia’s testimony fails to conclusively determine the weight
                                      of Brazilian legal authority bearing upon this question. Therefore, by relying exclusively on her
                                      expert opinion, petitioners have failed to adequately establish that the contribution agreement




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                                      (70)              SUPERIOR TRADING, LLC v. COMMISSIONER                                        85


                                      V. Arapua’s Financial Reporting
                                         Finally, even assuming arguendo that Arapua validly
                                      contributed the receivables to a bona fide partnership so that
                                      Warwick would inherit Arapua’s basis in the receivables, we
                                      are not convinced that that basis would equal the receivables’
                                      face amount. In fact, respondent offered compelling and
                                      unrebutted evidence suggesting that even a carryover basis
                                      for the receivables would be closer to zero than to their face
                                      amount. Respondent showed that ‘‘the receivables which
                                      Arapua transferred to Warwick had previously been contrib-
                                      uted to, and returned by, another limited liability company,
                                      MPATRN, LLC’’ in 2002, before the purported contribution of
                                      the same receivables to Warwick. 15 Moreover, as respondent
                                      argues, after the receivables were returned to Arapua,
                                      ‘‘Arapua removed the receivables from its balance sheet,
                                      would be enforceable against the debtors. In the absence of such enforceability, we cannot con-
                                      clude that the contribution agreement effected a contribution of the receivables from Arapua to
                                      Warwick recognizable for U.S. tax purposes.
                                        There was a similar difference in opinion between these two Brazilian law experts regarding
                                      any requirement for obtaining prior approval of the contribution agreement from ‘‘Arapua’s
                                      creditors and the trustee and the judge overseeing the concordata’’. Tostes asserted that these
                                      parties ‘‘had a right to challenge the Contribution Agreement and would have done so if it had
                                      been brought to their attention directly prior to its execution’’. Bragaglia contended that mention
                                      of the contribution agreement in Arapua’s quarterly and annual financial reports, which were
                                      placed in the files of the concordata proceeding, sufficed. Again, we refrain from choosing be-
                                      tween these differing opinions regarding Brazilian law and, instead, focus on the commonality
                                      between them. Reconciling the two expert testimonies, we conclude that prior approval of the
                                      contribution agreement would not have been required if the agreement constituted Arapua’s ‘‘or-
                                      dinary course of business’’ during its bankruptcy reorganization. Petitioners have not convinced
                                      us that the contribution agreement in fact comprised routine and normal operations for Arapua
                                      during that time. To the contrary, Rogers indicated in his trial testimony that he had ‘‘deter-
                                      mined that Arapua’s receivables were strategically valuable to the company’’ and Arapua viewed
                                      the contribution agreement with Warwick as a strategic partnering arrangement. We take that
                                      testimony to mean that Arapua was, as to a material asset, venturing out into hitherto unex-
                                      plored territory, a premise inconsistent with ordinary course of dealings.
                                        15 Respondent has presented credible circumstantial evidence that supports this finding. Re-

                                      spondent has shown that: (1) ‘‘On June 1, 2002, Arapua transferred * * * defaulted receivables
                                      which were more than 180 days past due to MPATRN, LLC’’; (2) ‘‘By May 2003, Arapua had
                                      received * * * 1.7% of the face amount, and MPATRN, LLC had returned * * * [the remainder]
                                      of the receivables to Arapua; (3) ‘‘Sometime before May 7, 2003, Rogers obtained a copy of the
                                      audited financial statement which Arapua had submitted to the CVM [the Brazilian version of
                                      the U.S. SEC, see supra note 4] for the period ended Dec. 31, 2002. As a consequence, Rogers
                                      was aware that Arapua had transferred receivables to MPATRN, LLC’’; (4) and Rogers subse-
                                      quently negotiated for a putative contribution of these receivables to Warwick. Petitioners
                                      counter this carefully reconstructed and plausible narration of likely facts with a blanket denial,
                                      stating that ‘‘Respondent has presented no evidence that the defaulted receivables purportedly
                                      transferred by Arapua to MPATRN are the same, similar or related to the Arapua Receivables
                                      contributed to Warwick.’’ Petitioners have failed to convince us that the Arapua receivables that
                                      were the subject of the contribution agreement had not been previously transferred and reac-
                                      quired by Arapua.




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                                      raising a serious question whether Arapua had any basis in
                                      the receivables which could carry over to Warwick.’’
                                        Petitioners counter by arguing that a zeroing out of the
                                      receivables from Arapua’s accounting statements prepared
                                      for financial reporting purposes is not determinative of their
                                      proper tax treatment for Federal tax purposes. 16 We
                                      acknowledge
                                      the vastly different objectives that financial and tax accounting have. The
                                      primary goal of financial accounting is to provide useful information to
                                      management, shareholders, creditors, and others properly interested; the
                                      major responsibility of the accountant is to protect these parties from being
                                      misled. * * * Consistently with its goals and responsibilities, financial
                                      accounting has as its foundation the principle of conservatism. * * * [Thor
                                      Power Tool Co. v. Commissioner, 439 U.S. 522, 542 (1979).]

                                      Regardless, we shall not simply ignore the fact that Arapua’s
                                      management believed, albeit conservatively, that the receiv-
                                      ables were close to worthless. ‘‘The primary goal of the
                                      income tax system * * * is the equitable collection of rev-
                                      enue; the major responsibility of the Internal Revenue
                                      Service is to protect the public fisc.’’ Id. In pursuit of that
                                      goal, we may properly consider Arapua’s internal assessment
                                      of the receivables’ intrinsic value, and its implied unre-
                                      covered cost of the assets, in imputing a basis to the receiv-
                                      ables for section 721(a) purposes. After all, ‘‘the purpose of §
                                      721 is to facilitate the flow of property from individuals to
                                      partnerships that will use the property productively * * *
                                      [by preventing] the mere change in form from precipitating
                                      taxation.’’ United States v. Stafford, 727 F.2d 1043, 1048,
                                      1053 (11th Cir. 1984).
                                        Since the Arapua receivables were never within the pur-
                                      view of Federal taxation before their transfer to Warwick, we
                                      see no reason why, at least in this instance, we may not
                                      derive these receivables’ proper Federal tax basis from their
                                      reported value on Arapua’s financial statements at the time
                                         16 Petitioners acknowledge ‘‘a large accounts receivable balance * * * in 2001 and then a

                                      smaller number * * * in 2002’’, accompanied by a similar decline in the provision for doubtful
                                      debts over the same period. Though petitioners concede that ‘‘a large part of the receivables
                                      were no longer there’’, they counter that ‘‘Rogers does not know if, in fact, the * * * Arapua
                                      Receivables were previously transferred to MPATRN.’’ Petitioners emphasize that ‘‘the losses
                                      with respect to the [eliminated] receivables were not used for the reduction of taxes (charged-
                                      off).’’ They claim that Arapua’s financial accounting disclosure of a decline in receivables ‘‘did
                                      not tell Rogers whether the Arapua Receivables were written off for U.S. tax purposes. * * *
                                      Rogers’ inference is that the receivables * * * were not written off for U.S. tax purposes, but
                                      that a tax re-contribution to capital of a partnership was made.’’




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                                      (70)              SUPERIOR TRADING, LLC v. COMMISSIONER                                        87


                                      of transfer. Again, petitioners have failed to persuade us
                                      otherwise. 17
                                        The grounds we have discussed thus far, viz, failure to
                                      establish a bona fide partnership and a valid contribution,
                                      and contravention of applicable local law requirements, are
                                      sufficient to sustain respondent’s FPAAs and deny Warwick
                                      and the trading companies the claimed losses. Yet we choose
                                      not to stop here. We persevere for two related reasons. First,
                                      we wish to underscore that petitioners’ failings are not
                                      merely those that could have been remedied with proper
                                      execution of the contemplated transaction. The transaction
                                      here is inherently flawed and will not deliver the sought-
                                      after tax consequences. Rogers’ knowledge of tax law and
                                      experience with tax practice should have put him on notice
                                      of this obvious flaw. His failure to take such notice and the
                                      issues analyzed above support the application of the section
                                      6662 accuracy-related penalty that respondent has deter-
                                      mined.
                                      VI. Stepping Stones
                                        Rogers arranged for a sequence of convoluted and inter-
                                      related steps to proceed with the acquisition and servicing of
                                      the Arapua receivables. Other than the tax outcome he
                                      sought, there was no logical reason for the many inter-
                                      mediate exercises. Arapua’s purported membership in War-
                                      wick was engineered solely to obtain a carryover basis for the
                                      receivables and retain their built-in loss. Further, Arapua’s
                                      subsequent redemption was apparently contrived to complete
                                      a disguised purchase of the receivables and remove Arapua
                                         17 Respondent’s Brazilian law expert, Tostes, opined that ‘‘Arapua had certainly written off the

                                      receivables for both financial and tax reporting purposes by May 7, 2003, when it transferred
                                      them to Warwick.’’ Petitioners contend that ‘‘independent auditors viewed the Arapua financials
                                      and concluded that the receivables were recorded as credits in Arapua’s balance sheet as taxable
                                      income in the end of the year income statement, thus proving Rogers’ belief that Arapua did
                                      not ‘charge-off ’ the receivables for reduction of taxes in any year’’. Since Rogers was not admit-
                                      ted as an expert in Brazilian law, his beliefs are irrelevant for the purpose of determining the
                                      receivables’ prior Brazilian tax treatment. Petitioners counter Tostes’ expert opinion by claiming
                                      that ‘‘According to Mr. Tostes, examination of the Arapua financial statements does not allow
                                      a definitive conclusion that the Arapua Receivables were written off.’’ However, the burden of
                                      establishing that the receivables had a carryover basis is on petitioners, and they fail to meet
                                      that burden by merely suggesting that respondent’s expert allows for a possibility that the re-
                                      ceivables might have had some tax basis under Brazilian law. Finally, petitioners point to Rog-
                                      ers’ conclusion that the receivables ‘‘had not been charged off in any way pursuant to U.S. in-
                                      come tax law.’’ Other than revealing petitioners’ keen grasp of the obvious, this contention has
                                      little probative value since the receivables were never within the purview of Federal taxation
                                      before their transfer to Warwick.




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                                      from the picture when the built-in loss was recognized. The
                                      recognized loss could then be allocated away from Arapua
                                      and entirely to the holding companies. In other words,
                                      Arapua’s entry and exit were timed to maneuver in between
                                      the constraints of partnership tax accounting rules to pre-
                                      serve and bring to fruition an alleged tax loss.
                                         Are we at liberty to collapse or step together the trans-
                                      action’s intermediate points and, in effect, trace a direct
                                      path? In answering this question, we begin with the general
                                      proposition that a transaction’s true substance rather than
                                      its nominal form governs its Federal tax treatment. See gen-
                                      erally Commissioner v. Court Holding Co., 324 U.S. 331
                                      (1945); Gregory v. Helvering, 293 U.S. 465 (1935).
                                         Before we can recast this or any transaction in a manner
                                      that makes its underlying substance obvious and relegates
                                      its overt form to the background, we subject the transaction’s
                                      many twists and turns to ‘‘a searching analysis of the facts
                                      to see whether the true substance of the transaction is dif-
                                      ferent from its form or whether the form reflects what actu-
                                      ally happened.’’ Harris v. Commissioner, 61 T.C. 770, 783
                                      (1974); see also Gordon v. Commissioner, 85 T.C. 309, 324
                                      (1985) (holding that ‘‘formally separate steps in an integrated
                                      and interdependent series that is focused on a particular end
                                      result will not be afforded independent significance in situa-
                                      tions in which an isolated examination of the steps will not
                                      lead to a determination reflecting the actual overall result of
                                      the series of steps’’); Smith v. Commissioner, 78 T.C. 350, 389
                                      (1982) (applying the step transaction doctrine ‘‘in cases
                                      where a taxpayer seeks to get from point A to point D and
                                      does so stopping in between at points B and C. * * * In such
                                      a situation, courts are not bound by the twisted path taken
                                      by the taxpayer, and the intervening stops may be dis-
                                      regarded or rearranged.’’).
                                         Courts generally apply one of three alternative tests in
                                      deciding whether to invoke the step transaction doctrine and
                                      disregard a transaction’s intervening steps. These tests, in
                                      increasing degrees of permissiveness are: The binding
                                      commitment test, the end result test, and the interdepend-
                                      ence test.
                                         The least permissive of the three tests, the binding
                                      commitment test, considers whether, at the time of taking
                                      the first step, there was a binding commitment to undertake




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                                      the subsequent steps. See Commissioner v. Gordon, 391 U.S.
                                      83, 96 (1968) (holding that ‘‘if one transaction is to be
                                      characterized as a ‘first step’ there must be a binding
                                      commitment to take the later steps’’). In applying this test,
                                      we ask whether at the time of Arapua’s supposed contribu-
                                      tion of the receivables, it was assured of being subsequently
                                      redeemed out of Warwick.
                                         Though there has been no specific finding of fact on this
                                      issue, we observe that in the absence of any such redemption
                                      of Arapua’s so-called partnership interest, the tax losses
                                      would have remained Arapua’s and could not have been allo-
                                      cated to the holding companies. Thus, the very design of the
                                      transaction contemplated a subsequent redemption of Arapua
                                      from Warwick. However, the binding commitment test ‘‘is
                                      seldom used and is applicable only where a substantial
                                      period of time has passed between the steps that are subject
                                      to scrutiny.’’ Andantech LLC v. Commissioner, T.C. Memo.
                                      2002–97, affd. in part and remanded in part 331 F.3d 972
                                      (D.C. Cir. 2003).
                                         Less than a year elapsed between Arapua’s entering into
                                      the contribution agreement and its claimed redemption from
                                      Warwick. 18 It is unclear whether the binding commitment
                                      test is appropriate in these circumstances. See id.; see also
                                      Associated Wholesale Grocers, Inc. v. United States, 927 F.2d
                                      1517, 1522 n.6 (10th Cir. 1991) (declining to apply the
                                      binding commitment test because the case did not involve a
                                      series of transactions spanning several years).
                                         The end result test focuses on the parties’ subjective intent
                                      at the time of structuring the transaction. See True v. United
                                      States, 190 F.3d 1165, 1175 (10th Cir. 1999) (holding that
                                      what matters is not whether the parties intended to avoid
                                      taxes but if they intended ‘‘to reach a particular result by
                                      structuring a series of transactions in a certain way’’). The
                                      test examines whether the formally separate steps are pre-
                                      arranged components of a composite transaction intended
                                      from the outset to arrive at a specific end result. We have no
                                      hesitation in concluding that under the end result test, we
                                      can safely invoke the step transaction doctrine here. By peti-
                                      tioners’ own admission, the tax benefits were a legitimate
                                      inducement for individual U.S. investors to invest in the ven-
                                           18 See   supra notes 12 and 13 and accompanying text.




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                                      90                 137 UNITED STATES TAX COURT REPORTS                                        (70)


                                      ture. But arranging for these tax benefits required the care-
                                      fully choreographed entry and exit of Arapua. Such entry
                                      and exit could not but have been previously arranged to
                                      reach the desired end result—allocation of the recognized tax
                                      loss away from Arapua.
                                        The third, and least rigorous, of the tests is the inter-
                                      dependence test. This test analyzes whether 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. See Penrod v. Commissioner, 88 T.C.
                                      1415, 1428–1430 (1987). If, however, intermediate steps
                                      accomplished valid and independent economic or business
                                      purposes, courts respect their independent significance. See
                                      Greene v. United States, 13 F.3d 577, 584 (2d Cir. 1994); Sec.
                                      Indus. Ins. Co. v. United States, 702 F.2d 1234, 1246–1247
                                      (5th Cir. 1983).
                                        In applying the interdependence test, we ask whether any
                                      economic or business purpose was served by Arapua’s entry
                                      to, and exit from, Warwick. Alternatively, we question
                                      whether an outright sale of the Arapua receivables would
                                      have been just as effective in transferring title and facili-
                                      tating their subsequent servicing. In either formulation, the
                                      test is satisfied and we are free to invoke the step trans-
                                      action doctrine and collapse the formal steps into a single
                                      transaction.
                                        Note that the three tests we outline above are not mutu-
                                      ally exclusive. Arguably the requirements of all, and cer-
                                      tainly of two of the three tests, have been met here. More-
                                      over, a transaction need only satisfy one of the tests to allow
                                      for the step transaction doctrine to be invoked. See Associ-
                                      ated Wholesale Grocers, Inc. v. United States, supra at 1527–
                                      1528 (finding the end result test inappropriate but applying
                                      the step transaction doctrine using the interdependence test).
                                        We conclude that the various intermediate steps of the
                                      transaction structured and put into operation by Rogers are
                                      properly collapsed into a single transaction. This transaction
                                      consisted of Arapua’s selling its receivables to Warwick for
                                      the amount of cash payments that were eventually made to
                                      Arapua by and on behalf of Warwick. Consequently, War-
                                      wick’s basis in the Arapua receivables was no higher than
                                      the sum of these payments—but petitioners have failed to




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                                      (70)               SUPERIOR TRADING, LLC v. COMMISSIONER                                        91


                                      substantiate these payments. 19 Any subsequent losses are,
                                      therefore, properly measured against a basis of zero.
                                      VII. Accuracy-Related Penalty
                                        Respondent determined that ‘‘there is a gross valuation
                                      misstatement within the meaning of I.R.C. § 6662(h)’’ in all
                                      the consolidated cases. Under section 6662(e) and (h)(2)(A)(i),
                                      a gross valuation misstatement would arise if the adjusted
                                      basis of any property ‘‘claimed on any return of tax imposed
                                      by chapter 1’’ is 200 percent or more of the amount deter-
                                      mined to be correct. If the correct adjusted basis is found to
                                      be zero, any positive amount claimed on the return would
                                      constitute a gross valuation misstatement.
                                        Respondent contends that the correct basis of the receiv-
                                      ables in the hands of both Warwick and the trading compa-
                                      nies is zero. 20 Because petitioners have failed to substantiate
                                      the amount of payments Warwick made to Arapua for the
                                      receivables, and more importantly that they were contrib-
                                      uted, we agree with respondent. Therefore, we conclude that
                                      there are gross valuation misstatements on the respective
                                      returns of Warwick and the trading companies. Con-
                                      sequently, the applicable accuracy-related penalty is 40 per-
                                      cent in each of the consolidated cases.
                                        Under section 6664(c)(1), an accuracy-related penalty will
                                      not be imposed if we find that Warwick and the trading
                                      companies acted with reasonable cause and in good faith. We
                                      make this determination at the partnership level, taking into
                                      account the state of mind of the general partner. See New
                                      Millennium Trading, LLC v. Commissioner, 131 T.C. 275
                                      (2008).
                                           19 See
                                               supra note 12 and accompanying text.
                                           20 Each
                                                 partnership’s basis in the receivables is part of that partnership’s inside basis and is
                                      therefore a ‘‘partnership item’’ within the meaning of sec. 6231(a)(3) and sec. 301.6231(a)(3)–1,
                                      Income Tax Regs. Consequently, ‘‘we do have jurisdiction over the penalty in this partnership-
                                      level case’’. 106 Ltd. v. Commissioner, 136 T.C. 67, 75 (2011). ‘‘Since the overvalued * * * [asset]
                                      was a partnership item, the outside basis of individual partners is of no consequence.’’ Id. at
                                      76. Thus, our assertion of jurisdiction over penalties here is not affected by, and is distinguish-
                                      able from, the respective opinions of two Courts of Appeals which have held that a trial court
                                      lacks jurisdiction to determine partners’ outside bases in partnership-level proceedings. See
                                      Petaluma FX Partners, LLC v. Commissioner, 591 F.3d 649, 654–656 (D.C. Cir. 2010), affg. in
                                      part, revg. in part, vacating in part and remanding on penalty issues 131 T.C. 84 (2008); Jade
                                      Trading, LLC v. United States, 598 F.3d 1372, 1379–1380 (Fed. Cir. 2010). Further, a ‘‘portion
                                      of any underpayment [by the individual U.S. investors] * * * is attributable to’’ the gross valu-
                                      ation misstatement of the receivables within the meaning of sec. 6662(b).




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                                      92                 137 UNITED STATES TAX COURT REPORTS                                        (70)


                                        For Warwick and each of the trading companies, Jetstream
                                      was the managing member at the time the transactions at
                                      issue transpired. Rogers was the sole owner and director of
                                      Jetstream at all such times. Consequently, he was the only
                                      individual with the authority to act on behalf of petitioners.
                                      It is therefore Rogers’ conduct that is relevant for the pur-
                                      pose of determining whether we should sustain the asserted
                                      accuracy-related penalties. 21
                                        There has been no showing of reasonable cause or good
                                      faith on Rogers’ part in conceptualizing, designing, and exe-
                                      cuting the transactions. To the contrary, as we have detailed
                                      above, Rogers’ knowledge and experience should have put
                                      him on notice that the tax benefits sought by the form of the
                                      transactions would not be forthcoming and that these trans-
                                      actions would be recharacterized and stepped together to
                                      reveal their true substance.
                                      VIII. Conclusion
                                         We uphold respondent’s FPAAs. We conclude that the
                                      Arapua receivables had zero basis in Warwick’s hands. We
                                      further sustain respondent’s determination regarding the sec-
                                      tion 6662(h) accuracy-related penalty. We find that peti-
                                      tioners have failed to establish reasonable cause or good faith
                                      under section 6664(c).
                                         We have considered all the other arguments made by peti-
                                      tioners, and to the extent not discussed above, we conclude
                                      those arguments are irrelevant, moot, or without merit.
                                         To reflect the foregoing,
                                                                          Decisions will be entered for respondent.

                                                                               f




                                        21 Since none of the partnerships relied upon external ‘‘professional advice’’ within the mean-

                                      ing of Neonatology Associates, P.A. v. Commissioner, 115 T.C. 43, 99 (2000), affd. 299 F.3d 221
                                      (3d Cir. 2002), the three-factor test developed there is irrelevant for establishing reasonable
                                      cause and good faith in these partnership-level proceedings.




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