201 F.3d 505 (D.C. Cir. 2000)
ASA Investerings Partnership, et al.,Appellantsv.Commissioner of Internal Revenue, Appellee
No. 98-1583
United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT
Argued October 19, 1999Decided February 1, 2000

Appeal from the United States Tax Court(No. TAX-27320-96)
Jerome B. Libin argued the cause for appellants.  With  him on the briefs was Steuart H. Thomsen.
Edward T. Perelmuter, Attorney, U.S. Department of Justice, argued the cause for appellee.  With him on the brief  were Loretta C. Argrett, Assistant Attorney General, and  Richard Farber, Attorney.
Before:  Williams, Sentelle and Henderson, Circuit  Judges.
Opinion for the Court filed by Circuit Judge Williams.
Williams, Circuit Judge:


1
In January 1990 Allied Signal, a  company manufacturing aerospace and automotive products,  decided to sell its interest in Union Texas Petroleum Holdings, Inc., an oil, gas, and petrochemical company.  Anticipating a large capital gain, it sought to reduce the resulting tax  burden by entering into a set of transactions via a partnership with several foreign corporations.  The transactions took  advantage of provisions of the Internal Revenue Code (and  related regulations) designed to yield reasonable results when  property is sold on an installment basis and the value of the  installment payments cannot be known in advance.  With the  help of these provisions, transactions that in substance added  up to a wash were transmuted into ones generating tax losses  of several hundred million dollars;  the offsetting gains were  allocated to foreign entities not subject to United States  income tax at all.


2
The Commissioner of Internal Revenue in 1996 issued a  notice of final partnership administrative adjustment, reallocating to AlliedSignal much of the capital gain accrued by the  partnership.  ASA, via its "Tax Matters Partner," Allied Signal, petitioned for relief in the Tax Court, which agreed  with the Commissioner that AlliedSignal had not entered into  a bona fide partnership and upheld the Commissioner's determination.  ASA Investerings Partnership, AlliedSignal, Inc.,  Tax Matters Partner v. Commissioner, 76 T.C.M. (CCH) 325  (1998) ("Tax Court Decision").  We affirm.


3
*  *  *


4
The hardest aspect of this case is simply getting a handle  on the facts.  To make them manageable, we first discuss the  principal tax provisions in question and then show their  application through a series of examples, ending with a  simplified version of the transactions here.  Only then do we  lay out the exact transactions themselves.


5
Under the general provisions of the Internal Revenue Code  ("IRC"), gains and losses are generally "realized" in the year  that they are received or incurred.  See 26 U.S.C. § 1001  (1994).  A sale for future payments, however, presents several difficulties, among them that the deferred payment may be  contingent in amount or otherwise not susceptible to accurate  valuation.  Section 453 of the Internal Revenue Code, 26  U.S.C. § 453, provides methods for taxation of such an "installment sale," defined as "a disposition of property where at  least 1 payment is to be received after the close of the taxable  year in which the disposition occurs."  Id. § 453(b)(1).  It  specifies the "installment method" for such a sale, providing  that "the income recognized for any taxable year from a  disposition is that proportion of the payments received in that  year which the gross profit ... bears to the total contract  price."  Id. § 453(c).  Thus, if A owns a building with a basis  of $100, and sells it for $300 to be paid in five $60 annual  installments, A recognizes a taxable gain of $40 each year. The proportion of "gross profit" to "total contract price" is  200/300 or two thirds, so the income recognized for each year  is two thirds of the receipts of that year.


6
In 1980 Congress expanded § 453, authorizing the Secretary to make the installmentmethod available to deferred  payment transactions for which the sales price is indefinite, or  subject to a contingency.  Section 453(j) (previously § 453(i))  mandates that the Secretary shall promulgate regulations  "providing for ratable basis recovery in transactions where  the gross profit or the total contract price (or both) cannot be  readily ascertained."  In response, the Treasury promulgated  Temp. Treas. Reg. § 15A.453-1(c)(3)(i) (1981), which provides  that in contingent payment sales (and subject to irrelevant  exceptions), "the taxpayer's basis ... shall be allocated to the  taxable years in which payment may be received under the  agreement in equal annual increments."


7
Under these regulations, the taxpayer will have a recognized gain in years when payment from the sale exceeds the  basis recovered;  in years when payment is less than the basis  recovered, "no loss shall be allowed unless the taxable year is  the final payment year under the agreement or unless it is otherwise determined ... that the future payment obligation  under the agreement has become worthless."  Id.


8
The following examples should illustrate the ratable basis  recovery rule.  Property owner, A, sells a house with a basis  and current value of $1 million in exchange for an instrument  that will pay unpredictable amounts (e.g., a share of the  property's gross profits) over a five-year period.  In any year  in which the payout equals or exceeds $200,000, A will recover  $200,000 in basis under the ratable basis recovery rule and  will have a taxable gain equal to the difference between the  amount received from the note and $200,000.  In a year in  which the payout is less than $200,000, A will not report a  loss, but instead will recover a portion of the basis equal to  the payout;  the unused basis will then be carried forward to  the next year.  See id. § 15a.453-(c)(3), example (2).  Under  the rule just quoted above, unused basis would be recovered  only in the last year of scheduled payout.


9
The rule works similarly when the seller receives both an  instrument with indefinite value and an immediate payment  of cash.  In a variation on the preceding case, for example,  suppose A sells the property for a $500,000 cash payment and  an indefinite five-year instrument.  Once again, the basis is  recovered over the course of five years.  In the first year, A  recovers $200,000 in basis;  because he has received $500,000  that year, he must report a gain of $300,000.  If A sells the  note in Year 2 for $500,000, he can report a loss of $300,000,  equal to the difference between the remaining basis in the  note ($800,000) and the $500,000 he has received in exchange  for the note.1  In this example, of course, the results are  rather unappealing to the taxpayer:  although he had no real  gain, he recognized a nominal one early, offset by an equal  tax loss--but one that was deferred and therefore not a  complete offset.  Because of the rule against any recovery of basis in excess of gross receipts in any year except the last,  the taxpayer cannot manipulate the timing in his favor.


10
But suppose A finds a way of allocating the nominal tax  gain to a tax-free entity, reserving for himself a nominal tax  loss?  Here is how he might do it:  He forms a partnership  with a foreign entity not subject to U.S. tax, supplying the  partnership with $100,000 and inducing the "partner" to  supply $900,000.  The "partnership" buys for $1,000,000 property eligible for installment sale treatment under § 453, and,  as the ink is drying on the purchase documents, sells the  property, as in the last example, for $500,000 in cash and an  indefinite five-year debt instrument.  The cash payment produces a gain of $300,000, 90% of which goes to the nontaxable  foreign entity.  Then ownership adjustments are made so  that A owns 90% of the partnership.  In year 2 the instrument is sold, yielding a tax loss of $300,000, 90% of which is  allocable to A.  Presto:  A has generated a tax loss of  $240,000 ($270,000 loss in Year 2, offset by $30,000 gain in  Year 1), with no material change in his financial position-other than receipt of the valuable tax loss.  This example is  AlliedSignal's case, stripped to its essentials.


11
Now for the specifics of this case:  In 1990, AlliedSignal  anticipated that it would soon realize a capital gain of over  $400 million from the sale of its interest in Union Texas  Petroleum Holdings, Inc.  In February, AlliedSignal approached Merrill Lynch & Co. to discuss a set of transactions  that Merrill had developed to create tax losses to shelter  anticipated capital gains.


12
Under the plan AlliedSignal would form a partnership with  a foreign entity, which in turn would supply the majority of  the capital for and assume a majority stake in the partnership.  In Year 1, the partnership would purchase short-term  private placement notes ("PPNs"), which can be sold under  the installment method of accounting provided for in IRC  § 453.  See 26 U.S.C. § 453(k)(2)(A) (implying that the sale  of "stock or securities which are [not] traded on an established securities market" would be subject to the installment  method).  Several weeks later, the partnership would sell the instruments for 80% cash and 20% debt instruments, which  would pay out over several years and thus would be subject to  the ratable basis recovery rule.  As in the example above, the  partnership would report a large gain in the first year, equal  to the difference between the substantial cash payment and  the small share of basis recovered that year.  The gain would  be allocated according to each partner's interest, with the tax exempt foreign partner receiving the lion's share.


13
The next year, AlliedSignal would acquire a majority interest in the partnership, and sell the debt instruments.  The  sale would create a large tax loss because the basis available  for recovery would far exceed the value of the instruments.


14
Merrill would serve as the partnership's financial adviser  and, for a $7 million fee, would recruit the foreign partner  and arrange for the subsequent investments.  Tax Court  Decision, 76 T.C.M. at 326.  Merrill would also "structure and  enter into the requisite swap transactions" with the banks,  "[t]o ensure a market for [the] issuance and sale" of the  PPNs and the debt instruments to be received on their sale.Id.  In exchange for serving as the partnership's financial  intermediary, Merrill would receive roughly $1 to 2 million on  the initial sale of PPNs, and $200,000 to $400,000 on the sale  of the subsequent debt instruments.  Id.  The foreign partner would receive the greater of $2,850,000 or 75 basis points  (1 basis point = .01%) over the London International Bank  Offering Rate ("LIBOR") on any funds contributed to the  partnership, as well as reimbursement of all partnership  expenses incurred.  Id.


15
AlliedSignal and Merrill followed the proposal to the letter. Merrill contacted Algemene Bank Netherlands N.V. ("ABN"),  one of the Netherlands' largest commercial banks.  Id. at 327.ABN had previously participated in similar Merrill transactions, and anticipated that this partnership would strengthen  its preexisting lending relationship with AlliedSignal.  Id. On April 5, 1990 Johannes den Baas, Vice President of  Corporate Finance for ABN New York, an ABN affiliate, requested authorization to enter into this venture.  Id.  Den  Baas recommended the creation of two "special purpose  corporations" ("SPCs"), to which ABN would lend $990 million, and which would then contribute this money to the  venture.  Id.  The purpose of this structure, den Baas said,  was (1) to permit ABN, which would otherwise be a general  partner in the venture with AlliedSignal, to limit its exposure  to liability, and (2) to facilitate ABN's shifting part of the loan  to other banks for various reasons.


16
On April 17 and 18, den Baas and another representative of  an ABN affiliate met in Bermuda with a representative of  Allied Signal.  Id.  Both sides agreed that Allied Signal would  pay all partnership expenses, as well as ABN's costs funding  the requisite loans to the partnership (approximately  LIBOR), plus 75 basis points.  Id. at 328.2  The precise  amount, of course, would depend on the amount that ABN  contributed and how long the partnership, to be known as  ASA Investerings, held those funds.  In response to den  Baas's request that AlliedSignal pay $5 million up-front, the  parties agreed that Allied Signal would instead periodically  make "premium" payments upon the occurrence of certain  events.  Id.  The agreements reached during these negotiations were referred to by the Tax Court as the "Bermuda  Agreement."


17
ABN's Risk Management Division expressed concern that a  loss might arise out of the sale of the PPNs.  Id. at 327.  Den  Baas responded by assuring these officials that any such loss  would be added to the value of the subsequent debt instruments, and would in turn be borne by Allied Signal on liquidation of those instruments.  But there could be no written  agreement to this effect, explained den Baas, because "in that  case it would not be a matter of a general partnership."  Id.;  Memo from den Baas to Jos Albers, 4/22/90, Joint Appendix  ("J.A.") 676.  Den Baas nonetheless assured the authorities at  ABN of his confidence that AlliedSignal would bear any such  loss:


18
[T]he fact that the client is the only one who is interested in such a sale and wants to obtain the installment note, whereby the SPCs have a right of veto during the entire procedure--as is, in fact, set forth in the partnership document--makes ABN NY Corporate Finance more than confident that the client will continue to have this loss charged to his account in the future as well.


19
Id.  The loan-approving committees later authorized ABN's  participation.


20
On April 19 ASA Investerings Partnership was formed. Tax Court Decision, 76 T.C.M. at 328.  It consisted of AlliedSignal, AlliedSignal Investment Corporation ("ASIC"), a  wholly-owned subsidiary of AlliedSignal, and the two SPCs,  Barber Corp. N.V. and Domniguito Corp. N.V., which were  controlled by foundations in turn controlled by ABN.  Barber  and Dominguito entered into revolving credit agreements  with ABN.  The foundations which owned the SPCs granted  ABN an irrevocable option to buy shares of the respective  SPCs at par value.  Id.


21
On April 19th and 24th, the partners contributed a total of  $850 million, with each partner receiving a partnership interest in accordance with its contribution.  AlliedSignal's share  was 10%, the SPCs' 90%.  In May 1990, the parties supplemented their contributions (in the same ratio), bringing the  total contribution to $1.1 billion.


22
On April 25, 1990 ASA purchased from two Japanese banks  $850 million of 5-year floating rate notes which were not  traded on an established securities market--the planned  PPNs.  Id. at 329.  On May 8, the partnership met in  Bermuda and decided to sell the PPNs for 80% cash and 20%  LIBOR notes.  Id.  Between May 17 and May 24 (i.e., within  one month of purchase), ASA sold the PPNs to two banks in  exchange for a little under $700 million in cash and 11 notes.(With the cash it bought time deposits and 30-day commercial paper.)  These notes each made 20 quarterly payments consisting of the 3-month LIBOR rate, calculated at the beginning of each payment period, applied to 25% of the notional  principal amount, which in this case was $434,749,000.  Id. The LIBOR notes did not require a return of principal at  maturity;  rather, the quarterly payments of interest on the  "notional amount" can be seen as both interest and return of  actual principal.  ABN entered into swap transactions with  Merrill, Barber and Dominguito to hedge ABN's interest rate  risk relating to the LIBOR notes.  Merrill also entered into  swap transactions with the banks from whom it bought the  LIBOR notes (as it had with the PPNs) to induce their  participation.  Merrill's transaction costs in selling the PPNs  were $6.375 million.  Id.  This was added to the value of the  LIBOR notes in ASA's partnership books, so that Allied Signal would bear the costs of the sale when it acquired the  LIBOR notes from the partnership.  Id. at 329-330.


23
Because the LIBOR notes provided for 20 quarterly payments at a variable rate, and the PPNs were not sold on an  established securities market, the sale of the PPNs qualified  for use of the installment method.  For the taxable year  ending May 31, 1990, ASA recovered 1/6 of the basis in the  PPNs (because the completion of the scheduled payout would  occur in the sixth tax year after the sale, and reported  $549,443,361 in capital gains (= $681,300,000 in cash minus  1/6($851,139,836)).3  Id. at 331.  The gain was allocated according to partnership interest, 90% to the SPCs and 10% to  AlliedSignal and ASIC.  Id.


24
On August 2, 1990, AlliedSignal issued $435 million in  commercial paper, and with the proceeds purchased Barber's  entire interest in ASA for about $400 million and a 13.43%  interest in ASA from Dominguito for about $150 million.  Between November 1991 and April 1992, ASA further reduced Dominguito's interest to 25%.  AlliedSignal also paid a  $4.4 million "premium" payment, representing a portion of the $5 million requested by den Baas.  After this purchase,  AlliedSignal and ASIC entered into several swaps with Merrill to hedge their interest in the LIBOR notes.  Id. at 330.Between August 31 and September 28 AlliedSignal borrowed  $435 million from ASA, using the proceeds to repay the debt  incurred August 2;  this indebtedness was paid off May 1,  1992.


25
On August 21 the partnership authorized a distribution of  the LIBOR notes to AlliedSignal and ASIC, and about $116  million in cash and commercial paper to Dominguito.  Id. at  331.  During 1990, AlliedSignal and ASIC sold a fraction of  the LIBOR notes with a basis of $246,520,807, for a total of  $50,454,103, and reported a capital loss equal to the difference, $196,066,704.  Id.  That year, AlliedSignal also reported  a capital gain of $53,926,336, its share of ASA's capital gain  from the sale of the PPNs.  Id.


26
On December 5, 1991, AlliedSignal made a direct payment  of $1,631,250 to Dominguito, representing:  the difference  between ABN's funding costs and the SPCs' combined income  allocations;  interest on $92 million of ABN's funds that  remained in ASA beyond the agreed upon date;  and the  difference (plus interest) between the $5 million up-front  payment that ABN had requested and the $4.4 million it had  previously paid.  Id.


27
Prior to liquidation, ABN and AlliedSignal agreed that  ABN would refund $315,000, reflecting excesses of the SPCs'  income allocations over funding costs, and of ASA's returns  from November 22, 1991 through April 30, 1992 over LIBOR. Id. at 332.  On June 1, 1992, the partners liquidated ASA. On November 31, AlliedSignal sold its remaining LIBOR  notes for $33,431,000, and recovered the remainder of the  basis, $429,655,738, taking a capital loss of $396,234,738.  Id.


28
In a notice of final partnership administrative adjustment  the Commissioner disallowedASA's capital gain, reallocating  it to AlliedSignal and ASIC and thus in substance cancelling  out the tax losses otherwise enjoyed by AlliedSignal.  Id. at  333.  The Commissioner relied on alternative grounds:  first,  ASA was not a bona fide partnership, and Barber and Domin-guito were not correctly deemed partners;  and second, the  transactions lacked "economic substance."  Id.


29
*  *  *


30
The Tax Court agreed with the Commissioner that ASA  was not a valid partnership for tax purposes, and thus did not  reach the economic substance argument.  At the outset, the  court disregarded Barber and Dominguito "[f]or purposes of  [its] analysis," Tax Court Decision, 76 T.C.M. at 333, finding  that they were merely ABN's agents.  First, they were thinly  capitalized, and created just for purposes of the venture. Second, the parties themselves treated ABN as the partner,  disregarding Barber and Dominguito.  Third, Barber and  Dominguito were "mere conduits," to whom ABN lent funds  and in whom ABN owned options to purchase shares for a de  minim is amount.


31
Having found ABN to be the relevant party, the Tax Court  turned its attention to the question whether AlliedSignal and  ABN entered into a bona fide partnership.  Although the  Internal Revenue Code provides that "the term 'partnership'  includes a syndicate, group, pool, joint venture, or other  unincorporated organization through or by means of which  any business, financial operation, or venture is carried on," 26  U.S.C. § 761, the court set out to determine whether the  formal partnership had substance, quoting the Supreme  Court's language in Commissioner v. Culbertson, 337 U.S.  733, 742 (1949), which said that the existence of the partnership (for tax purposes) would depend on whether, "considering all the facts ... the parties in good faith and acting with a  business purpose intended to join together in the present  conduct of the enterprise."  Applying this test, the Tax Court  concluded that AlliedSignal and ABN did not have "the  requisite intent to join together for the purpose of carrying  on a partnership."  76 T.C.M. at 335.


32
*  *  *


33
We review decisions of the Tax Court "in the same manner  and to the same extent as decisions of the district courts in civil actions tried without a jury."  26 U.S.C. § 7482.  Factual  findings are reviewed for clear error, see Commissioner v.  Duberstein, 363 U.S. 278, 291 (1960), and determinations of  law de novo.  See United States v. Popa, 187 F.3d 672, 674  (D.C. Cir. 1999).  We have held that in tax cases mixed  questions of law and fact are to be treated like questions of  fact.  See Fund for the Study of Economic Growth and Tax  Reform v. IRS, 161 F.3d 755, 759 (D.C. Cir. 1998) (citing  Duberstein, 363 U.S. at 289 n.11).  Petitioner poses challenges to all three types of decisions constituting the Tax  Court judgment.


34
Much of petitioner's opening brief is directed to an attack  on the Tax Court's reasoning.  We confess that some of that  reasoning seems misdirected.  For example, the court  seemed to believe that because ABN and AlliedSignal had  "divergent business goals," 76 T.C.M. at 333, they were  precluded from having the requisite intent to form a partnership.  We agree with petitioner that partners need not have a  common motive.  In fact, the desirability of joining complementary interests in a single enterprise is surely a major  reason for creating partnerships.  But we see no reason to  think that this view, mentioned only in the opinion's initial  summary and concluding paragraph, was essential to the  court's conclusion.


35
Some of petitioner's argument seems an exercise in semantic ju jitsu.  It argues that we may not consider whether the  partnership was a "sham" because the Tax Court (a) explicitly  refused to consider that, and (b) never used the word "sham."The first point is false, the second irrelevant. Although the  Tax Court said that it would not consider whether the transactions at issue lacked "economic substance," id., its decision  rejecting the bona fides of the partnership was the equivalent  of a finding that it was, for tax purposes, a "sham."


36
Getting to the controlling issue, petitioner argues that  under the standard established in Moline Properties, Inc. v.  Commissioner, 319 U.S. 436 (1943), the partnership cannot be  regarded as a sham.  The Court there said that a corporation remains a separate taxable entity for tax purposes "so long as  [its] purpose is the equivalent of business activity or is  followed by the carrying on of business by the corporation."319 U.S. at 439.  The Tax Court has since applied Moline to  partnership cases.  See Bertoli v. Commissioner, 103 T.C.  501, 511-12 (1994).


37
Petitioner views Moline as establishing a two-part test,  under which a tax entity is accepted as real if either:  (1) its  purpose is "the equivalent of business activity" (not tax  avoidance), or (2) it conducts business activities.  Moline, 319  U.S. at 439.  Because ASA "engaged in more than sufficient  business activity to be respected as a genuine entity," petitioner argues that ASA was a partnership under the second  alternative.  Petitioner's Reply Br. at 12.  We agree if engaging in business activity were sufficient to validate a partnership ASA would qualify.  It was infused with a substantial  amount in capital ($1.1 billion), and invested it in PPNs,  LIBOR notes, and other short-term notes over a period of  two years.  In fact, however, courts have understood the  "business activity" reference in Moline to exclude activity  whose sole purpose is tax avoidance.  This reading treats  "sham entity" cases the same way the law treats "sham  transaction" cases, in which the existence of formal business  activity is a given but the inquiry turns on the existence of a  nontax business motive.  See Knetsch v. United States, 364  U.S. 361, 364-66 (1960).  Thus, what the petitioner alleges to  be a two-pronged inquiry is in fact a unitary test--whether  the "sham" be in the entity or the transaction--under which  the absence of a non tax business purpose is fatal.4


38
Shortly after Moline the Second Circuit held per Judge  Learned Hand in National Investors Corp. v. Hoey, 144 F.2d  466 (2d Cir. 1944), that the retention and sale of securities,  after the date when the corporate holding had served its nontax goals, could not be considered for tax purposes. There an investment trust corporation proposed to merge  with its subsidiaries.  To this end it created a new corporation into which it transferred its interests in the subsidiaries  in exchange for 10 shares of stock.  But the stockholders  decided to reject the plan to unify the four corporations.  The  investment trust then liquidated the new corporation, starting  with an exchange of 10% of the new corporation's shares and  taking a deduction based on the difference between the value  of 10% of the shares when originally issued to the trust, and  10% of their reduced value a year later.  In initiating even  this 10% liquidation, however, it delayed for some time after  the shareholders' vote.  The court held that the trust was  entitled to a deduction only for value decreases incurred from  the time of the original transfer of assets to the corporation  to "a reasonable time" after the stockholders rejected the  plan.  Id. at 468.  Thereafter, "there was no longer any  business for [the corporation] to do."  Id.  Retention of the  corporation merely for the purpose of tax minimization was  not enough.  The court explicitly read thecases as saying  that "the term 'corporation' will be interpreted to mean a  corporation which does some 'business' in the ordinary meaning, and that escaping taxation is not 'business' in the ordinary meaning."  Id.  So too, for ASA:  Although its investment in LIBOR notes might have had a business purpose, the  prior three-week investment in and subsequent sale of PPNs  was, like the retention of assets in Hoey, a business activity  merely conducted for tax purposes.5  Moreover, as discussed  later, AlliedSignal's interest in any potential gain from the  partnership's investments was in its view at all times dwarfed  by its interest in the tax benefit.


39
The Ninth Circuit has similarly held that "business activity" is inadequate in the absence of a nontax business purpose. In Zmuda v. Commissioner, 731 F.2d 1417 (9th Cir. 1984),  the taxpayers argued that the Tax Court incorrectly applied  the "economic substance" rule rather than the "business  purpose" rule.  The court found that the taxpayer's argument  "attempts to create a distinction where none exists.  There is  no real difference between the business purpose and the  economic substance rules.  Both simply state that the Commissioner may look beyond the form of an action to discover  its substance."  Id. at 1420.  The court went on to say:


40
The terminology of one rule may appear in the context of the other because they share the same rationale.  Both rules elevate the substance of an action over its form. Although the taxpayer may structure a transaction so that it satisfies the formal requirements of the Internal Revenue Code, the Commissioner may deny legal effect to a transaction if its sole purpose is to evade taxation. Id. at 1421.  At issue was the validity of certain trusts, so the  court's equation of the "transaction" test and the "entity" test  was clearly a holding.


41
We note that the "business purpose" doctrine is hazardous. It is uniformly recognized that taxpayers are entitled to  structure their transactions in such a way as to minimize tax. When the business purpose doctrine is violated, such structuring is deemed to have gotten out of hand, to have been  carried to such extreme lengths that the business purpose is  no more than a facade.  But there is no absolutely clear line  between the two.  Yet the doctrine seems essential.  A tax  system of rather high rates gives a multitude of clever  individuals in the private sector powerful incentives to game  the system.  Even the smartest drafters of legislation and  regulation cannot be expected to anticipate every device. The business purpose doctrine reduces the incentive to engage in such essentially wasteful activity, and in addition  helps achieve reasonable equity among taxpayers who are  similarly situated--in every respect except for differing investments in tax avoidance.


42
Thus the Tax Court was, we think, sound in its basic  inquiry, trying to decide whether, all facts considered, the  parties intended to join together as partners to conduct  business activity for a purpose other than tax avoidance.  Its  focus was primarily on ABN, curiously.  As we shall discuss  later, the absence of a nontax business purpose was even  clearer for AlliedSignal.  Nonetheless, given ABN's protection from risk, and even from the borrowing costs of providing its capital contribution, there was no clear error in the  finding that its participation was formal rather than substantive.6  Petitioner alleges two primary ways in which the Tax  Court erred in this regard.


43
First, petitioner says that the Tax Court incorrectly found  that Barber and Dominguito were mere agents of ABN  rather than partners in their own right.  But this issue of  classification makes no material difference.  Once the court  decided that the SPCs were mere conduits for ABN, it shifted  its focus to whether AlliedSignal and ABN (rather than the  SPCs) formed a bona fide partnership.  There was certainly  no clear error in the court's view of the SPCs as being within  the complete control of ABN, and there is no indication as to  how the SPCs' intent as to the "partnership" differed from  that of ABN.


44
Second, petitioner argues that the Tax Court erred by  finding that ABN did not share in profits and losses because  it received a specified return from AlliedSignal and hedged  against risk through swap transactions with Merrill.  On the  profit side, we find no clear error in the court's findings that  the direct payments made to ABN were to compensate it  merely for its funding costs.  Petitioner says that there was  no explicit agreement that ABN would receive a return of  LIBOR plus 75 basis points, pointing to the fact that the  payments actually made by AlliedSignal to ABN did not produce such a return.  See Petitioner's Brief at 59;  supra  note 2.  But petitioner makes no argument that these payments were related to the success of the partnership's investments (i.e., the PPNs and LIBOR notes), and under the  circumstances it is reasonable to infer that they were made  pursuant to a pre-arranged agreement to compensate ABN  for its funding costs (plus some amount above LIBOR, even if  not 75 basis points).


45
Den Baas's testimony, moreover, confirms that ABN could  make no profit from the transaction:  any potential profit  from the LIBOR notes would be offset by losses from the  concomitant swap transactions.  Petitioner cites Hunt v.  Commissioner, 59 T.C.M. (CCH) 635 (1990), for the proposition that a guaranteed return is not inconsistent with partnership status.  In Hunt, however, both parties had a bona fide  business purpose for entering into the partnership, and unlike  in the case at hand, the guaranteed return created a floor but  not a ceiling.  See id. at 648.


46
Turning to the risk of loss, we agree with the Tax Court  that any risks inherent in ABN's investment were de minim is. As a preliminary matter, the court did not err by carving out  an exception for de minim is risks, as no investment is entirely  without risk.  Unless one posited a particular asset (such as  the dollar) as the sole standard, its value could change in  relation to the values of other assets, and treating one--even  the dollar--as the sole standard would be arbitrary.  The Tax  Court's decision not to consider ABN's "de minim is" risk is  also consistent with the Supreme Court's view, albeit in the  "sham transaction" context, that a transaction will be disregarded if it did "not appreciably affect [taxpayer's] beneficial  interest except to reduce his tax."  Knetsch, 364 U.S. at 366  (emphasis added) (quoting Gilbert v. Commissioner, 248 F.2d  399, 411 (2d Cir. 1957) (Hand, C.J., dissenting)).


47
There was no clear error in the Tax Court's determination  that at no point during the transaction did ABN assume  greater than de minim is risk.  The PPNs were essentially  risk free:  not only were they issued by banks with the  highest credit ratings but they were held for a mere three weeks.  Moreover, because of the side agreement under  which any loss on the PPNs would be embedded in the value  of the LIBOR notes, AlliedSignal would bear any shortfall  over the brief period in which PPNs were held.  Petitioner  argues that ABN was subject to the risk that AlliedSignal  would ultimately decide not to acquire the LIBOR notes. This seems unlikely to the point of triviality, however, for two  reasons:  first, this step was integral to AlliedSignal's tax  objective, and to the entire transaction;  and second, at the  point when the LIBOR notes would be distributed, Dominguito still owned over 40% of ASA, and according to the partnership agreement, any act of the partnership committee would  require the consent of partners whose interest equaled or  exceeded 95%.  Nor was there any real hazard that Allied Signal might agree to distribute the LIBOR notes but refuse  to make the adjustment for any loss on the PPNs:  as den  Baas had stated in a memorandum to ABN officials, the SPCs  could counter by refusing consent for the distribution of the  notes altogether.


48
The LIBOR notes certainly had greater inherent risk than  the short-term PPNs;  ABN, however, entered into hedge  transactions outside the partnership to reduce the risk to a de  minim is amount.  In fact, the correlation between the swaps  and the LIBOR notes was 99.999%, i.e., the company succeeded in hedging all but a de minim is amount of the risk  associated with the LIBOR notes.  Petitioner concedes that  "the hedges provided the ABN parties with substantial protection from fluctuations in LIBOR Note value due to movements in interest rates."  Petitioner's Reply Br. at 18.  But  ASA nevertheless contends that ABN still bore the credit risk  associated with the issuers of the LIBOR notes and with  Merrill, which provided the hedges.  Once again, we find that  the Tax Court correctly found the risk to be de minim is:  the  LIBOR notes were issued by banks having a credit rating of  AAA and AA+, and were held by ASA for only three months. So too, the risk associated with the swaps with Merrill (a  single-A rated institution) was de minim is.  Finally, there was  little, if any, risk associated with the commercial paper that  ASA held at this point, which although unhedged, was found by the Tax Court to be "AAA-rated, short-term, and from  multiple issuers."  Tax Court Decision, 76 T.C.M. at 335.


49
Petitioner argues that ABN's side-transactions should not  be considered in deciding whether a bona fide partnership  was formed.  It draws an analogy to a partnership which  owns an uninsured building later destroyed by fire;  this  partnership is bona fide even if one partner had insured  against his portion of the loss.  The analogy, though imaginative, is not very telling.  The insurance in the hypothetical is  comparatively narrow, leaving a considerable range of potential business hazards and opportunities for profit.  Contrast  den Baas's observation at the outset of the present plan:"Credit risk:  The structure demands that virtually no credit  risk will be taken in the partnership since any defaults on the  principal of the investments will jeopardize the objective....Market interest rate risk:  ABN New york [sic] will take care  of perfect hedges in order to protect the bank from the  changes in the value of the underlying securities....  due to  interest rate fluctuations."  J.A. 680-81.  We note, moreover,  that petitioner directs us to no evidence that ABN even bore  the cost of these hedges.  Given that Merrill, which had  orchestrated the entire transaction and to whom AlliedSignal  had paid a substantial sum, engaged in the swap transactions,  it is likely that AlliedSignal assumed the costs of the swaps. A partner whose risks are all insured at the expense of  another partner hardly fits within the traditional notion of  partnership.


50
Petitioner argues that the Tax Court also erred in determining that ABN's capital contribution constituted a loan. We need not pass on this question because it is quite peripheral to the central issue of whether the parties entered into a  bona fide partnership.


51
We noted earlier that the Tax Court's focus on ABN's  intentions was a little puzzling.  AlliedSignal, after all, was  the driving force and AlliedSignal focused on tax minimization  to the virtual exclusion of ordinary business goals.  Of course  no one wants to pay more than necessary, even for a very  profitable tax minimization scheme, and the petitioner argues that even with the very substantial transaction costs associated with the partnership, AlliedSignal had grounds for expecting that it would come out more than $15 million ahead.  As it  proved, transaction costs were almost $25 million rather than  the roughly $12 million it anticipated, Tax Court Decision, 76  T.C.M at 326, 332, so the ultimate financial gain, according to  the parties, was actually about $3.6 million.  The expected  gain turned on the belief of Roger Matthews, AlliedSignal's  assistant treasurer--which proved correct--that interest  rates would shift in such a way that, when all the swaps were  taken into account, AlliedSignal would benefit.  But this  evidence says nothing about AlliedSignal's use of the elaborate partnership--with a pair of partners concocted for the  occasion.  There is no reason to believe that AlliedSignal  could not have realized Matthews's interest rate play without  the partnership at far, far lower transactions costs.  For the  deal overall, the most telling evidence is the testimony of  AlliedSignal's Chairman and CEO, who could not "recall any  talk or any estimates of how much profit [the transaction]  would generate."  The Tax Court concluded that none of the  supposed partners had the intent to form a real partnership,  a conclusion that undoubtedly encompasses AlliedSignal. And the record amply supports that finding.

The decision of the Tax Court is

52
Affirmed.



Notes:


1
  The regulation does not appear to provide expressly that in  the event that the taxpayer completely liquidates the instrument  before the end of scheduled payout he may recover all unused basis  in that year.  Both parties agree, however, that this is the case.


2
  Petitioner acknowledges that ABN might have "had in mind a  target return of LIBOR plus 75bp on the amount it invested,"  Petitioner's Initial Br. at 59, but argues that the Tax Court erred in  finding that the parties actually entered into such an agreement. Petitioner points to the fact that AlliedSignal's payments were  negotiated rather than specified in advance, and were not based on  a LIBOR plus 75 basis points return.  This dispute is, however,  immaterial.  See infra pp. 16-17.


3
  The parties stipulated in the Tax Court that ASA had erred in  calculating the gain on its 1990 tax return and that the correct  amount was $539,364,656.


4
  Indeed, one might logically enough place the Tax Court's  findings here under the "sham transaction" heading, viewing the  formation of the partnership as the transaction.  Because of the  ultimate unity of the tests, however, there is no need to address this  formulation.


5
  The PPNs cost $850 million.  When an expert was later  engaged by AlliedSignal to evaluate the partnership's gains and  losses, AlliedSignal asked that he assign to the LIBOR notes a  value which, together with the cash, would bring the total value of  the proceeds of the PPNs to $850 million.  See J.A. 1343.  AlliedSignal evidently did not believe that the initial investment in PPNs  increased the return from the transactions in the aggregate.


6
  Although petitioner argues that ABN's purpose was not tax avoidance, but rather "included a desire to enhance its business  relationship with AlliedSignal," Petitioner's Initial Br. at 41 n.19,  the desire to aid another party in tax avoidance is no more a  business purpose than actually engaging in tax avoidance.


