    Case: 13-30887   Document: 00512763188    Page: 1   Date Filed: 09/10/2014




         IN THE UNITED STATES COURT OF APPEALS
                  FOR THE FIFTH CIRCUIT
                                                                 United States Court of Appeals
                                                                          Fifth Circuit

                                                                        FILED
                               No. 13-30887                     September 10, 2014
                                                                   Lyle W. Cayce
                                                                        Clerk


CHEMTECH ROYALTY ASSOCIATES, L.P.,
As Tax Matters Partner Real Party in Interest Dow Europe, S.A.,

                                  Plaintiff–Appellant Cross-Appellee,

versus

UNITED STATES OF AMERICA,

                                  Defendant–Appellee Cross-Appellant.


                         ***************


CHEMTECH ROYALTY ASSOCIATES, L.P.,
by Dow Europe, S.A. as Tax Matters Partner,

                                  Plaintiff–Appellant Cross-Appellee,

versus

UNITED STATES OF AMERICA,

                                  Defendant–Appellee Cross-Appellant.


                         ***************
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                              No. 13-30887


CHEMTECH II, L.P.,

                                  Plaintiff–Appellant Cross-Appellee,

versus

UNITED STATES OF AMERICA,

                                  Defendant–Appellee Cross-Appellant.


                         ***************


CHEMTECH II, L.P. BY IFCO, INCORPORATED, as Tax Matters Partner,

                                  Plaintiff–Appellant Cross-Appellee,

versus

UNITED STATES OF AMERICA,

                                  Defendant–Appellee Cross-Appellant.




              Appeals from the United States District Court
                  for the Middle District of Louisiana




Before DAVIS, SMITH, and CLEMENT, Circuit Judges.
JERRY E. SMITH, Circuit Judge:


     This appeal concerns the tax consequences of two transactions

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                                      No. 13-30887
undertaken by Dow Chemical Company (“Dow”) and a number of foreign
banks 1 from 1993 through 2006. During those years, Dow and the foreign
banks purported to operate two partnerships that generated over one billion
dollars in tax deductions for Dow. After a five-day trial, the district court dis-
regarded the partnerships for tax purposes on three grounds: (1) The partner-
ships were shams; (2) the transactions lacked economic substance; and (3) the
banks’ interests in Chemtech Royalty Associates, L.P. (“Chemtech”), were debt,
not equity. The court also imposed substantial understatement and negligence
penalties but refused to impose substantial-valuation or gross-valuation mis-
statement penalties. Because, under these specific facts, the court did not
clearly err in holding that Dow lacked the intent to share the profits and losses
with the foreign banks, we affirm its sham-partnership holding. In light of
United States v. Woods, 134 S. Ct. 557 (2013), however, we vacate and remand
as to the penalty award.


                                             I.
       In the early 1990s, Goldman Sachs developed a financial product called
Special Limited Investment Partnerships (“SLIPs”), which it promoted as a tax
shelter. A series of steps typically had to be executed to create this type of
product. First, the American corporation had to identify a valuable group of
assets with a tax basis 2 at or near zero. Second, the corporation needed to



       1Bank of Brussels Lambert, Dresdner Bank A.G., Kredietbank N.V., National West-
minster Bank plc, and Rabo Mercent Bank N.V. (collectively, “the foreign banks”).
       2Basis generally refers to the amount of capital investment in a property for tax pur-
poses. Ordinarily, an asset’s basis is its cost. Tax basis may be reduced by allowances for
depreciation or amortization (which would then be referred to as the adjusted tax basis).
Adjusted tax basis may be used to recognize that an asset gained or lost money when deter-
mining tax liability from a taxable event. An adjusted tax basis cannot generally be lower
than zero.
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                                       No. 13-30887
create or designate subsidiaries through which it would participate in the
transaction. Those subsidiaries would then contribute the assets to the part-
nership. Third, the corporation had to entice foreign entities to participate in
the transaction.        The tax benefits generated by the partnership could be
attained only if the partnership’s income could be assigned to a tax-indifferent
party. Fourth, the parties would need to enter into various agreements that
would govern the transaction. 3 In 1992, Dow decided to pursue this transac-
tion, endeavoring to create an asset-backed equity financing vehicle.
       Following these steps, Dow selected 73 patents to contribute to the
partnership. The district court found that Dow did not select “patents that
would be attractive to a third party.” Instead, it contributed those patents that
(1) “had the highest value (in order to reduce the total number of patents),”
(2) had a zero or near zero tax basis, and (3) were actively used by one of Dow’s
businesses. For most patents, Dow “did not contribute all technology that
would have been necessary for third party licensees,” requiring a potential
third-party licensee to obtain licenses from both the partnership and Dow. In
line with these findings, Dow selected patents valued at roughly $867 million,
with 71 of the 73 patents having zero tax basis. 4
       Next, Dow created two domestic subsidiaries—Diamond Technology
Partnership Co. (“DTPC”) and Ifco, Inc. (“Ifco”)—and used a wholly-owned
foreign subsidiary—Dow Europe, S.A. (“DESA”)—to carry out this transaction.
Through these subsidiaries, Dow formed Chemtech as a Delaware limited part-
nership with its principal place of business in Switzerland. 5 Again through



       3 Usually, the entity would need to lease the assets back to the corporation, so that
the corporation could continue to use the asset, which would in turn provide the partnership
with its primary source of revenue.
       4   The other two patents had a combined tax basis of approximately $54,000.
       5   Before the foreign banks entered the transaction, Chemtech was owned 89% by
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                                       No. 13-30887
these subsidiaries, Dow contributed to Chemtech I 6 the identified 73 patents,
$110 million, and all of the stock of Chemtech Portfolio, Inc. (“CPI”), a pre-
existing shell corporation owned by Dow.
       Five foreign banks decided to participate as limited partners in Chem-
tech, investing a total of $200 million in the partnership. The entry of the
foreign banks forced Ifco’s partnership share to be retired. By October 1993,
Chemtech was owned 1% by DESA (the general partner), 81% by DTPC, and
18% by the foreign banks.
       Finally, Dow and the foreign banks entered into various agreements to
govern the transaction, including a patent license agreement, a partnership
agreement, and various indemnity agreements. The patent license agreement
allowed Dow to continue to use the patents contributed to Chemtech. Under
that agreement, Dow bore responsibility for all costs related to the patents and
paid a royalty to Chemtech, regardless of Dow’s use of the patents. Chemtech
did not change Dow’s use of its patents. The partnership agreement, in rele-
vant part, (1) required the maintenance of capital accounts for each partner, 7
(2) governed the allocation of profits and losses among the partners, 8 (3) limited
the types of assets the partnership could hold, 9 (4) included the conditions that



DTPC, 10% by Ifco, and 1% by DESA, which was the general partner.
       6 Dow entered into two transactions with the foreign banks. We refer to the first
transaction as Chemtech I and the second as Chemtech II. We refer to both jointly as the
Chemtech transactions.
       7The agreement required Chemtech to maintain assets worth 3.5 times the unrecov-
ered capital contributions of the foreign bank.
       8  The partnership agreement entitled the foreign banks to 99% of Chemtech’s profits
until they received their “annual ‘priority return’” of 6.947% on their contributions. If Chem-
tech generated sufficient profits in a given quarter, it was required to pay the full priority
return to the foreign banks. Even if profits for that quarter were insufficient, Chemtech was
still required to pay 97% of the priority return.
       9Chemtech could hold only the following assets: the patents, the chemical plant, and
the stock of CPI. CPI, in turn, was required to hold a minimum of $50 million and was
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triggered the right to liquidate the partnership, 10 and (5) provided the manner
in which assets would be allocated on liquidation. 11 Finally, because the for-
eign banks conditioned their willingness to participate in Chemtech on being
indemnified against any liability arising from the assets or any tax liability,
Dow indemnified them against those risks.
       Chemtech I operated from April 1993 through June 1998, during which
time Dow’s royalty payments served as Chemtech’s primary source of income,
totaling $646 million. Because Chemtech claimed $476.1 million of book depre-
ciation on the patents contributed to it, it reported book profits 12 of only $61.7
million, 13 out of which it paid (1) the 6.947% priority return to the foreign
banks, (2) a 1% distribution to DESA, and (3) a relatively small distribution to
each partner to pay its Swiss tax obligation. Chemtech then contributed the


permitted to own only cash equivalents, very low-risk securities, Dow loans, and Dow demand
notes.
       10 Section 14.1 of the partnership agreement lists twenty-three possible conditions
that could trigger the parties’ right to liquidate the partnership. To name a few: (a) “The
General Partner or Dow shall . . . fail to perform . . . any material term, covenant or obligation
required . . . under this Agreement, the Dow Liquidator Guaranty, the Supplemental Dow
Indemnity, or the Dow Limited Partner Guaranty . . . .”; (b) “The General Partner, Dow,
DTPC or Ifco shall fail to perform . . . any material term, covenant or obligation required . . .
under the License Agreement, the Master Lease, the Investment Agreements, or the Contri-
bution Agreement . . . .”; (e) “April 6, 2000 shall occur.”; (f) “The Partnership shall fail to
distribute to the [foreign banks] in immediately available funds on the last Business Day of
any Fiscal Quarter an amount equal to the product of (i) ninety-seven percent (97%) times
(ii) the amount described in section 4.2(a)(i) with respect to such Fiscal Quarter.”; (g) “The
Partnership or the Partnership Subsidiary shall fail to satisfy any of the Portfolio
Requirements . . . .”
       11 Upon liquidation, the foreign banks would receive the balance of their capital
accounts (effectively their initial investment), plus 1% of any gain or less 1% of any loss
resulting from a change in the value of Chemtech’s assets. Liquidation provisions compen-
sated the foreign banks for a shortfall in their expected return if Chemtech were terminated
before seven years.
       12Book profit refers to a gain of an investment that has not yet been realized but exists
for accounting purposes.
        Chemtech’s other expenses included management fees to DESA and a guaranteed
       13

payment to DTPC.
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                                       No. 13-30887
remaining cash to CPI, which loaned the bulk of the cash to Dow. Chemtech
allocated the overwhelming majority of its income to the foreign banks and
only a fraction of its income to Dow. As the district court observed, “[w]hile
Dow claimed royalty expense deductions for the money flowing to Chemtech,
it did not take into account the income of the bulk of the money flowing from
Chemtech.” 14
       In December 1997, DESA informed the foreign banks that new tax regu-
lations could potentially subject the banks’ priority return to a 30% withhold-
ing tax for which Dow would be responsible under the tax indemnity. In Febru-
ary 1998, Dow terminated Chemtech I. The foreign banks received the sum of
their capital account balances, the early liquidation amounts, 1% of the
increase in value of the contributed patents, and the priority return for one
month. Ifco also bought out DESA’s interest as general partner.
       Shortly after terminating Chemtech I, Dow began planning a similar
transaction that would operate essentially the same way. Dow again sought
to identify a high-value, low tax basis asset to contribute to Chemtech II. Dow
decided to use one of its Louisiana chemical plants. The chemical plant was
valued at $715 million but had a tax basis of only about $18.5 million.
       As in Chemtech I, Dow utilized a subsidiary to participate in the
transaction—this time Dow Chemical Delaware Corporation (“DCDC”). In
June 1998, DCDC contributed the chemical plant and all of the stock of a shell
subsidiary, Chemtech Portfolio Inc. II (“CPI II”), to Chemtech II. Dow entered
into a lease with Chemtech II for continued use of the chemical plant. Under


       14 The 1994 cash flows are illustrative: (1) Dow made a royalty payment to Chemtech
for $143.3 million; (2) Chemtech distributed $13.9 million to the foreign banks, as their pri-
ority return; and (3) Chemtech, through CPI, loaned $136.9 back to Dow. That year, Dow
deducted $143.3 million in royalty expenses. Chemtech had a taxable income of $122.4 mil-
lion for 1994, allocating $115 million of that income to the foreign banks and $28.1 million to
Dow. The district court’s order details similar cash flows for 1995, 1996, and 1997.
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                                       No. 13-30887
the lease, Dow remained responsible for all expenses associated with the plant
and was required to pay rent regardless of its use of the plant. As with the
patents in Chemtech I, Chemtech II did not change Dow’s use of the chemical
plant. During the transition from Chemtech I to Chemtech II, Dow retired
DTPC as a partner. 15
       In June 1998, RBDC, Inc. (“RBDC”), a U.S. affiliate of Rabo Mercent
Bank N.V, purchased a limited interest in Chemtech II for $200 million. Rabo
Mercent Bank N.V was one of the foreign banks that invested in Chemtech I.
At this point, Chemtech II was owned 6.37% by Ifco, 20.45% by RBDC, and
73.18% by DCDC. Ifco served as the general partner and RBDC and DCDC
served as limited partners. Chemtech II operated similarly to Chemtech I:
(1) Dow entered into similar agreements with substantially similar terms;
(2) the cash flows displayed similar patterns; 16 and (3) Dow enjoyed substantial
tax savings through a similar but not identical mechanism. 17
       Chemtech II’s partnership agreement permitted RBDC to elect to liqui-
date its interest in March 2003. At that time, Dow and RBDC negotiated a
new partnership agreement that reduced RBDC’s priority return to 4.207%.
Dow and RBDC continued to operate Chemtech II through June 2008.



       15 DTPC liquidated its interest in Chemtech in exchange for the patent portfolio, $4.5
million in cash, and a 70% interest in CPI. Shortly before this liquidation, CPI exchanged its
holdings of $700 million in demand notes for a deeply subordinated note payable in 33 years.
Dow avers that “that exchange was performed to eliminate any potential uncertainty over
whether [DTPC]’s CPI interest would be treated as a taxable ‘marketable security’ under the
distribution rules in 26 U.S.C. § 731.”
       16Each year, after paying a 6.375% priority return to RBDC and a $400,000 manage-
ment fee to Ifco, Chemtech II contributed its excess cash to CPI II, which in turn loaned the
funds to Dow. From 1998 through 2003, CPI II loaned a total of $356.5 million to Dow.
       17 Dow paid rent to Chemtech II and claimed deductions for that rent. Though Chem-
tech II allocated most of that rental income to DCDC and Ifco, the chemical plant’s stepped-
up basis allowed Dow to offset that increase in income with depreciation deductions that were
also allocated to DCDC and Ifco.
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       The Internal Revenue Service (“IRS”) issued Chemtech Final Partner-
ship Administrative Adjustments (“FPAAs”) for tax years 1993 through 2006.
It also asserted accuracy-related penalties under I.R.C. § 6662 for 1997
through 2006. Dow sued to contest the FPAAs. After a five-day trial, the court
disregarded the partnership for tax purposes on three grounds: (1) The part-
nerships were shams; (2) the transactions lacked economic substance; and
(3) the banks’ interests in Chemtech were debt, not equity. 18 The court also
assessed a twenty-percent penalty for each of the relevant tax years, awarding
substantial-understatement and negligence penalties. The court, however,
believed it could not impose a gross-valuation misstatement penalty.
       As to its sham partnership holding, the court found that Dow lacked both
the intent to act in good faith for some genuine business purpose other than
tax avoidance and the intent to share profits and losses with the foreign banks.
As to the second intent, the court found that “[t]he foreign banks were not true
partners” because “the banks were [essentially] guaranteed a return just under
7% each year” and “[a] valid partnership is not formed where, among other
things, one partner receives a guaranteed, specific return.”
       On appeal, Dow avers that the district court erred in finding the partner-
ships to be shams. Because Dow believes the foreign banks’ interest cannot be
classified as debt under United States v. South Georgia Railway Co., 107 F.2d 3
(5th Cir. 1939), it claims that it must have provided the foreign banks with
equity in Chemtech. It reasons that because the foreign banks received equity,
Dow entered into a valid tax partnership, regardless of any other criteria. As
to the penalty award, Dow concedes that the court erred in foreclosing the


       18For the reasons we detail below, we affirm the sham-partnership holding. We there-
fore do not address whether the court erred in (1) determining the transactions lacked econ-
omic substance or (2) classifying the transactions as debt. Accordingly, we do not address
the parties’ arguments relating to these conclusions by the district court.
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availability of a gross-valuation misstatement penalty. 19
       The government contends, for three reasons, that Dow did not intend to
share the profits or losses with the foreign banks: First, the agreement allo-
cated essentially all of the risk-bearing to Dow. “The banks [ ] insisted that
they bear no liability”—product, tax, or any other type—“for the patents or the
chemical plant.” Second, “[t]he banks did not have bona fide equity interests
in Chemtech.” And third, “[t]he evidence is [ ] clear that the banks did not view
themselves as joining with Dow to manage such assets.”


                                             II.
       “The starting point for our analysis is the cardinal principle of income
taxation: A transaction’s tax consequences depend on its substance, not its
form.” Southgate Master Fund, L.L.C. ex rel. Montgomery Capital Advisors,
LLC v. United States, 659 F.3d 466, 478−79 (5th Cir. 2011). That maxim “is
the cornerstone of sound taxation.” Estate of Weinert v. Comm’r, 294 F.2d 750,
755 (5th Cir. 1961). “‘Tax law deals in economic realities, not legal abstrac-
tions.’” Id. (quoting Comm’r v. Sw. Exploration Co., 350 U.S. 308, 315 (1956)).
“This foundational principle finds its voice in the judicial anti-abuse doctrines,
which prevent taxpayers from subverting the legislative purpose of the tax
code by engaging in transactions that are fictitious or lack economic reality
simply to reap a tax benefit.” Southgate, 659 F.3d at 479 (internal quotation
marks omitted).
       A taxpayer may not be able to claim the “tax benefits of a transaction—
even a transaction that formally complies with the black-letter provisions of


       19 Dow concedes this point in its reply brief: “Appellants agree with the Government
that if the district court’s holding on the merits is sustained (which it should not be), the
district court decision on the 40 percent substantial valuation misstatement penalty should
be remanded in light of . . . United States v. Woods, 134 S. Ct. 557 (2013).”
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the Code and its implementing regulations—if the taxpayer cannot establish
that ‘what was done, apart from the tax motive, was the thing which the stat-
ute intended.’” Id. (quoting Gregory v. Helvering, 293 U.S. 465, 469 (1935)).
“Because so many abusive tax-avoidance schemes are designed to exploit the
Code’s partnership provisions, our scrutiny of a taxpayer’s choice to use the
partnership form is especially stringent.” Id. at 483–84 (footnote omitted).
       “In an appeal from a bench trial, we review the district court’s findings
of fact for clear error and its conclusions of law de novo.” Id. at 480. “Specifi-
cally, a district court’s characterization of a transaction for tax purposes is a
question of law subject to de novo review, but the particular facts from which
that characterization is made are reviewed for clear error.”                   Id. (internal
quotation marks omitted). “Under the clearly erroneous standard, we will
uphold a finding so long as it is plausible in light of the record as a whole,”
United States v. Ekanem, 555 F.3d 172, 175 (5th Cir. 2009) (internal quotation
marks omitted), or so long as this court has not been “left with the definite and
firm conviction that a mistake has been made,” Streber v. Comm’r, 138 F.3d
216, 219 (5th Cir. 1998).


                                             III.
       A partnership “may be disregarded [for tax purposes] where it is a sham
or unreal.” 20 In order not to be a sham, or to be a valid partnership for tax
purposes, “persons [must] join together their money, goods, labor, or skill for
the purpose of carrying on a trade, profession, or business and [ ] there [must
be a] community of interest in the profits and losses.” Comm’r v. Tower, 327




       20 Moline Props., Inc. v. Comm’r, 319 U.S. 436, 439 (1943) (“In such situations the form
is a bald and mischievous fiction.”).
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U.S. 280, 286 (1946). 21 This court has recently reaffirmed the test announced
in Tower and repeated in Culbertson: “As the Supreme Court [has] explained
. . . , whether a partnership will be respected for tax purposes depends on
whether the parties in good faith and acting with a business purpose genuinely
intended to join together for the purpose of carrying on the business and shar-
ing in the profits and losses.” Southgate, 659 F.3d at 483 (internal quotation
marks omitted). “The fact that a partnership’s underlying business activities
had economic substance does not, standing alone, immunize the partnership
from judicial scrutiny.” Id. at 484.
       As Tower, Culbertson, and Southgate demonstrate, the parties, to form a
valid tax partnership, must have two separate intents: (1) the intent to act in
good faith for some genuine business purpose and (2) the intent to be partners,
demonstrated by an intent to share “the profits and losses.” If the parties lack
either intent, then no valid tax partnership has been formed. To determine
whether the parties had these intents, a court must consider “all the relevant
facts and circumstances,” including (a) “the agreement,” (b) “the conduct of the
parties in execution of its provisions,” (c) the parties’ statements, (d) “the
testimony of disinterested persons,” (e) “the relationship of the parties,” (f) the
parties’ “respective abilities and capital contributions,” (g) “the actual control
of income and the purposes for which it is used,” and (h) “any other facts
throwing light on their true intent.” Id. at 483 (internal quotation marks
omitted). Consistent with these directives, we limit our consideration and deci-
sion here to the specific facts and transactions that are presented.
       Southgate relied on TIFD III–E, Inc. v. United States (Castle Harbour II),


       21 See also Comm’r v. Culbertson, 337 U.S. 733, 740 (1949) (“[In Tower], [w]e [ ] said
that a partnership is created ‘when persons join together their money, goods, labor, or skill
for the purpose of carrying on a trade, profession, or business and when there is community
of interest in the profits and losses.’”).
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459 F.3d 220 (2d Cir. 2006), which involved a scheme very similar to the one
involved in this case. There, acting through various subsidiaries, General Elec-
tric Capital Corporation (“GECC”) formed a partnership with two Dutch banks.
Both GECC and the banks contributed assets to the partnership. 22 Although
“the Dutch banks[ ] contributed about 18% of the partnership’s capital and [ ]
nothing to its management, [they] were allocated . . . 98% of most of its taxable
income.” Id. at 227. The banks’ actual receipts, however, were much smaller:
“[T]he reimbursement of their investment, plus an annual return at an agreed
rate near 9%, plus a small share in any unexpectedly large profits,” which was
capped at less than 2.5% of the banks’ investment. Id. at 227, 229. In response
to the IRS’s issuance of two FPAAs, GECC sued to challenge their validity.
The district court found that the transactions had economic substance and that
Castle Harbour was a valid tax partnership.
       The Second Circuit reversed, determining “that the Dutch banks [were
not] equity partners in the Castle Harbour partnership because they had no
meaningful stake in the success or failure of the partnership.” Id. at 224. The
Dutch banks neither shared in the profits nor the losses. “As a practical mat-
ter,” GECC capped “the Dutch banks’ opportunity to participate in unexpected
and extraordinary profits (beyond the reimbursement of their investment at
the Applicable Rate of return) . . . .” Id. at 235. 23 And second, the Dutch banks


       22 “The assets transferred by GECC entities to the partnership were the fleet of air-
craft, with a market value of $272 million, $22 million in receivables from aircraft-rental
agreements, and $296 million in cash, making a total investment of $590 million. Shortly
thereafter, the two Dutch banks contributed $117.5 million in cash to the partnership.”
Castle Harbour II, 459 F.3d at 225.
       23See also id. at 234–35 (“First, the taxpayer [ ] held the full power to manage the
partnership, [which gave it] the right . . . to reclassify the income produced . . . from . . .
Operating Income (in which the banks would take 98%) to Disposition Gains (in which the
banks’ share was 1%, over and above approximately $2.85 million). Second, the taxpayer
could reduce drastically the net Operating Income . . . by redepreciating the already fully
depreciated aircraft, which had the effect of transferring the revenue covered by the
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faced no meaningful risk of loss: “[F]eatures of the Castle Harbour agreements
combined to provide the Dutch banks with not only a reasonable expectation,
but an ironclad assurance that they would receive repayment of their principal
at the Applicable Rate of return, regardless of the success of the Castle Har-
bour venture.” Id. at 239–40. 24
       In Castle Harbour II, in conducting the sham-partnership inquiry, the
Second Circuit considered it helpful first to address whether the interest has
“the prevailing character of debt or equity.” Id. at 232. 25 Dow insists that we
must first determine whether an interest qualifies as debt or equity before we
can address whether there is a sham partnership under Culbertson. To sup-
port that proposition, Dow points to South Georgia Railway, which it believes
demonstrates that debt requires (1) a fixed maturity date on which fixed
amounts are due and (2) a holder’s legal right to enforcement in the event of
default. The reasoning continues that the foreign banks were not legally enti-
tled to repayment of their investment even if the banks could recover the value
of their partnership share when terminating the partnership. Therefore, Dow
avers that the parties must have held equity in Chemtech and must have been



depreciation from the banks to the taxpayer. Finally, the taxpayer could at any time, and at
negligible cost, terminate the partnership.” (footnote omitted)).
       24 See also id. at 240 (“These features included (a) the Exhibit E payment schedules;
(b) the Investment Accounts; (c) the Class A Guaranteed Payments; (d) the requirement for
the benefit of the Dutch banks that CHLI maintain Core Financial Assets of 110% of the
obligation owed to the Dutch banks; (e) the banks’ ability to liquidate the partnership in
certain circumstances and receive reimbursement at the Applicable Rate of return; (f) the
$300 million worth of casualty-loss insurance, which was obtained by Castle Harbour for the
benefit of the Dutch banks; and, most importantly, (g) GECC’s personal guaranty of the
obligations owed by the partnership to the Dutch banks.”).
       25Castle Harbour II considered an interest to have the prevailing character of debt if
“the funds were advanced with reasonable expectations of repayment regardless of the
success of the venture or . . . the risk of the business.” Id. at 233 (internal quotation marks
omitted). For the reasons we discuss below, it is not helpful in this case to classify an interest
as debt or equity before conducting the Culbertson inquiry.
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                                        No. 13-30887
valid tax partners under Culbertson regardless of what else the record may
demonstrate.
       Dow’s argument fails. First, it has not identified any precedent that
requires us to (a) classify an interest as debt or equity before conducting the
Culbertson inquiry and (b) find a valid partnership solely because the parties
did not have a legal right to demand repayment of their principal investment
on any fixed future date. Even assuming that South Georgia Railway correctly
describes when we must classify an interest as debt, 26 that case does not have
any bearing on the sham-partnership inquiry. Southgate certainly did not rely
on South Georgia Railway in any respect. 27
       Second, such a requirement would run afoul of Culbertson and South-
gate. In essence, Dow wants us to limit our sham-partnership inquiry to two
considerations: whether the parties executed a legal document expressly
(1) allowing the foreign banks to demand repayment of their principal invest-
ment (as opposed to the value of their partnership share) and (2) specifying a
fixed date on which they could do so. Even further assuming Dow can demon-
strate the transactions lacked one of these criteria, 28 Southgate does not



       26 The government challenges whether South Georgia Railway provides the governing
test, pointing us to Plantation Patterns, Inc. v. Commissioner, 462 F.2d 712 (5th Cir. 1972).
We do not express any opinion as to what the proper test is for determining whether an
interest constitutes debt or equity.
       27 See Southgate, 659 F.3d at 485 (“In this case, an application of Culbertson’s totality-
of-the-facts-and-circumstances test demonstrates that the Southgate partnership was a
sham that need not be respected for tax purposes.”).
       28 Even assuming arguendo Dow has correctly stated the law, the government disputes
Dow’s characterization of the facts. The government claims that the foreign banks could
(1) opt to liquidate the interest by the passage of April 6, 2000 (the seven-year anniversary
of Chemtech), and (2) receive back their capital accounts and any undistributed interest pay-
ment on that date. Therefore, the government asserts that, as a matter of practical reality,
the foreign banks did have the right to demand repayment of their investment on a fixed
date. We take no position, for purposes of classifying this interest as debt instead of equity,
on whether in fact the foreign banks had creditor rights.
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                                         No. 13-30887
restrict our inquiry in that manner. “The sine qua non of a partnership is an
intent to join together for the purpose of sharing in the profits and losses of a
genuine business.” Southgate, 659 F.3d at 488. Accepting Dow’s suggestion
would require us to elevate the transaction’s form over its substance, contrary
to long-standing doctrine.
       Therefore, in assessing whether the district court erred in its sham-
partnership holding, we express no opinion as to whether the interests should
be classified as debt. Instead, we limit our inquiry to whether Dow possessed
the intent to be partners with the foreign banks, focusing on whether Dow had
the intent to share the profits and losses with the foreign banks. To make this
determination, we consider all relevant “facts throwing light on their true
intent,” id. at 484 (quoting Culbertson, 337 U.S. at 742), and review only for
clear error, id. at 480. 29


                                                    IV.
       As we explain, we consider the court’s finding on both the intent to share
profits and the intent to share losses to be plausible in light of the record as a
whole and therefore not clear error. First, the transactions were structured to
ensure that Dow paid the foreign banks a fixed annual return on their invest-
ment “regardless of the success of the [Chemtech] venture,” just as in the trans-
action in Castle Harbour II. The agreement entitled the foreign banks to 99%
of Chemtech’s profits until the banks received the priority return, but only 1%
after that. Even if Chemtech did not generate sufficient profits to pay the




       29 See Southgate, 659 F.3d at 487 n.68 (“The district court’s conclusion that [a partner]
had no intention of allowing the other partners to share in the [property contributed to the
partnership] was necessarily a finding of fact. . . . [T]he question of intent [is] the quintessen-
tial factual question.” (citations and internal quotation marks omitted)).
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                                     No. 13-30887
return, itself a highly unlikely situation, 30 the foreign banks were still entitled
to 97% of the priority return. Moreover, the banks received compensation even
if the partnership did not last the length anticipated by the parties, again
demonstrating that the banks were compensated regardless of profitability.
Dow even insulated the banks from bearing transactional costs incurred by
participating in Chemtech. 31
      Second, Dow agreed to bear all of the non-insignificant risks arising out
of the Chemtech transactions, which further shows that the parties did not
intend to share any possible losses. The transaction created only three possible
sources of loss: (1) tax liability, (2) liability arising from ownership of the pat-
ents or chemical plant, and (3) loss of the banks’ initial investment. Dow has
not identified any other possible source of loss. Because Dow indemnified the
foreign banks for any liability arising from the patents and the chemical plant
and for any tax liability, Dow did not intend to share that risk with the foreign
banks. In fact, the foreign banks would not have participated in Chemtech if
they had to bear any of that risk.
      Furthermore, just as in Castle Harbour II, the agreement included four
significant “ironclad” assurances to ensure that Dow would not misappropriate
or otherwise lose the banks’ initial investment: One, requiring Chemtech to
hold 3.5 times the unrecovered capital contributions of the bank, ensured that
if anything happened, the banks would be able to get back their money. Two,



      30  As a practical matter, payment of less than the full priority return was highly
unlikely because (i) the minimum royalty payments from Dow sufficiently funded the priority
return, and (ii) Chemtech could not incur more than $1 million in annual expenses without
the banks’ approval.
      31  For example, Dow compensated the foreign banks for any expenses they might owe
to other lending institutions that insured or financed their contributions to Chemtech. Dow
also indemnified the foreign banks for any liabilities attributable to Chemtech’s pre-
registration and winding-up activities.
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                                  No. 13-30887
by severely limiting the assets Chemtech could hold, the agreement again min-
imized the possibility that the foreign banks would lose their initial invest-
ment. Three, in light of all of the possible voluntary conditions that triggered
the right to terminate, if the banks perceived any risk to their investment, the
agreement allowed the banks to terminate the partnership and recoup effec-
tively their full initial investment with minimal transaction costs. Four, Dow
guaranteed that its subsidiaries would perform their obligations under the var-
ious agreements. All of these features worked together to ensure that the for-
eign banks faced effectively no risk to their initial capital investment or to their
priority return.
      Third, just as in Castle Harbour II, the foreign banks did not meaning-
fully share in any potential upside. The possibility that the foreign banks could
possibly obtain a fraction of residual profits does not make the finding on intent
clearly erroneous. This is true because residual profits were possible only if a
patent portfolio performed well enough to trigger Dow’s obligation to pay vari-
able royalties. Dow, however, does not contend―and nothing in the record
suggests―that Dow or the foreign banks expected the contributed patents to
increase in value. In fact, Dow does not even claim that it created Chemtech
for the purpose of managing its patents. The parties could not have intended
to share profits through a means no one expected or designed to be profitable.
Even assuming arguendo (a) the intent to share profits can be demonstrated
in a way not contemplated to be profitable at the time of the agreement, or
(b) Dow and the foreign banks believed the patents would increase in value, we
would still not consider the district court’s finding clearly erroneous. The
agreement (a) allocated only 1% of the increased value of a given patent port-
folio to all of the foreign banks collectively and (b) allowed Dow effectively to
control Chemtech’s ability to earn such additional profits by giving Dow the
ability to remove profitable patents.
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                                       No. 13-30887
       All of these considerations demonstrate that the district court did not
clearly err in determining that Dow lacked the intent to share the profits and
losses of the Chemtech transactions with the foreign banks. We therefore
affirm the district court’s sham partnership holding and do not reach its econ-
omic substance holding or its holding classifying the interest as debt.


                                              V.
       Section 6662 of the Internal Revenue Code imposes a twenty-percent
penalty to “the portion of any underpayment which is attributable to 1 or more
of the following: (1) [n]egligence or disregard of rules or regulations[,] (2) [a]ny
substantial understatement of income tax[, or] (3) [a]ny substantial valuation
misstatement under chapter 1 . . . .” 26 U.S.C. § 6662(a), (b)(1)–(3). The Code
increases the penalty to forty percent of the underpayment for a “gross” valua-
tion misstatement. 32 Id. § 6662(h). The Code does not allow penalties to be
stacked, even if more than one penalty applies. 33
       The district court imposed twenty-percent penalties for negligence and
substantial understatement but declined to impose either the substantial-
valuation or gross-valuation misstatement penalties. The court believed that
it could not impose a valuation-misstatement penalty when an entire transac-
tion had been disregarded (here under the economic substance doctrine). The




       32A substantial-valuation misstatement occurs if “the value of any property (or the
adjusted basis of any property) claimed on any return of tax . . . is 150 percent or more of the
amount determined to be the correct amount . . . .” 26 U.S.C. § 6662(e)(1)(A). A gross-
valuation misstatement occurs if the claimed value of any property is 200% or more than the
determined correct amount. See id. § 6662(h)(2)(A)(i).
       33 See 26 C.F.R. 1.6662-2(c) (“The maximum accuracy-related penalty . . . may not
exceed 20 percent of such portion (40 percent of the portion attributable to a gross valuation
misstatement), notwithstanding that such portion is attributable to more than one of the
types of misconduct described in paragraph (a) of this section.”).
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                                      No. 13-30887
court relied on Heasley v. Commissioner, 902 F.2d 380 (5th Cir. 1990). 34
       After the district court issued its order, the Supreme Court decided
United States v. Woods, 134 S. Ct. 557 (2013), which rejects the Heasley rule:
    Woods’ primary argument is that the economic-substance determina-
    tion did not result in a “valuation misstatement.” He asserts that the
    statutory terms “value” and “valuation” connote “a factual—rather than
    legal—concept,” and that the penalty therefore applies only to factual
    misrepresentations about an asset’s worth or cost, not to misrepresen-
    tations that rest on legal errors (like the use of a sham partnership).

      We are not convinced. . . . The statute contains no indication that the
    misapplication of one of those legal rules cannot trigger the penalty.

Id. at 566. Therefore, the district court erred in foreclosing the applicability of
both the substantial-valuation and gross-valuation misstatement penalties.
We remand for the court to determine whether to impose either or both of those
penalties. We express no opinion on whether the court erred in imposing the
negligence and substantial-understatement penalties. On remand, the court
should consider the extent to which imposing those penalties remains consis-
tent with this opinion.
       The judgment is AFFIRMED in part and VACATED and REMANDED
in part. In so deciding, we limit our reasoning to the specific facts and trans-
actions at hand.




       34 Heasley, 902 F.2d at 383 (“Whenever the I.R.S. totally disallows a deduction or
credit, the I.R.S. may not penalize the taxpayer for a valuation overstatement included in
that deduction or credit. In such a case, the underpayment is not attributable to a valuation
overstatement. Instead, it is attributable to claiming an improper deduction or credit.”).
                                             20
