                                                               NOT PRECEDENTIAL

                      UNITED STATES COURT OF APPEALS
                           FOR THE THIRD CIRCUIT
                                ____________

                                     No. 12-1779
                                    ____________

      ROVAKAT, LLC, A Partnership, Shant S. Hovnanian, Tax Matters Partner,
                                                     Appellant

                                           v.

                    COMMISSIONER OF INTERNAL REVENUE
                               ___________

                     On Appeal from the United States Tax Court
                                 (Docket No. 3251-09)
                 United States Tax Court Judge: Honorable David Laro
                                    ___________

                     Submitted Under Third Circuit L.A.R. 34.1(a)
                                 October 25, 2012

    Before: HARDIMAN, GREENAWAY, JR., and VANASKIE, Circuit Judges

                            (Opinion Filed: June 17, 2013)
                                    ___________

                                      OPINION
                                     ___________

VANASKIE, Circuit Judge.

      Rovakat, LLC, a partnership for tax purposes, by its tax matters partner, Shant S.

Hovnanian, appeals the December 21, 2011 decision of the United States Tax Court that

substantially upheld notices of Final Partnership Administrative Adjustments (“FPAAs”)

issued by the Commissioner of Internal Revenue (the “Commissioner”) for tax years
2002, 2003, and 2004. The FPAAs, in pertinent part, disallowed more than $5 million in

losses that Rovakat claimed from a “distressed asset/debt” (“DAD”) tax shelter, and

imposed accuracy-related penalties under §6662(h) of the Internal Revenue Code, 26

U.S.C. § 6662(h). Having carefully considered the Tax Court opinion, the record, and the

parties’ contentions, we will affirm.

                                              I.

       The parties are completely familiar with the complex transactions that provide the

context for this dispute, and we will not recount here the facts that are so

comprehensively presented in the Tax Court opinion. Instead, for purposes of our

decision, the following summary of the parties’ transactions suffices:

                      1. On June 7, 2001, Credicom Asia redeemed its
              worthless class A common stock from its parent corporation,
              Credicom NV (“CNV”), for 1,718,116 Swiss francs and
              $303,375. CNV’s claimed “basis” in the class A common
              stock, i.e., the amount it had invested in Credicom Asia’s
              class A common stock, approximated $184,000,000.

                     2. The next day, CNV transferred the 1,718,116 Swiss
              francs and $303,375 to International Capital Partners, LP
              (“ICP”), in exchange for a partnership interest in ICP. 1

                    3. On November 6, 2002, ICP transferred 50,000 of
              the Swiss francs, having a fair market value of $34,185, to
              Rovakat in exchange for a partnership interest in Rovakat.




       1
        ICP was a Cayman Islands limited partnership and founding partner of Rovakat.
ICP was controlled by Lance O. Valdez, a tax attorney and financial advisor who put
together DAD tax shelters. Valdez was also president of Credicom Asia, and directed the
transactions that formed the basis for the DAD tax shelter at issue in this case.

                                              2
                     4. On December 26, 2002, ICP transferred 90% of its
              partnership interest in Rovakat to Mr. Hovnanian for
              $30,776. 2

                     5. On December 27, 2002, Rovakat sold the 50,000
              Swiss francs to a third party for their fair market value of
              $35,468. 3

                     6. Rovakat incurred almost $400,000 in costs related
              to these transactions, including fees of more than $380,000 to
              Valdez, and $13,000 for a tax opinion from a law firm
              recommended by Valdez.

                    7. On its tax returns for 2002, 2003, and 2004,
              Rovakat claimed that its basis in the 50,000 Swiss francs was
              $5,805,000, so that its transfer of the Swiss francs for $35,468
              generated a loss of more than $5,700,000. 4

       In FPAAs issued for Rovakat’s 2002, 2003, and 2004 tax returns, the

Commissioner determined that Rovakat had not established the claimed basis of

$5,805,000 in the 50,000 Swiss francs, and thus was not entitled to deductions from



       2
         Mr. Hovnanian has a degree in economics from the University of Pennsylvania,
and is a sophisticated investor as well as an entrepreneur in the information technology
and medical devices fields.
       3
        The Tax Court opinion was inconsistent with regard to the fair market value of
the Swiss francs. The Tax Court first stated that the francs were valued at $35,268, (App.
21), but later stated that they were valued at $35,468 (App. 30.) We use the latter
number—$35,468—which is the value the parties stipulated to before the Tax Court.
(Supplemental App. 52.)
       4
         As a general rule, property received in exchange for a partnership interest
assumes the basis of the partner’s interest in the property. See 26 U.S.C. § 721(a). In this
case, Rovakat treated Credicom Asia as a partnership and CNV as one of its partners,
notwithstanding their corporate structures. Asserting that CNV liquidated its partnership
interest in Credicom Asia for “property” in the form of Swiss francs, Rovakat claimed
that CNV’s basis in the class A common stock, totaling approximately $184,000,000,
attached to the Swiss francs. Rovakat claims a pro rata share of the purported basis in the
Swiss francs.
                                             3
ordinary income for the purported “loss” incurred when the Swiss francs were sold for

$35,468. The Commissioner found in the alternative that the deductions should be

disallowed because the Swiss francs transaction lacked economic substance. The

Commissioner’s FPAAs also imposed a 40% gross valuation misstatement penalty

pursuant to 26 U.S.C. § 6662(h)(1) with respect to tax underpayments resulting from the

wrongfully claimed losses attributed to the Swiss francs transaction.

       Rovakat challenged the disallowances for the deductions attributed to the Swiss

francs transaction in the Tax Court. In rejecting Rovakat’s challenges, the Tax Court

applied the “substance-over-form” doctrine, and found that Credicom Asia’s redemption

of its class A stock from CNV, a corporation, could not be regarded as a transfer of a

partnership interest. Consequently, CNV’s basis in the class A stock did not attach to the

Swiss francs received by CNV in exchange for the class A stock. Alternatively, the Tax

Court held that Rovakat could not claim a basis of more than $5,800,000 in Swiss francs

having a market value of only approximately $35,000 because the transactions at issue

lacked “sufficient economic substance to be respected for federal tax purposes.” (App.

47.) Specifically, the Tax Court found that “[t]he francs transaction as a whole, when

viewed in the light of its individual steps, had no economic significance other than to

serve as a means for Mr. Hovnanian’s attempt to purchase and use CNV’s built-in-loss.”

(Id. at 48.) Observing that “[b]ecause a transaction that lacks economic substance is not

recognized for Federal tax purposes, and ‘cannot be the basis for a deductible loss,’” the

Tax Court ruled that Rovakat could not claim losses from that transaction. (Id. at 64.)

Finally, the Tax Court sustained the 40% accuracy-related penalties, rejecting Rovakat’s

                                             4
assertion that it had acted in good faith and with reasonable cause on the basis of opinions

from tax attorneys.

                                              II.

       Rovakat timely appealed the Tax Court decision, challenging the disallowances

for the losses it attributed to the Swiss francs transaction as well as the 40% accuracy-

related penalties. 5 The Tax Court had jurisdiction over this matter pursuant to 26 U.S.C.

§§ 6226(f) and 7442. We have jurisdiction pursuant to 26 U.S.C. § 7482.

                         A. The Disallowance of the Claimed Loss

       “[W]hile we conduct plenary review of the Tax Court's legal conclusions, we

review its factual findings, including its ultimate finding as to the economic substance of

a transaction, for clear error.” ACM P’ship v. Comm’r, 157 F.3d 231, 245 (3d Cir. 1998).

In this case, the Tax Court characterized the initial transaction in the series of transactions

that culminated with Rovakat’s sale of Swiss francs, i.e., the redemption of Credicom

Asia stock from CNV for Swiss francs and $303,375, to be a sale of common stock as

opposed to a transfer of partnership interests as asserted by Rovakat. It is firmly

established that the substance of a transaction, and not its form, governs its tax treatment.

See Comm’r v. Court Holding Co., 324 U.S. 331, 334 (1945) (“The incidence of taxation

depends upon the substance of a transaction.”). The Tax Court had ample justification

for characterizing the redemption of Credicom Asia’s stock from its parent, CNV, as a

       5
        The Tax Court also sustained other adjustments made by the Commissioner in the
FPAAs as well as the Commissioner’s 20% accuracy related penalty attributable to the
underpayment of taxes resulting from the other adjustments to income and deductions
made by the Commissioner in the FPAAs. Rovakat does not challenge on appeal these
aspects of the Tax Court’s decision.
                                              5
sale. In this regard, it is irrefutable that both CNV and Credicom Asia were corporations.

Because CNV could not have transferred a partnership interest in exchange for dollars

and Swiss francs, it could not carry over its basis in Credicom Asia class A stock to the

Swiss francs that ultimately were transferred to Rovakat and sold for $35,468. For this

and all the other reasons articulated by the Tax Court in its exceedingly thorough opinion,

the Tax Court did not err in rejecting the more than $5 million loss claimed by Rovakat. 6

                                            B.

       We review the Tax Court’s findings with respect to the assessment of accuracy-

related penalties for clear error. See Stobie Creek Invs. LLC v. United States, 608 F.3d

1366, 1381 (Fed. Cir. 2010). In this case, there is no dispute that Rovakat asserted a basis

in the Swiss francs that exceeded 400% of the correct amount, triggering a 40% penalty

for a “gross valuation misstatement[].” See 26 U.S.C. § 6662(h). Rovakat could avoid

       6
         Although we need not reach the alternative ground articulated by the Tax Court
for sustaining the disallowance of the claimed loss—the Swiss francs transaction lacked
economic substance—we note that we discern no error in the Tax Court’s application of
the economic substance doctrine as explicated in ACM Partnership. Under this doctrine,
“a transaction that is ‘devoid of economic substance’ must be disregarded for tax
purposes and ‘cannot be the basis for a deductible loss.’” ACM P’ship, 157 F.3d at 247
(quoting Lerman v. Comm’r, 939 F.2d 44, 45 (3d Cir. 1991)). The Tax Court faithfully
adhered to the requirements that both the “‘objective economic substance of the
transactions’ and the ‘subjective business motivation’ behind them” be examined. Id.
(quoting Casebeer v. Comm’r, 909 F.2d 1360, 1363 (9th Cir. 1990)). Its findings on both
prongs of the inquiry are well supported. For example, on the objective component, the
Tax Court properly considered that the nearly $400,000 in fees paid by Rovakat to obtain
Swiss francs having a value of approximately $35,000 did not make economic sense
independent of claiming a loss premised upon an artificially inflated basis in the Swiss
francs. As to the subjective component, the Tax Court likewise had substantial reasons
for finding that “the economic reality of the francs transaction is not consistent with a
bona fide profit objective.” (App. 64.) The Tax Court’s correct application of the
“economic substance” doctrine provides an alternative basis for sustaining the
disallowance of the claimed loss.
                                             6
the penalty only by demonstrating both reasonable cause for its gross misstatement and

good faith. 26 U.S.C. § 6664(c)(1). Rovakat asserts that it satisfied its “heavy burden”

of showing reasonable cause, Richardson v. Comm’r, 125 F.3d 551, 557 (7th Cir. 1997),

because it had relied upon opinions issued by law firms regarding the transaction. The

Tax Court rejected Rovakat’s argument because one opinion was obtained from a law

firm recommended to Rovakat by Valdez, the person that promoted and profited from the

transaction, and the other opinion was not given to Rovakat’s partner on tax matters, Mr.

Hovnanian, until years after the transactions were consummated. Moreover, both

opinions were found to be based upon unsupported assumptions. Given these factual

findings, we discern no error in the Tax Court’s conclusions that Rovakat lacked

reasonable cause and did not act in good faith. Accordingly, Rovakat cannot avoid the

gross misstatement penalties.

                                           III.

       Consistent with the foregoing and for substantially the same reasons articulated by

the Tax Court in its comprehensive opinion, we will affirm the Tax Court’s December 21,

2011 decision in this case.




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