  United States Court of Appeals
      for the Federal Circuit
              __________________________

  CONSOLIDATED EDISON COMPANY OF NEW
               YORK, INC.
            & SUBSIDIARIES,
             Plaintiff-Appellee,
                          v.
                 UNITED STATES,
                 Defendant-Appellant.
              __________________________

                      2012-5040
              __________________________

    Appeal from the United States Court of Federal
Claims in case no. 06-CV-305, Judge Marian Blank Horn.
               __________________________

               Decided: January 9, 2013
             ___________________________

   DAVID FARRINGTON ABBOTT, Mayer Brown LLP, of
New York, New York, argued for plaintiff-appellee. With
him on the brief were STEPHEN M. SHAPIRO, JOEL V.
WILLIAMSON, TIMOTHY S. BISHOP, THOMAS C. DURHAM,
and MICHAEL R. EMERSON, of Chicago, Illinois, and BRIAN
W. KITTLE, of New York, New York.

    JUDITH A. HAGLEY, Attorney, Tax Division, United
States Department of Justice, of Washington, DC, argued
for defendant-appellant. With her on the brief were
CONSOLIDATED EDISON CO OF NY   v. US                     2


KATHRYN KENEALLY, Assistant Attorney General, TAMARA
W. ASHFORD, Deputy Assistant Attorney General, and
GILBERT S. ROTHENBERG and RICHARD FARBER, Attorneys.
              __________________________

    Before LOURIE, DYK, and MOORE, Circuit Judges.
DYK, Circuit Judge.
     In its tax return for the year 1997, Consolidated Edi-
son Company of New York, Inc. and its subsidiaries
(“ConEd”) claimed multiple deductions pertaining to a
lease-in/lease-out (“LILO”) tax shelter transaction. The
Internal Revenue Service (“IRS”) disallowed these
claimed deductions and assessed ConEd a deficiency in
the amount of $328,066. ConEd paid the deficiency and
filed a refund claim with the IRS; when this claim was
denied, ConEd filed suit in the Court of Federal Claims
(the “Claims Court”). The Claims Court awarded ConEd a
full refund, and the United States appealed.
    Applying the substance-over-form doctrine under our
decision in Wells Fargo & Co. v. United States, 641 F.3d
1319 (Fed. Cir. 2011), we conclude that ConEd’s claimed
deductions must be disallowed. This is so because there
was a reasonable likelihood that the tax-indifferent entity
in the LILO Transaction (the lessor of the master lease)
would exercise its purchase option at the conclusion of the
ConEd sublease, thus rendering the master lease illusory.
Accordingly, we reverse and remand to the Claims Court
for the limited purpose of determining only the refund of
previously paid interest ConEd may be entitled to re-
ceive.1


   1   As the government noted in its brief, “[i]f this
Court reverses the [Claims Court’s] LILO determination,
a remand would be necessary to recompute the amount of
3                       CONSOLIDATED EDISON CO OF NY   v. US


                       BACKGROUND
                             I
    This case requires the court to determine the tax con-
sequences of a LILO transaction, which is one of many
“creative strategies” used by taxpayers to “receive greater
tax benefits from the property of tax-exempt entities.”
Wells Fargo, 641 F.3d at 1322. Though the LILO Transac-
tion at issue in this case is complex, it has a structure
typical of LILOs.
    The LILO Transaction is between ConEd and N.V.
Electriciteitsbedrijf Zuid-Holland (“EZH”), a Dutch utility.
EZH is a so-called tax-indifferent entity because it is not
subject to U.S. taxation. The transaction centered around
the lease and sublease of a gas-fired, combined cycle
cogeneration plant (the “RoCa3 plant”) located in the
Netherlands. EZH’s RoCa3 plant opened for commercial
operation in 1996 and delivers heat, electricity, and
carbon dioxide to its customers.
    ConEd’s avowed purpose in entering into the LILO
Transaction was to achieve tax avoidance benefits associ-
ated with rent and interest deductions. For example,
ConEd’s former Chief Financial Officer, Joan Frielich,
admitted that achieving “front-loaded earnings” was one
of the main reasons that ConEd entered into the transac-
tion, and that the “transaction would not have had the
front-loaded earnings without the tax benefits.” J.A. 2717-
18. She also admitted that, without the tax benefits, the
return on investment associated with the LILO Transac-
tion would have been insufficient to “make[] the project
acceptable.” J.A. 2718. A “Leasing White Paper,” which
was presented to ConEd’s board prior to the transaction’s

previously paid, assessed interest that should be refunded
to ConEd.” Appellant’s Br. 2 n.2.
CONSOLIDATED EDISON CO OF NY   v. US                      4


closing date, also emphasizes the LILO Transaction’s
“[f]ront [l]oaded [e]arnings” and “[g]ood to [e]xcellent
[i]nvestment [y]ields” resulting in part from the tax
deductions. J.A. 17,123, 13,469. ConEd’s Project Briefing
Memorandum, dated October 23, 1997, listed the benefits
of the transaction as including (i) tax deductions for the
allocated initial rent payment to EZH; and (ii) tax deduc-
tions for the interest paid on the loan financing the trans-
action.2
                             II
    EZH and ConEd formally completed the LILO Trans-
action on December 15, 1997 (the “Closing Date”), by
entering into several agreements. In the master lease
agreement governing the LILO Transaction (the “Head
Lease Agreement”), EZH conveyed to ConEd a lease
interest of an undivided 47.47%3 in the RoCa3 plant for a

   2    The third benefit listed in the Project Briefing
Memorandum is “cash-on-cash return of [ConEd’s initial
equity] investment,” along with “profit received at the end
of the term of the [s]ublease.” This latter return is merely
the return ConEd would receive from the maturity of the
zero-coupon U.S. government Treasury bonds, known as
STRIPS, that are held in the Equity Defeasance Account,
discussed below. This return, however, was reduced by
the transaction costs associated with the transaction,
such as the equity proceeds that went towards EZH’s
accommodation fee and its purchase of a letter of credit,
as described below.
    3   In order to simplify the analysis, in the following
discussion we treat ConEd as though it had a full interest
in the RoCa3 facility, notwithstanding the fact that
ConEd had only a 47.47% interest. Banc One Leasing,
Inc.—another investor represented by the same financial
advisor as ConEd—contemporaneously entered into a
LILO with EZH and holds the remaining 52.53% interest.
ConEd’s share is held, formally, by a trust operated for
the benefit of a ConEd subsidiary.
5                      CONSOLIDATED EDISON CO OF NY   v. US


lease term of 43.2 years (the “Head Lease Term”), com-
mencing on December 15, 1997 and ending on February
24, 2041 (the “Head Lease Termination Date”). Simulta-
neously, ConEd conveyed back the property to EZH.
ConEd entered into a sublease agreement with EZH (the
“Sublease Agreement”) in which EZH subleased ConEd’s
undivided interest in the RoCa3 plant from ConEd for a
term of 20.1 years. This initial term of the sublease (the
“Sublease Basic Term”) was set to end on January 2,
2018.
    Under the Head Lease Agreement, ConEd was obli-
gated to make an immediate Initial Basic Rent Payment
of $120,112,270.36. ConEd satisfied this obligation by
making an initial equity payment of $39,320,000.00 and
borrowing the remaining $80,792,270.36 as a nonrecourse
loan, at 7.10% interest, from Hollandsche Bank-Unie (the
“HBU Loan”). The equity payment and the HBU Loan
satisfied ConEd’s initial obligations to EZH under the
master lease.4
    EZH was immediately entitled to the equity payment
but, on the day following the Closing Date, the transac-
tion required EZH to transfer approximately $31 million
of ConEd’s equity payment to Credit Suisse First Boston
to create an Equity Defeasance Account.5 The funds in
this account were invested in zero-coupon U.S. govern-

    4   ConEd is also responsible for a Final Basic Rent
Payment under the Head Lease Agreement in the amount
of $831,525,734.00, which is due on the Head Lease
Termination Date in 2041. However, ConEd would not be
responsible for this payment in the event that EZH exer-
cises the Sublease Purchase Option, described below.
    5   Of the remaining $8 million of ConEd’s equity
contribution, EZH used $1.4 million to obtain a letter of
credit securing its sublease obligations to ConEd in the
event of EZH’s default, and retained the remaining $6.7
million as an “accommodation fee.”
CONSOLIDATED EDISON CO OF NY   v. US                  6


ment Treasury bonds known as STRIPS, and EZH
pledged its interest in the account to ConEd to secure
EZH’s payment obligations under the sublease.
    The account holding the proceeds of the ConEd HBU
Loan was called the Debt Defeasance Account, and was
held by ABN AMRO Bank N.V. (“ABN”) (the parent
company of HBU at the time of the closing). In general,
EZH was to make annual withdrawals from the Debt
Defeasance Account (satisfying ConEd’s obligations to
EZH under the Head Lease Agreement), and at the same
time was to make payments in identical amounts to HBU
to pay down ConEd’s HBU loan (satisfying EZH’s sub-
lease rent obligation to ConEd under the sublease). At
any given time, the amount remaining in the Debt Defea-
sance Account was to equal ConEd’s remaining principal
and interest payment obligations under the HBU Loan.6

   6    The amount EZH was to withdraw from the Debt
Defeasance Account was to be equal in amount to EZH’s
Sublease Basic Rent payments for the years 2005 through
2018. EZH was to satisfy its Sublease Basic Rent obliga-
tions from 1998 through 2003 by borrowing money from
ConEd under a loan (the “Sublessee Loan”). As with the
Debt Defeasance Account withdrawals, EZH’s scheduled
annual withdrawals under the Sublessee Loan were also
to be equal in amount and timing to the Sublease Basic
Rent owed to ConEd in each year of the Sublease Basic
Term (with the exception of 2004). For 2004, EZH’s Sub-
lease Basic Rent obligation was to be satisfied from a
combination of the scheduled withdrawals from the
Sublessee Loan and the Debt Defeasance Account. The
Sublessee Loan was established for EZH’s benefit so that
it could defer out of pocket payments on the Sublease
from 1997 through a portion of 2004. According to the
Sublessee Loan Documents, EZH was responsible to repay
the Sublessee Loan obligation to ConEd. EZH’s obligation
to repay the Sublessee Loan was to be extinguished if
EZH exercised the Sublease Purchase Option (which is
discussed below), because ConEd would extinguish EZH’s
7                       CONSOLIDATED EDISON CO OF NY   v. US


The Debt Defeasance Account was structured to earn
7.10% interest, which was the same interest rate as that
associated with the HBU Loan. The effect was such that
the HBU Loan proceeds were deposited in the Debt De-
feasance Account, and the principal and interest on the
loan were paid from those proceeds, together with the
interest those proceeds earned in the account.
    Under the Sublease Agreement, EZH was required to
“maintain, overhaul, inspect, test, repair, and service the
[RoCa3 plant] at its own expense during the Sublease
Basic Term on a basis comparable to EZH’s maintenance
of similar facilities that it owns, leases[,] or operates.”
Consol. Edison Co. of N.Y., Inc. v. United States (ConEd),
90 Fed. Cl. 228, 241 (2009). As described above, ConEd
paid EZH an “accommodation fee” of approximately $6.7
million in exchange for EZH’s willingness to enter into the
transaction.
    The transaction was structured so that EZH could re-
acquire its original interest in the RoCa3 Plant at the end
of the Sublease Basic Term. A Sublease Purchase Option
allowed EZH to purchase ConEd’s remaining interest in
the Head Lease Term for $215,450,949.20 in 2018. If EZH
declined to exercise the Sublease Purchase Option, ConEd
had the opportunity to exercise one of two options. It
could exercise the Sublease Renewal Option, under which
EZH would be required to renew the sublease for an
additional renewal term of 16.5 years. At the end of the
sublease renewal term, ConEd would operate the plant or
find a new sublessee for the remaining term of the head
lease (the “Shirt-Tail Period”). In the alternative, ConEd


loan obligation upon EZH’s exercise of the option. The
parties do not make clear whether the Sublessee Loan
was to be somehow repaid to ConEd by EZH or whether it
represented an additional transaction cost to ConEd.
CONSOLIDATED EDISON CO OF NY   v. US                     8


could exercise the Sublease Retention Option, under
which EZH would return the remaining interest in the
Head Lease Term to ConEd, allowing ConEd to take over
the RoCa3 Plant’s operations for the remainder of the
Head Lease Term.
                            III
    A LILO tax shelter is designed to accelerate losses to
the taxpayer and defer gains, so as to take advantage of
the time value of money by delaying tax payments. The
structure of the LILO Transaction facilitated several up-
front deductions that allowed ConEd to pay lower taxes in
1997 (and in later years) than it otherwise would have.
Because a large entity such as ConEd reports annual
income in the hundreds of millions of dollars, additional
deductions offset part of that income and produce sub-
stantial tax savings. A tax-indifferent entity such as EZH,
unlike ConEd, does not pay U.S. income taxes, and there-
fore cannot offset its income with such deductions. Mean-
while, the LILO Transaction allows EZH to benefit from
the accommodation fee and, at the same time, maintain
uninhibited operation of the RoCa3 Plant.
    The deductions ConEd claimed for tax year 1997 were
as follows. First, ConEd deducted rent it paid to EZH in
the amount of $1,072,652.7 Such rental deductions are
allowed under the Internal Revenue Code where those
payments are “required to be made as a condition to the

   7    ConEd calculated its rent deductions using the
terms of Internal Revenue Code § 467 that were applica-
ble at the time of the transaction Closing Date. According
to the government, the $120 million Initial Rent Payment
under the head lease was allocated over the first five
years of the head lease (plus a portion of 2003), and the
$831.5 million deferred head lease rent was allocated to
the remaining years of the head lease on an undiscounted
basis.
9                      CONSOLIDATED EDISON CO OF NY   v. US


continued use or possession, for purposes of the [taxpay-
ing] trade or business, of property.” I.R.C. § 162(a)(3).
Second, ConEd deducted interest payments associated
with the HBU Loan in the amount of $254,944. Interest
deductions are allowed for “all interest paid or accrued
within the taxable year on indebtedness.” I.R.C. § 163(a).
Although the tax impact at issue in this case—
specifically, the impact resulting from these deductions
for tax year 1997—was only $328,066, the projected tax
savings from ConEd’s use of these deductions in subse-
quent years of the transaction was substantial. For exam-
ple, the projected tax savings to ConEd during each tax
year from 1998 through 2001 was over $7 million per
year.
                           IV
    The government’s primary contention is that EZH
was reasonably likely to exercise the Sublease Purchase
Option, and that, as a result, the purported master lease
(or head lease) should not be treated as a true lease, and
the tax deductions that would flow from a true lease were
not available to ConEd. The government argues that the
interest deductions associated with the HBU Loan were
likewise not available.
    The government points out that in the event that EZH
exercised the Sublease Purchase Option the transaction
would be completed at no risk to ConEd. In general, the
head lease payments ConEd made would be recovered
through the sublease payments made by EZH. The pro-
ceeds ConEd obtained from EZH’s exercise of the Sublease
Purchase Option would include the amounts remaining in
the Debt Defeasance account and would ensure that the
remaining HBU Loan would be paid in full at no future
cost to ConEd. ConEd, meanwhile, would receive most of
the equity contribution in the Equity Defeasance Account
CONSOLIDATED EDISON CO OF NY    v. US                   10


back as part of the option purchase price (reduced by the
fees necessary to create the transaction). ConEd would
receive a return on its equity investment in the U.S.
government Treasury STRIPS invested through the
Equity Defeasance Account. ConEd would not need to
assume any risks associated with operating the RoCa3
Plant, since EZH would continue to manage and operate
the RoCa3 Plant as it had before. All of ConEd’s future
obligations under the head lease would be extinguished.
    So too, ConEd would bear no risk associated with the
HBU Loan. At the relevant time, HBU was a subsidiary of
ABN, which managed the Debt Defeasance Account that
held the loan’s proceeds. As discussed above, the ap-
proximately $81 million in loan proceeds were designed to
flow in a loop from HBU to ConEd to EZH and back to
HBU. Moreover, ConEd’s risk on the loan would be elimi-
nated because EZH purchased a letter of credit for ap-
proximately $1,412,594.12 to secure its obligations to
ConEd under the sublease. ConEd’s tax advisor described
the HBU Loan as containing “100% loop debt,” and ABN
treated the loan as being “off balance sheet.” J.A. 23,353,
17,140. Throughout the transaction, ABN had “irrevoca-
ble” control of the funds. J.A. 10,432, 10,444.
                            V
    The IRS assessed the deficiency against ConEd for
1997. ConEd paid the deficiency and sued for a refund in
the Claims Court. The Claims Court, after a trial, deter-
mined that the transaction could not be ignored under the
substance-over-form doctrine. It concluded that ConEd
had “established . . . that the RoCa3 [LILO] Transaction
was a unique LILO transaction, which provided tax and
bookkeeping advantages to the plaintiff; was, in form, a
true lease; . . . and, therefore, should be respected as
11                       CONSOLIDATED EDISON CO OF NY   v. US


qualifying for the tax deductions claimed.” ConEd, 90 Fed.
Cl. at 340.
    The Claims Court also “conclude[d] that there is no
certainty that EZH will exercise the Sublease Purchase
Option.” Id. at 295. It followed that the transaction,
“although insulated to minimize risk, was not without
risk” and that “[t]he RoCa3 [LILO] Transaction presented
three separate, viable Options [i.e., the Retention, Re-
newal, and Sublease Purchase Options] that could be
exercised at the end of the Sublease Basic Term, none of
which was guaranteed or inevitable at the time the
Transaction was consummated.” Id. at 340. Thus, the
Claims Court concluded that ConEd’s claimed interest
and rent deductions were “allowable.” Id. at 341. The full
judgment for ConEd was in the amount of $5,977,220.09,
which consisted of a full refund of the deficiency related to
the LILO ($328,066.00), a refund of ConEd’s overpayment
of previously-paid assessed interest ($3,226,868.90), and
reimbursement for a preexisting credit balance
($2,422,285.19).
    The United States timely appealed the Claims Court’s
ruling and challenges its ruling under the substance-over-
form doctrine.8 We have jurisdiction under 28 U.S.C. §
1295(a)(3). “We review the characterization of transac-
tions for tax purposes de novo, based on underlying find-
ings of fact, which we review for clear error.” Wells Fargo,
641 F.3d at 1325 (citing Stobie Creek Invs., LLC v. United
States, 608 F.3d 1366, 1375 (Fed. Cir. 2010)).


     8  The Claims Court also concluded that the LILO
Transaction satisfied the economic substance doctrine.
See ConEd, 90 Fed. Cl. at 341 (concluding that the trans-
action “possessed economic substance”). On appeal, the
government does not challenge the Claims Court ruling
under the economic substance doctrine.
CONSOLIDATED EDISON CO OF NY   v. US                      12


                        DISCUSSION
     As we stated in Coltec, judicial anti-abuse doctrines
“prevent taxpayers from subverting the legislative pur-
pose of the tax code.” Coltec Indus., Inc. v. United States,
454 F.3d 1340, 1354 (Fed Cir. 2006). One such doctrine is
the substance-over-form doctrine. Under this doctrine,
courts determine “the tax consequences of a transaction . .
. based on the underlying substance of the transaction
rather than its legal form.” Wells Fargo, 641 F.3d at 1325
(citing Griffiths v. Helvering, 308 U.S. 355, 357 (1939)).
“The major purpose of the substance-over-form doctrine is
to recharacterize transactions in accordance with their
true nature.” Southgate Master Fund, L.L.C. ex rel. Mont-
gomery Capital Advisors, LLC v. United States, 659 F.3d
466, 491-92 (5th Cir. 2011) (internal quotation marks
omitted)).
     This substance-over-form doctrine, like the economic
substance doctrine, “is merely a judicial tool for effectuat-
ing the underlying Congressional purpose that, despite
literal compliance with the statute, tax benefits not be
afforded based on transactions lacking . . . substance.”
Coltec, 454 F.3d at 1354. The Supreme Court recognized
the substance-over-form doctrine in Frank Lyon Co. v.
United States, where it noted that “[t]he Court has never
regarded ‘the simple expedient of drawing up papers’ as
controlling for tax purposes when the economic realities
[of the transaction] are to the contrary.” 435 U.S. 561, 573
(1978) (quoting Comm’r v. Tower, 327 U.S. 280, 291
(1946)).
    The government urges that we should reverse the
Claims Court’s refusal to apply the substance-over-form
doctrine here for two reasons. First, if the Sublease Pur-
chase Option were reasonably expected to be exercised,
the transaction would be recharacterized as one without
13                      CONSOLIDATED EDISON CO OF NY   v. US


any meaningful substance. Second, the government urges
that, even if the Sublease Purchase Option were not
exercised, ConEd would not bear any residual value risk
associated with the transaction because “ConEd has the
ability to exercise its sublease-renewal option, and
thereby recoup its investment through EZH’s continuing,
pre-determined rent obligations, the payment of which is
secured by the Treasury STRIPS held in the Equity
Defeasance Account and a letter of credit.” Appellant’s Br.
53-54. Because ConEd would not bear any risk, the gov-
ernment argues, the transaction should be ignored as
lacking substance. Since we agree with the government’s
first theory, we do not address the second.
                             I
    Both LILO and related sale-in/lease-out (“SILO”)
transactions have been utilized by taxpayers in attempts
to avoid taxes. A SILO transaction is identical to a LILO
transaction except that the head lease term is longer than
the useful life of the facility, so that the IRS ignores the
lease arrangement and “treats the head lease as a sale of
the asset.” Wells Fargo, 641 F.3d at 1321. The result, as
with a LILO transaction, is that the taxpayer is not
entitled to deductions premised on treating the transac-
tion as a genuine lease and sublease.
    Before Congress amended the Internal Revenue Code
and put an end to the tax benefits associated with LILO
and SILO transactions in 2004, see id. at 1323 (citing
American Jobs Creation Act of 2004, Pub. L. No. 108-357,
118 Stat. 1418), the LILO and SILO transactions were not
uncommon, nor was litigation concerning the tax conse-
quences of such transactions. Taxpayers have not been
successful in these cases. Every circuit (including our
own) that has considered LILOs or SILOs has held that
such transactions do not pass the substance-over-form
CONSOLIDATED EDISON CO OF NY   v. US                      14


test. See Altria Grp., Inc. v. United States, 658 F.3d 276
(2d Cir. 2011) (affirming a jury’s determination that a
series of LILO and other transactions did not withstand
the substance-over-form inquiry); Wells Fargo, 641 F.3d
1319; BB&T Corp. v. United States, 523 F.3d 461, 464
(4th Cir. 2008) (affirming district court’s conclusion that
“although the form of [a LILO] transaction involved a
lease financed by a loan, BB&T did not actually acquire a
genuine leasehold interest or incur genuine indebtedness
as a result of the transaction”).
    In addressing the issues here we are obligated to fol-
low this court’s prior decision in Wells Fargo. The transac-
tions at issue in Wells Fargo were SILO transactions
involving leases and subleases of various public transit
vehicles. The transactions, like those in BB&T, Altria,
and this case, contained purchase options as well as
options similar to the renewal and retention options here.
See Wells Fargo, 641 F.3d at 1323-24. The Claims Court
found that “Wells Fargo expected the tax exempt entities
to exercise their options to repurchase their assets be-
cause ‘the economic effects of the alternatives were so
onerous and detrimental that a rational tax-exempt entity
would do nothing other than exercise the options.’” Id. at
1324. The Claims Court had recharacterized the transac-
tions as ones that “‘essentially amount[ed] to Wells
Fargo’s purchase of tax benefits for a fee from a tax-
exempt entity that cannot use the deductions,’” and
disregarded the transactions under the substance-over-
form doctrine. Id. (alteration in original). We held that the
Claims Court did not clearly err in “finding that the tax-
exempt entities [we]re virtually certain to exercise their
repurchase options.” Id. at 1330. Thus, applying the
appropriate test under the substance-over-form doctrine,
which asks “whether Wells Fargo could have reasonably
expected that the tax-exempt entities would exercise their
15                      CONSOLIDATED EDISON CO OF NY   v. US


repurchase options,” id. at 1327, we easily concluded that
the court was “left with purely circular transactions that
elevate[d] form over substance.” Id. at 1330. Specifically,
“the claimed tax deductions [we]re for depreciation on
property that Wells Fargo never expected to own or
operate, interest on debt that existed only on a balance
sheet, and write-offs for the costs of transactions that
amounted to nothing more than tax deduction arbitrage.”
Id.
    In this case, as in Wells Fargo, our key inquiry is
whether EZH would exercise its purchase option at the
end of the Sublease Basic Term. If the Sublease Purchase
Option were exercised, the transaction would merely
become a transaction in which ConEd leased the RoCa3
Plant from EZH and leased it back for the same identical
period. Such a transaction lacks substance. This would
particularly be so here because EZH would maintain
uninterrupted use of the RoCa3 Plant without any in-
volvement on ConEd’s part and ConEd would not experi-
ence any benefits or burdens associated with its leasehold
interest.
                            II
    ConEd argues that, unlike in Wells Fargo, the Claims
Court (applying the proper standard) here made factual
findings in ConEd’s favor with respect to the likelihood
that the tax-indifferent entity would exercise the pur-
chase option. ConEd argues that these findings were not
clearly erroneous, and that this distinguishes this case
from Wells Fargo.
     ConEd’s argument rests on three erroneous premises.
                            A
   First, ConEd mistakenly argues that, under Wells
Fargo, the purchase option is significant only if it is
CONSOLIDATED EDISON CO OF NY      v. US                    16


“certain” to be exercised. While the district court found
that the options at issue in Wells Fargo were virtually
certain to be exercised and we held on appeal that this
finding was not clearly erroneous, see 641 F.3d at 1329,
we made clear that the relevant standard was reasonable
likelihood. In evaluating whether the LILO Transaction
in this case must be recharacterized, Wells Fargo requires
that we assess whether a prudent investor in ConEd’s
position would have reasonably expected that EZH would
exercise the purchase option. As we stated in Wells Fargo:
        We have never held that the likelihood of a
    particular outcome in a business transaction must
    be absolutely certain before determining whether
    the transaction constitutes an abuse of the tax
    system. The appropriate inquiry is whether a pru-
    dent investor in the taxpayer’s position would have
    reasonably expected that outcome. Characteriza-
    tion of a tax transaction based on a highly prob-
    able outcome may be appropriate, particularly
    where the structure of the transaction is designed
    to strongly discourage alternative outcomes.
641 F.3d at 1325-26 (emphasis added). This language
makes clear that a “reasonable expectation” standard,
rather than a “certainty” standard, governs the recharac-
terization of transactions under the substance-over-form
doctrine. In our view, and consistent with Wells Fargo,
therefore, the “critical inquiry” is whether ConEd “could
have reasonably expected that the tax-[indifferent] en-
tit[y] would exercise [its] repurchase option[].” Id. at 1327.
                              B
    Second, ConEd is mistaken in arguing that the
Claims Court here applied the correct Wells Fargo stan-
dard. ConEd argues that the Claims Court applied the
Wells Fargo standard and found that “EZH is not ‘likely’
17                      CONSOLIDATED EDISON CO OF NY   v. US


to exercise its purchase option.” Appellee’s Br. 41. This is
simply not an accurate characterization of the Claims
Court’s findings, and it is based on quoting a portion of
the Claims Court’s opinion that merely describes ConEd’s
evidence.9 When the Claims Court made factual findings
it assumed (erroneously) that the applicable standard was
whether EZH was “certain” to exercise the option. The
Claims Court specifically concluded that because “the
Sublease Purchase Option was not certain to be exercised
by EZH, . . . [ConEd] had the benefit of potential profit
and burdens of possible lost monies . . . .” ConEd, 90 Fed.
Cl. at 304. Similarly, it noted that ConEd’s investment
was subject to market risk “[b]ecause the Sublease Pur-
chase Option is not certain to be exercised,” id. at 298;
that the LILO Transaction “consisted of three possible
scenarios, none of which was certain to occur after the
initial lease term,” id. at 306; and that there was “no
guarantee” that the Sublease Purchase Option would be
exercised as of “December 1997, when the Transaction
was consummated.” Id.10 The Claims Court applied the

     9  The Claims Court opinion states that the ap-
praisal report commissioned by ConEd “conclude[d] that a
decision by EZH to exercise the Sublease Purchase Option
was not a necessary, or even likely outcome” of the trans-
action. ConEd, 90 Fed. Cl. at 277. ConEd, however,
cannot point to any passage in the opinion suggesting
that this was the Claims Court’s ultimate factual finding.
ConEd repeats its mischaracterization several times
throughout its brief.
    10  Other examples of the Claims Court’s application
of a certainty standard (or the equivalent) abound. See
ConEd, 90 Fed. Cl. at 293 (“[W]hat became clear is that in
1997 there was no certainty as to which of the out-year
options would be exercised by EZH . . . .”); id. at 294
(“[T]he court concludes that in the RoCa3 Transaction, the
Sublease Purchase Option is not certain to be exercised.”);
id. at 295 (“[T]he trial testimony and exhibits lead the
court to conclude that there is no certainty that EZH will
CONSOLIDATED EDISON CO OF NY       v. US                      18


wrong standard—understandably because, at the time
that it rendered its decision, the Claims Court here did
not have the benefit of our Wells Fargo decision.
                               C
    Finally, ConEd mistakenly argues that even if “rea-
sonable likelihood” is the correct standard, and was
misapplied by the Claims Court, a remand is required for
the Claims Court to decide this case under the correct
standard. This argument rests on ConEd’s view that the
record could support a finding that EZH was not reasona-
bly likely to exercise the option. We disagree with
ConEd’s assessment of the evidence. ConEd has the
burden of proof to show that EZH’s exercise of the pur-
chase option is not reasonably likely. See United States v.
Janis, 428 U.S. 433, 440-41 (1976) (“In a refund suit the
taxpayer bears the burden of proving the amount he is

exercise the Sublease Purchase Option . . . .”); id. at 306
(“The Transaction, as it was put into place by the parties,
consisted of three possible scenarios, none of which was
certain to occur after the initial lease term . . . .”); id.
(“[A]t the time of the Transaction, there was no certainty
that the Sublease Purchase Option would be exercised.”);
id. at 323 (noting that the Sublease Purchase Option is
“not certain to occur”); id. at 331-32 (“EZH is not certain
to exercise the Sublease Purchase Option, and if EZH
does not exercise the Sublease Purchase Option, both the
residual value risk and potential profit are present for the
plaintiff.”); id. at 335 (noting that “exercise of the Sub-
lease Purchase Option in the RoCa3 Transaction was not
all but certain”); id. at 340 (“There was no proof presented
or certainty that EZH would necessarily exercise the
Sublease Purchase Option.”); see also id. at 294 (“[T]he
Sublease Purchase Option is not guaranteed to be exer-
cised and, therefore, contrary to some other LILO cases, . .
. the plaintiff’s investment was placed at risk . . . .”); id. at
277 (stating that exercise of the option “[was] not the
inevitable outcome“ of the transaction).
19                       CONSOLIDATED EDISON CO OF NY    v. US


entitled to recover.”); Helvering v. Taylor, 293 U.S. 507,
515 (1935) (“Unquestionably the burden of proof is on the
taxpayer to show that the Commissioner’s determination
is invalid.”); Coltec, 454 F.3d at 1355 (“[I]t is the taxpayer
who bears the burden of proving that the transaction has
economic substance.”); Charron v. United States, 200 F.3d
785, 792 (Fed. Cir. 1999) (“Since the [plaintiffs] were
seeking refunds of taxes they had paid, they have the
burden of proving they are entitled to the amount
sought.”). And in this case, ConEd has not met this bur-
den.
    The record demonstrates that ConEd’s own contempo-
raneous statements made shortly before the Closing Date
reveal ConEd’s expectation that EZH would exercise the
purchase option. Brian DePlautt, the Vice President of the
ConEd subsidiary responsible for the RoCa3 transaction,
admitted that ConEd believed that EZH preplanned to
exercise the option before the closing date of the transac-
tion. Responding to an inquiry from ConEd’s accountant,
PriceWaterhouse, on November 21, 1997, asking whether
EZH’s exercise of the purchase option was “reasonably
assured,” DePlautt responded:
        Yes, among the reasons are (a) [the
        RoCa3] facility is a newly built key asset
        for [EZH], [and] (b) [EZH] has preplanned
        for purchase and done [its] economic
        analysis on the assumption that the plant
        will be purchased.
J.A. 25,776, 25,779. By that DePlautt meant that exercise
of the purchase option would “more likely than not” occur
(i.e., exercise was “over 50 percent” probable), and he
admitted that he believed going into the transaction “that
EZH had preplanned for the exercise of the purchase
option.” J.A. 4140, 4238. Additionally, in a November 26,
CONSOLIDATED EDISON CO OF NY   v. US                     20


1997, memo, ConEd acknowledged a Transaction Struc-
ture Description document from Cornerstone, the LILO
promoter, which indicated that “‘it is reasonable to as-
sume . . . that [EZH] will exercise the purchase option.’”11
J.A. 16,032. Finally, in ConEd’s own internal analyses of
the transaction, ConEd admitted that it “assume[d] no
economic benefit” from the Shirt-Tail period following the
Sublease Renewal Option, see J.A. 16,615, suggesting that
it did not fully consider situations that could arise where
EZH declined the Sublease Purchase Option. Although
ConEd asserted at oral argument before our court that
DePlautt’s admissions only constituted the subjective
views of one executive at the time the documents were
written, and that ConEd changed its prediction prior to
the Closing Date, the evidence ConEd cites for this propo-
sition merely indicates that ConEd, in its financial ac-
counting of the transaction, booked the transaction over
the entire 44-year term of the head lease. This is hardly a
surprise. ConEd was required to account for the transac-
tion in this manner if it wished to take the claimed deduc-
tions. This accounting treatment does not negate the

   11    The full quote from the Transaction Structure de-
scription document reads as follows:
       Although the Purchase Option Price will be greater
       than or equal to the expected fair market value of
       the Sublessor’s Lease Interest, taking into account
       possible required renewal rents, other non eco-
       nomic factors such as the strategic nature of the as-
       set to Sublessee’s business and the fact that the
       proceeds required to purchase the Sublessor’s
       Lease interest are set aside at closing tend to shift
       the probability of the Sublessee executing the pur-
       chase option. It is reasonable to assume, based on
       non economic factors mentioned above plus the
       credit and collateral requirements outlined below
       that the Sublessee will exercise the Purchase Op-
       tion.
21                     CONSOLIDATED EDISON CO OF NY   v. US


uncontradicted evidence that ConEd reasonably expected
the purchase option to be exercised.12
    ConEd also failed to establish that a reasonable com-
pany in ConEd’s position would not have expected that
EZH was reasonably likely to exercise the option. ConEd
relies on an appraisal it obtained from Deloitte & Touche
(the “Deloitte Report”) to demonstrate that a prudent
investor would not have reasonably expected that EZH
would exercise the Sublease Purchase Option. But the
Deloitte Report is primarily based on the notion that, in
Deloitte’s view, there was no “economic compulsion” to
exercise the Sublease Purchase Option because the Sub-
lease Option Price would exceed the projected value of the
property. J.A. 10,572.
    Deloitte’s analysis is insufficient to establish that
EZH was not reasonably likely to exercise the purchase
option. It is uncontested that several factors would bear
on the likelihood of exercise such as (1) non-economic
factors; and (2) the costs to EZH that would result from
ConEd’s exercise of the renewal or retention options if
EZH declined to exercise the Sublease Purchase Option.
Under either the renewal or retention option EZH faced
substantial risks and the potential for adverse financial
impacts, just as in ConEd’s view ConEd faced residual
risks if either option were exercised. If ConEd exercised


     12 ConEd argues that EZH’s formal statements that
“[t]here is no known factor to EZH which creates a mate-
rial inducement for EZH to exercise the Purchase Option,”
J.A. 11,511, 20,878, suggest that EZH did not preplan to
exercise the option. However, these statements appear to
be a boilerplate representations that EZH was required to
make under its Tax Indemnity Agreement with ConEd.
See J.A. 9677. These representations had no effect on
ConEd’s understanding that EZH preplanned to exercise
the option, as reflected in DePlautt’s testimony.
CONSOLIDATED EDISON CO OF NY   v. US                     22


the Renewal Option, for example, EZH would potentially
lose the ability to operate the plant profitably during the
Shirt-Tail Period; and under the Retention Option, EZH
would risk losing the right to operate the plant profitably
during the remainder of the head lease. As ConEd admits,
“EZH can be replaced as the operator of RoCa3” at the
end of the sublease. Appellee’s Br. 48.
    At the same time, the Sublease Purchase Option re-
quired no out-of-pocket funds, as the money EZH would
require to exercise the Sublease Purchase Options was set
aside in the two defeasance accounts. Cf. BB&T, 523 F.3d
at 473 n.13 (“BB&T supplied the funds for the purchase
[option] . . . . Because the ‘purchase’ is free to [the tax-
indifferent entity], price cannot be [an] obstacle.”). As of
2018, the Debt Defeasance Account would still have a
balance of $116,252,521.63, which EZH could apply to the
Sublease Purchase Option payment. Meanwhile, EZH
would be entitled to apply the amounts in the Equity
Defeasance Account to the Sublease Purchase Option
price using matured treasury STRIPS. All but one of the
zero-coupon U.S. Government treasury STRIPS in the
Equity Defeasance Account are set to mature in 2017 or
2018,13 and the total value of these bonds at maturity is
$99,199,000.00. The appropriate amounts that EZH
would be entitled to in 2018 thus amounted to just over
$215,451,000.00, the cost of the Sublease Purchase Op-
tion, rendering the option effectively costless to EZH.



   13   One other treasury STRIPS matured as of 2011
and is valued at $5,221,000.00. This bond is not included
in the total value of the bonds needed to exercise the
Sublease Purchase Option, but is paid in cash from EZH
to ConEd as an additional sublease rent payment in 2012.
This is referred to as the “free cash payment” in the
record.
23                       CONSOLIDATED EDISON CO OF NY   v. US


    Deloitte failed to address these considerations.
Though Deloitte’s Report contained boilerplate references
suggesting that Deloitte considered “other identifiable
factor[s]” as well as the costs that EZH would accrue if it
were to decline the Sublease Purchase Option, J.A.
10,572, there were no calculations cited in the Deloitte
Report that analyzed the non-economic and other consid-
erations described above.14 More importantly, the author
of the Deloitte report, Ellsworth, admitted at his deposi-
tion that Deloitte failed to consider the consequences to
EZH of not exercising the purchase option. The following
exchange occurred:
           Q. Mr. Ellsworth, did you consider in draft-
     ing your report the consequences to EZH of not
     exercising the purchase option?
           A. That subject was not something that we
      were asked to provide an opinion on as part of the
      appraisal report.
J.A. 3768. Ellsworth also admitted that Deloitte failed to
consider the source of the purchase option funding in
assessing the likelihood that EZH would exercise the

     14 Certain calculations that appear in the Deloitte
Report and Kelly’s expert report, see J.A. 28,857, 28,871,
purport to analyze the costs and benefits associated with
ConEd’s decisions to exercise either the sublease renewal
or retention options (in the event that EZH declines the
Sublease Purchase Option). However, these calculations
considered the cash flows that would flow to and from
EZH and ConEd under each of the two options, and do not
assess all of the factors discussed above that would be
relevant to EZH’s analysis of whether or not it would
prefer either of these options over exercise of the Sublease
Purchase Option. Additionally, these calculations do not
consider the probability that ConEd would exercise either
the renewal or retention option, which would bear on
EZH’s decision as well.
CONSOLIDATED EDISON CO OF NY   v. US                    24


purchase option. Finally, Deloitte admitted that it pro-
duced on “the order of magnitude” of 100 appraisal re-
ports of LILO transactions and never once found that
there was “economic compulsion” to exercise a purchase
option, further underscoring the boilerplate nature of its
analyses. J.A. 3795-96. ConEd also cites the Kelly expert
report as independent evidence that EZH was not rea-
sonably likely to exercise the Sublease Purchase Option,
but the Kelly report merely relied on the Deloitte Report’s
analysis.
    At oral argument, ConEd confirmed that Deloitte did
not consider either the non-economic factors relevant to
EZH’s exercise of the purchase option or the consequences
that EZH would face if it were not to have exercised the
Sublease Purchase Option. ConEd also admitted that the
Kelly expert report did not consider these factors. ConEd’s
other experts lend no support to its position. Though
ConEd argues that Reed’s testimony suggests that exer-
cise of the option was impossible to predict, for example,
he merely testified that there was “uncertainty associated
with whether the option will or will not be exercised” and
that it was “impossible to determine [the purchase op-
tion’s exercise] with virtual certainty as of December 15,
1997.”15 J.A. 4657; ConEd, 90 Fed. Cl. at 285 (emphasis
added).Thus ConEd presented no evidence that exercise of
the purchase option was not reasonably likely by a pru-
dent investor.

   15   Goulding, another ConEd expert, also does not
disturb our conclusion, as he merely testified that EZH
was not under any “compulsion” to exercise the purchase
option because EZH would not be bound by regulations to
supply power from the RoCa3 Plant in 2018. J.A. 4448.
Though this factor may not have compelled EZH to exer-
cise the option, he did not provide evidence suggesting
that the other factors described above would not make
EZH reasonably likely to exercise the option.
25                       CONSOLIDATED EDISON CO OF NY   v. US


     To the extent that ConEd argues that the govern-
ment’s experts made concessions that the likelihood of
EZH’s exercise of the purchase option was speculative, it
is clear that their “concessions” were merely admissions of
the obvious: that the future exercise of the purchase
option could not be guaranteed with complete certainty.
Samuel Ray, a consultant in equipment leasing and
financing, merely stated that he did not “know for certain”
if EZH was going to exercise the option, while making his
opinion clear in his expert report that “it is reasonable
that EZH will exercise the Sublease Purchase Option at
the end of the Sublease Bas[ic] Term.” J.A. 6866, 29,506.
David W. LaRue, a professor retained by the government,
admitted that there is “[a] certain amount of speculation”
associated with EZH’s exercise of the purchase option, but
also testified that he “conclu[ded] that it was highly likely
that EZH would exercise the fixed purchase option.”16 J.A.
7179 (emphasis added); Trial Tr. 5087. The government’s
evidence, therefore, would not support a finding that
exercise of the option was not reasonably likely.
    Because the undisputed evidence establishes that
EZH was reasonably likely to exercise the purchase
option, ConEd has failed to show that the substance of the
transaction included a genuine leasehold interest in
which ConEd would bear the benefits and burdens of a
lease transaction. Therefore, the LILO Transaction does
not constitute a true lease and ConEd’s rent deductions



     16 ConEd argues that LaRue testified that EZH’s ex-
ercise of the purchase option would be “pure speculation.”
J.A. 7179. This characterization of LaRue’s testimony is
incorrect, as he only stated that it would be “pure specula-
tion” to know, prior to 2018, any of the individual factors
relevant to EZH’s purchase option decision with certainty.
Id.
CONSOLIDATED EDISON CO OF NY   v. US                       26


were properly disallowed under § 162(a)(3) of the Internal
Revenue Code.
                             III
    Finally, we must also consider whether ConEd is enti-
tled to its interest deductions associated with the HBU
Loan under § 163(a) of the Internal Revenue Code. To
achieve such deductions, the taxpayer must incur “genu-
ine indebtedness” associated with the LILO Transaction.
See BB&T, 523 F.3d at 475 (internal quotation mark
omitted). In this case, it is clear that the loan is not genu-
ine. As noted above, ConEd undertook approximately $81
million in debt from HBU, EZH withdraws from this
account to satisfy ConEd’s Initial Head Lease Payment
obligation, and EZH pays back into this account (with
payments that are equal in amount) in order satisfy its
sublease obligations. The loan proceeds effectively remain
in the account to satisfy ConEd’s loan obligation to HBU.
Interest payments associated with genuine indebtedness
are viewed as “compensation for the use or forbearance of
money.” Deputy v. du Pont, 308 U.S. 488, 498 (1940).
Here, the funds from ConEd’s HBU Loan flowed from
ABN (to fulfill the head lease obligation) and then back to
ABN (to fulfill the sublease obligation) in a loop. The facts
that ConEd’s tax advisor referred to the transaction as
having “100% loop debt,” J.A. 23,353, and that ABN
treated the transaction as “off balance sheet,” id. 17,140,
are unsurprising given that the money from the transac-
tion would never leave ABN’s hands under the Sublease
Purchase Option. As in BB&T, “ABN, which treated the
loan as an off-balance sheet transaction, did not forbear
any money during the time period in which BB & T
sought to claim interest deductions.” 523 F.3d at 476; see
also Altria, 658 F.3d at 290-91 (“The evidence . . . rea-
sonably supported the jury’s finding that the nonrecourse
debt Altria incurred was not genuine. The lender never
27                     CONSOLIDATED EDISON CO OF NY   v. US


forbore use of the purportedly loaned funds and Altria
never obtained use of those funds.”). Following the Fourth
Circuit, we agree that “[a] party simply does not incur
genuine indebtedness by taking money out of a bank and
then immediately returning it to the issuing bank.”
BB&T, 523 F.3d at 477. ConEd is not entitled to its
interest deductions under § 163(a).
                      CONCLUSION
    For the foregoing reasons, we reverse the judgment of
the Claims Court in which it upheld ConEd’s claimed
deductions with respect to the LILO Transaction, and
remand to the Claims Court so that it may properly
recalculate ConEd’s refund in light of this decision.
            REVERSED AND REMANDED
