Saturday, October 1, 2011
We affirm in all respects the district court’s judgment disposing of this petition for a readjustment of partnership tax items under § 6226. The plaintiff, Southgate Master Fund, L.L.C., was formed for the purpose of facilitating the acquisition of a portfolio of Chinese nonperforming loans (“NPLs”). A partnership for tax purposes, Southgate’s disposition of its portfolio of NPLs generated more than $1 billion in paper losses, about $200 million of which were claimed as a deduction by one of its partners in tax year 2002. The Internal Revenue Service determined that Southgate was a sham partnership that need not be respected for tax purposes and that Southgate’s allocation of the $200 million loss to the deducting partner should be disallowed. The district court upheld these determinations. After laying out the pertinent factual background in Part I, we explain in Part II why the district court was correct to do so. The Service further determined that the accuracy-related penalties in §§ 6662(b)(1)–(3) applied to the underpayments of tax resulting from Southgate’s treatment of its losses. On this point, the district court disagreed, disallowing the accuracy-related penalties on the ground that Southgate had reasonable cause for, and acted in good faith with respect to, the tax positions that resulted in the underpayments of tax. Although this issue is a close one, we affirm the district court’s decision to disallow the penalties.
(Hat Tip: Richard Jacobus.)