Government Wins First Son of BOSS Case to be Tried

The Government won a major victory late Friday afternoon in the first Son of BOSS case to be litigated.  Jade Trading LLC v. United States, No 03-2164T (Fed. Cl. 12/21/07). The court held that the taxpayer's $450,000 investment that generated $40 million in tax losses lacked economic substance:

Poignantly at play here is the tension between technical compliance with the Internal Revenue Code and the longstanding common-law economic substance doctrine which compels courts to disregard transactions which lack economic substance despite their literal compliance with the Code. Plaintiffs characterize the tension differently, arguing that the economic substance doctrine cannot ignore “deliberately adopted rules of law,” ...

Plaintiffs’ theory cannot prevail in light of the Federal Circuit’s decision in Coltec Industries, Inc. v. United States, 454 F.3d 1340, 1352-54 (Fed. Cir. 2006), reaffirming the vitality of the economic substance doctrine. Coltec teaches that the legitimacy of a transaction for tax purposes is not guaranteed merely because a technical interpretation of the Code would support the tax treatment. Rather, Coltec mandates additional scrutiny of the bona fides of a transaction, requiring independently that the transaction pass muster under the objective economic substance test. Further, the Coltec Court clarified the parameters for applying that test holding that the taxpayer has the burden of proving that the transaction which gave rise to the tax benefit objectively had economic substance, i.e., was a real transaction structured in a particular way to provide a tax benefit as opposed to a transaction created for tax avoidance purposes.

Here, several factors compel a conclusion that Plaintiffs have not met their burden of demonstrating that the spread transactions contributed to Jade objectively had economic substance.

Here is the Conclusion:

Plaintiffs’ petition for readjustment of the partnership items of Jade is DENIED. This Court lacks jurisdiction to consider partner-level reasonable cause defenses in this proceeding. The Commissioner’s application of penalties at the partnership-level is affirmed without consideration of the reasonable cause defenses, which may be raised in any partner-level proceedings.

Jade Trading was the first Son of Boss tax shelter case to go to trial. After the trial concluded in December 2005, but before a decision was announced, the Federal Circuit issued its opinion in Coltec. In briefs filed in August 2006, the parties briefed Judge Williams on the application of the Coltec economic substance doctrine to Jade Trading. Although Son of Boss tax shelters were marketed to individuals, the principles underlying the government's victory in the Court of Federal Claims in Jade Trading will apply as well to the tax shelters sold to and used by corporations. (Hat Tip: Eileen O'Connor.)

Update:  Press and blogosphere coverage:

• Chart of Transaction
• Conde Nast Portfolio.com:  Tearing Down a Tax Shelter, by Jeffrey Cane
• New York Times:  Judge Hands I.R.S. Victory in Tax Shelter, by Lynnley Browning
• Reuters:  Court Denies Claim in Tax Refund Case
• Roth & Co.:  Broken Jade, by Joe Kristan
• A Taxing Matter:  Jade Trading Decision: Economic Substance Reinvigorated, by Linda Beale
• Wall Street Journal:  U.S. Prevails in Tax-Shelter Battle; "Son of Boss" Court Ruling Could be Used to Pressure Other Taxpayers to Settle, by Jesse Drucker
• Wall Street Journal Law Blog:  The Feds Prevail in Tax-Shelter Battle, by Peter Lattman