Paul L. Caron
Dean




Friday, August 6, 2010

Tax Court Upholds $37m Penalty Against TP Who Relied on Tax Opinion Issued by PWC for $800k Flat Fee

The Tax Court yesterday held that Chesapeake Corp.'s transfer of a wholly-owned subsidiary to a joint venture with Georgia Pacific Corp. was a disguised sale under § 707(a)(2)(B), resulting in a $524 million capital gain. Canal Corp. v. Commissioner, 135 T.C. No. 9 (Aug. 5, 2010). Thecourt found Chesapeake Corp. (now Canal Corp.) liable for a $37 million accuracy-related penalty under §  6662(a):

A taxpayer may rely on the advice of any tax adviser, lawyer or accountant. ... The advice must not be based on unreasonable factual or legal assumptions and must not unreasonably rely on representations, statements, findings, or agreements of the taxpayer or any other person. Reg. § 1.6664- 4(c)(1)(ii). Courts have repeatedly held that it is unreasonable for a taxpayer to rely on a tax adviser actively involved in planning the transaction and tainted by an inherent conflict of interest. ...

Chesapeake claims it reasonably relied in good faith on PWC’s tax advice and “should” opinion and therefore no penalty should be imposed. Respondent contends that Chesapeake unreasonably relied on an opinion riddled with improper assumptions written by a tax adviser with a conflict of interest. ...

Chesapeake paid PWC an $800,000 flat fee for the opinion, not based on time devoted to preparing the opinion. Mr. Miller testified that he and his team spent hours on the opinion. We find this testimony inconsistent with the opinion that was admitted into evidence. The Court questions how much time could have been devoted to the draft opinion because it is littered with typographical errors, disorganized and incomplete. Moreover, Mr. Miller failed to recognize several parts of the opinion. The Court doubts that any firm would have had such a cavalier approach if the firm was being compensated solely for time devoted to rendering the opinion.

In addition, the opinion was riddled with questionable conclusions and unreasonable assumptions. Mr. Miller based his opinion on WISCO maintaining 20% of the LLC debt. Mr. Miller had no case law or Code authority to support this percentage, however. He instead relied on an irrelevant revenue procedure as the basis for issuing the “should” opinion. A “should” opinion is the highest level of comfort PWC offers to a client regarding whether the position taken by the client will succeed on the merits. We find it unreasonable that anyone, let alone an attorney, would issue the highest level opinion a firm offers on such dubious legal reasoning.

We are also nonplused by Mr. Miller’s failure to give an understandable response when asked at trial how PWC could issue a “should” opinion if no authority on point existed. He demurred that it was what Chesapeake requested. The only explanation that makes sense to the Court is that no lesser level of comfort would have commanded the $800,000 fixed fee that Chesapeake paid for the opinion. ...

We find that Chesapeake’s tax position did not warrant a “should” opinion because of the numerous assumptions and dubious legal conclusions in the haphazard draft opinion that has been admitted into the record. Further, we find it inherently unreasonable for Chesapeake to have relied on an analysis based on the specious legal assumptions. ...

Moreover, Chesapeake did not act with reasonable cause or in good faith as it relied on Mr. Miller’s advice. Chesapeake argues that it had every reason to trust PWC’s judgment because of its long-term relationship with the firm. PWC crossed over the line from trusted adviser for prior accounting purposes to advocate for a position with no authority that was based on an opinion with a high price tag-–$800,000.

Any advice Chesapeake received was tainted by an inherent conflict of interest. We would be hard pressed to identify which of his hats Mr. Miller was wearing in rendering that tax opinion. There were too many. ...

We also find suspect the exorbitant price tag associated with the sole condition of closing. Chesapeake essentially bought an insurance policy as to the taxability of the transaction. PWC received an $800,000 fixed fee for its tax opinion. PWC did not base its fee on an hourly rate plus expenses. The fee was payable and contingent on the closing of the joint venture transaction. PWC would receive payment only if it issued Chesapeake a “should” opinion on the joint venture transaction. PWC therefore had a large stake in making sure the closing occurred.

Considering all the facts and circumstances, PWC’s opinion looks more like a quid pro quo arrangement than a true tax advisory opinion. If we were to bless the closeness of the relationship, we would be providing carte blanche to promoters to provide a tax opinion as part and parcel of a promotion. Independence of advisers is sacrosanct to good faith reliance. We find that PWC lacked the independence necessary for Chesapeake to establish good faith reliance. We further find that Chesapeake did not act with reasonable cause or in good faith in relying on PWC’s opinion. We sustain respondent’s determination that Chesapeake is liable for the accuracy-related penalty.

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