Courts Reject More BS Tax Shelters (10/5/11)

DOJ Tax is touting the stunning phenomenon of three major victories in BS tax shelters all in a single day. See Press Release, Justice Department Prevails in Three Tax Shelter Cases on Same Day (10/4/11), here (with links to the pdf files for the opinions). All of these cases were tried to judges in U.S. district courts. (Note the Altria case I discussed in the prior blogs here was tried to a jury with the same outcome.)

The common thread of these tax shelter is captured in Michael Graetz's famous characterization of a tax shelter as: "a deal done by very smart people that, absent tax considerations, would be very stupid." That is not a complete definition -- it is more like Potter Stewart's famous quotation (presented here in full):

I shall not today attempt further to define the kinds of material I understand to be embraced within that shorthand description ["hard-core pornography"]; and perhaps I could never succeed in intelligibly doing so. But I know it when I see it, and the motion picture involved in this case is not that.

Well, these courts knew abusive tax shelters when they saw them, as did the jury and judges in Altria.
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Altria # 4 - Second Circuit Declines Altria's Invitiation to Sustain a BS Tax Shelter (9/30/11)

The Second Circuit recently rejected another hokey tax shelter in Altria Group, Incorporated v. United States, ___ F.3d ___, 2011 U.S. App. LEXIS 19644 (2d Cir. 2011), here. I have previously blogged on the trial level results in the following blogs: (i) Altria # 1 - Frank Lyon and tax shelters (3/20/10), here, (2) Altria #2 - Economic Substance and Juries (3/22/10), here, and (iii) Altria #3 - What Were Those Guys Smoking? (3/23/10), here.

The only question I have about the appeal is whether Altria really harbored the fantasy that, having failed to smoke these these shelters past the jury and then the district judge, the Second Circuit just would not be paying attention? Altria's goofy adventures -- first in getting into these shelters and then thinking that it could con the jury and the judges -- should be the best refutation that if we just let business people be business people they will make good decisions.
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Matthew Krane Sentenced Regarding Quellos Shelters (6/14/11)

Matthew Krane, a tax attorney involved in the Quellos matter, has been sentenced. (I have previously blogged about Krane here and Quellos here.) Specifically, I discussed the bizarre facts of the Krane prosecution here. Krane has been sentenced to 36 months and must (i) return $17.9 million in fees to a wealthy former client and (ii) pay $23.1 million in back taxes. The relatively light sentence was "reward" for Krane's cooperation.

Hat tip to Tax Prof Blog
See also Kelly Phillips Erb, Show Biz Lawyer Finally Sentenced in Massive Fraud Case, TaxGirl Forbes Blog (6/11/11)

More on the Daugerdas Case - The Role of Nonpromoter Enablers (6/5/11)

The Chicago Tribune reports on the consequences of BDO Seidman's love affair with the Daugerdas shelters. See Ameet Sachdev, Tax shelters put BDO Seidman in middle of firestorm with federal prosecutors, Chicago Tribune, Business (6/4/11). It is interesting to consider what additional retribution, if any, the Government may visit on BDO now that its former chief executive, Denis Field, has been convicted and others down the BDO food chain have pled. For all of the firms participating in this genre of shelters, one has to ask where the gatekeeper was or the gatekeepers were. Was anyone concerned about the well-being of the firm?

Someone has asked that question about Jenkens & Gilchrist, the Dallas based firm with national ambitions that drove it to expand, inter alia, into Chicago and pick up the now disgraced and convicted tax shelter promoter par excellence, Paul Daugerdas. I have written about Daugerdas before and want to discuss here a variation of the Jenkens & Gilchrist story recounted in a recent article, Milton C. Regan, Jr., Taxes and Death: The Rise and Demise of an American Law Firm, STUDIES IN LAW, POLITICS AND SOCIETY: LAW FIRMS, LEGAL CULTURE, AND LEGAL PRACTICE, Vol. 52, pp. 107-144, Austin Sarat, ed., JAI Press 2010; Georgetown Law and Economics Research Paper No. 11-08.
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Economic Substance Doctrine Tax Felonies (6/1/11)

I write today to provide viewers access to Jasper Cummings' article, Jasper L. Cummings, Jr., Economic Substance Doctrine Felonies, 131 Tax Notes 977 (May 30, 2011) and 2011 TNT 104-10 (5/31/11). (This article is provided with the permission of Tax Analysts.)  Mr. Cummings writes on the use of the economic substance doctrine in criminal tax cases. Most particularly, he writes about Mr. R. J. Ruble who was convicted in the first round of Son-of-Boss criminal prosecutions. In that case, Ruble, a tax lawyer, was convicted along with John Larson and Bob Pfaff who provided financial services in the conceptualization and implementation of the shelters. Two prominent subsequent shelter prosecutions have also used the economic substance doctrine in the charges to the jury.

First, let me disclose that I represented one of the dismissed defendants in the sprawling prosecution that ended up in the conviction of Messrs. Ruble, Larson and Pfaff. Once my client was dismissed along with 12 others before trial, I no longer had an immediate interest in the case but I did observe the progress of the proceedings through conviction and appeal and now pending petition for certiorari in the Supreme Court. I was particularly interested in whether and how the economic substance doctrine would be presented to the jury.
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Jury speaks in the Daugerdas Case -- Guilty! (5/24/11)

I have blogged previously on various aspects of the Daugerdas trial. See here. The jury has just spoken. Guilty. I link below to some of the early articles from the web. The pundits will speak and this is just a preliminary and limited report.  For more information, see the articles linked below.

Update 5/25/11 9:50 AM:
From the USAO SD NY Press Release (setting aside the puffing):

DAUGERDAS, 60, of Wilmette, Illinois; GUERIN, 50, of Elmhurst, Illinois; and FIELD, 53, of Naples, Florida were each convicted of conspiring to defraud the IRS and to evade taxes, and of corruptly endeavoring to obstruct and impede the internal revenue laws. The defendants were also convicted on multiple counts of tax evasion relating to the use of various tax shelters for specified clients, and of mail fraud. DAUGERDAS also was convicted of tax evasion based on his use of fraudulent tax shelters to eliminate or reduce his personal income tax liabilities between 1999 and 2001. PARSE 49, of Elmhurst, Illinois, was found guilty of mail fraud and obstructing internal revenue laws.

On the conspiracy charge, each defendant faces a maximum penalty of 5 years in prison; 3 years' supervised release; a fine of the greatest of $250,000 or twice the gross gain to the defendant or twice the gross loss to the IRS; and restitution. On the mail fraud charge, each defendant faces a maximum penalty of 20 years in prison. Each count of tax evasion carries a maximum penalty of 5 years in prison; 3 years' supervised release; a fine of the greatest of $250,000 or twice the gross gain to the defendant or twice the gross loss to the IRS; and costs of prosecution. Each defendant also faces a maximum penalty of 3 years in prison; 1 year supervised release; and a fine of the greatest of $250,000 or twice the gross gain to the defendant or twice the gross loss to the IRS on the charge of corruptly endeavoring to obstruct and impede internal revenue laws.

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Petitions for Cert in US v. Pfaff, Ruble & Larson

Petitions for certiorari have been filed in the criminal convictions of John Larson, Robert Pfaff and R.J. Ruble in the massive KPMG-related criminal case which drew fame in an earlier iteration (United States v. Stein before 13 defendants were dismissed for prosecutorial abuse). The Second Circuit summary affirmance of the convictions of Larson, Pfaff and Ruble is here. The petition for John Larson and Robert Pfaff is here. The petition for R. J. Ruble is here..
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Another Chapter Closes in the Tax Shelter Wars - DB Admits Crimes and Takes $553,633,153 Hit

Yesterday, the USAO SDNY and Deutsche Bank ("DB") announced that had agreed to a nonprosecution agreement ("NPA") requiring, among other things, the following:

1. DB admits criminal wrongdoing.
2. A payment of $553,633,153, representing DB's total fees from its participation in tax shelter activity, the tax and interest the IRS was unable to collect from the taxpayers entering those shelters, and a civil penalty of over $149 million.
3. DB provided a detailed Statement of facts admitting its tax shelter shenanigans.
4. DB must implement and maintain an effective compliance and ethics program. Incident to this commitment, DB must install a government-appointed independent expert to oversee the program. The independent expert is Bart Schwartz of Guidepost Solutions.
5. The shelters involved, with the ubiquitous, sometimes tongue in cheek, acronyms included:
   a. BLIPS (involving KPMG)
   b. FLIP/OPIS (involving KPMG)
   c. Short Option Strategies (SOS) (involving Jenkens & Gilchrist (Daugerdas et al), KPMG,. E&Y and others.
   d. PICO and POPS (involving "various accounting firms and other entities)

Obviously, with this settlement and the predicate settlements with KPMG and Jenkens & Gilchrist the Government is signaling to those players and those tempted to play in these games with deep pockets and reputations that their pockets will be lighter and their reputations tarnished.

The documents related to the settlement are:
Nonprosecution Agreement (including Statement of Facts)
USAO SDNY Press Release
DB Press Release

Another Tax Shelter Lawyer Bites the Dust

Erwin Mayer, a Paul Daugerdas partner and co-defendant in the tax shelter indictment in SD NY, has pled guilty. I have previously blogged on various aspects of the indictment in four parts: Part 1, Part 2, Part 3, and Part 4. Mayer pled to two counts -- conspiracy and tax evasion, both 5 year felonies exposing him to a maximum 10 year sentence.  He also agreed to forfeit money and property worth in excess of $10,000,000,.

The press release by USAO SDNY here summarizes the key admissions for guilts as follows:

During the guilty plea proceeding, MAYER acknowledged that he knew that the tax shelter transactions would be allowed by the IRS only if there was a reasonable possibility of a profit and if the clients were entering into the tax shelter transactions for genuine, non-tax business reasons. MAYER also acknowledged that the losses from the transactions would be allowed only if the clients were utilizing the entities involved in the tax shelters -- such as the partnerships and corporations-- for legitimate, non-tax business reasons and not simply to produce tax losses. MAYER admitted that the tax shelters had no reasonable possibility of resulting in a profit because among other reasons, the costs and fees for most of the transactions exceeded the potential profit, if any.

For some more nuance, see the WSJ Law Blog here.

Daugerdas and a fellow lawyer Donna Guerin remain standing defendants in the case, at least for now.  It is unlikely that the prosecutors will offer Daugerdas a deal -- at least one that would not put him away for a very long time.  But we'll see what happens on Guerin.

More on the Confrontation Clause and Tax Liabilities of Out of Court Witnesses

United States v. Jewell, ___ F.3d ___ (8th Cir. 2010), discussed in the last two blogs, is a jewel of many facets. This one is near and dear to my heart.  The issue is whether, in proving the crime of tax evasion which requires a tax due and owing, the Government can introduce the tax returns and resulting tax liabilities of other taxpayers who are not before the court so that they can be confronted as to the claims of tax loss for their taxes, an essential element of the crime. I have discussed this issue previously here (with a downloadable memo on the subject).

The key facts in Jewell are that the defendant, a tax lawyer, assisted husband and wife in evading the husband and wife's taxes.  As is often the case, one spouse was the principal player in the scheme, and in this case it was the husband, Carl Evans.  The Court summarized the proof of tax evasion as follows (case citation and quotation marks omitted):

The elements of tax evasion are willfulness, the existence of a tax deficiency, and an affirmative act constituting evasion or attempted evasion of the tax.  [Carl] Evans testified at trial that Jewell concocted the venture capital agreement as a means of significantly reducing the amount of personal income tax reported by Carl and Patricia Evans in the tax year 2000. An IRS agent testified the difference between the tax liability the Evanses actually paid in 2000 and the amount they should have paid resulted in a tax deficiency of $ 737,436. This evidence was clearly sufficient for a reasonable jury to have found the government presented evidence to satisfy all three elements of aiding and abetting tax evasion.

The defendant argued that the proof was insufficient to establish the tax due and owing.  The Jewell court responded with this jewel (perhaps overdoing the metaphor) at fn 6:

n6 Jewell also claims the evidence was insufficient because the admission of the Evanses' 2000 tax return violated Crawford v. Washington, 541 U.S. 36 (2004). Jewell contends a tax return is "testimonial" because it is signed by taxpayers under penalty of perjury. The government offered the tax returns prior to trial as business records, and Jewell did not object to them except as to relevancy, so we review this claim for plain error only. We find no plain error. Because Carl Evans testified, Jewell had an opportunity to challenge the accuracy of the tax returns. In addition, in United States v. Garth, 540 F.3d 766 (8th Cir. 2008), abrogated on other grounds, United States v. Villareal-Amarillas, 562 F.3d 892 (8th Cir. 2009), we rejected the argument that admission of tax returns, even as to non-testifying witnesses, violated Crawford. Id. at 778 (noting Crawford did not consider business records to be testimonial, and that the defendant stipulated the tax returns were business records).

Note that the Jewell Court encountered several problems with Jewell's Confrontation claim. His counsel's failure to object real time at trial made it subject to the plain error rule. More importantly, one of the taxpayers did in fact testify and could have been fully cross-examined on the of the tax liability in question. Finally, the Eighth Circuit is correct that, in Garth, it had held that tax returns are not testimonial as to the non-testifying taxpayers. I therefore serve up the cryptic discussion from Garth (p. 778):

[Garth] argues her rights under the Confrontation Clause were violated when the district court admitted tax returns of non-testifying witnesses. We review de novo alleged violations of the Confrontation Clause. United States v. Heppner, 519 F.3d 744, 751 (8th Cir. 2008), cert. filed, 08-5334 (U.S. July 12, 2008) [cert. denied, 129 S. Ct. 250, 172 L. Ed. 2d 188 (2008)]. The Confrontation Clause applies only to testimonial statements, such as prior testimony at a preliminary hearing, former trial, or before a grand jury and statements made in the course of police interrogations. Crawford v. Washington, 541 U.S. 36, 68, 124 S. Ct. 1354, 158 L. Ed. 2d 177 (2004). "'Testimony,' in turn, is typically '[a] solemn declaration or affirmation made for the purpose of establishing or proving some fact.'" Id. at 51 (quoting 2 N. Webster, An American Dictionary of the English Language (1828)). The Court observed, "Most of the hearsay exceptions covered statements that by their nature were not testimonial -- for example, business records or statements in furtherance of a conspiracy." Id. at 56; see also id. at 76 (Rehnquist, C.J., concurring in the judgment) ("[T]he Court's analysis of 'testimony' excludes at least some hearsay exceptions, such as business records and official records."). Garth stipulated at trial that the tax returns were business records to avoid the "need to bring in a business records witness[]." She makes no attempt, in her brief, to argue that the tax returns were testimonial. And, in fact, the returns were not prepared for litigation, as is expected of testimonial evidence. See United States v. Torres-Villalobos, 487 F.3d 607, 613 (8th Cir. 2007) (holding that warrants of deportation were "properly characterized as non-testimonial official records that were prepared independent of this litigation" and were not prepared "to prove facts for use in future criminal prosecutions.") Consequently, the admission of tax returns did not violate Garth's right to confront her accusers.

I am not persuaded. Tax returns are quintessentially testimonial. Taxpayers are required to sign under oath to reinforce that the Government needs the truth and will rely upon the oath to establish the truth until and unless an audit proves the contents of the return are not truthful and then the Government may prosecute for tax perjury -- yes, that's perjury, of the tax perjury variety in Section 7206(1) -- if they are not truthful. Perjury is the punishment for false testimonial statements.  Beyond being quintessential "testimony" in this respect, I had thought that Crawford made clear that some exception to exclusion of hearsay does not alone suffice to meet Confrontation concerns, yet the Eighth Circuit seems to suggest that the business record exception suffices. In this regard, I think the Garth court reads the Crawford majority's passing comment to business records far too broadly:  merely because some business records may not be testimonial does not mean that all are not testimonial and thus pass Confrontation scrutiny.  The Crawford court was going back to basics of constitutional interpretation which, I doubt, would read into the Confrontation guaratee a business records exception created to address hearsay issues for what is plainly testimonial statements in a tax return.  And what does preparation for litigation have to do with whether or not statements made under oath are testimonial and prosecutable for perjury?  Perhaps the Court's final holding is that the Garth did not timely raise the objection, but it seems to me that the error in Garth is plain and the holding is wrong. At least I have seen nothing in the reasoning of the defendant losses on this issue that is persuasive to me. But, then, I am not the judge.

Of course, the taxpayer's testimony in Jewell does satisfy the Confrontation concerns because only a single couple's tax returns were involved and the principal of those taxpayers -- Carl Evans -- did testify and was subject to confrontation to the extent the defendant and his counsel chose to confront him.

The Lawyers For the Parties in the Egan Trial

I have previously discussed here Judge Saylor's epic opinion in Egan knocking down two tax shelters as fraudulent and offered here here excerpts from the opinion knocking the lawyers roles in the underlying fraudulent tax shelter transactions. I now provide the list of attorneys from LEXIS-NEXIS who appeared before Judge Saylor to represent the parties and certain nonparties (a movant, a third party witness, and 2 interested parties). It appears that all involved were well-represented.  The lawyers are:

For Fidelity International Currency Advisor A Fund, L.L.C., by the Tax Matters Partner, Plaintiff: David J. Curtin, James D. Bridgeman, Kiara Rankin, Sheri A. Dillon, William F. Nelson, LEAD ATTORNEYS, Bingham McCutchen LLP - DC, Washington, DC; John O. Mirick, LEAD ATTORNEY, Mirick, O'Connell, DeMallie & Lougee, Worcester, MA; Michelle Levin, LEAD ATTORNEY, PRO HAC VICE, Bingham McCutchen LLP - DC, Washington, DC; Ronald L. Buch, LEAD ATTORNEY, PRO HAC VICE, Bingham McCutchen LLP, Washington, DC; David K. McCay, Mirick, O'Connell, DeMallie & Louggee, LLP, Worcester, MA.

For United States of America, Defendant: Dennis M. Donohue, LEAD ATTORNEY, Washington, DC; Barry E. Reiferson, U.S. Department of Justice, Trial Attorney, Tax Division, Washington, DC; Heather L. Vann, U.S. Department of Justice, Washington, DC; John Lindquist, U.S. Department of Justice, Tax Division, Washington, DC.

For BDO Seidman LLP, Movant: Diana L. Erbsen, Ellis L. Reemer, LEAD ATTORNEYS, Frank J. Jackson, DLA Piper US LLP, New York, NY; Lisa S. Core, DLA Piper Rudnick Gray Cary US LLP, Boston, MA.

For Proskauer Rose LLP, Third Party Witness: Christopher L. DeMayo, LEAD ATTORNEY, Dewey & LeBoeuf LLP, Boston, MA; David M. Lederkramer, LEAD ATTORNEY, Proskauer Rose LLP, New York, NY; Lawrence M. Hill, Mark D. Allison, LEAD ATTORNEYS, Dewey & LeBoeuf LLP, New York, NY.

For KPMG LLP, Interested Party: Armando Gomez, LEAD ATTORNEY, Skadden, Arps, Slate, Meagher & Flom LLP, Washington, DC.

For RSM McGladrey, Inc., Interested Party: David E. Walters, Matthew M. Neumeier, LEAD ATTORNEYS, Howrey LLP, Chicago, IL; Peter J. Karol, Robert L. Kann, Sunstein Kann Murphy & Timbers LLP, Boston, MA.

What the Egan Court (Judge Saylor) Said About the Lawyers

In the Egan case I discussed yesterday here, Judge Saylor was tough on the lawyers. I thought lawyers (who I presume are the principal readers of this blog) may find it at least interesting to read his detailed conclusions regarding the lawyers’ behavior.

There were two principal law firms involved in issuing the Egan opinions that would, the parties hoped, give the taxpayers risk-free access to the audit lottery for which they charged large premium fees (sort of like the driver of the get away car for a bank robbery charging a lot more than a tax driver would charge). These firms were Proskauer Rose, LLP ("Proskauer") and Sidley Austin Brown & Wood LLP ("Sidley Austin"). The principal partner at Proskauer was Ira Akselrad. The partner at Sidley was R.J. Ruble. The following portions of the opinion are Judge Saylors' focused factual conclusions (and are based on many detail fact findings earlier in the opinion)

UU. The Egans Did Not Receive Independent Legal Advice from Proskauer and Sidley Austin

1234. Both Proskauer and Sidley Austin had an inherent conflict of interest in purporting to render legal advice to the Egans.

1. Proskauer and Sidley Austin Did Not Provide Independent Legal Advice

1235. As described above, R.J. Ruble of Sidley Austin and Ira Akselrad of Proskauer Rose actively assisted DGI/Helios in the design, development, marketing, and implementation of the tax shelter strategy and its variants. (Exs. 797, 798, 809, 814).

1236. Among other things, Ruble and Akselrad provided input on the strategies, commented on the marketing materials, and provided or commented on model legal opinions to use in the promoting tax shelter strategy.

1237. Ruble and Akselrad knew, or reasonably should have known, that DGI/Helios used the names and reputations of their law firms and their model opinions in marketing the strategy to prospective clients.

1238. As part of the strategy, Ruble and Akselrad agreed in advance to provide favorable legal opinions in order to induce taxpayer-investors to utilize the strategy.

1239. Ruble and Akselrad knew, or reasonably should have known, that the issuance of favorable legal opinions from prominent law firms was a central feature of the successful promotion of the strategy.

1240. As also described above, in the FDIS marketing materials, DGI/Helios had stated that one of its "most valuable" contributions to its clients was in "ability to firmly manage and control the process of getting . . . attorneys . . . to expeditiously reach the desired conclusions" (Ex. 809 (emphasis added)).

1241. Ruble and Akselrad knew, or reasonably should have known, that DGI/Helios was marketing the strategy in that fashion.

1242. Proskauer provided at least 28 favorable opinions, and Sidley Austin provided at least 30 favorable opinions, in support of the tax shelter strategy. (Ex. 1519).

1243. Proskauer and Sidley Austin provided legal advice both to DGI/Helios and to the individual taxpayer/investors who invested in the tax shelter strategy.

1244. Proskauer specifically acknowledged to the Egans, in a draft representation letter dated April 11, 2002, that it represented DGI/Helios and therefore had a conflict of interest if it also represented the Egans. (Ex. 1772).

1245. In addition, Ira Akselrad of Proskauer personally participated in a DGI tax shelter transaction in 2000. (Exs. 669, 2759). The favorable opinion letter concerning his personal transaction was issued by Brown & Wood on December 31, 2000. (Ex. 669).

1246. As described above, DGI/Helios played a substantial role in the drafting and delivery of the legal opinions by Proskauer and Sidley Austin.

1247. As described above, in nearly all instances, the legal fees of Proskauer and Sidley Austin were paid by DGI/Helios rather than the taxpayer/investors. Ruble and Akselrad were aware of that arrangement.

1248. DGI/Helios paid the fees of Proskauer and Sidley Austin in order to assert firmer management and greater control over the opinions rendered by the law firms. (Ex. 809).

1249. Proskauer and Sidley Austin derived substantial profit from the promotion and sale of the tax shelter strategy, and therefore had a financial interest in upholding the strategy.
1250. The Egans knew, or reasonably should have known, that the legal advice they received from Proskauer and Sidley Austin was not independent, and that the firms had an inherent conflict of interest.

2. The Egans Knew That the Legal Advice from Proskauer and Sidley Austin Was Not Independent

1251. The Egans were highly sophisticated taxpayers with considerable business experience,

1252. The Egans and their advisors knew that DGI/Helios marketed its ability to "manage and control the process" of getting attorneys "to expeditiously reach the desired conclusions." (Id.).

1253. The Egans and their advisors knew, or reasonably should have known, that DGI/Hellos had arranged in advance for four law firms, including Proskauer and Sidley Austin, to render favorable opinions to taxpayer/investors.

1254. The Egans and their advisors knew, or reasonably should have known, that Proskauer and Sidley Austin had developed model opinions, and that they had rendered favorable opinions for other taxpayer/investors who had used the same or similar strategies.

1255. The Egans and their advisors knew, or reasonably should have known, that Proskauer and Sidley Austin intended to render favorable opinions from the onset of the transactions.

1256. The Egans and their advisors knew that their communications with Proskauer and Sidley Austin were frequently shared with DGI/Helios and KPMG.

1257. The Egans and their advisors knew that none of their communications with Proskauer and Sidley Austin were privileged, or marked "privileged."

1258. The Egans and their advisors provided their comments on the draft opinions to James Haber or Tim Speiss, and not exclusively (or even always directly) to the law firms.

1259. The Egans received a draft engagement letter from Proskauer that specifically noted a conflict of interest based on the fact that Proskauer also represented DGI/Helios.

1260. The Egans and their advisors knew, or reasonably should have known, that Proskauer had a conflict of interest, because it also represented DGI one of the principal promoters of the tax shelter strategy.

1261. The Egans and their advisors knew that the fees of Proskauer and Sidley Austin (other than the fee for the non-disclosure letter by Proskauer) were paid by DGI/Helios.

1262. The Egans would not have paid Helios for the transactions until Helios provided satisfactory and favorable legal opinion letters.

VV. The Proskauer Opinion for Fidelity High Tech Was Based on Unreasonable Factual Assumptions

1263. The Proskauer opinion letter dated April 5, 2002, on the Fidelity High Tech transaction was based on unreasonable factual assumptions, including assumptions that the Egans knew, or reasonably should have known, were untrue.

1264. The Egans did not reasonably rely on the April 5, 2002, Proskauer opinion letter for tax reporting purposes.

1. The Opinion Contained False and Misleading Factual Assumptions

1265. The Proskauer opinion letter was purportedly based on factual representations that were false and misleading.

a. Investor Representation No. 1 Was False

1266. Paragraph I of the Investor Representations in the Proskauer opinion letter stated:

Investors entered into the options trades to hedge against market volatility in a large concentrated holding of technology stock so as to produce an overall economic profit. Investors believed that the options were correlated to this concentrated position so that the options would produce an effective hedge.

(Ex. 122 at 8-9). This representation was also made verbatim in the Certificate of Facts executed by Richard and Maureen Egan. (Ex. 1766).

1267. That representation was false from both a subjective and objective standpoint.

1268. From a subjective standpoint, the Egans did not enter into the option trades '"to hedge against market volatility." Moreover, the Egans did not believe that the options "would produce an effective hedge."

1269. From an objective standpoint, as described above, the transaction was not reasonably designed to create an effective hedge.

b. Investor Representation No. 2 Was False

1270. Paragraph 2 of the Investor Representations in the Proskauer opinion letter stated:

Based on advice of the Investment Advisor as to the probability of the referenced property reaching certain price levels at which the Option would be profitable and on Investors own independent evaluation, Investors believed they had a reasonable opportunity to earn a profit from the option trades in excess of all fees and transaction costs without regard to tax benefits.

(Ex. 122 at 9 (emphasis added)). That representation was also made verbatim in the Certificate of Facts executed by Richard and Maureen Egan. (Ex. 1766).

1271. That paragraph is template language, and is also contained in the Sidley Austin opinion letter. (Ex. 121 at 12).

1272. That representation was false from both a subjective and objective standpoint.

1273. From a subjective standpoint, the Egans did not believe that they had "a reasonable opportunity to earn a profit from the option trades in excess of all fees and transaction costs without regard to tax benefits." Moreover, the Egans did not rely on the advice of the "Investment Advisor [that is, Alpha] as to the probability of the referenced property reaching certain price levels at which the Option would be profitable," nor did they conduct an "independent evaluation."

1274. From an objective standpoint, as described above, there was no reasonable possibility of profit on the option trades in excess of all fees and transaction costs and without regard to tax benefits.

c. Investor Representation No. 3 Was False

1275. Paragraph 3 of the Investor Representations in the Proskauer opinion letter stated:

Each investor contributed his or her membership interest in [Index] or [Option] to [Fidelity High Tech] for substantial non-tax business reasons, including the short term risk management of concentrated stock positions.

(Ex. 122 at 9). That representation was also made almost verbatim in the Certificate of Facts executed by Maureen Egan and Richard Egan. (Ex. 1766).

1276. That paragraph is template language, and similar language is also contained in the Sidley Austin opinion letter. (Ex. 121 at 12).

1277. That representation was false from both a subjective and objective standpoint.

1278. From a subjective standpoint, the Egans did not enter into the transaction for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid taxes.

1279. From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. There was no reasonable possibility of profit on the transaction, and the transactions did not provide "short term, risk management of concentrated stock positions."

d. Investor Representation No. 10 Was False or Misleading

1280. Paragraph 10 of the investor Representations in the Proskauer opinion letter stated:

There existed no understanding, agreement, obligation, or arrangement pursuant to which any of the parties described herein committed to undertake all or any of the transactions described herein upon the happening of any other transaction, except to the extent that owner of the Options and Bank were contractually obligated to perform under the Options in accordance with their stated terms.

(Ex. 122 at 9). That representation was also made verbatim in the Certificate of Facts executed by Maureen Egan and Richard Egan. (Ex. 1766).

1281. That paragraph is template language, and is also found essentially verbatim in the Sidley Austin opinion letter. (Ex. 121 at 13).

1282. The language is apparently intended to provide a basis for the inapplicability of the step-transaction doctrine. In context, the representation was misleading or false.

1283. If the language is construed to mean only that there was no legal obligation on the part of the Egans to undertake any of the steps of the transaction, it is literally true, but misleading. The opinion itself recognizes that the "binding commitment test" is only one of three possible tests in determining the applicability of the step-transaction doctrine. (Ex. 122 at 36).

1284. If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity High Tech transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.

e. The Date of the Original Contribution of EMC Stock Was False

1285. The High Tech Certificate of Facts falsely stated that Richard and Maureen Egan had contributed shares of EMC stock to High Tech on February 7, 2001. Those shares were actually contributed on September 8, 2000.

1286. If the Proskauer opinion letter had correctly stated that Fidelity High Tech had been holding EMC stock since September 8, 2000, it would have been more obvious that there was no business purpose for the Egans to acquire options in Index A and Option A, and then within days thereafter transfer those options to High Tech.

2. The Opinion Omitted Essential Facts

1287. The Proskauer opinion letter did not include any facts concerning the true purpose of the Fidelity High Tech transaction, which was to create an artificial step-up in basis in order to reduce the Egans' tax liability. The omission of those facts was unreasonable.

1288. The Proskauer opinion letter did not include any facts concerning the design and implementation of the Fidelity High Tech transaction, including the fact that it involved an orchestrated series of steps that were intended to occur in a particular order, and were executed in that order. The omission of those facts was unreasonable.

1289. The Proskauer opinion letter did not include any facts concerning the amounts of fees paid to Helios and KPMG on the transaction. The omission of those facts was unreasonable.

1290. The opinion omitted any reference to the fees paid to Helios and KPMG, even though it appeared to recognize that a critical question was whether the Egans had a reasonable opportunity to earn a profit "in excess of all fees and transaction costs."

1291. The omission of the fees was deliberate, and was done at the instruction of Orrin Tilevitz to Michael Swiader at Proskauer. (Ex. 1621).

3. Proskauer Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts

1292. As described above, Ira Akselrad of Proskauer personally provided substantial assistance in the design, marketing, and development of the FDIS strategy.

1293. As also described above, Akselrad was personally substantially familiar with the Fidelity High Tech transaction independent of the Certificate of Facts executed by the Egans, including the Egans' purposes in entering into the transaction.

1294. Among other things, Akselrad knew, or reasonably should have known, (1) that the strategy involved an elaborate series of planned steps to execute; (2) that the Egans paid large fees to Helios, KPMG, Refco, and others in connection with the transaction; (3) that the transaction was designed and intended to generate an artificial step-up in basis, and had no other purpose; (4) that the transaction served no genuine hedging or risk-reduction function; and (5) that there was no economic substance to the transaction.

1295. Ira Akselrad therefore knew, or reasonably should have known, that the opinion letter contained false and misleading factual assumptions and omitted critical facts.

4. Richard Egan Did Not Read the Certificate of Facts or the Proskauer Opinion Letter

1296. Richard Egan did not read the Certificate of Facts relating to the High Tech transaction before signing it. (R. Egan, 3:100-01).

1297. Richard Egan did not read the legal opinion letter from Proskauer relating to the High Tech transaction at the time it was issued, and, in fact, did not read it until the IRS initiated an audit years after the opinion was issued. (Id. at 3:76-77).

WW. The Sidley Austin Opinion for Fidelity international Was Based on Unreasonable Factual Assumptions

1298. The Sidley Austin opinion letter dated March 8, 2002, on the Fidelity International transaction was based on unreasonable factual assumptions. Including assumptions that the Egans knew, or reasonably should have known, were untrue.

1299. The Egans did not reasonably rely on the March 8, 2002 Sidley Austin opinion letter for tax reporting purposes.

1. The Opinion Contained False and Misleading Factual Assumptions

1300. The Sidley Austin opinion letter was purportedly based on factual representations that were false and misleading.

a. Investor Representation No. 1 Was False

 1301. Paragraph 1 of the Investor Representations in the Sidley Austin opinion letter stated:

Investor entered into the Transaction for substantial non-tax business reasons, predominately related to offsetting various investment risks associated with a large single concentrated holding in a U.S. technology company, and to hedge against currency fluctuations in international markets in which this technology company has significant currency exposure due to sales. . . . Also investor has entered into certain Options to hedge against interest rate fluctuations. . . .

(Ex. 121 at 12) (emphasis added). That representation was also made verbatim in paragraph 1 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1302. That representation was false from both a subjective and objective standpoint.

1303. From a subjective standpoint, the Egans did not enter into the transactions for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid income taxes.

1304. From an objective standpoint, there were no substantial non-tax business reasons to enter into the transaction. The transactions did not offset "various investment risks," nor was it reasonably designed to create an effective hedge against "currency fluctuations" or "interest rate fluctuations."

b. Investor Representation No. 2 Was False

1305. Paragraph 2 of the Investor Representations in the Sidley Austin opinion letter stated:

Based on advice of the Investment Advisor as to the probability of the referenced property reaching certain price levels at which the Options would be profitable and on Investor's own independent evaluation, Investor believed that he had a reasonable opportunity to earn a reasonable profit from the Transactions in excess of all fees and transaction costs and without regard to tax benefits.

(Ex. 121 (emphasis added)). That representation was also made verbatim in paragraph 2 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1306. That paragraph is template language, and is also contained in the Proskauer opinion letter. (Ex. 122 at 9).

1307. That representation was false from both a subjective and an objective standpoint.

1308. From a subjective standpoint, the Egans did not believe that they had a "reasonable opportunity to earn a reasonable profit from the transaction in excess of all fees and transaction costs and without regard to tax benefits." Moreover, the Egans did not rely on the advice of the "Investment Advisor" as to "the probability of the referenced property reaching certain price levels at which the Options would be profitable," nor did they conduct an "independent evaluation."

1309. From an objective standpoint, as described above, there was no reasonable possibility of profit from the transaction in excess of all fees and transaction cots and without regard to tax benefits.

c. Investor Representation No. 3 Was False

1310. Paragraph 3 of the Investor Representations in the Sidley Austin opinion letter stated:

Investor contributed the membership interest in World to [Fidelity] International for substantial non-tax business reasons. . . . .

(Ex. 121 at 12). That representation was also made verbatim in paragraph 3 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1311. That representation was false from both a subjective and an objective standpoint.

1312. From a subjective standpoint, the Egans did not enter into the transaction for "substantial non-tax business reasons," or indeed any non-tax business reasons; they did so solely to avoid taxes.

1313. From an objective standpoint, there were no substantial non-tax business reasons to contribute the membership interest in World to Fidelity International.

d. Investor Representation No. 9 Was False of Misleading

 1314. Paragraph 9 of the Investor Representations in the Sidley Austin opinion letter stated:

There existed no understanding, agreement, obligation, or arrangement pursuant to which any of the parties described herein committed to undertake all or any of the transactions described herein upon the happening of any other transaction, except to the extent that Investor/World (and International as transferee of Investor) and Counterparty were contractually obligated to perform under the Options in accordance with their stated terms.

(Ex. 121 at 13). That representation was also made verbatim in paragraph 9 of the representation letter signed by Richard Egan relating to the Fidelity International transaction. (Ex. 78).

1315. That paragraph is template language, and is also found verbatim in the Proskauer opinion letter. (Ex. 122 at 9).

1316. The language is apparently intended to provide a basis for the inapplicability of the step-transaction doctrine. In context, the representation was misleading or false.

1317. If the language is construed to mean only that there was no legal obligation on the part of the Egans to undertake any of the steps of the transaction, it is literally true, but misleading. The opinion itself recognizes that the "binding commitment test" is only one of three possible tests in determining the applicability of the step-transaction doctrine. (Ex. 121).

1318. If this language is construed to mean that the Egans had no "understanding" or "arrangement" that the parties would undertake the steps of the transaction in a particular order with a particular end result in mind, the language is false. The Fidelity International transaction was a planned and choreographed transaction from start to finish, and implemented for the sole purpose of avoiding taxes.

2. The Opinion Omitted Essential Facts

1319. The Sidley Austin opinion letter did not include any facts concerning the true purpose of the Fidelity International transaction, which was to create an artificial loss in order to reduce the Egans' tax liability. The omission of those facts was unreasonable.

1320. The Sidley Austin opinion letter did not include any facts concerning the design and implementation of the Fidelity International transaction, including the fact that it involved an orchestrated series of steps that were intended to occur in a particular order, and were executed in that order. The omission of those facts was unreasonable.

1321. The Sidley Austin opinion letter did not include any facts concerning the role of the foreign partner in the transaction, including the fact the fact that he invested no funds, bore no risk, added no value, and was separately compensated by the promoters for his role in the transaction.

1322. The Sidley Austin opinion letter did not include any facts concerning the amounts of fees to Helios and KPMG on the transaction. The omission of those facts was unreasonable.

1323. The opinion omitted the fees paid to Helios and KPMG, even though it appeared to recognize that a critical question was whether the Egans had a reasonable opportunity to earn a profit "in excess of all fees and transaction costs."

3. Sidley Austin Knew That the Opinion Contained False and Misleading Factual Assumptions and Omitted Critical Facts

1324. As described above, R.J. Ruble of Sidley Austin personally provided substantial assistance in the design, marketing, and development of the FDIS strategy.

1325. As also described above, Ruble was personally substantially familiar with the Fidelity International transaction independent of the representation letter executed by Richard Egan, including the Egans' purposes in entering into the transaction.

1326. Among other things, Ruble knew, or reasonably should have known, (1) that the strategy involved an elaborate series of planned steps to execute; (2) that the Egans paid large fees to Helios, KPMG, Refco, and others in connection with the transaction; (3) that Samuel Mahoney was not a true partner; (4) that the transaction was designed and intended to generate losses for tax purposes, and had no other purpose; (5) that the transaction served no genuine hedging or risk-reduction function; and (6) that there was no economic substance to the transaction.

1327. R.J. Ruble therefore knew, or reasonably should have known, that the opinion letter contained false and misleading factual assumptions and omitted critical facts.

4. Richard Egan Did Not Read the Investor Representation Letter

1328. Paragraph 10 of the representation letter relating to the Fidelity International transaction states as follows: "Investor has reviewed the description of the Transactions attached hereto and such description is accurate and materially complete." (Ex. 78).

1329. Richard Egan did not read the representation letter relating to the Fidelity International transaction before signing it. (R. Egan, 3:100).

XX. Both the Proskauer Opinion Letter and the Sidley Austin Opinion Letter Were Based on Unreasonable Legal Assumptions

1330. The purported purpose of the Proskauer and Sidley Austin opinion letters was to advise the Egans of the potential tax consequences of the Fidelity transactions.

1331. The April 5, 2002, Proskauer opinion letter, among other things, contained the following conclusions:

(1) "that for federal income tax purposes it is more likely than not" that the claimed step-up in basis would be "used to compute gain on the sale of the [stock in Fidelity High Tech]";

(2) that "[t]he sham transaction doctrine would not apply and, based on the representations of [the Egans and Alpha], the Transactions would have the requisite business purpose and economic substance";

(3) that "[t]he step transaction doctrine would not apply to recharacterize the Transactions";

(4) that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions would be upheld if challenged by the IRS"; and

(5) the IRS "should not be successful were it to assert a penalty against an Investor under Section 6662(b)(2) or (3)."

(Ex. 122 at 10-12).

1332. The March 8, 2002 Sidley Austin opinion letter, among other things, contained the following conclusions:

(1) that "for federal income tax purposes it is more likely than not" that the claimed step-up in basis, and the claimed allocations of gains and losses, would be respected;

(2) that "[t]he sham transaction doctrine would not apply and, based on the representations of investor, the Transactions would have the requisite business purpose and economic substance";

(3) that "[although the matter cannot be entirely free from doubt because of the factual nature of the inquiry, on balance, the requisite profit motive exists to support the deduction of any loss from the Transactions under Code Section 165(c)(2) and Code Section 183";

(4) that "[The step transaction doctrine would not apply to the Transactions";

(5) that "there is a greater than 50 percent likelihood that the tax treatment of the Transactions would be upheld if challenged by the IRS"; and

(6) that "the IRS should not be successful were it to assert a penalty against Investor Code Section 6662(b)(2) or (3) for positions taken on Investor's federal income tax return with respect to the Transactions."

(Ex. 121 at 16-18).

1333. A reasonable opinion letter would have laid out the likely positions that would be asserted by the IRS, and discussed the relevant authorities, whether favorable or unfavorable, in order to evaluate the likelihood that the courts would uphold the positions taken by the Egans.

1334. The opinion letters superficially purport to discuss the relevant authorities, but in reality their analysis is incomplete, incorrect, and misleading in multiple respects.

1335. Furthermore, the opinion letters were not written as a measured or reasoned analysis of a likely legal outcome, but rather as advocacy pieces intended to defend a previously determined conclusion.

1336. For example, any reasonable and experienced tax attorney would have recognized that the IRS would assert that the economic substance doctrine (or a variant) would apply to the Fidelity High Tech and the Fidelity International transactions. Both opinion letters recognize that fact, and both devote several pages to a purported analysis of that issue.

1337. The Proskauer opinion letter concluded that the Fidelity High Tech transaction would be upheld even if it had no economic substance, as long as the taxpayer was subjectively motivated by a business purpose other than obtaining tax benefits. (Ex. 122 at 29). It then stated in conclusory fashion that the Egans "contributed the Options and the Stock to [High Tech], and Maureen [Egan] contributed her interest in [High Tech] to [MEE Holdings], for substantial non-tax business reasons including investment management, risk control, and estate planning purposes which reasons would likely satisfy any business purpose requirement for engaging in the Transactions." (Id. at 31).

1338. The Proskauer opinion letter thus effectively assumed that the transaction would be upheld as long as the Egans represented that they subjectively believed the transaction had a business purpose.

1339. No reasonable tax attorney would assume that a transaction of that nature would be recognized and upheld by the courts simply because the taxpayer made a self-serving statement about his or her supposed business purpose.

1340. Because Richard Egan was a resident of Massachusetts, it should have been obvious that there was a substantial likelihood that the applicability of the economic substance doctrine would be litigated in the First Circuit. The opinion letter, however, contains no mention of any relevant First Circuit case law on the subject. Among other things, the opinion letter does not mention, much less analyze, the First Circuit's opinion in Dewees v. Comm'r, 870 F.2d 21 (1st Cir. 1989), a tax shelter case in which the court noted (in a discussion of Section 165(c)) that where the "objective features of the situation are sufficiently clear, self-serving statements from taxpayers could make no legal difference."

1341. Furthermore, and in any event, Proskauer knew, or reasonably should have known, that the Egans subjectively had no non-tax business reasons or purposes for entering into the transaction.

1342. The Sidley Austin opinion letter indicated that different circuits took different approaches to the economic substance doctrine, but that the "correct" approach was to uphold the transaction if it had either a business purpose (a subjective inquiry) or economic substance (an objective inquiry). (Ex. 121 at 62). The opinion later, and inconsistently, stated that it is "well-established that a transaction . . . will not be respected for tax purposes unless the transaction . . . [has] economic substance separate and distinct from the economic benefit derived from the tax reduction." (Id. at 70).

1343. Like the Proskauer opinion letter, the Sidley Austin opinion letter addressed the Egans' purported "business purpose" in conclusory fashion:

Investor believed that he had a reasonable opportunity to earn a reasonable profit, in excess of all fees and transaction costs, from the Transaction, without regard to tax benefits. Also as stated above, Investor contributed the Options to International for substantial non-tax business reasons, including hedging of risk in a highly concentrated stock, hedging currency risk as foreign markets made up an increasingly large component of the business in their concentrated holdings, and hedging currency risk with respect to a line of credit, the professional management provided by [Alpha], and the desire to create a larger pool of capital through the involvement of other investors such as [Samuel Mahoney].

(Id. at 62).

1344. Like the Proskauer opinion letter, the Sidley Austin opinion letter did not mention the Dewees case, or otherwise address the issue of whether the courts were likely to accept self-serving statements from taxpayers at face value.

1345. Like Proskauer, Sidley Austin knew, or reasonably should have known, that the Egans subjectively had no such business reasons or purposes for entering into the transaction.

1346. The discussion in the Proskauer opinion letter concerning the "economic substance" of the Fidelity High Tech transaction contained virtually no analysis of the actual facts of the transaction. (Ex. 122 at 32-34).

1347. The discussion in the Sidley Austin opinion letter concerning the "economic substance" of the Fidelity International transaction contained some factual analysis. (Ex. 121 at 70-77). That opinion letter, however, ignored several critical issues, such as whether the Fidelity International transaction actually served a reasonable hedging function, or whether the Egans had a reasonable possibility of profit in excess of fees and costs associated with the transaction.

1348. The discussion in both opinion letters as to whether the transactions described in IRS Notice 2000-44 are the "same as" or "substantially similar to" the High Tech transaction was incomplete and misleading. (Exs. 122 at 35; 121 at 93-98). Indeed, the opinion letters disposed of the issue summarily, with virtually no analysis.

1349. The Proskauer opinion letter stated that in the Notice 2000-44 transaction, the contribution of the option spread "directly results in a tax loss," whereas in the High Tech transaction, "the increased outside basis resulting from the contribution of the option spread simply permits investors to avoid a taxable gain." (Ex. 122 at 35). No explanation was given as to why the creation of an artificial basis step-up through the contribution of an option spread is not "substantially similar" to the creation of an artificial loss through the contribution of an option spread. Likewise, the opinion letter stated that in Notice 2000-44, the taxpayer's net economic outlay was described as "zero or nominal," whereas in the High Tech transaction it was "far greater than 'nominal.'" (Id.). Again, no explanation was given as to why a net economic outlay that was a small fraction of the claimed tax benefit is not "substantially similar" to an outlay that was "nominal."

1350. The Sidley Austin opinion letter contained the same language verbatim. (Ex. 121 at 97-98).

1351. In summary, the neither opinion letter provided a meaningful or coherent analysis as to several critical issues, including the applicability of the economic substance doctrine.

1352. The lack of a meaningful or coherent analysis as to those issues was deliberate. The authors of the opinion letters knew that it was not likely that the Fidelity High Tech or Fidelity International transaction would survive a legal challenge in which all the underlying facts were made known.

1353. The purpose of the opinion letters was not to provide legal guidance, but to provide a potential defense against the imposition of penalties, and thus to induce the taxpayer/Investor to enter into the transaction.

1354. The Egans were highly sophisticated and experienced taxpayers and knew, or reasonably should have known, that the legal analysis in the opinion letters was not reasonable.


[END OF EXCERPTS]
--------------------------------

Although not making similar findings and conclusions for other law firms, Judge Saylor does note (par. 123) that two other law firms were involved in "worked with DGI/Helios and KPMG to develop and market the strategy and to issue favorable opinions": Bryan Cave; and Lord, Bissell & Brook. Among other findings about their participation at the various steps in developing and marketing, Judge Saylors also finds (par. 476) that

476. As with the earlier marketing presentations, the September 17 PowerPoint presentation indicated that the Egans could obtain a "more likely than not" tax opinion from one of four law firms: Sidley Austin (the successor by merger to Brown & Wood), Proskauer, Bryan Cave, or Lord Bissell. (Id.).

Now, if one wanted to extrapolate or speculate, then ...

Judge Finds Ambassador's Tax Shelter Transactions Bullshit (Actually Worse Than That)

I have previously noted here that a Claims Court judge, in effect, held that a tax shelter transaction was bullshit. Another case does the same thing, although it does not exactly use the BS word. Judge F. Dennis Saylor, District Judge for Massachusetts, has handed down a whopping – both in length and effect on the taxpayers – opinion in Fidelity International Currency Advisor A Fund, LLC v. United States (4:05-cv-40151), a TEFRA proceeding involving Son-of-Boss tax shelters. The taxpayers involved (when the drill down on the partnerships is made) were Richard and Maureen Egan. Richard Egan was former Ambassador to Ireland. He and his wife made too much money. He and his wife did not like to pay tax. They entered phony transactions to shelter large gains.  They did not pay the tax. They tried to hide their activity from the IRS.  They were caught.  His estate and his wife will have to pay the tax, interest on the tax, apparently the accuracy related penalties, and interest on the accuracy related penalties. (I would think that, given the strength of the judge's view of the taxpayers' misbehavior, the Government / IRS might be sorely tempted to assert the civil fraud penalty when the action moves to the taxpayer level; note that if fraud was involved as the court held and the partnership is a sham, everything could drill down to the taxpayers' returns and the civil statute would be open indefinitely (see prior posts here and here); I haven't thought this through yet, so maybe someone will comment on it.)

The opinion is 357 pages long as issued by the court. The only copy of the opinion that I have is a whopping scanned pdf the original which is large, not easy to read and is not searchable. Hence, I offer up here an OCR'd version that I hope has been reasonably OCR'd (I have not tried to proof read it; note that when you click, the document will come up in google docs which I find difficult to work with; I recommend that you download the document (click on top of screen in Google Docs) and view it in regular pdf format which is both bookmarked and searchable.).

I won't try to summarize the opinion, because the Court does that for us as follows:

I. INTRODUCTION

A. Summary of Facts

Richard J. Egan was one of the founders of EMC Corporation, a large, publicly-traded manufacturer of computer storage devices. By the year 2000. Richard Egan and his wife Maureen had amassed enormous personal wealth, the great majority of which was in the form of EMC stock.

The Egans were highly sophisticated taxpayers; Richard Egan was one of the most successful businessmen in the history of the United States. His personal and family financial affairs, including the management of his wealth and the payment of his taxes, occupied an entire organization of twenty or so employees, which included his three sons, at least two certified public accountants, and a variety of other business and financial specialists. Richard and Maureen Egan expressly delegated power over their tax affairs to their son Michael, and explicitly and implicitly delegated authority for those matters throughout the family organization.

With the Egans' wealth and income came potentially large tax liabilities. As of 2000, the Egans beneficially owned approximately 25 million shares of EMC stock. At its peak in September 2000, EMC shares traded at more than $100 per share. Because the Egans' basis in those shares was extremely small -- approximately two cents per share -- the sale of any substantial portion of that stock would have produced huge capital gains, subject to a long-term capital gains tax at a rate of 20%.

In addition, the Egans owned non-qualified options to purchase more than 8 million shares of EMC stock at very low strike prices. The exercise of those options would generate large amounts of ordinary income, subject to taxes at a marginal rate that approached 40%.

In early 2000, Richard Egan and his son Michael became interested in investing in tax shelters to avoid taxes on the capital gains and ordinary income that was likely to result from the sale of EMC stock and the exercise of the options. With the assistance of an attorney from Chicago named Stephanie Denby, the Egans interviewed several tax shelter promoters in May 2000. They eventually selected the large international accounting firm KPMG. Through KPMG, the Egans were introduced to a small firm called Helios, which (with a related company called Diversified Group International, or DGI) had designed a highly complex tax shelter transaction that it was marketing to wealthy individuals.

The original tax shelter scheme involved the contribution of both paired offsetting options (in large notional amounts) and appreciated assets (such as EMC stock) to an entity taxed as a partnership. In simplified terms, the promoters claimed that the purchased option was an asset, but that the sold option was not a liability; the taxpayer thus supposedly contributed assets to the partnership entity, but not liabilities, creating a grossly inflated basis in his interest in the entity. The taxpayer's interest would then be sold, and the taxpayer would claim that the inflated basis (from the contribution of the options) "eliminated" any gain from the disposition of the stock or other assets. Variations of the scheme were designed to create artificial losses to offset ordinary income.

A significant feature of the scheme was the fact that four major law firms -- including Proskauer Rose and Brown & Wood, eventually Sidley Austin Brown & Wood -- had been recruited by the promoters to provide favorable opinion letters. The taxpayers were told in advance that they could choose one of the four firms for their favorable opinion. The opinion letters were in essence intended to serve as insurance against tax penalties should the IRS ever discover the transactions, and thus to induce investors to invest in the tax shelters.

By early August 2000, the Egans were on the brink of engaging in a transaction with KPMG and DGI/Helios that was designed to eliminate up to $200 million in capital gains by artificially inflating basis, and were considering a follow-up transaction designed to create up to $200 million in artificial losses to offset ordinary income.

In August 2000, the IRS issued Notice 2000-44. That notice directly attacked the types of tax shelter schemes that the Egans were about to enter into, and stated that the IRS would not recognize transactions of the type described in the Notice.

In the wake of Notice 2000-44, the promoters and their law firms concluded that it was too risky to proceed with the ordinary income portion of the scheme in its present form. The promoters and the Egans nonetheless pressed forward with the capital gains strategy, with a transaction designed to create $160 million in artificial basis. The strategy involved an orchestrated series of steps that were principally conducted through Fidelity High Tech Advisor A Fund, LLC. The essential steps of the transaction, other than the sale of the stock, were completed by early 2001. Unfortunately for the Egans, however, the price of EMC stock declined, to the point where they had created a purported "basis" of $160 million without sufficient offsetting assets to take advantage of it. The Egans accordingly decided to "stuff" additional low-basis stock into Fidelity High Tech in an effort to use the artificial basis they had created.

In the meantime, the Egans continued to speak with the promoters about a possible tax shelter strategy for ordinary income from the exercise of the options. By early 2001, the promoters had devised a new variation of the strategy that they called the "Financial Derivatives Investment Strategy," or FDIS. The FDIS strategy, among other things, generated paper "losses" for taxpayers by assigning any offsetting "gains" offshore -- to one of two Irish confederates of the tax promoters (neither of whom, of course, filed U.S. tax returns).

The Egans exercised their stock options at various points in 2001, resulting in a gain of $162.9 million. By early October 2001, the Egans had decided to use the FDIS strategy to shelter that income from taxes. Like the prior transaction, the strategy involved an orchestrated series of steps, this time through Fidelity International Currency Advisor A Fund, LLC. The various steps of the transaction were completed by the end of 2001.

The IRS, however, continued its efforts to crack down on tax shelters. In June 2002 -- before the Egans had filed their individual tax return for the year 2001 -- the IRS adopted a temporary regulation that required the filing of a disclosure statement if a taxpayer had participated in certain tax shelter transactions. KPMG, which was preparing the Egans' return, concluded that such a disclosure statement was required with the Egans' return. Rather than make the disclosure, however, the Egans fired KPMG and hired an accountant at another law firm -- who was also a confederate of the promoters -- to sign their return.

Around the same time, and as promised by the promoters, the Egans received opinion letters from Proskauer Rose (as to the Fidelity High Tech transaction) and Sidley Austin (as to the Fidelity International transaction) purporting to opine that it was "more likely than not" that the proposed tax treatment would be upheld. The Egans also received a separate letter from Proskauer Rose opining that the disclosure insisted upon by KPMG was not required.

The Fidelity International transaction resulted in the creation of artificial "losses" of $158.6 million in 2001, which the Egans used to offset the ordinary income of $162.9 million from the option exercise on their 2001 income tax return that year. The disclosure statement that was prepared by KPMG, and never filed, stated that "expected reduction in federal income tax liability" from the Fidelity International transaction was $65.5 million. The Egans also claimed a loss of $1.7 million from Fidelity International on their 2002 tax return.

The Egans sold all of the stock in Fidelity High Tech in 2002, for $76.2 million in proceeds. The real basis for that stock was $8.7 million; the inflated claimed basis was more than $163 million. Instead of reporting a capital gain of $67.4 million from the sale of that stock for 2002, the Egans reported a huge loss.

The IRS eventually learned of the scheme, and disallowed the treatment of the transaction on the various partnership returns on multiple grounds.

B. Summary of Legal Conclusions

In substance, plaintiffs Fidelity High Tech and Fidelity International seek to overturn the various adjustments made by the IRS to items on the partnership tax returns. The principal argument advanced by the government in response is premised on the economic substance doctrine, sometimes referred to as the sham transaction doctrine.

A fundamental principle of tax law is that transactions without economic substance, or sham transactions, will not be recognized. The precise contours of the economic substance doctrine have not been set, and vary from circuit to circuit. Nonetheless, it is clear that courts are required to consider the substance of a transaction, rather than its mere form, in considering the tax effect to be given to it. In making that determination, courts normally are required to consider two aspects of a transaction: the subjective purpose of the taxpayer (that is, whether the taxpayer actually had a non-tax business purpose for entering into the transaction) and the objective purpose of the transaction (that is, whether the transaction, objectively viewed, had a reasonable possibility of profit or other business benefit).

Here, the Egans claim that the principal purpose of the transactions, viewed objectively, was to serve as a hedge: to mitigate the risk of a decline in the price of EMC stock (in the case of the Fidelity High Tech transaction) or to mitigate the risk of fluctuating interest rates or foreign currency values (in the case of the Fidelity International transaction). From an objective standpoint, however, the transactions were entirely irrational; they were unnecessarily and extravagantly expensive, and did not hedge the purported risks effectively (or at all). The Egans also appear to claim that the transactions were entered into for profit. If so, they were also irrational for that purpose; the transactions were designed and intended to lose money, and in fact did so.

The objective features of the transactions were irrational because, of course, the Egans subjectively had no actual business purpose for entering into them. None of the participants in these complex transactions believed that they were real business transactions, with any purpose other than tax avoidance. Indeed, it is highly doubtful that any participant believed, even for a minute, that the transactions would withstand legal scrutiny if discovered. No one with the slightest understanding of the tax laws could reasonably believe that $160 million in basis could be created cut of thin air, or that $160 million in income could be made to vanish in a puff of smoke. In accordance with that belief, the Egans and their advisors went to great lengths to try to ensure that the IRS would never find out about the transactions -- including, among other things, the filing of partnership and individual tax returns with multiple false and misleading entries.

The Egans contend that their subjective intentions are irrelevant. In substance, they contend that as long as the transactions were not fictitious -- that is, as long as the entities existed, the money was transferred, and the options were purchased and sold -- the economic substance doctrine does not apply. But the transactions at issue were "real" only in the sense that a performance by actors on stage is "real." The actors are real human beings, and the stage sets are made of real wood and real paint. But the actors are reading from a script. No one watching "Macbeth" believes that they are witnessing the murder of a Scottish king, and the actors do not believe it either. Here, too, the participants were simply following a script -- a script that had little or no connection to any underlying business or economic reality.

The Egans also make a number of technical arguments, all of which assume that the transactions were real and should be respected. The linchpin of the scheme from a technical standpoint was a potential anomaly in the tax code: under a line of cases interpreting Section 752, a purchased option is an asset, but a sold option is only a contingent liability. The Egans thus take the position that a taxpayer can purchase offsetting options and contribute them to a partnership entity, and thereby contribute an asset but not a liability. From there, it is but a few steps to use the "asset" to inflate the basis of the partner's interest in the entity. If the tax system depended entirely on form over substance, the argument might well pass muster.

But tax liabilities are not so easy to dodge. It would be absurd to consider offsetting options -- purchased and sold at the same time, and with the same counterparties -- as separate items, and to act as if the one item existed and the other did not. That is particularly true where (as here) the individual option positions were gigantic, and might bankrupt the taxpayer or the options dealer if no offset were in place.

The Egans also point to the longstanding principle that it is perfectly legitimate to arrange one's affairs so as to pay as low a tax bill as possible. That assertion is true, as far as it goes. It is entirely appropriate, for example, for a taxpayer to decide to buy a house rather than to rent, in order to take advantage of the many tax advantages of home ownership. A taxpayer may buy a house with a mortgage in order to take advantage of the deductibility of mortgage interest. But a taxpayer cannot undertake phony or meaningless transactions and claim a tax advantage; he cannot, for example, lend money to himself, pay "interest" on the loan, and claim the interest deduction. If the tax laws permitted such a result, they would be nonsensical, and anyone who paid taxes would be a fool. The tax laws are neither so simple nor so easily evaded.

Finally, the Egans claim that they relied in good faith on formal legal opinions issued by Proskauer Rose and Sidley Austin, two highly prominent law firms. It is true that both firms issued opinions to the Egans. And it is true that both firms opined that it was more likely than not that their tax treatment of the transactions would be upheld.

But those opinions, too, were just additional acts of stagecraft. The lawyers were not in the slightest rendering independent advice; the promoters of the tax shelters had arranged favorable opinions from those firms well in advance, and as part of their marketing strategy. Indeed, the promoters (not the Egans) paid the law firms' fees. More fundamentally, the opinions were themselves fraudulent: they were premised on purported "facts" that the Egans and the law firms knew were false, and reached conclusions that everyone involved knew could not possibly be correct. The opinions had but one purpose: to serve as a form of insurance against the imposition of penalties if the transactions were ever to come to light.

The claim of good faith reliance on counsel is thus wholly without merit. The Egans knew that the opinion letters were simply part of the tax shelter scheme, and did not for a moment believe that they were receiving independent legal advice after a full disclosure of all underlying facts.

In short, the Fidelity High Tech and Fidelity International transactions were complete shams, without any economic substance of any kind. For that reason, and for the other reasons set forth below, the transactions should not be recognized, and the adjustments made by the IRS will be upheld.

Justice Stevens Announces Retirement

The papers announce today Justice John Paul Stevens' long expected retirement. He is a great judge and will be missed on the Supreme Court and throughout the country. 

I had first encountered Judge Stevens in arguments in the 7th Circuit Court of Appeals long ago.  I found him exceptionally sharp and willing to mix it up intellectually.  I eschew war stories here, however interesting they may be to me.  Being a tax lawyer and being concerned about the development of the tax law for the good of society as a whole, I can point to one particular matter in which his voice, spoken in dissent, should have been heeded.  That was in Frank Lyon Co. v. United States, 435 U.S. 561 (1978), a case that, in my opinion (I am not alone) was wrongly decided by the majority and has had disastrous consequences to the orderly development of the tax law over the years.  Therefore, I quote Judge Stevens' dissent in Frank Lyon in its entirety.  Although it would help to have read the majority opinion to knew the target he is shooting at, it is not critical.  If you have been more than casually involved in or observing the tax shelter industry over the years, you will understand why he is right:  The doctrine of economic substance developed on the shoulders of his dissent would have been a lot more coherent.
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Tax Shelter Lawyer Gets Probation

Peter Cinquegrani, a former Arnold & Porter partner, dodged the jail time bullet and was sentenced to only three years probation. He had previously pled to Klein conspiracy and tax evasion. His activity drawing the angst of the Government involved various shelters, including some promoted by Ernst & Young.

Here are some of the quotes attributed to Cinquegrani at the sentencing hearing from the various services cited below:

"I know what I did was wrong."

"I know what I did was wrong, and I did it anyway."

"When you break it down, I helped people cheat on their taxes."

"I helped people cheat on their taxes,"

In justification of the light sentence, the Judge Stein cited Cinquegrani's cooperation with the Government, including explaining the PICO shelter to investigators. Got that concept -- if you are going to cheat, do it in a complex way so that, if you are caught, you can help the Government and mitigate the sentence.

Sources:
Reuters
Business Week
JD Journal

Altria #3 - What Were Those Guys Smoking? (3/23/10)

Today is my final installment on Judge Holwell's Altria decision. I today have nothing to offer of tax substance (without making any claims that I have previously offered anything of tax substance). I do provide editorial comment. I caution my readers that, if they are looking for tax crimes nuggets, they won't find them in today's blog.

First, I went to Altria's web site here. The web site tell us that Altria, the maker of Phillip Morris cigarettes (including Marlboro, remember the Marlboro man -- actually more than one -- but three of whom, according to Wikipedia, died of lung cancer caused by, well, I don't have to say), supports regulation of cigarettes. If you believe that, Altria would have liked to have had you on the jury in its case.

Second, I just happen now to be teaching a series at my Church on the History of English Bible Translations. A pivotal focus of the series is, of course, the King James or so-called authorized version of the Bible. King James gets a lot of credit for that version. King James also was quite prescient about the horrors of smoking tobacco. In 1604 shortly after the Hampton Conference which started the process leading to the printing of the KJV in 1611, King James wrote a treatise called "A Counterblaste to Tobacco." The whole treatise (which may be viewed here); see also Wikipedia here) is a great read (and relatively short), but here is a snippet for flavor (in what is now called Early Modern English, about the same time Shakespeare was on his stage):

Have you not reason then to bee ashamed, and to forbeare this fllthie noveltie, so basely grounded, so foolishly received and so grossely mistaken in the right use thereof? In your abuse thereof sinning against God, harming your selves both in persons and goods. and raking also thereby the markes and notes of vanitie upon you: by the custome thereof making your selves to be wondered at by all forraine civil Nations, and by all strangers that come among you. to be scorned and contemned. A custome lothsorne to the eye, hatefull to the Nose, harmefull to the braine, dangerous to the Lungs, and in the blacke stinking fume thereof, neerest resembling the horrible Stigian smoke of the pit that is bottomelesse.

Now, if you like the way those guys expressed themselves in those days, you have the King James Bible 1611 edition, available from any number of sources, but I point particularly to the KJV Translator's Preface here.

Third, now, I just wonder whether those Altria guys were smoking when they got into this goofy deal and then when they decided to litigate it -- particularly before a jury and, if so, what were they smoking?

Altria #2 - Economic Substance and Juries (3/22/10)

In Altria (see blog here for introduction), Judge Holwell submitted the issues to the jury as follows:

The Court instructed the jury to analyze the transactions under the two common law disallowance methods relied on by the Government: the "substance over form" doctrine, and the "economic substance" doctrine. With respect to substance-over-form, the Court instructed the jury to put aside the labels used or names given to the documents and transactions, and decide whether Altria actually acquired and retained a genuine ownership interest in the Seminole, Oglethorpe, and Vallei facilities, and a genuine leasehold interest in the MTA facility. The jury was to consider "all the relevant facts and circumstances surrounding the transactions," including eight non-exclusive factors identified by the Court. 4 (Charge to the Jury, at 33-34 (Docket No. 146).) At the same time, the Court cautioned the jury that its analysis should turn on the facts as it found them, including its understanding of how the transactions were designed to unfold: "You must consider and give the appropriate weight to all the relevant facts and circumstances. In the end, the question is whether Altria retained significant and genuine attributes of traditional owner (or lessor) status." (Id. at 34.)

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Economic Substance Jury Instruction in Larson/Pfaff/Ruble

I previously attached deep in a blog Judge Kaplan’s economic substance charge to the jury in United States v. Larson (S.D. N.Y. No. 05 CR 888 (LAK)), dated 12/11/08, pp. 5225- 5232.  I have decided that, because of the ongoing discussion I should lift it up into a separate blog for those who might have missed it.

In order to prove that element in this case, we focus on the doctrine of economic substance. In this case, the government contends that the taxpayers whose tax returns are the subject of each count of tax evasion, owed more federal income tax then they reported on the returns for one reason only, in each case the taxpayer took a deduction from his taxable income due to a loss that the tax return attributed to one of the four tax strategies at issue in this case. You remember them, FLIP, OPIS, BLIPS and SOS.

The government argues that every one of those tax strategies lacked economic substance. That the tax deduction each one of those taxpayers took was improper, for that reason, and, therefore, that each taxpayer owed more federal income tax than was declared on the tax return. The defendants dispute that. They contend, among other things, that the tax strategies did not lack economic substance, that the deductions were proper, and that the tax returns, therefore, accurately stated the amounts of tax that were due and owing.

This means that your task here, with respect to the first element, is to decide for each count, whether the tax strategy that gave rise to the loss claimed as a deduction on that tax return, lacked economic substance in order to decide whether the relevant taxpayer owed more federal tax, income tax, than was shown that was due on the tax return. So I am now going to instruct you with respect to your consideration of the economic substance issue.

A transaction that lacks economic substance cannot enter into tax computations. Any deduction claimed for a tax loss that allegedly was sustained in such a transaction, therefore, is not properly claimed on a tax return.

In order to establish that a transaction lacks economic substance, the government must prove beyond a reasonable doubt both of two factors. The first factor is that the relevant taxpayer had no business purpose for engaging in the transaction apart from creating the tax deduction.

The second factor is that there was no reasonable possibility that the transaction would result in a profit.

Now, let me define one term and say a few things about each one of these factors.

First the definition. The word profit, as I use it in this context, means a return in excess of the cost of the investment, disregarding entirely any tax benefits. Let me give you an example. If somebody puts a million dollars into a deal, he would have to get a return of more than a million dollars without considering any tax benefits in order for the transaction to be profitable. Common sense. A return of $750,000 on a million dollar investment results in a loss of $250,000, not a profit. That's what I mean by profit. Forget the tax benefits, look at the investment and the return.

Now, let me discuss the first element that I mentioned, whether the taxpayer had any business purpose for entering into the deal. In deciding that question, you, of course, may consider any direct evidence of the taxpayer's motive. But you are not limited to direct evidence in deciding why a taxpayer did a transaction. You can consider circumstantial evidence as well.

I am going to talk to you later about what circumstantial evidence means. But for purposes of the present, think of it just as common sense, and then I will explain it later on.

For example, you may consider the manner in which the transaction was sold to the taxpayer. In other words, you are entitled to consider whether and to what extent it was sold to the taxpayer as a way to create a tax deduction to offset other taxable income, and/or as a way to generate a return, a profit, exclusive of tax benefits on the investment. You are entitled to consider that.

You may consider also whether a reasonable taxpayer would have paid the fees necessary to do the transaction in order to gain the chance of whatever profit potential existed if the transaction did not also carry with it tax benefits.

Now, let me try to put this into plain English. What helped me think about it, maybe it will help you, I am going to give you a couple of examples, so bear with me on the examples. Let's take an example in which a taxpayer has to put up $2 million to enter into some deal or strategy. Suppose further that the strategy in question offers a five percent chance, that's one chance out of 20, resulting in a payout, when all is said and done of $2,050,000. In other words, it's a one in 20 chance of making $50,000 on a $2 million investment.

Assume also that the taxpayer has a huge amount of income, and that there is a very big tax benefit to the strategy, maybe a $10 million tax loss or deduction.

Now, common sense will tell you that few, if any, people, no matter how rich they are, would put up $2 million for a five percent chance, a one out of 20 chance, of making $50,000. So on those facts you might conclude that there must have been only one reason for the taxpayer to have paid the $2 million. And that the $10 million tax loss or deduction probably was the only reason.

Let me give you another example, also an example in which the same taxpayer has to put up the same $2 million.

What's different in this example is this, assume there is a 33 percent chance, now it's one out of three we are talking about, of getting a payout of $3 million. And thus a profit of a million dollars within a year. Now, a 33 percent chance, a one out of three chance of making a profit, is not bad odds, it's pretty good odds. And a million dollars is nothing to sneeze at, even if you are very rich.

In this second example, the high likelihood, relatively high likelihood, and the large size of the potential profit, would be circumstances that might tend to show that the taxpayer had a nontax reason for doing the deal.

Many people might consider it a very good investment opportunity, without regard whether there was any tax benefit.

In the end, what you would do, is to consider all the evidence, direct, if there is any, and circumstantial, to decide whether the government had proved that the tax benefits were the only reason for doing the deal.

Those are my examples.

So let me come back to this case. If you find that the government has proved that the tax benefits were the only reason for doing the deal involved in any particular count, you will go on to consider the second part of the economic substance test that I gave you a moment ago. And that I am going to talk about more in a minute.

If you find, however, that the government has not proved that the tax benefits were the only reason for doing the deal, you must reject the government's economic substance argument. And you, therefore, must reject its contention that there was additional tax due and owing. That in turn would require you to find the defendant or defendants in question, not guilty on the particular tax evasion count that related to the particular taxpayer and year in question.

Now, let me say a word about the second fact in the economic substance test, which is whether there was a reasonable possibility that the strategy involved on the count you are considering would result in a profit.

Now, at one level this is largely self-explanatory, but I want to emphasize to you that this factor requires you to come to an objective judgment about whether the government has proved that there was no reasonable possibility that the strategy would result in a profit. In other words, this doesn't depend on what the taxpayer believed about the tax potential -- excuse me, the profit potential -- it requires you to consider all the evidence that you have, and reach a conclusion about whether the government has proved beyond a reasonable doubt, that there was no reasonable possibility of a profit.

In doing this, you are going to have to consider the evidence concerning investment aspects of each of the four tax strategies at issue in this case. For example, the transactions involving the Argentine peso and the Hong Kong dollar that were involved in the BLIPS strategy, and the foreign currency options that were involved in the SOS strategy. Of course, you have to consider the particulars of the other two strategies, as well, I mentioned those because they come immediately to mind.

Now, in considering whether the government has met its burden on the second factor, you should take into account whether the taxpayer, considering all the aspects of the strategy, had any reasonable chance of making a profit or suffering a loss as a result of changes in the market.

To take one example, if you are considering a BLIPS deal, you should consider whether the taxpayer had any reasonable chance of making a profit or suffering a loss as a result of changes in the value of the Argentine peso and the Hong Kong dollar, given the terms of the deal. If you find that the government has proved beyond a reasonable doubt both prongs of the economic substance test, in other words, both that the taxpayer had no nontax reason for doing the deals on the count in question, and that there was no reasonable possibility of making a profit, you may find that the requirement of additional tax due and owing will have been satisfied, and you will go on to consider whether the government has proved that the additional tax due and owing was substantial.