Tax News

CCH (cch.taxgroup.com) reports:

A financial services company was not entitled to rent and interest deductions associated with the its participation in a lease and sublease transaction of wood pulp manufacturing equipment that it entered into with the manufacturer that owned the equipment. The company failed to prove that the lease-in/lease-out (LILO) transaction constituted a genuine lease or indebtedness.
The taxpayer company entered a long term lease of equipment with a Swedish wood pulp manufacturer. The manufacturer was already using the equipment, which the taxpayer subleased to the manufacturer. The taxpayer understood it was entering a tax-driven deal with an after-tax investment yield largely generated by tax benefits associated with accelerated tax deductions for rent. Although large sums of money changed hands, the amounts ended up in the control of the entities from which they came, with the exception of a one-time payment from the company to the manufacturer as an inducement to enter the deal.
The company could not deduct rent and related expenses associated with the lease because the transaction did not amount to a genuine lease. The manufacturer owned and used the equipment and retained, in substance, all of the rights it possessed in the equipment before the transaction and during the term of the lease. The rights that the manufacturer transferred to the company under the lease were identical to the rights that the company transferred back to the manufacturer under the sublease.
The company also could not deduct interest on a nonrecourse loan the company took out to make an advance lease payment because the loan transaction was only a circular transfer of funds in which the loan was paid from the proceeds of the loan. When the reciprocal and offsetting obligations of the LILO transaction were disregarded, it was clear that the company paid only transaction costs and invested in government securities.
CCH Comment. Abusive LILO transactions were prohibited by regulations that were proposed in 1996 and became effective in 1999 (Reg. §1.467-1
through -5). This transaction took place in 1997. Doug Shulman, Commissioner of Internal Revenue, lauded the decision. He said in a statement "The IRS has fought hard to stop abusive tax shelters that twist and distort tax law to generate unwarranted deductions. We're pleased with today's decision. The court made the point that just because the promoters and participants called their arrangement a loan or a lease, doesn't make it so. Those taxpayers who comply with their obligations should find comfort that those who abuse the system are paying the price. The IRS has fought hard to stop abusive tax shelters that twist and distort tax law to generate unwarranted deductions. "
Affirming a DC N.C. decision, 2007-1 USTC ¶50,130.
BB&T Corporation, CA-4, 2008-1 USTC ¶50,306
Other References:
Code Sec. 162
CCH Reference - 2008FED ¶8754.174
Code Sec. 163
CCH Reference - 2008FED ¶9104.382
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