August 02, 2017

U.S. Tax Court Cites Testimony of A. Lawrence Kolbe in IRS Tax Shelter Case Decision

In the recently-concluded U.S. Tax Court cases Guy R. Baxter & Lonnie C. Baxter v. Commissioner of Internal Revenue and Curtis Investment Company, LLC, Henry J. Bird, a partner other than the tax matters partner v. Commissioner of Internal Revenue, the judge cited the testimony of Brattle Principal Emeritus A. Lawrence Kolbe in his opinion, ruling in favor of the Internal Revenue Service (IRS) and finding that the petitioners entered into custom adjustable rate debt structure (CARDS) transactions that reduced petitioners’ wealth and were designed to minimize tax liability.

The Petitioners stated that the CARDS transactions would provide funding for investments over a 30-year term, and that it was reasonable to expect investment returns in excess of the cost of the CARDS funding. Dr. Kolbe provided an expert report and testimony on the CARDS transactions. He opined that the CARDS transactions should be analyzed as financing decisions, and therefore analyzed whether CARDS was an economically rational source of financing. Dr. Kolbe concluded that CARDS was not an economically rational source of financing for the Petitioners absent the tax benefits. He found that the effective interest rate on the CARDS loans were materially higher than the market rate of interest on other sources of funding. The excessive CARDS interest rate, he concluded, served as a drag on the profitability of an investment funded with the CARDS proceeds, and Petitioners’ wealth was reduced as a result of the decision to enter into the CARDS transactions. Dr. Kolbe also concluded that the Petitioners had an incentive to repay the CARDS loan before the stated 30-year maturity because the longer the transaction was maintained, the worse off Petitioners would be, even ignoring tax effects.

The Court cited Dr. Kolbe’s opinion that investment returns were not a relevant consideration and that it was appropriate to evaluate the CARDS transactions without regard to how the proceeds were used. The Court stated that:

In reviewing the CARDS transactions without reference to the transfer of the proceeds to petitioners, we find Dr. Kolbe's report and related testimony persuasive that the CARDS transactions lacked economic substance. Dr. Kolbe's report shows that the CARDS transactions lacked profit potential. The report states that the CARDS transactions reduced petitioners' wealth by €2.19 million and would have reduced it even more had the CARDS transactions lasted longer than one year. These losses would exist no matter what investments petitioners made with the proceeds because the same investments could have been financed by a more conventional type of loan, and the artificial, unrelated losses would remain even if we accepted petitioners' position that we should consider the transfer of proceeds to them as part of the CARDS transactions. [footnote omitted]

Other members of The Brattle Group who have worked with Dr. Kolbe on the CARDS matters include Matt Aharonian, Darrell Chodorow, Florin Dorobantu, Mark Sarro, and Bin Zhou. Additional information about our Tax Controversy practice is available here.

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Principal Emeritus
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Dr. Kolbe's work focuses on applied financial economics and his projects address risk, return, and regulatory policy for rate-regulated industries; tax disputes; and firm, security, or project valuation questions in a wide variety of settings. More icon f02782c24cccaf6d90e1da53920c42f20e5a8955f54ac2ca5727ec7dc89987b4