Appeal from a judgment of the United States District Court for the Southern District of New York, Richard J. Holwell, Judge, denying Plaintiff-Appellant's motion for judgment as a matter of law or for a new trial, after the jury found that Plaintiff-Appellant was not entitled to the requested tax refunds. Affirmed.
The opinion of the court was delivered by: Pooler, Circuit Judge:
Before: NEWMAN, LEVAL, and POOLER, Circuit Judges.
In this tax refund suit, Altria Group, Inc. claims $24,337,623 in depreciation, interest, and transaction cost deductions for the tax years 1996 and 1997. The claimed deductions result from Altria's participation in nine leveraged lease transactions with tax-indifferent entities. In each transaction, Altria leased a strategic asset from a tax-indifferent entity; immediately leased back the asset for a shorter sublease term; and provided the tax-indifferent entity a multimillion dollar "accommodation fee" for entering the transaction and a fully-funded purchase option to terminate Altria's residual interest at the end of the sublease term. The Government described these transactions as tax shelters--or more precisely, as attempts by Altria to purchase unused tax deductions and transfer money from the public fisc to itself.
After an eleven-day trial before the District Court for the Southern District of New York (Holwell, J.), the jury found that Altria was not entitled to the claimed tax deductions. Applying the substance over form doctrine, the jury rejected Altria's contention that it retained a genuine ownership or leasehold interest in the assets and therefore was entitled to the tax deductions. The district court denied Altria's motion for judgment as a matter of law or for a new trial and entered judgment for the Government. Altria appeals, arguing, inter alia, that the district court erred in instructing the jury regarding the substance over form doctrine.
Because this appeal "comes to us after a jury verdict, we view the facts of the case in the light most favorable to the prevailing party," here, the Government. Brady v. Wal-Mart Stores, Inc., 531 F.3d 127, 130 (2d Cir. 2008) (internal quotation mark omitted).
This appeal concerns tax deductions that Altria claimed in 1996 and 1997, and which the Internal Revenue Service ("IRS") disallowed. Altria claimed the tax deductions after entering into nine leasing transactions, four of which the parties agreed to focus on at trial. Of these four transactions, three fit the structure of a "sale-in/sale-out" ("SILO") transaction and one fits the structure of a "lease-in/lease-out" ("LILO") transaction. See generally, e.g., Robert W. Wood & Steven E. Hollingworth, SILOs and LILOs Demystified, 129 Tax Notes 195 (Oct. 11, 2010) (defining and describing SILOs and LILOs); Maxim Shvedov, Cong. Research Serv., CRS Report for Congress: Tax Implications of SILOs, QTEs, and Other Leasing Transactions with Tax-Exempt Entities (2004), available at http://digital.library.unt.edu/ark:/67531/metacrs6848 (last visited July 15, 2011) (same). Altria's SILO and LILO transactions share three common features, described briefly below: (1) lease and leaseback; (2) debt financing and rent; and (3) options at sublease termination.
In the four representative SILO and LILO transactions, Altria, a taxable entity, entered into a primary or "head" lease with a tax-indifferent entity, such as a government agency or foreign entity, for an interest in a facility. The facilities included a Georgia hydroelectric facility; a New York rail yard; a Netherlands waste treatment plant; and a Florida electrical plant. In the three SILO transactions, the lease terms extended beyond the facility's remaining useful life, allowing Altria to assert that the transactions were sales for tax purposes. In the other transaction--the LILO transaction--the lease term spanned less than 80% of the remaining useful life of the asset, allowing Altria to assert that the transaction was a lease, not a sale. The tax-indifferent entities could not themselves benefit from tax deductions derived from utilization of these assets. Altria, however, as a profitable taxable entity, could benefit from tax deductions resulting from use of those assets. Therefore, both Altria and the tax- indifferent entities would benefit from a transaction in which Altria was treated as the owner or lessee of the facility (taking full tax deductions and paying the tax-indifferent entity an "accommodation fee"); the tax-indifferent entity was able to continue free, uninterrupted use of its facility; and both parties' economic risk of loss was minimized.
To allow the tax-indifferent entities to continue using the facilities, Altria immediately leased back each facility to the tax-indifferent entity, using a sublease. Each sublease had a shorter term than Altria's corresponding head lease, but (as discussed below) at the end of the sublease period the tax-indifferent entity could repurchase the facility (terminating Altria's head lease) using no funds of its own but exclusively funds that Altria had placed in escrow for that purpose. During the sublease periods, each tax-indifferent party had full operational control over the facility and was required to pay all insurance, maintenance, improvement, repair, and regulatory costs. As Altria described in a presentation at a worldwide Altria conference:
ALTHOUGH [ALTRIA] HAS THE TITLE AND IS THE OWNER OF THE ASSET, THE LESSEE BEARS ALL THE COSTS AND RISKS OF OWNERSHIP DURING THE LEASE TERM.
The financing for each of Altria's SILO and LILO transactions principally entailed: (a) the head lease rent owed by Altria; (b) the sublease rent owed by the tax-indifferent entity; (c) the debt service obligations incurred by Altria to pay the head lease rent; and (d) an accommodation fee paid by Altria to the tax-indifferent entity.
To pay its head lease rent, Altria borrowed about 80% of the needed money through a non-recourse loan. For the rest, Altria contributed its own cash. For each transaction, Altria paid the entire amount due under the head lease (which included the amount needed by the tax- indifferent entity to repurchase the facility at the conclusion of its sublease) in a single upfront payment. Cf. Reisinger v. Comm'r, 144 F.2d 475, 477-78 (2d Cir. 1944) (requiring depreciable interest in property at time deduction is claimed). According to each SILO or LILO agreement, those funds were not given to the tax-indifferent entity, but were placed in two accounts ("defeasance accounts") in which a third-party undertaker held the necessary funds and made payments when due under the agreements. See Wells Fargo & Co. v. United States, 91 Fed. Cl. 35, 41 (2010) (providing overview of defeasance).
For each transaction, Altria created a debt defeasance account and an equity defeasance account. Each debt defeasance account contained the money Altria borrowed for the transaction. Each equity defeasance account contained part of the cash Altria contributed for the transaction. Altria gave the rest of its cash contribution directly to the tax-indifferent entity as an accommodation fee for purporting to lease or sell its depreciable or amortizable asset. Altria claimed tax deductions totaling $136 million in 1996 and 1997. It paid accommodation fees of over $80 million to its counterparties, giving the hydroelectric facility owner $40.4 million, the rail yard owner $26.3 million, the electrical plant owner $10.6 million, and the waste treatment plant owner $5.5 million.
The undertaker of each debt defeasance account was responsible for using the funds to pay the tax-indifferent entity's rent on its sublease. However, the debt undertaker did not pay the sublease rent directly to Altria, but to Altria's lender to satisfy Altria's debt service obligations on its non-recourse loan. The sublease rent and the debt service obligations were set to match, in timing and amount, with very few exceptions. Thus, in each transaction the funds were transferred in a loop from the lender, to Altria (the non-recourse loan), to the tax-indifferent entity (to pay the head lease rent), to the debt undertaker (to pay the sublease rent), and then back to the lender (to pay the debt service obligations). Because the debt undertaker and the lender were affiliates, the actual funds never even left the bank for the duration of the transaction. Moreover, the tax-indifferent entities could not control or access the funds in the debt defeasance account. For each equity defeasance account, the cash contributed by Altria was invested in U.S. Treasury securities, in an apparent attempt to give the transaction a veneer of economic substance. David P. Hariton, Sorting Out the Tangle of Economic Substance, 52 Tax L. 235, 325-36 (1999) (noting it is always possible to produce a non-adjusted "profit" simply by including equity in a transaction). Altria prevented the tax-indifferent entities from accessing or exercising any control over the accounts during the sublease term. Even after their subleases ended, the tax-exempt entities had no entitlement to withdraw the funds, as discussed below.
At the end of each sublease term, the SILO and LILO agreements provided the tax- indifferent entities with a unilateral option to (re)purchase the facilities at issue, thus terminating Altria's remaining head lease interest. The agreements set the exercise price at a fixed amount, determined at the start of the transaction, equal to or greater than the property's projected fair market value at the end of the sublease term. The purchase option was fully funded by the U.S. Treasury securities in the equity defeasance account, which would increase in value during the sublease term to precisely the purchase option price. If the tax-indifferent entity exercised the purchase option, the funds in the equity defeasance account would flow in a loop, like the funds in the debt defeasance account: from Altria, to the undertaker, back to Altria.
Under the SILO and LILO agreements, if the tax-indifferent entity did not exercise its fully-funded purchase option, Altria had three general options: (1) force the tax-indifferent entity to renew the sublease or enter into a service contract; (2) enter into a replacement sublease with a third party; or (3) take possession of the leased property. The options were designed to allow the tax-indifferent entity to retain control of the asset, while reducing Altria's risk of economic loss.
This structure differs from a traditional leveraged lease in a number of ways. Because of the single-purpose nature of the assets at issue (e.g., a rail yard for a metro system), there was no viable secondary market for the facilities. See Altria Grp., Inc. v. United States, 694 F. Supp. 2d 259, 266 (S.D.N.Y. 2010) (noting that the jury heard evidence that "in each transaction, Altria and its counterparty effectively entered into a bilateral monopoly in which the asset's price after the transaction's closing would be determined by non-economic factors"). Further, in each transaction Altria invested in assets of "strategic importance" to the tax-indifferent entity's business operations, to ensure that the tax-indifferent party would exercise the purchase option at the end of the sublease term. In addition, the tax-indifferent parties' sublease rent and purchase options were fully defeased, so the transactions created no additional liquidity for Altria beyond the tax benefits. Id. at 267. Lastly, the transactions "had the effect of creating tax benefits" that Altria purchased for an accommodation fee, rather than the effect of "transferring a tax benefit between taxpayers that paid comparable tax rates." Id. (noting relevance of this fact under
Altria was aware that for tax purposes it needed to maintain a genuine ownership or leasehold interest in the facilities. Thus, Altria obtained financial appraisals for each of the
SILO and LILO transactions. At least one appraisal was not completed until years after the transaction, and none were shared with the tax-indifferent entities before the transactions. Each appraisal concluded that (1) the tax-indifferent entity would not exercise its fully-funded purchase option at the end of the sublease period; ...