Consolidated Edison Co. of New York, Inc. & Subsidiaries v. United States
2013 U.S. App. LEXIS 577
Fed. Cir.2013Background
- ConEd claimed 1997 deductions (rent and interest) from a LILO tax shelter with EZH; IRS denied deductions and issued a deficiency.
- ConEd paid the deficiency, then sought a refund; Claims Court awarded a full refund on LILO deductions.
- United States appealed, arguing the transaction lacked substance under the substance-over-form doctrine.
- Transaction involved a master (head) lease by EZH to ConEd and a sublease back to EZH, with a 43.2-year head lease and a 20.1-year sublease; EZH contemplated exercising a Sublease Purchase Option in 2018.
- Funds were structured with a Debt Defeasance Account and an Equity Defeasance Account using STRIPS, with a looped flow of loan proceeds and payments; several “options” (Renewal, Retention, Sublease Purchase) affected economics.
- The key question is whether EZH would reasonably exercise the Sublease Purchase Option, affecting whether the arrangement is a true lease and thus whether ConEd could deduct rent and interest.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether EZH’s reasonable likelihood to exercise the Sublease Purchase Option recharacterizes the LILO as non-lease. | ConEd argues the Claims Court correctly recognized a reasonable likelihood EZH would exercise the option. | US argues EZH’s exercise was reasonably likely, making the head lease illusory and the deductions inappropriate. | Yes; EZH was reasonably likely to exercise the option, so the LILO lacks substance and deductions are disallowed. |
| Whether ConEd’s interest deductions on the HBU loan are genuine indebtedness given the transaction structure. | ConEd contends the loan created genuine indebtedness and permitted §163(a) deductions. | US contends the loan proceeds stayed within a loop controlled by EZH/ABN, thus not genuine indebtedness. | No; the loan was not genuine indebtedness and interest deductions are improper. |
Key Cases Cited
- Wells Fargo & Co. v. United States, 641 F.3d 1319 (Fed. Cir. 2011) (standard: reasonable likelihood governs recharacterization under substance-over-form)
- Coltec Indus., Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006) (anti-abuse doctrine; substance-over-form framework)
- Frank Lyon Co. v. United States, 435 U.S. 561 (Supreme Ct. 1978) (economic realities override form in tax purposes)
- Griffiths v. Helvering, 308 U.S. 355 (Supreme Ct. 1939) (form vs. substance in tax transactions)
- Southgate Master Fund, L.L.C. ex rel. Montgomery Capital Advisors, LLC v. United States, 659 F.3d 466 (5th Cir. 2011) (substance-over-form context in tax investments)
- United States v. Janis, 428 U.S. 433 (Supreme Ct. 1976) (burden on taxpayer to prove entitlement in refund actions)