45 F.4th 150
D.C. Cir.2022Background:
- Congress created a refined-coal tax credit (26 U.S.C. §45) to encourage production of cleaner-burning coal; the credit could be allocated among multiple owners of a facility.
- AJG formed Cross Refined Coal, LLC to build and operate a refining facility at Santee Cooper’s Cross Generating Station and entered three ten-year contracts: a lease, a purchase-and-sale that required reselling coal at a loss, and a sublicense for AJG’s refining technology.
- Cross’s business model produced pre-tax losses; the venture was economically viable only if the refined-coal tax credits produced an after-tax profit.
- AJG recruited Fidelity and Schneider as members; each paid millions, shared management duties, and made ongoing contributions for operating expenses; Cross operated, suffered two lengthy shutdowns, generated some after-tax profits, and ultimately dissolved with buyouts and liquidated damages.
- The IRS issued an FPAA concluding Cross was not a partnership for tax purposes (a sham formed to monetize tax credits); the Tax Court found Cross a bona fide partnership. The D.C. Circuit affirmed.
Issues:
| Issue | Plaintiff's Argument (Commissioner) | Defendant's Argument (Taxpayers/Cross) | Held |
|---|---|---|---|
| Whether Cross was a bona fide partnership under federal law | Cross formed solely to monetize tax credits; no pre-tax profit, therefore a sham | Cross had legitimate business purposes (spread risk, deploy tech), active partner involvement, and statutory allocation of credits | Affirmed: Cross is a bona fide partnership; post-tax profitability can be a legitimate business purpose |
| Whether Fidelity and Schneider had a meaningful equity stake | Their capital at risk was small relative to expected tax benefits; protections (e.g., liquidated-damages, contract terms) insulated downside, so they effectively bought credits | They invested millions, shared management and losses, paid operating expenses, faced regulatory/operational risks, and fortunes rose/fell with production | Held: Fidelity and Schneider had meaningful downside risk and shared profits/losses; equity-character prevails |
| Whether lack of expected pre-tax profit defeats partnership status | Partnership must reasonably expect pre-tax profit; activity unprofitable absent credits is sham (relying on Alternative Carbon) | Congress authorizes tax incentives; an enterprise profitable only post-tax can still have economic substance and a bona fide business purpose (relying on Sacks) | Held: Lack of pre-tax profitability alone does not make a partnership a sham; after-tax profit motive permitted |
Key Cases Cited
- Comm’r v. Tower, 327 U.S. 280 (U.S. 1946) (defines partnership: intent to carry on business and share profits/losses)
- Comm’r v. Culbertson, 337 U.S. 733 (U.S. 1949) (partnership requires good-faith business purpose and present intent to join in conduct of enterprise)
- ASA Investerings P’ship v. Comm’r, 201 F.3d 505 (D.C. Cir. 2000) (sham partnership where transactions lacked post-tax profitability and served only to create tax losses)
- BCP Trading & Invs., LLC v. Comm’r, 991 F.3d 1253 (D.C. Cir. 2021) (partnership inquiry looks to profit motive and practical economic effect)
- Sacks v. Commissioner, 69 F.3d 982 (9th Cir. 1995) (tax-advantaged transactions are not shams merely because profitability depends on tax benefits)
- Alternative Carbon Resources, LLC v. United States, 939 F.3d 1320 (Fed. Cir. 2019) (questioning credits-only profitability where no reasonable expectation of non-tax profit existed)
- Historic Boardwalk Hall, LLC v. Comm’r, 694 F.3d 425 (3d Cir. 2012) (equity-character requires meaningful upside/downside; zero-risk arrangements inconsistent with partnership)
- Bank of N.Y. Mellon Corp. v. Comm’r, 801 F.3d 104 (2d Cir. 2015) (economic-substance analysis comparing tax and non-tax benefits to detect sham transactions)
- Reddam v. Comm’r, 755 F.3d 1051 (9th Cir. 2014) (transactions lacking practical economic effect can be disregarded for tax purposes)