Hewlett-Packard Co. v. Commissioner, 875 F.3d 494

In 1996 HP purchased preferred shares of a Dutch entity, Foppingadreef Investments (FOP), structured to buy contingent-interest notes that were taxable in the Netherlands but not immediately in the U.S., producing foreign tax credits (FTCs) for the U.S. investor.
HP paid ~ $200 million for the preferred stock and simultaneously bought a put option from ABN giving HP the right to sell the shares back in 2003 or 2007.
HP claimed large FTCs from 1997–2003 and later exercised the put, realizing a capital loss it reported for U.S. tax purposes.
The IRS issued notices of deficiency disallowing part of HP’s FTCs and denying the capital-loss deduction as a fee paid for a tax shelter; Tax Court found the investment was debt (not equity) and disallowed the loss.
On appeal, the Ninth Circuit reviewed whether the instrument should be characterized as debt or equity and whether the capital-loss claim was permissible or in substance a nondeductible fee tied to a tax shelter.

Issue	Plaintiff's Argument	Defendant's Argument	Held
Characterization: Was HP’s interest debt or equity?	HP argued the preferred shares were equity (to qualify for §902 FTCs) and labels/structure showed equity.	IRS argued the overall transaction functioned like debt (fixed return, de facto maturity, creditor rights).	Court: Affirmed Tax Court — instrument characterized as debt.
Consideration of related documents: Could HP’s put be treated as part of the overall transaction?	HP argued the put was separate and should not convert the interest into debt.	IRS argued the put and shareholders’ agreement integrated into one transaction.	Court: Put properly considered as part of the integrated transaction.
Standard of review: Is debt/equity characterization factual or mixed legal issue?	HP urged review that might be less deferential.	IRS favored deference to Tax Court’s factual findings.	Court: Applied clear-error deference to Tax Court’s factual findings and multifactor inquiry.
Capital-loss deduction: Was HP’s reported loss a bona fide capital loss or a nondeductible fee for a tax shelter?	HP claimed a legitimate capital loss on sale/exercise of the put.	IRS asserted the loss was essentially a fee for participation in a tax-savings scheme and thus nondeductible.	Court: Affirmed Tax Court — loss treated as a nondeductible fee/tax-shelter payment.

A.R. Lantz Co. v. United States, 424 F.2d 1330 (9th Cir. 1970) (sets out multi-factor debt/equity test)
Frank Lyon Co. v. United States, 435 U.S. 561 (1978) (distinguishes questions of general characterization and particular facts)
Cooter & Gell v. Hartmarx Corp., 496 U.S. 384 (1990) (standards for reviewing mixed questions of law and fact)
C.I.R. v. Duberstein, 363 U.S. 278 (1960) (deference and contextual factual inquiry in tax cases)
Welch v. Helvering, 290 U.S. 111 (1933) (taxpayer bears burden to prove correctness of deduction claim)