Reddam v. Commissioner
755 F.3d 1051
9th Cir.2014Background
- In 1999 petitioner J. Paul Reddam realized a $48.5 million capital gain on sale of DiTech and purchased a KPMG‑marketed Offshore Portfolio Investment Strategy (OPIS) seeking to shelter that gain.
- OPIS used related Cayman entities (Cormorant, Clara Street entities) to buy Deutsche Bank stock with nonrecourse bank financing, engage in swaps/options, and attempt a “basis‑shift” so a large offshore basis would be treated as available to Reddam, producing an artificial U.S. tax loss.
- Reddam invested roughly $6 million directly (including $2.5M for DB stock) and entered option and swap positions; Cormorant borrowed ≈$42M to buy DB stock and later sold it back to the bank under terms that produced little economic profit but a large claimed tax loss.
- On his 1999 return Reddam offset his $48.5M gain with about $50.2M of losses derived from the OPIS steps and basis‑shift theory.
- IRS disallowed the losses, assessed an $8M deficiency, and the Tax Court held after bench trial that the OPIS transaction “lacked economic substance” and disallowed the deduction; the Ninth Circuit affirmed.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether OPIS has economic substance (objective and subjective prongs) | Reddam: OPIS could produce pretax profit (23–25% of modeled paths) and thus had investment purpose; Tax Court did not adopt expert NPV but should not have treated probability as remote | Commissioner: Transaction was designed to create an artificial tax loss; subjective tax‑avoidance motive and structure show lack of substance | Court: Affirmed Tax Court — transaction lacked economic substance; objective profit potential remote, structure ensured tax loss, and Reddam’s overriding motive was tax avoidance |
| Whether taxpayer had a non‑tax profit motive (subjective inquiry) | Reddam: He hoped to make money and performed due diligence; not motivated solely by taxes | Commissioner: Timing and marketing show Reddam entered primarily to eliminate his DiTech gain; he ignored advice to obtain independent advice | Court: Found Reddam’s primary motive was tax avoidance; failure to obtain independent advice and KPMG materials corroborate tax motive |
| Whether small probability of profit suffices to establish substance | Reddam: 23–25% chance of profit is meaningful and defeats sham finding | Commissioner: Even if theoretical profit exists, magnitude and probability are insufficient given expected pretax losses and dominant tax effect | Court: Profit probability and magnitude were inadequate given near certainty of massive tax loss; small chance of upside does not confer substance here |
| Whether basis‑shift theory produced a legitimate deductible loss | Reddam: Constructive ownership and §302/§318 arguments permit transfer of offshore basis to offset his gain | Commissioner: The shift was artificial; transaction form masks reality and produces an artificial loss | Court: Treated the overall structure as sham and disregarded the basis‑shift result for tax purposes |
Key Cases Cited
- Frank Lyon Co. v. United States, 435 U.S. 561 (Sup. Ct.) (standards for reviewing Tax Court findings; factual findings reviewed for clear error)
- Sacks v. Commissioner, 69 F.3d 982 (9th Cir.) (economic substance inquiry focusing on whether transaction had practical economic effects beyond tax benefits)
- Bail Bonds by Marvin Nelson, Inc. v. Commissioner, 820 F.2d 1543 (9th Cir.) (two‑pronged economic substance/business purpose analysis)
- Sochin v. Commissioner, 843 F.2d 351 (9th Cir.) (sham analysis and consideration of business purpose and economic substance)
- Casebeer v. Commissioner, 909 F.2d 1360 (9th Cir.) (objective inquiry into whether transaction likely to produce economic benefits aside from tax deductions)
- United States v. Davis, 397 U.S. 301 (Sup. Ct.) (meaningful reduction test in redemption context)
- Welch v. Helvering, 290 U.S. 111 (Sup. Ct.) (burden of proof and presumption supporting IRS determinations)
- Gregory v. Helvering, 293 U.S. 465 (Sup. Ct.) (reviewing substance over form; disregarding corporate form when without substance)
- Sala v. United States, 613 F.3d 1249 (10th Cir.) (artificial tax loss argument cited as support for sham finding)