Superior Trading, LLC v. Commissioner
2013 U.S. App. LEXIS 17814
| 7th Cir. | 2013Background
- Warwick Trading, LLC and related entities challenged IRS disallowance of losses claimed in a DAD tax shelter and a 40% gross valuation misstatement penalty upheld by the Tax Court.
- Warwick was formed to transfer built-in losses from Arapuã’s nonperforming receivables to U.S. investors who would deduct them.
- Arapuã contributed receivables to Warwick; Jetstream was the active partner.
- Investors bought partnership interests to obtain the built-in losses, often paying only 3–6% of the loss value, while contributing promissory notes to inflate basis.
- The partnership was designed to be a tax shelter with little genuine business purpose and minimal collection activity, leading to substance-over-form concerns.
- Tax Court upheld the disallowance of partnership losses and the 40% penalty for a gross valuation misstatement, with the penalty tied to the overvaluation of assets (approximately $30 million) relative to near-zero basis.
Issues
| Issue | Plaintiff's Argument | Defendant's Argument | Held |
|---|---|---|---|
| Whether Warwick was a sham partnership that invalidates the losses | Warwick had business purpose via Arapuã/Jetstream; not a sham | Warwick lacked genuine business substance; housing a tax avoidance scheme | Yes, Warwick was a sham partnership; losses disallowed |
| Whether investors could deduct built-in losses through their partnership interests | Investors acquired basis to offset built-in losses | Basis inflated by sham contributions; losses improperly allocated | Loss deductions disallowed; investors cannot claim built-in losses |
| Whether the 40% penalty for gross valuation misstatement applies | Overstatement of basis justified by disclosed schemes | Penalty appropriate for overvaluation in a sham transaction | Penalty affirmed; overstatement treated as gross valuation misstatement |
| Whether reasonable-cause defense could avoid the penalty | Investors relied on Rogers' expertise; reasonable cause present | Rogers’ role as tax lawyer does not establish reasonable cause | No reasonable cause shown; penalty remains |
| Whether the transaction’s disregard for economic substance affects penalties | Overvaluation stands even if transaction disregarded | Disregarded transaction should mitigate penalties | Court adopts majority view; penalties apply despite lack of economic substance |
Key Cases Cited
- Southgate Master Fund, L.L.C. v. United States, 659 F.3d 466 (5th Cir. 2011) (absent non-tax business purpose; substance over form governs)
- Gregory v. Helvering, 293 U.S. 465 ((1935)) (substance prevails over form in tax shelter considerations)
- Moline Properties, Inc. v. Commissioner, 319 U.S. 436 ((1943)) (substance over form in tax shelters)
- Commissioner v. Tower, 327 U.S. 280 ((1946)) (assessing partnership intent and business purpose)
- ASA Investerings Partnership v. Commissioner, 201 F.3d 505 (D.C. Cir. 2000) (no tax-driven partnership without profit motive)
- TIFD III-E, Inc. v. United States, 459 F.3d 220 ((2d Cir. 2006)) (addressing substance and tax shelter structures)
- Crispin v. Commissioner, 708 F.3d 507 ((3d Cir. 2013)) (penalties for misstated valuation in tax shelters)
- Gustashaw v. Commissioner, 696 F.3d 1124 ((11th Cir. 2012)) (penalty/applicability in overvalued assets)
- Keller v. Commissioner, 556 F.3d 1056 ((9th Cir. 2009)) (disallowance of tax shelter benefits)
- Heasley v. Commissioner, 902 F.2d 380 ((5th Cir. 1990)) (review of valuation misstatements)
- United States v. Woods, 133 S. Ct. 1632 ((2013)) (Supreme Court context for penalties in tax shelters)