Opinion
Docket No. 32552-85
1987-02-5
IRA S. GREENE AND ROBIN C. GREENE, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
Elliot I. Miller, for the petitioners. Robert J. Foley, for the respondent.
A partnership, of which petitioners were members, was the lessee of equipment. HELD, upon a motion by petitioners for summary judgment that, even assuming that elements of business purpose, economic substance and profit motive independent of tax benefits should not be taken into account in determining the applicability of the safe-harbor leasing provisions of sec. 168(f)(8), I.R.C., they may be considered in determining the true nature and validity for Federal income tax purposes of a series of transactions of which the lease was a part. Consequently, petitioners' motion for summary judgment is denied. Elliot I. Miller, for the petitioners. Robert J. Foley, for the respondent.
OPINION
TANNENWALD, JUDGE:
Respondent determined a deficiency of $53,202.25 in petitioners' 1981 Federal income tax based on the disallowance of certain deductions in respect of recycling equipment.
This case is before us on petitioners' motion for summary judgment. It is one of a number of cases involving the same or similar arrangements in respect of the impact of the safe-harbor leasing provisions of section 168(f)(8) on leases of such equipment. The Court is in the process of coordinating the trial of one or more of such cases and it is clear that our disposition of the within motion will have a bearing on those cases.
Rule 121(b) provides that a motion for summary judgment is to be granted if ‘there is no genuine issue as to any material fact and * * * a decision may be rendered as a matter of law.‘ The burden of proof is on the moving party, and we are required to view the factual materials and inferences to be drawn therefrom in the light most favorable to the party opposing the motion. Casanova Co. v. Commissioner, 87 T.C. 214, 217 (1986). We begin by setting forth a summary of the factual background for our decision—a background with which the parties appear to be agreement for the purposes of this motion but which may be challenged, modified or amplified in the event of trial.
Petitioners are limited partners in the Resource Reclamation Associates limited partnership (hereinafter ‘RRA‘). RRA is the entity which passed through to petitioners the disallowed losses and tax credits at issue in this case.
RRA is a lessee of rights in seven Sentinel EPE Recyclers (‘Recyclers‘), which are manufactured by Packaging Industries Group, Inc. (‘PI‘) of Hyannis, Massachusetts. The Recyclers are designed to enable converters of waste polyethylene foam and film to recycle the scrap into a more densified form, which can then be further processed to produce resin pellets usable in industry.
According to the RRA Offering Memorandum, after a ‘sale‘ of the Recyclers from PI to Ethynol Cogeneration, Inc. (‘ECI‘) for $534,199 in cash and a twelve-year non-recourse promissory note in the amount of $6,332,801, ECI would then immediately sell the Recyclers to F & G Equipment Corporation (‘F & G ‘) for $619,466 in cash and a partial recourse promissory note in the amount of $7,519,201. The note was to be recourse to the extent of 10 percent of its face value, but the recourse portion was to be payable only after the non-recourse portion was satisfied. Each of these two notes carried a stated monthly repayment amount of $108,571, with the first payment due 8 months after closing.
Upon its purchase of the Recyclers, F & G would lease the equipment to RRA for twelve years for a monthly lease amount of $108,571, with seven months of the lease payments to be prepaid. RRA would then sublease or license the Recyclers to First Massachusetts Equipment Corporation (‘FMEC‘) for twelve years at a guaranteed minimum royalty of $108,571 per month, beginning with the seventh month of the 12-year period, plus a prepaid $25,000 non-refundable advance royalty payment. After the Recyclers had been placed in service, FMEC would be required to pay RRA additional royalties based on profits. FMEC would then sublease or sublicense the Recyclers back to PI on a month-to-month basis, subject to most of the terms of the sublease/license between RRA and FMEC. The foregoing transactions were formally implemented in accordance with the terms set forth in the RRA Offering Memorandum.
Section 168(f)(8), in effect for the year at issue, provides in pertinent part:
(8) SPECIAL RULE FOR LEASES.—
(A) IN GENERAL.—In the case of an agreement with respect to qualified leased property, if all of the parties to the agreement characterize such agreement as a lease and elect to have the provisions of this paragraph apply with respect to such agreement, and if the requirements of subparagraph (B) are met, then, except as provided in subsection (i), for purposes of this subtitle
(i) such agreement shall be treated as a lease entered into by the parties (and any party which is a corporation described in subparagraph (B)(i)(I) shall be deemed to have entered into the lease in the course of carrying on a trade or business), and
(ii) the lessor shall be treated as the owner of the property and the lessee shall be treated as the lessee of the property.
(B) CERTAIN REQUIREMENTS MUST BE MET.—The requirements of this subparagraph are met if
(i) the lessor is—
(I) a corporation (other than an S corporation or a personal holding company (within the meaning of section 542(a))) which is not a related person with respect to the lessee,
(II) a partnership all of the partners of which are corporations described in subclause (I), or
(III) a grantor trust with respect to which the grantor and all beneficiaries of the trust are described in subclause (I) or (II),
(ii) the minimum investment of the lessor
(I) at the time the property is first placed in service under the lease, and
(II) at all times during the term of the lease, is not less than 10 percent of the adjusted basis of such property, and
(iii) the term of the lease (including any extensions) does not exceed the greater of
(I) 120 percent of the present class life of the property, or
(II) the period equal to the recovery period determined with respect to such property under subsection (i)(2).
(C) NO OTHER FACTORS TAKEN INTO ACCOUNT.—If the requirements of subparagraphs (A) and (B) are met with respect to any transaction described in subparagraph (A), no other factors shall be taken into account in making a determination as to whether subparagraph (A)(i) or (ii) applies with respect to such transaction.
Petitioners take the position that the assumed facts show that they have literally complied with all of the foregoing provisions and that such literal compliance entitles them to the benefits which flow from section 168(f)(8), because subparagraph (C) thereof and the accompanying legislative history establish that literal compliance with the provisions of section 168(f)(8) is sufficient, irrespective of the presence or absence of business purpose, economic substance, profit objective, tax avoidance motive, or other potentially adverse elements. Respondent, with one exception (see pp. 13-15, infra) does not dispute petitioners' assertion of formal compliance but argues that the transactions described above were, either in whole or in part, ‘shams‘ and that, as a consequence, such formal compliance is insufficient to permit petitioners to obtain the benefits of section 168(f)(8).
Essentially, respondent's position has as its foundation the assertion that, irrespective of the validity of petitioners' claim that the elements of business purpose, economic substance, profit objective, or tax avoidance motive are irrelevant in determining whether the lease between F & G and RRA meets the requirement of section 168(f)(8), such elements may be taken into account in determining whether the transactions which surround the lease and to which the lease was directly related were ‘shams.‘ In this context, the roles of, and arrangements between and among, PI, ECI and F & G, entities which were part of the transactional pattern before RRA, as well as those of FMEC and PI which were part of the transactional pattern after RRA, become, according to respondent, highly relevant, as do the valuations of the equipment and the nature of the financial terms of said arrangements. As a consequence of the foregoing, respondent argues that various factual questions exist which can only be fleshed out by live testimony of witnesses, and particularly cross examination. For the reasons hereinafter set forth, we agree with respondent.
On its face, subparagraph (C) and the legislative history seem to support petitioners' position. The pertinent legislative history of the Economic Recovery Tax Act of 1981, Pub. L. 97-34, 95 Stat. 172 (hereinafter the ‘1981 Act‘), is reflected in the following explanation in the Conference Committee Report (H. Rept. 97-215 (Conf.) (1981), 1981-2 C.B. 481, 492-493):
LEASING
HOUSE BILL.—Under present IRS guidelines, a transaction is characterized as a lease if (1) the lessor's minimum at-risk investment in the property throughout the lease term is 20 percent of cost; (2) the lessor has a positive cash flow and a profit from the lease independent of tax benefits; (3) the lessee does not have a right to purchase the property at less than fair market value; (4) the lessee does not have an investment in the lease and does not lend any of the purchase costs of the owner, and (5) use of the property at the end of the lease term by a person other than the lessee must be commercially feasible.
The House bill creates a safe harbor that guarantees that a transaction will be characterized as a lease for purposes of allowing investment credits and cost recovery allowances to the nominal lessor. * * *
* * *
If a transaction meets the above requirements, the transaction will be treated as a lease and the parties of the transaction will be treated as lessor and lessee as stipulated in their agreement. The following factors will therefore not be taken into account in determining whether a transaction is a lease:
(1) whether the lessor or lessee must take the tax benefits into account in order to make a profit from the transaction;
(2) the fact that the lessee is the nominal owner of the property for state or local law purposes (e.g., has title to the property) and retains the burdens, benefits, and incidents of ownership (such as payment of taxes and maintenance charges with respect to the property);
(3) whether or not a person other than the lessee may be able to use the property after the lease term;
(4) the fact that the property may (or must) be bought or sold at the end of the lease term at a fixed or determinable price that is more or less than its fair market value at that time;
(5) the fact that the lessee or related party has provided financing or has guaranteed financing for the transaction (other than for the lessor's minimum 10-percent investment); and
(6) the obligation of any person is subject to any contingency or offset agreement.