Daily Tax Update - January 24, 2012: Second Circuit Reverses District Court Again In Castle Harbour Case

SECOND CIRCUIT REVERSES DISTRICT COURT AGAIN IN CASTLE HARBOUR CASE:  Today, the US Court of Appeals for the Second Circuit issued an opinion reversing the district court decision in TIFD III-E, Inc. v. United States, 660 F. Supp. 2d 367 (D. Conn. 2009). 

  • In 2004, the district court initially held that a partnership’s allocation of the majority of its taxable income to two foreign banks, both of which were not subject to US tax, should be respected because the banks’ interests were properly treated as equity.  TIFD III-E, Inc. v. United States, 342 F. Supp. 2d 94 (D. Conn. 2004).  On appeal, the Second Circuit reversed, concluding that the banks’ interests did not constitute equity in the partnership, but were more in the nature of a secured lender’s interest.  TIFD III-E, Inc. v. United States, 459 F. 3d 220 (2d. Cir. 2006). 
  • On remand, the district court found that the foreign banks qualified as partners in the partnership under section 704(e)(1), which generally provides that a person is recognized as a partner if the person owns a capital interest in a partnership in which capital is a material income-producing factor.  The district court also ruled that, even if the banks did not qualify as partners under section 704(e)(1), penalties against the taxpayer under section 6662 were inappropriate because substantial authority supported the treatment of the banks’ interests as equity for tax purposes.
  • In the opinion issued today by the Second Circuit, the court found that the foreign banks’ interests were not capital interests within the meaning of section 704(e)(1), citing the same reasons given by the court in its prior holding that the banks’ interests were not bona fide equity participation and were more in the nature of debt. 
    • The court found that the enactment of section 704(e)(1) did not change the law so that a holding of debt could qualify as a partnership interest.
    • The court also found that the government could impose a penalty under section 6662 because the taxpayer failed to point to substantial authority supporting its position.
  • The opinion can be accessed via: http://www.steptoe.com/publications/castle-harbour-ii-opinion-ca2.pdf
  • For additional information, contact - Aaron P. Nocjar - anocjar@steptoe.com

REPUBLICANS HAVE LOW EXPECTATIONS FOR PRESIDENT’S STATE OF THE UNION ADDRESS:  Today, House Speaker John Boehner said that he expected to hear a "campaign speech" and few new ideas from President Obama’s State of the Union Address.  Boehner said, "It sounds like we’re going to see a rerun of what we’ve heard over the last three years.  More spending, higher taxes and more regulation.  The president’s policies made our economy worse."  Boehner also said that Obama shouldn’t blame Republicans for the "legislative gridlock" this Congress.  Boehner said, "If the president wants to poke the finger at Congress, let’s poke the finger where it belongs, at the Democrat-controlled United States Senate."  Boehner added, "The president has been in total campaign mode since Labor Day.  Since the campaign apparently wrote the speech, I expect we’ll hear a campaign speech."

  • Minority Leader Mitch McConnell also downplayed the President’s address, "It's hard not to feel a sense of disappointment even before tonight's speech is delivered."
  • House Budget Committee Chairman Rep. Paul Ryan said that he expects the President will unveil a "spending wish list."  Ryan said, "It’s going to be a very political speech.  We’ve heard good speeches from the president before; we’ve heard the same kind of rhetoric before; and look at the kind of results we’re getting.  So it sounds to me like it’s going to be more of a spending wish list — more borrowing, more spending and tax increases, which really disproportionately hit small businesses and manufacturers."

FINANCE TAX REFORM HEARING TO DISCUSS TAX EXTENDERS:  On January 31, Senate Finance Committee Chairman Max Baucus will convene a tax reform hearing to discuss finding a long-term solution for the tax provisions that require frequent renewal, commonly called “tax extenders,” that can build certainty among taxpayers and help create jobs. The hearing is titled “Extenders and Tax Reform: Seeking Long-Term Solutions."  The witnesses will also "evaluate tax extenders through the lens of tax reform, evaluating what role tax extenders should play in a reform process aimed at broadening the tax base, lowering rates and making the tax code more fair, efficient and simple."

  • The witnesses at the hearing will be:
    • Dr. Rosanne Altshuler, Professor and Chair of the Economics Department, Rutgers University
    • Dr. Jason J. Fichtner, Senior Research Fellow, Mercatus Center, George Mason University
    • Calvin H. Johnson, Andrews & Kurth Centennial Professor of Law, The University of Texas School of Law
    • Caroline L. Harris, Chief Tax Counsel and Director of Tax Policy, US Chamber of Commerce

TAX BILLS INTRODUCED JANUARY 23RD:

1. [112nd] H.R.3800 : To amend the Internal Revenue Code of 1986 to extend the funding and expenditure authority of the Airport and Airway Trust Fund, to amend title 49, United States Code, to extend authorizations for the airport improvement program, and for other purposes.
Sponsor: Rep Mica, John L. [FL-7] (introduced 1/23/2012)      Cosponsors (6)
Committees: House Transportation and Infrastructure; House Ways and Means
Latest Major Action: 1/23/2012 Referred to House committee. Status: Referred to the Committee on Transportation and Infrastructure, and in addition to the Committee on Ways and Means, for a period to be subsequently determined by the Speaker, in each case for consideration of such provisions as fall within the jurisdiction of the committee concerned.

2. [112nd] S.2033 : A bill to amend the Internal Revenue Code of 1986 to end the costly derivatives blended rate loophole, and for other purposes.
Sponsor: Sen Levin, Carl [MI] (introduced 1/23/2012)      Cosponsors (None)
Committees: Senate Finance
Latest Major Action: 1/23/2012 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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