Free Motion for Issuance of Letters Rogatory - District Court of Federal Claims - federal

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EXHIBIT C

2375192.1

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EXHIBIT C DOCUMENTS TO BE PRODUCED BY HOLLANDSCHE BANK-UNIE N.V. DEFINITIONS & INSTRUCTIONS A. "Document," "record" and "material" include any written, printed, typed, electronic or graphic matter of any kind or nature. Any draft or non-identical copy constitutes a separate document for purposes of these requests. The terms shall be construed to include, but shall not be limited to, correspondence, electronic mail, notes, notations, contracts, brochures, agreements, deeds, leases, letters, memoranda, checks, bank statements, reports, analyses, projections, studies, records, corporate minutes, financial statements, financial records, accounting or audit workpapers (including permanent workpapers), spreadsheets, transcripts, recordings, and all other types of written or documentary materials. B. Any copy of a document that varies in any way from the original or from any other copy of the document, whether by reason of handwritten or other notation or any omission, shall constitute a separate document and must be produced. Each document is to be produced in its entirety, without abbreviation or expurgation, and the person who made the notation identified. C. If any documents are withheld under a claim of privilege, furnish a list identifying each document for which a privilege is claimed, together with the following information and sufficient details so as to permit a court to adjudicate the validity of the claim of privilege: date, sender, recipient, type (e.g., letter, memorandum, telegram, chart, photograph, etc.), subject matter of the document, the basis on which a privilege is claimed, and the paragraph or paragraphs of this request to which the document responds. D. If any document that would have been responsive to these requests no longer exists, please state the following for each document: the date of destruction, the reason for destruction, and the person(s) responsible for the decision to destroy the document(s) and for the actual destruction of the documents. E. Responses to these requests should be made in a manner consistent with Fed. R. Evid. 902(12), Certified Foreign Records of Regularly Conducted Activity. F. The term "Con Ed" shall refer to Consolidated Edison Company of New York, Inc. & Subsidiaries, and affiliated companies, including, but not limited to, Consolidated Edison Development, Inc., Consolidated Edison Leasing, Inc., and Consolidated Edison, Inc.

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G. The term "Banc One" shall refer to Banc One Leasing Corp. its related affiliates, subsidiaries, successors, and assigns, including, but not limited to, and any person, officer, director, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. H. The term "EZH" shall refer to N.V. Electriciteitsbedrifj Zuid-Holland, its related affiliates, subsidiaries, successors, and assigns, including, but not limited to, Preussen Elektra A.G. and E.ON Benelux Generation N.V., and any person, officer, director, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. I. The term "RoCa3" shall refer to the gas fired CHP facility located in the Netherlands on the border between Rotterdam and Capelle aan den IJessel, constituting the third unit alongside two previously built units, which was owned by EZH on or about December 15, 1997. J. The term "HBU" shall refer to Hollandsche Bank-Unie N.V., its related affiliates, subsidiaries, successors, and assigns, and any person, officer, director, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. K. The term "ABN AMRO" shall refer to ABN AMRO Bank N.V., its related affiliates, subsidiaries, successors, and assigns, and any person, officer, director, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. L. The term "Credit Suisse" shall refer to Credit Suisse Financial Products, Credit Suisse First Boston, their related affiliates, subsidiaries, successors, and assigns, and any person, officer, director, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. M. The term "Lease Transaction" shall refer to the series of transactions pertaining to the RoCa3 facility as described in paragraphs 61-77, inclusive of the complaint attached hereto as Exhibit C-1. N. The term "Lease Transaction Participants" refers to the following entities: ABN AMRO Bank N.V.; Hollandsche Bank-Unie N.V.; EZH; Con Ed; Credit Suisse; Bayerische Landesbank; Wilmington Trust Co.; and ABB Leasing GmbH, and any and all affiliated businesses, successors, assigns, predecessor or successor businesses, and any person, officer, director, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. O. The term "Capstar" refers to Capstar Partners L.L.C., its related affiliates, subsidiaries, successors, and assigns, and any person, officer, director, member, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations.
Exhibit C

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P. The term "Cornerstone" refers to Cornerstone Financial Advisors L.P., its related affiliates, subsidiaries, successors, and assigns, and any person, officer, partner, accountant, lawyer, agent, or entity acting on behalf of any of the foregoing organizations. DOCUMENTS TO BE PRODUCED THE LEASE TRANSACTION 1. The documents in the files of HBU that discuss the Lease Transaction.

2. The documents in the files of HBU that discuss or pertain to its solicitation as a potential participant in the Lease Transaction. 3. The documents in the files of HBU that discuss HBU's decision to participate in the Lease Transaction. 4. The documents in the files of HBU that contain the credit and/or risk of default analyses made in conjunction with the decision to participate in the Lease Transaction. 5. The documents in the files of HBU that describe or discuss the lease options the Lease Transaction provides to Con Ed and/or EZH, including documents that address the feasibility and/or likelihood of exercise of those options. 6. The documents in the files of HBU pertaining to the negotiation of any loans to Con Ed and/or EZH in conjunction with the Lease Transaction. 7. The documents in the files of HBU evidencing the transfer of any funds by or to any of the Lease Transaction Participants in connection with the Lease Transaction. 8. The documents in the files of HBU pertaining to the loans issued by HBU in connection with the Lease Transaction. 9. The documents in the files of HBU discussing a default or missed loan repayment by either Con Ed and/or EZH.

Exhibit C

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10. The documents in the files of HBU pertaining to the accounts at HBU related to the Lease Transaction. COMMUNICATIONS 11. The letters, memoranda, notes, e-mails, and other written communication in the files of HBU exchanged by and/or between HBU and any of the Lease Transaction Participants (or their affiliates, assigns, or successors in interest) in connection with the Lease Transaction. 12. The letters, memoranda, notes, e-mails, and other written communication in the files of HBU exchanged by and/or between HBU and Capstar in connection with the Lease Transaction. 13. The letters, memoranda, notes, e-mails, and other written communication in the files of HBU exchanged by and/or between HBU and Cornerstone in connection with the Lease Transaction. 14. The letters, memoranda, notes, e-mails, and other written communication in the files of HBU exchanged by and/or between HBU and Banc One in connection with the Lease Transaction or a substantially similar transaction involving the RoCa3 facility. SIMILAR TRANSACTIONS 15. The documents within the files of HBU that discuss or pertain to any of the following lease transactions considered by the plaintiff, Con Ed, between 1997 and 2001, including the documents discussing the solicitation of HBU as a potential participant in such a transaction and the documents reflecting HBU's consideration of such transactions and decision to participate in such transactions: a. b. c. d. e. f. g. NUON lease (Netherlands); MEGA Gas and Thermal Distribution lease/leaseback (Netherlands); EPON lease (Netherlands); ENECO lease (Netherlands); ENN lease (Nethelands); ENW gas lease (Netherlands); MCN lease (United States);

Exhibit C

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h. i. j. k. l. m. n. o. p. q. r. s. t. u. v.

ELECTRABEL power plant lease/leaseback (Belgium); Diefland gas and thermal distribution lease/leaseback (Netherlands); Linz power plant lease/leaseback (Austria); UNA power plant lease/leaseback (Netherlands); EG Laufenburg lease/leaseback (Switzerland); Humber power lease/leaseback (United Kingdom); EWZ electric transmission grid lease/leaseback (Switzerland); ESAG lease (Germany); REMU lease (Netherlands); DELTA lease (Netherlands); ZETA/TEL lease (Netherlands); EDON lease (Netherlands); DEW lease (Germany); VASA lease (Germany); and SWISCO lease (Switzerland).

16. The documents in the files of HBU that discuss any other transaction similar to the Lease Transaction and/or the transaction described in Revenue Ruling 2002-69, 2002-2 C.B. 760 (copy attached hereto as Exhibit C-2), from 1996 through 2001, including the documents discussing the solicitation of HBU as a potential participant in such a transaction and the documents reflecting HBU's consideration of such transactions and decision to participate in such transactions. REGULATORY COMMUNICATIONS 17. The correspondence, communication, and reporting made to governmental regulatory authorities by HBU or on HBU's behalf in the files of HBU that pertain to or refer to the Lease Transaction and/or the financing of the Lease Transaction.

Exhibit C

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EXHIBIT C-1

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS
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CONSOLIDATED EDISON COMPANY OF NEW YORK, INC. & SUBSIDIARIES.

) ) ) ) ) ) )
)

FILED APR 1 9 - .

Plaitiff,
v.

t06- 305 T
01' No.

THE UNITED STATES,

Defendant.

) ) ) )
)

COMPLAIN
Plaintiff, Consolidated Edison Company of New York, Inc. & Subsidiares, brings this
action for a refund of federal taxes paid in connection with the Internal Revenue Service's

proposed adjustments to its federal tax return for the taxable year ending December 31, 1997.
The adjustments ar related to Plaiiitiff s investment in an electric generation facility located

outside Rotterdam, The Netherlands.

In support of its refund claim, Plaintiff alleges as follows:

JUSDICTION AND SUMRY OF ACTION
1. Plaintiff, Consolidated Edison Company of New York, Inc. & Subsidiares ("Con

Edison NY"), brings this refund

action, founded upon the Internal Revenue Code of 1986. for the

recovery of federal income tax paid by Plaintiff for the taxable year ended December 31. 1997
("the 1997 taxable year").
2. Defendant is the United States of America.
3. This Court has jurisdiction by reason of 28 V,S.C. §§ 1346(a)(1) and 149I(a)(1)

and 26 D.S.C. § 7422.

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4. On or before September 9. 1998, Con Edison NY fied a timely federal
consolidated income tax return for the 1997 taxable year with the Internal Revenue Service

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("IRS") and timely paid income taxes in the amount of $291 ,003,408.

5. Con Edison NY's name, address, and identification number appearng on the
1997 tax return ar: Consolidated Edison Company of New York, Inc. & Subsidiares; 4 Irving

Place, Room 615-S, New York, New York, 1003; and 13-5009340, respectively,
6, During the 1997 taxable year, Con Edison NY, through its subsidiares, made an

investment in an electric generation plant in The Netherlands. The plant is generally known as
"RoCa3" and is owned by N.V. Electriciteitsbedrjf Zuid-Holland ("South Holland Electric").

This transaction is hereinafter referred to as the "RoCa3 Investment."
7. On its 1997 tax return, Con Edison NY reported rental income with respet to the

RoCa3 Investment and deducted rental expense, amortization of expenses, and !nterest expense

relating to the property and indebtedness incurrd in the RoCa3 Investment, for a net loss of
$937,331.
8. The IRS, during a routine audit of Con Edison NY's tax return for the 1997

taxable year, disputed Con Edison NY's tax treatment of the RoCa3 Investment.
9. On or about September 15,2005, the IRS issued a Notice of

Prposed Adjustment

to Con Edison NY, proposing additional federal income of $937,331 for the 1997 taxable year
with respect to the RoCa3 Investment.

10. The IRS's proposed adjustments resulted in a tax increase of $328,066, increasing
Con Edison NY's federal income tax liability for the 1997 taxable year from $291,003,408 to
$291,331,474.

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i i. On or about November 3, 2005, Con Edison NY paid the proposed tax deficiency

of $328,066 to the IRS.
12. On or about December 2, 2005. Con Edison NY fied a Form I04X (Amended

U.S. Corporation Income Tax Return) with the IRS requesting a refund of erroneously paid
federal income taxes for the 1997 taxable year in the amount of $328,066. The requested refund
was solely attributable to Con Edison NY's payment of the proposed tax deficiency referrd to in

paragraphs 10 and 11 above. A true and complete copy of this claim for refund is attached as
Exhibit A.
13. By a notice of disallowance dated March 15. 2005, the IRS disallowed Con

Edison NY's claim for refund. A true and complete copy of this notice of disallowance is
attached as Exhibit B.
14. The IRS's disallowance of Con Edison NY's claim for refund was erroneous.

15. Con Edison NY requests a refund of its overpayment of $328,066 of federal tax
for the 1997 taxable year, plus interest and allowable costs.

16. No action on the claim for refund attached as Exhibit A has been taken by
Congress or any agency of the United States or in any judicial proceeding, including any in the
Tax Court of the United States.
17. Con Edison NY has timely fied this Complaint for a refund of federal taxes paid

within two years of the date of the notice of disallowance as required under 26 V.S.C. § 6532(a).
18. Con Edison NY is the sole owner of the claim included in Exhibit A and asserted

herein. and has made no assignment thereof.

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FACTAL BACKGROUND
A. Con Edison NY's Energy Busines
19. At the time of the RoCa3 Investment. Con Edison NY was a widely-held and

publicly-traded company on the New York Stock Exchange. It owned 100% of Consolidated

Edison Development, Inc. ("Con Edison Development"), which in turn owned 100% of
Consolidated Edison Leasing, Inc. ("Con Edson Leasing"). Con Edison NY has since become a

wholly owned subsidiar of Consolidated Edison, Inc. ("CEl"), which also owns Con Edison
Developmen.t as welL. Like Con Edson NY before it, CEI is widely-held and publicly-traed on
the New York Stock Exchange.

20. Con Edison NY is one of the nation's oldest and largest investor-owned energy

companies with approximately $21 billon in assets. It is a regulated public utility that was
incorporated in 1884 and currntly delivers electric service to almost all of New York City and
most of Westchester County - a service ara having a population of approximately 9 million.

Con Edison NY also supplies gas in pars of New York City and Westchester County. Con
Edison NY also owns and operates the largest district steam system in the world, providing

steam service in most of Manhattan.'

21. Pror to the 1990s, Con Edison NY. as was the case with most electrc utilities,

offered electrc service in a "bundled" format. In other words, Con Edison NY owned and
operated the generation plants that produced electrcity as well as the trasmission and

distribution systems that delivered the electricity to its customers. Con Edison NY owned gas-

fired, oil-fired, and nuclear-powered plants with a total electrc-generating capacity of 8,300

megawatts. As a regulated public utilty, all of Con Edison NY's operations were subject to
regulation by the New York Public Service Commission ("PSC").

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B. The Deregulation of Con Edisn NY's Energy Business

22. Beginning in March 1993, the PSC took a number of steps to develop a

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competitive electric industry in the state of New York. This process commenced with the PSC's

initiation of a proceeding entitled "Proceeding On Motion Of The Commission To Address
Competitive Opportunities Available To Customers Of Electric And Gas Service And Develop
Criteria .For Utility Responses" (the "Competitive Opportunities Proceeding"). The purpse of

the Competitive Opportunities Proceeding was to deregulate the electric generation plants owned

by New York State utilities and to have the price for the output of those plants determined by
market

forces rather than through regulated rates.
23. The Competitive Opportunities Proceeding was divided into two phases. Phase I

was designed to discuss, investigate, and addrss the issues involved in moving to a competitive
marketplace. Phase II, commencing in August of 1994, involved a collaborative effort between

electric utilities and other interested paries to develop models for restructuring the electric

industry within New York.
24. Phase 11 of the proess culminated with a May 1996 PSC Opinion stating the

PSC's vision for the electric utility industr and ordering Con Edison and certain other major

electric utilties in New York State to fie plans descrbing how they would restructure their
operations to bring about a competitive marketplace for, among other things, electric generation.

The Opinion "strongly encouraged" the utilties to sell their generating plants to unregulated
entities so as to facilitate the development of a competitive marketplace. The May 1996 PSC
Opinion also invited utilities to propose the corporate structures, including unregulated

subsidiaries, that would further the PSC's restructuring goals.

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C. Con Edison NY'S Response to Deregulation
25. As a result of the Competitive Opportunities Proceeding, Con Edison NY knew in

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the mid-1990s that it would be required to restructure its regulated businesses and allowed 10
expand into competitive unregulated businesses. Con Edison NY further understood that it

might be required to sell most if not all of its electrc generation plants and concluded that it
should grw its business by (among other things) investing its capital in unregulated businesses

and facilties. Con Edison NY also recognized that the PSC's rules were likely to prohibit Con
Edison NY from reinvesting in electric generation plants within New York State.
26. Consequently. Con Edison NY began to develop a strtegy that would allow it to

effectively compete in a deregulated industry through the development and growth of
unregulated businesses. Con Edison NY's strategy included, among other things. growth

through the investmeÌ1t of capital in unregulated energy-related businesses and faci lities outside
of New York State.
27. . In May 1995, Con Edison NY requested permission from the PSC to invest up to

5% (approximately $504 million) of its consolidated capital in unregulated subsidiares that

would (i) provide energy services; (ii) invest and/or paricipate in international energy
infrastructure projects; and (iii) market its technical services.
28. In July 1996, the PSC issued an order (the "July 1996 Order") which deferrd
action on Con Edson NY's May 1995 reuest, but grted

Con Edison NY authority to invest up

to $50 million in unregulated subsidiares which would invest in two of the three requested
projects: the investment and/or partcipation in international energy infrastructure projects, and
the marketing of technical services internationally. The PSC stated that these investments would

be "largely international" and could be made through "development companies, investment

funds, joint ventures, or other vehicles." In accordance with the PSC's plan to encourage
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divestiture of public utility-owned electric generation plants, the PSC prohibited Con Edison NY

from investing in any project that might provide electric energy to customers within New York
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State.
29. In response to the July 1996 Order, in October 1996 Con Edson NY formed a

new subsidiar, Gramercy Development, Inc., to carr out the investments allowed by such
Order. Gramercy Development, Inc. later changed its name to Con Edison Development.

30. In October 1996, Con Edison NY fied a rate and restrcturing plan as mandated
by the PSC. This plan also included a petition to adopt a holding company structure. Con

Edison NY's restructuring plan proposed an approach to a competitive electric generation market

that included, among other things, divestiture of its generating plants, a plan for retail
competition, and a corporate reorganization into a holding company strcture. The proposed

holding company structure would allow Con Edison to form unrgulated subsidiaries whose
investment deisions would no longer require prior PSC approval.

31. . In September 1997, the PSC and Con Edson NY ultimately agreed on a
restrcturing plan that was embodied in a Settlement Agreement (''the Settlement"). The

Settlement included, among other things, (i) a new rate plan during the period of the transition to

competition, (ii) a commitment by Con Edison NY to divest at least 50% of its New York City

electric generation plants by 2002 to unregulated third paries so as to help implement a fully
competitive market for electric generation, and (iii) authorization for Con Edison NY to form a holding company whose subsidiaries would consist of Con Edison NY and several unregulated
subsidiares, including Con Edison Development.

32. The Settlement permitted the new holding company to invest up to 5% of its

consolidated capital in unregulated subsidiares, consistent with Con Edison NY's May 1995

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request. While the Settlement replaced the July 1996 Order, pursuant to a Statement of Policy

dated July 17, 1998, the PSC imposed a prohibition against investments in electric generation

assets in New York State by Con Edison NY's unregulated affliates, albeit as a rebuttable
presumption that such investments would unacceptably exacerbate the potential for the exercise
of vertical market power.
3,3. As allowed by the Settlement. the shareholders of Con Edison NY formed CEI in

Januar 1998. As par of the transition to a holding company strctur, Con Edison NY and Con

Edison Development, as well as several other unregulated subsidiares of Con Edison NY.
became

subsidiares of CEI.
34. In 199, pursuant to the Settlement with the PSC, Con Edison NY completed the

sales of almost 6,300 megawatts of its approximately 8,300 megawatts of electrc generation
assets for an aggrgate price of $1.8 bilion. In 2000. Con Edison NY entered into a contract to
sell'

its nuclear-generating facilities, with electric generating capacity in eiicess of 90

megawatts, for an aggrgate price of $502 milion, not including fuel and other adjustments.
That transaction closed in 2001. Today, the remaining electric generation assets owned by Con

Edison NY ar held in connection with, and are ancilar to, its steam generation business.
D, The Busines Of Con Edisn Development
35. Con Edison Development was formed to take advantage of the Con Edison
grup's expertse in the constrction and operation of electrc generating plants and to pursue

energy-related investments on a world-wide basis free from regulation by the PSc.
36. Con Edison Development's initial business plan, formulated in 1997. was a long-

term plan which was designed to take advantage of the world-wide trend to deregulation and

envisioned Con Edison Development's potential growth into a worldwide integrted utility
business. However, because the growth into unregulated investments, particularly those outside
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New York State. was a new venture for the Con Edison group, Con Edson Development
adopted a gradual and measured approach to these investments.
37. As the initial step in its business plan, Con Edison Development focused on three

categories of investment: (i) development of new energy projects, such as electrc power
generation; (ii) acquisition of existing infrastrcture, including portions of operating electric, gas,
thermal, .and water utilities; and (iii) leasing portions of energy systems, such as power plants or

distribution systems. Con Edison Development also planned to market technical services
regarding the design, building, operation, and management of modem utilities.
38. Pursuant to this strtegy, Con Edison Development began to paricipate in energy-

related projects through investments operated by others, such as investments in energy funds.
In July 1997, Con Edison Development made its first energy infrastructure investment, namely a
capital commitment to provide up to $5 milion to a fund spOnsored by Energy Investors Fund

called Project Finance Fund II, LP. Project Finance II utilized the funds reeived from Con
Edison Development and other similar equity investors to invest in energy and infrastrcture

projects worldwide.

39. Con Edison Development also relied on outside consultants to locate potential

international energy infrastructure investment opportunities. In March 1997, Con Edison
Development entered into an agrment with International Energy Parners, L.P. ("ffP"). ffP
had a portfolio of international energy infrastructure investment opportunities that it was

pursuing. Pursuant to this agreement, Con Edison Development was given preferrd rights to
paricipate in certain investment opportunities identified by ffP.

40. One of the earliest opportunities presented to Con Edison Development by llP

was a minority investment in a relatively small power facility (42 megawatts) in Eastern

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Guatemala, generally known as Generadora Electiica del Norte, Limitada ("Genor"). Con
Edison Development acquired and still owns indirectly through subsidiaries a 49% interest in
Genor; the remaining 51 % is owned by local investors.

41. Con Edison Development also explored leasing investments in energy facilities.

Con Edison Development was interested in investing through leases because these investments

(i) provided highly predictable and front-loaded earnings; (ii) achieved goo to excellent
investment yields; (iii) were less risky than direct ownership of operating assets; and (iv) could be implemented more quickly than direct investments in projects requiring a long development

cycle. Leases, from Con Edison Development's perspective, also provided a means to (i) forge

relationships with utilities abroad that would allow for further opportunities in the future; (ii)
compete effectively with other domestic entities already involved in overseas investments; and

(iii) diversify risk in terms of operations and geography. Con Edison Development was
interested in potential leasing investments in Europe, Australia, and the U.S.
42. Consistent with its objective of gradually becoming a worldwide integrated utility

business, Con Edison Development searched for opportunities related to utilties undergoing

privatization in Central and South America, Europe, Southeast Asia, and the United States.
Employees of the Con Edison group spent significant amounts of time in China. Australia, the

Philippines, Mexico, EI Salvaaor, Argentina and Nicaragua pursuing energy infratructure
investments and other potential energy-related businesses (such as the marketing of technical
services).
43. Con Edson Development continued to pursue energy infrastructure investments

both inside and outside the United States until the late 1999 to early 200 time frame. At that
time. a business decision was mad to focus on energy infrastructure opportunities in the United

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States, in particular the Northeast and Mid-Atlantic states (other than New York State). This
decision was based on a number of considerations, including (i) marketplace pricing indicated

that the risks inherent in energy infrastructure investments outside the United States could no
longer bejustified in light of anticipated returns on such investments, particularly in relation to
the anticipated returns and risks on such investments inside the United States, and (ii) the

recognition that Con Edison Development and its affliates could better employ their expertise in

the energy markets and the electric utility industry inside the United States, particularly in the
Northeast and Mid-Atlantic states,
E. The RoCa3 Investment

44. During 1997, Con Edison Development developed plans and guidelines for its
future growth as an unregulated subsidiar of the Con Edison group. Con Edison Development

also began to identify possible investment prospects, including a number of leasing investments.
45. Consistent with its business plan, one of the projects identified by Con Edison

Development during 1997 as a potential leasing investment was a recently constrcted 220

megawatt gas-fired combined cycle electric generation plant outside of Rotterdam, The
Netherlands. The plant is named "RoCa3," afer its location on the bordr between Rotterda

and Capelle aan den Ussel, and is next to two previously constructed plants. The RoCa3 plant
has at all relevant times been owned by South Holland Electrc, an electric generation company
in The Netherlands that has been involved in the coordination and transport of electrical energy

in the province of Zuid-Holland since 1941, and in the production of heat and electricity since
1987.
46. At the time Con Edison Development was considering an investment in the

RoCa3 plant. The Netherlands and the European Union were also in the process of deregulating
electric generation facilities.

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47. Since Con Edison Development did not have prior experience in complex leasing

transactions, it decided to invest in conjunction with experienced market participants. In the case

of the RoCa3 Investment, Con Edison Development decided to make its investment jointly with
Banc One Leasing Corp, ("Banc One").
48. Before making a decision to proceed with the RoCa3 Investment, Con Edison

Develop,ment considered many factors. including (i) South Holland Electric's business and
creitworthiness: (ii) conditions in the energy markets for The Netherlands and Europe; (iii) the

political, legal, and economic climate of The Netherlands; (iv) the economic return and
accounting income of the RoCaJ Investment; (v) the quality of the RoCa3 plant; (vi) the
connection

between the RoCa3 plant and the Con Edison group's core business activities;; and

(vii) the terrs of the transaction. Con Edison Development also considered the potential risks

and benefits associated with its residual value interest in the RoCa3 plant. In the leasing context,

residual value refers to the remaining useful life and value of an asset at the end of the lease of
that asset.

49. Con Edison Development retained a number of consultants to assist in its review

of the RoCaJ Investment.
50. On behalf of Con Edison Development and Banc One, Duke Engineering &

Serices ("Duke Engineering") performed a comprehensive engineering review of the RoCa3
plant's technology. Duke Engineering made a site visit to inspect the RoCa3 plant. interviewed
key plant personnel. and reviewed plant documents.
51. Duke Engineering found the RoCa3 plant's design and components to be of high

quality using state-of-the-ar proven technology and rated the RoCaJ plant as "above average" in
each of the four factors that contribute to a plant's useful life. Duke Engineering further

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concluded that the RoCa3 plant complied with currnt environmental regulations; that its fuel

supply was adequate under the current purchasing agreements; and that South Holland Electric's
maintenance philosophy, practices, and facilities were better than average.
52. On behalf of Con Edison Development and Banc One, Tauw Milieu bv (''Tauw

Mileu") conducted an environmental, health, and safety assessment of the RoCa3 plant. Tauw

Milieu performed an on-site inspection, interviewed South Holland Electric personnel, and
reviewed applicable environmental

laws and regulations in conducting its review.

53. Tauw Milieu concluded that the RoCa3 plant's environmental condition was very
good and that it was in substantial compliance with all applicable environmental and health and
safety requirements.
54. On behalf of Con Edison Development and Banc One, Deloitte & Touche
perfored a comprehensive valuation assessment of the RoCa3 plant. Deloitte & Touche

conducted a physical inspection of the RoCa3 plant, interviewed South Holland Electric
personnel, and analyzed the power industry in The Netherlands and its regulatory environment,

natural gas resources, and the Dutch natural gas industry.
55. To arve at a fair market value for the RoCa3 plant, Deloitte & Touche analyzed

South Holland Electric's financial statements, the RoCa3 plant's construction expenses and
projected operating and other expenses, .comparable market transactions, and similar publicly

listed companies. Deloitte & Touche then studied historical power plant useful life data to
determine the RoCa3 plant's useful

life and residual value. Finally, Deloitte & Touche assessed

the various options available to South Holland Electrc and Con Edison Development under the
proposed Investment.

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56. Deloitte & Touche concluded that. as of December 15. 1997, the proposed closing
date for the RoCa3 Investment, the RoCa3 plant had a remaining useful

life of at least 54 years.

57. In addition to the work performed by these consultants, Con Edison Development

sent a team of its own and Con Edison NY employees to inspet the RoCa3 plant and to discuss
the plant's operations with South Holland Electric's engineers.
5,8. Based upon its extensive review of the proposed RoCa3 Investment, the board of

directors of Con Edison Development approved the RoCa3 Investment on December 10, 1997.
The major benefits of the transaction were identified as follows:
(I) Highly predictable earnings
(2) Front loaded earnings under FASB accounting rules

(3) Good to excellent investment yields
(4) Relatively low risk
(5) Tax benefits of leasing

(6) Strtegic value of leasing, i.e.. the abilty to more fully
understand the legal, regulatory, commercial and tax
environment in The Netherlands and the European Union, thus
providing the basis for better informed decisions regarding

potential future investments.

59. Con Edison expeted a pre-tax economic prfit of at least $60 millon from the
RoCa3 Investment. This pre-tax profit would provide an internal rate of return of approximately

3% to 4%.
60. Con Edson Development expected that the yield on the RoCa3 Investment for

accounting and financial reporting purposes would be in excess of 12%.
61. On December 15, 1997, Con Edison Development, through its subsidiary Con

Edison Leasing, and South Holland Electric entered into a leas and sublease of RoCa3, whereby

Con Edison Leasing leased an undivided 47% interest in the RoCa3 plant from South Holland
14

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Electric for approximately 43.2 years ("the Headlease"). and then subleased the RoCa3 plant
back to South Holland Electrc for approximately 20.1 years ("the Sublease"). Banc One entered
into a similar Headlease and Sublease for the remaining interest in the RoCa3 plant.

62. Con Edison Leasing formed a trst to enter into the various leases and other
agreements that were involved in the RoCa3 Investment. The role of the trust has no effect on

the tax treatment of the RoCa3 Investment. Thus, for simplicity, this Complaint describes the
RoCa3 Investment as if Con Edison Leasing had invested directly in the RoCa3 Investment.

63. Under the Headlease, Con Edison Leasing, as lessee. is obligated to make two
lump-sum payments of

rent to South Holland Electric. The first payment was due in 1997 at the

beginning of the Headlease, and the second payment is due in 2041 at the end of the Headlease.

The amounts of these rent payments were based on the fair market rental value of the RoCa3
plant as of December 15, 1997.

64. Con Edison Leasing funded its initial payment of rent under the Headlease by
investing $39,320,00 of its own cash and by borrowing $80,792,270.36 from Hollandsche

Bank-Unie N.V. ("Hollandsche"). Con Edison Leasing also paid $4,125,00 in transaction costs
in connection with entering into the RoCa3 Investment.
65. At the end of the Headlease in 2041, the RoCa3 plant wil have a remaining useful

life of at

least 10.8 year. This period is 20% of the 54-year useful

life of the RoCa3 plant as of

December 15, 1997, as determined by Deloitte & Touche. Tax law has long recognized that if an
asset has a residual life at the end of the lease of 15% of the asset's original useful

life, then the

lease qualifies as a "true lease" for federal income tax purpses.
66. Deloitte & Touche also determined that at the end of the Headlease, the RoCa3

plant will have a remaining residual value of at least 20% of the fair market value of the RoCa3

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plant as of December 15, 1997. Tax law has long recognized that if an asset has a residual value
at the end of the lease of 15% of the asset's original cost, then the lease qualifies as a "true lease"
for federal income tax purpses.

67. The Sublease set forth the terms under which Con Edison Leasing leased its
undivided interest in the RoCa3 plant to South Holland Electric. Events of default under the
Subleas~ include South Holland Electric's failure to make rent payments, declaration or filing of

bankruptcy, failure to maintain RoCa3, and failure to maintain appropriate insurance. Con
Edison Leasing's remedies upon a default include causing South Holland Electrc to return Con
Edison Leasing's interest in the RoCa3 plant.
68. At the end of the 20.1.year term of the Sublease from Con Edison Leasing to

South Holland Electric, South Holland Electrc has an option to purchase Con Edison Leasing's remaining 23.1-year interest in the RoCa3 plant at a fixed price. Deloille & Touche determined
that the price of South Holland Electric's purchase option will exceed the fair maket value of the

23.1.year interest it would obtain and, therefore, South Holland Electric is not likely to exercise
that option.
69. If South Holland Electrc doe not exercise its purchase option. then Con Edison

Leasing. as lessee, has the opportunity to ear additional income by (i) claiming possession of its

interest in the RoCa3 plant for the remaining 23.1 year of the Headlease; (ii) subleasing the
RoCa3 plant to a third pary for the remaining 23. I years; or (iii) renewing the Sublease with

South Holland Electric for an addtional 16.5 year through the exercise of a "Renewal Option."

70. Deloitte & Touche determined that the fixed price of the rental payments due
from South Holland Electrc under Con Edison Leasing's Renewal Option wil be below the fair

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market rental value for a lease of a similar facilty during the 16.5 year renewal term and,

therefore, Con Edison Leasing is not likely to exercise its Renewal Option.
7 I. If South Holland Electric does not exercise its purchase option and Con Edison

Leasing does not exercise its Renewal Option, which Deloitte & Touche indicated is the most
likely outcome, then Con Edison Leasing wil have possession of its interest in the RoCa3 plant
for the 2.3.1 years remaining under the Headlease, which is 53.5% of its 43.2-year term. If Con
Edison Leasing does exercise its Renewal Option, then at the end of the Renewal Option, Con

Edison Leasing wil have possession of its interest in the RoCa3 plant for the 6.7 years remaining

under the Headleas, which is 15.5% of its 43.2-year term. In either case. Con Edison Leasing
will have a

residual interest in the RoCa3 plant that is grater than 15% of the Headlease term.

The value of Con Edison Leasing's residual interest in the RoCa3 plant is also expected to be
significantly higher than i 5%.
72. At the end of either (i) the Sublease in 2017 or Oil the Renewal Option term in

2034. as applicable, South Holland Electric is obligated to return to Con Edison Leasing its
undivided interest in the RoCa3 plant in its original condition, ordinary wear and tear excepted,
and the plant must pass certain speified redelivery acceptance tests. Duke Engineering

anticipated that the plant would meet the requirements stated in the transaction and expeted that

the plant would be in similar or better operational condition as compared to equivalent power
plants because of the high quality of the original equipment and design features.
73. South Holland Electric is the operator of the RoCa3 plant during the term of the
Sublease. Con Edison Leasing, Banc One, and South Holland Electric entered into agrements

providing for the operation and maintenance of RoCa3 upon the expiration of the Subleases to
South Holland Electric. Pursuant to these agreements, Con Edison Leasing and Banc One have

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the right to remove South Holland Electric as the operator of the RoCa3 plant upon the
expiration of the Subleases.
74. In entering into the RoCa3 Investment. Con Edison Leasing assumed a significant

amount of risk, includil)g the risk that South Holland Electric would not be able to make or
would refuse to make its required rent payments. the risk that South Holland Electric would go
bankrpt, and the risk that the leased equipment would be damaged or otherwise suffer an

unanticipated diminution in value.
75. As lessor under the Headlease. South Holland Electrc assumed the risk that Con

Edison Leasing would be unable to make the second lump-sum rent payment due under the terms
of the Headlease.
76. Hollandsche, Con Edison Leasing's lender. assumed the risk that Con Edison

Leasing would be unable to make the required loan payments.
77. As is typical in conservatively strctured transactions, the RoCa3 Investment

included a number of features that were designed to reduce the financial risks assumed by the
parties. These features included collateral deposits, pledges of collateral, and an early buy-out

option. However, these features did not and could not insulate Con Edison Leasing or the other
paries from all risks presented by the RoCa3 Investment.

COUNT ONE: THE IRS'S PROPOSED TAX TREATMENT

OF THE RoCa3 INESTMNT WAS ERRONEOUS
A. The Headlease and Subleae Between Con Edison Leaing and South

Holland Electric Should Be Respeted Becaus Con Edison Leaing

Retains Suffcient Benefts and Burdens of Ownership With Respect To Its Leahold Investment in the R0c Plant

78. Con Edison NY reincorporates by reference and re-alleges the facts set forth in
paragraphs 1 through 77 above.

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79. Generally, a lease is an arrangement where one party (the "lessor") has a property

interest in an asset or a tight to use an asset and provides possession and the right to use that
asset to another party (the "lessee") for a fixed period of time in exchange for payment of rent.
80. For federal income tax purposes, a lease arrangement will be respeted as a "true

lease" (instead of a loan or other form of transaction) if the lessor retains sufficient benefits and

burdens. of ownership. This determination generally depends on whether the lessor has a
meaningful equity investment in the asset throughout the entire lease term and a meaningful

residual interest in the asset at the end of the lease term. Decades of judicial authority have

found a 15% residual value to be meaningfuL. Thus, if at the end of the lease terr, the asset is
expeted to have a remaining useful life (and remaining value) equal to at least 15% of its

original estimated useful life (and original cost), the arrangement will be respected for tax
purposes as a true lease or sublease, as the case may be.

8 L The lessor in a lease transaction can use either equity or a combination of equity
and debt to finance the purchas or lease of the asset. When a lessor uses non-recourse debt to

finance the purchase or lease of the asset. the transaction is called a leveraged lease.
82. In a typical leveraged lease transaction, an investor purchases or leases an asset

and borrws money to finance some or all of the investment. The investor then leases the asset

to a third pary who uses the asset in its business operations. In this typ of transaction, it is a
common business practice for the investor to lease the asset to the pary which originally sold or
leased it to the investor. i.e., a "sale-leaseback" or "lease-leaseback" trnsaction.
83. In leveraged lease transactions the lessor wil earn profits from the rent payments

it reeives and from the residual value of the property once the lease expires. Additionally, a

leveraged lease transaction will often provide a benefit in the form of a limited tax deferrL. in

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which an amount of federal income tax that would otherwise have been paid one year is deferred

until a later year. This is so because leveraged lease transactions often produce losses for federal

income tax purpses in the early years of the transaction due to depreciation, rental expense.
amortization, and interest deductions. These losses are offset by profits or gains for federal

income tax purses in the later years of the transaction. This tax deferral effect of leveraged

lease transactions has been approved by the courts and the IRS for many year.
84. The RoCa3 Investment, entered into by Con Edison Leasing and South Holland

Electric on December 15. 1997, was a leveraged lease transaction beause a portion of Con
Edison

Leasing's investment was financed through a non-recourse loan from Hollandsche.
85. The Headlease from South Holland Electric to Con Edison Leasing and the

Sublease from Con Edison Leasing to South Holland Electric both qualify as leases for federal
tax purpses because in each case (i) the leases transferrd possession of the property interest in

return for the obligation to pay rent and provided for transfer of possession back to the lessor in

the event of a default, and (ii) the lessors' return depended upon the residual value of the
property at the end of the respective lease.
B, Con EdIson NY Properly Report the RoCa3 Investment on Its 1m

Tax Return
86. Con Edison NY properly reported income and claimed deductions on its 1997 tax

return in connection with the RoCa3 Investment.
87. As lessee under the Headlease, Con Edison Leasing is required to make rent

payments to South Holland Electric. Con Edison Leasing accrued rental deductions on its i 997
tax return for these payments in accordance with the terms of the Headlease.

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88. As lessee under the Sublease, South Holland Electric is required to make rent
payments to Con Edison Leasing. Con Edison Leasing accrued income on its 1997 tax return

with respect to these payments in accordance with the terms of the Sublease.
89. Section 4.67 of the Internal Revenue Code generally reuires rent to be allocated
to tax periods in accordance with the terms of a lease, except as otherwise required by section

467. Section 467 also authorizes the IRS to issue regulations regarding the allocation of rental

payments to tax periods. Although section 467 was enacted in 1984, the Treasury Deparment
did not promulgate final regulations pursuant to section 467 until 1999, that is, nearly 15 years
later.
90. On June 3, 1996, before Con Edison Leasing entered into the RoCa3 Investment,

the Treasury Department issued "proposed" regulations under Section 467 of the Internal

Revenue Code (the "Proposed Section 467 Regulations"). These regulations. however, were not
made final until May 18. 1999 (the "Final Section 467 Regulations").
91. Certain provisions of the Proposed Section 467 Regulations could have altered the

method in which Con Edison Leasing reported the rental expense and income resulting from the

Headlease and Sublease, respectively, on its 1997 income tax return, but these provisions were
not applicable to leases that were entered into prior to the Final Section 467 Regulations as long

as the allocation of rent agreed to by the. parties was not designed for the principal purpose of
avoiding income tax.
92. Both the Proposed Section 467 Regulations and the Final Section 467 Regulations

contain a "safe harbor" provision. This provision states that the avoidace of income tax will not
be considered to be a principal purpose for the method of allocating rent agreed to by the parties

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if the rent allocated to each calendar year is no more than 10% higher or lower than the average
rent for all calendar years under the lease.
93. The rent allocation contained in the Headlease and Subleas met the 10% "safe

harbor" rule that is contained in the Prposed Section 467 Regulations and the Final Section 467
Regulations. Under the IRS's own rules, the rent allocation methodology in each of the leases is

not considered to be for the principal purpse of avoiding income tax. Because the allocations of
rent under the Headlease and Sublease satisfied the 10% safe harbor provision, Con Edison NY's

reported rental expense deductions and rental income from the RoCa3 Investment as reported on

its 1997 income tax return complied with the Proposed Section 467 Regulations and the Final
Section 467 Regulations.

94. Con Edison NY properly reported deductions for accrual of interest expense with
respet to its loan from Hollandsche.

95. Con Edison NY properly reported deductions for the amortization of transaction
costs incurr with respect to the RoCa3 Investment.

COUNT TWO: CON EDISON NY IS ENTITLED

TO A REFU OF TAXES
96. Con Edison NY incorporates by reference and re-alleges the facts set fonh in
paragraphs 1 through 95 above.
97. Pursuant to 26 U.S.C. §§ 61 and 467. Con Edison NY included a total of

$399,963 in rental income on its income tax return for the 1997 taxable year with respet to
South Holland Electrc's obligation to pay rent under the terms of the Sublease.
98. Pursuant

to 26 U.S.C. §§ 162(a)(3), 167, and 467, Con Edison NY deducted a

total of $1,082.350 in rental expense and transaction costs on its income tax return for the 1997

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taxable year as a result of the rental payments made to South Holland Electric under the terms of,
and in amortization of transaction costs relating to. the Headlease.
99. Pursuant to 26 U.S.c. § 163, Con Edison NY deducted a total of $254,944 in

interest expense on its income tax return for the 1997 taxable year as a result of interest accruing
on the bank loan it obtained to fund a portion of its rental payments under the Headlease.
100. The IRS proposed to disallow all of Con Edison NY's deductions for (i) rental

payments required 10 be made to South Holland Electric under the terms of the Headlease, (ii)
the interest payments required to be made to Hollandsche. and (iii) the amortization of

trnsaction costs.
101. The IRS also proposed to reduce Con Edison NY's rental income by the amount

of rental payments due from South Holland Electric under the Sublease.
102. These proposed adjustments had the effect of recalculating Con Edison NY's

taxable income for the 1997 taxable year as if Con Edison NY had not engaged in the RoCa3
Investment.
103. The changes proposed by the IRS increased Con Edison NY's taxable income for

the 1997 taxable year by a net amount of $937,33 1.
104. As a result of this proposed increase in taxable income, the IRS demanded an

additional $328,066 in federal income tax from Con Edison NY for the 1997 taxable year.

105. On or about November 3, 2005. Con Edison NY paid to the IRS at Chicago,

Ilinois the proposed tax deficiency of $328,066.
106. The adjustments made by the IRS to Con Edison NY's taxable income for the

1997 taxable year were contrar to controllng tax law, and Con Edison NY is entitled to a

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complete refund of the $328,066 of federal income taxes erroneously paid with respect to the
RoCa3 Investment.

DEMAND FOR JUDGMENT
WHEREFORE, Con Edison of NY respectfully requests that this Court enter judgment in

its favor and against the Defendant in the amount of $328.066, plus interest and costs allowed by
law, and provide such other relief as the Court may deem just.

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Respectfully submitted this 18th day of April, 200.
Respectfully Submitted,

Thomas C. Duram

~t.)J~

MAYER, BROWN, ROWE & MAW LLP 71 South Wacker Drive

Chicago, Ilinois 6066
Tel: (312) 701-7216

Fax: (312) 706-9187

tdurham ~maverrownrowe.com
Attorney for Plaintiff

OF COUNSEL:
David P. Abbott

Brian P. Trauman MA YER, BROWN, ROWE & MAW LLP 1675 Broadway New York, New York 10019
Tel: (212) 506-2500 Pax: (212) 262-1910

Nicole Bielawski

MAYE, BROWN, ROWE & MAW LL
1909 K Strt, N.W.

Washington, D.C. 202 i 7

Tel: (202) 263-300
Pax: (202) 263-3300

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EXHIBIT C-2

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Internal Revenue

Bulletin No. 2002-44 November 4, 2002

(Q li ~ ~ ~~ 0 (f
HIGHLIGHTS

OF THIS ISSUE
Tl syopss are intnded only aa aida tllhe reder in
idnlilhe subjec mltr covered, They may not be reied upon as autoriti Intrpretaons.

SPECIA ANNOUNCEMENT
Anouncemen 2002-101, pap 80, This announcement solicts applications from potential partners to participate in the 2003 IRS Individual e-file Pertnership Proram. The partnership opportunities are a result of RRA 98. which reuire the IRS to receive 80 percnt of all reurns elecronically by 2007. RRA 98 authoried the IRS
Commissioner to proot the benefts of and encourae the

December 2002. This ruling also provides a summary of the bond

factor amounts for dispositons occurrng during the period January through September 2002.

REG-112306, paie 767,
Proposed regulations under section 1296 of the Code contain
procedures for certin United Staes persons holding market.

able stock in a passive foreign investent company (PRC) to elect

use of e-file services through pertnerships with various en-

tities that ofer low cost ta preparetlon and alecronic fil-

mark to market treatment for that stock. A public hearing is scheduled for November 6. 2002.

ing of income tax returns for qualifed taxpayers. Those
applicants that are accpted as partners will have a Iink(s) and descriptlon(s) of their services place on the IRS web-

REG-150313-1, paie 777,
Proposed regulations under sections 302. 304. and other sec.

site at ww.irs.gov (IRS e-file Partners Page).

tions of the Code provide guidance regarding the treatment of
the basis of redeemed stock when a distributon in redemption of such stock is treated as a dividend. The regulations also pro-

INCOME TAX
Rev. Rul. 2002-69, paie 760,

vide guidance regarding certain acquiSitions of stock by reo
lated corporatons that are treated as distributons in redemption of stock. A publiC hearing is scheduled for February 20. 2003.

Business expenses; Intrest; leaae-Iri/leaae-out transactions. A taxpayer may not deduct currently. under sectons 162 and 163 of the Code. rent and Interest paid or incurred in con. nection with a lease~n,ease-out (L1LO) transaction that prop-

Notice 2002-70, paie 765,
This notice alert taxpayers and their representatives about cer.
tain reinsurance transactions intended to shift income to off.

erly is characterized as conferring only a future interest in

shore related companies purported to be insurance companies
that are subject

propert. Rev. Rul. 99-14 modifed and superseded.
Rev. Ru.. 2002-71, paie 763.
Notonal principal contct (NPC), This ruling provides guid-

to lite or no U,S. federal income tax. These trans-

actions often do not generate the federal tax benefits that taxpayers claim are allowable for federal income tax purposes. This notice also alerts taxpayers. their representatives. and promot-

ance on the timing of recognition of gain or loss on the termination of a notional principal contract that hedges a portion of
the term of a debt instrument issued by the taxpayer.

ers of these transactions, to certin reportng and record keeping obligations and penalties that they may be subject to with respect to these transactions.
Announcement 2002-100, paie 799. This document contins corrections to proposed regulations un-

Rev. Rul. 2002-72, paie 759,
Low-income housini credit; sasfctry bond; "bond tac-

tor" amounts for the period Octber throup December
202. This ruling announces the monthly bond factor amounts

der section 1503(d) of the Code (REG-I06879-QO. 2002-34
I.R.B. 402) relating to the event that require the recapture of dual

to be used by taxpayers who dispose of qualified low-income buildings or interests therein during the period October through

consolidated losses.

Findini List belin on paie ii.
Index for July lhrough Octber belins on paie v.

$" ~ Dement of the Treasury

ldt/I Internl Revenue Sece

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Table 1 (oonl'd)

Rev. Rut 2002-72 Monthly Bond Factor Amounts for Dispositions Expressed As a Percentage of Total Credits
Calenda Year Building Placed in Service
or, if Section 42(f)(1) Election Was Mae.
the Succeding Calendar Year

Month of Disposition
Jan '02 Feb '02

1999

200
70.98 70.77 70.S8 70.40 70.24 70.09 69.94 69.81 69.68 69.57 69.4S 69.3S

2001

2002
72.SS 72.SS 72.5S 72.SS 72.SS 72.SS 72.5S 72.SS 72.SS 72.SS 72.SS 72.5S

Mar '02 Apr '02 May '02 Jun '02 Jul '02 Aug '02
Sep '02

Oct '02 Nav '02 Dec '02

70.13 69.92 69.73 69.5S 69.38 69.21 69.0S 68.90 68.76 68.62 68.49 68.37

72.28

7205
71.84 71.67
71.S1

71.37

71.is

71.4
71.04 70.94 70.86 70.78

For a list of bond factor amunts appli-

cable to dispositions ocurg dwig other
calenda yea. se: Rev. Rul. 98-3. 1998-1

Rev, Rul, 2002-69
ISSUE

the Healeas for the first 20 yeas is substantially the sam as FM's right to pos.

session under the Sublea for the prma
term.

C.B. 248; Rev. Rut 2001-2. 2001-1 C.B.

2S5; and Rev. Rut 2001-53. 2001-2 C.B.
488.

Maya taxpayer deduct currently. under §§ 162 and 163 of the Internal Rev-

DRAG INORMATION
The pricipa author of ths revenue nil-

enue Coe. ret and intest pad or incur
in connection with a "Iease-in/lease-out" ("LILO") transaction?
FACTS

The Headlease reuires X to mae two rental payments to FM during its 4Oyea term: (I) an $89 millon prpayment at the
beginning of year I; and (2) a postpay-

ment at the end of year 40 that has a discounted prsent value of $8 milion. For
federal income ta purses. X and FM al-

ing is Grgory N. Doran of the Ofce of
Associat Chief Counsel (Passthughs and

Speial Industres). For furher information regarding this revenue ruling, contact Mr. Doran at (202) 622-304 (not a
toll-fr call).

locat the prpayment ratably to the first 6

X is a U.S. corpration. FM is a foreign municipaity thai ha histocally owned

yea of the Healea an th futre value
of the postpayment ratably to the remaining 34 years of the Headlease.

and used cenain propert. As of 1997, it is
estimated that the properly has a remaining useful

life of 50 year and a fair mar-

Section 162.-Trade or
Business Expenses
26 CFR 1./62-11: Rentals.
(Also § /63; 1.163-1.)

ket value of $100 milion. BKI and BK2 ar

banks. None of these four parties is related to any of the others.
On Januar I, 1997. X and FM entered

The Sublea reuire FM to mae fixed. annual rental payments over both the prmary term and, if exercised. the put reo newal term. The fixed, annual payments
dwing the put renewal te ar equa to 90

percent of the amounts that (as of January I, 1997) are projected to be the fair

Business expenses; interest; lease-in!
leas..nt transactions. A tapayer may not deduct curntly, unde setions 162 and 163

into a LILO transaction under which FM leased the property to X under a "Headlease," and X immediately leased the prpert hack to FM under a "Sublease." The

maret value rental amounts for that tenn.

To parially fund the $89 milion Healease prepayment, X bolTWS $S4 milion
from BKI and $6 milion from BK2. Both

tenn of the Headlease is 40 years. The pr-

of the Code, rent or interest paid or incurr in connection with a leas-inlease-

mary term of the Sublease is 20 years. Moreover. as described below. the Subleae also may be renewed for a tenn of 10 year ("put renewal tenn") at the option of

out (LILO) transaction that properly is
charcteri as conferrng only a futu interest in property.

loans ar nonreurse, have fixed interest rates, and provide for annual debt service payments that fully amrtze the loans over the 20-year primary term of the Sublease.

X. X's right 10 possess the property under

The amount and timing of the debt ser-

November 4, 2002

760

2002-4 I.R.B.

Case 1:06-cv-00305-MBH

Document 23-4

Filed 04/05/2007

Page 36 of 79

vice payments mirrr the amount and tim-

nated, is substatially reuced through the
deposit arangement. As a result, neither

Having economically defeased both its
rental obligations unde the Subleae and its fixed-paymeni unde the fixed-paymeni

ing of the Sublease payments due during the primar term of the Sublease. The remaining $29 millon of the Healea prepayment is provided by X.

bank requires an independeni source of
funds to make the loans, or bears signifi-

opon, FMkee the remaining poon of

Upon reeiving the $89 milion Healease prepayment, FM deposits $54 million into a desit account with an afliate of BKI and $6 million into a deposii account with an afiate of BK2. The depoits with the afliate of BKJ an BK2 ea
BKJ and BK2. FM di the affliat of

canl risk of nonpayment. In short. during the primary Sublease term, the transac-

the Headlea pryment as its return on

the trsaon. If FM do not exerse the

tion is charrize by reiproal and circular obligations thai offset one another.

Ai the end of the Sublea prma te.
FM has a fixed-payment option to pur-

fixed-payment opon and X exercises ihe PUi renewal option, X can reuire FM to

purhas a let of crt guteing the
payment option.
For ta purpse. X claims dedctions
for intet on the loas and for the allo-

interet at the sae rate as the loas frm righi 10 use the property beyond the Sublea prima term subjeci 10 the obligaBKJ 10 pay BKJ annual amounts equal to

chas frm X the Healease residual (the
tion 10 make the rent postpayment) for a
fixed exerise prce equal to 105 pet of

put real rets. If FM do DOt obtn the let of crt, FM must exerse the fixed-

90 percent of FM's annual rent obligation under the Subleae (that is, amounts
suffcient to satisfy X's debt service obli-

cat rents on the Healea. X include in

the amount that (as of Januar I. 199) is

gr inco the rets reived on the Sublea. If ihe fixed-payment option is exer-

gaiion to BKJ). The paries Ireal these
amounts as having ben pad frm the af-

projec to be the future fair maket value
of the Heaeae reidual. If FM exerises
the option. the trsaion is ieinate at

cise, X also include the option prce and

repts rent deuctons tan durng the

filiate to FM, then frm FM to X as rental payments, and finally frm X 10 BKJ as debi service payments. In addition, FM
pledges the depsit accounl to X as secu-

th point, and X reves th exeise prce
of the option and is not reuire to make

primar Sublease term that are attributable 10 the potpyment it is no longer require to make.

rity for FM's obligations under the Subleae, while X, in tur, pledges its interet

any portion of the postpayment due under ihe Headlease. If FM does not exercise the option, X may eleci to (1) use the
prpert itslf for the remaining te of the

LAW AND ANALYSIS

in FM's pledge to BKJ as sec