Free Post Trial Brief - District Court of Federal Claims - federal

Case 1:06-cv-00305-MBH

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No. 06-305 T (Judge Marian Blank Horn)

IN THE UNITED STATES COURT OF FEDERAL CLAIMS

CONSOLIDATED EDISON COMPANY OF NEW YORK, INC. & SUBSIDIARIES Plaintiff v. THE UNITED STATES Defendant

UNITED STATES' REPLY BRIEF

NATHAN J. HOCHMAN Assistant Attorney General DAVID GUSTAFSON STEVEN I. FRAHM DAVID N. GEIER JOSEPH A. SERGI ADAM R. SMART KAREN M. GROEN Attorneys Tax Division Department of Justice Washington, D.C. 20044 (202) 616-3448 (telephone) (202) 307-0054 (facsimile)

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TABLE OF CONTENTS TABLE OF AUTHORITIES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . v INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 POST TRIAL RULINGS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 I. II. BB&T Corp. v. United States, Fourth Circuit . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Other Leasing Cases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 A. B. Fifth Third Bancorp v. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 AWG Leasing v. United States . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14

RESTATEMENT OF FACTS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 I. CED Did Not Bear Risk From the RoCa3 LILO Transaction . . . . . . . . . . . 18 A. There is a Lack of Market Risk to CED from Entering into the RoCa3 LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 The Structure of the Transaction Eliminates Credit Risk to CED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 The HBU Loan Does Not Pose Any Risk to CED's Return . . . . . . . . . . 24 The Possibility of a Premature Termination Does Not Create Risk to CED . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 The Existence of Other Remedies Does Not Imbue the Transaction With Risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 Plaintiff Erroneously Claims There Could Be a Final Basic Rental Payment Shortfall that CED Would Have to Pay . . . . . . . . . . . . . . . . . . 29 CED Even Protected Itself from Pre-Closing Risk . . . . . . . . . . . . . . . . . 32 CED's Internal Evaluation of the RoCa3 LILO Transaction Confirms the Lack of Risk Facing CED . . . . . . . . . . . . . . . . . . . . . . . . . 32 Inappropriate Focus on Risk to EZH . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 i

B.

C. D.

E.

F.

G. H.

I.

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II.

CED's Primary Purpose for Entering into the RoCa3 LILO Transaction was Tax Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 A. CED Entered the RoCa3 LILO Transaction for the Tax Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Plaintiff's Accounting Benefits Were Driven by the Tax Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 36 There Was not a Reasonable Expectation of Residual Upside From the RoCa3 LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38 1. CED Understood that the Transaction is Designed so that the Purchase Option Would be Exercised . . . . . . . . . . . . . . . . . . 38 The Transaction Contains Numerous Disincentives that Temper the Possibility of the Retention Option . . . . . . . . . . . . . 40

B.

C.

2.

D.

Plaintiff Has Failed to Prove that Other Than Tax Benefits Plaintiff Had a Legitimate Reason For Its Entry Into the RoCa3 LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43 1. 2. 3. Purported Entree into Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . 48 Core Competencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50 Purported Public Relations Benefits . . . . . . . . . . . . . . . . . . . . . . 53

III.

Plaintiff Mischaracterizes its Involvement and Use of the Due Diligence Conducted in Connection with the RoCa3 LILO Transaction . . . . . . . . . . . 53 A. Plaintiff had Limited Involvement in Securing the Due Diligence . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53 Plaintiff's Assertions as to the Reasons for the Due Diligence are Misleading . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55 Plaintiff's Reliance on the Deloitte Appraisal is Misplaced . . . . . . . . . 59 1. Deloitte Ignores the Pre-Funded Nature of the Sublease Purchase Option . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 60 Deloitte Ignores the Non-Recourse Nature of the Final Basic Rent Payment . . . . . . . . . . . . . . . . . . . . . . . . . . . 61 ii

B.

C.

2.

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3.

CED Did Not Actually Rely on the Deloitte Appraisal in Entering the Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 65

IV.

Other Areas in Which Plaintiff has Ignored or Misrepresented the Facts of the Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 A. B. C. EZH Operated the Facility as Before . . . . . . . . . . . . . . . . . . . . . . . . . . . 67 CED Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 68 Summary of Experts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

ARGUMENT . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 I. II. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72 Substance Over Form vs. Economic Substance . . . . . . . . . . . . . . . . . . . . . . . 73 A. III. The Doctrines . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74

Substance Over Form . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 78 A. B. CED Did Not Acquire a Current Leasehold Interest in the Facility . . . 78 Frank Lyon Supports the Government's Position, Not Plaintiff's . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 85 The HBU Loan Should be Disregarded . . . . . . . . . . . . . . . . . . . . . . . . . 87 The Court Should Collapse Reciprocal Rights and Obligations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Plaintiff's Attempt to Draw Distinctions Between Legal and Economic Defeasance is Without Merit . . . . . . . . . . . . . . . . . . . . . . . . . 94 At Least During the Term That They Overlap, the Lease and Sublease Are Not True Leases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96

C. D.

E.

F.

IV.

Economic Substance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 A. Plaintiff's Transaction Should be Disallowed Under the Economic Substance Doctrine . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98

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B.

There Was no Reasonable Expectation to Achieve Any Net Economic Benefit from the RoCa3 LILO Transaction . . . . . . . . . . . . . . . . . . . . . . 104 1. Plaintiff Could Not Reasonably Expect to Achieve Any Net Economic Benefit from the Cash Flows from the RoCa3 LILO Transaction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104 Plaintiff Could Not Reasonably Expect to Achieve Any Net Economic Benefit From Credit Fluctuations or Residual Value . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

2.

C.

Plaintiff Did Not Enter this Transaction for a Valid Non-Tax Business Purpose . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 1. Plaintiff Could Not Obtain an Accounting Benefit Without the Tax Benefits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 116 Plaintiff Did Not Enter this Transaction for Any Other Non-Tax Reason . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

2.

V.

Irrelevant Authority Cited by Plaintiff . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127

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TABLE OF AUTHORITIES FEDERAL CASES ACM P'ship v. Comm'r, 157 F.3d 231 (3d Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75, 105 Aderholt Specialty Co. v. Comm'r, 50 T.C.M. (CCH) 1101 (1985 . . . . . . . . . . . . . . . . . . . . . 7, 82 Alstores Realty Corp. v. Comm'r, 46 T.C. 363 (T.C. 1966) . . . . . . . . . . . . . . . . . . . . . . . . . 7, 124 Am. Elec. Power v. United States, 136 F. Supp. 2d 775 (S.D. Ohio 2001), aff'd 326 F.3d 737 (6th Cir. 2003) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Assoc. Wholesale Grocers, Inc. v. United States, 89-2 U.S. Tax Cas. (CCH) ¶ 9,518 (D. Kan. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 AWG Leasing Trust v. United States, 2008 WL 2230744 (N.D. Ohio May 28, 2008) . . . . Passim Ballagh v. United States, 166 Ct. Cl. 191 (1964) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 Basic, Inc. v. United States, 212 Ct. Cl. 399 (Ct. Cl. 1977) . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 BB&T Corp. v. United States, 2007 WL 37798 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim . BB&T Corp. v. United States, 523 F.3d 461 (4th Cir. 2008) . . . . . . . . . . . . . . . . . Passim

Benedict v. United States, 881 F. Supp. 1532 (D. Utah 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Big "D" Dev. Corp. v. Comm'r, 30 T.C.M. (CCH) 646 (1971) aff'd per curiam, 453 F.2d 1365 (5th Cir.), cert. denied, 406 U.S. 945 (1972) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Black & Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006) . . . . . . . . . . . . . . . 108, 124 Blue Flame Gas Co. v. Comm'r, 54 T.C. 584 (1970) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Bridges v. Comm'r, 39 T.C. 1064 aff'd 325 F.2d 180 (4th Cir. 1963) . . . . . . . . . . . . . . . . . . 88, 90 Buckeye Power v. United States, 38 Fed. Cl. 283 (Ct. Cl. 1997) . . . . . . . . . . . . . . . . . . . . . . . 123 Bussing v. Comm'r 88 T.C. 449, 451-55, reconsideration denied, 89 T.C. 1050 (1987) . . . . . . 92 In re CM Holdings, 301 F.3d 96 (3d Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Coltec Indus., Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006) . . . . . . . . . . . . . . . . . Passim v

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Comm'r v. Trans. Trading & Terminal Corp., 176 F.2d 570 (2d Cir. 1949), cert. denied, 338 U.S. 955 (1950) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Danielson v. United States, 378 F.2d 771 (3d Cir.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 Deputy v. DuPont, 308 U.S. 488 (1940) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 Douglas v. Willcuts, 296 U.S. 1 (1935) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Dow Chemical v. United States, 435 F.3d 594 (6th Cir. 2006) . . . . . . . . . . . . . . . . . . . . . . Passim Estate of Thomas, 84 T.C. 412 (1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Felcyn v. United States, 691 F. Supp. 205 (C.D. Cal. 1988) . . . . . . . . . . . . . . . . . . . . . . . . . 89, 90 Frank Lyon Co. v. United States, 435 U.S. 561 (1978) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Gefen v. Comm'r, 87 T.C. 1471 (1986) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77, 94 Goldstein v. Comm'r, 364 F.2d 734 (2d Cir. 1966) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 Greenberg's Express, Inc. v. Comm'r, 62 T.C. 324 (1974) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 Greenfield v. Comm'r, 44 T.C.M. (CCH) 1487 (1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Gregory v. Helvering, 293 U.S. 465 (1935) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75 Griffin Paper Corp. v. Comm'r, T.C. Memo 1997-409 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83 H.J. Heinz Co. v. United States, 76 Fed. Cl. 570 (2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Halle v. Comm'r, 83 F.3d 649 (4th Cir. 1996) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88 Helvering v. Fuller, 310 U.S. 69 (1940) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Hines v. United States, 912 F.2d 736 (4th Cir. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Illes v. Comm'r, 982 F.2d 163 (6th Cir. 1992) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 Jade Trading, LLC v. United States, 80 Fed. Cl. 11 (2007 . . . . . . . . . . . . . . . . . . . . . . . . . Passim Johnson v. United States, 11 Cl. Ct. 17 (1986) (Johnson I) . . . . . . . . . . . . . . . . . . . . . . . . 39, 99 Johnson v. United States, 32 Fed. Cl. 709 (1995) (Johnson II) . . . . . . . . . . . . . . . . . . . . . . 99, 100 vi

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Kenco Rest. Inc. v. Comm'r, 206 F.3d 588 (6th Cir. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123 Kirchman v. Comm'r, 862 F.2d 1486 (11th Cir. 1989) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Knetsch v. United States, 364 U.S. 361 (1960) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Kwiat v. Comm'r, T.C. Memo (RIA) 1992-433 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82, 83, 97 Lerman v. Comm'r, 939 F.2d 44 (3d Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Levy v. Comm'r, 91 T.C. 838 (1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76, 77 Lockhart Leasing Co. v. Comm'r, 446 F.2d 269 (10th Cir. 1971) . . . . . . . . . . . . . . . . . . . . . . . 81 Mahoney v. Comm'r, 808 F.2d 1219 (6th Cir. 1987)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121 McCulley Ashlock v. Comm'r, 18 T.C. 405 (1952) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 Mukerji v. Comm'r, 87 T.C. 926 (1986) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Northwest Acceptance Corp. v. Comm'r, 58 T.C. 836 (1972) . . . . . . . . . . . . . . . . . . . . . . . . . . 80 Odend'hal v. Comm'r, 748 F.2d 908 (4th Cir.1984) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Ockels v. Comm'r, T.C. Memo 1987-507 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77 Packard v. Comm'r, 85 T.C. 397 (1985) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 93 Penn-Dixie Steel Corp. v. Comm'r, 69 T.C. 837 (T.C. 1978) . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Pulvermacher v. United States, 1998 WL 240492 (S.D.N.Y. 1998) . . . . . . . . . . . . . . . . . . . . . 123 R.E. Dietz Corp. v. United States, 939 F.2d 1 (2d Cir. 1991) . . . . . . . . . . . . . . . . . . . . . . . . . . 123 Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89 (4th Cir. 1989) . . . . . . . . . . . . . . . . . . . . 6, 99 Rickey v. Comm'r, 502 F.2d 748 (9th Cir. 1974) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 Rogers v. United States, 281 F.3d 1108 (10th Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . Passim Rothschild v. United States, 186 Ct. Cl. 709 (1969) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108 Sacks v. Comm'r, 69 F.3d 982 (9th Cir. 1995) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 107

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Swift Dodge v. Comm'r, 692 F.2d 651 (9th Cir. 1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim TIFD III-E, Inc. v. United States, 342 F. Supp. 2d 94 (D. Conn. 2004) . . . . . . . . . . . . . . . . . . . 74 TIFD III-E, Inc. v. United States, 459 F.3d 220 (2d Cir. 2006) . . . . . . . . . . . . . . . . . . . . . . . . . 78 Torres v. Comm'r, 88 T.C. 702 (1987) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76, 96 Transamerica Corp. v. United States, 7 Cl. Ct. 441 (1985) (Transamerica I) . . . . . . . . 76, 77, 80 Transamerica Corp. v. United States, 15 Cl. Ct. 420, 439, 443 (1988) (Transamerica II) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 76, 81 United States v. Ingalls, 399 F.2d 143 (5th Cir. 1968) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91 United States v. Wexler, 31 F.3d 117 (3d Cir. 1994) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 79 Williams v. Commi'r, 1 F.3d 502 (7th Cir. 1993) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 98 Winn-Dixie Stores, Inc. v. Comm'r, 113 T.C. 254 (1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126 Winn-Dixie Stores, Inc. v. Comm'r, 254 F.3d 1313 (11th Cir. 2001) . . . . . . . . . . . . 101, 116, 119

DOCKETED CASES Fifth Third Bancorp v. United States, No. 1:05-cv-350 (S.D. Ohio) . . . . . . . . . . . . . . . . . . . . 3, 13

FEDERAL STATUTES H.R. Rep. No. 755, 108th Cong., 2d Sess. at 660, 662-63 (2004) . . . . . . . . . . . . . . . . . . . 126, 127 I.R.C. § 1.467-1(a)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125 I.R.C. § 467 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125, 126 I.R.C. § 470 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126, 127 I.R.C. § 6110(K)(3) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95 Rev. Rul. 72-543, 1972-2 C.B. 87 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82 Rev. Rul. 99-14, 1999-1 C.B. 835 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 124 viii

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Rev. Rul. 2002-69 2002-2 C.B. 760 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6, 82, 124

OTHER David P. Hariton, Response to "Old `Brine' in New Bottles" (New Brine in Old Bottles), 55 Tax L. Rev. 397, 402 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5, 15 Brief for Equipment Leasing Finance Association as Amicus Curiae Supporting Petitioner, BB&T, 523 F. 3d 461 (4th Cir. 2008) (Dkt # 07-1177, Motion for Amicus Brief at 3-4) . . . . . . . 6

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INTRODUCTION During December 1997, Plaintiff, through a subsidiary, Consolidated Edison Development ("CED"), engaged in a lease-in/lease-out tax shelter commonly referred to as a LILO (herein the "RoCa3 LILO Transaction" or "Transaction"). The RoCa3 LILO Transaction involved a facility located in the Netherlands ("the RoCa3 Facility") owned and operated by EZH. CED purported to lease a 47.47% interest in the RoCa3 Facility from EZH under a lease and simultaneously purported to sublease that interest back to EZH. To this day, EZH (and now its successor) operates the RoCa3 Facility in its business as it always has. Plaintiff's federal income tax return reported large deductions for rent expense, interest, and amortized transactions costs that far exceeded the reported rental income from the Transaction. The Internal Revenue Service disallowed the deductions and disregarded the rental income. Plaintiff then paid the resulting deficiency, and filed this suit for a tax refund. Plaintiff's claimed tax deductions are improper for three reasons. First, looking at the Transaction as a whole reveals that CED did not in substance acquire a present leasehold interest in EZH's property. Second, CED did not incur genuine indebtedness for the funds that were used to make payments that traveled in a circle and accounted for the claimed tax benefits. Third, and alternatively, the RoCa3 LILO Transaction should be disregarded under the economic substance doctrine. Plaintiff bears the burden of proof on all these issues. At the commencement of this case, Plaintiff represented that this was a simple case, involving a simple leveraged lease, requiring little discovery. Plaintiff has since shifted its strategy to one in which it is attempting to make this case confusing and unnecessarily complex. Plaintiff's opening brief was over 500 pages long. In addition, Plaintiff submitted a 50-page

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timeline that begins in 1823. The brief engages in lengthy, repetitious references to administrative actions and rulings, abandoned legislation, foreign law and discussion by the House of Lords. Despite its length, Plaintiff's opening brief skirts the legal issues. The brief fails to acknowledge the holding of the single decided case (at that time) involving an obviously similar transaction. Moreover, its recitation of the facts is both incomplete and erroneous. While it would be impossible to address all of the inaccuracies in plaintiff's extraordinarily lengthy brief, this reply points out the major problems. As an example, Plaintiff ignores its own key fact witness, Mr. Andrew Scher. Mr. Scher is a tax attorney and employee of plaintiff who was tasked with providing advice to plaintiff about this transaction and its tax consequences. He wrote two memoranda, each of which conveys Plaintiff's understanding and purpose regarding this transaction.1 Mr. Scher also was involved in the administrative and pretrial process in this case, and he testified over several days at trial. Nevertheless, Mr. Scher's name does not appear in the text of Plaintiff's brief, and Plaintiff even omits his name from its "glossary" of the witnesses who testified at trial (see Pl. Br. at A-1 though A-4). Plaintiff cannot erase Mr. Scher's testimony.

1

As we explained in our opening brief (see U.S. Brief at 55-56 n.59), Mr. Scher was the liaison between CED and CEI during CED's consideration of the RoCa3 LILO Transaction. He had regular meetings with CED to discuss legal issues facing CED. (Tr. 1999 (Muoio)). Further, as a tax attorney, he recognized the aggressive nature of the transaction from his early involvement in the matter and further recognized the dubiousness of any claim that EZH would not exercise the purchase option. (See U.S. Br. at 56, citing JX 390, Bates 8029). 2

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POST TRIAL RULINGS When the parties filed their opening briefs, one district court had ruled on the tax issues raised by LILOs . BB&T Corp. v. United States, 2007 WL 37798 (M.D.N.C. Jan. 4, 2007). The district court had granted summary judgment in favor of the United States, and BB&T had appealed to the Fourth Circuit. On April 29, 2008, the Fourth Circuit affirmed the district court's decision. BB&T Corp. v. United States, 523 F.3d 461 (4th Cir. 2008) (petition for rehearing denied on June 27, 2008). Like the District Court, the Fourth Circuit held for the government under the substance over form doctrine.2 Two other courts have addressed similar leasing transactions and found for the government since our opening brief was filed. AWG Leasing Trust v. United States, 2008 WL 2230744 (N.D. Ohio May 28, 2008) (Sale-in/Lease-out transaction "SILO"); Fifth Third Bancorp & Subsidiaries v. United States, Case No. 1:05-cv-350 (S.D. Ohio), (jury verdict for the government in a LILO case, in part, on the basis of the substance over form doctrine, and in part, on the basis of the economic substance doctrine).

The parties cross-moved for summary judgment. BB&T argued that the Transaction should be respected under two related but distinct common-law tax doctrines, the economic-substance doctrine and the substance-over-form doctrine (both of which BB&T had to satisfy). The United States opposed, arguing that it was entitled to summary judgment under the substance-over-form doctrine but that the economic-substance determination raised disputed factual issues (related to BB&T's motives and ability to profit from the headlease) that could not be decided on summary judgment. On appeal, BB&T again argued that the transaction had economic substance. In response, the government argued that economic substance was not relevant to the substance over form holding of district court and that BB&T's argument relied on disputed issues of fact. The Fourth Circuit agreed. BB&T filed a Petition for Reconsideration en banc and the Fourth Circuit denied the petition. 3

2

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In these cases, the courts have unanimously concluded that the circular debt incurred to finance these transactions does not reflect the substance of the transactions and have disallowed the interest deductions. In BB&T and AWG, the courts concluded that the overall transaction was a loan and not a lease. Finally, in Fifth Third, the jury concluded that LILO transaction lacked economic substance apart from the tax benefits generated by deductions, and consequently, that claimed interest amounts were not deductible. Because the RoCa3 LILO Transaction is fundamentally indistinguishable from these decided cases, and the rulings are persuasive, this Court likewise should disallow Plaintiff's claimed deductions. I. BB&T Corp. v. United States, Fourth Circuit As described in the United States' opening brief (U.S. Br. at 91-93, 97-98, 102), BB&T involved a nearly identical LILO transaction, which the IRS disregarded for federal tax purposes. BB&T, 2007 WL 37798. In 1997, BB&T, like CED here, purported to lease property from a foreign entity in a LILO transaction and reported sublease rent income and claimed much larger deductions for head lease rent, interest and transaction expenses. Id. at *1-4. The district court granted the United States' motion for summary judgment and held that BB&T failed to prove that it had acquired a genuine leasehold interest or had engaged in purposeful borrowing. Id. at *8, 10, 12. In form, BB&T had acquired a "lease" and a "loan," but the district court, noting the absence of an at-risk investment, determined that, in substance, the taxpayer lacked an interest in the property. Id. at *8. The district court held that the foreign entity, in substance, retained its interest in the property and continued to enjoy the benefits and burdens of ownership it had before the

4

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Transaction. Id. The court further concluded that the transaction was not sustainable under precedent upholding sale/leaseback transactions. Id. at *6-7. The taxpayer appealed. The Fourth Circuit affirmed. BB&T, 523 F.3d 461. The circuit court determined that the LILO was not a genuine lease and sublease, and the taxpayer was not entitled to deductions for head lease rent expense, interest expense or business expense amortization. Id. at 475. The circuit court further held that, although the transaction documents provided in form for substantial payments, the only money that actually changed hands between the leasing parties was payment to the foreign entity as an incentive for doing the deal. Id. at 473. The Fourth Circuit also determined that the foreign entity, through a purchase option, could have unwound the transaction without losing dominion and control over the "leased" asset, or the need to surrender any of its own funds to the taxpayer to "repurchase" the leasehold interest and that the structure of the transaction insulated the taxpayer from any risk. Id. Finally, the circuit court determined that the non-recourse loan involved in the LILO did not constitute genuine indebtedness, because the transaction did not, in fact, require the bank to pay any money as a result of the use of defeasance mechanisms.3 Id. at 476. In reaching its decision, the Fourth Circuit recognized the criticisms leveled at LILO transactions as tax shelters: LILOs have been harshly criticized as abusive tax shelters that serve only to transfer tax benefits associated with property ownership from tax-indifferent entities, which have no use for them, to U.S. taxpayers. See David P. Hariton, Response to "Old `Brine' in New Bottles" (New Brine in Old Bottles), 55 TAX L. REV. 397, 402 (2002) (noting one commentator's characterization

3

The BB&T Court did not rule on economic substance since there is a factual component to that determination. 5

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of LILOs as abusive tax shelters and agreeing that LILOs "purport[ ] to create tax benefits that Congress did not intend to confer on anyone in respect of transactions that involve no business investment at all"). BB&T, 523 F.3d at 465. In its opening brief, Plaintiff makes a weak effort to distinguish BB&T. First, Plaintiff complains that the decision does not take into consideration the views of the leasing industry. (Pl. Br. at 17). To the contrary, the Equipment Leasing and Finance Association (ELFA) submitted an amicus curiae brief to the Fourth Circuit. In its Motion, requesting leave to file an amicus brief, ELFA stated: Because ELFA members engage in lease finance transactions, ELFA has both an important interest in the outcome of this case and has the ability to provide information that is helpful to this Court. The present case involves a so-called "LILO" transaction (for "lease-in-lease-out") (see Rev. Rul. 2002-69 2002-2 C.B. 760), but it is, in essence, a lease leaseback transaction in which one of the parties is exempt from United States taxes. While Congress in 2004 adopted legislation that effectively limits LILOs (see 26 U.S.C. § 470(c)(21) and § 168(h)(2)(A)(ii)), nonetheless, this case has major significance to ELFA members because the consequences of the district court's opinion are not limited to LILOs. Rather, the district court's opinion potentially affects all lease leaseback as well as sale leaseback transactions, including those where all parties are subject to United States taxation. From its national perspective, ELFA s uniquely situated to assist the Court in its consideration of the important issues presented by this case. The attached brief will assist the Court by illuminating the compelling reasons why the district court's opinion should not be affirmed. The law concerning the tax treatment of lease leaseback and sale leaseback transactions is well-settled. Supreme Court and Fourth Circuit Court precedent establish that as long as such a transaction has tax independent considerations and is not solely motivated by tax avoidance features, the form of the transaction selected by the taxpayer should be respected. Frank Lyon Co. v. United States, 435 U.S. 561 (1978); Rice's Toyota 6

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World, Inc. v. Comm 'r, 752 F.2d 89 (4th Cir. 1989). Nonetheless, the district court in the present case, without adequate consideration of this settled law, concluded that the taxpayer only acquired a future interest and, therefore, was not entitled to current tax benefits from the transaction. The district court's resurrection of the future interest theory, rejected by a majority of the Supreme Court in Frank Lyon, casts an unwarranted cloud over numerous non-LILO transactions that have been completed, as well as threatening to deter the completion of future legitimate transactions. Brief for Equipment Leasing Finance Association as Amicus Curiae Supporting Petitioner, BB&T, 523 F. 3d 461 (4th Cir. 2008) (Dkt # 07-1177, Motion for Amicus Brief at 3-4). The Fourth Circuit accepted ELFA's amicus brief, but nonetheless affirmed the district court's ruling and held that the LILOs substance did not comport with its form. The Fourth Circuit distinguished the LILO from a traditional lease: In sum, the transaction does not allocate BB&T and Sodra's [the foreign counterparty] rights, obligations, and risks in a manner that resembles a traditional lease relationship. See [Alstores Realty Corp. v. Commissioner, 46 T.C. 363, 373 (T.C. 1966)] (holding that because a "so-called space-occupancy agreement placed the two parties' rights, obligations, and risks as they would be allocated in a typical lease arrangement[,] . . . the arrangement was a lease in substance as well as in form"); Swift Dodge v. Comm'r, 692 F.2d 651, 653-54 (9th Cir. 1982) (recharacterizing a lease as a conditional sales contract because the parties' obligations, legal rights, and risks were no different than they would be in a conditional sale arrangement and "Swift Dodge did not retain . . . significant and genuine attributes of a lessor"); Aderholt Specialty Co. v. Comm'r, 50 T.C.M. (CCH) 1101 (1985) (holding that a lease arrangement was a sale for federal tax purposes because the transaction "divested [the lessor] of any significant and genuine attributes of traditional lessor status" and "if the benefits, obligations, and rights of the putative lessor are essentially those of a secured seller, the substance of the arrangement must govern and it will be deemed a sale for tax purposes" (internal quotation marks omitted)). BB&T, 523 F.3d at 473. 7

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Plaintiff also argues that BB&T is distinguishable on the basis that BB&T was decided on a stipulated record: As was the case in Fifth Third, genuine issues of fact exist concerning the status of the RoCa3 Transaction. For this reason, the BB&T decision is distinguishable if for no other reason than the BB&T court ruled based on stipulated record. (Pl. Br. at 18 (citations omitted)).4 However, the evidence presented at trial demonstrates that the RoCa3 LILO Transaction is nearly identical to the BB&T LILO transaction. The following chart compares the RoCa3 LILO Transaction to the LILO in the BB&T case.5

4

As explained more fully below, the jury in that case determined that the overall transaction lacked economic substance and the loans were not true indebtedness.
5

Given that LILO transactions were marketed and sold based on their structure, and were implemented using form documents, it is not surprising that the RoCa3 LILO Transaction varies little from the transaction in BB&T, or the "typical" LILO structure. Plaintiff argues at page 80 of its opening brief that this Court should not infer that Plaintiff's use of precedent documents implies that the terms of the RoCa3 LILO Transaction are essentially the same as those used in EZH's previous LILO Transaction with Banc One, the Maasvlakte Transaction. (Pl. Br. at 7980). Plaintiff offered conclusory testimony that there are differences between the two transactions. For example, Plaintiff states that the documents for a successor transaction "would" look very different than the precedent documents. (Id. at 80). However, Plaintiff has not pointed to any examples of material distinctions for the purposes of this Court's determination, referring instead only to immaterial distinctions such as that one facility is coal fired and another is gas fired. (Id., citing Tr. 2874 (Mintun)). The truth is revealed in Mr. Holzman's detailed, contemporaneous notes, revealing that Woody Flowers, counsel from Shearman & Sterling, told Mr. DePlautt in connection with its consideration of LILO Transactions that "there wouldn't be much new negotiating except from new issues." (JX 282, Bates 5490). Thus, not only is the RoCa3 LILO Transaction nearly identical in all material respects to the LILO transaction at issue in BB&T, as well as the "typical LILO" discussed therein, it is similar in most material respects to the Maasvlakte LILO Transaction consummated by EZH and Banc One approximately ten months prior to the close of the RoCa3 LILO Transaction. 8

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BB&T BB&T formed a special purpose trust to enter the LILO transaction. Cir. 465 n.1;6 Dist. 1.7 BB&T leased equipment from Sodra (a foreign entity not subject to U.S. tax) for 36 years. Cir. 466; Dist. 1. Sodra subleased the equipment back from BB&T for 15.5 years. Cir. 466; Dist. 1. At the end of 15.5 years Sodra has the ability to buy back the equipment at no out of pocket cost by using the funds in the equity and debt defeasance accounts. Cir. 466; Dist. 3. If Sodra fails to buy the equipment back, BB&T has the ability to force Sodra to renew the lease for 13.3 years. Cir. 466; Dist. 3. If Sodra fails to buy the equipment back, BB&T has an option to lease the equipment to a third party. Cir. 466; Dist. 3. If Sodra fails to buy the equipment back, BB&T has an option to use the equipment itself. Cir. 466-67; Dist. 3. BB&T took a $68 million nonrecourse loan from HBU to consummate the transaction. Cir. 467; Dist. 2.

RoCa3 CED formed a special purpose trust to enter the LILO transaction. (Stip ¶¶ 102, 103). CED leased an interest in the Facility from EZH (a foreign entity not subject to U.S. tax) for 43.2 years. (Stip ¶¶ 104, 113, 135). EZH subleased this interest in the Facility back from CED for 20.1 years. (Stip ¶¶ 104, 113, 135). At the end of 20.1 years EZH has the ability to buy back the Facility at no out of pocket cost by using the funds in the equity and debt defeasance accounts. (Stip ¶¶ 165, 235; DX 20035, Bates 21361). If EZH fails to buy back its interest in the Facility, CED has the ability to force EZH to renew the lease for 16.5 terms. (Stip ¶ 169). If EZH fails to buy back its interest in the Facility, CED has an option to lease the interest in the Facility to a third party. (JX 46, Bates 1573)). If EZH fails to buy the facility back, Con Ed has an option to obtain the output from the Facility corresponding to its interest. (JX 46, Bates 1573; Tr. 3931 (Bent)). CED took a $81 million nonrecourse loan from HBU to consummate the transaction. (Stip ¶¶ 117, 118, 131).

6

Cir. cites to BB&T, 523 F.3d 461 (4th Cir. 2008). Dist. cites to BB&T, 2007 WL 37798. 9

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BB&T The proceeds of the loan were deposited in a defeasance account at ABN AMRO, the parent of HBU.8 Cir. 467; Dist. 2. Letters of credit were available to cover defeasance shortfalls in event of default. Cir. 470; Dist. 2. The rent payments under the Leaseback exactly match, in both amount and timing, the principal and interest payments due on BB&T's non-recourse loans. Cir. 468; Dist. 2. $12 Million in cash was deposited by BB&T into an equity defeasance account and used to purchase US Treasury Bonds to fund the repurchase its interest in the equipment.9 Cir. 467 and 468 n. 7; Dist. 2. The remaining cash, after transaction costs was used to pay Sodra an accommodation fee for its participation in the shelter. Cir. 467; Dist. 2. Other than the accommodation fee, Sodra receives no other money. Cir. 467. The transaction is structured so under the renewal option BB&T would not have to inject any further funds to make its final rent payment. Cir. 468-69 If the interest rates are not as the parties predict at the end of the basic lease term Sodra has no recourse to BB&T for any shortfall in the final rent payment. Cir. 469

RoCa3 The proceeds of the loan were deposited in a defeasance account at ABN AMRO, the parent of HBU. (Stip ¶¶ 126, 127, 187, 189, 198, 199). Letters of credit were available to cover defeasance shortfalls in event of default. (JX 397, Bates 8124). The rent payments under the Leaseback exactly match, in both amount and timing, the principal and interest payments due on CED's non-recourse loans. (Stip ¶¶ 118, 188, 199; Tr. 1272 (Holzman)). $31 Million in cash was deposited by CED into an equity defeasance account and used to purchase US Treasury STRIPS to fund the repurchase of its interest in the Facility. (Stip ¶¶ 208-210). The remaining cash, after transaction costs was used to pay EZH an accommodation fee referred to as its Net Present Value Benefit for its participation in the shelter. (Tr. 297173 (Mintun)). Other than the Net Present Value Benefit, EZH receives no other money. (Tr. 2971-73 (Mintun)). The transaction is structured so that under the Sublease Renewal Option CED would not have to inject any further funds to make its final rent payment. (U.S. Br. at 34). If the interest rates are not as the parties predict at the end of the basic lease term EZH has no recourse to CED for any shortfall in the final basic rent payment. (Infra at 29-32).

8

The debt defeasance was in substance defeasance and not legal defeasance. The equity defeasance was in substance defeasance and not legal defeasance. 10

9

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BB&T Deloitte performed an appraisal of the asset. Cir. 466; Dist. 1. Deloitte determined that there was no material inducement that would require Sodra to exercise the purchase option. Cir. 469. The Tax Indemnity Agreement required that for U.S. income tax purposes, neither Sodra nor any of its personnel would take a position inconsistent with the characterization of Sodra as the owner, head lessor, and sublessee of the Equipment. Cir. 469 n.10; Dist. 4. Deloitte determined the most likely option was for BB&T to use the equipment. Cir. 469; Dist. 3. Sodra continued to the use the facility as it always has. Cir. 466; Dist. 6. Each year BB&T has the right to make an inspection of the facility. Cir. 466; Dist. 6. BB&T describes the transaction as a "tax driven deal" with an after tax investment yield largely driven by tax benefits. Cir. 465; Dist. 1. Transaction was done in U.S. Dollars. Cir. 467. Without the deductions BB&T would "probably not" have gone forward. Cir. 465466.

RoCa3 Deloitte performed an appraisal of the asset. (Stip ¶ 83). Deloitte determined that there was no material inducement that would require EZH to exercise the purchase option. (Tr. 1795-96 (Ellsworth)). the Tax Indemnity Agreement required that for U.S. income tax purposes, neither EZH nor any of its personnel would take a position inconsistent with the characterization of EZH as the owner, head lessor, and sublessee of the RoCa3 Facility. (Stip ¶¶ 280-81). Deloitte determined the most likely option was for CED to use the facility. (Tr. 1795-96 (Ellsworth)). EZH continued to the use the facility as it always has. (U.S. Br. at 97, 101). Each year CED has the right to make an inspection of the facility. (Stip ¶¶ 149-150). Plaintiff says the taxes are what make this deal interesting because of an after tax investment yield largely driven by tax benefits. (JX 1231; JX 390, Bates 8029). Transaction was done in U.S. Dollars. (JX 397, Bates 8125; Tr. 967-68 (McCartney)). Without the tax benefits CED would not have entered this transaction. (JX 390; Tr. 850-51 (McCartney); Tr. 2039-40 (DePlautt); Tr. 2035-36 (Muoio)).

11

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As a result of these marked similarities, the analysis of BB&T by the district court and the Fourth Circuit is persuasive and relevant to any examination of Plaintiff's LILO Transaction.10 The Fourth Circuit describes what it considers to be a typical LILO: In a typical LILO, a U.S. taxpayer leases property from a tax exempt entity and simultaneously leases that property back to the owner. The tax-exempt owner's sublease has a shorter term than the taxpayer's lease. Upon expiration of the shorter sublease, the owner may exercise an option to buy back the remainder of the taxpayer's lease. Thus, in practical terms, the tax-exempt property owner continues to use the property during the sublease term just as it did before the transaction and bears no risk of losing control of its asset(s). The taxpayer, meanwhile, receives tax benefits by deducting the rental payments on its lease, amortizing certain transaction costs, and, depending on its financing arrangement, deducting interest payments. Maxim Shvedov, CRS Report for Congress: Tax Implications of SILOs, QTEs, and Other Leasing Transactions with Tax-Exempt Entities 8 (2004). The tax benefits can be substantial and are achieved primarily by "[a]ccelerating the transaction-related deductions and delaying recognition of the corresponding revenues." Id. at 3. This delayed recognition creates a tax deferral, which, in practice, will function as a tax reduction due to the time value of money. Id. at 2, 8. Generally, parties aim to structure a LILO in a way that essentially eliminates any risk of economic loss while maximizing the deductions that the taxpayer may claim. In this respect, the parties strive to "strike a balance between limiting their exposure to risks on one hand, and making sure the provisions do not disqualify the transaction as a [genuine] lease [for tax purposes] on the other. Id. at 9; see also Mark P. Gergen, The Logic of Deterrence: Corporate Tax Shelters, 55 Tax L. Rev. 255, 259 n.19 (2002) (noting that LILOs are often structured so that "there is no risk to any party, other than the tax law risk").

What is different in this case from BB&T is the issue of economic substance. Because there is a trial record, this Court has can resolve the factual issue whether Plaintiff has met its burden to show that the transaction has economic substance under Coltec Indust., Inc. v. United States, 454 F.3d 1340, 1355 (Fed. Cir. 2006). 12

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BB&T, 523 F.3d 464. The RoCa3 LILO Transaction is a typical LILO. In fact, a major theme of Plaintiff's brief is that this transaction is just like every other leveraged lease. Regarding the substance versus the form of the purported lease in BB&T, the Fourth Circuit provided this blunt assessment: In closing, we are reminded of "Abe Lincoln's riddle . . . `How many legs does a dog have if you call a tail a leg?'" Rogers v. United States, 281 F.3d 1108, 1118 (10th Cir. 2002). "The answer is `four,' because `calling a tail a leg does not make it one.'" Id. Here, BB&T styled the LILO as a lease financed by a loan, but did not in substance acquire a genuine leasehold interest or incur genuine indebtedness. Accordingly, although we decline to resolve whether the transaction as a whole lacks economic substance -- that is, whether it has "reached the point where the tax tail began to wag the dog," Hines, 912 F.2d at 741, we conclude that the Government was entitled to recognize that tail for what it was, not what BB&T professed it to be. BB&T Corp., 523 F.3d at 477. As in BB&T, the Court should disallow the claimed tax benefits purportedly arising from the RoCa3 LILO Transaction, because the form of the transaction does not comport with its substance. II. Other Leasing Cases A. Fifth Third Bancorp v. United States

The first decided case to address a LILO under the economic substance doctrine was Fifth Third recently tried before a jury in the Southern District of Ohio. Fifth Third, No. 1:05cv-350 (S.D. Ohio). The facts were similar to those in BB&T and the RoCa3 LILO Transaction. As explained in Plaintiff's Brief (Pl. Br. at 17-18), the district court, applying Sixth Circuit law, determined that summary judgment was premature on the issue of substance over 13

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form. At the close of the trial, the Court also denied the parties' cross-motions for judgment as a matter of law and submitted the case to the jury. The jury issued a verdict in favor of the United States.11 (Docket # 101, Exhibit B (Status Report in this case containing jury verdict). In response to special interrogatories, the jury found that there was no economic substance to the transaction other than the avoidance of tax. (Id.). The jury also determined that although the transaction was in substance a lease, the loan from HBU12 did not constitute bona fide indebtedness. (Id.). B. AWG Leasing v. United States

On May 28, 2008, the United States District Court for the Northern District of Ohio held that a bank involved in a SILO tax shelter never obtained an ownership interest sufficient to claim deductions for depreciation. AWG, 2008 WL 2230744, at *1. The court also determined that the bank was not entitled to deduct interest paid on the "loans," or to other claimed tax benefits. Id. Finally, the court sustained the imposition of accuracy-related penalties at the partnership level for the substantial understatement of tax liability. Id. The district court compared SILOs to LILOs: SILOs are a modified version of their tax-driven financial predecessors, lease-in/lease-out ("LILO") transactions. Although each transaction is factually distinct, SILOs generally differ from LILOs by having a longer-term head lease that is sufficiently long to qualify for tax purposes as a sale. In a typical LILO, the taxpayer leases property from a tax-exempt entity and simultaneously leases the same property back to the owner and gives the owner an option to repurchase the lease. In practical

11

There is no final judgment in the case. Plaintiff filed for a JNOV challenging the verdict.

12

As in BB&T and this case, the nonrecourse debt was borrowed from a bank and deposited into a defeasance account at a subsidiary institution. 14

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terms, the tax-exempt property owner continues unfettered use of the property just as before the transaction, but the taxpayer claims tax benefits. As the Fourth Circuit Court of Appeals recently noted, "LILOs have been harshly criticized as abusive tax shelters that serve only to transfer tax benefits associated with property ownership from tax-indifferent entities, which have no use for them, to U.S. taxpayers." BB&T Corp. v. United States, 523 F.3d 461, 465 (4th Cir. 2008) (citing David Hariton, Response to "Old `Brine' in New Bottles" (New Brine in Old Bottles), 55 TAX L. REV. 397, 402 (2002)). Id. at *2. There are several factual similarities between the transaction at issue in the AWG case, and those in BB&T, Fifth Third and here: Key Bank leased a German waste facility from AWG and called for AWG to lease the facility back. Id. at *9. The transaction documents also gave AWG an option to repurchase the facility in 2024 using "escrow-type accounts to guarantee AWG's sublease of the facility and to fund the exercise of the 2024 purchase option."13 Id. at *10. Because of these similarities, the court found "that both the facts and legal issues presented by the BB&T case and this present litigation are similar in many regards." Id at *24. Moreover, the court, over taxpayer's objections, concluded that "that the precedent set by the Fourth Circuit in BB&T is relevant and instructive, although certainly not binding on this Court."14 Id. After

trial, the court concluded there was no sale and that the Trust did not become the owner for tax purposes:

The court concluded that "unless AWG rejects that purchase option, the 1999 transaction results in a simple circular flow of money." Id. at *10. The escrow accounts in the AWG transaction are analogous to the defeasance accounts present in the RoCa3 LILO Transaction.
14

13

With regard to the structure of the transaction, the court stated, " the structure of the transactions in both cases are remarkably alike." With regard to the debt, the court noted, "The structure and intended use of the Series A and B Loans in this case is remarkably similar to the loan at issue in the BB&T case." Id. at *39. 15

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while the AWG SILO transaction does have some economic substance apart from the tax benefits, the transaction's stated form as a "sale" is not consistent with its economic reality. Because the Court finds that the Trust never actually became the owner of the Facility for purposes of U.S. federal tax law, the Court concludes that the Trust is not entitled to the depreciation or amortization deductions claimed on its tax returns for 1999, 2000, 2001, 2002, and 2003 ("the Taxable Years"). After discussing relevant case law on the issue, the Court will then analyze the AWG transaction under both the "economic substance" and the "substance over form" tests. Id. at *21.15 The Court offered several reasons for its conclusion: For the following reasons, the Court concludes that the AWG transaction is not properly characterized as a transfer of a depreciable ownership interest in the Facility to the Plaintiffs because: (I) no substantive benefits or burdens of ownership are transferred between the parties during the Initial Leaseback Period; (ii) no significant cash flows between the parties exist during the Initial Leaseback Period; (iii) the AWG transaction creates little, if any, risk for the Plaintiffs throughout the Head Lease; and (iv), most importantly, it is nearly certain that AWG will exercise the Fixed Purchase Option in 2024, thus ensuring that the Plaintiffs never actually acquire economic ownership of the Facility. In sum, the Court concludes that the Trust did not become the owner of the Facility at closing in 1999 and it is highly likely that the Trust never will acquire such ownership under the terms of the AWG sale-leaseback transaction.

The court in AWG found there to be substance because the taxpayers produced evidence that the return on their investment (2.5 and 3 percent) is the same rate of return that the taxpayers expected on their other leverage lease transactions. There is no evidence that shows that Plaintiff believed that its transaction had a reasonable rate of return without the tax benefits. In fact, the only evidence in this record is that Plaintiff would not have done this transaction for a 2 percent return. (JX 390; Tr. 850-51 (McCartney); Tr. 2039-40 (DePlautt); Tr. 335 (McGrath)). Moreover, there is no evidence in this record that shows how Plaintiff, who bears the burden, calculated the 2.4 percent return claimed in the White Paper. (JX 397, Bates 8124). Further, given that the source of this return is the investment of a portion of CED's equity investment in U.S. Treasury STRIPS, which could have been done without the artifice of a lease transaction to ratchet up the claimed tax benefits, this return is not truly a return from the lease transaction itself. 16

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AWG, at * 27. Because the RoCa3 LILO Transaction is fundamentally indistinguishable from those in the prior cases, the Court should disallow Plaintiff's claimed deductions.16

Undoubtedly Plaintiff will claim that the RoCa3 LILO Transaction should be treated differently by latching on to factor (iv) of the district court's analysis and claim that unlike in that case the Sublease Purchase Option here is not nearly certain to be exercised. As explained in BB&T this is not a necessary prerequisite to a finding that the substance fo the RoCa3 LILO Transaction does not match its form. See BB&T, 523 F.3d at 473 (Noting that even in the unlikely event that the tax exempt entity fails to exercise the purchase option, the structure of the transaction insulates [the taxpayer] from any risk of losing its initial investment . . . in the government bonds or incurring the obligation to invest additional funds."). In any event as explained infra, the Sublease Purchase Option is nearly certain to be exercised. Plaintiff will likely support its claim by citing to the Deloitte appraisal's conclusion (and Mr. Kelly's confirmation there of) that it is more likely EZH will not exercise the Sublease Purchase Option, and to the testimony of its expert John Reed, who offered his opinion that one could not say with "virtual certainty" that the purchase option would be exercised. (Tr. 2582, 2698-99 (Reed)). First, as explained in the United States' opening brief (U.S. Br. at 30-31) the Transaction is designed for the Sublease Purchase Option to be exercised. (See infra at n.17). Second, Deloitte's appraisal (and Kelly's supposed confirmation of that appraisal) do not change that result as they are faulty in many material respects including failure to consider either the fact that the Sublease Purchase Option is prefunded or the actual economic results of EZH choosing to exercise the Sublease Purchase Option. Third, Mr. Reed's opinion, even if accepted by the Court, that one cannot say with "virtual certainty" that EZH will exercise the Sublease purchase Option does not carry the day. Mr. Reed defined his term "virtual certainty" as approximately 98%-99% certainty. (Tr. 2699, 2724 (Reed)). In other words Mr. Reed was essentially saying that while you could not say with 100% certainty whether EZH would exercise the Sublease Purchase Option, you could say so with up to a 97% certainty. In other words, by providing such a low threshold, 2%-3% uncertainty, Mr. Reed has not demonstrated that, in light of the other evidence in the case, the exercise of the Sublease Purchase Option is not "nearly certain" as stated in the AWG opinion. Fourth, even Mr. Reed's limited conclusions are unreliable. Mr. Reed acknowledged that he had never worked with a transaction that had a structure like the RoCa3 LILO Transaction. (Tr. 2680-81 (Reed)). Mr. Reed acknowledged that he did not believe that the prefunded nature of the Sublease Purchase Option was something that effects whether the Sublease Purchase Option will be exercised. (Tr. 2702-03 (Reed)). He based this conclusion in part on his understanding (from Plaintiff's counsel) that EZH had unfettered access to the funds in the Equity Defeasance Account if it chose not to exercise the Sublease Purchase Option. (Tr. 2704-05, 2707 (Reed); PX 10076, Bates 20203). However, as acknowledged in Plaintiff's brief (Pl. Br. at 464, 467), this assumption was false (JX 19, Bates 971-73; U.S. Br. at 21-23). Mr. Reed acknowledged a change in this assumption could affect his opinion. (Tr. 2707 (Reed)). Further, Mr. Reed admitted that he had no actual understanding of the financial consequences to EZH if it failed to exercise the Sublease Purchase Option (Tr. 2707 (Reed)), (continued...) 17

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RESTATEMENT OF FACTS There are significant discrepancies between the factual assertions in the parties' opening briefs. The key differences between the facts presented by the parties are in the following areas: 1) the absence of risk in the RoCa3 LILO Transaction; 2) the purported non-tax benefits Plaintiff sought from entering into the RoCa3 LILO Transaction; and 3) Plaintiff's purported due diligence. In addition, Plaintiff's incomplete and inaccurate characterization of the structure of the RoCa3 LILO Transaction is an important factor in each of these areas. I. CED Did not Bear Risk from the RoCa3 LILO Transaction A. There is a Lack of Market Risk to CED from Entering into the RoCa3 LILO Transaction

Plaintiff argues that it is exposed to the risk of fluctuations in value of the RoCa3 Facility as a result of entering into the Transaction. (Pl. Br. at 362-63). However, Plaintiff ignores several key facts that eliminate this risk. Fluctuations in the value of the RoCa3 Facility have no impact on the return to CED from the Transaction. Plaintiff ignores that the exercise of the Sublease Purchase Option is the intended consequence of the Transaction.17 More importantly,

(...continued) instead relying on counsel's "general" explanation of the flow of funds in the Transaction. (Tr. 2700-02 (Reed)). In fact, instead of reviewing the entirety of the only Operative Documents he listed in his report (the Participation Agreement, Lease and Sublease), Mr. Reed relied on counsel to tell him which provisions were relevant to his opinion. (Tr. 2701 (Reed)). Even Mr. Reed's calculations (which were performed by his staff and not reviewed by Mr. Reed (Tr. 271314 (Reed)) rest on a flimsy basis as he relied heavily on the numbers set forth by Deloitte in its appraisal. Numbers which he made no attempt to verify. (Tr. 2711, 2714-15 (Reed)).
17

16

The Transaction was structured so that the Sublease Purchase Option would be exercised by EZH. (U.S. Br. at 29-32). The funds were set aside for this occurrence (Stip ¶¶ 234, 235, 237; Tr. 1326-29 (Holzman); Tr. 2167 (DePlautt); Tr. 1796-98 (Ellsworth)), and if EZH chose not to exercise the Purchase Option it did not receive the benefit of those funds, but had to reinvest (continued...) 18

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Plaintiff fails to acknowledge that even if fluctuations in the value of the Facility would impact EZH's decision with respect to the Sublease Purchase Option, CED is protected from such fluctuations. If, for example, the property appreciates and EZH exercises the Sublease Purchase Option in year 20, the funds held in the Equity Defeasance Account will be returned to Plaintiff providing its expected return from the Transaction. (U.S. Br. at 19-24, 95-97, 104). Alternatively, if hypothetically the value of the RoCa3 Facility declines to a point where EZH is purportedly disinclined to exercise the Sublease Purchase Option, and Plaintiff is unable to lease its interest in Facility to another lessee under the Retention Option for a price that will assure that it can recover its investment, as recognized by Plaintiff, CED can elect the Sublease Renewal Option and force EZH to extend the sublease for 16.5 more years. (Id.). Under this option, Plaintiff is assured to recover its equity investment, with interest, through the equity portions of the annual rental payments it will receive during the extended sublease term.18 (DX 20193, Bates 25093; JX 388, Bates 8021; JX 397, Bates 8121 ("If the utility did not purchase the plant at the end of year 20 the trust [for the benefit CED] would have the option to . . . require

(...continued) them in additional Treasury Securities. (JX 19, Bates 971-73; U.S. Br. at 21-23; Pl. Br. at 464, 467). Further, in order to not exercise the Sublease Purchase Option, EZH was required to reach an agreement with a successor lessee to step into the shoes of CED if CED so desired, and EZH was required to pay that successor lessee to do so. (JX 1, Bates 65 ("Designated Successor Lessee"); Tr. 3375-76 (Ellis)). Thus, the Transaction is designed to encourage EZH to exercise the Sublease Purchase Option, and eliminate any residual value risk to CED. And, of course, the Transaction is structured to allow those payments to be made from funds set aside under the Equity Defeasance Account. (U.S. Br. at 21-23, 26, 34). The mechanics of these payments under the Sublease Renewal Option, as explained in the United States' opening brief (JX 19, Bates 971-73; U.S. Br. at 21-23), and confirmed by Plaintiff (Pl. Br. at 464, 467), are that EZH is required to reinvest the proceeds of the IJssell Deposit (the equity defeasance account) to secure the free cash payments expected by CED in the later years of the lease term, which are the source of CED's expected return from the Transaction. 19
18

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the utility to re-lease the plant for an additional 17 years at prices that would assure CED of its expected return."); JX 390 ("In either case [comparing EZH's exercise of the Sublease Purchase Option and CED's exercise of the renewal option], CED will receive sufficient funds from the EZH Sub-lessee (as rent and/or proceeds from the sale of the Head Lease pursuant to the [Sublease Purchase Option]) to pay-off the third party loans, recover its equity investment, and earn a return."); Tr. 3051 (Mintun); Tr.3738-40 (Bent); DX 20194, Bates 25120 (noting that even if EZH does not exercise