Tax Court: Sale Leaseback Deal Fails Substance Over Form Test; Transaction An Improper Tax Dodge Treated As A Loan For Income Tax Purposes

From a recent post in CCH Tax Day Report:

• A series of transactions consisting of a like-kind exchange, coupled with a sale and leaseback between an electricity producer/distributor corporation and two tax-exempt public utilities, were disregarded because they failed the substance over form test.
  
  The transactions were recharacterized as loans because the taxpayer funded the transactions entirely with its own funds and received the funds back with interest in two payments: the first six months after the closing date and the second at the end of the sublease term in the form of the option cancellation payment. In addition, the taxpayer’s return on investment was predetermined and it did not have an upside potential or much of a downside risk.
  
  The transactions were similar to traditional sale/leaseback (SILO) and lease-in/lease-out (LILO) transactions because they created a circular flow of money accompanied by a transfer of tax benefits from a tax-exempt to a taxable entity. In addition, the terms of the transaction ensured that only six months into the deal, the taxpayer was in the same cash position as if it had taken out a loan to finance the transaction.
  
  Moreover, the taxpayer did not have any obligation regarding the maintenance, operation or insurance of the leased property during the sublease term or the remainder of the headlease. Under the terms of the sublease, the municipal utility accepted all of the risks associated with the operation of the power plant during the sublease term. Further, the taxpayer’s due diligence did not indicate any ownership rights because the taxpayer did not follow up on any of the red flags raised in the engineering reports.

For more, see Like-Kind Exchange with Sale and Lease-Back Transactions Were Loans; Penalties Imposed.

For the court ruling, see Exelon Corp. v. Commissioner. 147 T.C. 230 (2016), 147 T.C. No. 9 (September 19, 2016).

The case was subsequently appealed, and affirmed Exelon Corp. v. CIR, 906 F. 3d 513 (7th Cir. 2018).