Tax Court Holds Against Taxpayer In John Hancock
The Tax Court issued its first opinion on lease-in, lease-out ("LILO")/sale-in, lease-out ("SILO") leveraged lease transactions in John Hancock Life Insurance Co v. Commissioner on August 5.1 The controversy concerned John Hancock's involvement in 27 LILO and SILO transactions between 1997 through 2001, but to resolve the matters "expeditiously,"2 the parties agreed to try seven test transactions consisting of three LILOs and four SILOs. The court held in favor of the government and denied John Hancock the tax benefits of all the transactions. In its analysis, the court discussed the decisions of other federal courts that had decided cases involving LILOs and SILOs, including Altria Grp., Inc. v. US,3 BB&T Corp. v. US,4 and Wells Fargo & Co. v. US,5 all of which were also decided against the taxpayers. In John Hancock the IRS asserted that the transactions were, in substance, loans made by the taxpayer rather than true leases or equity investments. The Tax Court found that the IRS had failed to show that the taxpayer had no realistic expectation of profit or business purpose for the relevant transactions, thus holding that the IRS failed to prove that the test transactions lacked economic substance. Nevertheless, the court found that most of the test transactions failed a substance over form analysis and recharacterized those transactions as financing transactions. For the taxpayer, this resulted in additional original issue discount ("OID") income and the loss of various deductions, including interest on non-recourse debt incurred pursuant to the transactions.
Economic Substance Analysis
The Tax Court's 244-page decision begins its analysis of the subject transactions testing for economic substance. Economic substance analysis includes both an objective and subjective test. A transaction passes the objective test if there is economic substance separate from the tax benefits of the transaction. A transaction passes the subjective test if the taxpayer shows a legitimate non-tax business purpose for entering into the transactions. For the objective test, the taxpayer presented evidence of projected cash flow from the investments. The court stated that a net present value calculation for the investments could be useful in this analysis and found that the taxpayer's reports lacked a determination and were inconclusive with respect to the net present value calculation. Nevertheless, the court found that the IRS had not met its burden of proof...
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