Southlake, Texas, August 19, 2015:
In a decision for the United States, the U.S. Court of Federal Claims disallowed tax losses claimed by an affiliate of the Russian Recovery Fund in an unusual and complex tax shelter case.
The primary actors in the case are three hedge funds:
Tiger Management affiliated funds (“Tiger”) – an independent third party
Russian Recovery Fund (the “RRF”) – the plaintiff
FFIP – the taxpayer and a hedge fund affiliated with the RRF
In 1999, Tiger contributed more than 3.0 billion rubles of Russian debt instruments to the RRF as an in-kind contribution for RRF shares. Although the fair market value of the contribution approximated $15 million, Tiger’s tax basis in the contributed assets exceeded $230 million. Two weeks later, Tiger sold its RRF shares to FFIP for $14.1 million.
The high-level economics of the tax case are illustrated below:
Unlike other tax shelter cases, the RRF case was significantly more complex because the contributed securities generated significant economic returns and had economic substance. Debt typically contributed to Distressed Asset Debt (“DAD”) tax shams involves high basis debt instruments on which little or no value is ever recovered.
The Court’s Opinion
Through the facts of the case and the testimony of its expert witnesses, the U.S. Department of Justice (“DOJ”) demonstrated that Tiger’s in-kind contribution was a disguised sale. They also demonstrated that the RRF’s fund manager was aware that Tiger was a seller of Russian debt rather than an intentional investor in RRF, as the Taxpayer claimed.
The Court found the expert opinions of Chris Lucas, ValueScope Director, to be helpful, citing his testimony 16 times in its opinion, including:
“[Mr. Lucas’] primary opinion was that RRF was structured more as a tax shelter than as a legitimate hedge fund.”
The Court agreed with Mr. Lucas’ expert testimony:
“…that the losses claimed by RRF ($223 million in total) are so disproportionate to its investment in Tiger assets (roughly $14 million) as to be unreasonable. We found Mr. Lucas to be a persuasive and knowledgeable witness.” (page 22)
Mr. Lucas helped the Court appreciate the unreasonableness of the economics claimed by the Taxpayer based on its argument that it had made an at-risk investment in Russian debt. The Court saw through this, however, and realized that FFIP was attempting to earn a large, riskless profit from the US government with significant potential economic upside.
The Court reviewed the facts and concurred with Mr. Lucas’ testimony:
“Our conclusion that Tiger was never a real partner in RRF is arguably sufficient by itself to undo the loss carryover. We would not recognize the transaction as anything other than a sale because that is what Tiger intended it to be. However, there is a massive amount of circumstantial evidence that the RRF was aware early on that Tiger had no real interest in becoming a partner, and was a willing participant at some point in facilitating the transfer of assets through the sham partnership.” (page 35)
About ValueScope, Inc.
ValueScope, Inc. is one of the nation’s foremost experts in complex federal tax matters. ValueScope’s Principals and Directors are called upon to testify regularly in U.S. Tax Court and Federal District Courts. Its team includes experienced valuation experts, management consultants, Chartered Financial Analysts, Certified Public Accountants, PhD’s, statisticians and creative and strategic thinkers.* ValueScope develops sophisticated financial and econometric analyses to support our clients’ needs for litigation support, financial reporting, tax reporting, management consulting, transaction advisory, and other needs.
*ValueScope is not a licensed CPA firm.
For more information on this case contact:
Director and Capital Markets Practice Leader
817 310 5999