The Internal Revenue Service won another tax shelter case, this one involving a sale-in/lease-out transaction.
In the case, AWG Leasing Trust v. United States, two large national banks - Key Bank and PNC Bank -disputed adjustments that the IRS made to partnership returns for the 1999-2003 tax years. In those adjustments, the IRS found that the banks' partnership mischaracterized a 1999 transaction as a $423 million purchase of a German waste-to-energy facility. The IRS said the transaction was a thinly veiled tax dodge. The IRS claimed that AWG owed approximately $88 million in taxes for the 1999-2003 tax years and would owe much more in subsequent years.
The banks said they paid $423 million on Dec. 7, 1999, to buy a waste-to-energy facility in Wuppertal, Germany, and should be allowed to depreciate the facility. They argued that their contemporaneous lease of the facility back to the original owner under a very long-term triple-net lease and their grant of an option to repurchase the facility did not defeat their claim of ownership rights to the facility.
The banks also said they should be allowed to deduct interest on the $368 million long-term non-recourse loans that they obtained from two German banks to finance the transaction. However, the loan proceeds went to escrow-type accounts that the German entity could not access and were committed to paying the German company's lease payments and providing sufficient funding to complete the option exercise.
In deciding the case, U.S. District Judge James S. Gwin sustained the IRS's determination that the asserted tax benefits were improper and denied the claimed deductions. The court also upheld the IRS's imposition of accuracy-related penalties at the partnership level for substantial understatement of tax liability.
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