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TIFD III-E v. United States

459 F.3d 220 (2006)

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TIFD III-E v. United States

United States Court of Appeals for the Second Circuit

459 F.3d 220 (2006)

Facts

General Electric Capital Corporation (GECC) was in the business of owning airplanes and leasing them to airlines. GECC would offset the taxable income from the leases by depreciating the planes. GECC eventually fully depreciated the planes and sought to restructure its business to maintain the favorable tax treatment. GECC caused one of its subsidiaries, TIFD III-E, Inc. (plaintiff), to form a partnership called Castle Harbour. TIFD III-E contributed the airplanes and lease agreements and a large sum of cash and became the partner that handled Castle Harbour’s tax matters. Two Dutch banks that were not subject to United States tax also contributed cash comprising approximately 20 percent of Castle Harbour’s capital in exchange for what were ostensibly equity interests. The banks’ interests entitled them to a return of their investment at a fixed rate out of Castle Harbour’s operating income, and the banks could liquidate the partnership in the event of default. Moreover, the banks’ return was heavily secured and guaranteed by GECC. The banks were also nominally entitled to a share in surplus profits, although, in practical terms, TIFD III-E had authority to shift such excess returns back to entities affiliated with GECC. In effect, it was very unlikely that the banks would either fail to receive their entitled return or receive any amount substantially above their initial investment. TIFD III-E nevertheless maintained that the banks were equity partners. TIFD III-E allocated 98 percent of Castle Harbour’s taxable income to the Dutch banks. The Internal Revenue Service (IRS) rejected the classification of the Dutch banks as equity partners in Castle Harbour and thus reallocated Castle Harbour’s taxable income to TIFD III-E, which was subject to United States tax. TIFD III-E deposited the additional taxes caused by this reallocation and then sued the United States (defendant) to challenge the IRS’s adjustment. The district court found in favor of TIFD III-E, and the government appealed.

Rule of Law

Issue

Holding and Reasoning (Leval, J.)

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