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Federal Judge Shoots Down Hundreds of Millions in Tax Losses claimed by Broadcom Co-Founder

On Behalf of | Sep 27, 2012 | IRS, Tax Controversy, Tax Crimes, Tax Debt |

In Broadwood Investment Fund LLC v. United States, No. 08-0295 (C.D. CA Sept. 21, 2012), a California federal district court judge rejected, on summary judgment, a bid by Broadcom co-founder Henry Nicholas, III, to claim hundreds of millions in tax losses from a tax shelter. The shelter was marketed more than a decade ago by myCFO, Inc. The attorney for Mr. Nicholas said that the ruling will be appealed.

Mr. Nicholas’ case involves what is typically called a “DAD” shelter because of the use of distressed assets/debt to generate artificial losses. DAD tax shelters were mostly marketed to wealthy taxpayers in 2001through 2002 after the Internal Revenue Service (IRS) began cracking down on other shelters, such as the notorious Son of Boss shelter. In this shelter, a U.S. taxpayer purchases, via a pass through entity, junk foreign debt for a substantially discounted price, and then claims large paper tax losses. In these transactions, the losses are real, but that were sustained by a foreign lender, not the U.S. taxpayer. In 2004, Congress changed the relevant portions of the Internal Revenue Code to bar partnerships from being manipulated to transfer foreign losses to U.S. taxpayers.

According to government briefs, in December 2001, Mr. Nicholas’ holding company, N&S Holdings, arranged for myCFO to buy pay $6.2 million for $303 million in nonperforming Chinese and Korean loans marketed under the name of Dragons. The government successfully argued that the $6.2 million investment was expected to save Mr. Nicholas and his family trusts roughly $78 million in federal income tax. Not surprisingly, the IRS denied the losses claimed by five of Mr. Nicholas’ partnerships for 2002, 2003 and 2004. He paid the tax and filed multiple suits in district court asserting the losses were proper and that he had invested in distressed debt with a legitimate non-tax purpose diversifying his portfolio, reducing its volatility and enhancing his “risk-adjusted” returns.

U.S. Central District of California Judge, David O. Carter, granted the government’s motion to dismiss Mr. Nicholas’ suits on summary judgment, finding that Mr. Nicholas had failed to show that the partnerships were not shams or that they were formed for the purpose of “carrying on a trade or business by partners or for the sharing of profits and losses from such activity.” Since summary judgment ends a case without a full trial, the government had to show that there was no “genuine issue” of fact in the case. In his ruling, Judge Carter pointed to a December 10, 2001 “welcome letter” that Chenery Associates, which arranged the DAD losses and had a 1% interest in the partnerships, sent to Mr. Nicholas, assuring him the investments in his partnership could “be sold or exchanged before December 31, 2001, without risk of economic loss.” The letter also indicated that Mr. Nicholas would bear the risk of loss and retain the potential for profit for all sales and exchanges made after December 31, 2001.

As a result of the evidence presented by the government, Judge Carter an absence of good faith or business purpose for the partnerships. Additionally, the judge was persuaded by documents demonstrating intent to act without risk of economic loss and not share in profits or losses therefore entities were nothing more than “sham partnerships.”

You can read a copy of the order granting summary judgment here.

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