Reddam v. Commissioner

FOR PUBLICATION

UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT

JOHN PAUL REDDAM, No. 12-72135
Petitioner-Appellant,
Tax Ct. No.
v. 22557-08

COMMISSIONER OF INTERNAL
REVENUE,
Respondent-Appellee. OPINION

Appeal from a Decision of the United States Tax Court

Argued and Submitted
April 10, 2014—Pasadena, California

Filed June 13, 2014

Before: Jerome Farris and Andrew D. Hurwitz, Circuit
Judges, and Paul L. Friedman, District Judge.*

Opinion by Judge Hurwitz

*
The Honorable Paul L. Friedman, District Judge for the U.S. District
Court for the District of Columbia, sitting by designation.
2 REDDAM V. CIR

SUMMARY**

Tax

The panel affirmed the Tax Court’s decision affirming a
decision by the Commissioner of Internal Revenue
disallowing a capital loss deduction because it lacked
economic substance and was intended to create capital losses.

Taxpayer pursued a tax and investment program
marketed by KPMG, the Offshore Portfolio Investment
Strategy (OPIS), to reduce the tax liability associated with
either taking his company public or selling it. Applying the
economic substance doctrine, the panel held that the record
supported the Tax Court’s conclusion that taxpayer pursued
the OPIS product solely for its tax benefits, as well as the
conclusion that the product had no practical economic effects
other than the creation of income tax losses.

COUNSEL

David W. Wiechert (argued) and Jessica C. Munk, Law
Office of David W. Wiechert, San Clemente, California, for
Petitioner-Appellant.

Kathryn Keneally, Assistant Attorney General, Tamara W.
Ashford, Deputy Assistant Attorney General, Gilbert S.
Rothenberg, Richard Farber, and Judith A. Hagley (argued),

**
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
 REDDAM V. CIR 3

Attorneys, Tax Division, Department of Justice, Washington,
D.C., for Respondent-Appellee.

OPINION

HURWITZ, Circuit Judge:

John Paul Reddam claimed a deduction on his 1999 tax
return of $50,164,421 for a capital loss purportedly generated
by several Cayman Islands entities. The Commissioner of
Internal Revenue disallowed the deduction, finding that the
transaction lacked economic substance. After a bench trial,
the Tax Court affirmed. Reddam v. Comm’r, No. 22557-08,
2012 WL 1215220 (T.C. Apr. 11, 2012). We have
jurisdiction over Reddam’s appeal under 26 U.S.C.
§ 7482(a)(1) and affirm.

I. Factual Background

A. Reddam’s $48,500,000 capital tax gain and
search for tax reduction strategies

In 1995, Reddam founded several companies (collectively
“DiTech”) that originated, purchased, and serviced residential
home loans. Reddam was the sole shareholder, chief
executive officer, and chairman of the board of each entity.
Between 1995 and 1997, DiTech grew significantly.

Reddam used KPMG1 for his personal taxes and DiTech’s
corporate returns. KPMG also served as DiTech’s auditor.

1
The firm was named KPMG Peat Marwick until 1999.
4 REDDAM V. CIR

In 1998, Reddam hired a KPMG partner, Scott Carnahan, as
the president of DiTech.

In 1998, Reddam considered either taking DiTech public
or selling it; he also investigated ways to reduce the tax
liability associated with those strategies. Carnahan therefore
introduced Reddam to a KPMG tax partner, Carl Hastings.
Hastings recommended that Reddam pursue a tax and
investment program marketed by KPMG: the Offshore
Portfolio Investment Strategy (“OPIS”).

According to KPMG’s marketing materials, OPIS utilized
“100% leverage offshore” to allow investors “to avoid U.S.
regulatory rules that limit the amount of financing
permissible in securities transactions.” The materials stated
that the strategy “[m]aximizes U.S. investor’s basis in foreign
bank stock and thereby minimizes gain, or maximizes loss, on
the disposition of such stock,” something that would only be
desirable to a U.S. investor with other significant gains to
offset.2 KPMG emphasized that the costs of investing in
OPIS were not based on potential investment gains, but were
instead tied to the amount of “capital gain [tax] exposure” to
be eliminated.

After several meetings with KPMG tax partners, Reddam
understood OPIS to be a “complicated, technical” investment
strategy that involved “some kind of basis shift,” whose
“details were all very, very complicated.” He understood that
OPIS employed “hedging,” so that any potential upside relied

2
The tax code defines the basis of property as “the cost of such
property.” 26 U.S.C. § 1012(a). As a general matter, the greater the basis
a taxpayer has in an asset, the lower the gain on the disposition of that
asset and, hence, the lower the taxes owed.
 REDDAM V. CIR 5

entirely on a rise in an underlying foreign bank stock.
However, in general, Reddam did not “understand how
[OPIS] works.”

Reddam knew that OPIS might “make money,” but
chiefly was drawn to its potential “to be successful relative to
generating a tax loss.” He sought the advice of KPMG tax
partners because he was “looking to make sure that I paid the
lowest tax rate that I could.”

Before investing, Reddam had Carnahan contact KPMG’s
competitors to inquire if they were offering similar “tax
elimination” products. He was informed that several were,
but Ernst & Young was not, because it did not think such a
product “worked.” Carnahan advised Reddam to seek
independent advice because he was “a little concerned that
the same people pitching the transaction and receiving a fee
for that transaction would also be giving the [tax] opinion on
that transaction.” Nonetheless, Reddam never sought
independent investment or legal advice.

In April 1999, GMAC Mortgage Corporation purchased
DiTech, making an initial payment of $70,000,000. Reddam
incurred a $48,500,000 capital tax gain and decided to “enter
the OPIS transaction.”

In early May 1999, Reddam hired KPMG as his “tax
advisor” with respect to OPIS. KPMG again
“recommend[ed] that [Reddam] seek independent advice
concerning the investment aspects of the proposed
transaction.” Reddam never did.
6 REDDAM V. CIR

B. Simplified overview of Reddam’s OPIS
transaction

The Tax Court opinion thoroughly explains the byzantine
OPIS transaction.3 Reddam, 2012 WL 1215220, at *3–12.

3
A professor at the University of Texas at Austin who has testified on
behalf of plaintiffs seeking recovery of costs from KPMG explains OPIS
transactions this way:

The FLIP/OPIS shelter depends technically on the cost
basis of a Cayman Islands entity shifting over to a
related U.S. taxpayer after the Cayman Islands entity
was redeemed out. For each purchaser, a shell Cayman
Islands corporation or partnership was set up that was
related, within the constructive ownership rules of
[26 U.S.C.] section 318, to the U.S. taxpayer who
purchased the shelter. The Cayman Islands entity
bought stock of a foreign bank, either Deutsche Bank or
UBS, with funds borrowed on a nonrecourse basis from
the same bank, in the amount of the artificial loss to be
generated. A few weeks later, the same bank redeemed
all the stock, and the Cayman Islands entity repaid the
bank with the redemption proceeds. The redemption,
however, purported to fail to qualify as a redemption
under U.S. tax law. [See 26 U.S.C. § 302(b)(1).] A
shareholder giving up shares in a failed redemption has
a dividend rather than a sale or exchange and cannot
use its basis in the redeemed shares against the
redemption proceeds. [See id.] FLIP/OPIS rests on the
claim that the basis of the Cayman Islands entity that
could not be used in the redemption transferred over to
bank stock owned by the related U.S. taxpayer who had
purchased the shelter. [See id. § 302(c); 26 C.F.R.
§ 1.302-2(c).] The U.S. taxpayer thus purportedly had
an excess, built-in loss on his bank stock by the amount
 REDDAM V. CIR 7

Given the transaction’s complexity, we detail only those
aspects necessary to explain our holding, and append
KPMG’s graphical description of an OPIS transaction to this
opinion.4

of the original borrowed cost basis of the Cayman
Islands entity. The U.S. taxpayer reported the excess
loss on the sale of his bank stock.

Calvin H. Johnson, Tales from the KPMG Skunk Works: The Basis-Shift
or Defective-Redemption Shelter, 108 Tax Notes 431, 434 (July 25, 2005).
The parties’ joint stipulation of facts explains the steps in OPIS as follows:

KPMG’s OPIS generally involved the following
structured transactions: (i) KPMG client’s purchase of
foreign bank’s stock; (ii) KPMG client’s agreement to
a “swap” transaction with a foreign owned limited
liability company that owned partnership interests in an
off-shore partnership; (iii) KPMG client’s purchase of
a call option to acquire a fifty percent interest in the
general partner of the off-shore partnership; (iv) off-
shore partnership’s purchase of stock in foreign bank
using proceeds from a loan from that bank; (v) offshore
partnership’s purchase of options from foreign bank;
(vi) foreign bank’s purchase of options from off-shore
partnership; (vii) foreign bank’s redemption of the
stock acquired by offshore partnership; and
(viii) client’s purchase of an option to acquire foreign
bank’s stock in an amount equal to the foreign bank
stock redeemed.
4
KPMG planned OPIS transactions to be carried out in a specific
sequence. Although Reddam’s transactions did not occur in the precise
order envisioned by KPMG, the Commissioner does not argue that this
altered the Internal Revenue Code’s treatment of Reddam’s transaction
vis-a-vis a “properly” enacted OPIS transaction.
8 REDDAM V. CIR

First, Reddam5 entered into an Investment Advisory
Agreement with Presidio, a firm owned and operated by
former KPMG partners. Several entities were then created:
(i) a domestic limited liability company owned by a foreign
person (that therefore owed no U.S. taxes, see 26 U.S.C.
§§ 881–85), Clara Street, LLC; (ii) a Cayman Islands
corporation, Clara Street Ltd. (owned by Clara Street, LLC);
and (iii) a Cayman Islands limited partnership, Cormorant LP
(“Cormorant”), whose limited partner was Clara Street LLC
and general partner was Clara Street Ltd. Presidio also
created investment accounts at Deutsche Bank for Reddam
and the entities.

Second, Reddam deposited $6,000,0006 into his Deutsche
Bank account, of which $2,500,000 was used to purchase
Deutsche Bank common stock. The remaining funds were
used to (a) enter into a “rate swap transaction” under which
Reddam made two fixed rate payments to Clara Street LLC
in exchange for the LLC’s agreement to make payments to
Reddam based on the average price of Deutsche Bank stock
during the timeframe of the OPIS transaction (May to July
1999), and (b) buy a call option (the “first call option”) from
Clara Street LLC for $150,000 that permitted Reddam to
either (i) purchase fifty percent of Clara Street Ltd., or
(ii) receive the value of Clara Street Ltd. in cash.

5
On KPMG’s advice, Reddam formed the J. Paul Reddam Trust to
implement the OPIS transaction. Because a grantor trust is disregarded as
an entity for income tax purposes, see 26 U.S.C. § 671, we refer to
Reddam and the trust collectively as “Reddam.”
6
Much of the transaction was carried out in euros. To minimize
complexity, we describe the transaction in approximate U.S. dollar
amounts.
 REDDAM V. CIR 9

Third, Cormorant borrowed approximately $42,000,000
from Deutsche Bank to purchase Bank stock. The stock was
pledged as collateral for the loan, and Deutsche Bank retained
significant control over the stock. Deutsche Bank was also
given a security interest in Clara Street LLC and Clara Street
Ltd., the companies that owned Cormorant.

Fourth, Cormorant and Deutsche Bank engaged in several
options transactions. Cormorant purchased options
exercisable from May to July 1999 that had strike prices
within a narrow range, most of which were tied to the price
of Deutsche Bank stock during that time period.7 The options
permitted Deutsche Bank to purchase a portion of the Bank
stock owned by Cormorant if the price was within a certain
narrow range during May to July 1999.

Fifth, Cormorant sold all the Deutsche Bank stock it held
back to the Bank, using the proceeds to pay off the loan
originally used to purchase the shares. Although the value of
Deutsche Bank stock had risen in the interim, Cormorant
made virtually no profit because the purchase agreement
required Cormorant to sell ninety percent of the stock at a
price below its purchase price.

Sixth, Reddam purchased call options from Deutsche
Bank that permitted him to purchase Deutsche Bank stock in
July or August, 1999 (the “back end options”).

Seventh, Reddam exercised the first call option, opting to
have Clara Street LLC pay him a cash settlement, rather than
sell him the shares in Clara Street Ltd.

7
Cormorant bought a put option, European-style Asian call options, and
European-style fade-in options.
10 REDDAM V. CIR

Eighth, Reddam sold his back end call options to
Deutsche Bank for a profit of approximately $200,000.

Finally, Reddam sold the $2,500,000 of Deutsche Bank
stock he purchased directly for approximately $2,900,000.

C. Simplified overview of Reddam’s calculation of
basis in underlying securities from OPIS
transaction

The purported tax benefits of OPIS hinge on transferring
basis from an off-shore entity to a U.S. taxpayer.
Consequently, we set forth Reddam’s position on how his
bases in the securities underlying his OPIS transaction should
have been calculated.

Reddam paid approximately $2,500,000 for shares in
Deutsche Bank. Cormorant purchased approximately
$42,000,000 of Deutsche Bank stock, using the proceeds of
the loan it obtained from Deutsche Bank. Cormorant and
Reddam were related parties. See 26 U.S.C. § 318. Reddam
therefore took the position that, for tax purposes, he
constructively owned Cormorant’s Deutsche Bank stock. See
§ 318(a)(2)(A), (a)(2)(C), (a)(4), (a)(5). Similarly, Reddam
took the position that Cormorant constructively owned the
$2,500,000 worth of shares that he purchased directly. Thus,
on his 1999 tax returns, Reddam calculated his total basis in
the Deutsche Bank stock, including the purchase prices and
the various brokerage fees, as approximately $43,800,000.

When Cormorant sold its shares in Deutsche Bank back
to the Bank for $42,000,000, Cormorant ordinarily would be
treated as having been completely redeemed under 26 U.S.C.
§ 302(b)(3). But, Reddam took the position that because
 REDDAM V. CIR 11

Cormorant also constructively owned Reddam’s $2,500,000
worth of Deutsche Bank shares, Cormorant’s sale was neither
a complete redemption under § 302(b)(3), nor a substantially
disproportionate redemption under § 302(b)(2). Rather,
Reddam contended that after the sale, there was no
“meaningful reduction” in Cormorant’s ownership of
Deutsche Bank. United States v. Davis, 397 U.S. 301, 313
(1970) (“[T]o qualify for preferred treatment under
[§ 302(b)(1)], a redemption must result in a meaningful
reduction of the shareholder’s proportionate interest in the
corporation.”). Reddam took the position that Cormorant’s
sale of the $42,000,000 of stock to Deutsche Bank was
actually a dividend Cormorant was required to include in
gross income under 26 U.S.C. § 301(c)(1); as a result,
Cormorant now had $42,000,000 in basis it could not use to
offset its gain from the sale of that stock.8 Applying the
constructive ownership rules of § 318, Reddam treated
Cormorant’s unused basis as available to him. See § 302(a);
26 C.F.R. § 1.302-2(c). Hence, after fees and divisions
between the various entities, Reddam claimed a basis of
$43,800,000 in his Deutsche Bank shares, despite having
directly purchased only $2,500,000 worth of shares.

Using essentially the same analysis, Reddam contended
that his bases in (1) the first call option, (2) the rate swap
transaction, and (3) the back-end call options were,
respectively, $9,400,000, $3,650,000, and $164,000.

8
Because Cormorant was a Cayman Islands partnership, it was
indifferent to the U.S. tax consequences of this treatment. See 26 U.S.C.
§§ 881–85.
12 REDDAM V. CIR

D. Reddam’s reported gains and losses on his
1999 tax returns

On his 1999 returns, Reddam reported $48,500,000 of
capital gains from his sale of DiTech, and an offsetting loss
of $50,200,000 from the OPIS transaction. The $50,200,000
loss was based on the following calculations:

Sale Price Cost Basis Gain/Loss
Deutsche Bank $2,900,000 $43,800,000 -$40,900,000
Stock
First Call $800,000 $9,400,000 -$8,600,000
Option
Swap $3,000,000 $3,650,000 -$650,000
Transaction
Back-end Call $98,000 $164,000 -$66,000
Options
Total $6,800,000 $57,000,000 -$50,200,000

II. Procedural Background

In 2001, the IRS announced it would not recognize
alleged tax benefits attributable to OPIS transactions. I.R.S.
Notice 2001-45, 2001-2 C.B. 129. In 2003, the IRS offered
a settlement under which OPIS “participants would give up
80 percent of their tax losses and would still face appropriate
penalties.” Johnson, supra, at 434. The IRS later
“announced that 92 percent of the taxpayers it identified as
buying the shelter have taken the IRS settlement offer.” Id.

Reddam did not accept the offer. The Commissioner
disallowed all of Reddam’s claimed capital losses from the
OPIS transaction and determined a deficiency of $8,000,000
 REDDAM V. CIR 13

on his 1999 returns. Reddam timely challenged the
deficiency in the Tax Court, which conducted a bench trial.

In the Tax Court, the Commissioner urged five different
grounds in support of the deficiency determination. Reddam,
2012 WL 1215220, at *15 & n.12. The court, however,
upheld the deficiency on a single ground, finding that the
OPIS transaction “lacked economic substance.” Id. at
*15–20.

As the Tax Court correctly noted, the

economic substance doctrine is a judicial
mechanism which allows a court to disregard
a transaction for Federal income tax purposes
if it finds that the taxpayer did not enter into
the transaction for a valid business purpose
but rather sought to claim tax benefits not
contemplated by a reasonable application of
the language and purpose of the Code or the
regulations.

Id. at *15. And the Tax Court also recognized, in
determining whether a transaction lacks economic substance,
that the Ninth Circuit generally applies a two-pronged inquiry
addressing the objective nature of the transaction (whether it
has economic substance beyond tax benefits) and the
subjective motivation of the taxpayer (whether the taxpayer
had a non-tax business purpose for the transaction). Id. at
*16–17 (citing Bail Bonds by Marvin Nelson, Inc. v. Comm’r,
820 F.2d 1543, 1549 (9th Cir. 1987)). The Tax Court also
recognized, however, that we have “rejected the notion” that
this is a “‘rigid two-step analysis,’” but rather a single inquiry
into “whether the transaction had ‘any practical economic
14 REDDAM V. CIR

effects’ other than tax benefits.” Id. at *17 (quoting Sacks v.
Comm’r, 69 F.3d 982, 988 (9th Cir. 1995)).

A. Subjective inquiry

The Tax Court appropriately framed the inquiry as
“whether the taxpayer was induced to commit capital for
reasons relating only to tax considerations or whether a
nontax or legitimate profit motive was involved.” Id. at *19
(citing Shriver v. Comm’r, 899 F.2d 724, 726 (8th Cir.
1990)).

After considering the evidence, the court concluded that
Reddam’s “overriding purpose” was tax avoidance. Id.
Reddam became interested in OPIS only after learning it
would “eliminate” his gain from the sale of DiTech, and the
court held that the “economic reality of [the] investment”
belied any profit motive. Id. Reddam’s lack of
understanding of the OPIS transaction, coupled with his “lack
of due diligence” and reliance on opinion letters only from
marketers of the deal also indicated that “he knew he was
purchasing a tax loss rather than entering into a legitimate
investment.” Id. at *20. The Tax Court could not “excuse his
willful indifference as to the profit potential of the transaction
and accept that his uninformed position was sufficient to
satisfy [the] business purpose inquiry.” Id. Rather,
Reddam’s “refusal” to “fully investigate the transaction, by
. . . hiring outside counsel to analyze the transaction . . .
underscore[d] that [he] was entirely unconcerned with the
profitability of the investment.” Id.
 REDDAM V. CIR 15

B. Objective inquiry

The Tax Court acknowledged that a transaction satisfies
the economic substance doctrine if it has “‘any practical
economic effects’ other than tax benefits.” Id. at *16
(quoting Sacks, 69 F.3d at 988). The court therefore
addressed the experts’ reports on the OPIS transaction, to
determine whether “the transaction was likely to produce
benefits aside from tax deductions.” Id. (citing, inter alia,
Bail Bonds, 820 F.2d at 1549). The Commissioner’s expert
(Dr. Kolbe) calculated the OPIS transactions’ net present
value (“NPV”) and the expected rate of return of each
component relative to its individual cost of capital, while
Reddam’s expert (Dr. Miller) performed an expected rate of
return analysis “‘functionally equivalent’ to the NPV
analysis” performed by Dr. Kolbe. Id. at *17. The Tax
Court, however, “ascribe[d] little value” to either of these
calculations because they “do little to aid in our determination
of whether a profit was reasonably likely in the OPIS
transaction.” Id. (internal quotation marks and citations
omitted).

The court did find useful Dr. Kolbe’s “additional
comparison of the ‘values’ of the discrete elements of the
OPIS transaction to their purchase price” because it “does,
partially, illuminate the economics of petitioner’s
investment.” Id. According to Dr. Kolbe, Reddam “overpaid
$2,289,650 for the entire OPIS transaction” because, other
than his direct purchase of Deutsche Bank stock, “each
distinct aspect of the transaction was materially mispriced to
[his] disadvantage.” Id. Although this mispricing was not
“dispositive,” the Tax Court noted, it “signals to this Court
that the transaction was devoid of economic substance.” Id.
16 REDDAM V. CIR

Reddam’s expert, Dr. Miller, claimed that in twenty-three
to twenty-five percent of the possible future price paths the
OPIS transaction could have taken (based on possible
trajectories of the underlying Deutsche Bank stock) a profit
net of tax benefits would result. Id. at *18. Dr. Kolbe argued
that Dr. Miller used an improper measure of volatility and
that these transactions would have resulted in a profit no more
than ten to twelve percent of the time. Id. Without expressly
adopting either analysis, the Tax Court concluded that the
pretax profit potential of OPIS was “so remote as to render
disingenuous any suggestion that the transaction was
economically viable.” Id.

When the “allegedly purposeful mispricing” of the
options and swap agreement were also considered, the court
concluded “it is clear that petitioner remained in an
economically untenable position with little hope of profit
before taking into account the investment’s tax benefits.” Id.
The court was “unconvinced that the mere hint of future
profitability, be it at 10 or 25% likelihood . . . requires this
Court to conclude that the investment was ‘likely’ to produce
benefits aside from substantial capital losses.” Id. (citing Bail
Bonds, 820 F.2d at 1549).

The Tax Court also rejected Reddam’s argument that, had
“the transaction been entered into a few months later, he
would have made several million dollars” because Reddam
suffered a “significant economic loss of approximately
$342,507 on his OPIS transaction.” Id. Rather, the
undisputed facts indicated that “a pretax profit on the
investment was highly unlikely” and Reddam’s own expert
agreed that “on average, and at the median, the transaction
generates a substantial loss.” Id. (internal quotation marks
omitted). Thus, the Tax Court found that “the evidence
 REDDAM V. CIR 17

reveals the OPIS transaction to be clearly lacking in
economic substance,” id., and held that “accordingly, [it]
should be disregarded for tax purposes,” id. at *20.

III. Discussion

A. Standard of Review

The Tax Court’s factual determinations about a
transaction’s economic substance are reviewed for clear error,
but the legal standards it applies and the application of those
standards to the facts are reviewed de novo. Frank Lyon Co.
v. United States, 435 U.S. 561, 581 n.16 (1978); Sacks,
69 F.3d at 986. “In addition, the Commissioner’s
determination that the transaction is a sham is presumptively
correct, and Taxpayers have the burden of producing
evidence to rebut the deficiency determination and [the]
burden of persuasion to substantiate the deduction.” Sochin
v. Comm’r, 843 F.2d 351, 355 n.9 (9th Cir. 1988), abrogated
on other grounds by Landreth v. Comm’r, 859 F.2d 643,
648–49 (9th Cir.1988); see also Welch v. Helvering, 290 U.S.
111, 115 (1933) (stating that Commissioner’s determination
that expenses were not deductible is a “ruling [that] has the
support of a presumption of correctness, and the petitioner
has the burden of proving it to be wrong”).

B. Economic Substance Doctrine

The economic substance doctrine focuses both “on the
subjective aspect of whether the taxpayer intended to do
anything other than acquire tax deductions, and the objective
aspect of whether the transaction had any economic substance
other than creation of tax benefits.” Sacks, 69 F.3d at 987;
see also Casebeer v. Comm’r, 909 F.2d 1360, 1365 (9th Cir.
18 REDDAM V. CIR

1990) (“The economic substance factor involves a broader
examination of whether the substance of a transaction reflects
its form, and whether from an objective standpoint the
transaction was likely to produce economic benefits aside
from a tax deduction.”) (quotation marks and citation
omitted). “[T]he consideration of business purpose and
economic substance are simply more precise factors to
consider in the application of this court’s traditional sham
analysis; that is, whether the transaction had any practical
economic effects other than the creation of income tax
losses.” Sochin, 843 F.2d at 354.

1. Subjective Inquiry

Reddam argues that the Ninth Circuit requires only that
a taxpayer have “a business purpose and not be motivated
solely by tax benefits,” and that the Tax Court improperly
looked only at “whether taxes were the most important
purpose.” This court, however, has “repeatedly and carefully
noted that” the economic substance doctrine is not a “‘rigid
two-step analysis,’” Sacks, 69 F.3d at 988 (quoting Casebeer,
909 F.2d at 1363), but instead focuses holistically on whether
“‘the transaction had any practical economic effects other
than the creation of income tax losses,’” id. (emphasis added)
(quoting Sochin, 843 F.2d at 354).

Reddam argues that the Tax Court failed to properly
credit his testimony which acknowledged his tax motivation,
but also claimed that he entered into the OPIS transaction
hoping to “make money.” But, on the record before it, the
Tax Court was entitled to find that Reddam’s efforts “to
reduce his tax liabilities which prefaced the investment
evidenc[ed] his true motives for engaging in the transaction.”
Reddam, 2012 WL 1215220, at *19. The timing of the OPIS
 REDDAM V. CIR 19

transaction provided compelling evidence of Reddam’s
purpose—to offset the enormous taxable gains accumulated
from his sale of DiTech.

Reddam also argues that his “investment diligence”
distinguishes his case from another OPIS case relied upon by
the Tax Court, Blum v. Commissioner, in which the taxpayer
conceded that he had “no understanding” of many key aspects
of the transaction. No. 2679-06, 2012 WL 129801 (T.C. Jan.
17, 2012), aff’d, 737 F.3d 1303 (10th Cir. 2013). But, even
if Reddam’s due diligence exceeded Blum’s, the Tax Court
properly noted that Reddam nonetheless ignored both
KPMG’s and Carnahan’s recommendations that he seek
independent advice regarding the investment portions of
OPIS. The court was therefore entitled to find, as a matter of
fact, that Reddam was motivated to invest millions of dollars
in OPIS solely because of the anticipated tax benefits of the
transaction. Given the complicated structure of the OPIS
transaction, Reddam’s failure to investigate the scheme
(which he paid KPMG hundreds of thousands of dollars to
implement), belies a profit-making motive.

The KPMG marketing materials also undercut Reddam’s
argument that he entered into the OPIS transaction for its
profit potential. Those materials forthrightly state that the
OPIS transaction “minimizes gain, or maximizes loss,” an
anathema to a profit-seeking investor.9 The record amply

9
Moreover, in calculating the costs of the OPIS transaction, the KPMG
materials list the underlying Deutsche Bank stock and the back-end
options as investments, but list the swap transaction and the first call
option as out-and-out costs of the transactions, not investments capable of
earning a profit.
20 REDDAM V. CIR

supports the Tax Court’s factual conclusion that Reddam
pursued the OPIS product solely for its tax benefits.

2. Objective Inquiry

As noted above, although our cases have analyzed the
question of economic substance in two parts, objective and
subjective, the fundamental question remains whether the
transaction at issue “‘had any practical economic effects other
than the creation of income tax losses.’” Sacks, 69 F.3d at
988 (quoting Sochin, 843 F.2d at 354). Put differently, the
question is whether a reasonable investor would enter into an
OPIS transaction for its possible investment gains. In
addressing this question, we look to the “overall structure” of
the transaction. Keane, 865 F.2d at 1092. Even if a
transaction could “as a theoretical matter . . . result in
economic gains,” it nonetheless lacks substance if it was
“executed in such a manner as to insure that the net result . . .
would be tax deductible losses.” Id. at 1091; see also
Gregory v. Helvering, 293 U.S. 465, 467–70 (1935)
(reviewing the “whole undertaking” and affirming
Commissioner’s disregard of corporate reorganization as
being “without substance” because “[t]o hold otherwise
would be to exalt artifice above reality and to deprive the
statutory provision in question of all serious purpose”).

Reddam argues that, because the Tax Court did not
expressly adopt either expert’s calculation, it implicitly
credited Dr. Miller’s conclusion that the OPIS transaction
could have generated a profit twenty-three percent of the
time, and thus erred as a matter of law in holding that there
“was not a reasonable opportunity for profit under the
economic substance doctrine.” He contends that it “cannot be
 REDDAM V. CIR 21

said that a 23–25% chance of profit is not meaningful and has
no substance whatsoever or is remote.”

In response, the Commissioner argues that Reddam’s
subjective motivation in seeking tax avoidance alone is
sufficient to sustain the Tax Court’s ruling. The
Commissioner also focuses on the fact that the “$50 million
tax loss was wholly artificial” and argues that any transaction
which creates an artificial tax loss is an economic sham. See
Sala v. United States, 613 F.3d 1249, 1253 (10th Cir. 2010).

We decline the parties’ invitations, however, to apply a
one-size-fits-all test. We do not address these issues in
isolation; rather, they are part of a pragmatic total inquiry.
The application of the economic substance doctrine turns not
only on the percentage of possible profit or loss underlying
Reddam’s OPIS transaction, but also on the likely
corresponding magnitude of those possible profits or losses
and how would they be reported for tax purposes. See, e.g.,
Sacks, 69 F.3d at 987–88 (holding that a transaction was not
a sham because it had a purpose of making money after taxes
and shifted risk of non-payment to taxpayer); Casebeer,
909 F.2d at 1361 (holding that a transaction was a sham
because investors had nothing at risk and nothing to gain
except tax benefits); Sochin, 843 F.2d at 354 (holding that a
transaction was a sham because it had no “practical effects
other than the creation of income tax losses”). There was
some theoretical possibility that Reddam’s OPIS transaction
would create a net economic gain. But the magnitude of even
the most optimistic gain is dwarfed by the magnitude of the
tax loss it was designed to generate and the strong probability
of a pretax loss.
22 REDDAM V. CIR

Put differently, the small percentage chance that
Reddam’s OPIS transaction could have created a sizeable
economic gain in return for his multi-million dollar
investment10 pales in comparison to the expectation that it
would always create a tax loss of $42,000,000 to
$50,000,000. No matter how the underlying Deutsche Bank
stock performed, the OPIS transaction was designed
inevitably to produce a tax loss: the $42,000,000 shift of
basis from Cormorant to Reddam would always (even under
Reddam’s expert’s calculations) have overshadowed any
possible gain. On this record, the Tax Court was correct in
concluding that the percentage of likely potential gain did not
infuse economic substance into what was clearly a tax loss
scheme.

Unlike Reddam, we do not read the Tax Court as holding
that a transaction with a ten to twenty-five percent chance of
generating a profit always lacks economic substance. Instead,
we read the Tax Court as properly holding that, in this case,
the evidence is overwhelming that no objective investor or
taxpayer would enter into the OPIS transaction for its profit
making potential. Rather, the overall structure of the OPIS
transaction compels the conclusion that it would be purchased
solely for its ability to create capital losses. See Keane,
865 F.2d at 1091 (affirming the Tax Court’s conclusion that

10
Dr. Miller’s report states that only in highly uncommon circumstances
would the OPIS transaction make any kind of profit, but that five percent
of the time it could make between $3,450,000 and $6,300,000. It defies
belief that an objective investor would risk $6,000,000 on a transaction
that was designed to lose money at least seventy-five percent of the time,
could make a nominal profit twenty percent of the time, but might, only
five percent of the time, have generated profits in that range for any reason
other than to garner the eight-figure tax loss the transaction was designed
to generate.
 REDDAM V. CIR 23

it was the taxpayer’s “entire tax straddle scheme . . . which
taints the deductibility of the . . . losses”) (internal quotation
marks omitted). The Tax Court had ample record support for
its factual conclusion that the OPIS transaction has “‘no
practical economic effects other than the creation of income
tax losses.’” Sacks, 69 F.3d at 987 (quoting Sochin, 843 F.2d
at 354).11

IV. Conclusion

For the reasons above, the judgment of the Tax Court is
AFFIRMED.

11
Like the Tax Court, we therefore find it unnecessary to reach the
Commissioner’s other arguments in support of the deficiency
determination.
24 REDDAM V. CIR

APPENDIX
REDDAM V. CIR 25