Plaintiff appeals from defendant's Opinion and Order No. 84-5566 increasing plaintiff's 1981 corporate tax liability. The appeal concerns two deficiency assessments arising from the same transaction, one for Oregon Corporate Excise Taxes and one for Multnomah County Business Income Taxes.
The facts appear deceptively simple. In 1981, plaintiff received a cash payment from another corporation in exchange for the right to use some of plaintiff's federal tax benefits. The equally simple question is whether that payment is taxable either in part or in full. Some background explanation is required in order to appreciate the many facets associated with this question.
1. The Economic Recovery Tax Act of 1981 provided for what is commonly known as Safe Harbor leasing. This was an effort by Congress to stimulate capital investment and promote growth in the nation's economic base. By enacting IRC § 168(f)(8)(1981), Congress allowed one company to use a lease in form only to transfer its tax benefits to another taxpayer. This was a major departure from traditional tax rules. Traditionally, economic realities or the substance of a transaction determined its tax consequences. Safe Harbor leasing, however, elevated form over substance so that there was no pretense of requiring a true lease. The subject transaction, which the parties stipulate constitutes a valid Safe Harbor lease, is a good example.
Prior to 1981, plaintiff experienced some net operating losses which it carried forward for deduction in future years. Those losses would substantially delay realization of the federal tax benefits associated with the equipment plaintiff purchased in 1981. In fact, plaintiff acknowledged that there was "significant" risk that some of its tax benefits might expire before they could be used. Accordingly, plaintiff elected to take advantage of the Safe Harbor leasing provisions by selling the equipment purchased in 1981 to Atlantic Richfield Company (ARCO) and then leasing it back. Plaintiff "sold" *Page 80 $39,347,430.67 of equipment to ARCO at plaintiff's cost. The transaction was structured so that ARCO paid plaintiff $10,572.651.54 as a cash "down" payment and then executed four promissory instalment notes for the balance of $28,774,779.13. At the same time, plaintiff executed four separate leases leasing the equipment back from ARCO. The lease payments under the four leases exactly offset the amounts ARCO was obligated to pay plaintiff under the instalment notes. The only difference appears to be that at the end of the lease period, plaintiff was required to pay ARCO the sum of $1 to repurchase the equipment. The parties have stipulated "there was no actual or legal transfer of ownership of the leased properties" and there is no indication that the parties even went through the motions of making the offsetting payments.
In substance, ARCO paid plaintiff approximately $10 million dollars for the right to use federal income tax benefits associated with the ownership and use of approximately $39 million dollars of tangible property. Except for the Safe Harbor leasing rules, such a transaction would have been laughed out of a tax forum. Even the Safe Harbor leasing provisions recognize that such a lease is treated as such "solely" for federal income tax purpose.
Although Congress provided special rules for federal income taxes, it made no direct provision for the consequences to be realized by such a transaction under state income tax laws. In 1981, the year in issue, Oregon's corporate excise tax laws were patterned after the federal Code but not tied directly to it. That is, ORS chapter 317 contained state definitions of gross income, adjustments and taxable income. As a consequence, defendant asserted a tax on the payment made by ARCO to plaintiff. This was done on the rationale that the payment fell within the definition of gross income then contained in ORS chapter 317 and that there was no other provision expressly providing for its exclusion or deduction. Defendant allowed no basis to be allocated to the payment but treated all of the payment as gain. This resulted in imposition of approximately $809,946 in additional excise and Multnomah County Business Income Tax liabilities.
Is the cash payment taxable? Plaintiff contends not, on several grounds. First, plaintiff argues that the Oregon *Page 81 legislature never intended to tax such payments either before or after the passage of Oregon Laws 1983, chapter 162, section 25. Second, plaintiff contends that the character and nature of the payment make it a federal tax benefit which is not taxable by Oregon. Finally, plaintiff argues that taxing the payment would violate various provisions of the Oregon Constitution and constitute double taxation.
As mentioned above, Congress approved the Safe Harbor leasing in 1981 without specifically dealing with the issue of state income taxation. As a result, Safe Harbor leases were a "hot" issue when Oregon's 1983 Legislature convened. After some study, that legislature adopted chapter 162, section 25, which provides:
"To derive Oregon taxable income, federal taxable income shall be modified to the extent necessary to not treat as a lease purchase or in any other way recognize for Oregon tax purposes a transaction entered into pursuant to section 168(f)(8) of the Internal Revenue Code."
Plaintiff's basic argument is that the 1983 Legislature intended section 25 to apply to all Safe Harbor leases, both before and after 1983. Plaintiff maintains that not only did the legislature intend section 25 to be retroactive, it was also a restatement of the existing tax law.
2. Plaintiff's brief cites minutes and comments from the legislative history to support its view. The problem is that legislative history may be resorted to only if there are ambiguities or questions in the statutes themselves. Whipple v.Howser, 291 Or. 475, 632 P.2d 782 (1981). The first question that must be asked is whether there is any ambiguity or doubt as to the effective date of section 25. The answer to that question is no, since section 58 expressly provides:
*Page 82"Except as specifically provided otherwise, the amendments, repeals and new matter contained in sections 1 to 57 of this Act apply to taxable years beginning on or after January 1, 1983. For all prior taxable years, the law applicable for those years shall remain in full force for the purposes of assessment, imposition and collection of corporation excise and income taxes and for all interest, penalties or forfeitures that have accrued or may accrue with respect to those taxes."
Plaintiff argues strenuously that section 25 is merely a restatement of Oregon's prior law and points to section 41 of the Act as evidence.1 Section 41 provides:
"Insofar as the provisions of sections 2, 11 to 28 and 37 to 41 of this 1983 Act are substantially the same as existing law relating to the taxation of corporations, they shall be construed as restatements and continuations, and not as new enactments."
The court acknowledges an ambiguity is present in that the term "insofar" can be read to mean "inasmuch" or it can be read to mean "to the extent." If interpreted as meaning "inasmuch," then the legislature viewed the enumerated sections as being substantially the same as the existing laws. On the other hand, if it is interpreted to mean "to the extent," then the legislature intended some changes in the law. Despite the fact that the section makes more sense if read as "inasmuch" than "to the extent," the court believes that it is the latter position that must be adopted.2 The reason for the court's conclusion is its finding that section 25 is not merely a restatement of prior Oregon law.
3. Prior to 1983, no Oregon tax statute expressly addressed the problem of Safe Harbor leases. What was the law that would apply and which plaintiff says was the same as section 25? The point apparently had not been ruled on in Oregon. By analogy, one must come to the conclusion that a lease arrangement similar to that involved here would have been treated as a sham transaction. The doctrine of sham transaction was developed by the courts to prevent taxpayers from using labels and forms to avoid the intent and force of the income tax laws. See Gregoryv. Helvering, 293 U.S. 465, 55 S Ct 266, 79 L Ed 596 (1935) [35-1 US Tax Cas (CCH) ¶ 9043]. It is necessary to explore this doctrine in order to determine if it was the same as section 25.
The basic premise of the sham transaction doctrine is that, for purposes of income taxes, all transactions are to be judged by their substance rather than their form to determine *Page 83 their tax effects. For example, in James v. Commissioner,87 TC 905 (1986), a joint venture purported to purchase certain computer equipment from a related company. The equipment was already subject to existing leases. The purported seller of the equipment managed the leases for the joint venture. The court found that under the most optimistic expectations the joint venture could not anticipate any profit from the transaction. In finding that the transactions were totally without economic substance, the court stated:
"The joint ventures acquired no interest in the computer equipment or the leases covering that equipment. Instead, the joint ventures merely purchased a package of tax benefits from CALI." Id., at 924-25.
As the court explained in Rice's Toyota World, Inc. v.Commissioner, 752 F.2d 89, 91 (4th Cir 1985) [85-1 US Tax Cas (CCH) ¶ 9123]:
"To treat a transaction as a sham, the court must find that the taxpayer was motivated by no business purposes other than obtaining tax benefits in entering the transaction, and that the transaction has no economic substance because no reasonable possibility of a profit exists."
When the court finds that a transaction is a sham, it will disregard all aspects of the transaction lacking economic substance. This means, for example, that if a real estate transaction is viewed by the court as a sham, it may deny the taxpayer a cost basis in an asset actually transferred to it.See Decon Corp. v. Commissioner, 65 TC 829 (1976), and NationalLead Co. v. Commissioner, 336 F.2d 134, 141 (2d Cir 1964), certden 380 U.S. 908, 85 S CT 889, 13 L Ed 2d 795 (1965).
4. As the United States Tax Court noted in Rice's Toyota World,Inc. v. Commissioner, 81 TC 184, 207 (1983):
"Under the sham transaction theory by which we disregard the transaction in its entirety, it follows that the 'cash investment' is also not properly includable in taxpayer's basis. Since petitioner was not making an actual investment in an asset, the transaction presents no opportunity other than for tax reduction. The cash down payment, therefore, must be viewed as a fee for purchasing tax benefits."
However, to the extent that a sham transaction contains some element of economic substance, that substance must be recognized. In partially overruling the United States Tax Court, the *Page 84 Court of Appeals in Rice's Toyota World, Inc. v. Commissioner,752 F.2d 89, 96, [85-1 US Tax Cas (CCH) ¶ 9123] (1985) said:
"Grodt itself recognized that a sham transaction may contain elements whose form reflects economic substance and whose normal tax consequences may not therefore be disregarded."
The sham transaction doctrine was developed by the federal courts for purposes of the federal income tax law. The Oregon Legislature, as a matter of policy, has patterned Oregon's income tax laws after federal law with the intent:
"[T]o simplify demands on taxpayers by bringing our income and excise tax laws in substantial conformity with corresponding provisions of the federal law when such could be accomplished without sacrifice to legislative independence and yet retain certain distinct and different features from the federal code." Ruth Realty Co. v. Tax Commission, 222 Or. 290, 294, 353 P.2d 524 (1960).
5. In light of this policy, this court is convinced that prior to the enactment of section 25, a lease arrangement such as involved in this case would have been treated by Oregon courts as a sham transaction.3 Thus, contrary to plaintiff's contentions, section 25 does not incorporate the same treatment as would flow from the finding of a sham transaction. Section 25, by its plain language, ignores all aspects of a Safe Harbor lease arrangement regardless of whether any element of that arrangement has economic substance or not. In essence, the legislature has declared that a Safe Harbor lease will be without any economic substance for purposes of Oregon income tax. This is not the same as the sham transaction doctrine.
Finding that section 25 is neither retroactive nor a restatement of existing Oregon law, the question is: How would Oregon treat a federally approved Safe Harbor lease prior to 1983?
6. When Congress enacted IRC § 168(f)(8)(1981), it made it possible to actually transfer federal tax benefits. Congress thereby imbued such transactions with economic substance. Analyzing the transaction on the basis of its substance *Page 85 rather than its form, plaintiff sold certain rights associated with its tangible personal property to ARCO for cash. However, those rights pertained only to the federal income tax laws and not to Oregon's corporate tax laws. As to Oregon, that element of the transaction was not a sham. In the court's view, it is no different than if plaintiff sold its right to a federal grant or subsidy or some other government benefit. This was not an arrangement whereby the taxpayers hire a strawman or set up dummy corporations or trusts whose forms create shadows complying with the tax laws but which are devoid of economic substance. Zmuda v. Com., 731 F.2d 1417 (9th Cir 1984) [84-1 US Tax Cas (CCH) ¶ 9442] (affirming 79 TC 714). Rather, the transaction between plaintiff and ARCO was an arm's-length transaction negotiated by the parties to establish a price which was paid in cash. It is true that the overall form of the transaction was not a sale of tax benefits, but the sale and leaseback of equipment. However, the form was not a matter of choice, being dictated by federal law.4 Moreover, that element of the transaction containing economic substance, i.e. the sale of tax benefits, is adequately reflected in the form of the transaction. All other aspects of the transaction may be disregarded as a sham transaction without economic substance.
In summary then, the court finds that the sale and leaseback arrangement entered into by plaintiff and ARCO was, with one exception, without economic substance and should be ignored for purposes of Oregon corporate excise taxes. The one element of the transaction which has economic substance and should be recognized by Oregon is the sale by plaintiff of its rights to certain federal deductions and tax credits to ARCO in exchange for the cash payment.
Concluding that section 25 of the Act does not apply and that the existing Oregon law was different from section 25, the court must then consider the tax status of the payment received by plaintiff.
Plaintiff maintains that the payment was either a nonrecognizable refund of federal income taxes or an exempt *Page 86 federal tax subsidy or benefit. The court finds that it was neither. The payment was not a refund because a refund is a return of money from the government. The term "refund" means to recover or receive back money which had been previously paid to the government. US v. Woodmansee, 388 F. Supp. 36, 46 (1975). Plaintiff never paid the $10 million dollars to the government and the money was not returned from the government. The money was a payment from another corporation made to plaintiff in exchange for certain rights of plaintiff associated with plaintiff's property. Moreover, the transaction was not only conditioned on plaintiff maintaining the property in service but also plaintiff would have to pay the money back to ARCO if the IRC or regulations were amended to disallow the anticipated tax benefits.
Likewise, the payment is not a federal subsidy but payment from another taxpaying corporation. Even if it were viewed as an indirect subsidy, it would not be exempt from taxation. Both parties acknowledge in their briefs that Oregon's definition of gross income for ORS chapter 317 is as broad as the federal definition of gross income. The court is unable to find any state law exempting federal payments or subsidies from taxation by Oregon. Likewise, the court knows of no general federal exemption, either legislative or constitutional, that precludes taxation by Oregon. There are too many cases which make it clear that even direct payments from the government can be taxed by the states. See Kennecott Copper Corporation v. StateTax Commission, 116 Utah 556, 212 P.2d 187 (1949); McManus v.Dept. of Rev., 91 Wis 2d 682, 283 N.W.2d 576 (1979); and SaltLake County v. Kennecott Copper Corp., 163 F.2d 484 (10th Cir 1947) cert den 333 U.S. 832, 68 S Ct 458, 92 L Ed 1116 (1947).
Defendant maintains that the payment is entirely taxable gain from the sale of an intangible in which plaintiff had no basis. Defendant cites Copperhead Coal Co. v. Commissioner, 272 F.2d 45 [60-1 US Tax Cas (CCH) ¶ 9108] and H R Distributing Co. v.Commissioner, 31 TCM (CCH) 1014. Those cases are not applicable. The court cannot accept defendant's position because it would require viewing the federal tax benefits as intangible assets completely separate and independent of the tangible personal property involved. Investment tax credits and deductions for depreciation (ACRS) cannot be separated from ownership of the tangible property. If they *Page 87 could be separated there would be no need for a Safe Harbor lease since it is "ownership" of the property which allows ARCO to claim those tax benefits.
"Ownership of property is not a single indivisible concept but a collection or bundle of rights with respect to the property." Merrill v. Commissioner, 40 TC 66, 74 (1963).
One of defendant's reasons for contending that federal tax benefits have no basis is because it would be impractical and contrary to Oregon law to allocate basis to federal tax benefits at the time of purchasing the property. Allocation of basis at the time of purchasing property for purposes of depreciation is not the only time or purpose allocations are made. Basis may be allocated long after purchase when computing gain on the sale of a portion of the property. For example, there is no requirement that the cost basis of real estate be allocated with regard to potential easements, development rights or other ownership elements until such time as those sticks are sold or disposed of from the bundle. See Rev Rul 77-414, 1977-2 CB 299 and Watts, et al v. Erickson, 10 AFTR2d (P-H) 5832, (D Oregon 1962), 62-2 US Tax Cas (CCH) ¶ 9778.
Under Oregon corporate excise tax law existing prior to January 1, 1983, the taxpayer would not know if gain was realized under OAR 150-317.160-(F) until determined under OAR 150-317.210-(A). The relevant part of OAR 150-317.210-(A), which is basically the same as the federal regulation, provides:
"Where property is acquired as a whole without segregation into units and a part of it is subsequently disposed of, ordinarily gain or loss is to be computed on the part disposed of and not held in abeyance until the entire basis is recovered, and a proper portion of the basis is accordingly allocated to the part sold."
However, if it is "practically impossible" to apportion the cost, a taxpayer is entitled to treat the proceeds from the sale of a portion of the property as a recovery of capital up to the amount of his adjusted basis in the property. Rev Rul 79-276, 1972-2 CB 200. For example, in Inaja Land Co. v.Commissioner, 9 TC 727 (1947), the taxpayer sold a "portion" of his real property in the form of a flooding easement which permitted flooding of portions of his property. Since the tax *Page 88 court found that it was impossible to allocate the easement to any particular part of the property, it allowed the taxpayer to report the proceeds from the sale of the easement as a recovery of basis. See also Fasken v. Commissioner, 71 TC 650 (1979);Piper v. Commissioner, 5 TC 1104 (1945); and Rev Rul 70-510, 1970-2 CB 159.
Here it is impossible to allocate a portion of plaintiff's adjusted basis in the equipment to the federal tax benefits associated with the ownership and use of that equipment. The economic realities are that plaintiff has managed to recover a portion of its capital invested in the equipment by selling the federal tax benefits associated with that equipment.
"To avoid the double taxation of income, the concept of basis evolved. It provides a means to distinguish between amounts which have already been taxed or are exempt from tax and those amounts which have not been taxed because the gain or loss has not yet been realized." 3 Mertens, Law Of Federal Income Taxation, § 21.01, at 11.
7. By viewing the payment received by plaintiff as recovery of basis, plaintiff's adjusted basis in the equipment for purposes of state and local taxation in Oregon will be reduced accordingly. This will diminish plaintiff's depreciation deductions for Oregon. From an economic analysis point of view, plaintiff has simply reduced its cost of the equipment by the amount of the cash payment. This being the case, plaintiff's claims of double taxation, violation of the commerce clause and other constitutional violations need not be addressed. Defendant's Opinion and Order No. 84-5566 will be set aside and judgment will be entered consistent with this opinion.
Plaintiff to recover its costs and disbursements incurred herein.
1 Plaintiff's argument is weakened by its correct observation that "there was no clear statement of prior Oregon law or policy on SHLs." Plaintiff's Reply Brief, at 5.
2 The latter reading in effect has the legislature stating that to the extent the enumerated sections are the same as existing laws they are the same as existing laws.
3 It should be noted that except for the existence of IRC § 168(f)(8)(1981), the parties would not have entered into such a transaction since it clearly would fail to qualify as a valid sale-lease-back arrangement.
4 From one point of view the manner by which the tax benefits are transferred should not be important. See for example, Warren Auerbach, Transferability Of Tax Incentives And TheFiction Of Safe Harbor Leasing, 95 Harv L Rev 1752 (1982).