Andantech L.L.C. v. Comm'r

T.C. Memo 2002-97

UNITED STATES TAX COURT

ANDANTECH L.L.C., WELLS FARGO EQUIPMENT FINANCE, INC. (f.k.a.
NORWEST EQUIPMENT FINANCE, INC.), TAX MATTERS PARTNER, AND WELLS
FARGO & COMPANY (f.k.a. NORWEST CORPORATION), A PARTNER OTHER
THAN THE TAX MATTERS PARTNER, ET AL.,1 Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket Nos. 15532-98, 4277-00, Filed April 9, 2002.
6348-00.

On Sept. 28, 1993, A, a limited liability Wyoming
company, composed of two Belgian citizens, BP and FBE,
purchased a portfolio of 40 IBM mainframe computers (the
equipment) from C, for $122,415,762, which was paid: (1)
$14,995,931 in cash (which A borrowed from UBS, a Swiss
bank), and (2) $107,419,831 by A’s notes to C. At the
time of sale, the equipment was under existing leases to
end users and subject to existing liens; the equipment
was sold to A subject to the existing leases and liens.

Simultaneously with its purchase of the equipment,
A leased the equipment back to C.

1
Cases of the following petitioners are consolidated
herewith: Andantech L.L.C., Equipment Investors Co., Inc., A
Partner Other Than The Tax Matters Partner, docket Nos. 4277-00
and 6348-00.
 - 2 -

On Oct. 29, 1993, A sold a portion of the rents due
from C to NationsBank for $87,805,802. The sale of the
rents caused a portion ($87,805,802) of A’s note to C to
accelerate, and the proceeds A received from the sale
were paid to C.

On Dec. 9, 1993, FBE entered into an agreement with
EICI pursuant to which FBE assigned his 2-percent
interest in A to EICI.

On Dec. 10, 1993, BP entered into an agreement with
RDL, a subsidiary of NEFI, pursuant to which (1) BP
exchanged his 98-percent interest in A for 6,150 shares
of preferred stock in RDL, and (2) NEFI agreed to
contribute $14,817,382 in cash to RDL in exchange for 100
shares of RDL common stock.

BP’s transfer of his 98-percent interest in A caused
an acceleration of A’s note to UBS. As a result, RDL and
EICI contributed $14,817,382 and $302,396, respectively,
to the capital of A. A used these amounts (totaling
$15,119,778) to pay the principal and interest due under
its note to UBS.

On its Federal income tax return for the short
period from Sept. 28 to Dec. 10, 1993 (the 12/10/93 short
period), A reported net income of $86,930,096 that was
allocated to BP, FPE, and EICI. On its Federal income
tax return for the short period from Dec. 11 to Dec. 31,
1993 (the 12/31/93 short period), A reported a $2,143,937
loss (consisting of depreciation deductions and interest
expense). A reported a $50,069,397 loss for 1994 (also
consisting of depreciation deductions and interest
expense).

Respondent determined that the sale-leaseback
transaction described above was a prearranged transaction
that lacked business purpose as well as economic
substance. Consequently, in FPAAs issued to A,
respondent determined that the losses claimed by A
($2,143,937 for the 12/31/93 short period and $50,069,397
for 1994) should be disallowed. Additionally, respondent
determined that A should have reported $87,805,801 of
income for the 12/31/93 short period.

Held: A is disregarded because BP and FPE did not
intend to join together for the purpose of carrying on a
business as partners or sharing in the profits and losses
from an equipment leasing activity.
 - 3 -

Held, further, alternatively, participation of BP,
FBE, and EICI in the sale-leaseback transaction described
above is disregarded under the step transaction doctrine.

Held, further, the sale-leaseback transaction
described above lacked a valid business purpose, as well
as economic substance, and thus is not to be respected
for Federal tax purposes. Consequently, (1) A is not
required to include the sale of the rents ($87,805,801)
as income for the 12/31/93 short period, (2) A is not
entitled to deduct $2,143,937 as expenses from “other
rental activities” for the 12/31/93 short period, and (3)
A is not entitled to deduct $50,069,397 of similar
expenses for 1994.

Mark Alan Hager, Walter A. Pickhardt, John R. Kalligher,

William K. Wilcox, and Myron L. Frans, for petitioners in

docket No. 15532-98.

Walter A. Pickhardt, Mark Alan Hager, and William K.

Wilcox, for petitioner in docket No. 4277-00.

Walter A. Pickhardt, for petitioner in docket No. 6348-00.

Robert M. Ratchford, Donna C. Hansberry, John C. Schmittdiel,

and Robert J. Burbank, for respondent.
 - 4 -

CONTENTS

FINDINGS OF FACT . . . . . . . . . . . . . . . . . . . . . . . 7

I. Norwest and Its Affiliated Group . . . . . . . . . . . . . 7
A. Norwest . . . . . . . . . . . . . . . . . . . . . . . 7
B. NEFI . . . . . . . . . . . . . . . . . . . . . . . . 8

II. Comdisco and CIG . . . . . . . . . . . . . . . . . . . . . 8

III. Negotiations . . . . . . . . . . . . . . . . . . . . . . 12
A. CIG’s Initial Discussions With Norwest and NEFI . . 12
B. NEFI’s Credit Approval Presentation . . . . . . . . 14
C. Financial Projections and Appraisals . . . . . . . 16
D. The Foreign Investors . . . . . . . . . . . . . . . 25

IV. Formation of Andantech and the Sale-Leaseback (Appendixes
A, B, and C) . . . . . . . . . . . . . . . . . . . . . . 28
A. The Purchase Price . . . . . . . . . . . . . . . . 30
B. The Equipment Lease . . . . . . . . . . . . . . . . 31
C. The Bank Loan . . . . . . . . . . . . . . . . . . . 37

V. Sale of Comdisco Rents (Appendix D) . . . . . . . . . . 39

VI. Mr. de la Barre d’Erquelinnes’s and Mr. Parmentier’s
Withdrawal From Andantech . . . . . . . . . . . . . . . 41
A. Mr. de la Barre d’Erquelinnes’s and Mr.
Parmentier’s Withdrawal of Capital Contributed to
Andantech . . . . . . . . . . . . . . . . . . . . . 41
B. Transfer of Mr. de la Barre d’Erquelinnes’s
Membership Interest in Andantech to EICI (Appendix
E) . . . . . . . . . . . . . . . . . . . . . . . . 41
C. Transfer of Mr. Parmentier’s Membership Interest to
RD Leasing in Exchange for Preferred Stock
(Appendix F) . . . . . . . . . . . . . . . . . . . 42

VII. Repayment of Bank Loan (Appendixes F and G) . . . . . . 43

VIII. Sale of Computer to End User . . . . . . . . . . . . . 44

IX. Comdisco’s Exercise of Early Termination Options . . . . 45

X. Dissolution of RD Leasing and Andantech . . . . . . . . 50

XI. Andantech’s Federal Income Tax Returns . . . . . . . . . 50

XII. Respondent’s Determinations . . . . . . . . . . . . . . 52
A. FPAAs for the 1993 Short Years . . . . . . . . . . 52
B. FPAA for the 1994 Taxable Year . . . . . . . . . . 53
 - 5 -

OPINION . . . . . . . . . . . . . . . . . . . . . . . . . . . 53

I. Procedural Issues . . . . . . . . . . . . . . . . . . . 53

II. Whether the Sale-Leaseback Transaction Should Be
Respected . . . . . . . . . . . . . . . . . . . . . . . 55
A. Overview of Statutory Framework for the
Transactions . . . . . . . . . . . . . . . . . . . 56
B. Positions of the Parties . . . . . . . . . . . . . 61
C. Analysis . . . . . . . . . . . . . . . . . . . . . 62
1. Andantech Is Not a Valid Partnership and Is
Not Recognized for Federal Tax Purposes . . . 64
a. Andantech-Foreign Should Be Disregarded
Because Messrs. Parmentier and de la
Barre d’Erquelinnes Did Not Intend To
Join Together for the Purpose of Carrying
On a Business and Sharing in the Profits
or Losses From the Equipment Leasing
Activity . . . . . . . . . . . . . . . . 65
b. Andantech-US Should Be Disregarded
Because EICI Did Not Intend To Join With
RD Leasing for the Purpose of Carrying On
Partnership Business and Sharing in the
Profits or Losses From the Partnership’s
Equipment Leasing Activity . . . . . . . 68
2. Andantech Acted as a Mere Shell or Conduit To
Strip the Income From the Transaction and
Avoid Income Taxation and, Under the Step
Transaction Doctrine, Should Be Disregarded . 69
a. Binding Commitment Test . . . . . . . . . 71
b. End Result Test . . . . . . . . . . . . . 72
c. Interdependence Test . . . . . . . . . . 75
3. The Sale-Leaseback Transaction Lacked Business
Purpose and Economic Substance . . . . . . . . 82
a. The Experts . . . . . . . . . . . . . . . 84
b. No Reasonable Possibility for Profit
Existed . . . . . . . . . . . . . . . . . 89
c. RD Leasing/Norwest Was Not Motivated by
Any Business Purpose Other Than Obtaining
Tax Benefits . . . . . . . . . . . . . . 95
i. Presence or Absence of Arm’s-Length
Price Negotiations . . . . . . . . . 97
ii. The Relationship Between the Selling
Price and the Fair Market Value . . 99
iii. The Structure of the Financing . . . 99
iv. The Degree of Adherence to
Contractual Terms . . . . . . . . . 102
v. The Reasonableness of the Income and
 - 6 -

Residual Value Projections . . . . . 104
vi. Insertion of Other Entities . . . . 106
4. The Transaction Was Not a Sale and the
Financing Did Not Constitute Genuine Debt . . 108
D. Conclusion . . . . . . . . . . . . . . . . . . . . 112

APPENDIX A . . . . . . . . . . . . . . . . . . . . . . . 114

MEMORANDUM FINDINGS OF FACT AND OPINION

JACOBS, Judge: Respondent issued Andantech, L.L.C.

(Andantech), a limited liability Wyoming company, notices of final

partnership administrative adjustment (FPAAs) that reflected

adjustments to Andantech’s partnership returns for taxable years

which ended on December 10, 1993 (the 12/10/93 FPAA), December 31,

1993 (the 12/31/93 FPAA), and December 31, 1994 (the 12/31/94

FPAA).

These consolidated cases involve an equipment sale-leaseback

transaction that is described in flow chart form, in attached

appendixes A through G. The transaction is designed to produce tax

benefits to RD Leasing, Inc. (RD Leasing), a member of an

affiliated group in which Norwest Corp. (Norwest) is the common

parent, through RD Leasing’s membership in Andantech.

The substantive issue to be resolved is whether the sale-

leaseback transaction involved herein should be respected for

Federal tax purposes.

All section references are to the Internal Revenue Code as in

effect for the years in issue.
 - 7 -

FINDINGS OF FACT

Some of the facts have been stipulated and are found

accordingly. The stipulations of facts and the attached exhibits

are incorporated herein by this reference.

I. Norwest and Its Affiliated Group

A. Norwest

At all relevant times, Norwest was a Delaware corporation,

maintaining its principal place of business in Minneapolis,

Minnesota. In 1998, Norwest merged with Wells Fargo & Co. Norwest

was the surviving corporation, but it subsequently changed its name

to Wells Fargo & Co.

Norwest is a bank holding company registered with the Federal

Reserve Bank under the Bank Holding Company Act of 1956. Norwest’s

affiliates provide banking and other financial services. From 1993

through 1996, Norwest and its affiliated corporations filed

consolidated Federal income tax returns. Norwest is a publicly

held company whose stock is traded on the New York Stock Exchange

and on the Midwest Stock Exchange.

J. Daniel Vandermark was Norwest’s senior vice president of

tax; he reported to John Thornton, Norwest’s chief financial

officer. All sale-leasebacks had to be approved by Mr. Vandermark.

B. NEFI

Norwest Equipment Finance, Inc. (NEFI), now known as Wells

Fargo Equipment Finance, Inc., is a Minnesota corporation engaged

in the business of equipment leasing. At all relevant times, NEFI
 - 8 -

was a wholly owned subsidiary of Norwest Bank Minnesota, N.A.

(NBM), which in turn was a wholly owned subsidiary of Norwest.

NEFI was actively involved in leasing transactions involving

“middle market” equipment (i.e., equipment having a market value

between $25,000 and $2 million). NEFI was also involved, albeit to

a lesser extent, in leasing transactions involving higher end

equipment.

Within the Norwest group, sale-leasebacks were usually taken

in the name of NEFI’s parent, NBM. James Renner was president of

NEFI. Phyllis Grossman was vice president of sale-leaseback

transactions for NEFI. She was primarily responsible for reviewing

the structure of, and overseeing the completion of, all proposed

sale-leaseback transactions.

NEFI employed the law firm of Faegre & Benson (and used the

services of David Beadie and John Steffen) to render legal advice

with respect to the sale-leaseback transaction involved herein.

II. Comdisco and CIG

Comdisco, Inc. (Comdisco), is a Delaware corporation with its

principal place of business in Rosemont, Illinois. Comdisco is a

publicly held corporation whose stock is traded on the New York

Stock Exchange. Comdisco is a lessor, dealer, and remarketer of

computer equipment. In 1993, it was the largest independent

computer leasing company in the United States.

Comdisco purchases computers primarily through debt financing.

After entering into a lease with a customer (existing lease),
 - 9 -

Comdisco borrows, on a nonrecourse basis, an amount equal to the

present value of the rental payments due under the lease (existing

financing) from a financial institution or insurance company. Such

borrowing is secured by an assignment of the rents and a lien on

the equipment (existing lien). Comdisco rarely obtains sufficient

proceeds from the existing financing to fund the total cost of the

equipment. (The balance of the equipment cost is referred to as

the equity portion. The equity portion ranges from 10 to 25

percent of the cost of the equipment, depending on the length of

the lease and the type of equipment.) Comdisco recovers a portion

of the equity portion by entering into sale-leaseback transactions

with third parties.

In a sale-leaseback transaction, the third party purchases the

equipment (subject to the existing lease and existing lien) and

leases it back to Comdisco. Generally, the present value of rent

paid by Comdisco to the third party is less than the purchase price

paid by the third party. The third party obtains the depreciation

deductions associated with the equipment and is entitled to the

residual value of the equipment at the end of the lease. Ideally,

the transaction is structured so that the third party can recover

most of his investment from the residual value and profits from the

tax savings he receives from depreciation and interest deductions.

Comdisco also obtains a tax benefit from the transaction; the sale-

leaseback transaction allows Comdisco a deduction for the rent it

pays to the third party (instead of a deduction for depreciation of
 - 10 -

the equipment), thereby reducing Comdisco’s alternative minimum

tax.

Between 1993 and 1996, Comdisco had a wholly owned subsidiary,

Comdisco Investment Group, Inc. (CIG). CIG’s executives included:

Frank Trznadel-–president; Robert Snyder--executive vice president;

and Paula Ortmann–vice president.

CIG assisted Comdisco in structuring sale-leaseback

transactions of computers involving foreign investors and U.S.

corporations (domestic corporations), referred to by Comdisco as

cross-border equipment leasing transactions. CIG presented to

domestic corporations proposals for cross-border equipment leasing

transactions between Comdisco, partnerships made up of the foreign

investors, and the domestic corporations.2 The proposals stated in

relevant part:

COMDISCO EQUIPMENT LEASING CONCEPT

Comdisco has developed a cross-border equipment
leasing transaction that produces permanent U.S. tax
savings through the advantageous use of U.S. tax rules
concerning the acceleration of taxable income from rents.

Unlike most Western countries, the United States
treats as taxable income any amounts received as prepaid
rent or as proceeds from a sale, without recourse, of a
stream of rental payments. These amounts are income even
though they are unearned and are attributable to future
years.

2
Comdisco had entered into transactions similar to the
transaction at issue in these cases. Prior transactions involved
the participation of the following four partnerships: Fillupar
Leasing (1991); Astropar Leasing (1991); Compupar Leasing (I)
(1992); and Compupar Leasing (II) (1992).
 - 11 -

As will be shown below, the unusual U.S. treatment
of these income amounts creates an opportunity for an
“arbitrage” between the U.S. tax system and that of
another country (such as Belgium) which does not treat
the amounts as currently taxable income.

The essential elements of the transaction are as
follows:

1. Two Belgian individuals, with experience in all
aspects of the leasing business, purchase a portfolio of
U.S. computer equipment from Comdisco, Inc. (“Comdisco”).
The purchase is made through an entity that is treated as
a partnership for U.S. tax purposes (the “Partnership”).
The equipment is immediately leased back to Comdisco,
which in turn subleases the equipment to its customers,
the users of the equipment. Neither the Partnership nor
its partners are subject to U.S. tax.

2. Subsequently, the Partnership sells to a bank
the right to receive the rents payable by Comdisco under
the lease. The sale of the Comdisco rent stream is
without recourse to either the Partnership or to the
equipment. Accordingly, from a U.S. point of view, all
of the rental income from the Comdisco lease is deemed to
have been accelerated. Stated another way, the sale of
the rent stream removes or “strips” the rental income
from the leased equipment.

3. At a later date, but without any prior
commitment (formal or informal) to do so, a U.S. company
may acquire a 98% interest in the Partnership, utilizing
certain provisions of the U.S. tax code under which tax
attributes carry over to the new owner.

4. The U.S. company, as 98% partner, would be
entitled to depreciation with respect to 98% of the cost
of the equipment. No rental income would be reportable
by the U.S. company, that income having been accelerated
into the tax period prior to the U.S. company’s becoming
a partner.

5. The resulting U.S. tax savings from the
depreciation would be permanent tax savings, not mere
deferrals. They would be reflected in reported earnings.

The law firm of Baker & McKenzie provided Comdisco with legal

services related to the sale-leaseback transactions.
 - 12 -

III. Negotiations

A. CIG’s Initial Discussions With Norwest and NEFI

In June 1993, representatives from CIG (Mr. Trznadel, Mr.

Snyder, and Ms. Ortmann), Norwest (Mr. Vandermark), NEFI (Ms.

Grossman), and Peat Marwick met to discuss a cross-border equipment

leasing transaction involving a portfolio of IBM computer equipment

(ultimately, the sale-leaseback transaction involved herein). At

this meeting, representatives of CIG made a presentation from a

paper (entitled “Equipment Leasing Proposal” (the Proposal)), and

various flowcharts that outlined the elements and tax benefits of

a proposed cross-border equipment leasing transaction.

Following the June presentation by CIG, Ms. Grossman requested

additional information from Comdisco. On July 6, 1993, Ms. Ortmann

sent Ms. Grossman an economic analysis of a hypothetical sale-

leaseback transaction involving a $75 million portfolio of computer

equipment.3 On August 3, 1993, Ms. Ortmann provided Ms. Grossman

with sample documents (including a contract for sale of equipment,

lease, notes, security agreements, and a contract for sale of the

lease receivable) which could be used in connection with a proposed

cross-border equipment leasing transaction. Ms. Grossman gave

these documents to NEFI’s attorneys for their review. Ms. Grossman

also requested, by interoffice memo, that the articles of

3
The economic analysis of a $75 million portfolio shows
a cash investment by the 98-percent shareholder of $9,252,693 and
a pretax profit of 6.1 percent using an estimated residual value
on the lease termination date of $22,754,717.
 - 13 -

incorporation of a then-dormant corporation, known as Radio Dealers

Leasing, Inc.,4 be amended so as to change the name of the

corporation to RD Leasing, Inc. (RD Leasing).5 RD Leasing was to

become the U.S. company involved in the sale-leaseback transaction

which is the subject of this litigation.

On August 6, 1993, Ms. Ortmann provided Ms. Grossman with a

portfolio of computers owned by Comdisco valued at $94 million

which could be the subject of a cross-border equipment leasing

transaction. The equipment Comdisco proposed to sell and

simultaneously lease back was subject to existing leases between

Comdisco (as lessor) and others (i.e., large corporations and

institutions) as end users. The equipment was also subject to

existing liens securing nonrecourse loans. Some of the existing

leases required the consent of the end user to any sale of the

equipment by Comdisco. A draft of a letter to one of the end

users, dated August 30, 1993, requested written consent to a sale

of the equipment to Norwest Bank Corp. and assured that the

“transfers are subject, subordinate to and in no way alter your

rights under the Lease. Comdisco remains responsible for all of

its obligations as Lessor of the Equipment to the same extent as if

the transfers had not occurred.” Letters dated September 7, 1993,

4
Radio Dealers Leasing, Inc., was organized as a
corporation under Minnesota law on Apr. 20, 1988.
5
NEFI owned all the common stock of RD Leasing during
the years in issue and through the dissolution of RD Leasing in
1997.
 - 14 -

to two end users requested written consent for a sale to “a bank

with a combined capital and surplus of at least $50,000,000”. A

letter to another end user stated that the sale was to a Wyoming

limited liability company. The letters to the end users also

stated that Comdisco had the option to repurchase the equipment at

the end of the lease and “expect[ed] to do so”.

On August 30, 1993, Ms. Grossman faxed CIG Norwest’s credit

standards for end users of the equipment.6

B. NEFI’s Credit Approval Presentation

Mark Valentine, assistant vice president of credit for NEFI,

managed a staff of credit analysts and officers. His role in the

sale-leaseback transaction involved herein was limited to reviewing

Comdisco’s creditworthiness and ability to service any acquired

portfolio of leased computers.

On September 2, 1993, having received information regarding

the proposed sale-leaseback transaction from Ms. Grossman, Mr.

Valentine authorized a “Transaction Credit Analysis”, referred to

within NEFI as a “Credit Approval Presentation” (CAP). The stated

purpose of the CAP was to review “Comdisco’s ability to service an

acquired portfolio and, in the event of a sub-leasee default,

replace equipment leases.” The CAP emphasized that the risk of the

6
The creditworthiness of the end user was important
because the computers sold (as well as the rents due Comdisco
from the end users) had been used by Comdisco as collateral to
secure its own loans and were subject to the existing liens.
Ms. Grossman, however, did not inquire into the amounts of the
existing liens, and that information was not provided to her.
 - 15 -

transaction was rated “purely on the credit of Comdisco and not on

the risks inherent in this tax advantaged lease transaction”.

The CAP stated in relevant part: “All credit and tax risks

will be assumed by Norwest Tax Department”; NEFI’s role would be

“that of consultant”; and NEFI would be paid a fee for its

services. The CAP also contained a “Collateral” section,

reflecting that “Limited value is placed upon the collateral with

the transaction’s purpose being tax driven and subject to Norwest

Tax Department approval. However, there is upside potential for

the benefit of Norwest Corporation.” The CAP further stated that

“Credit risk is considered remote based upon Comdisco’s credit,

substantial underlying lessees and short 36 month term.”7

Because Mr. Vandermark was head of the Norwest tax department,

his signature was required on all CAPs involving sale-leaseback

transactions. Mr. Vandermark had to verify that Norwest had

taxable income sufficient to use the desired tax benefits.

Various Norwest and NEFI officers signed the CAP; the last

signature was dated September 21, 1993. The CAP approved

7
According to Mr. Vandermark and Mr. Renner, president
of NEFI, all sale-leaseback transactions have substantial tax
benefits; the “upside potential” (as referred to in the CAP) was
“in the residuals”. According to Ms. Grossman, the CAP’s
reference to “tax driven” meant that there were tax benefits
associated with the proposed sale-leaseback transaction and that
there was “residual upside”, meaning that the residual value of
the computers could produce a substantial economic profit.
 - 16 -

Comdisco’s credit rating but did not commit Norwest, NEFI, or RD

Leasing to enter into the sale-leaseback transaction involved

herein.

C. Financial Projections and Appraisals

CIG had a contract with Marshall & Stevens (M&S) pursuant to

which M&S agreed to provide appraisal reports for the computer

equipment in Comdisco’s portfolio. M&S agreed to perform quarterly

appraisals for $1,500 per quarter and to submit to CIG reports

derived from these quarterly appraisals at $300 per report. M&S

sent the reports to James Hastings, a CIG executive. Mr. Hastings

prepared financial analyses (including the modeling of the

economics of transactions CIG proposed), handled various accounting

issues, and worked with appraisers.

When the sale-leaseback transaction involved herein was

proposed, Mr. Hastings used the M&S report to interpolate the

values stated therein to arrive at values relevant to the specific

dates in the proposed transaction. He then presented these

interpolated numbers to Greg Barwick, one of M&S’s appraisers.8

CIG had a letter, dated September 25, 1993, delivered by

messenger to Ms. Grossman, as well as Messrs. Beadie and Steffen.

That letter included red-lined drafts of the documents for the

8
Mr. Hastings prepared an equipment schedule with
current and projected residual values to verify that the numbers
were still “in force as of the date of the transaction in case
the transaction date fell between a couple of quarters”. Mr.
Barwick used Mr. Hastings’ equipment schedule to write his
appraisal report.
 - 17 -

proposed sale-leaseback transaction, as well as a financial

analysis (the September Projections), which consisted of economic

projections relating to the transaction: one projection was

premised upon the assumption that Comdisco would exercise an early

termination option,9 while the other was premised upon the

assumption that Comdisco would not. The assumptions as to the

residual values were identical to the forecasts set forth in the

appraisal of the equipment dated September 28, 1993, provided by

M&S.

The following charts set forth the economic projections with

respect to the proposed purchasing partnership (charts 1-8) and to

the proposed U.S. company partner (charts 9-12):

9
Early termination dates and final termination dates
were specified in the documents.
 - 18 -

Chart 1
Computation of Partnership Taxable Income With Estimated Residual Value Proceeds
(Assumes Full Term)
Interest Expense
Year Sale Rent Additional Depreciation Install. Balloon Residual Taxable
Ending Receivable Fixed Rent Deduction Bank Loan Note Note Income Income(Loss)
11/28/93 $87,793,608 -0- -0- ($106,409) ($364,289) ($300,982) -0- $87,021,928
12/31/93 -0- -0- ($6,120,788) -0- -0- (305,514) -0- (6,426,302)
12/31/94 -0- -0- (46,517,990) -0- -0- (1,932,141) -0- (48,450,131)
12/31/95 -0- -0- (27,910,794) -0- -0- (2,113,390) -0- (30,024,183)
12/31/96 -0- $19,385,022 (16,746,476) -0- -0- (2,158,409) -0- 480,136
12/31/97 -0- 6,003,302 (25,119,714) -0- -0- (335,666) $25,418,982 5,966,904
Total 87,793,608 25,388,324 (122,415,762) (106,409) (364,289) (7,146,103) 25,418,982 8,568,352

Chart 2
Computation of Partnership Cash Flow With Estimated Residual Value Proceeds
(Assumes Full Term)
Debt Service
Year Equipment Install. Balloon Sale Rent Additional Residual Pretax
Ending Purchase Bank Loan Note Note Receivable Fixed Rent Income Cash Flow
11/28/93 ($122,415,762) $14,995,931 ($364,289) $19,990,512 $87,793,608 -0- -0- -0-
12/31/93 -0- (15,102,340) -0- -0- -0- -0- -0- ($15,102,340)
12/31/94 -0- -0- -0- -0- -0- -0- -0- -0-
12/31/95 -0- -0- -0- -0- -0- -0- -0- -0-
12/31/96 -0- -0- -0- (4,819,668) -0- $19,385,022 -0- 14,565,354
12/31/97 -0- 0- -0- (22,316,947) -0- 6,003,302 $25,418,982 9,105,338
Total (122,415,762) (106,409) (364,289) (7,146,103) 87,793,608 25,388,324 25,418,982 8,568,352
 - 19 -

Chart 3
Computation of Partnership Taxable Income Without Estimated Residual Value Proceeds
(Assumes Full Term)
Interest Expense
Year Sale Rent Additional Depreciation Install. Balloon Balloon Note Taxable
Ending Receivable Fixed Rent Deduction Bank Loan Note Note COD Income Income(Loss)
11/28/93 $87,793,608 -0- -0- ($106,409) ($364,289) ($300,982) -0- $87,021,928
12/31/93 -0- -0- ($6,120,788) -0- -0- (305,514) -0- (6,426,302)
12/31/94 -0- -0- (46,517,990) -0- -0- (1,932,141) -0- (48,450,131)
12/31/95 -0- -0- (27,910,794) -0- -0- (2,113,390) -0- (30,024,183)
12/31/96 -0- $19,385,022 (16,746,476) -0- -0- (2,158,409) -0- 480,136
12/31/97 -0- 6,003,302 (25,119,714) -0- -0- (335,666) $20,335,186 883,108
Total 87,793,608 25,388,324 (122,415,762) (106,409) (364,289) (7,146,103) 20,335,186 3,484,555

Chart 4
Computation of Partnership Cash Flow Without Estimated Residual Value Proceeds
(Assumes Full Term)
Debt Service
Year Equipment Install. Balloon Sale Rent Additional Residual Pretax
Ending Purchase Bank Loan Note Note Receivable Fixed Rent Income Cash Flow
11/28/93 ($122,415,762) $14,995,931 ($364,289) $19,990,512 $87,793,608 -0- -0- -0-
12/31/93 -0- (15,102,340) -0- -0- -0- -0- -0- ($15,102,340)
12/31/94 -0- -0- -0- -0- -0- -0- -0- -0-
12/31/95 -0- -0- -0- -0- -0- -0- -0- -0-
12/31/96 -0- -0- -0- (4,819,668) -0- $19,385,022 -0- 14,565,354
12/31/97 -0- 0- -0- (1,981,761) -0- 6,003,302 -0- 4,021,541
Total (122,415,762) (106,409) (364,289) 13,189,083 87,793,608 25,388,324 -0- 3,484,555
 - 20 -

Chart 5
Computation of Partnership Taxable Income With Estimated Residual Value Proceeds
(Assumes Early Termination)
Interest Expense Residual &
Year Sale Rent Depreciation Install. Balloon Early Term. Taxable
Ending Receivable Deduction Bank Loan Note Note Penalty Income (Loss)
11/28/93 $87,793,608 -0- ($106,409) ($364,289) ($300,982) -0- $87,021,928
12/31/93 -0- ($6,120,788) -0- -0- (305,514) -0- (6,426,302)
12/31/94 -0- (46,517,990) -0- -0- (1,932,141) -0- (48,450,131)
12/31/95 -0- (27,910,794) -0- -0- (2,113,390) -0- (30,024,183)
12/31/96 -0- (41,866,191) -0- -0- (940,072) $44,619,804 1,813,541
Total 87,793,608 122,415,762 (106,409) (364,289) (5,592,099) 44,619,804 3,934,853

Chart 6
Computation of Partnership Cash Flow With Estimated Residual Value Proceeds
(Assumes Early Termination)
Debt Service
Year Equipment Install. Balloon Sale Rent Early Term. Pretax
Ending Purchase Bank Loan Note Note Receivable Penalty Cash Flow
11/28/93 ($122,415,762) $14,995,931 ($364,289) $19,990,512 $87,793,608 -0- -0-
12/31/93 -0- (15,102,340) -0- -0- -0- -0- ($15,102,340)
12/31/94 -0- -0- -0- -0- -0- -0- -0-
12/31/95 -0- -0- -0- -0- -0- -0- -0-
12/31/96 -0- -0- -0- (25,582,611) -0- $44,619,804 19,037,193
Total (122,415,762) (106,409) (364,289) (5,592,099) 87,793,608 44,619,804 3,934,853
 - 21 -

Chart 7
Computation of Partnership Taxable Income Without Estimated Residual Value Proceeds
(Assumes Early Termination)
Interest Expense
Year Sale Rent Depreciation Install. Balloon Early Term. Taxable
Ending Receivable Deduction Bank Loan Note Note Penalty Income (Loss)
11/28/93 $87,793,608 -0- ($106,409) ($364,289) ($300,982) -0- $87,021,928
12/31/93 -0- ($6,120,788) -0- -0- (305,514) -0- (6,426,302)
12/31/94 -0- (46,517,990) -0- -0- (1,932,141) -0- (48,450,131)
12/31/95 -0- (27,910,794) -0- -0- (2,113,390) -0- (30,024,183)
12/31/96 -0- (41,866,191) -0- -0- (940,072) $25,926,467 (16,879,796)
Total 87,793,608 122,415,762 (106,409) (364,289) (5,592,099) 25,926,467 (14,758,484)

Chart 8
Computation of Partnership Cash Flow Without Estimated Residual Value Proceeds
(Assumes Early Termination)
Debt Service
Year Equipment Install. Balloon Sale Rent Early Term. Pretax
Ending Purchase Bank Loan Note Note Receivable Penalty Cash Flow
11/28/93 ($122,415,762) $14,995,931 ($364,289) $19,990,512 $87,793,608 -0- -0-
12/31/93 -0- (15,102,340) -0- -0- -0- -0- ($15,102,340)
12/31/94 -0- -0- -0- -0- -0- -0- -0-
12/31/95 -0- -0- -0- -0- -0- -0- -0-
12/31/96 -0- -0- -0- (25,582,611) -0- $25,926,467 343,856
Total (122,415,762) (106,409) (364,289) (5,592,099) 87,793,608 25,926,467 (14,758,484)
 - 22 -

Chart 9
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow With Estimated Residual Value Proceeds
(Assumes Full Term)
Cash Flow
Taxable Income Share of Preferred Stock
Year From Taxes Partnership Dividend/ Pre-Tax Taxes After-Tax
Ending Partnership (Paid) Saved Cash Flow Redemption Cash Flow (Paid) Saved Cash Flow
12/31/93 ($6,297,776) $2,376,151 ($14,800,293) -0- ($14,800,293) $2,376,151 ($12,424,142)
12/31/94 (47,481,128) 17,914,630 -0- ($48,966) (48,966) 17,914,630 17,865,663
12/31/95 (29,423,700) 11,101,562 -0- (48,966) (48,966) 11,101,562 11,052,596
12/31/96 470,533 (177,532) 14,274,047 (48,966) 14,225,081 (177,532) 14,047,549
12/31/97 5,847,566 (2,206,287) 8,923,231 (48,966) 8,874,265 (2,206,287) 6,667,978
12/31/98 -0- -0- -0- (661,045) (661,045) -0- (661,045)
Total (76,884,505) 29,008,524 8,396,985 (856,910) 7,540,074 29,008,524 36,548,598

Chart 10
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow Without Estimated Residual Value Proceeds
(Assumes Full Term)
Cash Flow
Taxable Income Share of Preferred Stock
Year From Taxes Partnership Dividend/ Pre-Tax Taxes After-Tax
Ending Partnership (Paid) Saved Cash Flow Redemption Cash Flow (Paid) Saved Cash Flow
12/31/93 ($6,297,776) $2,376,151 ($14,800,293) -0- ($14,800,293) $2,376,151 ($12,424,142)
12/31/94 (47,481,128) 17,914,630 -0- ($48,966) (48,966) 17,914,630 17,865,663
12/31/95 (29,423,700) 11,101,562 -0- (48,966) (48,966) 11,101,562 11,052,596
12/31/96 470,533 (177,532) 14,274,047 (48,966) 14,225,081 (177,532) 14,047,549
12/31/97 865,445 (326,533) 3,941,110 (48,966) 3,892,144 (326,533) 3,565,611
12/31/98 -0- -0- -0- (661,045) (661,045) -0- (661,045)
Total (81,866,625) 30,888,278 3,414,864 (856,910) 2,557,954 30,888,278 33,446,232
 - 23 -

Chart 11
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow With Estimated Residual Value Proceeds
(Assumes Early Termination)
Cash Flow
Taxable Income Share of Preferred Stock
Year From Taxes Partnership Dividend/ Pre-Tax Taxes After-Tax
Ending Partnership (Paid) Saved Cash Flow Redemption Cash Flow (Paid) Saved Cash Flow
12/31/93 ($6,297,776) $2,376,151 ($14,800,293) -0- ($14,800,293) $2,376,151 ($12,424,142)
12/31/94 (47,481,128) 17,914,630 -0- ($48,966) (48,966) 17,914,630 17,865,663
12/31/95 (29,423,700) 11,101,562 -0- (48,966) (48,966) 11,101,562 11,052,596
12/31/96 1,440,292 (543,422) 18,319,471 (48,966) 18,270,504 (543,422) 17,727,082
12/31/97 -0- -0- -0- (48,966) (48,966) -0- (48,966)
12/31/98 -0- -0- -0- (661,045) (661,045) -0- (661,045)
Total (81,762,312) 30,848,920 3,519,177 (856,910) 2,662,267 30,848,920 33,511,187

Chart 12
Computation of U.S. Company Taxable Income, Tax Savings, and Cash Flow Without Estimated Residual Value Proceeds
(Assumes Early Termination)
Cash Flow
Taxable Income Share of Preferred Stock
Year From Taxes Partnership Dividend/ Pre-Tax Taxes After-Tax
Ending Partnership (Paid) Saved Cash Flow Redemption Cash Flow (Paid) Saved Cash Flow
12/31/93 ($6,297,776) $2,376,151 ($14,800,293) -0- ($14,800,293) $2,376,151 ($12,424,142)
12/31/94 (47,481,128) 17,914,630 -0- ($48,966) (48,966) 17,914,630 17,865,663
12/31/95 (29,423,700) 11,101,562 -0- (48,966) (48,966) 11,101,562 11,052,596
12/31/96 (16,879,179) 6,368,514 -0- (48,966) (48,966) 6,368,514 6,319,548
12/31/97 -0- -0- -0- (48,966) (48,966) -0- (48,966)
12/31/98 -0- -0- -0- (661,045) (661,045) -0- (661,045)
Total (100,081,783) 37,760,857 (14,800,293) (856,910) (15,657,204) 37,760,857 22,103,653
 - 24 -

Ms. Grossman reviewed the September Projections. The

September Projections specifically forecasted that: (1) If

Comdisco exercised an early termination option under the lease, the

partnership would get a pretax return of 9.0 percent, and RD

Leasing would get a pretax return of 6.6 percent and an after-tax

return of 101.5 percent; and (2) if Comdisco exercised a final

termination option under the lease, the partnership would get a

pretax return of 15.1 percent, and RD Leasing would get a pretax

return of 14.0 percent and an after-tax return of 99.5 percent.

A copy of the M&S appraisal report dated September 28, 1993,

was given to Ms. Grossman. CIG provided two additional appraisal

reports, also dated September 28, 1993, one from Manufacturers’

Appraisal Co. (MAC) and the other from Appraisal Resources

International (ARI).

CIG paid for the M&S, MAC, and ARI appraisals.10 Ms. Grossman

was aware that the residual value forecasts of the IBM mainframe

computers in the M&S, MAC, and ARI appraisal reports were higher

than those of industry publishers, such as Daley Marketing Corp.

(DMC), International Data Corp. (IDC), and the Gartner Group. On

the basis of her own experience, Ms. Grossman believed that

forecasts of IDC and the Gartner Group tended to be overly

conservative.

10
According to Ms. Grossman, Ms. Ortmann, Mr. Renner, and
petitioners’ expert Thompson Ryan, it is common for the packager
of a leasing transaction (here, CIG) to pay the appraisal fees.
 - 25 -

The following reflects the projected residual values of the

equipment at the early and final termination dates, as set forth in

the M&S, MAC, and ARI appraisal reports:

M&S MAC ARI

Early termination $44,275,948 $48,442,600 $45,334,670
Final termination 25,418,982 34,257,000 26,769,965

Ms. Grossman provided copies of the three appraisal reports to

NEFI’s attorneys, Messrs. Beadie and Steffen.

Ms. Grossman discussed the proposed returns of the transaction

with Mr. Vandermark, who in turn discussed them with Mr. Thornton

(Norwest’s chief financial officer). Mr. Thornton subsequently

approved the transaction.

D. The Foreign Investors

As outlined in the materials provided to Norwest in June 1993,

CIG had discussions with potential Swiss investors, Hans Humbel and

Egon Riesterer, regarding the possibility of their involvement in

a sale-leaseback transaction. Messrs. Humbel and Riesterer

proposed to form an entity called Intared for this purpose. On

September 14, 1993, Comdisco sent Ms. Grossman and Faegre & Benson

copies of “Articles of Organization for Intared I, Limited

Liability Company”. Comdisco’s negotiations with Messrs. Humbel

and Riesterer, however, terminated in September 1993 because

Comdisco was unwilling to sign the tax indemnity agreement they

had proposed. Immediately thereafter, CIG sought other foreign

investors to complete the transaction.
 - 26 -

Richard Temko is an American attorney with an office in

Brussels, Belgium. CIG’s executive vice president (Mr. Snyder) was

acquainted with Mr. Temko. Baudouin Parmentier and Frederic de la

Barre d’Erquelinnes are citizens and residents of Belgium.11 Mr.

Temko introduced Mr. Parmentier to Mr. Snyder, and Mr. Parmentier

engaged Mr. Temko as his legal adviser to represent him in the

transactions at issue in this case.

On September 15, 1993, Mr. Snyder sent a memorandum (by

facsimile) to Mr. Temko describing a possible cross-border

equipment leasing transaction, along with flowcharts, in which Mr.

Parmentier would exchange an interest in a limited liability

company (ultimately, Andantech) for preferred stock to be issued by

a “U.S. Company” (ultimately, the preferred stock of RD Leasing).

The next day, although negotiations were ongoing with NEFI, Mr.

Snyder sent a second memorandum and summary sheet to Mr. Temko,

which stated that “No U.S. company has made any commitment to enter

into the exchange * * * and there can be no assurance any such U.S.

11
Neither Mr. Parmentier nor Mr. de la Barre
d’Erquelinnes was subject to our jurisdiction, and neither
appeared at trial. However, Mr. Parmentier agreed to be deposed
on May 4, 2000 (and to be interviewed on May 5, 2000), in
Brussels. The parties stipulated that had Mr. Parmentier
testified at trial, his testimony would be as set forth in the
transcript (including exhibits) of his May 4, 2000, deposition,
and the transcript (including exhibits) of his May 5, 2000,
interview.
We have examined the transcripts of Mr. Parmentier’s
deposition and interview and find many of his statements are
unsupported by other evidence in the record.
Mr. de la Barre d’Erquelinnes was neither deposed nor
interviewed.
 - 27 -

company will be found.” Mr. Parmentier was interested in

participating in the transaction but was concerned about his

potential tax liability, as well as the financial risk.

On September 17, 1993, Mr. Temko sent a letter (by facsimile)

from Mr. Parmentier to Comdisco “confirming the terms upon which he

and his co-investor are prepared to participate in the proposed

transaction.” Mr. Temko requested that Comdisco countersign the

letter. Mr. Parmentier’s conditions included assurances from

Comdisco that if the transaction did not proceed as reflected in

the flowcharts, then Mr. Parmentier and his partner could (1)

promptly recover their $200,000 investment, (2) withdraw from

Andantech at no expense, (3) incur no potential liability for

Andantech debts, and (4) incur no potential liability in connection

with managing Andantech. Further, Mr. Parmentier asked Comdisco to

provide assurances that he would be able to exchange his interest

for preferred stock on the basis described in the flowcharts and

realize the full value of the preferred stock “without any

significant risk of impairment”. Mr. Snyder advised Mr. Parmentier

that Comdisco could not make the requested assurances. However, by

letter dated September 24, 1993, Mr. Snyder confirmed to Mr.

Parmentier:

there will be no impediment to the sale of the preferred
shares at any time such a sale should be desired. (It
would be appreciated, from a tax point of view, if no
sale were arranged for one year, but no such legal
restriction would exist.)

Let me also confirm that, if the U.S. Company
 - 28 -

defaulted on dividends (or redemption), the preferred
shareholder(s) would take over voting control of U.S.
Company. This, in turn, would trigger the “excess loss
account” of U.S. Company (that is, the excess of tax
losses previously claimed from this transaction over the
parent company's investment in the U.S. Company) as
immediate taxable income of the parent. (This would be
a disaster since it plans to never have to trigger the
excess loss account). * * *

On September 25, 1993, Barbara Spudis with Baker & McKenzie

faxed to the firm’s Amsterdam office an urgent request for answers

to questions posed by Mr. Temko. The fax stated in part:

The client [Comdisco] is planning to close the
transaction involving the LLC on Tuesday, September 28,
1993. At the last minute, the two original investors
(Swiss individuals) in the transaction appear to have
backed out, and now the client is attempting to replace
them with two Belgian individuals. In order to do so, we
are attempting to describe the entire transaction and
satisfy their counsel as to the minimal risks associated
with the transaction on a rush basis. * * *

* * * * * * *

To give you more information about the transaction
I am attaching a description of the facts which was
prepared when Swiss involvement was contemplated. * * *
The entire transaction is expected to involve
approximately $120 million. Basically, the individuals
forming the company are involved for two months during
which the income allocation occurs and then the interest
is transferred to the U.S. corporate investor who reaps
the benefit of ongoing depreciation deductions.

IV. Formation of Andantech and the Sale-Leaseback (Appendixes A,
B, and C)

Andantech’s articles of organization were signed on September

25, 1993, by Ms. Spudis and Regina Howell, also of the Baker &

McKenzie law firm, and the certificate of organization was issued

by the Wyoming secretary of state on September 27, 1993.
 - 29 -

On September 27, 1993, Mr. Snyder, Ms. Ortmann, and Mr.

Trznadel flew to Minneapolis to meet with Messrs. Beadie and

Steffen (NEFI’s attorneys) to discuss the “red-lined drafts” of the

documents. During the meeting, Messrs. Beadie and Steffen provided

CIG with their changes to the drafts.

On September 27, 1993, Mr. Parmentier contributed $196,000 to

the capital of Andantech (Mr. Parmentier borrowed the entire amount

from Banque Internationale de Luxembourg), and Mr. de la Barre

d’Erquelinnes contributed $4,000 to the capital of Andantech (the

source of funds for Mr. de la Barre d’Erquelinnes’s capital

contribution is not reflected in the record). Andantech retained

N.V.O. Computerleasing B.V. (NVO), a Dutch corporation directed by

Nicholas van Onselen, as its first manager.12 A Dutch corporation

was chosen to avoid conducting any business activity in the United

States or Belgium.

The operating agreement of Andantech, dated September 28,

1993, provided for a priority return for Mr. de la Barre

d’Erquelinnes (or his successor in interest). Specifically, the

agreement provided that if, at the time of a distribution from the

partnership, Mr. de la Barre d’Erquelinnes had made capital

contribution other than his initial capital contribution of $4,000,

then distributions were to be made first to him in an amount equal

to his priority return (6 percent of his unreturned capital

12
In subsequent years, its managers were James Fetzer and
Andrew Rupprecht, NEFI employees.
 - 30 -

compounded monthly) plus his unreturned capital. Distributions

would then be made to Mr. Parmentier to the extent of his

unreturned capital. Any remaining amount would be distributed

among the members in proportion to their percentage interests.

Mr. Snyder did not disclose the identity of the foreign

investors to Ms. Grossman or to other NEFI representatives, nor did

he disclose the identity of the U.S. company to Mr. Parmentier. In

October or November 1993, Ms. Grossman learned that Mr. Parmentier

was a partner in Andantech; in November 1993, Messrs. Steffen and

Beadie learned Mr. Parmentier’s identity.

On September 28, 1993, Andantech and Comdisco executed an

“Equipment Purchase Agreement” (the purchase agreement), an

“Equipment Lease” (the equipment lease), and other documents, which

memorialized the sale-leaseback of 40 IBM mainframe computers (the

equipment) then owned by Comdisco. At the time the purchase

agreement was executed, the equipment was under lease to various

end users. Pursuant to the purchase agreement, the equipment was

sold subject to the user leases and liens in favor of different

Comdisco lenders.

A. The Purchase Price

The purchase price for the equipment was $122,415,762; the

purchase price was paid: (1) $14,995,931 in cash, which Union Bank

of Switzerland (UBS) lent to Andantech (the bank loan); and (2) the

$107,419,831 balance, by Andantech’s notes, consisting of (i) a

series of nine junior nonrecourse balloon notes (junior promissory
 - 31 -

notes 2a-2i, referred to as the balloon notes) aggregating

$19,990,51213 (the balloon notes, documenting the balloon loan), and

(ii) a junior recourse note in the amount of $87,429,31914 (the term

note, documenting the term loan). The bank loan, the balloon loan,

and the term loan all were tied to the equipment lease.

B. The Equipment Lease

Immediately after purchasing the equipment, Andantech leased

such equipment to Comdisco pursuant to the equipment lease; this

was a net lease. The equipment consisted of 40 IBM mainframe

computers and associated ancillary equipment. There were nine

different models–-four were IBM 9121s and five were IBM 9021s (the

IBM 9021s were larger and more powerful than the IBM 9121s). The

equipment lease separated the equipment into nine categories (A

through I) by model type. Equipment in categories A through D

included the IBM 9121s and equipment in categories E through I

included the IBM 9021s. The term of the equipment lease varied

from 41 to 47 months, depending upon the category of equipment.

During the term of the lease, Comdisco could, at its expense,

add or install upgrades on the equipment. Any upgrade did not

13
Interest accrued on the principal at 9 percent per
annum, compounded monthly. Accrued interest was payable at
maturity.
14
Principal and interest were payable in monthly
installments equal to the monthly rent due from Comdisco before
the early termination date under the lease. Interest was payable
on the principal at 5 percent per annum, compounded monthly,
subject to any increase in rent as provided in the lease.
 - 32 -

become an accession to the equipment and did not become the

property of Andantech.

Comdisco had an option (the final termination option) to

purchase the equipment at the end of the term of the equipment

lease at market value (as defined in the equipment lease). If

Comdisco installed any upgrades and did not exercise the final

termination option, Comdisco was required to either remove the

upgrade or consent to Andantech’s sale or re-lease of the equipment

with the upgrade. If, after termination of the lease, the

equipment with one or more upgrades was sold or re-leased to a

party other than Comdisco, Andantech would receive the portion of

the proceeds determined by multiplying the amount of the proceeds

by a fraction, the numerator of which would be the fair market

value of the equipment without the upgrades as of the date of the

sale or re-lease and the denominator of which would be the fair

market value of the equipment with the upgrades as of such date.

Comdisco was limited in its ability to selectively exercise

the final termination option. If Comdisco elected to exercise the

final termination option for any of the equipment in categories A

through D, it had to do so for all equipment in those categories.

Similarly, if Comdisco elected to exercise the final termination

option for any of the equipment in categories E through I, it had

to do so for all equipment in those categories.

Comdisco also had an option (the early termination option) to

terminate the equipment lease with respect to each category of
 - 33 -

equipment (and to purchase the equipment) on certain early

termination dates by paying to Andantech an amount equal to an

“early termination supplement” specified in the equipment lease for

that category of equipment plus the greater of (i) the then value

of the equipment in that category or (ii) the principal and accrued

interest on the balloon note for that category. The early

termination option was limited in a manner identical to the final

termination option; i.e., if Comdisco elected to exercise the early

termination option for any of the equipment in categories A through

D, it had to do so for all such equipment. Similarly, if Comdisco

elected to exercise the early termination option for any of the

equipment in categories E through I, it had to do so for all such

equipment.

Comdisco’s early termination option was subject to a further

restriction in that, unless the UBS bank loan (secured in part by

the rent due after the early termination date) was prepaid,

Comdisco could not exercise the early termination option without

Andantech's approval. The purchase price, termination date, early

termination date, early termination stated value, and early

termination supplement of the equipment by category were as

follows:
 - 34 -
Computation of Fair Market Value Sales Price and Early Termination Values & Supplements
Lease Early Termination
Type/Model/ List FMV Sale Stated Value
Category (LP) % of LP (SP) Date Mos. Date % of SP Amount % of SP Amount
9021/720/E $35,412,247 18% $6,374,205 2/27/97 41 5/27/96 21.59% $1,376,191 0.28% $17,848
9021/740/F 12,336,045 36 4,440,976 2/27/97 41 5/27/96 20.00 888,195 0.28 12,435
9021/820/G 68,624,690 36 24,704,888 2/27/97 41 5/27/96 20.00 4,940,978 0.28 69,174
9021/860/H 40,808,478 36 14,691,052 2/27/97 41 5/27/96 20.00 2,938,210 0.28 41,135
9021/900/I 139,926,914 36 50,373,689 2/27/97 41 5/27/96 20.00 10,074,738 0.28 141,046
Total 9021 297,108,375 100,584,810 20,218,312 281,638

9121/260/A 4,637,115 53 2,457,672 7/27/97 46 9/27/96 23.23 570,917 0.28 6,881
9121/320/B 18,186,545 49 8,911,407 8/27/97 47 10/27/96 24.72 2,202,900 0.29 25,843
9121/440/C 6,923,363 49 3,392,448 8/27/97 47 10/27/96 24.72 838,613 0.29 9,838
9121/480/D 14,427,399 49 7,069,425 8/27/97 47 10/27/96 24.72 1,747,562 0.29 20,501
Total 9121 44,174,422 21,830,952 5,359,992 63,063
Total all models 341,282,796 122,415,762 $25,578,304 344,701
 - 35 -

Rents payable under the equipment lease before the early

termination dates were subject to periodic adjustments to the

extent that prevailing market rates during the equipment lease term

increased or decreased from time to time above or below the rates

that were reflected in the original rent schedule. Comdisco had

the right, on any rent payment date that occurred more than 5

months after the commencement of the equipment lease, to prepay (on

a present value basis) certain of the then-remaining installments

of rent.

Pursuant to the terms of the equipment lease and the term

loan, for each category of the equipment, rents due to Andantech

from Comdisco were equal to the payments under the term loan due

from Andantech to Comdisco before the early termination date.

The leases with the end users were unaffected by the equipment

lease. When the initial subleases with the end users expired,

Comdisco had the right to re-lease the equipment.

Comdisco agreed to indemnify Andantech from and against

certain taxes imposed on Andantech (or its members) as a result of

the sale, purchase, or ownership of the equipment, the payment of

rents, and other factors. The indemnified taxes included State

sales and property taxes but did not include any Federal taxes.

Comdisco also agreed to indemnify Andantech against Federal

withholding taxes on rents or on income from the sale of any right

to receive rents; the indemnity was transferable to the benefit of

any purchaser, lender, or other assignee of Andantech.
 - 36 -

Additionally, Comdisco agreed to indemnify Messrs. Parmentier and

de la Barre d’Erquelinnes from Federal income taxes with respect to

the rents, proceeds from the sales of rents, or proceeds from the

sale of the equipment, provided (1) they did not engage in any

activities in the United States, and (2) Andantech, Mr. Parmentier,

and Mr. de la Barre d’Erquelinnes did not maintain a permanent

establishment in the United States.

Comdisco had the right to substitute a replacement computer

(replacement equipment) for a leased computer, but only if the

sublease (to an end user) of the computer terminated and a person

unrelated to Comdisco (such as an end user) made a bona fide offer

to purchase the computer. In that event, Andantech (as lessor) had

the right to request reasonable documentation from Comdisco before

transferring title pursuant to a bill of sale. If the replacement

equipment did not have the same model number as the leased

computer, then the replacement equipment had to have a then value

and an estimated residual value (supported by appraisals provided

by Comdisco), as well as a remaining useful life, at least as great

as those of the substituted computer.

C. The Bank Loan

UBS made a $14,995,931 bank loan to Andantech for the cash

portion of the purchase price. Denis Campbell, the account manager

at UBS who managed Comdisco’s account, worked on the bank loan.

UBS had been the lender in four prior Comdisco leveraged sale-

leaseback transactions, and Mr. Campbell had worked on all of those
 - 37 -

loans.

Initially, the transaction which is the subject of this

litigation was to involve Intared I (the entity formed by potential

Swiss investors Hans Humbel and Egon Riesterer). As of September

23, 1993, Mr. Campbell was evaluating the transaction with Intared

I. By September 25, 1993, however, the Swiss investors had pulled

out of the deal, and thereafter, Andantech, with Mr. Parmentier as

the member holding the largest interest, was to be the borrower.

On September 28, 1993 (at the time the leveraged sale-leaseback

transaction was scheduled to close), a UBS loan officer in New York

(David Bawden) refused to approve the loan to Andantech.15 Mr.

Bawden requested references as to Mr. Parmentier’s character. Mr.

Campbell then contacted UBS’s leasing affiliate in Switzerland,

which vouched for Mr. Parmentier’s character. On September 30,

1993, UBS made the bank loan by wire transferring $14,995,931 to

Comdisco on Andantech’s behalf in payment of the purchase price of

the equipment.

The bank loan was for a term of 47 months; however, the Bank

Note contained a mandatory payment acceleration clause in the event

3 percent or more of the ownership interest in Andantech was

transferred. UBS anticipated that the bank loan would be repaid

within 3 months, inasmuch as previous loans made in similar

15
UBS wired $14,995,931 to Comdisco on Sept. 28, 1993,
but the same amount was wired back from Comdisco to UBS on the
same day.
 - 38 -

Comdisco transactions had been prepaid in that timeframe.

V. Sale of Comdisco Rents (Appendix D)

On September 29, 1993, and October 13, 1993, Ms. Ortmann sent

Mr. Beadie drafts of a “corrected lease receivable purchase

agreement”. Mr. Beadie reviewed and made handwritten notations on

these drafts.

Michael Zehfuss is the manager for NationsBank in charge of

Comdisco’s account. In October 1993, he began working on the

transaction in which NationsBank was to purchase a portion of the

rents payable under the lease by Comdisco to Andantech.

NationsBank had established a credit limit (i.e., a limitation

on the extension of credit) of $125 million for Comdisco. The

proposed purchase of rents would have placed NationsBank’s exposure

(without considering demand deposit overdrafts) at $138 million.

Consequently, the transaction required the approval of numerous

NationsBank officers. Because of logistical problems, final

approval for the transaction was not given until October 27, 1993.

NationsBank’s records show that the bank treated the

transaction as a loan to Comdisco and anticipated prepayment by

March 28, 1994. The bank’s records describe the transaction as

follows:

Comdisco has approached NationsBank to provide financing
for a sale/leaseback transaction involving a lease
receivable purchase with Comdisco as the obligor. The
proposed structure is identical to two lease receivable
purchases the Bank funded for Comdisco in September 1991
($10MM related to Astropar L.P) and May 1992 ($35MM
related to Compupar L.P.). Each of these transactions *
 - 39 -

* * generated $168,000 in net interest income for
assuming a short-term, unsecured credit position with
Comdisco * * *.

* * * * * * *

Although Comdisco has historically prepaid each
receivable purchase transaction that NationsBank has
funded, the company may elect not to prepay the proposed
purchase. In this situation, NationsBank would hold a 36
month, unsecured loan to Comdisco at 75bp. In electing
not to prepay, Comdisco would reduce its ability to fund
future transactions in the bank market.

* * * * * * *

Based on the credit quality of Comdisco * * * , the
adequate yield * * *, and prepayment history we have
experienced in identical transactions, I recommend
approval of the $88MM TML. * * *

On October 29, 1993, NationsBank purchased from Andantech (on

a nonrecourse basis) a portion of the rents due from Comdisco under

the equipment lease for $87,805,802, pursuant to the lease

receivable purchase agreement. Pursuant thereto, NationsBank

received “designated rights” that included the right to receive the

rents but not the equipment.

The rents purchased by NationsBank (aggregating $94,109,445)

were those payable pursuant to the equipment lease after October

29, 1993, and before the early termination dates. Pursuant to a

Consent and Agreement, Comdisco agreed to make payment of the rents

to NationsBank.

Under the terms of the term note for the purchase of the

equipment, Andantech’s sale of the rents to NationsBank accelerated

the term note. Andantech directed NationsBank to wire transfer the
 - 40 -

proceeds for the rent sale ($87,805,802) to Comdisco in payment of

Andantech’s obligations to Comdisco under the term note.

NationsBank did so, and Comdisco canceled the term note.

VI. Mr. de la Barre d’Erquelinnes’s and Mr. Parmentier’s
Withdrawal From Andantech

A. Mr. de la Barre d’Erquelinnes’s and Mr. Parmentier’s
Withdrawal of Capital Contributed to Andantech

On November 30, 1993, Mr. Parmentier and Mr. de la Barre

d’Erquelinnes withdrew (in the aggregate) $189,882.89 from the

capital of Andantech.

B. Transfer of Mr. de la Barre d’Erquelinnes’s Membership
Interest in Andantech to EICI (Appendix E)

Equipment Investors Co., Inc. (EICI), was organized on

December 6, 1993, and at all relevant times thereafter validly

existed as a corporation, under the laws of Delaware. Initially,

Mr. de la Barre d’Erquelinnes was EICI’s sole shareholder; Mr.

Parmentier was EICI’s sole director.

Pursuant to an Assignment and Assumption of Membership

Interest of Andantech L.L.C., dated December 9, 1993, Mr. de la

Barre d’Erquelinnes transferred his 2-percent membership interest

in Andantech to EICI. Mr. de la Barre d’Erquelinnes thereafter

withdrew as a member of Andantech, and EICI was admitted.

On December 28, 1993, Mr. de la Barre d’Erquelinnes

transferred his EICI stock to a charitable support trust (the

Trust); thereafter, the Trust was at all relevant times the sole

shareholder of EICI. The Trust was established in 1988 by
 - 41 -

Comdisco, as settlor, and by Robert Kelman, as sole trustee. The

beneficiaries of the Trust were various charitable organizations,

and the Trust was a tax-exempt organization.

C. Transfer of Mr. Parmentier’s Membership Interest to RD
Leasing in Exchange for Preferred Stock (Appendix F)

Mr. Parmentier transferred his 98-percent membership interest

in Andantech to RD Leasing pursuant to an Exchange Agreement dated

December 10, 1993. RD Leasing issued 6,150 shares of series A

preferred stock (the RD Leasing preferred stock) to Mr. Parmentier

in exchange for his 98-percent membership interest. Mr. Parmentier

thereafter withdrew as a member of Andantech, and RD Leasing was

admitted.

The RD Leasing preferred stock provided for a dividend at the

rate of 6.878 percent. The 6,150 shares of RD Leasing preferred

stock issued to Mr. Parmentier had a liquidation preference of

$615,000 (plus unpaid dividends). The 6,150 shares of preferred

stock had a value of 0.5 percent of the equipment’s purchase price

(approximately $122 million).

Mr. Parmentier agreed to hold the RD Leasing preferred stock

for 1 year (i.e., through December 10, 1994). RD Leasing, however,

was required to maintain a portion of its assets in “permitted

investments” (low-risk securities) sufficient to satisfy the

liquidation preference, including all accrued but unpaid dividends.

RD Leasing had the option to redeem the RD Leasing preferred stock

on or after January 1, 2000, at a price equal to the liquidation
 - 42 -

preference (plus unpaid dividends), provided that RD Leasing had

funds legally available for payment. The holder of the RD Leasing

preferred stock had the option to require RD Leasing to redeem the

RD Leasing preferred stock on or after January 1, 1999, at a price

equal to the liquidation preference (plus unpaid dividends),

provided RD Leasing had funds legally available for payment.

The holder of the RD Leasing preferred stock did not have

voting rights, except upon the occurrence of certain specified

voting rights events, as defined in the terms of the RD Leasing

preferred stock. Such events included the failure to make the

required redemption of the RD Leasing Preferred Stock and the

failure to maintain investment assets at specified levels. Upon

the occurrence of such an event, the holder of the RD Leasing

preferred stock would have a right, voting with the common stock,

to cast in the aggregate 21 percent of the total votes cast by all

stockholders.

VII. Repayment of Bank Loan (Appendixes F and G)

Mr. Parmentier’s transfer of his 98-percent membership

interest in Andantech on December 10, 1993, triggered a mandatory

acceleration of the bank loan.

UBS informed Andantech that the payoff amount on the bank loan

was $15,119,777.60 and requested that this amount be wired on

December 10, 1993, to the account of UBS at the Federal Reserve

Bank in New York.

Andantech received the cash needed to repay the bank loan from
 - 43 -

capital contributions made by RD Leasing and EICI. Pursuant to a

Capital Contribution Agreement, dated December 10, 1993, RD Leasing

and EICI were obligated to make contributions to the capital of

Andantech in amounts proportionate to their respective membership

interests; accordingly, RD Leasing contributed $14,817,382.05, and

EICI contributed $302,395.55 to Andantech.

RD Leasing received from NEFI the $14,817,382.05 it needed to

contribute to the capital of Andantech. (NEFI had agreed (in the

Exchange Agreement) that it would purchase 100 additional shares of

common stock in RD Leasing for $14,817,382.05.) EICI borrowed from

UBS the $302,395.55 it needed to contribute to the capital of

Andantech. The bank records show that Comdisco guaranteed the UBS

loan to EICI.

RD Leasing and EICI made their capital contribution by wiring

$14,817,382.05 and $302,395.55, respectively, directly to UBS’

account in payment of the bank loan.

VIII. Sale of Computer to End User

In April 1994, one of the end users opted to purchase the IBM

9021 computer equipment it subleased from Comdisco. The computer

was one that had been sold to Andantech. Andantech did not receive

any of the proceeds from that sale. Instead, Comdisco elected to

substitute replacement equipment. Comdisco neither provided notice

to Andantech that it was exercising its right to substitute

replacement equipment nor invoked the procedures for substitution

required by the equipment lease.
 - 44 -

The equipment lease imposed an obligation upon Comdisco to

provide Andantech with annual reports, which, among other things,

contained information as to the location of the equipment. CIG

provided Andantech with location reports relating to the equipment

on March 1, 1994, February 27, 1995, and February 28, 1996. Ms.

Grossman received these reports.

The 40 mainframe computers in Andantech’s portfolio were

identified by serial number in the location reports. The computers

shown in the reports had the same serial numbers as those that were

on the 1993 bill of sale. The location of the equipment (and the

sublessee) sometimes changed. In light of the fact that the CIG

location reports reflected no changes in the serial numbers, Ms.

Grossman was unaware that Comdisco had substituted replacement

equipment for one of the 40 computers that Andantech purchased.

IX. Comdisco’s Exercise of Early Termination Options

On April 25, 1996, Comdisco informed Andantech that it was

exercising its early termination option to purchase the equipment

in categories E through I (i.e., the IBM mainframes in the 9021

series). On May 30, 1996, Comdisco received from Computer

Information Resources (CIR) an appraisal of the equipment in these

five categories, valuing the computers at $11,444,000.

Ms. Grossman asked Don Oram, an NEFI equipment manager, to

independently investigate the value of the equipment. After

reviewing several reports (Computer Price Watch and the Gartner

Group reports), on May 27, 1996, Mr. Oram informed Ms. Grossman
 - 45 -

that the value of the equipment in categories E through I was

between $11,600,000 and $12,225,000.

The principal amounts of the balloon notes for categories E

through I (junior promissory notes 2e-2i) were: $1,083,615;

$699,454; $3,891,020; $2,313,841; and $7,933,856, respectively.

The aggregate principal amount was $15,921,786. The notes bore

interest at 9 percent, compounded monthly. The total liability on

the early termination date was $20,222,439.

Ms. Grossman and Mr. Vandermark discussed Comdisco’s exercise

of its early termination option, as well as Comdisco’s belief that

the value of the equipment in categories E through I was less than

the liability for principal and interest on the balloon notes. Mr.

Vandermark was disconcerted to learn that there was a good chance

that RD Leasing would receive nothing for its position in the

lease. On May 30, 1996, Ms. Grossman engaged ARI Propertylink Co.

(ARI Propertylink) to appraise the 40 mainframe computers

comprising the Andantech portfolio as of the early termination

dates. Mary O’Connor (who had appraised the equipment in 1993) was

ARI Propertylink’s appraiser.

On June 5, 1996, ARI Propertylink advised Ms. Grossman that

the value of the equipment was $13,465,000. The appraisal stated

that the equipment had “eroded” in value more rapidly than had been

anticipated in 1993 because of: (1) A change in IBM pricing

strategy (i.e., increased discounting); (2) an increase in

production of mainframes by IBM; (3) the introduction of new
 - 46 -

products by IBM’s competitors (Amdahl Corp. and Hitachi Data

Systems, Inc.); and (4) the introduction of “CMOS based parallel

architecture” on April 5, 1994. On June 6, 1996, CIG advised

Andantech that the value of the equipment in categories E through

I inclusive did not exceed the principal plus accrued interest due

on junior promissory notes 2e through 2i.

After analyzing the information received from Mr. Oram and the

ARI PropertyLink appraisal, Ms. Grossman concluded that Andantech

was not entitled to consideration from Comdisco for the equipment

in categories E through I, beyond the cancellation of the balloon

notes relating thereto. Thus, Andantech accepted Comdisco’s

determination that the value of the equipment in categories E

through I did not exceed the principal plus accrued interest on

junior promissory notes 2e through 2i.

On July 2, 1996, Andantech executed a bill of sale for the

equipment in categories E through I to Comdisco. On July 10,

1996, Comdisco canceled the balloon notes relating to the equipment

in categories E through I (i.e., junior promissory notes 2e-2i).

On August 23, 1996, Comdisco advised Andantech that it was

exercising its early termination option to purchase the equipment

in categories A through D (i.e., the 9121 models). Comdisco

engaged two additional companies to provide appraisals of the

equipment in category A as of the early termination date. The

findings included the following: (1) In its September 23, 1996,

appraisal, Computer Merchants, Inc. (CMI), concluded that the value
 - 47 -

of category A of the equipment was $63,000 (as of September 27,

1996, the early termination date); and (2) in its September 24,

1996, appraisal, CIR concluded that the value of category A of the

equipment was $89,000 (as of September 27, 1996). Accordingly, on

September 25, 1996, Comdisco advised Andantech that the value of

the category A equipment did not exceed the principal plus accrued

interest due on the corresponding junior promissory note 2a.

On October 3, 1996, Mr. Oram advised Ms. Grossman that the IBM

computers corresponding to equipment in category A had a maximum

value of $56,000, as of September 27, 1996. Andantech accepted

Comdisco’s conclusion that the value of the equipment in category

A did not exceed the principal plus accrued interest on junior

promissory note 2a. Thereafter, Andantech executed an undated bill

of sale of the equipment in category A to Comdisco. On October 8,

1996, Comdisco canceled junior promissory note 2a.

Comdisco subsequently engaged CIR and CMI to appraise the

equipment in categories B through D. On October 21, 1996, CMI

informed Comdisco that the value of the equipment in categories B

through D was $52,000, as of October 27, 1996. On October 25,

1996, CIR advised Comdisco that the value of the equipment in

categories B through D was $62,000, as of October 27, 1996. Mr.

Oram advised Ms. Grossman of these findings.

In light of these appraisals, Ms. Grossman requested ARI

PropertyLink to update its June 4, 1996, appraisal. ARI

PropertyLink confirmed its earlier opinion as to the September 27,
 - 48 -

1996, value of the equipment in category A, and as to the October

27, 1996, values of the equipment in categories B, C, and D. As

a result of the appraisal, Andantech accepted Comdisco’s

determination that the value of the equipment in categories B

through D did not exceed the principal plus accrued interest on

three of the balloon notes. Accordingly, on December 5, 1996,

Andantech executed a bill of sale of the equipment in categories B

through D to Comdisco. On December 12, 1996, Comdisco canceled

three of the balloon notes.

The three bills of sale that Andantech executed in 1996 (the

1996 bills of sale) conveyed to Comdisco the identical computers

that Andantech had acquired pursuant to the 1993 bill of sale. The

serial numbers on the 1996 bills of sale were identical to those on

the 1993 bill of sale. Thus, the 1996 bills of sale reflect that

Comdisco never replaced any of the computers (i.e., did not

substitute a different computer for any of the original Equipment).

As stated previously, the equipment lease provided that

Comdisco would pay an early termination supplement if it elected to

exercise its early termination option. Comdisco paid early

termination supplements of $289,076, $57,084, and $7,206. Pursuant

to Andantech’s operating agreement, Andantech made an early

termination distribution of $353,366 to EICI.

X. Dissolution of RD Leasing and Andantech

On May 1, 1997, RD Leasing was dissolved. On or about May 29,

1997, Andantech was dissolved.
 - 49 -

XI. Andantech’s Federal Income Tax Returns

Andantech filed a Form 1065, U.S. Partnership Return of

Income, for the short tax year beginning September 28, 1993, and

ending December 10, 1993 (the 12/10/93 short period). On Schedule

K, Partners’ Shares of Income, Credits, Deductions, Etc., of the

return, Andantech reported $86,930,528 of income that included

$86,930,096 of net income from other rental activity ($87,805,801

of gross income from other rental activity and $875,705 of expenses

from other rental activity) and $432 of interest income. Andantech

reported on Schedules K-1, Partner’s Share of Income, Credits,

Deductions, Etc., for Mr. Parmentier, Mr. de la Barre

d’Erquelinnes, and NEFI that $85,191,494 of the income was

allocated to Mr. Parmentier, $1,738,736 to Mr. de la Barre

d’Erquelinnes, and $134 to NEFI.

Andantech also filed a Form 1065 for the short tax year

beginning December 11, 1993, and ending December 31, 1993 (the

12/31/93 short period). On Schedule L, Balance Sheets, of the

return, Andantech reported $20,459,014 as liability on mortgages,

notes, and bonds payable in 1 year or more. On Schedule K of the

return, Andantech reported a $2,143,937 loss attributed to a

$2,040,263 depreciation deduction and a $103,674 interest

deduction. Andantech reported no gross income from other rental

activity. Andantech reported on Schedules K-1 that 98 percent of
 - 50 -

the loss was allocated to RD Leasing and 2 percent to EICI. The

loss allocated to RD Leasing was included in Norwest’s 1993

consolidated return.

Andantech filed a Form 1065 for the tax year ending December

31, 1994. On Schedule L of the return, Andantech reported

$22,378,210 as liability on mortgages, notes, and bonds payable in

1 year or more. On Schedule K of the return, Andantech reported a

$50,069,397 loss attributed to a $48,150,200 depreciation deduction

and $1,919,197 interest deduction. Andantech reported no gross

income from other rental activity. Andantech reported on Schedules

K-1 that 98 percent of the loss was allocated to RD Leasing and 2

percent to EICI. The loss allocated to RD Leasing was included in

Norwest’s 1994 consolidated return.

XII. Respondent’s Determinations

A. FPAAs for the 1993 Short Years

On January 14, 2000, respondent issued a notice of final

partnership administrative adjustments (FPAA) regarding Andantech’s

12/10/93 short period (the 12/10/93 FPAA). On January 14, 2000,

respondent also issued an FPAA regarding Andantech’s 12/31/93 short

period (the 12/31/93 FPAA).16

Respondent determined that Andantech’s claimed 12/10/93 short

16
As explained hereinafter, respondent contends that
there is only one 1993 taxable period for Andantech and that
there was no termination of the partnership on Dec. 10, 1993.
 - 51 -

period should be disregarded and all income and deductions for that

period should be reported in Andantech’s 12/31/93 short period. In

the 12/10/93 FPAA, respondent determined that the $86,930,096

income reported should be reduced to zero for the 12/10/93 short

period. In the 12/31/93 FPAA, respondent determined that Andantech

should have reported income of $87,805,801, rather than the

$2,143,937 loss. Respondent increased the gross income for the

sale of the receivable and disallowed all the claimed deductions.

Included with each copy of the 12/10/93 FPAA and the 12/31/93

FPAA was a letter advising each person of his or its right to elect

to have partnership items treated as nonpartnership items pursuant

to section 6223(e). Neither Mr. Parmentier, Mr. de la Barre

d’Erquelinnes, NEFI, RD Leasing, Norwest, nor EICI filed such an

election.

On April 17, 2000, NEFI and Norwest timely filed a petition

for Andantech’s 12/31/93 short period (docket No. 4277-00). On

June 6, 2000, EICI timely filed a petition for Andantech’s 12/10/93

short period (docket No. 6348-00).

B. FPAA for the 1994 Taxable Year

On June 19, 1998, respondent issued an FPAA with regard to

Andantech’s 1994 tax year (the 1994 FPAA). Respondent determined

in the 1994 FPAA that $50,069,397 of deductions claimed by

Andantech should be disallowed. Alternatively, respondent

determined in the 1994 FPAA that the “sale” of the lease receivable
 - 52 -

was a “financing arrangement” and consequently Andantech’s income

should be increased by $34,482,268 for rent payable in 1994.

On September 21, 1998, NEFI and Norwest timely filed a

petition for Andantech’s 1994 taxable year (docket No. 15532-98).

OPINION

I. Procedural Issues

At the outset, we deal with two procedural matters. First, we

determine whether for purposes of this litigation the statute of

limitations period under section 6501(a) expired with respect to

the 12/10/93 short period and/or the 12/31/93 short period.

Second, we determine whether the FPAAs for the 12/10/93 short

period and/or the 12/31/93 short period are valid.

First, we turn to the period of limitations matter.

Petitioners acknowledge that the period for assessing a deficiency

in tax under section 6501(a) remains open for RD Leasing and EICI.

They assert, however, that section 6501(a) is inapplicable to

partnership items and affected items. They maintain that the

period for assessing a deficiency related to partnership items and

affected items is controlled by section 6229(a), and that the

periods within which respondent could issue an FPAA with respect to

Andantech’s 12/10/93 short period and its 12/31/93 short period had

expired under section 6229(a) before the mailing of those FPAAs.

Petitioners’ position is contrary to our holding in Rhone-

Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C.

533 (2000), interlocutory appeal dismissed (for lack of appellate
 - 53 -

jurisdiction) and remanded to the Tax Court for further proceedings

on the merits 249 F.3d 175 (3d Cir. 2001). See also CC & F W.

Operations Ltd. Pship. v. Commissioner, T.C. Memo. 2000-286, affd.

273 F.3d 402 (1st Cir. 2001). In Rhone-Poulenc, we stated that

section 6501(a) provides a general period of limitations for

assessing and collecting any tax imposed by the Code. Section

6229(a) sets forth a minimum period for assessing any income tax

with respect to any person that is attributable to any partnership

item or affected item; this minimum period can be greater than, or

less than, the period of limitations in section 6501. Id. at 540-

543.

Section 6501 contains no exception for deficiencies

attributable to partnership items. In drafting section 6229,

Congress did not create a completely separate statute of

limitations for assessments attributable to partnership items. Id.

at 545. Section 6229 merely supplements section 6501. CC & F W.

Operations Ltd. Pship. v. Commissioner, supra.

Petitioners concede that under the holding of Rhone-Poulenc

Surfactants & Specialties, L.P. v. Commissioner, supra, the

limitations period has not expired. They, however, request that we

reconsider Rhone-Poulenc. We decline to do so. We hold,

therefore, that the period of limitations for issuing the FPAAs for

both 1993 short periods had not expired at the time the FPAAs were

issued.

Second, we rely upon Wind Energy Tech. Associates III v.
 - 54 -

Commissioner, 94 T.C. 787 (1990), to conclude that issuing an FPAA

during the 120-day period set out in section 6223(d)(1) does not

invalidate an FPAA. Accordingly, we hold that the FPAAs for the

12/10/93 short period and the 12/31/93 short period are valid.

II. Whether the Sale-Leaseback Transaction Should Be Respected

We now turn to the substantive issue before us; namely,

whether the sale-leaseback transaction involved should be respected

for Federal tax purposes.

In essence, this case involves the stripping of income from

Andantech’s sale of the Comdisco rents (which income, for tax

purposes, passed through untaxed to Belgian citizens and residents)

and the subsequent use by Norwest (on its consolidated returns for

the years at issue) of Andantech’s losses from depreciation

deductions and interest expense related to Andantech’s purchase and

lease of the computer equipment.

A. Overview of Statutory Framework for the Transactions

We begin our analysis with an overview of the transactions

involved herein, and the statutory provisions and caselaw within

which Comdisco planned the series of transactions that petitioners

and Comdisco assert brought into play nonrecognition provisions of

the Code governing partnerships and corporations, as well as

treaties with foreign governments. This overview presupposes that

the transactions and entities are to be respected for Federal tax

purposes.

1. Andantech was organized as a limited liability company,
 - 55 -

intending to be taxed as a partnership. (Pursuant to sections 701

and 702, a partnership is treated as a flow-through entity for

purposes of Federal income taxation.) As such, if Andantech is

recognized as a partnership, its items of income, gain, loss,

deduction, and credit passed through to its partners.

2. A taxpayer is permitted to sell its right to future

income. If a bona fide sale of future income occurs at arm’s

length and for adequate consideration, then the seller of the

future income is taxed in the year of sale on the amount of

consideration he actually receives and the buyer is taxed on any

excess of income received over his purchase price. Mapco Inc. v.

United States, 214 Ct. Cl. 389, 556 F.2d 1107, 1110 (1977).

Petitioners assert that the sale-leaseback transaction between

Andantech and Comdisco should be respected, and Andantech’s sale of

the Comdisco rents to NationsBank should be considered a bona fide

arm’s-length sale for adequate consideration. On this premise,

Andantech contends it is deemed to recognize gain from the sale in

1993, the year of the sale, and the income passes through to

Andantech’s partners (i.e., Messrs. Parmentier and de la Barre

d’Erquelinnes/EICI).

3. Pursuant to section 708(b)(1)(B), a partnership is deemed

terminated (for Federal tax purposes) upon the sale or exchange of

50 percent or more of the total interest in the partnership’s

capital and profits within a 12-month period. Here, if as

petitioners assert the partnership is to be respected, Mr.
 - 56 -

Parmentier’s contribution of his 98-percent interest in Andantech

to RD Leasing in exchange for RD Leasing’s preferred stock caused

a deemed termination of the partnership. (For convenience, we will

refer to the partnership prior to the deemed termination as

Andantech-Foreign.)

If the sale or exchange of a partner’s interest in the

partnership results in the deemed termination of the partnership,

then pursuant to section 708(b)(1)(B), the partnership’s taxable

year is deemed closed upon the triggering sale or exchange. Sec.

706(c)(1). Consequently, if as petitioners assert the partnership

and the sale of the rent receivables are to be respected,

Andantech-Foreign’s taxable year is deemed closed on December 10,

1993, the date Mr. Parmentier exchanged his 98-percent interest in

the partnership for the preferred stock, and Andantech-Foreign is

required to include the income from the sale of the Comdisco rents

on its return for the 12/10/93 short period. That income would

then pass through to Messrs. Parmentier and de la Barre

d’Erquelinnes/EICI.

4. Section 894 provides that, to the extent required by any

treaty obligation of the United States, income (of any kind) is

exempt from U.S. taxation and excluded from gross income. Here,

petitioners assert that any income from the sale of the Comdisco

rents that passes through to Messrs. Parmentier and de la Barre

d’Erquelinnes would be exempt from U.S. taxation pursuant to the

treaty between the United States and Belgium. Further, petitioners
 - 57 -

assert, pursuant to section 351(a), no gain is recognized by Mr.

Parmentier on the exchange of his interest in Andantech for the

preferred stock of RD Leasing.17 Moreover, petitioners assert,

pursuant to section 358(a), Mr. Parmentier’s basis in his RD

Leasing preferred stock is the same as that in his 98-percent

interest in Andantech that was transferred to RD Leasing. And

pursuant to section 362(a)(1), RD Leasing’s basis in the 98-percent

Andantech interest received from Mr. Parmentier is equal to Mr.

Parmentier’s basis in the partnership interest immediately before

the partnership-interest preferred-stock exchange (approximately

$119 million18).

17
Sec. 351(a) provides:

SEC. 351(a). General Rule.–-No gain or loss shall
be recognized if property is transferred to a
corporation by one or more persons solely in exchange
for stock in such corporation and immediately after the
exchange such person or persons are in control (as
defined in section 368(c)) of the corporation.

Sec. 368(c) defines control as:

SEC. 368(c). Control Defined.–-* * * ownership of
stock possessing at least 80 percent of the total
combined voting power of all classes of stock entitled
to vote and at least 80 percent of the total number of
shares of all other classes of stock of the
corporation.
18
Mr. Parmentier’s basis in his partnership interest, if
computed according to petitioners’ contentions under secs. 705(a)
and 752, would be as follows:

Initial contribution $196,000
Plus
Share of UBS loan ($14,995,931 x 98%) 14,696,012
(continued...)
 - 58 -

5. Petitioners assert that a termination of Andantech-Foreign

occurred, see supra pp. 57-58, resulting in a deemed distribution

of partnership property to new and continuing partners (i.e., RD

Leasing and EICI) and that there was a deemed recontribution of the

property to a newly formed partnership. Sec. 1.708-1(b)(1)(iv),

18
(...continued)
Share of balloon notes ($19,990,512 x 98%) 19,590,702
Share of term note ($87,429,319 x 98%) 85,680,733
Share of income 85,191,494
Less
Share of term note Paid ($87,429,319 x 98%) (85,680,733)
Share of withdrawal ($189,883 x 98%) (186,085)
Basis 119,488,123
 - 59 -

Income Tax Regs. (For convenience, we will refer to the new

partnership as Andantech-US.)

Continuing, petitioners assert that, upon the deemed

recontribution of the property to Andantech-US, Andantech-US

acquired a substituted basis in the property equal to the adjusted

basis of the property in the hands of the contributing partners, RD

Leasing and EICI. Secs. 732, 723.

Thus, according to petitioners, the effect of the deemed

termination of Andantech-Foreign is that (1) no gain or loss is

recognized to RD Leasing or EICI under section 731(a) or to

Andantech-US under section 731(b), (2) Andantech-US has a basis in

the computer equipment of $119 million, and (3) RD Leasing has a

basis of $119 million in its 98-percent interest in Andantech-US.

6. Section 167 provides for a depreciation deduction with

respect to property used in a taxpayer’s trade or business or held

for the production of income by a taxpayer. Section 168

establishes the appropriate depreciation method, recovery period,

and convention for tangible property. (The depreciation deduction

allows a taxpayer to recover the cost of the property used in a

trade or business or for the production of income. United States

v. Ludey, 274 U.S. 295, 300-301 (1927); Durkin v. Commissioner, 872

F.2d 1271, 1276 (7th Cir. 1989), affg. 87 T.C. 1329 (1986).) Here,

according to petitioner, Andantech-US’s basis in the computer

equipment was $119 million, and Andantech-US properly reported the

depreciation deduction on its partnership tax returns for the
 - 60 -

10/31/93 short year and for 1994. Additionally, petitioners assert

that Andantech-US properly reported an interest expense deduction

under section 163(a) on its partnership tax returns for those

years. Ultimately, RD Leasing and EICI claimed these interest and

depreciation deductions as partners of Andantech-US.

B. Positions of the Parties

Petitioners assert that the sale-leaseback transaction

involved herein was a genuine multiple-party transaction, with

economic substance that was compelled or encouraged by business

realities, and was not shaped solely by tax-avoidance features. As

such, petitioners assert that the transaction should be respected

for Federal tax purposes because it satisfies the test of Frank

Lyon Co. v. United States, 435 U.S. 561, 583-584 (1978).

On the other hand, respondent contends that Comdisco devised

a transaction designed to allow foreign parties (not subject to

U.S. tax) to realize tax-free rental income, while allowing a U.S.

company to report significant tax deductions related to that rental

income. Here, approximately $87.8 million in rental income was

shifted (i.e., stripped) to non-U.S. taxpayers through Andantech-

Foreign, while Norwest, a U.S. taxpayer (for cash and preferred

stock totaling approximately $15.4 million), received, through RD

Leasing and Andantech-US, more than $100 million of depreciation

and interest deductions without recognizing any corresponding

rental income. Respondent contends that the “prearranged”

transaction at issue should not be respected for Federal tax
 - 61 -

purposes because it had no nontax business purpose and lacked

economic substance.

C. Analysis

The focus of each party’s position, in essence, is in terms of

substance over form and related (e.g., sham and step transaction)

judicial doctrines. Under these judicial doctrines, although the

form of a transaction may literally comply with the provisions of

a Code section, the form will not be given effect where it has no

business purpose and operates simply as a device to conceal the

true character of a transaction. See Gregory v. Helvering, 293

U.S. 465, 469-470 (1935). “To permit the true nature of a

transaction to be disguised by mere formalisms, which exist solely

to alter tax liabilities, would seriously impair the effective

administration of the tax policies of Congress.” Commissioner v.

Court Holding Co., 324 U.S. 331, 334 (1945). Conversely, if the

substance of a transaction accords with its form, then the form

will be upheld and given effect for Federal tax purposes. See

Blueberry Land Co. v. Commissioner, 361 F.2d 93, 100-101 (5th Cir.

1966), affg. 42 T.C. 1137 (1964).

A transaction may be treated as a sham where (1) the taxpayer

is motivated by no business purpose other than obtaining tax

benefits, and (2) the transaction has no economic substance because

no reasonable possibility of a profit exists. Rice’s Toyota World,

Inc. v. Commissioner, 752 F.2d 89, 91-95 (4th Cir. 1985), affg. on

this issue 81 T.C. 184 (1983). But a transaction that has a valid
 - 62 -

business purpose and economic substance may still be recast in

order to reflect its true nature. Packard v. Commissioner, 85 T.C.

397, 419-422 (1985).

Substance over form and related judicial doctrines all require

“a searching analysis of the facts to see whether the true

substance of the transaction is different from its form or whether

the form reflects what actually happened.” Harris v. Commissioner,

61 T.C. 770, 783 (1974). The issue of whether any of those

doctrines should be applied involves an intensely factual inquiry.

See Gordon v. Commissioner, 85 T.C. 309, 327 (1985); see also Bowen

v. Commissioner, 78 T.C. 55, 79 (1982), affd. 706 F.2d 1087 (11th

Cir. 1983); Gaw v. Commissioner, T.C. Memo. 1995-531, affd. without

published opinion 111 F.3d 962 (D.C. Cir. 1997).

After a thorough review of the record in these consolidated

cases, we find, and thus hold, alternatively, the following:

(1) Andantech is not a valid partnership and should not be

recognized for Federal tax purposes; more specifically:

(a) Andantech-Foreign should be disregarded because

Messrs. Parmentier and de la Barre d’Erquelinnes did not intend to

join together as partners for the purpose of carrying on a
 - 63 -

business; i.e., they did not join together to share in the profits

or losses from Andantech-Foreign’s equipment leasing activity; and

(b) Andantech-US should be disregarded because EICI did

not intend to join with RD Leasing for the purpose of carrying on

a business; i.e., they did not join together to share in the

profits or losses from Andantech-US’s equipment leasing activity;

(2) alternatively, the participation of Messrs. Parmentier

and de la Barre d’Erquelinnes, EICI, and Andantech in the

transactions involved herein should be disregarded under the step

transaction doctrine;

(3) additionally, with respect to Andantech, its sale-

leaseback transaction with Comdisco was a sham because it (a) was

not a true multiple-party transaction, (b) lacked economic

substance, (c) was not compelled or encouraged by business

realities, and (d) was shaped solely by tax-avoidance features;

(4) with respect to Norwest and RD Leasing, Andantech’s

sale-leaseback transaction with Comdisco should not be respected

because it lacked business purpose as well as economic substance.

Our reasons for these findings/holding now follow.

1. Andantech Is Not a Valid Partnership and Is Not
Recognized for Federal Tax Purposes

“A partnership is generally said to be created when persons

join together their money, goods, labor, or skill for the purpose

of carrying on a trade, profession, or business and when there is

community of interest in the profits and losses.” Commissioner v.
 - 64 -

Tower, 327 U.S. 280, 286 (1946); see also ASA Investerings Pship.

v. Commissioner, 201 F.3d 505, 513 (D.C. Cir. 2000), affg. T.C.

Memo. 1998-305. When the existence of an alleged partnership is

challenged, the question arises whether the partners truly intended

to join together for the purpose of carrying on business and

sharing in the profits or losses or both. Commissioner v. Tower,

supra at 286-287. “Business activity” excludes activity whose sole

purpose is tax avoidance. ASA Investerings Pship. v. Commissioner,

supra at 512.

a. Andantech-Foreign Should Be Disregarded
Because Messrs. Parmentier and de la Barre
d’Erquelinnes Did Not Intend To Join Together for
the Purpose of Carrying On a Business and Sharing
in the Profits or Losses From the Equipment Leasing
Activity

In these consolidated cases, we are convinced that Messrs.

Parmentier and de la Barre d’Erquelinnes did not intend to join

together in order to share in any profit or loss from the business

activity of Andantech-Foreign; namely, the sale and leaseback of

computer equipment. Rather, to the contrary, we are convinced that

Mr. Parmentier’s true business objective was to profit from the

preferred stock of RD Leasing that he expected to receive.

The correspondence between Mr. Parmentier’s attorney, Mr.

Temko, and Comdisco establishes to us that Mr. Parmentier’s sole

concern was with his potential tax liability and financial risk.

Mr. Parmentier wanted assurances that he and Mr. de la Barre

d’Erquelinnes could (1) promptly recover their $200,000 investment,
 - 65 -

(2) withdraw from Andantech at no expense, (3) incur no potential

liability for Andantech debts, and (4) incur no potential liability

in connection with managing Andantech. Further, Mr. Parmentier

asked Comdisco to provide assurances that he would be able to

exchange his partnership interest for preferred stock on the basis

described in the flowcharts and realize the full value of the

preferred stock “without any significant risk of impairment”.

Comdisco attempted to satisfy Mr. Parmentier, Mr. de la Barre

d’Erquelinnes, and their counsel as to the minimal risks associated

with the transaction.

Messrs. Parmentier and de la Barre d’Erquelinnes contributed

comparably minimal (and borrowed at that) funds ($200,000 in a

purported $122 million transaction) to Andantech-Foreign, which

they withdrew within 3 months. We are satisfied that Andantech-

Foreign and Messrs. Parmentier and de la Barre d’Erquelinnes were

but mere conduits used by Comdisco and NEFI. Neither took part in

any decisions regarding the sale and leaseback of the equipment;

rather, all of the negotiations took place between NEFI and

Comdisco. NEFI set the criteria for the end users, set the $122

million amount of the transaction, reviewed the projected cashflow

(which depended on the $15 million investment from Norwest), and

reviewed the documents and instruments for the various transactions

(including the sale of the rent receivables).
 - 66 -

Mr. Parmentier was rewarded for participating in the

transaction involved herein through the redemption of the RD

Leasing preferred stock, not through the equipment leasing

activity. Further, we are convinced that Mr. de la Barre

d’Erquelinnes had no intent to profit, and did not profit, from his

participation in any of the transactions. After withdrawing the

funds he had contributed to Andantech-Foreign, Mr. de la Barre

d’Erquelinnes transferred his 2-percent membership interest in

Andantech-Foreign to EICI and then transferred his EICI stock to a

charitable support trust established in 1988 by Comdisco.

The purpose underlying Messrs. Parmentier’s and de la Barre

d’Erquelinnes’ participation in the transaction at issue is clearly

stated in a September 25, 1993, fax from Barbara Spudis (of the

Baker & McKenzie law firm) to that firm’s Amsterdam office. The

fax stated: “The individuals forming the company are involved for

two months during which the income allocation occurs and then the

interest is transferred to the U.S. corporate investor who reaps

the benefit of ongoing depreciation deductions.”

The record reveals that Andantech-Foreign was not created for

the purpose of carrying on a trade or business but rather to strip

the income from the transaction and avoid U.S. taxation.

Consequently, we will not recognize Andantech-Foreign as a

partnership for Federal income tax purposes. See ASA Investerings

Pship. v. Commissioner, supra.
 - 67 -

b. Andantech-US Should Be Disregarded Because
EICI Did Not Intend To Join With RD Leasing for the
Purpose of Carrying On Partnership Business and
Sharing in the Profits or Losses From the
Partnership’s Equipment Leasing Activity

After Mr. de la Barre d’Erquelinnes transferred his 2-percent

membership interest in Andantech-Foreign to EICI, EICI borrowed

from UBS $302,395.55 that it needed to contribute to the capital of

Andantech. Comdisco guaranteed the loan, and UBS treated the loan

as a loan to Comdisco. Mr. de la Barre d’Erquelinnes then

transferred his EICI stock to a charitable support trust

established in 1988 by Comdisco.

There is no evidence that EICI had assets other than its

interest in Andantech. Moreover, EICI’s only means of repaying the

UBS loan was through its 6-percent priority return distribution in

the event Comdisco exercised its early termination option.

EICI did not participate in the negotiations of the

transactions and did not intend to profit, and did not profit, from

the transactions. EICI did not join with RD Leasing for purposes

of carrying on a trade or business or sharing in profit or loss

from the sale-leaseback transaction.

EICI did not exist before the transactions at issue. It was

created as a vehicle to dispose of Mr. de la Barre d’Erquelinnes’s

2-percent interest and to create the illusion of a second

participant required for partnership classification. Under the

principles of Gregory v. Helvering, 293 U.S. 465 (1935), Andantech-

US is not recognized as a valid partnership for Federal income tax
 - 68 -

purposes.

2. Andantech Acted as a Mere Shell or Conduit To Strip
the Income From the Transaction and Avoid Income Taxation
and, Under the Step Transaction Doctrine, Should Be
Disregarded

Even if we believed Andantech should be respected as a valid

partnership (which we do not), it should be disregarded under the

step transaction doctrine. “Under the step-transaction doctrine,

a particular step in a transaction is disregarded for tax purposes

if the taxpayer could have achieved its objective more directly,

but instead included the step for no other purpose than to avoid

U.S. taxes.” Del Commercial Props., Inc. v. Commissioner, 251 F.3d

210, 213-214 (D.C. Cir. 2001), affg. T.C. Memo. 1999-411; see also

Penrod v. Commissioner, 88 T.C. 1415, 1428-1430 (1987). As

described in Smith v. Commissioner, 78 T.C. 350, 389 (1982):

The step transaction doctrine generally applies in
cases where a taxpayer seeks to get from point A to point
D and does so stopping in between at points B and C. The
whole purpose of the unnecessary stops is to achieve tax
consequences differing from those which a direct path
from A to D would have produced. In such a situation,
courts are not bound by the twisted path taken by the
taxpayer, and the intervening stops may be disregarded or
rearranged. [Citation omitted.]

The existence of business purposes and economic effects

relating to the individual steps in a complex series of

transactions does not preclude application of the step transaction

doctrine. True v. United States, 190 F.3d 1165, 1176-1177 (10th

Cir. 1999).

To ratify a step transaction that exalts form over
substance merely because the taxpayer can either (1)
 - 69 -

articulate some business purpose allegedly motivating the
indirect nature of the transaction or (2) point to an
economic effect resulting from the series of steps, would
frequently defeat the purpose of the substance over form
principle. Events such as the actual payment of money,
legal transfer of property, adjustment of company books,
and execution of a contract all produce economic effects
and accompany almost any business dealing. Thus, we do
not rely on the occurrence of these events alone to
determine whether the step transaction doctrine applies.
Likewise, a taxpayer may proffer some non-tax business
purpose for engaging in a series of transactional steps
to accomplish a result he could have achieved by more
direct means, but that business purpose by itself does
not preclude application of the step transaction
doctrine. * * *

Id. at 1177.

Under the step transaction doctrine, a series of formally

separate steps may be collapsed and treated as a single transaction

if the steps are in substance integrated and focused toward a

particular result. Courts have applied three alternative tests in

deciding whether the step transaction doctrine should be invoked in

a particular situation; namely, (1) if at the time the first step

was entered into, there was a binding commitment to undertake the

later step (binding commitment test), (2) if separate steps

constitute prearranged parts of a single transaction intended to

reach an end result (end result test), or (3) if separate steps are

so interdependent that the legal relations created by one step

would have been fruitless without a completion of the series of

steps (interdependence test). See Penrod v. Commissioner, supra at

1428-1430. More than one test might be appropriate under any given

set of circumstances; however, the circumstances need satisfy only
 - 70 -

one of the tests in order for the step transaction doctrine to

operate. Associated Wholesale Grocers, Inc. v. United States, 927

F.2d 1517, 1527-1528 (10th Cir. 1991) (finding end result test

inappropriate but applying the step transaction doctrine using the

interdependence test). We now turn to the application of these

three tests to the transaction involved herein.

a. Binding Commitment Test

We first consider the application of the binding commitment

test. Petitioners posit that RD Leasing was not bound to engage in

the transaction until it actually entered the transaction in

December 1993, and that Messrs. Parmentier and de la Barre

d’Erquelinnes formed Andantech-Foreign independent of any

commitment by RD Leasing. For the reasons set forth below, we do

not believe it is appropriate to apply the binding commitment test

to our step transaction analysis in this case.

The purpose of the binding commitment test is to promote

certainty in tax planning; it is the most rigorous limitation of

the step transaction doctrine. It is seldom used and is applicable

only where a substantial period of time has passed between the

steps that are subject to scrutiny. Thus, it is not an appropriate

test to apply to the transactions before us inasmuch as the

transactions were prearranged by Comdisco, completed in 6 months,

and fell entirely within a single tax year. See, e.g., Associated

Wholesale Grocers, Inc. v. United States, supra at 1522 n.6

(rejecting use of the binding commitment test because the case did
 - 71 -

not involve a series of transactions spanning several years).

Because the transactions in the present case do not span a long

period of time or involve a binding commitment to pursue successive

steps, we do not analyze them under the binding commitment test.

Thus, in this case, only the end result and interdependence tests

are relevant to our step transaction analysis.

b. End Result Test

We now turn to the application of the end result test. The

end result test combines into a single transaction separate events

that appear to be components of something undertaken to reach a

particular result. Kornfeld v. Commissioner, 137 F.3d 1231, 1235

(10th Cir. 1998), affg. T.C. Memo. 1996-472; Associated Wholesale

Grocers, Inc. v. United States, supra at 1523. Under the end

result test, if we find that a series of closely related steps in

a transaction is merely the means to reach a particular end result,

we will not separate the steps but instead will treat them as a

single transaction. King Enters., Inc. v. United States, 189 Ct.

Cl. 466, 418 F.2d 511, 516 (1969); see also Helvering v. Ala.

Asphaltic Limestone Co., 315 U.S. 179 (1942); Morgan Manufacturing

Co v. Commissioner, 124 F.2d 602 (4th Cir. 1941), affg. 44 B.T.A.

691 (1941); Heintz v. Commissioner, 25 T.C. 132 (1955); Ericsson

Screw Mach. Prods. Co. v. Commissioner, 14 T.C. 757 (1950).

The end result test focuses upon the actual intent of the

parties as of the time of the transaction. It is flexible and

bases tax consequences on the substance of the transaction, not on
 - 72 -

the formalisms chosen by the participants. “The intent we focus on

under the end result test is not whether the taxpayer intended to

avoid taxes. * * * Instead, the end result test focuses on whether

the taxpayer intended to reach a particular result by structuring

a series of transactions in a certain way.” True v. United States,

190 F.3d at 1175.

Under the end result test, there is no independent tax

recognition of the individual steps unless the taxpayer shows that

at the time the parties engaged in the individual step, its result

was the intended end result in and of itself. Id. If this is not

what was intended, then we collapse the series of steps and give

tax consideration only to the intended end result. Id. “The

doctrine derives vitality, rather, from its application where the

form of a transaction does not require a particular further step be

taken; but, once taken, the substance of the transaction reveals

that the ultimate result was intended from the outset.” (Emphasis

in original.) King Enters., Inc. v. United States, supra at 518.

Applying the end result test to the sale-leaseback transaction

at issue, we examine whether Comdisco and Norwest intended from the

outset to transfer the benefits and burdens of the sale-leaseback

of the equipment to RD Leasing. If the intended end result was for

RD Leasing to have those benefits and burdens, then petitioners

cannot claim a right to favorable tax treatment for the various

intermediate transactions leading up to that intended result.

The record clearly indicates that every step taken by the
 - 73 -

parties (the formation of Andantech, the sale-leaseback of the

equipment between Comdisco and Andantech, the sale of the Comdisco

rents to NationsBank, and the contribution by Mr. Parmentier of his

interest in Andantech to RD Leasing) were but transitory steps.

All the legal documents relating to the transactions,

including the sale of the Comdisco rents, were negotiated and

reviewed by NEFI; and all profit and cashflow projections were

based on the assumption that a U.S. company would invest $15

million. We are unable to glean from the record that Messrs.

Parmentier and de la Barre d’Erquelinnes ever contemplated making

(and there is no evidence that they had the means to make) a $15

million investment. (On the other hand, NEFI bore the risk of loss

of its $15 million investment.) Moreover, the financial

projections never evaluate the transaction on the basis of the

initial contributions made by Messrs. Parmentier and de la Barre

d’Erquelinnes. Simply put, we are of the opinion that Messrs.

Parmentier and de la Barre d’Erquelinnes never intended to place

their funds at risk. They withdrew their minimal contributions as

soon as practicable and before transferring their interests to RD

Leasing and EICI. It is obvious to us that Mr. Parmentier’s only

concerns in entering into the arrangement were to ensure that he

would not be taxed on the sale of the Comdisco rents and that he

would profit from his receipt of the preferred stock. Neither Mr.

Parmentier nor Mr. de la Barre d’Erquelinnes had any of the

benefits or burdens associated with the sale-leaseback transaction.
 - 74 -

The intended result from the outset was to pass the benefits and

burdens of the sale-leaseback transaction to RD Leasing in order to

allow Norwest to claim large depreciation deductions and for Mr.

Parmentier to make his profit through the value of RD Leasing’s

preferred stock.

Thus, by applying the end result test, we will give tax

consideration only to that intended result.

c. Interdependence Test

We reach the same conclusion by reviewing the transactions

under the interdependence test. The “interdependence” test focuses

on whether “the steps are so interdependent that the legal

relations created by one transaction would have been fruitless

without a completion of the series.” Redding v. Commissioner, 630

F.2d 1169, 1177 (7th Cir. 1980), revg. and remanding 71 T.C. 597

(1979); see also Kass v. Commissioner, 60 T.C. 218 (1973), affd.

without published opinion 491 F.2d 749 (3d Cir. 1974); Farr v.

Commissioner, 24 T.C. 350 (1955); Am. Wire Fabrics Corp. v.

Commissioner, 16 T.C. 607 (1951); Am. Bantam Car Co. v.

Commissioner, 11 T.C. 397 (1948), affd. 177 F.2d 513 (3d Cir.

1949). This test concentrates on the relationship between the

steps, rather than on their “end result”. See Sec. Indus. Ins. Co.

v. United States, 702 F.2d 1234, 1245 (5th Cir. 1983).

The interdependence test requires a court to find whether the

individual steps had independent significance or had meaning only

as part of the larger transaction. Penrod v. Commissioner, 88 T.C.
 - 75 -

at 1429-1430. If the steps have “reasoned economic justification

standing alone”, then the interdependence test is inappropriate.

Sec. Indus. Ins. Co. v. United States, supra at 1247. If, however,

the only reasonable conclusion from the evidence is that the steps

have “meaning only as part of the larger transaction”, then the

step transaction doctrine applies as a matter of law. Id. at 1246.

In order to maintain this objectivity and ensure the steps have

independent significance, it is useful to compare the transactions

in question with those usually expected to occur in otherwise bona

fide business settings. See Merryman v. Commissioner, 873 F.2d

879, 881 (5th Cir. 1989), affg. T.C. Memo. 1988-72.

Here, the sale-leaseback transaction between Comdisco and

Andantech-Foreign and the sale of the Comdisco rents by Andantech-

Foreign to NationsBank would not have taken place without the

planned participation of RD Leasing. This point is demonstrated

both by the importance of the preferred stock to Mr. Parmentier in

the negotiations and the certain financial failure of Andantech-

Foreign without a cash infusion from RD Leasing.

Petitioners assert that the financial projections using

forecasts of the residual values made by the appraisers in 1993

show that Andantech had a reasonable opportunity to earn a profit

from the transaction. All of the financial projections, however,

were made on the basis of the $15 million supplied by RD Leasing

and the avoidance of Federal income tax on the rents payable by

Comdisco.
 - 76 -

Mr. Parmentier’s failure to seriously evaluate the likely

residual value of the equipment, his willingness to pay an

arbitrary purchase price, and his minimal investment in the

partnership (which would facilitate his abandonment of the

transaction in the event RD Leasing failed to take the next step),

collectively persuade us that Mr. Parmentier and Andantech-Foreign

did not have profit motivation for entering into the sale-leaseback

transaction.

Additionally, the loans to Andantech were attributable to a

desire by UBS and NationsBank to accommodate Comdisco. UBS, which

ultimately provided the approximate $15 million cash needed for the

purchase of the equipment, had provided similar amounts for other

similar Comdisco deals. UBS made the loan to Andantech on the

basis of Comdisco’s creditworthiness and on the basis that the

earlier loans had been paid off, usually within 3 months. On the

other hand, Andantech had minimal assets. Its only means of paying

the interest due on the approximate $15 million loan was from the

rents due from Comdisco. But Andantech had “sold” the Comdisco

rents to NationsBank and was required to use the proceeds received

from NationsBank to pay off the $87 million term note owed to

Comdisco. Thus, after the sale of the Comdisco rents to

NationsBank, Andantech had no means of paying the substantial

interest accruing on the approximate $15 million UBS loan as the

interest became due.

The funds provided by RD Leasing did not just enhance the
 - 77 -

financial condition of the partnership; they were essential to the

solvency of the partnership. The financial limitations placed on

Andantech made it extremely likely that the transfer of Mr.

Parmentier’s interest to RD Leasing would, as it did, take place

promptly.

Our review of the entire record persuades us that the

transactions did not take the form they did in order to afford

Andantech an opportunity to earn a profit. To the contrary, we are

convinced that the only purpose for structuring the sale-leaseback

transaction between Comdisco and Andantech, rather than directly

between Comdisco and RD Leasing, was to avoid tax that would have

been paid by NEFI on the acceleration of rental income from the

sale of the Comdisco rents had the transactions been structured as

direct sale-leaseback transactions between Comdisco and RD Leasing.

We find that Andantech acted as a mere shell or conduit to strip

the income from the transaction and avoid income for RD Leasing.

Accordingly, we hold the steps involved in the transactions at

issue lack any reasoned economic justification standing alone. As

stated, there was no apparent purpose for Messrs. Parmentier and de

la Barre d’Erquelinnes to purchase (through Andantech) and lease

back the equipment other than to facilitate the eventual transfer

of the property into the hands of RD Leasing. Andantech did not

exist before this transaction. It was created as a limited

liability company to serve as a passthrough vehicle specifically

for the transaction at issue.
 - 78 -

The exchange of Mr. Parmentier’s partnership interest for the

RD Leasing preferred stock is suspect. RD Leasing was a shell

corporation and was not involved in equipment leasing. It was

recapitalized for the purpose of engaging in this transaction. Mr.

Parmentier was not interested in any true investment in RD Leasing.

He wanted cash but agreed to take and hold the RD Leasing preferred

stock only in order to qualify the exchange under section 351.

RD Leasing was required to maintain sufficient funds to pay

the liquidation preference to Mr. Parmentier. We see no apparent

reasons for the use of an exchange of the preferred stock for Mr.

Parmentier’s interest in Andantech other than to facilitate the

tax-free transfer of the depreciation deductions to Norwest and to

compensate Mr. Parmentier for his services.

Standing alone, none of the individual steps in the

transaction at issue is the type of business activity one would

expect to see in a bona fide, arm’s-length business deal between

unrelated parties, and none of them makes any objective sense

standing alone without contemplation of the subsequent steps in the

transaction. Each step in the transaction leads inexorably to the

next. Consequently, the interdependence test is satisfied for

application of the step transaction doctrine.

We are of the opinion that NEFI and Comdisco recognized that

a direct transaction with RD Leasing would result in the offset of

depreciation deductions with the income from the rents.

Consequently, they passed ownership of the equipment through
 - 79 -

Andantech-Foreign in order to produce a more favorable tax result.

By channeling the sale and leaseback of the equipment through

Andantech-Foreign, and by using a series of unnecessary exchanges

and transfers, RD Leasing through Andantech-US ended up with a high

basis in the equipment. It would be unreasonable to assume that

the convoluted steps used in this transaction were anything other

than an integrated plan (prearranged by Comdisco and NEFI) to

accomplish tax advantages that could not be accomplished otherwise.

In essence, Comdisco and NEFI changed what would have been the

natural result of a direct purchase of the equipment by engaging in

a series of steps designed from the outset to circumvent the intent

of the Code. Fundamental principles of taxation dictate that “A

given result at the end of a straight path is not made a different

result because reached by following a devious path.” Minn. Tea Co.

v. Helvering, 302 U.S. 609, 613 (1938). Consequently, we (1)

ignore the indirect route of the individual steps, (2) view the

transactions in their entirety, and (3) treat the transaction as

one between Comdisco and NEFI.

Under either the end result test or the interdependence test,

courts will ignore a step in a series of transactions if that step

does not appreciably affect the taxpayer’s beneficial interest

except to reduce his tax. Del Commercial Props., Inc. v.

Commissioner, 251 F.3d 210 (D.C. Cir. 2001). There must be a

purpose for each step other than tax avoidance and the purpose

cannot be a “facade”. Id. at 214. The absence of a valid nontax
 - 80 -

business purpose is fatal. Id.

After reviewing Comdisco’s equipment leasing concept, see

supra pp. 10-12, and the economic effect of the transaction, we

conclude that the insertion of Andantech into the sale-leaseback

transaction involved herein served no valid nontax business purpose

and was devoid of any economic substance. Regardless of which test

is used under the step transaction doctrine, the facts in this case

require us to reach the same result.

If the sole purpose of a transaction with a foreign entity “is

to dodge U.S. taxes, the treaty cannot shield the taxpayer from the

fatality of the step-transaction doctrine. For a taxpayer to enjoy

the treaty’s tax benefits, the transaction must have a sufficient

business or economic purpose.” Del Commercial Props., Inc. v.

Commissioner, supra at 213-214; see also Gaw v. Commissioner, T.C.

Memo. 1995-531, affd. without published opinion 111 F.3d 962 (D.C.

Cir. 1997). The foreign entity must serve a role with a sufficient

business or economic purpose to overcome the conduit nature of the

transaction. Del Commercial Prop., Inc. v. Commissioner, supra at

215.

In this case, the creation of Andantech-Foreign did not

appreciably affect Norwest’s interests in the sale-leaseback

arrangement, except to reduce its U.S. tax. Andantech-Foreign’s

sole purpose was to enable Norwest to obtain the benefits of an

exemption established by treaty for income attributable to the sale

of the Comdisco rents. And a tax-avoidance motive standing by
 - 81 -

itself is not a business purpose which is sufficient to support a

transaction for tax purposes. See Knetsch v. United States, 364

U.S. 361 (1960); Higgins v. Smith, 308 U.S. 473 (1940); Gregory v.

Helvering, 293 U.S. at 469.

3. The Sale-Leaseback Transaction Lacked
Business Purpose and Economic Substance

We also agree with respondent that, even if we did not

disregard Andantech’s participation in the transaction, the sale-

leaseback transaction should not be respected for Federal income

tax purposes.19

Courts will give effect to “a genuine multiple-party

transaction with economic substance that is compelled or encouraged

by business or regulatory realities, that is imbued with tax-

independent considerations, and that is not shaped solely by tax-

avoidance features to which meaningless labels are attached”.

Frank Lyon Co. v. United States, 435 U.S. at 562.

In Horn v. Commissioner, 968 F.2d 1229 (D.C. Cir. 1992), the

Court of Appeals for the D.C. Circuit set forth the following test

for determining whether a transaction should be considered a sham

for tax purposes:

“To treat a transaction as a sham, the court must find

19
We note that, if the transaction has economic
substance, then RD Leasing is entitled to the interest and
depreciation deductions but must include the income from the sale
of the Comdisco rents. If, on the other hand, the transaction
lacks economic substance, then RD Leasing is not entitled to the
claimed deductions and is not required to include the income from
the sale of the rents.
 - 82 -

[1] that the taxpayer was motivated by no business
purpose other than obtaining tax benefits in entering the
transaction, and [2] that the transaction has no economic
substance because no reasonable possibility of profit
exists.” * * *

Id. at 1237 (quoting Friedman v. Commissioner, 869 F.2d 785, 792

(4th Cir. 1989)); see also IES Indus., Inc. v. United States, 253

F.3d 350 (8th Cir. 2001); ACM Partnership v. Commissioner, 157

F.3d 231 (3d Cir. 1998), affg. in part, revg. in part, dismissing

in part, and remanding T.C. Memo. 1997-115; Salina Partnership,

L.P. v. Commissioner, T.C. Memo. 2000-352; Shriver v. Commissioner,

T.C. Memo. 1987-627, affd. 899 F.2d 724, 727 (8th Cir. 1990). Our

inquiry as to the business purpose and economic substance of a

transaction is inherently factual. See Torres v. Commissioner, 88

T.C. 702, 718 (1987).

In this case, we conclude that the sale-leaseback should not

be respected for tax purposes because (1) no reasonable possibility

for profit existed, and (2) RD Leasing was not motivated by any

business purpose other than obtaining tax benefits.

Petitioners and respondent each retained expert witnesses to

assess the possibility of profit with respect to the sale-leaseback

transaction involved herein.

a. The Experts

In total, nine experts testified–-five for petitioners and

four for respondent. Two of the experts (David Fleming for

petitioners and Dr. James Schallheim for respondent) testified as

to the economics of the transaction. In particular, each testified
 - 83 -

as to the pretax returns RD Leasing could expect to receive. Each

agreed that if the estimated residual values of the computers (as

determined by M&S, MAC, and ARI) were attainable, then the leases

were economically viable (i.e., had economic substance) without

regard to tax considerations. The two experts differed, however,

on the amount of pretax return attainable.

In reviewing the other’s report, Mr. Fleming and Dr.

Schallheim each had one “major” disagreement with respect to the

computation of yield, specifically, the computations of yield with

regard to the scenario where Comdisco does not exercise its early

termination option. In his rebuttal report, Dr. Schallheim stated

that Mr. Fleming included $2,711,993 as rents to be received by

Andantech, whereas Dr. Schallheim thought those rents had been sold

to NationsBank. (In addition, Dr. Schallheim found that Mr.

Fleming had understated the interest on the balloon notes in the

full term option by $268,541.)

Dr. Schallheim based his conclusion on his understanding of

the definition of the term “Sale Rents” in the lease receivable

purchase agreement. That provision, which defined the rents sold

to NationsBank, stated that “Sale Rents” would mean “all payments

of Rent payable under the Lease after the Closing Date but before

the Early-Termination Date as set forth on Schedule I.” (Schedule

I was captioned “Rents Sold to Purchaser” and provided specific

dollar amounts of the rents that were sold.) Dr. Schallheim

testified that he treated all rents payable before the early
 - 84 -

termination dates as having been sold, whether or not they were

listed on Schedule I. Dr. Schallheim also based his conclusion on

the fact that Andantech-U.S. did not receive any rent payments from

Comdisco.

Thompson Ryan, one of petitioners’ experts, testified that had

the projected residual values of the computers been realized, and

had Comdisco exercised its early termination option, then the

pretax return for RD Leasing would have been 6.6 percent, as

reflected in the September Projections. John Deane, one of

respondent’s experts, agreed with Mr. Ryan’s calculation; however,

Mr. Deane believed a 6.6-percent return was at, or slightly below,

the low end of what an investor would consider acceptable in 1993.

The other experts (Ralph Page, Mary O’Connor, and Patrick

Callahan for petitioners and Susan Middleton and Peter Daley for

respondent) opined as to the reasonableness of the projected

residual values of the computers. Petitioners’ experts testified

that the price paid for the computers was fair and that the

projected residual values were attainable. Not surprisingly,

respondent’s experts believed otherwise.

Mr. Daley was the publisher of two industry reports-–the DMC

End-User Market Value Report and the DMC Residual Value Report.

The information contained in these reports was based on computer

(and related equipment) sales between dealers; hence, the amounts

reflected in the DMC reports were wholesale (marked up by 10

percent), rather than retail, prices. On the basis of the
 - 85 -

information contained in his reports, Mr. Daley opined that the

purchase price of the computers was inflated and that the projected

residual values of the computers were unattainable.

Ms. Middleton, an expert in the field of residual valuation of

mainframe computers at IDC, rebutted the expert opinion of Mr.

Page. She opined that Mr. Page’s estimated economic life for the

equipment was too long and explained that IDC projected a 6- to 7-

year life for the equipment as of June/July 1993. On the basis of

the residual values forecast by IDC in its IBM June/July 1993

Residual Value Report, the residual value of the equipment on the

early termination date was less than $20 million, and on the

termination date it was less than $10 million. Ms. Middleton

testified that IDC did not take into account (in its residual value

forecasting) the value of computers on lease, or the “lease

premium”.

The experts made their evaluation of residual values on the

basis of a percentage of list price, as did the three September

1993 appraisals. The following table sets forth the percentages

used in the various appraisals as well as the percentages published

in DMC’s 1993 publication:
 - 86 -

Computation of Residual Value as Percentage of List Price (LP)

Early Termination Date I II III IV V VI
Type/Model 8 Years % of LP
Category % of LP % of LP % of LP % of LP % of LP Retail/Wholesale
9021/720/E 5/27/96 6.67% 8% 7% 7.96% 1.81% 2.0/1.8% (4/96)
9021/740/F 5/27/96 12.67 14 13 14.83 5.35 6.1/5.5 (4/96)
9021/820/G 5/27/96 12.67 14 13 13.70 4.81 5.5/4.9 (4/96)
9021/860/H 5/27/96 12.67 14 13 14.12 4.81 5.5/5.0 (4/96)
9021/900/I 5/27/96 12.67 14 13 13.63 4.77 5.4/4.9 (4/96)
9121/260/A 9/27/96 20.66 20 20 13.44 5.27 5.2/4.7 (10/96)
9121/320/B 10/27/96 19.75 21 20 11.87 4.26 4.7/4.2 (10/96)
9121/440/C 10/27/96 19.75 20 20 15.14 4.09 4.5/4.0 (10/96)
9121/480/D 10/27/96 19.75 19 20 13.78 4.29 4.7/4.2 (10/96)
Value $44,275,948 $48,442,600 $45,334,670 $44,702,292 $16,238,905

End of Lease Term I II III IV V VI
Type/Model RV as RV as RV as RV as
Category % of LP % of LP % of LP % of LP % of LP Retail/Wholesale
9021/720/E 2/27/97 3.75% 5-6% 4% 4.84% 1.01% 1.2/1.1% (1/97)
9021/740/F 2/27/97 7.50 10 8 10.95 2.11 2.4/2.2 (1/97)
9021/820/G 2/27/97 7.50 10 8 9.93 1.85 2.2/1.9 (1/97)
9021/860/H 2/27/97 7.50 10 8 10.50 2.04 2.3/2.0 (1/97)
9021/900/I 2/27/97 7.50 10 8 9.88 1.94 2.2/2.0 (1/97)
9121/260/A 7/27/97 11.00 14 10 8.54 1.37 1.6/1.5 (7/97)
9121/320/B 8/27/97 10.00 14 10 7.70 1.10 1.6/1.4 (7/97)
9121/440/C 8/27/97 10.00 13-14 10 9.08 1.10 1.6/1.4 (7/97)
9121/480/D 8/27/97 10.00 13 10 8.27 1.10 1.6/1.5 (7/97)
Value $25,418,962 $34,257,000 $26,769,965 $31,607,012 $6,341,682

I. M&S appraisal
II. MAC appraisal
III. ARI appraisal
IV. Mr. Page’s appraisal using 8-year useful life.
V. DMC Consulting Group (Mr. Daley’s Expert Report)
VI. DMC Residual Value Reports (Third Quarter 1993)
 - 87 -

b. No Reasonable Possibility for Profit
Existed

Petitioners assert that RD Leasing had a reasonable

opportunity to earn a profit from the transaction based upon the

forecasts of residual values made by the appraisers in 1993.

Petitioners insist that the forecasts of residual values of the

equipment were realistic. For the reasons set forth hereinafter,

we conclude that the sale-leaseback transaction involved herein had

no realistic potential to earn a meaningful profit.

In order to hold that tax avoidance was not the sole

motivation for the transaction, we must determine that a profit was

reasonably likely. Estate of Thomas v. Commissioner, 84 T.C. 412,

440 n.52 (1985). On an objective basis, we conclude that RD

Leasing had no reasonable prospect for pretax profit.

The key to profitability rested in achieving the projected

residual values for the equipment on the early or final termination

Dates.20 The record reveals that forecasting residual values is

inherently difficult in light of the fact that a forecaster’s

predictions rely upon future economic events and trends.

20
The estimated yields from the perspective of RD Leasing
was as follows:

Early Final
Termination Termination

September projections 6.60% 14.00%
December projections 6.70 14.10
Mr. Fleming’s analysis 5.74 12.95
 - 88 -

Reasonable people can differ. Many of the experts agreed that

“residual value forecasting is more an art than a science” (and

that forecasting computer residual values was similar to predicting

the stock market).

We are not bound by the opinion of any expert witness when

that opinion is contrary to our own judgment. Chiu v.

Commissioner, 84 T.C. 722, 734 (1985). We may accept or reject

expert testimony as we, in our best judgment, deem appropriate.

Helvering v. Natl. Grocery Co., 304 U.S. 282 (1938); Silverman v.

Commissioner, 538 F.2d 927, 933 (2d Cir. 1976), affg. T.C. Memo.

1974-285. On the basis of our analysis of the transaction, and the

methods of evaluation employed by each expert, we find that

petitioners’ experts overvalued the residual value of the equipment

and that respondent’s experts undervalued it.

Petitioners’ experts posit that several unforeseen factors

resulted in RD Leasing’s failure to realize the projected residual

values of the computers: (1) The introduction and commercial

success of a new technology by IBM, called CMOS21 (complementary

metal oxide semiconductor), and IBM’s failure to provide a “path”

by which existing mainframes could be upgraded; (2) IBM’s

21
CMOS processors had the following advantages: they
cost less than 25 percent of the list price of IBM’s older
mainframes; they required substantially less floor space; they
did not require dedicated environmental support (i.e., they were
air cooled instead of water cooled); they could be maintained for
50 percent less than older machines; and they could be configured
to process data in less time.
 - 89 -

announcement that it would no longer publish list prices for its

9021 and 9121 computer models, and that it would provide discounts

to purchasers of those models in order to retain its market share;

(3) increased competition from other manufacturers (such as Amdahl

Computer Corp. and Hitachi Data Systems, Inc.); and (4) IBM’s

adoption of a “market basket approach”, whereby IBM bundled

hardware, software, and services into a single package, charging a

single price.

Respondent’s experts testified that in 1993 the mainframe

market community was aware that IBM would be introducing new

technology22 which would shorten the lives (and adversely affect the

residual values) of the IBM 9021 and 9121 models; however, they

acknowledged that the specifics of the new technology were unknown.

Ms. Middleton acknowledged that in the fall of 1993, there was some

speculation as to whether IBM could successfully develop CMOS

technology, and if IBM could, when IBM would be able to bring a

product (using that technology) to market.

The September 1993 ARI appraisal claims that the “unusual

pessimism” of the residual value estimates by the Gartner Group,

IDC, and DMC are the result of several assumptions, including the

prediction that “IBM will introduce revolutionary technology in

January 1996 and that the value of * * * [the computers] will

22
A Nov. 10, 1993, New York Times article reported that
IBM had introduced a big new computer to replace its antiquated
mainframe line.
 - 90 -

approach their estimated salvage value of 1% of list within one

year after the announcement.”

Additionally, the DMC Residual Value Report for the third

quarter 1993 forecast commentary for the IBM 9021 models states

that the lack of a list price was bothersome to most users because

of the lack of a reference point to begin negotiations. The report

indicates that there also was no list price for the IBM 9121

models. Thus, at the time of the transaction, IBM no longer

provided list prices and the lack of list prices was not an

unforeseeable event.

We think the market forces that resulted in a rapid decline in

the value of the equipment were predictable in 1993 and, at a

minimum, should not have been ignored by the appraisers and

petitioners’ experts in estimating the residual values.

The M&S report states that IBM typically introduces a new

series (or family) of mainframes every 3.5 to 5 years. Mr. Page,

a vice president of M&S, testified as an expert for petitioners in

this case. His estimate of the residual value of the computers is

based upon a chart from a study he prepared for M&S in spring 1993

using a 10-year useful life. His age/life depreciation curve was

based upon an annual study that he prepared beginning in 1980 and

continuing through 1992. The data for this study came from the

January issues of the “Computer Price Guide” (recognized as the

most authoritative source of secondary market information). In

1993 when he prepared the chart, he was aware of the fact that “the
 - 91 -

rate of technological changes was accelerating.” He did not

shorten the useful life; instead, he reduced the value by 10

percent for years 1 to 8 and a lesser amount for years 9 and 10.

Petitioners’ experts assert that respondent’s experts failed

to take into account the “foot print” value when estimating the

residual value of the equipment. The “foot print” value is the

value that accrues to a computer that is on lease. It includes the

ability to upgrade. Significant profits can be made from upgrades.

The record shows, however, that RD Leasing did not have the benefit

of the foot print. Rather, Comdisco had the right to that benefit.

All the experts opined that if the residual value estimates of

MAC, M&S, and ARI were valid, then the lease would appear to have

economic substance before taxes. However, we find that the

estimated values provided by petitioners’ experts are not reliable

as estimates of residual values of the equipment. Those estimates

inflate the residual values by including the “foot print” value and

ignoring predictable market events that affected the values

negatively. In sum, we do not accept the analyses and conclusions

of petitioners’ experts as to residual values.

Petitioners’ experts assert that residual values for January

1994, as set forth in the October 1992 DMC Residual Value Report,

were extremely low. They assert that the DMC forecasts undervalued

the residual values of the IBM 9021 models by up to 186 percent and

the IBM 9121 models by up to 13 percent. In our opinion, the

predictions of the earlier DMC Residual Value Report would have
 - 92 -

been less accurate than the report available at the time of the

transaction, in part because they were made shortly after the

computers were first introduced by IBM. Increasing the residual

values forecast in the DMC Residual Value Report available at the

time of the transaction by the undervaluation percentages provided

by petitioners’ expert Mr. Callahan for each model, a reasonable

estimate of the residual value of the equipment would have been as

follows:

Computation of Residual Value
Full Term
Type/Model/ List Price
Category (LP) DMC/(Increase) Amount
9021/720/E $35,412,247 1.2% (2.6) 3.12% $1,104,862
9021/740/F 12,336,045 2.4 (1.5) 3.60 444,098
9021/820/G 68,624,690 2.2 (1.5) 3.30 2,264,615
9021/860/H 40,808,478 2.3 (1.5) 3.45 1,407,892
9021/900/I 139,926,914 2.2 (1.5) 3.30 4,617,588
9121/260/A 4,637,115 1.6 (1.1) 1.76 81,613
9121/320/B 18,186,545 1.6 (1.1) 1.76 320,083
9121/440/C 6,923,363 1.6 (1.1) 1.76 121,851
9121/480/D 14,427,399 1.6 (1.1) 1.76 253,922
Total 10,616,524
Early Termination Date
9021/720/E $35,412,247 2.0% (2.6) 5.20% $1,841,437
9021/740/F 12,336,045 6.1 (1.5) 9.15 1,128,748
9021/820/G 68,624,690 5.5 (1.5) 8.25 5,661,537
9021/860/H 40,808,478 5.5 (1.5) 8.25 3,366,699
9021/900/I 139,926,914 5.4 (1.5) 8.10 11,334,080
9121/260/A 4,637,115 5.2 (1.1) 5.72 265,243
9121/320/B 18,186,545 4.7 (1.1) 5.17 940,244
9121/440/C 6,923,363 4.5 (1.1) 4.95 342,706
9121/480/D 14,427,399 4.7 (1.1) 5.17 745,897
Total 25,626,591

We find that at the time of the transaction, the estimated

residual value of the equipment for the final termination dates was
 - 93 -

no greater than $10,616,524 and for the early termination dates was

no greater than $25,626,591.

The projected balance due on the balloon notes at the end of

the full term of the lease was $20,335,186, and at the early

termination date the projected balance was $25,582,611.

Consequently, RD Leasing had no realistic potential to recover its

investment or to earn a pretax profit.

In sum, we conclude that under the objective economic

substance test, the leveraged sale-leaseback transaction involved

herein had no reasonable opportunity for economic profit. We now

turn our attention to whether RD Leasing/Norwest was motivated by

any business purpose apart from obtaining tax benefits.

c. RD Leasing/Norwest Was Not Motivated by Any
Business Purpose Other Than Obtaining Tax Benefits

The proper inquiry for the business purpose test is “whether

the taxpayer was induced to commit capital for reasons only

relating to tax considerations or whether a non-tax motive, or

legitimate profit motive, was involved.” Shriver v. Commissioner,

899 F.2d at 726. In other words, the business purpose test is a

subjective economic substance test. In making a “subjective

analysis of the taxpayer’s intent”, we review such factors as the

depth and accuracy of the taxpayer’s investigation into the

investment. Id. To the extent the taxpayer’s subjective intent is

material, we also consider factors that are arguably relevant to

the inquiry.
 - 94 -

Petitioners posit that, on a subjective basis, RD Leasing,

NEFI, and Norwest acted in a businesslike manner and were not

motivated solely by tax considerations. But we are not satisfied

that Norwest/RD Leasing (through its executive employees) believed

that the projected residual values were both realistic and

attainable.

In analyzing whether a taxpayer was induced to commit capital

for reasons relating only to tax considerations or whether a

legitimate profit motive was involved, the following factors are

particularly significant: (1) The presence or absence of arm’s-

length price negotiations, Helba v. Commissioner, 87 T.C. 983, 1004

(1986), affd. without published opinion 860 F.2d 1075 (3d Cir.

1988); see also Karme v. Commissioner, 73 T.C. 1163, 1186 (1980),

affd. 673 F.2d 1062 (9th Cir. 1982); (2) the relationship between

the selling price and the fair market value, Zirker v.

Commissioner, 87 T.C. 970, 976 (1986); Helba v. Commissioner, supra

at 1005-1007, 1009-1011; (3) the structure of the financing, Helba

v. Commissioner, supra at 1007-1011; (4) the degree of adherence to

contractual terms, id. at 1011; (5) the reasonableness of the

income and residual value projections, Rice’s Toyota World, Inc. v.

Commissioner, 81 T.C. at 204-207; and (6) the insertion of other

entities, Helba v. Commissioner, supra at 1011. Our application of

these factors to the transaction involved herein follows.

i. Presence or Absence of Arm’s-Length Price
Negotiations
 - 95 -

Arm’s-length bargaining is an obvious characteristic of

commercially valid transactions. Id.; see also Karme v.

Commissioner, supra. To determine that an arm’s-length transaction

took place, we must find that the buyer was motivated to secure the

lowest purchase price possible and, conversely, that the seller

looked to obtain the highest price. See Fox v. Commissioner, 80

T.C. 972, 1009 (1983), affd. without published opinion 742 F.2d

1441 (2d Cir. 1984), affd. sub nom. Barnard v. Commissioner, 731

F.2d 230 (4th Cir. 1984), affd. without published opinion 734 F.2d

9 (3d Cir. 1984), affd. without published opinions sub nom. Hook v.

Commissioner, Kratsa v. Commissioner, Leffel v. Commissioner,

Rosenblatt v. Commissioner, Zemel v. Commissioner, 734 F.2d 5, 6-7,

9 (3d Cir. 1984).

Here, it is evident that Ms. Grossman, who reviewed and

recommended the transaction for NEFI, had little interest in

securing the lowest purchase price for the computers. Indeed, the

opposite was true; the greatest projected profits stemmed from tax

deductions which in turn increased as the purchase price increased.

Cf. Patin v. Commissioner, 88 T.C. 1086, 1122 (1987), affd. without

published opinion sub nom. Hatheway v. Commissioner, 856 F.2d 186

(4th Cir. 1988), affd. sub nom. Skeen v. Commissioner, 864 F.2d 93

(9th Cir. 1989), affd. without published opinion 865 F.2d 1264 (5th

Cir. 1989), affd. sub nom. Gomberg v. Commissioner, 868 F.2d 865

(6th Cir. 1989); Ferrell v. Commissioner, 90 T.C. 1154, 1186

(1988).
 - 96 -

Nothing in any of the papers related to the negotiations

indicate that Ms. Grossman (or for that matter Mr. Parmentier) ever

attempted to negotiate a purchase price for the computers in an

amount less than that set forth in Comdisco’s proposal. Similarly,

there is no evidence that Ms. Grossman (or Mr. Parmentier)

negotiated to increase the amount of the rent payable under the

lease, to reduce the amount of the cash to be invested, or to

reduce the interest rates payable on the notes.

Succinctly stated, there is no evidence of any arm’s-length

negotiations by anyone in the sale-leaseback transaction at issue.

Rather, the participants allowed Comdisco to arrange all aspects of

the transactions. Moreover, the record is devoid of evidence that

the purchase price was in any way determined with a true regard for

the profitability of the activity. Brannen v. Commissioner, 78

T.C. 471, 509 (1982), affd. 722 F.2d 695 (11th Cir. 1984); see also

Helba v. Commissioner, supra at 1005-1011. And the lack of arm’s-

length negotiations indicates that NEFI did not enter into the

transaction for a legitimate profit purpose.

ii. The Relationship Between the Selling
Price and the Fair Market Value

In this case, all but $15 million of the selling price was

financed by Comdisco. The transaction was arranged so that the

payments due on the financing were offset by the rents payable by

Comdisco. In fact, the rents were determined by reference to the

purchase price. Therefore, the selling price and the fair market
 - 97 -

value of the equipment at the time of the purchase had little

effect on the pretax profitability of the transaction. The pretax

profitability was dependent on the residual value at the early

termination date or the final termination date; the overall

profitability was dependent on the tax savings. See Zirker v.

Commissioner, supra at 976; Helba v. Commissioner, supra at 1005-

1007, 1009-1011.

iii. The Structure of the Financing

The structure of the financing is an important factor in

evaluating the claimed economic substance of the sale-leaseback

transactions. Helba v. Commissioner, supra at 1007-1011. In this

case, most of the purchase price of the properties was financed by

debt that in reality was functionally identical to nonrecourse

obligations.

On numerous occasions, courts have found that a

disproportionately large amount of nonrecourse debt included in the

purchase price of a piece of property indicates that a transaction

lacks economic substance. See, e.g., Waddell v. Commissioner, 86

T.C. 848, 902 (1986), affd. per curiam 841 F.2d 264 (9th Cir.

1988); Elliott v. Commissioner, 84 T.C. 227, 238 (1985), affd.

without published opinion 782 F.2d 1027 (3d Cir. 1986); Estate of

Baron v. Commissioner, 83 T.C. 542, 552-553 (1984), affd. 798 F.2d

65 (2d Cir. 1986). This is especially true when, as a practical

matter, there is little possibility that the debt will ever be

paid.
 - 98 -

RD Leasing was not liable to a third party for the debt.

Unlike the transaction in Frank Lyon Co. v. United States, 435 U.S.

561 (1978), if Comdisco had failed to make its lease payments, RD

Leasing would not have had to provide its own capital to make

mortgage payments to a third party. If RD Leasing did not make its

final balloon payments on the equipment, Comdisco’s only remedy was

to retake the equipment. Thus, RD Leasing had the option to

abandon the equipment, leaving Comdisco no recourse against RD

Leasing.23

The transaction did not occur on a public market but rather in

an environment controlled by Comdisco and NEFI. When the sale-

leaseback transaction involved herein was proposed, Mr. Hastings

used the M&S report to interpolate the values stated therein to

arrive at values relevant to the specific dates in the proposed

transaction. He then presented these interpolated numbers to Greg

Barwick, one of M&S’s appraisers. The cost of the computers, the

financing of the purchase price (including the interest rates), and

the rents, as well as the estimated residual values, were easily

manipulated to project a pretax profit.

NationsBank’s records show that the bank treated the

“purchase” of the rents receivable as a loan to Comdisco and

anticipated prepayment by March 28, 1994. The bank’s records

23
The equipment was Andantech’s only asset, and the
Andantech interest was RD Leasing’s principal asset (RD Leasing,
however, was required to maintain sufficient investments to
redeem Mr. Parmentier’s preferred stock).
 - 99 -

indicate that Comdisco approached NationsBank to “provide

financing” for a sale/leaseback transaction involving a lease

receivable purchase with Comdisco as the obligor. NationsBank

expected the transaction to generate “$168,000 in net interest

income for assuming a short-term, unsecured credit position with

Comdisco”. Although Comdisco had historically prepaid each

receivable purchase transaction funded by NationsBank, Comdisco

could elect not to prepay. “In this situation, NationsBank would

hold a 36 month, unsecured loan to Comdisco at 75bp.”

Under the terms of the term note for the purchase of the

equipment, Andantech’s sale of the rents to NationsBank accelerated

the term note. Andantech directed NationsBank to wire transfer the

proceeds from the rent sale ($87,805,802) to Comdisco in payment of

Andantech’s obligations to Comdisco under the term note.

NationsBank did so, and Comdisco canceled the term note.

The rents owed by Comdisco before the early termination date

were calculated to equal the amount due on the term note. The sale

of those rents to NationsBank was in fact a short-term loan to

Comdisco, and Andantech was required to use the proceeds to pay off

the term note. There was no substance to the financing of the

transaction. See Mapco Inc. v. United States, 556 F.2d at 1110.

iv. The Degree of Adherence to Contractual
Terms

A transaction having economic substance has as one of its

characteristics an intent by the parties of having their agreements
 - 100 -

enforced. The parties’ failure to enforce their agreements

indicates that the transaction does not conform to economic

realities. Helba v. Commissioner, 87 T.C. at 1011; cf. Arrowhead

Mountain Getaway, Ltd. v. Commissioner, T.C. Memo. 1995-54 (finding

of sham transaction supported by showing that promoter was “notably

careless and unbusinesslike” in documenting and altering legal

relationships of the partnership), affd. 119 F.3d 5 (9th Cir.

1997).

In the instant matter, Comdisco had the right to substitute

replacement equipment if the end user made a bona fide offer to

purchase the computer. In that event, RD Leasing had the right to

request reasonable documentation from Comdisco before transferring

title pursuant to a bill of sale.

In April 1994, one of the end users purchased the IBM 9021

computer equipment it subleased from Comdisco. The computer was

one that had been sold to Andantech. Comdisco elected to

substitute replacement equipment. But Comdisco failed to provide

notice to Andantech that it was exercising its right to substitute

replacement equipment and did not follow the procedures for

substitution required by the equipment lease.

We are also mindful that Comdisco provided Ms. Grossman with

location reports relating to the equipment on March 1, 1994,

February 27, 1995, and February 28, 1996. The 40 mainframe

computers that were the subject of the sale-leaseback were

identified by serial number in the location reports. The computers
 - 101 -

shown in the reports had the same serial numbers as those that were

on the 1993 bill of sale. Ms. Grossman was unaware that Comdisco

had substituted replacement equipment for the equipment purchased

by the end user.

When Comdisco exercised its early termination option, the 1996

bills of sale conveyed back to Comdisco the identical computers

that Andantech had acquired pursuant to the 1993 bill of sale. The

serial numbers on the 1996 bills of sale were identical to those on

the 1993 bill of sale. Thus, the 1996 bills of sale inaccurately

reflect that Comdisco never replaced any of the computers (i.e.,

did not substitute a different computer for any of the original

equipment). Andantech never transferred title to the end user.

Comdisco treated the equipment as its own and transferred ownership

of the equipment to the end user.

We are also mindful that, as Dr. Schallheim points out, under

the schedule of rents, Andantech did not sell all of the rents to

NationsBank. Comdisco should have paid $2,711,993 of rent to

Andantech. Petitioners’ expert, Mr. Fleming, included those rents

in his analysis of the profit potential. Petitioners argue that

those rents should be included in evaluating the profit potential,

but they fail to explain why Andantech never sought to collect the

rents.

The low degree of adherence to the entities’ contractual

terms, particularly those relating to the actual ownership and the

right to transfer ownership to a third party, indicates a lack of
 - 102 -

substance to the transaction. Rose v. Commissioner, 88 T.C. 386,

410-411 (1987), affd. 868 F.2d 851 (6th Cir. 1989); Helba v.

Commissioner, 87 T.C. at 1009.

v. The Reasonableness of the Income and
Residual Value Projections

We have examined the reasonableness of projections of income

expected to emanate from a transaction as a means of evaluating its

economic substance. See, e.g., Rice’s Toyota World, Inc. v.

Commissioner, 81 T.C. at 204-207.

We are mindful that it is inappropriate to use hindsight in

determining whether residual projections were correct. However, in

1993, the public was aware that IBM was developing CMOS, which, if

and when brought to market, would affect the normal depreciation

curve. We find it difficult to believe that NEFI, being actively

involved in the financing and leasing of computers, was unaware of

the potential that such events could occur.

Ms. Grossman received three appraisals from Comdisco. Ms.

Grossman testified that she did not have “a sufficient level of

comfort” with only one (the M&S) appraisal, and she requested

additional appraisals. She admitted, however, that the MAC

appraisal provided little information. The ARI appraisal discloses

that the appraisal would be used for support of true lease

requirement related to Federal taxation and as support in the

investment decision process. The report clearly states that

industry publications such as Gartner Group, IDC, and DMC forecast
 - 103 -

significantly lower residual values. Ms. Grossman admitted that

she wanted the file to show that she had looked for as much

information as she could. In our opinion, the appraisals provided

by Comdisco were nothing more than an attempt to color the

transaction with legitimacy. Although NEFI had entered into many

other leveraged sale-leaseback transactions and had expertise in

this area, it failed to use any of its expertise in analyzing the

residual values. In fact, the CAP places little value on the

collateral (the value of the equipment).

Further, the testimony of Ms. Grossman at trial indicates that

NEFI officials knew that there was a high risk that the transaction

would result in a loss. Ms. Grossman testified that the

transaction was too large for NEFI, and that it was more

appropriate for Norwest. That claim is contradicted by the fact

that the transaction was conducted through RD Leasing, at the time

an inactive shell corporation without any other assets. Ms.

Grossman admitted that if anything went wrong with the deal, NEFI

officials would not receive bonuses. RD Leasing was used because

the corporate officers did not want any losses from the transaction

to be attributed to NEFI. Ms. Grossman’s admission leads us to

conclude that she was aware that it was unlikely that any pretax

profit would be made on the transaction.

We are satisfied that at the time Norwest/RD Leasing entered

into the sale-leaseback transaction involved herein, the

Norwest/NEFI executives did not reasonably believe that an economic
 - 104 -

profit, independent of tax benefits, was attainable and knew that

a genuine risk of loss existed. The projections showed that,

regardless of any pretax profit, Norwest/NEFI would realize an

after-tax profit ranging from 92 to 101 percent. NEFI never

considered the financial consequences of the transaction without

the prior stripping of the rents from the transaction. A

reasonable person would not believe that there was a basis for

entering into the transaction other than for the acquisition of tax

benefits. See Helba v. Commissioner, supra at 1012.

vi. Insertion of Other Entities

In determining a lack of economic substance, the fact the

parties created and/or used intermediate entities for no valid

business purpose is of significance. See, e.g., id. at 1011.

Here, Comdisco and NEFI created and/or used various entities to

participate in the sale-leaseback transaction in order to strip the

income from the transaction and for no other purpose.

Specifically, Comdisco enlisted Messrs. Parmentier and de la Barre

d’Erquelinnes to create Andantech and EICI. Mr. de la Barre

d’Erquelinnes then used EICI and the Trust, a charitable trust (tax

exempt) previously created by Comdisco, as a depository for his

interest after his participation had served its purpose. And NEFI

used RD Leasing (previously known as Radio Dealers Leasing, Inc.),

an inactive shell corporation.

Our review of these factors shows that the sale-leaseback

transaction at issue was not compelled or encouraged by business or
 - 105 -

regulatory realities. Rather, it was “shaped solely by tax-

avoidance features that have meaningless labels attached”. Frank

Lyon Co. v. United States, 435 U.S. at 583-584.

The Comdisco designed cross-border sale-leaseback transaction

had no valid business purpose, independent of tax benefits. It is

one of those no-business-purpose transactions that would not have

occurred, in any form, but for tax-avoidance reasons and, thus, is

not to be given effect for Federal income tax purposes. See, e.g.,

ACM Partnership v. Commissioner, 157 F.3d at 233-243 (sophisticated

investment partnership formed and manipulated solely to generate a

capital loss to shelter some of Colgate-Palmolive’s capital gains);

Karr v. Commissioner, 924 F.2d 1018, 1021 (11th Cir. 1991) (facade

of energy enterprise developed solely to produce deductible losses

for investors), affg. Smith v. Commissioner, 91 T.C. 733 (1988);

Kirchman v. Commissioner, 862 F.2d 1486, 1488-1489 (11th Cir. 1989)

(option straddles entered to produce deductions with little risk of

real loss), affg. Glass v. Commissioner, 87 T.C. 1087 (1986);

Rice’s Toyota World, Inc. v. Commissioner, 752 F.2d at 91 (sale-

leaseback of a computer by a car dealership, solely to generate

depreciation deductions); cf., e.g., Frank Lyon Co. v. United

States, supra at 582-584 (sale-leaseback was part of genuine

financing transaction, heavily influenced by banking regulation, to

permit debtor bank to outdo its competitor in impressive office

space).

4. The Transaction Was Not a Sale and the
 - 106 -

Financing Did Not Constitute Genuine Debt

Assuming arguendo that the transaction in issue was not a tax

avoidance scheme devoid of economic substance, still petitioners

would not be entitled to the claimed depreciation unless the

transaction constituted a sale for Federal income tax purposes.

See e.g., Packard v. Commissioner, 85 T.C. 397, 419 (1985).

Depreciation is not predicated on legal title but rather on an

actual investment in property. Mayerson v. Commissioner, 47 T.C.

340, 350 (1966). Likewise, to be deductible, interest must be paid

on genuine indebtedness. Knetsch v. United States, 364 U.S. 361

(1960).

A sale-leaseback will not be respected for Federal tax

purposes unless the lessor retains significant and genuine

attributes of a traditional owner-lessor. Frank Lyon Co. v. United

States, supra at 584; Levy v. Commissioner, 91 T.C. 838 (1988);

Estate of Thomas v. Commissioner, 84 T.C. at 432. Accordingly, it

is the existence of the benefits and burdens of ownership that

determines how a sale-leaseback agreement will be treated for tax

purposes. Frank Lyon Co. v. United States, supra at 582-584.

We have considered whether RD Leasing obtained and held

sufficient benefits and burdens of ownership to be regarded as the

owner of the equipment for Federal income tax purposes.

Factors of particular significance in determining whether a

taxpayer is the owner of property are: (1) The taxpayer’s equity

interest in the property as a percentage of the purchase price; (2)
 - 107 -

the existence of a useful life of the property in excess of the

leaseback term; (3) renewal rental at the end of the leaseback term

set at fair market rent; (4) whether the residual value of the

equipment plus the cashflow generated by the rental of the

equipment allows the investors to recoup at least their initial

cash investment; (5) the expectation of a “turnaround” point which

would result in the investors’ realizing income in excess of

deductions in the later years; (6) net tax benefits during the

leaseback term less than their initial cash investment; and (7) the

potential for realizing a profit or loss on the sale or re-lease of

the equipment. Levy v. Commissioner, supra; Torres v.

Commissioner, 88 T.C. at 721; Gefen v. Commissioner, 87 T.C. 1471,

1490-1495 (1986); Mukerji v. Commissioner, 87 T.C. 926, 967-968

(1992); Estate of Thomas v. Commissioner, supra at 433-438.

Here, the residual value plus the cashflow would not enable RD

Leasing to recoup its $15 million investment. Additionally, there

was no turnaround point that would result in RD Leasing’s realizing

income in excess of deductions--the net tax benefits greatly

exceeded RD Leasing’s initial investment. And RD Leasing had no

potential for realizing a profit on the sale or re-lease of the

equipment.

Further, in this case, the economics of the transaction were

such as to mandate that Comdisco would exercise its early

termination option and reacquire the equipment. This is so because

the estimated residual value of the equipment at the early
 - 108 -

termination date was $44,275,948; the balance on the balloon notes

as of the early termination date totaled $25,582,611, and the early

termination supplement was $343,856. If the equipment had a value

equal to the $44,275,948 estimated residual value, in order to

repurchase the equipment Comdisco would have to pay $19,037,193

(the fair market value $44,275,948, plus the $343,856 supplement,

less the $25,582,611 balance due on the balloon notes).

Thus, it is clear in this case that the parties never intended

to permanently transfer ownership of the equipment to Andantech.

Consequently, the transaction did not constitute a sale for Federal

tax purposes. Even if the estimated residual value set forth in

the proposal had been realistic, RD Leasing’s $4 million profit

would have been attributable to contract rights rather than to a

depreciable ownership interest in the equipment.

By contrast, in the Frank Lyon Co. case, “it was highly

unlikely, as a practical matter, that any purchase option would

ever be exercised.” Frank Lyon Co. v. United States, 435 U.S. at

569-570.

In this case, the seller-lessee, Comdisco, retained an

additional economic interest in the equipment. Comdisco’s right to

substitute equipment gave Comdisco the right to the difference

between the value of the equipment to the end user and the value on

the open market. The sale-leaseback agreements did not alter

Comdisco’s relationship to the end users or diminish Comdisco’s

control over the equipment. Comdisco never relinquished the
 - 109 -

burdens and benefits of owning the equipment.

In sum, although RD Leasing had no realistic hope of realizing

a profit on the investment, the tax benefits generated were more

than sufficient to cover RD Leasing’s potential losses. Looking to

the substance of the transaction, we conclude that RD Leasing “did

not purchase or lease a computer, but rather, paid a fee * * * in

exchange for tax benefits.” Rice’s Toyota World, Inc. v.

Commissioner, 752 F.2d at 95 (citation omitted).

Our analysis leads us to conclude that RD Leasing did not

obtain sufficient benefits and burdens of ownership to be regarded

as the owner of the equipment for Federal income tax purposes.

Consequently, Norwest/NEFI is not entitled to claim depreciation

deductions for the equipment. The $15 million payment by RD

Leasing was simply the mechanism by which Norwest/NEFI became

involved in the transaction. And, in our opinion, the payment was

intended to secure tax benefits, not an interest in depreciable

property or in any economically viable project. Falsetti v.

Commissioner, 85 T.C. 332, 347 (1985).

Similarly, as discussed supra pp. 99-102, the seller financing

arrangement did not constitute bona fide debt; consequently,

Norwest/NEFI is not entitled to a deduction for interest.

D. Conclusion

In Higgins v. Smith, 308 U.S. at 476-477, the Supreme Court

stated:

There is no illusion about the payment of a tax exaction.
 - 110 -

Each tax, according to a legislative plan, raises funds
to carry on government. The purpose here is to tax
earnings and profits less expenses and losses. If one or
the other factor in any calculation is unreal, it
distorts the liability of the particular taxpayer to the
detriment or advantage of the entire tax-paying group. *
* *

The sale-leaseback transaction was designed by Comdisco to create

just such a distortion.

It is axiomatic that taxpayers may structure transactions to

take advantage of tax benefits. But “After a certain point, * * *,

the transaction ceases to have any economic substance and becomes

no more than a sale of tax profits.” Hines v. United States 912

F.2d 736, 741 (4th Cir. 1990). Here, the evidence in the record

clearly indicates that the investment scheme devised and

orchestrated by Comdisco “reached the point where the tax tail

began to wag the dog.” Id.

To conclude, the record demonstrates that the sale-leaseback

transaction involved herein was not bona fide and was, from an

economic viewpoint, unreasonable. Under the theories advanced by

respondent, the transaction should not be respected for Federal tax

purposes. Consequently, we hold that (1) Andantech’s claimed

12/10/93 short period should be disregarded, (2) Andantech is not

required to include the income from the sale of the rents and is

not entitled to deduct $2,143,937 as expenses from other rental

activities for the 12/31/93 short period, and (3) Andantech is not

entitled to deduct $50,069,397 of similar expenses for 1994.
 - 111 -

To reflect the foregoing,

Decisions will be entered for

respondent in docket Nos. 15532-98

and 6348-00.

An appropriate decision will be

entered in docket No. 4277-00.
- 112 -
- 113 -
- 114 -
- 115 -
- 116 -
- 117 -
- 118 -