In the Marketplace

The Equipment Leasing and Finance Association ('ELFA') has filed two separate amicus curiae briefs regarding the use of deductions generated through participation in Lease-In/Lease-Out ('LILO') transactions. In both briefs, the ELFA argues that the correct tax treatment of leaseback transactions ' and commercial leasing transactions in general ' are cast into doubt.

In the first case, the ELFA filed a motion and amicus brief before the Fourth Circuit in support of the appellant, BB&T Corporation, in its appeal of the decision of the U.S. District Court for the Middle District of North Carolina in BBT Corporation v. USA, No. 1:04-cv-00941-NCT (Jan. 4, 2007). The transaction involved the lease and sublease of pulp manufacturing equipment. The plaintiff, BB&T Corporation, had certain tax deductions disallowed by the Internal Revenue Service in connection with BB&T's participation in a LILO transaction with Sodra Cell AB, a Swedish company. As described by the court, the deal consisted of a 'Head Lease' in which BB&T acquired an undivided interest in the equipment for a period of 36 years and an immediate shorter term sublease of the undivided interest in the equipment back to Sodra for a term of 15.5 years.

Prior to the closing date of the transaction in this case, the IRS issued proposed rules pursuant to '467 of the IRC, and these proposed rules were adopted as final regulations on May 18, 1999. As a result, BB&T did not participate in any other LILO transactions after April 1, 1999. With respect to this transaction, however, BB&T reported the following items of income on its 1997 federal income tax return: 1) rent from Sodra in the amount of $3,381,518; and 2) amortization of an advisory fee it received from a consulting firm in the amount of $55,120. BB&T claimed the following deductions on its 1997 federal income tax return associated with the transaction: 1) rent to Sodra in the amount of $9,894,362; 2) interest expense in the amount of $2,820,925; and 3) amortization of the fees and expenses paid in connection with the transaction in the amount of $137,943. Upon audit of BB&T's 1997 federal income tax return, the IRS disregarded the income and disallowed the deductions associated with the transaction, resulting in an increase of $9,416,592 in BB&T's taxable income for 1997. BB&T paid a deficiency for 1997 in the amount of $3,295,807 plus $1,296,861 in interest for a total of $4,592,668. BB&T filed a claim for refund, which the IRS denied. BB&T filed suit for the refund of the deficiency and interest. Both parties filed motions for summary judgment, and the district court sided with the IRS.

In its amicus curiae brief, the ELFA cautions that the BB&T case raises issues that upend established legal principles and thus potentially impede capital formation. Specifically, the decision ignores the historical case law standard applied to determine whether the form of sale/leaseback or lease/leaseback transactions will be respected for federal income tax purposes, as such transactions have been financial staples of commercial finance in the United States. The ELFA contends that the district court should have followed the established precedent and at a minimum made a factual inquiry to determine whether the rights and obligations imposed on the taxpayer had economic substance. The ELFA is seeking the reversal of this decision or in the alternative that the case be remanded to the district court with directions to apply the economic substance analysis as established by the decisions of the Supreme Court and the Fourth Circuit.

In addition to the BB&T amicus curie brief, the ELFA also filed a brief in the U.S. District Court for the Southern District of Ohio on June 18 in support of Fifth Third Bancorp's opposition to the United States' motion for summary judgment on the same issue.

Given the strong position that the government has taken with respect to this issue and the significant dollar amounts at stake, it is likely that this battle is far from over.

The Equipment Leasing and Finance Association ('ELFA') has filed two separate amicus curiae briefs regarding the use of deductions generated through participation in Lease-In/Lease-Out ('LILO') transactions. In both briefs, the ELFA argues that the correct tax treatment of leaseback transactions ' and commercial leasing transactions in general ' are cast into doubt.

In the first case, the ELFA filed a motion and amicus brief before the Fourth Circuit in support of the appellant, BB&T Corporation, in its appeal of the decision of the U.S. District Court for the Middle District of North Carolina in BBT Corporation v. USA, No. 1:04-cv-00941-NCT (Jan. 4, 2007). The transaction involved the lease and sublease of pulp manufacturing equipment. The plaintiff, BB&T Corporation, had certain tax deductions disallowed by the Internal Revenue Service in connection with BB&T's participation in a LILO transaction with Sodra Cell AB, a Swedish company. As described by the court, the deal consisted of a 'Head Lease' in which BB&T acquired an undivided interest in the equipment for a period of 36 years and an immediate shorter term sublease of the undivided interest in the equipment back to Sodra for a term of 15.5 years.

Prior to the closing date of the transaction in this case, the IRS issued proposed rules pursuant to '467 of the IRC, and these proposed rules were adopted as final regulations on May 18, 1999. As a result, BB&T did not participate in any other LILO transactions after April 1, 1999. With respect to this transaction, however, BB&T reported the following items of income on its 1997 federal income tax return: 1) rent from Sodra in the amount of $3,381,518; and 2) amortization of an advisory fee it received from a consulting firm in the amount of $55,120. BB&T claimed the following deductions on its 1997 federal income tax return associated with the transaction: 1) rent to Sodra in the amount of $9,894,362; 2) interest expense in the amount of $2,820,925; and 3) amortization of the fees and expenses paid in connection with the transaction in the amount of $137,943. Upon audit of BB&T's 1997 federal income tax return, the IRS disregarded the income and disallowed the deductions associated with the transaction, resulting in an increase of $9,416,592 in BB&T's taxable income for 1997. BB&T paid a deficiency for 1997 in the amount of $3,295,807 plus $1,296,861 in interest for a total of $4,592,668. BB&T filed a claim for refund, which the IRS denied. BB&T filed suit for the refund of the deficiency and interest. Both parties filed motions for summary judgment, and the district court sided with the IRS.

In its amicus curiae brief, the ELFA cautions that the BB&T case raises issues that upend established legal principles and thus potentially impede capital formation. Specifically, the decision ignores the historical case law standard applied to determine whether the form of sale/leaseback or lease/leaseback transactions will be respected for federal income tax purposes, as such transactions have been financial staples of commercial finance in the United States. The ELFA contends that the district court should have followed the established precedent and at a minimum made a factual inquiry to determine whether the rights and obligations imposed on the taxpayer had economic substance. The ELFA is seeking the reversal of this decision or in the alternative that the case be remanded to the district court with directions to apply the economic substance analysis as established by the decisions of the Supreme Court and the Fourth Circuit.

In addition to the BB&T amicus curie brief, the ELFA also filed a brief in the U.S. District Court for the Southern District of Ohio on June 18 in support of Fifth Third Bancorp's opposition to the United States' motion for summary judgment on the same issue.

Given the strong position that the government has taken with respect to this issue and the significant dollar amounts at stake, it is likely that this battle is far from over.