Note: As a tax avoidance scheme, UBC (Lessee/ Sublessor/Beneficiary) sought to rent an arena from the City of Anaheim (Lessor/Sublessee) and procure the tax benefits of ownership and indebtedness that the tax-exempt City of Anaheim, owner of the arena, could not enjoy. Accordingly, Lessee/Sublessor and Lessor/Sublessee executed a Participation Agreement on 26 January 1999 which set forth the terms of a lease (Head Lease) and simultaneous sublease (Sublease) of the arena on Arrowhead Pond of Anaheim (Pond) in Anaheim, California (Pond Transaction). The Head Lease provided that Lessee/Sublessor would lease an undivided interest in the Pond until 1 April 2038 while the Sublease provided that Lessee/Sublessor would simultaneously convey its interest in the Pond back to Lessor/Sublessee until 2 January 2019, with an option to renew through 29 May 2030. The Head Lease required Lessee/Sublessor to make an advance rent payment and a deferred rent payment. Lessee/Sublessor fulfilled its advance rent payment obligation by making an initial equity payment and obtaining a loan to pay the remaining amount. The Sublease required the Lessor/Sublessee to pay annual rental payments to Lessee/Sublessor. Furthermore, under the Participation Agreement, Lessor/Sublessee was required to use part of Lessee/Sublessor's equity payment to obtain an irrevocable standby letter of credit for the benefit of Lessee/Sublessor.

In addition, Lessor/Sublessee entered into an Equity Payment Agreement (EPA) with AIG Matched Funding Corp. (AIG MFC) to the effect that AIG MFC would make certain payments on behalf of Lessor/Sublessee. Under the EPA, AIG MFC was required to grant Lessee/Sublessor a first security interest in collateral, and Ogden, an entity contracted by the Lessor/Sublessee to operate and manage the Pond, agreed to obtain an irrevocable standby letter of credit for the benefit of Lessee/Sublessor.

This opinion explained the purpose of this arrangement as follows:

The Pond Transaction was a LILO, a leasein/ lease-out transaction "designed to transfer tax benefits from an entity not subject to U.S. income taxation (a tax-indifferent entity) to an entity that is subject to U.S. income taxation... In the typical LILO, a U.S. taxpayer purports to lease property from a tax-indifferent owner under a 'head lease,' and then simultaneously leases that property back to the owner under a sublease. Before and after the transaction, the tax-indifferent entity continues to operate the property. Nevertheless, the taxpayer claims deductions predicated upon the head lease... The tax-indifferent party receives a fee for agreeing, in effect, to transfer its 'wasted' tax deductions to a tax-paying entity that can use them."

"On its 1999 through 2002 tax returns, [Lessee/ Sublessor] reported rental income with respect to the Pond Transaction and claimed deductions for rental expense, amortization of transaction expenses, and interest expense in connection with the Pond Transaction. During an audit of [Lessee/Sublessor]'s tax returns for the 1998 through 2002 taxable years, the IRS disregarded the income and disallowed the deductions reported by [Lessee/Sublessor] in connection with the Pond Transaction. The IRS' proposed adjustments in connection with the Pond Transaction... resulted in... increases in [Lessee/ Sublessor]'s taxable income and corresponding deficiencies... [Lessee/Sublessor] paid these deficiencies in two installments, on or about July 2, 2003, and December 5, 2005. [Lessee/Sublessor] filed a claim for refund (Form 1120X) with the IRS on or about January 4, 2006, requesting a refund of Federal income taxes for the 1998 through 2002 taxable years in the amount of $90,846,856." Subsequently, Lessee/Sublessor sued the United States for a refund of income tax payments.

The U.S. Court of Federal Claims, Allegra, J., held that Lessee/Sublessor was not entitled to a refund because it did not incur "genuine indebtedness" associated with the LILO transaction. "[T]he debt incurred by [Lessee/Sublessor] was, in substance, decidedly not genuine, deriving from circular transactions largely with the subsidiaries of a single entity - transactions in which [Lessee/Sublessor]'s loan was paid with the proceeds of the same loan."



The views expressed in this Case Summary are those of the Institute of International Banking Law and Practice and not necessarily those of ICC or the other partners in DC-PRO.