UNITED STATES COURT OF APPEALS FOR THE D.C. CIRCUIT


ASA INVESTERINGS

v.

CMSNR IRS


98-1583a

D.C. Cir. 2000


*	*	*


Williams, Circuit Judge: In January 1990 AlliedSignal, a  company
manufacturing aerospace and automotive products,  decided to sell its
interest in Union Texas Petroleum Hold- ings, Inc., an oil, gas, and
petrochemical company. Anticipat- ing a large capital gain, it sought
to reduce the resulting tax  burden by entering into a set of
transactions via a partner- ship with several foreign corporations.
The transactions took  advantage of provisions of the Internal Revenue
Code (and  related regulations) designed to yield reasonable results
when  property is sold on an installment basis and the value of the 
installment payments cannot be known in advance. With the  help of
these provisions, transactions that in substance added  up to a wash
were transmuted into ones generating tax losses  of several hundred
million dollars; the offsetting gains were  allocated to foreign
entities not subject to United States  income tax at all.


The Commissioner of Internal Revenue in 1996 issued a  notice of final
partnership administrative adjustment, reallo- cating to AlliedSignal
much of the capital gain accrued by the  partnership. ASA, via its
"Tax Matters Partner," Allied-  Signal, petitioned for relief in the
Tax Court, which agreed  with the Commissioner that AlliedSignal had
not entered into  a bona fide partnership and upheld the
Commissioner's deter- mination. ASA Investerings Partnership,
AlliedSignal, Inc.,  Tax Matters Partner v. Commissioner, 76 T.C.M.
(CCH) 325  (1998) ("Tax Court Decision"). We affirm.


* * *


The hardest aspect of this case is simply getting a handle  on the
facts. To make them manageable, we first discuss the  principal tax
provisions in question and then show their  application through a
series of examples, ending with a  simplified version of the
transactions here. Only then do we  lay out the exact transactions


Under the general provisions of the Internal Revenue Code  ("IRC"),
gains and losses are generally "realized" in the year  that they are
received or incurred. See 26 U.S.C. s 1001  (1994). A sale for future
payments, however, presents sever- al difficulties, among them that
the deferred payment may be  contingent in amount or otherwise not
susceptible to accurate  valuation. Section 453 of the Internal
Revenue Code, 26  U.S.C. s 453, provides methods for taxation of such
an "in- stallment sale," defined as "a disposition of property where
at  least 1 payment is to be received after the close of the taxable 
year in which the disposition occurs." Id. s 453(b)(1). It  specifies
the "installment method" for such a sale, providing  that "the income
recognized for any taxable year from a  disposition is that proportion
of the payments received in that  year which the gross profit ...
bears to the total contract  price." Id. s 453(c). Thus, if A owns a
building with a basis  of $100, and sells it for $300 to be paid in
five $60 annual  installments, A recognizes a taxable gain of $40 each
year.  The proportion of "gross profit" to "total contract price" is 
200/300 or two thirds, so the income recognized for each year  is two
thirds of the receipts of that year.


In 1980 Congress expanded s 453, authorizing the Secre- tary to make
the installment method available to deferred  payment transactions for
which the sales price is indefinite, or  subject to a contingency.
Section 453(j) (previously s 453(i))  mandates that the Secretary
shall promulgate regulations  "providing for ratable basis recovery in
transactions where  the gross profit or the total contract price (or
both) cannot be  readily ascertained." In response, the Treasury
promulgated  Temp. Treas. Reg. s 15A.453-1(c)(3)(i) (1981), which
provides  that in contingent payment sales (and subject to irrelevant 
exceptions), "the taxpayer's basis ... shall be allocated to the 
taxable years in which payment may be received under the  agreement in
equal annual increments."


Under these regulations, the taxpayer will have a recog- nized gain in
years when payment from the sale exceeds the  basis recovered; in
years when payment is less than the basis  recovered, "no loss shall
be allowed unless the taxable year is  the final payment year under
the agreement or unless it is 


otherwise determined ... that the future payment obligation  under the
agreement has become worthless." Id.


The following examples should illustrate the ratable basis  recovery
rule. Property owner, A, sells a house with a basis  and current value
of $1 million in exchange for an instrument  that will pay
unpredictable amounts (e.g., a share of the  property's gross profits)
over a five-year period. In any year  in which the payout equals or
exceeds $200,000, A will recover  $200,000 in basis under the ratable
basis recovery rule and  will have a taxable gain equal to the
difference between the  amount received from the note and $200,000. In
a year in  which the payout is less than $200,000, A will not report a
 loss, but instead will recover a portion of the basis equal to  the
payout; the unused basis will then be carried forward to  the next
year. See id. s 15a.453-1(c)(3), example (2). Under  the rule just
quoted above, unused basis would be recovered  only in the last year


The rule works similarly when the seller receives both an  instrument
with indefinite value and an immediate payment  of cash. In a
variation on the preceding case, for example,  suppose A sells the
property for a $500,000 cash payment and  an indefinite five-year
instrument. Once again, the basis is  recovered over the course of
five years. In the first year, A  recovers $200,000 in basis; because
he has received $500,000  that year, he must report a gain of
$300,000. If A sells the  note in Year 2 for $500,000, he can report a
loss of $300,000,  equal to the difference between the remaining basis
in the  note ($800,000) and the $500,000 he has received in exchange 
for the note.1 In this example, of course, the results are  rather
unappealing to the taxpayer: although he had no real  gain, he
recognized a nominal one early, offset by an equal  tax loss--but one
that was deferred and therefore not a  complete offset. Because of the




__________

n 1 The regulation does not appear to provide expressly that in  the
event that the taxpayer completely liquidates the instrument  before
the end of scheduled payout he may recover all unused basis  in that
year. Both parties agree, however, that this is the case.


basis in excess of gross receipts in any year except the last,  the
taxpayer cannot manipulate the timing in his favor.


But suppose A finds a way of allocating the nominal tax  gain to a
tax-free entity, reserving for himself a nominal tax  loss? Here is
how he might do it: He forms a partnership  with a foreign entity not
subject to U.S. tax, supplying the  partnership with $100,000 and
inducing the "partner" to  supply $900,000. The "partnership" buys for
$1,000,000 prop- erty eligible for installment sale treatment under s
453, and,  as the ink is drying on the purchase documents, sells the 
property, as in the last example, for $500,000 in cash and an 
indefinite five-year debt instrument. The cash payment pro- duces a
gain of $300,000, 90% of which goes to the nontaxable  foreign entity.
Then ownership adjustments are made so  that A owns 90% of the
partnership. In year 2 the instru- ment is sold, yielding a tax loss
of $300,000, 90% of which is  allocable to A. Presto: A has generated
a tax loss of  $240,000 ($270,000 loss in Year 2, offset by $30,000
gain in  Year 1), with no material change in his financial position--
other than receipt of the valuable tax loss. This example is 
AlliedSignal's case, stripped to its essentials.


Now for the specifics of this case: In 1990, AlliedSignal  anticipated
that it would soon realize a capital gain of over  $400 million from
the sale of its interest in Union Texas  Petroleum Holdings, Inc. In
February, AlliedSignal ap- proached Merrill Lynch & Co. to discuss a
set of transactions  that Merrill had developed to create tax losses
to shelter  anticipated capital gains.


Under the plan AlliedSignal would form a partnership with  a foreign
entity, which in turn would supply the majority of  the capital for
and assume a majority stake in the partner- ship. In Year 1, the
partnership would purchase short-term  private placement notes
("PPNs"), which can be sold under  the installment method of
accounting provided for in IRC  s 453. See 26 U.S.C. s 453(k)(2)(A)
(implying that the sale  of "stock or securities which are [not]
traded on an estab- lished securities market" would be subject to the
installment  method). Several weeks later, the partnership would sell


instruments for 80% cash and 20% debt instruments, which  would pay out
over several years and thus would be subject to  the ratable basis
recovery rule. As in the example above, the  partnership would report
a large gain in the first year, equal  to the difference between the
substantial cash payment and  the small share of basis recovered that
year. The gain would  be allocated according to each partner's
interest, with the tax- exempt foreign partner receiving the lion's


The next year, AlliedSignal would acquire a majority inter- est in the
partnership, and sell the debt instruments. The  sale would create a
large tax loss because the basis available  for recovery would far
exceed the value of the instruments.


Merrill would serve as the partnership's financial adviser  and, for a
$7 million fee, would recruit the foreign partner  and arrange for the
subsequent investments. Tax Court  Decision, 76 T.C.M. at 326. Merrill
would also "structure and  enter into the requisite swap transactions"
with the banks,  "[t]o ensure a market for [the] issuance and sale" of
the  PPNs and the debt instruments to be received on their sale.  Id.
In exchange for serving as the partnership's financial  intermediary,
Merrill would receive roughly $1 to 2 million on  the initial sale of
PPNs, and $200,000 to $400,000 on the sale  of the subsequent debt
instruments. Id. The foreign part- ner would receive the greater of
$2,850,000 or 75 basis points  (1 basis point = .01%) over the London
International Bank  Offering Rate ("LIBOR") on any funds contributed
to the  partnership, as well as reimbursement of all partnership 
expenses incurred. Id.


AlliedSignal and Merrill followed the proposal to the letter.  Merrill
contacted Algemene Bank Netherlands N.V. ("ABN"),  one of the
Netherlands' largest commercial banks. Id. at 327.  ABN had previously
participated in similar Merrill transac- tions, and anticipated that
this partnership would strengthen  its preexisting lending
relationship with AlliedSignal. Id.  On April 5, 1990 Johannes den
Baas, Vice President of  Corporate Finance for ABN New York, an ABN


requested authorization to enter into this venture. Id. Den  Baas
recommended the creation of two "special purpose  corporations"
("SPCs"), to which ABN would lend $990 mil- lion, and which would then
contribute this money to the  venture. Id. The purpose of this
structure, den Baas said,  was (1) to permit ABN, which would
otherwise be a general  partner in the venture with AlliedSignal, to
limit its exposure  to liability, and (2) to facilitate ABN's shifting
part of the loan  to other banks for various reasons.


On April 17 and 18, den Baas and another representative of  an ABN
affiliate met in Bermuda with a representative of  AlliedSignal. Id.
Both sides agreed that AlliedSignal would  pay all partnership
expenses, as well as ABN's costs funding  the requisite loans to the
partnership (approximately  LIBOR), plus 75 basis points. Id. at 328.2
The precise  amount, of course, would depend on the amount that ABN 
contributed and how long the partnership, to be known as  ASA
Investerings, held those funds. In response to den  Baas's request
that AlliedSignal pay $5 million up-front, the  parties agreed that
AlliedSignal would instead periodically  make "premium" payments upon
the occurrence of certain  events. Id. The agreements reached during
these negotia- tions were referred to by the Tax Court as the "Bermuda


ABN's Risk Management Division expressed concern that a  loss might
arise out of the sale of the PPNs. Id. at 327. Den  Baas responded by
assuring these officials that any such loss  would be added to the
value of the subsequent debt instru- ments, and would in turn be borne
by AlliedSignal on liqui- dation of those instruments. But there could
be no written  agreement to this effect, explained den Baas, because
"in that  case it would not be a matter of a general partnership."




__________

n 2 Petitioner acknowledges that ABN might have "had in mind a  target
return of LIBOR plus 75bp on the amount it invested,"  Petitioner's
Initial Br. at 59, but argues that the Tax Court erred in  finding
that the parties actually entered into such an agreement.  Petitioner
points to the fact that AlliedSignal's payments were  negotiated
rather than specified in advance, and were not based on  a LIBOR plus
75 basis points return. This dispute is, however,  immaterial. See
infra pp. 16-17.


Memo from den Baas to Jos Albers, 4/22/90, Joint Appendix  ("J.A.")
676. Den Baas nonetheless assured the authorities at  ABN of his
confidence that AlliedSignal would bear any such  loss:


[T]he fact that the client is the only one who is interested  in such a
sale and wants to obtain the installment note,  whereby the SPCs have
a right of veto during the entire  procedure--as is, in fact, set
forth in the partnership  document--makes ABN NY Corporate Finance
more  than confident that the client will continue to have this  loss
charged to his account in the future as well.


Id. The loan-approving committees later authorized ABN's 
participation.


On April 19 ASA Investerings Partnership was formed.  Tax Court
Decision, 76 T.C.M. at 328. It consisted of Allied- Signal,
AlliedSignal Investment Corporation ("ASIC"), a  wholly-owned
subsidiary of AlliedSignal, and the two SPCs,  Barber Corp. N.V. and
Domniguito Corp. N.V., which were  controlled by foundations in turn
controlled by ABN. Barber  and Dominguito entered into revolving
credit agreements  with ABN. The foundations which owned the SPCs
granted  ABN an irrevocable option to buy shares of the respective 


On April 19th and 24th, the partners contributed a total of  $850
million, with each partner receiving a partnership inter- est in
accordance with its contribution. AlliedSignal's share  was 10%, the
SPCs' 90%. In May 1990, the parties supple- mented their contributions
(in the same ratio), bringing the  total contribution to $1.1


On April 25, 1990 ASA purchased from two Japanese banks  $850 million
of 5-year floating rate notes which were not  traded on an established
securities market--the planned  PPNs. Id. at 329. On May 8, the
partnership met in  Bermuda and decided to sell the PPNs for 80% cash
and 20%  LIBOR notes. Id. Between May 17 and May 24 (i.e., within  one
month of purchase), ASA sold the PPNs to two banks in  exchange for a
little under $700 million in cash and 11 notes.  (With the cash it
bought time deposits and 30-day commercial 


paper.) These notes each made 20 quarterly payments con- sisting of the
3-month LIBOR rate, calculated at the begin- ning of each payment
period, applied to 25% of the notional  principal amount, which in
this case was $434,749,000. Id.  The LIBOR notes did not require a
return of principal at  maturity; rather, the quarterly payments of
interest on the  "notional amount" can be seen as both interest and
return of  actual principal. ABN entered into swap transactions with 
Merrill, Barber and Dominguito to hedge ABN's interest rate  risk
relating to the LIBOR notes. Merrill also entered into  swap
transactions with the banks from whom it bought the  LIBOR notes (as
it had with the PPNs) to induce their  participation. Merrill's
transaction costs in selling the PPNs  were $6.375 million. Id. This
was added to the value of the  LIBOR notes in ASA's partnership books,
so that Allied-  Signal would bear the costs of the sale when it
acquired the  LIBOR notes from the partnership. Id. at 329-330.


Because the LIBOR notes provided for 20 quarterly pay- ments at a
variable rate, and the PPNs were not sold on an  established
securities market, the sale of the PPNs qualified  for use of the
installment method. For the taxable year  ending May 31, 1990, ASA
recovered 1/6 of the basis in the  PPNs (because the completion of the
scheduled payout would  occur in the sixth tax year after the sale,
and reported  $549,443,361 in capital gains (= $681,300,000 in cash
minus  1/6($851,139,836)).3 Id. at 331. The gain was allocated ac-
cording to partnership interest, 90% to the SPCs and 10% to 


On August 2, 1990, AlliedSignal issued $435 million in  commercial
paper, and with the proceeds purchased Barber's  entire interest in
ASA for about $400 million and a 13.43%  interest in ASA from
Dominguito for about $150 million.  Between November 1991 and April
1992, ASA further re- duced Dominguito's interest to 25%. AlliedSignal
also paid a  $4.4 million "premium" payment, representing a portion of




__________

n 3 The parties stipulated in the Tax Court that ASA had erred in 
calculating the gain on its 1990 tax return and that the correct 
amount was $539,364,656.


the $5 million requested by den Baas. After this purchase, 
AlliedSignal and ASIC entered into several swaps with Mer- rill to
hedge their interest in the LIBOR notes. Id. at 330.  Between August
31 and September 28 AlliedSignal borrowed  $435 million from ASA,
using the proceeds to repay the debt  incurred August 2; this
indebtedness was paid off May 1,  1992.


On August 21 the partnership authorized a distribution of  the LIBOR
notes to AlliedSignal and ASIC, and about $116  million in cash and
commercial paper to Dominguito. Id. at  331. During 1990, AlliedSignal
and ASIC sold a fraction of  the LIBOR notes with a basis of
$246,520,807, for a total of  $50,454,103, and reported a capital loss
equal to the differ- ence, $196,066,704. Id. That year, AlliedSignal
also reported  a capital gain of $53,926,336, its share of ASA's
capital gain  from the sale of the PPNs. Id.


On December 5, 1991, AlliedSignal made a direct payment  of $1,631,250
to Dominguito, representing: the difference  between ABN's funding
costs and the SPCs' combined income  allocations; interest on $92
million of ABN's funds that  remained in ASA beyond the agreed upon
date; and the  difference (plus interest) between the $5 million
up-front  payment that ABN had requested and the $4.4 million it had 
previously paid. Id.


Prior to liquidation, ABN and AlliedSignal agreed that  ABN would
refund $315,000, reflecting excesses of the SPCs'  income allocations
over funding costs, and of ASA's returns  from November 22, 1991
through April 30, 1992 over LIBOR.  Id. at 332. On June 1, 1992, the
partners liquidated ASA.  On November 31, AlliedSignal sold its
remaining LIBOR  notes for $33,431,000, and recovered the remainder of
the  basis, $429,655,738, taking a capital loss of $396,234,738. Id.


In a notice of final partnership administrative adjustment  the
Commissioner disallowed ASA's capital gain, reallocating  it to
AlliedSignal and ASIC and thus in substance cancelling  out the tax
losses otherwise enjoyed by AlliedSignal. Id. at  333. The
Commissioner relied on alternative grounds: first,  ASA was not a bona
fide partnership, and Barber and Domin-


guito were not correctly deemed partners; and second, the  transactions
lacked "economic substance." Id.


* * *


The Tax Court agreed with the Commissioner that ASA  was not a valid
partnership for tax purposes, and thus did not  reach the economic
substance argument. At the outset, the  court disregarded Barber and
Dominguito "[f]or purposes of  [its] analysis," Tax Court Decision, 76
T.C.M. at 333, finding  that they were merely ABN's agents. First,
they were thinly  capitalized, and created just for purposes of the
venture.  Second, the parties themselves treated ABN as the partner, 
disregarding Barber and Dominguito. Third, Barber and  Dominguito were
"mere conduits," to whom ABN lent funds  and in whom ABN owned options
to purchase shares for a de  minimis amount.


Having found ABN to be the relevant party, the Tax Court  turned its
attention to the question whether AlliedSignal and  ABN entered into a
bona fide partnership. Although the  Internal Revenue Code provides
that "the term 'partnership'  includes a syndicate, group, pool, joint
venture, or other  unincorporated organization through or by means of
which  any business, financial operation, or venture is carried on,"
26  U.S.C. s 761, the court set out to determine whether the  formal
partnership had substance, quoting the Supreme  Court's language in
Commissioner v. Culbertson, 337 U.S.  733, 742 (1949), which said that
the existence of the partner- ship (for tax purposes) would depend on
whether, "consider- ing all the facts ... the parties in good faith
and acting with a  business purpose intended to join together in the
present  conduct of the enterprise." Applying this test, the Tax Court
 concluded that AlliedSignal and ABN did not have "the  requisite
intent to join together for the purpose of carrying  on a
partnership." 76 T.C.M. at 335.


* * *


We review decisions of the Tax Court "in the same manner  and to the
same extent as decisions of the district courts in 


civil actions tried without a jury." 26 U.S.C. s 7482. Factual 
findings are reviewed for clear error, see Commissioner v. 
Duberstein, 363 U.S. 278, 291 (1960), and determinations of  law de
novo. See United States v. Popa, 187 F.3d 672, 674  (D.C. Cir. 1999).
We have held that in tax cases mixed  questions of law and fact are to
be treated like questions of  fact. See Fund for the Study of Economic
Growth and Tax  Reform v. IRS, 161 F.3d 755, 759 (D.C. Cir. 1998)
(citing  Duberstein, 363 U.S. at 289 n.11). Petitioner poses chal-
lenges to all three types of decisions constituting the Tax  Court


Much of petitioner's opening brief is directed to an attack  on the Tax
Court's reasoning. We confess that some of that  reasoning seems
misdirected. For example, the court  seemed to believe that because
ABN and AlliedSignal had  "divergent business goals," 76 T.C.M. at
333, they were  precluded from having the requisite intent to form a
partner- ship. We agree with petitioner that partners need not have a 
common motive. In fact, the desirability of joining comple- mentary
interests in a single enterprise is surely a major  reason for
creating partnerships. But we see no reason to  think that this view,
mentioned only in the opinion's initial  summary and concluding
paragraph, was essential to the  court's conclusion.


Some of petitioner's argument seems an exercise in seman- tic ju jitsu.
It argues that we may not consider whether the  partnership was a
"sham" because the Tax Court (a) explicitly  refused to consider that,
and (b) never used the word "sham."  The first point is false, the
second irrelevant. Although the  Tax Court said that it would not
consider whether the trans- actions at issue lacked "economic
substance," id., its decision  rejecting the bona fides of the
partnership was the equivalent  of a finding that it was, for tax


Getting to the controlling issue, petitioner argues that  under the
standard established in Moline Properties, Inc. v.  Commissioner, 319
U.S. 436 (1943), the partnership cannot be  regarded as a sham. The
Court there said that a corporation 


remains a separate taxable entity for tax purposes "so long as  [its]
purpose is the equivalent of business activity or is  followed by the
carrying on of business by the corporation."  319 U.S. at 439. The Tax
Court has since applied Moline to  partnership cases. See Bertoli v.
Commissioner, 103 T.C.  501, 511-12 (1994).


Petitioner views Moline as establishing a two-part test,  under which a
tax entity is accepted as real if either: (1) its  purpose is "the
equivalent of business activity" (not tax  avoidance), or (2) it
conducts business activities. Moline, 319  U.S. at 439. Because ASA
"engaged in more than sufficient  business activity to be respected as
a genuine entity," peti- tioner argues that ASA was a partnership
under the second  alternative. Petitioner's Reply Br. at 12. We agree
if engag- ing in business activity were sufficient to validate a
partner- ship ASA would qualify. It was infused with a substantial 
amount in capital ($1.1 billion), and invested it in PPNs,  LIBOR
notes, and other short-term notes over a period of  two years. In
fact, however, courts have understood the  "business activity"
reference in Moline to exclude activity  whose sole purpose is tax
avoidance. This reading treats  "sham entity" cases the same way the
law treats "sham  transaction" cases, in which the existence of formal
business  activity is a given but the inquiry turns on the existence
of a  nontax business motive. See Knetsch v. United States, 364  U.S.
361, 364-66 (1960). Thus, what the petitioner alleges to  be a
two-pronged inquiry is in fact a unitary test--whether  the "sham" be
in the entity or the transaction--under which  the absence of a nontax


Shortly after Moline the Second Circuit held per Judge  Learned Hand in
National Investors Corp. v. Hoey, 144 F.2d  466 (2d Cir. 1944), that
the retention and sale of securities,  after the date when the
corporate holding had served its 




__________

n 4 Indeed, one might logically enough place the Tax Court's  findings
here under the "sham transaction" heading, viewing the  formation of
the partnership as the transaction. Because of the  ultimate unity of
the tests, however, there is no need to address this  formulation.


nontax goals, could not be considered for tax purposes.  There an
investment trust corporation proposed to merge  with its subsidiaries.
To this end it created a new corpora- tion into which it transferred
its interests in the subsidiaries  in exchange for 10 shares of stock.
But the stockholders  decided to reject the plan to unify the four
corporations. The  investment trust then liquidated the new
corporation, starting  with an exchange of 10% of the new
corporation's shares and  taking a deduction based on the difference
between the value  of 10% of the shares when originally issued to the
trust, and  10% of their reduced value a year later. In initiating
even  this 10% liquidation, however, it delayed for some time after 
the shareholders' vote. The court held that the trust was  entitled to
a deduction only for value decreases incurred from  the time of the
original transfer of assets to the corporation  to "a reasonable time"
after the stockholders rejected the  plan. Id. at 468. Thereafter,
"there was no longer any  business for [the corporation] to do." Id.
Retention of the  corporation merely for the purpose of tax
minimization was  not enough. The court explicitly read the cases as
saying  that "the term 'corporation' will be interpreted to mean a 
corporation which does some 'business' in the ordinary mean- ing, and
that escaping taxation is not 'business' in the ordi- nary meaning."
Id. So too, for ASA: Although its invest- ment in LIBOR notes might
have had a business purpose, the  prior three-week investment in and
subsequent sale of PPNs  was, like the retention of assets in Hoey, a
business activity  merely conducted for tax purposes.5 Moreover, as
discussed  later, AlliedSignal's interest in any potential gain from
the  partnership's investments was in its view at all times dwarfed 




__________

n 5 The PPNs cost $850 million. When an expert was later  engaged by
AlliedSignal to evaluate the partnership's gains and  losses,
AlliedSignal asked that he assign to the LIBOR notes a  value which,
together with the cash, would bring the total value of  the proceeds
of the PPNs to $850 million. See J.A. 1343. Allied- Signal evidently
did not believe that the initial investment in PPNs  increased the
return from the transactions in the aggregate.


The Ninth Circuit has similarly held that "business activi- ty" is
inadequate in the absence of a nontax business purpose.  In Zmuda v.
Commissioner, 731 F.2d 1417 (9th Cir. 1984),  the taxpayers argued
that the Tax Court incorrectly applied  the "economic substance" rule
rather than the "business  purpose" rule. The court found that the
taxpayer's argument  "attempts to create a distinction where none
exists. There is  no real difference between the business purpose and
the  economic substance rules. Both simply state that the Com-
missioner may look beyond the form of an action to discover  its
substance." Id. at 1420. The court went on to say:


The terminology of one rule may appear in the context of  the other
because they share the same rationale. Both  rules elevate the
substance of an action over its form.  Although the taxpayer may
structure a transaction so  that it satisfies the formal requirements
of the Internal  Revenue Code, the Commissioner may deny legal effect 
to a transaction if its sole purpose is to evade taxation.


Id. at 1421. At issue was the validity of certain trusts, so the 
court's equation of the "transaction" test and the "entity" test  was
clearly a holding.


We note that the "business purpose" doctrine is hazardous.  It is
uniformly recognized that taxpayers are entitled to  structure their
transactions in such a way as to minimize tax.  When the business
purpose doctrine is violated, such struc- turing is deemed to have
gotten out of hand, to have been  carried to such extreme lengths that
the business purpose is  no more than a facade. But there is no
absolutely clear line  between the two. Yet the doctrine seems
essential. A tax  system of rather high rates gives a multitude of
clever  individuals in the private sector powerful incentives to game 
the system. Even the smartest drafters of legislation and  regulation
cannot be expected to anticipate every device.  The business purpose
doctrine reduces the incentive to en- gage in such essentially
wasteful activity, and in addition  helps achieve reasonable equity
among taxpayers who are  similarly situated--in every respect except
for differing in- vestments in tax avoidance.


Thus the Tax Court was, we think, sound in its basic  inquiry, trying
to decide whether, all facts considered, the  parties intended to join
together as partners to conduct  business activity for a purpose other
than tax avoidance. Its  focus was primarily on ABN, curiously. As we
shall discuss  later, the absence of a nontax business purpose was
even  clearer for AlliedSignal. Nonetheless, given ABN's protec- tion
from risk, and even from the borrowing costs of provid- ing its
capital contribution, there was no clear error in the  finding that
its participation was formal rather than substan- tive.6 Petitioner
alleges two primary ways in which the Tax  Court erred in this


First, petitioner says that the Tax Court incorrectly found  that
Barber and Dominguito were mere agents of ABN  rather than partners in
their own right. But this issue of  classification makes no material
difference. Once the court  decided that the SPCs were mere conduits
for ABN, it shifted  its focus to whether AlliedSignal and ABN (rather
than the  SPCs) formed a bona fide partnership. There was certainly 
no clear error in the court's view of the SPCs as being within  the
complete control of ABN, and there is no indication as to  how the
SPCs' intent as to the "partnership" differed from  that of ABN.


Second, petitioner argues that the Tax Court erred by  finding that ABN
did not share in profits and losses because  it received a specified
return from AlliedSignal and hedged  against risk through swap
transactions with Merrill. On the  profit side, we find no clear error
in the court's findings that  the direct payments made to ABN were to
compensate it  merely for its funding costs. Petitioner says that
there was  no explicit agreement that ABN would receive a return of 
LIBOR plus 75 basis points, pointing to the fact that the  payments
actually made by AlliedSignal to ABN did not 




__________

n 6 Although petitioner argues that ABN's purpose was not tax-
avoidance, but rather "included a desire to enhance its business 
relationship with AlliedSignal," Petitioner's Initial Br. at 41 n.19, 
the desire to aid another party in tax avoidance is no more a 
business purpose than actually engaging in tax avoidance.


produce such a return. See Petitioner's Brief at 59; supra  note 2. But
petitioner makes no argument that these pay- ments were related to the
success of the partnership's invest- ments (i.e., the PPNs and LIBOR
notes), and under the  circumstances it is reasonable to infer that
they were made  pursuant to a pre-arranged agreement to compensate ABN
 for its funding costs (plus some amount above LIBOR, even if  not 75
basis points).


Den Baas's testimony, moreover, confirms that ABN could  make no profit
from the transaction: any potential profit  from the LIBOR notes would
be offset by losses from the  concomitant swap transactions.
Petitioner cites Hunt v.  Commissioner, 59 T.C.M. (CCH) 635 (1990),
for the proposi- tion that a guaranteed return is not inconsistent
with partner- ship status. In Hunt, however, both parties had a bona
fide  business purpose for entering into the partnership, and unlike 
in the case at hand, the guaranteed return created a floor but  not a
ceiling. See id. at 648.


Turning to the risk of loss, we agree with the Tax Court  that any
risks inherent in ABN's investment were de minimis.  As a preliminary
matter, the court did not err by carving out  an exception for de
minimis risks, as no investment is entirely  without risk. Unless one
posited a particular asset (such as  the dollar) as the sole standard,
its value could change in  relation to the values of other assets, and
treating one--even  the dollar--as the sole standard would be
arbitrary. The Tax  Court's decision not to consider ABN's "de
minimis" risk is  also consistent with the Supreme Court's view,
albeit in the  "sham transaction" context, that a transaction will be
disre- garded if it did "not appreciably affect [taxpayer's]
beneficial  interest except to reduce his tax." Knetsch, 364 U.S. at
366  (emphasis added) (quoting Gilbert v. Commissioner, 248 F.2d  399,
411 (2d Cir. 1957) (Hand, C.J., dissenting)).


There was no clear error in the Tax Court's determination  that at no
point during the transaction did ABN assume  greater than de minimis
risk. The PPNs were essentially  risk free: not only were they issued
by banks with the  highest credit ratings but they were held for a
mere three 


weeks. Moreover, because of the side agreement under  which any loss on
the PPNs would be embedded in the value  of the LIBOR notes,
AlliedSignal would bear any shortfall  over the brief period in which
PPNs were held. Petitioner  argues that ABN was subject to the risk
that AlliedSignal  would ultimately decide not to acquire the LIBOR
notes.  This seems unlikely to the point of triviality, however, for
two  reasons: first, this step was integral to AlliedSignal's tax 
objective, and to the entire transaction; and second, at the  point
when the LIBOR notes would be distributed, Domingui- to still owned
over 40% of ASA, and according to the partner- ship agreement, any act
of the partnership committee would  require the consent of partners
whose interest equaled or  exceeded 95%. Nor was there any real hazard
that Allied-  Signal might agree to distribute the LIBOR notes but
refuse  to make the adjustment for any loss on the PPNs: as den  Baas
had stated in a memorandum to ABN officials, the SPCs  could counter
by refusing consent for the distribution of the  notes altogether.


The LIBOR notes certainly had greater inherent risk than  the
short-term PPNs; ABN, however, entered into hedge  transactions
outside the partnership to reduce the risk to a de  minimis amount. In
fact, the correlation between the swaps  and the LIBOR notes was
99.999%, i.e., the company succeed- ed in hedging all but a de minimis
amount of the risk  associated with the LIBOR notes. Petitioner
concedes that  "the hedges provided the ABN parties with substantial
pro- tection from fluctuations in LIBOR Note value due to move- ments
in interest rates." Petitioner's Reply Br. at 18. But  ASA
nevertheless contends that ABN still bore the credit risk  associated
with the issuers of the LIBOR notes and with  Merrill, which provided
the hedges. Once again, we find that  the Tax Court correctly found
the risk to be de minimis: the  LIBOR notes were issued by banks
having a credit rating of  AAA and AA+, and were held by ASA for only
three months.  So too, the risk associated with the swaps with Merrill
(a  single-A rated institution) was de minimis. Finally, there was 
little, if any, risk associated with the commercial paper that  ASA
held at this point, which although unhedged, was found 


by the Tax Court to be "AAA-rated, short-term, and from  multiple
issuers." Tax Court Decision, 76 T.C.M. at 335.


Petitioner argues that ABN's side-transactions should not  be
considered in deciding whether a bona fide partnership  was formed. It
draws an analogy to a partnership which  owns an uninsured building
later destroyed by fire; this  partnership is bona fide even if one
partner had insured  against his portion of the loss. The analogy,
though imagina- tive, is not very telling. The insurance in the
hypothetical is  comparatively narrow, leaving a considerable range of
poten- tial business hazards and opportunities for profit. Contrast 
den Baas's observation at the outset of the present plan:  "Credit
risk: The structure demands that virtually no credit  risk will be
taken in the partnership since any defaults on the  principal of the
investments will jeopardize the objective....  Market interest rate
risk: ABN New york [sic] will take care  of perfect hedges in order to
protect the bank from the  changes in the value of the underlying
securities.... due to  interest rate fluctuations." J.A. 680-81. We
note, moreover,  that petitioner directs us to no evidence that ABN
even bore  the cost of these hedges. Given that Merrill, which had 
orchestrated the entire transaction and to whom AlliedSignal  had paid
a substantial sum, engaged in the swap transactions,  it is likely
that AlliedSignal assumed the costs of the swaps.  A partner whose
risks are all insured at the expense of  another partner hardly fits
within the traditional notion of  partnership.


Petitioner argues that the Tax Court also erred in deter- mining that
ABN's capital contribution constituted a loan.  We need not pass on
this question because it is quite periph- eral to the central issue of
whether the parties entered into a  bona fide partnership.


We noted earlier that the Tax Court's focus on ABN's  intentions was a
little puzzling. AlliedSignal, after all, was  the driving force and
AlliedSignal focused on tax minimization  to the virtual exclusion of
ordinary business goals. Of course  no one wants to pay more than
necessary, even for a very  profitable tax minimization scheme, and
the petitioner argues 


that even with the very substantial transaction costs associat- ed with
the partnership, AlliedSignal had grounds for expect- ing that it
would come out more than $15 million ahead. As it  proved, transaction
costs were almost $25 million rather than  the roughly $12 million it
anticipated, Tax Court Decision, 76  T.C.M at 326, 332, so the
ultimate financial gain, according to  the parties, was actually about
$3.6 million. The expected  gain turned on the belief of Roger
Matthews, AlliedSignal's  assistant treasurer--which proved
correct--that interest  rates would shift in such a way that, when all
the swaps were  taken into account, AlliedSignal would benefit. But
this  evidence says nothing about AlliedSignal's use of the elabo-
rate partnership--with a pair of partners concocted for the  occasion.
There is no reason to believe that AlliedSignal  could not have
realized Matthews's interest rate play without  the partnership at
far, far lower transactions costs. For the  deal overall, the most
telling evidence is the testimony of  AlliedSignal's Chairman and CEO,
who could not "recall any  talk or any estimates of how much profit
[the transaction]  would generate." The Tax Court concluded that none
of the  supposed partners had the intent to form a real partnership, 
a conclusion that undoubtedly encompasses AlliedSignal.  And the


The decision of the Tax Court is


Affirmed.