Canal Corp. v. Comm'r, 2010 U.S. Tax Ct. LEXIS 25 (T.C. Aug. 5, 2010), has serious implications for U.S. taxpayers and their advisors, especially regarding the issuance of tax opinions requiring a high degree of certainty. Fundamental points of the case as to advisor independence and economic substance are important for in-house counsel and external advisors to grasp in mitigating enterprise risk that often accompanies complex transactions.
In this case, the court's ruling that the taxpayer placed unreasonable reliance on its accounting firm's opinion cost the taxpayer nearly $37 million in substantial-underreporting penalties, third party "should" level opinion notwithstanding. While a particularly egregious example, this case demonstrates the court's laser-like focus on economic substance over form and the importance of acknowledging and dealing with conflicts of interest-real or perceived.
A Conflict of Interest. Chesapeake's tax advisor, PwC, was involved in drafting the operating agreements and indemnity agreement. PwC also researched and wrote the tax opinion. For its services, PwC received a flat fee of $800,000, instead of billing its standard hourly rates for work performed, payable and contingent upon the closing of the joint venture transaction. Chesapeake's directors conditioned closing of the transaction on receiving at closing a "should"-level opinion regarding tax deferral from PwC... Based on the facts and circumstances presented, the court ruled that Chesapeake's reliance on the opinion issued by PwC was unreasonable and lacked good faith, and held Chesapeake liable for accuracy-related penalties in 26 USC § 6662.
... [A]s courts have repeatedly held in the past, it is unreasonable for a taxpayer to rely on the same tax advisor that actively planned the transaction; that is an inherent conflict of interest. [Mortensen v. Comm'r, 440 F.3d 375, 387 (6th Cir. 2006), affg. T.C. Memo 2004-279; Pasternak v. Comm'r, 990 F.2d 893 (6th Cir. 1993), affg. Donahue v. Comm'r, T.C. Memo 1991-181; Neonatology Assocs, P.A. v. Comm'r, 115 T.C. 43 (2000), affd. by 299 F.3d 221 (3d Cir. 2002).]
Lessons for Practitioners.
Key Takeaways. Attempting to fit the facts and circumstances to advantageous but ultimately irrelevant guidance puts the taxpayer and the advisor in peril, although the attempt may reduce short-term friction between taxpayer and advisor. On occasion, the best advice in-house counsel and external advisors can give is "No." Winning the battle of substance over form requires careful business and economic planning and execution-not just a flat-fee third-party opinion.
LEXIS users can view the entire commentary here. Additional fees may be incurred. (Approx. 6 pages)
Hear further analysis of Canal Corp. v. Comm'r on this site in Robert Jennings and Elizabeth Sweigart's podcast interview.
View also on this site commentary insights by Lexis Federal Tax Analysts Charles Zubrzycki.
RELATED LINKS: For further insights, see:
Lexis Tax Advisor -- Federal Topical 2D:7.01
Lexis Tax Advisor -- Federal Topical 5A:16.04
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