A California federal district court judge on Friday rejected, on summary judgment, a bid by billionaire Broadcom co-founder Henry Nicholas, III, to claim hundreds of millions in tax losses from a shelter marketed more than a decade ago by myCFO, Inc. the wealth advisory firm started by Forbes 400 member James Clark, co-founder of Netscape, and backed by venture capitalistJohn Doerr. An attorney for Nicholas, BakerHostetler partner Jeffrey H. Paravano, said Monday that Friday's ruling will be appealed.
The Nicholas case involves what the Internal Revenue Service has branded the distressed asset/debt or "DAD" shelter. In this ploy, a U.S. taxpayer purchases (through a partnership) junk foreign debt for pennies on the dollar and then claims big paper tax losses—losses that are real, but that were sustained by a foreign lender, not the U.S. taxpayer. DAD was marketed to the ultra-wealthy in 2001 and 2002 after the IRS began cracking down on even more brazen tax gambits, such as the notorious Son of Boss shelter. New 400 member Shahid Khan, owner of the NFL's Jacksonville Jaguars, is currently suing BDO Seidman for, among other things, selling him DAD shelters for both 2002 and 2003. In October 2004, Congress changed the tax code to bar partnerships from being used to transfer foreign losses to U.S. taxpayers, thus clearly outlawing DAD after that point.
BMO Harris Bank acquired the myCFO name and client list in late 2002 and was not a part of the shelter promotion. A 2007 Wall Street Journal post mortem reported that with the encouragement of Doerr, myCFO's tax strategies group sold 17 clients a tax shelter known as CARDs, invented by Raymond J. Ruble, a former partner of SidleyAustin LLP who is now doing 78 months for tax evasion at the Lewisburg federal pen. But according to the government, Ruble was also involved in the development of myCFO's DAD shelter. A government expert's report filed in the Nicholas case indicates that myCFO sold the DAD shelter to at least 20 rich taxpayers in 2001.
A version of DAD was rejected last year by the Fifth Circuit Court of Appeals in a case involving Texas banker and Forbes 400 member Andrew Beal. Beal, who attempted to claim $1.1 billion in tax losses based on an investment of just $19 million in distressed Chinese debt, is still wrangling with the government over his final tax bill and last month filed another lawsuit covering DAD losses he claimed for 2006 and 2007. In Beal's case, the trial court rejected the IRS' attempts to impose penalties, finding that Beal had "good cause" to believe his ploy might work; the appeals court decision described the penalty issue as a "close one" but let the trial court's ruling against penalties stand. Also last year, in Superior Trading LLC, theU.S. Tax Court ruled against a variant of the DAD shelter promoted to more modestly wealthy individuals by former Seyfarth Shaw partner and Harvard law grad John E. Rogers. It upheld penalties in that case. (Last October, a courtpermanently barred Rogers from promoting tax shelters.)
No court had previously ruled on the myCFO promoted version of DAD and in court papers Nicholas' lawyers asserted the Beal decision "turned upon at least three groups of idiosyncratic facts (found after lengthy trials) that are not present" in their client's case.
According to the government, in December 2001, Nicholas' family holding company, N&S Holdings, arranged through myCFO to pay $6.2 million for $303 million in nonperforming Chinese and Korean loans marketed under the name of DRAGONS. That $6.2 million investment was expected to save Nicholas and his family trusts $78 million in tax, the government contends. After the Internal Revenue Service denied the losses claimed by five Nicholas partnerships for 2002, 2003 and 2004, he filed multiple suits in district court asserting the losses were proper and that he had invested in distressed debt with a legitimate non-tax purpose—namely to diversify his portfolio, reduce its volatility and enhance his "risk-adjusted" returns.
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