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1040X QUALIFIES AS AAR UNDER DOCTRINE OF SUBSTANTIAL COMPLIANCE

05 / 17 / 2011

Rigas v. United States, 2011 U.S. Dist. LEXIS (S.D.Tex. 2011)

A Federal Court in Texas has found that the doctrine of substantial compliance will be applicable in determining whether a purported partner's Form 1040X qualifies as an AAR that then gives rise to jurisdiction to hear a refund claim filed under Section 6228(b) of the Code. In this case, a partner sought to reclassify as a capital gain, an item of ordinary income flowing to and out of a management company limited partnership called Odyssey Energy Capital I, LP, for a Performance Fee. In so doing, the Federal Court aligned itself with the Fifth Circuit in Young v. Commissioner, 783 F.2d 1201, 1205 (5th Cir. 1986), the Ninth Circuit in Wall v. United States, 133 F.3d 1188, 1189 (9th Cir. 1998), and the Tax Court in Samueli v. Commissioner, 132 T.C. 336, 343 (T.C. 2009). In contrast, the Federal Claims Court rejected this argument, in Rothstein v. United States, 81 A.F.T.R.2d 2132 (Fed. Cl. 1998), finding that one is required to actually file AAR, viewing the Treasurey Regulations as mandating "strict compliance." The key appears to be whether substantially the same information has been submitted, and in this case, the second amended Form 1040X submitted by the partner identified the partner (John Rigas), the partnership (Odyssey), their addresses and taxpayer identification numbers, and the partnership tax year, and an explanation of the changes to income, deduction, and credits. While the second amended return departed in some ways from the regulations, and was not filed in Ogden, Utah, the Federal Court found that it substantially complied with the Treasury Regulations set forth in 301.6227(d)-1 because it "provided the key information needed by the IRS to realize that the Rigases were requesting an adjustment of a partnership item."

At that point, the court noted that both parties had moved for summary judgment on whether the relationship between Odyssey and the service recipient (Hydrocarbon) was one of mere servicing (independent contractor) or a joint venture or partnership, for Federal tax purposes. At this point, the Court applied federal tax law, by engaging in a factual inquiry as to whether the parties in good faith and acting with a business purpose intended to join together in the present conduct of the enterprise, relying on the Culbertson case, 337 U.S. 733 (1949), and the factors set forth in Luna v. Commissioner, 42 T.C. 1067, 1078 (T.C. 1964). In applying the factors, the Court first looked to the management agreement entered into by and between the two entities, Hydrocarbon and Odyssey, which specifically disclaimed a partnership or venture relationship. The Federal Court noted that the "conduct of the parties" is key, and so language in the Management Agreement was not dispositive. The Federal Court did find that Odyssey contributed both capital and services to the relationship with Hydrocarbonb, but that merely providing for compensation to be measured by reference to profits derived from the sale of property did not convert a relationship into a partnership for tax purposes. The Federal Court noted that Odyssey possessed a great deal of autonomy in managing the day-to-day operations of the asset portfolio with Hydrocarbon, but could not withdraw funds nor enter into binding agreements in Hydrocarbon's name, or otherwise extend into key areas of acquiring or disposing of assets that would indicate a partnership relationship. Also, when Odyssey did not own title to any of the assets in the portfolio, and it did not share control with Hydrocarbon ovr the bank accounts that corresponded with the companies in the asset portfolio, this was indicative of a mere service provider relationship. Further, the parties appeared to have maintained separate accounting and financial arrangements, indicative of a service providing relationship.

After considering the Luna factors, the Federal Court held that the Government, bearing the burden of proof under the proof shifting statute, Section 7491, established by a preponderance of the evidence that a partnership relationship did not exist, and granted summary judgment to the Government.