While the initial tax court disagreed with the IRS’s position in Boardwalk, the appeals court sided with the IRS, agreeing that the corporate member of the HBH project partnership assumed virtually no risk in joining the project. Instead, the Third Circuit Court of Appeals found that the corporate member’s lack of a guaranteed return contingent upon the success of the project combined with its automatic allocation of tax credits was tantamount to a guaranteed repayment of its capital contribution to the partnership. The corollary then, according to the Third Circuit, was that the corporate member was not a true partner in the project for federal income tax purposes.
In its petition, HBH forcefully refutes the notion that the corporate partner was not at risk and argues that the Third Circuit’s findings contradict both the tax code and previous case law. In fact, it points out, the Supreme Court previously held that a legitimate partnership exists so long as the parties merely intended to conduct business together and share in the profits and losses of that business. And while the corporate member of the partnership may have lacked a guaranteed return hinging on the success of the project, it was entitled to a preferred return based on the cash flow of the partnership. In other words, the petition insists that the corporate member sufficiently bound itself to the fate of the project to qualify as a legitimate partner.
The petition also emphasizes that, as with the Third Circuit’s decision to deny the legitimacy of the project partnership, the Third Circuit’s treatment of the allocation of credits within the partnership as a sale or repayment of the corporate member’s capital contribution has no grounds in any case, statute, or other legal authority. By definition, the petition argues, the tax credits are benefits provided by the US Treasury and do not constitute “property” that can be sold. Thus, the partnership could never “own” the tax credits in order to sell them to the constituent corporate member.
Instead, the petition contends, the allocation of credits is more appropriately viewed as the result of the operation of law, as both the tax code and partnership operating agreement dictated the allocation of credits. In this case, the operating agreement stipulated that tax credits would be allocated based on ownership interest. As a result of having a 99.9% stake in the HBH partnership, the corporate member thus received all of the tax credits. While this argument may seem dubious on the surface, the petition takes care to point out that the partnership arrangement in this case is not an uncommon one; yet, no other court has ruled as the Third Circuit Court of Appeals did.