Reddam v. CIR

A capital loss tax deduction must have economic substance; and, under the economic substance doctrine, a transaction must not be intended only to create a capital loss with no real expectation of generating income.

In 1995, John Paul Reddam founded various companies, known collectively as DiTech. Reddam used KPMG for his personal taxes and for DiTech’s corporate taxes. KPMG was also Reddam’s corporate auditor. In 1998, while deciding whether to go public or sell DiTech, Reddam met with a KPMG tax partner who recommended an Offshore Portfolio Investment Strategy (“OPIS”). Through a series of transactions, the OPIS was intended to minimize gains or maximize losses. Reddam admitted that the transaction was complicated and the intended benefit was creation of a tax deduction. Although Reddam was advised to seek independent counsel, Reddam relied solely on KPMG’s representations of the OPIS. In April 1999, Reddam sold his business. As a result of the sale, Reddam incurred a $48.5 million capital tax gain. At that time, he contacted KPMG to enter into an OPIS. The result of Reddam’s OPIS was a $50.2 million loss. The potential for profitability of the transaction was found to be between 10 and 25 percent, although Reddam’s admissions coupled with his failure to seek independent counsel on such a large transaction provided evidence that the transaction lacked economic substance and was intended solely to create a tax deduction. The Ninth Circuit affirmed the Tax Court’s decision and held that when a taxpayer enters into an economic transaction only to create a tax benefit, the transaction lacks economic substance and the deduction will be disallowed. AFFIRMED.