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Salty Brine I, Ltd. v. United States

United States Court of Appeals, Fifth Circuit

July 31, 2014

SALTY BRINE I, LIMITED, Plaintiff,
v.
UNITED STATES OF AMERICA, Defendant. THOMAS & KIDD OIL PRODUCTION, LIMITED, By and Through Thomas/Kidd -- Texas Operating Co., Incorporated, Tax Matters Partner, Plaintiff-Appellant,
v.
UNITED STATES OF AMERICA, Defendant-Appellee

Page 485

Appeal from the United States District Court for the Northern District of Texas.

For THOMAS & KIDD OIL PRODUCTION, LIMITED, By and Through Thomas/Kidd - Texas Operating Company, Incorporated, Tax Matters Partner, Plaintiff - Appellant: Josh O. Ungerman, Anthony P. Daddino, Esq., Meadows, Collier, Reed, Cousins, Crouch & Ungerman, L.L.P., Dallas, TX.

For United States of America, Defendant - Appellee: Ellen Page DelSole, Esq., Trial Attorney, Tamara W. Ashford, Esq., Deputy Assistant Attorney General, Richard Bradshaw Farber, Esq., Supervisory Attorney, U.S. Department of Justice, Tax Division, Appellate Section, Washington, DC; Christopher R. Egan, U.S. Department of Justice, Tax Division, Dallas, TX; Gilbert Steven Rothenberg, Esq., Deputy Assistant Attorney General, U.S. Department of Justice, Washington, DC.

Before DAVIS, ELROD, and COSTA, Circuit Judges.[1]

OPINION

Page 486

W. EUGENE DAVIS, Circuit Judge:

Plaintiff Thomas & Kidd Oil Production, Ltd. (" TKOP" ) appeals from the district court's determination, after a nine-day bench trial, that the transfer of certain overriding royalty interests through a complicated transaction was an invalid attempt to assign income. The record amply supports this finding and supports the district court's conclusion that the income was taxable to TKOP for the 2006 tax year. We affirm.

I. Introduction

On April 5, 2010, The Commissioner of Internal Revenue issued a Notice of Final Partnership Administrative Adjustment to TKOP for the tax year ending December 31, 2006, establishing what the IRS believes to be TKOP's total tax liability. TKOP deposited the amount required by 26 U.S.C. § 6226(e) with the IRS, then commenced this action seeking readjustment of partnership items, which was consolidated with seven lawsuits under the Salty Brine I caption. The district court had jurisdiction under 26 U.S.C. § 6226(a) and 28 U.S.C. § 1346(e), and we have jurisdiction over this timely appeal under 26 U.S.C. § 6226(g) and 28 U.S.C. § 1291.

TKOP disputed the determination of several partnership items before the district court, including whether TKOP's purchase of so-called Business Protection Policies (" BPPs" ) resulted in deductible business expenses, and whether the transfer of certain overriding royalty interests by TKOP was an invalid attempt to assign income that should have been taxed to it.

The district court ultimately concluded that the purchase of the BPPs did not result in deductions and that the transfer of the overriding royalties should be disregarded and the royalty income assigned to

Page 487

TKOP instead. TKOP has appealed only the overriding royalty determination, but it is necessary to discuss the BPP scheme because both the BPP scheme and the royalty transaction concerned some of the same business entities and methods.

II. Factual Background

This case largely turns on the complicated facts surrounding the overriding royalty interest transaction, which the district court addressed in a detailed order.

In an appeal from a bench trial, we review the district court's findings of fact for clear error and its conclusions of law de novo. " Specifically, a district court's characterization of a transaction for tax purposes is a question of law subject to de novo review, but the particular facts from which that characterization is made are reviewed for clear error." [2]

We take our facts from the district court's findings, which are not clearly erroneous.

A. TKOP's Ownership

The district court found that the ultimate taxpayers, John Thomas and Lee Kidd, own and operate a group of oil and gas related businesses based in West Texas, including TKOP. The district court noted that Thomas and Kidd did not own their businesses directly, but rather owned them through the trusts and investment partnerships that were involved in the BPP and royalty interest transaction. Thomas and Kidd owned TKOP through two grantor trusts, the Kidd Living Trust and Thomas Living Trust; and two additional investment partnerships, Kiddel II, Ltd. and JTOM II, Ltd. The ownership structure is unquestionably complex, but the essential finding is that all of the related entities were owned and controlled by Thomas and Kidd.

B. The BPP Scheme

The district court found that Thomas and Kidd's accountant, H. Glenn Henderson, introduced them to the concept of BPPs, which were issued by Fidelity Insurance Company and Citadel Insurance Company, both based offshore in the British West Indies. Fidelity and Citadel were associated with several other companies under the umbrella of the Alliance Holding Company, Ltd., including a trust company, an administrative services company, and a marketing firm, Foster & Dunhill. Fidelity and Citadel were not owned by Thomas and Kidd.

The idea behind the BPPs was to set up an offshore " asset protection trust" then purchase cash-value life insurance policies, whose cash values would be invested with the principal and interest allocated to " separate asset" accounts (or " segregated accounts" ). The goal was to set aside the assets of these accounts and account for them separately from other insurance policies, shielding them from the owners of other insurance policies and from the creditors of the insurance companies. One of the district court's key findings is that the accounts were invested in accordance with the client's instructions.

Thomas and Kidd purchased cash-value life insurance policies, through their various companies, from Fidelity and/or Citadel beginning in 2002, and in the relevant tax year, 2006, they had policies in place from both Fidelity and Citadel.

The final step was the purchase of a BPP, which ostensibly insured a given business against risks. At the end of the policy ...


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