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April 23, 2012
Brattle Principal Provides Testimony in Two Offshore Portfolio Investment Strategy (OPIS) Tax Disputes

Brattle principal Dr. Lawrence Kolbe provided testimony on behalf of the U.S. Internal Revenue Service that helped shape the outcome of a pair of Offshore Portfolio Investment Strategy (OPIS) tax disputes in U.S. Tax Court in Los Angeles, CA. On January 17, 2012, Judge Diane L. Kroupa ruled in favor of the IRS in Scott and Audrey Blum v. Commissioner of Internal Revenue, finding that the transaction lacked economic substance. Part of her decision discussed Dr. Kolbe’s testimony, saying that he

looked at the net present value and the expected rate of return relative to the cost of capital. He concluded that the OPIS transaction, as a whole, was extremely unprofitable. Dr. Kolbe determined that petitioners’ entry into OPIS resulted in an immediate loss of 36 percent of the invested amount because the securities were priced far above their value. A bad deal or a mispriced asset need not tarnish a legitimate deal’s economic substance. A finding of grossly mispriced assets or negative cashflow can, however, contribute to the overall picture of an economic sham…

On April 11, 2012, Judge Joseph Robert Goeke ruled in favor of the IRS in John Paul Reddam v. Commissioner of Internal Revenue, also finding that the transaction lacked economic substance. Part of the decision stated that Dr. Kolbe’s testimony “performed a comprehensive analysis of petitioner’s OPIS transaction examining both the transaction, as a whole, and its discrete elements.” Judge Goeke went on to say that

… Dr. Kolbe’s additional comparison of the “values” of the discrete elements of the OPIS transaction to their purchase price does, partially, illuminate the economics of petitioner’s investment. Dr. Kolbe concluded that petitioner overpaid $2,289,650 for the entire OPIS transaction. … Such findings are not always indicative of the true nature of an investment. … Nonetheless, “grossly mispriced assets or negative cashflow can contribute to the overall picture of an economic sham” [citing Blum]. Accordingly, the significant mispricing of the OPIS transaction, while not a dispositive factor in our present inquiry, certainly signals to this Court that the transaction was devoid of economic substance.

At both trials, Dr. Kolbe testified regarding the OPIS transaction’s structure and the financial underpinnings of each transaction. He explained the economic and financial principles necessary to evaluate the transactions, and opined on the objective profitability of the transaction and the economic rationality of using such a transaction to further its stated non-tax business purposes. Dr. Kolbe concluded that the OPIS transaction had a materially negative expected return and was an economically irrational way of achieving its stated non-tax purposes, as compared to other standard and non-standard potential investments. Dr. Kolbe, a principal in Brattle’s Cambridge, MA office, specializes in financial economics, particularly as it applies to rate regulation and project or asset valuation. He was assisted in this case by Brattle research analyst David Hutchings.