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April 11, 2013
Court of Appeals Upholds Decision in a CARDS Tax Transaction in Which Brattle Principal Provided Testimony on Economic Substance and Business Purpose

The U.S. Court of Appeals for the Sixth Circuit, in Case No. 11-1822, upheld a Tax Court decision in a Custom Adjustable Rate Debt Structure (CARDS) dispute that relied in part upon testimony from Brattle principal Dr. Lawrence Kolbe. On Monday, April 8, 2013, the Court upheld a March 8, 2011 decision in Tax Court (Docket No. 15895-06) that ruled in favor of the Commissioner of Internal Revenue and found that the CARDS transaction lacked economic substance and lacked a business purpose other than the creation of an income tax benefit. An issue in the appeal was whether Dr. Kolbe’s testimony should be ignored under the U.S. Supreme Court’s Daubert precedent, regarding the standards required for admission of testimony by an expert witness. Dr. Kolbe’s analysis addressed four specific tasks: (1) review the transactions at issue in the dispute from an economic perspective; (2) analyze the risk-return characteristics of the various transactions; (3) assess the economic rationality of what is known about the non-tax business purposes for the transactions; and (4) assess the economic rationality, before and after tax considerations, of the decision by the taxpayer to engage in the transactions. The Court of Appeals held that the Tax Court had properly accepted Dr. Kolbe’s testimony, holding that his analysis “both rests on a reliable foundation and is relevant to the task at hand” (quoting Daubert). The Court of Appeals upheld both the disallowance of the tax deduction and the imposition of a 40 percent valuation misstatement penalty. 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 senior associate Florin Dorobantu.