IRS Files Reply Brief in Ya Global Tax Court Case

Ya Global Investments, LP f.k.a. Cornell Capital Partners, LP; Yorkville Advisors, GP LLC, Tax Matters Partners and Ya Global Investments, LP f.k.a. Cornell Capital Partners, LP; Yorkville Advisors, LLC, Tax Matters Partners,
Petitioners,
v.
Commissioner of Internal Revenue
Respondent.

Docket No. 14546-15

UNITED STATES TAX COURT

Electronically Filed

Simultaneous Reply Brief

UNITED STATES TAX COURT

UNITED STATES TAX COURT YA GLOBAL INVESTMENTS, LP
F/K/A CORNELL CAPITAL PARTNERS, LP, ET AL.,
Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

Docket Nos. 14546-15, 28751-15

Filed Electronically

Judge Halpern

REPLY BRIEF FOR RESPONDENT

WILLIAM M. PAUL
Acting Chief Counsel
Internal Revenue Service

OF COUNSEL: ROBIN GREENHOUSE Division Counsel (Large Business & International) JOHN M. ALTMAN National Strategic Litigation Counsel (Large Business & International) MARY HELEN WEBER Deputy National Strategic Litigation Counsel (Large Business & International)

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CONTENTS

PRELIMINARY STATEMENT

RESPONDENT’S RESPONSE TO PETITIONERS’ "STATEMENT OF THE CASE" (PETITIONERS’ BRIEF pp. 26-42)

RESPONDENT’S OBJECTIONS TO PETITIONERS’ PROPOSED FINDINGS OF FACT

ARGUMENT

CONCLUSION

CITATIONS

Cases

Adda v. Commissioner, 10 T.C. 273 (1948), aff’d per curiam, 171 F.2d 457 (4th Cir. 1948)

Adler v. Commissioner, 85 T.C. 535 (1985)

Anderson v. Commissioner, T.C. Memo. 1964-193, 23 T.C.M. (CCH) 1170 (1964)

Bank of America v. United States, 680 F.2d 142 (Ct. Cl. 1982)

Barker v. Magruder, 95 F.2d 122 (D.C. Cir. 1938)

Bauschard v. Commissioner, 279 F.2d 115 (6th Cir. 1960), aff’g 31 T.C. 910 (1959)

Beard v. Commissioner, 82 T.C. 766 (1984), aff’d per curiam, 793 F.2d 139 (6th Cir. 1986)

Bell v. Commissioner, 700 Fed. Appx. 654, 656 (9th Cir. 2017) (unpublished opinion), aff’g T.C. Memo. 2015-111

Berkowitz v. United States, 411 F.2d 818 (5th Cir. 1969)

Betts v. Commissioner, 62 T.C. 536 (1976)

Bielfeldt v. Commissioner, 231 F.3d 1035 (7th Cir. 2000)

Bollinger, Commissioner v., 485 U.S. 340 (1988)

Bordo Products Co. v. United States, 476 F.2d 1312 (Ct. Cl. 1973)

Bufferd v. Commissioner, 506 U.S. 523 (1993)

Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598 (S.D.N.Y. 1980)

Camp v. Pitts, 411 U.S. 138 (1973)

Carlo Bianchi & Co., United States v., 373 U.S. 709 (1963)

Central States Southeast and Southwest Areas Pension Fund v. Messina Products, LLC, 706 F.3d 874 (2013)

Cerand & Co. v. Commissioner, T.C. Memo. 2001-271, 82 T.C.M. (CCH) 755 (2001) 414, 418, 419, 420

Chemtool, Inc. v. Lubrication Technologies, Inc., 148 F.3d 742 (7th Cir. 1998)

Chesapeake & O. Ry. Co. v. Martin, 283 U.S. 209 (1931)

Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., N.A., 957 F. Supp. 2d 316, rev’d on other grounds, 773 F.3d 110 (2d Cir. 2014)

Chesapeake Fin. Corp. v. Commissioner, 78 T.C. 869 (1982)

Chicago and North Western Railway v. Commissioner, 29 T.C. 989 (1958)

Christiana Trust v. Riddle, 911 F.3d 799 (5th Cir. 2018)

Citron v. Commissioner, 97 T.C. 200 (1991)

Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440 (2003)

Cobalis Corp. v. Cornell Capital Partners, LP, 2011 WL 4962188 (D. N.J. 2011)

Cobalis Corp. v. YA Global Investments, L.P., 517 B.R. 169 (C.D. Cal. 2014), aff’d 638 Fed. Appx. 638 (9th Cir. 2016)

Complex Media v. Commissioner, T.C. Memo. 2021-14, 2021 WL 487024

Consol. Edison Co. of N.Y., United States v., 366 U.S. 380 (1961)

Container Corp. v. Commissioner, 134 T.C. 122 (2010), aff’d, 2011 WL 1664358 (5th Cir. May 2, 2011)

Corra Resources, Ltd. v. Commissioner, 945 F.2d 224 (7th Cir. 1991)

Dagres v. Commissioner, 136 T.C. 263 (2011)

Danielson, Commissioner v, 378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965)

De Amodio v. Commissioner, 34 T.C. 894 (1960), aff’d, 299 F.3d 623 (3d Cir. 1962)

Deely v. Commissioner, 73 T.C. 1081 (1980)

Dunitz v. Commissioner, 7 T.C. 672 (1946), aff’d, 167 F.2d 223 (6th Cir. 1948)

Echols v. Commissioner, 93 T.C. 553 (1989)

Echols v. Commissioner, 935 F.2d 703 (5th Cir. 1991)

Ellwest Stereo Theatres of Memphis, Inc., et al. v. Commissioner, T.C. Memo. 1995-610, 70 T.C.M. (CCH) 1655 (1995)

Ellwest Stereo v. Commissioner, T.C. Memo 1995-610, 70 T.C.M. (CCH) 1655 (1995)

Estate of Durkin, 99 T.C. 561 (1992)

Estate of Greenfield v. Commissioner, T.C. Memo. 2008-16, 95 T.C.M. (CCH) 1080 (2008)

Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972)

Estate of Mundy v. Commissioner, 36 T.C. 703 (1961)

Estate of Rogers v. Commissioner, T.C. Memo. 1970-192, 29 T.C.M. (CCH) 869 (1970)

Estate of Yaeger v. Commissioner, 889 F.2d 29 (2d Cir. 1989)

European American Bank and Trust Co. v. United States, 20 Cl. Ct. 594 (1990), aff’d per curiam, 940 F.2d 677 (Fed. Cir. 1991)

Ewing v. Commissioner, 122 T.C. 32 (2004), decision vacated by, 439 F.3d 1009 (9th Cir. 2006)

Farrar v. Commissioner, T.C. Memo. 1988-385, 55 T.C.M. (CCH) 1628 (1988)

Federal Express v. United States, 645 F. Supp. 1281 (W.D. Tenn. 1986)

Federal Home Loan Mortgage Corp. v. Commissioner, 125 T.C. 248 (2005)

Federal National Mortgage Association v. Commissioner, 100 T.C. 541, 578 (1993)

Fin Hay Realty Co. v. United States, 398 F.2d 694 (3d Cir. 1968).

G.D. Parker, Inc. v. Commissioner, T.C. Memo. 2012-327, 104 T.C.M. (CCH) 627 (2012)

Georgia School-Book Depository, Inc. v. Commissioner, 1 T.C. 463 (1943)

Georgia-Pacific Corp. v. Commissioner, 63 T.C. 790 (1975)

Gilbert v. Commissioner, 248 F.2d 399 (2d Cir. 1957)

Golson v. Commissioner, 54 T.C. 742 (1970)

Gooding Amusement Co. v. Commissioner, 23 T.C. 408 (1954), aff’d, 236 F.2d 159 (6th Cir. 1956)

Groetzinger v. Commissioner, 82 T.C 793 (1984)

Grove v. Daniel Valve Co., 874 S.W.2d 150 (Tex. App. 1994)

Handfield v. Commissioner, 23 T.C. 633 (1955)

Hansche v. Commissioner, 457 F.2d 429 (7th Cir. 1972)

Hardaway Construction Co., Inc. v. United States, 852 F.2d 174 (6th Cir. 1988)

Hatfried, Inc. v. Commissioner, 162 F.2d 628 (3d Cir. 1947)

Haywood Lumber & Min. Co. v. Commissioner, 178 F.2d 769 (2d Cir. 1950)

Heiner v. Mellon, 304 U.S. 271 (1938)

Henderson, United States v., 375 F.2d 36 (5th Cir. 1967)

Higgins v. Commissioner, 312 U.S. 212 (1941)

Hoffman v. Commissioner, T.C. Memo 1989-154, 57 T.C.M. (CCH) 51 (1989)

Huff v. Commissioner, 138 T.C. 258 (2012)

Hunt v. Commissioner, T.C. Memo. 1989-335, 57 T.C.M. (CCH) 919 (1989)

In re Google LLC, 949 F.3d 1338 (Fed. Cir. 2020)

In re Lehman Bros. Mortg.-Backed Sec. Litig., 650 F.3d 167 (2d Cir. 2011)

In Re v. Loewer’s Gambrinus Brewery Co. v. Loewer Realty Co., 167 F.2d 318 (2d Cir. 1948)

In re: Teleplus World, S.D. Fla. Case No. 09-13799

In Re: TXP Corp., N.D. Tex. Case No. 09-43659

Industrial Credit Co., Inc. v. Commissioner, T.C. Memo. 1967-75, 26 T.C.M. (CCH) 377 (1967)

InverWorld v. Commissioner, T.C. Memo. 1996-301, 71 T.C.M. (CCH) 3231 (1996)

InverWorld, Ltd. v. Commissioner, 98 T.C. 70 (1992), aff’d, 979 F.2d 868 (D.C. Cir. 1992)

Iroquois Master Fund, Ltd. v. Quantum Fuel Systems Technologies Worldwide, Inc., No. 13 Civ. 3860 (CD)(SN), 2014 WL 12776748 (S.D.N.Y. 2014)

Jackson National Life Insurance Co. v. Merrill Lynch & Co. Inc., 32 F.3d 697 (1994)

James v. United States, 366 U.S. 213 (1961)

Johnson v. Priceline.com, 711 F.3d 271 (2d Cir. 2013)

Jones Lumber Co. v. Commissioner, 404 F.2d 764 (6th Cir. 1968)

Kaltreider v. Commissioner, 28 T.C. 121 (1957), aff’d, 255 F.2d 833 (3d Cir. 1958)

Kanawha Valley Bank v. Commissioner, 4 T.C. 252 (1944)

Kemon v. Commissioner, 16 T.C. 1026 (1951)

Kim v. Commissioner, T.C. Memo. 1996-142, 71 T.C.M. (CCH) 2530 (1996)

King v. Commissioner, 89 T.C. 445 (1987)

Kronish v. Commissioner, 90 T.C. 684 (1988)

Kroy (Europe) Ltd, In Re, 70 AFTR 2d 92-6092 (D. Ariz. 1992)

Lane-Wells Co., Commissioner v., 321 U.S. 219 (1944)

LDS, Inc. v. Commissioner, T.C. Memo. 1986-293, 51 T.C.M. (CCH) 1433 (1986)

Lefebvre v. Commissioner, T.C. Memo. 1984-202, 47 T.C.M. (CCH) 1572 (1984), aff’d per curiam, 758 F.2d 1340 (9th Cir. 1985)

Lender Management, LLC v. Commissioner, T.C. Memo. 2017-246, 114 T.C.M. (CCH) 638 (2017)

Lewenhaupt v. Commissioner, 20 T.C. 151 (1953), aff’d, 221 F.2d 227 (9th Cir. 1955)

Liang v. Commissioner, 23 T.C. 1040 (1955)

Long-Term Capital Holdings v. United States, 330 F.Supp. 2d 122 (D. Conn. 2004), aff’d, 150 Fed. Appx. 40 (2d Cir. 2005)

Makric Enters., Inc. v. Commissioner, T.C. Memo 2016-44, 111 T.C.M. (CCH) 1183 (2016)

Martuccio v. Commissioner, T.C. Memo. 1992-311, 63 T.C.M. (CCH) 3082 (1992), rev’d on other grounds, 30 F.3d 743 (6th Cir. 1992)

McLaine v. Commissioner, 138 T.C. 228 (2012)

MCM Investment Management, LLC v. Commissioner, T.C. Memo. 2019-158, 118 T.C.M. (CCH) 437 (2019)

Merritt v. Commissioner, 47 T.C. 519 (1967), aff’d, 400 F.2d 417 (5th Cir. 1968)

Metropolitan Mortgage Fund, Inc. v. Commissioner, 62 T.C. 110 (1974)

Meyer v. Holley, 537 U.S. 280 (2003)

Michael v. Commissioner, 22 B.T.A. 639 (1931), aff’d. per curiam, 75 F.2d 966 (2d Cir. 1935)

Miller v. Commissioner, 70 T.C. 448 (1978)

Miller v. Commissioner, T.C. Memo. 1989-153, 57 T.C.M. (CCH) 46 (1989), aff’d, 900 F.2d 269 (6th Cir. 1990)

Morgan Pacifie Corp. v. Commissioner, T.C. Memo. 1995-418, 70 T.C.M. (CCH) 540 (1995)

National Can Corp. v. United States, 687 F.2d 1107 (7th Cir. 1982)

National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949)

New York Guangdong Finance, Inc. v. Commissioner, 588 F.3d 889 (5th Cir. 2009)

Newman v. Commissioner, T.C. Memo. 1989-63, 56 T.C.M. (CCH) 1232 (1989)

Northern Indiana Public Service Co. v. Commissioner, 101 T.C. 294 (1993)

Owens v. Commissioner, T.C. Memo. 2017-157, 114 T.C.M. (CCH) 188 (2017)

Paxman v. Commissioner, 50 T.C. 567 (1968), aff’d, 414 F.2d 265 (10th Cir. 1969)

Petersen v. Commissioner, 148 T.C. 463 (2017)

Petty v. Commissioner, 77 T.C. 482 (1981)

Phillips v. Commissioner, 114 T.C. 115 (2000)

Piarulle v. Commissioner, 80 T.C. 1035 (1983)

Pinchot v. Commissioner, 113 F.2d 718 (2d Cir. 1940)

Plante v. Commissioner, 168 F.3d 1279 (11th Cir. 1999)

Porter v. Commissioner, 130 T.C. 115 (2008)

Republic Supply Co. v. Commissioner, 66 T.C. 446 (1976)

Rhodes v. Commissioner, 100 F.2d 966 (6th Cir. 1939)

Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. 533 (2000)

Robinette v. Commissioner, 123 T.C 85 (2004), rev’d, Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006)

Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006)

Robson v. Commissioner, T.C. Memo. 2000-201, 79 T.C.M. (CCH) 2225, 2000 WL 863543

Roth Steel Tube Co. v. Commissioner, 800 F.2d 625 (6th Cir. 1986)

Schiff v. United States, 942 F.2d 348 (6th Cir. 1991)

Schmitz v. Commissioner, 51 T.C. 306 (1968), aff’d sub nom., Throndson v. Commissioner, 457 F.2d 1022 (9th Cir. 1972)

Schuster v. Commissioner, 84 T.C. 764 (1985)

Scriptomatic, Inc. v. United States, 397 F. Supp. 753 (E.D. Pa. 1975), aff’d, 555 F.2d 364 (3rd Cir. 1977)

Scriptomatic, Inc. v. United States, 555 F.2d 364 (3d Cir. 1977), aff’ing 397 F.Supp. 753 (E.D. Pa. 1975)

Segel v. Commissioner, 89 T.C. 816 (1987)

Serot v. Commissioner, T.C. Memo. 1994-532, 68 T.C.M. (CCH) 1015 (1994)

Sherwood Memorial Gardens v. Commissioner, 42 T.C. 211 (1964)

S-K Liquidating, 64 T.C. 713 (1975)

Smith v. Dunn, 224 F.2d 353 (5th Cir. 1955)

Smithfield Co. v. Commissioner, 1942 WL 9253 (BTA 1942)

Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934)

Square D Co. v. Commissioner, 121 T.C. 168 (2003)

Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013)

Sunnen, Commissioner v., 333 U.S. 591 (1948)

Taisei Fire & Marine Ins. Co. v. Commissioner, 104 T.C. 535 (1995)

Taiyo Hawaii, Ltd. v. Commissioner, 108 T.C. 590 (1997)

Tallal v. Commissioner, 77 T.C. 1291 (1981), aff’d, 778 F.2d 275 (5th Cir. 1985)

Tharp v. Commissioner, T.C. Memo. 1972-10, 31 T.C.M. (CCH) 22 (1972)

Trans-Atlantic Co. v. Commissioner, 469 F.2d 1189 (3d Cir. 1972)

Tseytin v. Commissioner, T.C Memo 2015-247, 110 T.C.M. (CCH) 617 (2015), aff’d in part, remanded in part, 698 F. App’x 720 (3rd Cir. 2017)

Tucker v. Commissioner, 841 F.3d 1241 (11th Cir. 2016)

Ullman v. Commissioner, 264 F.2d 305 (2d Cir. 1959), aff’g. 29 T.C. 129 (1957)

United Dairy Farmers, Inc. v. United States, 267 F.3d 510 (6th Cir. 2001)

Van Camp & Bennion v. United States, 251 F.2d 862 (9th Cir. 2001)

Van Der AA Investments, Inc. v. Commissioner, 125 T.C. 1 (2005)

Venture Funding Ltd. v. Commissioner, 110 T.C. 236 (1998), aff’d, 198 F.3d 248 (6th Cir. 1999)

Voss v. United States, 329 F.2d 164 (7th Cir. 1964)

Wagner Electric Corp. v. United States, 36 AFTR 2d 75-5898, (Ct. Cl. 1975)

Walk-in Medical Centers, Inc. v. Breuer Capital Corp., 651 F. Supp. 1009 (S.D. N.Y. 1986)

Welch v. Solomon, 99 F.2d 41 (9th Cir. 1938)

Whipple v. Commissioner, 301 F.2d 108 (5th Cir. 1962), vacated and remanded on other issue, 373 U.S. 193 (1963)

Whipple v. Commissioner, 373 U.S. 193 (1963)

Whipple v. Commissioner, T.C. Memo. 1960-36, 19 T.C.M. (CCH) 187 (1960), aff’d, 301 F.2d 108 (5th Cir. 1962), vacated and remanded on other issue, 373 U.S. 193 (1963)

Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158 (1946), aff’d, 162 F.2d 513 (10th Cir. 1947)

Williams v. Commissioner, 123 T.C. 144 (2004)

Wilshire & W. Sandwiches, Inc. v. Commissioner, 175 F.2d 718 (9th Cir. 1949)

Wood, United States v., 943 F.2d 1048 (9th Cir. 1991)

Wyche v. United States, 36 AFTR 2d 75-5816 (Ct. Cl. 1974)

YA Global Investments, LP v. Commissioner, 151 T.C. 11 (2018)

YA Global Investments, LP v. McKenzie Bay International Ltd., 2010 WL 398379 (D. N.J. 2010)

Code Sections

I.R.C. § 56

I.R.C. § 56(d)

I.R.C. § 163(1)

I.R.C. § 163(1)(1)

I.R.C. § 163(1)(2)

I.R.C. § 163(1)(3)

I.R.C. § 165

I.R.C. § 165(a)

I.R.C. § 166

I.R.C. § 171(b)(1)

I.R.C. § 172

I.R.C. § 211(b) (1939)

I.R.C. § 249(a)

I.R.C. § 267(a)

I.R.C. § 351

I.R.C. § 385

I.R.C. § 385(c)

I.R.C. § 385(c)(1)

I.R.C. § 385(c)(2)

I.R.C. § 386(c)(2)

I.R.C. § 475

I.R.C. § 475(b)(1)

I.R.C. § 475(b)(1)(A)

I.R.C. § 475(b)(1)(B)

I.R.C. § 475(b)(1)(C)

I.R.C. § 475(b)(2)

I.R.C. § 475(c)(1)

I.R.C. § 475(c)(1)(A)

I.R.C. § 475(c)(1)(B)

I.R.C. § 475(c)(2)(A)

I.R.C. § 475(c)(2)(C)

I.R.C. § 475(c)(2)(E)

I.R.C. § 704

I.R.C. § 861(a)(3)

I.R.C. § 862(a)(3)

I.R.C. § 864

I.R.C. § 864(b)

I.R.C. § 864(b)(2)

I.R.C. § 864(b)(2)(A)(i)

I.R.C. § 864(b)(2)(A)(ii)

I.R.C. § 864(c)

I.R.C. § 864(c)(4)(B)

I.R.C. § 875

I.R.C. § 875(1)

I.R.C. § 881

I.R.C. § 881(c)

I.R.C. § 882

I.R.C. § 882(c)

I.R.C. § 882(c)(2)

I.R.C. § 884

I.R.C. § 1221

I.R.C. § 1221(a)(1)

I.R.C. § 1221(a)(4)

I.R.C. § 1234(b)

I.R.C. § 1234(b)(3)

I.R.C. § 1236

I.R.C. § 1236(a)(1)

I.R.C. § 1256(e)(2)

I.R.C. § 1446

I.R.C. § 1446(a)

I.R.C. § 1446(c)

I.R.C. § 1446(d)

I.R.C. § 1461

I.R.C. § 1463

I.R.C. § 1464

I.R.C. § 6015

I.R.C. § 6212(c)

I.R.C. § 6229

I.R.C. § 6229(a)

I.R.C. § 6229(b)

I.R.C. § 6231(a)(2)

I.R.C. § 6330

I.R.C. § 6330(d)

I.R.C. § 6501

I.R.C. § 6501(a)

I.R.C. § 6501(c)(3)

I.R.C. § 6501(c)(4)

I.R.C. § 6629

I.R.C. § 6630

I.R.C. § 6651(a)(1)

I.R.C. § 6651(a)(2)

I.R.C. § 7482

I.R.C. § 7482(b)(1)(E)

I.R.C. § 7701(a)(1)

Regulations

Treas. Reg. § 1.165-1(b)

Treas. Reg. § 1.165-1(d)(2)(i)

Treas. Reg. § 1.171-1(e)(1)(iii)

Treas. Reg. § 1.446-1(c)(1)(ii)

Treas. Reg. § 1.451-1(a)

Treas. Reg. § 1.475(b)-2

Treas. Reg. § 1.864-2(c)(1)

Treas. Reg. § 1.864-2(c)(2)(iv)(a)

Treas. Reg. § 1.864-2(c)(2)(iv)(b)(1)

Treas. Reg. § 1.864-3(a)

Treas. Reg. § 1.864-4(c)(5)(ii)

Treas. Reg. § 1.864-7

Treas. Reg. § 1.864-7(d)(3)(i)

Treas. Reg. § 1.864-7(d)(3)(ii)

Treas. Reg. § 1.864-7(d)(3)(iii)

Treas. Reg. § 1.882-4

Treas. Reg. § 1.882-4(a)

Treas. Reg. § 1.882-4(a)(3)

Treas. Reg. § 1.882-4(a)(3)(i)

Treas. Reg. § 1.882-4(a)(3)(ii)

Treas. Reg. § 1.882-4(a)(3)(ii)(A)

Treas. Reg. § 1.882-4(a)(3)(ii)(D)

Treas. Reg. § 1.882-4(a)(3)(iii)

Treas. Reg. § 1.882-4(a)(3)(vi)

Treas. Reg. § 1.882-4(c)(3)

Treas. Reg. § 1.1221-2(f)

Treas. Reg. § 1.1272-1(e)

Treas. Reg. § 1.1273-2(g)(2)

Treas. Reg. § 1.1273-20)

Treas.Reg. § 1.1275-4

Treas. Reg. § 1.1275-4(a)(4)

Treas. Reg. § 1.1446-3(e)

Treas. Reg. § 1.1446-3(e)(1)

Treas. Reg. § 1.1446-3(e)(2)

Treas. Reg. § 1.1446-3(e)(3)

Treas. Reg. § 1.1446-3(e)(4)

Treas. Reg. § 1.1446-3(f)

Treas. Reg. § 1.1446-6

Treas. Reg. § 1.1463-1(a)

Treas. Reg. § 1.1464-1(a)

Other Authorities

"At-the-market offering." Wikipedia, https://en.wikipedia.org/wiki/At-the-market_offering

15 U.S.C. § 77b(a)(11)

15 U.S.C. § 77k

Andrew Bloomenthal, "Market Maker." Investopedia, https://www.investopedia.eom/terms/m/marketmaker.asp (updated Mar 1, 2021)

Bittker & Eustice: Federal Income Taxation of Corporations & Shareholders (WG&L)

Black’s Law Dictionary (7th ed.1999)

Black’s Law Dictionary Free Online Legal Dictionary 2d ed. (found at https://thelawdictionary.org/receivable/viewed on February 22, 2021)

Cayman Islands Exempted Limited Partnership Law (2007 Revision) Cayman Islands Partnership Law (2002 Revision), § 6

Chief Counsel Advice 201501013, 2015 WL 44392

Del. Code Ann. tit. 6 § 15-301(a)

Del. Code Ann. tit. 6 § 17-403(a)

Del. Code Ann. tit. 6 § 17-403(c)

E. Johnson, M. Blankenship, B. Smolij, & J. Niedzwiecki (Winston & Strawn LLP), "Market Trends 2019/20: Follow-On Offerings," Lexis Practice Advisor® Practice Note, https://www.winston.com/images/content/2/0/v2/202821/Market-Trends-201920-Follow-On-Offerings.pdf

Fed. R. Evid. 802

Foerster, Bennett & Posner, Capital Markets Handbook (6th ed. 2021 Supp.)

H.R. Rep. No. 105-220 (1997) (Conf. Rep.)

H.R. Rep. No. 89-1450 (1966), as reprinted in 1966-2 C.B. 965

Investment Company Act of 1940, 15 U.S.C. § 80a

IRM 31.1.1.2(1)

IRM 31.1.1.2(2)

IRM 4.31.2 (06-20-2013)

IRM 4.31.2 (10-01-2010)

IRM 4.31.2.2.17.2

IRM 4.46.6.11 (12-29-2009)

IRM 4.46.6.9 (12-26-2019)

Joshua Lerner, Ann Leamon, & Felda Hardymon, "Venture Capital, Private Equity, and the Financing of Entrepreneurship" (4th ed. 2011)

Julia Kagan, "Cancellation of Debt (COD)." Investopedia, https://www.investopedia.com/terms/c/cancellation-of-debt.asp (updated Mar 16, 2021)

Julia Kagan, "Secondary Offering," Investopedia (updated Dec. 28, 2020), https://www.investopedia.com/terms/s/secondaryoffering.asp

Keyes: Federal Taxation of Financial Instruments & Transactions (WG&L)

Louis Loss et al., Securities Regulation 163-64 (2d ed. 1961.)

Michael Rave (Day Pitney LLP), "Understanding At-the-Market Offerings" (2016), Lexis Practical Advisor, https://www.lexisnexis.com/lexis-practical-guidance/the-journal/b/pa/posts/understanding-at-the-market-offerings

Notice 94-47, 1994-1 C.B. 537

Restatement (Second) of Agency (1958)

Restatement (Third) of Agency (2006)

Rev. Proc. 94-29, 1994-1 CB 616

Rev. Rul. 2004-58, 2004-1 C.B. 1043

Rev. Rul. 2007-32, 2007-1 C.B. 1278

Rev. Rul. 69-91, 1969-1 CB 106

Rev. Rul. 70-540, 1970-2 C.B. 101

Rev. Rul. 72-265, 1972-1 C.B. 222

Rev. Rul. 78-182, 1978-1 C.B. 265

Rev. Rul. 80-361, 1980-2 C.B. 165

Rev. Rul. 81-160, 1981-1 C.B. 313

Rev. Rul. 83-98, 1983-2 C.B. 40

Rev. Rul. 85-119, 1985-2 C.B. 60

Rev. Rul. 97-39, 1997-2 C.B. 62

Securities Act of 1933, 15 U.S.C. § 77e

T.C. Rule 142

T.C. Rule 142(a)

T.C. Rule 151

T.D. 8322, 1990-2 C.B. 172

Thomas Lee Hazen, Law of Securities Regulation (2020)

Thomas Lee Hazen, Law of Securities Regulation (6th ed. 2011)

W. Plumb, Jr.,

Weygandt et al., Accounting Principles (3d ed.1993)

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UNITED STATES TAX COURT

UNITED STATES TAX COURT YA GLOBAL INVESTMENTS, LP
F/K/A CORNELL CAPITAL PARTNERS, LP, ET AL.,
Petitioners,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

Docket Nos. 14546-15, 28751-15

Filed Electronically

Judge Halpern

REPLY BRIEF FOR RESPONDENT

PRELIMINARY STATEMENT

This brief ("Reply") responds to Petitioners’ Brief ("Petitioners’ Brief’ or "Pet’rs Brief") in this case.¹ Reply briefs are due to the Court on or before March 22, 2021.

RESPONDENT’S RESPONSE TO PETITIONERS’ "STATEMENT OF THE CASE" (PETITIONERS’ BRIEF pp. 26-42)

At pages 26-42 of their Brief, petitioners include a section entitled "Statement of the Case." This section encompasses petitioners’ statement of "Issues Presented" (pp. 26-31), "Background" (pp. 31-33), and "Summary of Argument" (pp. 34-42).

Consistent with Rule 151 of the Tax Court’s Rules of Practice and Procedure, respondent identified the "issues to be decided" at pages 4 to 6 of Respondent’s Brief and provided a statement of the points on which he relied at pages 198 through 203.

Petitioners’ "Background" and "Summary of Argument" sections appear to summarize their view of the facts, which presumably is reflected in their "Proposed Findings of Fact," and their arguments. Respondent address petitioners’ findings in "Respondent’s Objections to Petitioners’ Proposed Findings of Fact" (pp. 3-269). Respondent addresses petitioners’ "Summary of Argument" throughout his "Argument" beginning on page 270 of this Reply.

RESPONDENT’S OBJECTIONS TO PETITIONERS’ PROPOSED FINDINGS OF FACT

Respondent asks that the Court adopt Respondent’s Request for Findings of Fact ("RPFF") and Ultimate Findings of Fact ("RPUFF") as set forth in Respondent’s Brief.

Respondent objects² to petitioners’ Proposed Findings of Fact ("Pet’rs’ PFF") and proposed Ultimate Findings of Fact ("Pet’rs’ PUFF") as follows:

General Objection No. 1

Throughout their proposed findings, petitioners repeatedly propose findings of fact that cite to exhibits and testimony containing the terms "invest," "investor," and "investment." Petitioners’ obvious objective is to convey that these labels as used in the trial record are meaningful and relevant to issues before the Court and probative of material facts in dispute. That is incorrect.

This case requires that the Court interpret what actually occurred in substance in the transactions in which YA Global engaged and determine whether YA Global was engaged in the conduct of a trade or business in the context of section 864(b) of the Internal Revenue Code (the "Code").³ The terms "invest," "investor," and "investment," as used in the documents and testimony petitioners cite, are not helpful to the Court’s task.

For federal income tax purposes, and specifically for purposes of determining whether a taxpayer is engaged in the conduct of a trade or business in the context of section 864(b), the terms "invest," "investor," and "investment" have narrow and specific definitions. To "invest" means to purchase and hold stock and securities for capital appreciation and income. Groetzinger v. Commissioner, 82 T.C 793, 801 (1984) (quoting Liang v. Commissioner, 23 T.C. 1040, 1043 (1955)). An "investor" "makes purchases for capital appreciation, usually without regard to short-term developments that would influence prices on the daily market." King v. Commissioner, 89 T.C. 445, 459 (1987) (citing Groetzinger v. Commissioner, 82 T.C 793, 801 (1984) and Liang v. Commissioner, 23 T.C. 1040, 1043 (1955)). An "investment" refers to the acquisition of property to hold for capital appreciation and income and not primarily for sale. See I.R.C. § 1221. These narrow meanings are not necessarily, and typically are not, what is meant when the terms are employed by others than tax specialists, outside the specialized realm of section 864(b).

Outside of the federal income tax and section 864(b) context, these terms are used in a broader, less exacting sense. Respondent’s hedge fund expert, Leon Metzger noted the differences between the way the terms "invest," "investor," and "investment" are used for federal income tax purposes and the way they are used in general hedge fund parlance. (Ex. 2003-R at pp. 4-5.) Petitioners’ expert in finance, David Stowell explained that, in the finance industry, the term "investor" is understood to broadly cover any person who puts its capital at risk. (Tr. 1824:7-11, 1829:6-25.) For example, a fund that makes loans, i.e. a lender, would be referred to as an "investor." (Tr. 1829:15-25.) This is also the sense in which Jay Wright, the Chief Executive Officer of one of YA Global’s clients, used the term. (See Tr. 728:19-23 (stating that a bank is a "debt investor").)

Petitioners have not established, nor even claimed, that the terms "invest," "investor," and "investment," each time as they appear in the record through the exhibits or testimony pointed to by Petitioners, were being employed by persons educated in their specialized meaning for purposes of federal tax law or qualified to use them authoritatively, correctly and purposefully in that context as evidence of legal conclusions the Court should draw. The authors or speakers used the words in ordinary layman’s parlance or as used in fields other than the instant tax law context. Even if that were not the case, the opinions of the writers or speakers cannot supplant the Court’s judgment. Whether the actions, persons, or events referred to actually constitute "investing," "investors," or "investments" for purposes of section 864(b) is for the Court to determine, without regard to the labels applied by these others.

The labels to which petitioners cite thus should not be afforded particular weight or significance as Petitioners’ plainly appear to seek. Respondent objects to all of petitioners’ proposed findings that cite to evidence containing these terms and asks the Court to reject those proposed findings as misleading, argumentative, and not probative of any issues in this case.

General Objection No. 2

Throughout their proposed findings, petitioners refer to "funds" or other language indicating that Yorkville Advisors operated more than one fund during the years at issue. This is incorrect and misleading. Further, by using a generic term to describe YA Global and the other funds, petitioners imply that all of the funds were equally viable and significant and entirely unrelated. This too is incorrect and misleading. Respondent, therefore, objects to petitioners’ repeated use of the term "funds" and other similar language.

In late 2004, Mr. Angelo and Yorkville Advisors started Highgate House Funds, Ltd. ("HHF"), Montgomery Equity Partners, Ltd. ("MEP"), and Cornell Rx Funds, Ltd. ("CRX"). (RPFF ¶¶ 498, 501; Pet’rs PFF ¶¶ 30, 32.) Although CRX was formed in December 2004, it did not actually commence operations until March 1, 2005. (Ex. 1294-P at p. 007.) These funds were short lived, each operating separately for approximately 18 months. HHF and MEP were merged into YA Global in May 2006 and July 2006, respectively, (RPFF ¶¶ 514-515; Pet’rs’ PFF 36), and CRX was terminated in 2006 (RPFF ¶ 512; Pet’rs’ PFF ¶ 35). Further, HHF, MEP, and CRX were significantly smaller and less active than YA Global. (Ex. 204-J at p. 001 (showing YA Global’s having approximately $400 million in assets under management); Ex. 305-J (showing HHF’s having approximately $40 million in assets under management); Ex. 310-J (showing MEP’s having approximately $40 million in assets under management). HHF, MEP, and CRX did not generate significant income per their financial statements for 2005 (RPFF ¶ 505) or generate significant fee income for Yorkville Advisors (RPFF ¶ 510). Virtually of all of Yorkville Advisors’ fee income was derived from transactions involving YA Global in 2006 through 2008. (RPFF ¶ 510-511.)

Yorkville Advisors started YA Global Investments II, LP in 2009 but, for all intents and purposes, YA Global Investments II was not a separate, independent fund. YA Global and YA Global II participated in the same transactions. (RPFF ¶ 516.)

In essence, YA Global was the only fund operated by Yorkville Advisors during the years at issue.

General Objection No. 3

The testimony of Yorkville Advisors’ employees was often self-serving and contradicted by other evidence. Consequently, petitioners’ proposed findings that rely on the testimony of these individuals should be reviewed with heightened scrutiny and either rejected entirely or given limited weight.

At various times, Mr. Angelo took positions in his testimony that were inconsistent with other statements he made or YA Global’s published materials, which were generally reviewed by him and/or other executives. For example, Mr. Angelo professed that YA Global held stock for long periods for a variety of reasons (Tr. 137:9-13) but admitted that YA Global would only convert a convertible debt to equity, or exercise a warrant, to sell immediately the acquired stock. (Tr. 108:5-11.) At trial, Mr. Angelo denied the similarities between SEDAs and ATMs. (Tr. 232-33.) But, in at least one quarterly letter to investors, he wrote that ATMs "are effectively similar to Yorkville’s SEDA." (Ex. 254-J at p. 006.) Also at trial, Mr. Angelo categorically denied providing services to the companies to which YA Global provided financing (Tr. 96:19-25) and specifically denied YA Global provided a service through the use of a SEDA (Tr. 130:11-17). Yet, in a quarterly letter to investors, he stated, "We have seen that the market for the services we provide through our SEDA structures has dramatically increased in recent months." (Ex. 254-J at p. 006 (emphasis added).) Mr. Angelo’s denial is also contrary to the information on YA Global’s webpage. (Exs. 141-R through 143-J, 146-J through 156-R.) Similarly, Mr. Angelo repeatedly decried the inaccuracy of the "SEDA FAQ," stating that the entire document "was wrong." (Tr. 129-134. E.g., Tr. 134:1.) However, a comparison of the SEDA FAQ with other evidence shows the SEDA FAQ to be accurate in all essential respects. (Resp’s’ objection and response to Pet’rs’ PFF ¶ 188.)

The testimony of other Yorkville Advisors’ employees involved similar credibility issues. For example, at trial, Mr. Schinik testified that YA Global relied on Valuation Resources Co. ("VRC") to value certain of its assets, including Compass Resources, for purposes of its financial statement reporting and that he understood that VRC did not value the Compass Resources convertible debentures but rather the likelihood that YA Global’s DOCA proposal would be accepted. (Tr. 581.) Despite Mr. Schinik’s alleged understanding of VRC’s valuation, however, Mr. Schinik prepared YA Global’s financial statements (which were audited by RSM McGladrey), using the values shown on the VRC reports as the values of the Compass Resources convertible debentures for 2009 and 2010.

Overview of the Relevant Entities

A. YA Global Investments, LP

1. YA Global Investments, LP (the "Fund" or "YA Global"), formerly known as Cornell Capital Partners, LP, was originally formed as a domestic limited partnership in 2001. (S. ¶ 6; Ex. 285-J, p. 13.)

No objection. However, see RPFF ¶ 1, which presents a more accurate, complete statement of fact than petitioners’ proposed finding.

2. On or about January 31, 2007, YA Global redomiciled as a Cayman Island exempted limited partnership. (See, e.g., Ex. 123-J, p. 11.)

No objection.

3. At the time the petitions were filed in these cases, YA Global’s principal place of business was in the Cayman Islands. (Dkt. Entry No. 1, Petition (June 4, 2015), ¶ 1.)

Objection: contrary to the weight of the evidence. YA Global represented in various documents that its place of business was 101 Hudson Street, Suite 3700, Jersey City, New Jersey. (RPFF ¶ 11; Exs. 144-J, 145-J; Exs. 207-J through 224-J; Exs. 243-J through 248-J.)

4. YA Global did not have any employees or physical office. (Ex. 1-J, p.4 (showing no wages or rents paid); Ex. 2-J, p. 1 (same); Ex. 3-J, p. 1 (same); Ex. 4, p. 1 (same); Ex. 5-J, p. 1 (same); Ex. 6-J, p. 3 (same); Entire Record.)

Objection: incomplete, misleading, contrary to the weight of the evidence. Technically, YA Global did not have employees However, like other hedge funds, YA Global’s general partner or manager employed individuals to act of YA Global’s behalf. (RPFF ¶ 75.) Typically, a hedge fund’s general partner or manager employs employees, leases office space, pays expenses, and hires independent third-party service providers, such as brokers, legal counsel, auditors, and administrators on behalf of the fund. (RPFF ¶ 681.) For a more complete and accurate statement of facts regarding YA Global’s employees, see RPFF ¶¶ 75-92. With respect to the "physical office," see Resp’s Obj. to Pet’rs’ PFF ¶ 3.

B. The Feeder Funds

5. Prior to redomiciling in 2007, YA Global was structured as a so-called "mini-master." Under this structure, YA Global was the master fund, and it had an offshore feeder fund, YA Offshore Global Investments, Ltd (known as Cornell Capital Partners Offshore, Ltd in 2006) ("YA Offshore"). (See, e.g., Ex. 30-J (YAREL0000012061); Ex. 101-J, p. 12.)

Objection: vague, not supported by the record, immaterial, irrelevant. The term "mini-master" is not defined, and nothing in the record explains the meaning of this term. Neither Exhibit 30 or Exhibit 101-J supports that YA Global used the "mini-master" structure since inception. Because YA Offshore was not incorporated until June 1, 2003 (RPFF ¶ 7), YA Global could not have been structured as a "mini-master," however that term is defined, with YA Global and YA Offshore from inception in January 2001 through June 1, 2003. For a more accurate and complete statement of facts, see RPFF ¶¶ 1 through 8.

6. After redomiciling in 2007, YA Global continued as the master fund with YA Offshore as the offshore feeder. A new fund, YA Global Investments (U.S.), LP ("YA Onshore"), became a domestic feeder. (See, e.g., Ex. 287-J, p. 16.; Ex. 288-J, p. 19; Ex. 289-J, p. 18, Ex. 290-J, p. 14; Ex. 291-J, p. 14.)

No objection.

7. YA Offshore had no employees and did not carry on any active business activities in the United States or anywhere in the world. (Ex. 297-J, p. 4 (not showing payroll among expenses); Ex. 298-J, p. 4 (same); Ex. 299-J, p. 5 (same); 300-J, p. 4 (same); Ex. 301-J, p. 3 (same); Ex. 302-J, p. 5 (same); 303-J, p. 6 (same).)

Objection: inaccurate, misleading, contrary to the weight of the evidence. The directors of YA Offshore have primary responsibility for managing YA Offshore. (Ex. 99-J at p. 0016.) The record does not reflect to what extent the directors were considered "employees" of YA Offshore. YA Offshore’s directors delegated the primary duties relating to the implementation of YA Offshore’s investment strategy and day-to-day management of YA Offshore to Yorkville Advisors, and YA Offshore compensated Yorkville Advisors for its services. (Ex. 99-J at p. 0016-0017; Ex. 297-J at p. 5.) Yorkville Advisors employed individuals, paid expenses, and hired third-party service providers on behalf of YA Offshore. Further, to the extent that YA Global engaged in a trade or business, YA Offshore was engaged in a trade or business. I.R.C. § 875(1). The evidence demonstrates that YA Global was engaged in the trade or business of lending, underwriting, or other financial services. Consequently, YA Offshore did carry on active business activities in the United States. The pages cited by petitioners, except one (Ex. 299-J at p. 5), do not reflect income and expenses of YA Offshore. YA Offshore’s "statement of income" or "statement of operations" for each year does show payment of a management fee to Yorkville Advisors. (Ex. 297-J at p. 005; Ex. 298-J at p. 005; Ex. 300-J at p. 005; Ex. 301-J at p. 005; Ex. 302-J at p. 007; Ex. 303-J at p. 007.)

8. Both YA Onshore and YA Offshore invested substantially all their assets into the Fund. (Exs. 297-J, 298-J, 299-J, 300-J, 301-J, 302-J, 303-J; see also Ex. 99-J, p. 13; Ex. 100-J, p. 13; Ex. 104-J, p. 11; Ex. 111-J, p. 11; Ex. 123-J, p. 3; Ex. 125-J, p. 2; Ex. 129-J, p. 2; Ex. 130-J, p. 2.)

Objection: immaterial, irrelevant. Whether YA Onshore or YA Offshore invested substantially all of its assets in YA Global does not have any tendency to prove or disprove any legal element of the case and does not have any probative value to make any such legal element of the case more or less likely.

9. As is typical with master-feeder structures, U.S. investors generally invested in YA Global through limited partnership interests in YA Onshore (which was classified as a partnership for U.S. tax purposes) (Ex. 2003-R, pp. 7-8), and non-U.S. investors and U.S. tax-exempt investors generally invested in YA Global through investments in YA Offshore (which was classified as a corporation for U.S. tax purposes) (Ex. 2003-R, p. 7). (See also S. ¶ 12.)

No objection.

C. The General Partner

10. Yorkville Advisors, LLC ("Yorkville") was formed in 2001 and was YA Global’s general partner from the Fund’s inception until January 14, 2007. (S. ¶ 7.)

No objection. However, see RPFF ¶¶ 2, 12, which presents a more accurate, complete statement of facts than petitioners’ proposed finding.

11. Effective January 15, 2007, Yorkville Advisors GP, LLC ("Yorkville GP") became the general partner for YA Global. (S. ¶ 9; Ex. 1320-J, p. 3, § 2.1; Tr. 52:13-53:3.)

No objection, except to the extent the finding is not supported by the evidence cited. See RPFF ¶ 5. Ex. 1320-J at section 2.1 does not support any part of this finding. The transcript reference does not support a finding that Yorkville GP became the general partner of YA Global effective January 15, 2007.

12. Throughout the years at issue, Yorkville and Yorkville GP were owned and managed by the same four individuals, Mark Angelo, Matthew Beckman, Jerry Eicke, and David Gonzalez (the "Yorkville Principals"). (Ex. 30-J (YAREL0000012064), p. 14; Ex. 97, p. 14; Ex. 114-J, p. 31; Ex. 119-J, p. 12; Ex. 122-J, p. 12; Ex. 123-J, p. 13; Ex. 125-J, p. 12; Ex. 129-J, p. 12; Ex. 130-J, p. 13; Ex. 1292-J, p. 15.)

Objection: incomplete, misleading. This finding is incomplete in its failure to note that Mark Angelo founded YA Global and Yorkville Advisors (RPFF ¶¶ 1, 12), held a 70% interest in Yorkville Advisors and Yorkville GP for the majority of the years at issue (RPFF ¶¶ 13, 22), and served as Yorkville Advisors’ president (RPFF ¶ 17). For a more accurate and complete statement of facts, see RPFF 12-17, 20-23.

13. The Yorkville Principals also served as Directors of YA Offshore. (See, e.g., Ex. 99-J, pp. 16-17; Ex. 100-J, pp. 16-17; Ex. 104-J, pp. 12-13; Ex. 111-J, pp. 12-13.)

No objection.

14. The Fund’s general partner, whether Yorkville or Yorkville GP, had broad power to perform all acts and carry out all purposes for the Fund. (Ex. 24-J, §§ 2.1, 2.2; Ex. 25-J, §§ 2.1, 2.2.)

No objection. However, RPFF 25-30 present a more accurate and complete statement of the facts than that in this finding.

15. Rather than manage the Fund directly, the Fund’s general partner could cause the Fund to contract with any investment manager for the management of any or all aspects of the Fund and its affairs. (Ex. 24-J, § 2.1; Ex. 25-J, § 2.1.)

Objection: imprecise, misleading. See General Objection No. 1 regarding use of the term "investment." The language cited by petitioners states that the general partner may cause YA Global "to contract with any other person . . . for management of any or all aspects of [YA Global] and its business." (Ex. 24-J at § 2.1; Ex. 25-J at § 2.1.) RPFF ¶¶ 25-30 present a more accurate and complete statement of the facts than that in this finding.

16. The Fund’s general partner did, in fact, delegate its duties relating to the implementation of YA Global’s investment strategies and day-to-day administration to an investment manager throughout the period in issue. (Ex. 23-J, § 2.1; Ex. 24-J, § 2.1; Ex. 25-J, § 2.1; Ex. 27-J; Ex. 28-J; see also Ex. 30-J (YAREL0000012081); Ex. 97-J, p.31.; Ex. 122-J, p. 31; Ex. 123-J, p. 32; Ex. 125-J, p. 30; Ex. 129-J, p. 30; Ex. 130-J, p. 31.)

Objection: vague, inaccurate, contradicted by other evidence, not supported by evidence cited, misleading. See General Objection No. 1 regarding use of the term "investment." See Resp’s Obj. to Pet’rs’ PFF ¶ 15. Petitioners have not provided a definition of "day-to-day administration" and "investment manager" for the purposes of this finding. It is unclear from this finding whether petitioners are proposing that "the implementation of YA Global’s investment strategies and day-to-day administration" were delegated to the same person and whether petitioners are proposing that these duties were delegated to the same person for the entire period at issue. YA Global engaged an administrator, SEI Global Services, Inc., not an "investment manager," to perform administrative duties. (Ex. 30-J at YAREL0000012065; Exs. 1329-J through 1332-J.) Further, section 2.1 of Exhibits 23-J through 25-J do not support a finding that YA Global’s general partner did, in fact, delegate the duties to a manager. For a more accurate and complete statement of the facts, see RPFF ¶¶ 35-37.

17. The general partner’s only activity was to sign legal documents, as necessary, for the Fund. (See Tr. 104:2-12.)

Objection: incorrect, misleading, not supported by the record. The transcript citation does not support this finding. Moreover, the finding is not accurate. Throughout the Relevant Period, the management of YA Global was vested exclusively in its sole general partner (successively, Yorkville Advisors and Yorkville GP). (RPFF ¶¶ 25, 28.) In addition to signing legal documents, YA Global’s general partner hired a manager and an administrator. (RPFF ¶¶ 35-37; Exs. 1329-J through 1332-J.) YA Global’s general partners represented YA Global during the examination and served as YA Global’s TMP. (1st Stip. ¶¶ 8, 9; e.g., [citations to 872-Ps and 872s].) The owners of the general partners reviewed documents as well. (Tr. 1349:7-13; 1350:6-8, 12-25.) Moreover, the interests of YA Global’s general partner and manager were at all times aligned, and the activities performed by YA Global’s general partner and those performed by YA Global’s manager were effectively indistinguishable. During 2006, Yorkville Advisors served as the general partner and manager simultaneously. The activities performed by Yorkville Advisors as general partner and those performed by Yorkville Advisors as manager are not separable. Also, the same individuals, Messrs. Angelo, Beckman, Eicke, and Gonzalez, owned both Yorkville Advisors and Yorkville GP and approximately in the same percentages. (RPFF ¶¶ 15, 21.) Any activities performed by Messrs. Angelo, Beckman, Eicke, and Gonzalez were just as easily attributable to Yorkville GP, as the general partner, as they were to Yorkville Advisors, as the manager. Mr. Angelo controlled both Yorkville Advisors and Yorkville GP, as well as YA Global. (RPFF ¶¶ 13, 14, 23.) Even Mr. Angelo could not keep track of which entity did what. (RPFF ¶ 454.) All three entities, YA Global, Yorkville Advisors, and Yorkville GP used the same office space at 101 Hudson Street office. (RPFF ¶¶ 11, 18, 24.). Neither of the general partners was independent of YA Global, nor of the Investment Manager (RPFF ¶ 2, 5, 19, 20, 21, 22, 24, 25, 28, 35, 36.)

D. The Investment Managers

18. Yorkville Advisors Management, LLC ("YAM") was retained to be the YA Global’s investment manager from June 1, 2002. (Ex. 27-J (Preamble).)

Objection: incomplete, misleading. This finding appears to be missing language at the end. Also, this finding does not adequately describe the relationship among YA Global, Yorkville Advisors, and Yorkville Advisors Management, LLC ("YAM"). On June 1, 2002, Yorkville Advisors, as YA Global’s general partner, caused YA Global to hire YAM, Yorkville Advisors’ affiliate, as YA Global’s manager. (RPFF ¶ 35.) For a more accurate and complete statement of facts, see RPFF ¶¶ 35-37.

19. As of December 1, 2005, Yorkville became the Fund’s co-investment manager with YAM, with the idea that YAM would eventually be merged into Yorkville so that Yorkville would become the sole investment manager. (Ex. 27-J; see also Ex. 30, p. 31; Ex. 97-J, p. 14.)

Objection: incomplete, incomplete, contrary to the weight of the evidence. After Yorkville Advisors, as YA Global’s general partner, caused YA Global to hire Yorkville Advisors as its manager, Yorkville Advisors was the sole manager. Nothing in the record indicates that YAM performed any duties for YA Global after December 1, 2005. (RPFF ¶ 37.) For a more accurate and complete statement of facts, see RPFF ¶¶ 35-37.

20. The merger of YAM into Yorkville took place on or around October 13, 2006. (S. ¶ 11; Ex. 29-J.)

No objection.

21. Yorkville acted as both the general partner and the investment manager (or co-investment manager) of the Fund from December 1, 2005, until Yorkville GP took over the general partner role on January 15, 2007. (Ex. 30-J; Ex. 97-J, p. 14.; Ex. 122-J, p. 12.)

No objection.

22. This overlap between the general partner and the investment manager is not uncommon in the hedge fund industry. (Ex. 2003-R, p. 6.)

No objection.

23. In addition to acting as investment manager for YA Global, Yorkville was also retained to manage YA Offshore and its investments. (See, e.g., Ex. 99-J, pp. 16-17; Ex. 100-J, pp. 16-17; Ex. 104-J, pp. 12-13; Ex. 111-J, pp. 12-13.)

No objection.

II. Yorkville’s Business

A. Background and Structure

24. Yorkville was in the business of providing investment management services and managing investment funds during the years at issue. (Tr. 84:23-85:5; 89:25-90:7; 596:1-597:8; see also Tr. 972:10-973:4.)

Objection: incomplete, misleading, contrary to the weight of the evidence. See General Objection No. 1 relating to use of the term "investment." For a more accurate and complete description of Yorkville Advisors’ business and relationship to YA Global, see RPFF ¶¶ 507-11.

25. Yorkville was headquartered in Jersey City, New Jersey. (See, e.g., Ex. 30, p. 7; Ex. 97, p. 7; Ex. 122 p. 6; Ex. 123, p. 7; Ex. 125, p. 6; Ex. 129, p. 6; Ex. 130-J, p. 6.)

No objection.

26. Mr. Angelo founded Yorkville in 2001 and was its president from inception through the years at issue. (E.g., Ex. 114-J, p. 31; Tr. 50:6-7.)

Objection: inaccurate, incomplete. Mr. Angelo founded Yorkville Advisors on December 28, 2000. (RPFF ¶ 12.) Mr. Angelo founded Yorkville Advisors shortly before founding YA Global on January 2, 2001. (RPFF ¶ 1.) At relevant times, Mr. Angelo had sole and exclusive authority over decisions made with respect to YA Global. (RPFF ¶ 14; Ex. 114-J at p. 31 (stating, "As portfolio manager to the Fund, he is responsible for overseeing all aspects of the Fund’s day-to-day operations from; deal structuring, investment decisions, business development to trading, while continuing his emphasize on the preservation of the Fund’s capital with low volatility.").) RPFF ¶¶ 1, 2, 12, 13, and 14 present a more accurate and complete statement of facts.

27. Before starting Yorkville, Mr. Angelo worked as a securities trader (see, e.g., Ex. 114-J, p. 31) and then at the May Davis Group (see, e.g., Ex. 30-J (YAREL0000012081); Ex. 114-J, p. 31).

Objection: incomplete, misleading. Although early in his career, Mr. Angelo was a securities trader, the YA Global materials did not promote his experience as a securities trader. As the exhibits to which petitioners cite demonstrate, Mr. Angelo’s background was held out to be more in the nature of that of an investment banker, with expertise in structured financings, than as that of a securities trader. At page 31 of Exhibit 144-J as cited by petitioners, YA Global describes Mr. Angelo as follows:

. . . As an authority on structured financing products, Mark is frequently cited for commentary in industry publications and news sources.

Prior to co-founding Yorkville, Mark co-ran the Corporate Finance Division of the May Davis Group, a boutique investment bank focused on emerging growth companies. Before joining the May Davis Group, Mark was a securities trader with The Boston Group LP, a broker dealer located in New York City.

More informative, however, is the description at YAREL0000012081 of Exhibit 30-J:

Mark has specialized in the unique capital needs of small and mid-cap companies for over a decade. An authority on structured finance products, Mark is frequently cited for commentary in industry publications and news sources. Prior to co-founding Cornell Capital Partners, LP, Mark co-ran the corporate finance division of The May Davis Group, a boutique investment bank focused on emerging growth companies. With extensive transaction expertise and a broad array of relationships, Mark witnessed first hand the relative strengths and weaknesses of a variety of financing structures from both the issuer and investor perspective. These insights led Mark to consider new mechanisms for companies to acquire capital while protecting the downside of the liquidity providers and his answer-the SEDA-provided the impetus for Mark to launch the Cornell investment fund. Mark continues to work with issuers to develop creative financing solutions at all levels of the capital structure.

Mr. Angelo attempted to downplay this experience and the reasons he founded YA Global at trial. (Tr. 308:18-310:313; 314:25-316:11.)

28. When Mr. Angelo formed Yorkville, his plan was to raise a fund for investment, manage that fund, and potentially raise other investment funds and have a family of funds under Yorkville’s management. (Tr. 50:18-23.)

Objection: vague, not supported by credible evidence, contrary to the weight of the evidence. See General Objection No. 1 relating to the use of "investment." See also Resp’s Obj. to Pet’rs’ PFF ¶ 27. The proposed finding is based solely on Mr. Angelo’s self-serving testimony and is not credible. As demonstrated with the language from Exhibit 30-J quoted in response to petitioners’ proposed finding 27, Mr. Angelo formed Yorkville Advisors and YA Global to provide financing services to companies. "Cornell Capital was created . . . to address the financing needs of publicly traded companies that exhibit a clear business vision, and to turn PIPE’S [sic] into a mainstream form of financing." (Ex. 139-J. See Ex. 142-J; Exs. 146-J through 154-J (characterizing the "investments" as services).) Further, this proposed finding mischaracterizes YA Global’s trade or business as investment, rather than finance. The weight of the evidence demonstrates that YA Global was in the trade or business of finance. RPFF ¶¶ 56, 62, 63, 65, and 661 present a more accurate and complete statement of facts.

29. YA Global was the first fund that Yorkville raised and managed, starting in 2001. (See S. ¶ 6; Ex. 30-J (YAREL0000012063 (discussing formation of other funds in 2004) and YAREL0000012064 (discussing formation of Yorkville on December 28, 2000)).)

Objection: misleading, contrary to the weight of the evidence. This proposed finding implies that Yorkville Advisors was engaged in the trade or business of starting up and managing funds and that Yorkville Advisors managed numerous funds. Neither is true. See Resp’s Obj. to Pet’rs’ PFF ¶ 24. Yorkville Advisors served as manager almost exclusively for YA Global. Yorkville Advisors formed three other funds before 2006 but these funds were short-lived, small funds that were merged into YA Global or terminated in 2006. During the years at issue, virtually all of Yorkville Advisors’ activities were performed in respect of YA Global, and virtually all of Yorkville Advisors’ revenues and assets were attributable to YA Global’s activities and assets. RPFF ¶¶ 13, 14, 22, 23, 509, 510, 511 represent a more accurate and complete statement of this fact.

30. In October 2004, Yorkville formed Highgate House Funds, Ltd. ("HHF"), and Montgomery Equity Partners, Ltd. ("MEP"), both Cayman companies, for the purpose of purchasing, holding, selling and trading in securities and other financial instruments of U.S. And foreign entities. (Ex. 1301-P, p. 11; Ex. 1308-P, p. 11; Tr. 83:3-83:11; Tr. 597:9-17; see also Ex. 30-J (YAREL0000012063).)

Objection: misleading, incomplete. HHF and MEP did not simply purchase, hold, sell, and trade in securities and other financial instruments, as this proposed finding suggests. HHF’s and MEP’s transactions were similar to YA Global’s transactions in that, like YA Global, HHF and MEP sourced and directly negotiated alternative funding options for small to mid-sized publicly traded companies (as well as some private companies) and made loans evidenced by promissory notes and convertible debentures and, in the case of HHF, structured equity line commitments. (Ex. 30-J at YAREL0000012062; Ex. 204-J; Ex. 1304-P at p. 006; Ex. 1305-J; Ex. 1309-J at p. 0014; Ex. 1310-J; Tr. 85:25-86:10.) Further, this proposed finding implies that HHF and MEP were comparable to YA Global, but HHF and MEP were significantly smaller and less active than YA Global. (Ex. 204-J at p. 001 (showing YA Global’s having approximately $400 million in assets under management); Ex. 305-J (showing HHF’s having approximately $40 million in assets under management); Ex. 310-J (showing MEP’s having approximately $40 million in assets under management).) Moreover, HHF and MEP did not exist as entities or funds separate from YA Global except for a few months in 2006. (RPFF ¶.) RPFF ¶¶ 498-519 represent a more accurate and complete statement of this fact.

31. HHF and MEP had similar investment strategies, focusing on "small-cap" public companies, but also investing in private companies. (Tr. 86:3-9; Ex. 1301-P, p. 11; Ex. 1308-P, p. 11.)

Objection: misleading, incomplete. The proposed finding indicates that HHF’s strategy was similar to MEP’s strategy but does not also indicate that both HHF’s and MEP’s strategies were similar to YA Global. See Resp’s Obj. to Pet’rs’ PFF ¶ 30.

32. In December 2004, Yorkville formed Cornell Rx Funds, Ltd. ("CRX") to invest and trade in primarily U.S. and European healthcare companies. (Ex. 30-J (YAREL0000012063); Ex. 1294-P, p. 7; see also Tr. 86:1-3.)

Objection: misleading, incomplete. Although CRX was formed in December 2004, it did not actually commence operations until March 1, 2005. (Ex. 1294-P at p. 007.) The proposed finding fails to identify CRX’s specific strategy, which is markedly different from YA Global’s strategy and which makes clear the difference between the language used to describe an investment-trading strategy, such CRX’s strategy, and the language used to describe a business strategy, such as YA Global’s strategy: "[CRX’s] core investment strategy of the Fund will be to buy and sell the stock of companies that provide favorable long-term risk/reward profiles based on the underlying medical and financial fundamentals. The net exposure of the Fund will be dynamic, changing according to the opportunities that become available on the long and short side." (Ex. 195-P at p. 0011.) Further, this proposed finding implies that CRX was comparable to YA Global, but CRX was significantly smaller than YA Global and existed for less than 19 months. (Ex. 1297-J (showing CRX’s having approximately $17 million in assets under management); Exs. 1297-J at p. 7 (showing operations beginning in March 2005), 119-J (no longer identifying CRX in YA Global’s private placement memoranda as of October 2006).

33. In 2009, Yorkville’s formed YA Global Investments II, Ltd. ("YAGI II"). (Ex. 1313-J; Ex. 28-J.)

Objection: misleading, incomplete, not supported by cited evidence. By failing to identify YA Global IPs strategy, as they do for HHF, MEP, and CRX, or acknowledge the relationship between YA Global and YA Global II, petitioners imply that YA Global II was a fund dissimilar to, and independent of, YA Global. YA Global and YA Global II had identical investment strategies and participated in the same investments. (RPFF ¶.)

34. Each of YA Global, HHF, MEP, CRX and YAGI II had a portfolio manager, but all five funds were managed by Yorkville. (Tr. 84:10-16; Ex. 1301-P, p. 11; Ex. 1308-P, p. 11; see also Ex. 1299-J (CRX); Ex. 1302-J (HHF); Ex. 1312-J (MEP).)

Objection: vague, misleading, incomplete. Petitioners fail to define the terms or phrases "portfolio manager" or "managed by" or describe the distinction between having a portfolio manager and being "managed by Yorkville Advisors." Petitioners also fail to identify a time frame. The proposed finding suggests that each fund had a different portfolio manager. This is not true. Mr. Angelo was the portfolio manager or co-portfolio manager for YA Global, HHF, MEP, and YA Global II. (Exs. 204-J (YA Global), 1303-J (HHF), 1305-J (HHF), 1310-J (MEP).) CRX was led by portfolio managers Italo Apicella and David Gonzalez, an executive and principal of Yorkville Advisors. (Ex. 1298-J.) As noted, petitioners do not define the phrase "managed by" but the record shows that Italo Apicella managed CRX (Ex. 1299-J at p. 001) and Yorkville Advisors, as general partner "assist[ed] with investment oversight and compliance as well as back-office functionality." (Ex. 1297-J.)

35. CRX was wound down in 2006. (S. ¶ 129.)

Objection: vague, misleading. Petitioners do not define the term "wound down." The term "wound down" implies that Cornell Rx engaged in activities in 2006 and slowly discontinued those activities. Nothing in the record indicates that Cornell Rx engaged in any activities in 2006. (See Ex. 1314-J at pp. 20-22, 24-26, 33 (Yorkville Advisors’ reporting no income or investment in CRX).) For a more accurate statement of fact, see RPFF ¶ 512.

36. HHF and MEP were merged into YA Global in 2006. (Ex. 287-J, p. 16.)

Objection: imprecise, misleading. Petitioners fail to identify the specific time when HHF and MEP merged into YA Global, suggesting that HHF and MEP were separate from YA Global for a longer period than they were. HHF and MEP were merged into YA Global on May 1, 2006, and July 1, 2006, respectively. (RPFF ¶¶ 514-515.)

37. Yorkville provided operational and management services to the funds it managed, such as raising money, managing investor subscriptions and redemptions, and providing regular tax and accounting reports. (Tr. 596:1-9.)

Objection: misleading, contrary to the weight of the evidence. Petitioners overstate the facts by referring to "the funds [Yorkville Advisors’] managed" and imply that Yorkville Advisors had a robust corral of funds. YA Global was Yorkville Advisors’ only significant and long-running fund. HHF, MEP, and CRX were significantly smaller than YA Global and were short-lived. (RPFF ¶¶ (HHF was separate from YA Global for at most 18 months), (MEP was separate from YA Global for less than 2 years), (CRX operated for at most 19 months).

38. Yorkville also made all decisions to buy and sell securities for the funds it managed. (See, e.g., Ex. 30-J; (YAREL0000012089); Ex. 97-J, p. 39; Ex. 100-J, p. 46; Ex. 114-J, p. 38; Ex. 122-J, p. 37; Ex. 123-J, p. 38; Ex. 125-J, p. 36; Ex. 129-J, p. 38; Ex. 130-J, p. 39; Ex. 1303-J, p. 13.)

Objection: inaccurate, misleading. The proposed finding implies that YA Global bought and sold securities as an investor or trader. This is incorrect as respondent argues throughout Respondent’s Brief and this Reply. Also see Resp’s Obj. to Pet’rs’ PFF ¶ 37. Moreover, the proposed finding overstates Yorkville Advisors’ role. Mr. Angelo had sole and exclusive authority over all portfolio decisions made on behalf of YA Global, HHF, MEP. (Ex. 1291-J at § 4.3; Ex. 1292-J at § 4.3; Ex. 1320-J at § 4.3; Ex. 1321-J at § 4.3.) CRX was managed by Italo Apicella, and he made all decisions with respect to CRX’s investments. (Ex. 1299-J.)

39. In exchange for managing a fund and its investments, Yorkville generally earned a management fee equal to 2% of the value of the fund’s assets and an incentive fee equal to 20% of the fund’s profits or gains. (Tr. 84:6-10; Ex. 30-J (YAREL0000012065); Ex. 97-J, p. 15; Ex. 100-J, p. 18; Ex. 114-J, pp. 16-17; Ex. 122-J, p. 15; Ex. 123-J, p. 16; Ex. 125-J, p. 15; Ex. 129-J, p. 15; Ex. 130-J, p. 16; see also Ex. 1314, p. 1, In. 7, p. 18; Ex. 1315-J, p. 1, In. 7, p. 43; Ex. 1316-J, p. 1, In. 7, p. 22; Ex. 1317-J, p. 1, In. 7, p. 21; Ex. 1318-J, p. 1, In. 7, p. 32.) These fees are common in the hedge fund industry and are often referred to as compensation of "2 and 20." (Ex. 2003-R, p. 15.)

First sentence. Objection: incomplete, misleading, not supported by the record. See General Objection No. 1. This proposed finding implies that Yorkville Advisors received a management fee and incentive fee/allocation from each fund that it managed. This is not true. YA Global did not pay or allocate any management and incentive fees to Yorkville Advisors after 2006, when Yorkville Advisors was no longer YA Global’s general partner. (Compare Ex. 286-J at pp. 0013-0014 (YA Global’s 2006 financial statements with, e.g., Ex. 287-J at pp. 0013-0014 (YA Global’s 2007 financial statements).) Further, in 2006, Yorkville Advisors received a variety of fees, in addition to the 2% management fee and 20% incentive allocation, in exchange for the activities it performed for YA Global or on YA Global’s behalf. After 2006, Yorkville Advisors continued to receive fees, other than the 2% management fee and 20% incentive fee/allocation.

Second sentence. Objection: misleading, not supported by the record. Yorkville Advisors received a variety of fees, in addition to the 2% management fee and 20% incentive allocation, in exchange for the activities it performed for YA Global or on YA Global’s behalf. Nothing in the record indicates that receipt of fees, other than the 2% management fee and 20% incentive compensation, was common in the hedge fund industry. In his testimony (both his report and trial), respondent’s expert Leon Metzger discussed only management fees and incentive fees/allocations, implying that the only fees paid for managing a hedge are the management fee and the incentive fee/allocation. (See Ex. 2003-R; Tr. 1500-1550.)

40. The Yorkville Principals held relatively insignificant interests in the Fund, generally representing between 0% and 3.5% of the Fund’s capital. (Ex. 1-J (YALIT000102); Ex. 2-J (YALIT000505); Ex. 3-J (YALIT000843); Ex. 4-J (YALIT000888); Ex. 5-J (YALIT000976); Ex. 6-J (YALIT001037.)

Objection: inaccurate, incomplete, misleading, vague. The Yorkville Principals, and primarily Mark Angelo, as the majority owner and President of Yorkville Advisors, had a significant stake in YA Global. Their reputation and that of Yorkville Advisors was inextricably tied to the performance of YA Global. Moreover, outside investors expected the Yorkville Principals to have their own money at stake in YA Global; whether that ownership interest was large or small, the fact of that ownership interest was significant to the outside investors.

41. The Yorkville Principals did not seek to generate significant income based on their small equity interests in Yorkville’s funds. (Tr. 56:10-15.) Instead, they hoped to generate substantial income from their ownership of Yorkville, which earned management and incentive fees as a result of successfully managing various funds. (Id.)

Objection: incomplete, misleading, vague. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 24, 29, 30, 32, 39, and 40. The Yorkville Principals held interests in YA Global because they were principals of Yorkville Advisors and the outside investors in YA Global expected them to have an ownership stake in YA Global. Their ownership interests were, therefore, tied to their management interests. As petitioners’ expert Dr. Lerner stated, the management fees and incentive fees are "used to align the economic interests of the investment manager (in this case, Yorkville Advisors, LLC) with those of its LPs." (Ex. 3003-P at ¶ 114.) Stated differently, the amounts of the management and incentive fees are tied to the performance of YA Global. In addition to the management and incentive fees, Yorkville Advisors received other fees associated with YA Global’s transaction. Further, the only fund operated by Yorkville Advisors was YA Global generally but especially during the years at issue. HHF, MEP, and CRX were small, short-lived funds that generated very little revenue for Yorkville Advisors and were either merged into YA Global or terminated in early 2006.

42. The "2 and 20" structure described in PFF ¶ 39 generally incentivizes investment managers to take risks with the funds they manage. (Ex. 3003-P, ¶¶ 114-115.)

Objection: inaccurate, not supported by the record, immaterial, irrelevant. See General Objection No. 1. Dr. Lerner at the cited paragraphs does not actually state that the "2 and 20 structure" "incentivizes investment managers to take risks." Dr. Lerner states that the "2 and 20 structure" is designed to align to the interests of the manager with the interests of the limited partners. (Ex. 3003-P at ¶¶ 114-115.) He also states that the management fee is used to pay for expenses and overhead (¶ 115) or operating costs (¶ 113) and the incentive fee allows the manager to share in the profits it has created (¶ 115). (See also Ex. 2003-R at p. 16.) Further, YA Global’s "2 and 20 structure" was different from typical hedge fund and venture capital funds in that Yorkville Advisors received fees in addition to the management and incentive fees. (Compare RPFF ¶¶ with Ex. 2003-R at pp. 15-16 and Ex. 3003-P at ¶¶ 113-115.) Whether the "2 and 20" structure generally incentivizes the manager is immaterial and irrelevant to the issue of whether YA Global was engaged in U.S. trade or business.

43. Yorkville and Yorkville GP filed partnership returns each year showing their income from the investment management business. (Ex. 1314-J, pp. 1, 19; Ex. 1315-J, pp. 1, 44; Ex. 1316-J, pp. 1, 23; Ex. 1319-J, pp. 1, 29; Ex. 1317-J, pp. 1, 21; Ex. 1318, pp. 1, 33.)

Objection: misleading, irrelevant. See General Objection No. 1. Whether and how Yorkville Advisors and Yorkville GP reported income is not at issue in this case and is irrelevant to whether YA Global was engaged in the conduct of U.S. trade or business.

44. Yorkville and Yorkville GP provided Schedules K-1 to the Yorkville Principals each year. (Exs. 1314-J, pp. 36-79; 1315-J, pp. 16-30; 1316-J, pp. 31-42; 1317-J, pp. 31-46; 1318-J. pp. 26-58; Exs. 1324-J, pp. 23-47; 1325-J, pp. 13-32; 1326-J, pp. 15-35; see also Tr. 58:12-59:2.)

Objection: irrelevant. Whether Yorkville Advisors and Yorkville GP provided Schedules K-1 to the Yorkville Principals is not at issue in this case and is irrelevant to whether YA Global was engaged in the conduct of U.S. trade or business.

45. Mr. Angelo included the Schedule K-1 income from Yorkville and Yorkville GP in his personal returns and paid tax on it each year. (Tr. 58:12-59:2; Ex. 1314-J, pp., 35-45; Ex. 1315-J, pp. 16-19; Ex. 1316-J, pp. 31-33; Ex. 1317-J, pp. 31-34; Ex. 1319-J, pp. 47-49; Ex. 1324-J, pp. 24-29; Ex. 1325-J, pp. 13-17; Ex. 1326-J, pp. 16-20.)

Objection: irrelevant. Whether Mr. Angelo paid tax his distributive share of Yorkville Advisors’ and Yorkville GP’s income is not at issue in the case and is irrelevant to whether YA Global was engaged in a U.S. trade or business.

46. There is no reason to think the other Yorkville Principals did not also report and pay tax on their income from Yorkville and Yorkville GP. (Entire record.)

Objection: speculative, not supported by the record, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶ 45. This proposed finding is pure speculation and not based on any facts in the record. There is nothing in the record to determine (or assume) one way or another that the other Yorkville Principals reported and paid their taxes. Because whether they reported and paid tax was not at issue, the parties had no reason to educe any such facts. This proposed finding has no relevance to whether YA Global was engaged in a U.S. trade or business.

B. Operations

47. To conduct its investment management services business, Yorkville employed approximately 40 to 50 or more employees during the years at issue. (Exs. 131-J to 135-J; S. ¶ 158; Tr. 596:16-22.)

Objection: not supported by the record, misleading. See General Objection No. 1. YA Global engaged Yorkville Advisors to operate its lending, underwriting, and finance business. Yorkville Advisors employed individuals who worked primarily for or on behalf of YA Global during the years at issue. RPFF ¶¶ 75, 78, 79, 80, 81, 82, 83, 84, and 85 represent a more accurate and complete statement of this fact.

48. Each of the four Yorkville Principals had a role in the company’s operations. (PFFs ¶¶ 49-52.)

Objection: vague. Petitioners fail to define the term "company." Each of the four Yorkville Principals acted for or on behalf of YA Global during the years at issue.

49. Mr. Angelo had sole and exclusive authority over all portfolio decisions made on behalf of any fund in which Yorkville served as the general partner or investment manager. (Ex. 1291-J § 4.3; Ex. 1292-J § 4.3 (as investment manager only).)

No objection.

50. Mr. Beckman was in charge of trading and brokerage relationships and was responsible for evaluating and making trading decisions with respect to investments managed by Yorkville for its funds. (Tr. 54:9-11; Tr. 55:1-10; Ex. 30-J (YAREL0000012081) 31; Ex. 114-J, p. 31.)

Objection: not supported by the record, misleading. See General Objection No. 1. Petitioners overstate Mr. Beckman’s duties as he generally was not deciding when to buy "investments managed by Yorkville." Nothing in the record indicates that Mr. Beckman was involved in decisions to make loans to companies or to enter into SEDAs. Moreover, neither Mr. Beckman nor anyone else at Yorkville Advisors decided when to buy shares subject to an advance notice under a SEDA; as Mr. Angelo repeatedly stated at trial, YA Global’s clients decided when YA Global would buy the clients’ shares. At best, Mr. Beckman decided when to sell stock, but even then he decided this only with respect to conversions of convertible debentures. For the SEDAs, YA Global intended to sell the stock they purchased as soon as possible. In any event, Mr. Beckman’s activities were not that of "trading"; they were selling activities associated with their lending and underwriting business.

51. Mr. Eicke managed Yorkville’s investment pipeline and its corporate finance professionals to source investment deals. (Tr. 54:15-21; Ex. 30-J (YAREL0000012081); Ex. 119-J, p. 32.)

Objection: not supported by the record, incomplete, misleading. See General Objection No. 1. Mr. Eicke held a position within Yorkville Advisors, but in reality, he was managing YA Global’s "investment pipeline." Yorkville Advisors did not enter into any transactions itself; it sourced and negotiation transactions for and on behalf of YA Global. YA Global was engaged in U.S. lending, underwriting, and finance business. Mr. Eicke oversaw the bankers who sourced, investigated, and negotiated the transactions YA Global entered into.

52. Mr. Gonzalez was Yorkville’s general counsel. (See, e.g., Ex. 114-J, p. 32.)

Objection: incomplete, misleading. Mr. Gonzalez had the title of General Counsel within Yorkville Advisors. But he served as general counsel for and on behalf of YA Global, as well.

53. Yorkville’s employees’ areas of responsibilities included corporate finance and investment sourcing, investor relations, trading, legal, and accounting. (Tr. 53:22-54:11, 55:18-21, 84:23-85:5; Ex. 131-J; Ex. 132-J;Ex. 133-J; Ex. 134-J; Ex. 135-J.)

Objection: not supported by the record, misleading. See General Objection No. 1 and Resp’s Obj. to Pet’rs’ PFF 50, 51, and 52. Petitioners mischaracterize the roles of the employees. They were not conducting Yorkville Advisors’ investment management business; rather they assisted in the operation of YA Global’s lending, underwriting, and finance business.

54. Between 2006 and 2011 Yorkville paid between approximately $7 million and $16 million of salaries and wages and between approximately $350,000 and $800,000 of associated payroll taxes. (Ex. 1314-J, pp. 1, 19; 1315-J, pp. 1, 44; Ex. 1316-J, pp. 1, 23; Ex. 1319-J, pp. 1, 29; Ex. 1317-J, pp. 1, 21; Ex. 1318-J, pp. 1, 33.)

Objection: incomplete, misleading irrelevant. Petitioners imply that Yorkville Advisors’ paying employees demonstrates Yorkville Advisors’ independence. To the contrary, Yorkville Advisors was able to pay the employees because it received a management fee and other fees, all of which were intended to cover Yorkville Advisors’ overhead and expenses, such as employees’ salaries. (Ex. 2003-R at p. 16; Ex. 3003-P at ¶¶ 113, 115; Ex. 28-J at §§ 4(b), 5(b).) In any event, whether Yorkville Advisors incurred costs in running YA Global’s business is not relevant to whether YA Global was engaged in a U.S. trade or business.

55. Yorkville’s employees were located across the several offices that Yorkville had around the world. (Ex. 131-J; Ex. 132-J; Ex. 133-J; Ex. 134-J; Ex. 135-J; see also Tr. 180:15-181:2.)

Objection: vague, incomplete, misleading, mischaracterizes the evidence. Petitioners do not define "around the world." In any event, petitioners overstate YA Global’s offshore presence. According to the organizational charts, Yorkville Advisors had one overseas office location, i.e., London, from 2006 through at least 2008 (Exs. 131-J through 133-J) and two overseas offices, i.e., London and Hong Kong from October 2009 on (Exs 134-J, 135-J). This is hardly "around the world." Also petitioners overstate generally Yorkville Advisors’ presence. In addition to their headquarters, Yorkville Advisors had two U.S. offices but nothing in the record indicates how many employees worked in these offices. (Exs. 131-J through 135-J.) Moreover, Yorkville Advisors’ employees worked for or on behalf of YA Global. (Entire record.)

56. As a result of its operations, Yorkville had significant operating and overhead expenses. It leased office space (Ex. 1357-J) and purchased furniture and computers (see, e.g., Ex. 1314-J, pp. 15-18; Ex. 1315-J, pp. 10-15.). It maintained insurance. (Exs. 1343-P, 1344-J, 1345-J, 1346-J, 1347-J, 1348-J, 1349-J, 1350-J, 1351-J, 1352-J, 1353-J, 1354-J.) In addition to paying employees’ compensation, it incurred costs for travel, telephone, data and subscriptions services, marketing, computer and information technology, legal, accounting, and other operating and administrative expenses. (Ex. 1314-J, p. 19; Ex. 1315-J, p. 44; Ex. 1316-J, p. 23; Ex. 1317-J, p. 54; Ex. 1318-J, p. 33.)

Objection: incomplete, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶ 54. Yorkville Advisors’ overhead and operating costs, such as those described in this proposed finding, were covered by the management fee and fees received with respect to the transactions YA Global entered into. (Ex. 2003-R at p. 16; Ex. 3003-P at ¶¶ 113, 115; Ex. 28-J at §§ 4(b), 5(b).) In any event, whether Yorkville Advisors incurred costs in running YA Global’s business is not relevant to whether YA Global was engaged in a U.S. trade or business. RPFF ¶¶ 75, 77, 88, 93, 123, 368-393, 442, and 681 represent a more accurate and complete statement of this fact.

57. Yorkville was always responsible for and paid for its own operating and overhead expenses. (Tr. 972-973; Ex. 30-J (YAREL0000012068, YAREL0000012085); Ex. 97-J, pp.17, 35; Ex. 122-J, pp. 16, 35; Ex. 123-J, pp. 17, 36; Ex. 125-J, pp. 16, 35; Ex. 129-J, pp. 16, 36; Ex. 130-J, pp. 17, 37; Ex. 1293-J, p. 5, § 3; Ex. 1300-J, p. 5, § 3; Ex. 1307-J, p. 4, § 4(b); Ex. 1307-J, pp. 4-5, § 4.)

Objection: incomplete, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 54 and 56.

58. Yorkville had full authority to operate, conduct, and expand its business and incur expenses of any kind or nature as it saw fit, in its sole and absolute discretion, without prior notice to or consent from the Fund. (Ex. 24-J, § 2.4; Ex. 25-J, § 2.4; Ex. 26-J, § 2.4; Ex. 30-J (YAREL0000012064-65, YAREL0000012082, YAREL0000012084); Ex. 97-J, pp. 16, 34; Ex. 122-J, pp. 31, 36; Ex. 123-J, pp. 32, 37; Ex. 125-J, pp. 30, 36; Ex. 129-J, pp. 31, 37; Ex. 130-J, pp. 32, 38.)

Objection: not supported by the record, inaccurate, irrelevant. Petitioners’ citations to section 2.4 of the partnership agreements do not support this finding.

C. Accounting and Finance

59. Edward Schinik has been Yorkville’s chief financial officer since 2005. (Ex. 101-J, p. 34; Tr. 569:18-22.). In that role, Mr. Schinik was responsible for day-to-day reconciliations, books and records, payment of invoices, the year-end audits, tax issues, and the financial part of the business in general. (Tr. 570:25-571:7; 612:11-17.)

Objection: incomplete, misleading. See General Objection No. 2. Petitioners overlook that Yorkville Advisors operated essentially only one fund during the years at issue and that Yorkville Advisors’ activities were centered around operating YA Global’s business. Up until sometime in 2007, Yorkville Advisors’ employees were treated and identified as YA Global’s employees. On its website, Cornell Capital identified the team of professionals as its own. (Ex 157-J; Ex 159-J; Tr. 187:3-188:9.) Ed Schinik had a Cornell Capital email address. Several emails sent by Mr. Schinik provide that he is eschinik@comellcapital.com and he is also identified in the signature block of his emails as Chief Financial Officer of Cornell Capital Partners. (Ex. 1359-J at p. 001; Ex. 1360-J at p. 001; Ex. 1361-J at p. 001; Ex. 1362-J at p. 001; Ex. 1364-J at p. 001; Ex. 1365-J at p. 001.) See RPFF ¶¶ 75, 77, 97, and 579.

60. Oren Franks was Yorkville’s controller. (Tr. 886:16-22.) As the controller, Mr. Franks was responsible for accounting and managing the books and records for the funds under Yorkville’s management. (Tr. 886:23-887:5; 936:7-20; see also Tr. 572:3-8.)

Objection: incomplete, misleading. See General Objection No. 2 and Resp’s Objections to Pet’rs’ PFF ¶¶ 59.

61. Mr. Franks’ responsibilities included booking all of the trades for each fund on a daily basis, providing data to the funds’ third-party administrator, creating month-end net asset value reports and financial reconciliations for each fund, preparing monthly investor statements, and providing accountants and tax preparers with information for year-end financial audits and tax returns. (Tr. 887:9-19; see also Tr. 572:3-8.)

Objection: immaterial. See General Objection No. 2. See also Resp’s Objections to Pet’rs’ PFF ¶¶ 59.

62. In order to carry out his functions as controller, Mr. Franks entered all securities transactions and trading data for the funds into Yorkville’s accounting system, Axys. (Tr. 891:24-892:5.)

Objection: misleading, incomplete. See General Objection Nos. 1 and 2. Petitioners mischaracterize the transactions recorded by Mr. Franks. YA Global was engaged in a lending and underwriting business. YA Global maintained comprehensive records of its lending activity. Loans (and payments under the loans) were recorded by Yorkville Advisors’ internal accounting team using the Advent Axys portfolio management system. (Tr. at 892-893, 915.) This internal data was also shared with and recorded by SEI, the fund administrator. Interest accruals were tracked separately by SEI. (Tr. at 603, 920.) YA Global also prepared audited financial statements reflecting the value of its outstanding loans. (Exs. 286-J, 287-J, 288-J, 289-J, 290-J, and 291-J.) YA Global’s lending practices were formal and rigorous. After a deal was originated and the transaction was structured, it was subject to multiple layers of review by the investment banking team, the investment committee, attorneys performing legal due diligence, and the executive committee. (Tr. at 101-102, 1397-1398; Ex. 170-J at p. 0011.) See RPFF ¶¶ 75, 443, 444.

63. Yorkville engaged SEI, an unrelated fund administration company, to administer the funds managed by Yorkville. (Exs. 1329-J, 1330-J, 1331-J, 1332-J.)

Objection: inaccurate, incomplete, misleading. See General Objection No. 2. Petitioners misstate the facts. SEI was engaged by YA Global, among other funds, in June 21, 2005. Yorkville Advisors did not sign the June 21, 2005 Administration Agreement. (Ex. 1329-J at p. 0014.) Yorkville Advisors was added as a signatory alongside YA Global in the June 8, 2006 Amendment to Administration Agreement, the September 30, 2008 Second Amendment to the Administration Agreement, and the April 15, 2009 Third Amendment to Administration Agreement. (Ex. 1330-J at p. 003; Ex. 1331-J at p. 003; Ex. 1332-J at p. 003-004.)

64. Each fund managed by Yorkville had its own books and records. (Tr. 936:7-20.)

Objection: incomplete, misleading, not supported by the record, vague. See General Objection No. 2. Yorkville Advisors did not operate multiple funds during the years at issue. Petitioners do not define the term "books and records." The "books and records" of the funds Yorkville Advisors operated consisted of a separate tab in a spreadsheet for each fund. (Tr. 935-36.)

65. Each fund managed by Yorkville had its own accounts with third-party brokers. (Exs. 1333-J, 1334-J, 1335-J, 1336-J, 1337-J, 1338-J, 1339-J, 1340-J, 1341-J, 1342-J.)

Objection: incomplete, misleading, immaterial. See General Objection No. 2. YA Global was the only fund Yorkville Advisors operated during the years at issue. Whether Yorkville Advisors acted on behalf of more than one fund is immaterial to whether Yorkville Advisors’ activities were attributable to YA Global or whether YA Global was engaged in a U.S. trade or business.

66. Yorkville had its own books and records, separate from that of the funds it managed. (Ex. 334-J; Tr. 936:22-937:15.)

Objection: immaterial. See General Objection No. 2. Whether Yorkville Advisors kept its own books and records is immaterial to whether Yorkville Advisors acted on YA Global’s behalf or whether YA Global was engaged in a U.S. trade or business.

D. Yorkville’s Investment Process

67. Yorkville sourced investment opportunities for the funds that it managed, including YA Global. Sometimes, Yorkville was approached by third parties seeking investors, and sometimes Yorkville approached investment opportunities directly. (Tr. 84:23-85:5; 92:10-93:5; 101:5-14.)

Objection: incomplete, misleading. See General Objections Nos. 1 and 2. Petitioners mischaracterize Yorkville Advisors’ activities. Yorkville Advisors operated YA Global’s lending, underwriting, and financing business and conducted all activities from sourcing the transactions to negotiating the terms of the loans and SEDAs to funding of the transactions. Yorkville Advisors performed all of these activities on behalf of YA Global. See, e.g., RPFF ¶¶ 57, 59, 75-93, 147.

68. Yorkville had an investment committee and an executive committee. (Tr. 101:15-102:14.)

Objection: incomplete, misleading. Yorkville Advisors operated YA Global’s lending, underwriting, and financing business and had investment and executive committees to serve the needs of YA Global and that business. See, e.g., RPFF ¶¶ 57, 75, 124-131, 436-437.

69. The investment committee was responsible for evaluating potential investment opportunities, including identifying risks and risk mitigation strategies, and recommending an investment after such evaluation. (Tr. 101:15-102:7.)

Objection: incomplete, misleading. See General Objection No. 1. See Resp.’s Objections to Pet’rs’ ¶ 68.

70. If the investment committee determined an investment could generate a superior return on a risk-adjusted basis, it recommended the potential investment to the executive committee. (Tr. 102:1-7.)

Objection: incomplete, misleading. See General Objection No. 1. See Resp.’s Objections to Pet’rs’ ¶ 68.

71. The executive committee could approve or reject an investment recommended by the investment committee. (Tr. 102:8-14.)

Objection: incomplete, misleading. See General Objection No. 1. See Resp.’s Objections to Pet’rs’ 68.

72. After Yorkville approved an investment, it would allocate the investment to one or more funds under its management. (Tr. 83:12-83:20; Tr. 103:23-104:8; see also Ex. 30-J (YAREL0000012076, YAREL0000012085-86, YAREL0000012125); Ex. 97, pp. 26, 35, 75.)

Objection: incomplete, misleading. See General Objection Nos. 1 and 2. YA Global was Yorkville Advisors’ only fund during the years at issue. YA Global was engaged in a lending, underwriting, and financial services business, and Yorkville Advisors’ acted on YA Global’s behalf in operating that business.

73. Once an investment was allocated to a fund managed by Yorkville, then the general partner of that fund would execute the necessary legal documents on behalf of that fund to enter into that investment. (Tr. 104:9-105:1.)

Objection: incomplete, misleading. See General Objection Nos. 1 and 2 and Resp’s Obj. to Pet’rs’ PFF ¶ 72. See, e.g., RPFF ¶¶ 57, 75, 161, 164, 214, 215, 309, 319-25, 372, 439, 440, 472, 476, and 494

E. Yorkville’s Trading Activities

74. Mr. Beckman and his team were responsible for all trading decisions for YA Global and other funds under Yorkville’s management. (Tr. 105:15-23; 893:16.)

Objection: incomplete, misleading. See General Objections Nos. 1 and 2. YA Global did not engage in trading. YA Global was engaged in a U.S. trade or business of lending, underwriting, and financial services. Petitioners overstate Mr. Beckman’s activities and responsibilities. See Resp’s Obj. to Pet’rs’ PFF ¶ 50 and RPFF ¶¶ 57, 75, 86, 116, 358-367.

75. Yorkville was never registered as a broker-dealer. (Tr. 109:25-110:2, 242:7-18.)

Objection: misleading, immaterial, irrelevant. Whether Yorkville Advisors was, or should have been, registered with the Securities Exchange Commission as a broker-dealer is immaterial and irrelevant to the issues in the case. Petitioners suggest that Yorkville Advisors could not act on YA Global’s behalf and originate loans or enter into SEDAs on YA Global’s behalf without being a broker-dealer. Nothing in the record indicates that YA Global was required to be broker-dealer. At issue is whether the activities conducted by Yorkville Advisors on YA Global’s behalf constituted lending and underwriting. As the evidence demonstrates, YA Global was engaged in a lending, underwriting, and financial services business.

76. Instead, it engaged third-party brokers to hold the stock that it acquired from portfolio companies and to execute trades on public stock exchanges. (Tr. 108:12-109:17; 184:9-185:8, 210:19-20, 328:22-329:7.)

Objection: incomplete, misleading, contrary to the weight of the evidence, immaterial. The exact process by which YA Global executed trades on public exchanges is irrelevant. YA Global created a market for issuers and connected the issuers with buyers. YA Global and Yorkville Advisors were "convinced that by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor.". (Ex. 252-J at p.004.)

77. Mr. Beckman worked with Yorkville’s prime broker and executing brokers to provide Yorkville the best possible execution of its equity sales. (See, e.g., Ex. 114-J, p. 31.)

Objection: inaccurate, incomplete, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ ¶¶ 50 and 59. Petitioners suggest that Yorkville Advisors is working with brokers for their own account. Yorkville Advisors did not engage in equity sales. YA Global was always the buyer and seller of the securities. Yorkville Advisors served only as YA Global’s agent and acted on YA Global’s behalf in executing transactions.

78. Mr. Beckman was also responsible for monitoring the performance of Yorkville’s brokers as it related to the timely delivery and settlement of trades. (See, e.g., Ex. 114-J, p. 31.)

Objection: irrelevant, incomplete. See Resp’s Obj. to Pet’rs’ ¶¶ 50, 59, 77.

79. Once Mr. Beckman and his team made the decision to convert a convertible security, Yorkville would send a conversion notice to the portfolio company. (Tr. 893:16-20; see, e.g., Ex. 452-J.)

Objection: inaccurate, incomplete, irrelevant. See Resp’s Obj. to Pet’rs’ ¶¶ 50, 59, 77. Yorkville Advisors conducted all of its activities for and on behalf of YA Global. See RPFF ¶¶ 75, 86, 161-260

80. Once conversion of a convertible debenture was completed, shares would be transferred to the broker, and a copy of the conversion information would be provided to Mr. Franks to be entered into Yorkville’s system. (Tr. 893:20-25.)

Objection: inaccurate, incomplete, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ ¶¶ 50, 59, 77. Petitioners suggest that Yorkville Advisors’ activities were performed for its own account and that transactions were recorded in Yorkville Advisors’ system. This is incorrect. Yorkville Advisors conducted all of its activities for and on behalf of YA Global.

81. When a stock was sold, the sale information would be provided by the broker to Mr. Franks to be entered into Yorkville’s system. (Tr. 894:9-15.)

Objection: inaccurate, incomplete, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ ¶¶ 50, 59, 77, 80. Mr. Franks’ exact responsibilities are irrelevant to the issue of whether YA Global had income that is effectively connected with the conduct of a trade or business within the U.S. for 2006-2009. Also, YA Global’s records and tax liability are at issue, not Yorkville’s. YA Global (or related fund) entered into the loan transactions, not Yorkville Advisors, and YA Global was the "Holder" with respect to convertible debentures, not Yorkville Advisors. (Ex. 311-J at p. 001 (Cornell Capital Partners, LP as "Holder" of the debenture); Ex. 648-J at p. 001 (Cornell Capital Partners, LP as "Holder" of the debenture); Tr. 346:4-10.).) YA Global operated through the actions of its general partner or manager, Yorkville Advisors. (Tr. 180:1-4.) Typically, a hedge fund does not have employees, but its general partner or manager employs individuals on the hedge fund’s behalf. (Ex. 2003-R, p. 9.) Therefore, Yorkville employees, on behalf of YA Global, would decide when to convert a convertible security and would send the conversion notice to the portfolio company. (Ex. 311-J at p. 0023; Ex. 648-J at p. 0017; Ex. 452-J at p. 003; Ex. 453-J at p. 003; Ex. 454-J at p. 004; Ex. 456-J at p. 002; Ex. 626-J at p. 002 (Conversion Notice signed by Troy J. Rill as Co-Portfolio Manager of Highgate House Funds, Ltd.); Ex. 690-J at p. 1; Ex. 758-J at p. 002; Ex. 795-J at p. 1.)

III. Yorkville’s Management of YA Global

82. Management and control over YA Global was vested exclusively in its general partner and investment manager. (Ex. 24-J, § 2.1; Ex. 25-J, § 2.1; Ex. 30-J (YAREL0000012073, YAREL0000012122); Ex. 97-J, pp. 23-24; Ex. 284-R, p. 10.)

Objection: contrary to the weight of evidence, incomplete. Petitioners ignore the common ownership of Yorkville Advisors and Yorkville GP, Mr. Angelo’s majority ownership in both entities, and Mr. Angelo’s sole and exclusive authority over decisions made on behalf of YA Global. See RPFF ¶¶ 13-17, 20-23.

83. As the investment manager, Yorkville was solely responsible for determining YA Global’s investment strategies (Ex. 30-J (YAREL0000012077, YAREL0000012080); Ex. 97, pp. 27, 30; Ex. 100-J, p. 31; Ex. 114, pp. 27, 30; Ex. 122-J, pp. 27, 30; Ex. 123-J, pp. 28, 31; Ex. 125-J, pp. 26, 29; Ex. 129-J, pp. 28, 30; Ex. 130-J, pp. 28, 31)

Objection: inaccurate, not supported by the evidence, misleading. See General Objection No. 1 and Resp’s Obj. to Pet’rs’ PFF ¶ 82. Petitioners suggest that YA Global did not have control over Yorkville Advisors. This is incorrect. By virtue of the relationship, YA Global had control over Yorkville Advisors whether it exercised that control or not. Under the management agreements, YA could have imposed specific restrictions on Yorkville Advisor’s activities. (RPFF ¶ 43, 49.)

84. It promoted the Fund to investors based on the strategies it selected. (Ex. 30-J (YAREL0000012106); Ex. 97-J, p. 56; Ex. 122-J, p. 55; Ex. 123-J, p. 56; Ex. 125-J, p. 54; Ex. 129-J, p. 56; Ex. 130-J, p. 58; Tr. 50:18-23.)

Objection: vague, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 82-83. See RPFF ¶¶ 57, 75, 161, 164, 214, 215, 309, 319-25, 372, 439, 440, 472, 476, 494. Petitioners do not define "it."

85. These strategies were explained to potential investors in YA Global’s private placement memoranda ("PPMs"), and investors purchased interests in the Fund in accordance with the terms described in the PPMs. (Ex. 1584-J § 1(d); Ex. 1586-J § 1(d).)

Objection: incomplete, misleading, irrelevant. YA Global’s private placement memoranda described YA Global’s activities as including loans and SEDAs and noted that YA Global was considered to be a statutory underwriter by the Securities Exchange Commission. (Ex. 30 at YAREL0000012077, YAREL0000012095, YAREL0000012096, YAREL0000012103, YAREL0000012116; Ex. 89-J at YAREL0000057813.)

86. A PPM has to disclose all risk factors, both corporate and tax risks, of an investment in the fund, any regulatory filing or payment obligations, any positions that the government may or may not take. (Tr. 518:1-9; Ex. 2003-R, pp. 14-15.)

Objection: not supported by the record, misleading. Petitioners mischaracterize the evidence and suggest that a standard exists for what information is included in a private placement memorandum. This is not correct. A private placement memorandum is not required to be provided to investors. (Ex. 2003-R at p. 14.) The information contained in private placement memoranda varies from fund to fund. (Ex. 2003-R at p. 15)

87. When an investor subscribed for an interest in the Fund, the investor had to execute a "Subscription Agreement" and had to acknowledge that the investor had been provided a copy of the applicable PPM and had reviewed the PPM. (See, e.g., Ex. 1585-J, pp. 7-8 and § 3(d); Ex. 1586-J, pp. 7-8 and § 3(d); see generally Ex. 2003-R, p. 13.) The Subscription Agreement, together with the PPM and the "Related Documents," constituted the full and entire agreement between the subscribing investor and the Fund and superseded all previous discussions and agreements regarding the investment. (See, e.g., 1585-J, §§ 3(ee), 6; 1586-J, §§ 3(ee), 6.)

First sentence. No objection.

Second sentence. Objection: legal conclusion, irrelevant. The universe of what could be considered the full and entire agreement between the subscribing investor and YA Global is irrelevant to the issue of whether YA Global was engaged in a U.S. trade or business.

88. Between 2001 and 2008, under Mr. Angelo’s management, Yorkville grew the size of YA Global to approximately $1 billion. (Tr. 261:23-262:22.)

No objection.

89. Throughout those years, Yorkville guided the Fund in making over 500 investments. (See Ex. 130-J, p. 32.)

Objection: incomplete, misleading. See General Objection No. 1. YA Global was engaged in a lending and underwriting business in which it, during the years at issue, originated and made over 500 loans directly to its clients (RPFF ¶ 466) and committed, in about 350 SEDAs, to stand ready to distribute its clients’ stock to the market (RPFF ¶ 325). For these services, YA Global was compensated both in the form of interest and the spread on discounted stock but also through various fees paid in cash and stock or warrants. (RPFF ¶¶ 60, 257, 297, 299-300, 334, 341, 356, 372-373, 392-396.)

90. The Fund paid Yorkville its standard "2 and 20" management and incentive fees described more generally in PFF ¶ 39. (Tr. 84:6-10; Ex. 30-J (YAREL0000012065); Ex. 97-J, p. 15; Ex. 122-J, p. 15; Ex. 123-J, p. 16; Ex. 125-J, p. 15; Ex. 129-J, p. 15; Ex. 130-J, p. 16; see also Ex. 1314, p. 1, In. 7, p. 18; Ex. 1315-J, p. 1, In. 7, p. 43; Ex. 1316-J, p. 1, In. 7, p. 22; Ex. 1317-J, p. 1, In. 7, p. 21; Ex. 1318-J, p. 1, In. 7, p. 32.)

Objection: not supported by the record. See Resp’s Obj. to Pet’rs’ ¶¶ 39, 42. YA Global did not pay or allocate any management and incentive fees to Yorkville Advisors after 2006. Further, Yorkville Advisors received a variety of fees, in addition to the 2% management fee and 20% incentive allocation, in exchange for the activities it performed for YA Global or on YA Global’s behalf. See RPFF ¶¶ 13, 55, 368, 372-379, 381-386, 392, 393, 409, 516, 518-519, 684.

91. Between 2007 and 2011, however, YA Offshore incurred and paid its share of the incentive allocation directly to Yorkville. (Tr. 969:3-971:3; 299-J, p. 9; 300-J, p. 9; Ex. 301-J, p. 9; Ex. 302-J, p. 13; Ex. 303-J, p. 13.)

No objection.

92. Yorkville had the exclusive authority to make binding valuation determinations with respect to the Fund’s assets, including the determination of the "net asset value" of the Fund. (Ex. 25-J, §§ 2.11, 3.5; see also, e.g., Ex. 30-J (YAREL0000012090); Ex. 97, p. 40.)

Objection: inaccurate, misleading. Petitioners overstate Yorkville Advisors’ authority. YA Global’s general partner and/or its manager may establish and maintain policies, including those relating to valuation. (Ex. 25-J at § 2.11.) Consequently, starting in 2007, either Yorkville GP, as YA Global’s general partner, or Yorkville Advisors, as YA Global’s manager, could have made such determinations.

93. In cases where the Fund had breach of contract or other claims against the companies in which it invested, Yorkville had full discretion regarding whether and how to enforce legal remedies. (See, e.g., Ex. 97-J, pp. 22, 47, 59-60.)

Objection: incomplete, misleading. See General Objection No. 1. Yorkville Advisors had a broad mandate to act on YA Global’s behalf. Because Yorkville Advisors operated YA Global’s lending and underwriting business, it had the authority to make decisions on YA Global’s behalf as to whether and how to enforce the lending and underwriting transactions. The private placement memoranda indicate that Yorkville Advisors acts for YA Global in this regard: "The Fund intends to aggressively enforce its rights under its contractual relationships with issuers, although the Investment Manager understands and will take into account the costs of litigation." (Ex. 97-J at p. 0047.)

A. Investors’ Rights to Participate

94. Investors in the Fund had no right to participate in the management of the Fund. (PFF ¶ 112.)

Objection: immaterial, irrelevant, vague. The term "investors" is not defined. To the extent "investors" means the limited partners of YA Global, whether the limited partners had the right to participate in the management of YA Global is immaterial and irrelevant to the issues in this case. The relationship of consequence is the relationship between YA Global and Yorkville Advisors. As the evidence demonstrates, Yorkville Advisors acted for and on YA Global’s behalf and operated YA Global’s lending, underwriting, and financial services business.

95. Investors in the Fund had no right to participate in the decisionmaking process with respect to the Fund’s investment strategies or techniques. (Tr. 61:9-20; PFF ¶ 106.)

Objection: misleading, immaterial, irrelevant. See General Objection No. 1 and Resp’s Obj. to Pet’rs’ PFF ¶ 94.

96. Investors in the Fund had no right to participate in any trading decisions for the Fund. (See PFFs ¶¶ 38, 107.)

Objection: immaterial, irrelevant. See General Objection No. 1 and Resp’s Obj. to Pet’rs’ PFF ¶ 94.

97. In fact, the Fund’s general partner had sole discretion, without prior notice to or consent from investors, to offer different classes of interests in the Fund, and those different classes could have different fee structures, voting rights and redemption privileges. (See, e.g., Ex. 30-J (YAREL0000012061, YAREL0000012065, YAREL0000012066, YAREL0000012069, YAREL0000012070, YAREL0000012087); Ex. 97-J, pp. 11, 15, 16.)

Objection: immaterial, irrelevant. See General Objection No. 1 and Resp’s Obj. to Pet’rs’ PFF ¶ 94.

98. Neither the Fund nor its investors had any opportunity to control or instruct Yorkville with respect to the execution of any portfolio transactions relating to the Fund’s investments. (PFF ¶ 38; Entire Record.)

Objection: inaccurate, legal conclusion, misleading, contrary to the weight of the evidence, irrelevant. See General Objection No. 1. The case law under section 864(b) does not require a taxpayer to have or exercise control over the person acting on its behalf. Even if this were relevant, YA Global had the right to control Yorkville Advisors. It specified the terms of the initial arrangement; it had the right to impose restrictions on Yorkville Advisors’ activities; and it could withdraw its funds or terminate the arrangement with 30 days’ notice. (RPFF ¶¶ 40, 43-46, 49-51.)

99. Yorkville could also establish internal policies regarding the operations of YA Global that would be binding on the Fund, and those policies could be changed at any time without notice to or prior approval of the Fund’s investors. (Ex. 24-J, § 2.11; Ex. 25-J, § 2.11; Ex. 30-J (YAREL0000012076, YAREL0000012085-86, YAREL0000012125); Ex. 96-J, pp. 13, 26, 35; Ex. 97, pp. 26, 35, 75.)

Objection: inaccurate, misleading. Petitioners overstate Yorkville Advisors’ authority. YA Global’s general partner and/or its manager may establish and maintain policies. (Ex. 25-J at § 2.11.) Consequently, starting in 2007, either Yorkville GP, as YA Global’s general partner, or Yorkville Advisors, as YA Global’s manager, could have made such decisions.

100. Investors in YA Global had no right to inspect any book or record or document of the Fund except as conferred by law or authorized by Yorkville, and Yorkville determined all the conditions under which the books and records would be open to investors’ inspection. (See, e.g., Ex. 30-J (YAREL0000012126); Ex. 96-J, p. 76; Ex. 97-J, p. 76; Ex. 120-J, p. 75; Ex. 122-J, p. 75; Ex. 123-J, p. 76; Ex. 125-J, p. 78; Ex. 129-J, p. 80; Ex. 130-J, p. 82.)

Objection: not supported by the record, irrelevant. The partnership agreements provided YA Global’s limited partners a right to inspect YA Global’s books or records. (Ex. 24-J at § 10.3; Ex. 25-J at § 10.5; Ex. 26-J at § 10.5.) The exact rights of the limited partners to inspect YA Global’s books and records under state law and under the operating agreements is irrelevant to the issue of whether YA Global was engaged in a U.S. trade or business.

B. Yorkville’s Independence

101. While serving as the Fund’s general partner or investment manager, Yorkville could engage in other businesses and provide investment management services to other investment funds, and the Fund had no authority to prevent Yorkville from doing so. (Ex. 28-J, § 17; see also, e.g., Ex. 30-J (YAREL0000012064-65, YAREL0000012075); Ex. 96-J, pp. 13, 14, 25; Ex. 97-J, pp. 14, 54, 55.)

Objection: incomplete, misleading, legal conclusion not supported by evidence, immaterial, irrelevant. See General Objection No. 1 relating to the use of "investment." Whether Yorkville Advisors could have engaged in other businesses or managed other funds is immaterial to the questions of whether Yorkville Advisors acted on YA Global’s behalf or whether YA Global engaged in a U.S. trade or business or whether Yorkville Advisors acted on YA Global’s behalf. Hypothetical scenarios do not tend to prove one way or another whether Yorkville Advisors served as YA Global’s agent or whether YA Global conducted a business. Here, Yorkville Advisors did not actually engage in other businesses (entire record) and did not actually "provide investment management services to other investment funds." See General Objection No. 2 and Resp’s Obj. to Pet’rs’ PFF ¶ 24. Yorkville Advisors did not actually perform significant, if any, services with respect to other funds during the years at issue. (RPFF ¶ 509.) Highgate House Fund and Montgomery Equity Partners were merged into YA Global in May and June of 2006, respectively, (RPFF ¶¶ 514-515.) and had minimal, if any, activity in 2006 (RPFF ¶ 505). Petitioners did not offer evidence of any transactions by Highgate House Fund or Montgomery Equity Partners in 2006 or 2007. (Entire record.) YA Global Investments II, LP was formed in 2009, but YA Global and YA Global II participated in the transactions pari passu. But even if Yorkville Advisors were considered to be providing services to other funds, this fact is not material to whether Yorkville Advisors acted on YA Global’s behalf or whether YA Global engaged in a U.S. trade or business. Yorkville Advisors could have served as YA Global’s agent while also serving as another entity’s agent. Further, whether and to what extent YA Global had any authority or legal remedy to prevent Yorkville Advisors from engaging in other businesses or managing other funds is a legal issue with respect to which no evidence was adduced by petitioners. Exhibits 30-J, 96-J, and 97-J are private placement memoranda, not operative documents setting forth the rights of the parties. The private placement memoranda simply set forth or disclose the risks of investing in YA Global. While Ex. 28-J was one of the agreements between YA Global and Yorkville Advisors, section 17 of that agreement does not set forth YA Global’s rights as to Yorkville Advisors’ other businesses or services; section 17 states only that Yorkville Advisors’ conducting another business or serving another fund does not by itself create a conflict of interest.

102. Because Yorkville did, in fact, source and negotiate investments for multiple funds, the Fund’s PPMs disclosed that Yorkville could have conflicts of interest with regard to determining which fund(s) would have access to various investments. The PPMs further explained that Yorkville would develop an investment allocation policy to address any conflict-of-interest scenarios, and that that policy would binding on the Fund. (Ex. 30-J (YAREL0000012076, YAREL0000012085-86, YAREL0000012125); Ex. 97, pp. 13, 26, 35, 75; Ex. 99-J, pp. 15-16, 29, 41, 62-63; Ex. 100-J, pp. 15-16, 28-29, 41, 62-63; Tr. 86:20-87:6.)

Objection: inaccurate, misleading, immaterial, irrelevant. See General Objection No. 1. See also Resp’s Obj. to Pet’rs’ PFF ¶ 101.

103. In accordance with the investment management agreement, the Fund was permitted by Yorkville to adopt its name "YA Global Investments, L.P.," but the Fund was given the non-exclusive right to use that name only while Yorkville served as the Fund’s investment manager. (Ex. 28-J, § 18.)

No objection.

104. The goodwill and the name of the Fund remained the exclusive possession of the Fund’s general partner at all time, and the Fund’s investors had no right to the Fund’s name or its goodwill value. (Ex. 24-J, § 11.5; Ex. 25-J, § 11.8.)

No objection.

105. The Fund could not distribute any sales literature or promotional materials that contained any reference to Yorkville without Yorkville’s prior approval. If Yorkville ceased to be the Fund’s investment manager, the Fund would have to change its name and stop using the name of Yorkville in any manner. (Ex. 28-J, § 19.)

No objection.

106. YA Global’s general partner and investment manager could change the Fund’s investment objective as well as the investment strategies and techniques used to accomplish the Fund’s objective without notice to or the consent of the investors or holders of any interests in the Fund. (Ex. 30-J (YAREL0000012077, YAREL0000012080); Ex. 97, pp. 27, 30; Ex. 100-J, p. 31; Ex. 114, pp. 27, 30; Ex. 122-J, pp. 27, 30; Ex. 123-J, pp. 28, 31; Ex. 125-J, pp. 26, 29; Ex. 129-J, pp. 28, 30; Ex. 130-J, pp. 28, 31.)

Objection: misleading, immaterial, irrelevant. See General Objection No. 1 relating to the use of "investment." Almost by definition, limited partners do not, and cannot, have rights to participate in a partnership’s management or to control a partnership’s operations. If a limited partner managed or operated the partnership, the limited partner potentially opened itself up to personal liability for the partnership’s obligations. Consequently, whether YA Global’s general partner or manager made decisions without notice or consent of YA Global’s limited partners is immaterial and irrelevant.

107. Under the Amended IMA and the Second Amended IMA, the investment manager (i.e., Yorkville and YAM) was responsible for all portfolio management and investment advisory services, including selection of investments in which the Fund would invest, and exercising the rights of the Fund with respect to its interests in such investments. (Ex. 27-J, § 1; Ex. 28-J, § 1; see, e.g., Ex. 30-J (YAREL0000012082); Ex. 97, p. 32.)

Objection: incomplete, misleading, contrary to the weight of the evidence. See General Objection No. 1 relating to the use of "investment."

108. Yorkville and Yorkville GP were able to generate profits even during the years when the Fund generated large losses. (Ex. 1317-J, p. 1; Ex. 1318-J, p. 1; Ex. 1319-J, p. 1; Ex. 1326-J, p. 4; Ex. 1327-J, p. 6; Ex. 1328-J, p. 5; Cf. Ex. 4-J (YALIT000853); Ex. 5-J (YALIT000916); Ex. 6-J (YALIT000987).)

Objection: incomplete, misleading, immaterial, irrelevant.

IV. YA Global

A. Investors

109. Like many hedge funds, YA Global offered interests to investors in reliance on Section 3(c)(7) of the Investment Company Act of 1940 ("the Act"), which exempts "investment companies" from registering with the Securities and Exchange Commission ("SEC"). (See Ex. 2003-R, pp. 8-9; Ex. 30-J (YAREL0000012053); Ex. 97-J, p. 3; Ex. 107, pp. 4-5; Ex. 129, p. 3).

Objection: inaccurate. Section 3(c)(7) of the Investment Company Act of 1940 does not exempt "investment companies" from registering with the SEC. Section 3(c)(7) exempts from the definition of "investment company" any issuer meeting the criteria set forth in section 3(c)(7). The private placement memoranda cited by petitioners did not provide that YA Global was an investment company. Rather, the private placement memoranda provided that YA Global was "not registered as an investment company under the Investors Act of 1940 . . . in reliance on Section 3(c)(7) thereof." (See e.g., 30-J at YAREL0000012061.)

110. Investments in hedge funds organized under Section 3(c)(7) of the Act are limited to qualified purchasers who are investors with a high degree of financial sophistication and are in a position to appreciate the risks associated with investment pools that do not have the protections afforded by the Act. (Ex. 2003-R, pp. 9-10.)

No objection.

111. As a result, YA Global sought capital only from investors with sufficient net worth and sophistication to allow them to absorb large losses, such as high net worth individuals and institutional investors (i.e., "accredited investors"). (Tr. 51:20-52:7; Ex. 97-J, p. 3; Ex. 100-J, p. 21; Ex. 114-J, p. 14; Ex. 122-J, p. 3; Ex. 123-J, p. 4; Ex. 125-J, p. 3; Ex. 129-J, p. 3; Ex. 130-J, p. 3.)

Objection: inaccurate. An "accredited investor" is defined under Rule 501D of the Securities Act of 1933. Rule 501D provides a list of categories and a person will be considered an accredited investor only if the person comes within any of the categories.

112. Investors had no voting rights or rights to participate in the management of the feeder funds or YA Global itself. (Ex. 24-J, § 2.1; Ex. 25-J, § 2.1; Ex. 30-J (YAREL0000012065, YAREL0000012073); Ex. 97-J, pp. 14, 23; Ex. 99-J, p. 16; Ex. 100-J, p. 16; Ex. 104-J, p. 13; Ex. 114-J, p. 13; Ex. 123-J, pp. 13, 19, 34, 72; Ex. 125-J, pp. 12, 18-19, 33, 73; Ex. 129-J, pp. 12, 20, 34, 76; Ex. 130-J, pp. 14, 21, 35, 78.)

Objection: inaccurate. Under the YA Global 2006 Partnership Agreement and the 2007 Partnership Agreements, no limited partner could take part in the management of YA Global. (RPFF ¶¶ 26, 28; Ex. 24-J at § 2.1; Ex. 25-J at § 2.1; Ex. 26-J at § 2.1.) However, the general partner was vested with exclusive authority to manage YA Global. (RPFF ¶ 28.) To the extent "investor" in Pet’rs’ PFF ¶ 112 refers only to the limited partners in YA Onshore (or the limited partners of YA Global prior to the formation of YA Onshore) and the shareholders in YA Offshore, no objection.

113. Investors were subject to significant lockup periods and redemption restrictions, with general partner being able, in its discretion, to suspend the right of investors to redeem their interests for any reason. (See, e.g., Ex. 24-J, §§ 5.2, 5.3; Ex. 25-J, §§ 5.3, 5.4, 5.5; Ex. 30-J (YAREL0000012071-73) (discussing redemptions); Ex. 97-J, pp. 21-23 (discussing redemptions), 83 (discussing two-year lock-up); Ex. 100-J, p. 49 (discussing redemptions and two-year lock-up); Ex. 114-J, pp. 18-19; Ex. 125-J (discussing withdrawals).)

Objection: inaccurate, argumentative. The general partner could suspend a limited partner’s right to withdraw its investment if, and only if, certain conditions existed. (Ex. 24-J at § 5.3 (YA Global); Ex. 25-J at §§ 5.4 and 5.5 (YA Global); see Ex. 125-J at p.0004 (YA Onshore) ("The General Partner reserves the right to suspend withdrawals under certain circumstances").) The general partner could suspend payment of any withdrawals (i) during the existence of any state of affairs which in the opinion of the general partner makes the determination of the partnership’s investments impractical or (ii) when withdrawals or distributions in the opinion of the general partner may result in violation of applicable law. (Ex. 24-J at § 5.3 (YA Global); Ex. 25-J at § 5.5 (YA Global).) The general partner could suspend the payment of any withdrawal if the limited partners requested withdrawal in the aggregate of more than 15% of the partnership’s net worth. (Ex. 24-J at § 5.3(b) (YA Global); Ex. 25-J at § 5.4 (YA Global); Ex. 125-J at p. 0040 (YA Onshore).) The Board of Directors of YA Offshore could suspend a shareholder’s right to redeem its investment if, and only if, certain conditions existed. (Ex. 111-J at p.005 ("The Board of Directors reserves the right to suspend redemptions under certain circumstances").) The Board of Directors of YA Offshore could suspend the payment of any redemptions if the requested redemptions amounted in the aggregate to more than 15% of YA Offshore’s net worth. (Ex. 111-J at p. 0018 (YA Offshore).)

A lock-up period is the time during which the investor may not withdraw its capital after its initial investment. (Ex. 2003-R at p.24.) During the Relevant Period, in order to withdraw its capital, an investor in YA Global, YA Onshore or YA Offshore may have been subject to a lock-up period of 1-2 years or no lock-up period at all, depending on the investor’s class of ownership. (Exs. 206-J through 238-J at p.001 of each.) A two-year lock-up period was popular in and around 2004. (Ex. 2003-R at p. 24.) Therefore, a range of lock-up periods from 0 to 2 years was not "significant."

B. Investment Strategy

114. Hedge funds pool capital from their investors and, based on an investment strategy, invest the proceeds. (Ex. 2003-R, p. 5.)

No objection: for proposed fact that hedge funds pool capital from their investors.

Objection: to remainder of proposed finding, see General Objection no. 1.

115. In this case, YA Global’s partnership agreement imposed no limits on the types or sizes of investment that the Fund could make or how the investments could be made. (Ex. 30-J (YAREL0000012080); Ex. 97, p. 30; Ex. 100-J, p. 34; Ex. 114, p. 30; Ex. 122-J, p. 30; Ex. 123-J, p. 31; Ex. 124-J, p. 30.)

Objection: see General Objection no. 1., misleading. Nothing in the partnership agreements prevented YA Global from operating a business, which could include financing, lending and underwriting. (RPFF ¶ 34.)

116. Yorkville had broad discretion to make any investments for the Fund (Ex. 30-J (YAREL0000012095); Ex. 97-J, pp. 45, 56; Ex. 122-J, p. 27; Ex. 123-J, p. 28; Ex. 125-J, p. 26; Ex. 129-J, p. 28; Ex. 130-J, p. 28; Tr. 88:21-89:10), and it could change the Fund’s financing structures or investment strategies without notice to or approval from the limited partners (Ex. 30-J (YAREL0000012062); Ex. 97, p. 12, 45; Ex. 100-J, p. 14; Ex. 114, p. 12; Ex. 122-J, p. 11; Ex. 123-J, p. 12; Ex. 125-J, p. 11; Ex. 129-J, p. 11; Ex. 130-J, p. 12; Tr. 62, 88:21-89:10).

Objection: see General Objection no. 1., inaccurate, incomplete, misleading, irrelevant. To support the proposed finding "Yorkville had broad discretion to make any investments for the Fund," Pet’rs’ PFF ¶ 116 cites to various private placement memoranda that, in pertinent part, actually state that the "general partner" had broad discretion in making investments for the fund. (See e.g., Ex. 30-J at YAREL0000012077.) Yorkville Advisors was the general partner of YA Global until January 14, 2007 and the manager of YA Global during the Relevant Period. (1st Stip. ¶ 8 and RPFF ¶ 37.) Pet’rs’ PFF ¶ 116 does not specify whether it is referring to "Yorkville" in its capacity as general partner or manager. In its capacity as YA Global’s manager, Yorkville Advisor’s activities undertaken on behalf of YA Global were subject to the policies and control of YA Global’s general partner. (Ex. 28-J at § 9.) Also, YA Global had the right to advise its manager Yorkville Advisor of any specific investment restrictions. (RPFF ¶ 43; Ex. 27-J at § 3.)

To support the proposed finding Yorkville Advisors "could change the Fund’s financing structure or investment strategies without notice or approval from limited partners," Pet’rs’ PFF ¶ 116 cites to various private placement memoranda all of which but one do not actually name a particular person (e.g. "Yorkville Advisors") which could change the fund’s structures or strategies without notice to or approval from the limited partners. (See e.g., Ex. 30-J at YAREL0000012062 ("Due to the Fund’s broad investment objective, no prior notice to or consent of the Limited Partners is required for changes in the Fund’s financing structures."); but see, Ex. 125-J at p.26 ("The investment objective of the Fund and the investment strategies and techniques by which it seeks to accomplish its objective may be changed by the General Partner and/or Investment Manager without notice to or the consent of the existing investors in the Fund.").) Also, the private placement memoranda of YA Offshore cited in Pet’rs’ PFF ¶ 116 do not refer to "limited partners" but rather to "shareholders" because YA Offshore is a corporation. (See e.g. Ex. 114-J at p.12.) The private placement memoranda define Limited Partners as those individuals and institutional investors investing in YA Global (prior to the formation of YA Onshore) or the feeder funds. (See e.g. 30-J at YAREL0000012061.) To the extent "limited partners" in Pet’rs’ PFF ¶ 116 refers only to these individuals and institutional investors who are limited partners of YA Onshore (or the limited partners of YA Global prior to the formation of YA Onshore) and the shareholders in YA Offshore, this part of Pet’rs’ PFF ¶ 116 is irrelevant. That Yorkville Advisors could make changes without notifying these investors is irrelevant to the consideration of the issues in this case. As discussed above, Yorkville Advisors was subject to the policies and control of YA Global and its general partner.

117. During the period at issue, YA Global’s investment strategies and objectives were articulated in the PPMs of the Fund and its feeders (see, e.g., Ex. 30-J (YAREL0000012062), p. 12; Ex. 97-J, p. 12; Ex. 122, p. 10; Ex. 123, p. 11; Ex. 125-J, p. 10, Ex. 129-J, p. 10; Ex. 130-J, p. 11), with the discussion of the investments, investment objectives, and strategies of the feeders including those of the Fund (Ex. 99-J, p. 13; Ex. 100-J, p. 13; Ex. 104-J, p. 11; Ex. 114-J, p. 11; Ex. 123-J, p. 3; Ex. 125-J, p. 2; Ex. 129-J, p. 2; Ex. 130-J, p. 2.)

Objection: see General Objection No. 1., incomplete. YA Global’s strategies and objectives were also articulated on its website and in materials provided to potential and existing investors in YA Global and its feeder funds and to companies interested in securing financing from YA Global. (RPFF ¶¶ 93, 94, 96, 103, 104, 106, and 109.)

118. The PPMs made clear in many sections that the Fund’s strategy was to "invest." (PFFs ¶¶ 119-121.)

Objection: misleading, incomplete. See General Objection No. 1 and Resp’s Obj. to Pet’rs’ PFF ¶¶ 119-211, below.

119. The Fund’s "principal investment strategies" were as follows:

• Investing a majority of its assets in equity and convertible debt instruments, which are often lower-quality debt securities;

• Providing capital appreciation, rather than seeking a current yield;

• Investing in companies in troubled or uncertain financial condition;

• Investing in money market, commercial paper and investment-grade cash equivalents; and

• Investing in domestic and foreign issuers.

(E.g., Ex. 30-J (YAREL0000012062); Ex. 97-J, p. 12; Ex. 100-J, p. 14; Ex. 114-J, p. 11; Ex. 122, p. 10; Ex. 123, p. 11; Ex. 125-J, p. 10, Ex. 129-J, p. 10; Ex. 130-J, p. 11.)

Objection: see General Objection No. 1, inaccurate, incomplete. Pet’rs’ PFF ¶ 119 purports to list the "principal investment strategies" that are listed in bullet point form in the cited private placement memoranda. Pet’rs’ PFF ¶ 119 claim that one of YA Global’s "principal investment strategies" listed in the private placement memoranda was "Providing capital appreciation, rather than a current yield." Pet’rs’ PFF ¶ 119 misrepresents this bullet point. The relevant bullet point from several private placement memoranda cited by petitioners actually reads in full:

• Providing capital appreciation from an investment in the Fund rather than seeking a current yield.

(Ex. 30-J at YAREL000012062; Ex. 97-J at p.12; Ex. 100-J at p. 14 (emphasis added); see also Ex. 96-J at p.12 (same); Ex. 97-J at p. 12 (same); Ex. 99-J at p.14 (same).)

Therefore, this bullet, as properly quoted, conveys how an investor should view an investment in YA Global or one of its feeder funds, not the source of revenue or returns that YA Global sought to capture from financing companies. The remaining private placement memoranda cited by petitioners at Pet’rs’ PFF ¶ 119 contain the abbreviated version of this bullet point about how an investor should view an investment in YA Global.

To the extent Pet’rs’ PFF ¶ 119 could be interpreted as proposing a finding that YA Global had a principal strategy to acquire stock from a company and hold that stock for a long-term period in order to profit from an increase in the market value of that stock, respondent objects on the basis that such a finding would be incomplete, inaccurate and contrary to the record.

The private placement memoranda explained that in financing companies YA Global earned interest, received fees, acquired stock at a discount to the market price, and received warrants and other compensatory stock. (See e.g., Ex. 30-J at YA REL0000012067, YAREL0000012078, YAREL0000012079, YAREL0000012116.) Consistent with this, YA Global claimed in various materials that it principally sought to achieve returns from earning interest, receiving fees, the "spread" between the amount paid for stock it obtained directly from companies at a discount to the market price and the proceeds from selling that stock into the public market at the market price, executing warrants and selling other compensatory stock. (RPFF ¶¶ 60, 68, 72, 73, 236, 257, 297, 300, 332, 341, 372, 374, 386-398, 451.)

YA Global’s financing transactions undertaken with companies confirm that YA Global did not principally endeavor to acquire and hold stock long-term in order to profit from an appreciation in the market price of that stock. YA Global did not in fact hold stock in companies for the long term. (RPFF ¶¶ 68, 352.) Relative to its other assets, YA Global actually held relatively very little stock in the companies it financed. (RPFF ¶ 72.) YA Global’s gains were almost entirely realized in 2006 (97%) and 2007 (98%). (RPFF ¶ 352, 354, 355.)

YA Global would only exercise a conversion on a convertible debenture if it had decided that it was going to immediately sell the stock received from the conversion. (RPFF ¶¶ 68, 248, 445.) YA Global "made money" from warrants in a similar way to how it made money from converting the convertible debentures-exercising the warrant when the exercise price was below market price and then selling the stock at the market price. (Tr. 216:10-17.)

YA Global considered a "primary" return on SEDAs to come from the "spread," i.e., the difference between the amount it paid for the stock acquired upon a SEDA advance at a discount to the market price and the proceeds from selling that stock into the public market at the then-prevailing market price. Hence, the "spread" was not dependent upon an increase in the stock’s market price. (RPFF ¶¶ 73, 329, 330, 334, 335.) Companies that had entered into SEDAs with YA Global understood that YA Global would have an incentive to immediately sell stock acquired from a SEDA advance in order to capture the spread. (RPFF ¶ 350.) YA Global informed companies up front that it intended to promptly sell the stock acquired from a SEDA advance. (RPFF ¶ 351.) In fact, a company had to first secure and maintain an effective registration for the stock from the SEC as pre-condition to making an advance request under a SEDA. (RPFF ¶ 273(a).) Similarly, YA Global was not obligated to pay for the stock on the advance date if the registration was not declared effective by the SEC. (RPFF ¶ 282(b).)

YA Global typically received compensatory shares as fees from companies. (RPFF ¶¶ 300, 372-374.) YA Global sold these shares fairly quickly after it received them. (RPFF ¶ 402.)

120. The Fund’s investment objective was to achieve superior risk adjusted returns through capital appreciation primarily by making directly negotiated private equity and debt investments in public and private companies. (Ex. 30-J (YAREL0000012062); Ex. 97-J, p. 12; Ex. 100-J, p. 14; Ex. 114-P, p. 11; Ex. 122-J, p. 11; Ex. 123-J, p. 12; Ex. 125-J, p. 11; Ex. 129-J, p. 11; Ex. 130-J, p. 12.)

Objection: see General Objection No. 1. See Resp’s Obj. to Pet’rs’ PFF ¶ 119.

121. Investors seeking current income were advised not to invest in the Fund. (E.g., Ex. 30-J (YAREL0000012078); Ex. 97-J, p. 28; Ex. 100-J, p. 32; Ex. 114-J, p. 28 Ex. 122, p. 28; Ex. 123, p. 29; Ex. 125-J, p. 27, Ex. 129-J, p. 28; Ex. 130-J, p. 29.)

Objection: misleading, irrelevant. Pet’rs’ PFF ¶ 121 cites to private placement memoranda. Each private placement memorandum cautioned prospective and existing investors that it is not "advice." (See e.g., Ex. 30-J at YAREL0000012052, YAREL0000012054, YAREL0000012070.) The private placement memoranda actually stated in relevant part: "Investors seeking current income should not invest in the Fund." The timing and type of an investor’s income derived from investing in one of the feeder funds (or in YA Global directly prior to the formation of YA Onshore) has no bearing on whether YA Global was engaged in a trade or business under section 864(b).

122. YA Global’s Forms 1065 listed its principal business activity as "investment." (Ex. 1-J (YALIT000081); Ex. 2-J (YALIT000463); Ex. 3-J (YALIT000815); Ex. 4-J (YALIT000850); Ex. 5-J (YALIT000913); Ex. 6-J (YALIT000984).)

No objection: to the finding that YA Global’s Forms 1065 listed its principal business activity as "investment."

Objection: self-serving, to the extent the finding implies that YA Global’s principal activity was "investment" during the Relevant Period for federal tax purposes.

123. YA Global’s financials explained that the Fund was formed for the purpose of purchasing, holding, selling and trading in securities and other financial instruments of U.S. and foreign entities. (Ex. 285-J, p. 13; Ex. 286-J, p. 16; Ex. 287-J, p. 16; Ex. 288-J, p. 19; Ex. 289-J, p. 18; Ex. 290-J, p. 14.)

No objection: to the finding that YA Global’s financial statements stated that YA Global was formed for the purpose of purchasing, holding, selling and trading in securities and other financial instruments of U.S. and foreign entities.

Objection: contrary to the record, to extent that the finding implies that YA Global engaged in trading for U.S. federal tax purposes during the Relevant Period. See Resp’s Brief at Argument, sec. II.D.

124. YA Global’s governing partnership agreements also made clear that YA Global was established for the purpose of investing. They provided that the Fund was organized for the following purposes:

• To invest, on margin or otherwise, in securities and other financial instruments of U.S. and non-U.S. entities . . .;

• To engage in such other related activities and transactions as the General Partner may from time to time determine; and

• To enter into, and . . . to make and perform all contracts and other undertakings, and engage in all activities and take all such actions, as may be necessary or advisable for carrying out the purposes of the Partnership . . .

(Ex. 24-J, § 1.5; Ex. 25-J, § 1.7; Ex. 24-J, § 1.7; Ex. 26-J, § 1.7; Tr. 61:25-62:21.)

First sentence. Objection: see General Objection no. 1., self-serving.

Second sentence. Objection: see General Objection no. 1., incomplete. The second sentence of Pet’rs’ PFF ¶ 124 purports to depict the purposes for which YA Global was organized, as set forth in the agreements. This sentence provides an incomplete depiction of the purposes set forth in the agreements. For example, Pet’rs’ PFF ¶ 124 neglects to mention that, according to the agreements, a purpose of YA Global’s organization was to enter into and engage in all activities as may be necessary to purchase or otherwise acquire securities, including notes, debentures, loans and other obligations and instruments or evidence of indebtedness of whatever kind or nature. (Ex. 24-J at §§ 1.5(c)(i) and (a); Ex. 25-J at §§ 1.7(c)(i) and (a); Ex. 26-J at §§ 1.7(c)(i) and (a).) Pet’rs’ PFF ¶ 124 also neglects to mention that the partnership agreements provided that YA Global could enter agreements to authorize others to perform these undertakings "on behalf of’ YA Global. (Ex. 24-J at § 1.5(c); Ex. 25-J at § 1.7(c); Ex. 26-J at § 1.7(c).

125. YA Global’s lockup period and redemption restrictions were hallmarks of funds organized for investment purposes. (Ex. 3003-P, ¶¶ 100-105; see also Ex. 24-J, §§ 5.2, 5.3; Ex. 25-J, §§ 5.3, 5.4, 5.5; Ex. 30-J (YAREL0000012071-73) (discussing redemptions); Ex. 97-J, pp. 21-23 (discussing redemptions), 83 (discussing two-year lock-up); Ex. 100-J, p. 49 (discussing redemptions and two-year lock-up); Ex. 114-J, pp. 18-19, 71; Ex. 125-J (discussing withdrawals).)

Objection: see General Objection no. 1., inaccurate, uncorroborated, unsupported conclusion, no competent evidentiary support in the record, self-serving. The citations for Pet’rs’ PFF ¶ 125- Exs. 3003-P, 24-J, 25-J, 30-J, 97-J, 100-J, 114-J or 125-J- do not support the finding, or even address, that YA Global’s lockup period and redemption (withdrawal) restrictions were "hallmarks of funds organized for investment purposes."

126. Thus, YA Global’s "activities" were limited to those related to or necessary or advisable for investing, and the investors in YA Global had no common purpose other than investing. (PFFs ¶¶ 124, 125; Tr. 62:8-21.)

Objection: see General objection no. 1., see Resp’s Obj. to Pet’rs’ PFF ¶¶ 114-125. Also, Pet’rs’ PFF ¶ 126 is conclusory rather than factual.

127. The Fund did not generally take board seats or engage in active management of its portfolio companies. Rather, it was a passive investor. (E.g., Ex. 30-J (YAREL0000012099); Ex. 97-J, p. 49; Ex. 100-J, p. 55-56; Ex. 114-J, p. 48; Ex. 125-J, p. 48; Ex. 129-J, p. 50; Ex. 130-J, p. 52; Tr. 94:2-95:2.)

First sentence. Objection: misleading. As part of its financings, YA Global did not seek a management role or board seats. (RPFF ¶ 70.) However, at times YA Global did take board seats or engage in active management in companies to which it provided financing.

Second sentence. Objection: see General Objection no. 1, uncorroborated, unsupported conclusion. The exhibits cited for Pet’rs’ PFF ¶ 127 do not support the finding that YA Global was a "passive" investor. To the extent the second sentence suggests that YA Global was an investor for U.S. tax purposes, conclusory in nature and contrary to record. (See Resp’s Brief at sec. II.C.)

128. YA Global was regularly recognized by market participants as an investor. (Exs. 1588-P, 1589-P, 1590-P, 1591-P. 1592-P, 1593-P, 1594-P, 1595-P.)

Objection: see General Objection no. 1. No other objection except to note that the so-called market participants do not appear to differentiate between YA Global and Yorkville Advisors as those names are used interchangeably in the exhibits. Compare Exs. 1588-P; 1589-P, 1590-P, 1591-P (referring to YA Global as the "investor") with Exs. 1592-P, 1593-P, 1594-P, 1595-P (referring to Yorkville Advisors as the "investor").

C. Target Portfolio Companies

129. The Fund invested primarily in microcap and low-priced public companies traded in over-the-counter ("OTC") public markets. (Tr. 63:1-10; Ex. 30-J (YAREL0000012062); Ex. 97-J, p. 12; Ex. 100-J, p. 14; Ex. 114-J, pp. 2, 12; Ex. 125-J, pp. 2, 10; Ex. 130-J, pp. 2, 11; Ex. 2001-R, ¶ 38.)

No objection.

130. In reviewing potential investments for the Fund, Yorkville focused on the strength of a company’s management team. (E.g., Ex. 882-J, pp. 8-9; Ex. 883-J, p. 2; Ex. 893-J; Ex. 902-J, pp. 3-5; Ex. 905-J, pp. 8-9; Ex. 936-J, p. 4; Ex. 961-J, p. 2; Ex. 972-J, p. 12; Ex. 975-J, pp. 7-8, 9.)

Objection: misleading, incomplete. See General Objection No. 1. YA Global took into account numerous factors in deciding whether to originate a loan to a company or to enter into a SEDA. Such factors included, but were not limited, to a company’s corporate structure, management team, cash flow, ability to repay the loan, credit risk, the company’s assets that could be used to secure the loan, prior financings and exit strategies. (RPFF ¶¶ 115., Ex. 167-J at p.009, Ex. 178-J at p.0011.)

131. It also focused on a company’s management business model and competitive position (e.g., Ex. 882-J, pp. 13-14, 24-57; Ex. 884-J, p. 15; Ex. 902-J, p. 2; Ex. 905-J, p. 1, 7; Ex. 1033-J, p. 14), the strengths of a company’s product or technology (e.g., Ex. 882-J, pp. 4, 6-7, 10-11, 24-57; Ex. 925-J, p. 4; Ex. 952-J, p. 2; Ex. 958-J, p. 1; Ex. 993-J, p. 1; Ex. 994-J, p. 1), the total addressable market for a company’s products or services (e.g., Ex. 882-J, pp. 12, 24-57; Ex. 902-J, pp. 2-3; Ex. 905-J, pp. 10, 12; Ex. 922-J, pp. 5-8; Ex. 936-J, p. 2), and a company’s valuation (e.g., Ex. 882-J, p. 20, Ex. 883-J, p. 2, Ex. 905-J, p. 6; Ex. 925-J, p. 4; Ex. 952-J, p.2, Ex. 967-J, p. 1; Ex. 975-J, p. 2).

Objection: misleading, incomplete. See Resp’s Obj. to Pet’rs’ ¶ 130.

132. YA Global often funded companies looking to expand their business, develop new technologies, or to acquire major assets. (See, e.g., Tr. 696:23-696:24, 696:14-696:15 (discussing that YA Global was MobilePro’s primary investor for several years and that MobilePro at that time tried to acquire telecommunication services companies); Ex. 883-J, p. 2 (Skreem Entertainment convertible debenture was to be used to fund an acquisition); Ex. 886-J, p. 1 (Cord Blood America funds to be used for an acquisition); Ex. 894-J (Jaguar Mining funds to be used to develop Monte Cristo mines); Ex. 902-J (Axiom Energy funds to be used to build a biodiesel plant); Ex. 905-J (Maritime Logistics funds to be used to acquire 2 companies); Ex. 922-J, p. 1 (Pure Biofuels funds to be used to build a biodiesel processing plant); Ex. 1033-J, p. 7 (funds to be used by ZVUE Corp, f.k.a. Handheld Entertainment in order to fund an acquisition of EbaumsWorld, Inc.).)

Objection: misleading, incomplete. See Resp’s Obj. to Pet’rs’ ¶ 130.

133. Yorkville often focused on whether a company’s value was likely to increase. (See, e.g., Ex. 952-J, p. 2 (Investment Committee minutes regarding LocatePlus providing, "[T]his Company is undervalued and presents a lot of upside potential."); Ex. 980-J, p.22 (Investment Committee minutes for BlueCreek providing, "If [the Fund] can add to the industry by assisting a company of BlueCreek’s stature become public, we expect our investment to be worth a great deal more than its initial valuation.".)

Objection: misleading, incomplete. See Resp’s Obj. to Pet’rs’ ¶ 130.

134. The due diligence process focused on a portfolio company’s potential business, not just its current business. (PFFs ¶¶ 130, 131, 132, 133.)

Objection: misleading, incomplete. See Resp’s Obj. to Pet’rs’ ¶ 130.

Objection: misleading, incomplete. See Resp’s Obj. to Pet’rs’ ¶ 130.

135. Portfolio companies frequently had limited cash flow and few assets. (Tr. 95:18-96:4, 337:19-338:11, 920:3-9; Ex. 1495-J, p. 25 (prior to obtaining the funds from YA Global, LocatePlus had assets with a combined value of $5,670,815, and it had only $29,822 in cash).)

Objection: misleading, incomplete, not supported by the record. See Resp’s Obj. to Pet’rs’ ¶ 130.

136. The companies’ SEC filings disclosed their weak financial condition. (E.g., Ex. 527-J, pp. 6, 7 (discussing history of losses for LocatePlus and noting that the company’s accountants expressed doubt as to the assumption that LocatePlus could continue as a going concern); Ex. 1529-J, p. 21 (annual SEC report for Pure Biofuels discussing lack of operating history); Ex. 1568-J, p. 15 (SEC filings for Wherify Wireless disclosing lack of liquidity and limited revenues).)

Objection: misleading, incomplete. See Resp’s Obj. to Pet’rs’ ¶ 130.

137. The companies had frequent name changes, stock splits, mergers, and changes in management, strategy and direction. (Tr. 916:25-917:9.)

Objection: misleading, incomplete, immaterial. Whether a company changed its name, had stock splits, and other changes is immaterial to whether YA Global made loans or provided underwriting or other financial services to the company.

138. They were at high risk of bankruptcy. (Ex. 3003-P, ¶ 92-94, Figure 7.)

Objection: misleading, incomplete, immaterial. Whether a company is a high risk of bankruptcy is immaterial to whether YA Global made loans or provided underwriting or other financial services to the company.

139. YA Global’s portfolio companies would be unable to obtain loans from traditional banks because they lacked the attributes that a commercial bank would consider in making a loan. (See Tr. 452:10-12; Tr. 1174:20-1175:1; see also PFFs ¶¶ 135, 136, 137, 138, 140, 141, 142.)

Objection: misleading, incomplete, immaterial. Whether a company could obtain a loan from a tradition back is immaterial to whether YA Global made loans or provided underwriting or other financial services to the company.

140. The portfolio companies’ stocks were thinly traded, which often made it difficult to sell in any significant quantities. (E.g., Ex. 1432-J, p. 38 (Epicept stated in its SEC filings that there were factors that "may cause the market price and demand for our stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock and may otherwise reduce the liquidity of our common stock"); Ex. 1437-J, p. 9; Ex. 1438-J, p. 10 (FacePrint Global explained in its annual reports, "Trading in our common stock has generally been limited and sporadic, and should not be deemed to constitute an ‘established trading market"); Ex. 1503-J, p. 47 (Mobile Pro’s quarterly report included multiple paragraphs explaining the risk associated with low trading activity in the secondary market for its stock); Ex. 527-J, p. 12 (explaining the consequences of LocatePlus being traded only in over the counter ("OTC") markets); Ex. 3008-P, ¶ 45 (stating that limited liquidity was associated with significant risk that investment exit could take an extended period of time). See also PFFs ¶¶ 163, 164)

Objection: misleading, immaterial. Whether a company was thinly traded is immaterial to whether YA Global made loans or provided underwriting or other financial services to the company.

141. YA Global’s portfolio companies were rarely covered by research analysts or credit ratings agencies, which contributed to their shares being thinly traded. (Ex. 3008-P, ¶ 46.)

Objection: misleading, immaterial. Whether a company is covered by research analysts is immaterial to whether YA Global made loans or provided underwriting or other financial services to the company.

142. YA Global’s portfolio companies were high-risk, "penny stock" companies. (PFFs ¶¶ 135, 136, 137, 138, 140.)

Objection: misleading, immaterial. Whether a company is high risk is immaterial in determining whether YA Global made loans or provided underwriting or other financial services to the company

D. Funding Mechanisms and Investment Structures

143. YA Global funded portfolio companies using convertible debentures, standby equity distribution agreements ("SEDAs") and other securities. (See, e.g., Ex. 285-J, p. 13; Ex. 286-J, p. 17; Ex. 287-J, p. 16; Ex. 288-J, p. 19; Ex. 289-J, p. 18; Ex. 290-J, p. 14; see also Ex. 30-J (YAREL0000012062); Ex. 97-J, p. 12; Ex. 122-J, p. 11; Ex. 123-J, p. 12; Ex. 125-J, p. 11; Ex. 129-J, p. 11; Ex. 130-J, p. 12.)

No objection.

144. The majority of YA Global’s assets were invested in convertible debentures, but it also held convertible preferred stock, common stock, promissory notes, warrants and cash. (Ex. 285-J, pp. 5-9; Ex. 286-J, pp. 5-12; Ex. 287-J, pp. 4-12; 288-J, pp. 5-15; Ex. 289-J, pp. 5-16; Ex. 290-J, pp. 8-13; Ex. 291-J, pp. 7-13.)

Objection: see General objection, no. 1. No other objection other than to note that for a more complete statement of facts on the relative percentage that each asset class comprised of YA Global’s total assets, as well as on YA Global’s SEDA commitments, see RPFF ¶¶ 72, 160, 255, 325, 469, 663, and 664.

145. Although YA Global used a variety of different instruments to provide funding, "the common flavor of all of them was that they were equity or equity-linked." (Tr. 698:1-3.)

Objection: misleading, inaccurate, contrary to the record. Pet’rs’ PFF ¶ 145 cites only the testimony of Jay Wright, the CEO of MobilePro, a company that YA Global financed during the Relevant Period. (Tr. 696:1-2, 20-25; Tr. 697:105.) Mr. Wright was speaking only about financing transactions that MobilePro entered into with YA Global and not any of the transactions that any other companies entered into with YA Global. (Tr. 697:6-25, 698:1-3.) Therefore, to suggest that Mr. Wright’s personal view, from a very limited perspective, supports a description of YA Global’s financing transactions and structures generally is misleading. Moreover, it is unclear what Mr Wright meant by "equity-linked." Mr. Wright testified that MobilePro used "both debt and equity" financing from YA Global. (Tr. 699:13-16.)

Also, Mr. Wright was specifically referencing only SEDAs and convertible debentures when describing the financing as "equity or equity-linked." (Tr. 696-698.) During the Relevant Period, YA Global originated and acquired over 200 promissory notes, i.e. loans without conversion features. (RPFF ¶¶ 148, 155.) Therefore, to suggest, as Pet’rs’ PFF 145 does, that a commonality among YA Global’s financing structures was that they were all "equity or equity-linked," is undeniably wrong for that reason alone.

146. The Fund’s investments were always for its own account. (Tr. 78:19; Ex. 30-J (YAREL0000012116, YAREL0000012118); Ex. 97-J, pp. 66, 68; Ex. 104-J, p. 57; Ex. 111-J, pp. 55-56; Ex. 118-J, pp. 55-56; Entire Record.)

Objection: see General objection no. 1. To the extent the finding is intended to suggest that YA Global satisfied the trading safe harbor at section 864(b)(2)(A)(ii), objection: not supported by the record. (See Resp’s Brief at Argument sec. II.D.)

147. Yorkville, on behalf of the Fund, would often negotiate a "blockage discount" when negotiating conversion price for convertible debentures or share price for SEDAs to compensate for the risk of illiquidity. (Tr. 1819:23-1820:16; PFFs ¶¶ 141, 142.)

Objection: misleading, contrary to record. Mr. Brokaw testified that he viewed the discounts as compensation for YA Global’s services. (Tr. 1607, 1627-28. Moreover, the discounts were small as compared to actual blockage discounts. Tr. 1627-6128.

1. Transactions in Convertible Debentures⁶

FN6 For purposes of illustration of the contents of convertible debenture documents generally, the parties have agreed that the documents in Exhibits 310-J through 320-J, which governed the transactions between YA Global and LocatePlus Holdings, are typical. S. ¶ 62.

Objection: misleading, inaccurate. Petitioners imply that the parties stipulated that the transaction between YA Global and LocatePlus Holdings was typical of a convertible debenture transaction. The parties did not so stipulate. The parties stipulated that the specific terms of the convertible debenture transaction could vary but that the types of documents and types of provisions within the documents were generally typical. (2d Stip. ¶ 62.)

148. The convertible debentures purchased by YA Global typically had a stated rate of interest and a maturity date of 2 to 3 years from the date of issuance. (Tr. 339:19-340:1; see also, e.g., Ex. 311-J, § 1(a).)

No objection, except to note that it was not uncommon for the maturity date to be less than 2 years. (See e.g., Exs. 461-J, 560-J, 565-J, 582-J, 623-J, 691-J, 727-J.)

149. YA Global had the right to convert portions of the debt into common stock of the company, and number of shares issued upon conversion was determined using a conversion price that was the lower of (i) a fixed price or (ii) a discount to an average market price computed over a specific period preceding the installment date. (Ex. 311-J, p. 19 ¶ 16(i)).)

Objection: inaccurate. YA Global had the right to convert a convertible debenture into shares of common stock in whole or in part, subject to certain limitations. (RPFF ¶¶ 196, 202.) For a more complete statement of facts on the typical conversion provisions of a convertible debenture, see RPFF ¶¶ 192-208.

150. YA Global typically converted debt into stock in tranches. (See, e.g., PFF ¶¶ 162)

Objection: uncorroborated, unsupported conclusion. The citation provided for Pet’rs’ PFF ¶ 150 does not support or corroborate the finding proposed.

151. Once YA Global owned the company’s stock, it could sell it in the public market, but convertible debenture agreements did not create any obligations for YA Global to sell a portfolio company’s stock. (See, e.g., Ex. 311-J (none of the provisions requiring YA Global to sell shares; see also PFF ¶ 164.)

No objection: except to note that, in practice, YA Global only converted if it was going to immediately sell the stock. (RPFF ¶¶ 68, 248, 445.)

152. Convertible debentures were typically issued with stock or warrants that gave YA Global additional upside in the company’s stock. (E.g., Exs. 310-J, 311-J, 312-J, 313-J, 314-J, 315-J, 316-J, 317-J (LocatePlus Holdings Corp. ("LocatePlus") convertible debenture issued concurrently with 6 different warrants); Ex. 416-J, 418-J (Homeland Security Capital Corp. ("Homeland Security") convertible debenture issued with preferred stock).)

Objection: misleading. YA Global could earn a profit from the sale of such stock without any increase in the market price of the stock.

153. The securities purchase agreements pursuant to which YA Global purchased convertible debentures contained a provision stating that the Fund was buying the securities for its own account and for investment only. (E.g., Ex. 310-J, § 2(a); see also S. ¶ 62 (the parties have stipulated that provisions contained in Ex. 310-J are typical of convertible debenture transactions in which YA Global entered).)

Objection: see General Objection no. 1, contrary to record, legal conclusion, inaccurate. To the extent the finding implies that YA Global satisfied the trading safe harbor at section 864(b)(2)(A)(ii), objection as contrary to the record. See Resp’s Brief at Argument sec. II.D. To the extent the finding implies that the inclusion of this language satisfies the identification requirement in section 475(b)(2), objection as a legal conclusion and inaccurate. (See Resp’s Brief at Arg. Part V.A.4; Resp’s Reply at Arg. Part VI.A.2.)

154. In a typical convertible debenture transaction, payments of installments were, by default, made via issuances of stock. (S. ¶ 62; Ex. 311-J, p. 5 (§ 3(a)).)

Objection: inaccurate, misleading, contrary to the record. With the exception of the convertible debentures that are Exs. 311-J and 849-J, the convertible debentures issued to YA Global that are exhibits in the record either did not call for installment payments or, if they did call for installment payments, did not provide that payment of the installments were by default made via issuance of stock. (See Exs. 344-J, 416-J, 425-J, 432-J, 442-J, 461-J, 518-J, 552-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 668-J, 679-J, 691-J, 727-J, 735-J, 736-J, 816-J, 829-J.) Therefore, this particular provision in Ex. 311-J that provided that installment payments were by default made in stock should not be viewed as typical or representative of convertible debentures generally.

To the contrary, many of the convertible debentures issued to YA Global that are exhibits in the record did not allow the company to elect to make any payments in stock. (See Exs. 416-J, 425-J, 432-J, 461-J, 518-J, 552-J, 603-J, 623-J, 648-J, 661-J, 727-J, 816-J, 829-J.) If a convertible debenture allowed for a company to elect to make payments in stock, such an election may have been limited to only payments of interest. (See e.g. Ex. 442-J, 668-J, 679-J, 735-J, 736-J.) Also, an issuer’s ability to pay in stock may have been unavailable unless numerous conditions were satisfied. (See e.g., Ex. 679-J at §§ 1(b), 17(i).)

155. In a typical convertible debenture transaction, YA Global could elect not to collect an installment payment, in which case the amount of the installment would remain due. (Ex. 311-J, p. 6 (§ 3(d)).)

Objection: inaccurate, misleading, contrary to record. With the exception of the convertible debentures at Exs. 311-J and 849-J, the convertible debentures issued to YA Global that are exhibits in the record and that called for installment payments did not provide that YA Global could elect not to collect an installment payment. (See Exs. 344-J, 416-J, 425-J, 432-J, 442-J, 461-J, 504-J, 518-J, 552-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 668-J, 679-J, 691-J, 727-J, 735-J, 736-J, 816-J, 829-J.) Therefore, this particular provision in Ex. 311-J that provided that YA Global could elect not to collect an installment payment should not be viewed as typical or representative of convertible debentures generally.

156. In a typical convertible debenture transaction, it was possible for a portfolio company to pay its debt in cash, but only if the company’s stock price was lower than a fixed conversion price, and even then only if (1) the company paid a redemption premium, and (2) YA Global chose not to convert. (Ex. 311-J, p. 7 (§ 3(f)) (redemption premium of 15%); Tr. 65:21-66:2, 66:21-24 (M. Angelo testimony); Tr. 934:18-935:3 (O. Franks testified that the redemption premium was a "penalty that a company would have to pay if they repaid a convertible debenture in cash" and that it was typically 20 percent).)

Objection: inaccurate, misleading, contrary to the record. Pet’rs’ PFF ¶ 156 misrepresents § 3(f) of Ex. 311-J. § 3(f) of Ex. 311-J does not set forth the only circumstances under which the company could have paid its debt in cash. § 3(f) of Ex. 311-J sets forth the circumstances under which the company may have "redeemed" a portion or all amounts outstanding under the debenture "in addition to" any installment amount "prior to" the Maturity Date. § 3(a) and (c) of Ex. 311-J provided that the company had the option to pay installment amounts on their corresponding installment dates in cash which would not be subject to the redemption premium under section 3(f). Also, specifically with regard to Ex. 311-Docket J, on the maturity date, the company was required to pay in cash the amount of all outstanding principal and interest. (Ex. 311-J at § 1(a).)

More generally with convertible debentures, a company would be required to pay a "redemption premium" only when the company sought to make payment prior to the scheduled date for that payment. (RPFF ¶¶ 192-193; see Exs. 311-J, 416-J, 425-J, 432-J, 442-J, 518-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 668-J, 679-J, 816-J, 829-J, 849-J.)

Also, many of the convertible debentures issued to YA Global that are exhibits in the record did not allow the company to elect to make any payments in stock. (See Exs. 416-J, 425-J, 432-J, 461-J, 518-J, 552-J, 603-J, 623-J, 648-J, 661-J, 727-J, 816-J, 829-J; see Resp’s Obj. to Pet’rs’ PFF ¶ 154.)

For these reasons, and setting aside the misrepresentations of Ex. 311-J in Pet’rs’ PFF ¶ 156, Pet’rs’ PFF ¶ 156 should not be viewed as typical or representative of convertible debentures generally.

157. YA Global and its portfolio companies expected the Fund to recoup its investments in convertible debentures primarily, if not exclusively, via selling the companies’ stock. (Tr. 66:24-67:4, 67:24-68:4 (testimony of M. Angelo testimony), 920:3-11 (O. Franks testimony), 729:20-24 (testimony of Jay Wright, CEO of MobilePro Corp. ("MobilePro") testimony), 1175:6-9 (Kevin Kreisler, CEO of Greenshift Corp. ("Greenshift") testimony); Ex. 30-J (YAREL0000012092) ("The Fund anticipates that repayment of convertible loans will come from the sale of the common stock underlying the convertible loans . . ."); see also Ex. 882-J, p. 5 (Nanoscience presentation to YA Global stated that it was looking for equity financing to execute its business plan).

Objection: misleading. See General objection no. 1. YA Global and the companies structured each convertible debenture to have a stated principal amount, rate of interest and maturity date. (RPFF ¶¶ 183, 185, 186.) The convertible debenture specified the amount of principal in dollars. (RPFF ¶¶ 185.) The company promised to pay the principal together with accrued but unpaid interest by the maturity date. (RPFF ¶ 183). The company’s obligations to pay the principal and the interest were absolute and unconditional. (RPFF ¶ 187). Each convertible provided for payment of principal and accrued but impaid interest in cash on the maturity date. (RPFF ¶¶ 183-187.) The convertible debentures provided that if an event of default occurred, the full principal amount together with interest became, at YA Global’s election, immediately due and payable in cash. (RPFF ¶ 189.) YA Global commonly asserted its right as senior secured creditor. (RPFF ¶¶ 132-136, 238, 240-242.)

158. YA Global was, in fact, highly likely to receive stock in exchange for the convertible debentures it held. (E.g., Tr. 920:12-20 (O. Franks testimony).)

Objection: misleading. Mr. Franks approximated that companies timely paid principal and interest in cash in approximately 15% of the convertible debentures. (Tr. 920:3-18.) While Mr. Franks did not provide any support or source for this approximation, it is not an insignificant amount given that YA Global acquired 481 convertible debentures during the Relevant Period. (RPFF ¶ 254.) Also, it does not necessarily follow, and cannot be assumed, from Mr. Franks’ testimony that YA Global was "in fact, highly likely to receive stock in exchange for the convertible debentures it held." YA Global was due the full amount of unpaid principal and interest in cash at the maturity date. (RPFF ¶¶ 183, 185, 187.) Also, Pet’rs’ PFF ¶ 158 fails to account for YA Global’s recovery on convertible debentures on which companies did not make full payments of principal and interest. A convertible debenture was typically secured and the most senior indebtedness of the company. (RPOFF ¶¶ 71, 210, 213, 235, 448.) YA Global routinely enforced its rights as a creditor and may have recovered all or some of its financing through such enforcements. (RPFF ¶¶ 132-135, 240, 447.) Also, if an "event of a default" occurred, YA Global could immediately demand payment in cash. (See RPFF ¶ 191.)

159. YA Global consistently represented in convertible debentures documentation that it was an accredited investor for purposes of securities laws. (E.g., Ex. 310-J, p. 3 (§ 2(b)).)

Objection: see General objection No. 1, to the extent the implication of Pet’rs’ PFF ¶ 159 is that YA Global was an investor for federal tax purposes.

160. Convertible debentures typically included provisions to ensure that YA Global would not hold so much stock in a company that it would be required to report its holdings to the SEC. (See, e.g., Ex. 311-J, p. 9 (§ 4(c)(i)) (4.99% cap).)

Objection: incomplete. See RPFF ¶ 202 for a full statement of facts on the provision in convertible debentures prohibiting a conversion from resulting in YA Global, together with any affiliate, from owning more than 4.99% of the company’s stock.

161. Typically, a default was triggered under the convertible debenture if a portfolio company’s stock was delisted or if the company had problems with its SEC registration. (Ex. 311-J, p. 3 (§§ 2(a)(iv), 2(a)(vi)); see also S. ¶ 62 (parties’ stipulation).)

Objection: incomplete, misleading. Pet’rs’ PFF ¶ 161 mentions two "events of default" under a convertible debenture. Typically, a convertible debenture listed ten or more "events of default." (RPFF ¶ 191 (listing typical events of default); see e.g., Ex. 648-J at § 2.) Upon the occurrence of an event of default, the outstanding amount of the convertible plus accrued but unpaid interest became immediately due and payable in cash to YA Global. (RPFF ¶ 189.)

162. Because the price of shares used to determine the number of shares to be received by YA Global was different from the market price at which such shares would eventually be sold, YA Global had no way of predicting the amount it would ultimately receive not only at the time the funds were advanced, but up until the date upon which the full amount of the debt was extinguished. (See, e.g., Ex. 1282-J, 2008 tab, rows 503, 504 (showing conversion of convertible debentures for LocatePlus); see also Tr. 920:21-921:10 (O. Franks’ testimony); see also discussion with examples in note 53 below and in Section III.A.1. of the Legal Discussion.)

Objection: vague, inaccurate, misleading, irrelevant, contrary to the record. The purpose of Pet’rs’ PFF ¶ 162 is unclear and the language is vague. For example, it is unclear whether "shares eventually sold" refers to shares sold to YA Global by the company upon a conversion by YA Global or to converted shares sold by YA Global into the public market. It is also unclear whether "amount it would ultimately receive" refers to the amount of stock YA Global would receive upon a conversion or the amount of cash YA Global would receive upon selling converted stock into the public market.

A convertible debenture had a stated principal amount, rate of interest and maturity date. (RPFF ¶¶ 183, 185, 186.) Pet’rs’ PFF ¶ 162 assumes that YA Global elected to convert. YA Global could have chosen not to elect to convert and be paid in cash. (Exs. 344-J, 416-J, 425-J, 432-J, 442-J, 461-J, 504-J, 518-J, 552-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 668-J, 679-J, 691-J, 727-J, 735-J, 736-J, 816-J, 829-J.) Similarly, if there was an "event of default," the outstanding principal and interest became immediately due and payable to YA Global in cash. (RPFF ¶ 189.) Each of these facts by itself proves Pet’rs’ PFF 162 is wrong to propose that YA Global had "no way of predicting the amount that it would ultimately receive . . . up until the date upon which the full amount of the debt was distinguished."

Even in the event that YA Global did convert, Pet’rs’ PFF ¶ 162 is still wrong. YA Global could convert the debenture in whole or in part. (RPFF ¶ 196.) If YA Global converted a convertible debenture, YA Global would submit a Conversion Notice which would set forth the amount of the conversion which, upon the conversion, would have the effect of lowering, as applicable, the principal amount plus accrued and impaid interest. (See, e.g., Exs. 311-J at § 4(b)(iii) and 648-J at § 3(a)(iii); Tr. 732:20-25, 733:1-14, 920:9-11.) YA Global and the company were required to maintain records showing the principal amount converted. (See, e.g., Ex. 648-J at § 3(a)(iii).) If YA Global elected to convert, YA Global would receive payment in stock (priced at a discount) with a value equal to the amount of cash it otherwise would have received. RPFF ¶¶ 199-200.

163. In the vast majority of cases, it would have taken YA Global at least two to three days to dispose of the stock it acquired via a conversion, and in most cases it would have taken upwards of ten days. (Ex. 3008-P, Ex. 7 p. 36 (Exhibit 7 of Stowell Report).)

Objection: misleading, incomplete. The cite does not support the proposed finding.

164. YA Global frequently held stock it acquired via conversion for long periods of time. (E.g., Ex. 2001-R, Appendix F-2 (it took YA Global one to two months to sell shares of MobilePro acquired under convertible debentures), Ex. 2001-R, Appendix F-6 (YA Global held a long position in Homeland Security for approximately 2½ years), Ex. 2001-R, Appendix F-7 (the Fund held stock in Immune Response for a month or longer), Ex. 2001-R, Appendix F-12 (the Fund held NanoScience for 4½ years).)

Objection: misleading, not supported by the record. YA Global would only convert convertible debentures if it intended to sell the stock immediately and there was a bid in the market. (RPFF ¶¶ 243-48.)

165. YA Global generally held convertible debentures for around 18 months. (See, e.g., Ex. 97-J, p. 29, Ex. 100-J, p. 33; Ex. 114-J, p. 29; Ex. 125-J, p. 28; Ex. 129-J, p. 29; Ex. 130-J, p. 30; Ex. 2001-R, p. 27, fn. 76.)

Objection: misleading. The private placement memoranda cited by Pet’rs’ PFF ¶ 165 provided that with convertible debentures the "target horizon is generally less than one year or so." (See, e.g., Ex. 97-J at p.29.) The private placement memoranda provided a timeline which depicted approximately 150-180 days lapsing from the issuance of the convertible debenture to the registration for the stock being declared effective by the SEC. (Id.) The timeline further provided that after the 150-180 day period, YA Global could convert. (Id.) YA Global would sell immediately the stock received upon a conversion. (RPFF ¶¶ 243-245, 248.) Therefore, Pet’rs’ PFF ¶ 165 is misleading to the extent that it suggests that YA Global held stock in the company received upon a conversion for "around 18 months." Also, YA Global may have held the convertible debenture longer than 18 months if the company defaulted under the terms of the convertible debenture, in order to enforce its rights under the debenture, typically as a senior secured creditor. (RPFF ¶¶ 132-137, 156, 213, 225, 235, 237-238, 240-242.)

166. There was typically a period of at least 4-6 months between the time YA Global advanced funds to a company and the time it could begin to get "repaid" via conversions to stock. (See, e.g., Ex. 97-J, p. 29 (stating that typically YA Global would start converting on days 150-180 after the closing of a convertible debenture), Ex. 100-J, p. 33 (same); Ex. 114-J, p. 29 (same); Ex. 125-J, p. 28 (same); Ex. 129-J, p. 29 (same); Ex. 130-J, p. 30 (same).)

Objection: misleading. YA Global could have chosen not to elect to convert and get "repaid" with cash. (See Exs. 416-J, 425-J, 432-J, 461-J, 518-J, 552-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 727-J, 816-J, 829-J.) Also, a convertible debenture may have called for periodic payments of principal and interest during the 4-6 month period. (See RPFF ¶ 183, note 4; Ex. 727-J at p. 1.)

167. Portfolio companies’ defaults on convertible debt were so common that Mr. Franks had to manually enter long-term maturities into Yorkville’s financial reporting system, Axys, when the maturity dates passed. (Tr. 911:11-912:4, 912:13-22; 918:24-919:5.)

Objection: inaccurate. The only support for Pet’rs’ PFF ¶ 167 is the testimony of Mr. Franks. Mr. Franks did not testify that he had to manually enter maturity dates because defaults on convertible debentures were so common. Mr. Franks testified that the Axys system would generate error messages if a convertible debenture did not have a maturity date stated. (Tr. 911:25-912:1-4.) To prevent that from occurring, Mr. Franks explained that he simply input a meaningless "plug" date as the maturity date for a convertible debenture whose maturity date had passed. (Tr. 917:20-22.)

168. When companies failed to pay their debt obligations timely, YA Global frequently provided them with additional funding. (See discussion with examples in Section III.A. 5 of the Legal Discussion.)

Objection: Contrary to record, immaterial. The record does not support that YA Global "frequently" provided companies who failed to pay with additional funding. (Entire record.) That YA Global may have done so is immaterial as whether convertible debentures issued to YA Global, which was unrelated to the companies, were considered as debt or equity for U.S. tax purposes.

169. YA Global frequently let maturity dates on "loans" pass without event. (See discussion with examples in Section III. A. 5 of the Legal Discussion.)

Objection: Not supported by the record, immaterial. The record does not support that YA Global "frequently" let maturity dates pass without event. (Entire record.) YA Global enforced its right as a secured creditor and stated it would aggressively enforce its rights. That YA Global may have let a maturity date pass without event is immaterial as to whether a convertible debentures issued to YA Global, which was unrelated to the company, were considered as debt or equity for U.S. tax purposes.

170. Despite high risks involved in investments in portfolio companies, stated interest rates for convertible debentures purchased by YA Global were often close to or even below the prime rate. (See, Ex. 3003-P, Figure 2 (prime rate in 2006-2007 approximately 8%), Ex. 311-J, § 1(b) (LocatePlus, 8.5% stated interest); Ex. 816-J, p. 1 and Ex. 829-J, p. 1 (Wherify, 7% stated interest); Ex. 603-P, p. 1 (Nanoscience, 8% stated interest).)

Objection: See General Objection no 1. Not supported by the record, immaterial. The record does not support that the interest rates were close or below prime. (Entire record.) Whether the interest rate was close to prime or not is immaterial to whether a convertible debenture acquired by YA Global, unrelated to the company and acting at arm’s length, was debt or equity for federal tax purposes.

171. Even when a company had a history of nonperformance, it could still obtain convertible debenture financing from YA Global at a low interest rate. (See, e.g., Exs. 506-J, 516-J (repackaging three prior convertible debentures issued by iVoice Technology, Inc. ("iVoice") into a single, new convertible debenture with a stated rate of 5%).)

Objection: Not supported by the record, immaterial. The record does not support the finding proposed. (Entire record.) That a company with a history of nonperformance could obtain convertible debenture financing from YA Global, an unrelated party acting at arm’s length with the company, is immaterial to whether the convertible debenture is debt or equity for federal tax purposes.

172. There was a significant risk that the convertible debentures that YA Global held would never get repaid. (Ex. 97, p. 53; Ex. 100, p. 59; Ex. 114-J, p. 50; Ex. 122-J, p. 51; Ex. 123-J, p. 52; Ex. 125-J, p. 50; Ex. 129-J, pp. 52-53; Ex. 130-J, p. 54.)

Objection: inaccurate. The private placement memoranda cited in support of Pet’rs’ PFF ¶ 172 do not support the finding that there was a significant risk that the convertible debentures would never get repaid. The private placement memoranda make the unremarkable point that an issuing company may not abide by its obligations under the convertible debenture, or related agreements, which could impact YA Global’s return. In contrast to Pet’rs’ PFF ¶ 172, the private placement memoranda also make the point that YA Global would do everything it could do to ensure it got paid the principal and interest due under a convertible debenture when highlighting that YA Global "intends to aggressively enforce its rights under its contractual relationships with issuers." (RPFF ¶ 240; see e.g., Exs. 97-J at 47; 100-J at 53 and 114-J at 46.)

Furthermore, YA Global built numerous provisions into the convertible debentures to protect its financing. First, YA Global became a creditor of the issuing company upon the issuance of a convertible debenture. (RPFF ¶¶ 226, 242, 447, 489, 711.) YA Global had no rights as a shareholder in the issuing company unless, and until, it converted any portion of the convertible debenture. (RPFF ¶ 209.) For example, YA Global could not vote or receive dividends unless it converted. (RPFF ¶ 209.) As a creditor, YA Global had preference over the shareholders of the company in the event of liquidation or dissolution. (RPFF ¶¶ 242, 447.) YA Global’s position as a creditor was typically secured which afforded it additional protection. (RPFF ¶ 213.) Moreover, YA Global’s secured position was typically senior to all other debt holders which afforded even additional protection. (RPFF ¶¶ 210, 258.) The convertible debenture typically assured that YA Global would remain a senior secured creditor. A convertible debenture typically provided that, absent the consent of YA Global, the company (or any subsidiary) was prohibited from issuing any debt of any kind that would be senior to the obligation of the company under the convertible debenture issued to YA Global. (RPFF ¶ 211.) The convertible debenture also typically prevented the issuing company from granting another person a security interest in any assets of the company at any time that any of the principal or interest on the convertible debenture remained unpaid and unconverted. (RPFF ¶ 194(c).)

The convertible debenture contained numerous other provisions which afforded additional protections to YA Global’s debt financing. For example, a convertible debenture provided "events of default" which upon the occurrence of any would make the full amount of the principal and accrued but unpaid interest immediately due and payable in cash. (RPFF ¶ 191.) Events of default included: any default in payment of principal or interest, commencement of bankruptcy of the company, any default of the company on an obligation other than the convertible debenture, cessation of the company’s stock being listed or traded on an exchange, the company’s failure to file a share registration statement for the stock, and the company’s failure to timely deliver stock certificates upon a conversion. (RPFF ¶ 191.)

In the securities purchase agreement accompanying the convertible debenture, the issuing company made numerous representations and warranties that served to protect YA Global’s financing. (See RPFF ¶¶ 167-170.) For example, in a securities purchase agreement, the company represented and warranted that: no shares of its common stock were subject to any preemptive rights or any other similar rights or liens or encumbrances (RPFF ¶ 167); there were no outstanding options or warrants or commitments of any character whatsoever relating to any shares of capital stock of the company by which the company may become bound to issue additional shares (RPFF ¶ 168); the convertible debenture was duly authorized and upon issuance should be duly issued, fully paid and nonassessable and free from all taxes, liens and charge (RPFF ¶ 169); and the "Conversion Shares" issuable upon conversion had been duly authorized and reserved for issuance. (RPFF ¶ 170.)

Under a securities purchase agreement, so long as any portion of the convertible debenture remained outstanding, typically the company could not directly or indirectly consummate any merger, reorganization, sale of all or substantially all of the company’s assets or similar organizational change without YA Global’s consent. (RPFF ¶ 174.)

173. YA Global mitigated its risk by taking security interests in the issuer’s assets, but the Fund’s expectation was to recover its investment by converting, not by enforcing its rights in collateral. (See Ex. 97, p. 52; Ex. 100, p. 58; Ex. 114-J, p. 50; Ex. 122-J, p. 50; Ex. 123-J, p. 51; Ex. 125-J, p. 49; Ex. 129-J, p. 52; Ex. 130-J, p. 53; see also PFFs ¶¶ 154, 157.)

Objection: see General Objection no 1, misleading, incomplete. Objection to the extent that the proposed finding suggests that YA Global did not intend to enforce its rights as a secured creditor. YA Global made clear that it "intends to aggressively enforce its rights under its contractual relationships with issuers." (RPFF ¶ 240; see e.g., Exs. 97-J at 47; 100-J at 53 and 114-J at 46.) Companies anticipated that YA Global would enforce its secured interests. (See, e.g., Ex. 1478-J at pp. 006, 0013, 0029.) YA Global enforced its rights as a creditor. (RPFF ¶¶ 132-135, 240, 447.)

In addition to obtaining the position of a senior secured creditor on a convertible debenture, YA Global benefited from numerous other favorable provisions that it secured through negotiating and acquiring convertible debentures in order to mitigate its financing risk. (See Resp’s Obj. to Pet’rs’ PFF ¶ 172.)

2. SEDA Transactions⁷

FN 7 For purposes of illustration of their contents generally, the parties have agreed that the documents in Exhibits 324-J through 328-J, which governed the transactions between YA Global and Face Print Global Solutions, are typical of SEDAs. (S. ¶ 66.)

174. In a SEDA, YA Global committed to purchasing up to a ceiling dollar amount of a portfolio company’s shares over a fixed time period, typically two years. (Ex. 324-J, §§ 1.7, 1.8.)

No objection.

175. If the company issued a notice seeking an "advance," the Fund was obligated to purchase the company’s stock, regardless of whether the stock was priced high or low, regardless of the volume of shares of the company’s stock that were currently being traded in the market, and regardless of market conditions. (E.g., Ex. 324-J; Tr. 232:21-233:12; Ex. 1467-J, p. 35 (the publicly filed prospectus associated with the SEDA between YA Global and Immune Response stated, "The amount available under the Standby Equity Distribution Agreement is not dependent on the price or volume of our common stock").)

Objection: misleading, incomplete. Pet’rs’ PFF ¶ 175 cites to Mr. Angelo’s testimony that YA Global was required to purchase the amount of stock in a SEDA advance at the agreed upon purchase price. (Tr. 232:21-233:12.) Mr. Angelo neglected to explain that the company’s ability to issue an advance pursuant to a SEDA, and YA Global becoming obligated to purchase the stock under an advance, were subject to numerous conditions and restrictions.

The company could deliver an advance notice to YA Global only if the company had fulfilled all of the numerous conditions precedent set forth in the SEDA. (RPFF ¶ 273.) The conditions precedent are set forth at RPFF ¶ 273(a)-(j). The conditions precedent ensured, among other things, that the common stock was registered for resale by YA Global with the SEC, that the registration remained in effect on any advance date, that the company had no reason to know of any problems with the registration statement, and that the company had obtained all state permits, etc. for offer and sale of the common stock. (See RPFF ¶¶ 273(a)-(d), (f)-(i).)

The conditions precedent in the SEDA also limited the number of shares that the company could request in an advance notice for YA Global purchase. (RPFF ¶ 273(h).) The number of shares issuable to YA Global pursuant to an advance notice could not result in YA Global and its affiliates owning more than 9.9% of the then outstanding common stock of the company. (Id.)

The company was also limited in the amount that it could request in a single advance (the "Maximum Advance Amount") and in the aggregate (the "Commitment Amount"). (RPFF ¶¶ 268, 270.) The Maximum Advance Amount typically amounted to 2-10% of the Commitment Amount. (See, RPFF ¶ 271; Ex. 355-J at §§ 1.7 and 1.17; Ex. 465-J at §§ 1.7 and 1.17; Ex. 493-J at §§ 1.7 and 1.17; Ex. 513-J at §§ 1.7 and 1.17; Ex. 515-J at §§ 1.7 and 1.17; Ex. 535-J at §§ 1.7 and 1.16; Ex. 542-J at §§ 1.7 and 1.17; Ex. 710-J at §§ 1.7 and 1.16; Ex. 719-J at §§ 1.7 and 1.17; Ex. 825-J at §§ 1.7 and 1.17.)

YA Global was not required to deliver payment for the shares specified in the advance until numerous conditions were completed. These conditions are set forth at RPFF ¶ 282(a)-(f).

Further, the company was prohibited for a certain number of days after delivering an advance notice from delivering another one. (RPFF ¶ 307.)

The obligation of YA Global to make an advance terminated permanently in the event that (i) a stop order or suspension of the effectiveness of the Registration Statement occurred for an aggregate of fifty (50) Trading Days, other than due to the acts of YA Global during the Commitment Period, or (ii) the company failed to materially comply with its covenants set forth in the SEDA and such failure was not cured within thirty (30) days of written notice from YA Global. (RPFF ¶ 306.)

176. The price at which the shares were to be purchased was established by a formula that was negotiated as part of the agreement; it typically included a discount to the volume weighted average price ("VWAP") of the stock over a "pricing period." (Ex. 324-J, §§ 1.16, 1.21, 1.23.)

Objection: incomplete, misleading. It was not uncommon for the price at which YA Global purchased the stock from a SEDA advance to be at a discount from the lowest share price during the pricing period. (See e.g., Ex. 355-J (3% discount from lowest "bid price" during the pricing period); Ex. 513-J (5% discount from lowest bid price during the pricing period); Ex. 515-J (5% discount from lowest bid price during the pricing period); Ex. 710-J J (3% discount from lowest bid price during the pricing period).) Mr. Franks confirmed this when he explained that the price at which YA Global would pay for the stock in a SEDA advance "could be the lowest price in that five-day period." (Tr. 995:15-24.)

177. In exchange for its agreement to purchase a portfolio company’s stock, Yorkville and the Fund often received a commitment fee, in the form of warrants, shares in the portfolio company or cash (Ex. 30-J (YAREL0000012066-68); Ex. 97-J, pp. 16-17; Ex. 100-J, pp. 19-20; Ex. 114-J, p. 17; Ex. 122-J, p. 16; Ex. 123-J, p. 17; Ex. 125-J, p. 16; Ex. 129-J, p. 16; Ex. 130-J, p. 17), with non-cash fees, such as stock and warrants, typically received by the Fund (Ex. 122-J, p. 16; Ex. 123-J, p. 17; Ex. 125-J, p. 16; Ex. 129-J, p. 16; Ex. 130-J, p. 17).

Objection: incomplete, misleading. It is unclear whether Pet’rs’ PFF ¶ 177 proposes that the "commitment fee" and the "non-cash fees" were received "in exchange for [YA Global’s] agreement," or just the commitment fee. Either way, the citations for Pet’rs’ PFF ¶ 178 do not expressly provide that the fees are "in exchange for [YA Global’s] agreement to purchase" a company’s stock.

The fees typically found in a SEDA are more fully set forth in RPFF ¶¶ 297-305. A SEDA typically required the company to pay various fees upon executing the SEDA and then various additional fees upon each Advance Date. (RPFF ¶ 297; Ex. 355 at § 12.4; Ex. 465 at § 12.4; Ex. 493 at § 12.4; Ex. 513 at § 12.4; Ex. 515 at § 12.4; Ex. 535 at § 12.4; Ex. 542 at § 12.4; Ex. 710 at § 12.4; Ex. 719 at § 12.4 and Ex. 825 at § 12.4.) The company typically was required to pay a "structuring fee" in cash to Yorkville Advisors on the date that the SEDA was executed. (RPFF ¶ 298; Ex. 355 at § 12.4(a)(i)-(ii); Ex. 465-J at § 12.4(a); Ex. 493-J at § 12.4(a); Ex. 513-J at § 12.4(a); Ex. 515-J at § 12.4(a); Ex. 535-J at § 12.4(a)(i)-(ii); Ex. 710-J at § 12.4(a); Ex. 719-J at § 12.4(a); Ex. 825-J at § 12.4(a)(i)-(ii).) The company typically was required to pay "commitment fees" to YA Global on the date the SEDA was executed. (RPFF ¶ 299; Ex. 355-J at § 12.4(c)(ii); Ex. 465-J at § 12.4(c)(ii), Ex. 493-J at § 12.4(b)(ii); Ex. 513-J at § 12.4(b)(ii); Ex. 515-J at § 12.4(b)(ii); Ex. 535-J at § 12.4(c)(ii)(-(iii); Ex. 542-J at § 12.4(b)(ii); Ex. 710-J at § 12.4(c)(ii)(-(iii); Ex. 719-J at § 12.4(b)(ii).) These commitment fees paid to YA Global typically took the form of common stock of the company and may also have included warrants to purchase common stock of the company. (RPFF ¶ 300; Ex. 355-J at § 12.4(c)(ii); Ex. 465-J at § 12.4(c)(ii), Ex. 493-J at § 12.4(b)(ii); Ex. 513-J at § 12.4(b)(ii); Ex. 515-J at § 12.4(b)(ii); Ex. 535-J at § 12.4(c)(ii)(-(iii); Ex. 542-J at § 12.4(b)(ii); Ex. 710-J at § 12.4(c)(ii)(-(iii); Ex. 719-J at § 12.4(b)(ii).) The shares of common stock, including the shares covered by the warrants, received by YA Global on the date the SEDA was executed were deemed fully earned as of that date and had "piggy-back" registration rights. (RPFF ¶ 301.) The company typically paid a "structuring fee" in cash to Yorkville Advisors on each Advance Date. (RPFF ¶ 302; Ex. 355-J at § 12.4(a)(ii); Ex. 465-J at § 12.4(a); Ex. 493-J at § 12.4(c); Ex. 513-J at § 12.4(a); Ex. 515-J at § 12.4(a); Ex. 535-J at § 12.4(a)(ii); Ex. 710-J at § 12.4(a); Ex. 719-J at § 12.4(a); Ex. 825-J at § 12.4(c)(ii).) The company typically paid a "commitment fee" of 3-6% of each Advance to YA Global on the Advance Date for each such Advance. (RPFF ¶ 303; Ex. 355-J at § 12.4(c)(i), Ex. 465-J at § 12.4(c)(i); Ex. 493-J at § 12.4(b)(i); Ex. 513-J at § 12.4(b)(i); Ex. 515-J at § 12.4(b)(i); Ex. 535-J at § 12.4(c)(i); Ex. 542-J at § 12.4(b)(i); Ex. 710-J at § 12.4(c)(i); Ex. 719-J at § 12.4(b)(i).) To the extent that the company had not paid the fees due to YA Global, YA Global could deduct the amount of such fees directly out of the gross proceeds of the Advance with no reduction in the amount of shares of the company’s common stock to be delivered on the Advance Date. (RPFF ¶ 304; Ex. 355-J at § 2.3; Ex. 465-J at § 2.3; Ex. 493-J at § 2.3; Ex. 513-J at § 2.3; Ex. 515-J at § 2.3; Ex. 535-J at § 2.3; Ex. 542-J at § 2.3; Ex. 710-J at § 2.3; Ex.719-J; Ex. 825-J at § 2.3.)

178. SEDA agreements contained a statement that YA Global was purchasing the securities for its own account, and for investment purpose. (See, e.g., Ex. 324-J, § 3.4; S. ¶ 62 (the parties have stipulated that Ex. 324-J contains provisions that are typical in a SEDA agreement that YA Global would enter into.)

Objection: see General Objection no. 1. Objection to the extent that the proposed finding suggests that YA Global was an investor for federal tax purposes. YA Global was not an investor for federal tax purposes. See Respondent’s Brief at Argument II. C. and V.A. To the extent the finding implies that the inclusion of this language satisfies the identification requirement in section 475(b)(2), objection as a legal conclusion and inaccurate. See Resp’s Brief at Arg. Part V.A.4; Resp’s Reply at Arg. Part VI.A.2.)

179. SEDAs were typically combined with warrants and/or issuance of stock. (E.g., Exs. 324-J, 326-J, 327-J, 328-J (Face Print SEDA issued concurrently with 3 different warrants).)

Objection: vague, incomplete. It appears, but is not clear, that "issuance of stock" in Pet’rs’ PFF ¶ 179 is intended to reference stock other than stock that YA may have been required to purchase pursuant to a SEDA advance. For purposes of this objection, it is assumed that this is the intention.

A SEDA typically provided that YA Global received common stock in the company and/or warrants as "commitment fees" upon execution of the SEDA. (RPFF ¶ 300; Ex. 324-J at § 12.4(b)(ii); Ex. 355-J at § 12.4(b) and (c)(ii); Ex. 465-J at § 12.4(c)(ii); Ex. 493-J at § 12.4(b)(ii); Ex. 513-J at § 12.4(b)(ii); Ex. 515-J at § 12.4(b)(ii); Ex. 535-J at § 12.4(c)(ii)-(iii); Ex. 542-J at § 12.4(b)(ii); Ex. 710-J at § 12.4(c)(ii)-(iii); Ex. 719-J at § 12.4(b)(ii); Ex. 825-J at § 12.4(c)(i).) YA Global would receive and retain these fees regardless of whether the company ever sought any advance under the SEDA and regardless of whether YA Global was ever required to pay for the company’s stock from an advance under the SEDA. (Id.) YA Global received these fees in addition to other fees it received under the SEDA, such as a commitment fee of 3-6% of each advance that YA Global received from the company upon each advance. (RPFF ¶ 303; Ex. 355-J at §12.4(c)(i), Ex. 465-J at § 12.4(c)(i); Ex. 493-J at § 12.4(b)(i); Ex. 513-J at § 12.4(b)(i); Ex. 515-J at § 12.4(b)(i); Ex. 535-J at § 12.4(c)(i); Ex. 542-J at § 12.4(b)(i); Ex. 710-J at § 12.4(c)(i); Ex. 719-J at § 12.4(b)(i).)

180. Once YA Global owned the company’s stock, it could sell it in the public market, but SEDA agreements did not create any obligations for YA Global to sell a portfolio company’s stock. (Ex. 324-J; Tr. 1030:2-8).

Objection: misleading. While a SEDA did not mandate that YA Global sell stock received under a SEDA, the companies and YA Global understood that the SEDA was designed to allow a company to raise capital in the public market in tranches as it needed, which required YA Global’s distribution of the stock. (See Ex. 252-J at p.004 (". . . we are convinced that by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor.").) Companies described the discount at which YA Global purchased stock under a SEDA advance as an "underwriting" discount. (Ex. 1423-J at p. 002; Ex. 1426-J at p. 003; Ex. 1428-J at pp. 001, 0013.)

Furthermore, under a SEDA, YA Global had the right to sell shares of the company’s common stock corresponding with a particular advance notice after it received the advance notice. (RPFF ¶ 288; Ex. 355-J at §§ 2.2(a) and 3.11; Ex. 465-J at §§ 2.2(a) and 3.11; Ex. 493-J at §§ 2.2(a) and 3.11; Ex. 513-J at §§ 2.2(a) and 3.11; Ex. 515-J at §§ 2.2(a) and 3.11; Ex. 535-J at §§ 2.2(a) and 3.11; Ex. 542-J at §§ 2.2(a) and 3.11; Ex. 710-J at §§ 2.2(a) and 3.11; Ex. 719-J at §§ 2.2(a) and 3.11; Ex. 825-J at §§ 2.2(a) and 3.11.) Consequently, YA Global had the right to sell during the pricing period, which preceded the advance date, all or a portion of the shares of common stock to be received on the advance date. (RPFF ¶ 289; Id.) While the SEDA itself did not require YA Global to sell the stock, the companies understood that YA Global had an incentive to sell the stock immediately to capture the "spread." (RPFF ¶ 351; Resp’s Obj. to Pet’rs’ PFF ¶ 119.) At times, YA Global informed the companies that it intended to sell the stock immediately. (RPFF ¶ 350; Resp’s Obj. to Pet’rs’ PFF ¶ 119.)

181. Because the companies YA Global funded had low share prices and low trading volumes, YA Global took significant risk in committing to purchase stock pursuant to SEDAs over a multi-year horizon. (PFFs ¶ 135, 136, 137, 138, 140, 141, 142.)

Objection: unsupported, misleading. The companies did not have low share prices and low trading volumes. See Resp.’s Obj. to Pet’rs’ PUFF ¶ 182. The SEDA provided that only upon a valid advance notice would YA Global be obligated to purchase stock, and at a discount to the market price. Therefore, YA Global was not exposed to any market risk when it entered into a SEDA and committed to purchase shares at some point in the future.

182. YA Global was frequently required to purchase very large blocks of a company’s stock under a SEDA close to or exceeding daily trading volume. (See, e.g., Ex. 323-J, pp. 2, 16, 18, 31, 37; see also text with examples in Section III.B.1.b.ii of the Legal Discussion section.)

Objection: inaccurate, misleading, contrary to the record

Pet’rs’ PFF ¶ 182 proffers that the amount of shares of stock in a company that YA Global was required to purchase under a SEDA advance was frequently close to or exceeded that company’s so-called "daily trading volume." Pet’rs’ PFF ¶ 182 does not define or otherwise specify what is meant by a company’s "daily trading volume" in this context. Regardless, it is unclear what relevance is served by comparing the amount of stock that YA Global was obligated to purchase under a SEDA advance to the trading volume of that company’s stock on a given single day. It is also misleading to focus on the ability to sell on a given single day. YA Global had the right to sell shares of the company’s stock after it received the advance notice, and therefore could sell during the five-day "pricing period" (or on any date thereafter) all or a portion of the stock to be received on the advance date. (RPFF ¶¶ 288-289.)

Pet’rs’ PFF ¶ 182 cites to Exhibit 323-J which provides 25 examples of calculations determining the number of shares of stock that YA Global would be required to purchase pursuant to SEDA advances. PFFF ¶ 182 cites to only five of these calculations as support for its proposed finding. With the exception of one (Americana Distribution, Inc., Ex. 323-J at p. 002) of these five, the calculations actually show that the number of shares of stock YA Global was required to purchase pursuant to the SEDA advance in each example was far less than the volume of the stock traded during the pricing period. (Ex. 323-J at pp. 0016, 0018, 0031,0037.) The remaining examples overwhelmingly show the same. (See Ex. 323-J at pp. 004, 006, 008, 0010, 0012, 0020, 0023, 0025, 0027, 0029, 0033, 0035, 0039, 0041, 0043, 0045, 0047, 0049, 0051) And in the case of the outlier advance made in Americana Distribution, Inc, the data reveals that YA Global was able to sell a number of shares greater than the number of shares purchased pursuant to the advance, within about one week of receipt of the shares from the advance. (Ex. 1282-J, at Tab 2006-2007.)

Pet’rs’ PFF ¶ 182 cites to "examples" of advances in Petitioners’ Brief at Legal Discussion sec. III.B.1.b.ii as support for its proposed finding. The examples do not support Pet’rs’ PFF ¶ 182. In these examples, the number of shares that YA Global was required to purchase pursuant to the advance was substantially less than the trading volume during the pricing period. In one of the examples, YA Global made a cash advance to Faceprint Global Solutions and in return received 9,200,000 shares. (See Ex. 368-J at p.001.) The trading volume of shares during the pricing period was 18,267,273. (Ex. 368-J at pp. 0010, 0013.) In another example, petitioners assert that YA Global made a cash advance to Immune Response on January 13, 2006 and in return received 7,936,508 shares. This is incorrect. YA Global received an advance notice on January 13, 2006 which triggered a pricing period from January 16 to January 23, 2006. (Ex. 477-J at p. 0051.) The trading volume of shares during the pricing period was 22,913,156 shares. (Ex. 477-J at p.0051.) Therefore, assuming that YA made an advance immediately after the pricing period and received 7,936,508 shares, that would still be significantly less than the trading volume (22,913,156 shares) during the pricing period.

Moreover, a SEDA significantly limited the amount of stock of a company that YA Global could own. A company could not submit an advance notice under a SEDA if the amount of the advance being requested would cause YA Global and its affiliates to beneficially own in the aggregate more than 9.99% of the then outstanding common stock of the company. (RPFF ¶ 273(h).)

183. YA Global often ended up maintaining a "long" position in the companies with which it had SEDAs for many months, or even years. (E.g., Ex. 2001-R, Appendix F-1 (YA Global held long positions in MobilePro for approximately 2½ months on multiple occasions), Ex. 2001-R, Appendix F-3 (YA Global held a long position in Epicept for over a year), Ex. 2001-R, Appendix F-11 (The Fund held stock in Marshall Edwards for nearly 3 years), Ex. 2001-R, Appendix F-16 (YA Global held stock in Signalife for over a year).)

Objection: inaccurate, misleading, not supported by the record. Dr. Lerner testified that in evaluating holding periods, he would treat YA Global as holding an interest in an issuer even if YA Global’s held no stock of the issuer for some period in the year. Tr. 1147. Appendix F to Ex. 2001-R demonstrates that YA Global was frequently acquiring and selling stock of issuers, frequently many times per year.

184. YA Global did not have relationships with institutional investors that it contacted in order to sell stock, and it did not engage in road shows or otherwise market the stock of its portfolio companies. (Tr. 97:11-97:17.)

No objection.

185. YA Global never worked on a best efforts basis to sell stock for a company (Tr. 77:16-78:3.)

No objection, except to note that YA Global described itself as providing financing to companies on a "firm commitment" basis with a SEDA. (Exs. 146-J, 147-J, 148-J, Tr. 137:7-8.)

186. Yorkville did not prepare research reports to help portfolio companies get market exposure. (Tr. 97:3-6.) Yorkville did not assist companies with credit ratings. (Tr. 97:7-10.)

No objection.

187. Although the SEDA FAQ was provided in discovery in response to an IDR asking for "any documents contained materials discussing in any way stand by equity distribution agreements (SEDAs)" (S. ¶ 63), there is no evidence that the SEDA FAQ actually was provided to investors. (Entire Record.)

Objection: incomplete, misleading. During the examination of YA Global’s returns, respondent submitted Information Document Request IE-13, question 38 which provided in relevant part:

At any time during 2007, were any documents that contained materials discussing in any way stand-by equity distribution agreements (SEDAs) provided to any potential investors? If yes, with respect to each such document please provide: (a) a copy of the agreement.

YA Global’s response to IDR IE-13, question 38 included a copy of the "SEDA FAQ" document which is Ex. 321-J. (2d Stip. ¶ 63.) Thus, YA Global represented to respondent that the SEDA FAQ was provided to potential investors.

There is no evidence in the record that provides, or even suggests, that the representation made by YA Global to respondent with its response to IDR IE-13 that the SEDA FAQ was provided to potential investors was incorrect.

188. Nearly every statement in the SEDA FAQ appears to be incorrect. (Tr. 129:10-134:16; PFFs ¶¶ 75, 197, 198, 199, 200.)

Objection: conclusory, argumentative, speculation, contrary to record. Pet’rs’ PFF ¶ 188 relies heavily on a portion of Mr. Angelo’s testimony in which he provides his reactions to a few statements from the SEDA FAQ hand selected by his counsel. (Tr. 129:10-134:16). Generally, Mr. Angelo testified that the SEDA FAQ "could not be more incorrect." (Tr. 129:16-18.) But various statements of Mr. Angelo are contradicted by other evidence.

At transcript page 130, Mr. Angelo denied the statement in the SEDA FAQ: "Yorkville provides this service through use of their proprietary product known as the stand-by equity distribution agreement." Mr. Angelo’s denial is contrary to the record and contradicted by documents contemporaneously prepared by Yorkville Advisors during the Relevant Period which explicitly referred to a SEDA as a "service" that YA Global offered companies, (see RPFF ¶¶ 93, 313, 314, 315.) Consistent with its characterization of providing services during the Relevant Period, YA Global explicitly referred to the companies as its "clients." (Ex. 149-J at p.001, 150-J at p.001, 151-J at p.001, 177-J at p.004, 272-J at p.005.)

Also at transcript pages 130-31, Mr. Angelo stated that the SEDA FAQ’s representation, "SEDA allows Yorkville to act as a statutory underwriter for a company to distribute shares via the public market," "could not be more false." (Tr. 131:5.) Despite this repudiation, Mr. Angelo goes on to acknowledge that YA Global was deemed to be a statutory underwriter as a result of its role in a SEDA. (Tr. 131:7-8.) Mr. Angelo also disagreed that YA Global "distributes shares" because the "company is selling shares to us." (Tr. 131:14-21.)

Mr. Angelo overlooks the very name of the product "Standby Equity Distribution Agreement." During the Relevant Period, Yorkville Advisors explained to fund investors that the companies and YA Global understood that the SEDA was designed to allow a company to raise capital in the public market in tranches as it saw fit, which YA Global facilitated through its distribution of the stock to the public. (Ex. 252-J at p.004 (". . . we are convinced that by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor.").) Moreover, the record in this case is replete with evidence showing that YA Global intended to, and had an incentive to, quickly distribute the stock received from SEDA advances into the public market in order to capture the discount spread and that the companies were aware of this. (RPFF ¶¶ 350, 351.)

At transcript pages 131-32, Mr. Angelo disagreed with the SEDA FAQ’s statement, "Additionally, there is a weekly dollar limit which is usually set at less than 10 percent of the company’s average weekly dollar volume." (Tr. 131:23-132:9.) Yet he also admitted that with a SEDA "you’re agreeing to a specific dollar amount." (Tr. 132:5-6.) Here, Mr. Angelo shows his agreement with the SEDA FAQ that there is indeed a limit on the amount that a company can request in an advance but criticizes the SEDA FAQ for not precisely articulating the limitation. However, Mr. Angelo’s explanation of the limitation as a "specific dollar amount" is imprecise as well. The limitation on the amount of the advance was typically a fixed dollar amount, or in some cases the greater of a fixed dollar amount or the volume weighted average price of the stock during the 5 trading days before the advance notice multiplied by the average daily volume traded during those 5 days. (See Exs. 324-J, 355-J, 465-J, 493-J, 513-J, 515-J, 535-J, 542-J, 710-J, 719-J, and 825-J.)

At transcript page 132, Mr. Angelo found "virtually none" of the following statement to be true:

Once a company decides to draw down on its SEDA, it faxes Yorkville an advance request for a certain dollar amount; upon receipt, Yorkville is deemed legally long that dollar amount of the company’s stock. Yorkville then proceeds to sell the specific dollar amount of shares into the public market over the next five days. At the end of the five-day period, Yorkville places the cash into an escrow account.

(Tr. 132:15-25.) Mr. Angelo’s assertion that this statement is incorrect is contrary to the record. Mr. Franks confirmed the SEDA FAQ’s description that YA Global was legally long the stock after the advance notice and could sell the stock received from the advance during the corresponding pricing period. (Tr. 993:12-23.) The SEDAs that are exhibits in this case provided that YA Global could sell the stock during the five-day "pricing period." (RPFF ¶¶ 288, 289; Ex. 355-J at §§ 2.2(a) and 3.11; Ex. 465-J at §§ 2.2(a) and 3.11; Ex. 493-J at §§ 2.2(a) and 3.11; Ex. 513-J at §§ 2.2(a) and 3.11; Ex. 515-J at §§ 2.2(a) and 3.11; Ex. 535-J at §§ 2.2(a) and 3.11; Ex. 542-J at §§ 2.2(a) and 3.11; Ex. 710-J at §§ 2.2(a) and 3.11; Ex. 719-J at §§ 2.2(a) and 3.11; Ex. 825-J at §§ 2.2(a) and 3.11.) Petitioners in their Brief expressly acknowledged this. (Pet’rs’ PFF ¶ 181.) The marketing materials produced by Yorkville Advisors and YA Global repeatedly illustrated a SEDA with an example in which YA Global sells during the corresponding pricing period the stock that it will receive from an advance. (RPFF ¶ 328.) At times, YA Global informed companies that it intended to immediately sell the stock into the public market. (PFF ¶ 350.)

At transcript pages 133-34, Mr. Angelo disagreed with the entire statement in the SEDA FAQ, providing:

What’s left is to determine the number of shares that the company must deliver to Yorkville. The terms of the agreement state that the share amount, amount to be delivered by the company, is calculated by taking 2 to 3 percent discount to the lowest share price of the five-day pricing period and dividing that share price into the dollar amount placed into the escrow account. This results in the company having to deliver to Yorkville more shares than were sold over the previous five-day period. These additional shares represent Yorkville’s profit. Because Yorkville has no cost basis, the shares are sold into the market at a profit.

(Tr. 133-34.) Mr. Angelo explained that the "2-3 percent discount would be to the lowest daily VWAP." (Tr. 134:11-12.) Mr. Angelo’s response is inaccurate, misleading, incomplete and contrary to the record.

It was not uncommon for the price at which YA Global purchased the stock from a SEDA advance to be at a discount from the lowest share price during the pricing period, just as described in the SEDA FAQ. (See e.g., Ex. 355-J (3% discount from lowest "bid price" during the pricing period); Ex. 513-J (5% discount from lowest bid price during the pricing period); Ex. 515-J (5% discount from lowest bid price during the pricing period); Ex. 710-J J (3% discount from lowest "bid price" during the pricing period).) Mr. Franks confirmed this exact point when he explained that the price at which YA Global would pay for the stock in a SEDA advance "could be the lowest price in that five-day period." (Tr. 995:15-24.)

Mr. Angelo also stated that "you couldn’t make a penny" with the 2-3 percent discount given execution costs. (Tr. 134:11-16.) Mr. Angelo did not quantify the execution costs but rather just summarily offers that "all of the data will support this." (Tr. 134:22-25.) There is no evidence in the record showing that YA Global could not make any profit whatsoever from exploiting the discount price at which YA Global purchased stock under a SEDA advance, i.e. from the "spread." The record actually shows that YA Global could, and did, profit from spread. YA Global considered a "primary source" of its return to be from "SEDA spreads." (RPFF ¶ 332.) YA Global stressed that it captured a small spread from each SEDA advance to "generate return." (RPFF ¶ 334.) Also, Mr. Angelo disregarded the various fees collected by YA Global from a SEDA transaction, either directly from the companies or indirectly from Yorkville Advisors. (RPFF ¶¶ 297-304, 386-391.)

At transcript page 137, Mr. Angelo agreed with the SEDA FAQ that YA Global did not assume credit risk with a SEDA but did have market risk, contrary to the statement in the SEDA FAQ. (Tr. 137:14-19.) Mr. Angelo’s explanation for why YA Global had "market" risk reveals that he was primarily describing risk unrelated to risk that the stock would not appreciate in value.

Mr. Angelo explained that the issuing companies have "very limited liquidity" and that with SEDAs, the "primary risk is volatility, inability to sell — to sell the stock . . ." (Tr. 138:4-11.) Here, Mr. Angelo was simply pointing out that YA Global faced liquidity risk — the risk that it would be unable to distribute all of the stock immediately into the public market. Mr. Angelo did not couch the risk in terms of the failure of the stock to appreciate in value after the advance. This makes sense given that YA Global received the stock at a discount to market and could sell immediately after the advance notice date, including during the pricing period, which was before YA Global actually paid for the stock. (See RPFF ¶¶ 288-289.) Mr. Angelo’s view that the "primary" risk was liquidity and not risk related to market price is consistent with Yorkville Advisors and YA Global’s explanation of SEDAs in numerous documents. (RPFF ¶¶ 326-330 (noting in marketing materials that there is no "market risk" with a SEDA).) Moreover, the terms of a SEDA significantly mitigated YA Global’s liquidity risk by, for example, requiring that the company have an effective registration for sale of the stock and that the stock be actively trading on each advance date, limiting the amount of each advance, and prohibiting YA Global from owning more than 9.9% of the outstanding stock at anytime. (RPFF ¶¶ 270, 273.)

At transcript pages 138-39, Mr. Angelo found the following statement in the SEDA FAQ to be "literally the exact opposite" of the facts:

In effect, Yorkville is providing its clients with a service and is not risking its own capital. In contrast, traditional underwriters assume the responsibility of distributing shares to the public, and, thus, if they can’t sell all of the shares at the specific offering price, they may be forced to sell the securities for less than they paid for them.

(Tr. 138:20-139:14.) Mr. Angelo explained that "if you look at underwriting, many of them are on a best-efforts basis." (Tr. 139: 7-10 (emphasis added).) Mr. Angelo is correct to acknowledge that not all underwriting is conducted on a best-efforts basis. Underwriting can also be conducted on a firm commitment basis. Mr. Angelo testified that YA Global acted under a firm commitment with a SEDA. (Tr. 137:7-8.) During the Relevant Period, YA Global described itself as having a "firm commitment" under a SEDA. (Ex. 146-J at p.001; Ex. 147-J at p.001; Ex. 148-J at p.001.) Companies described the discount at which YA Global purchased stock under a SEDA Advance as an "underwriting" discount. (RPFF ¶ 340.)

By contracting to make a "firm commitment" to purchase a company’s stock, YA Global engaged in underwriting. See Foerster, Bennett & Posner, Capital Markets Handbook § 2.05 (6th ed. 2021 Supp.) ("In a firm commitment underwriting, the underwriter(s) purchases the securities from the issuer or selling security holder(s), or both, as principal; once the UA [underwriting agreement] is signed, the underwriter(s) is at risk — i.e., the underwriter(s) owns the securities. Such a purchase defines the underwriting function: underwriters taking market risk on behalf of an issuer"). YA Global significantly mitigated its exposure to risk, for example, through the conditions precedent to a company making an advance notice under a SEDA (RPFF ¶ 273), the discounted price at which it purchased the stock from an advance (RPFF ¶ 263), the limitations set on the amount of an advance request and the amount of stock in the company that it could hold, (RPFF ¶ ¶ 270 and 273(h)) and its ability to sell immediately after receiving the advance notice (and therefore during the pricing period) the stock that corresponded to the advance notice (RPFF ¶¶ 288-289).

E. Services to Portfolio Companies (None)

189. Yorkville (and therefore the Fund) did not provide any services to the portfolio companies. The only services provided by Yorkville were to the Fund and other funds it managed. (Tr. 96:19-96:25; Tr. 700:4-700:11 (J. Wright testimony); Tr. 904:10-14 (O. Franks testimony); Tr. 1175:25-1176:2 (K. Kreisler testimony).) Yorkville did not provide consulting services. (Tr. 97:1-2.)

Objection: inaccurate, contrary to record. Pet’rs’ PFF ¶ 189 is contradicted by documents contemporaneously prepared by Yorkville Advisors during the Relevant Period in which Yorkville Advisors explicitly referred to promissory notes, convertible debentures and SEDAs as "services" that YA Global offered companies. (See RPFF ¶¶ 93, 223, 313, 314, 315.) Consistent with its characterization of providing services during the Relevant Period, YA Global explicitly referred to the companies as its "clients." (Ex. 149-J at p.001; 150-J at p.001; 151-J at p.001; 177-J at p.004; 272-J at p. 005.)

190. The Securities Purchase Agreements between YA Global and its portfolio companies explicitly acknowledged that YA Global was "not acting as a financial advisor or fiduciary of the company (or in any similar capacity)." (Ex. 310-J, pp. 9-10 (§ 3(j)).)

Objection: misleading. The actual relevant language in the securities purchase agreements, accompanying the convertible debentures and the SEDAs, between YA Global and the companies stated that YA Global was "not acting as a financial advisor or fiduciary of the Company (or in any similar capacity) with respect to this Agreement and the transactions contemplated hereby . . ." (See e.g. Ex.310-J at § 3(i).) Instead, YA Global provided financing services to the companies, including through promissory notes, convertible debentures and SEDAs. (RPFF ¶¶ 93, 223, 313, 314, 315.) YA Global referred to the companies as its "clients." (Exs. 149-J at p.001; 150-J at p.001; 151-J at p.001; 177-J at p.004; 272-J at p.005.)

191. YA Global/Yorkville never got any fees unless the Fund closed a deal and put its capital at risk. (Tr. 100:16-25.)

Objection: misleading. YA Global and Yorkville Advisors received various fees upon YA Global entering into a SEDA. (RPFF ¶¶ 296, 297, 298, 300, 304.) YA Global’s did not provide any "capital" when it entered into a SEDA with a company but it did receive fees. At that time of entering a SEDA, it was possible that the company may never request an advance on the SEDA. In that situation, YA Global and Yorkville would retain all the fees received from YA Global executing the SEDA, despite no cash outlay. (See e.g. Ex. 1497-J, pp. 79, 115 (explaining that YA Global received $1,642,00 worth of stock and warrants as a commitment fee upon executing the SEDA with Marshall Edwards, Inc. but Marshall Edwards, Inc. then cancelled its SEDA without making any advance requests).)

192. The fees associated with transactions varied, both in name and in amount, on a deal by deal basis. (Tr. 664:13-20 (E. Schinik testimony); Tr. 982:21-983:5 (O. Franks testimony).)

No objection except to note that fees were paid by the companies on all transactions. (Entire record.)

193. The financial industry understood YA Global to be an investment fund, not an investment bank. (See Exs. 1589-P, 1590-P, 1591-P, 1592-P, 1593-P, 1594-P and 1595-P (YA Global included on lists of institutional investors, not on lists of investment banks).)

Objection: see General Objection no. 1, contrary to record. During the Relevant Period, Yorkville and YA Global referred to itself as an "investment bank" or "merchant bank." (RPFF ¶ 57.) Yorkville touted that its "investment bankers" sourced and negotiated deals with companies. (RPFF ¶¶ 83, 84, 85.) Yorkville employed 19-34 investment bankers during the Relevant Period. (RPFF ¶ 85.) YA Global and Yorkville described receiving "investment banking" fees from companies. (RPFF ¶ 389.)

Despite YA Global’s repeated references during the Relevant Period to itself as a "bank" and Yorkville’s "bankers," respondent does not argue that YA Global was an "investment bank" during the Relevant Period. Rather, respondent argues that YA Global originated financing arrangements for companies that were [qualitatively] akin to financings arrangements commonly provided by banks, just focused on [targeted to] a niche market. (See Resp’s Brief at Arg. II.C.) This is perfectly consistent with how YA Global described its over-arching strategy to potential investors: YA Global "aims to fill the void for issuers who are too small to attract the attention of the investment banking community and/or who are not eligible for a traditional bank loan." (RPFF ¶¶ 56, 62; Exs. 206-J through 241-J.) YA Global pointed out that during the Relevant Period investment banks began to offer financing arrangements similar to SEDAs. (RPFF ¶ 347; see Ex. 252-J ("Since banks have dramatically cut back lending practices, many alternative lenders such as sovereign wealth funds and hedge funds (including Yorkville) have stepped in to fill the void.").) YA Global noted that investment banks also competed with YA Global in the equity financing space. (RPFF ¶ 348.)

194. YA Global’s portfolio companies did not consider YA Global to be acting as an investment bank. Some portfolio companies had their own placement agents to advise them with respect to the terms of their transactions with YA Global. (E.g., Ex. 367-J, p.1; Ex. 464-J, p. 1; Ex. 503-J, p. 1; Tr. 701:9-702:2.)

First sentence. Objection: see Resp’s Obj. to Pet’rs’ PFF ¶ 193, misleading, irrelevant. In support of the finding in the first sentence, petitioners cites only the testimony of Jay Wright, the CEO of MobilePro, a company that YA Global financed during the Relevant Period. (Tr. 696:1-2, 20-25; Tr. 697:105.) Mr. Wright was speaking only about financing transactions that Mobile Pro had entered into with YA Global and not about any transactions that any other companies had entered into with YA Global. (Tr. 697:6-25, 698:1-3.) Therefore, to suggest that Mr. Wright’s personal view from a limited perspective represents the collective view of the hundreds of other companies with which YA Global transacted during the Relevant Period is misleading.

Mr. Wright did not testify that Mobile Pro did not consider YA Global to be "acting as an investment bank." Petitioners’ counsel asked Mr. Wright whether "Yorkville was acting as your investment bank? To which Mr. Wright responded "No." (Tr. 700:21-23.) Respondent does not argue that YA Global was Mobile Pro’s investment bank, or anyone else’s investment bank. (See Resp’s Obj. to Pet’rs’ PFF ¶ 93.)

Second sentence. No objection.

195. Yorkville (and therefore YA Global) never provided any typical investment banking services to portfolio companies, such as consulting, providing research reports, assisting with credit ratings, or seeking buyers for the companies’ stock. (Tr. 97:1-97:10; PFF ¶ 189; Ex. 3008-P, ¶¶ 15-19 (describing typical services provided by investment banks, such as consulting services to issuers, providing research reports, providing valuation analysis, coordinating with rating agencies on behalf of issuers, bringing together issuers and investors).)

Objection: inaccurate, misleading, contrary to record. YA Global provided certain services to companies that were qualitatively akin to certain services typically provided by investment banks. (See Resp’s Obj. to Pet’rs’ PFF ¶ 189.) During the relevant period, Yorkville Advisors explicitly referred to promissory notes, convertible debentures and SEDAs as "services" that YA Global offered companies. (See RPFF ¶¶ 93, 223, 313, 314, 315.) YA Global received fees as income. (See, e.g., Ex. 287-J at p.0012.)

196. Yorkville negotiated against portfolio companies, not on their behalf, trying to get the best deals it could for itself and for YA Global. (Tr. 97:18-98:1 (M. Angelo testimony); Tr. 1177:7-16 (K. Kreisler testimony).)

Objection: irrelevant, inaccurate. Respondent does not contend that Yorkville Advisors negotiated "on behalf’ of the companies. Yorkville Advisors negotiated on behalf of YA Global. (RPFF ¶¶ 26, 30, 46, 47, 48, 439, 685; Tr. 188:17-189-2; Tr. 334:19-335:7; Tr. 336:18-20; Resp’s Brief at Argument sec. II.B.3.) YA Global strived to develop relationships with the companies that it financed. (RPFF ¶ 140.) YA Global marketed itself as "custom tailoring" financial arrangements to fulfill the goals and the particular needs of a company. (RPFF ¶ 140.)

197. YA Global did nothing to make a market in stocks. (Entire Record.)

Objection: unsupported conclusion, not supported by the record. Pet’rs’ PFF ¶ 197 is not supported by any specific citations to the record. See Resp’s Brief at Arg. II.C.4., II.D.6, V.A.

198. YA Global did not advertise its holdings as inventory or provide price quotes to potential purchasers. (Entire Record.)

Objection: unsupported conclusion. Pet’rs’ PFF ¶ 198 is not supported by any specific citations to the record.

199. YA Global did not buy or sell stock as a merchant or to generate market liquidity. (Entire Record.)

Objection: unsupported conclusion, vague. Pet’rs’ PFF ¶ 199 is not supported by any specific citations to the record. It is unclear what Pet’rs’ PFF ¶ 200 means by "generate market liquidity." YA Global acted as a merchant during the Relevant Period. (See Resp’s Brief at Argument, sec. II.C.4.(d).)

200. Portfolio companies and investors were not YA Global or Yorkville’s clients. (PFFs ¶¶ 189, 190, 193, 194, 195, 196.)

Objection: inaccurate, contrary to the record. YA Global explicitly referred to the companies as "clients." (Exs. 149-J, 150-J, 151-J, 177-J at p.4, 272-J at p. 005.) YA Global explicitly referred to the products that it offered companies as "services." (See Resp’s Obj. to Pet’rs’ PFF ¶ 189.)

F. Profits and Losses

201. YA Global’s profits in early years were offset by huge losses in later years. (Tr. 68:14-69:10.)

Objection: vague, misleading, not supported by the record. From inception through 2011, YA Global had an overall net income of $122,837,045, using the amounts reported on YA Global’s financial statements, as follows:

	Net Income	Ex. No.
2001	$1,879,284	281-R at p. 006
2002	2,072,640	282-R at p. 005
2003	11,107,740	283-R at p. 007
2004	21,267,807	284-R at p. 007
2005	51,465,356	285-R at p. 0010
2006	101,271,742	286-J at p.0013
2007	122,436,158	287-J at p.0013
2008	61,266,616	288-J at p. 0016
2009	14,403,832	289-J at p. 0015
2010	(207,299,911)	290-J at p. 005
2011	(57,034,219)	291-J at p. 005
Total	$122,837,045

202. YA Global’s profits and losses did not arise from the operation of a trade or business. (Entire Record.)

Objection: contrary to the weight of the evidence. (Entire record.)

203. YA Global’s profits and losses arose as a result of the Fund putting its capital at risk in the ventures of its portfolio companies. (See PFFs ¶¶ 775, 120, 122, 209.)

Objection: misleading, incomplete. YA Global’s profits and losses arose from its lending, underwriting, and financial services business.

204. If the portfolio companies were successful, YA Global earned profits; if they were not, YA Global had losses. (Tr. 68:14-69:10.)

Objection: not supported by the record, self-serving testimony, contrary to the weight of the evidence. See General Objection No. 3. YA Global earned significant profits regardless of the success of the companies; YA Global received fees and other remuneration upon entering into transactions with companies, earned interest on the loans, and received fees and other remuneration through discounted property and spreads.

205. The likelihood that the Fund could realize income or gain depended on the acumen, expertise and skill of Yorkville and its principals in determining the investments of the Fund and providing access to such investments. (See, e.g., Ex. 30-J (YAREL0000012096), p. 46; Ex. 97-J, pp.46, 53; Ex. 100-J, p. 52; Ex. 114-J, p. 45; Ex. 122-J, p. 45; Ex. 123-J, p. 46; Ex. 125-J, p. 45; Ex. 129-J, p. 47; Ex. 130-J, p. 48.)

Objection: vague, misleading, contrary to the weight of the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶ 204.

206. YA Global’s monthly returns during the period at issue on a GAAP basis ranged from a high of 9.0% to a low of -41.2%. (Ex. 205-P.)

Objection: immaterial, incomplete. YA Global’s monthly returns are not indicative of whether YA Global was engaged in a U.S. trade or business.

207. The Fund lost some or all of its investment in 46% of the companies it funded, but it generated significant returns (in excess of 100%) in 3% of them. (Ex. 3003-P, ¶ 136.)

Objection: vague, incomplete, misleading, based on faulty evidence, immaterial, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶ 206.

208. Five percent of YA Global’s investments generated cash-on-cash returns of more than 70.5%. (Ex. 3003-P, p. 50, Figure 10.)

Objection: vague, incomplete, misleading, based on faulty evidence, immaterial, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶ 206 and Exs. 2002-R and 2004-R.

209. The fact that YA Global’s profits (when it had profits) were generated from a few strong successes offsetting many failures indicates that its income was from investing. (Ex. 3003-P, ¶ 137.)

Objections: vague, misleading, legal conclusion, contrary to the weight of the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶ 206.

G. Investment in Compass Resources, Ltd.

210. Compass Resources, Ltd. ("Compass") was an Australian mining company. (Ex. 863-J, p. 17.)

Objection: misleading, not supported by the record. This proposed finding suggests that Compass Resources, Ltd. ("Compass") no longer exists or operates a mining company. Nothing in the record supports this conclusion. Respondent does not object, however, to a proposed finding that Compass was an Australian mining company during the years at issue.

211. YA Global provided Compass with $25,000,000 in convertible debt in November 2007, and it invested another $11,000,000 in convertible debt in May 2008 ("Compass Convertibles"). (Ex. 861-J, p. 25; Ex. 862-J, p. 1; Ex. 2249-R, p. 1; Tr. 1010:11-14, Tr. 1011:7-13.)

Objection: vague, imprecise, confusing, misleading, misrepresents the record, argumentative. See General Objection No. 1. It is unclear how petitioners are defining the phrase "provided Compass with $25 million in convertible debt," as this language was not how any witness described YA Global’s transactions. It is also unclear what petitioners mean by "invested $11 million in convertible debt" as the word "invest" is overly broad and nondescriptive. This language is petitioners’ tortured attempt to avoid the terminology YA Global and Compass used to describe these transactions, i.e., a loan. (Ex. 861-J, "Series A Convertible Loan Agreement.") As shown by references cited by petitioners, Exhibits 861-J and 862-J, YA Global provided Compass with a loan in the amount of $25 million (Ex. 861-J at p. 25 (defining "Initial Loan Amount" as "US$25,000,000") and later "subscribed for the Balance Loan Amount of US $11,00,000" (Ex. 862-J a p. 1). YA Global made the $25 million and $11 million loans pursuant to a convertible loan agreement. (RFPP ¶¶ 475, 476.) YA Global treated the transactions as loans made in exchange for convertible notes. (RFPP ¶¶ 495, 496.) This treatment is consistent with Oren Franks’ testimony as cited by petitioners. (Tr. 1010:11-14 (stating "a convertible debenture was purchased in the amount of $11 million.").)

212. At the end of 2008, these two Compass convertibles were valued at $12,500,036 and $10,500,000, respectively. (Ex. 2249-R, p. 1; Tr. 1011:4-6; Tr. 1012:14-16.)

Objection: incomplete, misleading. At the start of 2008, the outstanding balance of the initial loan was $25 million. (Ex. 2249-R at p. 1, column E.) During 2008, Compass made principal and interest payments totaling $14,693,950, with $12,499,963 credited to principal and $2,193,987 credited to interest. (Ex. 2249-R at p. 1, columns G and J; RPFF ¶ 480 (reflecting principal payments made on the $25 million and $11 million loans).) At the end of 2008, the outstanding balance on the initial loan was $12,500,036 ($25,000,000-$12,499,963). (Ex. 2249-R at p. 1, column K.) On May 21, 2008, YA Global funded the additional $11 million loan. (RPFF ¶ 477.) Compass made principal and interest payments totaling $1,099,176, with $500,000 credited to principal and $599,176 credited to interest. (Ex. 2249-R at p. 1, columns G and J; RPFF ¶ 480 (reflecting $500,000 payment on $11 million loan on September 26, 2008 (citing Ex. 1282-J, tab "2008," line 8969)).) At the end of 2008, the outstanding balance on the $11 million loan was $10,500,000 ($11,000,000-$500,000). (Ex. 2249-R at p. 1, column K.) These amounts reflected the outstanding balances of the loans at the end of 2008.

213. In January 2009 Compass became insolvent (S. ¶ 98; Ex. 863-J, p. 21) and entered into voluntary administration under Australian law (S. ¶ 98; Tr. 1014:22-25), and its stock was suspended from trading immediately following the appointment of joint and several voluntary administrators (S. ¶ 98).

Objection: misrepresents the record, not supported by the record. The record does not establish that Compass became insolvent in January 2009 or that insolvency was the reason for entering into voluntary administration. Stipulation ¶ 98 does not state that Compass became insolvent in January 2009. Exhibit 863-J at page 21, to which petitioners cite, states: "[T]he directors formed the view that the companies were likely to become insolvent. Accordingly, on 29 January 2009, the directors resolved to appoint Administrators to CMR and CMPL." Compass therefore was not insolvent on January 29, 2009. Compass’ directors formed this view after seeking advice on Compass’ financial position in light of "the current declining price for metals, delays encountered in full metal production commencing from the Browns Oxide Plant, continuing support from HNC to fund the Browns Oxide Project; and the current debt and cash position of the company." (Ex. 863-J at p. 20.)

214. In 2009, during the pendency of the voluntary administration, YA Global, which was an unsecured creditor (Ex. 863-J, p. 32), made a Deed of Company Arrangement ("DOCA") proposal to Compass’ creditors and shareholders to recapitalize Compass so that Compass could settle its creditors’ claims and continue its operation (Ex. 863-J, pp. 51-54, 90-92).

Objection: inaccurate, incomplete, not supported by the record cited. Exhibit 863-J is a Circular to Creditors dated April 22, 2009, enclosing a report to creditors and notifying creditors of a Deed of Company Arrangement ("DOCA") proposed by Compass’ directors. Exhibit 863-J does not address YA Global’s proposed DOCA. The record also does not contain a specific statement as to why YA Global made its proposal. For a more complete statement of facts relating to the Compass’ voluntary administration, see RPFF ¶¶ 488-494.

215. Under the DOCA proposal, the Fund would acquire new shares issued by Compass constituting 80% of Compass’ outstanding voting shares after the proposed recapitalization. (Ex. 864-J, pp. 9, 14.)

Objection: inaccurate, incomplete, misleading. Exhibit 864-J does not represent the final proposal made by YA Global. YA Global’s original proposal, as represented in Exhibit 864-J, was rejected by Compass’ shareholders. Exhibit 867-J contains the final proposal made by YA Global that was approved by the shareholders. Further, with this finding, petitioners suggest that YA Global simply acquired newly issued shares of Compass stock. Petitioners misrepresent YA Global’s proposal. YA Global received shares of Compass stock in satisfaction of the loans made by YA Global to Compass. Exhibit 864-J at page 9, as cited by petitioners, states that Compass will issue "new shares to YA Global . . . in exchange for release of the admitted debts owed to [YA Global] at 29 January 2009." YA Global’s proposal also included other elements, such as YA Global’s obtaining seats on Compass’ board of directors and making additional loans to Compass. (Ex. 864-J at p. 009-0010.) For a more complete description of YA Global’s final proposed DOCA, see RPFF ¶ 494. Exhibit 867-J at pages 0016 and 0017 shows YA Global holding 77.4% of Compass’ shares after the recapitalization.

216. Another Compass creditor, Coffee House, would receive 15% of the shares, and the remaining 5% of the shares would be owned by those shareholders who owned stock of Compass prior to the recapitalization (including the Fund). (Ex. 864-J, pp. 9, 13-14.)

Objection: inaccurate, incomplete, misleading. See Resp’s Obj. to Pet’rs’ PFF ¶ 215. Exhibit 864-J at page 9, as cited by petitioners, states that Compass will issue "new shares to YA Global . . . and Coffee House . . . in exchange for release of the admitted debts owed to them at 29 January 2009." Exhibit 867-J at pages 0016 and 0017 shows Coffee House holding 12.5% of Compass’ shares after the recapitalization and other shareholders holding 10.1% of Compass’ shares.

217. As part of the restructuring, the Fund would provide additional funds to Compass of approximately $42 million, some of which would be used to pay off other creditors, and the rest of which would provide working capital to Compass so that it could resume its mining activities and begin production. (Ex. 864-J, pp. 9-10.)

Objection: inaccurate, incomplete, misleading. See objection and response to petitioners’ proposed finding ¶ 215. It is not clear from the pages cited by petitioners where petitioners derived "approximately $42 million" of additional funds or whether, and to what extent, the $42 million represents the amount of the loans to be made at the close of Compass’ recapitalization. YA Global agreed to make 3 loans to Compass. (RPFF ¶ 494; Ex. 867-J at pp. 0011, 0017, 0020.) The first loan was to be in the amount of $5.75 million for the purpose of enabling Compass to meet its payment obligations under YA Global’s DOCA proposal and its immediate working capital requirements; the second was to be in the amount of $6 million in the first 12 months and "conceivably a further $37.5 million" so that Compass can meet its payment obligations under YA Global’s DOCA proposal; and the third loan was to be in the amount of $7.5 million to meet Compass’ payment obligations to Human Nonferrous Metals Corp Ltd. and HNC (Australia) Resources Pty Ltd., companies with which Compass engaged in a joint venture. (Ex. 867-J at pp. 0020, 0070-0071; Ex. 863-J at pp. 0019-20.) YA Global was granted security to ensure repayment of the loans. (Ex. 867-J at p. 0011.)

218. The existing debt that Compass owed to the Fund and to Coffee House would be cancelled in the reorganization. (Ex. 864-J, pp. 9, 13.)

Objection: vague, inaccurate, misleading, not supported by the record cited. See Resp’s Obj. to Pet’rs’ PFF ¶ 215. Ex. 864-J does not use the term "cancelled" or similar term, and it is unclear how petitioners are defining the term "cancelled." Exhibit 864-J at page 9, as cited by petitioners, states that Compass will issue "new shares to YA Global . . . in exchange for release of the admitted debts owed to [YA Global] at 29 January 2009." The term "release" typically indicates payment or discharge of the debt. The debt owed to YA Global was deemed repaid or discharged in full by the issuance of 1,083,618,669 shares of new fully paid ordinary shares of Compass stock to YA Global. (Ex. 867-J at pp. 007, 0011.)

219. Compass’s administrators obtained an independent expert report to advise them in connection with the Fund’s DOCA proposal, which concluded that Compass did not have any equity value prior to recapitalization, and if the proposed DOCA were accepted, the value of the non-associated shareholder interests in Compass after the proposed recapitalization would be greater than the value of their interests before the proposed transaction (i.e., more than worthless). (Ex. 864-J, p. 24.)

Objection: vague, not supported by the record cited. See Objection to petitioners’ proposed finding ¶ 215. It is unclear whether petitioners are referring to market value or book value of equity. Ex. 864-J at page 39 shows Compass as having a book equity value of $81,637,000 as of December 31, 2008. Further, Ex. 864-J at page 24 does not state, "Compass did not have any equity value prior to recapitalization"; rather, it states, "[W]e have assessed the current value of the Non-Associated Shareholders’ [non-YA Global shareholders’] interests in Compass at nil."

220. In 2009, the only Compass securities held by the Fund were shares of stock, warrants and convertible debt. (Ex. 2249-J, p. 2.)

No objection/Objection: vague, incomplete, misleading.

221. YA Global engaged a third-party valuation company, Valuation Research Corporation ("VRC"), to assign a value to the Fund’s interest in Compass for 2009. (See Ex. 869-P; Tr. 574:7-17; Tr. 1023:11-2.)

Objection: vague, inaccurate, incomplete, misleading. Valuation Research Corporation ("VRC") was not engaged to assign a value to YA Global’s interest in Compass. VRC was engaged "to assist [Yorkville Advisors’] valuation committee (the ‘Committee’) in their evaluation of certain" of YA Global’s assets as of September 30, 2009. (Ex. 869-J at p. 006.) "The fair value of each investment is ultimately determined in good faith by the Committee, and VRC has been retained as an independent advisor to assist the Committee in their evaluation." (Ex. 869-J at p. 006.) VRC considered YA Global’s interests in 12 companies, including Compass. (Ex. 869-J at p. 0010.)

222. VRC’s report showed that VRC determined the value of YA Global’s interest based, not on the existing securities that it held, but rather on a percentage likelihood that the Fund’s DOCA proposal would be accepted. (Ex. 869-P, pp. 18-19.)

Objection: improper use of Exhibit 869-P, inaccurate, misleading. Exhibit 869-P was offered, and admitted, into evidence for nonhearsay purposes. (See [exhibit summary].) Petitioners’ counsel stated, "I actually don’t care at all if you believe what VRC wrote." Now, however, petitioners are asking the Court to believe what VRC wrote. Petitioners are proposing a finding that VRC determined a value for "YA Global’s interest based, not on the existing securities that it held but rather on a percentage likelihood that the Fund’s DOCA proposal would be accepted." This proposed finding asks the Court to find as fact what VRC did, i.e., the truth of the matters asserted in Exhibit 869-P, which is contrary to petitioners’ representation and contrary to the Court’s ruling for admitting this exhibit into evidence. Petitioners did not call any representative of VRC as a witness, and respondent did not have any opportunity to cross-examine VRC on what it valued or any other aspects of its valuation of Compass. Respondent renews the objection to exclude this exhibit on the ground that it constitutes inadmissible hearsay.

Even if the Court were to find petitioners’ use of Exhibit 869-P does not violate the purposes for which Exhibit 869-P was admitted, petitioners misrepresent and misstate what VRC valued. VRC did, in fact, value the convertible note held by YA Global. VRC concluded that, under YA Global’s proposal, "its 31.4 mm convertible note is exchanged for an 80% equity interest in" Compass. (Ex. 869-P at p. 0019.) In other words, the convertible note has a value equal to 80% of the value of Compass. Consequently, VRC estimated Compass’ enterprise value, using the discounted cash flow method, and took 80% of that amount for the value of YA Global’s investment. Because, under YA Global’s proposal, YA Global was also providing additional loans to Compass, VRC next subtracted the amount of the additional loans, showing them as approximately $42 million, to get to the value of the $31.4 mm convertible note. (Ex. 869-P at pp. 0018-0019.) To account for the slim possibility that YA Global’s proposal would not be approved, VRC discounted this value by 10 percent to get to the range of $130.6 million to $166.0 million. (Ex. 869-P at p. 0019.)

223. Based on the assumptions in VRC report, it showed that VRC assigned a range of values between $130.6 million and $166 million to the DOCA proposal as of September 30, 2009. (Ex. 869-P, pp. 10, 19.)

Objection: improper use of Exhibit 869-P, inaccurate, misleading. See Resp’s Obj. to Pet’rs’ PFF ¶ 222.

224. YA Global relied on the VRC report to value its interest in Compass. (Tr. 575:2-13, Tr. 581:4-582:3.)

Objection: vague, misleading. It is unclear to what the phrase "interest in Compass" is referring or on what YA Global relied in the VRC report. At page 575, Mr. Schinik stated that Exhibit 869-P was "a valuation of Compass Resources that was used in the financial statements for December 31st, 2009." At pages 581 to 582, Mr. Schinik attempts to describe what VRC did and then stated that the VRC report served as a basis for YA Global’s valuation of its interest in Compass, which "ended up in the financial statements." YA Global’s financial statements reported YA Global’s interest in Compass only under the section for "Convertible Notes and Debentures" and reported the value of the Compass convertible loan as $148,269,798, the mid-point of VRC’s range. (See RPFF ¶¶ 495-497.) As VRC indicated in its report, a valuation committee was tasked with determining the fair value of YA Global’s assets (Ex. 869-J at p. 006. See also Ex. 289-J at p. 003 (stating that fair values were determined by the general partner in the absence of readily ascertainable fair values).) The valuation committee met at least quarterly to review and monitor the valuation of YA Global’s assets. (E.g., Ex. 211-J at p. 009. See also RPFF ¶ 465.) The valuation committee maintained minutes of its meetings (Ex. 1266-J), but no minutes of the valuation committee addressing the valuation of Compass was offered by petitioners into evidence. (Entire record.) The testimony of Mr. Schinik (and, although not cited, petitioners’ expert Charles Lundelius) regarding what VRC valued and on what YA Global relied with respect to the VRC report is not credible, especially in light of what YA Global actually reported on its financial statements, i.e., that the value of the convertible note issued by Compass as of December 31, 2009 was $148,269,798 and that YA Global did not hold any of other investment in Compass. (RPFF ¶¶ 495-497.)

225. In order to account for the difference between the value of its Compass convertible debentures at the end of 2009 and the midpoint of the VRC range of $148.3 million, the Fund recognized on its books in 2009 an "other asset" valued at $116,308,517. (Ex. 2249-R, p. 2; Tr. 1015:1-1016:2.)

Objection: misleading, inconsistent with the record. See Resp’s Obj. to Pet’rs’ PFF ¶ 224. YA Global reported on its 2009 financial statements that the convertible note issued by Compass to YA Global had a value of $148,269,798. Interpreting Exhibit 2249-R as showing (a) the outstanding balances on the initial $25 million and additional $11 million loans made by YA Global and (b) the difference between the fair value of those loans and the outstanding balances is a more reasonable explanation of the amounts shown on Exhibit 2249-R than Mr. Oren’s explanation, as cited by petitioners. The testimony of Messrs. Schinik and Franks regarding what VRC valued and on what YA Global relied with respect to the VRC report is not credible, especially in light of what YA Global actually reported on its financial statements, i.e., that the value of the convertible note issued by Compass as of December 31, 2009 was $148,269,798 and that YA Global did not hold any of other investment in Compass. (RPFF ¶¶ 495-497.)

226. This $116,308,517 was included in the unrealized gain reported on the Fund’s 2009 Schedule M-3 in order to reconcile its tax gains with its financial statements. (Ex. 4-J (YALIT000855-857).)

Objection: not supported by the record, vague, mischaracterizes the evidence. This proposed finding does not state with any precision to what "[t]his $116,308,517" refers. To the extent the proposed finding implies that the unrealized gain of $116,308,517 relates to an asset other than the convertible note issued by Compass, the proposed finding is inaccurate and not supported by the record. (See Resp’s Obj. to Pet’rs’ PFF ¶¶ 224, 225.) Further, petitioners did not present any evidence of what amounts were included in the computation of the unrealized gains and losses for purposes of Schedule M-3, Net Income (Loss) Reconciliation for Certain Partnerships. (Entire record.) And the information in the record is inconsistent and does not detail what amounts were included as unrealized gains and losses for purposes of the Schedule M-3. In the FPAA, respondent determined that YA Global had unrealized gains and losses in the amount of $103,852,672 based on the 2009 Schedule M-3. (Ex. 18-J at YALIT000066 (determining net ordinary business income to be Sch. M-3 part II, line 26(d) less line 22(b) plus $46,506,023); Ex. 4-J at YALIT000856, line 22(b) (showing other income and loss of $103,852,672).) The amount shown on Sch. M-3 is different from the amount of unrealized gain and loss shown on other documents. (See Ex. 289-J at p. 0015 (showing increase in unrealized appreciation of $115,625,880); Ex. 1285-J at col. I, line 3055 (showing a third number, total portfolio unrealized gains of $69,331,668).)

V. YA Global’s Interest Write-Off

227. At the beginning of January 2009, YA Global had accrued interest receivables that remained unpaid in the total amount of approximately $66 million. (Ex. 1289-P, tab "1-31-09", cell E2.). By December 2009, YA Global had accrued interest receivables that remained unpaid in the total amount of approximately $71.7 million. (Ex. 1289-P, tab "12-31-09", cell E2.)

Objection: incomplete, misleading, unreliable evidence cited, irrelevant. It is unclear the purpose of these findings. If the purpose of these findings is to show what interest was accrued, what interest was paid, and what interest remained unpaid for 2009, these findings fail in meeting that purpose. Also, looking at the snapshot of the receivables at the beginning of December 2009 is meaningless as it does not reflect a full year of interest accruals and does not elucidate what was paid and what written down for book purposes. For a more accurate description of the interest receivables for 2009, respondent asks the Court to adopt the alternative findings of fact set forth below.

Respondent’s Alternative Findings of Fact

227a. As of December 31, 2008, YA Global had an interest receivable of $66,237,160. (Ex. 288-J at p.; Ex. 1289-P at Tab "1-31-09," cell E2.)

227b. During 2009, YA Global had interest and dividend income of $41,185,455. (Ex. 289-J at p.0015.)

227c. YA Global’s 2009 financial statements show a "write-off of interest receivable deemed uncollectible" of $46,506,023. (Ex. 289-J at p.0015.)

227d. As of December 31, 2009, YA Global had an interest receivable of $34,581,418. (Ex. 289-J at p. 004.) Exhibit 1289-P is an unreliable source of evidence because the accrued interest receivable as of December 31, 2009 does not match YA Global’s 2009 financial statements. (Compare Ex. 289-J at p. 004 with Ex. 1289-P at Tab "12-31-09," cell C2 (showing "Accrued Income" in the amount of $34,794,780, which is supposed to represent the accrued but impaid interest as of December 31, 2009).)

227e. During 2009, YA Global received interest payments totaling $26,335,174 (opening receivable, $66,237,160, plus interest income, $41,185,455, less write-off, $46,506,023, less ending receivable, $34,581,418). (Respondent’s alternative findings 227a through 227d.)

228. At the end of December 2009, YA Global charged off $46,505,924 of interest receivables from it books because it determined the receivables became uncollectible. By charging off the interest receivables from its books, YA Global unequivocally abandoned the collection of the charged-off receivables. (Ex. 1290-J, tab "Income (Rllfwd)", cell D125.)

First sentence. Objection: inaccurate; mischaracterizes the evidence, unreliable evidence cited, misleading, irrelevant. Per YA Global’s financial statements, YA Global "[wrote] off interest receivable deemed uncollectible" in the amount of $46,506,023. (Ex. 289-J at p. 0015.) On its 2009 return, YA Global claimed $46,506,023 as part of "deductions related to portfolio income." (RPFF ¶ 539.) Petitioners have been unable to assemble the correct debts and amounts to arrive at $46,506,023. (Ex. 1289-P (showing a total of $46,822,987); Ex. 1290-P (showing a total of $46,505,924).) Exhibit 1289-P includes debts not included on Exhibit 1290-P, and Exhibit 1290-P includes debts not included on Exhibit 1289-P. For example, Exhibit 1289-P includes "blue interest," Certo Group 10% 11/07," and "Earthshell P-Note 2.0%," among others, which are not on Exhibit 1290-P, and Exhibit 1290-P includes additional BlueCreek, Falcon Natural Gas, and US Helicopter notes, among others, which are not on Exhibit 1289-P. The foregoing demonstrates that Exhibits 1289-P and 1290-P are unreliable and should not be given any credence or weight. (See also respondent’s alternative finding of fact 227d, above.)

Further, the record does not demonstrate that YA Global made determinations regarding the collectability of the receivables identified in Exhibits 1289-P and 1290-P. The valuation committee was tasked with reviewing and monitoring the valuation of YA Global’s assets and maintained minutes of its meetings. (Ex. 211-J at p. 009; Ex. 1266-J. See also RPFF ¶ 465.) Exhibit 1266-J is the only evidence relating to the valuation committee’s meetings in the record and is the only evidence of the general partner’s decisions with respect to fair value of YA Global’s assets for financial statement purposes. Exhibit 1266-J reflects a fair value assessment of only about 14 of the 46 the companies listed on Exhibit 1290-P. The following companies from Exhibits 1289-P and 1290-P are mentioned in the minutes at Exhibit 1266-J: Access Beverage, Certo Group, Cobalis, Future Media, Isonics, MM2 Group, NS8 Corp., Poseidis, Renewable Fuels, Speech Switch, TXP Corp., Titan Global, US Helicopter, Wherify. Of these few companies mentioned in the minutes, only 3 entries indicate that collection is unlikely (Certo Group, NS8 Corp., TXP Corp.). (Ex. 1266-J.)

Finally, "charge off" is a concept for book purposes, not tax purposes. Whether YA Global "charged off the receivables as uncollectible for book purposes is not relevant to whether YA Global is entitled to a deduction for tax purposes.

Second sentence. Objection: not supported by the record, misleading, argumentative. See objection to the first sentence. YA Global’s "charging off the interest receivables is not an "abandonment" of the interest receivables. None of petitioners’ witnesses testified that YA Global abandoned the interest receivables. And petitioners presented no other evidence that YA Global abandoned the interest receivables. YA Global continued to have a right to collect the interest; YA Global did not release the debtors from their obligations to repay the principal and interest. (Entire record.) In fact, YA Global had an outstanding legal action with respect to one or more of the companies listed on Exhibits 1289-P and 1290-P. See Cobalis Corp. v. Cornell Capital Partners, LP, 2011 WL 4962188 (D. N.J. 2011); YA Global Investments, LP v. McKenzie Bay International Ltd., 2010 WL 398379 (D. N.J. 2010). See also In re: Teleplus World, S.D. Fla. Case No. 09-13799 (where YA Global filed a limited objection to the debtor’s emergency motion to use of cash collateral); In Re: TXP Corp., N.D. Tex. Case No. 09-43659 (where YA Global filed an objection to the debtor’s motion for various orders).

229. Among the interest receivables charged off by YA Global were interest receivables that became due and accruable in 2009, totaling $17,137,938. (Ex. 1290-J, tab "Income (Rllfwd)", cell E125.)

Objection: unsubstantiated, unreliable evidence cited, misleading. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 227, 228.

230. Despite interest "payments" made during 2009, the amount of accrued interest receivables due to YA Global increased by $5 million. (See Ex. 1289-P, cell D2 in each monthly tab; PFF ¶ 227.)

Objection: vague, inaccurate, misleading, irrelevant. See Resp’s Obj. to Pet’rs’ PFF ¶ 227 and respondent’s alternative findings of fact. Petitioners do not explain why the word "payments" is set off by quotes. Petitioners’ witnesses acknowledged that YA Global received interest payments. (Tr. 919:21-922:17.) YA Global asset reconciliation statements show interest payments. Respondent asks the Court to adopt the alternative findings of fact below which set forth the interest paid from 2006 through 2008. (See respondent’s alternative findings of fact 227a through 227e for 2009 interest payments received.)

Respondent’s Alternative Findings of Fact

230a. For 2006, YA Global received interest payments in the amount of $8,363,798, computed as follows:

12/31/2005 interest receivable	$6,807,764	Ex. 285-J at p. 004
12/31/2006 interest income	+ 27,467,736	Ex. 286-J at p. 0013
12/31/2006 interest receivable	-25,911,711	Ex. 286-J at p. 004
2006 interest paid	$8,363,789

230b. For 2007, YA Global received interest payments in the amount of $22,832,457, computed as follows:

12/31/2006 interest receivable	$25,911,711	Ex. 286-J at p. 004
12/31/2007 interest and dividend income	+ 45,806,127	Ex. 287-J at p. 0013
12/31/2007 interest receivable	-48,885,381	Ex. 287-J at p. 004
2007 interest paid	$22,832,457

230b. For 2008, YA Global received interest payments in the amount of $33,104,189, computed as follows:

12/31/2007 interest receivable	$48,885,381	Ex. 287-J at p. 004
12/31/2008 interest and dividend income	+ 50,455,968	Ex. 288-J at p. 0016
12/31/2007 interest receivable	-66,237,160	Ex. 288-J at p. 004
2008 interest paid	$22,832,457

231. There existed no reasonable expectation that $17,137,938 of interest receivables that became accruable in 2009 would ever be collected within a reasonable time. (Entire Record.)

Objection: not supported by the record, unsubstantiated. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 227-229. Petitioners failed to present any evidence establishing that there was no reasonable expectation of payment of interest on any of the loans identified in Exhibits 1289-P and 1290-P. Petitioners presented only Exhibit 1266-J, minutes of a November 24, 2009, valuation committee meeting, which identified the valuation committee’s assessment of a limited number of the loans identified in Exhibits 1289-P and 1290-P and the valuations committee’s assessment that 3 loans were uncollectible. These assessments were performed to address YA Global’s required evaluation of the fair value of its assets for financial statement purposes and not for tax purposes. This self-serving assessment is not sufficient to establish uncollectibility for tax purposes.

232. A number of identifiable events occurred in 2009, in addition to the abandonment described in PFF ¶ 228, that evidenced the worthlessness of the interest receivables charged off by YA Global. Many of the portfolio companies suffered from the following identifiable events: (1) the financial statement auditor had expressed substantial doubt as to whether the particular portfolio company could continue as a going concern, (2) the portfolio company was in bankruptcy or similar proceedings, (3) the portfolio company was in default on its current obligations, (4) the portfolio company suffered substantive negative cash flows in its operations, making any recovery of the interest receivables hopeless:

[table omitted]:

Objection: vague, incomplete, misleading, not supported by the record. Petitioners do not define "substantial doubt as to whether the particular portfolio company could continue as a going concern" or when the auditor applies this qualification to a company. Petitioners offered the testimony of YA Global’s auditor, Mr. Yager of RSM McGladrey, but did not have him explain the significance of the qualification. Petitioners also seem to misrepresent the significance of the "substantial doubt" qualification, as this qualification can appear in multiple years of SEC filings and, in some instances, YA Global made loans to companies despite the qualification. For example, for the fiscal year ending December 31, 2005, Handheld Entertainment, Inc. included the "substantial doubt" qualification in its financial statements (Ex. 1450-J); Handheld Entertainment, Inc. also included this qualification for the period ended September 30, 2008. (Ex. 1449-J.) Despite this qualification for the fiscal year 2005, YA Global made a loan to Handheld Entertainment, Inc. in 2007. (See also, e.g., Ex. 1427-J at pp. 003-004 (describing the history of Cobalis).)

Further, as illustrated in the chart below, which is based on petitioners’ table, all but a handful of exhibits relate to periods ending before 2009, and only 1 of the bankruptcies was filed in 2009.

Company	Ex. No.	Going Concern Qualification	Bankruptcy or Other Proceedine
Cobalis	1427-J	2002-2007	2007
Compass	863-J		2009
Earth Biofuels	1430-J	Qtr 9/30/2008
Falcon	1439-J	Qtr 9/30/2006
Futuremedia	1443-J	FYE 6/30/2007
Handheld	1449-J	Qtr 9/30/2008
Ignis	1458-J	FYE 6/30/2008
Innova	1474-J	Qtr 9/30/2007
Isonics	1478-J	Qtr 10/31/2008
iVoice	1481-J	FYE 12/31/2008
	1482-J	FYE 12/31/2009
	1485-J	Qtr 9/30/2009
McKenzie Bay	1499-J	Qtr 6/30/2006
MM2 Group	1501-J	Qtr 3/31/2009
Pacific Gold	1525-J	Qtr 9/30/2008
Poseidis	1527-J	Qtr 5/31/2006
Savi	1535-J	Qtr 9/30/2007
Tech Labs	1549-J	Qtr 3/31/2007
Teleplus	1551-J	Qtr 9/30/2008
TXP Corp	1560-J	FYE 12/31/2007
US Helicopter	1562-J	Qtr 9/30/2008	no bankruptcy at page cited
Wherify	1566-J	Qtr 3/31/2008	no bankruptcy at page cited
	1568-J	FYE 6/30/2006
	1569-J	FYE 6/30/2007

In their table, petitioners cite to Exhibit 1554-J in support of the The Certo Group Corp.’s being in bankruptcy or receivership. Exhibit 1554-J is an application to withdraw The Certo Group Corp.’s F registration statement. The exhibit does not mention bankruptcy, receivership, or default, or refer to any of the column headings from petitioners’ table at pp. 93-94.

Several references to defaults in petitioners’ table are misleading. For example, for Falcon Natural Gas, petitioners point to Exhibit 1439-J at page 11. The information reported does not reflect a current default on the part of Falcon Natural Gas; rather it reflects a default on notes outstanding in 2005, for which an agreement was reached for Falcon Natural Gas to repay the notes. For Future media, petitioners point to Exhibit 1443-J, which reports a technical default for failing to register its shares and not a default for failure to make required principal or interest payments.

Further, many of the references to "substantive negative cash flows" are incorrect or misleading. For example, petitioners cite to pages 6 and 7 of Exhibit 1555-J as support for Titan Global Holdings as having "substantive negative cash flows in its operations." Page 7 shows positive net cash flow provided by operating activities as of November 30, 2008 of $5,744,000 and a net increase in cash and cash equivalents of $462,000.

Respondent’s alternative findings of fact.

232a. Petitioners cannot establish what notes and amounts comprise the deduction of $46,506,023. Exhibits 1289-P and 1290-P both show numbers inconsistent with YA Global’s audited financial statements for 2009. Exhibits 1289-P and 1290-P both were presented as substantiation of the interest write-off and the 2009 interest that was incorrectly accrued but each has different information.

(a) The following loans appear on Exhibit 1289-P’s list of uncollectible interest receivables but do not appear on Exhibit 1290-P’s list: Blue Interest (no symbol), Certo Group 10% 11/07 ("certo"), Earthshell P-Note 2.0% ("newerth"), K&B Equity PNUS 5% 5/1/10 ("k&b equity"), NS8 Corp. ("nseo21"), NS8 Corp. ("nseo22"), Poseidis Inc. 8% 09/07 ("psed").

(b) The following loans appear on Exhibit 1290-P’s list of uncollectible interest receivables but do not appear on Exhibit 1289-P’s list: BlueCreek 17% 04/01/2011 ("bluecreek3"), BlueCreek 17% 04/01/2011 ("bluecreek4"), BlueCreek 17% 05/01/2012 ("bluecreek5"), Falcon Nat Gas Corp CVT ("fngc16"), Falcon Nat Gas Corp CVT ("fngc16"), Falcon Nat Gas 15% ("fngc15"), Innova Holdings Inc -.02 ("ivhg3"), Merrill Collateral Interest (no symbol), Terminal 1-Demand Note 6% ("terminable" or "terminlnc"), US Helicopter 15% 12/2009 ("ushp10"), US Helicopter 15% 12/2009 ("ushp10"), USD Credit Interest (no symbol), Westport Energy, LLC ("westport3"), Westport Energy, LLC ("westport4").

(c) The loan identified as "Terminal 1-Demand Note 6%" with symbol "terminable" or "terminine" is not shown as an asset of YA Global. (Ex. 1285-J.)

(d) The interest receivables identified as "Blue Interest," "Merrill Collateral Interest," and "USD Credit Interest" are not shown as assets of YA Global. (Ex. 1285-J.)

232b. YA Global established a corporate subsidiary, New Earthshell Corp. (Ex. 5-J at YALIT000914; Ex. 6-J at YALIT000996; Ex. 289-J at p. 0020; Ex. 839-J. See also Pet’rs’ Requests for Admission No. 23.)

232c. In 2009, various loans were held by New Earthshell Corp, or subsidiaries of New Earthshell Corp. (Ex. 1285-J, lines 1667-1908.)

(a) The BlueCreek loans described with security symbols (Ex. 1290-P, col. AH) "bluecreek," "bluecreek2," bluecreek3," "bluecreek4," and "bluecreek5" are reported as held by "New Earthshell — Mountain Hawk Energy, LLC." (Ex. 1285-P, lines 1735, 1740-1749.)

(b) The Earthshell loans described with security symbol (Ex. 1289-P, col. T) "newerth," "newerth3," and "newerth4" are reported as held by "New Earthshell." (Ex. 1285-P, lines 1667, 1687, 1691, 1695.) The Earthshell loan described as "newerth" is not part of the uncollectible interest receivables identified on Exhibit 1290-P.

(c) The K&B loan described with security symbol (Ex. 1289-P, col. T) "k&b equity" is reported as held by "New Earthshell — Spring Magnolia, LLC (Fort Worth)." (Ex. 1285-P, lines 1754, 1758.) The K&B loan is not part of the uncollectible interest receivables identified on Exhibit 1290-P.

(d) While the "Terminal 1-Demand Note 6%" with symbol "terminable" or "terminine" is not shown as an asset, loans of "Terminal Subsidiaries" are held by New Earthshell. (Ex. 1285, lines 1823-1839.)

232d. The income and losses associated with loans held by New Earthshell Corp, do not flow to YA Global. (Exs. 5-J, 6-J. See also Pet’rs’ Requests for Admission Nos. 23, 24.)

232e. YA Global recorded unrealized gains (i.e., an increase in value) in 2008 for companies whose debts were shown as uncollectable (i.e., an increase in value). (Ex. 1284-J (searching BlueCreek, EYI (eyii4), Falcon Natural Gas, Handheld Entertainment (ZVUE), Ignis Petroleum, Innova Holdings, Isonics).)

232f. YA Global received interest payments in 2008 on debts shown as uncollectable. (Ex. 1284-J (searching Corporate Strategies, CSI Business, EYI, Futuremedia, Handheld Entertainment (ZVUE), Ignis Petroleum, Innova Holdings, Isonics).)

232g. As late as May 8, 2009, Mr. Angelo advised investors of 3 examples where the debtor’s equity value declined but the valuation committee "still sees no reason why the debt should be impaired." These debtors appear on Exhibits 1289-P and 1290-P and were Titan Global, Texas Prototypes (referred to as TXP Corp, on Exhibits 1289-P and 1290-P), and US Helicopter. (Ex. 254-J at p. 002.)

232h. In 2009, after conducting due diligence, YA Global extended a new $15 million loan to United Fiber Systems, a company which YA Global financed seven times previously and is identified on Exhibits 1289-P and 1290-P. United Fiber had never missed a debt payment. (Ex. 256-J at p. 002.)

232i. Petitioners allege that YA Global relied on VRC’s valuation reports, including Exhibits 869-P, which is dated as of September 30, 2009.

(a) YA Global’s write-off of the BlueCreek interest receivable is inconsistent with information presented/reported in Exhibit 869-P, stating that YA Global’s loan to BlueCreek was based on, among other things, "[s]ignificant cash flow to be generated in immediate future" and that BlueCreek expected to "turn a slight profit in 2010, with large gains beginning in 2011." (Ex. 869-P at p. 0012.)

(b) YA Global’s write-off of the Earthshell interest receivable is inconsistent with information presented/reported in Exhibit 869-P, stating that Earthshell’s management projected 15% to 20% annual growth, which "Yorkville’s [sic] believes this is ultra-conservative given recent robust and retail channel interest." (Ex. 869-P at p. 0024.)

(c) YA Global’s write-off of the KD Resources interest receivable is inconsistent with information presented/reported in Exhibit 869-P, stating that YA Global’s loan to KD Resources based on, among other things, "[profitable company with quality acreage in areas with proved hydrocarbon reserves" and that KD Resources had "already begun earning significant revenue despite being the early stages of production." (Ex. 269-P at p. 0043.)

(d) YA Global’s write-off of the Westport interest receivable is inconsistent with information presented/reported in Exhibit 869-P, stating that YA Global’s loan to Wesport was based on, among other things, "[significant cash flow to be generated in immediate future" and that Westport "will reach full production levels likely around 2011." (Ex. 869-P at p. 0090.)

VI. YA Offshore

233. In 2007 YA Offshore Feeder directly incurred $12,081,846 in expenses related to its investment in YA Global, $11,767,026 of which was fees payable to Yorkville Advisors. S. ¶ 183.

No objection except to the extent that this proposed finding implies that YA Offshore is entitled to deduct the amounts shown or that YA Global is entitled to take these amounts into account in computing its liability for withholding tax under section 1446. YA Offshore did not file a timely return under section 882(c) for 2007 and cannot benefit from any deductions, losses, or credits that it otherwise may have been entitled to claim for 2007. Further, YA Global did not receive any forms from YA Offshore or other limited partners certifying their deductions or losses and cannot take any such deductions or losses into account in calculating its withholding tax liability.

234. In 2008 YA Offshore Feeder directly incurred $22,187,150 in expenses related to its investment in YA Global, $22,067,097 of which was fees payable to Yorkville Advisors. S. ¶ 184.

No objection except to the extent that this proposed finding implies that YA Global is entitled to take these amounts into account in computing its liability for withholding tax under section 1446. YA Global did not receive any forms from YA Offshore or other limited partners certifying their deductions or losses and cannot take any such deductions or losses into account in calculating its withholding tax liability.

235. In 2009 YA Offshore Feeder directly incurred $19,966,780 in expenses related to its investment in YA Global, $19,803,391 of which was fees payable to Yorkville Advisors. S. ¶ 185.

No objection except to the extent that this proposed finding implies that YA Global is entitled to take these amounts into account in computing its liability for withholding tax under section 1446. YA Global did not receive any forms from YA Offshore or other limited partners certifying their deductions or losses and cannot take any such deductions or losses into account in calculating its withholding tax liability.

236. In 2010 YA Offshore Feeder directly incurred $11,723,323 in expenses related to its investment in YA Global, $11,711,323 of which was fees payable to Yorkville Advisors. S. ¶ 186.

No objection except to the extent that this proposed finding implies that YA Global is entitled to take these amounts into account in computing its liability for withholding tax under section 1446. YA

Global did not receive any forms from YA Offshore or other limited partners certifying their deductions or losses and cannot take any such deductions or losses into account in calculating its withholding tax liability.

VII. Yorkville and Its Outside Tax Advisors

A. Ed Schinik

237. Yorkville’s CFO, Mr. Schinik, had limited knowledge about tax and international tax issues and sought advice from outside tax advisors, including Yorkville’s accounting firm and legal counsel when encountering tax issues. (Tr. 570:19-24; 571:8-14.)

Objection: misleading, overly broad, self-serving and uncorroborated testimony that is inconsistent with the record. More accurate findings of fact about Mr. Schinik’s background are at RPFF ¶¶ 579-583. More accurate findings of fact about Mr. Schinik’s communications with YA Global’s accountants and outside counsel are at RPFF ¶¶ 562-574, 576-577, 584-599, & 601-608.

238. Mr. Schinik was responsible for obtaining tax advice for the funds under Yorkville’s management. (Tr. 586:15-17; PFf ¶ 59.)

Objection: inaccurate, misleading, and unsupported by the cited reference. Mr. Schinik testified that he was "[r]esponsible for the day to day reconciliations, books and records, payment of invoices, the year-end audits, the year-end tax returns; everything that sort of goes along with the financial part of the business." (Tr. 571:1-7.)

239. As Yorkville’s CFO, Mr. Schinik was the main contact with Yorkville’s outside advisors. (Tr. 524:8-11.)

Objection: incomplete, inaccurate, misleading, and unsupported by the cited reference. The cited reference to the transcript at page 524 does not support a finding that Mr. Schinik was the main contact for all of Yorkville’s "outside advisors".

240. At all relevant times, Yorkville retained professional advisors to provide accounting and tax advice with respect to the funds it managed, including YA Global and YA Offshore. (Tr. 586:15-24; Ex. 28-J, § 1(h) (the investment manager to retain attorneys, accountants, and other personnel); see also Ex. 30-J, p. 7 (YAREL0000012057); Ex. 97-J, p. 7; Ex. 104-J, p. 7; Ex. 111-J, p. 7; Ex. 118-J, p. 7; Ex. 122-J, p. 6, Ex. 123-J, p. 7; Ex. 125-J, p. 6; Ex. 129-J, p. 6; Ex. 130-J, p. 6; Ex. 1304-J, pp. 8-9; Ex. 1309-J, p. 9; Ex. 1397-J, pp. 82-167 (Engagement Letters).)

Objection: inaccurate, misleading and unsupported by the record before the Court or the cited references. More accurate findings of fact are that:

A. Petitioners’ cited references to the PPMs found at Ex. 104-J, p. 7; Ex. 111-J, p. 7; Ex. 118-J, p. 7; Ex. 122-J, p. 6, Ex. 123-J, p. 7; Ex. 125-J, p. 6; Ex. 129-J, p. 6; Ex. 130-J, p. 6 and Ex. 1309-J are nothing more than a "Directory List" and do not support a finding that Yorkville retained professional advisors to provide "accounting and tax advice, including YA Global and YA Offshore" regarding the matters at issue in this case.

B. Petitioners’ cited reference to Ex. 1304-J is a list that provides that Marcum and Kligman LLP was an auditor and Seward Kissel was counsel and does not support a finding that Yorkville retained professional advisors to provide "accounting and tax advice, including YA Global and YA Offshore." The cited reference does not provide that those firms were engaged to provide advice on this matters at issue in this case.

C. Petitioners’ cited reference to Ex. 1397-J does not support a finding that RSM was engaged to provide tax advice. The engagement letters found at pages 82-167 of Exhibit 1397-J establish that RSM was engaged to provide audit services and tax return preparation services, not "tax advice" as petitioners’ proposed finding implies.

Moreover, certain of the Engagement Letters specifically provide that

"In connection with your Federal and state tax returns, or in response to your request(s), we may also provide you with Federal or state tax advice concerning matters that are not the subject of a separate arrangement letter. This tax advice is beyond the scope of tax return preparation and is not included in the fees for tax return preparation. Our fees for this tax advice will be based on the time required for work performed, plus out-of-pocket expenses. We will submit our bill for these services on a monthly basis, and payment is due upon submission of our bill."

(See, e.g., Ex. 1397-J, at 120-121, 128). The record before the Court is devoid of any evidence that RSM provided tax advice to YA Global on any matter or that RSM billed them separately as the engagement letters provide.

D. RSM employees, Mr. Karst and Mr. Yager, both testified that RSM was not engaged by Yorkville Advisors or YA Global to provide tax advice which would have required a separate agreement and fee schedule. Moreover, RSM was not engaged at all to provide any tax services or advice to YA Offshore. (Tr. 361:13-18; Entire record.) Instead, RSM was engaged to provide audit and tax return preparation services to Yorkville and YA Global. (Tr. 359:17-22, Tr. 375:12-17; Entire Record.)

E. YA Global engaged Schulte Roth to prepare PPMs not to provide tax advice on the U.S. trade or business issue as the proposed finding implies. (Tr. 436:16-23, Tr. 438:1-7 and Tr. 523:7-22; Entire Record.)

B. RSM

241. Before May 2005 Marcum & Kliegman LLP ("Marcum") was engaged to provide financial statement audit services as well as tax advisory services for YA Global and YA Offshore. (See, e.g., Ex. 95-R, p. 8; Ex. 98-J, p. 10.)

Objection: inaccurate, misleading and unsupported by the cited references and the record before the Court. Petitioners’ cited references to the Exhibit 95-R, p. 8 and Exhibit 98-J (sic), p. 10 do not support a finding that Marcum was engaged to provide financial statement audit services as well as tax advisory services for YA Global and YA Offshore. Instead, Exhibit 95-R, p. 8 merely lists Marcum is the "Partnership Accountants" and Exhibit 98-R, p. 8 lists that Marcum was "the auditors of the fund". Neither exhibit nor any other evidence presented at trial provides any details as to what services Marcum was engaged to provide. (Entire record.)

242. In May 2005 RSM McGladrey, Inc. ("RSM") was engaged to provide tax return preparation services for the funds managed by Yorkville that were required to file tax returns in the United States. (Tr. 357:22-358:5; Ex. 1397-J, pp. 92-95, 120-167.)

Objection: inaccurate, incomplete, misleading and unsupported by the cited reference. The engagement letters to which petitioners cite provide that RSM was to provide tax return preparations services to Cornell Capital Partners LLP/YA Global US for tax year 2006 through 2009 with the earliest engagement letter dated December 29, 2006 (Ex. 1397-J, p. 92 and 120-139); for YA Global Investments II, Ltd’s tax year 2009 (Ex. 1387-J, p. 140); and tax return preparation services to YA Global Master SPV Ltd, YA Global Investments SPV, LLC, YA Onshore SPV 609, YA Onshore SPV 909 LLC and YA Onshore SPV 309 LLC for tax year 2009. (Ex. 1397-J, p. 148-167.)

A more accurate finding of fact is that RSM was engaged to provide tax preparation services for "certain funds" as Mr. Yager testified. (Tr. 358:1-5.)

243. RSM continued to provide tax advisory services to Yorkville with respect to the funds under Yorkville’s management through the funds’ 2009 year. (Ex. 1397-J, pp. 120, 128, 138; Tr. 450:16-451:4, 586:15-24.)

Objection: inaccurate, misleading and unsupported by the cited reference. The Engagement Letters cited to provide that RSM was to provide "Tax Return Preparation Services" to a specific fund, not "tax advisory services to Yorkville" as petitioners’ proposed finding incorrectly states. (Ex. 1397-J, p. 82-167.)

244. In May 2005 Goldstein Golub Kessler, LLP ("GGK"), which was affiliated with RSM, was engaged by Yorkville to provide financial statement audit services for the funds under Yorkville’s management. (Tr. 357:22-358:5; Ex. 1397-J, pp. 84-91, 96-119.)

Objection: inaccurate, misleading and unsupported by the cited reference. The engagement letters to which petitioners cite provide that RSM was to provide audit services alone to Cornell Capital Partners LLP for tax year 2006, Cornell Capital Partners Offshore Ltd. for tax year 2006 and YA Global Investments LP for tax years 2007 and 2008. (Ex. 1397-J, pp. 84-91, 96-119.)

A more accurate finding of fact is that GGK/RSM was engaged to provide audit services for CCP and CCP Offshore for tax year 2006 and YA Global for tax years 2007 and 2008. (Tr. 358:1-5.)

245. GGK continued to provide audit services to Yorkville with respect to the funds under its management through the funds’ 2009 year.

Objection: unsupported by a cited reference to the record.

246. While operating under different names, GGK and RSM (hereinafter, together as "RSM") were part of the same firm providing audit services and tax return preparation and tax advisory services, respectively. (Tr. 586:21-24; Tr. 354:7-21.)

Objection: inaccurate, misleading and unsupported by the cited reference. GGK/RSM was engaged to provide tax return preparation and audit services for certain specified entities as outlined in the Engagement Letters in the record. GGK/RSM was not engaged to provide "tax advisory services" as petitioners’ proposed finding incorrectly states. (Ex. 1397-J, p. 82-167.)

247. As part of the due diligence performed on YA Global and YA Offshore when RSM was first engaged to audit the financial statements Yorkville’s funds, RSM’s audit team had to become familiar with the funds and their operations, including performing a complete audit of the funds and due diligence. (Tr. 361:19-362:12.)

Objection: inaccurate, incomplete and misleading. The due diligence performed by RSM involved is not as broad as petitioner’s proposed finding. Mr. Yager testified that RSM conducted a complete audit of the client; he did not indicate that it conducted a complete audit of the clients funds. (Tr. 362.) RSM did not perform an independent analysis of YA Global’s lending and financing activités. (Tr. 429:6-13; entire record.)

248. As Yorkville’s financial statement auditor and tax return preparer for its funds, RSM was intimately involved in Yorkville’s investment management business and had access to its records. (Tr. 670:9-25.)

Objection: Argumentative, inaccurate, misleading and unsupported by the record before the Court. Mr. Karst of RSM testified that he was not aware that YA Global that RSM employees that testified at trial indicated that he was not aware that YA Global had in its portfolio promissory notes and equities that it acquired outside of SEDA transactions. (Tr. 464-65.)

249. As part of the audit, RSM requested Yorkville to provide a large number of transactional documents for review. Based on this review, Mr. Yager understood that YA Global made equity investments in public companies using convertible debentures of companies, SEDAs, and straight equity instruments. (Tr. 371:4-17.)

Objection: Argumentative, irrelevant and immaterial. Whether YA Global was involved in financing/lending activities or investment activities is an issue to be decided by the Court. RSM was not engaged to provide advice to YA Offshore relative to its lending activities. Mr. Yager’s purported conclusion was based on incomplete information relative to all of YA Global’s activities. (Tr. 417:18-23.)

250. RSM’s audit team and tax return preparation team worked closely together and it was not uncommon for the two teams to exchange and share information about a client. (Tr. 358:12-21.) Any information gathered during the course of the audit that was also relevant to the tax return preparation was made available to the tax team. (Tr. 359:4-12.) There is no reason to believe that this practice did not apply to the engagement between RSM and Yorkville regarding Yorkville’s funds. (Entire Record.)

Objection: Argumentative, irrelevant, immaterial, unsupported by the record. Mr. Karst of RSM testified that he was not aware that YA Global that RSM employees that testified at trial indicated that he was not aware that YA Global had in its portfolio promissory notes and equities that it acquired outside of SEDA transactions. (Tr. 464-65.)

251. During the years at issue, Jeffrey Yager was an audit partner at RSM and was generally responsible for planning and executing the overall audit of a client, supervising staff when reviewing the key components of the audit, supervising the progress of the audit, interfacing with the client, identifying any potential issues that would come up, helping to resolve those issues, and ultimately signing off on the audit report before it’s issued in final form. (Tr. 355:3-23.)

Objection: irrelevant and immaterial.

252. Mr. Yager’s practice focuses on the financial services industry, which included private investment funds, hedge funds, private equity funds, broker dealers, and investment managers. (Tr. 356:4-9.)

Objection: Inaccurate. Mr. Yager testified that he "primarily worked in the financial services area, which included private — financial services, which included private investment funds, hedge funds, private equity funds, broker dealers, and investment managers." (Tr. 356:4-9.)

253. Mr. Yager was a certified public accountant at least during the years at issue. (Tr. 415:19-24.)

No objection.

254. Lawrence Karst was a tax partner at RSM during the years at issue. Mr. Karst has a law degree from the State University of New York at Buffalo and an LL.M, in Taxation from New York University. Mr. Karst has been a practicing tax attorney since 1981. (Tr. 448:20-449:16.)

No objection.

255. As a tax partner at RSM, Mr. Karst provided tax advice to clients in connection with tax questions that might arise. Mr. Karst specialized in international tax issues. (Tr. 449:17-450:4.)

Objection: Inaccurate, incomplete and misleading. Mr. Karst testified that "I was primarily engaged in the consulting practice at RSM as opposed to the compliance practice. And, as such, I served as a resource for my partners and my clients in connection with tax questions that may arise. . . . I tended to focus at that point in time in my career in the international arena with a fair amount of transaction work in the domestic arena." (Tr. 449:17-450:4.)

1. RSM’s Tax Advice Regarding USTB and ECI

256. Between 2006 and 2010 RSM had several discussions with Yorkville about whether YA Global was engaged in a USTB and communicated its conclusion to Yorkville that, based on YA Global’s activities, YA Global was not engaged in a USTB during the years at issue. (Tr. 374:13-376:7.)

Objection: Argumentative, legal conclusion that is unsupported by the record. Mr. Yager testified that RSM did not provide tax advice to YA Global relating to the U.S. trade or business issue, was only engaged to provide audit services and tax preparation services, and that "the conclusion that YA Global was not engaged in a U.S. trade or business originated with Yorkville [Advisors]." (Tr. 376:22-25, 412:21-24; Exhibit 1397-J, p. 82-167; Entire record.) Mr. Karst confirmed that RSM did not provide any opinion or formal tax advice to YA Offshore, YA Global or Yorkville Advisors regarding the U.S. trade or business issue. (Tr. 437:23-438:1, 494:25-495:1-2.)

257. Mr. Karst provided tax advice to YA Global, specifically around the issue of whether it was in a USTB and had ECI. Mr. Karst advised YA Global that it was not in a USTB because its activities qualified the Trading Safe Harbor under section 864(b)(2)(A). (Tr. 450:16-451:4.)

Objection: Incomplete, inaccurate and misleading. Also, argumentative legal conclusion that is unsupported by the record. There is no credible evidence in the record that RSM was engaged to provide or provided any tax advice to YA Global relating to U.S. trade or business issue. (Entire record.) The engagement letters between RSM and YA Global provided that YA Global should not rely upon verbal communications from RSM. (See, e.g., Ex. 1397-J, at pp. 00123, 00130.) Both Mr. Yager and Mr. Karst confirmed that RSM did not provide any advice or opinion to YA Offshore, YA Global or Yorkville Advisors regarding the U.S. trade or business issue. (Tr. 375:8-17; 437:23-438:1, 494:25-495:1-2.) Moreover, Mr. Karst admitted that any purported conclusions relating to the U.S. trade or business issue and safe harbor provisions under section 864(b)(2)(A) did not consider all YA Global’s activities, such as originating promissory notes. (Tr. 461-464, 479-482.)

258. Mr. Karst did not consider the convertible debentures in which YA Global invested were loans but considered them as equity for equity-type investments. (Tr. 455:8-456:8, 456:20-22, 497:23-499:23.)

Objection: Inaccurate, incomplete and misleading. Mr. Karst testified that whether a convertible debenture is considered debt versus equity is a complicated question that depends on all facts and circumstances. (Tr. 456:3-8.) Mr. Karst further admitted that any conclusions relating to the U.S. trade or business issue did not consider all of YA Global’s activities, such as originating promissory notes. (Tr. 461-464, 479-482.)

259. Mr. Karst considered the SEDAs as put options held by portfolio companies and as equity or equity-type investments in the portfolio companies. (Tr. 456:9-22.)

Objection: Argumentative legal conclusion that is unsupported by the record.

260. Mr. Karst communicated his conclusions that the convertible debentures and the SEDAs were equity investments to Mr. Schinik. (Tr. 456:23-457:4.)

Objection: Incomplete, inaccurate and misleading. Mr. Yager and Mr. Karst confirmed that RSM did not provide any advice or opinion to YA Global regarding the U.S. trade or business issue. (Tr. 375:8-17; 437:23-438:1, 494:25-495:1-2.) Mr. Karst also admitted that any discussions relating to the U.S. trade or business issue and safe harbor provisions under section 864(b)(2)(A) did not consider all of YA Global’s financing activities, such as promissory notes. (Tr. 461-464, 479-482.) Finally, Mr. Karst testified that the ECI Memo prepared by Mr. Schinik "provided a superficial analysis in general" and the question of whether YA Global was engaged in a U.S. trade or business "requires a much deeper analysis of many more factors and a fairly complete understanding of the business." (Tr. 476:6-13.)

261. Mr. Karst reviewed YA Global’s transactional documents as well as YA Global’s PPMs in reaching the conclusion that it was more likely than not YA Global was not in a USTB. (Tr. 476:14-477:6, 478:14-24.)

Objection: Argumentative legal conclusion that is unsupported by the record. Also, incomplete, inaccurate and misleading. Both Mr. Yager and Mr. Karst confirmed that RSM did not provide any advice or opinion to YA Global regarding the U.S. trade or business issue. (Tr. 375:8-17; 437:23-438:1, 494:25-495:1-2.) Mr. Karst testified that the ECI Memo prepared by Mr. Schinik "provided a superficial analysis in general" and the question of whether YA Offshore was engaged in a U.S. trade or business "requires a much deeper analysis of many more factors and a fairly complete understanding of the business." (Tr. 476:6-13.)

262. In reaching his conclusions regarding the character of YA Global’s activities, Mr. Karst believes he had sufficient facts gathered from YA Global to make his conclusions and would have asked for additional information if he felt he needed more information. (Tr. 502:7-503:2.)

Objection: Inaccurate, incomplete and misleading. Mr. Karst testified that any conclusions relating to the U.S. trade or business issue did not consider all of YA Global’s activities and admitted that these factors (promissory notes, underwriting, etc.) would be problematic for purposes of qualifying for the safe harbor provisions under section 864. (Tr. 461-464, 479-482.) Finally, Mr. Karst testified that the question of whether YA Global was engaged in a U.S. trade or business "requires a much deeper analysis of many more factors and a fairly complete understanding of the business." (Tr. 476:6-13.)

263. In reviewing the character of YA Global’s activities, Mr. Karst had unfettered access to all information about YA Global’s activities for purposes of his review. (Tr. 503:3-5.)

Objection: Argumentative, inaccurate, incomplete, misleading and unsupported by the record. Mr. Karst admitted that he was not familiar with all of YA Global’s activities, such as originating promissory notes. (Tr. 461-464, 479-482.) Mr. Karst also testified that the question of whether YA Offshore was engaged in a U.S. trade or business "requires a much deeper analysis of many more factors and a fairly complete understanding of the business." (Tr. 476:6-13.)

264. RSM had advised Yorkville that MEP, another fund under its management, was not subject to section 1446 withholding tax. (Ex. 1375-P.)

Objection: Irrelevant and immaterial.

2. The ECI Memo

265. Mr. Schinik first heard about the question of whether YA Global might be in a USTB from an investor who requested additional information about whether YA Global was in a USTB. (Tr. 587:4-6.)

Objection: incomplete, misleading, argumentative. YA Global and YA Offshore were each aware that it might be considered engaged in a U.S. trade or business at the latest December 2005. (Exs. 30-J, at p. YAREL0000012067; 99-J at p. 0067.)

266. To be able to respond to the investor’s inquiry, Mr. Schinik reached out to Yorkville’s tax advisors to address the question. (Tr. 587:10-17.)

Objection: Inaccurate, misleading and unsupported by the record. Mr. Schinik testified that at some unspecified time, he reached out to "our accounting team — or accounting/tax team as well as outside legal counsel team." (Tr. 587:10-17.) However, both RSM and Schulte Roth, YA Global’s accountants and legal counsel, testified that neither was engaged to or provided tax advice to YA Global or Yorkville Advisors on the U.S. trade of business issue. (Tr. 375:8-17; 494:25-495:1-2, Tr. 523-524, 526-527, 554-556.)

267. Based on the discussions of the USTB/ECI issues with Yorkville’s tax advisors, including Sutherland, SRZ and RSM, Mr. Schinik drafted a memorandum (the "ECI Memo") to memorialize the substance of the discussions and to explain the conclusion that YA Global was not engaged in a USTB. (Tr. 381:10-382:18, 587:21-588:20, 642:7-18; Ex. 1359-J; see also PFFs ¶¶ 293, 294, 295, 297.)

Objection: Self-serving, uncorroborated testimony. A more accurate finding of fact is that Mr. Schinik drafted the ECI Memo so that he could forward it to prospective investors. (Tr. 589:6-9, 590:4-7; Ex. 1359-J.) Mr. Yager "reviewed" the ECI memo in 35 minutes for grammar and stylistic edits nor for legal correctness. (See RPFF ¶¶ 590-592.) Mr. Yager also testified that RSM did not originate the conclusion in the ECI Memo and that RSM did not advise YA Global on the U.S. trade or business issue. (Tr. 375:8-17, 377:16-20, 412:21-24.)

268. In April 2007 Mr. Schinik provided the ECI Memo to Mr. Yager for further review and comments so that the ECI Memo could be a more complete document that could be provided to investors. (Tr. 377:7-13; 587:21-588:1; 589:2-9; Ex. 1364-J.)

Objection: Inaccurate, misleading, uncorroborated self-serving testimony that is not supported by the record. Mr. Yager testified that he did not review the ECI Memo substantively and only made stylistic and grammar edits. The "review" was over a 35-minute period and did not involve any independent research or analyses. (Tr. 377:16-20; Ex. 1397 at pp. 3-4; RPFF ¶¶ 590-600.) In addition, Mr. Karst testified that the ECI Memo provided a "superficial analysis" and that the issue required "a much deeper analysis of many more factors." (Tr. 476:6-13.) Finally, both RSM and Schulte Roth, YA Global’s accountants and legal counsel, testified that neither was engaged to or provided tax advice to YA Global or Yorkville Advisors on the U.S. trade of business issue. (Tr. 375:8-17; 494:25-495:1-2, Tr. 523-524, 526-527, 554-556; see also RPFF ¶¶ 590-608.)

269. Mr. Yager provided his comments and revisions in a marked-up ECI Memo to Mr. Schinik. (Ex. 1365-J.)

Objection: Incomplete, inaccurate and misleading. Mr. Yager testified that he did not review the ECI Memo substantively and only made stylistic and grammar edits. (Tr. 377:16-20; Ex. 1397 at pp. 3-4; see also RPFF ¶¶ 590-608.)

270. Mr. Yager believes that the ECI Memo was a fair summarization of the discussions that Yorkville had with its outside advisors around the ECI and USTB issues and the conclusions that were reached. RSM had concurred with those conclusions. (Tr. 377:16-378:1.)

Objection: Inaccurate, misleading and wholly unsupported by the cited reference and the record before the Court. Mr. Yager did not state that RSM reached any conclusion with respect to the U.S. trade or business issue. (Tr. 377:21-25; see also RPFF ¶¶ 590-608.) RSM did not provide any tax advice to YA Global or Yorkville Advisors on the U.S. trade or businesses issue. (Tr. 375:8-17, 377:16-20, 412:21-24; Entire record.)

271. In revising the ECI Memo, Mr. Yager added that YA Global’s position was "based upon advice from counsel and our auditors." (Ex. 1365-J.)

Objection: Incomplete and misleading. A more accurate finding of fact is that although Mr. Yager added the stated language, Mr. Schinik drafted the ECI memo to provide to prospective investors and there is no evidence in the record that the ECI Memo was review by any counsel or auditors for legal accuracy. (Entire record.) Moreover, Mr. Yager added several comments that questioned the accuracy of the ECI Memo, including Mr. Yager’s comment that "Doesn’t some of these fees get passed along to CCP?" and his comment in the conclusion section regarding cash compensation, inquiring whether "Is this true. Maybe say "directly" to the fund." Mr. Yager did not review the ECI Memo for accuracy or conduct his own independent analysis of the applicable facts and law. (See RPFF ¶¶ 580-608.)

272. The "advice from counsel and our auditors" referenced in the ECI Memo included advice form Yorkville’s prior and then current tax advisors, in addition to RSM, which all concluded that YA Global was not engaged in a USTB that would give rise to ECI. (Tr. 381:10-382:10; 436:7-15.) Yorkville’s counsel involved in these discussions included Sutherland and SRZ. (Tr. 382:11-18.)

Objection: Speculative, inaccurate, misleading, unsupported by the record. The ECI Memo does not state which counsel or auditor that purportedly provided advice or any information about the purported advice. (Exhibit 1365-J.) RSM and Schulte Roth, YA Global’s accountants and legal counsel, testified that neither was engaged to or provided tax advice to YA Global, YA Offshore or Yorkville Advisors on the U.S. trade of business issue. (Tr. 375:8-17; 494:25-495:1-2, Tr. 523-524, 526-527, 554-556; see also RPFF ¶¶ 590-608.)

273. In revising the ECI Memo, Mr. Yager also added a new sentence at the end of the ECI Memo, stating, "Please feel free to contact Jeffrey Yager of Goldstein Golub Kessler LLP if you have any questions. He can be reached at Jeffrey. Yager@rsmi.com." (Ex. 1365-J.) Mr. Yager added this information so that he could act as a point of contact for any potential future inquiries about YA Global’s position on ECI and USTB. (Tr. 382:22-383:18.)

Objection: Inaccurate, incomplete and misleading. Mr. Yager testified that:

"I added the sentence to provide a single point of contact so anybody that was provided this memo would have someone to contact regarding any questions that they may have. I was the relationship lead for the Yorkville account. It is not unusual for a relationship lead in an audit firm to be that point of contact, not to necessarily address or answer every question that might come in from a third party, but at least to be knowledgeable about who would be the person to address that question that comes in. So, I added my name to be that point person for any potential inquiries, you know, that may result from this." (emphasis added). (Tr. 382-383.)

274. Yorkville provided the ECI Memo to investors. (Exs. 1358-R, 1372-J, 1373-J, 1374-J; Tr. 530:23-531:5.)

Objection: Irrelevant and immaterial.

3. NYCB Report

275. On May 7, 2007, Mr. Karst sent an e-mail to Mr. Yager and attached a document titled "Report Offering Proposed Guidance Regarding U.S. Federal Income Tax Treatment of Certain Lending Activities Conducted Within the United States" issued by the Committee On Taxation of Business Entities of the New York City Bar and dated May 3, 2007 (the "NYCB Report"). In the e-mail, Mr. Karst stated that he thought "the section dealing with PIPES (pp. 18-19) may be relevant to" to the principals at Yorkville. Mr. Yager forwarded Mr. Karst’s e-mail and the NYCB Report to Mr. Schinik shortly thereafter. (Ex. 1366-P; see also Ex. 1366-P, pp. 21-22.)

Objection: Exhibit 1366-P was admitted solely to establish that an email with attached article sent from Mr. Yager to Mr. Karst and not for the truth of the matters asserted therein. Respondent’s objects to any proposed findings relating to the content of the NYCB letter as inadmissible hearsay, and this proposed finding is not permissible based on the Tax Court’s ruling on the exhibit. (Tr. 396:11-22; 398:3-19.)

Further objects to Exhibit 1366-P as irrelevant and immaterial.

276. Mr. Yager sent the NYCB Report to Mr. Schinik because he thought the facts and circumstances discussed in the report were very similar to YA Global’s with respect to its investment activities and thus the report’s conclusion was pertinent to YA Global’s position that it was not engaged in a USTB. (Tr. 400:2-14.)

Objection: Inaccurate, misleading and unsupported by the record. There is no evidence in the record Court that the NYCB letter comprehensively discusses all of YA Global’s activities and is therefore irrelevant and immaterial to the issues presented. (Entire record.)

277. The NYCB Report concluded at p. 18 of the report that "[I]ending transactions that are in the nature of private equity transactions (e.g., because they are coupled with the acquisition of rights to acquire equity in the issuer or a person related to the issuer) should not be treated as ‘lending.’" (Ex. 1366-P, p. 21.) Messrs. Karst and Yager thought this conclusion would be relevant to Yorkville’s principals regarding the funds under its management. (PFFs ¶¶ 2765-2776.)

Objection: Exhibit 1366-P was solely admitted to establish that an email with attached article sent from Mr. Yager to Mr. Karst and not for the truth of the matters asserted therein. Respondent’s objects to any proposed findings relating to the content of the NYCB letter as inadmissible hearsay, and this proposed finding is not permissible based on the Tax Court’s ruling. (Tr. 396:11-22; 398:3-19.)

Further objects as irrelevant, immaterial and unsupported by the record. There is no evidence in the record before the Court that the NYCB letter comprehensively discusses all of YA Global’s lending activities and is therefore irrelevant to the issues presented. (Entire record.)

278. The NYCB Report also stated that "[t]here is widespread agreement among tax practitioners that certain investments, such as private investments in public equity (PIPEs), do not implicate trade or business issues for a Foreign Person even though one of the components of the investment package might be a loan or a debt-like preferred stock." (Ex. 1366-P, p. 21; see also Tr. 553:15-25.)

Objection: hearsay, incomplete, misleading. Exhibit 1366-P was admitted solely to show that an email with attached article sent from Mr. Yager to Mr. Karst and not for the truth of the matters asserted therein. Respondent’s objects to any proposed findings relating to the content of the NYCB letter as inadmissible hearsay and petitioners’ PFF is not permissible based on the Tax Court’s ruling. (Tr. 396:11-22; 398:3-19.)

Further objects as irrelevant, immaterial and unsupported by the record. There is no evidence in the record before the Court that the NYCB letter comprehensively discusses all of YA Global’s lending activities and is therefore irrelevant to the issues presented. (Entire record.)

279. During the years at issue, it was well known in the industry that there was a lack of authoritative guidance regarding whether investments such as PIPEs would create a USTB. (Tr. 431:7-432:4, 467:22-468:9.)

Objection: Argumentative, self-serving testimony.

280. There was no clear guidance on what constituted a USTB or how a foreign corporation could qualify for the Trading Safe Harbor. (Tr. 467:22-468:9, 504:8-11, 554:18-23.)

Objection: Argumentative, self-serving testimony.

4. Communications with Investors

281. When presented with questions from an investor regarding whether YA Global’s activities would give rise to a USTB, Mr. Schinik referred those questions to RSM, specifically Mr. Karst. (Ex. 1369-J, 1370-J.)

Objection: Inaccurate and misleading. The cited reference represents one instance where Mr. Schinik referred questions to Mr. Yager. The record before the Court establishes that YA Global received multiple inquires relating to the U.S. trade or business issue. (Tr. 587:1-6.) Mr. Schinik testified that he prepared the ECI Memo, not a competent tax adviser, for the express purpose of providing the same to prospective investors. (Tr. 589:6-9, 590:4-17, Ex. 1359-J.)

282. To provide responses to the investor’s questions, Mr. Karst responded to Mr. Schinik, stating that "[YA Global] is not viewed as engaged in a lending activity. The fund has always taken the position that it is not engaged in banking, lending or financing business. The Fund is engaged in an investment activity that is statutorily excluded from trade or business characterization. This position is based on the facts and circumstances surrounding the Fund’s investment activities. Basically the Fund’s investment decisions are driven by the equity component of the deal not an interest rate spread. The Fund seeks its return based on equity growth." (Ex. 1371-J.)

Objection: Argumentative, incomplete, inaccurate and misleading. Exhibit 1371-J does not address all of YA Global’s activities, does not provide a comprehensive analysis of the facts and circumstances and cites to no legal authority to support the assertions with respect to the U.S. trade or business issue. (Ex. 1371-J.) As communicate in an email, RSM recommended not relying solely on it. (See, e.g., Ex. 1397-J at p. 00123)

5. Returns Prepared by RSM

283. RSM prepared Fund’s tax returns that it thought would be required for funds managed by Yorkville, including the Forms 1042 and Forms 1042-S described in Part VIII. (See, e.g., Ex. 1376-J, p. 3.)

Objection: Incomplete, inaccurate and misleading. The relevant Engagement Letters specifically provide that:

"In connection with your Federal and state tax returns, or in response to your request(s), we may also provide you with Federal or state tax advice concerning matters that are not the subject of a separate arrangement letter. This tax advice is beyond the scope of tax return preparation and is not included in the fees for tax return preparation. Our fees for this tax advice will be based on the time required for work performed, plus out-of-pocket expenses. We will submit our bill for these services on a monthly basis, and payment is due upon submission of our bill."

(See Ex. 1397-J, at pp. 120-121, 128.)

RSM was not engaged to prepare returns or provide advice to YA Offshore. (Entire record.) Mr. Karst recollected that advising YA Offshore or preparing YA Offshore’s tax returns "frankly . . . might have been beyond the scope of [RSM’s] engagement." (Tr. 471:11-17.)

284. The Schedules K-l prepared by RSM and issued to YA Global’s partners, including YA Offshore, stated that "[t]he Partnership has taken the position that it is an ‘investor’ and is not engaged in the active conduct of a trade or business." (Exs. 1-J (YALIT000160), 2-J (YALIT000488), 3-J (YALIT000841), 4-J (YALIT000879).) RSM believed this statement to be accurate when it included it in the Schedules K-1. (Tr. 408:16-22.)

Objection: Argumentative, speculative, inaccurate, misleading and speculative, see General Objection no.1. Mr. Yager was an audit partner and did not participate in the preparation of YA Global returns and thus would not have first-hand knowledge. (Entire record). In addition, Mr. Yager testified that "any statements that are made on the return would "presumably be reviewed by us for accuracy" not that he knew for a fact that the tax return prepares confirmed the statements to be accurate. (Tr. 408:16-22.)

285. RSM believed that it was more likely than not that YA Global was not engaged in any USTB, a position that was reflected on the tax returns that it prepared and filed for YA Global. (Tr. 468:22-469:1.)

Objection: Inaccurate, incomplete and misleading. Although Mr. Karst initially testified that he thought YA Global’s return position had a more likely than not chance of prevailing on the U.S. trade or business issuer; however, he then testified that if YA Global earned fee income, engaged in underwriting, and lending would need to be taken into consideration into evaluating whether YA Global had ECI. Tr. 479-83. Mr. Karst admitted that several factors were not considered (i.e. promissory notes, underwriting activities, and the receipt of fee income) that would directly impact any conclusions relating to the U.S. trade or business issue. (Tr. 461-463.) Mr. Karst also stated that RSM did not provide a tax opinion to YA Global on the U.S. trade or business issue. (Tr. 474-475.)

C. SRZ and Communications Regarding ECI

286. Before engaging SRZ for legal advice for its managed funds, Yorkville engaged a number of other law firms to provide legal and tax advice, including Sutherland Asbill & Brennan LLP. (Ex. 30-J (YAREL0000012057); Ex. 97-J, p. 7; Tr. 382:11-14, 435:18-23.)

Objection: Vague, irrelevant, immaterial and unsupported by the cited reference. There is no evidence in the record to establish that Yorkville Advisors or YA Global engaged "any other law firm" to provide legal and tax advice relating to the issues before the Court. (Entire record.)

287. Yorkville retained SRZ to provide legal advice, including legal tax advice, with respect to certain funds managed by Yorkville, including YA Global, YA Onshore, and YA Offshore. (Ex. 111-J, p. 7; Ex. 118-J, p. 7; 125-J, p. 6; Ex. 129-J, p. 6; Ex. 130-J, p. 6; Tr. 516:8-9.)

Objection: Inaccurate and misleading. Petitioners’ cited references to the PPMs found at Ex. 104-J, p. 7; Ex. 111-J, p. 7; Ex. 118-J, p. 7; Ex. 122-J, p. 6, Ex. 123-J, p. 7; Ex. 125-J, p. 6; Ex. 129-J, p. 6; Ex. 130-J, p. 6 and Ex. 1309-J are nothing more than a "Directory List" and do not support a finding that Yorkville retained SRZ to provide legal advice, including legal tax advice with respect to certain funds managed by Yorkville. The cited references do not indicate what services SRZ was purportedly engaged to provide.

Mr. Griffel of Schulte Roth testified that his firm was

"engaged to provide offering materials, like a prospectus, we call private placement memorandum, for prospective investors in the funds that they were running, which would describe the terms of the funds and the risks to investors. They should be aware of what the fund could do. Pretty typical securities disclosure documentation." (Tr. 516:15-22).

Moreover, Mr. Griffel expressly testified that Schulte Roth did not provide a tax opinion to YA Global or Yorkville Advisors relating to the U.S. trade or business issue. (Tr. 523-24, 526-27, 534, 538-39, 546, 551-52, 554-55, 556, 558-59.)

288. SRZ was consistently ranked #1 in industry publications listing investors’ counsel with the most deal experience. (Ex. 1589-P, p. 2; Ex. 1590-P, p. 3; Ex. 1591-P, p. 2; Ex. 1592-P, p. 3; Ex. 1593-P, p. 4; Ex. 1594-P, p. 4; Ex. 1595-P, p. 3.)

Objection: Irrelevant and immaterial.

289. At all relevant times, SRZ had access to all necessary records to determine whether YA Global was in a USTB. (Tr. 670:11-25.)

Objection: Self-serving testimony that is irrelevant and immaterial. Schulte Roth was engaged to prepare marketing material such as PPMs and did not opine on the U.S. trade or business issue. (Tr. 523-524, 526-527; Entire record.) Mr. Griffel admitted that his firm does not "have every single detail of everything the fund does." (Tr. 562:15-27.) There is no evidence in the record as to what documentation was provided to Schulte Roth for purposes of the engagement. (Entire record.)

1. Private Placement Memoranda

290. SRZ prepared private placement memoranda for certain funds managed by Yorkville, including YA Global, YA Onshore and YA Offshore. (Tr. 516:15-25.)

Objection: Vague, inaccurate and misleading and unsupported by the cited reference. Mr. Griffel did not specify which funds Schulte Roth prepared PPMs for during the years at issue. (Tr. 516:15-22.)

291. As Yorkville’s legal counsel who prepared the private management memoranda for Yorkville’s managed funds, SRZ also had intimate knowledge of Yorkville and its managed funds and had access to its records. (Tr. 670:9-20.)

Objection: Self-serving, uncorroborated testimony. Mr. Griffel testified that his firm was engaged to provide offering materials, like a prospectus, we call private placement memorandum, for prospective investors in the funds that they were running, which would describe the terms of the funds and the risks to investors. (Tr. 516:15-22; see also RPFF ¶¶ 630-635.) Mr. Griffel, although called as a witness by petitioner, did not testify that he had intimate knowledge of Yorkville Advisors or any of its managed funds or that Schulte Roth had access to records. Rather, he testified that his firm lacked all of the details about what YA Global did. ("And what people do, it’s the devil’s in the detail. We don’t have every single detail of everything the fund does."

(Tr. 562:15-17.)

292. David Griffel was a tax attorney at SRZ and worked on the YA Global matter. Mr. Griffel was the most knowledgeable attorney at SRZ about YA Global’s tax matter. During the time period of the engagement, Mr. Griffel was an associate and then later promoted to special counsel at SRZ. (Tr. 517:3-10, 557:7-17.)

Objection: Inaccurate and misleading. Mr. Griffel testified that his firm was engaged to provide offering materials, like a prospectus, we call private placement memorandum, for prospective investors in the funds that they were running, which would describe the terms of the funds and the risks to investors. (Tr. 516:15-22; see also RPFF ¶¶ 630-635.) Mr. Griffel further testified that he "would have been the most knowledgeable on the tax side" not most knowledgeable of YA Global’s tax matter. (Tr. 517:6-10.)

293. As legal counsel responsible for preparing the YA Global’s and its feeder funds’ PPMs, SRZ had to review all the relevant materials and provide all relevant disclosures. (519:14-22.)

Objection: Argumentative, inaccurate and misleading. Mr. Griffel testified that "[Schulte Roth] prepared the [marketing] materials, we’ve reviewed the materials, and that we have represented the — in this case the fund, in the preparation of this document [PPM], that this represents our disclosure based on what we were discussing with the client. (Tr. 519:14-22.) He did not testify that SRZ had to review all the relevant materials and provide all relevant disclosures or as to what documents and information Schulte Roth actually reviewed as part of the engagement. (Tr. 519:14-22; Entire record.) Mr. Griffel testified that his firm lacked all of the details about what YA Global did. ("And what people do, it’s the devil’s in the detail. We don’t have every single detail of everything the fund does." Tr. 562:15-17.)

294. The section of an PPM regarding taxation contained boilerplate language that disclosed all potential tax risk factors that any investors should be made aware of. Such disclosure would include language stating that there was no assurance that the Internal Revenue Service would agree that the offshore investment fund was not in a USTB. (Tr. 520:5-521:16.)

Objection: Argumentative, incomplete, inaccurate, misleading. Mr. Griffel did not testify that the potential tax risk disclosure language was "boilerplate language" but stated that tax risk disclosures generally are not unique to Yorkville. (Tr. 520-521.) Mr. Griffel testified that when dealing with an offshore hedge fund Schulte Roth thought it would be material for investors to know the tax risk factors even though the PPM states that the Fund intends to act within the safe harbor provisions of section 864(b)(2). (Tr. 520:5-10.) Schulte Roth did not make a determination or provide a legal opinion to Yorkville Advisors or YA Global that YA Global’s activities did not give rise to a U.S. trade or business. (Entire record.)

295. SRZ did not believe YA Global was engaged in a USTB. (Tr. 522:17-523:6; 642:7-12.)

Objection: Inaccurate, incomplete and misleading. Schulte Roth did not make a determination or provide a legal opinion to Yorkville Advisors or YA Global as to whether YA Global’s activities would be considered engaging in a U.S. trade or business. (Entire record; see also RPFF ¶¶ 630-635.) Mr. Griffel testified that Schulte Roth was asked but did not provide YA Global with a tax opinion and that it was his firm’s policy not to provide tax opinions on ECI, although he could not articulate a basis for that policy. (Tr. 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62.)

296. If SRZ believed YA Global was engaged in a USTB, it would not have prepared the type of disclosure provided in the various PPMs of YA Global and of YA Offshore. SRZ would have made the disclosure that YA Global would be expected to be taxed as a USTB. (Tr. 522:22-523:6; 555:24-556:3; 559:22-560:14.)

Objection: Argumentative, inaccurate, incomplete and misleading. Schulte Roth did not make a determination or provide a legal opinion to Yorkville Advisors or YA Global as to whether YA Global was or was not engaged in a U.S. trade or business. (Entire record; see also RPFF ¶¶ 630-633; Tr. 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62.)

297. If SRZ believed YA Global could be deemed to be engaged in a USTB, it would have advised Yorkville to restructure its activities so that it would not be deemed to be engaged in a USTB. (Tr. 522:24-523:2, 560:2-9.) The fact that SRZ did not so advise suggests that SRZ concluded YA Global was not in a USTB.

Objection: Argumentative, inaccurate, incomplete and misleading. Schulte Roth did not make a determination or provide a legal opinion to Yorkville Advisors or YA Global as to whether YA Global was or was not engaged in a U.S. trade or business. (Entire record; see also RPFF ¶¶ 630-633; Tr. 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62.)

298. On the advice of counsel, Yorkville provided YA Global’s PPMs to prospective investors. (Tr. 556:4-8.)

Objection: Inaccurate, misleading and unsupported by the cited reference. In response to a question on cross examination asking whether a PPM is a disclosure by a fund to its potential investors, Mr. Griffel testified "As advised by counsel. This is a legal offering document with our name on it we would have signed off on its content." (Tr. 556:4-8.) He did not testify that Yorkville provided YA Global PPMs to prospective investors on the advice of counsel. (Tr. 556:4-8.)

Mr. Griffel testified that PPMs are not legal opinions, but a disclosure of the material risks associated with investing in a fund. (Tr. 520-521.) Mr. Metzger testified that PPMs are not required materials but are expected as an industry practice. (Ex. 2003-R, p. 17.)

2. SRZ’s Tax Advice Regarding ECI

299. SRZ communicated its conclusion that YA Global was not in a USTB to Yorkville during discussions with Yorkville and its other advisors about ECI issues. (Tr. 522:17-523:6; PFFs ¶¶ 271, 295.)

Objection: Inaccurate, misleading and unsupported by the cited reference. Schulte Roth did not make a determination or provide a legal opinion to Yorkville Advisors or YA Global as to whether YA Global was engaged in a U.S. trade or business. (Entire record; see also RPFF ¶¶ 630-633; Tr. 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62.) Mr. Griffel unequivocally stated that Schulte does not provide anything less than a "will" opinion in the U.S. trade or business arena and would only provide a "will" opinion if a fund could make affirmative representations to a specific set of guidelines, which YA Global could not or would not do. (RPFF ¶¶ 630-633; Tr. 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62.); entire record.)

300. SRZ’s policy was that it would not provide formal legal opinions to clients as to whether an offshore fund was engaged in a USTB (except with respect to issuers involved in securitizations of collateralized loan obligations). (Tr. 523:7-23, 539:5-14.)

Objection: Inaccurate, incomplete and misleading. Mr. Griffel testified that Schulte Roth would not issue opinions to clients about ECI unless they could provide that client with a "will" opinion. (Tr. 523-24, 526-27.) In order to provide a "will" opinion the client would have to meet a set of guidelines. (Tr. 527, 535, 536-38; Ex. 1363-J.) One of those representations is that the firm does not charge fees for the origination, distribution, or syndication or any loan, obligation, or security. (Tr. 537-38.) YA Global was unwilling or unable to make the requisite representations in order to obtain a tax opinion from Schulte Roth. (Entire record.)

301. Opinions on whether an offshore fund would be engaged in a USTB were typically not provided in the hedge fund industry. (Tr. 552:17-553:14.)

Objection: Incomplete, inaccurate and misleading. Petitioners’ proposed finding is misleading insofar as it implies that opinions are never provided in the U.S. trade or business realm. Mr. Griffel testified that ECI opinions are not typically given because "they are not expected" and that if an opinion is requested on every issue, no work would ever get done. (Tr. 553-554.) Mr. Griffel testified that his firm would provide "will" opinions if clients could affirm that they met applicable guidelines. (Tr. 538.)

302. SRZ did not in fact provide a formal legal opinion to Yorkville as to whether YA Global was engaged in a USTB. (Tr. 523:7-10, 546:19-22.)

No objection.

D. Yorkville’s Understanding of YA Global’ USTB Status

303. Yorkville’s managing team, including Mr. Schinik as Yorkville’s CFO, managed the affairs of Yorkville. (See, e.g., Ex. 104-J, pp. 32-34; Ex. 111-J, pp. 31-33.)

No objection.

304. Yorkville intended to conduct the activities of YA Global and those of YA Offshore in a manner that would meet the requirements of the Trading Safe Harbor. This intention was communicated to YA Offshore and its investors through YA Offshore’s PPMs. (See, e.g., Ex. 99-J, p. 67; Ex. 100-J, pp. 66-67; Ex. 104-J, pp. 57-58; Ex. 111-J, pp. 55-56.)

Objection: Argumentative, self-serving testimony that is unsupported by the record before the Court. Yorkville’s purported intent is immaterial. YA Global’s activities during the years at issue evidence that it was engaged in a U.S. trade or business regardless of their claimed intent. (Entire record.)

305. Because Mr. Karst and others had advised Yorkville that YA Global was not in a USTB, YA Offshore’s management had no reason to file any Form 1120-F. (Tr. 457:2-458:13; PFF ¶¶ 256 et seq., 272, 287 et seq.) In fact, YA Offshore’s management did not believe YA Offshore was required to file any such returns. (See Tr. 163:15-164:7, 170:8-171:10 (M. Angelo testimony).)

Objection: Argumentative, inaccurate and misleading. Also, self-serving testimony that is unsupported by the record. RSM, Schulte Roth and their respective employees were not engaged to nor did they provide legal advice to Yorkville Advisors and/or YA Global that YA Offshore was not engaged in a U.S. trade or business. (Tr. 376, 436-438, 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62; entire record.) Mr. Angelo’s testimony regarding YA Offshore management’s beliefs is not supported by the record. (Entire record.)

306. Because Mr. Karst and others had advised Yorkville that YA Global was not in a USTB, YA Global’s management had no reason to file and did not believe it needed to file any Form 8804. (PFF ¶ 256 et seq., 272, 287 et seq.)

Objection: Argumentative, inaccurate and misleading. RSM, Schulte Roth and their respective employees were not engaged to nor did they provide legal advice to Yorkville Advisors and/or YA Global that YA Global was not engaged in a U.S. trade or business. (Tr. 376, 436-438, 523, 534, 538-39, 546, 551-52, 553, 554-55, 556, 558-59, 561-62; entire record.)

307. Yorkville and its principals did not believe that YA Glogal was in a U.S. trade or business during any of the years at issue. (See, e.g., Tr. 160:17-161:15, 165:6-24.)

Objection: Argumentative, self-serving testimony that is unsupported by the record.

308. Due to the lack of guidance or guidelines from the Commissioner as to what would constitute a USTB, Mr. Karst and Mr. Griffel had to rely on their judgment in determining whether YA Global was in a USTB. (Tr. 503:19-23, 554:18-23.)

Objection: Argumentative, self-serving testimony. Section 864 of the Internal Revenue Code, the Treasury Regulations and relevant cases provide guidance and guidelines that YA Global’s activities would be deemed engaging in a U.S. trade or business. (Entire record.)

VIII. Tax Returns Filed

309. During the years at issue, the Fund filed Forms 1065, U.S. Return of Partnership Income ("Form 1065"), to report its U.S.source investment income and losses and attached Schedules K-1 to such Forms 1065 to report its partners’ distributive shares of such U.S.-source investment income and losses. (S. ¶ 2; Exs. 1-J, 2-J, 3-J, 4-J, 5-J, 6-J)

Objection: incomplete, misleading. See General Objection No. 1. YA Global incorrectly reported its income as investment or portfolio income. As a U.S. partnership in 2006, YA Global was required to report all of its income, whatever the source, not just "U.S.-source investment income and losses." Also, YA Global’s Forms 1065 for the years at issue did not include a Schedule K-1 for every partner during the year. (Exs. 5-J and 6-J, which have no Schedules K-1 for foreign limited partners.)

310. YA Global filed its Form 1065 for 2006 on or about October 15, 2007. (S. ¶ 2.)

No objection.

311. Because YA Global was a domestic partnership in 2006, it filed its Form 1065 with the Ogden Service Center, as instructed by the instructions to the Form 1065 for 2006. (Ex. 1581-J).

Objection: inaccurate, misleading, not supported by the record. YA Global did not file its returns "as instructed by the instructions to the Form 1065 for 2006." YA Global filed its returns as instructed by its tax return preparer, RSM McGladrey. (Ex. 1-J at YALIT000078-YALIT000079.) Per RSM McGladrey’s instructions for filing, YA Global’s 2006 Form 1065 was filed electronically by RSM McGladrey. (Ex. 1-J at YALIT000079-YALIT000080.)

312. YA Global filed its Form 1065 for 2007 on or about September 29, 2008. (S.¶ 2.)

No objection.

313. Because YA Global was a foreign partnership in 2007, it filed its Form 1065 with the Ogden Service Center, as instructed by the instructions to the Form 1065 for 2007. (Ex. 1582-J).

Objection: inaccurate, misleading, not supported by the record. Nothing in the record supports the finding that YA Global filed its 2007 Form 1065 "as instructed by the instructions to the Form 1065 for 2007." As with its 2006 Form 1065, YA Global was likely given filing instructions by RSM McGladrey. (Ex. 1-J at YALIT000078-YALIT000079.) Though not shown on the "client copy" of the 2007 Form 1065, the 2007 Form 1065 was likely filed electronically by RSM McGladrey, just as the 2006 Form 1065 had been.

314. The annual Schedules K-1 issued to YA Global’s partners, including YA Offshore, stated that "[t]he Partnership has taken the position that it is an ‘investor’ and is not engaged in the active conduct of a trade or business." (Exs. 1-J (YALIT000160), 2-J (YALIT000488), 3-J (YALIT000841), 4-J (YALIT000879).)

Objection: inaccurate, incomplete, misleading, see General Objection, no.1. YA Global’s 2010 and 2011 Forms 1065 do not include the language quoted in this finding.

315. YA Global filed Forms 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, and Forms 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, with respect to U.S.-source income received by YA Offshore for 2006, 2007, and 2008. (Exs. 1376-P, 1377-P, 1378-P.)

Objection: incomplete, misleading. Tax was not withheld on all U.S.-source income allocable to or received YA Offshore or any foreign partners. (Compare Ex. 1-J at YALIT000159 with Ex. 1376-P at p. 005 (showing that tax withheld only on YA Global’s dividend income allocable to YA Offshore).) In addition, YA Offshore was not the only foreign partner with respect to which YA Global withheld tax in 2006.

316. YA Global remitted to Respondent the withholding tax shown in the Forms 1042 in PFF ¶ 315. (Ex. 1376-P, p. 2; Ex. 1378-P.p. 3.)

Objection: inaccurate, not supported by the record. Nothing in the record supports a finding that YA Global actually remitted the tax withheld. Exhibits 1376-P through 1378-P are copies of completed Forms 1042 required to be filed by YA Global but are not evidence of any payments made with respect to the Forms 1042. Exhibit 1377-P, in fact, is just an email with an unsigned Form 1042 included as an attachment. Exhibit 1378-P appears to be RSM McGladrey’s file copy reflecting what was sent to YA Global and when.

317. YA Global did not file Forms 8804. (S. ¶ 3.)

No objection.

318. The instructions to Form 8804 for 2006 and 2007 directed a filer to file Form 8804 with the Internal Revenue’s Ogden Service Center. (Ex. 1579-J, Ex. 1580-J.)

No objection.

319. For 2006 and 2007 YA Global filed its Form 1065 at the Internal Revenue’s Ogden Service Center where Forms 8804 were required to be filed. (PFFs ¶¶ 311, 312.)

Objection: inaccurate, misleading, not supported by the record. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 311 and 313.

320. Before Respondent began his examination of YA Global’s income tax returns in 2009, YA Offshore did not file any Forms 1120-F because neither YA Global nor its tax advisors thought that YA Global’s investment activities in the United States gave rise to a USTB. (PFFs ¶¶ 256, 257, 267, 269, 270, 272, 286, 287, 296.)

Objection: See Resp’s Obj. to Pet’rs’ PFF ¶¶ 260-263, 267-273, 282, 284, 285, 294-297, 299, 305, 306.

321. After Respondent began examining YA Global’s tax returns and suggested YA Global might have a USTB, YA Offshore filed protective Forms 1120-F pursuant to Treasury Regulation § 1.882-4(a)(3)(vi) to ensure that it would be able to claim any deductions allocable to ECI. (S. 29.)

Objection: inaccurate, incomplete. Respondent informed YA Offshore that it had not filed and income tax return for 2006 on June 7, 2010. (RPFF ¶ 544.)¶

322. YA Offshore did not file the protective Forms 1120-F for 2006 and 2007 within the time period prescribed in Treasury Regulation § 1.882-4(a)(3)(i). (S. ¶ 29.)

No objection.

323. YA Offshore filed the protective Form 1120-F for 2008 through 2011 within the time period prescribed in Treasury Regulation § 1.882-4(a)(3)(i). (S. ¶¶ 29, 196; Exs. 1381-J, 1382-J, 1383-J, and 1384-J.)

No objection.

IX. Consents to Extend the Statute of Limitations

324. Respondent sought and obtained the following Consents to Extend the Time to Assess Tax Attributable to Partnership Items ("Forms 872-P") from the Fund’s tax matters partner ("TMP"):

Forms 872-P	Years Extended	Date Executed by TMP	Date Executed by IRS	Extension Date
Ex. 31-J	2006	1/29/10	02/25/10	02/28/11
Ex. 32-J	2006	7/19/10	07/21/10	06/30/11
Exs. 33-J, 38-J	2006, 2007	12/20/10	01/03/11	12/31/11
Exs. 34-J, 39-J	2006, 2007	8/31/11	09/01/11	11/30/12
Exs. 35-J, 40-J	2006, 2007	2/24/12	04/02/12	07/31/13
Exs. 36-J, 41-J	2006, 2007	3/29/13	04/02/13	12/31/14
Exs. 37-J, 42-J	2006, 2007	7/16/14	07/22/14	03/31/15

Objection: inaccurate, incomplete. All of the exhibits cited in the table above are Forms 872-P for the taxable year 2006. (1st Stip. ¶¶ 14, 15.) Further, the date executed by respondent is incorrect for Exhibit 3 8-J. (1st Stip. ¶ 15. See also 1st Stip. ¶¶ 18, 19 for other Forms 872-P extending the period of limitations to December 31, 2011.) Exhibits 31-J through 37-J were signed by Yorkville Advisors, YA Global’s tax matters partner for 2006. (1st Stip. ¶¶ 8, 14.) In an abundance of caution, respondent also asked Yorkville GP to sign Forms 872-P for 2006. Yorkville GP was YA Global’s general partner at the time of respondent’s examination of YA Global and was YA Global’s tax matters partner for 2007 through 2011. (1st Stip. ¶ 9.) Exhibits 38-J through 42-J are the Forms 872-P signed by Yorkville GP for 2006. (1st Stip. ¶ 15.) For the dates and exhibit numbers of the Forms 872-P signed with respect to 2007, see 1st Stip. ¶¶ 18 (Forms 872-P signed by Yorkville Advisors) and 19 (Forms 872-P signed by Yorkville GP, YA Global’s tax matters partner). Respondent and YA Global’s tax matters partners timely executed the Forms 872-P, extending the limitations period for assessment of taxes attributable to partnership and affected items to March 31, 2015. (RPFF ¶ 541.)

325. The first four sets of Forms 872-P executed by the TMP on January 29, 2010, July 19, 2010, December 20, 2010, and August 31, 2011 (the "Original Forms 872-P") stated, in pertinent part, "[t]he Internal Revenue Service may assess any federal income tax attributable to the partnership items of [the Fund] against any partner of [the Fund] * * *." (Exs. 31-J ((YAREL0000119741); 32-J (YAREL0000119744); 33-J (YAREL0000119751); 34-J (YAREL0000119768); 38-J (YAREL0000119753); 39-J (YAREL0000119770).)

Objection: vague, incomplete, misleading. The phrase "the first four sets of Forms 872-P" is vague, and the use of the term "Original Forms 872-P" is similarly vague and misleading. Further, all of the Forms 872-P signed by the parties with respect to 2006 and 2007 contained the language quoted by petitioners in this finding. (Exs. 31-J through 42-J (2006 Forms 872-P); Exs. 55-J through 64-J (2007 Forms 872-P); Exs. 75-J through 77-J (2008 Forms 872-P; Exs. 81-J, 82-J (2009 Forms 872-P); Ex. 85-J (2010 Form 872-P).)

326. The last 3 sets of Forms 872-P executed by the TMP (the "Modified Forms 872-P") included additional language in the form of an asterisk footnote to the above statement: "Including income and/or withholding tax required to be paid and/or withheld at source (under Chapter 3 of the Code) due on Form 8804 or Form 1042." (Exs. 35-J (YAREL0000119785); 36-J(YAREL0000119806); 37-J (YAREL0000119833); 40-J (YAREL0000119787); 41-J (YAREL0000119808); 42-J (YAREL0000119835.))

Objection: vague, incomplete, misleading. The phrase "the last three sets of Forms 872-P" is vague, and the use of the term "Modified Forms 872-P" is similarly vague and misleading. Starting with Forms 872-P signed by petitioners in 2012, respondent incorporated the language quoted. Petitioners imply with this proposed finding that respondent did not intend to extend the limitations period with respect to the withholding tax under section 1446 with the Forms 872-P signed before 2012 or that the additional language makes clear that the Forms 872-P did not cover the withholding tax under section 1446. This implication is not supported by anything in the record. Respondent’s agents added the additional language pursuant to changes in the Internal Revenue Manual ("IRM") (or in anticipation of expected changes to the IRM). Compare Internal Revenue Manual 4.31.2 (known as the "Pass-Through Entity Handbook, TEFRA Examinations — Field Office Procedures") effective as of October 1, 2010 (which does not address withholding tax under section 1446 or extensions of the limitations period for withholding tax) with IRM 4.31.2 effective as of June 20, 2013 (which incorporates an entirely new section on "Statute of Limitations — Foreign Withholding" (IRM 4.31.2.2.17.2.).)

327. In addition to the Forms 872-P, the IRS sought and obtained the following Consents to Extend the Time to Assess Tax ("Forms 872") from the Fund:

Forms 872	Years Extended	Date Executed by TMP	Date Executed by IRS	Extension Date
Exs. 43-J, 49-J	2006	7/19/10	07/23/10	06/30/11
Ex. 44-J	2006, 2007	12/20/108	03/02/11	12/31/11
Ex. 50-J	2006, 2007	6/21/119	6/21/2011	12/31/11
Exs. 45-J, 51-J	2006, 2007	8/31/11	09/01/11	11/30/12
Exs. 46-J, 52-J	2006, 2007	2/24/12	03/14/12	07/31/13
Exs. 47-J, 53-J	2006, 2007	3/29/13	04/03/13	12/31/14
Exs. 48-J, 54-J	2006, 2007	7/16/14	07/22/14	03/31/15

FN 8 The Forms 872 extending the statute to December 31, 2011 were signed by Yorkville Advisors on December 20, 2010.

FN 9 The Forms 872 extending the statute to December 31, 2011 were signed by YA GP on June 21, 2011.

Objection: inaccurate, incomplete. All of the exhibits cited in the table above are Forms 872 for the taxable year 2006. (1st Stip. ¶¶ 16, 17.) Exhibits 43-J through 48-J were signed by Yorkville Advisors, YA Global’s tax matters partner and general partner for 2006. (1st Stip. ¶¶ 8, 14.) In an abundance of caution, respondent also asked Yorkville GP to sign Forms 872-P for 2006. Yorkville GP was YA Global’s general partner at the time of respondent’s examination of YA Global and was YA Global’s tax matters partner for 2007 through 2011. (1st Stip. ¶ 9.) Exhibits 49-J through 54-J are the Forms 872 signed by Yorkville GP for 2006. (1st Stip. ¶ 15.) For the dates and exhibit numbers of the Forms 872 signed with respect to 2007, see 1st Stip. ¶¶ 20 (Forms 872 signed by Yorkville Advisors) and 21 (Forms 872 signed by Yorkville GP, YA Global’s general partner). Each of the Forms 872 were signed by the parties before the limitations periods for 2006 and 2007 (as extended) expired. (Exs. 43-J through 54-J; Exs. 65-J through 74-J.)

328. The first four sets of Forms 872 executed by the TMP on July 19, 2010, December 20, 2010, June 21, 2011, and August 31, 2011 (the "Original Forms 872") stated that the "kind of tax" for which the statute of limitations was extended was "withholding tax under section 1441-1442." (Exs. 43-J, 44-J, 45-J, 49-J, 50-J, 51-J.)

Objection: vague, incomplete, misleading, irrelevant. The phrase "the first four sets of Forms 872" is vague, and the use of the term "Original Forms 872" is similarly vague and misleading. Respondent has not asserted that the Forms 872 signed before 2012 extended the limitations periods with respect to the withholding tax under section 1446 for 2006 and 2007.

329. Beginning with the Forms 872 executed by Yorkville and YA GP on February 24, 2012 (the "Modified Forms 872"), the "kind of tax" for which the statute of limitations was extended was "withholding tax under section 1441-1446." (Exs. 46-J, 47-J, 48-J, 52-J, 53-J, 54-J.)

Objection: vague, incomplete, misleading. The use of the term "Modified Forms 872" is vague and misleading. Starting with Forms 872-P signed by petitioners in 2012, respondent revised the kind of tax to which the Forms 872 applied to include all withholding tax provisions under sections 1441 through 1446. Petitioners imply with this proposed finding that respondent did not intend to extend the limitations period with respect to the withholding tax under section 1446 with the Forms 872-P signed before 2012 or that the revised language in the Forms 872 signed after 2011 makes clear that the Forms 872-P did not cover the withholding tax under section 1446. This implication is not supported by anything in the record. Respondent’s agents added language to the Forms 872-P and revised the language in the Forms 872 out of an abundance of caution and pursuant to changes in the IRM (or in anticipation of expected changes to the IRM). Compare IRM 4.31.2 (known as the "Pass-Through Entity Handbook, TEFRA Examinations-Field Office Procedures") effective as of October 1, 2010 (which does not address withholding tax under section 1446 or extensions of the limitations period for withholding tax) with IRM 4.31.2 effective as of June 20, 2013 (which incorporates an entirely new section on "Statute of Limitations — Foreign Withholding" (IRM 4.31.2.2.17.2).)

X. The Audit and YA Offshore’s Waiver Request

330. On February 24, 2012, YA Offshore submitted its Request for Waiver Under Treasury Regulation Section 1.882-4(a)(3) (the "Initial Waiver Request"). (Ex. 92-P; S. ¶ 34.)

Objection: mischaracterizes the evidence. Characterizing the request dated February 24, 2012 as the "Initial Waiver Request" misrepresents the facts. YA Offshore submitted but one request, the one dated February 24, 2012 at Exhibit 92-P (the "Waiver Request"). The document petitioners have identified as the "Second Waiver Request" (see Pet’rs’ PFF ¶ 344) is not an actual request for waiver but was "intended to serve as [a more complete written response to subparts (c) to (e) of IDR IE-43, #3] as well as to further detail why granting the Taxpayer’s waiver request pursuant to Section 1.882-4(a)(3)(ii) of the Treasury Regulations is appropriate." (Ex. 1398-J at p. 001.)

331. The Initial Waiver Request explained that YA Global relied on its outside advisors, "and particularly on its Certified Public Accountants, "Marcum LLP and RSM McGladrey ("RSM"), to comply with applicable tax rules. (Ex. 92-P (YAREL0000187630-187631).)

Objection: incomplete, misleading, self-serving, mischaracterizes the evidence, irrelevant. See objections and response to petitioners’ proposed finding 330. In the Waiver Request, Mark Angelo stated, "The Taxpayer i.e., YA Offshore] solely relied on its outside professional advisors to comply with applicable tax rules, and particularly on its Certified Public Accountants with respect to U.S. tax compliance." (Ex. 92-P at YAREL0000187630.) During the examination, YA Offshore did not present any documentation showing that it engaged either Marcum LLP or RSM McGladrey to perform tax preparation services on its behalf or to assist in complying with applicable tax rules. The materials provided during the examination show that, as part of its engagement by YA Global, RSM McGladrey was not responsible for any tax preparations services with respect to YA Offshore.

Considering evidence outside the administrative record reinforces the conclusion that no one was engaged to evaluate YA Offshore’s tax obligations or to prepare tax returns for YA Offshore as needed. (Mr. Karst confirmed that "RSM was not responsible for filing returns for anyone other than YA Global" and recollected that advising YA Offshore or preparing YA Offshore’s tax returns "frankly . . . might have been beyond the scope of [RSM’s] engagement." (Tr. 471:11-17.))

332. The Initial Waiver Request explained that Yorkville’s principals and its employees had little or no formal tax training on cross-border U.S. tax issues. (Ex. 92-P (YAREL0000187630).)

Objection: inaccurate, incomplete, misleading, self-serving, mischaracterizes the evidence. See objections and response to petitioners’ proposed finding 330. In the Waiver Request, Mr. Angelo stated, "The small group of employees who handled the Taxpayer’s tax and financial matters had either no or little formal tax training on cross-border U.S. tax issues." It is inaccurate and misleading to conclude from this statement, as this proposed finding does, that Yorkville Advisors’ principals did not have tax training on cross-border U.S. tax issues. Indeed, in its responses to respondent’s IDR IE-42, YA Offshore identified only Ed Schinik and Oren Franks as part of the "small group of employees." (Ex. 1394-J at pp. 001-002; Ex. 1396-J at pp. 004-005.)

It is also inaccurate and misleading considering evidence adduced at trial. Mr. Karst testified that everyone knew and understood that there was doubt and insufficient guidance as to YA Global’s position that it was not engaged in a U.S. trade or business as a result of its activities. (Tr. 468:5-9; 504:18-25.) Further, RSM McGladrey and Schulte Roth & Zabel provided YA Global with guidelines and other materials describing this issue. To this extent, Yorkville Advisors’ principals and employees were versed in cross-border U.S. tax issues, even if they did not have "formal" training.

333. The Initial Waiver Request explained that Marcum and RSM, as YA Global’s and YA Offshore’s auditors, were responsible for reviewing tax compliance issues for Yorkville’s funds as part of their evaluation of tax reserves, including the possible presence of a trade or business in a jurisdiction. (Ex. 92-P (YAREL0000187630).)

Objection: incomplete, misleading, hearsay, self-servicing, mischaracterizes the evidence, irrelevant. See objections and response to petitioners’ proposed findings 330 and 331. The relevant engagement letters for financial audits did not provide that Marcum or RSM was responsible for reviewing the possible presence of a trade or business in a jurisdiction. (See Ex. 1397-J at pp. 00100-00103, 00104-00107, 00108-00111, 00112-00115.) These engagement letters provided that YA Global and YA Offshore, and not Marcum or RSM, were responsible for identifying and ensuring that they each complied with the laws and regulations applicable to their activities. (Ex. 1397-J at pp. 00101, 00105, 00108, 00112.) During his testimony, Mr. Yager, an RSM audit partner on the YA Global audit, made no mention of considering the possibility of YA Global being engaged in a trade or business within the U.S. as part of RSM’s evaluation of tax reserves. Tr. 352-448.

334. The Initial Waiver Request explained that neither Marcum nor RSM advised Yorkville or its principals that YA Global was in a U.S. trade or business during any of the years at issue. (Ex. 92-P (YAREL0000187630-31).)

Objection: inaccurate, not supported by the record, mischaracterizes the evidence. See objections and response to petitioners’ proposed findings 330 and 331. The proposed finding misrepresents statements made by Mr. Angelo in the Waiver Request. Mr. Angelo was quite precise in his language. He never stated in the Waiver Request that (1) Marcum/RSM McGladrey advised him or Yorkville Advisors that YA Global was not engaged in a U.S. trade or business or that neither advised him or Yorkville Advisors that YA Global was engaged in a U.S. trade or business. Rather, Mr. Angelo stated:

The Taxpayer [YA Offshore] has not discovered any advice or communication from either of these firms indicating that the Taxpayer was not in compliance with U.S. federal income tax return filing rules, that the Taxpayer may have had a trade or business within the United States or that the Taxpayer should have filed protective returns.

(Ex. 92-P at YAREL0000187630-31.) Similar language was used elsewhere in the Waiver Request. (Ex. 92-P at YAREL0000187631 ("The Taxpayer has not discovered any advice from Marcum or RSM . . . suggesting that the Taxpayer should file protective returns under the relevant circumstances."), YAREL0000187632 ("The Taxpayer . . . has not discovered any advice from Marcum or RSM that federal income tax returns or protective returns should have been filed for those years."), YAREL0000187632 ("The Taxpayer has not located any advice from these firms stating that the Taxpayer should have filed protective returns or should have filed Forms 1120-F on the basis that the Taxpayer was engaged in the conduct of a trade or business in the United States."), YAREL0000187632-33 ("Again, the Taxpayer has not located any advice from its professional advisors stating that the Taxpayer was engaged in a U.S. trade or business or should have filed Forms 1120-F or protective returns.") The engagement letters for preparation of YA Global’s tax returns provide that RSM’s services are limited to tax preparation and advice on a specific matter on a return would be outside the scope of the services covered by the engagement. (Ex. 1397-J at pp. 00123, 00130.)

335. After receiving the Initial Waiver Request, Respondent issued IDR IE-42, which had 20 questions comprising over 60 subparts and requests for documents. (Ex. 1393-J.)

No objection: incomplete, mischaracterizes the evidence. See objections and response to petitioners’ proposed findings 330. The proposed finding does not indicate the date on which respondent issued IDR IE-42, which was May 12, 2012.

336. Respondent’s IDR IE-42 sought detail regarding YA Offshore’s and YA Global’s reliance on advisors, including the names of everyone who acted as an outside advisor, their positions within their firms, and their current contact information, as well as copies of each engagement letter and the names of the people at YA Offshore and the Fund who dealt with the outside advisors. (Ex. 1393-J, p. 2.)

Objection: incomplete, misleading. This proposed finding together with petitioners’ proposed finding 337 do not identify or describe all of the information respondent sought through IDR IE-42, even though they purport to do so.

337. Respondent’s IDR IE-42 also sought information about the positions of everyone at YA Offshore and YA Global who was responsible for tax and financial matters, all contemporaneous documents containing professional advice rendered by advisors, information regarding whether YA Offshore or the Fund sought advice regarding the ECI Issue or the Form 1120-F Issue, and other related matters. (Ex. 1393-J.)

Objection: incomplete, misleading. This proposed finding together with petitioners’ proposed finding 336 do not identify or describe all of the information respondent sought through IDR IE-42, even though they purport to do so.

338. In September 2012, YA Global and YA Offshore responded to IDR IE-42 and provided responsive documents ("YA Offshore’s Response to IDR IE-42"), which included engagement letters from RSM and an affidavit from their tax preparer, George Teixeira, a partner at RSM ("Teixeira Affidavit"), who stated that, "because of the technical nature regarding whether to even prepare and file Forms 1120-F, RSM would have been responsible for originally suggesting and advising to the client that those forms should have been prepared and filed." Mr. Teixeira further stated in his affidavit that RSMI did not, in fact, advise anyone to file Forms 1120-F for YA Offshore. (Ex. 1394-J, p. 28.)

Objection: inaccurate, incomplete, misleading, contrary to other evidence, mischaracterizes the evidence. YA Offshore’s September 5, 2012 response to IDR IE-42 could hardly be called a response or to have provided responsive documents. YA Offshore objected to, and failed to respond to, more than half of the 20 questions. (Ex 1394-J.) The only documents attached to the response were (1) Tab A — engagement letters for Cornell Capital for audit and tax return services for 2005 and YA Offshore for audit services for 2005, none of which related to the years at issue or specifically 2006 and 2007, (2) Tab B with nothing following it, which was supposed to be engagement letters for Schulte Roth & Zabel, and (3) Tab C — an incomplete affidavit of George Teixeira. (Ex. 1394-J at pp. 0010-0028.) Mr. Teixeira’s level of involvement is suspect. Mr. Teixeira’s level of involvement in the case is suspect. In all of the documents produced by YA Offshore in June 2013 in response to IRS Examination’s request for information IDR IE-42, Mr. Teixeira’s name appears only once, as a signatory to an unsigned engagement letter. (Ex. 1397-J, at p. 0094.) Mr. Teixeira was not mentioned by any witnesses at trial. (Entire transcript.) Further, Mr. Teixeira’s affidavit is contradicted by other materials presented in response to IDR IE-42. No engagement letter, providing that RSM McGladrey perform tax return services for YA Offshore, was provided in response to IDR IE-42. (Exs. 1394-J through 1398-J.) The engagement letters relating to RSM McGladrey’s performing tax return services for YA Global do not cover tax return preparation for YA Offshore. (Ex. 1397-J at pp. 00120, 00127.) Moreover, Mr. Teixeira state in has affidavit, "RSM did not provide any tax advice to, . . . Cornell Capital Partners Offshore, Ltd. or YA Global Offshore Globe Investments, Ltd. [szc] between 2006 and 2009." (Ex. 1394-J at p. 0028.) Petitioners do not offer Mr. Teixiera’s affidavit to prove the truth of any matters asserted therein. Pet’rs’ Brief at p. 270, n.1 10, p. 279, n.1 14.

Mr. Teixeira’s affidavit is also contradicted by trial testimony. Mr. Karst testified, "RSM was not responsible for filing returns for anyone other than YA Global." (Tr. 471:11-17.)

339. YA Offshore’s Response to IDR IE-42 also identified RSM and SRZ as outside advisors during the relevant period. It specifically identified Mr. Yager, Mr. Teixeira, and Mr. Griffel and provided their contact information. (Ex. 1394-J, pp. 1-2.)

Objection: incomplete, misleading. This proposed finding implies that these outside advisors provided advice to YA Offshore regarding the preparation and filing of its returns. This is incorrect. RSM McGladrey was not engaged to prepare returns or provide advice to YA Offshore. (Resp’s’ Obj. to Pet’rs’ PFF ¶¶ 331, 338.) (Notably, YA Offshore’s Response to IDR IE-42 did not identify Lawrence Karst of RSM McGladrey, who petitioners later identified as knowledgeable about tax matters and called as a witness at trial.) YA Offshore identified Schulte Roth & Zabel as an outside professional but did not engage or rely on them for advice regarding the filing of returns. (Ex. 1394-J at p. 009 (stating that YA Offshore relied solely on RSM McGladrey for advice on which returns needed to be filed); Ex. 1395-J.)

The fact that RSM McGladrey and Schulte Roth & Zabel did not provide advice to YA Offshore was corroborated at trial. (Tr. 471:11-17 (Mr. Karst’s testimony regarding RSM McGladrey’s responsibilities with respect to YA Offshore); Tr. 523-524, 526-527 (Mr. Griffel’s testimony that Schulte Roth & Zabel was not engaged to provide tax advice to Yorkville Advisors or YA Global on the U.S. trade or business issue).)

340. After receiving YA Offshore’s Response to IDR IE-42, Respondent did not request to speak to or interview Mr. Yager, Mr. Teixeira, or Mr. Griffel. Respondent did not, in fact, speak to or interview Mr. Yager, Mr. Teixeira, or Mr. Griffel. (Entire Record.)

Objection: incomplete, misleading, immaterial, irrelevant. After careful review of YA Offshore’s February 24, 2012 submission, respondent issued a comprehensive request for information to YA Offshore for purposes of obtaining all relevant information from YA Offshore to support the Waiver Request. (Ex. 1393-J.) Respondent must evaluate the information presented in support of the Waiver Request but has no obligation or responsibility to perform its own investigation. Under Treas. Reg. § 1.882-4(a)(3)(ii), YA Offshore bore the burden of establishing to respondent’s satisfaction that a waiver was warranted. Moreover, YA Offshore initially objected to respondent’s obtaining information from its representatives. (Ex. 1394-J.)

341. Respondent requested to speak with Mr. Yager and Mr. Griffel for the first time during pretrial discovery in these cases. (Entire Record.)

Objection: immaterial, irrelevant. See objections and response to petitioners’ proposed finding 340.

342. In June 2013, YA Global and YA Offshore provided additional responses and documents to Respondent ("YA Offshore’s Supplemental Responses to IDR IE-42"), including additional engagement letters with RSM and communications exchanged with their lead partner at RSM, Mr. Yager, and RSM’s international tax partner, Mr. Karst. (Exs. 1396-J, 1397-J.)

Objection: incomplete, misleading. See objections and response to petitioners’ proposed finding 338. YA Offshore’s original response to IDR IE-42 was hardly responsive, as YA Offshore objected to over half of respondent’s requests and did not provide any documents relating to the relevant years, 2006 and 2007. More than 12 months after respondent’s IDR IE-42, in June 2013 YA Offshore finally provided some answers to some of the questions in IDR IE-42. All the relevant facts and circumstances, which included all YA Offshore’s submissions, failed to establish that YA Offshore was entitled to a waiver request based on the relevant factors to be considered under Treas. Reg. § 1.882-4.

343. Among the June 2013 Responses to IDR IE-42 was an email from Mr. Yager, which included a marked-up version of the ECI Memo described in PFF ¶ 269 and Mr. Karst’s draft response to an investor described in PFF ¶ 282. (Ex. 1397-J, pp. 3, 10)

Objection: incomplete, misleading, mischaracterizes the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 269 and 282.

344. In September 2013, YA Offshore and the Fund sent Respondent a memorandum entitled Request for Waiver under Treasury Regulation Section 1.882-4(a)(3)(ii) (the "Second Waiver Request"). (Ex. 1398-J.)

Objection: inaccurate, misleading, not supported by the evidence, mischaracterizes the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶ 330. The memorandum is not "entitled Request for Waiver under Treasury Regulation Section 1.882-4(a)(3)(ii)" and was not a second request for waiver. It was a memorandum written with respect to YA Offshore’s Waiver Request (the "2013 Memo"). In the first paragraph, the author clearly states the purpose of the memorandum, "In our amended response to IDR Request IE-42, #3, we stated that the Taxpayer would ‘provide a more complete written response to subparts (c) to (e) in the next 30 days.’ This document is intended to serve as that written response as well as to further detail why granting the Taxpayer’s waiver request pursuant to Section 1.882-4(a)(3)(ii) of the Treasury Regulations is appropriate." (Ex. 1398-J at p. 001.)

345. The Second Waiver Request explained that YA Offshore had never filed any Form 1120-F because it believed that it was not required to file any U.S. income tax return based on the affirmative advise from competent, highly qualified tax advisors, including Mr. Yager and Mr. Karst, that YA Global was not engaged in a USTB. (Ex. 1398-J, pp. 3-5.)

Objection: incomplete, inaccurate, misleading, unsupported by the record, mischaracterizes the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 330, 331, and 344. The representations in this proposed finding and the 2013 Memo are incorrect and inconsistent with YA Offshore’s previous responses. RSM McGladrey was not engaged to prepare returns or provide advice to YA Offshore. (RPFF ¶¶ 590-608; Tr. 375:8-17; 471:11-17, 494:25-495:1-2.) According to Mr. Teixeira’s affidavit, RSM McGladrey did not provide any advice to YA Offshore. (Ex. 1396-J at p. 28.) Mr. Yager was not a tax advisor, let alone a competent, highly qualified tax advisor; he was identified by YA Offshore as the "audit partner." (Ex. 1394-J at p. 001; Ex. 1396-J at p. 001.) Mr. Karst had not been identified previously as an outside advisor who had provided services to YA Offshore. (Exs. 1394-J, 1396-J.)

Messrs. Yager and Karst confirmed at trial that they did not provide advice or opinion to YA Offshore. (Tr. 375:12-16; 494:25-495:2.)

346. The Second Waiver Request reiterated that Yorkville was not aware of the availability of the protective return (Form 1120-F) filing procedure under Treas. Reg. § 1.882-4 despite the fact that it engaged multiple competent tax advisors during the years at issue. (Ex. 1398-J, pp. 1-3.)

Objection: inaccurate, misleading, not supported by the record, mischaracterizes the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 330, 331, 344, and 345. In the 2013 Memo, YA Offshore for the first time represented that Yorkville Advisors, YA Global, and YA Offshore were unaware that it could have filed a protective return. In the Waiver Request, Mr. Angelo never states that he was unaware that YA Offshore could have filed a protective return. He claims only that YA Offshore could not find any advice or communication stating that YA Offshore should file a protective return. (Ex. 92-J.)

347. The Second Waiver Request also explained that YA Offshore, through Yorkville, raised the protective return issue with Respondent at a meeting with Tim Taggart in early 2012 before the IRS raised the issue with YA Offshore. (Ex. 1398-J, p. 3.)

Objection: inaccurate, misleading, self-serving, not supported by credible evidence, irrelevant, mischaracterizes the evidence. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 330 and 344. This proposed finding ignores respondent’s notification to YA Offshore by letter dated June 7, 2010 that YA Offshore had not filed a return for 2006. (RPFF ¶ 544; Ex. 1391-J.) Respondent discovered no later than October 7, 2009, that YA Offshore had not filed Forms 1120-F for 2006, 2007, and 2008. (RPFF ¶ 544; Ex. 1401-J at p. 0031.)

348. The Second Waiver Request contended that YA Global, YA Offshore, and Yorkville reasonably believed the conclusions reached by their outside tax advisors that YA Global was not engaged in a USTB and had no reason to question their conclusions. (Ex. 1398-J, p. 6.)

Objection: not supported by the record, self-serving, argumentative, mischaracterizes. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 330 and 344. Of course, YA Offshore contended that it "reasonably believed the conclusions reached by their outside tax advisors that YA Global was not engaged in a USTB and had no reason to question their conclusions." YA Offshore was seeking a waiver of the timely filing requirements under section 882(c), and Treas. Reg. § 1.882-4(a)(3)(ii) requires a taxpayer to show that it acted reasonably and in good faith. YA Offshore could not have been granted a waiver without this contention.

349. Respondent summarily denied YA Offshore’s waiver requests on March 11, 2015. (Ex. 92-J.)

Objection: not supported by the record, inaccurate, misleading. Respondent denied YA Offshore’s Waiver Request after careful consideration of the facts and materials presented by YA Offshore and comprehensive application of the factors outlined in Treas. Reg. § 1.882-4(a), as evidenced by the contemporaneous Forms 5701, Notices of Proposed Adjustment dated March 6, 2015 with attached Form 886-A, Explanation of Adjustments (the "NOPAs"). (Exs. 1399-J through 1401-J.)

350. During pretrial discovery in these cases, Respondent provided three internal documents in response to Petitioners’ request for identification of all facts upon which Respondent relied in denying YA Offshore’s waiver requests. (S. ¶¶ 193, 194, 195.) Respondent never provided these documents to YA Global or YA Offshore before discovery in these cases. (Entire Record.)

Objection: misleading, not supported by the record, immaterial, irrelevant. See objections and response to petitioners’ proposed finding 349. When respondent provided YA Offshore with the NOPAs is immaterial. Respondent prepared the NOPAs contemporaneously with the letter sent to YA Offshore advising it that the Waiver Request had been denied. (Exs. 1399-J and 1400-J (signed March 6, 2015, five days before the letter dated March 11, 2015, denying YA Offshore’s Waiver Request); Ex. 1401-J.) The NOPAs were available to YA Offshore upon request. (Ex. 93-P at p. 002 (asking that inquiries regarding the denial be directed to Tim Taggart).) YA Offshore did not seek any explanation of the denial. (Entire record.)

351. One of the internal documents described in PFF ¶ 350 is a Form 5701, Notice of Proposed Adjustment ("NOPA"), for YA Offshore’s 2006 and 2007 taxable years, signed by Thomas Wan on March 6, 2015. The NOPA appears to allow "$0" of "Other Deductions" for 2006 and 2007 and states "See attached Form 886-A." (Ex. 1399-J.)

First sentence. Objection: incomplete, inaccurate, misleading, mischaracterizes the evidence. Petitioners imply that a Form 5701, Notice of Proposed Adjustment, is a stand-alone document, separate from a Form 886-A, Explanation of Items. This is incorrect. A Form 5701 generally is not issued without a Form 886-A. Form 5701 itself notes that if the reasons for the proposed explanation is longer than will fit on the one-page form, "the entire explanation should begin on Form 886-A (Explanation of Items." Further, the IRM ("IRM"), as in effect in 2015, required the revenue agents to "[p]repare a Form 886-A by attaching a Form 5071. IRM 4.46.6.11 (12-29-2009). See also IRM 4.46.6.9 (12-26-2019) (stating, "The Form 886-A attachment is mandatory and must be attached to all Form(s) 5701 for all unagreed issues."). The Form 5701 with the Form 886-A are generally referred to as a "NOPA."

Here, it is quite clear that the Forms 5701 at Exhibits 1399-J and 1400-J and the Form 886-A at Exhibit 1401-J work together. The Forms 5701 show adjustments for 2006, 2007, and 2008 that correspond to, and match, the adjustments for 2006, 2007, and 2008 shown on the Form 886-A. The Forms 5701 state, in the "Reasons for Proposed Adjustment," "See attached Form 886-A." (Exs. 1399-J, 1400-J.)

The Form 5701 was also signed by Anton New on June 6, 2015.

Second sentence. Objection: inaccurate, misleading, mischaracterizes the evidence. See objections and response to the first sentence. The Form 5701 relating to 2006 and 2007 and the Form 886-A, which together constitute the Notice of Proposed Adjustment ("NOPA") clearly indicated that respondent was denying YA Offshore’s Waiver Request and disallowing any deductions YA Offshore might claim for 2006 and 2007 that respondent determined that "$0.00" in other deductions are allowable. The fact of the Form 5701 for 2006 and 2007 shows $0 as the adjustment because YA Offshore did not file a return claiming any deductions or credits. (Ex. 1401-J at p. 001.)

352. One of the internal documents described in PFF ¶ 350 is a Form 886-A, Explanation of Items, that purports to provide the basis for denying YA Offshore’s waiver requests. The Form 886-A is neither signed nor dated. (Ex. 1401-J.)

Objection: inaccurate, misleading, not supported by the record, speculative, mischaracterizes the evidence, immaterial. See Resp’s Obj. to Pet’rs’ PFF ¶¶ 349 through 351. Petitioners imply that respondent manufactured the Form 886-A after the denial of the Waiver Request. This thinly veiled accusation is baseless and not supported by anything in the record. The Forms 5701 and 886-A work together and are generally considered one document. The Form 886-A provides a comprehensive 3 5-page analysis of the facts and materials YA Offshore presented in support of its Waiver Request and reflects respondent’s careful and considered examination of the factors outlined in Treas. Reg. § 1.882-4(a)(3)(ii) in denying YA Offshore’s Waiver Request. Form 886-A does not provide for a signature of the revenue agent or for a date. (Ex. 1401-J.)

353. Respondent’s case activity records do not show any NOPA was issued or any Form 886-A was finalized or approved. (Ex. 1392-J.)

Objection: incomplete, misleading, mischaracterizes the evidence, not supported by the record, immaterial. Petitioners imply that respondent did not prepare a Form 5701 or 886-A and that respondent manufactured this evidence to support the denial of YA Offshore’s misrepresent and draw unreasonable conclusions the evidence they cite. The activity record at Exhibit 1392-J, to which petitioners cite for their proposed finding, cannot possibly speak to whether the Forms 5701 and Form 886-A were finalized, approved, or signed because the last entry is dated February 23, 2012. Forms 5701 and 886-A were clearly prepared, approved, and signed, as evidenced by Forms 5701s (Exs, 1399-J, 1400-J) digitally signed with the computer imprinted date of March 6, 2015, by Thomas Wan and Anton New. (Exs. 1399-J, 1400-J.) Nothing in the record suggests that the digital signatures were manipulated.

354. Respondent did not provide YA Offshore an opportunity to respond to the NOPA or to offer any additional information bearing on the proposed denial of the waiver requests, even though the NOPA itself indicated that the taxpayer would have the opportunity to do so. (Entire Record.)

Objection: inaccurate, incomplete, misleading. YA Global declined to extend the statute of limitations for assessment and respondent issued the FPAA in accordance with IRM procedures requiring the issuance of the FPAA when there was short statute of limitations period and the taxpayer does not agree to sign an extension. The record is devoid of any evidence that respondent failed to follow IRM procedures in the instant case. (Entire record.)

Moreover, YA Global was given ample opportunity during the examination of the tax years at issue to provide any and all information to support its waiver request but failed to establish that a waiver was warranted. (Ex. 1401-J.).

Also, the letter dated March 11, 2015 in which IRS Examination informed YA Offshore in writing that its Request for Waiver was being denied concluded with the following offer to YA Offshore: "Any inquiries regarding this letter should be directed to the undersigned." (Ex. 93-P at YALIT000077.) The undersigned was IRS Examination Team Manager Timothy Taggart. Id. Messrs. Ellis Reemer and Jonathan Strouse, YA Offshore’s outside attorneys at the time, were provided copies of the letter. (Id.) Petitioners have offered no evidence that YA Offshore or its outside attorneys acted upon this offer to contact IRS Examination to inquire about "any" aspect of the denial letter, for example to discuss or request the reasons supporting the denial which IRS Examination had earlier memorialized via the Form 5701 and the accompanying Form 886-A. See Exs. 1399-J and 1401-J (March 6, 2015 Form 5701 and accompanying Form 886-A).

355. Respondent issued CCA 201501013 to YA Global on or about September 5, 2014.

No objection, although it is unsupported by citation to the record as required by Tax Court Rule 151.

XI. Ultimate Findings of Fact

1. Yorkville and Yorkville GP had a business managing investment funds.

Objection: misleading, incomplete. See General Objection Nos. 1 and 2, and Resp’s Obj. to Pet’rs’ PFF ¶¶ 24, 29-30, 40-41. Yorkville Advisors ran YA Global’s lending, underwriting, and finance business, managing all aspects of YA Global’s business and making all decisions for, and on behalf of, YA Global. (Entire record.)

2. In that business, Yorkville and Yorkville GP provided services to various funds, including YA Global.

Objection: misleading, incomplete. See General Objection No. 2 and Resp’s Obj. Pet’rs’ PFF 29-30, 32-33, 37-38. During the years at issue, Yorkville Advisors operated but one fund, YA Global. HHF, MEP, and CRX, three other funds that Yorkville Advisors operated, were smaller, short-lived funds that were essentially engaging in no activity by 2006. (RPFF ¶¶ 498, 504-505, 509-512, 514-515, 518.)

3. Yorkville, Yorkville GP and the Yorkville Principals controlled all aspects of the Fund’s management and investments.

Objection: misleading, incomplete. See General Objection No. 1. Yorkville Advisors, Yorkville GP, and the principals of Yorkville Advisors ran YA Global’s business of lending, underwriting, and financing. Yorkville Advisors, Yorkville GP, and the principals at Yorkville Advisors worked for, and on behalf of, YA Global. (Entire record.)

4. The Fund had no control over Yorkville or Yorkville GP.

Objection: not supported by the record. Through the partnership and management agreements, YA Global specified the acts that Yorkville Advisors and Yorkville GP could undertake on YA Global’s behalf. Through the management agreement, YA Global had the right to place restrictions on Yorkville Advisors’ activities and to withdraw funds or terminate the agreement on 30 days’ notice. (RPFF ¶¶ 43, 49, 441; Exs. 24-J through 28-J.)

5. When Yorkville sourced investments, negotiated deals, and made trades, it did so as a service provider to YA Global, not as the Fund’s agent.

Objection: unclear, inaccurate, not supported by the record. Petitioners do not define the term "service provider." Titles ascribed to Yorkville Advisors, however, are not relevant or probative. The issue is whether Yorkville Advisors performed activities on YA Global’s behalf. Regardless of whether Yorkville Advisors is called a "service provider" as petitioners allege or an "agent," Yorkville Advisors sourced investments, negotiated deals, and made trades for, and on behalf of, YA Global and legally could bind YA Global. (Entire record.)

6. Yorkville did not provide any services to YA Global’s portfolio companies.

Objection: not supported by the record. YA Global, through Yorkville Advisors, made direct loans to its clients and agreed to distribute its client’s stock to the market. (Entire record.) Both of these activities, lending and underwriting, are services which YA Global provided, through Yorkville Advisors, to its clients. YA Global marketed its services on its website. (RPFF ¶ 93.) Mr. Angelo agreed that YA Global provided services to its clients: "We have seen that the market for the services we provide through our SEDA structures has dramatically increased in recent months." (Ex. 254-J at p. 006.)

7. Yorkville’s business activities were undertaken on its own behalf, not as YA Global’s agent.

Objection: not supported by the record. Yorkville Advisors did not have a business without YA Global; Yorkville Advisors acted for, and on behalf of, YA Global with respect to everything it did. (Entire record.) During the years at issue, Yorkville Advisors operated in effect only the one fund, YA Global. And even when it operated other smaller, short-lived funds, YA Global and the transactions it entered into was the source of substantially all of Yorkville Advisors’ revenues. (RPFF ¶¶ 504-505, 509-512, 514-515.)

8. YA Global generated its profits and losses by putting its capital at risk.

Objection: misleading, incomplete. Both "investors" (as the term is defined for federal income tax purposes) and businesses (such as banks and other lenders) generate profits and losses by putting their capital at risk. What distinguishes the two groups is whether and how the person is compensated. YA Global was compensated through interest, receipt of discounted property, spreads, and fees (both cash and non-cash). In its own words, YA Global admitted to realizing returns from non-investment type activities, returns from interest on loans, "from purchasing stock at a discount to where it sells shares into the public markets, and from the sale of the warrants and other restricted shares it may receive in connection with each financing." (E.g., Ex. 207-J at p. 0010.)

9. YA Global was an investor.

Objection: not supported by the record. See General Objection No. 1. During the years at issue, YA Global originated and made over 500 loans directly to its clients (RPFF ¶ 466) and committed, in about 350 SEDAs, to stand ready to distribute its clients’ stock to the market (RPFF ¶ 325). For these services, YA Global was compensated both in the form of interest and the spread on discounted stock but also through various fees paid in cash and stock or warrants. (RPFF ¶¶ 60, 257, 297, 299-300, 334, 341, 356, 372-373, 392-396.)

10. YA Global did not provide any services and did not earn compensation for services.

Objection: not supported by the record. See Resp’s Obj. to Pet’rs’ PUFF ¶¶ 6 and 9. YA Global made direct loans to its clients and agreed to distribute its client’s stock to the market. (Entire record.) Both of these activities, lending and underwriting, are services which YA Global provided, through Yorkville Advisors, to its clients. For these services, YA Global was compensated both in the form of interest and the spread on discounted stock but also through various fees paid in cash and stock or warrants. (RPFF ¶¶ 60, 257, 297, 299-300, 334, 341, 356, 372-373, 392-396.)

11. YA Global had no customers.

Objection: not supported by the record. YA Global had customers with which YA Global negotiated terms of transactions and maintained long-term relations, in many cases entering into multiple and different financings. They included the companies to which YA Global loaned money and committed to purchase and sell stock. YA Global’s portfolio companies for whom it performed lending and underwriting were its customers.

12. Stock in YA Global’s portfolio companies was traded in very low volumes.

Objection: vague. Petitioners do not define what they mean by "traded in very low volumes." The trading volume of company stock during the pricing period was generally greater than the number of shares that YA Global was required to acquire pursuant to a SEDA advance. (Ex. 323-J; Resp’s Obj. to Pet’rs’ PUFF ¶ 182.)

13. Because the portfolio companies’ stock was so illiquid, reasonable investors would require a discount from the trading price in exchange for purchasing a large block of shares.

Objection: vague; not supported by the record. Petitioners do not define what they mean by "a large block of shares." YA Global and the companies negotiated the terms of the deals, including the amount of any discount to market price at which YA Global may acquire stock, at arm’s length. (Tr. 704:2-19; Tr. 1177:7-16; Ex. 58-J, Ex. 138-J, Ex. 685-J.)

14. YA Global frequently held long positions in its portfolio companies for weeks, months or years.

Objection: not supported by the record. YA Global never held stock that it received on a conversion of a convertible debenture or upon the exercise of a warrant because, in Mr. Angelo’s words, "that doesn’t make sense." (Tr. 108:3-9. See also RPFF ¶¶ 68, 243, 244, 245, 248.)) With respect to advances on SEDAs, YA sold the shares from the advance either during the pricing period or as soon as possible after the draw down. (RPFF ¶¶ 289, 328, 331, 343, 350, 351.)

15. YA Global was not in the business of underwriting or stock distribution. YA Global provided capital to businesses that were at high risk of failure and that often failed to repay it.

Objection: contrary to the weight of the evidence. YA Global served an underwriting function, distributing stock by connecting companies to buyers on the public market. (Entire record.) Mr. Angelo advised investors, "[W]e are convinced that by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor." (Ex. 252-J at p.004.)

16. YA Global and its portfolio companies intended and expected that convertible debentures would be repaid in stock.

Objection: not supported by the record. YA Global and the companies structured each convertible debenture to have a stated principal amount, rate of interest and maturity date. (RPFF ¶¶ 183, 185, 186.) The convertible debenture specified the amount of principal in dollars. (RPFF ¶ 185.) The company promised to pay the principal together with accrued but unpaid interest by the maturity date. (RPFF ¶ 183). The company’s obligations to pay the principal and the interest were absolute and unconditional. (RPFF ¶ 187). Each convertible provided for payment of principal and accrued but unpaid interest in cash on the maturity date. (RPFF ¶¶ 183-187.) The convertible debentures provided that if an event of default occurred, the full principal amount together with interest became, at YA Global’s election, immediately due and payable in cash. (RPFF ¶ 189.)

17. When it purchased convertible debentures, there was no way for YA Global to know when it would be able to get payments or how much those payments would be.

Objection: not supported by the record. Each convertible debenture had as stated principal amount, rate of interest and maturity date. (RPFF ¶¶ 183, 185, 186.) The company promised to pay the principal together with accrued but unpaid interest by the maturity date. (RPFF ¶ 183). The company’s obligations to pay the principal and the interest were absolute and unconditional. (RPFF ¶ 187).

18. YA Global frequently repackaged its portfolio companies’ debts into new ones and otherwise failed to pursue collection actions.

Objection: vague, not supported by the record. There is nothing in the record to establish that YA Global "frequently" repackaged debt or otherwise failed to pursue collection activities. YA Global was typically a senior secured creditor with respect to its promissory notes and convertible debentures. (RPFF ¶¶ 156, 210, 211, 213.) YA Global disclosed that it intended to aggressively enforce its rights under contractual relationships with the companies. (RPFF ¶ 240.) YA Global pursued the enforcement of its rights. (RPFF ¶¶ 132-137.)

19. The portfolio companies could not have obtained funds from banks or others in the business of lending.

Objection: not supported by the record; immaterial. While companies that YA Global financed may have been distressed, the record does not establish that all companies could not get obtain any funds from any banks or any others in the business of lending. (Entire record). A company’s difficulty in obtaining funds from banks and others in the business of lending is immaterial to whether a convertible debenture issued to YA Global, acting an arm’s length with, and unrelated to, the company, is debt or equity for federal tax purposes.

20. YA Global was not in the business of lending.

Objection: not supported by the record. Over a six-year period, YA Global originated and made over 500 loans directly to its clients. (RPFF ¶ 466.) By any standard, YA Global regularly, continuously, and substantial conducting lending activities.

21. YA Global was not engaged in a trade or business.

Objection: contrary to the weight of the evidence. Over a six-year period, YA made over 500 loans (RPFF ¶ 466) and entered into about 350 SEDAs. (RPFF ¶ 325.) For these services, YA Global received compensation. YA Global did not have returns realized simply from interest, dividends, and capital gains. (RPFF ¶¶ 60, 257, 297, 299-300, 334, 341, 356, 372-373, 392-396.)

22. At the end of December 2009, YA Global charged off $46,505,924 of interest receivables from its books because it determined the receivables became uncollectible. By charging off the interest receivables from its books, YA Global unequivocally abandoned the collection of the charged-off receivables.

First sentence. Objection: not supported by the record. See Resp’s Obj. to Pet’rs’ PFF ¶ 228. Petitioners failed to present any evidence as to whether YA Global determined anything with respect to the interest receivables or what it determined.

Second sentence: not supported by the record, legal conclusion, argumentative. See Resp’s Obj. to Pet’rs’ PFF ¶ 228. The mere act of charging an asset off the books does not, and cannot, possibly be evidence of an abandonment of that asset. YA Global did not cancel the underlying debts or forgive the interest due on the debts; it continued to have the right to enforce payment on the loans. (Entire record.)

23. There existed no reasonable expectation that any interest receivables of YA Global that became accruable in 2009 would ever be collected within a reasonable time.

Objection: not supported by the record. See Resp’s Obj. to Pet’rs’ PFF ¶ 231. Petitioners failed to offer any evidence substantiating this proposed finding.

24. YA Global reasonably relied on advice from its tax advisors in taking the position that it had no USTB.

Objection: contrary to the weight of the evidence. Mr. Yager, from RSM, stated that RSM did not provide advice to YA Global with regard to whether YA Global was engaged in a U.S. trade or business. (RPFF ¶ 1602.) Mr. Karst, from RSM, stated that RSM did not provide any opinion to YA Global with regard to whether YA Global was engaged in a U.S. trade or business. (RPFF ¶ 1603.) Mr. Griffel, from Schulte, Roth & Zabel LLP, stated that Schulte, Roth & Zabel, LLP, did not provide any opinion to YA Global with regard to whether YA Global was engaged in a U.S. trade or business. (Tr. 523-24, 526-27, 534, 538-39, 546, 551-52, 554-55, 556, 558-59.) The so-called ECI Memo was prepared by Mr. Schinik from Yorkville Advisors and purportedly memorialized oral communications Mr. Schinik had with Mr. Yager (and Schulte, Roth & Zabel, LLP), communications which RSM’s engagement letter cautioned should not be relied upon. (RPFF ¶¶ 524, 525, 586.) Messrs. Yager and Karst expressed ignorance about material information pertaining to YA Global’s activities. As disclosed in its private placement memorandum, YA Global was aware that it may be considered engaged in a U.S. trade or business. (RPFF ¶ 159.) YA Global did not reasonably rely upon the advice of any tax advisor that it was not engaged in a U.S. trade or business.

25. YA Offshore reasonably relied on advice from its tax advisors in taking the position that it had no USTB, and its reliance was in goodfaith.

Objection: contrary to the weight of the evidence. YA Offshore did not engage any tax professional to advise on any U.S. tax matters, including the rules regarding U.S. tax filings and the possible filings available to YA Offshore. (Entire Record). YA Global’s engagement of RSM for tax return preparation services covered only YA Global, and therefore did not cover YA Offshore. (RPFF ¶¶ 521-523, 525, 527, 528.) YA Offshore’s private placement memoranda provided that neither YA Global nor YA Offshore had obtained an opinion of counsel with respect to any tax issues. (RPFF ¶ 620.) As disclosed in its private placement memoranda, YA Offshore was aware that it may be considered engaged in a U.S. trade or business due to certain of YA Global’s activities. (RPPF ¶ 617.) YA Offshore could not reasonably rely on any purported advice from RSM for the same reasons set forth in objection to Pet’rs’ PUFF ¶ 24. YA Offshore did not reasonably rely on the advice of a tax advisor that it was not considered engaged in a U.S. trade or business.

26. YA Offshore was unaware of its obligation to file Forms 1120-F or protective Forms 1120-F.

Objection: contrary to the weight of the evidence. YA Offshore’s private placement memoranda suggest that YA Offshore was aware, or may have been aware, of the obligation. (RPPF ¶¶ 616-619.) If YA Offshore was unaware, it was unaware because it did not exercise reasonable diligence in determining what its filing obligations were, including the availability of filing protective Forms 1120-F. (See Resp’s Obj. to Pet’rs’ PUFF ¶¶ 25.)

27. YA Global’s Forms 1065 contained all the information necessary for Respondent to compute any withholding tax due under section 1446.

Objection: inaccurate, not supported by the record. YA Global’s Forms 1065 specifically deny liability for the section 1446 withholding tax. In any event, a Form 1065 does not contain sufficient information from which to calculate the section 1446 withholding tax because it does not identify the amount of income and expenses that is effectively connected with the conduct of a U.S. trade or business or how that amount is allocable to the foreign partners.

28. YA Global’s did not consent to extensions of the statute of limitations with respect to section 1446 withholding tax for 2006 or 2007.

Objection: not supported by the record. Yorkville Advisors and Yorkville GP both signed Forms 872-P, Consents to Extend the Time to Assess Tax Attributable to Partnership Items, for the years 2006 and 2007. (RPFF ¶ 541.) Each consent is valid on its face and was executed by respondent and Yorkville Advisors and Yorkville GP before the expiration of the existing limitations period for 2006 and 2007. (Exs. 31-J through 42-J, 55-J through 64-J.) The section 1446 withholding tax is a partnership item of YA Global, and, therefore, covered by Form 872-P. See YA Global Investments, LP v. Commissioner, 151 T.C. 11 (2018).

29. Respondent abused his discretion in denying YA Offshore’s Request for Waiver Under Treasury Regulation Section 1.882-4(a)(3).

Objection: not supported by the record. Respondent requested additional information from YA Offshore to support YA Offshore’s Waiver Request, and carefully considered the facts and circumstances, as well as the factors outlined in Treas. Reg. § 1.882-4(a)(3)(ii), in evaluating and denying YA Offshore’s Waiver Request. (RPFF ¶¶ 559-560, 609-610.)

ARGUMENT

I. YA Global was more than just a "pool of assets"; through the activities Yorkville Advisors performed on YA Global’s behalf, YA Global was a lender, underwriter, and financier to underserved companies.

At trial and in their Brief, petitioners dwell on the notion that YA Global was merely a "pool of assets" or a "pot of money" and that YA Global "invested" or was an "investor." (E.g., Pet’rs’ Brief at pp. 34, 124, 133, 156; Tr. 52:13, 52:22, 105:3-5, 188:6-9.) However, as respondent has repeatedly observed, labels are inconsequential in this case and are not helpful to the question whether YA Global’s activities give rise to a trade or business.⁴

Citing to respondent’s expert Leon Metzger, petitioners open their argument with the claim that YA Global falls squarely within the definition of a hedge fund: "Hedge funds pool capital from their investors, and based on an investment strategy, invest the proceeds." (Pet’rs’ Brief at pp. 124-25 (quoting Ex. 2003-R at p. 5).) Respondent does not dispute that YA Global was a hedge fund or that a hedge fund "pools" money, as does any jointly owned vehicle, whether a partnership or corporation.

But this terminology does not elucidate any fact tending to show that YA Global was, or was not, engaged in a U.S. trade or business. While petitioners selectively rely on a partial quotation from Mr. Metzger, they ignore the most critical portion of his opinion: "There is no limit to the choice of strategies [of a hedge fund] unless they are forbidden by statute or not permitted by the fund’s governing documents." (Ex. 2003-R at p. 12.) Elaborating, he stated:

It is naïve to think that hedge funds only make money from purchasing stock in companies in the open market and selling that stock at a profit because of an increase in the market price of that stock. In other words, hedge funds can profit from implementing strategies that do not rely solely on swings in the stock market. For example, a hedge fund could be formed to make money from providing equity lines of financing to portfolio companies or making direct loans to companies.

(Ex. 2003-R at p. 12.) That is, a typical hedge fund may engage in the conduct of a trade or business for U.S. income tax purposes. YA Global’s "pool of capital" or "pot of money" was put to use as in any business and gave way to loan receivables and stock held for distribution as the result of business activities.

In arguing for what amounts to a "hedge fund exception" to section 864, petitioners, in effect, are claiming that a business can be divided into compartments — one holding the assets and one holding the personnel with full discretionary authority to deploy those assets — and thereby engage in any form of business whatsoever within the United States while avoiding U.S. tax on the resulting income. Courts have recognized, however, that a U.S. trade or business can be effectively conducted through another party acting on the taxpayer’s behalf and that, without attribution, the U.S. trade or business standard would be easily avoided and toothless. See Adda v. Commissioner, 10 T.C. 273 (1948), aff’d per curiam, 171 F.2d 457 (4th Cir. 1948) (stating, "[The taxpayer] seeks to accomplish in this case, through his brother as his agent, what he could not accomplish directly by himself, that is, to effect transactions by decisions made in the United States . . . and not be taxed upon the gains."). There is nothing in the law that exempts a "hedge fund" from this analysis.

In this case, by virtue of the power of attorney granted to, and discretionary authority exercised by, Yorkville Advisors, YA Global carried on its business through the employees of Yorkville Advisors just as if they were employees of YA Global. YA Global is not permitted to avoid U.S. tax by claiming that activities carried on for its direct benefit are conducted by personnel housed in a separate legal entity, Yorkville Advisors, rather than its own employees. As discussed at page 275, below, this relationship epitomizes a lack of independence, and in another context, a court has found this relationship to be consistent with an agency relationship. See Cambridge Fund, Inc. v. Abella, 501 F. Supp. 598, 614 (S.D.N.Y. 1980) (discussed at page 318, below).

A related theme is that YA Global had no employees, and that respondent incorrectly engrafts the actions of others onto it.⁵ (See Pet’rs’ Brief at p. 125.) Respondent agrees that YA Global did not have employees, but YA Global empowered Yorkville Advisors to perform the activities that YA Global’s employees would have performed had it chosen to hire employees directly. Petitioners attempt to cast this relationship as something other than what most rationally and realistically reflects the facts, i.e., a relationship in which Yorkville Advisors was empowered (via a power of attorney and contractual agreements) to, and did, perform activities on YA Global’s behalf. Those activities that Yorkville Advisors performed on behalf of YA Global constituted a U.S. trade or business of YA Global under section 864.

Further, the facts that petitioners portray as important to petitioners’ argument — that YA Global did not have its own employees and employees of Yorkville Advisors conducted the activities — do not prove that YA Global was not in a trade or business in this case but rather evince the mutual interdependence between the two and a merging of identities. Under such circumstances, courts have found that a manager’s activities are properly attributed to the fund that it manages. See Sun Capital Partners III, LP v. New England Teamsters & Trucking Indus. Pension Fund, 724 F.3d 129 (1st Cir. 2013); Cambridge Fund, 501 F. Supp. at 614.

A. Whether Yorkville Advisors and Yorkville GP had their own businesses is immaterial to the issues in this case; they conducted activities on behalf of YA Global.

Beginning at page 125 of their Brief, petitioners argue that Yorkville Advisors and Yorkville GP operated their own, independent businesses and, therefore, neither could have been an agent of YA Global. Even leaving aside the actual lack of independence, petitioners do not offer any authority that actually supports the latter proposition. As discussed below, in several cases decided under section 864 (or its predecessor), the putative agent had a separate, independent business from that of the taxpayer, but was nevertheless determined to be an agent acting on behalf of the taxpayer. See De Amodio v. Commissioner, 34 T.C. 894 (1960), aff’d, 299 F.3d 623 (3d Cir. 1962); Handfield v. Commissioner, 23 T.C. 633 (1955); Lewenhaupt v. Commissioner, 20 T.C. 151 (1953), aff’d, 221 F.2d 227 (9th Cir. 1955).

Yorkville Advisors was not independent from YA Global

Petitioners from pages 125-133 endeavor to show that Yorkville Advisors was an "investment management" business founded by Mark Angelo to create an "investment bind" (YA Global), and that Yorkville thereafter operated independently from YA Global. This portrayal is misleading and inaccurate. Essentially from the time of their inceptions, Yorkville and YA Global were commonly controlled and inseparable.

Petitioners indicate Yorkville was an investment management firm formed by Mr. Angelo, who petitioners suggest was steeped in investment management experience. Although at trial, Mr. Angelo offered testimony that he wanted to manage investments, his actual background was as an investment banker, with experience in structured financings, not as a trader or investment manager with expertise or a track record in different "investment strategies." YA Global’s marketing materials described his structured financing expertise, as follows:

Mark has specialized in the unique capital needs of small and mid-cap companies for over a decade. An authority on structured finance products, Mark is frequently cited for commentary in industry publications and news sources. Prior to co-founding Cornell Capital Partners, LP, Mark co-ran the corporate finance division of The May Davis Group, a boutique investment bank focused on emerging growth companies. With extensive transaction expertise and a broad array of relationships, Mark witnessed firsthand the relative strengths and weaknesses of a variety of financing structures from both the issuer and investor perspective. These insights led Mark to consider new mechanisms for companies to acquire capital while protecting the downside of the liquidity providers and his answer-the SEDA-provided the impetus for Mark to launch the Cornell investment fund. Mark continues to work with issuers to develop creative financing solutions at all levels of the capital structure.

(Ex. 30-J at YAREL0000012081.) On many occasions, Mr. Angelo (or YA Global) described YA Global as an investment or merchant bank wrapped in a hedge fund structure. (Ex. 2001-R at ¶ 38 n.48; Ex. 240-J at p. 0019; Ex. 241-J at p.0019; Ex. 242-J at p. 0018; Ex. 279-J at p. 001.) The tilt of his professional formation decidedly favored finance, not investment or trading.

At pages 127 and 128, petitioners relate that, after Yorkville Advisors established YA Global, Yorkville Advisors managed four funds going into 2006: YA Global, Highgate House Funds, Ltd. ("HHF"), Montgomery Equity Partners, Ltd. ("MEP"), and Cornell Rx Funds, Ltd. ("CRX"). Petitioners attempt to create the impression that the funds were each equally viable and significant and entirely unrelated. However, while these funds did exist at the start of 2006, the first year at issue in this case, petitioners’ depiction overstates reality. HHF, MEP, and CRX were small funds that had little activity in 2006, before HHF and MEP were merged into YA Global and CRX was terminated. (RPFF ¶¶ 504-505, 512, 514-515.) For the vast majority of the years in issue in this case, these other funds did not exist and thus were not clients of Yorkville. Moreover, HHF and MEP had virtually identical business plans to that of YA Global. (RPFF ¶ 513.) In essence, Yorkville Advisors operated only YA Global during the years at issue.⁶

Because Yorkville Advisors did not increase the number of funds during the years at issue, petitioners’ statement at page 128 that Yorkville Advisors’ "investment management and advisory business grew" is ambiguous and potentially misleading. It was YA Global’s increase in size from 2001 through 2008 to about $1 billion assets under management that caused Yorkville Advisors to need to hire more people. (Pet’rs’ Brief at p. 127.) Most of Yorkville Advisors’ costs as outlined at pages 128 and 129 of Petitioners’ Brief were incurred to operate YA Global, as Yorkville Advisors did not manage any other independent funds during the years at issue.

In exchange for operating YA Global, Yorkville Advisors received a management fee based on the value of YA Global’s assets; a management fee traditionally is intended to cover the manager’s overhead/operating expenses. (Ex. 2003-R at p. 16.) Under the 2007 Management Agreement, YA Global could have been required to reimburse Yorkville Advisors for any expenses related to deal sourcing (as those expenses are defined in the agreement) in excess of the fees Yorkville Advisors received from the client companies. (Ex. 28-J at § 6(b).) In addition, Yorkville Advisors or Yorkville GP was entitled to an incentive allocation based on YA Global’s gains; an incentive allocation traditionally is designed to reward the manager for generating profits ("i.e., an alignment of interests between the investors and the manager"). (Ex. 2003-R at p. 16. See also Ex. 3003-P at ¶¶ 114-15.)

As the foregoing facts demonstrate,⁷ contrary to petitioners’ assertions, Yorkville Advisors’ business was not independent of YA Global’s business, but rather was inextricably tied to it. This fact is not altered by the circumstance that Yorkville Advisors may have sometimes earned profits when YA Global lost money.⁸ (Pet’rs’ Brief at p. 130). Yorkville Advisors served only YA Global, its only significant fund during the years at issue, and its activities were conducted entirely on behalf of YA Global. As a consequence, Yorkville Advisors was dependent wholly on YA Global for its income and on YA Global’s performance for its reputation. Moreover, for 2006 and part of 2007, Yorkville Advisors was YA Global’s sole general partner, making any question of Yorkville Advisors’ being disassociated from YA Global moot at least for those years.⁹ As described in Respondent’s Brief, YA Global engaged in the business of lending, performing underwriter-type stock distribution activities, and providing financial services to its clients, and Yorkville Advisors was tasked with operating this business, "including deal sourcing, due diligence, investment decisions, account and trading," as petitioners state at page 127, among other activities.

Attribution of Yorkville Advisors’ Activities to YA Global

It is unnecessary that Yorkville Advisors be deemed to be a "co-investor" or engaged in a "joint venture" with YA Global’s limited partners for Yorkville’s activities to be attributed to YA Global, as petitioners suggest at page 130 of their Brief. What is significant is that Yorkville Advisors was acting on behalf of YA Global. As one court put it:

Whether the arrangements between the two were technically sufficient to constitute a joint venture, we regard as immaterial. If not a joint venture, the relationship of principal and agent clearly existed. A taxpayer may engage in business through an agent, and the sales activities of an agent for the benefit of the principal will be imputed to the principal."

Bauschard v. Commissioner, 279 F.2d 115, 118 (6th Cir. 1960), aff’g 31 T.C. 910 (1959). See also Anderson v. Commissioner, T.C. Memo. 1964-193, 23 T.C.M. (CCH) 1170 (1964), ("Whatever was done [by the developer] was done at the instance and for the benefit of the [providers of capital]. . . . In a transaction of this type, the tax consequences must be determined by a realistic and common sense interpretation of the actions of the parties. As we see it, both groups . . . were making a contribution essential to the ultimate realization of a profitable enterprise."); Wyche v. United States, 36 AFTR 2d 75-5816 (Ct. Cl. 1974).

Similarly, petitioners’ references at page 129 to disclosures in the private placement memoranda do not further petitioners’ theory that an independent business is incapable of acting on behalf of another. The referenced language merely outlines the potential risks if Yorkville Advisors were to engage in activities beyond those on behalf of YA Global, which, during the years at issue, Yorkville Advisors did not. As a matter of law, an agent can serve multiple principals. See, e.g., Lewenhaupt, 20 T.C. at 151 (involving licensed real estate broker with other clients); Handfield, 23 T.C. at 633 (involving distributor with multiple clients).

In an attempt to bolster their position, petitioners discuss Dagres v. Commissioner, 136 T.C. 263 (2011) and Lender Management, LLC v. Commissioner, T.C. Memo. 2017-246, 114 T.C.M. (CCH) 638 (2017); however, neither of these cases substantiates petitioners’ theory that an independent business is incapable of acting on behalf of another. In both cases, the issue before the Tax Court was whether the taxpayer, a manager of investment funds, was engaged in a trade or business. In both cases, the court found the taxpayer to be engaged in a trade or business of investment management. See Dagres, 136 T.C. at 264; Lender Management, T.C. Memo. 2017-246, at 32, 38. From these holdings, petitioners jump to the unsupported conclusion that the fund manager could not have been acting on the fund’s behalf, which is a separate question. (Pet’rs’ Brief at p. 133.)

Neither Dagres nor Lender Management addresses the taxation of the fund being managed, which is the issue in this case, or whether the activities of the manager are attributable to the funds they managed. Neither case presents facts similar to those in this case. Each addresses a business activity of the taxpayer-manager from his or its own perspective and without regard to whether the taxpayer acted on behalf of a fund or the nature of any such actions. Petitioners’ stated conclusion, i.e., that the activities of a manager cannot be attributed to a fund, cannot be drawn from these cases.

In Dagres, the court considered whether the taxpayer was entitled to a business bad debt deduction in connection with his activities as a member-manager of the general partner for various venture capital funds. Dagres, 136 T.C. at 280, 283. In holding that the taxpayer was entitled to the deduction, the court found that the general partners (and hence the taxpayer) were engaged in the business of managing a number of venture capital funds. Id. at 286. The parties had agreed that the venture capital funds made only investments, and no issue was raised as to whether the venture capital funds were engaged in a trade or business. Id. at 269. The issue before the court involved the taxation of the managing member of the general partners of various funds and not the taxation of any fund.

Consequently, whether the activities of a general partner were attributable to a fund did not arise. Further, since the parties had agreed in Dagres that the funds only made investments, attributing to the funds activities of the taxpayer-manager that merely facilitated or were ancillary to the funds’ business of investing would not have given rise to a finding that the funds were in a trade or business and would have been irrelevant to that question. See Whipple v. Commissioner, 373 U.S. 193 (1963); Higgins v. Commissioner, 312 U.S. 212 (1941). Thus, both the focal point of taxation and the facts in Dagres are fundamentally different than those in this case, where the entity being examined is the fund, YA Global, whose profits arose from, and whose assets were held in connection with, an active business conducted in its behalf by a general partner or manager having virtually no other clients, Yorkville Advisors.

The Tax Court faced a similar issue in Lender Management’, whether the taxpayer was entitled to deduct as business expenses its expenses incurred in connection with its activities as an investment advisor to three limited liability companies owned by various family members. Lender Management, T.C. Memo. 2017-246 at 1, 33. One of the companies invested in private equity, one in public equity and one in hedge funds. The taxpayer arranged for investments on behalf of the companies and provided investment advisory and financial planning services to individual investors in the entities. The court held that the taxpayer was entitled to claim the business expenses on the basis of the services it provided. Id. at *38. As in the Dagres case, the taxation of the advisor, not of a fund, was before the court. No dispute existed as to the nature of the related entities’ activities or as to whether the related entities were engaged in a trade or business (they apparently were not, given that, as in Dagres, their activity consisted of making investments. Again, the court did not have to address the attribution of the taxpayer’s activities to the related entities and attribution of the taxpayer’s activities related to the investing of those entities’ assets would have been inconsequential.

Other than these two cases, which, as shown above, are inapposite, petitioners do not cite to any authority supporting their "independent business" theory. Several cases within the context of section 864 (or its predecessor) demonstrate that petitioners’ theory — that one business cannot act on behalf of another — is baseless. For example, in Handfield, the court found the American News Company to be an agent of the taxpayer. Handfield, 23 T.C. at 633. At the time, American News Company was a large U.S. magazine and book distributor with a business separate and apart from the taxpayer, a Canadian manufacturer of post cards.¹⁰ See also De Amodio, 34 T.C. at 894 (where independent company and agent treated as agents of the taxpayer); Lewenhaupt, 20 T.C. at 151 (where licensed real estate broker spending 50% of time for taxpayer treated as taxpayer’s agent).

In other contexts, a person’s independence similarly has not been an impediment to finding the person to be acting as an agent for another.

It is true that the real estate agents orally retained by the Hansche brothers were independent in the sense that they were acting as independent contractors but this is true of the ordinary real estate broker-owner relationship. The mere retention of an independent real estate broker does not per se take the case out of the broad first exception of 26 U.S.C. § 1221 [related to "capital asset" not including property held by resale]. It is not imperative that the final moving of the real estate from the owner to the customer need be done by the taxpayer. That the actual advertising sales activities are here not performed by the taxpayers does not mean that they were not holding the property "primarily for sale to customers in the ordinary course of [Hansches’] trade or business."

Hansche v. Commissioner, 457 F.2d 429, 434 (7th Cir. 1972), aff’g T.C. Memo. 1970-342.

B. Yorkville Advisors acted on behalf of YA Global and as its agent in conducting a U.S. trade or business of YA Global. Where an agent conducts a U.S. trade or business for a hedge fund, the "pool of funds," as petitioners describe it, can, indeed, be a U.S. trade or business.

Petitioners assert that YA Global was just a "pot of money" that was managed by Yorkville Advisors and over which Yorkville Advisors had complete, unfettered control. (Pet’rs’ Brief at pp. 133-34.) According to petitioners, " [authorization to enter into binding transactions alone is insufficient to give rise to an agency relationship, and here, the investors who pooled their funds and gave them over to be managed by Yorkville and Yorkville GP did not exercise the requisite control to create an agency relationship." (Pet’rs’ Brief at p. 134.)

Petitioners’ variegated argument against Yorkville Advisors’ being an agent is, to begin, contrary to partnership law. Under partnership law, the general partners of a partnership, here Yorkville Advisors and Yorkville GP, are agents of the partnership, here YA Global. Del. Code Ann. tit. 6 §§ 15-301(a) and 17-403(a) and (c); Cayman Islands Partnership Law (2002 Revision), § 6; Cayman Islands Exempted Limited Partnership Law (2007 Revision), § 3. An agency relationship can exist between a limited partner and another partner in a limited partnership, even though, under partnership law, limited partners in a limited partnership have no right to participate in the management of the partnership, which is handled by the general partners (and therefore, no right to control the general partners). Here, Yorkville Advisors and Yorkville GP were agents of YA Global, a limited partnership, throughout the years at issue, and their activities can and should be attributable to YA Global.

To the extent petitioners are claiming activities performed by Yorkville Advisors when it was no longer YA Global’s general partner could not have been performed as YA Global’s agent, petitioners are incorrect. Throughout the Relevant Period, the management agreements authorized Yorkville Advisors to act on behalf of YA Global, irrespective of whether Yorkville Advisors was YA Global’s general partner. (RPFF ¶¶ 40-42, 46-48.)

Petitioners’ reference to the investors in YA Global and the degree of control they may have had over Yorkville Advisors is misplaced. The relevant relationship for these purposes is the one between Yorkville Advisors and YA Global, the relationship between Yorkville Advisors and YA Global’s limited partners).

Petitioners’ application of agency case law is similarly imprecise and flawed. In determining whether Yorkville Advisors’ activities were attributable to YA Global for purposes of section 864, the federal common law principles set out in the case law under section 864 (or its predecessors) should be applied. Petitioners’ invocation of a variety of common law principles courts have used in non-section section 864(b) cases are inapposite to the question before the Court, which deals with attribution of actions in the section 864(b) context.

1. The federal common law to be applied is that set forth in the case law relating to section 864(b) (and its predecessors).

At page 134 of their Brief, petitioners state, "When Congress says nothing about when an agency relationship exists, the federal courts look to general common law principles for guidance." Attempting to set forth the principles appropriate for use in this case, petitioners cite to several non-tax cases and point to several tax cases, not involving section 864(b), where the courts purportedly applied "federal common law of agency" to evaluate an alleged agency relationship. Petitioners then assert the novel position, without precedent in the context of section 864 and contrary to existing precedent, that the appropriate common law principle to be applied is the standard set forth in the Restatement (Third) of Agency, which requires mutual assent by the principal and agent that the agent acts on the principal’s behalf and subject to the principal’s control. (Pet’rs’ Brief at pp. 135-37).

In fact, the courts have not adopted a uniform definition of agency that applies in every context (or even in every federal income tax context), as petitioners suggest at page 135 of their Brief. The courts adapt the standards depending on the context in which, and the purpose for which, they are being used.

As explained in Respondent’s Brief at pages 210 through 217, the attribution standard set forth in cases addressing section 864(b) (or its predecessors) is the federal common law standard that applies specifically for purposes of section 864. Because the attribution standard applicable under section 864 is intended to prevent a taxpayer from circumventing a U.S. nexus by transacting business through another party, it differs from the common law agency principles that apply in other contexts. As the cases discussed in Respondent’s Brief and in subpart 2, below, the section 864 standard is met even if the taxpayer does not exercise control over those acting on its behalf. The attribution standards that may apply in other contexts, where the policy concerns of a taxpayer’s using another’s presence to achieve economic returns while claiming itself to avoid taxable nexus are not implicated, do not apply for purposes of section 864.

Notably, the tax cases cited by petitioners (Pet’rs’ Brief at p. 135) do not involve section 864 and do not apply here. Further, many of those cases do not even reference the standard in the Restatement of Agency, which petitioners have posited as laying out the common law principles the court should apply. The difference in standards among these authorities is demonstrated in the cases discussed below.

In Commissioner v. Bollinger, 485 U.S. 340 (1988), which applies for purposes of whether a legal entity may be disregarded as an agent, the Court did not refer to the agency standard in the Restatement of Agency¹¹ but discussed National Carbide Corp. v. Commissioner, 336 U.S. 422 (1949)¹² and the indicia and requirements of a "‘true corporate agent . . . of [an] owner-principal.’" Id. at 346 (quoting National Carbide, 336 U.S. at 437)). The "six National Carbide factors," as the Court called them, do not explicitly identify control as a key element. In fact, in the context of a corporate agent-owner principal, the Court found a parent corporation’s control over a subsidiary to be meaningless. See id. (citing National Carbide, 336 U.S. at 429-434). Rather, the Court found determinative of a principal-agent relationship for that purpose (1) a written agreement between principal and agent at the time the property was acquired, (2) the corporation’s functioning as an agent with respect to the property for all purposes, and (3) the corporations’ holding itself out as the agent and not the principal in all dealings with third parties.¹³ Id. at 349-350.

In Voss v. United States, 329 F.2d 164 (7th Cir. 1964), the Seventh Circuit considered other factors than the "six National Carbide factors," before finding that, for purposes of section 1221, the taxpayer was not engaged in the real estate business, by virtue of his realtor’s activities in developing and selling the taxpayer’s property. In finding for the taxpayer, the court considered whether the taxpayer’s activities, including those of an agent properly imputed to the taxpayer, taken together with all other relevant factors, caused the taxpayer to be treated as holding property for sale in the ordinary course of its trade or business. Id. at 166 (quoting Estate of Mundy v. Commissioner, 36 T.C. 703, 712 (1961). Like the Supreme Court, the Seventh Circuit did not rely on, or refer to, the Restatement when it determined whether to impute the agent’s activities to the taxpayer. (Voss will be discussed in more detail in subpart 2.(b), below.)

Schuster v. Commissioner, 84 T.C. 764 (1985), presents a third standard. In Schuster, the Tax Court considered, for purposes of income recognition, whether the taxpayer was the agent of her religious order when she worked for the federal government and received compensation (which she endorsed over to the order). To create an agency relationship in this scenario, the court required the participation of three parties: the taxpayer, her order, and the federal government. It was immaterial, therefore, whether the taxpayer and the order had created an agency relationship between themselves or whether the taxpayer acted on the order’s behalf and was subject to its control. The issue was whether the taxpayer performed her services as an employee of the government or whether the government contracted to receive the services from the order, with the taxpayer performing those services as the order’s agent. Schuster, 84 T.C at 775. As with the other tax opinions, the majority opinion does not apply or refer the Restatement of Agency.¹⁴

The other three tax cases cited by petitioners refer to the Restatement or similar standards but involved issues and policies very different from those presented here. See Huff v. Commissioner, 138 T.C. 258 (2012) (rejecting the taxpayer’s argument that the Tax Implementation Agreement between the United States and the Virgin Islands created an agency relationship between the Internal Revenue Service and the Virgin Islands Bureau of Internal Revenue); Petty v. Commissioner, 77 T.C. 482 (1981) (finding that a taxpayer who hired a contractor to build a residence could not claim a deduction for sales taxes paid by the contractor for building materials); Smithfield Co. v. Commissioner, 1942 WL 9253 (BTA 1942) (finding that a parent could not claim a deduction for inventory shrinkage of its subsidiary because they were separate entities and there was no evidence of any agreement between the two entities).

The different standards highlighted in the cases above belie petitioners’ notion of a uniform "general common law" of attribution for federal income tax purposes generally and petitioners’ assertion that this "general common law" must be applied, instead of the separate and relatively clear jurisprudence on attribution under section 864.

The non-federal tax cases petitioners cite do not require a different conclusion and are easily distinguishable. In Clackamas Gastroenterology Associates, P.C. v. Wells, 538 U.S. 440 (2003), the Court interpreted the word "employee" as used in the Americans with Disabilities Act. The court concluded that, when Congress used this term, it meant to refer to the common law definition of an employment relationship. In Meyer v. Holley, 537 U.S. 280 (2003) and Christiana Trust v. Riddle, 911 F.3d 799 (5th Cir. 2018), the courts state "when Congress creates a tort action, it legislates against a legal background of ordinary tort-related vicarious liability rules and consequently intends its legislation to incorporate those rules." The case before the Court does not involve a federally created tort action or the interpretation of a statutory term (such as "employee") that is intended to incorporate common law principles.

Even if the Court were to accept petitioners’ novel proposition, i.e., that the standard for determining attribution in the context of section 864 is the standard set forth the Restatement (Third) of Agency, petitioners do not prevail. Even under the Restatement, Yorkville Advisors’ acted as YA Global’s agent because YA Global and Yorkville Advisors agreed that Yorkville Advisors’ would act on YA Global’s behalf and YA Global had the right to control Yorkville Advisors’ conduct. Petitioners’ arguments and the application of the Restatement to the facts of this case are discussed more thoroughly in subpart 3, below, which does not have a corresponding subsection in Petitioners’ Brief.

2. Petitioners misconstrue the case law when asserting that courts consistently focus on control and independence when deciding whether an agent’s actions create a trade or business.

Petitioners assert that "control" is a critical element for attribution, even in the cases under section 864(b). (Pet’rs’ Brief at pp. 136-37.) They further assert that for an agency relationship to exist, the principal must have "the right to give interim instructions or directions to the service provider as to the manner and details of the provider’s work beyond the initial specification." (Pet’rs’ Brief at pp. 136-37 (citations omitted).) Petitioners’ analysis is strained and does not find support in the federal income tax law.

a. Case law relating to a U.S. trade or business under section 864(b) does not require the principal to exercise control, as petitioners contend.

As explained in Respondent’s Brief at pages 210 through 217, the section 864 attribution standard focuses on whether a party has agreed to act on behalf and for the benefit of the taxpayer and has been delegated authority to do so. In particular, courts have repeatedly held that the activities of a party who is vested with broad discretionary authority to transact business for the taxpayer must be treated as activities of the taxpayer for purposes of section 864(b).

Yorkville Advisors met this standard based on the broad authority delegated to it under the power of attorney and other terms of the partnership Agreements and management agreements. Whether YA Global has a right to "control" Yorkville Advisors is not a requirement for purposes of section 864 attribution.¹⁵ That is even more the case where the two entities are inextricably connected and operated as one, as is the fact here.

Petitioners’ contrary interpretation of the section 864(b) cases is strained, inapposite, or both, as illustrated by the below case law.

i. Adda

Petitioners appear to concede that the taxpayer in Adda had no control over his brother. The court stated: "The petitioner gave [his brother] full and complete authority in dealing for the petitioner in commodities to use his own discretion and judgment as to when to buy or sell for the petitioner’s account and the prices at which the sales or purchases were to be made." Adda, 10 T.C. at 275. The purpose of this arrangement was to allow his brother to trade commodities even if the taxpayer was cut off from communicating with him.

Petitioners argue that "the Court’s concern in Adda is that the brother was not a broker." (Pet’rs’ Brief at p. 138) To the extent the court was concerned with this fact, the language quoted by petitioners from Adda demonstrates that its concern related to the application of the safe harbor (as in effect at the time), which applied to "the effecting of transactions in the United States in stocks, securities, or commodities through a resident broker, commission agent, or custodian."

Petitioners conflate the concept of attributing activities and the safe harbor. In Adda, the court held the taxpayer was attributed the trading activity conducted by his brother because the grant of discretionary authority gave him a "potent means of doing business in the United States." Adda, 10 T.C. at 278. The fact that, under the then-applicable safe harbor, the activities of certain specified types of agents were not considered as activities giving rise to a U.S. trade or business was irrelevant outside of the safe harbor (and the same is true under the current safe harbor).¹⁶ As the court noted, the safe harbor implicitly recognizes that agent activity outside its scope can be attributed to a foreign taxpayer. Id. The standard for attribution is not affected by whether an agent is properly characterized as a "broker" or has its own business.

Thus, Adda demonstrates that the activities of a party who is vested with broad discretionary authority to transact on behalf of a taxpayer are treated as activities of the taxpayer for purposes of section 864, even if the agent is not subject to the taxpayer’s control.

ii. Lewenhaupt

Petitioners argue that in Lewenhaupt, the taxpayer exercised control over his agent, a U.S. real estate broker named LaMontagne. (Pet’rs’ Brief at p. 139.) Even if control were relevant, petitioners overlook the fact that there were two parties acting on behalf of the taxpayer in that case — LaMontagne and the taxpayer’s father.

The taxpayer gave his father a power of attorney because he anticipated that he would not be able to communicate with LaMontagne or his father, which by itself, shows that the father was not subject to the taxpayer’s control. Id. at 153. LaMontagne likewise was not subject to the taxpayer’s control, because he could act with the approval of the taxpayer’s father (who could grant approval without consulting the taxpayer if it was not practicable to do so). Id. at 154 ("Prior to taking any major action with respect to petitioner’s property in the United States, LaMontagne would consult with petitioner’s father and, where practicable, with petitioner." (emphasis added)). In other words, LaMontagne and the father could collectively act without the taxpayer’s authorization. Petitioners incorrectly claim that LaMontagne provided monthly reports to the taxpayer. Those reports were provided to the taxpayer’s father.

As in Adda, the whole point of this arrangement was to allow the business to move forward even if the taxpayer lost contact with both his father and LaMontagne due to the war:

Petitioner gave LaMontagne a broad power of attorney so that he might be able to act for him in case both Sweden and the United Kingdom were cut off from the United States and so that he would have sufficient power to handle petitioner’s funds should the funds of Swedish nationals be frozen in the United States. . . . Petitioner gave his father a power of attorney because it was feared that Sweden might be invaded or cut off from contact with the United States and England, so that he could no longer communicate with his father in England or with LaMontagne in the United States.

Id. at 153.

De Amodio

In footnote 15, appended to their discussion of Lewenhaupt, petitioners address De Amodio. Petitioners conclude, "Nothing in the case indicates whether the taxpayer controlled or had a right to control his agents." (Pet’rs’ Brief at p. 140.) They speculate: "[I]t seems reasonable to assume that the taxpayer could have refused to purchase properties his agents suggested he purchase, and he could have decided whether he wanted to enter into leases with particular tenants." (Pet’rs’ Brief at p. 140, n. 15.) Petitioners offer no support for this so-called "reasonable assumption."

In any event, petitioners’ assumption ignores the fact that the court held that the taxpayer’s agents managing the taxpayer’s U.S. real properties were "independent agents" for purposes of whether interest and dividends were attributable to a U.S. permanent establishment under the U.S.-Switzerland treaty. De Amodio, 34 T.C. at 894. Although the court did not explain the basis for its conclusion, the "independent agent" analysis under a treaty generally turns on legal independence (i.e., whether the agent is subject to the principal’s control) and economic independence (i.e., whether the agent bears entrepreneurial risk and has multiple customers). See Taisei Fire & Marine Ins. Co. v. Commissioner, 104 T.C. 535 (1995). Therefore, by finding the taxpayer’s real property agents to be "independent agents," the court implicitly concluded that the taxpayer did not exercise control over its agents.

In holding that the activities of the same independent agents were attributed to the taxpayer for purposes of the statutory predecessor of section 864(b), the court implied that control is not required for this purpose.

iii. Handfield

Handfield involved a contract between the taxpayer and American News Company, which distributed the taxpayer’s postcards to newsstands in the United States, where they were sold to the public. Handfield, 23 T.C. at 633. Petitioners assert that the taxpayer had control over American News Company because the contract specified the manner in which the postcards would be distributed.¹⁷ (Pet’rs’ Brief at p. 140.)

Petitioners further speculate that the taxpayer had control because his employee visited newsstands to ensure the cards were being properly displayed. (Pet’rs’ Brief at p. 140-41.) However, the Handfield court held it did not have enough information to conclude whether the news dealers (which the taxpayer’s employee visited) were agents of the taxpayer. Therefore, any control exercised by the taxpayer’s employees over the news dealers was apparently not sufficiently demonstrated to support a ruling.

The court made no mention of control as a factor in its decision. The case turned on whether the transaction was properly characterized as (1) a sale of postcards by the taxpayer to the distribution company, which resold to news dealers (or through news dealers to the public); or (2) a consignment sale, in which American News Company sold postcards on behalf of the taxpayer. In other words, the question was whether American News Company was acting on behalf of the taxpayer or for its own account.

The court concluded that the transaction was a consignment sale. Id. at 637. The opinion highlights the features of the contract that were "particularly persuasive" in reaching this conclusion but does not mention the ability of the taxpayer to control the American News Company. Id. The implication of the court’s opinion is that a distributor who holds a taxpayer’s products for sale on consignment is treated as an agent of the taxpayer, regardless of whether the taxpayer has control over the distributor.

iv. InverWorld

The taxpayer in InverWorld did, as a factual matter, have control over the U.S. subsidiary that acted on its behalf. InverWorld v. Commissioner, T.C. Memo. 1996-301, 71 T.C.M. (CCH) 3231 (1996). However, the court’s opinion does not give any indication that control is required for purposes of section 864 attribution. While the court’s analysis is limited,¹⁸ it appears to place more weight on the authority delegated to the taxpayer’s U.S. subsidiary to purchase certificates of deposit on behalf of the taxpayer and its clients, than on the taxpayer’s control over the subsidiary’s actions in doing so.

v. Pinchot

Noticeably absent from petitioners’ discussion is Pinchot v. Commissioner, 113 F.2d 718 (2d Cir. 1940). In Pinchot, the principal did not exercise control over the agent. To the contrary, the agent "bought and sold property for the co-owners in his discretion without consulting the decedent who did not personally take part in the transactions." Id. at 719. And yet, the court found that the agent acted on the principal’s behalf for purposes of determining a U.S. trade or business.

b. The other trade or business cases to which petitioners cite are not persuasive or on point.

In furtherance of their argument that the principal’s control is paramount in agency cases, petitioners cite to three cases under section 1221(a)(1) in which a taxpayer hired a realtor to subdivide and sell property that was originally held for the purpose of investment. (Pet’rs’ Brief at p. 143.) Petitioners overstate the significance of these three cases and ignore other cases in this area.

In the line of cases under section 1221, the court must determine whether the property at issue should be treated as "held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business" and, therefore, not as a capital asset. Generally, courts have recognized a need to impute the trade or business activities carried on by an agent to the taxpayer for purposes of section 1221; otherwise taxpayers could obtain the benefit of capital gain treatment simply by acting through others. "A taxpayer need not personally conduct real estate sales to be in the business; he may act through agents. Moreover, a taxpayer may not insulate himself from the acts of those whose efforts are combined with his in an endeavor to make a profit." Voss, 329 F.2d at 166.

In the case of property acquired by inheritance or held for a long period of time by an individual as an investment, for example, a farm, the courts have been hesitant to find that the purpose of holding the property had changed to holding the property "primarily for sale to customers in the ordinary course of [the individual’s] trade or business" by reason of the decision to liquidate the property in the best, or even only commercially viable, way. See, e.g., Smith v. Dunn, 224 F.2d 353, 356 (5th Cir. 1955) ("If we should consider the words of this exclusion alone, the problem would be relatively simple because appellant held this property solely by reason of the fact that he inherited it, and not primarily for sale to customers, his trade and business was architecture and its ordinary course related alone to that profession.").

Certain guides have evolved from the various cases deciding this issue to address these concerns. See Estate of Mundy, 36 T.C. at 710 (identifying some factors to include the circumstances under which the taxpayer acquired the property, the length of time he held it, the purpose in acquiring the property and disposing it, the activities of the taxpayer and those acting for him, among others). See also Smith, 224 F.2d at 356-57 (discussing the various factors). "[T]hese guides or factors may be entitled to different weight in different cases, and there is no definitive pointer which can be used to arrive at the correct result in all cases." Estate of Mundy, 36 T.C. at 710.

In recognition of the multitude of factors, the courts frame the issue broadly and do not focus, as petitioners contend, on "control and independence in finding agency." (Pet’rs’ Brief at p. 143.) Petitioners misrepresent the issue in the cases they cite to fit their narrative. The Tax Court in Estate of Mundy, cited by petitioners at page 143, framed the issue as follows:

[W]hether the activities of the taxpayer, including the activities of an agent that can properly be imputed to him, taken together with all other relevant factors pertaining to the taxpayer’s relationship to the property, place the taxpayer in the real estate business so that the property in question can be said to be held by taxpayer for sale to customers in his business.

Estate of Mundy, 36 T.C. at 712 (1961) (emphasis added).

In this context, courts may take a seemingly relaxed view of the selling activities undertaken by a realtor in disposing of the property. The courts, however, are deciding each case based on the case’s own particular facts and weighing the factors in a manner they view as appropriate. The cases petitioners cite should be viewed in this context.

In Voss, the taxpayer purchased the property at issue for investment and held the property for 25 years before he decided to sell it. After trying to sell it unsuccessfully himself and then through a realtor, the taxpayer accepted the realtor’s suggestion to subdivide the property and sell the resulting lots. The court found that the taxpayer was not personally involved in any part of the subdivision and sales activity, which was conducted entirely by his realtor, and was not considered to be engaged in the real estate business. Because the taxpayer acquired the property 25 years earlier as an investment and did not personally participate in subsequent subdivision and sales activity, the court found "the taxpayer’s relationship to the property" to be still one of investment. Voss, 329 F.2d at 167. The court did not hold that control was a necessary element for attribution of the realtor’s activities to the taxpayer. Rather, the court held that the realtor’s activity, even if attributable, was not sufficient to change the purpose for which real property was held by the taxpayer (from investment to a trade or business), given that the property had been held for investment for 25 years and the taxpayer did not supervise the development and sale but only signed deeds of conveyance and continued in the practice of dentistry.

Similar analyses can be drawn from the other two cases petitioners cite, which also involved sympathetic facts (inherited property): Smith, 224 F.2d at 353 (liquidation of inherited land); Estate of Mundy, 36 T.C. at 703 (liquidation of inherited land). Other cases reach different results on slightly different facts. For example, in Hansche, the taxpayers acquired a farm, which they operated for several years but held with an eye toward future subdivision and sale. The taxpayers engaged personally in some activities toward the future development of the land. Ultimately, the taxpayer hired real estate agents and brokers to sell the property. The parties stipulated that the development and sale of the property was handled exclusively by the realtors. The court held that the taxpayer’s property was considered to be "held by the taxpayer primarily for sale to customers in the ordinary course of his trade or business" even though the agent who sold the property was an independent contractor and was not supervised by the taxpayer. Hansche, 457 F.2d at 429. Notably, the Tax Court did not address Voss, even though the taxpayer argued it, and the Seventh Circuit, which had also decided Voss, did not find Voss compelling and distinguished it. See id. at 434.

Similarly, in Merritt v. Commissioner, 47 T.C. 519 (1967), aff’d, 400 F.2d 417 (5th Cir. 1968), the court held the property to be held for sale to customers, regardless of whether the taxpayer exercised control over the agents.

While petitioners claim that the realtors and contractors acted independently of them, it is clear from the record that since petitioners held legal title to the lots and starter houses, such parties were merely acting as their agents. Whatever was done by the realtors and contractors was done at the instance and for the benefit of petitioners. Thus the developing and selling activities by others must be attributed to petitioners.

Merritt, 47 T.C. at 530. See also, e.g., Welch v. Solomon, 99 F.2d 41, 43 (9th Cir. 1938) (stating, "The personal attention which a taxpayer gives to a business is certainly not decisive as to whether a resulting profit is ordinary income or capital gain. One may conduct a business through others, his agents, representatives, or employees. The business is nonetheless his because he chooses to let others bear all of the burdens of management."); Kaltreider v. Commissioner, 28 T.C. 121, 124 (1957), aff’d, 255 F.2d 833 (3d Cir. 1958) (stating, "[I]t is an accepted principle of law that one may conduct a business through agents, and, although others may bear the burdens of management, the business is nonetheless his.")

In each of the cases cited by Petitioners, the court was faced with whether an individual taxpayer who clearly held property with a purpose other than described in section 1221(a)(1) should be treated as changing that intent to in effect conduct the business of a dealer in property, where the individual was only trying to liquidate the property in a commercially viable way through a realtor. Given the focus on whether intent with respect to long-held or inherited property of an individual had changed, the decisions, including the reluctance to attribute a realtor’s actions in certain situations, simply are not relevant outside of their context. Moreover, the holdings of Voss and the other cases cited by petitioners have questionable precedential value outside of their specific facts in light of the numerous cases with contrary results on different facts.

A standard looking to control, and even actual control as in Voss, does not apply for purposes of section 864, as illustrated by the case law described above and the legislative history surrounding the specific section 864(b) safe harbors. See H.R. Rep. No. 89-1450, at 55 (noting that, under prior law, a taxpayer who granted discretionary authority to an agent did not qualify for the safe harbor, and, even as amended, a dealer "is specifically excluded from those who may grant discretionary authority and not be deemed to be conducting a business in the United States."). In any event, factually, YA Global did have control/oversight of Yorkville Advisors, as discussed in the latter portion of the next section.

3. The Restatement standard as set forth by petitioners does not apply in the context of section 864(b), but even if it were deemed to apply, Yorkville Advisors would still have been YA Global’s agent, as shown by the facts of the relationsip.¹⁹

As noted above, petitioners take a novel approach that is without precedent in the context of section 864 and is actually contrary to existing precedent. They claim the standard to be applied to determine whether Yorkville Advisors acted as YA Global’s agent should derive from the Restatement and require: (1) mutual assent of the principal and agent that the agent will act on the principal’s behalf and (2) the principal’s right to control the agent’s conduct. (Pet’rs’ Brief at pp. 135-36.)

To reiterate the arguments in Respondent’s Brief and in this Reply, the Restatement is not the governing standard for section 864 attribution. "Agency" as described in the Restatement is based on commercial and tort law, where "agent" is used in a more general sense to describe a relationship whereby one person serves as an instrument by which something is accomplished for another person. "Attribution" for purposes of section 864 is a broader concept than "agency" in the Restatement and reflects the concern that another entity or party may be used to avoid a taxable nexus to the United States, based on form. The importance of agency and attribution is evidenced not only in the case law above but also the legislative history surrounding the specific section 864(b) safe harbors. See H.R. Rep. No. 89-1450, at 13 (discussing implications of discretionary authority under the safe harbor).

Further, the Restatement of Agency, as with all Restatements of Law, is in the nature of secondary authority, meaning it contains statements about the law from unofficial commentators without authority to set legal rules in the relevant jurisdiction. Introducing the Restatement into the analysis under section 864(b) would only sow confusion and would undermine the long-standing jurisprudence under section 864(b).

Even if the Restatement were the appropriate standard, the arrangement between YA Global and Yorkville Advisors met it. Petitioners seemingly have conceded that YA Global and Yorkville agreed that Yorkville Advisors could act on YA Global’s behalf, as they have not presented any arguments to the contrary. Indeed, that fact is incontrovertible.

The only dispute, therefore, is whether YA Global had the right to control Yorkville Advisors. According to petitioners, the right to control is an essential element in establishing an agency relationship and the power to give interim instructions is determinative of an agency relationship. (Pet’rs’ Brief at pp. 136-37 (citing In re Google LLC, 949 F.3d 1338, 1345-1346 (Fed. Cir. 2020) and Johnson v. Priceline.com, 711 F.3d 271, 278-279 (2d Cir. 2013)²⁰).

Petitioners misinterpret the phrases "right to control" and "power to give interim instructions" and, consequently, place undue emphasis on the power to give interim instructions. Under the Restatement,

A principal’s right to control the agent is a constant across relationships of agency, but the content or specific meaning of the right varies. Thus, a person may be an agent although the principal lacks the right to control the full range of the agent’s activities, how the agent uses time, or the agent’s exercise of professional judgment. A principal’s failure to exercise the right of control does not eliminate it.

Restatement (Third) of Agency, § 1.01 comment c.

[W]ithin any relationship of agency the principal initially states what the agent shall and shall not do, in specific or general terms. Additionally, a principal has the right to give interim instructions or directions to the agent once their relationship is established. . . .

. . .

To the extent the parties have created a relationship of agency, however, the principal has a power of control even if the principal has previously agreed with the agent that the principal will not give interim instructions to the agent or will not otherwise interfere in the agent’s exercise of discretion.

Restatement (Third) of Agency § 1.01 comment f.

Stated differently, the right to control can arise as a legal matter from the agency relationship itself, even if the principal has agreed not to interfere in the agent’s exercise of discretion. The reference to "interim instructions" in the Restatement language quoted by petitioners at page 136 does not elevate the right to give interim instructions in the way they propose.

The quoted language draws a distinction between an agent and a service provider from whom a principal has contracted to receive services, and it applies only in that context. If a principal hires a service provider to provide discrete goods or services that are separate from or comprise only a small part of the principal’s business activity, then "[t]he power to give interim instructions distinguishes principals in agency relationships from those who contract to receive services provided by persons who are not agents." However, if a putative agent has authority to perform central functions of the principal’s business (as in the case of a manager who has discretionary authority to operate the principal’s entire enterprise) and to deal with third parties on the principal’s behalf, this authority demonstrates that the manager is acting as an agent on behalf of the principal, and not as a mere service provider. In that context, the principal has control as a legal matter even if the parties have agreed "that the principal will not give interim instructions to the agent or will not otherwise interfere in the agent’s exercise of discretion."

This distinction is illustrated in the cases cited by petitioners: In re Google LLC, 949 F.3d 1338 (Fed. Cir. 2020), Johnson v. Priceline.com, Inc., 711 F.3d 271 (2d Cir. 2013), and Chemtool, Inc. v. Lubrication Technologies, Inc., 148 F.3d 742 (7th Cir. 1998). In these cases, a service provider or vendor furnished specific goods or services to meet the needs of consumers (in Priceline.com), to facilitate delivery of another business’s products and services (in In re Google), or to provide limited-scope customer support for another business’s products (in Chemtool). The service provider or vendor was engaged in a different line of business from the putative principal (to the extent the principal was engaged in business at all) and was not acting on its behalf.

By contrast, when an agent is delegated broad discretionary authority to perform central functions of the principal’s business (or to manage the principal’s entire business) and to deal with third parties on the principal’s behalf, this delegation of authority unequivocally demonstrates that an agency relationship exists. Even if the principal explicitly agrees not to give interim instructions or to otherwise interfere with the manager’s discretion, the element of control is present as a matter of law. See Restatement (Third) of Agency § 1.01, comment f, illustration 4 (providing an example where a professional baseball team hired a new manager and agreed to give the manager autonomy in running the team).

Several cases have addressed these agency principles in the context of funds and fund management. In Cambridge Fund, a fund attempted to disavow the agency relationship between the fund and its investment manager, claiming, as petitioners do here, "the fund is almost totally under the control of the adviser and not the reverse." Cambridge Fund, 501 F. Supp. at 614. The court rejected this argument. The court observed that the management of the fund was housed externally but was performed in the same way that employees of the fund would have performed in managing an enterprise and concluded: "The fact that substantial discretion was vested in Management in making those recommendations does not negate agency."²¹ Id. at 615.

In Sun Capital Partners III, the court rejected a claim that the general partner entered into a management services contract for its own accord, rather than on behalf of the partnership. Sun Capital Partners III, 724 F.3d at 147-48. The court focused on the scope of authority and for whose benefit the activities were performed, rather than on the exercise of control, to find that the general partner was an agent of the Fund and that its activities were attributable to the partnership. The court reasoned:

[Providing management services was done on behalf of and for the benefit of the Sun Funds. Cf. [Central States Southeast and Southwest Areas Pension Fund v. Messina Products, LLC, 706 F.3d 874, 884 (2013)] (individuals acting for benefit of married couple are agents whose acts are attributable to the couple). The investment strategy of the Sun Funds could only be achieved by active management through an agent, since the Sun Funds themselves had no employees.

Id. at 148.

Despite petitioners’ assertions to the contrary, YA Global did not contract with Yorkville Advisors simply to be a service provider. YA Global empowered Yorkville Advisors to run its business and to be YA Global’s "agent and attorney-in-fact with full power and authority to buy, sell, and otherwise deal in Securities . . . and to do and perform every act necessary and proper to be done in the exercise of the foregoing powers as fully as the Partnership might or could do personally." (Ex. 27-J at § 2; Ex. 28-J at § 2.) As a consequence of this relationship, YA Global had the right to control Yorkville Advisors, regardless of whether YA Global chose to exercise it or agreed not to exercise it.

For 2006 and 2007, when Yorkville Advisors was YA Global’s general partner, Yorkville was per se YA Global’s agent. Restatement (Third) of Agency § 1.01, comment c (stating, "The elements of common-law agency are present in the relationships between . . . partnership and general partner."). See Del. Code Ann. tit. 6 §§ 15-301(a) and 17-403(a) and (c). Yorkville Advisors’ activities while YA Global’s general partner were attributable to YA Global. See Sun Capital Partners III, 724 F.3d at 146-47 (finding partner was an agent of the partnership under Delaware law and requiring the trade or business activities of the partner to be attributed to the partnership).

After ceasing to be general partner, Yorkville Advisors continued to conduct YA Global’s business in the same manner as it had previously done in its capacity as general partner. YA Global had the right to control Yorkville Advisors, even in this separate capacity, under the management agreements.

At the outset, YA Global specified the activities that Yorkville Advisors could undertake on its behalf in the management agreements. (Exs. 27-J, 28-J.) Further, YA Global had the power to give interim instructions or directions. At all times, Yorkville Advisors’ activities on behalf of YA Global were "subject to the policies and control of the General Partner." (Ex. 28-J at § 9.) A change in YA Global’s policies served as an instruction or direction to Yorkville Advisors. At any point, YA Global could have placed restrictions on Yorkville Advisors’ activities. (RPFF ¶¶ 43, 49.) Yorkville Advisors was required to submit periodic reports to YA Global, at YA Global’s request. (Ex. 28-J at § 9.) YA Global had the right to withdraw all or part of the funds on 30 days’ notice and to terminate the management agreement on 30 days’ notice, without cause. (RPFF ¶¶ 44-45, 50-51.)

Beyond these provisions, as a practical matter, Yorkville Advisors was subject to YA Global’s control. After January 2007, Mark Angelo held dual roles as a managing member of Yorkville GP, YA Global’s general partner, and as President of Yorkville Advisors, YA Global’s manager. (RPFF ¶¶ 17, 22, 23.) And at all times, Mr. Angelo had exclusive authority over all decisions made on behalf of YA Global, whether made by Yorkville GP or Yorkville Advisors. (RPFF ¶¶ 14, 23.) As a member of the executive committee, Mr. Angelo had the power to reject transactions. If Mr. Angelo approved a transaction, he was the one, as YA Global’s general partner, who signed the transaction documents. (Tr. 104:9-20.) The unification of roles bespeaks control.

C. Yorkville Advisors’ activities are attributable to YA Global; Yorkville Advisors meets the standard for attribution under section 864.

At pages 145 through 150, petitioners attempt to make the case that the relationship between YA Global and Yorkville Advisors was more similar to the relationships between the taxpayers and the real estate professionals in Voss, Smith, and Estate of Mundy than the relationships between the taxpayers and their agents "in the cases relied on by Respondent in CCA 201501013 and his pretrial memorandum." This claim has been addressed, and the cases on which petitioners rely have been distinguished, in previous parts of this Brief.

In making their argument, petitioners repeatedly confuse the relationship between YA Global and Yorkville Advisors with the relationship between the investors and Yorkville Advisors. (See, e.g., Pet’rs’ Brief at pp. 145 (stating, "[T]he investors had no right to exercise control over [Yorkville’s] business or over Yorkville’s decisions with regard to their money"), 146 (stating, "The investors had no right or power to participate in the Fund’s management, nor could they fire Yorkville and Yorkville GP and replace them with new management"), 148 (stating, "Investors were not only kept out of the investment decision-making process; they did not even have the right to inspect any books or records or any document of the Fund unless Yorkville permitted it").)

As noted earlier, whether the investors had the right to control Yorkville’s actions is immaterial. It is the right of YA Global, not the investors, that is relevant. It was YA Global itself that engaged Yorkville Advisors as its agent with the management agreements. The trade or business of YA Global (acting through Yorkville Advisors) is imputed to the limited partners under section 875.

As explained in Respondent’s Brief and in this Reply, the attribution standard applied in the context of section 864 focuses on whether a party has agreed to act on behalf, and for the benefit, of the taxpayer and has been delegated authority to do so. In particular, courts have repeatedly held that the activities of a party who is vested with broad discretionary authority to conduct activities on behalf of a taxpayer are treated as activities of the taxpayer for purposes of section 864. Yorkville Advisors meets this standard based on the broad authority delegated to it under the Partnership Agreements and the Investment Management Agreements, including the power of attorney.

Petitioners’ attempts to distinguish Lewenhaupt, Handfield, and InverWorld are strained and unavailing in establishing their argument that Yorkville Advisors was not YA Global’s agent. Rather many of petitioners’ points actually support respondent’s position that YA Global and Yorkville Advisors entered into an arrangement whereby the latter would run YA Global’s business and perform the services that employees, if hired by YA Global, would have performed in running YA Global’s business. As petitioners state: "Yorkville exercised complete power and dominion over YA Global’s management and assets." (Pet’rs Brief at p. 150.)

An argument similar to petitioners’ was rejected in Sun Capital Partners III. Similar to provision of management services to the fund in Sun Capital III, Yorkville Advisors’ "providing management services was done on behalf of and for the benefit of" YA Global. The investment strategy of YA Global could only be achieved by active management through an agent, since YA Global itself had no employees. See Sun Capital Partners III, 724 F.3d at 148.

II. YA Global was not a mere investor. It engaged in the business of lending, underwriting, and other financial services.

Petitioners contend that even if attributable to YA Global, Yorkville Advisors’ activities were performed in furtherance of "investing YA Global’s own funds and managing its portfolio." (Pet’rs’ Brief at p. 150-51.) In support, petitioners make three arguments: YA Global derived profits from putting their capital at risk (Pet’rs’ Brief at pp. 151-55), YA Global repeatedly used the term "investment" to describe its strategy (Pet’rs’ Brief at pp. 155-59), and YA Global’s pattern of returns demonstrates the investment nature of its activities (Pet’rs’ Brief at pp. 160-64).

Petitioners’ arguments are superficial and do not address the specific activities that Yorkville Advisors undertook on behalf of YA Global. Identifying activities as "putting capital at risk" or as "investment" is neither informative nor helpful, as many types of persons, whether engaged in a trade or business or otherwise, "put their capital at risk" and "invest" as those terms are used in the finance world. Petitioners’ expert David Stowell acknowledged that a lender, such as a bank, puts its capital risk and is considered to be an "investor." (Tr. 1824:7-11, 1829:6-25.)

A. Petitioners’ contention that YA Global derived profits (and losses) from investment because it put capital at risk is incomplete and misleading. The activities and economics of YA Global’s business model are fundamentally different from mere investment.

Petitioners assert that YA Global was engaged in investment (rather than in a trade or business) because it derived income from putting capital at risk. (Pet’rs’ Brief at pp. 151-55.) As support, petitioners cite and discuss Higgins v. Commissioner, 312 U.S. 212 (1941) and Whipple v. Commissioner, 373 U.S. 193 (1963). Leaving aside the fact that putting capital at risk is not a distinguishing feature of investment (or trading) as opposed to a business, YA Global’s activities were qualitatively very different from those of the taxpayers in Higgins and Whipple.

In Higgins, the taxpayer "merely kept records and collected interest and dividends from his securities, through managerial attention for his investments." Higgins, 312 U.S. at 218. In Whipple, the taxpayer advanced funds and provided services to corporations which he owned and controlled and derived only a normal investor’s return in the form of dividends and appreciation in the value of his stock. Whipple, 373 U.S. at 202-03.

Despite petitioners’ assertions, YA Global did not merely keep records and collect only a "normal investor’s return" of interest and dividends from corporations under its control. While YA Global did receive interest, dividends, and gains from stock, they were received as a result of substantial business activities with unrelated parties. First, YA Global originated loans to third-party issuers, marketing to potential clients, negotiating the terms of agreements, and performing due diligence. (E.g., RPFF ¶¶ 59, 65, 93, 115, 124-125, 138, 439.) It engaged in similar activities in acquiring equity directly from issuers for the purpose of prompt resale. (E.g., RPFF ¶¶ 59, 93, 115, 138, 263-264, 439.) YA Global offered various financing alternatives as a service to its customers, for which it was compensated with fees, interest, and discounts. (E.g., RPFF ¶¶ 93, 117, 223, 409, 428, 451, 455-456.) These are critical distinctions between activities of the taxpayers in Higgins and Whipple and YA Global, which petitioners ignore. The holding and analysis of Whipple are discussed in more detail below.

Whipple demonstrates that YA Global was not a mere investor.

In Whipple, the taxpayer argued that he was engaged in the trade or business of, among other things, (1) lending money to corporations that he owned and (2) providing services to corporations that he owned. The Supreme Court did not analyze the taxpayer’s lending argument, but instead held that the Tax Court’s decision holding that the taxpayer was not in a trade or business was not clearly erroneous. Whipple, 373 U.S. at 204. The Tax Court held there was no lending business because "the bulk of petitioner’s loans went to corporations and partnerships in which he had an investment and we cannot find that the purpose of these loans was other than to protect that investment." Whipple v. Commissioner, T.C. Memo. 1960-36, 19 T.C.M. (CCH) 187 (1960), aff’d, 301 F.2d 108 (5th Cir. 1962), vacated and remanded on other issue, 373 U.S. 193 (1963). In affirming, the Fifth Circuit noted that "the relatively small number of interest bearing loans made by the taxpayer did not constitute a separate business engaged in by him." Whipple v. Commissioner, 301 F.2d 108, 110-11 (5th Cir. 1962), vacated and remanded on other issue, 373 U.S. 193 (1963).

YA Global’s lending business is nothing like that addressed in Whipple. YA Global made loans to over one hundred corporations in which it did not have a preexisting equity investment. The purpose of YA Global’s loans was not to support an equity investment but rather to profit from interest, fees, and discounts regardless of whether the issuer’s stock went up or down (in addition to the gain that would be realized if an issuer’s stock price appreciated above the fixed conversion price). YA Global received warrants as a fee incidental to its lending activity. It did not make loans incidental to acquiring warrants. Therefore, unlike the taxpayer in Whipple, YA Global was engaged in the trade or business of lending. Courts have long recognized that lending does not constitute investment — even though a lender does put its capital at risk. There is a well-established standard for determining whether a lender’s activity is sufficiently extensive and continuous to be treated as a trade or business, and YA Global easily meets that standard. (Resp’s Brief at pp. 235-255.) Even petitioners concede that lending is a trade or business, though they argue that the convertible debentures in this case should be recharacterized as equity (which is unavailing, as discussed in Part III.A, below).

As noted above, Whipple also addressed the shareholder-taxpayer’s argument that he was engaged in the business of providing services to corporations that he controlled. The Court made clear that a shareholder-taxpayer is not engaged in a trade or business "[w]hen the only return is that of an investor." A shareholder-taxpayer will be considered to be engaged in a trade or business, however, if "the compensation he seeks from his activities is other than the normal investor’s return" and the "income received is directly for his services rather than indirectly through the successful operation of the corporate enterprise." Deely v. Commissioner, 73 T.C. 1081, 1093 (1980) (emphasis added). See also, e.g., Farrar v. Commissioner, T.C. Memo. 1988-385, 55 T.C.M. (CCH) 1628 (1988) (where the shareholder-taxpayer’s separate trade or business was that of "promoter"); Newman v. Commissioner, T.C. Memo. 1989-63, 56 T.C.M. (CCH) 1232 (1989). For the activities of a shareholder to be a separate business from the corporation, such activities "must be conducted for a fee or commission or with the immediate purpose of selling the corporations at a profit in the ordinary course of that business." Deely, 73 T.C. at 1093 (emphasis added).

The facts regarding YA Global and its relationship to its issuer-clients are distinguishable from the facts in Whipple because: (i) YA Global marketed and entered into negotiated debt financing arrangements and SEDA commitments with numerous counterparties (RPFF ¶¶ 59, 138, 148, 254, 663; Exs. 1278-J through 1281-J) (ii) YA Global did not hold a controlling interest in any of the issuers (and generally was not even a shareholder of any issuer prior to the transaction) and YA Global ensured that it would not acquire a significant equity interest by imposing restrictions on the size of the interest it could acquire in the issuers (RPFF ¶¶ 202, 273), and (iii) YA Global did not enter into transactions to support the business and enhance the value of the stock of issuers held by it but rather to provide financing or stock distribution services to unrelated issuers, while avoiding holding longterm positions in issuers’ stock (RPFF ¶ 68). For these reasons, Whipple is inapposite, and YA Global’s profit-oriented activities instead resemble those of dealers and lenders, as discussed below (Part III).

Petitioners assert that "YA Global’s profits and losses were predicated on whether the companies to which it provided funds were successful in their own operations." (Pet’rs’ Brief at p. 155.) Leaving aside the fact that this is true of lenders and even for dealers holding shares, YA Global’s own words belie this assertion and show that, in many cases, the profit it specifically targeted (in effect, compensation) with respect to convertible debentures and SEDAs was independent of the issuer’s success: "Regardless of whether the Company’s share price goes up or down, [YA Global] can capture a positive spread." (RPFF ¶ 230 (convertible debentures), ¶ 329 (SEDAs). See also RPFF ¶ 143.) As Deely noted, income is from a trade or business, rather than investment, when that compensation is independent of the successes of the corporation. Deely, 73 T.C. at 1093. The fact that YA Global’s profit surely would be higher if potential purchasers viewed the relevant issuer’s business as potentially successful is not inconsistent with a distribution business and is in fact common to any underwriting.

Petitioners appear to suggest that the fact that YA Global did not obtain board seats shows that it was not receiving income directly related to its services. Participation in management could be relevant in determining whether YA Global was engaged in business as a "promoter" of corporations. However, respondent is not claiming that YA Global was a promoter; YA Global’s business model, in which it provided debt and equity financing as a service to unrelated clients, included functions of a commercial lender and underwriter. Whether a taxpayer has seats on the board of its issuer-clients is not a factor in whether its financing activity is a business, but on the contrary would be more characteristic of a fact pattern such as that in Whipple.

YA Global’s transactions were different from those of a mere investor.

The transactions through which YA Global earned its income were very different from those of a mere investor. YA Global entered into promissory notes and convertible debentures in the course of its lending business, which does not constitute investment activity (as even petitioners recognize). Likewise, a SEDA commitment (which required YA Global to purchase stock at the issuer’s option at a time and price that was not predetermined) differs dramatically from an equity investment in terms of the manner in which income is derived, the diligence and controls around the risks assumed, and the functions performed. (The acquisition of debt and stock instruments directly from the issuers on the terms negotiated by YA Global (i.e., origination) also distinguishes these activities from those of a trader.)

The nature of YA Global’s SEDA income and the risks it assumed demonstrate that YA Global was not a mere investor but served an intermediary function similar to that performed by an underwriter or other dealer. This is evident from the business plan of YA Global, which was to generate consistent returns by, in effect, acting as a conduit for securities to the market (as discussed in Part III below). (See Ex. 252-J at YA101237 ("by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor.").)

SEDAs were not intended to generate a "normal investor’s return" from appreciation of the issuers’ stock. Upon entering into a SEDA, YA Global became obligated, at the issuer’s option, to purchase stock at a discount to the market price. (RPFF ¶ 141.) The return from this transaction was not tied to a "directional" bet on the issuer’s stock price, because the purchase price floated with the market. Thus, the actual stock price was largely irrelevant, as YA Global always acquired the stock at a discount to the market price at the time. YA Global also earned a commitment fee (usually in the form of stock and warrants to purchase stock of the issuers) upon entering into a SEDA. (RPFF ¶¶ 299-300.) In contrast to a normal investor’s return from the appreciation of stock, these commitment fees were compensation for the service that YA Global provided to the issuers.

If YA Global had wanted to make a directional bet on the price of its issuers’ stock, it could easily have done so by purchasing stock from issuers or on the open market without the need for a complicated SEDA or convertible debenture transaction and the associated risk of buying at a time and price selected by the issuer. YA Global chose not to do so because it did not want to bear the risks of an investor. (RPFF ¶ 67.)

In its marketing materials, YA Global told its investors²² that it "does not assume market risk by speculating on the future direction of markets or individual securities." (Ex. 198-R at p. 0010 (emphasis in original).) YA Global told investors that it "makes investment decisions based on the merits of a unique alternative financing structure rather than a company’s market valuation." (Id. at 0011.) "As a result of these unique financing structures, TYA Gioball does not buy shares in the open market." (Id. at 0016 (emphasis in original).)

At trial, Mr. Angelo freely admitted that SEDAs were not a good strategy for investment. (Tr. at 75:21 ("It’s typically not a great investment.").) As discussed below (Part III.B), although petitioners claim SEDAs may be considered mere put options, suggesting an investment instrument, the reality is that their terms (e.g., floating strike price) and purpose (standby equity to be immediately resold) is designed to meet the needs of YA Global’s underwriting and financial services business.

Further, the profit profile YA Global targeted was very different than that of mere investment. (RPFF ¶¶ 344, 345. See Ex. 279-J, at p. 001 (stating "[W]e have historically had stable returns . . . since the returns on our investments are also complimented by business type income that we generate through our proprietary financing product, the SEDA."); Ex. 253-J at p. 003.) YA Global marketed SEDAs to its investors as a "non-directional" transaction that would generate income whether the issuers’ stock prices went up or down. (RPFF ¶¶ 143, 230.) YA Global also sought to earns fees from issuers for the services it provided, as discussed below (Part III.C.). (RPFF ¶ 451.)

Finally, the risk incurred by YA Global in making a SEDA commitment was different from the risk borne by an equity investor. An equity investor bears the first dollar of risk that the value of the corporation (and, therefore, the price of its stock) will decline over the course of the investor’s holding period. See Estate of Yaeger v. Commissioner, 889 F.2d 29, 33 (2d Cir. 1989). By contrast, the primary risk assumed by YA Global under a SEDA was "the risk that the public equity markets of the public companies in which we invest might begin to have very low volume or that the companies’ public markets disappear entirely." (See Ex. 279-J, at p. 001.)

B. Petitioners’ assertion that YA Global was organized and operated for the purpose of investment is self-serving and contrary to the weight of the evidence. The labels YA Global used to describe itself and its strategies are overly broad and irrelevant.

Petitioners seek to distract from the economics of their business model by battologizing variations of the term "invest" as though the term, as they are using it, has particular relevance or meaning. For example, petitioners contend, "That investing was YA Global’s raison d’etre is obvious from its name, ‘YA Global Investments, LP.’" (Pet’rs’ Brief at p. 156 (emphasis in original).) They also point to boilerplate language in its private placement memoranda and partnership agreements that contains the word "investment" or "invest." (Pet’rs’ Brief at pp. 156-57.) Petitioners do not specifically define the term "invest"; they do, however, seem to equate "investing" with "putting capital at risk." (Pet’rs’ Brief at pp. 151-55.)

Defining "investing" as "putting capital at risk" does not advance an understanding of whether YA Global engaged in a U.S. trade or business. Petitioners’ expert in finance, David Stowell, agreed that, in the finance industry, the term "investor" (meaning any person who puts its capital at risk) includes an entity that makes loans, e.g., a bank. (Tr. 1824:7-11, 1829:6-25.) Jay Wright, the Chief Executive Officer of one of YA Global’s clients, used the term in a similar way, agreeing that a bank is a "debt investor." (Tr. 728:19-23.) Yet an entity that makes loans (i.e., puts its capital at risk) on a regular, continuous, and substantial basis is treated as engaged in a trade or business.

Petitioners’ persistent repetition of the term "invest" and all its variations is an attempt to divert attention away from the critical issues: (1) what activities did YA Global or Yorkville Advisors (on YA Global’s behalf) perform during the years at issue? (2) were those activities regular, continuous, and substantial? and (3) do the activities give rise to a U.S. trade or business? Petitioners do not adequately answer any of these questions.

The Court should look beyond petitioners’ labels and self-serving characterizations and examine the substance of the activities performed by YA Global (or by Yorkville Advisors on YA Global’s behalf) and the manner in which YA Global earned its income. Hansche, 457 F.2d at 429. See Martuccio v. Commissioner, T.C. Memo. 1992-311, 63 T.C.M. (CCH) 3082 (1992), rev’d on other grounds, 30 F.3d 743 (6th Cir. 1992) (stating, "[C]ourts must look beyond labels and self-serving declarations when applying Federal tax law.") (citing Schiff v. United States, 942 F.2d 348, 352 (6th Cir. 1991)).

In support of their argument focusing on YA Global’s name and private placement memoranda, petitioners cite Miller v. Commissioner, 70 T.C. 448 (1978). In that case, the taxpayer’s argument that it was not engaged in investment activity was undercut by the fact that the taxpayer listed its principal business activity as investment on its own return. At the same time, a taxpayer’s self-serving characterization of its own activities is not entitled to any weight as evidence in support of the taxpayer’s position. See Hansche, 457 F.2d at 429; Martuccio, T.C. Memo. 1992-311 (1992).

YA Global prepared detailed pitchbooks and marketing materials for prospective investors and sent quarterly letters to current investors to explain its strategy in detail so that investors could understand how YA Global planned to derive a profit. (RPFF ¶¶ 99, 103, 106, 109, 118, 230, 326.) Those materials clearly demonstrate that YA Global was not a mere investor (as discussed above, in Part II.A). These materials were essential disclosure given that the description of YA Global’s objective, strategies, and policies in the private placement memoranda consists of boilerplate language that could describe any investment or financing strategy involving small publicly traded companies. (See Ex. 30-J at 17.)

Dr. Lerner’s report, on which the petitioners rely, is similarly off the mark in its attempt to cast an investment halo on YA Global’s activities. Dr. Lerner compares YA Global to a venture capital firm because it was organized as a limited partnership with a general partner and investment manager, sought capital from high net-worth individuals and organizations, and imposed a lockup period and restrictions on redemption. (Ex. 3003-P at ¶¶ 84-85, 102.) These factors are simply not relevant in determining whether the nature of YA Global’s activities constitute a trade or business. As Mr. Brokaw cogently explained:

[T]hese observations relate to YA Global’s interactions with its partners and investors, and not to the Fund’s underlying transactions with client companies (‘Issuers’) through which it generates returns for its investors. In other words, while details about fund organization may shed light on how profits are apportioned across owners, they do not explain how the profits are made in the first instance.

(Ex. 2002-R at ¶ 5.)

Dr. Lerner also asserts that YA Global’s due diligence process was similar to that of a venture capital firm because it "focused on a portfolio company’s potential business, not just its current business." (Pet’rs’ Brief at p. 159 (citing Ex. 3003-P at ¶¶ 118-122) (emphasis in original).) But obviously, evaluation of a borrower’s prospects for future growth is entirely consistent with a lending business, as the lender is very interested in maximizing the possibility of repayment. See Owens v. Commissioner, T.C. Memo. 2017-157, *5, 114 T.C.M. (CCH) 188 (2017) (describing that the taxpayer’s willingness to make personal loans "depended less on the value of any assets they might be backed by than it did on his belief in the borrower and his business model.").

For his opinion, Dr. Lerner relied on Investment Committee minutes pertaining to certain SEDA and convertible debenture transactions. (Ex. 3003-P at ¶ 120.) Under the convertible debentures, YA Global was entitled to payments of principal and interest generally in cash and in an amount determined regardless of how the borrower’s stock performed (unless YA Global elected to convert). In the event that the borrower’s stock price appreciated above the fixed conversion price, YA Global could realize additional profit by converting. This is simply the nature of convertible debentures. Originating convertible debt is still a trade or business. (Resp’s Brief at pp. 235-242.)

Consistent with the debt nature of the debentures, YA Global’s due diligence process for convertible debentures focused on the prospects for repayment of principal and interest, as well as the potential for the issuer’s stock to appreciate in the future. For example, the August 22, 2006, Investment Committee minutes relating to MobilePro described its business model, revenues, cash flow, and available collateral (believed to have sufficient value so that they could be sold "for at least the amount of Cornell’s debt"). (See Ex. 884-J.) The May 2, 2007, Investment Committee minutes relating to Homeland Security Capital Corp, noted that "[a]lthough the success of the company has not been reflected in the stock, management has a clear path towards redeeming our debentures through the flip of investments and/or a significant raise wrapped around a significant acquisition." (Ex. 975-J at 9.)

Similarly, YA Global’s due diligence process for SEDA commitments focused on its ability to perform an underwriting function to earn fees and acquire stock at a discount. For example, the Investment Committee minutes relating to Red Rock Pictures Inc. noted the risk that SEDA issuances could have a dramatic effect on the stock price. YA Global expected to mitigate this risk by advising the company to "initially take small advances until the liquidity justifies larger draws." (Ex. 936-J at 3.) The Investment Committee minutes relating to Epicept (which involved a straight equity investment as well as a SEDA commitment) stated: "We are making them take a 15M SEDA that they can’t use, just so we can generate additional fees. They will cancel it when they go for their next round of financing in 3 months." (Ex. 924-J at 5.)

YA Global acquired convertible debentures as part of its lending business. Similarly, YA Global entered into SEDA commitments to help its clients obtain equity capital from the public markets. Neither of these activities is the type of seed-capital long-term investment of a venture capital firm that may be treated as investment for tax purposes.

C. Petitioners’ analysis of the alleged pattern of YA Global’s economic returns and purported resemblance to funds engaged in different activity is defective. An alleged pattern of returns is not indicative of whether YA Global was in a trade or business.

In arguing that YA Global’s profits were in the nature of investments, petitioners insist that YA Global’s transactions must be viewed as a whole and not as individual transactions.²³ (Pet’rs’ Brief at p. 160.) Viewing YA Global’s transactions as whole, petitioners contend, YA Global was an investor because its overall returns were not low or stable like a commercial bank but were high and volatile like a venture capital fund. (Pet’rs’ Brief at p. 161.)

The cases to which petitioners cite at page 160 cannot be read to support petitioners’ proposal. Nothing in these cases indicates that an entity will be evaluated as being in a particular trade or business based on a comparison of its total returns to those of other entities so engaged. Determinations of whether an entity engages in a trade or business depends on the nature and extent of the entity’s activities and not on the level or volatility of its returns. See Pinchot, 113 F.2d at 719.

Petitioners rely on Dr. Lerner for their analysis regarding the volatility of YA Global’s returns. According to Dr. Lerner, YA Global lost money on 46 percent of the clients it funded and generated significant returns on 3 percent of its clients, which is similar (according to Dr. Lerner) to the returns generated by a venture capital firm. (Pet’rs’ Brief at p. 162 (citing Ex. 3003-P at ¶¶ 136-37).)

The accuracy of Dr. Lerner’s quantitative analysis is questionable. (Ex. 2002-R.) But even accepting the numbers in Dr. Lerner’s analysis, over half of YA Global’s client relationships were profitable. Dr. Lerner’s analysis only confirms what no party disputes: YA Global provided financing to high-risk companies. The existence of high-risk borrowers does not defeat a finding of a lending trade or business. See Owens, T.C. Memo. 2017-157, 114 T.C.M. (CCH) at 188 (where taxpayer who made personal loans to borrowers too risky for a mortgage broker treated as engaged in lending business); Serot v. Commissioner, T.C. Memo. 1994-532, 68 T.C.M. (CCH) 1015 (1994) (where taxpayer was a lender of last resort who made high-risk loans in exchange for a high rate of interest and services fees); Industrial Credit Co., Inc. v. Commissioner, T.C. Memo. 1967-75, 26 T.C.M. (CCH) 377 (1967) (where "petitioner is engaged in a high risk financing business"; allowed bad debt deduction).

Dr. Lerner’s qualitative analysis is equally suspect. Dr. Lerner ignores the nature of the profit-oriented activities in which YA Global was engaged. Fundamentally, YA Global was not a venture capital fund in any normal sense of the term. It did not buy stock with the intention of holding it during an incubation period and profiting from its appreciation. (RPFF ¶ 68.) It did not seek to participate on the board or in the management of the firms to which it loaned money or committed to advance capital through a SEDA. (RPFF ¶ 70.)

YA Global provided alternative funding options for micro-cap and small-cap publicly traded companies with short-term exit strategies. Generally, the promissory notes, convertible debentures, and SEDAs had terms of less than 3 years. (RPFF ¶¶ 184, 262.) YA Global also sought to exit the convertible debentures or other holdings within 12 to 18 months. (E.g. Ex. 198-R at p. 005; Ex. 220-J at p. 0013; Ex. 236-J at p. 0013.) Those strategies allowed YA Global to fill a niche in the market for companies that were not served by traditional lenders or traditional investment banks such as J.P. Morgan or Goldman Sachs. (Tr. 95:3-96:18. See also RPFF ¶ 118; Ex 30-J at YAREL 12077 ("The Fund specializes in financing structures negotiated directly with issuers, some of which are private companies.") Ex. 252-J at YA101237 ("[I]t is very difficult for many institutions to find a single investor who is willing to take risk involved in buying a large amount of a company’s shares (there are not many Warren Buffets in the world) but we are convinced that by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor.").)

Petitioners contend that the Tax Court’s opinion in Betts v. Commissioner, 62 T.C. 536 (1976), supports and illustrates that Dr. Lerner’s approach is appropriate in determining the nature of YA Global’s income. (Pet’rs’ Brief at p. 162.) Petitioners misrepresent the facts in Betts, which are distinguishable from the facts relating to YA Global, and they misconstrue the Tax Court’s holding.

In Betts, the taxpayer was a partner in a limited partnership that made equity investments in portfolio companies and provided consulting services to those companies. During a six-year period, the partnership made only two interest-bearing loans to its portfolio companies and did so as part of a transaction in which it also acquired common stock (and, in one case, warrants) of the issuer. The partnership contemplated that it would distribute the stock and warrants to its partners "so that they could participate in any appreciation in value of the equity in the business." Betts, 62 T.C. at 537. The court held the partnership was not engaged in a trade or business.

The court first found that the partnership’s objective was "to have the limited partners receive the warrants and common stock so that they could benefit from the anticipated corporate growth through the appreciation in value and eventual sale of equity holdings." Id. at 540. Therefore, the partnership was considered to be engaged in investment activity.

However, this did not conclude the court’s analysis. The court next evaluated whether the partnership’s loans "in and of themselves constitute the carrying on of a trade or business." Id. The court held they did not: "During the years 1961 through 1966, the record reveals that the only loans made by Electronics were those made to Commercial and Gibraltar. The making of just two loans in a period of 6 years is not sufficient activity to warrant a finding that such activity was the carrying on of a trade or business." Id. at 540-541. The court noted that the taxpayer herself appeared to recognize that the partnership "was not in a separate business of making loans." Id. at 541.

The clear implication of the court’s opinion is that the partnership’s loans would have "in and of themselves constitute[d] the carrying on of a trade or business" if the partnership had made a substantial number of loans during the relevant time period. In contrast to the fact pattern addressed in Betts, a lender who is engaged in substantial lending activity is not characterized as an investor merely because the taxpayer’s debt instruments contain equity-like features that produce volatile returns. Owens, T.C. Memo. 2017-157, 114 T.C.M. (CCH) at 188.

In Owens, the court addressed a "participating" loan which accrued interest at a rate of 15 percent and gave the taxpayer the right to participate in the borrower’s income above a certain threshold. The taxpayer said the participation feature was fairly typical for a loan originated by a junior creditor because "‘there’s more risk and you want a greater reward.’" Id. at *10. The taxpayer forecasted that the borrower would be in "growth mode" for two years and sought to participate in its growth. The taxpayer further testified that "the return on a personal loan was higher than any return that he’d see at a bank and that because his lack of experience made him uncomfortable investing in the stock market, he instead invested his assets by way of loans." Id. at *5. After enumerating the relevant factors, including the number of loans (33 loans in excess of $21 million over six years) and the taxpayer’s lending practices (which were identical to those of the mortgage-broker company and utilized the same resources), the court concluded that the taxpayer was engaged in a lending business. Id. at *23.

Given the nature and scale of its lending business, YA Global is easily distinguishable from the partnership in Betts and the taxpayer in Owens. YA Global made several hundred more loans to borrowers than the purported lenders in Betts. (RPFF ¶ 184.) Moreover, unlike the partnership in Betts, YA Global did not hold a near-majority equity stake in any of its borrowers, and YA Global did not make loans for the purpose of acquiring stock that it would hold for investment purposes (or would distribute to its partners so that they could hold the stock as an investment). YA Global did not convert until it was ready to sell. (RPFF ¶¶ 68, 243-248.)

The U.S. trade or business standard under section 864(b) does not hinge on labels, or on the degree of consistency of profitable rather than unprofitable client relationships. Rather, it focuses on whether a taxpayer’s profit-oriented activities within the United States are considerable, continuous, and regular. Because YA Global meets this standard, it was engaged in a trade or business.

It is possible to be engaged in a trade or business and have volatile returns, or to be engaged in investment and have uniformly profitable stable returns, and vice versa. It all depends on the activities involved and where on the risk spectrum the taxpayer is operating. In this case, the evidence demonstrates that YA Global earned income from lending and from SEDA transactions in which it served an underwriting function.

Even if the "patterns of the Fund’s performance" identified by Dr. Lerner were correct, they are entirely consistent with the conduct of a lending and underwriting business. This business produced an income stream composed of four components: (1) fees and spread income; (2) interest income; (3) losses incurred when a borrower defaulted; and (4) gain upon conversion of a convertible debt instrument (or exercise of a warrant) when the issuers’ stock price appreciated above the fixed conversion price. (RPFF ¶¶ 73, 256, 332-334, 354-355, 395-396, 409, 451; Ex. 166-J at p. 0017.)

YA Global profited from fees, interest, and spread income regardless of how the issuer’s stock performed. (RPFF ¶ 230 (describing convertible debentures, YA Global explained to its investors that "[r]egardless of whether the Issuer’s share price goes up or down, [YA Global] can capture a positive spread."); RPFF ¶ 329 (describing SEDAs, YA Global explained to its investors that "[r]egardless of whether the company’s share price goes up or down, Cornell can capture a positive spread."); Ex. 170-J at p. 0018 (YA Global noted that "convertible returns are not predicated on market conditions.").)

As in Owens, YA Global made loans to risky borrowers. When these borrowers defaulted, YA Global lost money. See also Serot, T.C. Memo. 1994-532, 68 T.C.M. (CCH) at 1015 (taxpayer was a lender of last resort who made high-risk loans in exchange for a high rate of interest and services fees).

The majority (around two-thirds) of YA Global’s debt instruments were convertible. (RPFF ¶ 255.) Similarly, YA Global received warrants to acquire issuer’s stock as a fee incidental to its other activities. (RPFF ¶¶ 144, 249, 257, 300.) In some cases, the stock of the issuer appreciated above the fixed conversion price or strike price, enabling YA Global to realize additional gains. These returns were not a result of investment activities but rather were returns ancillary to YA Global’s lending business.

The combination of these profit (and loss) streams produced returns that varied widely from year to year and from issuer to issuer. However, YA Global was not a venture capital firm and did not earn its income in the same way. YA Global’s income was derived from its lending and SEDA activities, which constitute a trade or business for the reasons discussed above. Any facial similarity between the pattern of YA Global’s returns and those of a venture capital fund is irrelevant.

III. YA Global was engaged in the conduct of a U.S. trade or business.

As explained in Respondent’s Brief and in the parts of this Reply below, YA Global’s activities were not "solely in furtherance of investing," as that term is used for federal income tax purposes, as petitioners argue. (Pet’rs’ Brief at p. 164.) YA Global regularly, continuously, and substantially engaged in a lending, underwriting, and financing business during the years at issue. Respondent’s position on this issue has been constant from the examination through the trial and the filing of the brief.

Petitioners complain that respondent’s position has changed over time such that they thus face an inherent challenge in proving that YA Global was not engaged in a U.S. trade or business. This complaint is baseless and disingenuous. From the time of the audit through trial, respondent’s position has been the same, that YA Global engaged in a lending, underwriting (including stock distribution), and financing business. This was explained in the CCA issued in this case in 2015 (CCA 201501013) and has been consistent ever since. The cases petitioners cite at footnote 48 (Pet’r’s Brief at p. 166), all of which involved taxpayers asked to prove nonreceipt of income, are plainly distinguishable from the present case, which involves whether YA Global’s observable facts cause it to fall within statutory provisions in areas where relevant case law exists to guide the Court’s determination. At the heart of petitioners’ complaint is a discomfort with the facts and their import under applicable law. Petitioners cannot explain away that YA Global, through active marketing, conducted a business of lending money to unrelated companies and committed to purchase shares from issuers for prompt resale, and received fees or other remuneration for doing so.

A. YA Global engaged in a lending business.

Petitioners contend that YA Global was not engaged in the business of lending. (Pet’rs’ Brief at p. 167.) To support this contention, throughout Part III. A and its subparts 1 through 7 of their Brief, petitioners discuss their views as to why the convertible debentures originated by YA Global should not be considered as debt for federal income tax purposes. (Pet’rs’ Brief at pp. 167-68.) There are a number of significant fundamental points to be made in refutation of petitioners’ overall premise that respondent believes are best made before addressing petitioners’ subparts 1 through 7. These include, among other things, that YA Global’s origination of numerous promissory notes, which petitioners do not address, by itself constitutes a lending business during the Relevant Period, and that under section 385(c) (and other authorities), petitioners are bound to the form of the convertible debentures as debt.

Accordingly, the organization of respondent’s reply below deviates from the organization of petitioners’ argument at Part III.A. of their Brief. Respondent addresses his significant fundamental responses to petitioners’ contentions at the outset, in respondent’s Part III.A.1. (and subsections) below, before more specifically addressing petitioners’ Part III.A.1-7 in respondent’s Part III.A.2. (and subsections), because petitioners chose to ignore a critical activity in YA Global’s business, i.e., origination of loans for promissory notes (covered in subpart 1.a. below), and to ignore important principles relating to the treatment of debt and equity, such as section 385 and the Danielson rule (covered in subpart 1.b.), as well as overlook factors in the debt-equity analysis. Where a part responds specifically to petitioners’ argument, that corresponding part in Petitioners’ Brief is noted.

1. Petitioners ignore critical facts and legal principles in arguing that YA Global was not in a lending business.

a. YA Global’s origination of promissory notes by itself constituted a lending trade or business during the Relevant Period.

During the Relevant Period, YA Global originated over 200 promissory notes. (RPFF ¶ 148.) The aggregate principal amount on these promissory notes was over $190 million. (RPFF ¶ 148; Ex. 1280-J (filtering for Col. C in each tab for "pn" and Col. F.) The fair value of the promissory notes held by YA Global during 2006 through 2011 was $13,832,842, $66,736,081, $170,703,195, $107,204,626, $76,999,292 and $53,847,379, respectively. (RPFF ¶ 160.)

The promissory notes referred to YA Global as the "lender." (RPFF ¶ 149.) The promissory notes provided for a principal amount stated in dollars, a stated interest rate, and a maturity date. (RPFF ¶¶ 151-153.) In the promissory notes, the issuer agreed to pay YA Global in dollars the principal amount together with interest at the stated rate. (RPFF ¶ 154.) The promissory notes did not contain any provision allowing YA Global to convert the notes to common stock. (RPFF ¶ 155.) The promissory notes were typically secured. (RPFF ¶ 156.) In private placement memoranda, YA Global and its feeder funds repeatedly referred to promissory notes as "loans." (RPFF ¶ 158.) Mr. Angelo conceded that the promissory notes were loans. (Tr. 282:13-16.) YA Global reported interest income from the promissory notes for financial and tax purposes. (See, e.g., Ex. 1-J; Ex. 287-J at p. 0018.)

Unlike their contention about convertible debentures, petitioners do not contend in their Brief that the promissory notes were equity for federal tax purposes. YA Global’s origination of the promissory notes during the Relevant Period included sourcing, directly negotiating, undertaking rigorous formal due diligence and executing the notes. YA Global’s activities with regard to the promissory notes were substantial, continuous, and regular. (See Resp’s Brief at Argument II.C.3.)

YA Global was engaged in a direct lending business based during the Relevant Period based solely on its origination of promissory notes.

b. The convertible debentures were established as debt and must be treated as debt for federal income tax purposes.

Petitioners appear to concede that if the convertible debentures are treated as debt for federal income tax purposes then YA Global was engaged in a lending business during the Relevant Period. (Pet’rs’ Brief at p. 167 (stating, "It is possible for a taxpayer to have a trade or business that is derived from providing capital to others if that trade or business is lending.") (citation omitted) (emphasis in original).)

Along with origination of promissory notes, YA Global’s origination of convertible debentures was part of its lending business. Petitioners allege that the convertible debentures should not be treated as debt for federal tax purposes. (Pet’rs’ Brief at Arg. Part III.A.)

A debenture is by definition a debt instrument. Moreover, the convertible debentures had all the hallmarks of a debt instruments in form — labeled as "debentures," fixed maturity dates, fixed principal amounts, stated interest rates, and creditor’s rights. (RPFF ¶¶ 182-186, 209-211, 213.) Specifically:

1. The convertible debentures provided that the company’s obligation to pay principal and interest were absolute and unconditional. (RPFF ¶ 187.)

2. The convertible debentures provided for immediate and complete payment in cash in the event of default. (RPFF ¶ 189.)

3. The convertible debentures provided for security in the form of collateral. (RPFF ¶ 213.)

4. The convertible debentures typically provided that no indebtedness was senior to the convertible debenture nor would any other indebtedness be senior. (RPFF ¶¶ 210-211.)

5. The convertible debentures expressly provided that YA Global did not have any rights of a stockholder in the companies unless and until it converted the debenture into stock. (RPFF ¶ 209.)

6. YA Global and the companies were unrelated parties that negotiated these features and terms of the convertible debentures at arm’s length. (Tr. 704:2-19; Tr. 1177:7-16; Ex. 58-J, Ex. 138-J, Ex. 685-J.)

The debenture form of the instruments evidences and, in the absence of contrary evidence, demonstrates the characterization by the issuers of the instruments as indebtedness. See, e.g., Miller v. Commissioner, T.C. Memo. 1989-153, 57 T.C.M. (CCH) 46 (1989) (stating, "We conclude that petitioner has failed to establish that the promissory notes were erroneously characterized as debt. The form of the notes and the fact that interest and principal payments were actually made clearly indicates indebtedness."), aff’d, 900 F.2d 269 (6^th Cir. 1990).

As discussed below, the conversion features do not detract from the formal characterization as debt, and, as demonstrated below, YA Global’s convertible debentures are debt for federal income tax purposes. The burden is on the taxpayer in respect of whether an instrument is debt or equity. See, e.g., Trans-Atlantic Co. v. Commissioner, 469 F.2d 1189, 1191 n.2 (3d Cir. 1972); Taiyo Hawaii, Ltd. v. Commissioner, 108 T.C. 590, 601 (1997). Petitioners also bear the burden of proof under the Tax Court’s Rules. T.C. Rule 142(a).

i. Under section 385(c), the issuing companies’ treatment of the convertible debentures as indebtedness should be binding on YA Global for federal income tax purposes.

Section 385(c)(1) provides that the characterization by the issuer of an interest in a corporation as stock or indebtedness shall be binding on the issuer and on all holders of the interest (but does not bind respondent). This rule does not apply to a holder if such holder on his return discloses that he is treating the interest in a manner inconsistent with the characterization under section 385(c)(1). Section 385(c)(2).

For purposes of complying with section 385(c), petitioners have presented no evidence to show, or even suggest, that the issuers did not characterize the convertible debentures as debt for federal income tax purposes. Petitioners have failed to meet their burden of proof. Moreover, petitioners’ failure to introduce evidence of the issuers’ characterizations of the convertible debentures on their federal income tax returns gives rise to the presumption that the evidence, if produced, would be unfavorable. Wichita Terminal Elevator Co. v. Commissioner, 6 T.C. 1158, 1165 (1946), aff’d, 162 F.2d 513 (10th Cir. 1947).

The record indicates that the issuing companies treated the convertible debentures as debt. The CEOs of the issuing companies who testified at trial confirmed that they understood the convertibles to be debt in accordance with their form. The CEOs considered the stock that YA Global received upon conversion of a convertible debenture to serve as payment of the principal and/or interest that the company owed to YA Global. (Tr. 732:20-25, 733:1-14, 920:9-11.) Mr. Wright, the CEO of MobilePro, understood the interest to be deductible for tax purposes. (Tr. 1181:9-15.) Mr. Kreisler, the CEO of Greenshift, explained that the convertibles were treated as "long-term recurrent maturities debt" and the accrued interest was treated as an expense on its financial statements under Generally Accepted Accounting Principles ("GAAP"). (Tr. 1181:9-15, 1181:16-1182:9, 1186:23-1187:1.)

Consistent with the form and treatment of the convertible debentures as debt, the issuer companies reported the convertible debentures on their financial balance sheets as liabilities. (Exs. 1423-J, 1425-J, 1426-J, 1429-J, 1430-J, 1439-J, 1443-J, 1449-J, 1454-J, 1458-J, 1469-J, 1470-J, 1471-J, 1473-J, 1474-J, 1478-J, 1481-J, 1482-J, 1493-J, 1499-J, 1501-J, 1505-J, 1506-J, 1509-J, 1510-J, 1513-J, 1515-J, 1525-J, 1527-J, 1530-J, 1535-J, 1540-J, 1551-J, 1555-J, 1560-J, 1562-J, 1566-J, 1571-J.)

Petitioners have not met their burden of proving that the issuers characterized the convertible debentures for federal income tax purposes as anything other than debt. Moreover, all relevant evidence indicates that the issuers of the convertible debentures consistently characterized the convertible debentures as debt. Accordingly, absent disclosure in accordance with section 385(c)(2), petitioners are bound by this characterization for federal income tax purposes under section 385(c)(1).

YA Global did not disclose in its returns that it was treating the convertible debentures in a manner inconsistent with the characterization by the issuers. (Exs. 1-J through 6-J.) YA Global’s returns indicate that it treated the convertible debentures as debt for tax purposes. On its Forms 1065 for the 2006-2011 tax years, YA Global reported substantial amounts of interest income: $27,557,943, $45,083,015, $50,148,704, 42,617,464, $5,139,252, and $1,820,369, respectively. (RPPF ¶ 256.) Consistent with this, YA Global’s audited financial statements during the Relevant Period noted that interest income was recognized on convertible debentures and promissory notes. (See, e.g., Ex. 287-J at p. 0018.)²⁴ Thus, YA Global has not proven, and in any event its returns do not show, that it disclosed on its returns that it was treating the convertible debentures in a manner inconsistent with the issuers’ characterization of the convertibles as debt. T.C. Rule 142(a).

Accordingly, petitioners may not now claim that the convertible debentures were equity for federal tax purposes. I.R.C. § 385(c). Section 385(c) requires the convertible debentures to be treated as debt, and this is sufficient to moot petitioners’ argument for equity recharacterization without the need for any further analysis. Nonetheless, for the avoidance of doubt, respondent has refuted petitioners’ argument at length below.

ii. Under the Danielson rule, petitioners are prohibited from challenging the form of the convertible debentures as debt for tax purposes.

While section 385(c) should be dispositive of any debt-equity issue with respect to the convertible debentures in this case, courts addressing taxable periods for which section 385(c) was not in effect have evaluated transactions in which a taxpayer seeks to challenge the form of a transaction or instrument from a similar principle of consistency and fairness to the Commissioner.

In Commissioner v. Danielson, 378 F.2d 771 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965), the Court of Appeals for the Third Circuit adopted the following rule of law:

[A] party can challenge the tax consequences of his agreements as construed by the Commissioner only by adducing proof which in an action between the parties to the agreement would be admissible to alter that construction or to show its unenforceability because of mistake, undue influence, fraud, duress, etc.

Id. at 775. The court in Danielson further opined that "to allow the Commissioner alone to pierce formal arrangements does not involve any disparity of treatment because taxpayers have it within their own control to choose in the first place whatever arrangements they care to make." Id. at 775.

Outside of circuits which have adopted the Danielson rule, a similarly elevated standard referred to as the "strong proof" rule may apply. See, e.g., Ullman v. Commissioner, 264 F.2d 305, 308 (2d Cir. 1959), aff’g. 29 T.C. 129 (1957) (holding that a party seeking to disavow the form of its own transaction may be required to present "strong proof" that the substance differs from the form); Estate of Rogers v. Commissioner, T.C. Memo. 1970-192, 29 T.C.M. (CCH) 869, *5 (1970), (recognizing that the "difference between the ‘strong proof rule’ and the [Danielson] rule may not be great" and that "the ‘strong proof’ called for would be tantamount to proof that a subterfuge was committed during negotiations.").

These elevated standards have been applied for purposes of determining whether an instrument is debt as opposed to equity. See, e.g., Plante v. Commissioner, 168 F.3d 1279, 1282 (11th Cir. 1999) (applying the Danielson rule to find that advances pursuant to a stock purchase agreement were capital contributions); Taiyo Hawaii, 108 T.C. at 604 (in rejecting the taxpayer’s attempt to disavow the debt form of the transaction, concluding that "[i]n its tax and financial reporting and other actions, petitioner has not demonstrated an honest and consistent respect for what it now contends was the substance of the transaction" and so "is bound by the form of the transaction and that, for purposes of section 884, the advances in issue were debt as opposed to equity")²⁵; Republic Supply Co. v. Commissioner, 66 T.C. 446 (1976); Miller, T.C. Memo. 1989-153, 57 T.C.M. (CCH) at *5 (in rejecting the taxpayer’s attempt to argue that promissory notes that the taxpayer had treated as debt should be treated, given their substance, as equity, noted that "[p]erhaps most persuasive, however, is the fact that it is petitioner himself who chose the form of the transaction and he cannot be allowed to engage in post-transactional tax planning."), aff’d, 900 F.2d 260 (6th Cir. 1990) (unpublished). Certain earlier cases have held that a taxpayer may assert that the reality of a financing is contrary to its form without bearing an elevated burden of proof. Georgia-Pacific Corp. v. Commissioner, 63 T.C. 790, 795-96 (1975); LDS, Inc. v. Commissioner, T.C. Memo. 1986-293, 51 T.C.M. (CCH) 1433 (1986). These cases, however, antedated the decision in Taiyo Hawaii, which recognized the unfairness to the Commissioner of parties taking inconsistent positions with respect to the classification of instruments as debt versus equity.

A taxpayer faces an even a steeper climb when the characterization of the transaction that the taxpayer argues for is inconsistent with the taxpayer’s own prior characterization. Miller, T.C. Memo. 1989-153, 57 T.C.M. (CCH) at *5 (after explaining the "strong proof" standard, the court added that "[t]he taxpayer’s burden is far heavier when his tax reporting and other actions did not consistently reflect the substance which he later argues should control the form." (citation omitted)).

The Tax Court has not adopted the Danielson rule. Schmitz v. Commissioner, 51 T.C. 306, 318 (1968), aff’d sub nom., Throndson v. Commissioner, 457 F.2d 1022 (9th Cir. 1972). However, the Danielson rule applies to petitioners’ cases as these cases are appealable to the Third Circuit because YA Global’s principal place of business at the time that the petitions were filed was in Jersey City, New Jersey. Section 7482(b)(1)(E); Makric Enters., Inc. v. Commissioner, T.C. Memo 2016-44, *18, 111 T.C.M. (CCH) 1183 (2016) (citing Golson v. Commissioner, 54 T.C. 742, 757 (1970) (stating, "However, we look to our own precedent and to the law of the U.S. Court of Appeals for the circuit in which appeal of the case would lie.")). (RPFF ¶ 11.)²⁶

Petitioners assert that the same facts and circumstances test used by the Commissioner to re-characterize a transaction also applies when the taxpayer seeks to recharacterize its own debt as equity. (Pet’rs’ Brief at p. 167.) While some support for that proposition may be found, the better and more recent view of the Tax Court is reflected in the decision of Taiyo Hawaii, discussed above.²⁷ Further, the enactment of section 385(c) in 1997 reflected a Congressional policy and intent to disfavor taxpayer (as opposed to Commissioner) assertions of characterization of debt or equity based on claimed substance that is inconsistent with the form selected or reporting made. This is in accord with the heightened standards imposed on taxpayers (as opposed to on the Commissioner) to disavow form that have developed under the common law beyond the debt-equity issue. Danielson, 378 F.2d at 775; Ullman, 264 F.2d at 308; Estate of Rogers, T.C. Memo. 1970-192, 29 T.C.M. (CCH) at *5 (describing the respective abilities of the taxpayer and the Commissioner to argue that form does not control as a "so-called ‘two-way street’ [that] seems to run downhill for the Commissioner and uphill for the taxpayer.").

Petitioners cite Segel v. Commissioner, 89 T.C. 816 (1987) in which the court found certain advances made by shareholders to be equity as argued by the taxpayer. In Segel, shareholders of a subchapter S corporation made payments to the corporation in direct proportion to their stock interests in the corporation. Id. at 820-21. There was no written agreement between the corporation and the shareholders evidencing that the corporation intended to repay the payments or that the corporation would repay the repayments in any fixed manner or at any fixed date. Id. at 821. The shareholders received no security for their payments. Id. The corporation never paid interest to the shareholders with respect to the payments. Id. The corporation’s federal and state income tax returns and general ledgers treated the payments as loans. Id. at 823. The corporation’s unaudited financial statements treated the payments inconsistently as both loans and additional paid-in capital. Id.

The shareholders argued that the payments were equity. Id. at 825. The Commissioner argued that the payments were loans based on the denomination of the payments as loans on the tax returns. Id. at 824. The case was appealable to the Third Circuit. Id. at 827.

The court found that the payments were not in form loans, primarily given the lack of any written evidence of indebtedness. Id. As a result, the taxpayers were not seeking to disavow its form. Thus, the Danielson rule was not implicated and the court proceeded to analyze the debt-equity issue under a facts and circumstances test. Id.

YA Global’s convertible debentures are easily distinguished from the payments in Segel. YA Global’s convertible debentures were supported by written evidence of indebtedness. (RPFF ¶ 182.) The convertible debentures provided for stated principal, interest, and a fixed maturity date. (RPFF ¶ 183-186.) The convertible debentures provided that the company’s obligations to pay principal and interest were absolute and unconditional. (RPFF ¶ 187.) YA Global was typically a senior secured creditor with respect to the convertible debentures. (RPFF ¶¶ 210, 211, 213, 235, 237.) During the Relevant Period, YA Global treated the convertible debentures as debt for all purposes. (Ex. 1-J through 6-J; 286-J through 291-J.) Also, unlike the payments in Segel which were made by each shareholder exactly proportional to equity interest, the amount of YA Global’s convertible debentures bore no relation to any pre-existing equity interest, which YA Global typically did not have anyway. Clearly, unlike the payments in Segel, YA Global’s convertible debentures were in form debt.

As noted above, the discussion of an elevated standard for petitioners’ burden with respect to the treatment of the convertible debentures should be rendered irrelevant as section 385(c) governs the outcome. Nevertheless, we note that, under either the Danielson rule (or, if it were applicable, the strong proof rule), the convertible debentures would be treated as debt for federal income tax purposes (and as discussed below, would be treated as debt even under a preponderance of evidence standard).

YA Global consistently treated the convertible debentures as debt for financial and tax purposes and reported substantial interest income from the convertible debentures on its timely filed Forms 1065 for the tax years at issue. As explained at Part III.A.1.b., above, the form of the convertible debentures was undoubtedly debt. Petitioners do not allege that the construction of any convertible debenture, or any particular term therein, should be altered or is unenforceable and thus have not adduced any proof of such. (Entire record.) As a result, the Danielson rule prohibits the petitioners from challenging the form of the convertible debentures as debt. Danielson, 378 F.2d at 775. See also Tseytin v. Commissioner, T.C. Memo. 2015-247 at 15, 110 T.C.M. (CCH) 617 (2015), aff’d in part, remanded in part, 698 F. App’x 720 (3rd Cir. 2017) (concluding that since the taxpayer "ha[d] not challenged the agreements . . . on the grounds of fraud, mistake, undue influence or the like, "the Danielson rule . . . prohibited . . . [the taxpayer] from challenging the form of the transaction.").

Moreover, permitting petitioners to challenge the form of the convertible debentures would result in unjust enrichment. Danielson, 378 F.2d at 775 (warning, "to permit a party to an agreement fixing an explicit amount for the covenant not to compete to attack that provision for tax purposes, absent proof of the type which would negate it in an action between the parties, would be in effect to grant, at the instance of a party, a unilateral reformation of the contract with a resulting unjust enrichment."). For withholding purposes (and on its returns), YA Global treated amounts received under the convertible debentures as interest, and thus eligible for the portfolio interest exception under section 881(c). If the convertible debentures had been characterized as equity for withholding purposes, amounts received thereunder would have been treated as distributions ineligible for the portfolio interest exception. Having failed to withhold on these payments (presumably pursuant to section 881(c)), Petitioners now attempt to reap an unjust tax benefit through "post-transactional tax planning," by seeking to re-cast the convertible debentures as equity in order to avoid tax on effectively connected income. Miller, T.C. Memo 1989-153, 57 T.C.M. (CCH) at *5.

Specifically, YA Global’s U.S. withholding tax payments and reporting were consistent with the treatment of the amount with respect to convertible debentures as interest.²⁸ On its 2006 Form 1042, YA Global withheld tax of $178,320 with respect to gross income of $594,399 allocable to YA Offshore. (Ex. 1376-J.) YA Global reported this income using income code 06, dividends paid by U.S. Corporation. (Ex. 1376-J.) For 2006, YA Global reported $1,212,218 of ordinary dividend income and $27,557,943 of interest income on schedule K of its form 1065. (See Ex. 1-J at PDF p. 6; see also Ex. 1-J at PDF p. 82 (showing that YA Offshore was allocated $13,191,139 of interest income and $594,399 of ordinary dividends).) Notably, YA Global did not withhold on the $13,1919,139 of interest income allocable to YA Offshore, presumably pursuant to section 881(c). In its private placement memoranda, YA Global noted that "[t]o the extent any interest income that otherwise constitutes FDAP is considered ‘portfolio interest,’ such interest income will not be subject to withholding." (See, e.g., Ex. 30-J at YAREL0000012117).

Further, if equity treatment were permitted, issuers that had claimed a deduction in respect of interest paid would have received an inappropriate benefit, resulting in whipsaw for the Government.

Even under a strong proof standard, the debt form of the instruments in question (as described above) should govern. See Taiyo Hawaii, 108 T.C. at 604 and Miller, T.C. Memo. 1989-153, 57 T.C.M. (CCH) at *5, referenced above. This is discussed further below in Part III.A.1.b.iii.(b).

iii. Apart from the standard under the Danielson rule, the convertible debentures carried hallmark features of, and were in fact, debt for federal tax purposes.

Even if petitioners were not bound by the characterization of the convertible debentures by the issuer under section 385(c) or by the form of the convertible debentures under the Danielson rule, the convertible debentures would still be treated as debt. The convertible debentures had the hallmark debt features described in Part III.A.1.b., above. Both parties treated the convertible debentures as debt. The companies made principal and interest payments to YA Global. (Tr. 919:21-922:17; Exs. 1283-J through 1288-J (showing principal (col. G) and interest (col. J) payments on its asset reconciliation statements).) YA Global touted that a source of its income, and return, was interest from convertible debentures. (RPFF ¶¶ 73, 236.) YA Global consistently reported the convertible debentures as debt on its audited financial statements, (showing amounts of interest income in its audited financial statements, see, e.g., Ex. 286-J at p. 0013). YA Global reported substantial amounts of interest income on its Forms 1065 during the Relevant Period. (RPFF ¶ 256 (summarizing interest reported on Forms 1065); Ex. 1-J (reporting $27,557,943 interest income in 2006); Ex. 2-J (reporting $45,083,015 interest income in 2007); Ex. 3-J (reporting $50,148,704 interest income in 2008); Ex. 4-J (reporting $42,617,464 interest income in 2009); Ex. 5-J (reporting $5,139,252 interest income in 2010); Ex. 6-J (reporting $1,820,360 interest income in 2011)). The companies treated the convertible debentures as liabilities on their balance sheets.²⁹ Petitioners have provided no evidence that YA Global and the issuers viewed the convertible debentures as anything other than debt. As explained in this subpart, given that the convertible debentures were the products of arm’s length dealings, their form as debt controls.

In cases generally involving related parties, the courts have articulated numerous factors for evaluating the characteristics of an instrument for the purpose of determining whether the instrument is debt or equity. See, e.g., Fin Hay Realty Co. v. United States, 398 F.2d 694, 696 (3d Cir. 1968); Estate of Mixon v. United States, 464 F.2d 394, 402 (5th Cir. 1972). In Fin Hay Realty, the Third Circuit enumerated the following factors:

(1) the intent of the parties; (2) the identity between creditors and shareholders; (3) the extent of participation in management by the holder of the instrument; (4) the ability of the corporation to obtain funds from outside sources; (5) the ‘thinness’ of the capital structure in relation to debt; (6) the risk involved; (7) the formal indicia of the arrangement; (8) the relative position of the obligees as to other creditors regarding the payment of interest and principal; (9) the voting power of the holder of the instrument; (10) the provision of a fixed rate of interest; (11) a contingency on the obligation to repay; (12) the source of the interest payments; (13) the presence or absence of a fixed maturity date; (14) a provision for redemption by the corporation; (15) a provision for redemption at the option of the holder; and (16) the timing of the advance with reference to the organization of the corporation.

Fin Hay Realty, 398 F.2d at 696. When this test is applicable, no particular factor or series of factors is conclusive; the determination depends on the facts and circumstances of the individual case. Id. at 697. As we discuss below, however, and even apart from section 385(c) and Danielson, the form should largely or entirely govern with respect to a debt instrument involving unrelated parties.

(a). As YA Global and the companies were unrelated and acting at arm’s length, the form of the convertible debentures as debt controls.

The Third Circuit has recognized that the factors only have "meaning or function" if considered in the context of the relatedness of the parties, i.e., where the parties are not acting at arm’s length. Scriptomatic, Inc. v. United States, 555 F.2d 364, 368 (3d Cir. 1977), aff’g 397 F.Supp. 753 (E.D. Pa. 1975). In Scriptomatic, the Third Circuit enunciated a simplified test for determining whether an instrument is debt or equity when the instrument is in form debt. In this situation, "the debt-equity" question may be expressed in terms of two lines of inquiry: assuming that the obligation is debt in form, (1) did the form result from an arm’s length relationship, and/or (2) would an outside investor have advanced funds on terms similar to those agreed to by the shareholder." Scriptomatic, 555 F.2d at 368 (footnotes omitted). If question (1) is answered in the affirmative — the form resulted from an arm’s length relationship — then dispositively "the obligation is debt." Id.

The Scriptomatic court explained that the arm’s length relationship between the parties "inevitably results in a transaction where form mirrors its substance." Id. at 367. See Federal Express v. United States, 645 F. Supp. 1281, 1291 (W.D. Tenn. 1986) (in adopting the Scriptomatic mode of inquiry, explaining, "the Scriptomatic court’s determination that an instrument in the form of debt entered into by the parties acting at arm’s length evidences the economic reality of debt"). In effect, under Scriptomatic, a standard similar to Danielson applies to the debt-equity determination where unrelated parties are involved.

The Scriptomatic court noted that one or more of the factors enumerated in Fin Hay may be relevant to the threshold question of whether the instrument is debt in form. Scriptomatic, 555 F.2d at 368. However, most factors enumerated in Fin Hay apply only in a situation in which the shareholder wholly owns or controls the issuing corporation and thus does not involve parties dealing at arm’s length. See Federal Express, 645 F. Supp. at 1290-91 (noting that the simplified framework from Scriptomatic is appropriate when the parties dealt at arm’s length). As the author of a highly respected scholarly survey of the debt-equity landscape stated: "The farther we get from proportionality, the more respect is paid to the form in which the parties have cast their arrangement." W. Plumb, Jr., "The Federal Income Tax Significance of Corporate Debt: A Critical Analysis and a Proposal," 26 Tax Law Review 369, 473 (1971) (footnote omitted).³⁰ "Except in certain extreme situations, such factors as thin capitalization, by which the reality of the expressed intentions of shareholder-creditors is tested, have little relevance where outside parties are involved." Id. at 474 (footnotes omitted).

In Federal Express, the court refused to evaluate the "risk" of underpayment assumed by the holders of notes who had dealt at arm’s length with the issuing corporation, recognizing that doing so would "undermine[ ] the analysis in Scriptomatic under which the decision of arm’s length investors were found to provide the best standard for evaluating the risk of repayment." Federal Express, 645 F. Supp. at 1292. In Scriptomatic, the court also pointed out that "labels" given to instruments by unrelated parties acting at arm’s length are "perhaps the best expression of subjective intention of the parties to a transaction" but "lose their meaningfulness" in the case of a closely held corporation. Scriptomtatic, 555 F.2d at 367.

Under the Scriptomatic inquiry, YA Global’s convertible debentures are considered debt for federal income tax purposes. First, as described above, YA Global’s convertible debentures were in form debt because they were labeled "debentures," provided in writing for stated principal, interest, interest rates, maturity dates, an unconditional promise to pay by the company, security for YA Global, and immediate and complete payment in cash in the event of default. See Part III.A.1.b. The convertible debentures expressly provided that YA Global did not have any rights of a stockholder in the companies unless and until it converted the debenture into stock. (RPFF ¶ 209.)

Second, YA Global and the borrowers acted at arm’s length with each other in negotiating and executing the convertible debentures. (RPFF ¶¶ 58, 138, 685.) The representatives from the only borrowers who testified at trial explained that they sat across the table from YA Global in arm’s-length negotiations and that YA Global sought the best deal for its partners. (Tr. 704:2-19 (Mr. Wright testified that "[t]his was the arm’s length negotiation where both sides were trying to do the best they could for their constituencies."); Tr. 1177:7-16 (Mr. Kreisler testified that Troy Rillo, from Yorkville Advisors, was not trying to get the best deal for Mr. Kreisler’s company Greenpoint).)

Consequently, because they were in form debt and negotiated at arm’s length, under the standard expressed in Scriptomatic, YA Global’s convertible debentures were debt for federal income tax purposes.

(b). Even analyzed under the case law addressing related parties, the convertible debentures were debt.

Even if petitioners were not prohibited from disavowing the form of YA Global’s convertible debentures and even if the Scriptomatic standard did not apply (e.g., if related parties were involved), the convertible debentures would still be characterized as debt under the case law. Even under standards not applying a Danielson standard, the level of proof for a taxpayer arguing against form is very high, such as one requiring "strong proof." See Miller, T.C. Memo. 1989-153, 57 T.C.M. (CCH) at *5.

Miller involved a wholly owned corporation to which the taxpayer paid $150,000 in exchange for common stock. Miller, T.C. Memo. 1989-153, 57 T.C.M. (CCH) at *1. The corporate minutes recorded $135,000 of this payment as a loan, but there was no contemporaneous writing evidencing the loan (the taxpayer received a promissory note for $135,000). Id. The taxpayer also made other payments to the corporation which were recorded on the corporate books as loans and for which the taxpayer received promissory notes. Id. The notes called for principal payable on demand and a stated interest rate. Id. at *2. No collateral was pledged, and the borrower was, in the words of the court, "exceedingly undercapitalized." Id. at *4. The corporation initially paid the taxpayer interest and principal, but the taxpayer later concluded that the corporation’s business would not be profitable and the promissory notes were reclassified on the corporate books as common stock. Id. at *2.

Although the court found that the notes contained characteristics of both debt and equity, the court held that the taxpayers could not recharacterize the notes as equity. Id. at *5. The court noted, "[T]axpayers have little freedom to ignore the form of their own transactions and are ordinarily bound by the tax consequences that flow from the form of transactions they use." Id. Although a taxpayer can avoid the tax consequences of the form of a transaction by presenting "strong proof," "[t]he taxpayer’s burden is far heavier when his tax reporting positions and other actions did not consistently reflect the substance which he later argues should control the form." Id. (citation omitted). In finding that the taxpayer had failed to meet this burden, the court noted, "[I]t is petitioner himself who chose the form of the transaction and he cannot be allowed to engage in post-transactional tax planning." Id.

Notably, the instruments at issue in Miller had much more by way of equity features than YA Global’s convertible debentures, yet the court still found that the notes were debt. Among other differences in relevant facts, YA Global’s convertible debentures were senior and secured, and restricted issuers from incurring debt or granting security interests to other lenders (RPFF ¶¶ 194, 210, 211, 213, 235, 237.) Moreover, unlike the taxpayer in Miller, YA Global was not related to the companies that issued the convertible debentures and, even leaving aside the nearly per se rule under the Scriptomatic standard discussed above, disproportionality between holdings of equity and of the instrument tested as debt is strongly indicative of debt. See, e.g., Federal Express, 645 F. Supp. at 1292; Plumb, 26 Tax Law Review, at 474 (noting that factors like thin capitalization have little relevance when lender and creditor are unrelated).

2. Petitioners arguments at subparts 1 through 7 lack merit; the evidence shows that YA Global’s convertible debentures were debt.

In their Brief, petitioners appear to argue that YA Global’s convertible debentures should not be considered debt under the multi-factor tests established under common law and, therefore, YA Global "was not in the lending business." (Pet’rs’ Brief at Arg. Part III.A.)³¹ Petitioners do not provide an exhaustive discussion of all of the relevant factors with respect to the convertible debentures, but rather cherry-pick, or misrepresent, facts from their case that they believe evidence an equity interest while omitting the facts that undeniably evidence indebtedness. For example, petitioners fail to acknowledge that, as described in Part III.A.1.b., above, the convertible debentures: were labeled debentures, explicitly provided that YA had no rights as a shareholder unless and until a conversion, included fixed maturity dates, provided for collateral, set forth an absolute and unconditional obligation by the companies to pay the principal and interest and were treated as debt during the Relevant Period by the parties. This Part III.A.2, below, explains why the limited (or purported) facts offered and argued by petitioners do not support their post-transactional position that YA Global’s convertible debentures gave rise to equity interests.

a. Petitioners’ argument that the conversion feature negated a fixed payment of principal and interest is without merit. (Pet’rs’ Brief at III.A.2)

Petitioners erroneously assert that the convertible debentures did not provide for a fixed payment of principal and interest because YA Global was highly likely to receive stock as payment on a convertible debenture. The convertible debentures originated by YA Global provided for fixed payment terms. Each convertible debenture had a stated principal amount and a fixed rate of interest. (RPFF ¶¶ 185-186.) Each convertible debenture provided that the company was obligated to pay the principal and interest and that this obligation was absolute and unconditional. (RPFF ¶ 187.) The company’s absolute and unconditional obligation to pay the stated principal amount and any interest was indisputably an "unqualified obligation to pay a sum certain." Gilbert v. Commissioner, 248 F.2d 399, 402 (2d Cir. 1957).

The issuers’ absolute and unconditional obligation to pay the stated principal amount and interest to YA Global was not negated by the conversion feature of the convertible debentures. The Code clearly contemplates that convertible debt is generally treated as debt for federal income tax purposes. For instance, the Code and Treasury regulations provide a detailed set of rules providing for the tax treatment of convertible debt, all of which are based on the premise that a debt instrument with a conversion right is still respected as debt. See, e.g., I.R.C. §§ 163(1), 171(b)(1), 249(a);); Treas. Reg. §§ 1.171-1(e)(1)(iii), 1.1272-1(e), 1.1273-2(j), and 1.1275-4(a)(4). A conversion feature embedded in debt, absent extraordinary terms on its face, has been accepted as not affecting the debt status to such an extent that the issue only rarely occurs in the case law, and when addressed, the courts have found debt. See National Can Corp. v. United States, 687 F.2d 1107 (7th Cir. 1982); Scriptomatic, 397 F. Supp at 753; Federal Express, 645 F. Supp. at 1281. This is consistent with the approach taken by the Commissioner. See, e.g., Rev. Rul. 85-119, 1985-2 C.B. 60 (holding that notes that permitted, at the holder’s option, the principal amount to be repaid with the company’s stock at maturity were treated as debt); Rev. Rul. 72-265, 1972-1 C.B. 222. Secondary authorities are consistent. See, e.g., Bittker & Eustice: Federal Income Taxation of Corporations & Shareholders (WG&L), ¶ 4.03[5][b] ("Convertible debt is ordinarily treated as a single item of property, consisting of a pure debt interest until conversion, after which the investment becomes an equity interest. In effect, until conversion, debt genes are treated as dominant while equity genes are treated as recessive.") (footnote omitted).

Moreover, the convertible debentures expressly provided that YA Global had no rights as a shareholder unless and until it converted (RPFF ¶ 209), a fact that respondent has relied upon to conclude that a convertible instrument was debt prior to conversion. Rev. Rul. 69-91, 1969-1 C.B. 106 ("The debentures, which have all the indicia of valid indebtedness, confer upon the holder no rights or liabilities as a shareholder of Y unless and until the holder exercises the conversion privilege.").

The convertible debentures originated by, and issued to, YA Global provided that YA Global had the right to convert the debenture into shares of common stock in whole or part at any time after the Original Issue Date. (RPFF ¶ 196.) Most of YA Global’s convertible debentures provided for two different conversion prices, one fixed and one floating.³² (RPFF ¶ 200.) As a result, each convertible debenture generally provided for two different ways for YA Global to convert debt into equity, which are referred to below as the "Fixed Conversion Price Option" and the "Market Conversion Price Option."

Specifically, the "Fixed Conversion Price Option" provided that YA Global could convert at a predetermined fixed strike price per share. (RPFF ¶ 200.) The conversion price was typically set at a substantial premium to the market price of the issuers’ stock at the time the convertible debenture was issued. (Tr. 666:3-5 ("Typically these convertible debentures had a very significant premium above the conversion price"). Therefore, YA Global could participate in equity appreciation only if (and to the extent) the stock price appreciated above the conversion price. The Fixed Conversion Price Option provided YA Global the opportunity for participation in upside appreciation of issuers’ stock once the strike price was in the money.

The Fixed Conversion Price Option is a common feature of traditional convertible debt instruments. Such a conversion option held by the lender does not affect the substance of the convertible debentures as debt. See Federal Express, 645 F. Supp. at 1281 (W. D. Tenn. 1986).

The other conversion feature was "the Market Conversion Price Option," which provided that YA Global could elect to receive payments of principal and interest in the form of stock with a value equal to the amount owed. For this purpose, stock value was determined after applying a discount. (RPFF ¶ 200.) By exercising the Market Conversion Price Option, YA Global could recoup outstanding amounts of principal and interest by receiving property of equivalent value. The value of the stock received was slightly higher than the cash amount owed (because the stock was priced at a discount) but was not affected by fluctuations in the stock price prior to the date of exercise and did not provide upside participation.

The number of shares delivered was determined based on a fixed amount of the principal or accrued interest being converted, divided by a floating conversion price set at a discount to the market price at the time of conversion (rather than by a fixed conversion price as in the case of the Fixed Conversion Price Option). (RPFF ¶¶ 199-201.)

When YA Global exercised the Market Conversion Price Option, the market price of the stock was determined based on the average price, or the lowest price, over several trading days preceding the settlement date. (RPFF ¶ 200.) As a result of this pricing convention, the trading price on the settlement date of the shares acquired would not be identical to the amount of the issuer’s cash payment obligation per shares to be delivered. However, the number of shares to be delivered was always determined under a formula tied to the issuer’s cash payment obligation and the average or lowest price of the issuer’s stock during the applicable pricing period. (RPFF ¶ 199.)

In other words, when YA Global exercised the Market Conversion Price Option, it received stock (priced at a discount) with a value equal to the amount of cash it would otherwise have received. YA Global could elect to receive stock instead of cash as the medium of payment, but the payment obligation (and the value of the stock to be delivered) was fixed at a specified dollar amount. (RPFF ¶¶ 196-197.)

YA Global only converted if it was going to immediately sell the stock received. (RPFF ¶¶ 243-248, 463; Ex. 279-J at p. 0022 ("we do need our issuer companies to have a liquid public market so that we can monetize our principal and interest payments each month.").) Conversion followed by immediate sale is economically identical to cash repayment, as the court found in Federal Express, 645 F. Supp. at 1285 (W.D. Tenn. 1986) ("The full principal amount of the 1973 Notes and all interest accrued on the 1973 and 1974 Notes was repaid from the proceeds of Federal Express’s public offering of common stock in April 1978. All of the holders of the 1974 Notes opted to convert the principal amount of the Notes to common stock, which they then sold in the public offering.")

Some convertible debentures issued to YA Global that are exhibits in the record also permitted the issuer to make payments of principal and interest (or just interest, as applicable) in stock (the "Issuer Option").³³ For this purpose, the conversion price was determined in a manner similar to that of the Market Conversion Price Option, described above. Typically, the company could only elect to pay principal and interest (or just interest, as applicable) in stock if certain conditions were satisfied. (See e.g., Ex. 679-J at §§ 1(b), 17(i).) In practice, issuers that had the option to make payments in stock did not do so. (Pet’rs’ Brief at pp. 175 ("In short, YA Global generally got payments against the convertible debt it held only when it converted that debt to cash") (emphasis added) and 213 ("As a general matter, the decision whether and when to convert was made by YA Global. There were, however, occasions where the portfolio company had a right to make certain payments in stock.").)

Even under the Issuer Option, YA Global received payments of principal and interest in the form of publicly traded property with a value tied to the amount of the issuer’s fixed payment obligation, which was promptly monetized. As a well-known treatise on financial instruments observes: "The concern of the Service [with payment in stock] would appear to be justified only in cases such as bankruptcy, where the mandatory receipt of worthless stock would place the creditor in the same position as a shareholder, or where the amount of stock is fixed by number, not value, so that the creditor bears a similar risk of loss." Keyes: Federal Taxation of Financial Instruments & Transactions (WG&L), ¶ 3.06[3][1] Payment Mode Required by the Instrument. See discussion of Notice 94-47, 1994-1 CB 537, discussed below.

Petitioners cite Sherwood Memorial Gardens v. Commissioner, 42 T.C. 211 (1964) in support of its argument that YA Global’s convertible debentures did not provide for fixed payments, which would signal equity. (Pet’rs’ Brief at p. 172.) Petitioners considerably misconstrue the findings of the court in that case.

In Sherwood Memorial Gardens, the taxpayer issued "certificates of indebtedness" to its holders in exchange for land and cash from the holders which was to be used by the taxpayer in a cemetery business. Sherwood Memorial Gardens, 42 T.C. at 216-217. In the certificates, the taxpayer agreed to pay the holders 25 percent of the base sales price of every burial space sold during a period of fifteen years from the date of the first sale. Id. The certificates did not provide for the payment of interest. Id. at 228. The taxpayer treated the payments it made to its certificate-of-indebtedness holders as the cost of land and argued that its certificates represented a bona fide indebtedness incurred in the purchase of the cemetery property. Id. at 226. The court found that the payments the taxpayer made to the certificate holders were nondeductible distributions made in respect to the equity investment which the certificate holders had in the taxpayer. Id. at 230. The court focused on the obligation of the obligor to the instrument, noting that the classic definition of debt is "an unqualified obligation to pay a sum certain." Id. at 228 (citing Gilbert, 248 F.2d 399). The court found that under the facts presented "there is no way of ascertaining from the certificates of indebtedness (or from the first agreement which gave rise to their issuance) the principal amount of petitioner’s purported obligation. To the extent that petitioner is obligated upon its certificates of indebtedness, it is obligated only for a percentage of its dales (sic) (assuming such sales occur), and in no event is it bound to repay the funds initially furnished to it." Id. at 228.

The relevant terms of YA Global’s convertible debentures are completely distinguishable from the terms of the instrument in question in Sherwood Memorial Gardens. YA Global’s convertible debentures set forth a stated principal amount and a fixed interest rate. (RPPF ¶¶ 185-186.) YA Global’s convertible debentures expressed that the companies had an unconditional and absolute obligation to repay the principal amount furnished to it and with interest. (RPFF ¶ 187.) Even upon conversion, the convertible debentures were designed so that YA Global would receive its full amount of principal and interest.

Although petitioners relies on Rev. Rul. 83-98, 1983-2 C.B. 40, this revenue ruling is inapplicable to the case before the court, given the fundamentally different facts involved. In Rev. Rul. 83-98, "adjustable rate convertible notes" ("ARCNs") were issued for $1,000 (when a share traded for $20). After 2 years from issuance, the issuer had the right to call the notes at a price of $600 cash. At such time, the holder of a note would have the right to convert the note into 50 shares. Thus, absent a 40 percent drop in the per share value of issuer’s stock, it would have been economically disadvantageous for the note holder to permit redemption of the notes for cash. The issuer could have effectively forced conversion after two years even if the stock price had dropped substantially, and hence the economics of the arrangement in effect created an issuer option that could be exercised by delivering shares — the value of which, depending on stock performance, could be substantially less than the issue price of the debentures. The Service concluded that the built-in economic features created a compulsion to convert and thus did not create true indebtedness. The "ARCN’s do not in reality represent a promise to pay a sum certain." Rev. Rul. 83-98.

The ruling, under which the holder risked losing dollar for dollar up to 40 percent of the principal lent as share price declined, obviously is far afield from the terms of either the conversion feature or the Issuer Option or other facts before the Court.

b. Petitioners’ argument that repayment of the convertible debentures was expected to be made in stock supports equity treatment is without merit. (Pet’rs’ Brief at III.A.1.)

Petitioners assert that YA Global and the companies expected that repayment of the convertible debentures would come from YA Global’s selling stock in the issuing corporations. Petitioners support this assertion by referring, in part, to Messrs. Angelo and Franks’ testimony that YA Global sought to exit the convertible debentures by converting to equity. (Pet’rs’ Brief at p. 169.) However, an expectation of conversion is not inconsistent with debt treatment, as discussed above in Part III.A.2.a. See Federal Express, 645 F. Supp. at 1285. A rational purchaser of a convertible debenture, which offers a conversion right for reduced interest, would not acquire the instrument without expectation that appreciation in the underlying shares (or, in this case, the ability to acquire stock at a discount in the absence of appreciation³⁴) would make conversion into shares profitable.

The amounts of principal and interest that the companies were obligated to pay YA Global were fixed. (RPFF ¶¶ 185, 186, 209.) In this fundamental regard, the instruments are described by even the narrowest and most traditional description of debt (i.e., even leaving aside debt that is contingent as to amount and/or timing of principal, interest, or both).³⁵ See Sherwood Memorial Gardens, 42 T.C. at 228 (citation omitted) ("The classic debt is an unqualified obligation to pay a sum certain at a reasonably close fixed maturity date along with a fixed percentage of interest payable regardless of the debtor’s income or lack thereof." (emphasis added)).

Moreover, petitioners make several incorrect statements about the mechanics of the convertible debentures. Petitioners’ misstatement of the mechanics creates the false impression that the companies were generally required to make payments in stock.

First, petitioners state that typically payments of installments were by default made in stock. (Pet’rs’ Brief at p. 170.) This is incorrect. With the exception of the convertible debentures that are Exhibits 311-J and 849-J, the convertible debentures issued to YA Global that are exhibits in the record either did not call for installment payments or, if they did call for installment payments, did not provide that payment of the installments were by default made via issuance of stock. (See Exs. 344-J, 416-J, 425-J, 432-J, 442-J, 461-J, 518-J, 552-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 668-J, 679-J, 691-J, 727-J, 735-J, 736-J, 816-J, 829-J.) Therefore, this particular provision in Exhibit 311-J (LocatePlus Holdings Secured Convertible Debenture) that provided that installment payments were by default made in stock should not be viewed as typical or representative of convertible debentures generally. (See 2d Stip. ¶ 62.) In fact, many of the convertible debentures issued to YA Global that are exhibits in the record did not even allow the company the option to make any payments in stock. (See Exs. 416-J, 425-J, 432-J, 461-J, 518-J, 552-J, 603-J, 623-J, 648-J, 661-J, 727-J, 816-J, 829-J.) If a convertible debenture allowed for a company to elect to make payments in stock, such an election was at times limited to only payments of interest and was only allowed if certain conditions were satisfied. (See, e.g., Ex. 442-J at § 1(a) and (b); Ex. 668-J at § 1(a) and (b); Ex. 679-J at § 1(a) and (b), 17(i): Ex. 735-J at YAREL0000025952.)

Even under those convertible debentures which allowed the company to pay in stock, the company was required to pay cash in certain circumstances. For example, if an "Event of Default" occurred, the full principal amount together with interest and other amounts owing became, at YA Global’s election, immediately due and payable in cash. (RPFF ¶ 189.) Also, the company could not pay in stock if the payment would result in YA Global (and its affiliates) owning more than 4.99% of the common stock shares. (RPFF ¶ 203.) And each YA convertible required that all outstanding principal and interest on the maturity date be paid by the company in cash. (RPFF ¶¶ 183, 186, 187.)

Second, petitioners state that YA Global could elect not to collect an installment payment. (Pet’rs’ Brief at p. 170.) This is incorrect. With the exception of the convertible debentures at Exhibit 311-J and 849-J, the convertible debentures issued to YA Global that are exhibits in the record and that called for installment payments did not provide that YA Global could elect not to collect an installment payment. (See Exs. 344-J at YAREL0000005628, 461-J at YAREL0000038705, 504-J at YAREL0000008507, 552-J at YAREL0000037325, 560-J at YAREL0000034953, 565-J at YAREL0000064673, 582-J at YAREL0000034970, 727-J at YAREL0000093217, 735-J at YAREL0000025952, 736-J at YAREL0000093844, 816-J at YAREL0000071065, 829-J at YAREL0000071047.) Therefore, this particular provision in Exhibit 311-J that provided that YA Global could elect not to collect an installment payment should not be viewed as typical or representative of convertible debentures generally. (See 2d Stip. ¶ 62.)

Third, petitioners state that it was possible for a portfolio company to pay its debt in cash, but only if the company’s stock price was lower than a fixed conversion price, and even then only if (1) the company paid a redemption premium, and (2) YA Global chose not to convert. (Pet’rs’ Brief at p. 170.) This is incorrect. For this statement, petitioners cite to section 3(f) of Exhibit 311-J and Mr. Franks’ testimony. (See Pet’rs’ PFF ¶ 156.)

Petitioners misrepresent section 3(f) of Exhibit 311-J, and Mr. Franks is mistaken in his testimony. Section 3(f) does not set forth the only circumstances under which the company could have paid its debt in cash. It sets forth the circumstances under which the company may have "redeemed" a portion or all amounts outstanding under the debenture "in addition to" any installment amount "prior to" the Maturity Date. Section 3(a) and (c) provided that the company had the option to pay installment amounts on their corresponding installment dates in cash which would not be subject to the redemption premium under section 3(f). Also, specifically with regard to Exhibit 311-J, on the maturity date, the company was required to pay in cash the amount of all outstanding principal and interest. (Ex. 311-J at § 1(a).)³⁶

More generally, if the convertible debenture called for a redemption premium, the company was required to pay a premium only if it sought to make a payment prior to the scheduled date for that payment. (RPFF ¶¶ 192-193; see Exs. 311-J, 416-J, 425-J, 432-J, 442-J, 518-J, 560-J, 565-J, 582-J, 603-J, 623-J, 648-J, 661-J, 668-J, 679-J, 816-J, 829-J, 849-J.)³⁷

With the exception of the YA Global convertibles at Exhibits 311-J and 849-J, the companies always had the ability to make timely payments in cash which would not be subject to any penalty. Also, the companies in all YA convertibles debentures, even those at Exhibits 311-J and 849-J, were required to pay all outstanding principal and interest on the maturity date in cash.

If anything, the convertible debentures imposed a premium for payment in stock. When principal and interest were paid in stock pursuant to the Market Conversion Price Option, the issuers’ stock would be priced at a discount (requiring the issuer to deliver stock with a market value higher than the cash amount being converted). (See, e.g., Ex. 311-J, at § 17(i) (definition of "Company Conversion Price").)

The right of an issuer to make payments under an instrument in its own stock can be problematic for debt classification, depending on various factors. The mere fact, however, that some payments may be made in issuer equity, or that payments may be made under certain circumstances, is not inconsistent with debt classification.

For example, section 163(1), added to the Code in 1997, contemplates that a debt instrument exists even if certain payments may be made in equity, and instead of reclassifying the instrument (which could affect, for example, withholding tax), it disallows a deduction for any interest paid or accrued on a "disqualified debt." I.R.C. § 163(1)(1). Disqualified debt is defined as "any indebtedness of a corporation which of the issuer or a related party or equity held by the issuer (or any related party) in any other person." I.R.C. § 163(1)(2). Indebtedness is "payable in equity" if "a substantial amount of the principal or interest is required to be paid or converted, or at the option of the issuer . . . is payable in, or convertible into, such equity" or determined by reference to the value of such equity. See I.R.C. § 163(1)(3) (to determine if debt is payable in equity). The legislative history confirms that Congress did not intend to recharacterize the convertible debt as an equity interest. H.R. Rep. No. 105-220, at 523-524 (1997) (Conf. Rep.). ("The bill is not intended to affect the characterization of instruments as debt or equity under present law"). In addition, the holder of this debt is not impacted by section 163(1). Id. ("The bill does not affect the treatment of a holder of an instrument.").

Section 163(1) was enacted in 1997 as Congress responded to the issuance of certain instruments that also were the subject of a notice that the IRS had issued a few years earlier. See Notice 94-47, 1994-1 C.B. 537 (the Service announced that, in view of certain recent debt issuances designed to be treated as equity "for regulatory, rating agency, or financial accounting purposes," "[u]pon examination, the Service will scrutinize instruments of this type to determine if their purported status as debt for federal income tax purposes is appropriate," and in that context stated that "an instrument does not qualify as debt if it has terms substantially identical to the Notes [in Rev. Rul. 85-119, 1985-2 C.B. 60], except for a provision that requires the holder to accept payment of principal solely in stock of the issuer").³⁸

The Issuer Option in the circumstances exercisable (e.g., if no event of default and the share of overall ownership or trading volume would not exceed a threshold) and on the terms permitted (e.g., discounted valuation of the stock) is not inconsistent with payment of amounts owed, and hence with debt classification. See, e.g., Keyes: Federal Taxation of Financial Instruments & Transactions (WG&L), ¶ 3.06[3][1] Payment Mode Required by the Instrument ("The concern of the Service [with payment in stock] would appear to be justified only in cases such as bankruptcy, where the mandatory receipt of worthless stock would place the creditor in the same position as a shareholder, or where the amount of stock is fixed by number, not value, so that the creditor bears a similar risk of loss.").

Petitioners cite Betts v. Commissioner, 62 T.C. 536 (1974) to support its argument that "both YA Global and its portfolio companies intended the convertible debentures to be repaid as equity indicates that they were not true loans." (Pet’rs’ Brief at pp. 171-72.) Petitioners misconstrue Betts. The court in Betts did not recharacterize the loans at issue there as equity. Instead, the court only found that the taxpayer was not in the business of lending when the taxpayer entered into two loans in six years. Id. at 540 ("The loans made by [the partnership] did not in and of themselves constitute the carrying on of a trade or business . . . The making of just two loans in a period of 6 years is not sufficient activity to warrant a finding that such activity was the carrying on of a trade or business." (citations omitted) (emphasis added).

More generally, the presence of equity components in this case does not assist Petitioners’ claim. The Third Circuit has respected debt even where the debt was subordinated and sold in units with common stock and "could not have been sold without the equity in 1963 and 1965." Scriptomatic, 555 F.2d 364; Scriptomatic, Inc. v. United States, 397 F. Supp. 753, 759 (E.D. Pa. 1975) (the issuance of common stock with each debenture "did not automatically convert the indebtedness into equity"). See Taiyo Hawaii, 108 T.C. at 603 (debt despite fact that advances were not evidenced by promissory notes, had no fixed maturity date, were unsecured, and were not repaid during the years in issue); Morgan Pacific, T.C. Memo. 1995-418 (debt was found in a conduit even though the shareholders of the ultimate borrower, including the lending entity, agreed that the lender would receive equity, based on an obligation of that lender to on-pay the amount of the financing to a related party); Miller, T.C. Memo. 1989-153 (debt where instruments, discussed above, had many factors favoring equity).

The contemporaneous intent of the parties indicated that the convertible debentures were intended to be debt. YA Global repeatedly referred to the convertible debentures as debt in marketing materials to investors and potential clients, referred to itself as, and held itself out as, a lender, treated the convertible debentures as debt for financial reporting purposes, and reported payments with respect to the convertible debentures as interest on its tax returns. (RPFF ¶¶ 65, 74, 96, 139, 146, 228, 256; see also RPFF ¶¶ 71, 226, 447.) At trial, the only borrowers to testify confirmed that they viewed the convertible debentures as debt, for tax in one case and for GAAP in the other. (Testimony of Wright, Tr. 727:8-14 (for tax); Testimony of Kreisler, Tr. 1186:19-1187:1 (for GAAP).)

c. The conversion feature does not detract from the characterization of the convertible debentures as debt, as petitioners argue. (Pet’rs’ Brief at III.A.3)

Petitioners argue that YA Global’s ability to convert the debentures to equity and thus share in the "upside potential" of the companies evidences that the debenture is an equity interest. Petitioners’ assertion, however, flies in the face of relevant law. Convertible debt is treated as debt for tax purposes (see parts III.A.1.b. and III.A.2.a. above).

Petitioners ignore the importance of YA Global’s status as creditor. Petitioners quote In Re v. Loewer’s Gambrinus Brewery Co. v. Loewer Realty Co., 167 F.2d 318, 320 (2d Cir. 1948) for the point that "shareholders stand to lose first, but in return they have all the winnings above the creditors’ interests, if the venture is successful." (Pet’rs’ Brief at p. 176.) Petitioners’ rationale in their Brief for treating convertible debt as equity focuses only on the upside potential of a shareholder while overlooking the equally (if not more) important requirement that a shareholder also have downside risk, which foregoes the benefits of a bond floor.³⁹ But, in actually running its business, YA Global was acutely aware of the benefits and protections that the convertible debentures afforded by reason of conferring on it the status of a creditor. (RPFF ¶¶ 226, 240, 242.) In negotiations, YA Global ensured that it was almost always protected as a secured creditor, in usually a first priority position even amongst creditors. (RPFF ¶¶ 71, 210, 211, 213.) YA Global declared in private placement memoranda that it "intended to aggressively enforce its rights under its contractual relationships with issuers." (RPFF ¶ 240.) Consistent with its private placement memoranda, YA Global in fact routinely asserted its right as a creditor under its convertible debentures. (RPFF ¶ 132-137.) And borrowers anticipated that YA Global would enforce its secured lender rights. (See, e.g., Ex. 1478-J at pp. 006, 0013, 0029.)

The fact that the conversion rights under the loans generally were exercised by YA Global does not affect the treatment as debt or the existence of a lending business. The key activities of a financing trade or business are the same, regardless of whether conversion occurs, including the frequency with which funds are advanced, the manner in which the activity is described, the outreach to attract potential customers through advertising, direct meetings, etc., the sophistication of the documentation and nature of the representations and covenants and even security interests, and the number of personnel involved and their capacities. The debt structure reduced the commercial risk of YA Global and provided tax advantages through potential interest deductibility to the issuers.

Conversions ordinarily occurred only as appropriate to facilitate a related part of the business, namely to distribute the underlying stock to the equity markets in an orderly fashion, which is the service that an underwriting business provides, and that activity (discussed further at Part III.B.2., below) supplemented and reinforced YA Global’s overall financing business giving rise to a trade or business within the United States.

d. YA Global’s financing business servicing lower credit borrowers is consistent with debt financing and a lending business, contrary to petitioners’ argument. (Pet’rs’ Brief at III.A.4)

Petitioners claim that the companies from which YA Global acquired convertible debentures had "high risk" profiles and an inability to obtain loans from other financing institutions indicates that the convertible debentures were not debt. Petitioners’ claim is wrong because the case law supports finding that the convertible debentures are debt, particularly when the loans are made to unrelated parties as they are in this case, and that YA Global engaged in a lending business that included doing business with lower credit borrowers. See Part II.B., above (discussing Dr. Lerner’s testimony).

While some of YA Global’s customers may have been of lower credit standing (arguably "high risk") and some may not have been able to obtain loans from traditional sources, that is not inconsistent with a debtor-creditor relationship. Courts have found that taxpayers have engaged in a lender business where the borrowers were high-risk and may not have had access to traditional lenders. See Serot, T.C. Memo. 1994-523, 68 T.C.M. (CCH) 1015 (taxpayer was a lender of last resort who made high-risk loans in exchange for a high rate of interest and services fees); Federal Express, 645 F. Supp. at 1284 (finding that convertible notes were debt and noted "[d]espite the company’s insolvency at the time of the financing, they believed that Federal Express could service and repay the debt to the Chase Group as well as the Notes."); Owens, T.C. Memo. 2017-157, at *13, 114 T.C.M. (CCH) 188 (noting that some third-party lenders were not willing to provide financing, but others were); Industrial Credit, T.C. Memo. 1967-75 ("petitioner is engaged in a high risk financing business"; allowed bad debt deduction).

Petitioners cite Roth Steel Tube Co. v. Commissioner, 800 F.2d 625 (6th Cir. 1986) and Estate of Mixon v. United States, 464 F.2d 394 (5th Cir. 1972) for the proposition that the lower credit borrowers from whom YA Global acquired convertible debentures could not have gotten the same deals from other creditors as evidence that the convertible debentures were not debt. (Pet’rs’ Brief at pp. 178-89.) The lower credit status of the borrowers becomes relevant when there is substantial proportionality of ownership by the purported creditors and the shareholders of the borrower. This is evident by the test applied (comparison with whether an unrelated party would have made the loan). See generally, e.g., Estate of Mixon, 464 F.2d at 410 ("The purpose of this inquiry is obviously to test whether the shareholder contributors acted in the same manner toward their corporation as ordinary reasonable creditors would have acted.")); Roth Steel Tube, 800 F.2d at 626 (evaluating a taxpayer’s unrepaid advances to a subsidiary corporation); Segel, 89 T.C. at 832 (examining the terms of purported loans by shareholders and comparing to the terms that would be offer by a third-party); Scriptomatic, 397 F. Supp. at 763 (E.D. Penn. 1975) ("Under this analysis, any stockholder advance should be treated as debt if an unrelated outside party would have advanced funds under like circumstances."); Cerand & Co. v. Commissioner, T.C. Memo. 2001-271, 82 T.C.M. (CCH) 755 (2001) (involving a contribution made by a sister corporation).

On the other hand, when the lender is unrelated, as in the cases before the Court, a loan to a low-credit borrower generally has been respected as debt. For example, in Federal Express, which dealt with transactions between unrelated parties, the court rejected the contention that "only loans to companies with ‘minimal risk of failure’ and ‘solid background in [their] field[s] of endeavor’ constitute unconditional obligations to repay." Federal Express, 645 F.Supp at 1292 (modified in original). The court noted that where parties are unrelated and acting at arm’s length, the court would not second guess the risk set by the parties, and found that while the borrower’s "success was by no means certain at the time the Notes were executed, uncontroverted evidence establishes that the [borrower] nevertheless undertook an unconditional obligation to repay these loans." Id. In Miller, the court explained that whether the borrower could have secured funding from an outside party is a relevant factor to consider when the borrower is related to the lender. Miller, T.C. Memo. 1989-153 at *4 (explaining that "[w]here, as here, the shareholder and the creditor are one, the validity of a debt instrument can be gauged by testing whether it would have appealed to an outside investor.").

In sum, the companies and YA Global were unrelated and negotiated the terms of the convertible debentures at arm’s length. Consequently, the fact that the companies may have been considered to be low credit borrowers by, or unattractive to, other lenders is irrelevant to the determination whether the convertible debentures created a debt or equity interest. As such, YA Global’s cherry-picked references to companies with allegedly poor credit or distressed finances are not informative of the issue.

e. YA Global’s business decision to refrain from enforcement upon default or to continue extending credit, on occasion, is not inconsistent with debt financing. (Pet’rs Brief at III.A.5)

Petitioners point out that, in some cases, YA Global refrained from taking enforcement action upon default by the companies on convertible debentures and continued to make advances to companies despite the companies having failed to make payments on prior advances. (Pet’rs’ Brief at Arg. Part III.A.5.) Petitioners argue that these facts indicate that the convertible debentures were intended as equity. (Id.)

To refrain from pursuing collection does not indicate that the original transactions were not intended as bona fide debt obligations but a business calculation that a better recoupment of principal and interest could be obtained by means alternative to exercising creditor’s rights. For example, in Wagner Electric Corp. v. United States, 36 AFTR 2d 75-5898, 1975 WL 3594 at *16 (Ct. Cl. 1975), the Government argued that, after December 1, 1963, the borrower ("Ltd.") "was constantly insolvent and the prospects of repayment were even more remote and unlikely than prior to that time," and that "unrelated parties would not have made such advances in light of Ltd.’s poor financial condition." Id. at *16. The Court found it "impossible to characterize the advances in question as equity contributions." Id. at *17. The court stated that, "as in [Bordo], Tung-Sol was presented with a difficult choice — it could either assert its rights immediately as to the open account amounts and drive Ltd. into immediate liquidation or it could forbear such rights, with Ltd.’s steadily increasing sales but its operating difficulties viewed as only temporary in nature, Tung-Sol’s decision to forbear can reasonably be viewed as within the scope of sound business practice." Id.

In the case cited, Bordo Products Co. v. United States, 476 F.2d 1312, 1326 (Ct. Cl. 1973), the court had held that lending more money or refraining from exercising creditor’s rights may yield a better outcome than calling the loan and does not undercut status as bona fide debt. See also Wilshire & W. Sandwiches, Inc. v. Commissioner, 175 F.2d 718, 720-721 (9th Cir. 1949) (stating no adverse inference should be drawn from a party’s failing to demand payment immediately when due from a related party, though not demanding payment would weigh against the taxpayer if other indicia of non-debtor-creditor behavior are present).

In Federal Express, the lenders agreed to defer all payments of interest and repayment of principal on notes for a period of time. Federal Express, 645 F. Supp. at 1285. The government argued that the lenders’ agreement to allow for deferral of interest payments indicated that the notes were equity interests. Id. at 1290. In rejecting that argument, the court explained that it "gives no weight to the one-year deferral in interest payments. As long as it does not affect the ultimate adequacy of the interest . . . this timing of the payments does not alter the underlying obligation to pay." Id.

Petitioners cite United States v. Henderson, 375 F.2d 36, 40 (5th Cir. 1967) to support a claim that YA Global’s continuing to advance funds even after the borrowers failed to repay indicates equity interests. (Pet’rs’ Brief at p. 183.) While that was a factor considered by the court in Henderson, there were additional factors in that case that also supported finding that the advance was equity, including that the taxpayer was making advances to her grandson-in-law, the advance was subordinate to other creditors, and that repayment was only expected to made from profits. 375 F.2d at 40. Here, YA Global made loans to unrelated parties, ensured that the convertible debentures were senior secured obligations, and expected, and was entitled to, repayment regardless of profits.

Petitioners cite other cases in which a court found advances to be an equity interests where the alleged lender did not enforce terms of the advances or continued to advance funds despite prior non-payment. (Pet’rs’ Brief at p. 187 citing Berkowitz v. United States, 411 F.2d 818, 821 (5th Cir. 1969); Cerand, T.C. Memo. 2001-271, 82 T.C.M. (CCH) 755 (2001); Gooding Amusement Co. v. Commissioner, 23 T.C. 408 (1954), aff’d, 236 F.2d 159 (6th Cir. 1956).) As with its treatment of Henderson, petitioners fail to disclose that each of these cases had other facts, not present in YA Global’s case, that on their own overwhelmingly demonstrated that the advances were equity interests and not indebtedness.⁴⁰

In Berkowitz, the shareholders had complete control over a closely-held corporation. 411 F.2d at 821. The shareholders made advances to the corporation that were in direct proportion to their equity interests. Some of the advances were not represented by notes. Id. The corporation was thinly-capitalized (a consideration limited to related party transactions). Id. The shareholders made no effort to repay the principal. Id.

In Cerand, a corporation made advances to three sister corporations. Cerand, T.C. Memo. 2001-271. All of the corporations were owned and controlled by a sole individual shareholder. Id. The advance had no fixed date or schedule for repayments. Id. The three sister corporations never actually paid any interest. Id. The advances were subordinate to the debt of any other creditors. Id.

In Gooding Amusement, the three shareholders of a closely held corporation each advanced funds to the corporation in exchange for notes. The three shareholders were a husband, his wife and their infant daughter. Gooding Amusement, 23 T.C. at 418. In deciding that the advances were capital contributions and not debt interests, the court opined that the "most significant aspect of the instant case, in our view, is the complete identity of interest between and among the three stockholder, coupled with their control of the corporation." Id. The court noted that the husband owned the majority of the stock in the corporation and that the wife and daughter never contemplated acting independent or contrary to the husband. Id. at 419. The shareholder-lenders never intended to enforce payments, no payments were ever made on the notes and the notes were subordinated to claims of creditors. Id.

All of these facts, upon which each court primarily supported its finding of equity interests in Berkowitz, Cerand and Gooding Amusement, are either completely absent from YA Global’s case, or irrelevant to the determination of debt-equity in YA Global’s case because YA Global and the companies which issued its convertible debentures were unrelated and acted at arm’s length.

Petitioners are also incorrect to suggest as a factual matter that YA Global "regularly" did not enforce its rights under the convertible debentures. (Pet’rs’ Brief at 183.) In its private placement memoranda, YA Global made clear that its intent was just the opposite by stating that "[i]n order for [YA Global’s] investment strategy to be effective, the issue of such securities must abide by its contractual obligations. [YA Global] intends to aggressively enforce its rights under its contractual relationships with issuers." (RPFF ¶ 240; see also e.g., Exs. 97-J at 47; 100-J at 53 and 114-J at 46.) Consistent with its private placement memoranda, YA Global in fact asserted its rights as a creditor under its convertible debentures. (RPFF ¶¶ 132-137, 240, 447.) Companies anticipated that YA Global would enforce its secured interests. (See, e.g., Ex. 1478-J at pp. 006, 0013, 0029.) YA Global frequently highlighted the benefit of being a secured creditor under all of its convertible debentures. (RPFF ¶¶ 238, 239, 241.)

f. Funding a borrower for the purpose of expanding its business is not inconsistent with debt treatment. (Pet’rs’ Brief at III.A.6)

Petitioners assert that YA Global entered into convertible debentures with companies "looking to expand their businesses, to develop new technologies, or to acquire major assets" rather than to funded basic operational needs. (Pet’rs’ Brief at at p. 187.) Petitioner relies on Roth Steel Tube, 800 F.2d at 632 (concluding that the advances were equity despite the funds being used for day-to-day operations and not to purchase capital assets); Estate of Mixon, 464 F.2d at 410 (funds used for day-to-day operations); Henderson, 375 F.2d at 40 (finding equity where, among other factors previously described, the "substantial portions of these funds were used for the purchase of capital assets and for meeting expenses needed to commence operations"). However, as explained above, those cases are distinguishable because they involved related parties. Even in the related party context, commentators have noted that this factor only should be relevant in combination with other significant factors pointing to equity. See Bittker & Eustice, Federal Income Taxation of Corporations & Shareholders, § 4.05[3][d] ("Since loans from outsiders would be honored as such even if they were used to purchase essential assets, a similar use of shareholder advances is not a satisfactory reason for treating the advances as equity investments."); W. Plumb, Jr., "The Federal Income Tax Significance of Corporate Debt: A Critical Analysis and a Proposal," 26 Tax Law Review at 522 (1971) ("the core asset concept is not and cannot not be the rule of law, since essential assets of a business are often acquired with the aid of outside credit and there is no reason, per se, to discriminate merely because the shareholders provide the funds").

When the lender and borrower are unrelated, courts have treated instruments as debt for tax purposes even if the proceeds are used to acquire capital assets. For example, in Federal Express, the taxpayer issued the convertible debentures at issue to obtain the financing needed to develop a nationwide package delivery system. Federal Express, 645 F. Supp. at 1283 ("The third phase of development was the implementation of a national, overnight package delivery system utilizing thirty-three airplanes, ground transportation equipment, a sorting facility and miscellaneous support equipment. Smith knew from the beginning that this third phase development could not be accomplished without a substantial amount of external financing in the form of bank debt and venture capital."). Similarly, in Scriptomatic, the district court noted that it would be "unrealistic and unfair" to require a company to acquire core assets solely from equity. Scriptomatic, 397 F. Supp. at 763 ("It is common business practice to obtain financing to buy core assets from many different sources."). Numerous other cases, such as Miller, T.C. Memo. 1989-153, have found debt despite the taxpayer’s claim for equity where the funds were used for the business’s basic operating assets. While YA Global may have loaned money to some companies who used those funds to expand their business or acquire assets, courts have found that lending to such borrowers may be consistent with indebtedness.

g. Conclusion: YA Global’s convertible debentures were debt for tax purposes and YA Global’s origination of convertible debentures and promissory notes constituted a lending trade or business. (Pet’rs’ Brief at III.A.7)

The convertible debentures originated by YA Global are debt for tax purposes. First, section 385(c) governs the characterizations of the convertible debentures and bound petitioners to the characterization of the borrowers for federal income tax purposes; petitioners did not satisfy their burden of showing that the borrowers characterized the convertible debentures in a manner inconsistent with the form of the debentures. Second, even if the court were to entertain petitioners’ request to recharacterize the convertible debentures, petitioners cannot show that the instruments are equity under Danielson or the Scriptomatic standard. Finally, even under the factors test, the convertible debentures are debt for tax purposes because (1) formal factors indicate that the convertible debentures were debt and that form resulted from arm’s length negotiations between YA Global and the borrowers, (2) any factors that may point to equity are relevant in a related party context, which are not applicable to the facts before the court, and those factors do not overcome the totality of the factors supporting the characterization of debt; and (3) under the strong proof or similar standard adopted by most Circuits that have not adopted Danielson, a taxpayer arguing against its form, as is the taxpayer, is held to a very high standard that is not met simply by the presence of, for example, certain equity features (even if the transaction were between highly related parties, which is not the case here).

YA Global engaged in regular, continuous, and considerable activities with respect to the negotiation and origination of hundreds of convertible debentures and promissory notes. As discussed in Respondent’s Brief at Part II.C.3, these activities clearly demonstrated that YA Global engaged in a lending business.

B. YA Global engaged in an underwriting and stock distribution business.

For tax purposes, whether YA Global was engaged in a trade or business in the United States (including a business of stock distribution or underwriting, closely related to its debt financing business) is determined based on the substance of the functions it performed and the services it provided. In an effort to draw focus away from the substance of its stock distribution function, petitioners assert that YA Global’s practices differed in some respects from the underwriting activities most commonly used by large investment banks. Petitioners’ arguments are unsupported by evidence and irrelevant to the trade or business determination.

Because YA Global performed the function of an underwriter, acting as intermediary between issuers and the public markets, YA Global is treated as a dealer in securities under section 864(b) (as discussed below in this Part III.B.). In addition, because underwriting is a service business, YA Global was engaged in the performance of personal services within the United States, which also constitutes a trade or business under section 864(b). (See Part III.C.)

YA Global’s business model focused on helping publicly traded companies secure equity financing (in addition to its lending business, described above, which served a complementary function). "We help publicly listed companies gain access to capital quickly by working closely with their senior management to design effective financing structures that meet the company’s short and long-term capital needs." (Ex. 198-R at 0016.) In particular, YA Global sought to "[l]everage our specialization in Standby Equity Distribution Agreements to provide publicly listed companies with a more flexible alternative to the traditional secondary offering." (Id. at 0017.) To that end, the full name of the SEDA — "Standby Equity Distribution Agreement" — reflects YA Global’s intentions to use the SEDA to distribute issuers’ stock rather than hold it as an equity investment.

YA Global’s own description of its stock distribution or underwriting business in contemporaneous statements to current and prospective investors reveals that YA Global viewed itself as an underwriter and held itself out as one. YA Global told investors that its returns were composed of two components: "1) Generating an underwriting spread and 2) Share price volatility throughout a five-Docket day pricing period." (Id. at 0012.) YA Global also highlighted the fees it received from issuers for the services it provided, as discussed below (Part III.C.). (RPFF ¶ 451.)

YA Global’s marketing materials frequently compared SEDAs with other forms of public equity offerings facilitated by an underwriter. In particular, as compared to a traditional secondary offering, a SEDA offered issuers reduced dilution ("a company’s CFO can issue more equity as its stock price improves"), more control (issuers could "significantly reduce the overhang of stock in the market . . . by controlling when it issues stock"), less implementation risk ("less time to market than a secondary offering"), and lower costs. (Ex. 198-R at 0023.)

In a quarterly letter to investors, YA Global summarized its function in the market, noting that "it is very difficult for many institutions to find a single investor who is willing to take risk involved in buying a large amount of a company’s shares." (Ex. 252-J at YA101237.) However, "by putting a SEDA in place companies that are in need of cash can access their public markets as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor." (Ex. 252-J at YA101237.) In other words, YA Global was not an investor, but acted as a conduit to help its clients obtain funding from "tens of thousands" of investors in the public markets. (Ex. 252-J at YA101237.) This distinction was also reflected on YA Global’s website. (See Ex. 155-J (noting that while SEDAs were available "to public companies of almost any size and coverage," PIPEs (private investments in public equity) were "limited by number of financial and strategic investors").)

YA Global’s statements to issuers were remarkably consistent with the way it held itself out to its investors — as an underwriter of issuer stock. YA Global’s website listed SEDAs under the heading "Services," and described the benefits that a SEDA afforded to issuers as: "Control," "Certainty," "Flexibility," "Antidilutive," "Low cost," and "Safety net." (Ex. 148-J.) In communicating with issuers, YA Global described a SEDA as a "proactive financing structure that gives a public company the right, but not the obligation, to do what is essentially a mini secondary offering on a weekly basis." (Ex. 176-J at p. 0012.) "The ‘SEDA’ allows the Company [to] put shares to [YA Global] on a weekly basis to raise capital out of that week’s equity market by selling stock directly to [YA Global]." (Id.) As compared to a traditional secondary offering, a SEDA "can be less dilutive and more time/cost effective." (Id.) YA Global explained that, as compensation for its role as statutory underwriter, it "captures a small spread from each advance to generate a return." (Id.)

Moreover, the SEC filings of several Issuers indicate that they knew that YA Global acted as an intermediary who would bring their newly issued and registered common stock to the public markets. Several issuers stated in SEC filings that YA Global "has indicated that it intends to promptly sell any stock received under the Standby Equity Distribution Agreement." (RPFF ¶ 350.)

Although Petitioners now seek to distance itself from these contemporaneous statements, YA Global made these statements repeatedly and continuously when it was seeking capital investors and transactions with issuers. They amply support Mr. Brokaw’s opinion that YA Global acted as an underwriter for its clients. (Ex. 2001-R at ¶ 9.) Yet petitioners contend that Mr. Brokaw drew conclusions "without any foundation and/or completely inaccurate facts." (Pet’rs’ Brief at p. 190.) That is not true. Mr. Brokaw reviewed a wide gamut of information, including the SEDA agreements, convertible debenture agreements, issuer SEC filings relating to those agreements, YA Global’s marketing materials, and statements made by and interviews of Mark Angelo. (Ex. 2001-R at Appendix D). The SEDA and convertible debenture transactional documents are key to understanding YA Global’s business; yet Dr. Lerner did not consider any of the SEDA or convertible debenture documents and Mr. Stowell testified that he only read a few. (Tr. 1228, 1776-77.)

A leading securities law treatise describes the role of an underwriter as follows: "Underwriters form an essential link in the process of offering securities for public consumption. Underwriting practices have varied over time. There is no single universally accepted underwriting mechanism; instead, there are a variety of underwriting arrangements. The particular underwriting arrangement for any offering will generally be a reflection of the financial exigencies of the situation." Thomas Lee Hazen, Law of Securities Regulation § 2:2 (2020) (emphasis added).

Like tax law, securities law focuses on the substance of the underwriter’s intermediary role rather than on the underwriting practices it follows or the risk it assumes. For securities law purposes, an underwriter is defined as "any person who has purchased from an issuer with a view to . . . the distribution of any security." 15 U.S.C. § 77b(a)(11). An underwriter is held responsible for material misstatements and omissions contained in the registration statement. 15 U.S.C. § 77k.

With respect to the SEDAs, Petitioners disclosed to potential investors that the SEC deemed it to be a statutory underwriter and that YA Global could be jointly and severally liable with the issuers to the purchaser of shares in the issuers if it were deemed a statutory underwriter. (Ex 30-J at YAREL0000012103.) The statutory definition of an underwriter is intended to "include as underwriters all persons who might operate as conduits for securities being placed into the hands of the investing public." In re Lehman Bros. Mortg.-Backed Sec. Litig., 650 F.3d 167, 180-81 (2d Cir. 2011) (quoting Hazen, Law of Securities Regulation § 4:27[1] (6th ed. 2011)). YA Global was, in fact, listed in SEC filings as a statutory underwriter of its issuers’ securities. (See Ex. 1426-J at YALIT004173; Ex. 1428-J at YALIT004323.) And YA Global did, in fact, operate as a conduit for securities being placed into the hands of the investing public.

YA Global may not have performed all the services of a traditional investment bank described in Mr. Stowell’s report, but it served the same function as an underwriter does for its clients. Even public companies that are eschewed by large investment banks, like YA Global’s issuers, have a need for equity financing and require the services of an intermediary to sell their stock on the public markets. (Tr. 1771-72.)

Moreover, even Mr. Stowell recognized that not all investment banks are like the full-service Wall Street underwriters. Mr. Stowell testified small investment banks do provide underwriting services. (Tr. at 1766:6-1767:9.) Accordingly, although YA Global may not be like a large investment bank, firms of its size do provide underwriting services to underserved companies that may not be able to get the attention of a white-shoe investment bank or to access capital from a commercial bank. (See, e.g., Ex. 206-J at p. 0012 ("Cornell Capital aims to fill the void for issuers who are too small to attract the attention of the investment banking community and/or who are not eligible for a traditional bank loan.").

Petitioners claim that YA Global can be distinguished from underwriters because it did not have relationships with individual investors, engage in road shows, or market the stock. (Pet’rs’ Brief at p. 191.) However, for tax purposes, it is not relevant whether YA Global’s business practices are identical to those of a conventional underwriter. Rather, the analysis focuses on whether YA Global performed the intermediary function of an underwriter (which it did) and was compensated for services performed in that capacity (which it was).

1. Petitioners are incorrect in arguing that transactions in SEDAs are not like ATMS and that SEDAs provided portfolio companies with options to sell large blocks of stock to a single investor, YA Global. YA Global was acting principally as stock distributor and underwriter, not as an investor.

Petitioners recognize that underwriters commonly "provide their clients with access to capital markets through a type of follow-on equity issuance," namely at-the-market offerings or ATMs. (Ex. 2001-R at ¶ 14; Pet’rs’ Brief at p. 192.) ATMs allow a publicly held company to sell newly issued common stock on the secondary market, and an underwriter can underwrite the offering on either an agented basis or on a principal basis. (Ex. 2001-R ¶¶ 14-16.; Ex. 3008-P at n. 2.)⁴¹ If an ATM is done on an "agented" basis, "the financial intermediary acts in the capacity of an agent, there is no market risk because the bank does not hold the new stock in its inventory." (Ex. 2001-R, ¶ 17.) When a bank acts as a "principal," then it has market risk from stock held in inventory it may not be able to sell the stock or to sell it at the desired price. (Ex. 2001-R, ¶ 30). The issuer may provide the newly issued stock to the ATM underwriter at a discount. (See Ex. 2001-R at ¶ 18.)

Petitioners further concede that an ATM offering is like a SEDA in that it "allows a company to raise funds by selling newly issued, registered shares on an as-needed basis," and "allows a company to sell shares over a period of time at prices that reflect current market demand." (Pet’rs’ Brief at pp. 192-93.) Moreover, the fees and discounts received by YA Global under a SEDA were similar to those received by an underwriter in an ATM offering. (Ex. 2001-R at ¶ 46.) Thus, when it entered into SEDAs, YA Global served the same intermediary function as an underwriter in an ATM offering and was compensated in a similar way.

Petitioners now claim that SEDAs and ATMs are fundamentally different. However, Mark Angelo told YA Global’s investors in several Quarterly Letters that SEDAs are similar to ATMs — and specifically referred to several of the same ATMs addressed in Mr. Brokaw’s opening report. In the 2009 first quarter letter, Mr. Angelo told investors:

In recent years, many other firms, and more recently investment banks and broker dealers, have engaged in ATM ("At the Money") offerings, Controlled Equity Offerings and other transactions that are similar to the SEDA. It has been interesting for us to see these products (which are effectively similar to Yorkville’s SEDA) enter the marketplace recently and to see large financial institutions offering the same type of product that we have been structuring for years. Below are examples of some of these transactions that were signed in 2008. . . .

(Ex. 254-J at YA1012058 (emphasis added).)

Two of the examples cited by Mr. Angelo in the 2009 first quarter letter are also included in Appendix E to Mr. Brokaw’s opening report regarding ATM’s, namely the Zion Bancorporation N.A. ATM and the Wilmington Trust ATM.⁴² The 2009 first quarter letter is not an exception; Yorkville’s (or YA Global’s) subsequent letter to investors, its 2009 second quarter letter, also compares SEDAs to ATMs and provides:

In last quarter’s letter to investors, we highlighted new equity raises that were closed in the marketplace using facilities that resembled our SEDA product. The trend only continued this quarter. In fact, Bank of America carried out is largest raise of this type ever by issuing $13.4 billion of its own stock using its ATM ("At the Market") structure. The reasons Bank of America gave for deciding to use the ATM structure were many of the same reasons we have cited when promoting our SEDA product over the past eight years. A Bank of America spokeswoman was quoted as saying, ‘In a volatile market, the ATM structure is beneficial because it allows you to sell shares when you like the price and leave the market when you don’t . . . we were able to minimize dilution and maximize flexibility.

(Ex. 255-J at page 002 of 0015 (emphasis added).)

The 2009 Second Quarter Letter, like other Quarterly Letters, bears Mr. Angelo’s signature. The Bank of America ATM is addressed in Appendix E of Mr. Brokaw’s report as an ATM transaction. (See 2001-R at App. E, p. 81.) Merrill Lynch acted as Bank of America’s underwriter for that ATM as well. (See 2001-R at App. E, p. 81.)

a. SEDAs and ATMs are not economic opposites.

Petitioners contend that SEDAs and ATMs are economic opposites because ATMs are generally "agented" transactions while YA Global acts as a principal under a SEDA transaction. (Pet’rs’ Brief at 193-94.) Yet Petitioners’ own expert conceded in his report that some ATM transactions are conducted on a "principal" basis, as discussed in more detail below (Part III.B.1.(c)).

Mr. Brokaw opined that YA Global was engaged in underwriting because it committed to purchase stock from issuers with a view to laying off the risk, generally by selling the stock as soon as practicable. YA Global intermediated those transactions as a principal in a "bought" or "firm commitment" deal, where it took on market risk, namely the risk of not being able to sell the stock or not being able to sell the stock at the desired price. (See Ex. 2001-R ¶ 23.) This characterization of an underwriter taking on principal risk in buying a company’s stock is consistent with how that term has been used by other courts. See Chesapeake Energy Corp. v. Bank of New York Mellon Trust Co., N.A., 957 F. Supp. 2d 316, 344, rev’d on other grounds, 773 F.3d 110 (2d Cir. 2014)., ("a typical ‘best efforts’ offering, where the underwriter does not buy the notes but simply markets them as the issuer’s agent, entails significantly less risk for the underwriter than a ‘bought deal’ or ‘firm commitment’ deal, where the underwriter commits upfront to purchase the notes being issued and then seeks to resell them."); see also Walk-in Medical Centers, Inc. v. Breuer Capital Corp., 651 F. Supp. 1009, n. 2 (S.D. N.Y. 1986) ("Firm commitment underwriting, the most prevalent type of American underwriting, assures the issuer of a specified amount of money at a certain time (subject frequently to specified conditions precedent in the underwriting contract) and shifts the risks of the market . . . to the investment bankers." (emphasis added)); Louis Loss et al., Securities Regulation 163-64 (2d ed. 1961.)"); Jackson National Life Insurance Co. v. Merrill Lynch & Co. Inc., 32 F.3d 697, 701 (2d Cir. 1994)) ("In a firm commitment underwriting, the underwriter agrees to purchase an agreed upon percentage of the offering irrespective of whether the securities can be sold in the public market; therefore, the underwriter bears the risk if the offering is undersubscribed.")

As these cases demonstrate, YA Global’s SEDA activity falls well within the commonly accepted definition of firm commitment underwriting. Moreover, the U.S. trade or business analysis does not turn on whether YA Global’s underwriting practices are identical to the most common form of ATM offering currently used by conventional investment banks. It focuses instead on the substance of YA Global’s intermediary role. As discussed above, YA Global served as a conduit to help its clients obtain equity funding from the public markets — a role that would otherwise have been served by another underwriter through an ATM offering. Because it performed this critical function as a service to its clients, YA Global was engaged in a trade or business by reason of this activity as well its other financing activities.

b. Mr. Brokaw’s claim that YA Global took only minimal risks with SEDAs is supported by the evidence.

Petitioners contend that traditional underwriters do not bear market risk, and therefore YA Global is not an underwriter. (Pet’rs’ Brief at p. 195.) But as the above-cited cases demonstrate, underwriters do bear market risk in respect of stocks and securities that are underwritten. Most obviously, "firm commitment" underwriting, as the name implies, require the underwriter to purchase the shares of the issuer regardless of the ability to place the shares. Underwriters minimize market risk by selling stock to the public market as soon as possible; if an underwriter retains stock for a longer period, then it may take steps to mitigate risk, such as hedging the position. (Ex. 2001-R at ¶ 31.)

Mr. Brokaw explained that, like other underwriters, YA Global mitigated risk through the negotiated terms of the SEDA transactions and by selling stock as soon as practicable. Mr. Brokaw relied on several sources for this opinion. (Tr. 1565, 1566, 1570; Ex. 2001-R at ¶¶ 50, 52.) For example, Mr. Brokaw cited several due diligence questionnaires that YA Global provided to potential investors, which provide: "Typically, the fund does not hold long term positions in the common stock in the companies in which it invests." (Ex. 2001-R at p. 18 (citing Ex. 208-J, p. 007; Ex. 209-J, p. 008; Ex. 210, p. 008).)

As discussed below, the analysis in Appendix F of Mr. Brokaw’s report reflects frequent acquisitions of stock by YA Global and frequent offsetting dispositions of stock by YA Global. As depicted in the graphs in Appendix F, YA Global was generally able to sell the stock shortly after acquiring it. (Ex. 2001-R at App. F.)

i. Petitioners’ contention that YA Global faced a risk because its issuers were thinly traded is unpersuasive.

YA Global contends that its issuers were "thinly traded" because they were not covered by analysts of credit ratings agencies. (Pet’rs’ Brief at p. 196). The relevance of this assertion (if any) is not clear.

YA Global held itself out as a specialist in dealing with thinly traded companies, and its expertise in this area enabled it to perform an underwriting function while mitigating market risk. For example, in its DDQs, YA Global said it "dominates small-cap financings and has topped the league tables for both transaction volume and total capital commitments for the past three years." (Ex. 206-J at p. 0012. See also RPFF ¶ 63.) Moreover, the PPMs provide that "[t]he Fund specializes in financing structures negotiated directly with issuers." (Ex. 30-J at YAREL0000012077; Ex. 89-J at YAREL0000057779.) The fact that YA Global targeted a niche market segment does not detract from the role it played in helping those customers obtain equity financing from the public markets. (Ex. 2001-R at ¶¶ 9-b., 117.)

ii. Petitioners’ contention that YA Global was often required to purchase large blocks of stock relative to trading volume is unavailing.

In support of his conclusion that YA Global performed an underwriting function, Mr. Brokaw stated:

As is the case with ATM offerings, YA Global’s SEDA offerings specified a pre-determined limit to how much dollar volume the Issuer can sell, based on how much liquidity the market for the underlying stock can support without adversely impacting the selling price. The selling volume limit on YA Global’s SEDAs was generally set to 10% of the Issuer’s average weekly dollar volume.

(Ex. 2001-R at ¶ 45.) In other words, YA Global mitigated its liquidity risk under the SEDAs by limiting the amount and timing of each advance. All the SEDAs limited the amount of each advance to a specified dollar amount. In some cases, this limitation was also determined by reference to trading volume. (See Ex. 355-J at § 1.17; Ex. 719-J at § 1.17.) In practice, YA Global succeeded in limiting its liquidity risk: the number of shares of stock YA Global was actually required to purchase pursuant to a SEDA advance was typically far less than the volume of the stock traded during the pricing period. (See Resp’s Obj. to Pet’rs’ PFF ¶ 182 for a detailed discussion.)

For example, the MobilePro SEDA demonstrates how YA Global mitigated risks through the SEDA terms. Although YA Global committed to acquire up to $100 million of MobilePro stock over a maximum 2 year period, it could only advance up to $2 million in exchange for MobilePro stock pursuant to an advance notice, and there was a minimum of seven trading days between advance notices. (Ex. 542-J at § 2.2.)

Petitioners criticize Mr. Brokaw, at page 198 of their Brief, for relying on the SEDA FAQ (which they claim to be of "dubious provenance") to show that the SEDA advances were generally set to 10% of trading volume. The provenance of this document, however, is undisputed: it was produced by petitioners in response to an IDR. (2d Stip. ¶ 63.) While petitioners are understandably concerned by the fact that this document undercuts their litigating position, it is evidence tending to show that YA Global sought to mitigate liquidity risk by limiting the amount of each SEDA advance.

In some cases, YA Global may have made a business judgment that it would be able to quickly sell more than 10% of an issuer’s average weekly trading volume, or may have overestimated the future trading volume of an issuer’s stock at the time a SEDA was negotiated. For example, petitioners point to the FacePrint SEDA, under which YA Global made a cash advance of $23,000 in exchange for 9,200,000 shares on June 4, 2007. (See Ex. 368-J at p. 001.) Petitioners claim this exceeded the trading volume for the subsequent week (June 4-8). However, it was substantially less than the trading volume during the pricing period (18,267,273), which was the preceding week. (Resp’s Obj. to Pet’rs’ PFF ¶ 182.) Regardless, this anecdotal argument and the other isolated situations petitioners cite do nothing to undermine the fundamental point that YA Global structured the terms of each SEDA to mitigate liquidity risk to the extent necessary in its own business judgment.

iii. Contrary to petitioners’ claim, Mr. Brokaw’s report shows YA Global did sell stock shortly after its acquisition.

Mr. Brokaw’s report demonstrates that YA Global sold a significant portion of the stock it acquired under SEDAs and convertible debentures at or before the time of issuance. YA Global used its own capital to acquire issuers’ newly registered stock under SEDAs and convertible debentures, which it generally sold to the public markets, thereby recouping its money (sometimes more, sometimes less) and effectively replacing its capital with capital from the public markets; it would then redeploy that capital by entering into more transactions. YA Global earned income on the spread between the sales price and the discounted purchase price, as well as advance fees and similar fees. That pattern occurred with most of the transactions Mr. Brokaw examined, including MobilePro (Ex. 2001-R at Appx. F-1 & F-2), Epicept (Ex. 2001-R at Appx. F-3), Face Print (Ex. 2001-R at Appx. F-4), Handheld (Ex. 2001-R at Appx. F-5), Immune Response (Ex. 2001-R at Appx. F-7), In Veritas (Ex. 2001-R at Appx. F-8), iVoice (Ex. 2001-R at Appx. F-9), Locate Plus (Ex. 2001-R at Appx. F-10), NeoMedia (Ex. 2001-R at Appx. F-13), Pure Biofuels (Ex. 2001-R at Appx. F.14), Red Rock (Ex. 2001-R at Appx. F-15), Signalife (Ex. 2001-R at Appx. F-16), and Smartire (Ex. 2001-R at Appx. F-17).

Petitioners assert that YA Global had exposure to market risk when it was unable to immediately dispose of issuers’ stock. However, as discussed above (Part III.B.1.(a)) and below (Part III.B.3), underwriters and other dealers commonly assume market risk during the course of performing their intermediary functions. The fact that YA Global was not always able to sell all the stock it acquired immediately at issuance is entirely consistent with its status as a dealer engaged in a U.S. trade or business.

As a factual matter, petitioners mischaracterize Mr. Brokaw’s report as showing lengthy holding periods for stock acquired under SEDAs and convertible debentures. (Pet’rs’ Brief at pp. 201, 215.) But the report speaks for itself, as do the underlying data. If YA Global had actually pursued a "buy and hold" strategy as petitioners insinuate, then the grey "Quantity Held" line in each page of Appendix F would continually increase (or increase to a plateau and remain steady). (Ex. 2001-R, Appx. F.) Instead, Appendix F demonstrates a series of sawtooth graphs, with the acquisition of stock represented by positive changes in the grey Quantity Held line (together with green "buy" lines or blue "cover short" lines) and offsetting sales of stock represented by negative changes in the grey Quantity Held line (together with red "sell" lines and orange "short sell" lines.) (Ex. 2001-R, Appx. F.) Although YA Global may not have been able to unload all of its issuers’ stock on the public markets immediately, it generally disposed of those shares in a matter of days and weeks.

In several transactions, YA Global held the issuer’s stock for a relatively long period of time, such as its transactions with Homeland, Marshall Edwards, and NanoScience (Ex. 2001-R at Appx. F-7, F-11, F-12.) However, in all three cases, YA Global was continuously buying and selling stock.

In this regard, Dr. Lerner’s methodology is flawed because he computed the holding period based solely on the date on which an issuer’s stock was first acquired and the last date on which the same issuer’s stock was disposed of. Dr. Lerner thus ignored interim periods in which YA Global did not hold stock. (Tr. 1147.) For example, with regard to Homeland, YA Global actually did not hold any Homeland stock for two periods, as observed by Mr. Brokaw. (Ex. 2001-R, Appx. F-6.)Under his flawed methodology, Dr. Lerner would nonetheless view that as an unabridged holding period.

YA Global’s financial statements support the conclusion that YA Global effectively cycled its money by acquiring newly registered issuer stock, selling that stock, and then redeploying those funds to issuers for newly registered issuer stock. Between 2006 and 2010, the number of SEDA transactions that YA Global entered into grew substantially, from 38 to 83, as did its commitment under those SEDAs, growing from $331,000,000 to $5,355,515,000. (Ex. 286-J at p. 18; Ex. 287-J at p. 19; Ex. 288-J at p. 24; Ex. 289-J at p. 24; and Ex. 290-J at p. 22.) The commitment amounts in some years substantially exceeded available capital, yet YA Global generally did not borrow funds from third parties. For example, in 2009, YA Global’s outstanding commitments were $5,626,000,000, and its stated partner capital was $540,522,303. (Compare Ex. 289-J at p. 24 with Ex. 289-J at p. 16.) Without borrowing, YA Global would have no ability to meet those commitments if it actually bought and held the issuer stock underling those SEDA commitments. The only way YA Global could meet those commitments, or even a fraction of those commitments, would be to acquire the newly registered common stock, sell the stock into the market, and redeploy its capital.

YA Global’s SEDA commitments and its assets as compared to capital on hand is shown below for each year in the Relevant Period.

Year	Exhibit	Stated Total Assets	Stated Partner Capital	Approximate No. of SEDAs (See RPFF ¶ 325)	Stated SEDA Commitment
2006	286-J	$626,716,234	$592,149,802	38	$331,000,000
2007	287-J	$931,361,925	$859,291,925	37	$606,000,000
2008	288-J	$985,072,251	$853,288,924	38	$756,000,000
2009	289-J	$864,379,256	$540,522,303	67	$5,626,000,000
2010	290-J	$429,154,243	$126,101,337	83	$6,072,553,000
2011	291-J	$232,267,937	$53,214,023	87	$1,470,093,000

Plainly, YA Global could not have met its funding commitments without quickly disposing of the stock it acquired to free up funds for new advances. The circular flow of funds between issuers, YA Global, and the public markets is not a form of investment activity; it is a means of serving as a conduit between issuers and the public.

c. Mr. Brokaw’s claim that "ATM offerings can be intermediated on a principal basis" is accurate.

Petitioners criticize Mr. Brokaw for claiming that ATM underwriters can be buy-sell principals. (Pet’rs’ Brief at pp. 202-03.) Yet even Mr. Stowell’s report acknowledges that in some circumstances an investment bank will underwrite ATMs on a principal basis. The report provides: "In contrast, when investment bank underwriters engaged in ATM offerings, they do not commit to provide any particular amount of funding to the issuer. Rather, investment banks almost always act as agents for the issuers, committing only to use their best efforts to raise capital requested by the issuers." (Ex. 3008-P, ¶ 10.) Footnote 2 to Mr. Stowell’s report further provides that "Although almost all ATM programs involve investment banks operating as agents that take no market risk, a small number of ATM programs include an option for an issuer to accept an investment bank’s offer to purchase a block of shares as principal that include a small amount of market risk for the investment bank (small because the bank normally lines up in advance an investor that will buy the block of shares from the bank)." (See Ex. 3008-P at n.2.)

Petitioners further criticize Mr. Brokaw because he referred to a UBS ATM transaction, wherein UBS acted as an agent for the issuer but could also act as principal. (Ex. 1467-J at § 1.) The fact that UBS could, in its business discretion, act as a principal, supports respondent’s view that ATMs can be distributed by an entity taking on principal, as opposed to agent, risk. Petitioners speculate without any basis in fact or evidence, that "Presumably, UBS would decline to act as principal if the firm did not have confidence based on previous communications with investors that the investors would purchase most or all of the shares that UBS would acquire as principal through an ATM drawdown." (Pet’rs’ Brief at p. 204.) This is pure speculation; the contract gave UBS latitude to make a business decision to sell additional stock on a principal basis. The UBS contract demonstrates that large investment banks could take on principal risk in underwriting ATM transactions.

Although petitioners now claim that SEDAs are not like ATM transactions, the fundamental similarity of SEDAs and ATMs is demonstrated by YA Global’s own contemporaneous characterization of those transactions, as set forth in the Quarterly Investor letters signed by Mr. Angelo, addressed above in Part III.B.1.

d. YA Global earned fees for underwriting services under the SEDAs.

Petitioners mischaracterize their own business dealings, documents, and testimony to allege that the only profits YA Global earned from SEDAs were from capital transactions and not from providing services. (Pet’rs’ Brief at pp. 204-05.) However, YA Global consistently told investors that it generated fee income (in addition to interest, dividends and capital gains). For example, the Due Diligence Questionnaires, which were sent to prospective YA Global investors, describe YA Global’s "edge" as including that the "fee origination side of Yorkville’s business helps to generate revenue for the Fund." (See, e.g., Ex. 237-J at p. 0014, Ex. 238-J at p. 0016.)

YA Global’s PPMs and Quarterly Letters stated that YA Global received fees as compensation in connection with SEDAs and other financing transactions. (See, e.g., Ex. 89-J at YAREL0000057784.) For instance, YA Global’s 2008 Fourth Quarter Letter addressed several recent transactions, including a SEDA with Newron Pharmaceuticals S.p.A under which YA Global received a commitment fee worth CHF 300,000 in shares, and a SEDA with MediGene AG €25,000,000 that provided for a €500,000 cash fee. (Ex. 253-J at p. 006. See Ex. 30-J at YAREL0000012067-68.)

The issuers who entered into financing transactions with YA Global characterized YA Global’s fees and discounts as amounts paid for underwriting services. Face Print characterized YA Global as providing underwriting with regard to the SEDA, as follows: "The Company paid Cornell a one time commitment fee equal to $190,000 in the form of 1,187,500 shares of common stock and paid Yorkville Advisers, LLC a structuring fee of $20,000, all of which are underwriting discounts payable or paid to Cornell." (Ex. 1438-J, p. 71.) Immune Response characterized the payments it made to YA Global as "underwriting discounts", as follows: "In addition, Cornell Capital Partners will retain 5% of each advance under the Standby Equity Distribution Agreement. Cornell Capital Partners also received a one-time commitment fee equal to $515,000 payable in the form of 725,353 shares of common stock. The 3% discount, the 5% retainage fee and the $515,000 commitment fee paid in shares of common stock are underwriting discounts payable to Cornell Capital Partners." (Ex. 1467-J at p. 004.)

In the face of this evidence, petitioners now seek to recast amounts received under the SEDAs as option premium and blockage discounts. Each of these arguments conflict with the contemporaneous evidence of the parties’ intent and ignores the economic reality of the underwriting service that YA Global provided to issuers.

i. Petitioners’ contention that commitment fees were proceeds from selling a put, which is a capital transaction, is not supported by the record.

One element of the remuneration received by YA Global for entering into SEDA transactions was a commitment fee. The issuer paid a fixed dollar amount commitment fee to YA Global on the date the SEDA was executed; therefore, this fee was paid to YA Global even if the issuer did not draw on the SEDA. (RPFF ¶ 299.) The commitment fees paid to YA Global typically took the form of common stock of the company and also may have included warrants to purchase common stock of the company. (RPFF ¶ 300.) The issuer also paid a commitment fee to YA Global at each advance, typically in an amount equal to 3-6% of each Advance.⁴³ (RPFF ¶ 303.) Although an issuer was typically prohibited for a certain number of days after delivering an Advance Notice from delivering another (for example, five trading days), an issuer often requested advances and paid the commitment fee with respect to the advance. (RPFF ¶¶ 307-308. See, e.g., Ex. 368-J at p. 1 (showing nine advances by Face Print in approximately a four-month period); Ex. 480-J (showing three advances by Immune Response between January 4, 2006, and January 30, 2006); Ex. 523-J (showing 14 advances by iVoice between February 24, 2006, and August 11, 2006, and 22 advanced by iVoice between March 23, 2007, and February 4, 2008).) These fees were paid to YA Global as compensation for the intermediary function it performed and the services it provided. Petitioners contend that the SEDA commitment fees should be treated as premiums for options on stock of the issuers. (Pet’rs’ Brief at pp. 205.)

YA Global referred to the SEDA arrangements as "equity lines of credit." Further, at trial, Mr. Angelo explained: "what we’re trying to distinguish when we say ‘proprietary’ is the SEDA was what I would describe, for lack of a better way of saying it, a much more fundamental big-boy version of an equity line of credit." (Tr. 227-28.) A February 8, 2006, PPM provides, "In a SEDA, the Fund will commit to make a certain amount of funds available through the equity line of credit for a certain period of time (generally two years), but the issuer will not be obligated to use the equity line." (Ex. 96-J at p. 0028.)

Consistently with its references to the SEDAs as equity lines of credit, YA Global did not reflect the commitment fees as option premiums in its financial statements. YA Global also has not demonstrated that the "counterparties" — namely YA Global’s clients, the SEDA issuers — characterized the commitment fees paid to YA Global as put option premiums or viewed the SEDA arrangements as some form of option transaction (to the contrary, as described above, issuers referred to the commitment fees as underwriting discounts). (Ex. 1438-J at p. 71; Ex. 1467-J.)

Recognizing that the transaction as they structured it is contrary to their interests in this controversy, Petitioners now contend that the commitment fees were analogous to the premiums paid for put options, implying that SEDAs were analogous to put options. But similar arrangements (standby letters of credit, loan commitments, etc.) are made routinely by financial institutions as an integral part of their business. While there may be some economic overlap between those ordinary business arrangements and selling a put option, the tax characterization differs depending on the context.⁴⁴ In the case of a transaction involving outstanding instruments in the secondary market between investors or traders, treatment of an amount structured as an option and premium payment generally should be respected as such for federal income tax purposes as neither party is involved in origination or dealer activities but rather trading in the market. In the case of a primary market transaction involving newly issued stock or securities to a taxpayer engaged in marketing its ability to provide funding, the focus is on the negotiated and bespoke funding provided by the originator and sought by the borrower. Not only does the terminology in this case fail to reflect an option arrangement, but the legal documentation itself, with representations and covenants of the issuer, is analogous to the negotiated terms of credit agreements.⁴⁵

The commitment fees earned by YA Global were similar to the commitment fees paid by a borrower for a line of credit. Such amounts typically have been treated as ordinary income derived by the lender/financing party when paid or accrued (typically treated as for services). See Metropolitan Mortgage Fund, Inc. v. Commissioner, 62 T.C. 110, 120 (1974); Rev. Rul. 70-540, 1970-2 C.B. 101, Situation 3, ruling declared obsolete in certain other respects, Rev. Proc. 94-29, 1994-1 C.B. 616, upheld in Chesapeake Fin. Corp. v. Commissioner, 78 T.C. 869 (1982). Cf. Federal National Mortgage Association v. Commissioner, 100 T.C. 541, 578 (1993). See also Treas. Reg. § 1.1273-2(g)(2)).⁴⁶ The rule was summarized by Judge Beghe in 1998 as follows:

Petitioner’s undertaking to provide necessary financing, as well as management services, would appear to cause the shares allocable to that undertaking to be treated as a commitment fee, included in the gross income of the recipient as compensation for services at the time of accrual or receipt. See Rev. Rul. 70-540, 1970-2 C.B. 101 (issue 3), declared obsolete on another issue by Rev. Proc. 94-29, 1994-1 C.E. 616, 621; see also Chesapeake Fin. Corp. v. Commissioner, 78 T.C. 869, 879, 1982 WL 11098 (1982); Metropolitan Mortgage Fund, Inc. v. Commissioner, 62 T.C. 110, 120, 1974 WL 2713 (1974).

Venture Funding, Ltd. v. Commissioner, 110 T.C. 236, 255 n.6 (1998) (Judge Beghe concurring in result, dissenting in part), aff’d, 198 F.3d 248 (6th Cir. 1999).

While Petitioners assert that a put option must be treated as an investment, because section 1234(b) provides that transactions in options give rise to capital gain or loss, section 1234(b) does not apply to "any option granted in the ordinary course of the taxpayer’s trade or business of granting options." I.R.C. § 1234(b)(3). The statute plainly recognizes that an option can be granted in the course of a taxpayer’s trade or business. YA Global entered into SEDAs in the course of its underwriting business.

In support of their "put option" argument, petitioners cite Federal Home Loan Mortgage Corp. v. Commissioner, 125 T.C. 248 (2005) (referred to hereinafter as "Freddie Mac") That case addressed the timing at which Freddie Mac was required to recognize income for commitment fees it received in secondary market acquisitions from mortgage originators (not whether Freddie Mac was engaged in a trade or business, which of course it was). Id. at 249. In holding that the commitment fees were characterized as option premium (and not fees for services), the court noted that Freddie Mac merely purchased mortgages from originators and did not itself originate loans. Id. at 268. The court distinguished a previous case in which the taxpayer acted as a loan originator and served as an intermediary between borrowers and institutional investors. Id. at 268-269 (distinguishing Chesapeake Fin. Corp., 78 T.C. 869). See also Federal National Mortgage Association v. Commissioner, 100 T.C. 541, 578 (1993) (notes purchased in transactions that the court considered closely associated with the process of origination constituted notes receivable were "acquired in the ordinary course of trade or business for services rendered" within the meaning of section 1221(a)(4)).

In Freddie Mac, 125 T.C. at 261, the court stated that a contract is an option contract when it provides: "(A) the option to buy or sell, (B) certain property, (C) at a stipulated price, (D) on or before a specific future date or within a specified time period, (E) for consideration." Freddie Mac, 125 T.C. at 261. SEDAs do not meet this definition because they did not set forth a stipulated "strike price" at which YA Global was required to acquire stock. Rather, SEDAs allowed issuers to request a cash advance (subject to a specified dollar limit) but did not identify the quantity or price of the stock to be acquired. The terms under which the stock was sold were determined at the time the issuer requested an advance based on the amount requested and the trading price during the pricing period. (See, e.g., Ex. 324-J at §§ 1.1, 1.3, 1.17.) This reflects the fact that, unlike Freddie Mac in the case cited by petitioners, YA Global acted as an underwriter of instruments acquired directly from issuers pursuant to the SEDAs (i.e., it originated equity to be promptly disposed of to a purchaser). YA Global’s role was analogous to that of a lender who commits to advance funds at the borrower’s request in exchange for a newly issued debt instrument. No authority has indicated that an originator of an instrument under such circumstances should be viewed as issuing a put option.

The difference between a SEDA and an option to purchase stock at a stipulated price is mirrored in the court’s description of the economics of a typical put option, 125 T.C. at 263-64:

An essential part of any option is that its potential value to the optionee and its potential future detriment to the optionor depends on the uncertainty of future events. An optionee is willing to pay for potential future value, and the optionor is willing to accept a potential future detriment for a price. For example, in a typical put option, the optionee is willing to pay a premium to the optionor for the right to sell a security to the optionor at an agreed price sometime in the future. If the market value of the security falls below the exercise price, the optionee can sell the security to the optionor at a price greater than its value on the exercise date. That potential opportunity is what the optionee paid for. Likewise, the premium received by the optionor is compensation for accepting the potential risk of having to purchase at an unfavorable price. If the market value of the security rises above the exercise price, the option will not be exercised, and the optionor keeps the option premium for having accepted the risk associated with uncertainty.

Freddie Mac, 125 T.C. at 263-64. In effect, the writer of a typical put option makes a bet that the stock will not decline in value over the term of the option (and stands to lose money if it does). By contrast, when YA Global entered into a SEDA, it did not have any exposure to price fluctuations prior to the time of "exercise" (when it acquired stock from the issuer), because it always bought stock at a discount to the prevailing market price. Consistently with its role as an intermediary, YA Global did not enter into SEDA commitments in order to make a directional bet on the price of issuers’ stock. YA Global deliberately sought to minimize its exposure to market risk and did not purchase issuers’ stock on the open market. YA Global entered into SEDAs as a means for providing liquidity to its customer base and was compensated for serving this function with typical financing fees (including commitment fees) and spread income.

Unlike a put option, the potential value and detriment of a SEDA did not depend on the "uncertainty of future events." The only uncertainty was whether the issuer would request an advance on the SEDA and how much funding the issuer would request. Like an equity line of credit, SEDAs were designed to provide issuers with a dependable source of cash on flexible terms. Unlike a put option, SEDAs did not protect issuers against the risk of a decline in their stock price (due to the floating purchase price).

Therefore (and regardless of whether a SEDA commitment technically meets the definition of a put option), making a SEDA commitment cannot be characterized as investment activity. The commitment fees must be characterized as remuneration for YA Global’s intermediary function in serving as a conduit for issuers to obtain equity capital from the public markets.⁴⁷ Whether that remuneration is characterized as for services or as other ordinary income (e.g., an amount paid for the availability of funding, analogous to rent for part of the balance sheet) is not important.

ii. Petitioners’ contention that price computations included blockage discounts is unsupported and beside the point.

Alternatively, Petitioners assert that the SEDA discounts to which YA Global was entitled should be characterized as "blockage discounts." (Pet’rs’ Brief at pp. 208-09.) Petitioners attempt to disguise the nature of the commercial negotiations and relationship of the parties in this case by invoking a term generally used in the context of valuation studies to characterize the negotiated distribution discount. While there was a discount, YA Global and the issuers agreed to the discount in connection with, and to incentivize YA Global to undertake the distribution activities.

Mr. Brokaw opined that in his experience underwriters receive compensation for their underwriting services through stock price discounts on issuer stock that they handle. (Ex. 2001-R, ¶ 31.) YA Global built in similar discounts into its SEDAs. (See Ex. 2001-R, ¶¶ 31, 46, 47-51, 52, 53, Ex. 7.) Neither Dr. Lerner nor Mr. Stowell computed blockage discounts for YA Global stock or engaged in any rigorous analysis of the stock discounts as blockage discounts.

Petitioners attempt to support their "blockage discount" theory by pointing to testimony given by Mr. Brokaw in a different case. Iroquois Master Fund, Ltd. v. Quantum Fuel Systems Technologies Worldwide, Inc., No. 13 Civ. 3860 (CD)(SN), 2014 WL 12776748 at *7 (S.D.N.Y. 2014) (A blockage discount is an "amount or percentage deducted from the current market price of a publicly traded stock to reflect the decrease in the per-share value of a block of stock that is of a size that could not be sold in a reasonable period of time given normal trading volume.") (quoting Mr. Brokaw)). In that case, Mr. Brokaw opined that a blockage discount should apply where a purchaser acquired a "very large block of stock," namely 4.9 million shares of a company’s 51 million outstanding shares (9.8% of an entities outstanding shares), which had an average daily trading volume of 200,000 shares (4,450% of its average daily trading volume). Id. The purchaser also purchased a warrant to acquire an additional 2.9 million shares of common stock. Id. The investment fund appears to have acquired the stock to hold it as a long-term investment. Those are not the facts here.

At trial, Mr. Brokaw disputed the blockage discount characterization. (Tr. 1607:3-10.) Petitioners attempted to show, using anecdotal evidence in Exhibit 323-J, that the sale of a purportedly large amount of stock (in that case, 16,428,571 shares worth $23,000) could depress stock prices and warrant a blockage discount. (Tr. 967.) In fact, the exhibit to which they allude seems to suggest that the stock price went up on days when there was a significant amount of trading (counter to petitioners’ block trading theory), as compared to the day before and after the day with significant trading. For instance, on May 23, 2006, 11,250 shares traded at a price of $.0019, on May 24, 2006, 9,772,826 shares traded at $.0025 and on May 25, 2006, 4,297,692 shares traded at $.0021. (Ex. 323 at p. 2) On April 10, 2006, 85,375 shares traded at $.0025, on April 11, 2006, 5,993,125 shares traded at $.0027, and on April 12, 2006, 1,789,000 shares traded at $.025. (Ex. 323-J at 2.)

At bottom, the problem with petitioners’ blockage discount argument is that it is inconsistent with the economics of a SEDA transaction and unsupported by expert testimony. Expert testimony provided in a different case and in a different factual context cannot be used to characterize the transactions at issue here (particularly when the expert disputes the petitioners’ characterization).

2. YA Global’s transactions in convertible debentures did constitute underwriting.

YA Global’s origination of convertible debentures in its lending business worked hand-in-hand with its origination of stock in its underwriting business. Convertible debentures served a dual role, allowing YA Global’s customers to obtain debt financing and also to issue equity to the public markets.⁴⁸

Mr. Brokaw opined that financing a company through a convertible debenture is a common investment banking activity. (Ex. 2001-R at ¶ 63.) Mr. Brokaw also opined YA Global’s convertible debentures were or could be a bridge to equity, as they allowed for several ways for an issuer to bring newly registered shares to market. (Ex. 2001-R at ¶¶ 57-73.) Convertible debentures could, in effect, enable the issuer "to finance its operations with new stock, achieving an end result similar to financing under SEDA arrangements." (Ex. 2001-R at ¶ 58.)

In the ordinary course of its lending business, YA Global negotiated and structured convertible debentures with terms that dovetailed with the needs of its underwriting business. YA Global offered convertible debentures as part of a suite of complementary financial products, thus functioning both as a conduit to the public markets and a source of debt financing.

YA Global contends that "Mr. Brokaw crafted a narrative about the Fund’s transactions in convertible debentures to fit his presumption." (Pet’rs’ Brief at 212.) But Mr. Brokaw’s analysis was based on YA Global’s own documents describing its own transactions.

YA Global’s PPMs, website, and investor presentations provide that YA Global engaged in bridge financing. The PPM provided: "Therefore, no capital is invested by the Fund at the time of entering into a SEDA (unless bridge financing is also provided) and therefore there is no risk of loss of capital at that time." (Ex. 96-J, p. 0052; see also Ex. 97-J, p. 0052; Ex. 99-J, p. 00059; Ex. 100-J, p. 59.) Cornell’s website provides that it provides bridge financing to clients prior to the effective date of a SEDA through short term promissory notes, convertible debentures, and convertible preferred stock. (See Exs. 150-J, 151-J.) Cornell’s investor presentations provide that it provided bridge financing to issuers "in cases where capital is required prior to the effective date of the SEDA" and "Bridge financing provides management quick access to capital while offering the flexibility to repay the obligation form either cash flows or from proceeds of the SEDA once the registration statement is deemed effective." (Ex. 164-J, p. 0022; Ex. 175-J, p. 0022.)

YA Global’s Investment Committee [or Yorkville] characterized convertible debentures as bridge financing arrangements. For instance, in considering a convertible debenture with Pure Biofuels Corp., the Investment Committee notes provides: "Banker explained that this is a short term loan with the expectation that it well be taken out by a placement by Cannacord Adams. . . . The Banker explained that timing is of the essence since this is a very short term bridge." (Ex. 931-J, p. 50.) The Investment committee notes regarding Transdermal Cosmetics proposed convertible debentures provide: "Banker explained that this deal can be classified as a bridge to an IPO." (Ex. 951-J, p. 001.) An investment committee memorandum addressed a convertible debenture for Pure Biofuels Corp, and provided: "Cornell will provide the bridge piece through a 3-month Senior Secured Convertible Debentures. The Company has acknowledged that a follow on financing will (i) take out the bridge financing herein or (ii) allow Cornell to convert all or part of the outstanding debenture (including principal and accrued interest) into 120% of the securities or securities to be issued under the Canaccord Adams financing . . ." (Ex. 961-J.) Other investment committee notes address bridge financing in potential deals. (See Exs. 1076-J, 1077-J, 1127-J, 1140-J, 1150-J, Ex. 1280-J at line 178.) In accord with the investment committee discussions about bridge financing, YA Global exchanged "bridge debenture term sheets" with several issuers. (See Exs. 463-J, 500-J.)

The terms of the convertible debentures reflected their dual purpose. In addition to the Fixed Conversion Price Option (which, like traditional convertible debt instruments, would not be converted unless the share price appreciated above the fixed conversion price), many of YA Global’s convertible debentures also contained an additional Market Conversion Price Option. (RPFF ¶ 200.) The Market Conversion Price Option, exercisable by YA Global, is not generally found in traditional convertible debt instruments. If it exercised the Market Conversion Price Option, YA Global received stock (priced at a moderate discount from the prevailing market price) with a value equal to the amount of cash it would otherwise have received. Therefore, the Market Conversion Price Option could make exercise viable even if the issuers’ stock price did not substantially appreciate above the fixed conversion price by allowing YA Global to acquire issuers’ stock at a discount and sell it to the public. If in any given case the combination of discount and any market appreciation did not sum to manage risk sufficiently, the convertible debenture could simply be held.

Consistent with the dual debt financing and underwriting function of convertible debentures, Messrs. Angelo and Schinik testified that YA Global generally sold the stock it received under the convertible debentures when the stock was received. (Tr. 108, 679.) In particular, in responding to petitioner’s question as to whether YA Global would ever convert and hold the stock, Mr. Angelo testified that "Generally speaking, no. That doesn’t make sense. If you’re sitting in convertible debt, you would typically convert only when you are ready to sell." (Tr. 108:8-11.)

YA Global retorts that "to the extent conversions were made at YA Global’s election, the fact that the stock acquired in a conversion may have been sold promptly is not probative." (Pet’rs’ Brief at 215.) Respondent disagrees; it is probative as to whether YA Global wanted to hold stock it received upon conversion or sought to act as a middleman distributing stock to the public. Consistent with Mr. Brokaw’s analysis (described above) YA Global disposed of its issuer’s stock as soon as possible.

Petitioners contend that convertible debentures could not serve an underwriting function because (1) "that capital came from YA Global, not from anonymous investors in the public market," and (2) YA Global held the convertible debentures for approximately 18 months. (Pet’rs’ Brief at 215 (emphasis in original).) But this argument talks past the dual role of convertible debentures in providing immediate debt financing (with the capital provided by YA Global) and enabling issuers to later obtain equity financing from the public markets. Lending is a trade or business, and underwriting is a trade or business. YA Global did both, and the convertible debentures were an integral part of both businesses.

3. YA Global was engaged in a trade or business as a section 864(b) dealer in securities.

By performing an underwriting function, YA Global acted as a dealer in securities for purposes of section 864(b) and, therefore, was engaged in the conduct of a U.S. trade or business. Petitioners recognize that a taxpayer that is classified as a dealer in stock or securities is considered to be engaged in a trade or business. See, e.g., United States v. Wood, 943 F.2d 1048, 1051 (9th Cir. 1991). However, petitioners incorrectly claim that YA Global was not a dealer in securities.

Petitioners acknowledge, "The key consideration is the mechanism by which the taxpayer is compensated. A dealer’s income is based on the service it provides in the chain of securities distribution, not on fluctuations in the market value of the securities." (Pet’rs Brief at p. 217.) Yet they do not include any discussion of the various fees or other remuneration (including discounted stock) that YA Global received or how YA Global earned its income.

Instead, petitioners summarily declare that YA Global did not make a market in stocks, did not connect buyers and sellers of stock, did not engage in any merchandizing function, did not have customers, and did not acquire stock as a merchant. (Pet’rs’ Brief at pp. 218-19.) As explained in detail in Respondent’s Brief at pages 255-78, petitioners are wrong on these points.

YA Global acted as an intermediary under the SEDAs, connecting buyers and sellers of stock. For example, YA Global helped publicly listed companies gain access to the public markets "as needed to raise money in smaller tranches from tens of thousands of shareholders instead of just one large investor." (Ex. 252-J at p. 004. See also Ex. 176-J at p. 0012 (stating, "The ‘SEDA’ allows the company [to] put shares to [YA Global] on a weekly basis to raise capital out of that week’s equity market by selling stock directly to [YA Global].") The issuers understood that YA Global acted as an intermediary to the public markets and planned to sell stock promptly (to the extent feasible) instead of holding it as an investor or trader waiting for a favorable market move. (RPFF ¶ 350.) As compensation for serving as the middleman, YA Global received fees and "capture[d] a small spread from each advance to generate a return." (Ex. 176-J at 0012.)

The fact that YA Global did not register, and allegedly was not required to register, as a "broker-dealer" with the Securities Exchange Commission is immaterial. Dealer activities, both commercially and for federal income tax purposes, covers more than just broker activities. Consequently, while every broker is a dealer, not every dealer is a broker.

A "dealer in stocks or securities" is defined in Treas. Reg. § 1.864-2(c)(2)(iv)(a) as "a merchant of stocks or securities, with an established place of business, regularly engaged as a merchant in purchasing stocks or securities and selling them to customers with a view to the gains and profits that may be derived therefrom." This definition of a dealer is not limited to broker functions. Further, the regulations under section 864(b) expressly contemplate that an underwriter may be treated as a dealer in securities, other than in the specific circumstances carved out by the regulations. See Treas. Reg. § 1.864-2(c)(2)(iv)(b)(1) (excluding a foreign person who acts as an underwriter solely "for the purpose of making a distribution of stocks or securities of a domestic issuer to foreign purchasers of such stocks or securities"). In this respect, and in respect of having an "established place of business" and being "regularly engaged," it is obvious that the definition is tailored to the purposes of section 864(b) and should be construed consistently with those purposes.

Accordingly, a person can act as a dealer within the meaning of section 864(b) by regularly serving as a middleman between the issuer of stocks or securities and the marketplace for gains or profit (which is the role typically played by an underwriter). YA Global was a dealer because it served this middleman function, acting as a "merchant" buying and selling securities for income or gain. It dealt with customers in the same sense that an investment bank deals with customers, and further, as explained in Respondent’s Brief, that concept reflects the activities involved rather than a conventional concept of customer and may be considered met automatically on that basis.

In fact, Petitioners themselves recognize that "transactions undertaken to raise capital and provide financing for the public Issuers through the equity markets" in order to generate returns "through fee-based activities" are "exactly the characteristics of securities dealers." (Pet’rs’ Brief at p. 216-17.) Petitioners have not disputed that an underwriter is a dealer in securities within the meaning of section 864(b).

Further, consistently with its purpose as an exception to trading, the scope of the section 864(b) dealer concept extends to regular conduct of a trade or business involving any "buy and sell" transactions in stocks or securities that go beyond mere trading. It thus includes situations such as addressed (in a domestic context) in certain case law finding ordinary income treatment on sales of stocks or securities by a person who was not a conventional dealer. See Dunitz v. Commissioner, 7 T.C. 672 (1946), aff’d, 167 F.2d 223 (6th Cir. 1948); Kanawha Valley Bank v. Commissioner, 4 T.C. 252 (1944) (taxpayer who purchased Treasury bonds at issuance in excess of the amount of bonds than it intended to hold as an investment and resold the bonds to dealers in government securities was treated as selling the bonds in the ordinary course of its trade or business).

In contrast to dealers, who purchase securities "with the expectation of reselling at a profit . . . because they have or hope to find a market of buyers who will purchase from them at a price in excess of their cost," investors "depend upon such circumstances as a rise in value or an advantageous purchase to enable them to sell at a price in excess of cost." Kemon v. Commissisoner, 16 T.C. 1026, 1033 (1951). In addition, an investor’s "status as to the source of supply is not significantly different from that of those to whom they sell," because "the securities are as easily accessible to one as the other and the seller performs no services that need be compensated for by a mark-up of the price of the securities he sells." Id. at 1033.

In this case, YA Global entered into SEDA transactions with a view to the gains and profits that could be derived from its intermediary function. By reason of such function, YA Global’s customers included both issuers and the parties to whom YA Global sold the issuers’ shares. The transactions were dilutive secondary offerings⁴⁹ (also referred to as primary follow-on offerings),⁵⁰ as additional shares are being issued by the issuer). The purchasers in such transactions are deemed to be customers of YA Global for purposes of the dealer test of section 864(b) under applicable case law because they acquired from YA Global in the course of YA Global’s distribution business (through intermediary brokers) newly issued shares of the issuers. See Dunitz, 7 T.C. at 672, and Resp’s Brief at Part II.C.4.(d). The fact that the shares were sold into the open market, such that the purchasers, were anonymous parties on an exchange, is completely consistent with the underwriting practice in similar offerings. Underwriters in dilutive secondary offerings, including distribution agents in an "at the market" offering (which most closely resembles the activities of YA Global), sell shares directly into the secondary trading market (i.e., on an exchange).⁵¹ Such intermediaries may either purchase and resell the shares (as in a traditional firm commitment underwriting) or may act as an agent for a commission⁵² but in either case are conducting a stock distribution business that is a type of underwriting.

The origination from client issuers as the source of supply, the marketing efforts, the structured arrangements permitting staged timing and discounts from market value, the contractual terms, the fees, and the overall business plan, together reflecting activities of an underwriter distributing shares in the market, distinguish this case from the cases disallowing a trader both buying and selling on an exchange from claiming on ordinary loss. Very simply, the stock distribution portion of YA Global’s business consisted of providing cash to issuers for newly issued shares and moving those shares to the markets in an orderly fashion. Neither industry practice nor the nature and function of the activity conducted by YA Global would support a distinction based on whether YA Global first sold to a broker which then sold on an exchange (a normal course of business), or instead sold (through a broker) directly on an exchange, and such a distinction would elevate form over substance.⁵³ Therefore, and as described in Respondent’s Brief, YA Global is deemed to have sold to customers.

The evidence demonstrates that YA Global’s purpose in making SEDA commitments was to derive profits from its role as a middleman between the issuer and the market, which reflect the nature of its underwriting activities that fall within the ambit of a section 864(b) dealer. YA Global told investors that it "seeks to achieve absolute returns by employing a non-directional strategy known as the Standby Equity Distribution Agreement" that would "lock in the price difference between what we are able to sell stock into the market with the lower price that we buy it at directly from the company over a 5 day pricing period." (Ex. 198-R at p. 009.) Similarly, YA Global marketed its convertible debentures to investors as "non-directional alternative financing structures." (RPFF ¶ 229.) YA Global also highlighted the fees it received from issuers for the services it provided, as discussed below (Part II.C.3). (RPFF ¶ 451.) YA Global’s business model was designed to work without regard to market price fluctuations, and the fact that YA Global (just like an underwriter that has made a firm commitment, to the extent it has not presold all the securities) faced market risk does not make it less of a dealer for purposes of section 864(b).⁵⁴

YA Global must be characterized as a dealer because it hoped to profit from the difference between the market price of its issuers’ stock and the price at which it could acquire stock from the issuer. Kemon, 16 T.C. at 1032. YA Global earned this "mark-up" as compensation "for its labors as a middleman" in helping clients access the public markets. See id. at 1033.

Very importantly, YA Global’s "status as to the source of supply" was "significantly different" from the public shareholders to whom it sold issuers’ stock. Id. YA Global purchased stock pursuant to agreements negotiated with issuers at a price that reflected its intermediary function and was not available to the public.

Petitioners argue that YA Global was not an underwriter (and thus, not a dealer) because YA Global assumed market risk in ways that certain other underwriters do not. As noted above in connection with underwriters, this argument is not only factually groundless but also irrelevant to the standard for determining whether YA Global is a dealer. There is no question that dealers can (and do) put their capital at risk. By definition, the value of inventory and other stocks and securities held by a dealer is subject to market movements. For example, a market maker "actively quotes two-sided markets in a security, providing bids and offers (known as asks) along with the market size of each," and "signals a willingness to buy and sell the securities of a defined set of companies to broker-dealer firms that are member firms of that exchange."⁵⁵ Market makers earn a bid-ask spread as compensation "for the risk of holding assets because they may see a decline in the value of a security after it has been purchased from a seller and before it’s sold to a buyer."⁵⁶

A floor specialist (which is a kind of market maker⁵⁷) is treated as a dealer even though this role "blurs the distinction between deriving income from providing a service in the purchase or sale of an asset and deriving income from changes in the market value of an asset." Bielfeldt v. Commissioner, 231 F.3d 1035, 1037 (7th Cir. 2000). Similarly, a "stockbroker who owned shares that he sold to his customers at market price plus a commission would be a bona fide dealer." Id.

As these examples demonstrate, dealer and underwriter activities both can involve holding stocks and securities that are subject to market fluctuations, thereby putting capital at risk. Market risk is not inconsistent with section 864(b) dealer status. So long as a taxpayer seeks to derive dealer profits, the assumption of market risk ancillary to its dealer activities does not transform a dealer into a trader or investor.

In this case, YA Global acquired issuers’ stock in the course of performing its dealer function. The sale of this stock to the public markets was an essential element of YA Global’s business. The fact that YA Global was not always able to sell all the stock it acquired immediately at issuance is entirely consistent with its status as a dealer. Further, even a dealer often holds certain securities with no immediate intention to sell or for investment. See, e.g., I.R.C. § 475(b)(1).

4. The evidence unequivocally demonstrates that YA Global was engaged in an underwriting business.

Petitioners conclude this part of their argument by reiterating their attacks on Mr. Brokaw. However, Mr. Brokaw’s opinion was based on an array of YA Global information, including its PPMs, promotional materials, agreements with third parties, transaction information, and how the issuers reported those transactions in their SEC filings. (See Ex. 2001-R.) In contrast, neither of petitioners’ experts evaluated YA Global’s transactions in detail; in fact, petitioners experts rely on Appendix F to Mr. Brokaw’s report (Ex. 2001-R) to demonstrate that YA Global was an "investor." Mr. Stowell did not appear to be familiar with basic facts about a SEDA, as he testified that under a SEDA that YA Global could not directly acquire shares from an issuer. (Tr. 1785; 1799-1801.) Moreover, Mr. Stowell did not consider any of the presentations, also known as pitchbooks, even though he routinely considered those types of documents when he was an investment banker. (Tr. at 1764.)

C. The evidence shows that YA Global received fees and compensation for providing services; petitioners’ argument that this is a new issue lacks merit.

Petitioners assert at pages 220-29 of their Brief that Respondent untimely introduced into this case the contention that YA Global’s lending and underwriting activities were services for which YA Global was compensated. Petitioners’ argument is meritless. Respondent has always contended that YA Global provided services for compensation. Years ago, in Chief Counsel Advice 201501013, 2015 WL 44392, respondent found that YA Global engaged in lending and underwriting business and received compensation in exchange for performing its lending and underwriting activities. A pre-trial stipulation, at ¶ 1.(d), stated that respondent maintains that YA Global’s business included "associated services" and at ¶ 1.(e), that YA Global’s activities included "services performed by YA Global and others on YA Global’s behalf" (Stipulation entered at docket entry 75).) Respondent’s Pretrial Memorandum also set forth this position (pp. 16-18, 30, 33 & 37). (Resp’s’ Pretrial Memo, at pp. 30-31, 37, 55). Indeed, lending and underwriting themselves constitute services. (Resp’s Brief at pp. 241-42, 255-77.)

Petitioners express concern at page 221 of their Brief that, according to them, respondent first alluded to "personal services," independent of lending or underwriting, in the pretrial memorandum. This is not the case. Respondent has not argued that services are involved apart from YA Global’s lending and underwriting activities. Petitioners purport to cite that respondent, in his pretrial memorandum, "claimed, ’In addition [to lending and underwriting] . . . YA Global, through its agent, Yorkville Advisors, performed services in the United States for fees." (Pet’rs’ Brief (quoting Resp’s Pretrial Memo, at p. 16) (emphasis in Pet’rs’ Brief).) However, this was not respondent’s language or meaning. The actual text stated, "In addition, as part of this business activity [referring to the previous sentence’s description of lending and underwriting business], YA Global, through its agent Yorkville Advisors, performed services in the United States for fees." (Resp’s Pretrial Memo. at p. 16 (emphasis added).) The italicized language, omitted from petitioners’ citation, is critical to the sentence’s meaning and makes plain that the fees-for-services argument is associated with, not independent of, respondent’s argument that YA Global was in the lending and underwriting business.

1. Respondent has argued since the time of the audit that YA Global received compensation for services.

Some six years before trial, Chief Counsel Advice 201501013 set forth respondent’s position on YA Global’s business and the reasons supporting that position. Petitioners had a copy of this document as of September 2014. Chief Counsel Advice 201501013 included the following specific statements, among others:

a. "[YA Global] profited from its lending and underwriting activities by earning fees, a spread, and interest payments."

b. "[I]n exchange for performing lending and underwriting activities, [YA Global] received compensation in the form of fees, discounted property, and spreads. Both the activities performed and the compensation received by [YA Global] demonstrate that [YA Global’s] activities are not properly characterized as trading in stocks or securities."

c. "[YA Global], as an underwriter, distributed stock or securities in exchange for fees, discounted securities, and other property. That compensation constitutes ‘income . . . based on the service [an underwriter] provides in the chain of distribution of the goods he buys and resells,’ rather than profits derived from market fluctuations." (citation for internal quotation omitted)

Respondent could not have been more clear that YA Global’s receipt of fees and other compensation was an important component of respondent’s position. As noted, the parties also filed a Stipulation for Trial on August 23, 2020 (docket entry 75), to the same effect, and respondent also set forth his position in his Pretrial Memorandum at pages 16-18, 30-31, 33, 37-55.

Petitioners suggest they have been prejudiced (Pet’rs’ Brief at p. 224) and that they did not understand the significance of the fees or other forms of compensation YA Global received, and if they had, they would have provided additional evidence concerning fees.

But documents the parties discussed for stipulation included materials concerning fees and compensation. The evidence in the record supporting respondent’s position that YA Global was engaged in a financial services business, including lending and underwriting, is the same evidence necessary to support respondent’s position with respect to fees and services. Petitioners themselves elicited testimony from witnesses they called relating to fees and services. (E.g., Tr. 96:19-97:17, 98:22-25, 705:5-707:18, 934-937, 1177:17-1178-15.) In particular, petitioners asked Messrs. Wright and Kreisler, representatives from two of YA Global’s clients, whether their companies paid YA Global fees and whether their companies paid those fees for services. (Tr. 705:5-707:18, 1177:17-1178:15.) It cannot be said that petitioners were unaware of either respondent’s argument or the types of evidence that would be relevant.

2. Respondent does not have the burden of proof as to whether YA Global received compensation and fees for services.

Under Tax Court Rule 142, petitioners bear the burden of proof on all issues raised in the notice of Final Partnership Administrative Adjustment.

The FPAAs in this case were sufficient to put petitioners on notice of the issues in this case, and at the start of the trial, the Court seemed to agree. (Tr. 38:11-39:4.). Each FPAA identified the year at issue, the adjustments made for the year, and the basis for the adjustments. In particular, the FPAAs set forth respondent’s determinations that YA Global was engaged in a U.S. trade or business and was a dealer in securities within the meaning of section 475, and that all of YA Global’s income was ordinary and effectively connected with the conduct to a U.S. trade or business under section 864(c). This information is all that is required to establish adequate notice and to be presumed correct.

It was respondent’s understanding that this issue had been put to rest, although the Court did not specifically deny petitioners’ oral motion at the start of trial. The Court asked petitioners’ counsel, after its colloquy with respondent’s counsel, whether petitioners were satisfied with respondent’s explanation and the narrowing of the issues, to which petitioners indicated that they were. (Tr. 47:5-8.) The Court also advised petitioners’ counsel to object if petitioners thought respondent were "tending out of bonds." (Tr. 46:14-47:4.) Petitioners did not object to respondent’s examinations of witnesses on these grounds.

As described above, respondent has not raised a new issue or argued any theories beyond what respondent outlined at the start of trial and well before. Accordingly, petitioners’ argument that respondent has the burden of proof on whether YA Global’s activities involved services performed as part of YA Global’s lending and underwriting business for which YA Global received fees and compensation, should be rejected.

3. The record demonstrates that YA Global performed services and was compensated for them.

YA Global’s financial statements demonstrate that it received substantial fee income. For instance, in 2007, YA Global reported transaction fees and other income (reported as a separate line item from interest, dividends, and capital gains) of $56,406,0125. (Ex. 287-J, p. 0012 of 0020.) For that same year, Yorkville Advisors received cash fees of approximately $24,300,000, of which it remitted $1,600,617 to YA US Feeder and reduced YA Offshore’s management fees by $4,299,733. (Ex. 287-J, p. 0019 of 0020.)

YA Global earned these fees by performing services. Its lending and underwriting activities included, and were imbued with, the performance of services in addition to the provision of financing amounts. The customer interaction and customization of offerings reflects the services element of YA Global’s loan origination and underwriting explains and accentuates their treatment as a trade or business.

Petitioners set up a false dichotomy between providing loan and equity capital and performing services. They argue that because YA Global provided capital to its clients, it was not providing services. This argument is flawed on several grounds.

First, the activity required to arrange and provide for intermediate funding on a tailored basis is itself a service to companies and individuals seeking financing. For example, a bank is treated as providing services (and not just money) to customers when it originates loans. See Burbank Liquidating Corp. v. Commissioner, 39 T.C. 999 (1963); Federal Nat’l Mortgage Ass’n v. Commissioner, 100 T.C. 541 (1993). As in the case of a bank, providing capital includes significant service features when it is performed in a manner designed to meet the needs of those seeking funding. The fact that the resulting instrument may thereafter be held for some longer period of time does not eliminate the service element in the spectrum of activities.

In this case, the evidence demonstrates that YA Global’s financial products were designed to meet the funding needs of its clients and were customized to the unique situations of individual issuers. YA Global listed SEDAs and convertible debentures as "Services" on its website and marketed them as services to issuers and investors. (See Exs. 148-J, 151-J.) YA Global had a significant cadre of personnel (the employees of Yorkville Advisors — investment bankers, bankers, or analysts — acting on its behalf) engaged in origination activities, and implementing and servicing its financial products. (RPFFs ¶¶ 78-82.) YA Global’s marketing materials represented that its internal legal staff would "structure contracts," "adapt to SEC registration statement comments," and "facilitate expeditious closing of transactions." (Ex. 176-J at 9.) Through the personnel acting for it, YA Global implemented its blueprint designed to permit client issuers to bring newly issued shares to the public market with relatively short engagement of its own capital, and structured and provided bridge financing on a basis tailored to the needs of specific issuers. Based on the specific service features and the embedded service aspects of the activities performed by it, YA Global is properly characterized as engaged in the performance of personal services, which is treated as a trade or business under section 864(b) and, perhaps more significantly, underscores the trade or business status of its debt financing and stock distribution activities. For example, as discussed above, courts have held that the receipt of fee income, in addition to a return on securities, is an important factor in distinguishing between business activity and investment. See, e.g., Deely, 73 T.C. at 1093.

Second, YA Global received a substantial amount of fee income as remittances (or offsets) received from Yorkville Advisors. The portfolio companies paid fees to Yorkville Advisors, which passed on a portion of those fees to YA Global. Yorkville Advisors was not providing capital to issuers (and thus fees paid to Yorkville Advisors could only represent compensation for services). These fees included structuring fees, investment banking fees, legal fees, and due diligence fees. (See Ex. 97-J, YA1004559-60; Ex. 324-J at § 12.4; Ex. 861-J at § 6.1; see also Ex. 2001-R, Exs. 7 & 8).

Yorkville Advisors shared its service fees with YA Global because the services were performed by Yorkville Advisors on behalf of YA Global, as evidenced by its entitlement to economic benefit therefrom.⁵⁸ Whether in the form of an offset or a remittance, YA Global was entitled to receive and did receive a direct economic benefit from the services performed on its behalf. See Sun Capital, 724 F.3d at 146 ("[T]he Sun Funds . . . were able to funnel management and consulting fees to Sim Fund IV’s general partner and its subsidiary. Most significantly, Sun Fund IV received a direct economic benefit in the form of offsets against the fees it would otherwise have paid its general partner."). As discussed in detail (Part II), the services performed by Yorkville Advisors on behalf of YA Global properly are imputed to YA Global for purposes of section 864(b).

In support of their narrow definition of services, Petitioners cite Container Corp. v. Commissioner, 134 T.C. 122, 132 (2010), aff’d, 2011 WL 1664358 (5th Cir. May 2, 2011). In that case, the court held that guaranty fees were not "[c]ompensation for labor or personal services" for purposes of the source of income rules in sections 861(a)(3) and 862(a)(3). Quoting a dictionary definition, the court stated that "[t]he common meaning of" labor or personal services’ implies the continuous use of human capital, ‘as opposed to the salable product of the person’s skill.’"

However, as the court noted in Container Corp., income is characterized for sourcing purposes based on the predominant feature of the transaction. Id. at 137 (citing Bank of America v. United States, 680 F.2d 142, 149 (Ct. Cl. 1982)). Although the taxpayer in Container Corp did perform some services, the court held that those services did not represent the predominant feature of the guaranty transaction.

By contrast, the same standard does not apply for purposes of section 864(b). The U.S. trade or business determination focuses on whether a taxpayer has engaged in sufficient activity (including the performance of personal services) to create a nexus with the United States. If a taxpayer performs personal services to any extent within the United States, the taxpayer has a U.S. trade or business regardless of whether those services are the predominant feature of the taxpayer’s business or transactions, and even if the business income is largely derived from payments in respect of stocks or securities. Apart from any amounts actually characterized as compensation such as fee income, even a service-oriented financing business generally produces income characterized as interest, dividends, and ordinary or capital gain on sales of stock or securities. See Treas. Reg. § 1.864-4(c)(5)(ii).

In this case, YA Global performed underwriting services and provided custom-tailored financing solutions to serve the needs of its clients. (RPFF ¶ 140.) It provided those services through employees of Yorkville Advisors acting on its behalf within the United States. Therefore, regardless of the character of most of its income (e.g., for sourcing purposes), the inherent service aspects of its activities as well as activities earning specifically identified fees resulted in YA Global’s having been engaged in the performance of personal services within the United States, which is treated as a trade or business under section 864(b) and, perhaps more importantly, reinforces the trade or business status of its debt financing and underwriting/stock distribution activities.

Petitioners also suggest that YA Global’s substantial fee income was "just a mechanism for enhancing the return on investment capital." (Pet’rs’ Brief at p. 229.) However, Mr. Brokaw identified the fees associated with services that YA Global and its agent Yorkville Advisors performed in furtherance of its financing business. See Ex. 2001-R, Exs. 7 & 8. Although YA Global may find references to those services "cringeworthy" and fatal to its theory that it was merely investor and not providing financing services to issuers, the fees it earned (in particular, those received by Yorkville Advisors and passed on to YA Global) are nonetheless identified in PPMs, SEDAs, and convertible debenture transactions (in particular, those received by Yorkville Advisors and passed on to YA Global) as structuring fees, investment banking fees, legal fees, or due diligence fees. (See Ex. 97-J, YA1004559-60; Ex. 324-J at § 12.4; Ex. 861-J at § 6.1.)

Petitioners’ argument also represents a marked shift from what investors were told at the time. YA Global sold itself to investors on the basis of the fees it earned from the services it provided, in addition to the gains it derived from selling stock acquired at a discount. (RPFF ¶ 451.)

In describing its "edge" in several DDQ’s, YA Global emphasized its expertise in structuring investments, which it described as "Yorkville is an expert in structuring privately negotiated debt investments in public companies, as this has been the principal strategy of the Investment Manager since Fund I’s inception. The Firm’s five person in-house legal and compliance team, which includes a former SEC attorney on staff, are experts at drafting, structuring, diligence and securing Yorkville’s transactions." (See, e.g., Ex. 237-J, at 0016 of 0019; Ex., 238 at pp. 0016-0020.) YA Global charged structuring fees, which were paid to the Yorkville Advisor’s general counsel "in exchange for structuring transactions." (Ex. 209-J, p. 002 of 0014.) Petitioners now claim that all of these fees were nothing more than a means to manipulate the overall economics of a passive investment strategy. This argument is not credible.

IV. Respondent’s criticisms of Dr. Lerner’s analysis are accurate and on point.

Petitioners attempt to discredit the rebuttals presented by respondent’s experts Mr. Brokaw and Dr. Strebulaev addressing the report and testimony of petitioners’ expert, Dr. Josh Lerner. Petitioners’ attempt is unavailing. The rebuttals raise valuable criticisms of Dr. Lerner’s views.

A. Response to Petitioners’ Criticisms of Mr. Brokaw Critiques of Dr. Lerner

1. Contrary to petitioners’ assertion, Mr. Brokaw’s criticism #1 of Dr. Lerner’s proposition that YA Global resembles a venture capital fund is valid because Dr. Lerner did not review YA Global’s agreements and marketing materials and he failed to address the relevant standard.

Dr. Lerner opined that YA Global more closely resembled a VC firm and not a commercial bank. (Ex. 3003-P, ¶ 143.) Whether YA Global, or a VC firm or a commercial bank, is engaged in a trade or business within the United States is determined by looking at the nature of the entity’s profit-oriented activities conducted in the United States. Even an entity labeled a VC firm can conduct business activities.

Dr. Lerner focused on YA Global from an investor perspective and did not meaningfully address YA Global’s financing activities with its issuers. (Ex. 2002-R, ¶ 5.) Dr. Lerner did not consider any agreements between YA Global and the issuers or any SEC filing by those issuers that address their transactions with YA Global. (Ex. 2002-R at ¶ 5. See also Ex. 3003-P,) Dr. Lerner, like Mr. Stowell, did not consider YA Global’s marketing materials or public statements made by Mr. Angelo or others that shed light YA Global’s financing services in the U.S. Mr. Stowell was aware that Mr. Angelo characterized YA Global as hedge fund wrapped around an investment bank, however, in his report he provides "I am also unable to explain Mr. Angelo’s characterization of YA Global as ‘an investment bank wrapped in a hedge fund structure.’" (See Ex. 3008-P at n. 43.) The Court should give little weight to Dr. Lerner’s analysis in considering whether YA Global was engaged in a U.S. trade or business or not.

2. Petitioner incorrectly asserts that Mr. Brokaw’s criticism #2 and Dr. Strebulaev’s Criticism # 1 are spurious; Dr. Lerner used the incorrect standard and failed to consider the full spectrum between commercial banks and venture capital firms.

Dr. Lerner produced a two-point spectrum — with commercial banks on the least risky side and venture capital funds on the riskiest side. (Ex. 3003-P, ¶ 140.) Whether YA Global resembles a commercial bank or a venture capital firm is not the relevant inquiry to the question of whether YA Global was engaged in a U.S. trade or business. Both a commercial bank or a venture capital firm may be engaged in a trade or business in the United States depending on the fact and circumstances of their profit-oriented activities.

In addition, Dr. Lerner, a professor at Harvard Business School, is certainly aware of other financial intermediaries; however, for some inexplicable reason, he only chose those two. Moreover, Dr. Lerner’s simplistic spectrum is inconsistent with a similar analysis that he included in the textbook that he co-wrote, namely "Venture Capital & Private Equity: A Casebook." In Dr. Lerner’s textbook, he has a two-dimensional "Funding Continuum" graph and not a one-dimensional "spectrum," with the "stage" of the company on the Y axis and "risk/return" on the X axis. (See Ex. 2004-R at ¶¶ 30, 31, Fig. 7.) Dr. Lerner used the graph to evaluate the "Silicon Valley Bank". On his "Funding Continuum," Dr. Lerner included traditional commercial banks, "the Domain of the VCs", venture banks, venture leasing, venture lenders, public markets, and investment bank. Dr. Strebulaev identified a number of other financial intermediaries that could have been considered, such as buyout funds, commercial banks, credit unions, hedge funds, investment banks, merchant banks, retail banks, shadow banks, venture capital, distressed debt funds, and mutual funds. (See Ex. 2004-R at Fig. 6.)

Dr. Lerner certainly was aware of the role that investment banks play in financing transactions such as an acquisition. In responding to the Court’s questions about fees, Dr. Lerner testified: "a lot of these originated out of the idea that normally the private equity group would have to hire an investment banker to do an acquisition or something along those lines, and here the P group [sic PE or private equity group] was doing the transaction itself. So their argument would be, well, the investment bank would charge 5 percent; we instead did it for you; you know, we’ll just charge you 3 percent or something like that." (Tr. at 1323:19-1324:4.) Dr. Lerner’s testimony at trial suggests that YA Global was performing services similar to the services performed by an investment bank and that YA Global charged fees for those services.

In his report, Dr. Lerner does not even evaluate YA Global as a hedge fund or private equity fund, upon which he has published extensively. (See Ex. 3003-P at Ex. 1.) Moreover, Dr. Lerner did not cite to any materials or other evidence that YA Global ever identified itself to the public as a venture capital fund. Accordingly, the Court should afford little weight to Dr. Lerner’s testimony because of his selective and unobjective evaluation of YA Global on a two-point spectrum between a commercial bank and venture capital ("VC") firm.

3. Despite petitioners’ contention, Mr. Brokaw’s Criticism #3 is valid because Dr. Lerner professed to compare YA Global to banks and VC firms but used different metrics to evaluate the returns of banks and the returns of VC firms.

In evaluating whether YA Global is more like a commercial bank than a VC firm, Dr. Lerner used a two-point spectrum, with commercial banks on the less risky side and VC funds on the more risky side. (Ex. 3003-P, ¶ 140.) In comparing the returns for those firms, he does not use the same measure to evaluate returns. He uses return on assets for banks and return on equity for VC firms. Those returns are computed differently. (Ex. 2002-R, ¶¶ 22-29 & Ex. 1-A.) Mr. Brokaw addressed this mismatch by redetermining a commercial bank’s returns based on a return of equity and in doing so found that banks did not necessarily have "low, stable returns" as claimed by Dr. Lerner. (Ex. 2002-R at ¶ 26 & Ex. 1-A & 1-B.) Furthermore, YA Global engaged in a lending and underwriting or stock distribution business that provided alternative financing to a niche market. (RPFF ¶ 661.) The fact that its returns varied from those a commercial bank does not detract from finding that YA Global engaged in a trade or business; in fact, it is consistent with the market its business served.

4. Petitioners’ contention that Mr. Brokaw’s Criticism #4, i.e., that Dr. Lerner improperly ignored the time value of money in computing returns, is incorrect.

Dr. Lerner evaluated YA Global’s returns on the issuers’ stock using a method that lacked a time dimension and, without such a time dimension, it could not reflect a rate of return. (Ex. 2002-R at ¶¶ 32-35.) In essence, Dr. Lerner does not consider the time value of money when he is comparing the returns on YA Global’s holdings in its issuers. Dr. Lerner computed returns by formula, where the numerator included the sum of and issuer’s realized gains (losses), unrealized gains (losses) and interest income (losses) over the denominator, which includes the sum of the market value of the securities at the start of the period and purchases adjusted for conversions. (Ex. 2002-R at ¶ 32.) Dr. Lerner’s formula did not account for time and, thus, there is no way in which to compute a quarterly or yearly return or other time-sensitive return. (Ex. 2002-R at ¶¶ 32-35.) In Dr. Lerner’s textbook, he criticizes such return analysis because it "does not consider the timing of the cash flows that it compares. This violates one of the central tenets of finance that ‘a dollar today is worth more than a dollar tomorrow.’" (Ex. 2002-R at ¶ 33 (quoting Joshua Lerner, Ann Leamon, & Felda Hardymon, "Venture Capital, Private Equity, and the Financing of Entrepreneurship," at 279 (4th ed. 2011).)

5. Mr. Brokaw’s Criticism #5 of Dr. Lerner’s computation reflects the view that YA Global should be evaluated as a financing business and not on a deal-by-deal basis.

Mr. Brokaw and Dr. Lerner took two different approaches to evaluating YA Global. Mr. Brokaw viewed YA Global as engaged in a financing business through its SEDAs, convertible debentures, and its other financing vehicles, whereas Dr. Lerner tried to fit it within a VC business model and in doing so, disregarded or ignored some of the key characteristics of YA Global’s business and the way it generates profits. (Ex. 2002-R at § IV.)

In concluding that YA Global was engaged in an investment banking-type activity, Mr. Brokaw considered and evaluated a broad swath of information to get a true sense of YA Global’s business: YA Global’ presentations or PowerPoints and similar documents that YA Global used to explain its financing business to prospective investors and issuers; statements made by Mr. Angelo to the media and during depositions; transactional documents between YA Global and the issuers; SEC filings made by the issuers reporting on their transactions with YA Global; and trade information. This information demonstrated that YA Global generally tried to sell the stock it acquired under a convertible debenture or SEDA as soon as possible. (See Exs. 2001-R, 2002-R.) Considering that information, Mr. Brokaw concluded that in his experience as an investment banker that YA Global engaged in the same type of activities as an investment bank. (Ex. 2002-R at ¶ 4.)

In contrast, Dr. Lerner approached this case with the preconceived notion that YA Global should be categorized as being either closer to a commercial bank or a VC firm. Dr. Lerner ignored or did not consider any transactional documents between YA Global and the issuers or any of the materials that the issuers filed with the SEC to report their transactions with YA Global (Tr. 1228-29). Had he looked at this material, he may have concluded that YA Global engaged in investment banking type activities. However, having determined that YA Global was similar to a VC firm, Dr. Lerner approached YA Global on a transaction-by-transaction basis, and he ignored some fees earned by YA Global and other types payments, such as returns on lawsuits that an investment banking-type firm would include (Ex. 2002-R at ¶ 31.)

Mr. Brokaw addressed Dr. Lerner’s report by identifying his differences with Dr. Lerner that arise from treating YA Global as an ongoing concern instead of a group of transactions. Ex. 2002-R, sec. IV. For instance, Dr. Lerner excluded the comp shares YA Global received from Red Rock Pictures because they generated an infinite return; Mr. Brokaw viewed those comp shares for a SEDA where the issuer paid the commitment fee and then never made an advance request. An investment banker would take those fees into consideration. (Ex. 2002-R, ¶¶ 54, 66.)

6. Petitioners incorrectly claim that anomalies in the data have no material impact on Dr. Lerner’s overall conclusions; Dr. Lerner used data inconsistently, which produced inaccurate results.

Dr. Lerner claimed that he did not include any comp shares in his analysis; he testified that "we just simply left them out" of his analysis because they "are like an extremely tiny slice of pie." (Tr. 1158, 1165.) Mr. Brokaw determined that Dr. Lerner did include some comp shares and attributed a very high return to them, because some of those comp shares were paid by issuers who did not use their SEDAs or made very little use of the SEDAs thereby showing a very high return. (See Ex. 2002-R at ¶ 53.) Dr. Lerner identified at least one extraordinary return in his report, where the stock reflected a growth in the price of one stock by almost 60,000%. (See Ex. 3004-P at ¶ 20 and n. 20.) That single stock accounted for a yearly return of 467.22%; however, if that stock had been excluded form Dr. Lerner’s analysis, then yearly YA Global’s yearly stock appreciation would have been -32.21%. However, in any case in which YA Global held a position in a "loser" company that had negative stock appreciation, Dr. Lerner excluded that company, as well as the fees and interest earned from that company, form his analysis. (See Tr. 1079-82.) Dr. Lerner also justified excluding the "loser" companies because of his concern about the quality of transaction data available for those companies; however, as noted in note 20 of his report, Dr. Lerner did not exclude "winners" even if they reflected a stock price increase of 60,000%. The Court should afford little weight to Dr. Lerner’s analysis, which excludes all "loser" companies (those with equity losses) from his analysis yet includes a company with a 60,000% appreciation (Tr. 1219-20), even though he could not determine the accuracy of that extraordinary figure.

Petitioners argue in this context that the returns of YA Global indicate investment activity rather than business activity. The rate of return, however, is not relevant to the question before the court. The nature and extent of YA Global’s lending and underwriting/stock distribution activities are relevant to the question of whether YA Global engaged in a trade or business. The fact that YA Global received high rate with respect to its business with certain companies and losses from its business with other companies reflects that the niche market that YA Global targeted for its business.

B. Response to Petitioners’ Criticisms of Dr. Strebulaev

1. Response to petitioners’ assessment of Dr. Strebulaev’s Criticism #2

Dr. Lerner applied the Altman Z score to evaluate YA Global’s risk. VC funds (which Dr. Lerner has cited for analogy in a different context) are not evaluated using Altman Z scores. (Ex. 2004-R at ¶ 35.) Petitioners’ argue that "[w]hether VC funds use Altman’s Z scores has, of course no bearing whatsoever on their value as an indicator of the financial health of YA Global’s portfolio companies." (Pet’rs’ Brief at p. 238.) Respondent accepts Dr. Lerner’s testimony and petitioners’ statements acknowledging the difference between YA Global’s business and the activities of typical VC firms and the point that credit risk tools used by active lenders, of which an Altman Z score is one example, may be appropriate to a business such as YA Global’s.

2. Petitioners’ argument that Dr. Strebulaev’s Criticism #3 (i.e., that YA Global’s beta demonstrates that its investments were low risk) fails to consider the characteristics of YA Global’s portfolio and misconstrues Dr. Strebulaev’s points.

Petitioners criticize Dr. Strebulaev because he addressed YA Global’s beta in his report. Dr. Strebulaev noted that betas are a "bedrock concept in modem finance theory" and that beta should be considered "when evaluating a portfolio financial asset," such as YA Global. (Ex. 2004-R at ¶ 37.) Dr. Strebulaev considered betas because Dr. Lerner evaluated YA Global on a spectrum that included VC firms, and Dr. Strebulaev observed that empirical research shows that VC firms have a betta between 1 and 2.7. (Ex. 2004-R at ¶ 38.) Dr. Strebulaev considered 45 "one pagers" in evaluating this case, which consistently reported that YA Global had a very low beta and reflect a risk level "near that associated with risk free Treasury bonds." (See Ex. 2004-R at ¶¶ 37-38.) Dr. Lerner did not address beta in either of his reports and he did not even look at YA Global’s betas. (Tr. 1132-33.) The point remains that lower risk levels further distinguish YA Global from typical VC firms, which typically have a beta between 1 and 2.5.

3. Dr. Strebulaev’s remaining criticisms show that Dr. Lerner’s analysis ignored critical facts relevant to YA Global’s business

Dr. Strebulaev reviewed common characteristics of a VC firm and determined that YA Global lacked almost all of those characteristics. YA Global did not invest in early stage private companies with substantial potential growth, like VC funds generally do; instead it financed public companies most often with debt securities (e.g., convertible debentures) and lending arrangements, and also through SEDAs, which VCs generally do not do. (Ex. 2004-R at ¶¶ 40, 71, 73.) YA Global did not manage the issuers with which it entered into transactions. (Ex. 2004-R at ¶ 40.) Dr. Strebulaev quantified a number of characteristics of VC funds (screen a large number of potential investments, primarily invest in private companies, primarily invest in convertible preferred stock, long investment horizon, actively monitor and advise portfolio companies, typically take board seats, typical fund life of 10 years, structured as a limited partnership). (Ex. 2004-R at Fig. 8.) YA Global only met one of those factors; it was structured as a limited partnership.

Dr. Lerner mentions a "stale price problem" and petitioners speculate that the "stale price problem" is somehow correlated with a low beta, however, he did not provide any robust analysis to support his claim other than a nebulous assertion that stale stock prices may give rise to low betas. (Pet’rs’ Brief at p. 239.) Beta measures the sensitivity of a financial asset to market movements, such as the S& P 500. (Ex. 2004-R at ¶ 37.) One other reason YA Global could have reported a low beta would be to imply to potential investors that it was a stable place in which to invest — at least as compared to the S&P 500. At trial, Dr. Lerner conceded that he excluded YA Global’s transactions with "loser" companies, which had equity losses. Dr. Lerner also testified that he had significant data problems with those same companies, far more so than YA Global’s gain companies. (Tr. 1078-1082.) Dr. Lerner did not address these trade-related problems with regard to his staleness issue, even though they both relate, at least in part, to public information about YA Global’s trades of newly registered issuer stock. For instance, Dr. Lerner noted that he would sometimes see pink sheet stock — penny stocks — with $1 million per share values. (Tr. 1078.) Given those concerns about public trading information, as well as the large number of trades YA Global entered into, the Court should not afford any weight to the reliability of Dr. Lerner’s stale price analysis.

Petitioners contend that Dr. Strebulaev did not understand YA Global’s business because he relied, at least in part, on the SEDA FAQ. Dr. Strebulaev did consider the SEDA FAQ as part of his analysis but he also considered SEDA contracts. (See Ex. 2004-J at ¶ 72 and n. 101.)

Petitioners also imply that Dr. Strebulaev relied on Mr. Brokaw’s opening report. Dr. Strebulaev did not rely on Mr. Brokaw’s report; his opinion was based entirely on his own work. If petitioners thought otherwise, then they should have cross examined him on that topic.

V. YA Global’s activities do not fall within the trading safe harbors provided in section 864(b)(2).

For the trading safe harbors in section 864(b)(2) to apply, YA Global must have been "trading" in stocks and securities. Petitioners do not explain how YA Global’s activities constitute trading, other than reciting generalities about what constitutes "investing," "trading," and "effecting of transactions in stocks and securities." (Pet’rs’ Brief at pp. 242-43.)

In asserting that all of YA Global’s transactions fall with the definition of "trading in stocks and securities," petitioners first ignore the facts of the case as they relate to YA Global’s operations and transactions. For example, petitioners claim that YA Global’s purchases of convertible debentures fall within the definition. But YA Global did not simply "purchase" convertible debentures and promissory notes. A purchase and sale denotes a transaction in respect of preexisting property, such as and acquisition from a debt holder or through a public market. YA Global, on the other hand, originated loans, evidenced by convertible debentures and promissory notes, directly with its clients; the convertible debentures and promissory notes, with terms specifically reflecting the individual negotiations, came into existence and were issued as the result of the origination activities. YA Global was compensated for this service through interest, fees (both cash and stock), and discounts on conversions of debentures.

Similarly, "entering into a SEDA" is not simply a purchase of a security. A SEDA by its name is a stock distribution agreement and provides the issuing company with an underwriting and market access service. Again, YA Global was compensated through fees, whether or not the issuer ever drew down on the SEDA, and the spread between the price at which YA Global purchased the stock and the market price. As discussed at length in Respondent’s Brief at pages 279-87, originating loans and underwriting services do not qualify as "trading" for purposes of the trading safe harbors.

A. Petitioners misapply the (A)(i) Safe Harbor. YA Global was not an independent agent within the meaning of the (A)(i) Safe Harbor.

Petitioners altogether misrepresent and misapply the (A)(i) Safe Harbor. (Pet’rs’ Brief at p. 245.) Yorkville Advisors was not an "independent agent" as that term was interpreted in InverWorld, as petitioners propose, or as that term was intended to mean when Congress enacted the (A)(i) Safe Harbor (and modified it).

"Independent agent" under Treas. Reg. § 1.864-7

The (A)(i) Safe Harbor excludes from the definition of a U.S. trade or business "[t]rading in stocks or securities through a resident broker, commission agent, custodian, or other independent agent." In InverWorld, the court considered whether the taxpayer’s activities fell within the (A)(i) Safe Harbor. The court found the definition of "independent agent" under Treas. Reg. § 1.864-7 (defining "independent agent" for purposes of determining whether a foreign taxpayer has an office in the United States under section 864(c)(4)(B)) provided a "proper framework for interpreting the term ‘independent agent’ for purposes of section 864(b)(2)(A)(i)." InverWorld, T.C. 1996-301, 1996 WL 352998, *26.

As petitioners quote in footnote 16 (at page 142), an "independent agent" for purposes of Treas. Reg. § 1.864-7(d)(3)(i) is "a general commission agent, broker, or other agent on an independent status acting in the ordinary course of his business in that capacity." Status as an "independent agent" is made based on the facts and circumstances of each case, but without regard to any facts indicating ownership or control of the agent by the principal, or vice versa. Treas. Reg. § 1.864-7(d)(3)(ii). However,

Where an agent who is otherwise an independent agent within the meaning of subdivision (i) of this subparagraph acts in such capacity exclusively, or almost exclusively, for one principal who is a nonresident alien individual or a foreign corporation, the facts and circumstances of a particular case shall be taken into account in determining whether the agent, while acting in that capacity, may be classified as an independent agent.

Treas. Reg. § 1.864-7(d)(3)(iii).

In light of this latter provision, the court in InverWorld found that the taxpayer’s subsidiary, which was registered as an investment adviser with the SEC, was not an "independent agent." The subsidiary had few clients other than the taxpayer and the taxpayer’s clients, performed services almost exclusively for the taxpayer, had gross revenues that were almost exclusively derived from its arrangement with the taxpayer, and did not market its services to clients on its own. InverWorld, T.C. 1996-301, 1996 WL 352998, *27.

The facts in InverWorld are substantially similar to those in this case. Yorkville Advisors had few, if any, clients other than YA Global. During the years at issue, Yorkville Advisors operated only 4 other funds, three of which (HHF, MEP, and CRX) were merged into YA Global or terminated in 2006, and one of which (YA Global II) was formed in 2009 and participated in the same transactions as YA Global. (RPFF ¶¶ 504-505, 512, 514-516.) Yorkville Advisors performed services almost exclusively for YA Global during the years at issue (exclusively from mid-2006 through at least 2008), and nearly all of Yorkville Advisors’ revenues throughout the period was generated from activities performed for YA Global. (RPFF ¶¶ 510-511.) Hence, it was economically dependent on YA Global during the years at issue. Further, nothing in the record indicates that Yorkville Advisors marketed itself as an advisor to outside capital providers.

In addition, Yorkville Advisors was the general partner of YA Global in 2006 and 2007 and even when it was not the management and ownership of the general partner of YA Global and Yorkville Advisors substantially overlapped.

From all indications, YA Global was created as a vehicle to be managed by Yorkville Advisors and was not independent in no sense of the word. (Tr. 50:18-23.)

Consequently, Yorkville Advisors was not an independent agent for purposes of the (A)(i) Safe Harbor under the InverWorld test.

"Independent agent" under the (A)(i) Safe Harbor

Petitioners discount the application of Adda in analyzing the (A)(i) Safe Harbor. (Pet’rs’ Brief at p. 245 (stating, "Adda says no such thing, nor could it in light of the fact that Section 864(b)(2) was not enacted at the time Adda was decided.")

Before the current iteration of the (A)(i) Safe Harbor, however, section 211(b) of the 1939 Code provided for the exclusion from the definition of a U.S. trade or business "the effecting of transactions in the United States in stocks, securities, or commodities through a resident broker, commission agent, or custodian." This is essentially the (A)(i) Safe Harbor without the inclusion of "or other independent agent." Accordingly, Adda is on point.

In Adda, the Tax Court interpreted the predecessor to the (A)(i) Safe Harbor as not applying to a situation where a nonresident alien grants discretionary authority to a U.S. resident to deal in commodity futures for the nonresident alien’s account. Adda, 10 T.C. at 277-78. After Adda, Congress (in addition to adding "other independent agent" to the (A)(i) Safe Harbor as noted above) enacted a second safe harbor, the (A)(ii) Safe Harbor, which allows trading in stocks and securities for one’s own account through resident agents vested with discretionary authority. As explained more fully in Respondent’s Brief at pages 289-90, the express allowance for discretionary authority in the (A)(ii) Safe Harbor, but not in the (A)(i) Safe Harbor, indicates that a resident broker, commission agent, custodian, or other independent agent may not exercise discretion when trading pursuant to the (A)(i) Safe Harbor. The legislative history makes plain that a dealer (who is not eligible for the (A)(ii) safe harbor but can qualify for the (A)(i) safe harbor) "is specifically excluded from those who may grant discretionary authority and not be deemed to be conducting a business in the United States." R.H. Rep. No. 89-1450, at 13.

In this case, it is undisputed that Yorkville Advisors had full discretionary authority to conduct its activities on YA Global’s behalf in the United States.

Moreover, for the reason set forth in Respondent’s Brief at pages 291-97, YA Global had a U.S. office through, and by direction of which, its transactions were effected.

Accordingly, YA Global is not eligible for the (A)(i) Safe Harbor.

B. YA Global is not eligible for the (A)(ii) Safe Harbor.

Petitioners do not add any additional arguments to what they may have asserted in other sections, concluding that the (A)(ii) Safe Harbor clearly applies and YA Global was not a dealer as purportedly discussed in section III, and particularly III.B.3 of petitioners brief.

As discussed in Respondent’s Brief at pages 297-98, YA Global is not eligible for the (A)(ii) Safe Harbor because YA Global was a dealer in securities. Moreover, as discussed above, YA Global is not eligible for either safe harbor because its activities do not qualify as trading in stock or securities.

VI. Respondent did not err in determining the amount of the section 1446 withholding tax due from YA Global.

As explained in Respondent’s Brief and this Reply, respondent correctly determined that YA Global was engaged in the conduct of a U.S. trade or business for the years at issue. Respondent also correctly determined that (1) YA Global was a dealer in securities for purposes of section 475 and was required to include the unrealized gains and losses arising from the securities YA Global held at the end of the year in its income, (2) YA Global was not entitled to deduct approximately $46 million as an "interest write-off," and (3) any losses YA Global incurred in 2010 and 2011 were not sufficient to eliminate YA Global’s withholding tax liability. Respondent, therefore, correctly computed YA Global’s withholding tax liability.

A. Respondent appropriately applied section 475 to YA Global as YA Global was a dealer in securities.

Petitioners claim that respondent inappropriately applied section 475 to YA Global. (Pet’rs’ Brief at p. 247.) In support, petitioners offer little, if any, analysis other than a short survey of cases, without any explanation as to whether or how the cases apply to the facts in this case, and summary conclusions that YA Global did not make a market or have customers. (Pet’rs’ Brief at pp. 216-19, 247-48.)

Petitioners do not adequately address YA Global’s activities and the extent to which these activities implicate the rules under section 475, thus making response to petitioners’ position difficult. Moreover, petitioners ignore completely the largest portion (by volume) of YA Global’s business, i.e., lending. Petitioners mention only respondent’s position on underwriting and YA Global’s purchase and sale of stock, but they never address YA Global’s lending activities. And they never fully explain their position as to why section 475 does not apply to the underwriting business, which includes the purchase and sale of stock.

1. Petitioners fail to establish that YA Global was not a dealer in securities for purposes of section 475.

At pages 247 and 248 of their Brief, petitioners correctly recite the definition of a "dealer in securities," as set out in section 475(c)(1), as a taxpayer who either purchases securities from or sell securities to customers in the ordinary course of business or regularly offers to enter into, assume, offset, assign, or otherwise terminate positions in securities with customers in the ordinary course of business. Petitioners, however, do not address all that is required under section 475 to be a dealer in securities either under section 475(c)(1)(A) or (B). (See Resp’s Brief at pp. 339-43.)

Petitioners then conclude, "Regardless [of which provision respondent asserts] it is clear that YA Global fits neither." (Pet’rs’ Brief at pp. 248.) The only basis petitioners provide for this conclusion: YA Global had no customers. (Pet’rs’ Brief at pp. 248.) Despite indicating that this conclusion is "discussed in detail in Section III.B.3," petitioners never explain "in detail" their position. (Pet’rs’ Brief at pp. 248; Pet’rs’ Brief, Section III.B.3.) As noted, petitioners state summarily that YA Global did not make a market, connect buyers and sellers of stock, have a merchandising function, act as a middleman, or provide market liquidity. (Pet’rs’ Brief at pp. 218-19.) To the extent these summary statements constitute an explanation, that explanation, at best, addresses only customers in the context of YA Global’s underwriting activity and making a market in stock.

The explanation does not address customers in the context of YA Global’s lending activity. The explanation does not address the fact that section 475 only requires a dealer in securities to either buy or sell securities to customers, although dealers may both buy and sell, or the application of section 475 in the context of YA Global’s lending activity. YA Global conducted dealer activity just by purchasing securities from or selling securities to customers. For example, originating a loan is considered a purchase of a security from a customer for purposes of section 475(c)(1)(A). YA Global originated hundreds of loans with customers. (RPFF ¶¶ 148, 254. See Resp’s Brief at pp. 344-345.)

As explained in Respondent’s Brief at pages 344-348 and this Reply at III.B., YA Global did make a market in stock, did connect buyers and sellers of stock, did have a merchandising function, did act as a middleman, and did provide market liquidity, and was compensated for these activities with fees, discounted property, and spreads. YA Global filled a niche in the market for companies that were underserved by traditional lenders or investment banks, such as YA Global’s micro-cap and small cap publicly traded company customers. YA Global actively marketed its lending and capital raising services to potential customers, holding itself out to the public as being willing to originate loans in the form of debt and equity lines of credit and to purchase customers’ securities through SEDAs and sell the stock through the public markets. (RPFF ¶¶ 79, 93, 124-126, 130-131, 223.) YA Global made a profit not merely through a rise in prices of the underlying securities, but rather through a charge, a spread or mark-up as a middleman, and discounted stock prices and service fees. (RPFF ¶¶ 283-285, 297, 299-300, 303, 327-332; Ex. 324-J.)

At page 218, petitioners claim that had YA Global engaged in the activities petitioners list (e.g., making a market, connecting buyers and sellers), YA Global would have had to register as a broker-dealer, which "it neither did . . . nor was required to do." But petitioner ignores the fact that YA Global was deemed to be a statutory underwriter by the SEC, required registration statements to be executed by the portfolio companies before it would advance any funds under the SEDAs (making the stock immediately disposable on the open market), and required that the registration statements remain effective. YA Global made it clear that it intended to sell any stock it purchased through the SEDAs and did so earning a spread between the discounted prices at which it purchased the stock from the portfolio companies and the market prices at which it sold the stock in the public markets. (RPFF ¶ 56, 65, 117-118, 138, 229, 243-245, 328, 330-332, 334, 350-351, 356, 409; Ex. 322-J.) As mentioned above, YA Global created a niche market for the portfolio companies (a certain type of borrower) to raise capital by borrowing funds and selling their equity into the public markets.

2. Petitioners have not established that YA Global identified the securities as required by section 475.

At pages 248 and 249, petitioners contend that YA Global properly identified its securities as being held for investment in accordance with section 475(b)(1) when it included language in the securities purchase agreements and the SEDAs regarding these securities being purchased for investment purposes or acquired for investment only. Petitioners assert: "[T]here is nothing in the Code or regulations that requires a taxpayer to identify a security in any particular way. The only requirement is that it be done before the close of the day on which the security was acquired." (Pet’rs’ Brief at p. 249.) These assertions about identification under section 475 are incorrect. Petitioners in their Brief reference the possible exceptions to marking under section 475(b)(1), but they fail to address the identification requirement under section 475(b)(2) for securities subject to one of the exceptions listed in section 475(b)(1). (Pet’rs Brief at pp. 248-49.)

To timely identify a security under section 475(b)(2), the identification must be specific to section 475. Section 475(b)(2) provides:

A security shall not be treated as described in subparagraph (A), (B), or (C) of paragraph (1), as the case may be, unless such security is clearly identified in the dealer’s records as being described in such subparagraph before the close of the day on which it was acquired, originated, or entered into (or such other time as the Secretary may by regulations prescribe).

I.R.C. § 475(b)(2) (emphasis added). See also Treas. Reg. § 1.475(b)-2 (stating, "An identification of a security as exempt . . . does not satisfy section 475(b)(2) if it fails to state whether the security is described in — (1) Either of the first two subparagraphs of section 475(b)(1) . . . or (2) the third subparagraph thereof.") Stated differently, both the Code and regulations require the identification under section 475(b)(2) to include that the security is described in section 475(b)(1)(A), (B), or (C).

While the language in the securities purchase agreements and the SEDAs may indicate that the securities are being held for investment, this language is not an identification specific to section 475. It does not state that the security is described in one of the subsections of section 475(b)(1); it does not specify that the language is even applicable for federal tax purposes. This language was most likely added for securities law purposes. Consequently, the language does not meet the identification requirement of section 475(b)(2).

In addition to the requirement that an identification must be specific to section 475 as set forth in section 475(b)(2) and the regulations thereunder, additional administrative guidance makes clear that an identification must specify that the identification is for section 475 purposes. In Rev. Rul. 97-39, 1997-2 C.B. 62, Issue 6 provides that the identification must be made in, and retained as part of, the dealer’s books and records and must clearly show which security or hedge is being identified and that the identification is being made for purposes of section 475. Otherwise, Issue 6 does not require any special procedures to comply with the identification requirements under section 475; any reasonable method of identifying securities for taxpayers’ books and records is permissible. Issue 6 also identifies alternative methods that may be used instead of identifying each individual security. In addition, Issues 4 and 5 of the revenue ruling also provide that GAAP identifications are not dispositive for section 475 purposes and identifications under section 1236 do not cover section 475 identifications.

For federal tax purposes, the requirement that a particular identification be made with specific reference to a Code section or regulation is not unique to section 475. The regulations under Treas. Reg. § 1.1221-2(f), relating to identifications of hedging transactions, require specific identifications of hedges for tax purposes and makes clear that identifications for financial accounting or regulatory purposes are not acceptable for tax purposes. See also I.R.C. §§ 1236(a)(1) and 1256(e)(2).

Petitioners have failed to meet the identification requirements under section 475(b)(2); therefore, section 475 applies to the securities.

3. Petitioners’ claim that the increase in value associated with Compass Resources was not an increase in the value of a security is not supported by the record.

If respondent is correct that YA Global was a dealer in securities for purposes of section 475 and did not adequately identify its securities as held for investment, petitioners contend that the Court must decide "whether increases in unrealized value of certain assets that Respondent included as part of his mark-to-market adjustment . . . were in fact increases in unrealized value of ‘securities’ at all." (Pet’rs’ Brief at pp. 249-50.) It is unclear from Petitioners’ Brief to what "certain assets" (in the plural) petitioners are referring, and that this unrealized gain should not be recognized under section 475.

Petitioners contend that $103,852,872 of unrealized gain, as determined by respondent in the notice of Final Partnership Administrative Adjustment for 2009 (the "Section 475 Adjustment"), "is not in fact associated with any securities." (Pet’rs’ Brief at p. 250.) This assertion appears to be based on petitioners’ claim that the 475 Adjustment includes an unrealized gain of $116,308,517 attributable to YA Global’s interest in Compass Resources.

As petitioners note, the Section 475 Adjustment is derived from YA Global’s 2009 Form 1065, Schedule M-3 (Pet’rs’ Brief at p. 250.) Nothing in the record, however, establishes how YA Global calculated the amount shown on the 2009 Schedule M-3 or whether the unrealized gain of $116,308,517 attributable to Compass Resources was included in this calculation. The financial materials petitioners presented at trial are not consistent, and no witnesses testified as to their meaning. (Compare Ex. 4-J at YALIT000856, YA Global’s 2009 Schedule M-3 reporting at line 22 "[o]ther income item (loss) with differences (attach schedule)" of $103,852,672,⁵⁹ with Ex. 1285-J, YA Global’s asset reconciliation spreadsheet for 2009, showing at line 3055, column I a total unrealized gain of $69,331,668, with Ex. 289-J, YA Global’s 2009 financial statements, showing at page 0015 an "[i]ncrease in unrealized appreciation of investments and forward currency contracts for the year" of $115,625,880.)

Even if petitioners could show the Section 475 Adjustment took into account an unrealized gain of approximately $116 million with respect to Compass Resources (the "Compass Gain"), petitioners are wrong that this amount "was not attributable to any security that YA Global held." (Pet’rs’ Brief at pp. 250-51.) YA Global held several securities in Compass Resources at year end 2009: the Series A Convertible Loan ("Compass Loan"),⁶⁰ stock and warrants. Petitioners contend that the Compass Gain was "an amount recorded on YA Global’s books to account for the value associated with the likelihood that YA Global would be entitled to enter into a new funding arrangement with Compass." (Pet’rs’ Brief at p. 251 (emphasis in original).)

This assertion is not supported by the record. Petitioners misrepresent the facts and attempt inappropriately to use as evidence, for the truth of the matters asserted therein, exhibits that were admitted only for non-hearsay purposes.

Petitioners’ Factual Inaccuracies

At pages 251-52, petitioners provide a brief synopsis of the events that occurred in 2009 with Compass Resources. Petitioners recount that YA Global made a proposal, Deed of Company Arrangement ("DOCA") (which was later approved) for the recapitalization of Compass Resources and payment of Compass Resources’ creditors’ claims as part of Compass Resource’s voluntary administration. Petitioners, however, misrepresent YA Global’s proposal and its effect on the outstanding Compass Loans owed by Compass Resources to YA Global. Petitioners indicate that, as part of the recapitalization, YA Global would acquire new shares in Compass Resources and would agree to provide additional funding to Compass Resources. Petitioners then state, "The existing debt that Compass owed to the Fund and to Coffee House would be cancelled in the reorganization." (Pet’rs’ Brief at p. 252.)

"Cancellation" of YA Global’s existing debt implies, if not outright avers, that YA Global relieved Compass Resources of its obligation to repay the existing debt.⁶¹ This assertion is categorically incorrect. YA Global received shares of Compass stock in satisfaction of the loans made by YA Global to Compass. The resolution approved by Compass Resources’ shareholders read: "Shareholders approve the issue of 1,083,618,669 new fully paid ordinary shares to YA Global in full and final release of the debt owing to YA Global at 29 January 2009, (approximately $35,538,068 in total) in accordance with terms of the Proposal at a deemed issue price of $0.04. "(Ex. 867-J at p. 007 (emphasis added).) A "release" of debt is not the same as "cancellation" of debt. A debt is released when the creditor has been satisfied and paid in full; a debt is cancelled when the creditor relieves the debtor from its obligations to repay the debt. Indeed, YA Global had no leverage in the resolution of Compass Resources’ voluntary administration or in obtaining a majority interest in Compass Resources but for its role as a creditor of Compass Resources and its desire for the Compass Loan to be repaid, whether in cash or stock.

At page 254, petitioners assert that YA Global recorded the increase in value related to Compass Resources as an "other asset" on its books in 2009. Messrs. Franks and Schinik, Controller and Chief Financial Officer, respectively, testified as to the entries on YA Global’s 2009 asset reconciliation spreadsheet. This testimony, and the 2009 asset reconciliation spreadsheet, however, are undermined by YA Global’s actual treatment of Compass Resources on its financial statements. On its 2009 financial statements, YA Global treated its interest in Compass Resources as a convertible debenture, and not as any other asset, and reported the value of the Compass Loan consistently with the value range in the VRC Report. (Ex. 289-J at pp. 005, 009; RPFF ¶¶ 496, 497.) YA Global reported on its 2009 financial statements the value of the Compass Loan as $148,269,798. (Ex. 289-J at pp. 005.) This is the same value petitioners claim is a separate asset, i.e., YA Global’s likelihood that it would be entitled to enter into a new funding arrangement with Compass Resources that would render YA Global a controlling shareholder in Compass Resources. (Ex. 289-J at p. 005.)

Petitioners’ Inappropriate Use of the VRC Report

At pages 253-54, petitioners rely on a valuation report prepared by Valuation Research Corporation ("VRC"), Exhibit 869-P, to show that VRC valued YA Global’s likelihood of being entitled to enter into a new funding arrangement with Compass Resources. Petitioners spend an entire page describing what VRC did and what VRC’s report showed.

This use of Exhibit 869-P violates the Court’s ruling that Exhibit 869-P would be admitted, over respondent’s hearsay objection, solely for non-hearsay purposes. The Court relied on petitioners’ counsel’s representation that petitioners did not care whether the contents of the report were true.

Now petitioners are citing Exhibit 869-P precisely to show what VRC valued. Petitioners try to rationalize what they are doing by creating some groundless distinction between what VRC valued and what YA Global believed VRC valued, stating:

The VRC report is not discussed herein in order to prove the truth of its contents. Instead, the VRC report is described for the non-hearsay purpose of showing the basis for the asset gain included in YA Global’s books in 20009 [sic] by its accounting and finance team.

(Pet’rs’ Brief at p. 253, fn 97.)

Showing "the basis for the asset gain included by YA Global" requires the statements in the VRC report to be accepted as true. Specifically, it requires petitioners’ assertion that VRC valued YA Global’s likelihood of being entitled to enter into a new funding arrangement with Compass Resources, to be true. This is hearsay and is inadmissible. Fed. R. Evid. 802. The VRC report is in the nature of an expert report, and an expert report without the testimony of the expert is inadmissible hearsay. Van Der AA Investments, Inc. v. Commissioner, 125 T.C. 1, 6 (2005).

Petitioners did not call a representative from VRC to testify as to its valuation and the asset it valued. Consequently, respondent did not have an opportunity to cross-examine the VRC representative on the report or the asset that petitioners are contending VRC valued. Rather, they called an expert Charles Lundelius to opine as to what VRC valued.⁶² It can be presumed, by petitioners’ failure to offer testimony of a VRC representative, that such testimony would not support petitioners’ claim. See Wichita, 6 T.C. at 1165.

In any event, what has been established by the record is that YA Global reported a value of $148,269,798 on its 2009 financial statements for the Compass Loan under the heading "Convertible Notes and Debentures." (Ex 289-J at p. 005, 009; RPFF ¶¶ 496, 497.) There is no issue that the Compass Loan was held by YA Global at year end 2009. The Compass Loan is a security under section 475(c)(2)(C). Petitioners now assert a position inconsistent with YA Global’s own financial reporting. Petitioners, however, have not provided evidence to establish that the unrealized gain attributable to Compass Resources was for anything other than the Compass Loan, including the creditors’ rights arising from the loan.

Petitioners’ Incorrect Statements Regarding Values at Year End

Petitioners assert that the only securities attributable to Compass Resources held by YA Global at year end 2009 were YA Global’s shares of stock, warrants and convertible debt, and because of Compass Resources’ insolvency and receivership, these securities were worthless. Petitioners conclude from this that (1) the value of the interest YA Global held in Compass Resources was not attributable to any security at all and (2) the interest VRC valued was "merely the potential that [YA Global] would be entitled to acquire stock of Compass as part of the recapitalization of the company if [the DOCA] were approved." (Pet’rs Brief at pages 254-255). Petitioners’ assertions are wrong.

Petitioners attempt to confuse the issue as to whether YA Global held any securities that were subject to marking under section 475 and whether those securities had any value at year end 2009. By arguing that the unrealized gain from 2009 attributable to Compass Resources was not from a security, but rather was from a separate asset, petitioners ignore the fact that the Compass Loan was a security under section 475(c)(2)(C) and it was subject to marking at year end 2009. The Compass Loan had value as demonstrated by the fact that YA Global reported a value for that loan of $148,269,798 on its financial statements for the 2009 year. (Ex. 289-J at pp. 005)

Petitioners also ignore the fact that YA Global had creditors’ rights with respect to the Compass Loan, and those rights provide value for the Compass Loan in the voluntary administration. YA Global took those creditors’ rights into consideration when proposing the DOCA, in which the Compass Loan would be exchanged for stock comprising a majority interest in Compass Resources in full release of the underlying Compass Loan. When determining the fair market value of the Compass Loan at year end 2009, YA Global looked to what it knew about the Compass Loan at that point in time. The DOCA had been proposed in 2009 and YA Global believed there was a 90% probability the DOCA would be approved. The value reported by YA Global for the Compass Loan appears to reflect the fact that YA Global took into consideration the value of the exchange of the debt for stock. Petitioners’ assertion that the Compass Loan was worthless also ignores the fact that the Compass Loan had liquidation value. (Ex. 870-J at pp. 0012-0013; Ex. 871-J at p. 0016; Ex. 3001-P at App. C (p. 49).)

In addition, shares of Compass Resources stock held by YA Global at year end 2009 are securities under section 475(c)(2)(A). The warrants held by YA Global are securities under section 475(c)(2)(E). The shares of stocks and warrants had to be valued at year end. Petitioners also failed to address how the values of the shares of stock and warrants it held at year end 2009 are affected by the DOCA proposal. Regardless, respondent does not contest petitioners’ allocation of the entire value reported on its financial statement to the Compass Loan.

Petitioners are incorrect in their assertions that the Compass Loan, the stock and warrants have no value at year end 2009.

B. YA Global was not entitled to deduct its claimed loss with respect to interest receivables for 2009; YA Global correctly accrued interest for the taxable year 2009.

1. YA Global was not entitled to deduct its claimed loss for 2009 under section 165.

Petitioners assert, at page 255 of their Brief, that YA Global sustained losses "in connection with interest receivables that became uncollectible." In their pretrial memorandum, petitioners cited to both section 165 and 166 as bases for allowing the deduction for the write-off of accrued interest. (Pet’rs’ Pretrial Memo, at p. 75.) Now, they rely only on section 165 as the basis for YA Global’s entitlement to a deduction for the alleged losses and declare, without explanation, section 166 to be inapplicable.

a. Deduction of claimed loss under section 165 is precluded.

Petitioners summarily dismiss the applicability of section 166 at page 256 of their brief and assume, without explanation, the applicability of section 165. They incorrectly assert that an accrual-basis taxpayer may deduct any receivable that becomes uncollectible, as an uncompensated loss under section 165.

In making this assertion, petitioners ignore well settled law. As noted in Respondent’s Brief at pages 354-55, a bad debt is deductible under section 166 or not at all. Tharp v. Commissioner, T.C. Memo. 1972-10, 31 T.C.M. (CCH) 22, 24 (1972) (citing Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934)). Stated differently, if the amount being deducted as a loss represents a debt for purposes of section 166, the loss must be tested under section 166, and a remedy under section 165 is precluded. See Tharp, T.C. Memo. 1972-10, 31 T.C.M. (CCH) at 24. "The making of the specific provision as to debts [former section 234(a)(5) of the Revenue Act of 1918] indicates that these were to be considered as a special class and that losses on debts were not to be regarded as falling under the preceding general provision [former section 234(a)(4)⁶³]." Spring City Foundry Co. v. Commissioner, 292 U.S. 182, 189 (1934).

YA Global’s interest receivables are debts owed to YA Global, and losses relating to them should be analyzed under section 166, not section 165. Petitioners repeatedly express their position that YA Global is entitled to take losses "sustained in connection with interest receivables that became uncollectible." (Pet’rs’ Brief at p. 255.) As noted, petitioners dismiss the applicability of section 166 without any explanation as to why YA Global’s interest receivables are not debt or why section 166 does not apply.

By definition, the term "receivable" refers to a debt owed by a customer, employee, supplier, or other debtor. See The Law Dictionary (featuring Black’s Law Dictionary Free Online Legal Dictionary 2d e) (defining "receivable" to be an "amount due from a customer, employee, supplier or other source" (found at https://thelawdictionary.org/receivable/ viewed on February 22, 2021). See also Robson v. Commissioner, T.C. Memo. 2000-201, 79 T.C.M. (CCH) 2225, 2000 WL 863453, *7-8 (quoting Black’s Law Dictionary (7th ed.1999) for definition of "accounts receivable" as "[a]n account reflecting a balance owed by a debtor; a debt owed by a customer to an enterprise for goods or services" and quoting Weygandt et al., Accounting Principles 324 (3d ed.1993) for explanation of "receivables" in terms of account receivables (amounts owed by customers on account) and other receivables, such as interest receivables definition of "receivables" as "amounts due from individuals and other companies")).

Without an alternative definition of "receivables" offered by petitioners, YA Global’s interest receivables are debt, and section 166 applies for purposes of determining whether YA Global is entitled to a deduction for interest deemed uncollectible. As discussed in Respondent’s Brief at page 355, for YA Global to be entitled to a deduction under section 166, petitioners must establish that the debts underlying YA Global’s interest receivables became worthless in 2009 or that the accrued interest income became uncollectible, which petitioners failed to do.⁶⁴ See Hunt v. Commissioner, T.C. Memo. 1989-335, 57 T.C.M. (CCH) 919, 943-44 (1989) (citing Spring City Foundry Co. v. Commissioner, 292 U.S. 182 (1934)); Rev. Rul. 2007-32, 2007-1 C.B. 1278; Rev. Rul. 80-361, 1980-2 C.B. 165.

Petitioners ignore the long-standing rule under Spring City Foundry, calling for analysis of debts under section 166. Only one of the three cases cited by petitioners at page 256, Hardaway Construction Co., Inc. v. United States, 852 F.2d 174 (6th Cir. 1988), addresses the deduction of a loss relating to income reported in a previous year that was not collected. But even Hardaway Construction did not involve a debt owed to the taxpayer for purposes of section 166, which is why the court allowed the taxpayer to take a deduction under section 165.

Hardaway Construction explicitly addresses the distinction between losses under section 165 and bad debt losses under section 166. Before addressing the main issue, i.e., whether the taxpayer could take a loss under section 165, the court first had to decide, based on the operative contract, whether the taxpayer had an unconditional right to the income. The court stated:

If the contract created an unconditional right to receipt of the builder’s fee, as the government contends, the taxpayer loses; the taxpayer admittedly made no effort to collect the fee, and if the taxpayer had a matured right to the money, it could not claim a loss without having attempted to enforce that right. If the contract created only a conditional right to the fee, on the other hand, as the taxpayer contends, the taxpayer wins; all possibility that the "condition" would be met disappeared in 1975, and under the taxpayer’s interpretation of the contract there was nothing to enforce.

Hardaway Construction, 852 F.2d at 175-76. The court found that the taxpayer did not have a right to receive the fee reported as income in the previous year, i.e., the fee was not a debt owed to the taxpayer. Because the taxpayer reported the fee in income in a previous year but was never going to receive the fee, it could claim a loss under section 165. Id. at 181. This holding is consistent with Tharp and Spring City Foundry, as the fee the taxpayer in Hardaway Construction reported as income was not a debt owed to the taxpayer, and is inapposite to the facts with respect to YA Global’s interest write-off deduction in 2009, as YA Global’s interest receivables are debts for purposes of section 166.

The other two cases cited by petitioners, James v. United States, 366 U.S. 213 (1961) and Barker v. Magruder, 95 F.2d 122 (D.C. Cir. 1938), address whether ill-begotten gains constituted taxable income in the year received or accrued. In both cases, the courts recognized a long-standing rule that requires a taxpayer "who derives profit in a particular year to return it as income in the year when received — even though it may be claimed he is not entitled to retain the money and even though he may be ultimately adjudged liable to restore its equivalent." Barker, 95 F.2d at 124. See also James, 366 U.S. at 220. Petitioners fail to explain how this rule has any application to the facts relating to YA Global’s interest receivables. The specific issue here is not whether YA Global was required to report the income but whether once reported, YA Global was entitled to deduct a loss for amounts it deemed uncollectible.

In James, the Supreme Court considered whether embezzled funds were to be included in income in the year the funds were misappropriated.⁶⁵ At the time of James, another Supreme Court case had concluded that embezzled money did not constitute taxable income because the taxpayer did not have a legal claim of right to the money. The Court essentially reversed its stance on this issue, finding the previous case to have been wrongly decided. James, 366 U.S. at 220. The dicta on which petitioners seem to rely addresses the situation where, hypothetically, the embezzled funds or other income mistakenly or illegally received (not to be confused with accrued) must be returned. In that instance, as the court stated, the taxpayer may deduct as a loss the amount repaid in the year the repayment was made. Id. at 219-220. James is not inconsistent with Tharp or Spring City Foundry. The income reported by the taxpayer in James did not represent a debt owed to the taxpayer. James also does not elucidate any standard applicable to the facts with respect to YA Global’s interest receivables, as YA Global had not actually received the interest when YA Global reported it as income.

In Barker, the court considered whether uncollected accrued usurious interest constituted taxable income when it was accrued. The court found that the usurious interest was taxable when accrued because of the existing probability of such interest actually being received by the taxpayer. Barker, 95 F.2d at 124-25. In dicta, the court noted that a taxpayer could deduct any amount received and included as income on the taxpayer’s return, but which was later adjudged to be usurious and legally not collectible. Barker, 95 F.2d at 123-24. Because Barker dealt only with the accrual of usurious interest, it does not appear relevant to the facts relating to YA Global’s deduction of uncollectible interest receivables. To the extent that the dicta in Barker offers any insight on the deductibility of YA Global’s uncollectible interest receivable under section 165, which respondent does not believe it does, the dicta is consistent with Tharp or Spring City Foundry. The income reported by the taxpayer in Barker did not represent a debt for purposes of section 166 because the debt arising from the usurious interest was not legally enforceable. Unlike the taxpayer in Barker, YA Global has a legally enforceable right to the interest accrued.

The holdings in the cases petitioners cite do not support YA Global’s being entitled to take a loss deduction under section 165 for its interest receivables it deemed uncollectible. YA Global’s interest receivables represent debts owed to YA Global and whether YA Global has a loss with respect to those receivables must be measured under section 166 with respect to bad debts, not section 165.

b. Even if the Court were to determine that section 165 were applicable, petitioners have not established that YA Global’s interest receivables were deductible under section 165.

Even if the Court were to entertain petitioners’ claim with respect to section 165, petitioners have not offered sufficient evidence and/or specific instances that YA Global suffered any losses during 2009. Petitioners’ attempt to rely on the "Great Recession," self-serving declarations of "abandonment," and outdated SEC filings of its clients (Pet’rs Brief at pp. 257-259) is unpersuasive and insufficient to meet their burden that YA Global sustained a loss and that the loss was sustained in 2009.

Under section 165(a), a taxpayer may deduct any loss sustained during the taxable year but not compensated for by insurance or otherwise. To be deductible, the loss must be evidenced by closed and completed transactions, fixed by identifiable events, and actually sustained during the taxable year. Treas. Reg. § 1.165-1(b).

Generally, a "closed and completed transaction" occurs upon a sale or other disposition of the property for which a taxpayer claims a loss. The requirement can be met by a showing that the taxpayer abandoned the property or that the property became worthless. Tucker v. Commissioner, 841 F.3d 1241, 1249 (11th Cir. 2016). No sale or other disposition took place with respect to YA Global’s interest receivables, so petitioners must show abandonment or worthlessness of the interest receivables. Petitioners have shown neither.

Even if section 165 were to be applicable to YA Global’s interest receivables, petitioners would have to establish abandonment, i.e., that (1) YA Global intended to abandon the interest receivables and (2) YA Global made an affirmative act of abandonment. Citron v. Commissioner, 97 T.C. 200, 208-09 (1991). YA Global’s interest receivables are intangible assets; consequently, YA Global cannot demonstrate actual physical abandonment. Proving abandonment of an intangible asset requires more than mere self-serving declarations of an intent to abandon an asset and the write-off of the asset (Pet’rs’ Brief at p. 258); it requires an express manifestation of abandonment. Citron v. Commissioner, 97 T.C. 200, 209-10 (1991) (finding abandonment of partnership interest requires express manifestation). See also Rev. Rul. 2004-58, 2004-1 C.B. 1043 (analyzing when a taxpayer may deduct the costs of acquiring and developing creative property). "The ‘identifiable event’ must be observable to outsiders and constitute ‘some step which irrevocably cuts ties to the asset.’" United Dairy Farmers, Inc. v. United States, 267 F.3d 510, 522 (6th Cir. 2001) (quoting Corra Resources, Ltd. v. Commissioner, 945 F.2d 224, 226-27 (7th Cir. 1991)). "[T]he abandoning party must manifest an intent to abandon by some overt act or statement reasonably calculated to give a third party notice of the abandonment." Echols v. Commissioner, 935 F.2d 703, 707 (5th Cir. 1991) (quoting Echols v. Commissioner, 93 T.C. 553, 557-58 (1989).

YA Global did not take any contemporaneous actions expressly showing to others that it was abandoning its interest receivables, and petitioners, at trial and on brief, have not offered evidence of any such express manifestation. The record does not include any evidence that YA Global forgave the interest (or the debt underlying the interest), relinquished its right to collect the interest or to enforce the underlying debt, or otherwise cut ties with the interest receivables. (Entire record.) In fact, as of 2009, YA Global had ongoing legal action with companies for which it claimed losses, including actions to collect on unpaid obligations. See Cobalis Corp. v. Cornell Capital Partners, LP, 2011 WL 4962188, *2-3 (D. N.J. 2011) (describing history of bankruptcy and Cornell Capital’s efforts to get repaid and/or foreclose on collateral)⁶⁶; YA Global Investments, LP v. McKenzie Bay International Ltd., 2010 WL 398379 (D. N.J. 2010) (describing action brought by YA Global for unlawful interference with its attempts to exercise its conversion rights). See also In re: Teleplus World, U.S. Bankruptcy Court, S.D. Fla. Case No. 09-13799 (where YA Global, as a creditor of Teleplus World, filed a limited objection to the Teleplus World’s emergency motion to use of cash collateral filed in Teleplus World’s Chapter 11 bankruptcy proceeding); In Re: TXP Corp., U.S. Bankruptcy Court, N.D. Tex. Case No. 09-43659 (where YA Global, as a creditor of TXP Corp., filed an objection to TXP’s motion for various orders in TXP’s Chapter 11 bankruptcy proceeding).

To establish worthlessness, "a taxpayer must demonstrate ‘his subjective determination of worthlessness in a given year, coupled with a showing that in such year the asset in question is in fact essentially worthless.’" Tucker, 841 F.3d at 1251 (quoting Echols v. Commissioner, 935 F.2d 703, 708 (5th Cir. 1991)). Petitioners have not shown the worthlessness of YA Global’s interest receivables or that 2009 was the year in which YA Global’s interest receivables became worthless.

For the first prong relating to YA Global’s "subjective determination of worthlessness," petitioners have offered the write-off of the interest receivables and one set of valuation committee minutes. Although meetings of YA Global’s valuation committee were regularly convened to assess and monitor the value of its assets, the record includes minutes of only one such meeting. (RPFF ¶¶ 465; Ex. 1266-J; Resp’s Obj. to Pet’rs’ PFF ¶¶ 228, 231.) The minutes for this November 24, 2009 meeting, Exhibit 1266-J, mention only 14 of the companies listed on Exhibits 1289-P and 1290-P and show that the valuation committee identified that collection was unlikely with only 3 of the 14 companies. These minutes, therefore, show that the valuation committee did not determine the remaining 43 companies to be worthless. It can be presumed, by petitioners’ failure to present other valuation committee meeting minutes, that any other minutes of the valuation committee would not support a subjective determination of worthlessness for these companies or for any other company listed on Exhibits 1289-P or 1290-P. See Wichita, 6 T.C. at 1165.

For the second prong relating to objective indicia of being essentially valueless, again petitioners offer only spreadsheets and generally outdated SEC filings in support. Petitioners make a general appeal to the "Great Recession" at page 258 of their Brief but do not offer anything of substance. Petitioners cannot rest on this general circumstance alone to establish a loss.

The Board and the Courts may take judicial notice of a business depression and require less specific facts to prove a loss when a depression is current. This does not mean, however, that a taxpayer can justify a loss deduction by merely offering testimony that business generally is depressed or stagnant.

Rhodes v. Commissioner, 100 F.2d 966, 969 (6th Cir. 1939). Petitioners then appeal to outdated filings or bankruptcies of their clients. As shown in MCM Investment Management, LLC v. Commissioner, T.C. Memo. 2019-158, 118 T.C.M. (CCH) 437 (2019), a case on which petitioners rely, this evidence alone is not sufficient to establish worthlessness. In MCM Investment, the taxpayer presented a wealth of evidence showing that the asset at issue had no liquidating value or potential future value in the year of the claimed loss and pointed to no less than 8 identifiable events supporting a finding of worthlessness.

Petitioners provide a chart (Pet’rs’ PFF ¶ 232) allegedly supporting its claim with respect to 22 of the 44-46 companies identified on Exhibits 1289-P and 1290-P for which YA Global wrote off the interest receivables. The evidence primarily consists of one filing by each debtor where the debtor’s auditor qualified the financial statements for doubt as to the debtor’s ability to continue as a going concern and where petitioners allege the debtor’s financial statements reflect "substantive negative cash flow."⁶⁷ The significance of this "substantial doubt" qualification is completely unexplained as petitioners did not offer any testimony about it, plus many of the companies listed in petitioners’ chart received the "substantial doubt" qualification long before the 2009 taxable year, the year YA Global claimed losses. Below is a chart of the companies with "substantial doubt" qualifications for periods ending before 2009.

Company	Ex. No.	Going Concern Qualification	Bankruptcy or Other Proceeding
Cobalis	1427-J	2002-2007	2007
Earth Biofuels	1430-J	Qtr 9/30/2008
Falcon	1439-J	Qtr 9/30/2006
Futuremedia	1443-J	FYE 6/30/2007
Handheld	1449-J	Qtr 9/30/2008
Ignis	1458-J	FYE 6/30/2008
Innova	1474-J	Qtr 9/30/2007
Isonics	1478-J	Qtr 10/31/2008
iVoice	1481-J	FYE 12/31/2008
McKenzie Bay	1499-J	Qtr 6/30/2006
Pacific Gold	1525-J	Qtr 9/30/2008
Poseidis	1527-J	Qtr 5/31/2006
Savi	1535-J	Qtr 9/30/2007
Tech Labs	1549-J	Qtr 3/31/2007
Teleplus	1551-J	Qtr 9/30/2008
TXP Corp.	1560-J	FYE 12/31/2007
US Helicopter	1562-J	Qtr 9/30/2008	no bankruptcy at page cited
Wherify	1566-J	Qtr 3/31/2008	no bankruptcy at page cited
	1568-J	FYE 6/30/2006
	1569-J	FYE 6/30/2007

YA Global made a loan to Handheld Entertainment, Inc. in 2007 (and perhaps others) despite a "substantial doubt" qualification. (Ex. 849-J. See also Resp’s Obj. to Pet’rs’ PFF ¶ 232.)

Petitioners cited to SEC filings showing 5⁶⁸ of the 22 companies as being in default. (Pet’rs’ PFF ¶ 232.) Petitioners’ citations are misleading. For example, for Falcon Natural Gas, petitioners point to Exhibit 1439-J at page 11. The information reported does not reflect a current default on the part of Falcon Natural Gas; rather it reflects a default on notes outstanding in 2005, for which an agreement was reached for Falcon Natural Gas to repay the notes. For Futuremedia, petitioners point to Exhibit 1443-J, which reports a technical default for failing to register its shares and not a default for failure to make required principal or interest payments. Further, most of the defaults occurred before 2009.

Also, petitioners cited to SEC filings showing only 2⁶⁹ of the 22 companies were in bankruptcy or similar proceedings. (Pet’rs’ PFF ¶ 232.) One bankruptcy, Cobalis, was filed in 2007 and was still ongoing after 2009. Cobalis, 2011 WL 4962188, *2-3. The other was Compass Resources, which is discussed at Part VI.A.3.

Even if a company filed for bankruptcy in 2009, YA Global can claim a loss only if there exists no reasonable prospect of recovery. See Treas. Reg. § 1.165-1(d)(2)(i). If an event occurs which may result in a loss and, in the year of such event, "there exists a claim for reimbursement with respect to which there is a reasonable prospect of recovery, no portion of the loss with respect to which reimbursement may be received is sustained, for purposes of section 165, until it can be ascertained with reasonable certainty whether or not such reimbursement will be received." Treas. Reg. § 1.165-1(d)(2)(i). For example, Compass Resources entered into voluntary administration in January 2009, but during that same year, YA Global made a proposal which would require Compass Resources to repay the outstanding loans owed to YA Global with shares of Compass Resources stock. YA Global believed that this proposal had a 90% chance of being approved, and YA Global’s proposal was, in fact, approved. Moreover, in light of YA Global’s proposal, VRC estimated the value of Compass Resources as of September 2009 to be x. Accordingly, YA Global cannot claim a loss with respect to Compass Resources as YA Global had a reasonable prospect of being repaid.

Petitioners have not provided sufficient evidence to establish YA Global’s entitlement to a deduction under section 165 or 166. Even if petitioners’ arguments were compelling, they have offered evidence with respect to less than half of the companies identified on Exhibits 1289-P and 1290-P. They cannot use this evidence to establish YA Global’s entitlement to the claimed loss with respect to the remaining debts.

2. Petitioners have not established the interest income accrued in 2009 was not collectible and was not properly accrued.

Petitioners argue, apparently in the alternative, at pages 259 through 261 of their Brief, that YA Global was not obligated to accrue interest income of $17,137,938 in 2009 because the interest was not collectible at the time the accrual arose. The only bases for this argument seem to be the "Great Recession" and the alleged large amount of interest remaining unpaid. (Pet’rs’ Brief at p. 261.) According to petitioners, in light of these two facts, "it would not be reasonable for YA Global to expect that it would receive $17,137,938." (Id.) This argument is unavailing and is not sufficient to meet the standards for establishing uncollectibility.

As discussed in Respondent’s Brief at page 356, a taxpayer must accrue income when all the events have occurred which fix the right to receive such income and the amount thereof can be determined with reasonable accuracy (the "all events" test). Treas. Reg. § 1.451-1(a); Treas. Reg. § 1.446-1(c)(1)(ii). The exception to the "all events" test, allowing a taxpayer to avoid accrual when the income item is uncollectible at the time the right to receive the income arises, is strictly construed. European American Bank and Trust Co. v. United States, 20 Cl. Ct. 594, 605 (1990), aff’d per curiam, 940 F.2d 677 (Fed. Cir. 1991). Doubt as to collectibility must be substantial and greater than the mere possibility of default on the debt. Hoffinan v. Commissioner, T.C. Memo 1989-154, 57 T.C.M. (CCH) 51, 54 (1989). "In fact, it has been said that to prevent accrual because of doubtful collectibility there must be a definite showing that the insolvency of the debtor makes receipt improbable." Jones Lumber Co. v. Commissioner, 404 F.2d 764, 766 (6th Cir. 1968) (citing Georgia School-Book Depository, Inc. v. Commissioner, 1 T.C. 463 (1943)).

Petitioners cite to Chicago and North Western Railway v. Commissioner, 29 T.C. 989 (1958), as support for their position that the large amount of unpaid debts and the "Great Recession" are enough to establish uncollectibility. Petitioners are incorrect and misrepresent the court’s holding. The court took into account several factors in reaching its conclusion.

[I]n view of the fact that both the debtor and creditor directed that payments made by the debtor by first applied to the earliest debts, we think that, in determining whether the current interest falling due in 1942 and 1943 would be paid within a reasonable time thereafter, we must take into consideration the large amount of past due debts owed by Omaha to petitioner, together with the facts that Omaha was hopelessly insolvent and that the sudden increase in Omaha’s earnings was largely due to war conditions and probably would not continue with the ending of hostilities. Taking all of this into consideration, together with the entire record, we hold that the respondent erred in determining that petitioner should have accrued as income, interest due from Omaha.

Chicago and North Western Railway v. Commissioner, 29 T.C. at 996-97. (emphasis added). As reflected in this opinion, the court found the insolvency of the debtor to be a critical factor.

Petitioners did not propose findings or make arguments that the debtors listed in Exhibits 1289-P and 1290-P were insolvent in 2009. Only two of YA Global’s debtors filed for bankruptcy, and with respect to both, YA Global had a means for collecting, at least in part, on the outstanding debts. Further, having a large amount of unpaid debts is not the same as having a large amount of past due debts. Petitioners did not propose findings or make arguments that the debts for which YA Global accrued income, but now seeks a loss, were past due.

In an attempt to shore up their position, petitioners make a distorted comparison of YA Global’s December 2009 interest receipts to YA Global’s overall interest accruals as of December 2009. It is unexplained why comparing one month in 2009 to the previous years’ accruals plus 2009’s accruals is informative of any point. Interest receivables do not demonstrate past due debts. To the extent this is even a point worth considering, the comparison should at least be between the interest received for the entire year and the accrued interest receivables. YA Global received $25.2 million of interest for the entire year of 2009, which is roughly 35% of the total accruals as of December 29. (Exhibit 1289-P (sum of cell D2 on each monthly tab).)

Moreover, YA Global received interest income with respect to several of the notes listed on Exhibit 1290-P. In fact, YA Global received a total of almost $3 million in interest income. (Ex. 1290-P at Tab "Income (Rllfwd)" (sum of columns H, J, L, N, P, R, T, V, X, Z, AB, AD).) It is incongruous for YA Global to claim doubt as to collectibility on these notes in 2009 when it actually received interest payments in 2009. Also as reflected on petitioners’ chart at petitioners’ proposed finding 232, only a handful of companies were in default on their loans, which indicates that the most of companies were meeting their payment obligations. Finally, YA Global identified all, but two,⁷⁰ notes on Exhibit 1290-P, as having value as of December 31, 2009. (Ex. 1285-J.)

Petitioners have failed to establish the interest that was accrued in 2009 to be uncollectable.

C. Respondent’s holding YA Global liable for withholding tax which YA Global was required, but failed, to pay is not a windfall; respondent properly computed YA Global’s liability for the section 1446 withholding tax.

Petitioners complain that by holding YA Global accountable for withholding tax that it was required to pay but did not, respondent somehow is benefitting from a windfall. Petitioners invoke what seems to them the inequity of requiring YA Global to pay withholding tax for 2006 through 2009 when, according to petitioners, YA Global suffered significant losses over the six-year period from 2006 through 2011. According to petitioners, "[e]ven if YA Global were engaged in a USTB, Respondent’s claims would be excessive." (Pet’rs’ Brief at p. 262.) Both the factual and legal premises for this argument are flawed.

Factual Inaccuracies

Factually, petitioners misstate the losses of YA Global’s investors. At page 261, petitioners claim that YA Global’s investors lost $145 million, which includes $65 million of management and incentive fees paid directly by YA Offshore. (Pet’rs’ Brief at p. 262 n. 101.) This calculation is incorrect.

First, limiting the analysis to only the six-year period at issue is arbitrary and does not provide an accurate picture of YA Global’s performance. From inception through 2011, YA Global had an overall net income of $122,837,045, using the amounts reported on YA Global’s financial statements, as follows:

	Net Income	Ex. No.
2001	$1,879,284	281-R at p. 006
2002	2,072,640	282-R at p. 005
2003	11,107,740	283-R at p. 007
2004	21,267,807	284-R at p. 007
2005	51,465,356	285-R at p. 0010
2006	101,271,742	286-J at p. 0013
2007	122,436,158	287-J at p. 0013
2008	61,266,616	288-J at p. 0016
2009	14,403,832	289-J at p. 0015
2010	(207,299,911)	290-J at p. 005
2011	(57,034,219)	291-J at p. 005
Total	$122,837,045

Second, even assuming that the six-year period at issue is the proper period to consider, petitioners miscalculate YA Global’s losses. YA Global had an overall income of $84,745,608 for the six-year period, when taking into account respondent’s adjustments.⁷¹ This amount is calculated as follows:

	Net Income	Respondent’s Income Adjustments	Ex. No.
2006		$102,861,052	15-J at p. 009
2007		122,405,903	16-J at p. 006
2008		61,936,273	17-J at p. 009
2009		24,790,341	18-J at p. 009
	$311,993,569
2010		(156,976,398)	5-J at YALIT000916
2011		(70,271,563)	6-J at YALIT000987
	(227,247,961)
Total	$84,745,608

Legal Inaccuracies

Legally, petitioners’ appeal to fairness and equity cannot play a part in the Court’s determination in this case. At pages 261 and 262 (and the subsequent subarguments), petitioners are asking the Court to ignore the Internal Revenue Code and find for YA Global because, according to petitioners, YA Global was unprofitable in two of its 11 years of existence and, therefore, the application of the law to YA Global, which respondent argues, results in an unjust outcome.

It is well settled, however, that our federal income tax system is based on an annual accounting of profits and losses. Heiner v. Mellon, 304 U.S. 271, 275 (1938). "[E]ach ‘taxable year’ must be treated as a separate unit, and all items of gross income and deduction must be reflected in terms of their posture at the close of such year." United States v. Consol. Edison Co. of N.Y., 366 U.S. 380, 384 (1961). See also Commissioner v. Sunnen, 333 U.S. 591, 598 (1948) (stating "Each year is the origin of a new liability and of a separate cause of action.").

It is immaterial to the calculation of a taxpayer’s income tax liability for one tax year whether the taxpayer suffered losses in a later year. Heiner, 304 U.S. at 276.

The fact that it might prove that when the [taxpayer’s] business was fully liquidated the profits of 1920 were offset by heavy loss of later years is immaterial. Losses suffered by a taxpayer in a later year may be deducted from profits, if any, earned by him in that later year; but the tax on a year’s income may not be withheld because losses may thereafter occur.

Heiner, 304 U.S. at 276. Similarly, it is immaterial in determining YA Global’s section 1446 withholding tax liability for 2006 through 2009, which is based on each of YA Global’s year’s ECTI, respectively, whether YA Global suffered significant losses in later years. YA Global’s liability for the section 1446 withholding tax is based on the facts as they existed in the particular taxable year.

Further, it is well understood that the Tax Court is not a court of equity. Paxman v. Commissioner, 50 T.C. 567, 576 (1968), aff’d, 414 F.2d 265 (10th Cir. 1969). The Court is bound by the provisions of the Internal Revenue Code enacted by Congress. See id. at 576-577 (stating, "The power to legislate is exclusively the power of Congress and not of this Court or any other court.") As described in detail in Respondent’s Brief, the applicable provisions here are straightforward:

1. Section 1446 prescribes the rules for calculating the section 1446 withholding tax liability. Under these rules, the section 1446 withholding tax liability is computed using, in effect, the foreign partners’ distributive shares of the partnership’s effectively connected income, loss, deductions, and credits, but it is not computed using the foreign partners’ own expenses (unless, as set forth in the regulations, the foreign partners’ certify such expenses).

2. Section 1463 provides relief to a withholding agent from collection of the withholding tax where the tax against which the tax withheld may credited, has already been paid.

3. For purposes of calculating a foreign corporate taxpayer’s underlying tax liability, section 882(c) prohibits a foreign corporate taxpayer from benefitting from deductions and credits when the foreign corporate taxpayer has failed to file a timely return.

4. Sections 56 and 172 prescribe rules and limits for the carry back of losses.

Applying these provisions, YA Global is liable for the section 1446 withholding tax in the amount determined by respondent.

1. Certification on Form 8804-C is not relevant now, as YA Global failed to withhold timely under section 1446.

Petitioners misstate respondent’s position when they assert: "Respondent claims that, under Treas. Reg. § 1.1446-6, YA Offshore’s deductions and losses cannot be taken into account in determining YA Global’s withholding tax liability because YA Offshore did not provide YA Global with a certification of those deductions and losses on Form 8804-C." (Pet’rs’ Brief at p. 263.) Respondent agrees that the certifications are no longer relevant, because YA Global failed to withhold timely under section 1446.

As explained in Respondent’s Brief at pages 311-314, section 1446 imposes a tax on a partnership for effectively connected taxable income ("ECTI") allocable to its foreign partners. A partnership may reduce the amount of withholding it is required to pay under section 1446 by taking into account deductions certified to it on Form 8804-C, Certificate of Partner-Level Items to Reduce Section 1446 Withholding. Treas. Reg. § 1.1446-6.

The parties agree that YA Global did not receive any Forms 8804-C and that YA Global did not pay any section 1446 withholding tax. Consequently, respondent correctly computed the section 1446 withholding tax under the provisions of section 1446.

At this point, YA Global can reduce its liability for the section 1446 withholding tax only by meeting the requirements of Treas. Reg. § 1.1446-3(e), which was described in Respondent’s Brief at pages 315-316 and is described below. Section 1464 is not applicable as discussed below.

2. Respondent properly computed YA Global’s liability for the section 1446 withholding tax.

Petitioners contend "YA Global cannot be required to pay withholding tax in excess of the amount of income tax due from YA Offshore." (Pet’rs Brief at p. 264.) Petitioners base this assertion on a misunderstanding of section 1446 and incorrect interpretations of sections 1463 and 1464.

Petitioners interpret sections 1463 and 1464 as mandating that YA Offshore’s expenses and losses be taken into account in computing YA Global’s withholding tax liability and "effectively ensure that Respondent cannot collect Section 1446 withholding tax from YA Global in excess of the income tax due from its partners." (Pet’rs’ Brief at p. 264.) This is an incorrect reading of these provisions.

Sections 1446 and 1461

As noted, section 1446 requires a partnership to pay a withholding tax on ECTI allocable to its foreign partners. Under section 1461, a withholding agent required to deduct and withhold any tax is made liable for such tax. If the partnership fails to pay the withholding tax timely, the partnership becomes separately liable under section 1461 for the tax. I.R.C. § 1461; New York Guangdong Finance, Inc. v. Commissioner, 588 F.3d 889, 893 (5th Cir. 2009); D.G. Parker, Inc. v. Commissioner, T.C. Memo. 2012-327, 104 T.C.M. (CCH) 627 (2012). The foreign partners are also liable for tax on the ECTI under sections 881 and 882. As discussed below, however, the tax will be collected only once.

Section 1463

Despite petitioners’ assertions, section 1463 does not relieve the withholding agent of its liability under section 1461. Rather, section 1463 provides the withholding agent relief from collection of the tax under certain circumstances.

If —

(1) any person, in violation of the provisions of this chapter, fails to deduct and withhold any tax under this chapter, and

(2) thereafter the tax against which such tax may be credited is paid, the tax so required to be deducted and withheld shall not be collected from such person, but this section shall in no case relieve such person from liability for interest or any penalties or additions to tax otherwise applicable in respect of such failure to deduct and withhold.

(emphasis added). That is, the tax will not be collected twice.

Treas. Reg. § 1.1463-1(a) provides that, for purposes of applying section 1463 to section 1446 withholding, the rules in Treas. Reg. § 1.1446-3(e) and (f) apply. Under Treas. Reg. § 1.1446-3(e)(1), a partnership that is required to pay the section 1446 withholding tax, but fails to do so (or pays less than the amount required), is liable for the payment of the section 1446 withholding tax required to be withheld, unless the partnership can establish that a foreign partner has paid the full amount of tax required to be paid by such partner to the Internal Revenue Service. For this purpose, the partnership must provide sufficient information to show that the foreign partner’s tax liability was satisfied or was zero. Treas. Reg. § 1.1446-3(e)(2). See also Treas. Reg. § 1.1446-3(e)(4) Ex. 1.

Nothing in the regulations indicates that a foreign partner’s income tax liability, except to the extent it is established to have been satisfied or was zero, is relevant to the computation of YA Global’s section 1446 withholding tax liability. None of the examples in the regulations support petitioners’ assertion that YA Global’s section 1446 withholding tax liability may not exceed a foreign partner’s income tax liability that is greater than zero. In other words, unless petitioners can show that the foreign partner’s income tax liability was zero or fully satisfied, the amount of the foreign partner’s income tax liability is irrelevant for purposes of the determining petitioners’ liability under section 1461.

Section 1464

As petitioners state at page 264, section 1464 allows a refund or credit of an overpayment of withholding tax to be made to the withholding agent, when no taxes were actually withheld at the source. Petitioners claim that no taxes were withheld at the source or can be withheld at the source. This is true because YA Global did not make any payments under section 1446.

Section 1464 allows a refund of withholding taxes only if an overpayment of withholding tax occurs. Treas. Reg. § 1.1464-1(a). The example in the regulations illustrates this rule. The withholding agent is entitled to a refund because it paid in more than the $300 tax it was required to withhold on rents paid to a nonresident alien individual. It does not provide that the withholding agent was entitled to a refund because it paid in more withholding tax than the nonresident alien individual’s tax liability. The income tax liability of the nonresident alien was not taken into account.

Section 1464 is simply not applicable and does not provide YA Global with any relief from its section 1446 withholding tax liability. Section 1464 does not allow YA Global to reduce its section 1446 withholding tax liability to equal the foreign partners’ total income tax liability. Section 1464 allows a partnership, as the withholding agent, a refund of an overpayment of the section 1446 withholding tax only to the extent the partnership pays to the Internal Revenue Service an amount in excess of its section 1446 withholding tax liability. That has not been done here.

Application

In subsequent subsections, petitioners attempt to apply the principles of sections 1446, 1463, and 1464 to the taxable years 2007 (part (b)) and 2008 and 2009 (part (a)). As explained below, petitioners’ arguments fail.

Petitioners do not contend that YA Offshore paid its tax liability for 2006 or that YA Offshore’s tax liability was zero for 2006. Accordingly, petitioners should be deemed to have conceded that neither requirement is met and that YA Global is liable for the section 1446 withholding tax in the amount determined by respondent.

a. Petitioners have not established that YA Global’s section 1446 withholding tax liable should be anything less than the amount determined by respondent for 2008 and 2009.

Petitioners incorrectly assert that section 1463 eliminates YA Global’s section 1446 withholding tax liability for 2008 and 2009. (Pet’rs’ Brief at p. 264-65.) As noted above, for YA Global to be deemed to have satisfied its section 1446 withholding tax liability with respect to a foreign partner in 2008 and 2009, petitioners must establish either that the foreign partner paid the full amount of tax required to be paid by such partner to the Internal Revenue Service or that the foreign partner had no tax liability. Petitioners have not made this showing.

In 2008, YA Global had only 1 foreign partner, YA Offshore. In 2009, YA Global had several foreign partners, with YA Offshore holding the largest interest at 54% at the end of 2009. Petitioners have not asserted any reduction or elimination of YA Global’s section 1446 withholding tax liability with respect to any foreign partner, other than YA Offshore. (Entire record.)

For 2008 and 2009, petitioners claim, "Even if all the adjustments in the FPAAs are sustained by this Court, YA Offshore’s income in 2008 and 2009 would be zero as a result of [YA Offshore’s direct] expenses and its NOL carry backs from 2010 and 2011." (Pet’rs’ Brief at p. 265.) This assertion is flawed with respect to 2008. Also, by focusing only on YA Offshore, petitioners overlook other foreign partners with respect to which YA Global would still be liable for the section 1446 withholding tax.

2008

Petitioners have made no showing that YA Offshore paid its tax liability in full for 2008. (Entire record.) To prevail, petitioners must show that YA Offshore’s tax liability was zero for 2008. Petitioners cannot; YA Offshore cannot have a zero tax liability for 2008, as explained below.

YA Global’s ECTI allocable to YA Offshore for 2008 is $48,235,840. YA Offshore’s expenses as stipulated, $22,187,150, are significantly less than YA Offshore’s income. To eliminate the remaining income of $26,048,690 ($48,235,840 - $22,187,150), YA Offshore must have had a net operating loss in 2010⁷² at least equal to $26,048,690.

YA Global’s 2010 return filed with the Internal Revenue Service and stipulated as an exhibit for trial does not show the loss, if any, allocable to YA Offshore for 2010 for tax purposes or the percentage ownership held by YA Offshore at the end of 2010.⁷³ (Ex. 5-J.) Without this information, YA Offshore’s loss, if any, for 2010 that potentially could be carried back to 2008 cannot be determined.

Even assuming YA Offshore’s loss for 2010 could be determined and it were carried back to 2008, YA Offshore had a tax liability greater than zero for 2008 because YA Offshore was liable for alternative minimum tax. YA Offshore had alternative minimum taxable income of at least the ordinary business income determined by respondent, before any NOL carryback from 2010. Nothing in the record indicates or even suggests that YA Offshore had an alternative minimum taxable income of zero, before any NOL deduction. For alternative minimum tax purposes, the NOL deduction is generally limited to 90% of the taxpayer’s alternative minimum taxable income. I.R.C. § 56(d). With the NOL deduction so limited, YA Offshore cannot have alternative minimum taxable income of zero and is liable for income tax.

Accordingly, petitioners have not established, and cannot establish, YA Offshore’s tax liability for 2008 to be zero. Under the test under Treas. Reg. § 1.1446-3(e), YA Global cannot establish that YA Offshore paid its tax liability for 2008 or that YA Offshore’s tax liability was zero. Consequently, YA Global must pay the section 1446 withholding tax liability in full.

2009

As noted, YA Global had multiple foreign partners, including YA Offshore, in 2009. Petitioners have made no arguments asserting that any foreign partner, other than YA Offshore, paid its income tax liability or had zero tax liability. Petitioners have conceded, therefore, that YA Global is liable for the section 1446 withholding tax attributable to YA Global’s other foreign partners for 2009.

With respect to YA Offshore, respondent concedes that for 2009, YA Offshore’s expenses as stipulated, $19,966,780, exceed YA Global’s ECTI allocable to YA Offshore. Respondent, therefore, would concede that YA Global is deemed to have paid its 2009 withholding tax liability. However, as discussed in Respondent’s Brief at pages 367-69, YA Global is still liable for any interest, penalties, and additions to tax arising from YA Global’s failure to pay its section 1446 withholding tax liability. See Treas. Reg. § 1.1446-3(e)(3).

b. Section 1464 is not applicable because YA Global has not overpaid the section 1446 withholding tax; YA Global’s section 1446 withholding tax liability cannot be reduced by any alleged "overpayment" of YA Offshore’s income tax for 2007.

For 2007, petitioners assert that section 1464 would allow YA Global to claim an overpayment of the section 1446 withholding tax to the extent that YA Global’s section 1446 withholding tax liability exceeds YA Offshore’s income tax liability.⁷⁴ Because YA Offshore is not entitled to the benefit of any deductions or credits for 2007 under section 882(c), YA Global’s section 1446 withholding tax liability does not exceed YA Offshore’s income tax liability. But even if YA Global’s section 1446 withholding tax liability were to exceed YA Offshore’s income tax liability, petitioners misapply section 1464.

YA Global cannot avail itself of section 1464. As discussed above, section 1464 applies only if YA Global overpaid its section 1446 withholding tax liability. YA Global has not yet paid any section 1446 withholding tax. Indeed, the purpose of this proceeding is to determine the correct amount of YA Global’s section 1446 withholding tax liability. Only if petitioners pay in more than the amount determined under this proceeding would section 1464 be relevant. As a result, section 1464 does not apply to this case.

Further, section 1464 does not take into account the tax liability of the person with respect to whom the withholding agent withholds. (Because YA Offshore did not meet the requirements of Treas. Reg. § 1.1446-3(e), the amount of its income tax obligation under section 882 is not relevant to this proceeding.) Section 1464 does not permit YA Global to reduce its section 1446 withholding tax liability to the amount of YA Offshore’s income tax liability.

The examples in the regulations and cases to which petitioners cite as support are unavailing. (Pet’rs’ Brief at pp. 266-68.) In the examples in the regulations, the tax required to be withheld was actually paid by the withholding agent to the Internal Revenue Service. That is not the case here; YA Global has not actually paid the tax required to paid under section 1446. In McLaine v. Commissioner, 138 T.C. 228 (2012), the employer paid the tax but did not actually withhold the required tax from the amounts paid to the employee. Moreover, the question was whether the employee was entitled to a credit for the amounts paid by the employer, not whether the employer was entitled to a refund. Accordingly, McLaine is inapposite. Neither the regulations nor McLaine addresses the situation here, where the withholding agent has failed to withhold at all.

Petitioners then argue, "In fact, section 1446 tax cannot be withheld at this point" because YA Offshore’s interest has already been liquidated. (Pet’rs’ Brief at p. 267 (emphasis in original).) Setting aside the absence of a factual basis for this claim, which is not supported by the record,⁷⁵ this argument does not make sense. Petitioners argument would subvert the whole purpose of section 1461 — making the withholding agent liable for the tax it was required to withhold — if not the entire purpose of chapter 3 — requiring withholding on foreign persons because of the difficulty of collecting taxes from them. Accepting petitioners’ argument would mean that the partnership’s withholding tax obligation would be extinguished upon the departure of a foreign partner from the partnership. Again, McLaine does not appear to provide support for this argument.

This leads to petitioners’ next appeal: "Even if tax could be withheld at this point, the Court should consider any potential overpayment of withholding tax in determining, in a single proceeding, the correct amount of withholding tax liability due today."⁷⁶ (Pet’rs’ Brief at pp. 267-68 (emphasis in original).)

The correct amount of section 1446 withholding tax due is the amount calculated under sections 1446 and 1461 and the regulations thereunder. Nothing in section 1464 requires a different calculation.

To do as petitioners suggest would require the Court to determine YA Offshore’s income tax liability. Section 1464 does not require, or even suggest, that the Court must consider or determine YA Offshore’s income tax liability to determine YA Global’s section 1446 withholding tax liability. As discussed, section 1464 addresses the situation where a withholding agent has actually paid in excess of the amount due. Additionally, nothing in the regulations indicates that YA Offshore’s income tax liability is relevant. The examples in Treas. Reg. § 1.1464-1(a) look only at the extent to which the withholding agent has overpaid its liability.

In further illustration, where a withholding agent who is required . . . to withhold $300 tax from rents paid to a nonresident alien individual mistakenly withholds $320 and mistakenly pays $350 . . ., the amount of $30 shall be credited or refunded to the withholding agent . . . and the amount of $20 shall be credited or refunded . . . to the person from whose income such amount has been withheld.

Treas. Reg. § 1.1464-1(a).

Because YA Global has not actually paid the section 1446 withholding tax liability and YA Offshore has not actually paid its income tax liability, it is difficult to see how the Court could find an overpayment or "any potential overpayment," as petitioners urge.

3. YA Global is barred from receiving the benefit of deductions and credits due to its failure to file timely tax returns pursuant to section 882(c)(2) and the regulations thereunder.

As set forth in Respondent’s Brief, the parties agree that YA Offshore failed to file returns for its 2006 and 2007 tax years by the deadlines set forth in Treas. Reg. § 1.882-4(a)(3)(i). (1st Stip. ¶ 29; RPFF ¶ 552; Pet’rs’ PFF ¶ 322.) As a result, YA Offshore could not take into account deductions and credits under section 882(c)(2) for those years, other than credits for amounts withheld on its distributive share of U.S. source income from YA Global (and other credits not applicable in this case).

After those deadlines had passed, on February 24, 2012, YA Offshore requested, pursuant to Treas. Reg. § 1.882-4(a)(3)(ii), a waiver from the filing deadlines "for any year that the IRS concludes that [YA Offshore] was engaged in the conduct of a trade or business within the United States, an appropriate Form 1120-F should have been filed or a protective return was not effective to enable [YA Offshore] to claim deductions." ("Request for Waiver"). (Ex. 92-P, 1st Stip. ¶ 34.)⁷⁷

Petitioners maintain that the information they provided in support of their Request for Waiver, including contact information for their outside professionals and an affidavit from one of them, George Teixeira, demonstrates that respondent should have granted the Request for Waiver. However, upon careful and objective analysis of petitioners’ evidence according to the factors prescribed in the regulations, IRS Examination determined that petitioners’ information was unpersuasive in establishing that YA Offshore had acted reasonably and in good faith in failing to file U.S. income tax returns, including protective returns pursuant to Treas. Reg. § 1.882-4(a)(3)(vi), for its 2006-2008 tax years.⁷⁸ (Exs. 1399-1401.) Accordingly, IRS Examination reasonably exercised its discretion to deny the Request for Waiver.

a. IRS Examination did not abuse its discretion in denying YA Offshore’s Request for Waiver.

Petitioners argue that IRS Examination abused its discretion in denying YA Offshore’s Request for Waiver. As explained in detail below, contrary to petitioners’ position, IRS Examination properly applied the regulations to the facts and considered all relevant facts and circumstances, including all information YA Offshore submitted in making its Request for Waiver.

i. In evaluating respondent’s denial of YA Offshore’s request for a waiver, the question to be addressed is whether respondent abused his discretion, based on a review of the administrative record.

Petitioners correctly state that, in evaluating respondent’s denial of YA Offshore’s request for a waiver under Treas. Reg. § 1.882-4, the question to be addressed is whether respondent abused his discretion. (Pet’rs’ Brief at p. 272.)

While respondent earlier indicated that he believed the Court should apply an abuse of discretion standard subject to a de novo record, after further consideration of the issue, respondent believes the denial of a waiver request under Treas. Reg. § 1.882-4 should be reviewed for an abuse of discretion based on the administrative record before the IRS at the time of the request for waiver. See Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006) (rejecting the Tax Court’s de novo review of section 6630 decision and limiting scope of review to the administrative record). The administrative record in this case consists of Exhibits 92-P, 93-P, and 1391-J through 1401-J.

Under section 882(c)(2), a foreign corporation receives the benefit of any deductions and credits allowed to it under the Code only by filing a timely, accurate return. Treas. Reg. § 1.882-4 provides, in pertinent part:

The filing deadlines . . . may be waived if the foreign corporation establishes to the satisfaction of the Commissioner or his or her delegate that the corporation, based on the facts and circumstances, acted reasonably and in good faith in failing to file a U.S. income tax return (including a protective return (as described in paragraph (a)(3)(vi) of this section)).

Treas. Reg. § 1.882-4(a)(3)(ii).

When determining the scope of review pertaining to an administrative determination made by respondent, courts have considered whether Congress intended the court’s review of the determination to be de novo. E.g., United States v. Carlo Bianchi & Co., 373 U.S. 709, 715 (1963) (stating, "Indeed, in cases where Congress has simply provided for review, without setting forth the standards to be used or the procedures to be followed, this Court has held that consideration is to be confined to the administrative record and that no de novo proceeding may be held.") (citing pre-APA cases). See also Ewing v. Commissioner, 122 T.C. 32, 57-67 (2004) (Halpern & Holmes, JJ., dissenting), decision vacated by, 439 F.3d 1009 (9th Cir. 2006); Robinette v. Commissioner, 123 T.C 85, 127-28 (2004) (Halpern & Holmes, JJ., dissenting), rev’d, Robinette v. Commissioner, 439 F.3d 455 (8th Cir. 2006).

For example, in Porter v. Commissioner, 130 T.C. 115 (2008), the Tax Court noted that section 6015 provides that the Court shall "determine" whether the taxpayer is entitled to relief under section 6015 and concluded that, therefore, the Commissioner’s determination is subject to a de novo scope of review. The court compared the language of section 6330(d), which provides for a judicial "review" of the Commissioner’s determination under section 6330 by allowing the taxpayer to "appeal such determination to the Tax Court" and vesting the Tax Court with "jurisdiction with respect to such matter." In that situation, the scope of the court’s review is limited to the administrative record. The court stated that the use of the word "determine" in section 6015 suggests that the court in a section 6015 case should conduct a trial de novo. That Congress chose not to use the word "determine" or some derivation thereof in section 6330(d) distinguished section 6330(d) cases from cases arising under section 6015. Porter, 130 T.C. at 120.

Waivers like the one at issue in this case are granted by respondent under the authority of Treas. Reg. § 1.882-4(a)(3)(ii), not by a statute enacted by Congress. Congress has not indicated that actions relating to a request to waive the timely filing requirements of section 882 should be reviewed de novo. To determine whether respondent abused his discretion in denying the waiver request, the Court thus should consider the information before respondent at the time the denial was made. Considering information outside of the administrative record would not provide an accurate framework within which to determine if respondent exercised his discretion. See Camp v. Pitts, 411 U.S. 138, 141 (1973) (stating "In applying [an abuse of discretion] standard, the focal point for judicial review should be the administrative record already in existence, not some new record made initially in the reviewing court."). Respondent could only consider information that was before it when the waiver was requested. Accordingly, the Court should limit the scope of review to the administrative record.⁷⁹

In the event that the Court were to determine in this case that the scope of review is properly de novo, respondent posits that the standard of review should also be de novo because the Court would then be reviewing evidence outside of the administrative record in order to determine whether the denial of the waiver is proper.

Irrespective of the standard and scope of review which the Court determines is correct when dealing with the denial of the waiver under Treas. Reg. § 1.882-4(a)(3)(ii) in this case, the outcome is the same: denial of YA Offshore’s waiver request was proper.

That is, if the Court chooses to determine whether respondent abused his discretion based on a review of the administrative record, the evidence in the administrative record amply demonstrates that respondent did not abuse his discretion in denying YA Offshore’s waiver request. Petitioners in their Brief cite to some evidence from the trial but all of the essential points on which petitioners rely were expressed to and considered by respondent during the administrative consideration, such that the conclusion still would be that respondent did not abuse his discretion even if the scope of review included trial evidence. If the Court were to review respondent’s action using a de novo standard and scope based on the entire record including the trial, there still was a proper basis to deny the waiver.⁸⁰

ii. IRS Examination’s denial of YA Offshore’s Request for Waiver was preceded by and based on an extensive explanation of respondent’s analysis in a Form 886-A attached to a Form 5701 "NOPA."

Petitioners make a variety of assertions in asserting that respondent abused his discretion in denying YA Offshore’s Request for Waiver. The first assertion is that IRS Examination’s letter dated March 11, 2015 to YA Offshore informing YA Offshore that its Request for Waiver was denied provides no "discussion" or "justification" for the denial, and hence there was no evidence that its request was given full consideration. (Pet’rs’ Brief at Part VI.C.3.a.ii.) Petitioners acknowledge, however, that IRS Examination prepared: (1) Forms 5701 "Notice of Proposed Adjustment" for YA Offshore which are signed and dated on March 6, 2015 and expressly referenced a "Form 886-A" and (2) and a Form 886-A "Explanation of Items" that provided a lengthy discussion and justification for the denial. However, petitioners appear to argue that because they did not obtain copies of these forms until pretrial discovery and because the Form 886-A was "not signed or dated" there is purportedly uncertainty as to whether the Form 886-A was prepared contemporaneously with the Form 5701 on March 6, 2015, prior to the March 11, 2015 denial letter, and if it were not contemporaneously prepared the failure could itself constitute an abuse of discretion by respondent in addressing the Request for Waiver. (Pet’rs’ Brief at pp. 273-74.) These arguments have no basis in the facts and are merely an attempt to baselessly discredit IRS Examination’s determination.

Although the Forms 5701 and 886-A were not provided with the March 11th denial letter, that fact has no bearing on whether the Form 886-A was prepared before that date, nor is it material in determining whether IRS Examination arbitrarily or capriciously denied the Request for Waiver. Indeed, petitioners’ argument rests on a fundamental misunderstanding of the procedures at issue: Forms 886-A always accompany a Form 5701 and are never independently signed and dated, and thus the analysis included in the Form 886-A was reviewed and approved contemporaneously with it and prior to the issuance of the letter. The evidence before the Court establishes that, prior to informing YA Offshore in writing on March 11, 2015 that its Request for Waiver was being denied, IRS Examination personnel signed a Form 5701 for the 2006-2007 tax years on March 6, 2015. That Form 5701, at Exhibit 1399-J, contained a reference "See attached Form 886-A." The Form 886-A, at Exhibit 1401-J, with identical identifiers as the Form 5701, comprehensively explained IRS Examination’s reasons for denying YA Offshore’s Request for Waiver. The Form 886-A was not signed, but as it was an attachment to the Form 5701, which was signed, it was incorporated as part of the Form 5701 and did not require an independent signature. Petitioners’ attempt to overcomplicate what happened and imply without a rational basis that the denial letter was not preceded by IRS Examination’s extensive consideration of the Request for Waiver and recordation of IRS’s rationale for denying the waiver amounts to an effort to distract the Court and discredit IRS Examination’s determination on the basis of groundless inuendo.

After YA Offshore submitted its Request for Waiver on February 24, 2012, IRS Examination undertook development which included issuing requests for additional information. (RPFF ¶¶ 559, 571.) YA Offshore provided several responses to IRS Examination’s requests. (RPFF ¶¶ 562, 567, 572, 573.)

Prior to March 11, 2015, IRS Examination prepared a detailed and thorough explanation for the denial of the request for waiver via the Forms 5701 and accompanying Form 886-A. IRS Examination prepared a Form 5701 for YA Offshore’s 2006 and 2007 tax years which lists YA Offshore as the taxpayer and references "Form 1120 (sic "F") L5h and Section II L28_Other Deductions" for each year 2006 and 2007. Ex. 1399-J. This Form 5701 was signed by IRS Examination personnel Messrs. Thomas Wan and Anton New on March 6, 2015. (Id.) The Form 5701 has a section with pre-printed language stating: "Reason for Proposed Adjustment (If the explanation of the adjustment will be longer than the space provided below, the entire explanation should begin on Form 886-A (Explanation of Items))." In this section, IRS Examination wrote "See attached Form 886-A.⁸¹ (Id.)

Exhibit 1401-J is the Form 886-A referenced by the Form 5701. The Form 886-A is entitled "Explanation of Items." The Form 886-A at Exhibit 1401-J lists YA Offshore as the taxpayer. The first page of the Form 886-A lists the items at issue as "Form 1120F, section II, Line 28_Other Deductions (flow-through deductions)" and "Form 1120F, Line 5h Withheld at source from Form 8805." The Form 886-A goes on to provide a 35-page explanation for the denial of YA Offshore’s Request for Waiver.

In its March 11, 2015 letter, IRS Examination informed YA Offshore that it had determined to deny YA Offshore’s Request for Waiver under Treas. Reg. § 1.882-4(a)(3)(ii) as it pertained to the 2006-2008 taxable years. (Ex. 93-P.) Despite petitioners’ criticism to the contrary, the letter did not purport to provide the reasoning underlying IRS Examination’s determination.

The regulations that allow a taxpayer to request a waiver from the deadlines to file do not establish the format by which IRS Examination memorializes its determination of the request or how conveys its determination to the taxpayer. Treas. Reg. § 1.882-4(a)(3)(ii). In this case, the detailed explanation and justification was included in the Form 886-A referenced by the Form 5701. (Ex. 1401-J.)

The Form 5701 at Exhibit 1399-J refers to an attached Form 886-A. All of the pertinent information on the Form 886-A at Exhibit 1401-J tracks the information on the Form 5701. Respondent submits that the undisputed facts lead to the inescapable and common-sense conclusion that the Form 886-A at Exhibit 1401-J is in fact the Form 886-A referenced in the Form 5701 dated March 6, 2015 at Exhibit 1399-J. Thus, the Form 886-A was in existence prior to IRS Examination’s March 11, 2015 letter to YA Offshore.

Petitioners fixate on the unremarkable fact that the Form 886-A is not dated or signed by IRS Examination. Petitioners overlook the very simple explanation that the template for the Form 886-A does not require, or provide anywhere for, IRS Examination to sign or date it. (See Ex. 1401-J.) The purpose of the Form 886-A is to accompany the Form 5701. See IRM 4.46.6.11 (12-29-2009); see also IRM 4.46.6.9 (stating, "The Form 886-A attachment is mandatory and must be attached to all Form(s) 5701 for all unagreed issues").

Petitioners cite Exhibit 1392-J for the proposition that "Respondent’s case activity records do not show any NOPA had been issued or any Form 886-A had been finalized or approved when he issued the denial letter." (PFOF ¶ 274.) This assertion misrepresents the scope of Exhibit 1392-J, which is the case activity record of a single revenue agent through February 23, 2012. It is impossible for this case activity record to have referenced a Form 5701 (and its accompanying Form 886-A) that was only signed on March 6, 2015. Petitioners were well aware that numerous IRS revenue agents worked on the examinations of YA Global and YA Offshore for years after February 23, 2012. Petitioners did not seek to have introduced into the record any other case activity records of any other IRS personnel for any other periods of time (including through March 11, 2015).

To summarize: The evidence before the Court establishes that prior to informing YA Offshore in writing on March 11, 2015 that its Request for Waiver was being denied, IRS management signed a Form 5701 for the 2006-2007 tax years on March 6, 2015. That Form 5701 provided "See attached Form-886-A," which in turn comprehensively explained IRS Examination’s reasons for denying YA Offshore’s Request for Waiver. (Exs. 1399-J, 1401-J.) That Form 886-A is Exhibit 1401-J. Petitioners’ complaints to the contrary should be rejected by this Court.

Finally, the letter dated March 11, 2015 in which IRS Examination informed YA Offshore in writing that its Request for Waiver was being denied concluded with the following offer to YA Offshore: "Any inquiries regarding this letter should be directed to the undersigned." (Ex. 93-P at YALIT000077.) The undersigned was IRS Examination Team Manager Timothy Taggart. Id. Messrs. Ellis Reemer and Jonathan Strouse, YA Offshore’s outside attorneys at the time, were provided copies of the letter. Id. Petitioners have offered no evidence that YA Offshore or its outside attorneys acted upon this offer to contact IRS Examination to inquire about "any" aspect of the denial letter, for example to discuss or request the reasons supporting the denial which IRS Examination had earlier memorialized via the Form 5701 and the accompanying Form 886-A. (See Exs. 1399-J and 1401-J (March 6, 2015 Form 5701 and accompanying Form 886-A).) YA Offshore did not request any information about the denial until pretrial discovery. (Entire Record; Stip. ¶ 195).

iii. The Form 886-A reflects IRS Examination’s thorough and comprehensive consideration of the facts and circumstances and proper application of the regulations

More generally, petitioners allege that the Form 886-A demonstrates that IRS Examination did not use "the proper standards" in its consideration of YA Offshore’s Request for Waiver. (Pet’rs’ Brief at Arg. Part VI.C.3.a.iii.) To the contrary, as explained next, IRS Examination properly applied the regulations in its consideration of the Request for Waiver. Because the original request was not comprehensive, IRS Examination undertook further development of all the facts and circumstances necessary to evaluate YA Offshore’s request, including issuing requests for additional information (RPFF ¶¶ 559, 571) to which YA Offshore responded (RPFF ¶¶ 562, 567, 572, 573.) Taking into account all information provided by petitioners, IRS Examination prepared a detailed and thorough explanation for the denial of the Request for Waiver considering each factor in Treas. Reg. § 1.882-4(a)(3)(ii).

(a). YA Offshore’s situation is distinguishable from the foreign corporation’s situation in Treas. Reg. § 1.882-4(a)(3(ii), example 1.

Treas. Reg. § 1.882-4(a)(3) includes both substantive guidance concerning the consideration of waiver requests and examples that illustrate salient aspects of those substantive rules. Petitioners assert that IRS Examination did not follow the regulations because it did not properly consider and follow one such example, Example 1 of Treas. Reg. § 1.882-4(a)(3)(ii). (Pet’rs’ Brief at Arg. Part VI.C.3.a.iii.) Petitioners contend that IRS Examination wrongly interpreted Example 1 to require that a foreign corporation must provide contemporaneous documents to demonstrate that it had affirmatively engaged a tax advisor to provide advice specifically on tax filing rules. (Pet’rs’ Brief at p. 275.) Having made that assertion, petitioners argue that Example 1 illustrates its falsity. IRS Examination did not interpret Example 1 as alleged by petitioners and nothing in the Form 886-A even implies that it did.

Petitioners misstate IRS Exam’s position from the Form 886-A and fail to appreciate the material differences between YA Offshore’s facts and those illustrated in Example 1. In the Form 886-A, IRS Examination considered Example 1 and explained why it was distinguishable from YA Offshore’s situation. (Ex. 1401-J at p. 0033.)

In Example 1, FC, a foreign corporation which had never filed a U.S. income tax return before, became a limited partner in a U.S. limited partnership that was knowingly engaged in a U.S. trade or business. During years 1 through 4 of partnership operations, FC incurred only losses with respect to its partnership interest. Considering those facts, FC’s "foreign tax director" incorrectly concluded that FC was not required to file a U.S income tax return. FC’s management was also unaware of FC’s obligation to file and of its ability to file protective returns. In year 5, FC realized a profit and engaged a U.S. tax advisor to handle filing income tax returns. This tax advisor promptly brought FC’s failure to file to the attention of the IRS. Example 1 concludes that FC should be granted a waiver under these facts. Also, one can readily infer from these facts that the tax director did not believe FC to have any U.S. tax filing obligation for those years.

YA Offshore’s facts are clearly distinguishable from FC’s in Example 1. Importantly, Example 1 is captioned "Foreign corporation discloses own failure to file" — referring to the first of the six relevant factors in determining whether a waiver should be granted, and facts presented in the Example must be considered in light of that factor. See Treas. Reg. § 1.882-4(a)(3)(ii)(A). As explained in the Form 886-A, unlike FC in Example 1, YA Offshore did not bring its failures to file to the attention of the IRS prior to the IRS discovering the failures. (Ex. 1401-J, at p. 0031; RPFF ¶ 544.) Also, in Example 1, FC engaged a U.S. tax advisor as soon as it began to earn profits. YA Offshore was in the exact opposite situation. YA Offshore immediately had positive income from its interest in YA Global in the 2006 and 2007 tax years. As explained in the Form 886-A, in its Request for Waiver, YA Offshore admitted during the waiver process that despite making significant profits, it had never had an in-house tax counsel or tax department or anyone with experience on cross-border tax issues and never engaged a U.S. tax advisor specifically to determine its U.S. tax liability. (Ex. 1401-J at p. 004.)

Petitioners counter that Example 1 is on point because "YA Offshore, as an investment fund, was managed by Yorkville who retained outside advisors to advise it of the tax obligations of the funds under its management." (Pet’rs’ Brief at p. 277.) This is both misleading and incorrect. As explained by IRS Examination in the Form 886-A and summarized below, neither YA Offshore nor Yorkville retained any outside advisors to advise YA Offshore on the U.S. tax rules, in particular the U.S. tax filing rules, applicable to it.⁸² (Ex. 1401-J at pp. 0023-26.)

Clearly, IRS Examination did not act arbitrarily or capriciously in its consideration of Example 1, but rather thoroughly and thoughtfully compared YA Offshore’s facts with Examplels facts, distinguished Example 1, and reasonably concluded that Example 1 did not support YA Offshore’s Request for Waiver. (See Ex. 1401-J.)

Petitioners state that while IRS Examination acknowledged that a foreign corporation could rely on a tax advisor to support a request for waiver under Treas. Reg. § 1.882-4(a)(3)(ii), IRS Examination determined that YA Offshore failed to make such a showing because neither YA Offshore, YA Global or Yorkville "had engaged any tax advisor to advise on the tax filing rules that may have been applicable to YA Offshore . . . [or] to advise specifically YA Offshore on whether it was engaged in a US trade or business and whether it should file a Form 1120-F (including protective)." (Pet’rs’ Brief at p. 275 (quoting Ex. 1401-J at p. 0023).) From this, petitioners extrapolate that respondent’s position generally is that in order for a taxpayer to rely on the advice of a tax advisor to support a request for waiver under Treas. Reg. § 1.882-4(a)(3)(ii) it must provide contemporaneous documents that it affirmatively engaged a tax advisor to provide specific advice on tax filing rules. (Pet’rs’ Brief at p. 275.)

Petitioners take the quoted text from the Form 886-A out of context. At that point in the Form 886-A, IRS Examination was simply pointing out that, as factual matter, the contemporaneous documents provided by YA Offshore during the Request for Waiver process, particularly the engagement letters with outside professionals, showed that YA Offshore and Yorkville Advisors had not engaged any tax advisors to advise on U.S. tax rules and/or filing rules that may apply specifically to YA Offshore. (Ex. 1401-J at pp. 23-4.) Petitioners admit as much. Pet’rs’ Brief at p. 278. IRS Examination was not staking out some overarching legal test for when a foreign corporation can argue that it relied upon a tax professional as petitioners insinuate. At issue in the regulation is whether a foreign corporation exercised "reasonable diligence (taking into account its relevant experience and level of sophistication"). See Treas. Reg. § 1.882-4(a)(3)(ii)(D). YA Offshore was a feeder fund into a master fund that was involved in sophisticated financial transactions involving hundreds of millions of dollars. Such taxpayers are reasonably expected to have made more substantial efforts to comply with U.S. tax filing obligations than those that are, say, "mom and pop" operations.

(b). After considering all of the facts and circumstances, IRS Examination reasonably concluded that YA Offshore failed to demonstrate that it relied upon tax professionals in failing to file U.S. income tax returns.

Petitioners also argue that in the Form 886-A IRS Examination "clearly erred": (1) in finding that YA Offshore did not have outside advisors to provide tax advice, (2) in finding that YA Offshore’s private placement memorandum cast doubt on the completeness of its request and (3) by mischaracterizing the "ECI Memo." (Pet’rs’ Brief at Arg. Part VI.C.3.iii.b.) A close review of the Form 886-A demonstrates that petitioners’ claims of clear error are baseless. Not only were these findings not the result of clear error, these finding were compelled by the facts and circumstances, including the information submitted by YA Offshore and thoroughly considered by IRS Examination during the waiver process.

IRS Exam correctly determined that YA Offshore failed to show that any tax professional was engaged to advise on how the U.S., tax rules applied to YA Offshore.

During the Request for Waiver process, YA Offshore asserted that its engagement letter with RSM Cayman "makes clear" that RSM Cayman would be advising YA Offshore with respect to YA Offshore’s compliance with U.S. tax rules. (Ex. 1401-J, p. 0024.) However, as IRS Examination explained in the Form 886-A, the engagement letter to which YA Offshore referred was for financial audit service and not for any advisory or tax services. (Ex. 1401-J at p. 0024; Ex. 1397-J at pp. 00104, 00112.)⁸³ Petitioners admit in their Brief that YA Offshore itself did not engage any tax professional to provide tax advice. (Pet’rs’ Brief at p. 278.)

Having been forced to retreat from its assertion that YA Offshore had engaged a tax professional to provide tax advice, petitioners resort to YA Offshore’s argument made during the Request for Waiver process that YA Offshore relied on advice of outside tax professionals who "explicitly advised" YA Offshore, YA Global and Yorkville "on numerous occasions" that YA Global was not engaged in a trade or business within the United States. (Ex. 1401-J at p. 0012.) YA Offshore stated that the engagement letters upon which this advice was given had been produced to IRS Examination at YA 260082-260167. (Ex. 1401-J at p. 0012.)

In its Request for Waiver, YA Offshore claimed that after a potential investor "raised the issue of whether YA Global (and therefore YA Offshore) was ETB [engaged in a U.S. trade or business] . . . [Mr. Schinik] initiated verbal communications" with RSM. (Ex. 1401-J at p. 0012.) According to YA Offshore, Mr. Schinik, then "held a series of discussions with Messrs. Yager and Karst from RSM as to the ETB issue and why Messrs. Yager and Karst believed the Fund was not ETB." (Id.) Petitioners argue that these discussions constituted advice upon which YA Offshore could and did rely upon, to not timely file returns. (Pet’rs’ Brief at p. 278.)

In their Brief, petitioners summarized their position as follows:

Although it may be technically correct that the engagement letters failed to say RSM would provide tax advice directly to YA Offshore, YA Offshore’s only activity was its investment in YA Global. Thus, whether YA Offshore had a USTB [U.S. trade or business] turned on only one question: whether YA Global had a USTB. Because Yorkville managed both YA Global and YA Offshore, the advice that it received regarding YA Global’s tax status was sufficient to inform Yorkville as to YA Offshore’s tax obligations in the United States."

(Pet’rs’ Brief at p. 278.) In the Form 886-A, IRS Examination carefully explained why YA Offshore did not act reasonably and in good faith in relying on verbal discussions with RSM, which were supposedly later captured in the so-called "ECI Memo," to justify its failure to timely file returns. (Ex. 1401-J at pp. 0028-29.) While the Form 886-A itself provides a comprehensive discussion on these matters, we summarize here the pertinent facts relied upon, and analyses undertaken, in the Form 886-A.

IRS Examination determined that facts relevant to its consideration of YA Offshore’s position that it acted reasonably and in good faith in failing to file due to its reliance on the advice of tax professionals included:⁸⁴

(1) YA Offshore itself had:

(a) Never employed anyone with U.S. tax expertise, particularly in international tax, and neither had Yorkville Advisors nor YA Global;

(b) Never engaged a tax professional to advise on how U.S. income tax rules may apply to it or how it may comply;

(c) Never engaged or retained a tax professional to advise on how U.S. income tax filing rules may apply to it, including which returns were possibly available to it;

(d) Never engaged a tax professional to prepare its tax returns;

(e) Never received formal written advice by a tax professional that it was not engaged in a trade or business.

(2) Despite the fact that YA Offshore’s private placement memoranda from December 2005 stated that "certain of YA Global’s activities (such as making loans to and receiving fees from companies) may cause YA Global to be considered to be engaged in a United States trade or business, it never sought clarification of the tax consequences of that statement with respect to its own U.S. filing obligations. (RPFF ¶ 617.)

(3) Despite the fact that YA Offshore’s December 2005 private placement memorandum pointed out that a foreign corporation with income effectively connected with the conduct of a U.S. trade or business was "generally subject to U.S. tax on a net basis at graduated rates upon the filing of a U.S. tax return," it never sought clarification for the inclusion of the sentence in its private placement memorandum. (RPFF ¶ 616.)

(4) YA Global engaged RSM to prepare YA Global’s federal and state tax returns for the 2006 and 2007 tax years. (Ex. 1397-J at p. 00120, 00127.) In the engagement letter for RSM’s preparation of YA Global’s 2006 tax return, RSM McGladrey cautioned YA Global that "[i]f you choose to add taxpayers or jurisdictions, this will increase the amount of our fees and expenses described below." (RPFF ¶ 522.) YA Global did not provide any documentation showing that it added any taxpayer, including YA Offshore, to either the 2006 or 2007 engagement. (Entire record.)

(5) In the engagement letter for RSM’s preparation of YA Global’s 2006 tax returns, RSM warned YA Global about the limitations and risks of engaging in merely oral or email discussions of tax issues with RSM:

We may discuss with you our views regarding the tax treatment of certain items. We may also provide you with tax information in the body of an email. Any advice or information delivered orally or in the body of an email will be based upon limited research and a limited discussion of the underlying facts. Additional research or a more complete review of the facts may affect our analysis and conclusions. Because of these limitations and related risks, we do not recommend that you proceed with any transaction solely on the basis of any oral or email communication and we will not be liable for any loss, cost, or expense resulting from any reliance on any oral or email communication. (RPFF ¶ 524.)

(6) The engagement letter for RSM’s preparation of YA Global’s 2007 return included nearly identical language regarding the risks and limitations of engaging in oral or email communication. (RPFF ¶ 525.)

As pointed out by IRS Examination in the Form 886-A, YA Global’s engagement of RSM for tax return preparation was expressly limited to preparation for YA Global and no other taxpayer. (Ex. 1401-J; Ex. 1397-J at pp. 00120, 00127.) As also pointed out in the Form 886-A, in this engagement, RSM cautioned YA Global that it should not rely upon oral communications made by RSM. (Ex. 1401-J; Ex. 1397-J at 00123, 00130.) These facts are undisputed. Thus, petitioners are reduced to contending that YA Offshore should be able to rely upon oral communications, purportedly constituting advice, that did not directly address YA Offshore, made by a tax professional (RSM) to another entity (Yorkville Advisors) pursuant to a written engagement of RSM by a third entity (YA Global) which specified that no taxpayer other than YA Global was covered (such as YA Offshore) and that verbal communications received from RSM should not be relied upon. The Court should not be misled by this sleight-of-hand argument.

Petitioners want to have their cake and eat it too. They contend that YA Offshore should be allowed to rely upon the so-called advice rendered by RSM verbally to Yorkville pursuant to YA Global’s engagement of RSM without being subject to the exclusions and limitations of that engagement. The YA Global-RSM engagement letters for tax return preparation expressly excluded coverage of any taxpayer other than YA Global (such as YA Offshore) and expressly cautioned that oral communications should not be relied upon. (RPFF ¶¶ 522, 524, 525.) The YA Global-RSM engagement letters also provided that RSM’s tax return preparation did not include rendering advice on specific matters on the returns. (Ex. 1397-J at pp. 00123, 00130.) Thus, the so-called advice on the trade or business issue, delivered orally by RSM to Mr. Schinik via their "numerous discussions," was beyond the scope of the engagement, did not cover YA Offshore and was not intended by RSM to be relied upon by Mr. Schinik, YA Global, Yorkville Advisors, YA Offshore or any other person.

Moreover, petitioners have not properly framed the issue regarding reliance on a tax professional. In a request for waiver under Treas. Reg. § 1.882-4(a)(3)(iii), the issue is whether the foreign corporation has established that it acted reasonably and in good faith in failing to timely file the returns (including protective returns) within the deadlines set forth in Treas. Reg. § 1.882-4(a)(3)(i). When a foreign corporation relies upon the advice of a tax professional to establish that it acted reasonably and in good faith in failing to file, the foreign corporation should establish that the tax professional was engaged to advise, and did advise, the foreign corporation on the U.S. tax filing rules applicable to the foreign corporation.

However, the so-called advice from RSM that YA Offshore seeks to rely upon to establish that it acted reasonably and in good faith in failing to timely file under Treas. Reg. § 1.882-4(c)(3) did not even address the U.S. tax filing rules potentially applicable to YA Offshore, including the filings possibly available to it (i.e., protective returns). RSM purportedly discussed with Mr. Schinik solely whether YA Global would be considered engaged in a lending business. YA Offshore did not claim in its Request for Waiver that these discussions touched upon the U.S. tax filing rules potentially applicable to YA Offshore or the filings possibly available to it.

YA Offshore emphasized in its Request for Waiver that its understanding of the law was that a foreign corporation either filed a U.S. return if it was considered to be engaged in a trade or business within the U.S or it did not file a return if it was not so considered. (Ex. 1401-J at pp. 0012-13.) YA Offshore did not provide any basis for that understanding, but in any event, that inquiry misses the mark in a request for waiver under Treas. Reg. § 1.882-4(a)(3)(ii). The relevant inquiry is whether the foreign corporation has established that it acted reasonably and in good faith in failing to timely file the returns (including protective returns) within the deadlines set forth in Treas. Reg. § 1.882-4(a)(3)(i). A factor that must be considered in this inquiry is whether the corporation failed to file because, after exercising reasonable diligence (taking into account its relevant experience and level of sophistication), the corporation was unaware of the necessity for filing the return. Treas. Reg. § 1.882-4(a)(3)(ii)(D).

After YA Offshore submitted its Request for Waiver in 2012, YA Offshore filed protective returns for the 2006 and 2007 tax years pursuant to Treas. Reg. § 1.882-4(a)(3)(vi). (Ex. 1401-J at pp. 0004, 0013.) YA Offshore claimed that it was not aware of the availability of protective returns for those years prior to the deadlines for filing. (Ex. 1401-J at p. 0012.) This change in stance is evidence that it in fact never did engage a competent U.S. tax advisor, nor did YA Global or Yorkville, or that it deliberately chose not to exercise due diligence in determining its tax options, since the option to file protective returns is not buried in some section of an internal revenue manual, it has been an option in Treas. Reg. § 1.882-4(a)(3)(vi) since 1990. See T.D. 8322, 1990-2 C.B. 172. If YA Offshore (including Yorkville acting on its behalf) had engaged a tax advisor to advise on the U.S. tax rules, including the filing rules, applicable to YA Offshore, it would have inevitably been made aware of the option to file protective returns.⁸⁵

Furthermore, as explained by IRS Examination in the Form 886-A, YA Offshore’s particular facts made its failure to engage a tax professional to advise on the U.S. tax filing rules all the more unreasonable.

Prior to Mr. Schinik’s discussions with RSM, YA Offshore disclosed in a December 2005 private placement memorandum that, while it believed that it would not be considered engaged in a trade or business in the U.S. because of the trading safe harbors under section 864(b)(2), it recognized that it may be considered engaged in trade or business in the United States due to activities of YA Global. (Ex. 99-J at p. 0067.) Specifically, YA Offshore itself pointed out that it may be considered engaged in a trade or business within the U.S. given "certain of YA Global’s activities (such as making loans to and receiving fees from companies)." (Ex. 99-J at p. 067; Ex. 1401-J at p. 026.)⁸⁶

Given that YA Offshore recognized that it may be considered engaged in a U.S. trade or business because of certain activities conducted by YA Global, a foreign corporation exercising reasonable diligence would have engaged a tax professional to advise on U.S. rules, including which filings were possibly available to it. See Treas. Reg. § 1.882-4(a)(3)(vi) (setting forth that a foreign corporation may file a protective return if it conducts limited activities in the United States and determines that its activities do not give rise to income effectively connected to a trade or business within the U.S. in order to protect the right to use deductions and credits if it is later determined that the original determination was incorrect).

Petitioners next contend, citing Hatfried, Inc. v. Commissioner, 162 F.2d 628, 632 (3d Cir. 1947) that RSM’s preparation of Forms 1042 and 1042-S for YA Global and YA Offshore, without preparation or filing of any Form 1120-F for YA Offshore was "itself substantive advice to YA Offshore." (Pet’rs’ Brief at pp. 278-79.) According to petitioners, the Forms 1042 and 1042-S would not have been prepared if RSM had concluded that YA Offshore had a U.S. trade or business. (Pet’rs Brief at p. 279.)⁸⁷ Petitioners do not explain why the preparation of Forms 1042 and 1042-S would by itself preclude a person from being considered engaged in any trade or business within the U.S. Also, petitioners misconstrue Hatfried.

In Hatfried, the taxpayer was a corporation whose tax returns were prepared and filed by a certified public accounting firm (CPA). 162 F.2d at 630. The CPA never suggested that a personal holding company surtax return should be filed and none was. Id. The Commissioner determined that the taxpayer was a personal holding company and liable for a personal holding company surtax and imposed a penalty for failure to file a personal holding company return. Id. at 629.

In preparing and filing the taxpayer’s Form 1120, the CPA disclosed on the return itself all the information that was necessary to establish that the taxpayer was in fact a personal holding company. Id. at 632. Despite this, the CPA answered "no" to the question on the Form 1120 asking whether the taxpayer was a personal holding company. Id. at 629.

The Tax Court in Hatfried sustained the Commissioner in full. Id. On appeal, the Third Circuit affirmed the Tax Court on its holdings that the taxpayer was a personal holding company and liable for the surtax. Id. at 631. However, the Third Circuit reversed the Tax Court’s holding on the failure to file penalty, concluding that the taxpayer had demonstrated that its failure to file was due to reasonable cause. Id. at 635. The Third Circuit found that the return itself disclosed all of the facts necessary to determine that the taxpayer was a personal holding company and those facts conclusively established that the taxpayer was a personal holding company. Id. at 632. Because all the facts necessary to establish that the taxpayer was a personal holding company were so disclosed and because the CPA stated on that return itself that the taxpayer was not a personal holding company, the court held that this cumulatively constituted advice by the CPA to the taxpayer that the taxpayer was not a personal holding company. Id.

YA Offshore’s facts are clearly distinguishable from those at issue in Hatfried. Petitioners contend that RSM prepared Forms 1042 and 1042-S and did not prepare Forms 1120-Fs and thus RSM advised YA Offshore that it was not engaged in a trade or business. In contrast to the factual disclosures on the return in Hatfried that conclusively established whether the taxpayer was a personal holding company, the Forms 1042 and 1042-S do not provide facts that would provide any indication whether YA Global was engaged in a trade or business within the United States. See Resp’s Brief at Arg. Part II (showing the analysis necessary to determine whether YA Global was engaged in a trade or business within the United States). Thus, Hatfried does not support petitioners’ contention that the preparation of the Forms 1042 and 1042-S and the failure to prepare Forms 1120-F alone constituted substantive advice.⁸⁸

Petitioners next claim that IRS Examination "completely disregarded" and "refused to consider" Mr. Teixeira’s affidavit submitted in one of YA Offshore’s supplemental submissions during the Waiver Process. (Pet’rs’ Brief at pp. 279-80.) Petitioners claim that there is "not even a scintilla of evidence suggesting that Mr. Teixeira’s sworn statement was untrue." (Id.) These claims are baseless.

IRS Examination carefully considered the content, and weighed the probative value, of Mr. Teixeira’s affidavit in light of all of the facts and circumstances. IRS Examination raised several concerns with the affidavit that led it to accord relatively little value under the totality of the facts and circumstances of the case. First, IRS Examination pointed out that Mr. Teixeira based the content of his affidavit on the erroneous belief that RSM was responsible for advising its "client" YA Offshore on its U.S. tax filing requirements. (See Ex. 1394-J at p. 0028; Ex. 1401-J at pp. 0024-25.) As described above, this belief is directly refuted by the controlling and contemporaneous tax return preparation agreements between RSM and YA Global and the auditing services agreements between RSM Cayman and YA Offshore that were provided by YA Offshore to IRS Examination during the waiver process.⁸⁹ (Ex. 1397-J at pp. 00100, 00108, 00120, 00127.) Second, IRS Examination pointed out that if Mr. Teixeira was correct in his belief and RSM was engaged to perform this function, it would have been memorialized in an engagement letter, and that no such letter was provided despite IRS Examination’s requests for any such letters. (Ex. 1401-J at pp. 0024-25.) Third, IRS Examination observed that YA Offshore only supplied the affidavit of Mr. Teixiera after YA Offshore was unable to produce any contemporaneous agreements establishing that RSM was engaged to provide tax return preparation or tax advisory services to YA Offshore, including informing YA Offshore of U.S. filing rules potentially applicable to it. (Ex. 1401-J at pp. 0024-25.) In sum, petitioners’ claims that IRS Examination "completely disregarded" and "refus[ed] to consider" Mr. Teixeira’s affidavit during the waiver process are plain wrong.

Petitioners are not offering Mr. Teixeira’s affidavit to prove the truth of the statements contained therein. (Pet’rs’ Brief at p. 270, n.110; p. 279, n.114.) However, in the same breath, petitioners complain that IRS Examination failed to consider the affidavit despite there being no evidence suggesting that it was untrue. Id. at 280. As just explained, IRS Examination carefully considered the affidavit and noted that material evidence in the form of the contemporaneous controlling engagement agreements contradicted content of the affidavit. Therefore, given the controlling evidence to the contrary pointed out by IRS Examination, petitioners’ current complaints that IRS Examination failed to consider the affidavit and that the affidavit has not been contradicted by other evidence are without merit.⁹⁰

Under the standard requiring that all relevant facts and circumstances be considered, IRS Examination acted reasonably in considering YA Offshore’s discussions in its 2005 private placement memoranda about U.S, tax rules for foreign corporations and whether it could be considered engaged in a U.S, trade or business for federal tax purposes.

Petitioner assert that IRS Examination was wrong to take into account, or misunderstood, a discussion of "tax risk" contained in YA Offshore’s December 15, 2005 private placement memorandum. (Ex. 99-J at p. 0067.) Petitioners contend that IRS Examination failed to appreciate that this discussion was just "boilerplate" language intended to convey a mere "theoretical" risk. (Pet’rs’ Brief at pp. 282-83. Petitioners claim that IRS Examination used the language in the private placement memorandum to "ignore evidence that clearly showed YA Offshore reasonably relied on professional advice in failing to file Forms 1120-F." (Pet’rs’ Brief at p. 283.) Petitioners confuse different sections of YA Offshore’s private placement memoranda and misrepresent the content of the December 2005 private placement memorandum, and their claims are otherwise without merit.

IRS Examination noted in the Form 886-A that YA Offshore’s December 2005 private placement memorandum warned that "certain of YA Global’s activities (such as making loans to and receiving fees from companies) may cause YA Global to be considered to be engaged in a United States trade or business." (Ex. 1401-J at p. 0026; Ex. 99-J at p. 0067.) Petitioners allege that ". . . the PPM stated YA Global intended to conduct its activities in a manner as to meet the Trading Safe Harbor, and the disclosure language clearly meant that there was just a theoretical risk that Respondent might disagree with YA Global’s position." (Pet’rs’ Brief at p. 282.) Petitioners misrepresent the content of the private placement memorandum. The full relevant part of the private placement memorandum provides:

Section 864(b)(2) of the Code provides a safe harbor pursuant to which a foreign entity that engages in the United States in trading securities for its own account will not be deemed to be engaged in a United States trade or business. Except as described below, the Master Fund intends to conduct its activities in a manner so as to meet the requirements of this safe harbor. If the activities are conducted in such a manner, neither the Master Fund’s securities trading activities should constitute a United States trade or business, and the Fund generally should not be subject to the regular United States federal income tax on its allocable share of the Master Fund’s trading profits. However, certain of the Master Fund’s activities (such as making loans and receiving fees from portfolio companies) may be determined to be outside the scope this safe harbor, in which case the Master Fund may considered to be engaged in a United States trade or business.

(Ex. 99-J at p. 0067.)

Therefore, YA Offshore explained in its private placement memorandum that while YA Global intended for its "securities trading activities" to meet the trading safe harbor, it warned that certain other activities, i.e. "making loans and receiving fees from portfolio companies" may be "outside the scope" of the trading safe harbor. Petitioners’ summary of the private placement memorandum language incorrectly lumps all of YA Global’s "activities" into the category of activities that YA Global "intends" to meet the trading safe harbor. Petitioners’ imprecise representation of the private placement memorandum fails to appreciate that YA Offshore warned in the private placement memorandum that YA Global had specific concerns about certain of its activities ("making loans and receiving fees from portfolio companies") giving rise to a trade or business within the U.S.

Petitioners are also wrong to label YA Offshore’s warning about "making loans and collecting fees" possibly giving rise to a trade or business within the U.S. as mere "boilerplate" and "theoretical."

First, there is nothing in the private placement memorandum to suggest that this warning was qualified as merely "boilerplate," "theoretical," less material or otherwise less important relative to any other warnings or risks disclosed therein.

Second, for their description of the text as "boilerplate," petitioners rely on the testimony of Mr. Griffel from Schulte Roth & Zabel. (See Pet’rs’ PFF ¶ 294, citing Tr. 520:5-521:16.)⁹¹ At this point in his testimony, Mr. Griffel was discussing the "Tax Aspects" section of YA Offshores’ November 2008 private placement memoranda at Ex. 118-J, p. 0055. This "Tax Aspects" section initially comprises basic high-level generic discussions of U.S. tax law. It is initially non-fund-specific information and later contains minimal discussion of potential application of the tax law to YA Global’s activities. (See Ex. 118-J at p. 0055-56.) In the Form 886-A, IRS Examination was not referring to Exhibit 118-J nor to a portion of a"Tax Aspect" section addressing generic discussion of tax law. Rather, IRS Examination referenced language from a different YA Offshore private placement memorandum (Ex. 99-J) that explicitly considered the application of U.S. tax law to the specific activities of YA Global in detail. (Ex. 99-J at p. 0067 (. . . certain of the [YA Global’s] activities (such as making loans and receiving fees from portfolio companies) may be determined to be outside the scope this safe harbor, in which case [YA Global] may be considered to be engaged in a United States trade or business.").)⁹² Thus, Mr. Griffel’s testimony did not address the private placement memorandum that IRS Examination referenced in its Form 886-A. The private placement memorandum that IRS Examination referenced, Exhibit 99-J, contained a far more detailed discussion about the potential U.S. tax implications of YA Global’s activities than that contained in the private placement memorandum (Ex. 118-J) that Mr. Griffel was asked by petitioners’ counsel to review at trial. The more reasonable view of the specific language in YA Offshore’s private placement memoranda at Exhibit 99-J that was highlighted by IRS Examination in its Form 886-A is that it was custom tailored to fit YA Global’s particular facts. This is anything but boilerplate.

Third, given the "all facts and circumstances" standard, IRS Examination was reasonable in considering YA Offshore’s private placement memoranda. As pointed out by IRS Examination in the Form 886-A, the disclosure in the private placement demonstrates that, at the latest December 15, 2005, YA Offshore appreciated that it might be considered to be engaged in a trading business within the U.S. due to YA Global’s activities. (Ex. 1401-J.) This appreciation directly informs on whether the steps ultimately taken by YA Offshore to determine its U.S. tax filing obligations, including determining which returns were potentially available to file, reflected an exercise of reasonable diligence.

Fourth, as set forth IRS Examination’s Form 886-A, YA Offshore explained in its private placement memorandum that ". . . ECI is generally subject to U.S. tax on a net basis at graduated rates upon the filing of a U.S. tax return." (Ex. 99-J at p. 0066.) That a foreign corporation would be subject to U.S. tax on a "net" basis only "upon the filing" of a U.S. tax return suggests that YA Offshore may have been aware, or made aware, of the special rule for foreign corporations under section 882(c)(2).⁹³ (See Ex. 1401-J at p. 0027.)

IRS Examination properly considered the ECI Memo.

Petitioners believe that IRS Examination’s position is that "a taxpayer may only rely on professional advice if it comes in the form of a formal, written opinion." (Pet’rs’ Brief at p. 283.) Petitioners base their belief on IRS Examination’s treatment of the so-called ECI Memo. Id. Petitioners’ description of IRS Examination’s position is wrong.

In the Form 886-A, IRS Examination noted that YA Offshore claimed that Mr. Schinik had no international tax experience and was unable to answer an investor’s inquiry whether YA Global was engaged in a U.S. trade or business, yet he wrote the ECI Memo. Ex. 1401-J at pp. 28-9. Petitioners do not dispute this. (See Pet’rs’ PFF ¶¶ 265-267.) Petitioners allege that IRS Examination did not consider that the ECI Memo was based on Mr. Schinik’s discussions with RSM. (Pet’rs Brief at p. 284.) This allegation is false. In the Form 886-A, IRS Examination acknowledged YA Offshore’s representation that, in the ECI Memo, Mr. Schinik "memorialized ‘discussions’ that he had with Messrs. Yager and Kast" from RSM. (Ex. 1401-J, at p. 0028.) IRS Examination went on to explain that YA Offshore had not engaged RSM to provide any tax services. Petitioners do not dispute this. (See Pet’rs’ Brief at p. 278.) IRS Examination further explained that if the "discussions" that Mr. Schinik had with RSM were held pursuant to YA Global’s engagement with RSM, then under the express terms of that engagement those discussions should not be relied upon by YA Global (or anyone else for that matter) and, accordingly, should not be considered advice upon which YA Global could reasonably rely. (See Ex. 1401-J at p. 0028; RPFF ¶¶ 524, 525; Ex. 1397-J at 00123, 00130.)⁹⁴ Therefore, despite Petitioners’ baseless claim to the contrary, IRS Examination not only took into account the "discussions" that preceded the ECI Memo, it explained how those discussions were treated under YA Global’s engagement with RSM and factored into its consideration of the Request for Waiver.

Petitioners claim that IRS Examination came to the "implausible conclusion that RSM was not sufficiently familiar with YA Global’s business to provide advice." (Pet’rs’ Brief at p. 283.) Petitioners are doing nothing more than trying to distract from IRS Examination’s careful consideration of facts relevant to whether YA Offshore relied upon the advice of a tax professional.

IRS Examination noted that the ECI Memo did not contain any detailed analysis or citations to authority. (Ex. 1401-J at p. 0028.) This is apparent on the face of the ECI Memo. IRS Examination pointed out that the substance and detail of purported advice is a factor to consider in determining whether a taxpayer was reasonable in relying on advice. (Ex. 1401-J at p. 0028.)

IRS Examination also pointed out that the ECI Memo did not specify what information was considered in reaching the conclusions therein and contained very cursory descriptions of a convertible debenture and a SEDA. (Ex. 1401-J at pp. 28-29.) IRS Examination also pointed out that Mr. Yager expressed his unfamiliarity with how fees from issuing companies were handled. (Ex. 1401-J, p. 0029, n.23.) These facts are also relevant to consider in determining whether a taxpayer relied upon, or was reasonable in relying upon, advice from a tax professional.

IRS Examination determined that YA Offshore did not establish that it acted reasonably and in good faith in failing to timely file returns (including protective returns) by the deadlines prescribed for the 2006 and 2007 tax years and, consequently, was not entitled to a waiver of those deadlines. Petitioners’ attempt to show that IRS Examination abused its discretion in reaching this determination is unavailing and should be rejected by the Court.

b. YA Offshore is not entitled to a waiver.

Petitioners contend at Part VI.C.3.b. of their Brief that, based on both the record before IRS Examination when it made its determination and evidence adduced at trial, YA Offshore is entitled to a waiver from the filing deadlines under Treas. Reg. § 1.882-4(a)(3)(ii). As described above at Part VI.C.3, respondent now believes that the scope of the record for the Court’s review of the denial of the waiver should be limited to the information that was available to IRS Examination at the time that it made its determination. Therefore, IRS Examination’s reasoning for its denial of YA Offshore’s Request for Waiver, and the facts and circumstances on which that denial was based, that are fully set forth in the Form 886-A (see Ex. 1401-J), should be the focus of the Court’s inquiry, and evidence adduced post-determination, such as trial testimony, should not be considered.⁹⁵

In Part VI.C.3.b. of their Brief, petitioners repeat many points and arguments that they made in Part VI.C.3.a., to which respondent replies above. Therefore, in response to petitioners’ VI.C.3.b, respondent at this point will address only facts and contentions which were not made or raised by petitioners earlier in their section VI.C.3.a.

Also, in the event that the Court determines that the scope of the record for purposes of determining whether IRS Examination abused its discretion should be de novo, in this part respondent will reply to petitioners’ reliance on evidence that was not available to IRS Examination and cite, as appropriate, to other evidence that was not available to IRS Examination. As will be shown below, the evidence adduced at trial on the whole amply corroborates IRS Examination’s decision to deny YA Offshore’ Request for Waiver.

i. No tax professional was engaged to advise YA Offshore on U.S. tax filing rules; petitioners cannot rely on not receiving advice from persons not engaged to provide advice.

Petitioners assert that YA Offshore and its "management" did not know that YA Offshore was required to file any U.S. corporate income tax return and was not aware of the possibility of filing protective tax returns. (Pet’rs’ Brief at p. 287.) Petitioners cite to Mr. Teixeira’s affidavit for support but, again, the content of the affidavit is flatly contradicted by the engagement letters and the affidavit cannot be used to prove the truth of the matters asserted therein.⁹⁶ Petitioners cite Haywood Lumber & Min. Co. v. Commissioner, 178 F.2d 769 (2d Cir. 1950) for the proposition that a taxpayer can rely on the absence of advice to file a tax return. Petitioners’ reliance on Haywood Lumber is misplaced and easily distinguished from YA Offshore’s case. In Haywood Lumber, the court held that the taxpayer had reasonable cause for failing to file personal holding company returns where the taxpayer actually engaged a competent tax advisor to determine which returns needed to be filed by the taxpayer, the taxpayer was unaware that it was a personal holding company and the advisor neglected to advise to file the personal holding company returns. Haywood Lumber, 178 F.2d at 771. Again, unlike in Haywood Lumber, no tax professional was engaged to advise YA Offshore on U.S. tax rules applicable to YA Offshore, including which returns were required to be filed or possibly available to file (i.e. protective returns). Also, as discussed earlier, YA Offshore’s own private placement memorandum demonstrates that it was aware that it may be considered to be engaged in a trade or business within the U.S. due to certain of YA Global’s activities and, if so engaged, only entitled to taxation on a net basis if a return is filed.

Review of the contemporaneous engagement letters made available to IRS Examination dispositively shows that no tax professional was engaged to advise on YA Offshore’s U.S. tax filings or tax compliance generally. In addition, if the trial record is also considered, Mr. Karst’s testimony is consistent. In considering responsibilities to YA Offshore, Mr. Karst recollected that "RSM was not responsible for filing returns for anyone other than YA Global. We were engaged by YA Global, and we advised them and prepared their tax return . . ." and so advising YA Offshore on tax issues or preparing YA Offshore’s tax returns "frankly . . . might have been beyond the scope of [RSM’s] engagement." (RPFF ¶ 528; Tr. 471:11-17)

ii. Neither YA Offshore nor Yorkville were "advised" that YA Global was not engaged in a U.S. trade or business, and in any event, any such advice would not alter the fact that they did not engage any tax professional to advise on the U.S. tax filing rules potentially applicable to YA Offshore.

Petitioners contend that YA Offshore, via Yorkville, was "affirmatively advised multiple times and in numerous ways that YA Global (and therefore [YA Offshore])" did not have a trade or business within the U.S. (Pet’rs’ Brief at Arg. Part VI.3.b.ii.) Petitioners’ contention misconstrues and mispresents the actual facts.

First, petitioners contend that Yorkville’s tax advisors "advised" Mr. Schinik orally in multiple conversations that YA Global’s activities would not constitute a U.S. trade or business. (Pet’rs’ Brief at p. 287.) The record belies petitioners’ contention. Mr. Yager made very clear that these conversations did not constitute "advice" in any form. (RPPF ¶ 602; Tr. 375:6-17.) Also, as explained earlier, YA Global’s engagement letters with RSM specified that oral communications should not be relied upon. (RPFF ¶¶ 524, 525.) The engagement letters also specified that advice on specific matters on the returns was beyond the scope of the engagements. (Ex. 1397-J at pp. 00123, 00130.) Petitioners claim that Messrs. Griffel, Yager and Karst all testified that Yorkville was repeatedly told by its advisors that YA Global was not engaged in a U.S. trade or business. (Pet’rs’ Brief at p. 289.) The citations provided by petitioners for this claim do not support it. Pet’rs’ PFF ¶¶ 258-260 concern Mr. Karst’s views on convertibles and SEDAs but nothing specifically regarding the U.S. trade or business issue. Mr. Karst admitted that he was not aware that YA Global financed companies with promissory notes. (Tr. 461:2-5.) Mr. Karst made clear that RSM did not provide an opinion on whether YA Global was engaged in a U.S. trade or business. (Tr. 494:25-495:2) Mr. Griffel stated that Schulte Roth & Zabel did not provide an opinion to anyone regarding whether YA Global was engaged in a U.S. trade or business. (Tr. 523:7-10; 539:5-18.) Mr. Griffel stated that he did not even attempt to quantify the risk to YA Global that it may be considered to be engaged in a U.S. trade or business. (Tr. 561:8-19.) Mr. Griffel even stated that his firm wouldn’t "have every single detail of everything the fund does." (Tr. 562:16-17.) Notably, private placement memoranda for YA Offshore spanning November 2006 through March 2009 provided that neither YA Global nor YA Offshore had "obtained an opinion of counsel with respect to any tax issues." (RPFF ¶ 620.)

Second, petitioners contend that the ECI Memo memorialized discussions between Mr. Schinik and "his tax advisors" and that Mr. Yager reviewed the ECI Memo and added his name and e-mail as a contact. (Pet’rs’ Brief at p. 290.) Again, Mr. Yager unequivocally confirmed that RSM did not provide any "advice" to YA Global or Yorkville Advisors. (RPPF ¶ 602; Tr. 375:6-17.) Therefore, according to Mr. Yager, neither the ECI Memo nor Mr. Yager’s adding his name to the memo constituted advice.

Petitioners contend that Messrs. Schinik and Yager believed that the ECI Memo was an accurate summary of the discussions that Yorkville had with its various advisors about the U.S. trade or business issue. Petitioners contend that the ECI Memo was not "casual, off-the-cuff" advice. (Pet’rs’ Brief at p. 290.) But Mr. Karst’s view of the ECI Memo was in stark contrast to that of petitioners.’ According to Mr. Karst, the ECI Memo was,

a fairly superficial analysis in general. The question [whether engaged in a trade or business] — the question requires a much deeper analysis of many more factors and a fairly complete understanding of the business.

(Tr. 476:9-13.) Therefore, Mr. Yager confirmed that the verbal discussions upon which the ECI Memo was purportedly based did not constitute "advice," and Mr. Karst dismissed the ECI Memo as "superficial" and as having provided an inadequate analysis of the question whether YA Global was engaged in a U.S. trade or business.

Third, petitioners quote the following substantive statement from the NYCB Report that RSM sent to Mr. Schinik: "There is widespread agreement among tax practitioners that certain investments, such as private investments in public entities (PIPES), do note implicate trade or business issues for a Foreign Person even though one of the components of the investment package might be a loan or a debt-like preferred stock." (Pet’rs Brief at p. 290.) Petitioners contend that this language from the NYCB Report showed Mr. Schinik that the conclusion that YA Global was not engaged in a U.S. trade or business was widely shared by tax practitioners. (Pet’rs’ Brief at p. 290-91.) However, the NYCB report, which is Exhibit 1366-P, was admitted by the Court solely for the limited purpose to establish that Mr. Yager sent Mr. Karst an email containing the NYCB report. (Tr. 396:14-22.) To the extent that petitioners seek to use substantive language from within the NYCB report to show the views of tax practitioners regarding whether hedge funds undertaking PIPE transactions may be considered engaged in a U.S. trade or business, such a use would go beyond the limited use for which the document was admitted. Regardless, the mere fact that RSM sent Mr. Schinik a copy of the NYCB report does not constitute advice, make the report advice, or inform on whether RSM provided any advice previously, especially when RSM’s transmittal did not endorse the report or apply its theories specifically to YA Global’s’ facts.

Fourth, petitioners contend that RSM’s preparation of Forms 1042 and 1042-S for YA Global and YA Offshore would not have been appropriate if YA Global was engaged in a U.S. trade or business and equates to advice that YA Global was not so engaged and YA Offshore had no duty to file returns. (Pet’rs’ Brief at p. 291.) Petitioners similarly contend that RSM prepared YA Global’s Forms 1065 and Schedules K-1 which stated: "The Partnership has taken the position that it is an ‘investor’ and is not engaged in the active conduct of a trade or business." Petitioners contend that these actions constitute substantive tax advice to YA Offshore, citing Hatfried. Respondent has already addressed this contention above in distinguishing Hatfried. See part VI.C.3.a.iii.(b). Also, language contained on a Schedule K-1 issued by YA Global to YA Offshore is self-serving and not probative by itself.

iii. Application of the factors set forth at Treas. Reg. § 1.882-4(a)(3)(ii) confirms that YA Offshore has not established that it acted reasonably and in good faith in failing to file U.S. returns (including protective) by the prescribed deadlines.

In Part VI.C.b.iv. of their Brief, petitioners review the factors set forth at Treas. Reg. § 1.882-4(a)(3)(ii) and conclude that the review demonstrates that a waiver is appropriate. IRS Examination and respondent applied the factors in the Form 886-A and Respondent’s Brief, respectively. (See Ex. 1401-J at pp. 31-33 (including that the factors were largely implicitly addressed in IRS Examination’s consideration of all the facts and circumstances throughout the Form 886-A) and Resp’s Brief at pp. 328-336.) Both IRS Examination’s and Counsel’s applications of the factors compelled the conclusion that YA Offshore had not established that it acted reasonably and in good faith in failing to file U.S. returns (including protective) by the prescribed deadlines. Respondent’s application of the factors, in the context of all the facts and circumstances, is set forth in full at the Form 886-A and in his Brief. In this part, respondent responds only to points raised by petitioners in their Brief that are not addressed in the Form 886-A or Respondent’s Brief.

(a). Factor 1 — "Whether the corporation voluntarily identified itself to the Internal Revenue Service as having failed to file a U.S. income tax return before the Internal Revenue Service discover the failure to file"

Petitioners allege this factor is neutral because YA Offshore had no reason to believe it had any filing obligation so it "did not request any waiver . . . until respondent suggested during audit that YA Global could be deemed engaged in a USTB . . ." (Pet’rs’ Brief at p. 292.) Petitioners conclude that this factor is neutral. Petitioners misinterpret the factor. This objective factor simply asks whether the corporation identified the failure before the IRS discovered the failure. The factor does not inquire into the reasons that the foreign corporation would offer to explain the failure to file.⁹⁷ As explained in the Form 886-A and Respondent’s Brief, YA Offshore did not disclose its failures to timely file for the 2006 and 2007 tax years before the IRS discovered the failures. Petitioners appear to concede that YA Offshore did not voluntarily identify its failure to file before the IRS discovered the failure. (See Pet’rs Brief at p. 292 (claiming that since YA Offshore had no reason to believe it had any filing obligation, it "did not request any waiver . . . until respondent suggested during audit that YA Global could be deemed engaged in a USTB . . .").) This factor favors a finding that the Request for Waiver should have been denied.

(b). Factor 2 — "Whether the corporation did not become aware of its ability to file a protective return (as described in Treas. Reg. § 1.882-4(a)(3)(vi) by the deadline for filing a protective return"

Petitioners allege this factor favors a finding that the Request for Waiver should have been granted. Petitioners argue that neither Yorkville nor YA Offshore was aware that YA Offshore had any filing obligations and that neither were made aware of the possibility of filing protective returns. (Pet’rs’ Brief at p. 292.) Respondent’s application of this factor is fully explained in IRS Examination’s Form 886-A and Respondent’s Brief.

(c). Factor 3 — "Whether the corporation had not previously filed a U.S. income tax return"

Petitioners allege that this factor favors a finding that the Request for Waiver should have been granted given that YA Offshore had never filed a U.S. income tax return in the past because it did not know or believe it had to. Pet’rs’ Brief at p. 292. Respondent’s application of this factor is fully explained in IRS Examination’s Form 886-A and Respondent’s Brief.

(d). Factor 4 — "Whether the corporation failed to file a U.S. income tax return because, after exercising reasonable diligence (taking into account its relevant experience and level of sophistication), the corporation was unaware of the necessity for filing the return"

Petitioners allege that this factor favors a finding that the Request for Waiver should have been granted. Petitioners argue that for the reasons discussed in their Brief, "both the administrative record and the additional evidence presented at trial show that Yorkville and YA Offshore exercised the utmost diligence in engaging multiple, highly qualified tax advisors to advise them regarding the tax filing obligations of YA Global and its feeders."

As set forth in detail above, as well as in IRS Examination’s Form 886-A, neither Yorkville nor YA Offshore (nor YA Global) engaged any professional to advise on the application of U.S. tax rules, including tax filing rules applicable or possibly applicable, to YA Offshore.

(e). Factor 5 — "Whether the corporation failed to file a U.S. income tax return because of intervening events beyond its control"

Petitioners allege that this factor is inapplicable. Respondent’s application of this factor is fully explained in IRS Examination’s Form 886-A and Respondent’s Brief.

(f). Factor 6 — "Whether other mitigating or exacerbating factors existed"

Petitioners allege that this factor is inapplicable. Respondent’s application of this factor is fully explained in IRS Examination’s Form 886-A and Respondent’s Brief.

c. Petitioners’ conclusion is unwarranted; irrespective of the scope of review, YA Offshore has not demonstrated that IRS Examination abused its discretion in denying YA Offshore’s Request for Waiver.

In their conclusion, petitioners primarily complain that IRS Examination did not attempt to speak with the tax professionals engaged by YA Global. This is a meritless complaint.

In order to secure a waiver from the filing deadlines, YA Offshore bore the burden of establishing "to the satisfaction of the Commissioner" that it acted reasonably and in good faith in failing to file. Treas. Reg. § 1.882-4(a)(3)(ii). Moreover, the taxpayer has the burden of proof when alleging an abuse of discretion. Phillips v. Commissioner, 114 T.C. 115, 133 (2000) (citation omitted). Examination’s consideration of the request is evidenced by its 35-page explanation of its decision to deny the Request for Waiver. (Ex. 1401-J.) Petitioners seem to believe that under Treas. Reg. § 1.882-4(a)(3)(ii) IRS Examination was obligated to exhaust every measure of factual development and independent investigation to the satisfaction of YA Offshore and a failure to do so would be an abuse of discretion. Clearly, Treas. Reg. § 1.882-4(a)(3)(ii), which expressly places the burden on YA Offshore to "establish to the satisfaction" of IRS Examination that it was entitled to a waiver, does not operate in the way petitioners suggest.

Regardless, as explained in the Form 886-A and summarized in Respondent’s Brief and this Reply, the information available to IRS Examination showed that YA Offshore did not reasonably rely on any advice of any tax professional in failing to file the returns (including protective returns). As also explained in respondent’s briefs, the evidence adduced at trial only bolsters that conclusion. In sum, petitioners have not met their burden of proving that IRS Examination abused its discretion in denying YA Offshore’s Request for Waiver under Treas. Reg. § 1.882-4(a)(3)(ii).

VII. The limitations periods to assess the section 1446 withholding tax for 2006 and 2007 did not expire before the issuance of the FPAAs.

Petitioners contend that the period of limitations for assessment of the section 1446 withholding tax for 2006 and 2007 expired before the issuance of the notices of Final Partnership Administrative Adjustment. This argument is based on two false premises: (1) a Form 1065 triggers the limitations period for assessment of the section 1446 withholding tax and (2) YA Global did not consent to extend the limitations period for the section 1446 withholding tax. Petitioners’ arguments are unsound. The limitations periods for 2006 and 2007 had not expired when the FPAAs were issued.

As explained in Respondent’s Brief at pages 370 to 377, the filing of a Form 8804, Annual Return for Partnership Withholding Tax (Section 1446), triggers the limitations period for assessing the section 1446 withholding tax. Form 8804 was required to be filed by YA Global. Unlike Form 1065, Form 8804 meets the requirements of section 6501(a) and contains all of the information necessary to compute the section 1446 withholding tax.

Even if Form 8804 were not the form whose filing date properly started the running of the period of limitations on assessing the section 1446 withholding tax, Yorkville Advisors and Yorkville GP consented to extend the limitations period by signing Forms 872-P, Consents to Extend the Time to Assess Tax Attributable to Partnership Items. A Form 872-P covers all partnership items, including the section 1446 withholding tax. Respondent’s notices were issued within the extended periods agreed to in the Forms 872-P.

A. Petitioners bear the burden of proving that the limitations period expired before the issuance of the FPAAs.

Petitioners are correct that they bear the burden of proving that the limitations period for assessing the section 1446 withholding tax expired before the issuance of the FPAAs. (Pet’rs’ Brief at p. 297.) They incorrectly assert, however, that they have established a prima facie case that the FPAAs were mailed after the normal 3-year limitations period or that the Forms 872-P for 2006 and 2007 are not valid on their face. They also improperly try to shift to respondent the burden they failed to meet.

At page 297, petitioners suggest that they have made a showing that the FPAAs were mailed after normal 3-year limitations period and the burden of going forward shifts to respondent. Petitioners cannot, and did not, make this showing because, as they concede, YA Global did not file a Form 8804 (1st Stip. ¶ 3), and the 3-year limitations period under section 6501(a) never began to run.

Assuming incorrectly that they have made their prima facie showing, petitioners contend that respondent has failed to meet the burden of going forward to show, by a preponderance, that an exception to the 3-year limitations period applies. However, even had the burden of going forward shifted to respondent, respondent met it by introducing consents, valid on their face, that extended the period of limitations to the date of the mailing of the notice of deficiency. Estate of Greenfield v. Commissioner, T.C. Memo. 2008-16, 95 T.C.M. (CCH) 1080, 1082 (2008).

Her, the parties stipulated to the Forms 872-P for 2006 and 2007, all of which are valid on their face. The Forms 872-P (Exs. 31-J through 42-J, 55-J through 64-J) relate to the partnership items of YA Global, which include the section 1446 withholding tax liability, and they properly identify YA Global, bear the signatures of YA Global’s TMPs, properly identify the years affected, and are dated prior to the expiration of the existing limitations periods. See Kim v. Commissioner, T.C. Memo. 1996-142, 71 T.C.M. (CCH) 2530 (1996); Lefebvre v. Commissioner, T.C. Memo. 1984-202, 47 T.C.M. (CCH) 1572 (1984), aff’d per curiam, 758 F.2d 1340 (9th Cir. 1985). The Forms 872-P are sufficient to meet any burden on respondent of going forward.

Once respondent establishes the existence of valid consents, the burden of going forward shifts back to petitioners to show "affirmatively that the consent is invalid." Estate of Greenfield, 95 T.C.M. (CCH) at 1082 (citing Adler v. Commissioner, 85 T.C. 535, 540-41 (1985)). Petitioners have not shown that the Forms 872-P in this case are invalid.

The above relates to the burden of going forward, which, as explained, respondent either did not have to satisfy or satisfied even if it were considered at some point to have resided with respondent. The burden of proof, i.e., the burden of ultimate persuasion, however, never shifts from the party who pleads the bar of the statute of limitations. Adler v. Commissioner, 85 T.C. 535, 540 (1985). As explained below, petitioners have not carried this burden.

B. The filing of the Forms 1065 did not start the period of limitations for assessing the section 1446 withholding tax.

Petitioners claim that YA Global’s 2006 and 2007 Forms 1065 trigger the limitations period for assessing the section 1446 withholding tax. Petitioners advance two reasons as support. First, the Form 1065, they argue, is the return required to be filed by the taxpayer for purposes of section 6501(a) and, therefore, starts the running of the limitations period. Alternatively, they believe that, even if a Form 1065 is not the return triggering the statute, it contains sufficient information to calculate the section 1446 withholding tax and should be considered to have satisfied the requirement to file a Form 8804. Petitioners are wrong on both points. Because YA Global failed to file a Form 8804 for 2006 and 2007, the limitations period for assessing the section 1446 withholding tax never began to run.

1. Form 1065 is not the return required to be filed under the Code to trigger the running of the limitations period.

As noted, petitioners insist that the Form 1065 is the appropriate return to trigger the limitations period for assessing the section 1446 withholding tax. They believe that the section 1446 withholding tax’s status as a partnership item is determinative of what return triggers the limitations period. This is contrary to Bufferd v. Commissioner, 506 U.S. 523, 527 (1993), as explained below. They also misread the Supreme Court’s jurisprudence on when the filing of the wrong return will nonetheless trigger the running of the limitations period.

a. Form 8804 does trigger the period of limitations.

Petitioners’ argue that the characterization of the section 1446 withholding tax as a partnership item somehow is determinative of what return is required to be filed and somehow transforms the Form 1065 into a return of tax which can trigger the start of the section 6501(a) limitations period. Petitioners’ logic is flawed.

Petitioners claim, "Because a section 1446 withholding tax is a partnership item that must be taken into account at the partnership level, a partnership is required to file a Form 1065 with respect to it." (Pet’rs’ Brief at p. 299.) But a Form 1065 is not a "return of partnership items"; it is a "return of partnership income." That is clear from the form’s name, "U.S. Return of Partnership Income." The return contains line items that relate to income, loss, deductions, credits, and other items such as distributions that affect a partner’s tax liability. It does not include any line items where a partnership could report any withholding taxes due, including the section 1446 withholding tax. (See Exs. 1-J, 2-J, 1581-J, 1582-J.) Moreover, finding that Form 1065 is the appropriate return for reporting the section 1446 withholding tax would render superfluous Form 8804 and the regulations prescribing its filing.

Petitioners’ appeal to section 6629 as support for their position ignores long standing authority on (1) the relationship between sections 6501 and 6229 and (2) whether Form 1065 is a return that triggers. Section 6229 does not create a separate limitations period but rather provides a minimum period which merely extends the general limitations period under section 6501. Rhone-Poulenc Surfactants & Specialties, L.P. v. Commissioner, 114 T.C. 533, 542-43 (2000). This means that "a return required to be filed by a taxpayer" still needs to be filed before the section 6501 limitations period begins. And Form 1065 is not it. See Bufferd v. Commissioner, 506 U.S. 523, 527 (1993).

In Bufferd, the Supreme Court rejected an argument similar to petitioners’ position, at page 301, that more than one return can trigger the section 6501 limitations period. The taxpayer in Bufferd was a shareholder in a TEFRA subchapter S corporation. Both the shareholder-taxpayer and corporation filed returns. Respondent issued a deficiency notice to the shareholder-taxpayer adjusting various corporate items that flowed to the shareholder before the expiration of the limitations period with respect to the shareholder-taxpayer’s return but after the 3-year limitations period for the corporation’s return. The Supreme Court held that the corporate return did not trigger the limitations period under section 6501 and ruled for the government.⁹⁸ Bufferd, 506 U.S. at 527-28. In rejecting the taxpayer’s argument, the Court stated:

Under [the taxpayer’s] approach, ‘the’ return referred to in § 6501(a) becomes two returns, and petitioner claims that there is adequate statutory basis for his submission. We have no doubt that the courts below properly concluded, as the Commissioner argued, that it is the filing of petitioner’s return that triggers the running of the statutory period.

Id. at 527.

Section 6501(a) establishes the operative limitations period with respect to returns required to be filed by a "taxpayer." This is different from any limitations period that would apply to an informational return, such as a Form 1065, filed by an entity other than in its capacity as a taxpayer. YA Global was required to file two tax returns, one as an information reporter (Form 1065), the other as a taxpayer (Form 8804). But only the latter return could trigger the running of the limitations period under section 6501(a). In this case, that return was never filed.

Petitioners claim they are "not aware of any other authority, suggesting that a taxpayer has to file two different returns in order to get the benefit of the period of limitations." (Pet’rs’ Brief at p. 301.) The Supreme Court case, Commissioner v. Lane-Wells Co., 321 U.S. 219 (1944), seems to say exactly that. In Lane-Wells, the Supreme Court held that the taxpayer’s good faith filing of a Form 1120, in which the corporation denied being a personal holding company, was not sufficient to start the running of the limitations period for assessment of the personal holding company tax (which was required to be reported on former Form 1120H). Id. at 222-224. That is, the taxpayer was required to file two returns, both a Form 1120 and a Form 1120H.

Petitioners rely heavily on Zellerbach Paper Co. v. Helvering, 293 U.S. 172 (1934) to support their position. (Pet’rs’ Brief at p. 302.) But Zellerbach is readily distinguishable from the facts here. In Zellerbach, the taxpayer was required to file two returns with respect to the same tax, one filed under then-current law and one which was supposed to be filed following a change in the law but was not. The Court rejected respondent’s argument that the limitations period did not begin to run with respect to the second return because the second return had not been filed. The Court viewed the second return as a "supplement" or "amendment" to the first return, which made corrections to the computation of the tax liability.

These are not the facts here. YA Global was required to file a return of partnership income for informational purposes so that respondent has a means of corroborating or validating the partners’ income tax liabilities. Simultaneously, YA Global was required to file a return reporting its own income tax liability under sections 1446. Each return serves a different purpose and requires different information to be reported. In addition, Form 1065 does not make any computations of income tax and cannot be used standing alone to compute a partners’ income tax liability or the partnership’s section 1446 withholding tax liability. See Bufferd, 506 U.S. at 527-28.

Because the returns in Zellerbach were for the same tax, the first return contained sufficient information to calculate the tax due. Here, the returns present different information. Form 1065 identifies the income, loss, deductions, and credits that flow through to the partners but does not contain sufficient information from which to calculate the section 1446 withhold tax.

More importantly, in Zellerbach, the Court considered whether the first return filed by the taxpayer purported to be a return, was sworn to as such, and evinced an honest and genuine endeavor to satisfy the law. Here, YA Global’s Forms 1065 did not purport to be returns reporting the section 1446 withholding tax. YA Global did not report any income as business income on its Forms 1065, which would have been necessary to calculate section 1446 withholding tax; it did not identify any income amounts as effectively connected to a U.S. trade or business; and it did not report anywhere on its Forms 1065 an amount, even if zero, for the section 1446 withholding tax due.

YA Global did not report this information and did not intend to do so. YA Global specifically denied any liability for the section 1446 withholding tax, as the taxpayer in Lane-Wells had done, when it included on the Schedules K-1, attached to its Forms 1065, copies of which were issued to its partners, a statement that YA Global was an investor and not engaged in a U.S. trade or business.

Relying on Zellerbach, petitioners suggest that the Court treat Form 8804 as a "supplement return" because the regulations do not explicitly state "that a failure to . . . file a Form 8804 leaves the statute of limitations open indefinitely." (Pet’rs’ Brief at p. 303.) Nothing in Zellerbach suggests that the regulations must take any position on the application of section 6501. And petitioners cite to no other authority. Their argument has no merit. Section 6501 itself advises taxpayers that if a "return required to be filed by a taxpayer" is not so filed, the tax may be assessed at any time. I.R.C. § 6501(c)(3). As petitioners acknowledge, "the regulations require that a Form 8804 be filed." (Pet’rs’ Brief at p. 303.) Form 8804 is the return subject to section 6501, and the consequences of YA Global’s failure to file the required Form 8804 are not ambiguous. The section 1446 withholding tax may be assessed at any time.

b. Form 1065 does not have sufficient information to commence the limitations period for assessing the section 1446 tax.

Notwithstanding YA Global’s requirement to file a Form 8804, petitioners argue that the Forms 1065 which it actually filed were adequate for purposes of starting the limitations period for assessing the section 1446 withholding tax. (Pet’rs’ Brief at pp. 303-07.) Curiously, despite filing Forms 1065 that did not indicate that was any liability for the section 1446 withholding tax, petitioners maintain that those same forms set forth facts that make it clear that YA Global was liable for the section 1446 withholding tax.

Petitioners claim that YA Global’s Forms 1065 "made clear that it was a partnership and that it had foreign partners, the facts that establish liability for Section 1446 withholding tax." (Pet’rs’ Brief at p. 304.) This claim misconstrues and oversimplifies the provisions in section 1446. Section 1446(a) provides, "If — (1) a partnership has effectively connected taxable income for any taxable year, and (2) any portion of such income is allocable under section 704 to a foreign partner, such partnership shall pay a withholding tax." The section 1446 requirement to have "effectively connected taxable income" clearly requires more facts than, as petitioners contend, just being a partnership with foreign partners. It requires: (1) a U.S. trade or business, (2) taxable income that is effectively connected with such trade or business, and (3) some portion of that taxable income that is allocable to foreign partners. See I.R.C. § 1446(a) and (c).

The information included on YA Global’s Forms 1065 neither established liability for the tax nor provided the information necessary to compute the tax. YA Global’s Forms 1065 do not reveal that YA Global was engaged in a U.S. trade or business; in fact, they deny that YA Global was so engaged. As a consequence, they do not show that any income was effectively connected with a U.S. trade or business or what portion is allocable to the foreign partners.

As a result, it was incumbent upon respondent to verify the facts on which liability would be predicated, including the amount of ordinary business income and whether that income was effectively connected with a trade or business within the United States. Respondent was only able to do this after spending considerable time reviewing documents obtained during examination that revealed the nature of the transactions that YA Global entered into with its customers. The fact that respondent was eventually able to compute the section 1446 withholding tax based on information from YA Global’s Forms 1065, as petitioners allege at pages 304-305, is immaterial and is in no way indicative that YA Global’s section 1446 withholding tax liability was readily ascertainable from YA Global’s Forms 1065.

None of the cases cited by petitioner supports its contention that its Forms 1065 sufficed to commence the running of the limitations period. In particular, petitioners rely, at page 306, on Germantown Trust Co. v. Commissioner, 309 U.S. 304 (1940). In Germantown, the Court found that the Form 1041 fiduciary return filed by the taxpayer contained all of the data from which a tax could be computed and assessed and that respondent prepared a substitute return Form 1120 based on the information reported on that return.

Such was not the case here. Based only on the Forms 1065, respondent could not determine the fact of the liability much less the amount. Only upon examination was respondent able to determine and calculate YA Global’s liability for the section 1446 withholding tax. The very purpose of requiring a Form 8804 was to obtain data on which partnerships subject to withholding tax could be identified and assessed. "The purpose is not alone to get tax information in some form but also to get it with such uniformity, completeness, and arrangement that the physical task of handling and verifying returns may be readily accomplished." Commissioner v. Lane-Wells Co., 321 U.S. 219, 223 (1944) (emphasis added).

The case with facts most similar to the YA Global scenario is Lane-Wells. Like YA Global, the taxpayer in Lane-Wells was required to file two tax returns for the same taxable year but only filed one return. On the return it did file, the taxpayer disclaimed any liability for the tax subject to the second return. The Court stated:

But it seems admitted that the returns did not show the facts on which liability would be predicated. Such liability was expressly denied by the return, and to obtain data on which corporations subject to the tax could be identified and assessed was the very purpose of requiring a separate return addressed to that liability.

Lane-Wells, 321 U.S. at 223. Since the required return containing the information upon which the tax could be determined and assessed was never filed, the Court found that "the statute of limitations did not commence to run, and the assessment of the tax was not barred." Lane-Wells, 321 U.S. at 224.

2. YA Global’s Forms 1065 for 2006 and 2007 were not sufficient to trigger the period of limitations under substantial compliance principles.

Petitioners contend that YA Global’s Forms 1065 substantially comply with the requirement to file a Form 8804 and are sufficient to start the section 6501 limitations period. Petitioners’ arguments here are substantially similar those they present in the previous section, and respondent’s response is equally applicable here. In any event, the Forms 1065 actually filed by YA Global do not substantially comply with the section 1446 filing requirement, irrespective of where those returns were filed.

a. YA Global’s Forms 1065 do not meet the Beard test.

Petitioners’ reliance on Beard v. Commissioner, 82 T.C. 766 (1984), aff’d per curiam, 793 F.2d 139 (6th Cir. 1986) is misplaced. The Beard Court was focused on the issue of whether a tampered return constituted a return for various statutory purposes. There is no dispute that the Forms 1065 filed by YA Global were valid returns. The question is whether those returns can be used to satisfy a dual purpose.

As explained in the previous part above (Part VII.B.1.), it is clear that the Forms 1065 cannot be used as substitutes for the prescribed Forms 8804. Nonetheless, to the extent the Beard test can be used to determine whether the Forms 1065 constitute "substantial compliance" with the Form 8804 return filing requirement, the test has not been satisfied. As this Court articulated in Beard, for a return to be valid it must satisfy a four-part test: (1) the information on the purported return must be sufficient to calculate the tax liability; (2) the document must purport to be a return; (3) the purported return must be an honest and reasonable attempt to satisfy the requirements of the tax law; and (4) the purported return must be executed by the taxpayer under penalties of perjury. Beard v. Commissioner, 82 T.C. at 777.

YA Global’s Forms 1065 do not meet the first three parts of the Beard test. For the reasons previously discussed, YA Global’s Forms 1065 lack sufficient information to enable respondent to calculate YA Global’s section 1446 withholding tax liability, and do not purport to be returns of section 1446 withholding tax.

As to the third part of the test, petitioners argue that YA Global "honestly and reasonably intended to comply satisfy [sic] its tax obligations by filing the Forms 1065" and relied on its tax advisors’ guidance. (Pet’rs’ Brief at p. 309.) Petitioners transplant the third element from Beard out of its proper context and distort its import. The third element under Beard addresses whether, in filing a deficient or incorrect form, the taxpayer thought it had filed what was required, and the form appears to be such on its face. See Beard, 82 T.C. at 777-79. Beard did not involve an issue as to what form(s) the taxpayer was obligated to file or whether the form taxpayer thought was a correct one could serve as a proxy for another, totally different tax form, for statute of limitations purposes. YA Global’s Forms 1065 were never intended by YA Global to be a reporting of its section 1446 withholding tax liability because, as petitioners state and as the point of this litigation demonstrates, YA Global did not think it was liable for the section 1446 withholding tax. It seems axiomatic, therefore, that YA Global’s Forms 1065 were not intended to be and cannot represent valid substitutes for returns YA Global did not believe it was obligated to file. The Forms 1065 cannot be considered honest and reasonable attempts to satisfy the Form 8804 filing requirements for purposes of starting the limitations period on withholding tax reportable on Form 8804.

b. Where YA Global filed its Forms 1065 is immaterial.

Although respondent agrees generally that the required return must be filed at the proper location, whether some other return (the Form 1065) was properly filed is immaterial to the analysis in this case because YA Global’s Forms 1065 do not meet the Beard test, and the required return, Form 8804, was never filed.

C. YA Global’s TMPs consented to extend the period of limitations for assessing the section 1446 withholding tax.

Even if it were assumed that the limitations period for assessing the section 1446 withholding tax began to run with the filing of YA Global’s Forms 1065, the limitations periods for 2006 and 2007 were extended with the execution of the Forms 872-P, notwithstanding petitioners’ arguments.

It is well settled that a consent to extend the limitations period "is essentially a unilateral waiver of a defense by the taxpayer and is not a contract." Piarulle v. Commissioner, 80 T.C. 1035, 1042 (1983). "Contract principles are significant, however, because section 6501(c)(4) requires that the parties reach a written agreement as to the extension." Id. Whether the parties reached an agreement depends on the objective manifestation of assent as demonstrated by the parties’ overt acts. Kronish v. Commissioner, 90 T.C. 684, 693 (1988).

Mutual assent to the Forms 872-P at issue here is evidenced by the uncontroverted showing of the signatures of YA Global’s TMPs and general partners and respondent. See Id. at 694-95. The Forms 872-P signed by YA Global’s TMPs and general partners with respect to 2006 and 2007 were valid on their face. They correctly identify YA Global as the entity whose partnership items are being extended; they accurately identify the taxable years; and both parties executed the agreements before the existing limitations periods expired. Respondent did not alter any portion of the Forms 872-P after YA Global’s TMPs and general partners executed them.

1. Respondent is not relying on Forms 872 to extend the period for assessing the section 1446 withholding tax.

Respondent is not relying on the Forms 872 signed by the parties as extending the limitations periods for assessing the section 1446 withholding tax for 2006 and 2007.

2. YA Global’s TMPs consented to extend the period for assessing the section 1446 withholding tax with the Forms 872-P.

Petitioners argue that the Forms 872-P signed by YA Global’s TMPs do not show that the limitations period for assessing the section 1446 withholding tax was being extended because the Forms 872-P address income tax and petitioners argue a withholding tax is not an income tax to be assessed against a partner. (Pet’rs’ Brief at p. 312.) Petitioners are incorrect. Withholding tax is an income tax, and the TMPs’ assent to the extensions was evidenced by their signatures on the Forms 872-P. See Kronish, 90 T.C. at 693-95.

a. The extension made by Form 872-P includes an extension of the section 1446 withholding tax.

According to petitioners, the Tax Court has made clear that a withholding tax is not an income tax. This is incorrect. As explained in Respondent’s Brief at pages 380 to 382, a withholding tax is an income tax. Petitioners reliance on InverWorld, Ltd. v. Commissioner, 98 T.C. 70 (1992), aff’d, 979 F.2d 868 (D.C. Cir. 1992), is misplaced.

In InverWorld, the Tax Court had to decide whether it had jurisdiction under the particular facts of the case, not whether withholding tax was an income tax. Specifically, the court considered whether it had jurisdiction to determine an income tax deficiency, which was the subject of a notice of deficiency, in a proceeding brought by the taxpayer with respect to a notice of liability for a withholding tax. The court concluded that even though a withholding tax is an income tax, the liability for the withholding tax gave rise to a separate cause of action from the liability for an income tax. Nothing in the case speaks to whether extending the limitations period for assessing an income tax also extends the limitations period for assessing a withholding tax.

Petitioners misinterpret InverWorld. InverWorld is part of a line of cases generally holding that issuance of separate statutory notices with respect to withholding tax and corporate income tax does not violate section 6212(c) because withholding tax and corporate tax are separate taxes and separate taxpayers are ultimately liable for these separate taxes insofar as the corporation is liable for withholding tax as withholding agent of one or more foreign taxpayers and also liable for income tax as a taxpayer.

This line of cases is relevant to the instant case because the Tax Court recognized that both taxes are "income taxes." Therefore, where a petition was with respect to only one statutory notice, an untimely amendment to the petition contesting the deficiencies asserted in the another statutory notice could not bring those deficiencies under jurisdiction of the Tax Court, even though both corporate tax and withholding tax were "income taxes." See InverWorld, 98 T.C. at 81-82 ("In particular, we emphasized that although both taxes are imposed under subtitle A (Income Tax) of title 26, they were based upon two separate returns, and the liabilities originated from taxes enacted for different purposes.") (citing Michael v. Commissioner, 22 B.T.A. 639 (1931), affd. per curiam, 75 F.2d 966 (2d Cir. 1935)); S-K Liquidating, 64 T.C. 713, 714 (1975) ("Here both deficiencies were for ‘income tax’ in that they were imposed under subtitle A (Income Tax of title 26, United States Code . . ."). See also Northern Indiana Public Service Co. v. Commissioner, 101 T.C. 294, 298-99 (1993).

The Forms 872-P in the present case extended the limitations periods for "income tax." They were not limited to any particular income tax. The InverWorld line of cases does not support that the section 1446 withholding tax is not included in the reference to "income tax," the limitations period with respect to which the Forms 872-P extended.

Furthermore, the language of the Form 872-P should be read in light of the statute for which the form is being used. Section 6229(b) states that the limitations period under section 6229(a) may be extended with respect to all partners by an agreement entered into by the Secretary and the TMP (or other person authorized by the partnership to enter into such an agreement.) The limitations period under section 6229(a) is "the period for assessing any tax imposed by subtitle A with respect to any person which is attributable to any partnership item for a partnership taxable year." Section 1446 is a provision under subtitle A of the Code, which titled "Income Taxes." Therefore, the term "federal income tax" in Form 872-P is synonymous with taxes imposed under subtitle A.

b. An agreement to extend the time to make an assessment against any partner is an agreement to extend the time to make an assessment against the partnership because in this context, the partnership is a partner.

Petitioners further argue that, based on the common understanding of the word "partner," the extension in the Forms 872-P did not apply to YA Global itself. However, the common understanding of the term "partner" is not determinative here, as the TEFRA provisions under former sections 6221 et seq. have their own definitions and structure which govern the interpretation of the Forms 872-P.

As defined in section 6231(a)(2), the term "partner" includes "any other person whose income tax liability under subtitle A is determined in whole or in part by taking into account, directly or indirectly, partnership items of the partnership." YA Global meets this definition because it is a person under section 7701(a)(1), it has an income tax liability, which is a tax liability under subtitle A, in the form of the section 1446 withholding tax, and section 1446 withholding tax is a partnership item of the partnership.

Because YA Global qualifies as a partner of itself under section 6231(a)(2), the Forms 872-P do, indeed, extend the statutory period of limitations against YA Global.

3. Respondent did demonstrate an objective manifestation to extend the time to assess the section 1446 withholding tax.

Finally, petitioners claim that respondent’s procurement of Forms 872, in addition to Forms 872-P, suggests that the Forms 872-P were not intended to include extensions of the limitations periods with respect to the section 1446 withholding tax. On the contrary, it was expressly because the Service intended to include section 1446 in the extension that the Service obtained the Forms. 872. At the time the forms were prepared and executed the status of withholding tax as a partnership item had not been litigated. The Service’s procurement of Forms 872 was a measure to prevent a whipsaw, i.e., a measure intended to hedge against the outlying possibility that the section 1446 withholding tax could be considered not a partnership item. (The Service also issued statutory notices of deficiency in addition to FPAAs in the instant case as a whipsaw measure intended to hedge against the outlying possibility that the section 1446 withholding tax could be considered not a partnership item.) As an "anti-whipsaw measure," the Service’s procurement of Forms 872, in addition to Forms 872-P, in no way undermines the Forms 872-P extension of the statutory period of limitations with respect to the section 1446 withholding tax. This "anti-whipsaw" measure was taken in light of petitioners’ earlier argument that section 1446 withholding tax was not a partnership item. See YA Global Inv. v. Commissioner, 151 T.C. 11, 12 (2018) ("This case comes before the Court on a motion to dismiss for lack of jurisdiction filed by the tax matters partner (TMP) for YA Global Investments, LP (YA Global). In its motion, the TMP argues that withholding tax under section 1446 is not a partnership item and as a result the adjustments in the notices of final partnership administrative adjustment (FPAA) relating to withholding tax liability under section 1446 must be dismissed for lack of subject matter jurisdiction.").

Also, petitioners argue that the addition of the asterisk on subsequent Forms 872-P denoting a statement specifying that "federal income tax attributable to the partnership items of the partnership" included "income and/or withholding tax required to be paid and/or withheld at the source (under Chapter 3 of the Internal Revenue Code) due on Form 8804 or Form 1042" demonstrates that respondent understood that the earlier Forms 872-P for 2006 and 2007 were ineffective to extend the period to assess withholding tax. To the contrary, the addition of the asterisked sentence on subsequent Forms 872-P is consistent with the earlier Forms 872-P for 2006 and 2007 and merely underscores the intended meaning. The earlier Forms 872-P for 2006 and 2007 were valid on their face because, as discussed above, they extended the limitations period with respect to any federal income tax attributable to the partnership items of the partnership against any partner. As discussed above, section 1446 withholding tax is a type of income tax, it is also a partnership item, and YA Global qualifies as a partner of itself under section 6231(a)(2). Objective manifestation of mutual consent to extend a statutory period of limitations on assessment is generally evidenced by the parties’ overt acts, not their secret intentions. Kronish v. Commissioner, 90 T.C. 684, 693 (1988); Tallal v. Commissioner, 77 T.C. 1291, 1294 (1981), aff’d, 778 F.2d 275 (5th Cir. 1985). The addition of the asterisk on subsequent Forms 872-P only served to clarify the subsequent years’ Forms 872-P; It does not detract from the validity of the earlier Forms 872-P for 2006 and 2007.

4. Conclusion

The Forms 872-P were valid on their face and extended the limitations period for assessing the section 1446 withholding tax. The parties manifested their assent to extending the limitations period by the application of their signatures on the Forms 872-P. Respondent was not attempting to "revive" the limitations periods by adding additional language to the Forms 872-P. Petitioners have the burden to show otherwise and have not carried it.

VIII. Respondent properly determined that additions to tax under sections 6651(a)(1), 6651(a)(2) and 6655 are applicable.

Petitioners maintain on brief that penalties are not appropriate in the instant case because YA Global had reasonable cause for not filing Forms 8804 or paying its section 1446 withholding taxes. (Pet’rs’ Brief at pp. 318-322.) YA Global has not demonstrated that it had reasonable cause for failing to file Forms 8804 and paying the section 1446 withholding taxes. (See Resp’s Brief at pp. 359-68; entire record).

A. The filing of the Forms 1065 do not satisfy the filing requirement for purposes of section 6651(a)(1).

On brief, petitioners make the argument that YA Global’s filing of a Form 1065 meets a four-prong test set forth in Beard v. Commissioner, 82 T.C. 766, 777 (1984). In Beard, the taxpayer significantly altered his Form 1040 income tax return and the court had to decide a statute of limitations issue where the taxpayer filed an altered Form 1040. Id.

The Beard court addressed whether a return "sufficient to trigger the running of the statute of limitation must also be sufficient for the purpose of section 6651(a)(1)." Id. Unlike the taxpayer on Beard, YA Global was required to file two tax returns, each satisfying different filing obligations. YA Global’s reliance in Beard is therefore misplaced.

The Supreme Court has held in situations where two returns are required that a return being offered for both purposes must contain not only sufficient information to compute the tax at issue, but also sufficient facts on which the second liability would be predicated. Commissioner v. Lane-Wells Co., 321 U.S. 219, 224 (1944). (See Resp’s Brief at pp. 374-77).

YA Global’s Form 1065 did not contain sufficient information from which to determine its withholding tax liabilities because the form does not set forth specific information about the amount of effectively connected income. Form 1065 shows only a total amount of income and overall adjustments. Thus, the substance of the Forms 1065 filed in this case effectively denied liability for the section 1446 withholding tax.

In addition, YA Global’s Forms 1065 did not show any business income, a prerequisite for having income effectively connected to a U.S. trade or business subject to the section 1446 withholding tax. YA Global’s Forms 1065 reveal no facts on which respondent could ascertain that YA Global was liable for the section 1446 withholding tax.

Based on the foregoing, Respondent maintains that YA Global’s Forms 1065 for 2006 and 2007 were not sufficient to meet YA Global’s section 1446 withholding tax filing obligations.

B. YA Global has not shown reasonable cause existed for its failures to file Forms 8804 and pay the section 1446 withholding tax.

YA Global contends that reasonable cause exists for its failure to file Forms 8804 and failure to pay the section 1446 withholding tax because it relied on RSM’s conclusion that YA Global was not engaged in a U.S. trade or business and, in the event that YA Global did not rely on advice from RSM, whether YA Global was engaged in a U.S. trade or business was a novel issue with no clear guidance. (Pet’rs’ Brief at pp. 319-22.) The record before the Court belies these contentions. YA Global has not shown reasonable cause in this case. (See Resp’s’ Brief at pp. 363-66.)

Petitioners first argue that YA Global, through Yorkville, engaged RSM to prepare YA Global’s tax returns, and having concluded that YA Global was not engaged in a U.S. trade or business, RSM prepared and filed Forms 1042 but not Forms 8804 and did not advise YA Global to pay section 1446 withholding tax. (Pet’rs’ Brief at p. 320.) Petitioners contend that if RSM was wrong in its conclusion that YA Global was not engaged in a U.S. trade or business, YA Global reasonably relied upon RSM in failing to timely file Forms 8804 and pay the section 1446 withholding tax, and thus has reasonable cause for these failures. Id. Petitioners offer that YA Global was reasonable in its reliance "for all the same reasons, discussed in Part VI.C.3.b of their brief" (arguing that YA Offshore was entitled to have its Request for Waiver granted under Treas. Reg. § 1.882-4(a)(3)).

Additions to tax are imposed under section 6651(a)(1) and (2) for failure to file a return and pay tax, respectively, within the prescribed periods, unless it is shown that such failure was due to reasonable cause and not due to willful neglect.

The failure is due to reasonable cause if the taxpayer exercised ordinary business care and prudence but was nevertheless unable to perform its tax obligations in timely manner. Ellwest Stereo Theatres of Memphis, Inc., et al. v. Commissioner, T.C. Memo. 1995-610, 70 T.C.M. (CCH) 1655 (1995) (citations omitted). Reliance on the advice of a tax professional may only be considered an exercise of ordinary business and prudence if the taxpayer demonstrates that: (1) the adviser was a competent professional who had sufficient expertise to justify reliance, (2) the taxpayer provided necessary and accurate information to the adviser and (3) the taxpayer actually relied in good faith on the adviser’s judgment. Eldest Stereo, T.C. Memo 1995-610, 70 T.C.M. (CCH) at *5.

The burden is on the taxpayer to demonstrate that all three elements have been met. Id. Petitioners clearly have not established that the second and third elements have been met.

Regarding the second element, petitioners contend that either the ECI Memo or the oral discussions preceding the ECI Memo between RSM and Mr. Schinik memorialized in the ECI Memo were advice from RSM. (See Pet’rs’ Brief at p. 284.) Petitioners cannot establish that the second prong is met with respect to such purported "advice" under either contention because the record demonstrates that RSM did not receive facts that were accurate and necessary to render the advice.⁹⁹

Petitioners contend that the ECI Memo encompassed an accurate summary of the discussions between RSM and Mr. Schinik about the "trade or business" issue that served as the basis for the ECI Memo. (Pet’rs Brief at p. 290 (citing testimony of Messrs. Schinik and Yager).) Thus, the facts contained in the ECI Memo should reflect the facts that were previously discussed between RSM and Mr. Schinik. It is indisputable that the ECI Memo, and therefore the discussions upon which it was based, omitted material information about the financial transactions undertaken by YA Global and how it makes money. The ECI Memo erroneously implied that YA Global did not receive any cash fees. (See, e.g., RPFF ¶¶ 303, 386-391.) It omitted any mention or analysis of interest that YA Global accrued with regard to the convertible debentures, any discussion of promissory notes, any conclusion about SEDAs, and the impact of non-cash fees in its conclusion. Messrs. Yager and Karst acknowledged that this type of information would all be relevant to a competent tax professional advising on whether a foreign person is engaged in a U.S. trade or business. (See Tr. 464-75, 480-81, 541, 542-543, 562-64.) Mr. Yager expressed his unfamiliarity with how fees were handled. (Tr. 474-475; Ex. 1365 (Mr. Yager’s tracked changes inquiring whether the representation about fees was accurate).) Mr. Karst stated that he was not aware that YA Global entered into promissory notes. (Tr. 461:1-5.)¹⁰⁰ Accordingly, RSM did not have, or was unaware of, the accurate and necessary facts to advise YA Global. Consequently, petitioners cannot claim that the ECI Memo or the discussions that are "embodied" in the ECI Memo constituted reliance on a tax professional.

While petitioners’ failure to establish the second element is on its own fatal to their claim that YA Offshore relied upon the advice of tax professionals via the ECI Memo or the discussions embodied therein, petitioners also fail to establish that the third element has been met. Petitioners have not established that YA Global reasonably relied in good faith on an adviser’s judgment.

Implicit in the third element is that the adviser provided advice to the taxpayer. As a threshold matter, petitioners have not established that the ECI Memo or the discussions purportedly embodied therein constituted "advice," as fully explained in Part VI.C.3.b., above. Mr. Yager stated that RSM did not provide any advice (Tr. 375:6-16) and Mr. Karst stated that RSM did not provide any opinion (Tr. 494:25-495:2). The engagement letters that YA Global entered into for tax return preparation services with RSM warned that YA Global should not rely on verbal discussions with RSM. (Ex. 1397-J, at pp. 00123, 001130.)¹⁰¹ The ECI Memo itself cannot be considered advice from RSM to YA Global. Mr. Schinik wrote the ECI Memo and Mr. Yager did not consider it to be the work of RSM. (RPFF ¶ 624; Tr. 435:11-12, 437:12-15.)¹⁰²

Therefore, since neither the ECI Memo nor the discussions supposedly embodied in the ECI memo constituted advice, YA Global could not rely on either as advice; and thus petitioners have not established that the third element is met.

Even assuming that the ECI Memo or the discussions embodied in the ECI Memo was considered "advice" for purposes of the third element, petitioners cannot show that YA Global actually relied on such advice in good faith. Mr. Schinik, YA Global’s CFO with years of experience in the hedge fund industry, knew or should have known that the information about YA Global discussed above under the second element that was omitted from the ECI Memo was material to the issue. Moreover, YA Global’s private placement memorandum explicitly cautioned that some of YA Global’s activities such as making loans and receiving fees from companies may cause it to be considered engaged in a U.S. trade or business. (RPFF ¶ 614.) Also, the ECI Memo, which allegedly contained the discussions held on the issue, did not contain any citations to authority and was demonstrably lacking any meaningful analysis. See Long-Term Capital Holdings v. United States, 330 F.Supp. 2d 122, 248-9 (D. Conn. 2004), aff’d, 150 Fed. Appx. 40 (2d Cir. 2005) (court rejected taxpayer’s reliance on advisor defense to accuracy related penalty, in part, because the alleged advice failed to cite to relevant authority and contained no meaningful analysis). Tellingly, Mr. Karst viewed the ECI Memo as providing a "superficial analysis in general" and the question [whether YA Global was engaged in a U.S. trade or business and subject to ECI] "requires a much deeper analysis of many more factors and a fairly complete understanding of the business." (Tr. 476:6-13, RPFF ¶ 599.)

A reasonably prudent taxpayer with YA Global and Yorkville’s sophistication exercising ordinary business care and prudence would have sought out advice from an independent tax professional who was willing to opine on the matter; instead, Mr. Schinik took it upon himself to draft an internal memo based upon oral discussions of an incomplete fact set held pursuant to the terms of an engagement letter that expressly warned against relying on such discussions.

For all of these reasons, YA Global did not reasonably rely in good faith on the purported advice from RSM in the form of either the ECI Memo itself or the discussions with RSM supposedly embodied in the ECI Memo.

Petitioners also may be implying that RSM’s failure to file Forms 8804 was by itself advice to YA Global that it need not file Forms 8804. (See Pet’rs Brief at p. 320.) Petitioners made a similar argument in its claim that its Request for Waiver under Treas. Reg. § 1.882-4(c)(3) should have been granted by respondent, relying on Haywood Lumber. (See Pet’rs’ Brief at p. 287.) However, unlike the taxpayer in Haywood Lumber which was not aware that it may be a personal holding company and thus had no reason to concern itself with filings that may be implicated by being so characterized, YA Global was already on full alert that it may be engaged in a U.S. trade or business (as discussed, petitioners claim Mr. Schinik held numerous discussion with outside professionals about the issue; YA Global’s private placement disclosed YA Global may be considered engaged in a U.S. trade or business; there had been inquiries from potential investors about whether YA Global was engaged in a U.S. trade or business). Also, that YA Global cannot be considered to have acted reasonably in relying on purported advice from RSM as to whether it was engaged in a U.S. trade or business for the reasons set forth above, necessarily taints, if not precludes, its reliance on RSM’s tax return preparation as it relates to whether YA Global was engaged in a U.S. trade or business. For these reasons, YA Global cannot claim it meets the third element based on RSM’s failure to prepare and file Forms 8804.

Petitioners next assert that even if YA Global did not receive any advice (and therefore, presumably, is unable to claim reliance on a tax professional to establish reasonable cause) respondent’s position, i.e., that YA Global’s activities gave rise to a U.S. trade or business, was "novel and without precedent in an area that lacks guidance" and that courts "routinely" decline to impose penalties under such circumstances. (Pet’rs’ Brief at pp. 320-321 (citing Petersen v. Commissioner, 148 T.C. 463 (2017); Williams v. Commissioner, 123 T.C. 144, 153 (2004); Van Camp & Bennion v. United States, 251 F.2d 862 (9th Cir. 2001)).) Petitioners are mistaken in their assertion and the case law is distinguishable. The case law cited by petitioners concerns legal issues of first impression. See Petersen (considering for first time technical legal issue of the application of section 267(a) to employers and ESOP participants); Williams (considering for first time legal issue of whether filing individual bankruptcy alters the rules that otherwise apply under subchapter S regarding the allocation and deductibility of losses of S corporations incurred in the calendar year in which the individual shareholder files for bankruptcy); Van Camp & Benion (court imposed accuracy related penalty because, in part, the issue was not an unsettled legal issue of first impression).

Whether a foreign person is engaged in a trade or business under section 864, or its predecessor provisions, is not a "novel’ legal issue of first impression Rather, this issue has been contested for many decades. (See Resp’s Brief at Argument, Part II.) YA Global’s facts may be intensive and complex, but section 864(b) is not a new or novel legal issue. Also, the court opinions cited by petitioners are devoid of any mention that the taxpayer was aware that the IRS may challenge the position taken on the taxpayer’s return, as is the case here.

Petitioners also suggest that respondent’s decision to seek, and ultimately receive, Chief Counsel Advice (CCA) indicates that respondent considered the issues in the case to be novel or the law unsettled. (Pet’tr’s Brief at p. 321 (citing IRM 31.1.1.2(2)).) Petitioner’s depiction of CCAs is erroneously narrow as it neglects to consider that Chief Counsel may issue a CCA simply to ensure that Division Counsel attorneys are taking positions consistent with an Associate Office’s view, and one way that is done is through "other advisory products," like the CCA. see IRM 31.1.1.2(1).¹⁰³

In conclusion, petitioners have not demonstrated that YA Global’s failure to timely file Forms 8804 under section 6651(a)(1) and failures to timely pay section 1446 withholding tax under section 6651(a)(2) were due to reasonable cause.

CONCLUSION

It follows that the determination of the Commissioner of Internal Revenue should be sustained.

Date: March 22, 2021

WILLIAM M. PAUL
Acting Chief Counsel
Internal Revenue Service

By: GRETCHEN A. KINDEL
Special Trial Attorney
(Large Business & International)
Tax Court Bar No. KG0243
JW Peck Federal Building
550 Main St., Suite 9-351
Cincinnati, OH 45202-3222
Telephone: (513) 263-4875
gretchen.a.kindel@irscounsel.reas.gov

ROBERT T. BENNETT
Senior Counsel
(Large Business & International)
Tax Court Bar No. BR1395
Robert.T.Bennett@irscounsel.treas.gov

SHAWNA A. EARLY
Special Trial Attorney
(Small Business/Self-Employed)
Tax Court Bar No. ES0127
Shawna.A.Early@irscounsel.treas.gov

OF COUNSEL:
ROBIN GREENHOUSE
Division Counsel
(Large Business & International)
JOHN M. ALTMAN
National Strategic Litigation Counsel
(Large Business & International)
MARY HELEN WEBER
Deputy National Strategic Litigation Counsel
(Large Business & International)

CHARLES BUXBAUM
Special Trial Attorney
(Large Business & International)
Tax Court Bar No. BC0694
Charles.E.Buxbaum@irscounsel.

KELLY M. DAVIDSON
Senior Attorney
(Large Business & International)
Tax Court Bar No. DK0084
Kelly.M.Davidson@irscouinsel.treas.gov