Tuesday, April 29, 2008, 5:02 PM

BB&T Loses Fourth Circuit Tax Appeal Over LILO Transaction

Today in BB&T Corp. v. U.S. the Fourth Circuit upheld the IRS's disallowance of deductions that BB&T claimed for a "lease in/lease out" (LILO) transaction. (A LILO transaction involves a taxpayer leasing property from a tax-exempt entity while simultaneously leasing the property back to the owner, enabling the taxpayer to deduct the rental payments on its lease, amortize costs, and possibly deduct interest payments. Many large financial institutions executed LILO transactions in the late 1990s.) Applying the substance-over-form doctrine, the Court held that even though the form of the transaction was a lease and immediate sublease, in substance BB&T didn't acquire a genuine leasehold interest in the property. In substance, it was a financing arrangement, not a genuine lease and sublease, the Court held.

The Court's opinion, authored by Chief Judge Williams, concluded with this closing (citation omitted): "In closing, we are reminded of 'Abe Lincoln's riddle . . . "How many legs does a dog have if you call a tail a leg?"' 'The answer is "four," because "calling a tail a leg does not make it one."' Here, BB&T styled the LILO as a lease financed by a loan, but did not in substance acquire a genuine leasehold interest or incur genuine indebtedness. Accordingly, although we decline to resolve whether the transaction as a whole lacks economic substance — that is, whether it has "reached the point where the tax tail began to wag the dog'", we conclude that the Government was entitled to recognize that tail for what it was, not what BB&T professed it to be."

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