Ninth Circuit: Joint venture not operated as bona fide partnership

Joint venture not operated as bona fide partnership

The U.S. Court of Appeals for the Ninth Circuit today affirmed decisions of the U.S. Tax Court, and concluded that the Tax Court did not err in finding that there was no intent by the parties that had formed a joint venture to operate it as a bona fide partnership. The Ninth Circuit thus agreed with the Tax Court that the joint venture was not a valid partnership, thereby affecting the allocation of income for income tax purposes.

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The case concerns taxpayers who were owners of an asbestos removal business that had been structured using various holding corporations. 

An opportunity arose to do environmental remediation work for a massive redevelopment project for the U.S. Navy. The contract would require that a large bond be posted against the possibility that the work would not be completed. To afford the bond, a joint venture was formed. 

Under the terms of the joint venture agreement, one company would do the environmental remediation work, and the other party (a partnership whose ultimate owners were tax-exempt retirement plans) would supply financial guaranties. In exchange for these services, the company would receive 30% of the venture’s profits, and the partnership would receive 70%. Accordingly, under the joint venture, the company would pay corporate income tax on its 30% share of the venture’s profits, but the partnership, would pay no income tax on its 70% share. Instead, that income would pass through to its owners, two holding corporations that were S corporations, so that the income would pass through to the S corporations’ shareholders. All shares of the holding corporations were in turn owned by tax-exempt retirement savings plans. 

The IRS determined income tax deficiencies, which the Tax Court upheld. Today, the Ninth Circuit affirmed. The case is: DJB Holding Corp. v. Commissioner, No. 12-70574 (9th Cir. October 7, 2015). Read text of the Ninth Circuit’s decision [PDF 183 KB]

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