IRS Keeps $20M of Foreign Trust Corpus – Settlor Was in “Control,” Federal Judge Rules
Nathaniel K. MacPherson
Cititrust EDGE Magazine4Q 2011 (October 2011): 22-24.
In June of this year, after traveling from London to Los Angeles, the trustee of a Turks & Caicos Islands grantor trust (“Trust”) gave testimony in federal court, claiming that the U.S. taxpayer, Joe, a young and very successful entrepreneur, did not control the Trust or its assets, many of which were held in a Caymanian corporation, Rothwell, Ltd. Likewise, an attorney licensed in the U.S., who served as trust “protector,” testified that Joe lacked control over the Trust. But the court found this testimony “unconvincing in light of the facts established” by IRS. Moreover, a successor trustee “testified that he was not totally in control of the assets of the Trust, but rather that Rothwell, directed by [the original trustees], controlled Rothwell’s assets, even after he became sole trustee.” And, with respect to the purchase and development of property in Mexico, largely undertaken by world-famous luxury developer Mohamed Hadid who also testified, the court found “the sequence of events…strongly indicates that despite [Joe’s] lack of formal ownership over Rothwell, he exercised control over [Rothwell] and use of its assets. Rothwell assets included $20 million in a Los Angeles brokerage account, seized by IRS through a “nominee levy” and the subject of the lawsuit.
In 1999, with the help of his U.S. attorney and offshore professionals, Joe settled the trust, naming as beneficiaries his parents, his children, and a U.S. company owned by Joe. Over $14 million from Joe’s U.S. companies funded the trust, some of which ultimately funded the Los Angeles brokerage account of Rothwell. The same broker handled Joe’s personal account. IRS jeopardy assessed Joe personally with a major income tax liability, and levied the Rothwell account, claiming Rothwell is Joe’s “nominee.” Rothwell in turn sued IRS for wrongful level, seeking return of the funds to its rightful owner, Rothwell. A bench trial resulted, with the seminal issue: whether IRS met its burden by proving that Rothwell held its asset as nominee of Joe, subject to Joe’s control.
After detailed recitation of its findings of fact, the court, in drawing its conclusions of law, cited to several principles of nominee law, including, inter alia: (1) “a nominee holds legal title to property while another retains the benefits of the property;” (2) California law recognizes that when property is held by a nominee, the beneficial owner retains interest in the property;” (3) “a third party will be considered a nominee to the extent that the taxpayer exercises control over the party and it assets;” (4) “some factors held by other courts as relevant to determine control in the nominee analysis include a lack of consideration paid by the nominee for the property, a close relationship between the taxpayer and the nominee, and continued enjoyment of the benefits of the property by the taxpayer.” The court then set forth its specific reasons for finding that IRS “carried its burden to demonstrate a nexus between the [Rothwell assets and Joe], and was “persuaded that Rothwell held the assets as a nominee for [Joe], who retained control over the assets.” Reasons included, inter alia:
Joe and Rothwell were “intertwined” – as to management, operation, and expenditures.
Joe was listed as the sole “beneficial owner” of Rothwell in a document submitted by the trustee to a Bermuda bank.
Brokerage accounts of Joe and Rothwell were at the same Los Angeles branch and with the same broker.
Joe’s attorney also counseled Rothwell, the trust, other entities owned by the trust, and was trust protector.
Apparently as agent for Joe, his attorney “communicat[ed] directives” to the trustees; which “indicates a possible locus of control” by Joe. After a successor trustee was appointed, the original trustees, who received directives from Joe’s attorney, “continued to direct the operations of Rothwell.” Joe never received consideration for the $14 million he caused to be transferred to Rothwell. (Query: how is this relevant given the fact that Joe settled the trust and a settlor receives no consideration – he effects a gift.)
Acquisition and development of the property in Mexico evidences control by Joe; e.g., he directed the construction and utilized funds from his companies.
Drawing these factual conclusions, the court found that in the “face of indicia of control” the court was “persuaded that a nexus existed between [Joe] and Rothwell’s assets,’ causing the burden to shift back to Rothwell to prove that Joe held no ownership over the property. Finding “lack of formal ownership or rights to control Rothwell’s assets,” the court nonetheless found that: (1) because the assets were subject to Joe’s control; (2) Rothwell is nominee of Joe; (3) therefore, the levy was proper – IRS keeps the $20 million. This does not however end the inquiry; as trial attorneys are wont to say, “no pancake so thin it does not have two sides.” Rothwell has lodged an appeal with the U.S. Court of Appeals for the Ninth Circuit. Stay tuned for the ruling by a panel of three judges.
Meanwhile, although not discussed in the Rothwell order as such, readers should be mindful of the adage, oft applied to offshore arrangements: “form cannot be exalted over substance.” By this we by no means opine re the merits of this case; this article by design is confined to the four corners of the order, good or bad, disregarding the many arguments made orally and written, prior to and during trial. Indeed, the pancake will be flipped during the appeal process.
About the Authors:
Nathaniel K. (Nathan) MacPherson spent nearly four years as an international finance lawyer in Frankfurt and London representing global banks and finance ministries in cross-border securitization, factoring, and derivatives transactions before heading the California office of The MacPherson Group, P.C. Nathan represents, inter alia, German companies with U.S. subsidiaries, U.S. citizens and expatriates with civil and criminal tax problems, and foreign nationals with U.S. tax issues. Nathan is fluent in German and conversant in Brazilian Portuguese and has lived and worked in four countries on three continents.
Donald W. (Mac) MacPherson is a West Point graduate, Vietnam combat veteran, and former Green Beret officer. He is the only attorney in the United States board certified as a specialist in both tax law & criminal law and has tried over 55 criminal tax cases in 25 states over the past thirty-three years. Many of his clients were embroiled in offshore tax issues. Mac has authored three tax books, appeared regularly on radio & television talk shows, and teaches at tax seminars in the U.S. and overseas – litigation of offshore issues. Beginning in 1987 he developed expertise in the discharge of tax debts through bankruptcy. Mac is admitted to practice before scores of courts, including the U.S. Supreme Court and the U.S. Tax Court.
 Rothwell, Ltd. v. United States of America, Case No. SA CV 10-00479-RGK(FFMx), United States District Court, Central District of California. Order dated June 30, 2011.  Id., pg. 13, para. 23.  Id., pg. 4, para. 17.  Hadid was the developer of the Nimes Road estate “Le Belvedere” in Bel Air, California, “America’s most expensive mansion.” On June 4, 2010, it sold “for as much as $72 million.” http://www.forbes.com/2010/06/18/most-expensive-le-belvedere-lifestyle-real-estate-mansion.html  Order, pg. 11, para. 20.  Id., pg. 7, para. 37.  26 U.S.C. § 6861(a); used when IRS has evidence that collection is in jeopardy, e.g., taxpayer is dockside loading his yacht for the Caribbean or on the tarmac loading his jet aircraft.  Order, pg. 6, para. 35.  Right to a jury trial was waived.  Order, pgs. 8-9, para. 8-10.  Id., pg. 9, para. 11.  Id., pg. 9, para. 12.  Id., pg. 9, para. 14.  Id., pg. 10, para. 16.  Id., pg. 10, para. 17.  Id., pg. 12, para. 21.  Id., pg. 12, para. 23.  As basis for appeal, Rothwell’s counsel gives the reason of, inter alia, the judge’s failure to apply Turks & Caicos trust law as required by international treaty.