Full opinion text
OPINION & ORDER [Resolving Doc. No. 1] JAMES S. GWIN, District Judge: I. Introduction With this action, two large national banks dispute adjustments that the Internal Revenue Service (“IRS”) made to partnership federal income tax returns for the 1999, 2000, 2001, 2002, and 2003 tax years. In those adjustments, the IRS found that the banks’ partnership, the AWG Leasing Trust, mis-characterized a 1999 transaction as a $423 million purchase of a German waste-to-energy facility. The IRS says the transaction was a thinly-veiled tax dodge that attempted to skirt IRS and Congressional action directed to limiting transactions that had the purpose of transferring tax deductions for rental payments, depreciation, amortization, and interest payments from tax neutral entities. As a result, the IRS claims that the Plaintiffs owe approximately $88 million in taxes for the 1999-2003 tax years and will owe much more for subsequent years. As will be described below, the banks say that they paid $423 million on December 7, 1999 to buy a waste-to-energy facility in Wuppertal, Germany and should be allowed to depreciate the Wuppertal plant. The banks argue that their contemporaneous lease of the facility back to the original owner under a very long-term triple-net lease and their grant of an option to repurchase the facility does not defeat their claim of ownership rights to the facility. The banks also say that they should be allowed to deduct interest on the $368 million long-term non-recourse loans that they obtained from two German banks to finance the transaction even though the loan proceeds went to escrow-type accounts that the German entity could not access and that were committed to paying the German company’s lease payments and to providing sufficient funding to complete the option exercise. In deciding this case, the Court makes two determinations. First, the Court decides whether the 1999 transaction has economic substance apart from the tax benefits at issue. Second, the Court considers whether the banks enjoyed the benefits and burdens of ownership of the Facility when the transaction pre-funded the repurchase of the facility and also required the original owner to repurchase the facility unless it met near-impossible conditions. As will be described, the Court finds that the transaction had some minimal substance apart from the tax benefit. However, the Court finds that the Plaintiffs never obtained an ownership interest sufficient to obtain a depreciable interest in the facility. The Court further concludes that the Plaintiffs are not entitled to deductions for interest paid or accrued on the underlying transaction loans because such loans do not constitute genuine indebtedness. For the reasons that follow, this Court SUSTAINS the IRS’s determination that the Plaintiffs’ asserted tax benefits relating to the AWG transaction are improper. The Court DENIES the Plaintiffs’ claimed depreciation deductions under 26 U.S.C. § 168, interest expense deductions under § 168(a), and amortization of transaction costs deductions. The Court also upholds the IRS’s imposition of accuracy-related penalties at the partnership level for substantial understatement of tax liability under ¡80 U.S.C. § 6662(a). II. Background This case revolves around a 1999 sale-in/lease-out (“SILO”) transaction. Under some SILO transactions, a party acquires assets from a tax-exempt party under a “head lease.” A SILO head lease typically involves a lease term sufficiently long to qualify as a sale under United States tax law. The acquiring party then simultaneously leases the assets back to the original owner under a longterm triple-net “sublease” with lease and option payments that exhaust almost all of the sale proceeds. The original owner also receives an option to repurchase the asset. Depending upon the transaction provisions, the exercise of the repurchase option may be nearly certain. In practical terms, the tax-exempt property owner continues to use the property as it did before the transaction and has no risk of losing control of the property. Meanwhile, the taxpayer receives tax benefits, sometimes significant tax benefits, by depreciating the assets, amortizing certain transaction costs, and deducting interest payments. Where the original owner seems extremely likely to repurchase the facility that it originally sold, the IRS argues that a true sale has not occurred and that the owner-lessor is not entitled to claim tax benefits associated with ownership, such as deductions for depreciation. The IRS also says that where a transaction has no economic substance apart from tax benefits, the taxpayer is not entitled to deduct interest on loans used to fund the transaction or expenses associated with the transaction. A. Histone Tax Treatment of Leveraged Lease Transactions For some time, financial leasing has served as an important vehicle for commercial enterprise fund raising. Leasing can mitigate the capital commitment that usually accompanies asset purchases. Often, commercial leases also allow parties to transfer tax benefits in an efficient fashion. Lessees who were unable to fully utilize tax benefits (usually because of a lack of profits) could obtain lower financial cost by entering a transaction that allowed them to transfer the tax benefits associated with depreciation and interest expense deductions to lessors who could more fully use these tax benefits. In theory, the lessees obtained lower financing costs in recognition of their transfer of the tax benefit. Accounting rules that apply to leveraged leases also make them significantly more attractive. Concerned that financial leases unfairly undercut the federal tax sys-tern, the IRS and Congress have adopted rules to ensure that the risks and indices of true ownership pass to the lessor before tax benefits can be claimed. SILOs are a modified version of their tax-driven financial predecessors, lease-in/ lease-out (“LILO”) transactions. Although each transaction is factually distinct, SILOs generally differ from LILOs by having a longer-term head lease that is sufficiently long to qualify for tax purposes as a sale. In a typical LILO, the taxpayer leases property from a tax-exempt entity and simultaneously leases the same property back to the owner and gives the owner an option to repurchase the lease. In practical terms, the tax-exempt property owner continues unfettered use of the property just as before the transaction, but the taxpayer claims tax benefits. As the Fourth Circuit Court of Appeals recently noted, “LILOs have been harshly criticized as abusive tax shelters that serve only to transfer tax benefits associated with property ownership from tax-indifferent entities, which have no use for them, to U.S. taxpayers.” BB & T Corp. v. United States, 523 F.3d 461, 465 (4th Cir.2008) (citing David Hariton, Response to “Old ‘Brine’ in New Bottles” (New Brine in Old Bottles), 55 Tax L. Rev. 397, 402 (2002)). In 1996, the IRS issued proposed regulations that generally eliminated any favorable tax treatment associated with LILOs. These proposed regulations sought to reduce the tax benefits of lease-leaseback transactions by treating prepaid rent as a loan. Section 467 Rental Agreements, 61 Fed. Reg. 27,834 (June 3, 1996). On May 19, 1999, the IRS issued a final ruling under I.R.C. § 4,67, significantly reducing the tax benefits commonly associated with LILO structures. See Rev. Rul. 99-14, 1999-1 C.B. 835, modified and superseded by Rev. Rul. 2002-69, 2002-2 C.B. 760. In its 1999 ruling, the IRS determined that LILOs were abusive and impermissible tax shelters and announced that it would seek disallowance of rent and interest deductions on the grounds that these transactions lack economic substance. These regulations did not retroactively apply to any transactions created before May 19, 1999, but “there remained a risk that the IRS would invoke generally applicable tax law principles to disallow LILO-related deductions.” BB & T Corp. v. United States, 523 F.3d 461, 465 (4th Cir.2008). KeyCorp (“Key”) and PNC Financial Services Group, Inc. (“PNC Financial”) previously participated in a large number of LILO transactions. As a result of the 1999 IRS regulations, Key and PNC stopped taking part in new LILO transactions. [Joint Ex. 56, Doc. 167-7 at KSP0197639-42; Angel Tr., Doc. 178-1 at 224.] Presumptively alerted that the IRS would challenge exotic efforts to transfer tax deductions from tax indifferent entities, one might have thought that banks would step away from similar transactions. Instead, some United States banks began to enter into sale-leaseback transactions (“SILOs”) that were designed to substantially replicate lease-leaseback transactions. [Joint Ex. 56, Doc. 167-7 at KSP0197639-42; Angel Tr., Doc. 178-1 at 224.] Having given notice that purposeless efforts to transfer tax benefits would be addressed, it was no surprise when in 2004, Congress passed the American Jobs Creation Act to explicitly eliminate all tax advantages of SILO transactions created after March 12, 2004. America Jobs Creation Act of 2004, Pub. L. No. 108-357, § 848, 118 Stat. 1418 (2004). Consequently, neither Key nor PNC participated in any new cross-border lease to service contract transactions after that date. [Angel Tr., Doc. 178-1 at 224-25; Larkins Tr., Doc. 178-1 at 291; Keener Tr., Doc. 178-1 at 336.] The last SILO transaction to which Key was a party, for example, closed on January 7, 2004. [Joint Ex. 56 (Leveraged Lease Portfolio Rep.), Doc. 167-7 at KSP0197639-42.] In 2005, the IRS issued a notice about tax-exempt leasing involving defeasance in which it declared that it would contest claimed tax deductions for any SILO transactions that it suspected had no economic purpose apart from tax benefits. IRS Notice 2005-12, 2005-1 C.B. 630. Unsurprisingly, after the efforts of both Congress and the IRS to eliminate the tax benefits of lease-in/lease-out and sale-in/ lease-out transactions, both LILOs and SILOs have become almost non-existent in the leveraged leasing industry today. Many SILOs that were created before 2004, however, remain in effect and the tax implications of these economic structures present the dispositive issue for this Court today. B. Overview of the Instant Litigation The present case involves a SILO transaction entered into in 1999 for the “sale” and “leaseback” of a fully integrated waste-to-energy disposal and treatment plant located in Wuppertal, Germany (the “Facility”). Built in 1976, the Facility uses state-of-the-art technology to burn waste from households and small businesses. [Joint Stip., Doc. 83-1 at ¶ 30, 32; Ells-worth Tr., Doc. 178-1 at 415-16; Gonzalez Tr., Doc. 178-1 at 370-71; Joint Ex. 24 (Duke Rep.), Doc. 161-1 at KSP0175821-24; PI. Ex. 119 (Appraisal), Doc. 14.2 at PNC0004930-34.] The Facility then converts the waste into fuel to generate electricity and steam heat, as well as other byproducts. Prior to the 1999 transaction at issue, Abfallwirtschaftgesellsehaft mbH Wupper-tal (“AWG”) owned the Facility. [Joint Stip., Doc. 83-1 at ¶ 32.] Founded in 1971, AWG is a German corporation that is owned and maintained by a consortium of west German municipalities, including the cities of Wuppertal, Remscheid, and Vel-bert. The public utilities arm of the City of Wuppertal, Wuppertaler Stadtwerke WSWAG, is the largest shareholder in AWG. [Joint Stip., Doc. 83-1 at ¶ 34.] AWG has owned and operated the Facility since the plant became operational in 1976. [Joint Stip., Doc. 83-1 at ¶ 32; PL Ex. 80 (Final Key Credit Package), Doc. 137-1 at KSP0169527.] At the time of the 1999 transaction, AWG operated at a profit, having earned over $10 million in 1999. AWG also had relatively little debt despite having recently completed a major renovation. At the end of 1999, AWG had long-term debt of $177 million. [PL Ex. 128, Doc. 144-1 at KSP0165568.] AWG receives all of its revenue from the operation of the Facility. 90.8% of the revenue from the Facility is generated through “tipping” fees that the Facility charges to its customers for the disposal of their solid waste. The Facility produces the remaining 9.2% of its revenue by selling electricity, steam heat, and other byproducts created during the waste incineration process. [Joint Stip., Doc. 83-1 at ¶ 31, 34-35; Pl. Ex. 119 (Appraisal), Doe. 142 at PNC0004991-92; Joint Ex. 49 (1998 AWG Annual Rep.), Doc. 166-8.] The municipalities that own and operate AWG are also important customers of the Facility. These German municipalities provide large amounts of the materials incinerated at the Facility and are responsible for much of the tipping fee income that AWG receives. [Joint Stip., Doc. 83-1 at ¶ 35.] The municipalities therefore control, at least indirectly, the tipping fees that they charge themselves. [Joint Stip., Doc. 83-1 at ¶¶ 34-35; PI. Ex. 119 (Appraisal), Doc. 11/.2 at PNC0004991-92; Joint Ex. 49 (1998 AWG Annual Rep.), Doc. 166-8.] German law generally treats AWG like a privately-held corporation and requires AWG to produce financial statements and to pay trade and corporate income taxes. [Schweiss Tr., Doc. 178-1 at 1060; Joint Ex. 49 (1998 AWG Annual Rep.), Doc. 166-8.] Between 1991 and 1997, AWG refurbished and renovated the Facility. [PI. Ex. 52 (AWG Equity Mem.), Doc. 133-39 at IRS-ADM-000468; Joint Ex. 24 (Duke Rep.), Doc. m-1 at KSP0175811.] During this time period, AWG replaced the Facility’s boilers, essential components to the waste-to-energy production process. AWG also replaced the grates that are used to load waste into the boilers and assorted other related pieces of equipment. After this renovation, in 1999, Duke Engineering Services (“Duke”) conducted an engineering evaluation of the Facility and concluded the plant had a useful life of 46 years and was in as good a condition as that of a four year old facility. [Joint Stip., Doc. 83-1 at ¶¶ 50-51; Gonzalez Tr., Doe. 178-1 at 371-74, 393; Joint Ex. 24 (Duke Rep.), Doc. 161^-1 at KSP0175816.] Under German law, municipalities have a duty to dispose of domestic waste and waste generated in their respective territories. Germany had also passed a law forbidding the use of landfills after 2005, making the AWG incinerating facilities more important to the AWG owners. The municipal owners of AWG had no known reason for selling the Facility and no apparent need for capital. Yet, in early 1998, for unclear and unexplained reasons, a promoter sought investors on behalf of AWG by requesting proposals for a sale-leaseback of the Facility. Against this backdrop, the Plaintiffs offer no explanation as to what purpose motivated AWG to enter the Transaction. AWG’s 1999 financial statements indicate that AWG was profitable as the sole owner and operator of the Facility, earning a net income of DM 19,114,814.62 (or $10,113,658.53 in 1999 U.S. dollars). [PI. Ex. 128, Doc. lkh-1 at KSP0165569.] Although the Plaintiff Banks enjoy a contractual right to require testimony from responsible AWG officers regarding what motivated the Transaction, they offered no evidence to explain why AWG wanted, or needed, the Transaction. No representatives of AWG or its German municipality shareholders testified at trial. As described, the Facility had just undergone a significant renovation that placed it in a like-new condition in 1999. AWG earned a profit, was able to pay its bills, including the costs associated with the renovation, and nothing suggests it needed additional capital. Against this background, the Court surmises that the promoters simply devised a scheme to allow AWG to convey a tax-avoidance transaction for a fee. Nothing suggests that AWG had ever had any financial relation with Key Global Finance or with PNC Financial Services Group, Inc. (“PNC”). There is no evidence that AWG itself ever approached Key Global Finance or PNC about putting together a financial transaction involving the Facility. Instead, facilitators put AWG in contact with the Plaintiffs. Promoters Deutsche Anlagen-Leasing GmbH (“DAL”) and Macquarie Corporate Finance (USA), Inc. (“Macquarie”) initiated the process of securing a U.S. leasing transaction involving the Facility. Mac-quarie contracted with the accounting firm of Deloitte & Touche LLP (“Deloitte”) to provide appraisals for the possible transaction. After being solicited to participate by promoter Macquarie, in April 1998, Key Global Finance, an affiliate of KeyCorp (“Key”), a financial services company with its headquarters in Cleveland, Ohio, drafted an Offering Memorandum seeking American investors to take part in a $250 million LILO transaction involving the Facility. [Joint Stip., Doc. 88-1 at ¶ 37.] Apparently, in 1998, Deloitte had valued the AWG facility at $250 million. Shortly thereafter, Deloitte informed Key that it believed the Facility could support a higher appraised value than $250 million. [Def. Ex. E, Doc. 151-17.] In a June 10, 1998 letter, Key stated that “Deloitte & Touche has valued the current FMV [fair market value] of the facility at approximately $450 million, which is well beyond the preliminary estimates we received in February ...” Id. That same month, Key Global Finance drafted another Offering Memorandum attempting to find equity investors to participate with it in a $450 million LILO transaction for the Facility. [Joint Stip., Doc. 88-1 at ¶ 38; Joint Ex. 53 (Offering Mem.), Doc. 167-1/..] These efforts, however, did not result in any contracts between AWG and potential lessors. [Joint Stip., Doc. 83-1 at ¶ 39.] In late 1998, PricewaterhouseCoopers Global Structured Finance Group (“PWC”) and debis Financial Engineering GmbH began promoting a cross-border leveraged leasing transaction for the Facility on AWG’s behalf. [Joint Stip., Doc. 83-1 at ¶ 40, 41.] In April 1999, PWC sent an Equity Information Memorandum to possible investors proposing a prospective LILO transaction for the Facility. [Joint Stip., Doc. 83-1 at ¶ 41; PI. Ex. 52 (AWG Equity Mem.), Doc. 133-39.] Both Key and PNC, a financial services company headquartered in Pittsburgh, Pennsylvania, responded favorably to this memorandum. Key and PNC generally compete against each other in the leasing industry. [Joint Stip., Doc. 88-1 at ¶¶ 27-29.] As large bank-based institutions, Key and PNC offer a variety of financial products and services, including leasing services, and each company maintains leasing portfolios worth several billion dollars. [Larkins Tr., Doc. 178-1 at 266-69; Angel Tr., Doc. 178-1 at 54.] Both corporations have engaged in domestic leveraged leasing transactions for several decades, arguably in an attempt to increase after-tax profits. Neither corporation, however, had participated in any cross-border leveraged leasing transactions prior to 1996. [Angel Tr., Doc. 178-1 at 223; Keener Tr., Doc. 178-1 at 320-21, 335-36.] Beginning in 1996, however, Key and PNC both began engaging in significant cross-border lease-in/lease-out (“LILO”), and later sale-in/lease-out (“SILO”), transactions. [Angel Tr., Doc. 178-1 at 223; Keener Tr., Doc. 178-1 at 320-21, 335-36.]. As previously discussed, many banks, including Key and PNC, stopped engaging in LILO transactions and began using SILO structures as the result of the IRS final regulations that took effect in May 1999. [Angel Tr., Doc. 178-1 at 224; Sec tion 467 Rental Agreements, 64 Fed. Reg. 26863 (May 18, 1999).] On August 23, 1999, Key and PNC sent AWG conditional and separate proposals to participate in a sale-in/lease-out transaction for the Facility for $425 million. [Joint Stip., Doc. 83-1 at ¶¶42, 43; Joint Ex. 41 (PNC Leasing Proposal), Doc. 165-13.\ On August 26, 1999, Key and PNC submitted a joint proposal to AWG. AWG approved the proposal that same week. [Joint Stip., Doc. 83-1 at ¶¶ 45, 46.] The parties signed a conditional term sheet allowing for further negotiation and due diligence. [Joint Stip., Doc. 83-1 at ¶¶ 42-46; PI. Ex. 73 (Key Proposal), Doc. 135-2; PI. Ex. 83, (PNC Proposal), Doc. 138 at PNC005663-65.] Key and PNC subsequently hired independent experts to advise them about various legal, engineering, financial, and environmental issues associated with the possible AWG leveraged leasing transaction. [Angel Tr., Doc. 178-1 at 104-119, 155; Keener Tr., Doc. 178-1 at 322-31.] Among these experts, Key and PNC hired Duke Engineering & Services, Inc. (“Duke”) to do an engineering assessment of the Facility. [Joint Stip., Doc. 83-1 at ¶ 47.] Duke, a qualified engineering firm, provided a comprehensive 186-page report that complimented the design, construction, and operation of the Facility, and predicted a 46 year useful life for the Facility. [Joint Stip., Doc. 83-1 at ¶¶ 47-51; Gonzalez Tr., Doc. 178-1 at 363-69; Joint Ex. 24 (Duke Rep.), Doc. 164-1.] Key and PNC also retained the accounting and consulting firm of Deloitte & Touche LLP (“Deloitte”) to provide an appraisal of the Facility and to conduct a financial analysis of the proposed SILO transaction (hereinafter, the “Deloitte Appraisal”). [Joint Stip., Doc. 83-1 at ¶ 53.] Apart from the Deloitte Appraisal, the Plaintiffs obtained no other appraisals of the Facility. The Plaintiff banks acknowledge that they never engaged in any negotiations with AWG over the price for the Facility. In attempting to explain why they never attempted to test whether AWG would accept a lower price, the Plaintiffs say bargaining seldom occurred in such transactions. Responding, the United States says that the Facility was not worth the suggested price and the Plaintiffs accepted the price without negotiations to increase their tax deductions. The final Deloitte Appraisal for the Facility also concluded that the remaining economic useful life of the Facility was 46 years. Id. at ¶ 54-56. In its appraisal, Deloitte studied three different aspects of the proposed AWG transaction. First, Deloitte assessed the fair market value of the Facility at the closing date, December 7, 1999 (the “Closing Date”). Second, Deloitte predicted the future fair market value of the Facility both at the end of the Leaseback period and at the end of the Service Contract. Deloitte conducted this analysis to assess expected residual values of the Facility. Finally, Deloitte assessed the economics of the Service Contract option as part of its compulsion analysis regarding the options that AWG would face in 2024. [PI. Ex. 119 (Appraisal), Doc. 142.] Deloitte followed standard appraisal methodology by considering three different types of appraisal methods — the cost approach, the discounted cash flow approach, and a market comparable method — and reaching a “conclusion of value.” Deloitte’s application of the discounted cash flow approach and the market comparable approach, however, were flawed. In its report, Deloitte concluded that the cost approach offered the best indication of the Facility’s current fair market value. [Pl. Ex. 119 (Appraisal), Doc. 112 at PNC0004996.] The Court finds that this cost approach provides a reasonable estimate of the value of the Facility. The cost approach measures an asset’s value by utilizing the cost of another asset of equal or comparable utility. Id. at PNC0004972. Deloitte was aware of construction costs and value indications of similar waste-to-energy plants in Germany and other Western European countries from its work on other valuation assignments. Id. at PNC0004976-78; Ellsworth Tr., Doc. 178-1 at 456. Deloitte believed the most comparable construction costs for a similar waste-to-energy plant was a plant in Cologne, Germany. [Ellsworth Tr., Doc. 178-1 at 428-29; Pl. Ex. 55 (AWG Resp.), Doc. 133-12 at DT000031.] The Cologne facility cost DM 900 million to construct and was a 450,000 tons/year plant. This was very similar to AWG’s Facility, which Deloitte valued at DM 800 million and was a 385,000 tons/year plant. This comparable cost evidence is the best evidence of what it would cost to replace the AWG Facility in 1999. [Ellsworth Tr., Doc. 178-1 at 428-29; Pl. Ex. 55 (AWG Resp.), Doc. 133-12 at DT000031.] Utilizing these generally accepted appraisal methods, Deloitte concluded that the total project costs to replace or reconstruct the Facility, as of December 7, 1999, would be approximately DM 800 million or $423 million U.S. dollars. [Joint Stip., Doc. 88-1 at ¶ 57; Pl. Ex. 119 (Appraisal), Doc. 112 at PNC0004972-78.] This appears to have been a reasonable conclusion, particularly in light of the credible evidence regarding the costs of replacing the Facility based on the similarly situated Cologne plant. Deloitte also generally considered that, in 1999, it was known that a new German law that prohibited most forms of landfill-ing in Germany would take effect in 2005. This law, commonly known as TASI, was anticipated to depress tipping fee rates in the short-term while customers tried to make use of their landfills’ capacity, but was expected to lead to increased market tipping fees for incinerators after 2005. Increased market tipping fees obviously increase the value of the Facility to its owners. As AWG explained, “[F]rom the year 2005 — the directive is suspended until this point in time — waste incineration plants were given a kind of monopoly status.” [Pl. Ex. 54 (AWG Resp.), Doc. 138-11 at DT000021; Pl. Ex. 55 (AWG Resp.), Doc. 138-12 at DT000043; Pl. Ex. 119 (Appraisal), Doc. 142 at PNC0004940-41; Ellsworth Tr., Doc. 178-1 at 410-13, 426-27.] Without any apparent negotiation, the Plaintiffs agreed that the purchase price of the Facility should be $423 million. Joint Ex. 6, (Lease) Doc. 158-1 at IRS-ADM-002835. On December 7,1999, KSP Investments, Inc. (“KSP”), a wholly-owned subsidiary of Key, and PNC Capital Leasing, LLC (“PNC Leasing”), a wholly-owned subsidiary of PNC, entered into the leveraged leasing transaction with AWG for the “sale” and “leaseback” of the German waste-to-energy Facility. [Joint Stip., Doc. 83-1 at ¶ 2.] The Plaintiffs finalized the transactions with a series of written agreements, including the Participation Agreement that was executed by all of the parties. Id. at ¶ 72; Joint Exs. 1-25. In total, the Plaintiffs generated over 2,000 pages of closing documents to govern their relationship. KSP and PNC Leasing made their respective investments in the AWG Transaction through a Delaware business trust called the AWG Leasing Trust (the “Trust”). [Joint Stip., Doc. 83-1 at ¶ 3.] Both KSP and PNC Leasing each own a 50% interest in the Trust. Id. at ¶¶ 2-7. KSP and PNC are the beneficiaries and the grantors of the AWG Leasing Trust. Id. at ¶ 4. The AWG Leasing Trust is treated as a partnership for federal income tax purposes. [Joint Stip., Doc. 83-1 at ¶ 8.] The Trust annually files a U.S. Return of Partnership Income (Form 1065) and is treated as a pass-through entity whereby its partners, Key and PNC, receive annual K-l schedules that report their allocable portions of the Trust’s income and deductions. [Joint Stip., Doc. 83-1 at ¶ 9.] Pursuant to 26 U.S.C. § 6231(a)(l)(B)(ii), the AWG Leasing Trust chose to have the tax treatment of all partnership items determined at the partnership level. Id. at ¶ 10. KSP was designated as the “Tax Matters Partner” for the AWG Leasing Trust pursuant to 26 U.S.C. § 6231(a)(7). [Joint Stip., Doc. 83-1 at ¶ 11.] In this capacity, KSP represents the AWG Leasing Trust and brought the present action on the Trust’s behalf against the United States to determine the propriety of the IRS’s proposed adjustments to several “partnership items” in the Trust’s tax returns. Id. at ¶ 11. C. Procedural History of the Present Case The Trust filed timely federal income tax returns for the taxable years of 1999, 2000, 2001, 2002, and 2003. [Joint Stip., Doc. 83-1 at ¶ 16.] In its tax returns for these years, the Trust reported income in the form of accrued rent payments from AWG under the Leaseback. The Trust also reported deductions for depreciation on the Facility, interest expense on loans, and amortization expenses for the transaction costs (i.e. attorneys’ fees and appraisal costs). [Joint Exs. 30, 31, 32, 35, and 38 (Tax Returns), Doc. 165.] On December 26, 2006, the IRS challenged the tax positions asserted on the Trust’s tax returns for these years and also imposed several adjustments in the Final Partnership Administrative Adjustment (“FPAA”). [Joint Stip., Doc. 83-1 at ¶ 18.] In the FPAA, the IRS claimed that the Trust did not become the owner of the Facility for purposes of United States federal tax law and therefore could not claim tax benefits associated with ownership. Id. at ¶ 19; PI. Ex. 161 (IRS Notice), Doc. 117-1. The IRS also made adjustments to the Trust’s tax return for these years to disallow certain deductions claimed by the Trust and to restate the nature of the transaction in other ways that may reduce the Trust’s claimed tax benefits. [Joint Stip., Doc. 83-1 at ¶ 20; PI. Ex. 161 (IRS Notice), Doc. 117-1.] KSP, as the Tax Matters Partner of the Trust, took an appeal through this present lawsuit under 26 U.S.C. § 6226(a)(2). [Joint Stip., Doc. 83-1 at ¶ 25.] On March 22, 2007, KSP filed a complaint against the United States in this Court to determine the propriety of the IRS’s proposed adjustments to several “partnership items” in the Trust’s 1999, 2000, 2001, 2002, and 2003 tax returns. [Complaint, Doc. 1.] After fully conducting discovery, the parties filed pre-trial briefs and proposed findings of fact and conclusions of law, as well as a joint stipulation of facts. [Docs. 81, 82, 88, 8k, 85.1 Beginning on January-21, 2008, this Court conducted a week-long bench trial in the case. [Docs. 100, 101, 102, 10k, 106.1 As remarked at the trial, counsel for both parties provided admirable representation of their respective positions. After the completion of the trial, the parties filed post-trial briefs and reply briefs, along with final proposed findings of fact and conclusions of law. [Docs. 105, 118, 119, 120, 121, 122, 128.1 Before analyzing whether the 1999 SILO should receive favorable tax treatment, this Court provides a detailed discussion of the structure of the 1999 transaction. III. The Structure of the AWG Transaction The AWG deal was structured as a “sale-leaseback-to-service-eontract” transaction regarding the waste-to-energy plant in Wuppertal, Germany (the “Facility”). [Angel Tr., Doc. 178-1 at 149-50.] In summary, the transaction seemingly called for the Plaintiffs to pay $423 million to lease the Facility from AWG and called for AWG to lease the facility back. The transaction also gave AWG an option in 2024 to repurchase the balance of the Plaintiffs’ lease. Of the $423 million, all of the payment excepting $28.6 million was committed to escrow-type accounts to guarantee AWG’s sublease of the facility and to fund the exercise of the 2024 purchase option. Unless AWG rejects that purchase option, the 1999 transaction results a simple circular flow of money. As with most SILOs, the AWG transaction had two significant components: a head lease under which the Plaintiffs “acquired” the Facility from AWG, and a simultaneous sublease under which the Plaintiffs leased the Facility back to AWG. The 1999 transaction also provides AWG with an option to reacquire the Facility for a fixed purchase price in 2024. Alternatively, the 1999 transaction requires AWG to enter into a service contract with the Plaintiffs in 2024 if the Plaintiffs do not exercise the purchase option. However, to choose the service contract instead of the purchase option, the transaction strangely requires AWG, a lessee under the sublease and a customer under the Service Contract, to arrange non-recourse financing for the Plaintiffs. Unless AWG obtains such non-recourse financing for the Plaintiff, the purchase option must be exercised and the circular flow of moneys completed. A. The Transaction Structure at Closing 1. The Head Lease The Plaintiffs executed a Head Lease Agreement (“Head Lease”). Under the terms of the Head Lease, AWG “sold” the economic and tax ownership of the Facility to the Plaintiffs for 75 years in exchange for a lump sum payment of $423 million, payable at closing via a wire transfer into AWG’s bank account (“the head lease rent”). [Joint Stip., Doc. 83-1 at ¶ 73-77.] Section 9(k) of the Head Lease states, “The Head Lessee [the Trust] and the Head Lessor [AWG] intend this Head Lease to constitute an agreement for the sale of the Facility by the Head Lessor to the Head Lessee on the Closing Date for U.S. federal income tax purposes.” [Joint Ex. 4, Doc. 157-2 at IRS-ADM-002735; Angel Tr., Doc. 178-1 at 151.] Under the terms of the Head Lease, the Trust is entitled to any condemnation proceeds if the Facility is taken by eminent domain during the 75 year period. [Joint Ex. 4, Doc. 157-2 at IRS-ADM-002733.] As will be discussed later, AWG and the Plaintiffs treated the Head Lease as a sale of the Facility from AWG to the Trust on the closing date under U.S. federal income tax law, but not under German tax law. AWG’s lease of real property to the Plaintiffs was not recorded as is typically required under German title law. In its audited financial statements, AWG did not record any sale of the Facility and continues to deduct depreciation for tax purposes under German tax law. 2. The Leaseback (“Leaseback”) Along with the above-described Head Lease Agreement, at closing the parties simultaneously executed a Lease Agreement (the “Leaseback”) in which the Trust “leased” the Facility back to AWG until January 1, 2024 (the “Initial Leaseback Period”) in exchange for a series of annual rent payments. [Joint Stip., Doc. 88-1 at ¶ 82.] The Leaseback is a “triple net” lease, meaning that the lessee (AWG) must bear the costs of operating the Facility during the Leaseback Term, including taxes, insurance, and maintenance expenses. Id. at ¶ 85. The Leaseback states, “It is the intent of the parties hereto that this Lease is a true lease, and that the Lessor [the Trust] is the owner and lessor and the Lessee [AWG] is the lessee of the Facility for all U.S. Federal, state and local income tax purposes.” [Joint Ex. 6, Doc. 158-1 at IRS-ADM-002809.] Under the Leaseback, AWG is entitled to the sole possession and operation of the Facility during the Leaseback Term if it satisfies certain obligations under the Leaseback. [Joint Stip., Doc. 83-1 at ¶¶ 86, 87.] AWG must pay all costs for the use and maintenance of the Facility during the Leaseback term, and AWG is also entitled to keep all profits generated from the Facility during the Leaseback. Id. at ¶¶ 89, 90. The Leaseback requires that AWG operate, maintain, and repair the Facility in accordance with certain standards set forth in the Leaseback. Id. at ¶ 88. The Leaseback establishes annual reporting requirements, including certifications of AWG’s compliance with maintenance and repair obligations, environmental reporting obligations, financial reporting obligations, insurance requirements, and other Leaseback obligations. [Joint Ex. 2, Doc. 156 at IRS-ADM-002300-05.] AWG has provided this information to the Trust each year since 1999. [Angel Tr., Doc. 178-1 at 158-59.] Under the Leaseback, AWG also is required to maintain and return the Facility in specified good condition. The return conditions are detailed in the Leaseback, including fourteen engineering performance tests that the Facility must pass at the end of the Leaseback. [Joint Ex. 2 (Participation Agreement), Doc. 156 at IRS-ADM-002245-48; Angel Tr., Doc. 178-1 at 153-55.] B. Cash Flows at Closing Under the terms of the Participation Agreement, AWG “receives” the $423 million lump sum “head lease payment” at closing. To fund the closing, the Plaintiffs contributed a relatively small amount and borrowed the rest. The Plaintiffs contributed $55.1 million in cash to the transaction with AWG. The Plaintiffs borrowed $368 million from two German banks. [Joint Ex. 8 (Loan and Security Agreement), Doc. 159-1; Joint Ex. 25 (Closing Funding Mem.), Doc. 161-2 at IRS-ADM-000510; Def. Graphic 1, Doc. 151-5.] In reality, however, approximately $383 million of the $423 million is instantly transferred to other parties involved in the transaction. AWG keeps only $28.5 million, or approximately 7% of the stated head lease payment, for itself. [Joint Ex. 2 (Participation Agreement), Doc. 156; Joint Ex. 9 (Series A PUA), Doc. 159-2 at IRS-ADM-002973; Joint Ex. 10 (Nord LB PUA), Doc. 159-3 at IRS-ADM-002999; Joint Ex. 15(PUA), Doc. 160-5 at IRS-ADM-003166; Joint Ex. 25 (Closing Funding Mem.), Doc. 161-2, at IRS-ADM-00503-10.] The remaining $26.5 million of the cash that the Plaintiffs paid at closing goes to AIG Matched Funding, a subsidiary of American International Group (“AIG”), in the form of a “Payment Undertaking Agreement Fee” (the “Equity PUA”). [Keener Tr., Doc. 178-1 at 341-42; Joint Ex. 15(PUA), Doc. 160-5 at IRS-ADM-003166; Joint Ex. 25 (Closing Funding Mem.), Doc. 161-2, at IRS-ADM-00503-10.] This $26.5 million payment to AIG serves as an investment that, over the initial 24 year sublease term, grows to an amount that is sufficient to permit AWG to repurchase the plant if it chooses to exercise its option in 2024. Key and PNC each provided equity contributions of $27.6 million to the Trust to fund the $28.5 million payment to AWG and to fund the $26.5 investment with AIG. In addition to the $55 million equity investment, the Plaintiffs also paid approximately $4.9 million to the entities, including lawyers, consultants, and arrangers, that helped to set up the deal with AWG. [Def. Graphic 1, Doc. 151-5.] After contributing the $55.1 million, the Plaintiffs obtained the remaining 87% of the purchase price, or $368 million, through long-term, non-recourse loans from two banks in Germany. [Joint Stip., Doc. 83-1 at ¶ 78; Joint Ex. 2 (Participation Agreement), Doc. 156 at IRS-ADM-002090; Joint Ex. 8 (Loan and Security Agreement), Doc. 159-1; Joint Ex. 25, Doc. 161-2 at IRS-ADM-000510 (Closing Funding Mem.); Def. Graphic 1, Doc. 151-5.] Norddeutsche Landesbank loaned the Trust $331.1 million (the “Series A loan”) and Landesbank Baden-Wurttenburg loaned them $36.8 million (the “Series B loan”). [Joint Ex. 25, Doc. 161-2 at IRS-ADM-000510 (Closing Funding Mem.); Def. Graphic 1, Doc. 151-5.] The Series A loan is equal to 90% of the loan proceeds, and the Series B loan constitutes the remaining 10%. The Loan Agreement amortizes principal ratably so that the Series A and Series B loans are, at all times, in a 90/10 ratio. [Joint Ex. 8, Doc. 159-1 at IRS-ADM-002962-67.] As stated, the Plaintiffs borrowed these funds on a non-recourse basis, that is as debts whose satisfaction may be obtained on default only out of the particular collateral given and not out of the Plaintiffs’ other assets. The Loan Agreement establishes the terms and conditions of the Series A and Series B Loans. [Joint Ex. 8 (Loan Agreement), Doc. 159-1.] Both loans have a term of 34 years and bear an annual interest rate of 7.28%. Id. at IRS-ADM-002912; Joint Ex. 2, Doc. 156 at IRS-ADM-002229-33. The borrower Trust’s interest in the Facility secures the loans by a collateral assignment of the Trust’s rights under the Lease, Site Lease, Site Leaseback, Assumption Agreement, and Facility Support Agreement. [Joint Ex. 8 (Loan Agreement), Doc. 159-1 at IRS-ADM-002907-09.] As non-recourse loans, the Plaintiffs would not be obligated if, for any reason, some of the monies to pay the note were not available. The Series A Loan is not subordinated to the Series B Loan. The loans are pan passu, meaning that they are secured by the same collateral (i.e. the Facility) on a ratable 90/10 basis in the event of default, for example, for every dollar of available collateral, the Series A Lender is entitled to recover 90 cents. [Joint Ex. 8, Doc. 159-1 at IRS-ADM-02922-23; Angel Tr., Doc. 178-1 at 166-69.] Under its agreement with the Plaintiffs, AWG was required to put the $368 million obtained from the Series A and Series B loans into two Payment Undertaking Accounts (the “Debt PUAs”). These Debt PUAs act as defeasance accounts, which means that they are created to pay AWG’s obligations under the sublease and to apply those payments to Plaintiffs’ debts that are incurred under the transactions. At closing, AWG purchased the Series A, Series B, and AIG PUAs as required by the agreement. [Joint Stip., Doc. 88-1 at ¶ 72.] The Debt PUAs make payments to the German banks, and neither AWG nor any of its creditors can access the funds until 2024. The money in the Debt PUAs is held by an affiliate of Norddeutsche Lan-desbank and purportedly is used to pay AWG’s “rent” under the Leaseback and the Plaintiffs’ debts under the loans. The rent payments under the Leaseback exactly match, in both amount and timing, the principal and interest payments due on the Plaintiffs’ non-recourse loans. [Lys Tr., Doc. 178-1 at 880; Keener Tr., Doc. 178-1 at 342; Meilman Tr., Doc. 178-1 at 535-36; Def. Graphic 2, Doc. 151-6; Joint Ex. 6 (Lease Agreement), Doc. 158-1 at IRS-ADM-002818; Joint Ex. 8 (Loan and Security Agreement), Doc. 159-1 at IRS-ADM-002962, 2967.] The only exception to this perfectly off-setting payment schedule is a $1.2 million payment to be made from the Equity PUA to PNC on March 7, 2000. [Joint Ex. 15(PUA), Doc. 160-5 at IRS-ADM-003183.] By purchasing the PUAs, AWG did not legally discharge any of its payment obligations to the Trust. [Joint Ex. 9 (Series A PUA), Doc. 159-2 at IRS-ADM-002974-75; Joint Ex. 10, Doc. 159-8 at IRS-ADM-003000-01; Joint Ex. 15(PUA), Doc. 160-5 at IRS-ADM-003167-68.] By the terms of the PUAs, AWG remained the primary obligor in respect of all rent owed under the Leaseback. If the PUA German banks go bankrupt and do not timely pay AWG’s rent obligations to the Trust, AWG remains liable to the Trust for such amounts and would be in default under the terms of the Leaseback. After AWG purchased the PUAs, AWG’s obligations to pay rent and the Trust’s obligations to pay debt costs remained in full force and effect. However, risk of the PUA banks going bankrupt seems exceedingly small. The Series A PUA is pledged as collateral for repayment of the Loans, except in the event of default. [Joint Ex. 8, Doc. 159-1 at IRS-ADM-002908.] The PUA funds belong to AWG during the Leaseback term but the payment undertaking agreements restrict the funds to being used to make payments required by the Leaseback. If, in 2024 at the end of the Leaseback, AWG does not exercise its option to repurchase the Facility, the balance of the funds will be paid out to AWG. [Angel Tr., Doc. 178-1 at 182.] AWG may arrange for a refinancing of the Series A and Series B Loans on a non-defeased basis. [Joint Ex. 2, Doc. 156 at IRS-ADM-002156-60; Meilman Tr., Doc. 178-1 at 529-32.] This refinancing would terminate the related PUAs and release the PUA funds for the benefit of AWG. [Joint Ex. 9, Doc. 159-2 at IRS-ADM-002972-74; Joint Ex. 10, Doc. 159-3 at IRS-ADM-02998-3000.] Any refinancing, however, would require AWG to pay a “Make Whole Amount” to the German banks. The “Make Whole Amount” includes both outstanding principal and lost future interest, discounted at the then-prevailing United States Treasury rate. By requiring that all interest be paid, and by then discounting that interest to the current United States Treasury rate, the agreement makes refinancing highly unlikely. Typically, refinancing would occur when interest rates fall. But the make-whole provision requires that all interest that would have otherwise been paid continue to be paid, and then discounts such obligation only by the current, presumptively lower rate. In effect, the make-whole provision penalizes refinancing. This make-whole provision makes it very unlikely that AWG would choose to refinance. In sum, the cash flows resulting from the AWG transaction at closing, ignoring any intermediate payments, may be described as follows: Source of Funds German Banks $367.9 million Plaintiffs $ 59.9 million $127.8 million Total: Receivers of Funds German Banks (for Debt PUAs) $367.9 million AIG (for Equity PUA) $ 26.5 million AWG $ 28.6 million Professional Service Fees $ 4.8 million Total: $127.8 million [Govt. Post-Trial Prop. Findings of Fact, Doc. 121 at 13; Joint Ex. 25 (Closing Funding Mem.), Doc. 164-2 at IRS-ADM-00503-10; Def. Ex. VWW (AWG Transaction Expense Detail).] As described, AWG’s Leaseback requires AWG to pay “rent” during the initial Leaseback term. In reality, however, those rent payments are made by the two German banks under the PUAs and AWG does not use its operating funds to pay this rent. The rent thus is essentially paid by the German banks to the German banks as payments on the Plaintiffs loan obligations. The Debt PUAs therefore simultaneously satisfy both AWG’s rent payments and the Plaintiffs’ debt payments. Due to these off-setting payment plans, no actual cash flows occur between AWG and the Plaintiffs during the 24 years of the Initial Leaseback Period, except for the previously mentioned $1.2 million payment to PNC from the Equity PUA on March 7, 2000. [Angel Tr., Doc. 178-1 at 228-30; Keener Tr., Doc. 178-1 at 349-50; Lys Tr., Doc. 178-1 at 879-81; Def. Graphic 2, Doc. 151-6.] C. AWG’s “Options” in 2021 Under the 1999 transaction documents, AWG will have two options when the Initial Leaseback Period ends in 2024. 1. The Fixed Purchase Option In 2024, AWG can exercise a “Fixed Purchase Option” to regain the Plaintiffs’ interest in the Facility for $521 million. If AWG exercises the Fixed Purchase Option, the funds in the Debt PUAs will be released to the lenders and will be sufficient to satisfy the $521 million purchase cost. In 2024, the balances in the Debt PUAs will exactly match the outstanding loan balance of $383 million. All of the proceeds of the loans, therefore, will return directly to the lenders. Neither AWG nor the Plaintiffs have to provide any cash to repay these loans. [Angel Tr., Doc. 178-1 at 244-45; Joint Ex. 6 (Lease Agreement), Doc. 158-1 at IRS-ADM-002808; Joint Ex. 8 (Loan and Security Agreement), (Doc. 159-1 at IRS-ADM-002910).] In effect, the German banks lent money to the Trust, the Trust paid AWG who was required to place the proceeds into the PUAs with the German banks; and the PUAs will then have sufficient balances after making rent payments to repurchase the Facility with the balances in the PUAs in 2024. The $521 million Fixed Purchase Option has two components. First, the $383 million in the Debt PUAs will go towards paying off the remaining loans owed to the German banks. Second, the remáining $138 million in funds that will have accrued by 2024 in the Equity PUA will go to the Plaintiffs. [Lys Tr., Doc. 178-1 at 884-85; Def. Graphic 2, Doc. 151-6; Def. Graphic 3, Doc. 151-7; Joint Ex. 6 (Lease Agreement), Doc. 158-1 at IRS-ADM-002807-09.] This $138 million represents the Plaintiffs’ “return” on its equity “investment” in the AWG transaction if AWG exercises the 2024 purchase option. Each of the Plaintiffs banks will therefore receive approximately $39.1 million above their initial equity investments. [Supp. Joint Stip., Doc. 105.] The Plaintiffs, therefore, will obtain an internal rate of return on the AWG transaction of approximately 3.5% if the 2024 purchase option is exercised. [PL Ex. 113, Doc. 141-2; Angel Tr., Doc. 178-1 at 90-91; Graves Tr., Doc. 178-1 at 798-801.] Under the Fixed Purchase Option, the $55.1 million “equity” investment that the Plaintiffs made in 1999 thus is returned to the Plaintiffs with a guaranteed, albeit low, pre-tax rate of return. [Lys Tr., Doc. 178-1 at 883; Joint Ex. 15, Doe. 160-5 at IRS-ADM-003170; Def. Graphic 2, Doc. 151-6; Def. Graphic 3, Doc. 151-7.] As will be discussed later in this opinion, the Court finds that it is very likely that AWG will exercise the Fixed Purchase Option in 2024. In theory, however, AWG also has the option to enter into a Service Contract in 2024, which the Court will now describe. 2. The Service Contract Option If AWG does not exercise the Fixed Purchase Option (“FPO”), AWG and the Trust, or its designee, are obligated to enter into a waste disposal service contract (“Service Contract”) at the end of the Leaseback Term. Under that Service Contract, AWG agrees to purchase solid waste disposal services from a third-party provider, chosen by the Plaintiffs, from January 1, 2024 until September 23, 2036. [Joint Stip., Doc. 83-1 at ¶¶ 96, 97; Joint Ex. 2, Doc. 156 at IRS-ADM-002149; Joint Ex. 13, Doc. 160-3 at IRS-ADM-003094-3100.] In order to enter into the Service Contract, however, AWG must first arrange for a non-recourse refinancing of the entire $383 million in non-recourse debt that will still be outstanding in 2024. Under the terms of the Service Contract, any refinanced debt cannot include a defeasance provision. [Joint Ex. 2, Doc. 156 at IRS-ADM-002149-50.] As will be discussed later in this opinion, the Court finds the allocation of the obligation to obtain refinancing upon AWG difficult to explain if the 1999 transaction had intended to sell the Facility to the Trust. Under this provision, if AWG chooses to actually receive the monies from the 1999 sale, it need enter an expensive twelve-year service contract that will significantly raise the tipping fees AWG charges its municipal owners. Further, even though the Trust is said to be the “owner” of the Facility, AWG is strangely saddled with the requirement to obtain non-recourse financing. Assuming that AWG is able to secure such non-recourse refinancing, AWG then can enter the Service Contract in 2024. Under the Service Contract, AWG will engage the Trust to provide solid waste disposal services for twelve years, until 2036. During the Service Contract, AWG must pay a periodic fee (the “Service Fee”) to the Trust or its designee. The Service Fee is the sum of a “Capacity Charge”, an operations and maintenance charge (the “0 & M Charge”), and a charge for all solid waste delivered to the Facility in excess of a set, baseline amount (the “Excess Tonnage Charge”); minus credits to AWG in respect of service fees realized by the Trust or its designee from the use of the Facility to serve third party customers. [Joint Stip., Doc. 83-1 at ¶ 103.] As indicated, the Service Contract requires AWG to pay Capacity Charges. The Capacity Charge includes ‘Debt Portion’ payments that are sufficient to totally pay the principal and interest on the new non-recourse loan. [Joint Stip., Doc. 83-1 at ¶ 104; Joint Ex. 13, Doc. 160-3 at IRS-ADM-003080-81.] In effect, under the Service Contract AWG must pay all borrowing costs associated with the non-recourse loan. In addition to paying all of the Trust’s debt costs as part of its Capacity Charges, AWG must also pay all the operation and maintenance costs together with amounts necessary to fund a modest reserve for working capital. [Joint Stip., Doc. 83-1 at ¶ 105.] Beyond paying all debt costs and operating and maintenance costs, the Service Contract requires payment of an Excess Tonnage Charge, that is $40 per ton of solid waste delivered by, or on behalf of, AWG to the Facility in excess of 200,000 tons of waste per year. [Joint Ex. 13, Doc. 160-3 at IRS-ADM-003085; Angel Tr., Doc. 178-1 at 213; Graves Tr., Doc. 178-1 at 779.] This Excess Tonnage Charge is a relatively low charge for quantities of more than 200,000 tons per year to the Facility. Under the Service Contract, AWG retains the right to charge “tipping fees” to its customers for the disposal of solid waste, but the third-party service provider has the right to any revenue gained from the sale of electricity and steam heat created by the Facility. [Joint Stip., Doc. 83-1 at ¶¶ 103-05; Joint Ex. 2, Doc. 156 at IRS-ADM-002148-53 (Participation Agreement); Joint Ex. 13 (Service Contract), Doc. 160-3 at IRS-ADM-003080, 3082, 3105.] The Service Fees are not to be paid on a “hell or high water” basis. [Joint Stip., Doc. 83-1 at ¶ 102.] This means that, under the Service Contract, AWG is required to pay Service Fees to the Trust only to the extent that the Trust or its designee actually performs the obligations required of them under the Service Contract. If a disruption in service occurs that stops the incineration of waste at the Facility, then AWG is not required to pay and it can terminate the Service Contract or pursue other legal remedies. [Angel Tr., Doc. 178-1 at 208-16; Joint Ex. 13, Doc. 160-3 at IRS-ADM-003105-06, 003114.] However, the Service Contract also requires AWG to reimburse the Plaintiffs for the cost of insurance, including business interruption and environmental insurance. If AWG exercises the Service Contract option, then it also obtains a second option to repurchase the Facility. In 2036, at the end of the Service Contract, AWG may terminate the Head Lease by giving the Plaintiffs an amount equal to the fair market value of the Facility (“the second purchase option”). [Joint Stip., Doc. 83-1 at ¶ 98.] If, however, AWG does not terminate the Head Lease at the conclusion of the Service Contract, then the Plaintiffs will have effective ownership and control of the Facility for the remaining 38 years of the Head Lease and AWG will retain only bare title to the Facility. [Joint Ex. 13 (Service Contract), Doc. 160-3 at IRS-ADM-003102.] D. German Tax Law Treatment of the AWG Transaction Under German tax law, the AWG transaction is not a sale of ownership in the Facility. The Plaintiffs did not take legal title to the Facility. [Angel Tr., Doc. 178-1 at 257; Heisse Tr., Doc. 178-1 at 1023-24; Joint Ex. 28 (German Tax Ruling Req.), Doc. 161.-5 at CLIF-005512.] During the Initial Leaseback Period, AWG operates the Facility in largely the same manner and with the same freedoms as it did prior to entering into the Participation Agreement with the Plaintiffs. Under the terms of the Participation Agreement, AWG is guaranteed the right to “quiet enjoyment” of the plant throughout the Initial Leaseback Period. Additionally, the contract provides that the Plaintiffs are only allowed to inspect the Facility on one single calendar day each year. [Joint Ex. 6 (Lease Agreement), Doc. 158-1 at IRS-ADM-002778, 002796.] AWG does not use its own operating funds to pay rent during the Initial Leaseback Period due to the requirement that rent payments be made out of the PUA accounts that AWG funded at closing. Lys Tr., Doc. 178-1 at 874; Joint Ex. 46 (PNC Purpose/Transaction Summary), Doc. 166-5. Further, AWG continues to carry many burdens of ownership that it held prior to 1999. For example, AWG must maintain insurance on the Facility, must operate the Facility in compliance with German law, must maintain the Facility with its own funds, must make capital improvements to the Facility at its own expense, and is permitted to take depreciation deductions on the plant under German tax law. The Plaintiffs’ own engineering expert specifically testified that AWG will not need make any changes to its maintenance procedures for the Facility during the Initial Leaseback Period. [Gonzalez Tr., Doc. 178-1 at 385-90; Joint Ex. 6 (Lease Agreement), Doc. 158-1 at IRSADM-002781-92.] Additionally, during the Initial Leaseback Period, AWG remains solely responsible for any environmental liabilities incurred by the Facility because it remains the legal owner and operator of the Facility under German law. [Angel Tr., Doc. 178-1 at 227; Heisse Tr., Doc. 178-1 at 1024; PI. Ex. 81 (Asset Management Eval.), Doc. 187-2 at KSP0169558-59; Joint Ex. 46 (PNC Purpose/Transaction Summary), Doc. 166-5 at IRS-ADM-E0213.] Thus, under German law, AWG has not represented the transaction with the Plaintiffs to be a “sale” of its ownership or interest in the Facility. In fact, when AWG asked for a binding advanced German tax ruling on the consequences of its transaction with the Plaintiffs, AWG stated that it would maintain “economic ownership” of the plant for at least the first 25 years, and perhaps for the entire transaction if the Fixed Purchase Option was exercised in 2024. In fact, AWG represented to the German tax authorities: [T]he head lease and the sublease are entered into simultaneously, so that possession, use, and the obligations will at no time — not even for one legal second — be transferred to the U.S. Trust, if [AWG] exercises the [Fixed Purchase Option], [Joint Ex. 28 (Adv. Tax Ruling Req.), Doc. 161-5 at CLIF-005512.] AWG continues to list the plant as an asset on its financial statements and tax balance sheets. AWG still claims and receives depreciation deductions for the Facility under both German corporate and trade income taxes. The Plaintiffs are aware of this German tax treatment. [Angel Tr., Doc. 178-1 at 252; Jacob Tr., Doc. 178-1 at 741-42; Schweiss Tr., Doc. 178-1 at 1061.] IV. Legal Standard In this action brought under 26 U.S.C. § 6226(a)(2), the Plaintiffs ask the Court to determine: (i) whether the IRS erroneously adjusted certain partnership items on AWG Trust’s tax returns for 1999, 2000, 2001, 2002, and 2003 (the “Taxable Years”) that relate to the 1999 SILO transaction entered into by the Trust; (ii) whether the IRS properly asserted that any underpayments of tax resulting from these adjustments are subject to accuracy-related penalties under 26 U.S.C. § 6662; and (iii) whether amounts deposited by Plaintiff KSP with the Secretary of Treasury, pursuant to 26 U.S.C. § 6226(e)(1), should be refunded with interest. [Complaint, Doc. 1.] In such actions, Section 6226(f) of the Internal Revenue Code of 1986 establishes that the Court should “determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.” 26 U.S.C. § 6226(f). The Court must conduct a de novo review of the adjustments made by the IRS in the FPAA. See Jade Trading, LLC v. United States, 80 Fed.Cl. 11, 43-44 (2007). The Plaintiffs bear the burden of proving the correct amount of their tax liability. See id. at 46-47; Dow Chem. Co. v. United States, 435 F.3d 594, 599 (6th Cir.2006) (citing INDOPCO, Inc. v. Comm’r, 503 U.S. 79, 84, 112 S.Ct. 1039, 117 L.Ed.2d 226 (1992)) (stating that an “income tax deduction is a matter of legislative grace and ... the burden of clearly showing the right to the claimed deduction is on the taxpayer”). V. Discussion A. General Principles of Federal Tax Law As the Fourth Circuit recently noted, a taxpayer may attempt to reduce his tax liability by any means available under the law, but a taxpayer may not “claim tax benefits that Congress did not intend to confer by setting up a sham transaction lacking any legitimate business purpose, or by affixing labels to its transactions that do not accurately reflect their true nature.” BB & T Corp. v. United States, 523 F.3d 461, 471 (4th Cir.2008). Similarly, the Sixth Circuit has held: Because even the most patriotic citizens do not have a duty to increase [their] taxes, it is entirely legal and legitimate to minimize taxes through permissible means. But if a transaction or entity has no valid, non-tax business purpose, nominally uses another person or entity as a conduit through which to pass title, or br[ings] about no real change in the economic relation of the [taxpayers] to the income in question, the Commissioner has the authority to find that the transaction or entity lacks economic substance and disregard it for tax purposes. Richardson v. Comm’r, 509 F.3d 736, 741 (6th Cir.2007) (internal quotation marks omitted). In order to determine whether a taxpayer is entitled to claimed tax deductions, therefore, the Court must decide whether the underlying transaction had genuine economic substance apart from tax benefits. If the Court finds that the transaction does have economic substance aside from tax benefits, then the C