On tax day — April 15, 2011 — a federal appeals court agreed with a lower court and dealt Wells Fargo & Co. an unexpected tax blow by denying the bank $115 million in claimed deductions. The deductions were tied to transactions dating back to 1997, and involved 26 SILO (sale-in/lease-out) transactions with tax-exempt organizations.
To get an appreciation of how the tables were turned on Wells Fargo, it’s best to understand how a SILO works. Generally, it comprises two concurrent leases of an asset owned by a tax-exempt organization. In the first lease, which is known as the “head lease,” the tax-exempt organization leases the asset to a corporate taxpayer for a term that exceeds the useful life of the asset. The Internal Revenue Service treats the head lease as a sale of the asset. In the second lease, which is known as the “sublease,” the taxpayer leases the asset back to the tax-exempt organization for a term that is less than the asset’s remaining useful life.
The taxpayer prepays the entire rent on the head lease in one lump sum, and funds the prepayment in part with its own funds and in part with a nonrecourse loan. The tax-exempt organization receives a small percentage (4% to 8%) of the head lease prepayment as its “fee” for participating in the transaction. The remainder of the prepayment is placed in two restricted accounts. The “debt portion account” is used to make the sublease rental payments. This payment account contains sufficient funds to cover the organization’s payments for the life of the sublease — or equivalently, the taxpayer’s payments for the life of its nonrecourse loan.
In addition, an affiliate of the nonrecourse lender invests the “equity portion account” in high-grade debt. The growth of this account is managed so that the tax-exempt organization has sufficient funds to repurchase its asset from the taxpayer at the conclusion of the sublease. The repurchase price is established at the beginning of the transaction. If the organization chooses not to exercise its repurchase option, the taxpayer can elect either the “return option” or the “service contract option.” That’s the quick version of how a SILO works.
The Wells Fargo SILO Mentality
The Wells Fargo case looks back to transactions completed from 1997 through 2003. During that time, the bank entered into several SILO transactions with tax-exempt entities, and in 2002 Wells Fargo claimed $115 million in tax deductions based on 26 SILO transactions.
To be entitled to deductions for depreciation of assets and accrued interest, as well as transaction expenses, Wells Fargo had to show that it owned the SILO equipment. To qualify as an owner for tax purposes, the taxpayer must bear the benefits and burdens of property ownership. However, Wells Fargo did not bear such benefits and burdens and, as a result, was denied the tax benefits that accrue to the owner of property. (See Wells Fargo & Company and Subsidiaries v. United States, _F.3d_ (Fed. Cir. 2011).)