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5-Hour Energy Company Petitions Tax Court for Redetermination

MAR. 26, 2019

Innovation Ventures LLC et al. v. Commissioner

DATED MAR. 26, 2019
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Innovation Ventures LLC et al. v. Commissioner

[Editor's Note:

The exhibits can be viewed in the PDF version of the document.

]

INNOVATION VENTURES, LLC, MANOJ BHARGAVA,
Tax Matters Partner
Petitioner,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent.

UNITED STATES TAX COURT

PETITION FOR READJUSTMENT OF PARTNERSHIP
ITEMS UNDER CODE SECTION 6226

Innovation Ventures, LLC, by and through Manoj Bhargava, Tax Matters Partner (“Petitioner”) hereby petitions for a redetermination of the partnership items and penalties asserted by the Commissioner of Internal Revenue (“Respondent”) under section 6662 of the Internal Revenue Code,1 in the Notices of Final Partnership Administrative Adjustment. As the basis for this case, Petitioner alleges as follows:

1. Petitioner is Innovation Ventures, LLC (the “Partnership”), a Michigan limited liability company, by and through Manoj Bhargava, Tax Matters Partner. Petitioner is taxed as a partnership for U.S. federal income tax purposes and subject to the TEFRA Unified Partnership Procedures of Internal Revenue Code sections 6221-6234 for the tax years ended December 31,2009, 2010, 2011, 2012, and 2013. The principal place of business and mailing address for the Partnership is 38955 Hills Tech Drive, Farmington Hills, MI 48331.

2. The Partnership's Form 1065, U.S. Return of Partnership Income, for 2009 was timely filed with the Internal Revenue Service at Ogden, Utah 84201, and its Forms 1065 for 2010 through 2013 were timely filed electronically with the Internal Revenue Service. The Partnership timely filed an amended Form 1065 for its 2009 tax year.

3. Manoj Bhargava (“Mr. Bhargava”) is the tax matters partner of the Partnership for the years at issue here. Mr. Bhargava's state of legal residence is Michigan and his mailing address is 38955 Hills Tech Drive, Farmington Hills, MI 48331.

4. Mr. Bhargava is also a notice partner within the meaning of section 6231(b)(8).

5. Mr. Bhargava has an ownership interest in the Partnership and has an interest in the outcome of this matter within the meaning of section 6226(d).

6. The tax matters partner has not previously filed a petition for readjustment of partnership items within the period specified in section 6226(a).

7. The Notices of Final Partnership Administrative Adjustment, each of which is dated October 29, 2018, were issued by the Appeals Office of the Internal Revenue Service in Milwaukee, Wisconsin. The Notices of Final Partnership Administrative Adjustment propose adjustments to partnership items of the Partnership for 2009 (the “2009 FPAA”), 2010 (the “2010 FPAA”), 2011 (the “2011 FPAA”), 2012 (the “2012 FPAA”), and 2013 (the “2013 FPAA”) (collectively, the “FPAAs”). Copies of the FPAAs are attached as Exhibit A. Pursuant to Rule 241(h) of the Tax Court Rules of Practice and Procedure, Petitioner is filing this petition seeking readjustments with respect to the FPAAs.

8. The FPAAs propose adjustments to what they refer to as the Partnership's “IRC § 754 Amortization” deductions (“Section 754 Amortization Deductions”) for 2009 in the amount of $43,166,039, for 2010 in the amount of $75,065,401, for 2011 in the amount of $104,327,789, for 2012 in the amount of $111,914,157, and for 2013 in the amount of $111,914,157. All of these amounts are in dispute. Respondent also asserted penalties under section 6662, contending that the Partnership improperly took the amortization deductions due to negligence or intentional disregard of the rules and regulations. All asserted penalties are also in dispute.

9. The determinations set forth in the FPAAs are based upon the following errors:

9.a. Respondent erred by decreasing the Partnership's Section 754 Amortization Deductions in the amount of $43,166,039 in the 2009 FPAA.

9.b. Respondent erred by decreasing the Partnership's Section 754 Amortization Deductions in the amount of $75,065,401 in the 2010 FPAA.

9.c. Respondent erred by decreasing the Partnership's Section 754 Amortization Deductions in the amount of $104,327,789 in the 2011 FPAA.

9.d. Respondent erred by decreasing the Partnership's Section 754 Amortization Deductions in the amount of $111,914,157 in the 2012 FPAA.

9.e. Respondent erred by decreasing the Partnership's Section 754 Amortization Deductions in the amount of $111,914,157 in the 2013 FPAA.

9.f. Respondent erred by contending that the Partnership improperly reported amortization deductions for each of the years at issue.

9.g. Respondent erred by asserting that the section 6662 penalty is applicable to any underpayment of tax in any year resulting from the proposed decrease in the Section 754 Amortization Deductions.

9.h. Respondent erred in not determining that Petitioner had at least substantial authority for its determinations of the Section 754 Amortization Deductions for the tax years ended 2009, 2010, 2011, 2012, and 2013.

9.i. Respondent erred in not determining that Petitioner had reasonable cause and acted in good faith in its reporting of the Section 754 Amortization Deductions for the tax years ended 2009, 2010,2011,2012, and 2013.

10. The facts and mixed facts and points of law upon which the Partnership relies as the basis for this case, include, but are not limited to:

10.a. Mr. Bhargava's Gift to Rural India Supporting Trust. Mr. Bhargava is the founder of the Partnership. The Partnership manufactures and distributes 5-Hour ENERGY, the popular energy shot. Since its launch in 2004, 5-Hour ENERGY has been a phenomenally successful consumer products company and a category sales leader. Mr. Bhargava's success with 5-Hour ENERGY and other ventures provided him with the means to support charitable interests and the desire to share his success with others in need.

10.a.1. Mr. Bhargava has a history of giving substantial portions of his net worth to charities. He joined The Giving Pledge, an effort created by Bill Gates, Warren Buffet, and other persons of substantial wealth in which they commit more than half of their wealth to philanthropy or charitable causes. As a signatory of The Giving Pledge, Mr. Bhargava has committed to giving away the majority of his wealth. Prior to joining The Giving Pledge, Mr. Bhargava had already begun to gift his wealth to charity, and by joining the pledge, he was hoping to continue his philanthropic giving so that his charitable gifts could achieve maximum impact.

10.a.2. In furtherance of his philanthropic commitment, in 2009, Mr. Bhargava gave a significant portion of his then-existing ownership interest in the Partnership to charity.

10.a.3. Before the charitable donation described in Paragraph 10.a.7, Mr. Bhargava directly owned 500,000 (approximately 50 percent) of the issued and outstanding Class A Units of the Partnership (the “Founder Units”). Mr. Bhargava had acquired the Founder Units at the formation of the Partnership.

10.a.4. Also, before the charitable donation described in Paragraph 10.a.7, Mr. Bhargava indirectly owned 305,656 Class A Units (the “Encumbered Units”) that he had purchased in several transactions through a wholly-owned disregarded entity, Innovation Ventures Acquisition Co., LLC (“Acquisition Co.”).

10.a.5. In consideration of each of Acquisition Co.'s purchases of Class A Units that combined to make up the Encumbered Units, it issued a promissory note, which was secured by a pledge of the respective Class A Units being purchased. Thus, the 305,656 Encumbered Units held indirectly by Mr. Bhargava were encumbered by pledges of the Encumbered Units.

10.a.6. In the aggregate, before the charitable donation described in Paragraph 10.a.7, Mr. Bhargava directly and through disregarded entities owned 805,656 Class A Units (500,000 Founder Units and 305,656 Encumbered Units), representing an approximate 80% interest in the Partnership. Under the Partnership's Second Amended and Restated Limited Liability Company Agreement (the “Operating Agreement”), ownership of approximately 80% of the Class A Units gave Mr. Bhargava the legal right to control all actions by the Partnership, including the right to approve transfers of ownership interests and the substitution of transferees as members of the Partnership.

10.a.7. In 2009, Mr. Bhargava donated 454,545 of his Founder Units (the “Donated Units”), an approximate 45% interest in the Partnership, to Rural India Supporting Trust (“RIST”).

10.a.8. RIST is a qualified tax-exempt charity under section 501(c)(3) and a Type I supporting organization, as defined by section 509(a)(3).

10.a.9. RIST's mission is to provide funds to advance public health, education, and economic opportunity in India. Through RIST's support, for example, multiple hospitals and health clinics have been founded and funded to provide affordable quality health care to India's rural populations who would otherwise lack access to quality care. In addition, programming for the advancement of education for children in India, with a special focus on girls in rural and disadvantaged communities and on the mentally and physically disabled, has also been funded through RIST's support.

10.a.10. Mr. Bhargava received no consideration for the charitable contribution of the Donated Units to RIST, and his gift to RIST decreased his wealth by the value of the Donated Units. While Mr. Bhargava reported the gift of the Donated Units as a charitable contribution deduction on his 2009 tax return, at the end of the five-year carryforward period, 98% of the deduction would have expired unused.

10.a.11. Ernst & Young valued the Donated Units at $623,640,000.

10.a.12. The donation and assignment of the Donated Units to RIST was unanimously approved by all voting members, as required by the Operating Agreement, and RIST was admitted as a substitute member of the Partnership with respect to the Donated Units.

10.a.13. After his gift of the Donated Units to RIST, Mr. Bhargava directly and indirectly owned approximately 34.8% of the Class A Units of the Partnership and no longer had the power or authority to take any action unilaterally with regard to the Partnership, including consenting to the transfer of Class A Units and the substitution of a transferee as a member.

10.a.14. Upon receipt of the gift from Mr. Bhargava, RIST owned approximately 45% of the Class A Units of the Partnership, which was the largest interest held by any member.

10.a.15. RIST's Sale of the Donated Units to Nevada 5. Shortly after its acceptance of the Donated Units, RIST sold the Donated Units to Nevada 5, Inc. (“Nevada 5”) pursuant to a Membership Interest Purchase Agreement (the “Purchase Agreement”).

10.a.16. At the time RIST accepted the Donated Units from Mr. Bhargava, RIST was not legally bound, nor could RIST be compelled, to sell the Donated Units to Nevada 5.

10.a.17. Nevada 5 is a duly organized Nevada corporation.

10.a.18. Nevada 5's sole shareholder is Knowledge Medical Research Charitable Trust (“KMRCT”). KMRCT is a qualified medical research organization under Michigan law, Mich. Comp. Laws § 700.7101 et seq., and as described in section 170(b)(1)(A)(iii). Pursuant to the Knowledge Medical Research Charitable Trust Agreement, KMRCT was founded for the purpose of conducting medical research.

10.a.19. Mr. Bhargava is the President of Nevada 5, but did not own any Nevada 5 stock. At the time of Nevada 5's purchase of the Donated Units, Mr. Bhargava was a member of the board of directors of KMRCT, but neither he nor any person related to him was a beneficiary of KMRCT.

10.a.20. Nevada 5 purchased the Donated Units from RIST by issuing a secured promissory note in the amount of $623,640,000 (the “Nevada 5 Note”).

10.a.21. Pursuant to Article 5, Earnout, of the Purchase Agreement, Nevada 5's purchase price for the Donated Units was subject to adjustment on the first and second anniversary dates of the Purchase Agreement to take into account the performance of the Partnership (the “Earnout Provision”).

10.a.22. In 2010, the Earnout Provision resulted in a $364,184,104 increase in the purchase price payable by Nevada 5 for the Donated Units under the Nevada 5 Note. In 2011, the Earnout Provision resulted in a $394,491,091 increase in the purchase price payable by Nevada 5 for the Donated Units under the Nevada 5 Note.

10.a.23. As required by the Operating Agreement, the sale of the Donated Units to Nevada 5 and the admission of Nevada 5 as a substitute member was approved by all voting members (including RIST) who held Class A Units before the sale.

10.a.24. Nevada 5 's basis in the Donated Units was equal to its purchase price for the Donated Units, as adjusted by the Earnout Provision.

10.a.25. The Partnership had a section 754 election in effect for its 2008 tax year and all subsequent tax years.

10.a.26. Under section 743(b), as a result of Nevada 5's purchase of the Donated Units in 2009, Nevada 5 was entitled to a basis adjustment of $585,604,261 to equalize its share of the Partnership's “inside basis” in its assets with its “outside basis” in its interest in the Partnership.

10.a.27. Under section 743(b), the Earnout Provision price adjustments for the Donated Units resulted in additional section 743(b) basis adjustments to Nevada 5's interest in the Partnership's assets of $364,184,104 and $394,491,091 in 2010 and 2011, respectively.

10.a.28. These basis adjustments, among others, gave rise to the Section 754 Amortization Deductions.

10.a.29. Without explanation, the FPAAs decrease the Section 754 Amortization Deductions for each of the years at issue.

10.a.30. Respondent's determination that the basis adjustments reflected on the Partnership's tax returns should be decreased is contrary to the law and not supported by the facts. Because a section 754 election was in effect, under section 743(b), the Partnership was required to adjust Nevada 5's proportionate share of basis in the Partnership's assets upon Nevada 5's purchase of the Donated Units (and the subsequent purchase price adjustments pursuant to the Earnout Provision) to eliminate the disparity between Nevada 5's basis in its partnership interest and its proportionate share of basis in the Partnership's assets.

10.b. Impact of the Gift of the Donated Units on Section 743(b) Basis Adjustments Attributable to the Encumbered Units. Prior to the gift of the Donated Units to RIST, Mr. Bhargava's direct and indirect ownership of Class A Units was as follows:

10.b.1. Mr. Bhargava directly owned the Founder Units, 500,000 Class A Units. His acquisition of these units did not result in any section 743(b) adjustment to his share of the Partnership's basis in its assets with ' respect to the Founder Units. The Founder Units were free and clear of any encumbrance. As stated in paragraph 10.a.7, in 2009, Mr. Bhargava gifted 454,545 of the 500,000 Founder Units to RIST.

10.b.2. At the time Mr. Bhargava gave the Donated Units to RIST, he also owned the Encumbered Units through his ownership of Acquisition Co. Acquisition Co. had purchased the Encumbered Units in four transactions that occurred before the gift of the Donated Units.

10.b.3. Specifically, in 2008, Acquisition Co. purchased 295,000 of the Class A Units in exchange for a promissory note in the amount of $438,075,000. This promissory note was secured by such units, but not by any other Class A Units or other property held by Mr. Bhargava or Acquisition Co. The pledge was fully enforceable against Acquisition Co., which was prohibited from selling, conveying, or otherwise disposing of the pledged Encumbered Units.

10.b.4. In 2009, before Mr. Bhargava gave the Donated Units to RIST, Acquisition Co. purchased an additional 10,656 Class A Units from RIST in three separate transactions for promissory notes totaling $13,170,000. Each of the three promissory notes was secured by the pledge of the respective Encumbered Units acquired in exchange for such promissory note, but not by any other Class A Units or other property held by Mr. Bhargava. Acquisition Co. assigned the 10,656 Class A Units to MIR Acquisition Co., LLC (“MIR”), formerly known as SKG-L6, LLC, which acquired the units subject to the obligation to pay the associated promissory notes. MIR was a disregarded entity wholly owned by Mr. Bhargava. Thus, Mr. Bhargava was the tax-regarded owner of all of the Encumbered Units.

10.b.5. For each purchase of Class A Units by Acquisition Co., Acquisition Co. became entitled to a section 743(b) basis adjustment, which increased its proportionate share of inside basis in the Partnership's assets with respect to the units acquired in each purchase. Specifically, Acquisition Co.'s purchase of 295,000 of the Encumbered Units in 2008 resulted in a $430,851,704 section 743(b) basis adjustment, and its purchase in 2009 resulted in a $2,426,427 section 743(b) basis adjustment.

10.b.6. The Encumbered Units held by Acquisition Co. and MIR were held directly by each of those entities and were not commingled with the Founder Units that had been directly held by Mr. Bhargava. The Encumbered Units were separately stated interests in the Partnership's books and records and were accounted for separately. None of the Encumbered Units were included in the Class A Units donated to RIST.

10.b.7. In accordance with sections 742 and 743, the Partnership determined that Mr. Bhargava's gift of the Donated Units to RIST had no effect on the pre-transfer section 743(b) adjustments attributable to the retained Encumbered Units.

10.c. Section 6662 Penalties are Not Applicable. The Partnership properly reported the Section 754 Amortization Deductions, had at least substantial authority for its determinations of the section 743(b) basis adjustments and had reasonable cause and acted in good faith within the meaning of section 6664 in reporting its Section 754 Amortization Deductions.

WHEREFORE, Petitioner prays that after due proceedings the Court:

(i) Determine that the Partnership correctly reported the amounts of Section 754 Amortization Deductions on its tax returns for 2009, 2010, 2011, 2012, and 2013;

(ii) Determine that the adjustments of partnership items as determined by Respondent in the FPAAs for 2009, 2010, 2011, 2012, and 2013 are erroneous;

(iii) Determine that no adjustment of any partnership item is appropriate for tax years 2009,2010,2011, 2012, and 2013;

(iv) Determine that no section 6662 penalty may be imposed on any underpayments for 2009, 2010, 2011, 2012, and 2013; and

(v) Grant such other and further relief as this Court may deem proper.

Respectfully submitted,

Dated: March 26, 2019

Jennifer E. Breen
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue NW
Washington, D.C. 20004
Telephone No.: (202) 739-5577
Tax Court Bar No. BJ1937
jennifer.breen@morganlewis.com

William F. Nelson
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue NW
Washington, D.C. 20004
Telephone No.: (202) 373-6782
Tax Court Bar No. NW0106
william.nelson@morganlewis.com

Sheri A. Dillon
Morgan, Lewis & Bockius LLP
1111 Pennsylvania Avenue NW
Washington, D.C. 20004
Telephone No.: (202) 739-5749
Tax Court Bar No. DS0248
sheri.dillon@morganlewis.com

Counsel for Innovation Ventures, LLC, by and through Manoj Bhargava, Tax Matters Partner

FOOTNOTES

1 All “section” references are to the Internal Revenue Code of 1986 (26 U.S.C.) and the regulations issued thereunder, as amended and in effect for the years at issue, unless otherwise stated.

END FOOTNOTES

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