United States v. Rapower-3, LLC

960 F.3d 1240

UNITED STATES of America, Plaintiff - Appellee.

v.RAPOWER-3, LLC; International Automated Systems; LTB1; R. Gregory Shepard; Neldon P. Johnson, Defendants - Appellants.

United States of America, Plaintiff - Appellee,

v.RaPower-3, LLC; International Automated Systems; LTB1; R. Gregory Shepard; Neldon P. Johnson, Defendants - Appellants,andHeideman & Associates, re 290 Motion, Respondent.

No. 18-4119

No. 18-4150

United States Court of Appeals, Tenth Circuit.

FILED June 2, 2020

Denver C. Snuffer, Jr. (Steven R. Paul, with him on the briefs), Nelson, Snuffer, Dahle & Poulsen, P.C., Sandy, Utah, for Defendants-Appellants.

Clint A. Carpenter (Richard E. Zuckerman, Principal Deputy Assistant Attorney General, Joan I. Oppenheimer, and John W. Huber, United States Attorney, of Counsel, with him on the briefs), Tax Division, Department of Justice, Washington, D.C., for Plaintiff-Appellee.

Before LUCERO, HARTZ, and MATHESON, Circuit Judges.

HARTZ, Circuit Judge.

After a bench trial the district court decided that Defendants—RaPower-3, LLC; International Automated Systems, Inc. (IAS); LTB1, LLC; Neldon Johnson (the sole decision-maker for the preceding entities); and R. Gregory Shepard (who assisted Johnson in marketing and sales for the entities)—had promoted an unlawful tax scheme. To remedy the misconduct, the court enjoined Defendants from continuing to promote their scheme and ordered disgorgement of their gross receipts from the scheme. See United States v. RaPower-3, LLC , 343 F. Supp. 3d 1115 (D. Utah 2018). Defendants appeal. Exercising jurisdiction under 28 U.S.C. § 1291, we affirm.

I. THE SCHEME

Defendants’ tax scheme was based on a supposed project to utilize a purportedly new, commercially viable way of converting solar radiation into electricity. Mr. Johnson's design, as he advertised it, was to install arrays of framed, triangular plastic sheets ("lenses") on towers. The lens arrays would track the sun and focus its radiation onto a "receiver," where it would heat a "heat transfer fluid." RaPower-3 , 343 F. Supp. 3d at 1124. The transfer fluid would be pumped to a "heat exchanger" to boil water and generate steam. Id. at 1125. The steam would spin a turbine to produce electricity, which would be sent onto wires connected to the electricity grid.

From 2006 to 2008, nineteen towers were constructed at a site near Delta, Utah. The evidence showed that the towers had lenses installed on them, but little more. Many of the towers with receivers "ha[d] no collector or mechanism to transmit energy from a receiver to a generator," id. at 1124, and Mr. Johnson testified that he had not even determined what substance he would use as the "transfer fluid," id. at 1125. There was no connection from the towers to the electricity grid; the only thing at the site was "a brown pole with wires dangling from the top." Id. at 1149.

Mr. Johnson testified that he could have "easily" put electricity onto the grid "at any time since 2005," but he had "made a business decision" not to do so. Id. at 1147 (internal quotation marks omitted). There was no "third party verification of any of Johnson's designs." Id. at 1151. Nor did he have any "record that his system ha[d] produced energy," and "[t]here [were] no witnesses to his production of a useful product from solar energy," a fact that he attributed to his decision to do his testing "on the weekends when no one was around because he didn't want people to see what he was doing." Id. (original brackets omitted). Defendant Shepard testified that "the only application that he heard of for [heat from the lenses] was to burn wood, grass, shoes, a man, and a rabbit." Id. at 1150.

Needless to say, Defendants never secured a purchase agreement for the sale of electricity to an end user. The district court found that "Johnson's purported solar energy technology is not now, has never been, and never will be a commercial-grade solar energy system that converts sunlight into electrical power or other useful energy." Id.

Despite this, Defendants’ project generated tens of millions of dollars between 2005 and 2018. At first the money came from individuals leasing lenses from IAS; but beginning in 2006, buyers would purchase lenses from one of Mr. Johnson's entities, IAS or RaPower-3 (or, because Mr. Johnson and Mr. Shepard used a multilevel-marketing structure, from a "downline" marketer who had purchased the lens from IAS or RaPower-3) for a down payment of about one-third of the purchase price. The entity would "finance" the remaining two-thirds of the purchase price with a zero- or nominal-interest, nonrecourse loan. No further payments would be due from the customer until the system had been generating revenue from electricity sales for five years. The customer would agree to lease the lens back to LTB1 for installation at a "Power Plant"; but LTB1 would not be obligated to make any rental payments until the system had begun generating revenue.

The district court found that each plastic sheet for the lenses was sold to Defendants for between $52 and $70, and the correct valuation of each lens was not more than $100, yet the purchase price of a lens was between $3,500 and $30,000.

Although Defendants sold between 45,000 and 50,000 lenses, fewer than 5% of them were ever installed. Stacks of uncut plastic sheets were in a warehouse in Utah, and Defendants could not tell which customer owned which lens.

Customers were told that buying a lens would have very favorable income-tax consequences. Mr. Johnson and Mr. Shepard sold the lenses by advertising that customers could "zero out" federal income-tax liability by taking advantage of depreciation deductions and solar-energy tax credits.

II. TAX-LAW IMPLICATIONS

A. Validity of claimed deductions and credits

The Internal Revenue Code (IRC) provides favorable tax treatment for investments in solar-energy projects and other capital expenditures. But the requirements to qualify are strict, and the government, believing that purchases of lenses for Defendants’ project did not satisfy them, filed this action in the United States District Court for the District of Utah seeking injunctive and other equitable relief against Defendants. After a 12-day bench trial in which Defendants did not call any witnesses, the district court agreed with the government.

The district court concluded, as discussed in more detail below, that Defendants had engaged in conduct subject to penalty under 26 U.S.C. § 6700(a)(2)(A) by telling customers that they could claim solar-energy tax credits under 26 U.S.C. § 48 and depreciation deductions under 26 U.S.C. § 167(a), including deductions and credits in excess of both passive income, see 26 U.S.C. § 469, and the amounts at risk, see 26 U.S.C. § 465. It also concluded that Defendants engaged in conduct subject to penalty under § 6700(a)(2)(B) because they made a gross-valuation overstatement "each time they told someone the price of a lens (whether $9,000, $3,000, or $3,500)." RaPower-3 , 343 F. Supp. 3d at 1191.

The district court determined that Defendants’ "customers were not allowed a depreciation deduction or the solar energy credit" for several reasons. Id. at 1173. To begin with, "customers were not allowed a depreciation deduction ... because [they] were not in a ‘trade or business’ related to the solar lenses and did not hold the lenses for the production of income." Id. The court evaluated whether customers had acquired lenses in good faith with the primary purpose of earning a profit. It relied on Tenth Circuit precedent, in particular Nickeson v. Commissioner , 962 F.2d 973 (10th Cir. 1992), which identifies factors indicating that an activity is an abusive tax scheme as opposed to a bona fide trade or business. The factors include: "marketing on the basis of projected tax benefits, grossly inflated purchase price set without bargaining, failure of taxpayers to inquire into the potential profitability of the program, taxpayers’ lack of control over activities, and use of nonrecourse indebtedness[.]" Id. at 977 (citations omitted).

Defendants’ project fit the bill. The district court found (1) that the benefits of lens ownership were marketed by reference to "the tax benefits it would provide," RaPower-3 , 343 F. Supp. 3d at 1181 ; (2) that "no customer earned or would earn income from buying solar lenses," id. at 1174 ; (3) that "customers had no control over their purported ‘lens leasing’ businesses," id. at 1179 ; and (4) that "any purported obligation [of the customer] to pay is substantial—and perhaps indefinitely—deferred debt," "[c]ustomers borrow for free," and "the only security for the customers’ promise to pay the[ ] outstanding amounts is the lens itself," id. at 1180. The district court concluded that "the solar lenses were a smokescreen for ... unlawful ‘sales’ of tax deductions and credits to customers," id. at 1182, and that "customers’ ‘lens leasing’ businesses were not bona fide and ongoing businesses," id. at 1183.

The district court concluded that depreciation deductions were also not allowed because the lenses were not "placed in service" by the same tax year as the claimed deductions. It relied on Treasury Regulation 26 C.F.R. § 1.167(a)–10(b), which prohibits depreciation deductions unless the property for which the deduction is sought had been "placed in service" by the year that the deduction is claimed. "Property is first placed in service when first placed in a condition or state of readiness and availability for a specifically assigned function, whether in a trade or business, in the production of income, in a tax-exempt activity, or in a personal activity." 26 C.F.R. § 1.167(a)–11(e)(1)(i). The district court evaluated whether the lenses were "placed in service" under the framework articulated in Sealy Power, Ltd. v. Commissioner , 46 F.3d 382 (5th Cir. 1995), action on decision , AOD-1995-10 (Aug. 7, 1995), nonacq. , 1995-33 I.R.B. 4, 1995-2 C.B. 1 (Aug. 14, 1995).

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