Tales from the KPMG Skunk Works: The Basis-Shift or Defective-Redemption Shelter

Calvin H. Johnson


Calvin H. Johnson is professor of law at the University of Texas at Austin. In this report, Johnson argues that the basis-shift or defective-redemption shelter, called FLIP or OPIS by KPMG, was an early product of KPMG's endeavor to develop complete tax packages that could be sold for multimillion-dollar fees to many customers. The FLIP/OPIS shelter gives a rare opportunity, he says, to see both KPMG internal deliberations and also the profession's many independent evaluations. KPMG said the shelter was likely to prevail, Johnson writes, but the tax profession has reached a consensus that the shelter did not meet professional standards, shown by its acceptance of the IRS's generous settlement offer. In the FLIP/OPIS shelter, Johnson says, a Cayman Islands straw entity borrowed from a foreign bank, bought the bank's stock, and was redeemed out of the stock a few weeks later. The technical claim was that the basis of the Cayman Islands straw could not be used in the redemption, but was shifted to stock held by a related U.S. taxpayer to produce a large artificial tax loss for that taxpayer. Johnson argues that the basis did not shift, in part because the Cayman Islands entity did not recapture any significant fraction of the redeemed shares, so that the redemption was not "essentially equivalent to a dividend." Johnson also argues that various substance-over-form doctrines prevent the loss: Non-bona-fide losses are not allowed; transactions without expectation of pretax profit are not respected; accounting that does not clearly reflect income can be defeated by the IRS; and the step transaction doctrine applies. Prof. Johnson is unwilling to speculate as to how broadly the lessons learned from FLIP/OPIS describe the current professional culture.