Free Reply to Response to Motion - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS MARRIOTT INTERNATIONAL RESORTS, L.P., MARRIOTT INTERNATIONAL JBS CORPORATION, Tax Matters Partner, Plaintiffs, v. THE UNITED STATES, Defendant. ) ) ) ) ) ) ) ) ) ) ) ) ) )

Nos. 01-256T and 01-257T Judge Charles F. Lettow

PLAINTIFFS' REPLY TO DEFENDANT'S OPPOSITION TO PLAINTIFFS' CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT

Harold J. Heltzer Robert L. Willmore Alex E. Sadler CROWELL & MORING LLP 1001 Pennsylvania Avenue, N.W. Washington, D.C. 20004 Tel: (202) 624-2915 Fax: (202) 628-5116 May 9, 2008

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TABLE OF CONTENTS PLAINTIFFS' REPLY TO DEFENDANT'S OPPOSITION TO PLAINTIFFS' CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT.........................1 A. Defendant's Attempt To Distinguish The Section 752 Case Law Prior To Rev. Rul. 95-26 Misrepresents The Holdings And Rationale Of The Cases And Ignores The "All-Events" Test. .................................................................1 Defendant's Argument That The Obligation To Close A Short Sale Should Be Considered A "Fixed" Obligation Because The Short Sale Proceeds Are Used As Collateral For The Short Sale Is A "Red Herring" That Is Completely Irrelevant To Whether An Obligation Is A "Liability" For Purposes Of Section 752. ..................................................................................5 Defendant's Attempt To Distinguish Judge Williams' Decision In Jade Trading, And The District Court Decisions In Klamath And Cemco Investors, Is Unpersuasive. Defendant Is Merely Arguing A Position Which Each Of Those Courts Rejected.............................................................7 Defendant Does Not Deny That The Court In COLM Producer Based Its Ruling On An Erroneous Understanding Of The Relevant Time When The Obligation Had To be "Fixed" In Order To Be Considered A Liability Under Section 752..............................................................................9 Defendant's Response Regarding the Salina Decision Simply Assumes Away The Issue Through Circular Reasoning. ..............................................10 There Is No Legal Basis For Defendant's Argument That This Court Should Accord Chevron Deference To Rev. Rul. 95-26. In Fact, Rev. Rul. 95-26 Should Not Even Be Accorded Skidmore Deference Given That It Does Not Evidence Thoroughness Of Consideration, Employs Flawed And Invalid Reasoning, And Is Inconsistent With A Long Line Of Cases Which The Revenue Ruling Does Not Even Acknowledge, Much Less Explain..........................................................................................12 Defendant Now Argues That Marriott Engaged In A "Tax Shelter Scheme" Because It Interpreted Section 752 In A Manner Consistent With The Interpretation Of That Provision In 1994 By Both The U.S. Tax Court And The IRS. .................................................................................18

B.

C.

D.

E. F.

G.

CONCLUSION...........................................................................................................20

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APPENDIX B Investopedia® Article .................................................................................... B-1 APPENDIX C April 22, 2008, Slip Opinion in Sala v. United States, Dkt. No. 05-cv-00636 (D.C. Colo.)................................................................. C-1 ATTACHMENT Declaration of Robert L. Willmore with Plaintiffs' Exhibit 10

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TABLE OF AUTHORITIES CASES America Online, Inc. v. United States, 64 Fed. Cl. 571 (2005) ........................ 12 Brountas v. Commissioner, 692 F.2d 152 (1st Cir. 1982) ................................ 12 Cemco Investors, LLC v. United States, 2007-1 USTC ¶ 50,385 (N.D. Ill. 2007), aff'd, 515 F.3d 749 (7th Cir. 2008) ............................passim COLM Producer, Inc. v. United States, 460 F. Supp. 2d 713 (N.D. Tex. 2006), appeal pending, Kornman & Associate Inc. v. United States, No. 06-11422 (5th Cir.) ............................................................................. 9-10 Federal Nat'l Mtg. Ass'n v. United States, 379 F.3d 1303 (Fed. Cir. 2004) ............................................................................................................. 13 Fox v. Commissioner, 80 T.C. 972 (1983), aff'd sub nom. Barnard v. Commissioner, 731 F.2d 230 (4th Cir. 1984) .............................................. 12 Gibson Prods. Co. v. United States, 637 F.2d 1041 (5th Cir. 1981) ................ 12 Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975) ............................passim Jade Trading, LLC v. United States, 80 Fed. Cl. 11 (2007) .....................passim Klamath Strategic Investment Fund, LLC v. United States, 440 F. Supp. 2d 608 (E.D. Tex. 2006)..............................................................passim La Rue v. Commissioner, 90 T.C. 465 (1988) ............................................passim Long v. Commissioner, 71 T.C. 1 (1978), aff'd in part and rev'd in part on other issues, 660 F.2d 416 (10th Cir. 1981) ........................passim Long Island Care at Home, Ltd. v. Coke, 127 S.Ct. 2339 (2007) ................ 14-18 Officemax, Inc. v. United States, 428 F.3d 583 (6th Cir. 2005) ....................... 12 Sala v. United States, Dkt. No. 05-cv-00636 (D.C. Colo. April 22, 2008) ........................................................................................ 16-18

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Salina Partnership L.P. v. Commissioner, 80 T.C.M. (CCH) 686 (2000)....................................................................................................... 10-11 United States v. Cleveland Indians Baseball Co., 532 U.S. 200 (2001)....................................................................................................... 17-18 USA Choice Internet Serv., LLC v. United States, 73 Fed. Cl. 780 (2006)....................................................................................................... 12-13 STATUTES, REGULATIONS AND OTHER MATERIALS 26 U.S.C. § 752 ...........................................................................................passim Treas. Reg. § 1.1233-1(a)(1) ................................................................................ 4 29 C.F.R. § 552.109 ........................................................................................... 15 Rev. Rul. 95-26, 1995-1 C.B. 131...............................................................passim Rev. Rul. 88-77, 1988-2 C.B. 128 ................................................................ 12, 16 Fed. R. Evid. 704 ................................................................................................. 7

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS MARRIOTT INTERNATIONAL RESORTS, L.P., MARRIOTT INTERNATIONAL JBS CORPORATION, Tax Matters Partner, Plaintiffs, v. THE UNITED STATES, Defendant. ) ) ) ) ) ) ) ) ) ) ) ) ) )

Nos. 01-256T and 01-257T Judge Charles F. Lettow

PLAINTIFFS' REPLY TO DEFENDANT'S OPPOSITION TO PLAINTIFFS' CROSS-MOTION FOR PARTIAL SUMMARY JUDGMENT Plaintiffs Marriott International Resorts, L.P., Marriott International JBS Corp., Tax Matters Partner ("Marriott"), respectfully submit this Reply to Defendant's Opposition to Plaintiffs' Cross-Motion for Partial Summary Judgment ("Def. Opp."). For the reasons set forth below and in Marriott's opening memorandum, Plaintiffs respectfully request that Plaintiffs' Cross-Motion for Partial Summary Judgment be granted. A. Defendant's Attempt To Distinguish The Section 752 Case Law Prior To Rev. Rul. 95-26 Misrepresents The Holdings And Rationale Of The Cases And Ignores The "All-Events" Test. Defendant argues that the cases cited by Marriott for the principle that it was well established prior to Rev. Rul. 95-26 that contingent obligations are not "liabilities" under Section 752 are distinguishable on the ground that they only involve obligations where the fact of liability was still contingent. But this reading

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of the case law is plainly wrong, as shown below. Moreover, because Defendant's revisionist interpretation of the case law cannot be reconciled with the "all-events" test, Defendant simply ignores that test in its discussion of the case law. The fact that the Section 752 "liability" holdings in question were not limited to situations where the fact of liability was contingent is clear from both Long v. Commissioner, 71 T.C. 1 (1978), aff'd in part and rev'd in part on other issues, 660 F.2d 416 (10th Cir. 1981), and La Rue v. Commissioner, 90 T.C. 465 (1988). In Long, the Tax Court held that the obligation in question was not a liability both because the fact of liability "had not been established," and because "the amounts of damages sought were by no means definite or fixed." 71 T.C. at 8. Significantly, the Tenth Circuit, in affirming this holding, specifically observed that the liability was contingent as to amount. 660 F.2d at 419 ("[The Tax Court] held that because the lawsuit claims against the partnership were indefinite and contingent liabilities, they should not be recognized for basis adjustment purposes until the exact amounts of the liabilities were established. . . . We agree with this approach and holding.") (emphasis added). La Rue is even more clear in this regard. There, the partnership's contractual obligation to correct the "back office" trading failures had already been established and was not in question. 90 T.C. at 479. The key contingency in La Rue was not the fact of liability, but the amount of liability (that is, what it would ultimately cost to correct the "back office" failures). This point could not be more clear from the Tax Court's opinion:

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Once the "back office" failures occurred, Goodbody incurred an obligation. The partnership was contractually obligated to its customers under the NYSE rules. . . . All of petitioners' witnesses testified that these were transactions for which the partnership was liable. There was, however, a contingency or speculative quality concerning the amount of Goodbody's liability. Until any missing securities were purchased or excess securities sold, at market price, there was no way of determining the amount of loss, or in some circumstances, gain. Petitioners have not shown that these amounts were determinable with reasonable accuracy. . . . A loss is not determinable until the securities are actually purchased or sold and the transaction closed. We accordingly hold that because the reserves were not a fixed obligation of the partnership sufficiently determinable in amount in 1970, they cannot be included in the partners' basis in that year. La Rue, 90 T.C. 479-80 (emphasis added) (footnote omitted). It also is worth noting La Rue's discussion of Long, which completely undercuts Defendant's argument that Long was only concerned with whether the obligation in question was contingent as to the fact of liability. The Tax Court in La Rue had a very different understanding of its prior decision: The test used in Long focused on the fact of liability and whether the amount of the liability was definite or fixed. This test is similar, if not identical, to the "all-events" test for deduction of accrued expenses. . . . [W]e think that test may be properly used to determine when the corresponding liability is includable in basis. La Rue, 90 T.C. 478 (emphasis added). See also Klamath Strategic Investment Fund, LLC v. United States, 440 F. Supp. 2d 608, 616 (E.D. Tex. 2006) ("Long held there were two reasons that the claims were not liabilities under Section 752: the obligations were contingent and they were indefinite in amount.") The Klamath court's analysis of La Rue also is inconsistent with Defendant's argument:

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In La Rue v. Comm'r, 90 T.C. 465 . . . (1988), the Service again argued, and the Court agreed, that obligations that are fixed in the sense that it is known that some amount will be paid, but that remain contingent in amount, do not constitute "liabilities" for purposes of Section 752. The La Rue Court held that even though a contractual obligation is fixed, that obligation does not represent a liability under Section 752 until the cost of that obligation becomes fixed in amount. Id. at 479 . . . ; see also Long, 71 T.C. at 8. Id. at 616 (emphasis added). See also Jade Trading, LLC v. United States, 80 Fed. Cl. 11, 44-45 (2007) (citing La Rue and Long for proposition that non-fixed obligations are not liabilities for purposes of Section 752). Even though the Tax Court in La Rue indicated that its holding was based on the "all-events" test,1 there is absolutely no discussion in Defendant's brief of that test or the Tax Court's use of that test in applying Section 752. This was not a mere oversight by Defendant. The reason Defendant does not discuss the "all-events" test is because that test ­ which provides that a fixed liability cannot exist until the fact of liability has been established and the amount of that liability is determinable with reasonable accuracy ­ is fundamentally irreconcilable with Defendant's present argument.2

1

The syllabus to La Rue summarizes the pertinent holding as follows: "Held, liabilities attributable to an accrual basis partnership's deductible expenses must meet the `all events' test before they may be included in the bases of Ps' partnership interests." 90 T.C. at 466. Defendant argues (Def. Opp., at 11-12) that Code section 1233 ­ which provides that recognition of taxable gain or loss from a short sale transaction is determined at the time the short sale is closed ­ is irrelevant to the issue before the Court. It is noteworthy, however, that Code section 1233 (as well as the relevant Treasury Regulation, Treas. Reg. § 1.1233-1(a)(1)) is consistent with the "all-events" test.

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Accordingly, Defendant's argument that the cases that have held that a contingent obligation is not a "liability" for purposes of Section 752 are limited to those situations where the fact of liability is contingent is not only unsupported by the case law but is incompatible with the reasoning of those decisions. B. Defendant's Argument That The Obligation To Close A Short Sale Should Be Considered A "Fixed" Obligation Because The Short Sale Proceeds Are Used As Collateral For The Short Sale Is A "Red Herring" That Is Completely Irrelevant To Whether An Obligation Is A "Liability" For Purposes Of Section 752. Defendant argues that, because the proceeds of a short sale (that is, the money the short seller obtains when he sells the borrowed securities) are typically held as collateral by the lender of the shorted securities, the obligation to close the short sale by returning the borrowed securities should be considered a "fixed" obligation and therefore a "liability" under Section 752. It is not altogether clear what point Defendant is trying to make with its argument. If Defendant is arguing that there is a contractual obligation to return the borrowed securities, which is, in turn, secured by collateral, that is not a point that is or ever has been controverted in this case. Marriott has never argued that there was not a contractual obligation to return the shorted Treasury Notes, and, in fact, the Treasury Notes were returned when the short sale was closed. In this regard, it should be noted that the role of collateral in a short sale transaction was described in Dr. Lamont's expert report3 (at page 4) and covered in

3

Dr. Lamont's expert report is attached as Exhibit 8 to the Declaration of Harold J. Heltzer dated March 25, 2008.

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his deposition.4 As Dr. Lamont noted in his report, and as he explained in his deposition, the proceeds from the sale of the shorted securities are typically used as part of the collateral provided to the lender of the securities, and the amount of the required collateral can increase or decrease as the value of the shorted securities increases or decreases. See Plaintiffs' Exhibit 8, at 4; Plaintiffs' Exhibit 10, at 2832, 44-50.5 The existence of collateral, however, does not change the fundamental reality that the ultimate cost of closing the short sale simply cannot be determined until the replacement securities have been purchased by the short seller. Defendant's argument that the existence of collateral somehow makes that obligation "fixed" in amount is illogical. The three CSFB confirmation statements that Defendant submits with its Opposition (see Defendant's Exhibit 13) do not suggest otherwise or demonstrate anything of significance to the legal issues before this Court.6 It also should be noted that Defendant's "collateral" argument was made to and expressly rejected by the District Court in Klamath: The government's proposed distinctions are not borne out by the cases. In La Rue, for example, the Tax Court specifically found that the taxpayer was obligated to make payment. See La Rue v. Comm'r,
4

Relevant pages from Dr. Lamont's deposition are attached as Exhibit 10 to the Declaration of Robert L. Willmore dated May 9, 2008, filed concurrently. For illustration purposes only, attached to this brief as Appendix B is an article from Investopedia® showing how the amount of collateral can change with the change in the value of the shorted securities. Moreover, to the extent the CSFB confirmation statements show the amount of collateral securing the short sales, they would only show the amount of collateral at the time of the confirmation statements.

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90 T.C. 465, 479 . . . (1988). Moreover, the taxpayer had established reserves to pay this obligation, and such reserves are the functional equivalent of the collateral account here. Nevertheless, the Tax Court found the existing obligation was not a liability under Section 752 because it was still "contingent in amount." Id. at 479 . . . . Klamath, 440 F. Supp. 2d at 618 (emphasis added). Finally, it bears emphasis that Defendant does not contest any of the points made by Marriott in its opening memorandum (at pages 17-21) explaining why the obligation to close a short sale is by its very nature a contingent obligation.7 C. Defendant's Attempt To Distinguish Judge Williams' Decision In Jade Trading, And The District Court Decisions In Klamath And Cemco Investors, Is Unpersuasive. Defendant Is Merely Arguing A Position Which Each Of Those Courts Rejected. Defendant argues that this Court should not treat Judge Williams' decision in Jade Trading, or the District Court decisions in Klamath and Cemco Investors,8 as persuasive authority in this case, even though each of those decisions ­ citing the Tax Court opinions discussed above ­ held that contingent obligations are not "liabilities" for purposes of Section 752.

7

In a footnote (Def. Opp., at 11 n.10), Defendant states that Dr. Lamont's report is improper if it is being used to support a legal conclusion. This statement is a nonsequitur. As the Court can readily ascertain from reviewing his report, Dr. Lamont does not claim to be offering any legal opinions of any kind. Rather, he explains the mechanics of a short sale transaction and describes the various contingencies that can arise in the course of a short sale transaction. Moreover, even though Dr. Lamont's report shows that a short sale transaction is by its nature a contingent obligation, expert opinion testimony embracing an ultimate issue in a case is entirely appropriate. See Fed. R. Evid. 704 (a). In sum, there is absolutely nothing improper about Dr. Lamont's report. Cemco Investors, LLC v. United States, 2007-1 USTC ¶ 50,385 (N.D. Ill. 2007), aff'd, 515 F.3d 749 (7th Cir. 2008).

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The precise reason why these holdings should be rejected by this Court is not altogether clear from Defendant's Opposition, but it appears that Defendant is taking the position that, because each Court ultimately concluded that the underlying transaction lacked economic substance, each Court also should have ruled that there was no contingent obligation for purposes of Section 752. One obvious problem with Defendant's argument is that none of the three courts saw it Defendant's way. Certainly, Judge Williams of this Court did not, given that her opinion in Jade Trading rejected the Government's Section 752 argument on the ground that a contingent obligation is not a Section 752 "liability," see 80 Fed. Cl. at 44-45, but nonetheless held in favor of the Government with respect to the economic substance of the underlying transaction. Id. at 45-52. Klamath and Cemco Investors came to similar conclusions. Interestingly, Defendant even complains that the court in Klamath denied the Government's motion to vacate its Section 752 summary judgment ruling based on the court's subsequent decision rejecting the economic substance of the transaction. See Def. Opp., at 9 n.7. A more basic problem with Defendant's argument is that the economic substance of the Marriott short-sale transactions is not at issue in these crossmotions for summary judgment and relevant summary judgment evidence as to that question is not before this Court. If Defendant had seriously wanted to pursue this theory, it should have moved for summary judgment on the economic substance doctrine (although it seems clear that there would be numerous disputed issues of

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material fact). But Defendant chose not to do so. It is entirely inappropriate for Defendant now to argue that this Court should nevertheless attempt to view the Section 752 "liability" issue through the prism of the economic substance doctrine. D. Defendant Does Not Deny That The Court In COLM Producer Based Its Ruling On An Erroneous Understanding Of The Relevant Time When The Obligation Had To be "Fixed" In Order To Be Considered A Liability Under Section 752. Defendant accuses Marriott of "gamely attempt[ing] to disparage" the decision in COLM Producer9 by pointing out that the court in that case based its ruling on an error regarding the relevant time at which the obligation had to be "fixed" in order to be considered a "liability" under Section 752. See Def. Opp., at 10. Respectfully, Marriott would simply note that Defendant's own appellate counsel conceded to the Fifth Circuit that the District Court had erred in this regard. See Plaintiffs' Opening Mem., at 32. As explained in Marriott's opening memorandum, the court in COLM Producer believed that the relevant time for determining when the obligation to close the short sale was "fixed" was at the time the partnership was sold to a third party. As the court noted, at that time, the entity that sold the partnership to the third party would not be subject to any further interest rate fluctuations. See Plaintiffs' Opening Mem., at 31-32. In fact, the correct time for determining whether or not the obligation was "fixed" was when the obligation was transferred

9

COLM Producer, Inc. v. United States, 460 F. Supp. 2d 713 (N.D. Tex. 2006), appeal pending, Kornman & Assoc. Inc. v. United States, No. 06-11422 (5th Cir.)

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to the partnership. Presumably, at that earlier point in time, the entity that eventually sold the partnership would still have been subject to further interest rate fluctuations. Marriott can only speculate how this error affected the court's ultimate ruling in COLM Producer. But, applying the court's analytical framework without this error suggests that, at the time the obligation to close the short sale was transferred to the partnership, the obligation was still contingent and therefore not a "liability" within the meaning of Section 752. See COLM Producer, at 716 ("The cases on which COLM relies stand for the proposition that liabilities that are contingent as to the obligation itself or as to the amount of the obligation do not qualify as `liabilities' for purposes of section 752.") (emphasis added).10 E. Defendant's Response Regarding the Salina Decision Simply Assumes Away The Issue Through Circular Reasoning. In its opening memorandum, Marriott noted that the Salina Tax Court Memorandum11 upon which Defendant relies for its position here did not go through the same careful analysis as the Federal court decisions that reviewed and applied the Helmer,12 Long and La Rue line of cases, but instead based its ruling on a broad

10

Defendant claims that "Marriott presumably agrees that the short sale obligations were determinable and fixed when MORI contributed to MIR the short sale proceeds . . . ." Def. Opp., at 10-11. Marriott does not agree with that statement. Since the profit or loss on the short sale could not be determined until the short sale was closed at a later point in time, the obligation obviously was not "fixed" at the time it was transferred to the partnership and therefore not a "liability" under Section 752. That is the teaching of the Tax Court's opinion in La Rue. Salina Partnership L.P. v. Commissioner, 80 T.C.M. (CCH) 686 (2000). Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975).

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definition of "liability" found in Black's Law Dictionary. Marriott observed that, if the term "liability" in Section 752 really were to be defined using this broad definition, then virtually all the cited cases applying Section 752 ­ both from the Tax Court and the various refund forums ­ would have been incorrectly decided given the breadth of that definition. Defendant contends that this is not so because "[t]hose cases involved transactions that the respective courts found to be contingent in nature . . . ." Def. Opp., at 10. But this response simply assumes away the issue though circular reasoning. For purposes of Section 752, either an obligation is a "liability" or is not a "liability." Helmer, Long, and La Rue all analyzed the issue by determining whether the obligation in question was or was not contingent in nature.13 Salina, however, applied an entirely different (and highly superficial) analytical approach, and in the process ignored two binding Tax Court Opinions (La Rue and Long). If the correct analytical approach ­ as Defendant appears to concede in its Opposition ­ is to determine whether the obligation is or is not contingent in nature, than Salina must be considered to have been wrongly decided since that is not what the Salina court did. If, on the other hand, the correct analytical approach is to ignore the question of whether the obligation is contingent in nature, and instead only consider whether the obligation fits within the broad definition of "liability" found in Black's Law Dictionary, then presumably the Salina court was right. In that

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As discussed above, his approach was followed by Judge Williams in Jade Trading and the District Courts in Klamath and Cemco Investors.

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event, however, Helmer, Long, La Rue, Brountas, Gibson, Fox, Jade Trading, Cemco Investors and Klamath would all have been wrongly decided. F. There Is No Legal Basis For Defendant's Argument That This Court Should Accord Chevron Deference To Rev. Rul. 95-26. In Fact, Rev. Rul. 95-26 Should Not Even Be Accorded Skidmore Deference Given That It Does Not Evidence Thoroughness Of Consideration, Employs Flawed And Invalid Reasoning, And Is Inconsistent With A Long Line Of Cases Which The Revenue Ruling Does Not Even Acknowledge, Much Less Explain. Defendant argues that this Court should accord Chevron deference to Rev. Rul. 95-26, 1995-1 C.B. 131. In making this argument, Defendant ignores this Court's analysis in two recent decisions regarding the appropriate degree of deference to be accorded IRS revenue rulings. See America Online, Inc. v. United States, 64 Fed. Cl. 571, 580 (2005); USA Choice Internet Serv., LLC v. United States, 73 Fed. Cl. 780, 792-93 (2006); see also Officemax, Inc. v. United States, 428 F.3d 583, 595 (6th Cir. 2005). As noted in Marriott's opening memorandum (at 3536), there is no legal basis for Defendant's position that this Court should accord Chevron deference to Rev. Rul. 95-26.14 The more significant question is whether any deference should be accorded Rev. Rul. 95-26, such as Skidmore deference. In its decisions in America Online and

14

Defendant also argues that Chevron deference should be accorded to Rev. Rul. 88-77, 1988-2 C.B. 128. But as discussed in Marriott's opening memorandum (at 23-26), Defendant's argument regarding Rev. Rul. 88-77 completely misconstrues the purpose and meaning of that revenue ruling, which had nothing to do with whether the obligation to close a short sale is a contingent obligation. Defendant simply ignores Marriott's argument, but nonetheless asks the Court to accord Chevron deference to its misapplication of Rev. Rul. 88-77.

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USA Choice, this Court discussed the factors that bear on that question. See also Federal Nat'l Mtg. Ass'n v. United States, 379 F.3d 1303, 1307-09 (Fed. Cir. 2004) (analyzing deference due an IRS revenue procedure). In its opening memorandum, Marriott reviewed each of those factors and demonstrated why, applying those factors, Skidmore deference is not appropriate. Defendant essentially ignores these factors and, instead, argues that this Court must defer to any Internal Revenue Code interpretation by the Service set forth in a revenue ruling as long as that interpretation is not unreasonable. See Def. Opp., at 14-15. Marriott will not reiterate here all of its arguments from its opening memorandum (at 35-41) why this Court should not defer to Rev. Rul. 95-26. But one key consideration in this regard is the revenue ruling's complete failure to even acknowledge, much less explain, its departure from the Helmer, Long and La Rue line cases regarding what type of obligation will be considered a "liability" for purposes of Section 752. This should be juxtaposed against the preamble to the 2003 proposed Treasury Regulations which candidly conceded that "[t]he definition of liability contained in these proposed regulations does not follow Helmer v. Commissioner." See Plaintiffs' Opening Mem., at 29. Marriott respectfully submits that judicial deference of the kind Defendant requests here is particularly inappropriate when an agency does not even acknowledge that it is using an informal procedure to change established law, much less explain why. Defendant argues in response that "[i]t is unremarkable that Rev. Rul. 95-26 doe not discuss Helmer, Long and La Rue, because . . . those cases have no

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relevance to the question of whether a short sale obligation is a liability for purposes of § 752." Def. Opp., at 15. But this contention obviously is not correct given the above-noted concession in the preamble to the 2003 proposed Treasury regulations which recognized the relevance of Helmer and its progeny, as well as the decisions in Jade Trading, Klamath and Cemco Investors regarding the holdings of those Tax Court decisions. Moreover, it is difficult to accept Defendant's argument that Rev. Rul. 95-26 did not represent an effort to change established law when the contemporaneous internal IRS notes produced by Defendant in this case show the obvious discomfort of the Service's own attorneys with the approach being urged by the Treasury Department to achieve its desired policy outcome. See Plaintiffs' Opening Mem., at 21-23 (noting that Treasury wants to use § 752 to "cram through [that] result" even though it "understands it is not an entirely clean way of doing it"); Plaintiffs' Exhibit 5.15 With respect to its deference argument, Defendant relies heavily on the Supreme Court's recent opinion in Long Island Care at Home, Ltd. v. Coke, 127 S.Ct. 2339 (2007). But Long Island Care does not support Defendant's general argument; in fact, it undermines Defendant's argument. It was important in Long Island Care, and the Court repeatedly noted, that the rule in question had been

15

As other portions of those internal IRS notes reflect, the Service was well aware of the inconsistency between Treasury's proposal and Helmer. See Jade Trading, 80 Fed. Cl. at 44-45 n.65.

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formally promulgated subject to notice and comment procedures.16 One of the issues in Long Island Care was whether the rule was an "interpretive regulation," which the Court noted "may `persuade' a reviewing court, . . . but will not necessarily `bind' a reviewing court." Id. at 2349-50 (citations omitted). In holding that the regulation was not an interpretive regulation, the Court emphasized that the agency had used "full public notice-and-comment procedures." Id. at 2350. Defendant appears to suggest in its Opposition that the Court in Long Island Care was upholding a guidance issued by the agency. See Def. Opp., at 16. But this so-called guidance was an "`Advisory Memorandum' issued only to internal Department personnel" which explained and defended the regulation in question. 127 S.Ct. at 2345 & 2349. Although the courts considered the internal "Advisory Memorandum," the issue before the Supreme Court was not the validity of (or any deference to be accorded) the "Advisory Memorandum," but the validity of the regulation being challenged (29 C.F.R. § 552.109(a)). If Long Island Care stands for anything relevant to these cross-motions, it strongly suggests that a revenue ruling should not be accorded Chevron deference given the lack of public notice-andcomment procedures. Defendant even cites Long Island Care for the proposition that an agency should be permitted to change its interpretation of a statute as long as the changed

16

See, e.g., 127 S.Ct. at 2346 ("The Department focused fully upon the matter in question. It gave notice, it proposed regulations, it received public comment, and it issued final regulations in light of that comment.")

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interpretation creates "no unfair surprise." See Def. Opp., at 16.17 Defendant contends that Rev. Rul. 95-26 did not create an "unfair surprise" because of Rev. Rul. 88-77. But as discussed in Marriott's opening brief (at 23-26), Rev. Rul. 88-77 did not deal with the proper treatment of contingent obligations, but dealt with an entirely different issue; that being, restricting the scope of the term "liability" when a cash basis taxpayer transfers its accounts payable to a related entity. In no sense would Rev. Rul. 88-77 have alerted anyone prior to 1995 that the IRS intended to abandon ­ at least with respect to short sales ­ a principle it had successfully established in the Tax Court over several decades.18 This Court may also wish to consider the U.S. District Court's recent opinion in Sala v. United States, Dkt. No. 05-cv-00636 (D.C. Colo. April 22, 2008) (slip opinion attached hereto at Appendix C). In that opinion, entered after trial, the court ruled that the Government could not retroactively apply its 2003 regulations defining the term "liability" under Section 752 to a transaction which had occurred

17

In support of this proposition, Defendant quotes a passage from Long Island Care. But it should be noted that, in the quoted passage, Defendant deleted through ellipsis the portion of the Court's discussion observing that it was "the Department's recourse to notice-and-comment rulemaking in an attempt to codify its new interpretation . . . [that] makes any such surprise unlikely here." Long Island Care, 127 S.Ct. at 2349. Defendant also contends in its Opposition that there was no "unfair surprise" because Marriott filed its 1994 Federal tax return after Rev. Rul. 95-26 had been issued. See Def. Opp., at 17. But Defendant simply disregards the fact that all the relevant transactions had been entered into and completed by the end of 1994, prior to the issuance of Rev. Rul. 95-26 and while Marriott had no reason to believe that the governing law was anything other than that articulated by the Tax Court in Helmer, Long and La Rue.

18

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in 2000. Slip op. at 51-57. The court noted that retroactive application of a regulation may be considered an abuse of discretion if "the retroactive regulation alters settled prior law or policy upon which the taxpayer justifiably relied and if the change causes the taxpayer to suffer inordinate harm." Id. at 53 (quoting CWT Farms, Inc. v. Comm'r of Internal Revenue, 755 F.2d 790, 802 (11th Cir. 1985)). As the Court noted in Sala: Treasury Regulation § 1.752-6 not only alters settled prior law ­ as the Treasury acknowledged, see Fed. Reg. 37434, 37437 (June 24, 2003) ("The definition of a liability contained in these proposed regulations does not follow Helmer v. Commissioner, T.C. Memo 1975160.") ­ it directly contradicts the underlying statutes ­ 26 U.S.C. §§ 358 and 752 ­ the abuse of which it supposedly prevents. As such, the regulation does not "protect" the statute from abuse, but rather amends the statute to reach an outcome different from ­ and contrary to ­ that the statute would require. Slip op. at 53. It is ironic that Defendant here asks this Court to apply a revenue ruling retroactively to invalidate a transaction through a new definition of "liability" when the court in Sala would not even allow the Government to accomplish that purpose through the retroactive application of a 2003 Treasury regulation defining the term "liability" for purposes of Section 752. Finally, it is noteworthy that neither of Defendant's briefs even mentions the Supreme Court's opinion in United States v. Cleveland Indians Baseball Co., 532 U.S. 200 (2001), in which the Court addressed but did not resolve the issue of the appropriate deference to be accorded a revenue ruling. In that case, the Court concluded that it would defer to the IRS's longstanding and steady interpretation of

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its regulations. Id. at 220 ("We do not resist according such deference in reviewing an agency's steady interpretation of its own 61-year-old regulation implementing a 62-year-old statute.") Here, of course, this Court is faced with precisely the contrary situation; that is, a revenue ruling that seeks to alter (without even acknowledging such) a longstanding and steady interpretation of a statute. Essentially, this point also was made by the District Court in Sala in its rejection of the Government's deference argument. Citing and distinguishing Long Island Care, the court in Sala noted that: "This is not a case like the one in Long Island Care where a regulation was intended to settle a question the agency had `struggled' with for years. To the contrary, the regulation sought to reverse a policy the Treasury had relied upon ­ whenever such reliance inured to its benefit ­ since 1975." Sala, slip op. at 55. The very same is true here. G. Defendant Now Argues That Marriott Engaged In A "Tax Shelter Scheme" Because It Interpreted Section 752 In A Manner Consistent With The Interpretation Of That Provision In 1994 By Both The U.S. Tax Court And The IRS. In its opening memorandum, Defendant referred to the Marriott short sale transactions as "Son of Boss" transactions. Marriott pointed out that this characterization of the transactions was incorrect and unfair, and that Defendant was merely attempting to cast the short sale transactions in a negative light. In its Opposition (at 18-19), Defendant abandons the "Son of Boss" label, but instead argues that the Marriott short sale transactions should nonetheless be considered a "tax shelter scheme" because of Marriott's "failure to treat the short sale obligations as liabilities in calculating MIR's partnership basis." Def. Opp., at

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18-19. What Defendant fails to mention, however, is that Marriott's treatment of the short sale obligations in this manner in 1994 was not only consistent with a well established line of Tax Court cases regarding what type of obligations constitute "liabilities" under Section 752, but also was consistent with the IRS's own understanding at the time of what constituted a Section 752 "liability."19 As noted in Marriott's opening memorandum, the Service understood that Rev. Rul. 95-26 ­ issued the year following the Marriott short sale transactions ­ was "not an entirely clean way" of achieving Treasury's policy goal, but decided to proceed anyway because, for Treasury, it was "no matter how [to] get to that result." See Plaintiffs' Opening Mem., at 21-23; Plaintiffs' Exhibit 5. It is odd, indeed ­ particularly in light of the circumstances surrounding the genesis of Rev. Rul 95-26 ­ that Marriott now stands accused of having engaged in a "tax shelter scheme" because it interpreted a provision of the Internal Revenue Code in a manner consistent with the interpretation of that provision by both the U.S. Tax Court and the IRS.20

19

See also Jade Trading, supra, at 44-45 (contingent obligations are not considered Section 752 "liabilities"); Klamath, supra, at 625-26 (same). Defendant also proffers two supplemental proposed findings of uncontroverted facts related to Mr. Roy Hahn, which Defendant implies support its "tax shelter scheme" accusation. But, as the Court can see from Plaintiffs' response to the proposed findings, Mr. Hahn had no personal knowledge of the actual Marriott short sale transactions and apparently did even know (prior to being informed by Defendant's counsel) that Marriott had entered into those transactions. See Plaintiffs' Response to Defendant's Supplemental Proposed Findings of Uncontroverted Facts, at 2-3.

20

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CONCLUSION For the reasons stated above and in Plaintiffs' opening memorandum, Plaintiffs respectfully request that Plaintiffs' Cross-Motion for Partial Summary Judgment be granted. Respectfully submitted, May 9, 2008 s/Harold J. Heltzer Harold J. Heltzer (Attorney of Record) Robert L. Willmore Alex E. Sadler CROWELL & MORING LLP 1001 Pennsylvania Avenue, N.W. Washington, D.C. 20004 Tel: (202) 624-2915 Fax: (202) 628-5116 Counsel for Plaintiffs

5564394

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What are the minimum margin requirements for a short sale account?

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In a short sale transaction, the investor borrows shares and sells them on the market in the hope that the share price will decrease and he or she will be able to buy them back at a lower price. The proceeds of the sale are then deposited into the short seller's margin account. Because short selling is essentially the selling of stocks that are not owned, there are strict margin requirements. This margin is important, as it is used for collateral on the short sale to better insure that the borrowed shares will be returned to the lender in the future. While the initial margin requirement is the amount of money that needs to be held in the account at the time of the trade, the maintenance margin is the amount that must be in the account at any point after the initial trade. Under Regulation T, the Federal Reserve Board requires all short sale accounts to have 150% of the value of the short sale at the time the sale is initiated. The 150% consists of the full value of the short sale proceeds (100%), plus an additional margin requirement of 50% of the value of the short sale. For example, if an investor initiates a short sale for 1,000 shares at $10, the value of the short sale is $10,000. The initial margin requirement is the proceeds $10,000 (100%), along with an additional $5,000 (50%), for a total of $15,000. Maintenance margin requirement rules for short sales add a protective measure that further improves the likelihood that the borrowed shares will be returned. In the context of the NYSE and NASD, the maintenance requirements for short sales are 100% of the current market value of the short sale, along with at least 25% of the total market value of the securities in the margin account. Keep in mind that this level is a minimum, and it can be adjusted upward by the brokerage firm. Many brokerages have higher maintenance requirements of 30-40%. (In this example, we are assuming a maintenance margin requirement of 30%.)

Figure 1

In the first table of Figure 1, a short sale is initiated for 1,000 shares at a price of $50. The proceeds of the short sale are $50,000, and this amount is deposited into the short sale margin account. Along with the proceeds of the sale, an additional 50% margin amount of $25,000 must be deposited in the account, bringing the total margin requirement to $75,000. At this time, the proceeds of the short sale must remain in the account; they cannot be removed or used to purchase other securities.

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The second table of Figure 1 shows what happens to the short seller if the stock price increases and the trade moves against him or her. The short seller is required to deposit additional margin in the account when the total margin requirement exceeds the original total margin requirement of $75,000. So, if the stock price increases to $60, then the market value of the short sale is $60,000 ($60 x 1000 shares). The maintenance margin is then calculated based on the market value of the short, and it is $18,000 (30% x $60,000). Added together, the two margin requirements equal $78,000, which is $3,000 more than the initial total margin that was in the account, so a $3,000 margin call is issued and deposited into the account.

Figure 2

Figure 2 shows what happens when the stock price decreases and the short sale moves in the short seller's favor: the value of the short sale decreases (which is good for the short seller), the margin requirements also change, and this change means the investor will start to receive money out of the account. As the stock heads lower and lower, more and more of the margin in the account - the $75,000 - is released to the investor. If the price of the stock falls to $40 a share, the short sale value will be $40,000, down from $50,000. Whenever the price falls, investors are still required to have an additional 50% in the account - so the additional margin required in this case will be $20,000, down from $25,000. The difference between the initial margin requirement total and the margin requirement total as the price falls is released to the short seller. In this example, the amount released when the price falls to $40 is $15,000, which consists of the $10,000 drop in the short sale value and the $5,000 drop in the additional margin requirement. The short seller could then use this money to purchase other investments. To learn more, see our Short Selling Tutorial and our Margin Trading Tutorial.

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Appendix C

IN THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF COLORADO LEWIS T. BABCOCK, JUDGE Civil Case No. 05-cv-00636-LTB CARLOS E. SALA, and TINA ZANOLINI-SALA, Plaintiffs, v. UNITED STATES OF AMERICA, Defendant. ______________________________________________________________________________ FINDINGS OF FACT, CONCLUSIONS OF LAW, AND ORDER ______________________________________________________________________________ Babcock, J. This action concerns a claim by Plaintiffs Carlos E. Sala and Tina Zanolini Sala (referred to herein as "Sala," since Tina Zanolini-Sala is a named plaintiff only because the Salas filed a joint tax return) for a refund on Sala's 2000 federal taxes. Sala timely filed his 2000 federal tax return on or before April 15, 2001. Although Sala had income in 2000 of more than $60 million, he claimed a tax loss that essentially nullified his tax burden. Sala achieved the alleged loss through his involvement in a foreign currency options investment transaction known as Deerhurst. Sala filed an amended return on November 18, 2003, eliminating the loss claimed on his original 2000 return and paying over $26 million in taxes, plus penalties and interest. Sala later filed another amended return reclaiming the tax loss and seeking a refund of the taxes, interest, and penalties. The Government contends Sala is not entitled to claim the tax loss because Deerhurst

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was an improper tax shelter. Sala disagrees, and brought suit against the Government to obtain a refund of the taxes, interest, and penalties he paid to the Government. An eight day trial to the Court in this matter was held commencing March 10, 2008, and concluding March 19, 2008. The two claims at issue were Sala's entitlement to a refund of the taxes, penalties, and interest he paid on his 2000 income and--to the extent any refund was due Sala on putatively "excess" interest--the Government's entitlement to an accuracy-related penalty owed, but not assessed. After a review of all the evidence presented both at trial and by deposition, I find in favor of Carlos Sala and Tina Zanolini-Sala and against the Government on all claims and counterclaims. I. BACKGROUND FACTS The following facts are not disputed. In 1997, Sala became employed as CFO, Secretary, and Treasurer of Abacus Direct, Inc. Sala's compensation included cash and stock options. In June 1999, Abacus was acquired by DoubleClick, Inc. In connection with the acquisition, Sala received DoubleClick stock options. Sala sold his DoubleClick options in February or March of 2000. Largely as a result of the sale of these options, Sala realized more than $60 million in income in 2000. Sala invested most of this income into municipal bonds and other fixed income financial products. Approximately $9 million, however, was invested in a foreign currency investment program, which is collectively referred to herein as the "Deerhurst Program." As part of the Deerhurst Program, Sala deposited $500,000 on October 23, 2000, into a personal account at Refco Capital Markets ("Refco") that was managed by Deerhurst Management Company, Inc.

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("Deerhurst Management"). Deerhurst Management was principally owned and managed by Andrew Krieger, a renowned foreign currency trader. On November 21, 2000, Sala deposited an additional $8,425,000 into his personal account at Refco. Between November 20 and November 27, 2000, Deerhurst Management acquired 24 foreign currency options on Sala's behalf. The options consisted of both long and short options in various foreign currencies with a net cost to Sala of approximately $728,297.85. On November 8, 2000, Sala formed Solid Currencies, Inc. ("Solid" or "Solid Currencies")--a Delaware S Corporation in which he was the sole shareholder. On November 28, 2000, Sala transferred the 24 options, plus approximately $8 million in cash, to Solid and then from Solid to Deerhurst Investors, GP, ("Deerhurst GP") in exchange for a partnership interest. Deerhurst GP was liquidated prior to December 31, 2000. Upon liquidation of Deerhurst GP, Solid received a share of the proceeds. Solid transferred its share of the Deerhurst GP proceeds to Deerhurst Trading LLC. Krieger continued to manage these funds on behalf of Sala in various entities through 2004. On or before April 15, 2001, Sala filed a corporate income tax return for Solid for the 2000 tax year. The return was prepared and signed by David Schwartz, the brother of Michael Schwartz--the person who introduced Sala to the Deerhurst Program. The return reported an ordinary loss from a trade or business of $60,449,984. The approximately $60 million loss claimed was allegedly achieved by a series of predetermined steps, orchestrated under a then-existing tax rule that disregarded short options as liabilities for purposes of establishing partnership basis. Under this rule, established in Helmer v. Commissioner of Internal Revenue, T.C. Memo. 1975-160 (1975), liabilities created by short -3-

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options were considered too contingent to affect a partner's basis in the partnership. Upon transfer of the 24 foreign currency options from Sala to Solid and then to Deerhurst GP, Solid's basis in Deerhurst GP was increased by the value of the long options, $60,987,866.79, but was not offset by the $60,259,568.94 cost of the short options. Accordingly, Solid's claimed basis in Deerhurst GP was approximately $69 million--the value of the cash plus the long options. Upon liquidation of Deerhurst GP, Solid received a portion of Deerhurst GP's liquidated assets equal to the proportionate size of Solid's basis. Solid claimed to have received approximately $8 million in cash and two foreign currency contracts. Under the Tax Code, the foreign currency contracts were considered to be "property" at transfer. The value of the foreign exchange contracts distributed to Solid, therefore, was claimed to be approximately $61 million--$69 million (Solid's original basis in Deerhurst GP) less the $8 million in cash. When Solid sold the foreign currency contracts, its loss was equal to the $61 million dollar value of the contracts, offset by any profit received from their sale. According to Solid's 2000 tax return, the combined loss on the foreign currency contracts was approximately $60,250,065.94. When combined with Solid's other expenses and losses, Solid's 2000 loss was reported as $60,449,984. On or before April 15, 2001, Sala filed a personal federal income tax return for the 2000 year ("2000 return"). The 2000 return reported wages of $51,748,681; taxable interest income of $1,837,561; dividend income of $410,300; taxable refunds, credits, or offsets of state and local income taxes of $7,846; a capital gain of $6,472,000; and other income of ($23). The 2000 return reported on line 17 (rental real estate, royalties, partnerships, S corporations, trusts, etc.) the $60,449,984 loss attributed to a non-passive loss from Solid Currencies. The 2000 return reported adjusted gross income of $26,381. Sala reported owing no federal taxes. -4-

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In November 2003, Sala filed a form 1040X amending his 2000 return. The amended return reported the same income amounts as the original return, but did not report the $60,449,984 loss previously attributed to Solid Currencies. Sala paid the resulting approximately $26 million in taxes, interest, and penalties. On or about June 18, 2004, the IRS issued a Notice of Deficiency to Sala, asserting he owed additional taxes in the amount of $22,204 due to the disallowance of $56,071 of losses Sala reported as attributable to Solid Currencies. The Notice of Deficiency also asserted an accuracy-related penalty in the amount of $4,400.80 for tax year 2000. In September 2004, Sala filed another form 1040X for the 2000 tax year reclaiming the loss attributable to Solid Currencies and claiming a refund due of $23,727,630. In the Amended Pretrial Order [Docket # 195], the parties stipulated to the following additional relevant facts. In late 1999, Sala was introduced to KPMG partner Tracie Henderson through Sala's friend Tim Gillis--also a KPMG partner. KPMG prepared Sala's federal and state tax returns for the years 2000, 2001, 2002, and 2003. Prior to 2000, Sala's tax returns were prepared by PricewaterhouseCoopers. On August 13, 2000, IRS Notice 2000-44 was released electronically; on September 18, 2000, it was published. On or about April 15, 2001, Sala paid R. J. Ruble $75,000 for a tax opinion letter involving the tax benefits of the Deerhurst Program. II. ISSUES PRESENTED AT TRIAL Five distinct issues were presented at trial: (1) whether the transactions creating Sala's 2000 tax loss constituted sham transactions; (2) whether Sala entered into the transactions -5-

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creating his 2000 tax loss for profit; (3) whether the transactions creating Sala's 2000 tax loss, as executed, allowed the tax loss; (4) whether any allowable tax loss was rendered retroactively disallowed by 26 C.F.R. § 1.752-6; and (5) whether the Government is entitled to an offset of any excess interest payments made by Sala with an accuracy-related penalty. The second issue is an issue of fact. See Hildebrand v. Comm'r of Internal Revenue, 28 F.3d 1024, 1026 (10th Cir. 1994). The fourth issue is a question of law. The remaining issues are mixed questions of law and fact. Before addressing these issues, however, it is necessary to define the appropriate burden of proof in this case and define the scope of the loss-generating transaction. III. BURDEN OF PROOF The allocation of burdens as to each specific factual issue will be addressed where appropriate throughout this order. I therefore lay out only the general framework here. Under 26 U.S.C. § 7491, when a taxpayer produces credible evidence with respect to any factual issue relevant to ascertaining the taxpayer's liability, the Government has the burden of proof with respect to such factual issue so long as (1) the taxpayer has complied with the requirements of the Tax Code to substantiate any item, and (2) the taxpayer has maintained all records required and has cooperated with reasonable requests for witnesses, documents, meetings, and interviews. It cannot genuinely be disputed that Sala has complied with the requirements of the Tax Code to substantiate each of his factual claims and that Sala has maintained all records required and has cooperated with reasonable requests for witnesses, documents, meetings, and interviews. Sala has provided the Government with thousands of pages of records, including written -6-

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explanations and other supporting information substantiating his factual claims. Moreover, Sala consented to extending the period in which the IRS could assess an additional tax deficiency for the 2000 tax year. Sala's cooperation with the IRS was clearly sufficient to meet the requirements under § 7491. Accordingly, the Government has the burden of proof as to each issue of fact so long as Sala supports his factual account with credible evidence. For the purposes of § 7491, "credible evidence . . . is the quality of evidence which, after critical analysis, the court would find sufficient upon which to base a decision on the issue if no contrary evidence were submitted (without regard to the judicial presumption of IRS correctness)." Griffin v. Comm'r of Internal Revenue, 315 F.3d 1017, 1021 (8th Cir. 2003). When considering penalties, however, the burden of production is on the Government to make a prima facie case that penalties should apply. If the Government meets this burden, the burden then shifts to Sala to show his underpayment was not the result of negligence and that he did what a reasonably prudent person would have done under the circumstances. Sparkman v. Comm'r of Internal Revenue, 509 F.3d 1149, 1161 (9th Cir. 2007); Van Scoten v. Comm'r of Internal Revenue, 439 F.3d 1243, 1258 (10th Cir. 2006). The determination of whether a taxpayer meets his burden of proving due care is a factual one. Mortensen v. Comm'r of Internal Revenue, 440 F.3d 375, 385 (6th Cir. 2006). IV. SCOPE OF THE LOSS-GENERATING TRANSACTION Before analyzing whether Sala was entitled to the loss allegedly generated by the Deerhurst Program, it is necessary to define the scope of the "transaction" that caused the loss. I must look beyond the form of the Deerhurst Program to determine whether the portion of the program that created the loss is bona fide. See Rogers v. United States, 281 F.3d 1108, 1114­17 -7-

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(10th Cir. 2002). I examine Sala's involvement in the Deerhurst Program as a whole, considering each step, to determine if the substance of the transaction is consistent with its form. ACM P'ship v. Comm'r of Internal Revenue, 157 F.3d 231, 246­48 (3d Cir. 1998). The "transaction" to be analyzed is the transaction that gave rise to the particular tax benefit, not collateral transactions which do not produce the tax benefits. See James v. Comm'r of Internal Revenue, 899 F.2d 905, 910 (10th Cir. 1990). So long as the transaction that creates the tax benefit is bona fide, any tax benefit achieved will be presumed legitimate. See Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1356­57 (Fed. Cir. 2006) (discussing cases). The threshold issue, therefore, is whether (a) the "transaction" includes only the portions of the Deerhurst Program occurring in 2000--that is, Sala's purchase of the 24 foreign currency option contracts and the subsequent transfers from Sala to Solid Currencies and from Solid Currencies to Deerhurst GP, the subsequent sale of the contracts, and the return to Solid of a reported $8 million in cash and two foreign currency contracts--or (b) whether the "transaction" also includes the reinvestment of the Deerhurst GP liquidation proceeds into Deerhurst LLC and the trading occurring from 2001 onward. For the reasons stated below, I find and conclude that--for purpose of determining whether the loss-generating transaction was bona fide--both the Deerhurst GP portion of the Deerhurst Program and the Deerhurst LLC portion of the Deerhurst Program must be considered together as a single transaction. A. Findings of fact The subjective intent of the parties to a loss-generating transaction is a significant factor when determining whether the transaction was bona fide. See, e.g., Klamath Strategic Inv. Fund, LLC v. United States, 472 F. Supp. 2d 885, 896­98 (E.D. Tex. 2007). Sala testified at trial that -8-

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his participation in the Deerhurst Program was undertaken in accordance with a five year plan. Under the plan, potential Deerhurst investors were required to place a minimum of $500,000 into a Refco account, to be traded on each individual's behalf by Krieger through Deerhurst. Investors were free to withdraw their funds without penalty at any time during this initial test period. If investors desired to continue investing in Deerhurst, they were required to deposit additional funds--which combined were to equal at least 15% of their expected tax loss--into a Deerhurst GP account. This second round of investment was to remain under Deerhurst management through 2000. If the Deerhurst GP account was profitable after liquidation in late 2000, investors were required to reinvest their liquidation proceeds in Deerhurst LLC for a minimum of five years, or face a significant early-withdrawal penalty. Sala's testimony--which was not contradicted by any Government evidence--was both credible and well-supported by documentary evidence and the deposition testimony of Mich