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UNITED STATES COURT OF FEDERAL CLAIMS

MARRIOTT INTERNATIONAL RESORTS LIMITED PARTNERSHIP, AND MARRIOTT INTERNATIONAL JBS CORPORATION, Plaintiffs, v. UNITED STATES, Defendant.

) ) ) ) ) ) ) ) ) ) ) ) ) ) )

Docket Nos.:

01-256T 01-257T (Consolidated)

Pages: Place: Date:

1 through 93 Washington, D.C. May 19, 2008

HERITAGE REPORTING CORPORATION Official Reporters 1220 L Street, N.W., Suite 600 Washington, D.C. 20005-4018 (202) 628-4888 [email protected]

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1 IN THE UNITED STATES COURT ) ) ) ) ) ) ) ) ) ) ) ) ) ) ) OF FEDERAL CLAIMS

MARRIOTT INTERNATIONAL RESORTS LIMITED PARTNERSHIP, AND MARRIOTT INTERNATIONAL JBS CORPORATION, Plaintiffs, v. UNITED STATES, Defendant.

Docket Nos.:

01-256T 01-257T (Consolidated)

Courtroom 7 National Courts Building 717 Madison Place NW Washington, D.C. Monday, May 19, 2008 The parties met, pursuant to the notice of the Court, at 9:59 a.m. BEFORE: HONORABLE CHARLES F. LETTOW Judge

APPEARANCES: For the Plaintiff: HAROLD J. HELTZER, Esquire ROBERT L. WILLMORE, Esquire HOWARD M. WEINMAN, Esquire Crowell Moring 1001 Pennsylvania Avenue, N.W. Washington, D.C. 20004-2595 (202) 624-2565 / 624-2915 / 624-2725

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2 APPEARANCES: (Cont'd)

For the Defendant: G. ROBSON STEWART, Esquire THOMAS J. SAWYER, Esquire U.S. Department of Justice Tax Division P.O. Box 26, Ben Franklin Station Washington, D.C. 20044 (202) 307-6493 / 514-8129

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3 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 States. THE COURT: Welcome, Mr. Stewart. We have THE CLERK: All rise. P R O C E E D I N G S (9:59 a.m.) The United States

Court of Federal Claims is now in session, the Honorable Charles F. Lettow presiding. THE COURT: Please be seated. I apologize

for being a minute early.

The case before the Court

this morning is Marriott International Resorts Limited Partnership and Marriott International JBS Corporation v. The United States, Nos. 01-256T and 01-257T. Mr. Heltzer, will you introduce yourself and your colleagues, please? MR. HELTZER: Your Honor, I'm Harold

Heltzer, Crowell & Moring, representing the Plaintiffs, and we have on my right, Robert Willmore, Crowell & Moring, and Howard Weinman. THE COURT: MR. HELTZER: the argument. THE COURT: MR. STEWART: THE COURT: MR. STEWART: All right, thank you. Good morning, Your Honor. Good morning. Rob Stewart for the United Welcome. Mr. Willmore will be making

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4 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the interesting situation of cross-motions. It has

taken awhile to get this case to this point, but we're there. The first motion by the parties' agreement

some time ago under the schedule we had adopted for submission of cross-motions was and is the government's. Accordingly, I would propose that the

government begin first with its argument and then, Mr. Willmore, if you would respond. The Could would also

propose to give each of you brief time to reply. Now we don't have a time limit. But on the

other hand, the Court has in hand the documents, and especially has, I call it, the charts that describe the transaction, as well as the statements of uncontested fact. Mr. Stewart, if you would proceed. Certainly, Your Honor -- good

MR. STEWART:

morning, and may it please the Court, at issue in this summary judgment proceeding is the application of the Subchapter K partnership basis provisions of the Internal Revenue Code. Specifically, the discreet legal issue here is whether a short sale obligation incurred by an American controlled entity was a liability for the purposes of partnership basis calculations under Section 752 of the Code. This issue arises because Marriott used a Heritage Reporting Corporation (202) 628-4888

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5 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 short sale of Treasury notes and a pre-arranged series of partnership transactions to create an enormous artificial tax loss of $71 million, with only a minor meaning corresponding economic loss. THE COURT: Let's sort through the fact that

these were Treasury notes rather than, for example, Treasury bills. notes? MR. STEWART: Your Honor. I believe it was five years, What was the term of the Treasury

According to the Department of Treasury

reps, that constitutes a Treasury note. THE COURT: Right, anything over a year and

less than the term of a bond -- so I understand the distinction. That's what I'm trying to sort out. Sure. Go ahead. I was just going to say, I

MR. STEWART: THE COURT: MR. STEWART:

don't think the term of the Treasury note makes any difference in this case, that I'm aware of. THE COURT: MR. STEWART: THE COURT: related to that. It might to the Court. Okay, very well. Let me ask a set of questions

Because to the Court's eye, a short

term Treasury bill -- let's say, a three month bill -is almost like cash. Heritage Reporting Corporation (202) 628-4888

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6 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 There is an interest rate uncertainty associated with it. short period of time. But it's only for a relatively So it's virtual cash. That's In

why I was interested in the term of the notes. your eye, does it make any difference? MR. STEWART: I don't think in this

particular part of the proceeding for the 752 issue that it does. THE COURT: So you think a short sale of

even a six month bill would raise the same legal issues? MR. STEWART: Yes, yes -- while the facts of

this case may seem complex, the ultimate facts necessary to resolve the 752 issue are relatively straight forward. In a nutshell, the facts are that a

Marriott subsidiary entered into two short sales of the Treasury notes, for them to receive cash and incur the obligation to return the borrowed Treasury notes that were used to generate the short sale proceeds. That subsidiary then formed another partnership with another Marriott-controlled entity, and contributed the short sale proceeds, some other assets, timeshare mortgages notes, to that partnership, and the partnership assumed the obligation to return the borrowed Treasury notes to Heritage Reporting Corporation (202) 628-4888

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7 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the broker. THE COURT: Let's stop right there. In

parts of the government's moving papers, there is a suggestion that there was not a business purpose to this set of transactions; only a suggestion. I take

it, you are not actually making the claim that these were entirely tax motivated transactions without a business purpose. MR. STEWART: In this 752 proceeding, we're

not asserting the lack of business purpose at this point. That's wrapped up in the issues of economic

self-sensitive transactions, that would require factual findings after a trial. THE COURT: this case at all? MR. STEWART: Well, yes, I mean, the basis But do you make the claim in

of one of the adjustments in the FPA was a lack of business purpose for parts of this transaction. THE COURT: But you have the situation where

Marriott was ostensibly hedging its interest rate risk on the mortgages or whatever they were, securing the sale of the timeshares. What do you do with that? Is

it proper to hedge a transaction like that? MR. STEWART: At this point, for the

purposes of this motion, we're assuming that the Heritage Reporting Corporation (202) 628-4888

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8 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 right. issue. business purpose of hedging the mortgage notes was a valid business purpose at this point. THE COURT: Still, do you think in the case,

depending on the outcome of this motion -- let's say the motions are denied and we go to trial in due course. MR. STEWART: THE COURT: Right. Do you think that would be an

open issue, that we'd have to retried? MR. STEWART: Well, it's a complicated

I don't think the government disputes that

Marriott had the intent to somehow hedge its interest rate risk on holding the mortgage notes. is the manner in which it was done. What we find lax business purpose is the short sale itself, if it works out to be a hedge this time, MORI, which is Marriott Ownership Resorts International, that held the mortgage notes during that time period, wanted to purportedly hedge their interest rate risk, entering in the short sale may have been one valid way of doing that. THE COURT: doing that. MR. STEWART: It's one way of doing that, Well, it's the usual way of Our dispute

To hedge those interest rate risks, it didn't Heritage Reporting Corporation (202) 628-4888

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9 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 require contributing the short sale proceeds to a partnership. THE COURT: That's true. You could have

held the proceeds from the short sale, and the mortgage notes or whatever they were. MR. STEWART: And it's that fact that we That was something

claim lacks the business purpose.

that wasn't necessarily to the purpose of hedging interest rate risk. I think the Jade Trading case had

a good quote about that. THE COURT: I understand that part. But I'm

sorry, I interrupted you in mid-flow on a very complicated transaction. You were about to say that

the obligation to close the short sale and some assets were transferred to a partnership. MR. STEWART: Right. The partnership,

Marriott International Resorts I think is the full name of the corporation. We've been referring to it But anyway, I thought

as MIR I think in the papers.

the Court was actually going to ask another question about the assumption of the liabilities. THE COURT: MR. STEWART: anticipate. I'm about to get there. Okay, that's fine; I won't

But anyway, going on from there, I'll

just finish summing up my short factual summary. Heritage Reporting Corporation (202) 628-4888

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10 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 In calculating its basis, MORI calculated its basis and the contribution to MIR, took into account the value of the mortgage notes that were contributed to the partnership and the short sale proceeds; but it did not account for the obligation to close the short sales. THE COURT: All right, now we have the

distinction between inside and outside basis arising, and that's what you were anticipating in a sense. MR. STEWART: Well, to some extent -- now I

thought the Court's question was going to whether there was a valid assumption by the partnership of the obligation to close. Again, for our purposes here,

we're assuming that it was done. THE COURT: question about that? MR. STEWART: factual question. Well, yes, I think there's a That's right. Is there a

If we get to a trial of this case,

one can still point to some of the economic substance transaction doctrines. Some of the paperwork that we submitted in briefing seemed to indicate that MORI was obligated to close the short sales; or actually did close the short sales; not MIR. THE COURT: I missed that; I will have to

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11 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 tell you. MR. STEWART: If you looked at the trading

confirmation statements that we submitted, they still list MORI as the plight for the trades. THE COURT: Well, that's probably because

the account had been opened in MORI's name, and it never shifted. I don't know. I mean, that would be a

MR. STEWART: question that -THE COURT:

Who is legally obliged to do it

might be another issue. MR. STEWART: can provide more facts. Right, right -- but anyway, I I was prepared to go more

detailed into the facts if the Court would like. THE COURT: what happened. Well, let's just sort through

Let's assume the obligation was The obligation to close the

actually transferred.

short sale was transferred. Let's also assume that the assets were transferred, and there is a valuation added to them. What do you think happened to the basis, inside and outside, at that point? MR. STEWART: Well, the government's

position is that the basis should have been adjusted to include the obligation to close the short sales, Heritage Reporting Corporation (202) 628-4888

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12 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 bidding. steps. of did. THE COURT: It's just they took a couple of which is valued based on the proceeds; that generally, the short sale, was at the time they were contributed to the partnership. So MORI took its basis based on the fair market value of the mortgage notes, and then added the short sale proceeds, which were approximately $63 million at that point, the first short sale. Again,

later on, they executed another short sale, and received about another $8 million. THE COURT: Yes, but these are basically

short sales that, in a sense, matched the mortgage notes. MR. STEWART: I think eventually they sort

Can we ignore, as far as the government's

purposes are concerned, the fact that there were two rather than just one; or does it make a difference? MR. STEWART: Well, no, I think we can just It's the same

consider them as one transaction.

effect, because they did the same thing in calculating the basis, by leaving out the obligations in calculating the basis. THE COURT: All right, just now review the

From what you just said, this occurred in, I Heritage Reporting Corporation (202) 628-4888

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13 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 always forget, 1994, right? MR. STEWART: THE COURT: Right. Or these steps occurred in 1994.

At that point, you would say, MORI had a basis based on the assets contributed. MR. STEWART: THE COURT: partnership. This is an outside basis.

Right. Assets contributed to the

But it actually had a reduction in its

basis because it contributed also to the short sale obligation. That is a liability. Correct. So you know, whatever the That's what you

MR. STEWART: THE COURT:

meaning was, was its outside basis. said. MR. STEWART: THE COURT: Right.

The inside basis in the At that point, the Is

partnership was the same netting.

inside basis and the outside basis were the same. that right? MR. STEWART: Right, well, not quite,

because there was another partner involved in the case. THE COURT: MR. STEWART: Oh, that's right. JBS had one percent. So I

think we've sort of been assuming, because MORI owned Heritage Reporting Corporation (202) 628-4888

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14 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 99 percent that the amounts basically net out. You

know, there would be a slight difference, because any interest partnership, the partnership interest differed. Because MORI would actually only be liable for the 99 percent of its share of the obligation assumed by the partnership. difference. THE COURT: MR. STEWART: Right. For our purposes, essentially, So there is a slight

it's a netted transaction here. I had prepared a little sort of cheat sheet that has some of the dates and transactions, if the Court would like. I have copies here. Thank you, that's the one thing

THE COURT:

that's missing from the materials that were filed in 2006. But they're in the other papers. MR. STEWART: Well, I realize that the But it took several

charts we did, they were helpful. pages to get through them. THE COURT: MR. STEWART:

Well, it's just steps. Right, anyway, as we've talked

about here, the main partnership provisions at issue here are 722 and 752. As we've discussed, 722 is the

provision that accounts for the basis on the Heritage Reporting Corporation (202) 628-4888

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15 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 contribution to a partnership by partner, and 752 accounts for any liabilities that are either contributed to a partnership or assumed by a partner with respect to the partnership. The definition of liability is not provided in Section 752. That's part of the problem here.

Because we are confronted with an issue of whether these short sale obligations are liabilities for purposes of 752. There are several other authorities which give guidance on the question of what constitutes a liability for 752. In 1984, Congress enacted a rule

with respect to the treatment of liabilities and a corporate assumption of why those, in Section 357(c)(3)(b). In that section, it talked about obligations constitute liabilities when they create or increases basis in property. Therefore, they are treated as

liabilities for the purposes of that section and the corporate section. THE COURT: The Court has learned, if it

didn't know before, that the Tax Code is very precise, specifying different entities to which given sections apply; sometimes partnerships, sometimes individuals, sometimes special purpose entities, Subchapter S, and Heritage Reporting Corporation (202) 628-4888

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16 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 so on and so forth. corporations. MR. STEWART: That's true, Your Honor. But it gives a That This appears to apply only to

provision does apply though.

groundwork for getting to a definition of liability for 752 purposes. Clearly, it doesn't control. So are the entities, because The tax flows through

Partnership is a hybrid.

they're not taxed individually. to the partners.

Another relevant authority that helps define the liability under Section 752 is the rule in 8878. It echoes the same definition of liability as something that creates or increases basis in property. That Revenue Ruling, which was promulgated in 1988, dealt specifically with partnerships. So the concept of a liability being something that creates or increases basis in property for partnership purposes was established or clarified many years before the transactions that took place here. Then we have Revenue Ruling 9526. THE COURT: At some point, you're going to

talk about precedence having to do with contingencies. You haven't used the word contingencies really yet. MR. STEWART: No, that's true, Your Honor.

Well, the most recent precedent on that is the Kornman Heritage Reporting Corporation (202) 628-4888

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17 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 decision out of the Fifth Circuit. THE COURT: progression. Well, let's go to your It's just

You were about to get to 95.

you'd skipped over a couple. MR. STEWART: Okay, well, 9526 deals

specifically with the short sale situation, and reaches the conclusion that's consistent with 8877 and 357(3)(b), that an obligation is considered a liability when it creates or increases basis in property. I think some of the cases you are referring to are hallmarks for the Tax Court decision of Helmer, LaRue, and Long, that concerned contingent liabilities. It's certainly true that those cases

held that if a liability or an obligation is contingent, then it wouldn't be constituted a liability for Section 752. Those cases are distinguishable from the facts here. The Fifth Circuit in Kornman examined

those cases, and also the Tax Court in Salina examined those cases and found that they weren't comparable to a short sale obligation here. Helmer, for example involved options. They

sold options for purchase of some property, received the payments on those options. Those payments were

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18 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Helmer. MR. STEWART: THE COURT: Sure. On the facts of Helmer, let's In light of the unrestricted. They had no obligation to make any

repayment of those auction payments, and they weren't used to increase any basis in the partnership. So

they were found not to constitute liabilities for 752. THE COURT: Let me ask a question about

say the same facts arise today.

regulations and 752, what would be the result in Helmer? MR. STEWART: would be different. THE COURT: Explain how and why; how would The result in Helmer today

it be different and why would it be different. MR. STEWART: The IRS issued regulations --

I think it was in 2003 -- that changed the definition or included contingent liabilities such as the ones in Helmer, as obligations under Section 752. That We're

regulation is not controlling for our purposes. dealing with a different type of obligation. THE COURT: Well, I understand that.

But

you're saying basically that raises the perspective of any retroactivity questions, if the Court recalls correctly, that Klamath addressed. Heritage Reporting Corporation (202) 628-4888

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19 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 opposite. Heritage Reporting Corporation (202) 628-4888 MR. STEWART: Right, and I think Plaintiff Because 7805 concerns the

was in a different posture.

retroactivity of regulations and rulings was changed in July of 1996. Before that date, revenue rulings

and regulations were presumed to be retroactive, unless the IRS specifically said that they would not have retroactive effect. That changed in 1996. So we're really

talking about two different situations with respect to anything after 1996. THE COURT: specifically? MR. STEWART: of liabilities? THE COURT: MR. STEWART: changed after 1996. specifically -THE COURT: It was prospective unless it was Retroactivity. That was in 7805(b). It was With respect to the question After 1995, what was the change,

The regulation had to be

specifically retroactive. MR. STEWART: THE COURT: Right. And you had to explain why it

would be retroactive, rather than the opposite. MR. STEWART: Right, so it was the mere

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20 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 THE COURT: That's right, and that was the Is that

situation that was addressed in Klamath. correct? MR. STEWART: THE COURT: Correct.

All right, you're saying now, if

Helmer arose, under the regulations under 752 that were adopted whenever it was, 2003 -MR. STEWART: THE COURT: Right. -- that option arrangement would

give rise to a recognized liability for purposes of basis. MR. STEWART: Yes, and I think the

regulation specifically states it's changing the result under Helmer. THE COURT: Okay, this is just wonderful. Well, in

We have different elements of contingency.

Helmer, you had the contingency, whether or not the option would be exercised at all. There were a whole set of circumstances in which you could imagine that the option would not be exercised. One party just bought the option, and it But at a

had some value at the time it was purchased. given point, it would disappear.

You're saying, okay, that result still requires a recognition, both of the liability in terms Heritage Reporting Corporation (202) 628-4888

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21 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of the inside and outside basis aspects of the thing, right? MR. STEWART: THE COURT: MR. STEWART: we're talking about. THE COURT: Just to cut through all this, Under the regulation. That's right. Right, yes. Not at the time

you're saying that the contingency aspect of this thing, which arose well before the regulations and a year before the Revenue Ruling, 95-26, the contingency here was really just an interest rate contingency. Because they were, after all, Treasury security notes. MR. STEWART: THE COURT: Right. And the interest rate

contingency was not enough to lead to non-recognition under the prior precedence for 752. just encapsulate this thing. MR. STEWART: more to it than that. Well, there's a little bit Unlike Helmer, with the short I'm trying to

sale, there is a binding secured legal obligation to return the borrowed treasurers. THE COURT: interest rate risk. MR. STEWART: THE COURT: For the value. That's right. That's what I say, it's just an

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22 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 value. THE COURT: MR. STEWART: That's all there is. Right, and in this case also, MR. STEWART: You're talking about the

the proceeds from the short sale were used to increase the basis in the partnership, whereas, in Helmer, that had occurred. THE COURT: difference? MR. STEWART: Well, because that's how a Why would that make a

partnership basis can be manipulated improperly. Because if something is used to increase partnership basis that constitutes a liability, it's as if -THE COURT: I understand that part in terms I'm just

of the tax effect of the transaction.

looking at the contingency aspect of recognition going on and why would that make that fact, that is, the proceeds from the sale, short sale, make a difference? MR. STEWART: contingency aspect. THE COURT: MR. STEWART: were asking. Yes. I misunderstood then what you Not with respect to the

But yes, contingency is a sliding scale.

I mean, as the Salina Court mentioned, there's a general proposition that contingent propositions are Heritage Reporting Corporation (202) 628-4888

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23 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the scale? MR. STEWART: Well, it requires an liabilities. rule. THE COURT: your regulation. MR. STEWART: Well, I don't think so. I Well, at least there was before But there's no hard and fast white line

mean, because our position here is that this isn't affected by the regulation. THE COURT: That's right. I'm just saying,

after the regulation, contingency doesn't care. MR. STEWART: THE COURT: understand each other. MR. STEWART: sliding scale. THE COURT: You're saying there is this Okay, so yes, there is a Right, right.

Okay, all right, I think we

scale; and you have to get to kind of a tipping point on the scale for recognition or non-recognition. MR. STEWART: THE COURT: Right. How do you tell where you are on

examination of each of the types of obligations involved. Here, this type of obligation, where you

have a binding either obligation to return the board securities is sufficient to put it on the tipping Heritage Reporting Corporation (202) 628-4888

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24 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 point to make it a liability, if not a contingent obligation. THE COURT: All right, you're saying because

the short sale -- or, in fact, regulatory requirements respecting a short sale required that it be closed at some point, and indeed in this point. You say there are five year notes. We don't

know when the term of the five year notes these transactions arose. But at least it was a little

bracket -- it was not a little, but a medium term bracket of time in which the short sale had to be closed. MR. STEWART: THE COURT: MR. STEWART: THE COURT: Correct. It wasn't indefinite. Correct. It was definite by the

definition of the securities that were sold in the short sale. MR. STEWART: THE COURT: Right. That makes a difference, you're

saying, to Helmer, because there the option could never be exercised. MR. STEWART: Right. There was no repayment

obligation on those option payments. THE COURT: That's not repaid, okay.

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25 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 isn't it? MR. STEWART: They were seen free and clear, Here you had the

and I think that's the difference. obligation to return.

The Board of Treasuries would

never be extinguished until it was extinguished. THE COURT: What in the prior precedence --

that is, before 1995 -- indicated that there was this sliding scale, and you could have some contingencies but not others; and if you got to a given point, you had to recognize for basis purposes a contingent obligation? MR. STEWART: In many cases, it dealt with

different types of liabilities, of debts, what constitutes a debt. Particularly, some taxpayers were

trying to structure debt obligations that really weren't bona fide debt and things like that. THE COURT: Well, that's a little different,

Because you're saying those basically were They were shams,

not effective transactions. basically. MR. STEWART:

Well, but there were cases

where whether the liability was contingent or not had to be determined. This wasn't a unique situation with I

respect to whether option payments were contingent. mean, there were a lot of different types of transactions where this question arose. Heritage Reporting Corporation (202) 628-4888

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26 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Specifically here though, since we're dealing with a short sale that has some similarity to auction type transactions, I think that's why the Plaintiffs have focused on those particular tax cases. THE COURT: Well, it's been a little bit

since the Court has looked at Revenue Ruling 9526. There doesn't appear to be anything in Revenue Ruling 9526 that goes into the kind of analysis that you've described today. MR. STEWART: No, not with respect to the

contingency aspect of the transaction. THE COURT: MR. STEWART: Right. It focuses more on the aspect

that deals with whether an obligation gets lodged in an increase, a creation of basis in property. I think

that's where the ruling hangs its hat, so to speak, based on where the Rule 8877, which made that clear; and also Section 357, which had also dealt with the same issue. So you're right, there are two problems: the contingency aspect and the basis creation aspect. But distinguishing Helmer and the rule in Long involves both of those aspects. Because in those

other cases, the obligations hadn't been used to increase partnership basis. Heritage Reporting Corporation (202) 628-4888

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27 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 So the general principle of equalizing inside and outside basis, well, it would have been violated if those obligations had been considered. THE COURT: In fact, Marriott argues that it

was the government, prior to the revenue sharing, that had sought a difference in inside and outside basis for its own tax purposes. MR. STEWART: Well, no, in Helmer, there

would have been a list match, because the options weren't taken into basis calculations at the time. I think Long was the same way. They were

deferred and the income from them, and LaRue was the same thing. There was an initial basis increase, So there was no call for

based on those obligations. liability to offset that. THE COURT:

Yes, and that's one of the

reasons the Court asked you about what the result in Helmer would be today, because if you take a look at those, it really is a deferral. Because I take it, at

some point, based on the facts of those prior cases, there would be a recognition; either when the option expired or was exercised, right? MR. STEWART: THE COURT: MR. STEWART: The deferral of the income -That's right. -- well, in some of the cases

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28 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Helmer. THE COURT: That's right. So the income it was provided for by statute; but, yes. THE COURT: MR. STEWART: THE COURT: Say it wasn't. Right. When you say right, are you

agreeing with me that it, in effect, was a deferral situation; when the contingency was removed, then you had a recognition situation? MR. STEWART: For the payments, right, in

would have been, one way or another, offset against the obligation; either that it had expired or exercised. MR. STEWART: Well, the obligation in Helmer

was for the eventual sale of the property. THE COURT: MR. STEWART: Right. So if the property had never

been sold, the options would expire. THE COURT: That's right. But at that

point, I guess what I'm asking you is whether the income would have been recognized at that point. You'd recognize that as income. MR. STEWART: THE COURT: Right. Otherwise, it would have been I don't know. I don't

offset against, I take it.

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29 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 remember the details of the transaction. It would

have been offset against the purchase price of the property or not? I don't know. Well, that's what was called

MR. STEWART:

for in the contract; that if the option was exercised, then the payments that had been made would be given credit to them. THE COURT: I'm asking you about the Would have

recognition situation before or pre-1995. happened? MR. STEWART:

Well, the income would have

been recognized at the time that the payments were made. I can't remember specifically. I remember in

Helmer -- I think I may be confusing it with Long. Long used a completed contract method of accounting, and that allowed them to defer the income. THE COURT: Maybe I'm confused. Right, that's what I'm thinking. That's what I'm thinking. Right, yes, Helmer, at the But Long is the case where

MR. STEWART: time, it received them.

they received the deferred payments under the completed contract method. you're talking about. So under that method of counting, they were allowed to defer the income until the contract was Heritage Reporting Corporation (202) 628-4888 I think that may be what

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30 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 completed. Now that's a specific statutory provision

that allows them to account for a contract completion in that manner. So that's a separate question from

what we're talking about here. THE COURT: Well, I have a few questions

about that, and we'll come to them in due course. MR. STEWART: Sure, I think maybe if the

Court is alluding to Section 1233 in the open transaction doctrine with respect to the short sales, the income from the short sales wouldn't be recognized until the short sale was ultimately closed. But that concept is answered or the question of when the basis has to be calculated for partnership basis purposes is 722. Because that specifies that

the partnership basis has to be calculated at the time of the contribution of the asset to the partnership. As the Tax Court in Salina said, 752 and 1233 just have no interaction. One, 1233 is used for

calculating income amounts and 752 is partnership basis. So there's just no overlap there between them.

It would be the same as if a partners contributed stock to a partnership. THE COURT: That goes back to your first

question, that there was really no need for MORI to set up the partnership or MORI and JBS to set up the Heritage Reporting Corporation (202) 628-4888

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31 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 partnership. If MORI had simply held the timeshare

mortgage -- if they were mortgages or whatever they were -- secured notes and held the short sale obligation, then the recognition under 1233 would have come at the time. The recognition of any gain or loss

on the hedge, as a hedge, would have been recognized at the time the thing closed. MR. STEWART: THE COURT: MR. STEWART: Correct, right. Nobody disagrees with that. I don't think so, no. If MORI

held the short sale and then eventually closed it out when it did, it would have just recognized the gain or income at that time. It was only because they went

through the partnership transactions that creates this question at all. So that's why we have the difference

between the partnership basis. THE COURT: Well, let me cut through all

this and say, let me look at your sheet, because at some point, MIR disappears and you go to new MIR. I

am trying to get this square in my mind as to dates. But by that time -- well, I'm trying to get the fact that the first short sale closed, you say on your sheet, September 29, 1994. closed October 17, 1994. The second short sale That appears to be before

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32 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 been. Marriott International Capital Corporation. MR. STEWART: THE COURT: Yes. When the short sale closed -When the

let's say two, let's just talk them as one.

short sale obligation closed, why wasn't there a recognition event on the liability side, at least at that point? MR. STEWART: Well, there could well have

I mean, that's the -- the date of lost was But, the partnership basis

determined with that time.

was determined back in May 6th of 1994. THE COURT: When the assets were and

liabilities were contributed? MR. STEWART: THE COURT: Were contributed. There isn't any rule that says,

okay, it might have been sufficiently contingent under the old rules that we're not going to account in a basis step for the liability that was transferred, but the contingency could be removed at a given point and at that point, you have to recognize the liability? It's not a rule like that? MR. STEWART: THE COURT: outside basis. Not that I'm aware of. So, we have a disappearing

It just goes away. With respect to the short sale

MR. STEWART:

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33 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 rule. Heritage Reporting Corporation (202) 628-4888 proceeds? You mean -THE COURT: MR. STEWART: THE COURT: No. -- the actual asset? To the liability. If you don't

recognize it at the time the liability -- let's just talk about the liability side rather than the asset side. If you don't recognize it at the time it's

contributed and subsequently the contingency is removed, but let's just pass over the question whether the obligation to close the short sale was actual or not and say it was, there isn't a later step that says, okay, when the contingency is removed, then at least the contribution of the liability will be recognized for outside basis purposes? MR. STEWART: Not that I'm aware of. Under

722, it specifies that the basis calculation is made at the time the property is contributed to the partnership. THE COURT: a liability. But, this is not property. It's

So, it falls under 752. Well, but those things are The

MR. STEWART:

determined at the time of the contribution. proceeds were contributed at that time and -THE COURT:

Pardon me, but that's a nutty

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34 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 MR. STEWART: Well, the partnership basis

provisions are completely -THE COURT: MR. STEWART: To the point where that rule -I mean, the Court has a good

point, because the short sales weren't closed within the same taxable year. THE COURT: MR. STEWART: THE COURT: MR. STEWART: Yeah, they were. Presumably -I just don't understand it. It would make it much easier

for us here if that was the case and all of what would happen is that the basis would be adjusted to recognize what the actual trade transaction was. THE COURT: risk contingency. If there was an interest rate

But, it was removed during the

period we're talking about. MR. STEWART: Right. Then, basically, you You would have the

get a symmetrical accounting.

proceeds and then the offsetting loss or sale and that eliminates the liability and then you would be left with either a gain or loss of the trade, which -THE COURT: Which is the effect that 1233

otherwise would provide. MR. STEWART: Right. But, under that --

once it's contributed to the partnership, it becomes Heritage Reporting Corporation (202) 628-4888

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35 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the income to the partnership. So, it's accounted for There is a basis

in the partnership as its income.

adjustment to the partners, as a result of that fact, but it would just be based on the gain or loss of the sale. It would just be the same as any partnership

operation, if they were selling timeshares directly. Whatever they made on their timeshare sales as profit would be adjusted -- make a basis adjustment. THE COURT: That's part of what I don't

understand, because the inside basis to the partnership was reflected in the assets, but then you have this contingency rule, why don't you take that into account and then it's a pass through, if you see what I'm driving at. So, why don't you -- because the

short sale was closed before all of this wrapped up, I just -- it's a mystery to me how the liability just disappeared. MR. STEWART: Well, it would be much easier

in this case if we could do that. THE COURT: MR. STEWART: the contribution. You say you can't. Under 722, it's at the time of

So, the short sale was contributed

back in May of 1994 and that's when you make the basis calculation. That's when Mori's partnership interest So, it would certainly make life a

came into being.

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36 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 lot easier if we could make those adjustments within the year. But, it would just be as if Mori

contributed a long position stock and then the partnership may have sold it in the same year. Whatever the gain or loss to the partnership is -wouldn't directly effect the initial basis in the partnership. operations. THE COURT: That's the one thing about this I understand what you say There has It would have some effect based on the

I have never understood.

the timing is, but I just -- you know, why? to be a reason. MR. STEWART:

Well, I think because

partnerships are hybrid entities. THE COURT: MR. STEWART: THE COURT: corporation. MR. STEWART: Right. And the basis rules Well, it's a pass through. Right. It's like a Chapter S

are meant to try to equalize some treatment. Sometimes, it doesn't always work out that way. I

mean, it's not a hard and fast rule, that inside and outside basis always have to match, because they don't always. But, in this situation where we have such a

huge basis increase based on a purported asset, which Heritage Reporting Corporation (202) 628-4888

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37 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 were proceeds from an insurance sale, we're saying that you have to take that liability into recognition at that time, as opposed to waiting until the transaction closes. THE COURT: for your position. So, you really have two grounds

One is that you have the proceeds

from a short sale and the second is that you have this sliding scale on contingency; is that right? are the two grounds for your position? MR. STEWART: Yes. I mean, I don't know if I mean, Those

I want to characterize it as "sliding scale."

at some point, some things are contingent and some things aren't. So, we're only here to draw the line

with respect to one. THE COURT: MR. STEWART: I'm sorry? I said, we're only here to

draw the line with respect to this particular one. THE COURT: I understand that. But, I asked

you before what would happen if the proceeds from the short sale were not contributed. MR. STEWART: To the partnership? Then,

there would be no increase in Mori's basis in the partnership, any adjustment to -- it's only basis would be the value of the mortgage notes that it contributed and those are the assets that were Heritage Reporting Corporation (202) 628-4888

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38 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of it. MR. STEWART: By the very fact that they did It's sort of a basic here. MR. STEWART: There wouldn't be a mismatch ultimately sold -THE COURT: MR. STEWART: Right. -- which gave it a gain. So,

the other way to look at it is if you don't increase the basis by the short sale proceeds, then the problem goes away, too. THE COURT: But, the short sale occurred

obviously before the partnership was formed and the assets and the obligation to close the short sale were contributed. You didn't have to contribute the

proceeds from the short sale to the partnership. MR. STEWART: THE COURT: Right, that's true. And I'm trying to figure out why

that makes a difference in this, if you see what I'm driving at. MR. STEWART: THE COURT: Yes. There didn't have to be a match

if they hadn't contributed the short sale proceeds to the partnership. THE COURT: Right. I understand that aspect

is what creates the issue.

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39 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 accounting issue. liability. You've got the asset offsetting the

They're trying to sever the two and we're The asymmetrical treatment isn't

just adding up.

possible under the basis partnership rules, because you get this humongous distortion that creates a tax loss. And I think that's what Revenue rule 9526 is a The fact

recognition of those kinds of manipulations.

that it wasn't a longstanding Revenue rule is -really is a non-factor, because it was promulgated in response to these kinds of operations that were being used. And for the same reason the lack of notice and

comment of the Revenue rule, it was -- the IRS was trying to issue something quickly to make sure that these kinds of transactions were stopped. And, again, Revenue rulings don't create law or change law. They interpret existing law. So, when

you talk about retroactive effect of Revenue rules is somewhat of a misnomer. The predicate for Revenue

ruling 9526 was already established in 8877 for the transactions here and also 357-3(b). So, to that

extent, we believe that 9526 is entitled to substantial deference in the Court's consideration of the issue here. THE COURT: Well, this is kind of a peculiar

case, because you could have a short sale obligation Heritage Reporting Corporation (202) 628-4888

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40 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of IBM stock, a short sale and an obligation to close the short sale respecting IBM stock. It didn't have

to be a Treasury bill or, in this case, a Treasury note, which was near catch. this exercise. That's where we started

And I'm trying to figure out whether,

in your eyes, that makes a difference. MR. STEWART: You know, I think each

individual asset would and the type of transaction would need to be looked at individually. We thought

about that kind of a situation, if you're talking about a stock, as opposed to a Treasury note. But,

that would make a difference with respect to the contingent nature of the obligation. I really don't

think it will, because with the unique aspect of the short sale is that obligation to return the property exists until the short sale is done. THE COURT: You could have it respecting any

traded security basically -MR. STEWART: THE COURT: Correct. -- under the short sale rules.

That's what I'm driving at. MR. STEWART: Sure. And under regulation T

and exchange rules and brokerage rules, those proceeds aren't anything but free and clear as the amounts were in Calibar that were received by the taxpayer there. Heritage Reporting Corporation (202) 628-4888

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41 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Mori. MR. STEWART: Mori was the original -THE COURT: Which goes back to your question Oh, certainly. Sure. I mean, I mean, Marriott couldn't have withdrawn them and invested them outside of the company. THE COURT: But it could have kept them in

about whether or your point about whether there was an actual transfer, the aggregation to MIR. MR. STEWART: Well, that's a question we

don't have to address here, resolve here. THE COURT: MR. STEWART: Okay. So, I think at this point,

Your Honor, that's all I have. THE COURT: A wonderful case. Thank you,

very much, Mr. Stewart. sorts of questions.

Sorry to besiege you with all Mr. Willmore? I'd

That helped.

MR. WILLMORE:

Thank you, Your Honor.

like to address one issue of fact before the liability issue, which is the partnership. And I wasn't sure if

the government said the mortgages never needed to be - did not need to be transferred to the partnership. They had to be transferred to the partnership, because the way in which these mortgages were sold was through a securitization and there had to be a bankruptcy Heritage Reporting Corporation (202) 628-4888

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42 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 it did. MR. WILLMORE: obligation. Yes. MIR assumed the remote entity and that's what the partnership here was. MIR was a bankruptcy remote special corpus

entity and that permitted the securitization to take place. And so, the mortgages did have to be

transferred to the partnership and they were what was being hedged. And so the hedging vehicle, which was

the short sale, the obligation to close the short sale was also transferred -- well, it was actually acquired by MIR. THE COURT: You would -It was a business purpose.

MR. WILLMORE: THE COURT:

You would accept the fact that

the obligation to close the short sale actually was transferred from Mori to MRI. MR. WILLMORE: THE COURT: MIR.

In fact, you would assert that

MIR received the mortgages, it received

the proceeds from the short sale, and it assumed the obligation to close the short sale. THE COURT: But, let me ask what -- where we Mori did not have to It

finished with Mr. Stewart.

transfer to MIR the proceeds from the short sale. did not have to create the basis under 722. Heritage Reporting Corporation (202) 628-4888

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43 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 MR. WILLMORE: Your Honor, I think it was

economically very logical for Mori when it transferred the mortgages, which were being hedged, to transfer what was hedging -- the other part of the hedge, in other words. You had a hedge in place. The mortgages

were one part of the hedge. other part of the hedge. other.

The short sale was the

They were hedging each

And when Mori transferred the mortgages down,

it transferred the other part of the hedge down, too. THE COURT: Well, it didn't have to do that,

because the ­ if you're really just protecting yourself against interest rate risk, you had the asset in terms of the mortgage and you had the short sale obligation. You didn't -- and you essentially could

have kept the proceeds in Mori, essentially monetized -- I hate to use that kind of -- but monetized the mortgages from Mori's standpoint. MR. WILLMORE: I'm not sure from an

accounting standpoint, however, it worked, Your Honor, because you would have one part of the hedge and the other part of the hedge in another entity. would have the hedge -THE COURT: As I say, you would have Well, anyway -So, you

essentially monetized the mortgages. all right.

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44 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 of it. MR. WILLMORE: With respect to -- and I'm MR. WILLMORE: But, I just want to be clear,

the partnership had very clear business purposes, not just the hedge, itself, but the partnership had to exist. THE COURT: I understand the hedging aspect

addressing both our opposition and our cross-motion at this point, I assume, Your Honor. With respect to the

question before the Court, which is, is the obligation to close a short sale a liability within the meaning of Section 752 of the Code, I think what we would suggest is that the Court would have to put itself in the position of Marriott in 1994 asking itself that question. If I have an obligation to close a short

sale, is that or is that not a liability within the meaning of Section 752. And I think any objective

reasonable taxpayer asking itself that question in 1994 would have looked primarily at what the Tax Court had already articulated in accepting the IRS's position that a contingent obligation is not a liability within the meaning of Section 752. And it

would have looked -- any taxpayer would have looked at the three central cases, Helmer, Long, and LaRue. There was a lot of discussion of Helmer, but Heritage Reporting Corporation (202) 628-4888

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45 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 the case that's really closest on point is actually the last of these cases, the LaRue case, which is a 1988 decision. And it's the closest case on point,

because economically, what was at issue was very similar to a short sale. In LaRue, the brokerage had They had to The

made a number of back office errors. correct those errors.

The liability was clear.

court made that point repeatedly in the decision. Nobody was disputing the liability to correct those back office errors. But, the court nevertheless held

that it was not a liability in LaRue, because the cost of correcting those errors, purchasing the securities to correct those errors, could not be determined until the securities were actually purchased. THE COURT: That comes very close to the

question I asked Mr. Stewart about the difference between IBM stock, it could be any stock, any listed security, as contrasted to Treasury notes, would it, because -MR. WILLMORE: Your Honor. It don't think it matters,

I really don't think it matters, because

what we're dealing with here -- Your Honor mentioned interest rate risk. But, what we're really dealing

with is the balance -THE COURT: That's because it's a hedging

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46 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 transaction. I'm sorry. But what we're dealing with

MR. WILLMORE:

is the value of the security and in a short sale, as Your Honor knows, you borrow the security, you sell it, you hold it for a certain amount of time, it can be days, months, years, then you purchase the replacement securities, whether it's IBM stock or Treasury notes, and you deliver them back to the lender securities. And from an economic standpoint, I

don't think it matters. Now, there's a reason Treasury notes were used here, because of hedging. standpoint -THE COURT: risk rather than -MR. WILLMORE: THE COURT: speculation. necessarily. Speculation. Well, you wanted interest rate But from the

That's right -- well,

You didn't want business risk tacked on So, the Court understands that part. One of the other reasons that

MR. WILLMORE:

LaRue is really the case that's closest on point is because LaRue not only deals clearly with the situation where there is a -- where the contingency is contingency, an amount, and because the government in one of its -- I think it may have been its opening Heritage Reporting Corporation (202) 628-4888

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47 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 brief, maybe it was its reply brief, I can't remember, argued that these Tax Court cases were distinguishable as some of the later cases, because they really dealt with the fact of liability, not whether there was contingency as to the amount of liability, but the fact of liability. And LaRue is very clear that the And I believe it

issue is the amount of liability.

was Judge Gerber, I believe, in LaRue, who, as I indicated, said the fact of liability is established. The amount of liability is not established. And

interestingly enough, he goes back to Long and looks at Long and says in Long, it was both the fact of liability and the amount of liability that was at issue -- that was contingent, I should say. If you were a taxpayer in 1994, asking yourself, is the obligation to close a short sale a liability, you would look at these Tax Court decisions where the Tax Court ruled in favor of the government. It accepted the government's arguments that contingent obligations are not liabilities. LaRue was also

important in the sense that the court there created a conceptual framework for this holding and they said this is like the all events test. And, in fact, when

one looks at the holding, itself, that's in the syllabus to LaRue, it's phrased in terms of the all Heritage Reporting Corporation (202) 628-4888

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48 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 events test. THE COURT: Well, that comes very close to

what I think of now as the second ground for Mr. Stewart's position, that is the sliding scale on contingency. You're just going to have to tell me I'm one, that the

wrong, but I have two points here:

proceeds for the two things that he says make this obligation a liability recognizable under 752 are the fact that the proceeds from the short sale were contributed; and the second thing is this sort of sliding scale on contingency. And you're saying,

well, LaRue affects the second position. MR. WILLMORE: I think -- I'm not sure I see What I see is the all

the sliding scale, Your Honor. events test ­ THE COURT:

Well, did I mishear Mr. Steward? Oh, I mean, I'm not speaking

MR. WILLMORE: on behalf of Justice. sliding scale.

Plaintiff doesn't see the

What I see is the all events test. It's one

The all events test is a pretty clear test. that's very well understood. THE COURT:

Well, but that suggests -Okay.

MR. WILLMORE: THE COURT:

I'm not a tax lawyer, but the

all events test to me is a recognition test. Heritage Reporting Corporation (202) 628-4888

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49 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 MR. WILLMORE: It basically tells the

taxpayer when he can -- when the taxpayer can recognize a certain liability or a certain deduction. THE COURT: Not only can, must. Must, yes, Your Honor. And

MR. WILLMORE:

what the all events test basically says is that when the fact of liability is fixed and the amount of liability is fixed, you can recognize the event. THE COURT: But, that's like 1233. 1233 is very consistent with

MR. WILLMORE: the all events test.

In fact, that's why it's so

interesting that in the government's brief, the government never talks about the all events test. But, it is the holding of LaRue. And a taxpayer in

1994 would have looked at these three decisions and would have looked at LaRue and that's the understanding any taxpayer would have had in 1994. And the reason I don't think the government can talk about the all events test is because it can't reconcile the all events test with the position that it is now advocating. Now, the government argues -- the government's argument apparently has changed a little bit and maybe has been refined. THE COURT: Well, I think it's not the

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50 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 argument that necessarily would have been made in 1994. MR. WILLMORE: The government's argument now

is more focused on whether or not a basis was created by the obligation. And that focuses back on Revenue

ruling 8877 and, of course, they're also citing the Kornman case, which was decided last week. Now, one

of the things I just want to say, because I'm not entirely clear what the government's position is, in light of Kornman, I think there is an issue about whether or not in Helmer there was creation of basis, because in Helmer, as the Court will recollect, there were premiums paid to the partnership, which were these premiums, paid to the partnership, which were then distributed to the partners. And there must have

been basis associated with those cash premium options payments that were then distributed to the partners. So when the government says there was no basis in the partnership, I'm just not sure that's accurate. THE COURT: Well, the partners, themselves,

had a basis, obviously, in the asset respecting which the option was issued. MR. WILLMORE: THE COURT: The partners had ­ I'm talking about an

Yeah.

outside basis rather than an inside basis. Heritage Reporting Corporation (202) 628-4888

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51 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Honor. Heritage Reporting Corporation (202) 628-4888 MR. WILLMORE: But what the partners wanted

to do is when they received the premium payments, they wanted to treat that as a liability. And the

government said, no, you can't and the Tax Court agreed with the government's position. THE COURT: I understand that part. But,

that led us to the discussion of recognition and 1233. Let's say there was that -- well, I'm still not exactly clear what ultimately happened to the receipt in Helmer by the partners of the distribution from the partnership. MR. WILLMORE: It was cash, so presumably it

was treated as a distribution and as a distribution, it would have decreased their basis. And I think what

they were trying to do was to get the -- get a liability recognized, which would then increase their basis. Helmer. And that's what the Tax Court wouldn't do in But, I do believe the cash payment would have

been treated as a distribution and, therefore, a decrease in their basis. THE COURT: That's right. But, a decrease

in their basis, not actual income in the year that the distribution was made. MR. WILLMORE: That, I don't know, Your

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52 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 either. MR. WILLMORE: THE COURT: Okay. THE COURT: Well, that's what I don't know

That's why I was hesitating.

Anyway, that's where you get the inside, outside basis distinction. MR. WILLMORE: Now, at least at one point,

the government's argument, as I indicated, was that these Tax Court cases only dealt with contingencies of fact, rather than contingencies of amount. clearly not the case in LaRue. That's

And that argument, I

would simply say, Your Honor, was made to the court Klamath and specifically rejected by the court of Klamath, which said the case law does not support that position. So, I'm not entirely sure if that is still

the government's position here. THE COURT: Well, I think that's why Mr.

Stewart put forward this sliding scale, which is a little unspecific. MR. WILLMORE: Yeah, I don't know where to

draw the line in the sliding scale and I don't know of any case law that supports the sliding scale. The

case law that is out there, the three Tax Court cases we've discussed, and then the subsequent cases, the Jade Trading case, the Klamath case, the Cemco Heritage Reporting Corporation (202) 628-4888

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53 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 that. MR. WILLMORE: Your Honor. Yes, but that is correct, Investors case, they all talk about is it a contingent obligation in the sense, can you determine the amount of the obligation. Klamath. And that's clearly the issue in In

That's clearly the issue in LaRue.

LaRue, LaRue -THE COURT: That'