Free Memorandum - District Court of Federal Claims - federal

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CANTLEY & SEDACCA~ LLP
\TTORNEYS AT LAW
LDW ARD SLi)ACCA PARTNER

5220 SPRING VALLEY ROAD, SUIT!', lJ: () DALLAS, TEXAS 75254
rEL (972) 36 i -D090

MIAMI, FI DALLAS, TX SAN FRANCISCO, C,,\

FAX (r)72) 361-D644

January 22,2002

PRIVILEGED AND CONFIDENTIAL ATTORNEY WORK PRODUCT
Mr. Mark Hutton 7118 West Clearmeadow Court Wichita, Kansas 67205

Re: Investment Transactions
Dear Mr. Hutton:

You (the "Investor") havc requested our opinions regarding certain federal
income tax consequences of the investment transactions ("Transactions") described below.

In rendering our opinions, we have reviewed and relied upon representations and advice, including financial information, from you and various other parties to the

Transactions and made certain assumptions, which representations, advice and
assumptions are referred to herein. We have also examined such documents, and we have made such other inquiries of offcers, owners and other persons involved in the Transactions, as we have considered necessary to render the opinions set forth herein,
We have made no independent verification of such representations, advice, assumptions,

documents, and responses to such inquiries, If any such item is inaccurate in any
material respect, or any such documents prve not to be authentic, the opinions contained

herein may not be relied upon. We have reviewed the applicable provisions of the Internal Revenue Code of 1986, as amended ("Code"), and of the final, temporary, and

proposed Treasury Regulations ("Treas. Reg.," "Treasury Regulations," or "Regulations") promulgated thereunder; relevant decisions of the federal courts;
published Revenue Rulings ("Rev, RuL.") and Revenue Procedures ("Rev. Proc.") of the

Internal Revenue Service ("Service" or "IRS"); and such other materials as we have considered relevant. In certain instances, we have detennined that there is no authority directly on point, and in such instances we have reached our opinion reasoning from such
other authority as we believe to be relevant to the issues addressed. We must caution

you, however, that our opinions are not binding upon the IRS or the courts and there can
:: DEFENDAN1S
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be no assurance that the IRS or a court considering these matters would agree with our

opinions set forth herein.

Based upon our understanding of the facts and assumptions as described herein, we believe that it is more likely than not that our opinions set forth herein would be upheld by a court if they were challenged by the IRS and fully litigated on the merits. Any conclusion set forth in this letter that an issue "should," "would," "will" or "likely" be resolved in a particular manner means only that it is our opinion it is more likely than not that a court would sustain that conclusion.

i. THE TRANSACTIONS
We understand that the Investor is a United States citizen. We also understand
that the Investor was introduced to Dan Brooks of Clarion CapitaL. Clarion Capital is in

the business of structuring foreign currency based derivative products. We understand that Mr. Brooks has nearly 20 years of investment and trading experience. Most recently, Mr. Brooks was employed by Deutsche Bank in its Institutional Trading/Derivative Structuring group from 1996 until 2001. Prior to joining Deutsche Bank, Mr. Brooks was employed: (l) as a management trainee in Chemical Bank's Institutional Currency Trading group from 1982 through 1984, (2) then, as Chief Currency Trader for Bank of America's Institutional Currency Trading group from 1984 through 1989, (3) then, as Chief Currency Trader for Lehman Brothers from 1989 through 1991, and (4) then, as Head of Proprietary Currency Trading for Banque Nationale de Paris from 1991 through
1996. Mr. Brooks is currently principal owner of and is employed by Clarion CapitaL.
Mr. Brooks has a B.A., and a Masters of Business Administration in financelinvestment

from Duke University.
We understand that the Investor had communicated his concerns to Mr. Brooks

regarding the current status of the United States equities markets, as well as the lack of perceived opportunity for investment type yields in the bond markets. We further understand that the Investor communicated to Mr. Brooks that he believed interest rates
were also well below his comfort leveL. With this in mind, Mr. Brooks introduced the

Investor to a foreign currency based investment strategy comprised of certain foreign currency market linked deposit ("MLD") type investments and other structured foreign currency based derivative products. Mr. Brooks, with his vast experience, felt there was still tremendous opportunity in the foreign currency derivativc products area and that he
has represented to us that, if the Investor were to continue his investment in the

Transactions and with Mr. Brooks (and his entity) for at least five (5) years, his
investment strategy could yield the Investor an annual return of somewhere between 15%

and 17% net of all of the Investor's fees and expenses from the Transactions. The
Investor decided to invest with Mr. Brooks.

Mr. Brooks initially introduced the Investor to certain foreign currency market linked deposit type investments or MLDs. It was with the initial intent of investing in
foreign currency type derivative products that on October 10, 2001 the Investor form

cd

Cleanneadow Investments, LLC (the "LLC"), a Delaware limited liability company, and
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contributed $287,500 in cash to the LLC. At this time, the Investor was the sale member

and beneficial owner of the LLC. Then, the Investor, through the LLC, opened an account with Deutsche Bank on October 12, 2001 and deposited into the account the
$287,500 that the Investor had contributed to it in order to purchase long and short MLD positions amongst other investments. The long and short MLDs are separate instruments that can be bought or sold separately. The maturity date on an MLD is usually less than

one year (typically 10, 15, 30, 45 or 90 days). An MLD, like a money market or certificate of deposit, is a cash deposit. In addition, an MLD contains two interest
components, a fixed rate of return component which is paid in all events at the maturity of the cash deposit and a variable rate of return component which is tied to the performance of a market item (such as a foreign currency). The obligation of the counterparty to pay the variable interest component of an MLD at maturity is determined by reference to a specific financial market measure, such as the value or price of an

equity index or a commodity, or to a change in foreign exchange rates. Further, the determination of whether a depositor would be entitled to receive the variable interest
component of his/her deposit would not be determined (or determinable) until the maturity date set for the deposit. The cost of purchasing an MLD position is generally determined by the overall rate of return that a depositor is seeking.

The long MLD position that the LLC entered into constituted a deposit of EUR1 27,472,520 (the "Long Deposit Amount") made by the LLC on October 15,2001 ("Long Deposit Date") with Societe General ("SB"). Under the terms of this long MLD position, on December 14, 2001 (the "Long Maturity Date"), SG would be required to pay to the LLC an amount equal to the sum of: (i) the Long Deposit Amount, plus (ii) the "Long Fixed Yield" (as defined below), plus (iii) the "Long Bonus Yield" (as defined below), except that the Long Bonus Yield is only payable if at 10 a.m. New York time on the Long Maturity Date, the JPY/USD spot market exchange rate is at least 124.65. For purposes of the foregoing, the "Long Fixed Yield" means interest on the Long Deposit i\mount determined from the Long Deposit Date to the Long Maturity Date calculated at
an annual rate of3.67% on the basis ofa 30 day month/360 day year. The "Long Bonus Yield" means an amount equal to the product of: (a) 16%, and (b) the Long Deposit

Amount. On the Long Deposit Date, the spot market JPY /USD exchange rate was
121.05. The premium paid by the LLC for the long MLD position was EUR 2,747,252.

The short MLD position entered into by the LLC constituted a deposit of EUR 27,472,520 (the "Short Deposit Date") made by SG with the LLC on October 15, 2001 (the "Short Deposit Date"). Under the terms of this short MLD position, on December 14, 2001 (the "Short Maturity Date"), the LLC would be required to pay to SG, an
amount equal to the sum of: (i) the Short Deposit Amount, plus (ii) the "Short Fixed Yield" (as defined below), plus (iii) the "Short Bonus Yield" (as defined below), except

that the Short Bonus Yield is only payable if at 10 a.m. New York time on the Short Maturity Date, the spot market JPY/uSD exchange rate is at least equal to 124.67. For purposes of the foregoing, the "Short Fixed Yield" means interest on the Short Deposit
Amount determined from the Short Deposit Date to the Short Maturity Date calculated at
, For purposes of this opinion, "EUR" refers to Eurodollars, "JPY" refers to Japanese Yen and "USD" or "$" refers to United States dollars. 137
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an annual rate of 3.67% on the basis of a 30 day month/360 day year. The "Short Bonus Yield", means an amount equal to the product of: (a) 15.82%, and (b) the Short Deposit

Amount. On the Short Deposit Date, the JPY/USD spot market exchange rate was

121.05. The premium received by the LLC from SG was EUR 2,717,033. We
understand, and have assumed for purposes of our opinions herein, that the LLC's receipt of this premium did not constitute an income recognition event for federal income tax

purposes for either the LLC or the Investor at the time of receipt and that no incomc
recognition event in respect of

this premium will arise until the Short Maturity Date.

All amounts payable under a long MLD position or short MLD position are payable in U.S. dollars at the then spot JPY/USD cxchange rate. It has also been
represented to us that, as of the Short Deposit Date or Long Deposit Date, there was an approximate 28% statistical probability (based on Black/Scholes) of the contingencies of both the short and long MLD positions being satisfied and of thc LLC (and, thus, the Investor) thus realizing a 60% return (net of direct transaction costs associated with the MLD positions) on its net investment in its MLD investments and an approximate 1.3% statistical probability (based on Black/Scholes) of the contingency of the long MLD position (but not the short MLD position) being satisfied and of the LLC thus realizing an approximate 14,446% return (net of direct transaction costs associated with the MLD positions) on its MLD investment. It has been further represented to us that the LLC (and,
thus, the Invcstor) has a statistical probability (based on Black/Scholes) of approximately

70% of neither contingency being satisfied and of, thus, losing its entire MLD
investment.

We have been advised that the MLD positlOns entered into by the LLC were private contractual arrangements with SG and for which there was (i) no market on a national securities exchange that is registered under section 6 of the Securities Exchange Act of 1934 (15 U.S.C. 78f); (ii) no market on an interdealer quotation system sponsored
by a national securities association registered under section l5A of the Securities

Exchange Act of 1934; (iii) no market on a domestic board of trade designated as a contract market by the Commodities Futures Trading Commission; (iv) no market on a
foreign securities exchange or board of trade that satisfies analogous regulatory

requirements under the law of the jurisdiction in which it is organized (such as the
London International Financial Futures Exchange, the Marche a Terme International de France, the International Stock Exchange of the United Kingdom and the Republic of Ireland, Limited, the Frankfurt Stock Exchange, and the Tokyo Stock Exchange); (v) no interdealer market2; and (vi) solely with respect to a debt instrument, no debt market for such instrument.3 We understand from Mr. Brooks, however, that while an MLD position
2 For this purpose, an interdealer market refers to a system of general circulation (including a computer

listing disseminated to subscribing brokers, dealers, or traders) that provides a reasonable basis to
deteiwine fair market value by disseminating either recent price quotations (including rates, yields, or other pricing information) of one or more identified brokers, dealers, or traders or actual prices (including rates,
yie Ids, or other pricing information) of recent transactions; except that it does not refer to a directory or

listing of brokers, dealers, or traders for specific contracts (such as yellow sheets) that provides neither price quotations nor actual prices ofrecent transactions. , For this purpose, a debt market exists with respect to a debt instrument if price quotations for the

llstrument are readily available from brokers, dealers, or traders, although no debt market exists with
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is an exotic derivative structure, any number of sophisticated options desks could and
would make a price on said position.

In general, the long and short MLD positions could be transferred independently
of each other, although under the International Swap Dealers Association Master

Agreement ("ISDA Agreement") entered into by the LLC, together with the
Confirmation For Currency Linked Deposit Swap for the LLC's long MLD position (the "Confirmation"), other than transfers of the long MLD position to majority-owned and

controlled entities, any transfer by the LLC of its MLD position requires SG's prior written consent. It is our understanding that this consent requirement is intended merely to serve as a protection to SG against the situation of SG having an obligation to pay on
the long MLD position without the ability to offset its obligation with any amount that it would be entitled to receive under the short MLD position (e.g., because the short MLD position is owned by a different person). It is also our understanding that SG would not be adverse to granting its consent to the assignment by the LLC of its short MLD position (without the long MLD position) if SG was satisfied with the creditworthiness of the
assignee. Moreover, we understand that SG does, in fact, enter into only MLD positions

where it is the depositor (without entering into any offsetting positions) where it is satisfied as to the creditworthiness of the counterparty.
On October 17, 2001, the Investor transferred his entire membership interest in

the LLC to Clearmeadow Capital Corp., a Delaware corporation (the "Corporation") and, pursuant to that Assignment of Membership Units and Joinder Agreement, dated October 17, 2001, by and among the Investor and the Corporation (the "Assignent Agreement"), the Investor withdrew from the LLC and the Corporation was admitted as a member of

the LLC. Simultaneously with the Investor's transfer, CF Advisors XXXVII, LLC, a domestic limited liability company that is wholly-owned and controlled by Mr. Brooks ("CC"), was admitted as a member of the LLC, and CC and the Corporation entered into
the Amended & Restated Operating Agreement of Clearmeadow Investments, LLC, dated October 19, 2001 (the "Operating Agreement"). CC is also the investment advisor

to the LLC. In exchange for 1,000 Class B Units in the LLC, CC contributed $2,500 in cash to the LLC out of its Additional Consideration (as defined below). At this time, the Corporation had 99,000 Class A Units in the LLC.
It was represented to us that the Corporation was and remains a validly formed

and validly existing corporation under Delaware law. It was further represented to us that
a Department of the Treasury/Internal Revenue Service Form 2553 (Election by a Small
Business Corporation under section 1362 of the Internal Revenue Code) for the

respect to a debt instrument if (A) no other outstanding debt instrument of the issuer (or of any person who guarantees the debt instrument) is traded on an established financial market described in clauses (i), (ii),

(iii), (iv), (v), or (vi) above; (B) the original stated principal amount of the issue that includes the debt

instrument does not exceed $25 million; (C) the conditions and covenants relating to the issuer's

performance with respect to the debt instrment arc materially less restrictive than the conditions and

covenants included in all of the issuer's other traded debt (e.g., the debt instrment is subject to an
economically significant subordination provision whereas the issuer's other traded debt is senior); or (D) the maturity date of the debt instrument is more than 3 years after the latest maturity date of the issuer's
other traded debt.

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Corporation was timely fied to be effective beginning with the Corporation's first taxable year, and that such election remains effective. It has been further represented to us that such election will not be terminated (either voluntarily or involuntarily) at any time during the Corporation's existence.
It was represented to us that the Investor's purpose in investing in the MLD investments through the LLC was to utilize an entity that would enable the Investor to minimize personal liability on his MLD investment (and, in particular, the short MLD

position) and which was a flow-through (or disregarded) entity for tax purposes. Moreover, the use of the LLC to acquire and hold the MLD positions and other
Investments allowed for the direct participation of, and direct loss exposure for, CC (and

Mr. Brooks) in the Transactions. It was further represented to us that the Investor's
purpose for contributing his LLC membership interest to the Corporation was to isolate his investment with CC and Mr. Brooks in a separate investment vehicle through which the Investor could make other investments without the participation or involvement of
Mr. Brooks.

In general, the Operating Agreement provides that LLC net profits are first
allocated to the members to offset previous allocations of LLC net losses, and then to the Corporation (and, thus, the Investor), until the Corporation has been allocated an amount of net profits equal to LO% of the fair market value of its contributed assets4 (unreduced by any liabilities assumed by the LLC), and then to the Corporation and CC in proportion

to their respective Units. See Section 4.2(b) of the Operating Agreement. In general,
LLC net losses are first allocated to the members to offset previous allocations of LLC net profits, and then to the Corporation (and, thus, the Investor) until the Corporation's

capital account5 has been reduced to zero, and then to Cc. See Section 4.2(a) of the
Operating Agreement. The Corporation (and, thus, the Investor) is also specially
allocated all deductions, losses and other items related to the Additional Consideration

payable to CC for its investment advisory services to the LLC. See Section 4.3(f) of the Operating Agreement.
The sale member of CC is Mr. Brooks who, as better described above, has nearly
20 years of experience trading, managing and advising clients with respect to foreign currency contracts, MLD positions and other similar investments.

In general, management and control of the LLC is reserved exclusively to the
members of

the LLC, although those members acting pursuant to a "Required Vote" have

the power and authority to manage, and direct the management of, the business and affairs of the LLC. See Sections 5.1 and 6.2(c) of the Operating Agreement. As the owner of 99% of the total Units in the LLC, the Corporation (and, thus, the Investor) is essentially vested with management and control of the business and affairs of the LLC.
4 For purposes of our opinions, we have assumed that this is intended to mean and refer to the Investor's
capltal contribution to the LLC.

, The Corporation's capital account balance would be deemed to equal the amount of cash and the fair market value of the assets held by the LLC at the time of CC's admission as a member of the LLC and CC's contribution of$2,500 to the LLC. See Rev. Rul. 99-5,1999-1 CB 434.
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However, CC is vested with the power and authority to direct the LLC's investment
activity, and to manage the LLC's portfolio in the manner deemed best by CC to grow its value and provide the greatest investment return to all of the members. See Section 5.2 of

the Operating Agreement. As compensation for its investment advisory services, CC receives quarterly services fees, payable no later than the last day of each quarter, of an amount that, when annualized, equals (a) 2% of the net asset value of the LLC as of the last day of the fiscal year (unreduced by LLC distributions for such fiscal year), and (b) 20% of the LLC's income and gains during such fiscal year, except that for the first quarter of the first fiscal year, a front-end loaded service fee of $10,000 for such quarter
is due and payable as of the effective date of the Operating Agreement (the "Additional

Consideration"). See Section 5.5 of the Operating Agreement.

The purposes of the LLC are to: (i) engage in the acquisition, maintenance, and disposition of foreign currency investments and foreign currency derivatives; (ii) acquire, invest in, and sell other investments for the mutual benefit of the members; (iii) enable
CC to consolidate and manage various foreign currency and foreign currency derivative

investments of the members within the ownership and management structure of the LLC consistent with the investment strategy which CC deems in its sole discretion to provide

the greatest yield for the members in light of the risks of such investments; and (iv) conduct any other business or joint enterprise which shall be legal for a limited liability
company to conduct under the Limited Liability Company Act of the State of Delaware. See Section 1.5 of the Operating Agreement. Representations consistent therewith were also made to us by the LLC. For purposes herein, the investments made and held by the

LLC shall be referred to, individually, as an "Investment" and, collectively, as the
"Investments".
It has been represented to us that based on the investment information provided

by CC as to the probability of the Investments reaching certain price levels at which they would be profitable, and on the advice of the Investor's own investment advisors, the

Investor believed, and continues to believe, that he has, and will continue to have, a reasonable opportunity to earn a significant economic profit from the Transactions in excess of all fees and transaction costs and without regard to tax benefits. It has been further represented to us that Investor intends to continue his Investment for a period of
time to enable Investor to earn a reasonable profit from the Transactions, in excess of all fees and transactions and without regard to tax benefits.
Subject to certain conditions, the Operating Agreement also permits the holders of the Class A Units (here, the Corporation) to transfer any or all of their Class A Units in the LLC at any time and without the need for any advance written notice to any other

member. See Section 8.1 of the Operating Agreement. Also, to entice the Investor to enter into the LLC, CC agreed to incorporate a provision into the Operating Agreement which provides, inter alia, that, at any time after the expiration of the period ending fifteen (15) days prior to the end of the first complete quarter after the cffective date of the Operating Agreement, a Class A Mcmber may, at its option, either require that CC purchase all of its Class A LLC Units for a purchase price equal to the "book value" for
such units as determined in accordance with Treasury Regulations Section 1.704-

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1 (b )(2)(iv) or the Class A Members, by a Required Vote, may require that CC sell all of its Class B LLC Units to the Class A Members for a purchase price equal to the "book
value" for such units as determined in accordance with Treasury Regulations Section

the Operating Agreement. Whether, when and how a Class A Member exercises this option is within its sale discretion and control. It has
1.704-1 (b)(2)(iv). See Section 8.4 of

been represented to us that the Operating Agreement's reference to "book value" in

connection with this option was intended by the parties to mean the "fair market value" of said units, after booking up or down the members' capital accounts to reflect any and all umealized gain and loss from the Investments and the other assets then held by the LLC, and that the Operating Agreement shall be interpreted and applied consistently with
such interpretation. The purpose of the option is to provide the Investor with an incentive

to invest with CC and to allow for either CC's removal or a liquidation of the Class A

LLC Units in the event CC's investment strategies do not meet the Investor's
expectations. This option provides the Investor with an evaluation period of CC's

investment activities to ascertain whether he believes CC's investment strategy will be able to produce the intended or expected retums set forth at the beginning of the
investment period.

It has been represented to us that the U.S. dollar has been, and will continue to be, the functional currency of the Investor, the Corporation and the LLC and, also, that each of them are calendar year taxpayers.

II. ANALYSIS
A. Status of LLC prior to admission of CC as member

Prior to the admission of CC as a member of the LLC, we believe that it is more

likely than not that the LLC, at the time that the Investor was its sole member and
beneficial owner, was a disregarded entity for federal income tax purposes. See Treas.
Reg. § 301.7701-3(b)(l)(ii). We further believe that it is more likely than not that, for federal income tax purposes, the Investor himself would be treated as the person having

entered into the MLD positions and that, for federal income tax purposes (including, without limitation, for purposes of Sections 35 i, 358, 721, 722 and 752), the Investor's contribution of his LLC membership interest to the Corporation constituted a direct contribution by the Investor of the short and long MLD positions, cash and other assets thcn held by thc LLC
B. Admission of CC as member of LLC - Formation of LLC as

partnership for federal income tax purposes

A single member entity disregarded as an entity separate from its owner is
classified as a partnership when the entity has more than one member. Treas. Reg. §

301.7701-3(£)(2). Guidance on the federal tax consequences of such changes is provided in Rev. Rul. 99-5, i 999- i CB. 434, and Rev. Rul. 99-6, 1999-1 CB. 432. See TD 8844 (November 29, 1999).
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the time of the Corporation's deemed contribution of the short MLD position to the
LLC. 42

Also, for the same reason that we believe that Section 358(h) would not apply to
the Investor's _contribution of his LLC membership interest to the Corporation, see 1I.L.2 supra, we also believe that it is more likely than not that Section 358(h) would not apply

to the Corporation's deemed contribution to the LLC (as a partnership).

M. Nonapplication of Notice 2000-44.
In Notice 2000-44, 2000-36 I.R.B. 255 (the "Notice"), the Service addressed
several fact patterns, including the following:

(A J taxpayer purchases and writes options and purports to

create substantial positive basis in a partnership interest by transferring those option positions to a partnership. For example, a taxpayer might purchase call options for a cost

of $ i ,OOOX and simultaneously write offsetting call options, with a slightly higher strike price but the same

expiration date, for a premium of slightly less than
$L,OOOX. Those option positions are then transferred to a

partnership which, using additional amounts contributed to the partnership, may engage in investment activities.

Under the position advanced by the promoters of this
arrangement, the taxpayer claims that the basis in the

taxpayer's partnership interest is increased by the cost of the purchased call options but is not reduced under S 752
as a result of the partnership's assumption of the

taxpayer's obligation with respect to the written call
options. Therefore, disregarding additional amounts

contributed to the partnership, transaction costs, and any
42 Furthermore, the amount of the liability is not the amount that the obligor 1111ght have to pay the obligee

currently to free himself of the obligation. Accord, Rev. Rul. 95-45, supra, the Service ruled that the
assumed obligation was a "liability" in the amount of S 1 OO()x even though the obligee would have had to

pay only $800 to free himself from the obligation. Similarly, except in the case of the original issue discount rules (which are an overlay on the common tax law of debt obligations and in any event apply
only after a de minimis threshold), the amount of a deht obligation for tax purposes tS set when the

obligation is issued: it does not change with fluctuations in interest rates or the issuer's credit rating, even

though these changes would affect the value of the debt obligation and therefore the amount that an
economically rational issuer would pay the holder to discharge the debt. Also, while discharge of indebtedness income is measured by the original issue price and not by the face amount, for numerous other tax purposes the amount of a debt obligation is its face amount ~, the amount that the holder would receive at maturity. See, e.gc, IRe §§ 144(a)(1), l48(f)(4)(D), 453A(c)(4), 691(a)(5)(8). We believe that it is more likely than not that the Short Bonus Yield has no "face amount" per .Ie, but particularly when there is no payment obligation in respect thereof and, otherwise, the amount of such payment obligation, if any,
iS unasccrtainable and cannot be determined with reasonable accuracy.

142A
\lark Hulton)

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income realized and expenses incurred at the partnership level, the taxpayer purports to have a basis in the partnership interest equal to the cost of the purchased call
options ($l,OOOX in this example), even though the

taxpayer's net economic outlay to acquire the partnership
interest and the value of the partnership interest are

nominal or zero. On the disposition of the partnership
interest, the taxpayer claims a tax loss ($ i ,OOOX in this

example), even though the taxpayer has incurred no corresponding economic loss.

The purported losses resulting from the transaetions described above do not represent bona fide losses
reflecting actual economic consequences as rcquired for purposes of Section 165. The purported losses from these transactions (and from any similar arrangements designed to produce noneconomic tax losses by artificially overstating basis in partnership interests) are not allowable as deductions for federal income tax purposes. The purported tax benefits from these transactions may also be subject to disallowance under other provisions of the Code and regulations. In particular, the transactions may be
subject to challcnge under § 752, or under § 1.701-2 or
other anti-abuse rules. In addition, in the case of

individuals, these transactions may be subject to challenge
under S 165(c)(2). See Fox v. Commissioner, 82

T.c. 1001 (1984), Furthermore, tax losses from similar transactions designed to produce noneconomic tax losses by artifcially overstating basis in corporate stock or other property are not allowable as deductions for federal
income tax purposes.

Appropriate penalties may be imposed on participants in

these transactions or, as applicable, on persons who

participate in the promotion or reporting of these
transactions, including the accuracy-related penalty under
§ 6662, the return prcparer penalty under § 6694, the

promoter penalty under § 6700, and the aiding and

abetting penalty under § 6701.

(Emphasis added).
Even assuming, arguendo, that (i) the Service and Treasury had the requisite

statutory authority to issue the Notice, and (ii) the Notice is somehow binding on
taxpayers, see discussion infra, we believe that it is more likely than not that the Notice was intended by the Service to address the purchase and sale of options and, therefore,
142B
\13r;' H ~itt()n)

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would not apply to the MLD positions which more likely than not constitute debt
instruments for federal income tax purposes.

As for the Investor's contribution of his LLC mcmbership interest to the
Corporation in what is more likely than not a Section 35 i exchange, the Notice noted that

"tax losses from similar transactions designed to produce noneconomic tax losses by artificially overstating basis in corporate stock or other property are not allowable as

deductions for federal income tax purposes." The Notice addressed a transaction
involving a Section 721 exchange of options for a partnership interest. A Section 351
exchange would, arguably, be viewed as similar to a Section 721 exchange. However,

we believe that it is more likely than not that the Investor's Section 351 exchange would not be "similar" to the Section 721 options transaction addressed in the Notice. For one
thing, unlike the options transaction in the Notice, the Investor's net economic outlay to acquire the Corporation stock - i.c., approximately $674,187.50 in MLD positions, cash

and other foreign currency investments-- would more likely than not not be considcred "nominal or zero".
As for the Corporation's decmed contribution of the MLD positions to the LLC,

the Notice provides little, if any, technical analysis rcgarding the possible application of Scction 752 or other provisions of the Code or Regulations to evcn thc fact pattern set
forth therein and, that, it is impossible to determine how Section 752 should (if at all) apply to said MLD positions.
In Rev, Rul. 95-26, 1995-1 C.B. 131, the Service addressed whether a

pai1ncrship's short sale of securities crcatcd a liability within the meaning of Section 752. In that ruling, a partnership entered into a short sale of securities on a national securities exchange and the partnership's broker-dealer took securities on hand and sold them on behalf of the partnership. The partnership left the cash proceeds from the sale with the broker-dealer as collateral and deposited additional cash with the broker dealer as further collateraL. The partnership was obligated to deliver idcntical securities to the brokcrdealer to closc out the short sale. On these facts, the Servicc concluded that the short sale

created a partnership liability within the meaning of Section 752, and relied upon Rcv.

Rul. 88-77, supra, for the proposition that a liability under Seetion 752 includcs an obligation to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets. The Service concluded that a short sale
creates such a liability because (a) a short sale crcated an obligation to return the

borrowed securities, and (b) the partnership basis in its assets was increased by the amount of the cash received on the sale of borrowed securities. See also Salina
Partnership, supra.

As quoted above, the Notice provides that the "transactions may be subject to challenge under § 752," but it does not provide any critical analysis on how Section 752 should apply. The Notice concludes that the taxpayer would be incorrect in increasing its basis in its partnership interest by the cost of the call option while not reducing the basis the taxpayer's obligation with respect to the the partnership's assumption of as a result of offsetting call option. Yet, the Notice fails to articulatc how Section 752 would reducc
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the basis since any decrease in a partner's individual liabilities by reason of assumption

by the partnership of such liabilities (under Section 752(b)) would be offset by an
increase in its basis provided under Section 752(a). See Treas. Reg. ~ 1.752-1(f).

Moreover, when it issued the Notice, the Service did not revoke its long-standing position regarding the definition of liability espoused in Rev. Rul. 88-77. The Notice is also inconsistent with the Tax Court's view that granting an option does not create a
liability under Section 752, as expressed in the ! ¡elmer case discussed above.

Accordingly, we believe that it is more likely than not that the Short Bonus Yield does not rise to the level of a liability for either Section 358 or 752 purposes and, thus, no reduction in basis in respect thereof would be warranted. Even assuming, arguendo, that the Notice was intended to apply to transactions involving MLD positions, we believe that it would be more likely than not that the Transactions would be sufficiently distinguishable from the option transaction described in the Notice. For one thing, as noted above, the Corporation's (and, thus, the Investor's) "net economie outlay" for its interest in the LLC (i,e., EUR 27,472,520 in MLD positions, cash and other foreign currency investments) would more likely than not not be considered "nominal or zero".

~. Ne2ative basis adjustments under Section 705(a)(2)(B) or 752(b) upon

maturity of short MLD position where no Short Payment Amount required to be made.
Other than the basis adjustment for any net income, gain or loss in respect of the

MLDs at maturity, we believe that it is more likely than not that if, upon the Short
Maturity Date, no payment is required to be made in respect of the Short Bonus Yield,

the Corporation would have no negative basis adjustment in its Class A LLC Units under either Section 705(a)(2)(B) or 752(b). Section 705(a)(1)(B) provides, in part, that the
adjusted basis ofa partner's interest in a partnership is dccreased by "expenditures of

partnership not deductible in computing its taxable income and not properly chargeable to

the

capital account." This language should be viewed as applying to expenditures which

deplete partnership assets but which do not give rise to a deduction or basis. See McKee,
Nelson and Whitmire, Federal Taxation of Partnerships and Partners, '1 6.02(3)(c) (3d
ed, 1997), Although the Regulations do not elaborate on the kinds of expenditures

included in this category, typical examples of such expenditures arc disallowed losses undcr Sections 267(a)( I) or 707(b), life insurance premiums not deductible under Section 264, and interest on debts ineurred or continued in order to purchase tax-exempt notes not deductible under Section 265. See id; Willis, Pennell and Postlewaite, Partnership
Taxation, '1 5.02(4) (6th ed. 1999).

If, on the Short Maturity Date, the contingency that triggcrs thc obI igation to pay

the Short Bonus Yield (i.e., if the spot market JPY/USD rate reaches 124.67) is not
satisfied, then no obligation or liability would arise in respect of the Short Bonus Yield,
and the Short Bonus Yield component of

the short MLD position would be worthless. In

such event, we believe that it is more likely than not that the Corporation would not be
i \13rk ¡¡ urton)

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tax liability is affected by the transaction even if it is not a direct party to the transaction (e. g., it participates through a
partnership or through a controlled entity). A separate

disclosure statement is required for each reportable
transaction. The fact that a taxpayer files a disclosure

statement for a reportable transaction shall not affect the legal determination whether the tax benefits claimed with
respect to the transaction are allowable.

(Emphasis added).

As relevant, under these rules, a taxpayer that is required to file a return for a
taxable year with respect to the income tax imposed on a C corporation (i.e., the tax imposed under Section 11) must attach to its return a statement of any "reportable

transaction" in which the taxpayer directly or indirectly participated. In defining those transactions that constitute "reportable transactions", the Regulations make reference to certain aspects and criteria used in Sections 6 i 11 and 6112 to determine whether a transaction constitutes a "tax shelter", Corporate Tax Shelter and "potentially abusive tax shelter", See Temp. Reg. § 1.601l-4T(b). Since an S corporation is not a taxpayer that is
subject to the tax imposed under Section 11, the Corporation, which is an S corporation,

would more likely than not not be subject to these disclosure rules.
As none of the other direct or indirect participants that could derive potential federal income tax benefits from the Transactions were corporations (or entities treated as corporations for federal income tax purposes) - i.e., the lnvestor is an individual and CC

is a single member limited liability company the sale member of which is Mr. Brooks,

also an individual - we believe that it is more likely than not that the Transactions
would not constitute a Corporate Tax Shelter.

Moreover, even assuming, arguendo, that the Transactions could be viewed as structured for the avoidance or evasion of Federal income tax for a direct or indirect participant which is a corporation, it has been represented to us that no aspect of the Transactions was offered to the Investor, the LLC, the Corporation or any other person
under "conditions of

confidentiality" (within the meaning ofSectIon 6111(d)(2)).

Accordingly, we believe that it is more likely than not that the Transactions would not constitute a "tax sheltcr" under Section 6111 and, therefore, would not be required to be registered under Section 6l11(a).

III. OPINIONS

Based on the above discussion and analysis, and subject to the
qualifications, representations, limitations and assumptions set forth herein, we are of the opinion that under current federal income tax law, it is more likely than not that:

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A. The Investor's contribution of his LLC membership interest to the Corporation (at a time when the Investor was the sole member and
beneficial owner of

the LLC) was not a taxable transaction.

B. The MLD positions would be treated as debt instruments for federal
income tax purposes with a contingent interest component that would

not be includable as income under Section 1275 unless and until the
contingency is satisfied.
C. The Short Bonus Yield portion of the short MLD position would not be treated as a liability for purposes of Section 752.
D. The Investor's tax basis in his Corporation stock immediately

following his contribution of his LLC membership interest to the
Corporation was equal to the amount of the gross premium paid by the LLC for its long MLD position plus the amount of cash then held by the LLC and the LLC's basis in its other assets, without any downward the Short Bonus Yield. adjustment in respect of
E. Other than the basis adjustment for any net income, gain or loss in respect of the MLD positions at maturity, if, upon the Short Maturity
Date, no payment is required to be made in respect of the Short Bonus

Yield, the Corporation would have no negative basis adjustment under
either Section 705(a)(2)(B) or 752(b).
F. The Corporation's sale of

its Class A LLC Units to CC pursuant to its option undcr the Operating Agrcement would result in a capital gain or loss to the Corporation (except to the extent subj ect to recharacterization under Section 751) and, thus, to the Investor, measured by the difference between the Corporation's amount realized from such sale and the Corporation's then current adjusted tax basis in its Class A LLC Units.
all of

G. The Corporation's purchase of

all ofCC's Class B LLC Units pursuant to its option under the Operating Agreement would result in the LLC being treated as having liquidated under Section 708(b)(1 )(A) for federal income tax purposes, and that the Corporation would take an adjusted tax basis in the LLC's then remaining assets (other than cash

and "marketable securities,,76) deemed received in the deemed liquidation of LLC (i.e., the remaining Investments) equal to the
Corporation's adjusted tax basis in its LLC interest immediately before

70 In general, subject to the exceptions of Section 731 (c )(3), the term '"marketable securities" means

financial instruments and foreign currencies which are, as of the date of the distribution, actively traded
(within the meaning of Section 1 092( d)(1)), IRe § 731 (c )(2)(A), as well as those additional items identified In Section 731 (c)(2)(B).

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