Free Joint Preliminary Status Report - District Court of Federal Claims - federal

Case 1:05-cv-01223-FMA

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS

CLEARMEADOW INVESTMENTS, LLC, CLEARMEADOW CAPITAL CORP., Tax Matters Partner, Plaintiff, v. UNITED STATES OF AMERICA, Defendant. )

) ) ) ) ) ) ) ) ) )

No. 05-1223 T (Judge Allegra)

JOINT PRELIMINARY STATUS REPORT The parties, pursuant to Appendix A of the Rules of the United States Court of Federal Claims ("RCFC"), submit this Joint Preliminary Status Report. Jurisdiction The parties agree that the court has jurisdiction to determine the matters described in 26 U.S.C. § 6226(f). Consolidation The parties are not aware of any other case with which this case should be consolidated. Trial Bifurcation The parties agree that trial should not be bifurcated. Deferral of Proceedings The parties are not currently aware of a reason to defer further proceedings in this case pending consideration of another civil case.

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Additional Statement by plaintiff: The plaintiff understands that the United States may be pursuing a criminal case against certain individuals which plaintiff believes are not related to plaintiff or plaintiff's case. The United States (Internal Revenue Service) made an affirmative decision to disallow the losses claimed by the plaintiff in this matter which has resulted in this case being filed in this Court. The plaintiff should not be unduly prejudiced in this matter by having this case unduly delayed for no reasons concerning the plaintiff, nor should plaintiff be prejudiced during trial preparation by the defendants counsel seeking a protective order with respect to information that is otherwise discoverable and relevant to this case. Additional Statement by the United States: The Office of the United States Attorney for the Southern District of New York has advised counsel for the United States that it is conducting a criminal investigation with respect to certain tax shelter transactions. That office has asked that it be kept apprised of discovery in this action in order to ensure that this action does not adversely affect its pending criminal investigations. In the event that it does, the United States anticipates that it may seek a protective order or other such relief, including a stay, if necessary, to protect the important interests of law enforcement. Counsel for the United States has notified plaintiff that, in addition to Rule 6(e) of the Federal Rules of Criminal Procedure which protects grand jury information, the IRS criminal files are also privileged and not subject to discovery at this time. Remand and Suspension Not applicable.

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Joinder of Other Parties The parties do not expect additional parties to join this lawsuit. Motions Under RCFC 12(b), 12(c) or 56 The parties do not anticipate filing any motions under RCFC 12(b) and 12(c). The parties have not yet determined whether motions under RCFC 56 might be appropriate. Relevant Factual and Legal Issues In its Complaint, plaintiff asks the Court to redetermine (in effect, to void) the adjustments to partnership items of Clearmeadow Investments, LLC that the IRS made in its Notice of Final Partnership Adjustments (FPAA) dated August 24, 2005. Plaintiff also asks the Court to redetermine the applicability of penalties under 26 U.S.C. § 6662. Plaintiff's assertions: Mark and Mary Hutton ("the Huttons") are the owners of a construction company based in Wichita, Kansas. Taxpayers were advised by their investment broker that they could potentially earn a substantial rate of return by investing in the foreign currency markets. The investment broker introduced taxpayers to certain foreign currency market linked deposit ("ML deposits") investments. The Huttons formed Clearmeadow Investments, LLC ("CLEARMEADOW LLC"), a LLC wholly-owned by the Huttons that is treated for federal tax purposes as a disregarded entity. At the time of formation, the Huttons contributed cash to CLEARMEADOW LLC. CLEARMEADOW LLC made investments in ML Deposit positions. ML Deposits are cash deposits similar to money markets or certificates of deposit. ML Deposits contain two interest components--(1) a fixed rate of return component that is paid on

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the maturity date of the ML Deposits, and (2) a variable interest component that is paid on the maturity date if certain contingencies occur. The contingency is determined by reference to a specific financial market measure such as a foreign currency. Whether the contingency is satisfied is generally not known or determined until the maturity date. CLEARMEADOW LLC entered into a ML Deposit, which constituted a deposit of 27,472,520 Eurodollars. Under the terms of this ML Deposit position, on December 14, 2001, the bank would be required to pay to CLEARMEADOW LLC an amount equal to the ML Deposit amount plus a fixed yield calculated at an annual rate of 3.67%, plus, a contingent variable yield calculated at an annual rate of 16%. The variable yield was contingent upon the Japanese Yen/US Dollar spot market equal to or exceeding 124.65 on the maturity date. CLEARMEADOW LLC paid a premium to acquire this position in this ML Deposit equal to 2,747,252 Eurodollars. CLEARMEADOW LLC also entered into a short ML Deposit position, in which it accepted a deposit of 27,472,520 Eurodollars. Under the terms of this short ML Deposit position, on December 14, 2001, CLEARMEADOW LLC was required to pay to the depositor an amount equal to the ML Deposit amount plus a fixed yield calculated at an annual rate of 3.67%, plus, a contingent variable yield calculated at an annual rate of 15.82%. The variable yield was contingent upon the Japanese Yen/US Dollar spot market equal to 124.67 on the maturity date. Through these separable and distinct ML deposit positions, CLEARMEADOW LLC stood to earn a 14,446% return on its ML deposit investments if the Japanese Yen/US dollar spot

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market was greater than or equal to 124.65 on the maturity date but less than 124.67. In addition, the Huttons, through CLEARMEADOW LLC, would earn a modest investment return if the Japanese Yen/US dollar spot market was greater than or equal to 124.67 on the maturity date. On October 17, 2001, the Huttons transferred their entire ownership interest in CLEARMEADOW LLC to a newly formed, wholly-owned S corporation called Clearmeadow Capital Corp. (hereinafter, the "Corporation"). The Corporation was admitted as a member of CLEARMEADOW LLC. Simultaneously with the transfer of CLEARMEADOW LLC to the Corporation, CF Advisors XXXVII, LLC (hereinafter, "CF Advisors"), a domestic LLC wholly-owned by a non-related, third-party contributed cash to CLEARMEADOW LLC in exchange for ownership interests. At the time of contribution, the Corporation and CF Advisors amended the CLEARMEADOW LLC agreement to include a provision, which allows the Corporation to cause CF Advisors to purchase the ownership interests of the Corporation in CLEARMEADOW LLC at fair market value or to cause CF Advisors to sell its ownership interests to the Corporation. The Corporation exercised this right prior to December 14, 2001, and caused CF Advisors to acquire the Corporation's ownership interests in CLEARMEADOW LLC. On December 14, 2001, the Japanese Yen/US Dollar exchange rate was equal to 121.05. I.R.C. § 722 provides, in general, that "[t]he basis of an interest in a partnership acquired by a contribution of property, including money, to the partnership is the amount of money and the contributing partner's adjusted basis of such property at the time of the contribution...." In

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the case at hand, when CF Advisors was admitted as a member of CLEARMEADOW LLC, CLEARMEADOW LLC is deemed converted from a disregarded entity to a partnership for federal income tax purposes. As such, the Corporation is treated as having contributed the ML Deposit positions and the other assets of CLEARMEADOW LLC (as a disregarded entity) to a newly formed CLEARMEADOW LLC (as a partnership). The Corporation's basis in its ownership interests in CLEARMEADOW LLC at such time is equal to the gross premium paid by CLEARMEADOW LLC for its ML Deposit position plus the amount of CLEARMEADOW LLC's cash and basis in other assets. The contingent yield on the short position is not treated as a liability under I.R.C. § 752, and, thus, basis is not reduced for the contingent yield on the short position. Defendant's assertions: The United States believes that the purported creation of Clearmeadow, and the transactions in which it and its "partners" allegedly engaged during the last three months of 2001, constitute an abusive tax shelter, commonly known as a "Son of Boss" shelter described in IRS Notice 2000-44 (issued in August 2000). The United States asserts that the offsetting "foreign currency market linked deposit transactions," entered into by one of the "partners" of Clearmeadow, were designed and contributed to Clearmeadow for the purpose of creating fictitious, paper tax losses of approximately $1,000,000 that could be used to offset other income of Mark and Mary Hutton, the taxpayers behind Clearmeadow. Accordingly, the United States believes that, under the relevant Code sections, regulations and case law, Clearmeadow and the market linked deposit transactions did not create the tax benefits claimed, and should be disregarded for tax purposes.

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Agreed Issues: The parties agree that this case presents the legal and factual issues listed below: · whether the formation of Clearmeadow, and the transactions in which it and its purported partners engaged, had a business purpose and economic substance, or were, instead, economic or factual shams that are not respected for tax purposes; · whether the formation of Clearmeadow, and the transactions in which it and its purported partners engaged, were transactions entered into for a principal purpose of reducing substantially the present value of its members' aggregate income taxes in a manner inconsistent with the intent of the relevant provisions of the Code, and should, therefore, be disregarded under Treas. Reg. §1.701-2; · · whether the step-transaction doctrine applies to bar the tax benefits claimed; whether, if the formation of Clearmeadow is respected, the contribution to it of one of the purported foreign currency market linked deposit transactions (the "short position") must be accounted for under section 752 of the Code and Treas. Reg. §1.752-6, or, alternatively, whether the alleged contribution of two foreign currency market linked deposit transactions must be accounted for as the contribution of only one, net transaction; · whether the losses claimed as a result of the transactions are not allowable under section 165(c)(2) of the Code; · whether accuracy-related penalties are applicable pursuant to section 6662 of the Code.

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The parties set forth the above description of potential issues only for the purpose of providing a brief summary for this status report. Neither party intends to concede or waive any factual or legal claim or defense. Settlement The parties do not believe settlement is likely at this stage of the case. They do not contemplate alternative dispute resolution. Trial The parties anticipate proceeding to trial. Additional statement of plaintiff: Plaintiff requests timely trial scheduling. Plaintiff requests that trial be held in Wichita, Kansas. Wichita is the most sensible location for trial because all books, records, and third-party witnesses are located in Wichita. Additional statement of defendant: Defendant does not request expedited trial scheduling. At this time, the United States does not object (or agree) to trial in Wichita, and reserves the right to suggest an alternative location according to the convenience of the witnesses. Electronic Case Management Issues None.

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Plaintiff's Proposed Discovery Schedule Plaintiff proposes the following schedule: Discovery (including depositions) begins: Experts Disclosed and Reports Exchanged: Rebuttal Experts Disclosed and Reports Exchanged (if any): Discovery Closes:

May 12, 2006

August 12, 2006

September 12, 2006 October 31, 2006

Defendant's Proposed Discovery Schedule Defendant proposes the following schedule: Discovery (other than depositions) begins: Deposition Discovery Begins: Experts Disclosed and Reports Exchanged: Rebuttal Experts Disclosed and Reports Exchanged (if any): Discovery Closes:

May 12, 2006 November 11, 2006

May 12, 2007

August 12, 2007 October 31, 2007

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Respectfully submitted,

United States of America

Clearmeadow Investments, LLC

s/Cory A. Johnson CORY A. JOHNSON Attorney of Record U.S. Department of Justice Tax Division Office of Civil Litigation Post Office Box 403 Ben Franklin Station Washington D.C. 20044 (202) 307-6586 Eileen J. O'Connor Assistant Attorney General David Gustafson Chief, Court of Federal Claims Section Steven I. Frahm Assistant Chief, Court of Federal Claims Section s/ David Gustafson Of Counsel

s/Robert J. Stientjes ROBERT J. STIENTJES Attorney of Record Gasaway & Stientjes LLC 1120 Olivette Executive Parkway, Ste. 220 Saint Louis, MO 63132 (314) 872-3988

Dated: May 12, 2006

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