Free Cross Motion - District Court of Federal Claims - federal

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IN THE UNITED STATES COURT OF FEDERA CLAIMS
No. 05-231 T (Chief Judge Damich)

JZ Buckingham Investments LLC as Tax Matters Parer
of JBJZ Parers, a South Carolina general parership,

Plaintiff,
v.

United States of America,
Defendant.

APPENDIX

Exhibit At

United States' Second Amended Answers to First Interrogatories and United States' Answers to Set of Second Set of Interrogatories dated August 11, 2006.

Pages 001-027

Exhibit A2

United States' Answers to Plaintiffs Third Set of Interrogatories dated October 24, 2006.
United States' Response to Second Set of Production Requests dated August 4,2005.

Pages 028-055

Exhibit B

Pages 056-059 Pages 060-090
Pages 091-109

Exhibit C
Exhibit D

Case Management Plan dated March 13,2006.
Notice of

Deposition dated March 30, 2007 with

attchments.

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f)
Facsimile No. (202) 514-5238
Trial Attorney: David M. Steiner

u.s. Department of Justice

Tax Division
Please reply to: Civil Trial Section, Northern Region
P.o. Box 55

Attorney's Direct Line: (202) 307-5892

Ben Frank/in Station Washinflon. D.C. 20044

EJO'C:DMD:DMSteiner 154-2270 CMN 2005103170

. Augut 1 1,2006

VIA FEDERA EXPRESS
Joel N. Crouch, Esquire Meadows, Owens, Coller, Reed, Cousins &'Blau, L.L.P 901 Main Stret, Suite 3700 Dallas, Texas 75202
Re: JZ Buckingham Investments LLC as Tax Matters Parner

of mJZ Parers, a South Carlina general parership v. United States Fed. Cl. No. 05-231 T
Dear Mr. Crouch:

Enclosed please find the United States' Second Amended Answers to First Set of Interrogatories.
Interrogatories as well as United States' Amended Answers to Second Set of

Sincerely yours,

~ ~ jJ
DAVID M. STEINR
Trial Attorney Civil Trial Section, Nortern Region

Ene.
cc:

F. Anthony Paganell, Esq,
Sommer Barnard, P .C.
One Indiana Squae, Suite 3500 Indianapolis, IN 46204

~ GOVERNMENt

. i : EXHIBIT .i. ¡~ l.;~c;~

.s',ai

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Joseph A. Pitzinger, Esq. Unites States Dept. of Justice

717 Nort Harood, Suite 400
Dallas, TX 75201

Jonath Blacker, Esq. Unites States Dept. of Justice

717 Nort Harood, Suite 400 .
Dallas, TX 75201

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IN TH UNTED STATES COURT OF FEDERAL CLAIMS
) J

No. 05-231 T (Chief Judge Damich)

JZ Buckingham Investments LLC as Tax Matters Parer of mJZ Parers, a South Carolina general parership,

Plaintiff,
v.

United States of America,
Defendant.

UNITD STATES' SECOND AMENDED ANSWERS TO

FIRST SET OF INTRROGATORIS
In accordance with Rule of

Civil Procedure 33, Respondent, the United States of

America, responds to Plaintiff s First Set of Interrogatories as follows:
1. Do you contest that the transactions described in IRS Notice 2000-44 generally, and this
case speCifically, do not involve the acceleration or duplication of by Section 309 of 114 Stat 2763)? If any of the Community Renewal Tax Relief Act of

losses as contemplated 2000 (public Law 106-554,

you contest ths fact, explain how a loss is accelerated or'duplicated in the transactions described in IRS Notice 2000-44 generally and in ths case

specifically.

Answer: Respondent objects to ths interrogatory on the grund that it involves "inquiries into
'issues of

pure law'" to the extent that it seeks,information with respect to transactions described

in IRS Notice 2000-44 generally. IRS Notice 2000-44 refers to a number of different
transactions not at issue in this casè. Accordingly, to that extent, this interrogatory involves a

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pure question oflaw and is improper. Kendrick v. Sullvan, 125 F.R.D. 1,2 (D.C. 1989) citing
Notes of Advisory Comm. On Ru1es, 1970 Amend. to Rule 33; Steil v. Hunana Kansas City,
Inc., 197 F.R.D. 445,447 (D., Ka. 2000); Langer v. Presbyterian-University o/Pennslvania
Medical Center, 1988 W.L. 56972 (E.D. Penn. 1988). Cour of

Fed. Cl. Rule 33(c) requies tht

contention interrogatories be posed in a maner that inquire into the application of law to the
facts at issue. See e.g. Kendrick v. Sullvan, 125 F.R.D. at 3. Interrogatones that seek abstrt
opinions of the law or pur legal contentions fall outside the bounds of

Rule 33(b) and are

therefore impermissible. See, e.g., Abbott v. United States, 177 F.R.D. 92,93-94 (N.D.N.Y.
i 997). Ransom v. United States, 8 CL.Ct. 646, 647-48 (1985); Notes of Advisory Comm. on
Rules, 1970 Amend. to Rule 33.

With respect to the transactions at issue in this case, Respondent is not taing the position
that these trnsactions involve the acceleration or duplication oflosses, Rather, it is our position
that the purose of the issuance of

Temporary Treasury Regulation § 1. 752-6T was reflected in

the preamble to these regulations. The preamble expressly noted that prior to the enactment of
IRC Section 358(h) and Section 309(è) and (d)(2) of

the Community Renewal Tax Relief Act of

2000 ("Act"), there was a lack of specific rules addressing the treatment of liabilities upon the
transfer of

propert to a corpration or a parership, which, in tu, led to interpretations of then

existing law that failed to reflect the true economics of certin transactions. In some cases,
taxpayers continued to assert these interpretations even after the enactment of

the Section 358(h)

and Section 309(c) and (d)(2) of

the Act. For example, in a transaction addrssed in Notice

2000-44 (2000-2 C.B. 255), a tapayer, as in the inst case, pUrhases and wrtes economically

offsetting options and then purorts to create substantial positive basis by transferrng those
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option positions to a parership. On the disposition of

the parership interest, the liquidation of

the parer's interest in the parership, or the taxpayer's sale or deprec~ation of distrbuted

parership assets, the tapayer claims a ta loss, even though the taxpayer has incured no

corresponding economic loss. See, Proposed Rules Deparent of the Treasur Internal Revenue

Service 26 CFR Par 1, Assumption of

Parer Liabilties, Tuesday, June 24,2003,68 FR 37414-

01 (June 24, 2003). The regulations were designed to prevent such abuse of a tapayer claiing

a tax loss where it has incured no real economic loss.

2. The preamble to Tempora Treasur Regulaton § 1. 752-6T states that the reguation is
necessa to prevent abuse. Please

explain how Treas. Reg. §1.752-6 or §1.752-6T is

necessar to prevent the ty of abuse perceived by the IRS in the transactions descnbed

in IRS Notice 2000-44 generally and in the tractions at issue in ths case specifi~aly.

Answer: Respondent objects to tms interrogatory on the ground tht it involves "inquiries into
'issues of

pure law" to the extent that it seeks information with respect to transactions descrbed

in IRS Notice 2000-44 generally. IRS Notice 2000-44 refers to a number of different

transactions not at issue in ths case. Accordingly, to that extent, ths interrogatory involves a
pure question oflaw and is improper. Kendrickv. Sullvan, 125 F.R.D. 1,2 (D.C. 1989) citing

Notes of Advisory Comm. On Rules, 1970 Amend. to Rule 33; Steil v. Hunana Kansas City,
lnc" 197 F.R.D. 445, 447 (0. Kan. 2000); Langer v. Presbyterian~University a/Pennslvania
Medical Center, 1988 W.L. 56972 (E.D. Penn. 1988). Cour of

Fed. Cl. Rule 33(c) requires tht

contention interrogatories be posed in a maner that inquire into the application of law to the

facts at issue. See e.g. Kendrick v. Sullvan, 125 F.R.D. at 3. Interrogatones that seek abstract
opinions of the law or pure legal contentions fall outside the bounds of Rule 33(b) and are

therefore impermissible. See, e.g., Abbott v. United States, 177 F.R.D. 92,93-94 (N.D.N.Y.
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1997). Ransom v. United States, 8 Ci.Ct. 646, 647-48 (1985); Notes of Advisory Comm. on
Rules, 1970 Amend. to Rule 33. With respect to the tranactions at issue in ths case, see anwer

to interrogatory I, above, which explains the ty of abuse tht Temporar Treasur Reguation
§1.752-6T was directed to prevent and why it was necessar to issue this regulation ro prevent
such abuse.

3. Do you contest tht the Optiòns contrbuted to JBIZ Parers would constitute "liabilties

within the meang of26 U.S.C.§ 752 in the absence ofTreas. Reg. §§ 1.752-6T and you do contest tls fact, fully describe your position and provide a complete 1.752-6? .If
explanation of its legal and factual basis.
Answer: Respondent objects to this interrogatory on the ground that it poses a hypthetical

legal

scenario unelated to the law and facts of

the cae. Abbott v. United States, 177 F.R.D. 92, 93-94

(N.D.N.Y. 1997); Kendrick v. Sullvan, 125 F.R.D. at 3; Mobil Oil Corporation v. Department of

Energy, 1982 W.L i 135 (N.D. N.Y. 1982). Respondent has not, in this litigation, made the
subject of dispute, contention or litigation, that options contrbuted to JBIZ Parers constitute
"liabilties" within the meang of26 U.S.C. § 752 in the absence of

Treas. Reg. §§ 1.752-6T

and 1.752-6. This is because the purorted assumption of liabilties by JEIZ parers occurd
on November 24, 1999,

after the effective date for Treas. Reg. § 1.752-6. See FP AA, Exhibit A,

Item 4. Interrogatories callng for an opinion or contention based on hypothetical scenaro ar
always improper. See, e.g., Mobil Oil Corporation v. Department of Energy, 1982 W.L 1135
(and cases cited therein.); Kendrick v.,Sullvan, 125 F.~.D. at 3; Abbott v. United States, 177
F.R.D. 92, 93-94. Without waiving these objections, the' United States states that even absent
Treas. Regs. §§ i, 752-6T and 1.752-6, the options offset each other and you can't just disregard

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one leg and clai a phony loss tht does not reflect reality. As such; there was no liabilty in

fact.
Secondly, IRe § 752 in no way limits the meag of

the term "liabilty." The term
liabilties, including contingent liabilties. 'See, Coltee

"liability" in Section 752 encompasses all

Industries v United States, 2006 WL 1897077 (Fed Cir, July 12,2006) Section 752 must be
read in pari materia with Section 358. Both of

these statutes use the term "liabilty in the sae

,manner and context. In 2000, Congress specifcally stated that "the term 'liabilty' in Section 358
shall include any fixed or contingent obligation to make payment, without regar to whether the
obligation is otherse taken into account for purses of

th title." IRC § 358(h)(3). Congress

made clear that this amendment, and rues to prevent abuses under subchapter K, would be
effective as of October 18, 1999, before the trsactions in ths case took place. See Community
Renewal Tax Relief Act of

2000, P.L. 106-554, § 309(c) and (d).

Moreover, even if

the transactions in this matter had occured prior to October 18, 1999,

the short options would stil have been liabilties for puroses of Section 752. It is clea that the
Community Renewal Tax Relief Act was a clarification, and not a change, in the law. Section
358 does not limit the meaning of

the term liability or the tye ofliabilities that are included

within its scope. Indeed, when Congress enacted Section 358(d)(1)'s predecessor, Section
lI3(s)(6) of

the Internal Revenue Code of 1939, it intended that in determining basis under that
the taxpayer assumed by the trsferee. . . shall be considered as

section, "any liabilties of

money received by the taxpayer upon the exchange." 84 Congo Rec. 7481 (1939Xemphasis

added), reprinted in Seidman's Legislative History of Federal Income Tax Laws 1953- i 939 at

1634 (1954). Whether a liabilty is fixed or contingent, it is stil a "liabilty," as Congress made
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clea when it enacted Section 358(h) in order to definitively shut down the contingent liabilty
shelters. See illinois Tool Works, Inc. v. Commissioner, 355 F.3d 997, 1002 (7th Cir.

2004)(refusing to treat contingent liabilties differently than fixed liabilties and holdig that both
tyes of liabilties must be capitaized by an entity which purchased a business because "that
the,

contingent liabilty fonned par of

purchae price); Holdcroft Transp. Co. v. Commissioner,

153 F.2d 323, 324 (8th Cir. 1946) (applying same rue for ta free exchage).

The enactment of

Section 358(h) in no way indicates ihat, prior to October 18, 1999,
Section 358(d)~ Instead, Section 358(h)

contingent liabilties were excluded from the scope of

provides that if "any" liabilty (whether fixed or contingent) somehow escapes the basisreduction rule set out in Section 358(d), then Section 358(h) will apply to "reduc(e) the

transferor's basis in potentially abusive situations." Burke, 106 Tax Notes at 588. It is afortiori
clear that Section 752 always included contingent liabil.ities as liabilities because the Communty
Renewal Tax Relief Act directed the Commissioner to prevent any such abuses without making
any changes in the language of

Sections 752 whatsoever.

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I, Denns M. Donohue, pursuat to the provisions of28 U.S.C. Section 1746 declare
under penalty of perjur that the foregoing responses to the plaintiffs interrgatories ar tre and

correct to the best of my knowledge, inormation, and belief.

Dated ths AUflst I L 2006. in Washington, D.C.

Respectfly submitted,

~ , ~ Vy'\
DENNIS M. DONOHU
SENIOR LITIGATION COUNSEL OFFICE OF CIVIL LmOA nON Trial Attorney, Tax Division U.S. Deparent of Justice P.O. Box 403 Ben Franlin Station Washington, D.C. 2004
Telephone: (202) 307-5892

E-mail: denns.donohue~usdoj.gov

EILEEN J. O'CONNOR
Assistat Attorney General

DAVID OUST AFSON Federal Claims Section Chief, Cour of

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CERTIFICATE OF SERVICE
I hereby certfy that on August 11, 2006, a copy of the foregoing UNTED STATES'

SECOND AMED ANSWERS TO FIRST SET OF INTERROGATORIS was mailed by
Federal Express, pre-paid, and properly addressed to the following:

Joel N. Crouch, Esq. Meadows, Owens, Coller, Reed Cousins & Blau, L.L.P. 901 Main Street, Suite 3700 Dallas, Texas 75202

F. Anthony Paganell, Esq.
Sommer Bard, P.C.

One Indiana Square, Suite 3500 Indianapolis, IN 46204

DAVID M, SlllNR Trial Attorney, Tax Division U.S. Deparent of Justice P.O. Box 55

li~~. J1

Ben Franlin Station Washington, D.C. 20044
Telephone: (202) 307-5892 Facsimile: (202) 514-5238 E-mail: David.M.Steiner2~USDOJ.GOV

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IN TI UNTED STATES COURT OF FEDERAL CLAIMS

No. 05-231 T (Chief Judge Damich)

JZ Buckingham Investments LLC as Tax Matters Parer
of JBJZ Parers, a South Carolina genera parership,

Plaintiff,
v.

United States of America,
Defendant.

UNTED STATES' AMNDED ANSWERS TO

SECOND SET OF INRROGATORIS
Respondent, the United States of

America, hereby responds to Plaintiffs Second Set of

Interrogatories as follows:

GENERAL OBJECTIONS
The United States objects to each of

these interrogatories on the ground that they, and the

instrctions thereto, fail to recognize that this proceeding requires a tral de novo and not a
review of an administrative record. The United States is not bound by or limited to any position
taken by the Internal Revenue Service at the administrative stage of

ths case, including any

position taken by the Internal Revenue Service in the FP AA.
The United States also objects to each of

these interrogatories because they ar, in

substance, contention interrogatories and thus prematu. Contention interrogatories are not

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had the opportity to review the documents produced to us and depose the necessar paes and

thrd-pares having iIiormation relevant to our legal positions. We also anticipate that the
reports and testimony of expert witnesses will support some of the factu positions set fort,

below.
4. Describe all legal theories and factu support for your contention set fort in Exhbit A,

paragrph 1 to the FP AA and identify all documents that support your contention.
ANSWER: In paagrph 1 of Exhbit A of

the FPAA the Internl Revenue Serice "determined

that neither mJZ Parers parership nor its purrted parers have established the existence of

JBJZ Parers as a parership as a matter of fact." The United States contends tht the Internal
Revenue Service correctly'determined tht the plaintiff

has failed to establish that the JBJZ

Parters parership is not a factul sham. At ths early stage of discovery, the pnncipal factul

basis of ths position is that this entity was organed for the sole purpse of ilegally avoiding
federal and state income taxes. As such, it was not formed for a legal purose as is required by
state law. Consequently, this entity would not be recognized to exist as a parership under state

law.
5. Describe all

legal theories and factual support for your contention set fort in Exhbit A. paragraph 2 to the FP AA and identify all documents that support your contention.
Exhibit A of

ANSWER: In pargrph 2 of

the FPAA the Internal Revenue Service determined:

Even if JBJZ Parters partership existed as a parership, the purrtd
paership was formed

and availed of solely for puroses of ta avoidance by arificially overstating basis in the partership interests of its purrted partners. The formation of JBJZ Parters parership, the acquisition of any interest in the

purrted parership by the purrted parer, the purhase of offsetting options,
the transfer of offsetting options to a partership, and the distribution of those assets to mJZ investors, Inc., a corporation controlled by the purprted parers in

complete liquidation of the parership interests, and the subsequent sale of those assets to generate at a loss, all within a period of less than 2 Months, had no
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business purose other than tax avoidance, lacked economic substance, and. in

fact and substce, constitutes an economic sham for federa income ta puroses.
Accordingly. the paership and the trsaction described above shall be

disregarded in ful and: (1) any purrtd losses resulting from these tractions ar not allowable as deductions; (2) increases in basis of assets ar not allowed to

eliminate gain for federa income ta purses. '
The United States contends that the Internal Revenue Service corrctly deteImined tht
even if JBJZ Parers existed as a paership under state law, this entity was a sham for federal

income ta purses. That is, the LLCs did not')oin together as parers to conduct business

activity for a purose other than tax avoidance." ASA Investerings P'ship v. Comm'r, 201 F.3d
505,513 (D.C.Cir.2000). "'(T)he absence ofa nontax business purose is fatal' to the arguent

that the Commissioner should respect an entity for federal tax puroses." Saba P'ship v. Comm'r,
273 F.3d 1135, 1141 (D.C.Cir. 2001), quoting ASA Investerings P'ship v. Comm'r, 201 F.3d'at

512. At ths early stage of discover and apar from the facts set fort in paragraph 2 of Exhibit

A of the FP AA, the fudamental factul basis of this position is that this purported entity was not
formed or availed of for a valid business purose. Rather, it was organized' and av.ailed of solely

for puroses oftax avoidance which was to be accomplished by arificially inflating the basis of

the parters' parership interests.
The United States also contends that the Internal Revenue Service correctly determined
that the purchase of the offsetting option transactions and their contrbution to JBJZ Parers was

an economic sham. First, these offsetting option trsactions did not have objective economic
substance. At ths early stage of discovery, the principal factual basis of

that position is that

absent the tax benefits, there was no reasonable possibilty that the LLCs or the purorted
parnership would realize a profit in excess of the enormous fees and transaction costs on these

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Accordingly, the Internal Revenue Servce correctly determined that the purrted
parership and the offsetting option trsactions descnbed above should be disregarded in ful

and: (l) any purorted losses resulting from these "trsactions are not allowable as deductions;

and (2) incrases in basis in parership interests and increases in basis of assets are not allowed

to eliminate gain for federal income ta puroses.
6. Describe all legal theories and factu support for your contention set fort in Exhbit A,

paragraph 3 to the FP AA and identify all documents that support your contention.

ANS WER: In pargraph 3 of Exhibit A of the FP AA the Internal Revenue Servce determined:
(T)hat JBJZ Parers parnership was a sha, lacked economic substance and,
under §1.701-2 ofIncome Tax Regulations, was formed and availed of

in

connection with a trsaction or transactions in taxable year 1999, a principal
purse of which was to reduce substatially the present value of its parers'

aggregate federal ta liability in a maner that is inconsistent with the intent of Subchapter K of the Internal Revenue Code. It is consequently determined that:
a. the JBJZ Parers parnership is disregarded and that all trsactions engaged in
by the purrted parership ar trated as engaged in directly by its purorted

parners. Ths includes the determination that assets purportdly acquired by mJZ Parers parership, including but not limited to foreign curency options,

were acquired directly by the purrted parèrs.
b. the foreign curency option(s), purrtedly contrbuted to or assumed by JBJZ
Parers parnership, are treated as never having been contrbuted to or assumed

by said parership and any gains or losses purortedly realized by JBJZ Parer
parnership on the option(s) are treated as having been realized by its parers.

c. the purorted parers of JBJZ Parers parership should be treated as not being

parers in JBJZ Parers partnership.

d. contrbutions of JBJZ Parers parership will be adjusted to reflect clearly the
parership's or purorted parters' income.

Apart from the legal contentions set fort in our response to Interrogatory 5, the United States

contends that Internal Revenue Service correctly determined tht the formation of JBJZ Parers

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and the contrbution of

the offsettng option tranctions to mJZ Parers violated the Anti

Abuse regulations of Subchapter Kof the Intern Revenue Code - i.e., Tre. Reg. § 1.701-2.
At ths early ste of discovery and apar frm the facts set fort in par~ph 3 of

Exhibit A of

the FP AA, the principal facts that support the application of

the Anti Abuse proviions ofTrea.

Reg. § 1.701-2 ar the same facts as listed in our Response to Interrogatory 5.
7. Describe all legal theories and factul support for your contention set fort in Exhbit A,

paragraph 4 to the FP AA and identify all docwnents tht support your contention.
ANSWER: In paragrph 4 of Exhibit A of

the FPAA the Internal Revenue Service deteined

"(t)hat the obligations under the short positions (wrtten call options) trsferred to JBJZ Parers
parership constitute liabilties for purses of Treasur Reguation § 1. 752-6T, the assumption

of

which by mJZ Parers partership shall reduce the purorted parers' bases in ffJZ

Parers parnership in the amounts of$42,750,000.00 and $4,750,000.00, respectively, but not
below the fair market value of

the purorted parership interest." The United States contends

that the Internal Revenue Service corrctly determined that the obligations inherent in the short
positions (wrtten call options) tranferred to mJZ Parers parnership constitute liabilities for
puroses of

Section 752 and Treas. Reg. §1.752-6T. The term "liabilty" in Section 752

encompasses all

liabilties, including contingent liabilties. See, Co/tee Industries v United
the

States, 2006 WL 1897077 (Fed Cir, July 12,2006). Thus, mJZ Parers's asswnption of

obligations under the short positions constituted a distribution of money to the purorted parers

under Section 752(b), thereby decreasing their basis in the purrtd parership. Moreover,
Helmer v. Commissioner, 34 T.C.M. (CCH) 727, T.C.M (1975) is inapposite to these facts
because it did not involve simultaneously executed long and short options of

the same underlying

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propert with virtlly identical terms, whch offsetting options eliminated all financial risk to
the purorted parers in excess of the net premiums paid by them. Also, Helmer did not involve

offsettg option trctions which were entered into as pa of an elaborate and prearged

scheme to avoid federa income taes. Finally, Helmer is also inapplicable for the same reasons

set fort in the Confidential Memorandum of Jared Blanchard dated Januar 5, 2000. See,
2003EY004049-4062, and parcularly 2003 EY 4056-4061.
8. Describe all legal theories and factu support for your contention set fort in Exhibit A,

paragrph 5 to the FP AA and identify all documents that support your contention.
ANSWER: In paragraph 5 of Exhbit A of

the FPAA the Internl Revenue Service determined

"that neither JBJZ Parers parership nor its purorted parers entered into the option(s)

positions or purchase the foreign curency or stock with a profit motive for puroses of
§165(c)(2)." The United States contends that the Internal Revenue Service corrctly determined
that the purorted parters of JBJZ Parers parership did not acquire the opton(s)

positions or

contribute them to the purorted parership for the principal purse of realizing a profit. At
this early stage of discovery, the principal facts that support that position are the same facts as set
fort in our response to Interrogatory 5, It is also expected that expert testimony will address this

issue.
9. Describe all legal theories and factual support for your contention set forth in Exhibit A,

paragrph 6 to the FP AA and identify all documents that support your contention.
ANSWER: In paragraph 6 of Exhbit A of

the FPAA the Internal Revenue Service determined:

Even'ifthe foreign curncy option(s) ar treated as having been contributed to
JBJZ Parters parership, the amount treated as contrbuted by the parners under
section 722 of

the Internal Revenue Code is reduced by the amounts received by
the call option(s) to
Thus, the basis of

the contributing parers from the contemporaneous sales of the same counter-par.

the contributed option(s) is reduced,

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both in the hads of

the contrbuting parers and mJZ Parers paership.

Consequently, any corrsponding claied increaes in the outside basis in JBJZ the foreign curency Parers parership resultig from the contrbutions of

option(s) are disalowed.
The United States contends tht the Intern Revenue Servce correctly determined tht even if

JBJZ Parers parership is trated as a parership for federal income ta purses and even if
the foreign curency option(s) ar therefore treated as having been contributed to this paership,

these nominally separte offsetting (long and short) options were in'substace a "single" position.
It a foundational .principle of the tax law that the substace of a tranaction controls for federal
income ta purses. At ths early stage of

the discovery, the principal facts supporting ths

position ar that in form, these nominally separate options required huge gross premiums

losses. In
(totaing many millons of dollar) and exposed the option wrters to massive potential

substance, however, these nominaiiy separate private trades economically nearly totaly offset
each other, thereby only requiring a relatively small net premium. Moreover, because of

their

incredibly close strke prices, as discussed in our response to Interrogatory 5, there was virtly
no risk that only one position would be exercised. Thus, assuming these alleged trdes were not
"factual shams,"

these nominally separte positions constituted, in substace and in re~lity, a

single position. As such, the basis of these offsetting option positions would be limited to the net

premium paid on their acquisition - with the corrsponding result that the contrbuting parers'
basis of

their parership interests would also be limited to this net premium amount. It is

expected that expert testimony will also address ths issue.
10. Describe all

legal theories and factual support for your contention set forth in Exhibit A, paragraph 7 to the FP AA and identify all documents that support your contention.

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ANSWER: In

paagrph 7

of

Exhbit

A of

the FPAA the Internal Revenue Service deteined

tht:
(T)he adjusted bases of

the long call positions (purhaed call options), zero

coupon notes, and other contrbutions purrtdly contbutd by th paers to

JBJZ Parers parerhip ha not ben established under I.R.C. § 723. It is
consequently determined tht the paers of JBJZ Parers parership have not

established adjusted bases in their resctive parership interest in an amount
'greater th zero (-0-).

The Uiuted States contends tht the Intern Revenue Service correctly determined that the

adjusted basis of the offsettng options and other propert contrbuted to JBJZ Parers is zero.

As noted in our response to Interrgatory 9, even though th offettg options must be viewed as
a "single position" with the result that the basis of these offsettng options would be equa to the
net premium paid for these positions, the.burden is on the plaintiff

to establish tht they made a

net "out of pocket" payment for these options and also to establish the amount of this net cash
payment. Also, the buren is on the plaintiff

to establish what was the adjusted basis in the
the other propert contrbuted to the purported partership.

hands of

the purorted parers of

However, even assuming that plaintiff sustains its burden of showing what net amounts were
these
paid for the offsettng options, the basis ofthese option positions would still be zero if

transactions were determined to be factual or economi~ shams.
1 i . Describe all legal theories and factual support for your contention set fort in Exhibit A,

paragraph 8 to the FP AA and identify all documents that support your contention.
ANSWER: In paragraph 8 of Exhibit A of the FPAA the

Intemal Revenue Service determined

"that, in the cases of a sale, exchage, or liquidation of JBJZ Parters (or 1 the paers'

parnership interests, neither the purrted partership nor its purorted parers have established
that the bases of

the partners' partership interests were greater th zero for puroses of

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determining gain or loss to such parers from the sale, exchange, or liquidation of such

parnership interest. The United States contends that the Internal Revenue Service corrctly
determined tht in the case of the purrted paers' nominl trfer of

their parership
their pmprted

interests to JBJZ Investors Inc, a purorted Subchapter S corporation, the basis of

parership interests (both before and after the transfer) is zero. Ths position is based on the

same facts and contentions discussed in our resns to Interrogatory 10. See 26 U.S.C. §§ 705

and 722, which provide, in relevant par, that the basis of a cotrbuting parer's parership
interest is equal to the adjusted basis of the contributed propert at the time of contrbution.
Since plaintiff has not established what was the net (out of pocket) amount of

the premium

payments for the offsetting positions, the adjusted basis of such options is zero ~ with the result
that the basis of

the contributing parters' purported parership interests must also be zero.
legal

l2. Describe all additional adjustments not described in the FP AA that you intend to asser
relating to JBJZ Parters' short tax year ending December 27, i 999 and describe all

theories and factual support for these additiona adjustments and identify all documents that support your contentions.

ANSWER: Apar from our general objection to disclosing our legal positions at the beginning of
discovery as set fort above, the United States specifically objects to this interrogatory seeking
our additional legal positions (apar from those advanced in the FPAA) before we have had

the

opportty to obtain all of

the relevant documents and conduct any fact or expert depositions.

Without waiving this objection, the United States provides the following preliminar response to
this interrogatory.

First, the United States contends that the step transaction doctrine is applicable in this
case, requiring that the individual steps of

the COBRA transaction be collapsed. The purorted

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parership in this scheme was simply used as a conduit to crate an arficially infated basis in
the purorted parers' parershlp interests, which inated basis could, in tu, thn be allocate

to propert distrbuted to the purrted Subchapter S corpration upon the prearanged
dissolution of the purorted parership. The purorted Subchapter S corpration wa also

simply used as a conduit to generate a paper ta loss on the sae of this propert whose basis had
been artificially infated, which loss could then be passed thugh the individua tapayers.
Under the step transaction doctrne, the steps of the transfer of

the offsettg options to the

purrted parership and the distbution of the parership propert on the liquidation of the
parnership to the purprted subchapter S corpration are disregarded. With,these steps

disregarded, the basis of propert distributed to the Subchapter S corporation would therefore be
required to equal the actual cost of this propert - and not the arficially inated basis of the

disregarded parership interests. Thus, the disposition of such propert would not give not nse
to an arificially-generated tax loss. At this stage of discovery, the pricipal facts supporting this

the promoters which make it crystal clear that each of position are the marketing materials of

the

steps of this COBRA traction was meticulously prearanged with the ultimate end result in
mind to achieve an arificially-generated tax loss for the individual investors.

Second, the United States contends tht the offsetting option transactions may be factul
shams. That is, it appears that while these transactions ar, at least to some extent, documented
on paper, this documentation may not reflect the reality of

these transactions. Based on the

allegations in the investors' suits against the promoters, these option contracts may ultimately be
determined to be ilusory. The pricipal facts to support this position will only be known afer

full discovery (documentar and depositions) has been conducted upon the Deutsche Ban.
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Third, the United States contends that the "at risk" rules ofI.R.C. § 465 apply here to
preclude the allowace of

the claimed losses. Section 465(a)(1) provides tht individuas may

claim losses and deductions only to the extnt of the aggregate amount to which the tapayer is at
risk. Section 465(b) provides that a taxpayer is not considered at risk with respet to amounts
protected against loss though some related agreement. At ths early stage of discovery, the

.'

, principal facts supporting ths legal position are that the COBRA trsactions were carfuly
designed to 'limit the financial risk of

the investors, their LLCs and their purortd parership.

As discussed in our response to Interrogatory 5, the offsettg options were expressly designed

to ensure that the investors, though their LLCs and their parership, were exposed to risk only
the
to the extnt of the net premium paid to the Deutsche Ban. Morever, the operation of

offsetting options limited their risk because the values of the options moved in opposite
directions in economically offsetting amounts. The amount that could be gained or lost was
therefore fixed at the time the offsetting options came into existence. As neither the LLCs nor

JBJZ Parers were "at risk" for more than the amount ofthe net premium, §465 precludes JBJZ
Parers from claiming a basis in the offsetting option positions in excess of the net premium.

13. Describe all legal theories and factul support for any penalty or addition to ta you intend to assert should be applied and identify all documents that support your contentions.

ANSWER: The United States objects to this interrogatory to the extent that it seeks
information that is protected under the attorney-client and deliberative process privileges.

Without waiving these objections, the United States states that no determintion has yet been
made as to whether penalties should be asserted.

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As note in the FP AA. no penaties were asserted in the FP AA as to JBJZ Parers

parership because the parers along with JBJZ Investors. Inc. (corpration controlled by the
parer) filed a disc10sur,e with the Internal Revenue Service and represented that they provided

all information required by Anouncement 2002-2. To disclose an item under Anouncement

2002-2; a tapayer was required to provide the followig:
a. A statement describing the material facts of the item;

b. A statement describing the tapayer's ta tratment of the item;

c. The taable year afected by the item;
d. lfthe tapayer is a Coordinated Industr Case (CIC) tapayer, a statement tht the

taxpayer will agree to address the disclosed item under the Accelerated Issue requested Resoluton process described in Rev. Proc. 94-67, 1994-2 C.B. 800, if

to do so by the IR;
e. The names and addrsses of (a) any paries who promoted, solicited, or

recommended the tapayer's paricipation in the transaction underlying the item and who had a financial interest including the receipt of fees, in the taxpayets
decision to paricipate, and (b) if

known to the tapayer. any pares who advised

the promoter, solicitor or recommender with respect to that transaction;
f. A statement agreeing to provide. if requested, copies of all of the following:

1.

All trsactional documents. including agreements, contracts, instrents,

schedules, and, if the taxpayer's parcipation in the tranaction was
promoted, solicited or recommended by any other par, all material
received from that other part or that pars advisor(s);

n.

All internal documents or memoranda used by the taxpayer in its decIsionmaking process, including, if applicable. information presented to the
taxpayets board of directors;

iii.

All opinions and memorand~ that provide a legal analysis of the item, whether prepared by the taxpayer or a tax professional on behalf of the taxpayer; and

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iv. A penaltY of

perjur staement that the person signng the disclosue has examined the disclosure and that to the best of tht person's knwledge
and belief, the information provided as par of the disclosur contans all
relevant facts and is tie, correct, and complete. In

the case of an individual taxpayer, the declartion must be signed and dated by the
the

taxpayer, and not the tapayets representative. In the case of a corprate

tapayer, the declartion must be signed and dated by an offcer of the
corporate tapayer who has personal knowledge of the facts. If

corprate taxpayer is a member of an afliated group filig consolidated
retus, a penalties of perur sttement also mus be signed, dated, and
submitted by an offcer ofthecommòn parnt of

the grup. The person

signng for a trt, a state law parership, or a limte liabilty compay
must be, respectively, atrustee, genera parer, or member-manager who
has personal knowledge of

the facts. A staped signatue is not

permittd.
Announcement 2002-2, fuer provides that "(i)t should not be inferred by the

determination of th~ Accurcy Related Penalty in this notice that fraud penalties wil not be
sought on any portion of an underpayment subsequently determined to be attbutable to frud or

that prosecution for criminal offenses will not be sought under IRC § 7201, 7206 or other

provisions offederal law if determined to be appropriate.
The United States contends that accuracy-related penalties may also be asserted if it is

determined, though the course of discovery, that the individual parcipants, following their
election to disclose, failed to fuly disclose the tranaction and(or made false or fraudulent

statements to the Intern Revenue Service about the transactions.

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I, Denns M. Donohue, puruat to the provisions of28 U.S.C. Section 1746 declare
under penaty of perjur tht the foregoing responses to the plaintiffs integatories ar tre and

correct to the best of my knowledge, information, and beÍief.

Dated ths August 11. 2006, in Washington, D.C.

Respectflly submitted,

~

~ \M)

DENNS M. DONOHUE SENIOR LITIGATION COUNSEL OFFICE OF CIVIL LITIGA nON Trial Attorney, Tax Division U.S. Deparent of Justice P.O. Box 403

Ben Frànlin Station Washington, D.C. 20044
Telephone: (202) 307~5892 E-mail: denns.donohue~usdoj .gov
EILEEN J. O'CONNOR
Assistat Attorney General

DAVID GUSTAFSON Federal Claims Section Chief, Cour of

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CERTIFICATE OF SERVICE
I hereby certfy that on August i i, 2006, a copy of the foregoing UNTED STAlES'

AMED ANSWERS TO SECOND SET OF INRROGATORIS was mailed by Federal
Express, pre-paid, and properly addrssed to the followig:

Joel N. Crouch Texas State Bar No. 05144220
Meadows, Owens, Coller, Reed,

Cousins & Blau, L.L.P. 901 Main Street, Suite 3700 Dallas, Texas 75202
F. Anthony Paganell, Esq.

Sommer Barard, P .C.
One Indiana Squae, Suite 3500

Indianapolis, IN 46204

DAVID M. STEINR

~ V\,lL

Trial Attorney, Tax Division U.S. Deparent of Justice P.O. Box 55

Ben Fralin Station
Washington, D.C. 20044 Telephone: (202) 307-5892 Facsimile: (202) 514-5238 E-mail: David.M.Steiner2~usdoi. gov

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