United States v. Brown , 334 F.3d 1197 ( 2003 )

UNITED STATES COURT OF APPEALS
TENTH CIRCUIT
UNITED STATES OF AMERICA,
Plaintiff-Appellant,
v.
DOUGLAS E. BROWN, HANS H. No. 01-4229
KUHLEN, WELLSHIRE ( D.C. No. 2:95-CR-245-B)
SECURITIES (DEUTSCHLAND) (D. Utah)
GMBH, WELLSHIRE SECURITIES,
INC., WELLSHIRE SECURITIES
BAHAMAS, LTD., WELLSHIRE
SERVICES, INC., and BENETIX,
A.G.,
Defendants-Appellees,
STEVEN W. CALL,
Receiver-Appellee,
GROUP 2 CLAIMANTS,
Appellees.
ORDER
Filed November 4, 2003
Before MURPHY , McWILLIAMS , and HARTZ , Circuit Judges.
This matter is before the court on Appellees’ petition for rehearing en banc.
The members of the hearing panel have determined that it is appropriate to revise
section III(A)(2)(b)(ii) of the opinion. The panel therefore GRANTS rehearing
IN PART, WITHDRAWS the opinion filed on July 8, 2003, VACATES the
judgment, and substitutes the modified opinion attached to this order.
The petition for rehearing en banc was transmitted to all of the judges of
the court who are in regular active service. As no member of the panel and no
judge in regular active service on the court requested that the court be polled, the
petition is denied.
Entered for the Court
PATRICK FISHER, Clerk of Court
By:
Deputy Clerk
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F I L E D
United States Court of Appeals
Tenth Circuit
PUBLISH
NOV 4 2003
UNITED STATES COURT OF APPEALS
PATRICK FISHER
Clerk
TENTH CIRCUIT
UNITED STATES OF AMERICA,
Plaintiff-Appellant,
v. No. 01-4229
DOUGLAS E. BROWN, HANS H.
KUHLEN, WELLSHIRE
SECURITIES (DEUTSCHLAND)
GMBH, WELLSHIRE SECURITIES,
INC., WELLSHIRE SECURITIES
BAHAMAS, LTD., WELLSHIRE
SERVICES, INC., and BENETIX,
A.G.,
Defendants-Appellees,
STEVEN W. CALL,
Receiver-Appellee,
GROUP 2 CLAIMANTS,
Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF UTAH
(D.C. NO. 2:95-CR-245-B)
Joel McElvain, Attorney, Department of Justice, Washington, D.C. (Eileen J.
O’Connor, Assistant Attorney General, Thomas J. Clark, Attorney, Department of
Justice, Washington, D.C., with him on the briefs, Paul M. Warner, United States
Attorney, Salt Lake City, Utah, of counsel), for Plaintiff-Appellant.
Steven W. Call (Herschel J. Saperstein, Bruce L. Olson, and Steven H. Gunn,
with him on the brief), of Ray, Quinney & Nebeker, Salt Lake City, Utah, for
Receiver-Appellee.
Matthew C. Barneck (Diana G. Matkin, with him on the brief), of Richards,
Brandt, Miller & Nelson, Salt Lake City, Utah, for Appellees.
Before MURPHY , Circuit Judge, McWILLIAMS , Senior Circuit Judge , and
HARTZ, Circuit Judge.
HARTZ , Circuit Judge.
A number of German citizens were defrauded when they attempted to invest
in United States securities. Assets were obtained from the perpetrators of the
fraud to create a receivership estate to compensate the victims. The United States
has claimed that the estate is a Qualified Settlement Fund (QSF) that is liable for
income taxes on its earnings. The district court ruled that the fund did not satisfy
the criteria to be a QSF, and the United States appealed. We reverse.
I. BACKGROUND
Hans H. Kuhlen and Douglas E. Brown managed or controlled various
businesses (the businesses) that were involved in a scheme to market securities to
investors. The businesses contracted with hundreds of German citizens for the
purchase of securities in the United States. An FBI investigation produced
evidence that Brown, Kuhlen, and several of the businesses had wrongfully
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represented that the securities they offered were (1) regulated and insured by the
National Association of Securities Dealers and the Securities Investor Protection
Corporation, (2) freely transferable, and (3) traded on recognized exchanges. The
FBI also found evidence that some of the businesses were dealing in securities
without obtaining the appropriate broker/dealer registrations, were misleading
their clients as to the history of one of the businesses, and were falsely
representing one of the businesses as a “world-leading” investment bank.
The FBI obtained a search warrant for the premises of one of the
businesses, Wellshire Services, Inc. (Wellshire), and seized a number of stock
certificates. Wellshire then moved under Rule 41(e) of the Federal Rules of
Criminal Procedure for return of some of the seized property, including stock
certificates that belonged to German investors. The court initially allowed stock
certificates to be released to Wellshire upon proof that its customers were entitled
to possession. But the court halted release of the stock when it suspected that
Wellshire had fabricated claims and did not own or control as many shares of
stock as it had sold.
Brown, Kuhlen, and five of the businesses were later indicted for securities
fraud and related offenses. The indictment sought forfeiture of “any and all
property, real and personal, involved in the . . . offenses, and any and all property
traceable to such property.” Aplt. App. at 32. Both Brown and Wellshire entered
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into stipulations with the United States whereby they released their claims to
certain property and placed that property in a fund designed to provide restitution
to the defrauded investors. Two other businesses entered into similar stipulations:
Desert Mountain Properties, Inc. stipulated to the sale of a residence and its
furnishings; and the D. E. Brown Family Trust relinquished its claims to the
proceeds of a sale of stock seized by the United States. The proceeds of the sales
were added to the restitutionary fund.
To make a claim on the fund, a Wellshire customer needed to complete a
form that asked the customer to “[i]dentify each stock or security purchased, the
number of shares purchased, [the] purchase price per share, [the] date of
purchase, the amount . . . paid for the shares[,] and whether [the investor] . . .
[had] received the shares purchased.” Id. at 73. The form announced a deadline
for submitting claims.
The United States asked that a receiver be appointed “[b]ecause of the
complex nature of the interests involved” and the fact that “the interests of the
[investors could] potentially conflict with respect to some assets.” Id. at 78. The
district court granted the United States’ request, appointing Steven W. Call (the
Receiver). At the same time, the court identified the receivership estate (the
Estate) as “[a]ll property [then] held by the United States of America and/or its
agencies or employees in connection with the . . . case, including but not limited
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to the assets of Wellshire Securities and/or its principles [sic] or affiliated entities
which were seized.” Id. at 81. The court authorized the Receiver “to endorse,
sell and/or transfer all of the securities in his possession for the benefit of the
estate, and . . . to liquidate any securities belonging to the estate that are in the
possession of other brokers.” Id. at 94.
The Receiver proceeded to gather and liquidate the Estate’s assets, which
included not only cash, stocks, and real estate, but also art, wine, and furniture.
Ultimately, the Receiver was successful in converting most of the Estate’s assets
to cash. At one point the Estate’s value exceeded $10,000,000. Nevertheless, the
Receiver reported that “the total assets held in the . . . [E]state are worth less than
one-fourth of the total claims filed against the . . . [E]state.” Rec. Br. at 23.
Although some claimants suggested that the Receiver distribute the seized
stock certificates (or the proceeds of their sale) directly to the owners of each
particular certificate, the Receiver rejected this suggestion as contrary to the
court’s earlier order directing him “to sell and not return stock.” Aplt. App. at
108. Instead, the Receiver suggested that the claimants “share pro-ratably based
upon the amount of their allowed claim.” Id.
Almost two years after the Estate was established, the IRS submitted a
proof of claim stating that the Estate owed taxes in the amount of $1,288,932.05
(plus interest). The original proof of claim identified the Estate as a Designated
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Settlement Fund (DSF), but an amended version identified it as a Qualified
Settlement Fund (QSF). The Receiver objected to the proof of claim on the
ground that the Estate was not taxable as either a DSF or QSF.
The court then ordered appointment of a special master (the Master) to
recommend a final resolution of all claims asserted against the Estate, including
the tax claim. After briefing and argument the Master issued a report concluding
that the Estate was not a QSF and recommending denial of the tax claim. The
district court adopted the Master’s report and recommendation.
The United States appeals. Appellees are the Receiver and the Group 2
Claimants (Claimants), a set of claimants for whom the district court appointed
counsel. (The Group 1 Claimants, who had separate counsel, have settled and are
not parties on appeal.)
II. JURISDICTION
In the order being appealed, the district court addressed the IRS’s tax claim
without addressing the individual claims of the investors. We entered a show-
cause order directing the parties to file memoranda regarding the appealability of
the district court’s order, because only final orders are appealable as of right, and,
in general, an order is not final unless it disposes of all remaining claims, see
Ashley Creek Phosphate Co. v. Chevron USA, Inc., 315 F.3d 1245, 1263 (10th
Cir. 2003). In their memoranda the parties agreed that immediate appeal was
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available under the collateral order doctrine. See Cohen v. Beneficial Indus. Loan
Corp., 337 U.S. 541 (1949). The jurisdictional issue was then referred to the
merits panel. Before we heard oral argument, however, the parties asked the
district court to certify its order as final and appealable under Federal Rule of
Civil Procedure 54(b). The district court, by order dated May 17, 2002, issued the
requested certification.
On appeal neither party questions our jurisdiction. Nor do we. If the
district court’s original order was not a final order under the collateral order
doctrine, it became a final order when the district court properly certified it under
Rule 54(b). After obtaining certification under Rule 54(b), a party need not file a
second notice of appeal. “[W]e will deem the notice of appeal to ripen as of the
date of certification and will accept jurisdiction pursuant to the savings provision
of Fed. R. App. P. 4(a)(2).” Lewis v. B. F. Goodrich Co., 850 F.2d 641, 645
(10th Cir. 1988) (en banc). Our jurisdiction being secure, no further discussion is
necessary.
III. THE MERITS
The United States claims that the Estate is a taxable entity, subject to tax as
a QSF on any income generated by assets in the Estate. Appellees, on the other
hand, dispute that the Estate is a QSF, arguing, in essence, that the Estate’s assets
should be treated as if owned by the claimants to whom those assets will
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ultimately be distributed. Because those claimants are German citizens, a treaty
exempts them from United States taxes on capital gains and other investment
income. Thus, the stakes are high.
Treasury Regulation § 1.468B-1, entitled “Qualified settlement funds,” and
accompanying regulations (§§ 1.468B-2, -3, and -4) constitute an effort to deal
with the various tax questions that arise when an independent settlement fund is
created to pay a debtor’s liabilities. The proper approach to taxation of financial
transactions involving such a fund is not immediately apparent. The transactions
could be treated as if the assets still belonged to the person who contributed the
assets to the fund or as if the assets belonged to those to whom the assets would
ultimately be distributed, or the fund itself could be treated as a taxpayer that
owns the assets. Other questions that may arise include: When can a debtor who
contributes to the fund take a tax deduction for its contribution (assuming that the
contribution is otherwise deductible)—when the payment is made into the fund,
when a claimant receives payment, or at some other time? Or when does the
claimant recognize income? See generally Ellen K. Harrison & Gary B. Wilcox,
Settlement Fund Final Regs. Answer Many Questions, But Problems Still Exist, 78
J. Tax’n 342 (1993); Ellen K. Harrison, IRS Fills Void on Tax Treatment of
Settlement Funds With Generally Favorable Rules, 76 J. Tax’n 358 (1992).
In this case, treatment of the Estate as a QSF appears to provide no benefit
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to those who contributed to the Estate or those who will receive distributions from
it; only the IRS stands to gain. But often treatment of a settlement fund as a QSF
benefits a taxpayer. For example, one who contributes funds to a QSF may be
able to take a deduction that would otherwise not be available until the funds are
distributed to claimants. See § 1.468B-3(c). In the following discussion it will be
helpful to keep in mind that the QSF regulations were designed to cover a host of
circumstances, not just the specific, and rather unusual, circumstances presented
here.
Section 1.468B-1(c) defines a QSF as follows:
A fund, account, or trust satisfies the requirements of
this paragraph (c) if—
(1) It is established pursuant to an order of, or is
approved by, the United States, any state (including the
District of Columbia), territory, possession, or political
subdivision thereof, or any agency or instrumentality
(including a court of law) of any of the foregoing and is
subject to the continuing jurisdiction of that
governmental authority;
(2) It is established to resolve or satisfy one or more
contested or uncontested claims that have resulted or
may result from an event (or related series of events)
that has occurred and that has given rise to at least one
claim asserting liability. . . [a]rising out of a tort, breach
of contract, or violation of law; . . . and
(3) The fund, account, or trust is a trust under
applicable state law, or its assets are otherwise
segregated from other assets of the transferor (and
related persons).
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The United States contends that the Estate is a QSF within this definition because
(1) the Estate was established by a court order; (2) the purpose of the Estate is to
pay claims arising out of fraudulent transactions in violation of the securities
laws; and (3) the Estate’s assets are segregated from the assets of all other
persons. Appellees bear the burden of establishing the error in the IRS’s
determination of the tax due. See Dolese v. Comm’r, 811 F.2d 543, 546 (10th Cir.
1987).
Appellees mount numerous attacks (some by both Appellees and some by
only one) on the contention that the Estate should be treated as a QSF. First, they
argue that the Estate does not satisfy the regulation’s criteria for being a QSF.
Although they concede that the Estate satisfies the requirements of subparagraph
(3) of § 1.468B-1(c), they raise objections concerning the other subparagraphs.
With respect to subparagraph (1), they claim that the court order was inadequate
to establish a QSF because the order did not conform to a local court rule. And as
for subparagraph (2), they argue that the Estate does not “resolve or satisfy”
claims because it will not extinguish them, and that none of the liabilities at issue
here is the type of liability (what we will call a “predicate liability”) which a fund
must “resolve or satisfy” for it to be a QSF. Appellees further assert that the
Estate cannot be a QSF because it does not have a transferor, as implicitly
required by the regulations, and that a proposed Treasury regulation indicates that
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funds like the Estate are not meant to be treated as QSFs.
Next, Appellees challenge the validity of the regulations. They contend
that the statute authorizing the QSF regulations is an unconstitutional delegation
of legislative power, that the QSF regulations go beyond what is permitted by the
authorizing statute, and that the regulations cannot be applied here because such
application would violate a United States treaty with Germany. Finally, they
argue that the Estate should be taxed as a liquidating grantor trust and that its
capital gains should be offset by the investors’ losses.
We now address each of the arguments. “We review the district court’s
interpretation of federal statutes and regulations de novo . . . .” Seneca-Cayuga
Tribe of Okla. v. Nat’l Indian Gaming Comm’n, 327 F.3d 1019, 1030 (10th Cir.
2003) (internal citation omitted). The pertinent facts are undisputed.
A. Does the Estate Satisfy the QSF Criteria?
1. Subparagraph (1)
A fund satisfies subparagraph (1) of § 1.468B-1(c) if “[i]t is established
pursuant to an order of . . . a court of law . . . .” Appellees do not dispute that the
Estate was established by an order of the district court. But Claimants contend
that the order could not have created a QSF because it did not conform to District
of Utah Local Rule 67-1(b)(3), which states:
Order of the Court. A designated or qualified settlement
fund will be established by the clerk only on order of the
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court on motion and stipulation by all parties or on
acceptance by the court of the terms of the settlement
agreement. The court reserves the authority to designate
its own outside fund administrator.
D. Utah Civ. R. 67-1(b)(3). They note that the Estate was not created as a QSF by
stipulation or settlement of all parties, as the local rule appears to require.
Although we doubt that a local court rule could alter the requirements for a
fund to be a QSF, we need not decide the matter. Rule 67-1(b)(3) is inapplicable
here. It is merely a provision within Local Rule 67, which governs the deposit,
receipt, and subsequent treatment of court registry funds, see D. Utah Civ. R. 67-
1, 1 as does Fed. R. Civ. P. 67. The assets of the Estate, however, were not
1
Local Rule 67-1 (a) & (b) state:
RECEIPT AND DEPOSIT OF REGISTRY FUNDS
(a) Court Orders Pursuant to Fed. R. Civ. P. 67. Any party
seeking to make a Rule 67 deposit, with the exception of criminal
cash bail, cost bonds, and civil garnishments, must make application
to the court for an order to invest the funds in accordance with the
following provisions of this rule.
(b) Provisions for Designated or Qualified Settlement Funds
(1) By Motion. Where the parties jointly seek to deposit funds into
the court's registry to establish a designated or qualified settlement
fund under 26 U.S.C. § 468B(d)(2), the parties must identify the
deposit as such in a joint motion and stipulation for an order to
deposit funds in the court's registry. Such motion also must
recommend to the court an outside fund administrator who will be
responsible for (i) obtaining the fund employer identification
(continued...)
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deposited into the district court’s registry, but were held by the United States.
2. Subparagraph (2)
The United States contends that the Estate satisfies subparagraph (2) of
§ 1.468B-1(c) because it was “established to resolve or satisfy one or more
contested or uncontested claims that have resulted or may result from an event (or
related series of events) that has occurred and that has given rise to at least one
claim asserting liability . . . [a]rising out of a tort, breach of contract, or violation
of law.” Treas. Reg. § 1.468B-1(c)(2). Appellees challenge that contention on
two grounds. One ground, supported by alternative arguments, is that the Estate
1
(...continued)
number, (ii) filing all fiduciary tax returns, (iii) paying all applicable
taxes, and (iv) otherwise coordinating with the fund depository to
ensure compliance with all IRS requirements for such funds.
(2) By Settlement Agreement. Where the parties enter into a
settlement agreement and jointly seek to deposit funds into the
court's registry to establish a designated or qualified settlement fund
under 26 U.S.C. § 468B(d)(2), the settlement agreement and
proposed order must (i) identify the funds as such, and (ii)
recommend to the court an outside fund administrator whose
responsibilities are set forth in subsection (b)(1) of this rule.
(3) Order of the Court. A designated or qualified settlement fund will
be established by the clerk only on order of the court on motion and
stipulation by all parties or on acceptance by the court of the terms of
the settlement agreement. The court reserves the authority to
designate its own outside fund administrator.
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cannot be a QSF because it does not extinguish the claims—the Estate has far too
little money to compensate the claimants fully and the claimants are not required
to release anyone from liability. The alternative arguments are (1) that one cannot
“resolve or satisfy” a claim without extinguishing it, and (2) that the liabilities at
issue are “for the provision of services or property,” and the regulations explicitly
require that a fund extinguish those liabilities if it is to be considered a QSF.
Their second ground is that the liabilities at issue here cannot be predicate
liabilities for a QSF, because they do not “[a]ris[e] out of a tort, breach of
contract, or [other] violation of law,” and are of a type explicitly excluded by the
regulation from being predicate liabilities. We now address their arguments.
a. Failure to Extinguish Liabilities
(i) “Resolve or Satisfy”
Claimants assert that the Estate cannot “resolve or satisfy” claims unless
the claims are extinguished, either by full payment or release. The United States
concedes that a claim cannot be “satisfied” unless it is extinguished and that
distributions from the Estate will neither fully pay the victims’ claims nor result
in releases from liability by the victims. It argues, however, that “resolve” in this
context means only “to reach a decision about.”
We take a different approach. Subparagraph (2) requires that a QSF be
“established to resolve or satisfy one or more . . . claims.” Treas. Reg. § 1.468B-
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1(c)(2). In our view, the words “established to” are the key. When we say that a
program has been “established to” do something, we do not necessarily mean that
the program will fully accomplish that task, or even that we expect the task to be
fully accomplished. We may be merely stating the aim, the direction, of the
program. One could say that the War on Poverty was established to eradicate
poverty or that the United Nations was established to end military conflict, even
though partial success would be considered a victory. More closely in point,
mediation programs, even settlement conferences, can be said to be “established
to settle disputes”; yet no one expects all disputes to be settled, and partial
resolution would be welcome.
Of course, an institution “established to” do something may invariably
accomplish that task. Courts are established to resolve disputes; and, for better or
worse, they do so. The point here is only that the phrase “established to resolve
or satisfy. . . claims” is ambiguous. It may mean that all claims are to be resolved
or satisfied; or it may mean only that the institution is directed toward that end,
and partial resolution or satisfaction, or even failure, is a potential result. To
determine the meaning of this ambiguous language, we look for clues elsewhere
in the regulations. See OXY USA, Inc. v. Babbitt, 268 F.3d 1001, 1005 (10th Cir.
2001) (en banc) (court deciphers the meaning of a particular statutory provision
by “considering the language and structure of the statute as a whole”).
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One compelling clue comes from the section of the regulations dealing with
liabilities for the provision of services or property. The section’s general rule is
that such a liability cannot be the predicate liability for a QSF unless the fund
extinguishes the liability, although there is a limited exception for liabilities
under the Comprehensive Environmental Response, Compensation, and Liability
Act (CERCLA). The language is as follows:
Resolve or satisfy requirement—(1) Liabilities to
provide services or property. Except as otherwise
provided in . . . [subsection (2) below], a liability is not
described in paragraph (c)(2) of this section [the section
describing the resolve-or-satisfy requirement generally]
if it is a liability for the provision of services or
property, unless the transferor’s obligation to provide
services or property is extinguished by a transfer or
transfers to the fund, account, or trust.
(2) CERCLA liabilities. A transferor’s liability under
CERCLA to provide services or property is described in
paragraph (c)(2) of this section if following its transfer
to a fund, account or trust the transferor’s only
remaining liability to the Environmental Protection
Agency (if any) is a remote, future obligation to provide
services or property.
Treas. Reg. § 1.468B-1(f) (emphasis added). That the drafters chose specifically
to require extinguishment when the transferor has an obligation to provide
services or property suggests that extinguishment is not generally required.
Indeed, if we were to reach the opposite conclusion—that the phrase “resolve or
satisfy” creates a complete-extinguishment requirement for all predicate
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liabilities—the specific requirement would be rendered superfluous, a result to be
avoided, see OXY USA, 268 F.3d at 1006 (“We must avoid, whenever possible, a
statutory interpretation that would render superfluous other provisions in the same
enactment.” (internal quotation marks omitted)).
Claimants respond that because a fund does not need to extinguish
completely a transferor’s liability for the provision of services or property when
that liability arises under CERCLA, the drafters found it necessary to reiterate (in
the services-or-property provision) that complete extinguishment is generally
required. A dispositive problem with this theory, however, is that the purported
clarification comes before the exception has been announced. We cannot believe
that the drafters were so obtuse.
Moreover, there is a reason why the regulations distinguish between
obligations to pay money and obligations to provide services or property. As the
IRS explained when the final QSF regulations were promulgated, paragraph (f)(1)
was added to maintain consistency with the general rules set forth in 26 U.S.C.
(I.R.C.) § 461 regarding when an accrual-basis taxpayer can claim a deduction.
See Settlement Funds, 57 Fed. Reg. 60,983, 60,985 (Dec. 23, 1992). Under
§ 461(h)(2)(B) a liability of the taxpayer to provide property or services is not
incurred until “the taxpayer provides such property or services.” (So, for
example, a taxpayer that assumes in 1990 an obligation to remove a drilling
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platform in 1998 does not “incur” the $200,000 removal cost until the actual
removal in 1998, even if it prepaid most of the removal cost to a service company
in 1990. See Treas. Reg. § 1.461-4(d)(7) Ex. 1.)
Example 1 in the regulation also illustrates that extinguishment is not
generally required. “[E]xamples set forth in regulations remain persuasive
authority so long as they do not conflict with the regulations themselves.” Cook
v. Comm’r, 269 F.3d 854, 858 (7th Cir. 2001). The example states:
In a class action brought in a United States federal
district court, the court holds that the defendant,
Corporation X, violated certain securities laws and must
pay damages in the amount of $150 million. Pursuant to
an order of the court, Corporation X transfers $50
million in cash and transfers property with a fair market
value of $75 million to a state law trust. The trust will
liquidate the property and distribute the cash proceeds to
the plaintiffs in the class action. The trust is a qualified
settlement fund because it was established pursuant to
the order of a federal district court to resolve or satisfy
claims against Corporation X for securities law
violations that have occurred.
Treas. Reg. § 1.468B-1(k). Significantly, the trust was a QSF despite the deposit
of $25 million less than the court had awarded. Claimants seek to avoid the
import of this example by arguing that because the assets in the example were
transferred “[p]ursuant to an order of the court,” the defendant “satisfied or
discharged” the judgment and would have been insulated from actions to recover
the remaining $25 million under Fed. R. Civ. P. 60(b)(5). They suggest that the
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deficiency was attributable to a compromise in lieu of an appeal, or the
corporation’s lack of additional assets. Claimants’ argument, however, is founded
on pure speculation. Example 1 nowhere states that the court ordered the transfer
of only $125 million, that the parties compromised, or that Corporation X lacked
sufficient assets to satisfy the entire judgment. Nor can we see any reason for the
example to speak of a $125 million payment, rather than the full $150 million, if
the $125 million fully absolved the defendant of liability. We can only infer that
the drafters created the $25 million deficiency specifically to illustrate that a fund
can qualify as a QSF even if it does not completely extinguish a transferor’s
liability.
Reinforcing our conclusion further is a comparison of the QSF regulations
with the earlier statute creating the entity known as a Designated Settlement Fund
(DSF), an entity which we will have reason to discuss later in more detail. The
statute provides that to be a DSF, a fund must both have “the principal purpose of
resolving and satisfying . . . claims,” I.R.C. § 468B(d)(2)(D), and “extinguish[]
completely the taxpayer’s tort liability with respect to [those] claims,” id.
§ 468(d)(2)(A). If “extinguish completely” and “resolve and satisfy” were
synonymous, there would have been no need to include both phrases in the DSF
statute. And if “resolve and satisfy” does not necessarily mean “completely
extinguish” in the DSF statute, it is logical to conclude that “resolve or satisfy,” the
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phrase used in the QSF regulations, also stands for something less than complete
extinguishment.
In light of the services-or-property section, Example 1, and the DSF statute,
we hold that the QSF regulations do not create a complete-extinguishment
requirement. Thus, the Estate can still be a QSF even though the victims will not
be completely compensated for their injuries and their claims may therefore
survive.
(ii) Liability for the Provision of Services or Property
As previously noted, “a liability for the provision of services or property”
cannot be the predicate liability for a QSF “unless the transferor’s obligation to
provide services or property is extinguished by a transfer or transfers to the
[purported QSF].” Treas. Reg. § 1.468B-1(f)(1). The Receiver contends that this
provision “applies when the basis of liability underlying the claim arises from the
sale of property or services.” Rec. Br. at 34. Because the victims’ claims arise out
of the sale of securities and the provision of brokerage services, he reasons, they
would therefore come within the provision.
We disagree. Paragraph (f)(1) does not speak of the source of the liability.
Rather, it comes into play when the transferor has an “obligation to provide
services or property.” Perhaps there was at one time an obligation with respect to
some of the victims to provide them with the securities they had paid for, but that is
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not the obligation addressed by the Estate. After the plan to return securities to
Wellshire on behalf of the victims was terminated, the Estate was created to
compensate the victims for their financial losses. The obligations being satisfied
(at least in part) by the Estate were the obligations to refund the purchase price of
the securities. The Estate’s purpose was not to pay for services or property to be
provided to the victims. Therefore, paragraph (f)(1) is not applicable.
b. Predicate Liabilities
Appellees contend that the liabilities here do not “[a]ris[e] out of a tort,
breach of contract, or violation of law,” as required by Treas. Reg. § 1.468B-
1(c)(2), and are in fact liabilities excluded by § 1.468B-1(g).
(i) “Arising out of a tort, breach of contract, or
violation of law”
On the first point, Appellees appear to argue as follows: (1) the claims here
sound in restitution, since the sole purpose is to refund, to the extent possible, the
victims’ original investments; and (2) a cause of action for restitution does not
arise “out of a tort, breach of contract, or violation of law.” We are not persuaded.
We agree that the victims have a cause of action for restitution (often called “unjust
enrichment”). But even if liability for unjust enrichment does not come within the
language of the QSF regulations, an issue we need not address, the fact that the
victims have such claims is unimportant because a claim for unjust enrichment can
coexist with a claim sounding in tort, contract, or violation of law. See, e.g.,
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Restatement (Third) of Restitution and Unjust Enrichment § 13 cmt. a (Tentative
Draft No. 1, 2001) (“In the case of a contractual transfer . . . , the consequences of
fraudulent inducement may be simultaneously a part of contract law and of the law
of restitution.”). Here, the fraudulent transactions give rise not only to claims for
unjust enrichment, but also to common-law claims in fraud and contract, as well as
claims for securities fraud. And for each of these claims a potential remedy is
refunding the amount of the original investment. See Dan B. Dobbs, Law of
Remedies § 9.1 (2d ed. 1993) (fraud); id. § 12.1(1) (contract); id. § 9.2(1)
(securities fraud). Thus, the victims’ “claims . . . result from . . . event[s] . . . that
ha[ve] given rise to . . . claim[s] asserting liability . . . [a]rising out of a tort, breach
of contract, or violation of law.” Treas. Reg. § 1.468B-1(c)(2).
(ii) Excluded Liabilities
As for Appellees’ claim that the QSF regulations explicitly exclude the
liabilities here from being the predicate for treating the Estate as a QSF, they rely
on the exclusions in Treas. Reg. § 1.468B-1(g)(2) & (g)(3).
Before addressing each exclusion, we reject the Receiver’s suggestion that
the United States waived its right to respond to these (and other) arguments when it
did not discuss them in its opening brief. These arguments do not relate to the
basis of the district court’s ruling; they raise potential alternative grounds for
affirming that ruling. When an appellee raises in its answer brief an alternative
-22-
ground for affirmance, the appellant is entitled to respond in its reply brief. See
Sadeghi v. INS, 40 F.3d 1139, 1143 (10th Cir. 1994).
Section 1.468B-1(g)(2) excludes “obligation[s] to refund the purchase price
of, or to repair or replace, products regularly sold in the ordinary course of the
transferor’s trade or business.” In our view, this provision does not apply here
because the word “products,” as used in the provision, refers to tangible goods, not
intangibles like investments in securities. This is one of the common usages of the
word. See, e.g., Restatement (Third) of Torts: Products Liability § 19(a) (1998)
(“A product is tangible personal property distributed commercially for use or
consumption.”); 15 U.S.C. § 2301(1) (Magnuson-Moss Warranty Act) (“The term
‘consumer product’ means any tangible personal property which is distributed in
commerce and which is normally used for personal, family, or household
purposes . . . .”). And this usage fits the context. Consider the three obligations
referenced in the provision. Certainly, businesses do not “repair” intangibles, and
an obligation to “replace” one is rare, if not nonexistent. To be sure, there are
occasions, as in this case, when a business can incur an obligation to refund the
purchase price of an intangible. But this provision was intended to prevent
taxpayers from taking advantage of favorable tax treatment of QSF’s when dealing
with “certain regularly recurring liabilities,” Settlement Funds, 57 Fed. Reg. 5399,
5401 (Feb. 14, 1992); and any enterprise that regularly incurs obligations to refund
-23-
the purchase price of intangibles (obligations that are most likely to result from
fraud or a statutory violation) is better referred to as a “racket” than by the
regulation’s terms “trade” or “business.”
If the intent were to include intangibles, we believe the drafters would have
used language specifically conveying that meaning. We note that in the
immediately preceding paragraph, the drafters used the word “property.” See
§ 1.468B-1(f)(1) (“Liabilities to provide services or property.”). Use of the word
“product” in paragraph (g) suggests a narrower focus. The liabilities here do not
arise out of the sale of tangible goods and are therefore not encompassed by this
provision.
In their petition for rehearing en banc, Appellees argue that certificated
securities are tangible. But the enterprises of Brown and Kuhlen were not in the
business of selling stock certificates; they were selling investments. We are
confident that § 1.468B-1(g)(2) does not apply to the circumstances of this case.
Cf. In re Oakley, 344 F.3d 709 (7th Cir. 2003) (currency is not “tangible property”
for purposes of Indiana’s debtor exemptions).
Turning to § 1.468B-1(g)(3), it excludes “obligation[s] of the transferor to
make payments to its general trade creditors or debtholders that relate[] to a title 11
or similar case.” As the United States acknowledges, a receivership is a “similar
case.” See I.R.C. § 368(a)(3)(A)(ii). Nevertheless, the victims are neither general
-24-
trade creditors nor debtholders of any of the perpetrators of the fraud or their
enterprises.
Addressing first the term “general trade creditors,” the word “general,” when
used to modify “creditor,” simply means “unsecured.” See Black’s Law Dictionary
375 (7th ed.1999). And the term “trade creditors” refers to those to whom a debt is
owed for the provision of goods (or perhaps goods or services) used in the conduct
of one’s business. See, e.g., David W. Pearce, The Dictionary of Modern
Economics 430 (1981) (“Trade Credit” is “[c]redit extended by a trader or producer
to his customers through terms of sale which allow payment at some time after the
actual transfer of the goods”); 12 C.F.R. Pt. 202, Supp. I, ¶ 9(a)(3) (Federal
Reserve Board official staff interpretation of Regulation B, relating to the Equal
Credit Opportunity Act, states: “The term trade credit generally is limited to a
financing arrangement that involves a buyer and a seller—such as a supplier who
finances the sale of equipment, supplies, or inventory; . . . .”); R. J. Shock &
Robert L. Shock, The Wall Street Dictionary 428 (1990) (Trade credit is “[a]n
account that a supplier keeps for the company buying its goods or services”); In re
Stratford of Texas, Inc., 635 F.2d 365, 367 (5th Cir. 1981) (“their indebtedness was
to trade creditors, i.e., suppliers of goods and services for these operations”).
Thus, the victims are not “general trade creditors.”
As for the term “debtholders,” it does not refer to just any creditors owed a
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debt, but only to those who hold a debt instrument. See Gretchen Morgenson &
Campbell R. Harvey, The New York Times Dictionary of Money and Investing 74
(2002). The victims are not debtholders.
Our rejection of an overly expansive interpretation of the terms “general
trade creditors” and “debtholders” is supported by the statement in the final
regulations that liabilities are not excluded from the coverage of the QSF
regulations just because they are associated with a title 11 or similar case:
The final regulations exclude claims of general trade
creditors and debtholders that relate to a title 11 or similar
case, or to a workout. However, qualified settlement fund
treatment remains available for other liabilities such as
tort liabilities irrespective of whether the liability, for
example, relates to a title 11 case.
Settlement Funds, 57 Fed. Reg. 60,983, 60,984 (Dec. 23, 1992). In sum, Appellees
cannot find relief in § 1.468B-1(g)(3).
3. Other Arguments that the Fund is not a QSF
a. Absence of a Transferor
Appellees claim that the Estate is not a QSF because those who were the
sources of the assets in the Estate are not “transferors” within the meaning of the
regulations. “A ‘transferor’ is a person that transfers (or on behalf of whom an
insurer or other person transfers) money or property to a qualified settlement fund
to resolve or satisfy claims described in paragraph (c)(2) of this section against that
person.” Treas. Reg. § 1.468B-1(d)(1). The Receiver argues that a transferor must
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own the assets that it deposits in the fund, and that such was not the case here
because the assets transferred were actually owned by the investors. Claimants
appear to argue additionally that a transferor must either (1) claim a deduction
arising from the transfer or (2) be identified by the IRS as entitled to one, and that
neither condition was satisfied here. As we proceed to explain, however, the
requirements that Appellees would impose cannot be found in the QSF regulations,
nor can they be inferred from the operation of the regulations.
(i) Ownership
Under the regulations, assets transferred to a fund for the purpose of
resolving or satisfying claims are “treated as owned by the transferor” until the
fund meets all the requirements for QSF treatment. Treas. Reg. § 1.468B-1(j)(1).
From this provision, the Receiver infers that a person who does not own the
transferred assets is not a “transferor.” We need not, however, determine whether
those who transferred assets to the Estate were actual owners of any of the assets
placed in the Estate because the Receiver’s inference is incorrect.
The tax laws do not require a person to be a true owner in order to be treated
as one. For example, embezzled funds are generally included as gross income, see
James v. United States, 366 U.S. 213, 215, 222 (1961); see also Treas. Reg. § 1.61-
14(a) (“Illegal gains constitute gross income.”), despite the fact that the embezzler
lacks title to the funds and his victims are entitled to restitution, see James, 366
-27-
U.S. at 216. One cannot conclude that just because the transferor may be treated as
the owner for tax purposes, the transferor must in fact be the actual owner.
(ii) Deductibility
Claimants assert that one of the purposes of the QSF regulations is to enable
a taxpayer who transfers property to a QSF to take a tax deduction, and therefore a
QSF cannot be established until the person entitled to a deduction has been
identified. This argument ignores, however, that there are situations in which no
deduction is available. A transferor who is an accrual-basis taxpayer may claim a
deduction if (1) economic performance has occurred, see I.R.C. § 461(h)(2), and
(2) the transferred funds are a deductible expense under another provision of the
Tax Code, see id. § 161; Treas. Reg. § 1.446-1(c)(1)(ii)(A). If the expense itself is
not deductible, the transferor cannot claim a deduction even if, by transferring
assets to the QSF, it has economically performed. Moreover, the transferor may be
a tax-exempt organization, which, of course, takes no deductions. Thus, the
creation of a QSF is not dependent on there being an identified taxpayer who can
take a tax deduction for transfers to the QSF. The IRS’s alleged failure to identify
a transferor entitled to claim a deduction does not prevent the Estate from meeting
the QSF requirements.
b. The Proposed Regulation
For their final assault on the characterization of the Estate as a QSF,
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Appellees rely on a proposed regulation. In February 1999 the IRS issued a notice
that it was considering a regulation that would create a new entity, the Disputed
Ownership Fund (DOF). See Escrow Funds and Other Similar Funds, 64 Fed. Reg.
4801, 4810 (proposed Feb. 1, 1999) (to be codified at 26 C.F.R. pt. 1). According
to Claimants, the Estate satisfies the proposed requirements for a DOF. They
would have us conclude that the apparent need for additional regulations implies
that the QSF regulations do not cover entities described in the DOF regulation.
This argument is defeated by the language of the proposed regulation. The
proposed DOF regulation explicitly recognizes potential overlap with the QSF
regulations by stating that a fund can be a DOF only if it is not a QSF. Id. The
existence of the proposed regulation, therefore, does not in any way alter the
method of determining whether a fund is a QSF.
B. Validity of the QSF Regulations
Appellees contend that even if the Estate satisfies all the requirements to be a
QSF, it still should not be treated as one. They claim that (1) the statutory
authorization for the QSF regulations was an unconstitutional delegation of
authority, (2) the regulations violate the statutory authorization, and (3) application
of the regulations in this case would violate a treaty with Germany. We reject each
argument.
1. Unconstitutional Delegation
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Claimants argue that I.R.C. § 468B(g), the source of Treasury authority to
issue the QSF regulations, is an unconstitutional delegation of legislative power.
To understand the issue, we must examine the history of this provision.
Section 468B(g) is a 1988 amendment to the 1986 statute that created a new
entity called the Designated Settlement Fund (DSF). I.R.C. § 468B. In essence,
the statute provides that a fund is a DSF if (1) it has the principal purpose of
resolving and satisfying claims against the taxpayer, (2) the claims arise out of
personal injury, death, or property damage, (3) it is established pursuant to court
order, (4) it is funded entirely by qualified payments, (5) it is administered by
individuals unrelated to the taxpayer, (6) it completely extinguishes the liabilities
involved, (7) its transferor has elected DSF treatment, and (8) neither its transferor
nor related parties hold beneficial interests in the fund’s income or corpus. I.R.C.
§ 468B(d)(2)(A)-(F). A DSF is subject to taxation at the maximum rate applicable
to trusts, and the tax is directly imposed on the fund itself, not on its transferors or
beneficiaries. Id. § 468B(b)(1). Under the DSF rules, a person “economically
performs” by making a “qualified” payment to the DSF. Id. § 468B(a). Thus, the
DSF’s transferor can immediately claim a deduction for the amount contributed and
does not need to wait until the funds are distributed to the beneficiaries.
Because DSF treatment is elective and the statute’s requirements are
relatively strict, many settlement funds do not qualify as DSFs. Congress addressed
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taxation of these other settlement funds in 1988 when it added the challenged
subsection to the DSF statute. That subsection reads:
Nothing in any provision of law shall be construed as
providing that an escrow account, settlement fund, or
similar fund is not subject to current income tax. The
Secretary [of the Treasury] shall prescribe regulations
providing for the taxation of any such account or fund
whether as a grantor trust or otherwise.
Id. § 468B(g).
Under current Supreme Court doctrine, § 468B(g) does not delegate authority
unconstitutionally. The nondelegation doctrine provides “that Congress may not
constitutionally delegate its legislative power to another branch of Government.”
Touby v. United States, 500 U.S. 160, 165 (1991). The doctrine derives from
Article I, § 1 of the Constitution, which states that “[a]ll legislative Powers herein
granted shall be vested in a Congress of the United States.” The nondelegation
doctrine does not, however, prohibit all delegation of authority. Congress may
obtain the assistance of the other branches so long as it provides an “intelligible
principle” to guide the exercise of the delegated authority. Mistretta v.
United States, 488 U.S. 361, 372 (1989) (internal quotation marks deleted)
(upholding power of Sentencing Commission). The Supreme Court has not been
reluctant to find such a principle. See id. at 373-74 (“[W]e have upheld . . .
Congress’ ability to delegate power . . . to determine excessive profits[,] . . . to fix
commodity prices that would be fair and equitable[,] . . . to determine just and
-31-
reasonable [utility] rates[,] . . . [and] to regulate public broadcast licensing ‘as
public interest, convenience, or necessity’ require.” (internal citations omitted)).
Indeed, it is enough if Congress “clearly delineates the general policy, the public
agency which is to apply it, and the boundaries of th[e] delegated authority.” Id. at
372-73 (internal quotation marks omitted). The Court has invalidated statutes
under the nondelegation doctrine only twice, both times in 1935. See A.L.A.
Schechter Poultry Corp. v. United States, 295 U.S. 495 (1935); Panama Refining
Co. v. Ryan, 293 U.S. 388 (1935).
We find no unconstitutional delegation here. In § 468B(g) Congress (1)
expressed its general policy to permit taxation of settlement funds not then taxed
under the DSF regulations, (2) expressly directed the Secretary of the Treasury to
promulgate regulations, and (3) limited the exercise of the Secretary’s authority to
“escrow account[s], settlement fund[s], . . . [and] similar fund[s].” I.R.C.
§ 468B(g). Also, implicit in the delegation of authority was that the regulations
would “fit” within the rest of the tax laws, so that similar cases would be treated
similarly and opportunities for manipulation would be minimized. The delegation
of authority in § 468B(g) was not out of line with other delegations upheld by the
Supreme Court. Indeed, the Court has “‘almost never felt qualified to second-guess
Congress regarding the permissible degree of policy judgment that can be left to
those executing or applying the law.’” Whitman v. Am. Trucking Ass’ns, Inc., 531
-32-
U.S. 457, 474-75 (2001) (quoting Mistretta, 488 U.S. at 416 (Scalia, J.,
dissenting)).
2. Misuse of Delegated Power
Both Appellees argue that the Secretary of the Treasury exceeded his
authority under I.R.C. § 468B(g) because the QSF regulations issued under that
authority rendered other parts of the original statute obsolete. They point out that
under the statute, DSF status is elective, meaning that a fund otherwise meeting the
DSF requirements is not a DSF unless the taxpayer elects DSF treatment. With the
addition of the QSF regulations, however, a fund that has not elected DSF status
but otherwise meets the DSF requirements is a QSF, and is taxed in exactly the
same manner as a DSF.
This argument, however, ignores the scope of the authority granted: “The
Secretary shall prescribe regulations providing for the taxation of any such account
or fund whether as a grantor trust or otherwise.” I.R.C. § 468B(g). The statute
leaves it open to the Secretary of the Treasury to determine the proper taxation of
settlement funds and the like. There is no proviso that taxation must be subject to
an election by the potential taxpayer, any more than there is a proviso that some
other DSF requirement be retained. The regulation did not provide for electivity
because that would result in undesirable complexity and inconsistency of tax
treatment of similar funds, claimants, and transferors. Settlement Funds, 57 Fed.
-33-
Reg. 60,983, 60,984 (Dec. 23, 1992). In our view, the QSF regulations are within
the delegation of authority.
3. Treaty With Germany
Appellees argue that a treaty between the United States and Germany
precludes taxation of the Estate because German investors are the Estate’s
beneficial owners and the treaty generally exempts German investors in
United States securities from taxation on interest income and capital gains derived
from those securities. The argument is flawed because our tax laws distinguish
between taxable entities, like QSFs, and their beneficial owners.
In Maximov v. United States, 373 U.S. 49 (1963), the Supreme Court
examined the taxation of an American trust whose only beneficiaries were British
citizens exempt by treaty from United States taxation. Id. at 50, 52. The
beneficiaries asked that the trust’s gains be exempted from taxation because only
the exempt beneficiaries would experience the economic burden of the tax and such
a result would undermine the treaty’s overriding purpose. Id. at 52. The Court
found that the treaty exempted only United Kingdom “residents,” and that the trust
itself was not a United Kingdom “resident.” Id. at 52-53. It declined to extend
treaty rights to the trust, stating, “Mindful that it is a treaty we are construing, and
giving the [treaty] all proper effect, we cannot, and do not, either read its language
or conceive its purpose as encompassing, much less compelling, so significant a
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deviation from normal word use or domestic tax concepts.” Id. at 52.
Like the treaty at issue in Maximov, the treaty at issue here exempts foreign
“residents” from certain United States taxes. See Convention for the Avoidance of
Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on
Income and Capital and to Certain Other Taxes, August 29, 1989, U.S.-F.R.G., S.
Treaty Doc. No. 101-10 (1991) (the Treaty). “[A]ny entity that is treated as a body
corporate for tax purposes” is a “person,” id. at Art. 3, cl. 1(d)-(e), and therefore
can be a “resident,” id. at Art. 4, cl. 1. The Estate is a “person” because, as a QSF,
it is treated as a corporation with respect to when and how it files its income tax
returns. See Treas. Reg. § 1.468B-2(k). But the Estate is not a German “resident”
because under the Treaty a person is a resident of a foreign state only when “under
the laws of that State, [that person] is liable to tax therein by reason of his
domicile, residence, place of management, place of incorporation, or any other
criterion of a similar nature . . . .” Treaty, Art. 4, cl. 1. Neither Appellee has
argued that under the laws of Germany the Estate owes tax “by reason of [its]
domicile” or otherwise. Under the laws of the United States, however, a QSF is “a
United States person and is subject to tax on its modified gross income.” Treas.
Reg. § 1.468B-2(a) (emphasis added). Thus, the Estate is a resident of the
United States, not a resident of Germany. As such, the Estate is not entitled to
relief from United States taxes under the Treaty. Accordingly, we reject Appellees’
-35-
argument that the Treaty exempts the Estate from taxation.
C. Taxation as a Grantor Trust
The Receiver argues that the Estate is a liquidating grantor trust and should
be taxed under the rules applicable to such an entity, not under the QSF regulations.
The Estate may in fact be a liquidating grantor trust. See Treas. Reg. § 301.7701-
4(d) (“An organization . . . [is] a liquidating trust if it is organized for the primary
purpose of liquidating and distributing the assets transferred to it, and if its
activities are all reasonably necessary to, and consistent with, the accomplishment
of that purpose.”). Whether it is such an entity, however, is irrelevant because
under the regulations a QSF that “could be classified as a trust within the meaning
of [Treas. Reg.] § 301.7701-4 [the section classifying organizations as trusts for
federal tax purposes] . . . [,] is classified as a qualified settlement fund for all
purposes of the Internal Revenue Code.” Treas. Reg. § 1.468B-1(b) (emphasis
added).
D. Offsetting
The Receiver’s final argument is that even if the Estate qualifies as a QSF, it
does not have taxable gain because the investors’ losses of more than $40 million
offset any gains that the Estate may have enjoyed. It is not clear that this issue was
raised below. In any event, the argument fails because the Estate’s gains or losses
are not determined with reference to the beneficiaries’ gains and losses. The
-36-
Estate’s gain or loss with respect to a particular asset is the difference between the
value of the asset when the Estate received it and the value of the asset when the
Estate distributed or sold it. See Treas. Reg. § 1.468B-2(b),(e),(f). We therefore
reject the Receiver’s offsetting-loss theory.
IV. CONCLUSION
We REVERSE the district court’s determination that the Estate is not a QSF.
We REMAND for proceedings consistent with this opinion to determine the
amount of income tax owed by the Estate as a QSF.
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