Marriott International Resorts, L.P. v. United States , 586 F.3d 962 ( 2009 )

United States Court of Appeals for the Federal Circuit
2009-5007
MARRIOTT INTERNATIONAL RESORTS, L.P.,
and MARRIOTT INTERNATIONAL JBS CORPORATION,
Plaintiffs-Appellants,
v.
UNITED STATES,
Defendant-Appellee.
Robert L. Willmore, Crowell & Moring LLP, of Washington, DC, argued for
plaintiffs-appellants. With him on the brief were Harold J. Heltzer and Alex E. Sadler.
Joan I. Oppenheimer, Attorney, Appellate Section, Tax Division, United States
Department of Justice, of Washington, DC, argued for defendant-appellee. With her on
the brief were John A. DiCicco, Acting Assistant Attorney General, Gilbert S.
Rothenberg, Acting Deputy Assistant Attorney General, and Richard Farber, Attorney.
Appealed from: United States Court of Federal Claims
Judge Charles F. Lettow
United States Court of Appeals for the Federal Circuit
2009-5007
MARRIOTT INTERNATIONAL RESORTS, L.P.,
and MARRIOTT INTERNATIONAL JBS CORPORATION,
Plaintiffs-Appellants,
v.
UNITED STATES,
Defendant-Appellee.
Appeal from the United States Court of Appeals of Federal Claims in consolidated case
nos. 01-CV-256 and 01-CV-257, Judge Charles F. Lettow.
___________________________
DECIDED: October 28, 2009
___________________________
Before MAYER, RADER and MOORE, Circuit Judges.
PER CURIAM.
Marriott International Resorts, L.P. and Marriott International JBS Corporation
(collectively, “Marriott”) appeal the decision of the United States Court of Federal Claims
in Marriott International Resorts, L.P. v. United States, 83 Fed. Cl. 291 (2008). The
court determined that in 1994 the obligation to close a short sale qualified as a liability
under I.R.C. § 752 and that the IRS properly adjusted the outside basis of the Marriott
partners for the 1994 tax year to account for the partnership’s assumption of the
obligation to close certain short sales. Therefore, the court granted the United States’
motion for summary judgment and entered judgment for the United States. Marriott Int’l
Resorts, L.P. v. United States, Nos. 01-256-T and 01-257-T (consolidated) (Fed. Cl.
Aug. 28, 2008) (judgment). Marriott, relying primarily on a line of cases from the United
States Tax Court beginning with Helmer v. Commissioner, 34 T.C.M. (CCH) 727 (1975),
argues that as of 1994, the obligation to close a short sale did not qualify as a “liability”
for purposes of I.R.C. § 752.
We review a trial court’s grant of summary judgment de novo, reapplying the
same standard used by the trial court. Ethicon Endo-Surgery, Inc. v. U.S. Surgical
Corp., 149 F.3d 1309, 1315 (Fed. Cir. 1998). We have applied that standard in our
consideration of the record, including the briefs and arguments of counsel, and we
conclude that the Court of Federal Claims correctly determined that the obligation to
close a short sale qualified as a “liability” under I.R.C. § 752 as of 1994. We therefore
affirm, and we adopt the opinion of the Court of Federal Claims for the reasons stated in
its opinion, a copy of which is attached as an Appendix.
AFFIRMED
COSTS
Each party shall bear its own costs.
APPENDIX
Marriott Int’l Resorts, L.P. v. United States, 83 Fed. Cl. 291 (2008).
Nos. 01-256T and 01-257T.
UNITED STATES COURT OF FEDERAL CLAIMS.
(Filed: August 28, 2008)
2009-5007 2
In the United States Court of Federal Claims
Nos. 01-256T & 01-257T (consolidated)
(Filed: August 28, 2008)
********************************
)
MARRIOTT INTERNATIONAL ) Cross-motions for summary judgment
RESORTS, L.P., et al., ) in a tax case; recognition of basis upon
) contribution of assets and liabilities to
Plaintiffs, ) a partnership; 26 U.S.C. §§ 722, 752;
) contingent liabilities; short sales;
v. ) Federal Reserve Board’s
) Regulation T
UNITED STATES, )
)
Defendant. )
)
********************************
Harold J. Heltzer, Crowell & Moring LLP, Washington, D.C., for plaintiff. With him on
the briefs were Robert L. Willmore and Alex E. Sadler, Crowell & Moring LLP, Washington,
D.C.
G. Robson Stewart, Court of Federal Claims Section, Tax Division, United States
Department of Justice, Washington, D.C., for defendant. With him on the brief were Nathan J.
Hochman, Assistant Attorney General, John A. Dicicco, Deputy Assistant Attorney General,
David Gustafson, Chief, and Mary M. Abate, Assistant Chief, Court of Federal Claims Section,
Tax Division, United States Department of Justice, Washington, D.C.
OPINION AND ORDER
LETTOW, Judge.
1
Pending before the court are cross-motions for summary judgment, filed by the parties in
this partnership-taxation case.1 At issue is a claimed tax loss of $71,189,461 on the sale of
Mortgage Notes, as manifested on a partnership tax return. This loss was the planned result of a
series of transactions entered into by Marriott-affiliated entities with the intention of recognizing
a tax loss based upon the premise that the obligation to close a short sale2 is not considered a
liability for partnership-tax-basis purposes.3 The Internal Revenue Service (“IRS” or “the
Service”) took issue with this premise and disallowed the claimed loss. Following extensive
prior proceedings related to discovery and privilege,4 the motions now at issue were filed and
have been fully briefed. A hearing on the cross-motions was held on May 19, 2008, and
supplemental briefs were filed on June 6, 2008. The competing motions accordingly are ready
for disposition.
1
This case arises under the Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No.
97-248, 96 Stat. 324, 648-671 (“TEFRA”) (codified in scattered sections of the Internal Revenue
Code (“I.R.C.”), including especially 26 U.S.C. (“I.R.C.”) §§ 6221-6234). A TEFRA partnership
proceeding provides a means to determine the appropriateness of the partnership’s reporting of
“partnership items” on its annual information return. See McGann v. United States, 81 Fed. Cl.
642, 643-44 (2008). Partnerships are pass-through entities for tax purposes, I.R.C. §§ 701, 702,
and when the IRS disagrees with a partnership’s reporting of any partnership item, it must issue a
Final Partnership Administrative Adjustment (“FPAA”) before making any assessments against
the partners attributable to such an item. See I.R.C. §§ 6223(a)(2), (d)(2), 6225(a). The timely
mailing of the FPAA suspends the running of the limitations period for assessing any income
taxes that are attributable to any partnership item or affected item. I.R.C. § 6229(d).
2
A short sale has been defined as “consisting of two transactions: (1) the taxpayer’s sale
of property (typically, securities) borrowed from another person (typically, a broker), and (2) the
subsequent closing out of the short position by the taxpayer’s delivery of securities to the person
who loaned the securities that were sold.” Salina P’ship v. Commissioner, 80 T.C.M. (CCH)
686, 690 n.5 (2000) (citing 2 Boris Bittker & Lawrence Lokken, Federal Taxation of Income,
Estates and Gifts ¶ 54.3.1, at 54-21 (2d ed. 1990)).
3
Generally, “basis” is a concept that is fundamental to the reporting of gain or loss on a
transaction for tax purposes. Gain or loss is typically calculated by subtracting “basis” from the
“amount realized.” I.R.C. § 1001(a). The “basis” of property is usually the cost of the property
or the value when received, although there are a number of specific exceptions to this general
rule. See I.R.C. §§ 1011-1016.
4
See Marriott Int’l Resorts, L.P. v. United States, 437 F.3d 1302, 1308 (Fed. Cir. 2006)
(holding that the Commissioner of the IRS by formal explicit action could delegate authority to
invoke the deliberative process privilege on the Service’s behalf to an Assistant Chief Counsel).
After this decision, the government submitted for the court’s inspection in camera over 4,000
pages of agency records as to which the deliberative-process privilege was claimed.
2
FACTS5
The parties provided the court with charts that set out the competing federal income tax
consequences of Marriott’s transactions. See Joint Status Report (Oct. 16, 2006), Ex. A (“Joint
Submission”). Subsequently, the government provided a summary setting out specific dates and
dollar amounts for aspects of the transactions. See Exhibit submitted in conjunction with the
hearing held on May 19, 2008 (“Gov’t’s Summary”). These submissions, together with the
parties’ proposed findings of uncontroverted facts and responses, supply a baseline of agreed
facts underpinning the cross-motions for summary judgment.
A. The Transactions
Plaintiff, Marriott International Resorts (“Marriott Resorts”) is a Delaware limited
partnership with its principal place of business located in Montgomery County, Maryland.
Compl. ¶¶ 1, 4.6 For a tax period ending October 28, 1994, Marriott International JBS
Corporation (“JBS”) and Marriott Ownership Resorts, Inc. (“MORI”) were Marriott Resorts’
general partner and limited partner, respectively. Compl. ¶¶ 1, 15. For a tax period ending
December 30, 1994, JBS and Marriott International Capital Corporation (“MICC”) were Marriott
Resorts’ general partner and limited partner, respectively. Defendant’s Proposed Findings of
Uncontroverted Facts (“DPFUF”) ¶ 3. JBS, MORI, and MICC were, at all times relevant to this
case, controlled subsidiaries of Marriott International, Inc (“Marriott International”)7 and Marriott
Resorts was wholly owned initially by MORI and JBS and subsequently by MICC and JBS.
Plaintiffs’ Response to Defendant’s Proposed Findings of Uncontroverted Facts (“PRDPFUF”) at
6, 9-10.
During the periods at issue, MORI engaged in the business of selling timeshare interests
in resort properties. Compl. ¶ 9. As part of this business, MORI offered buyers the opportunity
to finance their purchases by having the buyer execute a promissory note, secured by a mortgage
on the timeshare unit (“Mortgage Notes”). Compl. ¶ 9. The Mortgage Notes issued by MORI to
the purchasers of its time-share units bore interest at a fixed interest rate. See Heltzer Decl., Ex.
5
The recitations that follow do not constitute findings of fact by the court. Instead, the
recitals are taken from the parties’ filings and are undisputed or alleged and assumed to be true
for purposes of the pending motions, except where a factual controversy is explicitly noted.
6
References to “Compl. ¶ __” are to the complaint filed in No. 01-256T. References to
“Compl. in No. 01-257T ¶ __” are to the complaint in No. 01-257T.
7
In October of 1993, Marriott International was spun off from its former parent, Marriott
Corporation. Pls.’ Opp’n to Def.’s Mot. for Summary Judgment and Pls.’ Cross-Mot. for Partial
Summary Judgment (“Pls.’ Cross-Mot.”), Attached Decl. of Harold J. Heltzer (Mar. 25, 2008)
(“Heltzer Decl.”), Ex. 6 (Dep. of M. Lester Pulse, Jr. (Dec. 11, 2002)) at 87; Ex. 7 (Dep. of
Michael E. Dearing (Dec. 12, 2002)) at 24.
3
1 (Pls.’ Resp. to Def.’s First Set of Interrogs. (Oct. 8, 2002) (“Pls.’ Interrog. Resp.”)) at 3; Ex. 2
(Mem. to Growth Committee regarding “Hedging MORI Note Exposure” (Apr. 22, 1994)) at
MAR-008867. On November 22, 1993, MORI and another Marriott entity, MTMG Corporation,
entered into an agreement with Teachers Insurance and Annuity Association of America
(“TIAA”), an unrelated third party, in which the Marriott entities agreed to sell and TIAA agreed
to buy up to $175,000,000 of Mortgage Notes. Def.’s Mot. for Summary Judgment (“Def.’s
Mot.”), Attached Decl. of G. Robson Stewart (Feb. 1, 2008) (“First Stewart Decl.”), Ex. 1
(MTMG Corp. Purchase Agreement, (Nov. 22, 1993)) at 1-2.8
On January 3, 1994, Philip Hamon of the investment banking firm CS First Boston, sent
by facsimile to Lester Pulse, Senior Vice President of Marriott International, a document which
described a series of transactions that might enable Marriott to recognize a loss for Federal
income tax purposes based upon the premise that a short-sale obligation would not be considered
a liability for partnership tax-basis purposes. First Stewart Decl., Ex. 3 (Facsimile from Hamon
to Pulse (Jan. 3, 1994)). The transactions described in the CS First Boston tax document
consisted of the following steps:
• Marriott International sells short two-year Treasury notes and invests the proceeds
in five-year Treasury notes.
• Marriott International, as a limited partner, and a third party, as the general
partner, form a partnership.
• Marriott International contributes the five-year Treasury notes, subject to the
short-sale obligations, to the partnership and the general partner contributes some
cash.
8
MORI’s sale of the Mortgage Notes to TIAA in 1994 was priced to provide TIAA with a
yield of 240 basis points (a 2.4% spread) above the average yields on U.S. Treasury securities
adjusted to a constant maturity of four years. Heltzer Decl., Ex. 2 (Mem. to Growth Committee)
at MAR-008866; Ex. 3 (Mem. to Corp. Growth Comm. entitled “MORI Note Sale to TIAA
Closed” (Dec. 7, 1994)) at MAR-008673. Because the interest rate on the Mortgage Notes was
fixed, and the yield TIAA received at the time of its purchase of the Mortgage Notes changed
with the prevailing interest rate, MORI was exposed to interest-rate risk on the sale of the
Mortgage Notes to TIAA. Heltzer Decl., Ex. 1 (Pls.’ Interrog. Resp.) at 2-5; Ex. 2 (Mem. to
Growth Committee) at MAR-008866-67.
The Mortgage Notes were sold by MORI to TIAA in the form of interests in securitized
portfolios, referred to as “pass-through certificates.” First Stewart Decl., Ex. 1 (MTMG Corp.
Purchase Agreement) at 1. The securitization of the Mortgage Notes involved the use of a
bankruptcy-remote special purpose entity, with Marriott Resorts functioning in that role. Heltzer
Decl., Ex. 1 (Pls.’ Interrog. Resp.) at 3-5. The use of such an entity allowed the securitized
Mortgage Notes to receive a higher credit rating, and thus be sold at a higher price. Heltzer
Decl., Ex. 1 (Pls.’ Interrog. Resp.) at 3-5; Ex 6 (Dep. of M. Lester Pulse, Jr., (Dec. 11, 2002)) at
35-36; Ex. 7 (Dep. of Michael E. Dearing (Dec. 12, 2002)) at 101-02.
4
• The partnership obtains additional assets and subsequently sells the five-year
Treasury notes and closes the short sale obligation on the two-year Treasury notes.
• Marriott International transfers its partnership interest to another Marriott
subsidiary.
• No gain or loss is recognized on the transfer, but the partnership-interest transfer
results in a technical termination of the partnership which causes a deemed
distribution of the assets to each partner and a re-contribution of the assets to a
new partnership.
• The tax basis of the assets takes on the “outside” tax basis of Marriott
International’s interest, i.e., the value of the five-year Treasury notes Marriott
International contributed to the first partnership, which value is not reduced by the
short-sale obligation.9
• The remaining additional assets later are depreciated or are sold, and Marriott
International recognizes the resulting tax losses.
First Stewart Decl., Ex. 3 (Facsimile from Hamon to Pulse); see also First Stewart Decl., Ex. 4
(Letter from Hamon to Michael Dearing (June 24, 1994) (“Intent Letter”)), Ex. 5 (Letter from
Hamon to Dearing (June 24, 1994) (“Agreement Letter”)).
Thereafter, on or about April 25, 1994, MORI established a short position in five-year
Treasury securities with a face amount of $65,000,000 (“First Short Sale”). Compl. ¶ 13. The
First Short Sale was executed through CS First Boston. First Stewart Decl., Ex. 6 (Letter from
Brit Bartter, CS First Boston, to Dearing (July 8, 1994)) at 1. MORI received cash proceeds in
the amount of $63,703,816 that were invested in repurchase obligations (“Repos”) yielding a
fixed return. Compl. ¶ 13; Gov’t’s Summary.10
On May 9, 1994, JBS was incorporated in the State of Delaware.11 On May 10, 1994,
MORI and JBS entered into a partnership agreement and created Marriott Resorts with the filing
of a Certificate of Limited Partnership. First Stewart Decl., Ex. 8 (Marriott Resorts Limited
Partnership Agreement).12 JBS was the general partner of Marriott Resorts holding a 1% interest,
9
The distinction between a partner’s “outside” basis in its partnership interest and the
partnership’s “inside basis” is addressed infra, at 12-13.
10
The Repos were repurchase transactions in 30-day Eurodollar equivalent investments
adjusted to the prevailing 30-day LIBOR rate. First Stewart Decl., Ex. 4 (Intent Letter).
11
Although the Complaint recites the date of incorporation as May 6, 1994, documentary
evidence shows that incorporation actually occurred on May 9, 1994. See First Stewart Decl.,
Ex. 7 (Certificate of Incorporation of Marriott International JBS Corporation).
12
The Complaint states this date as May 6, 1994, but documentary evidence indicates that
it occurred on May 10, 1994. See First Stewart Decl., Ex. 8 (Marriott Resorts Limited
5
and MORI was a limited partner of Marriott Resorts holding a 99% interest. Compl. ¶ 22.
Contemporaneously, MORI contributed to Marriott Resorts (i) the Repos, and (ii) Mortgage
Notes with a face amount of approximately $65,200,000, and Marriott Resorts also assumed
MORI’s obligations to close the First Short Sale. Compl. ¶¶ 16-17; First Stewart Decl., Ex. 8
(Marriott Resorts Limited Partnership Agreement) ¶ 10. JBS also contributed $1,000,000 to
Marriott Resorts. Compl. ¶ 18; Gov’t’s Summary; First Stewart Decl., Ex. 8 (Marriott Resorts
Limited Partnership Agreement) ¶ 9.
On or about August 15, 1994, MORI established a short position in five-year Treasury
securities with a face amount of $10,000,000 (“the Second Short Sale”). Compl. ¶ 14. The
Second Short Sale was also executed through CS First Boston. First Stewart Decl., Ex. 10
(Facsimile from Timothy Lu, CS First Boston, to Dearing (Oct. 12, 1994)) at 2. MORI received
cash proceeds in the amount of $9,463,451 that were invested through CS First Boston in Repos.
Compl. ¶ 14; Gov’t’s Summary. On August 16, 1994, MORI contributed to Marriott Resorts
(i) the Repos and (ii) Mortgage Notes with a face amount of approximately $11,900,000, and
Marriott Resorts also assumed the obligation to close the Second Short Sale. Compl. ¶¶ 19-20;
Gov’t’s Summary. On October 1, 1994, MORI contributed additional Mortgage Notes with a
face amount of approximately $6,200,000. Compl. ¶ 21.
On September 29, 1994, Marriott Resorts closed the First Short Sale with CS First Boston
by using the funds invested in the Repos to purchase replacement Treasury notes with a face
amount of $65,000,000 at a cost of $62,667,034. First Stewart Decl., Ex. 9 (Facsimile from Lu
to Dearing (Sept. 29, 1994)) at 2; Gov’t’s Summary. On October 17, 1994, Marriott Resorts
closed the Second Short Sale with CS First Boston by purchasing replacement Treasury notes
with a face amount of $10,000,000 at a cost of $9,279,811. Compl. ¶ 23; First Stewart Decl., Ex.
10 (Facsimile from Lu to Dearing) at 2, 5.13 The short sales were closed by liquidating the Repos
and using those funds to buy back the Treasury securities, which then were returned to CS First
Boston. Joint Submission at 5; Gov’t’s Summary. In connection with the transactions related to
the short sales and Repos, Marriott paid CS First Boston a “structuring fee” of $200,000 and
expenses of $22,540.22, for a total transaction cost of $222,540.22. First Stewart Decl., Ex. 6
(Letter from Bartter to Dearing (July 8, 1994)) at 2, Ex. 9 (Facsimile from Lu to Dearing (Sept.
29, 1994)) at 2, Ex. 11 (Marriott Resorts’ partnership return (Form 1065) for the taxable year
ended Oct. 28, 1994) at 3. In addition, the trading price of the transactions included a bid-ask
spread of $50,000. First Stewart Decl., Ex. 9 (Facsimile from Lu to Dearing) at 2.
On October 28, 1994, MORI transferred its entire partnership interest in Marriott
Resorts to MICC. Joint Submission at 6; Compl. ¶ 24. The transfer of MORI’s interest in
Marriott Resorts to MICC triggered a technical termination of Marriott Resorts under I.R.C.
Partnership Agreement) at MAR-009198.
13
The net gain on the short sales reported by Marriott Resorts after trading and transaction
costs was $819,532.
6
§ 708(b)(1)(B). Joint Submission at 7; Compl. ¶ 25. Under I.R.C. § 708(b)(1), the termination
resulted in a deemed distribution of Marriott Resorts’s assets to its partners (JBS and MICC)
followed by the creation of a new partnership by JBS and MICC, and contribution of the assets
previously held by Marriott Resorts to the new partnership, which also was named Marriott
Resorts. Compl. ¶ 26. The actual assets held by Marriott Resorts prior to, and after, the
termination consisted of the Mortgage Notes, $1 million cash, and a receivable with a face
amount of $3,303,164. Compl. ¶¶ 26, 28.
Prior to the termination, MICC had a purported basis of $159,444,635 in its interest in
Marriott Resorts (i.e., not reduced by the obligation to close the short sales by purchasing
replacement Treasury securities), attributable to the bases of the Mortgage Notes, the Repos, and
minor adjustments due to Marriott Resorts’ operations (i.e., interest and investment income).
Compl. ¶ 27. After the termination, JBS’s and MICC’s partnership bases were allocated to the
new Marriott Resorts’ assets (the Mortgage Notes, cash, and the receivable). Compl. ¶ 29. Thus,
the new Marriott Resorts was assigned a purported basis in the Mortgage Notes of $155,141,472.
Compl. ¶ 29.
On or about November 14, 1994, Marriott Resorts conveyed the Mortgage Notes to a
grantor trust and received a certificate representing all of the interest in the trust other than the
residual interest. Compl. ¶¶ 30-31. On the same date, Marriott Resorts sold to TIAA the
certificate for $81,974,204 less transaction fees of $522,093, for a net amount realized of
$81,452,111. Compl. ¶ 31. The purported basis of the certificate of interest in the timeshare
mortgages sold to TIAA was $150,894,679 (i.e., not reduced by the obligation to close the short
sales by purchasing replacement Treasuries), and on its partnership return (Form 1065) for the
period ended December 30, 1994, Marriott Resorts reported a loss on the sale of the interest in
the timeshare mortgages of $71,189,461. First Stewart Decl., Ex. 12 (Marriott Resorts’ Form
1065 for the taxable year ended Dec. 30, 1994); Gov’t’s Summary.14
B. Disallowance by the IRS
On February 2, 2001, the IRS issued an FPAA with respect to Marriott Resorts’ taxable
year ended October 28, 1994. Compl. ¶ 35 and Ex. A (FPAA). In the FPAA, for Marriott
Resorts’ October 28, 1994, taxable year, the IRS reduced the partnership basis by $75,000,000 to
reflect the obligation to complete the short sale by returning the Treasury notes to CS First
Boston. Compl. Ex. A.
14
In its Complaint, Marriott states that the loss on the sale of the interest in the timeshare
mortgages was $69,442,568 ($81,452,111 minus $150,894,679). Compl. ¶ 33. Plaintiffs’
position is that the loss alleged in the Complaint is correct. PRDPFUF at 11 n.1. Both parties
agree that the difference is immaterial to the resolution of the pending motions. Def.’s Mot. at 12
n.15; PRDPFUF at 11 n.1.
7
Also on February 2, 2001, the IRS issued an FPAA with respect to Marriott Resorts’s
taxable year ended December 30, 1994. Compl. in No. 01-257T ¶ 35 and Ex. A (FPAA). In the
FPAA for Marriott Resorts’ December 30, 1994 taxable year, the IRS determined that Marriott
Resorts realized a gain on the sale of the Mortgage Notes of $1,757,378, not the loss reported on
the Marriott Resorts’ Form 1065 of $71,189,461. This determination was based on the reduction
in the partnership basis of $75,000,000 which reflected the obligation to return Treasury notes to
CS First Boston. Compl. in No. 01-257T Ex. A.
JURISDICTION
Marriott Resorts and JBS filed their complaints in this court pursuant to 28 U.S.C. § 1508and I.R.C. § 6226. In accord with I.R.C. § 6226(e)(1), Marriott Resorts and JBS deposited funds
with the Secretary of the Treasury in amounts that at least equaled the tax liability including
interest that would arise if the treatment of the partnership items on Marriott Resorts’ return was
made consistently with the FPAAs. Compl. ¶ 7; Compl. in No. 01-257T ¶ 7.
STANDARD FOR DECISION
Summary judgment is appropriate only if “there is no genuine issue as to any material fact
and . . . the moving party is entitled to a judgment as a matter of law.” Rule 56(c) of the Rules of
the Court of Federal Claims; see Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 247-49 (1986).
The moving party carries the burden of establishing that no genuine issue of material fact exists.
Celotex Corp. v. Catrett, 477 U.S. 317, 322-23 (1986). A “genuine” dispute is one that “may
reasonably be resolved in favor of either party.” Anderson, 477 U.S. at 250. A material fact is
one that “might affect the outcome of the suit under the governing law.” Id. at 248. In
considering the existence of a genuine issue of material fact, a court must draw all inferences in
the light most favorable to the non-moving party. Matsushita Elec. Indus. v. Zenith Radio Corp.,
475 U.S. 574, 587 (1986). If no rational trier of fact could find for the non-moving party, a
genuine issue of material fact does not exist and the motion for summary judgment may be
granted. Id.With respect to cross-motions for summary judgment, each motion is evaluated on its
own merits and reasonable inferences are resolved against the party whose motion is being
considered. Mingus Constructors, Inc. v. United States, 812 F.2d 1387, 1391 (Fed. Cir. 1987).
To the extent there is a genuine issue of material fact, both motions must be denied. Id.ANALYSIS
This case turns on I.R.C. § 752, which governs the change in basis that occurs when a
partner’s liabilities are either increased or decreased.15 The government asserts that under I.R.C.
15
In full, Section 752 provides:
§ 752. Treatment of certain liabilities
8
§ 752, “[Marriott Resorts] must include in its partnership basis the short sale obligations it
‘assumed’ from [MORI], because [(1)] the short sale obligations to replace the borrowed
Treasury Notes are legal liabilities secured by the proceeds from the Treasury short sale, and [(2)]
the proceeds from the short sales quantify the amount of liability for purposes of § 752,
irrespective of the term of the underlying securities.” Def.’s Supp. Br. at 2. In opposition,
Marriott contends that the obligation to close a short sale is not a “liability” under I.R.C. § 752
for the purposes of calculating partnership basis. Pls.’ Cross-Mot. at 1.
A. Short Sales
In a short sale, the seller trades securities that he does not own, “seek[ing] to profit by
trading stocks which he expects to decline in value.” Zlotnick v. TIE Commc’ns, 836 F.2d 818,
(a) Increase in partner’s liabilities. Any increase in a partner’s
share of the liabilities of a partnership, or any increase in a
partner’s individual liabilities by reason of the assumption by
such partner of partnership liabilities, shall be considered as a
contribution of money by such partner to the partnership.
(b) Decrease in partner’s liabilities. Any decrease in a partner’s
share of the liabilities of a partnership, or any decrease in a
partner’s individual liabilities by reason of the assumption by
the partnership of such individual liabilities, shall be considered
as a distribution of money to the partner by the partnership.
(c) Liability to which property is subject. For purposes of this
section, a liability to which property is subject shall, to the extent
of the fair market value of such property, be considered as a
liability of the owner of the property.
(d) Sale of exchange of an interest. In the case of a sale or
exchange of an interest in a partnership, liabilities shall be
treated in the same manner as liabilities in connection with the
sale or exchange of property not associated with partnerships.
I.R.C. § 752. Section 752 has remained unchanged since its enactment as part of the Internal
Revenue Code of 1954.
In 1984, Section 752 was affected by enactment of a collateral statute that overruled the
decision rendered in Raphan v. United States, 3 Cl. Ct. 457 (1983), which had interpreted
Section 752. See Pub. L. No. 98-369, Div. A, Title I, § 79, 98 Stat. 597 (July 18, 1984), set out at
I.R.C. § 752 note. Raphan held that a guarantee by a general partner of an otherwise nonrecourse
debt of the partnership did not require the partner to be treated as personally liable for that debt.
3 Cl. Ct. at 465-66.
9
820 (3d Cir. 1988); see also Provost v. United States, 269 U.S. 443, 450-53 (1926).16 In
Zlotnick, the Third Circuit provided a useful description of short sales:
Short selling is accomplished by selling stock which the investor does not yet own;
normally this is done by borrowing shares from a broker at an agreed upon fee or rate of
interest. At this point the investor’s commitment to the buyer of the stock is complete; the
buyer has his shares and the short seller his purchase price. The short seller is obligated,
however, to buy an equivalent number of shares in order to return the borrowed shares. In
theory, the short seller makes this covering purchase using the funds he received from
selling the borrowed stock. Herein lies the short seller’s potential for profit: if the price of
the stock declines after the short sale, he does not need all the funds to make his covering
purchase; the short seller then pockets the difference. On the other hand, there is no limit
to the short seller’s potential loss: if the price of the stock rises, so too does the short
seller’s loss, and since there is no cap to a stock’s price, there is no limitation on the short
seller’s risk. There is no time limit on this obligation to cover.
“Selling short,” therefore, actually involves two separate transactions: the short sale itself
and the subsequent covering purchase.
836 F.2d at 820; see also James W. Christian, Robert Shapiro, & John-Paul Whalen, Naked Short
Selling: How Exposed are Investors?, 43 Hous. L. Rev. 1033, 1041-42 (2006) (describing short
sales).
Short sales are federally regulated. See Levitin v. PaineWebber, Inc., 159 F.3d 698, 705
(2d Cir. 1998). The Securities and Exchange Act of 1934 (the “Act”) provides the general
authority for the imposition of rules with respect to the extensions of credit by brokers and
dealers to customers for purchasing and carrying securities. 15 U.S.C. § 78g(a). The Act directs
the Board of Governors of the Federal Reserve System to prescribe rules and regulations with
respect to the amount of credit that may be initially extended and maintained by a broker or
dealer on any security. Id. Section 10(a) of the Act gives the Federal Reserve Board authority to
regulate short sales and the withdrawals by a customer of funds or securities, 15 U.S.C. § 78j(a);
the Federal Reserve Board promulgated Regulation T in 1938. Levitin, 159 F.3d at 705.
The purpose of Regulation T is “to regulate extensions of credit by and to brokers and
dealers; it also covers related transactions within the Board’s authority under the Act. It imposes,
among other obligations, initial margin requirements and payment rules on securities
16
Although the decision in Zlotnick addresses the short sale of stocks, the same basic
principles apply to a short sale of Treasury notes or other securities. See Kornman v. Assocs.,
Inc. v. United States, 527 F.3d 443, 450-51 (5th Cir. 2008).
10
transactions.” 12 C.F.R. § 220.1(a) (1994).17 The margin requirements are designed to protect
brokerage houses by guaranteeing that their loans to short sellers are repaid. See Cromer Fin.
Ltd. v. Berger, 137 F. Supp. 2d 452, 472 (S.D.N.Y. 2001). Regulation T governs all short sales
executed by United States broker-dealers. 12 C.F.R. §§ 220.1(a), 220.18(c)-(d) (1994).
Under Regulation T, a creditor is “any broker or dealer,” and a customer is any person “to
or for whom a creditor extends, arranges, or maintains any credit.” 12 C.F.R. §§ 220.2(b), (c)
(1994). Thus, CS First Boston is a creditor and MORI is a customer for purposes of Regulation
T. As a creditor, CS First Boston was required to maintain a record for MORI’s account showing
the full details of all transactions. 12 C.F.R. § 220.3(a) (1994). MORI’s short sale transactions
were required to be maintained in a margin account. 12 C.F.R. §§ 220.1(b)(1), 220.4(a)(1)
(1994). MORI was required to post initial margin for the short sales of Treasury notes equal to
100 percent of the market value of the notes the short sale proceeds plus any additional
margin that may have been required by CS First Boston. 12 C.F.R. §§ 220.5(b)(1), 220.12(d)
(1994).18 Only items in MORI’s margin account in which the short sales were conducted could
be considered by CS First Boston to determine whether MORI had posted the required margin
collateral. 12 C.F.R. § 220.3(b) (1994). Moreover, MORI was prohibited from withdrawing any
funds or securities from its CS First Boston margin account if doing so would create or increase
any margin deficiency. 12 C.F.R. § 220.4(e)(1)(ii) (1994); see United States v. Russo, 74 F.3d
1383, 1388 (2d Cir. 1996) (“[A]ny proceeds from the [short] sale are frozen under [Regulation T]
until the seller covers the short sale.”); see also Federal Reserve Staff Opinion, Nov. 21, 1979,
F.R.R.S. 5-693 (stating that even when the short seller covers some of his short sales, the broker
may only release the frozen funds to the extent that the customer’s account balance exceeds the
margin requirements established by Regulation T).
Regulation T thus forms a linkage that binds the two steps of the short-sale transaction
together. The practical effect of Regulation T on short sales was explained by the Second Circuit
in Levitin:
[A] broker who lends a customer stock for a short sale does not typically pay the proceeds
of the sale to the customer to be spent when and how she wants, waiting for the customer
to cover when and if it suits her. If a broker did that, the price might increase and the
customer become insolvent or disappear, leaving the broker out the entire value of the
stock the price at the time of the sale plus its increase. Brokers therefore demand
collateral, usually by taking an amount from the customer’s account equal to the security
17
Citations to Regulation T in this opinion are to the version in effect in 1994 because that
was the date of the transactions at issue.
18
Under Regulation T, a United States Treasury Note is considered an “exempt” security
because it is a government security. 12 C.F.R. § 220.2 (r) (1994); 15 U.S.C. §§ 78c(a)(12), (42).
By contrast, a “nonexempt” security requires a higher initial posted margin, equal to 150 percent
of the market value of the security. 12 C.F.R. § 220.12(c) (1994).
11
required. The proceeds from the sale will, of course, usually be available as security, but
if those proceeds and the balance in the customer’s account are not sufficient to satisfy
the security requirement, the customer will have to post additional collateral. . . . The
collateral posted must satisfy federal margin requirements associated with short trades.
159 F.3d at 700.
In its reply brief, the government has argued that because Regulation T requires collateral
be maintained with the broker-dealer while the short sale is outstanding, it is relevant to the issue
at hand. See Def.’s Reply at 2, 4-5, 17-18. The government contends that “short sale obligations
are binding, secured liabilities because the short sale proceeds are ‘frozen’ as collateral until the
short sales are closed,” “the short sale obligations are [thus] fixed and determinable for
partnership basis purposes on the date the obligations become partnership obligations, and the
amount of the obligations equals the amount of the proceeds from the short sales that were
contributed to [Marriott Resorts].” Def.’s Reply at 2 (citing Rev. Rul. 95-45, 1995-1 C.B. 53).
Accordingly, “[b]ecause [Marriott Resorts] increased its tax basis by the amount of the short sale
proceeds, the corresponding short sale obligation is similar to a conventional purchase-money
financing that would be included in partnership liabilities under [I.R.C.] § 752. . . . Unlike short
sales, a liability that is truly contingent does not immediately create or increase the borrower’s
tax basis in any property precisely because the obligation is contingent.” Def.’s Reply at 18.
Marriott replies that “[t]he existence of collateral . . . does not change the fundamental
reality that the ultimate cost of closing the short sale simply cannot be determined until the
replacement securities have been purchased by the short seller,” and the obligation thus is not
“fixed” in amount. Pls.’ Reply at 6. Rather, Marriott asserts that the margin requirements
fluctuate with the value of the short security subject to a “maintenance margin,” which is not
specifically addressed in Regulation T but rather is established by the applicable Exchange rule,
typically New York Stock Exchange Rule 431 (“NYSE Rule 431”). Pls.’ Supp. Br. at 3 (citing
Charles F. Rechlin, Securities Credit Regulation in 22 West’s Securities Law Series §§ 3:32 &
3:33 (2d ed. 2007); Steven Lofchie, Lofchie’s Guide to Broker-Dealer Regulation 564-65, 569,
589, 596 (2005)). Marriott contends that until the short seller purchases the securities he must
deliver to the broker-dealer to close the short sale, “the cost of closing the short sale is contingent
and undetermined, and the obligation thus cannot constitute a ‘liability’ for purposes of Section
752,” with the consequence that the partnership basis is not adjusted on account of the obligation.
Pls.’ Supp. Br. at 3.
The government responds that Marriott’s argument that a short sale obligation is a
contingent liability “is impossible to square with Regulation T’s requirement that the full market
value of the short sale liability be posted as collateral for the binding obligation to replace the
shorted securities.” Def.’s Supp. Br. at 5.
12
B. “Inside” Basis and “Outside” Basis for Partnerships and Partners
A partnership’s basis in its assets is referred to as its “inside basis,” and a partner’s basis
in his or her partnership interest is called his or her “outside basis.” Kligfeld Holdings v.
Commissioner, 128 T.C. 192, 195-96 (2007). Generally, I.R.C. § 723 provides the rule for
calculating “inside basis”:
The basis of property contributed to a partnership by a partner shall be the adjusted basis
of such property to the contributing partner at the time of the contribution increased by
the amount (if any) of gain recognized under [S]ection 721(b) to the contributing partner
at such time.
I.R.C. § 723. A partner’s basis in the interest it owns in the partnership itself, or “outside basis,”
is governed by I.R.C. § 705 which provides that such basis is calculated by applying I.R.C. § 722
for “contributions to a partnership” or I.R.C. § 742 for “transfers of a partnership interest.”19
Section 722 provides:
The basis of an interest in a partnership acquired by a contribution of property, including
money, to the partnership shall be the amount of such money and the adjusted basis of
such property to the contributing partner at the time of the contribution increased by the
amount (if any) of gain recognized under [S]ection 721(b) to the contributing partner at
such time.
I.R.C. § 722. Apart from Section 721(b), a partnership and its partners do not recognize a gain or
loss if the partner contributes property to the partnership in exchange for a partnership interest.
I.R.C. § 721(a).
C. Applicability of Section 752
1. Statutory language.
Section 752 of the I.R.C. specifies the adjustments that are made in a partner’s basis in
his or her partnership interest to reflect his or her share of the partnership’s liabilities. In relevant
part, Section 752 provides that: “[a]ny increase in a partner’s share of the liabilities of a
partnership, or any increase in a partner’s individual liabilities by reason of the assumption by
19
Section 705 states that once the outside basis is determined under Sections 722 or 742,
the basis is increased by the partner’s respective share of income items. I.R.C. § 705(a)(1). The
basis calculation continues by decreasing basis by (1) “distributions” that are set forth in Section
733, i.e., money or property that the partnership transfers to its partners, (2) “losses of the
partnership,” and (3) certain expenditures of the partnership which are “not deductible in
computing taxable income and not properly chargeable to a capital account.” I.R.C. § 705(a)(2).
13
such partner of partnership liabilities, shall be considered as a contribution of money by such
partner to the partnership.” I.R.C. § 752(a). Conversely, “[a]ny decrease in a partner’s share of
the liabilities of a partnership, or any decrease in a partner’s individual liabilities by reason of the
assumption by the partnership of such individual liabilities, shall be considered as a distribution
of money to the partner by the partnership.” I.R.C. § 752(b). The legislative history does not
address the meaning of the term “liability,” but rather merely explains that Section 752 was
intended to deal with the effect of a partner’s assumption of partnership liabilities and the
partnership’s assumption of a partner’s liabilities. See S. Rep. No. 83-1622, at 405 (1954), as
reprinted in 1954 U.S.C.C.A.N. 4621, 5047; accord H.R. Rep. No. 83-1337, at S236-237 (1954),
as reprinted in 1954 U.S.C.C.A.N. 4017, 4376-77.
In 1994, at the time the transactions at issue in this case occurred, there was no regulatory
definition of “liability” for purposes of Section 752. A revenue ruling and judicial precedents
delineated the statutory framework as it existed during Marriott Resorts’ short sale transactions.
A subsequently issued chain of revenue rulings, Treasury Regulations, and judicial precedents
significantly changed that framework after the transactions at issue here were completed.
2. The Helmer, Long and La Rue decisions.
The first significant interpretation of Section 752 came in Helmer v. Commissioner, 34
T.C.M. (CCH) 727 (1975). In Helmer, a partnership received payments in accord with an
agreement that gave a third-party corporation the option to buy certain real estate in which the
partnership held a two-thirds interest. Id. at 728. During the term of the option agreement, the
partnership retained the right to possess and enjoy profits from the property in question, and there
was no provision in the option agreement for repayment of the amounts paid under the option
agreement should the agreement terminate. Id. at 729. The taxpayers received payments directly
from the third party pursuant to the option agreement during the years in issue, and listed these
amounts as distributions to the taxpayers on the partnership’s books and tax returns. The
taxpayers received partnership distributions during the years in issue, and had the partnership pay
personal expenses, in excess of their adjusted bases in the partnership. Id.
The Tax Court held in Helmer that the option agreement and receipt of the option
payments “created no liability on the part of the partnership to repay the funds paid nor to
perform any services in the future . . . [N]o liability arose under [S]ection 752 and the partners’
bases cannot be increased by such amounts.” 34 T.C.M. (CCH) at 731. The court noted that
there were no provisions in the option agreement for repayment of, or restrictions on, the option
payments. Id. Further, the court emphasized that income attributable to the option payments was
subject to deferral at the partnership level due only to the inability of the partnership to determine
the character of the gain, not because the partnership was subject to a liability to repay the funds
paid or to perform any services in the future. Id.
A few years after Helmer, the Tax Court again considered the reach of Section 752 in
Long v. Commissioner, 71 T.C. 1 (1978), aff’d in part and rev’d in part on other grounds, 660
14
F.2d 416 (10th Cir. 1981). Long addressed an estate’s recognition of taxable gain on the
liquidation of the decedent’s partnership interest. 71 T.C. at 5. The partnership was a
construction company that had pending against it claims in litigation, and the question presented
was whether those claims could be considered liabilities includable in the estate’s outside basis
under Section 752. Id. at 6-7. The Tax Court in Long held that the claims were not sufficiently
definite to be treated as liabilities that could be included in the decedent’s outside basis because
they had been in contested litigation at the time of decedent’s death. Id. at 7-8 (“Although they
may be considered ‘liabilities’ in the generic sense of the term, contingent or contested liabilities
. . . are not ‘liabilities’ for partnership basis purposes at least until they have become fixed or
liquidated. . . . Those liabilities should be taken into account only when they are fixed or paid.”).
This emerging line of precedent was extended ten years later by the Tax Court’s decision
in La Rue v. Commissioner, 90 T.C. 465 (1988). That case concerned reserves reflecting “back
office” errors of a brokerage partnership. The reserves were established to cover the brokerage’s
potential failure to execute trade orders by customers. To correct such errors, the brokerage had
to purchase securities and deliver them to customers. Id. at 468. “Gain or loss was incurred on
these transactions measured by the difference between the customer’s contract price and what the
broker had to pay to obtain the securities.” Id. “The precise amount of gain or loss was not
determinable until the securities in question were actually bought or sold.” Id. at 475. The
question was whether the partnership’s reserves for the “back office” errors was a liability within
the meaning of Section 752 that increased the partners’ outside basis. 90 T.C. at 477-78. The
IRS argued that the reserves were not liabilities for purposes of Section 752. The Tax Court
concurred. Citing its opinion in Long, the court held that the “all-events” test determines when a
liability is includable in basis under Section 752. Id. at 478. As that test would have it, a liability
can only be included in basis “for the taxable year in which all the events have occurred which
determine the fact of liability and the amount thereof can be determined with reasonable
accuracy.” Id. The court concluded that the amount of liabilities was not determinable “until the
securities are actually purchased . . . and the transaction closed.” Id. at 479.
Notably, the Tax Court in Helmer, Long, and La Rue determined in each case that the
obligations at issue were not sufficiently free from contingencies to be deemed liabilities that
would give rise to a change in a partner’s outside basis under Section 752. However, the IRS
soon indicated that there were circumstances in which some degree of contingency would not
prevent recognition of a liability that changed a partner’s basis under Section 752.
3. Revenue Rulings and Treasury Regulations.
Six months after La Rue was decided by the Tax Court, on September 19, 1988, the IRS
issued Revenue Ruling 88-77, 1988-2 C.B. 128, 1988 WL 546796, which defined liability under
Section 752. The ruling states:
For purposes of section 752 of the Code, the terms ‘liabilities of a partnership’ and
‘partnership liabilities’ include an obligation only if and to the extent that incurring the
15
liability creates or increases the basis to the partnership of any of the partnership’s assets
(including cash attributable to borrowings), gives rise to any immediate deduction to the
partnership, or, under section 705(a)(2)(B), currently decreases a partner’s basis in the
partner’s partnership interest.
Rev. Rul. 88-77.
A few months after issuing Revenue Ruling 88-77, the Commissioner issued a temporary
regulation containing a similar definition of “liability” under Section 752:
[U]nder section 752, an obligation is a liability of the obligor for purposes of [S]ection
752 and the regulations thereunder to the extent, but only to the extent, that incurring or
holding such obligation gives rise to
(1) The creation of, or an increase in, the basis of any property owned by the obligor
(including cash attributable to borrowings);
(2) A deduction that is taken into account in computing the taxable income of the
obligor; or
(3) An expenditure that is not deductible in computing the obligor’s taxable income
and is not properly chargeable to capital.
Temp. Treas. Reg. § 1.752-1T(g), 1989-1 C.B. 180, 192, 53 Fed. Reg. 53,140, 53,150-51 (Dec.
30, 1988). However, the final regulations adopted in 1991 omitted any definition of “liability.”
See 1992-1 C.B. 218, 56 Fed. Reg. 66,348 (Dec. 23, 1991). According to the IRS, “[t]his change
was made only for the purpose of simplification and not to change the substance of the
regulation.” IRS Field Service Advisory, 1997 WL 33313960 (Nov. 21, 1997).
Thereafter, in 1995, the Commissioner issued Revenue Ruling 95-26, which addressed
whether a partnership’s short sale of securities creates a liability within the meaning of Section
752. Rev. Rul. 95-26, 1995-1 C.B. 131. The revenue ruling concludes that a liability under
Section 752 includes an obligation to the extent that incurring the liability creates or increases the
basis to the partnership of any of the partnership’s assets, including cash attributable to
borrowings. The Commissioner reasoned that a short sale creates such a liability inasmuch as
(1) the partnership’s basis in its assets is increased by the amount of cash received on the sale of
the borrowed securities, and (2) a short sale creates an obligation to return the borrowed
securities. See Rev. Rul. 95-26, 1995-1 C.B. at 132. In this respect, the Commissioner relied on
Revenue Ruling 88-77. Id. Accordingly, for those partners directly affected by Revenue Ruling
95-26, the Commissioner concluded that the partners’ bases in their partnership interests were
increased under Section 722 to reflect their shares of the partnership’s liability under Section
752.20
20
Revenue Ruling 95-45 held that a corporation’s assumption of its shareholders’
“obligation to deliver replacement securities to close out a short-sale constitutes the assumption
of a liability for purposes of [S]ections 357 and 358 of the Code.” Rev. Rul. 95-45, 1995-1 C.B.
164. Treasury Regulation § 1.752.
On May 26, 2005, the IRS published regulations dealing with the assumption of some
fixed and contingent obligations in connection with the issuance of a partnership interest. Treas.
Reg. § 1.752-1(a)(4)(I) (effective May 26, 2005); see Prop. Treas. Reg. § 1.752-1(a)(1)(ii), 68
Fed. Reg. 37,434, 37,436 (proposed June 24, 2003). These final regulations include a new
definition of liability, expanding the definition to include “any fixed or contingent obligation to
make payment without regard to whether the obligation is otherwise taken into account for
purposes of the Internal Revenue Code.” Treas. Reg. § 1.752-1(a)(4)(ii); see also Treas. Reg.
§ 1.752-6(a); Treas. Reg. § 1.752-7(b)(3). The Treasury Department made this new regulation
and the attendant definition of “liability” retroactive, applying it to all assumptions of “liabilities”
(as newly defined) by partnerships occurring on or after June 24, 2003 (i.e., the date the
regulation was proposed). See Treas. Reg. 1.752-1(a)(4)(iv). In addition, the new regulation also
reached back in part to transactions occurring during the period between October 18, 1999 and
June 24, 2003, by requiring a partner to reduce his basis in his partnership interest by the amount
of any contingent obligation assumed by the partnership between October 18, 1999 and June 24,
2003. See Treas. Reg. § 1.752.6(a), (d). However, unlike the statute, the new regulation “would
not allow the partner to increase his [or her] basis for the share of the new partnership liability.”
Klamath Strategic Inv. Fund, LLC v. United States, 440 F. Supp. 2d 608, 620 & n.9 (E.D. Tex.
2006).
By promulgating the regulation, the government intended to change the law governing
liabilities under Section 752. The regulation itself indicates that it modifies settled law regarding
“liabilities” for Section 752: “The definition of a liability contained in these proposed regulations
does not follow Helmer v. Commissioner, TC Memo 1975-160. (The Tax Court . . . in Helmer
held that a partnership’s issuance of an option to acquire property did not create a partnership
liability for purposes of Section 752.).” See Notice of Proposed Rulemaking, 68 Fed. Reg.
37,434, 37,436 (June 24, 2003).
5. Marriott’s transactions predate regulations.
Generally, retroactive regulations are prohibited, except under limited circumstances. See
I.R.C. § 7805(b)(1)(A), (b)(3) (allowing treasury regulations to operate retroactively to “prevent
abuse”), or (b)(6) (permitting retroactivity if authorized by Congress).21 However, because
53, 1995 WL 335770 (June 6, 1995). Further, “the amount of the short-sale liability is the
amount of basis to which the short sale gave rise.” Id. In other words, “[t]he amount of the
liability assumed equals the proceeds of the original short sale.” Id.; see also IRS Field Service
Advisory, 1997 WL 33313960 (Nov. 21, 1997) (stating that the liability-basis principles
contained in Revenue ruling 95-45 are applicable to partnerships).
21
Courts have struggled with the question whether the retroactivity provisions of Treasury
Regulation § 1.752 are valid and enforceable. Compare Cemco Investors, LLC v. United States,
17
Marriott’s transactions occurred in 1994 and thus predate even the retroactive portions of
Treasury Regulation § 1.752, the new regulatory definition of “liability” put forth in that
regulation does not apply to the case at hand. Rather, the pertinent analysis focuses on the law as
it stood in 1994 at the time of Marriott’s transactions, prior to Revenue Ruling 95-26 and
Treasury Regulation § 1.752.
D. Treatment of Short Sales As Of 1994 Under Section 752
None of the precedents extant at the time of Marriott’s transactions addressed short sales
and the effect of Regulation T. See La Rue, 90 T.C. 465; Long, 71 T.C. 1; Helmer, 34 T.C.M.
(CCH) 727; Rev. Rul. 88-77. The short-sale concept was introduced into an analysis of Section
752 in Revenue Ruling 95-26, which was issued a year after the transactions at issue.
The courts that have addressed the issue of whether short sales involve contingent
obligations have tended to hold that the obligation to close such sales is a liability under Section
752. See, e.g., Kornman Assocs., Inc. v. United States, 527 F.3d 443, 452 (5th Cir. 2008).
However, because of timing, Kornman is not a precedent squarely applicable to Marriott’s
transactions. The transactions here preceded the Revenue Ruling 95-26 while the transactions at
issue in Kornman occurred in 1999, five years after the Revenue Ruling was issued. See
Kornman, 527 F.3d at 447. The Fifth Circuit in Kornman was able to state that the taxpayer
there had adequate notice of the IRS’s position:
We do not believe that the Appellants were unfairly surprised or
prejudiced by the IRS’s challenge to this tax shelter because they
were on notice as early as 1988, and certainly by 1995, that the
IRS considered the obligation to close a short sale to be a liability
under section 752. Revenue Ruling 95-26 is distinguishable from
the earlier cases and revenue rulings cited by the Appellants, and it
is fully consistent with regulations promulgated by the IRS after 1995.
Id. at 462. The same observation could not be made in this instance. Marriott was not put on
explicit notice. Its transaction in 1994 preceded Revenue Ruling 95-26 which addressed short
sales. The earlier revenue ruling issued in 1988, Revenue Ruling 88-77, neither expressly
mentioned short sales nor cited the Federal Reserve Board’s Regulation T.
515 F.3d 749, 752 (7th Cir. 2008) (applying Treas. Reg. § 1.752 retroactively), with Klamath
Strategic Inv. Fund, LLC v. United States, 440 F. Supp. 2d. 608, 619-25 (E.D. Tex. 2006)
(declining to apply Treas. Reg. § 1.752 retroactively). See generally Jade Trading LLC v. United
States, 80 Fed. Cl. 11, 44-45 & n.64 (2007) (opining that a “sold call option” contributed to a
partnership “would not be considered a liability for purposes of section 752” as it was interpreted
prior to the regulations issued by the Department of Treasury in 2005, but noting that under those
regulations the option would be treated as a liability).
18
Nonetheless, in 1994 Marriott had indirect notice that the obligation to close a short sale
might well give rise to a liability under Section 752. Revenue Ruling 88-77 emphasized that the
IRS considered that symmetry had a bearing on the interpretation of Section 752. As the Fifth
Circuit pointed out in Kornman, “Revenue Ruling 88-77 . . . defined liability under section 752
to ‘include an obligation only if and to the extent that incurring the liability creates or increases
the basis to the partnership of any of the partnership’s assets (including cash attributable to
borrowings).’” 527 F.3d at 458 (quoting Rev. Rul. 88-77). Here, as in Kornman, the cash
received in the short sale was an asset of the partnership and the basis of the partnership’s assets
was increased by those receipts. Symmetrical treatment would call for recognition of the
corresponding obligation to replace the borrowed Treasury notes.
This case has a relatively close parallel to a second precedent, Salina P’ship v.
Commissioner, 80 T.C.M. (CCH) 686, 2000 WL 1700928 (2000), which involved, among other
things, a short sale of Treasury bills in 1992. The timing of the transaction in Salina thus was
pragmatically the same as those carried out by the Marriott entities. At issue in Salina was
“whether Salina’s obligation to close out its short sale transaction by returning the Treasury bills
that it borrowed from ABN and Goldman Sachs represent[ed] a liability within the meaning of
section 752.” 80 T.C.M. (CCH) at 697. The Tax Court began its analysis by noting the absence
of a statutory definition of liabilities and then turned to Revenue Ruling 88-77 and the definition
of liabilities set out in Temp. Treas. Reg. § 1.752-1T(g) issued late in 1988. Id. at 697-98. After
taking account of the interpretation of Revenue Ruling 88-77 that had been set out in Revenue
Ruling 95-26, the Tax Court focused on the difference that would exist between the partnership’s
inside basis and the partners’ outside basis if the taxpayer’s position were to prevail. See 80
T.C.M. (CCH) at 698. The taxpayer had argued that the differential was dictated by I.R.C.
§ 1233 and Treas. Reg. § 1.1233-(1)(a), which require a short sale to be treated as an “open
transaction” for income tax purposes. Id. For such transactions, income recognition is deferred
until the transaction is closed with the return of the borrowed securities. The Tax Court refused
to apply Section 1233 by analogy, however, viewing Sections 1233 and 752 as serving different
purposes. 80 T.C.M. (CCH) at 698. It considered that Section 1233 was intended to clarify and
simplify the recognition of gain or loss on the two steps of a short sale transaction, while the
basis adjustment provisions of I.R.C. §§ 705 and 752 were “intended to avoid distortions in the
tax reporting of partnership items by promoting parity between a partnership’s aggregate inside
basis in its assets and its partners’ outside bases in their partnership interests.” Id. Because
Salina “had a legally enforceable financial obligation to return the borrowed Treasury bills” and
had “reported the obligation as a liability on its opening balance sheet,” the Tax Court sustained
the IRS’ adjustments in Salina’s partners’ “outside bases” to reflect their shares of the liability
arising with the obligation to return the borrowed Treasury bills. Id. at 700.
The decision in Salina is persuasive insofar as it refuses to apply the “open transaction”
principles reflected in I.R.C. § 1233 to the definition of liability in I.R.C. § 752. The concepts do
not fit conformably. The partnership basis rules embodied in Sections 705, 722, and 752
contemplate adjustments to basis at the time the transaction occurs and do not leave basis open to
be resolved definitively when a stepped transaction is closed. Hr’g Tr. 35:21-25 (May 19, 2008)
19
(“Under [Section] 722, . . . [you make the basis calculation] at the time of the contribution.
That’s when [the] partnership interest came into being.”); see also Hr’g Tr. 30:12-16 (“[Section
722] specifies that the partnership basis has to be calculated at the time of the contribution of the
asset to the partnership.”). Moreover, the intention that symmetry will apply with the partnership
basis rules is a strong consideration. Otherwise, manipulation of basis could readily generate
distortion of gain or loss. These precepts supplied the analytical foundation for Rev. Rul. 88-77
and provided indirect notice to Marriott that the short sales in 1994 might well not produce the
tax consequences it sought.
The government urges the court to adopt the broad rationale that any short sale of
borrowed securities, ranging from a traded speculative common stock to a short-term Treasury
bill, generates an obligation to return securities that is cognizable as a liability under Section 752.
Def.’s Mot. at 26-29; Def.’s Supp. Br. at 6-7.22 The court considers that it is not necessary to go
that far to resolve the dispute in this case. Rather, where Treasury bills or notes are involved, the
risks in closing the short sale transaction are relatively circumscribed and the resulting liability
should be recognized for basis-adjustment purposes under Section 752.23 Other unusual
circumstances may exist where a basis adjustment may not be appropriate, notwithstanding the
symmetrical considerations that underpin basis adjustments generally under Sections 705, 722,
and 752.
The court thus concludes that the IRS properly adjusted the outside basis of the Marriott
partners to reflect the Marriott partnership’s obligation to return the borrowed Treasury notes.
Constraints on short sales established by the Federal Reserve Board’s Regulation T were always
implicitly present in Section 752 from the date of that Section’s adoption in 1954. Marriott’s
argument about the short sales “treats [their] contingent assets and . . . contingent liabilities
asymmetrically.” See Robert Bird & Alan Tucker, Tax Sham or Prudent Investment:
Deconstructing the Government’s Pyrrhic Victory in Salina Partnership v. Commissioner, 22 Va.
22As the government’s counsel explained at the hearing:
“[E]ach individual asset would and the type of transaction would
need to be looked at individually. We thought about that kind of a
situation, if you’re talking about a stock, as opposed to a Treasury
note. But, that would make a difference with respect to the contingent
nature of the obligation. I don’t really think it will, because . . .
the unique aspect of the short sale is that [the] obligation to return
the property exists until the short sale is done.
Hr’g Tr. 40:7-16 (May 19, 2008).
23
In this instance, Marriott’s contingency in closing the short sales of Treasury notes was
constrained both by the Federal Reserve Board’s Regulation T and by the nature of the securities
involved. The only risk involved was interest-rate risk, not credit risk. Even the interest-rate risk
with the Treasury notes Marriott borrowed was relatively small because the notes had a maturity
of less than five years.
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Tax Rev. 231, 254 (2002). Regulation T seeks to prevent just such treatment, albeit for the
purpose of preventing a loss to a broker dealer stemming from a short seller who would borrow
securities, sell them short, and then abscond with or otherwise impair the proceeds before
completing the purchase and return of the securities. Here, when MORI contributed the
obligation to close the short sales to Marriott Resorts, it treated the contribution as a contingent
obligation that did not require a decrease in its outside basis in Marriott Resorts under Section
752. Pls.’ Cross-Mot. at 7-8. However, when MORI contributed the $73 million in Repos to
Marriott Resorts, it treated the transaction as a contribution of a fixed asset, entitling it to
increase its outside basis in Marriott Resorts. Id. This asymmetry distorted the tax laws
pertaining to outside basis. As the Fifth Circuit commented in Kornman: “If the obligation to
replace the borrowed securities was a ‘contingent liability’ that did not increase the amount
realized on the sale, then the proceeds from the short sale should also be treated as a ‘contingent
asset’ that has no effect on the outside basis calculation under [S]ection 722.” Kornman, 527
F.3d at 460. The initial short sale, which generates the cash proceeds, and the subsequent
covering transaction are “inextricably intertwined,” because under Regulation T the proceeds are
chained to the obligation to close the short sale. Thus, the proceeds of the first step in the short
sale transactions are also subject to the uncertainties of closing the short sale. Id. (citing
Zlotnick, 836 F.2d at 820). In short, if contribution of the proceeds of the short sale increased the
partners’ outside basis, the contribution of the obligation to return the Treasury notes that had
been sold short required a decrease in the partners’ outside basis.
CONCLUSION
For the reasons stated, the government’s motion for summary judgment is GRANTED
and Marriott’s cross-motion for summary judgment is DENIED. In accord with IRC § 6226(h),
this disposition shall be considered as a decision of the court that the notice of final partnership
administrative adjustment issued by the IRS was correct. The clerk shall enter judgment for the
defendant.
No costs.
IT IS SO ORDERED.
s/ Charles F. Lettow
Charles F. Lettow
Judge
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