OPINION
“When pondering sexy legal issues,” one commentator recently noted, “it is doubtful that tax law crosses the minds of many.”
The BOSS strategy employed a series of transactions seemingly to increase the tax basis of an asset that would eventually be sold, supposedly at a loss. In its simplest form, it worked like this:
Two companies are set up by a promoter— Company A and Company B.
Company A buys a bond with a market value of $50.
Taxpayer X buys the bond from Company A for $1,000,050. However, Taxpayer X pays only $50 in cash, with the remainder of the purchase price taking the form of a promissory note payable by Taxpayer X to Company A for $1 million due in twenty years. Taxpayer X claims that his adjusted tax basis in the bond is $1,000,050. Taxpayer X then sells the bond to Company B for $50. Because Taxpayer X claims a basis in the bond of $1,000,050 and sells it for only $50, he argues that he has incurred a $1 million loss, which he promptly deducts to offset income that would otherwise be subject to tax.
In the Community Renewal Tax Relief Act of 2000 (the 2000 Renewal Act), Pub.L. No. 106-554, § 309, 114 Stat. 2763A-587 to 638, Congress devitalized this strategy by modifying key provisions in the Internal Revenue Code (the Code) to prevent, in absolute terms, the increase in basis essential to generating the large loss deductions.
Their efforts eventually led to the christening of the “Son of BOSS” strategy. Under this brainchild, the taxpayer typically would form a partnership and contribute to it an option he had purchased. The partnership would contemporaneously assume a second
That, in a nutshell, is what happened in the case sub judice, which is a partnership proceeding involving a Son of BOSS transaction, pending before the court on the parties’ cross-motions for summary judgment. After carefully considering the parties’ briefs and oral argument, the court grants defendant’s motion for summary judgment and denies plaintiff’s cross-motion for summary judgment. As will be described below, the court finds, as a matter of law, that the Son of BOSS transactions that led to the tax losses at issue did not, under the Code, generate the losses claimed and, at all events, lacked economic substance. It also holds that, aside from any defenses the individual partners may raise in later proceedings, the Service properly asserted the gross valuation overstatement penalty of section 6662 of the Code.
I. BACKGROUND
First things first. Mark Hutton, a resident of Wichita, Kansas, has been a licensed general contractor since 1992, doing business through Hutton Construction Corporation, an S-corporation.
On October 9, 2001, Edward Sedaeca (the eponymous partner of the aforementioned firm) signed a certificate of formation for Clearmeadow Investments, LLC (Clearmea-dow), as a limited liability company, dear-meadow’s initial operating agreement, which was dated October 10, 2001, named Mr. Hutton the company’s sole member and represented that he had made a capital contribution thereto of $287,500. On October 12, 2001, Robert Bloink (another attorney with Cantley & Sedacea) signed a certificate of incorporation for Clearmeadow Capital Corporation (Capital), again naming Mr. Hutton as the sole member. (Two days earlier, on October 10, 2001, Mr. Hutton had filed an election to treat Capital as an S-eorporation under section 1362 of the Code.) On October 15, 2001, Clearmeadow deposited $287,500 into an account with Deutsche Bank Alex Brown (Deutsche), a brokerage firm. Clear-meadow was formed to invest in certain foreign currency market-linked deposits (MLDs) — instruments similar to certificates of deposit, but with fixed and variable rate interest components. The variable component is paid on the maturity date only if certain contingencies determined by reference to specific financial market measures occur. In this case, those contingencies were based upon variations in the value of certain foreign currencies.
(1) On December 14, 2001, SG would pay Clearmeadow the Deposit Settlement Amount of Q 27,472,520 converted into U.S. dollars at the current spot exchange rate. SG would also pay Clearmeadow a “Fixed Yield,” defined as interest on the Deposit Settlement Amount from the date of deposit to that of maturity, calculated at 3.6650 percent per annum.
(2) On December 18, 2001, SG would also pay Clearmeadow a “Premium Yield” if on December 14, 2001, the exchange rate of Japanese yen per U.S. dollar was equal to or greater than ¥124.65. The Premium Yield was to be €4,395,604. As consideration for this option, Clearmeadow was to pay SG a premium of €2,747,252, which SG would retain if the exchange rate of Japanese yen per U.S. dollar was less than ¥124.65 on December 14, 2001.
These transactions were collectively referred to as the “long MLD position.”
On the same day, Clearmeadow and SG entered into a second agreement captioned “Confirmation for Currency Linked Deposit Swap.” In this agreement, the parties swapped rotes — SG was the “Depositor” and Clearmeadow the “Deposit Recipient.” This agreement envisioned that SG would deposit €27,472,520 ($25 million) with Clearmeadow. Again the agreement foresaw two transactions, the first of which was the mirror image of the “long MLD position:”
(1) On December 14, 2001, Clearmeadow would pay SG the Deposit Settlement Amount of €27,472,520 converted into U.S. dollars at the current spot exchange rate. Clearmeadow would also pay SG a “Fixed Yield,” defined as interest on the Deposit Settlement Amount from the date of deposit to that of maturity, calculated at 3.6650 percent per annum.
(2) On December 18, 2001, Clearmeadow would also pay SG a “Premium Yield” if on December 14, 2001, the exchange rate of Japanese yen per U.S. dollar was equal to or greater than ¥124.67. The Premium Yield was to be €4,347,352. As consideration for this option, SG was to pay Clear-meadow a premium of €2,717,033, which premium Clearmeadow would retain if the exchange rate of Japanese yen per U.S. dollar was less than ¥124.67 on December 14, 2001.
These transactions were collectively referred to as the “short MLD position.” Under this second leg, Clearmeadow stood to profit if the exchange rate of Japanese Yen to U.S. Dollars was between ¥ 124.65 and 124.67 on December 14, 2001. In that instance — and that instance alone — SG would have owed Clearmeadow a Premium Yield of €4,395,604 on the long position, but Clearmeadow would not have owed SG the offsetting Premium Yield of €4,347,352 on the short position.
On October 15, 2001, Mr. Hutton, on behalf of Clearmeadow, authorized Deutsche to “transfer the necessary funds to complete the purchase of the market linked deposits in the notional amount of U.S. $25,000,000 and also to pay the premiums totaling U.S. $2,500,000 associated therewith” from its account to SG. This transfer, however, never occurred. On October 16, 2001, Clearmea-dow instead wired $27,500 to SG, to cover the difference between the premium Clearmea-dow owed on the long MLD position and received on the short MLD position. (This amount, perhaps not coincidentally, was precisely equal to the amount Deutsche charged to set up the options). Despite the aforementioned transactions, and the apparent need for the Huttons to obtain $27.5 million to finance the MLD transactions, at no point during 2001 did Cleaimeadow’s account with Deutsche ever exceed $287,500.
On December 12, 2001, two days prior to the stated maturity date for the MLDs, SG deposited $30,800 to Clearmeadow’s account at Deutsche, representing the difference between the variable interest income from the long position — $2,800,000—and the short position -$2,769,200. On December 14, 2001, the Japanese yen/U.S. dollar exchange rate was ¥127.35, meaning that the premium payments on the short and long legs of the MLD cancelled each other out. On December 14, 2001, Clearmeadow paid $1,000 in U.S. dollars to acquire $1,487.51 in Canadian dollars. On December 18, 2001, Capital exercised its right to terminate CF Advisors’ interest in Clearmeadow, thus ending the partnership and causing the partnership assets to be distributed to Capital. When Clearmeadow was liquidated, Capital claimed a tax basis in the Clearmeadow property equivalent to its basis in the former partnership, which Capital contended was $2,501,000, or the cost of the long MLD position that Capital had contributed to Clearmeadow, unreduced by the short MLD position. On December 24, 2001, Capital sold $597.98 of its Canadian currency (equal to 40.2 percent of its Canadian currency holding) for $323.08 in American currency. On its 2001 tax return, Capital claimed that the Canadian currency had a basis of $1,005,402 (equal to 40.2 percent of the $2,501,000 basis it claimed in all of its Canadian currency). It claimed a loss of $1,004,040, corresponding to the difference between the proceeds on the currency sale ($323.08), plus $1,039 in income on four small scale trades,
On August 29, 2002, Clearmeadow filed a partnership return for the taxable period ended December 2001. The return reported distributions of $284,315 in cash and $2,501,000 in property other than money. The return defined the distributed property as 1,487.51 units of Canadian currency, with a fair market value of $1,000 and a cost basis of $2,501,000. Attached to the return was a K-l that reported a distribution to Capital of $281,815 in cash and $2,501,000 in property other than money. On August 29, 2002, Capital filed a S-corporation return for the taxable period ended December 2001. That return reported a portfolio loss of $1,004,040,
On May 20, 2004, the IRS sent the Hut-tons a letter advising them of announcement 2004-46, which provided taxpayers with an opportunity to resolve tax liabilities associated with transactions described in Notice 2000^44. That notice, which was entitled “Tax Avoidance Using Artificially High Basis,” addressed the tax treatment of “transactions that purport to generate tax losses for taxpayers” and described an arrangement similar to that in which the Huttons participated. See IRS Notice 2000-44, 2000-
On November 21, 2005, Clearmeadow, through its tax matters partner, filed a petition in this court seeking: (i) a refund of $175,870 in taxes paid pursuant to the FPAA; (ii) a determination of partnership items and the related adjustments set forth in the FPAA; and (iii) a determination that it did not owe the penalties asserted in the FPAA. On January 23, 2007, Mr. Hutton and Clear-meadow filed a class action suit under the Racketeer Influenced and Corrupt Organizations Act (RICO), 18 U.S.C. §§ 1961-68, in the United States District Court for the District of Kansas against, inter alia, Deutsche Bank, SG, CF Advisors, and other related entities.
II. DISCUSSION
Summary judgment is appropriate when there is no genuine dispute as to any material fact and the moving party is entitled to judgment as a matter of law. RCFC 56; Anderson v. Liberty Lobby, Inc.,
When reaching a summary judgment determination, the court’s function is not to weigh the evidence, but to “determine whether there is a genuine issue for trial.” Anderson,
A.
At the outset, the court is faced with several issues concerning its jurisdiction, the resolution of which necessarily requires it to delve into the partnership audit provisions of the Code.
1.
“Although they file information returns under section 701 of the Code, partnerships, as such, are not subject to federal income taxes,” but “[i]nstead, under section 702 of the Code, ... are conduit entities, such that items of partnership income, deductions, credits, and losses are allocated among the partners for inclusion in their respective returns.” Grapevine Imports Ltd. v. United States,
Judicial review of the FPAA findings is provided by section 6226 of the Code. Subsection (a) of that section provides that “Lwjithin 90 days after the day on which a notice of a final partnership administrative adjustment is mailed to the tax matters partner, the tax matters partner may file a petition for a readjustment of the partnership items for such taxable year with — ... (3) the Court of Federal Claims.” 26 U.S.C. § 6226(a). On or before the date such a readjustment proceeding is filed, the partner filing the petition must deposit with the Treasury Department the amount by which its tax liability would be increased if the FPAA is sustained. 26 U.S.C. § 6226(e). Section 6226(f) of the Code describes this court’s jurisdiction in such TEFRA cases thusly—
A court with which a petition is filed in accordance with this section shall have jurisdiction to determine all partnership items of the partnership for the partnership taxable year to which the notice of final partnership administrative adjustment relates, the proper allocation of such items among the partners, and the applicability of any penalty, addition to tax, or additional amount which relates to an adjustment to a partnership item.
26 U.S.C. § 6226(f); see also id. at §§ 6211(c), 6230(a)(1). While TEFRA defines a “partnership item” in various ways, the concept generally encompasses items “required to be taken into account for the partnership’s taxable year” and those “more appropriately determined at the partnership level than at the partner level.” Id. at § 6231(a)(3); see Keener v. United States,
Under these provisions, this court is authorized to determine all the partnership items that enter into the calculation of Clear-meadow’s basis in its assets-a concept referred to as the “inside basis” of the partnership. See Treas. Reg. § 301.6231(a)(3)-l(a)(l)(v); Treas. Reg. § 301.6231(a)(3)-l(c)(2)(i). The court thus may determine, inter alia, the tax impact, at the partnership level, of Clearmeadow’s apparent assumption of the liability contributed by Mr. Hutton’s S-eorporation (the MLD short position) and whether any of the partnership-level transactions lacked economic substance. The impact of those determinations will be felt by the individual partners after this proceeding is concluded, particularly in determining the Huttons’ basis in their partnership interest (the “outside basis” in the partnership). See 26 U.S.C. § 6230(a); Treas. Reg. § 301.6231(a)(6)-1(a)(2); Domulewicz v. Comm’r of Internal Revenue,
2.
The parties disagree, however, as to whether this court has jurisdiction to consider whether the “reasonable cause” exception to the “gross valuation misstatement” penalty contained in section 6664(c) of the Code applies here. Section 6664(c)(1) states that “[n]o penalty shall be imposed under section 6662 ... with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and that the taxpayer acted in good faith with respect to such portion.” 26 U.S.C. § 6664(c)(1). Defendant asserts that this exception may be invoked only by individual partners and then only in actions brought by those individual partners on their own behalf. Plaintiffs, however, claim that jurisdiction to consider the “reasonable cause” exception springs from the portion of section 6226(f) which allows this court to consider “the applicability of any penalty ... which relates to an adjustment of a partnership item.” And they note—correctly, as it turns out—that several cases have so held, including Stobie Creek Investments, LLC v. United States,
The first of these is that this jurisdictional point is not addressed by the relevant Treasury Regulations—a contention recently reiterated by the Fifth Circuit in Klamath, when it stated that the regulation “does not indicate that reasonable cause and good faith may never be considered at the partnership level.”
The second non sequitur underpinning the cases cited by plaintiffs is that jurisdiction to consider the reasonable cause defense in a partnership-level proceeding somehow directly derives from section 6664(c)(1), a claim perhaps most visible in Stobie,
Finally, despite intimations to the contrary, see Stobie,
Accordingly, with all due respect, the court is compelled to conclude that the decisions cited by plaintiffs are in error. Contrary to plaintiffs’ claim, the court must demur to the assertion that it has jurisdiction to resolve issues involving a “reasonable cause” defense to the gross value misstatement penalty asserted in the FPAA here. Instead it holds, as many other cases have concluded, that the penalty inquiry here is necessarily limited to defenses that can be raised properly only at the partnership level.
B.
While the primary focus here is on Clearmeadow and the so-called “inside basis” of the partnership, it is important not to forget that the losses asserted by the Hut-tons based upon their S-corporation’s “outside basis” in the partnership are deductible, if at all, under section 165 of the Code. That section provides, in pertinent part:
SEC. 165. LOSSES.
(a) General Rule. — There shall be allowed as a deduction any loss sustained during the taxable year and not compensated for by insurance or otherwise.
(b) Amount of Deduction. — For purposes of subsection (a), the basis for determining the amount of the deduction for any loss shall be the adjusted basis provided in section 1011 for determining the loss from the sale or other disposition of property.
Under sections 1011 and 1012 of the Code, a taxpayer’s basis in an item is generally its cost. See United States v. Chicago, B. & Q.R. Co.,
Part and parcel of this argument is the claim that the partnership’s assumption of the obligation did not constitute the assumption of a “liability” for purposes of section 752. The pertinent portions of the latter section, which defines a partner’s adjusted basis in a partnership, state:
SEC. 752. TREATMENT OF CERTAIN LIABILITIES.
(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.
So “when a partnership assumes a liability from a partner or a partner contributes property to a partnership subject to a liability, the partner will be treated as receiving a deemed distribution of money from the partnership to the extent of the difference between the amount of the liability and the partner’s share of such liability after the partnership’s assumption of the liability.” Blake D. Rubin, Andrea Macintosh "White-way, “Final Partnership Liability Regulations Target ‘Son of Boss’ Abuse But Sweep More Broadly,” 857 PLI/Tax 839, 843 (2009). Completing this statutory scheme, section 733(1) of the Code requires that the partnership’s basis in the partnership interest be reduced (but not below zero) by “the amount of any money distributed to such partner.” 26 U.S.C. § 733(1). In other words, the assumption by the partnership of an individual partner’s liabilities is considered a distribu
1.
The Code does not define the term “liability” for purposes of section 752. Nevertheless, in enacting, in 2000, the provisions that effectively ended the BOSS transactions, Congress took steps to address this issue administratively. It enacted section 309(c)(1) of the 2000 Renewal Act, which directed the Secretary to prescribe rules to provide “appropriate adjustments under subchapter K of chapter 1 of [the Code] to prevent the acceleration or duplication of losses through the assumption of (or transfer of assets subject to) liabilities described in section 358(h)(3) ... in transactions involving partnerships.” § 309(e)(1), 114 Stat. 2763A-638. Section 358(h)(3) — part of the provisions that addressed the BOSS transactions — defines the term “liability” 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 Code. 26 U.S.C. § 358(h)(3). Under section 309(d)(2) of the 2000 Renewal Act, the regulations are to apply to assumptions of liability that occur after October 18, 1999, or such later date as may be prescribed. § 309(d)(2), 114 Stat. 2763A-638; see also Stobie,
On May 26, 2005, the IRS promulgated regulations under this provision. See T.D. 9207, 70 Fed.Reg. 30334 (May 26, 2005). Treas. Reg. § 1.752-6 applies retroactively to transactions occurring after October 18, 1999, and before June 24, 2003.
If, in a transaction described in section 721(a), a partnership assumes a liability (defined in section 358(h)(3)) of a partner (other than a liability to which section 752(a) and (b) apply) then, after application of section 752(a) and (b), the partner’s basis in the partnership is reduced (but not below the adjusted value of such interest) by the amount (determined as of the date of the exchange) of the liability. For purposes of this section, the adjusted value of a partner’s interest in a partnership is the fair market value of that interest increased by the partner’s share of partnership liabilities under §§ 1.752-1 through 1.752-5.
At the same time it promulgated this regulation, the IRS modified Treas. Reg. § 1.752-l(a)(4)(i) to include the following definition of liability:
An obligation is a liability for purposes of section 752 and the regulations thereunder (§ 1.752-1 liability), only if, when, and to the extent that incurring the obligation—
(A) Creates or increases the basis of any of the obligor’s assets (including cash);
(B) Gives rise to an immediate deduction to the obligor; or
(C) Gives rise to an expense that is not deductible in computing the obligor’s taxable income and is not properly chargeable to capital.
See also Rev. Rul. 88-77, 1988-
2.
On brief, defendant argues that, consistent with its terms, this regulation applies retroactively to the transaction in question, resulting in Capital’s basis in Clearmeadow being-reduced by the amount of the short MLD position. Faced with similar arguments, other taxpayers have challenged the validity of the regulation itself, particularly in terms of its retroactivity.
First, they assert that the regulation is wholly inapplicable because Clearmea-dow never assumed any liability from Capital — essentially arguing that the receipt by Clearmeadow of Capital’s liability was a contribution to capital under section 351 of the Code and thus did not represent an assumption of that liability by the partnership for purposes of Treas. Reg. § 1.752-6. This argument, however, assumes that when Clear-meadow admitted CF Advisors as an additional member, what was formed was not a partnership, but rather a “multi-member disregarded entity” (as plaintiffs call it). Plaintiffs, however, cite no authority recognizing the existence of the latter entity and, for good reason, as it is the reddest of red herrings — a total fiction, that is. Treas. Reg. § 301.7701-3(a) indicates that a “business entity” that is not a corporation “with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner.” The latter was the case here when Clearmeadow was owned by Mr. Hutton. When CF Advisors was admitted to the entity, Clearmeadow could have elected to be taxed as a corporation under Treas. Reg. § 301.7701-3(a), but it did not do so. In that instance, it automatically became a partnership-the regulations state that, “unless the entity elects otherwise,” a domestic business entity is “[a] partnership if it has two or more members.” Treas. Reg. § 301.7701-3(b); see McNamee v. Dep’t. of the Treasury,
Next, plaintiffs argue that Treas. Reg. § 1.752-6 does not apply to them because the transaction in question falls within an exception to the regulation provided by section 358(h)(2)(A) of the Code (which was enacted by Congress as part of the 2000 Renewal Act). This claim requires a bit of explanation. Section 358(h)(1) of the Code provides basis tracing rules for certain reorganizations, generally providing that where property is transferred to a corporation in exchange for stock and the corporation assumes certain obligations of the transferor, the basis in the stock received is reduced by the amount of liability assumed. See Martin D. Ginsburg & Jack S. Levin, Mergers, Acquisitions and Buyouts ¶ 901.2.2 (2009). Section 358(h)(2) of the Code provides exceptions to this rule, stating:
*525 (2) Exceptions. — Except as provided by the Secretary, paragraph (1) shall not apply to any liability if—
(A) the trade or business with which the liability is associated is transferred to the person assuming the liability as part of the exchange, or
(B) substantially all of the assets with which the liability is associated are transferred to the person assuming the liability as part of the exchange.
Treas. Reg. § 1.752-6(b) explicitly precludes taxpayers who participated in transactions described in Notice 2000-44 from relying on the exception contained in section 358(h)(2)(B), stating:
(b) Exceptions—
(1) In general. Except as provided in paragraph (b)(2) of this section, the exceptions contained in section 358(h)(2)(A) and (B) apply to this section.
(2) Transactions described in Notice 2000-44. The exception contained in section 358(h)(2)(B) does not apply to an assumption of liability (defined in section 358(h)(3)) by a partnership as part of a transaction described in, or a transaction that is substantially similar to the transactions described in, Notice 2000-44 (2000-2 C.B. 255 )....
But, as plaintiffs correctly observe, the regulation does not bar them from relying on section 358(h)(2)(A). See Sala,
Neither section 358 itself, the regulations thereunder, nor Treas. Reg. § 1.752-6 defines what is a “trade or business” for purposes of the exception in section 358(h)(2)(A). See Moller v. United States,
Applying the Groetzinger test, the court concludes, as a matter of law, that Clearmea-dow was not conducting a “trade or business” when, having become a partnership by the addition of CF Advisors as a member, it effectively assumed the short MLD position. Several uncontroverted facts lead to this conclusion. At the time the positions were transferred, Clearmeadow had not conducted any activity with “continuity and regularity,” as required by the Groetzinger “trade or business” test. Rather, it had been in existence for only ten days. And, at least up to the time of the transfer, the activities in which it had participated were all part of a single, pre-orchestrated transaction planned by outside parties (primarily the Cantley and Sedacca firm) and presented to Hutton for his approval. In analogous settings, courts have concluded that individuals and entities involved in such limited transactions were not conducting a “trade or business” within the meaning of the Code. In Harris,
Indeed, taking a step back, there is little to distinguish this case from many involving whether a taxpayer who engages in securities activities is engaged in a trade or business. In this factual context, courts have long distinguished between “tx-aders,” who are viewed as conducting a trade or business, and “investoi’s,” who are not, based upon the nature and extent of the activity in which the taxpayer is involved. Under these decisions, a taxpayer who is directly involved in activity which is frequent, continuous and regular- is a trader, while those whose activity is more isolated and passive are investoi-s.
Based on the foregoing, the court finds that Treas. Reg. § 1.752-6 applies with full force here, having the effect of eliminating the increased basis claimed by the partnership in the Canadian currency.
C.
The economic substance doctrine prevents taxpayers from reaping tax benefits from transactions lacking in economic reality. See Klamath,
[w]here ... there is a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities, is imbued with tax-independent considerations, and is not shaped solely by tax-avoidance features that have meaningless labels attached, the Government should honor the allocation of rights and duties effectuated by the parties.
Frank Lyon Co. v. United States,
Plaintiffs argue that this doctrine is inapplicable here because they complied with the letter of the relevant statutes, in particular, the basis rules in section 752. They assert that “all the i’s were dotted and the t’s were crossed.” But, if the economic
So what do plaintiffs need to show in order to demonstrate that their transactions had economic substance? In Coltec, the Federal Circuit found that “a number of different factors [are] pertinent to the determination of whether a transaction lacks economic substance.” Coltec,
It appears, however, that these are distinctions without a difference in this case. In their briefs, plaintiffs claim that genuine issues of material fact exist as to whether they followed the “black letter of the law as it was written during the time the transaction was entered,” seeming to assert that the existence of those questions precludes the court from granting defendant’s motion for summary judgment. But, of course, these fact questions are immaterial because, as noted, plaintiffs’ literal compliance with the Code avails them naught. Yet, strangely, at other points in their briefs, plaintiffs readily appear to concede that the MLD investment lacked economic substance. In their response brief, they state (at 13) that “[w]ith
Although the transaction, the MLD investment, followed the black letter of the law as it was written during the time the transaction was entered and at the time the 2001 tax return was prepared and filed with the Internal Revenue Service, the plaintiff will concede for its cross-motion that the underlying transaction lacked economic substance as stated within the FPAA as issued by the Internal Revenue Service.
And, apparently for good measure, plaintiffs reiterate the same sentiments twice more in the brief in support of their cross-motion (at 9, 14). Finally, at oral argument, plaintiffs’ counsel indicated: “For purposes of [the] summary judgment motion and cross-motion summary judgment, plaintiff is at this point willing to acknowledge that, in 2008, the legal climate has changed and now the transaction which was perceived differently in 2001 is a transaction, because there is substantial case law that the transaction lacked economic substance, that it is a transaction that lacked economic substance.” Oral Argument of October 29, 2008, Argument of Mr. Shine Lin at 2:46:13-2:46:50.
That plaintiffs, in Janus-like fashion, appear simultaneously to contest and concede defendant’s economic substance claims obviously raises concerns as to how far their concessions reach. Those concerns have both procedural and substantive dimensions. Proeedurally speaking, a party may concede a fact for purposes of its own summary judgment motion and yet reserve the right to litigate that fact should its motion be overruled. See Begnaud v. White,
In the case sub judice, plaintiffs have conceded that the transaction in question lacked economic substance not only for purposes of their cross-motion, but also for defendant’s motion. To be sure, they are unwilling to admit when Mr. Hutton first realized this and, indeed, deny that he knew, back in 2001, that the transactions in which he was participating lacked economic substance. Nevertheless, in substantive terms, the comb cannot read plaintiffs’ concessions as anything other than a complete and utter admission that the transactions in question lacked economic substance and thus could not give rise to the greatly inflated inside basis that Clearmea-dow attributed to its assets. See Petaluma FX Partners,
When a motion for summary judgment is properly made and supported, an opposing party may not rely merely on allegations or denials in its own pleading; rather, its response must — by affidavits or as otherwise provided in this rule — set out specific facts showing a genuine issue for trial. If the opposing party does not so respond, summary judgment should, if appropriate, be entered against that party.
Highlighting the operation of the similarly-worded Federal Rule of Civil Procedure, the Supreme Court recently found that when a plaintiff neither opposed the factual claims made in a defendant’s motion for summary judgment nor specifically challenged the defendant’s statement of undisputed facts, but instead filed a cross-motion for summary judgment claiming that the undisputed facts entitled him to summary judgment, summary judgment in the defendant’s favor was appropriate. Beard v. Banks,
Such is also the case here. Plaintiffs admitted many of the defendant’s statements of undisputed facts and failed to challenge, with any specificity, most of those findings which they denied. Nor did their response contain affidavits and other evidence to rebut the documentary evidence that defendant supplied in support of its findings. Such eonelusory denials are insufficient to create material questions of fact under RCFC 56. See SRI Int'l v. Matsushita Elec. Corp. of Am.,
D.
The final question before the court is whether the FPAA correctly asserted that the partners of Clearmeadow are liable for the 40 percent penalty imposed by section 6662 of the Code, attributable to a gross valuation misstatement.
Section 6662 of the Code imposes a variety of accuracy-related penalties for tax underpayments attributable to a variety of conduct, including negligence and other actions giving rise to substantial understatements of tax.
While the amount of the penalty under section 6662(b)(3) must be resolved at the partner level, the determination whether there was a “gross valuation misstatement” should be made in this partnership-level proceeding. Defendant asserts that the penalty applies because the determinations made in the FPAA regarding Clearmeadow’s partnership items cause the bases of its partners’ interests in the partnership to be reduced to zero instead of the $2,501,000 claimed. It notes that while the underpayment of tax the partners were required to show on their returns were due to the overstatement of each partner’s share of the Canadian currency, under section 732(b) of the Code, the partners determined their adjusted bases in the currency by reference to their outside bases in Clearmeadow before its liquidation. This is significant for, under the Treasury Regulations discussed above, “[ijf a property has a basis of zero, any basis claimed above will be a gross valuation overstatement and the 40 percent penalty will apply.” Petaluma,
For their part, plaintiffs challenge the overvaluation penalty on several grounds. They contend that section 6662(b)(3) is inapplicable because there was no “valuation overstatement” here, let alone a “gross valuation overstatement,” within the meaning of that provision. They asseverate that the Service, in the FPAA, did not contend that Clearmeadow overstated its inside basis, but more broadly claimed that the transactions at issue lacked economic substance. This, plaintiffs assert, is tantamount to having the Service find that there was no inside basis at all. Put in terms of the statutory language, they assert that any tax underpayment here was “attributable to” the transaction’s lack of economic substance, not a valuation misstate
That is not to say that those arguments lack case support. Indeed, there are widely divergent views among the circuits on whether the overstatement penalty applies when a transaction is successfully challenged as lacking economic substance. One on side of this divide are the Fifth and Ninth Circuits. In Todd v. Commissioner,
Later, in Heasley v. Comm'r of Internal Revenue,
Whenever the “I.R.S.” totally disallows a deduction or credit, the IRS may not penalize the taxpayer for a valuation overstatement included in that deduction or credit. In such case, the underpayment is not attributable to a valuation overstatement. Instead, it is attributable to claiming an improper deduction or credit.
Id. More recently, in Weiner v. United States,
Around the time that the Fifth Circuit decided Heasley, the Ninth Circuit, in Gainer v. Comm’r of Internal Revenue,
If we follow this formula and make an adjustment here, Gainer’s overvaluation becomes irrelevant to the determination of any tax due. The parties stipulated that the container had not been placed in service in 1981 and the Tax Court therefore found no deductions or credits could have been taken in that year. Even if Gainer has correctly valued the container, the underpayment of tax would be the same because the container was not placed in ser*533 vice. Thus, Gamer’s actual tax liability, after adjusting for failure to place the container in service, was no different from his liability after adjusting for any overvaluation.
Id. at 228. More recently, in Keller,
On the other side of the divide are no fewer than five circuits — the Second, Third, Fourth, Sixth and Eighth — as well as the U.S. Tax Court.
This is a false distinction. The tax benefit generated by the ... shelter was directly dependent upon the valuation overstate*534 ment, and the amount of the tax benefit was actually determined by the amount of the overvaluation. The entire artifice of the ... shelter was constructed on the foundation of the overvaluation of its assets. Plainly, then, Illes’s underpayment was attributable to his valuation overstatement.
Illes,
In concluding to the contrary, the Fifth and Ninth Circuits unduly relied upon the Blue Book, which in no way should be viewed as a proxy for legislative history. Blue Books are “not signed by any member of Congress and [are] never approved (even by reference) by the full membership of either body.” Michael Livingston, “What’s Blue and White and Not Quite as Good as a Committee Report: General Explanations and the Role of the ‘Subsequent’ Tax Legislative History,” 11 Am. J. Tax Pol’y 91, 101 (1994). Reflecting on this, the Federal Circuit has said that “[a]s a post-enactment explanation, the Blue Book interpretation is entitled to little weight.” Fed. Nat’l Mortgage Ass’n v. United States,
Perhaps more importantly, the Fifth and Ninth Circuit misconstrued what the Joint Committee actually said. Those courts dwelled on the portion of the Explanation that states:
The portion of a tax underpayment that is attributable to a valuation overstatement will be determined after taldng into account any other proper adjustments to tax liability. Thus, the underpayment resulting from a valuation overstatement will be determined by comparing the taxpayer’s (1) actual tax liability (i.e., the tax liability that results from a proper valuation and which takes into account any other proper adjustments) with (2) actual tax liability as reduced by taking into account the valuation overstatement. The difference between these two amounts will be the underpayment that is attributable to the valuation overstatement.
General Explanation, at 333. But, as has been said elsewhere, this passage “does not contemplate and was not intended to include situations where the deficiency related to a single transaction that could be sustained on multiple grounds.” McCrary,
The determination of the portion of a tax underpayment that is attributable to a valuation overstatement may be illustrated by the following example. Assume that in 1982 an individual files a joint re ton showing taxable income of $40,000 and tax liability of $9,195. Assume, further, that a $30,000 deduction which was claimed by the taxpayer as the result of a valuation overstatement is adjusted down to $10,000, and that another deduction of $20,000 is disallowed totally for reasons apart from the valuation overstatement. These adjustments result in correct taxable income of $80,000 and correct tax liability of $27,505. Accordingly, the underpayment due to the valuation overstatement is the difference between the tax on $80,000 ($27,505) and the tax on $60,000 ($17,505) (ie., actual tax liability reduced by taking into account the deductions disallowed because of the valuation overstatement), or $9,800.
General Explanation, at 333 n. 2. Accordingly, there is absolutely no indication in the Blue Book that a taxpayer should be spared from the overstatement penalty simply because the overstatement arises from a transaction that lacks economic substance.
To rule otherwise is to invite the sort of gamesmanship that may be lurking in the shadows here — to hold forth the prospect that a taxpayer might engage in an abusive transaction that hinges upon the overstatement of an asset’s basis; claim on its tax return the tax advantages associated with that transaction; enjoy the financial benefits of the claimed tax treatment while waiting to see if the transactions is discovered by the IRS; aggressively defend the transaction on audit and even in filing suit; only, in the last instance — perhaps in the face of a motion or on the eve of trial — to concede the resulting deficiency on economic substance grounds and thereby avoid the imposition of the penalty. How convenient. See McCrary,
In sum, the court finds that there was an underpayment of tax here attributable to a gross valuation overstatement. Accordingly, absent a partner-level defense, the penalty under section 6662(b)(3) for a gross valuation overstatement should apply here.
III. CONCLUSION
This court need go no further. Based on the foregoing, it GRANTS defendant’s motion for summary judgment and DENIES plaintiffs’ cross-motion. As it appears that several minor issues may yet need to be resolved before a final judgment may be entered in this case, on or before July 13, 2009, the parties shall file a joint status report indicating how this case should proceed.
IT IS SO ORDERED.
Notes
. Hale E. Sheppard, “Only Time Will Tell: The Growing Importance of the Statute of Limitations in an Era of Sophisticated International Tax Structuring,” 30 Brook. J. Int'l L. 453, 453 (2005).
. In Section 309 of the Act, Congress enacted section 358(h)(1) of the Code, which requires the basis of stock received in the sorts of transactions employed in ihe BOSS strategy to be reduced by the amount of any liability assumed in the exchange. For this purpose, section 358(h)(3) of the Code defines the term "liability” 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 Code]." 26 U.S.C. § 358(h)(3).
. Subchapter S of the Code (26 U.S.C. §§ 1361— 79), establishes, in considerable detail, the circumstances under which certain "small business corporations” can be treated as flow-through entities for federal tax purposes. If the requirements of this subchapter are satisfied, the corporation may elect to have its income and expenses treated as belonging to its shareholders, with the result that the corporation itself is not separately taxed (similar to the treatment afforded partnerships). In the parlance of the Code, corporations qualifying for this treatment are called "S-corporations.”
. Several documents in the record indicate that if this happened, Mr. Hutton would receive a "14,446% profit” on his "net investment of $27,500.”
. While Mr. Hutton claims that he believed
. According to the restated operating agreement, Capital had solicited CF Advisors as an investment advisor and specialist in foreign currency and foreign currency derivative investments. The parties agrees to pay CF Advisors a fee of $10,000, plus two percent of Clearmeadow's net asset values as of the end of the fiscal year and 20 percent of all income and gains realized during the fiscal year. The $10,000 fee appears to have been paid in two installments — the first was authorized by Clearmeadow on October 10, 2001 (nine days before CF Advisors became a member) and the second on October 18, 2001 (the day before CF Advisors became a member).
. These trades occurred between October 22 and December 6, 2001. In them, Clearmeadow acquired either put or call options involving foreign currency, each time for $2,500, expending a total of $10,000 on the four option purchases. Those transactions produced gross proceeds of $11,039, which when offset by Clearmeadow’s $10,000 investment, yielded a gain of $1,039, reported under section 988 of the Code.
. Notice 2000-44 stated that both the IRS and Department of the Treasury had “become aware of ... arrangements that have been designed to produce noneconomic tax losses on the disposition of partnership interests,” adding that "[t]hese arrangements purport to give taxpayers artificially high basis in partnership interests and thereby give rise to deductible losses on disposition of those partnership interests." Id. The notice asserted that two variations of the loss-generating transactions — one based upon a loan transaction, the other based upon an option— lacked economic substance. The transaction entered into by plaintiffs fit the description of the option variation, which involved the purchase and writing of options and the transfer of those option positions to a partnership. This variation involved the taxpayer “claimfing] that the basis in the taxpayer’s partnership interest is increased by the cost of the purchased call options but is not reduced under [I.R.C.] § 752 as a result of the partnership's assumption of the taxpayer's obligation with respect to the written call options.” The notice asserted that "[t]he purported losses resulting from the transactions described ... do not represent bona fide losses reflecting actual economic consequences as required for purposes of [I.R.C.] § 165,” which defines the appropriate treatment of losses. Id. It further observed that the "purported losses from these transactions (and from any similar arrangements designed to produce noneconomic tax losses by artificially overstating basis in partnership interests) are not allowable as deductions for federal income tax purposes” and that such "purported tax benefits ... may also be subject to disallowance under other provisions of the Code and regulations.” Id.
. In his RICO complaint, Mr. Hutton averred:
As described more fully herein, the defendants knowingly acted in concert to market and implement the fraudulent and illegal ML deposit transaction and of the Son of Boss tax shelter transaction. In doing so, the defendants acted*518 with full knowledge and awareness that the transaction was designed to give the false impression that a complex series of financial transactions were legitimate business transactions which had economic substance from an investment standpoint when in fact they lacked those features (which was necessary for successful tax strategy).
. In their responses to defendant’s proposed findings of fact, plaintiffs repeatedly object to defendant’s use of deposition testimony to support its proposed findings, claiming that the use, in particular, of the deposition of Daniel Brooks (who owned CF Advisors) violates RCFC 32. The latter rule, however, does not preclude the use of a deposition in conjunction with a motion for summary judgment. Indeed, the use of depositions to supplement an affidavit is explicitly authorized by RCFC 56. See RCFC 56(e)(1) (“The court may permit an affidavit to be supplemented or opposed by depositions, answers to interrogatories, or additional affidavits.”); see also Abdallah v. Caribbean Security Agency,
. As part of the Taxpayer Relief Act of 1997, Pub.L. No. 105-34, § 1238(a), 111 Slat. 1026,
. As will be discussed in greater detail below, a gross valuation misstatement is one in which "the value of any property claimed on any tax return is four hundred percent or more of the amount determined to be the correct amount.” Maguire Partners-Master Investments, LLC v. United States,
. See Grupo Dataflux v. Atlas Global Group, L.P.,
. Plaintiffs also claim that evidence that Congress intended the "reasonable cause” defense to be considered at the partnership level may be found in the aforementioned 1997 amendments to sections 6221 and 6226(0, which provided that the applicability of penalties that relate to adjustment to partnership items may be determined at the partnership level. But, Congress did not intend these amendments to decree broadly that every issue governing the imposition of a penalty on a partner be determined at the partnership level. To the contrary, the House Report accompanying this legislation makes clear that the penalty issues to be resolved at the partnership level essentially involve the partnership as a whole and that partners were expected to raise "partner-level defenses” in individual proceedings, such as a refund suit. H. Rep. No. 105-148, at 594 (1997).
.See Jade Trading,
. In their petition, plaintiffs asserted that the FPAA was untimely under section 6229(a) of the Code. They, however, abandoned this issue in their briefs. At all events, it appears that the FPAA here was timely, having been filed less than three years after the date the relevant partnership return here was filed. See 26 U.S.C. § 6229(a)(1); see also Grapevine Imports,
. Another set of regulations applies to transactions occurring on or after June 24, 2003. See Treas. Reg. § 1.752-7. While plaintiffs intimate that defendant seeks to apply these regulations to their transaction, there is no evidence of this— rather, defendant focuses solely on Treas. Reg. § 1.752-6.
. Compare Sala v. United States,
. Any notion, moreover, that the liability somehow remained with Capital is belied by the fact that the liability was later paid not by Capital, but by Clearmeadow. Moreover, it was Clear-meadow and not Capital which reported the payment as a deductible expenditure on its tax return.
. The Groetzinger test has been employed in interpreting the phrase "trade or business” with respect to the following Code sections—section 165 (loss): Culberson v. Comm’r of Internal Revenue,
. To be sure, Clearmeadow participated in a few minor currency option deals after the date of the relevant transfer. But, none of these transactions affect its status as of the date the MLD positions were transferred. Moreover, it should not be overlooked that these other currency transactions still numbered only a handful and were extraordinarily minor — involving not the $2.5 million premiums in the MLD transactions, but rather $2,500 premiums.
. See, e.g., Diamond v. Comm'r of Internal Revenue,
. At oral argument, defendant ultimately admitted that determining whether, and to what extent, the regulation applies requires the resolution of material factual questions, specifically, questions involving the value of liability assumed by Clearmeadow as of the date of the exchange. In the order that follows this opinion, the court will establish a procedure for resolving these questions.
. See Richardson,
. The oral argument was recorded by the court’s Electronic Digital Recording (EDR) system. The lime stamp refers to the EDR record of the argument.
. The penalties authorized by this section cannot be "stacked." Treas. Reg. § 1.6662-2(c). For example, even if an underpayment is attributable to both negligence and a substantial understatement of income tax, only a single penalty may be imposed. Id. In this case, the IRS imposed multiple penalties, albeit in the alternative. The parties agree that, for purposes of this motion, the court need consider only the penalty associated with a gross valuation misstatement.
. Congress enacted the predecessor of this provision (former section 6659 of the Code) in 1981 to discourage taxpayer from significantly overvaluing certain types of properties. See H. Rep. No. 97-201, at 243 (1981), U.S.Code Cong. & Admin.News 1981, p. 105. In 1984, Congress enacted section 6621(d) of the Code to provide for enhanced interest on overstatements, doing so "to put more teeth into section 6659.” Neely v. Comm'r of Internal Revenue,
. Subsection (h)(2)(A) accomplishes this result by modifying the formula for calculating a valuation misstatement in subsection (e). Merlens, supra, at § 55:22 (explaining how this modification applies).
. The timing of depreciation deductions is governed, inter alia, by Treas. Reg. § 1.167(a)-10(b), which states that 'Tt]he period for depreciation of an asset shall begin when the asset is placed in service and shall end when the asset is retired from service."
. Under Golsen v. Comm'r of Internal Revenue,
. See also Merino v. Comm'r of Internal Revenue,
.In this regard, the Second Circuit in Gilman observed:
Had the Commissioner been confined to his fallback position that the taxpayer's basis for depreciation was fair market value, a value far below his claimed purchase price, it would have been entirely sound to say that the asset had been ''overvalued" and to impose the section 6659 penalty. If the Commissioner is more successful and persuades the Court to disregard not only the nonrecourse notes but the entirety of the purchase price, thereby lowering the "price” down not only to fair market value but all the way to zero, should the Commissioner’s success have the perverse effect of sparing the taxpayer the overvaluation penalty?
Gilman,
. See also Estate of Hutchinson v. Comm'r of Internal Revenue,
. See Flood v. United States,