MARRIOTT INTERNATIONAL RESORTS, L.P., and MARRIOTT INTERNATIONAL JBS CORPORATION, Plaintiffs-Appellants, v. UNITED STATES, Defendant-Appellee.
2009-5007
United States Court of Appeals for the Federal Circuit
October 28, 2009
Before MAYER, RADER and MOORE, Circuit Judges.
Appealed from: United States Court of Federal Claims, Judge Charles F. Lettow
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.
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
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
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
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)
In the United States Court of Federal Claims
Nos. 01-256T & 01-257T (consolidated)
(Filed: August 28, 2008)
MARRIOTT INTERNATIONAL RESORTS, L.P., et al., Plaintiffs,
Cross-motions for summary judgment in a tax case; recognition of basis upon contribution of assets and liabilities to a partnership;
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.
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
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.
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,
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.
- 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,
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
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
Joint Submission at 7; Compl. ¶ 25. Under
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
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.
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
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
ANALYSIS
This case turns on
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.
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
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.
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
transactions.”
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.”
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
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.
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
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.
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,
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.
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.
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
such partner of partnership liabilities, shall be considered as a contribution of money by such partner to the partnership.”
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
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
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
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
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
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.
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
Marriott‘s
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 v. 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.
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.
The decision in Salina is persuasive insofar as it refuses to apply the “open transaction” principles reflected in
(“[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
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.
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.
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
No costs.
IT IS SO ORDERED.
s/ Charles F. Lettow
Charles F. Lettow
Judge
Notes
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.
§ 752. Treatment of certain liabilities
“[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).