Partnerships Insist They Have Economic Substance

In 1989, Brunswick Corporation entered into two arrangements designed by Merrill Lynch to create substantial paper capital losses for itself that would allow it to shelter from tax the substantial capital gains it expected to report from the impending sales of certain of its businesses and the sale of its stock in a Japanese corporation. The partnerships would purchase short-term private placement notes (PPNs) and sell the PPNs several weeks later for 80 percent cash and 20 percent debt instruments that would pay out over several years (LIBOR-indexed installment notes). The partnerships would report a large gain in the first year, most of which would be allocated to the foreign partner.

The next year, Brunswick would acquire a majority interest in the partnerships and sell the LIBOR notes, creating a large tax loss because the basis available for recovery would exceed the notes' value. The primary foreign entity was Algemene Bank Netherlands N.V. (ABN), and the partnerships formed were Saba Partnership and Otrabanda Investerings Partnership. Brunswick ultimately used the paper losses created by the transactions (which approached $200 million) to shelter from tax the capital gains it reported in 1987, 1989, and 1992-1995. The IRS determined that the transactions that gave rise to the paper gains and losses lacked economic substance, and therefore adjusted the partnership returns filed by Saba and Otrabanda to eliminate the gains and losses reported from the transactions. Saba and Otrabanda then filed Tax Court petitions contesting the proposed adjustments. The Tax Court upheld the IRS's determination that the tax-motivated transactions engaged in by Saba and Otrabanda lacked economic substance.

The partnerships argue that the Tax Court erred in applying the economic substance doctrine as an independent requirement and not as a rule of statutory interpretation. They emphasize that the court applied the economic substance test without regard to whether "what actually occurred" qualified as a "sale" within the meaning of section 1001. The partnerships further maintain that the underlying purpose of section 1001 requires that the transfers of the PPNs and LIBOR notes be respected as sales. The partnerships note that Congress has expressly indicated that a corporate taxpayer's purpose for making a sale is not relevant in determining either whether the sale has economic substance or whether the corporation is entitled to claim a loss on the sale. The partnerships emphasize that their transfer of beneficial ownership of the PPNs exchange for cash and beneficial ownership of the LIBOR notes resulted in a meaningful change in economic position.

[1] A. PARTIES AND AMICI. The parties who have appeared before the Tax Court are the appellants Saba Partnership, Otrabanda Investerings Partnership, and Brunswick Corporation, which has acted as the tax matters partner for each of the Partnerships, and the appellee, the Commissioner of Internal Revenue. There were no intervenors or amici curiae in the Tax Court action giving rise to this appeal. The parties in this Court are the appellants, Saba Partnership, Otrabanda Investerings Partnership, and their tax matters partner, Brunswick Corporation, and the appellee, the Commissioner of Internal Revenue.

[2] Saba Partnership and Otrabanda Investerings Partnership were investment partnerships during the years relevant to this case but they were dissolved in 1991 and are no longer in existence. During Saba's existence, Brunswick Corporation, Sodbury Corporation, Ronde Klip Foundation, Petermaii Foundation, and Algemene Bank Nederlands N.V. ("ABN") were parent corporations of Saba. During Otrabanda's existence, Brunswick Corporation, Bartolo Corporation, Rocky Foundation, Jasper Foundation, Clavicor Corporation, N.V., and ABN were parent corporations of Otrabanda.

[3] Brunswick Corporation is also an appellant in this case in its role as tax matters partner of the Partnerships. Brunswick Corporation is a publicly-held company engaged in the marine and recreation businesses. No corporation owns more than 10% of the outstanding shares of Brunswick Corporation.

[4] B. RULINGS UNDER REVIEW. The rulings at issue in this Court were made in a consolidated case involving the partnership returns of Saba Partnership and Otrabanda. Investerings Partnership (the "Partnerships"). The Tax Court held that the Partnerships' purchase and sale of certain private placement notes and certificates of deposit lacked economic substance and would not be respected for Federal income tax purposes. These rulings were set forth in the October 27, 1999, opinion of the Honorable Arthur L. Nims III in Saba Partnership, et al. v. Commissioner of Internal Revenue, T.C. Memo 1999-359 (1999). The Tax Court's opinion was not officially reported. The decision was entered by the Tax Court by order dated April 19, 2000. The Tax Court's opinion is included in the deferred Appendix at pages * * *.

[5] C. RELATED CASES. The case on review has not previously been before this Court or any other Court (other than the Tax Court). A case currently pending in the District Court for the District of Columbia presents some legal issues similar to the issues presented by the case on review. Boca Investerings Partnership v. United States, No. 1:97-cv-602 (PLF).

Dated: April 27, 2001

ABN            Algemene Bank Nederlands N.V.

Opinion        Page references to the Tax Court's opinion dated

[8] Relevant statutes and regulations are included in an addendum to this brief.

JURISDICTIONAL STATEMENT

[9] On January 23, 1997, Brunswick Corporation, tax matters partner for Saba Partnership and Otrabanda Investerings Partnership (collectively, the "Partnerships"), filed a separate Petition for each Partnership in the Tax Court challenging the adjustments to partnership items asserted by the Commissioner of Internal Revenue in Final Partnership Administrative Adjustments ("FPAAs") issued to each Partnership on December 30, 1996. The separate Petitions were consolidated for purposes of trial, briefing, and opinion. The Tax Court had jurisdiction pursuant to I.R.C. sections 6226(a) and (f) ¹ and entered final decisions on April 19, 2000. The Partnerships filed a timely joint Notice of Appeal on July 17, 2000. The United States Court of Appeals has jurisdiction to review the decision of the Tax Court. Sections 6226(g) and 7482.

[10] On August 11, 2000, the Commissioner filed a timely cross- appeal. The Partnerships liquidated in 1991 and were no longer in business at the time their Petitions were filed. Accordingly, venue is properly placed with this Court. Section 7482(b)(1).

STATEMENT OF ISSUES

[11] When a partnership purchases private placement notes (Saba), or certificates of deposit (Otrabanda), and assumes all of the benefits, risks, and burdens of holding such instruments, and subsequently exchanges such instruments for cash and installment notes with materially different characteristics, can the resulting sale be disregarded as lacking in economic substance if the sale was motivated solely by tax considerations? See Parts I-III.

[12] If the Partnerships' installment sale transactions are disregarded as lacking in economic substance, did the Tax Court err in concluding that the basis in the installment notes received by the Partnerships should be fixed at an amount which would effectively deny Brunswick a tax deduction for its economic loss on such notes? See Part IV.

STANDARD OF REVIEW

[13] The legal standard applied by the Tax Court in determining that a transaction lacks economic substance is subject to de novo review. Jacobson v. Commissioner, 915 F.2d 832, 837 (2d Cir. 1990).

STATEMENT OF THE CASE

[14] Saba and Otrabanda purchased financial instruments ("PPNs and CDs") and subsequently sold such instruments in exchange for cash and notes ("LIBOR Notes") which provided for a series of installment payments over a five-year period. The Partnerships' sales of the PPNs and CDs qualified as "installment sales" for tax purposes. Section 453(b)(1). As described below, see pages 12-13, the Partnerships were required to report gain from the sale under the ratable basis recovery rules set forth in Temp. Treas. Reg. section 15A.453- 1(c)(3)(i). These rules required that, in calculating gain, the Partnerships allocate one-sixth of their basis in the PPNs and CDs to the year of sale. Each Partnership reported a significant gain in the year of sale and allocated this gain to its partners in accordance with their respective interests in the Partnerships.

[15] Since the remaining basis in the LIBOR Notes after the year of sale (i.e., five- sixths of the original basis in the PPNs and CDs) was greater than the value of the LIBOR Notes, the installment sales regulations required that the Partnerships and their partners report tax losses when they disposed of the LIBOR Notes. The Partnerships subsequently distributed the LIBOR Notes to Brunswick. As required by section 732, Brunswick recorded its basis in the LIBOR Notes as the lower of the Partnerships' bases in the Notes or Brunswick's basis in the Partnerships.

[16] The Commissioner, acting under the authority of section 6225(a), issued FPAAs to the Partnerships proposing adjustments to their partnership tax returns for the taxable years ending March 31, 1990, March 31, 1991, and June 21, 1991 (Saba) and July 31, 1990 and June 21, 1991 (Otrabanda). The FPAAs proposed a series of alternative determinations, including a claim that the Partnerships' sales of the PPNs and CDs should be disregarded for tax purposes as lacking in economic substance. The primary effect of the Commissioner's determination was to eliminate the gain each Partnership reported on its installment sale. The Commissioner also adjusted the Partnerships' bases in the LIBOR Notes as distributed to Brunswick, and proposed the disallowance of certain expenses claimed by the Partnerships.

[17] The Tax Court held a trial in September of 1998. In an opinion dated October 27, 1999, the Tax Court held that the Partnerships' installment sale transactions should be disregarded as lacking in economic substance. The Tax Court's determinations were reflected in orders dated April 19, 2000 which provided that:

(i) the sales of the PPNs and CDs would be disregarded and

STATEMENT OF FACTS

A. BRUNSWICK AND ITS BUSINESS

[20] In 1989, Brunswick decided to sell its Technical businesses and to concentrate on the Marine and Recreation businesses. (Stip. paragraph 69). Brunswick expected that this sale would produce approximately $175-200 million in cash, which represented a significant portion of Brunswick's market value. (Tr. 390; Ex. 85-J). The receipt of such a large amount of cash posed several issues for Brunswick's management. Mr. Jack Reichert, Brunswick's CEO, was concerned that this cash could be used to finance a hostile takeover. (Tr. 945-46). Mr. Reichert was particularly concerned because the economic conditions in 1989, including a worsening recession in the marine industry, were similar to the conditions which had led to a prior takeover attempt. ³ Takeover rumors in the financial press and increased trading in Brunswick's stock increased Mr. Reichert's concern. (Tr. 930).

[21] Brunswick was unaccustomed to investing large amounts of cash, since it historically had carried large amounts of debt. The worsening recession in the marine industry reduced Brunswick's need for cash as Brunswick closed plants, laid-off 20% of its workforce, and reduced inventory. (Tr. 161-63).

[22] Mr. Reichert considered and rejected several plans for investing the expected proceeds of the sale of the Technical businesses. (Tr. 166-67, 173-74). On December 8, 1989, representatives of Merrill Lynch met with William McManaman, Brunswick's Vice President of Finance, to propose new ideas for the investment of Brunswick's cash proceeds. (Stip. paragraphs 150-51; Tr. 175). Merrill Lynch was responsible for selling the Technical businesses, and therefore was familiar with the issues presented by Brunswick's receipt of a large amount of cash. During the second half of the meeting, Judy Zelisko, Brunswick's Assistant Vice President and Director of Taxes, was brought into the meeting to listen to Merrill Lynch's proposal that Brunswick invest in a partnership with a foreign partner. (Tr. 78-79).

[23] Mr. McManaman subsequently met with Richard O'Brien, Brunswick's Treasurer, who had not been able to attend the December 8 meeting. Mr. McManaman instructed Mr. O'Brien to meet with Merrill Lynch to learn more details of the partnership proposal. (Tr. 439- 40).

[24] After Mr. O'Brien's review was completed, Mr. McManaman recommended to Mr. Reichert that Brunswick invest in the partnership. (Tr. 180-81, 475-76; Ex. 357-J). Mr. Reichert decided to propose the partnership investment to Brunswick's board of directors for several reasons. Mr. Reichert understood the partnership provided an investment vehicle for Brunswick's excess cash which, in his view, would make the cash less accessible to a party attempting a hostile takeover. (Tr. 964, 966). Mr. Reichert also believed a partnership with a foreign bank could provide Brunswick with critical financial resources in the event of a takeover attempt. (Tr. 966). Mr. O'Brien was in favor of the idea because the proposed partnership's investment in LIBOR Notes would provide a hedge against rising interest rates. Brunswick's business was very sensitive to rising interest rates since Brunswick's customers often financed their purchases of boats through loans. As interest rates rose, sales of the more expensive boats declined. The LIBOR Notes would provide additional income in an environment of rising interest rates, and thus would partially offset the reduction in boat sales. (Tr. 160-61, 176, 779-80). Finally, Ms. Zelisko liked the partnership idea because, depending upon how the partnerships' assets were managed, the partnership could produce tax losses which would offset Brunswick's gains from the sale of the Technical businesses. (Ex. 408-J).

[25] On February 13, 1990, Brunswick's board of directors approved Mr. Reichert's decision to invest in a partnership with a foreign bank. At the board of directors meeting, Brunswick's management described the three facets of the partnership proposal: i) its strategic value as a takeover defense; ii) the counter-cyclical nature of the LIBOR Notes; and iii) the potential tax benefits from claiming tax losses generated by the partnership. (Tr. 1004-06, 1008; Ex. 9-J(25) at BC0 15969).

[26] The Tax Court concluded that Brunswick's plans to use the partnership as a takeover defense and a counter-cyclical investment were "a derivative or by product" of its desire to reduce taxes. (Opinion 114). While the Partnerships respectfully disagree, on appeal the Partnerships do not challenge the Tax Court's factual finding as it is irrelevant to the legal issue presented by this appeal.

B. SABA

[28] After becoming convinced of ABN's suitability as a partner, Brunswick agreed to form a partnership, to be called Saba Partnership, with Sodbury Corporation, a special purpose corporation controlled by ABN. Skokie Investment Corporation, a Brunswick subsidiary, also became a partner in Saba. (Ex. 106-J).

[29] Sodbury, Brunswick, and Skokie agreed to, and did in fact, share in the gains, losses, income, and expenses of Saba in accordance with their interests in the partnership as set forth in their written partnership agreement. (Ex. 107-J). The written partnership agreement governed the parties' rights and responsibilities, and there were no contrary agreements between the partners. Sodbury expected it would share in any of Saba's losses. Brunswick did not agree to protect Sodbury against loss, and did not guarantee a specific return to Sodbury. (Tr. 192, 524, 1077-80).

[30] Following Saba's formation, Merrill Lynch proposed that Saba purchase PPNs issued by Continental Bank. Mr. O'Brien rejected this proposal, as he was concerned about Continental's credit risk. Merrill Lynch subsequently proposed that Saba buy PPNs to be issued by Chase Manhattan Corporation. After reviewing Chase's financial information, Mr. O'Brien agreed to the purchase. (Tr. 482-83; Ex. 489-J).

[31] On February 28, 1990, the partners made the following contributions to and received the following interests in Saba:

          Skokie         $   1,000,000          .5%

[32] On February 28, 1990, Saba purchased five-year PPNs in the principal amount of $200,000,000 from Chase. The Chase PPNs provided for monthly interest payments at a rate based on the one-month commercial paper rate. On March 21, 1990, Chase made a timely interest payment of $975,298.51 to Saba, which Saba included on its partnership income tax return for the taxable year ended March 31, 1990. (Stip. paragraphs 210-15).

[33] Since the Chase PPNs paid a floating interest rate, their principal value would remain stable despite changes in market interest rates. The value of the Chase PPNs was subject to fluctuation, however, as the result of changes in credit risk, event risk, credit spread risk, and liquidity risk. ⁴ Saba was exposed to all of these risks, and did not take any steps which would have provided protection from these risks inherent in owning the Chase PPNs. (Tr. 1532-52; Ex. 539-P at 6, 8).

[34] On March 23, 1990, Saba sold half of the Chase PPNs to Norinchukin Bank and half to Fuji Capital Markets. Norinchukin and Fuji each paid Saba with $80,000,000 in cash and two LIBOR Notes. (Stip. paragraphs 222-24). The four LIBOR Notes received by Saba were worth a total of approximately $38,600,000. Saba sold the Chase PPNs at a discount; according to Merrill Lynch's calculations, the value of the cash and the LIBOR Notes received by Saba was $1.5 million less than the value of the Chase PPNs (including accrued interest). ⁵ (Stip. paragraphs 233, 237). Saba sold the Chase PPNs; at a discount in order to provide Norinchukin and Fuji the return above LIBOR which they required to issue the LIBOR Notes. (Tr. 1170-71).

[35] The Fuji and Norinchukin LIBOR Notes provided for twenty quarterly payments, beginning July 2, 1990, based on three-month LIBOR multiplied by the notional principal value of each note (a total of $51,440,000 for the two Fuji Notes and $51,530,000 for the two Norinchukin Notes). (Stip. paragraphs 223-24, 230). The Notes were self-amortizing; that is they provided for twenty quarterly payments, but did not include a stated principal amount, as the notional principal amount was used solely as a multiplier to determine the amount of the LIBOR based contingent payments. Since the LIBOR Notes were based on a notional principal amount, their value was extremely sensitive to changes in interest rates. (Tr. 1174-75; Ex. 539-P at 22).

[36] Since the LIBOR Notes provided for a series of variable payments over five years, Saba could not determine the maximum sales price of the Chase PPNs by the end of its March 31, 1990 taxable year. Consequently, Saba was required to report the sale of the Chase PPNs as an installment sale under section 453(b) and calculated its gain using the method set forth in Temp. Treas. Reg. section 15A.453- 1(c)(3)(i) to recover its basis in the Chase PPNs. (Stip. paragraph 239).

[37] Since, taking into account the receipt of the $160 million in cash and the twenty quarterly payments on the LIBOR Notes, Saba would receive payments on the sale of the PPNs over six taxable years, Temp. Treas. Reg. section 15A.453-1(c)(3)(i) required that Saba apply one-sixth of its basis of $200,000,000 in the Chase Notes in computing its gain on the sale. Saba reported a gain of $126,666,667 on the sale of the Chase PPNs for the taxable year ended March 31, 1990:

               Cash                          $160,000,000

[38] Saba allocated this gain to its partners in accordance with their interests in the partnership:

               Skokie              5%         $   633,333

[39] Skokie and Brunswick reported this gain on their consolidated federal income tax return for the taxable year ended December 31, 1990. (Stip. paragraphs 778-79). Since Sodbury was not subject to U.S. tax, it did not report any gain for federal tax purposes.

[40] On July 2, 1990, Fuji and Norinchukin made timely payments to Saba on the LIBOR Notes in the amounts of $1,115,320.33, and $1,113,372.36, respectively. Saba included $49,882 of these payments in interest income on its partnership tax return for the taxable year ended March 31, 1991. The remaining portion of the payments was allocated as a return of principal on the self-amortizing LIBOR Notes. (Stip. paragraph 277).

[41] At a partnership meeting in July of 1990, Sodbury requested that Brunswick purchase half of its interest in Saba. Brunswick was able to comply with this request because it had recently agreed to sell one of its Technical businesses for approximately $90 million. On July 13, 1990, Brunswick purchased 50% of Sodbury's interest in Saba for $92,452,227 in cash. This additional investment was consistent with Mr. Reichert's goal as it made the cash less accessible for use in a takeover. (Stip. paragraphs 144, 269; Tr. 494-95, 797-98; Exs. 150-J).

[42] On August 17, 1990, at Brunswick's request, Saba distributed the two Fuji LIBOR Notes and one of the two Norinchukin LIBOR Notes to Brunswick. On September 6, 1990, Brunswick sold these three LIBOR Notes to the Bank of Tokyo for $26,601,451. Brunswick reported a capital loss on this sale of $97,011,580 on its federal income tax return for the taxable year ended December 31, 1990:

               Sales Price              $ 26,601,451

[43] On October 2, 1990, January 2, 1991, and April 2, 1991, Norinchukin made timely payments of $551,442.57, $548,356.47, and $488,126.30, respectively, on the remaining LIBOR Note. Saba reported a portion of these payments as interest income on its partnership tax returns and allocated the remainder as a return of principal on the LIBOR Note. (Stip. paragraphs 382, 384).

[44] On April 3, 1991, Saba formed SBC International Holdings, Inc. ("SBC"). Saba transferred the remaining Norinchukin LIBOR Note, cash, and commercial paper to SBC in exchange for all of SBC's outstanding stock. (Stip. paragraph 340).

C. OTRABANDA

               Skokie              $1,500,000          1%

[46] On June 29, 1990, Otrabanda purchased four $25 million CDs for a total of $100 million from the Industrial Bank of Japan. The IBJ CDs bore interest at 8.25% for the first month and at the one- month LIBOR rate minus 12.5 basis points thereafter. Interest on the IBJ CDs was due monthly. (Stip. paragraphs 446-49). The purchase of the IBJ CDs presented the same type of risks as Saba's purchase of the Chase PPNs, and Otrabanda did not take any steps to protect itself from these risks. On July 18, 1990, IBJ made a timely interest payment of $435,416.62 to Otrabanda, which reported this payment on its partnership tax return for the taxable year ended July 31, 1990. (Stip. paragraph 450).

[47] On July 27, 1990, Otrabanda sold the IBJ CDs to Sumitomo Bank Capital Markets. In exchange for the CDs, Sumitomo paid Otrabanda with $80,000,000 in cash and four LIBOR Notes worth a total of approximately $19,450,000. ⁷ The Sumitomo LIBOR Notes provided for twenty quarterly payments, beginning November 1, 1990, based on three-month LIBOR multiplied by a total notional principal amount of $53,396,000 ($13,349,000 for each of four notes). (Stip. paragraphs 460-61, 464).

[48] Otrabanda was required to report the sales of the IBJ CDs as installment sales in the same manner as Saba had reported the sales of the Chase PPNs. Otrabanda reported a gain of $63,333,334 on its partnership tax return for the taxable year ended July 31, 1990:

               Cash                          $ 80,000,000

[49] Otrabanda allocated this gain to its partners in accordance with their interests in the partnership:

               Skokie              1%           $   633,333

[50] Skokie and Brunswick reported this gain on their consolidated federal income tax return for the taxable year ended December 31, 1990. Since Bartolo was not subject to U.S. tax, it did not report any gain for federal tax purposes. (Stip. paragraphs 780- 81).

[51] On October 11, 1990, Brunswick purchased 50% of Bartolo's interest for $69,239,696 in cash. (Stip. paragraph 487).

[52] On November 1, 1990, Sumitomo made a timely interest payment of $1,085,255.84 on the Sumitomo LIBOR Notes. Otrabanda reported $23,907 of this amount as interest income on its partnership tax return and allocated the remainder as a return of principal. (Stip. paragraph 492).

[53] On November 1, 1990, Otrabanda distributed the four Sumitomo LIBOR Notes to Brunswick and also distributed $15,968,064 and $354,523 in cash to Bartolo and Skokie, respectively. (Stip. paragraph 493).

[54] On November 28, 1990, Brunswick sold the four Sumitomo LIBOR Notes to Banque Francaise du Commerce Exterieur for $17,458,827. Brunswick reported a capital loss on this sale of $65,874,506 on its federal income tax return for the taxable year ended December 31, 1990:

               Sales Price              $ 17,458,827

[55] On April 3, 1991, Otrabanda formed OBC International Holdings, Inc. ("OBC"). Otrabanda contributed cash and commercial paper to OBC in exchange for all of its outstanding stock. (Stip. paragraph 535).

D. THE TERMINATION OF THE PARTNERSHIPS

[57] On June 21, 1991, Saba dissolved and made liquidating distributions of the shares of SBC to Brunswick and cash to Sodbury and Skokie. On June 21, 1991, Otrabanda made liquidating distributions of the OBC shares and cash to Brunswick and Skokie and cash to Bartolo. SBC and OBC both continue in existence as subsidiaries of Brunswick. (Stip. paragraphs 349, 352, 542, 544; Tr. 518).

[58] On July 2, 1991, SBC sold the remaining Norinchukin LIBOR Note back to Norinchukin for $7,040,954. This payment included the quarterly payment of $419,262.75 due on that same date, of which SBC reported $41,579 as interest income with the remainder allocated as a return of principal. SBC reported a capital loss on the sale of the remaining Norinchukin LIBOR Note of $32,631,287:

               Sale Price               $ 6,621,692

E. GENERAL CONSIDERATIONS

[60] Interest rates as measured by three-month LIBOR fluctuated within a narrow range throughout the spring and summer of 1990, reaching a high of 8.75% on May 1 following the formation of Saba. Beginning in October of 1990, following the August commencement of the Persian Gulf War, the Federal Reserve Board began a series of cuts in the federal funds rate, which led to a precipitous decline in overall interest rates from 1991 through 1992. Three-month LIBOR reached a low point of 3.125% on September 14, 1992, which was its lowest level in nearly thirty years. (Tr. 502-03, 1456-59; Exs. 523- J, 539-P at 28-29).

[61] The "symmetric" model of interest rates states that the possibility of interest rates increasing by a given amount above the projected rate is equally likely as interest rates decreasing by the same amount below the projected rate. If interest rates had increased along a symmetric path, i.e., had risen as much as they actually fell from 1990-1995, and the Partnerships had held the LIBOR Notes to maturity, they would have received a profit of over $40 million. (Tr. 1382-85, 1526; Ex. 539-P at 31-32).

[62] The "lognormal" or "equal probability" model of interest rates states that the possibility of interest rates doubling is equally likely as interest rates decreasing by half. The "lognormal" model is widely used and accepted in modern finance. (Tr. 1162, 1529; Ex. 539-P at 33). If interest rates had increased along a lognormal path, and the Partnerships had held the LIBOR Notes to maturity, they would have received a profit of over $80 million. (Tr. 1382-85; Ex. 539-P at 33).

[63] Although Brunswick was aware that a certain series of transactions would generate capital losses, Brunswick had no assurance these transactions would take place. Each of these transactions was subject to the risks of the marketplace and would not occur if the parties could not negotiate mutually acceptable terms at the time each transaction took place. (Tr. 192, 483, 1062- 63). For example, in June and September of 1990, after Saba had sold the Chase PPNs to Fuji and Norinchukin, S&P and Moody's twice lowered Chase's credit rating, reducing Chase's credit to near "junk bond" status. As a result, the value of Chase's debt fell by 8-9%. (Tr. 1168, 1241). Fuji became concerned about Chase's credit rating, and requested Merrill's assistance in selling the Chase PPNs it had acquired from Saba. While Fuji sold some of the Chase PPNs, Merrill was not able to find a buyer for the remainder and Fuji was forced to hold the remaining PPNs until it exercised a put option in April of 1991. (Exs. 146-J(2), (3), (5), (6), (8)). If the Chase PPNs had declined in value in March instead of in June, i.e., before Saba sold them, Saba would not have been able to engage in the installment sale transaction. (Tr. 1242).

SUMMARY OF THE ARGUMENT

[64] The issue presented by this appeal can be simply stated: Should the Partnerships' transfers of the PPNs and CDs in exchange for cash and LIBOR Notes be treated as "sales" for tax purposes as defined in section 1001 of the Internal Revenue Code? The Tax Court agreed that the Partnerships' transfers of the PPNs and CDs contained all the traditional elements of a sale:

There is no dispute that the partnerships owned the PPNs

[65] This transfer of beneficial ownership of property (the PPNs and CDs), in exchange for money and beneficial ownership of property (the LIBOR Notes) with materially different characteristics, is the essence of a "sale" as it has been defined for tax purposes. Commissioner v. Brown, 380 U.S. 563, 570-72 (1965); see Cottage Savings Ass'n. v. Commissioner, 499 U.S. 559 (1991).

[66] In spite of its factual finding that the "partnerships sold the PPNs and CDs for cash and LIBOR Notes," the Tax Court nevertheless upheld the Commissioner's claim that the Partnerships' purchases and sales of the PPNs and CDs should be ignored as lacking "economic substance" and therefore held that no gains or losses should be recognized on the "sales of the PPNs and CDs." (Opinion 6, 85-87, 130) In reaching this conclusion, the Tax Court was principally influenced by its finding that the purchase and sale of the PPNs and CDs was structured to create potential tax benefits for Brunswick and therefore lacked business purpose. (Opinion 113, 127)

[67] Given the Tax Court's factual findings, the issue on this appeal can be restated as follows: When a taxpayer actually transfers the beneficial ownership of property, in exchange for cash and materially different property, does the resulting "sale" lack economic substance as such when the sale was structured solely to create tax benefits?

[68] By holding that a transaction could in fact qualify as a sale as defined in section 1001, yet nevertheless lack economic substance, the Tax Court applied the economic substance doctrine as an independent requirement and not simply as an aid in interpreting the underlying statute. In doing so, the Tax Court applied the economic substance doctrine in a manner directly contrary to the law of this Circuit. See Horn v. Commissioner, 968 F.2d 1229 (D.C. Cir. 1992).

[69] The Tax Court erred by emphasizing Brunswick's intent to reduce tax and by failing to determine whether "what actually occurred," see Gregory v. Helvering, 293 U.S. 465, 469 (1934), qualified as a sale as defined in section 1001. Since there is no dispute that the Partnerships actually transferred beneficial ownership of the CDs and PPNs in exchange for cash and LIBOR Notes, the Partnerships' sales had all of the economic substance which can possibly be required of a sale transaction as defined in section 1001.

I. THE TAX COURT ERRED IN APPLYING THE ECONOMIC SUBSTANCE DOCTRINE

[71] As long ago as 1940, a leading commentator stated "Few cases have been the subject of such violent disagreement and confusion as the Gregory case. The case is all things to all men." R. Paul, Studies in Federal Taxation 125-126 (3d Series 1940). The intervening sixty years have only produced further "disagreement and confusion," as the conflicting decisions in Horn and Lerman demonstrate.

[72] In Gregory, the taxpayer, Mrs. Gregory, owned all of the stock of United Mortgage Corporation ("United"), which in turn owned 1,000 shares of Monitor Securities Corporation ("Monitor"), which had appreciated in value. Mrs. Gregory wanted to sell the stock of Monitor and to receive the proceeds in cash without being taxed on the receipt of a dividend from United. In order to bring about this result, Mrs. Gregory caused United to transfer the shares of Monitor to the newly formed Averill Corporation ("Averill"), which then issued its stock directly to Mrs. Gregory. Averill then dissolved and distributed its only asset (the Monitor stock) to Mrs. Gregory, who promptly sold it. Claiming that the receipt of the Averill stock was pursuant to a "plan of reorganization" under section 112(i)(1)(B) of the Revenue Act of 1928 and therefore tax-free, Mrs. Gregory reported a capital gain on the receipt of the Monitor shares in liquidation of Averill and no further gain on the sale to the third party. Gregory v. Commissioner, 27 B.T.A. 223, 226 (1932).

[73] Mrs. Gregory's plan required that the distribution of the shares of Averill to her qualify as being made "in pursuance of a plan of reorganization," rather than being treated as a dividend. The Board of Tax Appeals treated the transaction as a "reorganization," and ruled in Mrs. Gregory's favor. Id.

[74] The Second Circuit reversed. Judge Learned Hand understood that the issue before the Second Circuit was a matter of statutory interpretation, stating:

Therefore, if what was done here, was what was intended by

[75] In the context of interpreting the statute, Mrs. Gregory's purpose to save taxes was irrelevant. Since, however, Mrs. Gregory had no intention of reorganizing her business, but instead intended to sell a portion of her business to a third party, her transaction did not fit within the definition of a "reorganization" as set forth in the statute:

The purpose of the section is plain enough; men engaged in

[76] On appeal, the Supreme Court also approached the issue as one of statutory interpretation, stating that "what actually occurred" was not a "reorganization in reality" and therefore not "the thing which the statute intended." Gregory, 293 U.S. at 469.

[77] The most controversial portion of Gregory is the Supreme Court's description of Mrs. Gregory's purpose. The Supreme Court correctly observed that Mrs. Gregory had no "business or corporate purpose . . . to reorganize a business or any part of a business." Id. Some courts have taken this passage to state a general requirement that all tax transactions must satisfy a "business purpose" test. The Supreme Court's opinion, however, does not justify such a sweeping generalization. Mrs. Gregory's. lack of business purpose was relevant only because the statute by its very terms required purposive conduct, i.e., that her actions be "'in pursuance of a PLAN of reorganization'. . . of corporate business," and the facts left no doubt that Mrs. Gregory had no such "plan" to reorganize her business, but had only a "plan" to receive a dividend. Id. (emphasis added) (citation omitted) ("a preconceived plan, not to reorganize a business . . . but to transfer a parcel of corporate shares to the petitioner.") Id. The Supreme Court's reference to "business or corporate purpose" merely acknowledges that the statute under consideration required purposive conduct -- "a plan" -- to reorganize a business, and that Mrs. Gregory had no such plan.

[78] Although Mrs. Gregory's transaction did not qualify as a "reorganization," the Second Circuit did not accept the Commissioner's claim that her transaction should be ignored as a nullity:

We do not indeed agree fully with the way in which the

[79] Since the distribution of the Averill shares to Mrs. Gregory matched both the statutory definition of a dividend and Mrs. Gregory's underlying intent to receive a dividend, Mrs. Gregory was taxed on the receipt of the Averill shares, not on the receipt of the Monitor shares as the Commissioner had urged. In other words, while "what actually occurred" may have lacked the economic substance of a reorganization, it did have the economic substance of a dividend and was taxed as such.

[80] Gregory v. Helvering thus stands for four basic principles:

i) The economic substance doctrine is a rule of statutory

It is important to observe just what the Supreme Court held in

[82] Therefore, when a taxpayer intends to secure tax benefits by engaging in a specific transaction, "[t]he inquiry is not what the purpose of the taxpayer is, but whether what is claimed to be, is in fact." Kraft Foods Co. v. Commissioner, 232 F.2d 118, 128 (2d Cir. 1956). A taxpayer's "motives and expectations are relevant only insofar as they contribute to an understanding of the external facts of the situation." Gilbert v. Commissioner, 248 F.2d 399, 407 (2d Cir. 1957). The taxpayer's intent is relevant only to the extent it reflects whether the taxpayer actually entered into the legal relationships necessary to secure the tax benefit as described in the tax law. Kraft, 232 F.2d at 122 ("In other words, taxpayer intended to become indebted because the desired deductions could be secured only if it created genuine indebtedness. . . . If it was their 'purpose' or 'intent' to do so, then they succeeded because they performed consciously and successfully the legal acts that establish a debt.").

[83] Transactions motivated solely by tax considerations have repeatedly been upheld when the taxpayer's conduct actually creates the legal relationships contemplated by the statute, i.e., the substance of the taxpayer's conduct is consistent with its form. Similarly, these cases have rejected the Commissioner's claim that Gregory requires a "business purpose." See Granite Trust Co. v. United States, 238 F.2d 670, 677-78 (1st Cir. 1956) (purpose for entering into a sale was irrelevant under Gregory); Kraft, 232 F.2d at 127-28 (rejecting Commissioner's claim that Gregory requires a business purpose); see also Peter Pan Seafoods, Inc. v. United States, 417 F.2d 670, 673 (9th Cir. 1969) (tax avoidance does not establish liability); Nassau Lens Co., Inc. v. Commissioner, 308. F.2d 39, 44-45 (2d Cir. 1962) (lack of business purpose not controlling); Humphreys v. Commissioner, 301 F.2d 33, 34 (6th Cir. 1962); Evans v. Dudley, 295 F.2d 713, 714 (3d Cir. 1961); Fabreeka Products Co. v. Commissioner, 294 F.2d 876, 878 (1st Cir. 1961); Maysteel Products, Inc. v. Commissioner, 287 F.2d 429, 431 (7th Cir. 1961). Each of these cases upholds the principle that the purpose "to escape taxation . . . [is] legally neutral" and that the taxpayer's purpose is relevant only insofar as it demonstrates the taxpayer's intent (or lack thereof) to create the legal relationships called for by the statute. Chisholm, 79 F.2d at 15. In particular, the courts have routinely upheld "sales" transactions against claims that they lacked economic substance when the transactions resulted in an actual transfer of the benefits and burdens of ownership. See Part II.A., below.

[84] In Horn, this Court was critical of other courts which have applied Gregory in a generic manner without taking into account the underlying statute. The Horn case involved a commodities dealer who had entered into a straddle transaction which was admittedly devoid of any profit motive or other nontax business purpose. Section 108(b) of the Deficit Reduction Act of 1984 (the "Act"), ¹⁴ however, created an irrebuttable presumption that any losses incurred by a commodities dealer, such as Mr. Horn, were losses incurred in a "trade or business." As a result of this presumption, Mr. Horn's losses were deductible under section 108(a) of the Act, which allowed losses "incurred in a trade or business." Horn, 968 F.2d at 1234.

[85] The Commissioner argued that even though Mr. Horn's losses were authorized by section 108, the "sham transaction doctrine applies independently" of the provisions of the tax code and therefore Mr. Horn's losses were unallowable. Id. at 1238. The Commissioner found support for this argument in the Third Circuit's decision in Lerman, 939 F.2d at 52, which held that '"economic substance is a PREREQUISITE to the application of any Code provisions allowing deductions."' Horn, 968 F.2d at 1238 n.12 (quoting Lerman, 939 F.2d at 52).

[86] This Court rejected the Commissioner's arguments, holding that the application of the economic substance doctrine in a manner independent of the statute was clearly inconsistent with the plain meaning of section 108, which authorized the losses under review:

[W]hile following the parties' assumptions that the transactions

[87] The decision in Horn is therefore consistent with Gregory's admonition to focus on "the thing which the statute intended." As Horn acknowledges, the economic substance doctrine has often been stated as requiring either (i) a nontax business purpose, or (ii) a prospect for profit. These two tests, however, are only "general factors" to be used in interpreting the statute. Id. at 1237. Since the language of section 108 contained detailed provisions concerning profit motive and business purpose, this Court held that it was "inconceivable that Congress intended that the 'sham' transaction doctrine be laid OVER the statute." Id. at 1238. This Court therefore rejected the Commissioner's argument that the economic substance doctrine applies "independently" of the statute and upheld Mr. Horn's tax deduction even though his conduct did not have either a business purpose or a possibility of profit.

[88] The interpretation of Gregory set forth in this Court's decision in Horn will promote consistency and certainty in the application of tax statutes, as it is based on the words of the statute. The Third Circuit's (and the Tax Court's) view that "economic substance" is an independent requirement can only lead to confusion as an inherently amorphous concept will be inconsistently applied to produce different results for different taxpayers. See Nassau Lens, 308 F.3d at 45-46 (imposition of "judicial gloss" such as a "business purpose" test runs the risk of imposing requirements not reflected in statutory language).

B. THE TAX COURT APPLIED THE ECONOMIC SUBSTANCE TEST AS AN

[90] In ruling against the Partnerships, the Tax Court followed its earlier decision in ACM Partnership v. Commissioner, 73 T.C.M. (CCH) 2189 (1997), aff'd in part, rev'd in part, 157 F.3d 231 (3d Cir. 1998). In that decision, the Tax Court stated "[o]nly after we conclude that a transaction has economic substance will we consider the transaction's tax consequences under the Code." Id. at 2217. In Horn, this Court criticized the Third Circuit's similar approach to economic substance as expressed in Lerman. Horn, 968 F.2d at 1238 ("we are at a loss to understand the Commissioner's suggestion, adopted by several courts, that the sham doctrine applies independently" of the Code).

[91] In the appeal of ACM, the taxpayer argued that the Tax Court had improperly applied a "generic" interpretation of Gregory, without regard to the purpose of the underlying statute. The Third Circuit, relying in part on its earlier decision in United States v. Wexler, 31 F.3d. 117 (3d Cir. 1994), cert. denied, 513 U.S. 1190 (1995), rejected ACM's arguments and upheld the Commissioner's claim that the economic substance doctrine should be applied in a manner independent of the Code's language. ACM, 157 F.3d at 253-54. The Third Circuit's interpretation of "economic substance" as set forth in Wexler, and as followed in ACM, however, is itself based on the Third Circuit's earlier decision in Lerman, ¹⁵ which this Court has directly criticized as inconsistent with Gregory.

[92] The Tax Court's and the Third Circuit's analysis therefore turns Gregory on its head: while the Supreme Court in Gregory held that the economic substance doctrine depended upon "the thing which the statute intended," in ACM both the Tax Court and the Third Circuit held that they would determine economic substance PRIOR to examining the statute.

[93] In the case below, the Tax Court recognized that there was "no dispute" the transfer of the PPNs qualified as a sale for purposes of section 1001, but then applied the economic substance doctrine as a separate test independent of the Code. The Tax Court's repeated emphasis on Brunswick's motive to reduce taxes demonstrates that the Court did not "put aside," see Gregory, 293 U.S. at 469, the motive to reduce taxes, but in fact relied on its conclusions concerning Brunswick's motive in lieu of performing the statutory analysis required by Gregory and Horn.

[94] Finally, the Tax Court's opinion fails to give any coherent explanation of how the Partnerships' transactions should be characterized. The Tax Court agrees that the transactions were in fact sales, but denies that they should be treated as sales, without providing an alternative explanation for the events which occurred. The Tax Court's opinion therefore fails to "fix[ ] the character of the proceeding by what actually occurred." Gregory, 293 U.S. at 469. See note 13, above.

II. THE UNDERLYING PURPOSE OF SECTION 1001 REQUIRES THAT THE

[96] Section 1001 requires taxpayers to recognize gain or loss on the "sale or exchange of property." Section 1001(c) provides:

(c) Recognition of Gain or Loss. -- Except as otherwise provided

[97] When Congress first adopted this provision, as section 203 of the Revenue Act of 1924, it expressed an intent to tax the gain or loss on ALL exchanges: ¹⁶

It appears best to provide generally that gain or loss is

[98] Treasury Regulations reflect Congress' intent that exceptions from the general rule be strictly construed:

"STRICT CONSTRUCTION OF EXCEPTIONS FROM GENERAL RULE. The

[99] The Code is therefore explicit in its requirement that ALL sales are subject to section 1001 unless subject to a specific exception. The Commissioner has never argued that the sales of the PPNs and CDs falls under one of these exceptions.

[100] The Supreme Court exhaustively addressed the purpose of section 1001 in Cottage Savings. In Cottage Savings, the taxpayer transferred its interest in certain mortgages in exchange for other mortgages with a similar value in order to trigger a tax loss. The transaction admittedly had no business purpose aside from tax savings. See Cottage Savings Assoc. v. Commissioner, 90 T.C. 372, 385 (1988), rev'd, 890 F.2d 848 (6th Cir. 1989), rev'd, 499 U.S. 554 (1991).

[101] The taxpayer's argument depended upon its transfers qualifying as "dispositions" as defined in section 1001. In ruling in favor of the taxpayer, the Supreme Court held that the requirements of section 1001 are founded on administrative convenience and require a simple test which can easily be applied: "`[a] change in the form or extent of an investment is easily detected by a taxpayer or an administrative officer.'" Cottage Savings, 499 U.S. at 559 (quoting R. Magill, Taxable Income 79 (rev. ed. 1945)).

[102] The Commissioner argued for a "subjective test" which would take into account a variety of factors in determining the existence of a sale. Id. at 562. The Court rejected the application of "subjective tests" as inconsistent with section 1001:

[T]he complexity of the Commissioner's approach ill serves the

[103] In Cottage Savings, the Supreme Court repeatedly emphasized the need for a simple and objective application of section 1001.

o "Section 1001(a)'s language provides a straightforward test."

[105] Since the essence of a sale as defined in section 1001 is a transfer of beneficial ownership of property, a transaction which actually results in a transfer of the "benefits and burdens of ownership" to the buyer is a sale in fact as well as in form and must be respected as having "economic substance." Grodt & McKay, 77 T.C. at 1237; see Chisholm, 79 F.2d at 15. Thus, in a variety of contexts, the Courts have rejected the Commissioner's economic substance arguments when a challenged sale or transfer actually resulted in a transfer of the benefits and burdens of ownership. Brown, 380 U.S. at 573-79 (transfer to tax exempt organization designed to convert ordinary income to capital gain had substance as a sale); Chisholm, 79 F.2d at 15-16 (sale designed to avoid tax had substance as a sale); Rushing v. Commissioner, 441 F.2d 593, 594-98 (5th Cir. 1971) (installment sale designed to minimize tax had economic substance since taxpayers transferred ownership); Granite Trust, 238 F.2d at 677-78; see Estate of Stranahan v. Commissioner, 472 F.2d 867, 869-70 (6th Cir. 1973).

[106] The decision in Granite Trust is particularly instructive, since it directly addresses the issue presented here: whether Gregory requires that a sale be disregarded when the sale was motivated solely by tax considerations. In Granite Trust, the taxpayer sold a portion of a subsidiary's stock to a third party in order to avoid the application of the complete liquidation rules, which would have prevented a deduction on a planned liquidation of the subsidiary. The Court ruled in favor of the taxpayer, stating "Why the parties may wish to enter into a sale is one thing, but that is irrelevant under the Gregory case so long as the consummated agreement was not different from what it purported to be." Granite Trust, 238 F.2d at 677. The Court held that the transfer in question was a sale in substance as well as form, since the parties had actually transferred beneficial ownership of the subsidiary's stock. Id.

[107] A leading article (cited in Horn) has summarized what ought to be the correct application of the economic substance doctrine in questions involving sales:

In a number of cases, courts have had to decide whether a

[108] A sale will therefore lack economic substance if the transaction, while nominally structured as a "sale," does not in fact result in a transfer of the benefits and burdens of ownership. In Higgins v. Smith, 308 U.S. 473 (1940), the Supreme Court considered the case of a taxpayer who transferred securities to his wholly-owned corporation at a price below their cost and continued to exercise "domination and control" over the securities after the purported sale. The Court applied Gregory and held that since the taxpayer retained control of the securities, he had not actually "sold" the securities. Id. at 475-76; see Cottage Savings, 499 U.S. at 568. ¹⁷

[109] In Higgins, the Supreme Court did not apply either a "business purpose" or a "profit motive" test. The Tax Court's reliance on Higgins in ruling against the Partnerships is therefore puzzling. Higgins actually supports the Partnerships' claim that in the context of section 1001, economic substance must be measured by whether a sale actually conveys the benefit and burdens of ownership. The Partnerships' transfers of the PPNs and CDs WOULD pass the test actually applied in Higgins, since it is undisputed that the Partnerships actually transferred dominion and control over the PPNs and CDs to their purchasers.

[110] The differences between this case and Gregory are therefore both simple and conclusive. When one examines "what actually occurred," Mrs. Gregory lost because her actions did not constitute a "plan of reorganization" as defined in the statute; since it is not in dispute, however, that the Partnerships engaged in a "sale" as defined in the statute, this appeal must necessarily result in a different conclusion.

B. CONGRESS HAS EXPRESSLY INDICATED THAT A CORPORATE TAXPAYER'S

[112] Section 1001 sweeps broadly in providing that all gains or losses are to be recognized for tax purposes. As indicated in the legislative history, however, see page 37, above, while Congress intended to "recognize" all gains and losses (with certain specified exceptions), it did not intend to allow deductions for all losses. Losses, while they may be "recognized," do not produce tax deductions unless they pass the additional tests set forth in section 165:

(a) GENERAL RULE. -- There shall be allowed as a deduction

[114] Different rules apply for corporations. If a corporation buys property which is neither used in the corporation's business nor held with an expectation of profit and later sells the property for a loss, the corporation will nonetheless -- unlike an individual -- be able to claim a loss on the sale of the property. This is so because the "trade or business" and "profit" limitations which Congress has clearly imposed on individuals in section 165(c) just as clearly do not apply to corporations. International Trading Co. v. Commissioner, 484 F.2d 707, 710-11 (7th Cir. 1973).

[115] The "crystal-clear rules" of section 165(c) -- and Congress' equally clear decision not to impose such rules on corporations -- leave no room for doubt that section 165 is a clear and complete statement of Congress' intent concerning the role of "profit motive" and "business purpose" in the context of sale transactions. International Trading Co. v. Commissioner, 57 T.C. 455, 467-68 (1971) (Tannenwald, J., dissenting), rev'd, 484 F.2d 707. Thus, the application of the "economic substance" doctrine to impose ADDITIONAL "business purpose" and "profit motive" tests onto section 1001 is, at best, unnecessary and at worst will contradict Congress' intent as spelled out in section 165.

[116] Taken together, sections 1001 and 165 are closely parallel to section 108 of the Act as applied in Horn. To paraphrase Horn, the structure of section 165 "closely tracks the sham transaction doctrine" in that losses are allowed for individuals "if and only if the transaction is entered into for profit or in a trade or business." Horn, 968 F.2d at 1238. Corporations -- like Mr. Horn, the commodities dealer -- are expressly exempted from this requirement. Given the similarities between section 165(c) and the sham transaction doctrine, it is "inconceivable that Congress intended that the 'sham' doctrine be laid OVER the statute." Id.; see International Trading Co., 4 84 F.2d at 711 ([i]t can hardly be argued that Congress was not aware of what it was doing in placing the limitation on the deductibility of losses by individuals only.") (quoting 57 T.C. at 467, Drennen, J., dissenting).

[117] With the exception of the decisions in ACM and the Tax Court's opinion below, the Partnerships are not aware of any case which holds that a transfer of property which results in a transfer of beneficial ownership, and therefore qualifies as a "sale" under the normal meaning of the term, nonetheless lacks economic substance due to the motive to reduce tax. ¹⁸ See Horn, 968 at 1238-39 (no reported cases apply sham transaction analysis to disallow loss otherwise allowed by section 165).

[118] In fact, two recent cases illustrate the Tax Court's confusion over whether transfers of property which actually convey ownership must be respected for tax purposes, even when the conveyances are motivated solely by tax avoidance. In these cases, the Tax Court respected property transfers which clearly lacked a business purpose. Estate Of Strangi v. Commissioner, 115 T.C. No. 35 (2000); Knight v. Commissioner, 115 T.C. No. 36 (2000). In a concurring opinion in Strangi, Chief Judge Wells observed that the majority's opinion was inconsistent with ACM. The fully-reviewed decisions in Strangi and Knight constitute binding precedent of the Tax Court, unlike the Tax Court's decisions in ACM and this case, which were issued as only memorandum opinions. See Kenseth v. Commissioner, 114 T.C. 399, 427-28 (2000) (memorandum decisions are not binding precedent).

III. THE PARTNERSHIPS' TRANSFERS OF BENEFICIAL OWNERSHIP OF THE PPNs

[120] As demonstrated above, see Part II.A., a transaction which qualifies as a "sale" as defined in section 1001 will, by definition, reflect a transfer of the benefits and burdens of ownership of property. Neither the Tax Court nor the Commissioner has disputed that when the Partnerships transferred the PPNs and CDs in exchange for the LIBOR Notes and cash, the Partnerships received back property "materially different" from the property they gave up. ¹⁹ Therefore, the Tax Court's acknowledgment that the Partnerships did, in fact, sell the PPNs and CDs in exchange for cash and LIBOR Notes cannot possibly be reconciled with its claim that these sales "did not meaningfully change Brunswick's economic position." (Opinion 129). If the Partnerships did indeed sell the PPNs and CDs to Norinchukin, Fuji, and Sumitomo -- which the Tax Court does "not dispute" -- then it necessarily follows that the Partnerships meaningfully changed their economic position when they exchanged the PPNs and CDs for property with materially different characteristics.

[121] Therefore, a transfer which satisfies the "materially different" standard of Cottage Savings and therefore qualifies as a sale as defined in section 1001, necessarily results in a meaningful change in economic position and a fortiori has all the economic substance which can possibly be required of a sale.. In his dissenting opinion in ACM, Judge McKee recognized this truism:

ACM's sales of the Citicorp Notes for cash and LIBOR Notes

[122] The Tax Court pointed to a number of factors as supporting its conclusion that the transfers of the PPNs and CDs did not result in a meaningful change in economic position. Each of these factors should be analyzed to determine whether it "defeats or contradicts" the economic elements normally associated with a sale. Chisholm, 79 F.2d at 15. First, although the Tax Court agreed that the Partnerships "accepted the benefits and burdens of ownership of the PPNs and CDs," it claimed these risks were minimal because the PPNs and CDs were issued by "highly rated banks." (Opinion 118-19). The Court's comment is both contrary to the record ²⁰ and legally irrelevant. If a taxpayer has actually assumed all the "benefits and burdens" of owning a particular piece of property, it should be irrelevant whether these benefits and burdens are minimal, so long as the taxpayer is in fact exposed to the "practical economic effects" of owning the property. While the owner of a Treasury bill may be regarded as owning a safe investment, he cannot be regarded as any less an "owner" of the Treasury bill than an owner of volatile stock should be regarded as the owner of the stock.

[123] The correct analysis is not whether the risks of owning the CDs and PPNs were minimal, but whether the Partnerships did in fact assume all of the risks of ownership, regardless of whether those risks were minimal or substantial. Since there is no dispute that the Partnerships were the beneficial owners of the PPNs and CDs and all their attendant risks and benefits, the Partnerships' ownership of these instruments cannot be disregarded.

[124] The Tax Court then claimed that the sales of the PPNs and CDs were "at best a wash" since the transactions produced small losses as a result of transaction costs. (Opinion 122). Once again, the Tax Court's point is difficult to understand. Many sales transactions produce either a loss or a "wash," but so long as these transactions represent the exchange of materially different property, their status as sale transactions has never been questioned. There is no case law to support the Tax Court's claim that sales which result in a "wash" are to be disregarded for tax purposes. Any such rule would obviously undermine the principles of administrative convenience set forth in Cottage Savings.

[125] While the Tax Court apparently recognized that the LIBOR Notes were materially different from the CDs and PPNs, it held that the acquisition of the LIBOR Notes did not have objective economic substance for two reasons. (Opinion 122). First, the Court stated that Brunswick never intended to hold the LIBOR Notes more than a brief time. There are several problems with this analysis. It is not clear how Brunswick's subjective intent alters the objective reality of "what actually occurred." See Gregory, 293 U.S. at 469. Regardless of Brunswick's intent, it is impossible to deny that, in acquiring the LIBOR Notes, both Partnerships acquired instruments with characteristics materially different from the PPNs and CDs for which they were exchanged. Saba held the LIBOR Notes for a substantial period of time -- long enough for their value (as reported by Merrill Lynch) to fluctuate by more than $4.5 million. ²¹ Also, if the Court's suggestion is correct, absolutely identical "sales" could be taxed differently, depending upon the taxpayer's intent. Such a test, once again, would obviously frustrate the purpose of section 1001 as set forth in Cottage Savings.

[126] Second, the Court held that the LIBOR Notes were unlikely to produce a profit. The Court made this determination based on evidence concerning the expected path of interest rates. While the expected direction of interest rates is obviously a subject on which experts may disagree, it is not in dispute that the LIBOR Notes placed the Partnerships in a materially different position with respect to changing interest rates than the PPNs and CDs. This point was proved when actual interest rates plummeted, which was contrary to both parties' evidence concerning the expected path of interest rates. If the Partnerships had not entered into hedges and subsequently sold their LIBOR Notes in time to avoid this downturn in interest rates, they would have lost millions of dollars.

[127] The more important point to make concerning the Tax Court's analysis, however, is that there is no support for the Tax Court's claim that a "profit" analysis is relevant in determining whether a given transaction should be considered as a sale. Certainly, there is nothing in the definition of a sale, or in the case law, which would indicate that a profit expectation is an inherent element of a sale. In fact, taxpayers are regularly advised at year-end to sell stocks which have declined in value in order to report the losses on their tax returns. The logic of the Tax Court's opinion would indicate that such sales lack, economic substance, since they are made for tax purposes and have no possibility of profit.

[128] It is easy to see where the Tax Court was side-tracked in search of a profit motive. Many economic substance cases have involved statutes which either explicitly require a profit motive or require a "trade or business," which obviously implies a profit motive. When the statute includes a "profit motive" or a "trade or business" requirement, Gregory requires an examination of the taxpayer's motive to ascertain whether the taxpayer's behavior matches the words of the statute. ²² As this Circuit's decision in Horn makes clear, however, there is no reason to overlay an expectation of profit onto a statute unless there is a reason to believe Congress intended such a requirement in enacting the statute, and there is no support in the case law for the Tax Court's claim that an expectation of profit is an essential element of a sale as described in section 1001.

IV. THE TAX COURT ERRED IN DENYING A TAX DEDUCTION FOR THE ECONOMIC LOSS INCURRED ON THE SALE OF THE LIBOR NOTES

[129] If this Court upholds the Tax Court's conclusion that the sales of the PPNs and CDs should be disregarded as lacking in economic substance, then it must address whether the Tax Court erred in calculating Brunswick's basis in the LIBOR Notes so as to deny Brunswick a deduction for its economic loss on the sale of the LIBOR Notes.

[130] The Tax Court's decision in this case departs from the Third Circuit's decision in ACM in one important respect. In ACM, the partnership incurred an economic loss of approximately $6 million upon the sale of the LIBOR Notes. This loss was due to a decline in the value of the LIBOR Notes as a result of declining interest rates and was not attributable to the installment sale rules. In ACM, the Tax Court disallowed a deduction for this loss, even though the ACM partnership was required to include the interest income from the LIBOR Notes in its taxable income.

[131] On appeal, the Third Circuit recognized that it was inconsistent to tax the ACM partnership on income from the LIBOR Notes yet deny a deduction for the loss on their sale. The Third Circuit therefore held that since the economic losses on the LIBOR Notes were both "economically substantive and separable" from the underlying installment sale, it would recognize both the income and loss aspects of the LIBOR Notes, and thus reversed the Tax Court's conclusion that the ACM partnership was not entitled to a deduction on the loss of the LIBOR Notes. ACM, 157 F.3d at 260-63.

[132] In the present case (unlike ACM), the sales of the LIBOR Notes did not take place inside the partnership, but were instead made by Brunswick after it received a distribution of the LIBOR Notes. Thus, the losses claimed by Brunswick are not within the jurisdiction of the Tax Court or this Court ²³ The Tax Court did, however, have jurisdiction to determine Brunswick's basis in the LIBOR Notes distributed from the Partnerships. The Tax Court arbitrarily decided that Brunswick's basis should be equal to the eventual sales price of the LIBOR Notes. The Tax Court obviously chose this value in order to deny Brunswick a loss deduction on the subsequent sale of the LIBOR Notes. The Tax Court did so even though its opinion acknowledged that Brunswick "lost nearly $5 million on the sale of the LIBOR Notes." (Opinion 122). There was clearly no legal basis for this action. The Tax Court's decision has the illogical effect of requiring Brunswick to set its basis in the LIBOR Notes upon their distribution by reference to an event -- the sale of the Notes -- which obviously would take place after the distribution. The basis of the LIBOR Notes as distributed by the Partnerships to Brunswick should have been calculated as the Partnerships' basis in the Notes. section 732(a). The Tax Court made no pretense of applying this rule.

[133] The Tax Court compounded this error by overturning the parties' express agreement on interest income from the LIBOR Notes. In its opinion, the Tax Court expressly noted the parties' "agreement that the partnerships are required to include in their taxable income the interest payments that they received on the LIBOR Notes." (Opinion 131) Through motions following the issuance of its opinion, however, the Tax Court became aware of the inconsistency in setting the basis in the LIBOR Notes at an amount which would prevent Brunswick from claiming the economic loss, while simultaneously requiring that the Partnerships report income from the LIBOR Notes. See ACM, 157 F.3d at 261. To avoid this inconsistency, the Tax Court -- without a request to do so from either party -- reversed the parties' express agreement concerning the income from the LIBOR Notes.

[134] The Tax Court emphasized that seven of the Partnerships' LIBOR Notes were " only held between 4 and 6 months," while acknowledging that one of the LIBOR Notes was held for "16 months." (Order 2). The Tax Court apparently concluded that these shorter holding periods distinguished ACM, where the holding period for the LIBOR Notes was approximately two years.

[135] It is impossible, however, to make any principled distinction between a holding period of two years and one of four to six months. The $5 million in losses which Brunswick actually suffered on the sale of the LIBOR Notes proves that its holding period was long enough to "pose[ ] an actual risk to the principal value" of the LIBOR Notes and that the ownership of the LIBOR Notes therefore had an "economically substantive impact." ACM, 157 F.3d at 262.

[136] The Tax Court also claimed that Brunswick's hedges negated the ownership of the LIBOR Notes. The Tax Court, however, neglected to add that Brunswick reported income on these hedges as interest rates fell. As in ACM, denying a deduction for the LIBOR Notes would be inconsistent with the reporting of income on the hedges. Accordingly, this Court should reverse and remand the Tax Court's decision concerning the basis in the LIBOR Notes in the event that this Court upholds the Tax Court's decision that the sale of the PPNs and CDs lacked economic substance.

CONCLUSION

[137] The Partnerships respectfully request that the Tax Court's decision be reversed.

Dated: April 27, 2001

(2) I.R.C. section 732(a)

(3) Temp Treas. Reg. section 15A.453-1(c)

Sec. 453 [1986 Code]. (a) GENERAL RULE. -- Except as otherwise provided in this section, income from an installment sale shall be taken into account for purposes of this title under the installment method.

(b) INSTALLMENT SALE DEFINED. -- For purposes of this section --

* * * *

(c) Contingent payment sales -- (1) In general. Unless the taxpayer otherwise elects in the manner prescribed in paragraph (d)(3) of this section, contingent payment sales are to be reported on the installment method. As used in this section, the term "contingent payment sale" means a sale or other disposition of property in which the aggregate selling price cannot be determined by the close of the taxable year in which such sale or other disposition occurs.

* * * *

This paragraph prescribes the rules to be applied in allocating the taxpayer's basis (including selling expenses except for selling expenses of dealers in real estate) to payments received and to be received in a contingent payment sale. The rules are designed appropriately to distinguish contingent payment sales for which a maximum selling price is determinable, sales for which a maximum selling price is not determinable but the time over which payments will be received is determinable, and sales for which neither a maximum selling price nor a definite payment term is determinable. In addition, rules are prescribed under which, in appropriate circumstances, the taxpayer will be permitted to recover basis under an income forecast computation.

* * * *

(3) Fixed period -- (i) In general. When a stated maximum selling price cannot be determined as of the close of the taxable year in which the sale of other disposition occurs, but the maximum period over which payments may be received under the contingent sale price agreement is fixed, the taxpayer's basis (inclusive of selling expenses) shall be allocated to the taxable years in which payment may be received under the agreement in equal annual increments. In making the allocation it is not relevant whether the buyer is required to pay adequate stated interest. However, if the terms of the agreement incorporate an arithmetic component that is not identical for all taxable years, basis shall be allocated among the taxable years to accord with that component unless taking into account all of the payment terms of the agreement it is inappropriate to presume that payments under the contract are likely to accord with the variable component. If in any taxable year no payment is received or the amount of payment received (exclusive of interest) is less than the basis allocated to that taxable year, no loss shall be allowed unless the taxable year is the final payment year under the agreement or unless it is otherwise determined in accordance with the rule generally applicable to worthless debts that the future payment obligation under the agreement has become worthless. When no loss is allowed, the unrecovered portion of the basis allocated to the taxable year shall be carried forward to the next succeeding taxable year. If application of the foregoing rules to a particular case would substantially and inappropriately defer or accelerate recovery of the taxpayer's basis, a special rule will apply. See paragraph (c)(7) of this section.

² As discussed below, see page 54, the Court ruled that the Partnerships were not required to report interest income from the LIBOR Notes even though both parties agreed the Partnerships were required to report this income.

³ Mr. Reichert became CEO as a direct result of his leadership in defending Brunswick against a hostile takeover by Whittaker Corporation in 1982. Throughout his tenure at Brunswick, one of Mr. Reichert's principal goals was to preserve Brunswick's value as an independent company. (Tr. 888-90, 898-99).

⁴ Credit risk reflects the possibility that a borrower will not make a scheduled interest or principal payment. Event risk is the possibility that a single event could have a major effect on the ability of an issuer to repay an obligation. Credit spread risk is the risk that general credit spreads (the difference between the promised rate on corporate instruments with a given credit risk and the rate on Treasury instruments) will rise or fall, which would have affected the value of the PPNs. Liquidity risk is the risk that the owner of an instrument cannot convert the instrument into cash at its fair market value. (Tr. 1532-52).

⁵ The sales price included $94,384 of accrued interest on the PPNs for the period from March 21 through March 23, 1990. Saba reported this amount as interest income on its partnership tax return for the taxable year ended March 31, 1990. (Stip. paragraph 225).

⁶ The basis of a LIBOR Note is each Note's allocable share of the following items: (a) the original cost of the PPNs or CDs, reduced by (b) amounts previously allocated as an annual return of basis under the installment sale regulations, and further reduced by (c) payments on the LIBOR Notes allocated as a return of principal. The parties have agreed that Brunswick should have reported its basis in the LIBOR Notes as $123,365,892 to take into account the July 2, 1990 payments on the LIBOR Notes which were allocated to principal. (Stip. paragraph 325).

⁷ The sale price as calculated by Merrill Lynch included approximately $200,000 of accrued interest on the IBJ CDs, which Otrabanda included on its partnership tax return, and a discount of approximately $750,000. (Stip. paragraphs 462, 467).

⁸ The parties have agreed that Brunswick should have reported its basis as $82,271,984 to take into account amounts treated as principal payments on the LIBOR Notes. (Stip. paragraph 521).

⁹ In Horn, this Court used the phrase "economic sham transaction doctrine" in describing transactions lacking economic substance. Horn, 968 F.2d at 1235. In this brief, we have followed the Tax Court's terminology and refer to the issue as the "economic substance doctrine."

The Tax Court incorrectly stated that the Partnerships have argued an "economic substance analysis is not warranted." (Opinion 96,102) The Partnerships have never made such a claim, but rather have argued that in the context of section 1001, "economic substance" requires only an examination of whether the transfer in question actually results in a transfer of the benefits and burdens of ownership.

¹⁰ Horn, 968 F.2d at 1236-38.

¹¹ Gregory, 293 U.S. at 469.

¹² Therefore, when a specific Code provision requires purposive conduct, such as pursuit of a trade or business, or an expectation of profit, a transaction motivated solely by tax considerations will lack economic substance because its purpose will not match the purpose required by the statute. See note 22, below.

¹³ See, e.g., Frank Lyon Company v. United States, 435 U.S. 561, 582 (1978) (Government's "theorizing" that transaction was a financing failed to explain certain facts); Grove v. Commissioner, 490 F.2d 241, 247 (2d Cir. 1973) (court refused government's request to recast "actual transactions" into "fictional transactions"); Esmark, Inc. v. Commissioner, 90 T.C. 171, 188-89 (1988) (Commissioner's argument failed to account for actual events).

¹⁴ As amended by the Tax Reform Act of 1986.

¹⁵ Wexler, 31 F.3d at 124 ("[W]e stated in Lerman that 'economic substance is a PREREQUISITE to any Code sections allowing deductions.'" (citation omitted)).

¹⁶ Tax statutes conferring a benefit should be interpreted narrowly. See INDOPCO, Inc. v. Commissioner, 503 U.S. 79, 84 (1992).

The situation is different, however, with statutes such as section 1001, which, in accordance with congressional intent, should be broadly interpreted to sweep in all sale transactions.

¹⁷ Other cases also hold that a "sale" lacks economic substance only when the purported sale fails to convey ownership. See, e.g., Mapco, Inc. v. United States, 556 F.2d 1107, 1109 (Ct. Cl. 1977) (buyer's lack of ownership rights "more important" than tax motive).

¹⁸ In ACM, the Third Circuit identified several cases in which it claimed the taxpayers' transactions were not recognized for tax purposes even though they had "actually and objectively disposed of their property." ACM, 157 F.3d at 249. These cases do not support the Third Circuit's claim. Yosha v. Commissioner, 861 F.2d 494 (7th Cir. 1988) and Kirchman v. Commissioner, 862 F.2d 1486 (11th Cir. 1989) both involved the application of the "profit motive" test of section 165(c)(2), which is not relevant here. In Merryman v. Commissioner, 873 F.2d 879, 882 (5th Cir. 1989), the evidence indicated that the purported purchaser had "surrendered total control" back to the seller. Moreover, as explained above, Lerman is contrary to the law of this Circuit.

¹⁹ The PPNs were designed to maintain their principal value and thus were relatively stable investments, although they were subject to certain risks. See note 4, above. The LIBOR Notes, on the other hand, were extremely volatile investments which, depending upon movements in interest rates, could have produced profits -- or losses -- of tens of millions of dollars.

²⁰ In the summer and fall of 1990 -- only several months after Saba sold the Chase PPNs -- S&P and Moody's twice lowered Chase's credit rating, and as a result the value of Chase's debt fell by 8-9 percent.

²¹ (Stip. paragraph 264). The Commissioner may argue that Brunswick entered into hedges which served to reduce the volatility of the LIBOR Notes. Brunswick did not enter into such hedges for several months, however, until after it became concerned over a possible decline in interest rates, and never hedged the full value of the LIBOR Notes. In any event, the necessity of purchasing the hedges demonstrates that Brunswick materially altered its economic position when it purchased the LIBOR Notes, since if Brunswick had not altered its economic position, the purchase of the hedges would have been unnecessary.

²² Glass v. Commissioner, 87 T.C. 1087, 1175-76 (1986) (transactions undertaken by individuals with "no business or profit- making purpose" were . . . not the thing which the statute intended," since the statute expressly required a business purpose or profit motive) (quoting Gregory, 293 U.S. at 469); Kirchman v. Commissioner, 862 F.2d 1486, 1491 (11th Cir. 1989) ("If a transaction is not motivated by profit or economic advantage, then that transaction is a sham for purposes of analysis under I.R.C. section 165(c)(2)."); Cottage Savings, 90 T.C. at 388 (lack of business purpose "conclusive" for purposes of sections 183(a) and 165(c)(2)).

In contrast, as noted above, see Part II.B., corporations are entitled to claim losses under section 165 even if the underlying transaction did not have a business purpose or a possibility of profit. International Trading Co., 484 F.2d at 709 ("business-profit nexus" not a prerequisite for the deductibility of corporate losses).

²³ See page 5, above.