International Air Lease Files Third Amended Bankruptcy Complaint Against IRS, CARDS Promoters

I. JURISDICTION AND VENUE

1. This is an adversary proceeding brought pursuant to Bankruptcy Rule 7001.

2. This Court has subject matter jurisdiction over the declaratory judgment claim pursuant to 11 U.S.C. § 505(a)(1), 28 U.S.C. §§ 1334, Fed. R. Bankr. P. 7001(9).

3. This Court has subject matter jurisdiction over the remaining claims pursuant to 28 U.S.C. § 1334 because these claims are related to IAL's and/or IALPR's proceeding pending in this Court.

4. This Court has personal jurisdiction over the non-creditor defendants pursuant to Section 48.193, Florida Statutes, and otherwise by virtue of either the defendant's presence or substantial activity in this jurisdiction and/or because events giving rise to IAL's and/or IALPR's claims against the Defendants occurred in the State of Florida.

5. Venue is appropriate in this Court pursuant to 28 U.S.C. § 1409, because IAL's and/or IALPR's Chapter 11 Bankruptcy Petition is pending in this District.

II. PARTIES

6. Plaintiff, IAL, is a Delaware corporation wholly owned by IALPR and a Chapter 11 Debtor under Case No. 02-12215-BKC-RAM pending before this Court.

7. Plaintiff, IALPR, is a Puerto Rican corporation and a Chapter 11 Debtor under Case No. 02-12214-BKC-RAM pending before this Court.

8. Defendant, USA, is a legal entity that filed a Proof of Claim in IAL's bankruptcy case through its agency, the Internal Revenue Service ("IRS"').

9. Defendant, Sidley Austin, is a national law firm organized as a Delaware limited liability partnership, with its principal place of business located at 875 Third Avenue New York, New York. Upon information and belief, Sidley Austin is the successor in interest to the law firm of Brown & Wood, LLP and shall be referred hereinafter as "Sidley Austin."

10. Defendant, Ruble, is an individual and upon information and belief, a resident of the State of New York. At all times material hereto, Ruble was a partner at Sidley Austin and a promoter of the CARDS Transaction described herein.

11. Upon information and belief, Deutsche Bank is a New York corporation with its principal place of business at 130 Liberty Street, Floor 31, New York, New York 10006, and doing business at 2 South Biscayne Blvd., Miami, Florida 33131.

III. GENERAL ALLEGATIONS

12. On November 12, 1998, IAL's sole shareholder George Batchelor ("Batchelor") executed a Stock Purchase Agreement to sell his stock in IAL and IAL's related companies to IALPR for $475,000,000.

13. Prior to the closing date, the deal was modified. The modified agreement provided that simultaneous with or prior to the closing, Batchelor would redeem half his shares in IAL, Aircraft Leasing Inc., ("ALI") and N304 Corp. ("N304") for cash and assets valued at $234,675,304.00 ("Redemption"). The amended agreement then provided that IALPR would pay Batchelor $267,506,337.00 for the purchase of the remaining shares of IAL, ALI and N304. This sum was payable as follows:

15. Post closing, IAL immediately sought a means to obtain the capital necessary to finance its ongoing business operations, including its further financial obligations to Batchelor as well as mechanism to minimize the tax effect and liabilities created from the gain IAL realized from the Batchelor Transaction.

16. In 1999, Sussex Financial Enterprises, Inc. f/k/a Chenery & Associates, Inc. ("Sussex"), an investment banking firm together with Ruble on behalf of Sidley Austin and Deutsche Bank promoted financial and tax planning services to IAL. These individuals and entities represented that they had investment banking, tax management, legal and financial expertise possessing insights that can grow a company's capital and reduce its tax burden.

17. Apparently, Sussex and Ruble, an attorney and partner at Sidley Austin, developed a credit facility known as "custom adjustable rate debt structure" ("CARDS"). Upon information and belief, Ruble assisted Sussex and Hahn in creating, organizing, marketing, selling, soliciting, and executing the CARDS Transaction for IAL. Deutsche Bank accommodated the promotion of CARDS as a tax planning mechanism by acting as the "lender" at Sussex's and/or Ruble's request. The essential feature of a CARDS transaction involves a foreign currency loan that provides capital to fund the borrower's business operations, and creates, through a subsequent foreign currency exchange, a loss transaction that the borrower can apply to offset pre-existing capital gain for federal tax purposes. Ruble and Sidley Austin developed the "legal opinion" regarding the purported propriety of the CARDS transaction to qualify as a legitimate federal tax planning mechanism ("CARDS Transaction").

18. Ruble also promoted and marketed the CARDS Transaction as a viable credit facility and legitimate tax planning mechanism, and worked hand-in-hand with Sussex to sell the CARDS Transaction to Sussex's prospective clients, including IAL. In fact, Ruble solicited IAL and IALPR to participate in a CARDS Transaction and was an instrumental and central figure in IAL's decision to engage Sussex to provide IAL with the CARDS Transaction. IAL relied on Ruble's promotion of the CARDS Transaction legal opinions, and promises regarding IAL's ability to use the CARDS Transaction in its business and representations that the CARDS Transaction was a legitimate tax planning transaction which would satisfy IAL's needs and requirements for current funding and tax benefits.

19. IAL and IALPR assert that Sidley Austin and Ruble created, initiated, marketed, promoted and devised some, if not all, of the transaction known as CARDS. Sidley Austin also prepared the legal or tax opinion that established the tax shelter, participated in the execution of the CARDS transaction and provided CARDS with the veil of legitimacy which induced IAL and IALPR to participate in CARDS. Ruble allowed other law firms and attorneys to copy his canned legal opinions for inflated fees for himself, other law firm promoters and Deutsche Bank.

20. Ruble and Sidley Austin had a significant financial interest in promoting and selling the CARDS Transaction because Sussex regularly engaged and paid Ruble and Sidley Austin, on behalf of Sussex's clients, to provide a purportedly "independent" legal opinions regarding the validity of the CARDS Transaction to qualify as a legitimate federal tax planning mechanism. Ruble and Sidley Austin's compensation for their opinions not only included the fees incurred in preparing the opinion, but also included a "bonus" for participating as a promoter of the CARDS Transaction.

21. The "fee" Sidley Austin received from IAL and/or IALPR was not based on hourly charges, but in fact, related to the total amount of losses created by CARDS for IAL.

22. Ruble, Sidley Austin and Deutsche Bank participated in the marketing and promoting of the CARDS Transaction to IAL in order to convince IAL to engage in the transaction to the exclusion of other financial arrangements. Ruble, Sidley Austin and Deutsche Bank were instrumental in promoting the CARDS Transaction to IAL as a legitimate financing mechanism with tax benefits. Ruble and Sidley Austin induced IAL into hiring Sussex to arrange the CARDS Transaction.

23. IAL was advised that the elements of the CARDS Transaction were as follows:

24. Each step in the CARDS Transaction was carefully crafted with Ruble and Sidley Austin's participation in advance to ensure that IAL would become obligated to pay the CARDS Transaction fee to the Defendants. Deutsche Bank was instrumental in the scheme to accommodate IAL in the CARDS Transaction and caused IAL to be obligated for this fee. In turn, IAL was promised that it would receive the promised dual benefit.

25. IAL advised Ruble and Sidley Austin that its primary interest in entering into this CARDS Transaction was obtaining the proceeds from the loan to finance its ongoing business operations and to pay IAL's obligations to George Batchelor. Deutsche Bank knew, or should have known this fact by virtue of its involvement with Sussex, Ruble and Sidley Austin.

26. IAL was advised by its professional including Ruble and Sidley Austin that:

28. Rather than advising IAL that it was insolvent, incapable of participating in the CARDS Transaction and that it would not obtain the loan proceeds from the CARDS Transaction, this information was concealed by Ruble, Sidley Austin and/or Deutsche Bank in order to lure IAL to assume the Loan in July 1999.¹ It was only upon the assumption date that IAL became obligated to pay the professional fees associated with CARDS. The Defendants, Ruble, Sidley Austin and/or Deutsche Bank knew that the rejection of the substitute collateral would occur after IAL had obligated itself to transfer in excess of $11.55 in cash to Sussex and the preferred shares valued by Bakerloo and Sussex at $3.2 million.

30. Sussex's original fee for arranging the CARDS Transaction was $11.7 million. The fee (including the fees for Ruble, Sidley Austin and Deutsche Bank) was calculated on and related to the total amount of the alleged losses to be created by the CARDS Transaction. Part of this fee was to be used to pay for the professional and other fees involved in executing a CARDS Transaction on behalf of 1A.L, including fees for legal opinions, legal advice and/or bank fees.

31. Sussex's fee was subsequently adjusted up to $14.75 million by virtue of an Amended Engagement Letter. The $14.75 million fee was divided into to [sic] components: a cash component of $11.55 million (the "cash component") and an equity component provided to Bakerloo which Bakerloo and Sussex valued at $3.2 million (the "equity component").

32. From the $14.75 million dollar fee set forth in the Amended Engagement Letter:

36. The CARDS Transaction requires an accommodating bank to provide Bakerloo with the "loan" which IAL would then assume.

37. Upon information and belief, on or about June 1999, Bankers Trust Corporation agreed to participate in this transaction only as the "accommodating bank." Bankers Trust Company was subsequently acquired by Deutsche Bank and shall hereinafter be referred to as Deutsche Bank.

38. Unbeknownst to IAL, Deutsche Bank agreed to provide the loan, but refused to agree to substitute IAL's collateral. Deutsche Bank refused to incur any risk of releasing any proceeds of the "loan" to IAL. Thus, Ruble, Sidley Austin and Deutsche Bank, knew as of June 1999 that Deutsche Bank would not substitute the collateral and provide the current funding promised. Thus, these Defendants knew, or should have known the CARDS offered IAL no current funding and in all likelihood no tax benefits; all contrary to these Defendants' promises.

39. In an effort to ensure their fees were paid, this information was concealed, by Ruble, Sidley Austin and Deutsche Bank, from IAL and/or IALPR.

40. IAL continued to remind the Defendants, Ruble and Sidley Austin that a primary reason for IAL electing to participate in the CARDS Transaction and paying the significant fee was to obtain current funding for its business purposes. Ruble and Sidley Austin assured IAL that the transaction was being implemented as promised. Deutsche Bank knew, or should have known this by and through its agents or co-promoters, Sussex, Ruble and/or Sidley Austin.

41. On or about June 1, 1999, Deutsche Bank entered into a Credit Agreement with Bakerloo to loan Bakerloo the principal sum of € 310 million ("Loan"). As part of the Loan, Bakerloo was required to use these Loan proceeds to purchase approximately € 225 million worth of German government € denominated treasury bonds ("Bonds"). These Bonds were deposited, together with the remaining € 55 million cash proceeds, into a loan collateral account at Deutsche Bank, The interest generated from the Bonds was used. to pay the interest due on the Loan. Thus, Deutsche Bank simply transferred the money from one account to another. Deutsche Bank has no real economic risk in this transaction.

42. Deutsche Bank received a $5.1 million fee for its participation in the CARDS Transaction. The fee paid to Deutsche Bank was paid for IAL's ostensible benefit and solely for the purpose of facilitating the CARDS Transaction. This fee was calculated based upon the alleged tax loss provided to IAL and Deutsche Bank's commitment to Sussex to promote CARDS together with Sussex, Ruble and Sidley Austin.

43. Deutsche Bank was a willing participant in the CARDS Transaction, fully aware that its role in the CARDS Transaction included facilitating the Loan and holding the Loan proceeds and treasuries as collateral. At all times material hereto, Deutsche Bank never informed IAL nor IALPR that it was merely an accommodating promoter.

45. On June 23, 1999², IAL, relying on the Defendants, Ruble, Sidley Austin and Deutsche Bank, representations and promises IAL executed the Assumption Agreement ("Assumption") with Bakerloo and all the documents necessary for closing, including those documents Deutsche Bank demanded. At the Assumption, IAL reasonably believed that it would receive its current funding set forth in the Amended Engagement Letter. Pursuant to the Assumption Agreement, Bakerloo assigned or sold to IAL € 55 million balance of the Loan proceeds.

46. At all times material hereto, Deutsche Bank retained the Loan and the collateral for the Loan. At no time did Deutsche Bank release any money to IAL.

47. Ruble and Sidley Austin advised IAL that IAL would have a basis in the foreign currency equal to the amount of the Loan and that the sale of the high basis, low value foreign currency would result in an ordinary loss to IAL. IAL relied on its professionals including Ruble, Sidley Austin and Deutsche Bank, to ensure that the CARDS Transaction would generate the promised loss. IAL relied on Ruble, Sidley Austin and Deutsche Bank and their representations and promises to claim the loss on its tax returns.

49. Upon information and belief, and unknown to IAL at the time, Ruble and Sidley Austin, had already prepared "canned" opinion letters regarding the CARDS Transaction, and needed only to fill in several blanks for each of the many clients to whom they rendered such "opinion" letters. Upon information and belief, Sidley Austin's "opinion" letter was prepared without:

51. Sidley Austin's "opinion" letter advised IAL of the following:

54. The representations that Deutsche Bank would substitute IAL's collateral and release certain Loan proceeds to IAL were knowingly false.

55. On or about October 1999, Deutsche Bank advised that it refused to accept IAL's assets as substitute collateral, and would not release the Loan proceeds to IAL. Thus, IAL received no working capital to fund its operations.

56. Sidley Austin,Ruble and Deutsche Bank knew that Deutsche Bank would not accept IAL's assets as substitute collateral. Yet, each participated in the CARDS Transaction solely to cause Plaintiffs to pay almost $11.7 million in fees to professionals. Deutsche Bank never intended to release any part of the Loan proceeds, and participated in the CARDS Transaction solely to accommodate the professionals in earning a fee for itself of $5.1 million.

57. After Deutsche Bank rejected IAL's collateral, and on or about October 16, 1999, Deutsche Bank called in the Loan by demanding that the Loan be repaid. IAL was unable to pay the Loan. Thus, Deutsche Bank seized the collateral the Bank was holding; i.e., the Bonds, and liquidated the collateral to satisfy the Loan.

58. IAL was then forced to seek alternate financing and incur additional fees and delay, in order to meet its financial obligations, including its alleged obligation to Sussex.

59. Although IAL received no funding from the CARDS Transaction, IAL paid the professionals in excess of $11.7 million in cash and compensated Bakerloo with IAL's preferred stock.

60. Based on the professionals representation including Ruble, Sidley Austin and Deutsche Bank's participation legitimizing the CARDS Transaction, regarding the validity of the CARDS Transaction as a legitimate tax planning mechanism, and PricewaterhouseCoopers, ("PWC"), agreed to allow IAL to report the loss allegedly created by the CARDS Transaction on its FYE 00 federal tax return to off-set its pre-existing gain, and reduce its current federal tax liability. Relying on its professionals, IAL signed and filed its tax returns which included the loss from the CARDS Transaction.

62. On July 6, 2002, the IRS filed an amended Proof of Claim against IAL for $255,785,133.22, a copy of which is attached as Exhibit "B". Of this sum, the IRS alleges that $208,867,667.47 is a priority tax claim and $46,917,465.75 is an unsecured claim. The IRS claim arises from its disallowance of the loss deductions created by the CARDS Transaction, and determination that the CARDS Transaction, as designed and structured, does not qualify as a legitimate tax shelter.

63. IAL and IALPR have retained the law firms of Kozyak Tropin & Throckmorton, P.A., and Meland Russin Hellinger and Budwick, P.A. to bring this action, and is obligated to pay them a reasonable fee for their services.

65. The IRS has nationally targeted the legitimacy of the CARDS transaction, and has nationally targeted all federal tax returns with such a deduction for examination and disallowance. The alleged tax liability set forth in the IRS' Proof of Claim is grounded, in part, on the disallowance of an ordinary loss deduction IAL claimed pursuant to its participation in the CARDS transaction.

66. The IRS proposes that IAL has unpaid federal income tax deficiencies for FYE 3/31/94; 3/31/95; 3/31/99; 3/31/00 and 3/31/01. Adjustments serving as bases for these proposed deficiencies include but are not limited to:

68. The IRS' tax claim has not been previously adjudicated by a judicial or administrative tribunal, but is the subject of IAL's pending objection.

69. IAL is unsure of its liability to the United States for this tax claim asserted by the IRS, or the appropriate amount of the taxes due and owing, if any, plus any interest and/or penalties attributable thereto.

70. Pursuant to 11 U.S.C. § 505 and 28 U.S.C. § 2201, IAL is entitled to a declaration whether it is liable to the IRS for such taxes, interest and/or penalties, and the amount thereof

WHEREFORE, IAL demands judgment against the United States of America, pursuant to 11 U.S.C. § 505 regarding IAL's liability for federal income taxes, interest and/or penalties claimed by the IRS in its bankruptcy proceeding, and such other relief as this Court deems just and proper.

72. Prior to IAL engaging Sussex, Ruble and Sidley Austin, Ruble met with IAL and represented that Sussex and Ruble had developed a credit facility known as a CARDS Transaction that would provide IAL with two distinct benefits: (i) a Loan for funding its business operations, and; (ii) enormous tax savings benefits. Deutsche Bank promised that it would provide IAL with the loan so that IAL would be able to claim the tax savings.

73. At the time these representations were made, Ruble, Sidley Austin and Deutsche Bank made them to cause IAL and/or IALPR to be obligated to pay $11.7 million to Sussex, including, but not limited to, $5.1 million to Deutsche Bank and $500,000.00 to Sidley Austin and/or Ruble.

74. These representations were knowingly false representations and made by Defendants, Ruble, Sidley Austin and Deutsche Bank as part of their efforts in selling, marketing promoting and implementing the CARDS Transaction.

75. At the time Ruble, Sidley Austin and Deutsche Bank made these material representations, they knew, or should have known, that IAL did not qualify as a borrower under the CARDS Transaction and that it did not have sufficient assets to use as collateral for the Loan, and that it was, in fact, insolvent.

76. Ruble made material representations to IAL that Ruble and Sidley Austin would provide an independent legal opinion to confirm the validity of the CARDS Transaction to qualify as a legitimate tax planning mechanism under applicable federal tax laws, rules, codes and regulations, which would withstand scrutiny should the IRS audit IAL.

77. At the time Ruble, Sidley Austin and Deutsche Bank made these material representations, they knew, or should have known, that these representations were false, or recklessly made without knowledge of their truth or falsity, and that the CARDS Transaction was not a legitimate tax planning mechanism or means to provide current funding.

78. Ruble, Sidley Austin and/or Deutsche Bank intended that these material representations would induce IAL to enter into the CARDS Transaction and pay millions of dollars to Sussex and the other participants in the CARDS Transaction, and cause IAL to forego other legitimate tax planning and financing or credit services.

79. Ruble failed to inform IAL that it could be liable for substantial interest and/or penalties if the IRS disallowed the loss created by the CARDS Transaction and reported by IAL on its federal tax returns.

80. Ruble's, Sidley Austin's and/or Deutsche Bank's false representations and omissions were willful, wanton and with reckless disregard for IAL. Ruble knew or should have known that the CARDS Transaction would not provide IAL any current funding and/or tax savings benefits. Rather, the CARDS Transaction would expose IAL to penalties and interest from the IRS. At no time did Ruble advise IAL that the CARDS Transaction was a listed transaction or the detrimental consequences to IAL that would result from the CARDS Transaction being deemed a listed transaction.

81. IAL did not know when it entered into the CARDS Transaction, that the representations made by Ruble, Sidley Austin and/or Deutsche Bank were false, or recklessly made without knowledge of their truth or falsity.

82. IAL reasonably relied upon the false representations made by Ruble, Sidley Austin and/or Deutsche Bank to its detriment. Had IAL known that these representations were false, it would not have engaged Sussex, paid it millions of dollars, and would have pursued alternative tax planning and funding opportunities.

83. As a result of Ruble's, Sidley Austin's and/or Deutsche Bank's false representations and fraudulent inducement, IAL has been damaged because it: (i) paid Defendants, through Sussex millions of dollars; (ii) has incurred or will incur liability for substantial interest and/or penalties on unpaid federal taxes; (ii) has incurred or will incur professional fees to rectify these damages; and (iv) has forgone alternate legitimate tax planning opportunities.

84. IAL retains the right to amend this count and assert a claim for punitive damages.

WHEREFORE, IAL demands judgment against Ruble, Sidley Austin and/or Deutsche Bank for compensatory damages, interest, attorneys' fees, costs incurred in bringing this action, and other such relief this Court deems just and proper.

86. Ruble, Sidley Austin and Deutsche Bank made numerous false representations and intentional omissions to IAL including that: (i) the CARDS Transaction would provide IAL a loan to fund its business operations; (ii) IAL's aircraft portfolio would be acceptable and sufficient collateral for Deutsche Bank to release to IAL Loan proceeds needed to fund its operations; (iii) the CARDS Transaction would generate a large loss which IAL could use to offset its pre-existing gain and thus reduce its federal tax liability; and (iv) the opinion letters provided by Sidley Austin and Miller Canfield would satisfy the IRS of the validity of the loss transaction and the propriety of IAL's calculation of its federal tax liability.

87. Ruble, Sidley Austin and Deutsche Bank each knew, or should have known, that the representations made to IAL were false, that they were material to IAL and IALPR and would induce IAL and IALPR into paying these defendants, directly or indirectly, their fees. The false representations and omissions of material fact were intentional and made to induce IAL to enter into the CARDS Transaction, and pay these defendants millions of dollars, and to induce IALPR to invest in IAL sufficient sums to pay them fees.

88. Ruble, Sidley Austin and Deutsche Bank knew or should have known that the CARDS Transaction would not provide IAL any current funding or tax savings benefits but rather would expose IAL to federal tax penalties and interest. At no time did any of these defendants advise IAL and/or IALPR that the CARDS Transaction was a listed transaction nor did they advise IAL and/or IALPR of the consequences of the CARDS Transaction being deemed a listed transaction.

89. Ruble, Sidley Austin and Deutsche Bank failed to disclose to IAL and/or IALPR that if IAL filed federal tax returns claiming a loss based on the CARDS Transaction, and the IRS disallowed the loss, IAL would be liable not only for the tax, but for interest and/or penalties for underpaid federal taxes.

90. Ruble, Sidley Austin and Deutsche Bank. knew that the CARDS Transaction was an illegitimate scheme and would not provide the benefits to IAL that defendants represented it would. The CARDS Transaction was merely a fraudulent scheme and conduit for payment of money to each of the defendants.

91. Ruble, Sidley Austin and Deutsche Bank knowingly concealed vital information about the substitution of collateral from IAL prior to IAL assuming the debt with the purpose of luring IAL to assume the Loan. As a result of the Assumption, IAL became obligated to pay the fees.

92. In reasonable reliance on the false representations and omissions of material fact made by each defendant, and in reliance that the CARDS Transaction would provide IAL with current funding and tax savings benefits as represented by these defendants, IAL paid these professionals millions of dollars for fees, which included the payment of fees to Sidley Austin, and Deutsche Bank.

93. In addition, the Sussex Defendants defrauded IAL by knowingly withholding the final tax opinions for a period in excess of one year as a means to strong arm IAL into paying the fees they asserted were due and owing.

94. IAL and IALPR have been damaged as a direct and proximate result of this fraud and as a result of the false representations and omissions of material fact made by each defendant because: (i) IAL paid millions of dollars in reliance on these representations and omissions; (ii) IAL has incurred or will incur interest and/or penalties on underpaid federal taxes; (iii) IAL and/or IALPR have incurred or will incur substantial costs in hiring new tax and legal advisors to rectify the damages; and, (iv) IAL has foregone alternate legitimate tax planning opportunities.

95. IAL and IALPR retain the right to amend this count and assert a claim for punitive damages.

WHEREFORE, IAL and IALPR demand judgment against Ruble, Sidley Austin and Deutsche Bank for compensatory damages, interest, attorneys' fees, costs incurred in bringing this action, and any further relief the court deems proper and just.

97. Ruble, Sidley Austin and Deutsche Bank each either created and/or participated in the CARDS Transaction which was formed as a scheme to defraud corporations such as IAL into paying each defendant fees for services under the pretext that the CARDS Transaction is a legitimate tax shelter and source of funding. Deutsche Bank was the accommodating bank which facilitated the CARDS Transaction. Deutsche Bank's Structured Transaction department along with its counsel prepared all the financial documents to implement the CARDS Transaction as otherwise promoted.

98. Ruble, Sidley Austin and Deutsche Bank knew that the CARDS Transaction was either an illegitimate tax shelter plan that would provide no tax savings benefits or a sham loan that would not provide capital to IAL to fund its operations, and that was merely a conduit for payment of money to each defendant, or knew that the CARDS Transaction was improper.

99. Ruble, Sidley Austin and Deutsche Bank knew that the CARDS Transaction would not provide IAL the current funding for general purposes which the IAL had been promised it would receive.

100. Ruble, Sidley Austin and Deutsche Bank agreed to participate in and play key roles in effectuating the CARDS Transaction with the intent of receiving fees for services they knew or should have known would not be provided to IAL or for services which would render no benefit to IAL. The amount of fees earned was not tied to or reflective of the amount of time or effort the Defendants expended in providing legal or banking services, but rather was tied to the amount of tax losses claimed by IAL.

101. In addition, Ruble, Sidley Austin and Deutsche Bank knew that Sussex and its principals had arranged for IAL to retain Austin as IAL's "counsel" to control and convince IAL to complete the assumption of the CARDS Transaction, thereby triggering the payments from IAL and/or IALPR.

102. Collectively, these defendants received millions of dollars in fees for services they knew they could not perform, were invalid, illegal or illegitimate or for services that would provide no benefit to IAL.

103. Ruble, Sidley Austin and Deutsche Bank acted together to create the CARDS Transaction and/or substantially assisted in perpetuating a fraud on IAL with the goal of obtaining $11.7 million in fees and the IAL preferred stock.

104. Ruble and Sidley Austin rendered knowing and substantial assistance to the fraud by: (i) rendering legal and other advice to IAL; (ii) participating in the creation of the CARDS Transaction; (iii) issuing the legal opinion upon which IAL relied on to enter into the transaction; (iv) acting as the accommodating bank for the transaction and preparing all necessary documents; and/or, (v) participating in the execution of the CARDS Transaction.

105. Ruble, Sidley Austin and Deutsche Bank knew prior to IAL assuming the Loan, that Deutsche Bank would not accept the substitute collateral and therefore IAL would not receive the current funding that was promised. Ruble, Sidley Austin and Deutsche Bank knowingly concealed this information in an effort to lure and ensure that IAL would assume the Loan thereby becoming obligated to pay the $14.75 million fee.

106. Ruble, Sidley Austin and Deutsche Bank's action aided and abetted the fraudulent CARDS Transaction scheme and are each liable for the damages caused thereby to the same extent as the other. Absent these Defendant's participation, the CARDS Transaction on would fail.

107. Ruble, Sidley Austin and Deutsche Bank's conduct in aiding and abetting the fraud had no benefit to IAL, was adverse to IAL and was not in furtherance of IAL's purpose and needs. As a result of these Defendant's conduct, IAL and IALPR have suffered damages because: (i) IAL paid the defendants millions of dollars and IALPR invested in IAL sufficient sums to pay them fees; (ii) IAL has incurred or will incur interest and/or penalties on federal income taxes deemed owing by this Court; (iii) IAL and/or IALPR have incurred or will incur substantial additional costs in hiring new tax and legal advisors to rectify the damages; and, (iv) IAL has foregone legitimate alternate tax planning opportunities.

108. IAL and IALPR retain the right to amend this count and assert a claim for punitive damages.

WHEREFORE, IAL and IALPR demands judgment against Ruble, Sidley Austin and Deutsche Bank, jointly and severally, for compensatory damages as result of aiding and abetting the fraud, attorney's fees, interest, costs incurred in bringing this action, and such other relief as this Court deems just and proper.

110. The participants in the CARDS Transaction collectively received more than $11.7 million from IAL, and Bakerloo received IAL's preferred stock, for services which were either not rendered or provided no benefit to IAL. Specifically, Sidley Austin received a sum in excess of $500,000.00 and Deutsche Bank received a fee in excess of $5 million.

111. Sidley Austin and Deutsche Bank fees were contingent upon (i) current funding; and (ii) tax benefits. As a result of the CARDS Transaction failure, neither Sidley Austin nor Deutsche Bank are entitled to retain their fees.

112. Sidley Austin received fees that far exceeded the hourly time expended on the IAL CARDS Transaction and represented an enhancement or success fee. Deutsche Bank received fees that far exceeded the value of the services provided. Although Deutsche Bank was only required to receive 1% of the tax benefits provided to IAL as a fee for being the accommodating bank, Deutsche Bank received $5.1 million. The amount of fees earned was not tied to or reflective of the amount of time or effort the Defendants expended in providing legal or banking services, but rather was tied to the amount of tax issues claimed by IAL.

113. Sidley Austin and Deutsche Bank have been unjustly enriched because each voluntarily accepted and retained the benefit of the payments, but provided nothing of benefit to IAL in exchange.

114. The circumstances render each defendant's retention of the benefit of these payments inequitable and unjust.

WHEREFORE, IAL demands judgment against each Sidley Austin and Deutsche Bank for compensatory damages equal to the amount of fees paid to each, interest, attorneys' fees, costs incurred in bringing this action, and any other relief the court deems just and proper.

116. An attorney/client relationship existed between IAL and Ruble and Sidley Austin, wherein Sidley Austin, through Ruble, provided legal services to IAL in the form of rendering tax and legal advice to IAL.

117. IAL paid Sidley Austin for these services through payments made to Sussex which were intended to be used to procure the legal services of Sidley Austin for IAL.

118. As a result of the attorney/client relationship between IAL and Ruble and Sidley Austin, both Ruble and Sidley Austin had a duty to represent IAL in a competent manner and to provide legal services with the level of skill, knowledge, experience, preparation and care, as is reasonably necessary for such representation and in conformity with the standard of a competent tax lawyer in the community.

119. Ruble and Sidley Austin each breached this duty to IAL and was negligent by failing to represent IAL in a competent manner by: (i) failing to conduct the necessary due diligence for the legal opinions; (ii) advising IAL that the CARDS Transaction was a legitimate tax shelter that would create a general loss that could be used to offset IAL's federal tax liability; (iii) advising IAL that the CARDS Transaction would qualify as a foreign exchange under I.R.C. § 988; (iv) failing to advise IAL that if IAL filed tax returns claiming losses based on the CARDS Transaction, and the IRS disallowed such loss, IAL could be liable for interest and/or penalties for past due federal taxes; (vi) failing to advise IAL that the CARDS Transaction was a "listed transaction;" and (iv) failing to advise IAL of the consequences of the CARDS Transaction being a "listed transaction."

120. As a direct and proximate result of Ruble and Sidley Austin's professional malpractice, IAL suffered damages because it: (i) paid millions of dollars in professional fees; (ii) paid these defendants a substantial fee; (iii) has incurred or will incur interest and/or penalties on underpaid federal taxes; (iv) has incurred or will incur substantial additional costs in hiring new tax and legal advisors to rectify these damages, and (v) has foregone alternate legitimate tax planning opportunities.

WHEREFORE, IAL demands judgment against Ruble and Sidley Austin, jointly and severally, for compensatory damages, interest, attorneys' fees, costs incurred in bringing this action, and such other relief as this Court deems just and proper.

122. Within four years prior to the petition date, IAL paid Sussex $500,000 that Sussex transferred to Sidley Austin as compensation for tax and legal advise provided to IAL, as more fully described above.

123. Transfers to Sidley Austin were made at a time when IAL owed its creditors significant sums and were fraudulent whether such creditors' claim arose before or after the transfer to the Sidley Austin, because such transfers were with the actual intent to hinder and delay or defraud IAL's creditors.

124. IAL did not receive reasonably equivalent value in exchange for the transfer.

125. In addition, at the time of the transfers, IAL was about to engage in a business transaction for which its remaining assets were unreasonably small in relation to its business.

126. The transfers to Sidley Austin are fraudulent as to existing and future creditors and may be avoided pursuant to 11 U.S.C. § 544(b) and Florida Statutes § 726.108. IAL is entitled to judgment against Sidley Austin for the value of the transfer, pursuant to 11 U.S.C. § 550 and Florida Statutes § 726.109(2).

WHEREFORE, IAL demands judgment against Sidley Austin for the value of the transfer, together with attorneys' fees, interest, costs incurred in bringing this action, and such other relief as this Court deems just and proper.

128. Within four years prior to its petition date IAL paid Sussex $5.1 million which Sussex transferred to Deutsche Bank as a loan origination fee for funding a loan under the CARDS Transaction.

129. Transfers to Deutsche Bank were made at a time when IAL owed its creditors significant sums and were fraudulent whether such creditors' claim arose before or after the transfer to the Deutsche Bank, because such transfers were with the actual intent to hinder and delay or defraud IAL's creditors.

130. IAL did not receive reasonably equivalent value in exchange for the transfer.

131. In addition, at the time of the transfers, IAL was about to engage in a business transaction for which its remaining assets were unreasonably small in relation to its business.

132. The transfers to Deutsche Bank are fraudulent as to existing and future creditors and maybe avoided pursuant to 11 U.S.C. § 544(b) and Florida Statutes § 726.108. IAL is entitled to judgment against Deutsche Bank for the value of the transfers, pursuant to 11 U.S.C. § 550 and Florida Statutes § 726.109(2).

WHEREFORE, IAL demands judgment against. Deutsche Bank for the value of the transfer, together with attorneys' fees, interest, costs incurred in bringing this action, and such other relief as this Court deems just and proper.

134. The participants in the CARDS transaction, individually and collectively, aided and abetted in the transfer of fees to Sussex and then on to others in excess of $11.7 million, and $3.2 million in IAL preferred stock to Bakerloo, for services each defendant knew would not be performed, were invalid or for services that would provide no benefit to IAL.

135. IAL did not receive reasonably equivalent value for the transfer of $11.7 million and/or the transfer of IAL's preferred stock.

136. At the time of the transfers, IAL was about to engage in a business transaction for which its remaining assets were unreasonably small in relation to its business.

137. The transfers to Sussex and then on to others are fraudulent as to existing and future creditors and may be avoided pursuant to 11 U.S.C. § 544(b) and Florida Statutes § 726.108, and judgment obtained against Sussex and Bakerloo for the value of the transfer, pursuant to 11 U.S.C. § 550 and Florida Statutes § 726.109(2).

138. Each defendant aided and abetted the fraudulent transfers to Sussex and Bakerloo and are liable for the damages caused thereby to the same extent as Sussex and Bakerloo.

139. As a direct and proximate result of each defendant aiding and abetting these fraudulent transfers, IAL has suffered damages because it: (i) paid Sussex millions of dollars and transferred $3.2 million of IAL preferred stock to Bakerloo; (ii) has incurred or will incur interest and/or penalties on federal income taxes deemed owing by this Court; (iii) has incurred or will incur substantial additional costs in hiring new tax and legal advisors to rectify the damages caused by these defendants; and (iv) has foregone legitimate alternate tax planning opportunities.

WHEREFORE, IAL demands judgment against Ruble, Sidley Austin, and Deutsche Bank, jointly and severally, for compensatory damages equal to the value of the transfers, attorney's fees, interest, costs incurred in this action, and such other relief as this Court deems just and proper.

I HEREBY CERTIFY that I am admitted to the Bar of the United States District Court for the Southern District of Florida and I am in compliance with the additional qualification to practice in this Court set forth in Local Rule 2090-1.

²Although the documents are dated June 23, 1999, the events memorialized in these agreements occurred on or about July 8, 1999.

International Air Leases, Inc., a Delaware corporation which we have been advised is treated as a C corporation for U.S. Federal income tax purposes ("Purchaser"), has requested our opinion regarding the U.S. Federal income tax consequences of certain transactions ("Transactions"), summarized below, that have been concluded by Purchaser. The Transactions have been registered as a "tax shelter", pursuant to Section 6111 of the Internal Revenue Code of 1986, as amended ("Code"). We have relied upon the representations set forth in II below in reaching our conclusions.

I. Summary of the Transactions

Bakerloo Financial Trading LLC ("LLC") is a special purpose limited liability company organized under the laws of Delaware. 100% of the Interests in LLC is owned by two nonresident alien individuals ("Members") who have represented that each is tax resident in the United Kingdom. Members have also represented that LLC is tax resident in the United Kingdom. Members have capitalized LLC with contributions of approximately $300,000. The managing member ("Managing Member") has represented that he is solvent and has a net worth in excess of $1 million. As permitted under Delaware law, the Managing Member has waived his right of limited liability.

Members, through LLC, and others have designed a financial structure that replicates for the user a long-term zero coupon borrowing in a foreign currency. To create the structure, LLC has entered into a Credit Agreement dated as of June 1, 1999 ("Credit Agreement" or "Loan") pursuant to which it has borrowed EUR 310,000,000 from Bankers Trust Company, London Branch, ("Bank") for a term of 30 years. Interest under the Credit Agreement is payable annually in arrears and the entire principal amount is due and payable at maturity. Interest accrues at a fixed rate under a formula established at the inception of the Loan until July 16, 1999, unless the Bank has waived its right to reset the interest rate spread on such date, in which case the initial period ends on a date approximately 1 year after the date on which the Loan is funded ("Initial Period"). The initial interest rate is 3.3125%. Thereafter the interest rate is generally reset every twelve months pursuant to an interest rate reset mechanism described below. Upon receipt of the proceeds of the Loan, LLC purchased EUR 255 million German government Euro-denominated Treasury obligations which, together with EUR 55 million cash, it deposited with Bank as collateral for the Loan pursuant to custody, pledge, and security agreements attached as exhibits to the Credit Agreement (collectively "Security Agreement").

Under the terms and conditions of the Credit Agreement and the Security Agreement:

Under the Credit Agreement, upon the date for an interest rate reset, the Bank may inform the borrower that it is unwilling to maintain the Loan in whole or in part, or if it is, inform the borrower of the rate at which it would do so, based upon the Bank's judgement as to the rate necessary to allow the Bank to dispose of the Loan at a price equal to the Loan's then principal amount. LLC (or if there is a co-obligor, LLC and the co-obligor) may reject the proposed rate or, alternatively, present another financial institution that will acquire the Loan from Bank. In the event that LLC does not accept the reset rate and does not provide a financial institution to acquire the Loan from Bank, the Loan will become due and payable in full. Under the interest rate reset mechanism it would be possible for the borrower to request a change in interest rate based upon changes in the characteristics of the Loan, such as a change in the collateral.

To create a synthetic zero coupon foreign currency debt instrument, Members and LLC have calculated the present value of the principal amount of the Loan using a market rate of interest which represents a reasonable rate of interest on such a zero coupon instrument. LLC will sell such amount to a U.S. individual ("Purchaser") pursuant to an agreement of sate ("Sale Agreement") an amount of EUR equal to such present value. (The aggregate amount of EUR transferred to Purchaser is hereinafter referred to as the "Assets".) The remainder of the Loan proceeds remain invested in cash or in foreign government or high-grade corporate obligations, as collateral for the Loan. The Assets remain collateral under the Security Agreement. However, the Purchaser has the right to substitute other collateral acceptable to the Bank. Purchaser, however, may be required to provide other collateral to secure Purchaser's obligation to Bank. The consideration LLC receives from Purchaser in exchange for the Assets is (i) Purchaser assuming and becoming jointly and severally liable as a co-obligor on the Assumed Obligations under the Credit Agreement and meeting such other requirements as are provided in the Credit Agreement, and (ii) 3,000 shares of redeemable preferred stock of Purchaser ("Preferred Stock") having a term of 7 years.

Pursuant to the Sale Agreement, LLC and Purchaser determined the manner in which responsibility, vis-a-vis each other, for payments pursuant to the Credit Agreement will be shared, while recognizing that they remain jointly and severally liable to the Bank for the entire amount of principal and interest on the Loan. As a result, LLC undertook to make all interest payments under the Credit Agreement and Purchaser undertook to pay the principal due under the Credit Agreement at maturity. Under the Credit Agreement, if the Loan is prepaid, the collateral is to be surrendered and the co-obligors will utilize their own funds to satisfy any shortfall that might arise. In such event, under the Sale Agreement, Purchaser undertook, vis-a-vis LLC, to pay the difference between the value of the collateral provided to Bank and the total amount under the Loan. In the event the value of the collateral exceeds the amount due to the Bank, such excess wilt remain the property of LLC.

We have been advised that, following their purchase, Purchaser will deposit the Assets in an interest bearing Euro-denominated deposit with Bank. We have also been advised that at some time thereafter, but no less than a week from the date of deposit, Purchaser will withdraw amounts from the Bank deposit and purchase Euro-denominated government or investment grade corporate debt obligations. We have been advised that thereafter, Purchaser intends to substitute non-liquid business assets as collateral, with Bank's consent.

II. Representations

In rendering our opinions, we have reviewed representations and advice from various parties to the transactions described herein, which representations and advice are referred to below. In rendering our opinions, we have also examined such corporate records and such other agreements, certificates, instruments, and documents as we have believed are relevant, and we have made such other inquires of officers, owners and representatives of the entities involved in the transactions described herein as we have considered necessary to render the opinions set forth herein. We have made no independent verification of such representations, advice, records, agreements, certificates, instruments, documents, and responses to such inquiries, if any such representations, advice, records, agreements, certificates, instruments, documents, or responses is inaccurate in any material respect, the opinions contained herein may not be relied upon. If such description or assumptions are inaccurate in any material respect, or the documents prove not to be authentic, the opinions contained herein may not be relied upon. In rendering our opinion, we have reviewed the applicable provisions of the Code and of the final, temporary, and proposed Treasury Regulations ("Treas. Reg." or "Treasury Regulations") promulgated thereunder; relevant decisions of the U.S. Federal courts; published Revenue Rulings ("Rev. Rul.") and Revenue Procedures ("Rev. Proc.") of the Internal Revenue Service; and such other materials as we have considered relevant. In certain instances we have determined that there is no authority directly on point, and in such instances we have reached our opinion reasoning from such other authority as we believe to be relevant to the issues addressed. We have been engaged by Chenery Associates, Inc., financial advisor to Purchaser, to render this opinion to purchaser. Although we are not representing Chenery in connection with the Transactions, in the past we have represented Chenery and persons affiliated with Chenery with respect to certain matters and may continue to do so in the future. Furthermore, we are representing LLC in connection with the Transactions. In the past we have represented LLC, its members, and persons affiliated therewith with respect to certain matters and may continue to do so in the future. You have agreed to waive any legal conflict that may anise from such past or future representations.

Based on and subject to the summary set out at I above, the representations set out at II, above, and the analysis of the pertinent statutory provisions at IV. A-D, as affected by the analysis of the statutory provisions and legal doctrines at IV. E, below, all as of the date hereof, we are of the opinion that for U.S. Federal income tax purposes, although a factual situation such as the one described above has not been before a court of law addressing the issues addressed herein; on the basis of authority arising in analogous contexts:

IV. Analysis

Given the fact that the Assets remained subject to the Security Agreement after their transfer to Purchaser, the IRS might contend that Purchaser never acquired the Assets. The rationale for doing so can be found in those cases in which a cash basis taxpayer attempts to deduct interest paid with funds lent to it by the person to whom the interest is owed. In a line of case culminating with the recent decision in Davison v. Comm'r, ___ F.3rd ___ (2d Cir. 3/18/98), aff'g per curiam 107 T.C. 35 (1996), the courts have not respected the payment of the interest with funds borrowed from the lender, unless the borrowing could be substantively separated from the underlying transaction. Historically this was referred to as the "unrestricted control" test, and the taxpayer merely had to legally have "unrestricted control" over the borrowed funds. However, over time this standard evolved into a substance-over-form analysis. See, 107 T.C. 35, 43-49. As articulated by the Tax Court in the Davison case, when a borrower borrows funds from a lender and uses the funds to satisfy an interest obligation to the same lender, the factors relevant to determine whether the payment will be respected include whether the relevant transactions were simultaneous, whether the borrower had sufficient funds in its account to pay the interest without regard to the borrowing, whether the funds are traceable, and whether the borrower had any realistic choice to use the borrowed funds for any other purpose. 107 T.C. 35, 49. Although only analogous, the IRS might attempt to apply these authorities to the transactions described herein to disregard the sale of the Assets to Purchaser.

In the instant case, although the Assets remain subject to the Security Agreement after their transfer to Purchaser, Purchaser has the right to substitute collateral acceptable to Bank for the Asset and is at risk to the Bank in the manner as any borrower. Consequently, although the matter cannot be free from doubt because of the lack direct authority, based on the authorities discussed at IV.B.3.a, below, the IRS should not be successful were it to contend that Purchaser never acquired the Assets.

Whether or not a person is the owner of assets for U.S. Federal income tax purposes is a factual issue. Factors that are taken into account include legal ownership of the assets, the right to possession of the assets, and the right to derive income or the risk of suffering loss from the assets. See, e.g., Rev. Rul. 73- 524, 1973-2 C.B. 307; Rev. Rul. 82-144, 1982-2 C.B. 34.

Rev. Rul. 85-42, 1985-1 C.B. 36, addressed a situation analogous to the instant case. In that Ruling, a corporation pledged U.S. Treasury securities to a creditor to defease in substance a liability under a loan. By so doing, the corporation was able to avoid reflecting the liability on its balance sheet. Pursuant to the in substance defeasance arrangement, the Treasury securities were placed in a trust. The interest on the Treasury securities and the amount paid on their redemption was anticipated to satisfy the liability in full at its maturity date and any monies remaining in the trust after paying off the loan upon its maturity reverted to the Corporation. Rev. Rul. 8542 concluded that the corporation notwithstanding the defeasance arrangement owned the Treasury securities. Although there are no analyses leading to this conclusion, it appears that legal ownership, risk of loss if the securities were insufficient to satisfy the loan, and the reversionary right to any income remaining in the trust upon the satisfaction of the loan at its maturity were sufficient incidents of ownership to enable the IRS to reach its conclusion. See, PLR 9748005 (8/19/97). See, also PLR 9131001 (12/12/90); PLR 8804020 (10/29/87)². The fact that assets are, or become, subject to additional restrictions under cross- collateral and cross-default arrangements between co-obligors and the lender does not appear to diminish the owner's ownership interests in the secured assets. Cf. PLR 9640001 (11/29/94), in which the owner of property who was a co-obligor to a bank transferred property subject to such arrangements to a corporation in a valid Code Section 351 transaction. See also, PLR 8730063 (8/29/87), revoked by PLR 9032006 (4/26/90).

In Rev. Rul. 99-14, 1999-13 IRB 3, the IRS distinguished Rev. Rul. 85-42 in a so-called "LILO" transaction, which Rev. Rul. 99-14 concluded had no economic substance. The basis for the distinction was that in Rev. 99-14 the equivalent transaction occurred at the inception of the transaction "eliminating any need by [the parties] for an independent source of funds". Although this rationale may have some pertinence to the economic substance of a transaction, the use of an in substance defeasance transaction at the outset should have no bearing on whether the borrower remains the owner of the collateral under the general tax principles discussed below where, as in the instant case, the loan is recourse to a creditworthy borrower.

In Rev. Rul. 73-524, supra, and Rev. Rul. 72-478, 1972-2 C.B. 487, the IRS concluded that a taxpayer that entered into a short-against-the-box transaction with respect to securities that the taxpayer owned did not cause a sale of such securities until the transaction closed. This was the case even though in the transaction the taxpayer had foregone any opportunity to profit further from the securities and any risk of loss with respect to the securities, although the taxpayer did not surrender legal ownership or possession of the securities. Similarly in published and private letter rulings regarding sale and repurchase, or "repo", transactions, the IRS concluded that the seller of securities remained the owner of such securities for U.S. Federal income tax. purposes notwithstanding the transfer of legal ownership and possession when the purchaser had no freedom to dispose of the securities and the seller retained the ability to profit from, or could suffer a loss with respect to the securities. See, e.g., Rev. Rul. 74-27, 1974-1 C.B. 24, PLR 9322039 (3/11/93); PLR 9125038 (3/27/91). Although recently enacted Code Section 1259 will cause taxpayers to mark their positions to market if they enter into certain offsetting positions that eliminate their risk with respect to appreciated property, this is not equivalent to treating the taxpayer as disposing of such property for all purposes of the Code. See, Code Section 1259(e)(1). It merely requires the taxpayer to recognize a gain. Therefore, Code Section 1259 should not change this conclusion were it applicable to the transactions described herein.

In the instant case, prior to the sale by LLC to Purchaser of the Assets, LLC pledged the proceeds of the Loan and the assets acquired with such proceeds as security for the Loan under the Security Agreement: All documents indicate that legal ownership of such pledged assets remains with LLC. Furthermore, the Security Agreement does not prevent LLC from regaining possession of the pledged assets through a substitution of collateral. If the value of the pledged assets were to decline, LLC will be liable to Bank for any such loss and is therefore at risk for any loss suffered with respect to the pledged assets.³ In addition, under the Credit Agreement, LLC is entitled to any funds remaining in the collateral account upon satisfaction of the Loan at maturity.

Upon entering into the Sale Agreement and related documents, LLC and Purchaser as co-obligors have agreed as between themselves how they will share responsibility under the Loan and, in certain instances, how they will deal with the assets. LLC will nevertheless remain liable to Bank for the entire amount of the Loan, although by becoming a co-obligor, Purchaser will gain through the Sale Agreement certain rights with respect to the collateral. For example, LLC may not substitute collateral without Purchaser's consent, such consent cannot be unreasonably withheld. Because, however, under the Sale Agreement Purchaser has agreed to pay the principal amount of the Loan at its stated maturity date, LLC will continue to be entitled to any funds remaining in the collateral account at that time.

Prior to selling the Assets to Purchaser and entering into the Sale Agreement and related documents, LLC should be treated as the owner of the collateral for U.S. Federal income tax purposes under the authorities discussed above, because LLC was the recognized legal owner of the collateral and had a profit potential and risk of loss with respect to the collateral. Although through the Sale Agreement and other agreements entered into by LLC in connection with the sale of the Assets to Purchaser provide Purchaser with certain nights in connection with the collateral, LLC remains the recognized owner of the collateral. Under the Security Agreement, LLC may obtain possession of the collateral, and LLC retains both a profit potential and risk of loss with respect to the collateral, although diminished by Purchaser's rights. LLC is at risk for losses arising with respect to the collateral, and LLC has the possibility of profiting from the collateral. Based on these facts and the authorities discussed above the IRS should not be successful were it to contend that LLC sold the collateral to Purchaser for U.S. Federal income tax purposes, and that LLC would continue to be regarded as the owner of the collateral for U.S. Federal income tax purposes after entering into the Sale Agreement with Purchaser.

The undertakings generally do not create an obligation by LLC to pay money to Purchaser; rather the undertakings in the Purchase Agreement merely coordinate the payment of the interest and principal under the Credit Agreement for which both are jointly and severally liable. Pursuant to the Purchase Agreement, as between LLC and Purchaser, LLC will undertake to pay the interest under the Credit Agreement and Purchaser will undertake to pay the principal under the Credit Agreement.

There is no authority that directly addresses the issue of the nature of such lights among co-obligors as property. Cf. PLR 8217207 (1/29/82), modifying PLR 8051172 (9/29/80), involving a corporate restructuring in which the existence of an agreement among jointly liable co-obligors regarding who would bear which payments was disregarded. In a related context, those authorities which address the assumption of liabilities in Code Section 351 non-recognition transactions do not even allude to the possibility that the right to reimbursement or contribution is "property". See, e.g., Rosen v. Comm'r, 62 T.C. 11 (1974), aff'd without published opinion, 515 F.2d. 507 (3rd Cir. 1975); PLR 8117091 (1/28/81).

There is, however, significant authority which, by analogy, indicates that the Federal income tax consequences relating to payments under an obligation in which a shareholder and the corporation are both liable are determined at the time payments are actually made. In Maher et at. v. Commissioner, 469 F.2d. 225 (8th Cir. 1992), the taxpayer contributed "all right, title and interest" in one company to another company in exchange for the latter company's stock. The latter company also assumed taxpayer's liability on certain notes, for which the taxpayer remained secondarily liable. The taxpayer owned all of the outstanding stock of each company prior to the transfer and continued to own all of the stock of the latter company after the transfer. The Court of Appeals confirmed the Tax Court's finding that the transaction amounted to a distribution under Code Section 304(a)(1) in an amount equal to the notes. However, the Court of Appeals overruled the Tax Court and held the tax event, i.e. the distribution, occurred when the corporation made actual payments on the notes and not when the notes were assumed. See Rev. Rul. 77-360, 1977-2 C.B. 86, in which the IRS stated that it will follow the Maher case in similar factual circumstances.

Another pertinent case is Yelencsics v. Comm'r, 74 T.C. 1513 (1980), acq. 1981-2 C.B. 2. In Yelencsics the shareholders and the corporation were co-obligors on a note which was incurred in connection with the purchase of the stock in the corporation by the shareholders. An issue before the Tax Court was whether the corporation's payment on the note amounted to a constructive dividend to the shareholders. The Tax Court found that the corporation assumed the liability solely for a non-corporate motive, and consequently, the Tax Court found that the corporation's payments on the note were constructive dividends to the shareholders. Id. at 1531. However, of significance, as in Maher, the tax consequences were triggered when payments on the note were actually made and not when the corporation became the co-obligor on the note. Maher and Yelencsics teach that in the co- obligor context, as between a shareholder and corporation, the tax consequence with respect to the satisfaction of an obligation for which both parties are liable is triggered not when the obligation is undertaken, but when a payment is made.

The issue of the treatment of payments benefiting co-obligors should be distinguished from the situation in which the shareholder transfers its own obligation to the corporation where no joint liability exists. This issue was addressed by the Second Circuit Court of Appeals in Lessinger v. Comm'r, 872 F.2d 519 (2d Cir. 1989). In this case, the taxpayer transferred his own obligation to pay to the corporate transferee and argued that his own obligation was property. The taxpayer's obligation was memorialized as a promissory note shortly after the transfer and pledged by the corporation as collateral for a bank loan to the corporation. One of the central issues in Lessinger was whether the taxpayer's debt to his corporation offset the liabilities assumed by the corporation, thus preventing a net excess of liabilities over assets. Id. at 523. The Tax Court concluded that the taxpayer's note was not bona fide debt and did not net the note against the assumed liabilities or treat the debt as "property" for purposes of Code Section 351. The Court of Appeals, however, reversed. In so doing, the Court of Appeals also did not conclude that the taxpayer's note reduced the amount of liabilities assumed. Rather it found that the receivable was a bona fide enforceable demand obligation that would have basis in the transferee's hands and that basis should be taken Into account in determining the transferor's gain.⁴ More recently, in Peracchi v. Comm'r, 143 F.3rd 487 (9th Cir. 1998), rev'g and rem'g T.C. Memo 1996-191, a divided court held that the transfer of the taxpayer's own negotiable note was a contribution of property for purposes of Code Section 351. the dissent took issue on this point, citing Don E. Williams Co. v. Comm'r, 429 U.S. 569 (1977). In that case the Supreme Court held that a corporation did not make payments to an employee profit sharing plan when it delivered its own notes to the trustee, but rather held that payment occurred when payments on the notes were made.

Because the arrangements with respect to the sharing of responsibility under the Loan generally do not specifically provide for payments from one of the parties to the other (except in the event of default), the facts in the instant case are distinguishable from the facts of Lessinger and Peracchi and are consistent with the Maher, Yelencsics, and Don E. Williams Co. cases, discussed above. Consequently, the undertakings in the Purchase Agreement should not constitute property to which basis should be allocated by Purchaser.

The courts and the IRS have consistently adopted the view that where all or a portion of the purchase price of an item of property consists of the purchaser assuming indebtedness of the seller, the purchaser's "cost", and thus its tax basis, includes the amount of the seller's liabilities assumed. This view was first articulated in Consolidated Coke Co. v. Comm'r, 70 F.2d 446 (3rd Cir. 1933), aff'g 25 B.T.A. 345 (1932). In that case, the taxpayer acquired the assets of another solely in exchange for assuming the liabilities of the seller. Affirming the Board of Tax Appeals, the court concluded that the taxpayer's cost of the acquired assets equated the amount of the liabilities assumed. This result was followed in Comm'r v. Oxford Paper Corp., 194 F.2d 190 (2d Cir. 1952). In Oxford, the taxpayer acquired certain assets from the seller for which it assumed liabilities of the seller under a lease. Relying on the Consolidated Coke decision, the court held as a matter of law that the taxpayer's cost of acquiring the property included the amount of the liabilities assumed, but remanded the case for a finding as to the amount of such liabilities. In Rev. Rul. 55-675, 1955-2 C-B. 567, the IRS affirmatively cited the Oxford decision and concluded that the cost of purchased property includes the amount of liabilities assumed by the purchaser. The IRS, however, distinguished Oxford from the facts in the Ruling because of the contingent nature of the liabilities involved in the Ruling's fact pattern. See also, U.S. v. Hendler, 303 U.S. 564 (1938); Roberts v. Comm'r, a District Court case unofficially reported at 60-1 U.S.T.C. ¶ 9120 (D.C. Ore. 1959); Smith v. Comm'r, T.C. Memo 1965-169.

This position is consistent with the rules regarding the measurement of the amount realized by a seller in a transaction in which the buyer assumes the entire amount of the seller's liability. See, Treas. Reg. § 1.1001-2(a)(4)(ii). In light of this, one commentator has stated "In such cases [where the seller must treat the assumed liabilities as consideration] it is conceptually not difficult to include the amounts of the liability in the basis of the property to the buyer". Mertens, Law of Federal Income Taxation, § 21.05.

Based on the foregoing, Purchaser's tax basis in the Assets should equal the amount of LLC's liabilities assumed by Purchaser, addressed below, and the amount of cash and the fair market value of other consideration paid by Purchaser to LLC.

Notwithstanding the foregoing, a number of cases have been cited for the proposition that a taxpayer's tax basis in purchased property cannot exceed its fair market value, even if the purchase price is wholly or partially paid with a recourse note. See, Lemmen v. Comm'r, 77 T.C. 1326 (1981), acq. 1983-2 C.B. 1; Bixby v. Comm'r, 58 T.C. 757 (1962), acq. 1975-2 C.B. 1 and acq. 1975-2 C.B. 2; Webber v. Comm'r, T.C. Memo 1983- 633. aff'd sub nom; Bryant v. Comm'r, 790 F.2d 1463 (9th Cir. 1986); and Roe v. Comm'r, T.C. Memo 1986-510.

In Lemmen, the taxpayer paid amounts in excess of the fair market value of two herds of cattle for the cattle and cattle management contracts. The taxpayer paid with a cash down payment and a recourse promissory note. The Tax Court allocated the excess over the herds' fair market value to the management contracts. This allocation was in part at least based upon the taxpayer's admission at trial that the excess was allocable to the contracts. Thus, it appears that Lemmen is in fact a purchase price allocation case in which the cattle and the management contracts were acquired by the taxpayer in a single transaction from the seller. As discussed above, Purchaser is not acquiring additional assets from LLC to which basis should be allocated.

The Bixby case is cited in Lemmen for the proposition that cost basis is limited to fair market value when transactions are not at arm's length and the transaction is based upon "peculiar circumstances". In reaching its conclusion, the court disregarded $1,600,000 of deeply subordinated debentures. However, the court's fading of facts indicated that, although the debentures were recourse in form, their subordination provisions were very close to non-recourse obligations in substance. In fact, in connection with the taxpayer's claim for original issue discount deduction, the court concluded that the debentures did not constitute bona fide indebtedness. In the instant case, the Loan is a valid, enforceable obligation of Purchaser.

The Webber case involved the purchase by the taxpayer of beavers for breeding and resale. The taxpayer paid for the animals with a recourse note. The purchase price was determined to be in excess of the animals' fair market value. The notes, however, could be satisfied by delivering beavers, thus ensuing that the taxpayer never had to pay the amount due to the creditor, who was also the seller of the beavers. Again, the instant situation should be distinguishable. The Loan is a real obligation for which Purchaser is fully liable, and cannot be satisfied merely by Purchaser's surrender the of Assets.

In Roe, the court determined that the nominal recourse notes did not constitute genuine indebtedness because of the unlikeliness that the notes would ever be paid. For the reasons discussed above, the instant case should be distinguishable.

For the reasons discussed above, IRS should not be successful were it to attempt to limit the tax basis of the Assets in Purchaser's hands on the basis of the foregoing.

Key factors that the courts have focused on in treating an instrument as debt for tax purposes are (i) whether the instrument has a fixed maturity date at which time the holder can demand payment, (ii) whether the return paid with respect to the instruments is contingent on the earnings and assets of the issuer or is payable in all events, and (iii) whether, in the event of a failure to make an anticipated payment of yield or principal, the holder of the instrument has typical creditors or shareholder's rights. See, e.g., Fin Hay Realty Co. v. U.S., 398 F.2d. 694 (3rd Cir. 1968); Roth Steel Tube Co. v. U.S., 800 F.2d 625 (6th Or. 1986), cert. denied 107 S. Ct. 1888; Hardman v. U.S., 827 F.2d 1409 (9th Cir. 1987); Monon RR v. Comm'r, supra; Notice 94- 47, 1994-1 C.B. 357. Additional factors include the name given to the instrument and the intent of the parties. See, e.g., Fin Hay Realty Co. v. U.S., supra; Hardman v. U.S., supra. In the instant case, the Loan has a fixed maturity date, payments on the Loan are not contingent upon the earnings of LLC and are payable in all events, and upon an event of default, Bank has all of the typical creditor's rights. In addition, the Loan is documented as debt and the parties have agreed in the Credit Agreement to treat the Loan as debt. Thus, based on the terms of the instrument, that Loan should be treated as debt of LLC for U.S. Federal income tax purposes.

Although an instrument may be classified as debt for U.S. Federal income tax purposes based on its terms, the courts have from time to time taken into account other factors, such as whether the loan is made by a shareholder of the debtor or whether the debtor is too thinly capitalized. In the instant case, the lender, Bank, is totally unrelated to LLC. With respect to thin capitalization, the test has been applied on a facts and circumstances basis and primarily as a touchstone for determining the likelihood that the debt will in fact be paid on its maturity date in accordance with its terms. See, e.g., Schnitzer v. Comm'r, 13 T.C. 43 (1949), aff'd, 183 F.2d 70 (9th Cir. 1950), cert. denied, 340 U.S. 911 (1951). In viewing the test in this light, the courts have held that quite significant debt-equity ratios did not turn an instrument that was otherwise debt into equity. See, e.g., Baker Commodities, Inc. v. Comm'r, 48 T.C. 374 (1967), aff'd on another issue, 415 F.2d 519 (9th Cir. 1969), cert. denied, 397 U.S. 988 (1970). Lastly, in determining the adequacy of equity the courts have looked in addition to the assets of the debtor to commitments to provide capital by the debtor's shareholders. See, Gunn v. Comm'r, 25 T.C. 424 (1955), aff'd sub. nom. Perrault v. Comm'r, 244 F.2d 408 (10th Cir.), cert denied, 355 U.S. 830 (1957). Based on the adequacy of the collateral as determined by the Bank, the capital provided by Members which should cover any negative "spread", and the unlimited liability of the Managing Member to the creditors of LLC, the thin capital factor should not be pertinent to the analysis of whether the Loan is debt of LLC for U.S. Federal income tax purposes.

Based on all the foregoing, the Loan should be treated as debt, i.e., a liability, for U.S. Federal income tax purposes.

Hovis v. Comm'r, T.C. Memo. 1995-60, involved the issue of the deductibility of certain expenses which were satisfied by the taxpayer and a number of other co-obligors with a note. The taxpayer argued that the amount he was entitled to deduct should be increased because one of his co-obligors was discharged from liabilities, including the note to issue, in a bankruptcy proceeding, i.e., the right of contribution from such person was eliminated. The Tax Court in Hovis, as in Dunnegan, took the position that, vis-à-vis the creditor, the taxpayer and each of the other co- obligors was liable for the entire amount of the debt and should not be viewed as liable for only a portion thereof, with the result that the discharge of one co-obligor did not affect the amount for which the other co-obligors were liable.⁶

To be compared to Dunnegan and Hovis is Snowa v. Comm'r, T.C. Memo 1995-336, rev'd 123 F.3d 190 (4th Cir. 1997). The Snowa case involved the calculation of the cost to the taxpayer in purchasing a new residence under the "rollover" rules of Code Section 1034. The case presented a novel set of facts, because the taxpayer was married to X when the first residence was sold and married to Y when the second residence was purchased. The Tax Court concluded that as a spousal Joint owner of the first residence, her gain for purpose of Code Section 1034 was limited to 50% of the amount of the entire gain from the sale of such residence (including any gain attributable to the assumption of any mortgage on the property) and that her cost of the new residence as a spousal joint owner was limited to 50% of the cost of the new residence (including as a cost the amount of any mortgage acquired pursuant to the purchase). In reaching this conclusion, the Tax Court dismissed the taxpayers argument that she was entitled to include the entire amount of the mortgage on the new property on the basis that she had a night of contribution against her husband for his "share" of the liability. Snowa however, appears to be the only case that gave such effect to a right of contribution, and must be read in the context of Code Section 1034.

With respect to Code Section 1034, the Tax Court pointed out that the Treasury Regulations under Code Section 1034 require that a spousal joint owner who is selling a residence to take into account 50% of the gain from the sale. In such a case, the Treasury Regulations permit a rollover of the gain based on the cost of a new residence purchased by the seller as the sole owner, but do not address the situation when the seller is a joint owner with someone who did not also jointly own the former residence. Thus, Snowa can be read as an equitable extension of the joint owner sale rule to a joint owner purchase, i.e., because one is only required to recognize 50% of the gain from the sale of a jointly owned residence, one should only take into account 50% of the cost of the new jointly owned residence for purposes of the Code Section 1034 rollover rules. In reversing the Tax Court's decision, the Court of Appeals did not address the issue of the appropriate amount of the joint liability to be included in basis. Rather, the court focused on the purpose of Code Section 1034 to permit taxpayer to roll over gain on the disposition of a principal residence, regardless of the identity of the taxpayer's spouse at the time of sale and at the time of reinvestment.

Given the context in which the Snowa decision was decided, and the otherwise consistent view of the Tax Court in Hovis and Dunnegan that a taxpayer's liability as a co- obligor is measured by his obligation to the creditor and not with respect to the arrangements, statutory or contractual, among the co- obligors, the Snowa decision decision should not be viewed as controlling in the context of the Transactions.

On the basis of the foregoing, the arrangements between LLC and Purchaser regarding responsibility for payment of principal or interest under the Credit Agreement should not diminish the amount for which Purchaser is considered liable, i.e., the entire principal amount due under the Credit Agreement.⁷

Treas. Reg. § 1.988-2(a)(2)(i) provides that exchange gain or loss realized from the disposition of a nonfunctional currency is determined by reference to the taxpayer's basis in such currency and the amount realized. Treas. Reg. § 1.988- 2(a)(2)(ii)(B) provides that the exchange of nonfunctional currency for property is treated as an exchange of such currency for units of functional currency at the then spot rate and the purchase of the property for such units of functional currency. Treas. Reg. § 1.988-2(a)(2)(ii)(C) provides an example that involves the use of a nonfunctional currency to purchase items of equipment. The example concludes that such purchase is a disposition of such currency with the amount realized measured by reference to the price of the currency on the date of purchase and the use of such functional currency to purchase the equipment.

Based upon Purchaser's representation, the U.S. dollar should be treated as Purchaser's currency. Based upon the foregoing, the deposit of the Assets in a Bank deposit or the withdrawal of Euros from such deposit should not be a disposition of foreign currency upon which gain or toss would be recognized. However, the acquisition of Euro-denominated government or corporate debt with funds withdrawn from such deposit should be a transaction that is treated a "Section 988 transaction" on which gain or loss is recognized. Code Section 988(c)(1)(C). Under Code Section 988(a)(1) and Treas. Reg. § 1.988-3(a), such gain or loss is treated as ordinary income or loss.

Treas. Reg. § 1.988-2 provides rules for determining the amount of gain or loss that arises from a Section 988 transaction and that is characterized as ordinary under Treas. Reg. § 1.988-3. Treas. Reg. § 1.988-2(a)(2)(i) provides that on a disposition of a non-functional foreign currency the exchange gain is the entire amount of the excess of the amount realized over the adjusted basis in the currency and the amount of exchange loss is the entire amount of the excess of the taxpayer's adjusted basis in the currency over the amount realized on its disposition. Treas. Reg. § 1.988- 2(a)(2)(ii) provides that the amount realized on the disposition of a non-functional currency is determined under Code Section 1001(b), and Treas. Reg. § 1.988-2(c)(2)(iii)(A) provides that the adjusted basis of a non-functional currency is determined under the applicable provisions of the Code. Neither such Treasury Regulation nor the preamble thereto limit the amount of exchange gain or loss on the disposition of nonfunctional foreign currency to that portion of the gain or loss attributable to a change in exchange rates. Instead, such Treasury Regulation simply applies the mechanical provisions of other Code sections in order to determine the amount of gain or loss and then characterize all of such gain or loss as exchange gain or loss.¹⁰

Treas. Reg. § 1.988-1(a)(11) gives the IRS the power to exclude a transaction from the provisions of Code Section 988 if the substance of the transaction or transactions indicates that the transactions are not property considered section 988 transactions. There is no guidance under Treas. Reg. § 1.988-1(a)(11) as to what would not property be considered a Code Section 988 transaction. Some insight may be gained from the example in the Regulation, which deals with the reverse situation. In the example, the taxpayer transfers nonfunctional currency to a newly-formed corporation with no other assets and sells the stock claiming that the transaction is not a section 988 transaction. In the example, the Commissioner recharacterized the transaction as being a section 988 transaction because an asset not subject to Code Section 988, the stock, was substituted for an asset that is subject to Code Section 988. In the instant case, Purchaser acquired the Assets in a transaction described in Treas. Reg. § 1.988-1(a)(1) and -2(a)(1). The acquisition of the Assets is not the surrogate for a transaction involving an asset not described in Code Section 988. Based on the foregoing, the IRS should not be successful were it to attempt to recharacterize the transaction under Treas. Reg. § 1.988- 1(a)(11).

Treas. Reg. § 1.988-2(f) gives the Commissioner the power to recharacterize the timing, source, and character of gains and losses with respect to a section 988 transaction in accordance with its substance. The example in the Regulation involves a taxpayer who denominated a transaction that was in substance a forward sales contract as a notional principal contract and who attempted to apply the rules relating to notional principal contracts to the transactions. In the instant case, the acquisition and disposition of the Assets are reported consistently with the form of the transactions and consistently with their economic substance. Consequently, the IRS should not be successful were it to attempt to change the timing, character or source of the loss recognized by the Purchaser from engaging in the Transactions.

Treas. Reg. § 1.988-2(a)(1)(i) provides that the recognition of gain or loss from the sale or disposition of a nonfunctional currency is governed by the other provisions of the Code that apply to the sale or disposition of property, and cites Code Section 1001 and 1092 as examples of such provisions. Treas. Reg. § 1.988-2 does not, however, specifically refer to Code Section 165 in connection with the allowance of a deduction of a loss sustained under Code Section 988. Consequently, there is some uncertainty as to whether Code Section 988 independently provides for the allowance of a loss sustained in a Section 988 transaction or whether such loss must also be tested under Code Section 165. The language of Code Section 988(a)(1) to the effect that notwithstanding any other provisions of the Code a loss sustained in a Section 988 transaction shall be treated as an ordinary loss, supports the view that Code Section 988 provides an independent allowance. This position is further supported by Code Section 988(e) which limits the loss incurred by an individual to those incurred in transactions in which expenses allocable to the transaction would be deductible under Code Section 162 or 212. Because the individual loss allowance rules of Code Section 165(c) contain provisions that are substantially the same, if Code Section 988 losses of an individual were subject to Code Section 165(c) there would have been no need to include similar limitations with Code Section 988(e). Thus, although the law is not entirely clear, Code Section 988 would be viewed as providing for the deduction of a loss from a Code Section 988 transaction independently of Code Section 165.

Even were the IRS to successfully contend that a loss recognized under Code Section 988 must meet the requirements of Code Section 165, the loss should still be deductible in the instant case. This is because Code Section 165(b) calculates the amount of deduction based on the adjusted basis rules of Code Section 1011, which equally apply under Treas. Reg. § 1.988-2(a).

Notwithstanding this general statutory language relating to Code Section 165, Treas. Reg. § 1.165-1(b) provides that for the loss to be allowable under Code Section 165(a) the loss must be evidenced by closed and completed transactions, fixed by identifiable events, and be actually sustained during the taxable year; that the loss be a bona fide loss; and that substance rather than form should govern. As discussed above, the loss on the Assets is evidenced by closed and completed events and fixed by an identifiable event, their expiration. Consequently, the IRS should be unsuccessful were it to attempt to deny under Code Section 165 the deduction of a loss recognized by Purchaser with respect to the options under Code Section 988.

Based on the forgoing, if Purchaser disposes of the foreign currency acquired from LLC at a gain or loss, the entire amount of such gain or loss should constitute ordinary income or ordinary loss under Code Section 988 and Treas. Reg. § 1.988-3(a).

LLC by making payments with respect to the Loan is eliminating its own liability to Bank and in so doing protecting its assets which are not pledged as collateral from claims of Bank or of Purchaser arising under the Sale Agreement and related documents. Consequently, the payment by LLC should be viewed as satisfying a business purpose of LLC, even though it also confers a benefit on Purchaser. Consequently, by analogy to the authorities discussed above, the payments should not constitute taxable income to Purchaser.

In addition, while LLC owns the Preferred Stock, LLC will be a shareholder of Purchaser. In PLR 8117091 (1/28/81), the IRS ruled that the corporate subsidiary did not recognize gain or loss when corporate parent paid interest on the debt on which the corporate parent became a co-obligor.¹¹ Similarly, in Bratton v. Comm'r, 217 F.2d 486 (6th Cir. 1954), corporate debts paid by a shareholder to its creditors pursuant to a guarantee did not create income to the corporation. Rather, such payments created an obligation of the corporation to reimburse the shareholder under the law of subrogation, which could be viewed as analogous to the rights of contribution among co-obligors. Subsequently, the shareholder released the corporation from this reimbursement obligation. The court concluded that the release of the right to reimbursement did not create income to the corporation, but rather was a contribution to capital, holding that the shareholder was not entitled to a bad debt deduction. The conclusion of the court in Bratton was cited affirmatively in Lidgerwood Mfg. Co. v. Comm'r, 229 F.2d 246 (2d Cir.), cert. denied, 351 U.S. 951 (1956). See also In Re Lane, 742 F.2d 1311, 1319-1320 (11th Cir. 1984); Casco Bank and Trust Co. v, United States, 544 F.2d 528 (1st Cir 1976), cert. denied, 430 U.S. 907 (1977); Kavich v. United States, 507 F. Supp. 1339 (D. Neb. 1981). Cf. Hartland v. Comm'r, 54 T.C. 1580 (1970).

Consequently, although there is no authority as to the tax effects of payments of interest by a co-obligor in factual circumstances such as the instant case, based on the foregoing authority, LLC's payments of interest on its Loan should be treated as non-taxable contributions to capital of Purchaser by LLC.

It is anticipated that Purchaser will make the principal payment due under the Credit agreement at maturity or on an earlier termination of the Loan. There is case law that holds that voluntary principal payments by a corporation on behalf of a shareholder amounts to a constructive distribution to the shareholder.¹² Of significance in these cases, however, the corporation was not a joint obligoror was, at best, a guarantor. Old Colony Trust v. Comm'r, 279 U.S. 716 (1929); Wortham Machinery Company v. U.S., 521 F.2d 160 (10th Cir. 1975) (corporation was not obligated to pay loan; consequently, voluntary payments which reduced the shareholders' obligations were constructive dividends); Tennessee Securities, Inc. v. Comm'r, 674 F.2d 570 (6th Cir. 1932); Enoch v. Comm'r, 57 T.C. 781 (1972). On the other hand, where the corporation previously assumed sole liability (i.e., a novation) in connection with a tax-free transaction, any interest and principal payments subsequently made by the corporation on what became its own obligation are not deemed to be constructive distributions to the shareholder. Jewell v. U.S., supra; U.S. v. Smith, 418 F.2d 589 (5th Cir. 1969). Were this not the case, the shareholder would potentially be taxed twice, once on the assumption (assuming Code Section 1001 applied) and again on the payment of the assumed debt. Because Purchaser will assume joint and several liability as co-obligor under the Loan and, consequently, will be making payments to satisfy its own liability even though LLC remains jointly and severally liable, under the rationale of the Jewell and Smith cases any payments due under the Credit Agreement by Purchaser should not result in a constructive distribution to LLC. Were such payments to constitute a distribution from Purchaser to LLC, such distribution would ultimately constitute a dividend to the extent of Purchaser's current or accumulated earnings and profits. Code Section 301.¹³

Were the principal amount due under the Credit Agreement to be prepaid, under the Purchase Agreement LLC would surrender to Bank the collateral. If LLC is a shareholder of Purchaser at the time such payment is made, such contribution should be a non-taxable contribution of capital to Purchaser under the authorities discussed above with respect to LLC's payments of interest under the Credit Agreement.

The logic of these cases is supported by analogy to Code Section 108. Were Purchaser solely liable under the Credit Agreement, and LLC purchased all or a portion of the Loan at its principal amount and cancelled Purchaser's obligation to make payments under the Credit Agreement as a contribution to the capital of Purchaser, Purchaser would not have cancellation of indebtedness income under Section 108. First, given the fact that LLC is not a related person to Purchaser within the meaning of Treas. Reg. § 1.108-2(d)(2), the Code Section 108(e)(4) and Treas. Reg. § 1.108-2 rules relating to the acquisition of debt by a person related to the debtor would not be triggered. Even if LLC were related, however, because LLC would have a tax basis in the Loan (on the portion deemed acquired) equal to the indebtedness acquired, Purchaser would have no cancellation of indebtedness income on such acquisition. Treas. Reg. § 1.108-2(f)(1). Second, as a shareholder contributing the Loan to Purchaser's capital, under Code Section 108(c)(6) Purchaser would have no cancellation of indebtedness income, because LLC's tax basis in the Loan would equal the amount of the indebtedness so contributed. It should be noted that Code Section 108(e)(6) does not require the contributing shareholder to receive additional shares as consideration for its contribution to capital, and it has been recognized that a shareholder's step-up in the tax basis of its shares is a reasonable quid pro quo. See, Frantz v. Comm'r, 83 T.C. 162, 172 (1984), involving the contribution of debt to a corporation without the receipt of additional shares by a 65% shareholder. see also, Comm'r v. Fink, 483 U.S. 89 (1987) involving a non-pro rata shareholder contribution to capital.¹⁴

Based on the foregoing, even if the IRS were to disagree with our conclusion set forth above that payments by LLC of its own liability do not create taxable income for Purchaser any payment by LLC under the Credit Agreement should be treated as a non-taxable contribution to capital of Purchaser, if LLC is a shareholder of Purchaser at the time such payment is made.

In the first instance it is possible that the IRS might contend that the LLC should be disregarded for U.S. Federal income tax purpose, with the result that the Loan would be treated as having been made directly to Purchaser. Were the IRS successful in making such contention, the basis of the Assets would not be increased in an amount equal to the gain recognized by LLC. The IRS recently made such a contention in a field service advice regarding so-called lease stripping transactions. The IRS determined that certain transactions by intermediary persons should be disregarded essentially because the intermediary had no economic stake in the transaction, i.e. had no economic risk and no opportunity to make a profit from its role. In the instant case, based on LLC's representation in relating to its non-tax objectives relating to the Transactions and, because of the unlimited liability of Managing Member for the obligations of LLC, Managing Member/LLC bears meaningful economic risk from participating in the Transactions, the IRS should be unsuccessful were it to attempt to disregard LLC. See, e.g., Northern Indiana Public Service Company v. Comm'r, 105 T.C. 341 (1995), aff'd 115 F.3d.506 (7th Cir. 1997).

With respect to Purchaser, in Frank Lyon Co. v. U.S., 435 U.S. 561, 583-584 (1978), the Supreme Court concluded that the tax benefits of a genuine multiple-party transaction with economic substance which is compelled or encouraged by business or regulatory realities should not be disregarded where the transaction was not shaped solely by tax-avoidance features that have meaningless labels attached.

After Lyon, the courts created a two-part test to determine whether a transaction should be disregarded as a sham. In order for a transaction to be disregarded, "the court must find that the taxpayer was motivated by no business purpose other than obtaining tax benefits in entering into the transaction, and that the transaction has no economic substance because no possibility of profit exists." Rice's Toyota World, Inc. v. Comm'r, 752 F.2d 89, 91 (4th Cir. 1985), aff'g in part and rev'g in part, 81 T.C. 184 (1983). Although the test laid down in Rice's Toyota World is a two-part test, taxpayer typically have been unsuccessful in merely showing that a transaction had some business purpose where the transaction lacked economic substance. Thus, in general, the courts have respected transactions having a reasonable profit potential.

Based on Purchaser's representations in relating to its non-tax objectives relating to the Assets, the transactions described herein should not be struck down as a sham.

Despite being inconsistent with the bulk of sham transaction cases, one case has suggested that there must be not only a reasonable possibility of making a profit, but the possibility must relate to a profit that is expected to be greater than de minimus. See, Sheldon v. Commissioner, 94 T.C. 738 (1990). The facts present in the instant case indicate that this standard would also be met. See also; Seykota v. Comm'r, T.C. Memo 1991-234, supp. op. T.C. Memo 1991-541; Leema Enterprises Inc. v. Comm'r, T.C. Memo 1999-18.¹⁵

Some courts have indicated that they would consider whether the profit motive for a transaction was greater or less than the tax motive. See, Fox v. Commissioner, 82 T.C. 1001 (1994); Estate of Baron v. Commissioner, 83 T.C. 542 (1984), aff'd, 798 F.2d 65 (2d Cir. 1986). However, a transaction should not be disregarded merely because its principal purpose was to avoid or evade tax. Congress has precluded such a broad test for all disallowance by incorporating such a principal purpose test into specific Code Sections such as Code Section 269. Long-standing judicial authority has also recognized that "any one may so arrange his affairs that his taxes shall be as low as possible" Helvering v. Gregory , 69 F.2d 809 (2d Cir. 1934). See, also Cottage Savings Association v. Comm'r, discussed above, involving a transaction executed solely for tax purposes.

ACM Partnership v. Comm'r, T.C.M. 1997-115, aff'd in part and rev'd in part on another issue, 157 F.3rd 231 (3rd Cir. 1998), has certain parallels, and significant distinctions, to the present situation.¹⁶ACM involved a foreign partnership that engaged in contingent installment sales transactions of certain notes that shifted income to a foreign partner and generated a capital loss to its U.S. partner, Colgate-Palmolive, which incurred all the costs. The Tax Court found that at the time it entered into the partnership, Colgate's only real opportunity to earn a profit was through an increase in the credit quality of the issuers of the notes, or a 400- 500 basis point increase in 3-month LIBOR interest rates. The court found no impact of credit quality was possible as the lenders were extremely highly rated at the time of the transaction. Moreover, the court did a 6-year review of 3-month LIBOR rates and did not find an increase of even 300 basis points in the necessary time frame. Since the analysis of the historical data showed no reasonable basis for expecting a profit, the court ruled against ACM. "We do not suggest that a taxpayer refrain from using the tax laws to the taxpayer's advantage. In this case, however, the taxpayer desired to take advantage of a loss that was not economically inherent in the object of the sate, but which the taxpayer created artificially through the manipulation and abuse of the tax laws. A taxpayer is not entitled to recognize a phantom loss from a transaction that lacks economic substance."

In its analysis, the Third Circuit focused upon the foregoing finding of the Tax Court, stating that: "Tax losses such as these, which are purely an artifact of tax accounting methods and which do not correspond to any actual economic losses, do not constitute the type of 'bona fide' losses that are deductible under the Internal Revenue Code and regulations: The Third Circuit also noted, "on November 3, 1989, [the partnership] invested $175 million of its cash in private placement Citicorp notes paying just three basis points more than the cash was earning on deposit, then sold the same notes 24 days later for consideration equal to their purchase price, in a transaction whose terms had been finalized by November 10, 1989, one week after ACM acquired the notes. These transactions . . . offset one another and with no net effect on ACM's financial position." See, similarly, Merryman v. Comm'r, 873 F.2d 879 (5th Or. 1989) (conduit partnership without economic substance disregarded).

Unlike ACM, the facts in the Transactions have economic substance and reveal that each party had a distinct profit motive to its participation in the Transactions. As discussed above, the Loan is a bona fide obligation of Purchaser that is taken into account as part of the cost of acquiring the Assets. Furthermore, we have been advised that each of the parties reviewed the economics underlying each of the transactions described herein, and concluded that it had a reasonable chance to earn a reasonable profit from these transactions, in excess of all associated fees and costs and not including any tax benefits. Thus, we believe that under the present state of law, the sham transaction doctrine should not apply and that based on the representations of Purchaser the requisite economic substance should exist under the preceding authority, because Purchaser reasonably believed Purchaser had a chance of making a reasonable profit.

Although there is general agreement regarding the existence of the step-transaction doctrine, its application by the courts has not been altogether uniform, and three basic formulations of the doctrine have been developed. These are the "binding commitment", the "mutual interdependence", and the "end result" formulations. See Penrod v. Comm'r, 88 T.C. 1415, 1429 (1987).

The "binding commitment" formulation requires the integrations of a series of transactions only if there is a binding legal commitment to undertake each of the steps. See Comm'r v. Gordon, 391 U.S. 83, 96 (1968). Purchaser and LLC have represented that prior to the actual closing of the purchase of the Assets by Purchaser. Purchaser was under no obligation to purchase the Assets from LLC and LLC was under no obligation to sell the Assets to Purchaser. Furthermore, between the time LLC received the proceeds of the Loan and the time LLC entered into negotiations with the Purchaser to acquire the Assets, there was no communication between LLC and Purchaser regarding the purchase of the Assets. Consequently, there is no binding obligation between LLC on the one hand and Purchaser on the other hand to sell the Assets to Purchaser or for Purchaser to assume liability on the Loan. Purchaser has also represented that it was not legally obligated to enter into the Transactions. Consequently, the binding commitment formulation of the step transaction doctrine should not be applicable to the sale of the Assets to Purchaser and the assumption of liability on the Loan by Purchaser.

The "mutual interdependence" formulation requires the integration of a series of transactions only if each step is interdependent on the others, and that the legal relationship created by each step is fruitless without the completion of the series. Redding v. Comm'r, 30 F.2d 2d 1169, 1177 (7th Cir. 1980), cert. denied 450 U.S. 913 (1981). See, also, Dyess v. Comm'r, T.C. Memo. 1993-219. It should be noted that the 10th Circuit Court of Appeals recently has applied the "mutual interdependence." formulation of the step transaction doctrine in Associated Wholesale Grocer, Inc. v. U.S., 927 F.2d 1517 (10th Cir. 1991). Unlike the factual situation in Associated Wholesale Grocer, none of the agreements among the various parties with respect to the transfer of the Assets to Purchaser and Purchaser's assumption of liability under the Loan are dependent upon the effectiveness of any of the other agreements. Furthermore, although the various contemplated transactions may occur within a relatively short period of time, LLC was economically at risk with respect to the Assets and the Loan prior to the sale of the Assets to Purchaser, and Purchaser has represented that it was not economically compelled to enter into the Transactions. It should also be noted that while generally adopting the criteria of Redding v. Comm'r, supra, in stating its view of the "mutual interdependence" formulation, the IRS has added an additional criterion, i.e., that each step be undertaken for a valid business reason, See, Rev Rul. 79-250, 1979-2 C.B. 156. This criterion was not espoused by the court in Redding, but was referred to in ACM Partnership v. Comm'r, supra, in the Tax Court's general discussions of business purpose.

Based upon the foregoing, each step undertaken by the parties to the Transactions should be viewed as independent from the others and consequently the formulation of the step transaction doctrine should not be applicable to the Transactions.

The "end-result" formulation integrates a series of transactions into a single transaction when it appears that they were really component parts of a single transaction intended from the outset to be undertaken for the purpose of reaching an ultimate result. King Enterprises, Inc. v. U.S., 418 F.2d 511, 516 (Ct. Cl. 1969). See also, Blake v. Comm'r, 697 F.2d 473 (2d Cir. 1982). Notwithstanding the seemingly broad scope of the end-result formulation, the courts have recognized a significant limitation on tits application. This was recently articulated by the Tax Court in Esmark, Inc. v. Comm'r, supra, wherein the court stated: "[The IRS's] recharacterization does not simply combine steps, it invents new ones. Courts have refused to apply the step transaction doctrine in this manner." 90 T.C. at 196. In support of its conclusion, the Tax Court cited, among a number of other cases, Grove v. Comm'r, 490 F.2d 241 (2nd Cir. 1973), aff'g, T.C. Memo. 1972-98.

The Esmark case is of particular relevance in the instant case. In Esmark, the taxpayer desired to dispose of certain unwanted businesses. The taxpayer and its Advisors formulated a plan to contract its capital structure through a redemption of its outstanding shares by having a third party tender for a portion of the taxpayer's outstanding shares and then tender the acquired shares for an asset, stock of a wholly-owned subsidiary, of the taxpayer. In addition to achieving the desired business results, the proposal was tax efficient, because, under law as then in effect, the exchange of its subsidiary's stock for its outstanding shares would have been tax free to the taxpayer, whereas a sale of the subsidiary's stock for cash, which cash could then have been used for a self-tender, would have produced a taxable transaction.

Concluding that the step-transaction doctrine could not be applied to so recast the transaction, the Tax Court recognized that the reduction of taxes was a significant factor in Structuring the transaction and that Mobil's tender offer was part of an overall plans. The court also recognized that Mobil, not the taxpayer, had borne the economic cost of the tender offer and that Mobil's ownership of the Esmark shares, "however transitory", must be respected. 90 T.C. at 198. Esmark has recently been followed by the Tax Court in Turner Broadcasting Company v. Comm'r, 111 T.C. 315 (1998), in which the Tax Court stated:

The National Office of the IRS has also recognized the premise of the Esmark case, i.e., that the step-transaction does not permit the creation of new steps or the reordering of existing steps, in a series of Technical Advice Memoranda. See PLR 8815003 (12/11/87), PLR 8738003 (5/22/87), PLR 8735007 (5/28/27) and PLR 8735006 (5/18/87). Each involves the acquisition of a corporation's outstanding debt by an unrelated underwriter, the exchange of debt for other securities of the corporation, and the sale of such other securities by the underwriter to the public. In each case, the Technical Advice Memoranda concluded that the end result formulation does not require that the transactions be stepped together.

To be contrasted to the Esmark cast are the more recent cases, Salomon, Inc. v. U.S., 976. F.2d 837 (2nd Cir) aff'g 92-1 USTC ¶ 50,155 (DC NY 1992) and Wait Disney, Inc. v. U.S., 4 F.3d 735 (5th Cir. 1993), rev'g 97 T.C. 221 (1991). Both cases involved the issue of whether there had been a disposition of assets that would trigger investment credit recapture under Code Section 47(a)(1). Both cases involved similar divisive "D" reorganizations in which assets were transferred to a subsidiary and the shares of the subsidiary were spun off to the shareholders of the parent corporation. Although both courts claimed to apply the "end result" formulation in order to integrate the drop-down and spin-off, facts were present which were present which were much closer to the facts found in "binding commitment" and "mutual independence" [sic] cases. In Walt Disney, Inc., the court reached its conclusion on overall intention for the steps to occur, plus the existence of a binding agreement which "manifests" such intent and which overcame the fact that the transactions were separated by a 59 day period of time during which the parent company was at risk with respect to the transferred assets. In Salomon, the court based its conclusion on an overall intention for the steps to occur which was supported by the statements regarding the integration of the steps to the IRS in the ruling request and the fact that the spin-off occurred immediately after the drop-down.

In the Transactions, LLC, an independent party, placed itself at risk with respect to the foreign currency including the Assets and the Loan. Purchaser, on the other hand, bore no risk with respect to the Loan until Purchaser affirmatively assumed liability by becoming a co-obligor under the Credit Agreement. Furthermore, there, was no obligation for Purchaser to enter the Sates Agreement or to assume liability under the Loan, an neither Purchaser nor LLC made any representation to third parties that such transactions would occur. Nevertheless, the IRS could argue that the closeness in time of such transactions, the involvement of Purchaser and Members and LLC in the planning of the transactions from their initial phase, and the fact that Purchaser became the ultimate owner of the Assets and obligor on the Loan could evidence an anticipated end-result. Cf., PLR. 9447024 (8/23/94). However, based on the factual distinctions from the Idol, Walt Disney, Inc. and Salomon, Inc. cases, and on the decision of the Tax Court in the Esmark case, the "end-result" formulation of the step-transaction doctrine should not apply to the sale of the Assets to Purchaser or the assumption of liability under the Loan by Purchaser.

In a recent field service advice relating to a so-called lease stripping transaction the IRS contended that it can apply Code section 482 to transactions between a non-controlling party and a corporation If the non-controlling party acts in concert with a controlling party. As discussed below, (he existing case law does not support such a contention.

The Code does not define the requisite ownership or control necessary to fall within Code Section 482. Treas. Reg. § 1.482- 1(i)(4), defines "controlled" as follows:

Such an argument should not succeed. As discussed above, the concept of "acting in concert" in the context of Treas. Reg. § 1.482-1(i)(4) relates to two or more person so acting to exercise control over a third person. Any other interpretation would subject any arm's length commercial transactions undertaken pursuant to a contract to Code Section 482. The only case which appears to deal with the "acting in concert" element of Code Section 482 is B. Forman Co., Inc. v. Comm'r, 453 F.2d 1144 (2d Cir. 1972), cert. denied 407 U.S. 934, reh'g denied, 409 U.S. 899 (1972), which is factually distinguishable from the instant situation. In Forman, two corporations acquired equal interests in a third corporation, neither individually having the requisite voting power to control the third, but having a written agreement and jointly appointed officers and directors pursuant to which they mutually exercised control over the third. In the instant case no such agreement or mutual exercise of control exists. This situation is markedly different from the instant situation in which LLC and Purchaser are not acting in concert to control any third party. Consequently, there should be no concerted action of the type required so as to permit the IRS to reallocate income or deductions between the two under Code Section 482.

In Notice 95-53, 1995-2 C.B. 334, the IRS raises the possibility that a noncontrolling and controlling party could be considered "acting in concert" for purpose of applying Code Section 482 in the context of a tax-advantaged transaction. Here again, however, the acting in concert aspect of Code Section 482, was asserted with respect to a noncontrolling party exercising control over a third party. Furthermore, Proposed Treasury Regulations issued pursuant to the Notice were issued under Code Section 7701(1) and not under Code Section 482, and to our knowledge, the position has not been reviewed by a court and we believe that the decision of B. Forman Co., Inc. v. Comm'r, supra, is the appropriate standard and, as discussed above, under such standard Code Section 482 should not be applicable to the Transactions.

The instant transaction does not involve any "lease or similar agreement" as defined in the Proposed Regulations, but rather involves the transfer of a fee interest in property. It is clear that the Proposed Regulations were aimed at a narrow category of transactions, so-called "stripping transactions," in which the owner of leased property accelerates the income to be derived from the property before transferring the "stripped" property to a third party who can benefit from the deductions generated by the ownership of the property free of the offsetting income. Consequently, the transactions described above should not be treated as transactions falling under Prop. Treas. Reg. § 1-7701(1)-2(a),

Notice 97-21 by its terms does not apply to the Transactions. Rather, It is limited to the basic transactions described in the Notice and to other transactions that "involve the use of other conduit entities whose income is generally subject to tax only at the shareholder level, where the amount of tax depends on the receipt or non-receipt by the shareholder of earnings over profits of the conduit entity". Although LLC is an entity whose income is generally subject to tax at the shareholder level, taxation does not depend on LLC's earnings and profits. The Notice represents another attempt by the IRS to use the multiple party conduit rule of Code Section 7701(1) to attack a perceived abuse, however, the Notice is limited to a specific type of transaction that does not include the Transactions and, consequently, the Notice should have no adverse effect on the Transactions.

This opinion does not address, and is not intended to address any tax Issues, whether U.S. Federal, state, local or foreign, other than those specifically addressed herein. This opinion is being issued to the addressee solely for the addressee's use and the use of the addressee's professional advisors to determine the amount, if any, of the addressee's U.S. Federal income liability. The addressee or the addressee's professional advisors may not use this opinion for any other purpose without our prior written consent.

²Although General Counsel's Memoranda and private letter rulings, including Technical Advice Memoranda, may not be relied upon as authority, they do indicate the view of the Internal Revenue Service on the issues addressed at the time of its issuance. In addition, private letter rulings issued after October 31, 1976 can be used to establish "substantial authority" for purposes of avoiding certain penalties under Code Section 6662, Treas. Reg. § 1.6662- 4(d)(3)(iii).

³Because Managing Member has waived its limited liability under the LLC Documents, Managing Member would also bear the risk of any decline in value of the pledged assets. Both LLC and Managing Member have assets in excess of the pledged assets and Managing Member has represented that it is solvent and has a net worth in excess of $1 million.

⁴The Second Circuit's conclusion in Lessinger that the shareholder note created property has been criticized as inconsistent with prior law. See, Bittker and Eustice, Federal Income Taxation of Corporations and Shareholders (6th Ed.), 3-33. At footnote 17 in its decision in Peracchi, the Ninth Circuit also has taken issue with the Second Circuit's position in Lessinger.

⁵From Bank's perspective, the law would not require it to treat the collateral held under the security arrangement as income. See, e.g., Illinois Power Co. v. Comm'r, 792 F.2d 683 (7th Cir. 1986).

⁶Support for the conclusions that contractual or legal rights of contribution should not determine the amount of the liability can also be found in those cases and private letter rulings regarding the allowance of the entire amount of interest paid by a co-obligor. See the authorities cited in the second paragraph of footnote 11.

⁷The IRS might contend that the arrangement between LLC and Purchaser regarding responsibility for payments under the Loan create two separate loans under the rationale of Rev. Rul. 84-118, 1984-2 C.B. 120, and Rev. Rul. 82-224, 1982-2 C.B. 5. Each of these rulings treated a partial recourse loan as a separate recourse and non-recourse loan for certain purposes of the Code. These Revenue Rulings are factually distinguishable from the instant situation, because under the Credit Agreement each of LLC and Purchaser has full recourse liability for all amounts due under the Credit Agreement. Furthermore, neither Revenue Ruling asserted that the bifurcation of the loans had general application, and both Revenue Rulings were issued prior to the Dunnegan and Hovis cases cited in the text.

⁸Prior to the adoption of Treas. Reg. § 1.1001-3, Purchaser's becoming a co-obligor also should not have caused a modification that would have constituted an exchange. See, PLR 8117091 (1/28/81).

⁹On PLR 9711024 (12/12/96), the IRS concluded that there was no change in payment expectations to create a modification where notes retained the same rating before and after their assumption.

¹⁰Code Section 988(b)(1). It appears that this regulatory approach was adopted based upon the legislative history of the amendments made to Code Sections 988(b) and (c) in the Technical and Miscellaneous Revenue Act of 1988. The House, Senate and Conference Committees each included identical language in their reports describing the measurement and recognition of foreign currency gain or loss. The Committees said: "Further, any gain or loss on a nonfunctional currency disposition is foreign currency gain of loss regardless of whether the difference between acquisition and disposition prices is due to spot rate movements between acquisition and disposition dates, forward discount or premium, bid-asked spreads, or other factors". Treasury's all gain/loss approach would appear to be based upon this directive.

¹¹Commentators have suggested that principal payments by the corporate parent on joint obligations should be either added to the corporate parent's basis in its stock of the subsidiary or deducted as a loss. The better view, however, should be that such principal payments should be a tax-free contribution to capital under Code Section 118(a) and that the corporate parent should increase its basis in its stock of the subsidiary by a corresponding amount. See PLR 8633046 (5/22/86). Code Section 119(a) states that "[i]n the case of a corporation, gross income does not include any contribution to the capital of the taxpayer."

PLR 811709 (1/28/81) also adopts the view that interest paid with respect to an obligation for which more than one party is a co- obligor is deductible by the party that makes the interest payment. See, e.g., In re Barry, supra; Arrigoni v. Comm'r, supra; Williams v. Comm'r, supra; Larson v. Comm'r, supra; Colston v. Comm'r, 21 BTA 396 (1930), aff'd 59 F.2d 867 (D.C. Cir), cert. denied 287 U.S. 640 (932); PLR 8633046 (5/22/86). But see, Abdalla v. Comm'r, 647 F.2d 487 (5th Cir. 1981).

¹²In the event that Purchaser had sufficient current or accumulated earnings and profits, any such constructive distribution would be a constructive dividend.

¹³Because the payment of the principal of the Loan serves a business purpose of Purchaser by eliminating its liability under the authorities discussed in the first paragraph of this Section 4 of the text, it is arguable that such payment has no tax effect even if Purchaser were to have earnings and profits.

¹⁴Although the courts in Frantz and Fink focused on the shareholder's business purpose in aiding a financially troubled corporation, an even more compelling business purpose exists in the instant situation in that any payments LLC makes on its Loan reduces its own liability as co-obligor.

¹⁵On December 23, 1997, the IRS issued Notice 98-5, announcing that the IRS will issue regulations effective on and after such date dealing with foreign taxes paid or accrued in connection with certain abusive transactions. Such transactions were described as those in which the anticipated economic benefits are insubstantial in relationship to the anticipated tax benefits. It is currently uncertain as to when or whether such Regulations will be issued. the criteria they will establish with respect to the insubstantiality of anticipated economic benefits, or whether such Regulations will have application beyond the area of foreign taxes.

¹⁶A case involving similar transactions, ASA Investerings Partnership, T.C. Memo. 1998-305, was decided on different grounds.

¹⁷No case addresses facts specifically like the instant case. The Fifth Circuit Court of Appeals has held in a different factual context that the burden of proof is upon the government to demonstrate the appropriateness of the presumption. See Dallas Ceramic Co. v. U.S., 598 F.2d 1382 (5th Cir. 1979). Once the presumption has been established, however, the burden of proof would appear to fall on the taxpayer.