Free Motion for Summary Judgment - District Court of Federal Claims - federal

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Nos. 01-256 T and 01-257 T (Judge Charles Lettow)

MARRIOTT INTERNATIONAL RESORTS, L.P., MARRIOTT INTERNATIONAL JBS CORPORATION, TAX MATTERS PARTNER Plaintiff v. THE UNITED STATES, Defendant

______________________ MOTION OF THE UNITED STATES FOR SUMMARY JUDGMENT AND BRIEF IN SUPPORT THEREOF ______________________

NATHAN J. HOCHMAN Assistant Attorney General DAVID GUSTAFSON G. ROBSON STEWART Attorneys Department of Justice, Tax Division Court of Federal Claims Trial Section P.O. Box 26 Ben Franklin Station Washington, D.C. 20044 (202) 307-6493

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Page TABLE OF CONTENTS Motion of the United States for Summary Judgment . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1 Brief of the United States in Support of its Motion for Summary Judgment . . . . . . . . . . . . . . . . 3 Question Presented . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Statutes and Regulations Involved . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4 Procedural Background of the Case . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Summary of Argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Statement of Facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Standard of Review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 I. THE TREASURIES SHORT SALE OBLIGATIONS CONSTITUTE LIABILITIES THAT MUST BE INCLUDED IN THE BASIS OF THE PARTNERSHIP . . . . . . . . . . . . . . . . . . 14 A. B. C. D. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Partnership's Basis in Partnership Assets - "Inside Basis" . . . . . . . . . . . 17 Partner's Basis in its Partnership Interest - "Outside Basis" . . . . . . . . . . 17 The Effect of Liabilities on the Calculation of Outside Basis . . . . . . . . . 18 1. 2. The Rule under § 752 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19 Application of § 752(b) - - MIR's assumption of the obligation to close the short sale reduces MORI's outside basis because MIR is taking responsibility for the replacement of the Treasuries and, because that transfer of the obligation is a benefit to MORI, it is as if MIR is paying cash to MORI . . . . . . . . . . . . . . . . . . . . 19

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Page (Continuation): 3. Application of § 752(a) - - With the obligation to close the short sale now residing in MIR, MORI and JBS increase their basis by their shares of the partnership's obligation to close the short sales. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 Application of § 752(b) to the closing of the short sales . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

4.

II.

DEFENDANT'S LEGAL POSITION IS SUPPORTED BY THE PLAIN LANGUAGE OF THE STATUTE, THE CASE LAW, AND ADMINISTRATIVE RULINGS . . . . . . . . . . . . . . . . . . . . . 22 A. B. A plain reading of § 752 supports the Government's position . . . . . . . . 22 The IRS's consistent position is that when, as here, an obligation creates or increases the basis of any of the obligor's assets, that obligation is a "liability" under § 752 . . . . . . . . . . . . . . . . . . . . . . . . . . . 24 The case law supports the Government's position . . . . . . . . . . . . . . . . . 27

C.

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 30 Appendix A: Internal Revenue Code of 1986 (26 U.S.C.): § 351 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A1 § 357 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A3 § 702 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A5 § 704 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A6 § 705 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A9 § 708 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A10 § 721 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A10 § 722 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A11 § 723 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A11 § 732 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A12

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Page § 733 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A13 § 742 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A13 § 752 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . A14 Appendix B: Chart 1, Marriott's Claimed Basis Calculations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . B1 Chart 2, Basis Calculations Including the Short Sale Obligations . . . . . . . . . . . . . . . . . B2 TABLE OF AUTHORITIES Cases: ACM Partnership v. Commissioner, 157 F.3d 231 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7 American Tobacco Co. v. Patterson, 456 U.S. 63 (1982) . . . . . . . . . . . . . . . . . . . . . . . . 22 Bissell v. Merrill Lynch & Co., 937 F. Supp. 237 (S.D.N.Y. 1996), aff'd, 157 F.3d 138 (2d Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Colm Producer, Inc. v. United States, 460 F. Supp. 2d 713 (N.D. Tex. 2006 ) appeal pending, Kornman & Assoc. v. United States, No. 06-11422 (5th Cir. July 31, 2007)) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8, 29 Coltec Indus., Inc. v. United States, 454 F.3d 1340 (Fed. Cir. 2006), cert.denied, 127 S. Ct. 1261 (2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Delong v. Dep't of Health & Human Servs., 264 F.3d 1334 (Fed. Cir. 2001), cert. denied, 536 U.S. 958 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Deputy v. du Pont, 308 U.S. 488 (1940) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26, 28 Kornman & Assoc. v. United States, No. 06-11422 (5th Cir. July 31, 2007) . . . . . . . . . . 8 Jading Trading, LLC v. United States, No. 03-2146 WL 4553043 ( Fed. Cl. 2007) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8 Laney v. Comm'r, 674 F.2d 342 (5th Cir. 1982), aff'g in part and rev'g in part on another ground T.C. Memo. 1979-491 . . . . . . . . . . . . . . . . . . . . . . . 24

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Page New Colonial Ice Co. v. Helvering, 292 U.S. 435 (1934) . . . . . . . . . . . . . . . . . . . . . . . . 13 NovaCare v. United States, 52 Fed. Cl. 165 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13 Salina Partnership, LP v. Comm'r, T.C. Memo 2000-352, 80 T.C.M. (CCH) 686 (2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7, 10, 23,27 United Savings Assoc. of Tex. v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365 (1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 Zlotnick v. TIE Communications, 836 F.2d 818 (3d Cir. 1988) . . . . . . . . . . . . . . . . . . . 15 Statutes: Internal Revenue Code of 1986 (26 U.S.C.): § 357 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23 § 702 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 28 § 704 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23, 28 § 705 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17, 20, 24, 28 § 708 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11, 16, 28 § 721 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 § 722 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 29 § 723 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 § 732 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 § 733 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18, 20 § 742 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 § 752 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Passim

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Page Statutes (Continuation): § 1001 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6, 27 §§ 1011 - 1016 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6 § 6223 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 § 6225 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 § 6226 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1, 4 § 6229 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14 Miscellaneous: 12 C.F.R.§ 220.12(c)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 H.R. Rep No. 98-861 (1984), 1984-3 (Vol. 2) C.B. 110 . . . . . . . . . . . . . . . . . . . . . . . . . 23 IRS Notice 2000-44, 200-36 I.R.B 255, 200-2-2 C.B. 255 . . . . . . . . . . . . . . . . . . . . . . . . 5 Prop. Treas. Reg. § 1.752-1(a)(1)(ii), 68 Fed. Reg. 37434 (2003 . . . . . . . . . . . . . . . . . . 24 Rev. Rul 88-77, 1988-2 C.B. 128 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23, 24, 25 Rev. Rul. 95-26, 1995-1 C.B. 131 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25, 26 Rev. Rul. 95-45, 1995-1 C.B. 53 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Treasury Regulations (26 C.F.R.): § 1.708-1(b)(1)(iv) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16 § 1.752-1(a)(4), T.D. 9207, 2005-1 C.B. 1344 . . . . . . . . . . . . . . . . . . . . . . . . . . 25 § 1.752-1(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20 § 1.752-1T(g), 1989-1 C.B. 180 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

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Page Miscellaneous (Continuation): 2 Bittker & Lokken, Federal Taxation of Income, Estates And Gifts ¶ 54.3.1, at 54-21 (2d ed. 1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10 Black Law Dictionary (6th ed) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22 Christopher Pietruszkiewicz, Of Summonses, Required Records and Artificial Entities: Liberating the IRS from Itself, 73 Miss. L.J. 921 & n.2 (2004) . . . . . . . . . . 5 Corporate Tax Shelters or Plus Ca Change, Plus C'est La Meme Chose," Michael S. Powlen . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Raj Tanden 431 Practising Law Institute Tax Law and Estate Planning Course Handbook 1003, 1020 (October-November 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 Laura E. Cunningham & Noel B. Cunningham, The Logic of Subchapter K 105 (2d ed. 2000) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18 Robert Bird & Alan Tucker, Tax Sham or Prudent Investment: Deconstructing the Government's Pyrrhic Victory in Salina Partnership v. Commissioner, 22 Va. Tax. Rev. 231, 253 (2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26 Zachary Knepper, Future-Priced Convertible Securities and the Outlook for "Death Spiral" Securities Fraud Litigation, 26 Whittier L. Rev. 359, 371 & n.79 (2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 26

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS __________ Nos. 01-256 T and 01-257 T (Judge Charles Lettow) MARRIOTT INTERNATIONAL RESORTS, L.P., MARRIOTT INTERNATIONAL JBS CORPORATION, TAX MATTERS PARTNER, Plaintiff v. THE UNITED STATES, Defendant.

______________________ MOTION OF THE UNITED STATES FOR SUMMARY JUDGMENT ______________________ Pursuant to Rule 56(b) of the Rules of the United States Court of Federal Claims, defendant, the United States, moves for summary judgment in defendant's favor on the grounds that this case presents no genuine issue of material fact and defendant is entitled to judgment as a matter of law. These cases are filed pursuant to § 6226 of the Internal Revenue Code of 1986, for readjustment of the partnership items set forth by the Commissioner of Internal Revenue in Notices of Final Partnership Administrative Adjustment. If defendant prevails on this motion for

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summary judgment, the Notices of Final Partnership Administrative Adjustment should be sustained and an appropriate order entered.1 In support of its motion, defendant relies upon the accompanying brief (with Appendices A and B), Defendant's Proposed Findings of Uncontroverted Fact, and the exhibits attached to the Declaration of G. Robson Stewart, filed herewith.

Respectfully submitted, s/G. Robson Stewart G. ROBSON STEWART U.S. Department of Justice - Tax Division Court of Federal Claims Section Post Office Box 26 Ben Franklin Station Washington, DC 20044 tel: (202) 307-6493 fax: (202) 514-9440 NATHAN J. HOCHMAN Acting Assistant Attorney General DAVID GUSTAFSON Chief, Court of Federal Claims Section s/David Gustafson Of Counsel Dated: February 1, 2008

In the Notice of Final Partnership Administrative Adjustment for the tax period ending December 30, 1994, the Commissioner made an adjustment of $17,507 relating to an interest expense deduction. This adjustment is raised in Fed. Cl. No. 01-257 T but not Fed. Cl. No. 01256 T. Defendant's counsel believes that this is merely a computational adjustment that can be resolved by the parties after the resolution of this motion for summary judgment involving the primary $75,000,000 adjustment. -2-

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IN THE UNITED STATES COURT OF FEDERAL CLAIMS __________ Nos. 01-256 T and 01-257 T (Judge Charles Lettow) MARRIOTT INTERNATIONAL RESORTS, L.P., MARRIOTT INTERNATIONAL JBS CORPORATION, TAX MATTERS PARTNER, Plaintiff v. THE UNITED STATES, Defendant. ______________________ BRIEF FOR THE UNITED STATES IN SUPPORT OF ITS MOTION FOR SUMMARY JUDGMENT ______________________ Through these partnership actions, Marriot International Inc. (Marriott) claims a purported tax loss of almost $70 million based on a subsidiary's short-term profitable investment in U.S. Treasuries. Marriott engineered this feat by having one of its subsidiaries enter into several short sales of U.S. Treasuries (borrowing Treasuries from a broker and then selling the borrowed Treasuries), and then contributing the cash received from the short sales to a partnership­but without accounting for the binding legal obligation to replace the borrowed Treasuries (i.e., close the short sales). Marriott claims that it did not have to account for the obligation to close the short sales at the time the short sale proceeds were contributed to the partnership because the value of the obligation was contingent­i.e., Marriott did not know how much it would cost to close the short sales until the short sales were closed at a later date. Under the applicable law,

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however, the obligation to close the short sales constituted a binding legal liability which must be taken into account by the partnership. When the obligation to close the short sales is taken into account by the partnership, the tax losses claimed by MIR vanish as quickly as they materialized. QUESTION PRESENTED Through pre-arranged transactions, two Marriott-controlled entities contributed mortgage notes and short-sale obligations to a partnership, Marriott International Resorts, L.P., (MIR).2 After one of the subsidiaries transferred its partnership interest to another Marriott-controlled entity, the mortgage notes ultimately were sold with a real economic loss of $522,093. Asserting that short-sale obligations are not liabilities under the partnership basis rules of § 752, plaintiff claims it realized a tax loss on the sale of the mortgage notes in the amount of $69,442,568.3 Is the obligation to close a short sale a liability under § 752?4 STATUTES AND REGULATIONS INVOLVED The primary statute involved in this case is § 752 of the Internal Revenue Code. The relevant statutes are set forth in Appendix A.

Under § 6226, the partnership is neither the plaintiff nor a party to this proceeding. Chef's Choice Produce Ltd. v. Commissioner, 95 T.C. 388, 394-95 (1990), Barbados #6 Ltd. v. Commissioner , 85 TC 900, n.1 (1985). On its partnership return (Form 1065) for the period ended December 30, 1994, MIR reported a loss on the sale of the Mortgage Notes of $71,189,461. For purposes of this motion, the discrepancy between the MIR tax return and the Complaint does not need to be resolved. Except as otherwise noted, all sections cited herein refer to the Internal Revenue Code of 1986, 26 U.S.C. (the "Code") in effect during the periods in issue. Relevant sections are reproduced in Appendix A attached hereton. -44 3

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PROCEDURAL BACKGROUND OF THE CASE The Complaints in this case were filed on April 30, 2001. The first Complaint (Fed. Cl. No. 01-256 T) involves MIR's the short taxable year ending October 28, 1994. The second Complaint (Fed. Cl. No. 01-257 T) involves MIR's short taxable year ending December 30, 1994. The cases were consolidated on May 25, 2001. This is a so-called "TEFRA" partnership proceeding, filed pursuant to § 6226. The issue in this case is whether the partners are permitted to take a tax loss of $71,189,461 claimed on MIR's partnership income tax return for the period ending December 31, 1994. Complaint, ¶ 33 (Fed. Cl. No. 01-256 T); Complaint, ¶ 33 (Fed. Cl. No. 01-257 T). SUMMARY OF ARGUMENT This case involves a tax shelter that was marketed to corporate taxpayers. See IRS Notice 2000-44, 2002-2 C.B. 255.5 This type of tax shelter is referred to by several names including "Basis Pump" or "Son of BOSS."6 In this case, Marriott followed a script for a series of orchestrated transactions which had been proposed by an investment banking firm aimed at artificially increasing Marriott's deductible tax basis in a subsidiary partnership interest, in order to create an enormous non-

See also Michael S. Powlen and Raj Tanden, "Corporate Tax Shelters or Plus Ca Change, Plus C'est La Meme Chose", 431 Practising Law Institute Tax Law and Estate Planning Course Handbook 1003, 1020 (October-November 1998) (rating this transaction an "X" using the movie ratings scale (i.e., G, PG, PG-13, R, and X)). BOSS is an acronym for Bond and Options Sales Strategy and refers to an abusive tax shelter intended to generate non-economic tax losses. See Christopher Pietruszkiewicz, "Of Summonses, Required Records and Artificial Entities: Liberating the IRS from Itself," 73 Miss. L.J. 921 & n.2 (2004). -56

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economic tax loss.7 At the heart of this scheme is the claim that the obligation to close a short sales of U.S. Treasuries is not a liability for purposes of computing partnership tax basis. The essential steps orchestrated by Marriott to achieve this alleged result were as follows:8 1. Two Marriott subsidiaries (MORI and JBS) form a partnership (MIR) and MORI has a 99% interest in MIR. MORI enters into two short sales of U.S. Treasuries with the broker that introduced Marriott to the tax shelter strategy, and invests the short sale proceeds of $73 million in repurchase obligations (Repos) with the same broker. MORI contributes (a) $83 million in time-share mortgage notes, (b) the proceeds from the two short sales ($73 million in Repos), and (c) the obligation to close the short sales to MIR. MORI calculates its purported tax basis in MIR by adding the value of the mortgage notes and the Repos (for a total of $156 million), but ignoring the short sale obligation. MIR sells the Repos and use the proceeds to close the short sales (i.e., to buy back the Treasury securities that were sold short and replace the borrowed Treasury securities) for a $1 million trading gain­thereby increasing the subsidiary's purported basis in MIR to $157 million­and not reducing that basis by the amount the partnership used to close the short sales. MORI's interest in MIR is transferred to another Marriott subsidiary (MICC), which causes a "technical termination" of MIR under § 708(b)(1)(B), and MICC gets the purported $157 million basis, of which $153 million is assigned to the time-share mortgage notes. MICC and JBS form a new MIR partnership and contribute the time-share mortgage notes to the new MIR. MICC's purported basis in the mortgage notes is carried over to the new MIR, and it allocates a purported basis to the mortgage notes of $153 million.

2.

3.

4.

5.

6.

Generally, "basis" is a concept that is fundamental to the tax reporting of gain or loss on a transaction. Normally, gain or loss is calculated by subtracting "basis" from the "amount realized." § 1001(a). The "basis" of property is usually the cost of the property which can be adjusted up or down, based on differing sets of circumstances. §§ 1011-1016.
8

7

The amounts used in this description are approximate. -6-

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7.

The new MIR sells the most of the time-share mortgage notes to a third-party for $82 million, resulting in a cash loss of less than $1 million. The mortgage notes sold, however, have a purported tax basis of $151 million, so the sale results in a claimed tax loss of $71 million.

Thus, Marriott's strategy transformed the sale of the time-share mortgage notes that resulted in a tangible economic loss of less than $1 million into a sale with a claimed noneconomic tax loss of $71 million. Marriott claims that its contrived events involving the short sales of Treasuries and the transfers of interests among various subsidiaries produced a spectral tax loss that is 13,600% greater than the actual loss on the mortgage notes sale. Marriott conjures this illusion by asserting that the obligation to close a short sale is not a "liability" under § 752 for the purposes of calculating partnership basis. Marriott's legal position is not correct. "Tax losses . . 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." ACM Partnership v. Commissioner, 157 F.3d 231, 252 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999). In this case, the plain meaning of the term "liability," contained in § 752, does encompass the obligation to close a short sale, because one who borrows securities in a short sale has an unconditional legal obligation to replace the borrowed property. This obligation is not contingent, as Marriott erroneously contends. An obligation to close a short sale is a binding legal obligation to replace the borrowed property, not to return a sum of money. Thus, the borrower's obligation is fixed at the time the short sale occurs. That the cost of satisfying the obligation may fluctuate with the market does not make the obligation itself contingent. Consequently, the obligation to close a short sale is a "liability" under § 752(a) and (b), as the two cases on the issue -- Salina Partnership, LP v. Comm'r, T.C. Memo. 2000-352, 80 T.C.M. -7-

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(CCH) 686 (2000), and Colm Producer, Inc. v. United States, 460 F.Supp.2d 713 (N.D. Tex. 2006 ) appeal pending, Kornman & Assoc. v. United States, No. 06-11422 (5th Cir. July 31, 2007)) -have held. Accordingly, when MIR's partnership tax basis is computed to reflect the partnership's closing of the short sales, Marriott's claimed tax loss evaporates. STATEMENT OF FACTS9 Plaintiff, Marriott International Resorts, LP, (MIR) is a Delaware limited partnership with its principal place of business located in Montgomery County, Maryland. (PF 1.)10 For the tax period ending October 28, 1994, Marriott International JBS Corporation (JBS) and Marriott Ownership Resorts, Inc. (MORI) were MIR's general partner and limited partner, respectively. (PF 2.) For the tax period ending December 30, 1994, JBS and Marriott International Capital Corporation ( MICC) were MIR's general partner and limited partner, respectively. (PF 3.) JBS, MORI, and MICC were, at all times relevant to this case, controlled subsidiaries of Marriott International, Inc. (PF 4.) During the periods in issue, MORI engaged in the business of selling timeshare interests in resort properties. (PF 5.) As part of this business, MORI offered buyers the opportunity to

Only for purposes of this motion for summary judgment, defendant assumes that the allegations in plaintiff's Complaints are true and accurate. Defendant also assumes that additional information contained in this fact statement, which was derived from documents produced by plaintiff and third-parties, and deposition testimony, is true and accurate. If this case proceeds to trial, however, defendant reserves the right to challenge the truth, accuracy, and/or credibility of all such allegations and information. Moreover, defendant reserves the right to challenge the transactions engineered by Marriott on the grounds that they were factual shams and/or they lack economic substance. See Coltec Indus., Inc. v. United States, 454 F.3d 1340, 1347 (Fed. Cir. 2006), cert. denied, 127 S. Ct. 1261 (2007); Jade Trading, LLC v. United States, No. 03-2164 T, WL 4553043 (Fed.Cl., December 21, 2007). References to "PF" are to defendant's proposed findings of uncontroverted facts filed with this brief. -810

9

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finance their purchases by having the buyer execute a promissory note, secured by a mortgage on the timeshare unit ("Mortgage Notes") (PF 6.) On November 22, 1993, MORI, and another Marriott entity, MTMG Corporation, entered into an agreement with Teachers Insurance and Annuity Association of America ("TIAA") ­an unrelated third party--in which the Marriott entities agreed to sell and TIAA agreed to buy up to $175,000,000 of Mortgage Notes. (PF 7. ) On January 3, 1994, Philip Hamon of the investment banking firm CS First Boston, faxed to Lester Pulse, the Tax Director of Marriott International, an "Executive Summary" which set forth a blueprint for a series of transactions that were designed to enable Marriott to create a noneconomic loss for Federal income tax purposes based on the premise that a short-sale obligation is not considered a liability for partnership tax basis purposes. (PF 8.) The transactions described in CS First Boston tax loss blueprint consist of the following steps (PF 9): · · · · · · Marriott International (MI) sells short 2-year Treasuries and invests the proceeds in intermediate term Treasuries. MI, as a limited partner, and another Marriott entity, as the general partner, form a partnership. MI contributes the intermediate term Treasuries and short sale obligations to the partnership and the general partner contributes some cash. The partnership obtains additional assets and subsequently sells the intermediate term Treasuries and closes the short sale obligation on the 2-year Treasuries. MI transfers its partnership interest to another subsidiary on which no gain or loss is recognized. The partnership interest transfer results in a technical termination of the partnership which causes a deemed distribution of the assets to each partner and a re-contribution of the assets to a new partnership. The tax basis of the partnership assets takes on the high outside tax basis of MI's interest based on the value of the intermediate term Treasuries which is not reduced by the short sale obligation. The assets later are sold at a loss as a result of the artificially high tax basis and through its subsidiary MI recognizes the tax benefit of the non-economic loss.

·

·

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On or about on April 25, 1994, MORI established a short position11 in five-year Treasury securities with a face amount of $65,000,000 (the "First Short Sale"). (PF 10.) The First Short Sale was executed through CS First Boston. (PF 11.) MORI received cash proceeds in the amount of $63,703,816 that were invested through CS First Boston in repurchase obligations ("Repos") yielding a fixed return. (PF 12.) On May 6, 1994, JBS was incorporated.12 (PF 13.) On May 6, 1994, MORI and JBS entered into a partnership agreement and created MIR with the filing of a Certificate of Limited Partnership.13 (PF 14.) JBS was the general partner of MIR holding a 1% interest, and MORI was a limited partner of MIR holding a 99% interest. (PF 15.) On or about on May 6, 1994, MORI contributed to MIR (1) the Repos, (2) Mortgage Notes, and (3) the obligations to close the First Short Sale. (PF 16.) Also, on or about on May 6, 1994, JBS contributed $1,000,000. (PF 17.) On or about on August 15, 1994, MORI established another short position in five-year Treasury securities with a face amount of $10,000,000 (the Second Short Sale). (PF 18.) The Second Short Sale was also executed through CS First Boston. (PF 19.) MORI received cash proceeds in the amount of $9,463,451 that were invested through CS First Boston in Repos. (PF 20.) On August 16, 1994, MORI contributed to MIR (1) the Repos, (2) Mortgage Notes with a A short sale has been defined as "consisting of two transactions: (1) the taxpayer's sale of property (typically, securities) borrowed from another person (typically, a broker) and (2) the subsequent closing out of the short position by the taxpayer's delivery of securities to the person who loaned the securities that were sold." Salina Partnership L.P., 80 T.C.M. (CCH) 686, 690, n. 5, citing 2 Bittker & Lokken, Federal Taxation of Income, Estates And Gifts ¶ 54.3.1, at 54-21 (2d ed. 1990). There is documentary evidence that this actually occurred on May 9, 1994. However, for purposes of this motion, defendant will assume the allegation in the Complaint to be true because for the present legal argument, the difference in dates is of no consequence.
13 12 11

There is documentary evidence that this actually occurred on May 11, 1994. -10-

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face amount of approximately $11,900,000, and (3) the obligation to close the Second Short Sale to MIR. (PF 21.) On October 1, 1994, MORI contributed additional Mortgage Notes with a face amount of approximately $6,200,000. (PF 22.) On September 29, 1994, MIR closed the First Short Sale with CS First Boston by purchasing replacement Treasuries with a face amount of $65,000,000 at a cost of $62,667,034. (PF 23.) On October 17, 1994, MIR closed the Second Short Sale with CS First Boston by purchasing replacement Treasuries with a face amount of $10,000,000 at a cost of $9,279,811.14 (PF 23.) The short sales were closed by liquidating the Repos and using those funds to buy back the Treasury securities that were "returned" to CS First Boston. In connection with the Treasuries short sale and Repo transactions, Marriott paid CS First Boston a "structuring fee" of $200,000 and expenses of $22,540.22, and paid a bid-ask spread of $50,000 on the trades, for a total transaction cost of $272,540.22. (PF 24.) On October 28, 1994, MORI transferred its entire partnership interest in MIR to MICC. (PF 25.) The transfer of MORI's interest in MIR to MICC triggered a technical termination of MIR under § 708(b)(1)(B). (PF 26.) Under § 708(b)(1)(B), the termination resulted in a deemed distribution of MIR's assets to its partners (JBS and MICC) followed by the creation of a new partnership by JBS and MICC, and contribution of the MIR assets to the new partnership­which also was named MIR. (PF 27.) The actual assets held by MIR prior to, and after, the termination were the Mortgage Notes, $1 million cash, and a receivable with a face amount of $3,303,164. (PF 27.)

14

The net gain on the short sales reported by MIR after trading and transaction costs was -11-

$819,532.

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Prior to the termination, MICC had a purported basis of $159,444,635 (i.e., not reduced by the obligation to close the shorts sales by purchasing replacement Treasuries) in its interest in MIR, which consisted of the bases of the Mortgage Notes, the Repos, and minor adjustments due to MIR's operations (i.e., interest and investment income). (PF 28.) After the termination, JBS's and MICC's partnership bases were allocated to the new MIR's assets (the Mortgage Notes, cash, and the receivable). Thus, the new MIR was assigned a purported basis in the Mortgage Notes of $155,141,472. (PF 29.) On or about on November 14, 1994, MIR conveyed the Mortgage Notes to a grantor trust and the received a Certificate in the Trust representing all of the interest in the Trust other than the Residual interest in the Trust. (PF 30.) On this date, MIR sold to TIAA the certificate for an amount realized of $81,452,111. (PF 31.) The fair market value of the interest sold to TIAA was $81,974,204, thus the loss on the sale was $522,093. (PF 31.) The purported basis of the Mortgage Notes interest sold to TIAA was $150,894,679 (i.e., not reduced by the obligation to close the shorts sales by purchasing replacement Treasuries). (PF 32.) On its partnership return (Form 1065) for the period ended December 30, 1994, MIR reported a loss on the of the Mortgage Notes of $71,189,461.15 (PF 33.) On February 2, 2001, the IRS issued a Notice of Final Partnership Administrative Adjustment ("FPAA") with respect to MIR's taxable year ended October 28, 1994. (PF 34.) In the FPAA for MIR's October 28, 1994, taxable year, the IRS reduced the partnership basis by $75,000,000 to reflect the obligation to return the Treasuries sold short to CS First Boston. (PF 35.) On February 2, 2001, the IRS issued

In the Complaint (¶ 33), however, Marriott states that the loss on the sale of the Mortgage Notes was $69,442,568 ($81,452,111 - $150,894,679). For purposes of this motion, the discrepancy between the MIR tax return and the Complaint does not need to be resolved. -12-

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an FPAA with respect to MIR's taxable year ended December 30, 1994. (PF 36.) In the FPAA for MIR's December 30, 1994, taxable year, the IRS determined that MIR realized a gain on the sale of the Mortgage Notes of $1,757,378, instead of the loss reported on the MIR Form 1065 of $71,189,461. (PF 37.) This determination was based on the reduction in the partnership basis of $75,000,000 which reflected the obligation to return the Treasuries sold short to CS First Boston. (PF 37.) STANDARD OF REVIEW This is a motion for summary judgment filed pursuant to Rule 56 of the Rules of the United States Court of Federal Claims. Summary judgment is appropriate when the record could not lead a rational trier of fact to find for the nonmoving party and there is no genuine issue for trial. "In such a case, there is no need for the parties to undertake the time and expense of a trial, and the moving party should prevail without further proceedings." NovaCare v. United States, 52 Fed.Cl. 165, 169 (2002). The particular tax item at issue here is a claimed tax loss of $71,189,461 on the sale of the Mortgage Notes, which manifests itself as a "deduction" on a partnership tax return. "Whether and to what extent deductions shall be allowed depends upon legislative grace; and only as there is clear provision therefor can any particular deduction be allowed." New Colonial Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).

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ARGUMENT I. THE TREASURIES SHORT SALE OBLIGATIONS CONSTITUTE LIABILITIES THAT MUST BE INCLUDED IN THE BASIS OF THE PARTNERSHIP A. Introduction This TEFRA partnership proceeding involves a "Son of BOSS" tax shelter.16 In a Son of BOSS tax shelter, a partner contributes encumbered property to the partnership, which expressly assumes the associated obligation. The partner, however, computes his tax basis in this partnership interest as equal to the value of the contributed property without reducing that value by the amount of the encumbrance--i.e., the partner fails to adjust its basis in its partnership interest under § 752(a) and (b), which ultimately results in partnership assets with a vastly overstated basis. When the assets with the "pumped" basis are sold, they generate a large noneconomic tax loss. In this case, Marriott used the short-sale variant of the Son of BOSS scheme to create an enormous artificial tax loss without any corresponding economic loss. Marriott followed a script proposed by CS First Boston to use the short sale of Treasuries to create an artificially high basis in certain assets which were then sold at a tax loss that far out-weighed any real economic loss. "`Selling short' . . . involves two separate transactions: the short sale itself and the subsequent

A TEFRA partnership proceeding is a proceeding to determine the correctness of the partnership's reporting of "partnership items" on its annual information return. When the IRS disagrees with a partnership's reporting of any partnership item, it must issue an FPAA (final partnership administrative adjustment) before making any assessments against the partners attributable to this item. §§ 6223(a)(2), (d)(2), 6225(a). The timely mailing of the FPAA suspends the running of the limitations period for assessing any income taxes that are attributable to any partnership item or affected item. § 6229(d). -14-

16

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covering purchase." Zlotnick v. TIE Communications, 836 F.2d 818, 820 (3d Cir. 1988). In the first transaction, the investor sells securities that he does not own; he typically does this by borrowing the securities from a facilitating broker. "The short seller is obligated, however, to buy an equivalent number of shares in order to return the borrowed [securities]." Id. The short sale thus gives rise to the second transaction -- the covering purchase. The short seller typically makes this covering purchase using the funds he received from selling the borrowed securities. If the securities decline after the short sale, as anticipated, the investor does not need to use all the proceeds from the short sale to make the covering purchase. Id. Thus, the two transactions are offsetting­the sale of borrowed securities and their ultimate replacement with identical securities. The only unknown element prior to the close of the short sale is the cost of the replacement securities. In this case, MORI's short sale of Treasuries with a face value of $75 million through CS First Boston generated sale proceeds of $73 million and gave rise to a binding legal obligation for MORI to return to CS First Boston Treasuries with a face value of $75 million. MORI then contributed the short-sale proceeds to MIR which Marriott manipulated, through various transactions, in an attempt to "pump up" the basis of time share mortgage notes Marriott had agreed to sell to TIAA. Thus, Marriott reported that it incurred a capital loss of $71 million as a result of the short sales, the partnership transactions involving various subsidiaries, and the sale of mortgage notes. Marriot reaches this incredible conclusion by taking the position that MORI had a basis of approximately $157 million in its partnership interest in MIR as a result of the contribution of the short-sale proceeds and the mortgage notes to MIR, of which $155 million was assigned to the

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time share mortgage notes. Marriott asserts that it does not have to account for the obligation to close the short sales in MORI's basis in MIR.17 Thus, after MORI's interest in MIR was transferred to MICC, the new MIR was formed, and the mortgage notes ultimately were sold to TIAA, Marriott claims that it realized a non-economic tax loss of $71 million, even though it realized a real economic loss on the sale of the mortgage notes of only $522,093.18

Contained in Appendix B is Chart 1, which tracks Marriott's claimed basis calculations. Following the January 4, 1994, script provided by CS First Boston, Marriott forced a "technical termination" of MIR by transferring MORI's partnership interest in MIR to MICC in a § 351 exchange and then forming the new MIR. This step was vital in order to shift the inflated outside basis of MORI to the basis of MIR's assets under § 708(b)(1)(B), which provides that a partnership terminates when fifty percent or more of the total interest in the partnership is sold or exchanged. The transfer of fifty percent or more of a taxpayer's interest in a partnership to a corporation wholly owned by the taxpayer in a transaction qualifying under § 351 is an exchange that terminates the partnership under § 708(b)(1)(B), and under § 362 MICC takes a basis in the partnership equal to the basis MORI had in MIR. Under former Treas. Reg. § 1.708-1(b)(1)(iv)(T.D. 6175 was amended by T.D. 8717 on May 8, 1997), the effect of the technical termination is twofold. The partnership is deemed to distribute its property to the transferee partner and remaining partners. Under § 732(b), the partners take a substituted basis for the constructively distributed partnership property equal to their preexisting bases for their partnership interests. Under § 732(c) this substituted basis is then allocated among those properties in proportion to their respective adjusted bases in the hands of the partnership. In this case, MORI transferred its 99% MIR partnership interest to MICC which caused a technical termination for tax purposes. Therefore, MIR is deemed to distribute the timeshare mortgages, with a basis of $83,300,000, and the cash, with a basis of $1,000,000, to the transferee partner, MICC, and the remaining partner, JBS, in proportion to their respective interests in the partnership, 99% and 1% respectively. At the time of the termination, MORI had a purported outside basis of $156,500,000 and JBS had a outside basis of $1,000,000. Hence, MICC took an outside basis of $156,500,000 and JBS retained its outside basis of $1,000,000. When MICC and JBS are deemed to contribute the assets to the "new" tax partnership, MIR took a carryover basis of $156,500,000 in the assets--primarily the mortgage notes--which were then sold for $81,452,111. -1618

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When MIR's assumption of MORI's obligation to replace the $75 million face value of Treasuries is properly taken into account in the partnership basis calculation, however, the fictitious $71 million loss on the mortgage notes sale is eliminated.19 As we shall demonstrate, the critical premise of Marriott's argument, i.e., that the obligation to replace borrowed securities with equivalent securities is a contingent obligation entirely outside the scope of § 752 for purposes of basis calculation, is wrong and, accordingly, the argument in support of the fictional $69 million loss fails. B. Partnership's Basis in Partnership Assets - "Inside Basis" The partnership's basis in its assets is referred to as "inside basis". Generally, § 723 provides the rule for calculating inside basis: The basis of property contributed to a partnership by a partner shall be the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under section 721(b) to the contributing partner at such time. C. Partner's Basis in its Partnership Interest - "Outside Basis" The issue presented in this motion for summary judgment involves the application of the partnership basis calculations of Subchapter K of the Internal Revenue Code.20 Section 705 sets forth the equation for calculating a partner's basis in the interest it owns in the partnership­i.e.,

Contained in Appendix B is Chart 2, which tracks the basis calculations that include the short-sale obligations. Under Treas, Reg. § 301.6231(a)(3)-1(a)(4), items relating to contributions and distributions from a partnership are partnership items to the extent that a determination of such items can be made from determinations that the partnership is required to make. Under Treas. Reg. § 301.6231(a)(3)-1(c)(2)(iv), the partnership needs to determine the basis to the partnership of contributed property, including necessary preliminary determinations such as the partner's basis in the contributed property. Nussdorf v. Commissioner, 129 T.C. 30, 41 (2007), Cemco Investors LLC v. U.S., No. 04-C-8211, 2007 WL 951944, at *6 (N.D. Ill. Mar. 27, 2007). -1720

19

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"outside basis"--and that rule provides that basis is calculated by applying § 722 for "contributions to a partnership" or § 742 for "transfers of a partnership interest." Section 722 provides: The basis of an interest in a partnership acquired by a contribution of property, including money, to the partnership shall be the amount of such money and the adjusted basis of such property to the contributing partner at the time of the contribution increased by the amount (if any) of gain recognized under section 721(b) to the contributing partner at such time. Section 705 then states that once the outside basis is determined under § 722 or § 742, the basis is increased by the partner's respective share of income items. The basis calculation continues by decreasing basis by (1) "distributions" that are set forth in § 733,21 (2) losses of the partnership, and (3) certain expenditures of the partnership which are not deductible in computing taxable income and not properly chargeable to a capital account.22 D. The Effect of Liabilities on the Calculation of Outside Basis Under the aggregate notion of partnership taxation, partnership liabilities must be allocated among the partners.23 This is accomplished through §752, which treats a partner's increase in his/her share of partnership liabilities as a contribution of money by the partner, or a partner's decrease in his/her share of partnership liabilities as a distribution of cash to the partner.24 What is particularly significant under the facts of this case, is the treatment of the
21

"Distributions" mean money or property that the partnership transfers to its partners.

A charitable contribution is an example of a partnership expenditure which is not deductible and which is not chargeable to a capital account, and hence decreases outside basis. See Laura E. Cunningham & Noel B. Cunningham, The Logic of Subchapter K 105 (2d ed. 2000). If a partner contributes partnership property in which he has a cost basis of $100, in exchange for a 50% interest in the partnership, he will have a basis of $100 in his 50% -1824 23

22

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decrease in a partner's liabilities when the short sale is closed and the obligation to replace the borrowed securities is extinguished. Under § 752(b), the decrease in a partner's share of liabilities that results from covering the short sale is considered a distribution of money to the partner and should result in a decrease in basis in the partnership. 1. The Rule under § 752

Section 752 provides for adjustments to the calculation of outside basis for transactions involving "liabilities." Section 752 provides, in relevant part: (a) Increase in Partner's Liabilities. - Any increase in a partner's share of the liabilities of a partnership, or any increase in a partner's individual liabilities by reason of the assumption by such partner of partnership liabilities, shall be considered as a contribution of money by such partner to the partnership. (b) Decrease in Partner's Liabilities. - Any decrease in a partner's share of the liabilities of a partnership, or any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities, shall be considered as a distribution of money to the partner by the partnership. Since the obligation to close the short sales were part and parcel of the proceeds that resulted from the short sales, and both the obligations and the proceeds from the short sales were contributed to the partnership, the MIR partners' share of the obligations/liabilities are affected.

partnership interest. If the contributed property was encumbered by a liability of $80, his basis in the partnership will instead be $60, which is calculated as follows: $100 basis for the cost of the contributed property, less $80 for the liability assumed by the partnership, plus $40 for his 50% share of what is now a partnership liability. The adjustment appropriately reflects the economic effect of the liability. If partnership liabilities are involved, § 752(a) and (b) adjusts this initial outside basis to reflect the partners' respective shares of those liabilities. The omission of an obligation from partnership liabilities under § 752 creates a claim by the participant that his outside basis remained $100 because no adjustment is made for the partnership's assumption of the obligation under § 752(b). In this way, a Son of BOSS participant artificially inflates his outside basis by the amount of the omitted obligation and the participant claims an artificial tax benefit in the form of a built-in capital loss equal to the omitted obligation­all without any meaningful economic investment. -19-

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2.

Application of § 752(b) - - MIR's assumption of the obligation to close the short sale reduces MORI's outside basis because MIR is taking responsibility for the replacement of the Treasuries and, because that transfer of the obligation is a benefit to MORI, it is as if MIR is paying cash to MORI

Section 752(b) provides that any decrease in a partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities is considered a distribution of money to the partner by the partnership. Therefore, in combination with §§705(a)(2) and 733(1), § 752(b) has the effect of decreasing the partner's adjusted basis in a partnership interest by the amount of the reduction in the partner's individual liabilities by reason of the assumption by the partnership of such individual liabilities. Treas. Reg. § 1.752-1(d), (effective for liabilities incurred after December 27, 1991). In this case, the short sales obligations became liabilities of the partnership. MORI contributed the obligations to close the short sales to MIR on or about on May 6, 1994, and August 16, 1994. Indeed, the proceeds from the short sales were contributed to MIR, along with the obligations. Treating MIR's assumption of the obligation to close the short sale as an assumption of a liability under § 752(b) results in a deemed distribution to MORI which reduces its outside basis by that obligation to replace the shorted $75,000,000 in Treasuries. In other words, when MIR assumed MORI's obligation to close the short sales, MORI was required to reduce its outside basis by the obligation to replace the shorted $75,000,000 in Treasuries. 3. Application of § 752(a) - - With the obligation to close the short sale now residing in MIR, MORI and JBS increase their basis by their shares of the partnership's obligations to close the short sale

Section 752(a) provides that any increase in a partner's share of the partnership's liabilities is considered a contribution of money to the partnership by the partner. Under § 722, the computation of a partner's outside basis in the partnership interest received includes the -20-

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amount of money it contributes. Therefore, § 752(a) has the effect of increasing the partner's outside basis by the amount of the increase in the partner's share of the partnership's liabilities. Under § 752(a), MORI's outside basis is increased by its share of the liability assumed by MIR (i.e., the amount to close the short sales), which is approximately $74,250,000 (99% of $75,000,000). MORI held a 99% interest in MIR. 4. Application of § 752(b) to the closing of the short sales

The final step in the transaction was to close MIR's obligation to return Treasury securities with a face amount of $75,000,000 to CS First Boston. MIR closed the short sales by liquidating the Repos and using the proceeds to purchase the Treasury securities that it returned to CS First Boston. Thus, when MIR closed the short sales, MIR's liabilities were reduced by $75,000,000. Because the partnership liabilities are reduced, under § 752(b), a reduction in the partners' share of the partnership liabilities is treated as a distribution by MIR of $75,000,000 to its partners. This distribution decreases MORI's and JBS's outside basis in MIR. Accordingly, after the deemed distribution, MORI's basis in its MIR partnership interest equaled $81,500,000 ($155,750,000 less (99 percent of $75,000,000))­not the $156,500,000 claimed by Marriott.

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II. DEFENDANT'S LEGAL POSITION IS SUPPORTED BY THE PLAIN LANGUAGE OF THE STATUTE, THE CASE LAW, AND ADMINISTRATIVE RULINGS A. A plain reading of § 752 supports the Government's position Construction of a statute begins with its plain language. Delong v. Dep't of Health & Human Servs., 264 F.3d 1334, 1339 (Fed. Cir. 2001), cert. denied, 536 U.S. 958 (2002). The Supreme Court has stated (American Tobacco Co. v. Patterson, 456 U.S. 63, 68 (1982)): As in all cases involving statutory construction, `our starting point must be the language employed by Congress, and we assume that the legislative purpose is expressed by the ordinary meaning of the words used. Thus, absent a clearly expressed legislative intention to the contrary, that language must ordinarily be regarded as conclusive. The question is whether the obligation to close the short sale is a "liability" within the meaning of § 752. Black's Law Dictionary 914 (6th ed.) defines "liability" as follows (citations omitted): Liability. The word is a broad legal term. It has been referred to as of the most comprehensive significance, including almost every character of hazard or responsibility, absolute, contingent, and likely. It has been defined to mean: all character of debts and obligations, amenability or responsibility; an obligation one is bound in law or justice to perform; an obligation which may or may not ripen into a debt; and kind of debt or liability, either absolute or contingent, express or implied; condition of being actually or potentially subject to an obligation; condition of being responsible for a possible or actual loss, penatly, evil, expense, or burden; condition which creates a duty to perform an act immediately or in the future; duty to pay money or perform some other service; duty which must at least eventually be performed; estate tax; every kind of legal obligation, responsibility, or duty; fixed liability; legal responsibility; penalty for failure to pay tax when due; present, current, future, fixed or contingent debts; punishment; responsibility for torts; tax; that which one is under obligation to pay, or for which one is liability; the state of being bound in law and justice to do something which may be enforced by action; unliquidated claim. In light of the clear meaning of liability, Marriott's effort to cast a binding legal obligation to replace securities borrowed from a brokerage firm as anything other than a liability must be ignored, especially in light of its tax avoidance purpose. -22-

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Moreover, Marriott's position would produce a result that is inconsistent with the tax statute. As discussed by the Tax Court (Salina, T.C. Memo. 2000-352, 80 T.C.M. (CCH) 686, 696 n. 15 (2000) (citations omitted)): In an effort to avoid distortions in income tax reporting associated with the blending of the entity and aggregate approaches within subchapter K, Congress enacted a number of provisions that generally are intended to equate the aggregate of the partnership's inside bases in its assets with the aggregate of its partners' outside bases in their partnership interests. Defendant's position is consistent with the general Congressional intent that is reflected in the 1984 legislative history underlying the amendment to § 704(c). It is evident that Congress contemplated consistent definitions of the word "liability" under § 752 and § 357(c)(3). See H.R. Rep. No. 98-861, at 856-857 (1984), reprinted in 1984-3 (Vol. 2) C.B. 110, 111. Section 357(c) provides rules regarding the assumption of a liability in corporate reorganization. Under § 357(c)(3)(B), obligations that result in the creation, or an increase in the basis, of any property are treated as liabilities for purposes of that section. See Rev. Rul. 88-77, 1988-2 C.B. 128. Statutory construction "is a holistic endeavor" and the meaning of a provision is "clarified by the remainder of the statutory scheme . . . [when] only one of the permissible meanings produces a substantive effect that is compatible with the rest of the law." United Sav. Assn. of Tex. v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 371 (1988). In Salina, at 696 n. 15, the Tax Court, quoting a tax treatise, explained: If a partnership borrows money, the basis of its assets increases by the amount of cash received, even though the receipt of the borrowed funds is not income. By treating the partners as contributing cash in an amount equal to their shares of the debt, inside/outside basis equality is preserved and distortions are avoided. If a liability for borrowed money were not added to the partners' bases, they could be taxed on a distribution of the borrowed cash even though there is no gain inherent in the partnership's assets. A similar result could occur if a partnership incurs a purchase money liability to acquire property, since the liability is added to the partnership's basis in the property. McKee, supra, par. 7.01[1], at -23-

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7-2; see Laney v. Comm'r, 674 F.2d 342, 345-346 (5th Cir. 1982), aff'g in part and rev'g in part on another ground T.C. Memo. 1979-491. In this case, MORI borrowed the Treasuries from CS First Boston, sold them (i.e., the short sale transactions), and received the proceeds from the short sale. Contributing the short sale proceeds to MIR, MORI increased its outside basis in MIR by the amount of the short sale proceeds. Accordingly, the corresponding short sale liability, which gave rise to the increase in basis, must be factored into the MIR basis calculation. B. The IRS's consistent position is that when, as here, an obligation creates or increases the basis of any of the obligor's assets, that obligation is a "liability" under § 752 The IRS has consistently ruled that when, as here, an obligation creates or increases the basis of the obligor's assets, that obligation is a liability under § 752. The IRS espoused this position as early as 1988. In Rev. Rul. 88-77, 1988-2 C.B. 128, 129, it defined liability under § 752 to "include an obligation only if and to the extent that incurring the liability creates or increases the basis to the partnership of any of the partnership's assets (including cash attributable to borrowings), gives rise to any immediate deduction to the partnership, or, under section 705(a)(2)(B), currently decreases a partner's basis in the partner's partnership interest." In 1989, the Treasury Department promulgated a temporary regulation containing a similar definition of "liability" under § 752. Temp. Treas. Reg. § 1.752-1T(g), 1989-1 C.B. 180, 192, provided as follows: [U]nder section 752, an obligation is a liability of the obligor for purposes of section 752 and the regulations thereunder to the extent, but only to the extent, that incurring or holding such obligation gives rise to-(1) The creation of, or an increase in, the basis of any property owned by the obligor (including cash attributable to borrowings);

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(2) A deduction that is taken into account in computing the taxable income of the obligor; or (3) An expenditure that is not deductible in computing the obligor's taxable income and is not properly chargeable to capital.[25] For reasons that are unclear, the final regulations adopted in 1991 did not contain a definition of "liability." See 1992-1 C.B. 218 In Rev. Rul. 95-26, 1995-1 C.B. 131, the IRS, relying, in part, on Rev. Rul. 88-77, ruled that a partnership's short sale of securities creates a partnership liability under § 752. The IRS reasoned that a short sale creates an obligation on the part of the seller to return the borrowed property. In addition, the short sale produces cash, and the cash is a partnership asset that increases the partnership's basis in its assets. Therefore, the short sale creates a liability under § 752 to the extent that the proceeds of the short sale increases the partnership's basis in its assets, and the partners' bases in their partnership interests were increased under § 722 to reflect their shares of the liability under § 752.26 Accord, Rev. Rul. 95-45, 1995-1 C.B. 53 ("The initial proceeds of an open short sale are . . . an asset of the short seller, increasing the aggregate

In 2003, the IRS issued a proposed regulation containing a similar definition, which was adopted in 2005. Prop. Treas. Reg. § 1.752-1(a)(1)(ii), 68 Fed. Reg. 37434, 37436 (2003); Treas. Reg. § 1.752-1(a)(4), T.D. 9207, 2005-1 C.B. 1344, 1354. Under Treas. Reg. § 1.7521(a)(4)(i)(A), an obligation is a "liability" under § 752 if, inter alia, incurring the obligation "[c]reates or increases the basis of any of the obligor's assets (including cash)." In addition, an "obligation" is "any fixed or contingent obligation to make payment without regard to whether the obligation is otherwise taken into account for purposes of the Internal Revenue Code" and includes an obligation under a short sale. Treas. Reg. § 1.752-1(a)(4)(ii). The new definition applies to liabilities incurred or assumed by a partnership on or after June 24, 2003 (id. § 1.7521(a)(4)(iv)), and, therefore, is inapplicable here. In Rev. Rul. 95-26, the Commissioner correctly