No. 10-41132IN THE UNITED STATES COURT OF APPEALS

FOR THE FIFTH CIRCUIT

BEMONT INVESTMENTS, L.L.C., by and through its Tax Matters Partner,

Plaintiff-Appellee/Cross-Appellant,v.

UNITED STATES OF AMERICA,Defendant-Appellant/Cross-Appellee.

BPB INVESTMENTS, L.C., by and through its Tax Matters Partner;DANIEL BEAL, BPB Investments, L.L.C. Tax Matters Partner,

Plaintiffs-Appellees/Cross-Appellants,v.

UNITED STATES OF AMERICA,Defendant-Appellant/Cross-Appellee.

ON APPEAL FROM THE JUDGMENT AND ORDEROF THE UNITED STATES DISTRICT COURT

FOR THE EASTERN DISTRICT OF TEXAS

COMBINED ANSWERING AND REPLY BRIEF FOR THE UNITED STATES

GILBERT S. ROTHENBERG Acting Deputy Assistant Attorney General

RICHARD FARBER (202) 514-2959Of Counsel: JUDITH A. HAGLEY (202) 514-8126

AttorneysJOHN M. BALES Tax Division United States Attorney Department of Justice

Post Office Box 502 Washington, D.C. 20044

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TABLE OF CONTENTS

Page

Table of contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iTable of authorities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . iiiGlossary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . xIntroduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1

Answering Brief for the United States as Cross-Appellee . . . . . 3

Statement of the issue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3Statement of the facts . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3

B. Coscia’s tax opinion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5

C. District Court’s opinion . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

Summary of argument . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9Argument:

The District Court correctly determined that the negligence penalty applied to the $200 million artificial loss generated by Beal’s Son-of-BOSS shelter . . . . . . . . . . . . . . 11

Standard of review . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

A. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

B. The District Court correctly found that the Partnershipswere negligent in claiming the $200 million artificial loss generated by Beal’s Son-of-BOSS shelter . . . . . . . . . 15

C. The alternative penalty for substantial understatements of tax also applies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

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Page

D. The District Court correctly rejected the Partnerships’reasonable-cause defense to penalties .. . . . . . . . . . . . . . . 23

Reply Brief for the United States as Appellant . . . . . . . . . . . . . 32

I. The Partnerships have failed to demonstrate that taxpayer Andrew Beal’s Son-of-BOSS tax shelter had been adequately disclosed to the IRS in May 2005 so as to trigger the running of § 6501(c)(10)’slimitations period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32

A. The two e-mail attachments that Deutsche Bank produced to the IRS in May 2005 satisfy neither the plain language nor the intent of § 6501(c)(10)(B) and § 6112 .. . . . . . . . . . . . . . . . . . . 35

1. Taxpayer Andrew Beal was not identified . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

2. Even if the two Deutsche Bank e-mailattachments sufficiently identified Beal and his Partnerships (which they did not), they did not trigger the running of § 6501(c)(10)’slimitations period because they did not purport to be § 6112 lists, as Deutsche Bankconfirmed . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

B. The Temporary Regulations were properlypromulgated . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

1. § 7805(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48

2. APA’s exemption for interpretiveregulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52

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Page(s)

C. The two e-mail attachments do not satisfy Treasury Regulation § 301.6112-1T’s requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

D. The Partnerships’ sanctions motion, denied by the District Court as moot, does not provide analternative ground for affirming the court’s statute-of-limitations decision . . . . . . . . . . . . . . . . . 62

II. The Partnerships have failed to demonstrate that § 6662’s penalty for basis misstatements does not apply to Beal’s basis-inflating Son-of-BOSS shelter . . . . . 66

Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 73Certificate of service .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74ECF certifications .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 74Certificate of compliance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 75

TABLE OF AUTHORITIES

Cases:

106 Ltd. v. Commissioner, 136 T.C. 67 (2011) . . . . . . . . 13, 27, 29Am. Boat Co. v. United States, 583 F.3d 471 (7th Cir.

2009). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14Am. Tobacco Co. v. Wix, 62 F.2d 835 (C.C.P.A. 1933) . . . . . . . . 40Arthur Andersen v. Carlisle, 129 S. Ct. 1896 (2009) . . . . . . . . . 16Asiana Airlines v. FAA, 134 F.3d 393 (D.C. Cir. 1998) . 49, 50, 52Auer v. Robbins, 519 U.S. 452 (1997) . . . . . . . . . . . . . . . . . . . . . 69Avoyelles Sportsmen’s League, Inc. v. Marsh,

715 F.2d 897 (5th Cir. 1983) . . . . . . . . . . . . . . . . . . . . . . . 52Badaracco v. Commissioner, 464 U.S. 386 (1984) . . . . . . . . . . . 44Bailey v. United States, 516 U.S. 137 (1995) . . . . . . . . . . . . . . . 51

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Page(s)

Cases (continued):

Bishop v. United States, 338 F. Supp. 1336 (N.D. Miss. 1970), aff’d without opinion, 468 F.2d 950 (5th Cir. 1972). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 43

Burks v. United States, 633 F.3d 347 (5th Cir. 2011). . . . . . 47, 48Cemco Investors, LLC v. United States,

515 F.3d 749 (7th Cir. 2008). . . . . . . . . . . . . . . . . . . . . . . . 13Chilcutt v. United States, 4 F.3d 1313 (5th Cir. 1993). . . . . . . . 63Clearmeadow Invs., LLC v. United States,

87 Fed. Cl. 509 (2009) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69Continental Equities, Inc. v. Commissioner,

551 F.2d 74 (5th Cir. 1977) . . . . . . . . . . . . . . . . . . . . . . . . 54FDIC v. Conner, 20 F.3d 1376 (5th Cir. 1994) . . . . . . . . . . . 64, 65FTC v. Nat’l Business Consultants, Inc.,

376 F.3d 317 (5th Cir. 2004) . . . . . . . . . . . . . . . . . . . . . . . 38Fidelity Int’l Currency Advisor A Fund, LLC v.

United States, 747 F. Supp. 2d 49 (D. Mass. 2010), appeal pending, No. 10-2421 (1st Cir.) . . . . . . . . . . . . 13, 26,

29, 32Gilman v. Commissioner, 933 F.2d 143 (2d Cir.

1991). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71Gregory v. Missouri Pacific R. Co., 32 F.3d 160

(5th Cir. 1994). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47Heasley v. Commissioner, 902 F.2d 380

(5th Cir. 1990). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66-69, 71Hoffman v. Commissioner, 119 T.C. 140 (2002). . . . . . . . . . . . . 38Illes v. Commissioner, 982 F.2d 163 (6th Cir. 1992). . . . . . . . . . 70Insulglass Corp. v. Commissioner, 84 T.C. 203 (1985). . . . . . . . 43Klamath Strategic Inv. Fund v. United States,

568 F.3d 537 (5th Cir. 2009). . . . . . . . . . . . . . . . . . 14, 15, 23Kornman & Assocs., Inc. v. United States,

527 F.3d 443 (5th Cir. 2008). . . . . . . . . . . . . . . . . . . . . . . . . 4

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Page(s)

Cases (continued):

Long-Term Capital Holdings v. United States,330 F. Supp. 2d 122 (D. Conn. 2004), aff’d by summary order, 150 Fed. Appx. 40 (2d Cir. 2005) . . . 26, 32

Maguire Partners-Master Invs., LLC v. United States,No. 06-7371, 2009 WL 4907033 (C.D. Cal. Dec. 11, 2009), appeal pending, No. 09-55650(9th Cir.) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13, 16, 17, 31

Marshall v. Segona, 621 F.2d 763 (5th Cir. 1980).. . . . . . . . . . . 63Murfam Farms, LLC v. United States, 94 Fed. Cl.

235 (2010). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13Nat’l Cable & Telecomm. Ass’n v. Brand X Internet

Servs., 545 U.S. 967 (2005). . . . . . . . . . . . . . . . . . . . . . 67, 70Neonatology Assocs. v. Commissioner, 299 F.3d 221

(3d Cir. 2002) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24Nevada Partners Fund, LLC v. United States,

714 F. Supp. 2d 598 (S.D. Miss. 2010), appeal pending, No. 10-60559 (5th Cir.) . . . . . . . . . . . . . . 17

New Phoenix Sunrise Corp. v. Commissioner,408 Fed. Appx. 908 (6th Cir. 2010) . . . . . . . . . . . . . . . . . . 13

New Phoenix Sunrise Corp. v. Commissioner, 132 T.C. 161 (2009), aff’d, 408 Fed. Appx. 908(6th Cir. 2010) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21

Ogden v. Commissioner, 244 F.3d 970 (5th Cir. 2001) .. . . . . . . 11Palm Canyon X Invs., LLC v. Commissioner,

98 T.C.M. (CCH) 574 (2009) .. . . . . . . . . . . . . . . . . . . . 13, 22Pickus v. U.S. Bd. of Parole, 507 F.2d 1107

(D.C. Cir. 1974) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53Professionals & Patients for Customized Care v. Shalala,

56 F.3d 592 (5th Cir. 1995) . . . . . . . . . . . . . . . . . . . . . . . . 53Richardson v. Commissioner, 125 F.3d 551

(7th Cir. 1997) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12Santa Monica Pictures, LLC v. Commissioner,

89 T.C.M. (CCH) 1157 (2005) .. . . . . . . . . . . . . . . . . . . . . . 27

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Page(s)

Cases (continued):

Scarborough v. Principi, 541 U.S. 401 (2004) . . . . . . . . . . . . . . 44Shell Offshore Inc. v. Babbitt, 238 F.3d 622

(5th Cir. 2001). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52Stanford v. Commissioner, 152 F.3d 450

(5th Cir. 1998). . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23Stobie Creek Invs., LLC v. United States,

82 Fed. Cl. 636 (2008), aff’d, 608 F.3d 1366 (Fed. Cir. 2010) .. . . . . . . . . . . . . . . . . . . . . . . . 21, 22, 27, 29

Stobie Creek Invs. LLC v. United States,608 F.3d 1366 (Fed. Cir. 2010) .. . . . . . . . . . . . . . . 13, 16, 30

Streber v. Commissioner, 138 F.3d 216 (5th Cir. 1998) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19

Texas Comm’l Energy v. TXU Energy, Inc., 413 F.3d 503 (5th Cir. 2005) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 47

United States v. Boyle, 469 U.S. 241 (1985) . . . . . . . . . . . . . . . . 11United States v. Johnson, 632 F.3d 912 (5th Cir. 2011) . . . . . . 55United States v. Tex. Heart Inst., 755 F.2d 469

(5th Cir. 1985), overruled on other grounds sub nom. United States v. Barrett, 837 F.2d 1341 (5th Cir. 1988) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

Weiner v. United States, 389 F.3d 152 (5th Cir. 2004) . . . . . 69, 70Yokum v. United States, 66 Fed. Cl. 579 (2005) . . . . . . . . . . . . . 49Young v. Commissioner, 783 F.2d 1201 (5th Cir. 1986) .. . . . . . 61

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Page(s)

Statutes:

5 U.S.C. § 553 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50, 535 U.S.C. § 553(b)(3)(A) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52, 62

Internal Revenue Code of 1986 (26 U.S.C.):

§ 752 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21§ 6103 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 64§ 6112 . . . . . . . . . . . . . . . . . . . . . 32-43, 45, 46, 54-56, 58-61§ 6112(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35§ 6226(f) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14§ 6501(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42§ 6501(c)(10) . . . . . . . . . . 2, 32, 33, 35-38, 40, 41, 43, 44, 46

47, 60, 62§ 6501(c)(10)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33, 35-37§ 6662 . . . . . . . . . . . . . . . . . . . . . . . . . . 2, 7, 9, 11, 66, 70, 72§ 6662(b) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69§ 6662(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15§ 6662(d)(1)(A) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19§ 6662(d)(2)(B) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19§ 6662(d)(2)(C)(i) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20§ 6662(d)(2)(C)(iii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20§ 6662(h)(1) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11§ 6664(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12, 21, 31, 32§ 7805 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54§ 7805(a) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53-55§ 7805(e) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 48-52§ 7805(e)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50§ 7805(e)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50, 51

49 U.S.C. § 45301(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 49, 50

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Page(s)Miscellaneous:

135 Cong. Rec. S13898 (Oct. 24, 1989) . . . . . . . . . . . . . . . . . . . . 72Asimow, Public Participation in the Adoption of

Temporary Tax Regulations, 44 Tax Law. 343(1990) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 53, 54

Congressional Statements on the IRS Son-of-BOSS Global Resolution Initiative (May 5, 2004) (available at www.irs.gov). . . . . . . . . . . . . . . . . . . . . . . . . 13

General Accounting Office, Abusive Tax Avoidance Transactions: IRS Needs Better Data to Inform Decisions about Transactions, GAO-11-493 (May 2011) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

H.R. Conf. Rep. No. 100-1104 (1988) . . . . . . . . . . . . . . . . . . . . . 51H.R. Rep. No. 98-861 (1984) . . . . . . . . . . . . . . . . . . . . . . 36, 57, 60H.R. Rep. No. 108-755 (2004) . . . . . . . . . . . . . . . . . . . . . . . . . . . 60Joint Committee on Taxation, Enron Report

(JCS-3-03) (2003) .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25Notice 2000-44, 2000-2 C.B. 255 . . . . . . . . . . . . . . . 5, 10, 15-18, 22Prop. Treas. Reg. § 301.6112-1:

49 Fed. Reg. 34246 (1984). . . . . . . . . . . . . . . . . . . . . . . 53, 55 65 Fed. Reg. 11271 (2000). . . . . . . . . . . . . . . . . . . . . . . . . . 55

65 Fed. Reg. 49955 (2000). . . . . . . . . . . . . . . . . . . . . . . 49, 55

Prop. Treas. Reg. § 301.6501(c)-1(g)(4), 74 Fed. Reg. 51527 (2009) . . . . . . . . . . . . . . . . . . . . . . . . . 37

Rev. Proc. 2005-26, 2005-1 C.B. 965 . . . . . . . . . . . . . . . . . . . . . . 37S. Rep. No. 97-494 (1982) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

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Page(s)

Miscellaneous (continued):

T.D. 8896, 65 Fed. Reg. 49909 (2000). . . . . . . . . . . . . . . 49, 55, 56T.D. 9046, 68 Fed. Reg. 10161 (2003). . . . . . . . . . . . . . . . . . . . . 49Treas. Reg. (26 C.F.R.):

§ 1.6662-2(c) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7, 8§ 1.6662-3(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15§ 1.6662-3(b)(2) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15§ 1.6662-4(d)(3)(i) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19§ 1.6662-4(d)(3)(iii) . . . . . . . . . . . . . . . . . . . . . . . . . . . . 19, 22§ 1.6662-4(g)(4) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 21§ 1.6662-5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 71§ 1.6662-5(d) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66, 68, 70§ 1.6662-5(g) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 66-68, 70§ 1.6664-4(b)(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23§ 1.6664-4(c)(1) . . . . . . . . . . . . . . . . . . . . . . 20, 21, 23, 25, 29§ 301.6111-1T . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 59§ 301.6112-1T . . . . . . . . . . . . . . . 33, 35, 40, 47, 49, 54-60, 62

U.S. Treas. Dep’t, Office of Tax Policy, Penalty and InterestProvisions of the Internal Revenue Code (1999) . . . . . . . . . 12

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GLOSSARY

APA Administrative Procedure Act

Bank Deutsche Bank

BPB BPB Investments, LC

FPAA Final partnership administrative adjustment

IRS Internal Revenue Service

LLC Limited liability company

OTSA Office of Tax Shelter Analysis

The Partnerships Bemont Investments, LLC (formerly known as BM Investments LLC) & BPB Investments, LC

TIN Taxpayer identification number

All “§” references are to the Internal Revenue Code (26 U.S.C.). 1

“R” refers to the paginated record. “Op/R” refers to the court’s opinions. “Ex.” refers to the exhibits. “Tr.” refers to the transcripts.

INTRODUCTION

This case concerns a basis-inflating tax shelter entered into by

taxpayer Andrew Beal in order to produce a $200 million tax loss that

was — as the Partnerships conceded at trial (3/25/10 Tr. 869) — wholly

artificial. The scheme (referred to as the Son-of-BOSS shelter)1

manipulates the partnership basis rules in order to create artificially

high basis in partnership interests and assets that can be used to

generate enormous, wholly artificial tax benefits. With the exception of

one district court decision (which was reversed on appeal), every court

that has considered the Son-of-BOSS scheme (including this Court) has

held that the fictional tax losses and other tax benefits generated by

the scheme are invalid. See Gov’t Br. 5-8. And the vast majority of the

courts that have considered the issue have concluded that accuracy-

related penalties apply to those invalid tax benefits. See, below, pp. 13-

14.

Consistent with this case law, the District Court determined that

the shelter’s tax benefits were properly disallowed by the IRS and that

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the negligence penalty was properly imposed. The court further

determined, however, in a case of first impression, that the IRS was

barred from assessing over $70 million in tax and penalties, because it

could not avail itself of § 6501(c)(10), a special limitations period

enacted specifically to extend the assessment period for listed-

transaction participants, particularly Son-of-BOSS shelter-purchasers

like Beal.

In our opening brief, we demonstrated that the District Court

erred in determining (i) that the statute of limitations precluded the

IRS from assessing taxes and penalties against Beal for one of the two

years at issue (2001), and (ii) that the accuracy-related penalty for

basis misstatements did not apply to Beal’s basis-inflating tax shelter.

In their cross-appeal, the Partnerships concede (by not challenging) the

District Court’s determination that Beal’s Son-of-BOSS scheme lacked

economic substance, and instead challenge only the court’s

determination that § 6662’s negligence penalty applied to Beal’s

attempt to claim a $200 million artificial loss from a transaction

lacking economic substance.

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ANSWERING BRIEF FOR THE UNITED STATES AS CROSS-APPELLEE

STATEMENT OF THE ISSUE

Whether the District Court correctly determined that the

negligence penalty applied to the $200 million artificial loss generated

by Beal’s Son-of-BOSS tax shelter.

STATEMENT OF THE FACTS

The facts set out below, pertinent to the Partnerships’ cross-

appeal, supplement the statement of the facts set forth in our opening

brief.

A. Introduction

In 2001, Beal (through the Partnerships) entered into a basis-

inflating Son-of-BOSS shelter, and claimed a $151 million artificial tax

loss in 2001, and a $46 million tax loss in 2002. See Gov’t Br. 8-11. The

artificial losses were generated by engaging in offsetting long and short

foreign-currency swaps whereby the long swaps would be recognized for

purposes of increasing basis, but the short swaps would be disregarded

for purposes of decreasing basis. By disregarding the offsetting short

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swaps, Beal’s shelter “attempt[ed] to transform [a] wash transaction

(for economic purposes) into a windfall (for tax purposes)” reminiscent

“of an alchemist’s attempt to transmute lead into gold.” Kornman &

Assocs., Inc. v. United States, 527 F.3d 443, 456 (5th Cir. 2008).

Neither Beal nor the Partnerships disclosed the tax scheme on

their federal income tax returns, although they were required by law to

do so. See Gov’t Br. 11-13. When the IRS audited Beal’s 2002 tax

return and inquired about the $46 million loss reported for that year,

Beal’s tax representative, Beth Montgomery, informed the auditor

about the long swaps but “deliberately withheld” information relating

to the offsetting short swaps. (Op/R5978-5979,5994.) Relying on her

representations, the auditor did not adjust Beal’s 2002 tax return

concerning the swaps transaction, and was not prompted by the audit

of that return to audit Beal’s 2001 return before the general three-year

assessment period for the 2001 return expired. (Id.)

Although Beal and his representatives took steps to ensure that

the IRS would not uncover his Son-of-BOSS shelter, they knew that if

the IRS were to discover his tax scheme, Beal could be subject to

certain accuracy-related penalties. (Ex. P-2010 at BPB153-161.) A

-5-

year before Beal engaged in the Son-of-BOSS shelter, the IRS classified

the scheme as an abusive tax shelter, and warned taxpayers that the

IRS would impose penalties on both users and promoters of the shelter.

Notice 2000-44, 2000-2 C.B. 255 (“Tax Avoidance Using Artificially

High Basis”). Aware that Notice 2000-44 might apply to his Son-of-

BOSS transaction, and that penalties would be imposed, Beal sought a

tax opinion from Matt Coscia. (Op/R5989.) Coscia had previously

worked with Tom Montgomery, Beal’s tax accountant, who

implemented the Son-of-BOSS shelter for him. (Op/R5988.)

B. Coscia’s tax opinion

Coscia provided Beal a tax opinion that concluded that the

artificial losses generated by the Son-of-BOSS shelter were proper

under (among other applicable tax doctrines and provisions) the

economic-substance doctrine. (Ex. P-2013.) As Coscia informed Beal, a

transaction will be disregarded for tax purposes under the economic-

substance doctrine if it lacks a business purpose or reasonable

expectation of profit. (Id. at 83-96.) Coscia’s opinion concluded that the

swaps transaction had economic substance based on Beal’s factual

representations that he (i) had a “non-tax business reason” for engaging

-6-

in the swaps, and (ii) “believed that there was a reasonable opportunity

to earn a reasonable profit, in excess of all fees and transaction costs,

from the [swaps] Transactions, without regard to tax benefits.” (Id. at

17.) Coscia warned Beal that the tax advice was premised on the

accuracy of those factual representations. (Id. at 96.)

C. District Court’s opinion

The District Court determined (among other things) that the

swaps transaction lacked economic substance. (Op/R5981-5984.) In so

ruling, the court rejected the Partnerships’ argument that Beal’s

Son-of-BOSS shelter had economic substance based on Beal and

Montgomery’s investment in, and potential take-over of, the Australian

company Solution 6. The court found that “the proposed tender offer in

this case was just a smokescreen for tax avoidance,” and that the

offsetting foreign-currency swaps “provided no economic benefit to the

purported tender offer.” (Op/R5981.) The court further found (i) that

before purchasing the swaps, BPB had made the determination not to

actively pursue Solution 6, (ii) that a takeover would not require

Australian currency, and (iii) that even if BPB were actively pursuing

Solution 6, and needed Australian currency to do so, using the

-7-

Because there is no “stacking” of accuracy-related penalties, the2

maximum penalty that can apply under § 6662 is 40 percent (20percent in the absence of a gross valuation misstatement). Treas. Reg.

(continued...)

offsetting swaps would have provided only a “marginal benefit” with

regard to Beal’s purported concern about currency risk, a concern that

the court found could have been addressed by means that “made more

economic sense” than the offsetting swaps. (Op/R5981-5983.) As the

court explained, Beal, through the Partnerships, paid $2.5 million to

obtain $600,000 of currency protection (Op/R5976), and was willing to

overpay for the swaps in order to obtain “extraordinary high and

artificial tax losses” (Op/R5983-5984).

The District Court next addressed whether accuracy-related

penalties were applicable to the $200 million artificial loss generated by

Beal’s Son-of-BOSS shelter. The IRS had determined that certain

accuracy-related penalties should be imposed on any resulting tax

underpayment by Beal, including § 6662’s mandatory 40-percent

penalty for underpayments of tax attributable to gross misstatements

of value or basis, the 20-percent penalty for negligence, and the 20-

percent penalty for substantial understatement of tax. (Op/R5979;2

-8-

(...continued)2

§ 1.6662-2(c).

Exs. P-2129 & P-2130.) In a prior summary-judgment ruling, the court

had held that the valuation-misstatement penalty was inapplicable.

(Op/R5441-5446.) The court concluded that the negligence penalty

applied, and did not therefore address whether the alternative 20-

percent substantial-understatement penalty applied. (Op/R5988-5993.)

In concluding that the negligence penalty applied, the District

Court rejected the Partnerships’ argument that penalties were

inapplicable because they reasonably relied on Coscia’s tax opinion.

The court found that the Partnerships could not reasonably rely on

Coscia’s opinion because Coscia “was not truly an independent advisor”

(Op/R5989), but merely “said what he was paid to say” (Op/R5992). As

the court emphasized, “neither Montgomery nor Coscia were credible in

their testimony as to the real purpose behind the foreign currency

swaps.” (Op/R5989.)

-9-

SUMMARY OF ARGUMENT

This case involves an attempt by taxpayer Andrew Beal to

generate wholly artificial tax losses to shelter from tax $200 million of

taxable income. The District Court thwarted this attempt by holding

(among other things) that this transaction designed to effectuate a raid

on the public fisc failed under the economic-substance doctrine. The

court further held that § 6662’s 20-percent penalty for negligence

applied to any resulting underpayment of tax and that the

Partnerships (through which Beal implemented his tax-avoidance

scheme) did not reasonably and in good faith rely on their tax advisor’s

(Coscia) opinion that the tax shelter was legitimate. In so ruling, the

court joins the vast majority of courts that have concluded that

accuracy-related penalties are applicable to the abusive Son-of-BOSS

tax shelter. On appeal, the Partnerships concede (by not challenging)

the court’s determination that the shelter lacked economic substance,

and appeal only the court’s penalty determination.

The District Court correctly determined that the negligence

penalty applied to the $200 million basis misstatement that is at the

heart of Beal’s scheme. Beal chose to engage in a Son-of-BOSS shelter

-10-

even after being warned by the IRS that the shelter produced unlawful

tax benefits and that taxpayers who claimed such benefits would be

penalized. See Notice 2000-44, 2000-2 C.B. 255. Moreover, he and the

Partnerships should have known that engaging in a transaction that

cost $2.5 million and produced a $200 million loss was simply too good

to be true. The Partnerships’ purported reliance on Coscia’s legal

opinion was unreasonable, because (i) Coscia’s testimony regarding

Beal’s purpose for engaging in the shelter was not credible, and (ii) his

opinion was based on the false assumption that the transaction was

entered into for a legitimate business purpose. Finally, the fact that

Beal and his Partnerships intentionally failed to disclose their

transaction to the IRS, and deliberately withheld information about the

shelter from the IRS during the audit, demonstrates that they were not

acting in good faith.

-11-

ARGUMENT

The District Court correctly determined that thenegligence penalty applied to the $200 millionartificial loss generated by Beal’s Son-of-BOSS shelter

Standard of Review

The District Court’s “determination of negligence for an

accuracy-related penalty” is reviewed for “clear error.” Ogden v.

Commissioner, 244 F.3d 970, 971 (5th Cir. 2001). “Whether the

elements that constitute ‘reasonable cause’ are present in a given

situation is a question of fact, but what elements must be present to

constitute ‘reasonable cause’ is a question of law.” United States v.

Boyle, 469 U.S. 241, 249 n.8 (1985) (emphasis omitted).

A. Introduction

Section 6662 imposes a penalty equal to 20 percent of the portion

of any underpayment of tax that is attributable to one or more of the

following: (i) negligence or disregard of rules or regulations; (ii) any

substantial understatement of income tax; and (iii) any substantial

valuation misstatement under chapter 1 (income tax). The

valuation-misstatement penalty is increased to 40 percent in the case of

a gross valuation misstatement. § 6662(h)(1).

-12-

Although accuracy-related penalties are inapplicable if the

taxpayer proves that there was reasonable cause for his underpayment

and that he acted in good faith, § 6664(c), penalties play a critical role

in our system of “self-assessed” taxes. They are designed to deter

taxpayers from playing the “audit lottery” by providing a “downside

risk [to] taking highly questionable positions on their tax returns.” S.

Rep. No. 97-494, at 272-73 (1982). Further, these penalties assure the

taxpaying public that all taxpayers are expected to meet their tax

obligations, and that those — like Beal — who do not will pay a price.

See U.S. Treas. Dep’t, Office of Tax Policy, Penalty and Interest

Provisions of the Internal Revenue Code 36 (1999). Thus, Congress

envisioned that relief from penalties would be the “exception” to the

rule of mandatory accuracy-related penalties, § 6664(c), and taxpayers

bear a “‘heavy burden’” of proving that they fit within the exception,

Richardson v. Commissioner, 125 F.3d 551, 558 (7th Cir. 1997) (citation

omitted).

Both Congress and the courts have concluded that taxpayers who

have purchased the Son-of-BOSS shelter should be penalized. As the

Senate Permanent Subcommittee on Investigations explained, such

-13-

taxpayers should “pay Uncle Sam the amount of taxes they owe with

interest and penalties” and thereby send “a clear message that those

who use abusive tax shelters will be held accountable.” Congressional

Statements on the IRS Son-of-BOSS Global Resolution Initiative (May

5, 2004) (available at www.irs.gov). Similarly, the vast majority of the

courts that have addressed the issue have concluded that accuracy-

related penalties apply to the abusive Son-of-BOSS tax scheme. See,

e.g., Stobie Creek Invs. LLC v. United States, 608 F.3d 1366, 1383 (Fed.

Cir. 2010) (affirming determination that penalties applied to Son-of-

BOSS shelter); New Phoenix Sunrise Corp. v. Commissioner, 408 Fed.

Appx. 908, 917-918 (6th Cir. 2010) (same); Cemco Investors, LLC v.

United States, 515 F.3d 749 (7th Cir. 2008) (same); Murfam Farms,

LLC v. United States, 94 Fed. Cl. 235, 245-252 (2010) (applying

penalties to Son-of-BOSS shelter); Palm Canyon X Invs., LLC v.

Commissioner, 98 T.C.M. (CCH) 574, 593-598 (2009) (same); 106 Ltd. v.

Commissioner, 136 T.C. 67, 77-81 (2011) (same); Fidelity Int’l Currency

Advisor A Fund, LLC v. United States, 747 F. Supp. 2d 49, 246 (D.

Mass. 2010), appeal pending, No. 10-2421 (1st Cir.) (same); Maguire

Partners-Master Invs., LLC v. United States, No. 06-7371, 2009 WL

-14-

The 40-percent penalty for basis misstatements is also3

applicable, as demonstrated in our opening brief (pp. 63-72) and below(pp. 66-72).

In partnership proceedings, courts have jurisdiction to review4

both the claimed tax treatment of a partnership item, and theapplicability of any penalty which relates to an adjustment to apartnership item. § 6226(f). When (as here) the partnership itself isasserting reasonable cause for its return position, courts may

(continued...)

4907033, at *20-21 (C.D. Cal. Dec. 11, 2009) (same), appeal pending,

No. 09-55650 (9th Cir.); but see Klamath Strategic Inv. Fund v. United

States, 568 F.3d 537, 548 (5th Cir. 2009) (affirming on jurisdictional,

but not substantive, grounds determination that penalties did not apply

to Son-of-BOSS shelter); Am. Boat Co. v. United States, 583 F.3d 471,

483-486 (7th Cir. 2009) (affirming under clearly erroneous standard of

review determination that penalties did not apply to Son-of-BOSS

shelter, “[e]ven though we might have reached a different conclusion”).

As demonstrated below, the District Court correctly determined

that the 20-percent negligence penalty applied to Beal’s basis-inflating

Son-of-BOSS shelter. The court further correctly determined that the3

there was no reasonable cause for claiming the shelter’s astronomical,

and wholly artificial, tax benefits. 4

-15-

(...continued)4

adjudicate such defense in a partnership-level proceeding and look tothe conduct of the partnership’s managing partners in evaluating thereasonableness of the partnership’s reporting position. Klamath, 568F.3d at 548. The Partnerships’ reasonable-cause defense is based onthe conduct of Montgomery and Beal. (Op/R5991.)

B. The District Court correctly found that thePartnerships were negligent in claiming the $200million artificial loss generated by Beal’s Son-of-BOSSshelter

An underpayment of tax is due to “negligence” if the taxpayer

fails to make a reasonable attempt to comply with the tax laws or

carelessly disregards IRS “rules or regulations.” § 6662(c). “Rules or

regulations” include IRS Notices, such as Notice 2000-44. Treas. Reg.

§ 1.6662-3(b)(2). Negligence is strongly indicated where the taxpayer

claims a deduction that would seem to a reasonable and prudent person

to be “too good to be true” under the circumstances. Treas. Reg.

§ 1.6662-3(b)(1). Return positions that have a reasonable basis,

however, are not attributable to negligence. Id.

The District Court correctly found that the negligence penalty

applied to any underpayment in Beal’s tax resulting from his Son-of-

BOSS shelter. As he acknowledged at trial, Beal attempted to leverage

-16-

an out-of-pocket cost of approximately $2.5 million into a tax-sheltering

loss of $200 million. (3/24/10 Tr. 577, 620.) A reasonable person would

understand that the tax results Beal sought were plainly “too good to

be true.” See, e.g., Stobie Creek, 608 F.3d at 1383 (experienced

businessman should have known that Son-of-BOSS shelter was “too

good to be true”); Maguire Partners, 2009 WL 4907033, at *21

(negligence penalty applied to Son-of-BOSS transaction that increased

basis to “$101,500,000” based on “actual economic outlay of $1.5

million” and was, therefore, “‘too good to be true’”); cf. Arthur Andersen

v. Carlisle, 129 S. Ct. 1896, 1899 (2009) (describing “illusory losses”

generated by Son-of-BOSS shelter as “too good to be true”).

Further, Beal had no reasonable basis — let alone “substantial

authority” as the Partnerships contend (Br. 69) — for claiming artificial

tax losses from a transaction that plainly lacked economic substance.

To the contrary, in 2000, before Beal entered into his Son-of-BOSS

shelter in 2001, the IRS issued Notice 2000-44, which put him on notice

that the purported tax benefits generated by the Son-of-Boss shelter

would be disallowed and that penalties would be imposed. Notice

2000-44, 2000-2 C.B. 255. See Maguire Partners, 2009 WL 4907033, at

-17-

*21 (taxpayer was negligent where shelter entered into “after the IRS

issued IRS Notice 2000-44”); Nevada Partners Fund, LLC v. United

States, 714 F. Supp. 2d 598, 639 (S.D. Miss. 2010) (same), appeal

pending, No. 10-60559 (5th Cir.). The District Court determined — and

the Partnerships have not challenged on appeal (Br. 61) — (i) that

Beal’s Son-of-BOSS shelter was substantially similar to the scheme

outlined in Notice 2000-44 (Op/R5986-5988,5997-5998), and (ii) that the

Partnerships were aware of Notice 2000-44 before they engaged in the

Son-of-BOSS transactions (Op/R5975,5989; 3/22/10 Tr. 171-172).

Indeed, the Coscia opinion upon which the Partnerships seek to rely for

penalty protection quotes the Notice at length, including its warning

that the losses at issue in the Notice — like the losses claimed by Beal

— do not reflect “actual economic consequences” but were instead

wholly artificial. (Ex. P-2013 at 106.) Although Coscia concluded that

Notice 2000-44 did not apply to Beal’s Son-of-BOSS shelter (as the

Partnerships note (Br. 61)), Beal could not reasonably rely on that

conclusion because it was premised on the representation that the

swaps “were motivated by non-tax reasons” (id. at 111; 3/23/10 Tr. 392-

393), a representation that Beal knew or should have known to be false.

-18-

Similarly, if (as we contend) the 40-percent valuation-5

misstatement penalty applies, then none of the 20-percent penaltiescan be assessed.

See Op/R5989 (“The Court finds that neither Montgomery nor Coscia

were credible in their testimony as to the real purpose behind the

foreign currency swaps.”). Having engaged in the shelter even after

Notice 2000-44 was issued, Beal cannot now complain that he thought

that the wholly artificial $200 million loss would be respected by the

Commissioner and the courts. He took a gamble that his scheme would

not be uncovered, lost, and must now face the consequences.

C. The alternative penalty for substantialunderstatements of tax also applies

As noted above, the accuracy-related penalties are not cumulative

and, therefore, having determined that the 20-percent negligence

penalty applied, the District Court was not required (as the

Partnerships suggest (Br. 62)) to address whether the alternative 20-

percent substantial-understatement penalty also applied. If the

negligence penalty applies, then the substantial-understatement

penalty cannot also be assessed. As demonstrated below, that penalty5

(like the negligence and valuation-misstatement penalties) properly

-19-

In Streber v. Commissioner, 138 F.3d 216, 223 (5th Cir. 1998),6

this Court stated that “substantial authority” included “factual”authority. That statement need not, and should not, be followed by thisCourt because it (i) conflicts with Treasury Regulation § 1.6662-4(d)(3)(iii), and (ii) was “dicta,” Streber, 138 F.3d at 229 (dissentingopinion).

applies to Beal’s Son-of-BOSS shelter, and the Partnerships’ arguments

to the contrary lack merit.

In the case of noncorporate taxpayers, an understatement of tax

is substantial if it exceeds the greater of (i) 10 percent of the tax

required to be shown on the return, or (ii) $5,000. § 6662(d)(1)(A). For

these purposes, the amount of an understatement is reduced by the

portion thereof that is attributable to (i) the tax treatment of any item

if there is substantial authority for such treatment; or (ii) any item that

is adequately disclosed, if taxpayer has a reasonable basis for the item’s

tax treatment. § 6662(d)(2)(B). There is substantial authority for an

item’s tax treatment only if the weight of the authorities supporting the

treatment is substantial in relation to the weight of authorities

supporting contrary treatment. Treas. Reg. § 1.6662-4(d)(3)(i).

“Authority” is limited to certain specified legal authorities. Treas. Reg.6

§ 1.6662-4(d)(3)(iii).

-20-

In the case of any item of a noncorporate taxpayer that is

attributable to a tax shelter, the “adequate disclosure” alternative to

substantial-authority relief is not available, and substantial-authority

relief is not available unless the taxpayer reasonably believed that its

tax treatment of such item was more likely than not the proper

treatment. § 6662(d)(2)(C)(i). For these purposes, the term “tax

shelter” includes any partnership, plan, or arrangement, a “significant

purpose” of which is the avoidance of Federal income tax.

§ 6662(d)(2)(C)(iii). Since the District Court determined that the

“structuring of the various entities was only done to accomplish tax

objectives for a sheltered writeoff” (Op/R5981), and that the “main”

purpose for the swaps was “to merely generate tax losses” (Op/R5982),

the tax-shelter rule applies.

For purposes of the tax-shelter rule, a taxpayer’s “more likely

than not” belief will be considered reasonable if the taxpayer

reasonably relies on a legal opinion that (i) concludes that there is a

greater than 50-percent likelihood that the item’s tax treatment will be

upheld if challenged by the IRS, and (ii) satisfies the minimum

requirements of Treasury Regulation § 1.6664-4(c)(1) (relating to

-21-

§ 6664’s reasonable-cause exception). Treas. Reg. § 1.6662-4(g)(4). As

demonstrated in the following section, the Coscia opinion upon which

the Partnerships rely does not satisfy Treasury Regulation § 1.6664-

4(c)(1)’s minimum requirements because it was based on unreasonable

factual assumptions. Therefore, the Partnerships cannot satisfy the

tax-shelter rule, and the substantial-understatement penalty properly

applies here.

Ignoring the applicable tax-shelter rule, the Partnerships contend

(Br. 62-68) that the substantial-understatement penalty should not

apply because (in their view) they had substantial authority for the

technical position underlying all Son-of-BOSS shelters, i.e., that the

obligations under an option (or similar obligations) contract are not

treated as liabilities for purposes of § 752. This myopic, wooden

approach to the substantial-authority inquiry in the context of

offsetting-obligations shelters — an approach that disregards the

bedrock principle that transactions devoid of economic substance are to

be disregarded for federal tax purposes — has been rejected by

numerous courts. See New Phoenix Sunrise Corp. v. Commissioner, 132

T.C. 161, 190 (2009), aff’d, 408 Fed. Appx. 908 (6th Cir. 2010); Stobie

-22-

Creek Invs., LLC v. United States, 82 Fed. Cl. 636, 706-707 & n.65

(2008), aff’d, 608 F.3d 1366 (Fed. Cir. 2010); Palm Canyon, 98 T.C.M.

(CCH) at 597.

As the foregoing cases recognize, beginning in August 2000, there

was direct authority — in the form of Notice 2000-44 — contrary to the

claimed tax treatment of the offsetting-obligations shelter. See Treas.

Reg. § 1.6662-4(d)(3)(iii) (IRS notices constitute “authority” for these

purposes). Given the lack of any other authority at the time (pro or

con) directly addressing this shelter, it follows that the claimed tax

treatment of Beal’s offsetting-swaps transaction could not have

satisfied the substantial-authority standard.

-23-

D. The District Court correctly rejected thePartnerships’ reasonable-cause defense to penalties

The determination whether a taxpayer acted with reasonable

cause and good faith is made on a case-by-case basis, taking into

account all pertinent facts and circumstances. Treas. Reg.

§ 1.6664-4(b)(1). Taxpayers bear “the burden of proof on a reasonable

cause defense.” Klamath, 568 F.3d at 548. Reliance on the advice of a

professional tax advisor does not necessarily satisfy that burden. Id.

For purposes of determining whether such reliance was reasonable, the

taxpayer’s education, sophistication, and business experience must be

taken into account. Treas. Reg. § 1.6664-4(c)(1). In this regard, the

Partnerships were managed by Beal and Montgomery, both highly

sophisticated businessmen. (Op/R5966,5991.)

Although advice from a tax professional can (in certain instances)

provide a taxpayer reasonable cause, that advisor must be independent

and cannot be part of a tax-avoidance scheme. See Stanford v.

Commissioner, 152 F.3d 450, 461 (5th Cir. 1998) (upholding

reasonable-cause defense where advisor was “‘independent’” and there

was no evidence that advice “had as a purpose the facilitation of tax

-24-

avoidance”) (citation omitted); cf. Neonatology Assocs. v. Commissioner,

299 F.3d 221, 234 (3d Cir. 2002) (rejecting defense where advice was

not from “independent tax professional”). The District Court here

correctly determined that Coscia did not provide independent, objective

advice regarding Beal’s Son-of-BOSS shelter based on the court’s

findings that (i) Montgomery and Coscia had a close association,

(ii) neither Montgomery nor Coscia were “credible” in their testimony

regarding the “real purpose behind the foreign currency swaps,” and

(iii) instead of analyzing the real purpose behind the swaps, Coscia

instead simply “gave Montgomery [what] he wanted — an opinion that

passed on the investment strategy.” (Op/R5989.) The Partnerships

have failed to demonstrate that those findings are clearly erroneous.

Although the Partnerships contend that the court should not have

doubted Coscia’s objectivity (Br. 71), they ignore the undisputed fact

that the court did so only after finding that Coscia was not credible

regarding a critical factual issue regarding the shelter.

Moreover, even if the tax advice was from an independent,

disinterested advisor (which it was not), it could not, as a matter of law,

establish reasonable cause because the Partnerships have failed to

-25-

demonstrate that the Coscia opinion satisfies the threshold regulatory

requirements. See Ex. P-2010 at BPB161 (Coscia warns Beal that “a

tax opinion based on unreasonable facts, assumptions or

representations will be disqualified, even if it is rendered by an

otherwise independent tax advisor”). To qualify for reasonable cause,

legal advice (i) must be based on all of the pertinent facts, and (ii) must

not be based on “unreasonable factual” assumptions, including an

assumption “the taxpayer knows, or has reason to know, is unlikely to

be true.” Treas. Reg. § 1.6664-4(c)(1). As relevant here, the Regulation

emphasizes that the advice must not be based on an “inaccurate

representation or assumption as to the taxpayer’s purposes for entering

into a transaction or for structuring the transaction in a particular

manner” so as to generate the tax benefits at issue. Id. This

requirement is particularly key in the tax-shelter context, where

attorneys often provide their clients favorable tax opinions by simply

assuming they had a legitimate business purpose for entering a

particular transaction or structuring it in a particular manner. See

Joint Committee on Taxation, Enron Report (JCS-3-03) 22-25, 172-180,

C326-370 (2003) (criticizing King & Spalding’s facilitation of Enron’s

-26-

tax shelters by issuing tax opinions that assumed the shelter’s

structure had a “business purpose”).

If the tax advice fails to satisfy these minimum threshold

requirements, then the taxpayer cannot — as a matter of law — rely on

that advice to support a reasonable-cause defense, as Coscia expressly

warned Beal (Ex. P-2010 at BPB155). For example, in Long-Term

Capital, the district court held — and the Second Circuit affirmed —

that a partnership lacked reasonable cause for its shelter where the tax

opinion contained factual assertions regarding the transaction’s

structure that the taxpayer should have known were false. Long-Term

Capital Holdings v. United States, 330 F. Supp. 2d 122, 206, 209 (D.

Conn. 2004), aff’d by summary order, 150 Fed. Appx. 40 (2d Cir. 2005).

Other courts have similarly refused to allow shelter-purchasing

taxpayers to escape penalties by relying on tax opinions that were

premised on the assumption that the shelter at issue was entered into

for business purposes and therefore had economic substance. See

Fidelity, 747 F. Supp. 2d at 214-219 (no reasonable reliance on Son-of-

BOSS opinion letter containing false factual representations regarding

taxpayer’ purported business purpose for, and reasonable expectation of

-27-

profit from, options); Stobie Creek, 82 Fed. Cl. at 720-721 (same); 106

Ltd., 136 T.C. at 78-79 (same); Santa Monica Pictures, LLC v.

Commissioner, 89 T.C.M. (CCH) 1157, 1233 (2005) (same, regarding

basis-shifting shelter).

Applying that Regulation to the unchallenged District Court

findings further demonstrates that the court correctly rejected the

Partnerships’ reasonable-cause defense. The Coscia opinion was

expressly based on Beal’s factual representation that he had a “non-tax

business reason” for engaging in the swaps. (Ex. P-2013 at 17, 91, 96.)

That representation was false, as the District Court found. (Op/R5984

(“the real purpose of the swaps was tax avoidance”).) Moreover, the

Partnerships should have known it was false, as the court’s findings

demonstrate. See Op/R5989 (“The Court finds that neither

Montgomery nor Coscia were credible in their testimony as to the real

purpose behind the foreign currency swaps.”). The Partnerships have

not challenged the court’s findings, which are fully supported by the

record. Testifying about his purpose for structuring the transaction as

he did, Beal could not explain any business purpose for engaging in

both long and offsetting short swaps (i.e., the critical step that

-28-

purportedly turned an economic-wash into a $200 million loss for tax

purposes). (3/24/10 Tr. 554-556.) He acknowledged, however, that he

knew before entering into the offsetting swaps that doing so would

provide him “tax benefits.” (3/24/10 Tr. 577.)

The Coscia opinion was also expressly based on Beal’s factual

representation that he had conducted an “independent evaluation” of

the swaps and “believed that there was a reasonable opportunity to

earn a reasonable profit, in excess of all fees and transaction costs, from

the [swaps] Transactions, without regard to tax benefits.” (Ex. P-2013

at 17, 96.) That representation was false, as the District Court found.

(Op/R5984 (“There was no reasonable expectation of profit from the

transaction.”).) Moreover, the Partnerships should have known it was

false, as the court’s findings demonstrate. See Op/R5983-5984 (finding

that the swaps were “overpriced” and that there was “no attempt” to

“independently verify the pricing of the swaps”); Op/R5976 (“Beal could

have gotten the same protection on the currency swaps by investing

$600,000 [instead of $2.5 million] if the ‘sweet spot’ were disregarded.”).

Again, the Partnerships have not challenged those findings, which are

fully supported by the record. Experts for both parties testified that,

-29-

ignoring a hypothetical outcome (referred to as the “sweet spot”) that

all parties agreed was “next to impossible” (Op/R5973,5976; e.g.,

3/22/10 Tr. 190-191; 3/24/10 Tr. 586, 709-715), Beal obtained $600,000

worth of currency protection for $2.5 million. (Op/R5975-5976; 3/23/10

Tr. 280-281, 287; 3/24/10 Tr. 694; 3/25/10 Tr. 803-808.) In light of the

vast discrepancy between the economic benefit and the cost, the

transaction could not — as Coscia falsely assumed in his opinion letter

— be expected to return a profit.

Like the Son-of-BOSS opinion letters in 106 Ltd., Fidelity, and

Stobie Creek, the Son-of-BOSS opinion letter here contains false factual

representations and therefore cannot — as a matter of law — support a

reasonable-cause defense. Treas. Reg. § 1.6664-4(c)(1).

Given that Coscia’s opinion was expressly premised on false

factual representations, the Partnerships’ complaint (Br. 24, 62, 70)

that the District Court did not discuss the quality of Coscia’s legal

analysis rings hollow. The quality of the legal analysis is only as good

as the underlying facts upon which the analysis is based. See Stobie

Creek, 82 Fed. Cl. at 706. Similarly misplaced is the Partnerships’

reliance (Br. 70) on “expert testimony” regarding the quality of Coscia’s

-30-

opinion. An expert’s evaluation is irrelevant where — as here — the

opinion is based on facts that were “false.” Stobie Creek, 608 F.3d at

1384. As the expert acknowledged, he assumed the “facts” recited in

Coscia’s opinion to be “true,” and his expert testimony regarding the

quality of Coscia’s legal opinion was premised on the accuracy of the

factual representations. (3/23/10 Tr. 464-466.)

Unable to defend the substance of Coscia’s opinion, the

Partnerships contend (Br. 73) that the District Court penalized their

failure to waive their attorney-client privilege for a separate tax

opinion prepared by the law firm of De Castro West. That claim is

baseless. Far from assuming “that the privileged opinion was

incriminating” (Br. 73), the court simply noted that, if the Partnerships

had been able to obtain an opinion from an independent law firm, and

the law firm’s “opinion backed the partnerships’ position and been

introduced at trial, the Court would [have been] inclined” to find that

the Partnerships had reasonable cause. (Op/R5992.)

Finally, even if the Partnerships had reasonable cause for

claiming the $200 million artificial loss (which, as the District Court

correctly found, they did not), they have failed to demonstrate that they

-31-

The Partnerships have not challenged the District Court’s7

finding that Beth Montgomery deliberately withheld criticalinformation regarding Beal’s tax shelter. That she provided the IRS adocument containing the reference numbers for all of the swaps (Ex. P-2109 at IRS0549) does not mean (as the Partnerships suggest (Br. 13))that she informed the IRS about the short swaps. As the court noted

(continued...)

acted in “good faith,” as § 6664(c) requires. See § 6664(c) (no accuracy-

related penalty shall be imposed with respect to any portion of an

underpayment “if it is shown that there was reasonable cause for such

portion and that the taxpayer acted in good faith with respect to such

portion”) (emphasis added). The Partnerships (acting for Beal) did not

act in good faith because they entered into the Son-of-BOSS scheme

even after they were expressly warned against doing so by the IRS in

Notice 2000-44. See Maguire Partners, 2009 WL 4907033, at *21 (no

reasonable-cause defense where transaction was entered into “after the

IRS issued IRS Notice 2000-44”). Moreover, Beal and the Partnerships

admittedly failed to disclose their transaction on their federal income

tax returns, as they were required by law to do. See Gov’t Br. 37-38.

Finally, during the audit of Beal’s 2002 tax return, his tax

representative “deliberately withheld” information that would have

revealed the shelter’s existence. (Op/R5979.) Such steps taken to7

-32-

(...continued)7

during the trial, the document did not “identify anything, it’s just abunch of numbers.” (3/23/10 Tr. 509-510.)

“evade IRS detection” demonstrate a “lack of good faith” that precludes

§ 6664(c)’s reasonable-cause defense. Long-Term Capital, 330 F. Supp.

2d at 211-212; accord Fidelity, 747 F. Supp. 2d at 243.

REPLY BRIEF FOR THE UNITED STATES AS APPELLANT

I. The Partnerships have failed to demonstrate that taxpayerAndrew Beal’s Son-of-BOSS tax shelter had beenadequately disclosed to the IRS in May 2005 so as totrigger the running of § 6501(c)(10)’s limitations period

In our opening brief, we addressed the District Court’s

determination that Beal could avoid liability for over $70 million in tax

and penalties for his 2001 tax year, because (in the court’s view)

Deutsche Bank had “substantially complied” with § 6112’s

requirements by producing to the IRS, in May 2005, over one million

pages of unsearchable documents that contained — in two e-mail

attachments — a reference to the Partnerships, even though those

documents did not identify taxpayer Beal. (Op/R5994,5998-6002.) We

-33-

demonstrated that the court’s statute-of-limitations ruling was wrong

as a matter of law because it (i) is contrary to § 6501(c)(10)(B), § 6112,

and Treasury Regulation § 301.6112-1T, (ii) undermines Congress’s

purpose for enacting § 6501(c)(10)’s limitations extension for listed

transactions and § 6112’s list-maintenance requirement, and

(iii) disregards the judiciary’s duty to strictly construe limitations

provisions in favor of the Government in tax cases.

In making those arguments, we emphasized the following

undisputed facts. First, the documents that the District Court deemed

to be a § 6112 tax-shelter-investor list (P-108A and P-117A) were

attachments to internal Deutsche Bank e-mails, neither of which

indicated that they included a tax-shelter-investor list. P-108A is a

one-page attachment to an internal Deutsche Bank e-mail concerning

the allocation of September 2001 commissions between the Bank’s

Chicago and Dallas offices. (7/26/10 Hearing, Gov. Exs. 1A & 1B; a

copy of the e-mail is contained in the Government’s Record Excerpts,

Tab 10.) And P-117A is a 15-page attachment to an internal Deutsche

Bank e-mail directing a Deutsche Bank employee to “sell the [Canadian

currency] for the account at the bottom of the list.” (7/26/10 Hearing,

-34-

Gov. Exs. 2A & 2B; a copy of the e-mail is contained in the

Government’s Record Excerpts, Tab 11.) Second, Deutsche Bank never

claimed that P-108A and P-117A satisfied its obligations under § 6112,

or that it had provided the IRS a § 6112 list regarding Beal’s

participation in a Son-of-BOSS transaction in 2005. To the contrary,

Deutsche Bank produced P-108A and P-117A during discovery in this

case with the specific understanding that the two documents were not

“lists pursuant to 6112,” as Beal’s counsel noted to the District Court

(7/26/10 Tr. 26). Further, in response to a query as to when Deutsche

Bank provided such a list to the IRS that identified Beal and the

Partnerships, counsel for Deutsche Bank informed counsel for the

Government that Beal’s and the Partnerships’ names were provided in

2007. (7/26/10 Hearing, Gov. Ex. 4, Jacobus Decl. Ex. A.) In this

regard, the Partnerships have failed to explain — and no explanation is

apparent — as to why the IRS should have recognized that it had been

provided a § 6112 list in 2005 when the material advisor itself denied

that it had done so.

Ignoring these undisputed facts — which standing alone

demonstrate that the District Court erred in concluding that the special

-35-

limitations period set out in § 6501(c)(10) had been triggered by

Deutsche Bank’s production in May 2005 of the two e-mail attachments

— the Partnerships nevertheless contend that the two e-mail

attachments (i) satisfied § 6501(c)(10)’s and § 6112’s requirements (Br.

31-32, 44); (ii) did not need to satisfy Treasury Regulation § 301.6112-

1T because (in the Partnerships’ view, asserted for the first time on

appeal) the Regulation violates the Administrative Procedure Act’s

(APA) notice-and-comment requirements (Br. 32); (iii) substantially

complied with Treasury Regulation § 301.6112-1T (Br. 34-41); and

(iv) should, in any event, be deemed sufficient to trigger § 6501(c)(10)’s

special limitations period as a sanction against the Government (Br.

47-56). As explained below, each of those contentions lacks merit.

A. The two e-mail attachments that Deutsche Bankproduced to the IRS in May 2005 satisfy neither theplain language nor the intent of § 6501(c)(10)(B) and§ 6112

1. Taxpayer Andrew Beal was not identified

By its terms, § 6501(c)(10)(B) does not apply to trigger the

running of the statute of limitations on an undisclosed listed

transaction until “a material advisor meets the requirements of section

6112 with respect to a request by the Secretary under section 6112(b)

-36-

relating to such transaction with respect to such taxpayer.”

§ 6501(c)(10)(B). Section 6112, in turn, required any person who

organizes, or sells an interest in, any potentially abusive tax shelter to

“maintain (in such manner as the Secretary may by regulations

prescribe) a list identifying each person who was sold an interest in

such shelter and containing such other information as the Secretary

may by regulations require.” To identify a person within the meaning

of § 6112, the “list will include the name, address, and taxpayer

identification number of the purchaser, as well as any other information

that the Secretary may, by regulations, require.” H.R. Rep. No. 98-861,

at 982 (1984) (emphasis added). Therefore, even if the Secretary did

not, by regulation, require any other information, § 6112 could not be

satisfied for purposes of triggering Beal’s limitations period under

§ 6501(c)(10) unless the documents produced by Deutsche Bank

provided Beal’s name, address, and taxpayer identification number

(TIN). P-108A and P-117A provide none of that information, as

previously demonstrated (Gov’t Br. 40-41, 43-48). The District Court

did not — and could not — find that those e-mail attachments

-37-

As explained in our opening brief (pp. 45-48), the e-mail8

attachments do not sufficiently identify the Partnerships either,because they do not contain the Partnerships’ addresses or TINs.

identified taxpayer Beal. Its limitations ruling should be reversed on

that ground alone.

In response, the Partnerships contend (Br. 32 n.5) that

§ 6501(c)(10)’s limitations period could be triggered even if Beal himself

was not identified. That contention conflicts with the plain language of

§ 6501(c)(10). That section keeps open the “time for assessment” for

any taxpayer — such as Beal — who has failed to file a disclosure

statement with the IRS unless, and until, the taxpayer’s material

advisor provides the IRS a list that complies with § 6112 “with respect

to such taxpayer.” § 6501(c)(10)(B) (emphasis added); accord Rev. Proc.

2005-26 § 5, 2005-1 C.B. 965; Prop. Treas. Reg. § 301.6501(c)-1(g)(4), 74

Fed. Reg. 51527 (2009). Therefore, it is not sufficient (as the District

Court and the Partnerships wrongly assume) for the list to identify the

name of the Partnerships; the actual taxpayer whose assessment8

period is at issue must be identified, and only Beal — not the

Partnerships (which are not subject to tax and thus have no “time for

assessment”) — has an assessment period at issue. Thus, contrary to

-38-

The Partnerships’ contention (Br. 30) that the Government bore9

the burden of proof on the limitations issue lacks merit. Thelimitations bar is an affirmative defense that “places the burden ofproof on the party pleading it.” FTC v. Nat’l Business Consultants, Inc.,376 F.3d 317, 322 (5th Cir. 2004). Although the “burden of goingforward” shifts to the Government once the taxpayer demonstrates thatthe three-year statute-of-limitations period has expired, and theGovernment must then introduce evidence that an exception to thethree-year period applies, “the burden of ultimate persuasion nevershifts from the party” pleading the limitations bar. Hoffman v.Commissioner, 119 T.C. 140, 146-147 (2002). The cases cited by thePartnerships (Br. 30) are not to the contrary. In any event, theGovernment satisfied any burden of proof that it may have borne by(i) providing evidence — from both the IRS and Deutsche Bank — thatDeutsche Bank did not provide names to the IRS as a § 6112 investorlist until after the 2001 FPAA was issued, and (ii) demonstrating thatthe 2005 e-mail attachments relied on by the Partnerships did notsatisfy § 6501(c)(10)’s requirements.

the District Court’s ruling, the May 2005 disclosure to the IRS could

have triggered the running of the special limitations period in

§ 6501(c)(10) only if that disclosure sufficiently identified Beal as

having engaged in the Son-of-BOSS tax shelter at issue. The

Partnerships’ half-hearted attempt (Br. 36) to show that Beal himself

had been adequately identified in the two e-mail attachments received

by the IRS in May 2005 is meritless, as demonstrated below. 9

The Partnerships’ related contention (Br. 37) that they, not Beal,

were the tax-shelter investors defies common sense — Beal was the

-39-

only taxpayer whose taxes were sheltered by the Son-of-BOSS scheme.

(3/22/10 Tr. 123.) Moreover, the Partnerships’ suggestion that they, not

Beal, purchased the shelter (Br. 37) ignores the fact that Beal provided

the Partnerships the money used to purchase the shelter for his benefit.

(3/22/10 Tr. 179.) Indeed, when Deutsche Bank submitted lists to the

IRS in 2007 that were intended to be § 6112 lists, the Bank listed

“Andrew D. Beal” as “Investor.” (Ex. P-102, Attachment A.)

Equally lacking merit is the Partnerships’ claim (Br. 36) that Beal

himself has been identified in the May 2005 disclosures because P-117A

contains the word “Beal,” even though it does so without any first name

or initials, address, or TIN. As we demonstrated in our opening brief

(pp. 44-45) and the Partnerships do not deny, there are literally

thousands of individuals with the last name “Beal” in the United States

and, thus, his surname alone cannot be regarded as having identified

taxpayer Andrew Beal to the IRS. The trademark case cited by the

Partnerships (Br. 36) does not support their position because that case

recognizes that “in modern times the significant portion of the name of

an individual is the surname, and that baptismal names serve only as a

means of distinguishing between persons bearing the same surname.”

-40-

Am. Tobacco Co. v. Wix, 62 F.2d 835, 837 (C.C.P.A. 1933) (emphasis

added). To distinguish taxpayer Beal from the thousands of other

Beals that file tax returns — and thus to identify him for purposes of

§ 6112 — the Deutsche Bank disclosure was required to have included

more than just his surname. See United States v. Tex. Heart Inst., 755

F.2d 469, 477 (5th Cir. 1985) (“surnames” are not the same as “names”

for purposes of an IRS summons), overruled on other grounds sub nom.

United States v. Barrett, 837 F.2d 1341 (5th Cir. 1988).

2. Even if the two Deutsche Bank e-mailattachments sufficiently identified Beal and hisPartnerships (which they did not), they did nottrigger the running of § 6501(c)(10)’s limitationsperiod because they did not purport to be § 6112lists, as Deutsche Bank confirmed

As noted in our opening brief (p. 51), it is not surprising that the

Deutsche Bank documents relied on by the District Court contain

essentially none of the information required by the Code (or, as

demonstrated below, by Treasury Regulation § 301.6112-1T) regarding

Beal’s participation in the Son-of-BOSS transaction, because the

documents that the court deemed to constitute a § 6112 list for

purposes of triggering § 6501(c)(10)’s special, additional limitations

period were neither created nor maintained by Deutsche Bank as a

-41-

§ 6112 tax-shelter-investor list. See Gov’t Br. 24-26. Simply put,

Deutsche Bank did not intend these two internal, business e-mail

attachments to be investor lists for purposes of § 6112, as it advised the

parties to this litigation. (7/26/10 Tr. 26.) That the documents were

produced “pursuant to a summons seeking just such investor lists” (as

the Partnerships contend (Br. 44)) in no way means that the IRS should

have concluded that the two internal, business e-mails — buried in a

million-page document production on 103 unsearchable CDs — were

intended to be the “lists” the Bank was required by § 6112 to maintain.

Such a conclusion would have been anomalous given the nature of the

two documents and Deutsche Bank’s purpose for creating them.

To trigger the running of § 6501(c)(10)’s limitations period, the

material advisor must “make such list available to the Secretary for

inspection upon request by the Secretary.” § 6112. The District Court’s

determination that providing two internal e-mail attachments (with a

cover letter that did not even hint that a § 6112 list was enclosed)

within a million-page document production satisfies § 6112’s

requirements cannot be reconciled with the statutory language. The

plain language of the Code provides that the IRS should be able to

-42-

inspect the “list,” not search in a massive document production for

scraps of the information that is required to be maintained by a

material advisor on a § 6112 list.

In response, the Partnerships assert that the District Court

“found as fact” that the IRS “did ‘inspect’ the lists” in 2005 (Br. 44).

That assertion is erroneous. The court merely found that the IRS had

“notice” in 2005 that the Partnerships had engaged in swaps

(Op/R6006), because (apparently) the IRS had possession of 103 CDs

containing that information, even though the IRS could not search

those disks until 2007 (Op/R6002). Nor did the court find (as the

Partnerships assert (Br. 28)) that the IRS had “actual notice” of Beal’s

Son-of-BOSS transaction before the normal three-year limitations

period ran. See § 6501(a). To the contrary, the court expressly found

(and the record supports) that “Beal’s name came up in the

investigation of another unrelated shelter he was involved in prior to

BPB” (Op/R5993), and that investigation began in December 2005, after

the three-year limitations period for Beal’s 2001 tax return had expired

-43-

According to the undisputed evidence, the 2005 documents10

produced by Deutsche Bank to the IRS did not trigger the audit ofBeal’s Son-of-BOSS transaction. (3/4/10 Tr. 45-48; 4/14/10 Tr. 8-15.)

in October 2005 (4/14/10 Tr. 8-19, 47-51). See Gov’t Br. 14-16. As the10

court further found, the IRS did not have “all the information” about

Beal’s Son-of-BOSS shelter when it audited his individual tax return in

2005, before the three-year limitations period expired. (Op/R5979,

5994.) In any event, whether the IRS had “actual notice” of the

transaction is legally irrelevant; § 6501(c)(10)’s special limitations

period is triggered only by the provision to the IRS of a list that

complies with § 6112. Thus, even if the IRS learned of Beal’s

transaction by some other means, that knowledge would not trigger the

running of the limitations period. See Bishop v. United States, 338 F.

Supp. 1336, 1349-1353 (N.D. Miss. 1970), aff’d without opinion, 468

F.2d 950 (5th Cir. 1972); Insulglass Corp. v. Commissioner, 84 T.C. 203,

207 (1985).

Treating Deutsche Bank’s internal e-mails as a § 6112 list

sufficient to trigger § 6501(c)(10)’s limitations period not only

disregards the plain language of § 6112 and § 6501(c)(10), but it also

thwarts Congressional intent, as we previously demonstrated (Gov’t Br.

-44-

It also conflicts with the rule of construction (noted in our11

opening brief (p. 60)) that “‘limitations statutes barring the collection oftaxes otherwise due and unpaid are strictly construed in favor of theGovernment.’” Badaracco v. Commissioner, 464 U.S. 386, 392 (1984)(citation omitted). The Partnerships contend (Br. 46-47) thatBadaracco is no longer good law, but do not cite any case that hasoverruled it (and our research has uncovered none). The case cited bythem, Scarborough v. Principi, 541 U.S. 401 (2004), was not a tax caseand did not cite — let alone overrule — Badaracco.

55-59). The Partnerships’ primary response (Br. 46) — that11

Congressional intent was satisfied here because Beal’s Son-of-BOSS

transaction was audited “within the limitations period” — is meritless.

As discussed above, that argument is contrary to the District Court’s

finding that the IRS was unable to uncover the tax shelter during the

audit because Beal’s tax-return preparer (Beth Montgomery) obscured

that Beal had engaged in a Son-of-BOSS scheme by disclosing only the

long swaps to the auditor, and by “deliberately” withholding

information regarding the related offsetting short swaps that underlay

the scheme’s artificial basis inflation. (Op/R5978-5979,5994.) Indeed,

the concealment of Beal’s scheme from the IRS exemplifies the very

problem that Congress sought to remedy when it enacted § 6501(c)(10).

See Gov’t Br. 35-37.

-45-

In sum, neither Deutsche Bank nor the IRS considered the two e-

mail attachments to be § 6112 investor lists because (among other

things) they were never presented to the IRS as investor lists for

purposes of § 6112. See Gov’t Br. 52-53. Although the District Court

apparently dismissed this undisputed fact as a technicality (Op/R6003),

and the Partnerships attempt to minimize its significance (Br. 44), the

record makes clear that if a document is not provided to the IRS as a

§ 6112 list, it does not get processed as such and thus fails to serve the

very purpose that Congress intended. As explained in our opening brief

(p. 15 & n.4), when the IRS receives a list that is designated as a § 6112

list, it is sent to the Office of Tax Shelter Analysis (OTSA), which then

forwards the information to the appropriate auditing teams. (4/14/10

Tr. 11-21.) If (as here) the IRS receives a document that does not

purport to be a § 6112 list, it will not be processed and used as

Congress intended. See General Accounting Office, Abusive Tax

Avoidance Transactions: IRS Needs Better Data to Inform Decisions

about Transactions, GAO-11-493 at 19 (May 2011) (“[i]f OTSA does not

receive disclosures, it cannot identify transactions that merit

examination for appropriateness as well as possible penalties.”).

-46-

To affirm the District Court’s contrary ruling would have a

serious adverse impact on the IRS’s ability to discover abusive tax

shelters within the applicable limitations period. Receiving an investor

list that complies with § 6112 triggers the special limitations period for

every taxpayer on the list, and thus the U.S. Treasury stands to lose

billions of dollars if information received by the IRS that is not provided

to the IRS as a § 6112 list (as was the situation here) nevertheless

subsequently is deemed by a court to constitute a list for purposes of

§ 6112 and § 6501(c)(10). Indeed, the instant case graphically

illustrates the disastrous consequences to the Treasury resulting from

the District Court’s construction of the term “list.” Those consequences

are that Beal, as matters now stand, has been relieved of a $70 million

liability for taxes and penalties that he would otherwise owe under the

court’s ruling on the merits of Beal’s tax shelter, because the court

deemed two attachments to internal e-mails, that neither were

maintained by Deutsche Bank as a § 6112 list nor intended by the Bank

to satisfy its requirement to maintain such a list, to nevertheless

constitute a § 6112 list. Indeed, the court’s interpretation of the term

“list” stands Congress’s purpose for enacting that statute on its head.

-47-

The Partnerships suggest (Br. 33 n.6) that this Court’s decision12

in Burks v. United States, 633 F.3d 347 (5th Cir. 2011), supports theirbelated raising of the regulation-is-invalid argument. Burks, however,

(continued...)

This could not have been the intent of Congress in enacting

§ 6501(c)(10).

B. The Temporary Regulations were properlypromulgated

Because the Deutsche Bank documents upon which the District

Court relied fail to satisfy § 6501(c)(10), it is unnecessary to address

whether the documents also fail to satisfy Treasury Regulation

§ 301.6112-1T (which, as shown in our opening brief (pp. 41-51) and in

Section C below, they did not). Nevertheless, in the interest of

completeness, we address the Partnerships’ flawed contention (Br. 32-

34) that Treasury Regulation § 301.6112-1T is invalid because it was

adopted as a temporary regulation without notice and comment. We

note that the Partnerships raise this argument for the first time on

appeal, as they acknowledge (Br. 33 n.6), and such arguments are

generally deemed “waived.” Texas Comm’l Energy v. TXU Energy, Inc.,

413 F.3d 503, 510 (5th Cir. 2005); Gregory v. Missouri Pacific R. Co., 32

F.3d 160, 164 (5th Cir. 1994). In any event, the Partnerships’12

-48-

(...continued)12

is inapposite. There, the Court rejected a temporary TreasuryRegulation that the Court determined to be inconsistent with an“unambiguous” statutory provision. Id. at 360. The Court did notaddress whether temporary regulations were procedurally valid, only“whether the Regulations would be entitled to Chevron deference.” Id.at 360-361 n.9.

argument conflicts with § 7805(e) of the Internal Revenue Code and

with the APA itself.

1. § 7805(e)

The Partnerships’ newly minted argument completely disregards

§ 7805(e), which specifically addresses the procedural requirements

applicable to temporary Treasury regulations. That section authorizes

Treasury to issue temporary regulations (which, by definition, are

issued without notice and comment) and provides:

(e) Temporary Regulations. —

(1) Issuance. — Any temporary regulation issued bythe Secretary shall also be issued as a proposed regulation.

(2) 3-year duration. — Any temporary regulation shallexpire within 3 years after the date of issuance of suchregulation.

§ 7805(e). Thus, pursuant to that section, Treasury is authorized to

issue temporary regulations without notice and comment so long as the

-49-

Final regulations were issued in February 2003, T.D. 9046, 6813

Fed. Reg. 10161, less than three years after the temporary regulationswere issued in August 2000, T.D. 8896, 65 Fed. Reg. 49909. Inaddition, the temporary regulations were issued simultaneously asproposed regulations, Prop. Treas. Reg. §§ 301.6112-1, 65 Fed. Reg.49955.

regulations are (i) also issued as proposed regulations, and (ii) expire in

3 years. See Yokum v. United States, 66 Fed. Cl. 579, 590 n.16 (2005)

(“When the IRS wishes to institute a binding regulation immediately, it

may promulgate a temporary regulation with the proposed regulation.”)

(citing § 7805(e)). In issuing Treasury Regulation § 301.6112-1T,

Treasury complied with both of those requirements.13

The specific procedures for temporary Treasury regulations set

out in § 7805(e) evidences a departure from the APA’s notice-and-

comment procedures. “[W]hen Congress sets forth specific procedures

that ‘express[ ] its clear intent that APA notice and comment

procedures need not be followed,’ an agency may lawfully depart from

the normally obligatory procedures of the APA.” Asiana Airlines v.

FAA, 134 F.3d 393, 398 (D.C. Cir. 1998) (citation omitted). In Asiana

Airlines, the D.C. Circuit upheld such a departure. That case involved

49 U.S.C. § 45301(b)(2), which provided that “‘the Administrator shall

-50-

publish in the Federal Register an initial fee schedule and associated

collection process as an interim final rule, pursuant to which public

comment will be sought and a final rule issued.’” Id. (quoting statute).

Reasoning that “Congress specified procedures under § 45301(b)(2) that

cannot be reconciled with the notice and comment requirements of

§ 553,” id., the court held that “the FAA was not required to conform to

APA § 553 procedures,” id. at 399. The court elaborated as follows:

A cardinal principle of interpretation requires us to construea statute ‘so that no provision is rendered inoperative orsuperfluous, void or insignificant.’ . . . Were we to hold thatthe FAA had to issue a proposed rule and allow meaningfulopportunity to comment before issuing the IFR [initial feeschedule], the resulting process would be so nearlyindistinguishable from normal notice and comment as todeprive this special procedural provision of any effect, and tothwart the apparent intent of Congress in enacting thespecial procedure.

Id. at 398 (citations omitted).

Just as 49 U.S.C. § 45301(b)(2) warranted departure from the

APA’s notice-and-comment requirements, so too does § 7805(e). Added

to the Code in 1988, § 7805(e) requires any temporary regulation to be

issued simultaneously as a proposed regulation (§ 7805(e)(1)) and gives

temporary regulations a three-year duration (§ 7805(e)(2)), thereby

providing specific procedures for the issuance by Treasury of temporary

-51-

regulations. If the absence of notice and comment renders temporary

regulations invalid (as the Partnerships contend), then § 7805(e) is

meaningless. The Partnerships’ argument thus violates the canon of

construction that “‘a legislature is presumed to have used no

superfluous words,’” Bailey v. United States, 516 U.S. 137, 145 (1995)

(citation omitted), and should be rejected.

The Partnerships’ contention is also at odds with the legislative

history of § 7805(e). When Congress enacted § 7805(e), it knew that

Treasury’s temporary regulations are not preceded by notice and the

opportunity for public comment, but “are effective immediately upon

publication and remain in effect until replaced by final regulations.”

H.R. Conf. Rep. No. 100-1104, at 217 (1988). Nevertheless, in enacting

§ 7805(e), Congress specifically authorized the IRS to “continue its

present practice of issuing proposed regulations by cross-reference at

the time temporary regulations are issued.” Id. at 218. Moreover,

§ 7805(e)’s legislative history expressly states that expiration of the

temporary regulations at the end of three years (§ 7805(e)(2)) “is not to

affect the validity of those regulations” during that period. Id.

Congress surely did not authorize temporary regulations only to have

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them declared invalid for violation of the APA. To the contrary, in

enacting § 7805(e), “Congress has established procedures so clearly

different from those required by the APA that it must have intended to

displace the norm.” Asiana Airlines, 134 F.3d at 397.

2. APA’s exemption for interpretive regulations

Even if the Internal Revenue Code did not explicitly authorize the

Treasury to issue temporary regulations without notice and comment,

the specific Regulation at issue would nevertheless be exempt from the

APA’s notice-and-comment requirements because those requirements

do not apply to interpretive (as opposed to legislative) regulations. 5

U.S.C. § 553(b)(3)(A). As this Court has explained, an “interpretative

application” of the governing statute need not comply with the APA’s

“notice and comment requirements.” Avoyelles Sportsmen’s League,

Inc. v. Marsh, 715 F.2d 897, 910 (5th Cir. 1983); see Shell Offshore Inc.

v. Babbitt, 238 F.3d 622, 628 (5th Cir. 2001) (“‘Generally speaking, it

seems to be established that ‘regulations,’ ‘substantive rules,’ or

‘legislative rules’ are those which create law; whereas interpretive rules

are statements as to what the administrative officer thinks the statute

or regulation means.’”) (citation omitted).

-53-

In analyzing whether an agency’s rule is an interpretive rule, “the

starting point is ‘the agency’s characterization of the rule.’”

Professionals & Patients for Customized Care v. Shalala, 56 F.3d 592,

596 (5th Cir. 1995) (citation omitted). The Treasury Department has

characterized its list-maintenance regulations as interpretive. When

issuing the original list-maintenance Regulations in 1984, as both

temporary and proposed regulations, the Treasury Department stated

that “the regulations proposed herein are interpretative and that the

notice and public procedure requirements of 5 U.S.C. 553 do not apply.”

49 Fed. Reg. 34246-34247.

Further supporting the IRS’s characterization of the regulations

as interpretive is the fact that they were issued pursuant to § 7805(a),

which authorizes the Treasury Department to issue “all needful”

regulations for the enforcement of the Code. Regulations issued

pursuant to that authority generally have been viewed as interpretive.

See Pickus v. U.S. Bd. of Parole, 507 F.2d 1107, 1113 (D.C. Cir. 1974)

(“Treasury Regulations interpreting the Internal Revenue Code are a

prime example” of “interpretive rules” for purposes of the APA’s rule-

making procedures). See Asimow, Public Participation in the Adoption

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Although this Court has referred to rules issued pursuant to14

§ 7805(a) as “legislative rules,” it did so in a case that did not involve a“procedural” challenge, and therefore did not address whetherregulations issued pursuant to § 7805(a) were interpretive for APApurposes. Continental Equities, Inc. v. Commissioner, 551 F.2d 74, 82(5th Cir. 1977).

of Temporary Tax Regulations, 44 Tax Law. 343, 359 (1990) (“Courts in

tax cases should continue to draw the interpretive-legislative line by

determining whether the Treasury derived its authority from a specific

delegation [of authority] or from its general rulemaking power under

section 7805(a)”). In enacting Treasury Regulation § 301.6112-1T,14

Treasury cited both § 7805 and § 6112 as authority for the Regulation.

The Regulation is therefore an interpretive rule because it was

promulgated pursuant to § 7805(a)’s general rulemaking authority.

That the Regulation also cites § 6112 as a source of authority does not

transform the Regulation into a legislative regulation. In § 6112,

Congress mandated that material advisors maintain tax-shelter-

investor lists, and imposed no affirmative directive on the Treasury

Department, only discretionary authority to develop regulations that

interpreted Congress’s list-maintenance mandate. As such, the

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authority provided in § 6112 simply mirrors the authority provided in

§ 7805(a).

Finally, any failure to comply with the APA’s procedures would be

“harmless error” based on the facts of this case. See United States v.

Johnson, 632 F.3d 912, 930-933 (5th Cir. 2011) (agency’s failure to

follow the APA’s notice-and-comment requirements deemed to be

“harmless error”). The “purpose of notice-and-comment rulemaking is

to ‘assure[ ] fairness and mature consideration of rules having a

substantial impact on those regulated.’” Id. at 931 (citation omitted).

Prior versions of the list-maintenance Regulation had been issued as

temporary and proposed regulations in 1984, Prop. Treas. Reg.

§ 301.6112-1, 49 Fed. Reg. 34246, and the 1984 Regulation was

subsequently amended in March 2000, 65 Fed. Reg. 11271 (proposed

regulations), and again in August 2000, 65 Fed. Reg. 49955 (proposed

regulations). Therefore, this Regulation was available for notice and

public comment. Indeed, the preamble to the August 2000 revisions

(i.e., the temporary Regulation at issue) notes that the Regulation had

been revised in order to incorporate prior comments, and emphasized

that Treasury “continue[s] to invite comments on all provisions of the

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temporary and proposed regulations.” T.D. 8896, 65 Fed. Reg. 49909,

49910. Thus, the temporary Regulation at issue here was not a shot

out of the blue; Treasury had been considering — and responding to

public comments regarding — the list-maintenance requirements for

over 16 years. Given that Beal and the Partnerships had plenty of time

to submit comments to Treasury regarding the list-maintenance

requirements before the temporary Regulation at issue was adopted, if

APA notice and comment were determined to be applicable, the failure

of Treasury to follow the APA procedures was harmless error.

C. The two e-mail attachments do not satisfy TreasuryRegulation § 301.6112-1T’s requirements

In our opening brief (pp. 41-51), we demonstrated that the

documents that the District Court determined constituted a § 6112 list

plainly did not satisfy the Treasury Department’s regulatory

requirements for a § 6112 list. The Partnerships have failed to

demonstrate otherwise.

Their contention (Br. 35) that Deutsche Bank did not have to

provide the name, address, and TIN of each investor conflicts with both

Congressional intent and the language of the Regulation. As noted

above, Congress intended that a § 6112 “list will include the name,

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address, and taxpayer identification number of the purchaser, as well as

any other information that the Secretary may, by regulations, require.”

H.R. Rep. No. 98-861, at 982 (emphasis added). Consistent with

Congressional intent, Treasury Regulation § 301.6112-1T requires the

list to include that information and does not (as the Partnerships

contend (Br. 35)) limit the requirement to material advisors who know

that information. In this regard, the Partnerships’ complaint that it

“makes no sense” to “require DB to disclose more than it knew” misses

the mark. Rather, it makes no sense to claim Deutsche Bank is a

“material advisor” for purposes of triggering Beal’s limitations period if

it did not have — or could not obtain — this basic identifying

information. In fact, as the record makes clear, Deutsche Bank had

this information all along which (other than Beal’s TIN) it provided to

the IRS in 2007. E.g., Ex. P-102, Attachment A (2007 Deutsche Bank

list providing IRS with names and addresses for Beal and the

Partnerships), Attachments C-E (2007 Deutsche Bank lists providing

IRS with TINs for the Partnerships); Ex. P-2166 (2001 letter from Beal

to Deutsche Bank containing Bemont’s address); Ex. P-2180 (2001

Deutsche Bank correspondence with BPB containing BPB’s and Beal’s

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address). Thus, Deutsche Bank did not — as the Partnerships contend

(Br. 36) — disclose “all that it knew” in P-108A and P-117A; it simply

had no reason to disclose “all that it knew” in the two internal e-mail

attachments that it created for business, not § 6112, purposes.

Similarly lacking merit is the Partnerships’ contention (Br. 38)

that P-108A and P-117A did not have to satisfy Treasury Regulation

§ 301.6112-1T’s requirement that the § 6112 list contain a detailed

description of the tax shelter and its intended benefits. Although the

cover letter enclosing the 103 CDs indicated that the documents were

responsive to a summons headed Son of BOSS/Digital Options (as the

Partnerships note (Br. 38)), the specific e-mail attachments at issue

were created for business purposes and do not themselves refer to the

shelter and are not identified as a “list” the Bank was required to

maintain under § 6112. Moreover, the Regulation requires the

material advisor to maintain a list containing the information specified

and furnish such list to the IRS upon request; it does not provide for

incorporation by reference. Further, the Regulation certainly does not

allow a material advisor to claim that scraps of information pertaining

to a tax-shelter participant that are buried in a document dump of

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millions of pages satisfies the advisor’s obligations under § 6112.

Indeed, Deutsche Bank never claimed that the e-mail attachments

constituted the list it was required to maintain under § 6112. On the

contrary, it expressly disavowed any such claim. (7/26/10 Tr. 26.)

Finally, the Partnerships’ contention (Br. 37-38) that Deutsche

Bank was not required to provide the IRS the copy of Coscia’s draft tax

opinion that it possessed misinterprets the Regulation. The Regulation

requires Deutsche Bank to provide the IRS a copy of any opinion

provided the tax-shelter investor by “any other person who has

participated in the offering of the tax shelter.” Treasury Regulation

§ 301.6112-1T, A-17(9). Although that Regulation does not define

“offering,” a related Regulation requiring registration by tax-shelter

organizers and sellers defines the “offering for sale of an interest in the

shelter” as “making any representation, whether oral or written,

relating to participation in a tax shelter as an investor.” Treasury

Regulation § 301.6111-1T, A-43. By providing Beal a tax opinion,

Coscia is a person who “has participated in the offering of the tax

shelter” because he made the written “representation” that the shelter’s

tax benefits would more likely than not be upheld.

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The District Court accorded no significance to the 2007 lists in15

reaching its decision that the 2005 disclosure of the e-mail attachmentsto the IRS constituted the provision of a § 6112 list sufficient to triggerthe running of § 6501(c)(10)’s limitations period.

Unable to demonstrate that the Deutsche Bank documents

comply with Treasury Regulation § 301.6112-1T, the Partnerships

instead contend that full compliance was not required (Br. 39-40). That

contention lacks merit. As we noted in our opening brief (pp. 57-58)

and the Partnerships ignore, Congress intended (i) that each of the

mandatory list-maintenance requirements be satisfied, H.R. Rep. No.

98-861, at 982, and (ii) that the IRS penalize any material advisor that

“maintains an incomplete list,” H.R. Rep. No. 108-755, at 598 (2004)

(emphasis added).

The Partnerships’ reliance on the lists that Deutsche Bank

provided the IRS in 2007 to support their substantial-compliance

argument (Br. 41-42) is misplaced. Whether those lists satisfied

Treasury Regulation § 301.6112-1T was not an issue before the District

Court, because they were provided to the IRS months after the IRS

issued the 2001 FPAA to Bemont and therefore were irrelevant to the

statute-of-limitations issue. Moreover, the Partnerships’ contention15

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that the 2005 e-mail attachments and the 2007 investor lists are

“materially indistinguishable” (Br. 43) is baseless. The 2007 lists differ

from the 2005 documents in critical respects. First, and foremost, the

2007 lists were presented to the IRS as § 6112 lists (as we explained in

our opening brief (pp. 52-53) and the Partnerships ignore), whereas P-

108A and P-117A simply were attachments to business e-mails

concerning Deutsche Bank commissions and buy/sell orders, and

contained no indication that they were intended by the Bank to be a

§ 6112 list. Second, the 2007 lists — unlike the 2005 documents —

contain taxpayer Beal’s full name and address, as well as the

Partnerships’ addresses and TINs. (Ex. P-102, Attachments C-E.)

Further, the Partnerships’ substantial-compliance argument

conflicts with their APA challenge to the temporary Treasury

Regulation. As the case law cited by them makes clear (Br. 39),

“regulatory requirements that relate to the substance or essence of a

statutory provision of the Internal Revenue Code must be strictly

complied with” unless the regulation is “merely procedural.” Young v.

Commissioner, 783 F.2d 1201, 1205 (5th Cir. 1986). Procedural rules,

however, are exempt from the APA’s notice-and-comment

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requirements. 5 U.S.C. § 553(b)(3)(A). In arguing that Treasury

Regulation § 301.6112-1T violates the APA, the Partnerships concede

(Br. 34) that the rule is not procedural. That concession undermines

their contention that the Regulation is exempt from the rule that

Treasury Regulations must be strictly complied with. In any event,

even if substantial compliance with the temporary Regulation were

sufficient, the meager bits of information concerning Beal and the

Partnerships contained in the two e-mail attachments cannot

reasonably be regarded as being in substantial compliance with the

requirements of the temporary Regulation.

D. The Partnerships’ sanctions motion, denied by theDistrict Court as moot, does not provide analternative ground for affirming the court’s statute-of-limitations decision

Finally, the Partnerships’ contention (Br. 48) that their “sanctions

motion provides an alternative ground for affirming the statute-of-

limitations judgment” is misconceived. The Partnerships assert in this

regard that, even if this Court agrees with the United States that P-

108A and P-117A are insufficient to trigger the running of

§ 6501(c)(10)’s one-year limitations period, the Court should

nevertheless deem those documents to be sufficient to commence the

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limitations period as a sanction against the United States for what the

Partnerships term “discovery misconduct” (Br. 48). That contention

fails as a matter of law.

The Partnerships’ request that this Court, in the event that it

holds that the assessment of additional tax against Beal for 2001 is not

barred by the statute of limitations, nevertheless deem Beal’s

limitations period for 2001 to have expired is, in effect, a request for a

default judgment against the Government. As such, the Partnerships,

as a threshold requirement, must demonstrate substantial prejudice. A

“court’s decision to deem certain facts established may equate to a

default judgment in some circumstances.” Chilcutt v. United States, 4

F.3d 1313, 1320 (5th Cir. 1993). Deeming the statute of limitations to

have run on Beal’s 2001 tax year (as the Partnerships urge) is

tantamount to issuing a default judgment against the United States for

the $70 million in tax and penalties otherwise owed by Beal for that

year. The “‘draconian remedy of dismissal’” or default judgment should

be “sparingly used.” Marshall v. Segona, 621 F.2d 763, 767-768 (5th

Cir. 1980) (citation omitted). To justify this severe sanction, a party

“must” demonstrate that the violating party’s conduct “‘substantially

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When the District Court first suggested that the Partnerships16

seek this information from Deutsche Bank, instead of the IRS, in orderto avoid any problems raised by § 6103 (which prohibits the IRS fromreleasing taxpayer information), counsel for the Partnerships stated“I’m okay with that on some level as long as — if we get theinformation from Deutsche Bank.” (5/28/08 Tr. 66-67.) As counsel latertold the court, they asked Deutsche Bank for documents relating toBeal and the Partnerships that were provided to the IRS, and was “ableto secure these documents” from the Bank. (4/14/10 Tr. 72.) ThePartnerships therefore suffered no prejudice. No remand is necessary.The Partnerships’ speculation on appeal (Br. 52) that Deutsche Bank“may have produced even more pertinent information by 2005, and thegovernment may still be sitting on it” is entirely unfounded.

The deposition took place in November 2009. The17

(continued...)

prejudice[d] the opposing party.’” FDIC v. Conner, 20 F.3d 1376, 1380

& n.3 (5th Cir. 1994) (citation omitted).

The Partnerships have not alleged — let alone demonstrated —

that they were substantially prejudiced by the Government’s failure to

produce P-108A and P-117A from the IRS’s files. There was no16

prejudice here. As the Partnerships acknowledge (Br. 49), the

Government’s trial attorneys “turned over copies” of P-108A and P-

117A to their counsel as soon as they received those documents from

Deutsche Bank in 2007. After receiving those documents, the

Partnerships’ counsel asked for, and received, a deposition of an IRS

witness regarding whether the documents had been received in 2005. 17

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(...continued)17

Partnerships’ suggestion (Br. 54) that the United States caused a 2-year delay is incorrect. Pursuant to the parties’ joint motion (R2876-2878), the case was stayed from June 2008 to June 2009 to await theoutcome of a related Fifth Circuit appeal. (R2881,2976,3034.)

(9/17/09 Tr. 22, 36-37.) During the deposition, the IRS witness (Donald

Berkowitz) testified that the IRS had received P-108 in 2005 (Berk.

Dep. 37), as the District Court found (Op/R6002). His testimony was

later confirmed by a declaration that the Partnerships obtained from

Deutsche Bank’s law firm, which demonstrated that P-108A and P-

117A were both provided to the IRS in 2005. (Ex. P-2203.) Not only

did the Partnerships obtain the information that they sought before the

trial of the case, they used that information at trial to prevail on the

statute-of-limitations issue in the District Court. (Op/R6000-6002.) In

these circumstances, the Partnerships cannot demonstrate any

prejudice (let alone substantial prejudice), and therefore their request

for a $70 million default judgment against the United States for Beal’s

2001 tax year as a discovery sanction is wholly inappropriate. See

Conner, 20 F.3d at 1381 (reversing district court’s dismissal sanction

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We would also point out that, although the District Court in its18

opinion (Op/R6003-6006) criticized the conduct of Government trial“counsel,” the “Government” and the “IRS,” the court did not deem itappropriate to impose any sanctions against the Government’sattorneys or the United States itself.

where “FDIC’s conduct did not cause the defendants to suffer

substantial prejudice”).18

II. The Partnerships have failed to demonstrate that § 6662’spenalty for basis misstatements does not apply to Beal’sbasis-inflating Son-of-BOSS shelter

As previously explained (Gov’t Br. 63-72), the Code’s penalty for

basis misstatements applies to the Partnerships’ $200 million basis

misstatement, and, to the extent that Heasley v. Commissioner, 902

F.2d 380 (5th Cir. 1990) indicates to the contrary (as the District Court

held), that decision’s interpretation of the valuation-misstatement

penalty had since been abrogated by regulation. See Treas. Reg.

§ 1.6662-5(g) (any misstatement of basis concerning property with a

correct basis of “zero” is subject to gross-valuation-misstatement

penalty); Treas. Reg. § 1.6662-5(d), ex. 3 (gross-valuation-misstatement

penalty applies to underpayment of tax resulting from total

disallowance of depreciation deduction where property’s correct basis is

zero). In response, the Partnerships do not — and cannot — challenge

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the proposition that courts must defer to a subsequently issued

regulation, even if it conflicts with the court’s prior case law, if (as here)

the prior case law had interpreted an ambiguous statute. See Nat’l

Cable & Telecomm. Ass’n v. Brand X Internet Servs., 545 U.S. 967, 985

(2005). Instead, the Partnerships contend (Br. 57) that the Regulation

does not address Heasley’s rule that, when a deduction is totally

disallowed, the resulting tax underpayment is not attributable to a

valuation misstatement. The Partnerships are mistaken.

To read (as the Partnerships do) the Regulation as not displacing

Heasley’s total-disallowance rule would render Treasury Regulation

§ 1.6662-5(g) a nullity. Basis-dependent deductions (like the losses at

issue here) will always be totally disallowed if the correct basis is zero.

Therefore, if the valuation-misstatement penalty cannot apply

whenever a deduction is totally disallowed (as Heasley held), then the

penalty can never apply if the correct basis is zero. If that were the

case, there would be no need for Treasury Regulation § 1.6662-5(g),

which addresses how to apply the penalty when the correct basis is

zero. The Regulation thus clearly envisions that the

valuation-misstatement penalty would apply if the correct basis is zero,

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and clarifies that the gross-valuation-misstatement penalty (rather

than the substantial-valuation-misstatement penalty) applies in that

circumstance. Treas. Reg. § 1.6662-5(g).

Although Treasury Regulation § 1.6662-5(g) does not expressly

address the attribution question raised by Heasley, Example 3 in

Treasury Regulation § 1.6662-5(d) does, and thereby demonstrates that

the Regulation does not merely “solve a basic mathematical problem,”

as the Partnerships contend (Br. 57). In that example, a claimed

depreciation deduction was totally disallowed because the taxpayer had

“fully depreciated” the asset in prior years. That total disallowance

caused the property’s basis to be adjusted from the $1,250,000 claimed

by the taxpayer to the correct basis of zero. The Regulation expressly

provides that the resulting underpayment of tax was “attributable” to a

gross-valuation misstatement and that therefore the penalty applied.

Treas. Reg. § 1.6662-5(d), ex. 3. Similarly, here, the Partnerships’

claimed $200 million basis in the Australian currency has been reduced

to zero under the economic-substance doctrine, and to $2.5 million

under the District Court’s alternative holdings, and the disallowed

losses (which had been premised on the inaccurate $200 million basis)

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The Government’s interpretation is neither “inconsistent” with19

the Regulation nor a “post hoc rationalization,” as the Partnershipscontend (Br. 60). And, as demonstrated in the text, the Regulation doesmuch more than “merely repeat[ ]” (Br. 60) the language of § 6662(b).

The Partnerships’ reliance (Br. 58-59) on cases like Weiner v.20

United States, 389 F.3d 152 (5th Cir. 2004), that followed Heasley after

(continued...)

are — under the Regulation’s reasoning — attributable to a

gross-valuation misstatement.19

The Government’s interpretation gives meaning to the entire

Regulation, and is entitled to deference. See Auer v. Robbins, 519 U.S.

452, 461-462 (1997) (agency’s interpretation of its own regulation is

entitled to “controlling weight,” even where agency’s interpretation is

“in the form of a legal brief”). In this regard, the Government did not

assert in its opening brief that “other circuits have agreed with its

interpretation of the regulation,” as the Partnerships inaccurately

claim (Br. 60). What we said (and the Partnerships cannot refute) is

“that the majority of the circuits agree that the valuation-misstatement

penalty applies when a deduction has been totally disallowed and the

correct basis is zero” (Gov’t Br. 71). See Gov’t Br. 67 n.27 (listing

cases); Clearmeadow Invs., LLC v. United States, 87 Fed. Cl. 509,

530-536 (2009) (describing circuit-split). Those circuits found no need20

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(...continued)20

the Regulation was promulgated is misplaced, because they did notaddress Treasury Regulation §§ 1.6662-5(d), 1.6662-5(g) or theGovernment’s Brand X argument. The Partnerships’ complaint thatthe Government did not present its Brand X argument to the Court inWeiner (Br. 59) ignores the fact that Brand X was decided after Weinerwas issued.

to rely on the Regulation because they correctly interpreted § 6662’s

valuation-misstatement penalty to apply to situations where a tax

benefit had been totally disallowed under the economic-substance

doctrine. These courts recognize that any distinction between (i) a

factual valuation misstatement, which may reduce, but not eliminate, a

claimed tax benefit, and (ii) a valuation misstatement resulting from an

economic-substance determination, which eliminates the claimed tax

benefit, is a “false distinction.” Illes v. Commissioner, 982 F.2d 163,

167 (6th Cir. 1992). Indeed, to hold otherwise would be “perverse” as a

policy matter, as the Second Circuit has explained:

Had the Commissioner been confined to his fallback positionthat the taxpayer’s basis for depreciation was fair marketvalue, a value far below his claimed purchase price, it wouldhave been entirely sound to say that the asset had been‘overvalued’ and to impose the section 6659 penalty. If theCommissioner is more successful and persuades the Court todisregard not only the nonrecourse notes but the entirety ofthe purchase price, thereby lowering the ‘price’ down notonly to fair market value but all the way to zero, should the

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Commissioner’s success have the perverse effect of sparingthe taxpayer the overvaluation penalty?

Gilman v. Commissioner, 933 F.2d 143, 150 (2d Cir. 1991). Treasury

Regulation § 1.6662-5 provides this Court the opportunity to join the

circuit majority, notwithstanding its prior ruling in Heasley.

The Partnerships’ attempt to reconcile Heasley with the

Regulation (Br. 58) lacks merit. They contend that, under Heasley, the

valuation-misstatement penalty still can apply to a tax benefit that has

been totally disallowed so long as the reason for the disallowance is not

“independent of the fact that the property’s correct basis is zero” (Br.

58). But when a tax benefit is disallowed under the economic-

substance doctrine, the disallowance is not independent of the fact that

the property’s correct basis is zero; the economic-substance

determination causes the property’s correct basis to be zero.

In sum, given Treasury Regulation § 1.6662-5, we respectfully

submit that this Court is no longer bound to follow Heasley. Consistent

with the Regulation, the gross-valuation-misstatement penalty should

apply to the Partnerships’ $200 million basis misstatement, just as it

has been applied to similar Son-of-BOSS schemes. See Gov’t Br. 72.

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Section 6662 was enacted to ensure that the “amount of the

penalty should be proportionate to the culpability of the taxpayer,” and

that “big time tax cheats will be punished.” Statement of Senator

Pryor, 135 Cong. Rec. S13898 (Oct. 24, 1989) (introducing legislation to

revise the civil tax penalties, which ultimately culminated in § 6662).

Applying the gross-valuation-misstatement penalty to a taxpayer that

attempted to turn a $2.5 million “investment” into a $200 million tax

loss is precisely what Congress intended when it enacted that penalty.

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CONCLUSION

The District Court’s judgment should be reversed with regard to

its rulings that the 2001 FPAA was untimely and that the

gross-valuation-misstatement penalty was inapplicable. In all other

regards, the court’s judgment should be affirmed.

Respectfully submitted,

GILBERT S. ROTHENBERG Acting Deputy Assistant Attorney General

/s/ Judith A. Hagley

RICHARD FARBERJUDITH A. HAGLEY Attorneys

Tax Division Department of Justice

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CERTIFICATE OF SERVICE

It is hereby certified that the foregoing combined answering &

reply brief for the United States as appellant/cross-appellee was filed

with the Court and served on counsel for the appellees/cross-appellants

(set out below) on this 11th day of July, 2011, via the Court’s CM/ECF

system. On that same date, seven paper copies were mailed to the

Clerk by First Class Mail:

M. Todd Welty, EsquireSNR Denton U.S. LLP2000 McKinney Ave., Suite 1900Dallas, TX 75201

ECF CERTIFICATIONS

Pursuant to Fifth Circuit Rule 25.2, I hereby certify on this 11th

day of July, 2011, that (i) any required privacy redactions have been

made, (ii) the electronic submission is an exact copy of the paper

document, and (iii) the document has been scanned for viruses with a

commercial virus scanning program and is free of viruses.

/s/ Judith A. Hagley

JUDITH A. HAGLEY Attorney for appellant/cross-appellee United States

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CERTIFICATE OF COMPLIANCE

1. This brief complies with the type-volume limitation of Fed. R.App. P. 28.1(e)(2)(A) because:

[X] this brief contains 13,997 words, excluding the parts of thebrief exempted by Fed. R. App. P. 32(a)(7)(B)(iii), or

[ ] this brief uses a monospaced typeface and contains [state thenumber of] lines of text, excluding the parts of the brief exempted byFed. R. App. P. 32(a)(7)(B)(iii).

2. This brief complies with the typeface requirements of Fed. R.App. P. 32(a)(5) and the type style requirements of Fed. R. App. P.32(a)(6) because:

[X] this brief has been prepared in a proportionally spacedtypeface using Corel Word Perfect X3 in Century Schoolbook 14 pt.type, or

[ ] this brief has been prepared in a monospaced typeface using[state name and version of word processing program] with [statenumber of characters per inch and name of type style].

3. The undersigned hereby further certifies that the foregoingbrief filed electronically with the Court is in PDF searchable format,that the text of the PDF copy is identical to the text of the paper copy,that the PDF version has been electronically scanned for viruses with the Trend Micro OfficeScan 8.0 antivirus program (copyright 2007) andthat, according to the program, no viruses were detected.

/s/ Judith A. Hagley(s)_______________________________________

Attorney for appellant/cross-appellee United States

Dated: July 11, 2011