[00:00:01] Speaker 00: Case number 19-1068 et al, BCP Trading and Investments LLC et al, versus Commissioner of Internal Revenue, Virginia Simpson, A Balance. [00:00:12] Speaker 00: Mr. Marwell for the A Balance, Galcova and Petit Partnerships. [00:00:15] Speaker 00: Mr. Clark for the A Balance, Esri LeMay Partnerships. [00:00:19] Speaker 00: Ms. [00:00:19] Speaker 00: Rubin for the APOE Commissioner of Internal Revenue. [00:00:23] Speaker 01: Morning, Council. [00:00:24] Speaker 01: Mr. Marwell, when you're ready, please proceed. [00:00:27] Speaker 02: Thank you, Your Honor. [00:00:28] Speaker 02: May it please the court, Jeremy Marwell, for the Kalkovin-Pettit Appellants. [00:00:32] Speaker 02: I will address the statute of limitations and sham partnership issues and questions about Kalkovin and Pettit. [00:00:38] Speaker 02: Mr. Clark will address the Rule 63 issue, questions about Esri and LeMay. [00:00:43] Speaker 02: And if I'd like to reserve two minutes, if I can. [00:00:46] Speaker 02: The statute extensions in this case were invalid because they were signed at Ernst & Young's urging and direction at a time when the government at least had reason to know of Ernst & Young's serious and undisclosed conflicts of interest. [00:01:01] Speaker 02: And that is so for two main reasons. [00:01:03] Speaker 02: First, the tax court was wrong to conclude that just because taxpayers had noticed that the IRS was questioning the transactions, they also had noticed that Ernst & Young, their trusted advisor, was itself under criminal investigation and faced intense pressure to put its own interest above its clients. [00:01:22] Speaker 02: Ernst & Young's disclosure letters were at best half-truths and never timely disclosed the existence of a criminal investigation. [00:01:30] Speaker 02: Second, [00:01:31] Speaker 02: The result here, in our view, is a straightforward application of Transpac and Black Letter Contract and agency principles. [00:01:39] Speaker 02: Ernst & Young ran the show with these transactions. [00:01:42] Speaker 02: The record shows that Bolton and the taxpayers relied entirely on Ernst & Young's advice to extend the limitations period, and the IRS [00:01:51] Speaker 02: knew or at least had reason to know. [00:01:53] Speaker 02: The IRS knew about the existence of Ernst & Young's conflicts because it was involved in creating those conflicts, and it knew that Ernst & Young was not disclosing those conflicts to its clients, among other things, because Ernst & Young told the IRS that and said, we cannot disclose that we're paying a penalty here, otherwise our clients will use it against us in litigation. [00:02:14] Speaker 01: Can I ask you a question, Mr. Marwold? [00:02:18] Speaker 01: So one [00:02:19] Speaker 01: part about your submission that I don't completely follow is the reason that the IRS would, let me rephrase it, the reason that it would be disadvantageous to people in the taxpayers position to not know this fact, because it seems to me that even if you know the fact, [00:02:48] Speaker 01: I'm not understanding what's gained by denying the extension. [00:02:52] Speaker 01: And I know that Olson – I know they rely on Olson's testimony, and Olson says that, well, in some situations, if the IRS has a criminal prosecution in mind, they might forego a civil proceeding. [00:03:04] Speaker 01: But it just seems to me that that was a conclusion, and I wasn't quite understanding the logic behind it. [00:03:09] Speaker 01: Why is it that it would be advantageous to deny the extension? [00:03:13] Speaker 02: So I think the best part of Olson's testimony is 1901 to 1903 of the JA, where he explains this and he gives a couple of specific reasons. [00:03:24] Speaker 02: This is the former Assistant Attorney General for the Tax Division and Department of Justice explaining how these criminal investigations work. [00:03:30] Speaker 02: And I take there to be several propositions there. [00:03:33] Speaker 02: One is that the practical effect of denying an extension could be to accelerate the government's work. [00:03:40] Speaker 02: The government would have to choose between issuing the FPAW, the final partnership administrative adjustment, or potentially letting the statute lapse. [00:03:49] Speaker 02: And if that occurs early in the overall swirl of investigations, as the tax court put it, [00:03:55] Speaker 02: The government might be effectively locked into a particular theory because it's going to have to write issue the FPAW. [00:04:03] Speaker 02: And Olson testified that it's possible that theory would be advantageous to the taxpayer. [00:04:08] Speaker 02: It's possible that the FPAW would not include findings that would be necessary to support a later claim of fraud. [00:04:15] Speaker 02: And there's also the possibility that there's a desire to keep the criminal investigation [00:04:21] Speaker 02: confidential, and that might be a known enough or some of the concerns that occurred that have occurred in where you have the target of a civil investigation, providing documents or perhaps, you know, interacting, providing information to the government without knowing that there's a criminal investigation. [00:04:40] Speaker 02: So pending, you might have amendment concerns. [00:04:43] Speaker 02: So there's the need for very careful coordination within the government. [00:04:48] Speaker 02: And that I think is the key [00:04:51] Speaker 02: That is what the taxpayers here didn't know about, and they – So on that issue, within the government, you mean between the criminal civil parts of IRS? [00:05:01] Speaker 02: Yes, and I think there's also coordination. [00:05:05] Speaker 02: Here we had the criminal side, I think, kicked off when the Southern District of New York called Ernst & Young's general counsel and said, hey, we saw this newspaper article. [00:05:14] Speaker 02: Please preserve documents. [00:05:15] Speaker 02: We're considering convening a grand jury. [00:05:17] Speaker 02: And we have evidence in the record that there was coordination happening, both between the civil promoter audit team and the criminal investigative division within the IRS. [00:05:30] Speaker 02: both Ernst and Young and, as I understand it, the IRS, aware of the existence of the Southern districts. [00:05:37] Speaker 01: What do we do, as between civil and criminal, what do we do with the stipulation that civil didn't know? [00:05:44] Speaker 02: So the stipulation, as I read it, talks about the team that was doing the audits, the CDS audits, like of the partnership here. [00:05:55] Speaker 02: I think the facts are different as to the promoter audit team. [00:05:59] Speaker 02: So the team within IRS, the civil promoter audit team that was investigating Ernst & Young. [00:06:05] Speaker 02: And that team, the record shows, had, [00:06:07] Speaker 02: full awareness of the criminal side. [00:06:10] Speaker 02: In fact, they met with the criminal investigative division in 2003. [00:06:17] Speaker 02: And you have the Phillips case from the Ninth Circuit, which says, we're not going to look just at what individual employees within an agency. [00:06:23] Speaker 02: We're going to attribute that knowledge to the commissioner as a whole. [00:06:28] Speaker 02: So I think unless you want to take a different approach than the Ninth did on that, [00:06:33] Speaker 02: it's a little slices it too fine to kind of divide division by division. [00:06:37] Speaker 02: And, I mean, the degree of knowledge is something that the tax court did not really provide findings on. [00:06:45] Speaker 02: As I read the opinion, they more or less agreed with us that they're insinuating had a conflict and they agreed that didn't dispute that the IRS had awareness of the conflict. [00:06:53] Speaker 02: The tax court's ground of decision was focused on the notion that the [00:06:58] Speaker 02: taxpayers here either should have known or had reason to know. [00:07:01] Speaker 02: And so if you are concerned about issues like the IRS knowledge, I think that wouldn't be a terrible reason to remand and allow the tax court to make some findings in the first instance and that you could then potentially review later. [00:07:14] Speaker 02: But as to [00:07:16] Speaker 02: The knowledge of the taxpayers. [00:07:18] Speaker 02: This is somewhere. [00:07:18] Speaker 02: This is somewhere where tax court just had significant errors that I think even understanding the difficult burden of a clear error standard review. [00:07:28] Speaker 02: There are problems here. [00:07:29] Speaker 02: So for instance, the tax court said that [00:07:31] Speaker 02: that in July 2004, Ernst & Young wrote to my clients at Calco and Pettit to say, to disclose the existence of the grand jury investigation. [00:07:39] Speaker 02: That's just contrary to the stipulation. [00:07:41] Speaker 02: The stipulation is there is no evidence in the record that those letters were ever sent to our clients. [00:07:47] Speaker 02: And so when you look at the only other evidence in the record, the earlier disclosures, they're really cramped. [00:07:56] Speaker 02: If you look at this through the lens of a fiduciary, it's hard to understand what Ernst and Young was doing, you know this sort of half true as well there was, there was a promoter audit but they don't mention the fact that they paid a penalty. [00:08:11] Speaker 02: when in 2004, when Pettit called the Ernst & Young and said, what is this about the grand jury? [00:08:19] Speaker 02: The testimony undisputed at JA 1419 was that Ernst & Young's contact partner said, oh, don't worry about that. [00:08:27] Speaker 02: That has something to do with some individual partners. [00:08:29] Speaker 02: It's really not. [00:08:30] Speaker 02: It doesn't have anything to do with you. [00:08:34] Speaker 02: Under the we view Transpac as kind of an application of the more general generally applicable agency and fiduciary principles and it's [00:08:45] Speaker 02: in our view, artificial to distinguish between Bolton, who signed the partnership extension here, and Ernst & Young on these particular facts. [00:08:55] Speaker 02: I mean, the government raises concerns of what is the practical consequence of our position for their conduct of investigations. [00:09:04] Speaker 02: I think the answer is on these facts, where you have Ernst & Young at the center of the storm, and the government went after them first for creating and marketing these transactions. [00:09:15] Speaker 02: And you had Ernst & Young listed as the power of attorney for the individual taxpayers and you have evidence in the record that the IRS said, okay, we know we want to get these extensions. [00:09:26] Speaker 02: Ernst & Young is going to help us out, especially if the partnerships are uncooperative. [00:09:30] Speaker 02: I don't view it as a material extension of Transpac. [00:09:34] Speaker 02: And our bottom line on what the practical consequence for the government would be is what they should have done here was asked. [00:09:41] Speaker 02: And that's what their own regulations say. [00:09:43] Speaker 02: If you have a reason to know that somebody representing the taxpayer before the commission has a conflict, you need to ask, did you disclose and did you get a waiver? [00:09:52] Speaker 02: That's what circular 230, which is in the CFR, it's the regulation says, and it's what didn't happen here. [00:09:57] Speaker 01: I know that this is this is not something that would feedback necessarily into the legal conclusion that you're urging upon us, but as just as a matter of what happened once even after everybody knew what was going on, there was still an agreement to extend further extensions. [00:10:13] Speaker 02: Yes, two response to that. [00:10:16] Speaker 02: First, we have a somewhat unusual statute extension language here that says if you're going to extend, you have to do it before the expiration of the period. [00:10:25] Speaker 02: I think that's at A5 to A6 of our blue brief. [00:10:28] Speaker 02: And so once the statute is expired, I don't think the subsequent extensions are legally relevant just to that analysis. [00:10:36] Speaker 02: But I take the broader point to be, is there something unfair about [00:10:40] Speaker 02: allowing the proposition that we are advancing. [00:10:44] Speaker 02: And I guess I would say two things. [00:10:47] Speaker 02: One, the calculus about what a taxpayer might do changed over time. [00:10:52] Speaker 02: We started with the discussion of Olson and the reasons at this early point. [00:10:57] Speaker 02: It might have been the right point to sort of make the choice. [00:11:00] Speaker 02: Once you've chosen a fork, the IRS investigation or the criminal investigation is further along and the calculus might be different. [00:11:08] Speaker 02: And second, [00:11:10] Speaker 02: the undisputed testimony from Kalpova and Pettit is that they didn't know until much later. [00:11:16] Speaker 02: And that they didn't ask, at least at the key time for the extensions that were challenging, they weren't asking, you know, their outside counsel. [00:11:24] Speaker 02: In some instances, the outside counsel didn't exist yet. [00:11:27] Speaker 02: And then the later extension, that just wasn't something they were asking their outside counsel about. [00:11:35] Speaker 02: My time has expired. [00:11:39] Speaker 01: Yeah, Judge Walker. [00:11:40] Speaker 05: If I could ask one question on the extension and then maybe a question or two about the second issue of whether this was a tax shelter or not. [00:11:52] Speaker 05: On the extension, can you give me a, this is similar to a question I asked in the last argument, can you give me a case where it wasn't the tax partner who had a conflict, but it was an advisor to the partnership [00:12:07] Speaker 05: that had a conflict with regard to either the tax partner or the other partner signing an extension and the court ruled that the extension was invalid. [00:12:20] Speaker 02: Right. [00:12:21] Speaker 02: So I may have to patch that together. [00:12:24] Speaker 02: The case, the case that exists applying the propositions to statute extensions is the 22 strategic case, it comes out the other way, admittedly, but the claim there was that the, the individual taxpayers accountant had a conflict, and I think [00:12:41] Speaker 02: The best part of that case for us is the notion that the court said, well, there wasn't a conflict for the advisor. [00:12:46] Speaker 02: I don't read the cases disputing that the general Transpac proposition would apply there. [00:12:53] Speaker 02: But in terms of doctrine to get us all the way home, that's why we think you should read Transpac in light of these agency and fiduciary principles. [00:13:04] Speaker 02: And we cited the restatement [00:13:05] Speaker 02: you know, a part as a collection of actual law. [00:13:08] Speaker 02: But that's where you get essentially the third leg of the triangle, you've got, you know, the advisor and there if you have, I don't take it to be disputed that if you have an agreement, and that's the word in the statute here, right, the agreement, that's what we're doing with these extensions, where you [00:13:26] Speaker 02: a party knows or has reason to know that somebody is entering into that agreement because of a breach of fiduciary duty by an advisor, that that is grounds to avoid the contract. [00:13:39] Speaker 02: So I have to put those two things together. [00:13:41] Speaker 02: So admittedly, it's not a case from this court, but I think that's what we have. [00:13:47] Speaker 05: I appreciate that. [00:13:48] Speaker 05: And then to shift to how the [00:13:53] Speaker 05: partnership. [00:13:54] Speaker 05: And to the extent that I know you don't think say it was a tax shelter, but I want to try to figure out how it worked. [00:14:04] Speaker 05: I think I have a sense of how it worked is at least as much a sense as someone who has never run a tax shelter before might be able to figure this out. [00:14:16] Speaker 05: But I don't know if I'm supposed to ask you this or Mr. Clark. [00:14:20] Speaker 02: I'm happy to answer the question. [00:14:23] Speaker 02: OK. [00:14:23] Speaker 05: So here's how I understand it. [00:14:28] Speaker 05: And if I wanted to put something like this in a fact section of an opinion, I want to see if you think it's right or not. [00:14:38] Speaker 05: One of these limited partnerships claimed a basis in BCP that was equal to, let's say, $700 million. [00:14:49] Speaker 05: That number, according to the IRS, was high because it took into account the long option while disregarding the corresponding short option. [00:15:04] Speaker 05: I know you would say it's not artificially high, but let's put that question aside. [00:15:09] Speaker 05: This limited partnership that has claimed the basis of $700 million has a capital account with BCP [00:15:20] Speaker 05: that is reflected with a $3 million figure. [00:15:25] Speaker 05: So basis of 700 million, but a capital account of 3 million. [00:15:32] Speaker 05: And that's because that 3 million is what the limited partnership paid for the options when the premiums were netted together. [00:15:42] Speaker 05: They took the long option premium, they subtracted the short option premiums they received. [00:15:49] Speaker 05: it comes to $3 million. [00:15:52] Speaker 05: Then time passes and the limited partnership withdraws from BCP and it receives about half a million dollars worth of yen. [00:16:03] Speaker 05: And so it claims $700 million minus half a million dollars in losses. [00:16:12] Speaker 05: Now, putting aside whether that's legal, perfectly legal or [00:16:16] Speaker 05: a little sketchy or completely illegal? [00:16:19] Speaker 05: That's not my question. [00:16:20] Speaker 05: My question is, do I basically have a sense of what happened? [00:16:26] Speaker 02: I think that's right. [00:16:27] Speaker 02: I don't know that those are the exact numbers from the record. [00:16:30] Speaker 02: It's going to be hypothetical numbers. [00:16:31] Speaker 02: But that is the basic framework. [00:16:35] Speaker 02: If I could pivot to the one sentence legal point, which is that as I read ASA and BOCA, this court's decisions, the question is, [00:16:46] Speaker 02: Is there a legitimate non tax business purpose, and the thing that makes this case different from all the other cases that the commissioner sites is that we had undisputed expert testimony about the diversification benefit from this setup. [00:17:01] Speaker 02: your honor's hypothetical didn't talk about, but what is it that was being contributed? [00:17:06] Speaker 02: And I think that's the hard thing if you're going to write an opinion against us. [00:17:11] Speaker 02: What is it that you say? [00:17:13] Speaker 02: Because for whatever reason on the facts of this case, the government did not engage with the expert testimony that you in fact had diversification benefit by pooling [00:17:25] Speaker 02: options from one partner that were in some currencies with options with other partners. [00:17:30] Speaker 02: And by doing that, you did what diversification usually does, which is reduce variability. [00:17:35] Speaker 02: So it's a little like putting some money in a bank account and not leaving it all on the stock of the company you just left. [00:17:41] Speaker 05: So since you opened that door, let me ask. [00:17:46] Speaker 05: Here's my thinking on diversification here, and you tell me why you think I'm wrong. [00:17:53] Speaker 05: Diversification is obviously a business purpose if you are taking money in the bank and deciding how to invest it in a way that will make more money. [00:18:05] Speaker 05: So maybe I'll invest it in bonds and that'll make some money. [00:18:08] Speaker 05: Maybe I'll invest in stocks, that'll make some money. [00:18:10] Speaker 05: Maybe I'll invest it in real estate. [00:18:13] Speaker 05: But you could always just keep it in the bank and neither make nor lose money. [00:18:19] Speaker 05: And your argument seems to be [00:18:22] Speaker 05: that this was diversification because they took some of the money that they could have kept in the bank and they put it in a place where they were guaranteed to lose money. [00:18:33] Speaker 05: And I don't see how that is consistent with diversification as a business purpose. [00:18:44] Speaker 02: So I think my fundamental response to that is that diversification needs to be thought of distinct from profit motive. [00:18:52] Speaker 02: And I think the point your honor just made conflates the two. [00:18:57] Speaker 02: I mean, one way to think about it is [00:18:59] Speaker 02: Preservation of capital is another business purpose and the facts we had here were these were executives who were coming out of companies almost all of their net wealth was in the stock of that company so they needed to diversify and [00:19:15] Speaker 02: So it's not a question of having their funds in a bank and leaving them there. [00:19:20] Speaker 02: It's a question of what is the portfolio they can put together that, in aggregate, will make money, but what will avoid potentially lost capital? [00:19:30] Speaker 02: And so I take the point that there may have been other investments, and that these may not be the investments that your honor might make. [00:19:39] Speaker 02: But these were essentially bullish bets on currency. [00:19:43] Speaker 02: The experts did agree that the taxpayers had essentially a 30% chance of doubling their money if the options expired in the money. [00:19:51] Speaker 02: And so it was a losing investment. [00:19:53] Speaker 02: But the question is, does that [00:19:56] Speaker 02: cross over the business, does that have no business purpose? [00:20:00] Speaker 02: And that, I think, to return to what is hard for the court, if you're going to rule against us, is what do you say in the portion of the opinion where you say, we know we have undisputed expert testimony that there was, in fact, a diversification benefit achieved, and you have the language of BOCA and ASA which says, [00:20:20] Speaker 02: It's the absence of a non-tax business purposes that is fatal. [00:20:25] Speaker 02: So we're not talking about, you know, a facade, we're talking about a case where you have evidence of a substantial business purpose and you need to balance the language, BOCA and ASA against the other proposition, which is the taxpayers are allowed to organize their affairs in light of tax benefits and sometimes to take advantage of tax benefits. [00:20:47] Speaker 05: You said that there's evidence there was a 30% chance of doubling their investment. [00:20:52] Speaker 05: I thought that there was something that was either undisputed or was a factual finding by the tax court, that there was no way that the amount of money your clients could have made [00:21:15] Speaker 05: there was no way that that amount would be bigger than the amount of the fees that came along with the transactions. [00:21:22] Speaker 02: Yeah, and I'm sorry, I should correct. [00:21:25] Speaker 02: 30% is if you have a particular option pair, what are the chances that it expires in the money, not the lottery payment, but just if the currency moves, and then you would double. [00:21:37] Speaker 02: The net premium paid was 16.5 for all the pairs, and you would then have 34. [00:21:42] Speaker 02: But you're correct that if you're thinking about it from a profit potential, you have to also take into account the fees paid, which as I understand it were 40 million on top of the 16.5 premium that you paid. [00:21:58] Speaker 02: So if I run that math and you take into account, you know, [00:22:02] Speaker 02: the 30% chance of doubling your money. [00:22:04] Speaker 02: It is a losing proposition, as your honor stated, but the question is, you're still preserving some capital. [00:22:09] Speaker 02: I think it gets to something like, you know, you have a chance of preserving 60% of your capital. [00:22:15] Speaker 02: So again, that may not be what the optimal investment would have been. [00:22:19] Speaker 02: It may not be. [00:22:20] Speaker 05: And this is a friendly question, but I take it that when you're dealing with this much amount of money, [00:22:25] Speaker 05: You can't just safely put it in one bank account and leave it there and say, well, I know it won't make money or lose money because I guess there's a risk what the bank would would go under. [00:22:35] Speaker 05: And there's not that much amount of money is not insured by FDSE. [00:22:38] Speaker 05: I mean, I'm way over my head here. [00:22:40] Speaker 05: But am I [00:22:41] Speaker 05: Is that kind of your point? [00:22:43] Speaker 02: I agree. [00:22:45] Speaker 02: And that's part of the reason. [00:22:46] Speaker 02: That's why I said the facts here, you have four corporate executives whose net wealth was completely concentrated in the stock of the company they had just finished running. [00:22:57] Speaker 02: They couldn't trade while they were still there. [00:23:00] Speaker 02: And that is very different than a bank account. [00:23:03] Speaker 02: If your company gets into trouble as can occur, then your net wealth may go down. [00:23:09] Speaker 02: And I don't think the FDIC ensures at the level of assets we're talking here. [00:23:16] Speaker 01: But there's other places you could get in terms of diversification. [00:23:18] Speaker 01: There's other places you could go. [00:23:21] Speaker 01: that would allow for that kind of diversification without baking in a profit loss? [00:23:25] Speaker 02: That's correct. [00:23:28] Speaker 02: But I think the question is not, was this the optimal investment? [00:23:33] Speaker 02: Or even the question is not, was this a rational investment? [00:23:38] Speaker 02: Is there a legitimate non-tax business purpose? [00:23:42] Speaker 02: Again, the thing about the record of this case that I don't think the tax court engaged with was the expert testimony unrebutted that there was, in fact, an objective diversification benefit because of the pooling. [00:23:54] Speaker 02: And that's a fact that's not present, as I read, in any of the other cases cited by the commissioner. [00:24:00] Speaker 01: OK. [00:24:01] Speaker 01: Thank you, Mr. Marwell. [00:24:02] Speaker 01: Unless my colleagues have further questions? [00:24:04] Speaker 01: No. [00:24:05] Speaker 01: We'll hear from Mr. Clark, and we'll give you the rebuttal time you requested. [00:24:09] Speaker 01: Mr. Clark? [00:24:10] Speaker 04: Good morning, and may it please the court, George Clark on behalf of the Esri and LeMay appellate entities. [00:24:16] Speaker 04: As Mr. Marwell indicated, I'm going to address Rule 63, but obviously also here to field any specific questions you have about Esri and LeMay. [00:24:25] Speaker 04: Rule 63 requires two things, basic things. [00:24:28] Speaker 04: One, that the judge be sufficiently familiar with the record, and two, that the judge determine that the case can be completed without prejudice. [00:24:36] Speaker 04: On that second point, [00:24:37] Speaker 04: The rule actually puts an affirmative duty on the judge to make that determination. [00:24:41] Speaker 04: And as the advisory committee specifically cautioned, courts risk error to determine the credibility of a witness that's never been seen or heard. [00:24:49] Speaker 04: And that's natural. [00:24:50] Speaker 04: That makes sense, right? [00:24:51] Speaker 04: I mean, the Supreme Court's instructed that courts always have to be sensitive to the problems of making credibility determinations. [00:24:57] Speaker 04: We understand that, right? [00:24:58] Speaker 04: You need to be able to see these witnesses speak. [00:25:01] Speaker 04: Echoing the advisory committee, you know, this court in Thompson explained that a retrial could be warranted even with the party's consent if the credibility of witnesses is in question. [00:25:13] Speaker 04: So let's talk about these credibility determinations, right, that Judge Holmes made. [00:25:17] Speaker 04: As Mr. Marwell and you have been discussing, you know, a key question in the case is whether E and Y misled the taxpayers regarding its criminal investigation when the statute extensions were signed by Charles Bolton. [00:25:30] Speaker 04: That's kind of core to the case on the timeliness point. [00:25:34] Speaker 04: Now, for their part, the taxpayers testified that E and Y never told them about the investigation and certainly never told them that E and Y had a desire to cooperate or intended to cooperate, right, with the government. [00:25:46] Speaker 04: But without hearing from the taxpayers, Judge Holmes, and the sites I'm going to give you are from the Joint Appendix of 2408, which is the opinion at 44, Judge Holmes found that he could not believe that ENY hid its intent from the taxpayers as they claim. [00:26:01] Speaker 04: He also found that as to Mr. Estrin and Mr. LeMay, that they understood quote, far more than they let on, and that this quote undercut their claim that they had blindly relied on ENY. [00:26:12] Speaker 04: Again, this is all without ever hearing them speak. [00:26:15] Speaker 04: Finding witnesses lacking credibility on such critical points without even seeing them speak isn't even due process, much less consistent with Rule 63. [00:26:24] Speaker 04: Now, in fairness, [00:26:26] Speaker 04: Judge Holmes pointed to King and Spaulding. [00:26:28] Speaker 04: That was an outside counsel. [00:26:29] Speaker 04: Mr. Manuel referred to some of these people had outside counsel. [00:26:32] Speaker 04: So he referred to King and Spaulding's involvement as a contemporaneous advisor is one of the reasons why he didn't believe that they relied solely on Ian White. [00:26:39] Speaker 04: But both Mr. Esfrey and Mr. Lemay testified in detail as to why King and Spaulding was hired, what their relationship was, how they talked to King and Spaulding, what they relied on King and Spaulding for, what they didn't. [00:26:50] Speaker 04: And remember this, King and Spaulding didn't know about this criminal investigation, right? [00:26:54] Speaker 04: They couldn't have. [00:26:55] Speaker 04: Ian White didn't tell them, and Ian White didn't tell the clients. [00:27:00] Speaker 04: Similarly, Judge Holmes relies on this mid-2003 call from the New York Times to Mr. LeMay. [00:27:07] Speaker 04: He says that's something that should have gotten Mr. LeMay as a sophisticated businessman should have got his antenna up. [00:27:12] Speaker 04: but nowhere in the opinion nowhere in the opinion does it address that on in the witness stand mr lemay specifically talked about what he did after he got that call that he picked up the phone and called bob copeland eny and said bob what is going on with this and bob copeland told him look this has nothing to do with you it has nothing to do with this case it has to do with you know these eny record keeping and filing compliance issues mr mr clark let me give you a chance to uh [00:27:42] Speaker 05: to correct where I am on this. [00:27:45] Speaker 05: I understand your argument to be that very sophisticated businessmen, your clients, had read in the newspaper, had been told by a newspaper reporter, and had been told by King and Spalding that Ernst and Young might be up to no good. [00:28:05] Speaker 05: And the reason, according to you, why it was justifiable for them to continue to rely on Ernst & Young is because they called Ernst & Young and said, is everything on the up and up? [00:28:14] Speaker 05: And Ernst & Young said, yes. [00:28:18] Speaker 05: I don't know that that would be justifiable reliance with the most unsophisticated party, but we're talking about corporate tycoons here. [00:28:29] Speaker 05: Tell me why I shouldn't go down that road. [00:28:33] Speaker 04: First, Your Honor, I would say that the sophistication of the executives notwithstanding, they had been in relationships with ENY since the 80s. [00:28:43] Speaker 04: They trusted ENY with everything in their financial lives. [00:28:48] Speaker 04: So there's an evolution. [00:28:49] Speaker 05: I'm sorry, Mr. Clark, hadn't they already been asked to resign by Sprint because they had previously taken the advice of Ernst & Young? [00:29:01] Speaker 04: It depends on which points of time you're talking about, Your Honor. [00:29:05] Speaker 04: You'd have to look at the timeline. [00:29:06] Speaker 04: There are points in time when some of this happened that was after that point. [00:29:10] Speaker 05: The first time they signed the extension was December 4, 2003. [00:29:14] Speaker 05: That was as May. [00:29:18] Speaker 05: So let's take that. [00:29:20] Speaker 05: By December 4, 2003, hadn't they already [00:29:25] Speaker 05: been asked, maybe I'm wrong on my timeline, had they been asked to resign by sprint by December 4th, 2003, because they had followed in part because they had made some decisions based on bad advice from Ernst & Young. [00:29:37] Speaker 04: Your honor, I believe that is correct. [00:29:39] Speaker 04: I believe that is correct. [00:29:41] Speaker 05: But your argument is that it was still justifiable for them, even having lost their jobs. [00:29:46] Speaker 05: to continue to rely on the people whose advice had cost them their jobs? [00:29:51] Speaker 04: Your honor, what I'm saying is, E and Y was telling them that there was nothing to worry about, that they were OK, and that this would work out OK. [00:29:59] Speaker 04: And what matters in our context is no one that has decided this opinion has sat and listened to them and seen their faces and had them explain this, not me, about what they were thinking. [00:30:12] Speaker 05: But they can send it to that. [00:30:14] Speaker 05: They can send it to that, right? [00:30:17] Speaker 04: Go ahead. [00:30:18] Speaker 04: Sorry. [00:30:18] Speaker 04: We consented to a decision without recall of witnesses. [00:30:21] Speaker 04: We didn't agree to a decision that made factual findings that were contradicted by unrebutted testimony. [00:30:26] Speaker 04: Okay. [00:30:26] Speaker 04: When I say unrebutted, well, but your honor, when I say unrebutted, right, we're not talking about consent. [00:30:31] Speaker 05: Let's say I consented to arbitration, but I didn't like how the arbitrator found facts. [00:30:36] Speaker 05: No, I don't think you can go over that. [00:30:37] Speaker 05: I mean, this is also on my mind. [00:30:39] Speaker 05: So I'll give you a chance to tell me why I shouldn't be. [00:30:42] Speaker 05: You know, Sprint, for example, while your clients were running it, had contracts of adhesion all the time. [00:30:50] Speaker 05: And I'm sure Sprint was arguing in court every day of the week that, for example, the arbitration clauses in those contracts of adhesion should be enforced. [00:30:59] Speaker 05: And I'm sure that their opposing parties were saying, you know, like, we didn't really know what we were getting into. [00:31:04] Speaker 05: And your clients would be saying, no, the deal is a deal. [00:31:06] Speaker 05: A contract is a contract. [00:31:07] Speaker 05: An agreement is an agreement. [00:31:09] Speaker 05: And for them to then come here and say like, yes, we signed the extensions and we made an agreement. [00:31:15] Speaker 05: But, you know, we were, we were misled by a third party advisor. [00:31:21] Speaker 04: You know, this isn't a little thing. [00:31:22] Speaker 04: This is a big thing. [00:31:23] Speaker 04: Your third party advisor under criminal investigation after Arthur Anderson has actually imploded because of a criminal investigation. [00:31:30] Speaker 04: Ian, why it was all hands on deck to try to save that entity. [00:31:33] Speaker 04: I mean, they hired Williams and Connelly, the most sophisticated criminal tax counsel in D.C., right? [00:31:38] Speaker 04: They were seriously concerned about this. [00:31:40] Speaker 04: But let me go back to the point about, you know, this unrevoted point. [00:31:43] Speaker 04: We're not talking about a situation where [00:31:45] Speaker 04: We have one witnesses that my witness said the light was green and the other witness said the light was red. [00:31:50] Speaker 04: Okay. [00:31:51] Speaker 04: In that you can blame us for not asking for, you know, for not asking for a retrial. [00:31:56] Speaker 04: Okay. [00:31:57] Speaker 04: No witnesses testified to the contrary and all these statements that I was talking about no witnesses contest with the country. [00:32:02] Speaker 04: There's no contrary documents. [00:32:04] Speaker 04: When IRS counsel cross examine these men, they drew the same testimony. [00:32:08] Speaker 04: It's all one way. [00:32:10] Speaker 04: And as Judge Holmes was putting his opinion together, if he's thinking to himself, I don't believe these people. [00:32:15] Speaker 04: I just don't believe them. [00:32:16] Speaker 04: He needs to ask for a recall himself so that he can see what they say. [00:32:20] Speaker 04: I thought they were credible. [00:32:21] Speaker 04: I can't vouch for my own clients. [00:32:22] Speaker 04: I can't vouch for witnesses. [00:32:24] Speaker 04: But somebody needs to hear them say this as a matter of due process and under Rule 63. [00:32:29] Speaker 05: My only last thing, Mr. Clark, is with regard to Williams and Connolly, I'd always heard everyone say that Baker and McKenzie were the best tax lawyers in D.C. [00:32:41] Speaker 05: I'll take your word for it on Williams and Connolly. [00:32:45] Speaker 04: Thank you, Your Honor. [00:32:46] Speaker 01: Unless my colleagues have anything further for you, Mr. Clark, we'll hear from the government. [00:32:51] Speaker 01: Thank you. [00:32:53] Speaker 01: Mr. Rubin? [00:32:56] Speaker 03: Good morning. [00:32:57] Speaker 03: May it please the court? [00:32:58] Speaker 03: My name is Jennifer Rubin, and I represent the commissioner in this case. [00:33:02] Speaker 03: This case arises from a marketed tax shelter in which taxpayers used short-term, self-contained, guaranteed money-losing transactions to generate artificial tax losses far in excess of the money [00:33:16] Speaker 03: that they paid to participate in it. [00:33:18] Speaker 03: The tax court properly appell timeliness and the substance of the commissioner's administrative adjustments. [00:33:24] Speaker 03: I'd like to start with timeliness. [00:33:27] Speaker 03: And, you know, as I was reading through the reply brief, it really struck me that the taxpayers here are seeking to expand the TransPAC line of cases in four critical ways. [00:33:39] Speaker 03: Let's go through each of the four and then go through back through them in more detail. [00:33:43] Speaker 03: Number one, they're seeking to expand to advisors and not just to the signatories on the extension concepts. [00:33:51] Speaker 03: Number two, they're seeking to broaden [00:33:54] Speaker 03: conflict to include any time that a third party has an incentive to favor their own interest without requiring any IRS knowledge that these taxpayers in particular likely have different views on extending the time. [00:34:10] Speaker 03: Number three, they're trying to rely on institutional knowledge without any showing that the people who obtained the extensions, the people in exams had any reason to know of any alleged conflict. [00:34:22] Speaker 03: And number four, they've tried to expand the understanding of what is a criminal investigation. [00:34:28] Speaker 03: Let's go through each of those back in order. [00:34:32] Speaker 03: Back to number one. [00:34:33] Speaker 01: Can you repeat number two? [00:34:35] Speaker 01: Sorry. [00:34:35] Speaker 01: I just wanted to make sure I get that before you go back to number one. [00:34:39] Speaker 03: Sure. [00:34:39] Speaker 03: And if you'd like, I could start by talking with that one. [00:34:41] Speaker 03: It's broadening the concept of conflict of interest. [00:34:44] Speaker 03: to include any time a third party has an incentive to favor their own interests and not requiring RS knowledge that the taxpayers likely have a contrary view on extending the time. [00:34:57] Speaker 03: And I'm going to hook here directly to the Henry Martinez case out of the Fifth Circuit. [00:35:02] Speaker 03: At 564 F3rd at 729, it says it requires a showing that the tax matters partner had cause to prefer his own interests and that the IRS knows that the quote, actions are more than likely contrary to the wishes and interests of the limited partners. [00:35:21] Speaker 03: All three invalidating cases here actually include those specific facts, both that the IRS knew that there were incentives to favor their own interests and that the tax matter partners interests actually conflicted with the actual or likely interests of the partners. [00:35:40] Speaker 03: Transpact, the IRS knew that the tax matters partner were aware that they were targets of an active criminal investigation and they knew that the limited partners had refused to sign extensions. [00:35:52] Speaker 03: Leather stocking, the IRS knew that the tax matter partner had a secret plea agreement. [00:35:57] Speaker 03: with the government, promising to help resolve the tax claims of the taxpayers. [00:36:03] Speaker 03: And also knew that the taxpayers partner was defrauding the limited partners who therefore had an interest in expediting the investigation in order to establish, to learn about the fraud and to stop the fraud. [00:36:20] Speaker 03: Number three, River City ranches. [00:36:22] Speaker 03: The IRS knew that the taxpayers partner was defrauding the limited partners [00:36:27] Speaker 03: and knew that the IRS had already lost the first case in that particular tax shelter and needed additional time to investigate the tax shelters. [00:36:36] Speaker 03: which was how they uncovered the fraud, such that the limited partners had specific reasons to expedite litigating their case. [00:36:45] Speaker 03: And what's really interesting is the taxpayers in their reply brief go into, oh, here's this tax court remand from River City's ranches where they threw out this extension. [00:36:56] Speaker 03: But what's really interesting there is that they didn't throw out all the extensions in the case. [00:37:01] Speaker 03: They only threw out the extensions after the IRS learned [00:37:04] Speaker 03: of those contrary interests after they learned about the fraud. [00:37:08] Speaker 01: So can I ask you, is your broader point here, I get that there's some detail factual points about these cases that may or may not be salient distinctions, but is your broader point here that, look, there's only so much that the IRS can be expected to investigate and look into before it relies on these extensions because it needs to be able to rely on extensions because that sets the kind of administrative architecture so that the IRS can go on and do its work. [00:37:33] Speaker 01: And you'd have to dig really, really deeply to figure out what was underlying some of this. [00:37:37] Speaker 01: Whereas in some of the cases that you were just talking about, it was obvious. [00:37:40] Speaker 01: The IRS already knew. [00:37:41] Speaker 01: Is that the point? [00:37:43] Speaker 01: Or is it that actually the underlying incentive structures were different in those cases as opposed to this one? [00:37:50] Speaker 01: And that in those cases, there was actually a reason to want to deny the extensions. [00:37:53] Speaker 01: Whereas here, there's not a reason to want to deny the extensions. [00:37:58] Speaker 01: Because as to the latter one, there is [00:38:01] Speaker 01: There is testimony in the record that there was a reason that the taxpayers might want to deny the extensions. [00:38:05] Speaker 01: There was a tactical reason that they might want to deny the extensions. [00:38:09] Speaker 03: It takes both points. [00:38:11] Speaker 03: Obviously, as we argue in our brief, we need to be able to rely on extensions and but I would say that [00:38:19] Speaker 03: The fact that there's specific knowledge of reasons specific to these taxpayers in Transpac, Leatherstocking, River City, Ranches, why they in particular might not want to extend is actually quite relevant because they don't have anything of that here. [00:38:35] Speaker 03: They have somebody who comes back after the fact as an expert, I don't think actually admitted to talk about this point, but in all events comes in and says, well, theoretically, hypothetically, it might have been to their benefit to not extend, maybe. [00:38:50] Speaker 03: But there's no indication that the IRS was aware that they were more than likely [00:38:55] Speaker 03: would not have wanted to extend. [00:38:56] Speaker 03: In fact, the IRS was aware of one very big reason why they would want to extend, and that is the potential to participate in a global settlement initiative, which in fact, for the CDS shelters, the IRS did provide a global settlement offer in 2006, which only taxpayers who had extended their time were gonna be eligible to try to get ahold of. [00:39:21] Speaker 03: And notably, most taxpayers did in fact [00:39:24] Speaker 03: seems to be like they settled their cases for CDS. [00:39:28] Speaker 03: Very few actually tried to litigate their CDS shelters. [00:39:34] Speaker 03: And so from the IRS's perspective, and there's absolutely nothing contrary to this to show that the IRS had specific knowledge that these taxpayers had more interest in expediting than in extending. [00:39:51] Speaker 03: you know, they would look at it and say, I think they have an interest in continuing to go forward and have the period be extended so that they could potentially be offered at the global settlement. [00:40:04] Speaker 03: And so I would say it's really both of the points that she made, because clearly, especially when you consider going back to my first point, that they're trying to extend TransMAC beyond just the tax matters partner who actually signed [00:40:18] Speaker 03: The extension to the advisor. [00:40:21] Speaker 03: It really does mean that we would have to do an investigation of each and every extension, particularly in partnership cases and that Can I ask you this question, though, just at a high level of generality. [00:40:30] Speaker 01: So, so if you have a situation in which let's suppose there's no gap between Bolton and the and why let's just take that Out of the field division. [00:40:38] Speaker 01: I know you don't want to do that. [00:40:39] Speaker 01: And, and I think that might have been your first of four points. [00:40:41] Speaker 01: I can't remember, but let's just, let's just suppose that we just collapse it and we only have one [00:40:47] Speaker 01: conjoined entity that's an issue. [00:40:49] Speaker 01: So we remove that gap. [00:40:51] Speaker 01: And then we also say that the IRS knows that that joint entity has a conflict of interest. [00:41:02] Speaker 01: But the IRS doesn't know that the taxpayers would have a reason to deny an extension. [00:41:11] Speaker 01: But are you saying that even in that situation, [00:41:14] Speaker 01: that we should take the extensions at face value? [00:41:18] Speaker 03: Yes, because you need to, for there to really be a conflict of interest under these cases. [00:41:23] Speaker 03: And again, I'm going to point you to Martinez. [00:41:25] Speaker 03: You need to show both that the person you signed, let's just say hypothetically that Bolton was the one that there was an investigation of. [00:41:34] Speaker 03: So we'll just take Borenstein-Young for a moment. [00:41:36] Speaker 03: You'd have to know that Bolton had an incentive to favor his own interests, but you'd also need to know that his interests actually conflicted, more than likely conflicted, with the interests of the taxpayers. [00:41:50] Speaker 03: Otherwise, if you have an interest to favor your own interests, but they happen to align with the taxpayers, [00:41:57] Speaker 03: No harm, no foul. [00:41:58] Speaker 03: And that's what the case law says. [00:42:00] Speaker 03: And there's been absolutely no cases that have thrown out any extension consents where there hasn't been a showing that the IRS was aware of specific facts establishing that the taxpayers either objected to extending the time as in TransPAC. [00:42:16] Speaker 03: Or likely would have objected as in leather stocking and River City ranches. [00:42:21] Speaker 03: There's simply no case that supports that and for good reason. [00:42:25] Speaker 03: You need to be able the tax system relies on extensions extensions are very frequently given out [00:42:32] Speaker 03: It's a kind of standard, you know, I believe both Phillips and Madison Recycling made the point. [00:42:39] Speaker 03: This is kind of plain vanilla. [00:42:41] Speaker 03: This is something that happens all the time. [00:42:43] Speaker 03: And so for the IRS to look behind it, they really need to have some reason to think that these taxpayers had reason not to sign. [00:42:51] Speaker 03: And not just some hypothetical that someone came up with years after the case, but actually had facts at the time saying these taxpayers had reason not to extend. [00:43:01] Speaker 03: And therefore, I have reason to distrust the extension that I'm going to rely on. [00:43:06] Speaker 03: There's several hundred million dollars of taxes at issue here. [00:43:10] Speaker 03: The IRS relied on these extensions. [00:43:12] Speaker 01: It's not enough that there's just a conflict. [00:43:15] Speaker 01: I mean, when we talk about a conflict of interest, we're assuming that there's a conflict of interest as between and you're the way you helpfully refashioned the hype of Bolton. [00:43:23] Speaker 01: and the taxpayers. [00:43:25] Speaker 01: We're assuming that there's a conflict of interest, but what you're saying is even the existence of a conflict of interest as between those two doesn't matter unless the IRS has reason to think that as to the particular issue of granting an extension, there would be a reason that Bolton would want to acquiesce on an extension, but the taxpayers might not. [00:43:41] Speaker 03: Exactly, exactly. [00:43:43] Speaker 01: I don't think you need to win that in order to get an affirmance here. [00:43:49] Speaker 01: I understand that that may be your theory. [00:43:51] Speaker 03: No, I think they lose if they lose on any one of these points. [00:43:56] Speaker 03: This is a tremendous expansion they're looking for and every single one of these points I think is very problematic, but we don't have to win all four. [00:44:03] Speaker 03: Absolutely not. [00:44:04] Speaker 03: They're all independent. [00:44:06] Speaker 03: Turning to number three, they're relying on an institutional knowledge of a conflict and they're not requiring any showing that the employees in examinations knew the alleged conflict. [00:44:16] Speaker 03: Again, in each of the cases, as best as I can read them, Transpac, Leatherstocking, River City Ranches, the people handling the exams, the ones who actually obtained and relied upon the administrative adjustments, they actually had knowledge of the facts that were relevant, which is not true here. [00:44:34] Speaker 03: Now, it is true, as my opposing counsel noted. [00:44:39] Speaker 03: There is some language in Phillips regarding attributing knowledge of examinations [00:44:44] Speaker 03: and the Criminal Investigation Division to the Commissioner, but there's nothing saying that you should go in reverse. [00:44:52] Speaker 03: And the fourth and final thing is that they've really expanded an understanding of what it is for there to be an active criminal investigation for anybody to be aware of. [00:45:01] Speaker 03: You know, as my opposing counsel described it, you know, you have this phone call that comes from somebody at the Southern District of New York who says, hey, I saw an article. [00:45:10] Speaker 03: I think you should be preserving documents and let me know if there's anything illegal has gone on. [00:45:15] Speaker 03: The following month in July 2002, the chief counsel of the IRS talks to counsel for Ernst & Young and says, [00:45:25] Speaker 03: you know, we have not made any criminal referral for Ernst & Young. [00:45:29] Speaker 03: Also, that same person from the Southern District of New York also talks to Ernst & Young's counsel and says, yeah, they have not made any criminal referral at this time, which they hint a lot on that at this time language. [00:45:43] Speaker 03: But, you know, I'm still concerned. [00:45:45] Speaker 03: And based on that, they say, well, there's your incentive to go against [00:45:51] Speaker 03: our interest, which again, no showing that it is against their interest, but it also is very problematic that they have expanded it to this extent that if somebody somewhere in the Department of Justice makes a phone call that there you go, suddenly we should be assuming that Ernst & Young is acting outside of the interests [00:46:10] Speaker 03: of the taxpayers. [00:46:11] Speaker 03: And again, I know for hypothetical sake, we assumed that Bolton had a conflict. [00:46:17] Speaker 03: But again, there's absolutely no evidence of that in the record and certainly no evidence that the IRS would have been aware that he had any conflict. [00:46:26] Speaker 03: And that being the fact, if you focus solely on the tax matters partner, which we believe you should under the case law, they lose. [00:46:34] Speaker 03: And one final point, they did make a point, my opposing counsel made a point regarding timeliness saying, well, you know, you have to have the [00:46:44] Speaker 03: The extension has to be done before the time has run out. [00:46:47] Speaker 03: And so you should ignore all the subsequent ones. [00:46:49] Speaker 03: We don't think that's true because I think it does go to whether in fact they actually had any conflict of interest here. [00:46:55] Speaker 03: But in all events, that really raises the point that since they've conceded everything, all the extensions that were done after [00:47:02] Speaker 03: September 2004, they basically conceded timeliness for tax year 2001 because all the extensions that happened for tax year 2001 were in later timeframes after Insta-MUON was no longer involved. [00:47:18] Speaker 03: So really, timeliness only goes to tax year 2000. [00:47:21] Speaker 03: If I could briefly turn to the sham partnership thing, I just wanted to reiterate that to the extent that there was any diversification benefit, it was solely within the context of this short-term self-contained money losing tax shelter. [00:47:39] Speaker 03: And it only really operated in tandem with doing two things that were critical to operation of the tax shelter. [00:47:46] Speaker 03: Number one, consolidating in one partnership so you could get that basis increase. [00:47:50] Speaker 03: And number two, ensuring that you've got some distribution of yen. [00:47:55] Speaker 03: It basically kind of reduced the chances that any one of these partnerships would have $0 distributed to them from the partnership. [00:48:04] Speaker 03: Are there any further questions on sham partnership or on Wilson? [00:48:09] Speaker 05: On sham partnership, Ms. [00:48:10] Speaker 05: Rubin, what's the difference between an illegal tax arrangement and [00:48:20] Speaker 05: the things that people do all the time, where they, you know, instead of putting your money, instead of putting money that you want your kids to inherit, in a bank account, you put it in a trust, or you want, you know, you want, my understanding is that people make decisions all the time that have no purpose other than to avoid paying taxes, and that those are, [00:48:50] Speaker 05: those are legal. [00:48:51] Speaker 05: And then I also am completely on board with the case law from our circuit and elsewhere that there is a line that someone can cross and it becomes illegal. [00:49:02] Speaker 05: How is this different than a parent putting money in a trust so the kid inherits money that's more tax free than it would otherwise be? [00:49:15] Speaker 03: Well, the trust situation is one where somebody has actually taken a material step to remove themselves from having control of that money and put it into some other entity. [00:49:25] Speaker 03: And the laws of trust are pretty complex. [00:49:30] Speaker 05: But maybe just like a, you know, they put their money in a 401k instead of a regular stock market account and they do it because it has tax benefits. [00:49:39] Speaker 03: Right. [00:49:41] Speaker 03: that's because that's what the law intended and what the economic sham doctrine basically is really all about is saying you know congress can't think of every single thing and so we're going to look behind this transaction and say was there a legitimate business purpose or was this simply for tax avoidance and not for what congress intended congress [00:50:05] Speaker 03: Say, for instance, with your 401k example, Congress decided to give an incentive to people to put money aside for their retirement and said, okay, we're going to let you do this up to this certain amount, and you're going to get some tax benefits from that because we want you to do that. [00:50:23] Speaker 03: Ms. [00:50:24] Speaker 05: Rubin, let's imagine that I'm a tax lawyer and a client comes in and says, [00:50:30] Speaker 05: You know, I have $100 million and I want to pay as little taxes as possible. [00:50:35] Speaker 05: That's my only goal. [00:50:37] Speaker 05: Give me your advice. [00:50:38] Speaker 05: Am I allowed to answer that question? [00:50:43] Speaker 03: Yes, you're allowed to answer that question, but you're not allowed to pick a tax shelter that is basically just economic waste done in order to create artificial tax losses. [00:50:54] Speaker 03: A lot of the problem here is that there were artificial tax losses. [00:50:59] Speaker 05: That's my question is, what's the difference between artificial tax losses and tax losses? [00:51:07] Speaker 03: Okay, so for example, they paid $16.5 million net to purchase these option pairs, but they claimed $3.1 billion of losses from them. [00:51:20] Speaker 03: And you know that since they didn't economically experience those losses, they weren't really the types of losses that Congress intended you to deduct. [00:51:29] Speaker 03: That's an artificial tax loss. [00:51:31] Speaker 03: It's money that you claim you lost, you didn't lose. [00:51:35] Speaker 03: You know, and here what you have is these taxpayers, you know, CalCOVID and Pettit saw that they were going to have a whole lot of money coming in. [00:51:49] Speaker 03: So they engaged in a whole bunch of tax shelters. [00:51:51] Speaker 03: They engaged in Cobra Shelter, they engaged in CTS, and then they engaged in add-on. [00:51:58] Speaker 03: add-on in particular, it created these absolutely artificial tax losses and had zero chance of being profitable, which is at this point, really, it's uncontested. [00:52:12] Speaker 03: That being the case, you know, you look at it and you say, is this really what Congress intended was for someone to engage in something that has zero chance of profiting in order to claim losses they didn't experience on their tax returns? [00:52:24] Speaker 03: And that's really where Ace Investorings and the Culbertson line of cases that ASA actually relied upon. [00:52:34] Speaker 03: And Boca Investorings, which cited both ASA and Culbertson, and in tech, which cited both ASA and Culbertson. [00:52:42] Speaker 03: That's what these cases are really saying, is that when you really have this transaction that's actually just a wasteful transaction, [00:52:49] Speaker 03: way of claiming false artificial tax losses without any real business benefit. [00:52:56] Speaker 03: And we stand by on our brief as to why, in fact, their diversification argument really was just a facade. [00:53:04] Speaker 03: Because again, it was just within the context of this tax shelter that was designed to create artificial tax losses. [00:53:12] Speaker 01: Can I ask just one last, one last, unless my colleagues have further questions. [00:53:15] Speaker 01: One last question, which I think is in the same vein as Judge Walker's question. [00:53:20] Speaker 01: There's some sense that this tax, I'm not trying to use scheme pejoratively, but I just, I can't think of off the top of my head of another word for this, but the tax enterprise at issue here is a sec is a cousin of son of boss. [00:53:35] Speaker 03: Yes. [00:53:36] Speaker 01: And can you just describe at whatever level of generality you choose? [00:53:41] Speaker 01: and as efficiently as possible, why this is a cousin of son of boss, since we already know that son of boss is a tax mechanism that fits in the category of unlawful ones. [00:53:55] Speaker 03: So basically you have this transfer to a central partnership of a pair of assets, one of which was [00:54:09] Speaker 03: in theory, worth a lot of money. [00:54:11] Speaker 03: And the other one, which was absolutely attached, had a contingent liability. [00:54:19] Speaker 03: And then by putting in the partnership, they claim the basis [00:54:23] Speaker 03: for the high value item and ignored the contingent liability. [00:54:29] Speaker 03: Even though when they actually bought these two items, they paid a net premium that was substantially lower. [00:54:36] Speaker 03: Then when they inevitably lost money, they came back and said, oh my gosh, [00:54:43] Speaker 03: I lost all of the spaces that I had in this partnership in BCP. [00:54:48] Speaker 03: And it really all comes down to that same stream. [00:54:51] Speaker 03: I believe the tax court has a nice little paragraph that we quoted in full in our brief that just kind of goes through why this is a cousin, but that's really what it comes down to is the pairing of the asset and the contingent liability while ignoring the contingent liability for purposes of your basis claim. [00:55:09] Speaker 01: Okay. [00:55:10] Speaker 01: Thank you, Ms. [00:55:10] Speaker 01: Rubin. [00:55:11] Speaker 01: Mr. Marwell, I believe you requested two minutes. [00:55:14] Speaker 01: We'll give you your two minutes of rebuttal. [00:55:17] Speaker 02: Thank you, your honor. [00:55:19] Speaker 02: If I can talk first about whether we are asking for material expansion of Transpac. [00:55:25] Speaker 02: One observation, a decent portion of the commissioner's argument relied on issues that the tax court did not make findings on, such as the IRS's knowledge or lack of knowledge. [00:55:39] Speaker 02: And that puts this court in an awkward position [00:55:42] Speaker 02: If the court concludes that those are the key issues, then a remand may well be appropriate. [00:55:49] Speaker 02: Two reasons why we're not asking for a substantial extension. [00:55:52] Speaker 02: First, the basic conflict here that the extension was being granted [00:55:59] Speaker 02: at the urging or direction of somebody who was under criminal investigation is the same as in Transpac. [00:56:05] Speaker 02: And the Second Circuit found it essentially self-evident that somebody signing, that there would be a divergence between the interest of the person who's under investigation and the limited partners. [00:56:20] Speaker 02: As to the question of whether the IRS had specific reason to know that the signatories here might have had a different interest than the taxpayers, Transpac cited the Internal Revenue Manual for this proposition. [00:56:35] Speaker 02: The IRS would, I think, would at least be on notice of that and that fundamental conflict. [00:56:42] Speaker 02: On the institutional knowledge and the question of which agency employees, I take the Commissioner to be asking this court to do something different than the Ninth Circuit. [00:56:53] Speaker 02: And you do have, even if you disagree with the Ninth Circuit, you have things like the IRS's Non-Docketed Service Advice quoted in our brief that says, [00:57:01] Speaker 02: even the target of a civil promoter audit can have a conflict for largely the same reasons as the criminal, as the target of a criminal investigation. [00:57:10] Speaker 02: And as to whether there was an active criminal investigation or not, I mean, the key is whether the Ernst & Young and the signatory was under intense pressure because of the existence of a criminal investigation. [00:57:24] Speaker 02: And the Southern District called Ernst & Young a week after Arthur Anderson was convicted and essentially imploded [00:57:29] Speaker 02: because of these kinds of things. [00:57:31] Speaker 02: And so I think whether or not you think it's one investigation or it was interrupted, the pressure existed, in our view, until 2013. [00:57:39] Speaker 02: I see my rebuttal time. [00:57:42] Speaker 02: Could I make one point on the sham partnership? [00:57:45] Speaker 02: Thank you. [00:57:49] Speaker 02: The key problem for the commissioner, I think, is the record here at trial and the undisputed expert testimony about the diversification benefit. [00:57:57] Speaker 02: There is all sorts of things that taxpayers do with an eye towards tax benefits. [00:58:03] Speaker 02: Think about purchasing municipal bonds, an investment you might not make, but for the tax benefit. [00:58:08] Speaker 02: The court should hold the line on VOCA and ASA and stick with the view that if you have a legitimate non-tax business purpose, that is enough to avoid this very harsh medicine of shamming the partnership. [00:58:22] Speaker 02: If there are no further questions. [00:58:24] Speaker 01: Thank you, counsel. [00:58:25] Speaker 01: Thank you to all counsel. [00:58:26] Speaker 01: We'll take this case under submission.