[00:00:00] Speaker 05:
The next case is Grenier versus United States, 15-51-44.

[00:01:09] Speaker 05:
Mr. Desmond, you reserve three minutes for rebuttal, is that correct?

[00:01:15] Speaker 05:
Yes, Your Honor.

[00:01:19] Speaker 05:
Are you all ready on that side?

[00:01:22] Speaker 05:
Is everybody ready?

[00:01:22] Speaker 05:
Yes, please.

[00:01:22] Speaker 05:
All right, you may proceed.

[00:01:24] Speaker 01:
I appreciate the support.

[00:01:25] Speaker 01:
My name is Michael Desmond.

[00:01:26] Speaker 01:
I am the attorney for the appellants in this case, Jeffrey and Kim Greiner.

[00:01:31] Speaker 01:
This case, and if I may, I reserve three minutes of my time for rebuttal.

[00:01:35] Speaker 01:
This case involves a proper tax treatment

[00:01:37] Speaker 01:
of income received by Mr. Greiner on the buyout of a contractual earn-out right.

[00:01:43] Speaker 01:
The Court of Federal Claims below never reached the merits of that issue.

[00:01:46] Speaker 01:
Instead, looking to technical issues and technical rules under the accounting provisions of the tax code to find that there had been a change in method of accounting, and again, not addressing the merits of the case.

[00:01:57] Speaker 01:
There are three aspects of this case that I'd like to highlight for the Court today.

[00:02:01] Speaker 01:
First is just the basic nature of the earn-out right, which I think it's important to understand because it colors the understanding of the legal arguments.

[00:02:08] Speaker 01:
The second, and again, is how income associated with that earn-out right should be taxed or treated for the tax accounting rules in the Internal Revenue Code.

[00:02:17] Speaker 01:
And then third, I'd like to address an opening briefly of the government's duty of consistency argument.

[00:02:21] Speaker 01:
It's an alternative argument.

[00:02:22] Speaker 05:
Are you saying that there was not any change in the method of accounting that occurred?

[00:02:27] Speaker 05:
Correct.

[00:02:29] Speaker 05:
And this is including with the

[00:02:31] Speaker 05:
earn out in 2004, the treatment of that.

[00:02:34] Speaker 05:
Correct.

[00:02:37] Speaker 04:
And I think that gets to the crux of the issue.

[00:02:39] Speaker 04:
You're going to explain that at some point.

[00:02:41] Speaker 01:
I'm going to explain that, yes, your honor.

[00:02:43] Speaker 01:
Thank you.

[00:02:44] Speaker 01:
Let me just touch briefly on the nature of the earn out right.

[00:02:47] Speaker 01:
It's contractual earn out right, and there are three things that happen relevant to this case.

[00:02:51] Speaker 01:
The first is Mr. Greiner received that earn out right in kind, contractual right, in 2004 when his stock options in Advanced Bondes Corporation were canceled.

[00:03:01] Speaker 05:
And how do you treat that for accounting purposes?

[00:03:03] Speaker 01:
For accounting purposes, it was not taxed and not treated as income.

[00:03:07] Speaker 01:
So in 2004, the in-kind receipt of a contract right was treated as an open transaction.

[00:03:14] Speaker 01:
So no tax was paid in 2004.

[00:03:17] Speaker 01:
Moving forward, in 2006 and 2007, payments were made to Mr. Greiner with respect to the earn-out right.

[00:03:24] Speaker 01:
So there's a contract saying if certain targets are met, gross income targets on these product lines, you will get payments.

[00:03:30] Speaker 01:
Those payments were made.

[00:03:31] Speaker 01:
Tax was paid on those payments.

[00:03:35] Speaker 01:
Again, consistent with the open method.

[00:03:38] Speaker 01:
Well, yes, consistent with the open method.

[00:03:41] Speaker 01:
I don't think that that in and of itself is an open method, because you're actually looking at the income in 2006 and 2007.

[00:03:47] Speaker 01:
He's not deferring it in 2006.

[00:03:49] Speaker 01:
He's actually paying tax on it.

[00:03:51] Speaker 01:
But it is consistent with the open method was adopted in 2004.

[00:03:55] Speaker 01:
To contrast that with the closed method, if you want to look back in 2004,

[00:03:59] Speaker 01:
Had he paid tax in 2004 on receipt of the in-kind right, those payments made in 2006 and 2007 would have been tax-free to Mr. Greiner.

[00:04:08] Speaker 01:
He would have paid no tax because it would have been a recovery of his basis in the contract.

[00:04:14] Speaker 01:
And I think that the Court of Claims below recognized that.

[00:04:16] Speaker 05:
So your amended returns were, in effect, changed the open transaction of the 2004 earned out right.

[00:04:25] Speaker 01:
No, I think that begs the question as to what item we're talking about.

[00:04:28] Speaker 01:
And I will agree that it is inconsistent with an open transaction method.

[00:04:33] Speaker 01:
But it is not a change in method, and there's a key distinction there.

[00:04:37] Speaker 01:
So yes, in 2004, there was an open transaction method.

[00:04:41] Speaker 01:
So I think to illustrate, he received an in-kind contract right in 2004 and treated that as an open transaction.

[00:04:49] Speaker 01:
Had he received another contract, another earn-out right from a different company or from the same company in 2006 or 2008, 2009, he would have had an open method for the in-kind receipt of a contract right.

[00:05:01] Speaker 01:
But that's not what he got in 2008 and 2009.

[00:05:03] Speaker 01:
And it's not what he got in 2006 and 2007.

[00:05:05] Speaker 01:
There are separate items of income that came in.

[00:05:09] Speaker 01:
And if you've got separate items of income, as the Federated case says and the Capital One case say,

[00:05:16] Speaker 01:
You have a different item, and therefore no change.

[00:05:18] Speaker 01:
You've got a different transaction.

[00:05:21] Speaker 01:
And you can't have a change in method if you've got a totally different transaction.

[00:05:25] Speaker 03:
How is the difference in a different item of income between 2004 and 2006 and 2007?

[00:05:31] Speaker 03:
Let's put aside the settlement payments, even though I know those are at the heart of the case, because I think those are a little harder.

[00:05:37] Speaker 03:
But the earn out right gave him a right to income in the future.

[00:05:41] Speaker 02:
Correct.

[00:05:42] Speaker 03:
And that income in the future

[00:05:44] Speaker 03:
in the 2006-2007 was paid.

[00:05:47] Speaker 02:
Correct.

[00:05:49] Speaker 03:
I don't understand how those are different forms of income.

[00:05:52] Speaker 03:
One is guaranteeing you this or giving you this future income later to be terminated and the second is the result of that.

[00:06:00] Speaker 01:
I would turn to the language in the federated case which says, and there are very few cases that actually get into the specifics of defining what an item of income is.

[00:06:07] Speaker 01:
Federated and Capital One I think are the two leading cases.

[00:06:11] Speaker 01:
And federated has language that says you look to what generates the income

[00:06:14] Speaker 01:
the facts generating the income, the transaction generating the income is basically the same in different tax years, then you have the same item of income.

[00:06:24] Speaker 03:
Why isn't that 2004 agreement the transaction generating the income in 2006 and 2007?

[00:06:32] Speaker 03:
Because it set up the formulas and the rights to that income.

[00:06:36] Speaker 01:
Correct.

[00:06:36] Speaker 01:
Because the income is in kind receipt.

[00:06:39] Speaker 01:
If somebody gives you a contract, or a share of stock, or a car for performing services for them, that is income.

[00:06:47] Speaker 05:
Could you have treated the 2004 payment as a capital asset at that time, or as possession of a capital asset?

[00:06:56] Speaker 01:
Yes, but Section 83 would govern the treatment of it.

[00:07:00] Speaker 01:
And we recognize, so if somebody other than Mr. Greiner, who had provided services to Advanced Bionics, had received that right, and in fact, there were stockholders

[00:07:09] Speaker 01:
They were investors, so they would treat it as a capital asset.

[00:07:12] Speaker 01:
Mr. Greiner received the stock options initially as an employee.

[00:07:16] Speaker 05:
That's a crux there.

[00:07:17] Speaker 05:
Later on, you want to change the character of the 2004 payment to make it a capital asset.

[00:07:22] Speaker 01:
Well, I don't think we want to change the character.

[00:07:24] Speaker 01:
We want to change the reporting.

[00:07:25] Speaker 01:
The character is what it is.

[00:07:27] Speaker 01:
And yes, you're right.

[00:07:28] Speaker 05:
Well, I guess the name.

[00:07:31] Speaker 05:
You're now looking at it and saying this was a capital asset.

[00:07:36] Speaker 01:
Well, I think we are, Your Honor.

[00:07:38] Speaker 01:
In 2004, we say Section 83, which governs very broadly the receipt of property for services, we say that's turned off in 2004 because it was converted.

[00:07:48] Speaker 01:
And the regulations under Section 83, 1.83-7a, says specifically that although you can defer income when you get a stock option, as soon as you exercise the stock option or trade it for something else, you close the transaction.

[00:08:03] Speaker 01:
And it's taxable.

[00:08:05] Speaker 01:
So we say in 2004, Mr. Greiner, he didn't exercise the option, but he traded it for something else.

[00:08:12] Speaker 05:
Could you have treated that option as a capital asset at that time?

[00:08:17] Speaker 05:
Yes.

[00:08:18] Speaker 05:
But you chose not to?

[00:08:20] Speaker 01:
It was not reported that way.

[00:08:21] Speaker 01:
I don't know if there was a deliberate choice made.

[00:08:23] Speaker 01:
There was language in the disclosure documents.

[00:08:25] Speaker 01:
No, but that kind of determines the accounting method, right?

[00:08:28] Speaker 01:
For future receipts of contract rights in kind, we would agree with that.

[00:08:32] Speaker 01:
Right.

[00:08:32] Speaker 01:
Yes.

[00:08:33] Speaker 01:
But it doesn't determine the accounting method for payments made on the contract right.

[00:08:38] Speaker 01:
And it doesn't determine the accounting method for dispositions, income received on dispositions.

[00:08:43] Speaker 01:
And I go back, the analogy we draw in our briefs, Your Honor, is a share of stock.

[00:08:49] Speaker 01:
So if I receive a share of stock, that is income to me.

[00:08:52] Speaker 01:
It can be a gift.

[00:08:52] Speaker 01:
It can be for services provided.

[00:08:54] Speaker 01:
It can be a lot of things.

[00:08:54] Speaker 01:
But if somebody gives me a share of stock, that's income.

[00:08:58] Speaker 01:
Two years later, I get dividends on that stock.

[00:09:01] Speaker 01:
That's also income, but it's a different item of income.

[00:09:03] Speaker 01:
Why?

[00:09:03] Speaker 01:
If you look at federated, federated would say that the transaction that gave rise to that income in the later years.

[00:09:09] Speaker 03:
But in your hypothetical, if somebody gives you a share of stock, don't you pay taxes on it because it's income?

[00:09:15] Speaker 01:
Not necessarily.

[00:09:17] Speaker 01:
You could treat that as a gift.

[00:09:19] Speaker 01:
Non-taxable under section one or two of the income revenue code.

[00:09:22] Speaker 03:
Well, let's assume it wasn't a gift.

[00:09:25] Speaker 03:
I mean, it wasn't a gift here, clearly.

[00:09:27] Speaker 03:
Correct.

[00:09:27] Speaker 01:
Correct.

[00:09:28] Speaker 01:
You could treat it as compensation for services.

[00:09:31] Speaker 03:
In which case you would pay taxes on it, right?

[00:09:33] Speaker 01:
Unless you treat it as an open transaction, correct.

[00:09:36] Speaker 01:
But the basic rule is you would pay tax on that if you received it as services, correct?

[00:09:40] Speaker 01:
The ordinary income.

[00:09:41] Speaker 01:
Ordinary income if received in exchange for services, correct.

[00:09:44] Speaker 03:
And then if you treat it as income and then you sell it later on, and assume there was a profit, is that profit treated as income or capital gains?

[00:09:56] Speaker 01:
Capital gain is income.

[00:09:58] Speaker 01:
Capital gain is a type of income.

[00:09:59] Speaker 03:
Sure.

[00:10:00] Speaker 03:
I'm not a tax lawyer.

[00:10:01] Speaker 03:
Share with me.

[00:10:02] Speaker 03:
But as capital gains, income are regular taxable income.

[00:10:07] Speaker 04:
It would be taxed as a capital gain depending on how long you held it, wouldn't it?

[00:10:11] Speaker 01:
It would be capital gain irrespective, but as long-term capital gains subject to preferential tax if you held it more than a year.

[00:10:15] Speaker 01:
Correct.

[00:10:17] Speaker 01:
So, but I think I'll go back again to the language in federated and I think it's echoed also.

[00:10:22] Speaker 03:
Let me ask you this.

[00:10:23] Speaker 03:
If somehow you received that stock and you treat it as an open transaction and you didn't pay any taxes on it, regular taxes on it, when you sold it later, would the income from that be treated as a capital gain or a regular income tax?

[00:10:39] Speaker 01:
It would be treated as capital gain.

[00:10:41] Speaker 01:
The fact that you didn't pay tax in 2004 in this example,

[00:10:44] Speaker 01:
is irrelevant to the treatment.

[00:10:46] Speaker 01:
It would be very relevant to the duty of consistency, Doctor.

[00:10:49] Speaker 05:
How can you treat it as a capital gain if you don't treat it as a capital asset?

[00:10:54] Speaker 01:
Well, you would treat it as a capital asset, Your Honor.

[00:10:55] Speaker 01:
But you didn't in 2004.

[00:10:57] Speaker 01:
You just didn't report tax on it.

[00:10:59] Speaker 01:
That doesn't mean it's not a capital asset.

[00:11:01] Speaker 01:
A piece of property is generally going to be a capital asset.

[00:11:05] Speaker 05:
The accounting method that you used in 2004 did not treat it as a capital asset.

[00:11:12] Speaker 01:
I don't think it spoke to the treatment as capital ordinary.

[00:11:15] Speaker 01:
It treated it as an open transaction.

[00:11:19] Speaker 04:
Which he's entitled to do as if he hadn't received anything that was taxable.

[00:11:25] Speaker 01:
On the theory that it was too hard to value, the Burnett versus Logan case.

[00:11:29] Speaker 04:
When he received payments in later years, you keep saying those payments are not related to what he got in 2004, and I'm having trouble

[00:11:39] Speaker 01:
I'm saying they are definitely related, just like a dividend is related to receipt of the stock, just like disposition of stock, income on that is related to original receipt of the stock.

[00:11:51] Speaker 01:
They're just not the same quote item of income for tax purposes.

[00:11:55] Speaker 01:
And that's a very important distinction because you don't change methods for accounting purposes just because there's a factual nexus between in-kind receipt of stock and sale of the stock 50 years later doesn't mean they're the same thing.

[00:12:08] Speaker 03:
Again, this is difficult for me.

[00:12:10] Speaker 03:
I think what you're trying to say is that there's a difference if we look at the material items.

[00:12:16] Speaker 03:
The 2004 item is different from the 2007-2008.

[00:12:21] Speaker 03:
But what if what we're looking at for purposes of 2007-8 and 2004 is just the 2004 agreement, that that's the material item.

[00:12:32] Speaker 03:
accounting method you changed in 2007, 2008, the way you looked at that prior thing.

[00:12:38] Speaker 03:
Putting aside how you described the 2007 and 2008 payments.

[00:12:41] Speaker 03:
Right.

[00:12:43] Speaker 01:
I think, Your Honor, the distinction is that for accounting method purposes, you have to look to an item of income.

[00:12:51] Speaker 01:
So this pen is not an item of income.

[00:12:53] Speaker 01:
This is a piece of property.

[00:12:55] Speaker 01:
So for item of income purposes under section 446E, you don't call it the pen.

[00:13:01] Speaker 01:
You call it the income.

[00:13:02] Speaker 01:
Somebody gives this to me.

[00:13:03] Speaker 01:
That's an item of income.

[00:13:04] Speaker 01:
I rent this to somebody.

[00:13:06] Speaker 01:
I get income.

[00:13:07] Speaker 01:
I sell this.

[00:13:08] Speaker 01:
That's income.

[00:13:08] Speaker 01:
That's three distinct items of income.

[00:13:11] Speaker 01:
You don't say, well, that's a pen.

[00:13:13] Speaker 01:
That's a balance sheet item.

[00:13:14] Speaker 01:
We're talking about income.

[00:13:15] Speaker 05:
But what if you call that a capital asset?

[00:13:18] Speaker 05:
I bought the pen.

[00:13:19] Speaker 05:
I possess it.

[00:13:21] Speaker 05:
I expect that it's going to increase in value in the future.

[00:13:26] Speaker 05:
I'm going to treat this as a capital asset.

[00:13:30] Speaker 01:
The rental income you receive for renting out that pen would be ordinary income irrespective of the fact that it's a capital asset.

[00:13:37] Speaker 01:
So I think the capital asset versus ordinary asset really isn't the issue.

[00:13:41] Speaker 01:
It's the income that an asset generates.

[00:13:43] Speaker 01:
It's an income statement issue versus a balance sheet issue.

[00:13:47] Speaker 05:
The issue here is whether or not you changed accounting methods without the permission of the IRS.

[00:13:55] Speaker 01:
With respect to an item of income, correct.

[00:13:59] Speaker 01:
So you've got to have an item of income, not just an item.

[00:14:01] Speaker 04:
Your argument is that until those later payments came in, there was no item of income to account for.

[00:14:09] Speaker 01:
There was an item of income.

[00:14:11] Speaker 01:
It was in-kind receipt of contracts.

[00:14:14] Speaker 01:
So had Mr. Greiner, as I said, received another contract the next year, in-kind, from Advanced Bionics or anyone else, he would have adopted a method of reporting for in-kind receipt of contracts.

[00:14:27] Speaker 01:
But dividends paid on it

[00:14:29] Speaker 01:
or disposition of contracts is a different item of income.

[00:14:33] Speaker 01:
You have to look at the income coming in.

[00:14:35] Speaker 01:
The accounting treatment doesn't care about the balance sheet.

[00:14:37] Speaker 01:
The accounting treatment cares about the income or deductions as well.

[00:14:41] Speaker 04:
So what is your bottom line of all of this?

[00:14:44] Speaker 04:
Your bottom line is that there never was a change in?

[00:14:49] Speaker 01:
In the way Mr. Greiner and Mrs. Greiner treated dispositions of contract rights.

[00:14:57] Speaker 01:
buyout.

[00:14:58] Speaker 03:
What about the 2006, 2007 payments?

[00:15:00] Speaker 03:
Didn't they initially treat that as ordinary income times the regular rate?

[00:15:06] Speaker 03:
They did.

[00:15:08] Speaker 01:
And again, those are like dividends on stock.

[00:15:09] Speaker 01:
It's an item of income that is distinct factually.

[00:15:13] Speaker 03:
So I know you think it's a different characterization and you may be right on this, but suppose the 2007, 2008 items were also ordinary income.

[00:15:23] Speaker 03:
That's begging the question.

[00:15:26] Speaker 03:
They were the same types of payments.

[00:15:28] Speaker 03:
I know you say they were settlement payments versus payments of the earn-out right.

[00:15:32] Speaker 03:
Let's just assume they were also payments of the earn-out right.

[00:15:37] Speaker 03:
Wouldn't you now be changing the accounting method for those later payments versus the 2006-2007 payments?

[00:15:46] Speaker 01:
Yes, and that's what the lower court did below, is define the entire universe as a unitary item of income.

[00:15:52] Speaker 01:
And once you define the entire universe as the nail, then the change of method is a hammer that hits all of it.

[00:15:57] Speaker 01:
But Federated and Capital One and the other few cases that discuss the issue say you have to look to the facts that give rise to the income.

[00:16:05] Speaker 03:
OK, but I just want to make clear, because I don't think you... And again, it's probably my fault.

[00:16:10] Speaker 03:
Let's assume that 2006's payment of the earn-out rate was ordinary income that you treated as ordinary income, which is what you did.

[00:16:17] Speaker 03:
It was.

[00:16:20] Speaker 03:
Correct.

[00:16:21] Speaker 03:
it being a settlement payment, if the 2008 payment was also an ordinary, or not right, wouldn't this consistency require it to be treated the same?

[00:16:34] Speaker 03:
Yes, Your Honor.

[00:16:35] Speaker 03:
So the key distinguishing factor on that from six to eight is that

[00:16:39] Speaker 03:
You think it's a settlement payment, which is a different item of income.

[00:16:42] Speaker 03:
Correct.

[00:16:43] Speaker 01:
So if the settlement had never occurred and Mr. Greiner received the payments in 8 and 9 under the ordinary course of the contract right, he would have adopted a method for items, the dividends, if you will, in 6 and 7 that would have bound him in 8 and 9.

[00:16:57] Speaker 01:
But he didn't get those ordinary dividend type payments in 8 and 9.

[00:17:00] Speaker 01:
There was a corporate divorce, and he got what the papers characterize as buyout payments in 2008 and 2009.

[00:17:06] Speaker 01:
The facts giving rise to those are a corporate divorce.

[00:17:09] Speaker 01:
not dividends paid pursuant to the merged corporation, and not an in-kind contract received in connection with a corporate combination in 2004.

[00:17:17] Speaker 05:
OK, you're very close to being out of time, but I'll restore your rebuttal time.

[00:17:24] Speaker 05:
OK, thank you, Your Honor.

[00:17:29] Speaker 05:
That's true.

[00:17:29] Speaker 05:
Councillor Snyder.

[00:17:30] Speaker 00:
May it please the court, Deborah Snyder for the United States.

[00:17:34] Speaker 00:
The issue in this case is that the Griners cannot get the refunds that they seek for 2008 and 2009 without constructively changing their earn-out reporting going back to 2004.

[00:17:48] Speaker 00:
And in fact, the Griners have admitted that all the reporting is interdependent.

[00:17:52] Speaker 00:
When you look at their administrative refund claims, they said that they shouldn't have used the open transaction method.

[00:17:59] Speaker 00:
They should have reported a closed compensation transaction in 2004.

[00:18:04] Speaker 00:
And they should have paid tax on the fair market value of the earn-out payments in 2004.

[00:18:10] Speaker 03:
How is the 2004 earn-out right contract the same type of item as the seven and eight payment?

[00:18:17] Speaker 00:
Right.

[00:18:18] Speaker 00:
And I understand you're asking about the taxpayer's primary argument in this case, which is that it's different items of income.

[00:18:25] Speaker 00:
And that doesn't work.

[00:18:26] Speaker 00:
basically for three overarching reasons.

[00:18:30] Speaker 00:
First, it's beside the point.

[00:18:32] Speaker 00:
Second, it contradicts the record.

[00:18:33] Speaker 00:
And third, it's wrong as a matter of law.

[00:18:36] Speaker 00:
The reason it's beside the point is because the taxpayers have admitted that the open transaction method is a method of accounting.

[00:18:44] Speaker 00:
And they've also admitted that they need to use the closed transaction method as of 2004 in order to get the refunds that they seek in this case.

[00:18:53] Speaker 00:
So that's a claim that would change the timing of when they report the value of the earn-out right.

[00:19:01] Speaker 00:
And they admit that as well.

[00:19:02] Speaker 00:
There's actually a chart in the Court of Federal Claims opinion.

[00:19:06] Speaker 03:
The material items we're talking about here aren't really the 2007 and 2008 payments.

[00:19:11] Speaker 03:
It's the treatment of the 2004 earn-out right itself.

[00:19:16] Speaker 00:
It's the income associated with the earn-out right.

[00:19:21] Speaker 03:
In 2004, it was treated as an open transaction.

[00:19:25] Speaker 03:
In order to get the tax treatment they want for the 2007-2008 payments, they have to change the treatment of that earlier right.

[00:19:34] Speaker 00:
Right.

[00:19:34] Speaker 00:
I mean, the value of the earn-out right is really the same thing as the value of the payments.

[00:19:38] Speaker 05:
In the amended returns, you want to treat that income as a capital gain.

[00:19:43] Speaker 00:
That's right.

[00:19:44] Speaker 05:
And the only way you can get a capital gain is if you treat the 2004 earn-out payment as a

[00:19:51] Speaker 05:
capital asset, and they didn't do that.

[00:19:53] Speaker 05:
And that would be a closed transaction.

[00:19:55] Speaker 00:
They would have to treat it as a closed transaction.

[00:19:57] Speaker 00:
They'd also have to prove independently of the method of accounting issue that there was a sale or exchange of a capital asset.

[00:20:05] Speaker 00:
That's actually a separate hurdle that they have to overcome.

[00:20:08] Speaker 00:
But Your Honor is absolutely correct.

[00:20:10] Speaker 00:
In order to get the capital gain treatment for 08 and 09, they'd have to change their method of accounting to the closed transaction method, going back to... Why wouldn't IRS give them permission to do that?

[00:20:22] Speaker 05:
Excuse me?

[00:20:23] Speaker 05:
Why would the IRS not give them permission to do that?

[00:20:26] Speaker 05:
Because... Leading us up to amended returns.

[00:20:29] Speaker 00:
The statute... Well, the timing... I mean, the years 2004 is a closed year.

[00:20:35] Speaker 00:
But the statute, section 446E, says that a taxpayer cannot change a method of accounting retroactively.

[00:20:43] Speaker 00:
A taxpayer has to request the IRS's permission for a change before changing the method.

[00:20:49] Speaker 00:
And this is something that Capital One actually discusses, that if this were not the rule, you'd send revenue projection basically into a roiling and unpredictable state.

[00:21:00] Speaker 00:
So what Capital One is actually, it's a resounding reaffirmation of the government's ability to hold a taxpayer to the method of accounting that they use on their returns.

[00:21:12] Speaker 00:
What Capital One did is they had tried

[00:21:15] Speaker 00:
They had filed a request to change the method of accounting.

[00:21:18] Speaker 00:
The request was ambiguous.

[00:21:20] Speaker 00:
Then they reported late fees in a certain way on their returns.

[00:21:24] Speaker 00:
And then Capital One, sort of like taxpayers here, wanted to retroactively change their method and say, we should have reported it differently starting back then.

[00:21:33] Speaker 00:
And the court said, no, it doesn't matter.

[00:21:37] Speaker 00:
if the taxpayer is arguing that the new method is the only correct method, you can't retroactively change a method of accounting.

[00:21:46] Speaker 00:
I'd also note that the argument that the 2008 and 2009 payments are a different item from the other earn-out income contradicts the record.

[00:21:59] Speaker 00:
Because when you look at the amendments to the merger agreement, which is how the parties settle the litigation,

[00:22:05] Speaker 00:
The amendments refer to these payments as the first earn-out payment, that was the 2008 payment, and the earn-out obligation, that was the 2009 payment.

[00:22:16] Speaker 00:
So all of these rights arose from the 2004 merger agreement.

[00:22:22] Speaker 00:
Mr. Greiner received an earn-out right in exchange for the cancellation of his stock options.

[00:22:28] Speaker 00:
And basically what the settlement and what the amendments were doing is they were establishing

[00:22:34] Speaker 00:
a value and a payment schedule for that right as part of unwinding the merger, essentially.

[00:22:42] Speaker 00:
Another problem with the different item of income argument is that it also misunderstands how the open transaction method works.

[00:22:50] Speaker 00:
I understand that they're saying they adopted the open transaction method of accounting, but only for the in-kind receipt of contract rights.

[00:22:59] Speaker 00:
The reason that doesn't work is because the open transaction method

[00:23:04] Speaker 00:
is when a taxpayer takes the position that they've received something, but the value cannot be ascertained in the year of receipt.

[00:23:14] Speaker 00:
But the flip side of the open transaction method is that they need to report the income over time in the years that it's received.

[00:23:22] Speaker 00:
If a taxpayer adopted the only transaction method only for the first year, the taxpayer would never report any income, because that's the year that they're saying the value cannot be ascertained.

[00:23:33] Speaker 00:
So I mean, for all of those reasons, we think the Court of Federal Claims was correct when it defined the item of income as the income associated with the earn out, right, or earn out income for short.

[00:23:45] Speaker 00:
But again, we don't even necessarily have to get into what is or isn't an item of income, because the taxpayers have admitted the open transaction method is a method of accounting, and that they would have to change the closed transaction method of accounting as of 2004,

[00:24:00] Speaker 00:
in order to get the capital gain treatment that they seek for 2008 and 2009.

[00:24:08] Speaker 00:
Another point I would make is that this is not stock.

[00:24:13] Speaker 00:
So I'm not sure that an analogy to stock is really helpful.

[00:24:20] Speaker 00:
Really what this was is that it was a right to future payments, sort of like the lottery cases or something like that.

[00:24:30] Speaker 05:
the foundation of the government's argument that... Can a taxpayer choose to treat an earn-out right as a capital asset?

[00:24:38] Speaker 00:
Well, it's not a choice.

[00:24:42] Speaker 00:
It's a question.

[00:24:43] Speaker 00:
In order to get capital gain treatment, they would have to show that they sold or exchanged a capital asset.

[00:24:50] Speaker 00:
And the taxpayer in this case could not have chosen to treat the earn-out right as a capital asset because all it was was a right to future payments.

[00:24:58] Speaker 00:
analogous to the lottery cases.

[00:25:00] Speaker 00:
The principle is that if what a taxpayer holds is a right to future payments, getting a lump sum in exchange for those future payments does not convert the ordinary income to capital gain.

[00:25:15] Speaker 00:
So I would say no.

[00:25:16] Speaker 00:
And the other issue is that in order to get capital gain treatment, they would have to have sold or exchanged the earn-out right.

[00:25:26] Speaker 00:
Either a sale or an exchange involves a transfer.

[00:25:29] Speaker 00:
And there was no transfer of the earn-out right to Boston Scientific.

[00:25:34] Speaker 00:
It was essentially a settlement.

[00:25:36] Speaker 00:
And an extinguishment of a debt is not a sale or exchange.

[00:25:41] Speaker 00:
So no, I don't think that was a choice that was available.

[00:25:46] Speaker 00:
Anything else?

[00:25:54] Speaker 00:
If the court has no further questions, we will rest on our brief.

[00:25:58] Speaker 00:
Thank you.

[00:25:58] Speaker 05:
Thank you.

[00:26:03] Speaker 05:
Does anyone want to restore your three-minute time?

[00:26:05] Speaker 01:
Just briefly to follow up on the item of income question, I think Ms.

[00:26:10] Speaker 01:
Snyder characterized the question correctly in saying that the issue before this court is what is the income associated with the earn-out right.

[00:26:19] Speaker 01:
And I'd go back to the language, and I just looked at it again in Capital One.

[00:26:22] Speaker 01:
Capital One involved different types of fees being generated by a credit card business.

[00:26:27] Speaker 01:
And on page 161 of the tax court's decision in that case, later affirmed by the Fourth Circuit, the court says that late fees are earned for reasons independent of the reasons other type of income on credit cards is earned.

[00:26:43] Speaker 01:
And they say, finance charges, over-limit fees, interchange and advance fees.

[00:26:47] Speaker 01:
And then it concludes that late fees are a separate and distinct item of income.

[00:26:52] Speaker 01:
So capital one has all sorts of fees coming in on the credit card in the exact same year.

[00:26:56] Speaker 01:
And the court there at the government's insistence finds that those are separate items of income.

[00:27:02] Speaker 01:
Fees coming in, and I'll equate those to dividends on stock coming in the same year.

[00:27:05] Speaker 01:
If they're different kinds of dividends, preferred or ordinary, those are different items of income.

[00:27:10] Speaker 01:
We have something dramatically different from that here.

[00:27:12] Speaker 01:
We've got a corporate combination transaction

[00:27:15] Speaker 01:
where Mr. Greiner gets a contract in kind.

[00:27:19] Speaker 01:
And four years later, we have a corporate divorce where he is given buyout payments, characterized in the papers as buyout payments.

[00:27:26] Speaker 01:
So if at the government's insistence in Capital One, you've got different kinds of credit card fees in the same year being treated as separate and distinct items of income under Section 446E, how do you have completely

[00:27:41] Speaker 01:
Obviously, a corporate combination and a corporate divorce are not the same transaction.

[00:27:45] Speaker 01:
The facts giving rise to the income from those are not the same transaction.

[00:27:49] Speaker 01:
So that, I think, answers, from our perspective, the change in method.

[00:27:53] Speaker 01:
If they're different items, you don't have a change between different years.

[00:27:56] Speaker 01:
I do want to come back and touch just briefly on the duty of consistency doctrine, because I think that is where, if there's any sense of unfairness or windfall or prejudice to the government, that's where the court below should have focused its attention.

[00:28:11] Speaker 01:
reporting something in 2004 and coming back four years later saying, aha, the government statute is closed.

[00:28:17] Speaker 01:
I now get a windfall by reporting this as capital gain.

[00:28:20] Speaker 01:
And in the audit, before we ever got to the Court of Federal Claims, we presented calculations to the IRS showing that although we didn't pay tax in 2004 under an open transaction theory, not reporting method, we did pay tax up to almost the exact same amount in 2006 and 2007.

[00:28:40] Speaker 01:
such that by the time we get to 2008, we've cleared the decks on that.

[00:28:43] Speaker 01:
There's no windfall anymore.

[00:28:44] Speaker 01:
The government's not harmed.

[00:28:45] Speaker 01:
The government's not prejudiced.

[00:28:47] Speaker 01:
And as this court said in the Baker's Hughes case, in order to invoke the duty of consistency, you have to have harm and prejudice to the government.

[00:28:55] Speaker 01:
Crossley, cited by the court in Baker Hughes, calls that prejudice through the loss of taxes.

[00:29:02] Speaker 01:
Where's the loss of taxes?

[00:29:03] Speaker 01:
We showed that there is no loss of taxes.

[00:29:06] Speaker 01:
If there's some concern about paying fast and lose, it's the duty of consistency doctrine that comes back and helps the government address that.

[00:29:12] Speaker 01:
We confronted that head on.

[00:29:13] Speaker 01:
The Court of Federal Claims never addressed that.

[00:29:16] Speaker 01:
And the government doesn't address that here.

[00:29:17] Speaker 01:
It doesn't even cite Baker Hughes in its briefs.

[00:29:20] Speaker 01:
So we are not looking for a windfall.

[00:29:22] Speaker 01:
We're not looking to prejudice the government.

[00:29:24] Speaker 01:
We're looking for the proper federal tax treatment of the buyout payments received in 2008 and 2009.

[00:29:30] Speaker 01:
As a capital asset, those payments are, for Mr. Greiner,

[00:29:34] Speaker 01:
properly taxed at long-term capital gain rates.

[00:29:37] Speaker 01:
He held the contracts for more than a year.

[00:29:39] Speaker 01:
And I think on that discrete point, because Ms.

[00:29:40] Speaker 01:
Snyder referenced it, the FOIA case out of the tax court, I think, delves into the sale or exchange issue and those issues in some detail, and also the open transaction doctrine, to say that you can have contract rights.

[00:29:52] Speaker 01:
There it was janitorial service contract rights.

[00:29:55] Speaker 01:
That when you dispose of them, you get capital gain, preferential capital gain treatment.

[00:30:01] Speaker 01:
So unless the panel has any further questions, I would rest.

[00:30:04] Speaker 05:
I think we have that.

[00:30:05] Speaker 05:
Thank you very much.

[00:30:06] Speaker 01:
Thank you.