[00:00:00] Speaker 00:
is number 21-2353, GSS Holdings, Liberty, Incorporated, against the United States.

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Mr. Pinkus.

[00:00:10] Speaker 04:
Good morning, Your Honor, and may it please the Court.

[00:00:13] Speaker 04:
The context here may appear complex, but the particular question and the applicable legal principles are not.

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When parties agree to enter into a transaction in the future, it often is possible that economic circumstances will change.

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and the transaction could result in an unexpected and significant loss.

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It therefore is not uncommon for a party to obtain insurance or enter into a hedge or other backup transaction promise of payment by a third party contingent upon a loss on the underlying transaction.

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The decision below and the government's position here rest on the unprecedented and quite far reaching proposition that if such a backup payment occurs,

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The step transaction doctrine always requires that the hedge transaction and the underlying transaction be collapsed for tax purposes.

[00:01:05] Speaker 02:
Counselor, you're arguing that the court of federal claim violated the party presentation principle.

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What is it that you believe that the court created that was not addressed by any of the parties?

[00:01:21] Speaker 04:
Well, our focus in our briefs is on the Colte case and the use of the economic substance doctrine.

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But I think, Your Honor, we rest on our briefs on that issue.

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And I'd like to spend time with the court's permission to focus here on the merits, the underlying merits.

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Well, are you arguing here that the Court of Federal Claims committed a legal error independent of the violation of the party?

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presentation principle.

[00:01:47] Speaker 04:
Yes, we're arguing that the Court of Federal Claims misapplied the step transaction doctrine.

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And it may be helpful if I spend a couple of minutes just stepping through the relevant transactions, because I think that may help to sort of set the stage.

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So Liberty Street was a commercial paper conduit.

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That's an entity that issues short term notes and invests in longer term, higher yield instruments.

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And in 2006, the first transaction, Liberty purchased a note issued by Aardvark that at the time was rated AAA.

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To protect against any liquidity mismatch between its obligations on the short-term notes and its ability to get cash from its long-term investments, Liberty entered into a liquidity asset purchase facility, a LAPA.

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The LAPA provides a put for the particular asset at par value.

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BNS, which was Liberty's administrator,

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with the counterparty on the LAPA.

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And I think an important fact about LAPAs is they can be exercised even if there's no decline in value of the note.

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It can be possible that the commercial paper conduit may have to pay off its short-term notes and it may not be able to easily liquidate its long-term investments.

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So the LAPA provides for liquidity whether or not there is a decline in value of the investment that's covered.

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In 2007, to address new rules adopted by BNS's Canadian regulator that would have made that existing structure costly, Liberty Street issued a first loss note to a third party reconnaissance.

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And under that note, reconnaissance bore the first risk of first loss on all of Liberty's assets, not just the Aardvark note, but all of

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The LAPA was renewed in 2011, as BNS was obligated to do by contract.

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And in 2011, the regulatory rules again changed, and the first loss note from an independent entity no longer would have the advantageous regulatory effect.

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So a BNS affiliate, Scotia Ireland, purchased the first loss note for $40 million.

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In your opinion, is the intent in 2006-2007 different than the intent would be in 2011?

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Can you answer that question for me?

[00:04:10] Speaker 04:
Well, in two ways, Your Honor.

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Yes, it's different, and it's the 2006 and 2007 intent that is relevant under the step transaction doctrine.

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What courts have said, this court has said, and the Supreme Court have said is the inquiry.

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is whether the intent at the outset was to reach the ultimate result and the focus is on the taxpayers' subjective intent.

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And so we think... Are there record pages you could point me to?

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Pages in the joint appendix where I could see that this intent is different between those two timeframes that I just talked about?

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I think the... Well, the critical focus, I think, is on the transactions themselves.

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Because the reason that these two transactions, the LAPA and the first loss note, were entered into was for their immediate benefits to Liberty.

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The LAPA, because it provided the liquidity that I mentioned, and that liquidity was essential for Liberty to have the high credit rating that would enable it to market its commercial paper.

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So that was the intent of the LAPA.

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And the intent of the first loss note in 2007 when it was entered into was to provide

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change the structure so that the burdensome new regulatory rules would not require imposed new capital requirements.

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Those were the intended results and those were the results.

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There surely was a remote contingency that there would be the need to have underlying payoffs.

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kind of sum up what you just mentioned in terms of those two different intents.

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And if you need to give it to us on rebuttal, that's fine.

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I think I will give them to you on rebuttal.

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But I think that's what's critical.

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And I think the other critical facts to realize in 2006 and 2007 is that the contingency was extremely remote.

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The Aardvark note was rated AAA.

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When the first lost note was entered into, which covered all of Liberty's assets, the

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assessment was that there was a 0.023 percent risk that there would be any call on the first lost note.

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So we think the critical issues are the relevant timeline is 2006-2007, the relevant question is what was the intended result, and for the reasons I've said it was those immediate results, not the pay.

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So what's the error?

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Where is it that the court of thorough claims

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The Court of Federal Claims erred in two ways.

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It did not look that way.

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I'm asking again that you address your argument of the party presentation principle that the court, sua sponte, right, created a new rule.

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What is it that the court created?

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Well, what the court created was a rule that said, I can apply the first step transaction doctrine without looking at the outset of the series of transactions, the 2006, 2007 time frame.

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and only look at 2011 when the two transactions were consummated.

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Is the court limited only to the step transaction analysis here, or can it also become involved in the economic substance analysis?

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The government's entire argument below, Your Honor, was step transaction.

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its entire argument for this court, a step transaction.

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It's not relying on the economic substance doctrine.

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And in fact, that's not my question.

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Can the court rely on the economic substance analysis?

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I don't think so here, Your Honor, for two reasons.

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First of all, as I said, the government didn't raise it.

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And we think even if it was permissible there, they haven't defended it on this ground.

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This is the focus on your complaint, right?

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That the court erred because it

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it violated what you view as to be the procedure involved in the step transaction analysis.

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I think, Your Honor, we have two claims.

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We do make the procedural argument, but we go on to say the substantive merits.

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Even if there was no procedural error, the merits analysis of the Court of Federal Claims was wrong because it was a misapplication of the step transaction doctrine and because

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to the extent economic substance is relevant.

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And as I say, the government doesn't in this court defend the decision on a lack of economic substance.

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There was economic substance at each step of these transactions.

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I think just stepping back from a minute, the government's basic argument here is that it is always appropriate to collapse, as I said at the beginning, an underlying transaction with the hedge transaction that protects against the loss when the two things happen.

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Those two kinds of transactions have economic substance.

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They're widespread throughout the economy.

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People hedge all kinds of things.

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And so the notion that those transactions lack economic substance, and so as a matter of either the step transaction doctrine or the economic substance doctrine, they can sort of, in all circumstances, be collapsed, we think is just wrong, and there's no basis for it.

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And tell me if I'm understanding this correctly.

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My understanding is you're basically contending

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separate and apart from the party presentation principle, that there was a hybrid test created.

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Basically, they used an aspect of the step transaction doctrine and an aspect of the economic substance doctrine.

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Is that accurate, or could that be a misuse?

[00:09:33] Speaker 04:
I think yes, Your Honor.

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And I think it looked at under the Sepp transaction doctrine for the reasons we were discussing.

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We think that's clearly wrong.

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And looked at, even if the economic substance arguments were properly before the court, we think as a matter of economic substance, there's no showing of substance.

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Clearly, these two transactions, if you look at when they started out, the LAPRA transaction and the first loss note,

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There clearly was economic substance.

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The first lost note was held by a third party, reconnaissance.

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So if you look at those transactions when they started out and when they were renewed in 2011, they clearly had economic substance.

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They were different.

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There was a third party involved.

[00:10:09] Speaker 00:
So where does the economic substance consideration come into this?

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Anywhere?

[00:10:15] Speaker 04:
We don't think it comes in anywhere, Your Honor.

[00:10:17] Speaker 04:
We think if you look at the step transaction doctrine, the way this court has applied it, it's really a test for sort of looking at a series of transactions and saying, under the end result,

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theory, which is test, which is the one that is at issue here.

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If you look at the taxpayers' intended results at the beginning of this series of transactions, it was to reach this end result.

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And we're therefore going to disregard the transactions in the middle that create different tax consequences than if you simply went from A to D. And so that's the step transaction doctrine.

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Economic substance, obviously totally different.

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We don't think that the government makes any argument, and I don't think it could for the reasons that I was just saying, that any of these transactions lacked economic substance.

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As I say, they started out as transactions involving a third party.

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Yes, the first lost note was then sold to an affiliate of BNS, but it was sold for $40 million.

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BNS affiliates, Gosha Ireland, succeeded to the rights and obligations under it.

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It paid $40 million.

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The value of the deduction that's at issue here is about $7.5 million, so it's hard to say that there was some...

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If we conclude that the court below committed a legal error by creating what I'm calling this hybrid test that I was describing to you before, is it your opinion this legal error is not a harmless error?

[00:11:49] Speaker 04:
I think it's not harmless for multiple reasons, Your Honor.

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I think if you look at the way the step transaction doctrine should apply, as I said, it's the

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intent at the outset, if you look at the intent in 2007 and 2008, what were the intended results?

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They were the results that were realized, not these contingencies.

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So we think that legal error requires the opposite result from the one that the trial court reached.

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Do you agree in terms of a potential remedy, if we were to agree with you that was error,

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Would you agree that one remedy we could consider would be vacating and renaming?

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That certainly is one possibility.

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We think the record here, and I will supply you with some citations on rebuttal, is clear about what, just looking at the transactions, the intended results are clear.

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And looking at the state of play in 2006 and 2007, we think this court can reach that conclusion.

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But obviously, if the court decides that's not possible, a remand is an option.

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I'd like to save the remainder of my time for rebuttal.

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Let's hear from the government.

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We'll save you a rebuttal.

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Thank you, Your Honor.

[00:13:03] Speaker 00:
Ms.

[00:13:03] Speaker 00:
Wong, we were going to ask you why your view of the economic substance consideration.

[00:13:12] Speaker 01:
Mr. Pincus was actually correct that the government's argument is that the government's argument is not that any of these transactions lack economic substance.

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However, they are two separate doctrines.

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We are arguing that the step transaction doctrine applies.

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And the step transaction doctrine is, as a part of the umbrella of substance over form doctrine, the touchstone question is always what really happened.

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A tax avoidance motivation or a fictitious transaction is not necessary for that transaction doctrine to apply.

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And the court can see that in cases, the corporate reorganization cases in particular, such as a Clark from the Supreme Court,

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King Enterprises, World Court of Claims, security insurance from the Fifth Circuit.

[00:14:05] Speaker 00:
Of course, a lot of times when the step transaction doctrine is applied... Well, to interrupt the path you're on, there was no assertion that there was something fictitious about this transaction.

[00:14:21] Speaker 00:
Those were extraordinary times, I think, unforeseen, the dramatic changes in value those years.

[00:14:29] Speaker 01:
Right, so to answer the first part of your question, while we are on this economic substance of the big picture of what happened here, GSF wants to take a loss deduction under section 165 of the tax code, which gives a deduction for uncompensated business losses.

[00:14:51] Speaker 01:
So here, what happened?

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This $24 million loss was a payout from Liberty to BNS.

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And this 24 million, at the time of the transaction, came from Scotia, Ireland, which was a wholly owned subsidiary of BNS.

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So BNS, in some sense, owned the 24 million.

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So the 24 million was paid out by Liberty on the direction of BNS, as Liberty's administrator, to BNS at the Laka counterparty.

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in connection with an asset sale.

[00:15:28] Speaker 03:
So counsel, I wanted to ask you some kind of parallel questions to the questions I asked.

[00:15:32] Speaker 01:
Of course.

[00:15:33] Speaker 03:
So if we focus on that 06 to 07 time frame, are there issues of fact as to whether the end result was not the same compared to when you view it in 2011?

[00:15:46] Speaker 01:
Well, I think that before I answer the question, I think it's important to make sure that we define the end result correctly.

[00:15:54] Speaker 01:
GSS wants to define it differently than we do, and we think that's the wrong definition.

[00:15:59] Speaker 01:
It wants to define the end result as, do we make the LAPA call?

[00:16:03] Speaker 01:
Now, our definition, which is actually the last step in the transaction, the end result, is the first loss note payout of 24 million, which is relevant because, well, it's the last step, because it's the transaction on which they want to base this loss.

[00:16:21] Speaker 01:
So the intent was always for the first loss note to mitigate a loss in case of a LAPA call resulting in a loss.

[00:16:30] Speaker 03:
So just to answer my question though, are there issues of fact as to whether the end result was not the same?

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in the 2006 to 2007 versus 2011?

[00:16:39] Speaker 03:
Absolutely not.

[00:16:40] Speaker 03:
And what's your basis for saying absolutely not?

[00:16:43] Speaker 01:
Because of the legal documents, they are contemporaneous in black and white.

[00:16:47] Speaker 01:
In the program document supplement, which was thrown up on April 30, 2007.

[00:16:56] Speaker 03:
I'm going to need some record sites, but you're going to say this is so black and white.

[00:17:00] Speaker 01:
Yes, of course.

[00:17:01] Speaker 01:
Page 810, paragraph 5E.

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And that is from April 2007 and that is the document amending the administration agreement between Liberty and BNS.

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And that paragraph says, if there shall have been any losses on the Nalapa, then the administrator shall withdraw the amount of such losses and promptly pay such amount to the persons occurring such losses.

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There's an if, then, triggering

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relationship established there.

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And that was back in 2007.

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And if we want to look at it from 2011, with respect to this particular transaction, we see this intent, which was established from the beginning, from the establishment of the first loss account in the ScotiARLM memo.

[00:18:01] Speaker 01:
And that is December 21, 2011.

[00:18:04] Speaker 01:
The page site is 520.

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At that time, they knew that the bank was going to make the LAPA call on the artwork, and there would be a loss.

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And second, $24 million would be available to compensate for the loss.

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And third, by the way, there would be this tax benefit for carrying back.

[00:18:27] Speaker 01:
And nine days later, on the 30th, emails from the administrator of Liberty

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The artwork asset, which was transferred to BNS under the LAPA, has experienced the loss.

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As a result of such loss, BNS has determined the amount of the loss as $24 million.

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And I direct that amount from the first lost note account to reimburse BNS for such loss.

[00:18:52] Speaker 01:
The page site there is 11.05 from the appendix.

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So whether you look at it from 2007 or from 2011, the intent was always the same.

[00:19:05] Speaker 01:
If there is a loss, then the first loss note account gives a payout.

[00:19:11] Speaker 01:
And to go back to the rebate analogy that the government used below, because I think it makes things very simple.

[00:19:18] Speaker 01:
If a manufacturer manufactures a product, puts a coupon in the box, for some reason, it takes a year, two, three years for the customer to buy the product off the shelf.

[00:19:30] Speaker 01:
The intent of the rebate offer is still the same.

[00:19:35] Speaker 01:
The end result, the intended end result from the beginning was for the consumer to buy the product at a lower price.

[00:19:44] Speaker 02:
Did the court start at the beginning in this case?

[00:19:47] Speaker 02:
It seems to me your friend on the other side is saying that what the court did, it violated the step transaction doctrine because it did not start at the beginning.

[00:20:01] Speaker 02:
It started in the middle.

[00:20:03] Speaker 01:
Well, the Court of Federal Claims was correct, in our opinion, because it focused correctly on the transactions that we want to collapse.

[00:20:12] Speaker 02:
Do you concede that that's what the court did?

[00:20:15] Speaker 01:
Without losing sight of the intent from the beginning.

[00:20:19] Speaker 02:
How is that possible?

[00:20:20] Speaker 02:
Do you either start at the beginning or not?

[00:20:22] Speaker 01:
Well, the steps that we want to collapse are the two steps in December 2011.

[00:20:27] Speaker 01:
But we don't lose sight of what was intended from the beginning for how it was eventually intended to work.

[00:20:35] Speaker 02:
Let me ask you, if we were to find that the court did do that,

[00:20:39] Speaker 02:
started the analysis, the step transaction analysis, not at the beginning, then would you concede that you lose?

[00:20:49] Speaker 02:
Or let me phrase that differently.

[00:20:51] Speaker 02:
Would you concede that the court erred?

[00:20:52] Speaker 01:
If the panel were to find the court did not start at the beginning, meaning ignoring the intent in the beginning?

[00:21:02] Speaker 01:
Yes.

[00:21:03] Speaker 01:
Because the instruction from all the cases that the parties have cited is that you have to start the analysis from the beginning.

[00:21:11] Speaker 01:
And we look at the intent from the beginning.

[00:21:13] Speaker 02:
So if the court did not start at the beginning, and that's our decision, then the court erred, correct?

[00:21:21] Speaker 01:
If it did not look at the intent from the beginning.

[00:21:23] Speaker 01:
However, the relevant transactions happened in the end as was intended from the beginning is our argument here.

[00:21:31] Speaker 03:
And you would agree that,

[00:21:33] Speaker 03:
These are independent arguments that are being made in terms of the party presentation principle, and then separately, this independent argument about being kind of a hybrid test.

[00:21:44] Speaker 01:
Can I address that?

[00:21:45] Speaker 01:
Both of those.

[00:21:46] Speaker 01:
Yes.

[00:21:46] Speaker 01:
I can answer that.

[00:21:48] Speaker 01:
Please.

[00:21:51] Speaker 01:
Yes.

[00:21:52] Speaker 01:
OK.

[00:21:52] Speaker 01:
So about the hybrid test, because that's the last thing I remember, the lower court did borrow from COTEC, which is

[00:22:02] Speaker 01:
an economic substance case, but it borrowed from that case to identify the correct transaction, which are two steps that we want to collapse in this case.

[00:22:12] Speaker 01:
The court recognized, as we are arguing here, that we are not trying to collapse the creation of the first Lawson account, the sale of the note to Scotia Ireland.

[00:22:20] Speaker 01:
We are not collapsing that.

[00:22:22] Speaker 03:
Let's just go back to mine for a second, okay?

[00:22:27] Speaker 03:
So you agree that what they're arguing are two independent errors.

[00:22:31] Speaker 03:
They're arguing something about party presentation principle, and they're also arguing about kind of a hybrid test that was being created by the CFC.

[00:22:39] Speaker 03:
You at least agree, just answer this question.

[00:22:41] Speaker 03:
You agree that those are two independent errors that they're arguing?

[00:22:44] Speaker 01:
Yes, one is procedural, one's not a merit.

[00:22:48] Speaker 03:
And then what you just told me, too, though, is you also agree that the CFC's opinion, sorry, let me be more precise.

[00:22:55] Speaker 03:
The Court of Federal Claims opinion talks about both the economic substance doctrine and step transaction doctrine, right?

[00:23:03] Speaker 03:
Is that something you agree with as well?

[00:23:06] Speaker 03:
You mentioned the jobs law.

[00:23:07] Speaker 01:
Discussing, yes.

[00:23:08] Speaker 01:
It discussed both.

[00:23:11] Speaker 01:
OK.

[00:23:11] Speaker 03:
Thank you.

[00:23:12] Speaker 01:
Right.

[00:23:13] Speaker 01:
I'm sorry, was there another pop to your question?

[00:23:15] Speaker 01:
No, I'm OK.

[00:23:16] Speaker 01:
I'll let you know.

[00:23:17] Speaker 01:
Just making sure.

[00:23:17] Speaker 01:
Thank you.

[00:23:18] Speaker 00:
Let me ask you a policy question.

[00:23:24] Speaker 00:
Here we have some rules and protocols that as far as it looks on the record, were designed to prevent manipulation and tax avoidance.

[00:23:40] Speaker 00:
There's no question here that that was not what was behind what happened here.

[00:23:45] Speaker 00:
What happened here was because of the

[00:23:48] Speaker 00:
dramatic changes in value in those years.

[00:23:54] Speaker 00:
Is it totally inappropriate to disregard the policy and the purposes and the questions of why tax transactions where tax benefits were claimed?

[00:24:10] Speaker 01:
Your Honour is referring to what my colleague, Ms.

[00:24:13] Speaker 01:
Pincus, was saying about this being a kind of insurance ahead and then

[00:24:18] Speaker 01:
When economic circumstances changed, then they had to call in this insurance.

[00:24:24] Speaker 00:
I think there's no question here of the legitimacy of what was done.

[00:24:28] Speaker 00:
The question, until you start putting it together in this complex of, in some ways, not harmonious, I don't want to say conflicting doctrines, but they were designed for different purposes.

[00:24:47] Speaker 00:
And it makes one think just what is the role of the tax purposes and the role of judicial review?

[00:24:56] Speaker 01:
First of all, when I began my presentation, I was saying that the section of the tax code that they want to base the deduction on

[00:25:11] Speaker 01:
was this $24 million payout between related parties.

[00:25:15] Speaker 01:
So I want to make clear, first of all, that while there are legitimate business reasons for setting up each step of the transaction, as the transaction paid out, it was a loop.

[00:25:29] Speaker 01:
It's unclear where this real economic loss came from between all these related parties.

[00:25:36] Speaker 01:
And BNS controlled the timing of when to make the Laplacal.

[00:25:42] Speaker 01:
It controlled and including with the knowledge of how much was available in the first loss note.

[00:25:48] Speaker 01:
It controlled the timing of the deduction.

[00:25:53] Speaker 01:
And the step transaction doctrine does not require a nefarious

[00:26:00] Speaker 01:
a nefarious motive.

[00:26:02] Speaker 01:
Oh, one more thing I wanted to say.

[00:26:04] Speaker 02:
It does require consistency throughout the single transaction.

[00:26:11] Speaker 02:
It does require consistency throughout the steps of different transactions.

[00:26:17] Speaker 01:
The consistency of intent.

[00:26:21] Speaker 01:
Yes, and there is the consistency of intent.

[00:26:23] Speaker 02:
So if the evidence shows that they started with legitimate business reasons not to violate the tax code,

[00:26:30] Speaker 02:
then I'm having a difficult time understanding you as to how that changed later on.

[00:26:39] Speaker 01:
Because the consistency of intent is not an intent to avoid tax.

[00:26:44] Speaker 01:
It's an intent to reach a particular result.

[00:26:47] Speaker 01:
And I would refer the court to that.

[00:26:49] Speaker 01:
Right.

[00:26:49] Speaker 02:
And I think here you would say the result was to create a tax credit

[00:26:57] Speaker 02:
based on the loss between related parties.

[00:27:01] Speaker 01:
The intent was for the first loss note to mitigate a loss resulting from a LAPA call.

[00:27:11] Speaker 01:
Now, I wouldn't say the intent was to create a loss because of 707B.

[00:27:20] Speaker 02:
When you started with the first transaction, you can't discern an intent to create a loss and a write-off between

[00:27:29] Speaker 01:
related parties right but that's not the but that's not the question but that's my question to you okay sure that's correct your honor okay

[00:27:37] Speaker 01:
Yes, but I was going to refer the court to Gregory versus Helbring, an older Supreme Court case.

[00:27:44] Speaker 01:
And in that rather short opinion, the court said twice, the question for determination is whether what was done apart from the tax motive was the thing which the statute intended, and putting aside the question of motive in respect of taxation altogether and fixing the character of the proceeding by what actually occurred.

[00:28:04] Speaker 01:
And that's what we need to know here, what actually occurred.

[00:28:08] Speaker 01:
And if this happened reconnaissance, we would not have a Section 707B problem because we recognize that's a third party.

[00:28:14] Speaker 01:
However, this was Scotia Ireland as a partner in Liberty.

[00:28:19] Speaker 01:
And therein, Congress decided that this was not.

[00:28:21] Speaker 02:
So I see you're almost out of time.

[00:28:23] Speaker 02:
But I did want you to comment on the case of Falconwood.

[00:28:27] Speaker 02:
And how does that play in this case?

[00:28:31] Speaker 01:
Sure.

[00:28:33] Speaker 01:
In Falconwood, this court said that we have found no case that categorically says existence of a business motive would

[00:28:44] Speaker 01:
would preclude the step transaction doctrine.

[00:28:47] Speaker 01:
Now, it cited cases saying, well, we need the absence of a step transaction doctrine.

[00:28:54] Speaker 01:
I'm sorry, a legitimate business motive for the step transaction to apply.

[00:28:59] Speaker 01:
But it didn't really come down on one side or the other.

[00:29:02] Speaker 01:
And the facts of that case were rather singular because of the existence of a regulation.

[00:29:07] Speaker 01:
Here, we don't have that here.

[00:29:10] Speaker 01:
Did the case help or hurt you?

[00:29:13] Speaker 01:
I would say it's neutral because, in that case, there was a regulation.

[00:29:16] Speaker 02:
I'm sorry, what?

[00:29:17] Speaker 01:
It would be neutral because of the singular set of facts in Falconwood of the existence of a regulation.

[00:29:23] Speaker 01:
Here, we don't hear.

[00:29:24] Speaker 01:
We have a statute in Congress saying this kind of setup, an asset sale with this kind of setup, a loss arising from that is not deductible.

[00:29:34] Speaker 02:
That case found that there was no tax avoidance intent.

[00:29:37] Speaker 01:
Correct.

[00:29:38] Speaker 01:
But that was not

[00:29:41] Speaker 01:
That was not the fulcrum on which the court placed this decision.

[00:29:45] Speaker 01:
It was the existence of that regulation.

[00:29:48] Speaker 01:
And it gave the step transaction doctrine, which is a judicial doctrine, no place to apply in those particular set of facts.

[00:30:01] Speaker 01:
So if the court has no further questions, I would ask the court to affirm.

[00:30:08] Speaker 01:
Thank you.

[00:30:09] Speaker 01:
Thank you.

[00:30:11] Speaker 01:
Mr. Pinkus.

[00:30:13] Speaker 04:
Thank you, Your Honor.

[00:30:14] Speaker 04:
Judge Cunningham, to respond to your questions about record citations.

[00:30:18] Speaker 04:
First of all, about the LAPA and FLN underlying intent, I suggest you look at several categories.

[00:30:26] Speaker 04:
There's a 2007 memo that lays this out at appendix pages 130, 131, and 133.

[00:30:33] Speaker 04:
There also is testimony, point you to

[00:30:41] Speaker 04:
page 150.

[00:30:42] Speaker 04:
It's one of those pages that has four transcript pages on it, and the transcript page is 35 lines one to six, and also pages 239, 260, and 188.

[00:30:53] Speaker 04:
And then finally, my comments about the credit worthiness of the Aardvark note at the beginning and the assessment of what the FLN exposure was.

[00:31:03] Speaker 04:
1081 is the AAA rating of the Aardvark note.

[00:31:09] Speaker 04:
And 136 is the analysis of the first loss note exposure of 0.023%.

[00:31:16] Speaker 04:
The pages that my colleague pointed to, page 810, that's about how the FLI and the first loss note works.

[00:31:25] Speaker 04:
Yes, the first loss note, if there is a LAPA put and there is a loss, then yes, the payment under the first loss note follows.

[00:31:33] Speaker 04:
That's, of course, the structure of almost any hedge insurance transaction.

[00:31:36] Speaker 04:
So we don't think that.

[00:31:38] Speaker 04:
reference to what happens when that remote contingency occurs.

[00:31:41] Speaker 04:
It says anything about what the taxpayers' intent was in the beginning in 2006 and 2007, and my friend's reference to 520 is about something that occurred in 2011.

[00:31:53] Speaker 04:
With reference to Judge Newman's question, you know, we think it's important that stepping back, the purpose of the first loss of the step transaction doctrine, as Your Honor noted, was to look at

[00:32:07] Speaker 04:
to eliminate formalistic steps in the middle.

[00:32:11] Speaker 04:
And if you look at the transaction at the beginning, as Judge Raina mentioned, there was no intent to circumvent Section 707 because the first lost note was not with a related party.

[00:32:21] Speaker 02:
That only happened later in the transactions, and we think because those transactions... In fact, the transactions were legally mandated, whereas it appears in this case they're contractually obligated.

[00:32:34] Speaker 02:
Does that make a difference?

[00:32:36] Speaker 04:
I don't think so, Your Honor.

[00:32:37] Speaker 04:
I think Falconwood laid out, analyzed the step transaction doctrine, but ultimately said it couldn't apply to step transaction doctrine for the reason Your Honor gives because the steps were legally mandated.

[00:32:50] Speaker 04:
It would have been improper to sort of eliminate any of them.

[00:32:53] Speaker 04:
Here, the step transaction doctrine does apply, but we think, for the reasons that I've talked about, focusing at the beginning and what the taxpayer's intent was is the critical question.

[00:33:03] Speaker 04:
If you focus just on 2011 and the two transactions, then that is a rule that basically says any time you have a hedge, an underlying transaction that has a loss and the hedge is caused to operate, they will be collapsed no matter what.

[00:33:17] Speaker 04:
And I think the government forthrightly says in its brief,

[00:33:21] Speaker 04:
It believes those transactions would have been collapsed even when the first lost note was sold by reconnaissance and it was a third party.

[00:33:28] Speaker 04:
Obviously it wouldn't have had the tax implications, but I think that shows you that it doesn't really make any sense given the underlying purpose of the step transaction doctrine to say in that situation where no one could claim that there's sort of form over substance or just formalistic rules, their theory that if it had been exercised, those transactions would have been collapsed shows

[00:33:50] Speaker 04:
sort of how broad their theory is.

[00:33:53] Speaker 04:
And the other case I would point, Your Honor, too, is the Brown case.

[00:33:56] Speaker 04:
We talk about it in our brief, which is a case where the Court of Appeals there, not this court, said we are, you must, the government's, that was a case involving mineral leases.

[00:34:09] Speaker 04:
There was an initial lease.

[00:34:10] Speaker 04:
There were some advanced royalty payments that were deducted as business expenses, and then the lessor entered into a sublease, which would have made those

[00:34:19] Speaker 04:
business expenses non-deductible and the government's argument was we look at the intent in the middle period when those mineral payments were being made, not the intent at the beginning.

[00:34:30] Speaker 04:
And the Court of Appeals said, no, you have to look at the intent at the beginning.

[00:34:33] Speaker 04:
uh... and at the beginning it but the new argument is that here the court started at the middle and not the beginning exactly it well it started the middle focused on what happened in twenty eleven i think the government makes the argument that even if it looked at the beginning because there were these contingencies that could result in these payments it doesn't matter and our response to that is

[00:34:54] Speaker 04:
It's the intended result that matters and the intended results for the reasons I've been saying.

[00:34:59] Speaker 02:
Is a step transaction test that rigid that you have to start at one, two, three, four, you can't start at four and move on to five?

[00:35:11] Speaker 04:
Well, I think it is that rigid, and that's how this court described it in Falconwood.

[00:35:16] Speaker 04:
And the Supreme Court has decided, because the question is, do you collapse?

[00:35:19] Speaker 02:
Do you have authority for that, that says that if you sort of step to, that you somehow violated the transaction test?

[00:35:27] Speaker 04:
That's the Brown case, Your Honor.

[00:35:29] Speaker 04:
There, the government said, let's start at the time, in 1976, when these advance royalty payments were made.

[00:35:37] Speaker 04:
The intent there was to sublease.

[00:35:39] Speaker 04:
And therefore, we can combine those payments with the subsequent sublease and disallow them.

[00:35:44] Speaker 04:
And the court said, no, you have to look at the intent when the original lease was entered into.

[00:35:48] Speaker 02:
The questions I'm asking you, I get that out of your brief and the government's brief.

[00:35:57] Speaker 04:
uh... i lost my thought there for a second i'll come back to it i'm i'm going to you uh... you know i would say your honor and my time expired just to respond to that point there obviously are other doctrines that that might apply that don't require sort of looking at the whole series of transactions but those doctrines aren't issued at issue here's the government agrees okay this is what i uh... where i was hidden uh... you you argue that the court's to respond to it

[00:36:23] Speaker 02:
began at the middle of the step transaction test, right?

[00:36:28] Speaker 04:
Yes, because the government actually conceived it.

[00:36:30] Speaker 02:
You're saying that none of the parties advocated that.

[00:36:35] Speaker 02:
The court did that on its own.

[00:36:36] Speaker 04:
Yes, and then used the economic substance doctrine as the basis for the collapse.

[00:36:41] Speaker 02:
But as I say, we also- Did you object to that below?

[00:36:44] Speaker 02:
Did you make the arguments that you're making today with respect to this issue that we're focused on?

[00:36:52] Speaker 02:
Did you object to that?

[00:36:54] Speaker 02:
Did you make arguments below?

[00:36:56] Speaker 04:
It only arose in the court's opinion, unless the court- Anything else?

[00:37:00] Speaker 00:
Anything else?

[00:37:02] Speaker 00:
Thank you.

[00:37:03] Speaker 00:
Thanks to both counsel.

[00:37:04] Speaker 00:
The case is taken under submission.