Salman Ranch Ltd v. U.S.

• Decision Date: 30 July 2009
• Docket Number: No. 2008-5053.,2008-5053.
• Citation: 573 F.3d 1362
• Parties: SALMAN RANCH LTD and William J. Salman, Plaintiffs-Appellants, v. UNITED STATES, Defendant-Appellee.
• Court: U.S. Court of Appeals — Federal Circuit

573 F.3d 1362

SALMAN RANCH LTD and William J. Salman, Plaintiffs-Appellants, v. UNITED STATES, Defendant-Appellee.

No. 2008-5053.

United States Court of Appeals, Federal Circuit.

July 30, 2009.

Alan Poe, Holland & Hart LLP, of Greenwood Village, CO, argued for plaintiffs-appellants. With him on the brief was Adam M. Cohen, of Denver, CO.

Joan I. Oppenheimer, Attorney, Appellate Section, Tax Division, United States Department of Justice, of Washington, DC, argued for defendant-appellee. With her on the brief were Richard T. Morrison, Deputy Assistant Attorney General, Gilbert S. Rothenberg and Michael J. Haungs, Attorneys.

Before NEWMAN and SCHALL, Circuit Judges, and PATEL, District Judge.^*

Opinion for the court filed by Circuit Judge SCHALL.

Dissenting opinion filed by Circuit Judge NEWMAN.

SCHALL, Circuit Judge.

This is a tax case. On April 10, 2006, the Internal Revenue Service ("IRS") issued a Final Partnership Administrative Adjustment ("FPAA") adjusting the 1999 partnership tax return filed by Salman Ranch Ltd (the "Partnership"). On July 5, 2006, the Partnership and William J. Salman, the Partnership's tax matters partner (together, "Appellants"), filed suit in the United States Court of Federal Claims, challenging the validity of the FPAA pursuant to 26 U.S.C. ("I.R.C.") § 6226.¹ In due course, Appellants moved for summary judgment on the ground that the FPAA was untimely under the three-year statute of limitations of I.R.C. §§ 6501(a) and 6229(a). Therefore, according to Appellants, the adjustments in the FPAA were of no effect. The government cross-moved for partial summary judgment, seeking a ruling that the FPAA was timely. Ruling on Appellants' motion and the government's cross-motion, the court rejected the argument that the three-year statute of limitations controlled the issuance of the FPAA. Instead, the court held, the IRS was entitled to the benefit of the six-year statute of limitations of I.R.C. §§ 6501(e)(1)(A) and 6229(c)(2). Salman Ranch Ltd. v. United States, 79 Fed.Cl. 189, 204 (2007).

On December 6, 2007, the Court of Federal Claims certified its ruling for interlocutory review pursuant to 28 U.S.C. § 1292(d)(2). Salman Ranch Ltd v. United States, No. 06-CV-503, slip op. at 6-7, 2007 WL 4707751 (Ct.Fed.Cl. Dec. 6, 2007). Thereafter, on March 11, 2008, we granted Appellants permission to appeal. Salman Ranch Ltd. v. United States, 273 Fed.Appx. 926, 927 (Fed.Cir.2008). For the reasons set forth in this opinion, we now reverse the decision of the Court of Federal Claims that the IRS was entitled to the benefit of the six-year statute of limitations. Since it is undisputed that, without the benefit of that limitations period, the FPAA was untimely and thus invalid, the case is remanded to the Court of Federal Claims with the instruction that it enter judgment in favor of Appellants.

BACKGROUND

I.

The pertinent facts are set forth in the decision of the Court of Federal Claims. Salman Ranch ("Salman Ranch" or the "ranch") operates in Mora County, New Mexico. Salman Ranch, 79 Fed.Cl. at 190. On January 1, 1987, the owners of the ranch formed the Partnership. Principal shareholders included William J. Salman, the Partnership's tax matters partner David M. Salman, Frances S. Koenig, and the Frances D. Salman Testamentary Trust. Other shareholders included various Salman and Koenig family members. In exchange for partnership shares, the owners transferred their interests in the ranch to the Partnership.

On October 8, 1999, the Salman Ranch partners entered into short sale transactions involving U.S. Treasury Notes. In these transactions, the partners borrowed Treasury Notes from a third party and sold them for cash to another third party. A short sale gives rise to an obligation, known as a short position, to replace the borrowed security. See Zlotnick v. TIE Commc'ns, 836 F.2d 818, 820 (3d Cir.1988) (explaining a typical short sale).

The short sales generated cash proceeds of $10,982,373. Salman Ranch, 79 Fed.Cl. at 190. William J. Salman, in his capacity as tax matters partner, declared in the Court of Federal Claims that the Salman Ranch partners transferred both the approximately $10.9 million in cash proceeds from the short sales and the accompanying short positions (the obligation following the short sale to replace the borrowed securities, i.e., Treasury Notes) to the Partnership on October 13, 1999 (Decl.¶ 13). Some time thereafter, but before November 30, 1999, the Partnership purportedly closed the short position on the Treasury Notes at a cost of $10,980,866 (Decl.¶ 14). Specifically, the Partnership sold the Notes, which it had received from the partners, for $10,982,373, and then used that money to pay back the party from whom the partners had borrowed the Notes.

On November 30, 1999, the Salman Ranch partners contributed a portion of their partnership interests to three newly formed family partnerships. Salman Ranch, 79 Fed.Cl. at 191. As a result, each family partnership held a partnership interest in the Partnership. The Partnership in turn held the ranch.

The partners' transfer of interests in the Partnership to the three family partnerships triggered a technical termination of the Partnership under I.R.C. § 708(b)(1)(B).² This technical termination allowed an adjustment in the basis of the ranch under I.R.C. §§ 754 and 743(b)(1).³ The adjustment purportedly increased the Partnership's basis in the ranch to $6,850,276—a step-up in basis reflecting the original basis in the ranch, plus an allocated portion of the value of the short-sale cash proceeds contributed to the Partnership. Salman Ranch, 79 Fed. Cl. at 191.

On December 23, 1999, the Partnership sold a portion of the ranch and an option to acquire the remainder of the ranch. In its final partnership return for the period ending December 31, 1999, which was filed on or about April 13, 2000, the Partnership reported the sale of the ranch.⁴ The Partnership's return reported the gross sales price of the ranch as $7,188,588, the basis of the property as $6,850,276, and the resulting gain from the sale as $338,312. For the 1999 tax year, the individual tax return (IRS Form 1040) of each partner reported an amount purporting to be the respective share of each partner from the sale of the ranch.

"The IRS may challenge the reporting of any partnership item on a partnership tax return (Form 1065) by issuing an FPAA, which serves as a predicate to its making individual partner tax assessments. I.R.C. §§ 6223(a)(2), 6225(a)." AD Global Fund, LLC v. United States, 481 F.3d 1351, 1352-53 (Fed.Cir.2007). On April 10, 2006, the IRS issued the FPAA in this case. In it, the IRS stated:

Salman Ranch Ltd. was availed of for improper tax avoidance purposes by artificially overstating basis in the partnership interests of its partners.... The transactions involving short sales of Treasury Notes, including the formation of Salman Ranch Ltd., the acquisition of short positions in said Treasury Notes, the contribution of said Treasury Note positions to Salman Ranch Ltd. and the assignment of partnership interests to [the family limited partnerships] had no business purpose, lacked economic substance, and, in fact and substance, constitutes an economic sham for federal income tax purposes.

In other words, the FPAA asserted that a series of sham transactions, involving the technical termination of the Partnership, served to understate reported gains from the ranch's sale and to reduce the partners' aggregate federal tax liability. By inflating its basis in the ranch by a portion of the short sale proceeds while failing to offset that basis by the assumption of its obligation to close the short sale, the Partnership allegedly created an improper tax shelter.

Accordingly, to account for the short sale transactions, the IRS proposed an adjustment to the Partnership's treatment of its sale of the ranch on its December 31, 1999 partnership return. The adjustment reduced the basis in the ranch by subtracting the Partnership's obligation to close the short position on the Treasury Notes. This resulted in a corrected basis of the ranch in the amount of $1,917,978. Id. at 6. Thus, the IRS took the position that the Partnership's capital gain that resulted from the sale of the ranch should have been $4,906,261 instead of $338,312. The IRS therefore found capital gain understated by $4,567,949. This resulted in increased tax liability for the partners arising from their reporting, on their individual 1999 tax returns, their proportionate shares of the Partnership's gain on the sale of the ranch.

II.

On July 5, 2006, Appellants filed their complaint for readjustment of partnership items in the Court of Federal Claims, pursuant to I.R.C. § 6226, challenging the validity of the FPAA. Thereafter, Appellants moved for summary judgment, seeking a determination that the FPAA was untimely and therefore could not result in an adjustment of Partnership items. The government cross-moved for partial summary judgment, seeking a ruling that the FPAA was timely.

The general statute of limitations for assessment and collection of taxes is at I.R.C. § 6501(a), which provides that "the amount of any tax imposed by this title shall be assessed within 3 years after the return was filed." The three-year statute of limitations in I.R.C. § 6501(a) also applies to taxes imposed for partnership items. See AD Global Fund, 481 F.3d at 1354 ("Section 6501 explicitly provides that it applies to any tax imposed by the title, which would include tax imposed for partnership items. No exception is provided for assessment of taxes for partnership items." (citation and footnote omitted)); see also I.R.C. § 6229(a) (setting forth a minimum period of three years for assessments of partnership items).⁵ In the Court of Federal Claims, Appellants argued that the time for the IRS to issue the FPAA was governed by the three-year statute of limitations set forth in §...