Dow Chem. Co. v. United States - Opposition

No. 06-478

In the Supreme Court of the United States

DOW CHEMICAL COMPANY, PETITIONER

v.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

PAUL D. CLEMENT
Solicitor General
Counsel of Record
EILEEN J. O'CONNOR
Assistant Attorney General
RICHARD FARBER
ROBERT W. METZLER
Attorneys
Department of Justice
Washington, D.C. 20530-0001
(202) 514-2217

QUESTIONS PRESENTED

1. Whether the court of appeals correctly held that petitioner's transactions involving its corporate-owned life insurance plans lacked economic substance, and that petitioner was therefore not entitled to take tax deduc tions for interest and fees related to those plans, after discounting the possibility that petitioner would make uncharacteristically large cash contributions to the plans in the future.

2. Whether the court of appeals applied the correct standard of review in determining that petitioner's transactions lacked economic substance.

In the Supreme Court of the United States

No. 06-478

DOW CHEMICAL COMPANY, PETITIONER

v.

UNITED STATES OF AMERICA

ON PETITION FOR A WRIT OF CERTIORARI
TO THE UNITED STATES COURT OF APPEALS
FOR THE SIXTH CIRCUIT

BRIEF FOR THE UNITED STATES IN OPPOSITION

OPINIONS BELOW

The opinion of the court of appeals (Pet. App. 1a-34a) is reported at 435 F.3d 594. The opinion of the district court (Pet. App. 35a-186a) is reported at 250 F. Supp. 2d 748.

JURISDICTION

The judgment of the court of appeals was entered on January 23, 2006. A petition for rehearing was denied on May 24, 2006 (Pet. App. 205a-206a). On July 25, 2006, Justice Stevens extended the time within which to file a petition for a writ of certiorari to and including October 6, 2006. The petition was filed on October 4, 2006. The jurisdiction of this Court is invoked under 28 U.S.C. 1254(1).

STATEMENT

1. a. As the name suggests, corporate-owned life insurance (COLI) is life insurance purchased by a corpo ration in order to insure the lives of its employees. Cor porations originally purchased those policies in order to protect themselves from financial loss resulting from the death of key employees. Increasingly, however, corpo rations attempted to use those policies in order to re duce their federal income tax liability: namely, by ob taining loans on the policies (using the cash value of the policies as collateral), using those loans to pay most of the premiums on the policies, and then deducting the interest on the loans.

In 1986, Congress sought to curtail that practice by prohibiting a corporation from deducting the interest on any loan over $50,000 made in connection with a COLI policy. See 26 U.S.C. 264(a)(4) (1994). After that limita tion was enacted, corporations began using "broad- based" COLI plans, under which they would purchase life insurance for a much greater number of their em ployees. Those plans were designed to circumvent the per-policy limitation on deductions for interest on COLI-related loans, and thereby to manufacture mas sive interest deductions that could be used to shelter unrelated income from taxation. See Department of the Treasury, Report to the Congress on the Taxation of Life Insurance Company Products 14 (1990). In 1996, Congress effectively ended that practice by limiting the number of employees as to whom a deduction for COLI- related interest could prospectively be taken. See 26 U.S.C. 264(a)(4) and (e).

b. Even when a taxpayer would otherwise qualify for a deduction under the Internal Revenue Code, the de duction may still be disallowed if the underlying transac tion lacks economic substance, i.e., if "there was nothing of substance to be realized by [the taxpayer] from th[e] transaction beyond a tax deduction." Knetsch v. United States, 364 U.S. 361, 366 (1960); see Gregory v. Hel vering, 293 U.S. 465, 469-470 (1935). Before this case, three courts of appeals, applying the economic-sub stance doctrine, had disallowed tax deductions arising from "broad-based" COLI plans. See American Elec. Power Co. v. United States, 326 F.3d 737, 740-745 (6th Cir. 2003), cert. denied, 540 U.S. 1104 (2004); In re CM Holdings, Inc., 301 F.3d 96, 102-107 (3d Cir. 2002); Winn-Dixie Stores, Inc. v. Commissioner, 254 F.3d 1313, 1315-1317 (11th Cir. 2001), cert. denied, 535 U.S. 986 (2002).

2. In 1988 and 1991, petitioner, a major corporation, purchased two COLI plans that insured the lives of more than 21,000 of its employees. From 1988 to 2000, petitioner "paid" for its premiums on those policies pri marily by simultaneously taking loans on the policies (using the cash value of the policies as collateral) or by simultaneously making partial withdrawals from the portion of the cash value that had not already been used as collateral. Petitioner "paid" for nearly all of the in terest on its loans in the same manner. Although peti tioner "paid" nearly $1.6 billion in premiums and inter est over that period, petitioner actually disbursed less than $150 million in cash to the insurers. Pet. App. 3a- 5a.

Under both plans, the insurers charged a higher in terest rate for loans to petitioner than they used in cred iting the values of the policies. Accordingly, both plans were projected to generate negative pretax cash flows for the first 17 or 18 years of their existence. After that time, if petitioner made massive cash infusions for ap proximately 10 to 12 years, the plans would eventually generate positive cash flows-but not until some 40 years had passed since their inception. Petitioner was under no obligation to make such massive cash infusions. Even if petitioner did make those infusions, moreover, it was unclear whether the net present value of the cash flows from the plans would be positive or negative, with the answer depending on the discount rate used in the analysis. In addition, both plans had features that pro tected the insurers from the losses that would result from unexpectedly high mortality rates among the in sured employees. Pet. App. 5a-6a, 83a, 89a-94a, 103a- 107a.

On its income tax returns for 1989 to 1991, petitioner claimed deductions of over $33 million for interest paid on loans used to pay COLI premiums (and for adminis trative fees related to the COLI plans). On May 23, 2000, the Internal Revenue Service disallowed the de ductions, and assessed tax deficiencies and interest to taling more than $22 million. Pet. App. 6a n.5, 118a- 119a.

3. After paying the assessed amounts, petitioner filed a refund suit in the United States District Court for the Eastern District of Michigan. The district court held a bench trial, at which the government presented evidence that petitioner intended to engage in tax arbi trage through the COLI plans. See Gov't C.A. Br. 6-27 (summarizing evidence). At the conclusion of trial, how ever, the district court entered judgment in favor of pe titioner. Pet. App. 35a-186a. The district court recog nized that other courts had "generally determined that the ['broad-based'] COLI plans constituted economic shams, functioning only as interest-deduction engines that drove no legitimate financial vehicles." Id. at 57a. In this case, however, the district court ultimately con cluded that "there was an economic benefit that poten tially could be derived from the plans without relying solely on the tax deductions for policy loan interest." Id. at 58a.

As is relevant here, the district court rejected the government's arguments (1) that petitioner's plans were projected to generate negative pretax cash flows; (2) that petitioner would not benefit from the accrual of interest on the cash value of the policies; and (3) that petitioner's ability to realize mortality gains from the plans was limited. Pet. App. 128a-153a. The court noted that "there are prepurchase illustrations that show posi tive cash flow coming from the plan[s] even without the tax deduction for policy loan interest." Id. at 131a; see id. at 148a. The court rejected the government's conten tion that "these illustrations are not reliable because * * * they rely on a payment strategy which [peti tioner] would not likely adopt because it would require the infusion of significant amounts of cash in the middle years of the plan." Id. at 131a; see id. at 148a. Instead, the district court, crediting testimony from petitioner's officials, found that petitioner intended to make those cash infusions. Id. at 134a. The court further reasoned that, in determining whether petitioner's plans would generate positive pretax cash flows, it was required to "evaluate[] the transaction as a whole." Id. at 142a. After accepting petitioner's proposed after-tax discount rate for the net present value of the cash flows from the plans, the court concluded that petitioner had "demon strate[d] a substantial, non-tax benefit." Id. at 143a; see id. at 150a.

Additionally, the district court determined that the transactions did not lack economic substance insofar as the plans contained mechanisms limiting the insurers' risk of suffering mortality losses. The court reasoned that the plans did not entirely eliminate the insurers' risk. Pet. App. 145a-146a, 150a-152a.

4. The court of appeals reversed. Pet. App. 1a-34a.

a. At the outset, the court of appeals noted that a district court's "ultimate conclusion" that petitioner's transactions had economic substance was subject to de novo review. Pet. App. 9a. At the same time, the court stated that any underlying factual findings were re viewed only for clear error. Id. at 8a. The court further observed that both parties had agreed on the appropri ate standard of review. Id. at 9a n.8.

Turning to the merits, the court of appeals explained that, in determining whether similar transactions involv ing COLI plans had economic substance, courts had looked to "several indicators of the COLI plans' poten tial economic benefits: (i) projected pre-deduction cash flows, [(ii)] mortality gains to the beneficiary, who does not pay tax on proceeds, and [(iii)] interest-free inside build-up [the accrual of interest on the policy value]." Pet. App. 10a (internal quotation marks and citations omitted; brackets in original). The court of appeals pro ceeded to "examine the objective economic substance of [petitioner's] COLI plans against each of these stan dards." Ibid.

With regard to pre-deduction cash flows, the court of appeals noted that the district court had found that peti tioner "intended to inject large amounts of cash into the plans in their middle years." Pet. App. 11a. The court of appeals reasoned, however, that the critical inquiry was whether "such highly-contingent cash flows are rel evant as a matter of law to the economic-sham analysis." Ibid. If they were not, the court explained, "it would undermine the finding that the plans would generate positive cash flows in their later years, which would in turn preclude the finding that each plan had a positive [net present value]." Ibid.

The court of appeals concluded that "the district court erred in including in its cash-flow analysis the highly-contingent positive cash flows projected for later years." Pet. App. 14a-15a. The court of appeals rea soned that, under this Court's decision in Knetsch, su pra, "[c]ourts may consider future profits contingent on some future taxpayer action, but only when that action is consistent with the taxpayer's actual past conduct." Pet. App. 13a. On the other hand, "[c]ourts should be skeptical * * * when the asserted future profits hinge on future taxpayer action that seriously departs from past conduct, especially where such departure involves the expenditure of large sums of money." Ibid.

Applying those principles, the court of appeals deter mined that "the instant COLI plans would become prof itable only upon the taxpayer's large future outlay of additional cash, and, considering [petitioner] had hereto fore made no similar cash infusions, such additional spending would be a drastic departure from the tax payer's past conduct." Pet. App. 13a-14a. The court further noted that "there was no contractual provision requiring [petitioner] to make substantial cash infusions in the future." Id. at 14a. Having concluded that "the future positive cash flows [in this case] should have been ignored," the court determined that, "[w]hen the future infusion of cash is properly removed from the analysis, only negative cash flows remain." Id. at 15a. The court similarly determined that, absent the future cash infu sion, "[petitioner] would have been unable to realize the benefit of inside build-up," i.e., the accrual of interest on the cash value of the policies. Id. at 16a.

With regard to mortality gains, the court of appeals held that the district court erred by holding that peti tioner's transactions would lack economic substance only if the plans entirely eliminated the insurers' risk of mor tality losses. Pet. App. 17a-20a. The court of appeals reasoned that, in two of the three previous cases involv ing tax deductions related to "broad-based" COLI plans, "[the] challenged plans clearly did not eliminate 100% of all mortality gains and losses." Id. at 18a. The court also noted that "it is clear that the COLI plans were designed to reduce (even if not by 100%) [petitioner's] ability to realize mortality gains," and that "[the plans'] features are sufficiently similar to the other COLI-plan cases for us to conclude that [petitioner] would not sig nificantly benefit from mortality gains." Id. at 20a.

Because petitioner's COLI plans "did not generate any of [the] benefits" discussed in earlier cases, the court of appeals concluded that petitioner's COLI-re lated transactions lacked economic substance. Pet. App. 20a.

b. Judge Ryan dissented. He reasoned that this Court's decision in Knetsch stood only for the proposi tion that potential future cash flows were irrelevant to the economic-substance analysis where "the taxpayer did not intend to make the * * * future investment" at issue. Pet. App. 22a. Having concluded that petitioner's potential future cash infusion was relevant as a matter of law, Judge Ryan agreed with the district court that petitioner would have realized the benefit of inside build-up on its plans. Id. at 23a-27a. Judge Ryan also "disagree[d] * * * that the district court committed legal error" in concluding that petitioner's COLI plans were not mortality-neutral for purposes of the economic- substance doctrine. Id. at 27a. He reasoned that the plans in each of the two previous cases discussed by the majority were in fact designed to eliminate all mortality gains, id. at 28a-29a, and that the plans in this case were therefore distinguishable from those plans, id. at 29a.

5. The court of appeals denied a petition for rehear ing, with Judge Ryan indicating that he would have granted panel rehearing. Pet. App. 205a-206a.

ARGUMENT

1. Petitioner contends (Pet. 19-30) that, in holding that petitioner's transactions involving its COLI plans lacked economic substance, the court of appeals erred by discounting the possibility that petitioner would make uncharacteristically large cash contributions to the plans in the future. The court of appeals' decision in that regard was correct and does not conflict with any decision of this Court or another court of appeals.

a. As a preliminary matter, petitioner does not con tend that the court of appeals' ultimate holding-i.e., that petitioner's transactions involving its COLI plans lacked economic substance-conflicts with the holding of any other court of appeals. Nor could petitioner ad vance such a claim, because, as the court of appeals rec ognized (Pet. App. 9a-10a), all of the courts of appeals to have previously considered the issue similarly disal lowed tax deductions arising from "broad-based" COLI plans under the economic-substance doctrine. See American Elec. Power Co. v. United States, 326 F.3d 737, 740-745 (6th Cir. 2003), cert. denied, 540 U.S. 1104 (2004); In re CM Holdings, Inc., 301 F.3d 96, 102-107 (3d Cir. 2002); Winn-Dixie Stores, Inc. v. Commis sioner, 254 F.3d 1313, 1315-1317 (11th Cir. 2001), cert. denied, 535 U.S. 986 (2002).

b. Instead, petitioner contends only that the court of appeals erred by discounting the possibility that peti tioner would make uncharacteristically large cash con tributions to the plans in the future in determining, as part of its analysis under the economic-substance doc trine, (1) that petitioner's plans were projected to gener ate negative pretax cash flows and (2) that petitioner would not benefit from the accrual of interest on the cash value of the policies. See Pet. App. 10a-16a. This case, however, would constitute a poor vehicle for con sideration of any question concerning the legal rele vance of the possibility of future contributions under the economic-substance doctrine, because even a ruling in petitioner's favor on that issue would not necessarily change the ultimate conclusion that petitioner's transac tions lacked economic substance. In addition to deter mining that petitioner's plans were projected to gener ate negative pretax cash flows and that petitioner would not benefit from the accrual of interest on the cash value of the policies, the court of appeals determined that peti tioner's ability to realize mortality gains from the plans was significantly limited. See id. at 17a-20a. Petitioner does not challenge that determination before this Court.

Moreover, in light of its decision to discount the pos sibility that petitioner would make uncharacteristically large cash contributions to the plans in the future, the court of appeals did not reach the government's alterna tive arguments as to why petitioner's plans were pro jected to generate negative pretax cash flows-most notably, the argument that the district court used an erroneously low after-tax discount rate. See Pet. App. 15a. Because the alleged error by the court of appeals was not clearly outcome-dispositive, further review of that alleged error in this case is not merited.

c. In any event, in applying the economic-substance doctrine, the court of appeals correctly discounted the possibility that petitioner would make uncharacteristi cally large cash contributions to the plans in the future. In so doing, the court of appeals relied on a footnote in this Court's decision in Knetsch v. United States, 364 U.S. 361 (1960), for the proposition that a court may not consider future profits that are contingent on a tax payer's voluntary future conduct when that conduct would constitute a "drastic departure" from the tax payer's previous conduct. Pet. App. 14a.

Contrary to petitioner's contention (Pet. 19-21), the court of appeals correctly applied Knetsch. The tax payer in Knetsch claimed tax deductions for interest on loans used to pay for annuity savings bonds; the tax payer claimed that his transactions involving the bonds had economic substance because the bonds would even tually produce monthly annuity payments or insurance proceeds. 364 U.S. at 362-366. The Court rejected that argument on the ground that petitioner "kept the net cash value, on which any annuity or insurance payments would depend, at the relative pittance of $1,000." Id. at 366. In the footnote cited by the court of appeals, the Court rejected the taxpayer's argument that "in 10 years the net cash value of the bonds would have ex ceeded the amounts [the taxpayer] paid as 'interest,'" on the ground that "[t]his contention * * * is predi cated on the wholly unlikely assumption that [the tax payer] would have paid off in cash the original $4,000,000 'loan.'" Id. at 366 n.3.

The better reading of that footnote is that, in assess ing the pretax profitability of a scheme for purposes of the economic-substance doctrine, a court should dis count a taxpayer's future contributions when those con tributions are "wholly unlikely," as an objective matter, in light of the taxpayer's previous conduct-not, as the dissent in this case asserted (Pet. App. 22a), that a court should discount a taxpayer's future contributions only when the court expressly finds that the taxpayer did not actually intend to make them. Thus, even if the ultimate inquiry focuses on "the factual probability of [a tax payer's] claimed investment actually being made," as petitioner contends (Pet. 20-21), the court of appeals correctly applied Knetsch in holding that, when a tax payer's voluntary future investment would represent a "drastic departure" from its previous conduct, that in vestment is sufficiently unlikely that, regardless of the taxpayer's stated intention, the possibility that the in vestment would be made can be discounted as a matter of law.1

d. Petitioner contends (Pet. 21-27) that, by discount ing the possibility that petitioner would make uncharac teristically large cash contributions to the plans in the future for purposes of applying the economic-substance doctrine, the court of appeals' decision conflicts with various decisions of this Court and other courts of ap peals. That contention lacks merit.

The court of appeals' decision is consistent with this Court's decisions in Frank Lyon Co. v. United States, 435 U.S. 561 (1978), and Commissioner v. Duberstein, 363 U.S. 278 (1960). In Frank Lyon, the Court held that a transaction involving a sale-leaseback arrangement had economic substance, and therefore allowed a tax payer to claim depreciation and interest deductions re lating to the arrangement. 435 U.S. at 583-584. In re jecting the government's contention that the bank that originally sold the property (and then leased it back from the taxpayer) was effectively the owner of the property, the Court credited the district court's finding that "it was highly unlikely, as a practical matter, that any purchase option [by the bank] would ever be exer cised." Id. at 570; see id. at 581. To the extent that the Court used an objective standard in disregarding potential future events relevant to application of the economic-substance doctrine, that standard was analo gous to the objective standard used by the Court in Knetsch (and by the court of appeals in this case) in dis regarding a taxpayer's own potential future conduct.

In Duberstein, the Court did not invoke the economic-substance doctrine at all, but instead merely determined whether certain transfers of property con stituted "gifts" for purposes of the Internal Revenue Code. See 363 U.S. at 279-280. Duberstein therefore has no bearing on the question presented here: i.e., un der what circumstances a court should discount the pos sibility of a taxpayer's voluntary future investment in determining whether a scheme is profitable for purposes of the economic-substance doctrine.

Similarly, the court of appeals' decision does not con flict with any of the decisions of other courts of appeals cited by petitioner. Most of those decisions involve ar rangements that are plainly distinguishable from the arrangement at issue here, and do not present any ques tion concerning the relevance of a taxpayer's own poten tial future conduct. See Sacks v. Commissioner, 69 F.3d 982, 983-986 (9th Cir. 1995) (sale-and-leaseback arrange ment similar to arrangement in Frank Lyon); Bailey v. Commissioner, 912 F.2d 44, 46-47 (2d Cir. 1990) (ex change of nonrecourse notes for stream of payments of arguably lower value); Odend'hal v. Commissioner, 748 F.2d 908, 908-912 (4th Cir. 1984) (exchange of nonre course notes for property of lower value), cert. denied, 471 U.S. 1143 (1985).

Among the cases cited by petitioner, the only even arguably comparable case is Shirar v. Commissioner, 916 F.2d 1414 (9th Cir. 1990). In that case, the taxpayer had purchased a life-insurance policy for his wife in or der to cover anticipated estate-tax liability that would result from her death, and had paid the premiums in part with loans on the policy. Id. at 1416. The court of appeals concluded that transactions related to the policy had economic substance. Id. at 1416-1418. It was far from clear in that case, however, that the taxpayer's policy would generate negative pretax cash flows, or that the taxpayer would not benefit from the accrual of interest on the cash value of the policy, unless the tax payer made voluntary future investments that would represent a "drastic departure" from his previous con duct. Cf. id. at 1416 (noting only that the taxpayer would not use loans to fund his premiums for the fourth through seventh years of the policy). Moreover, as the court explained, the taxpayer unambiguously received a non-tax benefit from the policy, because, "absent the increased insurance coverage * * *, [the taxpayer] would not have had sufficient liquidity to meet the estate tax obligations upon the death of his wife." Id. at 1418. And the policy at issue, unlike the policy here, does not appear to have contained any features that would pro tect the insurer from losses resulting from premature mortality. Because Shirar is plainly distinguishable on its facts and does not hold that it is inappropriate to dis count the possibility that a taxpayer would make un characteristically large cash contributions to an insur ance plan in the future for purposes of applying the economic-substance doctrine, it does not conflict with the court of appeals' decision in this case.

e. Finally, even if petitioner could identify a conflict that might otherwise warrant the Court's review, this case would constitute a poor vehicle for consideration of any question concerning the relevance of potential fu ture investment under the economic-substance doctrine because it arises in a context of little if any prospective importance. In 1996, Congress effectively ended the prospective use of "broad-based" COLI plans to manu facture massive interest deductions for the purpose of sheltering unrelated income from taxation. See 26 U.S.C. 264(a)(4) and (e). We are aware of only one other pending case concerning the application of the economic- substance doctrine to such "broad-based" COLI plans. In the event that another court of appeals were subse quently to reject the approach of the court of appeals below, this Court could grant review to address the question identified by petitioner. In this case, however, further review on that question is unwarranted.

2. Petitioner also claims (Pet. 13-19) that the court of appeals erred by applying de novo review to the dis trict court's ultimate determination that its transactions had economic substance.2 That claim likewise does not warrant further review.

a. In this case, the court of appeals explained that, while a district court's underlying factual findings are reviewed only for clear error, a district court's "ultimate conclusion" as to whether a transaction had economic substance is subject to de novo review. Pet. App. 8a-9a. That description of the applicable standard of review is correct. As this Court explained in Frank Lyon (in holding that a transaction involving a sale-leaseback arrangement had economic substance), "[t]he general characterization of a transaction for tax purposes is a question of law subject to review," whereas "[t]he partic ular facts from which the characterization is to be made are not so subject." Frank Lyon, 435 U.S. at 581 n.16.3 That standard of review, moreover, is consistent with the standard of review applicable to similar "mixed" questions of law and fact. See, e.g., Ornelas v. United States, 517 U.S. 690, 696-697 (1996) (applying de novo review to "ultimate determinations of reasonable suspi cion and probable cause," while recognizing that clear- error review applies to the "determination of historical facts" underlying that ultimate determination); cf. Salve Regina Coll. v. Russell, 499 U.S. 225, 233 (1991) (noting that more deferential review of "mixed" questions is warranted only where "the district court is better posi tioned than the appellate court to decide the issue in question or * * * probing appellate scrutiny will not contribute to the clarity of legal doctrine") (internal quo tation marks and citation omitted).

Petitioner correctly notes (Pet. 14 n.7) that several courts of appeals have stated that a district court's de termination as to whether a transaction had economic substance was reviewable only for clear error. See, e.g., Nicole Rose Corp. v. Commissioner, 320 F.3d 282, 284 (2d Cir. 2002); ASA Investerings P'ship v. Commis sioner, 201 F.3d 505, 511 (D.C. Cir.), cert. denied, 531 U.S. 871 (2000); ACM P'ship v. Commissioner, 157 F.3d 231, 245 (3d Cir. 1998), cert. denied, 526 U.S. 1017 (1999); Yosha v. Commissioner, 861 F.2d 494, 499 (7th Cir. 1988); Rice's Toyota World, Inc. v. Commissioner, 752 F.2d 89, 92 (4th Cir. 1985). As petitioner concedes (Pet. 15), however, those decisions "[f]or the most part * * * have engaged in rote recital of conclusory lan guage from earlier opinions, with little analysis"-and it is therefore unclear, with regard to at least some of those decisions, whether the courts were deferring to the ultimate determination on economic substance, or merely to underlying factual determinations that may have been dispositive of that ultimate determination. Moreover, as petitioner seemingly also concedes (Pet. 17), to the extent that those courts did hold that a dis trict court's ultimate determination on economic sub stance was reviewable only for clear error, those deci sions cannot be reconciled with this Court's statement of the applicable standard of review in Frank Lyon.

b. In any event, this case does not provide the Court with a suitable opportunity to revisit any question con cerning the standard of review applicable to a district court's ultimate determination on economic substance, because petitioner did not preserve any argument that such a determination should be subject to deferential review. Far from "argu[ing] against de novo review," as petitioner now contends (Pet. 9 n.3), petitioner ulti mately conceded in the court of appeals that, "for pur poses of this appeal, * * * the ultimate conclusion on economic substance is reviewed de novo," and further agreed with the government that "legal standards are reviewed de novo and factual findings under the 'clearly erroneous' test." Pet. C.A. Br. 38; see Gov't C.A. Br. 33 (same). Petitioner proceeded to contend that the dis trict court's underlying findings-such as its finding that petitioner intended to build equity in its COLI plans-were not clearly erroneous. See, e.g., Pet. C.A. Br. 46-67. Accordingly, it is unsurprising that the court of appeals, without extended discussion, articulated the standard of review in the same way as petitioner. Pet. App. 8a-9a.4

This case would constitute a poor vehicle for consid ering the standard-of-review question now raised by petitioner for another reason. In reversing the decision of the district court, the court of appeals did not over turn any of the district court's factual findings (as peti tioner acknowledges, see Pet. 2, 9), but instead held that (1) the district court erred by failing to discount the pos sibility that petitioner would make uncharacteristically large cash contributions to the plans many years into the future, see Pet. App. 10a-16a, and (2) the district court erred by concluding that petitioner's transactions would lack economic substance only if the plans entirely elimi nated the insurers' risk of mortality losses, see id. at 17a-20a. Both of those errors were unquestionably legal in nature, as the court of appeals repeatedly noted. See, e.g., id. at 11a (stating that the relevant question was whether "such highly-contingent cash flows are relevant as a matter of law to the economic-sham analysis"); id. at 12a (referring to that question as a "legal question"); id. at 15a (holding that "[petitioner's] putative additional outlay * * * should be disregarded as a matter of law"); id. at 19a (rejecting "a rule that permitted a COLI plan to be deemed mortality neutral only upon proof that 'every dime of mortality profit' is elimi nated"); cf., e.g., id. at 21a (Ryan, J., dissenting) (criti cizing majority for "conclud[ing] that, as a matter of law, future profits contingent on taxpayer action are an ap propriate component of the economic substance calculus only when that action comports with the taxpayer's ac tual past conduct"). Petitioner does not argue that the clear-error standard of review could meaning fully have been applied to the district court's resolution of those subsidiary legal questions.5 A forti- ori, it would have been incongruous for the court of ap peals to have engaged in clear-error review of the dis trict court's ultimate determination that the transac tions at issue had economic substance, when that deter mination evidently rested on the district court's (errone ous) resolution of those subsidiary legal questions. Be cause the court of appeals did not pass on any subsid iary factual issues in reversing the district court's ulti mate determination on economic substance, this case is an exceptionally weak candidate for application of a def erential standard of review.

CONCLUSION

The petition for a writ of certiorari should be denied.

Respectfully submitted.

PAUL D. CLEMENT
Solicitor General
EILEEN J. O'CONNOR
Assistant Attorney General
RICHARD FARBER
ROBERT W. METZLER
Attorneys

JANUARY 2007

1 In the alternative, petitioner suggests (Pet. 28-29) that its future cash contributions would not represent a "drastic departure" from its previous conduct. The court of appeals noted, however, that petitioner would have to contribute around $315 million in order to make its COLI plans profitable-more than twice the amount that petitioner had contributed to the plans between 1988 and 2000. Pet. App. 5a, 10a n.9. And far from holding that no "future investment would ever be entitled to be considered" (Pet. 29), the court of appeals expressly "le[ft] for another day the consequences of less drastic departures." Pet. App. 14a n.13. In any event, the case-specific question whether the hypothet ical future contributions would represent a "drastic departure" from past conduct plainly does not merit review by this Court.

2 The same question is presented in Coltec Industries, Inc. v. United States, petition for cert. pending, No. 06-659 (filed Nov. 8, 2006). Unlike the petitioner in Coltec Industries, petitioner in this case does not contend that the court of appeals applied an erroneous substantive standard in determining that the relevant transactions lacked economic substance.

3 Petitioner contends (Pet. 17) that "this statement did not squarely address the proper standard of review for the determination whether a transaction has economic substance." The Court made the quoted statement, however, in the course of rejecting the government's contention that the taxpayer, although the nominal owner of the property purchased from and leased back to the bank, was not in substance the true owner entitled to take depreciation deductions. See Frank Lyon, 435 U.S. at 581. Moreover, the Court cited as authority for its statement of the standard of review a Fourth Circuit decision that similarly involved the economic-substance doctrine. See id. at 581 n.16 (citing American Realty Trust v. United States, 498 F.2d 1194, 1198 (4th Cir. 1974)).

4 Moreover, although petitioner sought rehearing on the court of appeals' substantive holdings, it did not seek rehearing on the standard- of-review issue. See, e.g., Pet. for Reh'g 14 (seemingly conceding that the standard of review in the court of appeals for the ultimate determi nation on economic substance was "now" de novo).

5 As discussed above, on the former issue, the court of appeals held that a taxpayer's voluntary future investment should be discounted for purposes of the economic-substance doctrine when it would represent a "drastic departure" from its previous conduct. Although petitioner repeatedly characterizes that holding as an "exclusionary rule" (Pet. 10, 11, 19, 20, 28, 29), petitioner does not contend that the court of appeals was resolving a question of fact rather than law. See, e.g., Pet. 2 (asserting that the court of appeals "bar[red] consideration, as a matter of law, of the trial court's finding regarding [petitioner's] intended cash investments"); Pet. 19 (criticizing court of appeals for characterizing Knetsch, supra, as holding that, "in any economic substance inquiry, investment by the taxpayer that somehow departs from the taxpayer's actual prior conduct is irrelevant as a matter of law").