Amicus Curiae Brief — Coltec Industries, Inc. v. United States (No. 06-659)

\

No. 06-659 [ Ell ED

IN THE | JAN 12 2007

Supreme Court of the United States; or THE CLERK

COLTEC INDUSTRIES, INC.,

Petitioner,

V.

UNITED STATES OF AMERICA,

Respondent.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Federal Circuit

BRIEF AMICI CURIAE OF THE NATIONAL

ASSOCIATION OF MANUFACTURERS AND

THE CHAMBER OF COMMERCE OF THE

UNITED STATES OF AMERICA

IN SUPPORT OF PETITIONER

JAN S. AMUNDSON PETER B. RUTLEDGE

Senior Vice President & Counsel of Record

General Counsel 127 Moncure Drive

QUENTIN RIEGEL Alexandria, VA 22314

Vice President & (202) 319-5140

Deputy General Counsel

NATIONAL ASSOCIATION OF

MANUFACTURERS

1331 Pennsylvania Avenue N.W.

Washington, D.C. 20004-1790

(202) 637-3000

Counsel for Amici Curiae

ROBIN S. CONRAD

AMAR D. SARWAI

NATIONAL CHAMBER

LITIGATION CENTER, INC.

1615 H Street. N.W.

Washington, D.C. 20062

(202) 463-5337

WiLSON-EPES PRINTING CO..INC. — (202) 789-0096 -— WASHINGTON, D C 20001

QUESTIONS PRESENTED

1. In determining that a transaction may be disregarded

for tax purposes, should a federal court of appeals review the

trial court’s findings that the transaction had economic

substance de novo (as three courts of appeals have held), or

for clear error (as five courts of appeals have held)?

2. Where a taxpayer made a good-faith business judg-

ment that the transaction served its economic interests, and

would have executed the transaction regardless of the tax

benefits, did the court of appeals (in acknowledged conflict

with the rule of other circuits) properly deny the favorable tax

treatment afforded by the Internal Revenue Code to the

transaction based solely on the court’s “objective” conclusion

that a narrow part of the transaction lacked economic benefits

for the taxpayer?

(i)

TABLE OF CONTENTS

Page

GFE SING PIN SEED oresicsccccctecsescescovecsnessossosvbees i

SARs OIE FART BUI 8 OE venienvesccecccscncssicsnececcseseneseees Vv

BPO Bees UW AMIE CURIA occevcsosnsetseveccossesoreensesevs l

SUMMARY OF THE ARGUMENT .............:ccccssseseeees 2

I. THE DECISION BELOW THWARTS

LONGSTANDING AND IMPORTANT

PRINCIPLES OF JUDICIAL DEFERENCE

TO BUSINESS JUDGMENT ...............cccsececeees 3

A. American Company Law Reflects A Tra-

dition Of Deference To Business Judgment ...

2

B. The Federal Circuit’s Economic Substance

Analysis Undercuts This Tradition of

EE SERIE LO ee Tee IO EED 4

1. The decision below sows confusion

over the meaning of various judicially

created doctrines governing the avail-

ability of deductions and credits under

the Internal Revenue Code ............:00:0060 4

i)

The lower court’s standard for eco-

nomic substance determinations virtu-

ally guarantees judicial second-guessing

of good-faith business judgments........... 7

2

3. The Federal Circuit’s division of a

transaction into discrete packages takes

an. unrealistic view of corporate gov-

ernance and calls into doubt a variety of

familiar, beneficial activities previously

approved bv this Court and others.......... 9

(ili)

1V

TABLE OF CONTENTS—Continued

Page

4. This case presents a particularly appro- ~

priate vehicle for resolving these im-

IIE CI aivinids pat cricentsccsiiatiinstintes 13

H. THE INTERCIRCUIT DISAGREEMENT

OVER THE STANDARD OF REVIEW OF

“ECONOMIC SUBSTANCE” DETERMINA-

TIONS IS AN IMPORTANT ISSUE FOR

AMERICA’S BUSINESS COMMUNITY ....... 14

SP FINE airsissacnsaseksrissencasdeldcsndanscranccbebeitiestasiaciens 16

y

TABLE OF AUTHORITIES

CASES Page

ACM P'ship v. Commissioner, 157 F.3d 231 (3d

I a ee 6

American Elec. Power Co., Inc. v. United States,

Fae ce FT Gl BD tetericnceseteeseseeneones 15

Aronson v. Lewis, 473 A.2d 805 (Del. 1984)........ 4

Black & Decker Corp. v. United States, 436 F.3d

I eR I: IONE ws cicedne Uaicctaceniaasencabelendsestapesonmnesas 15

Brehm v. Eisner, 746 A.2d 244 (Del. 2000)..........

Cooper Indus., Inc. v. Leatherman Tool Group,

BG. Foe Ue. SBS CQO) ceveccevecsevwsnes Bee et 14

Cottage Sav. Ass'n v. Commissioner, 499 U.S.

SIR NED odors tnoasioadls toni cieeldeadatemmaaniscepenabinegs 10

Daily Income Fund, Inc v. Fox, 464 U.S. 523

3 MARRIES ASRS cara 3

Dow Chem. Co. v. United States, 435 F.3d 594

SR Bt CIE wecticacabucgindientiaheiparsenignodeumessneciiinan 15

Frank Lyon Co. v. United States, 435 U.S. 561

SII acicns densa tein tad anda rata ce cag Te aa 9

Grutter v. Bollinger, 539 U.S. 306 (2003)............. Ss

Illinois Tool Works, Inc. v. Independent Ink, Inc.,

Ta a RD Gee inictnmstiecstueivevstestnsbcobensaccinen 4

Jacobellis v. Ohio, 378 U.S. 184 (1964) 0.0... 6

Keeler v. Commissioner, 243 F.3d 1212 (10th

Ee Rete Ri LON 210 Ee RR Ee AE 1S

Kumho Tire Co. v. Carmichael, 536 U.S. 137

Peri idinvssacdatucesshdsesnsenctaaeens iiesk ealaaddenupahinlinaeareass 14

Northern Indiana Pub. Serv. Co. v. Commis-

sioner, 115 F.3d 506 (7th Cir. 1997)........... amead 1]

Rogers v. United States, 281 F.3d 1108 (10th Cir.

UID scirislnscians ddegtoveaab vith ennaieeebiouninebbilinncdmmnbianeainaieete 6

State Oil Co. v. Kahn, 522 U.S. 3 (1997) 00.00.0000... 4

Sutton v. United Airlines, Inc... 527 U.S. 471

hy, TAMER dB ACI ik 2 eee ePIC DERI OT SENT GENET IED 4

v1

FABLE OF AUTHORITIES—Continued

Texas Dep't of Community Affairs v. Burdine,

A ee EE ie he nce nica kent nucccabibedon

TIFD III-E, Inc. v. United States. 459 F.3d 220

a a kre 2a tas be Te

United Parcel Serv. of Am. Inc. v. Com-

missioner, 254 F.3d 1014 (11th Cir. 2001)........

Winn-Dixie Stores, Inc. v. Commissioner. 254

ne aa Oe eas GUEE P cin dissccitiiehdaciniedsaniceeat

STATUTORY AUTHORITIES

Oe ee

I ra a a

Seis WN a ital niiesaiacesiniidencanmanninliatabbeacumsinnats

ES Pais SEE sideincsdiacesnsceinentaniadions Reece ony Sb —

OTHER AUTHORITIES

Korb Acknowledges U.S. Supreme Court May

Need to Clarify Economic Substance, Daily

Tax Rep. (BNA) (Oct. 27, 2006)..........00.......04.

Joseph Bankman, ZJhe Economic Substance

Doctrine, 74 S. Cal. L. Rev. 5 (2000)................

Richard W. Duesenberg, The Business Judgment

Rule and Shareholder Derivative Suits: A View

from the Inside, 60 Wash U. L. Q. 311 (1982)..

Daniel R. Fischel & Michael Bradley. The Role

of Liability Rules and the Derivative Suit in

Corporate Law: A Theoretical and Empirical

Analysis, 71 Cornell L. Rev. 261 (1986)...........

David P. Hariton, Sorting Out the Tangle of Eco-

nomic Substance. 52 Vax Law. 235 (1999)

IL.R.S. Pub. 583, Starting a Business and Keeping

Records, available at http://www.irs.gov/pub

EO sire socialist sccctnsdcsduaddsoouscsacnaementets

b&b

6,

—"

we

6

Vil

rTABLE OF AUTHORITIES— Continued

Page

[.R.S. Manual 31.1.1.1.3 (4), available at

http://www.irs.gov/irm/part3 1/ch01s01.html).... 13

John F. Prusiecki, Coltec: 4 Case of Misdirected

Analysis of Economic Substance, 112 Tax

Notes $24 (Aug. 7, 2006) ...cccccscscrorcoosesecrescesoeess 9

Mark J. Silverman et al., The Economic Sub-

stance Doctrine: Sorting Through the Federal

Circuit's “We Know It When We See It”

Ruling in Coltec, Tax Executive 423 (Nov./

EOE, DOOD ciniccicsteturtimaviciaenaenae 6,9, 12

Shery! Stratton. Government, Tax Bar Disagree

Over Impact of Coltec, 212 Tax Notes | (Nov.

Ly. POO Pccocsourcenseignssdatincsanspulensrinebbenraninmaaaaan 6

Sheryl Stratton, Korb Praises, Practitioners

Question Enforcement Shift, 113 Tax Notes

TAME (OC, BO, BOW) riscininisnceatavcttcaiiontnteans 13

Crystal Tandon & Shery! Stratton, Korb, Former

IRS Officials Discuss Recent Shelter Cases,

112 Tax Notes 1113 (Sept. 25, 2006)................ 10

U. S. Dep’t of Commerce, Small Bus. Adm.,

2006 Performance and Accountability Report .. |

ty

IN THE

Supreme Court of the Anited States

No. 06-659

COLTEC INDUSTRIES, INC.,

Petitioner,

We

UNITED STATES OF AMERICA,

Respondent.

On Petition for Writ of Certiorari to the

United States Court of Appeals

for the Federal Circuit

BRIEF AMICI CURIAE OF THE NATIONAL

ASSOCIATION OF MANUFACTURERS AND

THE CHAMBER OF COMMERCE OF THE

UNITED STATES OF AMERICA

IN SUPPORT OF PETITIONER

INTEREST OF AMICI CURIAE '

The National Association of Manufacturers (“NAM”) is

the nation’s largest industrial trade association, representing

small and large manufacturers in every industrial sector and

in all 50 states. The NAM’s mission is to enhance the

' Pursuant to Supreme Court Rule 37.6, amici state that the brief was

authored in its entirety by amici curiae and their counsel. No monetary

contribution toward the preparation or submission of this brief was made

by any person other than amici curiae, their members and their counsel.

By letters filed with the Clerk of the Court, petitioner and respondent have

consented to the filing of this brief.

2

competitiveness of manufacturers by shaping a legislative and

regulatory environment conducive to U.S. economic growth

and to increase understanding among policymakers, the media

and the general public about the vital role of manufacturing in

America’s economic future and living standards. In support

of this mission, the NAM regularly files briefs amicus curiae

in this Court and other courts.

The Chamber of Commerce of the United States of America

(“Chamber”) is the nation’s largest federation of business

companies and associations. It represents an underlying

membership of more than three million business, trade and

professional organizations of every size, sector and geo-

graphic region of the country. One of the Chamber’s primary

missions is to represent the interests of its members by filing

amicus curiae briefs in cases involving issues of national

importance to American business.

SUMMARY OF THE ARGUMENT

This Court should grant certiorari for two reasons, in

addition to those given in Coltec’s petition.

First, not only does the decision below fuel the intercircuit

disagreements over the economic substance doctrine, the

Federal Circuit’s entire approach jeopardizes important prin-

ciples of judicial deference to business judgment. Such

deference reflects both a desire to facilitate efficient capital

allocation and an awareness about the relative expertise of

government officials and businesspeople. The decision below

undermines this deep and important tradition of deference.

It sows confusion over the relationship between the eco-

nomic substance doctrine and other judicially created tax

doctrines, virtually invites unpredictable judicial second-

guessing of businesspersons’ decisions and takes a wholly

unrealistic view of business planning. Moreover, in light of

the IRS’s very public pronouncements about how it intends

3

to exploit the decision below, this Court’s prompt inter-

vention is necessary.

Second, the intercircuit disagreement over the standard of

appellate review of “economic substance” determinations also

presents an important issue for the business world. This

Court routinely has granted certiorari to resolve disagree-

ments over the proper standard of review and, thereby, to

provide a uniform nationwide rule. In the specific context of

economic substance determinations, the standard of review is

especially important. The plenary review required by the

court below exacerbates the lack of deference and effectively

provides the Government an added and inappropriate tool in

its litigation against American businesses.

ARGUMENT

I. THE DECISION BELOW THWARTS LONG-

STANDING AND IMPORTANT PRINCIPLES

OF JUDICIAL DEFERENCE TO BUSINESS

JUDGMENT.

A. American Company Law Reflects A Tradition

Of Deference To Business Judgment.

It is a “basic principle of corporate governance that the

decisions of a corporation . . . should be made by the board of

directors or a majority of the shareholders.” Daily Income

Fund, Inc v. Fox, 464 U.S. 523, 530 (1984). Stripped to its

essence, this case concerns whether courts will defer to those

judgments or second-guess them by employing a wholly

unpredictable test.

Several legal doctrines exemplify a long tradition of

judicial deference to business judgment. Perhaps the most

familiar is the business judgment rule in corporate law, which

creates “a presumption that in making a business decision, the

directors of a corporation acted on an informed basis, in good

faith and in the honest belief that the action taken was in the

4

best interests of the company.” Aronson v. Lewis, 473 A.2d

805, 812 (Del. 1984). Accordingly, good-faith business

decisions “will not be disturbed if they can be attributed to

any rational business purpose.” Brehm v. Eisner, 746 A.2d

244, 264 & n. 65 (Del. 2000).

Outside the familiar field of corporate governance, other

examples abound. For example, in employment law, courts

defer to the legitimate business explanations for an employ-

er’s treatment of a present or prospective employee. See, e.g.,

Sutton v. United Airlines, Inc., 527 U.S. 471, 493-494 (1999):

Texas Dep't of Community Affairs v. Burdine, 450 U.S. 248

(1981). In commercial law, courts do not question the certain

choices made in contracts “between merchants.” See, e.g.,

U.C.C. Art. 1-301, 2-201(2), 2-207(2). An entire chapter

of the Bankruptcy Code is dedicated to the proposition that

companies experiencing difficult—but ultimately surmount-

able—financial hardship are better left in the “possession” of

the debtor rather than the government. See 11] U.S.C. §§501

et. seg. In antitrust law, this Court's shift away from per se

rules and toward a “rule of reason” analysis reflects greater

judicial acceptance of business judgment about the economic

rationale for a transaction. See, e.g., /llinois Tool Works, Inc.

v. Independent Ink, Inc., 126 S.Ct. 1281 (2006): State Oil Co.

v. Kahn, 522 U.S. 3 (1997).

These deferential doctrines reflect two underlying prin-

ciples. First, excessive governmental intrusion into business

affairs chills commercial activity. See Richard W. Duesen-

berg, The Business Judgment Rule and Shareholder Deriv-

ative Suits: A View from the Inside. 60 Wash U. L. Q. 311.

314 (1982). Governmental scrutiny of good-faith business

activity increases its costs. Furthermore, if companies per-

ceive that such scrutiny is likely, they may choose to abandon

an undertaking altogether rather than risk costly and time-

consuming governmental second-guessing.

5

Second, business executives are better suited to determine

which transactions serve a company’s interests. Cf Grutter v.

Bollinger, 539 U.S. 306, 328 (2003) (deferring to university’s

determination that diversity was “essential to its educational

mission”). Government officials do not face the same choices

as American businesspersons. See Daniel R. Fischel &

Michael Bradley, The Role of Liability Rules and the

Derivative Suit in Corporate Law: A Theoretical and

Empirical Analysis, 71 Cornell L. Rev. 261, 273 (1986) (“A

manager who makes bad business decisions is likely to have

his wealth reduced or be fired; judges who make bad business

decisions will continue in office with the same salary as

before.”); Duesenberg, 60 Wash. U. L. Q. at 314. They are

not accountable to shareholders. They do not compete in a

marketplace. Under immunity doctrines, rarely must they

worry about liability for their actions. By contrast each of

these considerations—shareholder satisfaction, market com-

petition and liability management—is of paramount impor-

tance to the American business executive.

B. The Federal Circuit’s Economic Substance

Analysis Undercuts This’ Tradition’ of

Deference.

In three respects, the decision below undercuts the above-

described tradition of deference in American business law.

1. The decision below sows confusion over the

meaning of various judicially created doc-

trines governing the availability of deductions

and credits under the Internal Revenue Code.

A taxpayer who satisfies all of the technical requirements

for a deduction or credit under the Internal Revenue Code

does not necessarily receive that benefit. Instead, not only

must the taxpayer satisfy the requirements set forth by

Congress, it must also satisfy the requirements of certain

judicially created doctrines such as the “substance over form”

6

doctrine, the sham-transaction doctrine, the business purpose

requirement and the economic substance doctrine. See

Joseph Bankman, 7he Economic Substance Doctrine, 74 S.

Cal. L. Rev. 5, 12 (2000).

Even assuming their validity in a post-Erie world, these

judicially created doctrines at least should be clear. The

decision below deprives these doctrines of that essential

clarity. Whereas some courts have treated doctrines such as

“economic substance” and “substance over form” as separate

concepts with distinct and identifiable requirements, see, e.g.,

Rogers v. United States, 281 F.3d 1108, 1113-16 (10th Cir.

2002), the court below treats them almost interchangeably,

akin to some sort of general “equity” exception under the

Internal Revenue Code. (Pet. App. 18a).

This latter approach has sowed confusion within the busi-

ness community. See generally David P. Hariton, Sorting

Out the Tangle of Economic Substance, 52 Tax Law. 235,

241 (1999) (“Much confusion has been engendered, however,

by the fact that the courts have sometimes failed to address

lack of economic substance as a requirement separate and

apart from lack of business purpose.”). It deprives the busi-

ness community of any clarity over the meaning of these judi-

cially created doctrines and their requirements. Tax advisors

cannot realistically offer a confident opinion about the tax

treatment of a particular transaction, and, ultimately, the

businesspersons advised by them lack the confidence about a

transaction’s consequences for the company’s bottom line.

As one judge has observed, the approach exemplified by

the Federal Circuit’s decision amounts to litthe more than

a “smell test” under which courts can deny favorable tax

treatment to transactions that they just don’t like or, worse,

don’t understand. ACM P'ship v. Commissioner, 157 F.3d

231. 265 (3d Cir. 1998) (McKee, J.. dissenting). Just as such

amorphous tests chill desirable speech in the First

Amendment context. cf Jacobellis v. Ohio, 378 U.S. 184, 197

7

(1964) (Stewart, J., concurring), so too does the Federal

Circuit’s “I know it when I see it” test risk chilling corporate

actions that may be in a company’s best interest, see infra

Part 1.B.3. See Mark J. Silverman et al., The Economic

Substance Doctrine: Sorting Through the Federal Circuit's

“We Know It When We See It” Ruling in Coltec, Tax

Executive 423 (Nov.-Dec. 2006). Rather than risk the ex-

pense and burden of litigating a transaction, a company may

simply abandon it.

The typical duration of major business tax litigation makes

the chilling effects of this “smell test” especially nefarious.

In this case, for example, the appellate court issued its deci-

sion nearly ten years after Coltec reported the capital loss

giving rise to the contested deduction. (Pet. App. la). The

Federal Circuit’s “equitable” approach thereby gives courts

virtually unbounded latitude to apply the particular economic

or politica] theories in vogue—years, or even decades, after

the relevant business decisions were made.

At the threshold, therefore, this Court’s intervention is

necessary to decide the important and unresolved issue—

further unsettled by the decision below—about the common-

law power of courts to deny favorable tax treatment to trans-

actions that satisfy the requirements set forth by Congress in

the Internal Revenue Code.

2. The lower court’s standard for economic

substance determinations virtually guaran-

tees judicial second-guessing of good-faith

business judgments.

Coltec’s petition ably demonstrates the intercircuit conflict

over the proper test for economic substance determinations, a

conflict that both commentators and the IRS’s chief counsel

have acknowledged. Sheryl Stratton, Government, Tax Bar

Disagree Over Impact of Coltec, 212 Tax Notes 1 (Nov. I,

2006): Korb Acknowledges U.S. Supreme Court May Need to

8

Clarify Economic Substance, Daily Tax Rep. (BNA) (Oct. 27,

2006). While that confusion itself supplies a reason for

granting certiorari, the importance of the issue provides an

additional reason justifying review.

The upshot of the Federal Circuit’s “objective” test is that

it simply i:gnores—indeed renders legally irrelevant—the

actual reasons motivating a business executive’s decision to

undertake a transaction. Here is the critical portion of the

opinion:

[E]conomic substance is measured from an objective,

reasonable viewpoint, not by the subjective views of the

taxpayer’s corporate officers. (Pet. App. 31a).

This judicial disdain for the economic judgments of American

business executives undermines the above-described tradition

of deference and carries all the perils of such judicial second-

guessing—both the drag on economic activity and the risk of

error. See supra Part I.A. In its opinion, the Federal Circuit

quoted at length from the testimony of Coltec executives

recounting the multiple reasons why they chose to create the

Garrison subsidiary—to signal to the investment community

that Coltec had a grip on its potential asbestos liabilities, to

focus management and administration of these liabilities in a

single unit, to reduce the risk of veil piercing claims against

the parent company, and to make the company a potentially

attractive target for a corporate merger. (Pet. App. 28a-29a,

3la). The Federal Circuit then declared that these actual

subjective judgments are wholly irrelevant to its analysis.

(Pet. App. 3la). Having cast the actual motives to one

side, the emiy option left to a court umder the Federal Circuit's

test is © uvidertake its own fresh economic analysis of the

transaction.

That is precisely what the Federal Circuit did here. At

bottom, the Court’s opinion rests on the belief that Coltec

could have accomplished its desired business objective in

a different (and less economically - aeficial) way, so its

9

chosen course must lack economic substance. (Pet. App.

33a). Not only does this judicial second-guessing conflict

with the deferential approach taken by this Court in Frank.

Lyon Co. v. United States, 435 U.S. 561 (1978), see Pet. at

18-19, it also is fraught with risks. Apart from the lack of

deference, there is a real risk that the court might get the

economic analysis wrong. As a matter of tax law, several

critics have demonstrated that the Federal Circuit committed

just such an error in this case: it failed to explain how

Coltec’s very real contingent liabilities ultimately would

be treated under the Internal Revenue Code. See generally

John F. Prusiecki, Coltec: A Case of Misdirected Analysis of

Economic Substance, 112 Tax Notes 524 (Aug. 7, 2006)

(criticizing Federal Circuit’s economic analysis); Silverman,

Tax Executive at 432 (same). As a matter of corporate

governance, the success of the Coltec executives’ strategy

betrays the flaws in the Federal Circuit’s opinion: a major

company ultimately bought Coltec after it had implemented

the very plan criticized by the court below. (Pet. App. 59a).

3. The Federal Circuit’s division of a trans-

action into discrete packages takes an unrea-

listic view of corporate governance and calls

into doubt a variety of familiar, beneficial

activities previously approved by this Court

and others.

The other important—and erroneous—feature of the Fed-

eral Circuit’s economic substance analysis is its division of

the transaction into discrete steps, analyzing each separately

rather than the transaction as a whole. This approach presents

several problems.

For one thing, it takes a wholly unrealistic view of business

planning. As any corporate executive or corporate counsel

knows, transactions may proceed in multiple steps, but ulti-

mately a unified corporate strategy connects them. Almost

invariably, some step will be motivated in part—if not

10

wholly——-by the tax consequences. See Prusiecki, 112 Tax

Notes at 524 (“[A]ny transaction that involves any tax

planning at all has one or more aspects or elements that are

tax motivated and serve no nontax purposes.”); Silverman,

Tax Executive at 436 (“The potentially expansive reach of the

economic substance test articulated in [the decision below]

combined with the application of that test on a step-by-step

basis raises questions with respect to virtually all tax planning

.... ). By separating the transaction into discrete parts, the

Federal Circuit’s decision marks, according to several tax

practitioners, a “troubling shift” that ignores the realities of

business planning. Crystal Tandon & Sheryl Stratton, Korb,

Former IRS Officials Discuss Recent Shelter Cases, 112 Tax

Notes 1113 (Sept. 25, 2006).

For another thing, the logic of the decision below calls into

doubt a variety of business actions motivated by a mixture of

tax and non-tax considerations, including ones previously

approved by this Court and others:

e Mortgage Swaps: \n Cottage Savings Association v.

Commissioner, this Court considered the tax treatment

of mortgage swaps. 499 U.S. 554 (1991). These

transactions were precipitated by the declining value

of long-term, low-interest mortgages held by savings

and loan institutions. Because federal banking laws at

that time allowed them to swap mortgages without

taking losses for regulatory accounting purposes,

financial institutions swapped their mortgages in order

to claim tax losses reflecting the difference between

the high face value of the mortgages and their low fair

market value at the time of the swaps. This Court

held that the swaps qualified for the deduction and

rejected the (overnment’s argument to disallow them

under the economic substance doctrine. Jd. at 567-68.

The Federal Circuit, however, would have disallowed

the deduction. From an objective economic perspec-

tive, the swap worked no difference in the company’s

halance sheet— the original bundle of mortgages was

11

“substantially identical” to the swapped ones and had

the same fair market value. Jd. at 557. Thus, there

was no objective economic explanation apart from the

resulting tax benefits. The Federal Circuit’s rule

might well have deterred such swaps altogether, forc-

ing financial institutions to carry large losses on their

balance sheets without the opportunity to realize those

losses.

Foreign Lending Subsidiaries and NIPSCO: \n the

1980°s, American companies encountered difficulty

raising capital domestically due to high interest rates.

To ameliorate this problem, they established foreign

subsidiaries which could raise money from foreign

markets with lower interest rates and then lend that

money to the domestic parent, with a repayment

schedule tied to the foreign subsidiaries’ obligations

to its bond holders. The situs of those foreign sub-

sidiaries was closely tied to the tax consequences: by

locating the foreign subsidiary in a country that had

a bilateral tax treaty with the United States, the

domestic parent could utilize provisions relieving it of

the obligation to pay withholding taxes on interest

payments to the foreign subsidiary. The Seventh Cir-

cuit expressly approved this design (and the resulting

favorable tax benefits), see Northern Indiana Pub.

Serv. Co. (“NIPSCO”) v. Commissioner, 115 F.3d

506 (1997), but it would fail under the Federal

Circuit's rule. Under the logic of the Federal Circuit’s

decision, the choice to establish the foreign subsidiary

would be decoupled from the choice where to locate

it. While the establishment of the foreign subsidi-

ary might have a non-tax economic explanation. the

choice of location would not. It would be solely

driven by the tax benefits inuring to the domestic

parent from the tax treaty. Thus, if it had analyzed

the facts of NJPSCO, the Federal Circuit would have

disallowed the withholding benefit and, ultimately.

increased the cost of capital to the domestic parent.

12

e Choice of Corporate Form: Businesses may take a

variety of forms ranging from sole proprietorships to

partnerships to corporations. While non-tax consid-

erations may influence part of the decision, other parts

of the decision may be influenced entirely by tax

considerations. For example, a business may choose

to adopt a corporate form, rather than a partnership, to

take advantage of liability limitations. Yet tax con-

siderations may drive entirely the choice between

forms of corporation. Indeed, one of the IRS’s own

publications recognizes that “[ajn eligible domestic

corporation can avoid double taxation (once to the

corporation and again to the shareholders) by elect-

ing to be treated as an S-corporation.” I.R.S. Pub.

583, Starting a Business and Keeping Records at 3,

available at http://www.irs.gov/pub/irs-pdf/p583 .pdf

(emphasis added}. Yet under the Federal Circuit’s

logic, the IRS would be giving bad advice: A court

would have to bifurcate the “transaction” into two

parts—(1) the choice to incorporate and (2) the choice

of corporate form. While the former would have an

objective economic justification, the latter would not.

Consequently, a company opting for S-corporation

status would not receive the favorable tax benefit.

In sum, each of these examples demonstrates how the

Federal Circuit’s approach—disaggregating transactions into

separate steps and requiring an “objective non-tax” economic

explanation for the step giving rise to the tax benefit——is

simply incompatible with existing precedent and, if uncor-

rected, could have a damaging effect on economic activity.

See generally Silverman, Tax Executive at 432-36 (describ-

ing several additional transactions whose tax treatment is

potentially affected by Federal Circuit's analysis).

13

4. This case presents a particularly appropri-

ate vehicle for resolving these important

questions.

For two reasons, this Court needs to correct promptly the

flawed economic substance analysis in the decision below.

First, the Federal Circuit is a court of nationwide juris-

diction. Unlike a regional appellate court, the Federal Cir-

cuit’s decision has the potential to cast a wider precedential

net in any case governed by its precedents. See Stratton, 212

Tax Notes 1.

Second, the IRS itself has signaled that it intends to rely

heavily on that decision in its tax litigation. Just recently, the

IRS’s chief counsel heralded the case as one whose principles

“will be cited 20 years from now” and will be of “wide use”

to the IRS. Sheryl Stratton, Korb Praises, Practitioners

Question Enforcement Shift, 113 Tax Notes 394 (Oct. 30,

2006); Korb Acknowledges U.S. Supreme Court May Need to

Clarify Economic Substance, Daily Tax Rep. (BNA) (Oct. 27,

2006). In light of the IRS’s expected use of this decision,

timely correction is imperative.

Prompt correction is particularly important given the nature

of business planning. In many cases, taxpayers reach

settlements with the IRS before a case ever reaches trial

(much less final judgment). See I.R.S. Manual 31.1.1.1.3 (4),

available at http://www. irs.gov/irm/part3 1/ch0O1s01. html).

Moreover, risk-averse companies may well abandon trans-

actions altogether for fear of running afoul of the Federal

Circuit's “smell” test and risking litigation with the IRS.

While large companies perhaps can litigate these cases to

judgment and through appeal, smaller businesses, which form

the backbone of the American economy. do not have the

luxury—or the legal budgets—to afford such a course. See

U. S. Dep’t of Commerce, Small Bus. Adm., 2006 Per-

formance and Accountability Report, Executive Summary at

+

4 (noting that small businesses represent 99.7% of all

employer firms, employ half of all private sector employees

and have generated 60-80% of net new jobs annually over the

last decade), available at http://www.sba.gov/idc/groups/

public/documents/sba_homepage/03_summary.pdf.).

Thus, in addition to the reasons given in Coltec’s petition,

this Court should grant certiorari to address the important

issues raised by—and to correct the deep flaws contained in

—the Federal Circuit’s economic substance analysis.

Il. THE INTERCIRCUIT DISAGREEMENT OVER

THE STANDARD OF REVIEW OF “ECO-

NOMIC SUBSTANCE” DETERMINATIONS IS

AN IMPORTANT ISSUE FOR AMERICA’S

BUSINESS COMMUNITY.

Standards of review are important. They determine the

level of deference that an appellate tribunal affords to trial

courts. Thus, this Court has routinely granted review in cases

about the proper standard of review. These include ones of

special importance to the business community. See, e.g.,

Cooper Indus., Inc. v. Leatherman Tool Group, Inc., 532

U.S. 424 (2001); Kumho Tire Co., Lid. v. Carmichael, 526

U.S. 137 (1999).

This case too presents a question about the standard of

review warranting certiorari. Amici agree with Coltec that

certiorari is warranted to resolve a mature split among the

federal appellate courts on the issue. (Pet. 14-15). Addi-

tionally, the issue is important to the business community for

two reasons.

First, appellate courts have been aggressive in making de

novo determinations that transactions lack economic sub-

stance (or otherwise fail under similar doctrines) despite the

fact-intensive nature of that inquiry. In several recent cases,

including the decision below, the de novo standard has been

15

utilized to upset favorable rulings that taxpaying corporations

obtained at the trial level. See, e.g, TIFD III-E, Inc. v. United

States, 459 F.3d 220, 230-31 (2d Cir. 2006); Dow Chem. Co.,

v. United States, 435 F.3d 594 (6th Cir. 2006), petition for

certiorari filed, No. 06-478 (Oct. 4, 2006). By contrast, in

recent cases when the taxpayers lost in the trial court, plenary

review of an “economic substance” or similar determination

generally did not benefit them on appeal—the appellate court

found in the Government’s favor. See, e.g., American Elec.

Power Co., inc. v. United States, 326 F.3d 737, 741 (6th

Cir. 2003); Winn-Dixie Stores, Inc. v. Commissioner, 254

F.3d 1313, 1315 (11th Cir. 2001); Keeler v. Commissioner,

243 F.3d 1212, 1217 (10th Cir. 2001). But see United Parcel

Serv. of Am., Inc. v. Commissioner, 254 F.3d 1014, 1017

(11th Cir. 2001). The consistent tendency of appellate courts

—farther removed from the evidence and testimony—to find

no economic substance in business transactions suggests that

the standard of review is not neutral in operation.

Second, economic substance cases are increasingly reach-

ing the federal appellate courts. As late as the 1990's,

commentators bemoaned the paucity of reported decisions on

the doctrine. See Hariton, 52 Tax Law. 235. Since 2000,

however, there have been thirteen reported appellate deci-

sions on the subject, including four tn the last year alone. See

Pet. App. la-33a; T/FD III-E, Inc., 459 F.3d 220; Black &

Decker Corp. v. United States, 436 F.3d 431 (4th Cir. 2006);

Dow Chem. Co., 435 F.3d 594. Thus, the issue can only be

expected to grow in importance.

CONCLUSION

For the foregoing reasons, the Court should grant the

petition for a writ of certiorari.

JAN S. AMUNDSON

Senior Vice President &

General Counsel

QUENTIN RIEGEL

Vice President &

Deputy General Counsel

NATIONAL ASSOCIATION OF

MANUFACTURERS

1331 Pennsylvania Avenue N.W.

Washington, D.C. 20004-1790

(202) 637-3000

ROBIN S. CONRAD

AMAR D. SARWAL

NATIONAL CHAMBER

LITIGATION CENTER, INC.

1615 H Street, N.W.

Washington, D.C. 20062

(202) 463-5337

January 12, 2007

Respectfully submitted,

PETER B. RUTLEDGE

Counsel of Record

127 Moncure Drive

Alexandria, VA 22314

(202) 319-5140

Counsel for Amici Curiae

National Association of

Manufacturers and the

Chamber of Commerce of

the United States of America