## United States Court of Appeals for the Federal Circuit

04-5111

THE FALCONWOOD CORPORATION, Plaintiff-Appellant,

v.
UNITED STATES, Defendant-Appellee.

Sanford J. Davis , Withers Bergman LLP, of New York, New York, argued for plaintiff-appellant. On the brief was Donald Schapiro , Chadbourne & Parke LLP, of New York, New York. Of counsel on the brief was Alan I. Raylesberg . Of counsel was William C. G. Swift, Jr. , Withers Bergman LLP, of New York, New York. Michael J. Haungs , Attorney, Tax Division, Appe llate Section, United States Department of Justice, of Washington, DC, argued for defendant-appellee. With him on the brief were Eileen J. O’Connor , Assistant Attorney General, and Jonathan S. Cohen , Attorney. Appealed from: United States Court of Federal Claims Judge Diane Gilbert Sypolt

## United States Court of Appeals for the Federal Circuit

04-5111

THE FALCONWOOD CORPORATION, Plaintiff-Appellant,

v. UNITED STATES, Defendant-Appellee.

_________ __________________ DECIDED: September 2, 2005

_________ __________________ Before CLEVENGER, BRYSON, and PROST, Circuit Judges

. CLEVENGER, Circuit Judge

. Plaintiff-appellant The Falconwood Co rporation ("Falconwood") appeals the ruling of the United States Court of Federal Claims on cross-motions for summary judgment that an affiliated gr oup of corporations to which Falconwood belonged did not survive the "downstream merger" of a common parent corporation in to its subsidiary corporation, Falconwood's pr edecessor, because there did not remain after the merger one or more chains of includ ible corporations connected th rough stock ownership with a common parent that was a mem ber of the group prior to the date the former parent ceased to exist. See Falconwood Corp. v. United States , 60 Fed. Cl. 485 (2004). The Court of Federal Claims determined that because the group did not survive thedownstream merger under then existing law, 1 the group could not include in a final consolidated tax return losses inc u rred by Falcon wood' s predeces sor subsequent to the merger. Id

. at 488. Because we find to the cont rary that the aff iliated group survived the downst r eam merger of the former comm on parent corporation into Falconwood's predecess o r, we reverse the Court of F ederal Claims's ruling and remand for a determination of the tax refund due Falconwood.
I Prior to the events of Dece mber 23, 1986, as described hereinafter, the "Mocatta Group" of affiliated c o rporat ions consisted of TMC Hold ings Corporatio n, owned by
Dr. Henry Jarecki and various trusts esta blished for the Jarecki children, and five wholly-owned subsidiaries. T he group was organized as follows:

T M C Ho ld ings C o r p or a t ion ("TMC H ")

The Moc a tta Corporation 2 Falcon woo d Secu rities Corpo r ation Rimmon Co rpo r ation ("Falcon wood") ("FSC") ("RC")

Moc a tta Futures Corporation ("MFC")

Wallace Commodities Inc

. ("W C I " )

1 Throughout this opinion, we refer to various regulations promulgated by the United States Depa rtment of the Treasury and various sections of the U.S. Code. Exc ept where noted differently, we refer to the versions of the regulations and U.S. Code in existence at the time of the downstream merger.

2 The Mocatta Corporation is now k nown as The Falconwood Cor poration and is the plaintiff-appellant in the present di spute. We refer to it as " F alconwood" throughout this opinion.

04-5111 2Because t he group was an "af f iliated gro up" of corporations under 26 U.S.C

. § 1504(a)(1), it had filed cons olidated tax returns since 1981, based on an April 1-March 31 fiscal year. In 1986, the Jarecki family decided to restructure the group's ownership so that the surviving corporations could elect to be taxable under subchapt er S of the Internal Revenue Code ("Code") and thus hav e untaxed profits "pass through" to indiv i dual s hareholders. See Cameron v. Comm'r , 105 T.C. 380, 384 (1995) ("When a corporation elects pas s-through treatment under subchapter S, its net income earned a s an S corporation is taxed curr ently to the shareholders and thereafter is generally distributed tax-free."). During the same year, however, Congress passed the Tax Refor m Act of 1986 ("TRA" or "Act"), Pub. L. No. 99-514, 100 Stat. 2085, which among other things imposed a tax at the corporate level on pre-elec tion gains when a corpor ation taxable under subchapter C of the Code elects to be ta xed under subchapter S and recognizes those gains within ten years of the election. See Colo. Gas Compression, Inc. v. Comm'r , 366 F.3d 863, 865-66 ( 10th Cir. 2004) (disc u ssing the rele vant section of the Act and the purpose behind it s passage) . The TRA appli ed to all subc hapter S elec tions made after December 31, 1986. As a practical matte r, the Act placed the Jarecki family on the clock, so t o speak, by forcing them to elect to be taxed under subchapter S prior t o December 31, 1986, if they were to avoid the tax cons equences of the newly enacted
TRA. On Decem ber 23, 1986, the Jar e cki fam ily restructured the Mocatta Group. The diagram below depicts the three primary configur ations of the reorganization— Configurations A, B and C, respectively.

04-5111 3Configu r at ion A Configuration B TMCH Falc onwood

Falc onwood FSC RC MFC FSC MFC WCI Configuration C MFC Fa lc onwood FSC From the i n itial organizati on labeled Configuration A, TMCH merged "downstream" into Falcon woo d . See Harry G. Henn & John R. Alex ander, Laws of Corporations 981 (3d ed. 1983) (noting that a "downstream mer ger" describes the merger of a parent corporation into a subsidiary). At t he time, Falconwood held seats on various commodities exchanges, and the downst r eam merger of TMCH into Falconwood avoided the risk and delay incident to obtaini ng approval of a transfer of those seats from Falconwood to T M CH. RC also merged into F a lc onwood, a nd WCI was liq uidated into MFC. A certificate of merger was filed in Dela ware at 11:00 a

. m. showin g Falconwood as the surviving parent corpor ation. The combination of these initial mergers and the liquidation gave rise to the structure of Configuration B. FSC next paid a cas h dividend of $1, 538,677 to Falconwood at 1:20 p.m. and also transferred to Falconwood a note i ssued by Dr. Jarecki in the amount of $2,125,062 . MFC wir e-transferred a d i vid e nd of $13 million to F a lc on wood at 2:26 p.m. Falconwood then sold the stock of MFC and FSC to the Jarecki family. All that remained at the end of the day from the or iginal Mocatta Group was Falconwood, MFC and FSC, as shown in Confi gur ation C, each independently owned by t he Jareck i

04-5111 4children and set up in s u ch a way as to allow subchapter S elections effective January 1, 1987. Under the name "The Mocatta Corporat ion & Subsidiaries (Formerly TMC Hold ings Corp. & Sub s idiaries)," Falcon woo d ultimately filed a c onsolidated tax retur n as the common parent of the Mocatta Gr oup for the twelve-month period ending on March 31, 1987. The return covered Falconw ood's operations for the entire twelv e month period from April 1, 1986, to Marc h 31, 1987, and those oper ations of MFC and FSC only from April 1, 1986, to December 23, 1986, the latter date being t h e date the Mocatta Group terminated. MFC and FSC cove red the remainder of their operations— those from December 24, 1986, to March 31 , 1987—in separate individual tax returns. Some time after December 23, 1986, Falc on wood sustained a $10 .3 million loss. Because F a lconwood' s operations through March 31, 1987, were covered on the Mocatta Group's final consolidat ed return, Falconwood offset the group's inc o me for the 1984, 1986 and 1987 taxable y e ars against its ow n post-December 23 loss, which led t o a credit retroactive to 1981 and 1982. In 1989, Falconwood filed amended returns, seeking refunds for those years. The Internal Revenue Service s ubsequently determined that the Mocatta Group termi nated on December 23, 1986, with the downstream merger of TMCH in to Falconwood. It further determined that the group must file a final cons olidated return for the short taxable year from April 1, 1986, to December 23, 1986, and that the three remaining members—Falconwood, MFC and FSC—would need to f ile individual returns for the period from December 24, 1986, to March 31, 1987. The decision thus prec luded Falconwood from offsetting Mocatta

04-5111 5Group income with F a lconwood' s post-Decem ber 23 loss, resulting in incr eased ta x liability for the group. On July 27, 1995, Falc onwood brought suit in the Court of Federal Claims for the "refund of income taxes and interest err oneously and illegally assessed against and collected fr om [it]" for the tax years 1981 to 1986. (Joint App. at 67.) On January 16, 1998, Falc onwood filed a second complaint covering the tax y ear 1987. It argued in a motion for summary judgment of April 4, 2003, that the Mocatta Group survived the termination of TMCH, the group's former common parent, because the Mocatta Group succeeded to the assets of TMCH, and both FSC and MFC remained connected as subsidiaries to the new common parent, Falconwood, until the sa le of FSC and MFC stock approximately three hours later. Th e governm ent argued in its own motion for summary judgment of May 9, 2003, that the Mocatta Group's complianc e with the regulatory requirement that one or more chai ns of includible cor porations connected with a com m on parent "remain" after the do wnstream merger must be judged at the conclus i on of the reorganization, i.e. , after the remaining corporations reached Configuration C. Ruling on t he cross-motions for s u mmary judgment, the Court of Federal Claims determined that the Mocatta Group did not survive the downstream merger because 26 C.F.R. § 1.1502-75(d) , the regulation governing w hether a group remains in existence for purposes of f iling a consolidated tax return despite termination of the common parent, implied a temporal requirement not satisfied by t he group's short stay at Configur ation B. F a lconwood , 60 Fed. Cl. at 490-91. In the alternative, the court applied the "step transaction doctrine" to the Mocatta Group's reorganization and

04-5111 6determined that the "appropriate point in time to assess th e nature of the transaction and to apply the tests conditionin g the exc e ption upon which plai ntiff relies . . . is at the conclus i on of the restructuring transaction," id. a t 492, thus effectively erasin g Configuration B from the r eorganization. As explained below, without t he court's recognition of Configuration B, Falconwood did not satisf y the provisions of section 1.1502-75 and could not prev ail. The court thus granted summary judgment in favor of the government. Id. at 493. Falconwood appeals. We have jurisdiction over the appeal pursuant to 28 U.S.C. § 1295(a)(3) (2000).
II We review the sum m ary judgment by the Court of Federal Claims de novo

. Ammex, Inc. v. United States , 384 F.3d 1368, 1371 (Fed. Cir. 2004). Summary judgment is appropriate where, examined in a light most fa vorable to the non-movant, the record indic a tes "that there is no genuine i ssue as to any material fact and that the moving par ty is entitled to a judgment as a ma tter of l a w." R. Ct. Fed. Cl. 56(c); see also Fed. R. Civ. P. 56(c) (same).
III An "affiliated group" of corporations—i.e. , one that inclu des "1 or more chains of includible corporations connected thr ough stock ownership wit h a common parent corporation which is an inc l ud ible corporation," 26 U. S.C. § 1504(a)(1), provided that certain other stock ownership requirement s set forth in section 1504(a) ar e satisfied— may advantage itself of the privilege of filing a c onsolidat ed return in lieu of separat e returns for a taxable year if each corpor ation that has been a me mber of the group during any part of the taxable year covered by the consolidated return consents, 26

04-5111 7C.F.R. § 1.1502-75(a). At the time of the Moc a tta Group's reorga nization, t h e consolidated return must have included "t he inc o me of the common parent for that corporation's entire taxable year . . . and . . . the income of each subsidiary for the portion of such taxable year dur ing which it was a member of the group." 26 C.F.R. § 1.1502-76(b)(1). 3 If the group so chose, however, a nd until it elect ed to discontinue filing consolidated returns pur suant to 26 C.F.R. § 1.1502- 75(c), the group was required to file a consolidated return covering each successive year for which it remained in existence. See 26 C. F.R. § 1.1502-75(a)(2) ("A grou p which filed (or was required t o file) a c ons olidated return for the immediately preceding taxable y e ar is required to file a consolidated return for the taxable year un less it has an election to discontinue filing consolidated returns under paragraph (c) of this section."). At the time of the reorgani zation, "[a] group shall be considered as remainin g in existence if the common parent c o rporation remains as t he common parent and at least one subsid iary remains affiliated with it, whe t her or not such subsidiary was a member of the group in a prio r year and whether or not one or m o re corporations hav e ceased to be subs idiaries at any time after the group was formed." 26 C.F.R. § 1.1502- 75(d)(1). 4

3 The version of section 1.1502-76(b)(1) now in effect provides that "[a] consolidated return must include the commo n parent's items of income, gain, deduction , loss, and c r edit for the entire consolidated return year , and each subsidiary's items for the portion of the year for wh ich it is a member." 26 C. F.R. § 1.1502-76(b)(1)(i) (2005) (emphasis added). In other wor d s, a cons olidated return must now include the incom e of the common parent for the ent ire consolidated return year rather than for the common parent's entire taxable year. At oral argum ent, the parties disagreed as to whether the regulation as amended might com pel a different result in similar cases. Because that issue is not before the court, we pass no judgm ent on the applicability of this opinion to cases arising under the regulation as amended.

4 Section 1.1502-75(d)(1) was amended in 1994 to the version presently in effect, see T.D. 8560, 1994-2 C.B. 200, which now provides t hat " [ a] group remains in

04-5111 8Section 1.1502-75(d)(2)(ii) pr ovided an exception t o this general rule where the common parent is no longer in existence but transfers all of its assets "downstream" t o a subsidiary: The group shall be cons idered as remaining in existence notwithstanding that the common parent is no longer in existenc e if the members of the affiliated group succ e ed to a nd become th e owners o f substantially all of the assets of such former parent and t here remains one or more chains of includible corporations connected through stock ownership with a common parent corporation which is an incl udible corporation and which was a member of the group prior to the date such former pa rent ceases to exist. 26 C.F.R. § 1.1502-75(d)(2)(ii). This exc eption is squarely at issue in the present case. Because t he Mocatta Group did in fact file a cons olidated tax return for the taxable year immediately prec eding the one at issue and di d not elect to discontinue filing conso lidated returns under 26 C.F.R. § 1.1502- 7 5 (c), the group was r e quired by law to file a final c o nsolidated return for th e short taxable year from April 1, 1986, to December 23, 1986, that included the income of t he common parent for that corporation's entire taxable ye ar and the income of each subs idiary for the portion of such taxable year during which it was a member of the group. Prior to the December 23 reorganizat i on, MFC and FSC were subsid iaries. At the conc lusion of the reorganizat i on, howev er, the Mocatta Group no longer existed, and MFC and FSC wer e each free-standing S c o rporations

. The operations of M F C an d FSC from April 1, 1986,

existence f o r a tax y e ar if the c o mmon par ent remains as the c o mmon parent and at least one subsid iary that was affiliated with it at the end of the prior year remains affiliated with it at the begin n ing of the year , whether or not on e or more co rporations have ceas ed to be subsidiaries at any time after the group was formed." 26 C.F.R

. § 1.1502-75(d)(1) (2005) (emphasis added). Unlike the versi on of the regulation in existence at the time of the reorganization at issue in this case, the current regulation necessarily "prevents the group f r om terminating as the result of a gap in ownership of subsidiaries during a single taxable year." Wessel et al., The Cons olidated Group: Continuation and Termination Issues , 434 PLI/Tax 91, 105 (1998).

04-5111 9to December 23, 1986, were thus properly in cluded in the final co nsolidated return, and their operations subs equent to December 23 were included in s eparate individual t a x returns. The more burdensome task before t he Court of Federal Cla ims was to identif y the "income of the common par ent for that corporation's entire taxable year," whic h pursuant to 26 C.F.R. § 1.1502-76(b)(1) was to be included in the Mocatta Group's fina l consolidated tax return. The quest i on dis pos itive to that ta sk is whether the Mocatta Group's December 23, 1986, reorganizat i on from Configuration A to Configuration B satisfied the exc eption of sec t ion 1.1502-75(d)(2)(i i). If the Mocatta Group satisfied the requirements of secti on 1.1502-75(d)(2)(ii) and thus remained in existence through Configuration B, then for pur pos es of the s e ction 1.1502-76( b)(1) requirement that the final consolidated return inc l ude t he inc o me of the common parent fo r that corporation's entire taxable year, "the former common par ent shall be deemed to continue in existence and shall be regarded as the common parent for th e entire taxable year in which the acquis i tion occurs." 26 C.F.R. § 1.1502-76(b)(1). The taxable year of the common parent—the product of the TMC H /Falconwood downstream merger—then would not end until M a rch 31, 1987, and any lo ss sus t ained post

- December 23 by that entity properly would be inc l ude d in the consolidated tax return for the shortened ta x year ending on December 23, 1986. If inst ead the Mocatta Group did not satisfy the exception in section 1.1502-75(d )(2)(ii) and thus did not remai n in existence through Configuration B, then TMCH, the common parent, and its taxable year would terminate on Decem ber 23, 1986, when TMCH itself me rged "downstream" into Falconwood and

04-5111 10out of existence. In that case, any lo sses s u stained by Falconwood post-merger could not have been included in the group's final c onsolidated tax return. As discuss ed, the Court of Federal Claim s ruled that the Mocatta Group did not satisfy the section 1.1502-75(d)(2 )(ii) exception. The cour t based its decision both on its interpretation of the terms "the re remain s" in the sect ion and on an application of the step transaction doctrine to combine the sev e ra l steps of the reorganization into a singl e transaction for purposes of determining ta x liability. We address each in turn.
A Rely ing heavily on the dec isio n of our predecessor court in Un io n Electric Co. of Missouri v. United States , 305 F.2d 850, 854 (Ct. Cl. 1962), t he Court of Federal Claim s first determined that the existence of the subsidiaries MFC and FSC for approximately three hours after the downstrea m merger of TMCH into Falc onwood did not satisfy the requirement of continuity, which the Court of Federal Claims found to be rooted in the terms "there remains" in secti on 1.1502-75(d)(2)(ii). Falconwood , 60 Fed. Cl. at 490-91 (opining that "it is clear t hat the existence of subsidiari es for only three hours following the downst r eam merger does not satisfy the requi rement of continuity 'from one year to the subsequent year,' or 'continued existenc e,' set forth in Union Electric "). The Court of Federal Claims thus determined that "there remains" require s the "continued existence of at least one subsidiary in the s t atus of a s ubsidiary from one y e ar to the s ubsequent
year ." Id

. at 490 (quoting Union Elec. , 305 F.2d at 855). The Court of Federal Claims's reliance upon Union Electric was misplaced.

04-5111 11i In Unio n Electric , T he North American Company ("North American") was the common parent of a corporate group consisting of approximat ely eighty corporations engaged in a number of various business activities. 305 F. 2d at 850. Beginning in 1942, Nort h American filed c onsolidated tax returns wit h its subs idiaries. Id. During the years 1950 through 1953, however, four subsidiary c o rporati ons in the North American chain were eligible, as regulat ed public utility cor porations—those that derive at least 80 percent of their gross income (excluding dividends and capit a l gains/losses) from certain utilities operations—to elect a spec ial excess profits tax cr edit, provided in the Exc e ss Pr ofits Tax Act of 1950 ("EPT A") , 26 U.S.C. § 448 (1952). Id. at 851-52. Pursuant to the EPT A , North American was also eligible to and did jo in the subsidiaries in filing a consolidated tax return for the years 1950 through 1952. Id. at 852. The remaining corporations in the North American chain were not eligible for the tax credit and thus filed separate, individual ta x returns covering those years. Id. In 1953 an d 1954, North American had n o in come from regulated public utilit y sources and was cons equently pr ecluded by the EPT A from joining the f our public utility subsidiaries in filing a consolidated tax r e turn for those years

. Id. North American ultimately j o ined with an entir ely different group of s u bsidiari es to file consolidated tax returns. Id

. The succ essor to North American later brought an action for the refund of overpayments of income tax, claiming that it was entitled to deduct from the consolidated net income of the North American ut ilities group in 1952 lo sses attributable to North American for the mi scellaneous group of cor porations that joined in filing

04-5111 12consolidated tax returns in 1953 and 1954. Id. at 853. The question presented in Union Electric wa s thus whe t her a parent corporation was pa rt of one affiliated gro up whic h remained c ontinuous ly in operation during the years 1952 through 1954 or two separate affiliated gr oups, wher e no subs idiary corpo r ation inclu ded on the 1952 cons olid ated tax return remained affiliated with the parent corporation during 1953 and 19 54. Id. I n other words, the court considered whet her the 1952 group remained in existenc e through 1953 and 1954 solely by virtue of the fact that the common parent remained consistent throughout. In determi ning that it did not, the c ourt examined Treasur y Regu lations 129 § 24.11(c) and (d), as promulgated in 1951 under the 1939 Code: Sec. 24.11. Consolidat ed Returns for Subsequent Years

. . . . (c) When affiliated group remains in existenc e. For the purpose of these regula t ions, an affiliated group shall b e considered as remaining in exist ence if the common parent corporation remains as a common parent and at least on e subsidiar y remains affiliated with it, whether or not such subs idiary was a member of the group at the time the group was formed and whether or not one or more corporations have become subsidiaries or have ceas ed to be subsidiaries at any time after the group was formed. (d) When affiliated group terminates. For the purpose of these regula t ions, an affiliated group shall b e considered as terminated if the comm on parent corporation ceases to be the common parent or there is no subsid iary affiliated with it. The court fi rst noted that the prescriptions of subsections 24.11(c) and (d) are provided only to det ermine wh ether an affiliated gro up of corporations that files a c onsolidated return in one year continues in existenc e to the subsequent year for purposes of determining whether the group is required to file a consolidated return covering operations during the subsequent year. 305 F.2d at 8 5 4 ("They do not purport to define the composition of the group or the existence of the group generally."). The court next

04-5111 13determined that the word "remains" in the r egulations required that at least one of the affiliated c o rporations constitutin g subsid ia ries in 19 52 remain ed affiliated with the parent corporation in 1953 and 1954 in order for the gr oup in 1952 to continue i n existence through the subsequent two years. Id. at 855. Because none did, the court held that the carrybacks claimed by the successor to North American were not allo wab l e. Id. at 855. The question posed to the court in Union Electric is therefore quite distinct from that now before this court. The Union Electric court's interpretation of "remains" to require the continued existence of at least one subsidiary from one year to the next was very much appropriate in light of the context of the regulat ion from which the term came, a regulatio n promulga ted to def ine whether or not an affilia ted gro up on wh ole continue s in existenc e from one year to the next. That regulation necessa rily contemplates a comparison only of the physic a l make-up of a group of cor porations from one year to the next and was part of a regulatory scheme that c ontained no downstream merger

exce ption to the rules then governing wheth e r an affilia ted group remained in existenc e. The regulation at issue here contemplates an altogether different comparison of the make-up of a group as it exists both prior to and subs equent to a downstream merger of the former common parent corporat ion into its subsidiaries. We therefore cannot impute so easily the Union Electric court's "from one year to the subsequent year" interpretation to "there remains" in se ction 1.1502-75(d)(2)(ii).
ii Without dispositive benef it from Union Elec tric , the government is left to argue that the three hours in whic h the group "remained" after t he downstream merger of

04-5111 14TMCH into Falconwood simply does not suffice under the re gulation. Indeed, in its brief, the government recognizes that some passage of time would be enough to sav e the consolidated group, and that "a close ca se may one day arise" which calls for a more precise line between wher e "enough" ti me succ eeds and " not enough" time fails. (Appellee's Br. at 36.) But the government concludes that "thi s is not such a case." Id. We cannot agree that there is any principl ed difference between the three-hour time period in this case and the pas sage of days or week s or months in some other case where there could be no reasonable doubt about the satisfac tion of the "there remains"
test. Because the government chose not to def ine in section 1.1502-75(d)(2)(ii) more
express l y the temporal span of "there remains, " we think it inappropriate to accord the terms anything more than their plain meaning. See Gould v. Gould , 245 U.S. 151,
153 (1917) ("In the interpretation of statutes levying taxes it is the established rule not
to . . . enlarge their operations so as to embr ace matters not specific ally pointed out. In case of doubt they are construed most stro ngly agains t the government, and in favor of the citizen. "); Int'l Tel. & Te l. Cor p . v. Unite d States , 608 F.2d 4 6 2, 477 (Ct. Cl. 19 79) ("Consolidated return regulations are 'legis lative' in c haracter and have the force an d effect of law."). To "remain" is "to cont inue unchanged in form, conditio n , status, or quantity : c ontinue to be." Webs ter's Third New International Dictionary 19 19 (3d ed. 1993); see also The American Heritage Dict ionary of the English Language 1475 (4th ed. 2000) ("To continue in the s a me state or condition"; "T o be left after the removal, loss, passage, or destruction of others").

04-5111 15Though the ordinary meaning of the word "remain" when considered in the context of section 1.1502-75(d)(2)(ii) clearly fo recloses the sufficiency of a si multaneou s transaction to maintain a group's existence, it also pre s upposes no particular passage of time, e

. g. , no requirement that something "conti nues to be for three hours." Rather, the plain meaning of the regul ation requir e s only that ther e continues to be after the downstream merger one or more chains of in cludible corporations connected through stock ownership with a common parent corpor ation that was a member of the group prior to the date the former parent corporati on ceas ed to exist. In keeping with that meaning, we hold on the facts of this case that because Falconw ood was a member of the Mocatta Group prior to the date TMCH c eased to exist and became the owner of substantially all of the assets of TM CH, and because both MFC and FSC remained connected through stock ownership to Falc onwood after TMCH's downstream merger, albeit only for several hours, the downstream merger here sufficed to preserve the group's existence thro ugh Configuration B.
B We next turn our attention to the applic at ion by the Court of Federal Claims of the step transaction doctrine to collapse the Moca tta Group's reorganization int o a single step from Configuration A to Configuration C.
i The step transaction doctrine is a judicial manifestation of t he more general tax law ideal that effect should be given to t he substance, rather than the form, of a transaction, "by ignoring for tax purposes, steps of an integrat ed transac tion that separately are without substance. " Dietzsch v. United States , 498 F.2d 1344, 1346 (Ct.

04-5111 16Cl. 1974); see also King Enters., Inc. v. United States , 418 F.2d 511, 516 n.6 (Ct. Cl. 1969) ("[C]ourts have enunc iated a var i ety of doctrines, such as step t r ansaction, business purpose, and substanc e over for m . Although the v a rious doctrines overlap and it is not always clear in a particular ca se which one is most appropriate, their common premise is t hat the substantive realities of a transaction determine its ta x consequences."). The Supreme Court has expressly sanctioned the step transaction doctrine, noting that "interrelated yet formally distinct steps in an integrated transaction may not be cons idered inde pendently of the ov erall tr ans action." Comm'r v. Clark , 489 U.S. 726, 738 (1989); see also Comm'r v. Court Holding Co. , 324 U.S. 331,
334 (1945) ("To permit the true nature of a transaction to be disguis e d by mere formalisms, whic h e x is t solely to alter tax lia bi lities, would serious l y impair the effectiv e administration of the t a x policies of Congress."); Griffiths v. Helvering , 308 U.S. 355,
358 (1939) ("Taxes c annot be escaped 'by anticipatory a rrangements and contracts however s k illfu lly dev ised . . . by which th e fr uits are attributed to a different tree from that on which they grew.' " (quoting Lucas v. Earl , 281 U.S. 111, 115 (1930))); Minn. Tea Co. v. He lv ering , 302 U.S. 609, 613 (1938) ("A giv en result at the end of a straight path is not made a different result because reached by following a dev ious path.") ; Gregory v. Helvering , 293 U.S. 465 (1935). We too have noted that the objective of the doctrine is to "give tax effect to the subst ance, as opposed to the form of a transaction , by ignoring for tax purposes, steps of an integrated trans action that separately are without substance." Dietzsch , 498 F.2d at 1346. Though "there is no universal test applic able to step transaction s i tuations," King , 418 F.2d at 516, cour ts generally have enunciated three basic tests that define the

04-5111 17criteria upon whic h applic ation of the step transaction doctrine applies— the "interdependence test," the "end result test," and the "bind i ng commitment test." The interdependence test "requires an inquir y as to whether . . . the steps were s o interdependent that the lega l relations created by one transaction would have been fruitless wit hout a completion of the series ." Id. (quotation marks omitted). The end result test examines whether it appears t hat separate transactions were "really component parts of a single transaction intended from the outset to be taken for the purpose of reaching the ultimate result." Id. (quotati o n marks omi tted). The binding commitment test examines whether there wa s a "binding comm itment to undertake the later step" in a series of transacti ons. 5 Penrod v. Comm'r , 88 T.C. 1415, 1429 (1987).
In King , we further noted that various expres sions of the step transaction doc trine may have different meanings in different cont exts, and that there "may be not one rule, but several, depending on the subs tantive provision of the Code to which they are being applied." King , 418 F.2d at 516 (quotation marks omitted). Various opinions from the United States Tax Cour t have seemingly overlaid additional layers of analysis ont o the three tests, stating t hat the doctrine eviscerates meaningles s steps in a transaction, Esmark, Inc. v. C o mm'r , 90 T.C. 171, 195 (1988) ("combines a series of individually meaningl ess steps into a single transaction"), and

5 Courts have not often applied the binding commitme n t test. See Joshua D. Rosenberg, Tax Avoidanc e and Income Measurement , 87 Mich. L. Rev. 365, 406 (1988) ("[C]ourts, commentators, and the In ternal Revenue Service have generally rejected the use of the binding-c o mmitment tes t."). Indeed, the bindi ng com m itment test was squar ely rejected by our predecessor court in King . See King , 418 F.2d at 518 (stating that "the step transaction doctrine would be a dead letter if restricted to situations where the parties were bound to take certain step s" and refusing to apply the test).

04-5111 18does not apply " w hen the result of the steps is what is inte nded by the parties and fits within the particular statute, and when eac h of the several steps and the timing thereof has economic substance and is moti vated by valid business pur poses ," Tandy Corp. v. Comm'r , 92 T.C. 1165, 1173 (1989) (e mphasis added). See also Portland Mfg. Co. v

. Comm'r , 56 T.C. 58, 77 (1971) ("The artificiality of the transaction is apparent when . . . assets moved through the corporate hands . . . in a matter of days, never pausing long enough t o serve any business purpose, unt il they reached their ultimate destination . . . ."). Other courts have rejected the notion t hat a valid bus iness purpose nec es sarily bars applic ation of the step transaction doctrine. See Aeroquip-Vickers, Inc. v. Comm'r , 347 F.3d 173, 183 (6th Cir. 2003) ("Here, although the i ndividual steps of the transaction had a legitimate business reas on, the transaction must be treated as a single unit and judged by its end re sult."); True v. United St ates , 190 F.3d 1165,
1177 (10th Cir. 1999) (stating that a non-ta x "business purpose by itself does not preclude applic ation of the step transaction doctr ine" ); Kuper v. Comm'r , 533 F.2d 152,
158 (5th Cir. 1976) ("A legitimat e bus iness goa l does not grant t a xp ayer carte blanche to subvert Congressionally mandated tax patterns."); S. Bay Corp. v. Comm'r , 345 F.2d 698, 704 (2d Cir. 1965) ("[I]t must be doubted that the degree of int egration requisite . . . can, or ought to, go to the extreme of requiring that eac h step be devoid of business signific anc e unless united wit h one or more of the other steps."). But cf. De l Commercial Props., In c. v. Comm'r , 251 F.3d 210, 213-14 (D.C . Cir. 2001) ("Under the step-transaction doctrine, a par ticular step in a transaction is disregarded for tax purposes i f the tax payer coul d have achi eved i t s obj ecti ve mor e di rectl y , but i n stead

04-5111 19included the step for no other purpose than to avoid U.S. taxes. " (emphasis added)). Still others have con s idered an indepe nd ent busine ss purpose as part of the "sham transaction doctrine," a sister corollary of t he same basic substance-over-form principle that gives rise to the st ep transaction doctrine. See F r ank Lyon Co. v. Unit ed States , 435 U.S. 561, 580 (1 978) (holding that the t r ansaction at issue was not a sim p le s h am); see also Winn-Dixie Stores, Inc. v. Comm'r , 254 F.3d 1313, 1316 (11th Cir. 2001) (stating that the sham transaction doctrine "pro vides that a transaction is not entitled to tax respect if it lacks economic effects or substance other than the generation of tax benefits, or if the tr ansaction serves no business purpose"); True , 190 F.3d at 1177 n.11 (stating that "the sham transaction doctr ine focuse s on whether a questionable transaction has a business purpo se and economic effects othe r than the creation of tax benefits"); DeMartino v. Comm'r , 862 F.2d 400, 406 (2d Cir. 1988) ("A transaction is a sham if it is fictitious or if it has no bus ines s purpose or economic effect other than the creation of tax deductions."). The Tenth Circuit has further explained that: The law is unclear as to the rela tionship between the step transaction doctrine and the busine ss purpose requirement. Our survey of the relevant cases sugges ts that no fi rm line delineates the boundary between the two. Most cases applying the step transacti on doctrine, far from identifying business purpose as an element whose abs ence is prerequisite to that application, do not even include discussion of business purpose as a related issue. In some cases, t he existence of a business purpose is considered one factor in dete rmining whether form and substance coincide. In others, t he lack of business purpose is accepted as reason to apply the s t ep transaction doctrine. We have found no case holding that the existence of a bus i ness purpose pr ecludes the application of the step transaction doctrine. Associated Wholesale Grocer s, Inc. v. United States , 927 F.2d 1517, 1526-27 (10th Cir. 1991) (footnotes omitted).

04-5111 20That the Mocatta Group had an in dependent business purpose f o r the downstream merger in this case, which result ed in the structure of Configuration B, is not in dis pute. The downstream merger avoided "the risk and delay incident to obtaining r egulatory approval of a transfer of [Falconwood' s] seats, or options to purchase seats," on various commodities exchanges. Falconwood , 60 Fed. Cl. at 487 n.7. In light of existing ca se la w, what is less c l ear is the weight to be given that independent purpose in determini ng whether to ignore for tax pur poses certain steps o f the Mocatta Group's reorganization.
ii We hold on the facts of this case that the regulations at issu e leave no room for an applicat ion of the step transaction doctri ne, where the Mocatta Group proceeded to Configuration B for an independent bus iness purpose and was thereafter bound to follow the consolidated retu rn regulations at issue. Congress has expres sly delegat ed to the Secretary of the Tr easury the authority to promulg a te regulat ions n e ces s ary to de termine an d collect the ta x liab ility of a n affiliated gr oup of cor porations. See 26 U. S.C. § 1502 ("The Secretary shall prescribe such regulations as h e may dee m necessa ry in order that the tax liab i lity of any affiliated group of corporations making a consolidated return . . . may be returned, determined, computed, assessed, collected, and adjusted . . . ."); Unit ed Dominion Indus., Inc. v. United States , 532 U.S. 822, 826 (2001) (stating th at the Code permits an affiliate d group to file a single consolidated return and "leaves it to the Secretary of the Treasury to work out the details by promulgating r egulations governing s u ch returns"); Rite Aid Corp. v. United States , 255 F.3d 1357, 1359 (Fed. Cir. 2001) (dis cussing the legislativ e

04-5111 21history behind the de legation of authority to promulgate consolidat ed return regulations). The resulting regulations "u nlik e ordinary Treasury Regu la tions, are le gislativ e in character and have the force and e ffect of law." Union Elec. , 305 F.2d at 854; see als o Nicho ls v. United States , 260 F.3d 637, 648 (6th Cir. 2001) (stating that the regulation s pertaining t o consolidated returns are "legisl ative in nature and have the force and effect of law"); Conn. Gen. Li fe Ins. Co. v. Comm'r , 177 F.3d 136, 143 (3d Cir. 1999) (calling the regulations "legislative in character"). As the government notes in its brief on appeal, the Mocatta Group was thus bound to abi de by them. (Br. of Appelle e at 26.) Indeed, the express terms of the particular regulations at issue here belie any notion that complianc e by the Mocatta Group was dis c retionary. Having successfully succeeded to the assets of TMCH, in part to avoid the cost and delay in transferring various exchange seats, and having remai ned connected through stock ownership t o MFC and FSC prior to the ultimate termi nation of the group, the Mocatta Group was "required to file a consolidated return for the taxable y ear," 26 C.F.R. § 1.1502-75(a)(2) (emphasis added), and "must include the income of the common parent for that corporation's entire taxable year," id. § 1.1502-76(b)(1) (emphasis added). Upon completing a downstream merger for independent business reasons, Falconwo o d therefore had little choice in the face of quas i-legislative mandates but to file a fina l consolidated tax return for the group that cov e red Falc onwood's operations for its entire taxable year. In this context, we thus plac e great weight on the ex istenc e of a business purpose independent of t he ass o ciated tax consequences, for pursuit of that purpose led Falconwood down a regulatory path from which there were no exits.

04-5111 22Because the regulations brook no discret ion on the part of Falconwood in filing a consolidated tax retur n once the Mocatta Group proceeded to Config uration B, a move motivated by an independent busi ness purpose, we think it cor r ect to require both parties, turning squar e corners, to live wit h the end result of Falconwood's regulatory complianc e. 6 S e e Granite Trust Co. v. Unit ed States , 238 F.2d 670, 675 (1st Cir. 1956) (noting that applic able regulations "emphasize the rigid requirements of the section and make no allowance for the type of 'step transac tion' theory advanced in this case"); CSI Hydrostatic Testers, Inc. v. Comm'r , 103 T.C. 398, 411 (1994 ) ("[W]e will app l y th e consolidated return regulations a nd the Code as written."), aff'd , 62 F.3d 136 (5th Cir. 1995). We thus determine that an independ ent business purpose precludes application of the step transaction doctrine in the cont ext of the parti cular regulatory s c heme at issue here, where hav ing satisfied the presc r ipts of section 1.1502 -75(d)(2)(ii) and thu s surviving the downstream merger, Falconw ood was left with no option but to comply with the consolidated return regulations by including it s operations through March 31, 1987, in the Mocatta Group's final consolidated return. 7

6 The government stated at oral argument that the Commissioner of Internal Revenue enjoys what amounts to unfettered discretion to apply the step transaction doctrine in those cases wher e its application would ben e fit the gov ernment—a one-way ratchet of sorts. But Tr easury cannot with one hand prom ulgate consolidated return regulations that have t he force and effect of statutory law, and, with the other , require a taxpayer under the guise of the step trans action doct r ine to proceed contrary to the regulations but only when to th e governm ent's benef it. That is the practical effect of what the government purports to do here.

7 Hypothetic ally, had F a lconwood mer ged upstream into TMCH such that TMCH was the surviving entit y, TMCH would have remained as the parent corporation throughout the merger and until the Mocatta Gr oup reached Configuration C. Section 1.1502-76(b)(1) would then require TMCH to cover i t s operations through March 31, 1987, in the group's final consolidated return. Interestingly, an app lic ation of the step transaction doctrine t o remove Configurati on B from the reorganization process and

04-5111 23IV Reading no temporal requirement into the exception of sect ion 1.1502-75(d)(2)(ii) for the continued e x istence of an affiliated group despit e the down s tr eam merger of the former parent corporation, we conclude t hat the step transac tion doctrine cannot override the statutory and regulatory contex t gov erning consolidated tax returns from which this case aris es. The Court of F ederal Claims erred in granting summary judgment in favor of the gover nment that Falconwood may not in this cas e invoke the section 1.1502-75(d)(2)(ii) exc e pt ion to affiliated group continui ty r u les. We find instead that Falconwood's invocation was proper. In so doing, we have cons idered the government's arguments not addr essed express l y in this opinion and find them

thus collapse the reorganiza tion into one primary step from Configuration A t o Configuration C presumabl y would not have precluded TM CH from covering it s operations for the full taxable ye ar in the group's final return. This is so because even if Configuration B were ignor ed for tax purpos es, TMCH and its taxable year would hav e survived termination of the group upon reaching Configuration C, and "the income of the common parent for that corporation's entire taxable y e ar," TMCH' s tax year ending on March 31 in the hypothetical, must be in c l uded in the group's f i nal c onsolidated tax return. 26 C.F.R. § 1.1502-76(b)(1). Our holding thus avoids the peculiar re sult of the C ourt of Federal Claims's judgment in this case that in one sce nario, TMCH's downstr eam merger into Falconwood for an independent bus iness purpose allows for t he application of the step transaction doctrine to alter the associat ed tax cons equences of the reorganization, whereas in another, Falconwood's upstream merger into TMCH would not. The substantive outcome is the same under both s c enarios—the produc t of the Falconwood/TMCH merger and its taxable y ear survive termination of the group at Configuration C. But the associated ta x c onsequenc es under the Court of Federal Claims's judgment as explain ed are quite different, depend ing upon which of the two scenarios becomes reality. Such a result would turn on its head a doctrine that when used properly elevat es the substance of a transaction over its form. See Brown v

. United States , 329 F. 3d 664, 671 (9th Cir. 2003) ("su bstance should prevail over form" (quotation marks omitted)); King , 418 F.2d at 517 (stating that the doctrine assures that "tax consequences turn on the substance of a transaction rather than on its form").

04-5111 24unpersuasive. Accordingly, we reverse t he ruling of the Court of Federal Claims and remand for a determination of the refund due Falconwoo d.

REV E RS E AND REMAND

04-5111 25