By LINDA GREENHOUSE
Published: June 14, 1994
New York Times
http://www.nytimes.com/1994/06/14/business/high-court-backs-closing-tax-loophole-retroactively.html?pagewanted=all&src=pm
The United States Supreme Court ruled today that Congress did not violate the Constitution when it closed a tax loophole retroactively in 1987 and collected back taxes from those who had relied on the original provision.
The 9-to-0 decision involving an estate tax provision overturned a 1992 ruling by a Federal appeals court in California, which held that the retroactive application of the amended provision violated the constitutional guarantee of due process of law.
Because Congress often acts retroactively in the tax area -- most recently, in last summer's budget package that raised tax rates retroactively to the beginning of 1993 -- the decision alarmed the Government and prompted the Clinton Administration to seek Supreme Court review. This case involved an estate tax provision of the Tax Reform Act of 1986.
But in a second important decision today, the Government did not fare nearly as well. The Court ruled unanimously that the Federal Deposit Insurance Corporation is bound by state law when it takes control of a failed savings and loan and seeks to recover losses by suing the lawyers and accountants who had advised the previous management.
As a practical matter, the decision means that certain defenses the outside professionals would have been entitled to invoke had the Federal regulators never come on the scene remain available to them.
In this case, involving the failed American Diversified Savings Bank of Costa Mesa, Calif., the decision permits a Los Angeles law firm, O'Melveny & Myers, to assert that under California law, it cannot be sued by the F.D.I.C. for its role in preparing two real estate syndications shortly before the institution was declared insolvent in 1986.
In the tax case, Justice Harry A. Blackmun's opinion for the Court was a broad vindication of Congressional authority. "Tax legislation is not a promise, and a taxpayer has no vested right in the Internal Revenue Code," Justice Blackmun wrote.
He said that retroactive tax legislation did not violate due process as long as the Congressional purpose "was neither illegitimate nor arbitrary." In a concurring opinion, Justice Antonin Scalia said that the Court's reasoning "guarantees that all retroactive tax laws will henceforth be valid."
The retroactive tax case, United States v. Carlton, No. 92-1941, involved a provision of the 1986 tax law intended by Congress to help employee stock ownership plans by encouraging the sale of stock to these plans. Under the original provision, an estate could deduct from its Federal estate tax half the proceeds of the sale of a company's stock to that company's employee stock ownership plan. Big Tax Saving
Relying on that provision, the executor of a large California estate used the estate's funds to buy 1.5 million shares of MCI Communications Corporation stock, which he sold two days later to the MCI employee stock ownership plan. While the stock price had declined, and the estate lost $600,000 on the $10.6 million transaction, it saved $2.5 million in Federal estate tax.
Numerous other executors had the same idea, with the result that a provision that was supposed to cost $300 million over a five-year period was soon estimated to be draining the Treasury at the rate of $7 billion over five years. Fourteen months later, Congress closed the loophole by limiting the deduction to the sale of stock that had been owned immediately before the deceased person's death. The provision was made retroactive to the date of the original 1986 law, and the Internal Revenue Service then disallowed deductions that had been claimed for newly purchased stock. The California executor, Jerry W. Carlton, paid and sued for a refund.
Justice Blackmun's opinion was signed by five other members of the Court: Chief Justice William H. Rehnquist and Justices John Paul Stevens, Anthony M. Kennedy, David H. Souter and Ruth Bader Ginsburg. Justice Scalia's separate concurring opinion was signed by Justice Clarence Thomas, and Justice Sandra Day O'Connor also filed a separate concurring opinion.
In its F.D.I.C. ruling, the Supreme Court rejected the agency's argument that the Federal courts should create an overriding "Federal common law" that could negate the defenses available under state law. The Court did not, however, resolve the merits of this case or declare definitively what the California law actually provides in the particular situation. The lower Federal courts in California must now examine those questions.
The decision, written for the Court by Justice Scalia, was based in large part on the Justices' interpretation of a 1989 law, the Financial Institutions Reform, Recovery and Enforcement Act of 1989, or Firrea.
In that law, Congress created some special Federal rules enabling the F.D.I.C. to override some state laws in its capacity as receiver of failed savings and loans. For example, Congress explicitly extended the statute of limitations that might exist under state law, and gave the F.D.I.C. authority to sue directors and officers for gross negligence in situations that might not be permitted by state law.
Those powers have proved an important part of the F.D.I.C.'s legal strategy for recovering some costs of the savings and loan bailout. Justice Scalia said that because Congress was so precise and explicit about the situations that it addressed in Firrea, its silence on other situations must be interpreted as leaving state law in place.
The Court placed in this second category the legal question at issue in this case: whether the F.D.I.C., as the receiver of a failed savings and loan, can sue a third party when the savings and loan itself would have been unable to do so under state law.
In deciding that state law, rather than a court-created "Federal common law," governs such situations, the Court handed a substantial problem to the F.D.I.C. as well as to another Federal agency, the Resolution Trust Corporation, the authority of which is also defined by Firrea.
Jack D. Smith, the deputy general counsel of the F.D.I.C., said today that while he expected the agency eventually to prevail in this particular case, the Court's general theory would weaken the Government's position in another important category of savings and loan cases involving state statutes of limitation.
While Firrea gave the F.D.I.C. three years from the date of an institution's failure to bring its suits, some Federal courts have been dismissing cases that have not been brought within shorter state-imposed time-limits. Today, the Supreme Court refused without comment to hear the agency's appeal in one such case, F.D.I.C. v. Dawson, No. 93-1486. Mr. Smith, the F.D.I.C. lawyer, said there was some $1.5 billion at stake in cases involving the statute of limitations. The F.D.I.C. and the
Resolution Trust Corporation are seeking legislation to address the problem, he said.
Another $1.5 billion is potentially at stake in the legal question at issue in the case the Court decided today.
Under a principle known as the "general rule of imputation," corporate insiders' knowledge of wrongdoing is imputed, or attributed, to the corporation itself, so that as a legal matter, the corporation cannot be seen as the victim of a fraud that its insiders have in fact perpetrated.
In this case, O'Melveny & Myers, the outside law firm, argued that under California law, the savings and loan would not have been able to sue its own lawyers for failing to uncover the fraud that led to the institution's demise. Thus, the firm argued that the F.D.I.C. should also be barred from bringing the suit because, as receiver, the Federal agency "stands in the shoes" of the failed institution. Suit Was Reinstated
The Federal District Court in Los Angeles accepted this argument and dismissed the F.D.I.C.'s lawsuit in 1990, but the Court of Appeals for the Ninth Circuit in San Francisco reinstated the suit in 1992 on the ground that there existed a "Federal common law" that permitted the F.D.I.C. to overcome the "imputation" defense that might otherwise be available to the law firm.
Nearly simultaneously, and underscoring the confusion in this area, another Federal appeals court, the Fifth Circuit in New Orleans, reached the opposite conclusion on two Texas savings and loans, City Savings and Loan and Lamar Savings Association. The Supreme Court has not yet acted on the F.D.I.C.'s appeal of that ruling.
In his opinion today, O'Melveny & Myers v. F.D.I.C., No. 93-489, Justice Scalia made it clear that Congress could give the F.D.I.C. expanded powers to override state law defenses if it chose to do so. But in the absence of Congressional action, "there is no Federal general common law," he said.
Full article:
http://www.nytimes.com/1994/06/14/business/high-court-backs-closing-tax-loophole-retroactively.html?pagewanted=all&src=pm
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