               IN THE UNITED STATES COURT OF APPEALS

                       FOR THE FIFTH CIRCUIT

                       _____________________

                            No. 95-60102
                       _____________________


          VALERO ENERGY CORPORATION AND
          SUBSIDIARIES,

                                     Petitioner-Appellant,

          v.

          COMMISSIONER OF INTERNAL REVENUE,

                                      Respondent-Appellee.


_________________________________________________________________

             Appeal from the United States Tax Court
_________________________________________________________________
                          March 14, 1996

Before KING, DAVIS, and SMITH, Circuit Judges.

KING, Circuit Judge:

     The original majority opinion and dissent in this case,

Valero Energy Corp. v. Commissioner, No. 95-60102, slip op. at

1846 (5th Cir. Feb. 6, 1996), are withdrawn and the following

majority opinion and dissent are substituted in their place:

     Taxpayer corporation filed a petition in the tax court

contesting the Internal Revenue Service's determination that

taxpayer had overstated its 1984 net operating loss by taking a

double deduction for payments made pursuant to a settlement

agreement.   The tax court affirmed the determination, concluding

that the deduction was correctly disallowed.   Taxpayer appeals.

We affirm.
                 I.   FACTUAL AND PROCEDURAL BACKGROUND

     The relevant facts in this case are not disputed; many of

them are stipulated.     Valero Energy Corporation ("Valero") is a

Delaware corporation that had its principal offices in San

Antonio, Texas, when the petition in this case was filed.     The

predecessor of Valero was a subsidiary of Coastal States Gas

Corporation ("Coastal").     Valero and Coastal have always used the

accrual method of accounting for federal income tax purposes.

     In the early 1970s, Coastal and its subsidiaries were sued

by natural gas customers for breach of natural gas delivery

contracts.   The Texas Railroad Commission ruled that the

customers were due refunds in excess of $1.6 billion as a result

of those breaches.     In the settlement negotiations that followed

this ruling, the customers demanded, inter alia, that the refund

obligations be satisfied with cash.     Coastal and its

subsidiaries, however, did not have the capacity to make such

cash payments.    The customers' next preference was debt

securities, but this method of payment was also infeasible.

Therefore, the customers agreed to accept equity securities and

other negotiable instruments in lieu of cash or debt securities.

     To implement the settlement, the parties executed a

settlement plan ("the Plan").     One of the provisions of the Plan

was that Valero would be spun off from Coastal as an independent

corporation.   In addition, a trust ("the Settlement Trust") was

established for the benefit of the settling customers.      Pursuant

to the Plan, Valero transferred into the Settlement Trust various


                                    2
amounts of different equity securities and a promissory note, all

done in settlement, payment, and satisfaction of the settling

customers' claims.   The spinoff and transfer of property to the

Settlement Trust occurred on or about December 31, 1979.

     Among the assets transferred into the Settlement Trust were

1.15 million shares of newly-issued Valero $8.50 Cumulative

Series A Preferred Stock ("Valero Series A Stock").    When Coastal

and Valero first proposed including this stock in the settlement

package, the customers refused to accept it without an assurance

from Coastal and Valero as to the amount of proceeds that would

be realized from the stock.   Coastal and Valero initially

rejected such a provision, but later relented when restrictions

were placed on the sale and redemption of the stock.

Accordingly, the Settlement Trustee was authorized to sell the

Valero Series A Stock (subject to certain restrictions), to

receive dividends (if any),1 and to distribute the sale proceeds

and dividends to the settling customers.   The customers were only

entitled to the proceeds from the disposition of the stock, and

not the stock itself; if any of the stock remained as of December

1, 1986, Valero's Certificate of Incorporation required it to

begin redeeming the stock at a rate of 57,500 shares per year.

Under the Plan, Valero gave its assurance2 that the Settlement


     The Plan did not obligate Valero to declare any dividends on
the Valero Series A Stock because such action would depend on
Valero's earnings and financial condition.

     Both parties refer to this assurance as a "guarantee." As
the tax court correctly points out, however, this covenant was
not a guarantee in the true sense of the word, whereby the

                                 3
Trust would realize at least a total of $115 million from the

sale or redemption of and dividends on the stock by April 29,

1988:   When the Settlement Trustee disposed of the last of the

Valero Series A Stock, it would determine the aggregate amount of

proceeds collected from sales and dividends; if this amount was

less than $115 million, Valero would make up the difference.3

     The Plan also provided that, for purposes of the settlement

and federal income tax obligations, the value of the Valero

Series A Stock was its liquidation value of $115 million.4      This

arrangement was described in a prospectus, dated February 14,

1979, that was issued to the settling customers in connection

with the customers' approval of the Plan.      The prospectus advised

the customers, inter alia, that:       (1) the Plan provided that all

parties would treat the Valero Series A Stock as having a value

of $115 million; (2) in computing its taxable income, Coastal or

Valero would claim in the year of settlement a deduction equal to

the agreed value of the Valero Series A Stock; and (3) each

settling customer subject to federal income tax may recognize

ordinary income reflecting receipt of its proportionate interest



guarantor agrees to pay an obligation in the event of a default
by the principal obligor. In addition, the Plan itself uses the
word "assure."

     If the proceeds from the stock exceeded $115 million, the
excess was to be included in the distribution to the settling
customers. Valero did not make similar assurances with respect
to the other assets in the Settlement Trust.

     During this litigation, the parties stipulated that the fair
market value of the Valero Series A Stock in 1979 was, in fact,
$89.1 million.

                                   4
in the Settlement Trust at the time that the securities,

including the Valero Series A Stock, were transferred to the

Settlement Trust.     Coastal, Valero, and Coastal's other

subsidiaries filed a consolidated federal income tax return for

1979.    Pursuant to a tax deconsolidation agreement between

Coastal and Valero, effected as part of the Plan, (1) Valero

deducted $115 million in respect of its transfer of its own

preferred stock to the Settlement Trust; (2) the deduction was

reported on the Coastal group's consolidated tax return; and (3)

Valero was paid $50 million by Coastal in respect of the Coastal

group's tax benefit from Valero's deduction.

     Between 1980 and 1984, the following transactions occurred

with respect to the Valero Series A Stock in the Settlement

Trust:

            (1)   Valero paid approximately $34.5 million
                  in dividends on the stock.

            (2) An unrelated party, Variable Annuity
            Life Insurance Company, purchased 230,000
            shares of the stock for approximately $12.4
            million.

            (3) In two separate transactions, Valero
            redeemed a total of 920,000 shares of  the
            stock for approximately $48.3
            million.

When Valero redeemed the last of the stock held by the Settlement

Trust in August 1984, the Trust had only received approximately

$95.2 million from the transactions listed above.     This was

partly the result of a decline in the value of Valero securities

between August 1983 and August 1984.     Accordingly, in August

1984, pursuant to the assurance it had made in the Plan, Valero

                                   5
paid approximately $19.8 million into the Settlement Trust -- the

difference between the $115 million assured in the Plan and the

$95.2 million actually realized by the Settlement Trust from the

disposition of and dividends on the stock.    Valero deducted this

$19.8 million payment on its 1984 federal income tax return.

     On August 29, 1990, the Internal Revenue Service ("IRS")

issued a notice of deficiency to Valero asserting, inter alia,

that Valero had overstated its 1984 net operating loss by $19.8

million -- i.e., the amount it deducted for paying the shortfall

in the amount realized by the Settlement Trust from the

disposition of the Valero Series A Stock.    Valero filed a

petition in tax court contesting this determination.5

Specifically, Valero claimed that the two deductions were

separate because they were related to two separate obligations

under the Plan: (1) the obligation to transfer to the Settlement

Trust the 1.15 million shares of Valero Series A Stock, which had

an agreed value of $115 million; and (2) the obligation to pay

for any difference between $115 million and the amount realized

from the disposition of and dividends on the stock.     In response,

the Commissioner of Internal Revenue ("the Commissioner") argued

that Coastal had accrued and deducted the entire amount of its

obligation to the settling customers in 1979, including any

future payments that might be required by the assurance that the

customers would realize at least $115 million from the stock.



     Other issues were involved in the notice of deficiency, but
these were resolved before trial.

                                6
Accordingly, the Commissioner argued that Valero's 1984 deduction

of the $19.8 million payment was an improper double deduction of

an amount previously deducted in 1979.   The Commissioner further

contended that the duty of consistency in tax reporting precluded

Valero from taking the 1984 deduction.

     The tax court concluded that the Commissioner was correct in

disallowing the $19.8 million deduction in 1984.    The court

explained that Valero's assurance that the settling customers

would receive $115 million from the disposition of the stock was

"an integral part of a unified plan and agreement that settled

all claims," and therefore, each payment under the Plan could not

be considered a separate liability.   Consequently, the court held

that Coastal's $115 million deduction in 1979 included any

subsequent payments that Valero might have become obligated to

make under the assurance, so that Valero's 1984 deduction of the

$19.8 million payment was an improper double deduction.    Having

so held, the court did not reach the duty of consistency issue.

Valero timely appealed.



                          II.   DISCUSSION

     We review the decision of a tax court under the same

standards that apply to district court decisions.    Thus, issues

of law are reviewed de novo, and findings of fact are reviewed

for clear error.   Park v. Commissioner, 25 F.3d 1289, 1291 (5th

Cir.), cert. denied, 115 S. Ct. 673 (1994); McKnight v.

Commissioner, 7 F.3d 447, 450 (5th Cir. 1993).     Because the facts


                                  7
of this case are undisputed and the parties' contentions concern

purely legal issues, our entire review will be de novo.

     Valero contends on appeal that the $19.8 million payment it

made in 1984 was not included in the $115 million deduction taken

by Coastal in 1979.   First, Valero argues that the 1979 deduction

does not represent an obligation by Valero to pay $115 million to

the settling customers, but rather, it represents the value of

the Valero Series A Stock that was transferred to the Settlement

Trust.   Because the deduction was for the value of the stock

transferred, Valero argues that it could not have included any

future payments that Valero had to make under the assurance that

the customers would receive $115 million from the stock.

     Second, Valero contends that there were two deductions

because there were two separate obligations under the Plan

related to the Valero Series A Stock:    There was a fixed

obligation to transfer the stock, which had an agreed value of

$115 million, to the Settlement Trust.    There was also a second,

contingent obligation to pay for any difference between $115

million and the amount that the Settlement Trust realized from

the disposition of and dividends on the stock.    Valero took a

deduction for what it paid under each of these obligations.     As

evidence of the distinctiveness of these obligations, Valero

points to the sequence in which the settlement terms were

negotiated, noting that the assurance covenant was added some

time after the parties had agreed that the Valero Series A Stock

would be transferred to the Settlement Trust.


                                 8
     Finally, Valero contends that there never was an obligation

for Valero to pay the settling customers $115 million, and

consequently, the 1979 deduction could not have been for the

accrual of this obligation.   Valero maintains that its obligation

to pay the difference between $115 million and the amount

ultimately realized by the Settlement Trust from disposition of

the stock is not the same as an obligation to pay the settling

customers $115 million.   As evidence that no such obligation

existed, Valero points out that some of the $115 million received

by the customers did not come from Valero, but rather from an

unrelated company who purchased some of the Valero Series A

Stock.   In this same vein, Valero notes that another portion of

the $115 million came from its payment of dividends on the stock,

dividends that all parties agree Valero was not obligated to pay.

Valero also notes that the 1979 deduction could not have

contemplated an obligation to make future payments under the

assurance provision because there was no way to know in 1979

whether Valero would ever have to pay anything under this

provision.   Because its obligation under the assurance provision

was contingent on future events, Valero argues that this

obligation did not accrue in 1979, and therefore, was not part of

the $115 million deduction taken by Coastal.

     The Commissioner counters that, in 1979, Valero undertook a

contractual obligation that the settling customers would receive

$115 million from the disposition of and dividends on the Valero

Series A Stock, and that Coastal deducted this liability on its


                                 9
1979 federal income tax return.    In this regard, the Commissioner

points out that the parties have stipulated that the stock's fair

market value when transferred to the Settlement Trust was in fact

only about $89.1 million, and therefore, the $115 million

deduction taken by Coastal must have included more than the value

of the stock.   Because the entire $115 million obligation accrued

and was deducted in 1979, the Commissioner contends that any

future payments in satisfaction of this obligation were included

in the 1979 deduction.

     The Commissioner also argues that there were not two

separate obligations under the Plan related to the Valero Series

A Stock.   The Commissioner points out that the transfer of the

stock and the assurance provision were part of an integrated

agreement designed to ensure that the settling customers received

$115 million from one of the assets transferred to the Settlement

Trust.   In this regard, the Commissioner notes that the customers

would not have accepted the transfer of the stock without the

assurance provision and that the transfer and assurance are both

described in the same paragraph of the Plan.   Therefore, the

Commissioner argues that the order in which these items were

discussed in the settlement negotiations is irrelevant.

     Finally, the Commissioner maintains that the Plan created a

contractual right in the settling customers to receive $115

million, regardless of whether the funds came from sales of the

stock, dividends paid on the stock, or direct payments by Valero.

In other words, the overall liability to pay $115 million was


                                  10
fixed in 1979, although the source of the funding was contingent

on future events.   Because this obligation was established in

1979, the Commissioner contends that Coastal properly deducted it

in that year, and that the deduction included any future payments

that might be made in support of the obligation.   In this regard,

the Commissioner quotes Helvering v. Russian Finance & Constr.

Corp., 77 F.2d 324, 327 (2d Cir. 1935), for the proposition that

"[t]he existence of an absolute liability is necessary [for the

liability to be deducted]; absolute certainty that it will be

discharged by payment is not."

     Our decision in this case depends upon whose interpretation

of the settlement is correct.    Valero's interpretation is that it

had two separate obligations regarding the stock -- one to

transfer the stock to the Settlement Trust and one to pay any

difference between $115 million and the income generated by the

stock.   Valero then contends that these two separate obligations

gave rise to two separate tax consequences -- a $115 million

deduction for the transfer of the stock and a $19.8 million

deduction for satisfaction of the assurance provision.   The

Commissioner counters that Valero had one obligation -- to ensure

that the settling customers received $115 million from the

payment of the Valero Series A Stock into the Settlement Trust

and the operation of the assurance provision -- with one tax

consequence -- the $115 million deduction for this accrued

obligation.   The Commissioner characterizes the later payment of




                                 11
$19.8 million as in support of this previously deducted

obligation and thus not deductible itself.

     We believe that the Commissioner's interpretation of the

settlement is the correct one.   Viewing all the facts and

circumstances of the settlement, it is abundantly clear that

Valero had a contractual obligation to the settling customers in

the amount of $115 million.   It is equally clear that the

transfer of the Valero Series A Stock and the assurance were

inseparable provisions that operated in concert to extinguish

this obligation, and therefore should not be characterized as

distinct liabilities.

     First, in a real sense, Valero's obligation to the customers

did not arise out of the Plan, but out of the Railroad

Commission's ruling that the customers were entitled to refunds.

The Plan did not generate a new obligation as such, but

established the amount of the obligation and the means by which

Valero and Coastal were to satisfy that obligation.    The amount

of the portion of that obligation relevant in this case was

ascertainable in 1979 from Valero's assurance that the customers

would receive at least $115 million in cash as part of the

settlement.   The transfer of the Valero Series A Stock to the

Settlement Trust and the assurance provided the mechanism whereby

the customers received that $115 million.    Therefore, the

relevant portion of Valero's obligation to the customers was

fixed at $115 million in 1979.




                                 12
     Further, it is inappropriate to characterize the transfer of

the Valero Series A Stock and the assurance as two separate

obligations because the course of the settlement negotiations and

the terms of the Plan indicate that these provisions are properly

viewed as inseparable.    First, we note that the customers

initially demanded cash for satisfaction of the refund

obligations.   Had Coastal and Valero been able to meet this

demand, the customers would have received at least $115 million

in cash as part of the settlement and the Valero Series A Stock

would never have entered the negotiations.    Because Coastal and

Valero were unable to generate the necessary cash, the customers

agreed to accept the proceeds of the stock instead.    The

customers would not have accepted this arrangement, however,

without Valero's assurance that the customers would realize at

least $115 million from the disposition of the stock.    The

customers' demand for the assurance is understandable; the

expected proceeds from this newly-issued stock from a newly-

formed company were necessarily uncertain and speculative.

Without the assurance, the stock would not have been issued

because there would not have been a settlement.    Indeed, the

inclusion of the stock transfer and the assurance in the same

section in the Plan reflects the conjunctive nature of these

provisions.    As the tax court stated, "Valero's assurance that

the settling customers would realize at least $115 million in

proceeds from the series A preferred stock was an integral part

of a unified plan and agreement that settled all claims against


                                 13
Lo-Vaca, Valero, and Coastal."    Therefore, to parse the stock

transfer and assurance provisions of the Plan into separate

obligations is to belie the economic realities of the parties'

settlement.    Cf. Washington Post Co. v. United States, 405 F.2d

1279, 1283 (Ct. Cl. 1969) (while "analytically possible,"

misleading to view each relationship under taxpayer's incentive

plan as a separate liability where import of plan as a whole

dictates that relationships be viewed together).

     This explanation of the settlement becomes clearer when it

is observed that the customers ultimately received what they had

originally demanded -- cash.    Valero could not satisfy this

demand in 1979 because it did not have the cash on hand.

Therefore, it was necessary for Valero to create an income-

generating asset to produce the cash that the customers wanted.

Of course, it would have been inappropriate for Valero, as an

adverse party, to manage this asset to produce income for the

customers.    Consequently, the asset was transferred to a third

party -- the Settlement Trustee -- to manage the asset for the

benefit of the customers.    This transfer was only temporary; that

is, the customers did not have permanent ownership of the stock,

as Valero was required to redeem the stock after a certain date.

Rather, the customers held the stock for a discrete period while

it generated cash to satisfy the $115 million obligation to the

customers.    While the customers temporarily held the stock, the

assurance provision shifted the risk of loss due to fluctuation

in the stock's value to Valero, so that the customers were


                                 14
insured a minimum return regardless of the stock's performance.

Therefore, the Valero Series A Stock and the assurance provision

are more appropriately viewed as the means by which Valero

satisfied its $115 million obligation to the customers, as

opposed to obligations unto themselves.

     Because Valero had only one liability to the settling

customers with respect to the Valero Series A Stock, only one

deduction was proper.   An accrual basis taxpayer may deduct a

business expense in the first year in which the taxpayer

"incurs," or becomes liable for, that expense, regardless of when

the taxpayer actually pays the expense.   Treas. Reg. § 1.461-

1(a)(2); United States v. Anderson, 269 U.S. 422, 424 (1926).

Whether a taxpayer has incurred an expense is governed by the

"all events" test.   Under this test, all the events must have

occurred that establish the liability, and the amount must be

capable of being ascertained with reasonable accuracy.     Id.   As

stated above, Valero incurred a liability to the settling

customers when the Railroad Commission ruled that the customers

were entitled to refunds.   The amount of a portion of that

liability was ascertainable by reference to the assurance

provision in the Plan, which fixed that amount at $115 million.

Because the Plan was implemented in 1979, Coastal properly took a

deduction in the amount of $115 million in that year.

     We recognize that in 1979 it was uncertain whether Valero

would ever have to make any payments pursuant to the assurance

provision; such payments were dependent on the performance of the


                                15
Valero Series A Stock.   This uncertainty, however, does not

undermine the propriety of the $115 million deduction in 1979.

When a liability is fixed, "other uncertainties do not

necessarily destroy that initial certainty."    United States v.

Hughes Properties, Inc., 476 U.S. 593, 600 (1986).    Stated

differently, "[t]he existence of an absolute liability is

necessary; absolute certainty that it will be discharged by

payment is not."   Russian Finance & Constr. Corp., 77 F.2d at

327; see also Washington Post, 405 F.2d at 1284 (noting that

certainty of liability is significant for tax purposes, as

opposed to certainty of time over which payment is made or

certainty as to identity of payees).   Therefore, the deduction of

the $115 million liability in 1979 was proper, even if the amount

or time of payments in support of that liability under the

assurance provision was uncertain.

     Finally, because Coastal deducted the entire $115 million

liability when it was incurred in 1979, it was improper for

Valero to take further deductions when the liability was actually

extinguished by payment.   As such, Valero's 1984 deduction of the

$19.8 million payment made pursuant to the assurance provision

was an improper double deduction.    Accordingly, the IRS and the

tax court correctly determined that this deduction should be

disallowed.6




     Having so held, we need not reach the duty of consistency
issue.

                                16
                              III.    CONCLUSION

      For the foregoing reasons, we AFFIRM the judgment of the tax

court.7



JERRY E. SMITH, Circuit Judge, dissenting:

      Valero Energy Corporation (“Valero”) realized every tax-

payer’s dreamSSit took an improper deduction, and the

Commissioner of Internal Revenue (the “Commissioner”) decided not

to challenge it.      Rather than acknowledge that she has forfeited

her right both to challenge the 1979 deduction and to invoke the

“duty of consistency,”8 the Commissioner wants to exact a pound

of flesh by challenging the 1984 deduction.             I am puzzled by the



     We decide this case under the version of the Internal
Revenue Code of 1954, and the Treasury Regulations thereunder,
that were in effect in 1979. The result we reach today may have
been different if Valero's obligation under the Plan had been
incurred after July 18, 1984, the effective date of I.R.C. §
461(h). Since that date, I.R.C. § 461(h)(2) and Treas. Reg. §
1.461-4(g)(2) have required that an accrual method taxpayer's
obligation to make a payment or a series of payments to another
person, arising under, inter alia, a breach of contract, is not
deductible until economic performance occurs, defined as when
payment is actually made to the person to whom the obligation is
owed. This change was occasioned by a time-value-of-money
"loophole" resulting from an accrual method taxpayer's taking a
full deduction for the year in which an obligation to make
periodic payments that extend well into the future is incurred.
See Boris I. Bittker and Lawrence Lokken, Federal Taxation of
Income, Estates and Gifts ¶ 105.6.4 (2d ed. 1992 & Supp. 1995)
(discussing Burnham Corp. v. Commissioner, 878 F.2d 86 (2d Cir.
1989), a case illustrating the problem).
        8
          The “duty of consistency” is an equitable doctrine that prevents a
taxpayer from taking one position one year, and a contrary position in a later
year, after the limitations period has run on the first year. As I discuss
later, the duty of consistency is unavailable to the Commissioner in this case.
As a result, if she wishes to challenge the 1984 deduction, the Commissioner must
argue that the 1979 deduction was proper.

                                      -17-
Commissioner’s position, because in arguing that the 1979 deduc-

tion was proper, she undermines her position in countless cases

for the sake of a victory in the instant case.

      The majority’s mistake is that it sees only two options in

this case: reconcile the 1979 and 1984 deductions, or disallow

the 1984 deduction.9      Those are the only choices only if one

begins with the assumption that a taxpayer should always reim-

burse the Treasury for improper deductions.             When, as in this

case, the limitations period has run, courts are left with a

third choice: allow the later deduction; acknowledge that the

earlier deduction was improper; and admit that the “duty of

consistency” is the only barrier that prevents the taxpayer from

gaining a windfall.

      This case calls for the third choice:           The 1979 deduction

was improper, the 1984 deduction was proper, and the duty of

consistency does not apply.         This is so because, in 1979, Valero

replaced its obligation to pay the settling customers $115

million in cash with an obligation to deposit 1.15 million shares

of Series A stock in a trust fund and to make up the difference,

if any, between $115 million and the revenues of the trust.

      At that time, Valero was entitled to deduct the fair market

value of the stock, $89.1 million, because that obligation

accrued and in fact was fulfilled in 1979.            Any remaining cost of


     9
        See Maj. Op. at 11 (“Valero’s interpretation is that it had two separate
obligations regarding the stockSSone to transfer the stock to the Settlement
Trust and one to pay any difference between $115 million and the income generated
by the stock. Valero then contends that these two separate obligations gave rise
to two separate tax consequencesSSa $115 million deduction for the transfer of
the stock and a $19.8 million deduction for satisfaction of the assurance
provision.”).
satisfying the settlement agreement could not be deducted,

because it was a future expense “based on events that have not

occurred by the close of the taxable year.”   United States v.

General Dynamics Corp., 481 U.S. 239, 243-44 (1986).   That is to

say, in 1979 any further liability was conditional on (1) the

trustee’s disposing of the stock and (2) the existence of a

shortfall in the trust.   If, for example, the value of the stock

had increased substantially in the hands of the trustee, there

would have been no shortfall for which Valero would have to

compensate, and the contingent liability would have evaporated.

     Any windfall for the taxpayer was created by the Commis-

sioner’s negligence.   The Commissioner could have challenged the

1979 deduction and collected back taxes; she chose instead to

challenge the 1984 deduction.   As a result, the statute of

limitations on the 1979 return has now run.   The matter is made

worse by the fact that the Commissioner had notice of Valero’s

inconsistent treatment of the 1979 deduction before the end of

the limitations period.

     Thus, the “duty of consistency” does not prohibit Valero

from claiming that the 1984 deduction was proper.   If the Commis-

sioner had taken the sensible litigation strategy and challenged

both the 1979 and the 1984 deductions, Valero would not receive a

windfall.



                                 I.



                                -19-
        The correct way to determine Valero’s tax liability in 1979

is to focus on the substance of its obligations and ask what it

was obligated to pay in that year.           Under the settlement agree-

ment, Valero contributed stock with a stipulated market value of

$89.1 million to a trust fund.         It also had a contingent obliga-

tion to make up the difference between $115 million and the

proceeds to the trust, if and only if the stock did not realize

sufficient appreciation, and produce sufficient dividends, to

generate the remaining $25.9 million.           The only question is

whether Valero could take a deduction for that future, contingent

obligation.10

        Importantly, under the “all events” test, a liability does

not accrue until “the last link in the chain of events creating

liability” has occurred.        General Dynamics, 481 U.S. at 245.

General Dynamics illustrates how strict the “all events” test

is.11        There, the taxpayer sought to deduct estimates of its

        10
        The majority cites Washington Post Co. v. United States, 405 F.2d 1279,
1283 (Ct. Cl. 1969), for the proposition that a court may not “parse the stock
transfer and assurance provisions of the Plan into separate obligations” in order
to “belie the economic realities of the partes’ settlement.” Maj. Op. at 14.
But the majority fails to explain how this settlement agreement is analogous to
the bonus plan at issue in Washington Post, other than to cite two words from a
six-page opinion. Id.
      A close reading of Washington Post indicates that the court was more
concerned with the substance of the transaction than with the formal structure
of the plan. 405 F.2d at 1283 (“So we view this Plan for what it functionally
is . . . .”). The majority does exactly what the Washington Post court cautioned
againstSSit focuses on the form of the settlement agreement rather than the
substance of the transaction.
             11
          In the usual case, the “all events” test protects the Treasury by
deferring uncertain deductions into future years. The net result is that the
risk of taxpayers’ overestimating future obligations and thus, deductions, is
reduced. In this case, in order to reach a result that easily could have been
reached if the Commissioner had challenged the 1979 deduction, the Commissioner
                                                               (continued...)

                                      -20-
obligations to pay for the medical care of its employees.              The

medical care was obtained by the employees in the fourth quarter

of the year, but the taxpayer had yet to receive reimbursement

forms from those employees.        Id. at 240.     The Court disallowed

the deduction, noting that for a future obligation to be deduct-

ible, the liability must first be firmly established.             Id. at

243.    The liability had not been established, because the tax-

payer was liable only if properly documented forms were filed.

Until that event occurred, the taxpayer might not be liable for

the medical services.      Id. at 244-45.

       Like the taxpayer in General Dynamics, Valero did not have

an established liability in 1979.           Until an event occurred that

changed the status quo, Valero faced no liability.             The final

link in the chain of events was the disposition of the stock by

the Trustee.     Until the stock was sold, there was no liability,

because there was no shortfall in the trust.



                                     II.

       The majority opinion is based on the claim that “the Valero

Series A stock and the assurance provision are more appropriately

viewed as the means by which Valero satisfied its $115 million

obligation to the customers, as opposed to obligations unto

themselves.”     Maj. Op. at 15.     Because the settling customers


(...continued)
asks us, in effect, to make it easier for a taxpayer to deduct uncertain future
liabilities. While such an approach benefits the Treasury in this particular
case, it reduces tax revenues in other cases. Accordingly, I question both the
wisdom and the propriety of the Commissioner’s position in the case sub judice.

                                     -21-
were entitled to $115 million in cash from the Railroad Commis-

sion’s ruling, the majority reasons that the Settlement Agreement

did not affect that fixed liability, but only established a

contractual payment schedule.         Maj. Op. at 16.      This raises the

question of what the majority means by “fixed.”12

      The first problem with the majority opinion is that it

focuses on form over substance.          The only reason the majority

gives for the conclusion that Valero’s obligation was “fixed” is

that Valero’s initial liability was $115 million, and the settle-

ment agreement replaced that liability.            Thus, the majority

characterizes the settlement agreement as a single obligation



     12
        The majority correctly states that “[w]hen a liability is fixed, `other
uncertainties do not necessarily destroy that initial certainty.’” Maj. Op. at 16
(citations omitted). The majority’s characterization of the liability as “fixed”
begs the question, however.

      Moreover, cases cited by the majority are distinguishable. I.e., United
States v. Hughes Properties, Inc., 476 U.S. 593, 600 (1986) (holding that the
uncertainty as to when a slot machine will pay a jackpot does not make a
liability contingent, because the fact that state law prohibits an operator from
changing the odds makes liability certain); Helvering v. Russian Fin. & Constr.
Corp., 77 F.2d 324, 327 (2d Cir. 1935) (holding that liability accrued when
condition in contract was fulfilled, even though a condition subsequent could
erase the liability in the future); Washington Post, 405 F.2d at 1284 (holding
that incentive program in which taxpayer was irrevocably committed to paying a
certain sum was not a contingent liability even if the class of recipients and
timing of payment was uncertain).     In both Hughes and Washington Post, the
taxpayer entered into an irrevocable agreement to pay a sum certain. The final
event creating liability had occurred, and only the recipient and timing were
uncertain. In the instant case, it was uncertain, in 1979, whether Valero would
ever have to make payments (and if so, the amount of such payments) under the
settlement agreement.
      Russian Finance (which, coming from another circuit, is not binding on us)
is distinguishable, because there the taxpayer faced a liability subject to a
condition subsequent. 77 F.2d at 327. The court treated a condition subsequent
as an event that erases a preexisting liability rather than as an event upon
which liability is conditioned. Id. Accord Lawyers’ Title Guar. Fund v. United
States, 508 F.2d 1, 4-7 (5th Cir. 1975) (demonstrating the significance, in the
application of the all events test, of the differences among an imperfect right
subject to later perfection, a condition precedent, and a vested right subject
to divestment). Unlike the taxpayer in Russian Finance, Valero faced a liability
conditional upon a legal condition precedentSSthe sale of the stock.

                                     -22-
that guarantees that the settling customers receive $115 million.

As a formal matter, that may be precisely how the parties negoti-

ated the transaction, but the parties’ description of the trans-

action is irrelevant.13              That the majority’s approach

emphasizes form over substance is evidenced by the fact that its

rationale collapses when only the form of the transaction

changes.    If, for example, Valero had entered into the settlement

agreement before the Texas Railroad Commission had ruled on the

claims, the majority would not be able to argue that Valero had a

fixed liability of $115 million in 1979.                Or, assume hypothet-

ically that Valero paid the settling customers $115 million in

cash and then “sold” the settlement agreement to another party,

as an investment vehicle, for $115 million.             Once again, the

majority’s rationale for finding the liability to be fixed would

disappear, but Valero’s liability would not change.               The sub-

stance of the transaction is what matters, and the transaction

was not a simple payment plan; the settling parties gave up a

right to $115 million in cash for 1.15 million shares of stock

and the promise to make up a possible shortfall.

      The second problem with the majority opinion is that it

fails to recognize that Valero’s obligations are not measured by

the value the customers received from Valero, but from how much

it cost Valero to provide that value.           The majority argues that

      13
         United States v. Phillis, 257 U.S. 156, 168 (1921) (“We recognize the
importance of regarding matters of substance and disregarding forms in applying
the provisions of the Sixteenth Amendment and income laws enacted thereunder.”);
White Castle Lumber & Shingle Co. v. United States, 481 F.2d 1274, 1276 (5th Cir.
1973) (“For tax purposes, courts should not exalt form over substance . . . .”).

                                      -23-
because the settling customers gave up $115 million, Valero

necessarily incurred a debt of $115 million.     That may be true as

a matter of economic theory but not in the world of tax law.

     As this court has recognized, the tax laws do not accurately

reflect commercial accounting practice, and one reason for this

is the “all events test.”     See Mooney Aircraft, Inc. v. United

States, 420 F.2d 400, 404-05 (5th Cir. 1970).     The purpose of

‘accrual’ accounting in the taxation context is to try to match,

in the same taxable year, revenues with the expenses incurred in

producing those revenues.     Id. at 403.   One accounting technique

for matching expenses and revenues is the accrual of estimated

future expenses.    Id.   But the method of matching revenues and

future expenses is imperfect, because “the all events test is

designed to protect tax revenues by ‘(insuring) that the taxpayer

will not take deductions for expenditures that might never

occur.’    If there is any doubt whether the liability will occur

courts have been loath to interfere with the Commissioner’s

discretion [in] disallowing a deduction.”      Id. at 406.

     Focusing on the value paid to a taxpayer in return for an

obligation runs roughshod over the very purpose of the all events

test.    Under the majority’s analysis, anytime a taxpayer enters

into a contingent obligation in return for a sum certain, it

would be able to take a deduction in the amount of the payment.

In this case, the majority’s approachSSironically, supported by

the CommissionerSSallows Valero to deduct expenses it did not

incur.

                                 -24-
      According to the majority, Valero properly deducted

$115 million in 1979 for an obligation that actually cost it

$108.9 million,14 so Valero is being allowed to deduct $6.1

million in phantom expenses.         Such abuse, however, is precisely

what the “all events” test is meant to prevent.              See Mooney, 420

F.2d at 410 (stating that “the very purpose of the ‘all events

test’ is to make sure that the taxpayer will not deduct expenses

that might never occur.”).15

      If, on the other hand, the “all events” test were properly

applied here, Valero would have been allowed to take a

$89.1 million deduction in 1979 and a $19.8 million deduction in

1984,16     i.e., deductions equal to its actual cost.           Valero and

future taxpayers would not be able to play the odds and hope for

the type of windfall the majority is willing to countenance.



                                      III.



           14
            As the majority correctly points out, the trust fund received
approximately $95.2 million from transactions in the trust. Valero made up the
shortfall with a $19.8 million payment in 1984. Thus, Valero paid only $108.9
million to the settling customers, consisting of stock worth $89.1 million to the
trust and $19.8 million in cash. The difference came from price changes in, and
dividends on, the stock.
      15
         A number of plausible hypotheticals demonstrate that Valero’s liability
was uncertain in 1979. For example, if the trustee had disposed of the Series
A stock at $31 a share, the fund would have received $35.6 million from the sale.
Add to that the $34.5 million in dividends, and the trust would have a shortfall
of $44.7 million in 1984. Because Valero had already provided shares worth
$89.1 million, its total liability under the Settlement Agreement would be
$133.8 million. On the other hand, if the trustee had sold the stock at $53 per
share (and in fact, the trust sold 230,000 shares at $53.91), Valero’s actual
cost would be $108.65 million.
      16
         This is assuming, of course, that the Commissioner had not committed
what might be considered malpractice in the private sector.

                                      -25-
      Although the majority finds it unnecessary to reach the

issue, I would hold that the duty of consistency does not prevent

Valero from deducting the 1984 payment.    The duty of consistency

is based on the equitable principle that “no one shall be permit-

ted to found any claim upon his own inequity or take advantage of

his own wrong.”    Stearns Co. v. United States, 291 U.S. 54, 61-62

(1934).   “The duty of consistency is a doctrine that prevents a

taxpayer from taking one position one year, and a contrary

position in a later year, after the limitations period has run in

the first year.”   Herrington v. Commissioner, 854 F.2d 755, 757

(5th Cir. 1988).

      The requirements for the application of the duty of consis-

tency are “(1) a representation or report by the taxpayer; (2) on

which the Commission[er] has relied; and (3) an attempt by the

taxpayer after the statute of limitations has run to change the

previous representation or to recharacterize the situation in

such a way as to harm the Commissioner.”   Id. at 758.   If all

elements of the test are met, the Commissioner may act as if the

previous representation continued to be true, even if it is not.

Id.

      The Commissioner concedes that the third prong of the

Herrington test has not been met in this case but asks us to be

flexible in our approach to the “duty of consistency.”   This

argument is without merit.




                                -26-
       Herrington requires that the taxpayer change its position

after the statute of limitations has run.17                  Logically, the duty

of consistency protects the Commissioner from unscrupulous

taxpayers who purposely change positions after limitations has

run.    It does not protect the Commissioner from her own negli-

gence, however.        Once she was on notice that Valero had changed

its position on the 1979 deduction, the Commissioner should have

challenged the deduction before limitations had run.

       The Commissioner should be required to accept the conse-

quences of her error.          Accordingly, I respectfully dissent.18



      17
         See Davoli v. Commissioner, 68 T.C.M. (CCH) 104, 107 (1994) (“We have
previously held that where, prior to the expiration of the statute of limitations
with respect to the earlier year, the Commissioner knows or has reason to know
of the erroneous deduction claimed by the taxpayer, the Commissioner must
disallow the deduction for the year in which it is claimed rather than attempt
to recoup the applicable tax in the subsequent year.”); Southern Pac. Transp.
Co. v. Commissioner, 75 T.C. 497, 560 (1980) (“The doctrine of ‘duty of
consistency’ or ‘quasi-estoppel’ does not apply where all pertinent facts are
known to both the Commissioner and the taxpayer. ‘It is said that when both
parties know the facts, there is no reason to estop the taxpayer from changing
his position with respect to the transaction.’”).
        18
          In its revised opinion, the majority points out that the result it
reaches may have been different if Valero’s obligation had been incurred after
July 18, 1984, because of 26 U.S.C. § 461(h). Maj. Op. at 17 n.7. The “economic
performance” exception to the all events test does not affect my analysis,
however.
       Section 461(h) modifies the all events test in limited situations where a
taxpayer incurs a liability to make periodic payments over an indefinite period
of time. Prior to the enactment of § 461(h), the taxpayer could deduct the
entire liability, even if the time period was uncertain, because the taxpayer’s
liability for payment was fixed and the amount of liability was determinable with
reasonable accuracy. See BORIS I. BITTKER AND LAWRENCE LOKKEN, FEDERAL TAXATION OF INCOME,
ESTATES AND GIFTS ¶ 105.6.4 (2d ed. 1992 & Supp. 1995). The result was a windfall
to the taxpayer because of the time value of money. Section 461(h) closes the
loophole and makes such payments deductible only after economic performance, even
if the all events test is met.
      The difference between the cases covered by § 461(h) and the case sub
judice is obvious:     The liability incurred by Valero did not meet the
requirements of the all events test in 1979. To that extent, even if § 461(h)
had been in force in 1979, it would not apply to this case.

                                          -27-
