                                                 VIDAL SURIEL, PETITIONER v. COMMISSIONER                                OF
                                                       INTERNAL REVENUE, RESPONDENT
                                                    Docket No. 367–12.                      Filed December 4, 2013.

                                                P’s wholly owned S corporation, V, claimed deductions for
                                              unpaid obligations, both principal and interest, owed into the
                                              Tobacco Master Settlement Agreement (MSA) fund, which is
                                              a qualified settlement fund under I.R.C. sec. 468B. R dis-
                                              allowed the deductions on the basis that economic perform-
                                              ance did not occur until payment was actually made into the
                                              MSA fund, pursuant to sec. 1.468B–3(c)(1), Income Tax Regs.
                                              Under I.R.C. sec. 1366 R made adjustments to P’s individual
                                              income tax returns and determined deficiencies in P’s income
                                              tax. Held: V is not entitled to deductions for unpaid MSA
                                              obligations, because economic performance does not occur
                                              until the obligations are actually paid. See sec. 1.468B–3(c)(1),
                                              Income Tax Regs. Held, further, because the special rules gov-
                                              erning qualified settlement funds do not differentiate between
                                              interest and principal, we afford them equal treatment. Held,
                                              further, we sustain R’s deficiency determinations.

                                       Edward T. Yevoli, Paul D. Turner, and Joey M. Lampert,
                                     for petitioner.
                                       Robert M. Ratchford and Jeffrey B. Fienberg, for
                                     respondent.
                                        GOEKE, Judge: Respondent determined deficiencies in peti-
                                     tioner’s Federal income tax as follows:

                                                                    Year                          Deficiency

                                                                    2004                          $33,912,933
                                                                    2006                            5,837,489

                                       Respondent’s determinations of tax deficiencies result from
                                     adjustments made following respondent’s examination of

                                                                                                                                  507




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                                     508                 141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     returns of Vibo Corp., d.b.a. General Tobacco, Inc. (Vibo), 1 an
                                     S corporation, because pursuant to section 1366 2 all of the
                                     deductions and losses of Vibo properly passed through to
                                     petitioner as the sole shareholder during each of the tax
                                     years in issue.
                                        The issues in dispute concern Vibo’s accrual of unpaid
                                     obligations incurred when it settled with 46 States, the Dis-
                                     trict of Columbia, the Commonwealth of Puerto Rico, and 4
                                     U.S. territories (collectively, settling States) by entering into
                                     the Tobacco Master Settlement Agreement (MSA). After
                                     respondent’s concession, 3 the issues for decision are:
                                        (1) whether Vibo properly deducted its MSA payment
                                     obligations under section 461(h) before those obligations were
                                     actually paid into the MSA escrow account established at
                                     Citibank. We hold that it did not;
                                        (2) whether accrued interest owed into a qualified settle-
                                     ment fund is deductible in the tax year before actual pay-
                                     ment is made. We hold that it is not; and
                                        (3) whether adjustments to income or tax should be made
                                     with respect to petitioner’s 2004 and 2006 Forms 1040, U.S.
                                     Individual Income Tax Return, as a result of the adjustments
                                     made to Vibo’s 2004–06 Forms 1120S, U.S. Income Tax
                                     Return for an S Corporation. We hold that they should be
                                     made.
                                                                         FINDINGS OF FACT

                                       Some of the facts have been stipulated for trial under Rule
                                     91. The stipulation of facts and the attached exhibits are
                                     incorporated by this reference and are found accordingly.
                                       1 General Tobacco, Inc., is another subch. S corporation wholly owned by

                                     petitioner during the years in issue that was incorporated in the State of
                                     Florida on July 6, 2000. Because General Tobacco is the ‘‘d.b.a. name’’ of
                                     Vibo, and the parties use these two names interchangeably, we will refer
                                     to them collectively as Vibo throughout this Opinion to alleviate any confu-
                                     sion.
                                       2 Unless otherwise indicated, all section references are to the Internal

                                     Revenue Code (Code) in effect for the years in issue, and all Rule ref-
                                     erences are to the Tax Court Rules of Practice and Procedure.
                                       3 Respondent concedes that petitioner reasonably and in good faith relied

                                     upon tax professionals in reporting Vibo’s deductions of $302,221,719 for
                                     the 2004 tax year and thus is not liable for any accuracy-related penalty
                                     under sec. 6662(a). Respondent did not determine a sec. 6662 penalty for
                                     the 2006 tax year.




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                                     (507)                          SURIEL v. COMMISSIONER                                        509


                                     I. Background
                                       Respondent mailed a notice of deficiency to petitioner on
                                     October 6, 2011. Petitioner timely filed his petition with this
                                     Court on January 4, 2012. At the time the petition was filed,
                                     petitioner was a resident of Miami, Florida. The parties have
                                     stipulated that venue for purposes of an appeal is in the
                                     Court of Appeals for the Eleventh Circuit.
                                           A. Vibo
                                       Vibo, a Florida corporation, began to sell cigarettes in the
                                     United States in 1999. During 2000–2006, Vibo was taxed
                                     under subchapter S and wholly owned by petitioner. Vibo
                                     was an accrual method taxpayer during the tax years 2004–
                                     06. For each of the tax years in issue, Vibo filed a Form
                                     1120S. During the tax years at issue, Vibo did not own any
                                     cigarette manufacturing or packaging equipment.
                                           B. Protabaco
                                       Productora Tabacalera De Colombia S.A. (Protabaco), a
                                     Colombian company, is unrelated to petitioner by ownership.
                                     During the tax years in issue, Protabaco was in the business
                                     of manufacturing tobacco products. During the tax years in
                                     issue, Protabaco was the fabricator of Vibo’s cigarettes. As
                                     part of its entry into the MSA, Vibo entered into an exclusive
                                     manufacturing and distribution agreement with Protabaco,
                                     whereby Vibo appointed Protabaco as its exclusive manufac-
                                     turer and Protabaco appointed Vibo its exclusive importer.
                                     II. Tobacco Master Settlement Agreement (MSA)
                                           A. Background
                                        Before the MSA was executed various States either had
                                     commenced or were expected to commence litigation in order
                                     to assert claims for monetary, equitable, and injunctive relief
                                     against certain tobacco product manufacturers and other
                                     defendants for damages under State laws. Relief and dam-
                                     ages were sought under State laws such as consumer protec-
                                     tion or antitrust in order to further the States’ policies
                                     regarding public health, including policies to reduce smoking
                                     by youth. The central purpose of the MSA was to reduce
                                     smoking—particularly youth smoking—in the United States.




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                                     510                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                       On November 23, 1998, the MSA execution date, four
                                     tobacco product manufacturers (TPMs) entered into the MSA
                                     with representatives (the NAAG) 4 from the settling States.
                                     The four manufacturers were Brown & Williamson Tobacco
                                     Corp., Lorillard Tobacco Co., Phillip Morris, Inc., and R.J.
                                     Reynolds Tobacco Co. The settling States included 46 States,
                                     the District of Columbia, the Commonwealth of Puerto Rico,
                                     and 4 U.S. territories.
                                       A TPM as defined in the MSA is an entity that after the
                                     MSA execution date directly (and not exclusively through
                                     any affiliate):
                                           (1) manufactures Cigarettes anywhere that such manufacturer intends
                                           to be sold in the States, including cigarettes intended to be sold in the
                                           States through an importer * * *;
                                           (2) is the first purchaser anywhere for resale in the States of cigarettes
                                           manufactured anywhere that the manufacturer does not intend to be
                                           sold in the States; or
                                           (3) becomes a successor of an entity described in subsection (1) or (2)
                                           above.

                                     Amendment No. 24 (amendment 24) to the MSA provides:
                                           In addition, and in consideration for the above, * * * [Vibo] shall be
                                           considered to be a * * * [TPM] and a Participating Manufacturer, and
                                           Protabaco shall not be considered to be a * * * [TPM].

                                     A participating manufacturer as defined in the MSA is a
                                     TPM that is or becomes a signatory to the MSA, provided
                                     that: (1) in the case of a TPM that is not an original partici-
                                     pating manufacturer (OPM) (i.e., in Vibo’s case), that TPM is
                                     bound by the MSA in all settling States in which the MSA
                                     binds OPMs, and (2) in the case of a TPM that signs the
                                     MSA after the MSA execution date (i.e., also in Vibo’s case),
                                     that TPM, within a reasonable time after signing the MSA,
                                     makes any payments that it would have been obligated to
                                     make in the intervening period had it been a signatory as of
                                     the MSA execution date.
                                       Under the MSA, the settling States released a partici-
                                     pating manufacturer from all past and future tobacco-related
                                     claims that the States might have against that company,
                                     when the participating manufacturer became a signatory to
                                        4 The National Association of Attorneys General (NAAG) is an associa-

                                     tion of U.S. attorneys general whose tobacco project’s mission is to support
                                     the States in enforcing, defending, and administering the MSA.




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                                     (507)                           SURIEL v. COMMISSIONER                                        511


                                     the MSA. The MSA specifies two types of participating
                                     manufacturers: an OPM and a subsequent participating
                                     manufacturer (SPM). The OPMs consisted of the four TPMs,
                                     discussed supra, that signed the MSA on the MSA execution
                                     date. An SPM is a TPM (other than an OPM) that: (1) is a
                                     participating manufacturer and (2) is a signatory to the
                                     MSA, regardless of when that TPM became a signatory to
                                     the MSA.
                                       In consideration for the released claims, the participating
                                     manufacturers were required to make MSA payments to the
                                     settling States in order to promote educational programs tai-
                                     lored to preventing smoking and to compensating the States
                                     for healthcare costs incurred from the effects of smoking and
                                     tobacco use. Both the released claims and the MSA payments
                                     will be discussed in turn.
                                           B. Released Claims
                                       Section XVIII(d) of the MSA provides: ‘‘All payments to be
                                     made by the Participating Manufacturers pursuant to this
                                     Agreement are in settlement of all of the settling States’
                                     antitrust, consumer protection, common law negligence,
                                     statutory, common law and equitable claims for monetary,
                                     restitutionary, equitable and injunctive relief alleged by the
                                     settling States with respect to the year of payment or earlier
                                     years’’.
                                           C. MSA Payments
                                       Section IX(a) of the MSA, titled ‘‘Payments’’, provides that
                                     all payments made pursuant to the MSA (except those not at
                                     issue in this case) shall be made into escrow pursuant to the
                                     escrow agreement. The second and third sentences of section
                                     6 of the escrow agreement provide:
                                           The escrow established pursuant to this Escrow Agreement is intended
                                           to be treated as a Qualified Settlement Fund for Federal tax purposes
                                           pursuant to Treas. Reg. § 1.468B–1. The Escrow Agent shall comply with
                                           all applicable tax filing, payment and reporting requirements, including,
                                           without limitation, those imposed under Treas. Reg. § 1.468B * * *.

                                     The OPMs and SPMs are required under the MSA to make
                                     their payments to the settling States into an escrow fund.
                                     The parties stipulate that the MSA escrow fund is a qualified
                                     settlement fund under section 1.468B–1, Income Tax Regs.




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                                     512                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     The escrow fund was established with Citibank, N.A., which
                                     served as the escrow agent.
                                     III. Pre-MSA
                                       Tobacco manufacturers that do not join the MSA are
                                     known as nonparticipating manufacturers (NPMs). The MSA
                                     directed each settling State to enact legislation that would
                                     require an NPM to make deposits into an escrow account to
                                     satisfy any judgments that a particular State might bring
                                     against the NPM in that particular State. These statutes
                                     required an NPM to make annual deposits into State escrow
                                     accounts for each State where the NPM sold its tobacco prod-
                                     ucts. The escrow payment amounts were based on each com-
                                     pany’s sales in the respective State.
                                       The exclusive manufacturing and distribution agreement
                                     states in its recitals:
                                           WHEREAS, manufacturers of cigarettes sold in the United States are
                                           obligated under the laws of various U.S. states to either (i) join the
                                           * * * [MSA] or (ii) to establish and contribute funds to designated
                                           escrow accounts, which funds are intended to be made available for the
                                           settlement of tobacco-related litigation that may be brought against such
                                           cigarette manufacturers by authorities in those U.S. states;

                                     Because Protabaco manufactured cigarettes that were sold in
                                     the United States, it had an obligation to either join the MSA
                                     or contribute to the NPM escrow accounts, of which it chose
                                     the latter. Protabaco’s name was on the NPM escrow
                                     accounts, but Vibo made the account contributions. Once
                                     Protabaco chose the NPM route, there was no obligation to
                                     later join the MSA.
                                        The NPM escrow statutes, as originally enacted by the set-
                                     tling States, contained an unintended loophole that gave
                                     NPMs an unfair competitive advantage over TPMs partici-
                                     pating in the MSA. To close this statutory loophole, in late
                                     2003 the NAAG adopted a resolution supporting allocable
                                     share legislation, which made the passage of such corrective
                                     legislation its number one legislative effort in 2004. On
                                     March 30, 2004, Vibo submitted to the NAAG its application
                                     to join the MSA.
                                        In a Federal antitrust action, Vibo sued the settling States,
                                     the OPMs, and other SPMs in the matter of Vibo Corp. v.
                                     Conway, 669 F.3d 675 (6th Cir. 2012). In its complaint, Vibo
                                     alleged that the MSA violated its constitutional rights and




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                                     (507)                           SURIEL v. COMMISSIONER                                        513


                                     imposed an unreasonable restraint on trade in violation of
                                     antitrust laws and that it was fraudulently induced by the
                                     settling States to join the MSA. Vibo’s claims were dismissed
                                     and judgment was entered in favor of the defendants.
                                       Vibo further alleged that the settling States’ amendment of
                                     their escrow statutes made it increasingly difficult for Vibo
                                     to continue in business under the obligation of making NPM
                                     contributions. Vibo also stated that it came to understand
                                     that the only effective means to reach the vast majority of
                                     the national cigarette market was to join the MSA because
                                     most retail chains wanted the liability release afforded by
                                     the MSA to participating manufacturers and refused to carry
                                     Vibo products without it. That complaint was verified by J.
                                     Ronald Denman, Vibo’s vice president and general counsel.
                                       The exclusive manufacturing and distribution agreement
                                     petitioner signed states: ‘‘[Vibo] has agreed to make a consid-
                                     erable long term investment wherein it has obligated itself to
                                     make payments to the States * * * in order that it may
                                     become a signatory to the MSA, with the expectation of
                                     gaining a considerable increase in market share for the
                                     [Vibo] Cigarettes’’.
                                     IV. Entering Into the MSA
                                       Before Vibo entered into the MSA, it fulfilled all of the
                                     NPM escrow statute deposit requirements. On August 19,
                                     2004, effective as of July 1, 2004, petitioner executed the
                                     MSA on behalf of Vibo. The first paragraph of the MSA
                                     execution statement, which petitioner signed under oath,
                                     states:
                                           [the] undersigned authorized representative hereby executes the * * *
                                           [MSA], as amended (hereafter ‘‘Agreement’’) on behalf of * * * [Vibo]
                                           thereby becoming * * * [an SPM]. * * * [Vibo] and its authorized rep-
                                           resentatives agree to be bound by such Agreement and to fulfill all the
                                           obligations of a Participating Manufacturer under the Agreement,
                                           including, but not limited to, making all payments that it would have
                                           been obligated to make had it been a signatory as of the MSA execution
                                           date.

                                     As the MSA was originally drafted, only a TPM could enter
                                     the MSA as a participating manufacturer. The MSA was
                                     later amended by amendment 24 to allow the exclusive
                                     importer of cigarettes manufactured by another person out-




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                                     514                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     side the United States to enter the MSA. Vibo’s application
                                     to join the MSA was submitted on that basis. By signing and
                                     executing amendment 24, petitioner agreed and acknowl-
                                     edged that Vibo was liable to make the MSA payments on its
                                     cigarettes regardless of the identity of their manufacturer.
                                       If an NPM joined the MSA, it would become an SPM and
                                     be subject to the MSA obligations of an SPM and a partici-
                                     pating manufacturer. If an NPM joined the MSA more than
                                     90 days after its execution, as Vibo did, it was required to:
                                     (1) make payments to the States that it would have been
                                     obligated to make had it joined the MSA in November 1998
                                     (prior obligation); and (2) make annual payments going for-
                                     ward based on the company’s national market share (current
                                     obligation). Once a party becomes a signatory to the MSA, it
                                     no longer has an NPM escrow statute deposit obligation
                                     under a settling State’s NPM escrow statute.
                                       According to the General Tobacco adherence agreement,
                                     Vibo was required to make prior obligation payments based
                                     on the amount of Federal excise taxes that it had paid for
                                     cigarettes from January 1, 2000, through June 30, 2004. Vibo
                                     was required to make these payments in 12 annual install-
                                     ments from 2005 through 2016. After application of all of the
                                     NPM escrow account amounts and other credits, the net
                                     unpaid prior obligations totaled $242,314,534 as of June 30,
                                     2004.
                                       Vibo was required to make current obligation payments for
                                     all obligations arising from its market share of cigarettes it
                                     sold for the period July 1 through December 31, 2004, and
                                     for all post-2004 sales. Vibo’s current obligations were pay-
                                     able on April 15 of the year following the year in which Fed-
                                     eral excise taxes were collected on its cigarettes. 5 Vibo’s 2004
                                     current obligation amount due on April 15, 2005, totaled
                                     $65,854,272. The General Tobacco adherence agreement
                                     spells out that Vibo is the only party with MSA payment
                                     obligations. Nothing in the MSA documents places this pay-
                                     ment obligation on Protabaco. Protabaco was not a signatory
                                           5 The
                                             General Tobacco adherence agreement required Vibo to make quar-
                                     terly payments into escrow towards its current obligations based upon a
                                     fixed amount per cigarette. These quarterly payments were held by
                                     SunTrust Bank in Miami, which would then transfer those funds to the
                                     Citibank escrow account on the following April 15.




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                                     (507)                          SURIEL v. COMMISSIONER                                        515


                                     to this agreement, the MSA execution statement, or amend-
                                     ment 24.
                                       Vibo had a strong economic incentive to make its prior and
                                     current obligation payments into the MSA escrow account. If
                                     Vibo failed to make those payments, Vibo’s cigarette brands
                                     would end up delisted and retailers would not stock their
                                     shelves with those brands.
                                     V. Vibo’s Deductions
                                           A. Cost of Goods Sold Deductions
                                        On its 2004 Form 1120S, Vibo deducted $295,549,083 of its
                                     MSA payment obligations (both prior and current obliga-
                                     tions) as part of its cost of goods sold. None of this amount
                                     was actually paid into the MSA escrow account in 2004.
                                        On its 2006 Form 1120S, Vibo deducted $108,487,225 of its
                                     MSA current obligation as part of its cost of goods sold. In
                                     2006 Vibo paid $97,637,716 of its MSA current obligation.
                                           B. Interest Deduction
                                        On its 2004 Form 1120S, Vibo deducted $4,661,190 as
                                     interest. This represented interest accrued on, and made part
                                     of, Vibo’s prior obligation, for July 1 through December 31,
                                     2004. The interest amount was calculated by and confirmed
                                     in the letter drafted by Pricewaterhouse Coopers (PwC), the
                                     internal auditor under the terms of the MSA. No part of the
                                     $4,661,190 was paid in 2004, but this amount was paid on
                                     September 1, 2005.
                                        The PwC letter did not calculate or confirm an interest
                                     amount attributable to the prior obligation owed for the
                                     period January 1, 2000, through June 30, 2004.

                                     C. Other Deduction
                                        On its 2004 Form 1120S, Vibo deducted $2,011,446 under
                                     ‘‘Other Deductions’’, and it was specifically labeled ‘‘MSA
                                     Obligation—Paid.’’ No part of that $2,011,446 was paid in
                                     2004.




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                                     516                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                                                                  OPINION

                                     I. Burden of Proof
                                       Generally, taxpayers bear the burden of proving, by a
                                     preponderance of the evidence, that the determinations of the
                                     Commissioner in a notice of deficiency are incorrect. Rule
                                     142(a)(1); Welch v. Helvering, 290 U.S. 111, 115 (1933).
                                     Deductions are a matter of legislative grace, and a taxpayer
                                     bears the burden of proving entitlement to any claimed
                                     deductions. Rule 142(a)(1); INDOPCO, Inc. v. Commissioner,
                                     503 U.S. 79, 84 (1992). Petitioner has not argued that
                                     respondent bears the burden of proof with respect to the
                                     issues discussed below.
                                     II. The Danielson Rule
                                           A. Danielson Applies
                                       When a taxpayer casts a transaction in a certain form, the
                                     Commissioner may bind the taxpayer to that form for tax
                                     purposes. See Commissioner v. Danielson, 378 F.2d 771 (3d
                                     Cir. 1967), vacating and remanding 44 T.C. 549 (1965). The
                                     Danielson rule is a parol evidence rule applicable in Federal
                                     tax controversies. Id. at 779. Under the Danielson rule, as
                                     adopted by the Court of Appeals for the Third Circuit:
                                           [A] party can challenge the tax consequences of his agreement as con-
                                           strued by the Commissioner only by adducing proof which in an action
                                           between the parties to the agreement would be admissible to alter that
                                           construction or to show its unenforceability because of mistake, undue
                                           influence, fraud, duress, etc. * * * [Id. at 775.]
                                        The Court of Appeals for the Eleventh Circuit, to which an
                                     appeal in the instant case would lie, see sec. 7482(b)(1)(A),
                                     has accepted the Danielson rule, see Plante v. Commissioner,
                                     168 F.3d 1279, 1280–1281 (11th Cir. 1999), aff ’g T.C. Memo.
                                     1997–386; Bradley v. United States, 730 F.2d 718, 720 (11th
                                     Cir. 1984). Accordingly, if the Danielson rule applies, we will
                                     follow it. Golsen v. Commissioner, 54 T.C. 742, 756–757
                                     (1970), aff ’d, 445 F.2d 985 (10th Cir. 1971).
                                        Petitioner’s pretrial memorandum challenged the applica-
                                     tion of Danielson. On brief, however, he agreed that the
                                     Danielson rule applies to the MSA documents.




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                                     (507)                          SURIEL v. COMMISSIONER                                        517


                                           B. MSA Documents
                                        Although the parties agree that Danielson applies to the
                                     ‘‘MSA documents’’, they appear to disagree over which docu-
                                     ments that term covers. 6 The only disagreement appears to
                                     be whether the MSA execution statement should be included.
                                     Because petitioner had to sign the MSA execution statement
                                     to join the MSA, we find the execution statement to be an
                                     integral piece of the ‘‘MSA documents’’. Accordingly, we will
                                     use the term ‘‘MSA documents’’ to refer collectively to the fol-
                                     lowing documents: the MSA, amendment 24, the MSA execu-
                                     tion statement, the exclusive manufacturing and distribution
                                     agreement, and the General Tobacco adherence agreement.
                                           C. Arguments
                                        Respondent contends Vibo voluntarily entered into the
                                     settlement with the settling States and should be bound by
                                     the MSA documents. Consequently, respondent argues, the
                                     regulations prohibit Vibo from deducting the MSA payment
                                     obligations until it actually makes the payments.
                                        Petitioner contends that Protabaco was the manufacturer
                                     participating in the MSA, because all the documents refer to
                                     Vibo as the importer and distributor (not the manufacturer)
                                     and to Protabaco as the manufacturer. Consequently, peti-
                                     tioner argues, Vibo was simply assuming Protabaco’s MSA
                                     payment obligations as a cost of purchasing cigarettes and
                                     the Code allows Vibo to deduct the MSA payment obligations
                                     as an ordinary and necessary business expense or cost of
                                     goods sold.
                                        Before we can decide the tax consequences resulting under
                                     the MSA documents, we must discern the operative effect of
                                     the documents under Danielson. We begin by determining
                                        6 Respondent’s pretrial memorandum states: ‘‘The MSA Settlement Doc-

                                     uments include: the MSA, Amendment No. 24 to the MSA, the General To-
                                     bacco Adherence Agreement, the Exclusive Manufacturing and Distribu-
                                     tion Agreement, and the MSA Execution Statement.’’ However, petitioner’s
                                     brief states: ‘‘Petitioner concedes and agrees only that the Court apply
                                     Danielson and give effect to the clear and unambiguous terms of the ‘MSA
                                     Documents’ as defined herein.’’ Petitioner then defines the MSA documents
                                     to include: the MSA, amendment 24, the exclusive manufacturing and dis-
                                     tribution agreement, and the General Tobacco adherence agreement. The
                                     only difference between the two parties is with regard to the MSA execu-
                                     tion statement.




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                                     518                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     Vibo’s status under the MSA vis-a-vis its relationship to
                                     Protabaco.
                                     III. TPM, SPM, and Participating Manufacturer
                                           A. Tobacco Product Manufacturer
                                       The MSA defines a ‘‘tobacco product manufacturer’’ (TPM)
                                     as an entity that after the MSA execution date directly (and
                                     not exclusively through any affiliate):
                                           (1) manufactures Cigarettes anywhere that such manufacturer intends
                                           to be sold in the States, including cigarettes intended to be sold in the
                                           States through an importer * * *;
                                           (2) is the first purchaser anywhere for resale in the States of cigarettes
                                           manufactured anywhere that the manufacturer does not intend to be
                                           sold in the States; or
                                           (3) becomes a successor of an entity described in subsection (1) or (2)
                                           above.

                                     Amendment No. 24 to the MSA provides:
                                           In addition, and in consideration for the above, * * * [Vibo] shall be
                                           considered to be a * * * [TPM] and a Participating Manufacturer, and
                                           Protabaco shall not be considered to be a * * * [TPM].

                                     Petitioner contends that Vibo was not a TPM under the
                                     original draft of the MSA, and only TPMs were allowed to
                                     enter the MSA. The parties agree Vibo was not an actual
                                     manufacturer or fabricator of any cigarettes during the rel-
                                     evant periods. However, amendment 24 classifies Vibo as a
                                     TPM and explicitly allows the exclusive importer of foreign
                                     cigarettes to enter the MSA.
                                       On brief petitioner quoted portions of section (A)(1) and (2)
                                     of amendment 24 to support his argument that Vibo is not
                                     a TPM. That section states, in part, that Vibo agrees and
                                     acknowledges (1) that it is the sole importer and distributor
                                     in the United States of all cigarettes manufactured by
                                     Protabaco and (2) that Protabaco is the sole manufacturer of
                                     any cigarettes owned or licensed by Vibo or Protabaco. How-
                                     ever, petitioner failed to include the portions of that section
                                     that cuts against his argument. Both parts end with the
                                     phrase ‘‘subject to the terms of this Amendment.’’ This
                                     phrase is important, because as quoted above, the amend-
                                     ment provides in section (B) that ‘‘[Vibo] shall be considered
                                     to be a * * * [TPM] and a Participating Manufacturer, and
                                     Protabaco shall not be considered to be a * * * [TPM]’’.




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                                     (507)                           SURIEL v. COMMISSIONER                                        519


                                        Petitioner also points to section (D) of amendment 24 to
                                     support his argument that Vibo is not a TPM. Section (D)
                                     states: ‘‘If * * * [Vibo] creates or acquires its own manufac-
                                     turing facility, it shall assume all responsibilities as the
                                     * * * [TPM] of such Cigarettes under the MSA.’’ Petitioner
                                     interprets this statement to mean that Vibo will be consid-
                                     ered a TPM only if it creates or acquires its own manufac-
                                     turing facilities. We disagree. We interpret the statement to
                                     mean that if Vibo creates or acquires its own manufacturing
                                     facility, Vibo will be considered the TPM of the cigarettes
                                     manufactured at the new facility. The statement is not rel-
                                     evant to Vibo’s TPM status with respect to the cigarettes
                                     Protabaco manufactured.
                                        Finally, petitioner also relies on provisions in the exclusive
                                     manufacturing and distribution agreement to show that Vibo
                                     was not a manufacturer. First, petitioner points to the
                                     recitals, which describe Vibo as an ‘‘importer and dis-
                                     tributor’’. 7 Second, he cites a portion of the agreement in
                                     which Vibo appoints Protabaco as its exclusive manufacturer,
                                     and Protabaco appoints Vibo as its exclusive importer. How-
                                     ever, as we noted above, under amendment 24 an exclusive
                                     importer (Vibo) of cigarettes fabricated by another party
                                     (Protabaco) outside the United States could apply to partici-
                                     pate in the MSA. Vibo’s application to join the MSA was in
                                     fact submitted on that basis. Accordingly, we are not per-
                                     suaded that Vibo was incapable of being a TPM under the
                                     MSA merely because it did not actually manufacture ciga-
                                     rettes. We find that Vibo was a TPM under the MSA as it
                                     contractually agreed, and as the MSA permits by amend-
                                     ment.



                                           7 The   three recitals as quoted on brief are as follows:

                                     ‘‘WHEREAS, Protabaco has engaged in the business of manufacturing to-
                                     bacco products ’’. (Emphasis added.)
                                     ‘‘WHEREAS, * * * [Vibo] is a[n] * * * importer and distributer of ciga-
                                     rettes.’’ (Emphasis added.)
                                     ‘‘WHEREAS, Protabaco presently manufactures * * * [Vibo’s] cigarettes
                                     * * * and * * * [Vibo] * * * purchases such cigarettes for distribution in
                                     the United States.’’ (Emphasis added.)




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                                     520                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                           B. Legal Fiction
                                        Petitioner contends that Vibo’s position as a TPM is illu-
                                     sory, because amendment 24 deems Vibo a TPM merely to
                                     allow Vibo to assume Protabaco’s MSA payment obligation. If
                                     amendment 24 had not deemed Vibo a TPM, then Vibo could
                                     not have joined the MSA. Petitioner argues that Vibo’s TPM
                                     status is a legal fiction and that Vibo has actually agreed to
                                     make the MSA payments for Protabaco as part of Vibo’s pur-
                                     chase price for cigarettes.
                                        We reject petitioner’s contention for two reasons. First,
                                     Protabaco did not sign any of the MSA documents except for
                                     the exclusive manufacturing and distribution agreement,
                                     which merely appointed Protabaco as Vibo’s exclusive manu-
                                     facturer. Second, as discussed infra, Vibo obligated itself
                                     under the MSA for its own liabilities; Protabaco had no MSA
                                     liability for Vibo to assume.

                                           C. Subsequent Participating Manufacturer and Participat-
                                              ing Manufacturer
                                       Respondent contends that Vibo not only became a TPM by
                                     entering the MSA, but it also became an SPM and a partici-
                                     pating manufacturer as defined by the MSA’s terms. We
                                     agree. The first paragraph of the MSA execution statement
                                     provides:
                                           The undersigned authorized representative hereby executes the * * *
                                           [MSA], as amended (hereafter ‘‘Agreement’’) on behalf of * * * [Vibo]
                                           * * * thereby becoming a Subsequent Participating Manufacturer. * * *
                                           [Vibo] * * * and its authorized representatives agree to be bound by
                                           such Agreement and to fulfill all the obligations of a Participating Manu-
                                           facturer under the Agreement, including, but not limited to, making all
                                           payments that it would have been obligated to make had it been a signa-
                                           tory as of the MSA execution date. [Emphasis added.]

                                     Petitioner, as president of Vibo, signed this statement under
                                     oath. Also, amendment 24 specifically states: ‘‘[Vibo] shall be
                                     considered to be a * * * Participating Manufacturer’’.
                                       The MSA defines a participating manufacturer as a TPM
                                     that is or becomes a signatory to the MSA, provided that: (1)
                                     in the case of a TPM that is not an OPM (e.g., in Vibo’s case),
                                     that TPM is bound by the MSA in all settling States in
                                     which the MSA binds OPMs and (2) in the case of a TPM
                                     that signs the MSA after the MSA execution date (e.g., also




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                                     (507)                          SURIEL v. COMMISSIONER                                        521


                                     in Vibo’s case), that TPM, within a reasonable time after
                                     signing the MSA, makes any payments that it would have
                                     been obligated to make in the intervening period had it been
                                     a signatory as of the MSA execution date.
                                        By signing the MSA execution statement, Vibo agreed ‘‘to
                                     be bound by * * * [the MSA] and fulfill all the obligations
                                     of a participating manufacturer under the Agreement’’. The
                                     MSA binds Vibo in each settling State in which it binds the
                                     OPMs. Therefore, Vibo satisfies the first requirement.
                                        Vibo signed the MSA after the MSA execution date of
                                     November 23, 1998, and made its first prior obligation
                                     installment payment in 2005 in accordance with the General
                                     Tobacco adherence agreement. Therefore, Vibo also satisfies
                                     the second requirement.
                                        The MSA generally defines an SPM as a TPM that: (1) is
                                     a participating manufacturer, and (2) is a signatory to the
                                     MSA. As we noted above, Vibo has satisfied both of these
                                     requirements as well.
                                        The General Tobacco adherence agreement and the exclu-
                                     sive manufacturing and distribution agreement further dem-
                                     onstrate that Vibo obligated itself under the MSA as an
                                     SPM. Although we do not accord ‘‘whereas clause’’ recitals
                                     the weight of operative terms in an agreement, they can aid
                                     interpretation of that agreement. See, e.g., Grynberg v.
                                     FERC, 71 F.3d 413, 416 (D.C. Cir. 1995) (‘‘[I]t is standard
                                     contract law that a Whereas clause, while sometimes useful
                                     as an aid to interpretation ‘cannot create any right beyond
                                     those arising from the operative terms of the document.’ ’’
                                     (quoting Abraham Zion Corp. v. Lebow, 761 F.2d 93, 103 (2d
                                     Cir. 1985))).
                                        In relevant part, the General Tobacco adherence agree-
                                     ment states: ‘‘WHEREAS, * * * [Vibo] wishes to become
                                     * * * [an SPM] under the * * * [MSA] * * * and filed its
                                     application therefor’’. Also in relevant part, the exclusive
                                     manufacturing      and    distribution    agreement     states:
                                     ‘‘WHEREAS, * * * [Vibo] has agreed to make a considerable
                                     long term investment wherein it has obligated itself * * * as
                                     * * * [an SPM], in order that it may become a signatory to
                                     the MSA’’.
                                        Accordingly, we find that Vibo contractually obligated itself
                                     as an SPM and participating manufacturer and had the
                                     rights and obligations commensurate with that designation.




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                                     522                 141 UNITED STATES TAX COURT REPORTS                                    (507)


                                       Having determined Vibo’s status as a TPM, an SPM, and
                                     a participating manufacturer under the MSA documents, we
                                     next address petitioner’s assumption of liability argument.

                                     IV. Assumption of Liability
                                           A. Arguments
                                       Petitioner contends that Vibo entered into the MSA at
                                     Protabaco’s request to make the MSA payments on behalf of
                                     Protabaco as part of Vibo’s purchase price for cigarettes.
                                     Respondent argues that Protabaco had no liability under the
                                     MSA, so Vibo could not assume its liability.

                                           B. Whether Protabaco Has MSA Liability To Assume
                                           1. Pre-MSA Arrangement
                                         Petitioner argues that Protabaco was liable for the MSA
                                     payments, because State laws required Protabaco to either
                                     join the MSA or contribute to the NPM escrow accounts.
                                     Protabaco’s name was on the NPM escrow accounts, but Vibo
                                     made the account contributions. Petitioner argues this as evi-
                                     dence of an ongoing assumption of liability arrangement.
                                         We agree that Protabaco had an obligation to either join
                                     the MSA or contribute to the NPM escrow accounts, of which
                                     it chose the latter. We also agree that Vibo made the con-
                                     tributions to the NPM escrow accounts. However, that does
                                     not mean Protabaco continued to be the liable party after
                                     Vibo entered into the MSA. Once Protabaco chose the NPM
                                     route, it had no obligation to later join the MSA. As we will
                                     discuss, we are not convinced that Protabaco forced Vibo to
                                     join the MSA. We find that Vibo entered into the MSA volun-
                                     tarily.
                                         While it may have been possible for Protabaco to settle
                                     with the settling States and then pass on the MSA costs to
                                     Vibo in the form of increased prices, that did not happen.
                                     Petitioner must be taxed in accordance with the transaction
                                     he and Vibo consummated, not a transaction he might have
                                     consummated but did not. See Commissioner v. Nat’l Alfalfa
                                     Dehydrating & Milling Co., 417 U.S. 134, 148–149 (1974)
                                     (‘‘[W]hile a taxpayer is free to organize his affairs as he
                                     chooses, nevertheless, once having done so, he must accept
                                     the tax consequences of his choice, whether contemplated or




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                                     (507)                           SURIEL v. COMMISSIONER                                        523


                                     not, and may not enjoy the benefit of some other route he
                                     might have chosen to follow but did not.’’ (Citation omitted.)).
                                        Moreover, nothing in the MSA documents creates any
                                     Protabaco liability that Vibo could assume. As discussed
                                     supra, the MSA documents clearly show that Vibo obligated
                                     itself to make the MSA payments. By signing and executing
                                     amendment 24, petitioner agreed that Vibo alone was liable
                                     for the MSA payments on its cigarettes regardless of the
                                     identity of the manufacturer. 8 Therefore, we find that
                                     Protabaco had no liability under the MSA for Vibo to
                                     assume.
                                        Petitioner cites the General Tobacco adherence agreement
                                     as further evidence that Vibo assumed Protabaco’s liability.
                                     Under that agreement, Vibo received credit against its MSA
                                     payment obligations for a portion of the NPM escrow pay-
                                     ments it made on behalf of Protabaco. Petitioner argues that
                                     this simply bridges the gap to continue the prior arrange-
                                     ment under which Vibo paid Protabaco’s obligations.
                                        Petitioner’s argument does not convince us that Vibo
                                     assumed Protabaco’s liability. Under the MSA, if a TPM
                                     joined the MSA more than 90 days after the MSA execution
                                     date (as Vibo did), it was required to make payments—
                                     known as the prior obligation—to the States that it would
                                     have been obligated to make had it joined the MSA in
                                     November 1998. Because the prior obligation relates to the
                                     same cigarettes for which Vibo made the NPM payments in
                                     those earlier years, and the effect of the payments to both
                                     the MSA and NPM escrow accounts was the same, it makes
                                     sense economically that Vibo would receive credit for its
                                     NPM escrow contributions. Nothing about the credit gives
                                     rise to the legal effect of an assumption-of-liability arrange-
                                     ment.
                                        Moreover, the General Tobacco adherence agreement
                                     makes clear that Vibo alone is obligated to make the MSA
                                     payments—both prior and current. Nothing in the agreement
                                           8 See   amend. 24, sec. A(3):
                                           [Vibo] shall be responsible for all payments under the MSA for all Ciga-
                                           rettes manufactured by Protabaco * * *, as well as all Cigarettes sold
                                           under any Brand Name that is, or has been, or will be, owned or li-
                                           censed by * * * [Vibo] * * * regardless of the identity of the manufac-
                                           turer, including Cigarettes sold prior to the date of this Amendment.




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                                     524                 141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     suggests that Vibo agreed to undertake those obligations as
                                     part of its purchase of cigarettes from Protabaco. Protabaco
                                     was not even a signatory to that agreement, amendment 24,
                                     or the MSA execution statement. On these facts, we find that
                                     Vibo did not assume Protabaco’s MSA payment obligations as
                                     part of its purchase of cigarettes. Rather, Vibo’s liability
                                     arose when it contractually agreed with the settling States to
                                     be obligated under the MSA.
                                           2. Quarterly Report Requirement
                                        The exclusive manufacturing and distribution agreement
                                     requires Vibo to provide reports to Protabaco regarding its
                                     payment of current MSA obligations and its ability to make
                                     future payments. 9 Petitioner argues that this arrangement
                                     indicates an assumption-of-liability arrangement between
                                     Vibo and Protabaco. We disagree, because other plausible
                                     explanations for the reporting requirement exist.
                                        Protabaco has an interest in Vibo’s ability to meet its MSA
                                     obligations regardless of whether Vibo assumed Protabaco’s
                                     liability. If Vibo failed to make the necessary MSA payments,
                                     Vibo’s cigarette brands would end up delisted and retailers
                                     would not stock their shelves with those brands. Therefore,
                                     Protabaco had a vested interest in ensuring that Vibo could
                                     make its MSA payments, because nonpayment could lead to
                                     Vibo’s importing fewer (or no) cigarettes from Protabaco.
                                           3. Reason for Entering Into the MSA
                                        Petitioner contends that Vibo entered into the MSA on
                                     behalf of Protabaco at Protabaco’s request. However, the evi-
                                     dence indicates that financial considerations led Vibo to
                                     enter into the MSA voluntarily.
                                        The NPM escrow statutes, as originally enacted by the set-
                                     tling States, contained an unintended loophole that gave
                                     NPMs an unfair competitive advantage over TPMs partici-
                                     pating in the MSA. Congress closed the loophole in 2004, and
                                     Vibo submitted its application that year.
                                       9 Under the heading ‘‘MSA Obligations’’, the agreement states: ‘‘[Vibo]

                                     agrees to provide Protabaco with: (i) a quarterly report setting forth in de-
                                     tail the amount necessary for * * * [Vibo] to have available to make its
                                     MSA payments due each quarter, and (ii) documentation reflecting * * *
                                     [Vibo’s] quarterly deposit requirements pursuant to its MSA Adherence
                                     Agreement.’’




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                                     (507)                          SURIEL v. COMMISSIONER                                        525


                                        The exclusive manufacturing and distribution agreement
                                     petitioner signed states: ‘‘[Vibo] has agreed to make a consid-
                                     erable long term investment wherein it has obligated itself to
                                     make payments to the States * * * in order that it may
                                     become a signatory to the MSA, with the expectation of
                                     gaining a considerable increase in market share for the * * *
                                     [Vibo] Cigarettes’’. (Emphasis added.)
                                        In a Federal antitrust action, Vibo filed a verified amended
                                     complaint, arguing that the settling States’ amendment of
                                     their escrow statutes made it increasingly difficult for Vibo
                                     to continue in business under the obligation of making NPM
                                     contributions. 10 The complaint also stated that Vibo came to
                                     understand that the only effective means to reach the
                                     national cigarette market was to join the MSA because most
                                     retail chains wanted the liability release afforded by the
                                     MSA to participating manufacturers and refused to carry
                                     Vibo products without it. Vibo’s vice president and general
                                     counsel, Mr. Denman, verified the complaint.
                                        On cross-examination before this Court, Mr. Denman testi-
                                     fied that the statements in the complaint were accurate but
                                     that Vibo ultimately entered into the MSA ‘‘because
                                     Protabaco gave * * * [Vibo] no alternative.’’ This testimony
                                     without more does not outweigh the evidence that Vibo vol-
                                     untarily entered into the MSA after carefully considering the
                                     financial impact of its decision.
                                        Petitioner did not offer testimony from any Protabaco rep-
                                     resentatives to corroborate Mr. Denman’s statements. The
                                     failure to call a representative of Protabaco at trial gives rise
                                     to the adverse inference that had such a witness been pro-
                                     duced, his or her testimony would not support petitioner’s
                                     contentions. See Wichita Terminal Elevator Co. v. Commis-
                                     sioner, 6 T.C. 1158, 1165 (1946), aff ’d, 162 F.2d 513 (10th
                                     Cir. 1947). Vibo had significant business reasons for joining
                                     the MSA, and Mr. Denman’s self-serving testimony alone
                                     does not convince us that Protabaco forced Vibo to join. See
                                     Broz v. Commissioner, 137 T.C. 46, 59 (2011) (‘‘We need not
                                     accept the taxpayer’s self-serving testimony when the tax-
                                     payer fails to present corroborative evidence.’’); Tokarski v.
                                     Commissioner, 87 T.C. 74, 77 (1986).
                                       10 Verified Amended Complaint at 53, Vibo Corp. v. Conway, 594 F.

                                     Supp. 2d 758 (W.D. Ky. 2009), aff ’d, 669 F.3d 675 (6th Cir. 2012).




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                                     526                 141 UNITED STATES TAX COURT REPORTS                                    (507)


                                       Accordingly, we reject petitioner’s argument that Vibo
                                     entered into the MSA at Protabaco’s request.

                                     V. Deductions
                                           A. The Law
                                        Section 162(a) allows taxpayers to deduct all ordinary and
                                     necessary business expenses they pay or incur during the
                                     taxable year in carrying on any trade or business. Section
                                     461(a) provides that any deduction ‘‘shall be taken for the
                                     taxable year which is the proper taxable year under the
                                     method of accounting used in computing taxable income.’’
                                     During the years at issue, Vibo was an accrual method tax-
                                     payer. Under the accrual method of accounting, taxpayers
                                     record liabilities as they are incurred. A taxpayer incurs a
                                     liability in the taxable year in which (1) all the events have
                                     occurred that establish the fact of the liability, (2) the
                                     amount of the liability can be determined with reasonable
                                     accuracy, and (3) economic performance has occurred with
                                     respect to the liability. Sec. 1.461–1(a)(2), Income Tax Regs.;
                                     see sec. 461(h)(1), (4).
                                        Conditions (1) and (2) together compose what is known as
                                     the ‘‘all events’’ test. Sec. 461(h)(4). Section 461(h)(1) modifies
                                     the all events test, providing that ‘‘the all events test shall
                                     not be treated as met any earlier than when economic
                                     performance with respect to such item occurs.’’ Therefore, we
                                     must first determine if and when economic performance
                                     occurred. If petitioner failed to satisfy the economic perform-
                                     ance requirement, we need not address the all events test.
                                           B. Economic Performance
                                        Section 461(h)(2) determines the timing of economic
                                     performance according to the source of the liability. The par-
                                     ties disagree over the source of the MSA payment obligation.
                                     Petitioner argues that the obligation arose from the provision
                                     of property to Vibo from another person (Protabaco) and
                                     therefore economic performance occurred as Protabaco pro-
                                     vided cigarettes to Vibo. See sec. 461(h)(2)(A)(ii). Respondent
                                     argues that Vibo was required to make the MSA payments
                                     to a qualified settlement fund (QSF), and therefore economic
                                     performance does not occur until Vibo actually makes the
                                     payments. See sec. 468B(a) (‘‘For purposes of section 461(h),




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                                     (507)                          SURIEL v. COMMISSIONER                                        527


                                     economic performance shall be deemed to occur as qualified
                                     payments are made by the taxpayer to a designated settle-
                                     ment fund.’’); sec. 1.468B–3(c)(1), Income Tax Regs.
                                           1. Property Provided to Vibo
                                       As stated above, we are not convinced that Vibo made the
                                     MSA payments on behalf of Protabaco as a cost of purchasing
                                     manufactured cigarettes. Therefore, we do not apply section
                                     461(h)(2)(A), because it determines the timing of economic
                                     performance only when the liability arises from services or
                                     property provided to the taxpayer.
                                       Petitioner argues that although a QSF received Vibo’s pay-
                                     ments, and despite section 468B(a), we should focus our
                                     inquiry on what the payment was for and not necessarily to
                                     whom it was made. In his view, the QSF is nothing more
                                     than a straw man. Petitioner relies on two items to make his
                                     argument: (1) Priv. Ltr. Rul. 9852037 (Dec. 25, 1998), which
                                     ignored the fact that a taxpayer was making payments to a
                                     QSF, and (2) IES Indus., Inc. v. United States, 253 F.3d 350
                                     (8th Cir. 2001).
                                       A private letter ruling (PLR) can be relied upon only by the
                                     taxpayer to whom the ruling is addressed; however, ‘‘rulings
                                     do reveal the interpretation put upon the statute by the
                                     agency charged with the responsibility of administering the
                                     revenue laws.’’ Hanover Bank v. Commissioner, 369 U.S. 672,
                                     686 (1962). The Internal Revenue Service limited its ruling
                                     in Priv. Ltr. Rul. 9852037 to the specific facts and cir-
                                     cumstances of that case, and the facts in that ruling bear no
                                     resemblance to the facts before this Court. Accordingly, Priv.
                                     Ltr. Rul. 9852037 has no value in this proceeding.
                                       Petitioner cites IES Indus. as an example of an accrual
                                     basis taxpayer properly deducting a payment to the Govern-
                                     ment when accrued and not when paid because the payment
                                     was deemed to be for the provision of services. However, IES
                                     Indus. is distinguishable from this case.
                                       In IES Indus., the payment obligation arose out of the
                                     provision of services to the taxpayer. The U.S. Government
                                     provided uranium enrichment services to the taxpayer. The
                                     taxpayer then made payments into a fund for the decon-
                                     tamination and decommissioning of uranium enrichment
                                     plants. The extent of the taxpayer’s use of the uranium




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                                     528                 141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     enrichment services determined the amounts of the pay-
                                     ments.
                                        Petitioner equates the payments in IES Indus. with the
                                     payments here, because both arose from the taxpayers’
                                     receipt of services or property. Petitioner argues that the
                                     MSA payment obligations arose out of Protabaco’s provision
                                     of cigarettes to Vibo, and IES’ obligations arose out of the
                                     Government’s provision of uranium enrichment services to
                                     IES. Section 461(h)(2)(A) fixes the timing of economic
                                     performance for liabilities arising from the provision of both
                                     services and property. Thus, petitioner argues that we should
                                     find IES Indus. instructive on why economic performance
                                     occurred here when Vibo received the cigarettes. We do not
                                     agree.
                                        In IES Indus., the taxpayer’s obligation depended on the
                                     amount of uranium enrichment services the taxpayer
                                     received. The U.S. Government provided the services and
                                     assessed payment obligations based on the extent of the serv-
                                     ices IES used. Here the MSA calculated a current obligation
                                     based on Vibo’s share of the cigarette market, not the
                                     number of cigarettes Vibo received. Similarly, the MSA cal-
                                     culated a prior obligation based on the Federal excise taxes
                                     that Vibo had paid for cigarettes sold in the U.S. before
                                     joining the MSA. Protabaco could have provided an infinite
                                     number of cigarettes to Vibo, but without subsequent sales
                                     Vibo would have owed nothing to the MSA. The facts in IES
                                     Indus. also differ from those here in that IES was not
                                     making payments into a QSF.
                                        The Code and the regulations contain specific rules for
                                     determining the timing of economic performance for pay-
                                     ments made to QSFs. We discuss the effect of those rules
                                     below.
                                           2. Qualified Settlement Fund
                                        The parties have stipulated that the MSA escrow account
                                     is a QSF for Federal tax purposes. Section 1.468B–3(c),
                                     Income Tax Regs., provides that ‘‘economic performance
                                     occurs with respect to a liability described in § 1.468B–
                                     1(c)(2) * * * to the extent the transferor makes a transfer to
                                     a * * * [QSF] to resolve or satisfy the liability.’’ Section
                                     1.468B–1(c)(2), Income Tax Regs., describes several types of
                                     liabilities for which a QSF can be established, including




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                                     (507)                           SURIEL v. COMMISSIONER                                        529


                                     those arising out of tort, breach of contract, or violation of
                                     law.
                                           3. Tort, Breach of Contract, or Violation of Law
                                        Respondent argues that Vibo’s MSA payment obligation
                                     arose out of claims asserting liability for tort, breach of con-
                                     tract, or violation of law and that section 1.468B–1(c)(2),
                                     Income Tax Regs., should accordingly apply. Petitioner dis-
                                     agrees, because Vibo has not engaged in tortious conduct and
                                     has never been sued for injuries with respect to its tobacco
                                     products by the attorney general of any State that is a party
                                     to the MSA. Petitioner’s argument fails, because nothing in
                                     the regulation requires a claim to have been brought against
                                     Vibo specifically. It simply requires that the fund be estab-
                                     lished for the satisfaction of claims that may result from an
                                     event that has occurred and given rise to a claim asserting
                                     liability arising out of tort or violation of law.
                                        The MSA was made by the settling States’ representatives
                                     and the participating manufacturers ‘‘to settle and resolve
                                     with finality all Released Claims against the Participating
                                     Manufacturers and related entities as set forth * * *
                                     [therein].’’ The very first recital of the MSA states that more
                                     than 40 States have commenced litigation asserting various
                                     claims for monetary, equitable, and injunctive relief against
                                     certain TPMs and others as defendants. The second recital
                                     explains that those States sought to obtain equitable relief
                                     and damages under State laws, including consumer protec-
                                     tion and/or antitrust laws. The final recital says the settling
                                     States and the participating manufacturers wish to avoid the
                                     further expense and burden of continued litigation and have
                                     agreed to settle their respective lawsuits and potential
                                     claims. The MSA further states that in consideration of the
                                     payments made by the participating manufacturers and the
                                     release and discharge of all claims by the settling States, the
                                     parties enter into and memorialize the agreement.
                                        Section XVIII(d) of the MSA, titled ‘‘Payments in Settle-
                                     ment’’, provides as follows:
                                           All payments to be made by the Participating Manufacturers pursuant
                                           to this Agreement are in settlement of all of the Settling States’ anti-
                                           trust, consumer protection, common law negligence, statutory, common
                                           law and equitable claims for monetary, restitutionary, equitable and




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                                     530                  141 UNITED STATES TAX COURT REPORTS                                    (507)


                                           injunctive relief alleged by the Settling States with respect to the year
                                           of payment or earlier years * * *. [Emphasis added.]
                                       Under Danielson, we must give great weight to the explicit
                                     and unambiguous terms of the MSA documents in deter-
                                     mining the tax consequences of this arrangement. The
                                     explicit and unambiguous terms of the MSA documents
                                     indicate that the fund was established to satisfy claims that
                                     may result from an event that has occurred and given rise
                                     to a claim asserting liability arising out of tort or violation
                                     of law. Consequently, under section 1.468B–3(c)(1), Income
                                     Tax Regs., economic performance with respect to the MSA
                                     obligation could not occur until Vibo transferred funds to the
                                     QSF.
                                           C. Cost of Goods Sold Deductions
                                       On its 2004 Form 1120S, Vibo deducted $295,549,083 of its
                                     MSA payment obligations—both prior and current—as part
                                     of its cost of goods sold. None of this amount was actually
                                     paid into the QSF in 2004, so economic performance did not
                                     occur. Thus petitioner improperly deducted the expenses, and
                                     we sustain respondent’s disallowance of this deduction.
                                       On its 2006 Form 1120S, Vibo deducted $108,487,225 of its
                                     MSA current obligation as part of its cost of goods sold. In
                                     2006 Vibo paid $97,637,716 of its MSA current obligation.
                                     Therefore, only $97,637,716 of its deduction was proper.
                                           D. Interest Deductions
                                        Petitioner argues that Vibo is entitled to deduct all interest
                                     that accrued on the MSA liabilities. Petitioner specifically
                                     argues for two interest deductions: (1) the $4,661,190 claimed
                                     on Vibo’s 2004 Form 1120S and (2) an additional $6,164,475
                                     deduction for interest that accrued on the prior obligation
                                     but was included in the principal portion of the prior obliga-
                                     tion under the General Tobacco adherence agreement.
                                        Petitioner argues that section 461(h)(2) does not specifi-
                                     cally address interest, so section 461(h)(2)(D), labeled ‘‘other
                                     items’’, controls. Section 461(h)(2)(D) provides that in the
                                     case of any other liability not addressed in section 461(h)(2),
                                     economic performance occurs at the time determined under
                                     the regulations. Petitioner then cites section 1.461–4(e),
                                     Income Tax Regs., which states: ‘‘In the case of interest, eco-
                                     nomic performance occurs as the interest cost economically




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                                     (507)                          SURIEL v. COMMISSIONER                                        531


                                     accrues, in accordance with the principles of relevant provi-
                                     sions in the Code.’’
                                           1. Claimed Interest Deduction
                                        On its 2004 Form 1120S Vibo deducted $4,661,190 as
                                     interest accrued on its unpaid prior obligation for July 1
                                     through December 31, 2004. Respondent determined that
                                     Vibo deducted the expense prematurely and denied the
                                     deduction.
                                        The issue here is whether economic performance occurred
                                     with respect to Vibo’s accrued interest on the prior obligation
                                     by the time Vibo deducted it on its 2004 return. Petitioner
                                     argues that it did and cites section 1.461–4(e), Income Tax
                                     Regs., which provides that economic performance occurs for
                                     interest ‘‘as the interest cost economically accrues’’. However,
                                     section 468B(a) provides that economic performance occurs
                                     for obligations to a QSF when the taxpayer makes the pay-
                                     ments. The expense Vibo deducted here was both interest
                                     and an obligation to a QSF, so we must determine which of
                                     the conflicting rules applies. We hold that section 468B(a)
                                     controls the timing of economic performance for all obliga-
                                     tions to a QSF, including interest.
                                        Congress, and the Treasury acting on Congress’ instruc-
                                     tion, have provided comprehensive rules concerning tax-
                                     payers’ payments to settlement funds. Those rules prevail
                                     over more general rules that might otherwise govern the pay-
                                     ments. See Fourco Glass Co. v. Transmirra Prods. Corp., 353
                                     U.S. 222, 228–229 (1957); D. Ginsberg & Sons, Inc. v. Popkin,
                                     285 U.S. 204, 208 (1932) (‘‘Specific terms prevail over the
                                     general in the same or another statute which otherwise
                                     might be controlling.’’). Under the specialized rules, economic
                                     performance occurs with respect to payments made to a
                                     settlement fund when the taxpayer makes the payments. The
                                     rules do not differentiate between interest and principal, and
                                     we accordingly afford them equal treatment. Vibo did not
                                     make the interest payment on the prior obligation until 2005,
                                     and thus, his 2004 deduction was premature. Accordingly, we
                                     sustain respondent’s denial.
                                           2. New Additional Interest Deduction
                                       Petitioner raised a new argument on brief. He argues that
                                     Vibo is entitled to an additional interest deduction of




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                                     532                 141 UNITED STATES TAX COURT REPORTS                                    (507)


                                     $6,164,475. He claims that figure represents the amount of
                                     accrued interest included in the $239,018,305 prior obligation
                                     owed through June 30, 2004. Petitioner claims that PwC, the
                                     internal auditor, determined the interest amount, but he has
                                     failed to produce any evidence to support this claim. The
                                     record contains a letter from PwC, but the letter does not
                                     support petitioner’s contention. The letter includes the
                                     $4,661,190 interest calculation on the current obligation, but
                                     it does not mention anything about accrued interest on the
                                     prior obligation.
                                        Petitioner has provided no evidence that the initial prior
                                     obligation included any accrued interest. Because the record
                                     is devoid of any such evidence, petitioner raises this new
                                     issue untimely. Accordingly, we follow our well-settled rule
                                     that issues raised for the first time on brief will not be
                                     considered when doing so would prevent the opposing party
                                     from presenting evidence that might have been presented if
                                     the issue had been timely raised. DiLeo v. Commissioner, 96
                                     T.C. 858, 891 (1991), aff ’d, 959 F.2d 16 (2d Cir. 1992).
                                           E. Other Deduction
                                        On its 2004 Form 1120S Vibo deducted $2,011,446 under
                                     ‘‘Other Deductions’’ for MSA obligations. That $2,011,446
                                     was part of the current obligation Vibo deducted in 2004 but
                                     did not pay. In accordance with our findings above, the
                                     $2,011,446 is not deductible for 2004, because Vibo did not
                                     actually make the payments.
                                           VI. Petitioner’s Individual Income Tax Adjustment
                                        Section 1366(a) provides, generally, that income, losses,
                                     deductions, and credits are passed through pro rata to share-
                                     holders on their individual income tax returns. As a result of
                                     the above findings, certain adjustments must be made to
                                     petitioner’s 2004 and 2006 Forms 1040.
                                        Petitioner restricted his arguments to tax consequences at
                                     the S corporation level; he did not argue that the determina-
                                     tions would still be in error in the event we found economic
                                     performance occurred at the time payment was made into
                                     the QSF. Because respondent’s determinations in the notice




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                                     (507)                            SURIEL v. COMMISSIONER                                        533


                                     of deficiency are presumed correct and petitioner did not
                                     prove they were in error, we sustain those determinations. 11
                                       In reaching our holdings herein, we have considered all
                                     arguments made, and, to the extent not mentioned above, we
                                     conclude they are moot, irrelevant, or without merit.
                                       To reflect the foregoing,
                                                                      Decision will be entered for respondent as
                                                                    to the deficiency and for petitioner as to the
                                                                    accuracy-related penalty under section
                                                                    6662(a).

                                                                                 f




                                           11 Because
                                                   respondent’s determinations have been sustained, pursuant to
                                     the amendment to answer filed with this Court on January 11, 2013, peti-
                                     tioner’s taxable income for the 2004 tax year also shall be increased by an
                                     additional $2,491,164, resulting in an increase to the deficiency of
                                     $871,907 for petitioner’s 2004 taxable year.




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