   In the United States Court of Federal Claims
                                 No. 15-953T
                           (Filed: October 24, 2018)

********************

CITIGROUP, INC.,                           Tax refund suit; FIRREA;
                                           Winstar; Supervisory goodwill;
              Plaintiff,
                                           Worthless asset deduction;
       v.                                  Reliance damages; I.R.C. §
                                           597; Wounded bank damages;
THE UNITED STATES,                         Tax benefit rule.

              Defendant.

********************

      Jean A. Pawlow, Washington, DC, for plaintiff. Justin E. Jesse and
Lyndon D. Williams of counsel.

       Benjamin C. King, Jr., United States Department of Justice, Tax
Division, Washington, DC, with whom were Richard E. Zuckerman,
Principal Deputy Assistant Attorney General, David I. Pincus, Chief, and G.
Robson Stewart, Assistant Chief, for defendant.

                                  OPINION

BRUGGINK, Judge.

        This case concerns the tax consequences of a damages award paid by
the federal government to plaintiff in connection with the savings and loan
crisis of the 1970s and ‘80s. The courts, and this court in particular, wrestled
for several decades with the fallout from the federal regulators’ and later
Congress’ attempts, first, to save the industry, and then subsequently their
efforts to correct that initial reaction. See Winstar Corp. v. United States,
518 U.S. 839 (1996). Plaintiff now seeks a refund of income taxes
attributable to a disallowed $798 million dollar deduction for “supervisory
goodwill” that it alleges was lost when Congress changed the treatment of
that asset in 1989. Plaintiff also seeks a refund of taxes paid on the $381
million judgment obtained earlier in this court as part of the Winstar-related
litigation.

         Pending are plaintiff’s two motions for summary judgment. The
government contends that trial is necessary to resolve these issues. We agree.
Because we do not know the value of all of the intangible assets created by
the transaction at issue, trial is necessary as to the first question, and, because
we do not know whether Glendale previously deducted any of the specific
expenses for which it was compensated for by this court’s damages award,
trial is also necessary to determine whether the tax benefit rule mandates that
the damages award is properly treated as income.

                                                               BACKGROUND

        Interest rates in the late 1970s and early 1980s rose rapidly to keep
pace with ever-increasing economic inflation. This subjected the savings and
loan industry in the United States to serious financial stress. Many savings
and loan associations, known as “thrifts,” found themselves holding loan
portfolios consisting largely of long-term, fixed-rate mortgages at interest
rates significantly lower than what these thrifts were forced to pay to attract
retail depositors.1 For many of these banks, the interest service on the short-
term deposits overtook the revenues from their long-term loans; they quickly
became insolvent.

        Federal regulators sought to ease pressure on the industry by reducing
capital reserve requirements and changing the required accounting principles
to allow a broader definition of capital reserves. This further weakened the
stability of many thrifts by encouraging new investment without true capital
to shore up the banks in the event of losses.

       Faced with specter of impending thrift failures and the resulting losses
on federally-insured deposits, the Federal Savings and Loan Insurance
Corporation (“FSLIC”) and the Federal Home Loan Bank Board (“FHLBB”)
sought to stem the tide of potential liability by encouraging solvent thrifts to
merge with failing thrifts. The resulting transactions were known as
“supervisory mergers.” When needed, the regulators offered a variety of
incentives tailored to each particular transaction to facilitate the acquisition.

                                                            
1
      Thrifts
        are banks specializing in using savings account deposits to make
conventional mortgage loans. 
                                    2
 
These included rights to operate in new states (“branching rights”), the right
to amortize goodwill over 40 years, interest rate protection, credit
forbearance, favorable loans, cash, debt forgiveness, indemnity provisions,
and the right to count goodwill as “regulatory capital” towards the banks’
capitalization requirements. Not all supervised transactions required federal
assistance, however. Plaintiff here, in fact, acquired several thrifts without
FSLIC incentives.

        In general terms, the premium paid for an acquired business over what
its assets, minus its liabilities, are worth is known as “goodwill.” In the
context of these supervisory mergers, the failing thrifts had liabilities
exceeding their assets. The acquiring thrifts were permitted, however, to
treat the difference as “supervisory goodwill” and to mark it on their ledgers
as capital for the purpose of meeting reserve requirements. See id. at 848-
49. This permitted the acquiring thrifts to meet capital reserve requirements
even after assuming new net liabilities while simultaneously allowing the
government to shore up the industry without the need to reimburse
depositors.

       In November 1981, Glendale Federal Bank, FSB (“Glendale”), a
California thrift, acquired First Federal Savings and Loan of Broward
(“Broward”), a Florida thrift, in a merger supervised by the FHLBB and the
FSLIC. As with any acquisition of one thrift by another, the FHLBB was
required to give its approval, and ultimately it did. The deal was also
conditioned upon a Supervisory Action Agreement (“SAA”) between
Glendale and the FSLIC. In essence, the acquisition of Broward by Glendale
was a tripartite agreement with the United States in that it required an
agreement between the Glendale and Broward and an agreement between the
United States and Glendale.

       The SAA between Glendale and the FSLIC incorporated by reference
“any resolutions or letters issued contemporaneously herewith by the
FHLBB or the FSLIC” and the merger agreement between Glendale and
Broward. PX 1 at 14. This court previously held that these incorporated
documents include the November 19, 1981 FHLBB Resolution No. 81-710,
which approved the merger. Statesman Savs. Holding Corp. v. United States,
26 Cl. Ct. 904, 910 (1992). The FHLBB resolution required Glendale to
furnish an opinion from its independent accountant justifying under generally
accepted accounting principles (“GAAP”) the “use of the purchase method
of accounting for its merger with Broward,” recognizing “any goodwill or

                                      3
 
discount of assets from the merger to be recorded on Glendale’s books,” and
substantiating “the reasonableness of amounts attributed to goodwill and the
discount of assets and the resulting amortization periods and methods.” PX
2 at A25. Glendale was further required to “submit a stipulation that any
goodwill arising from this transaction shall be determined and amortized in
accordance with FHLBB Memorandum R-31b.” Id.

       The Supreme Court held that the totality of these documents
amounted to a valuable guarantee by the United States that Glendale would
be allowed to treat the supervisory goodwill as an asset for regulatory capital
compliance purposes. United States v. Winstar Corp., 518 U.S. 839, 863-64,
881 (1996). Included in that promise was a 40-year time period for keeping
the goodwill on Glendale’s books.2 Together these promises are known as
the “RAP right.”3

        The SAA listed the following obligations of the FSLIC to Glendale as
a part of this deal: 1) Interest rate protections; 2) indemnification for damages
arising out of litigation against Glendale as a result of the merger, damages
suffered as a result of the FHLBB or FSLIC’s actions to effectuate the
merger, and any amounts paid to satisfy any unknown liability of Broward;
and 3) a promise of FHLBB to use best efforts to restructure existing FHLBB
loans to Broward. In addition, attached to the SAA was a letter from the

                                                            
2
     As the Court noted, however, these promises were not binding on Congress.
Instead, they operated as any contractual promise does when it is for
something “beyond the promisor’s absolute control, that is, as a promise to
insure the promisee against loss arising from the promised condition’s
nonoccurence.” Winstar, 518 U.S. at 869. 
3
    “RAP” refers to the FHLBB’s new set of regulatory accounting principles
that it promulgated to supersede GAAP for purposes of compliance with
capital reserve requirements in supervisory mergers. See Winstar, 518 U.S.
at 846. The parties differ as to whether the right to count supervisory
goodwill as an asset was part of the RAP right. Defendant posits that it was
not, because the purchase method of accounting under GAAP already
permitted such a thing. As the Court noted, however, it was not clear from
GAAP and the applicable regulations at the time whether the purchase
method of accounting was applicable to the acquisition of failing thrifts. Id.
at 854. The supervisory merger agreements made it explicitly so, and thus
made the deals attractive to healthy thrifts. Ultimately it does not matter to
our conclusion.  
                                      4
 
FHLBB promising that any future applications of Glendale to establish or
maintain branches in Florida would be treated as if Glendale’s home office
was in Florida. These are the “branching rights” discussed above.

       In 1989, Congress passed the Financial Institutions Reform,
Recovery, and Enforcement Act of 1989, Pub. L. No. 101-73, 103 Stat. 18.
(1989) (“FIRREA”), in an effort to solve the Savings and Loan crisis and
patch up what legislators viewed as the excesses and errors of the regulators’
attempts to meet the crisis. Relevant here, FIRREA ended the favorable
treatment of supervisory goodwill as an asset for regulatory purposes,
requiring thrifts to phase out the goodwill from core capital over a five-year
period. This also had the effect of ending the favorable 40-year amortization
period of that goodwill. See Winstar, 518 U.S. at 856-57.

        Glendale thus found itself out of regulatory compliance with the loss
of the goodwill asset. In 1993, it thus began recapitalizing and selling assets,
including its entire Florida division in 1994. Glendale survived the effort but
incurred significant transactional costs in the process. Joining a wave of
thrifts impacted by FIRREA, Glendale filed suit against the United States in
1990 on a breach of contract theory. We ruled for Glendale in 1992, granting
summary judgment on liability, finding that FIRREA was a breach of the
government’s promise to allow the goodwill to be treated as an asset and to
be amortized over 40 years. Statesman Sav. Holding Corp. v. United States,
26 Cl. Ct. 904, 913-16 (1992) (citing Winstar Corp. v. United States, 25 Fed.
Cl. 541, 549 (1992)). The liability issue was certified for interlocutory appeal
and consolidated with other similar actions. The Federal Circuit eventually
affirmed en banc. Winstar Corp. v. United States, 64 F.3d. 1531 (Fed. Cir.
1995). The Supreme Court agreed a year later. 518 U.S. 839.

       The issue of liability having been finally decided, the case returned to
this court for the treatment of damages. In 1999, we awarded restitution and
“non-overlapping” reliance damages to Glendale in the combined amount of
$908,948,000. Glendale Fed. Bank, FSB v. United States, 43 Fed. Cl. 390
(1999). The Federal Circuit reversed the restitution award as unfounded in
fact, but affirmed the availability of reliance damages and remanded for a
proper determination of the quantum. 239 F.3d 1374 (Fed. Cir. 2011).
Reliance damages in the amount of $380,787,000 were awarded in 2002, 54
Fed. Cl. 8 (2002), and the Federal Circuit affirmed in 2004, 378 F.3d 1308
(2004), cert. denied, 544 U.S. 904 (2005).


                                       5
 
       Plaintiff attempted to deduct the loss of the supervisory goodwill in
1994-1997 and 2000-2002.4 The IRS denied those attempts because, among
other reasons, it found that Glendale lacked a basis in the goodwill and
because the possibility of recovery in litigation remained until the finality of
the lawsuits. In 1994, Glendale sold its Florida operations (those acquired
from Broward) and reported a gain of $200,874,684. No amount of the
goodwill from the Broward merger was included in the basis of the sale of
the Florida assets. The IRS audited Glendale’s 1994 tax year but did not
propose any adjustment to the amount of gain reported (and thus no
adjustment to the basis).

       After certiorari was denied in 2005, plaintiff again sought to deduct
the loss of supervisory goodwill in its tax return for that year. In its return,
Glendale also included $381 million in income representing the reliance
damages award from this court. It paid $545 million in taxes along with its
return. In December 2014, plaintiff filed a claim for a refund for the 2005
tax year, claiming a deduction for the $798 million loss of the supervisory
goodwill asset, and a few days later, plaintiff amended that refund claim to
include the erroneous inclusion of the $381 million as income. On May 18,
2015, the IRS denied the claim entirely. Plaintiff filed suit here on September
1, 2015, claiming a refund of $412,940,394 in overpaid taxes for the 2005
tax year.

                                                               DISCUSSION

I. Worthless Asset - Supervisory Goodwill Deduction

        The first motion concerns the tax treatment of FIRREA’s change to
the legal right to both consider the negative value of the Broward assets as
an intangible asset for capital reserve purposes and the right to amortize that
asset over a 40-year period. Plaintiff contends that its own accounting
records before and after FIRREA are sufficient to establish the necessary
facts: before, it had a $798 million dollar asset on its books, at least for capital
compliance purposes, and, after, it had no such asset on its books, and no
right to amortize that asset over 40 years. The disappearance of such an asset


                                                            
4
   In 1997, a series of corporate reorganizations and mergers began, which
culminated in the acquisition of Glendale’s parent corporation by Citigroup
in 2002. We will refer to Glendale and Citigroup interchangeably throughout.
                                       6
 
it views as a plainly deductible loss from income for the year in which it was
realized.

        I.R.C. § 165(a) provides that a taxpayer may deduct “any loss
sustained during the taxable year and not compensated for by insurance or
otherwise.”5 The amount of that deduction is the taxpayer’s “adjusted basis”
in the item lost. Id. § 165(b). Section 1011 points us to the next section for
determining the adjusted basis. Section 1012 states the general rule for
determining the basis: “The basis of property shall be the cost of such
property . . . .” Id. § 1012(a).6 Plaintiff argues that the cost of the supervisory
goodwill was the “assumption of liabilities” from Broward, citing Oxford
Life Insurance Co. v. United States, 790 F.2d 1370, 1374 (9th Cir. 1986)
(“Where a taxpayer acquires all the assets of another in a transaction, the
amount of a liability assumed is treated as part of the cost of acquiring the
tangible and intangible assets received.”).

         Plaintiff also points to the Federal Circuit’s first Winstar decision in
which the court stated that the government was bound by the SAA “to
recognize the supervisory goodwill and the amortization periods reflected in
the approved accountants’ letter.” 64 F.3d at 1541-42. Given that the federal
regulators signed off on the Marwick Letter’s allocation of most of the
purchase price to supervisory goodwill, plaintiff sees the value of that
intangible asset as having been clearly established by the contract documents.
Further, plaintiff argues that defendant has admitted the critical facts in its
answer to paragraph 40 of the Complaint, which reads: “On November 19,
1981, Glendale entered into an SAA with the FSLIC pursuant to which
Glendale agreed to assume, through a merger, the government’s financial
liability.” Compl. ¶ 40. In plaintiff’s view, the deal essentially was that
Glendale would assume the liabilities that the FSLIC was otherwise going to
face when Broward failed in exchange for the right to count those same
liabilities as an intangible asset for capital compliance purposes. The value
of the asset is thus in plaintiff’s view the same as the liability assumed.

      Defendant responds in two ways. First, defendant denies that the right
to account for the delta between the assets and liabilities of Broward as

                                                            
5
      “I.R.C.”
             refers to the Internal Revenue Code, codified at Title 26 of the
United States Code.
6
    Section 1012 provides a number of exceptions to this rule, none of which
apply here.   
                                        7
 
supervisory goodwill was granted as an assistance item by the SAA.
Defendant argues that such a right was already permitted by the applicable
accounting principles at the time (GAAP). The government urges that
plaintiff misreads the case law and instead argues that the assistance with
regard to the supervisory goodwill was the right to amortize it over 40 years,
the RAP right. Thus, defendant views the SAA as inapposite and not
controlling for tax purposes. And, in any event, defendant points out that the
law does not permit parties to a transaction to control the tax consequences
unless one of the parties is the Secretary of the Treasury, even when one party
is a federal regulatory agency. See, e.g., Centex Corp. v. United States, 48
Fed. Cl. 625, 632 (2001) (citing, inter alia, 26 U.S.C. § 7801 (1994)).

       Defendant’s second avenue of challenge is with respect to the other
particulars of the supervisory merger. It argues that Glendale received more
than just the RAP right from the FSLIC as part of the SAA. Defendant points
in particular to the income rate protections and branching rights as other
particularly valuable intangible assets. Defendant cites trial testimony from
Gordon Klett during the original Glendale trial in this court, in which Mr.
Klett stated that the principle inducement for Glendale to acquire Broward
was the right to operate in Florida. See DX. 3 at A7, A9. Before an $800
million dollar deduction can be taken, plaintiff must net out the other
intangible assets acquired along with the supervisory goodwill to ascertain
Glendale’s actual basis in that asset, argues defendant.7 Thus, summary
judgment on this record is impossible.

      In principle, we agree with defendant. It is undisputed that other rights
were granted Glendale in the supervisory merger. At least some of which
have an ascertainable value as intangible assets. As defendant pointed out,
Treasury Regulation 1.61-6 is relevant:

              When a part of a larger property is sold, the cost or other basis
              of the entire property shall be equitably apportioned among the
              several parts, and the gain realized or loss sustained on the part
              of the entire property sold is the difference between the selling
              price and the cost or other basis allocated to such part.

                                                            
7
      Other
        intangible assets, such as the branching rights, survived FIRREA.
Had all of the intangible assets from the merger been rendered worthless, the
case would be an easier one because no apportionment would be necessary
for Glendale to prove its basis.   
                                       8
 
26 C.F.R. § 1.61-6 (2018). If the price paid for the acquisition of Broward
was the negative value of Broward’s assets against its liabilities, that amount
must account for all assets acquired by Glendale, not all of which were
rendered worthless by defendant’s breach. We cannot, as plaintiff would
have us, restrict our view on valuation, or basis, to the deal between FSLIC
and Glendale. Legally, FSLIC was required to recognize the purchase price
as goodwill for regulatory purposes, but that is not controlling for tax
purposes. The tax laws look at the transaction as a whole. Thus, in order to
know the true value of any deduction that Glendale is owed for the loss of
one intangible asset, we must know Glendale’s basis in all other intangible
assets acquired as part of the same deal. A calculus can then be made to
reduce the value of the supervisory goodwill by the value of the surviving
intangible assets. The record on summary judgment, however, does not
contain the necessary valuation information to perform that calculus.

        The decisions in Washington Mutual’s (“WAMU”) two lawsuits
attempting to take similar deductions are instructive. WAMU filed suit in
2008 in district court for the Western District of Washington, seeking refunds
for tax years 1990, 1992, and 1993 for the loss of branching and RAP rights
that were acquired from a series of supervisory mergers in the 1980s.8 The
district court originally held that WAMU had no basis in these intangible
assets and thus could not take a deduction for their loss. Washington Mut.,
Inc. v. United States, No. C06-1550, 2008 WL 8422136 (W.D. Wash. 2008).
The Ninth Circuit reversed, holding that WAMU’s basis “was the excess of
the three failing thrifts’ liabilities over the value of their assets. Home
Savings, therefore, received a cost basis in the branching rights and the RAP
rights equal to some part of the total amount of that excess liability.” 636
F.3d 1207, 1219 (9th Cir. 2011). The case returned to the district court,
which held that WAMU’s income based valuation approach to the branching
rights was unreliable and failed to establish WAMU’s basis to a reasonable
degree of certainty.9 996 F. Supp. 2d. 1095, 1117 (W.D. Wash. 2014). That
decision was affirmed in 2017. 856 F.3d 711, 714 (9th Cir. 2017).

                                                            
8
     WAMU   claimed the loss of RAP rights as a result of FIRREA and the loss
of branching rights as an abandonment loss after it sold all of its offices in
Missouri, one of the states in which it had acquired branching rights through
a supervisory merger. 
9
    The court also held that WAMU failed to establish that it had abandoned
the Missouri branching rights. 856 F. Supp. 2d. at 119-20.  
                                       9
 
       Meanwhile, WAMU also filed suit in this court in 2008, seeking
similar refunds for tax years 1991, 1994, 1995, and 1998 for the loss of RAP
and branching rights. Judge Griggsby held that, as a matter of collateral
estoppel, plaintiff was faced with the same legal framework in proving its
basis. Washington Mutual, Inc. v. United States, 130 Fed. Cl. 653, 689
(2017). She also held that the cost basis for all of the assets acquired in the
mergers in question was established as the excess of liabilities over assets,
but found, as had the district court, that WAMU had not proven the value of
the RAP and branching rights. Id. at 694-95, 700.

        The Federal Circuit affirmed that decision earlier this year. It began
its discussion with the statement that “there is no dispute that [plaintiff] had
some cost basis in its RAP and branching rights collectively, and that
[WAMU] is entitled to a tax refund if it can allocate the cost basis to each of
those rights individually.” WMI Holdings Corp. v. United States, 891 F.3d
1016, 1021 (Fed. Cir. 2018). In order to do so, it had to establish the fair
market value of each asset for which it claimed a loss, but it was not required
to do so with “absolute precision.” Id. at 1022. The Federal Circuit ultimately
agreed on each point, including the holding that the RAP right was not a
contractual promise that WAMU’s predecessor be allowed to treat the excess
of liabilities as goodwill. Instead, the court stated, as did this court below,
that the nature of the RAP right was a regulatory guarantee that the purchase
be allowed to continue to account for that asset as it had and to amortize it
for 40 years should the financial regulations change in the future. Id. at 1025.
This was, in essence, an insurance against loss if the law changed. The
purchase method of valuation that required the treatment of goodwill as an
asset was already in place prior to the SAA. Id. The import of the holding
was that WAMU’s valuation was premised on the flawed assumption of a
contractual right to treat the goodwill as an asset. Id. at 1026.

       The Federal Circuit also affirmed Judge Griggsby’s holding that
WAMU’s income method of valuing the branching rights was unreliable. Id.
As this court stated, the data on which those models were based was outdated
or inapposite. The Federal Circuit found no error in those conclusions. Id.
at 1026-27. The court also made an important point in rejecting WAMU’s
argument that this court erred in rejecting the branching rights valuation due




                                      10
 
to the failure to establish the value of the RAP rights.10 The court rejected
that argument out of hand, noting that, in order for it to have any traction, the
taxpayer would have to show that only the RAP and branching rights were
acquired in the supervisory mergers. “[A]s the government points out, the
failing thrifts’ traditional goodwill could also absorb some of the cost basis,
even if such goodwill would have been of low value during the savings-and-
loan crisis.” Id. at 1028 (citing Desert Mgmt. Corp. v. United States, 112
Fed. Cl. 438, 450-51 (2013)).

         Although the circumstances of the WAMU cases are distinct—
WAMU sought a deduction for branching rights and RAP rights, and there
were more supervisory mergers at issue—the legal principles behind those
decisions mandate the result in this case. The parties here agree with the
Ninth Circuit and the Federal Circuit that the purchase price is the excess of
liabilities over assets. Plaintiff claims a deduction for the loss of the
goodwill asset. It values that asset as the entire purchase price (liabilities
over assets) because the purchase method of accounting allowed it to be
treated as such for capital compliance purposes. The result is not the same
for tax purposes, however. The concept of basis, as the Ninth Circuit
explained, is fundamental and “refers to a taxpayer’s capital stake in an asset
for tax purposes.” 636 F.3d at 1217. The basis in an asset is its cost to
acquire, including any liabilities assumed. Id. “Where a taxpayer acquires
all the assets of another in a transaction, the amount of liability assumed is
treated as part of the cost of acquiring the tangible and intangible assets
received.” Oxford Life Ins. Co., 790 F.2d at 1374. Because there is no doubt
that other rights were acquired in the Broward merger, and because the
parties do not agree on the basis allocable to those rights, we cannot assume
that the basis of the supervisory goodwill alone accounts for the entire
purchase price. Summary judgment on this issue is thus inappropriate.




                                                            
10
      As
     an alternative basis for her holding on the branching rights issue, Judge
Griggsby also held that the failure to establish the value of the RAP rights
cast doubt on the value of the branching rights because WAMU’s expert had
stated that he determined the purchase price of the mergers “based on the
determined fair market value of each item of government assistance provided
in those mergers.” 130 Fed. Cl. at 695. 
                                      11
 
II. Reliance Damages As Income

        We turn now to the second item for which plaintiff claims a refund,
which is the subject of its second motion for summary judgment. Plaintiff
claims that it is owed a refund for tax paid on the reliance damages originally
awarded by this court, which were paid in 2005 after all appeals were final.
Citigroup included the award of $381,538,696 as income in its return for the
2005 tax year. It now seeks to reverse that position and asserts that the
recovery was erroneously included in income. Plaintiff argues that the
damage award is statutorily exempt from taxation and, in any event, does not
otherwise represent an accretion of wealth. Under either approach, the award
is not income and should not be taxable. Defendant disagrees, as with the
first issue, contending that material issues of fact preclude summary
judgment under either of plaintiff’s theories, particularly pointing to the tax
benefit rule as potentially implicated by plaintiff’s claim. We begin with
plaintiff’s statutory argument.

       A. Section 597 Does Not Apply

       Plaintiff’s first argument is that the damages award is excluded from
gross taxable income pursuant to I.R.C. § 597, which read as follows at the
time that the SAA was formed:

       Exclusion from gross income. Gross income of a domestic
       building and loan association does not include any amount of
       money or other property received from the Federal Savings and
       Loan Insurance Corporation pursuant to section 406(f) of the
       National Housing Act (12 U.S.C. sec. 1729(f)), regardless of
       whether any note or other instrument is issued in exchange
       therefor.

26 U.S.C. § 597(a) (1988). The parties agree that this provision creates an
exemption from taxation for FSLIC assistance items. FIRREA subsequently
amended section 597 to include assistance items within taxable income, but
treasury regulations clarify that assistance items received on or after May 10,
1989 relating to an acquisition occurring before that date continue to be
governed by the version of section 597 in force at the time of acquisition. 26
C.F.R. § 1.597-8(b)(1) (2018). Thus the version of the statute cited above
controls here. The regulations also make clear that payments received in lieu


                                      12
 
of assistance items are covered by this section and thus not included in
taxable income. Id. § 1.597-8(b)(2).

       Plaintiff argues that this court’s damages award is such a payment in
lieu of a FSLIC assistance item. It sets up the following syllogism. The
major premise is that the right to count the negative value from the Broward
acquisition as supervisory goodwill was received from the FSLIC as a cash
substitute to induce Glendale to acquire Broward. This then should be
viewed as an assistance item, or “other property” as stated in the statute. The
minor premise is that this assistance item was rendered worthless by
FIRREA; the conclusion drawn is that any compensation for that loss
awarded by the court is a payment in lieu of the assistance item.

       Defendant disagrees with both premises, but argues that a trial is, in
any event, necessary to decide whether the supervisory goodwill was an
assistance item per the terms of the SAA and whether any provision of the
SAA controls the tax treatment of a subsequent damages award. We do not
agree with either party. No trial is necessary on this aspect of plaintiff’s
motion because the reliance damages award is not exempted from taxation
by section 597.

       The conclusion is wrong as a matter of law.11 Reliance damages are
compensation given to the non-breaching party for the economic harm
caused by acting in reliance on the breaching party’s promise to perform.
Glendale, 239 F.3d at 1382-83 (citing Restatement (Second) of Contracts §
344(b)). The measure of reliance damages is the cost incurred but for the
breached contract, minus any loss that would have occurred anyway.
Restatement (Second) of Contracts § 349. Unlike expectancy damages,
reliance damages are not a measure of the economic value of the promises to
the non-breaching party had the other party performed. Thus they are not in
any sense a payment in lieu of receiving a contractual promise, here the




                                                            
11
      The major premise is also incorrect.
                                      As Federal Circuit recently explained,
the government did not grant the supervisory goodwill as part of the
supervisory merger. It simply guaranteed the continued treatment of that
asset as it was accounted for under GAAP at the time. WMI Holdings Corp.,
891 F.3d at 1025.
                                     13
 
assistance items. Those are expectancy damages, which were not part of the
award.12

        Plaintiff was awarded damages that primarily compensated Glendale
for the increased cost of borrowing it faced after its ledgers were impacted
by the elimination of a nearly-$800 million dollar asset (supervisory
goodwill). Glendale’s own damages expert coined the phrase “wounded
bank damages” to describe the bulk of the loss that Glendale suffered due to
the government’s change of the rules as to how supervisory goodwill could
be accounted for and amortized. These wounded bank damages represented
the loss of Glendale’s “historic advantage in cost of funds over its
competitors” after it fell out of regulatory compliance due to FIRREA. 43
Fed. Cl. at 408. Glendale’s expert testified that the failure to maintain
regulatory compliance caused Glendale to increase its rates to attract and
keep depositors, i.e., its cost of funds increased. The court agreed and
awarded $335.4 million for this loss. The court also awarded another $45
million in reliance damages corresponding to increased deposit insurance
premiums, Office of Thrift Supervision assessments, and other transactional
costs incurred due to Glendale’s need to recapitalize and right its balance
sheets after FIRREA. These damages do not bear a direct correspondence to
any assistance item promised by the FSLIC; they are connected only because
plaintiff suffered losses from an unanticipated breach (failure to provide such
assistance items). These reliance damages are thus not payments in lieu of
an assistance item from the FSLIC and are therefore not exempt from
taxation under I.R.C. § 597. Summary judgment cannot be granted on this
basis.

              B. Reliance Damages Represent a Return of Capital

        Plaintiff also argues, irrespective of section 597’s applicability, that
its reliance recovery was not taxable because it was not income. Plaintiff’s
position is that reimbursement for costs incurred as a result of the breach is
not an accretion of wealth (income). The damages represent instead only a
return of capital lost, which is not taxable.


                                                            
12
      “[T]he injured party has a right to damages based on his expectation interest
as measured by (a) the loss in the value to him of the other party’s
performance caused by its failure or deficiency . . . .” Restatement (Second)
of Contracts § 347.   
                                     14
 
        Defendant responds that the current record is insufficient to determine
whether plaintiff is correct that the award was not an accretion to wealth.
Other than the potential application of the tax benefit rule, discussed below,
it is not clear from defendant’s papers what factual issues prevent summary
judgment.13 Rather, we agree with plaintiff as a general matter that a
damages award which only compensates for lost capital is not usually taxable
because such an award is not a realization of income. See, e.g., Freeman v.
Comm’r Internal Rev., 33 T.C. 323, 327 (1959) (“If the recovery is received
as the replacement of capital destroyed or injured rather than for lost profits,
the money received is a return of capital and not taxable.”). This rule is
dependent on the facts and circumstances of each case, or as the Tax Court
put it, “the nature of the claim and the actual basis of recovery.” Id.

        I.R.C. § 61 provides a broad definition of gross income, stating that it
“means all income from whatever source derived.” Inherent in this broad
definition is the principle of economic gain. “For a taxpayer to have income
under section 61, there must be an economic gain that benefits the taxpayer.”
Rev. Rul. 81-277, 1981-2 C.B. 14; see also United States v. Gotcher, 401
F.2d 118, 120 (5th Cir. 1968).

        Plaintiff argues that Glendale’s damages award is merely the
replacement of capital lost in two forms. The wounded bank damages were,
according to plaintiff, compensation for the impact on Glendale’s capital
structure, which the court measured by way of the increased cost to borrow
after the loss of capital reserve compliance. The other reliance damages were
reimbursement for costs incurred as a result of the breach, such as OTS fees
and transaction costs from recapitalization. None of these items, according
to plaintiff, represent an award of new money to plaintiff (income) because
there was no net economic gain to Glendale.

        Defendant does not disagree with the legal principles on which
plaintiff relies, but argues that factual differences make the cases plaintiff
cites inapplicable to the present circumstances. The government does
suggest that the mere fact that the award was one of reliance damages is not,
by itself, controlling. It cites Raytheon Production Corp. v. Commissioner
of Internal Revenue., 144 F.2d 110 (1st Cir. 1944), for the proposition that,

                                                            
   It was not entirely clear until after the court posed several questions for
13

supplemental briefing how defendant viewed the application of the tax
benefit rule to plaintiff’s second motion for summary judgment.   
                                       15
 
although a suit may not be for lost profits, some gain may have been realized
by the conversion of a company’s goodwill into cash. Defendant’s point is,
we presume, that there is some gain over basis inherent in the wounded bank
damages to plaintiff, but that is not clear from its brief.

        In Raytheon, the First Circuit was presented with the tax consequences
of a settlement of an earlier antitrust suit by Raytheon against a third-party.
The IRS had included the $410,000 settlement amount as income. The Tax
Court held that the settlement agreement itself provided no attribution as
between damages to capital and other types of compensation, such as lost
profits, and thus no basis for exclusion from income was present. The circuit
court affirmed, holding that, although the trial record of the original lawsuit
contained no indication that lost profits were at issue, that was not dispositive
because there might otherwise have been an accretion of wealth from the
conversion of property (goodwill of the business) into cash. 144 F.2d at 114.
The court stated that “compensation for the loss of Raytheon’s good will in
excess of its cost is gross income.” Id. The record contained no evidence on
which to ascertain Raytheon’s basis in the goodwill, and thus the court
affirmed the Tax Court’s finding that there was nothing in the record on
which to overturn the IRS’s inclusion of the settlement amount in the gross
income of the taxpayer. Id.

       Raytheon is inapposite. The award of reliance damages to Glendale
was for specific expenses incurred as a result of the contract and the breach.
Despite plaintiff’s phraseology, “injuries to Glendale’s capital structure,”
which its expert stated included “goodwill,” the actual measure of damages
was the increased interest rates that plaintiff paid. There was no conversion
of property into cash such as the circuit court hypothecated in Raytheon.
Likewise, compensation for transactional costs for recapitalization and the
sale of assets represents no net economic gain. The same is true of deposit
insurance premiums. These items are not ordinarily considered income.
There is only one possible exception: if those expenses awarded as damages
had already been deducted in a prior tax year. This is known as the “tax
benefit rule.”

       C. The Tax Benefit Rule

       Defendant invokes the tax benefit rule, which is a rule of judicial
creation that will not allow the exclusion of an item from income if it
represents a recovery for a loss that has already been deducted from income

                                       16
 
in a prior year. See generally Hillsboro Nat. Banks v. Comm’r of Internal
Rev., 460 U.S. 370, 383 (1983). The rule only applies, however, when “a
careful examination shows that the later event is indeed fundamentally
inconsistent with the premise on which the deduction was initially based.”
Id. at 184. Defendant avers that the record is not clear whether the specific
items for which reliance damages were awarded were deducted by Glendale
prior to 2005. It suggests that they likely were—banks generally deduct the
interest paid on deposits as a matter of course, for example—and thus argues
that trial is necessary because the record leaves the question unanswered.

        Plaintiff responds that there was no tax deduction associated with the
wounded bank damages because those were not a reimbursement “for any
specific expense incurred and deducted by Glendale on its federal income tax
returns.” Pl.’s Second Mot. for Summ. J. 29. Instead, plaintiff argues that
Glendale’s expert used an estimated historic cost of funds and estimated
increased cost of funds “to approximate the injury to Glendale’s financial
standing, credit, reputation, goodwill, and capital caused by the
government’s breach.” Id. at 30. Plaintiff urges that there is no evidence that
these amounts represent actual interest payments or the payments actually
previously deducted. Plaintiff cites extensively to the testimony of its former
expert at trial to show that he was not using actual amounts of interest paid
as an input to his calculation of damages. Plaintiff also states, without
citation, that it did not deduct the recapitalization costs of $24,235,000, but
instead those costs were capitalized. The status of the balance of the reliance
damages is also not clear. Plaintiff’s papers state no position as to the
inclusion of its increased deposit insurance premiums, OTS assessments,
transaction costs from the sale of a subsidiary bank, and fees paid to the
FHLBB.14

        After the initial briefing and oral argument we asked the parties to
brief, among other things, the question of whether, assuming plaintiff was
correct that reliance damages are not income, the court needed to consider
the tax benefit rule. We also asked the parties who bore the burden of proving




                                                            
14
   It is important to note that the primary argument plaintiff relies on to shield
its reliance award is section 597, which we have already rejected as a basis
of excluding these amounts from income.   
                                         17
 
that an item should be included in income, known as the “inclusionary
component of the tax benefit rule.”15

        Plaintiff answers the first question in the negative, arguing that the tax
benefit rule is an equitable defense that was not pled and thus has been
waived. It urges that defendant is in essence asking for a setoff against
plaintiff’s refund claim by invoking the rule, and a setoff must ordinarily be
pled in the answer or as a counterclaim. Plaintiff answers the second question
by stating that the burden to prove a setoff is on defendant.

        Defendant answers the questions differently. As to whether the tax
benefit rule might apply to an award of reliance damages even if those
damages were not income, the government answered that the rule might
apply if the elements of a “tax benefit” were met (and trial is necessary to
make that determination). It also argues that plaintiff bears the burden to
prove the inclusionary component of the rule because plaintiff bears the
burden in any tax refund suit to disprove the IRS’s determination of tax
liability.

                             1. Defendant’s Invocation of the Rule is not a Setoff

        We begin with plaintiff’s assertion that the tax benefit rule is a
defense, or a setoff, that must be pled affirmatively by the government. If
plaintiff is correct, of course, defendant may not rely on it to defeat summary
judgment because it has not pled the defense. We find no support, however,
for this proposition in the code or the case law. The tax benefit rule is a
judicial attempt, now partially-codified, to reconcile the transactional
realities present in any commercial endeavor with the necessity of tax
accounting on a yearly basis. See Hillsboro, 460 U.S. at 381-82. When
applicable, the courts apply the rule to protect the public’s interest in not
permitting taxpayers to receive a windfall from the deduction of a loss on a
transaction in one year and then receiving tax-free compensation as
reimbursement for that same loss in a subsequent year. It need not be pled


                                                            
15
       There
         is also an exclusionary component of the rule, which is partially
codified at 26 U.S.C. § 111(a). This application excludes from gross income
monies subsequently recovered but for which the earlier deduction did not
confer a tax benefit. See Hillsboro, 460 U.S. at 388. Plaintiff has not argued
the exclusionary component at the summary judgment stage.   
                                      18
 
for the court to consider its application. The question of the application of
the rule is thus properly before us.

                             2. Whether the Expenses Were Previously Deducted

        The question of who bears the burden of proving the inclusionary
component of the tax benefit rule is answered the same as any other issue in
a tax refund suit. The taxpayer bears the burden of proving the IRS’s
determinations incorrect. WMI Holdings Corp., 891 F.3d at 1021-22. Thus,
if the question of whether the taxpayer received a prior tax benefit is raised,
the taxpayer must establish by a preponderance of evidence any factual
predicates necessary to show that rule does not apply. Here the predicate
necessary to conclude in plaintiff’s favor is that the same losses for which
Glendale was compensated for by the reliance damages award were not
previously deducted from income.16 We find that defendant is correct that
the record lacks the necessary factual support to make that determination.

       Plaintiff’s damages expert in the Glendale trial, Dr. Baxter, calculated
the wounded bank damages by comparing Glendale’s historic 0.18 basis
points advantage in rates it had to offer to depositors with the actual rates it
was forced to pay after Glendale fell out of capital compliance in 1992. That
difference was calculated for each quarter from September 1992 through
December 1996. He then multiplied those excess cost of funds figures for
each quarter by the amount of Glendale’s “Average Funding Liabilities” each
quarter. The result of that math was $311.5 million. Assuming that amount
as available to meet other liabilities during that period had Glendale not been
forced to pay it as extra interest on deposits, Dr. Baxter calculated an
additional $23.9 million in interest that Glendale paid on liabilities that it
would not have paid had the $311 million available to meet those liabilities.
The total wounded bank damages figure was thus computed by Dr. Baxter to
be $335.4 million.

      Plaintiff characterizes these calculations as “hypothetical” and argues,
as mentioned above, that these figures do not correspond to actual interest

                                                            
16
      Or
     plaintiff could show that I.R.C. § 111’s exclusionary component of the
tax benefit rule applies by establishing that Glendale received no tax benefit
from the deductions made in prior years. Presumably plaintiff would have
argued the exclusionary component in its motion if it thought it applicable,
but the issue is preserved for trial nonetheless.  
                                       19
 
expenses deducted by plaintiff for any of the years at issue. Defendant
questions this characterization, citing to this court’s statement that the
reliance damages awarded were for “actual, ascertainable damages.” 54 Fed.
Cl. at 14 (after remand, the court reinstated its earlier reliance damages total
on a motion for entry of judgment). Defendant also points to several of
plaintiff’s SEC filings for the years at issue, which indicate that interest
expenses were deducted. It thus concludes that trial is necessary to determine
whether any of the expenses for which plaintiff was recompensed by this
court were previously deducted.

        We agree with defendant. Be it as it may that plaintiff’s expert was
not in fact comparing interest statements pre and post-Glendale’s loss of
capital compliance caused by FIRREA, what he did figure was very much a
component of actual expenses almost certainly deducted by Glendale in the
years they were paid. Dr. Baxter computed the increased cost of borrowing
during those years that FIRREA caused Glendale to be out of regulatory
compliance.17 If plaintiff deducted the actual interest that it paid during those
years, Glendale’s rates having risen in fact due to the loss of regulatory
compliance, as Dr. Baxter testified that they did, those amounts deducted
would necessarily encompass the premium that Glendale had to pay after
FIRREA and before it recapitalized. It is plaintiff’s burden to establish that
it did not deduct the extra interest that it had to pay as a result of FIRREA in
order to avoid the tax benefit rule. Citation to Dr. Baxter’s testimony is
insufficient to establish the point given what Dr. Baxter was attempting to
measure and the evidence supplied by defendant that interest was deducted.18

      Of course, if we concluded that the damages award was not
fundamentally inconsistent with the deduction, summary judgment would be
appropriate because it would not matter whether plaintiff has previously
deducted the losses for which it was compensated in the damages award. But
we cannot reach that conclusion here.

                                                            
17
       Weview what Dr. Baxter did as a shortcut to computing actual extra
expenses incurred by eliminating the need to actually compare statements
before and after FIRREA.
18
    This holding applies to the $311.5 million calculated as the actual increased
rates paid. The other items of reliance damages are also set for trial on
whether they were deducted, including the second component of Dr. Baxter’s
wounded bank damages, the $23.9 million of extra interest paid on other
liabilities.
                                        20
 
        Plaintiff argues that because the enactment of FIRREA was an
unanticipated breach of contract, recovery for that breach is not
fundamentally inconsistent with the deduction of ordinary expenses, such as
the interest paid by Glendale on deposits. In other words, plaintiffs were not
planning for nor trying to achieve any windfall—Glendale took its normal
deduction of operating expenses but was forced by FIRREA to sue the
government to attempt to recover losses brought about by the change in
treatment of supervisory goodwill.

        Plaintiff cites the Supreme Court’s Hillsboro decision as instructive
as to how the court should view these events. In Hillsboro, the Court stated
that the aim of the rule was “to protect the Government and the taxpayer from
the adverse effects of reporting a transaction on the basis of assumptions that
an event in a subsequent year proves to have been erroneous.” 460 U.S. at
383. The court went on to state that the application of the rule does not
always follow an unforseen (at the time of the deduction) later recovery of a
deducted loss. Id. “The tax benefit rule will ‘cancel out’ an earlier deduction
only when a careful examination shows that the later event is indeed
fundamentally inconsistent with the premise on which the deduction was
initially based.” Id. This, the court stated, is another way of saying that, had
the recovery happened in the same year as the loss, “it would have foreclosed
the deduction.” Id. at 384.

       In Hillsboro, two cases were consolidated for consideration. Plaintiff
urges that we consider the facts of the companion case in which the taxpayer,
Bliss Dairy, Inc., took a normal business expense deduction under I.R.C. §
162(a) (deduction for consumed materials or supplies). The relevant asset
was cattle feed. Instead of actually consuming the feed, the corporation
liquidated its assets in a planned reorganization. The assets of the company
were distributed to the shareholders of the corporation. The Court held that
the deduction and later distribution of the assets were fundamentally
inconsistent with one another because distribution of corporate assets to
shareholders in a planned liquidation was a conversion from business use to
personal use. Id. at 395-96. Plaintiff here avers that the facts of this case are
distinguishable because the enactment of FIRREA was unanticipated and not
planned by the taxpayer.

      Plaintiff asks this court to compare the Bliss Dairy results in Hillsboro
with a Tax Court decision in which the petitioners were farmers who

                                       21
 
deducted under section 162 the cost of certain supplies to be used in 2010.
See Estate of Backemeyer v. Comm’r of Internal Rev., 147 T.C. 526 (2016).
Mr. Backemeyer died before actually consuming any of the supplies. All of
Mr. Backemeyer’s assets, including the farming supplies, passed to a trust of
which his widow was the trustee. Mrs. Backemeyer then continued to
operate the farm. She took an in-kind distribution of the supplies from the
trust and consumed them during the normal course of farming in 2011. She
also deducted the cost of those supplies from her income in 2011. The IRS
issued a notice of deficiency, disallowing the deduction of those supplies.

       Before the Tax Court, the IRS argued that the tax benefit rule should
control the outcome because the distribution of the assets to the trust upon
Mr. Backemeyer’s death was a conversion from business to personal use,
which was inconsistent with the business expense deduction of section 162.
Id. at 534. The Tax Court held otherwise, stating that the death of Mr.
Backemeyer was not an inconsistent subsequent event that would render the
original deduction improper had it been taken in the same year as the
distribution to the trust upon Mr. Backemeyer’s death. Id. at 543-44.
Plaintiff believes its own case is analogous to that of the Backemeyers’. It
likens the breach of contract to the death of Mr. Backemeyer, a wholly
unanticipated event, which is thus not fundamentally inconsistent with the
deduction, making the tax benefit rule inapplicable.

       If defendant is correct that some or all of the amounts deducted as
expenses correspond with the damages award, the tax benefit rule will apply.
Plaintiff has misconstrued which events are relevant to the application of the
rule. The question is not whether the breach was fundamentally inconsistent
with the deduction of those expenses; rather, it is whether the recovery of
some or all of those expenses as a damages award in the same year that they
were deducted as business expenses would be consistent. We hold that the
two are inconsistent. This case is not analogous to that of Backemeyer.
Death is perhaps the clearest example of when the unanticipated event is not
inconsistent. Here we see no such intervening event. Had Glendale received
the damages award in the same year it deducted the expenses—assuming it
did deduct some or all of them—it would have been inconsistent with the
deduction of those expenses because it would have been counting as a loss
something for which it had already been compensated. This result is
consistent with the code’s general treatment of insurance and other
compensatory payments. Section 165, which covers deductible losses in
general, only allows deductions “not compensated for by insurance or

                                     22
 
otherwise.”19 I.R.C. § 165 (2012). We must have trial to determine what
was deducted by Glendale to know whether the inclusionary component of
the tax benefit rule applies.

                                                               CONCLUSION

       Because the question of Glendale’s basis in the various assistance
items received from the FSLIC is open and because the question of whether
Glendale took deductions for any of the expenses recompensed by this
court’s reliance damages award is also open, summary judgment cannot be
granted to plaintiff on either issue. Accordingly, the following is ordered:

              1. Plaintiff’s motion for partial summary judgment, filed on June 30,
              2018, and plaintiff’s second motion for partial summary judgment,
              filed on July 5, 2018, are denied.

              2. The parties are directed to consult and file a joint status report on
              or before November 16, 2018, with a proposal for further proceedings.



                                                                      s/ Eric G. Bruggink
                                                                      ERIC G. BRUGGINK
                                                                      Senior Judge
 




                                                            
19
   Section 186 of the code also provides further support for the notion that the
code does not treat damages for breach of contract as consistent with a
deduction for the same losses later awarded as damages. I.R.C. § 186 allows
a separate deduction of the lesser of the damages award or the net-operating
loss, after the damages award, as a result of a breach. The code thus
specifically contemplates damages awards for breach of contract separately.
Although our holding that the reliance damages award is not income because
it only represents a return of capital renders section 186 inapplicable, the
code provision is instructive on the question of whether the subsequent
recovery of damages is inconsistent with an earlier deduction of expenses
caused by the breach. 
                                      23
 
