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Equity Pros Cast Nervous Eyes On U.S. Tax Trial

The U.S. Internal Revenue Service has filed its answer to a petition made by two taxpayers regarding the taxation on proceeds of a so-called Structured Yield Product Exchangeable for Stock (STRYPES), according to court papers. In the impending case, to be heard at the United States Tax Court, the Internal Revenue is seeking that Bobby and Delaine Stevenson pay nearly USD25 million of tax on gains made from the transaction.

Robert Willens, managing director, tax and accounting analyst at Lehman Brothers in New York, said the case throws into question the previously held understanding that derivatives-based structures such as STRYPES are not subject to U.S. constructive sales rules, under which taxpayers pay tax on appreciated financial positions.

The IRS stated in its letter of May this year that the additional tax bill is based on the transfer of information technology firm Ciber's stock to Merrill Lynch, through the issuance of STRYPES. Under this structure, Bobby Stevenson, chairman of Ciber, made a profit of USD81,700,093.

Derivatives professionals claim STRYPES are not subject to tax at the start of the transaction because the holder of the note pays out a variable amount of stock or cash at the end of the transaction, which is not determined until maturity. Willens said, "The issuer keeps some of the upside with respect to the underlying stocks, and that was thought enough to keep the IRS at is amazing that this is in court. A lot rides on this case."

Edward Kleinbard, partner at Cleary, Gottlieb, Steen & Hamilton in New York, believes the IRS has no chance of succeeding in court and expects the issue to be resolved before making it to trial. The law is crystal clear on this issue, and there is no question that if properly litigated the taxpayer will win, he stated.

Val J. Albright, national partner at Baker & McKenzie in Dallas, Texas, who is representing the Stevensons, declined comment. Nancy Mathis, spokeswoman at the IRS in Washington, said the organization does not comment on court cases.

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