UNITED STATES OF AMERICA, PETITIONER V. CENTENNIAL SAVINGS BANK FSB (RESOLUTION TRUST CORPORATION, RECEIVER) No. 89-1926 In The Supreme Court Of The United States October Term, 1990 On Writ Of Certiorari To The United States Court Of Appeals For The Fifth Circuit Reply Brief For The United States 1. The purpose of the longstanding "materially different" requirement in the Treasury Regulations is to prevent the realization of gain or loss on economically meaningless exchanges that do not change the taxpayer's economic position. The swap of mortgage pools that respondent engaged in was precisely tailored to ensure that it would "not change the economic position of the association after it engaged in the swap." J.A. 58 (Bank Board memorandum). Respondent satisfied (through a computer match) the criteria of Memorandum R-49, and thus did "not change (its) economic position." Respondent then turned around and tried to deduct a $2.8 million loss on the ground that the "substantially identical" mortgage pools (J.A. 55) were actually "materially different." Respondent's position thus rests on an "inherent contradiction" (Portland Golf Club v. Commissioner, 110 S. Ct. 2780, 2789 (1990)); it should not be permitted "to have its cake and to eat it too." Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 546 (1979). The only way in which respondent can at once satisfy the "substantially identical" test of Memorandum R-49 and the "materially different" requirement of Treas. Reg. Section 1.1001-1(a) is to read the word "materially" out of the Regulation. Under respondent's test, the Regulation is satisfied whenever "an interest in property (is) exchanged for a different interest in property." Resp. Br. 20. /1/ The problem with this proposed definition is obvious. In essence, respondent contends that property is materially different if it is different. In the absence of a materially different requirement, however, economically meaningless exchanges of property -- such as 1000 bushels of Kansas wheat for a "different" 1000 bushels of Kansas wheat -- would constitute realization events and produce tax consequences. The end result, as we explain in our Cottage brief (at 14), would be effective nullification of the realization requirement for losses. /2/ Indeed, in our view, respondent all but gives up the game when it acknowledges that there should be "flexibility for finding nonrealization" in the case of an exchange of an old certificate for a new one with a "minor modification," and that a contrary rule would be "an obviously undesirable and impractical result." Br. 20 n.12. We agree; the whole purpose of the "materially different" requirement in the Regulation is to determine when a modification is "minor," and the flexibility respondent finds desirable is the Commissioner's in promulgating and applying his Regulation. /3/ 2. Respondent relies on several of this Court's decisions from the early 1920s for the proposition that any exchange of property for different property is a realization event. Br. 12-16. The cases do not establish that proposition, and, in any event, did not purport to establish the parameters for realization in all contexts. In both Eisner v. Macomber, 252 U.S. 189 (1920) and Weiss v. Stearn, 265 U.S. 242 (1924), the taxpayers ended up with something different from what they had before: additional shares of stock in Macomber and shares in a new corporation in Weiss. Because the differences "add(ed) nothing to (the property) of the shareholder" in Macomber (252 U.S. at 212) and did not "give() the stockholder a thing really different from what he theretofore had" in Weiss (265 U.S. at 254), however, this Court held that there was no realization. In contrast, in Marr v. United States, 268 U.S. 536 (1925), the Court held that a taxpayer who received stock in a new corporation in exchange for stock in the old realized a gain on the exchange, because the old and new corporations were "essentially different." Id. at 541 (emphasis added). See Gov't Cottage Br. 22-23 (discussing Marr). Indeed, the discussion in Marr of Weiss highlights this point. In Marr, the Court recognized that the old and new corporations involved in the Weiss exchange were different: "Technically there was a new entity; but the corporate identity was deemed to have been substantially maintained because the new corporation was organized under the laws of the same State, with presumably the same powers as the old." Marr, 268 U.S. at 541. Since the corporate identity was substantially maintained, the old and new corporations in Weiss were different, but not essentially different. See Gov't Cottage Br. 22 (discussing Weiss). These cases thus establish that a mere difference is not enough to establish realization from an exchange; the properties transferred must instead be "really different" or "essentially different." This teaching is of course entirely consistent with the Commissioner's promulgation of the "materially different" requirement in the Regulations. /4/ At the same time, the fact that there was no realization on the facts of Macomber and Weiss hardly means that there will always be realization unless the facts presented parallel the facts of those two cases. In any event, respondent is wrong to view those 1920s cases as the beginning and end of the inquiry. The question is not, as respondent would have it, whether the differences in the swapped mortgage pools were sufficient "to cause gain or loss to be realized under the Eisner line of cases." Br. 17. Rather, the question is whether the differences satisfied the "materially different" requirement in the Regulation. By focusing exclusively on the cases, respondent seeks to read out of this case the deference this Court has held is due the Commissioner in promulgating Treasury Regulations, see, e.g., Thor Power Tool, 439 U.S. at 533 n.11 ("it is well established, of course, that (Treasury Regulations) 'must be sustained unless unreasonable and plainly inconsistent with the revenue statutes' and 'should not be overruled except for weighty reasons'") and in interpreting those Regulations, see, e.g., Robertson v. Methow Valley Citizens Council, 109 S. Ct. 1835, 1850 (1989) (agency interpretation of own regulation is "controlling" unless it is "plainly erroneous or inconsistent with the regulation"). Macomber, Weiss, and Marr arose, in part, from taxpayers' constitutional objections that certain transactions did not produce "income" within the meaning of the Sixteenth Amendment. /5/ Even if the Commissioner's interpretation of the "materially different" requirement in the Regulation establishes a more rigorous test for realization than the constitutional test in the 1920s cases (a proposition we dispute), nothing in those decisions precludes a more rigorous test. Indeed, far from claiming that the Commissioner's interpretation somehow implicates Sixteenth Amendment concerns in this case, respondent repeatedly objects that the Commissioner's interpretation will allow income of other taxpayers to escape taxation (Br. 7, 16, 22) -- precisely the opposite of the taxpayers' claims in the early cases. Those cases clearly did not permanently tie the Commissioner's hands and prevent him from refining and clarifying the materially different requirement through promulgating and applying a Treasury Regulation; that is why we have such regulations in the first place. Thus, even if respondent's premise were correct (that the Commissioner's interpretation goes beyond the 1920s cases), respondent's corollary (that the Commissioner has no discretion to do so) is incorrect. /6/ 3. Respondent also maintains that its proposed definition is compelled by the nonrecognition provisions of Sections 1031 and 1091. That respondent's mortgage swap transactions did not fall within the specific nonrecognition provisions of Section 1031 (which governs "like kind" exchanges) and Section 1091 (which governs "wash sales" of stock or securities) does not mean that a loss was realized on the transactions. Contrary to respondent's argument, the Commissioner's interpretation of the "materially different" requirement for realization on exchanges in no way renders Sections 1031 and 1091 superfluous, since property of "like kind" is a much broader concept than property that is not materially different, and the "wash sale" rule applies regardless of whether the transaction can be characterized as an exchange. Like the petitioner in Cottage, respondent confuses the entirely distinct principles of realization and recognition. The fact that Congress elected to provide for nonrecognition in the situations covered by these Sections in no way suggests a determination that there must be realization in all other situations. See Gov't Cottage Br. 24-28. /7/ 4. Respondent also claims that the Commissioner's interpretation is "incapable of effective administration" (Br. 20) and that its proposed test is more desirable "(f)rom a tax administration point of view" and "(f)rom a revenue point of view" (id. at 16). The Commissioner -- charged by law with interpreting and administering the Internal Revenue Code, and entrusted with administrative discretion to discharge that responsibility -- disagrees. See National Muffler Dealers Ass'n v. United States, 440 U.S. 472, 476-477 (1979); United States v. Correll, 389 U.S. 299, 305-307 (1967). Indeed, the real threat to proper administration of the Internal Revenue Code would come from respondent's test, which would attribute tax consequences to meaningless exchanges, such as in the bushels of wheat example. Contrary to respondent's contention, the Regulation's "materially different" test is not too high a hurdle. The lengths to which respondent and its trading partner went in matching their swapped loans, see J.A. 55-56 (10 criteria for match), provide a good example of what it takes to fail the test. /8/ 5. We demonstrate in our opening brief (at 17-26) that the available evidence from (1) the conduct and intent of the parties, (2) the evaluation of the pertinent market (the secondary mortgage market), and (3) the determination of the agency charged with regulating federal savings and loan associations (the Bank Board), confirms that such differences as there were in the mortgage pools exchanged here were not material. Rejecting all of these sources of evidence, respondent instead would look to "the nature of each property." Resp. Br. 29. Such an inquiry, however, is really nothing more than a conclusion derived from consideration of the very factors respondent eschews. Two shares of stock of the same class in the same corporation are different in that they have different serial numbers, but that difference is not material. Why not? Because parties dealing in stock, and the market for stock, simply do not care what the serial numbers happen to be. If the parties and the market did care -- for example, if the stock at issue consisted of antique shares whose value derived from the certificate itself and not the ownership interest it represented -- then the different serial numbers would constitute a material difference. Nothing about "the nature" of serial numbers on stock answers the question whether the differences are material -- you need to know, inter alia, how the parties and the market regard such differences. That is not a "subjective" test; it simply recognizes that pertinent evidence, rather than preconceived notions about the abstract "nature" of property, needs to be considered before arriving at an objective conclusion. /9/ In the alternative, respondent also contends (at 30) that it had :sufficient information about the loans received" and "knew that the different characteristics of the loans assured that different economic consequences would ultimately result." Respondent ignores the fact that the district court specifically considered respondent's claimed awareness of general differences in the loan packages and determined that those claimed general differences were immaterial. See Pet. App. 39a, 52a; Gov't Br. 20 n.17. With regard to the evaluation of the pertinent market, respondent does not dispute the factual findings that the differences in the mortgage pools were immaterial to the secondary mortgage market. See Pet. App. 52a-53a; see also Gov't Br. 21-22. Instead, respondent maintains that the evaluation of the pertinent market is irrelevant because a "market-based inquiry is relevant only to determine values, not which factors are responsible for those values." Resp. Br. 31. As we have explained (Br. 22-23; Cottage Br. 32), there is a fundamental difference between the concept of equivalent value and the concept of material difference, and the evaluation of the pertinent market can be quite helpful in considering whether the differences are material even if the market (and the parties) assign the properties equivalent value. Respondent's suggestion that the market perspective is incapable of determination, moreover, ignores the fact that the issue was vigorously litigated in this very case, and the district court simply resolved the issue against respondent. Pet. App. 52a-53a. As the district court's findings confirm, the issue is fully capable of resolution, and the market perspective provides probative evidence of the nature of the exchange. Respondent successfully demolishes a series of straw men of its own creation. It argues that the Commissioner's position would lead to a finding of no realization on "the exchange of securities in one automobile company for securities in another automobile company, or stock of one oil company for stock of another oil company," or one AAA-rated corporate bond for an AAA-rated bond of a different corporation. Resp. Br. 27, 31 n.25. Of course not. Certainly the "materially different" requirement demands the drawing of lines, but that is true throughout the Internal Revenue Code and law in general. Saying that there is no material difference between computer-matched pools of mortgages of the same type, secured by single-family residences, in the same state, with the same interest rate, same stated terms to maturity, and similar remaining terms to maturity, principal amounts, fair market values, and loan-to-value ratios, swapped without recourse (see J.A. 55-56), is not the same as saying there is no material difference between Ford and GM stock, Mobil and Exxon stock, or Union Pacific and Southern Pacific bonds. The parties and the market tell the tale: an investor giving up his GM stock would care to know whether he was getting Ford or Chrysler stock in return; here, once the pools of mortgages were matched according to the rigorous R-49 criteria, respondent did not care whether John Doe or Tom Roe was the original borrower on one of the loans; indeed, respondent did not even obtain files showing who the borrowers were until six years after the swap, and the information was not even available at the time of the swap. Pet. App. 36a n.5. /10/ Respondent likewise rejects the Bank Board's evaluation of the mortgage pools at issue as "wholly irrelevant for tax purposes." Br. 33. According to respondent, the Bank Board's determination should be disregarded because it represents a "depart(ure) from traditional regulatory accounting." Id. at 34. As we explain in our opening brief (at 25-26), it is not the Bank Board's conclusion that no loss on an R-49 transaction need be reported for regulatory accounting purposes that is significant here; rather, it is the Bank Board's expert conclusion that loans meeting the R-49 criteria are substantially identical" (J.A. 55) and that a swap of such loans would "not change the economic position of the association after it engaged in the swap" (J.A. 58). Together with the conduct and intent of the parties and the evaluation of the market, the Bank Board's evaluation establishes that the differences in the loan pools were not material. /11/ Having rejected the relevance of the conduct and intent of the parties, the market perspective, and the expert agency's conclusion, respondent, like petitioner in Cottage, seeks to rely on differences in borrowers and collateral, the fact that the exchange was for 90% participation interests, and the fact that the loans eventually revealed different performances. Resp. Br. 17-18. As we have previously pointed out (Br. 26; Cottage Br. 33), an across-the-board rule based on the first two factors (such as that fashioned by the court of appeals) is far too sweeping and fails to take into account differences in contexts and transactions. The exchange of 90% participation interests, moreover, did not create a material difference in the properties exchanged, since 90% participation interests were swapped for substantially indentical 90% participation interests. See Gov't Cottage Br. 33. /12/ The reliance on eventual different performances is unavailing because the question of material difference turns on the significance of differences known at the time of the exchange, not on a post hoc evaluation of subsequent performance. The Internal Revenue Code could not properly be administered if we had to wait and see how property interests actually performed years down the road before determining whether or not they were materially different under the Regulation. Respondent's claim that its swap of mortgage pools produced a deductible loss is thus premised both on a crabbed construction of the "materially different" requirement and on an application of the requirement that ignores the perspective of the parties, the market, and the expert agency, and substitutes reliance on factors that were either unknown or insignificant at the time of the transactions. The Commissioner's reasonable construction of the Code and of his Regulation should be upheld, and the undisputed facts in the record establish that the claimed differences in the mortgage pools were not material. 6. The second issue presented is whether income received by respondent from its depositors as penalties for early withdrawal of their funds is excludable from gross income because it is income "by reason of the discharge * * * of indebtedness," within the meaning of Section 108 of the Internal Revenue Code. As we explain in our opening brief, not every debt that is cancelled or discharged results in income "by reason of the discharge" of the debt. I.R.C. Section 108(a)(1) (emphasis added). If the cancellation of a debt is simply the method by which a creditor makes a payment to a debtor, the debtor does not have income "by reason of" a debt discharge; he has income "by reason of" receiving a payment, and that income does not qualify for the Section 108 exclusion. Respondent agrees with this general principle. Br. 38-40. /13/ Our brief further explains (at 33-35) that application of this principle requires the conclusion that respondent's receipt of early withdrawal penalties (through an offset of the amount returned to depositors) represents payment of a separate obligation, rather than income "by reason of" the discharge of indebtedness. Respondent disagrees (at 35-38, 40-46) with this conclusion, but its objections are not well founded. a. As an initial matter, respondent ignores the fact that its offset of the amount due depositors simply reflects its choice of the method for receiving early withdrawal penalties. We explain in our opening brief (at 33) that, if the depositors making premature withdrawals had paid the penalty due respondent in cash, and, in turn, received from respondent the entire amount due on their accounts, then respondent would clearly have had income from the payment of a penalty, not from the discharge of indebtedness. Respondent does not address, much less dispute, this point. The result should not be different simply because respondent chose a different method of receiving the penalty -- namely, by an offset against the amount turned over to the depositor. /14/ b. That the early withdrawal penalty represents a separate obligation, rather than the discharge of indebtedness, is clear from the nature and purpose of the penalty: it is imposed not by the parties to the debtor/creditor relationship themselves but by federal regulations, and its purpose, even aside from the federal regulations, is to serve as a form of liquidated damages to compensate a financial institution for additional expenses. See Gov't Br. 34-35; Colonial Savings Ass'n v. Commissioner, 854 F.2d 1001, 1007 (7th Cir. 1988), cert. denied, 489 U.S. 1090 (1989). Respondent suggests that the early withdrawal payment should not be viewed as a "penalty"; it emphasizes that the 1981 version of the applicable regulation uses the term "forfeit," and suggests that the use of the term "penalty" in earlier versions of the regulation (which are also applicable in this case, see Gov't Br. 32 n.28) was a "misnomer." Resp. Br. 44-45 n.34. Respondent's effort is unavailing. First, to the extent that it matters, the word "penalty" remains in the very title of the 1981 regulation. See 12 C.F.R. 1204.103 (1981) ("Penalty for early withdrawals"). Second, Section 62(a)(9) of the Internal Revenue Code (26 U.S.C. (1988)), which governs the treatment of the depositor, similarly refers to "amounts forfeited * * * as a penalty for premature withdrawal of funds" (emphasis added). Third, respondent's own certificates of deposit set forth the amount of the penalty in a "Penalty Clause Section." J.A. 27-29. Respondent's effort now to recharacterize the obligation -- by stating that "the penalty characterization was a misnomer and that, in substance, the regulation was effecting a reduction of indebtedness" (at 45 n.34) -- is unsupportable. /15/ c. Respondent repeatedly maintains that its receipt of early withdrawal penalties (through an offset) was income "by reason of" the discharge of indebtedness because the income would not have arisen "but for" the discharge of indebtedness for less than its full amount. See, e.g., Resp. Br. 11, 39, 46. Recognition that the penalty is a separate obligation, however, highlights the fallacy of this contention. The depositor was obligated -- by federal regulations and by what the Seventh Circuit aptly termed a "liquidated damages" provision (Colonial Savings, 854 F.2d at 1007) -- to pay a penalty, and respondent's income arose "by reason of" that penalty. The income would not have arisen "but for" the discharge of indebtedness only because respondent chose an offset against the indebtedness as the method of payment for that obligation. Respondent's argument is essentially a tautology: because it chose an offset method for receiving its income, its income would not have occurred "but for" the offset. /16/ In the classic case covered by Section 108, A lends B $1,000 payable in two months. After six weeks, A and B agree to call it quits if B pays $800. B has received $200 in income by reason of the discharge of his indebtedness to A. In the classic case not covered by Section 108, A lends B $1,000 payable in two months, provided that B need only pay back $100 if he paints A's house. If B paints A's house and pays back the $100, he has received $900 not by reason of the discharge of his debt to A, but because he painted A's house. Respondent's proposed test for applying Section 108, however, would find income by reason of discharge of indebtedness in the second example. The $900 in income would not have arisen "but for" the discharge of indebtedness -- A did not contract to pay B for painting his house, apart from the income B would realize from the agreed-upon discharge of indebtedness. As noted, the "but for" test thus proves too much, since it is satisfied whenever an offset against the amount owed is specified as the method of payment. In terms of the statutory language, "but for" is not the same as "by reason of." The statutory phrase "by reason of" looks to the source of the income -- the "reason" for it. In the first example above, the source is the forgiveness of the debt; in the second, the source is the painting of the house. Here the source is the federal regulation which requires payment of a penalty, not any forgiveness by the depositor of what the institution owes him. /17/ d. Since the penalty is a separate obligation owed by the depositor, respondent's reliance (Br. 41-42) on Reliable Incubator & Brooder Co. v. Commissioner, 6 T.C. 919 (1946), is misplaced. In Reliable Incubator, unlike the instant case, the creditor had no separate obligation to the debtor. Respondent's reliance (Br. 43) on Columbia Gas System, Inc. v. United States, 473 F.2d 1244 (2d Cir. 1973), is misplaced for a similar reason. In that case, the taxpayer converted its bonds into stock and did not pay the bondholders the accrued interest on the debt. The bondholders had no separate obligation to the taxpayer. /18/ e. We explain in our opening brief (at 35-37) that the conclusion that early withdrawal penalties represent a separate obligation from the debt owed to depositors is further buttressed by the Commissioner's analysis of the tax consequences for the depositor in a Revenue Ruling (Rev. Rul. 73-511, 1973-2 C.B. 402), and by Congress's reaction to that analysis. Respondent concedes, as it must, that "(t)he ruling treats the forfeiture as a transaction separate from the payment or crediting of interest." Br. 47. Inasmuch as Congress explicitly relied on the analysis in this ruling in crafting a deduction for depositors' penalties (see Gov't Br. 36-37), this concession powerfully supports the Commissioner's position that the penalty is a separate obligation from the debt and that the use of an offset is a method of payment, rather than a discharge of indebtedness. But respondent finds an entirely different distinction lurking in the Revenue Ruling. In respondent's rendition, the ruling "held that a premature withdrawal forfeiture was not a discharge of the interest, but was a discharge of the principal." Br. 47. Nothing in the Revenue Ruling supports this attempted distinction between interest and principal; indeed, the ruling explicitly states thatt the penalty was paid by "the forfeiture of a portion of the interest previously paid." 1973-2 C.B. at 403 (emphasis added). The ruling is equally clear that the distinction it is drawing is not between principal and interest, but between the payment of interest and the early withdrawal penalty: "the interest paid or credited and the forfeiture incurred represent two separate transactions and are taxable as such." Ibid. /19/ Respondent further contends that the Revenue Ruling's conclusion that the depositor can deduct the amount of the penalty as a "loss" under Section 165 of the Code (1973-2 C.B. at 403) establishes that the premature withdrawal payment is not a separate obligation or penalty. Br. 48. Respondent's suggestion that the payment of "obligations" can never be a "loss" for purposes of Section 165, however, is clearly wrong. See, e.g., Stephens v. Commissioner, 905 F.2d 667 (2d Cir. 1990) (restitution payment deductible as loss under Section 165); Rev. Rul. 67-48, 1967-1 C.B. 50 (amount paid by taxpayer to former employer as liquidated damages for breach of employment contract deductible as loss under Section 165). /20/ f. Finally, respondent also suggests that the sole purpose of Section 108 is to alleviate the hardship of taxing income from the discharge of indebtedness because the discharge does not generate cash with which to pay the tax, and emphasizes that it received no cash from the transaction. Br. 36-37. As we point out in our opening brief (at 38-39), the statutory purpose of Section 108 and its predecessor was also to provide an incentive for liquidation of indebtedness -- a purpose wholly inapplicable to the completely creditor-controlled early withdrawals here. In emphasizing the lack of cash to pay taxes on the income resulting from the early withdrawals, respondent also fails to point out that, pursuant to Section 591 of the Code, a savings institution also receives full deductions for the interest paid to depositors, including any interest sacrificed by depositors as penalties for early withdrawals. See Colonial Savings Ass'n v. Commissioner, 85 T.C. 855, 864 n.15 (1985), aff'd, 854 F.2d 1001 (7th Cir. 1988), cert. denied, 489 U.S. 1090 (1989); Treas. Reg. Section 1.591-1(b). /21/ * * * * * For these reasons and those set forth in our opening brief, the judgment of the court of appeals should be reversed. Respectfully submitted. JOHN G. ROBERTS, JR. Acting Solicitor General /22/ JANUARY 1991 /1/ See also Resp. Br. 18 ("(T)he threshold for realization * * * is crossed whenever an interest in property is exchanged for an interest in other legally distinct property."). /2/ Many of respondent's arguments were also raised by the petitioner in Cottage, and are addressed in our Cottage brief. A copy of that brief has been supplied to respondent's counsel. /3/ Respondent's amici take varying approaches to the "materially different" requirement. Amicus Federal National Mortgage Association (FNMA) contends (Br. 10) that the requirement is satisfied if "the exchanged assets represent different property rights." Like respondent's argument, this contention strips the concept of materiality of any meaning. Amicus U.S. League of Savings Institutions acknowledges that the materially different requirement "has become the touchstone for identifying a realization of gain or loss" (Br. 7), but asserts that the requirement is "a relic of earlier times" (id. at 11) that has "outlived its usefulness" (id. at 24). Amici Main Line Federal Savings Bank, et al., similarly contend (Br. 5 n.4), as one of their arguments, that the regulation should be invalidated. As we explain in our Cottage brief (at 14-15), there is no basis for invalidating the materially different aspect of the realization requirement. Notably, at various points, respondent's amici acknowledge that exchanged properties must differ in some respect before an exchange can be a realization event. See, e.g., U.S. League Br. 3 (realization occurs "unless the properties exchanged are so similar that they represent the identical property rights") (emphasis added); Main Line, et al. Br. 3 ("The proper test (under the regulation) * * * is whether (properties) are inherently different from each other.") (emphasis added); FNMA Br. 7 (no realization if exchange is "so devoid of a change in substance that no disposition of property * * * has really occurred") (emphasis added). Yet once it is recognized that there is some requirement that the exchanged properties differ, the precise definition of that requirement should be left to the Commissioner. /4/ Respondent also relies (Br. 13-16) on three other early tax decisions in which this Court held, as it did in Marr, that a shareholder realized income upon the receipt of shares in a corporate reorganization. Cullinan v. Walker, 262 U.S. 134 (1923); United States v. Phellis, 257 U.S. 156 (1921); Rockefeller v. United States, 257 U.S. 176 (1921). In those three cases, the shareholders were taxed "on the ground that they received securities in an essentially different corporation having essentially different characteristics." 3 M. Weinstein, Mertens Law of Federal Income Taxation Section 20.02, at 20 (rev. 1990). Accordingly, the Fifth Circuit correctly held in San Antonio Savings Ass'n v. Commissioner, 887 F.2d 577, 585 (1989), petition for cert. pending, No. 89-1928, that "Phellis, Rockefeller, and Cullinan do not establish that an exchange of items which differ from each other only formally nevertheless constitutes a realization event." /5/ See, e.g., Marr, 268 U.S. at 539-540; Weiss, 265 U.S. at 253-254; Eisner v. Macomber, 252 U.S. at 199. See generally 1 B. Bittker & L. Lokken. Federal Taxation of Income, Estates and Gifts Paragraph 5.1 (2d ed. 1990). /6/ Respondent's statement (at 9, 19) that we conceded that the Treasury Regulation merely codifies earlier cases is incorrect. See Gov't Br. 15 n.10. Although, as we have noted (Br. 13 n.9), the enactment of the predecessor to Section 1001 was not intended to change the law, nothing in that Act or its successors precludes the usual discretion accorded an agency charged with interpreting and administering a statutory regime. In fact, the Code has always conferred on the Secretary of the Treasury the authority to issue regulations needful for the enforcement of the Code. See I.R.C. Section 7805. /7/ Respondent also relies (Br. 20-21) on Treas. Reg. Section 1.1002-1(c), which states that certain nonrecognition provisions of the Code apply to exchanges in which "differences (in the exchanged properties) are more formal than substantial." Respondent's contention that this statement in the Regulation establishes a general rule that "'formal' differences in exchanged properties are sufficient to cause realization" (Br. 21) is plainly incorrect. The Regulation is referring specifically to the nonrecognition provisions, not to the realization requirement, and the differences between the scope of the nonrecognition provisions and the realization requirement are readily apparent. See Gov't Cottage Br. 25-26. /8/ Notably, in contrast to respondent's repeated statement that it is "astonishing" that the realization effect of its exchange might be questioned (Br. 7, 22), the exchanges were apparently structured and initially defended as reciprocal sales in an effort to avoid the materially different inquiry for exchanges altogether. See Pet. App. 3a, 44a-47a; San Antonio Savings Ass'n v. Commissioner, 887 F.2d 577, 581 (5th Cir. 1989), petition for cert. pending, No. 89-1928. /9/ Indeed, amicus FNMA concedes that "whether the differences mattered to the parties to the transaction may be of some relevance in determining whether they matter in general." Br. 21. FNMA also advances the novel suggestion that this case be decided on the record in a different case, rather than the recod in the case before the Court. Br. 12. The facts regarding the swap transactions in this case, of course, were fully considered and addressed by the district court. The court of appeals viewed most of the facts as legally irrelevant, but that erroneous legal conclusion does not require borrowing the record and facts from a different case. We strongly disagree with FNMA's suggestion that the record in its case establishes a material difference, but those contentions can be addressed in the context of that case. Far from being representative, moreover, FNMA is unlike other financial institutions in many respects, including the fact that it was not even subject to Bank Board regulation. See Federal National Mortgage Ass'n v. Commissioner, 896 F.2d 580, 582 (D.C. Cir. 1990), petition for cert. pending, No. 89-1987. /10/ Thus, respondent is plainly wrong in asserting that it "did no more" than investors who dispose of devalued stocks and reinvest the proceeds in similar stocks of different issuers. Br. 3, 27. /11/ In its effort to minimize the significance of the Bank Board's determination, respondent seeks to recharacterize the Bank Board's analysis. According to respondent, "the purpose of Memorandum R-49's 'substantially identical' requirement" was simply "to maximize the probability that the potential for different performances would be modest." Resp. Br. 33. That is not how the Bank Board put it. According to that agency, its objective was to structure a transaction that "would * * * not change the economic position of the association after it engaged in the swap" (J.A. 58), "assur(e) that risk does not transfer" (J.A. 59), and "maintain the association's position with respect to the three types of risks in a loan portfolio" (J.A. 58). /12/ Indeed, the fact that 90% participation interests were exchanged, rather than 100% interests, actually reinforces the conclusion that there was no change in the taxpayer's economic position. The R-49 exchanges typically involved 90% interests so that the transferor would continue to service the entire loan and retain its relationship with the original borrower. Not even those incidents of mortgage ownership changed with the swap. As the district court noted, "the actual mortgages never changed hands, and borrowers were not aware that the transaction had taken place." Pet. App. 37a. Since no change of substance was contemplated by the swaps, it is not surprising that in the one case before this Court that did involve an exchange of 100% interests, the parties entered into a "Whole Loan Sale and Servicing Agreement," under which "the servicing of the loans would stay with the assignor institution." United States v. First Federal Savings & Loan Ass'n, 694 F. Supp. 230, 235 (W.D. Tex. 1988), aff'd, 887 F.2d 593 (5th Cir. 1989), petition for cert. pending, No. 89-1927. /13/ Respondent's statement that the "spread" between the debt and the payment is the rule for discharge-of-indebtedness (Br. 36-37) thus must be read in light of the method-of-payment principle, with which respondent agrees (Br. 38-40). /14/ Although failing to address the tax treatment of a cash payment of the penalty, respondent states that any discharge of indebtedness can be "recharacterized" as a two-step transaction. Br. 45. Unlike genuine income-by-reason-of-discharge-of-indebtedness transactions, however, each step of the transactions in this case has its own independent basis, purpose, and significance. The fact that the steps are related does not undermine the independent significance of each step, and the separateness of the obligations. See Gov't Br. 35 n.31. /15/ Respondent claims (Br. 45 n.35) that we construe "forgiveness" of debt to mean discharge of debt without any consideration. Once again, respondent attacks a straw man; we do not contend that forgiveness necessarily means an absence of consideration. Our point, rather, is that respondent's offset did not result from forgiveness of a debt at all; it resulted from the separate obligation of the premature withdrawal penalty and the choice of the offset as the method of paying the penalty. /16/ Respondent points out (Br. 44 & n.34) that some of its certificates provided a penalty greater than the minimum amount required by the regulations. J.A. 27-29. Other certificates provided a penalty in the amount set forth in the regulations. PX 26. That some depositors may have paid penalties to respondent in amounts greater than the required minimum amount does not mean that the penalty obligation was not imposed by the regulations. The regulations required the depositor to pay a penalty, and merely allowed the institution to increase the amount of the penalty. /17/ To cite another example, suppose federal law required payment of a $10 fee to a bank whenever a depositor withdraws funds. If respondent provided for payment of the fee by an offset against amounts withdrawn, its theory would lead to the conclusion that the fee was income "by reason of the discharge of indebtedness," even though there had been no premature withdrawal, because the income would not have arisen "but for" the withdrawal. Here the fact that the federal law obligation applies in a situation that might otherwise be characterized by negotiation between the parties leading to forgiveness of debt -- as the price of premature discharge -- should not obscure the fact that the payment arises "by reason of" a penalty imposed by federal law, and not any forgiveness or discharge. /18/ Respondent also contends that our "entire argument" rests on the fact that the penalty and method of payment were established in advance of the transactions; respondent then cites Columbia Gas System as the coup de grace knocking out this "entire argument." Resp. Br. 43-44. In fact, however, our position does not depend on the fact that the penalties were arranged in advance; rather, it rests on the fact that the penalty represents an independent obligation and the offset is a method of paying it. As our brief points out (at 35 n.31), the fact that the separate obligation was recognized by the parties from the outset serves to corroborate the conclusion that its payment did not constitute forgiveness or revision of the debt. /19/ The legislative history of the resulting congressional provision (Section 62(a)(9)) also reveals the congressional understanding that early withdrawal penalties ordinarily are paid out of previously credited interest rather than out of principal. See H.R. Conf. Rep. No. 1405, 93d Cong., 2d Sess. 5 (1974) (upon early withdrawal, depositor "is required to forfeit part of the interest previously earned"; new law permits nonitemizers "to obtain the benefit of a deduction for interest forfeited"); 120 Cong. Rec. 28,117 (1974) (Sen. Church) (effect of early withdrawal penalty is that interest is paid or credited and depositor is "required to return part of it to the financial institution as a penalty"). /20/ See also Rev. Rul. 83-60, 1983-1 C.B. 39, 41 (noting that the prior determination that a depositor is allowed a deduction under Section 165 "does not require a conclusion that a forfeiture suffered upon a premature withdrawal of a certificate may not be characterized as 'payment' of a penalty to the (savings institution)"). /21/ Respondent states (Br. 7) that the forfeitures were from principal. Although it makes no difference to the proper legal analysis, the extent to which the penalties were paid from interest or principal, or both, in this case has not been established. Cf. Rev. Rul. 83-60, 1983-1 C.B. at 39-40 (explaining that penalties may be from interest or from principal). Respondent also mischaracterizes our position as requiring a "solvency" inquiry. Resp. Br. 36 n.30. This contention is incorrect. See Gov't Br. 38 n.36. /22/ The Solicitor General is disqualified in this case.