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All Tax Shelters Are Not Illegal, Another Court Tells IRS

By Albert B. Crenshaw
Washington Post Staff Writer
Thursday, November 4, 2004; Page E02

For the third time in less than a month, the government this week lost a multimillion-dollar case in which a federal judge concluded that a deal that saved a company large sums of taxes had a legitimate business purpose and thus was not an illegal tax shelter.

In two of the cases, the judges specifically told the Internal Revenue Service that if it has a problem with the outcomes, the solution lies with Congress, not the courts.

In the most recent case, a U.S. district judge in Connecticut determined Monday that an arrangement by which General Electric Co., through subsidiaries and partnerships, shifted $310 million in income to two Dutch banks that don't pay U.S. taxes was not a sham and, as a result, GE was entitled to a $62 million tax refund.

GE, which through its GE Capital subsidiary owned a large number of commercial airplanes that it leased to airlines, contributed those planes, along with some cash, to a partnership in which the Dutch banks participated. The banks got a large share of the rental income that would have been taxable to GE, and GE, the judge noted, got to "re-depreciate" the planes for tax purposes.

However, the judge held that the arrangement was a real business deal, since it helped GE accelerate income from the leases on the planes, as well as save on taxes. "In short," wrote Judge Stefan R. Underhill, "the transaction, though it sheltered a great deal of income from taxes, was legally permissible. Under such circumstances, the IRS should address its concerns to those who write the laws."

IRS Chief Counsel Donald Korb, in a statement yesterday, said, "We are disappointed by the opinion issued in this case. However, the Service has prevailed in the litigation of other [similar] cases and we remain confident of our position" based on the so-called economic substance doctrine, the idea that a business deal must have real non-tax consequences to be legitimate.

"A loss in one particular tax shelter case in which it is asserted does not undermine our confidence to use the doctrine, when appropriate, to attack tax shelters in other cases," Korb said.

"The court agreed with GE's interpretation of the tax rules," said John Oliver, spokesman for GE Commercial Finance.

The case comes on the heels of an $82 million defeat for the IRS in the U.S. Court of Federal Claims here last Friday.

In that case, Judge Susan G. Braden ruled valid an arrangement under which a company called Coltec Industries Inc. transferred contingent liabilities associated with asbestos claims against a subsidiary to an entity it created and then sold at a loss.

"The court has determined that where a taxpayer has satisfied all the statutory requirements established by Congress, as Coltec did in this case, the use of the 'economic substance' doctrine to trump 'mere compliance with the code' would violate the separation of powers," Braden wrote.

Two weeks ago, U.S. District Judge William D. Quarles Jr. in Maryland awarded Black & Decker Corp. a $57 million refund in a case in which the IRS accused the company of a sham transaction involving transfer of its employee health insurance claims to a new entity.

The IRS can appeal any and all of these cases, and while it has not said it will do so, Korb also said the agency "stands by its position on the contingent liability shelter."

"The challenge to this shelter will play out in a number of forums -- the United States Tax Court, district courts and the appellate courts," Korb said.

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