IRS losing its battle against corporate tax shelters

  • Thursday, January 3, 2002 9:00pm
  • Business

Associated Press

WASHINGTON — The Internal Revenue Service suffered a string of setbacks recently in federal appeals courts on its aggressive campaign to crack down on corporate tax shelters.

The 5th U.S. Circuit Court of Appeals in New Orleans last week became the latest to reverse a lower court decision when it sided with Compaq Computer Corp. against the IRS. Earlier last year, appeals courts in St. Louis and Atlanta issued similar reversals, the latter in a big case involving United Parcel Service.

Although the facts differ, each case ultimately turned on whether the companies set up transactions solely to avoid taxes or for a legitimate business reason. The lower courts agreed with the IRS position that these were sham deals made for tax advantages.

"The government, feeling they have a legitimate concern about deals that have gone too far, may have overplayed its hand a little bit," said Timothy McCormally, executive director of the Tax Executives Institute, which represents corporate tax officers. "These decisions will restore a better sense of balance."

The IRS has been attempting in recent years to curb corporate tax shelters, citing billions of dollars in annual tax losses. In December, the agency said investors and corporations could avoid stiff penalties over a four-month period if they disclose their deals to the government.

IRS officials said Thursday the reversals will not slow down the agency’s efforts. They noted that the same Atlanta appeals court that ruled against the agency in the UPS decision upheld the IRS, on the same day, in a case involving the Winn-Dixie grocery chain.

"We really don’t bring litigation unless we believe we are correct," said David Harris, manager of the IRS tax shelter office. "This does send a message that courts are going to look at these transactions on an individual basis, based on the facts and circumstances."

In the Compaq case, the company in 1992 made a rapid series of moves involving Royal Dutch Petroleum Co. securities, buying them for $887 million and immediately reselling them for $868 million — still qualifying for a net dividend of $19.2 million after the Netherlands tax was paid.

The deal generated a $3.4 million U.S. foreign tax credit and $20.7 million in capital losses, which were used to offset capital gains Compaq realized in other deals, thus lowering its tax bill.

The IRS called this a blatant attempt to avoid taxation, and the U.S. Tax Court agreed, saying Compaq’s moves had no economic substance and no nontax purpose.

But the appeals court disagreed, pointing out that Compaq made a profit on the deal and that it took place in the very public New York Stock Exchange, where prices are often volatile.

The transaction, according to the court’s opinion, "had both a reasonable possibility of profit attended by a real risk of loss … the transaction was not a mere formality or artifice but occurred in a real market subject to real risks."

Ben Wells, vice president and corporate treasurer at Houston-based Compaq, said Thursday the Tax Court ruling considered the company’s rapid-fire purchases and sales of Royal Dutch securities innately suspicious — but disregarded many other aspects of the deal.

"We were not doing this for the sake of tax savings," Wells said. "We were hoping to make a reasonable return, just as we would with any investment."

Copyright ©2002 Associated Press. All rights reserved. This material may not be published, broadcast, rewritten, or redistributed.

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