IRS Wins Key Court Battle In Tax Shelter War

by Leroy Baker, Tax-News.com, New York

14 July 2006

The Internal Revenue Service has won a key victory in its war against abusive tax shelters, after a US appeals court overturned a previous ruling in favor of Coltec Industries Inc, a former subsidiary of Goodrich, a major manufacturer of aircraft landing systems.

In a ruling issued on Wednesday, the three judges on the US Court of Appeals for the Federal Circuit panel agreed with the IRS that Coltec had used a transaction known as a contingent liability deal to artificially generate capital losses which the firm then used to offset capital gains from the sale of a business unit in 1996.

Applying the much-debated 'economic substance' test, the judges wrote that the law as it stands "does not permit the taxpayer to reap tax benefits from a transaction that lacks economic reality”. The judges went on to write that a lack of economic substance "is sufficient to disqualify the transaction without proof that the taxpayer’s sole motive is tax avoidance”.

Their decision overturns a judgment by Judge Susan Branden in the US Court of Federal Claims in 2004, which rejected the IRS’s argument that the transactions had no economic purpose. Branden stated that, in her opinion, Coltec had complied with all the statutory requirements laid down by Congress and awarded the company an $82.8 million refund.

The latest ruling was welcomed by Assistant Attorney General Eileen J. O'Connor as a major boost for the government in its ongoing fight against abusive tax avoidance.

“Today’s decision...confirms that illusionary losses purportedly created by the so-called ‘contingent liability’ tax shelter are not deductible against actual taxable income," she stated.

"The Court’s decision is the second from a United States Court of Appeals to address this tax shelter scheme, and represents a significant advance in the Justice Department’s ongoing effort to combat abusive tax shelters and restore integrity to the tax laws," she added.

Goodrich revealed in a statement that the DoJ is studying the decision and will determine whether to seek further review. The company has 45 days to request further review by the US Court of Appeals and 90 days to request that the US Supreme Court review the decision.

In the event that the government ultimately prevails in the case, Goodrich may be required to make cash tax payments, including interest (net of federal benefit), of approximately $50 million, based on accrued interest through June 30, 2006.

Recommended