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Heinz Tax Claim Fails Economic Substance Test

by Mike Godfrey,, Washington

05 June 2007

US-based food company H J Heinz lost its bid for a $42.6 million tax refund after the Federal judge presiding over the case branded the transaction used by the company to generate a tax loss as an illegal tax shelter.

Judge Francis M. Allegra of the United States Court of Federal Claims wrote in his opinion that the company's claim for a tax refund could not be permitted because the underlying transaction was designed purely to generate an artificial loss and avoid taxation, and therefore lacked any economic substance.

“This court will not don blinders to the realities of the transaction before it,” Judge Allegra wrote.

At issue was whether H.J. Heinz Credit Company (HCC), a subsidiary of the H.J. Heinz Company (Heinz), could deduct a capital loss of $124.1 million on a sale of shares of Heinz stock in May 1995. In 1994, HCC purchased 3.5 million shares of Heinz stock, 3.325 million of which were transferred to Heinz in January of 1995 in exchange for a convertible note issued by Heinz.

In 1995, Heinz sold the stock and in the process realised a loss which the company asserted should have been carried back to reduce their taxes in their 1994, 1993 and 1992 taxable years.

However, according to judge Allegra: “Stripped of its veneer, the acquisition by HCC of the Heinz stock had one purpose, and one purpose alone — producing capital losses that could be carried back to wipe out prior capital gains. There was no other genuine business purpose. As such, under the prevailing standard, the transaction in question must be viewed as a sham — a transaction imbued with no significant tax-independent considerations, but rather characterized, at least in terms of HCC’s participation, solely by tax-avoidance features.”

The decision was welcomed by the US government which congratulated judge Allegra for aiding its campaign against aggressive corporate tax sheltering.

“Yesterday’s decision in H. J. Heinz Company vs. United States is another in a series that have concluded that regardless what labels are used, or how complicated are the transactions, courts will look at what really happened when deciding if a taxpayer has actually incurred the losses claimed on a tax return," said Assistance Attorney General Eileen J. O'Connor.

"United States Court of Federal Claims Judge Allegra rejected the company’s attempt to claim losses of $124 million on transactions that actually produced more than $6 million in profit. The Tax Division will continue its vigorous efforts to defend the integrity of our nation’s tax laws. The people and businesses who pay the tax the law requires deserve no less," she added.

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