(Updates with Department of Justice official’s statement in the 10th paragraph.)
Jan. 24 (Bloomberg) -- General Electric Co. lost a U.S. challenge of its 2009 victory in a battle with the U.S. Internal Revenue Service over tax benefits from a partnership structure with Dutch banks.
The U.S. Court of Appeals in New York today reversed an October 2009 ruling by a federal judge in Connecticut that concluded GE’s arrangement with a group of Dutch banks in the 1990s was legitimate. In its ruling today, the court said that the IRS properly imposed a monetary penalty against a General Electric subsidiary for substantially understating its income taxes for 1997 and 1998.
GE, the world’s largest lessor of aircraft, set up the Castle Harbour partnership in 1993 with Dutch banks including ING Bank NV and Rabo Merchant Bank NV. Under the terms of the transaction, the GE subsidiary received most of the actual leasing income. For tax purposes, 98 percent of the taxable income was allocated to the banks and was not subject to U.S. income taxes.
“The Court of Appeals holds that the evidence compels the conclusion that the banks do not qualify,” the three-judge appeals panel said in today’s ruling. “The government is entitled to impose a penalty on the taxpayer for substantial understatement of income.”
The arrangement shifted about $310 million in income from leases on old airplanes to the banks and saved GE about $62 million over a five-year period.
The IRS subsequently determined that the arrangement was a “sham,” and Fairfield, Connecticut-based GE paid the government the $62 million, according to the ruling. The partnership then sued to challenge the IRS claim that the partnership structure had no business purpose other than reducing tax expenses.
The federal appeals court has twice rejected the lower court’s view of the case. In 2006, the panel reversed U.S. District Judge Stefan R. Underhill’s 2004 ruling that concluded the banks were valid partners and sent the case back to him for reconsideration.
Underhill also found in favor of GE in 2009, ruling that the IRS couldn’t impose a penalty upon the subsidiary. The IRS appealed.
In today’s ruling, the federal appeals court panel said the Dutch banks were not valid partners in Castle Harbour under the tax code. The federal appeals court also said the IRS could impose penalties against the GE subsidiary, known as TIFD III-E.
“This decision shows that our courts will not allow large corporations to use complex disguises to get improper tax breaks,” John DiCicco, acting assistant attorney general for the Justice Department’s Tax Division, said in a statement. “In fact, companies that avoid paying their fair share of the tax burden by engaging in these types of games are setting themselves up for substantial penalties in addition to the taxes they should have paid in the first place.”
“We are disappointed that the Court of Appeals overturned the trial court’s most recent favorable decision,” GE said in an e-mailed statement. “This new ruling has no impact on GE’s current operations, nor will it have any adverse financial impact. We continue to analyze the court’s opinion and our options.”
The case is TIFD II-D Inc. v. United States of America, 10- 70, U.S. Court of Appeals for the Second Circuit (New York).
--With assistance from Jesse Drucker in New York. Editors: Charles Carter, Glenn Holdcraft
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