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Corporate Taxpayer (AIG) “Settles” Tax Shelter Litigation Admitting Tax Shelters Were Shams (10/24/20)

The SDNY U.S. Attorney (Acting) issued this stunning press release yesterday:  Acting Manhattan U.S. Attorney Announces Settlement Of Tax Shelter Lawsuit Against AIG For Entering Into Sham Transactions Designed To Generate Bogus Foreign Tax Credits (USAO 10/23/20), here.   Key excerpts for this blog entry (most of the release) are:

Audrey Strauss, the Acting United States Attorney for the Southern District of New York, announced today the settlement of a tax refund lawsuit brought by insurance and financial services company AMERICAN INTERNATIONAL GROUP, INC. (“AIG”) involving seven cross-border financial transactions that the United States asserted were abusive tax shelters designed to generate bogus foreign tax credits that AIG improperly attempted to use to reduce its tax liabilities in the United States.  AIG filed this tax refund lawsuit in 2009, seeking to recover disallowed foreign tax credits and other taxes related to the 1997 tax year.  The United States obtained overwhelming evidence that these transactions lacked any meaningful economic substance, were devoid of any legitimate business purpose, and instead were designed solely to manufacture hundreds of millions of dollars in tax benefits to which AIG was not entitled.  According to the terms of the settlement, approved yesterday by United States District Judge Louis L. Stanton, AIG agreed that all foreign tax credits that AIG claimed for the 1997 tax year and all later tax years for these same transactions, totaling more than $400 million, would be disallowed in their entirety.  AIG further agreed to pay a 10% tax penalty.

Acting U.S. Attorney Audrey Strauss said:  “AIG created an elaborate series of sham transactions that were designed to do nothing – and in fact did nothing – other than generate hundreds of millions of dollars in ill-gotten tax benefits for AIG.  Our system of taxation is built upon the premise that all citizens and corporations must pay the taxes they owe, no more and no less.  People and companies who game that system to avoid paying their fair share of taxes undermine public trust in our tax laws.  We will continue to be vigilant in holding accountable those who use economically empty transactions to avoid paying their taxes.”

As alleged in filings in Manhattan federal court:

During the mid-1990s, AIG Financial Products Corp. (“AIG-FP”), a wholly-owned subsidiary of AIG, designed, marketed, and entered into seven cross-border structured finance transactions with various foreign banks.  These complicated transactions, involving hundreds of agreements, numerous shell companies, and intricate cash flows, had no economic substance but rather exploited differences in U.S. and foreign tax laws to create profits from U.S. tax benefits.  In particular, the transactions generated more than $400 million in foreign tax credits that AIG used to reduce its U.S. tax liabilities.  The U.S. has a worldwide tax system that taxes companies on income earned abroad, but also grants credits for foreign taxes paid.  AIG, was able to turn a profit by obtaining credits from the U.S. Treasury for foreign taxes it did not actually pay in full.  AIG obtained more than $61 million in foreign tax credits during the 1997 tax year alone, the tax year resolved by the settlement. 

In 2008, the Internal Revenue Service (“IRS”) issued a Notice of Deficiency to AIG that, among other things, disallowed the foreign tax credits AIG had claimed in connection with the seven transactions and asserted a 20% tax penalty.  In 2009, after paying the deficiency, AIG filed a lawsuit against the United States in Manhattan federal court challenging the IRS’s determination and demanding a refund.  In response, the United States asserted that the IRS had correctly disallowed the tax benefits because the transactions had no economic substance, a basic requirement for seeking tax benefits. 

According to the terms of the Settlement, AIG agreed that all foreign tax credits that AIG claimed in connection with the seven cross-border transactions that were the subject of the litigation would be disallowed in full for the 1997 tax year and all subsequent tax years during which the transactions were operating, totaling more than $400 million.  AIG further agreed to pay a 10% penalty.  The settlement allows AIG to retain certain income expense deductions relating to six of the transactions that were structured as borrowings, as well as remove certain amounts related to the transactions from its taxable income.  In addition, the settlement resolves certain of AIG’s tax refund claims unrelated to the cross-border transactions stemming from AIG‘s restatement of its publicly filed financials.

One nuance not in the press release is that the press release suggests that the penalty is 10%.  The IRS originally proposed a substantial understatement penalty and a negligence penalty.  Both of those penalties are 20% but only one can apply, so that the taxpayer’s maximum exposure before the settlement was 20%.  Under the settlement, the taxpayer concedes the substantial understatement or negligence penalties for the bullshit transaction.  (See paragraph 7 of the Stipulation and Order of Settlement.)  That might suggest that the settlement could be read to imply some level of merit in the taxpayer’s position, although I suspect that, from the Government’s perspective, it was viewed that as simply a nuisance cost to the Government to resolve this bullshit litigation without expenditure of resources required to litigate the matter.

Of course, large corporations who should know better making sham (aka bullshit) tax shelter claims are not particularly unusual as I have noted on this blog.  But this litigation has one nuance that jumped out that I had not really focused on before – that is, the role of counsel bringing suits to sustain tax shelters that are shams.  I guess that problem lurked in all of the other civil litigation involving bullshit tax shelters.  But it just hit me here.  (I never personally had to face that issue because over my career of practice, I declined to represent taxpayers or promoters in civil tax cases involving bullshit tax shelters; although I do have an anecdote about that which I recount at the end of the blog.  See JAT Comments par. 2)

The question I ask is how exactly does an attorney sign the initial pleading and otherwise participate in a suit, either in the Tax Court or in one of the refund forums (district court or Court of Federal Claims), alleging that a sham tax shelter is entitled to the claimed tax benefits?  OK, I know, the argument is that sham is in the eye of the beholder so long as the technical tax traps appear to be checked off (even when sometimes they are not)?  The question I ask and cannot answer here is what is the role of the lawyers making such claims in litigation?  But, just think about how much energy (creative and  otherwise), time and resources were spent unnecessarily in creating the sham tax shelter to start with and then marshaling it through the administrative audit process (audit and appeals) and litigation before the taxpayer admitted the whole deal was a sham.  Isn’t there some better way to deploy our resources?

Oh well.  Can’t answer that here.

The following paragraph of the Stipulation and Order of Settlement (here) also caught my attention (emphasis supplied by JAT):

13. Notwithstanding the release given in Paragraph 12 above, or any other term of this Stipulation, the following claims of the United States are specifically reserved and are not released by this Stipulation:
  a. any criminal liability;
  b. except as explicitly stated in this Stipulation, any administrative liability;
  c. any liability to the United States (or its agencies) other than AIG’s 1997 Tax Liability;
  d. any liability based upon obligations created by this Stipulation; and
  e. any liability of individuals.

Not sure what is behind that reservation. 

JAT Comments:

1. I noticed in the listing of attorneys on CourtListener, here (click on Parties and Attorneys, updated from time to time from Pacer) that there seemed to be quite a roster of some of the best attorneys in the litigation and tax litigation universe, with numerous attorneys from (i) Sutherland Asbill & Brennan LLP (now named Eversheds Sutherland (US) LLP), (ii) Boies, Schiller & Flexner LLP, and (iii) Skadden, Arps, Slate, Meagher & Flom.  (It appears from the docket entries that Bois Schiller withdrew in April 2020 and Kevin R. Stults from Skadden Arps entered an appearance in April 2020, with Stults signing the Stipulation and Order of Settlement, here, as the top signature for the taxpayer.  I suppose there is a story there.

2. As I said above, I refused to represent promoters and taxpayers in sham / bullshit tax shelters.  I routinely referred that type of litigation to another Houston law firm that I formerly was associated with.  However, in around the 1981 to 1983 time frame, late one evening when I was in my office (then in the Houstonian complex) I saw an accountant who I knew from that other law firm who was waiting in the next door office.  I went up to him and shook his hand, saying that I was glad to see him.  I asked what he was doing there.  He said he was waiting to meet with some of the people he had “promoted” into a tax shelter that was conceived and implemented by that firm.  I told him that I was familiar with that tax shelter and that it was a loser, no possibility of that tax shelter prevailing on the merits in litigation.  He said that, based on what the law firm was saying, he thought they might have a chance and the investors may litigate it.  Then, I said totally tongue in cheek (this is probably not an exact quote but it is very close), “Well, if you must litigate, provided I could satisfy myself on Rule 11 (which I explained), I will forego my normal practice not to handle doggy (bullshit had not entered my lexicon in this context) tax shelters and will handle that one, with a guarantee that I will get at least as good a result as the other firm (a certain loss) and charge 1/3 or less the fees (being familiar with the other firm’s billing and litigation staffing practices and then being in the DOJ Tax trial practice mode I learned there of one lawyer per litigation and knowing that litigation did not require more than one lawyer).”  He and I both laughed which was the whole point.  Gotta see some humor in this stuff.

This blog post is cross-posted on my Federal Tax Procedure Blog, here.

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