In a bare-bones 12 page filing in the U.S. District Court for Connecticut, GE is vague about the IRS’ reasons for disallowing the loss, except to describe them as “erroneous.” But the dispute apparently centers on an internal restructuring of GE’s insurance business in December 2002 that manufactured $1.8 billion of the claimed $2.2 billion loss. If past cases are any guide, the IRS likely disallowed the loss on both technical grounds and on the basis that the restructuring itself was a tax motivated ploy lacking sufficient business purpose or economic substance. In its suit, GE insists the restructuring was done in response “to financial and regulatory issues confronting this business.” (Yep, if you’ve got a real business purpose, you can sometimes claim the benefit of an unreal tax loss.)
Determining exactly why GE did the 2002 restructuring and what the proper tax consequences of it are, could keep a squad of tax lawyers gainfully employed for years. But the Cliff Notes version goes something like this: As part of the restructuring of its insurance operations, ERC Life (which wasn’t a member of the GE Consolidated Group for tax purposes) sold its European based property and casualty reinsurance business for $1.8 billion cash to another GE affiliate, which was treated (for tax purposes) as a part of GE Investments Inc. (part of the GE Consolidated Group). ERC Life than distributed the $1.8 billion to its parent, ERC---a transaction which GE says didn’t, under the Tax Code, reduce ERC’s basis in ERC Life’s stock. When ERC Life was sold to Scottish Re the next year, it fetched just $151 million ---remember, it didn’t have either the property and casualty units or the $1.8 billion in cash anymore. But that $1.8 billion still counted (according to GE) as part of ERC’s $2.34 billion tax basis in ERC Life---thus producing (after selling expenses of $4.2 million) a $2.2 billion loss. In 2004, GE carried back the 2003 loss, using it to offset capital gains it had originally reported for 2000 and to get a refund.
GE had previously indicated in SEC filings that the IRS had disallowed an unspecified loss related to the ERC Life sale and that it planned to contest the matter in court. Even when companies plan to fight an IRS audit assessment, however, they typically pay the money to stop interest from accruing and so they can sue in federal district courts, which are considered friendlier to taxpayers than the U.S. Tax Court, where taxpayers who haven’t paid an IRS assessment are stuck.
In an e-mailed statement today, GE spokesman Seth Martin described the case as "a good-faith difference of opinion over the tax consequences of a restructuring done more than a decade ago." He added: "While we have paid the taxes in question, we believe it is in all parties’ interests to resolve this through a court decision.”
Exactly how much in U.S. corporate income taxes GE pays is unknown, but it is widely considered among the most aggressive and successful of U.S. multinationals when it comes to sheltering income and shifting it offshore. In an earnings call with investors last month, GE reported its overall effective tax rate in 2013 (excluding GE Capital) was 19%, while GE Capital’s rate was a negative 14%. But corporations report their tax liability differently to public shareholders than to the IRS and corporate tax returns are secret.
GE has shown itself willing to defend its techniques in court. It took more than a decade of litigation before, in January 2012, the 2nd Circuit Court of Appeals struck down (for a second and final time) GE Capital Corp.’s use of a purported 1993 partnership with Dutch banks to save $62 million in tax on profits from its airplane leasing business. (The case is known in tax circles as Castle Harbour—the name of GE’s partnership with the banks.) While GE kept most of the leasing income, the Castle Harbour partnership agreement assigned 98% of the taxable income to the foreign banks, thus putting it out of the IRS’ reach. The IRS said the banks were lenders and not real partners and the arrangement was a sham. But GE twice prevailed in the Connecticut federal district court before being shot down by the appeals court, which also found GE’s ploy questionable enough to warrant accuracy related penalties.
Castle Harbour is considered one of the government’s most important wins in its campaign against corporate tax shelters, particularly those that use partnerships. Last year, a federal district judge in Louisiana cited the Castle Harbour decision in disallowing a similar partnership (named Chemtech) that
