A federal appeals court revived a lawsuit yesterday pitting the Internal Revenue Service against Black & Decker Corp. over what the government has long claimed was an illegal tax shelter.
The ruling by the 4th U.S. Circuit Court of Appeals in Richmond, Va., is the latest volley between the Towson toolmaker and the IRS, which claimed the company set up an improper scheme to offset $303 million in capital gains it incurred from the sale of three companies in 1998.
Black & Decker claimed it was owed a $57 million refund and sued the IRS when the agency refused to pay. The IRS counter-sued the company for tax, interest and penalties totaling $215 million, court documents show. The company said in 2004 that a win for the IRS could cost it $140 million.
The U.S. District Court in Baltimore had ruled for Black & Decker without a trial. The appeals court, however, sent the case back to the local court, saying there were key questions that had to be decided at trial.
"We conclude that neither the IRS nor the taxpayer [Black & Decker] is entitled to summary judgment under the controlling tax statutes," Judge M. Blane Michael wrote for the three-judge panel. "Under the sham transaction doctrine, however, the validity of the claimed loss turns on unresolved issues of material fact."
The dispute provides a window into a form of complex corporate tax shelter that regulators have attempted to clamp down on in recent years. Congress passed a law in 2000 making it harder for companies to set up such shelters, but that law wasn't in effect at the time of the Black & Decker transaction.
In November 1998, the company transferred about $562 million to a new subsidiary called Black & Decker Health Care Management Inc., which was set up to assume the company's expected liability for worker health care benefits and claims. The company and its Canadian subsidiary owned all of the new subsidiary's shares, which they later sold for $1 million to Raymond DeVita, a retired Black & Decker executive. In turn, the subsidiary lent Black & Decker $564 million, which was to be repaid by the company to the newly created health management subsidiary in monthly installments.
The company then recorded a $560 million capital loss on its federal tax return, resulting in the claim for a $57 million refund for 1995 to 2000.
The IRS refused to pay, saying the transaction was nothing more than a tax-avoidance scheme with no legitimate business purpose. The company should have valued the assets it sold at $1 million, rather than $560 million, government lawyers said.
The company counters that the transaction did have a legitimate business purpose. In theory, Black & Decker Health Management stood to profit if actual worker health claims fell short of the $564 million in loan payments Black & Decker was required to pay in the deal. In practice, however, Black & Decker expected the health expenses to consistently exceed the interest income the subsidiary received from the loan, court documents said.
Yesterday's decision gave Black & Decker a partial victory by rejecting the IRS claim that the transaction is clearly banned by federal statutes. But the company will have to prove at trial that the deal did have economic substance, or "bona fide purpose."
"The court considered three issues," said Barbara Lucas, a Black & Decker spokeswoman. "It held for Black & Decker in two and remanded a third to District Court for consideration."
The Justice Department said the decision will "help to maintain the integrity of our federal tax system."
"In remanding the case for trial, the decision gives the government the opportunity to prove that the transaction was a sham, devoid of any economic substance apart from the tax consequences," said Assistant Attorney General Eileen J. O'Connor in a statement.
Black & Decker shares closed down 38 cents to $85.38 per share in trading yesterday.