Court Sides with Coltec in Tax-Shelter Lawsuit

For the second time in two weeks, a federal court has handed the Internal Revenue Service a major setback in its fight against abusive tax shelters.

Coltec Industries Inc., which makes aircraft-landing systems, used a strategy that involved transferring a $375 million promissory note to a subsidiary that was set up to take on liabilities associated with asbestos litigation. Coltec sold stock in the subsidiary to banks and law firms handling the litigation, producing a huge loss.

The U.S. Court of Federal Claims in Washington ruled that Coltec deserved an $82.8 million refund, the Wall Street Journal reported. The decision by Judge Susan Braden said that the actions did not represent sham transactions, as the IRS had claimed. The IRS said that they lacked economic substance even though they technically followed the tax code.

Braden wrote that "where a taxpayer has satisfied all statutory requirements established by Congress, as Coltec did in this case, the use of the 'economic substance' doctrine to trump 'mere compliance with the code' would violate the separation of powers" clause of the U.S. Constitution.

If Braden's ruling stands, the “contingent liability” transactions that the IRS listed as abusive tax shelters may be negated.

The Justice Department hasn't decided whether to appeal. The ruling was similar to one involving Black & Decker, which will receive a $57 million refund after another federal judge ruled against the IRS.

Black & Decker used an accelerated contingent liability strategy, which allowed the company to immediately deduct costs in one year rather than over several years.

Coltec's tax strategy was devised by Arthur Andersen.

"This case emasculates the judicial economic substance doctrine and explicitly invites Congress to codify the doctrine," said Lawrence Hill, a partner at the New York law firm Dewey Ballantine LLP, which had represented Andersen.

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