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IRS loses another ruling on tax shelters { November 4 2004 }

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November 4, 2004
I.R.S. Loses Another Ruling on Tax Shelters

A federal judge has dealt another blow to the Internal Revenue Service in its battle against questionable tax shelters, ordering the agency to refund to a private entity controlled by General Electric more than $62 million stemming from a transaction the I.R.S. had deemed a sham.

Judge Stefan R. Underhill of the United States District Court of Connecticut said in a ruling on Monday that a G.E.-controlled entity named TIFD III-E was entitled to the refund because of its work as the main tax partner of a commercial aircraft-leasing partnership. The partnership, Castle Harbour I-Limited Liability Company, was set up in 1993 by GE Capital, a unit of General Electric.

The ruling is the third such defeat in two months for the I.R.S., which recently lost two important decisions concerning tax-related transactions that it regarded as being invalid for deductions, involving Black & Decker and Coltec Industries.

"This makes a trilogy of resounding corporate tax-shelter defeats suffered by the I.R.S. in the last couple of weeks," said Lawrence M. Hill, a tax litigation partner at Dewey Ballantine in New York. Mr. Hill was not involved in the G.E. case.

The G.E. transaction was complex. In October 1993, three subsidiaries of GE Capital formed the partnership that was ultimately known as Castle Harbour, to which they contributed aircraft, cash, debt and stock worth more than $500 million in total.

Castle Harbour's three shareholders, which included TIFD III-E, then sold stakes in the partnership to two Dutch banks, ING Bank and Rabo Merchant Bank, for a total of $117.5 million.

From October 1993 through 1998, the Dutch banks, which do not pay federal income taxes in the United States, absorbed Castle Harbour's $310 million in taxable income, while GE Capital held onto the tax benefits from the depreciation of aircraft controlled by the partnership, a form of a practice known as lease stripping. GE Capital paid $62 million in taxes on the income, but later sued for a refund.

The government had argued that the partnership's sole purpose was the avoidance of taxes - one mark of an abusive tax shelter, in the judgment of the I.R.S. The agency had also argued that the Dutch banks were lenders to, not partners of, Castle Harbour, since GE Capital had prohibited them from selling their interests.

Donald Korb, chief counsel for the I.R.S., said yesterday that the agency was disappointed by the judge's ruling. "However," he said, "the service has prevailed in the litigation of other lease-strip cases, and we remain confident of our position."

Judge Underhill did agree that "by allocating 98 percent of the taxable income from fully tax-depreciated aircraft to the Dutch banks," GE Capital had "avoided an enormous tax burden, while shifting very little book income."

But he added that because the Dutch banks had invested in Castle Harbour, "the economic reality of such a transaction is hard to dispute." The government had argued that GE Capital guaranteed the banks' investments and minimum returns, preventing the transaction from being considered a true sale.

Copyright 2004 The New York Times Company

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