The 11th U.S. Circuit Court of Appeals has overturned a 1999 decision that ruled United Parcel Service had improperly tried to avoid federal income taxes when it restructured its program for providing extra package insurance to its customers.
The appeals court found that the Internal Revenue Service and U.S. Tax Court had been wrong when they said UPS had attempted a “sham transaction” to avoid its tax obligations.
After reversing the 1999 decision, the appellate court then sent the case back to the Tax Court, saying any claims by the IRS should be analyzed under provisions of the tax code cited by UPS.
“The sophistication [of the insurance revisions] does not change the fact that there was a real business that served the genuine need for customers to enjoy loss coverage and for UPS to lower its liability exposure,” the court majority wrote in a 16-page opinion June 21. “We therefore conclude that UPS' restructuring of its excess-value business had both real economic effects and a business purpose, and it therefore under our precedent had sufficient economic substance to merit respect in taxation.”
Based on the original Aug. 9, 1999 Tax Court decision, which applied to the 1984 tax year, UPS estimated its potential liability at $1.8 billion for all subsequent years if the ruling were allowed to stand. The company then recorded a special tax assessment on its books of $1.786 billion, reducing its income for the second quarter of 1999 by a net $1.442 billion.
Without conceding liability, UPS then paid $1.8 billion into a special account with the IRS, pending a decision by the 11th Circuit Court of Appeals. The balance will remain in place pending further proceedings.
“This case was much more to us than a dispute over tax regulations and tax code interpretations, because we hold nothing more sacred than our reputation,” UPS chairman/CEO Jim Kelly said. “So we are extremely pleased the original opinion has been reversed.”
The case, known as UPS vs. Commissioner of Internal Revenue, was argued before the appeals court on March 7. The case focused on the manner in which UPS decided to exit the excess value coverage business in 1984, creating an independent company known as Overseas Partners Ltd. OPL subsequently based itself in Bermuda and grew into one of the largest re-insurance companies in the world.
Prior to 1984, UPS provided excess value coverage itself. After creating and spinning off OPL, UPS engaged another U.S. company, National Union Fire Insurance Co., to provide the insurance bought by UPS shippers.
The IRS argued in 1997 that UPS had created OPL solely to avoid federal taxes and that UPS must pay federal taxes on OPL's income. UPS disputed the IRS' position, saying it had followed all applicable laws and tax regulations in establishing OPL. In its ruling last week, the appeals court ruled “that OPL is an independently taxable entity that is not under UPS' control.”
