Justice Department Prevails for a Second Time in Long-running Tax Shelter Case

A federal court of appeals has, for the second time, rejected an alleged abusive tax shelter engineered by a subsidiary of General Electric Capital Corporation, the Justice Department announced today. The U.S. Court of Appeals for the Second Circuit, based in New York City, also unanimously held that the Internal Revenue Service properly imposed a monetary penalty against the General Electric subsidiary for substantially understating its income taxes for 1997 and 1998.

Judge Pierre N. Leval wrote the court’s opinion in this case, which involves a 1993 transaction in which two Dutch banks purported to form a partnership with the General Electric subsidiary. The alleged partnership was named Castle Harbour LLC, and it held a fleet of leased commercial aircraft. The court found that, under the complex provisions of the partnership agreement, the General Electric subsidiary received most of the actual leasing income but, for tax purposes only, 98 percent of the taxable income was allocated to the banks, which were not subject to U.S. income taxes. The government alleged that the General Electric subsidiary attempted to shelter over $300 million of its income from taxes in 1993 through 1998. The government claimed that the company actually owed over $62 million more in taxes because the banks were not true partners in Castle Harbour and therefore could not be allocated any of its taxable income.

In 2004, Judge Stefan R. Underhill of the U.S. District Court for the District of Connecticut found that the banks were valid partners, but the court of appeals reversed that decision in 2006 and sent the case back for further consideration. In 2009, the district court relied on a specific provision of the Internal Revenue Code to conclude again that the banks were real partners for tax purposes. The district court also ruled that the IRS could not impose a penalty on the General Electric subsidiary, equal to 20 percent of its alleged tax understatement for 1997 and 1998, because the subsidiary’s treatment of the deal for tax purposes was supported by “substantial authority.”

In reversing the district court once again, the Second Circuit held that the Dutch banks were not valid partners in Castle Harbour under the tax code and that the IRS may impose penalties against the General Electric subsidiary.

“This decision shows that our courts will not allow large corporations to use complex disguises to get improper tax breaks,” said John A. DiCicco, Principal Deputy Assistant Attorney General of the Justice Department’s Tax Division. “In fact, companies that avoid paying their fair share of the tax burden by engaging in these types of games are setting themselves up for substantial penalties in addition to the taxes they should have paid in the first place.”

More information about the Tax Division’s enforcement efforts can be found on the Division’s website .

Opinion (PDF)