GE wins round in IRS court fight over leasing deal

General Electric Co. won a round in a long-running battle with the Internal Revenue Service over tax benefits from a partnership structure similar to one used by Merck & Co., which paid billions to settle tax disputes including the arrangement.

A federal court judge in Connecticut ruled on Oct. 7 that GE’s arrangement with a group of Dutch banks in the 1990s was legitimate. U.S. District Judge Stefan R. Underhill had been ordered by an appeals court that struck down his 2004 decision supporting the GE entity known as Castle Harbour LLC to consider an alternate argument from the company.

GE’s victory is a notable development in a case that has been closely watched by tax lawyers monitoring the IRS’ efforts in the last decade to launch a broad crackdown on tax shelters, said Lee Sheppard, a contributing editor at Tax Notes, a weekly industry journal published by Falls Church, Va.-based Tax Analysts.

The ruling lets a certain amount of partnership structures with tax benefits “have another argument to justify themselves,” Sheppard said.

GE, the world’s largest lessor of aircraft, set up the Castle Harbour partnership in 1993 with Dutch banks including ING Bank NV and Rabo Merchant Bank NV, according to the ruling.

The arrangement shifted about $310 million in income from leases on old airplanes to the banks and saved GE about $62 million over a five-year period. The partnership’s structure allowed GE to “re-depreciate” a fleet of airplanes that had already been fully depreciated for tax purposes, according to the ruling.

The IRS subsequently determined that the arrangement was a “sham,” and Fairfield, Conn.-based GE paid the government the $62 million, according to the ruling. The partnership then filed suit to challenge the IRS claim that the partnership structure had no business purpose other than reducing tax expenses.

“We are pleased that the court found in our favor,” GE spokesman Russell Wilkerson said last week. He declined to comment on the specifics of the case because litigation is ongoing. IRS spokesman Dean Patterson said the agency is reviewing the decision.

Underhill’s 2004 ruling that the partnership was legitimate was overturned two years later by the 2nd U.S. Circuit Court of Appeals in New York, which sent the case back to the district judge. The higher court found that Underhill placed too much emphasis on concluding that the tax shelter had a business purpose other than avoiding taxes and that he did not determine whether the banks were equity partners or lenders.

Underhill wrote in this month’s ruling that the Dutch banks were partners in Castle Harbour rather than lenders, as the IRS had claimed, making the transaction legitimate for tax purposes.

“Their interests in Castle Harbour should be treated as partnership interests for tax purposes,” Underhill concluded. “Castle Harbour properly allocated income among its partners, and the final partnership administrative adjustments issued by the IRS were in error.”

By Jesse Drucker and Ryan J. Donmoyer