Appeals court rejects internal revenue servcies request for new hearing in its fight to get United Parcel Service to pay back taxes and penalties related to UPS' operation of offshore captive reinsurance program

ORIGINAL TITLE: Appeals Court Rebuffs IRS Again Over UPS Captive.

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By: David Pilla

ATLANTA (BestWire) – The Internal Revenue Service lost another round in its fight to get United Parcel Service (NYSE:UPS) to pay back taxes and penalties related to the delivery firm’s operation of an offshore captive reinsurance program.

The U.S. 11th Circuit Court of Appeals in Atlanta rejected an IRS request for a new hearing on a judicial panel’s June decision that UPS’ former operation of Overseas Partners Ltd. was a legitimate business operation.

In June, a three-judge panel for the appeals court reversed an August 1999 ruling by the U.S. Tax Court that UPS had violated the U.S. Tax Code by funneling $100 million to Bermuda-based Overseas Partners in 1984. UPS set up the captive to cover damage claims from its customers.

Now that the full Court of Appeals has ruled that it will not allow a full hearing on the IRS’ case, the IRS will have to go back to the U.S. Tax Court for a hearing or appeal to the U.S. Supreme Court.

Norman Black, a spokesman for UPS, said he could not comment on the details of the decision. “All I can say is that it’s not over yet, but we welcome the decision of the appeals court,” he said.

Efforts to reach someone at the IRS for comment were unsuccessful.

In the June ruling, the three-member appeals court panel vacated a 1999 Tax Court finding siding with IRS claims that the captive insurer was a sham operation (BestWire, June 22, 2001). “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 panel’s ruling said. “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.”

Before forming its offshore captive in Bermuda in 1984, UPS charged an extra fee when handling packages worth more than $100 and promised to reimburse the client if the package was lost or damaged. The money was collected as income, and the company paid taxes on it. UPS formed Overseas Partners Ltd. to reinsure the insurance business that it passed through American International Group Inc.’s National Union Fire Insurance Company of Pittsburgh, the primary insurer.

As a captive domiciled in Bermuda, Overseas Partners didn’t have to pay taxes on the premium it received from National Union Fire. While National Union Fire wrote the primary business, it passed all of the risk back to Overseas Partners.

UPS said in a statement that it had placed $1.8 billion in an escrow account to cover damages should the courts rule against it. The company said the money would remain in that account “pending further proceedings on remand.”

The financial strength of Overseas Partners Ltd. is rated A (Excellent) by A.M. Best Co.

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