If the Deal Has No Economic Substance

This is a Hewlett-Packard disaster you can’t blame on Carly Fiorina, as Lewis Platt OK’d this one (right way to spell “Lewis”, though). It’s Hewlett-Packard Company and Consolidated Subsidiaries, 2012 T.C. Mem. 135, filed 5/14/12. And Judge Goeke has to wade through 82 pages to reach a simple conclusion.

Some tax wits at AIG concocted a Netherlands Guilder-USD shellgame, using an allowance of deductible contingent interest asymmetry between the IRC and the Dutch tax code. Essentially, AIG was going to lend ABN (that’s Algemene Bank Nederland) multiple millions and ABN was going to pay nominal real interest but a ton of contingent interest (currently taxable by Dutch law but not US law), disguised as “preferred stock dividends”,  via a stooge intermediary with the obviously stooge name Foppingadreef.

All of the interest, real and contingent, would be characterized for Dutch law as preferred dividends, and would be taxed, setting up a huge foreign tax credit for HP, which had tons of foreign income but no available foreign tax credits.

ABN’s ethics committee blesses the deal, the Dutch tax authorities give the equivalent of a PLR based on Dutch law, and various high-priced law firms sign off.

AIG flogs this unexploded ordnance to HP for a mere $15 million.

Cutting through the wheeling and dealing, Judge Goeke finds that the “dividends” weren’t; they were interest on a debt from ABN, Foppy being disregarded. HP got a minority interest in Foppy, but had stranglehold rights to bail out and get paid if the tax laws changed or the majority shareholder (ABN) tried to invest in anything but ABN notes. The actual interest HP got was less than 2%, at a time when US government bonds were paying over 6%, but when the foreign tax credits were factored in, HP got better than 9%, with ABN, one of the strongest banks in the Netherlands, essentially guaranteeing the deal.

HP wanted to deduct as a capital loss the upfront $15 million they paid AIG for the deal. No, says Judge Goeke. HP didn’t pay a commission to buy preferred stock, they paid a fee to AIG to facilitate a tax shelter. And that’s a non-starter first class.

Judge Goeke doesn’t have to get to economic substance, he says, but after reading the 82 pages, I couldn’t find any economic substance.