Followers of the “GE Pays no Taxes” meme were handed a victory by the Second Circuit this week when the panel rejected an alleged abusive tax shelter in which a GE subsidiary purported to form a partnership with two Dutch banks.
The panel rules that the partnership agreement’s intricate terms caused the General Electric subsidiary to received most of the actual partnership income but, for tax purposes only, 98 percent of the taxable income was allocated to the Dutch partners, which were not subject to U.S. income taxes. The government argued that GE used this structure to shelter over $300 million of its income from taxes in 1993 through 1998. The Court agreed, finding that the Dutch banks were not true partners in the venture and therefore could not be allocated any of its taxable income.
This case serves as a good reminder not to ignore the classic “debt or equity” analysis when structuring investment participation. If the potential volatility of your client’s carried interest is too narrow or includes a guaranteed return, your client may be treated as a debt holder. While not determinative in this week’s ruling, the foreign status of a holder will most likely garner further scrutiny. International tax counsel should always be consulted in such cases.
Decision can be found here
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