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Civil Court Rejects Tax Shelter Tied to KPMG
By David Reilly and Paul Davies
The Wall Street Journal
Friday, February 2, 2007

In a significant decision regarding the validity of a tax shelter at the heart of a criminal trial involving former KPMG LLP executives, a federal judge in Texas hearing a separate civil suit found the structure was a sham that "lacked economic substance."

Although the ruling doesn't directly affect the criminal case being heard in New York, it backs up prosecutors' arguments that the shelters were an elaborate tax dodge and supports a similar and long-standing contention by the Internal Revenue Service.

The decision, handed down Wednesday by U.S. District Judge T. John Ward, follows a ruling last April by a U.S. Tax Court Judge that upheld IRS arguments that a similar shelter was invalid.

The Texas decision was particularly significant for the IRS because Judge Ward ruled that loans and an investment strategy underlying the tax shelter, called Bond Linked Issue Premium Structure, or BLIPS, lacked economic substance and were undertaken only to create tax losses.

Yesterday, Don Korb, IRS chief counsel, said the agency was pleased by the Texas decision.

Jerry Cohen, an attorney with Sutherland Asbill & Brennan LLP who represented two individuals who fought the IRS's challenge of their use of the BLIPS product for tax purposes, said the decision was a mixed bag for his clients.  They were pleased the judge struck down IRS requests to assess penalties, but disappointed the judge declared the BLIPS product invalid and required them to pay tax owed and interest.

The BLIPS shelter is one of four at issue in the criminal case pending in federal court in Manhattan against 16 former KPMG executives and two individuals who worked at outside firms.  Prosecutors claim the shelters were designed to create phony paper losses to help wealthy individuals evade billions of dollars in tax.

A spokeswoman for the U.S. attorney's office in Manhattan, which is overseeing the criminal probe, declined to comment.

Joseph Bankman, a tax-law expert at Stanford University law school, said the ruling wouldn't directly give prosecutors ammunition.  But the Texas decision robs defense attorneys in the coming New York trial of a chance to argue that a federal judge had found that the structure had merit.

The individuals in the criminal case, who have all pleaded not guilty, are scheduled to stand trial in September.  KPMG in August 2005 entered into a deferred-prosecution agreement with the government, in which it admitted that the tax shelters it sold, including BLIPS, were improper.

KPMG wasn't a party in the Texas case.  Rather, that litigation involved the sale of a BLIPS structure to two prominent attorneys, Cary Patterson and Harold Nix, by investment firm Presidio Advisory Services LLC.

Presidio worked with KPMG to sell BLIPS and executives connected to Presidio are among those facing criminal charges in New York.

The IRS challenged the validity of more than $50 million in tax losses claimed by Messrs. Patterson and Nix as a result of their investment in BLIPS, saying they owed the taxes, interest and penalties.

The attorneys sued the government, contending they believed the structure was above board and they had relied on outside tax experts in using it and taking subsequent losses on tax returns.

Judge Ward sided with the attorneys' claims that they hadn't entered into the BLIPS products with tax losses in mind, but still found that the shelters lacked economic substance.

Write to David Reilly at david.reilly@wsj.com and Paul Davies at paul.davies@wsj.com

http://online.wsj.com/article/SB117037993542695651.html?mod=us_business_whats_news