Eleventh Circuit reverses TC decision in UPS.

• Author: Sair, Edward A.
• Position: Tax Court, United Parcel Service of America Inc.

In June 20, 2001, the Eleventh Circuit reversed and remanded the Tax Court's decision in United Parcel Service of America, Inc. (UPS), TC Memo 1999-268. The Tax Court held that UPS's restructured insurance program lacked economic substance and business purpose. On appeal, the Eleventh Circuit held that UPS's restructured insurance program should be respected. The case was remanded for consideration of the IRS's alternative arguments on income allocation under the Secs. 482 and 845(a) transfer-pricing provisions.

UPS was responsible for reimbursing customers for lost or damaged parcels up to $100 in declared value. Above that level, UPS would assume liability up to the parcel's declared value if the customer paid $0.25 per additional $100 in declared value (the "excess-value charge"). Under this program, UPS reported the excess-value charge as income and deducted the paid claims as expenses.

In 1984, UPS restructured its program for handling lost or damaged packages. First it formed and capitalized a Bermuda subsidiary, Overseas Partners, Ltd. (OPL), and then distributed OPL shares as a taxable dividend to UPS shareholders. As part of the new structure, UPS arranged for an insurance policy for its customers from National Union Fire Insurance Company (National Union), an unrelated insurance provider. Under the policy, UPS paid National Union the excess-value charges it collected as premiums; in return, National Union assumed the risk of damage to (or loss of) excess-value shipments.

National Union then entered into a reinsurance contract with OPL. Under the contract, OPE assumed risk commensurate with National Union's in exchange for premiums that equaled the excess-value payments National Union received from UPS, less commissions, fees and excise tax. After the restructuring, OPL received the excess-value payments (less paid claims and National Union's administration charges) and assumed ultimate liability for lost or damaged excess-value parcels.

Under the new structure, UPS did not report the premiums as income, nor deduct the paid claims as expenses. The IRS determined a deficiency in the amount of the excess-value charges collected in 1984 and imposed penalties. UPS petitioned for a redetermination; following a hearing, the Tax Court found for the Service under a combination of the assignment-of-income and economic-substance doctrines, and sustained the penalties.

On appeal, the Eleventh Circuit considered whether the restructured...