Tax Court holds UPS shifted income offshore in sham transaction.

• Author: Manning, Paul

In United Parcel Service of America, Inc. (UPS), TC Memo 1999-268, the Tax Court held that UPS improperly shifted $70 million of income offshore to a related Bermuda corporation, Overseas Partners Limited (OPL). Citing Basye, 410 US 441 (1973) and Lucas v. Earl, 281 US 111 (1930), the court found that UPS itself was-the true earner of the income under Sec. 61 and had improperly attempted to assign that income to OPL. According to the court, the transactional arrangements that would have allowed OPL to earn the income offshore, free of U.S. corporate income tax, lacked a legitimate, nontax business purpose. Therefore, under the sham transaction doctrine, OPL's participation in the arrangement should be ignored and the income should be taxed to UPS. In arriving at this conclusion, the court disregarded substantial testimony offered by UPS executives and relied instead on contemporaneous documentation as to the intent and purpose of the transactional arrangements. The court imposed penalties exceeding $15 million under Secs. 6653 (negligence), 6661 (substantial understatement of income) and 6621 (substantial understatements attributable to "tax motivated transactions").

UPS is engaged in the pick-up and delivery of small packages and parcels within the U.S. and in certain countries abroad. At all times, UPS's activities were regulated by the Interstate Commerce Commission (ICC), state transportation agencies, public utility commissions and the Civil Aeronautics Board. In connection with regulatory requirements, UPS's pricing structure was set forth in detailed tariffs filed with the ICC and most states' state transportation agencies. This pricing structure established certain "base rates" depending on the package size and delivery location. The base rate automatically provided the customer (the shipper) with coverage against loss or damage to its package up to $100. If a shipper desired to obtain additional coverage, it would declare the value of the package and pay an additional 25 cents ($0.25) of "Excess Value Charges" (EVCs) per additional hundred dollars of value declared.

For all of its tax years through 1983, UPS collected the EVCs and included them in its gross income. In 1983, however, UPS was approached by an insurance brokerage firm with a plan to restructure the EVC aspect of UPS's shipping business. Because the EVCs provided shippers with coverage against loss or damage to their packages, the excess value business had significant...