Offshore insurance arrangement had economic substance and business purpose.

• Author: Lerman, Jerry L.

In United Parcel Service of America, Inc. (UPS), 6/20/01, the Eleventh Circuit concluded that UPS's restructuring plan of its excess-value business had both economic substance and a business purpose, and had to be respected for tax purposes.

Excess-value Business

UPS, which has a primary business of shipping packages, had a business practice of reimbursing customers for lost or damaged parcels up to $100 in declared value. For amounts over $100, UPS would assume liability up to the parcel's declared value if the customer paid 25 cents per additional $100 in declared value (i.e., "excess-value charge"). The charges collected by UPS exceeded the amount paid out in claims. Prior to the restructuring plan, UPS included the revenue generated from the excess-value charges in income and deducted all expenses relating to the claims paid on damaged or lost excess-value parcels.

Restructuring Plan

An insurance broker suggested to UPS that taxes on the lucrative excess-value business could be avoided if UPS restructured the program as insurance provided by an overseas affiliate. As a result, UPS formed a Bermuda subsidiary, Overseas Partners, Ltd. (OPL). The OPL shares were distributed as a taxable dividend to UPS shareholders (most of whom were UPS employees). UPS then purchased an insurance policy from National Union Fire Insurance Company, under which National Union assumed the risk of damage to or loss from excess-value shipments. The policy premiums equaled the, excess-value charges that UPS collected.

National Union then entered into a reinsurance arrangement with OPL. This arrangement provided that OPL assume the full risk of the excess-value shipments in exchange for premiums that equaled the excess-value payments National Union received from UPS, less commissions, fees and excise taxes. UPS deducted the fees and commissions charged by National Union; the net remaining excess-value income ultimately passed to OPL.

Tax Court

The IRS determined that the excess-value payment remitted ultimately to OPL had to be treated as gross income to UPS. The Tax Court agreed, concluding that the redesign of the excess-value business had no business purpose. According to the court, the business realities were identical before and after the restructuring plan. The premiums paid for the National Union policy were well above industry norms, and the sole motivation...