Opinion ID: 2973232
Heading Depth: 3
Heading Rank: 1

Heading: Net Present Value (NPV) Analysis

Text: The district court’s conclusion that Dow’s COLI plans had economic substance because they generated inside buildup was based, in part, upon the court’s acceptance of the net present value (NPV) analysis of Dow’s financial expert. That was a finding of fact, and I am satisfied the court did not commit legal error in accepting Dow’s, rather than the government’s, NPV analysis. Courts have recognized that NPV analysis is an appropriate method to determine the economic effects of transactions designed to yield deferred returns. ACM P’ship v. Comm’r, 157 F.3d 231, 259 (3d Cir. 1998). NPV analysis consists of discounting future earnings by a factor No. 03-2360 Dow Chemical Co. v. United States Page 13 intended to reflect the time value of money. See Dow, 250 F. Supp. 2d at 806. The discount rate used is the rate of return on an alternate investment. The district court accepted the testimony of Dow’s expert, Stewart Myers, who stated that the appropriate discount rate for the NPV analysis of Dow’s delayed cash flows is an “after-tax” Moody’s Corporate Average, which is calculated by multiplying Moody’s Corporate Average by a factor of one minus Dow’s tax rate. This adjusted discount rate reflects the reality that the death benefits from Dow’s COLI plans were not taxable, whereas Dow would have to pay tax on the income from alternate investments. Dow’s actual return from alternate investments would be reduced by its income tax rate, but its return from the COLI plans would not. The government argues that, as a matter of law, the proper discount rate is an unadjusted Moody’s Corporate Average because using a discount rate that reflects the tax-free nature of death benefits conflicts with the “pre-tax” analysis required by this circuit and the Third Circuit, and mistakenly puts Dow in a “world without taxes.” See AEP, 326 F.3d at 743-44; CM Holdings, 301 F.3d at 95. I do not agree with the government’s argument that the “pre-tax” analysis required in this circuit under AEP requires an unadjusted discount rate. As the Third Circuit explained in CM Holdings, this “pre-tax” analysis requires only that there be removed from consideration the challenged deduction and the transaction be evaluated on its merits. CM Holdings, 301 F.3d at 105. It is not necessary, as the government suggests, that we must imagine a “world without taxes,” and we may take into account the reality that some investments are tax favored. Dow’s expert separated Dow’s COLI transactions into their investment and financing components or “legs” and analyzed the cash flows from each leg separately. The “investment leg” cash flows showed the benefits from inside buildup, whereas the “financing leg” cash flows showed the value added from financing—in this case, the interest deductions. The government does not claim that separating the investment and financing legs, as Dow’s expert did, is not standard practice in financial analysis. Dow’s expert concluded that the investment leg of Dow’s MetLife plan had an NPV of approximately $370 million and the investment leg of the Great West plan had an NPV of $76 million at the after-tax discount rate. By analyzing the investment leg separately, Dow’s expert viewed the transaction as a whole—from beginning to end—but removed the challenged deduction from consideration as AEP requires. By using an after-tax discount rate, he recognized the reality that corporations operate in a world with taxes and that some investments are tax favored. Since Dow’s expert’s analysis is a form of the “pre-tax” analysis required by this court in AEP, I am satisfied that the district court did not commit legal error by accepting Dow’s expert’s NPV analysis.