Opinion ID: 2973232
Heading Depth: 4
Heading Rank: 2

Heading: Inside Build-Up

Text: In each prior COLI-plan case, the court found that the plan ensured that at regular intervals net equity was adjusted to zero or some small number. AEP, 326 F.3d at 740, 742; CM Holdings, 301 F.3d at 103; Winn-Dixie Stores, Inc. v. Comm’r, 113 T.C. 254, 281, 284 (1999). This low or zero net equity precluded the taxpayer from realizing the benefit of inside build-up, because there would be little or no net equity to build up (i.e., earn interest). The district court found that “on the last day of each of policy years four through seven, the cash value of Dow’s Great West and MetLife policies was fully encumbered, yielding virtually zero 13 As the facts recited in the text demonstrate, the policy premiums had been funded principally through loans against and withdrawals from the policies, with Dow using little of its own cash. Yet the $315 million in projected future investments purportedly would have been coupled with Dow limiting its borrowing and withdrawals. Dow I, 250 F. Supp. 2d at 801-02, 807, 809-10. On these facts, there can be no doubt that the projected cash infusions would have required Dow to depart drastically from its past conduct. Thus, we leave for another day the consequences of less drastic departures. This obviates the dissent’s concern that our holding prohibits the consideration of contingent future profits whenever it depends on future investment that is merely “greater than the past investment.” Dissent at 11. Also, without citing any authority, the dissent argues that we should also consider “whether the projected future investment is feasible and there is evidence that it is likely to occur.” Dissent at 11. While we agree that the infeasibility of a future investment is indicative of a sham transaction, the fact that an investment is feasible is less likely to provide useful information because large future investments will almost always be feasible for large corporations or other resource-rich taxpayers. A factor that is too easily met is no factor at all. A likelihood factor presents problems of its own. How would one determine likelihood, i.e., what types of evidence would one consider? (The dissent does not say.) One possibility is the profitability of the transaction, because a taxpayer is more likely to make a future investment if it will make the transaction profitable. But this would be circular, requiring us to look to the profitability of the transaction to determine the likelihood of the investment, which we would then use to determine the economic substance (i.e., profitability) of the transaction all over again. Another possibility is the taxpayer’s plans, because internal deliberations might show that a future investment is likely to occur. But that crosses over to the subjective inquiry that we do not conduct until the transaction is determined to have economic substance in the first place. Illes, 982 F.2d at 165. In light of these difficulties, the better course is to remain true to Knetsch by limiting the inquiry to whether the future investment drastically departs from past conduct. 14 We do not hold that future profits contingent on new expenditures by the taxpayer may never be considered. For example (as we suggest in the text), if a taxpayer were contractually obligated to infuse additional cash into an investment at some point in the future, such spending would not constitute a serious departure from past conduct that should be disregarded under Knetsch. Instead, the eventual outlay would be consistent with actual past conduct, i.e., the obligation that existed all along. Of course, Dow was under no such obligation in the instant case. No. 03-2360 Dow Chemical Co. v. United States Page 8 net equity.” Dow I, 250 F. Supp. 2d at 814. The district court also noted that Gary Lake, an actuarial consultant who advised Dow on the COLI plans, id. at 766, “stated that for some of the years the purpose was to have low net equity,” id. at 774. Based on its finding that in the future Dow would infuse the plans with large sums of cash, however, the district court held that the company “stood to realize substantial economic gain from tax-free inside build-up” with respect to both plans. Id. at 807; see also id. at 810. For the same reasons discussed above in the context of cash flows, the district court erred in considering in its inside build-up analysis the prospect of large cash investments that might be (but did not have to be) made in the future. Instead, given the district court’s factual findings with respect to Dow’s actual conduct of maintaining little or no net equity, a simple application of AEP, CM Holdings, and Winn-Dixie yields the result that Dow would have been unable to realize the benefit of inside build-up. This conclusion further suggests that the COLI plans were an economic sham.