The local trial team that represented a bottling company in an important tax case against the IRS recently talked about its victory, which was called “one of the top 10 tax cases in 2014” by Forbes magazine.
Varnum attorneys Ronald DeWaard, Brion Doyle and Kaplin Jones represented ABC Beverage of Michigan in federal court in the case ABC Beverage Corporation & Subsidiaries v. United States of America.
ABC Beverage makes and distributes soft drinks for Dr. Pepper Snapple Group Inc.
Facility lease and purchase
The case involved a big bottling facility.
DeWaard explained that ABC Beverage had "a terrible facility lease," which was "written in such a way that as the years went on, it was incredibly expensive."
"To get out of the lease, they had to buy the property,” DeWaard said.
The trouble began 18 years ago, in 1997, when ABC Beverage acquired a company with a long-term lease on the bottling facility in Hazelwood, Mo. Shortly after acquiring the lease, ABC concluded that the rent due on its long-term lease was in excess by three times of the plant's fair market rent, because of a quirk in the lease that caused rent to go sky high in the last year.
DeWaard explained that ABC needed to purchase the facility for its operations, which was appraised at $2.75 million without the lease, but the company was forced to buy the facility for over three times the appraised value.
Because ABC had to overpay for the facility, it subsequently deducted $6.25 million on its tax return as a business expense for terminating the lease.
The IRS disallowed the deduction, because it believed the amount paid for the facility reflected a capital purchase and assessed a tax deficiency. ABC paid the deficiency and sued for a refund.
ABC was handed a win by a jury amounting to a multi-million judgment, but the IRS appealed the decision.
Varnum represented the company in 2014 at the U.S. Sixth Circuit Court of Appeals. The Sixth Circuit affirmed the lower court’s decision, saying ABC could deduct the excess purchase amount that exceeded the fair market value of the building as an ordinary business expense.
ABC Beverage received a $3,453,180.70 from the United States as a result.
Considering "substance" of transaction
"Any trial victory against the IRS is significant," Jones said. "This one is particularly so because it was upheld on appeal to the Sixth Circuit and establishes that the taxpayer can look past the form of a transaction to its substance in order to claim a tax benefit."
While the government relied upon the fact that a sale occurred, so that the deduction of a portion of the purchase price was improper, ABC convinced the court that the transaction in reality resulted in a lease termination as well as a purchase, where a deduction was appropriate for the termination portion.
Prior to this decision, there was very little precedent allowing a taxpayer to rely on the substance of a transaction in support of a deduction, whereas the IRS is commonly permitted to look past the form to the substance of a transaction for the purpose of denying a claimed deduction.
"This published decision opens up the possibility for similar types of tax challenges," Jones said.
DeWaard added, “There is a principle out there now that favors the taxpayer that previously didn’t really exist. Now, the taxpayer, not just the IRS, can look to the substance of the transaction, the real facts not just the form or surface level. It gives the taxpayer a real advantage. The IRS can’t just deny it the way it could before.”
He said he expects companies will begin taking advantage of the outcome of the ABC case in the near future.
The case was particularly interesting because of the jury component.
“We had to take a very complex business transaction and translate it and simplify it in a way the jury would understand,” Jones said. “It shows how good our litigation group is.”
He noted juries tend to defer to the government, which meant Varnum had to really focus on showing the equity and fairness aspect of the case, “rather than just a business trying not to pay its taxes.”