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Seventh Circuit Affirms Injunctive Relief for Energy Cooperative Involved in Tax-Related Leveraged Lease Transaction
The U.S. Court of Appeals for the Seventh Circuit affirmed a preliminary injunction order granted by a federal district court in a case concerning a surety guarantee made with respect to a leveraged lease transaction* that was entered into for federal income tax purposes by an energy cooperative and an insurance company.
Hoosier Energy Rural Electric Cooperative v. John Hancock Life Ins. Co., No. 08-4030 (7th Cir. September 25, 2009)
For an electronic version of the decision:
Hoosier Energy
* The transaction was designed to move the cooperative’s depreciation deductions to the insurance company, which had income exceeding its available income tax deductions. Concerning this transaction, it was observed that the IRS had not allowed similar transactions to transfer deductions from one corporation to another, and that the district court had found this transaction “probably should be unwound” as an abusive tax shelter.
Background
An energy cooperative had depreciation deductions that it could not use, and an insurance company had income exceeding its available deductions. The two companies engaged in a leveraged lease transaction that was designed to move the cooperative’s deductions to the insurance company.
The insurance company paid the energy cooperative $300 million for a 63-year lease of an undivided two-thirds’ interest in a power generation plant. The energy cooperative agreed to lease the plant back from the insurance company for 30 years, making periodic payments with a present value of $279 million—with profit to the cooperative of $21 million, representing some of the value to the insurance company of the deductions that it could take as the long-term lessee of the power plant.
To address certain risks that the insurance company faced, the energy cooperative agreed to provide additional security, in the form of both a credit-default swap and a surety bond. Under this agreement, if certain contingencies occurred, the entity providing the surety would pay $120 million to the insurance company. One of the contingencies in this transaction was a reduction in the surety’s own credit rating. If that rating fell below a prescribed threshold, the energy cooperative had 60 days to find a replacement that satisfied the contractual standards.
During 2008, the surety’s credit rating slipped below the threshold, and the insurance company demanded that the cooperative find a replacement. After reporting “trouble” complying with the replacement requirements, the cooperative filed this suit in federal district court for a temporary restraining order (which was subsequently replaced by a preliminary injunction).
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Tax Benefits
Whether the tax benefits of the transaction will ultimately be sustained was not decided in this case. The Seventh Circuit in affirming the district court’s order commented that the “…Commissioner of Internal Revenue will address the question whether the leveraged-lease transaction provides John Hancock with the tax benefits it seeks.”
For more information, contact KPMG’s National Director of Cooperative Tax Services:
David Antoni, in Philadelphia, (267) 256-1627,
dantoni@kpmg.com
Or Associate National Director of KPMG’s Cooperative Tax Services:
Brett Huston, in Sacramento, (916) 554-1654, bhuston@kpmg.com
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