Coltec Industries, Inc. v. United States: Significant Win for United States in Tax Shelter Case Reemphasizes Importance of Careful Tax Planning in Complex Business Transactions

In a much-anticipated tax shelter–related decision, the Court of Appeals for the Federal Circuit, on July 12, 2006, reversed a taxpayer victory in the Court of Federal Claims holding that the economic substance doctrine does not violate separation of powers principles, and that the transaction in question—the subsidiary’s assumption of the parent’s asbestos liabilities—failed the economic substance doctrine because it lacked business purpose and economic reality. Coltec Industries, Inc. v. United States. This decision will be viewed by the government as a major victory in its battle against corporate tax shelters, and it further clouds the debate among the circuit courts concerning the proper application of the economic substance doctrine.

In 1996, Coltec Industries, Inc. (Coltec) entered into a so-called contingent liability tax shelter designed by Arthur Andersen. The transaction at issue involved Coltec’s transfer of assets into a subsidiary in exchange for stock, and the subsidiary’s assumption of contingent asbestos-related liabilities. Coltec subsequently sold the high-basis stock at a significant discount, thereby generating a $378.7 million capital loss. Coltec took the position that the contingent liabilities assumed by the subsidiary did not reduce the basis of the stock.

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