In addition to reinforcing an earlier Tax Court decision involving COLI policies, which are generally used to provide extra benefits and income for key employees, a district court decision against Camelot Music earlier this week is significant because of the large amount of revenue potentially at stake, according to a Dow Jones report.

Pending COLI cases may involve contested revenues of as much as $6 billion, Lindy Paull, staff director of the Congressional Joint Committee on Taxation told the House Ways and Means Committee late last year, the article said.

In its Oct. 16 ruling, the Delaware district court agreed with the IRS that interest deductions totaling $13.8 million claimed by Camelot Music Inc. for the three years ending Aug. 31, 1993, should be disallowed and that the IRS could penalize Camelot for inaccurately estimating its tax liability, Dow Jones said. During the years in question, Camelot was a subsidiary of CM Holdings, which was subsequently acquired by Trans World Entertainment.

In an earlier case involving a COLI scheme, the Tax Court in November of 1999 disallowed COLI-related interest deductions claimed by Winn-Dixie Stores Inc. intended to produce tax savings totaling about $1.6 million in the first year of an arrangement that was intended to produce benefits extending over 60 years, Dow Jones said.

In both cases, the respective courts found that Winn-Dixie and Camelot Music employed sham transactions to claim the purported tax benefits. The companies attempted to generate tax deductions by purchasing life-insurance policies covering large numbers of employees through highly leveraged transactions. Camelot bought its policies from Mutual Benefit Life Insurance Co., and court documents said seven other life insurance companies have sold similar COLI plans to many Fortune 500 companies and mid-sized corporations, according to the report.

An opinion written by Senior District Judge Murray M. Schwartz reportedly said, "At the time of the trial, 85 taxpayers with similar plans had been identified by the IRS, 50 investigations were underway and many more were expected to be added to the list."

According to the article, Schwartz reportedly said Camelot "crossed the line separating a life-insurance contract where policy loan interest is deductible and a tax-advantaged investment program where it is not." The transactions were a sham because Camelot used "circular accounting treatment" to produce certain key elements of the arrangement, he said.

The court also found that the arrangement lacked economic substance because the company couldn't reasonably expect to receive any benefit from the transactions in questions other than their purported tax savings, Dow Jones said.

-- SmartPros News Staff

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