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Dow Chemical Loses $1 Billion in Deductions in Tax Case

Dow Chemical Co. (DOW)’s claim to $1 billion in tax deductions was based on transactions with sham partnerships promoted by Goldman Sachs Group Inc. (GS) and law firm King & Spalding LLP, a federal judge ruled, throwing out the company’s bid to recover the money.

The Internal Revenue Service correctly rejected the tax benefits created by the complex partnerships from 1993 to 2003 because the transactions were designed to exploit perceived weaknesses in the tax code and not for legitimate business purposes, U.S. District Judge Brian Jackson said in a ruling filed yesterday in federal court in Baton Rouge, Louisiana,.

“The facts of the present case indicate that Dow viewed its tax department as a profit center,” Jackson said in his opinion.

Nancy Lamb, a spokeswoman for Midland, Michigan-based Dow, said the company had paid the taxes sought by the IRS and had sued to recover money it believed it shouldn’t have had to pay.

“Dow is disappointed by the trial court’s decision in this case, and we believe the opinion is not supported by the facts and applicable law,” Lamb said in an e-mailed statement. “Dow is exploring all of its options, including appeal.”

Michael DuVally, a spokesman for New York-based Goldman Sachs, had no immediate comment on the ruling. Matt Hyams, a spokesman for Atlanta-based King & Spalding, said by phone that the law firm doesn’t discuss client matters.

Chemtech 1

Chemtech 1, was marketed by Goldman Sachs under the trade name SLIPs, standing for “Special Limited Investment Partnerships” and lasted at Dow from 1993 through 1997.

Dow’s SLIP provided a tax benefit in the form of deductions by the chemical company of royalty expenses paid for the use of its own patents.

Changes in U.S. tax law forced Dow to terminate Chemtech 1 at the end of 1997.

Chemtech II, designed by King & Spalding and covering tax years 1998 through 2003, produced deductions “for the depreciation of a chemical plant asset that had already, for the most part, been depreciated down to zero,” according to Jackson’s ruling.

The judge concluded that there was no economic substance to either set of transactions, labeling them “an economic sham.”

One indicator of the sham was “a circular flow of funds among related entities -- Dow and its subsidiaries,” Jackson said. “The cash flowed out, and flowed back in to Dow.”

In addition to rejecting the tax benefits, Jackson imposed a 20 percent penalty for tax years 1997 through 2003.

The case is Chemtech Royalty Associates LP v. U.S., 05-cv- 00944, U.S. District Court, Middle District of Louisiana (Baton Rouge).

To contact the reporter on this story: Andrew Zajac in Washington at azajac@bloomberg.net

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net

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