John Hancock Loses Suit Over $560 Million in U.S. Taxes

John Hancock Life Insurance Co.’s bid for deductions on a series of leveraged lease transactions was denied by the U.S. Tax Court in a decision addressing a $560 million tax dispute.

Judge Harry Haines accepted arguments by the U.S. Internal Revenue Service that “the substance of the transactions is not consistent with their form,” and denied claims for depreciation, rental and interest expense and transaction costs.

“John Hancock did not acquire the benefits and burdens of ownership” Haines wrote of one of the disputed transactions.

The ruling yesterday is the latest court victory for the IRS in challenges to lease-in-lease-out and sale-in-lease-out transactions, commonly called LILO and SILO, which the tax agency has determined are vehicles for improper tax avoidance.

“There have probably been six or seven of them and they’ve ultimately won all of them,” said Mark Allison, a tax attorney with Caplin & Drysdale Chartered in Washington.

In 2008, the IRS gave companies a chance to terminate LILO and SILO transactions in exchange for keeping 20 percent of the savings and getting reductions in some penalties.

In LILO and SILO transactions, a bank or other company purchases large assets, such as railroads or utilities, and leases them back to governments or other operating entities.

The companies purportedly buying the assets claim tax deductions such as depreciation on the equipment.

‘Sham’ Arrangements

The IRS has argued the arrangements are shams designed to produce tax benefits on assets the companies never actually owned.

John Hancock, the U.S. unit of Toronto-based Manulife Financial Corp., is considering an appeal of the decision, Roy Anderson, a company spokesman, said in an e-mailed statement.

“We continue to believe our position on the tax treatment of our lease investments was appropriate and factually distinguishable from other recent cases addressing the tax treatment of leverage lease investments,” he said.

Manulife said in its 2012 annual report it had established provisions for “possible disallowance of the tax treatment and for interest on past due taxes” on lease transactions.

‘Material Impact’

“We do not expect the decision will have a material impact on the Company’s finances,” Anderson said.

Based on company reporting, “reserves have been built up even more than we had previously realized such that incremental provisions at this point would be immaterial,” analyst Andre-Philippe Hardy, of RBC Capital Markets in Toronto, wrote in a note this morning.

Manulife reports second-quarter earnings Aug. 8 at 6 a.m. with an analyst conference call scheduled for 2 p.m. that day.

One of John Hancock’s SILOs scrutinized by Haines involved the company’s purchase of an interest in a high-speed rail line run by Societe Nationale de Chemins de Fer Belges, or SNCB, the owner and operator of the national rail system of Belgium.

The transaction resembled a loan from John Hancock, Haines wrote, denying John Hancock’s depreciation deductions.

The ruling applies to 27 lease transactions that occurred from 1997 to 2001 and affect John Hancock’s tax liability for those years as well as 1994.

Seven Transactions

The case examined seven of the transactions, with both parties agreeing to apply a formula to determine any taxes owed in the other cases.

Tax deficiencies claimed by the IRS range from $8.86 million in 1994 to $173.5 million in 1998.

Tax court decisions can be appealed to the U.S. Court of Appeals.

Haines’ ruling was not a blanket dismissal of John Hancock’s arguments. Unlike previous court rulings on lease transactions, Haines did not conclude that the company’s arrangements lacked economic substance, according to Allison.

“It’s good for the taxpayer community to know that the court wasn’t blindly following in the footsteps of other courts,” Allison said.

The case is John Hancock Life Insurance Co. v. U.S. Internal Revenue Service, 70830-10, U.S. Tax Court (Washington).

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