Thursday, July 27, 2006

Boeing Settlement:"Klieg Lights" on Tax Matters

A story in today’s BNA Daily Tax Report highlights controversy over a recent settlement by Boeing with the Justice Department over corporate misconduct regarding contract and hiring matters. In what appears to be the largest financial penalty ever imposed, Boeing will pay $615 million to the government to settle this case. (See Grassley Calls for Clarification on Settlements; Boeing Says No Deduction).

There are lots of cases where financial payments are negotiated to settle corporate disputes with the government. A list of them, along with comments on the Boeing matter, can be found here:

Some of these payments reflect additional outlays or costs of doing business which are akin to contract damages, which are appropriately taken into account as deductible expenses. Others, however, reflect fines or penalties, which are not deductible. Section 162(f) of the Code states: “No deduction shall be allowed … for any fine or similar penalty paid to a government for the violation of any law.” Unfortunately, the line between deductible payments and nondeductible ones can be blurry, particularly when the terms of a settlement are not clear. From the taxpayer’s perspective, the difference can be significant, as the corporate tax savings from deduction (assuming a marginal federal rate of 35%) substantially reduces the amount of any penalty.

Boeing CEO Jim McNerney announced, however, that no deduction would be taken by the company:
“We have been advised that the bulk of the settlement is in fact tax deductible, and that similar deductions have been allowed in the past. Without question, the short-term financial impact of the taxability issue is significant. However, the long-term value of Boeing's reputation is even more significant. Accordingly, I feel strongly that the right thing for Boeing to do is not to seek tax deductibility for the settlement charges.
This should be a signal to our employees, customers, suppliers, and our shareholders of our willingness to acknowledge responsibility, accept accountability, and to move forward in a manner reflective of the great legacy of our company and its employees.” (The quote is found in BNA Tax Core: (sorry - subscribers only).
In round figures, this would amount to some $215 million in tax benefits that will be foregone in this case.

Senator Grassley sharply criticized the DOJ in this case for not taking into account the tax consequences of the settlement. His statement includes these colorful observations:
“It's good Boeing won't seek a tax deduction for its $615 million settlement. That's the right decision. However, Boeing's lawyers believed the settlement was tax deductible. This tells me Department of Justice lawyers failed to take into account the settlement's tax treatment and allowed Boeing's lawyers to effectively negotiate a 35 percent discount. Any junior lawyer knows to look at a settlement's tax treatment, yet Justice lawyers were asleep at the switch. That's inexcusable. The Justice Department has to pay attention to the tax treatment in these big settlements. We can't depend on having klieg lights from Congress for the right thing to happen.” (The quote also comes from a statement in BNA Tax Core). (For those who are unfamiliar with klieg lights, see this site:

Two comments:
First, I’m glad Senator Grassley is of the opinion that “any junior lawyer knows” to consider tax issues. I try to tell my students that every semester, and those in my tax courses know that this is important. However, many students graduate from law school without taking tax courses. Perhaps some of these folks were working at the DOJ and let this issue pass. (Or perhaps they knew about it and negotiated the amount higher based on uncertainty in treatment - it may be unfair to assume that the government messed up in this case.)

Second, if Boeing got by with a negotiated settlement that allowed a deduction, I’m skeptical of the decision to leave $215 million in tax benefits on the table. Does the payment of extra taxes make one more virtuous? Can it repair a damaged reputation? I certainly don’t see it that way. One of the familiar comments in case law on this topic comes from Judge Learned Hand, who stated: “Any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes.”

There may be litigation on the tax issue that would keep Boeing in the limelight. That is a possible negative for the company, but after all it would be tax litigation. Contesting defensible tax treatments would be unlikely to have a negative impact in the investing world, which matters to shareholders. It would also be unlikely to impact markets for airplanes. After all, the purchasers of these large aircraft have their own problems with the government, and would likely sympathize.

If I were a Boeing investor, I would be a little concerned about why the Chairman (presumably with Board approval) decided to let $215 million get away.

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