Dow Loses COLI Legal Battle

January 26, 2006 ( - A federal appellate court has overturned a lower court decision and ruled that Dow Chemical Co. cannot take tax deductions for interest it incurred on loans used to pay for corporate-owned life insurance (COLI) policies.

The split 2-1 ruling by the US 6 th Circuit Court of Appeals found that Dow’s COLI plans were economic shams and that the tax deductions were properly disallowed by the Internal Revenue Service (IRS), BNA reported.

In 1988, Dow purchased COLI policies from Great-West Life Assurance Co. on the lives of 4,051 employees. In 1991, Dow purchased COLI policies from Metropolitan Life Insurance Co. on the lives of 17,061 employees. According to the ruling, Dow paid premiums on the policies by borrowing money from Great-West and MetLife, using the cash values of the policies as collateral. Dow also made partial withdrawals from the unencumbered cash values of the policies, the court said.

Between 1988 and 2000, Dow paid $377,062,000 in premiums and $131,986,000 in interest to Great-West. From 1991 to 2000, Dow paid $849,890,000 in premiums and $239,371,000 in interest to MetLife.

In the taxable years 1989 to 1991, Dow claimed on its federal tax return deductions totaling $33,004,360 for interest paid on loans used to pay the COLI premiums. IRS disallowed the deductions, and assessed tax deficiencies and interest totaling $22,209,570.

US District Judge David Lawson of the US District Court for the Eastern District of Michigan found that the COLIs were not economic shams and that IRS improperly had disallowed the deductions.

“[T]he district court erred in including in its cash-flow analysis the highly-contingent positive cash flows projected for later years. When the future infusion of cash is properly removed from this analysis, only negative cash flows remain. Therefore, without the benefit of the interest deductions, the COLI plans were cash-flow negative for all relevant periods, which is a ‘hallmark of an economic sham,’ ” Circuit Judge Karen Nelson Moore said in writing for the appellate court majority.

The case is Dow Chemical Co. v. United States, 6th Cir., No. 03-2360, 1/23/06.