Sky Mortgage

Looking over one of the legal papers in the KPMG tax shelter case, from July 20th 2006, one gets a bit of a feeling how the darn thing is done. The judge ruled that one of the assumptions against the tax shelter involved, BLIPS, was invalid, though it is still viewed as having no legitimate economic purpose. BLIPS stands for Bond Linked Issue Premium Structure. The issue of whether the BLIPS had any legitimate purpose is going to be decided at the trial of the KPMG accounting firm executives.

Looking at the court papers, the plaintiffs were Klamath Strategic Investment Firm LLC by and through St. Croix Joint Ventures LLC. Klamath and Kinabalu, both Investment Firms, moved that the determination of the IRS that they used "contingency funds" and liabilities, in a way that was ruled illegal by the IRS. They claimed that this ruling was done after the fact, in their case.

The issue of the FPPAs (Financial Partnerships Administrative Adjustments) was whether the loan premiums that the plaintiffs received from a bank in this connection are to be treated as liabilities.

St. Croix and another investment firm "Rogue" each borrowed $41.7 million from National Westminster Bank. The loans were for 7 years at fixed interest rates. The loans paid Interest Only, until a balloon payment at the end of the 7 years.

St. Croix and Rogue agreed to pay high interest rates of 17.97%, in exchange for a $25 million payment to them from Nat West at the time the loans originated. So St. Croix and Rogue, received at the beginning of the loans a total of $66.7 million. Then the $66.7 million plus $1.5 million from each was put in an interest bearing loan at Nat West. In addition, St. Croix and Rogue agreed to pay $25 million to NatWest, if they paid off the loan early, which is exactly what they did a couple of weeks later, May 25th, 2000.

The two companies behind St. Croix and Rogue, Klamath and Kinabalu, also signed an interest rate swap (floating for fixed interest rates) with Nat West, ostensibly to guard against falling interest rates. That was also for $25 million.

The most significant issue decided is whether or not the $25 million premium that St Croix and Rogue received from NatWest constituted a "liability" or not. Plaintiffs argue that the $25 million pre-payment was not a liability under IRS section 752, since at that point the "origin" of the loan, because this was before the loan went to maturity.

The government argues, this was really a loan for $66.7 million, at a much lower rate of interest, and no loan premium. So a loan was restructured so it looked like a lot of interest was paid (which is tax deductible) when it really wasn't. Interesting.