Grant Thornton ordered to pay US$100M for Cayman-related tax scheme

The Supreme Court of Kentucky ruled last week that Chicago-based Grant Thornton should pay a U.S. hotel operator some US$100 million for marketing a tax scheme the accounting firm knew would likely be disallowed by the Internal Revenue Service.

According to the judgment, Grant Thornton devised a tax shelter in 2000 for William J. Yung and his company, Columbia Sussex Corporation, which operates 38 hotels in the U.S.

The tax shelter involved two Cayman-based holding companies purchasing $30 million in U.S. treasuries with borrowed money and using the treasuries as collateral for the debt, and then transferring the treasuries to shareholders in the U.S. The Cayman holding companies would pay back the debt after they dispersed the treasuries to the shareholders, but before the treasuries matured, according to the judgment.

Because the treasuries were used as collateral for the debt, they ostensibly had no taxable value, and therefore did not result in reportable income to the shareholders when they matured, the judgment explained.

However, around the same time Grant Thornton was marketing this tax shelter product, the IRS was deeming similar schemes to not be allowable. Grant Thornton was aware of this, according to the judgment, and internal deliberations at the accounting firm found that there was more than a 90-percent chance that the IRS would disallow their new product’s tax benefits.

Despite Grant Thornton expressing internal doubt on its own new tax scheme, a tax partner at the firm’s Cincinnati office represented the product as a lawful tax strategy for Mr. Yung and his companies, the judgment stated.

The judgment stated that the partner represented to Mr. Yung that with an opinion letter from Grant Thornton, the “worst case scenario” would be if the IRS could require the Cayman corporations’ shareholders to pay taxes and interest on the treasury distributions – but the IRS would not assess penalties.

“As the trial court later found, [Grant Thornton partners] understood this advice would be relied upon not only by the Yungs on behalf of the Cayman corporations but also by the shareholders of the companies,” the Supreme Court judgment states. “[Grant Thornton partners] further knew when they made the ‘worst case’ representation that it was untrue [because] there was a 90% likelihood that the I.R.S. would disallow the tax benefits and assess penalties regardless of whether the participant had an accounting firm’s opinion letter.”

Sure enough, the IRS disallowed the tax scheme, and eventually assessed back taxes and penalties against Mr. Yung in the spring of 2005. Mr. Yung settled with the IRS in 2007, and sued Grant Thornton the same year.

The trial court found Grant Thornton liable for fraud and gross professional negligence in the marketing and sale of the tax shelter, and awarded approximately US$20 million in compensatory damages and US$80 million in punitive damages.

An appeals court later reduced the punitive damage award to equal the compensatory damage award, ruling that the punitive damage award was “manifestly unreasonable” and exceeded the amount justified to punish Grant Thornton and to deter like behavior.

However, the Supreme Court reinstated the original punitive damage award of US$80 million.

“The trial court concluded that penalties in the hundreds of millions of dollars, such as those levied against KPMG, were sanctions that the I.R.S. could have imposed on [Grant Thornton],” the Supreme Court reasoned. “Furthermore, several [Grant Thornton] partners could have had their law and/or accounting licenses suspended for the fraudulent acts involved in the Yungs’ transaction. Although [Grant Thornton] suggests otherwise, we do not find the trial court’s findings on this third indicium to be clearly erroneous.”

A Grant Thornton spokesman reportedly said the company is “disappointed with the most recent decision regarding this matter, which dates back almost 20 years, and is reviewing its options for appeal,” according to www.cincinnati.com.

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