IRS has privately ruled that a portion of a payment made by a manufacturer to settle a civil action, which was brought against the manufacturer after it entered a plea agreement for certain antitrust violations, wasn't subject to Code Sec. 162(g)’s two-thirds disallowance rule. IRS agreed with the manufacturer that only the portion of the settlement reflecting the ratio to which the volume of commerce covered by the plea agreement bore to the manufacturer's total volume of sales during that time period was subject to Code Sec. 162(g).
Background. Under Code Sec. 162(g), if a taxpayer is convicted of (or pleads guilty or nolo contendere to) federal antitrust violations, no deduction is allowed under Code Sec. 162(a) for 2/3 of the damages paid or incurred either under civil judgment or settlement of the suit based on the violation. Settlement payments include amounts paid after dismissal or other disposition of the suit, or following elimination of the claim by amendment of the complaint. (Reg. §1.162-22)
However, Code Sec. 162(f) doesn't apply to the portion of a settlement that relates to sales or products that are not the subject of a criminal case. (Reg. §1.162-22(f), Example 3) In that example, there were separate criminal and civil cases involving different products, and the Code Sec. 162(g) limitations didn't apply to the civil settlement amount because that case was based on a separate product than that of the criminal proceeding.
In Federal Paper Board Co., (1988) 90 TC 1011, a taxpayer was indicted for antitrust violations relating to folding cartons, and was then sued civilly on the theory that it violated the law in the sale of both folding cartons and milk cartons. The Tax Court ruled that the limitation deductions of Code Sec. 162(g) did not apply to that portion of the civil settlement that related to milk cartons, and accepted the taxpayer's method of determining the deductible portion of the settlement by the ratio of the taxpayer's sales of milk cartons to total sales.
Facts. Taxpayer manufactures and sells product A in area B. Taxpayer was investigated by the Department of Justice's (DOJ's) Antitrust Division for violations of the Sherman Act and entered a plea agreement on Date 1. The plea agreement addresses Taxpayer's antitrust violations by way of Taxpayer's agreement with its competitors to allocate customers of A in Location Q (violation), which is located within area B.
Taxpayer's plea agreement and other documents suggest that a portion of Taxpayer's sales during the time of the violation was “affected” by Taxpayer's unlawful conduct. In a later year, co-conspirator, another manufacturer of product A, also entered into a plea agreement relating to the same conduct in the same limited geographic area.
As a result of the plea agreement, nearly 100 civil actions were filed on behalf of direct purchasers (retailers) and indirect purchasers (consumers) of product A, which were consolidated into a single civil action pending in the Court. The plaintiffs in the civil suits alleged that manufacturers of product A conspired to allocate customers throughout the U.S., despite the limited geographic scope of Taxpayer's violation. At the co-conspirator's criminal sentencing, the Assistant U.S. Attorney overseeing the investigation and prosecution expressly informed the Court that the violation on which the plea agreement was based, which was the only criminal offense found, was not based on a nationwide conspiracy.
For purposes of expediency, and without admission of wrongdoing, Taxpayer entered into a civil settlement with the retailers by making a payment to resolve any and all potential claims of retailers nationwide. The settlement is based on all of Taxpayer's sales across area B through Date 4—in other words, it was derived from sales volume, rather than the volume of commerce set forth in the plea agreement, and it included sales beyond the time frame covered by the plea agreement. Thus, a percentage of Taxpayer's gross sales for the period were excluded from the “violation and fine” calculation under the plea agreement, but were included in the calculations of the civil settlement payment.
Taxpayer requested a ruling that, based on a method comparing the affected volume of commerce in the plea agreement to Taxpayer's total gross sales, a portion of the civil settlement is not subject to the deduction limitations of Code Sec. 162(g) because that portion applies to sales at times, in geographies, and as to sales volumes to which Taxpayer did not plead guilty in the criminal case. Therefore, Taxpayer argued that these payments are not on account of the criminal proceedings.
Taxpayer-friendly ruling. In a private letter ruling (PLR), IRS found that only a fraction of the civil settlement, with the numerator equal to the volume of commerce affected by Taxpayer's unlawful conduct and the denominator equal to Taxpayer's total volume of sales during the same time period, was subject to Code Sec. 162(g). Accordingly, 2/3 of that amount was nondeductible.
References: For the limitation on deduction of damages for antitrust violations, see, FTC 2d/FIN ¶L-2714; United States Tax Reporter ¶1624.391; TaxDesk ¶303,511; TG ¶16461.