372 F.3d 886 (7th Cir. 2004), 04-1148, United States v. Northern Trust Co.

Docket Nº:04-1148, 04-1150.
Citation:372 F.3d 886
Party Name:UNITED STATES of America, Plaintiff-Appellant, v. NORTHERN TRUST COMPANY, as trustee of the Caterpillar Incorporated Master Trust and the Inland Steel Industries Pension Trust, Defendant-Appellee.
Case Date:June 22, 2004
Court:United States Courts of Appeals, Court of Appeals for the Seventh Circuit
 
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Page 886

372 F.3d 886 (7th Cir. 2004)

UNITED STATES of America, Plaintiff-Appellant,

v.

NORTHERN TRUST COMPANY, as trustee of the Caterpillar Incorporated Master Trust and the Inland Steel Industries Pension Trust, Defendant-Appellee.

Nos. 04-1148, 04-1150.

United States Court of Appeals, Seventh Circuit

June 22, 2004

Argued June 8, 2004.

Page 887

Charles Bricken (argued), Department of Justice, Tax Division, Appellate Section, Washington, DC, Thomas P. Walsh, Office of the United States Attorney, Chicago, IL, for Plaintiff-Appellant.

Jeffrey E. Stone (argued), McDermott, Will & Emery, Chicago, IL, for Defendant-Appellee.

Before EASTERBROOK, KANNE, and DIANE P. WOOD, Circuit Judges.

EASTERBROOK, Circuit Judge.

Closed-end mutual funds pay federal income tax on income and capital gains, then notify their investors, to which the tax burden passes through. A shareholder that is tax exempt (such as a pension trust or a university endowment) can claim a refund of the taxes that the mutual fund paid on account of its proportionate investment. Taxable investors get income coupled with a credit for tax the mutual fund has paid. Two pension trusts (for employees of Inland Steel and Caterpillar) were shareholders of record in Quest for Value Dual Purpose Fund, a closed-end mutual fund. Quest reported to Northern Trust Co., as trustee of these pension trusts, the gains and taxes attributable to these shares. Northern Trust then filed tax returns and claimed refunds on behalf of the pension funds. During 1991 through 1995, the tax years at issue in this litigation, Northern Trust received more than $6 million in refunds for the benefit of these pension plans.

The United States wants the money back. It contends that, with the permission of the two pension funds, Northern Trust "lent" the Quest shares to "borrowers" that held all economic incidents of ownership--the right to any dividends on the shares, the right to vote the shares, even the entitlement to sell them and keep the profits. If a borrower elected to return the shares at the end of the term, it retained any capital gain or loss. For this set of rights, it paid the pension funds 102% of the market price of the Quest shares on the date the "loans" were made. As the United States sees things, these transactions were sales carrying a misleading label designed to allow the pension funds to reap tax benefits on shares that they no longer owned--while the "borrowers," though taxable entities, avoided the economic incidence of taxes on the mutual fund's undistributed income and capital gains.

These suits (one for each pension fund) were filed late in 1998, less than two years from the date the refund of 1995 taxes had been paid, but more than two after the refunds for the other tax years had been disbursed. Section 6532(b) of the Internal Revenue Code, 26 U.S.C. § 6532(b), gives the United States only two years to commence proceedings to recover erroneously paid refunds, "except that...

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