- 55 -
Malone & Hyde created Eastland for a legitimate business
purpose or whether the captive was in fact a sham
corporation. A taxpayer is "free to arrange his financial
affairs to minimize his tax liability." Thus, "the presence
of tax avoidance motives will not nullify an otherwise bona
fide transaction." However, the establishment of a tax
deduction is not, in and of itself, an "otherwise bona fide
transaction" if the deduction is accomplished through the
use of an undercapitalized foreign insurance captive that is
propped-up by guarantees of the parent corporation. The
captive in such a case is essentially a sham corporation,
and the payments to such a captive that are designated as
insurance premiums do not constitute bona fide business
expenses, entitling the taxpayer to a deduction under �
162(a). [Malone & Hyde, Inc. v. Commissioner, 62 F.3d at
840; citations omitted.]
The court noted that Malone & Hyde did not have any problem
obtaining insurance from an unrelated insurer but, without a
legitimate business reason, it had deviated from normal behavior
and had devised a circuitous scheme to obtain tax deductions
through the use of a captive insurer. Id. The court also
observed that there was no indication that Bermuda exercised
oversight over Eastland's activities. Id. at 841. The court
further noted that Eastland operated on extremely thin
capitalization and that Malone & Hyde had furnished Northwestern
with hold harmless agreements on two occasions. The court stated
that the presence of the hold harmless agreements and
undercapitalization (two factors which had been identified in
Humana Inc. v. Commissioner, 881 F.2d at 254 n.2, as weaknesses
that in themselves provided a sufficient basis on which to find
no risk shifting) "indicates that the captive insurance scheme
established by Malone & Hyde was not an 'otherwise bona fide
Page: Previous 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 NextLast modified: May 25, 2011