A federal judge in Texas has ruled that a widely used aggressive tax shelter was based on fake bank loans and is therefore not legitimate, giving an unexpected boost to federal prosecutors overseeing a widening criminal investigation into tax shelters.
The shelter, known as Blips, plays a central role in the criminal inquiry of Deutsche Bank over questionable tax shelters and in the pending criminal trial in federal court in Manhattan of 16 former employees of the accounting firm KPMG and two outsiders.
The civil ruling on Tuesday by Judge T. John Ward of Federal District Court for the Eastern District of Texas will probably add ammunition to Manhattan prosecutors' arguments that Deutsche Bank acted improperly by providing fake loans for Blips and similar shelters. Judge Ware's is the first major civil ruling on the legitimacy of Blips, or bond-linked issue premium structure.
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It is also likely to bolster prosecutors' case against certain KPMG defendants who are also named in the judge's ruling. They are John Larson, Robert Pfaff and David Amir Makov, all former employees of an investment firm called Presidio Advisory Services, now defunct. According to previously disclosed internal Deutsche Bank documents, Blips was created and sold primarily by Deutsche Bank, KPMG and Presidio.
Judge Ward's ruling is also notable in that it absolves of any guilt two wealthy Texas investors who bought Blips. The investors were Harold W. Nix and C. Cary Patterson, two lawyers on a legal team that earned sizable fees for winning a $17 billion tobacco settlement for Texas in 1998.
Mr. Nix and Mr. Patterson sued the Internal Revenue Service after it disallowed their claims for around $25 million each in losses stemming from Blips on their federal tax returns from 2000 through 2002.
Judge Ward ruled that both investors must pay the taxes they owe, but that they were not liable for multimillion-dollar penalties stemming from their use of Blips.
Judge Ward ruled that Mr. Nix and Mr. Patterson genuinely thought that what they were making a legitimate investment, that they learned only later of the tax benefits and that they reasonably relied upon the advice and opinions of their accountants and lawyers, including George A. Hrdlicka, a prominent Houston lawyer who told them that Blips was ''above the board.''
An I.R.S. spokesman, Terry Lemons, said, ''We're reviewing the decision.''
Blips, one of the most widely used aggressive shelters of the late 1990s through recent years, was sold to wealthy investors as a three-year, seven-stage investment that revolved around bank loans and trading of foreign currencies and securities.
But Judge Ward, echoing arguments made by Manhattan prosecutors pursuing Deutsche Bank and the KPMG group, found that Blips was not a real investment at all, that its loans were fake and that it had no economic substance or genuine business purpose -- hallmarks of a bogus tax shelter.
Instead, investors in Blips always got out of the deals after around 60 days and shifted artificial losses from the fake loans to partnerships that were then used to improperly claim tax deductions.
The judge's ruling may also draw yet more companies into the widening criminal investigation, because it details how NatWest, a British bank now owned by Royal Bank of Scotland, knowingly provided the fake loans for Mr. Nix's and Mr. Patterson's shelters.
''NatWest and Presidio viewed the loan transactions as involving zero credit risks,'' Judge Ward wrote. ''In truth, NatWest did not make any loans.'' NatWest, which is headquartered in London, could not be reached immediately for comment.
Another German bank, HVB Group, reached a $29 million deferred-prosecution agreement with the Justice Department in February 2006 after admitting to criminal wrongdoing in providing fake loans for Blips and other aggressive shelters. KPMG also admitted to criminal wrongdoing with Blips and three other shelters in its $456 million deferred-prosecution agreement in mid-2005.
In an earlier procedural decision last July, Judge Ward ruled that the I.R.S. had merely overstepped its authority when it retroactively applied tougher Treasury Department rules to liabilities like those used in Blips.
Copyright 2007 The New York Times Company