The puzzling IRS $3Billion claim against Nortel

If it is allowed to stand, the IRS claim of $3Billion against Nortel will devastate the estate and reduce the chances for all other creditors of being repaid anything reasonable.

The IRS claim could materially affect the global settlement, including the Canada Estate. If this claim stands, the Global Estate claim would fall from an estimated value of 40% to 14%.

The claim by the IRS is very puzzling. Nortel would have had to make incredible profits over the last decade in order to owe such a sum. I hope that there will be lots of challenges to this. It looks to me like the IRS is placing a claim (with priority) in order to get as much as possible back for themselves and maybe the PBGC: (the PBGC estimates the trust fund to be short by $514M). It will hurt all the other creditors and retirees if this is allowed to proceed and it will do nothing to help the US retirees since their pensions will be subject to the PBGC rules anyway.

The Canadian court and the monitor need to raise serious questions about this. The creditor committee in the US also needs to review this urgently and seriously. And the court appointed counsel for the unsecured creditors needs to be involved up front and objecting strenuously to this outrageous claim.

The basis for the claim seems to be somewhere in the transfer pricing methodology used by Nortel. This is even further mystifying since the IRS had already entered into a preliminary agreement with the Canadian tax authorities earlier.

In the first quarter 2009 Nortel submitted a 10-Q form which is an SEC requirement for declaration of financial status. There was discussion of agreement between the US and Canadian tax authorities, and Nortel apparently managed their taxes with the knowledge of both tax authorities. So why is the IRS submitting a claim of such magnitude at this point, and why was this not raised in prior years? Something definitely is awry.

This is an extract from the 10-Q

In September 2008, with respect to the 2001-2005 APA under negotiation, the Canadian tax authorities provided the U.S. tax authorities with a supplemental position paper (Canadian Supplemental Position). We have evaluated the Canadian Supplemental Position and have adopted it under FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109” (FIN 48), as the most likely of the possible outcomes. We believe that the Canadian Supplemental Position provides a reallocation of losses between the U.S. and Canada that moves toward a compromise of the reallocation provided in a prior U.S. position (U.S. Position) paper.

The Canadian Supplemental Position Paper resulted in a decrease as at September 30, 2008 of the deferred tax assets in the U.S. of $345, with a corresponding reduction in the valuation allowance, and an increase in deferred tax assets of $378 in Canada, with a corresponding increase in the valuation allowance. We received verbal communication from the Internal Revenue Service (IRS) in December 2008 stating that a tentative settlement on the 2001-2005 APA had been reached between the U.S. and Canadian taxing authorities. We have not received any written communication from the taxing authorities regarding the details of this tentative settlement. We expect the Canadian and U.S. tax authorities to meet to discuss the final settlement position in the next few quarters. We are unsure of the impact, if any, of the Creditor Protection Proceedings on the APA negotiations.

We are not a party to the government-to-government APA negotiations, but we do not believe the ultimate result of the negotiations will have an adverse impact on us or any further adverse impact on our deferred tax assets.