United Parcel Service v. Commissioner of Internal Revenue
Dr. Shapiro was retained by the Internal Revenue Service to opine on, among other things, the arm’s length nature of proposed payments to be made by Overseas Partners, Ltd. ("OPL"), a wholly-owned subsidiary of United Parcel Service, to National Union Fire Insurance Co. (“NUF”). Dr. Shapiro examined the reasonableness of the price set on the NUF policy using a return-on-equity (“ROE”) approach. That is, he calculated the ROE OPL would have earned had it received the set price, and compared this ROE to that earned by other companies during the relevant time frame. As Judge Ruwe explained in the United States Tax Court decision:
Respondent's expert, Prof. Alan Shapiro, Ph.D., professor of finance and business economics, estimated that $0.092 per $100 of declared value in excess of $100 would have been an arm's-length price for insurance covering petitioner's excess value activity. Professor Shapiro based his analysis on the proposition that an arm's-length price for OPL's excess value coverage would be one that over time provided OPL with a fair return on its necessary equity investment.
In coming to his conclusion, Professor Shapiro compared what OPL's return on equity would have been had it been reinsuring the EVC activity during the years 1979 through 1983 with that of other members of the insurance sector OPL would have operated in. Professor Shapiro's report contained the following chart, which includes Value Line statistics regarding return on equity in each year for 22 property/casualty insurers and diversified insurance companies:
[Chart and footnote in original not included]
Professor Shapiro concluded that had OPL been in existence during the periods preceding 1984 and had it charged a fee of 25 cents (instead of $0.092) per $100 in excess value coverage, it would have earned huge persistent returns and that "OPL's ROE would have been over four times as large as the highest return earned by any of the Value Line companies in any year, and its average ROE of 173.6 percent would have been almost 10 times the average ROE of 18.0 percent earned by the Value Line companies."
(pp. 97-99)
Dr. Shapiro’s opinions were favorably considered by the Tax Court, which ruled that the 25-cent price was not an arm’s length price.
After carefully considering the entire record, including the expert reports offered by both petitioner and respondent, we are persuaded that the price of 25 cents per $100 of excess value liability paid to NUF pursuant to the Shippers Interest contract that petitioner and NUF agreed to was not a result of arm's length negotiations and that the price of 25 cents per $100 was far in excess of the price that could have been negotiated by petitioner.
(pp. 101-102)
The full text of the Tax Court decision is available here.
