First Circuit Rules in Favor of Dialysis Operator in Tax Dispute

by King & Spalding

On August 13, 2014, the United States Court of Appeals for the First Circuit affirmed a district court’s judgment in a tax dispute proceeding that Fresenius Medical Care Holdings, Inc. (Fresenius) was entitled to more than $50 million in tax refunds relating to prior settlement payments made under the federal False Claims Act (FCA). The First Circuit concluded that the absence of a tax characterization agreement between the United States and Fresenius in connection with the resolution of an array of FCA claims did not preclude Fresenius from claiming that a certain portion of the total settlement amount was tax-deductible.

In 2000, Fresenius, an operator of dialysis centers, entered into a global settlement under which it agreed to settle a number of criminal and civil claims. As part of the settlement, Fresenius agreed to pay over $486 million, which included approximately $101 million in criminal fines and approximately $385 million relating to the allegations of civil violations of the FCA. Importantly, the agreements underlying the global resolution were silent as to the tax treatment of the sums paid by Fresenius.

Following the global resolution, a dispute arose between the United States and Fresenius concerning Fresenius’s ability to claim as tax-deductible a certain portion of the civil settlement payments. The parties did not dispute that the criminal fines levied against Fresenius were nondeductible or that the single damages under the FCA, which provides for up to treble damages, were deductible. (Punitive payments, such as criminal fines, are generally nondeductible, whereas compensatory payments can be deducted.) The parties disagreed, however, as to the treatment of roughly $127 million in excess of single civil damages.

Fresenius eventually filed a tax refund action in Massachusetts federal district court. A jury returned a verdict in Fresenius’s favor, finding that $95 million of the settlement payments was deductible. The district court then ordered tax refunds to Fresenius totaling more than $50 million. The United States appealed.

The issue before the First Circuit was whether a court is permitted to consider factors other than the presence, or absence (as in Fresenius’s case), of a tax characterization agreement when determining the tax implications of an FCA civil settlement. The First Circuit ruled that a court is permitted to do so, rejecting the government’s argument that, in the court’s words, “any FCA civil settlement sums in excess of single damages . . . be treated as punitive fines (and, thus nondeductible) unless the parties have manifested a contrary intention.”

Recognizing that its holding may be at odds with its sister Ninth Circuit’s decision in Talley Industries v. Commissioner, 116 F.3d 382 (9th Cir. 1997), the First Circuit noted that “generally accepted principles of tax law compel us to part company with the Ninth Circuit.” As a practical matter, the First Circuit observed that a rule requiring a tax characterization agreement as a precondition to tax-deductibility would allow the government to “always defeat deductibility by the simple expedient of refusing to agree.” The First Circuit further reasoned that courts tasked with determining tax characterizations of private transactions typically assess the substance of the transaction (i.e., its “economic realit[ies]”) rather than the form of the transaction. The court also pointed to a “fundamental tenet of tax law” providing that settlement payments should receive the same tax treatment “as would have applied had the dispute been litigated and reduced to judgment.” If an FCA claim is tried, the court observed, there can be no tax characterization agreement to address the tax impact of any awarded damages. For these and other reasons, the court concluded that the absence of a tax characterization agreement was not dispositive and that Fresenius was entitled to a refund.

The case is Fresenius Medical Care Holdings v. United States, No. 13-2144 (1st Cir.). You can read the First Circuit’s opinion here.

Reporter, Greg Sicilian, Atlanta, +1 404 572 2810,

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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