The Kentucky Court of Appeals has affirmed in part a decision by the Kentucky Circuit Court finding Grant Thornton liable for fraudulent misrepresentation in its selling of a tax shelter.

The Court of Appeals upheld the trial court’s award of nearly $20 million in compensatory damages, but reduced punitive damages from $80 million to $20 million in the case of Grant Thornton, LLP v. Yung.

The shelter, a variant of the son-of-BOSS shelter, was a product developed by Grant Thornton called the Leveraged Distribution 301, or Lev301, involving a foreign corporation borrowing money to purchase Treasury Notes, encumbered for their full amount to secure the debt incurred by the foreign corporation to purchase the notes.

The fully encumbered notes would then be transferred to corporate shareholders in the U.S. Since the notes were fully encumbered, they had no taxable value and would not be reported as income. When the foreign corporations repaid the loans, the loan repayment would not result in reportable income to the shareholders because they were not co-obligors on the loans.

The court said that Grant Thornton, by encouraging the Yungs to proceed with the Lev301 transactions even after the IRS issued notices rejecting similar transactions, committed fraudulent misrepresentation. Punitive damages were appropriate, according to the court, because Grant Thornton’s fraudulent conduct was carried out over an extended period of time and toward multiple customers. However, the amount of the punitive damages, in a 4:1 ratio of punitive to compensatory damages, exceeded the bounds of constitutional due process. Therefore, it remanded for a new judgment of punitive damages equal to the amount of compensatory damages.

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