Deferred Prosecution Agreements and Tax Write-Offs

Earlier today the US Department of Justice announced that it has reached a deferred prosecution agreement with Toyota Motor Corporation regarding the “unintended acceleration” issues that owners of certain models claim to have experienced back in 2009 and 2010.  The announcement is of little note; as with most announcements of its kind it represents a chance for the DOJ to publicize itself and it is understandably a bit over-eager to praise the victory for safety.  The agreement itself, however, is interesting as Toyota has agreed to treat the $1.2 billion settlement amount as a penalty paid to the US government, including for tax purposes.  The upshot is that Toyota will not be able to take a tax deduction or credit for paying the settlement.

This sort of stipulation against tax deductibility is not unique (BP’s settlement for the Deepwater Horizon oil spill was subject to a similar restriction), but it has historically been rarer than one might expect.  Today’s agreement with Toyota represents one more example of a developing trend in which the US government uses stipulations in settlements and deferred prosecution agreements to prevent companies from mitigating a portion of damages payouts by taking advantageous tax positions.  On the one hand, this seems only logical.  After all, the immediate emotional response to hearing that a company has written off the payment of a court settlement is, quite naturally, that there is a certain lack of “fairness” in allowing a company to get a tax benefit from a settlement or court-ordered payout.

On the other hand, those of us with a stronger background in Finance might argue that the net result is little different in the long run since companies will ultimately take the lack of potential deductibility into account when negotiating settlement amounts.  Naturally, such negotiation would not apply to court-ordered settlements resulting from litigation that reaches trial, but the tendency towards settlement in modern litigation suggests to me that these cases would be rather rare.

Even if the long-run financial affects of these stipulations are effectively null, as I believe they likely are, I still view the development and increased use of such restrictions to be an overall benefit.  By prohibiting the use of settlement payments for write-offs we increase the perceived fairness of both the tax and legal systems, which is never a bad thing.

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