Help Me! I'll sue you

U.S. Extends AIG Bailout by up to $30 Billion is the headline of the story; the sub-head is: New Terms Give Treasury 77.9% Equity Interest; Insurer Posts $61.66 Billion Loss

On the same page 12 that the story ends in today's ediutions of the Journal, is this nugget.

March 2, 2009, 12:02 a.m. ET

In Twist, AIG Sues Its Benefactor Over Taxes

by Jesse Drucker and Liam Pleven

In the midst of its negotiation with the federal government over revised terms of its bailout, American International Group Inc. sued the U.S. on Friday over a disputed $306 million in taxes, interest and penalties.

The federal government is giving the company over $150 billion to save it, and the company is suing the government. Hello?

The suit steps up a battle with the Internal Revenue Service largely over AIG's use of a controversial type of "tax arbitrage" transaction that authorities are challenging across the world.

With the company essentially suing its owner, the suit highlights the awkwardness of national control of AIG, which the government rescued from potential bankruptcy in September. If through litigation "you're moving money from one pocket to another, why should we be paying lawyers to do that?" says David Weisbach, a tax law professor at the University of Chicago.

Awkwardness of national control? How about awkwardness of corporate types not getting the message: the old days of ciutting corners are done. You messed up, you lost.

"AIG is taking this action to ensure that it is not required to pay more than its fair share of taxes," said a company spokeswoman. An IRS spokesman declined to comment. In its lawsuit, filed in U.S. District Court in Manhattan, AIG for the first time laid out significant details about its role in the so-called "foreign tax generators" in dispute with the IRS. The general nature of the disagreement was previously disclosed in company securities filings and reported by The Wall Street Journal in May.

The foreign tax credit transactions detailed in the lawsuit took place in 1997, but AIG said in a securities filing that it also expects the IRS to challenge similar deals from more-recent years. The company paid the amounts in dispute and is now suing for a refund.

In a typical transaction, an AIG subsidiary would borrow money at favorable interest rates from an overseas bank and also earn investment income. It would pay foreign taxes and earn a foreign tax credit in the U.S. for those foreign taxes. Simultaneously, the subsidiary would pay dividends to the foreign bank that lent it the money. The foreign tax laws generally exempted those dividends from taxation to the foreign bank.

Tax authorities are concerned that the arbitrage of the two sets of tax laws allows companies to essentially double-dip, taking two tax benefits in two different countries simultaneously.