* Goldman Sachs, King & Spalding marketed partnerships
* 5th Circuit directs judge to consider higher penalty
By Jonathan Stempel
Sept 10 (Reuters) - Dow Chemical Co is not entitled to more than $1 billion of tax deductions based on a decade of transactions with "sham" partnerships that Goldman Sachs Group Inc and the law firm King & Spalding promoted, a federal appeals court decided on Wednesday.
A unanimous three-judge panel of the 5th U.S. Circuit Court of Appeals let stand a lower court ruling that Dow entered the two Chemtech partnerships that ran from 1993 to 2003 mainly to avoid taxes, and had no legitimate business purpose for them.
Circuit Judge Jerry Smith said the partnerships left the foreign banks that participated in them with "effectively no risk" to their initial investments or intended returns, while also preventing them from meaningfully sharing in any upside.
"The district court did not clearly err in determining that Dow lacked the intent to share the profits and losses of the Chemtech transactions with the foreign banks," Smith wrote. "We therefore affirm the district court's sham partnership holding."
Wednesday's decision upheld a Feb. 2013 ruling by U.S. District Judge Brian Jackson in Baton Rouge, Louisiana.
Jackson agreed with the Internal Revenue Service that Dow did not deserve the tax benefits, and also imposed a 20 percent penalty for negligence and substantial understatement of taxes.
Citing an intervening U.S. Supreme Court decision, the 5th Circuit directed him to consider a possible 40 percent penalty for any alleged "gross valuation misstatement" of taxes.
Rebecca Bentley, a Dow spokeswoman, said the Midland, Michigan-based company is disappointed with Wednesday's decision.
"Dow has paid and accrued all taxes, interest and penalties relating to the transaction; however, Dow appealed the U.S. District Court ruling maintaining that the taxes at issue were wrongly assessed by the IRS," she said in an emailed statement. "We are evaluating our options."
Goldman spokesman Michael DuVally declined to comment. King & Spalding did not immediately respond to requests for comment. Goldman and King & Spalding are not defendants in the case.
The case involved the partnerships Chemtech I and Chemtech II, which ran respectively from 1993 to 1997, and 1998 to 2003.
Chemtech I was a type of tax shelter marketed by Goldman to large companies under the name SLIPs, which stood for Special Limited Investment Partnerships, while Chemtech II was created by King & Spalding. The law firm helped implement both.
The 5th Circuit said Chemtech I allowed deductions for royalty costs tied to the use of 73 Dow patents, while Chemtech II allowed deductions tied to the depreciation of a $715 million chemical plant that had a tax basis of just $18.5 million.
In afternoon trading, Dow shares were down 20 cents at $53.26 on the New York Stock Exchange.
The case is Chemtech Royalty Associates LP v. U.S., 5th U.S. Circuit Court of Appeals, No. 13-30887. (Reporting by Jonathan Stempel in New York; Editing by Bernard Orr)