Nortel Networks Corp. has reached an interim resolution with the U.S. Internal Revenue Service, removing a possible risk to the $900 million US sale of the Canadian company's enterprise solutions unit to Avaya Inc.

Nortel Networks Corp. has cleared a major hurdle in selling its enterprise unit to Avaya Inc. by settling a long-standing tax dispute with the U.S. Internal Revenue Service. (Fred Chartrand/Canadian Press)

According to documents filed in a U.S. bankruptcy court in Delaware on Thursday, Nortel and IRS officials reached an "interim resolution" over the U.S. government's claim that Nortel owes nearly $3 billion US in taxes.

While the settlement doesn't end Nortel's quarrels over claims it owes back taxes going back more than a decade, it does end the possibility the dispute will jam the deal with Avaya.

According to a Sept. 7 agreement filed with the court on Thursday, IRS will not try to hold Avaya Inc. responsible for any of Nortel's unpaid taxes.

In August, even before Avaya won an auction for the Nortel unit, the IRS filed a series of claims for taxes it says Nortel owed over a 10-year period from 1998 through 2008.

The claim, filed Aug. 20, says Nortel owes $1.8 billion US in taxes and $1.16 billion US in interest up to that date.

Major hurdle cleared

Nortel said the IRS claims were unfounded and noted Avaya has the right to walk away from the purchase of Enterprise Solutions if Nortel failed to come to an acceptable resolution of its tax issue by Oct. 15.

Nortel was told to prepare for a hearing on Oct. 13 so a U.S. bankruptcy judge could decide how much of the claim was legitimate.

Under the interim agreement with the IRS, that hearing will now be adjourned, according to court documents.

The documents say Nortel has agreed that it will owe the IRS a minimum claim of at least $9.8 million US after its final tax liability was determined.

In addition, Nortel and the IRS have agreed that a portion of the proceeds from the Avaya transaction will be held in an escrow account pending the resolution of the larger tax issue and a court order freeing the funds.

The IRS has also agreed that shares of Nortel Government Services and DiamondWare, which were part of the Enterprise Solutions transaction, will be transferred to Avaya "free and clear" of all IRS claims.

Since filing for bankruptcy in January, Nortel has been disposing of its units piece by piece to pay creditors, who are claiming they are owed more than $11 billion. The claims have yet to be approved by the court.