Attorney-at-Law

UPSTREAMING

In Uncategorized on 08/06/2018 at 17:24

They Have the Tools to Do the Job

Illinois Tool Works & Subsidiaries, 2018 T. C. Memo. 121, filed 8/6/18, has subsidiaries all over the world. ITW therefore had cash stashed all over the world. ITW brought back nearly $1 billion during the 2004 “tax holiday” for offshore repatriators, but wanted more. Alas, its top-tier subsidiary, a mega holding company, had no E&P left. And the holiday was over.

But ITW wanted more low-tax or no-tax cash. Its cash unstashing department decided to use their European “notional” cash pool. All the subs in Europe would borrow from various banks for operating purposes, and pool all their receipts with a Dutch bank. As receipts exceeded loan balances, each sub got a bookkeeping credit or debit, but no cash changed hands.

The “leader” of the “notionals” was the top-tier sub, but it didn’t have certified financials, so it couldn’t get a bank loan. Instead, ITW did an intercompany loan, and treated the proceeds as return of capital.

IRS claimed it was all taxable dividends.

Here’s Judge Albert G (“Scholar Al”) Lauber.

“This loan was documented in a one-page promissory note that provided for 6% simple interest and a five-year repayment term….  No principal payments were due until maturity, and there was no premium or penalty for early repayment.  The note stipulated that [upstreamer] could enforce payment of principal and interest, made no provision for subordinating the debt to [downstreamer’s] other obligations, and stated that Delaware law would govern its interpretation.  [Upstreamer] recorded this note on its books as an intercompany note receivable, and [downstreamer] recorded it as an intercompany note payable.” 2018 T. C. Memo. 121, at p. 13.

When the loan came due, IRS was auditing ITW, so the maturity of the note was extended for one year.

But it was truly debt. ITW and its subs ran over a hundred intercompany loans, and all were “paying as agreed,” as the credit reporters say. The documentation was binding and, while there was the usual; battle of the experts over whether the debt was bankable, the plurality of experts rated the note at BBB+.

And their books and their Forms 5471 reported the loan as such.

Whether or not ITW could have raised money by other means is not to the point. The upstreamer had the means to repay, and extending during the audit doesn’t count against ITW (and there’s caselaw that says so).

The suspicious factor is that the proceeds were used to give the parent tax-free cash.

“It is not clear how the ‘use of funds’ factor should be evaluated here.  The shareholder-debtor in this case is a corporation, not an individual, and corporations do not have ‘personal purposes.’  Nor is this a debt/equity case.  One might say that the immediate use of the lent funds–to make a corporate distribution—has the feel of a dividend.  But the ultimate use of the lent funds–to repay short-term CP [“cash pool”] indebtedness–may suggest a back-to-back loan driven by operational business necessities.  On balance, we conclude that this eighth factor is best regarded as neutral and in any event is not entitled to great weight.” 2018 T. C. 121, at pp. 43-44.

The ordinary “thou shalt not”s of commercial loans (no dividends, no acquisitions, no bonuses while loan outstanding) don’t apply in intercompany deals.

IRS tries economic substance (pre-2015 version), step transaction and conduit. All fail.

Judge Lauber gives a useful lecture on summary witness vs expert witness. All a summary witness does is tell what facts and methods used to reach a conclusion. No technical, scientific or specialized knowledge needed; much like a RA doing a show-and-tell on income reconstruction from bank records. And the summarizer establishes the upstreamer had sufficient basis to offload the loan proceeds as return of capital.

Now IRS did want the Section 6662(a) chop, and long-time readers of this my blog may recollect that IRS got a shot at it; see my blogpost “Upping the Ante,” 12/2/14. But when ITW wins, it goes down.

ITW’s tax team really had the tools.

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