Attorney-at-Law

ACT OF STATE

In Uncategorized on 09/18/2018 at 16:58

Judge Albert G (“Scholar Al”) Lauber gets to leap from Hong Kong to Cyprus without leaving the Glasshouse at 400 Second Street, NW, today, as IRS gets summary J in Hong Kong, but Cyprus is a question of fact.

Barry M. Smith and Rochelle Smith, 151 T. C.5, filed 9/18/19, had a couple wannabe CFCs (hi Judge Holmes) under their umbrella of grantor trusts and a Sub S. They were winding down the Hong Kong one, and hoped the big payout that the Hong Kong sub collected would be taxed at the preferential rate.

Judge Lauber takes upon the story: “Petitioners hoped that the contemplated distribution could be treated as ‘qualified dividend income’ (QDI) under section 1(h)(11)(B), which would allow the dividend to be taxed at a rate of 15% or lower. See sec. 1(h)(1), (11)(B). This would be possible only if [HK] were a ‘qualified foreign corporation’.” 151 T. C. 5, at p. 6.

Sorry, Barry and Rochelle. To be a CFC and get the Section 1(h)(11)(B) (author’s note: if the 11B means nothing to you, consider yourself lucky), the corp must either be incorporated in the US or in a country with a tax treaty with country of incorporation permitting same.

Problem: although China and the US have such a treaty, Hong Kong is expressly excluded from the terms thereof.

So Barry and Rochelle go shopping for a friendly country. And Cyprus is just the place. So they incorporate a Cypriot sub (hereinafter sometimes referred to as Cs), all of whose shares are owned by the US Sub S, transfer all their shares in HK to Cs, and do a Section 368(a)(1)(F) tax-free reorg.

Cs filed with IRS as a wholly-owned sub of a US Sub S.

Earlier, however, Barry and Rochelle took advantage of Section 951 on assets held by HK and paid tax. But Section 962 required inclusion of the net-after-tax amount of the remainder, and that Barry and Rochelle never did. Clear? Thought not.

Meanwhile, Cs held a big receivable owing from US Sub S, that Cs wrote off.

Barry and Rochelle get $57 million from Cs as a dividend, and claim qualified dividend (15% style) from Cs as a CFC.

“Petitioners alleged in their petition that [Cs] had ‘obtained a tax residency certificate from the Cyprus tax authorities confirming its Cyprus tax residence’ during 2009.
Petitioners subsequently amended their petition to allege that [Cs] had ‘obtained a confirmation letter of Amicorp (Cyprus) Ltd., administrators of [Cs], confirming that [Cs] was a tax resident of Cyprus during all relevant times.” 151 T. C. 5, at p. 11.

IRS, ever the spoiler, invokes the Competent Authority, the spokesperson at the highest level of International taxation. The Cypriot CA dished in extenso, and this made it into the record.

First, the light lifting. Whatever Barry and Rochelle got from HK before the Cyprus shift is ordinary; HK wasn’t incorporated in the US, and there wasn’t and isn’t a tax treaty with Hong Kong.

As for Barry’s and Rochelle’s claim that Section 962 “moved up” HK to a “notional US C Corp,” via the Section 962 taxed-as-if-US-C-Corp,  “(W)e discern no support for this theory in the statute, the legislative history, the regulations, or judicial precedent.” 151 T. C. 5, at p. 20.

The language of Section 962 is in the subjunctive mood, says Judge “Scholar Al” Lauber, and therefore counterfactual. Remember Hans Vaihinger and the “philosophy of ‘as if’.” If not, see my blogpost “As If,” 11/22/16.

HK is not a CFC, and the HK money is taxed at ordinary rates.

But Cs is another story.

Cs was Cyprus registered, but didn’t bother filing four (count ‘em, four) years’ worth of tax returns, got struck off the Cyprus corporation roster, but got quickly restored on an unsigned certificate of a director of Cs, who claims everything is just fine. But the key is actual management and control being vested in Cyprus, and there’s only the director’s filled-in form for that.

Barry and Rochelle claim restoring Cs to corporate status by Cyprus is an act of state, not to be interfered with by US Courts, lest they damage our foreign relations. But where there’s a treaty, it’s different. Here there is one, and the Cyprus CA says effective management and control onshore is the key.

“For several reasons we find that petitioners have not satisfied their burden to show that the act of state doctrine applies. To begin with, we question whether the issuance of the residency certificates rises to the level of an ‘act of state.’ The certificates were issued five days after the application was filed. The application consisted of unsubstantiated representations by a [Cs} director, who checked ‘yes’ boxes on the application form. Apart from confirming the filing of tax returns—[Cs]’s returns for [missing years] were submitted the day before the application, they were at least four years late, and two of them were unsigned– there is no evidence that the Ministry verified any of the applicant’s factual representations.” 151 T. C. 5, at p. 37.

This is more a clerical act than a sovereign act. So question of fact if Cs was really commanded and controlled from Cyprus.

The written-off receivable? Taxed as ordinary income. That there were tax payments in prior years don’t limit IRS.

 

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