Attorney-at-Law

WHEN JUDGE DAVID GUSTAFSON DISSENTS

In Uncategorized on 02/25/2019 at 15:59

Take Heed

That long-running saga, Eaton Corporation and Subsidiaries, 152 T. C. 2, filed 2/25/19, has Judge Kerrigan marrying Section 964 to Section 312, to nail Eaton’s upper tier CFC partners with the earnings and profits (E&P) of the partnership dragged in by Section 951(a).

The Uppers claim Section 964 just requires them to adjust their balance sheets and profit and loss statements to US accounting standards, rather than that of their home countries. Eaton had an LLC box-checked as a partnership, in which were members (partners) who were CFCs.

IRS wanted to bootstrap Section 312 corporate concepts onto Section 964 foreign concepts.

“We must first decide the universe of regulations to which the phrase ‘under regulations prescribed by the Secretary’, as used in section 964(a), refers.  That phrase, as enacted in 1969, is naturally read to refer to any regulations that the Secretary might later promulgate under section 964(a).  But given the statutory text, we believe that this phrase also refers to regulations that the Secretary had previously promulgated, or might in the future promulgate, under section 312.

“The phrase ‘under regulations prescribed by the Secretary’ immediately follows the phrase ‘rules substantially similar to those applicable to domestic corporations’.  Section 964(a) provides that the same general rules apply to E&P computations for domestic and foreign corporations.  Since those rules are set forth both in section 312 and in the regulations interpreting it, the reference to ‘regulations’ in section 964(a) is reasonably read to include regulations promulgated under section 312 as well as under section 964(a).  There is nothing in the text of section 964(a) that limits the scope of ‘regulations’ to regulations that might later be promulgated under that specific provision.” 152 T. C. 2, at pp. 12-13. (Footnotes omitted, but the second one says when Treasury wanted to limit the regulations to a specific subsection, they said so.).

Eaton claims Section 964 is a stand-alone. When they conformed the Uppers’ books to US GAAP, that was it. If Treasury should have gone farther, that’s Treasury’s problem.

Judge Kerrigan and the majority say that makes Section 964 meaningless. Why adjust your books if the adjustment has no tax consequences.  “Without reference to the detailed rules of section 312 and the regulations interpreting it, it would be without meaning–employing the section 964 regulations alone–to perform an E&P computation for a foreign corporation.  As noted earlier section 312 and the regulations thereunder explain how numerous corporate transactions and events affect E&P.  These include distributions of property, distributions of appreciated property, distributions of property subject to indebtedness, distributions of stock and securities, tax-free distributions, redemptions, corporate separations and reorganizations, discharge of indebtedness income, depreciation, installment sales, and LIFO inventory adjustments.  See sec. 312.  The section 964 regulations do not address or even mention any of these things.  This makes it clear that the E&P of a foreign corporation must be determined by applying the general rules of section 312 that govern E&P computations for a domestic corporation.” 152 T. C. 2, at pp. 23-24.

Judge Morrison concurs, but says the majority missed a step by not factoring in Reg. Section 1.964-1(a)(1), which requires CFC to compute E&P like a domestic.

Ch J Maurice B (“Mighty Mo”) Foley, joined by that Obliging Jurist Judge David Gustafson, says the majority got it backwards. Section 964 incorporates only the depreciation rules of Section 312(k(4), nothing else. Judge Kerrigan is reading everything else in.

But the Section 964 regs only require the onshore recomputation. The phrase “under regulations prescribed by the Secretary” did not mean anything other than the Section 964 regs, not any other Regulation, past, passing or to come, that IRS or Tax Court might see fit to throw into the mix.

And Ch J Mighty Mo leaves a good argument in a footnote. “In 2009 the Secretary identified transactions similar to the transaction at issue as a ‘Transaction of Interest’ that had the ‘potential for tax avoidance.’  See Notice 2009-7, 2009-3 I.R.B. 312.  In 2010 the Secretary stated he would promulgate regulations to address these purported ‘tax avoidance’ transactions. See Notice 2010-41, 2010-22 I.R.B. 715.  He has not.  Curiously, respondent now asks the Court, rather than his Office of Tax Policy scriveners, to interpret sec. 1.964-1, Income Tax Regs., to halt a transaction similar to those he has for a decade deemed problematic.” 152 T. C. 2, at pp. 30-31.

“The Secretary is bound by the terms of the rules he created.  Similarly, taxpayers are bound by the applicable rules, but they are not required to employ their imagination to divine them.  Petitioner may have found a hole in the dike, but the closing of the hole ‘calls for the application of the * * * [Secretary’s] thumb, not the court’s.”  Fabreeka Prods. Co. v. Commissioner, 294 F.2d 876, 879 (1st Cir. 1961), vacating and remanding 34 T.C. 290 (1960), Friedman v. Commissioner, 34 T.C. 456 (1960), and Sherman v. Commissioner, 34 T.C. 303 (1960).  In short, we must interpret, not make, the law.” 152 T. C. 2, at p. 31.

Given Judge Gustafson’s monumental silt-stir with Section 6751(b), don’t bet this is the last word on this subject. Especially when tax on $187 million is on the table.

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