In matter of first impression, U.S. Tax Court reviews the "check-the-box" regulations in the context of foreign companies
In the following case, the U.S. Tax Court addresses the interaction between the so-called "check-the-box" regulations and the definition of foreign personal holding company income. In particular, the Court reviews whether the deemed sale of assets immediately after their deemed receipt (pursuant to the check-the-box regulations) from a disregarded foreign entity gives rise to "foreign personal holding company income" (FPHCI).
Dover Corporation is a diversified industrial manufacturer incorporated in Delaware. It is publicly traded and has its main place of business in New York. Dover filed a consolidated income tax return for its group of companies.
In the United Kingdom (UK), Dover conducted its elevator business through a UK subsidiary that in turn owned subsidiary, Hammond & Champness Limited (H&C). In June 1997, Dover sold H&C to a German industrial conglomerate, Thyssen, for the entire issued share capital of H&C. In December 1998, Dover requested the Internal Revenue Service (IRS) to grant an extension of time for H&C to file a retroactive election to be a disregarded entity for Federal tax purposes (9100 relief).
The IRS eventually granted Dover's request, but stated that "no inference should be drawn from this letter that any gain from the sale of ... [H&C's] assets immediately following its election to be disregarded as an entity separate from its owner gives rise to gain that is not foreign personal holding company income as defined in section 954(c)(1)(B) of the Internal Revenue Code." Section 954(c)(1)(B)(iii) defines FPHCI in part, and is part of Subpart F that concerns controlled foreign corporations (CFCs). Section 951(a)(1)(A)(I) provides that each U.S. shareholder of a CFC shall include in gross income certain amounts, including the "pro rata share" of the CFC's subpart F income for the taxable year.
Subpart F income includes foreign base company income, which in turn includes FPHCI. Under Section 954Β©), FPHCI is "the portion of the gross income which consists of: .... (B) Certain property transactions. " The excess of gains over losses from the sale or exchange of property " ... (iii) which does not give rise to any income."
Subsequently, H&C made an election on Form 8833 [Entity Classification Election] to be disregarded as a separate entity. The IRS assessed a federal income tax deficiency for 1996 and 1997 totaling approximately $34 million, due largely to the sale of H&C.
The "check-the-box" regulations issued in December 1996 permit most domestic and foreign businesses organizations (included single-owner organizations) to elect between association and partnership classification for federal tax purposes. Single-owner organizations may elect "to be recognized or disregarded as entities separate from their owners." (Section 301.7701-1(a)(4), Proced. & Admin. Reg.). The preamble to the final regulations warns that the U.S. Treasury and the IRS will monitor the uses of partnerships in the international context and take appropriate action when partnerships are used to reach results that are inconsistent with rules, policies, or U.S. tax treaties.
The U.S. Tax Court concludes that the Dover's UK gain on the deemed sale of the H&C assets does not constitute FPHCI to Dover under Section 954(c)(1)(B)(iii).
Dover argues that the check-the-box regulations override the principle that the separate entity status of a corporation may not be ignored for federal tax purposes. Consequently, Dover's UK subsidiary was deemed engaged in H&C's business and H&C assets are excluded from the definition of property "which does not give rise to any income." Thus, Dover's sale of H&C assets did not give rise to FPHCI under Section 954(c)(1)(B)(iii).
The IRS responds that the deemed sale of the H&C assets was not a sale of property used or held for use in Dover's UK business. Therefore, the property was not excluded from the definition of property "which does not give rise to any income." Thus, the deemed sale gave rise to FPHCI taxable to Dover.
"Respondent specifically acknowledges that, for tax purposes, H&C's disregarded entity election constituted a deemed section 332 liquidation of H&C into Dover UK, whereby H&C became a branch or division of Dover UK. Respondent refers to the disregarded entity election as a "check-the-box liquidation' and states that there is no difference between it and an actual section 332 liquidation."
"Accordingly, the principal question before us is whether, attendant to a section 332 liquidation, the transferee parent corporation succeeds to the business history of its liquidated subsidiary with the result that the subsidiary's assets used in its trade or business constitute assets used in the parent's trade or business upon receipt of those assets by the parent." [...]
" ...[R]espondent, nevertheless, argues: "Dover UK must *** use, or hold for such, such assets for the requisite period of time in its trade or business before Dover UK is allowed to exclude from FPHCI the gain from the [deemed] sale of those assets.' Respondent refuses to attribute H&C's business history to Dover UK ..."
"... [A]s direct result of a section 332 liquidation of an operating subsidiary, the surviving parent corporation is considered as having been engaged in the liquidated subsidiary's preliquidation trade or business, with the result that the assets of that trade or business are deemed assets used in the surviving parent's trade or business at the time of receipt. ... As stated by respondent on brief, ... "there is no difference between a check-the-box liquidation and an actual liquidation.' Therefore, ... we conclude that respondent has conceded that Dover UK's deemed sale of the H&C assets immediately after the check-the-box liquidation of H&C constituted a sale of property used in Dover UK's business within the meaning of section 1.954-2(e)(3)(ii) through (iv), Income Tax Regs." [Slip op. 48-54]
Citation: Dover Corp. v. Commissioner of Internal Revenue, No. 12821-00 (U.S. Tax Ct. May 5, 2004).
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