The U.S. Tax Court today issued a “reviewed opinion” (including concurring and dissenting opinions) holding that the taxpayer and the IRS did not reach an agreement in a closing agreement with respect to the treatment of the accounts receivable under section 965; that section 965(b)(3) does not provide that the accounts receivable constituted related-party indebtedness arising during the testing period; and that the accounts receivable did not increase the controlled foreign corporation’s related-party indebtedness during the testing period.
The Tax Court concluded that the taxpayer was entitled to the full amount of its claimed dividends received deduction (DRD).
The case is: Analog Devices, Inc. v. Commissioner, 147 T.C. No. 15 (November 22, 2016). Read the Tax Court’s opinion [PDF 199 KB]
The taxpayer—a corporation that is a U.S. shareholder of a controlled foreign corporation (CFC)—repatriated cash dividends from the CFC and claimed an 85% dividends received deduction (DRD) under section 965 for 2005. The taxpayer reported no related-party indebtedness during its testing period (pursuant to section 965(b)(3)) when it claimed the DRD.
The IRS determined, and the taxpayer agreed, that the annual 2% royalty from the CFC to the taxpayer would be increased to 6% for 2001-05 to reflect arm’s length pricing pursuant to section 482. In 2009, the taxpayer and the IRS executed a closing agreement (pursuant to Rev. Proc. 99-32) to effect the secondary adjustments required after a primary allocation under section 482. The closing agreement established “accounts receivable” as described in Rev. Proc. 99-32 for 2001-05 and deemed them created as of the last day of the tax year to which they related. The IRS subsequently determined that the accounts receivable constituted an increase in related-party indebtedness under section 965(b)(3) during the testing period, and the IRS determined a decrease in the taxpayer’s DRD.
The Tax Court majority held that parties did not reach an agreement in the closing agreement with respect to the treatment of the accounts receivable under section 965; that section 965(b)(3) does not provide that the accounts receivable constituted related-party indebtedness arising during the testing period; and that the accounts receivable did not increase the CFC’s related-party indebtedness during the testing period.
Accordingly, the Tax Court concluded that the taxpayer was entitled to the full amount of its claimed DRD. With this opinion, the Tax Court overruled the decision in BMC Software I (holding that a closing agreement that established accounts receivable “for federal income tax purposes” created related-party indebtedness under section 965(b)(3)).
This case contains an important collateral transfer pricing issue concerning the application of Rev. Proc. 99-32 accounts receivable and section 956 / subpart F inclusions—a common and ongoing issue. Tax professionals note that the section 965 issue is running its course, given that the section 965 exclusion was only a temporary provision and one that has expired. Given that BMC Software I was overturned on appeal by the Fifth Circuit, today’s opinion reflects that the Tax Court has now joined the appellate court in rejecting the IRS’s position concerning Rev. Proc. 99-32 and section 965.
© 2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.
The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.