Ford Motor Company, (CA FC 11/9/2018) 122 AFTR 2d ¶ 2018-5414
The Court of Appeals for the Federal Circuit, affirming a Claims Court decision, has denied a U.S. company’s claim for a refund based on Code Sec. 6621(d)‘s interest netting provisions, finding that the U.S. company and its foreign sales corporation (FSC), i.e., a tax-favored corporation that was allowed under former law, weren’t the “same taxpayer.”
Background—interest netting. Code Sec. 6621(a)(1) establishes the interest rate for overpayments, and Code Sec. 6621(a)(2) establishes the interest rate for underpayments. Under Code Sec. 6621(d), to the extent that interest is payable for any period under Code Sec. 6601 (imposing interest on underpayments) and allowable under Code Sec. 6611 (paying interest on overpayments) on equivalent underpayments and overpayments by “the same taxpayer,” the net rate of interest under Code Sec. 6621 on the underpayment and overpayment amounts is zero for the overlapping period.
Background—foreign sales corporations (FSCs). Under prior law, an FSC was a corporation created, organized and maintained in a qualified foreign country or U.S. possession outside the U.S. that was entitled to certain tax benefits, including exemption from U.S. tax on a portion of its earnings. An FSC must have been organized under the laws of a foreign country, maintained a foreign office with a set of permanent books of account, had a board of directors with at least one director who was not a U.S. resident, held all shareholder and board of directors meetings outside the U.S., maintained its principal bank account in a foreign country, and paid all dividends and salaries from foreign bank accounts. The FSC could satisfy the statutory prerequisites through “any other person acting under a contract with the FSC,” including the FSC’s parent. (Former Code Secs. 921 – 927)
The FSC provisions were repealed for transactions occurring after Sept. 30, 2000.
Facts. Ford, a U.S. Corporation, formed Export, a Netherlands company, and owned all of Export’s common stock.
Export entered into an agreement with Ford to act as an FSC with respect to export transactions entered into by Ford companies. Under the contract, Export assumed responsibility for export-related activities such as making contracts for the sale of Ford’s exports, advertising for Ford, processing orders, arranging deliveries, and assuming credit risks associated with the sales. In exchange, Ford paid Export a commission for each sale. Both Ford and IRS agreed that Export satisfied all statutory prerequisites for FSC treatment.
As permitted by the FSC statute and related regs, Ford exercised near complete control over Export’s operations. Export had no employees. Instead, its day-to-day operations were administered by a Dutch trust company hired by Ford that operated Export in accordance with Ford’s instructions. Ford and Export also entered into an agreement in which Ford agreed to perform all export activities on Export’s behalf. Ford even prepared Export’s tax returns and paid all of Export’s tax liabilities to IRS on Export’s behalf.
In sum, Export never performed any activity that Ford did not direct.
For the years at issue in the case, Ford and Export filed separate tax returns using separate tax identification numbers, Ford had tax overpayments, and Export had tax underpayments.
Claims Court case. The Court of Federal Claims found that the legislative purpose underlying the FSC rules and Code Sec. 6621(d) supported the treatment of Export and Ford as separate entities. The FSC rules were based on an FSC’s formation as a substantive foreign corporation, with a separate identity from any parent corporation in the U.S. The court also found that the purpose of Code Sec. 6621(d)) was to ensure that the same taxpayer isn’t obligated to pay interest on equivalent underpayments and overpayments—and that Ford received tax benefits on the basis that Export was a separate entity under the FSC rules. The court rejected Ford’s attempt to take the opposite position in order to claim further benefits. (Ford Motor Company (Ct Fed Cl 2017) 119 AFTR 2d 2017-1998; see U.S. company denied $20M interest netting refund: foreign sales corp wasn’t “same taxpayer”)
Circuit Court affirms; no interest netting. The Circuit Court affirmed the lower court holding and disallowed the interest netting.
The Court frequently cited to Wells Fargo & Co., (CA FC 2016) 117 AFTR 2d 2016-2263, another Federal Circuit case which considered the Code Sec. 6621(d) “same taxpayer” issue. That case noted that the meaning of “same taxpayer” cannot be found in the statute’s text or other parts of the Code. Nor does the statute’s legislative history offer a clear indication of its scope. But Congress did not choose the term “same taxpayer” in a legal vacuum. Instead, Congress legislated against a background of legal principles that shed light on which persons or entities qualify as a “same taxpayer” for Code Sec. 6621(d) interest netting purposes.
The Court here said that the Supreme Court has long recognized that tax laws treat a corporation whose “purpose is the equivalent of business activity” as “a separate taxable entity.” (Moline Props. v. Comm’r, (S Ct 1943) 30 AFTR 1291) Because tax laws usually treat formally separate corporations as distinct taxable entities that must file their own returns, they will normally be different taxpayers under Code Sec. 6621(d) as well.
Another longstanding legal principle treats parent corporations and their subsidiaries as separate taxable entities. Based on Moline Properties’ holding that corporations with legitimate business purposes are separately taxable, the Federal Circuit recognized that “a parent corporation and its subsidiary corporation [should] be accorded treatment as separate taxable entities.” (Ocean Drilling & Expl. Co., (CA FC 1993) 71 AFTR 2d 93-1184)
The Court said that the general principle from Moline Properties resolved this case. Export engaged in substantial business activity. It contracted with Ford to manage Ford’s export operations, which included negotiating contracts, assuming credit risk, and receiving commissions. Export also maintained an office, accounting records, and a bank account. This business activity rendered the corporation a separate taxable entity absent an exception to Moline Properties’ general rule. It made no difference that Ford directed these activities because, citing, Nat’l Carbide Corp., (S Ct 1949) 37 AFTR 834, ownership and control “are no longer of significance in determining taxability.”
Ford argued that the FSC statute provided a background legal principle that displaced Moline Properties’ general rule that parent and subsidiary corporations are different taxpayers. In its view, the statutory prerequisites for FSC treatment consisted entirely of formalistic requirements devoid of economic substance. Parent corporations could carry out all of an FSC’s foreign business activity, and FSCs could immediately transfer any income to their parents as dividends. Thus, Ford reasoned, an FSC’s underpayments or overpayments should be attributable to the parent because Congress did not intend for FSCs to operate independently.
The Court said that Ford’s argument failed for two reasons. First, it misunderstands what types of background legal principles support treating two entities as the same taxpayer under Wells Fargo‘s test. In Wells Fargo, the Federal Circuit based its holding that an absorbed company and a surviving company should be treated as the same taxpayer on merger law principles that directly addressed corporate identity. In contrast, the FSC statute never states that FSCs and their parents should be treated as sharing an identity. Rather than point to a statutory provision analogous to the merger law principles discussed in Wells Fargo, “Ford asks us” to infer that Congress intended for FSCs and their parents to be treated as the same taxpayer from FSC statute provisions and regs that authorized parent corporations to control their FSCs. But, the Court said, for a background legal principle to displace the general rule that formally separate corporate entities are separate taxpayers, it must relate to whether two entities should be viewed as sharing an identity. Thus, the FSC statute does not supply a background legal principle that supports treating an FSC and its parent as the same taxpayer.
Second, the FSC statute unambiguously treated FSCs and their parents as different taxpayers. The FSC statute set forth numerous prerequisites for FSC treatment designed to ensure that FSCs possessed enough “economic substance” to comply with the international General Agreement on Tariffs and Trade (GATT) rules. It also provided that corporations that met these requirements and elected FSC treatment would be taxed differently from other domestic corporations. Unlike their parent corporations, a portion of an FSC’s income was tax exempt. “Short of an explicit statement that FSCs and their parents are different taxpayers under Code Sec. 6621(d), it is difficult to imagine a clearer way for a statute to express that two entities should be treated as different taxpayers than taxing them differently. Therefore, the FSC statute’s purpose and effect confirm that FSCs and their parents were different taxpayers under Code Sec. 6621(d).”