Finding that Treasury’s final transaction tax reg conflicts with the Tax Code, a federal district court agreed with transport industry giant FedEx that the corporation was wrongly denied foreign tax credits claimed in relation to certain foreign earnings. (FedEx (DC TN),131 AFTR 2d 2023-546)
FedEx’s victory came March 31 when the U.S. District Court for the Western District of Tennessee granted its motion for partial summary judgment, delivering an $89 million win to the taxpayer and its U.S. subsidiaries, which file consolidated federal income tax returns. At issue was whether FedEx was entitled to FTCs in connection with “offset earnings,” a simplified phrase used throughout the order to refer to “the portion of earnings from profitable foreign corporations that are offset by losses from other foreign corporations.”
“The government’s approach contradicts the ordinary and common meaning of the statute’s command that Offset Earnings be treated as included in income ‘[f]or purposes of applying section 959,’ the district court concluded.
While FedEx and the government agreed that offset earnings could be repatriated stateside without being included as income, the dispute revolved around how the FTC regime applied to foreign taxes paid on offset earnings. Particularly, the matter involved specific statutory language of Code Sec. 959, Code Sec. 960, and Code Sec. 965, as well as TD 9846, a Treasury reg finalizing the one-time transaction tax put in place following the enactment of the Tax Cuts and Jobs Act (TCJA; PL 115-97).
According to the opinion authored by Judge Samuel H. Mays, Jr., the TCJA “replaced the worldwide system of corporate taxation with a ‘territorial’ system'” where “foreign-source earnings can be brought to the United States effectively tax-free, and U.S. corporations are (with exceptions) taxed only on their domestically sourced income.” The transaction tax sought to remedy an issue where companies would receive an “unearned windfall by escaping the tax they would have owed” pre-TCJA, wrote Mays.
The final reg provided that “[n]o credit is allowed under section 960(a)(3) or any other section for foreign income taxes that would have been deemed paid under section 960(a)(1) with respect to the portion of a section 965(a) earnings amount that is reduced under § 1.965-1(b)(2) or § 1.965-8(b).” Although FedEx did not dispute the validity of the regs, the court was tasked with determining whether the reg “should be upheld.”
To do so, the court turned to the framework established in Chevron U.S.A. Inc. v. Natural Resources Defense Council, Inc. Step one of the two-step framework of that landmark case had the court look at whether Congress was ambiguous in its intent, as unambiguous language would require the court adhere to the statute and enforce accordingly.
The court observed that prior to the TCJA, Subpart F income “did not encompass all the earnings that foreign subsidiaries made, leading to the accumulation of substantial undistributed profits overseas.” Section 965, after the TCJA became law, mandated such undistributed profits be treated as Subpart F income.
“Section 959 permits funds to be distributed to the United States without additional tax if those funds have already been included in income under section 951,” the court explained. “Absent some other statutory language, Offset Earnings would be subject to tax once repatriated, an outcome that would effectively perpetuate the pre-TCJA status quo for corporations holding their accumulated earnings overseas.” This is where Code Sec. 965(b)(4)(A) comes in, with the debated phrase “for purposes of applying section 959 …” and how that affects FedEx’s FTC claim.
FedEx’s argued it should be allowed the credits because:
- Its distributed offset earnings were excluded from income under Section 959,
- Those offset earnings are treated as dividends for which a credit is given under Code Sec 901 and Code Sec. 902, and
- The foreign taxes associated with the Offset Earnings were not previously deemed paid by Code Sec. 960(a)(1).
“Because section 960(a)(3) unambiguously provides a credit, FedEx argues that the government cannot deny that credit by using a regulation to rewrite the statutory text,” read the order in summarizing the case the corporation made.
To counter, the government asserted that Code Sec. 960(a)(3) also denies a credit, but the court held that its interpretation was “not reasonable.”
“The government thus needs subsection (a)(1) to perform a dual and self-contradictory role— not deeming taxes paid for purposes of subsection (a)(1) itself, but treating taxes as previously deemed paid for purposes of subsection (a)(3),” the court ruled in denying the government’s cross-motion for partial summary judgment and essentially invalidating the Treasury reg.
For more information about netting among U.S. shareholders in an affiliated group, see Checkpoint’s Federal Tax Coordinator ¶ O-2711.
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