The Tax Court determined that a US company’s gain from the sale of its foreign subsidiary was not recharacterized as foreign-source income for purposes of the foreign tax credit. (Liberty Global, Inc., (2023) 161 TC No. 10)
Liberty sold its CFC stock.
In 2010, Liberty sold all its stock in a controlled foreign corporation (CFC), realizing gain of more than $3.25 billion. At that time, Liberty Global had an overall foreign loss (OFL) balance of approximately $474 million.
On its 2010 return, Liberty reported approximately $438 million of the gain as dividend income (to cover the OFL) and approximately $2.8 billion as foreign-source income. The allocation of $2.8 billion to foreign-source income allowed Liberty to claim foreign tax credits of more than $240 million and exempt all the gain from the sale of the CFC from US taxation.
After examining Liberty’s 2010 return, the IRS issued a deficiency notice stating that Liberty overstated its foreign-source income and, as a result, overstated its foreign tax credits.
In the Tax Court, Liberty argued that Code Sec. 904(f)(3)(A) is the only mechanism for recognizing gain from the disposition of CFC stock in this case. Therefore, it was only required to recognize gain in the amount necessary to recapture its OFL balance. The rest of its gain was foreign-source income.
In the alternative, Liberty argued that the statute is ambiguous but the regs require it to treat the balance of the stock gain as foreign-source income.
IRS says Liberty got it all wrong.
The IRS said that Liberty got it all wrong because Code Sec. 904(f)(3)(A) does not govern the treatment of the remaining $2.8 billion in gain, which is instead subject to other rules. In addition, the IRS said that the statute is not ambiguous, and Liberty was misreading the reg. According to the IRS, the regs require Liberty to recapture the $474 million OFL, but otherwise “neither exempt from taxation the remaining portion of [Liberty’s] gain nor change its source.”
Tax Court holding.
The Tax Court agreed with the IRS, holding that Code Sec. 904(f)(3)(A) is not ambiguous, doesn’t override any recognition provisions of the Code, and neither the statute nor the reg recharacterize as foreign-source gain amounts not needed to recapture Liberty’s OFL.
The Court noted that the IRS’s interpretation of the statute follows its text, which “provides no instruction at all regarding the amounts in excess of the gain necessary to recapture an OFL balance.” In fact, the statute doesn’t “exempt from recognition any amount from an applicable disposition.”
Thus, Code Sec. 904(f)(3)(A) required Liberty to recognize a specified amount of gain as taxable income but didn’t say that the remaining gain didn’t need to be recognized or that it should be recharacterized as foreign-source income.
For more information about overall foreign losses and applicable dispositions of controlled foreign corporation stock, see Checkpoint’s Federal Tax Coordinator ¶ O-4710.
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