Brown Grp., Inc. v. Comm'r of Internal Revenue
| Citation | 102 T.C. No. 24,102 T.C. 616 |
| Decision Date | 26 September 1994 |
| Docket Number | No. 104–92.,104–92. |
| Parties | BROWN GROUP, INC. and SUBSIDIARIES, Petitioner, v. COMMISSIONER OF INTERNAL REVENUE, Respondent. |
| Court | United States Tax Court |
OPINION TEXT STARTS HERE
Harold G. Blatt, Juan D. Keller, and Philip B. Wright, St. Louis, MO, for petitioner.
James A. Kutten and Richard A. Witkowski, St. Louis, MO, for respondent.
P1 is a member of an affiliated group of corporations that filed a consolidated Federal corporate income tax return for the year in issue. P is the parent of the affiliated group. R determined that P1's distributive share of a foreign partnership's (FP's) income is foreign base company sales income that is includable in the consolidated gross income of P as subpart F income. Relying on the holding in Rev.Rul. 89–72, 1989–1 C.B. 257, R contends that the income P1 received from FP should be considered as if earned by P1 directly from the source from which received by FP. P contends that P1's distributive share of FP's income is not subpart F income.
Held, the character of P1's distributive share of FP's income is determined at the partnership level.
Held, further, P1's distributive share of FP's income is not subpart F income.
Held, further, the holding in Rev.Rel. 89–72, 1989–1 C.B. 257, is incorrect; hence, the Court will not follow it.
Respondent determined a deficiency in petitioner's consolidated Federal income tax for its taxable year ended November 1, 1986, in the amount of $388,992.85.
The only issue in dispute is whether Brown Cayman Ltd.'s (Brown Cayman's) distributive share of partnership income from Brinco, a Cayman Islands partnership, is subpart F income, includable in the consolidated gross income of Brown Group, Inc. (Brown Group), a New York corporation, under section 951(a). We hold that it is not.
Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for the year in issue. All Rule references are to the Tax Court Rules of Practice and Procedure.
We incorporate the stipulation of facts and attached exhibits.
Brown Group is the common parent of an affiliated group of corporations which timely filed a consolidated Federal corporate income tax return for its taxable year ended November 1, 1986. Now and throughout the period in issue, the stock of Brown Group was traded on the New York Stock Exchange. The principal place of business of Brown Group at the time the petition was filed, and at all relevant times, was St. Louis, Missouri. The following diagram facilitates an understanding of the relationship of the parties involved:
Image 1 (4.44" X 4.04") Available for Offline Print
Throughout 1985 and 1986, Brown Group manufactured, imported, and sold (through its divisions) footwear at the retail and wholesale levels. Such footwear was manufactured in the United States or imported from other countries, including Brazil. Brown Group also sold fabric, family fashions, home decorating items, jewelry, and cosmetics through a retail division.
Brown Group International, a Delaware corporation, was incorporated in 1985. Throughout 1985 and 1986, Brown Group International was a United States shareholder of Brown Cayman within the meaning of section 951(b).
Brown Cayman, a Cayman Islands corporation, was incorporated in 1985. Brown Cayman was a controlled foreign corporation within the meaning of section 957(a) at all times relevant to this case.
Brinco, a partnership within the meaning of section 7701, and the regulations thereunder, was formed in March 1985.
T.P. Cayman, Ltd. (TP Cayman), a Cayman Islands corporation, was incorporated in March 1985.
Pidge, Inc. is a Missouri corporation; the date of its incorporation is not contained in the record.
Prior to the formation of Brinco, Brown Group utilized independent agents to purchase Brazilian manufactured footwear. At that time, Delcio Birck (Birck), a Brazilian citizen, and Ted Presti (Presti), a U.S. citizen, were employed by a company which purchased Brazilian manufactured shoes on behalf of Brown Group and others. In order to attract both Presti and Birck to source Brazilian footwear exclusively for Brown Group, and to consolidate Brown Group's Brazilian buying power, Brinco was formed. Brinco was structured as a partnership because: (1) Presti's salary requirements could not be satisfied within Brown Group's existing payroll structure; (2) it allowed Presti and Birck to have entrepreneurial interests in Brinco's operations; and (3) it permitted the partners to avoid Brazilian currency controls and currency fluctuations. During 1985 and 1986, Brinco acted as purchasing agent for the Brown Group with respect to footwear manufactured in Brazil. The footwear so imported was sold primarily in the United States.
Presti was the managing partner of Brinco. As such he was responsible for the design, manufacture, and quality control of the footwear. He also supervised Brinco's operations within Brazil.
Both Presti and Birck conducted a substantial portion of their activities on behalf of Brinco within Brazil. When not in Brazil, Presti conducted Brinco's operations out of Brown Group's offices in St. Louis, Missouri. Respondent concedes that Brinco is not a sham.
Brown Group paid Brinco a 10–percent commission for acting as its Brazilian purchasing agent. The commission was based on the purchase price of the footwear. For 1985, Brown Group's sales of footwear from Brazilian manufacturers for which Brinco acted as agent totaled $11,199,695; Brinco's commissions from such sales were $1,119,970. The amount of the commissions was included in Brown Group's inventory cost.
For the 7–month period beginning April 1985 to November 2, 1985, TP Cayman received guaranteed payments in 1985 totaling $151,662 ($21,666 a month for 7 months), instead of its distributive share of partnership earnings for such period. After making guaranteed payments to TP Cayman, Brinco's partnership net earnings for 1985 totaled $917,465, which were distributed as follows:
+--------------------------------+
¦Brown Cayman¦98 percent¦$897,281¦
+------------+----------+--------¦
¦Birck ¦2 percent ¦$ 20,184¦
+--------------------------------+
In 1986, TP Cayman received its distributive share of partnership income rather than the guaranteed monthly payments.
Brinco was dissolved on October 31, 1987. At that time, Presti became executive vice president of Brown Group International and Birck, as an independent agent, continued to source footwear for Brown Group International on a commission basis.
Respondent determined that Brown Cayman's distributive share of Brinco's earnings is foreign base company sales income, includable as subpart F income in the consolidated gross income of Brown Group.
OPINIONA. Subpart F of the Code1. General Rules
A “United States shareholder” of a “controlled foreign corporation” must include in gross income its pro rata share of the controlled foreign corporation's “subpart F income” for such year. Sec. 951(a)(1). A “United States shareholder” is defined as a “United States person” who owns or is considered as owning 10 percent or more of the total combined voting power of all classes of stock entitled to vote of a controlled foreign corporation. Sec. 951(b). The definition of a “United States person” includes a citizen or resident of the United States, a domestic partnership, a domestic corporation, and certain trusts and estates. Secs. 957(d), 7701(a)(30). A “controlled foreign corporation” is any foreign corporation of which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned or is considered as owned by “United States shareholders” on any day during the taxable year. Sec. 957(a).
With respect to the instant case, it is undisputed that Brown Cayman is a foreign corporation and that Brown Group International owns 100 percent of the total combined voting power of all classes of Brown Cayman stock. As such, Brown Cayman is a controlled foreign corporation within the purview of section 957(a). Since Brown Group International owns 100 percent of the total combined voting power of all classes of Brown Cayman's stock, Brown Group International is a “United States shareholder” of a “controlled foreign corporation” and thus must include in gross income its pro rata share of any “subpart F income” earned by Brown Cayman. Sec. 951(a)(1).
2. Subpart F Income Defined
“Subpart F income”, as defined under section 952(a), is the sum of four specifically defined types of income. Section 952(a) reads in pertinent part:
(a) In General.—For purposes of this subpart, the term “subpart F income” means, in the case of any controlled foreign corporation, the sum of—
* * *
(2) the foreign base company income (as determined under section 954) * * * [Emphasis added.]
Only one type of “subpart F income”, specifically “foreign base company income”, is involved in this case.
Section 952(a)(2) provides that “foreign base company income” is determined under section 954. “Foreign base company income”, as defined under section 954(a), is the sum of five specifically defined types of income. Only one type of “foreign base company income”, specifically “foreign base company sales income”, is involved in this case.
Section 954(d)(1) defines “foreign base company sales income” as follows:
(d) Foreign Base Company Sales Income.—
(1) In General.—For purposes of subsection (a)(2), the term “foreign base company sales income” means income (whether in the form of profits, commissions, fees, or otherwise) derived in connection with the purchase of personal property from a related person and its sale to any person, the sale of personal property to any person on behalf of a related person, the purchase of personal property from any person and its sale to a related person, or the purchase of personal property from any person on behalf of a related person...
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