Stanford v. C.I.R.

• Decision Date: 03 September 1998
• Docket Number: No. 97-60531,97-60531
• Citation: 152 F.3d 450
• Parties: -6085, 98-2 USTC P 50,696 Robert A. STANFORD; Susan Stanford, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
• Court: U.S. Court of Appeals — Fifth Circuit

Page 450

152 F.3d 450

82 A.F.T.R.2d 98-6085, 98-2 USTC P 50,696

Robert A. STANFORD; Susan Stanford, Petitioners-Appellants, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.

No. 97-60531.

United States Court of Appeals Fifth Circuit.

Sept. 3, 1998.

Larry A. Campagna, Lawrence W. Sherlock, Chamberlain, Hrdlicka, White, Williams & Martin, Houston, TX, for Petitioners-Appellants.

Thomas J. Clark, Loretta Argrett, Asst. Atty. Gen., App. Section, Gilbert S. Rothenberg, U.S. Dept. of Justice, Tax Div., Charles Casazza, Clerk, U.S. Tax Court, Stuart L. Brown, Chief Counsel, IRS, Washington, DC, for Respondent-Appellee.

Appeal from the United States Tax Court.

Before DUHE, BENAVIDES and STEWART, Circuit Judges.

STEWART, Circuit Judge:

This case, which calls for us to construe certain provisions of section 952(c)(1)(C) of the Internal Revenue Code (the "Code"), ¹ involves a dispute regarding the 1990 income tax liability of Robert A. Stanford and his wife Susan Stanford. ² On appeal, the Stanfords challenge a decision of the Tax Court upholding the Internal Revenue Commissioner's ("Commissioner") assessment of (1) a tax deficiency against them with respect to their jointly-filed 1990 income tax return and (2) an accuracy-related penalty for their resulting underpayment of tax. See Stanford v. Commissioner, 108 T.C. 344, 1997 WL 210796 (1997). For the following reasons, we VACATE the underpayment of tax penalty imposed against the Stanfords and AFFIRM the Tax Court's judgment in all other respects.

I.

A. FACTUAL BACKGROUND

The underlying facts of this case are, for the most part, undisputed. Between 1985 and 1987, Stanford, a United States citizen and Houston resident, formed three corporations in the crown colony of Montserrat in the British West Indies, each of which qualified as a "controlled foreign corporation" within the meaning of section 957(a) of the Code. The first corporation, Guardian International Bank, Ltd. ("Guardian Bank"), was incorporated in December 1985 to engage in offshore banking activities. In January 1986, Guardian Bank acquired a banking license from the Montserrat government authorizing it to engage in business as an offshore investment bank.

The second corporation, Guardian International Investment Services, Ltd. ("Guardian Services"), was incorporated in October 1986. Guardian Services' charter authorized it to engage in a broad array of business activities, including real estate development and trademark/patent acquisition. Pursuant to a 1988 written service agreement with Guardian Bank, Guardian Services provided marketing and advertising services to Guardian Bank during 1989 and 1990. The Commissioner concedes that the provision of these services by Guardian Services induced deficits in Guardian Services' earnings and profits for both those years.

Finally, Stanford Financial Group, Inc. ("Stanford Financial") was incorporated in February 1987, with Stanford owning 95 percent of its shares. In relevant part, Stanford Financial's objective was to "carry on the business of a [h]olding [c]ompany" and to "take part in the formation, management, supervision or control of the business operations of any company." Upon incorporation of Stanford Financial, all of the shares of stock of both Guardian Bank and Guardian Services were transferred to Stanford Financial; thus (1) Guardian Bank and Guardian Services became related as brother-sister corporations with (2) Stanford Financial as the common parent. Pursuant to a service agreement with Guardian Bank, Stanford Financial provided administrative and management services to Guardian Bank during 1989 and 1990. The Commissioner concedes that the provision of these services by Stanford Financial induced deficits in Stanford Financial's earnings and profits for both those years.

B. STATUTORY BACKDROP AND THE STANFORDS' 1990 INCOME TAX RETURN

Section 951(a) of the Code requires a United States shareholder of a controlled foreign corporation ("CFC") to include in his gross income his pro rata share of the controlled foreign corporation's "subpart F income"--as defined in section 952--whether or not such income is distributed to him. I.R.C. § 951(a). A CFC is defined as any foreign corporation where more than 50 percent of the corporation's stock, either by voting power or value, is owned directly, indirectly, or constructively by United States shareholders. I.R.C. § 957(a). Section 951(b) of the Code defines a "United States shareholder" as a United States person who owns directly, indirectly, or constructively 10 percent or more of the voting stock of a foreign corporation. I.R.C. § 951(b). In this case, the parties have stipulated that (1) Stanford is a United States shareholder of Guardian Bank, Guardian Services, and Stanford Financial, and (2) Guardian Bank, Guardian Services, and Stanford Financial are CFCs.

Of the three CFCs in this case, only Guardian Bank realized subpart F income in 1990. Subpart F income is defined in I.R.C. § 952 as including five different types of income, the most pertinent of which, in this case, is "foreign base company income (as determined under section 954)." I.R.C. § 952(a)(2). Section 954(a) defines foreign base company income as including "foreign personal holding company income," I.R.C. § 954(a), which consists of, among other things, dividends, interest, rents, gains from commodity transactions, and foreign currency gains. I.R.C. § 954(c)(1). The parties in this case have stipulated that Guardian Bank's 1990 income included interest, gains on foreign currency exchanges, dividends, and gains on commodity transactions, and that Guardian Bank's resulting subpart F income for that year was $2,789,722. Indeed, the Stanfords reported this figure as Guardian Bank's subpart F income on their 1990 joint federal income tax return.

The amount of subpart F income of a CFC that is ultimately taxed to a United States shareholder may be limited by any of three limitations set forth in I.R.C. § 952(c). The only limitation applicable here is that found in I.R.C. § 952(c)(1)(C), and it is the interpretation of the language of this provision that is at the heart of the dispute in this case. Section 952(c)(1)(C) reads, in pertinent part, as follows:

(C) Certain deficits of member of the same chain of corporations may be taken into account.--

(i) In general.--A controlled foreign corporation may elect to reduce the amount of its subpart F income for any taxable year which is attributable to any qualified activity by the amount of any deficit in earnings and profits of a qualified chain member for a taxable year ending with (or within) the taxable year of such controlled foreign corporation to the extent such deficit is attributable to such activity. * * *

(ii) Qualified chain member.--For purposes of this subparagraph, the term "qualified chain member" means, with respect to any controlled foreign corporation, any other corporation which is created or organized under the laws of the same foreign country as the controlled foreign corporation but only if--

(I) all the stock of such other corporation (other than directors' qualifying shares) is owned at all times during the taxable year in which the deficit arose (directly or through 1 or more corporations other than the common parent) by such controlled foreign corporation, or

(II) all the stock of such controlled foreign corporation (other than directors' qualifying shares) is owned at all times during the taxable year in which the deficit arose (directly or through 1 or more corporations other than the common parent) by such other corporation.

I.R.C. § 952(c)(1)(C). ³ Under section 952(c)(1)(C), a CFC may reduce its subpart F income attributable to a "qualified activity" by the deficits in earnings and profits of a "qualified chain member" to the extent the deficit of the chain member is "attributable to" to such qualified activity.

Relying on retained, expert tax advice, the Stanfords invoked Guardian Bank's section 952(c)(1)(C)(i) election and reduced Guardian Bank's 1990 subpart F income ($2,789,722) by the total deficits in the 1990 earnings and profits of Guardian Services and Stanford Financial, which total they determined to be $1,406,365. ⁴ On audit, however, the Commissioner disallowed this reduction as violative of section 952(c)(1)(C). Notably, the Commissioner conceded (and does not contest on appeal) that (1) Guardian Services and Stanford Financial accumulated deficits in earnings and profits in 1990; (2) these deficits in earnings and profits were generated exclusively through administrative, marketing, or management services provided to Guardian Bank under applicable service agreements; and (3) the deficits accrued to a total of $1,406,365. Such concessions notwithstanding, the Commissioner prohibited the Stanfords from offsetting these deficits against Guardian Bank's subpart F income, determining that (1) Guardian Services was not a "qualified chain member" with respect to Guardian Bank within the meaning of section 952(c)(1)(C)(ii) (and, thus, Guardian Services' deficit in earnings and profits was not deductible vis-a-vis Guardian Bank's subpart F income); and (2) Stanford Financial's deficit, although accrued by a "qualified chain member" with respect to Guardian Bank, was not "attributable to [the same] qualified activity" to which Guardian Bank's subpart F income was attributable (and, thus, was also not deductible vis-a-vis Guardian Bank's subpart F income). ⁵

The Commissioner determined the resulting deficiency in the Stanfords' 1990 tax to be $423,531.36. Additionally, because the Stanfords' understatement of tax was substantial, the Commissioner assessed the Stanfords an accuracy-related penalty of $84,706.27 under I.R.C. § 6662(a). ⁶ The Stanfords filed a petition challenging these determinations in the United States Tax Court.

C. THE TAX COURT'S OPINION

The Tax Court sustained the Commissioner's determinations. First, the...