503 F.3d 119 (D.C. Cir. 2007), 06-1034, PNC Financial Services Group, Inc. v. C.I.R.

Docket Nº:06-1034.
Citation:503 F.3d 119
Party Name:PNC FINANCIAL SERVICES GROUP, INC., d/b/a Riggs National Bank, and Subsidiaries, Appellant v. COMMISSIONER OF INTERNAL REVENUE SERVICE, Appellee.
Case Date:August 24, 2007
Court:United States Courts of Appeals, Court of Appeals for the District of Columbia Circuit

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503 F.3d 119 (D.C. Cir. 2007)

PNC FINANCIAL SERVICES GROUP, INC., d/b/a Riggs National Bank, and Subsidiaries, Appellant



No. 06-1034.

United States Court of Appeals, District of Columbia Circuit.

August 24, 2007

Argued December 14, 2006.

Rehearing En Banc Denied Oct. 22, 2007.

Appeal from the United States Tax Court (No. IRS-24368-89).

Thomas C. Durham argued the cause for appellant. With him on the briefs were Joel V. Williamson and Russell R. Young.

Frank P. Cihlar, Attorney, U.S. Department of Justice, argued the cause for appellee.

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With him on the brief was Bridget M. Rowan, Attorney.

Before: ROGERS, BROWN and GRIFFITH, Circuit Judges.


BROWN, Judge.

In prior litigation, PNC Financial successfully claimed a foreign tax credit for taxes paid on its behalf in Brazil. That credit, the Internal Revenue Service argues, must be reduced by the amount of an indirect subsidy PNC received from the Brazilian government. The Tax Court agreed, and we now affirm.


In an international tax case as complicated, economically and litigiously, as this one, we do well to start with the basics. When a U.S. bank makes a loan abroad, the interest income is susceptible to tax in both the United States and the foreign state. Congress avoids double-taxing international business by giving a credit for taxes paid to the foreign government, less any credit, refund, or subsidy given the taxpayer by the foreign government. I.R.C. § 901; Treas. Reg. § 1.901-2(e). Interest income of $100,000, for example, where the relevant tax rate in the U.S. was 50% and in the foreign country was 25% with a 10% refund, would work out to $15,000 to the foreign country and $35,000 to the IRS. Were the foreign rate 50% with no refund, $50,000 would flow to that country and nothing to the IRS. Thus the two countries are on a see-saw: When one country's tax revenue goes up, the other's goes down.

This case, or rather this iteration of this case (for it is the third time we have heard an appeal from the Tax Court concerning the same transaction), is a peculiar elaboration of these simple principles.1 During the 1970s and early 1980s, in an effort to increase its reserves of foreign currency, Brazil's government borrowed and (using tax breaks) encouraged its people to borrow substantial amounts from foreign lenders. In 1982, fiscal crisis led nearly to default on the loans, and Brazil embarked on a debt restructuring plan with an international consortium of banks. According to the plan, Brazil's government-controlled Central Bank stepped in as common debtor for the foreign banks, becoming a middleman on the old loans (paying the creditors what was owed to them from the original borrowers and in turn receiving payments from the original borrowers) and, since Brazil still needed foreign credit to function, borrowing billions of dollars in additional funds. Appellant PNC Financial Services Group, Inc. (formerly Riggs National Corporation and Subsidiaries) lent a portion of those additional funds. In 1984 and 1985, Brazil taxed PNC's interest income at a 25% rate, which came to $166,415 in 1984 and $181,272 in 1985. But a provision of Brazilian law, hanging on from happier economic days when the

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Brazilian government incentivized borrowing from foreign lenders, gave subsidies for these taxes worth 40% of the total--$66,566 in 1984, and $72,509 in 1985. This appeal is about the U.S. tax treatment of that $139,075 in subsidies. At first glance, it seems obvious enough that PNC should receive a credit of $166,415 less $66,566 toward its 1984 U.S. income tax, and $181,272 less $72,509 toward its 1985 U.S. income tax. But three factors complicate the picture.

First, PNC's loans to the Central Bank were "net, " not "gross." Riggs II gives a matchless explanation of the difference, which we will not belabor here. Suffice it to say that in a gross loan agreement, the lender pays local (Brazilian) taxes on his interest income (or the borrower withholds it), while in a net loan, the borrower "contractually agrees not only to pay interest to the lender, but also to pay any local (Brazilian) tax that the lender owes on that interest income." Riggs II, 163 F.3d at 1364. This is not necessarily a boon to lenders, for all else being equal, lenders must compensate borrowers for paying lenders' taxes with lowered interest rates. "The real difference between gross loans and net loans, " Riggs II explains, "lies not in who licks the stamp on the envelope to the Brazilian government, but in who bears the economic burden of the tax." Id. With a net loan, the borrower bears that burden, for the borrower faces the risk of change in local tax rates, while the lender's net income (the interest payments) is stable. With a gross loan, the lender suffers the loss or reaps the benefit of change; it is his net income that might vary with taxes. Either way, however, the foreign government imposes legal liability for the local tax on the lender, and so either way the IRS credits the foreign tax payments. Treas. Reg. § 1.901-2(f).2

Second, the Central Bank is, as Riggs II put it, "no ordinary Brazilian borrower." 163 F.3d at 1366. Created by law to implement Brazil's monetary and fiscal policies (including issuing currency), required to act on behalf of Brazil's government and prohibited from acting on behalf of anyone else, able to contract in the name of the National Treasury, responsible for managing foreign lending to Brazilian borrowers, and under the control of the Minister of Finance, the Central Bank is 100% a part of Brazil's federal government, as all parties agree. The Federal Constitution of Brazil makes the Central Bank immune

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from tax on its own income, and in fact until 1988 the Central Bank operated, along with the National Treasury and the Banco de Brasil (in which Brazil's government held a controlling share), a centralized system for funding Brazil's government that jointly controlled Brazil's tax revenue (although it was the Banco de Brasil that actually held the government's tax revenue in its coffers). Thus, if it were legally possible for the Brazilian government to impose a tax on its Central Bank, it is not clear how it would be economically possible for the Central Bank to pay it: At most, the money would go from the Brazilian government's right pocket to its left. And so when the Central Bank takes out net loans from a U.S. lender, certain questions arise: Will Brazilian law, in keeping with the principle that tax payments incidental to net loans are payments on behalf of lenders, require the Central Bank to pay despite the Bank's constitutional immunity from taxes? If so, should the IRS credit those payments? If the Brazilian government refunds a portion of them to the Central Bank, should the IRS subtract some of the refund from the credit?

We must pause at this point to understand PNC's and the Central Bank's (or rather, Brazil's) interests on the eve of their lending arrangement. Only if the Central Bank was subjected to compulsory tax payments on PNC's behalf could PNC qualify for the § 901 credit. See Riggs II, 163 F.3d at 1365-66. And such payments would represent no economic burden for Brazil even if the Central Bank actually moved cash from its (government-controlled) vaults to the Banco de Brasil's (government-controlled) vaults. See id. at 1369. So both PNC and Brazil had an interest in seeing the Central Bank subjected to the compulsory payments. For PNC, every cent thus paid to the Brazilian government was money PNC would not have to pay to the IRS, 3 and for Brazil, the "tax" just meant, so far as we can tell, more credit at a lower interest rate. The only loser in the arrangement was the IRS, which, economically speaking, would simply have transferred wealth to Brazil for Brazil and PNC to split. See id. The IRS ends up on the wrong end of the see-saw.

Only the Central Bank's constitutional immunity from taxes stood in the way, and the third complexity in this case concerns how that immunity was overcome. Given their interest in the foreign tax credit, PNC and other banks went to Brazil's highest ranking authority on tax matters, the Minister of Finance, to request definitive guidance on whether the Central Bank would be subjected to the compulsory tax payments on their behalf. The most natural way for the Minister to answer "Yes" would have been to hold the Central Bank's tax immunity inapplicable in net loan arrangements, since the tax-immune entity pays standing in the lender's shoes. But this way was closed: Brazilian law already had authority for the opposite proposition. Id. at 1366. Another way, however, was open, for the money PNC loaned the Central Bank was available and officially intended for re-lending to private borrowers in Brazil. If the Central Bank could not stand in for the private lenders, perhaps it could stand in for these private borrowers. The Minister issued a private letter ruling, not available to the public but binding on the parties under Brazilian law, which Riggs II describes:

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The Minister deemed it appropriate to "look through" the Central Bank to those ultimate private borrowers--so-called "borrowers-to-be"--for purposes of deciding the proper tax treatment of the loans. And it was settled Brazilian law that a private borrower in a net loan was required to pay the tax obligation it had contractually assumed from the lender. The Minister concluded that the "borrowers-to-be" aspect of the loans compelled an analogy to the garden variety private borrower situation, and that the Central Bank must "as a substitute for such borrowers [to-be] pay the income tax incident on the interest ...."

Id. (first alteration in...

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