Barnes Group, Inc. v. Commissioner of Internal Revenue, 041613 FEDTAX, 27211-09
|Opinion Judge:||GOEKE, Judge:|
|Party Name:||BARNES GROUP, INC. AND SUBSIDIARIES, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent|
|Attorney:||Robin Lee Greenhouse, James Riedy, and Nathaniel J. Dorfman, for petitioners. Stephen C. Best and William T. Derick, for respondent.|
|Case Date:||April 16, 2013|
|Court:||United States Tax Court|
MEMORANDUM FINDINGS OF FACT AND OPINION
Respondent determined the following deficiencies and section 6662(a)1 accuracy-related penalties with respect to petitioners' Federal income tax:
1, 304, 352
1, 733, 084
1, 807, 478
1Respondent disallowed petitioners' net operating loss carryback of $503, 654 from its 2000 tax year.
The issues for decision are:
(1) whether Barnes Group, Inc. (Barnes), 2 should have included in gross income $38, 919, 950 and $19, 378, 596 for 2000 and 2001, respectively, under sections 951(a)(1)(B) and 956 or under section 301 as a result of a series of transactions between Barnes and its subsidiaries. We hold that Barnes should have included the amounts in gross income under section 301;
(2)whether the fair market value of "clean rooms" transferred to Barnes in 2001 should be excluded from its income under section 109. We hold that the value of the clean rooms should not be excluded from income; and
(3)whether petitioners are liable for the section 6662(a) accuracy-related penalty for the years in issue. We hold that they are liable for the section 6662(a) penalty for all years in issue.
FINDINGS OF FACT
At the time the petition was filed Barnes was a publicly traded Delaware corporation that maintained its principal place of business in Connecticut.3
I. Business Operations
Founded in 1857, Barnes manufactures and distributes precision metal parts and industrial supplies. By 1999 Barnes operated three separate business segments through its domestic and foreign subsidiary corporations--Associated Spring, Barnes Aerospace, and Barnes Distribution. These three business segments had significant operations in the United States, Canada, Europe, Latin America, and Asia. Associated Spring manufactures precision mechanical and nitrogen gas springs. Barnes Aerospace manufactures and repairs aircraft engine and airframe components. Barnes Distribution distributes maintenance, repair, and operating supplies.
II. Overview of Events
We must address two unrelated events in this case. The first concerns the Agreement and Plan of Reinvestment (reinvestment plan or plan) executed between Barnes and its subsidiaries in 2000 and 2001. The second concerns an agreement to construct six "clean rooms" executed in 1985 between Barnes and International Business Machines Corp. (IBM).4
III. Events Leading to the Reinvestment Plan
The reinvestment plan was executed as a result of a series of events arising from Barnes' strategic objective to expand the company primarily through acquisitions. In accordance with Barnes' strategic objective: (1) Barnes hired new management (new management team) with strong backgrounds in growing companies and extensive experience with domestic and international acquisitions; and (2) made several acquisitions (early acquisitions) totaling approximately $200 million.
A. New Management Team
Between 1998 and the first quarter of 2000 Barnes replaced the majority of its executive officers as part of its strategic objective to expand the company. While the individuals most relevant to the reinvestment plan will be discussed in more detail below, in 2000 and 2001 Barnes' officers included: Edmund Carpenter--president and chief executive officer; William Denninger5--senior vice president, finance, and chief financial officer; Signe Gates–senior vice president, general counsel, and secretary; Francis Boyle--vice president, controller; Joseph DeForte--vice president, tax; Phillip Goodrich--senior vice president, corporate development; and John Locher6--vice president, treasurer.
B. Early Acquisitions
Before 1999 Barnes had not completed an acquisition for the better part of a decade. As part of the new expansion objective, the new management team engaged an outside consultant for assistance in identifying strategic growth areas for Associated Spring's business segment. The analysis and work product generated by the consultant provided Barnes with the necessary data and confidence to pursue an aggressive acquisition program specifically directed at Associated Spring's electronics business in Asia and Europe.
Barnes made three significant acquisitions during 1999 and 2000 totaling $197.1 million: (1) August 1999--Barnes acquired the nitrogen gas springs business of Teledyne Fluid Systems Division of Teledyne Industries, Inc., for $92.2 million; (2) May 2000--Barnes acquired Curtis Industries, Inc., for $63.3 million; and (3) September 2000--Barnes acquired AVS/Kratz-Wilde Machine Co. and Apex Manufacturing, Inc., for $41.6 million.7
C. Result of Early Acquisitions
At the end of 1998 before the acquisitions began, Barnes had approximately $50 million of outstanding long-term indebtedness and no outstanding balance on a revolving credit line. By the end of 2000 Barnes had approximately $230 million of outstanding long-term indebtedness including approximately $50 million due on its revolving credit line. This increase in debt transformed Barnes from a relatively low-leveraged firm to a firm with significantly above-average leverage for companies within the industrial equipment and components industries. The early acquisitions also increased Barnes' cost of borrowing and debt-to-equity ratio.8
D. The Predicament
As of May 31, 2000, Barnes and its subsidiaries collectively had $45.2 million of cash worldwide--Barnes and its domestic subsidiaries held $1.5 million and Barnes' foreign subsidiaries held the remaining $43.7 million.
Associated Spring-Asia PTE Ltd. (ASA), a Singapore corporation and second-tier Barnes subsidiary, conducted operations for Barnes' Associated Spring division in Southeast Asia. During the late 1990s ASA generated significant profits.9 As of September 1, 2000, ASA had approximately $12.9 million of existing cash reserves held in short-term accounts and approximately $26.1 million of cash receivables from foreign affiliates. ASA was generating cash in excess of its immediate operating needs, allowing ASA to borrow funds from the Development Bank of Singapore Ltd., an unrelated third-party bank (Singapore Bank), at a preferential interest rate.
Accounting for all of the bank deposits held by Barnes' domestic and foreign subsidiaries, Barnes was earning approximately 3% interest on its aggregate cash and short-term investment holdings. Conversely, Barnes' 2000 annual report indicated that Barnes had external borrowings with interest rates ranging from 7.13% to 9.47%. While ASA was permitted to make short-term money market style investments, other investments by ASA required approval from Barnes' CFO or treasurer.
Consistent with Barnes' growth by acquisition strategy, Barnes sought to use ASA's excess cash and borrowing capacity to finance one or more international acquisitions; however, no suitable targets had been identified during the late 1999 to early 2000 period.10 As a result, ASA's excess cash remained invested in short-term deposit accounts earning approximately 3% while Barnes was incurring debt at borrowing rates in excess of 7%. Barnes understood that either a dividend or a loan from ASA to Barnes would trigger a Federal tax liability.11
IV. The Search for a Solution
Mr. DeForte (Barnes' vice president, tax) was one of the primary players involved with the reinvestment plan. At the time of his hiring, Mr. DeForte had over 20 years of experience with large multinational corporations as an international tax accountant (Pfizer Corp. and Johnson & Johnson), an international tax manager (ITT Sheraton Corp.), and a vice president, tax (Millipore Corp. and Loctite Corp.).12 He worked on corporate acquisitions at various times throughout his career.
Upon arriving at Barnes, Mr. DeForte met with key personnel in the treasury, legal, and accounting departments to identify potential corporate opportunities, existing pitfalls, prior strategies, and the valuable assets and operations of Barnes' three business segments. Mr. DeForte first learned of the aforementioned predicament in late 1999 during a meeting with Barnes' assistant treasurer, David Sinder.13
Mr. DeForte first contacted Ernst & Young (E&Y) and Deloitte & Touche (Deloitte) for assistance in addressing the predicament. Specifically, Barnes sought a way to (a) "arbitrage" the interest rate differential, (b) without incurring Federal income tax, (c) while retaining the foreign funds for overseas investment opportunities. After rejecting the ideas proposed by E&Y and Deloitte, Mr. DeForte contacted Dennis Lubozynski, a tax partner at PricewaterhouseCoopers (PwC).14
Barnes had been a client of PwC since 1993. From 1993 through the time of trial, PwC provided Barnes with audit and tax advisory services. At the time Mr. DeForte contacted PwC for assistance, PwC had been providing these services to Barnes for over seven years.
After receiving the request for assistance, PwC reviewed its Ideasource database15 and spoke with several professionals around the firm to determine what ideas would be available to meet the needs of Barnes. PwC proposed several solutions. After some follow up meetings between members of Barnes' tax department and PwC professionals, Barnes decided to construct a domestic and foreign finance structure16 as a solution to...
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