Brown Group, Inc. v. C.I.R., 95-2110
| Decision Date | 16 April 1996 |
| Docket Number | No. 95-2110,95-2110 |
| Citation | 77 F.3d 217 |
| Parties | -510, 96-1 USTC P 50,055 BROWN GROUP, INC. and its Subsidiaries, Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Appellee. |
| Court | U.S. Court of Appeals — Eighth Circuit |
Thomas C. Walsh, St. Louis, Missouri, argued (Harold G. Blatt, St. Louis, Missouri, and Michael F. Solomon, Washington, DC, on the brief), for appellant.
Frank P. Cihlar, Washington, DC, argued (Loretta C. Argrett as Assistant Attorney General, Gary R. Allen and David English Carmack, Washington, DC, on the brief), for appellee.
Before FAGG, Circuit Judge, GARTH, ** Senior Circuit Judge, WOLLMAN, Circuit Judge.
This is an appeal from the en banc decision by the United States Tax Court (the "Tax Court"), assessing taxes against appellant, the Brown Group, Inc. ("the Brown Group") and its subsidiaries, on the commission distributions received by the Brown Group's wholly-owned Cayman Islands subsidiary, Brown Cayman, Ltd. ("BCL"), under Subpart F of the Internal Revenue Code ().
The issue we address on appeal is whether BCL's distributive share of a foreign partnership's earnings (Brinco partnership) should be taxed to the Brown Group under Subpart F of the Internal Revenue Code. We hold that a foreign partner's distributive share of foreign partnership income cannot be deemed to be "Subpart F income" where the commissions at issue did not constitute "Subpart F income" under the pre-1987 statute, 26 U.S.C. § 954(d)(3), in that the foreign partnership (Brinco) did not control a controlled foreign corporation such as BCL. Accordingly, we vacate the decision of the Tax Court assessing an income tax deficiency against the Brown Group for the tax year ending November 1, 1986.
The Brown Group is the publicly traded parent corporation of an affiliated group of corporations filing a consolidated income tax return. The Brown Group, whose principal place of business is St. Louis, Missouri, manufactured and sold footwear in the United States. The Brown Group imported footwear from Brazil and other countries and, up until 1985, used a number of independent agents to purchase Brazilian-manufactured footwear.
The Brown Group includes a wholly owned subsidiary, Brown Group International, Inc. ("BGII"), a Delaware corporation. BGII, in turn, is the parent of a wholly owned subsidiary, BCL, a Cayman Islands corporation. The parties have stipulated that BGII was a "United States shareholder" of BCL, and that BCL was a "controlled foreign corporation" ("CFC") within the meaning of the pre-1987 statutes, 26 U.S.C. §§ 957(a), 954(d)(1). Indeed, BCL is a CFC even under the post-1987 section 954(d)(1) as amended.
In 1985, the Brown Group decided to consolidate its buying power in Brazil by using only one purchasing agent there. The Brown Group formed Brinco P/S ("Brinco"), a limited foreign partnership, to be that purchasing agent, with the view toward attracting Mr. Ted Presti and Mr. Delcio Birck to purchase Brazilian footwear exclusively for the Brown Group. Brinco was structured as a partnership because this allowed the Brown Group to pay Presti a salary higher than that allowed within the Brown Group's existing payroll structure. It also allowed Presti and Birck to have entrepreneurial interests in Brinco's operations; and enabled the partners to avoid Brazilian currency instability.
Presti was the managing partner of Brinco. BCL held an 88% interest in Brinco, with the other 12% held by the other partners. 1
For ease in understanding the relationship of the various companies to which we have made reference, we include a schematic diagram of the various enterprises. This diagram appeared in both parties' briefs on appeal.
During 1985 and 1986, Brinco served as the purchasing agent for BGII with respect to footwear manufactured in Brazil. BGII paid Brinco a 10% commission for acting as its Brazilian purchasing agent. This commission was based on the purchase price of the footwear. BGII included the commissions paid to Brinco in its cost of goods sold. All of Brinco's income consisted of commission income. BCL, as a partner owning a 88% interest in Brinco, received a distributive share of Brinco's income. Brinco was dissolved on October 31, 1987.
On October 7, 1991, the IRS issued a Notice of Deficiency against the Brown Group in the amount of $388,992.85 for the tax year which ended November 1, 1986, on the ground that BCL's distributive share of Brinco's earnings was "foreign base company sales income" that was includable as "Subpart F income" taxable to the Brown Group under sections 951, 952, 954, and 701-709 of the Internal Revenue Code.
On January 2, 1992, the Brown Group filed a petition for redetermination of the IRS's assessment of an income tax deficiency. The case was tried before Tax Court Judge Julian Jacobs on March 9, 1993. On April 12, 1994, Judge Jacobs filed an opinion in favor of the Brown Group.
The IRS moved for reconsideration by motion filed May 12, 1994, contending that Judge Jacob's opinion was "unnecessarily broad and can reasonably be interpreted in a manner that effectively repeals virtually all of the subpart F provisions of the Code." The motion for reconsideration was granted on September 27, 1994, and the case was resubmitted to the entire Tax Court.
Without further briefing or argument, the Tax Court ordered that decision be entered for the IRS on January 25, 1995. Seven judges (Halpern, Hamblen, Parker, Cohen, Swift, Parr, and Beghe, JJ.) joined in the majority opinion. Of the seven judges, two judges (Swift and Beghe, JJ.) filed or joined in separate concurrences. Two judges who had not joined the majority opinion (Ruwe and Chiechi, JJ.) each filed separate concurrences. Three judges (Jacobs, Chabot, and Laro, JJ.) joined in a dissent authored by Judge Jacobs.
On January 30, 1995, the Tax Court entered its decision assessing an income tax deficiency in the amount of $388,992.85 against the Brown Group for the tax year ending November 1, 1986. The Brown Group has appealed to this Court.
Under Subpart F of the Internal Revenue Code, codified at 26 U.S.C. § 951 et seq., a United States shareholder 3 that controls a foreign corporation for an uninterrupted period of thirty or more days must include in its taxable gross income, its pro rata share of the controlled foreign corporation's "Subpart F" income. 26 U.S.C. § 951(a)(1). 4
"Subpart F income" is defined as four types of income under section 952(a). The only type of "Subpart F income" involved in this case is "foreign base company income." 26 U.S.C. § 952(a)(2).
There are five different types of "foreign base company income," as defined under section 954(a). The only type involved in this case is "foreign base company sales income."
"Foreign base company sales income" is defined in relevant part as:
Income ... derived in connection with 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 where--
(A) the property which is purchased ... is manufactured, produced, grown, or extracted outside the country under the laws of which the controlled foreign corporation is created or organized, and
(B) ... in the case of property purchased on behalf of a related person, is purchased for use, consumption, or disposition outside such foreign country.
26 U.S.C. § 954(d)(1) (emphases added).
Under the version of section 954(d)(3) in effect for the taxable year of 1986, a "related person" is defined as:
(A) an individual, partnership, trust, or estate which controls the controlled foreign corporation; or (B) a corporation which controls, or is controlled by, the controlled foreign corporation; or (C) a corporation which is controlled by the same person(s) which control the controlled foreign corporation.
26 U.S.C. § 954(d)(3) (emphases added). We are concerned here only with section 954(d)(3)(A) which requires that in order to be a "related person," Brinco, a foreign partnership, must control a controlled foreign corporation--in this case, BCL. For purposes of this section, "control" is defined as "the ownership, directly or indirectly, of stock possessing more than fifty percent of the total combined voting power of all classes of stock entitled to vote." Id.
In this case, the parties have stipulated that BGII is a "United States shareholder" and BCL is a "controlled foreign corporation." It is undisputed that Brinco was not a "related person," as defined in 26 U.S.C. § 954(d)(3), to either BCL or BGII. It is also undisputed that BGII was a "related person" to BCL. The IRS has conceded that Brinco was not a sham partnership.
The present case boils down to a very discrete question of law: whether BCL's distributive share of Brinco's partnership earnings (commissions) constituted "Subpart F income," under 26 U.S.C. § 954(d)(3), given that the commissions did not constitute "Subpart F income" when earned by Brinco. We exercise de novo review of this question of law. Jacobson v. Commissioner, 963 F.2d 218, 219 (8th Cir.1992).
We hold that the Tax Court erred in ignoring the partnership entity in characterizing BCL's earnings as taxable "Subpart F income." Instead, we are persuaded by, and adopt, the reasoning and holding of Judge Jacobs's January 25, 1995 opinion which dissented from the Tax Court's en banc opinion.
It is not disputed that under section 954(d)(3), as that statute existed in 1986, Brinco was not a "related person" to either BGII or BCL. Moreover, this conclusion is supported by the plain language of the statute. Brinco is not a corporation. Hence, the only portion of the "related person" definition that could apply to...
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