Del Commercial Prop. v. Comm'r of Internal Rev.

• Decision Date: 08 June 2001
• Docket Number: No. 00-1313,00-1313
• Citation: 251 F.3d 210
• Parties: (D.C. Cir. 2001) Del Commercial Properties, Inc., Appellant v. Commissioner of Internal Revenue Service, Appellee
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 210

251 F.3d 210 (D.C. Cir. 2001)

Del Commercial Properties, Inc., Appellant v. Commissioner of Internal Revenue Service, Appellee

No. 00-1313

United States Court of Appeals FOR THE DISTRICT OF COLUMBIA CIRCUIT

Argued March 13, 2001

Decided June 8, 2001

Appeal from the United States Tax Court (No. IRS-1887-98)

James P. Fuller argued the cause for appellant. With him on the briefs were David L. Forst, Kenneth B. Clark and William F. Colgin.

Kenneth W. Rosenberg, Attorney, U.S. Department of Justice, argued the cause for appellee. With him on the brief was Jonathan S. Cohen, Attorney. Edward T. Perelmuter, Attorney, entered an appearance.

Before: Sentelle, Tatel and Garland, Circuit Judges.

Opinion for the Court filed by Circuit Judge Sentelle.

Sentelle, Circuit Judge:

On July 18, 1990, Delcom Financial Ltd., a Canadian corporation, took out an $18 million loan from the Royal Bank of Canada. This loan initiated a series of transactions over the next twenty-four hours, involving five companies organized in Canada, the Cayman Islands, the Netherlands Antilles, the Netherlands, and the United States--all of which were related to each other and to Delcom Financial. The final transaction was a $14 million loan from Del Investments Netherlands B.V. ("Del BV"), a Dutch corporation, to Del Commercial Properties, Inc., an American corporation. Over the next year and a half, Del Commercial repaid Del BV, who then transferred the payments to Delcom Financial (or another related corporation), who in turn paid off the Royal Bank loan. In July 1992, Del Commercial began repaying Delcom Financial directly. Throughout this entire period, however, Del BV reported Del Commercial's interest payments on its Dutch tax returns.

In 1997, the Commissioner of Internal Revenue in the United States ("Commissioner") informed Del Commercial that it owed taxes and additions based on the interest payments it made between 1990 and 1993. See 26 U.S.C. 881, 1442, 6651(a)(1), 6656. Del Commercial petitioned the Tax Court, claiming that in light of a treaty between the United States and the Netherlands the corporation owed no tax on interest payments made to Del BV. The Tax Court ruled against Del Commercial, finding that the series of transactions between the related companies was a sham designed solely to avoid U.S. taxes. See Del Commercial Props., Inc. v. Commissioner, T.C.M. 1999-41, No. 1887-98, slip op. at 11 (Dec. 20, 1999). Based on this ruling, the Tax Court ordered Del Commercial to pay $1,194,573 in taxes and additions. Del Commercial now appeals from the Tax Court's decision. For the reasons set forth below, we affirm.

I. BACKGROUND

Del Commercial Properties, Inc. ("appellant") is an Illinois corporation whose principal place of business is in Ontario, Canada. It is a fourth-tier subsidiary of an affiliated group of corporations ("the Affiliated Group") whose common parent is DL Shekels Holdings Ltd. Delcom Financial Ltd. is a second-tier subsidiary in the Affiliated Group. Delcom Financial is a Canadian corporation that owns 100% of the outstanding stock of Delcom Holdings, Ltd., another Canadian corporation. In turn, Delcom Holdings owns 100% of Delcom Cayman, Ltd. (a corporation organized in the Cayman Islands), which owns 100% of the outstanding stock of Delcom Antilles, N.V. (a corporation organized in the Netherlands Antilles). Delcom Antilles owns 100% of the outstanding stock of Del Investments Netherlands B.V. ("Del BV"), a corporation organized in the Netherlands.

From 1990 through 1993, appellant's principal business was leasing industrial real estate it owned in the United States. In 1990, when appellant needed funding to refinance and improve some of its American properties, one of DL Shekels's first-tier subsidiaries, Tridel Corporation, arranged the following financing scheme: On July 18, 1990, the Royal Bank of Canada loaned $18 million (in U.S. dollars) to Delcom Financial. That same day, Delcom Financial made two unsecured interest-bearing loans to Delcom Holdings. One of those loans (the one directly relevant to this case) was for $14 million. Delcom Holdings then contributed "about $14 million to Delcom Cayman for common shares of stock." Stipulation of Facts at 5, Del Commercial Props., Inc. v. Commissioner, T.C.M. 1999-41 (Oct. 22, 1998). On the same day, "Delcom Cayman contributed about $14 million to Delcom Antilles and received common shares of stock in that entitiy. Later on that same date, Delcom Antilles contributed about $14 million to Del BV and received common stock in that entity." Id. at 5-6.

The following day, July 19, appellant borrowed $14 million from Del BV. That same day, appellant "guaranteed repayment of a portion of amounts owed by Delcom Financial to Royal Bank" and authorized Royal Bank to place a mortgage on its real property in the U.S. Id. at 7. Appellant also agreed to provide Royal Bank with "annual financial statements, to insure its real property, to assign the insurance policies to Royal Bank, to defer paying dividends to shareholders, and to use the proceeds from any sales of real property to make payments on the $14 million Royal Bank loan." Brief for the Appellee at 6.

On January 1, 1991, appellant began repaying Del BV. Del BV transferred these payments "either to Delcom Holdings or Delcom Financial. The funds were used to pay principal and interest owed on the $14 million Royal Bank loan." Del Commercial Props., T.C.M. 1999-411, slip op. at 7. Beginning in July 1992, however, appellant began making its loan payments directly to Delcom Financial, "and Delcom Financial then forwarded funds to Royal Bank in payment on the Royal Bank loan." Id. Throughout this time, Del BV reported the interest paid by appellant as income on its Netherlands tax returns. Meanwhile, appellant did not file United States withholding tax returns or deposit withholding taxes on any payments related to the loan.

On October 30, 1997, the Commissioner provided appellant with a Notice of Deficiency stating that it owed taxes and additions based on the interest payments made between 1990 and 1993. See 26 U.S.C. 881, 1442, 6651(a)(1), 6656. Appellant petitioned the Tax Court to determine the correct amount of taxes and additions, contending that under a treaty between the United States and the Netherlands, no tax is owed to the United States on interest payments made by an American corporation to a Dutch corporation. The Tax Court held that the series of loans and stock contributions that began with Delcom Financial and ended with appellant "reflect a step transaction created simply to bypass U.S. withholding tax." Del Commercial Props., T.C.M. 1999-411, slip op. at 11. Because the appellant had not "presented any credible argument" that its failure to file a tax return or deposit withholding taxes was "attributable to reasonable cause," the Tax Court concluded that appellant owed penalties in addition to the withholding taxes. Id. at 13. Accordingly, the Tax Court ordered appellant to pay $1,194,573 in taxes and additions.

Appellant appeals from that decision.

II. ANALYSIS

We review Tax Court decisions "in the same manner and to the same extent" as a decision issued by a district court. 26 U.S.C. 7482. That is, questions of law are reviewed de novo, while questions of fact are reviewed for clear error. See ASA Investerings P'ship v. Commissioner, 201 F.3d 505, 511 (D.C. Cir.), cert. denied, 121 S. Ct. 171 (2000). As we recently noted, "in tax cases mixed questions of law and fact are to be treated like questions of fact." Id.

Appellant challenges the Tax Court's decision on two grounds. First, it argues that the Tax Court erred in concluding that it was responsible for withholding United States taxes on the interest payments it made to Del BV. According to appellant, the financing scheme was not designed solely to avoid U.S. taxes. Rather, the scheme sought to allow the Affiliated Group to achieve substantial Canadian tax savings, a permissible business purpose under American tax law. Second, appellant contends that even if it should have withheld U.S. taxes on the interest payments, the Tax Court erred by imposing a penalty for appellant's failure to file withholding tax returns or to deposit the withholding tax. Specifically, appellant suggests that it should not be penalized because its decision not to withhold represented a reasonable difference of opinion with the Commissioner. We address each of these issues in turn.

A. Withholding of Interest Payments

The Internal Revenue Code requires foreign corporations to pay "a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as interest ... to the extent the amount so received is not effectively connected with the conduct of a trade or business within the United States." 26 U.S.C. 881(a). An American taxpayer who makes such interest payments is required to deduct and withhold the tax owed by the foreign corporation. See 26 U.S.C. 1441, 1442. If the American taxpayer fails to deduct and withhold the tax, he is personally liable for the tax due. See 26 U.S.C. 1461.

Pursuant to the United States-Netherlands Tax Treaty, interest payments made by American taxpayers to Netherlands corporations are exempt from taxes in the United States. See Supplementary Convention on Taxes on Income and Other Taxes, Dec. 30, 1965, U.S.-Netherlands, Art. VI, 17 U.S.T. 896, 901. In contrast, under the United StatesCanada Tax Treaty, the tax on interest payments "shall not exceed 15 percent of the gross amount of the interest" if the recipient of the payments is "the beneficial owner of such interest." Convention on Taxes on Income and Capital, Sept. 26, 1980, U.S.-Can., Art. XI, T.I.A.S. No. 11087.

Under the step-transaction doctrine, a particular step in a transaction is disregarded for tax purposes if the taxpayer could have achieved its objective more directly, but instead included the step...