Hewlett-Packard Co. & Consolidated Subsidiaries v. Comm'r of Internal Revenue
| Decision Date | 14 May 2012 |
| Docket Number | Docket No. 21976-07,Docket No. 10075-08 |
| Parties | HEWLETT-PACKARD COMPANY AND CONSOLIDATED SUBSIDIARIES, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | United States Tax Court |
P purchased an interest in a foreign corporation in 1996. A separate foreign shareholder held an interest in the foreign corporation that was four times greater than P's. The foreign corporation's business activities were effectively limited by its articles of incorporation and a shareholders agreement to include only the purchase of contingent interest notes from the separate foreign shareholder.
As part of P's acquisition of its interest in the foreign corporation, P contemporaneously purchased a put option from the separate foreign shareholder. The option gave P the right to put its shares in the foreign corporation to the foreign shareholder in January 2003 or January 2007 or upon the occurrence of particular events that were beyond the control of the parties. The put amount was defined as the fair market value of the shares on the respective option exercise dates. The put agreement was referenced in the shareholders agreement, to which the foreign corporation was a party. The shareholders agreement also afforded P, upon the occurrence ofcertain events, the exclusive authority to convene a shareholders meeting at which the shareholders could (1) cause the foreign corporation to reduce its capital in order to redeem or repurchase P's shares, or (2) cause the foreign corporation to dissolve. P anticipated receiving dividends from its investment in the foreign corporation and claiming substantial direct and indirect foreign tax credits associated with those distributions.
Held: P's investment in the foreign corporation is more appropriately characterized as a loan for Federal income tax purposes.
Held, further, P is not entitled to deduct a capital loss in connection with its exit from the transaction.
Albert H. Turkus, Alan J.J. Swirski, David J. Sotos, Patrick Evans, David W. Foster, and Lauren D. Laitin, for petitioner.
Jill A. Frisch, Anne Hintermeister, Caroline T. Chen, and Vincenza A. Taverna-Ciarlo, for respondent.
GOEKE, Judge: Respondent issued two notices of deficiency to petitioner, one for its 1999 and 2000 tax years and the other for its 2003 tax year, which, in part, disallowed foreign tax credits claimed for the tax years at issue, as well as a $15,569,004 capital loss petitioner claimed for its 2003 tax year. The foreign taxcredits claimed were subject to certain limitations and were not actually used to reduce petitioner's Federal income tax liabilities for those years. Corresponding adjustments to income under section 781 did, however, increase petitioner's alternative minimum tax liabilities for all three years in issue. Respondent did not reverse petitioner's section 78 income in the notices of deficiency. The parties submit three issues for decision:
(1) whether petitioner's investment in the foreign entity Foppingadreef (FOP) is more appropriately characterized as debt, rather than equity;
(2) whether petitioner's investment in FOP was a sham under the economic substance doctrine.
(3) whether FOP should be treated as a conduit entity under the step-transaction doctrine and the transaction recharacterized as a direct loan from petitioner to ABN AMRO Bank N.V. (ABN).
We hold that petitioner's investment in FOP is more appropriately characterized as debt for Federal income tax purposes and that petitioner is notentitled to deduct a capital loss for the sale of his interest in FOP. We need not consider the remaining issues as our holding renders them moot.
Some of the facts have been stipulated, and those facts are incorporated herein by reference. Petitioner, Hewlett-Packard Co. & Consolidated Subsidiaries (HP), is a company organized under the laws of the State of Delaware. At all relevant times HP maintained its principal corporate offices in Palo Alto, California.
In June or July of 1995, Robert Findling, a financial engineer employed by AIG-Financial Products Corp. (AIG-FP), a subsidiary of American International Group, Inc. (AIG), approached members of AIG-FP's Transactions Development Group (TDG) to discuss the possibility of engaging in a U.S.-dollar-linked Netherlands guilder stepped coupon contingent interest note (CIN) transaction. Mr. Findling understood that at that time most countries in Europe, including the Netherlands, had income recognition rules for contingent interest that were different from the rules that applied for U.S. Federal income tax purposes. Mr. Findling believed this asymmetric treatment provided AIG-FP with an opportunity to model a foreign investment that would generate a stream of preferred dividends and produce significant foreign tax credits. The contemplated transaction wouldrequire AIG-FP to transfer capital to a newly formed European entity in exchange for preferred stock and warrants to purchase additional stock; a separate European financial institution would simultaneously acquire common stock in the newly formed entity in an amount four times greater than AIG-FP's initial investment. Immediately thereafter, the new entity would lend money to the European financial institution in exchange for CINs. Most of the interest on the notes received by the new entity would then be distributed to AIG-FP through periodic dividends. The transaction in theory would enable the financial institution co-investor to obtain below-market funding with favorable regulatory treatment. AIG-FP would, in turn, profit through the receipt of dividends and claim indirect foreign tax credits for foreign taxes paid by the new entity.
AIG-FP CEO and TDG head Joseph Cassano, AIG-FP tax director and TDG member Richard Fabbro, and AIG-FP lawyer Doug Poling studied the viability of the transaction and discussed it with Andy Solomon, a lawyer with Sullivan & Cromwell. Lawyers from the law firms of Freshfields and Stibbe Simont Monahan Duhot (Stibbe) were also brought in for counsel as the transaction developed. Mr. Findling spent most of his time from June or July 1995 through December 1995 working on the transaction. During this period he met with his AIG-FP marketing colleagues to identify potential European counterparties withthe sophistication, the balance sheet, and the capacity to undertake such a transaction. He also reviewed financial information with marketing officers, worked on spreadsheets to develop overall balance sheet presentations, and participated in meetings with internal and external counsel. Toward the end of 1995, AIG-FP management communicated their decision to proceed with the transaction, which later became known as the FOP transaction, to Mr. Findling.
Around the same period, AIG-FP contacted ABN, a Dutch corporation, to gauge its interest in participating in the FOP transaction. AIG-FP believed ABN would be a worthwhile counterparty, in part because ABN was a large and financially secure banking group. During negotiations with ABN, AIG-FP represented that it would remain a principal in the transaction; however, it remained open to selling its interest to an unrelated third party sometime in the future.
In response to AIG-FP's initial communications, ABN began its own internal review of the transaction, including an evaluation by ABN's ethics committee. Typically, the ethics committee reviewed all ABN transactions with complex tax, economic, or accounting elements and all transactions that posed a reputational risk to the bank. ABN's internal policy was that if a transaction didnot meet the ethics committee's standards, ABN would not participate in the transaction, regardless of the benefits. Generally, in order for a transaction to be approved by the ethics committee, the transaction had to have an economic purpose, noncircular funding flows, and viability under pertinent bodies of law. The FOP transaction, in particular, was subject to ethics committee approval because there were distinct tax elements to the transaction and, as structured, it was not indicative of a traditional lending arrangement.
During internal review ABN recognized that the transaction posed a Dutch tax risk. Accordingly, while still engaged in negotiations with AIG-FP, ABN discussed the transaction with Dutch tax authorities and thereafter sought an agreement to secure the future tax treatment of the transaction. By letter dated December 21, 1995, Stibbe, on behalf of ABN, sought to procure a tax ruling from the Netherlands Tax Authority's Office Taxation Service Large Companies at Amsterdam (Dutch Tax Authority). The letter requested, primarily, that all contingent interest be included in FOP's income and that ABN be allowed to correspondingly deduct all such interest.
The letter also addressed the possibility that ABN would acquire the preferred shares held by the U.S. investor in the future and, thereafter, fail to paythe contingent interest on the CINs. Generally, for Dutch tax purposes, the nonpayment of the contingent interest would have resulted in both a tax loss to FOP, as the entity would have already recognized such interest, and an inclusion of income on the part of ABN, which would have previously deducted the contingent interest. ABN noted, however, that "at the moment of a potential loss in the year 2006, in all likelihood * * * [AIG-FP] will no longer be a shareholder of * * * [FOP] and * * * ABN will own all shares of * * * [FOP]", thereby forming a consolidated "fiscal entity". Accordingly, ABN requested that if it became a "fiscal entity" with FOP no later than December 31, 2005, its inclusion of interest income would be offset by the loss in FOP. Ultimately, the Dutch Tax Authority agreed to these proposed tax consequences and effected a ruling by executing the letter. A month after the tax ruling was issued, ABN requested that...
To continue reading
Request your trial