Limited, Inc. v. C.I.R.

Decision Date11 April 2002
Docket NumberNo. 00-2245.,00-2245.
Citation286 F.3d 324
PartiesThe LIMITED, INC., and consolidated subsidiaries, Petitioner-Appellant, v. COMMISSIONER OF INTERNAL REVENUE, Respondent-Appellee.
CourtU.S. Court of Appeals — Sixth Circuit

Joel V. Williamson (briefed), Roger J. Jones (argued and briefed), Russell R. Young (briefed), Mayer, Brown & Platt, Chicago, IL, James P. Fuller (briefed), Jennifer L. Fuller (briefed), Kenneth B. Clark (briefed), William F. Colgin (briefed), Fenwick & West, Palo Alto, CA, for Petitioner-Appellant.

Stuart L. Brown, Internal Revenue Service, Office of Chief Counsel, Washington, DC, Teresa E. McLaughlin (argued and briefed), Donald B. Tobin (briefed), U.S Department of Justice, Appellate Section Tax Division, Washington, DC, for Respondent-Appellee.

Stephen D. Gardner (briefed), Kronish, Lieb, Weiner & Hellman, New York, NY, for Amicus Curiae.

Before: JONES,* DAUGHTREY, and COLE, Circuit Judges.

OPINION

COLE, Circuit Judge.

Petitioner-appellant, The Limited, Inc. ("Taxpayer"), is one of the largest specialty retailers in the United States. As the common parent of a group of affiliated corporations, Taxpayer filed a consolidated income tax return for the taxable year ending on January 30, 1993 (the "1993 Tax Year"). The Commissioner of Internal Revenue informed Taxpayer of several deficiencies in its federal income tax returns for two tax years, including the 1993 Tax Year. Taxpayer and the Commissioner settled all of their differences except for a dispute regarding Taxpayer's subsidiary credit card company's sale of $174.9 million in certificates of deposit to a subsidiary of one of Taxpayer's controlled foreign corporations. In a two-step decision, the Tax Court concluded that Taxpayer should have recognized the purchase of $174.9 million in certificates of deposit as a taxable investment in "United States property" under I.R.C. §§ 951 and 956. First, the Tax Court held that the § 956(b)(2)(A) exception to the definition of "United States property" for "deposits with persons carrying on the banking business" does not apply because the subsidiary credit card company did not carry on the banking business. Second, and equally vital to its judgment, the Tax Court held that under temporary regulation § 1.956-1T, the $174.9 million in certificates of deposit should have been attributed to Taxpayer's controlled foreign corporation because the principal purpose for the creation, organization, or funding of the controlled foreign corporation's subsidiary was to avoid the application of § 956. Taxpayer appealed both grounds for the Tax Court's decision. The Tax Court erred in its analysis of § 956, and on that basis, we reverse its judgment.

I.

The disputed transaction was a January 28, 1993 wire-exchange of cash for interest-bearing certificates of deposit (the "January 28 Transfer"). Three of Taxpayer's subsidiaries were involved in the January 28 Transfer: Mast Industries (Far East), Ltd. ("MFE"), MFE (Netherlands Antilles) N.V. ("MFE-NV"), and the World Financial Network National Bank ("WFNNB").

MFE

MFE is a Hong Kong corporation that operates throughout Asia, manufacturing or obtaining garments for sale in Taxpayer's stores. MFE is a third-tier subsidiary of Taxpayer, and under I.R.C. § 957(a), MFE constitutes a controlled foreign corporation (a "CFC") of Taxpayer. For several years before the close of the 1993 Tax Year, MFE had accumulated and not distributed approximately $330 million in earnings and profits.

MFE-NV

MFE-NV is a Netherlands Antilles corporation created in January 1993, at the end of the 1993 Tax Year. MFE-NV is a fourth-tier subsidiary of Taxpayer and is wholly owned by MFE. Its corporate purposes include "engaging in group financing activities and providing for a means of investing and reinvesting liquid assets and funds." Consistent with those purposes, shortly after it was created, MFE-NV received a $175 million capital contribution from MFE.

WFNNB

WFNNB is a credit card company that issues credit cards to customers of Taxpayer's stores. Taxpayer wholly owns WFNNB. As a condition of being owned by a non-bank, WFNNB complies with 12 U.S.C. § 1841(c)(2)(F), which requires that it (i) engage in only credit card operations; (ii) not accept demand deposits or deposits that the depositor may withdraw by check or similar means for payment to third parties or others; (iii) not accept any savings or time deposit of less than $100,000; (iv) maintain no more than one office that accepts deposits; and (v) not engage in the business of making commercial loans. WFNNB is also a nationally chartered bank, authorized to carry on the business of banking under the laws of the United States. Consequently, WFNNB is regulated by the Office of the Comptroller of Currency, the Federal Deposit Insurance Company, and the Board of Governors of the Federal Reserve.

The January 28, 1993 Transfers

The January 28 Transfer was a two-part transaction between MFE, MFE-NV, and WFNNB. In the first part, MFE wired $175 million to MFE-NV. In the second part, MFE-NV used $174.9 million to purchase eight certificates of deposit with an annual yield of 3.14% (the "CDs") from WFNNB.

Taxpayer explained that the sole reason for this transaction was to protect MFE's assets from seizure by the People's Republic of China. Taxpayer believed that because Hong Kong was scheduled to return to China in 1997, China would begin to expropriate all assets in Hong Kong corporations on or before that date. To prevent the expropriation of MFE's assets, MFE created MFE-NV to hold MFE's assets and to act as a layer of protection from asset seizure. As a further shield against the asset expropriation, MFE-NV purchased CDs from WFNNB with $174.9 million that it received from MFE.

While this transfer may have been a good means of removing assets from Hong Kong (and funding WFNNB), it now presents a difficult international tax question. Taxpayer claimed that MFE-NV's purchase of $174.9 million in CDs from WFNNB did not constitute taxable "United States property" under § 956 and thus Taxpayer did not report § 951(a)(1)(B) taxes. Taxpayer argued that the CDs amounted to "deposits with persons carrying on the banking business," which is an exception to "United States property" under § 956(b)(2)(A). The Commissioner disagreed. The Commissioner believed that MFE-NV's purchase of the CDs did not qualify under the § 956(b)(2)(A) exception and therefore was an investment in "United States property" that was taxable under Subpart F of the Internal Revenue Code (I.R.C. §§ 951-64). Consequently, the Commissioner issued a notice of deficiency to Taxpayer. The Commissioner and Taxpayer could not resolve this issue and finally it was litigated before the Tax Court.

The Two Underlying Tax Issues

Two conclusions are necessary to sustain the Commissioner's finding of a tax deficiency: (1) that MFE-NV's purchase of CDs was not a deposit with persons carrying on the banking business under § 956(b)(2)(A) (the "§ 956 Issue") and (2) that under temporary regulation § 1.956-1T, the principal purpose for creating, organizing, or funding MFE-NV was to avoid the application of § 956 (the "Regulation Issue").

The first conclusion is necessary to sustain the deficiency because Subpart F of the Internal Revenue Code generally taxes CFCs when they invest their earnings in "United States property." See I.R.C. § 951(a)(1)(B). However, Section 956(b)(2)(A) excludes "deposits with persons carrying on the banking business" from the definition of "United States property." I.R.C. § 956(b)(2)(A). Thus, if MFE-NV's purchase of CDs from WFNNB is not a "deposit with persons carrying on the banking business," then it is an investment in "United States property."

The second conclusion — that the CDs should be attributed to MFE and recognized as income by the Taxpayer under § 951(a)(1)(B) — is also necessary to sustain the deficiency. Section 951(a), which taxes the income of CFCs, does not normally apply to an entity such as MFE-NV, which is a wholly-owned subsidiary of a CFC, and not a CFC itself. Consequently, even if MFE-NV had made investments in "United States property," that income would not have been subject to taxation. However, under temporary regulation § 1.956-1T, if the principal purpose for creating, organizing, or funding MFE-NV were to avoid the application of § 956, then the CDs that MFE-NV purchased would be attributed to MFE. If the CDs were attributed to MFE, which is a CFC, then, building off of the first conclusion, those CDs would be subject to taxation as part of MFE's earnings invested in "United States property."

Thus, for a deficiency to stand, the Commissioner must win the § 956 Issue and the Regulation Issue. The Tax Court resolved both issues in favor of the Commissioner and for that reason upheld the Commissioner's finding of a deficiency.

The Tax Court's Treatment of the § 956 Issue

On the § 956 Issue, the Tax Court concluded that MFE-NV's purchase of CDs from WFNNB was not a "deposit with persons carrying on the banking business," and therefore did not constitute an investment in "United States property." The Tax Court interpreted the use of the definite article, "the," in the phrase "carrying on the banking business" as indicating "a purpose to particularize the activity." In deciding which particularized business activity Congress was referring to in § 956(b)(2)(A), the Tax Court relied on the language of the statute and legislative history. Based on those sources, the Tax Court reasoned that the phrase, "the banking business," as used in § 956(b)(2)(A), applied only to deposits with banks offering banking services that facilitate the United States business activities of CFCs — the "business facilitation" rationale. Because WFNNB, as a credit card company, was restricted from engaging in business facilitation aspects of banking by 12 U.S.C. § 1841(c)(2)(...

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