Smith v. Comm'r
| Decision Date | 18 September 2018 |
| Docket Number | 151 T.C. No. 5,Docket No. 14900-15. |
| Parties | BARRY M. SMITH AND ROCHELLE SMITH, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Ps owned, through a pair of grantor trusts and an S corporation, controlled foreign corporations (CFCs) incorporated in Hong Kong and later in Cyprus. In 2008 the Hong Kong CFC paid Ps a dividend of $12.3 million. In 2009 the Cypriot CFC paid Ps a dividend of $57.1 million. In 2009 the Cypriot CFC also canceled an account receivable owed by Ps' S corporation. That account receivable had an outstanding balance of $21.1 million when it was canceled.
R determined that the dividend paid by the Hong Kong CFC in 2008 was taxable as ordinary dividend income under I.R.C. sec. 962(d), to the extent of the difference between the amount the Hong Kong CFC had distributed to them in 2008 and the tax they had previously paid on account of prior I.R.C. sec. 951(a) inclusions to which that E&P was attributable. R next determined that the Cypriot CFC was not a "qualified foreign corporation" within the meaning of I.R.C. sec. 1(h)(11)(C)(i) and hence that the $57.1 million dividend the Cypriot CFC paid Ps in 2009 was taxable as ordinary dividend income, not as "qualified dividend income" subject to a reduced rate of tax under I.R.C. sec. 1(h)(1). Finally, R determined that the cancellation of the account receivable balance owed to the Cypriot CFC was taxable to Ps in 2009 as a constructive dividend under I.R.C. secs. 301(c)(1), 316, and 1366.
1. Held: The Hong Kong CFC was neither a domestic corporation nor a "qualified foreign corporation" under I.R.C. sec. 1(h)(11)(C)(i). Its 2008 distribution of $12.3 million to Ps therefore was not "qualified dividend income" under I.R.C. sec. 1(h)(11)(B) but rather was taxable to them under I.R.C. sec. 962(d) at ordinary-income rates.
2. Held, further, petitioners have not established that the doctrine applies to require that we accord dispositive effect to a residency certificate issued by the Cyprus Ministry of Finance asserting that the Cypriot CFC was a resident of Cyprus during 2009. Because there exist genuine disputes of material fact concerning the CFC's residency, summary judgment is inappropriate on the question whether the Cypriot CFC was a "qualified foreign corporation" and hence as to whether the $57.1 million dividend it paid Ps in 2009 was "qualified dividend income" under I.R.C. sec. 1(h)(11)(B)(i)(II).
3. Held, further, Ps received from the Cypriot CFC in 2009 a constructive distribution of $21.1 million that was taxable to them as a dividend under I.R.C. secs. 301(c)(1) and 316(a).
Desiree E. Fernandez, Jose M. Ferrer, Summer A. Lepree, Jeffrey L. Rubinger, and Samuel C. Ullman, for petitioners.
Jeffrey B. Fienberg, Michael S. Kramarz, Sergio Garcia-Pages, and Richard A. Rappazzo, for respondent.
LAUBER, Judge: During 2008 and 2009 petitioners owned, through a pair of domestic grantor trusts and an S corporation, controlled foreign corporations (CFCs) incorporated in Hong Kong and later in Cyprus. The Internal Revenue Service (IRS or respondent) determined that petitioners during these years had received actual or constructive dividends from the Hong Kong CFC and from the Cypriot CFC. On the basis of these and other adjustments the IRS determined, for petitioners' 2008 and 2009 taxable years, deficiencies of $6,308,329 and $18,743,201, respectively.
This case is currently before the Court on cross-motions for partial summary judgment under Rule 121.1 These motions ask that we decide three questions:
(1) Whether a $12,307,591 dividend that the Hong Kong CFC paid petitioners in 2008 should be deemed to have been distributed by a domestic corporation, so as to be subject to a reduced rate of tax as a "qualified dividend" under section 1(h)(11)(B)(i)(I); (2) Whether a $57,106,892 dividend that the Cypriot CFC paid petitioners in 2009 was received from a "qualified foreign corporation," so as to be subject to a reduced rate of tax as a "qualified dividend" under section 1(h)(11)(B)(i)(II); and
(3) Whether petitioners received a constructive dividend of $21,055,123 in 2009 when the Cypriot CFC canceled a debt owed to it by petitioners' S corporation.
The parties have filed cross-motions for partial summary judgment on the first and third questions, and they agree that these questions are encumbered by no disputed issues of material fact. We agree that these two questions may appropriately be decided summarily, and we answer both questions in respondent's favor.
Petitioners seek summary judgment on the second question, and respondent opposes that motion on the ground that material factual disputes exist concerning the Cypriot CFC's residency. Petitioners urge that they are entitled to judgment as a matter of law on the theory that the doctrine requires us to accept, as dispositive of the Cypriot CFC's status as a bona fide resident of Cyprus, a certification from the Cyprus Ministry of Finance (Ministry) to that effect. Viewing the facts and inferences drawn from them in the light most favorable to respondent as the nonmoving party, we conclude that petitioners have not established that the act of state doctrine applies. Because there exist genuine disputes of material fact concerning the Cypriot CFC's residency, we will deny petitioners' motion for partial summary judgment on the second question.
The following facts are derived from the parties' pleadings and motion papers, the declarations and the exhibits attached thereto, and the parties' first stipulation of facts. Petitioners resided in Florida when they filed their petition.
Beginning in 1980 petitioners owned and operated a group of domestic and foreign corporations that manufactured and sold consumer electronic products. Through a pair of grantor trusts, petitioners owned Hopper Radio of Florida, Inc. (Hopper US), an S corporation. For Federal income tax purposes, petitioners were treated as owning 100% of the stock of Hopper US, and they were thus required to take into account 100% of its income. See sec. 1361(a) and (b).
Hopper US was the sole shareholder of Memcorp, Inc. (Memcorp US), a Florida corporation. As a "qualified subchapter S subsidiary" of Hopper US, Memcorp US was treated as a disregarded entity. See sec. 1361(b)(3)(A)(i), (B). For sake of simplicity, we will refer to all transactions conducted by Memcorp US as having been conducted by Hopper US directly.
From January 1995 until November 18, 2008, Hopper US was treated as owning, through Memcorp US, all the stock of Memcorp Asia Ltd. (Memcorp HK). Memcorp HK was incorporated in Hong Kong and, from the date of its incorporation until November 18, 2008, was a CFC within the meaning of section 957(a). For subpart F purposes, Hopper US, although an S corporation, was treated as a domestic partnership, and its shareholders were "treated as partners of such partnership." See sec. 1373(a). Petitioners were accordingly required to include in their gross income, under section 702, items of income, loss, deduction, and foreign tax credit attributable to Memcorp HK (and any other CFCs that Hopper US might own).
Before the tax years at issue petitioners began winding down their active business operations. In July 2007 they sold to a third party, for $47.5 million, the operating assets of Hopper US and Memcorp HK. This left Memcorp HK with substantial cash, both from its prior operations and from the sale proceeds. Petitioners planned to have this cash distributed to them.
Petitioners hoped that the contemplated distribution could be treated as "qualified dividend income" (QDI) under section 1(h)(11)(B), which would allow the dividend to be taxed at a rate of 15% or lower. See sec. 1(h)(1), (11)(B). This would be possible only if Memcorp HK were a "qualified foreign corporation." See sec. 1(h)(11)(B)(i)(II). But Memcorp HK's residency presented a complication in that respect. A "qualified foreign corporation" is defined to mean a company that is either "incorporated in a possession of the United States" or is "eligible for benefits of a comprehensive income tax treaty with the United States." Sec. 1(h)(11)(C)(i). Memcorp HK was not incorporated in a U.S. possession. And Hong Kong did not have an income tax treaty with the United States.2
Petitioners accordingly decided to move Memcorp HK to Cyprus, which did have an income tax treaty with the United States. Toward that end petitioners in August 2008 incorporated Hopper Cyprus as a subsidiary of Hopper US. From the date of its incorporation Hopper Cyprus has been a CFC within the meaning of section 957(a).
On November 18, 2008, Hopper US transferred to Hopper Cyprus all of its shares in Memcorp HK. Memcorp HK then filed with the IRS, and the IRS approved, a Form 8832, Entity Classification Election, by which Memcorp HK elected to be treated as a disregarded entity. The ultimate effect of these transactionswas that, as of November 18, 2008, Memcorp HK reorganized itself as Hopper Cyprus in a tax-free reorganization under section 368(a)(1)(F).
By virtue of this reorganization Hopper Cyprus inherited all the assets previously owned by Memcorp HK. These assets included (1) a large sum of cash generated from the sale of Memcorp HK's operating assets and (2) an account receivable that Hopper US had owed to Memcorp HK for many years.
The IRS examined petitioners' tax returns for 2004 and 2005, and the results of those examinations are relevant to certain issues we must address. The IRS determined that Memcorp HK during 2004 held an investment of $15,765,803 in "United States property" within the meaning of section 956(c)(1)(C) (U.S. property), which was attributable to the account receivable (mentioned above) that Hopper US owed to Memcorp HK. The IRS accordingly determined that petitioners for 2004 were required to include that amount in gross income under ...
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