Opinion ID: 15677
Heading Depth: 3
Heading Rank: 2

Heading: Attributable to Such Qualified Activity

Text: 27 We next consider whether the Tax Court erred, as the Stanfords claim, when it refused to allow them to reduce Guardian Bank's subpart F income by the deficits in earnings and profits of Stanford Financial, Guardian Bank's parent corporation. As discussed above, section 952(c)(1)(C)(i) provides that a CFC's subpart F income attributable to a qualified activity may be reduced by the deficits in earnings and profits of a qualified chain member to the extent the deficit of the chain member is attributable to such activity.  I.R.C. § 952(c)(1)(C)(i) (emphasis added). The parties agree that (1) Stanford Financial, by directly owning all of the stock of Guardian Bank in 1989 and 1990, was a qualified chain member with respect to Guardian Bank, I.R.C. § 952(c)(1)(C)(ii)(II); (2) Stanford Financial generated deficits in earnings and profits during 1989 and 1990, which deficits arose from the conferral of administrative and management support services to Guardian Bank; and (3) Guardian Bank's subpart F income in 1989 ($580,483) and 1990 ($2,789,722), which consisted exclusively of foreign personal holding company income earned through the active conduct of a banking business, was attributable to [a] qualified activity, I.R.C. sss 952(c)(1)(C)(i); 952(c)(1)(B)(iii)(VI); 952(c)(1)(B)(vi); see supra note 7. 15 Hence, the sole issue on appeal is whether the deficits of Stanford Financial were attributable to such activity, i.e. banking, so that they could be deducted against Guardian Bank's subpart F income on the Stanfords' 1990 tax return. 28 Our first task, then, is to interpret the phrase attributable to such activity, and in doing so, we must attempt to give the component words their ordinary, common meaning. G.M. Trading Corp., 121 F.3d at 981. While [t]he term 'attributable to' has no particular technical significance under the tax laws [--] [indeed,] nowhere in the Internal Revenue Code is such term defined, Lawinger v. Commissioner, 103 T.C. 428, 435, 1994 WL 471849 (1994) (punctuation omitted)--it has occasionally been interpreted in case law in both tax and nontax contexts: 29 Under the definition of collapsible corporation under section 117(m) of the 1954 Code, the Supreme Court interpreted attributable to, in the phrase gain attributable to such property, as merely confin[ing] consideration to that gain caused or generated by the property in question. Braunstein v. Commissioner, 374 U.S. 65, 70, 83 S.Ct. 1663, 10 L.Ed.2d 757 (1963). In interpreting the statutory language of section 165(i) of the 1954 Code that governs the ability of taxpayers to claim refunds or credits for property expropriated by the government of Cuba, the District Court of Mississippi held that the normal meaning of one thing to be attributed to another is that one thing is caused or brought about by that other thing. Ogden v. United States, 432 F.Supp. 214, 216 (S.D.Miss.1975), (citing Webster's Third New International Dictionary), aff'd, 555 F.2d 134 (5th Cir.1977). These interpretations are based on the conclusion that attribute or attributable connotes causation. See National Association of Greeting Card Publishers v. United States Postal Service, et al., 462 U.S. 810, 823, 103 S.Ct. 2717, 77 L.Ed.2d 195 (1983); Watson v. Employment Sec. Commn. of North Carolina, 111 N.C.App. 410, 432 S.E.2d 399, 401 (1993). For example, section 6663(a) provides: If any part of any underpayment    is due to fraud, there shall be added to the tax an amount equal to 75 percent of the portion of the underpayment which is attributable to fraud. ... Similarly, the accuracy-related penalty provision provides that the penalty applies to the portion of any underpayment which is attributable to negligence, substantial understatement of tax, etc. Sec. 6662(b). 30 Lawinger, 103 T.C. at 435. Based on this analysis, the Lawinger court found that the plain meaning of [the phrase] 'attributable to' is ... due to, caused by, or generated by. Id. On appeal, the Stanfords provide no reason why a different meaning should apply to this phrase in the context of this case. 31 The Stanfords argue that because the administrative and managerial services provided by Stanford Financial to Guardian Bank were driven solely by, directed solely to, and in all respects indispensable to Guardian Bank's qualified activity of banking, the deficits thereby generated by Stanford Financial were attributable to such activity. Because the plain meaning of the phrase attributable to does not embrace the interpretations given to it by the Stanfords, we cannot agree with their assessment. While there is no question that the deficit-inducing activities of Stanford Financial were (1) substantially related to Guardian Bank's qualified banking activity and indeed (2) helped give rise to Guardian Bank's subpart F income attributable to that activity which the Stanfords now hope to offset, section 952(c)(1)(C)(i) requires more--i.e., a causal relationship between such activity (banking) and Stanford Financial's deficits--before those deficits may offset that income; in short, the deficits must have been caused by or generated through the conducting of the same qualified activity which generated the subpart F income sought to be offset. While this requirement may seem an overly strict one, it is one mandated by a plain reading of the phrase to the extent such deficit is attributable to such activity  in section 952(c)(1)(C)(i). (emphasis added). Because Stanford Financial's deficits in earnings and profits were not due to, caused by, or generated by (1) Guardian Bank's qualified banking activity or (2) any similar qualified banking activity conducted by Stanford Financial, those deficits were not attributable to [the qualified] activity to which Guardian Bank's subpart F income was attributable. Read in the light of ordinary understanding, section 952(c)(1)(C)(i) thus precludes the Stanfords' ability to offset Guardian Bank's subpart F income by the earnings and profits deficits of Stanford Financial. The Tax Court's decision to this effect is accordingly affirmed. 16 3. Accuracy-Related Penalty 32 The final issue we address is whether the Tax Court erred in sustaining the Commissioner's determination that the Stanfords are liable for an accuracy-related penalty of $84,706.21 under I.R.C. § 6662. Section 6662 imposes a penalty equal to 20 percent of any substantial understatement of income tax. See I.R.C. §§ 6662(a); 6662(b). It is undisputed that the Stanfords' income tax deficiency that we affirmed in Sections II.B.1 and II.B.2 of this opinion was a substantial understatement of tax as defined by I.R.C. § 6662(d)(1)(A). Nonetheless, the statute provides that the amount of an understatement against which the penalty is imposed shall be reduced by the portion of the understatement that is attributable to (1) tax treatment that was supported by substantial authority, or (2) tax treatment for which (a) there is a reasonable basis and (b) the relevant facts were adequately disclosed in the return or in a statement attached to the return. I.R.C. § 6662(d)(2)(B). Furthermore, I.R.C. § 6664(c)(1) provides that [no] penalty shall be imposed ... with respect to any portion of an underpayment if it is shown that there was a reasonable cause for such portion and ... the taxpayer acted in good faith with respect to such portion. I.R.C. § 6664(c)(1). 17 Finding a lack of substantial authority to support the Stanfords' reduction of Guardian Bank's 1989 and 1990 subpart F income by the deficits in earnings and profits of Guardian Services and Stanford Financial, the Tax Court refused to set aside the accuracy-related penalty imposed against them by the Commissioner. On appeal, the Stanfords request a reversal of this penalty, contending either that (1) their tax treatment of the deficits was supported by substantial authority, or (2) any substantial understatement of tax resulting from this treatment was due to a reasonable cause and supported by good faith behavior on their part. 33 We need not resolve the Stanfords' substantial authority argument because we accept their alternative one--that the underpayment of tax resulting from their treatment of the deficits of Guardian Services and Stanford Financial was due to a reasonable cause and supported by good faith actions. We accordingly vacate the accuracy-related penalty imposed against them. See I.R.C. § 6664(c)(1). According to the applicable regulations, the extent of the taxpayer's effort to assess [his] proper tax liability is [g]enerally[ ] the most important factor in determining reasonable cause and good faith. Treas. Reg. § 1.6664-4(b); see Streber v. Commissioner, 138 F.3d 216, 223 (5th Cir.1998) (citing Heasley, 902 F.2d at 385). Additional [c]ircumstances that may indicate reasonable cause and good faith include [ (1) ] an honest misunderstanding of fact or law that is reasonable in light of all the facts and circumstances, including the experience, knowledge, and education of the taxpayer, Treas. Reg. § 1.6664-4(b), and (2) reliance on the advice of a professional tax advisor if, under all the circumstances, such reliance was reasonable and the taxpayer acted in good faith, id.; Reser v. Commissioner, 112 F.3d 1258, 1271 (5th Cir.1997). 34 Here, the Commissioner acknowledges that the Stanfords relied on the advice of attorney Kenneth Allen, an expert in international banking law, in setting up their Montserrat offshore banking enterprise. Nothing in the record indicates that the heeded advice, which called for the utilization of a tripartite corporate structure consisting of Guardian Bank, Guardian Services, and Stanford Financial, had as a purpose the facilitation of tax avoidance. More importantly, the Commissioner does not dispute that the Stanfords' 1990 tax return reporting the income and deficits from this enterprise was prepared by Harry Failing (Failing), an experienced CPA who (1) served as the Stanfords' principal tax advisor and regular tax-return preparer, and who (2) prior to starting his own extensive tax compliance practice, worked for Price Waterhouse in an office where he alone comprised the international tax department. At trial, Failing testified that before preparing the Stanfords' return he (1) reviewed the business and tax records of Guardian Bank, Guardian Services, and Stanford Financial; (2) studied the language of section 952(c)(1)(C), the section's legislative history, and what he considered to be the applicable regulations; and (3) concluded that the Stanfords could deduct under section 952 the deficits in earnings and profits of Guardian Services and Stanford Financial against Guardian Bank's subpart F income on their 1990 tax return. On appeal, the Commissioner does not allege that the Stanfords failed to advise Failing of any facts material to the determination of their 1990 tax liability or limited the scope of his research in any way. See Treas. Reg. § 1.6664-4(c)(1). 35 Although Mr. Stanford stated at trial that he was not an unsophisticated taxpayer, it is not reasonable under the above-stated facts to expect that the Stanfords could monitor [Failing,] [their] independent advisor[,] to make sure [he] [conducted] sufficient research to give knowledgeable advice. Mauerman v. Commissioner, 22 F.3d 1001, 1006 (10th Cir.1994). It is for exactly this reason that many intelligent investors hire independent, educated experts to advise them, particularly with respect to arcane matters of tax law such as those at issue in this case. Id. (emphasis added); see also Chamberlain v. Commissioner, 66 F.3d 729, 733 (5th Cir.1995) (To require the taxpayer to challenge the [expert], to seek a 'second opinion,' or to try to monitor [the expert] on the provisions of the Code himself would nullify the very purpose of seeking the advice of a presumed expert in the first place.) (quoting United States v. Boyle, 469 U.S. 241, 251, 105 S.Ct. 687, 692-93, 83 L.Ed.2d 622 (1985)). Here, Failing satisfied himself that the deficits of Guardian Services and Stanford Financial could offset Guardian Bank's subpart F income under section 952(c)(1)(C), and the Stanfords had reasonable cause, because of his extensive expertise in the field of international taxation, to trust his advice. Although Failing's legal interpretation of section 952(c)(1)(C) turned out ultimately to be incorrect--and indeed gave rise to a substantial understatement of tax on the Stanfords' 1990 joint return--we find that the Stanfords' reliance on that interpretation constitutes reasonable cause for purposes of precluding the penalty imposed against them for that understatement. See Boyle, 469 U.S. at 250, 105 S.Ct. at 692 ( '[R]easonable cause' is established when a taxpayer shows that he reasonably relied on the advice of an accountant or attorney that it was unnecessary to file a return, even when such advice turned out to have been mistaken.). Accordingly, the Tax Court's affirmance of the Stanfords' accuracy-related penalty is reversed. 18 III. 36 In summary, we hold that (1) because Guardian Services is not a qualified chain member with respect to Guardian Bank, the Tax Court correctly sustained the Commissioner's determination that the Stanfords may not offset Guardian Bank's subpart F income by the deficits in earnings and profits of Guardian Services; (2) because the deficits in earnings and profits of Stanford Financial are not attributable to the same qualified activity to which Guardian Bank's subpart F income is attributable, the Tax Court correctly sustained the Commissioner's determination that the Stanfords may not offset Guardian Bank's subpart F income by the deficits in earnings and profits of Stanford Financial; and (3) because the Stanfords had reasonable cause and acted in good faith with respect to the understatement of tax resulting from the disallowance of the aforementioned offsets, the Tax Court incorrectly sustained the Commissioner's determination that the Stanfords are liable for an accuracy-related penalty under section 6662(a). Accordingly, we VACATE the Stanfords' underpayment of tax penalty and AFFIRM the Tax Court's judgment in all other respects. 37