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

Heading: statutory backdrop and the stanfords' 1990 income tax return

Text: 6 Section 951(a) of the Code requires a United States shareholder of a controlled foreign corporation (CFC) to include in his gross income his pro rata share of the controlled foreign corporation's subpart F income--as defined in section 952--whether or not such income is distributed to him. I.R.C. § 951(a). A CFC is defined as any foreign corporation where more than 50 percent of the corporation's stock, either by voting power or value, is owned directly, indirectly, or constructively by United States shareholders. I.R.C. § 957(a). Section 951(b) of the Code defines a United States shareholder as a United States person who owns directly, indirectly, or constructively 10 percent or more of the voting stock of a foreign corporation. I.R.C. § 951(b). In this case, the parties have stipulated that (1) Stanford is a United States shareholder of Guardian Bank, Guardian Services, and Stanford Financial, and (2) Guardian Bank, Guardian Services, and Stanford Financial are CFCs. 7 Of the three CFCs in this case, only Guardian Bank realized subpart F income in 1990. Subpart F income is defined in I.R.C. § 952 as including five different types of income, the most pertinent of which, in this case, is foreign base company income (as determined under section 954). I.R.C. § 952(a)(2). Section 954(a) defines foreign base company income as including foreign personal holding company income, I.R.C. § 954(a), which consists of, among other things, dividends, interest, rents, gains from commodity transactions, and foreign currency gains. I.R.C. § 954(c)(1). The parties in this case have stipulated that Guardian Bank's 1990 income included interest, gains on foreign currency exchanges, dividends, and gains on commodity transactions, and that Guardian Bank's resulting subpart F income for that year was $2,789,722. Indeed, the Stanfords reported this figure as Guardian Bank's subpart F income on their 1990 joint federal income tax return. 8 The amount of subpart F income of a CFC that is ultimately taxed to a United States shareholder may be limited by any of three limitations set forth in I.R.C. § 952(c). The only limitation applicable here is that found in I.R.C. § 952(c)(1)(C), and it is the interpretation of the language of this provision that is at the heart of the dispute in this case. Section 952(c)(1)(C) reads, in pertinent part, as follows: 9 (C) Certain deficits of member of the same chain of corporations may be taken into account.-- 10 (i) In general.--A controlled foreign corporation may elect to reduce the amount of its subpart F income for any taxable year which is attributable to any qualified activity by the amount of any deficit in earnings and profits of a qualified chain member for a taxable year ending with (or within) the taxable year of such controlled foreign corporation to the extent such deficit is attributable to such activity.    11 (ii) Qualified chain member.--For purposes of this subparagraph, the term qualified chain member means, with respect to any controlled foreign corporation, any other corporation which is created or organized under the laws of the same foreign country as the controlled foreign corporation but only if-- 12 (I) all the stock of such other corporation (other than directors' qualifying shares) is owned at all times during the taxable year in which the deficit arose (directly or through 1 or more corporations other than the common parent) by such controlled foreign corporation, or 13 (II) all the stock of such controlled foreign corporation (other than directors' qualifying shares) is owned at all times during the taxable year in which the deficit arose (directly or through 1 or more corporations other than the common parent) by such other corporation. 14 I.R.C. § 952(c)(1)(C). 3 Under section 952(c)(1)(C), a CFC may reduce its subpart F income attributable to a qualified activity by the deficits in earnings and profits of a qualified chain member to the extent the deficit of the chain member is attributable to to such qualified activity. 15 Relying on retained, expert tax advice, the Stanfords invoked Guardian Bank's section 952(c)(1)(C)(i) election and reduced Guardian Bank's 1990 subpart F income ($2,789,722) by the total deficits in the 1990 earnings and profits of Guardian Services and Stanford Financial, which total they determined to be $1,406,365. 4 On audit, however, the Commissioner disallowed this reduction as violative of section 952(c)(1)(C). Notably, the Commissioner conceded (and does not contest on appeal) that (1) Guardian Services and Stanford Financial accumulated deficits in earnings and profits in 1990; (2) these deficits in earnings and profits were generated exclusively through administrative, marketing, or management services provided to Guardian Bank under applicable service agreements; and (3) the deficits accrued to a total of $1,406,365. Such concessions notwithstanding, the Commissioner prohibited the Stanfords from offsetting these deficits against Guardian Bank's subpart F income, determining that (1) Guardian Services was not a qualified chain member with respect to Guardian Bank within the meaning of section 952(c)(1)(C)(ii) (and, thus, Guardian Services' deficit in earnings and profits was not deductible vis-a-vis Guardian Bank's subpart F income); and (2) Stanford Financial's deficit, although accrued by a qualified chain member with respect to Guardian Bank, was not attributable to [the same] qualified activity to which Guardian Bank's subpart F income was attributable (and, thus, was also not deductible vis-a-vis Guardian Bank's subpart F income). 5 16 The Commissioner determined the resulting deficiency in the Stanfords' 1990 tax to be $423,531.36. Additionally, because the Stanfords' understatement of tax was substantial, the Commissioner assessed the Stanfords an accuracy-related penalty of $84,706.27 under I.R.C. § 6662(a). 6 The Stanfords filed a petition challenging these determinations in the United States Tax Court.