Global Tax Alert (News from Transfer Pricing) | 23 September 2013
US Tax Court Holds Account Receivable Established under Revenue Procedure 99-32 is Related-Party Indebtedness for Purposes of Section 965
In BMC Software Inc. v CIR, 141 T.C. 5, the Tax Court held that an account receivable of a US corporation established under Rev. Proc. 99-321 constitutes related party indebtedness for purposes of determining a possible reduction to the amount of dividends eligible for a dividends-received deduction (DRD) under Section 965. As a result, BMC Software Inc. (BMC) was denied a portion of a dividends-received deduction under Section 965 for certain cash dividends received from its controlled foreign corporations (CFCs) in its tax year ended 31 March 2006.
Rev. Proc. 99-32 permits taxpayers whose taxable income has been adjusted pursuant to Section 482 to make a conforming adjustment to their cash accounts via the establishment, for US tax purposes, of an interest-bearing account receivable or payable (the account) in an amount corresponding to the amount allocated to, or from, such taxpayer under Section 482. In the case of a US taxpayer, for example, by establishing an account, a loan by (or to) a US taxpayer could be created to explain why the US taxpayer has less (or more) cash than it would have had if its transactions had initially been consistent with the requirements of Section 482.
Section 965 provided a one-time DRD to certain US multinational corporations for certain qualifying cash dividends received from their CFCs. In relevant part, under Section 965(b)(3), the amount of dividends eligible for the 85% DRD was reduced by the amount of the increase in related party indebtedness, during the applicable measurement period (related party debt rule). The question in the BMC case, therefore, was whether an account established under Rev. Proc. 99-32 constitutes related party indebtedness for this purpose. In relevant part, the IRS has taken the position that an account receivable of a US shareholder from a CFC created under Rev. Proc. 99-32 constitutes related party debt for the purposes of Section 965(b)(3).2
The relevant facts considered by the Tax Court are as follows: BMCBMC, a domestic corporation, engaged in the development and licensing of software and entered into a cost sharing agreement with its European subsidiary. In 2002, BMC terminated the agreements and took sole ownership of the associated software. Following termination of the agreement, BMC agreed to pay royalties and license the software to the CFC. However, the IRS disagreed with the amount of the royalties paid. In 2007, BMC and the IRS entered into two closing agreements, the first pertaining to a redetermination of the arm's length amount for the aforementioned royalty payments (primary adjustments) and the second pertaining to the conforming adjustments necessary to reflect the primary adjustment. Pursuant to the second closing agreement, BMC elected treatment under Rev. Proc. 99-32 and created for Federal income tax purposes an interest bearing account receivable from its CFC. Concomitantly, in the same tax year to which the Section 482 adjustment relates, BMC received qualifying cash dividends from its CFCs and claimed a DRD with respect to such dividends under Section 482, without treating the account established under Rev. Proc. 99-32 as related party indebtedness for purposes of determining the available DRD. The IRS asserted, however, that the account established under Rev. Proc. 99-32 constituted related party indebtedness for purposes of Section 965, which, based on BMC's facts for that year, had the effect of reducing the available DRD.
In its opinion, the Tax Court first reviewed whether the related party indebtedness rule is limited to increased indebtedness resulting from intentionally abusive transactions. That is, transactions in which the US taxpayer increases related party indebtedness intentionally to increase the available DRD. The Tax Court
concluded the rule does not have an intent requirement. The Tax Court then analyzed whether accounts established under Rev. Proc. 99-32 are indebtedness for purposes of Section 965(b)(3), or whether such accounts could constitute “trade payable” for such purpose, in which case the accounts would not be included in the calculation. The Tax Court concluded that accounts established under Rev. Proc. 99-32 did not constitute trade payables and were related party indebtedness for purposes of Section 965. Thus, the Tax Court agreed with the IRS position and held that BMC overstated its DRD available under Section 965.
The Tax Court decision establishes that, for purposes of Section 965, accounts receivable created under Rev. Proc. 99-32 constitute related party indebtedness. Although Section 965 has sunsetted and its DRD regime is not currently available, the Tax Court's holding may be relevant to other taxpayers that claimed a DRD under Section 965 in a prior tax year. In addition, this case raises the possibility that like treatment might be afforded accounts created under Rev. Proc 99-32 for purposes of other sections of the Internal Revenue Code, for example, for purposes of Section 956.
1. Rev. Proc. 99-32, 1999-2 C.B. 296.
2. Advice Memorandum 2008-010 (9/14/08), Interaction of I.R.C. Section 965 and Rev. Proc. 99-32. (AR established by election to apply Rev. Proc. 99-32 constitutes related party indebtedness under I.R.C. Section 965(b)(3).
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP, International Tax Services, Washington, DC
- • Jose Murillo
+1 202 327 6044
- • Steve Wrappe
+1 202 327 7956
- • Ken Christman
+1 202 327 8766
- • Karyn Zizza
+1 202 327 7019
- • Carlos Mallo
+1 202 327 5689
- • Sweta Chari
+1 202 327 7056
EYG no. CM3819