This popular clothing store chain attempted “clever” tax planning. The changes of tax audit were high since this is a major public company. The Tax Court reviewed their tax plan (The Limited, Inc. v. Commissioner, 113 T.C. 169). The Court was not impressed.
The Tax Court held that certificates of deposit purchased from a taxpayer’s private label credit card bank subsidiary by a foreign subsidiary of the taxpayer’s controlled foreign corporation are U.S. property. When a controlled foreign corporation (CFC) invest in U.S. property, the amount invested is classified as a dividend income.
You may have heard how firms like Apple have $billions that they can’t bring back to the U.S. This is why.
Limited formed a new corporation to lend money to Limited’s domestic private label credit card company. They named the loan “certificate of deposit” hoping to use an exception to section 956 that applies to banking transactions. They also used a new foreign corporation that had no earnings, which would have made a distribution not taxable.
Of course, Limited’s credit card company is not a bank and thus, the “certificate of deposits” was not with persons carrying on the banking business.
But it got worse! And this is what I want you to know. The court also attributed ownership of the certificates to the CFC that formed the foreign subsidiary because a principal reason for the formation of the foreign subsidiary was the avoidance of Subpart F and tax code Section 956. This last part invokes an old tax doctrine that one must have a business purpose other than saving taxes in entering into a transaction (or as in this case, form a corporation).
It is a doctrine overlooked by many tax planners. I want all of my readers to have excellent tax planning. So, please take this gift of learning how a major corporation missed an essential doctrine into your tax planning.
If you need a corporation for tax planning, then embed the corporation with a business activity, have a business plan and corporate minutes. This story has a happy ending for the taxpayer. They appealed the court and provided a business purpose of the new foreign subsidiary.
They presented a witness that stated that the sole reason behind the creation of subsidiary was to shield the parent corporation’s assets from Chinese expropriation. The Appeal Court bought the story, and the IRS was defeated.
Lesson: Always document your business purpose. If you need to up the quality of your tax planning, then contact me, Brian Dooley, CPA, MBT, at [email protected]
Here is a link to this court case.
If you want to learn how to save taxes with an offshore business, then listen to the first five minutes of the audiobook (International Taxation in America for the Entrepreneur) by clicking on this link.
 Among the popular stores owned by petitioner (the stores) were The Limited, Lane Bryant, Lerner New York, Victoria’s Secret, and Abercrombie & Fitch.
 A “tax doctrine” is a tax law created by court cases. One court case does not make a doctrine. Usually, the Supreme Court has ruled on the concept. Congress told the IRS to make the regulations clear on this point. So, the IRS issued 1.956-1T (b)-4 with examples of this rule.