The Tax Court held earlier this month that an obligation from a corporation to its subsidiary constituted debt for U.S. federal income tax purposes.
In Illinois Tool Works, Inc. v. Commissioner
(T.C. Memo 2018-121), a member of a U.S. consolidated group, Paradym, directly held the stock of a Bermuda corporation, CSE. CSE was a holding company, which directly held the stock of a captive insurance company, Miller, and another Bermuda corporation, CSA. As of Nov. 30, 2006, CSA had substantial current and accumulated earnings and profits, but CSE had no earnings and profits.
In December 2006, CSA advanced $356,778,000 to CSE in exchange for a one-page promissory note. The note provided for 6% simple interest and a five-year repayment term. No payments of principal and interest were required before the maturity date. There was no provision in the note that subordinated it to CSE’s other obligations.
Shortly after the advance, CSE distributed $356,778,000 to Paradym.
Prior to the note’s maturity in December 2011, CSE and CSA extended the note for one year. In June 2012, CSE received $30 million from Miller, and used it to make a payment on the note. That December, CSE and CSA extended the maturity of the note for another year. In December 2013, Paradym contributed $344,411,130 to CSE and CSE used such funds to repay the note in full.
The taxpayer came under examination by the IRS in 2008. The IRS specifically challenged whether the note should be considered debt, and took the position that the advance from CSA should instead be regarded as a dividend to CSE in 2006.
The court held that the note constituted debt for U.S. tax purposes. In its analysis, the court considered 14 factors, as provided in Busch v. Commissioner
(728 F.2d 945 (7th Cir. 1984) and Dixie Dairies Corp. v. Commissioner
(74 T.C. 476 (1980)). It found that nine of those factors favored debt treatment, four were neutral, and one favored dividend treatment. Significantly, the court concluded that there was an intent to create a bona-fide debt from CSE to CSA, and that CSE had the financial capacity to repay the loan notwithstanding that it was a holding company.
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