Close
Close

Court: Obligation from parent to subsidiary constitutes debt

RFP
Tax Hot Topics newsletter 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.

Contact
Josh Brady
Principal, Washington National Tax Office
T +1 202 521 1563

Bryan Keith
Managing Director, Washington National Tax Office
T +1 202 861 4116

Jeff Borghino
Partner, Washington National Tax Office
T +1 202 521 1532

Tax professional standards statement
This content supports Grant Thornton LLP’s marketing of professional services and is not written tax advice directed at the particular facts and circumstances of any person. If you are interested in the topics presented herein, we encourage you to contact us or an independent tax professional to discuss their potential application to your particular situation. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this content may be considered to contain written tax advice, any written advice contained in, forwarded with or attached to this content is not intended by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, the reader’s specific circumstances or needs and may require consideration of tax and nontax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to “Section,” “Sec.,” or “§” refer to the Internal Revenue Code of 1986, as amended.