23 September 2013
International Tax Alert
News from Transfer Pricing
US Tax Court Holds Account
Receivable Established under
Revenue Procedure 99-32 is
Related-Party Indebtedness
for Purposes of Section 965
Executive summary
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.
Detailed discussion
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. 9932 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.
Implications
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.
Endnotes
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).
2
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