U.S. Parent Required to Include in Income CFCs’ Investments in U.S. Property (Crestek, Inc. & Subsidiaries, TC)

Transactions involving intercompany cash advances and trade receivables and loan guaranties between domestic subsidiaries and controlled foreign corporations (CFCs) under a common U.S. parent gave rise to investments in U.S. property under Code Sec. 956(c)(1)(C) and the parent was required to include various amounts in gross income under Code Sec. 951(a)(1)(B).

In particular, loans extended by four CFCs to a domestic subsidiary in the form of intercompany cash advances constituted U.S. property held by the CFCs. In addition, a CFC’s guaranty of a loan that a domestic subsidiary had secured from a foreign bank and direct or indirect pledge of assets as security for that loan constituted U.S. property held by the CFC.

Further, loans extended by two CFCs to a domestic subsidiary in the form of trade receivables, which had been outstanding for at least three years and bore no interest, were in excess of amounts that “would be ordinary and necessary” in a transaction between unrelated parties, within the meaning of Code Sec. 956(c)(2)(C), to carry on their respective trades or businesses.

Because the CFCs had invested substantial amounts of untaxed earnings and profits in U.S. property, the U.S. parent, as the ultimate shareholder of the CFCs, was required to include in income the amounts the CFCs had invested.

The taxpayer’s argument that the IRS’s adjustments were barred by the statute of limitations was rejected because the taxpayer had omitted from gross income substantial amounts properly includible under Code Secs. 951(a)(1)(B) and 956(a). As a result, the period of limitations on assessment was extended to six years under Code Sec. 6501(e)(1)(B).

A material dispute of fact remained as to whether the trade receivable balances owed by one domestic subsidiary to a CFC, which were incurred in an ongoing trade or business between those entities, were “ordinary and necessary” within the meaning of Code Sec. 956(c)(2)(C), to carry on their respective trades or businesses. Although it seemed likely that the volume of net receivables was excessive, determining the exact volume that qualified as “ordinary and necessary” depends on “all the facts and circumstances in each case” and, thus, would require trial.

Crestek, Inc. & Subsidiaries, 149 TC —, No. 5, Dec. 60,977

Other References:

Code Sec. 951

CCH Reference – 2017FED ¶28,474.021

Code Sec. 956

CCH Reference – 2017FED ¶28,576.30

CCH Reference – 2017FED ¶28,576.45

Code Sec. 6501

CCH Reference – 2017FED ¶38,963.24

Tax Research Consultant

CCH Reference – TRC INTLOUT: 9,252

CCH Reference – TRC INTLOUT: 9,256

AUTHOR

CCHTaxGroup

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