A US MULTINATIONAL lost its bid in court to treat its Japanese subsidiary as a “controlled foreign corporation,” or CFC, for US tax purposes.

The case is important to US power companies investing in Latin America, where sometimes the only way to prevent the IRS from taxing earnings from the project before the earnings are repatriated to the United States is to keep the earnings in the project country.

However, this strategy works only if any corporation formed to own the project in the project country is a CFC. Since that requires that US investors own more than 50% of the corporation by vote or value and this is not always the business deal, elaborate arrangements are sometimes worked out to give US investors slightly more than the appearance of control of the company.

Burndy Corp., a US manufacturer of electrical connectors, formed a joint venture company in Japan with two local manufacturers to make the same product for the Japanese market. Burndy owned exactly 50% of the shares in the Japanese company. Each of its Japanese partners owned 25%. Each shareholder appointed directors to the board of the company in this ratio. Burndy could also appoint the CEO of the company, but did not do so in fact. Many significant business decisions — like whether to pay dividends — required a consensus.

Burndy argued that it owned more than 50% of the company by value because it could get a “control premium” for its shares. It argued that it controlled the company because the chairman of the board was supposed to vote its way in the event of a tie.

The US tax court rejected both arguments. The court said the fact that many significant decisions required a consensus or supermajority vote meant that Burndy did not have control in fact, even though it may have looked that way without careful analysis.

The case is Framatome Connectors USA, Inc. v. Commissioner. The US Tax Court released its decision in the case on January 16.

Keith Martin