Sale of an offshore subsidiary did not trigger taxes in the United States, the US Tax Court said in a decision eagerly awaited by US industry.

Dover Corporation, an elevator manufacturer, sold a subsidiary in the United Kingdom in July 1997 to German elevator manufacturer Thyssen. Dover owned the subsidiary through a UK holding company; it was the UK holding company that sold the shares. Ordinarily when shares are sold in a foreign corporation that is owned even indirectly by a US company, any gain is taxed immediately in the United States. The US will tax the US parent company on any “passive” income received by its offshore holding companies. Gain from the sale of stock is passive income. Tax lawyers call such income “subpart F income.”

A sale of assets — rather than stock — would not have produced passive income.

Therefore, Dover asked the IRS in December 1998 — more than a year after the sale — for permission retroactively to make a “check-the-box” election to treat the subsidiary as a “disregarded entity” — in other words, to treat the company for US tax purposes as if it did not exist. The IRS initially said no. It later changed its mind in March 2000 after listening to further arguments from Dover, but warned Dover that no inference should be drawn that the company could avoid passive income by making the election.

Dover made the election and took the position that it had no passive income from the sale. The IRS assessed it almost $34 million in back taxes on audit.

In court, the judge said the problem was of the IRS’s own making. The election meant that the UK subsidiary no longer existed. What looked like a sale of stock was an asset sale for tax purposes. If the IRS did not like this result, it could amend its own regulations.

The case is Dover Corporation v. Commissioner. The court released its decision in May. The decision had been eagerly awaited by US power companies, a number of whom have been fighting the same issue on audit.

Keith Martin