Repatriation strategy that a US company used to bring back money parked in offshore holding companies for use in the United States ended up triggering US taxes, the US Tax Court said.
The Barnes Group manufactures and distributes precision metal parts and industrial supplies. The group has been in business since 1857. In the late 1990’s, the group brought in new management with the aim of growing the company through acquisitions. It made three significant acquisitions in 1999 and 2000 for $197.1 million.
As a consequence of the acquisitions, by the end of 2000, the company had $230 million in outstanding long-term debt and a debt-to-equity ratio that was high enough to cause its borrowing costs to increase.
The company was paying 7.13% to 9.47% interest to borrow while earning roughly only 3% interest on $43.7 million cash held in offshore holding companies.
The company’s tax director sought ideas from three of the big four accounting firms and eventually settled on a “reinvestment plan” suggested by PricewaterhouseCoopers. The plan came complete with an exit strategy to unwind the plan if Barnes wanted to return the funds to the offshore subsidiaries and a draft “business purpose” suggested by PwC.
The plan involved moving money held in a Singapore subsidiary to the US parent company, but through two new intermediate entities. Money was contributed to a new Bermuda company and then by the Bermuda company to a new Delaware company. The Delaware company then lent the money to Barnes in the US. Some of the money contributed as capital was the accumulated offshore cash. Some was money the Singapore subsidiary borrowed from a Japanese bank at a lower interest rate than the US parent could have borrowed because the Singapore subsidiary was generating significantly more cash than it needed.
PwC, which also acted as the auditors for Barnes, gave a tax opinion that repatriation done in this fashion would not trigger a tax in the United States. Earnings of a US-controlled foreign corporation become taxable in the United States if they are invested in US property. Shares in a Delaware corporation are normally such an investment. However, PwC relied on a 1974 revenue ruling that suggested the amount that should have become taxable in the US is the basis that the Bermuda company had in the Delaware company shares and that basis was zero in this case.
The US Tax Court invoked the step-transaction doctrine to treat the money as coming back to the US directly from Singapore. It said intermediate entities and complicated steps served no business purpose other than to avoid taxes, and the purported loans by the Delaware company were not real loans. There was no evidence that any interest or principal had been paid on loans in the company’s general ledgers or bank statements.
The case is Barnes v. Commissioner. The Tax Court released its decision in April. The courts have been showing less and less patience for complicated transactions intended to achieve a tax result based on a narrow technical reading of the law.