A Strategy for Repatriating Foreign Earnings was Upheld

A Strategy for Repatriating Foreign Earnings was Upheld

June 01, 2002

A STRATEGY FOR REPATRIATING FOREIGN EARNINGS was upheld.

The Limited, which owns a number of trendy clothing stores, used $175 million in earnings that were parked in a Hong Kong subsidiary to buy certificates of deposit, or CDs, from its US subsidiary that issues credits cards to customers of the company’s stores. In effect, the Hong Kong company lent the money for use by the company in the US.

The Hong Kong company did not lend the money directly to its US affiliate. Rather, the Hong Kong company first set up a new subsidiary in the Netherlands Antilles and then made a capital contribution of the $175 million to this new Netherlands Antilles subsidiary, which lent the money back to the United States.

No US taxes had been paid on the $175 million; the Limited organizes its offshore operations that so that US taxes can be deferred as long as the earnings remain offshore. US taxes are supposed to be triggered when the money is brought back to the US in any form that gives the US group effective use of the money in the United States. US tax is also triggered if an offshore subsidiary with earnings invests the earnings in “United States property.” However, there is an exception for “deposits with persons carrying on a banking business.” Thus, money can be parked in a US bank account without triggering a US tax.

The US Tax Court wasted no time in declaring the arrangement triggered US income taxes on the earnings.

However, a US appeals court overturned the decision. The appeals court said taxes were not triggered because the Netherlands Antilles company did nothing more than make a bank deposit. It said the credit card company qualified as a “bank.” The case is The Limited v. Commissioner. The appeals court announced its decision in April.

The decision is one of a series of losses for the US government in significant tax shelter cases in the past year. The government has tended to win such cases in the lower courts, where the judges seem more prone to set aside tax schemes that work technically but that arguably violate the law in spirit, only to lose on appeal.

Keith Martin