Appeals Court Invalidates US-Netherlands 'Double-Dip' Financing Structure
An appellate court recently found a US corporation liable for a failure to withhold on interest paid to its Netherlands affiliate. Applying the step-transaction doctrine, the appellate court disregarded the actual loan and treated the interest as paid to the corporation's Canadian affiliate. Consequently, the US-Netherlands treaty exemption was not available.
On June 8, 2001, the US Court of Appeals for the District of Columbia Circuit held that Del Commercial Properties, Inc., a US corporation ("Del US"), was liable for failing to withhold on payments of interest, made from 1990 to 1993, to Del Investments Netherlands BV, a Netherlands company ("Del Netherlands").(1) Del US had relied on the US-Netherlands treaty ("the Netherlands treaty"), which provides for a complete exemption from US withholding tax on interest.(2) The court held, however, that the Netherlands treaty was unavailable; applying the step-transaction doctrine, the court disregarded Del Netherlands' participation in the transaction and treated the interest as if it had been paid on a loan from Delcom Financial Ltd., a Canadian affiliate of Del US.(3)
Del US is an indirect wholly-owned subsidiary of an affiliated group of corporations ("the group") whose common parent is DL Shekels Holdings Ltd., a Canadian corporation ("Parent"). Delcom Financial Ltd., a Canadian corporation ("Del Canada") is a second-tier wholly owned subsidiary of Parent.(4) Del Canada owns 100 percent of Delcom Holdings Ltd., a Canadian corporation ("Del Canada Sub"), which in turn owns 100 percent of Delcom Cayman Ltd., a Cayman Islands corporation ("Del Caymans"). Del Caymans owns 100 percent of Delcom Antilles, NV, a Netherlands Antilles corporation ("Del Antilles"), which in turn owns 100 percent of Del Netherlands.
In 1990, Del US needed funding to refinance and improve certain real estate. One of its affiliates, Tridel Corporation ("Tridel"), a first-tier wholly-owned Canadian subsidiary of Parent, arranged for a series of financing transactions ("the Financing"). The steps involved in the financing included: (1) a US$14 million loan ("the RBC loan") by the Royal Bank of Canada ("RBC"), an independent Canadian commercial bank, to Del Canada;(5) (2) an unsecured US$14 million loan ("the Del Canada Loan") by Del Canada to Del Canada Sub;(6) (3) a transfer of approximately US$14 million by Del Canada Sub to Del Caymans in exchange for common stock of Del Caymans; (4) a transfer of approximately US$14 million by Del Caymans to Del Antilles in exchange for common stock of Del Antilles; (5) a transfer of approximately US$14 million by Del Antilles to Del Netherlands in exchange for common stock of Del Netherlands; and (6) a US$14 million loan ("the Del Netherlands loan") by Del Netherlands to Del US. All of the steps were effected over two days during July 1990.
In connection with the financing, Del US guaranteed repayment of a portion of the amounts owed by Del Canada to RBC and authorized RBC to place a mortgage on its US real property. Del US also agreed to provide RBC with annual financial statements, to insure its US real property, to assign the insurance policies to RBC, to defer the payment of dividends to shareholders, and to use the proceeds from any sales of real property to assure that payments were made on the RBC loan.
When Del US started making interest payments on January 1, 1991, the payments were made to Del Netherlands (which in turn transferred the payments to either Del Canada or Del Canada Sub). Beginning in July 1992, however, at RBC's request, Del US began making its payments directly to Del Canada. Throughout the term of the loan, Del Netherlands reported the interest paid by Del US as income on its Dutch tax returns. Del US did not file withholding tax returns, withhold on any payments to Del Netherlands or Del Canada, or deposit any amounts with the Internal Revenue Service ("IRS") in connection with the financing.
Finding that Del Netherlands' participation in the financing had no purpose other than tax avoidance, and relying on the step-transaction doctrine, the Tax Court concluded that the loan to Del US was in substance a loan from Del Canada rather than Del Netherlands. Consequently, the Tax Court held that, in substance, the interest paid by Del US was received by Del Canada and therefore should have been subject to US withholding tax.(7) The Tax Court also upheld penalties for failure to file withholding tax returns and failure to deposit withholding taxes under Code Sections 6651(a)(1) and 6656(a), stating that Del US had provided no credible argument that its failure to file and to deposit withholding taxes was due to reasonable cause.
The Court's Analysis
The US Court of Appeals for the District of Columbia Circuit analyzed the initial payments, made to Del Netherlands, and the subsequent payments, made to Del Canada, separately. Neither prong of the court's analysis is particularly satisfying.
Payments to Del Canada
The court began by disposing of the interest paid to Del Canada rather summarily as follows:
"The US-Netherlands Tax Treaty does not apply to direct transactions between a US corporation and a Canadian corporation. Accordingly, appellant unquestionably should have withheld taxes on its payments to [Del Canada] beginning in July 1992. The Tax Court plainly did not err in coming to this conclusion."(8)
Payments to Del Netherlands
The court was strongly influenced by its determination that there was no business purpose for the Del Netherlands loan, and that the loan's only purpose was to take advantage of the Netherlands treaty. The court's opinion reads in part as follows:
"Under the step-transaction doctrine, a particular step in a transaction is disregarded for tax purposes if the taxpayer could have achieved his objective more directly, but instead included the step for no other purpose than to avoid US taxes. In step-transaction cases, "the existence of formal business activity is a given but the inquiry turns on the existence of a nontax business motive." As we explained last year, "the absence of a nontax business purpose is fatal." Although taxpayers "are entitled to structure their transactions in such a way as to minimize tax," there must be a purpose for the "business activity . . . other than tax avoidance" and that purpose cannot be a "facade."(11)
The court later added:
"[T]he Tax court did not clearly err in concluding that the payments from appellant to [Del Netherlands] were in substance payments made to [Del Canada] and that those payments only served to avoid US taxes. The Tax Court's decision in Gaw v. Commissioner is instructive. Gaw dealt with a US corporation's interest payments to a Dutch corporation that was a subsidiary of a Hong Kong corporation. The Tax Court held that the payments were subject to US taxes because in substance they were directed to the Hong Kong corporation. The Tax Court explained that 'under the substance over form doctrine, although the form of a transaction may literally comply with the provisions of the [Internal Revenue] Code, that form will not be given effect where it has no business purpose and operates simply as a device to conceal the true character of that transaction.' The court reasoned that the taxpayer had not carried his burden of proving that the loans had not been structured for any nontax business reason. Consequently, the court treated the loan as if it had been made by the Hong Kong corporation and ruled that the loan was subject to the withholding tax."(12)
The court then stated that it considered the case before it to be similar to Gaw and that several facts demonstrated the "nexus" between the RBC loan and the Del Netherlands loan: (1) the interest rates and repayment schedules on the two loans "closely correspond[ed]"; (2) RBC obtained a guaranty of repayment from Del US and a security interest in Del US's US real property; and (3) beginning in the third quarter of 1992, Del US made payments directly to Del Canada at RBC's request. Thus, the court concluded, "Appellant has not shown that [Del Netherlands] served any role with a 'sufficient business or economic purpose to overcome the conduit nature of the transaction.' Rev. Rul. 84-153, 1984-2 C.B. at 384."(13)
Having thus made it abundantly clear that it would not respect payments on the Del Netherlands loan as having been made to Del Netherlands in the absence of a business purpose for the Del Netherlands loan, the Court of Appeals then proceeded to consider Del US' argument that the group did indeed possess such a business purpose.
Del US' principal argument appears to have been that the group obtained Canadian tax benefits as well as US tax benefits from the chosen financing structure. Specifically, Del US argued that the group was able to deduct Del Canada's interest payments to RBC for Canadian tax purposes without any offsetting income inclusion.(14) In this regard, Del US argued that, pursuant to Canadian law and the Canada-Netherlands treaty, no member of the group was required to pay tax on amounts remitted by Del Netherlands up the chain to Del Canada.(15)
The court was not persuaded. Observing that Del US had not submitted Del Canada's tax returns or corporate records, had not asked the court to take judicial notice of the relevant Canadian tax provisions, and had not even cited the relevant provisions of Canadian tax law or the Canada-Netherlands treaty on which it claimed to have relied, the appellate court upheld the Tax Court's determination that the transactions at issue had served no purpose other than avoidance of US tax.(16)
The court also distinguished Northern Indiana Public Service Co. v. Cir.(17) ("NIPSCO"). The taxpayer in that case, a US corporation, formed a Netherlands Antilles finance subsidiary ("Finance") in order to issue notes on the eurobond market free of the obligation to pay US withholding tax; Finance had remitted the net proceeds of the offering to the taxpayer in return for the taxpayer's note. The taxpayer's note had terms comparable to the euronotes but paid interest at an increased rate (18.25 percent, as opposed to 17.25 percent). Relying principally on the 1 percent spread earned by Finance as demonstrating recognizable business activity and a profit motive, the appellate court in NIPSCO upheld the Tax Court's determination that Finance's participation in the financing transaction should be respected for tax purposes.(18) Notably, the profit motive found by the appellate court appears to have related solely to Finance, rather than to the taxpayer's corporate group overall.
Expressly reserving judgment on whether it agreed with the legal analysis or holding in NIPSCO, the Court of Appeals in Del Commercial distinguished that case on the basis of its procedural posture.(19) Although the appellate court in NIPSCO concluded that the Tax Court had not clearly erred in holding for the taxpayer, that did not prove that the appellate court would have reversed the Tax Court's decision if the Tax Court had held for the IRS. Accordingly, the court in Del Commercial took the view that NIPSCO did not aid Del US.(20)
The court in Del Commercial also upheld the Tax Court's imposition of penalties for failure to file withholding tax returns and failure to deposit withholding taxes under Code Sections 6651(a)(1) and 6656(a), respectively. The appellate court affirmed the Tax Court's holding that no reasonable cause had existed for not filing and withholding.(21)
Comments on the Court's Analysis
The ultimate conclusion reached by the court in Del Commercial might be correct on its facts, but, as discussed in greater detail below, the court's rationale and analyses are unsatisfying. Indeed, an application of the court's rationale to other fact patterns could lead to inappropriate results.
Payments to Del Canada
The court's analysis of the payments made directly to Del Canada appears inadequate. As noted above, the court concluded that Del US "unquestionably should have withheld taxes" because the Netherlands treaty does not apply to direct transactions between a US corporation and a Canadian corporation. Interestingly, the court did not address the possibility that the interest paid to Del Canada could have been treated, for tax purposes, as if it had been paid to Del Netherlands. It is unclear whether the court considered it obvious that, on the facts presented, such recharacterization would have been inappropriate,(22) or whether the court considered the fact that payment was actually made to Del Canada to be determinative. That court resolved this issue before it addressed the issue of the payments made to Del Netherlands suggests the latter view.
The basis for this view is unclear, but the court may have thought that Del US's payment of interest directly to Del Canada caused the form of the loan to Del US to be a loan by Del Canada, and may have thought that Del US should be bound by its form. Such a rule, binding the taxpayer to the form of its transaction regardless of the true substance, is not without support in the case law, but appears inappropriate.(23) In any event, if the court intended to lay down such a harsh rule, it should have done so more clearly.
Payments to Del Netherlands
The court's holding that the Tax Court acted reasonably in recharacterizing the payments to Del Netherlands as payments to Del Canada appears to be unobjectionable on the specific facts presented. It is noteworthy that, in many respects, Del US and the other members of the group did not themselves respect the form of their own transaction.
As noted above, Del US provided RBC with a guaranty of repayment and a security interest in its US real property. Del US also agreed to provide RBC with annual financial statements, to insure its real property, to assign the insurance policies to RBC, to defer the payment of dividends to shareholders, and to use the proceeds from any sales of real property to make payments on the RBC loan. Further, beginning in July 1992, Del US made payments directly to Del Canada at RBC's request, and neither the Tax Court nor the Appeals Court decision indicated that Del Netherlands or any other corporation in the group consented to this arrangement. Finally, even before July 1992, interest payments received by Del Netherlands were transferred directly to Del Canada or Del Canada Sub, bypassing Del Antilles and Del Caymans.
The court's rationale, however, was considerably broader than this. As noted above, the court went to great lengths to emphasize that the participation of an intermediate financing entity will be disregarded in the absence of a business purpose. In this regard, it is clear that the court would not consider even a substantial spread (for example, 1 percent) earned by an intermediate financing entity to demonstrate the requisite business purpose.
Indeed, the court's opinion does not even discuss whether Del Netherlands earned a profit. On the basis of the facts set forth in the Tax Court's opinion (and omitted from the appellate court's opinion), Del Netherlands clearly did earn a significant profit for some of the years at issue.(24) Presumably, the court would not have considered -- or did not consider -- this observation to be particularly relevant.
The court's apparent refusal to respect a back-to-back loan structure in which the finance subsidiary earns a meaningful profit appears to represent an unwarranted extension of the existing case law.
The seminal case on the use of back-to-back financing arrangements to gain access to a treaty is Aiken Industries, Inc. v. Commissioner,(25) which, curiously, the court did not discuss or even cite. In Aiken, a Bahamian corporation ("B") that owned 99.997 percent of the stock of a US corporation ("U") and 100 percent of the stock of an Ecuadorean corporation ("E") loaned money to U in return for a note. The U note bore interest at 4 percent and had a 20-year term. Interest payments from U to B were subject to full 30 percent US withholding taxes.
Subsequently, E created a 100 percent owned Honduran subsidiary ("H") and B transferred the U note to H in exchange for nine demand notes that bore the same 4 percent interest rate and had the same aggregate principal amount as the U note. In reliance on the US-Honduras treaty then in force, U did not withhold on interest paid to H.
After holding, as a threshold matter, that H was a "real" corporation that could not be disregarded (as the IRS had argued), the Tax Court nevertheless concluded that the interest payments by U had not been "received by" H within the meaning of the applicable treaty provision, because H did not possess "complete dominion and control over the funds."(26) The Tax Court further explained:
"In these circumstances, where the transfer of [U's] note from [B] to [H] in exchange for the notes of [H] left [H] with the same inflow and outflow of funds and where [U], [B], and [H] were all members of the same corporate family, we cannot find that this transaction had any valid economic or business purpose. Its only purpose was to obtain the benefits of the exemption established by the treaty for interest paid by a United States corporation to a Honduran corporation. While such a tax-avoidance motive is not inherently fatal to a transaction, such a motive standing by itself is not a business purpose which is sufficient to support a transaction for tax purposes.
In effect, [H], while a valid Honduran corporation, was a collection agent with respect to the interest it received from [U]. [H] was merely a conduit for the passage of interest payments from [U] to [B], and it cannot be said to have received the interest as its own. [H] had no actual beneficial interest in the interest payments it received, and in substance, [U] was paying the interest to [B] which 'received' the interest within the meaning of article IX. Consequently, the interest in question must be viewed as having been 'received by' an entity ([B]) which was not a 'corporation or other entity' of one of the contracting States involved herein, and we therefore hold that the interest in question was not exempt from taxation by the United States under article IX of the convention."(27)
Clearly, the lack of any profit earned by H, the finance subsidiary, was a key factor in the Tax Court's decision. Moreover, although Aiken requires a business purpose, it appears that a business purpose on the part of H would have sufficed. Thus, if the transaction had been structured to provide H with a profit, it seems likely that H's participation in the financing would have been respected.(28)
Indeed, this appears to be precisely the approach taken by the appellate court in NIPSCO:
"[T]he Commissioner argues that the income Finance earned on the transactions with Taxpayer is irrelevant; that a transaction does not necessarily have economic substance for tax purposes merely because one party profits from the arrangement. The Commissioner characterizes the one-percent profit Finance earned from the spread created by its borrowing and lending activities as a 'fee' for accommodating Taxpayer in the Eurobond offering. The Commissioner's argument misses the mark. As we explained supra the transaction in [Knetch v. United States, 364 US 361 (1960)(29)] was unrelated to any economic activity. The taxpayer paid money solely to obtain tax deductions and did not intend to profit in a true sense, as evidenced by the fact that the pre-tax interest outlay would be greater than the pre-tax interest received. Here, a profit motive existed from the start. Each time an interest transaction occurred, Finance made money and Taxpayer lost money. Moreover, Finance invested the annual $700,000 interest income it netted on the spread in order to generate additional interest income, and none of the profits from these reinvestments are related to Taxpayer."
Accordingly, NIPSCO appears to stand emphatically for the proposition that, in a back-to-back financing transaction, the requisite business purpose will typically be present if the finance subsidiary earns a meaningful profit.(30) The efforts of the appellate court in Del Commercial to distinguish NIPSCO on procedural grounds therefore seem unconvincing.(31)
The court's failure to discuss Aiken, the leading "treaty-shopping" case, or to meaningfully distinguish NIPSCO, which presents a similar fact pattern, may be significant.
Ironically, the court, which, as noted above, neglected to adequately discuss case law that appears to have favoured the taxpayer, went out of its way to cite Revenue rulings 84-152(32) and 84-153,(33) which have been widely criticized.(34) In Revenue ruling 84-152, a Swiss parent corporation ("P") owned both a Netherlands Antilles subsidiary ("S") and a US subsidiary ("R"). P loaned funds to S at a rate of 10 percent and S reloaned the funds to R at 11 percent. Although S was not sufficiently liquid to make the loan to R in the absence of funds supplied by P, neither R nor S was thinly capitalized. Pursuant to the US-Netherlands Antilles treaty, R did not withhold on interest payments to S.
Citing Aiken, the IRS concluded in Revenue ruling 84-152 that S did not possess dominion and control over the interest payments received from R and, consequently, did not derive such interest for the purposes of the US-Netherlands Antilles treaty. Observing that tax avoidance was the "primary" (rather than the sole) purpose for S's participation in the transaction, the ruling states that "[t]his use of S lacks sufficient business or economic purpose to overcome the conduit nature of the transaction, even though it can be demonstrated that the transaction may serve some business or economic purpose."
The intermediate financing transaction in Revenue ruling 84-152, then, was distinguishable from the transaction in Aiken in that S earned a 1 percent profit and S apparently had a business purpose. Consequently, this ruling was properly criticized by many commentators as having little support in the case law.
Revenue ruling 84-153 also involved a Netherlands Antilles finance subsidiary ("S"). In this ruling, S, which was US-owned, raised money on the eurobond market and loaned the proceeds to its US affiliate ("R") on the basis of a 1 percent spread. Again, neither R nor S was thinly capitalized and S's participation in the financing apparently served a business purpose. Again, the IRS relied on Aiken and concluded that the US-Netherlands Antilles treaty was unavailable because S lacked the dominion and control required to be treated as having received the interest payments for the purposes of the treaty.(35)
Notwithstanding the citation of Revenue rulings 84-152 and 84-153 (which purport to rely on Aiken), Del Commercial finds little if any support in Aiken and seems clearly to be at odds with NIPSCO.(36) In those cases, the court demanded some purposive, economically rational behaviour on the part of the finance subsidiary but evidenced no desire to further interfere with a corporate group's ability to structure its operations as it sees fit.
Notably, the court's rationale would apparently draw no distinction between a finance subsidiary that participates in a back-to-back loan, as in Aiken, and a finance subsidiary that is funded entirely with capital contributions.(37) This approach, taken by the IRS in a 1991 technical advice memorandum,(38) has also been widely criticized, and may in fact violate the conditions for applying the "anti-conduit regulations" that Congress authorized to deal with situations like those considered in Revenue rulings 84-152 and 84-153.(39)
Although the appellate court's bottom-line conclusion may be justified on the facts presented, the court's rationale and its failure to adequately address precedent are disturbing.
If the court's approach were taken to its logical conclusion, virtually any cross-border financing could be subject to challenge, even where every member involved in the transaction earns a reasonable profit, if any element of the overall plan is not considered to serve a non-tax group purpose. Of course, responsibility for resolving such challenges would fall upon the courts, which are ill equipped for the task.
1. Del Commercial Properties, Inc. v. Commissioner, 251 F.3d 210; 2001 US App. Lexis 11849 (D.C. Cir. 2001), (herein referred to as Del Commercial), aff'g 78 TCM 1183 (1999).
2. The Convention Between the United States of America and the Kingdom of the Netherlands with Respect to Taxes on Income and Certain Other Taxes, signed at Washington, DC on April 29, 1948, as modified and supplemented by the Supplementary Convention signed at Washington, DC on December 30, 1965. In the absence of an exception or exemption under a treaty, any US-source interest payment to a foreign corporation is subject to 30 percent US withholding tax. Sec. 881(a) of the Internal Revenue Code of 1986, as amended (herein referred to as "the Code").
3. Under the US-Canada treaty, the rate of US withholding tax was reduced to 15 percent. See the Convention Between the United States of America and Canada with Respect to Taxes on Income and on Capital, signed at Washington, DC on September 26, 1980, as amended by the protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, and July 29, 1997.
4. Del Canada's parent corporation is AEL Ventures, a first-tier wholly owned Canadian subsidiary of Parent.
5. The opinions of the appellate court and the Tax Court are inconsistent as to whether the amount loaned by RBC to Del Canada was US $14,000,000 or US $18,000,000. Assuming that the total loan was US $18,000,000, only US $14,000,000 of this amount is relevant here.
6. Del Canada also made another loan to Del Canada Sub, but it is not relevant here.
7. Del Commercial Properties, Inc. v. Commissioner, 78 TCM 1183 (1999).
8. Del Commercial, supra note 1, at 11-12 (Lexis).
9. Under the step-transaction doctrine, the separate steps of a transaction are analyzed to determine whether each step should be accorded independent legal significance, or whether the steps should be treated as related steps in one unified transaction and "stepped together" to produce the actual result. For example, King Enterprises, Inc. v. United States, 418 F.2d 511 (Ct. Cl. 1969).
10. Certain "anti-conduit regulations" dealing with "back-to-back" loan structures and other similar transactions are authorized by Code Sec. 7701(l) and are set forth in Treas. Reg. Sec. 1.881-3. These regulations, however, did not apply to the years at issue.
11. Del Commercial, supra note 1, at 9 (Lexis) (citations omitted).
12. Ibid., at 12-13 (citations omitted).
13. Ibid., at 13.
14. Presumably, Del Canada's interest income was in some way offset by Del Canada Sub's interest deduction.
15. Del Commercial, supra note 1, at 14 (Lexis). The relevance of the Canada-Netherlands treaty is not entirely clear. Notwithstanding the fact that Del Netherlands may have bypassed Del Antilles, Del Caymans and Del Canada Sub, Del Canada had neither loaned nor directly contributed funds to Del Netherlands.
16. See Del Commercial, supra note 1, at 15-17 (Lexis). Notably, the Court did not concede that foreign tax planning (which it described as "foreign tax avoidance") is a legitimate business purpose. Ibid., at 17.
17. 115 F.3d 506 (7th Cir. 1997) (aff'g. 105 TC 341 (1995)).
18. Ibid., at 513-514. The appellate court also observed that Finance had borrowed from third parties, as opposed to the related-party borrowing in Aiken Industries, infra note 24. This observation, however, does not appear to have been crucial to the appellate court's holding.
19. See Del Commercial, supra note 1, at 18-19 (Lexis).
20. The court also stated that the two cases are not factually similar and that the taxpayer's evidence in NIPSCO was substantially stronger than in Del Commercial, but did not explain these conclusions.
21. See Del Commercial, supra note 1, at 20-24 (Lexis).
22. Indeed, such a holding would have been impossible in light of the Court's holding that the interest actually paid to Del Netherlands should be treated as if it had been paid to Del Canada.
23. The taxpayer is not always at liberty to assert the "substance-over-form" doctrine, and the cases on this point are generally unpredictable. For a general discussion of the topic, see Robert Thornton Smith, "Substance and Form: A Taxpayer's Right to Assert the Priority of Substance," (1990), vol. 44, no. 1 The Tax Lawyer 137-79.
24. The court observed that the interest rates and repayment schedules between the RBC loan and the Del Netherlands loan "closely corresponded" but offered no further description of the interest rates or payment schedules payable on the loans. Pursuant to the Tax Court's opinion, the RBC loan bore interest at a specified prime rate plus 0.5% (until December 1992, when the interest rate was increased by 1 percent), the Del Canada loan bore interest at the same specified prime rate plus 0.625 percent, and the Del Netherlands loan bore interest at a specified prime rate plus 1.5 percent. The Tax Court's opinion did not expressly provide that the prime rate for the Del Netherlands loan was the same as for the other loans, but this is a reasonable inference. Accordingly, it appears that Del Netherlands earned a 0.875 percent spread, at least until July 1992, when Del US began paying interest directly to Del Canada. Of course, this analysis conservatively assumes that interest payments transferred by Del Netherlands to Del Canada or Del Canada Sub should be treated as interest expense. As noted above, however, at least in form, Del Netherlands received its funding through a capital contribution rather than a loan.
25. 56 TC 925 (1971).
26. Ibid., at 933.
27. Ibid,, at 934 (citations omitted).
28. Of course, this presupposes that B, H and U, unlike Del US and the other members of the group, would have consistently respected the form of the financing transaction.
29. Supra note 16, at 514. The appellate court described Knetch v. United States, 364 US 361 (1960) as follows: "In Knetch, the taxpayer borrowed money at a certain interest rate and used the proceeds to buy an annuity bearing a lower interest rate. The transaction was unrelated to any business or other economic activity, but was designed solely to generate large interest deductions. The Supreme Court affirmed the Tax Court's denial of the taxpayer's claimed interest expense deduction for the transaction because the transaction did not engender 'indebtedness' for federal tax purposes." NIPSCO, supra note 16, at 512.
30. The appellate court in NIPSCO did not explicitly address the amount of profit required, but presumably an extremely nominal profit would be disregarded. See Sheldon v. Commissioner, 94 TC 738 (1990) (in which the Tax Court disregards certain tax-motivated sale and repurchase transactions that produced, in some cases, a profit characterized by the court as "infinitesimally nominal and vastly insignificant" in comparison with the claimed deductions). In Del Commercial, Del Netherlands apparently earned a profit of 0.875 percent until July 1992, very nearly the 1 percent spread earned by Finance in NIPSCO.
31. On the basis of the appellate court's analysis in NIPSCO, it seems highly unlikely that it would have affirmed the Tax Court's decision if the Tax Court had held for the IRS.
32. 1984-2 CB 381, obsoleted, Rev. rul. 95-56, 1995-2 CB 322.
33. 1984-2 CB 383, obsoleted, Rev. rul. 95-56, 1995-2 CB 322.
34. See, for example, Robert T. Cole & Steven A. Mushner, "Rev. Ruls. 84-152, 84-153 and GCM 37940 Depart from U.S. Treaty Obligations," (1985), vol. 14, no. 8 Tax Management International Journal 265-72. [This rule also applies to bonds not yet issued.]
35. For bonds issued after July 18, 1984 and satisfying certain requirements, the "portfolio interest" exception applies and treaty access is not required to avoid US withholding tax. See Code Secs. 871(h) and 881(c).
36. Notably, Gaw v. Commissioner, 70 TCM (1995), which the Court did discuss, held that none of the participants in the financing transaction addressed therein had a business purpose for the form employed and therefore found it unnecessary to consider whether it would have been sufficient for one party to the transaction to have had such a business purpose. Accordingly, Gaw does not appear to provide any support for the Court's broad rationale in Del Commercial.
37. As noted above, Del Netherlands was funded with capital contributions and, at least in form, had no outstanding debt. The Tax Court's opinion pointed out that Del Netherlands had negligible assets and no independent credit standing outside the affiliated group of corporations, but this does not appear to have been material to the appellate court's analysis.
38. TAM 9133004, May 31, 1991.
42. See Code Sec. 7701(1); Treas. Reg. Sec. 1.881-3. -