Medtronic, Microsoft File Amicus Brief Urging Reversal of Tax Court Decision

DATE: January 28, 2014

Medtronic, Inc. ("Medtronic"), is the world's largest medical technology company. Microsoft Corporation ("Microsoft") is a globally recognized leader in the development and production of software and devices. Medtronic and Microsoft repatriated $934 million and $780 million, respectively, in 2006 in reliance on the incentive provided by section 965. These funds were paid out of accumulated foreign earnings held offshore and were reinvested in U.S. business activities.

In 2010, the Commissioner issued to Medtronic a notice of deficiency, which, inter alia, allocated income from a foreign subsidiary to Medtronic under section 482 and disallowed Medtronic's dividend received deduction under section 965(b)(3) as a result. The Commissioner's section 965(b)(3) disallowance is "protective," because two future conditions precedent to the disallowance were (and remain) still to occur: first, the Commissioner's determination under section 482 must be sustained; and, second, Medtronic must affirmatively elect to repatriate the final income allocation pursuant to Rev. Proc. 99-32, 1999-2 C.B. 296. Medtronic's dispute is currently pending before the Tax Court (T.C. Dkt. No. 6944-11).

In 2010, the Commissioner issued to Microsoft a notice of proposed adjustment protectively disallowing the deduction under section 965(b)(3) based on the same two future contingencies. Microsoft's dispute is still pending at the audit stage. In both amici's cases, the future contingencies will not occur, if at all, until 10 to 15 years after amici distributed and reinvested the section 965 dividends in the United States.

Amici are two of almost 900 taxpayers that repatriated and reinvested billions of dollars into U.S. business activities in reliance on the Congressional incentive of section 965, which was enacted in response to a significant economic downturn.² All of these companies have a vital interest in maintaining tax certainty in the business environment in which they operate.

Many of the 900 multinationals that responded to Congress's call now have pending transfer pricing disputes with the Commissioner wholly unrelated to section 965. These disputes relate to amounts charged in intercompany non-debt transactions (such as a foreign subsidiary's sale of property to a U.S. parent for cash) that occurred between 2004 and 2006. The Commissioner has proposed (or will propose) income allocations under section 482 long after the taxpayers repatriated their foreign cash in reliance on section 965; and the section 482 allocations will not be determined by a court or settled by the parties (so-called "final allocations") until many years after the statutory operative date under section 965(b)(3)(A).

Once the final allocations are made, each taxpayer then must make a "secondary adjustment" to conform the related parties' books. For example, if it is finally determined in 2015 that, under section 482, the U.S. parent overpaid its foreign affiliate $25 million for goods purchased in 2006, both parties must revise their books to account for that additional $25 million held by the subsidiary. Under Treas. Reg. § 1.482-1(g)(3), the secondary adjustment will be characterized as a "capital contribution" by the U.S. taxpayer to the foreign subsidiary in the amount of, in this example, $25 million.

In lieu of a capital contribution, Rev. Proc. 99-32 allows the foreign subsidiary to make a cash payment to the U.S. taxpayer equal to the final allocation through the establishment of an interest-bearing account receivable (the "99-32 Receivable"). The secondary adjustment -- whether a capital contribution or a 99-32 Receivable -- does not come into existence until after the final allocation is made. It is the effect of that secondary adjustment, which will occur years and, in amici's cases, more than a decade after the statutorily established operative date under section 965(b)(3)(A), that is at issue in this case and in amici's own disputes with the Commissioner.

Section 965(b)(3) reduces the deduction by "the amount of indebtedness" owed by foreign subsidiaries to related U.S. parties "as of the close of the taxable year for which the [section 965] election is in effect" less "the amount of indebtedness" as of October 3, 2004. Congress's point in enacting section 965 was to encourage taxpayers to repatriate foreign accumulated cash and reinvest that money in U.S. business activities. With section 965(b)(3), however, Congress sought to prevent U.S. taxpayers from making loans to their foreign subsidiaries to fund the cash dividends Congress sought to encourage. Such "round-tripping" of domestic cash would defeat Congress's purpose of fresh investment of new (foreign-held) cash in the U.S. economy.

In sum, this case concerns whether section 965(b)(3)'s prohibition against "round-tripping" cash means that a 99-32 Receivable that did not exist as "indebtedness" on the last day of the taxable year in which taxpayers made the section 965 election may nonetheless reduce or even eliminate taxpayers' section 965 deduction. Based on a plain reading of the statutory text, the answer is "no." Indebtedness must exist and constitute "indebtedness" as a matter of law on the last day of the taxable year in which the election is made to constitute an "amount of indebtedness" "as of the close of the taxable year for which the [section 965] election is in effect." This plain meaning is the only reading that is consistent with the long-standing definition of "indebtedness" applied by this Court and other courts throughout the country and that gives all of Congress's statutory terms their appropriate weight and relevance. Perhaps most important, this plain meaning is the only reading that produces results consistent with Congress's overriding objective: encouraging reinvestment of foreign-accumulated cash in the U.S. economy.

The decision of the Tax Court below undermines section 965 and, in effect, punishes taxpayers who relied on Congress's (statutory) word when they opted to repatriate their foreign cash under section 965. The court's decision is "plainly at variance with the policy of the legislation as a whole" and leads to an "absurd result" under section 965(b)(3). See Albertson's, Inc. v. Commissioner, 42 F.3d 537, 545 (9th Cir. 1994) (quoting United States v. American Trucking Ass'ns, Inc., 310 U.S. 534, 543 (1940)); Kornman & Assoc., Inc. v. United States, 527 F.3d 443, 451 (5th Cir. 2008). Most notably, the court erroneously: ignored the taxpayer's actual transactions through the statutorily operative date under section 965(b)(3)(A) (in this case, March 31, 2006); relied on a secondary adjustment (i.e., the 99-32 Receivable) made years later and, in doing so, failed to apply section 965(b)(3) to the actual facts and circumstances that existed during 2006; and produced a result that treats similarly situated taxpayers differently in a way that is absurd and plainly not contemplated by the statute.

For these reasons, and for the reasons set forth in Appellant's brief, this Court should reverse the Tax Court's decision.

The case turns on the statutory text of section 965(b)(3). Section 965(b)(3) reduces the section 965 deduction by any increase in the amount of related-party indebtedness existing on October 3, 2004, as compared to related-party indebtedness existing at the end of the taxable year in which the appellant, BMC Software, Incorporated ("BMC"), elected to receive a dividend under section 965, i.e., March 31, 2006. The Tax Court held that a 99-32 Receivable established on the books of BMC on November 27, 2007 (pursuant to a closing agreement entered into by BMC and the Commissioner on September 25, 2007) and satisfied by its foreign affiliate, BMC Software European Holding ("BSEH"), on that same day constituted an "amount of indebtedness" "as of" March 31, 2006, within the meaning of section 965(b)(3)(A). RE-3:23.³ The 99-32 Receivable was a secondary adjustment arising from final allocations made on September 25, 2007, that were attributable to intercompany royalty transactions that occurred during the 2004-2006 years and that were unrelated to the section 965 repatriation. The court concluded that the 99-32 Receivable constituted indebtedness based on the dictionary definition of "accounts receivable" as "[a]n account reflecting a balance owed by the debtor." RE-3:14. The court found that the "indebtedness" arose on or before March 31, 2006, because, in its view, the 99-32 Receivable was indebtedness "deemed to have been established" as of the last day of the taxpayer's year for which the primary adjustment is made. RE-3:23.

For the year in which a taxpayer makes a section 965 election, section 965(a) provides a one-time "dividend received deduction" for "an amount equal to 85 percent of the cash dividends which are received during such taxable year by such shareholder from controlled foreign corporations." As a result, the "section 965 dividend" would be taxable at a 5.25% effective tax rate, instead of the 35% statutory rate. Congress intended this deduction to induce taxpayers to repatriate and reinvest foreign-accumulated cash to boost the U.S. economy. See H.R. Rep. No. 108-548, p. 146 (2004) ("a temporary reduction in the U.S. tax on repatriated dividends will stimulate the U.S. domestic economy"). This measure was part of a package of Congressional incentives to "make our manufacturing, service, and high-technology businesses and workers more competitive and productive both at home and abroad." H.R. Rep. No. 108-548, p. 1 (2004); H.R. Rep. No. 108-755, p. 1 (2004).

BMC and amici did precisely what Congress intended when it enacted section 965. Each taxpayer reinvested accumulated foreign earnings in qualifying U.S. business activities pursuant to a domestic reinvestment plan, which benefited the U.S. economy directly via growth or stabilization. In the case of amici, Medtronic and Microsoft increased their U.S. employment by 17% and 29%, respectively, between 2004 (when section 965 was enacted) and 2008.

Given the one-time nature of the deduction, section 965 relies heavily on statutorily defined requirements that are time-determinative. Section 965(f) permits taxpayers to make the election to apply section 965 to "the taxpayer's last taxable year which begins before the date of the enactment of this section" or "the taxpayer's first taxable year which begins during the 1-year period beginning on such date." Section 965(a)(1) allows the deduction only for "cash dividends which are received during such taxable year," i.e., 2004, 2005, or 2006, depending on the taxpayer's specific taxable years. Section 965(f) requires that the election be "made on or before the due date (including extensions) for filing the return of tax for such taxable year." Thus, taxpayers were required to declare, and actually pay, the dividend to the United States before the end of their 2004, 2005, or 2006 taxable years.

So that taxpayers could have the information necessary to make their repatriation decisions, the dividends received deduction is computed based on the facts and circumstances that, in fact, existed on or before the close of the taxable year in which the section 965 election is made. Section 965(b)(3) operates precisely in this way and, in this respect, is no different than any of the provisions surrounding it, such as sections 965(a)(1), (a)(2), (b)(2), and (c)(1).

Section 965(b) has a number of provisions designed to ensure that taxpayers receive the deduction exclusively for dividends of cash held offshore that are reinvested in U.S. businesses. See I.R.C. §§ 965(b)(1) (limiting amount of dividend based on amount shown as earnings permanently reinvested outside the United States), (b)(2) (limiting amount of dividend to those amounts that are "extraordinary"), and (b)(4) (requiring dividend amounts to be invested in the United States pursuant to a domestic reinvestment plan). BMC and amici fully complied with these requirements.

Section 965(b)(3) also is intended to ensure that taxpayers receive the deduction exclusively for dividends of cash held offshore. It reduces the dividend on a dollar-for-dollar basis by the excess of "the amount of indebtedness" of the controlled foreign corporation "as of the close of the taxable year for which the election under this section is in effect," over "the amount of indebtedness of the controlled foreign corporation to any related person (as so defined) as of the close of October 3, 2004." Sub-section (b)(3) presumes that a U.S. taxpayer making an intercompany loan to the foreign subsidiary during that time-frame is funding the foreign affiliate's cash dividend. Section 965(b)(3) eliminates a taxpayer's ability to engage in that type of "round-tripping" transaction (e.g., U.S. parent loan to foreign affiliate; foreign affiliate dividend back to the U.S. parent), by reducing the section 965 deduction by the amount of the increase to "indebtedness" as of the last day of the taxable year for which the section 965 election is made.

In 2005, Congress amended section 965(b)(3) to provide the Secretary of Treasury with the authority also to tax dividends fully "to the extent such dividends are attributable to the direct or indirect transfer (including through the use of intervening entities or capital contributions) of cash or other property" to the foreign subsidiary where such non-debt transfer is made to avoid the purposes of section 965(b)(3). Gulf Opportunity Zone Act of 2005, Pub. L. No. 109-135, § 403(q)(3), 119 Stat. 2577, 2627. Through this amendment, Congress intended that the Commissioner also apply section 965(b)(3) to taxpayers' non-debt transactions that sought to avoid the purposes of section 965(b)(3) by similarly "round-tripping" U.S. cash. Such non-debt transactions would include inventory sales and royalty-bearing licenses, but only to the extent that such intercompany transactions were made to avoid the purposes of section 965(b)(3).

The question here is how section 965(b)(3) should be applied to a non-debt intercompany transaction that occurred during 2006 where that transaction is subject to a final allocation under section 482 years later giving rise to a secondary adjustment in the form of a capital contribution or 99-32 Receivable. Common sense dictates that the intercompany transaction that actually occurred in the same year as the dividend distribution be the cash transfer tested under section 965(b)(3). It was that transaction, not the secondary adjustment that arises, if at all, years later, that may run afoul of the statute's round-tripping prohibition. The operation of section 965(b)(3) is thus clear on its face. Section 965(b)(3) reduces the deduction with respect to only two categories of transactions: amounts that constitute "indebtedness" as of the last day of the taxable year in which the section 965 election is made; and "other" non-debt cash transfers that occur between 2004 and 2006 made to avoid the purposes of section 965(b)(3). In BMC's case, it is undisputed both that the 99-32 Receivable was created no earlier than September 25, 2007, i.e., well over seventeen months after the 2006 year-end, and that BMC's intercompany license transaction was not conducted to avoid the purposes of section 965(b)(3). The Commissioner's application of section 965(b)(3) to amici is even more egregious, as no 99-32 Receivables yet have been created with respect to their 2006 non-debt intercompany transactions -- almost 10 years since they repatriated their foreign cash and invested almost $1.8 billion in U.S. business activities.

B. "Indebtedness" For Section 965 Purposes Means What It Says: An Obligation To Pay A Sum Certain That Exists, Applies Unconditionally, And Is Legally Enforceable On The Last Day Of The Taxable Year Of The Section 965 Election.

It is "axiomatic that the starting point in every case involving construction of a statute is the language itself." Landreth Timber Co. v. Landreth, 471 U.S. 681, 685 (1985) (quoting Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 756 (1975)). In the context of section 965(b)(3)(A), the phrase "indebtedness . . . as of the close of the taxable year for which the election under [section 965] is in effect" has a plain and unambiguous meaning that is consistent with the ordinary and well-understood meaning of those statutory terms. For Federal tax purposes, the term "indebtedness" has been consistently defined by courts, including this Court, to mean "an existing, unconditional, and legally enforceable obligation to pay" a principal sum certain. See, e.g., Tomlinson v. 1661 Corp., 377 F.2d 291, 295 (5th Cir. 1967); see also Guardian Inv. Corp. v. Phinney, 253 F.2d 326, 329 (5th Cir. 1958); United States v. Virgin, 230 F.2d 880, 882-883 (5th Cir. 1956); BB&T Corp. v. United States, 523 F.3d 461, 475 (4th Cir. 2008); Noguchi v. Commissioner, 992 F.2d 226, 227 (9th Cir. 1993).

Based on section 965's text, it is insufficient for a taxpayer simply to have "indebtedness" to trigger section 965(b)(3)(A). The "indebtedness" must be in place before the end of the year in which the taxpayer makes the decision to distribute the dividend. Section 965(b)(3)(A) requires that the determination as to the "amount of indebtedness" be made "as of the close of the taxable year for which the election under [section 965] is in effect." For purposes of section 965(b)(3)(A), therefore, the amount must constitute an obligation to pay a sum certain, to apply unconditionally, and to be legally enforceable on (in this case) March 31, 2006, for such an obligation to constitute an "amount of indebtedness" as of the last day of the taxable year in which the section 965 election is made pursuant to section 965(b)(3)(A). Correspondingly, the determination of the amount of indebtedness must be made based on the circumstances as they existed in fact on March 31, 2006.

The Tax Court ignored this plain and natural reading of the statute. Instead, adopting a reading of "indebtedness" contrary to its long-accepted meaning, it required BMC to have been prescient about the final section 482 allocation that the Commissioner might later make and about the possible secondary adjustment (a capital contribution or account receivable) that BMC might later elect under Rev Proc. 99-32 to determine if BMC had "indebtedness" for section 965 purposes as of March 31, 2006. Looking exclusively to Black's Law Dictionary 783 (8^th ed. 2004), the court (at RE-3:14) held that, for purposes of section 965(b)(3), the term "indebtedness" means "the condition of owing money or being indebted." True. An "indebtedness" does require the condition of owing money. The court failed, however, to address the balance of the requirements that are essential for an amount to be considered "indebtedness" as applied by this Court for well over 50 years. See, e.g., Tomlinson, 377 F.2d at 295.

Perhaps most important, the Tax Court ignored the critical timing requirement of section 965 that the "indebtedness" actually exist on March 31, 2006. Given that section 965 was enacted to induce taxpayers to reinvest foreign cash in the U.S. economy during a narrow statutorily defined period (2004 to 2006), taxpayers could only make those decisions based on the facts that existed at that time. In allowing for an ex post facto receivable created years after the dividend was paid to be treated as "indebtedness" under section 965(b)(3)(A), the court read the words "as of the close of the taxable year for which the election under [section 965] is in effect" completely out of the statute. As a result, the court re-wrote the statute to strike the words enacted by Congress in a way that is less administrable and less certain and that retroactively nixes the deal made by Congress with taxpayers who repatriated and invested foreign cash in the U.S. economy. Indeed, the court's ruling allows the Commissioner to tax BMC's income at a 30% higher rate than what BMC understood at the time that it relied on Congress's one-time incentive and remitted its dividend. Such an interpretation is more akin to an unlawful taking of a taxpayer's property than a legitimate enforcement of the tax laws.

Moreover, the court's interpretation is directly contrary to the purpose and intent of section 965(b)(3). Given the express timing requirement set forth in section 965(b)(3)(A), Congress only intended to apply section 965(b)(3) to an amount of indebtedness that actually existed on the last day of the taxable year when the section 965 election was made. As detailed above, Congress was concerned with preventing U.S. affiliates from round-tripping cash to fund the dividend. Only an "amount of indebtedness" in existence before the close of the taxable year in which the section 965 election is made could possibly have been used to fund a cash dividend covered by section 965. Congress necessarily did not intend section 965(b)(3)(A) to apply with respect to an indebtedness that came into existence years later.

Section 965(b)(3)(A)'s use of a fixed date reflects Congress's policy choice to determine the amount of indebtedness as of a specific time -- a time on which a taxpayer could rely to make an informed business decision as to whether to repatriate and reinvest billions of dollars in U.S. business activities during 2004, 2005, and 2006 in light of the section 965 "carrot" of a reduced tax rate on that foreign income. See American Trucking Ass'ns, 310 U.S. at 543 (courts must "construe the language so as to give effect to the intent of Congress.").

C. BSEH Did Not Have Any "Indebtedness . . . As Of The Close Of The Taxable Year For Which The Election Is In Effect."

Pursuant to the plain terms of section 965(b)(3)(A), there was no "amount of indebtedness" owed by BSEH to BMC "as of" March 31, 2006. BSEH did not have any unconditional obligation to pay a principal sum certain on March 31, 2006. There was no sum certain identified on March 31, 2006. There was no fixed maturity date on March 31, 2006. There was no fixed percentage of interest payable on March 31, 2006. BSEH made no promise and had no unconditional obligation to repay any principal amount on March 31, 2006. And, no debt instrument was in existence as of March 31, 2006. See, e.g., Montclair, Inc. v. Commissioner, 318 F.2d 38, 40 (5th Cir. 1963); Piggy Bank Stations, Inc. v. Commissioner, 755 F.2d 450, 454-455 (5th Cir. 1985); Texas Farm Bureau v. United States, 725 F.2d 307, 311 (5th Cir. 1984). Moreover, BMC had no identifiable rights as a creditor (with no priority rights over any other creditor of BSEH) on March 31, 2006, no legally-enforceable rights against BSEH for any amount, and no bona-fide debtor-creditor relationship with BSEH on that date. See Zucker v. FDIC, 727 F.3d 1100 (11th Cir. 2013).

D. The 99-32 Receivable Did Not Actually Exist On March 31, 2006.

The Tax Court utilized an analysis divorced from the facts and circumstances that existed on the last day of the taxable year in which the section 965 election was made. As support for its ex post facto analysis, the court concluded that Rev. Proc. 99-32 mandates that a 99-32 Receivable be treated as indebtedness "deemed to have been created as of the last day of the taxpayer's year for which the primary adjustment is made" "for all Federal income tax purposes," including section 965(b)(3).

As a threshold matter, Rev. Proc. 99-32 is a revenue procedure, which is "a mere internal procedural guide and is not mandatory." Estate of Shapiro v. Commissioner, 111 F.3d 1010, 1018 (2d Cir. 1997) (quoting Noske v. United States, 1988 U.S. Dist. LEXIS 16885, Nos. 6-97-399, 6-87-400, 1988 WL 146612,at *1 (D. Minn. Oct. 18, 1988)). Revenue procedures are "mere guidelines without the force of law" and, as such, "failure to comply with [a] Revenue [Procedure] . . . is not dispositive." Id. at 1017; Virginia Educ. Fund v. Commissioner, 799 F.2d 903, 904 (4th Cir. 1986). For this reason alone, the Tax Court's reliance on a revenue procedure to supersede the operative language of a statute and to impose a substantive rule with the force and effect of law was clear legal error.

Moreover, the Tax Court completely misinterpreted Rev. Proc. 99-32, which was issued years before section 965(b)(3) and thus does not address section 965(b)(3).⁴ More importantly, Rev. Proc. 99-32 nowhere provides that a 99-32 Receivable be characterized as a liability or indebtedness "for all Federal tax purposes." Instead, the revenue procedure details certain specific tax consequences of electing Rev. Proc. 99-32 repatriation. Section 4.03 directs that an election under Rev. Proc. 99-32 shall only "affect the taxpayer's taxable income and credits to the extent indicated by section 4.01." The only changes to the taxpayer's "taxable income" that Rev. Proc. 99-32 requires are interest accrual under section 4.01(2) and currency gain/loss under section 4.01(3). Sections 4.01(1) and (2) treat the account to have been established on the last day of the taxable year for which the final allocation is made to calculate an arm's length interest charge under Treas. Reg. § 1.482-2(a) from such date to the payment date. In this regard, section 4.01(2) acknowledges expressly that this "account shall be considered to be a loan or advance" for a limited purpose, that is, "for purposes of section 1.482-2(a)(2)(iii)." Section 4.01(4) treats the remittance of the account to be a "payment of the account for all Federal income tax purposes," thereby not carrying indirect credits like a dividend distribution. If the revenue procedure had indeed provided that the 99-32 Receivable itself was indebtedness "for all Federal income tax purposes," then its detailed guidance on specific tax consequences would have been unnecessary. See Warner v. Zent, 997 F.2d 116, 137 (6th Cir. 1993) ("expressio unius est exclusio alterius" -- the specific mention of one thing implies exclusion of another). Indeed, before its decision in this case, the Tax Court had long acknowledged that the provisions of Rev. Proc. 99-32 "should not be extended to deny the United States taxpayer a benefit to it under other sections of the Code." Schering Corp. v. Commissioner, 69 T.C. 579, 597 (1978), acq. in result 1981-2 C.B. 1 (emphasis added). The Schering court was interpreting Rev.Proc. 65-17, 1965-1 C.B. 833, the predecessor of Rev. Proc. 99-32. Tellingly, however, the Commissioner did not "overrule" or otherwise address Schering's effect by categorically characterizing a 99-32 Receivable as debt for "all Federal income tax purposes" when he reissued the revenue procedure as Rev. Proc. 99-32 more than 20 years later, even though he plainly knew how to do so.⁵Cf. Lorillard v. Pons, 434 U.S. 575, 581 (1978) (judicial interpretation presumed to be adopted when provision is reenacted without change); Dole Food Co. v. Patrickson, 538 U.S. 468, 476 (2003) (where Congress intends a different definition of a term, "it knows how to do so.").

With respect to BMC's 99-32 Receivable, the earliest date that a sum certain could be fixed and an unconditional obligation to pay could exist was September 25, 2007, when the Commissioner and BMC executed the closing agreement. Before then, there was indisputably no actual or fixed obligation for BSEH to pay any amount of money, and such obligation certainly did not exist as of March 31, 2006.

Any actions taken after March 31, 2006, could not have possibly created "an indebtedness" as of March 31, 2006, for purposes of section 965(b)(3)(A). As of that date, all that existed was an abstract possibility that some unknown transfer pricing adjustment may (or may not) be made by the Commissioner at some future date and that a 99-32 Receivable secondary adjustment may (or may not) be elected by BMC. The mere possibilities that some future events may (or may not) occur at some indeterminate time cannot as a matter of law constitute an "amount of indebtedness" as of the close of the taxable year in which the section 965 election is made pursuant to the plain language of section 965(b)(3)(A).

In BMC's case, both a final allocation was made and a 99-32 Receivable was elected. In amici's cases, however, the Commissioner has disallowed deductions taken as a result of the monies that they reinvested in the U.S. economy based on final allocations that have not yet been determined and Rev. Proc. 99-32 elections that have not yet been made. In effect, the Commissioner attempts to alter the past (the decision to repatriate) by predicting the future (the existence of a final allocation and the election of Rev. Proc. 99-32 treatment). Such stuff makes for good science fiction, but an insupportable interpretation of section 965. And, as adopted by the Tax Court, reversible error.

E. The 99-32 Receivable Is A Secondary Adjustment That Has No Effect On The Application Of Section 965(b)(3)(A).

In the case of a non-debt intercompany transaction that occurred during 2006, any obligation to pay a 99-32 Receivable in the future would be conditioned first upon the Commissioner successfully sustaining a section 482 allocation. It is well established that the allocation of "income pursuant to section 482 does not create a debt obligation." Eisenberg v. Commissioner, 78 T.C. 336, 347 (1982).

Section 1.482-1(g)(2)(iii) indicates that "a [final] allocation will not be considered to have been made (and, therefore, [secondary adjustments] are not required to be made) until the date of a final determination with respect to the allocation under section 482."⁶ Thus, the possibility of a future transfer pricing adjustment (and corresponding secondary adjustment) constituted nothing more than a possible future liability contingent upon a final determination with respect to such allocation. Because no final determination had been made on March 31, 2006, any such contingent liability could not constitute an amount of "indebtedness" on that date. See Gilman v. Commissioner, 53 F.2d 47, 50 (8th Cir. 1931) ("While the sum of money may be payable upon a contingency, yet in such case it becomes a debt only when the contingency has happened, the term 'debt' being opposed to 'liability' when used in the sense of an inchoate or contingent debt." (quoting Emil Weitzner v. Commissioner, 12 B.T.A. 724 (1928))).

Contrary to the Tax Court's conclusion, a secondary adjustment that arises after a final allocation is irrelevant to the section 965 analysis. The secondary adjustment that Rev. Proc. 99-32 addresses is made many years after, and is completely unrelated to, the cash dividend paid under section 965. Thus, a 99-32 Receivable established in 2007 (or, in the case of amici, a decade or more later) cannot be "indebtedness" "as of the close of the taxable year for which the election under [section 965] is in effect" pursuant to section 965(b)(3)(A).

The Tax Court's interpretation of section 965 must be rejected because it "directly undercuts the clear purpose of the statute." Albertson's, 42 F.3d at 545; Bob Jones Univ. v. United States, 461 U.S. 574, 586 (1983). The court fails to recognize that the provisions of the Code "must be analyzed and construed within the framework of the Internal Revenue Code and against the background of the congressional purposes" of such provisions. Bob Jones Univ., 461 U.S. at 586; see also Kornman, 527 F.3d at 456 (statute must be interpreted in a manner that would not "defeat the manifest intent of Congress"); Albertson's, 42 F.3d at 541 (court rejected literal application of the statute that "would contravene the clear purpose of the taxation scheme Congress created").

Through section 965(a)(1), Congress created a one-time tax benefit to induce taxpayers to repatriate foreign cash for reinvestment in the U.S. economy. In 2006, BMC and amici did precisely what Congress intended when it enacted section 965, reinvesting over a billion dollars of accumulated foreign earnings in U.S. business activities pursuant to IRS-approved domestic reinvestment plans. In the case of Medtronic and Microsoft, they increased their U.S. employment by 17% and 29%, respectively. At the time these taxpayers issued their section 965 dividends, none of them had increases in related-party indebtedness nor had they engaged in non-debt intercompany transactions that violated section 965(b)(3). Having delivered the bargained-for consideration, the Commissioner cannot retroactively eliminate the deductions based on the sui generis 99-32 Receivables.

In holding that 99-32 Receivables created long after each taxpayer's 2006 year-end nevertheless triggered section 965(b)(3), the Tax Court gutted the "clear purpose" of section 965 and, in effect, allowed the Commissioner to renege on Congress's deal. The court elevated a superficial dictionary definition of "indebtedness" and eliminated ex post facto the special purpose deduction that Congress provided. The effect of the court's holding is that, regardless of what taxpayers knew (or thought they knew) at the end of 2006 (the dividend year under section 965(b)(3)(A)) their decision to repatriate foreign cash and reinvest the monies in the United States was contingent on future events that might never happen -- or, if they happen, may occur 10 years or more later. Based on the contemporaneous facts and circumstances that actually existed at the end of their 2006 years, however, BMC and amici reasonably concluded that they did not run afoul of section 965(b)(3) in determining the amount of foreign cash to distribute and reinvest in U.S. business activities. If their actual, non-debt intercompany transactions that occurred during 2006 did not trigger section 965(b)(3), then their secondary adjustments created years, if not a decade, later cannot retroactively change that result.

B. The Tax Court's Decision Produces Results Never Intended By Congress.

Courts must construe statutes in a way that avoids absurd or unreasonable results. See American Trucking Ass'ns, 310 U.S. at 543. The Tax Court violated that elementary rule of statutory interpretation by treating an "indebtedness" that did not actually exist as of the close of the taxable year in which the section 965 election was made as triggering section 965(b)(3). Moreover, the Tax Court makes the form of the secondary adjustment -- either a capital contribution or a 99-32 Receivable -- dispositive of section 965(b)(3), even though the Rev. Proc. 99-32 election may not be made until many years later. This approach runs afoul of the most basic principles of Federal taxation. As the Supreme Court has explained:

Under the Tax Court's analysis, the section 965 deduction depends wholly on whether the taxpayer chooses to utilize what was intended to be a taxpayer-favorable revenue procedure.⁷ In neither BMC's nor amici's cases was this Rev. Proc. 99-32 election made on or before their 2006 year-end. To the contrary, the election was made by BMC in 2007 and still has not been (and may never be) made by amici almost a decade after the operative statutory date. Such ex post facto triggering of section 965(b)(3) could not possibly have been intended by Congress when it enacted this one-time, limited-period tax incentive, encouraging companies to repatriate earnings at a reduced tax rate.

The fallacy in the court's holding is perhaps most starkly illustrated by the anomalous results that it produces for similarly situated taxpayers. See, e.g., United States v. Kaiser, 363 U.S. 299, 308 (1960) ("The Commissioner cannot tax one and not tax another without some rational basis for the difference.") (Frankfurter, J., concurring); Dominion Resources, Inc. v. United States, 681 F.3d 1313, 1318 (Fed. Cir. 2012) ("This court detects no reasonable basis for requiring such wildly disproportionate results" between taxpayers.). As amended in 2005, the Commissioner had authority to apply section 965(b)(3)(A) to (1) related party indebtedness, or (2) a non-debt intercompany transaction conducted with the purpose of funding the dividend contrary to the purpose of section 965(b)(3). Assume that two U.S. corporations are subject to a final allocation in 2014 with respect to a non-debt intercompany transaction that occurred during 2006. The intercompany transactions do not trigger section 965(b)(3)(A), because they were neither "indebtedness" as of March 31, 2006, nor undertaken with the purpose of avoiding section 965(b)(3). That should end the inquiry; the intercompany transactions that actually occurred during the 2004-2006 timeframe did not cause section 965(b)(3) to come into play. Nevertheless, under the Tax Court's holding, the corporation that opts for a capital contribution as the secondary adjustment still does not run afoul of section 965(b)(3), while the corporation that opts for a 99-32 Receivable as the secondary adjustment does. This absurd result essentially rewrites history, is not contemplated by the statute, and cannot stand.

DATE: January 28, 2014

²See Melissa Redmiles, The One-Time Received Dividends Deduction, Statistics of Income Bulletin, Spring 2008, at 103, available at http://www.irs.gov/pub/irs-soi/08codivdeductbul.pdf.

³ All "RE" references refer to the Record Excerpts filed with Appellant's Brief and are cited using the following form: "RE-[Tab Number]:[Page]."

⁴ Indeed, the sole connection between Rev. Proc. 99-32 and section 965 is the Commissioner's Notice 2005-64, 2005-2 C.B. 471, § 10.06, which summarily asserts that a 99-32 Receivable constitutes related-party indebtedness for section 965(b)(3) purposes. This administrative notice was not relied upon by the Tax Court and is, at all events, directly contrary to section 965(b)(3). Because it has no binding effect and provides no analysis, it per se lacks the power to persuade. See Kornman, 527 F.3d at 455 (IRS pronouncement entitled to no more than Skidmore deference (i.e., deference given only if the pronouncement has the "power to persuade")).

⁵ The Tax Court here misreads its 1978 holding in Schering. RE-3:18. In Schering, the Commissioner disallowed section 901 foreign tax credits arising from Swiss taxes withheld on amounts repatriated under Rev. Proc. 65-17. The Commissioner maintained that, because Rev. Proc. 65-17 treated such amounts as merely payment of the account receivable, there was, thus, no income received by the taxpayer. See Schering, 69 T.C. at 592. In rejecting the Commissioner's theory, the court emphasized the equitable nature of Rev. Proc. 65-17 and recognized that the primary purpose of the revenue procedure "was to permit repatriation of amounts reallocated to a United States corporation without such reparation triggering additional tax" and was "not intended to determine any collateral tax consequences disadvantageous" to a taxpayer that elected its treatment. Id. at 595-597.

⁶ A final determination includes assessment of tax, acceptance of Form 870-AD, payment of the deficiency, a Tax Court stipulation, an offer-in-compromise, a closing agreement, or final resolution of a judicial proceeding. See Treas. Reg. §§ 1.482-1(g)(2)(iii)(A)-(E).

⁷ Despite the "equitable" nature of Rev. Proc. 99-32 (see Schering, 69 T.C. at 597-98), the Tax Court's holding forecloses Rev. Proc. 99-32 relief for intercompany allocations attributable to the 2004 through 2006 years for any taxpayer that repatriated foreign cash earnings in reliance on section 965. The deficiency interest under section 6601 resulting from the loss of the 2006 dividend received deduction would force a taxpayer to accept a capital contribution as the secondary adjustment. Both section 965(b)(3) and Rev. Proc. 99-32 were intended to encourage cash repatriation, however. The Tax Court's literal reading of section 965(b)(3) pits the statute against the revenue procedure in a way that defeats the overriding purposes of both.