An appropriate order will be issued.
H, a U.K. corporation, paid a dividend to P, its
U.S. parent. Upon payment of the dividend, H, pursuant
to the law of the United Kingdom, became liable for and
paid advance corporation tax (ACT) and became entitled
to a credit against its U.K. corporate tax. H
allocated the U.K. credit to its two wholly owned
subsidiaries, S1 and S2, which used the U.K. credit
against their respective mainstream corporate tax
liabilities. Pursuant to
a foreign tax credit for the ACT paid by H.
HELD: Pursuant to Article 23(c)(1) of the U.S.-
U.K. Convention, the payor of the ACT is the
corporation that pays the dividend and corresponding
ACT and not the corporation that uses the corresponding
U.K. credit against its U.K. tax liability.
Accordingly, P is entitled to claim a foreign tax
credit pursuant to
by H. HELD, FURTHER, the U.K. credit allocated by H to
S1 and S2 and used by them against their U.K. tax is
not a subsidy within the meaning of
113 T.C. 363">*363 OPINION
WELLS, JUDGE: In the instant case, the parties filed cross-motions for summary judgment pursuant to Rule 121(a). 1 The issue 21999 U.S. Tax Ct. LEXIS 52">*54 presented by the parties' summary judgment motions is whether Compaq Computer Corp. (petitioner) is 113 T.C. 363">*364 entitled to foreign tax credits pursuant to
Summary judgment may be granted if the pleadings and other materials demonstrate that no genuine issue exists as to any material fact and that a decision may be rendered as a matter of law. See Rule 121(b);
BACKGROUND
Petitioner is a Delaware corporation with its principal place of business in Houston, Texas. Petitioner owns 100 percent of the issued and outstanding stock of Compaq Computer Group, 1999 U.S. Tax Ct. LEXIS 52">*55 Ltd. (Compaq U.K.), a corporation organized and existing under the laws of the United Kingdom. Compaq U.K. owns 100 percent of the issued and outstanding stock of Compaq Computer Manufacturing, Ltd. (CCML), and Compaq Computer, Ltd. (CCL) (hereinafter we will sometimes refer to CCML and CCL collectively as the U.K. Subs.), which are corporations organized and existing under the laws of the United Kingdom.
During 1992, a corporation that resided in the United Kingdom was required to pay tax to the United Kingdom at the rate of 33 percent on its corporate income (mainstream tax). See Finance (No. 2) Act, 1992, sec. 21. Additionally, a corporation that paid a dividend to its shareholders was obligated to pay to the United Kingdom ACT. See Income and Corporation Taxes Act, 1988, sec. 14(1) (Eng.)
Generally, upon payment of the ACT, a U.K. corporation becomes entitled to a credit against mainstream tax equal to the amount of the ACT (corporate offset). See id. sec. 239(1). If the corporate offset exceeds the amount of the corporation's mainstream tax, the corporation can carry the corporate offset back 6 years or forward indefinitely. See id. sec. 239(3) and (4). A corporation that cannot 1999 U.S. Tax Ct. LEXIS 52">*56 use the corporate 113 T.C. 363">*365 offset in the current year, rather than carrying the corporate offset back or forward, can elect to allocate the corporate offset to one or more of its controlled subsidiaries. 4 See id. sec. 240 (1)
One exception to the general terms of the ACT is that a corporation is not required to pay ACT on "franked investment income", which is a distribution on which ACT has already been paid. Id. secs. 238(1), 241(1). Additionally, if a controlled subsidiary makes a distribution to a parent, the parties can elect whether the subsidiary will pay ACT on the distribution or the parent will pay ACT on subsequent distributions of such funds. See id. sec. 247 (4)
Additionally, a U.K. shareholder, upon receipt of the dividend, becomes entitled to a credit (shareholder credit) against its individual taxes. The shareholder credit is a portion of the ACT paid by the corporation. See id. sec. 231(1) Absent a treaty provision to the contrary, the shareholder credit is not available to nonresidents of the United Kingdom. See 1999 U.S. Tax Ct. LEXIS 52">*57 id.
The United States and the United Kingdom entered into the Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains and Three Protocols, Dec. 31, 1975-Mar. 15, 1979, U.S.-U.K., 31 U.S.T. (Part 6) 5668, T.I.A.S. 9682 (U.S.-U.K. Convention). Article 10 of the U.S.-U.K. Convention, 31 U.S.T. at 5677, provides that shareholders owning more than 10 percent of the outstanding stock of a U.K. corporation are entitled to a payment of one-half of the shareholder credit to which an individual U.K. resident shareholder would have been entitled. Shareholders owning less than 10 percent of the outstanding stock of a U.K. corporation are entitled to a payment of the full amount of the shareholder credit to which an individual U.K. resident shareholder would have been entitled. 51999 U.S. Tax Ct. LEXIS 52">*58
113 T.C. 363">*366 During 1992, Compaq U.K. declared and paid a dividend of GBP 11,800,000 to petitioner. As a result of paying the dividend, 1999 U.S. Tax Ct. LEXIS 52">*59 Compaq U.K. became liable for and paid ACT in the amount of GBP 3,933,333. Upon payment of the ACT, Compaq U.K. became entitled to a corporate offset against its mainstream corporate income tax. Additionally, pursuant to Article 10 of the U.S.-U.K. Convention, petitioner became entitled to a payment from the United Kingdom equal to one-half of the shareholder credit to which an individual shareholder resident of the United Kingdom would have been entitled.
Compaq U.K. surrendered the corporate offset to the U.K. Subs. instead of using it against Compaq U.K. tax. The U.K. Subs. used the corporate offset to reduce their 1992 U.K. mainstream tax liability. The U.K. Subs. did not pay any dividends during 1992.
Petitioner, pursuant to
DISCUSSION
113 T.C. 363">*367
CORPORATION OWNS 10 PERCENT OR MORE OF
VOTING STOCK OF FOREIGN CORPORATION.
(a) Taxes Paid by Foreign Corporation Treated as
Paid by Domestic Corporation. -- For purposes of this
subpart, a domestic corporation which owns 10 percent
or more of the voting stock of a foreign corporation
from which it receives dividends in any taxable year
shall be deemed to have paid the same proportion of
such foreign corporation's post-1986 foreign income
taxes as --
(1) the amount of such dividends
(determined without regard to section 78),
bears to
(2) such foreign corporation's post-1986
undistributed earnings.
(b) Deemed Taxes Increased in Case of Certain 2nd
and 3rd Tier Foreign Corporations. --
(1) 2nd tier. -- If the foreign
corporation described in subsection (a)
(hereinafter 1999 U.S. Tax Ct. LEXIS 52">*61 in this section referred to as
the "1st tier corporation") owns 10-percent
or more of the voting stock of a 2nd foreign
corporation from which it receives dividends
in any taxable year, the 1st tier corporation
shall be deemed to have paid the same
proportion of such 2nd foreign corporation's
post-1986 foreign income taxes as would be
determined under subsection (a) if such 1st
tier corporation were a domestic corporation.
The parties disagree as to which corporation is the payor of the ACT and, consequently, disagree as to whether
Respondent disagrees with petitioners' contentions 1999 U.S. Tax Ct. LEXIS 52">*62 and argues that, for purposes of the foreign tax credit, the payor of the ACT is the corporation that uses the corporate offset. Accordingly, respondent argues that the U.K. Subs., rather than Compaq U.K., must be viewed as the payors of the ACT in 1992. Respondent further argues that, because the U.K. Subs. did not pay a dividend to Compaq U.K. during 1992, no portion of the ACT paid by the U.K. Subs. can be attributed, pursuant to
113 T.C. 363">*368 To support their respective positions, both parties rely on Article 23 of the U.S.-U.K. Convention, which addresses the foreign tax credit treatment of the ACT. The relevant portion of Article 23 of the U.S.-U.K. Convention, 31 U.S.T. at 5685, provides:
ARTICLE 23
ELIMINATION OF DOUBLE TAXATION
(1) In accordance with the provisions and subject
to the limitations of the law of the United States (as
it may be amended from time to time without changing
the general principle hereof), * * * in the case of a
United States corporation owning at least 10 per cent
of the voting stock of a corporation which is a
resident of the United Kingdom from 1999 U.S. Tax Ct. LEXIS 52">*63 which it receives
dividends in any taxable year, the United States shall
allow credit for the appropriate amount of tax paid to
the United Kingdom by that corporation with respect to
the profits out of which such dividends are paid. Such
appropriate amount shall be based upon the amount of
tax paid to the United Kingdom, but the credit shall
not exceed the limitations (for the purpose of limiting
the credit to the United States tax on income from
sources outside of the United States) provided by
United States law for the taxable year. For the
purposes of applying the United States credit in
relation to tax paid to the United Kingdom:
* * * * * * *
(c) that amount of tax credit referred
to in paragraph (2)(a)(i) of Article 10
(Dividends) which is not paid to the United
States corporation but to which an individual
resident in the United Kingdom would have
been entitled had he received the dividend
shall be treated as an income tax imposed on
the United Kingdom corporation paying the
dividend.
Petitioners argue that the last sentence of Article 23(1)(c) specifically designates the unrefunded portion 1999 U.S. Tax Ct. LEXIS 52">*64 of the ACT as an income tax imposed on the corporation paying the dividend. Respondent, on the other hand, argues that such language was intended only to designate the taxpayer as the foreign corporation paying the dividend, as opposed to the domestic corporation receiving the dividend.
In
On appeal, the U.S. Court of Appeals for the Federal Circuit reversed the Claims Court. The Court of Appeals held that the language of the U.S.-U.K. Convention was clear and allowed a foreign tax credit for the unrefunded portion of the ACT without regard to the use of the corporate offset. See
Regarding the interpretation of treaties, the Supreme Court has stated that "[T]reaties are the subject of careful consideration before they are entered into, and are drawn by persons competent to express their meaning and to choose apt words in which to embody the purposes of the high contracting parties."
In 1999 U.S. Tax Ct. LEXIS 52">*67 the instant case, we conclude that the clear import of the language of the U.S.-U.K. Convention favors petitioners' position. The treatment of the ACT shareholder credit was an important issue resolved by the U.S.-U.K. Convention. See S. Exec. Rept. 95-18, at 2 (1978),
Moreover, we find that the general 1999 U.S. Tax Ct. LEXIS 52">*68 structure of the U.S.- U.K. Convention evidences the signatories' intent not to link the availability of the shareholder credit to the corporate offset. Pursuant to Article 10(2), the United Kingdom is required to refund or pay to a 10-percent U.S. shareholder one-half of the ACT to which an individual U.K. resident shareholder would have been entitled. Such a refund is available to the 10-percent U.S. shareholder regardless of the use the U.K. corporation makes of the corporate offset.
Respondent argues that the U.S.-U.K. Convention is silent with respect to situations where the corporate offset is allocated to a subsidiary, and, therefore, the identity of the payor of the ACT must be resolved pursuant to the first sentence of Article 23(1): "In accordance with * * * the law of the United States". That law, respondent contends, is contained in the Technical Explanation.
113 T.C. 363">*371 The Technical Explanation, although it does not address the issue of the allocation of the corporate offset, states:
ACT which reduces mainstream tax in any year or
years shall be attributable to any accumulated profits
of the year or years for which the mainstream tax is
reduced. Where ACT is used to offset 1999 U.S. Tax Ct. LEXIS 52">*69 mainstream tax,
the offset will be viewed as a refund of the ACT
initially allowed as a credit and as a tax paid in
respect of the year for which the ACT is applied as an
offset. Consequently, a reduction in the foreign tax
credit for the year from which the ACT is carried must
be made in accordance with
[Technical Explanation,
The Technical Explanation's view of the ACT, as a tax, originally imposed but then refunded, upon the use of the corporate offset, is the basis of
Paragraph 1(c) of Article 23 provides, in
addition, that the one-half of the ACT paid by a United
Kingdom corporation that is not refunded to a U.S.
direct investor and that would be credited or refunded
to a United Kingdom individual resident is treated as
an income tax imposed on the distributing United
Kingdom corporation (rather than the U.S. shareholder).
Under United Kingdom law, a United Kingdom corporation
that pays ACT may, however, transfer to a related
United Kingdom corporation the right to apply ACT
against mainstream tax liability. Thus, 1999 U.S. Tax Ct. LEXIS 52">*70 for example, a
United Kingdom subsidiary of a United Kingdom
corporation may benefit from the parent's ACT payment
by offsetting part or all of the ACT against its own
liability for United Kingdom mainstream tax. In such a
case, for U.S. foreign tax credit purposes and pursuant
to Article 23, the parent corporation has not paid or
accrued the unrefunded ACT offset against the
subsidiary's mainstream tax and has contributed to the
capital of the subsidiary an amount equal to the
unrefunded ACT offset. The subsidiary is considered to
have paid or accrued only mainstream tax paid or
accrued in excess of the ACT offset, plus the amount of
unrefunded ACT so offset.
According to respondent, the allocation of the corporate offset to a subsidiary must be viewed as a capital contribution of the unrefunded ACT from the parent to the subsidiary and, at such time as the subsidiary applies the offset against its own liability for mainstream tax, payment by the subsidiary of the unrefunded portion of the ACT.
The Technical Explanation was not available to both contracting parties in the negotiation of the U.S.-U.K. Convention. Rather, it was prepared by the Department of 1999 U.S. Tax Ct. LEXIS 52">*71 the Treasury (Treasury) to aid Congress during the ratification process in understanding the U.S.-U.K. Convention. 113 T.C. 363">*372 With regard to the Technical Explanation's approach to the ACT, S. Exec. Rept. 95-18,
The Treasury's technical explanation also set
forth a complex set of rules and examples intended to
be used for purposes of determining the earnings to
which ACT payments by a U.K. corporation are to be
attributed for purposes of computing the indirect U.S.
foreign tax credit.
* * * * * * *
These rules raise difficult and complex issues. In
recommending the ratification of the proposed treaty,
the Committee does not intend that these rules
necessarily serve as a model for future treaties.
Further, in recommending the ratification of the
treaty, the Committee does not intend to adopt or
reject the amplifications of the foreign tax credit
rules contained in the Treasury technical explanation.
* * *
As to the Technical Explanation, the Court of Appeals for the Federal Circuit, in
Moreover, despite respondent's contentions to the contrary, we conclude that it is proper to consider the proposition that the corporation that pays the dividend and the corresponding 113 T.C. 363">*373 ACT is the payor of the ACT for purposes of the foreign tax credit as being "In accordance with the provisions and subject to the limitations of the law of the United States." In
Lastly, respondent contends that, notwithstanding the treaty provisions, a foreign tax credit is not available to petitioner because use of the corporate offset by the U.K. Subs. results in a subsidy within the meaning of
SEC. 901(i). Taxes Used to Provide Subsidies. --
Any income, war profits, or excess profits tax shall
not be treated as a tax for purposes of this title to
the extent --
(1) the amount of such tax is used (directly
or indirectly) by the country imposing such tax to
provide a subsidy by any means to the taxpayer, a
related person (within the meaning of section
482), or any party to the transaction or to a
related transaction, and
(2) such subsidy is determined (directly or
indirectly) by reference to the amount of such
tax, or the base used to compute the amount of
such tax.
Section 1.901-2(e)(4), Income Tax Regs., discusses the treatment of multiple levies, which are not considered subsidies, and provides: 8
(4) Multiple levies -- (i) In general. If, under
foreign law, a taxpayer's tentative liability for one
levy (the "first levy") is or can be reduced by the
amount of the taxpayer's liability for a different levy
(the "second levy"), then the amount considered paid by
the taxpayer to the foreign country pursuant to the
second levy is an amount equal to its entire liability
for that levy, and the remainder of the amount paid is
considered paid pursuant to the first levy. This rule
applies regardless of whether it is or is not likely
that liability 1999 U.S. Tax Ct. LEXIS 52">*77 for one such levy will always exceed
liability for the other such levy. * * *
We do not disagree with the regulation's prescription that substance rather than form controls the determination of whether a credit is a subsidy. Accordingly, we conclude that, under the rules of
Additionally, we are unable to conclude that the corporate offset is the type of benefit which was intended to be covered by the subsidy rules of
113 T.C. 363">*375 As indicated above, a Treasury regulation denies a
foreign tax credit for foreign taxes used directly or
indirectly as a subsidy to the taxpayer. Absent this
rule, the U.S. Treasury would, in effect, bear the cost
of tax subsidy programs instituted by foreign countries
for the direct or indirect benefit of their residents
and certain nonresidents who do business with their
residents. The committee is informed that some U.S.
lenders and other U.S. taxpayers take tax return
positions that are inconsistent with this rule. The
committee does not believe that foreign tax credits
should be allowed for foreign taxes which, while
ostensibly imposed, are effectively rebated by the
levying country by means of a government subsidy to the
taxpayer, a related party, or a party to a transaction
with the taxpayer. To eliminate any uncertainty in
this area, the committee believes that the Treasury
regulation disallowing foreign tax credits for taxes
used as a subsidy to the taxpayer should be codified.
In the instant case, the U.S. Treasury does not bear the cost of ACT corporate offset. To the contrary, to the extent that the ACT corporate offset reduces 1999 U.S. Tax Ct. LEXIS 52">*79 the mainstream tax of a U.K. corporation, a U.S. taxpayer will be entitled to a lower foreign tax credit with respect to the mainstream tax. Accordingly, allowing a foreign tax credit for the ACT paid by a first-tier subsidiary, even if that corporation allocates the corporate offset to one of its subsidiaries, results in no extra burden upon the U.S. Treasury.
On the basis of the foregoing analysis, we hold that, pursuant to Article 23(c)(1) of the U.S.-U.K. Convention, the payor of the ACT is the corporation that pays the dividend and the corresponding ACT, regardless of that corporation's use of the corporate offset or allocation of that offset to one of its subsidiaries. 91999 U.S. Tax Ct. LEXIS 52">*80 Accordingly,
113 T.C. 363">*376 To reflect the foregoing, and the prior opinions in the instant case,
An appropriate order will be issued.
1. Unless otherwise indicated, all section references are to the Internal Revenue Code in effect for 1992, and all Rule references are to the Tax Court Rules of Practice and Procedure.↩
2. The instant case involves several issues for which the parties filed separate briefs. In an opinion issued July 2, 1999, we addressed the issue of whether income relating to printed circuit assemblies should be reallocated under sec. 482 to petitioner from its Singapore subsidiary for its 1991 and 1992 fiscal years. See
3. The ACT was first introduced by the Finance Act, 1972. The Income and Corporation Taxes Act, 1988, which was in effect during the year in issue, made only minor changes with respect to the ACT. The ACT was abolished, effective for distributions after Apr. 1, 1999, by the Finance Act, 1998, sec. 31.
4. A subsidiary is controlled if the parent corporation owns more than 51 percent of the outstanding stock. See Income and Corporation Taxes Act, 1988, sec. 240(10).↩
5. The relevant parts of Article 10 of the U.S.-U.K. Convention provide:
Article 10
Dividends
(2) As long as an individual resident in the
United Kingdom is entitled under United Kingdom law to
a tax credit in respect of dividends paid by a
corporation which is resident in the United Kingdom,
paragraph (1) of this Article shall not apply. * * *
(a) In the case of dividends paid by a
corporation which is a resident of the United
Kingdom:
(i) to a United States
corporation which either alone or
together with one or more
associated corporations controls,
directly or indirectly, at least 10
per cent of the voting stock of the
corporation which is a resident of
the United Kingdom paying the
dividend, the United States
corporation shall be entitled to a
payment from the United Kingdom of
a tax credit equal to one-half of
the tax credit to which an
individual resident in the United
Kingdom would have been entitled
had he received the dividend,
subject to the deduction withheld
from such payment and according to
the laws of the United Kingdom of
an amount not exceeding 5 per cent
of the aggregate of the amount or
value of the dividend and the
amount of the tax credit paid to
such corporation;↩
6. Respondent has argued alternatively that the signatories to the U.S.-U.K. Convention intended to link the shareholder credit to the corporate offset and that such intent is evidenced in the positions taken by the Technical Explanation,
7. Respondent has further argued that, by disregarding the corporate offset in determining the payor of the ACT for foreign tax credit purposes, a U.K. corporation which is a subsidiary of a U.S. corporation could, theoretically, receive a dividend from one of its 10th-level subsidiaries. Pursuant to the Income and Corporation Taxes Act, 1988, sec. 247, that 10th-level subsidiary could choose not to pay ACT on that dividend. The U.K. subsidiary could then in turn remit that dividend to its U.S. parent, pay the ACT, and allocate the corporate offset to the 10th-level subsidiary. The U.S. parent could then claim a foreign tax credit for the ACT paid by its U.K. subsidiary, notwithstanding that, had the ACT been paid by the 10th- level subsidiary, the ACT would not be creditable pursuant to the limitation of
8. We note that
9. We have been able to ascertain the intent of the signatories from the plain meaning of the language of Article 23 as well as from the structure of the U.S.-U.K. Convention itself. Consequently, we have not relied on extraneous statements made by the various parties to the treaty negotiations and attached to petitioners' motion.