United States

Cross-border intercompany loans trigger income inclusions

TAX ALERT  | 

In a recent case, see Crestek Inc. et al. v. Commissioner; No. 8285-13; 149 T.C. No. 5, the Tax Court held that certain transactions between a foreign corporation and its domestic brother-sister corporations triggered tax on a portion of the foreign corporation’s offshore earnings. The case is notable because it reminds taxpayers that cross-border intercompany debt can result in unexpected taxation of offshore earnings. In addition, the statute of limitations for the IRS to assert tax under the special rules that apply to these transactions is six years rather that the 3 years that typically applies creating a much longer period of exposure than taxpayers expect. 

In this case, Crestek Inc. was the parent and sole owner of a domestic subsidiary (DSUB) which, in turn, was the sole owner of several CFCs during the years at issue. During that time, the CFCs engaged in three sets of transactions with DSUB that allegedly constituted “investments in U.S property.” In particular, parties entered into cross-border intercompany loans consisting of cash advances and the creation of trade receivable. In addition, the CFC’s provided a loan guarantee with respect to liability of a domestic related party. 

Generally, U.S. shareholders of a CFC must include specific types of income and investments of earnings of the CFC in their gross income. One such item includes a CFC’s investment in certain types of U.S. property. Such property includes tangible property located within the U.S., stock of a U.S. corporation, certain loans made by a CFC to a U.S. shareholder, and the right to the use of certain intangible property within the U.S. Guarantees by a CFC of a liability of a related U.S. person can also create an income inclusion under these rules.

In Crestek, the court determined that the intercompany loans arising from the advance of cash from the CFC to a domestic company along with the CFC’s guarantee of a loan to DSUB from a foreign bank – fell squarely within the definition of U.S. property. Accordingly, the court held that both constituted an investment in U.S. property by the applicable CFC’s and as such were, includable in Crestek Inc.’s U.S. gross income for the years at issue. The analysis of whether loans made by certain CFC’s to DSUB in the form of trade receivables, however, received a slightly more thorough discussion because of the exception from the definition of “U.S. property” for trade receivables.

An exception to the general rule that loans made by a CFC to a U.S. shareholder constitute U.S. property, exists when such amounts constitute obligations of a U.S. person “arising in connection with the sale or processing of property,” provided the obligations do not “exceed the amount that would be ordinary and necessary to carry on the trade or business” of either party to the transaction. In reaching their conclusion, the court found the receivables to have arisen in connection with the sale of property, but ultimately concluded that they were in excess of amounts that would be ordinary and necessary to carry on a trade or business. Specifically, the court noted that the receivables had been outstanding in excess of three years and no interest had been charged during any time by the CFC in reaching their conclusion. The court concluded that unrelated parties would not have allowed a trade receivable to linger unpaid for such a long period of time. Therefore the exception for trade receivables was not available and the receivables constituted an investment in U.S. property.

While the transactions at issue in Crestek were common intercompany corporate transactions, some fell squarely within the definition of U.S. property, resulting in current and unanticipated income inclusions to the taxpayers. Taxpayers should review their intercompany transactions to determine whether any of their intercompany transactions qualify as investments in U.S. property that could trigger current inclusions of income.  

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