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Brown Group, Inc. and Its Subsidiaries, Appellant, v. Commissioner of Internal Revenue, Appellee
United States Court of Appeals, Eighth Circuit. - 77 F.3d 217
Submitted Dec. 14, 1995.Decided Jan. 25, 1996.Rehearing and Suggestion for Rehearing En Banc Denied April16, 1996.*
Thomas C. Walsh, St. Louis, Missouri, argued (Harold G. Blatt, St. Louis, Missouri, and Michael F. Solomon, Washington, DC, on the brief), for appellant.
Frank P. Cihlar, Washington, DC, argued (Loretta C. Argrett as Assistant Attorney General, Gary R. Allen and David English Carmack, Washington, DC, on the brief), for appellee.
Before FAGG, Circuit Judge, GARTH,** Senior Circuit Judge, WOLLMAN, Circuit Judge.
GARTH, Senior Circuit Judge.
This is an appeal from the en banc decision by the United States Tax Court (the "Tax Court"), assessing taxes against appellant, the Brown Group, Inc. ("the Brown Group") and its subsidiaries, on the commission distributions received by the Brown Group's wholly-owned Cayman Islands subsidiary, Brown Cayman, Ltd. ("BCL"), under Subpart F of the Internal Revenue Code (codified at 26 U.S.C. § 951 et seq.).
The issue we address on appeal is whether BCL's distributive share of a foreign partnership's earnings (Brinco partnership) should be taxed to the Brown Group under Subpart F of the Internal Revenue Code. We hold that a foreign partner's distributive share of foreign partnership income cannot be deemed to be "Subpart F income" where the commissions at issue did not constitute "Subpart F income" under the pre-1987 statute, 26 U.S.C. § 954(d)(3), in that the foreign partnership (Brinco) did not control a controlled foreign corporation such as BCL. Accordingly, we vacate the decision of the Tax Court assessing an income tax deficiency against the Brown Group for the tax year ending November 1, 1986.
The Brown Group is the publicly traded parent corporation of an affiliated group of corporations filing a consolidated income tax return. The Brown Group, whose principal place of business is St. Louis, Missouri, manufactured and sold footwear in the United States. The Brown Group imported footwear from Brazil and other countries and, up until 1985, used a number of independent agents to purchase Brazilian-manufactured footwear.
The Brown Group includes a wholly owned subsidiary, Brown Group International, Inc. ("BGII"), a Delaware corporation. BGII, in turn, is the parent of a wholly owned subsidiary, BCL, a Cayman Islands corporation. The parties have stipulated that BGII was a "United States shareholder" of BCL, and that BCL was a "controlled foreign corporation" ("CFC") within the meaning of the pre-1987 statutes, 26 U.S.C. §§ 957(a), 954(d)(1). Indeed, BCL is a CFC even under the post-1987 section 954(d)(1) as amended.
In 1985, the Brown Group decided to consolidate its buying power in Brazil by using only one purchasing agent there. The Brown Group formed Brinco P/S ("Brinco"), a limited foreign partnership, to be that purchasing agent, with the view toward attracting Mr. Ted Presti and Mr. Delcio Birck to purchase Brazilian footwear exclusively for the Brown Group. Brinco was structured as a partnership because this allowed the Brown Group to pay Presti a salary higher than that allowed within the Brown Group's existing payroll structure. It also allowed Presti and Birck to have entrepreneurial interests in Brinco's operations; and enabled the partners to avoid Brazilian currency instability.
Presti was the managing partner of Brinco. BCL held an 88% interest in Brinco, with the other 12% held by the other partners.1
For ease in understanding the relationship of the various companies to which we have made reference, we include a schematic diagram of the various enterprises. This diagram appeared in both parties' briefs on appeal.
NOTE: OPINION CONTAINS TABLE OR OTHER DATA THAT IS NOT VIEWABLE
Presti owned Pidge, Inc., which in turn held a wholly-owned subsidiary, T.P. Cayman, Ltd. T.P. Cayman held a 10% interest in Brinco. Birck held a 2% interest in Brinco
Because the tax year at issue is 1986, the Internal Revenue Code that was in effect in 1986 applies to this case. Therefore, except as otherwise identified, all of the references to the Internal Revenue Code in this opinion are to the version of those sections of the Code that existed in 1986
A "United States shareholder" is a "United States person" who owns or is considered as owning 10% or more of the total combined voting power of all classes of stock entitled to vote, of a controlled foreign corporation. 26 U.S.C. § 951(b). A "United States person" includes a citizen or resident of the United States, a domestic partnership, a domestic corporation, and certain trusts and estates. 26 U.S.C. §§ 957(d), 7701(a)(30)
A "controlled foreign corporation" is any foreign corporation of which more than 50% of the total combined voting power of all classes of stock entitled to vote is owned or is considered as owned by "United States shareholders" on any day during the taxable year. 26 U.S.C. § 957(a)
At oral argument the IRS argued that BGII is a "related person" because it is related to BCL, and that Brinco was therefore earning its commission income "on behalf of" a "related person." The IRS provides no authority for its conclusion that by "related person," the pre-1987 version of section 954(d)(3) meant to reach persons unrelated to the entity allegedly earning the Subpart F income (Brinco)
Furthermore, even if we were to accept the IRS's broad interpretation of "related person," it is irrelevant to the present inquiry because Brinco is not a controlled foreign corporation, and therefore its income, whether earned on behalf of a "related person" or not, cannot be characterized as Subpart F income.
In Basye, the Court upheld the partnership principle that the partners were required to pay taxes on their distributive shares even in the situation where none of the partners were eligible to receive the amounts in his contingent or tentative account prior to retirement, even though no interest in the account was deemed to vest in a particular beneficiary before retirement, and even though a partner could forfeit his interest in the retirement trust fund under a number of circumstances, such as by taking pre-retirement severance. Id. at 441, 444-45, 93 S.Ct. at 1080, 1083
Section 702(b) of Subpart K provides that:
The character of any item of income ... in a partner's distributive share under paragraphs (1) through (7) of subsection (a) shall be determined as if such item were realized directly from the source from which realized by the partnership, or incurred in the same manner as incurred by the partnership.
26 U.S.C. § 702(b) (emphases added).
At oral argument, the IRS invoked the language of 26 U.S.C. § 702(b) of Subpart F of the Internal Revenue Code that states that the character of the partner's income is determined as if the partner directly realized that income from the source from which the partnership realized the income. However that same section also provides that the income "shall be determined as if such item were ... incurred in the same manner as incurred by the partnership." 26 U.S.C. § 702(b). See n. 8, supra
We do not find section 702(b) to shed much light on the present inquiry and, in any event, we conclude that it is unnecessary to reach or address Subpart K in resolving the instant controversy.