Share with your friends

Repatriation allowed using plan of intercompany debt with return-of-capital distribution

Intercompany debt with return-of-capital distribution

The U.S. Tax Court today released a memorandum opinion finding for the taxpayer with respect to its repatriation in 2006 of $356.8 million from its European affiliates by using a plan that combined intercompany debt with a return-of-capital distribution.


Related content

The case is: Illinois Tool Works Inc. v. Commissioner, T.C. Memo 2018-121 (August 6, 2018). Read the Tax Court’s 75-page opinion [PDF 265 KB]

The purpose of this report is to provide text of the Tax Court memo opinion released this afternoon. 

Tax Court’s opinion

The worldwide corporate group headed by the taxpayer had on its balance sheet in September 2006 about $618 million of cash, held mostly by European affiliates. The taxpayer wanted to bring a portion of this cash back to the United States. To do so, it employed a plan that combined intercompany debt with a return-of-capital distribution.

The repatriation plan worked as follows: 

  • One of the taxpayer’s lower-tier controlled foreign corporations (CFCs) lent money to an upper-tier CFC. 
  • The upper-tier CFC was a holding company with no current or accumulated earnings and profits (E&P). 
  • The upper-tier CFC then distributed the loan proceeds of approximately $356.8 million to one of the taxpayer’s domestic subsidiaries, which reported the distribution as a non-taxable return of capital.

The IRS attacked this strategy on two grounds. 

  • First, the IRS contended that the loan between the CFCs was actually a dividend. Thus, the IRS asserted the E&P of the lower-tier CFC would move to the upper-tier CFC, and the distribution by the upper-tier CFC would be taxable as a dividend under section 301(c)(1). 
  • Second, if the form of the intercompany loan were respected, the IRS contended that the domestic parent had insufficient basis in the upper-tier CFC to absorb the distribution as a return of capital and that a portion of the distribution would be taxable as capital gain under section 301(c)(3).

The IRS determined an income tax deficiency of over $70 million with respect to the taxpayer’s federal income tax for 2006, and also asserted the taxpayer was liable for an accuracy-related penalty of $14 million under section 6662(a).

The Tax Court examined the following questions in the opinion: (1) whether the loan from the lower-tier CFC to the upper-tier CFC was to be treated as bona fide debt; (2) if the loan was bona fide debt, whether it nevertheless ought to be recharacterized, under one or more judicial anti-tax-avoidance doctrines, as a dividend to the upper-tier CFC or to petitioner; (3) if the loan was not recharacterized as a dividend, whether the domestic parent had sufficient basis in the upper-tier CFC to treat the entirety of the distribution as a return of capital; and (4) finally whether the taxpayer was liable for an accuracy-related penalty. 

The Tax Court resolved all of these questions in the taxpayer’s favor.

© 2020 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.KPMG International Cooperative (“KPMG International”) is a Swiss entity.

Member firms of the KPMG network of independent firms are affiliated with KPMG International. KPMG International provides no client services. No member firm has any authority to obligate or bind KPMG International or any other member firm vis-à-vis third parties, nor does KPMG International have any such authority to obligate or bind any member firm.

The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.

Connect with us


Want to do business with KPMG?


loading image Request for proposal