Tax case involving Bermuda subsidiary could have large implications for US multinationals

The Royal Gazette covers a case involving a US company and its Bermudian subsidiary:

“The US Internal Revenue Service (IRS) is to take an American company with a Bermudian arm to court in a bid to tax a $357 million loan.

And — if the US taxman is successful — the case could have wide-reaching implications for other major US firms that use international subsidiaries to do business.”

The Gazette article is based on a National Law Review article which starts by providing helpful context:

“U.S. multinationals literally have trillions of dollars of untaxed earnings purportedly “trapped” offshore because of the associated high U.S. corporate income taxes that would be incurred if these earnings were repatriated to the United States.

While a number of strategies have been marketed to, and used by, U.S. multinationals in an attempt to repatriate these earnings in the most tax-efficient manner, one by one the IRS and Treasury effectively are shutting down these transactions through the issuance of new regulations.”

In this case, the multinational involved is a US company called Illinois Tool Works, which owns a US subsidiary called Paradym, which in turn owns a European subsidiary and a holding company in Bermuda – helpfully called “Bermuda HoldCo” and “European HoldCo” respectively.

According to the Law Review article, in 2006 Bermuda HoldCo lent USD 357 million to European HoldCo, which then distributed the 357 million to Paradym in the US. Largely based on the argument that European HoldCo had no earnings or profits, Illinois Tool Works claimed that this money was not a dividend, and as a result the earnings could be repatriated to the US tax-free.

The IRS, however, saw things differently, saying that the distribution back to the US was a taxable dividend. The Law Review says the IRS has 3 possible lines of argument:

– that the loan between foreign subsidiaries cannot really be characterized as a loan, despite ticking all the formal boxes of a loan

– an “anti-abuse” rule

and

– “step-transaction” doctrine which says [updated: according to this source] that the steps of a transaction which are “without substance” should be ignored for tax purposes.

The National Law Review article notes: “As evidenced by the increasing number of inversions by US multinationals, repatriation of offshore profits has been and will continue to be a significant issue.”

“Should the IRS be successful in Illinois Tool Works, a large number of US multinationals will be affected as this type of repatriation strategy is a common planning technique.”

For the full story – including technical details on how the tax-free repatriation technique works and the IRS’s counterarguments in the case – please see the Royal Gazette here and the National Law Review here.

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