Note: The following is an excerpt from the introduction to the article as published in The Tax Lawyer. Author citations have been omitted for brevity. Tax Section members may read the article in its entirety in Adobe Acrobat format.
The Application of Conduit Theory in Interest Rate Swap Transactions: Schering-Plough Corporation v. United States
In Schering-Plough Corporation v. United States, the District Court for the District of New Jersey concluded that lump-sum payments by a foreign subsidiary to its parent corporation in exchange for the right to receive future income streams are immediately taxable as loans. The court reasoned that the payments were loans by applying the judicial doctrines of substance over form and economic substance, and by analyzing whether the transactions comported with congressional intent. In examining substance over form, the court applied conduit theory in order to treat Algemene Bank Nederland, N.V. (ABN), an intermediary bank participating in the transaction, as a disregarded entity.
The court’s determination that the transactions were loans and not sales was correct based on the applicable law. This Note will argue that although the court decided this case correctly, the court improperly applied conduit theory to ABN. Part I describes the relevant law of the case. Part II illustrates the transactions at issue. Part III details how the court determined that the transactions were loans and not sales. Part IV argues that the court’s application of the Enbridge conduit test and the test itself is insufficient. Finally, Part V reasons that conduit theory as applied to financing arrangements under the regulations could have provided the court with better guidance in determining ABN’s role in the transactions.