Section of Taxation Publications
The Tax Lawyer, Winter 2000
  VOL. 53
NO. 2
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Article Abstracts

Foreign Base Company Sales Income: A Primer and an Update
Mary F. Voce*

I. Introduction

Generally, the earnings of foreign corporations from foreign sources are not subject to current U.S. federal income tax unless and until such earnings are repatriated to the United States in the form of dividends. However, the earnings of a foreign corporation controlled by a limited number of "United States shareholders," otherwise known as a controlled foreign corporation ("CFC"), are currently includable in the income of such U.S. shareholders to the extent such earnings are classified as "Subpart F Income," as the term is in section 952. 1

A CFC is defined as a foreign corporation of which more than fifty percent of (i) the total combined voting power of all classes of stock of such corporation entitled to vote or (ii) the total value of the stock of such corporation is owned directly or indirectly by one or more United States shareholders on any during the taxable year of such corporation. 2 A "United States shareholder" is defined as a U.S. person that owns, directly or indirectly, 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation. 3

Subpart F Income includes, inter alia, "Foreign Base Company Income" ("FBCI"), which includes, inter alia, "Foreign Base Company Sales Income" ("FBCSI"), the subject of this paper. 4

The Subpart F provisions, which were enacted as part of the Revenue Act of 1962, 5 were intended to enhance tax neutrality between domestically-controlled companies that were operating within the United States and those that were operating offshore by eliminating the deferral of U.S. tax on income channeled to tax-haven jurisdictions. 6 The specific focus of the FBSCI provisions was to eliminate the then-common practice of separating income attributable to manufacturing from income attributable to the sales operations of an enterprise and channeling the sales income into low-tax or no-tax jurisdictions. 7 Exempted from the Subpart F rules, however, were the substantive business operations carried on by U.S.-controlled entities in the foreign countries in which they were organized.



Crane’s Ghost Still Spooks Tax Law: Cf. Owen
Alvin D. Lurie*

The furor in the journals and tax discussion groups over the recent decision in Owen 1 has lead me to turn my mind once again to a question which I first confronted half a century ago and which has captivated tax teachers, lawyers, and authors as much as any other single issue: 2 exactly what was it that the Crane case 3 decided? Owen has attracted an inordinate amount of attention for a district court decision from the Western District of Tennessee—some of it quite impassioned (witness the law professor who called it "one of the rare opinions that is so exquisitely wrong as a matter of plain vanilla tax law that I’m certain no court will top it"). 4 The "plain vanilla" of the quote presumably is a reference to the rule of the Crane case, a decision that has probably been the subject of more exegeses than any other case in the tax law, yet continues to defy comprehension fifty-two years after its reporting. What did the judge in Owen do to excite such derision? The Judge committed the unpardonable heresy of failing to follow Crane wherever it lead, or, at least, of seeming to flout the Crane rationale, if not its actual holding, in excluding from the basis of property the cost of a post-acquisition improvement paid for only by the issue of a promissory note. However, it would be best to suspend ready acceptance of that criticism until taking a closer look at Crane.

The Crane case, confined in recent years mostly to classroom discussion and occasional reference in scholarly journals, seems destined to come out of its relative obscurity for renewed critical study. Owen is certainly one reason for this renewed interest. But the publicity accorded to an aggressive tax shelter that was marketed late in 1999 by a major accounting firm under the acronym ‘BOSS" (standing for the not-very-descriptive name "Bond & Option Sales Strategy"), which depend heavily on the imposition of a not very-very-encumbering encumbrance on property which taxpayers received from their special-purpose investment corporations and partnerships, has also raised interest. The shelter required basis recognition for the encumbrance to work, in the same way that the result in Crane depended on full recognition of a non-personally-obligating mortgage in determining the tax consequences of the sale transaction there.

As Crane made clear—if it made anything clear about the tax effect on a property owner of mortgages encumbering property without imposing personal liability on the property owner—the mortgage must be given effect one way or another in the tax calculations in order to arrive at a result that gives the fisc its due. I will say no more about the BOSS transaction here other than to note that the way its sponsor makes use of such indebtedness to arrive at a result that denies the fisc its due seems to stand Crane on its head, warranting a reexamination of that case as it bears on the BOSS arrangement, which the reader will find elsewhere. 5



At Long Last—The Final Section 467 Regulations
James R. Shorter, Jr.*

Almost fifteen years after enactment of section 467 of the Internal Revenue Code of 1986 (the ‘Code"), final 467 regulations were published in the Federal Register on May 18, 1999 (the "Final 467 Regulations" or the "final regulations"). 1 The final 467 Regulations generally are applicable to (1) "disqualified leasebacks and long term agreements" (referred to herein as "Disqualified Lease") entered into after June 3, 1996, and (2) rental agreements (other than Disqualified Leases) entered into after May 18, 1999. 2 Furthermore, for transactions entered into during the period beginning June 4, 1996 and ending May 18, 1999 (the "interim period"), the proposed regulations may be relied upon to determine if the lease is a Disqualified lease that is subject to constant rental accrual. 3

The Article begins with a summary of significant changes and general concepts under the final 467 regulations. Important terms are defined including fixed and contingent rent, and determining the lease term and conventions used for computations. Accrual of fixed rent, accrual of contingent rent, section 467 loans and modification of a rental agreement are discussed at length. The article concludes with a discussion of miscellaneous issues including section 467 recapture, prevention of omission or duplication of items of income deduction, gain, or loss, and the special transition rule relating to certain types of property financed by tax-exempt bonds.



The Effectiveness and Constitutionality of State Tax Incentive Policies for Locating Businesses: A Simple Game Theoretic Analysis
James R. Rogers*

By just about any measure, tax incentive programs to attract businesses are popular state economic development policies. Meyer and Hassig report that forty-seven of forty-eight states they surveyed adopted at least one tax incentive for locating businesses between 1991 and 1993. 1 In 1994 and 1995, at least thirty-three states enacted additional location incentive programs or expanded existing programs. 2 The popularity of these policies, however, is initially puzzling because they have been "one significant factor behind the shrinkage of business taxes from one-half of state tax revenues in the 1950s to only a quarter by 1990." 3

Why do states enact incentive programs in spite of their adverse fiscal impact? The answer to this puzzle, as is now well known, is found in the incentive structure that states face when competing with each other for a tax base. Namely, states face an incentive structure akin to the so-called ‘prisoners dilemma," in which individually rational behavior is nonetheless collectively irrational. 4 Because of this pathological incentive structure, state authorities cannot and will not end incentive policies on their own. In order to end tax competition, states must have the help of an outside enforcement mechanism, such as courts. There are two doctrinal routes that constitutional attacks on state tax incentives might take. The first and most discussed doctrinal possibility is use of the dormant Commerce Clause. 5 The second, less-considered, doctrinal possibility is use of the Equal Protection Clause.

This Article develops a simple game theoretic model of interstate political economy to consider these doctrinal alternatives. It concludes that the dormant Commerce Clause does not offer a viable route of attack on state incentives, but that surprisingly, the Equal Protection Clause does. The "policy ineffectiveness" result of the model— that state tax incentive programs do not affect the geographical distribution of businesses— combined with recent Supreme Court decisions on the matter imply that the programs do not violate the dormant Commerce Clause. Nonetheless, while the model implies that the interstate implications of state tax competition do not raise constitutional problems under the Commerce Clause, the same cannot be said for the intrastate implications of these programs under the Equal Protection Clause. While it might be conceded that (as shown below) state incentive programs create tax classifications that discriminate against intrastate capital, it is not difficult to understand why an Equal Protection attack on the programs has been largely ignored in the legal literature. After all, it is well known that the mere demonstration of tax discrimination ordinarily triggers no serious constitutional questions under the Equal Protection Clause, because courts accord tax classifications highly deferential scrutiny under the clause. 6 The analysis developed below, however, demonstrates that because of the perverse incentive structure that states have to enact tax incentive programs for mobile businesses, state political processes cannot ordinarily be expected to remedy the problem. Thus, although the classifications concern an economic subject matter, their enactment results from a restricted political process that triggers heightened judicial scrutiny under the process rationale articulated in the footnote four of United States v. Carolene Products Co. 7 and in other constitutional areas. 8 The existence of a suspect legislative incentive structure thus reverses the presumption of constitutionality that courts ordinarily accord tax classifications, with the implications that courts would reject the constitutionality of many state incentive programs.



Using Selected Tax Principles To Determine Oppressive Conduct In Minority Shareholder Suits
Sandra K. Miller*

Minority shareholder disputes continue to plague owners of the privately-owned corporation. 1 The exclusion from a role in management, the improper use of corporate assets, the taking of unreasonable compensation, and the accumulation of unreasonable amounts of earnings without payment of dividends are typical of the minority shareholder. 2 In such circumstances, many states provide the remedy of involuntary corporate dissolution ore shareholder buy-out on the grounds of illegal, fraudulent, or oppressive conduct. 3 In addition, a growing number of states have recognized a direct action for a breach of fiduciary duty among shareholders of the private company. 4

Conduct characterized as a breach of fiduciary duty, or as an "illegal," "fraudulent," or :oppressive" action justifying corporate dissolution, is frequently the same type of behavior that results in income tax deficiencies. 5 Strategies to usurp corporate profits from one’s business associates frequently lead to significant adjustments by the Service as well. Complaints of underreporting income, 6 the payment of excessive salary to specified shareholder-employees, 7 the failure to declare dividends, 8 the failure to keep proper books and records, 9 and the personal use of exploitation of corporate assets are echoed in case after case involving shareholder disputes. 10 Although in an abstract discussion it appears obvious that such ssues are also the focal point of considerable tax litigation, in practice, a corporate lawyer may well overlook quite significant tax issues presented by the facts while focusing on the underlying shareholder dispute that leads the client to his or her door.

This article highlights the recent cases in which the plaintiff’s allegations of breach of fiduciary duty or "illegal" or "oppressive" conduct justifying corporate dissolution involve claims that the defendant has underreported income, failed to comply with payroll tax rules, or has otherwise engaged in conduct which causes or could cause a substantial tax penalty. The Article also reviews the recent cases in which majority owners have sued minority shareholders for a breach of fiduciary duty where the minority shareholders have engaged in conduct or have threatened to engage in conduct which places the company in a position of violating tax rules and/or incurring tax deficiencies. 11

Conversely, the Article suggests that objective standards developed under tax law may be useful in tax-sensitive oppression cases by providing judicial guidelines for determining when conduct breaches fiduciary duties. Objective standards of reasonableness for developing compensation and dividend policies have been well-developed under tax law, and could be creatively adapted for use as guidelines in the determination of whether a shareholder’s conduct in "oppressive." Indeed, the objective standards developed under tax law on reasonable compensation, dividend levels, and arm’s-length pricing provide far more certainty and guidance to the business community than the vague judicial tests currently employed for determining "oppressive" conduct, which rest on fairness in the circumstances and/or on the minority’s reasonable expectations

Both the fiduciary duty cases and dissolution controversies underscore the need for proactive business and tax planning to secure by contract the minority’s agreement to comport with the tax compliance objectives established by the majority. 12 Both lines of cases illustrate the value of developing exit or buy-out provisions and arbitration provisions for private companies with minority shareholders. 13

In light of the tax-sensitive oppression cases reviewed, the Article urges practitioners to encourage clients to adopt sound systems for bookkeeping as well as internal controls, and to document the business reasons for salary and dividend levels. Majority owners of private companies may become vulnerable to attack by the minority shareholders and the Service when internal controls are lacking, record keeping is sloppy, and salary and dividend policies are unsupported by documentation establishing the business reasons for such purposes. 14 Documentation of sound business purposes for compensation and dividend purposes, and for pricing regarding transactions between the corporation and the shareholder, may prove helpful not only in a controversy before the Service, but also in a civil dispute between majority and minority shareholders of a private company. 15

Finally, the Article suggests that as a policy matter, dissolution statutes themselves could be improved by identifying the factors that are indicative of oppressive conduct, such as the payment of excessive compensation, failure to pay dividends, unreasonable accumulation of earnings, underreporting of income, misuse of corporate assets, and lack of arm’s-length pricing. The statutes could borrow language from a rich body of well-developed objective standards developed under tax case law and regulations to establish criteria for determining reasonable compensation, reasonable dividend levels, appropriate record-keeping requirements, and arm’s-length pricing for the use of property or the provision of services by related parties. 16



Ebbs and Tides and Water Rise—What’s The Real Concern with MDPs?
Laurie Hatten-Boyd*

I. Introduction

Attorneys in this country are confronted with a potential sea change in the types of services they provide to clients and the ways in which they provide them. The practice of law is increasingly multidimensional and is shaped, forcefully, by client demands. Further, to an unprecedented degree, attorneys are faced with direct competition from non-attorneys— e.g., accountants and financial planners.

The issue affects the delivery of legal services, and the integrity and quality of those services. The affected parties are not only attorneys but also their clients and the non-attorneys who are presently engaged in activities which traditionally have been considered the practice of law. The resolution of the problem will affect these three categories of persons in a variety of ways and will result in a lasting change in the manner in which law is practiced in this country. To date, attorneys have been slow to recognize the problem and are now in the process of determining whether to accede to the change or attempt to derail it by turning back the clock.

This Article examines whether the American Bar Association (ABA) should relax its current ethical rules to permit multidisciplinary practices (MDPs) in the United States. To that end, Parts I and II address the current debates over ethical rules and the significance of those rules in both law and accounting, tracing the evolution of their existence. Part III outlines the specific ethical rules that are affected by MDPs and contrasts them with similar provisions that govern accountants. Part IV suggests that there is adequate reason to, at a minimum, revisit the concept of amending the Professional Rules of Conduct to permit MDPs. Part V contains the Commission on Multidisciplinary Practice’s models, eventual proposal, and comments. Finally, Part VI proposes that the ABA should phase in the MDP concept, thereby permitting the client to seek legal and non-legal advice from the same firm while ensuring that the bar retains the requisite control to protect all parties involved.



Published by
Section of Taxation, American Bar Association
With the Assistance of
Georgetown University Law Center


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