SCOTUS Reports

Tag: BMC Software Inc. v. Commissioner

  • BMC Software Inc. v. Commissioner, 141 T.C. 224 (2013): Interpretation of Related Party Indebtedness Under I.R.C. § 965

    BMC Software Inc. v. Commissioner, 141 T. C. 224 (2013) (United States Tax Court, 2013)

    In BMC Software Inc. v. Commissioner, the U. S. Tax Court ruled that accounts receivable established under a closing agreement to adjust transfer pricing could be considered related party indebtedness under I. R. C. § 965. This decision impacted the eligibility of dividends for a one-time deduction, affirming that such accounts receivable did not need to be part of an intentionally abusive transaction to reduce the deduction amount. The ruling clarified the scope of related party indebtedness, affecting how multinational corporations handle repatriated dividends and transfer pricing adjustments.

    Parties

    BMC Software Inc. (Petitioner) and Commissioner of Internal Revenue (Respondent) were the parties involved in this case. BMC Software Inc. was the plaintiff at the trial level, and the Commissioner of Internal Revenue was the defendant. On appeal, BMC Software Inc. remained the petitioner, and the Commissioner of Internal Revenue remained the respondent.

    Facts

    BMC Software Inc. , a U. S. corporation, developed and licensed computer software and was the parent of a group of subsidiaries, including BMC Software European Holding (BSEH), a controlled foreign corporation (CFC). BMC Software Inc. and BSEH had cost-sharing agreements (CSAs) for software development, which were terminated in 2002, resulting in BMC Software Inc. paying royalties to BSEH for distribution rights. The IRS audited BMC Software Inc. ‘s royalty payments for the years 2002 through 2006 and determined they were not at arm’s length under I. R. C. § 482. Consequently, BMC Software Inc. and the IRS entered into a closing agreement in 2007, adjusting BMC Software Inc. ‘s income for those years and requiring secondary adjustments. BMC Software Inc. elected to establish accounts receivable from BSEH under Rev. Proc. 99-32 to avoid the tax consequences of deemed capital contributions. Separately, BMC Software Inc. repatriated $721 million from BSEH and claimed a one-time dividends received deduction under I. R. C. § 965. The IRS determined that the accounts receivable established during the testing period constituted increased related party indebtedness, reducing the eligible deduction amount by $43 million.

    Procedural History

    The IRS issued a deficiency notice to BMC Software Inc. for the tax year ending March 31, 2006, disallowing $43 million of the claimed dividends received deduction due to increased related party indebtedness. BMC Software Inc. filed a petition for redetermination with the United States Tax Court. The Tax Court reviewed the case de novo, examining the legal issues and the facts as presented.

    Issue(s)

    Whether accounts receivable established under a closing agreement pursuant to Rev. Proc. 99-32 constitute increased related party indebtedness for the purpose of reducing the dividends received deduction under I. R. C. § 965(b)(3)?

    Whether the related party debt rule under I. R. C. § 965(b)(3) applies only to increased indebtedness resulting from intentionally abusive transactions?

    Rule(s) of Law

    I. R. C. § 965 provides a one-time dividends received deduction for U. S. corporations repatriating dividends from controlled foreign corporations, subject to certain limitations, including a reduction for increased related party indebtedness under I. R. C. § 965(b)(3). The statute does not specify an intent requirement for the related party debt rule. Rev. Proc. 99-32 allows taxpayers to establish accounts receivable in lieu of deemed capital contributions following a primary adjustment under I. R. C. § 482, avoiding certain tax consequences.

    Holding

    The Tax Court held that accounts receivable established under Rev. Proc. 99-32 may constitute increased related party indebtedness for the purposes of I. R. C. § 965(b)(3). The court further held that the related party debt rule under I. R. C. § 965(b)(3) does not apply only to increased indebtedness resulting from intentionally abusive transactions.

    Reasoning

    The court’s reasoning focused on the statutory interpretation of I. R. C. § 965(b)(3). The court applied general principles of statutory construction, emphasizing the plain language of the statute, which defines increased related party indebtedness as the difference in indebtedness between the end of the testing period and October 3, 2004. The court found no intent requirement in the statutory text. The court also considered the legislative history and regulatory authority granted under the statute, concluding that the related party debt rule’s scope was not limited to abusive transactions. The court rejected BMC Software Inc. ‘s argument that the accounts receivable should be exempt as trade payables, as they were established post-audit and not in the ordinary course of business. The court’s analysis of the closing agreement under Rev. Proc. 99-32 determined that the accounts receivable were established for all federal income tax purposes during the testing period, thus qualifying as related party indebtedness. The court referenced prior case law, such as Schering Corp. v. Commissioner, to support its conclusion that the closing agreement did not preclude all federal income tax consequences but allowed BMC Software Inc. to avoid the consequences of a deemed capital contribution.

    Disposition

    The Tax Court sustained the IRS’s determination, ruling in favor of the Commissioner of Internal Revenue. The court’s decision affirmed the deficiency notice, reducing the dividends received deduction by $43 million due to increased related party indebtedness.

    Significance/Impact

    This case significantly clarifies the application of the related party debt rule under I. R. C. § 965, establishing that accounts receivable established pursuant to Rev. Proc. 99-32 can be considered related party indebtedness, even if not part of an intentionally abusive transaction. The ruling impacts multinational corporations’ strategies for repatriating dividends and managing transfer pricing adjustments, as it affects the eligibility for the one-time dividends received deduction. Subsequent courts have followed this interpretation, and the decision has influenced IRS guidance on the application of I. R. C. § 965. The case underscores the importance of understanding the full scope of federal income tax consequences when entering into closing agreements with the IRS.

  • BMC Software Inc. v. Commissioner, 141 T.C. No. 5 (2013): Application of Section 965 Dividends Received Deduction and Related Party Debt Rule

    BMC Software Inc. v. Commissioner, 141 T. C. No. 5 (2013)

    In a landmark decision, the U. S. Tax Court ruled on the application of the one-time dividends received deduction under Section 965, clarifying the scope of the related party debt rule. The court determined that accounts receivable established under a closing agreement could be considered as increased related party indebtedness, impacting the eligibility of dividends for the deduction. This ruling significantly influences how multinational corporations manage repatriation of foreign earnings and navigate transfer pricing adjustments.

    Parties

    BMC Software Inc. (Petitioner) v. Commissioner of Internal Revenue (Respondent). BMC Software Inc. is a U. S. corporation that develops and licenses computer software. The Commissioner of Internal Revenue is the head of the Internal Revenue Service, responsible for enforcing the federal tax laws.

    Facts

    BMC Software Inc. (BMC) and its controlled foreign corporation, BMC Software European Holding (BSEH), collaboratively developed software under cost-sharing agreements (CSAs). After terminating the CSAs, BMC agreed to pay royalties to BSEH and licensed the software for distribution. The IRS determined that the royalty payments were not at arm’s length under Section 482, leading to primary adjustments that increased BMC’s income. BMC elected to establish accounts receivable under Rev. Proc. 99-32 instead of treating the adjustments as deemed capital contributions. BMC had previously repatriated funds from BSEH and claimed a one-time dividends received deduction under Section 965. The IRS disallowed a portion of the deduction, citing increased related party indebtedness due to the accounts receivable established during the testing period.

    Procedural History

    The IRS determined a deficiency in BMC’s federal income tax due to its interpretation of Section 965. BMC filed a petition for redetermination with the U. S. Tax Court. The court had to decide whether accounts receivable established under Rev. Proc. 99-32 could constitute increased related party indebtedness under Section 965(b)(3). The standard of review was de novo, as the case involved questions of law and statutory interpretation.

    Issue(s)

    Whether accounts receivable established under Rev. Proc. 99-32 constitute increased related party indebtedness for purposes of the Section 965 dividends received deduction?

    Rule(s) of Law

    Section 965 allows a U. S. corporation to elect a one-time 85% deduction for certain cash dividends received from its CFC, subject to a reduction for increased related party indebtedness during the testing period. Section 965(b)(3) states that the amount of dividends eligible for the deduction is reduced by the excess of the CFC’s indebtedness to any related person at the close of the taxable year over the indebtedness at the close of October 3, 2004. Rev. Proc. 99-32 allows a taxpayer to establish accounts receivable without the federal income tax consequences of secondary adjustments that would otherwise result from primary adjustments under Section 482.

    Holding

    The Tax Court held that accounts receivable established under Rev. Proc. 99-32 constitute increased related party indebtedness under Section 965(b)(3), reducing the amount of dividends eligible for the one-time deduction. The court further held that the accounts receivable closing agreement allowed BMC to avoid the federal income tax consequences of deemed capital contributions but did not preclude the application of the related party debt rule.

    Reasoning

    The court’s reasoning focused on statutory interpretation, emphasizing that the plain language of Section 965(b)(3) did not include an intent requirement for increased related party indebtedness. The court rejected BMC’s argument that the related party debt rule applied only to intentionally abusive transactions, noting that Congress did not amend the operative language when adding a grant of regulatory authority to address such transactions. The court also held that the term “indebtedness” in Section 965(b)(3) should be interpreted according to general federal income tax principles, encompassing accounts receivable established under Rev. Proc. 99-32. The court distinguished the trade payable exception, ruling that the accounts receivable did not qualify as they were not established in the ordinary course of business or paid within the required timeframe. Finally, the court interpreted the accounts receivable closing agreement as establishing the accounts for all federal tax purposes during the testing period, thus qualifying them as increased related party indebtedness.

    Disposition

    The Tax Court sustained the Commissioner’s determination, reducing the amount of dividends eligible for the Section 965 deduction by the amount of increased related party indebtedness attributed to the accounts receivable established under the closing agreement.

    Significance/Impact

    This decision clarifies the scope of the related party debt rule under Section 965, impacting how multinational corporations structure their repatriation strategies and manage transfer pricing adjustments. The ruling emphasizes that accounts receivable established under Rev. Proc. 99-32 can be considered as increased related party indebtedness, potentially limiting the benefits of the one-time dividends received deduction. The decision also highlights the importance of carefully drafting closing agreements to avoid unintended tax consequences. Subsequent courts have followed this precedent, and it has influenced IRS guidance on the application of Section 965 and related party indebtedness.