SIH Partners LLLP v. Commissioner of Internal Revenue, No. 18-1862 (3d Cir. 2019)Annotate this Case
A Controlled Foreign Corporation’s income is not taxable to its domestic shareholders unless the income is distributed to them. CFC shareholders began taking loans either from the CFC or from third-party financial institutions using the CFC’s assets as collateral or having the CFC guarantee the loans to obtain a monetary return on their foreign investment. The Revenue Act of 1962 requires the inclusion in the domestic shareholder’s annual income of any increase in investment in U.S. properties made by a CFC it controls, 26 U.S.C. 956(c)(1)(C), and provides that a CFC shall be considered as holding an obligation of a U.S. person if such CFC is a pledgor or guarantor of such obligations. IRS regulations determine when a CFC’s pledge or guarantee results in the CFC being deemed the holder of the loan, and how much of the “obligation” a CFC pledgor or guarantor is deemed to hold, 26 C.F.R. 1.956-2(c)(1) and 1.956-1(e)(2). Through the SIH family, Appellant owns two CFCs. Another SIH affiliate, SIG, borrowed $1.5 billion from Merrill Lynch in 2007 in a loan guaranteed by over 30 SIH affiliates, including the CFCs that Appellant owns. Although the loan dwarfed the CFCs’ assets (roughly $240 million), Merrill Lynch insisted on having the CFCs guarantee. In 2011, when the CFCs distributed earnings to Appellant, their domestic shareholder, the IRS determined that Appellant should have reported the income at the time the CFCs guaranteed the SIG loan, treating each CFC as if it had made the entire loan directly, though the amount included in Appellant’s income was reduced from the $1.5 billion principal of the loan to the CFCs’ combined “applicable earnings.” This resulted in an additional tax of $378,312,576 to Appellant. The IRS applied the then-applicable 35% rate for ordinary income. The Tax Court and Third Circuit ruled in favor of the IRS, rejecting Appellant’s challenges to the validity of the regulations and the use of the ordinary income tax rate.