The Right Regulation

Paraphrasing a well-known principle current in the select and elegant seminary for young ladies, among whose alumnæ and attendees are the daughter of Donald Trump and the daughters of Lewis C. Taishoff, before true income comes the Section 482 Regulations.

But Judge Laro leaves us wanting more, in Guidant LLC f.k.a. Guidant Corporation, and Subsidiaries, et al., 146 T. C. 5, filed 2/29/16.

There’s a bushelbasketful of et als, as Judge Laro leads us through a chain that reads like a cruise line brochure. “Guidant Corp.’s first-, second-, and third-tier foreign subsidiaries included two Netherlands corporations, Guidant BV (renamed Guidant Group BV in 2003) and Guidant Puerto Rico BV, and one Luxembourg corporation, Guidant Luxembourg SARL. Guidant Puerto Rico BV and Guidant Luxembourg SARL were subsidiaries of Guidant BV.” 146 T. C. 5, at p. 8. Oh, of course there were some Irish corporations in on the tackle.

And Guidant, health equipment manufacturer, swapped tangible and intangible personal property around, and provided services, with abandon, reporting all on a consolidated return.

IRS descends with Section 482 and a transfer pricing bouillabaisse featuring $3.5 billion in deficiencies.

 “Respondent considered whether the transfer of intangible property, the sale of components and finished goods, and the provision of services with respect to certain products (collectively, transactions at issue) were made at arm’s length.” 146 T. C. 5, at p. 15.

Holy Altera, Batman, what else is new?

But we have a consolidated return, right? So do we start with STI or CTI?

Well, usually Separate Taxable Income and work from the bottom up. But IRS claims the info Guidant supplied wasn’t sufficient to do that, so IRS went with Consolidated Taxable Income and re-routed the numbers as aforesaid.

Guidant wants summary J, and I like the tactic, as I’ve said before.

Not today. Guidant claims not doing separate STIs for each entity is an abuse of discretion as a matter of law.

“Nothing in the text of section 482 requires respondent to make member-specific adjustments to reflect income clearly. Petitioners do not dispute that the statute does not specifically set forth a member-specific adjustment requirement but argue that such a requirement is found in the regulations interpreting the statute, specifically, in section 1.482-1(f)(1)(iv), Income Tax Regs.” 146 T. C. 5, at pp. 25-26.

 But all the Reg does is require IRS to determine both STI and CTI consistently with consolidated principles. “The plain language of the regulation thus clearly mandates that both CTI and STI be determined, but the regulation does not specifically require that the Commissioner determine STI contemporaneously with his making of a section 482 adjustment.” 146 T. C. 5, at p. 27.

Judge Laro waxes eloquent. “Four score and three years ago, the U.S. Supreme Court stated in the setting of two corporations desiring to file a consolidated return that ‘[t]he requirement of consolidated returns was “based upon the principle of levying the tax according to the true net income and invested capital of a single business enterprise, even though the business is operated through more than one corporation.’” Atl. City Elec. Co. v. Commissioner, 288 U.S. 152, 154 (1933) (quoting Regs. 45, art. 631). The Supreme Court’s statement parallels a statement that the Senate Finance Committee memorialized in its report on (and issued contemporaneously with) the birth of the consolidated return regime. See S. Rept. No. 65-617, (1918), 1939-1 C.B. (Part 2) 123 (stating that the consolidated return regime was adopted with an understanding that the ‘principle of taxing as a business unit what in reality is a business unit is sound and equitable and convenient both to the taxpayer and to the Government’). The legislative history and the Supreme Court statement reveal that the primary principle underlying the consolidated return regime is a taxing of the true net income of the consolidated group as a whole.” 146 T. C. 5, at pp. 28-29.

Here’s the takeaway.

 “Consistent with the IRS practice on this matter, section 1.482-1(f)(1)(iv), Income Tax Regs., does not preclude the Commissioner from deferring making the ‘true’ STI determination for each member until the time when such a determination is actually required. Of course when that time comes, e.g., when a determination of STI is needed to process setoffs under section 482, see, e.g., sec. 1.482-1(g)(4)(i), Income Tax Regs., or to process separate return limitation year items such as net operating losses, see sec. 1.1502-21, Income Tax Regs., the regulation requires that a member’s STI must be determined consistently with the goal of taxing the consolidated group on its true CTI.” 146 T. C. 5, at p. 31.

Here’s the excuse. “Petitioners allege that they maintained all the necessary information and records to make the STI determinations, but it would be too costly or otherwise difficult for respondent to extract that information at the time of the audit from petitioners’ accounting databases. Whether respondent’s decision to delay the STI computations constitutes abuse of discretion under these circumstances is thus still in dispute and remains to be determined on the full record of the case as developed at trial.” 146 T. C. 5, at pp. 33-34.

Note the Court didn’t decide IRS wasn’t arbitrary, capricious or unreasonable; nor did the Court find any facts. All the Court found was that IRS wasn’t arbitrary, etc., as a matter of law.

Guidant claims IRS mixed services with tangible property with intangible property, and that goes a bridge too far despite the Regulations’ broad sweep.

No, again that’s a question of fact.

Let’s have a trial.

Wanna bet this settles?