Friday, June 3, 2011

Is Congress Poised to Undo Container Corp.?

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With August recess and the campaign season looming, Senate Democrats and Republicans are hurriedly attempting to negotiate final amendments to advance the Small Business Jobs Act (H.R. 5297; S. Amdt. 4519). For international tax professionals, the bill likely will not raise an eyebrow but for one provision: Section 2122 would amend Code §861 to characterize loan guarantee fees paid to foreign persons as U.S.-source income, if paid by a non-corporate U.S. resident, a U.S. corporation, or a foreign person (if the fee is effectively connected with a U.S. trade or business conducted by such person). Consequently, these fees would be treated just like outbound payments of interest and thereby subject to U.S. withholding tax.         

Indeed, the provision — aptly placed under Part III—Closing Unintended Loopholes of the bill — is meant to “correct” the U.S. Tax Court’s recent holding in Container Corp. v. Comr., 134 T.C. No.5 (2010), that loan guarantee fees paid by a U.S. subsidiary to its Mexican parent company were not subject to 30% withholding, because the fees were more analogous to a payments for services and, therefore, are sourced as foreign income. 

Since there are no rules for sourcing cross-border loan guarantee fees, the issue of how to characterize loan guarantee fees under current law has long been unsettled. However, due to case law concerning related issues, the trend since the 1980s has been to treat these fees as U.S.-source interest payments (see Bank of America v. U.S., 680 F.2d 142 (Ct. Cl. 1982) (fees issued for letters of credit); Centel Communications Co. v. Comr., 920 F.2d 1335 (7th Cir. 1990) (shareholder warrants issued for loan guarantees)). As such, Container Corp. was not only the first case to directly address this issue, but the decision also bucked the prevailing trend. 

Congressional concern is centered on the potential for abuse that Container Corp. is likely to invite, whereby taxpayers could utilize the fact pattern presented therein to structure payments so as to avoid U.S. withholding. In fact, according to the Senate Finance Committee, the provision is valued at $2 billion over ten years — a significant amount of revenue even in a rosy budget environment. 

Nevertheless, as of this writing, it is questionable (and doubtful) whether the Senate will reach agreement to quickly move the bill before the summer recess. Moreover, even if Congress can pass the bill in time, the effective date of section 2122 is after the date of enactment of the Act. Thus, the window of opportunity cracked open by the Tax Court in Container Corp. may still remain open for transactions taken before that date. Of course, other courts are not required to apply the holding in Container Corp. and the case may be overturned on appeal. In any event, the guidance of the Tax Court is out. And, although Congress may be poised, sooner or later, to undo Container Corp., it is unlikely to represent the final word on loan guarantee fees. 

Tome Tanevski, U.S. International Tax Editor  

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