Dover Corporation v. Commissioner Allows Tax Planning Opportunities
for the Sale of a Foreign Subsidiary
By Mary F. Voce and
Seth J. Entin, Greenberg
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On May 5, 2004, the U.S. Tax Court released its decision in Dover
Corporation v. Commissioner, 122 T.C. No. 19. The Tax Court held that
if a “check the box” election is made for a wholly owned foreign subsidiary
immediately prior to the sale of its stock, the sale will be considered
to be a sale of the foreign subsidiary’s assets rather than a sale of its
stock. If properly structured, this treatment permits U.S. shareholders
of the selling entity to defer U.S. taxation on the gain, which otherwise
may be currently taxable.
|"The Tax Court’s decision allows
U.S. taxpayers, with careful planning and structuring, to avoid
Subpart F 'deemed dividends' where a CFC sells the stock of its
wholly owned foreign subsidiary."
Dover addresses the impact of the U.S. “controlled foreign corporation”
(“CFC”) regime on the sale of the stock of a wholly owned foreign subsidiary.
Generally, U.S. shareholders of a foreign corporation are not taxed on the
foreign corporation’s income until it is “repatriated” back to the United
States (such as through a dividend distribution, a liquidation or an investment
in U.S. property). An important exception to this rule exists where the
foreign corporation is a CFC, and the CFC earns what is known as “Subpart
F income.” A CFC is a foreign corporation that is more than 50% owned by
a limited number of U.S. shareholders. Subpart F income includes certain
passive income and certain income from related party transactions. Generally,
the sale by a CFC of the stock of a subsidiary is considered passive income
and, thus, Subpart F income. Subpart F income is currently taxable as a
“deemed dividend” to those U.S. shareholders who own 10% or more of the
stock of the CFC.
The Dover case involved a Delaware corporation (“U.S. Parent”)
that owned a U.K holding company (“U.K. Holdco”). U.K. Holdco was a CFC.
U.K. Holdco owned 100% of a U.K. subsidiary (“U.K. Sub”). U.K. Holdco sold
the stock of U.K. Sub to a German acquirer. If U.K. Holdco’s sale of U.K.
Sub were treated as a stock sale for U.S. tax purposes, it would have given
rise to “Subpart F” income, resulting in a large “deemed dividend” to U.S.
In order to avoid a Subpart F “deemed dividend,” the following strategy
was employed: An election was filed for U.K. Sub to be treated as a “disregarded
entity” for U.S. tax purposes. (This election is often referred to as a
“check the box” election.) The check the box election caused U.K. Sub to
be deemed liquidated for U.S. tax purposes (which liquidation qualified
as tax free because the subsidiary was wholly owned), with U.K. Holdco thereafter
being treated as directly owning U.K. Sub’s assets. (What is particularly
interesting is that the check the box election in Dover was filed
some time after the transaction already took place, to be effective retroactively
to prior to closing.)
U.S. Parent took the position that since U.K. Sub “checked the box,”
U.K. Holdco was deemed for U.S. tax purposes to sell assets rather than
stock (for local law purposes, the sale would still be treated as a sale
of stock). Under the CFC regime, the sale of assets “used or held for use
in a trade or business” does not give rise to Subpart F income. Therefore,
U.S. Parent took the position that it did not recognize a “deemed dividend”
under the CFC rules as a result of the sale.
The IRS challenged this position on various technical grounds. The case
was heard by the Tax Court, which ruled last week in favor of U.S. Parent.
The Tax Court held that the trade or business status of U.K. Sub’s assets
carried over to U.K. Holdco and thus the sale did not give rise to Subpart
The Tax Court’s decision allows U.S. taxpayers, with careful planning
and structuring, to avoid Subpart F “deemed dividends” where a CFC sells
the stock of its wholly owned foreign subsidiary. Sales of stock of a majority
owned foreign subsidiary may, under certain circumstances, also benefit
from the results of Dover (although the deemed liquidation of a majority
owned subsidiary which results from the check the box election may itself
be partially or fully taxable).
© 2004 Greenberg Traurig
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