Rodriguez v. Commissioner , 722 F.3d 306 ( 2013 )

Case: 12-60533 Document: 00512297517 Page: 1 Date Filed: 07/05/2013
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
July 5, 2013
No. 12-60533 Lyle W. Cayce
Clerk
OSVALDO RODRIGUEZ; ANA M. RODRIGUEZ,
Petitioners–Appellants,
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent–Appellee.
Appeal from the Decison
of the United States Tax Court
Before DeMOSS, DENNIS, and PRADO, Circuit Judges.
PRADO, Circuit Judge:
Osvaldo Rodriguez and Ana M. Rodriguez (“Appellants”) challenge a
determination of tax deficiency made by the IRS. The IRS determined that, for
2003 and 2004, the gross income Appellants reported based on their ownership
of a controlled foreign corporation should have been taxed at the rate of
Appellants’ ordinary income rather than the lower tax rate Appellants had
claimed. Appellants challenged the IRS’s determination before the Tax Court
and lost. This appeal followed. For the reasons that follow, we affirm the Tax
Court’s determination.
Case: 12-60533 Document: 00512297517 Page: 2 Date Filed: 07/05/2013
No. 12-60533
I
Appellants are Mexican citizens and permanent residents of the United
States who, during the relevant time periods, owned all of the stock of Editora
Paso del Norte, S.A. de C.V. (“Editora”), a company that is incorporated in
Mexico. Editora has a branch in the United States called Editora Paso del
Norte, S.A. de C.V., Inc. Editora is a controlled foreign corporation (“CFC”).
On October 15, 2005, Appellants amended their 2003 tax return to include
an additional $1,585,527 of gross income attributable to their ownership of
Editora’s shares. At the same time, Appellants also filed their 2004 tax returns,
in which they included $1,478,202 in gross income attributable to Editora. They
reported both amounts as qualified dividend income, which was taxed at a rate
of 15%, rather than the 35% at which their other income was taxed. On March
20, 2008, the IRS issued a notice of deficiency to Appellants. The notice
indicated that Appellants’ income tax payments for 2003 and 2004 were deficient
in the amounts of $316,950 and $295,530, respectively, based on the IRS’s
determination that Appellants’ Editora-attributable income should have been
taxed as ordinary income rather than as qualified dividend income.
Appellants challenged the deficiency, and the case was submitted to the
Tax Court on a fully stipulated record.1 The only issue for the Tax Court was
one of statutory interpretation: whether Appellants’ income attributable to
Editora constituted qualified dividend income subject to a lower tax rate than
Appellants’ ordinary income. The Tax Court ruled in favor of the IRS. After
unsuccessfully seeking a revision of the Tax Court’s determination, Appellants
filed this appeal.
1
The parties do not dispute the amounts of Editora-attributable income or the amount
owed if the income is taxed as ordinary income. The parties also do not dispute that Editora
qualifies as a controlled foreign corporation.
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II
As this is a direct appeal from a final decision of the Tax Court, we have
jurisdiction pursuant to 26 U.S.C. § 7482(a)(1). In reviewing Tax Court
decisions, we apply the same standard as applied to district court
determinations. Terrell v. Comm’r, 625 F.3d 254, 258 (5th Cir. 2010). Since this
case presents a purely legal issue of statutory interpretation, we review the Tax
Court’s decision de novo. Id.
III
A
The issue in this case is whether amounts included in Appellants’ gross
income for 2003 and 2004 pursuant to 26 U.S.C. §§ 951(a)(1)(B) and 956
(collectively, “§ 951 inclusions”) constitute qualified dividend income under
26 U.S.C. § 1(h)(11). The § 951 inclusions would be subject to a lower tax rate
if they constitute qualified dividend income. Ordinary income is taxed at a
higher rate.
Sections 951 and 956 are provisions of the tax code intended to limit the
deferral of taxes that would otherwise be owed to the United States. See Elec.
Arts, Inc. v. Comm’r, 118 T.C. 226, 272 (2002). These sections require that CFC
shareholders include CFC-owned United States property as part of the
shareholder’s gross income. 26 U.S.C. §§ 951(a)(1), 956(a). Tax deferrals are
thus minimized because CFC shareholders lose the ability to defer United States
tax obligations by keeping the CFC’s earnings abroad or by investing in property
instead of repatriating income through the payment of dividends.2
2
“[I]ncome earned by a CFC . . . generally is subject to U.S. tax when the income is
repatriated, for example as a dividend or a royalty. If the CFC invested the income in the
United States, for example, by the purchase of property or a loan to the parent corporation,
the income would be effectively repatriated in a manner that would escape current tax. Thus,
generally, in the case of certain investments in U.S. property by a CFC, the U.S. shareholder
must include in income an amount calculated by reference to the amount invested in the U.S.
property.” OFFICE OF TAX POLICY, DEP’T OF THE TREASURY, THE DEFERRAL OF INCOME EARNED
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Section 951(a)(1)(B) requires that United States shareholders of CFCs
“shall include in [their] gross income . . . the amount determined under section
956 with respect to such shareholder for such year . . . .” 26 U.S.C.
§ 951(a)(1)(B). Section 956 describes how to determine a shareholder’s pro rata
share of United States property held by the CFC for inclusion as gross income.
Id. § 956(a). The parties do not dispute the amount calculated pursuant to § 956.
Their only dispute is whether the amount determined by § 956 and included as
income pursuant to § 951 constitutes “qualified dividend income” under
§ 1(h)(11). Section 1(h)(11)(B)(i)(II) defines qualified dividend income as
including “dividends received during the taxable year from . . . qualified foreign
corporations.” Id. § 1(h)(11)(B)(i)(II). A dividend is “any distribution of property
made by a corporation to its shareholders” out of its earnings and profits. Id.
§ 316(a).
There are also instances where a statute specifically states that certain
income is to be treated as if it were a dividend. See infra Part III.C. These
“deemed dividend” provisions operate by legislative fiat. Appellants argue that
their § 951 inclusions constitute either actual dividends or deemed dividends.
As explained below, Appellants’ § 951 inclusions do not qualify as either.
B
Section 951 inclusions do not constitute actual dividends because actual
dividends require a distribution by a corporation and receipt by the shareholder;
there must be a change in ownership of something of value. Since these § 951
inclusions involve no distribution or change in ownership, they do not constitute
qualified dividend income.
Section 316(a) defines a dividend as “any distribution of property made by
a corporation to its shareholders . . . .” 26 U.S.C. § 316(a) (emphasis added). In
THROUGH U.S. CONTROLLED FOREIGN CORPORATIONS: A POLICY STUDY xv (Dec. 2000),
http://www.treasury.gov/resource-center/tax-policy/Documents/subpartf.pdf.
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the same vein, § 1(h)(11)(B)(i) defines “qualified dividend income” as “dividends
received during the taxable year . . . .” 26 U.S.C. § 1(h)(11)(B)(i) (emphasis
added). These statutory provisions illustrate what case law explicitly states: in
determining when a dividend has issued, “[t]he question is not whether a
shareholder ends up with ‘more’ but whether the change in the form of his
ownership represents a transfer to him, by the corporation.” Comm’r v. Gordon,
391 U.S. 83, 91 n.5 (1968) (emphasis added); see also Jack’s Maint. Contractors,
Inc. v. Comm’r, 703 F.2d 154, 156 (5th Cir. 1983) (“[A]ll that is necessary [for a
dividend] is that the corporation confer an economic benefit on a shareholder
without expectation of repayment and that the primary advantage of the
transaction be to the shareholder’s personal interests rather than to the
corporation’s business interests.” (emphasis added)).
Section 951 inclusions do not qualify as actual dividends because no
transfer occurs. Indeed, these statutory provisions exist specifically to account
for instances where CFCs do not make transfers of value to shareholders. Under
the statutes at issue here, ownership of the CFC’s property does not change. On
this basis alone, § 951 inclusions do not constitute actual dividends. Section 951
inclusions are calculated purely on the basis of CFC-owned United States
property and the CFC’s earnings, without any change of ownership. 26 U.S.C.
§ 956(a). Shareholders are required to count the CFC’s earnings and property
as part of their own gross income to ensure that they cannot defer United States
tax obligations by keeping earnings abroad or investing in property instead of
repatriating income through the payment of dividends. Section 956(a) makes
clear that § 951 inclusions involve no transfer of ownership and no distribution
to shareholders. Section 951 inclusions are calculated solely on the basis of
property owned by the CFC. They thus do not constitute actual dividends.
It is also worth noting that, in the context of this case, Appellants—as
Editora’s sole shareholders—could have caused a dividend to issue. Had they
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done so, the income at issue would have unquestionably qualified as dividend
income subject to a lower tax rate, a point the IRS concedes. Appellants use this
point to decry the outcome reached here. They urge the Court to avoid the
“absurd, harsh, and unjust result” of taxing Appellants’ § 951 inclusions at a
higher rate than qualified dividend income, when Appellants, as Editora’s sole
shareholders, could have easily caused a dividend to issue, thereby avoiding this
issue altogether.
This argument is unavailing. Appellants could have caused a dividend to
issue. They could have also paid themselves a salary or invested Editora’s
earnings elsewhere. Each of these decisions would have carried different tax
implications, thereby altering our analysis. Appellants cannot now avoid their
tax obligation simply because they regret the specific decision they made.3
C
In the alternative, Appellants claim that their § 951 inclusions should be
deemed dividends. This argument is unpersuasive, however, because, when
Congress decides to treat certain inclusions as dividends, it explicitly states as
much, and Congress has not so designated the inclusions at issue here. See, e.g.,
26 U.S.C. § 851(b) (“For purposes of paragraph (2), there shall be treated as
dividends amounts included in gross income under section 951(a)(1)(A)(i) . . . for
the taxable year to the extent that . . . there is a distribution out of the earnings
and profits of the taxable year . . . .”) (emphasis added); 26 U.S.C. § 904(d)(3)(G)
3
Appellants also attempt to avoid the outcome reached here by cursorily claiming that
the tax law giving rise to beneficial treatment of dividend income came into effect after some
of the decisions at issue had been made. That is, they make a brief attempt at contesting
§ 1(h)(11)’s retroactivity. However, aside from providing no substantive argument on point,
their claim is unpersuasive. The Supreme Court has generally upheld tax laws with
retroactive effect, going so far as to describe such laws as “customary congressional practice”
that is often required by “the practicalities of producing national legislation.” United States
v. Darusmont, 449 U.S. 292, 296–97 (1981); see also United States v. Carlton, 512 U.S. 26,
32–35 (1994); United States v. Hemme, 476 U.S. 558, 568–71 (1986); Welch v. Henry, 305 U.S.
134, 150–51 (1938); Milliken v. United States, 283 U.S. 15, 23–24 (1931).
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(“For purposes of this paragraph, the term ‘dividend’ includes any amount
included in gross income in section 951(a)(1)(B).”) (emphasis added); 26 U.S.C.
§ 959(a)(1) (“For purposes of this chapter, the earnings and profits of a foreign
corporation attributable to amounts which are, or have been, included in the
gross income of a United States shareholder under section 951(a) shall not [be
included as gross income] when such amounts are distributed to . . . such
shareholder . . . .”) (emphasis added); 26 U.S.C. § 960(a)(1) (“For purposes of
subpart A of this part, if there is included under section 951(a) in the gross
income of a domestic corporation any amount attributable to earnings and
profits of a foreign corporation . . . then, except to the extent provided in
regulations, section 902 shall be applied as if the amount so included were a
dividend paid by such foreign corporation . . . .”) (emphasis added). Moreover,
if all § 951 inclusions constituted qualified dividends, then statutory provisions
specifically designating certain inclusions as dividends would amount to
surplusage. Cf. Freeman v. Quicken Loans, Inc., 132 S. Ct. 2034, 2042–43 (2012)
(statutory interpretations that avoid surplusage are favored); Microsoft Corp. v.
i4i Ltd. P’ship, 131 S. Ct. 2238, 2248–49 (2011) (same).
Relatedly, the original version of § 956 specifically stated that Congress
did not intend amounts calculated thereunder to constitute dividends. Under
the original language of § 956, enacted in 1962, CFC earnings invested in United
States property “[are] the aggregate amount of such property held, directly or
indirectly, by the [CFC] . . . to the extent such amount would have constituted a
dividend . . . if it had been distributed.” Revenue Act of 1962, Pub. L. No. 87-834,
Sec. 12, § 956, 76 Stat. 960, 1015–16 (emphasis added). This language was
removed only in 1993 when the entire subpart was rewritten in light of other,
new regulations. Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-
66, Sec. 13232, § 956, 107 Stat. 312, 501. It does not appear that the omission
of this language from the new version of the statute was intended to change the
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treatment of amounts calculated under § 956. As these examples demonstrate,
Congress specifically designates when § 951 inclusions are to be treated as
dividends, and Congress has not so stated here.
Appellants’ reliance on various non-binding secondary sources does not
alter our analysis here because the sources cited are in each instance either non-
binding or inapposite. In the historical sources cited by Appellants, references
to a conceptual equivalence between § 951 inclusions and dividend income do not
carry the weight Appellants attribute because such comments were made at a
time when there was no tax advantage to classifying CFC-owned property as a
dividend; the distinction was treated loosely at the time because it did not carry
tax implications. Section 1(h)(11), the statute creating the tax disparity between
dividend income and ordinary income, was not enacted until 2003. See Jobs and
Growth Tax Relief Reconciliation Act of 2003, Pub. L. No. 108-27, Sec. 302, 117
Stat. 752, 760 (enacting § 1(h)(11)).
For the reasons discussed above, it is clear that Congress did not intend
to deem as dividends the § 951 inclusions at issue here. The statute is
completely silent, a fact which carries added weight when compared to the
myriad provisions specifically stating that certain income is to be treated as if
it were a dividend. Appellants’ reliance on other non-binding sources is
unavailing. As such, we affirm the Tax Court.
IV
For the foregoing reasons, the judgment of the Tax Court is AFFIRMED.
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