In A Review of BMC Software, Inc. v. Commissioner of Internal Revenue: Should Intercompany Accounts Receivable Be Considered “Debt”? Samuel S. Nicholls of Willamette Management Associates writes:
In the matter of BMC Software, Inc. (“BMC”) v. Commissioner, the U.S. Tax Court (the “Tax Court”) ruled on the definition of “debt” as it relates to intercompany indebtedness between a U.S. tax¬payer and its foreign subsidiary.
At issue in this decision was the BMC accounts receivable owed from its foreign subsidiary, BMC Software European Holding (BSEH). This accounts receivable was created as a result of a transfer pricing settlement between BMC and the Internal Revenue Service (the “Service”) in 2007.
The specific question in the BMC decision was whether or not this accounts receivable increased the company’s related-party indebtedness between October 3, 2004, and March 31, 2006 (the testing period). If it did, then the amount of money that BMC repatriated under the Internal Revenue Code Section 965 tax holiday would be reduced, and BMC would owe additional tax.
That is, if the intercompany accounts receivable were deemed to be debt, then BMC would have over-stated its dividends received deduction (“special dividend”) and it would have to retroactively pay the regular tax on the amount of the overstatement.
Related-party indebtedness was relevant in this decision, because Section 965 does not permit any increase in related-party indebtedness to be included in the amount of funds eligible for the special dividend.
The testing period is relevant because Congress provided that the amount of the Section 965 special dividend deduction would be reduced by any increase in related-party indebtedness during the “testing period.”
The Service took the position that (1) the establishment of the account receivable, resulting from a transfer pricing adjustment in 2007, constituted increased related-party indebtedness, (2) the related-party debt should be applied retroactively to the testing period, and (3) this amount should not be included in the special dividend. BMC disagreed and petitioned the Tax Court for relief.
The Tax Court filed its opinion on September 18, 2013, ruling in favor of the Service. In its opinion, the Tax Court concluded that some of the funds repatriated by BMC under Section 965 wereineligible for the special dividend. This is because those funds included an intercompany accounts receivable that the Tax Court considered to be a form of intercompany debt.
BMC subsequently filed an appeal with the U.S. Court of Appeals for the Fifth Circuit (the “Fifth Circuit”), and the case is currently pending review. The Fifth Circuit’s decision could have broad implications for intercompany transfer pricing issues.
Mr. Nichols is a senior associate with Willamette Management Associates and has performed the following types of valuation and economic analyses: merger and acquisition valuations, business and stock valuations, and fairness opinions.
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