Kostelanetz LLP Partner Caroline Rule was recently quoted in Bloomberg Tax after speaking with senior reporter Michael Rapoport regarding the Varian ruling, a hot-button issue in international tax compliance for corporations.
Varian Medical Systems Inc. v. Commissioner, 163 T.C. No. 4, was decided on August 26, 2024. Varian’s victory in that case now has other large companies evaluating whether they, like Varian, can benefit from a loophole created by the Tax Cuts and Jobs Act of 2017 (TCJA). This loophole arises from a mismatch between effective dates of the TCJA’s new Section 245A, which provides a deduction for domestic corporate parents receiving foreign source dividends from certain 10% owned foreign subsidiaries, and a corresponding amendment to Section 78, which limits that deduction. Before the TCJA, Section 78 provided that when a domestic corporation chooses to claim a foreign tax credit (FTC) for foreign taxes deemed paid under Section 960(a)(1) (pre-TCJA, Section 902(a)), it is deemed to have received an equal dividend from the foreign corporation. This is known as the “Section 78 gross-up.” Section 78 has, however, always included an exception providing that a domestic corporation does not receive the Section 78 gross-up with respect to the Section 245 dividends received deduction; otherwise the Section 245 deduction would in effect undo the Section 78 gross-up. The TCJA expanded this Section 78 exception to include new Section 245A. The loophole is that new Section 245A applies to distributions made after December 31, 2017, while the corresponding amendment to Section 78 is effective for “taxable years of foreign corporations beginning after December 31, 2017.” Varian was a fiscal year taxpayer whose first taxable year beginning after December 31, 2017 began on September 29, 2018. As a result, the Section 245A deduction was available for any Section 78 gross-up deemed received between January 1, 2018 and September 28, 2018.
The unanimous Varian ruling held that Treasury regulations that tried to eliminate the effective date mismatch could not override clear and unambiguous statutory language enacted by Congress. This holding is now prompting US corporations with stakes in foreign corporations that had fiscal years ending after December 31, 2017 to consider amending prior tax returns and adjusting open tax returns to account for the Varian decision.
Per Bloomberg, other large multinational corporations are already claiming partial wins based on this outcome, including Sysco Corp. in a case where the taxpayer and the IRS agreed that the Varian holding applied. Kyocera AVX is also citing the Varian ruling in its ongoing case. But corporations considering making use of the Varian ruling should be careful to weigh the benefits of the effective date mismatch against the Tax Court’s additional holding that Section 245A(d)(1) disallows FTCs for the foreign taxes attributable to the Section 78 gross-up. Tax controversy attorney and Kostelanetz partner Caroline Rule was quoted in the article, “That is going to be so dependent on the facts of each case. It could become a very complicated matter.”
You can read the article in full here.
Partner Caroline Rule has been recognized by “New York Super Lawyers” since 2011. An experienced tax attorney who handles a variety of tax fraud allegations and white-collar controversies, Ms. Rule is a frequent contributor to several legal journals and magazines. She is also the chairperson of the American Bar Association’s subcommittee on tax crimes.
