On March 28, the US Tax Court issued its opinion in Good Fortune Shipping, S.A. v. Commissioner, 148 T.C. No. 10, upholding the validity of the “bearer share” regulations under section 883 of the Internal Revenue Code. Good Fortune filed a notice of appeal to the U.S. Court of Appeals for the D.C. Circuit on June 19.
Section 883(c)(1) exempts the United States source income from the international operation of ships from U.S. net and gross taxes provided the foreign country in which the corporation operating the ships grants a similar exemption to U.S. organized vessel operators. This exemption is available only if 50% or more of the value of the foreign corporation’s stock is owned, directly or indirectly, by individuals that are residents of a foreign country that also grants an equivalent exemption to U.S. corporations.
The applicable regulations provide that bearer shares are disregarded when determining if a corporation passes the ownership test.
The taxpayer in Good Fortune Shipping challenged the validity of the bearer share provision of the ownership regulations, asserting that they did not satisfy the tests required for deference under Chevron USA, Inc. v. Natural Resources Defense Council, Inc. 467 U.S. 837 (1984). Essentially, the taxpayer argued that the statue is unambiguous and further interpretation by the IRS in regulations is not necessary. Specifically, the word “own” as used in the statute has an unambiguous meaning and that renders the ownership regulations “arbitrary, capricious, or manifestly contrary to the statue”
The Tax Court concluded “that ‘Congress has [not] directly spoken to the precise question at issue,’” and “that section 883(c)(1) as well as its legislative history is silent; in other words, there is a “gap” in that section as well as its legislative history” and determined that the Treasury was authorized under Chevron to fill the gap with regulations.
So, the logical question is where does this leave the regulations under section 883 – carved in granite or carved in sandstone?
I believe the right answer is somewhere between. Subject to appeal by the taxpayer, the status of the bearer share regulations is settled. With respect to the remainder of the qualified ownership rules, there is a presumption of validity. So those seeking to challenge the publicly-traded and controlled foreign company tests would be well advised to seek counsel and, given the extreme consequences, take a conservative route if possible.
The remaining regulation defines what constitutes a qualified foreign corporation, qualified foreign country, an equivalent exemption and what constitutes income from the international operation of ships or aircraft. These terms are no better defined in the statute than the term “own” which Good Fortune litigated. Now that the Tax Court has opined that a portion of the regulations are due deference under Chevron, that could easily be extended to the other provisions. Simply put, establishing invalidity of these rules will, I believe, be an uphill battle and, although not impossible, should not be undertaken lightly.