The US District Court for the District of Puerto Rico has held that a US corporation is required to reduce the cap on the possessions tax credit under section 936 of the US Internal Revenue Code (IRC) when it transfers a major portion of its businesses to a foreign corporation. Pharmaceuticals, Inc., v. United States, Civil No. 11-1312 (GAG) (10 October 2012).
The case involved a US corporation that claimed tax credits for its manufacturing operations based in Puerto Rico under IRC section 936.
IRC section 936 allowed qualifying corporations to claim a credit against US income tax for income attributable to their active business operations in a US possession, including Puerto Rico. IRC section 936 was enacted to provide an incentive for US corporations to locate their manufacturing plants in US possessions.
The section 936 credit was repealed in 1996. Qualifying corporations, however, were allowed to continue to claim the credit during the 10-year transition period, subject to a cap. The cap is partly determined by IRC section 936(j)(5)(D), which adopts the provisions contained in IRC section 41(f)(3) for the research and development tax credit.
IRC section 41(f)(3)(A) increases the amount of the tax credit when a taxpayer acquires a major portion of a trade or business from "another person".
IRC section 41(f)(3)(B) provides that the amount of the tax credit is decreased when a taxpayer disposes of a major portion of a trade or business "in a transaction to which subparagraph (A) applies", and then the taxpayer furnishes the "acquiring person" with certain information.
The US corporation in the present case transferred its businesses to its Irish subsidiary, which was not subject to US taxation during the tax years at issue. The US corporation took the position that the cap reduction provision of IRC section 41(f)(3)(B) does not apply to its disposition.
The District Court first rejected the US corporation's assertion that IRC section 936 requires the acquisition to be made by a US taxpayer. The District Court explained that, if Congress had intended for the cap reduction provision of IRC section 41(f)(3)(B) to apply only to transactions between US taxpayers, Congress would have used the term "acquiring taxpayer", rather than "acquiring person". The District Court concluded that the provision applies to all dispositions of a major portion of a business, including transactions between a US taxpayer and a foreign corporation that is not subject to US taxation.
The District Court then considered the US corporation's argument that the phrase "in a transaction to which subparagraph (A) applies ..." requires a correlative relationship between the acquisition of a business and the disposition of a business. According to this argument, no reduction of the section 936 credit can occur unless there is a correlative increase in the acquiring party's section 936 credit. After discussing the purpose of the enactment and phase-out of the section 936 credit, as well as other provisions of IRC section 936, the District Court found that IRC section 936 does not require a corresponding increase in the acquiring party's cap in order to require the disposing party to decrease its cap.
Accordingly, the District Court determined that the US corporation was required to reduce the section 936 credit when it transferred major portions of businesses to its Irish subsidiary.
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