In Varian Medical Systems, Inc. v. Commissioner, the Tax Court addressed a seeming oversight in the Tax Cuts and Jobs Act of 2017 (the “TCJA”) involving the effective dates for amendments to section 78 and the enactment of section 245A of the Internal Revenue Code.
Legal Background
The TCJA added section 245A to the Internal Revenue Code. Section 245A gives U.S. corporations a deduction for the foreign-source portion of dividends they receive from certain foreign corporations.[1] The TCJA made section 245A effective for “distributions made after . . . December 31, 2017.”[2]
The TCJA also amended section 78 of the Internal Revenue Code to account for the changes made to section 245A. Section 78 provides that if a domestic corporation chooses to take claim a foreign tax credit, an amount equal to the taxes deemed to be paid by the foreign corporation under section 960 of the Internal Revenue Code will be treated as a dividend received by the domestic corporation from the foreign corporation for most purposes of determining the domestic corporation’s federal income tax liability. Section 960 provides that if certain subpart F income of a controlled foreign corporation (“CFC”) is taxable to a domestic corporation, then the domestic corporation is deemed to have paid any foreign taxes attributable to that income.[3] The TCJA amended section 78 to provide that such foreign taxes would not be treated as a dividend for purposes of section 245A.[4]
The TCJA stated that the amendments to section 78 applied “to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of United States shareholders in which or with which such taxable years of foreign corporations end.”[5] Thus, the effective dates for the amendments to section 78 were different based on whether a taxpayer and its foreign subsidiaries use a calendar year tax year (January 1st to December 31st) or a fiscal year tax year (e.g., July 1st to June 30th).
Facts
Varian is the parent company of a consolidated group of medical device and software manufacturers. Varian operates through corporations in many different countries, at least some of which are CFCs. Varian and its CFCs are fiscal year taxpayers, which means that their tax years are not based on the calendar year. As relevant here, the 2018 tax year for Varian and its CFCs began on September 30, 2017, and ended on September 28, 2018. Meaning that the amendments to section 78 apparently would not apply to Varian’s 2018 tax year.
On its 2018 federal income tax return, Varian elected to claim foreign tax credits for foreign taxes that it was deemed to pay under section 960 and therefore treated such foreign taxes as a dividend of approximately $159 million under section 78. Varian also claimed a deduction of approximately $60 million under section 245A in connection with the dividend it was treated as receiving under section 78 from its CFCs.
The IRS disallowed Varian’s deduction under section 245A.
The Tax Court’s Ruling
The Tax Court observed that the amendments made to section 78 had a different effective date from that used for section 245A. Moreover, section 78 required that Varian treat the amount to which section 78 applies as a dividend received from its CFCs for all relevant purposes. Section 245A(a) provides a deduction for the foreign-source portion of any dividend received from such subsidiaries. Thus, section 245A and section 78 authorize Varian to deduct its section 78 dividend for 2018. The Tax Court agreed with Varian that the different effective dates for section 245A and the amendments to section 78 resulted in a period in which its dividend under section 78 qualified for a deduction under section 245A. However, the Tax Court also ruled that section 245A(d)(1) prevented a foreign tax credit from being claimed in connection with distributions for which a deduction was allowed under that section.
[1] TCJA§ 14101(a), 131 Stat. at 2189-90.
[2] TCJA § 14101(f), 131 Stat. at 2192.
[4] TCJA § 14301(c), 131 Stat. at 2222.
[5] TCJA § 14301(d), 131 Stat. at 2225.
