The opinion
T.C. Memo. 2008-62
UNITED STATES TAX COURT
NEW YORK GUANGDONG FINANCE, INC., Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 14809-04. Filed March 11, 2008.
Larry Kars, for petitioner.
Joseph W. Fogelson and Nicole F. Cammarota, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
MARVEL, Judge: By a notice of deficiency dated May 25,
2004, respondent determined the following withholding tax
deficiencies and additions to tax against petitioner:1
1
Unless otherwise indicated, all section references are to
the Internal Revenue Code in effect for the years in issue, and
(continued...)
- 2 -
Withholding tax Additions to tax Addition to tax
Year deficiencies sec. 6651(a)(1) sec. 6651(a)(2)
1994 $35,416 $8,854.00 -0-
1995 102,532 25,633.00 -0-
1996 29,900 6,727.50 $7,475
After concessions,2 the issues for decision are:
(1) Whether petitioner, a corporation that paid interest to
Guang Xin Enterprises, Ltd. (GXE), during 1994, 1995, and 1996
(the years in issue), is liable for withholding tax deficiencies
under section 1461 for the years in issue in the amounts
determined by respondent or in some lesser amounts; and
(2) whether petitioner is liable for additions to tax under
section 6651(a)(1) for failing to file Forms 1042, Annual
Withholding Tax Return for U.S. Source Income of Foreign Persons,
or Forms 1042S, Foreign Person’s U.S. Source Income Subject to
Withholding, for the years in issue.
1
(...continued)
all Rule references are to the Tax Court Rules of Practice and
Procedure.
2
Respondent concedes that petitioner is not liable for the
sec. 6651(a)(2) addition to tax determined in the notice of
deficiency.
Petitioner alleged in its petition that the expiration of
the period of limitations barred the assessment and collection of
tax for the years in issue. However, petitioner did not pursue
this issue at trial or on brief, and we consider it abandoned.
See Leahy v. Commissioner, 87 T.C. 56, 73-74 (1986).
- 3 -
In order to decide issue (1), we must first decide how much
interest petitioner paid to GXE during each of the years in
issue, and then we must decide whether any of the interest paid
to GXE qualifies for exemption under the Agreement for the
Avoidance of Double Taxation and the Prevention of Tax Evasion
With Respect to Taxes on Income, U.S.-P.R.C., Apr. 30, 1984,
T.I.A.S. No. 12065 (China Agreement), either because GXE
collected the interest as an agent for Guangdong International
Trust & Investment Corp. (GITIC), a corporation resident in China
during the years in issue, or because the loan transaction with
GXE was in substance a loan transaction with GITIC.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
The stipulation of facts, the supplemental stipulation of facts,
and the second supplemental stipulation of facts are incorporated
herein by this reference. Petitioner’s principal place of
business was in Houston, Texas, when the petition was filed.
Petitioner is a closely held corporation that was incorporated in
Delaware on December 2, 1987.
During the years in issue, petitioner engaged in loan
transactions with GITIC and GXE, two foreign corporations. GITIC
was a financial institution that was incorporated in 1980 under
the laws of the People’s Republic of China and, throughout the
years in issue, was wholly owned and controlled by the government
- 4 -
of the Chinese Province of Guangdong (Guangdong government). GXE
was incorporated in 1985 under the laws of Hong Kong and was a
wholly owned subsidiary of GITIC from the date of its
incorporation through the end of 1996.
During the years in issue, GXE shared office space with
GITIC in GITIC Plaza in Hong Kong. The office suite housed
approximately 40-50 employees; approximately 6 to 8 of those
employees worked for GXE. GXE’s employees sat in separate rooms
from GITIC’s employees. GXE’s officers included Lin Wensheng,3 a
director and vice president of GITIC.
On March 20, 1990,4 petitioner borrowed $2 million from GXE
at an interest rate calculated as 1.5 percent over the London-
based Interbank Borrowing Rate, adjusted semiannually. The loan
agreement stated a term of 1 year, which could be extended for an
additional year.5 Lin Wensheng signed the loan agreement on
behalf of GXE, and Guo-Qing Tan signed on behalf of petitioner.
3
The record includes documents that romanize Lin Wensheng’s
name several different ways, including Ling Weizeng and Lee Wang
Chung. In this opinion, we adopt the romanization used in the
GITIC brochure that was admitted into evidence as Exhibit 8-J.
4
The English version of the loan agreement erroneously shows
an agreement date of Mar. 20, 1992.
5
Under the loan agreement, the maximum term of 2 years would
have ended on Mar. 20, 1992. However, petitioner’s president,
Lawrence Wong (Mr. Wong), credibly testified that the loan had
not been repaid before or during the years in issue, and the
record generally supports Mr. Wong’s testimony. In addition, the
parties do not dispute that petitioner had at least one
outstanding GXE loan during the years in issue.
- 5 -
The loan agreement identified GXE as the sole lending party. GXE
submitted a Form W-8, Certificate of Foreign Status, dated
March 20, 1990, to petitioner in connection with the loan.
On August 18, 1994, GITIC agreed to lend petitioner $2
million. The GITIC loan agreement provided for a 2-year term and
interest payments at a rate of 10 percent for the first year and
a predetermined market rate for the second year. Guo-Qing Tan
also signed the GITIC loan agreement on behalf of petitioner, and
Yao-Wei Xu signed on behalf of GITIC. On or about August 23,
1994, petitioner exercised its right to borrow $2 million under
the GITIC loan agreement. GITIC wired net loan proceeds of
$1,988,000 to petitioner on or about the same day.6
On its Forms 1120, U.S. Corporation Income Tax Return, for
1994, 1995, and 1996, petitioner claimed deductions for interest
it allegedly paid during those years. Two tax return preparers,
Mr. Steinhardt and Mr. Choy, assisted in the preparation of the
Forms 1120. Petitioner attached Form 5472, Information Return of
a 25% Foreign-Owned U.S. Corporation or a Foreign Corporation
Engaged in a U.S. Trade or Business, to its 1994 Form 1120.
Petitioner, however, did not attach Form 5472 to its Forms 1120
for 1995 or 1996.
6
The net loan amount was calculated by subtracting bank and
service fees of $12,000 from the $2 million GITIC loan amount.
- 6 -
The 1994 Form 5472 identified GITIC as a 25-percent-or-more
foreign shareholder of petitioner. The 1994 Form 5472 stated
that GITIC was incorporated in China and conducted its principal
business activities and filed income tax returns there. The 1994
Form 5472 identified GXE as a related party to petitioner and
described GXE as a foreign person conducting its principal
activity as a “trading company”. Petitioner reported $99,145 of
interest paid to GXE during 1994 on account of a loan with a
beginning and ending balance of $2 million. The 1994 Form 5472
further stated that GXE principally conducted its business
activity in and filed its income tax returns as a resident of
Hong Kong.
On a date that is not in the record, respondent issued to
petitioner a Form 4564, Information Document Request, regarding
interest paid by petitioner. By letter dated September 8, 1998,
petitioner informed Mr. Steinhardt that it paid interest to GITIC
of $177,010.41 in 1995 and $139,798.61 in 1996 on account of the
GITIC loan and that it paid interest to GXE of $164,762.08 in
1995 and $77,099.91 in 1996 on account of the GXE loan.
Petitioner apparently furnished a copy of the September 8, 1998,
letter to respondent in connection with respondent’s examination
of petitioner’s returns.
On July 27, 1999, petitioner filed a Form 1120X, Amended
U.S. Corporation Income Tax Return, with a Form 5472 attached,
- 7 -
for each year in issue.7 The 1994 amended Form 5472 reported
that petitioner obtained an additional $2 million loan from GXE
during 1994.8 The 1995 and 1996 Forms 5472 reported that
petitioner maintained the $4 million loan balance through the end
of 1996. The Forms 5472 also reported that petitioner paid
interest to GXE of $118,052.76, $341,772.49, and $99,666.39, for
1994, 1995, and 1996, respectively.
Petitioner did not file Form 1042 or Form 1042S for any of
the years in issue, on the advice of its president Lawrence Wong
(Mr. Wong). Before joining petitioner, Mr. Wong worked as a
certified public accountant (C.P.A.) and as a financial manager.
Mr. Wong began his career at Arthur Young & Co., an accounting
firm. He then practiced privately for 8 to 10 years in New York
City. After practicing as a C.P.A., Mr. Wong owned and managed a
finance corporation and served as its president from 1980 until
the time of trial. Mr. Wong became a shareholder of petitioner
in 1992 and its president in 1996.
On May 25, 2004, respondent issued a notice of deficiency to
petitioner in which respondent determined that petitioner was
liable for withholding tax deficiencies and additions to tax for
the years in issue. Respondent calculated the deficiencies using
7
No paid preparer signed the Forms 1120X.
8
The 1994 amended Form 5472 reported a beginning loan
balance of $2 million and an ending loan balance of $4 million.
- 8 -
the interest amounts petitioner reported on the Forms 5472 filed
with its Forms 1120X.
Petitioner timely petitioned this Court, alleging that
respondent’s determinations were in error. On June 13, 2005,
petitioner filed an amendment to its petition specifically
alleging that respondent erroneously calculated the deficiencies
for the years in issue because the Forms 5472 upon which
respondent relied reported interest paid to both GXE and GITIC.
In connection with the trial that followed, the parties
stipulated documentation of certain wire transfers during 1995
and 1996 and excerpts from petitioner’s general ledgers for 1995
and 1996. The exhibits reflect that petitioner made the
following interest payments on the GITIC and GXE loans during
1995 and 1996:
- 9 -
A. GITIC
General
Payment date Lender Amount ledger acct.
2/22/95 GITIC $102,222.22 Interest paid
8/23/95 GITIC 74,788.19 Interest paid
177,010.41
2/23/96 GITIC 70,916.67 Interest paid
8/23/96 GITIC 68,881.94 Interest paid
1
139,798.61
1
Petitioner also paid $65,000 by wire transfer to or for the
benefit of GITIC on May 29, 1996, and contends that the payment
was an interest payment. However, it does not appear from the
record as a whole that petitioner included this payment in
computing the amount identified in the Sept. 8, 1998, letter or
in its 1996 Form 5472, nor does it appear that respondent
included this amount in calculating the 1996 deficiency.
Consequently, we do not consider this payment in our analysis.
B. GXE
General
Payment date Payee Amount ledger acct.
1
3/31/95 GXE $33,475.15 From EB MMA
2
3/31/95 GXE 48,228.68 Interest paid
9/21/95 GXE 83,058.25 Interest paid
164,762.08
3/21/96 GXE 77,099.91 Interest paid
1
The last digit of this entry does not appear on the
exhibit, but we infer that it must be as reflected above because
petitioner apparently included this amount in calculating the
total amount of interest paid on the GXE loan during 1995 as
reflected in the Sept. 8, 1998, letter.
2
We cannot tell from an examination of the general ledger
whether the $33,475.15 payment is included in the $48,228.68
entry. However, because petitioner apparently treated it as a
separate and additional interest payment and because the total
coincides with the total interest amount in the Sept. 8, 1998,
letter, we shall also treat the $33,374.15 payment recorded in
the general ledger as a separate payment for purposes of our
analysis.
- 10 -
The total payments made on the GITIC loan for 1995 and 1996
and the total payments made on the GXE loan for 1995 and 1996, as
summarized above, coincide with the amounts set forth in
petitioner’s September 8, 1998, letter. However, a comparison of
the Forms 5472 that petitioner attached to its Forms 1120X for
1995 and 1996 with the interest amounts in the September 8, 1998,
letter reveals the following:
1995 1996
Interest paid to
GITIC per 9/8/98 letter $177,010.41 $139,798.61
Interest paid to GXE
per 9/8/98 letter 164,762.08 77,099.91
Total Interest
per 9/8/98 letter 341,772.49 216,898.52
Interest reported as paid
to GXE on Forms 5472
attached to amended returns 341,772.49 99,666.39
Difference -0- 117,232.13
OPINION
I. Burden of Proof
Generally, the Commissioner’s determination is presumed
correct, and the taxpayer bears the burden of proving that the
determination is erroneous. Rule 142(a)(1); Welch v. Helvering,
290 U.S. 111, 115 (1933). Petitioner argues, however, that the
burden of proof should shift to respondent because the notice of
- 11 -
deficiency was capricious and arbitrary.9 In support of its
position, petitioner cites Portillo v. Commissioner, 932 F.2d
1128 (5th Cir. 1991), affg. in part, revg. in part and remanding
T.C. Memo. 1990-68.10
In Portillo, the Commissioner determined that the taxpayer
had unreported income by comparing the amount of income reported
on a Form 1099 that had been issued to the taxpayer by a third
party with the amount of income from the third party payor
reported on the taxpayer’s Form 1040, U.S. Individual Income Tax
Return. Id. at 1131. When the amounts did not match, the
Commissioner concluded that the Form 1099 was accurate, even
though the third party who submitted the Form 1099 could not
substantiate the amount of income he allegedly paid. Id. The
Commissioner determined that the taxpayer had received unreported
income equal to the discrepancy between the Form 1099 amount and
the amount reported on the taxpayer’s return, and we upheld the
determination. Id. The Court of Appeals for the Fifth Circuit
reversed, holding that before the Commissioner could make a
determination that a taxpayer received unreported income, he
9
Petitioner does not contend that sec. 7491(a), which shifts
the burden of proof to the Commissioner if its requirements are
met, applies, and the record does not contain sufficient evidence
to establish that petitioner satisfies the sec. 7491(a)
requirements.
10
This case is appealable, barring a stipulation to the
contrary, to the Court of Appeals for the Fifth Circuit. See
sec. 7482(b)(1)(B).
- 12 -
needed “predicate evidence supporting * * * [his] determination.”
Id. at 1133. The Court of Appeals concluded that the
Commissioner could not simply rely on a Form 1099 in making his
determination when the taxpayer contested the accuracy of the
Form 1099.
This case is distinguishable from Portillo. Respondent did
not determine that petitioner had unreported income, nor did he
arbitrarily attribute veracity to the statement of a third party
when making his determination. Respondent used the Forms 5472
that petitioner filed with its amended income tax returns to
determine that petitioner was liable for withholding taxes.
Petitioner’s Forms 5472 reported interest paid to GXE, a Hong
Kong corporation that did not appear to satisfy the residency
requirements for favorable tax treatment under the China
Agreement.11
Petitioner argues, however, that respondent was on notice
because its Forms 5472 reported two loans, one of which was made
by GITIC, a Chinese corporation that is exempt from U.S. income
tax under the China Agreement. Petitioner alleges that it gave a
copy of its September 8, 1998, letter containing a summary of
interest paid during 1995 and 1996 on the GITIC and GXE loans to
11
The parties do not dispute that Hong Kong was not a part
of China during the years in issue. The Court takes judicial
notice that Hong Kong was a crown colony of the United Kingdom
until it became a Special Administrative Region of the People’s
Republic of China on July 1, 1997. See Fed. R. Evid. 201.
- 13 -
respondent before he issued his notice of deficiency and
therefore respondent was on notice that a portion of the reported
interest was not subject to U.S. income tax withholding under the
China Agreement.
Petitioner’s argument ignores the fact that petitioner filed
Forms 1120X under penalties of perjury before respondent issued
the deficiency notice and 10 months after petitioner sent the
September 8, 1998, letter to its accountant. The interest
payments that petitioner reported on the Forms 5472 attached to
the Forms 1120X are inconsistent with the letter in several
respects. Respondent did not act capriciously or arbitrarily
when he determined on the basis of the residency of the interest
recipient (Hong Kong) and the amounts petitioner reported on its
Forms 5472 that petitioner had income tax withholding
deficiencies. We conclude, therefore, that the burden of proof
remains with petitioner.
II. Taxation of Interest Received by Foreign Corporations
A. Generally
Except as provided in section 881(c), section 881(a) imposes
a tax of 30 percent on, inter alia, interest received from United
States sources by a foreign corporation12 to the extent the
12
A “foreign corporation” is a corporation that is not
organized in the United States or under the law of the United
States or of any State. Sec. 7701(a)(4) and (5). GITIC was a
corporation organized under the laws of China, and GXE was a
(continued...)
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interest received is not effectively connected with the conduct
of a trade or business within the United States.13 Section
1442(a) generally requires the payor of interest subject to the
tax imposed by section 881(a) to deduct and withhold that tax at
the source. If the payor does not do so, then it becomes liable
for such taxes under section 1461.
Under section 894, treaty provisions may modify the Code,
including its withholding tax provisions. However, foreign
corporations are not exempt from U.S. income taxation under a
treaty between the United States and a foreign country unless the
treaty is an income tax treaty and the corporation is a qualified
resident of such foreign country. Sec. 884(e)(1). A qualified
resident means, with respect to any foreign country, any foreign
corporation which is a resident of such foreign country unless
(1) 50 percent or more of the value of the corporation’s stock is
owned by individuals who are not residents of that foreign
12
(...continued)
corporation organized under the laws of Hong Kong.
13
Sec. 881(c)(1) generally exempts portfolio interest
received by a foreign corporation from sources within the United
States from the sec. 881(a) tax. “Portfolio interest” is defined
as interest paid on certain registered and unregistered
obligations that would otherwise be subject to tax. Sec.
881(c)(2). Portfolio interest, however, does not include such
interest received in certain circumstances by a bank in the
ordinary course of business, by a 10-percent shareholder, or by a
controlled foreign corporation from a related person. Sec.
881(c)(3). Petitioner does not argue that the interest in issue
was portfolio interest.
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country or who are not citizens or resident aliens of the United
States or (2) 50 percent or more of the corporation’s income is
used to satisfy liabilities to persons who are not residents of
the foreign country or residents or citizens of the United
States. Sec. 884(e)(4)(A). The Code specifically lists
exceptions for wholly owned subsidiaries of publicly traded
corporations. See sec. 884(e)(4)(B). However, no explicit
exception exists for wholly owned subsidiaries of privately owned
or government-owned corporations. See id.
B. China Agreement
Article 10, paragraph 3 of the China Agreement provides:
interest arising in * * * [the United States] and
derived by the government of * * * [the People’s
Republic of China] or any financial institution wholly
owned by that government, or by any resident of * * *
[the People’s Republic of China] with respect to debt-
claims indirectly financed by the government of * * *
[the People’s Republic of China] or any financial
institution wholly owned by that government, shall be
exempt from tax in the * * * [United States].
The China Agreement applies only to “residents of one or both of
the Contracting States.” Id. art. 1. The two Contracting States
to the China Agreement are the People’s Republic of China and the
United States of America. Id. art. 3, par. 1(c). A resident of
a Contracting State is a person who is liable to pay tax to that
State by reason of residency, location of offices, place of
incorporation, or other similar criterion. Id. art. 4, par. 1.
- 16 -
Respondent determined that petitioner is liable for
withholding taxes on all of the interest reported on its Forms
5472 filed with its 1994, 1995, and 1996 Forms 1120X because the
forms listed GXE, a Hong Kong corporation, as the interest
recipient. Petitioner argues that (1) the interest reported on
the Forms 5472 included interest paid to GITIC, a corporation
resident in China that was entitled to favorable tax treatment
under the China Agreement during the years in issue, and that (2)
interest paid to GXE should be treated as interest paid to GITIC.
Petitioner contends that the GXE loan was actually a loan from
GITIC and that GITIC chose to distribute the net loan proceeds
through GXE. Petitioner contends, therefore, that the loan
originated with the Guangdong government and should be exempt
under the China Agreement. Alternatively, petitioner argues that
GXE is GITIC’s agent and, as such, collected interest on the GXE
loan on GITIC’s behalf.
C. Interest Paid Directly to GITIC
Respondent concedes that any interest payments made directly
to GITIC with respect to a loan made by GITIC fall squarely
within the exemption from U.S. taxation provided in the China
Agreement. Respondent argues, however, that GXE and not GITIC
made the $2 million “GITIC” loan during the years in issue and
that the interest in question was paid to GXE on that loan.
Alternatively, respondent appears to argue that there are three
- 17 -
loans at issue--two from GXE and one from GITIC. Respondent
seems to interpret the Forms 5472 as reporting petitioner’s
payment of interest on two loans from GXE and none from GITIC.
Respondent argues that all interest reported on the Forms 5472
was attributable to GXE loans and was properly subject to U.S.
income tax withholding. Respondent urges this Court to treat
petitioner’s Forms 5472 as admissions that can only be overcome
by cogent proof. See Estate of Hall v. Commissioner, 92 T.C.
312, 337-338 (1989); Estate of Baird v. Commissioner, T.C. Memo.
2002-299, revd. on other grounds and remanded 416 F.3d 442 (5th
Cir. 2005).
1. Number of Loans Made by GXE
The preponderance of the evidence establishes that, during
the years in issue, petitioner had at least one outstanding loan
from GXE with a principal balance of $2 million and one
outstanding loan from GITIC with a principal balance of $2
million. Moreover, we are satisfied that regardless of the
number of loans that petitioner may have obtained from GXE, the
principal balance of the GXE loan(s) during the years in issue
did not exceed $2 million. Mr. Wong credibly testified that
petitioner received only $2 million from GXE. The interest
payments recorded in petitioner’s general ledger for 1995 and
1996 match the amounts petitioner reported to Mr. Steinhardt in
the September 8, 1998, letter that showed one loan by GXE and one
- 18 -
by GITIC.14 The total amount of interest petitioner reported on
its 1995 Form 5472 coincides with interest paid to GITIC and GXE
as recorded in petitioner’s general ledger and reported in the
September 8, 1998, letter. The evidence supports a finding that
petitioner had two outstanding $2 million loans, one from GITIC
and one from GXE, and we so find.
2. Whether Any Interest Attributable to the GITIC
Loan Was Included on the Forms 5472 Attached to
Petitioner’s Forms 1120X
We now address whether any of the interest reported on
petitioner’s Forms 5472 was interest paid on account of the GITIC
loan, which respondent concedes is exempt from U.S. taxation.
Petitioner has the burden of proving that respondent’s
determinations are incorrect. See Rule 142(a)(1); Welch v.
Helvering, 290 U.S. at 115.
(a) 1994
The record is devoid of any credible evidence establishing
that the amount of interest paid with respect to the GXE loan was
different from that reported on the amended Form 5472 that
petitioner attached to its Form 1120X. Consequently, unless we
14
The details of the GXE loan regarding the date of the loan
and the applicable interest rate, as described in the Sept. 8,
1998, letter, are not consistent with the facts and documents
regarding the 1990 GXE loan that were included in the parties’
stipulations of facts. Nevertheless, Mr. Wong confirmed in his
testimony at trial that, during the years in issue, petitioner
had an outstanding loan from GXE in the face amount of $2
million.
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conclude that GXE made its loan to petitioner as GITIC’s agent or
that the GXE loan in substance was a loan from GITIC, we shall
sustain respondent’s determination with respect to 1994.
(b) 1995
The record convincingly establishes that petitioner
erroneously reported interest paid with respect to both the GITIC
and GXE loans as interest paid to GXE on its 1995 Form 5472.
Petitioner’s 1995 general ledger and the September 8, 1998,
letter confirm that petitioner paid interest of $164,762.08 on
the GXE loan and $177,010.41 on the GITIC loan in 1995.
Petitioner reported the sum of these amounts on its 1995 Form
5472. Accordingly, we find that $177,010.41 of the $341,772.49
reported on the 1995 Form 5472 was paid on the GITIC loan and was
not subject to U.S. taxation under the China Agreement.
(c) 1996
The record regarding petitioner’s 1996 interest payments
supports a finding that on its 1996 Form 5472, petitioner
erroneously reported interest paid with respect to both the GITIC
and GXE loans as interest paid to GXE. Petitioner’s 1996 general
ledger and the September 8, 1998, letter are consistent with each
other and reflect that petitioner paid interest of $77,099.91 on
the GXE loan and $139,798.61 on the GITIC loan in 1996. However,
the total interest reported on Form 5472 attached to petitioner’s
1996 Form 1120X did not match the total interest paid to GITIC
- 20 -
and GXE as shown in petitioner’s general ledger and the September
8, 1998, letter. The total interest reported on petitioner’s
1996 Form 5472 was $117,232.13 less than the general ledger and
September 8, 1998, letter totals. Petitioner offered no
testimony to explain the discrepancy.
We agree with respondent that petitioner’s 1996 Form 5472
contains admissions that can only be overcome by cogent proof.
See Estate of Hall v. Commissioner, supra at 337-338. Although
the record as to 1996 is not as satisfying as the record with
respect to 1995 (in that the total interest reported on the 1996
Form 5472 does not equal the total interest paid to GXE and GITIC
as shown in the general ledger and the September 8, 1998,
letter), we nevertheless believe and conclude that the total
interest paid to GXE during 1996 is as shown in petitioner’s 1996
general ledger. Petitioner has convincingly established that it
paid only $77,099.91 of interest to GXE during 1996.
Accordingly, we find that only $77,099.91 of the $99,666.39
reported on the 1996 Form 5472 represented interest paid to GXE.
D. Interest Paid on the GXE Loan
Petitioner admits that GXE is incorporated and located in
Hong Kong, a geographical territory that for the relevant period
was not covered by the China Agreement.15 See China Agreement,
15
Petitioner did not timely raise any issue regarding GXE’s
residency or the taxability of GXE in China, and the location of
(continued...)
- 21 -
arts. 1, 3, 4. Petitioner argues, however, that because GXE is a
wholly owned subsidiary of GITIC, interest paid to GXE is
indirectly paid to GITIC, and therefore such interest should be
exempt from U.S. taxation under the China Agreement. Petitioner
relies on two alternative theories: (1) The GXE loan was, in
substance, a loan from GITIC; and (2) GXE made the loan and
collected interest as an agent of GITIC.
1. Substance Over Form
Petitioner argues that interest paid to GXE should be
treated as interest paid to GITIC because the parties intended
the loans to be from GITIC, regardless of which entity’s name
appeared on the loan agreements. Petitioner contends that the
sharing of corporate officers, directors, and office space by
GITIC and GXE is evidence of corporate informality that led
petitioner to believe it was dealing with GITIC when it entered
into the loan agreement with GXE. Petitioner contends that
GITIC, as the parent corporation, made all of the financing
decisions for GXE, including the decision to lend money to
petitioner. According to petitioner, GITIC used its assets to
fund GXE and enabled GXE to lend money to petitioner. Petitioner
also argues that GITIC guaranteed GXE’s loans and that a director
of GITIC signed the GXE loan agreement, evidencing the parties’
15
(...continued)
GXE’s office and its place of incorporation are in Hong Kong.
- 22 -
intent that the loan originate from GITIC. Petitioner asserts
that the form of the transaction--that petitioner borrowed $2
million from GXE and paid interest to GXE on account of that
loan--should be disregarded in favor of the true substance of the
transaction. Accordingly, petitioner would recast the GXE loan
transaction to reflect that petitioner borrowed an additional $2
million from GITIC, regardless of the fact that GXE signed the
loan agreement, distributed the net loan proceeds, and received
the interest payments.
As a general rule, a taxpayer is bound by the form of the
transaction that the taxpayer has chosen. Framatome Connectors
USA, Inc. v. Commissioner, 118 T.C. 32, 47 (2002), affd. 108 Fed.
Appx. 683 (2d Cir. 2004). A taxpayer may argue that the
substance of the transaction should prevail over its form only in
limited circumstances “where his tax reporting and actions show
an honest and consistent respect for the substance of a
transaction.” Estate of Weinert v. Commissioner, 294 F.2d 750,
755 (5th Cir. 1961), revg. and remanding 31 T.C. 918 (1959). The
taxpayer “must provide objective evidence that the substance of
the transaction was in accord with the position argued by * * *
[the taxpayer] rather than the form set forth by all the relevant
documents.” Groetzinger v. Commissioner, 87 T.C. 533, 541
(1986); see also Commissioner v. Natl. Alfalfa Dehydrating &
Milling Co., 417 U.S. 134, 149 (1974) (“while a taxpayer is free
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to organize his affairs as he chooses, nevertheless, once having
done so, he must accept the tax consequences of his choice,
whether contemplated or not, * * * and may not enjoy the benefit
of some other route he might have chosen to follow but did not”).
The record does not support petitioner’s contention that the
GXE loan was, in substance, a loan solely from GITIC and not from
GXE. Mr. Wong testified that it was GITIC that negotiated the
GXE loan with petitioner and that petitioner recorded the GXE
loan as a loan from GITIC in its accounting records. However,
petitioner’s general ledger segregates and identifies interest
payments made to GXE, and petitioner does not dispute that it
paid interest directly to GXE on the GXE loan. In addition,
petitioner’s original 1994 Form 5472 and amended Forms 5472 for
each of the years in issue reported that petitioner paid interest
to GXE. Moreover, in the September 8, 1998, letter, petitioner
admits that it had at least one GXE loan that was separate from
the loan it had with GITIC. The GXE loan agreement lists GXE as
the lender. Although the officer who signed the loan agreement
on behalf of GXE was also an officer of GITIC, related companies
frequently share officers and employees. See United States v.
Bestfoods, 524 U.S. 51, 69 (1998) (acknowledging that it is not
unusual for a parent corporation and its subsidiary to share
directors and officers who can and do represent the two
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corporations separately). Finally, GXE submitted a Form W-8 to
petitioner on the date the GXE loan agreement was signed.
There is no credible evidence in the record establishing
that GITIC funded the GXE loan.16 If GITIC had been the lender,
the parties easily could have prepared a loan agreement to
reflect that fact. The record does not demonstrate that
petitioner consistently treated the GXE loan as a loan from
GITIC. In fact, petitioner’s tax reporting, its general ledger,
and its loan agreements establish the contrary. We conclude
therefore that petitioner has failed to prove that the loan it
obtained from GXE was, in substance, a loan from GITIC.
2. GXE as an Agent of GITIC
Petitioner argues that GXE acted as GITIC’s agent in making
the GXE loan and, as such, collected interest on the loan for the
benefit of GITIC.
Where a genuine agency relationship exists, the tax
consequences of transactions involving property held by an agent
may be attributed to the principal. Commissioner v. Bollinger,
485 U.S. 340, 349 (1988). An agency relationship, however, does
not automatically result from the fact that a parent corporation
owns and controls its subsidiary. Id. at 346; Natl. Carbide
16
Although GITIC presumably capitalized GXE at its inception
in 1985, GXE lent the money in question to petitioner at least 5
years later. There is nothing in the record that indicates GITIC
contributed cash to GXE to enable GXE to make the loan to
petitioner.
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Corp. v. Commissioner, 336 U.S. 422, 437 (1949). In Natl.
Carbide Corp., the Supreme Court held that a parent-subsidiary
relationship does not qualify as an agency relationship unless
the subsidiary corporation’s relationship with its parent
corporation is not dependent on the parent corporation’s
ownership of the subsidiary (the ownership requirement) and the
subsidiary’s business purpose is “carrying on * * * the normal
duties of an agent.” Natl. Carbide Corp. v. Commissioner, supra
at 437. The Supreme Court further held that, if these two
criteria are satisfied, a subsidiary will qualify as an agent of
its parent corporation if (1) the subsidiary acts in the name of
and for its parent corporation, (2) the subsidiary binds its
parent corporation by its actions, (3) the subsidiary transfers
its receipts to its parent corporation, and (4) the income
received by the subsidiary is attributable to the services of its
parent corporation’s employees and assets. Id.
In Bollinger, the Supreme Court revisited the factors
identified and discussed in Natl. Carbide Corp. in deciding
whether a corporate nominee was the agent of several real estate
development partnerships. There the Supreme Court “[declined] to
parse the text of National Carbide” and agreed “that it is
reasonable for the Commissioner to demand unequivocal evidence of
genuineness in the corporation-shareholder context”.
Commissioner v. Bollinger, supra at 349. The Supreme Court
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concluded that there was unequivocal evidence that the
corporation was an agent of the partnerships without rigidly
applying the Natl. Carbide Corp. factors, explaining its holding
as follows:
It seems to us that the genuineness of the agency
relationship is adequately assured, and tax-avoiding
manipulation adequately avoided, when the fact that the
corporation is acting as agent for its shareholders
with respect to a particular asset is set forth in a
written agreement at the time the asset is acquired,
the corporation functions as agent and not principal
with respect to the asset for all purposes, and the
corporation is held out as the agent and not principal
in all dealings with third parties relating to the
asset. * * *
Id. at 349-350.
Petitioner argues that GXE was an agent of GITIC with
respect to the GXE loan under the standard articulated in Natl.
Carbide Corp. and clarified in Bollinger because a GITIC brochure
describes GXE as GITIC’s agent and states that GXE’s business
purpose is to “act as an agent for GITIC”. Petitioner, however,
offered no credible evidence to establish an agency relationship
between GITIC and GXE with respect to the GXE loan. For example,
petitioner provided no evidence that (1) GXE acted in the name of
or for GITIC in making the loan, (2) GXE could bind GITIC by
GXE’s actions, (3) the income received by GXE was transferred to
GITIC, or (4) GXE’s income was attributable to GITIC’s employees
and assets. Credible evidence in the record establishes GXE was,
among other things, in the business of investing in domestic and
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foreign enterprises. It was not a shell corporation that
functioned solely as GITIC’s agent. GXE hired employees,
maintained office space, and operated in a different market than
its parent company. The GXE loan fits squarely within GXE’s
scope of business. In addition, the GXE loan agreement reflects
that GXE, not GITIC, was the lending party, and the loan
agreement does not contain any reference to GITIC. The loan
agreement was signed by a director of GXE and does not contain
any indication that GXE entered into the loan agreement as an
agent of GITIC.
Petitioner argues that GITIC was bound by the GXE loan
agreement because GITIC guaranteed GXE’s debt. Petitioner bases
its argument on language in an offering circular dated
November 16, 1993, which states that GITIC provided a $15 million
working capital guaranty to GXE. The record, however, is devoid
of any credible evidence that GITIC guaranteed GXE’s loan to
petitioner. The loan agreement between petitioner and GXE is
silent regarding any guaranty made by GITIC, and the September 8,
1998, letter states that the GXE loan was not guaranteed.
Petitioner argues that GITIC controlled the destination of
the GXE loan interest payments and that the interest received by
GXE was attributable to the services of GITIC’s employees by
means of shared officers, directors, and office space. These
arguments are unavailing. There is no credible evidence in the
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record to indicate that GITIC controlled anything about the GXE
loan. In addition, although the sharing of employees can
indicate an agency relationship, companies frequently share
employees. See United States v. Bestfoods, 524 U.S. at 69
(citing Lusk v. Foxmeyer Health Corp., 129 F.3d 773, 779 (5th
Cir. 1997)). Although GITIC and GXE shared the GITIC office
building in Hong Kong, the employees of each company were
segregated.
We conclude that petitioner has failed to prove that GXE was
an agent of GITIC with respect to the GXE loan to petitioner. We
hold that the interest paid to GXE as found in this opinion was
properly subject to withholding tax for the years in issue.
III. Addition to Tax
Section 6651(a)(1) imposes an addition to tax for failure to
file a tax return, in the amount of 5 percent of the tax
liability required to be shown on the return for each month
during which such failure continues, but not exceeding 25 percent
in the aggregate, unless it is shown that such failure is due to
reasonable cause and not due to willful neglect. See United
States v. Boyle, 469 U.S. 241, 245 (1985); Denenburg v. United
States, 920 F.2d 301, 303 (5th Cir. 1991); Harris v.
Commissioner, T.C. Memo. 1998-332.
Petitioner admits, and the record clearly establishes, that
petitioner failed to file Forms 1042 for the years in issue.
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See secs. 6651(a)(1), 6001; Ellwest Stereo Theatres of Memphis,
Inc. v. Commissioner, T.C. Memo. 1995-610; sec. 1.1461-2, Income
Tax Regs. Consequently, petitioner is obligated to prove that
the failure to file Forms 1042 was due to reasonable cause and
not due to willful neglect. See Higbee v. Commissioner, 116 T.C.
438, 447 (2001).
A failure to file is due to reasonable cause where a
taxpayer “exercised ordinary business care and prudence and was
nevertheless unable to file the return within the prescribed
time”. Sec. 301.6651-1(c)(1), Proced. & Admin. Regs. Although
courts have sometimes found reasonable cause in determining the
amount of a taxpayer’s liability for the addition to tax where a
taxpayer relies upon expert advice, a taxpayer ordinarily is
responsible for ascertaining tax obligations such as filing
deadlines. United States v. Boyle, supra at 251. Lay persons
know that filing deadlines exist, and “reliance cannot function
as a substitute for compliance with an unambiguous statute.” Id.
However, where a taxpayer reasonably relied on the advice of a
competent accountant or attorney in possession of all relevant
facts that it was unnecessary to file a return, reasonable cause
may exist, even if the advice turns out to be mistaken. Id. at
250.
Petitioner does not contend that it was unaware that a
withholding liability might exist as a result of making interest
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payments to a foreign corporation. Petitioner also does not
contend that it relied on the informed advice of a competent
professional that it did not have to file Forms 1042 and 1042S
for the years in issue. Petitioner argues that the interest paid
to GITIC and GXE during the years in issue was exempt and that it
relied on the advice of Mr. Wong and other professionals to that
effect.
We reject petitioner’s argument for several reasons. First,
it does not appear that the professionals who allegedly advised
petitioner did anything to ascertain whether petitioner was
required to file Forms 1042 and 1042S before petitioner filed its
original returns for the years in issue. There is no credible
evidence in the record establishing that a competent professional
investigated petitioner’s obligation to file Forms 1042 and 1042S
before the filing due date for the years in issue or that a
competent professional advised petitioner that it did not have to
file the forms. This lack of evidence contrasts sharply with
applicable regulations that clearly and unambiguously require a
withholding agent to file Form 1042 for a calendar year, even if
otherwise taxable payments are exempt, if the agent is required
to file Form 1042S with respect to interest payments made during
such year. Secs. 1.1461-2(b)(1), (c)(1)(ii), Income Tax Regs.17
17
Sec. 1.1461-2(b)(1), Income Tax Regs., requires a
withholding agent to make an annual return on Form 1042 even if
(continued...)
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Second, the only evidence petitioner offered regarding the
section 6651(a)(1) addition to tax focused on advice allegedly
given to petitioner about its obligation to withhold U.S. tax on
the interest payments. Petitioner contends that it relied upon
professional advice, both from Mr. Wong and from other
professionals with whom Mr. Wong spoke, to determine whether the
China Agreement exempted its interest payments. However, the
only evidence petitioner introduced to support its argument was
testimony by Mr. Wong that he read the China Agreement and
consulted with unnamed experts regarding the obligation to
withhold tax on interest payments to GXE. This evidence is not
sufficient to establish that petitioner reasonably relied on
professional advice from a person who had full knowledge of the
relevant facts and who conducted the necessary investigation to
reach a reasoned conclusion regarding petitioner’s obligation to
file Forms 1042.
We conclude on the record before us that petitioner has
failed to establish reasonable cause for its failure to file
17
(...continued)
no withholding tax is required to be withheld if the withholding
agent is required by sec. 1.1461-2(c)(1), Income Tax Regs., to
file Form 1042S with respect to payments made during the year.
Sec. 1.1461-2(c)(1)(ii), Income Tax Regs., requires every
withholding agent to make an annual information return on Form
1042S of “Amounts upon which tax would have been required to be
withheld * * * but for an exclusion from gross income applicable
under any income tax treaty to which the United States is a
party”.
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Forms 1042 and 1042S for the years in issue. Accordingly, we
sustain respondent’s determination that petitioner is liable for
the section 6651(a)(1) addition to tax for each of the years in
issue, to the extent consistent with this opinion.
To reflect the foregoing,
Decision will be entered
under Rule 155.