The opinion
IN THE UNITED STATES COURT OF APPEALS
FOR THE FIFTH CIRCUIT United States Court of Appeals
Fifth Circuit
FILED
November 20, 2009
No. 08-60792 Charles R. Fulbruge III
Clerk
NEW YORK GUANGDONG FINANCE INC,
Petitioner-Appellant
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent-Appellee
Appeal from a Decision
of the United States Tax Court
Before HIGGINBOTHAM and STEWART, Circuit Judges, and * ENGELHARDT,
District Judge.
CARL E. STEWART, Circuit Judge:
New York Guangdong Finance, Inc. (“Guangdong”) appeals the Tax
Court’s judgment sustaining in part the Commissioner of Internal Revenue’s
(“Commissioner”) notice of deficiency for withholding tax deficiencies and
additions to tax. We AFFIRM.
*
District Judge of the Eastern District of Louisiana, sitting by designation.
No. 08-60792
I. BACKGROUND
During the 1990s, Guangdong engaged in loan transactions with two
foreign corporations, Guangdong International Trust & Investment Corporation
(“GITIC”) and Guang Xin Enterprises, Ltd. (“GXE”). GITIC, a financial
institution, was incorporated in the People’s Republic of China and was wholly
owned and controlled by the Chinese government. It was also a 50 percent
shareholder of Guangdong during the relevant period. GXE, a trading company
and a wholly owned subsidiary of GITIC, was incorporated in Hong Kong.
During the years at issue, GXE’s head office was located in Hong Kong. GXE
shared this office with GITIC employees, although GXE’s employees sat in
separate rooms from GITIC employees.
In 1990, Guangdong borrowed $2 million from GXE. The loan provided for
a term of one year, which could be extended for an additional year. The loan
agreement listed GXE as the sole lending party. GXE submitted a Form W-8,
Certificate of Foreign Status, to Guangdong notifying Guangdong that GXE was
not a U.S. citizen or resident.
In 1994, Guangdong borrowed $2 million from GITIC. The loan agreement
provided for a two-year term. GITIC was listed as the sole lending party.
On its Forms 1120, U.S. Corporation Income Tax Returns, for 1994, 1995,
and 1996, Guangdong claimed deductions for interest payments made during
those years. Guangdong 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 tax return, but not to its 1995 or 1996 returns. In
its 1994 Form 5472, Guangdong stated that GXE principally conducted its
business in and filed its income tax returns as a resident of Hong Kong.
Guangdong reported that it paid GXE $99,145 of interest in 1994 on its $2
million loan.
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In a 1998 letter, Guangdong provided its accountant with information on
interest payments in response to an Internal Revenue Service (“IRS”) Form
4564, Information Document Request. The letter stated that: (1) with respect
to the loan from GXE, Guangdong had paid $164,762 in interest in 1995 and
$139,798 in interest in 1996, and (2) with respect to the GITIC loan, Guangdong
had paid $177,010 in interest in 1995 and $139,798 in interest in 1996.
In 1999, Guangdong filed a Form 1120X, Amended U.S. Corporation
Income Tax Return, for 1994, 1995, and 1996. Guangdong attached a Form 5472
for each of the years at issue. The amended 1994 Form 5472 indicated that
Guangdong had received an additional $2 million loan from GXE in 1994. The
1995 and 1996 Forms 5472 reported that Guangdong maintained the $4 million
loan balance with GXE through 1996. The Forms 5472 stated that Guangdong
had paid interest to GXE of $118,052, $341,772, and $99,666, for the years 1994,
1995, and 1996, respectively. None of the Forms 5472 indicated that Guangdong
made interest payments to GITIC.
On the advice of its president, Lawrence Wong (“Wong”), Guangdong never
filed a Form 1042, Annual Withholding Tax Return for U.S. Source Income of
Foreign Persons, or a Form 1042-S, Foreign Person’s U.S. Source Income Subject
to Withholding, for any of the years in issue. Wong had worked as a certified
public accountant and a financial manager before joining Guangdong in 1992.
In 2004, the IRS issued a notice of deficiency to Guangdong, in which the
IRS determined that Guangdong was liable for withholding tax deficiencies and
additions to tax for 1994, 1995, and 1996. The notice stated that Guangdong had
made interest payments to GXE in the amount of $118,052, $341,772, and
$99,666 for the years 1994, 1995, and 1996, respectively. Those numbers
corresponded to the amounts Guangdong reported in its Forms 1120X for 1994,
1995, and 1996. Based on these reported interest payments, the IRS determined
that Guangdong had unpaid withholding tax liabilities of $35,416 for 1994,
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No. 08-60792
$102,532 for 1995, and $29,900 for 1996. The IRS also determined that
Guangdong was liable for additions to tax of $8,854 for 1994, $25,663 for 1995,
and $6,727 for 1996 for failing to file Forms 1042. Finally, the IRS determined
that Guangdong was liable for an addition to tax of $7,475 for failure to timely
pay the amount owed for its 1996 return.
Guangdong petitioned the Tax Court for a redetermination of the proposed
deficiencies and additions to tax. After a trial, the Tax Court sustained in part
the Commissioner’s asserted deficiencies. The court determined that Guangdong
had received only one $2 million loan. The court sustained the Commissioner’s
determination that Guangdong had paid GXE interest of $118,052 in 1994. The
court also held that $177,010 of the $341,772 reported as paid to GXE in 1995
was actually paid to GITIC, and thus exempt from U.S. taxation under the
Agreement for the Avoidance of Double Taxation and the Prevention of Tax
Evasion With Respect to Taxes on Income (“China Agreement”). With respect
to 1996, the court determined that only $77,099 of the $99,666 reported on the
1996 Form 5472 represented interest paid to GXE. The court concluded that the
interest paid to GXE was not exempt from U.S. taxation and, therefore, should
have been subject to withholding tax. Finally, the court sustained the
Commissioner’s determination of additions to tax.
II. DISCUSSION
On appeal, Guangdong raises three arguments: (1) the Tax Court erred
when it assigned Guangdong the burden of proof in determining that the
Commissioner’s determinations are erroneous; (2) it was not required to
withhold tax on loan payments to GXE because the China Agreement exempted
Guangdong from the usual requirement to withhold tax on such payments; and
(3) it should not be liable for additions to tax because its failure to file a tax
return was excused by its reliance on advice from its president.
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No. 08-60792
We review a Tax Court’s findings of fact for clear error and issues of law
de novo. Green v. Comm’r, 507 F.3d 857, 866 (5th Cir. 2007). We review its
discretionary rulings for abuse of discretion. Bilski v. Comm’r, 69 F.3d 64, 67
(5th Cir. 1995). In this case, we affirm all the Tax Court’s rulings.
A. Burden of Proof
The Commissioner’s determinations with respect to a taxpayer’s
withholding tax liabilities and additions to tax are presumed correct, and the
taxpayer bears the burden of proving that these determinations are erroneous.
Welch v. Helvering, 290 U.S. 111, 115 (1933); Payne v. Comm’r, 224 F.3d 415,
420 (5th Cir. 2000). If a taxpayer establishes that an assessment is “arbitrary
and erroneous,” the burden then shifts to the government to prove the correct
amount of taxes owed. Carracci v. Comm’r, 456 F.3d 444, 457 (5th Cir. 2006).
Guangdong argues that the Commissioner’s notice of deficiency was
arbitrary and erroneous because it grouped together loans from both GXE and
GITIC in determining Guangdong’s tax deficiency; therefore, the burden of proof
shifts to the Government. While the Commissioner did incorrectly include
interest paid to GITIC in its notice, as the Tax Court noted, nothing in the record
indicates that the determination was arbitrary. Indeed, the Commissioner based
its determinations on the information Guangdong itself reported in its Forms
5472. The Commissioner did not act arbitrarily when it relied on information
provided to it by Guangdong under penalties of perjury. Therefore, the Tax
Court correctly found that the burden of proof remained with Guangdong.
B. Withholding Tax on Loan Payments
I.R.C. § 881(a) imposes a 30 percent tax on interest received from U.S.
sources by a foreign corporation to the extent that the interest is not effectively
connected with trade or business within the United States. Section 1441
requires that the entity paying the interest to a foreign corporation must deduct
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No. 08-60792
and withhold the tax from the interest payment. If the paying entity does not
do so, it is liable for the tax under § 1461.
I.R.C. § 894(a) requires that the Code be applied with due regard to any
treaty obligation of the United States. Section 884(e)(1) clarifies that foreign
corporations are not exempt from United States income taxation under a treaty
unless the treaty is an income tax treaty and the corporation is a qualified
resident of such foreign country. A “qualified resident” is defined as any foreign
corporation that is a resident of a foreign country unless (1) 50 percent or more
of the stock of such corporation is owned by individuals who are not residents of
the foreign country and who are not United States citizens or resident aliens, or
(2) 50 percent or more of its income is used to meet liabilities to persons who are
not residents of the foreign country or citizens or residents of the United States.
I.R.C. § 884(e)(4)(A).
Article 1 of the China Agreement provides that the treaty shall apply only
to persons who are residents of one or both of the Contracting States, that is, the
People’s Republic of China and the United States. Article 4 defines a resident
of China as a person who, under the laws of China, is “liable to tax therein by
reason of his domicile, residence, place of head office, place of incorporation or
any other criterion of a similar nature.”1
Article 10(3) of the China Agreement exempts certain interest from
taxation. That provision states:
[I]nterest arising in a Contracting State and derived by the
government of the other Contracting State, a political subdivision
or local authority thereof, the Central Bank of that other
Contracting State or any financial institution wholly owned by that
government, or by any resident of the other Contracting State with
respect to debt-claims indirectly financed by the government of that
other Contracting State, a political subdivision or local authority
1
For purposes of the treaty, Hong Kong was not considered a part of China during the
years at issue because China’s tax laws did not apply at that time in Hong Kong.
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No. 08-60792
thereof, the Central Bank of that other Contracting State or any
financial institution wholly owned by that government, shall be
exempt from tax in the first-mentioned Contracting State.
Guangdong argues that the China Agreement exempts interest paid to
GXE from withholding tax because (1) GXE is a resident of China; (2) GXE is an
agent of GITIC, a resident of China; and (3) the loan from GXE was, in
substance, a loan from GITIC. Ultimately, these arguments are unavailing.
1. GXE’s Residency
Guangdong argues that the China Agreement applies to GXE because
GXE is a resident of China. During pre-trial proceedings, however, the Tax
Court granted in part the Commissioner’s motion in limine precluding
Guangdong from raising GXE’s residency as an issue at trial. As the Tax Court
correctly noted, Guangdong did not raise the issue of GXE’s residency until its
pre-trial memorandum, thus preventing the Commissioner from conducting
sufficient discovery on the issue. The Tax Court did not abuse its discretion in
excluding the issue. Bilski, 69 F.3d at 67.
Even if Guangdong properly raised the issue of GXE’s residency, all of the
evidence suggests that GXE is a resident of Hong Kong. GXE was incorporated
in Hong Kong. Its principal place of business was Hong Kong. Guangdong’s
Forms 5472 reported that GXE principally conducted its business in and filed its
income tax returns as a resident of Hong Kong.
Because GXE is not a resident of China and Guangdong failed to timely
raise the issue, the China Agreement does not apply to the transaction in
question. Therefore, the Tax Court correctly found that the China Agreement
did not exempt Guangdong from the withholding tax on its interest payments to
GXE.
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No. 08-60792
2. The “In Substance” Argument
Guangdong also argues that the loan from GXE was in substance a loan
from GITIC. Under this line of argument, the loan from GXE should be treated
as a loan from GITIC, a Chinese resident, thereby exempting it from withholding
tax under the China Agreement. This argument is unpersuasive.
Taxpayers are generally bound by the form of the transaction they have
chosen. Framatome Connectors USA, Inc. v. Comm’r, 118 T.C. 32, 47 (2002).
The substance of a transaction may prevail, however, when a taxpayer’s
“reporting and actions show an honest and consistent respect for the substance
of a transaction.” Estate of Weinert v. Comm’r, 294 F.2d 750, 755 (5th Cir. 1961).
Here, the Tax Court correctly noted that Guangdong’s reporting and actions fully
support its finding that the loan from GXE to Guangdong was not in substance
a loan from GITIC. The loan agreement was signed by a GXE representative,
was issued on GXE letterhead, listed GXE as the lender and made no mention
of GITIC. Guangdong’s general ledger segregated and identified interest
payments made to GXE, and Guangdong paid interest directly to GXE. All of
Guangdong’s Forms 5472 for the years in question reported that Guangdong
paid interest to GXE. Accordingly, we affirm the Tax Court’s ruling.
3. The Agency Analysis
Finally, Guangdong argues that GXE was an agent or conduit of GITIC in
connection with GXE’s loan. If GXE was an agent of GITIC, then, Guangdong
argues, the China Agreement applies to the loan transaction and exempts GXE
from the withholding tax. This argument is also unconvincing.
“[I]t is uncontested that the law attributes tax consequences of property
held by a genuine agent to the principal.” Comm’r v. Bollinger, 485 U.S. 340,
349 (1988). In National Carbide Corp. v. Commissioner, the Supreme Court
stated that, in determining whether a corporation is an agent of another, a court
should consider “whether the corporation operates in the name and for the
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account of the principal, binds the principal, by its actions, transmits money
received to the principal, and whether receipt of income is attributable to the
services of employees of the principal and to assets belonging to the principal.”
Nat’l Carbide Corp. v. Comm’r, 336 U.S. 422, 437 (1949). The subsidiary’s
agency relationship must not be dependent upon the fact that it is owned by the
principal. Id. The agent’s business purpose “must be the carrying on of the
normal duties of an agent.” Id. In Commissioner v. Bollinger, the Supreme
Court declined to “parse the text of National Carbide” and held that it is
“reasonable for the Commissioner to demand unequivocal evidence of
genuineness in the corporation-shareholder context.” Bollinger, 485 U.S. at 349.
The Tax Court correctly held that the record reflects no credible evidence
that GXE was acting as GITIC’s agent in making the loan to Guangdong.
Nothing in the loan agreement suggests that GXE was acting as GITIC’s agent.
GITIC’s later annual reports do not state that GXE is GITIC’s agent. There is
no evidence that GITIC guaranteed GXE’s debt or controlled anything about the
GXE loan. In sum, Guangdong has provided no evidence that GXE meets any
of the agency factors discussed in National Carbide Corp. Therefore, the Tax
Court correctly held that GXE was not acting as GITIC’s agent with respect to
its loan to Guangdong.
C. Additions to Tax
Under I.R.C. § 6651(a)(1), an addition to tax may be imposed for failure to
file a tax return, unless the taxpayer shows that such failure is due to
reasonable cause. “[W]hether the elements that constitute ‘reasonable cause’ are
present in a given situation is a question of fact, but what elements must be
present to constitute ‘reasonable cause’ is a question of law.” Roberts v. Comm’r,
860 F.2d 1235, 1241 (5th Cir. 1988) (citing United States v. Boyle, 469 U.S. 241,
250 n.8 (1985)). This court reviews the Tax Court’s findings “regarding the
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existence or presence of circumstantial factors which might give rise to
reasonable cause under the clearly erroneous standard.” Id. at 1242.
To demonstrate reasonable cause, a taxpayer “must show that he exercised
‘ordinary business care and prudence.’” Treas. Reg. § 301.6651-1(c)(1). “When
an accountant or attorney advises a taxpayer on a matter of tax law, such as
whether a liability exists, it is reasonable for the taxpayer to rely on that advice.”
Boyle, 469 U.S. at 251.
In this case, the IRS found Guangdong liable for additions to tax for failure
to file Forms 1042, Annual Withholding Tax Return for U.S. Source Income of
Foreign Persons, for 1994, 1995, and 1996. Guangdong argues that its failure
to file the Forms 1042 was due to reasonable cause because: (1) its very
obligation to file the returns is the issue being litigated in this case and (2) it
reasonably relied on the advice of Wong, its president and a former CPA, who
believed that the interest payments to GXE were not subject to withholding tax.
As the Tax Court correctly noted, Guangdong’s argument fails for a
number of reasons. First, there is no evidence that Guangdong was told that it
need not file Forms 1042. Guangdong points out that Wong advised it that the
interest payments to GXE were not subject to withholding. This fact, however,
is irrelevant to whether Guangdong was required to file a Form 1042. The
applicable Treasury Regulations require a taxpayer to file a Form 1042 even if
the interest paid is exempt from tax under a treaty. Treas. Reg. §
1.1461-1(c)(2)(I). Therefore, even if a tax professional advised Guangdong that
its interest payments to GXE were exempt from taxation under the China
Agreement, Guangdong would still be liable for failing to file Forms 1042.
Second, the record contains no evidence that Guangdong relied on the
advice of a competent professional in deciding not to file the Forms 1042 for the
years in question. Wong admitted that Guangdong had received no written
advice on the subject of withholding tax liability under the China Agreement.
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Wong himself was not an employee of Guangdong until August 1996, after the
Forms 1042 for 1994 and 1995 were due.
For these reasons, the Tax Court was not clearly erroneous when it
determined that Guangdong failed to establish reasonable cause for failure to
file Forms 1042 for the years at issue. Therefore, we affirm the Tax Court’s
holding that Guangdong is liable for additions to tax for each of the years in
issue.
III. CONCLUSION
In sum, the Tax Court correctly found that the burden of proof remained
with Guangdong. Guangdong’s interest payments to GXE were not exempt from
the withholding tax under the China Agreement because the China Agreement
did not apply to GXE, a Hong Kong resident. The record supports the Tax
Court's conclusion that GXE was not an agent for GITIC and that the loan from
GXE was not in substance a loan from GITIC. The Tax Court’s finding that
Guangdong was liable for addition to tax for each of years in issue was not
clearly erroneous. Accordingly, we affirm the well-reasoned rulings of the Tax
Court.
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