Judgment summary
This opinion follows an earlier decision, Varian Medical Systems, Inc. & Subs. v. Commissioner, 163 T.C. 76 (2024), in which the Court held that Varian was entitled to a deduction under I.R.C. section 245A for amounts treated as dividends under I.R.C. section 78 for its 2018 tax year, and that I.R.C. section 245A(d)(1) would disallow foreign tax credits attributable to those amounts.
After the earlier opinion, Varian and the Commissioner worked to compute the deduction and the disallowed foreign tax credits, and disputes arose. The Court now had before it Cross-Motions for Summary Judgment on those computational issues.
The Court declined to treat either party's arguments as forfeited. It held that I.R.C. section 246 disallows a portion of Varian's section 245A deduction, and that the formula for the foreign tax credit disallowance under section 245A(d)(1) must include the post-section 965(c) amount in the denominator.
The Court granted the Commissioner's Motion and denied Varian's Motion.
Background
Varian, originally founded in 1948, is the parent company of a consolidated group of medical device and software manufacturers, with its principal place of business in Palo Alto, California. It operates through corporations in many countries, at least some of which are controlled foreign corporations (CFCs) as defined in section 957(a).
Varian and its CFCs are fiscal year taxpayers. As relevant here, their fiscal year started on 30 September 2017 and ended on 28 September 2018 (the 2018 Year).
During the 2018 Year, 22 CFCs owned directly and indirectly by Varian and members of its U.S. consolidated group had Accumulated Post-1986 Deferred Foreign Income as defined in section 965. Shares in nine of those CFCs were held directly by a member of the U.S. consolidated group (first-tier CFCs). Shares in the remaining 13 CFCs were held indirectly through one or more foreign corporations (lower tier CFCs).
Varian filed a consolidated federal income tax return for the 2018 Year. It elected to claim foreign tax credits for foreign taxes deemed paid under section 960 and grossed up its taxable income under section 78 by reporting a dividend of approximately $159 million. 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 first-tier CFCs.
The Commissioner examined the return and issued a Notice of Deficiency disallowing the section 245A deduction, increasing Varian's section 78 dividend by nearly $1.9 million (which Varian does not dispute), and determining in the alternative that if the deduction were allowed, section 245A(d) would reduce Varian's foreign tax credits by approximately $6,362,356.
Varian petitioned the Court and also alleged for the first time that it was entitled to additional section 245A deductions of approximately $100 million, primarily related to its section 78 dividend arising from its lower tier CFCs. In August 2024 the Court issued its prior opinion. The parties then filed the Cross-Motions for Summary Judgment now before the Court.
Core dispute
The parties disputed the computation, for the 2018 tax year, of Varian's dividends received deduction under section 245A and its disallowed foreign tax credits under section 245A(d)(1).
Varian maintained that, procedurally, the Commissioner was precluded from arguing that section 246 disallows a portion of the claimed deduction because the argument came too late; that, substantively, section 246 allows the claimed deduction in full; and that the formula used to compute the foreign tax credit disallowance under section 245A(d)(1) must include a pre-section 965(c) amount in the denominator of the fraction.
The Commissioner disagreed on each point and contended that Varian had forfeited its arguments regarding section 245A(d)(1).
Central substantive questions were whether the phrase "held by the taxpayer" in section 246(c)(1) requires direct ownership or can be satisfied by indirect ownership through another entity, and whether the "net section 965 inclusion" in the denominator of the disallowance formula is the section 965(a) inclusion amount or that amount reduced by the section 965(c) deduction.
Court findings
On forfeiture, the Court declined to treat the Commissioner as having forfeited his section 246 argument. It noted that Varian's prior Motion was for partial summary judgment only, was focused on the effective date issue, and did not directly raise section 246, and that the Commissioner had consistently denied in his Answers that the section 246 holding period was satisfied. Because the qualification under section 246 is a pure legal issue with no disputed facts and there had been no trial, allowing the argument would not prejudice Varian. The Court likewise declined to treat Varian's section 245A(d)(1) arguments as forfeited, as the computational issues had not previously been raised or decided.
On section 246, the Court held that the section 78 dividends attributable to the lower tier CFCs are dividends "on any share of stock" of the CFC whose taxes they represent, because under section 78 Varian is treated as receiving the dividend directly from each CFC and the amount equals the taxes paid by that CFC.
The Court held that "held by the taxpayer" in section 246(c)(1) requires direct ownership. It relied on the ordinary meaning of "hold" as to own or possess, and on the principle that a parent corporation and its subsidiaries are separate entities and that a parent does not own its subsidiaries' property, citing Dole Food Co. v. Patrickson, 538 U.S. 468 (2003). It found that Congress used the term "held" with "directly or indirectly" in at least 22 other Code provisions and expressly approved indirect ownership in section 246(c)(5)(B), showing it knew how to include indirect ownership when intended.
The Court rejected Varian's counterarguments, including that section 78 dividends are not dividends on a share of stock, that "hold" is broad enough to encompass indirect ownership, and that section 246(c)(5)(B) provides a sufficient condition. It held that the phrase "only if" in section 246(c)(5)(B) establishes a necessary, not a sufficient, condition and does not supplant the holding period in section 246(c)(1).
The Court concluded that Varian satisfied the holding period with respect to its first-tier CFCs but not its lower tier CFCs.
On section 245A(d), the Court held that the "net section 965 inclusion" in the denominator of the disallowance formula is the section 965(a) inclusion amount reduced by the associated section 965(c) deduction. It reasoned that all other amounts in the formula, which the parties agreed were the post-section 965(c) amounts, are already reduced, and that using the pre-section 965(c) amount would create an inflated denominator and a meaningless ratio. Using the stipulated first-tier CFC numbers, the post-section 965(c) approach preserved a foreign tax rate of approximately 12.52 percent, while Varian's approach reduced the disallowance to 6.5 percent.
Outcome
The Court denied Varian's Motion for Summary Judgment and granted the Commissioner's Cross-Motion for Summary Judgment. An appropriate order will be issued.
Major issues / areas of contention
- Whether the Commissioner forfeited his argument that section 246 disallows part of Varian's section 245A deduction by not raising it earlier.
- Whether Varian forfeited its arguments regarding the section 245A(d)(1) foreign tax credit disallowance.
- Whether section 78 dividends attributable to lower tier CFCs are dividends "on any share of stock" within section 246(c)(1).
- Whether "held by the taxpayer" in section 246(c)(1) requires direct ownership or can be satisfied by indirect ownership through another entity.
- Whether section 246(c)(5)(B) provides a sufficient condition that replaces the section 246(c)(1) holding period for section 245A deductions.
- Whether the "net section 965 inclusion" in the section 245A(d)(1) disallowance formula denominator is the section 965(a) inclusion amount or that amount reduced by the section 965(c) deduction.