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Finance sub treated as conduit.

In a significant extension of revenue ruling 84-152, the IRS held in a letter ruling that a foreign-owned offshore finance subsidiary, established in a worldwide financial center, constitutes a conduit for U.S. withholding tax purposes. Interest paid by a U.S. subsidiary to the finance subsidiary, heretofore exempt by treaty, is now subject to U.S. withholding tax.

Revenue ruling 84-152 had involved loans through the intermediary finance subsidiary located in a treaty country. When its U.S. subsidiary needed working capital, the foreign parent loaned the funds to its finance subsidiary, which in turn reloaned the same amount to the taxpayer. The IRS held that interest paid by the taxpayer to the finance subsidiary was to be treated as if actually paid to the foreign parent, reasoning that the subsidiary was a conduit because it did not have "dominion and control" over the interest income.

In letter ruling 9133004, a technical advice, the finance subsidiary obtained funds from the foreign parent via a capital contribution and from proceeds derived from the sale of debentures. On the same day, it reloaned all these amounts to the taxpayer. The subsidiary paid almost all of the interest income from the taxpayer to the foreign parent as dividends in the same year.

Although the 1984 revenue ruling had concerned payments made to the foreign parent in the form of interest, the IRS disregarded this difference, reasoning that the form of payment made the finance subsidiary no less a conduit.

Observation: In this letter ruling, the IRS pierced the "equity wall" of a foreign finance subsidiary used for inbound financing. The analysis is flawed because it ignores the distinction between interest and dividends. Moreover, it appears to constitute a change from the position espoused in revenue ruling 84-152. Nevertheless, a 99% flow-through of funds under these circumstances should ve avoided.

Robert Willens, CPA, senior vice-president at Lehman Brothers New York City (corporate); Marianne Burge, CPA, director of international tax services, Kenneth Kral, CPA, international tax partner, and Marylouise Dionne, Esq., international tax manager, at Price Waterhouse, New York City (international).
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Author:Dionne, Marylouise
Publication:Journal of Accountancy
Date:Dec 1, 1991
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