Domestic Corporation Can't Claim Credits for Taxes Paid by Foreign Subsidiaries

(Parker Tax Publishing March 2025)

The Tax Court held that the domestic corporation and parent of two tiers of foreign corporations was not allowed foreign tax credits for income taxes paid or accrued by the lower tier of foreign corporations how by the parent corporation. The court found that, as a matter of law, the parent company was not deemed to have paid any foreign taxes under Code Sec. 902 or Code Sec. 960. Eaton Corporation and Subs. v. Comm'r, 164 T.C. No. 4 (2025).

Background

Eaton Corporation (Eaton) is a domestic corporation with its principal place of business in Cleveland, Ohio. During 2007 and 2008, Eaton was the parent of an affiliated group of corporations (Eaton Group) that filed consolidated federal income tax returns. During these years members of the Eaton Group were 100 percent shareholders of three foreign corporations that were controlled foreign corporations (CFCs) within the meaning of Code Sec. 957. The three CFCs (i.e., upper tier CFC partners) were (1) Eaton Holding III S.a.r.l., (2) Eaton Finance N.V., and (3) Eaton B.V. The upper tier CFC partners collectively held (directly or indirectly) 100 percent of the membership interests in a domestic partnership, Eaton Worldwide, LLC (EW LLC).

During 2007 and 2008 EW LLC owned equity interests in, and was the sole U.S. shareholder of, several CFCs (i.e., lower-tier CFCs). The lower tier CFCs earned subpart F income within the meaning of Code Sec. 952 and also generated amounts required to be determined under Code Sec. 956. EW LLC accordingly took into account under Code Sec. 951(a) the subpart F income and the amounts calculated under Code Sec. 956 with respect to the lower tier CFCs. EW LLC issued Schedules K - 1, Partner's Share of Income, Deductions, Credits, etc., to the upper tier CFC partners reflecting their distributive shares of its income inclusions under Code Sec. 951(a).

Eaton II, LP (Eaton II), a Scottish limited partnership, was one such lower tier CFC from February 1, 2007, through 2010. Eaton II was owned, directly and indirectly, by EW LLC and the upper tier CFC partners. Eaton II elected to be treated as a corporation for U.S. federal income tax purposes. Neither Eaton II nor any other lower tier CFC made any distributions of property to EW LLC in 2007 or 2008.

Separate from the lower tier CFCs, EW LLC during the relevant years owned all the common stock of Argo Tech Holdings Corp. (AT Holdings), a Delaware corporation, which EW LLC had purchased from a third party in March 2007. The sole asset of AT Holdings was the stock of Argo-Tech Corp., also a Delaware corporation. The parties stipulated that this interest constituted U.S. property held by the upper tier CFC partners for purposes of applying Code Sec. 951(a)(1)(B) and Code Sec. 956.

In 2019, the Tax Court held in Eaton Corp. and Subs. v. Comm'r (Eaton I), 152 T.C. 43 (2019), that the upper tier CFC partners must increase their E&P on account of their allocations of EW LLC's Code Sec. 951(a) inclusions with respect to the lower tier CFCs. Under Code Sec. 951 and Code Sec. 956, therefore, Eaton was required to include in its consolidated income for 2007 and 2008 at least $73,030,810 and $114,065,635, respectively - that is, Code Sec. 956 amounts related to EW LLC's ownership of AT Holdings. Before the Tax Court issued its opinion in Eaton I, Eaton and its affiliates had not included the full amount determined under Code Sec. 951(a)(1) and Code Sec. 956(a) with respect to AT Holdings because, in Eaton's view, the upper tier CFC partners had insufficient E&P.

After the Tax Court issued Eaton I, the IRS filed an amended answer contending that Eaton for 2007 had an additional Code Sec. 951(a) inclusion of $65,620,820. The IRS argued that this inclusion was required under Reg. Sec. 1.956-1T(b)(4), the so-called loan anti-abuse rule. This rule applied here, in the IRS's view, because the upper tier CFC partners were treated as holding certain debt obligations (CFC Loans) that were funded by EW LLC and extended by Eaton II (a lower tier CFC) to AT Holdings. The IRS based its position on the allegation that, in March 2007, the upper tier CFC partners contributed approximately $456.6 million in cash to EW LLC, which enabled EW LLC to fund the CFC Loans. The IRS contended that the CFC Loans were "obligations of a United States person" and, as such, are U.S. property under Code Sec. 956(c)(1)(C), generating an increased income inclusion for Eaton under Code Sec. 951(a)(1)(B).

The Tax Court did not, however, address the merits of the IRS's position under the loan anti-abuse rule. The question for the court to decide was whether, with respect to whatever Code Sec. 951 inclusions Eaton was ultimately determined to have, Eaton was entitled to deemed-paid foreign tax credits (FTCs) originating from the lower tier CFCs, again assuming that those CFCs had paid or accrued creditable foreign income taxes.

Eaton and the IRS filed cross motions for partial summary judgment on the purely legal question of whether the interposition of EW LLC between the two tiers of CFCs prevented Eaton from claiming deemed-paid FTCs stemming from income taxes paid or accrued by the lower tier CFCs. Eaton claimed FTCs on account of the Code Sec. 951 inclusions determined in Eaton I (those related to AT Holdings) and also on account of any additional Code Sec. 951 inclusions generated by the IRS's invocation of the loan anti-abuse rule. As to both sets of Code Sec. 951 inclusions, Eaton contended that it should be deemed to have paid foreign income taxes that were paid by the lower tier CFCs on the E&P underlying the inclusions. In other words, while Eaton's Code Sec. 951 inclusions reflected activity at the CFC partner level - i.e., EW LLC's investment in AT Holdings - Eaton argued that it was entitled to FTCs for taxes paid by the lower tier CFCs on their subpart F income and Code Sec. 956 amounts. Eaton's argument proceeded as follows: (1) the subpart F income and Code Sec. 956 amounts generated by the lower tier CFCs created Code Sec. 951 inclusions for EW LLC, (2) Eaton I held that those inclusions increased the E&P of the upper tier CFC partners, and (3) without the upper tier CFC partners' increased E&P, Eaton would not have had to include the Code Sec. 956 amount related to AT Holdings. The taxes, Eaton said, should follow the E&P.

There were two provisions that could potentially cause Eaton to have deemed-paid foreign tax credits: Code Sec. 902 and Code Sec. 960. Before 2018, Code Sec. 902(a) provided that a domestic corporation which owns 10 percent or more of the stock of a foreign corporation from which it receives dividends is deemed to have paid the same proportion of the foreign corporation's foreign income taxes as (1) the amount of such dividends bears to (2) such foreign corporation's undistributed earnings. Thus, for Code Sec. 902 to apply there needs to be receipt of a dividend. Eaton specifically relied on Code Sec. 960(a)(1), which provides that if there is included under Code Sec. 951(a) in the gross income of a domestic corporation any amount attributable to E&P of a foreign corporation which is a member of a qualified group with respect to the domestic corporation, then Code Sec. 902 is generally applied as if the amount included were a dividend paid by the foreign corporation. In short, Code Sec. 960(a) applies if a domestic corporation has a Code Sec. 951(a) inclusion with respect to the E&P of a member of its qualified group. If these conditions are met, Code Sec. 902 applies as if the amount so included were a dividend paid by the foreign corporation.

Analysis

The Tax Court held that Eaton was not entitled to claim a credit for foreign taxes paid by the lower tier CFCs under either Code Sec. 902 or Code Sec. 960. There was no credit under Code Sec. 902, in the court's view, because there was no dividend distribution. And the court determined that there was no credit under Code Sec. 960 because the Code Sec. 951(a) inclusions with respect to the lower tier CFCs were not taken into gross income by a domestic corporation. The court concluded that, because Eaton could not show it was entitled to be deemed to have paid foreign income tax, it was not entitled to a credit on account of the same under Code Sec. 901(a).

The court found that the same result would follow with respect to any additional Code Sec. 951 inclusions attributable to application of the loan anti-abuse rule to the upper tier CFC partners. According to the court, Code Sec. 960 would apply because Eaton (a domestic corporation) would have a Code Sec. 951(a) inclusion (the new Code Sec. 956 amount) with respect to the E&P of a member of its qualified group (the upper tier CFC partners). Therefore, Code Sec. 902 would apply as if that Code Sec. 951 inclusion were a dividend paid by the upper tier CFC partners, and Eaton would be entitled to FTCs for any taxes paid by the upper tier CFC partners with respect to such amounts. But no credit would be available for taxes paid by the lower tier CFCs with respect to their subpart F income and Code Sec. 956 amounts.

The court emphasized that Eaton chose this structure. If EW LLC were not interposed between two tiers of foreign corporations, Code Sec. 951(a) inclusions with respect to the lower tier CFCs would be taken into account directly by Eaton, and Code Sec. 960 would apply to deem Eaton to have paid the lower tier CFCs' foreign income taxes. Instead, Eaton structured ownership of its foreign corporations to avoid Eaton's making Code Sec. 951(a) inclusions with respect to the lower tier CFCs. Eaton's chosen structure did not trigger Code Sec. 960, and ultimately, Eaton did not get the benefit of being deemed to pay foreign income taxes paid by the lower tier CFCs.

For a discussion of foreign taxes deemed paid by a domestic corporation, see Parker Tax ¶101,810.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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