As we approach the end of 2013, with the House scheduled to be in session for less than three more weeks this year, it appears highly unlikely that we will see any comprehensive U.S. tax reform in 2013.  This provides numerous opportunities for taxpayers, because many techniques for tax minimization are likely to remain available, in spite of proposed but not enacted U.S. international tax reform measures, including the staff discussion draft on international business tax reform, just released on November 19, 2013, by Senate Finance Committee Chairman Max Baucus (D-Mont.).

There is nothing sinister about taxpayers arranging their affairs so as to keep taxes as low as possible.  As Judge Learned Hand famously stated, long ago: “Anyone may arrange his affairs so that his taxes shall be as low as possible; he is not bound to choose that pattern which best pays the treasury.  There is not even a patriotic duty to increase one’s taxes.”  Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934) (J. Hand), aff’d, 293 U.S. 465 (1935).  That quote remains true as ever today, but tax practitioners keep in mind an important Tax Court Memorandum (non-precedential) decision, released on April 16, 2013, namely, Barnes Group, Inc. v. Comm’r, T.C. Memo. 2013-109 (“Barnes Group”).

Barnes Group involved a large sum of cash “trapped” in a foreign subsidiary (generally, repatriation would involve taxation as a dividend), an aggressive “tax-free” repatriation plan (the “Repatriation Scheme”) championed by a Big Four accounting firm that provided a “more-likely-than-not” tax opinion (with the business purpose for the transactions assumed in the opinion) and received a “success fee” equal to a percentage of the expected tax savings.  The two financing subsidiaries, formed for the transaction, had no employees, earnings or bona fide business purposes for their existence.  In addition, on a key intercompany loan, the obligor made no payments.  Further, this taxpayer attempted this same scheme twice, using the same entities.   The Tax Court upheld a twenty percent (20%) accuracy-related penalty under Code section 6662(b)(2)(substantial understatement), even though the taxpayer relied on sophisticated tax advisors and a long-standing revenue ruling.  Rev. Rul. 74-503, 1974-2 C.B. 117 (the ”Zero Basis Ruling”) (since repealed).  The Zero Basis Ruling provided that when a corporate transferor transfers its own stock to a transferee corporation in exchange for transferee stock in a tax-free Code section 351 exchange, both the transferor and the transferee have a zero tax basis in the shares of the other they receive.

If the Service had respected the form of the Repatriation Scheme, there would be no dividend income on the repatriation under the principles of the Zero Basis Ruling and Code Section 956(a).  Instead, the Court looked at the “entire transaction,” and used substance-over-form principles and the step transaction doctrine to disregard two intragroup Code Section 351 transfers, and to find a taxable dividend to the U.S. parent.  It is easy to imagine a more favorable fact pattern, with stronger business purposes, than Barnes Group.