US Outbound: Fifth Circuit holds section 951 inclusions not qualified dividend income

International Tax Review is part of Legal Benchmarking Limited, 4 Bouverie Street, London, EC4Y 8AX

Copyright © Legal Benchmarking Limited and its affiliated companies 2025

Accessibility | Terms of Use | Privacy Policy | Modern Slavery Statement

US Outbound: Fifth Circuit holds section 951 inclusions not qualified dividend income

foley-sean.jpg

mcgrew-landon.jpg

Sean Foley and Landon McGrew, KPMG

The US Court of Appeals for the Fifth Circuit recently held in Rodriguez v. Commissioner, 13 No. 12-60533 (July 2013), that income inclusions under Subpart F of the Internal Revenue Code do not constitute qualified dividend income within the meaning of section 1(h)(11). As a result, the taxpayers in that case were required to pay US tax on their subpart F income inclusions at the higher ordinary income rate of 35%%, rather than the preferential qualified dividend income rate of 15%.

In the Rodriguez case, the taxpayers were married US residents that owned all of the stock of a Mexican controlled foreign corporation called Editora Paso del Norte, SA de CV (Editora). Editora in turn owned a branch in the US. Under the US subpart F rules, the taxpayers were required to include in gross income as investments in US property under section 951(a)(1)(B) and 956 certain amounts attributable to Editora's investment in the US branch. As a result, the taxpayers included in gross income approximately $1.59 million and $1.48 million on their tax returns for 2003 and 2004, respectively.

The dispute in the Rodriguez case turned on how the taxpayers characterised that income. Specifically, the taxpayers reported both amounts as qualified dividend income subject to a preferential 15% tax rate, rather than the 35% rate at which ordinary income is taxed. In March 2008, the Internal Revenue Service (IRS) issued a notice of deficiency arguing that section 951 inclusions do not constitute qualified dividend income within the meaning of section 1(h)(11). After an unsuccessful challenge in the US Tax Court (137 T.C. No. 14, December 2011), the taxpayers filed an appeal with the Fifth Circuit.

In affirming the US Tax Court's decision, the Fifth Circuit began by noting that section 316(a) defines a "dividend" as "any distribution of property made by a corporation to its shareholders". Furthermore, section 1(h)(11) defines a "qualified dividend" as "dividends received during the taxable year". Based on these statutory definitions, the court determined that to constitute an actual dividend, there must be "a distribution by a corporation and receipt by the shareholder; there must be a change in ownership of something of value". Because an inclusion under section 951 does not involve a transfer of ownership or distribution to shareholders, the court held that such an inclusion does not constitute an actual dividend.

The court also rejected the taxpayers' claim that the section 951 inclusions should be treated as deemed dividends for purposes of section 1(h)(11). The court found the argument unpersuasive "because, when Congress decides to treat certain inclusions as dividends, it explicitly states as much, and Congress has not so designated the inclusions at issue here".

The court also acknowledged that, as Editora's sole shareholder, the taxpayers could have caused Editora to issue an actual dividend in the amount of the section 951 inclusions. In that case, the income would have "unquestionably qualified as dividend income subject to the lower 15 rate". The court held, however, that the taxpayers "cannot now avoid their tax obligation simply because they regret the decision they made".

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG.

Sean Foley (sffoley@kpmg.com) and Landon McGrew (lmcgrew@kpmg.com)

KPMG, Washington, DC

Tel: +1 202 533 5588 Fax: +1 202 315 3087

Website: www.us.kpmg.com

more across site & shared bottom lb ros

More from across our site

Heads of tax need to push their teams forward as strategic business advisers to add value across the organisation, says Sandy Markwick
Scott Bessent reportedly felt undermined by Musk naming Gary Shapley as acting IRS commissioner; in other news, Baker Tilly will combine with a top 15 US firm
The promise of nine years’ tax certainty and a ‘rational and pragmatic’ government process makes APAs a no-brainer, Indian tax advisers tell ITR
Despite garnering significant revenues from multinationals, Italy’s digital services tax presents pressing double taxation issues, say Stefano Simontacchi and Francesco Saverio Scandone of BonelliErede
ITR’s research shows that in-house tax counsel in Asia also feel underserved by their advisers’ international networks
World Tax global head of research Jon Moore tells ITR how his team spots standout submissions, and gives early statistical insights into this year’s entries
Australia’s conservative opposition will repeal controversial tax agent reporting rules if elected in the country’s May general election
Shapley would be the fourth person to hold the job this year; in other news, UK tax advisory firm MHA raised fewer funds than expected from its London IPO
The US needs to be involved in pillar one for there to be more international acceptance of the project, Michael Masciangelo says
The UK regulator is investigating EY’s auditing of the national postal service as it relates to the high-profile Horizon scandal, which saw hundreds wrongfully convicted
Gift this article