Hewlett-Packard Co. et al. v. Commissioner, T.C. Memo. 2012-135, ruled that a special purpose corporation could not issue equity when the interest in the corporation was puttable by the holder to the other shareholder seven years after issuance, and the board of the issuer had to declare dividends annually to the extent of available cash profits. The opinion rested on the twin grounds of the put, which it treated as a put to the issuer, and the relative security of the investment, said to be insured by the limitations on the issuer’s ability to incur debt and make investments other than one secure loan.
The case arose in the context of an arrangement to derive excess foreign tax credits, relative to the amount of taxable income. The plan would now be prevented by Reg. 1.902-2(e)(5)(iv) “Structured passive investment arrangements.”
Taxpayers should be concerned with this ruling for two reasons:
- It calls into question the equity treatment of any preferred stock issued by a passive investment company that does not operate a business, if the holder has a put to the other shareholder or the issuer, or the issuer must redeem the stock after a fixed term, as is common in many preferred stock issuances.
- In the context in which the opinion was issued, a foreign tax credit generation plan, the 2008 regulation cited above is more of a current threat. The regulation arguably is beyond the interpretive power of the Treasury. Any taxpayer that becomes subject to its terms should consider an attack on the validity of the regulation.
