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Hewlett-Packard Co. v. Commissioner of Internal Revenue

United States Court of Appeals, Ninth Circuit

November 9, 2017

Hewlett-Packard Company and Consolidated Subsidiaries, Petitioner-Appellant,
v.
Commissioner of Internal Revenue, Respondent-Appellee. Hewlett-Packard Company and Consolidated Subsidiaries, Petitioner-Appellant,
v.
Commissioner of Internal Revenue, Respondent-Appellee.

          Argued and Submitted November 14, 2016 San Francisco, California

         Appeal from a Decision of the United States Tax Court Ct. Nos. 10075-08, 21976-07

          Alan I. Horowitz (argued), Marc J. Gerson, George A. Hani, and Steven R. Dixon, Miller & Chevalier Chartered, Washington, D.C., for Petitioner-Appellant.

          Arthur T. Catterall (argued), Francesca Ugolini, and Gilbert S. Rothenberg, Attorneys; Diana L. Erbsen, Deputy Assistant Attorney General; Tax Division, United States Department of Justice, Washington, D.C.; for Respondent-Appellee.

          Before: Sidney R. Thomas, Chief Judge, and Alex Kozinski and Michelle T. Friedland, Circuit Judges.

         SUMMARY[*]

         Tax

         The panel affirmed the Tax Court's decision on a petition for redetermination of federal income tax deficiencies that turned on whether an investment by taxpayer Hewlett-Packard (HP) could be treated as equity for which HP could claim foreign tax credits.

         HP bought preferred stock in Foppingadreef Investments (FOP), a Dutch company. FOP bought contingent interest notes, from which FOP's preferred stock received dividends that HP claimed as foreign tax credits. HP claimed millions in foreign tax credits between 1997 and 2003, then exercised its option to sell its preferred shares for a capital loss of more than $16 million. The Tax Court characterized the transaction as debt, thus upholding the deficiency for the credits.

         Acknowledging a circuit split over whether the debt/equity question is one of law, fact or a mix of the two, the panel explained that the best way to read circuit precedent is that the test is "primarily directed" at determining whether the parties subjectively intended to craft an instrument that is more debt-like or equity-like, taking into account eleven factors set forth in A.R. Lantz Co. v. United States, 424 F.2d 1330, 1333 (9th Cir. 1970). The panel concluded that the Tax Court didn't err in finding that HP's investment is best characterized as a debt.

         The panel also upheld the Tax Court's determination that HP's purported capital loss, which can be deducted, was really a fee paid for a tax shelter, which cannot be deducted.

          OPINION

          KOZINSKI, CIRCUIT JUDGE.

         It's a timeless and tiresome question of American tax law: Is a transaction debt or equity? The extremes answer themselves. The classic equity investment entitles the investor to participate in management and share the (potentially limitless) profits-but only after those holding preferred interests have been paid. High risk, high reward. The classic debt instrument, by contrast, entitles an investor to preferred and limited payments for a fixed period. Low risk, predictable reward. But a vast hinterland of hybrid financial arrangements lurks in the middle.

         Despite the boundless ingenuity of financial engineering, tax law insists on pretending that an instrument is either debt or equity, then treating it accordingly-with sharply different consequences for the taxpayer. A corporation's interest payments on debt are deductible, for example, while the dividends it pays to equity holders are not. This black-or-white tax treatment gives taxpayers an incentive to conjure up complex instruments that give them the perfect blend of economic and tax benefits. Taxpayer gamesmanship, in turn, puts courts in the ungainly position of casting about for bright lines along an ...


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