The U.S. Tax Court recently held in Osvaldo and Ana M. Rodriguez v. Commissioner, 137 T.C. No. 14 (2011), that amounts included in gross income under the controlled foreign corporation (CFC) rules of Code Sections 951 and 956 are not eligible for the reduced tax rate (typically 15%) available to “qualified dividends” under Code Section 1(h)(11). The case involved a situation where the taxpayers, who were Mexican citizens and permanent residents of the U.S., owned all of the stock of a Mexican corporation that had U.S. holdings. The taxpayers reported on their U.S. tax return the earnings of the Mexican company that were invested in U.S. property (as is required by Code Sections 951 and 956). However, the taxpayers took the position that the earnings were dividends from the Mexican corporation and eligible for the reduced tax rate available to qualified dividends.
The U.S. Tax Court, after an analysis of the CFC and dividend rules, said that Code Section 951 income inclusions are not to be treated as dividends, which may be eligible for the reduced tax rate, since they do not involve an actual distribution of property by a controlled foreign corporation to its shareholders. In the absence of such a distribution, the reduced tax rate of Code Section 1(h)(11) did not apply.
The conclusion of the Tax Court was consistent with the guidance the IRS had issued in Notice 2004-70, 2004-2 C.B. 724, on the identical issue. While not a surprise to practitioners, the decision now confirms that income inclusions under Code Section 951 are not classified as dividends for U.S. income tax purposes.