Academic journal article Journal of Accountancy

IRS Can't Shake Yardstick at Tax Treaty

Academic journal article Journal of Accountancy

IRS Can't Shake Yardstick at Tax Treaty

Article excerpt

The Court of Appeals for the Federal Circuit ruled a U.K. bank was entitled to a $65 million refund because the IRS applied a regulation that increased the institution's income by $155 million in violation of the U.S.-U.K. tax treaty of 1975.

In the tax years 1981-1987, National Westminster Bank PLC (NatWest), a U.K. corporation engaged in international banking activities, conducted wholesale banking operations in the U.S. through six permanently established branch locations (the "U.S. Branch"). On its U.S. federal income tax returns for the years at issue, NatWest claimed deductions for accrued interest expenses as recorded on the books of the U.S. Branch.

The IRS used the formula of Treas. Reg. [section] 1.882-5 to recompute the U.S. Branch's interest expense deduction. The formula excludes consideration of interbranch transactions for the determination of assets, liabilities and interest expenses under section 1.882-5(a)(5). The formula also imputed or estimated the amount of capital held by the U.S. Branch based on either a fixed ratio or the ratio of NatWest's average total worldwide liabilities to average total worldwide assets under section 1.882-5(b)(2).

At the trial court level, the Court of Federal Claims granted summary judgment for NatWest, ruling that the application of section 1.882-5 violated the 1975 U.S.-U.K. tax treaty, Convention for the Avoidance of Double Taxation and the Prevention of Fiscal Evasion with Respect to Taxes on Income and Capital Gains. …

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