Barry M. Smith & Rochelle Smith v. Commissioner

151 T.C. No. 5

UNITED STATES TAX COURT

BARRY M. SMITH AND ROCHELLE SMITH, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 14900-15. Filed September 18, 2018.

Ps owned, through a pair of grantor trusts and an S corporation,
controlled foreign corporations (CFCs) incorporated in Hong Kong
and later in Cyprus. In 2008 the Hong Kong CFC paid Ps a dividend
of $12.3 million. In 2009 the Cypriot CFC paid Ps a dividend of
$57.1 million. In 2009 the Cypriot CFC also canceled an account re-
ceivable owed by Ps’ S corporation. That account receivable had an
outstanding balance of $21.1 million when it was canceled.

R determined that the dividend paid by the Hong Kong CFC in
2008 was taxable as ordinary dividend income under I.R.C. sec.
962(d), to the extent of the difference between the amount the Hong
Kong CFC had distributed to them in 2008 and the tax they had
previously paid on account of prior I.R.C. sec. 951(a) inclusions to
which that E&P was attributable. R next determined that the Cypriot
CFC was not a “qualified foreign corporation” within the meaning of
I.R.C. sec. 1(h)(11)(C)(i) and hence that the $57.1 million dividend
the Cypriot CFC paid Ps in 2009 was taxable as ordinary dividend in-
come, not as “qualified dividend income” subject to a reduced rate of
 -2-

tax under I.R.C. sec. 1(h)(1). Finally, R determined that the cancel-
lation of the account receivable balance owed to the Cypriot CFC was
taxable to Ps in 2009 as a constructive dividend under I.R.C. secs.
301(c)(1), 316, and 1366.

1. Held: The Hong Kong CFC was neither a domestic cor-
poration nor a “qualified foreign corporation” under I.R.C. sec.
1(h)(11)(C)(i). Its 2008 distribution of $12.3 million to Ps therefore
was not “qualified dividend income” under I.R.C. sec. 1(h)(11)(B) but
rather was taxable to them under I.R.C. sec. 962(d) at ordinary-
income rates.

2. Held, further, petitioners have not established that the “act
of state” doctrine applies to require that we accord dispositive effect
to a residency certificate issued by the Cyprus Ministry of Finance
asserting that the Cypriot CFC was a resident of Cyprus during 2009.
Because there exist genuine disputes of material fact concerning the
CFC’s residency, summary judgment is inappropriate on the question
whether the Cypriot CFC was a “qualified foreign corporation” and
hence as to whether the $57.1 million dividend it paid Ps in 2009 was
“qualified dividend income” under I.R.C. sec. 1(h)(11)(B)(i)(II).

3. Held, further, Ps received from the Cypriot CFC in 2009 a
constructive distribution of $21.1 million that was taxable to them as
a dividend under I.R.C. secs. 301(c)(1) and 316(a).

Desiree E. Fernandez, Jose M. Ferrer, Summer A. Lepree, Jeffrey L.

Rubinger, and Samuel C. Ullman, for petitioners.

Jeffrey B. Fienberg, Michael S. Kramarz, Sergio Garcia-Pages, and Richard

A. Rappazzo, for respondent.
 -3-

OPINION

LAUBER, Judge: During 2008 and 2009 petitioners owned, through a pair

of domestic grantor trusts and an S corporation, controlled foreign corporations

(CFCs) incorporated in Hong Kong and later in Cyprus. The Internal Revenue

Service (IRS or respondent) determined that petitioners during these years had

received actual or constructive dividends from the Hong Kong CFC and from the

Cypriot CFC. On the basis of these and other adjustments the IRS determined, for

petitioners’ 2008 and 2009 taxable years, deficiencies of $6,308,329 and

$18,743,201, respectively.

This case is currently before the Court on cross-motions for partial summary

judgment under Rule 121.1 These motions ask that we decide three questions:

(1) Whether a $12,307,591 dividend that the Hong Kong CFC paid peti-

tioners in 2008 should be deemed to have been distributed by a domestic corpora-

tion, so as to be subject to a reduced rate of tax as a “qualified dividend” under

section 1(h)(11)(B)(i)(I);

1
All statutory references are to the Internal Revenue Code (Code) in effect
for the tax years at issue, and all Rule references are to the Tax Court Rules of
Practice and Procedure. We round all monetary amounts to the nearest dollar.
 -4-

(2) Whether a $57,106,892 dividend that the Cypriot CFC paid petitioners

in 2009 was received from a “qualified foreign corporation,” so as to be subject to

a reduced rate of tax as a “qualified dividend” under section 1(h)(11)(B)(i)(II); and

(3) Whether petitioners received a constructive dividend of $21,055,123 in

2009 when the Cypriot CFC canceled a debt owed to it by petitioners’ S corpora-

tion.

The parties have filed cross-motions for partial summary judgment on the

first and third questions, and they agree that these questions are encumbered by no

disputed issues of material fact. We agree that these two questions may appropri-

ately be decided summarily, and we answer both questions in respondent’s favor.

Petitioners seek summary judgment on the second question, and respondent

opposes that motion on the ground that material factual disputes exist concerning

the Cypriot CFC’s residency. Petitioners urge that they are entitled to judgment as

a matter of law on the theory that the “act of state” doctrine requires us to accept,

as dispositive of the Cypriot CFC’s status as a bona fide resident of Cyprus, a cer-

tification from the Cyprus Ministry of Finance (Ministry) to that effect. Viewing

the facts and inferences drawn from them in the light most favorable to respondent

as the nonmoving party, we conclude that petitioners have not established that the

act of state doctrine applies. Because there exist genuine disputes of material fact
 -5-

concerning the Cypriot CFC’s residency, we will deny petitioners’ motion for

partial summary judgment on the second question.

Background

The following facts are derived from the parties’ pleadings and motion pa-

pers, the declarations and the exhibits attached thereto, and the parties’ first stipu-

lation of facts. Petitioners resided in Florida when they filed their petition.

A. Business Structure

Beginning in 1980 petitioners owned and operated a group of domestic and

foreign corporations that manufactured and sold consumer electronic products.

Through a pair of grantor trusts, petitioners owned Hopper Radio of Florida, Inc.

(Hopper US), an S corporation. For Federal income tax purposes, petitioners were

treated as owning 100% of the stock of Hopper US, and they were thus required to

take into account 100% of its income. See sec. 1361(a) and (b).

Hopper US was the sole shareholder of Memcorp, Inc. (Memcorp US), a

Florida corporation. As a “qualified subchapter S subsidiary” of Hopper US,

Memcorp US was treated as a disregarded entity. See sec. 1361(b)(3)(A)(i), (B).

For sake of simplicity, we will refer to all transactions conducted by Memcorp US

as having been conducted by Hopper US directly.
 -6-

From January 1995 until November 18, 2008, Hopper US was treated as

owning, through Memcorp US, all the stock of Memcorp Asia Ltd. (Memcorp

HK). Memcorp HK was incorporated in Hong Kong and, from the date of its in-

corporation until November 18, 2008, was a CFC within the meaning of section

957(a). For subpart F purposes, Hopper US, although an S corporation, was treat-

ed as a domestic partnership, and its shareholders were “treated as partners of such

partnership.” See sec. 1373(a). Petitioners were accordingly required to include

in their gross income, under section 702, items of income, loss, deduction, and

foreign tax credit attributable to Memcorp HK (and any other CFCs that Hopper

US might own).

Before the tax years at issue petitioners began winding down their active

business operations. In July 2007 they sold to a third party, for $47.5 million, the

operating assets of Hopper US and Memcorp HK. This left Memcorp HK with

substantial cash, both from its prior operations and from the sale proceeds. Peti-

tioners planned to have this cash distributed to them.

Petitioners hoped that the contemplated distribution could be treated as

“qualified dividend income” (QDI) under section 1(h)(11)(B), which would allow

the dividend to be taxed at a rate of 15% or lower. See sec. 1(h)(1), (11)(B). This

would be possible only if Memcorp HK were a “qualified foreign corporation.”
 -7-

See sec. 1(h)(11)(B)(i)(II). But Memcorp HK’s residency presented a complica-

tion in that respect. A “qualified foreign corporation” is defined to mean a com-

pany that is either “incorporated in a possession of the United States” or is “eli-

gible for benefits of a comprehensive income tax treaty with the United States.”

Sec. 1(h)(11)(C)(i). Memcorp HK was not incorporated in a U.S. possession. And

Hong Kong did not have an income tax treaty with the United States.2

Petitioners accordingly decided to move Memcorp HK to Cyprus, which did

have an income tax treaty with the United States. Toward that end petitioners in

August 2008 incorporated Hopper Cyprus as a subsidiary of Hopper US. From the

date of its incorporation Hopper Cyprus has been a CFC within the meaning of

section 957(a).

On November 18, 2008, Hopper US transferred to Hopper Cyprus all of its

shares in Memcorp HK. Memcorp HK then filed with the IRS, and the IRS ap-

proved, a Form 8832, Entity Classification Election, by which Memcorp HK elect-

ed to be treated as a disregarded entity. The ultimate effect of these transactions

2
Although there is an income tax treaty between the United States and the
People’s Republic of China, it does not cover Hong Kong, which has an indepen-
dent taxation system. See Agreement for the Avoidance of Double Taxation and
the Prevention of Tax Evasion With Respect to Taxes on Income, China-U.S., art.
2(1), Apr. 30, 1984, T.I.A.S. No. 12,065 (stating that the taxes to which the treaty
applies are those in the United States and “in the People’s Republic of China”);
Notice 97-40, 1997-2 C.B. 287.
 -8-

was that, as of November 18, 2008, Memcorp HK reorganized itself as Hopper

Cyprus in a tax-free reorganization under section 368(a)(1)(F).

By virtue of this reorganization Hopper Cyprus inherited all the assets pre-

viously owned by Memcorp HK. These assets included (1) a large sum of cash

generated from the sale of Memcorp HK’s operating assets and (2) an account re-

ceivable that Hopper US had owed to Memcorp HK for many years.

B. Prior Year Audits

The IRS examined petitioners’ tax returns for 2004 and 2005, and the

results of those examinations are relevant to certain issues we must address. The

IRS determined that Memcorp HK during 2004 held an investment of $15,765,803

in “United States property” within the meaning of section 956(c)(1)(C) (U.S.

property), which was attributable to the account receivable (mentioned above) that

Hopper US owed to Memcorp HK. The IRS accordingly determined that

petitioners for 2004 were required to include that amount in gross income under

section 951(a)(1)(B).

Petitioners acquiesced in this determination and filed an amended return for

2004, electing the benefits of section 962 with respect to the $15,765,803 gross

income inclusion. This election allowed them to treat this inclusion as if the

$15,765,803 “were received by a domestic corporation.” Sec. 962(a)(1). This per-
 -9-

mitted petitioners to be taxed at the corporate tax rate under section 11 and thus

reduced their current tax liability.3 The IRS accepted petitioners’ election, and

petitioners paid tax of $5,518,031 on the section 951(a) inclusion for 2004.

This pattern repeated itself for the 2005 tax year. In its examination of peti-

tioners’ 2005 return, the IRS determined that Memcorp HK held during 2005 an

investment of $2,612,877 in U.S. property, again attributable to the account re-

ceivable that Hopper US owed to Memcorp HK. Petitioners again filed an

amended return electing the benefits of section 962, and they paid tax of $553,058

at the section 11 corporate tax rate.

C. Transactions During 2008 and 2009

In mid-2008, several months before its reorganization to Cyprus, Memcorp

HK distributed $18,378,680 to Hopper US. This amount equaled the sum of peti-

tioners’ section 951(a) inclusions for 2004 and 2005 ($15,765,803 + $2,612,877 =

$18,378,680). Because petitioners had elected the benefits of section 962 for both

inclusions, this distribution was subject to section 962(d), captioned “Special Rule

for Actual Distributions.”

3
Petitioners also became eligible to claim deemed-paid foreign tax credits
under sections 902 and 960 for the foreign taxes paid by Memcorp HK with
respect to the earnings and profits (E&P) included in petitioners’ gross income.
See sec. 962(a)(2). Those credits are not at issue here.
 - 10 -

Section 962(d) creates an exception to section 959(a)(1), which generally

excludes from a U.S. shareholder’s gross income a CFC’s previously taxed E&P.

Section 962(d) provides that, if a U.S. shareholder has elected the benefits of sec-

tion 962(a) with respect to prior section 951(a) inclusions, the related E&P of the

CFC, when actually distributed to the U.S. shareholder, “shall, * * * notwithstand-

ing the provisions of section 959(a)(1), be included in gross income to the extent

that such * * * [E&P] so distributed exceed the amount of tax” previously paid by

the U.S. shareholder.

The total amount of tax petitioners paid on account of the 2004 and 2005 in-

clusions was $6,071,089 (viz., $5,518,031 + $553,058). Memcorp HK had E&P

of $18,378,680 attributable to those prior inclusions, and that E&P was actually

distributed to petitioners in 2008. The excess of the amount actually distributed to

petitioners in 2008, $18,378,680, over the tax they had previously paid on account

of the section 951(a) inclusions, $6,071,089, is $12,307,591. Petitioners have

stipulated that they did not include this $12,307,591 in gross income under sec-

tions 962(d) and 702 for 2008.

At the beginning of 2009 Hopper Cyprus had, among the assets on its

books, a large account receivable owed by Hopper US. This was the same open

account receivable, previously held by Memcorp HK, that was the focus of the
 - 11 -

IRS’ examination of petitioners’ 2004 and 2005 returns. On March 31, 2009,

Hopper Cyprus wrote off $21,055,123, the then-outstanding balance of the ac-

count, thus canceling the debt that Hopper US owed to it.

D. Cyprus Competent Authority Proceedings

On March 24, 2009, Hopper Cyprus paid a cash dividend of $57,106,892 to

Hopper US. On their joint return for 2009 petitioners reported this dividend as

“qualified dividend income” under section 1(h)(11)(B)(i). They based this posi-

tion on the theory that Hopper Cyprus was a “qualified foreign corporation” within

the meaning of section 1(h)(11)(C)(i)(II).

Petitioners alleged in their petition that Hopper Cyprus had “obtained a tax

residency certificate from the Cyprus tax authorities confirming its Cyprus tax res-

idence” during 2009. Petitioners subsequently amended their petition to allege

that Hopper Cyprus had “obtained a confirmation letter of Amicorp (Cyprus) Ltd.,

administrators of Hopper Cyprus, confirming that Hopper Cyprus was a tax resi-

dent of Cyprus during all relevant times.” In June 2016 respondent filed, and we

granted, a motion to stay proceedings in this case temporarily, pending the out-

come of consultations and information exchanges between the U.S. competent

authority and the competent authority of the Republic of Cyprus under the

Convention for the Avoidance of Double Taxation and the Prevention of Fiscal
 - 12 -

Evasion With Respect to Taxes on Income, Cyprus-U.S., art. 28, Mar. 19, 1984,

T.I.A.S. No. 10,965 (Treaty). Respondent filed that motion to “learn the facts

surrounding petitioners’ request for, and Cyprus’ issuance of,” certificates

regarding Hopper Cyprus’ alleged residency in that country. The IRS received

responses from the Cypriot competent authority on July 1 and November 22, 2016,

and January 12, 2017, and those responses are included in the record of this case.

E. IRS Examination

Petitioners jointly filed Forms 1040, U.S. Individual Income Tax Return,

for 2008 and 2009, and the IRS selected both returns for examination. As a result

of this examination the IRS determined (among other things) that:

(1) for 2008 petitioners had failed to report, as ordinary dividend income

under section 962(d), the $12,307,591 difference between the amount Memcorp

HK had distributed to them in 2008 and the tax they had previously paid on ac-

count of the prior section 951(a) inclusions to which that E&P was attributable;

(2) for 2009 petitioners had erred in reporting the $57,106,892 dividend

from Hopper Cyprus, not as an ordinary dividend, but as “qualified dividend in-

come” subject to a reduced rate of tax under section 1(h)(1); and
 - 13 -

(3) for 2009 petitioners had failed to report, as a constructive dividend un-

der sections 301(c)(1), 316, and 1366, the $21,055,123 balance of the account re-

ceivable owed by Hopper US, which Hopper Cyprus had canceled in March 2009.

On the basis of these and other adjustments, the IRS on March 10, 2015,

issued petitioners a timely notice of deficiency, determining a deficiency of

$6,308,329 for 2008 and $18,743,201 for 2009. Petitioners timely petitioned this

Court for redetermination of these deficiencies.

Discussion

I. Summary Judgment Standard

Summary judgment is intended to expedite litigation and avoid costly, time-

consuming, and unnecessary trials. See FPL Grp., Inc. & Subs. v. Commissioner,

116 T.C. 73, 74 (2001). Either party may move for summary judgment upon all or

any part of the legal issues in controversy. Rule 121(a). A motion for summary

judgment or partial summary judgment will be granted only if it is shown that

there is no genuine dispute as to any material fact and that a decision may be ren-

dered as a matter of law. See Rule 121(b); Elec. Arts, Inc. v. Commissioner, 118

T.C. 226, 238 (2002).

The moving party bears the burden of proving that there is no genuine dis-

pute as to any material fact. For this purpose the Court views all factual materials
 - 14 -

and inferences in the light most favorable to the nonmoving party. Dahlstrom v.

Commissioner, 85 T.C. 812, 821 (1985). However, the nonmoving party “may not

rest upon the mere allegations or denials” of his pleadings but instead “must set

forth specific facts showing that there is a genuine dispute for trial.” Rule 121(d);

see Sundstrand Corp. v. Commissioner, 98 T.C. 518, 520 (1992), aff’d, 17 F.3d

965 (7th Cir. 1994).

The parties have filed cross-motions for partial summary judgment on the

first and third questions presented, evidencing their belief that these questions are

encumbered by no genuine disputes of material fact. We concur in that assessment

and conclude that those questions may be summarily adjudicated. As explained

more fully below, we reach a different conclusion as to the second question, con-

cerning Hopper Cyprus’ residency.

II. Governing Statutory Framework

A CFC is a foreign corporation more than 50% of whose stock (in terms of

voting power or value) is owned (directly, indirectly, or constructively) by United

States shareholders (U.S. shareholders). Sec. 957(a). A U.S. shareholder is a

United States person, as defined in section 957(c), who owns (directly, indirectly,

or constructively) 10% or more of the total combined voting power of the CFC’s

stock. Sec. 951(b). The parties agree that all of petitioners’ foreign subsidiaries
 - 15 -

were CFCs at the relevant times and that petitioners were U.S. shareholders of

these CFCs.

Section 951(a)(1) requires that a U.S. shareholder owning CFC stock on the

last day of the CFC’s taxable year include in gross income (among other things)

“the amount determined under section 956 with respect to such shareholder for

such year.” Under section 956(a), the amount determined under section 956 with

respect to a U.S. shareholder is the lesser of:

(1) the excess (if any) of

(A) such shareholder’s pro rata share of the average of
the amounts of United States property held (directly or
indirectly) by the controlled foreign corporation as of the close
of each quarter of such taxable year, over

(B) the amount of earnings and profits described in
section 959(c)(1)(A) with respect to such shareholder, or

(2) such shareholder’s pro rata share of the applicable earnings
of such controlled foreign corporation.

U.S. property includes (among other things) “an obligation of a United

States person.” Sec. 956(c)(1)(C). An “obligation” generally includes “any bond,

note, debenture, * * * account receivable, note receivable, open account, or other

indebtedness.” Sec. 1.956-2T(d)(2)(i), Temporary Income Tax Regs., 53 Fed.

Reg. 22171 (June 14, 1988).
 - 16 -

Section 962 sets forth an alternative taxing regime for individual U.S. share-

holders who invest abroad through CFCs. Section 962(a)(1) provides that an indi-

vidual U.S. shareholder may elect to be taxed on his section 951(a) inclusions at

the corporate tax rates specified in sections 11 and 55. This election may also

entitle the individual to claim deemed-paid foreign tax credits (FTCs) under sec-

tion 960, which would otherwise be unavailable. See sec. 962(a)(2).

Section 962(d), captioned “Special Rule for Actual Distributions,” provides

that, upon a CFC’s actual distribution of E&P previously included in a U.S. share-

holder’s gross income (962 E&P), that shareholder must include such distribution

in gross income to the extent it exceeds the U.S. tax he previously paid with re-

spect to the relevant section 951(a) inclusion(s). Regulations under section 962

implement this rule by bifurcating the 962 E&P into two categories: excludable

962 E&P and taxable 962 E&P. See sec. 1.962-3(b)(1), Income Tax Regs. Ex-

cludable 962 E&P equal the amount of U.S. income tax previously paid on the

section 951(a) inclusions, and the remaining amounts are taxable 962 E&P. Ibid.

Sections 301 and 316 govern the characterization for Federal income tax

purposes of corporate distributions of property to shareholders. If the distributing

corporation has sufficient E&P, the distribution is a dividend that the shareholder

must include in gross income. Secs. 301(c)(1), 316(a). If the distribution exceeds
 - 17 -

the corporation’s E&P, the excess represents a nontaxable return of capital or

capital gain. Sec. 301(c)(2) and (3). A dividend may be formally declared or it

may be constructive. See Boulware v. United States, 552 U.S. 421, 429-430

(2008); Truesdell v. Commissioner, 89 T.C. 1280, 1295 (1987). A constructive

dividend is an economic benefit conferred upon a shareholder by a corporation

without an expectation of repayment. Truesdell, 89 T.C. at 1295 (citing Noble v.

Commissioner, 368 F.2d 439, 443 (9th Cir. 1966), aff’g T.C. Memo. 1965-84).

As enacted in the Jobs and Growth Tax Relief Reconciliation Act of 2003,

Pub. L. No. 108-27, sec. 302, 117 Stat. at 760, section 1(h)(11) makes preferential

tax rates available for QDI.4 QDI includes dividends received during the taxable

year from “domestic corporations” and “qualified foreign corporations.” Sec.

1(h)(11)(B)(i). A “qualified foreign corporation” is a corporation that is

“incorporated in a possession of the United States” or is “eligible for benefits of a

comprehensive income tax treaty with the United States.” Sec. 1(h)(11)(C)(i).

Dividends that do not qualify as QDI under these provisions are subject to tax at

the rates applicable to the taxpayer’s ordinary income.

4
During the years at issue, section 1(h)(1) set forth reduced rates of tax, gen-
erally ranging from 0% to 15%, upon an individual taxpayer’s net capital gain (de-
fined to include QDI).
 - 18 -

III. Analysis

A. 2008 Distribution From Memcorp HK

The first issue concerns the $12,307,591 of taxable 962 E&P that Memcorp

HK distributed to petitioners in mid-2008. Petitioners now agree that this distrib-

ution was a dividend and that they were required by section 962(d) to include it in

gross income. The parties’ dispute concerns the character of this dividend.

Noting that Memcorp HK was neither a “domestic corporation” nor a “qualified

foreign corporation,” sec. 1(h)(11)(B)(i), respondent contends that the dividend

was taxable to petitioners at ordinary-income rates. Petitioners contend that the

$12,307,591 was distributed by a “notional” domestic corporation, that the

dividend thus constituted QDI under section 1(h)(11)(B)(i)(I), and that the divi-

dend was accordingly taxable at the reduced rates specified in section 1(h)(1). We

think respondent has the better side of this argument.

Memcorp HK was incorporated in Hong Kong and thus was not a “domestic

corporation.” Sec. 1(h)(11)(B)(i)(I); see sec. 7701(a)(4) (“The term ‘domestic’

when applied to a corporation * * * means created or organized in the United

States or under the law of the United States or of any State[.]”). If a company is

not “incorporated in a possession of the United States,” moreover, it cannot be a

“qualified foreign corporation” unless it is “eligible for benefits of a comprehen-
 - 19 -

sive income tax treaty with the United States.” Sec. 1(h)(11)(C)(i). Petitioners

concede that there did not exist during 2008 (and does not exist to this day) any

form of income tax treaty between the United States and Hong Kong. And peti-

tioners do not contend that Memcorp HK was a resident of any other country that

had a tax treaty with the United States.

Petitioners’ theory for treating the $12,307,591 dividend as QDI is based on

their having elected to receive the benefits of section 962. By virtue of those elec-

tions, the tax they paid on the section 951(a) inclusions was “an amount equal to

the tax which would be imposed under sections 11 and 55 if such amounts were

received by a domestic corporation.” Sec. 962(a)(1). Petitioners likewise became

entitled to deemed-paid FTCs because the prior inclusions were “treated as if they

were received by a domestic corporation.” Sec. 962(a)(2). And the effect of sec-

tion 962(d) is to treat a subsequent distribution of taxable 962 E&P “essentially as

though it was first received by the hypothetical domestic corporation * * * and

then redistributed to the individual taxpayer.” Boris I. Bittker & Lawrence

Lokken, Federal Taxation of Income, Estates and Gifts, para. 69.12, at 69-84 (3d

ed. 2005).

In essence, petitioners urge that what section 962 pretends to have occurred

actually happened. By virtue of their section 962 elections, petitioners contend
 - 20 -

that Memcorp HK’s E&P “moved up” to a notional domestic C corporation, which

later paid the $12,307,591 dividend as a “domestic corporation” consistently with

the terms of section 1(h)(11)(B)(i)(I). We discern no support for this theory in the

statute, the legislative history, the regulations, or judicial precedent.

We begin our inquiry, as we must, by considering the plain and ordinary

meaning of the text Congress enacted. See, e.g., Jimenez v. Quarterman, 555 U.S.

113, 118 (2009); Rainero v. Archon Corp., 844 F.3d 832, 837 (9th Cir. 2016).

“[C]ourts must presume that a legislature says in a statute what it means and

means in a statute what it says there.” Conn. Nat’l Bank v. Germain, 503 U.S.

249, 253-254 (1992). “When the words of a statute are unambiguous * * *

‘judicial inquiry is complete.’” Id. at 254 (quoting Rubin v. United States, 449

U.S. 424, 430 (1981)). Statutory text is ambiguous where “the ordinary and

common meaning of the statutory language supports more than one interpreta-

tion.” Carlson v. Commissioner, 116 T.C. 87, 93 (2001). Where “statutory

language is ambiguous * * * we may consult legislative history to assist us in

interpreting the language in question.” Ibid.

We do not find any of the relevant statutory texts to be ambiguous. Section

1(h)(11)(B)(i) defines QDI as dividends “received * * * from” a domestic corpora-

tion or a qualified foreign corporation. Petitioners’ $12,307,591 dividend was re-
 - 21 -

ceived from Memcorp HK. A corporation is a “domestic” corporation only if it is

organized in the United States or under U.S. or State law. Sec. 7701(a)(4). Be-

cause Memcorp HK was organized under the law of Hong Kong, and because

Hong Kong does not have an income tax treaty with the United States, Memcorp

HK was neither a domestic corporation nor a qualified foreign corporation.

Nor do we find any ambiguity in the text of section 962(a). In the case of an

electing U.S. shareholder, section 962(a)(1) provides that the tax imposed on the

section 951(a) inclusions “shall * * * be an amount equal to the tax which would

be imposed * * * if such amounts were received by a domestic corporation.” Sec-

tion 962(a)(2) enables the electing shareholder to claim deemed-paid FTCs by pro-

viding that the inclusions “shall be treated as if they were received by a domestic

corporation.” These provisions do not create hypothetical corporations or change

real-world facts. They simply provide a mechanism that enables an individual

U.S. taxpayer to elect what he or she may deem more desirable tax treatment.

Both clauses quoted above are drafted in the subjunctive mood. “Clauses of

this type are commonly used to express a counterfactual hypothesis.” Klein v.

Commissioner, 149 T.C. __, __ (slip op. at 17) (Oct. 3, 2017). For example, as-

sume a statute providing that certain persons (green card holders, perhaps) shall be

treated “as if they were citizens.” In such a statute, Congress would necessarily
 - 22 -

presume that such persons were not in fact citizens, providing merely that they

should be accorded the treatment which citizens receive. See id. at __ (slip op. at

17-18).

The same logic applies here. In drafting section 962 Congress adopted the

counterfactual hypothesis that the section 951(a) inclusions were received by a

domestic corporation, rather than by the individual U.S. shareholder, for the sole

and limited purpose of enabling that person to elect beneficial tax treatment under

section 962(a). There is nothing in the statutory text to suggest that Congress

intended this counterfactual hypothesis to apply for any other purpose under the

Code, least of all for purposes of section 1(h)(11), which was not enacted until 41

years later.5

Finally, we discern no ambiguity in the text of section 962(d). It provides

that the previously taxed E&P “of a foreign corporation * * * shall, when such

5
Petitioners err in citing section 1.962-1(b)(2)(ii), Income Tax Regs., and
two IRS field service advices (FSAs) for the proposition that section 962 estab-
lishes a fictional U.S. corporation. The regulation implements section 962(a)(2)
by providing that, for deemed-paid FTC purposes, “the term ‘domestic corpora-
tion’ * * * shall be treated as referring” to the electing U.S. shareholder. The
FSAs implement section 962(a)(1), which refers to the corporate tax “which would
be imposed under sections 11 and 55,” by adopting the same counterfactual hypo-
thesis for calculating the corporate alternative minimum tax. See FSAs
200247033 and 200247034 (Aug. 16, 2002). None of these authorities suggests
that this counterfactual hypothesis has any operation outside the confines of
section 962.
 - 23 -

earnings and profits are distributed,” be taxed to the U.S. shareholder in a speci-

fied way. There is no reference in this provision to any corporation other than the

CFC whose E&P is being distributed. The E&P to which the statute refers is the

foreign corporation’s E&P; there is no suggestion that this E&P has previously

“moved up” to a notional domestic corporation.6

Petitioners seek to inject ambiguity into the statute by positing that the E&P

must “move up” in order to maintain parity between individual U.S. shareholders

who invest in CFCs directly and those who invest in CFCs through domestic cor-

porations. The parity for which petitioners argue may or may not represent desir-

able tax policy. There is simply no textual evidence that Congress enacted peti-

tioners’ policy preference in the Code provisions we are considering.7

6
Petitioners assert that their 2008 dividend “had to come from E&P located
somewhere,” that this E&P “had to leave Memcorp HK when the amounts were
included by the deemed C corporation,” and that the E&P at the time of the 2008
dividend “could not have been located anywhere other than with the deemed U.S.
C corporation.” In making these assertions petitioners are assuming what they are
trying to prove. Contrary to their view, the regulations tell us where the E&P were
located--namely, in Memcorp HK, which at the time of the 2008 distribution had
excludable 962 E&P of $6,071,089 and taxable 962 E&P of $12,307,591. See sec.
1.962-3(b)(1), Income Tax Regs.
7
The regulations, which closely track the statute, support a plain language
interpretation of its terms. Like the statute, they clearly refer to the E&P of the
CFC and to a distribution by the CFC, not by a deemed domestic entity. See sec.
1.962-3(a), Income Tax Regs.
 - 24 -

Even if section 962 were thought ambiguous, the legislative history does not

provide meaningful assistance to petitioners. Section 962 was added to the Code

as part of the original subpart F regime. Revenue Act of 1962, Pub. L. No. 87-

834, sec. 12, 76 Stat. at 1006. At that time individuals were taxed at marginal

rates as high as 91%.8 The Senate Finance Committee explained that the purpose

of section 962 was

to avoid what might otherwise be a hardship in taxing a U.S. indi-
vidual at high bracket rates with respect to earnings in a foreign cor-
poration which he does not receive. This provision gives such indi-
viduals assurance that their tax burdens, with respect to these undis-
tributed foreign earnings, will be no heavier than they would have
been had they invested in an American corporation doing business
abroad. [S. Rept. No. 87-1881, at 92 (1962), 1962-3 C.B. 703, 798.]

The tax parity about which Congress expressed concern involved tax bur-

dens “with respect to these undistributed foreign earnings.” Ibid. (emphasis add-

ed). Under subpart F, U.S. shareholders were going to be taxed currently under

section 951(a)(1) even though they received no cash from the CFC. That being so,

Congress believed it might be harsh to tax them on deemed distributions “at high

bracket [individual] rates” and so made available (upon election) lower bracket

corporate rates.

8
See Thomas L. Hungerford, Cong. Research Serv., RL33786, Individual
Tax Rates and Tax Burdens: Changes Since 1960 at CRS-6 (2007) (“The highest
statutory marginal tax rate was 91% in the early 1960s.”).
 - 25 -

Congress obviously knew that individual income tax rates might change in

the future. When enacting section 962, it stated its understanding that taxable 962

E&P, when actually distributed by the CFC, would be treated as “a dividend” and

be taxed “at individual income tax rates.” S. Rept. No. 87-1881, at 92-93, 1962-3

C.B. at 799. Congress in 1962 expressed no concern--one way or the other--about

the terms on which future taxation of such dividends would occur.

Section 962 entered the Code 41 years before section 1(h)(11), and Con-

gress in 1962 could not have expressed any intention about how these two provi-

sions would interact. Petitioners in essence argue that a foreign corporation,

which is not a “qualified foreign corporation” under section 1(h)(11)(B)(i)(II),

should be deemed a “domestic corporation” under section 1(h)(11)(B)(i)(I) in any

case in which a U.S. shareholder has previously made a section 962 election.

Congress did not express any intention to that effect when enacting section

1(h)(11) in 2003. And even if it had done so, it did not embody that intent in the

text of the statute.

“[W]here Congress knows how to say something but chooses not to, its si-

lence is controlling.” CBS, Inc. v. PrimeTime 24 Joint Venture, 245 F.3d 1217,

1226 (11th Cir. 2001) (citing Griffith v. United States (In re Griffith), 206 F.3d

1389, 1394 (11th Cir. 2000)). “[T]he fact that Congress might have acted with
 - 26 -

greater clarity or foresight does not give courts a carte blanche to redraft statutes

in an effort to achieve that which Congress is perceived to have failed to do.”

United States v. Locke, 471 U.S. 84, 95 (1985). Petitioners invite us to rewrite

section 1(h)(11) or section 962 in a way that fills what they perceive as a statutory

gap. We decline this invitation: It is not our role to “soften the clear import of

Congress’ chosen words” even if we think those words produce a harsh result.

Locke, 471 U.S. at 95.

In sum, we hold that Memcorp HK’s distribution of $12,307,591 of taxable

962 E&P to petitioners was not QDI under section 1(h)(11)(B) but rather consti-

tuted an ordinary dividend taxable at ordinary-income rates. When filing their

amended returns for 2004 and 2005, petitioners made voluntary, irrevocable

elections under section 962. See Dougherty v. Commissioner, 61 T.C. 719, 722-

723 (1974); sec. 1.962-2(c)(2), Income Tax Regs. By making these elections peti-

tioners got what they bargained for: immediate deemed-paid FTCs and a lower

current tax rate on the section 951(a) inclusions. By requiring petitioners to forfeit

in large part the benefits of section 959(a), these elections may ultimately cause

them to include more gross income than they would otherwise have had to include.

Unfortunately, that is sometimes how the cookie crumbles.
 - 27 -

B. 2009 Distribution From Hopper Cyprus

The second question, like the first, involves the application of section

1(h)(11). In March 2009 Hopper Cyprus paid to Hopper US what petitioners con-

cede was a taxable dividend of $57,106,892. The dispute again concerns the pro-

per characterization of this dividend. Petitioners contend that Hopper Cyprus was

a “qualified foreign corporation,” see sec. 1(h)(11)(B)(i)(II), so that the dividend

constituted QDI subject to tax at the preferential rates made available by section

1(h)(1). Respondent disputes this proposition, contending that the dividend was

taxable as ordinary income.

As relevant here, a “qualified foreign corporation” is a corporation “eligible

for benefits of a comprehensive income tax treaty with the United States which the

Secretary determines is satisfactory for purposes of this paragraph and which

includes an exchange of information program.” Sec. 1(h)(11)(C)(i)(II). In 2006

the IRS published a list of income tax treaties that satisfied the statutory require-

ments. See Notice 2006-101, 2006-2 C.B. 930, 930-931, amplified by Notice

2011-64, 2011-37 I.R.B. 231. Section 2 of Notice 2006-101 states:

[I]n order to be treated as a qualified foreign corporation under the
treaty test, a foreign corporation must be eligible for benefits of one
of the U.S. income tax treaties listed in the Appendix. Accordingly,
the foreign corporation must be a resident within the meaning of such
term under the relevant treaty and must satisfy any other requirements
 - 28 -

of that treaty, including the requirements under any applicable limita-
tion on benefits provision.

The appendix to Notice 2006-101, supra, lists Cyprus as a country that has an

acceptable income tax treaty with the United States.

Article 3(1) of the Treaty provides that the term “resident of Cyprus” means

(among other things) a “Cypriot corporation.” Article 2(1) defines the term “Cy-

priot corporation” as “an entity (other than a United States corporation) treated as

a body corporate for tax purposes under the laws of Cyprus, which is resident in

Cyprus for the purpose of Cypriot tax.”

Article 26 sets forth limitation-on-benefits (LOB) provisions for residents of

the United States and Cyprus under the Treaty. Under article 26(1), a corporation

resident in Cyprus is entitled to benefits under the Treaty if (among other things)

75% percent of its shares are owned directly or indirectly by individual residents

of Cyprus. Because petitioners, who are U.S. residents, indirectly own 100% of

Hopper Cyprus, they concede that Hopper Cyprus is not entitled to Treaty benefits

under article 26(1).

If the terms of article 26(1) are not met, a company may still satisfy the LOB

requirements if it meets the terms of article 26(2). It provides that Treaty benefits

will not be denied if “it is determined that the establishment, acquisition and
 - 29 -

maintenance of such person and the conduct of its operations did not have as a

principal purpose obtaining benefits under the * * * [Treaty].”

Under the legal framework set forth above, Hopper Cyprus must satisfy two

separate tests to be treated as a “qualified foreign corporation” during 2009: (1) it

must have been a resident of Cyprus under the Treaty and (2) if it was a resident of

Cyprus, its establishment and operation must not have had, “as a principal pur-

pose,” the obtaining of benefits under the Treaty. Concluding as we do that there

exist genuine disputes of material fact as to whether Hopper Cyprus satisfied the

first test, we need not, at this stage of the case, address the second test.

In support of their position as to residency, petitioners provided declarations

from Mario Tofaros, a director of Hopper Cyprus, attaching certificates issued by

the Ministry stating that Hopper Cyprus during 2008-2011 was a Cypriot resident

under the Treaty. Certain facts concerning the issuance of these certificates were

established, pursuant to article 28 of the Treaty, through an Exchange of Informa-

tion between the U.S. and Cypriot competent authorities. See supra pp. 11-12.

These facts include the following:

• At a time not disclosed by the record, Hopper Cyprus was stricken from

the Cypriot registry of companies for failure to file tax returns and submit annual

reports to the Cypriot Registrar of Companies (Registrar).
 - 30 -

• For reasons not disclosed by the record, Hopper Cyprus was reinstated in

the Cypriot registry of companies on May 4, 2016.

• Eight days later, on May 12, 2016, Hopper Cyprus filed Cypriot tax re-

turns for 2008, 2009, 2010, and 2011. The returns for 2008 and 2011 were not

signed.

• One day later, on May 13, 2016, Mr. Tofaros submitted to the Ministry

Form T.D. 98, Tax Residency Certificate Request and Questionnaire for Legal En-

tities. On this form he checked the box marked “Yes” to each of the following

questions: (1) “Is the company incorporated in Cyprus?” (2) “Do the Majority of

the Board of Directors meetings take place in Cyprus?” (3) “Does the Board of

Directors exercise control and make key management and commercial decisions

necessary for the company’s operations and general policies?” (4) “Are Board of

Directors’ minutes prepared and kept in Cyprus?” (5) “Is the majority of the Board

of Directors tax residents [sic] in Cyprus?” and (6) “Do shareholders’ meetings

take place in Cyprus?”

• Mr. Tofaros attached to the Form T.D. 98 a certificate issued by the

Registrar on May 12, 2016, stating that the other two directors of Hopper Cyprus

were petitioner husband and Briantserve Ltd., and a letter from Mr. Tofaros to the

Ministry dated May 13, 2016, stating that the “management and control” of Hop-
 - 31 -

per Cyprus were exercised in Cyprus. He represented that Hopper Cyprus’ books

and records were maintained in Cyprus and that all of its Cypriot tax returns had

been duly filed. He supplied no documentary evidence to establish that board

meetings took place in Cyprus or to show that “management and control” of

Hopper Cyprus were exercised in Cyprus.

• Five days later, on May 18, 2016, after allegedly verifying that Hopper

Cyprus had complied with its Cypriot tax return filing obligations, the Ministry

issued the four residency certificates in question. Each certificate consisted of two

sentences and stated that Hopper Cyprus, for 2008, 2009, 2010, and 2011, “is a

resident of Cyprus within the meaning of the double taxation convention between

the Republic of Cyprus and the United States of America.” Each certificate bears

a stamp with the name of the certifying official.

According to petitioners, these certificates establish that Hopper Cyprus for

Treaty purposes was a resident of Cyprus at all relevant times. Under the act of

state doctrine, petitioners contend, the determination set forth in the certificates is

binding on this Court and cannot be disturbed. Respondent contends that petition-

ers are not entitled to summary judgment on this point because they have not sup-

plied, at this stage of the proceeding, sufficient evidence to show that the act of
 - 32 -

state doctrine applies or that management and control of Hopper Cyprus were

exercised in Cyprus. We agree with respondent.

“The act of state doctrine in its traditional formulation precludes the courts

of this country from inquiring into the validity of the public acts a recognized for-

eign sovereign power committed within its own territory.” Banco Nacional de

Cuba v. Sabbatino, 376 U.S. 398, 401 (1964). In Sabbatino the Supreme Court ad-

dressed a foreign sovereign’s expropriation of property indirectly owned by U.S.

residents. Although that act appeared to violate customary international law, the

Court held:

[T]he Judicial Branch will not examine the validity of a taking of pro-
perty within its own territory by a foreign sovereign government,
extant and recognized by this country at the time of suit, in the ab-
sence of a treaty or other unambiguous agreement regarding control-
ling legal principles * * * [Id. at 428.]

The act of state doctrine does not deprive a court of jurisdiction; rather, “it

functions as a doctrine of abstention.” Riggs Nat’l Corp. & Subs. v. Commission-

er, 163 F.3d 1363, 1367 n.5 (D.C. Cir. 1999), rev’g and remanding 107 T.C. 301

(1996). The doctrine is typically invoked when a litigant claims to have been

damaged by official action of a foreign Government or its officials. See, e.g.,

Sabbatino, 376 U.S. at 403-404 (expropriation of property); Ricaud v. Am. Metal

Co., 246 U.S. 304, 310 (1918) (same); Underhill v. Hernandez, 168 U.S. 250, 254
 - 33 -

(1897) (detention of a person by foreign official); Credit Suisse v. U.S. Dist. Court

for the Cent. Dist. of Calif., 130 F.3d 1342, 1347 (9th Cir. 1997) (asset freeze

orders).

In such circumstances, judicial reexamination of the legality of a foreign

sovereign’s acts may “imperil the amicable relations between governments and

vex the peace of nations.” Oetjen v. Central Leather Co., 246 U.S. 297, 303-304

(1918). The act of state doctrine reflects “‘the strong sense of the Judicial Branch

that its engagement in the task of passing on the validity of foreign acts of state

may hinder’ the conduct of foreign affairs.” W.S. Kirkpatrick & Co. v. Envtl.

Tectonics Corp., 493 U.S. 400, 404 (1990) (quoting Sabbatino, 376 U.S. at 423)).

As Chief Justice Fuller explained in Underhill, 168 U.S. at 252:

[T]he courts of one country will not sit in judgment on the acts of the
government of another, done within its own territory. Redress of
grievances by reason of such acts must be obtained through the means
open to be availed of by sovereign powers as between themselves.

At the outset, respondent urges with considerable force that the act of state

doctrine has no application here given the existence of a bilateral income tax treaty

between the United States and Cyprus. The Supreme Court ruled in Sabbatino that

the act of state doctrine applies “in the absence of a treaty or other unambiguous

agreement regarding controlling legal principles.” 376 U.S. at 428 (emphasis add-
 - 34 -

ed). When two sovereigns have executed a treaty that embodies agreed-upon prin-

ciples for resolving controversies, a court’s application of those principles is less

likely to upset sensitive diplomatic relations. Courts that have addressed this

question agree that the act of state doctrine does not apply where a treaty or other

binding agreement provides a controlling legal standard for a court to apply. See,

e.g., Banco Nacional de Cuba v. Chem. Bank N.Y. Tr. Co., 822 F.2d 230, 234-235

(2d Cir. 1987); Kalamazoo Spice Extraction Co. v. Provisional Military Gov’t of

Socialist Ethiopia, 729 F.2d 422, 424 (6th Cir. 1984); Foremost McKesson Inc. v.

Islamic Republic of Iran, Civ. A. No. 82-0220, 1989 WL 44086, at *5-*6 (D.D.C.

Apr. 18, 1989).

Here, articles 2 and 3 of the Treaty provide specific rules that govern Hop-

per Cyprus’ residency for tax purposes. Article 3(1)(a)(i) provides that the term

“resident of Cyprus” includes a “Cypriot corporation.” Article 2(1)(e)(ii) provides

that the term “Cypriot corporation” means “an entity (other than a United States

corporation) treated as a body corporate for tax purposes under the laws of Cyprus,

which is resident in Cyprus for the purpose of Cypriot tax.” The Cypriot income

tax law provides that the term “resident,” when applied to a company, “means a

company whose management and control is exercised” in Cyprus. During the

Exchange of Information process, the Cypriot competent authority informed the
 - 35 -

Department of the Treasury that Cyprus interprets “management and control” to

mean “the effective management of the company.”

Viewed together, these provisions supply a controlling legal standard for

determining Hopper Cyprus’ residency status. Under the Treaty, a corporation

will be treated as a resident of Cyprus if “the effective management of the

company” is exercised in Cyprus. There is no uncertainty about Cypriot law on

this point, because the Cypriot competent authority specifically informed the U.S.

competent authority about the legal standard it applies. And even if there were

some uncertainty about Cypriot law, this Court’s determination of an issue of for-

eign law “shall be treated as a ruling on a question of law.” Rule 146.

Both parties to the Treaty presumably understood that the courts of each na-

tion would apply the Treaty’s residency rules to the facts of particular cases as

they arose. Petitioners seek to limit the Sabbatino treaty exception to situations

where the foreign sovereign’s actions are contrary to a clearly enunciated standard

set forth in a treaty. But the case law supplies no support for this limitation; as the

Supreme Court stated in Sabbatino, 376 U.S. at 428, the question is simply wheth-

er “a treaty or other unambiguous agreement regarding controlling legal princi-

ples” exists. Given the existence of the Treaty and the absence of any dispute as
 - 36 -

to the legal principles that control the residency issue, the act of state doctrine

would appear to be inapplicable here.

Assuming arguendo that the act of state doctrine might apply, it counsels a

U.S. court against deciding a case “when the outcome turns upon the legality or

illegality * * * of official action by a foreign sovereign performed within its own

territory.” Riggs Nat’l Corp. & Subs., 163 F.3d at 1367. The party invoking the

doctrine bears the burden of establishing the act and its character as an act of state.

Grupo Protexa, S.A. v. All Am. Marine Slip, A Div. of Marine Office of Am.

Corp., 20 F.3d 1224 (3d Cir. 1994); Republic of the Phil. v. Marcos, 806 F.2d 344,

356-357, 359-360 (2d Cir. 1986); 1 Restatement, Foreign Relations Law 3d, sec.

443, cmt. i & reporter’s note 3 (1986).

The application of the act of state doctrine “depends on the likely impact on

international relations that would result from judicial consideration of the foreign

sovereign’s act.” Grupo Protexa, S.A., 20 F.3d at 1236 (quoting Allied Bank Int’l

v. Banco Credito Agricola de Cartago, 757 F.2d 516, 520-521 (2d Cir. 1985)).

The reviewing court must determine, on a case-by-case basis, “the extent to which

in the context of a particular dispute separation of powers concerns are implicat-

ed,” i.e., “whether there is evidence of a potential institutional conflict between the

judicial and political branches” of the U.S. Government. Id. at 1237. “At a mini-
 - 37 -

mum,” the party invoking the doctrine must show that the foreign sovereign “acted

in its sovereign capacity” and establish a “demonstrable, not a speculative, threat

to the conduct of foreign relations by the political branches” of this country. Id. at

1237-1238 (first quoting Liu v. Republic of China, 892 F.2d 1419, 1432 (9th Cir.

1989); and then quoting Envtl. Tectonics v. W.S. Kirkpatrick, Inc., 847 F.2d 1052,

1061 (3d Cir. 1988), aff’d, 493 U.S. 400 (1990)). “[T]he less important the impli-

cations of an issue are for our foreign relations, the weaker [is] the justification”

for invoking the act of state doctrine to require judicial abstention. Id. at 1237

(quoting Allied Bank Int’l, 757 F.2d at 521).

For several reasons we find that petitioners have not satisfied their burden to

show that the act of state doctrine applies. To begin with, we question whether the

issuance of the residency certificates rises to the level of an “act of state.” The

certificates were issued five days after the application was filed. The application

consisted of unsubstantiated representations by a Hopper Cyprus director, who

checked “yes” boxes on the application form. Apart from confirming the filing of

tax returns--Hopper Cyprus’ returns for 2008-2011 were submitted the day before

the application, they were at least four years late, and two of them were unsigned--

there is no evidence that the Ministry verified any of the applicant’s factual

representations.
 - 38 -

“The act of state doctrine ‘does not bestow a blank-check immunity upon all

conduct blessed with some imprimatur of a foreign government.’” Gross v. Ger-

man Found. Indus. Initiative, 456 F.3d 363, 392 (3d Cir. 2006) (quoting Timber-

lane Lumber Co. v. Bank of Am., 549 F.2d 597, 606 (9th Cir. 1976)). The courts

have held, for example, that the act of state doctrine does not apply to a foreign

Government’s grant of a patent. Mannington Mills, Inc. v. Congoleum Corp., 595

F.2d 1287, 1294 (3d Cir. 1979); cf. Williams v. Curtiss-Wright Corp., 694 F.2d

300 (3d Cir. 1982) (declining to apply act of state doctrine to foreign govern-

ment’s refusal to purchase aircraft parts from a particular supplier); Forbo-

Giubiasco SA v. Congoleum Corp., 516 F. Supp. 1210, 1217 (S.D.N.Y. 1981). On

the facts here, the issuance of the residency certificates appears to have been a

clerical act analogous to (and arguably less substantive than) the grant of a patent.

Petitioners have failed to show that this action rises to the level of an “act of

state.”9

9
Petitioners allege that IRS, when issuing a Form 6166, Certification of U.S.
Tax Residency, follows a process similar to that followed by Cyprus. We do not
see the logic of this argument. The question we are deciding is whether Cyprus
performed an official act of state in certifying Hopper Cyprus’ residency. Whether
the IRS follows a similar process for taxpayers who seek certification of residency
does not bear on this question.
 - 39 -

Nor have petitioners shown that failure to give binding effect to the residen-

cy certificates would pose a “demonstrable, not a speculative, threat to the conduct

of foreign relations by the political branches of the United States government.”

Grupo Protexa, S.A., 20 F.3d at 1238. As far as the record reveals, the clerk who

issued the residency certificates was discharging a routine task. Petitioners have

supplied no evidence that this act reflected “a considered policy determination” by

the Cypriot Government “to give effect to its political and public interests [in]

matters that would have [a] significant impact on American foreign relations.”

Mannington Mills, Inc., 595 F.2d at 1294 (refusing to apply act of state doctrine to

foreign Government’s grant of patent rights because judicial review posed no

threat to diplomatic relations).10

In assessing the effect of the certificates, moreover, we are not ruling on

“the legality or illegality * * * of official action by a foreign sovereign.” See

10
Petitioners view the Supreme Court’s opinion in W.S. Kirkpatrick & Co.
as suggesting that diplomatic concerns need not be implicated in order for the act
of state doctrine to apply. Petitioners’ view is incorrect. The Supreme Court in
that case rejected the doctrine’s application “because the validity of no foreign
sovereign act [wa]s at issue.” 493 U.S. at 410. The Court reached that conclusion
even though the litigation might have affected U.S. foreign policy by embarrassing
a foreign Government. See id. at 408. The Court simply held that the presence of
diplomatic concerns, in and of itself, is not sufficient to require application of the
act of state doctrine. The Court did not hold that the doctrine applies even where
such concerns are absent. Indeed, because the Court rejected the doctrine’s
application, it could not possibly have made any such holding.
 - 40 -

Riggs Nat’l Corp. & Subs., 163 F.3d at 1367. Nor are we “inquiring into the

validity of the public acts” of a foreign Government. See Sabbatino, 376 U.S. at

401. There is no dispute concerning the legal standard that governs whether

Hopper Cyprus was a Cypriot resident under the Treaty. See supra pp. 35-36. The

certificates reflect the Ministry’s opinion as to how that standard applies to the

particular set of facts involved here. In declining to give that opinion dispositive

effect for U.S. tax purposes, we are not questioning the validity or legality of the

Ministry’s action.

In urging that the act of state doctrine applies here, petitioners rely chiefly

on the opinion of the U.S. Court of Appeals for the D.C. Circuit in Riggs Nat’l

Corp. There, the taxpayer’s subsidiary, a U.S. bank, had made loans to the Central

Bank of Brazil as part of an international effort to prevent Brazil from defaulting

on its sovereign debt. See Riggs Nat’l Corp. & Subs., 163 F.3d at 1363-1364.

These loans were structured as “net loans,” whereby the Central Bank paid

Brazilian tax on the interest and remitted the interest on a net basis to the taxpayer.

Ibid.

The taxpayer claimed an FTC for the Brazilian taxes thus paid, taking the

position that it bore the economic cost of the Brazilian tax the Central Bank had

paid on its behalf. The IRS disallowed the claimed credit, determining that the
 - 41 -

Brazilian tax payments were “voluntary.” See sec. 901(b); sec. 1.901-2(a)(2)(i),

Income Tax Regs. That was assertedly so because the Central Bank, as a compo-

nent of the Brazilian Government, was a “tax-immune borrower” that had no obli-

gation to pay Brazilian tax. See Riggs Nat’l Corp. & Subs., 163 F.3d at 1367.

The dispute in Riggs Nat’l Corp. focused on the effect of a ruling by the

Brazilian Minister of Finance, “the highest ranking Brazilian authority on tax

matters.” Id. at 1366. That ruling concluded that “the Central Bank--notwith-

standing its tax-immune status--was required under Brazilian law to pay the tax

obligation assumed from lenders” on the net loan transactions. Ibid. The taxpayer

contended that the act of state doctrine required U.S. courts to give effect to this

ruling, thus establishing that the Brazilian tax had not been paid “voluntarily.”

The Commissioner urged on appeal that “a foreign administrative official’s

interpretation of foreign law is not the type of act of state contemplated by the

doctrine.” Id. at 1367. The D.C. Circuit acknowledged that the act of state doc-

trine has typically been applied where a party alleged injury from some “tangible”

act of a foreign sovereign, such as an expropriation of assets, a physical detention,

or an asset freeze order. See id. at 1367-1368. The court indicated that it was

“unaware of cases treating an interpretation of law as an act of state.” Id. at 1368.

And it said that it would be “hesitant to treat an interpretation of law as an act of
 - 42 -

state, for such a view might be in tension with rules of procedure directing U.S.

courts to conduct a de novo review * * * when an issue of foreign law is raised.”

Ibid. (citing Rule 146 and Fed. R. Civ. P. 44.1).

As its basis for holding that the act of state doctrine nevertheless applied,

the D.C. Circuit determined that “the Minister’s order to the Central Bank to with-

hold and pay the income tax * * * goes beyond a mere interpretation of law.” Id.

at 1368. The Finance Minister had explicitly “ordered that the Central Bank ‘must

* * * pay the income tax on the interest.’” Ibid. (quoting Riggs Nat’l Corp. &

Subs., 107 T.C. at 331). The court analogized the Finance Minister’s order to

asset freeze and currency control orders, which the courts had previously treated

as acts of state. See ibid. Any other conclusion, the Court of Appeals ruled,

would effectively declare “‘non-compulsory,’ i.e., invalid, the Minister’s order to

the Central Bank to pay the taxes.” Ibid. “The act of state doctrine,” the court

concluded, “requires courts to abstain from even engaging in such an inquiry.”

Ibid.

For at least two reasons, petitioners’ reliance on Riggs Nat’l Corp. is mis-

placed. First, the D.C. Circuit applied the act of state doctrine because it con-

cluded that the Finance Minister’s ruling was not a mere interpretation of law, but

rather was a binding order that compelled action by the Central Bank, a compo-
 - 43 -

nent of the Brazilian Government. In issuing the residency certificates, by con-

trast, the Cypriot Ministry was simply offering an interpretation of law, expressing

its view as to how the Treaty’s residency provisions apply to a particular set of

facts. The certificates are purely retrospective, relating as they do to Hopper Cy-

prus’ 2008-2011 tax years. The Ministry issued no order to any entity (govern-

mental or otherwise), and the certificates have no binding prospective effect on

anyone.

Second, the D.C. Circuit applied the act of state doctrine because it conclud-

ed that failing to do so would effectively declare the Finance Minister’s order “in-

valid.” Riggs Nat’l Corp. & Subs., 163 F.3d at 1368. In assessing the effect of the

residency certificates, by contrast, we are not ruling on “the legality or illegality

* * * of official action by a foreign sovereign.” See id. at 1367. We do not

question the validity of the certificates or whether they were properly issued in

accordance with the Ministry’s procedures. Because we are not second-guessing

the legality of the Ministry’s action, “the validity of no foreign sovereign act is at

issue” in this case. See W.S. Kirkpatrick & Co., 493 U.S. at 410.

In considering petitioners’ motion for partial summary judgment on this

question, we must view all facts and inferences drawn from them in the light most

favorable to respondent, the nonmoving party. See Dahlstrom, 85 T.C. at 821.
 - 44 -

Applying that standard, we conclude that petitioners are not entitled to summary

judgment on the question whether Hopper Cyprus during 2009 was a “qualified

foreign corporation” within the meaning of section 1(h)(11)(B)(i)(II). The answer

to that question depends (in part) on whether Hopper Cyprus was a resident of

Cyprus under the Treaty. The residency certificates issued by the Ministry are

relevant to that inquiry; to the extent those certificates are based on sound

reasoning and accurate factual representations, they will be accorded (at the least)

appropriate weight. But viewing all facts and inferences in the light most

favorable to respondent, we hold that petitioners have not established that the act

of state doctrine applies here, such that we are required, at this stage of the case, to

accord those certificates dispositive effect.

C. 2009 Constructive Dividend

The third issue is whether petitioners must include in gross income for 2009

a constructive dividend of $21,055,123 from Hopper Cyprus. Beginning as early

as 1999, Memcorp HK held an open account receivable from Hopper US on which

Hopper US was indisputably liable. The balance of this account reached its zenith

in 2005, when it stood at $64,911,625, and declined thereafter. When Memcorp

HK reorganized itself to Cyprus, Hopper Cyprus became the obligee on this ac-

count receivable. On March 31, 2009, when the account had an outstanding bal-
 - 45 -

ance of $21,055,123, Hopper Cyprus wrote off the entire balance, reducing the in-

debtedness of Hopper US to zero. Invoking sections 301(c)(1) and 316, respond-

ent contends that petitioners in consequence received a constructive dividend of

$21,055,123.

A dividend may be formally declared, or it may be constructive. See Boul-

ware, 552 U.S. at 429-430; Truesdell, 89 T.C. at 1295. A constructive dividend is

an economic benefit conferred upon a shareholder by a corporation without an ex-

pectation of repayment. Truesdell, 89 T.C. at 1295 (citing Noble, 368 F.2d at

443). When a corporation cancels its shareholder’s debt without consideration, the

cancellation is generally treated as a distribution to the shareholder, which will

constitute a dividend to the extent of the corporation’s E&P. See secs. 61(a)(12),

301(a), (c)(1); United States v. Kirby Lumber Co., 284 U.S. 1 (1931); Shephard v.

Commissioner, 340 F.2d 27 (6th Cir. 1965), aff’g T.C. Memo. 1963-294; Haber v.

Commissioner, 52 T.C. 255, 262 (1969), aff’d, 422 F.2d 198 (5th Cir. 1970); sec.

1.301-1(m), Income Tax Regs. (“The cancellation of indebtedness of a shareholder

by a corporation shall be treated as a distribution of property.”). These rules apply

to distributions from both domestic and foreign corporations.

“The notions of constructive dividend and cancellation of indebtedness

merge” in this setting. Midwest Stainless, Inc. v. Commissioner, T.C. Memo.
 - 46 -

2000-314, 80 T.C.M. (CCH) 472, 476. A constructive dividend involves “the

conferring of an economic benefit without expectation of repayment,” and the

cancellation confers upon the shareholder a definite economic benefit “when it

becomes clear that the debt will not have to be repaid.” Ibid. (citing Waterhouse

v. Commissioner, T.C. Memo. 1994-467; and then citing Cozzi v. Commissioner,

88 T.C. 435 (1987)).

Citing these principles, respondent contends that Hopper Cyprus’ cancella-

tion of the $21,055,123 debt constituted a constructive distribution through Hop-

per US to petitioners. He further argues that this distribution was taxable under

section 301(c)(1) as a dividend, to the extent that Hopper Cyprus had sufficient

E&P. Petitioners do not dispute that Hopper Cyprus had accumulated E&P in

excess of $21,055,123 in 2009. And they do not contend that these E&P were

previously included in their gross income.

In reply petitioners advance what seems to be a statute of limitations argu-

ment blended with a double-taxation argument. Both arguments have their roots

in the IRS’ examination of petitioners’ 2004 and 2005 returns. During that exami-

nation the IRS determined that Memcorp HK’s account receivable constituted an

investment in U.S. property within the meaning of section 956(a) and (c)(1)(C).

The IRS accordingly made adjustments that required petitioners to include in gross
 - 47 -

income, for 2004 and 2005, $15,765,803 and $2,612,877, respectively.11 Peti-

tioners acquiesced in these adjustments and made section 962 elections as de-

scribed above. See supra pp. 8-10, 17-19.

Noting that Memcorp HK’s account receivable balance peaked at $64.9 mil-

lion in 2005, petitioners contend that their CFCs made no additional investments

in U.S. property after that year. According to petitioners, therefore, the IRS was

obligated to make any section 956(a) inclusions when it examined their returns for

2004 and 2005. Because the period of limitations for 2004 and 2005 has now

lapsed, see sec. 6501(a), petitioners assert that the IRS cannot make any more sec-

tion 956(a) inclusions now and cannot pursue an alternative theory--i.e., its con-

structive dividend theory--to tax them when the debt was canceled in 2009.

Petitioners note that Memcorp HK’s account receivable triggered construc-

tive income inclusions to them in 2004 and 2005, whereby the IRS treated E&P

corresponding to a portion of that account as an investment in U.S. property.

11
Respondent represents that he erroneously computed (and substantially
understated) petitioners’ gross income inclusions for 2004 and 2005 by applying
an earlier version of section 956 that existed before its amendment in 1993. See
infra p. 50. For purposes of our present inquiry, the amount of previous section
951(a) inclusions is not relevant, except to the extent that these inclusions gave
rise to previously taxed E&P under section 959. Section 959(a)(1) does not allow
petitioners to exclude from gross income amounts that could have been, but were
not in fact, previously included in gross income under sections 956(a) and
951(a)(1)(B).
 - 48 -

From that premise petitioners conclude that the IRS is subjecting them to double

taxation by treating as gross income the cancellation of the remaining debt.

Petitioners’ theory appears to be that the entire account receivable balance was

constructively distributed to them in 2004 and 2005 and that this debt cannot give

rise to another constructive distribution in 2009.

Petitioners’ argument misses the mark for several reasons. Their critical

error is their assumption that the IRS was required to make any and all section

956(a) inclusions for 2004 and 2005, the years for which the IRS evidently first

discovered that Memcorp HK had made an investment in U.S. property. There is

no support for that assumption in the Code, the regulations, or judicial precedent.

Congress provided that the section 956 inclusion “for any taxable year”

shall be determined by measuring the average amount of U.S. property held by a

CFC “as of the close of each quarter of such taxable year.” Sec. 956(a) (flush

language); id. para (1)(A). The statute does not require that the inclusion be made

for the first year in which the CFC acquires its investment or that the inclusion be

made for any particular year. See Crestek, Inc. & Subs. v. Commissioner, 149

T.C. __, __ (slip op. at 17) (July 27, 2017). To the contrary: The statute defines

the inclusion for any particular year by reference to “the amounts of United States

property held (directly or indirectly) by the controlled foreign corporation” during
 - 49 -

that year. Sec. 956(a)(1)(A) (emphasis added). Thus, where a CFC holds an item

of U.S. property for multiple years--as Memcorp HK and Hopper Cyprus did--

section 956(a) permits an inclusion in income for any one of those years. Crestek,

Inc. & Subs., 149 T.C. at __ (slip op. at 17).

“The only relevant limitation is that a section 956 inclusion cannot be made

more than once for any particular investment by a CFC in United States property.”

Ibid. Congress accomplished this limitation by providing that any inclusion under

section 956 must be reduced by previously taxed income (PTI) under section

959(c)(1)(A). Petitioners have stipulated that the PTI limitation does not apply

here because no portion of the E&P attributable to the $21,055,123 debt cancel-

lation was previously included in their gross income under subpart F.

Petitioners likewise err in contending that the IRS can make a section 956

adjustment only for a year in which the CFC’s investment in U.S. property in-

creases, using a year-by-year approach. For this proposition they cite McCulloch

Corp. v. Commissioner, T.C. Memo. 1984-422, 48 T.C.M. (CCH) 802. But the

Court there was applying an earlier version of section 956(a), which was in effect

before Congress amended the statute to its current form in 1993. See Omnibus

Budget Reconciliation Act of 1993, Pub. L. No. 103-66, sec. 13232(a), 107 Stat. at

501. As in effect before 1993, former section 956(a)(2) determined the U.S.
 - 50 -

shareholder’s section 951(a) inclusion by reference to “the increase” of a CFC’s

earnings invested in U.S. property. For the tax years at issue here, section 956(a)

determined that inclusion, as noted above, by reference to the amount of U.S.

property “held” by the CFC, to the extent it exceeds PTI.

In short, the IRS was not required to make any and all section 956(a) in-

clusions relating to Memcorp HK’s investment in U.S. property during its exami-

nation of petitioners’ 2004 and 2005 tax years. That being so, petitioners’ statute

of limitations argument collapses. The fact that the period of limitations has ex-

pired for 2004 and 2005 has no relevance in determining whether they received a

constructive dividend when Hopper Cyprus canceled their indebtedness in 2009.

Despite the section 956(a) inclusions for 2004 and 2005, Memcorp HK con-

tinued to hold a very large debt obligation from Hopper US and that debt obliga-

tion remained at all times an investment in U.S. property. The IRS was free to

make additional section 956(a) adjustments for later years, to the extent permitted

by the statute. And when Hopper Cyprus canceled that debt on March 31, 2009,

the IRS was free to treat petitioners as having received a constructive distribution

of $21,055,123, the balance of the account on that date.

Respondent has acknowledged that, for 2004 and 2005, he understated peti-

tioners’ section 956(a) inclusions attributable to Memcorp HK’s investment in
 - 51 -

U.S. property. See supra p. 47 n.11. Petitioners repeatedly contend that the IRS,

having allegedly failed to tax them properly in 2004 and 2005, should not be given

“a second bite at the apple” when Hopper Cyprus canceled the debt in 2009. Once

again, the results of the 2004 and 2005 examination are irrelevant here. Petition-

ers concede that Hopper Cyprus had accumulated E&P in excess of $21,055,123

when it canceled the debt. And petitioners have admitted that the E&P attribut-

able to this writeoff, which were not previously included in Hopper US’ gross

income under section 951, constitute previously untaxed E&P under section

959(c)(3). Absent any override by section 959, the writeoff is properly treated as a

constructive dividend to Hopper US, as would be the case if this were an entirely

domestic arrangement.

Petitioners likewise err in asserting that the IRS has taken a “fundamentally

inconsistent position” by determining a constructive dividend for 2009. The sec-

tion 956(a) inclusions for 2004 and 2005 and the debt cancellation in 2009 are

separate taxable events, each with its own prescribed tax treatment. By virtue of

the 2004 and 2005 inclusions, petitioners were taxed on $18,378,680 of E&P that

Memcorp HK had accumulated by that time. By virtue of Hopper Cyprus’ cancel-

lation of the account receivable in 2009, petitioners realized a $21,055,123 acces-

sion to wealth. That accession to wealth was taxable to petitioners as a construc-
 - 52 -

tive dividend because Hopper Cyprus in 2009 had accumulated E&P in excess of

$21,055,123, no portion of which had previously been included in petitioners’

gross income.

Finally, there is no legal basis for petitioners’ assertion that Memcorp HK’s

account receivable balance was constructively distributed to them, in its entirety,

when $18,378,680 was included in their gross income for 2004 and 2005. Peti-

tioners cite various authorities for the proposition that income constructively re-

ceived in year 1 cannot be taxed again when actually received in year 2. But while

that proposition is generally correct, the premise for petitioners’ argument is not.

To begin with, the prior section 956 inclusions were not “constructive distri-

butions.” See SIH Partners LLLP v. Commissioner, 150 T.C. __, __ (slip op. at

52-53) (Jan. 18, 2018) (holding that inclusions under section 956(d) for guaranties

by CFCs do not constitute dividends); Rodriguez v. Commissioner, 137 T.C. 174

(2011), aff’d, 722 F.3d 306 (5th Cir. 2013). In any event, there is no legal basis

for petitioners’ assertion that the entire account receivable balance was construc-

tively distributed to them in 2004 and 2005 when E&P corresponding to a portion

of it (i.e., $18,378,680) was included in their gross income.

For these reasons, we conclude that petitioners in 2009 received from Hop-

per Cyprus a constructive distribution of $21,055,123 and that this distribution
 - 53 -

was taxable to them in full as a dividend under sections 301(c)(1) and 316(a). We

will therefore grant respondent’s cross-motion for partial summary judgment on

this point.12

To implement the foregoing,

An order will be issued granting

respondent’s motion for partial summary

judgment, denying petitioners’ cross-

motion for partial summary judgment, and

denying petitioners’ motion for partial

summary judgment.

12
In his cross-motion for partial summary judgment respondent contends
that this constructive dividend does not constitute QDI taxable at preferential rates
under section 1(h)(1). That depends on whether constructive dividends can con-
stitute “qualified dividend income” under section 1(h)(11)(B) and on whether
Hopper Cyprus during 2009 was a “qualified foreign corporation” under section
1(h)(11)(B)(i)(II). The parties have not addressed the first point and (as noted
above) we find that petitioner is not entitled to summary judgment on the second.
See supra pp. 27-44. We accordingly leave resolution of these questions to further
proceedings. Cf. Luczaj & Assocs. v. Commissioner, T.C. Memo. 2017-42, 113
T.C.M. (CCH) 1187, 1193 n.3.