IRS Issues Action on Decision and Nonacquiescence to the Fifth Circuit Court of Appeals Recent Decision in Tidewater, Inc. and Subsidiaries.
In Tidewater, Inc. and Subsidiaries v. U.S., 565 F.3d 299 (4/13/2009), the Fifth Circuit affirmed the District Court’s determination in a tax refund suit, reported at 100 AFTR2d 2007-6360 (DC LA 2007), which granted controlled group/oceangoing vessel owner-operators' refund of an overpayment of tax attributable to its claim that it could deduct, under the former foreign sales corporation provision, commissions paid to a foreign sales corporation on the portion of income allocated to the leasing component of time charters/mixed lease-service agreements. The Court agreed with the trial court below that time chartered vessels constituted qualified export property for purposes of former §927 and former Treas. Reg. § 1.927(a)-1T(f)(2) 's provision for leases to controlled group members of property that is held for sublease. The resolution of the issue hinged on whether the taxpayers' agreements with customers were in the nature of service contracts or leases/subleases. This analysis required application of the factors set forth in §7701(e). The six factors in §7701(e) that the Fifth Circuit analyzed were (1) physical possession of the property; (2) control of the property; (3) significant possessory or economic interest in the property; (4) substantial risk of nonperformance; (5) concurrent use of the property; and (6) that the total contract price does not substantially exceed the rental value of the property for the contract period.
The Fifth Circuit held that the control factor was most important and therefore concluded that the agreements in issue in this case were more akin to lease/sublease agreements due to the significant control customers exercised over every aspect of the vessels' use.
The AOD, (AOD 2010-01, posted on the IRS website May 17, 2010; 2010-22 IRB), states the Service’s disagreement with the the Fifth Circuit’s analysis and application of the factors test under §7701(e). The Service continues to hold its position that time charters should be treated as service contracts on the basis that the right to direct the destination and itinerary of boat trips for a specific period of time is not sufficient “control” or otherwise meets the requirements of a lease of property versus a contract for services.
