Courts decide actual dividend distribution needed for tax break


The 5th Circuit Court of Appeals has agreed with the Tax Court that income taxed in the United States as a result of a controlled foreign corporation’s investment in U.S. property is not eligible for the lower – in this case 15 percent – tax rate that applies to qualified dividend income.

Osvaldo and Ana Rodriguez, husband and wife, were Mexican citizens and permanent residents of the United States. They owned 100 percent of the stock of a Mexican corporation, which in turn operated a branch in the United States. The Mexican corporation was a controlled foreign corporation under U.S. tax law.

As a result of investments the Mexican corporation made in property located in the United States, the Rodriguezes were required to recognize income (over $3 million in the two years at issue in this case). The couple reported the income as dividend income qualifying for the 15 percent tax rate.

The IRS denied the lower tax rate, and the Tax Court and the Court of Appeals agreed with the IRS. Although the courts and the IRS agreed that the couple would have been eligible for the 15 percent tax rate if they had received an actual dividend distribution from the Mexican corporation, no actual distribution took place.

The Rodriguezes argued that they had received a deemed distribution, but the court did not agree.

The court concluded that income recognized by a U.S. taxpayer as a result of a controlled foreign corporation making an investment in U.S. property is not a qualified dividend for purposes of the lower tax rate. Only an actual distribution can result in a qualified dividend (Osvaldo Rodriguez and Ana Rodriguez v. Commissioner, 112 AFTR 2d 2013-XXXX, July 5, 2013).