Varian Ruling Opens Door for More Companies to Seek Deductions

More companies may get a boost from Varian Medical Systems’ recent court victory over the IRS and its ability to take advantage of a loophole in the 2017 tax-overhaul law.

Cisco Systems, the computer-networking giant, has said it’s looking at whether it can benefit from the Varian ruling, which allowed the company to take a big tax deduction on foreign dividends it received without the effects of a related measure that was supposed to limit the deduction.

Food-service distributor Sysco Corp. has already recorded a partial win over the IRS in a court case over claims similar to Varian’s, while Kyocera AVX, an electronics-component manufacturer, has cited the Varian ruling in support of its attempt to get a tax refund from the agency.

Beyond those companies, tax attorneys say they have other clients who are examining whether they can benefit from the deduction in the same way Varian did.

“It’s a very common fact pattern,” said Christopher Baratta, counsel at Davis Polk & Wardwell LLP. “My gut instinct is that it’s a large number” of companies that could apply the Varian ruling to their own situations, he said.

Practitioners cautioned that companies will have to do a complex analysis to determine whether a deduction like Varian’s will help them. That’s because under the Varian ruling, any company claiming the deduction in the way Varian did would have to balance that benefit against the loss of part of the foreign tax credit they took on the same income—and some companies might be better off not making that tradeoff.

“That is going to be so dependent on the facts of each case,” said Caroline Rule, a partner at Kostelanetz LLP. “It could become a very complicated matter.”

Mismatched Effective Dates

The Varian ruling stemmed from a mismatch in the effective dates of two provisions in the 2017 law—Section 245A, which allows companies to deduct dividends they received from their foreign affiliates, and an amended Section 78, which limits a company’s ability to take such deductions.

For some companies, the two changes took effect at different times: Section 245A was effective for dividend distributions after Dec. 31, 2017, while the Section 78 changes were effective for taxable years beginning after that date. As a result, companies whose fiscal year doesn’t correspond with the calendar year had a window of time in which they could take the deduction without the limitation.

The IRS tried to resolve the date mismatch via regulation and disallowed Varian’s claimed deduction, but Varian challenged that move. In August, the US Tax Court sided with the company, ruling that the law’s plain language dictated that Varian could claim the deduction.

In theory, practitioners said, any multinational company with foreign affiliates that aren’t on a calendar-year fiscal year, and that received dividends from those affiliates after the 2017 overhaul, might be able to do the same.

Such companies ”don’t have any reason not to at least look at the possibility,” said Steve Dixon, a partner at DLA Piper LLP.

“A minority of taxpayers, but a material number,” might be able to benefit, said Aaron Payne, a partner at Eversheds Sutherland.

Evaluating Benefits

Cisco Systems cited the Varian ruling in its annual report and said it was “currently evaluating the potential benefit of this ruling to our provision for income taxes.” Cisco didn’t respond to a request for comment.

Other companies may be similarly considering the matter but might not disclose it publicly for a while. Cisco uses an unusual July-end fiscal year and thus filed its annual report disclosing the potential effect of the Varian ruling in early September, shortly after the ruling was issued. A larger group of companies whose fiscal years end in September might benefit, but their annual reports aren’t due till November.

Sysco was able to claim $324 million in deductions after the company and the IRS agreed that the Varian ruling applied to their case, and the court granted partial summary judgment to both sides.

A Sysco spokesperson declined to comment.

Kyocera argued in a Sept. 6 court filing that the Tax Court’s Varian ruling applies in its case as well. Kyocera’s case is still pending; a spokesperson couldn’t be reached for comment.

In addition to blessing Varian’s deduction, the Tax Court’s ruling also indicated that if companies were to take a Section 245A deduction, it would reduce the foreign tax credit they can take. Companies will have to determine which benefits them more—and that won’t necessarily be an easy or quick analysis, practitioners said.

Some companies will have to do that analysis for many different jurisdictions in which they have affiliates, each with its own tax rates and rules.

Dixon said there are “pretty wide variances” among companies in the extent to which a limitation on the foreign tax credit would decrease the benefit a company could get from a Varian-like deduction.

“For some it’s a haircut; for others it cuts the benefit in half,” he said. “It depends on taxpayer-specific factors.”

At many companies, Baratta said, the question “is going to be whether it makes sense to do this.”