Container Corp. v. Comm’r: Clarity on Guarantee Fee Sourcing?

Editor's Note: The following is an excerpt from Rhoades & Langer U.S. International Taxation and Tax Treaties § 26.01[3][f] (Matthew Bender).

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The question of how to treat guarantee fees has long vexed both practitioners and the Internal Revenue Service.  Those fees look like interest--sort of--and they look like services income--sort of.

When faced with the question of how to characterize guarantee fees paid by a U.S. corporation to a foreign parent, in Container Corp. v. Comm'r, 2010 U.S. Tax Ct. LEXIS 5 (T.C. Feb. 17, 2010), the Tax Court found that a guarantee fee paid by a U.S. subsidiary of a Mexican parent was fixed or determinable annual or periodic income (FDAP), so if the source of the income were the United States, it would have been subject to withholding.  The court concluded that a guarantee fee should be treated as either interest is treated or as services are treated under the withholding rules.  The Commissioner argued that the guarantee fee was akin to interest which, had the court agreed, would have sourced the interest at the putative payor's (that is, the U.S. subsidiary) residence, so withholding would have been required.

The court's analysis is rather extensive.  The issue, however, is one that where the court draws the line is nowhere nearly as important as the actual drawing of the line somewhere. Treating a guarantee fee as interest, as opposed to services, will not endanger the fisc, so let's just applaud the court for drawing the line and treat its conclusion as the law: Guarantee fees are sourced at the place where the guarantor is.  Under Container's rationale, that place may or may not be the guarantor's place of residence, since the fees were based upon the guarantor's promise and assets.

Thus, even though we do not have complete clarity on the issue of the source of a guarantee fee, we are part way there--we know that the fees are not to be sourced at the residence of the one who is the beneficiary of the guarantee (and, of course, who paid the guarantee fee).  We still do not know where the fee is sourced.  The likelihood is that the fee will be sourced where the payee/guarantor resides.

Since the result is a sword that cuts both ways--and, hence, is neutral from the fisc's standpoint--let's hope that the Government does not appeal the decision and, indeed, that the Service acquiesces in it.  Settled law is always helpful to the business community.

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