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Nebraska Supreme Court holds Section 965 income does not qualify for Nebraska’s dividend received deduction
September 2024
In brief
What happened?
The Nebraska Supreme Court on August 30 sustained the Lancaster County District Court’s decision that IRC Section 965 income included on a taxpayer’s federal return did not qualify for the state’s dividend received deduction. The Court concluded that “the language of Section 965 does not deem the income included to be dividends, and we determine that Section 965 employs pass-through treatment to attribute earnings to shareholders without deeming a distribution to have been made to shareholders.” [Precision Castparts Corp. v. Nebraska Dept. of Rev., No. S-23-564, 317 Neb. 481, Aug. 30, 2024.]
Why is it relevant?
In addition to repatriation amounts under IRC Section 965 in a taxpayer’s 2017 and/or 2018 tax year, the decision may impact how Nebraska courts view other kinds of foreign income inclusion such as GILTI and Subpart F that are included as income to US shareholders under federal law. For example, the Department of Revenue’s guidance states that “under Nebraska law, with the exception of [Section] 78 dividends attributed to GILTI, there is no exclusion for GILTI income as a foreign dividend or deemed foreign dividend.” The decision also could impact the view of other state courts with respect to the treatment of these “deemed” income inclusion provisions, especially given the Court’s citation to the US Supreme Court’s Moore decision. (For more on the Supreme Court’s Moore decision, see PwC’s Insight here.)
Actions to consider
Although the decision is specifically about the treatment of IRC Section 965 income, the Court’s rationale also could apply to the Department’s position that GILTI and most components of Subpart F do not qualify for the state’s dividend received deduction. As such, taxpayers should consider how this ruling may impact both the 2023 and prior years’ corporate income tax filings to the extent those tax years are open under Nebraska law.
In detail
Nebraska provides a corporate income tax deduction for “dividends received or deemed to be received from corporations which are not subject to the Internal Revenue Code.” Neb. Rev. Stat. § 77-2716(5). In a declaratory order, the Tax Commissioner denied the request by the taxpayer, Precision Castparts Corp., to amend its 2017 Nebraska corporation income tax return to claim a dividend received deduction for Section 965 income included on its federal tax return.
The Tax Commissioner contended that nothing in the language of Section 965 deems the inclusion to be a dividend. The taxpayer countered that Section 965 deemed it to have received a distribution of retained earnings from its CFCs and that such distribution qualifies as a dividend.
District Court decision
In an order signed June 30, 2023, the Nebraska Lancaster County District Court ruled that IRC Section 965 income does not qualify for the state’s dividend received deduction. The District Court found that IRC Section 965 income was not a “dividend” because there was no actual distribution of funds. In addition, the District Court found that the term “deemed” “implies action taken by an actor” and that unlike IRC Sections 78 and 1248, which are specifically referred to as “deemed dividends,” IRC Section 965 is not similarly described as such.
The Nebraska Supreme Court accepted direct appeal of the case on February 8, 2024.
Nebraska Supreme Court finds no ‘deemed dividend’
The Nebraska Supreme Court noted that “exemptions from taxation are to be strictly construed in favor of the government and not extended by judicial construction.” The Court found that “Section 77-2716(5) provides a deduction from federal adjusted gross income to determine Nebraska taxable income, and it effectively exempts the deducted amount from taxation.”
Further, the Court noted that Neb. Rev. Stat. § 77-2714 provides that terms used in the Nebraska income tax statutes “have the same meaning as when used in a comparable context in the laws of the United States relating to federal income taxes, unless a different meaning is clearly required.” The Court found that under IRC Section 316(a), the term “dividend” generally is defined to mean “any distribution of property made by a corporation to its shareholders . . . out of its earnings and profits.”
The Court stated that “there does not appear to be any contention in this case that the Section 965 inclusion should be considered a ‘dividend,’ per se, because no actual distribution was made by Precision Castparts’ CFCs or received by Precision Castparts. The issue instead is whether Section 965 income qualifies as ‘dividends . . . deemed to be received’ under the language of § 77-2716(5).”
The Court first found that “there is nothing in the language of Section 965 that leads us to conclude that the statute operates by deeming the retained earnings to have been distributed.” This conclusion is supported by Section 965 providing specific tax rates and income inclusion rules, rather than providing that the inclusion should be taxed in the manner and at the rates applicable to dividends, the Court reasoned.
The Court then turned to the US Supreme Court’s decision in Moore v. United States, 144 S. Ct. 1680 (2024). The Court concluded that the US Supreme Court’s characterization of Section 965 “indicates that the statute does not operate by deeming shareholders to have received a distribution of retained earnings from CFCs.” Instead, the Court found that Moore supports the view that Section 965 employs a pass-through mechanism that attributes earnings realized by CFCs to the shareholders without regard to whether those earnings are distributed to the shareholders.
Potential impact for GILTI and Subpart F inclusion
The Court’s rationale also could apply to the Department’s position that GILTI and most components of Subpart F do not qualify for the state’s dividend received deduction. For example, in GIL 24-20-1 (Nov. 19, 2020), the Department stated that GILTI is not an excluded foreign dividend except for IRC Section 78 dividends that are attributed to GILTI pursuant to IRC Section 250(a)(1)(B)(ii). Likewise, in Revenue Ruling 24-21-1 (Feb. 17, 2021), the Department concluded that Subpart F income is neither a dividend nor deemed dividend under federal law and, therefore, is not a dividend or deemed dividend under Nebraska law. However, the Department noted that the following Subpart F inclusions are specifically deemed to be dividends under the IRC: Section 964(e)(4) gains on the sale or exchange by a CFC of stock in another foreign corporation, Section 245A(e)(2) hybrid dividends, and Section 954(c)(1)(A) foreign personal holding company dividends.
Observation: The Department’s guidance on GILTI and Subpart F inclusion also provides guidance on apportionment. While the guidance notes that “sales includes all gross receipts of the taxpayer” (emphasis added), it provides that only the amounts included in income should be represented in the denominator (i.e., the amount of GILTI or Subpart F to the extent not deductible). It remains to be seen whether the Court’s reliance on the Moore flow-through characterization of Section 965 income may impact the Department’s view on apportionment factor representation for the total CFC sales that are a part of the production of a Nebraska taxpayer’s apportionable income.
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