Brown Group, Inc. and Subsidiaries v. Commissioner of Internal Revenue

Brown Group, Inc. (Brown Group) (plaintiff) filed suit against the Commissioner of Internal Revenue (the commissioner) (defendant) regarding a declared deficiency of $388,992.85 from the tax year ending November 1, 1986. Brown Group made shoes in the United States and imported shoes from Brazil and other nations. Brinco, a partnership established in the Cayman Islands, acted as the purchasing agent for Brown Group International (International), an American corporation and wholly owned subsidiary of the Brown Group regarding Brazilian shoes. Brinco’s partners and their percent of interests in net profits and losses were: Brown Cayman (a controlled foreign corporation), 88 percent; T.P. Cayman, Ltd. (T.P. Cayman, a Cayman Islands corporation), 10 percent; and an individual agent named Delcio Birck, 2 percent. The Brown Group companies ultimately paid Brinco a 10 percent commission, which amounted to $1,119,970 for the tax year in question. T.P. Cayman received guaranteed payments of $151,662, and the remaining Brinco net-partnership earnings were divided 98-2 between Brown Cayman ($897,281) and Birck ($20,184). Brinco was dissolved on October 31, 1987. The issue before the court was whether Brown Cayman’s share of the partnership income from Brinco was Subpart F income and thus included in the gross income of a member of the affiliated group via § 951(a). Brown Group argued that Brinco was not a related person with regard to Brown Cayman or International. Accordingly, Brown Cayman’s share of the commission income could not be considered Subpart F income, as that applied only to the purchase of personal property on behalf of a related person. Brown Group alternatively argued that the character of the income must be determined at the partnership level, treating Brinco as a separate entity, and the income thus belonged to Brinco and not Brown Cayman and could not be held to be foreign-base-company sales income of Brown Cayman. Meanwhile, the government argued that the aggregate theory of partnerships, rather than the entity theory, must apply. The aggregate theory dictated that Brown Cayman’s share of Brinco’s income must be treated as foreign-base-company sales income and also as Subpart F income. International, as the United States shareholder of Brown Cayman, was then obligated to include its share of Brown Cayman’s subpart F income within its gross income under § 951(a).