An oil services company recently lost a deduction for an investment in a Russian subsidiary because the court found it to be an equity investment and neither a loan nor an ordinary and necessary business expense for performing a guarantee of the subsidiary’s contract. Baker Hughes Inc. v. United States, No. 4:15-cv-02675 (S.D. Tex. 2018). The takeaway is that parent guarantees are common, but if they are “performed” before the subsidiary goes into default, they are likely to result in a capital contribution, which may ultimately be deductible, but not currently as a business expense or bad debt.
The Russian subsidiary’s contract with Russian customers was guaranteed by the U.S. parent. The Russian government required the subsidiary to maintain a certain level of asset value. When that dropped, the parent had to supply $52 million, which it did in 2008. The parent claimed a current loss of the cash, either as a bad debt or for its performance of the guarantee.
The court found there was no debt because, among other facts, the parent signed a document that “confirms hereby that its financial assistance is free and that it does not expect the company to return the funds to the shareholder.”
Then the parent turned to a line of cases that sometimes allows a guarantor to deduct payments to protect its reputation. The court refused to apply those cases mostly because the subsidiary was not in default; no obligation to perform on the guarantee had accrued.
Parent guarantees are common, particularly when the subsidiary is operating in a foreign country. Obtaining deductions for payments related to such a guarantee is hard. Be careful of the agreements you sign, and the timing of the payments, and the identity of the payee if a deduction is desired.
For more information, please contact Jack Cummings at 919.862.2302.
The Russian subsidiary’s contract with Russian customers was guaranteed by the U.S. parent. The Russian government required the subsidiary to maintain a certain level of asset value. When that dropped, the parent had to supply $52 million, which it did in 2008. The parent claimed a current loss of the cash, either as a bad debt or for its performance of the guarantee.
The court found there was no debt because, among other facts, the parent signed a document that “confirms hereby that its financial assistance is free and that it does not expect the company to return the funds to the shareholder.”
Then the parent turned to a line of cases that sometimes allows a guarantor to deduct payments to protect its reputation. The court refused to apply those cases mostly because the subsidiary was not in default; no obligation to perform on the guarantee had accrued.
Parent guarantees are common, particularly when the subsidiary is operating in a foreign country. Obtaining deductions for payments related to such a guarantee is hard. Be careful of the agreements you sign, and the timing of the payments, and the identity of the payee if a deduction is desired.
For more information, please contact Jack Cummings at 919.862.2302.