According to Law360, the Internal Revenue Service lost a fight in the D.C. Circuit on July 27, 2018 when the court ruled that it unreasonably interpreted tax law to prevent Marshall Islands-based Good Fortune Shipping from proving it was entitled to a tax break based on its ownership.

Good Fortune sought to exclude its U.S.-source gross transportation income in 2007 under Internal Revenue Code Section 883, which provides an exemption for companies with more than 50 percent ownership by residents of countries whose tax laws grant U.S. companies reciprocity, according to court documents.

However, the IRS in 2003 had issued a regulation excluding companies whose stock consisted of bearer shares, an unregistered form of stock certificate that does not identify the owner. During the 2007 tax year all Good Fortune shares were in bearer form, and the company was assessed $143,500 in 2007 taxes. The company filed a petition in the U.S. Tax Court claiming the categorical exclusion of bearer shares was unreasonable. It lost and appealed.

A flat rejection of bearer shares is unreasonable, a D.C. Circuit panel ruled, calling bearer shares a legally valid form of ownership. While they make ownership is difficult to verify, it is not impossible, the panel added.

“If the IRS found that the transferable nature of bearer shares made substantiation impossible, we might conclude that the 2003 regulation reasonably implemented that finding,” the panel said. “But the IRS has never made (much less adequately supported) such an absolute claim of impossibility with regard to bearer shares.”

In 2010 the IRS amended its regulation and abandoned the categorical exclusion of bearer shares. Instead, it allowed bearer shares to show ownership if the shares could be represented by book entries with no physical certificates transferred, or if evidence of ownership was maintained by its issuer or a financial institution.
 

The IRS even allows bearer shares to prove ownership and qualify for favorable tax treatment in other contexts, such as in showing that a foreign corporation is not closely held in Section 884, the court said.

“If bearer shares were reliable enough under § 884, we see no reason why they wouldn’t have been reliable enough to justify their consideration under § 883,” the panel said.