OBH, Inc. v. Comm.
In OBH, Inc. v. Comm., the commissioner tried to assert that OBH, Inc (referred to as Berkshire) used proceeds from a loan to purchase short term stock investments. Berkshire, however, only had one active bank account and all daily transactions flowed. In this account the proceeds of the debt were mixed with the beginning cash balance, proceeds from operations, results of the sale of securities, and other funds. Through a series of complex transactions, the auditor (referred to as Powell) found that it was possible that the funds used to buy the stock in question could have been the proceeds of the debt. However, even Powell was not able to say for certain whether there was a direct connection between the two items.
A closer look at Powell’s tracing method shows that he would connect transactions that occurred during the same day, and would connect transactions of similar size. If he could not match up a transaction due to size, he would split the amount until he could find a match. He would also give preference to allocating towards the purchase of the stock in question. One such transaction, Powell would trace the proceeds of a $150 million debenture through 154 transactions, over the course of year in order to attribute the funds towards the purchase of some stock.
When the courts looked at the language of §246A, it was determined that there were two tests that must be satisfied in order for there to be a connection between debt and dividends, and consequently for the limitation to apply. §246A(d)(3)(A) states “The term “portfolio indebtedness” means any indebtedness directly attributable to investment in the portfolio stock.” The sentence became the foundation for the ‘directly traceable’ test. Revenue Ruling 88-66, which presents three fact patterns, provides more insight as to whether debt can be directly attributable to portfolio stock that is also held.
For the second test, the court looked to the case of H Enterprises International Inc. v. Comm. Here the court looked to the intent of the taxpayer in determining if §246A applied. In OBH, the court again looks to the intent of the taxpayer to see if the debt was intended to be used to purchase the stock.