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National Grid Holdings, Inc. v. Commissioner of Revenue

Appeals Court of Massachusetts, Suffolk

June 8, 2016


          Heard: December 11, 2015.

         Appeal from a decision of the Appellate Tax Board.

          John S. Brown (Donald-Bruce Abrams with him) for the taxpayers.

          Brett M. Goldberg for Commissioner of Revenue.

          Present: Cypher, Carhart, & Blake, JJ.

          CYPHER, J.

         The plaintiffs, National Grid Holdings, Inc. (NGHI), National Grid USA (NGUSA), and National Grid USA Service Company, Inc. (NG Service) (collectively, taxpayers), appeal from a decision of the Appellate Tax Board (board) in favor of the defendant, Commissioner of Revenue (commissioner), on the taxpayers' claims for an abatement of corporate excise for the tax year ended March 31, 2002. Primarily at issue is whether certain financing transactions, referred to as deferred subscription arrangements (DSAs), among various subsidiaries of National Grid plc (NGPLC), constituted true indebtedness so that the interest paid thereon qualified for the deduction allowed under the Massachusetts taxation of corporations statute, G. L. c. 63, § 30(4).

         NGPLC is a British electric and gas utility company that owns numerous entities in the United States (U.S.), the United Kingdom (U.K.), and beyond (collectively, National Grid). The DSAs were financing arrangements designed by National Grid to take advantage of the differences in the U.S. and U.K. tax codes.[2] National Grid attempted to cast the transactions as indebtedness under U.S. State and Federal tax laws, thereby reducing National Grid's tax liability in the U.S., and as equity, under U.K. law, thereby reducing its taxable income in the U.K. Of overriding concern was the avoidance of any appearance of indebtedness in the U.K., where a debenture between a U.K. entity and its foreign subsidiary is strictly prohibited by statute, under threat of criminal sanctions.[3] To that end, National Grid drafted the DSAs as agreements among various related entities to sell and repurchase shares of stock, maintaining in these proceedings that the mandatory nature of the stock repurchase constituted debt under Massachusetts corporate tax law.

         "We will not modify or reverse a decision of the board if the decision is based on both substantial evidence and the correct application of the law." Boston Professional Hockey Assn. v. Commissioner of Rev., 443 Mass. 276, 285 (2005). We find no error with the board's determination that the taxpayers failed to satisfy their burden of proving that the critical provisions of the DSAs, upon which they rely, gave rise to an unqualified obligation to repay. Accordingly, their claimed deductions for interest payments under the DSAs were properly rejected, as was their claim that the DSAs constituted a liability in calculating net worth.


         We summarize the factual and procedural background from the board's very thorough account, provided in its June 4, 2014, findings of fact and report, which we supplement from the record where appropriate.

         National Grid entered the U.S. utility market in 1998, when it acquired New England Electrical System (NEES) and, shortly thereafter, Eastern Utilities Association (EUA). Pursuant to the acquisition, National Grid General Partnership (NGGP) became the parent of the U.S. group and NEES merged with NGUSA. In order to achieve tax efficiency in the purchase, National Grid created a domestic reverse hybrid, a tax structure whereby the U.S. entity was taxable as a corporation in the U.S. but was transparent, for tax purposes, in a foreign country.[4] The domestic reverse hybrid was part of a thirty-three-step process known as Project Mayflower, by which National Grid acquired NEES and EAU. National Grid used existing affiliates, and also created several U.K. and U.S. entities in the process that issued various intercompany loans to finance the acquisition of NEES and EUA and permitted National Grid to claim interest deductions in the U.S.

         In February, 2001, the U.S. Treasury proposed regulations to restrict the use of domestic reverse hybrids. Under the new regulations, the interest payments made by the National Grid subsidiary would be treated as payment of dividends and subject to U.S. tax withholding. In the face of the proposed changes, National Grid sought to replace the domestic reverse hybrid with a different structure that would maintain its tax advantages, that is, the deductibility of interest payments in the U.S., and avoidance of income recognition in the U.K. Also to be avoided was running afoul of §§ 765-766 of the United Kingdom Income and Corporation Taxes Act 1988 (§ 765), which prohibits debentures between U.K. entities and foreign subsidiaries, and which carries criminal penalties.

         The result was known as Project Spam and Project Spa. Project Spam was a forty-seven-step series of transactions that refinanced the $2.68 billion indebtedness incurred in the NEES acquisition. Project Spa was a forty-four-step series of transactions created soon after the Project Spam financing to finance National Grid's acquisition of Niagara Mohawk Holdings, Inc. (Niagara Mohawk), a New York utility company. The projects utilized the DSAs, which were structured as stock purchases, to retain the interest deductions and other tax benefits of the domestic reverse hybrid while avoiding creation of a debenture, as prohibited under U.K law. The relevant documents and provisions of the two projects being similar, we principally focus on Project Spam.

         National Grid Eight Limited (NG8), was a U.K. entity created as part of Project Spam. The NG8 DSA was designed to reflect NGHI's $2.68 billion of outstanding debt for U.S. tax purposes. We are directed to three documents critical to the dispute: the articles of association of NG8 (articles); a December 20, 2001, offer for subscription of ordinary share capital; and an agreement for the sale and purchase of shares in NG8 (S&P agreement). The offer letter extended to NGHI the opportunity to subscribe for 10 million shares of NG8, for $2.695 billion, with an initial payment of $15 million and three additional payments, referred to as call payments, on or after the dates and in the amounts specified in the NG8 article. NG8 could make those calls only in the amounts and on dates specified in the documents. The offer letter required that any acceptance be oral, thereby avoiding a document that might be construed as a debenture under § 765.

         Upon NGHI's oral acceptance of the offer, NGHI paid $15 million to NG8 for 10 million NG8 shares, and then sold the shares for $2.695 billion to National Grid (US) Investments 4 (NGUSI4). NGHI used the proceeds, totaling $2.68 billion ($2.695 billion minus the $15 million it paid to NG8), to repay the loans for Project Mayflower, now refinanced.

         As noted, the articles provided that NG8 could make calls on NGHI for four call payments on or after specified dates. The first three payments represented interest, and the final payment was principal and interest. The S&P agreement provided that NGHI remain liable for the call payments, and that if NG8 failed to make a call according to the schedule in the articles, NGHI was entitled to procure, through NGUSI4, that NG8 make the call (thereby avoiding interest at a higher rate). However, NGHI was under no obligation to exercise that right.

         At the heart of this dispute is the nature of NGHI's obligation to repurchase the NG8 shares, and whether that obligation constituted the repayment of a debt, as determined by whether NGHI4's service of the notice to repurchase was discretionary or mandatory. Clause 2.9 of the S&P agreement provided that if NGHI failed to make a call payment within seven days of the call, or if NG8 made no call and NGHI failed to exercise its right to procure a call, NGUSI4 was "entitled to serve a notice" on NGHI requiring NGHI to repurchase the [NG8] shares. The parties agree that, under clause 2.9, NGUSI4's right to serve notice requiring NGHI to repurchase the shares was discretionary, as per the "shall be entitled to serve" language. Hence, clause 2.9 did not impose an unqualified obligation on NGHI to repurchase the shares.

         The parties' disagreement centers on clause 2.10 of the S&P agreement. We set forth clause 2.10 in its entirety:

"If for any reason whatsoever any sums due in respect of the [s]hares under [a]rticle 3 of the [a]rticles remain unpaid after 19 December[, ] 2004, the [b]uyer shall serve a notice on the [s]eller requiring the [s]eller to repurchase the [s]hares on 20 December[, ] 2004[, ] or if this is not a [b]usiness [d]ay, the next [b]usiness [d]ay thereafter for a consideration equal to the net asset value of the [c]ompany (as determined in accordance with clauses 2.11 to 2.14) and the aggregate of any sums remaining unpaid in respect of the [s]hares less the amount of any called up share capital not paid, and such consideration shall be paid in cash against delivery of a duly executed transfer on behalf of the [b]uyer in favour of the [s]eller and the delivery of the relevant share certificate. If the [b]uyer exercises its rights under this clause and the [s]eller fails to complete the repurchase of the [s]hares at the time specified by the [b]uyer[, ] the consideration due shall bear interest for the period from and including the date on which the failure to complete the repurchase has occurred up to the date of the actual payment (after as well as before judgment) at the rate which is the aggregate of [four] percent per annum above the base rate from time to time of Barclays Bank plc. The interest will accrue from day to day and shall be payable on demand and shall be compounded monthly in arrears provided that no interest shall accrue under this clause 2.10 where interest is accruing under [a]rticle 3 of the [a]rticles."

         The parties debate the interpretation of clause 2.10, and whether it required NGHI4, as the buyer, to serve notice to repurchase, or whether NGHI4 merely had the right to serve notice to repurchase. According to National Grid, clause 2.10 establishes that NGHI4 was required to serve notice to repurchase and, as such, imposed on NGHI an unqualified obligation to repurchase the shares -- and hence, repay a debt.[5]

         A month after Project Spam's implementation, Project Spa was carried out, consisting of forty-four steps, through which National Grid acquired Niagara Mohawk. The DSA components of Project Spa were similar to those for Project Spam, except for the companies involved, the dates, the number of shares, and the dollar amounts. Significant here, NGUSA filed a separate corporate excise return claiming a deduction in computing its taxable net worth for a liability for costs associated with the Niagara Mohawk acquisition.

         NG Service was the principal reporting corporation for NGHI and NGUSA for Massachusetts tax purposes. For the tax year ending March 31, 2002, the taxpayers deducted the interest payments made under the DSAs, treating the DSAs as indebtedness. Similarly, NGHI treated the DSAs as deductible for purposes of calculating taxable net worth. The commissioner made additional assessments of corporate excise for ...

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