## Facts

- Compaq Computer Corporation realized a long-term capital gain of $231,682,881 in July 1992 from the sale of Conner Peripherals, Inc. stock.
- An arbitrage firm, Twenty-First Securities Corporation, proposed an American Depositary Receipt (ADR) strategy designed to generate tax benefits tied to that capital gain.
- Compaq entered a prearranged, risk-minimized ADR “cum-dividend/ex-dividend” trade in Royal Dutch Petroleum ADRs:
  - Purchased 10 million ADRs cum dividend for approximately $887 million.
  - Agreed almost immediately to resell the same ADRs ex dividend for approximately $868 million.
- Because of settlement timing, Compaq became the shareholder of record on the dividend record date and was entitled to a $22,545,800 dividend, subject to $3,381,870 Netherlands withholding tax.
- Twenty-First received nearly $1 million in commissions connected to the transaction.
- On its tax return, Compaq reported:
  - Dividend income of $22,545,800;
  - A foreign tax credit for the $3,381,870 withholding tax;
  - A capital loss of about $20.65 million on the ADR resale, used to offset the earlier Conner Peripherals gain.
- The court found that, ignoring tax effects, the transaction produced a net cash-flow loss of $1,486,755.
- The IRS disallowed the foreign tax credits and related benefits and asserted an accuracy-related penalty under I.R.C. § 6662(a); Compaq petitioned for redetermination.

## Issues

1. Whether Compaq’s 1992 ADR purchase and immediate resale lacked economic substance such that the resulting dividend, capital loss, and foreign tax credit should be disregarded for federal income tax purposes.
2. Whether Compaq was liable for an accuracy-related penalty under I.R.C. § 6662(a) for negligence or disregard of rules or regulations.

## Decision

- The Tax Court held that the ADR transaction lacked economic substance and would be disregarded for federal income tax purposes.
- The court disallowed the claimed foreign tax credit arising from the Netherlands withholding tax.
- The court imposed the accuracy-related penalty under § 6662(a), finding Compaq negligent in claiming the tax benefits.

## Legal Principles

- Courts may deny claimed tax benefits when a transaction, though formally compliant with statutory provisions, lacks objective economic effect and meaningful non-tax purpose (economic substance/business-purpose doctrine).
- A prearranged transaction structured to eliminate market risk and producing a pre-tax loss supports a finding that the transaction’s only rational objective was tax benefits, warranting disregard for federal tax purposes.
- Foreign tax credits under I.R.C. § 901 may be disallowed when the foreign tax payment is a consequence of a transaction lacking economic substance.
- A taxpayer is subject to the § 6662(a) accuracy-related penalty for negligence when it fails to exercise reasonable care in evaluating and reporting large, tax-driven transactions, including by relying on promoter materials without adequate independent analysis.

## Conclusion

The Tax Court treated Compaq’s ADR dividend-arbitrage trade as a sham lacking economic substance, disallowed the resulting foreign tax credit and related tax effects, and imposed a § 6662(a) negligence penalty based on insufficient due diligence and the transaction’s tax-driven design.


Compaq Comput. Corp. & Subsidiaries v. Comm’r, 113 T.C. 214 (1999)