Sysco Corporation v. Commissioner of Internal Revenue: Court Reaffirms Limits on Section 245A Deductions and Foreign Tax Credits

Sysco's $324 Million Tax Deduction Dispute: What's at Stake?

The U.S. Tax Court has handed down a $323,924,795 tax deficiency ruling against Sysco Corporation, the nation’s largest foodservice distributor, in a dispute over whether the company could claim $324 million in dividends-received deductions under Section 245A for foreign dividends that included deemed-paid foreign taxes under Section 78. The case centers on whether Sysco’s foreign subsidiaries’ dividends—derived from earnings taxed under the Section 965 transition tax regime—qualified for the 100% dividends-received deduction (DRD) under Section 245A, which was enacted as part of the Tax Cuts and Jobs Act (TCJA) of 2017 to transition the U.S. to a territorial tax system.

At issue are $323,924,795 in disputed deductions claimed by Sysco on its 2018 federal income tax return, which the IRS disallowed in full in a Notice of Deficiency issued to the company. The dispute implicates five critical Code sections: Section 245A (the DRD for foreign-source dividends), Section 246(c)(1) (the holding period requirement for DRDs), Section 78 (the gross-up rule for deemed-paid foreign taxes), Section 965 (the transition tax regime), and Section 245A(d) (the formula for disallowing foreign tax credits on DRD-eligible dividends). The stakes are not merely monetary: the court’s ruling reaffirms the Tax Court’s authority to interpret the TCJA’s international tax provisions and sets a precedent that could affect how multinational corporations structure foreign dividend payments and foreign tax credit claims.

The Tax Court’s decision in Sysco Corporation v. Commissioner, T.C. Memo. 2026-84 (filed Sept. 14, 2026), directly rejects Sysco’s argument that the court’s prior rulings in Varian Medical Systems, Inc. & Subs. v. Commissioner (Varian I and II) were inapplicable to its facts. Instead, the court held that Sysco’s position was “unpersuasive” and that the Varian I and II holdings control the outcome. The ruling underscores the Tax Court’s willingness to exercise judicial power over the IRS’s interpretations of the TCJA’s international tax provisions, particularly where the court finds the statutory language unambiguous. For Sysco, the decision means the company must pay the deficiency in full—or face penalties and interest accruing since the IRS issued its notice. For the broader tax community, the case serves as a cautionary tale about the limits of aggressive tax planning under the TCJA’s international tax regime.

The Corporate Structure Behind Sysco's Tax Strategy

Sysco’s dispute with the IRS traces back to its role as a U.S. corporation and the common parent of a sprawling global group of affiliates. For the taxable year 2018, Sysco and several of its affiliates operated on a fiscal year basis rather than a calendar year, a structural detail that would later become central to the dispute. During that same year, Sysco held direct and indirect ownership stakes in foreign corporations that the IRS classified as specified foreign corporations under Section 965(e)—a provision enacted by the Tax Cuts and Jobs Act (TCJA) to define foreign entities subject to the new international tax regime.

The company’s tax strategy hinged on its inclusion of deferred foreign income in subpart F income under Section 965(a), a mechanism that allowed Sysco to account for earnings accumulated in its foreign subsidiaries as if they had been repatriated. This inclusion was not merely theoretical; it triggered a cascade of tax consequences, including the deemed payment of foreign taxes under Sections 902 and 960, which Sysco elected to claim as foreign tax credits for 2018. The IRS, however, would later challenge the legitimacy of these credits, setting the stage for a confrontation over the scope of permissible deductions.

A critical pivot in Sysco’s approach occurred when it initially did not claim the dividends received deduction (DRD) under Section 245A for amounts treated as dividends under Section 78—a provision that requires U.S. corporations to gross up their income by the amount of foreign taxes deemed paid. This omission was not an oversight but a strategic choice, one that reflected the uncertainty surrounding the interaction between Section 245A and the foreign tax credit regime. Yet, as the dispute escalated, Sysco reversed course, asserting in its petition that the IRS had erred by failing to account for a Section 245A DRD in an amount exceeding $323,924,795. The timing of this claim—filed after the Tax Court’s rulings in Varian I and Varian II—suggests a calculated gamble on judicial interpretation, one that would test the boundaries of the TCJA’s international tax provisions.

Sysco vs. IRS: Clashing Interpretations of Tax Code Provisions

The stakes in this dispute could not be higher. At issue is Sysco’s claim to a $323,924,795 dividends-received deduction (DRD) under Section 245A, which would eliminate U.S. tax on foreign-source dividends from its controlled foreign corporations (CFCs). The IRS, however, has taken the position that Sysco’s interpretation of the holding period rules in Section 246(c)(1)—and its proposed formula for calculating the net Section 965 inclusion under Section 245A(d)—are legally unsustainable. The outcome will determine whether multinational corporations can rely on indirect ownership structures to satisfy the holding period requirements for the Section 245A DRD, and whether the IRS’s formula for disallowing foreign tax credits (FTCs) on Section 965-derived dividends prevails.

The dispute centers on two distinct but interrelated legal questions. First, Sysco argues that the phrase “held by the taxpayer” in Section 246(c)(1) incorporates the indirect ownership rules of Section 958, allowing it to count stock owned by its CFCs toward the 365-day holding period requirement for the Section 245A DRD. The IRS counters that “held by the taxpayer” means direct ownership, as the Tax Court held in Varian II. Second, Sysco challenges the IRS’s formula for calculating the net Section 965 inclusion, arguing that the Section 965(c) deduction should not reduce the amount of dividends eligible for the Section 245A DRD, and that the IRS’s proposed alternative formulas are inconsistent with the statute.

Sysco’s Arguments

Sysco advances three principal arguments regarding Section 246(c)(1). First, it contends that the phrase “held by the taxpayer” must incorporate the indirect ownership rules of Section 958, because the term “taxpayer” in Section 246(c)(1) is defined in Section 7701(a)(14) as “any person subject to any internal revenue tax”—a category that includes U.S. shareholders under Section 951(b), who are defined by reference to Section 958. Sysco emphasizes that Section 951(b) explicitly incorporates Section 958(a) and (b), which include rules for indirect and constructive ownership. Under this interpretation, a U.S. shareholder would satisfy the “held by the taxpayer” requirement if the stock is held by a CFC in which the U.S. shareholder owns at least 10% of the vote or value.

Second, Sysco points to Treasury regulations that it claims support its interpretation. It cites Treas. Reg. §1.246-5(a), which provides that “[f]or purposes of this section, the term ‘stock’ includes stock owned directly or indirectly by the taxpayer.” Sysco argues that this regulation demonstrates that the IRS has historically recognized indirect ownership in the context of dividend-related provisions, and that the same principle should apply to Section 246(c)(1).

Third, Sysco invokes legislative history, arguing that Congress intended the holding period rules to apply broadly to prevent dividend stripping, and that interpreting “held by the taxpayer” to require direct ownership would create a loophole for taxpayers to avoid the rule by routing stock through CFCs. Sysco contends that the Tax Cuts and Jobs Act (TCJA) was designed to close such loopholes, and that the IRS’s narrow interpretation undermines that purpose.

Turning to the Section 245A(d) issue, Sysco argues that the IRS’s formula for calculating the net Section 965 inclusion is incorrect. The IRS’s position, as articulated in its briefs and in Varian II, is that the net Section 965 inclusion should account for the Section 965(c) deduction, which reduces the amount of the Section 965(a) inclusion by the applicable tax rate (15.5% for cash and cash equivalents, 8% for illiquid assets). Sysco disputes this, arguing that the Section 965(c) deduction is a separate tax benefit that should not reduce the amount of dividends eligible for the Section 245A DRD. Instead, Sysco proposes an alternative formula that would calculate the net Section 965 inclusion without reducing the dividend amount by the Section 965(c) deduction.

The IRS’s Arguments

The IRS rejects Sysco’s interpretation of Section 246(c)(1) on textual, structural, and historical grounds. It argues that the phrase “held by the taxpayer” in Section 246(c)(1) refers to direct ownership, as the Tax Court held in Varian II. The IRS emphasizes that the term “taxpayer” in Section 7701(a)(14) is not limited to U.S. shareholders, and that the phrase “held by the taxpayer” has a well-established meaning in tax law as referring to direct ownership of stock. The IRS points to Black’s Law Dictionary, which defines “held” as “owned or possessed,” and to longstanding judicial interpretations of similar phrases in other Code sections.

The IRS also highlights the statutory structure of Section 246(c), which includes specific rules for indirect ownership in other subsections. For example, Section 246(c)(5) modifies the holding period rules for Section 245A deductions by requiring that the U.S. shareholder and the specified 10%-owned foreign corporation maintain their statuses “at all times during such period.” The IRS argues that if Congress had intended to incorporate indirect ownership rules into Section 246(c)(1), it would have done so explicitly, as it did in Section 246(c)(5).

Finally, the IRS points to the legislative history of Section 246(c)(1), noting that the provision was originally enacted in 1958 to prevent dividend stripping in the context of domestic dividends-received deductions, long before the subpart F regime was enacted. The IRS argues that Congress has never amended Section 246(c)(1) to incorporate indirect ownership rules, despite amending it several times to include Section 245A in the list of covered provisions.

On the Section 245A(d) issue, the IRS defends its formula for calculating the net Section 965 inclusion, arguing that the Section 965(c) deduction is an integral part of the Section 965 inclusion and must be accounted for in determining the amount of dividends eligible for the Section 245A DRD. The IRS contends that Sysco’s proposed alternative formulas would allow taxpayers to claim the Section 245A DRD on dividends that are not truly foreign-source, in contravention of the statute’s purpose. The IRS also points to Varian II, in which the Tax Court upheld its formula for calculating the net Section 965 inclusion under Section 245A(d)(1).

The clash between Sysco and the IRS thus turns on fundamental questions of statutory interpretation: Does “held by the taxpayer” in Section 246(c)(1) incorporate indirect ownership rules, and should the Section 965(c) deduction reduce the amount of dividends eligible for the Section 245A DRD? The Tax Court’s resolution of these questions will have far-reaching implications for multinational corporations and tax planners, who have relied on indirect ownership structures to satisfy the holding period requirements for the Section 245A DRD and who seek clarity on the interaction between Section 245A and the foreign tax credit regime.

Section 246(c)(1): Why Direct Ownership Matters for Tax Deductions

The Tax Court’s ruling in Sysco Corp. v. Commissioner (T.C. Memo. 2026-15, Judge Lauber, filed Sept. 14, 2026) delivers a sharp rebuke to Sysco’s attempt to stretch the plain text of Section 246(c)(1) into a vehicle for indirect ownership. The court’s holding—that the phrase “held by the taxpayer” requires direct ownership—reinforces the Tax Court’s authority to police statutory interpretation, particularly where Congress has spoken clearly but taxpayers seek to exploit ambiguity. The decision is a textbook example of judicial restraint in statutory construction, rejecting Sysco’s policy-driven arguments in favor of a textualist approach that prioritizes the statute’s ordinary meaning over creative tax planning.

The court began by explaining the purpose and text of Section 246(c)(1), which imposes a holding period requirement for dividends-received deductions under Sections 243, 245, and 245A. The provision states that “[n]o deduction shall be allowed under section 243, 245, or 245A, in respect of any dividend on any share of stock . . . which is held by the taxpayer” for fewer than a specified number of days within a defined window around the ex-dividend date. The court emphasized that the term “taxpayer” is defined in Section 7701(a)(14) as “any person subject to any internal revenue tax,” a definition that includes U.S. shareholders but is not limited to them. The phrase “held by the taxpayer,” the court noted, is not defined by the Code, so its ordinary meaning controls.

Sysco argued that the phrase “held by the taxpayer” should be interpreted to mean “held by a U.S. shareholder within the meaning of section 951(b),” which incorporates indirect and constructive ownership rules under Section 958(a) and (b). The court rejected this argument, stating that Sysco’s interpretation “runs counter to the ordinary meaning of the statute.” The court explained that the term “held” in the context of stock ownership typically refers to direct ownership, citing longstanding principles of law and “statutory clues” in other provisions of the Code. The court also noted that the legislative history of Section 246(c)(1)—enacted in 1958 and amended in 1986 and 2017—shows that Congress has consistently used the phrase “held by the taxpayer” without incorporating subpart F concepts like indirect or constructive ownership.

The court further rejected Sysco’s reliance on Section 246(c)(5), which modifies the holding period requirements for deductions under Section 245A. Sysco argued that Section 246(c)(5)(B)—which provides that “[f]or purposes of applying [Section 246(c)(1)] with respect to section 245A, the taxpayer shall be treated as holding the stock referred to in [Section 246(c)(1)] for any period only if” the U.S. shareholder and specified foreign corporation maintain their statuses “at all times during such period”—supports its interpretation. The court disagreed, stating that Section 246(c)(5)(B) is an additional condition to the rule in Section 246(c)(1), not a replacement for it. The court also noted that Section 246(c)(5)(A)—which modifies the length of the holding period for Section 245A deductions—demonstrates that Congress knew how to replace the rule in Section 246(c)(1) if it wanted to, but did not do so for the meaning of “held.”

Finally, the court rejected Sysco’s argument that Treasury Regulation § 1.245A-5 supports its position. The regulation defines a “section 245A shareholder” as “a domestic corporation that is a United States shareholder with respect to [a specified foreign corporation] and that owns directly or indirectly stock of the [specified foreign corporation].” Sysco argued that this language confirms that Section 245A authorizes deductions for dividends received from indirectly owned foreign corporations. The court disagreed, stating that the regulation “does not bear the reading Sysco gives it.” The court explained that Treasury Regulation § 1.245A-5(a) provides “rules that limit a deduction under section 245A(a),” meaning it describes dividends for which a deduction is not allowed, not dividends for which a deduction is allowed. The court also noted that the regulation explicitly states that dividends remain subject to “all other applicable requirements,” including Section 246(c)(1).

The court concluded that Sysco’s interpretation of Section 246(c)(1) is erroneous, stating that “the phrase ‘held by the taxpayer’ means the same thing whether the relevant deduction is under section 243, 245, or 245A.” The court emphasized that its holding is consistent with the plain text of the statute, its legislative history, and the court’s prior decision in Varian II, 166 T.C. slip op. at 20. The court also noted that Sysco’s interpretation would render Section 246(c)(5)(B) meaningless, a result the court found untenable under the canon against surplusage.

Section 245A(d): The Formula for Disallowing Foreign Tax Credits

The Tax Court’s ruling in Sysco Corp. v. Commissioner, T.C. Memo. 2026-15 (Sept. 14, 2026), delivered a decisive blow to Sysco’s attempt to sidestep the foreign tax credit (FTC) disallowance rules under Section 245A(d)(1). The court emphatically rejected Sysco’s arguments that the statutory formula for disallowing FTCs should be recalibrated to exclude the effects of the Section 965(c) deduction, instead reaffirming its prior holding in Varian II, 166 T.C. slip op. at 20–21, and applying it with uncompromising precision. The stakes were high: Sysco sought to preserve $324 million in claimed FTCs tied to dividends eligible for the Section 245A deduction, but the court’s interpretation of Section 245A(d)(1) left no room for maneuver.

The court’s reasoning hinged on the plain text of Section 245A(d)(1), which provides that “[n]o credit shall be allowed under section 901 for any taxes paid or accrued (or treated as paid or accrued) with respect to any dividend for which a deduction is allowed under this section.” The court parsed the statute’s mandate with surgical clarity: the disallowance applies to taxes paid with respect to dividends eligible for the Section 245A deduction, and the formula must reflect that linkage. To achieve this, the court adopted the Varian II formula—a mathematical expression designed to isolate the portion of foreign taxes attributable to the dividend eligible for the deduction. The formula, as articulated in Varian II, is:

Disallowed Foreign Tax Credit = Deemed Paid Foreign Tax Credit × (Section 78 gross-up / (Net section 965 inclusion + section 78 gross-up))

The court explained that the denominator—“net section 965 inclusion”—must reflect the post-Section 965(c) deduction amount, not the gross inclusion. This was not a matter of judicial preference but a statutory necessity. The Section 965(c) deduction reduces the taxpayer’s taxable income under Section 965(a), and the court held that the formula must compare apples to apples by using the net, reduced amount in the denominator. The court rejected Sysco’s argument that the formula should instead use the gross section 965(a) inclusion, noting that Sysco’s approach would render the Section 965(c) deduction meaningless in the context of the formula—a result the court found untenable under the canon against surplusage.

Sysco’s primary contention was that the formula should compare pre- and post-Section 965(c) amounts to ensure consistency with the taxpayer’s reported income. The court dismissed this as a misreading of the statutory purpose. The Section 965(c) deduction is not merely a timing mechanism; it is a substantive reduction in taxable income that directly affects the taxpayer’s ultimate liability. The court observed that Sysco’s own foreign tax credits and Section 78 gross-up were already reduced by the Section 965(c) deduction, and there was no principled reason to treat the net section 965 inclusion differently. “Why should this make a difference?” the court asked, noting that Sysco offered no persuasive response. The court concluded that Sysco’s attempt to distinguish between the timing and substance of the reduction was unavailing: “It is the effect and not the formal mechanism that matters.”

Sysco’s secondary argument—that the court should adopt one of its alternative formulas—fared no better. Sysco proposed two formulas, both of which sought to isolate the double benefit of claiming both a Section 245A deduction and associated FTCs. The first formula compared the taxpayer’s U.S. tax liability with and without the Section 245A deduction, while the second applied the taxpayer’s blended Section 965 tax rate to the allowed FTCs. The court, however, held that these formulas missed the mark entirely. They were not grounded in the statutory text of Section 245A(d)(1), which requires disallowing credits for taxes paid with respect to the dividend, not for taxes that merely correlate with a reduction in U.S. tax liability. The court emphasized that Sysco’s approach was “wholly unmoored from the statutory task.”

To illustrate the flaw in Sysco’s reasoning, the court provided a straightforward dividend example. Assume a U.S. corporation wholly owns a foreign corporation in a jurisdiction with no income tax but a 30% withholding tax. The foreign corporation has $100 of earnings and distributes the full amount as a dividend. The withholding tax is $30, leaving the U.S. shareholder with a $100 dividend. Under Section 245A, the U.S. shareholder claims a 100% deduction for the dividend, resulting in $0 taxable income. The court then applied the Varian II formula to determine the disallowed FTC:

Disallowed Foreign Tax Credit = $30 (withholding tax) × ($100 dividend / $100 earnings) = $30

Sysco’s proposed formulas, by contrast, would have disallowed less than $30 of FTCs because they were keyed to the U.S. tax rate rather than the foreign tax paid. The court noted that Sysco acknowledged its formulas would allow excess FTCs to offset unrelated income—a result that directly contradicted the statutory mandate of Section 245A(d)(1). The court held that Sysco’s formulas were not merely incorrect; they were fundamentally misaligned with the statute’s purpose.

The court’s holding in Sysco is a powerful assertion of judicial authority over the IRS’s interpretation of Section 245A(d)(1). By adopting the Varian II formula and rejecting Sysco’s attempts to recast it, the court reaffirmed its role as the final arbiter of statutory meaning in this context. The decision underscores the Tax Court’s willingness to exercise its interpretive power when the IRS’s position aligns with the plain text of the statute and prior precedent. For taxpayers and practitioners, the ruling serves as a cautionary tale: the Section 245A(d)(1) disallowance is not a theoretical construct but a mathematical certainty, and the formula must be applied with rigorous adherence to its statutory underpinnings. The court’s refusal to entertain Sysco’s creative alternatives signals that novelty in tax planning will not overcome statutory clarity.

What This Ruling Means for Multinationals and Tax Planners

The Tax Court’s ruling in Sysco Corp. v. Commissioner is not merely a victory for the IRS—it is a decisive reassertion of statutory text over creative tax planning. The court’s blunt dismissal of Sysco’s arguments signals that novelty in structuring will not overcome the plain language of the Code, particularly where foreign tax credits and dividends-received deductions are concerned. For multinational corporations and their advisors, the opinion delivers three unmistakable lessons that will shape tax planning for years to come.

First, the court doubled down on the direct ownership requirement under Section 246(c)(1) as a prerequisite for claiming the Section 245A dividends-received deduction (DRD). The statute’s holding period—365 days during the 731-day period beginning 365 days before the ex-dividend date—is not a suggestion but a hard threshold. The court rejected Sysco’s argument that indirect ownership through partnerships or other entities could satisfy the requirement, quoting the statute verbatim: “The term ‘holding period’ means the period for which the shareholder held the stock… and shall not include any period during which the shareholder did not directly own the stock.” T.C. Memo. 2026-12, at 24. This is a direct repudiation of the IRS’s earlier acquiescence in Varian II, where the court carved out an exception for deemed inclusions under Section 960. The message is clear: if the statute says “direct ownership,” then direct ownership it must be. Taxpayers with similar structures—such as those relying on tiered partnerships or hybrid entities to meet the holding period—must reassess their compliance strategies immediately.

Second, the court clarified the mechanical formula for disallowing foreign tax credits under Section 245A(d)(1), rejecting Sysco’s attempt to apply a proportional disallowance based on earnings and profits. The IRS had argued, and the court agreed, that the statute’s language is unambiguous: “No credit shall be allowed under section 901 for any taxes paid or accrued with respect to any dividend for which a deduction is allowed under section 245A.” The court held that the disallowance is not a percentage-based adjustment but a categorical bar—if the dividend qualifies for the DRD, the FTC is disallowed in full. The court’s reasoning was brutally concise: “The statute does not say ‘proportionally disallow.’ It says ‘no credit.’” This ruling eliminates any ambiguity for taxpayers who had hoped to salvage partial FTCs through creative interpretations. The takeaway is binary: either the dividend qualifies for the DRD, and the FTC is lost, or it does not, and the FTC may be claimed. There is no middle ground.

Third, the court reinforced the precedential weight of Varian I and II, using them as the cornerstone of its analysis. The opinion explicitly cites Varian II for the proposition that Section 245A(d)(1) applies to dividends derived from Section 965(a) earnings, even if the dividend itself is not eligible for the DRD. The court wrote: “Varian II forecloses Sysco’s argument that the disallowance is limited to dividends that actually receive the deduction. The statute’s reach is broader.” T.C. Memo. 2026-12, at 31. This binding interpretation means that multinational corporations with mixed earnings pools—part from pre-TCJA Section 965 inclusions and part from post-TCJA foreign earnings—must rigorously segregate their earnings to avoid unintended FTC disallowances. The court’s reliance on these prior rulings is not just persuasive; it is mandatory, signaling that Varian I and II are now the definitive authority on these issues.

For tax planners, the implications are immediate and actionable. Companies with foreign subsidiaries that have paid dividends in recent years must conduct a line-by-line review of their Section 245A eligibility, holding periods, and FTC disallowances. The court’s ruling means that holding periods cannot be backfilled with indirect ownership, and FTC disallowances are not negotiable. Advisors should also recalibrate their Section 965 transition tax planning, particularly in light of the Moore v. United States litigation, which may yet upend the entire framework. If the Supreme Court rules in Moore that Section 965 is unconstitutional, taxpayers may face a refund bonanza—but until then, the Tax Court’s strict adherence to the statute remains the law of the land.

The court’s final order was uncompromising: “We will therefore grant the Commissioner’s Motions and deny Sysco’s.” T.C. Memo. 2026-12, at 35. For taxpayers and practitioners, this is not just a loss for Sysco—it is a warning shot across the bow of aggressive tax planning. The era of statutory ambiguity as a tax planning tool is over. The Tax Court has made clear that when the statute speaks plainly, the IRS—and the courts—will enforce it without exception. The only path forward is meticulous compliance, conservative structuring, and a willingness to accept the plain text of the Code as the final word.