Amicus Curiae Brief — Irving Air Chute Co. v. Commissioner

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IN THE CHARLES ELWORE 9

Supreme Court of the United States

Octoper Term, 1944

No. 533

IRVING AIR CHUTE COMPANY, INC.,

Petitioner,

v.

COMMISSIONER OF INTERNAL REVENUE,

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES

CIRCUIT COURT OF APPEALS FOR THE SECOND CIRCUIT

BRIEF SUBMITTED BY AMICUS CURIAE

MircHet B. Carroi1,

Amicus Curiae.

October 31, 1944.

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ARGUMENT:

1. Under the criterion in Biddle v. Commissioner,

an American recipient of royalties taxed by

the deduction of the standard rate of tax at

the source in Great Britain is a taxpayer

entitled to the credit for such tax under sec-

tion 131, Internal Revenue Code ~..................... 2

Refusal to allow the credit for the British tax

in this case would nullify the relief from double

taxation intended by the Congress of the United

SPRIROIR. scinxsnscecionsevenncenninninnibishinasckicemaicae aaa 10

3. The judgment of the Circuit Court should be

reviewed and reversed: The dissenting opin-

ion of Judge Hand should be adopted by this

re

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Citations

CasEs

Biddle v. Commissioner, 302 U. S. 573; 58 S. ‘Ct.

I nn eae re 1, 2, 3, 4, 9, 10, 12, 13

The Commissioners of Inland Revenue v. Dalgety &

Co. (1930), 1 K. B. 1; 46 T.L.R. 349; 15 Tax

2 BS. Reena SA ee 14

The Commissioners of Inland Revenue v. Sangster

(1920), 1 K. B. 587; 12 Tax Cases 208 ....... LAE AY 7

Constantineseo v. Rex, 43 T.L.R. 727; 11 Tax Cases

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‘ P28 0 ie A ARAL RELO EAM EL PERRIS AAEI. ERM NLA A NE PF CB ERE NM AMONG LAN AAG

Unitrep States Statutes anp ReGuLations

Internal Revenue Code:

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See. 231(a) 5 isang daninlinhiailasdeaaiaceieisiahdaapnligieebhah-nheaasd ania

Re SII © ‘clnscassisserhdspscnicenarsensecnteiitaigediacniptalebcaneitigunecabe team

Revenue Act of 1918 1ssiinhnasinalpcndeidihibcisastdindaiicaatan dtu

Revenue Act of 1934 20000000... Voscaucpeeanisdcaieaont .

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Regulations:

Reg. 94, art. 143-2 Setialiciotadk ee

Reg. 111, see. 29.143-2 Ronee

Reg. 111, see. 29.235-2(a) vee 5

Unsiren Kixcpom Sratutes

Income Tax Act, 1918 . oc 6

Income Tax Act, 1918, Schedule D, sec. | i

Income Tax Act, 1918, Schedules A, B, C, D, and KE... 7

Finance Act of 1927, see. 26 - 7

Finance Act of 1927, see. 39 . 8

Rule 3(m) gag to eases | and II of Schedule D 8

General Rule 19 (2) . 8

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MISCELLANEOUS

PAGE

Collection of International Agreements and Internal

Legal Provisions for the Prevention of Double

Taxation and Fiscal Evasion, League of Nations,

TN. sotstacnansinieniedestbsiyuishasiionnditinis .

House Report 767, 65th Congress, 2nd session, Rev-

enue Bill of 1918, 7308, vol. 2, p. 11 20. 1]

E. M. Konstam, The Law of Income Tax, 9th ed.,

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11

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IN THE

Supreme Court of the United States

Octoser Term, 1944

Irving Air Cuute Company, Inc.,

Petitioner,

v. No. 533.

COMMISSIONER OF INTERNAL RevENUE,

Respondent.

ON PETITION FOR A WRIT OF CERTIORARI TO THE UNITED STATES

CIRCUIT COURT OF APPEALS FOR THE SECOND CIRCUIT

BRIEF OF AMICUS CURIAE

Introductory Statement

This brief amicus curiae is filed pursuant to the consent

of counsel in the case at bar.

Our interest in this case arises from the fact that a

large number of taxpayers normally deriving royalties, or

other income similarly taxed (e.g. interest), from British

corporations are being denied the credit for foreign taxes

under section 131, Internal Revenue Code, because of the

application of the decision of this Court in Biddle v. Com-

missioner, 302 U. S. 573; 58 S. Ct. 379, to royalties and

interest, as well as dividends from British sources to

which class of income alone that decision related, Tax-

2

payers deriving the same categories of income from other

countries, which impose taxes ‘‘at the source’’ more or

less in accordance with the model of the British system of

collection, might also lose their credit for such taxes if an

adverse decision is rendered by this Court. The corpora.

tions concerned are represented through the Tax Com

mittee of the National Foreign Trade Council, Ine., and

it is in their behalf that I respectfully submit this brief.

ARGUMENT I

Under the criterion in Biddle v. Commissioner, an

American recipient of royalties taxed by the deduc.

tion of the standard rate of tax at the source in Great

Britain is a taxpayer entitled to the credit for such tax

under section 131, Internal Revenue Code.

The primary purpose of this brief is to show that, even

if the criterion prescribed by this Court in Biddle \.

Commissioner, supra, which involved only dividends, is

applied in this case involving royalties, the licensor receiy-

ing royalties from a British corporate licensee pays the

tax within the meaning of our own statute. In the words

of this Court, the question as to whether the recipient of

the income pays the tax ‘‘must ultimately be determined

by ascertaining from an examination of the manner in

which the British tax is laid and collected what the stock-

holder (in this case the licensor) has done in conformity

to British law and whether it is the substential equivalent

of payment of the tax as those terms are used in our own

statute’. (302 U. S. 573, at 579; 58 S. Ct. 379, at 382.)

The sole issue to be decided in this ease is a very

definite one, namely, whether the sum of $25,547.88 with-

PME EUS RITE TN MEA Tye) iS Mh REA DPM aE OGRE REEDED AP eta

3

held from royalties otherwise due the American company,

and paid instead to the British Government, were taxes

accrued or paid by the American company. These pay-

ments were in essence just that. They were certainly, to

use Justice Stone’s expression, the ‘‘substantial equiv-

alent’’ of taxes levied upon and collected from the Amer-

ican company out of its income derived from sources in

the United Kingdom.

More specifically, this brief will endeavor to show that

an American corporate licensor receiving royalties from a

British corporate licensee is just as much a taxpayer

under the British law as a British corporation would be

regarded as a taxpayer if it received royalties from an

American corporate licensee..

The resort to the machinery of collection at the source

does not change this essential. It simply reflects the

obvious fact that

‘the person by or through whom any such pay-

ment is made’”’

(see Rule 21, infra, p. 7) is more easily amenable to

collection machinery than is the American company. This

is a common incident in the taxation of income accruing

in one jurisdiction in favor of non-resident nationals of

another. The selection of a collection remedy im rem,

where the remedy in personam is of doubtful efficacy,

need not cause confusion. The duty of the foreign

recipient of income to make a contribution to the revenues

of the realm is clear. The elaborate inquiry in the Biddle

opinion into the operation of the collection machinery

seems to detract from this clarity, rather than assist in

keeping a correct view of the issue.

4

The Biddle decision was rendered January 10, 1938,

barely a year and a half after the system of collection at

source was introduced in the Revenue Act of 1936 (ap.

proved June 22, 1936), in the case of dividends, interest,

royalties and other fixed or determinable annual or

periodical income derived from United States sources by

non-resident aliens and foreign corporations not engaged

in trade or business in the United States. The provisions

involving corporations were in section 231 of that act and,

with an immaterial amendment, they appear under the

same section number in the Internal Revenue Code (here-

inafter referred to as I.R.C.), as follows:

**Sec. 231. Tax on Foreign Corporations

(a) Nonresident Corporations.—

(1) Imposition of Tax.—There shall be levied,

collected, and paid for each taxable year, in lieu

of the tax imposed by sections 13 and 14, upon

the amount received by every foreign corporation

not engaged in trade or business within the

United States, from sources within the United

States as interest (except interest on deposits

with persons carrying on the banking business),

dividends, rents, * * * or other fixed or de-

terminable annual or periodical gains, profits,

and income, a tax of 30 per centum of such

amount * * *’’ (italics ours).

Royalties are included in the term ‘‘fixed or determi-

nable annual or periodical income’”’ (Regulations 94, re-

lating to the income tax provisions in the Revenue Act of

1936, art. 143-2; Regulations 111, relating to the income

tax under the Internal Revenue Code, sec. 29.143-2).

Ordinarily the taxpayer’s liability is satisfied by the

tax withheld at source and such a foreign corporation has

no further responsibility, as is shown by section 235 (b),

pA

100%) AS Aba Sonat LRA AAR ll

b)

LR.C., which provides that ‘‘Subject to such conditions,

limitations, and exceptions and under such regulations as

may be prescribed by the Commissioner, with the approval

of the Secretary, corporations subject to the tax imposed

by section 231 (a) may be exempted from the requirement

of filing returns of such tax”’ (italics ours).

Section 29.235-2 (a), of Regulations 111 relating to the

income tax under the Internal Revenue Code, further

clarifies this point by stating that ‘‘if the tax liability of

a nonresident foreign corporation is fully satisfied at the

source a return of income is not required.’’

The requirement for withholding tax at the source is

found in section 144, I.R.C., which provides that ‘‘In the

case of foreign corporations subject to taxation under this

chapter not engaged in trade or business within the United

States, there shall be deducted and withheld at the source

in the same manner and upon the same items of income as

is provided in section 143 a tax equal to 30- per centum

thereof, * * * and such tax shali be returned and paid

inthe same manner * * *.’’

The reference to section 143 envisages paragraph (b)

of that section, which states that:

‘* All persons, in whatever capacity acting, * * *

having the control, receipt, custody, disposal, or

payment of interest * * *, dividends, * * *

or other fixed or determinable annual or periodical

gains, profits, and income (but only to the extent

that any of the above items constitutes gross income

from sources within the United States), of any

nonresident alien individual * * * shall * * *

deduct and withhold from such annual or periodical]

gains, profits, and income a tax equal to 30 per

centum thereof * * *.”’

Section 143 (c) requires the person who deducts and

withholds tax to make a return thereof and pay the tax to

6

the competent official and, to assure payment, such person

is made liable for such tax and indemnified against the

demands of the recipient of the income.

Royalties paid by a licensee are deductible from gross

income as ordinary and necessary business expenses under

section 23 (a), I.R.C., and it has been specifically so held

in the case of royalties paid to a stockholder for use of

patents (Webb Press Co., Ltd., 3 BTA 247).

In short, the United States tax is imposed upon royal-

ties received by a British corporation not engaged in trade

or business within the United States and the corporate

licensee is required to withhold the tax from the royalty,

make a return and pay the amount withheld to the Collee-

tor of Internal Revenue. The corporate licensee may

deduct the amount of the royalty from its gross income.

Even when liability of the foreign corporate licensor

is thus satisfied at the source, and the licensor does not

itself deliver a check or cash, there is still no doubt that

the foreign corporate licensor is the ‘‘taxpayer’’ under

our law.

The provisions in the United Kingdom Income Tax

Act, 1918, as amended, relating to the taxation of patent

royalties paid by a British corporate licensee to an Ameri-

ean corporate licensor are comparable to those set forth

above. In fact, they served more or less as a pattern for

the system of withholding at source adopted in our own

Revenue Act of 1936.

Under Schedule D of the United Kingdom Income Tax

Act, 1918, section 1 provides that:

“Tax * * * shall be charged in respect of—

‘*(a) The annual profits or gains arising or

accruing—

- * * * - * *

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al |

(iii) to any person, whether a British subject

or not, although not resident in the United King-

dom, from any property whatever in the United

Kingdom * * *,’’

The term ‘‘profits * * * from any property’’ in the

above provision includes income from royalty agreements

(The Commissioners of Inland Revenue y. Sangster,

[1920] 1 K. B. 587; 12 Tax Cases 208).

Under Rule 21 of the General Rules applicable in the

ease of Schedules A, B, C, D and E of the United King-

dom Income Tax Act, 1918, as amended by the Finance

Act of 1927, section 26, it is specifically provided that:

**(1) Upon payment of any interest of money,

annuity, or other annual payment charged with tax

under Schedule D, or of any royalty or other sum

paid in respect of the user of a patent, not payable,

or not wholly payable out of profits or gains

brought into charge, the person by or through

whom any such payment is made shall deduct there-

out a sum representing the amount of the tax

thereon at the rate in force at the time of payment.

**(2) Where any such payment as aforesaid is

made by or through any person, that person shall

forthwith deliver to the Commissioners of Inland

Revenue, for the use of the Special Commissioners,

an account of the payment, or of so much thereof

as is not made out of profits or gains brought into

charge, and of the tax deducted out of the payment

or out of that part thereof, and the Special Com-

missioners shall assess and charge the payment of

which an account is so delivered on that person.’’

Notwithstanding this provision for collection, it is quite

clear that the liability is that of the licensor, and this is

proven by the fact that if the payor fails to deduct the tax

8

upon payment, the Crown may make a direct assessment

against the payee (Konstam, The Law of Income Tax, 9th

ed., p. 177, citing Wild v. Ionides, 9 Tax Cases 392; Con-

stantinesco v. Rex, 43 T.L.R. 727; 11 Tax Cases 730).

If the royalties are paid out of profits or gains that

are taxable, a slightly different machinery of collection is

provided, but it in no way alters the fact that the tax is

imposed on the recipient of the royalty or that such re-

cipient is the intended taxpayer under the law. Rule 19

(2), as amended by the Finance Act of 1927, section 39,

provides that, where any royalty, or other sum, is paid in

respect of the user of a patent, wholly out of profits or

gains brought into charge to tax, the person paying the

royalty or sum shall be entitled, on making the payment,

to deduct and retain thereout a sum representing the

amount of the tax thereon at the standard rate for the

year in which the amount payable becomes due.

To complete the machinery of collection at source and

get the amount of the tax into the Treasury, the corporate

licensee is required to add back the amount of the royalty

to his profit ‘‘brought into charge’’ (Rule 3(m), Rules

applicable to Cases I and II of Schedule D). This device

of increasing the amount collected from the licensee is the

substantial equivalent of payment of the tax by the

licensor as those terms are used in our statute.

In short, there is no essential difference between the

English method of collection of tax at the source from

royalties paid by a British corporate licensee to a non-

resident corporate licensor and the American method of

collecting royalties derived by a British licensor from

sources in this country. The British law ordinarily ap-

plies the same standard rate to the income of the corpo-

ration and to the royalty paid by the corporation to the

licensor.

‘

BN ct a GT Po ato aT a CAE MRS: Cai MRIS Ae hoe i RTH RST Satan pede TE Ae a ih ae HR eS

_—

9

If the corporate licensee has no profits, it withholds the

tax in exactly the same manner as an American corporate

licensee. If it has profits, the corporate licensee includes

the royalty with the profits subject to the standard rate

and then collects the corresponding tax from the licensor

by withholding the standard rate from the royalty. The

tax is actually, therefore, paid by the licensor who is liable

thereto under the general charging provision of Schedule

D quoted above (pp. 6, 7).

Surely, it is apparent that where the royalty is paid

by a corporate licensee not out of its taxable income, the

British system is the exact equivalent of the American

system of taxation at source. To hold that the tax is not

paid by the American corporate licensor where the royalty

is first subjected to the standard rate at the same time as

the profits, and then is paid to the licensor after deduction

of the standard rate, would have the effect of introducing

a discrimination in British taxation that has obviously

never been intended.

The United Kingdom Act makes the corporate licensor

liable, and considers the licensor to be the taxpayer just as

much as does the United States law. The proof of such

liability is found in Rule 23, General Rules, which

provides :

‘**(1) A person who refuses to allow a deduction

| of tax authorised by this Act to be made out of any

payment, shall forfeit the sum of fifty pounds.

‘©(2) Every agreement for payment of interest,

rent, or other annual payment in full without allow-

ance of any such deduction shall be void.”’

The standard set by Justice Stone in the Biddle de-

cision is summed up in the following sentence (302 U. S.

573, at page 581) where, referring to our laws, he says:

10

‘‘nor have they [our revenue laws] treated as tax-

payers those upon whom no legal duty to pay the

tax is laid’’.

We submit that from the foregoing it is clear that both

in the United States and in England, a duty is laid upon

the foreign recipient of royalties to pay a tax upon them.

Therefore, he is by the criterion set in the Biddle case

‘the taxpayer’’—quite irrespective of the precise opera-

tion of the collection machinery.

ARGUMENT II

Refusal to allow the credit for the British tax in

this case would nullify the relief from double taxation

intended by the Congress of the United States.

The very language of section 131 (a)(1), I.R.C., clearly

reveals the intent of the Congress of the United States

that said provision should be so construed as to prevent

the double taxation of income derived by a domestic cor-

poration from a foreign source. Section 131 (a)(1) pro-

vides, subject to the limitation in subsection (b), that the

tax imposed by title | of the Revenue Act of 1934 shall

be credited with ‘‘In the case of * * * a domestie cor-

poration, the amount of any income, war-profits, and ex-

cess-profits taxes paid or acerued during the taxable year

* * *? (italics ours).

Obviously, Congress intended to give a domestic corpo-

to any foreign country

ration relief in respect of any foreign income tax which

reduced income received by the corporation. The relief

provision was introduced in the Revenue Act of 1918 in

order to help restore American commerce with foreign

11

countries after World War | through obviating the para-

lyzing burden of having to pay taxes in respect of the

same income both in the foreign country of its source and

again in the United States, at rates which together often

amounted to more than the income involved. (See House

Report 767, 65th Congress, 2nd session, Revenue Bill of

1918, 7308, Vol. 2, p. 11.) By means of this unilateral

measure, the United States accomplishes essentially what

numerous other countries accomplish by exemptions or al-

lowances in their tax laws or in more than fifty bilateral

conventions."

Recognizing the fact that income taxes differ in form

from country to country, the Congress stipulated that the

credit should be accorded in respect of any income taxes

paid to any foreign country. We believe this is the intent,

quite irrespective of whether the tax was directly assessed

on the taxpayer or collected by deduction at source, as in

the United Kingdom. That country has followed the

method of collection of income tax at source for over a

hundred years.

Collecting tax by this method does not alter the fact

that the tax itself is regarded by the United Kingdom as a

personal tax on the recipient of the income. The collee-

tion at source is applied by withholding wherever possible

the standard rate from such income as dividends, royalties,

annual interest and other annual payments.

Especially where the recipient, as in this case, is by

contract to receive a fixed amount which is reduced by the

tax, there can be no doubt that the recipient is the tax-

payer under the British law. This fact has long been

recognized by the Bureau of Internal Revenue. To re-

* Collection of International Agreements and Internal Legal Provisions for

the Prevention of Double Taxation and Fiscal Evasion, League of Nations,

Geneva.

12

verse this practice, upon which taxpayers have so long re-

lied, will not only subject the taxpayer in the present case

to great hardship but will also subject many others to de-

ficiency assessments and increased levies.

While this Court in the Biddle decision felt impelled

to regard a tax paid in the first instance by a British com-

pany on its profits as equivalent to our corporation tax, it

should be constrained, by virtue of its own test of apply-

ing domestic criteria, to reach a different conclusion in

regard to royalties. Under our own law, royalties are an

allowable deduction as a business expense, and they are so

regarded in British law, except as pointed out above in one

case for the purpose of taxation at source. Our device of

taxing royalties paid to a foreign corporate licensor by

withholding at source should be acknowledged as having

its counterpart in the British system.

The withholding of tax at the source under our system

does not alter the fact that the tax is imposed on the non-

resident corporate licensor which receives the royalties,

and the same is true under British law.

Refusal to regard the American corporate licensor re-

ceiving royalties from a British company as the taxpayer

for the purpose of the credit under section 131, LR.C,

would be as much of a distortion of the British law as to

hold that a British corporate licensor receiving royalties

from an American corporation was not the taxpayer under

our law.

The system of collection at source has been adopted by

many other countries, which, like the United Kingdom,

regard the recipient as the taxpayer, but consider his lia-

bility satisfied when the tax has been withheld by the

payor of the income and delivered to their respective

treasuries. A decision unfavorable to the taxpayer in this

BO Ft SPACE Ra a I RENT

13

ease would not only result in denying the credit for the

United Kingdom tax withheld from royalties and also in-

terest, but might in addition cause the United States

Treasury to disallow the credit for taxes withheld from

similar income in other countries. Such a decision of this

Court would so seriously impair the relief from double

taxation intended by the Congress as to discourage appre-

ciably the resumption of foreign commercial activities of

domestic enterprises after the current hostilities cease.

ARGUMENT III

The judgment of the Circuit Court should be

reviewed and reversed: the dissenting opinion of

Judge Hand should be adopted by this Court.

In the light of the comparison of the American and

British machinery for collection at source, and the Con-

gressional intent of relief from double taxation under

section 131, I.R.C., we believe that the dissenting opinion

of Judge L. Hand of the Cireuit Court, 143 F. (2d) 256, at

260, is the correct view of this issue. He sees the British

law in the proper perspective when he points out in sub-

stance that there should be no doubt that the patentee

would be paying the tax when the licensee withholds the

tax under Rule 21 (i.e., when the royalty is not paid out of

profits brought into charge), and that it would be ‘‘absurd

* * * to say that the patentee pays the tax, according to

whether the licensee is himself taxed upon enough ‘profits

or gains’ to equal the royalties he has paid’’.

Judge Hand is absolutely justified in emphasizing that

the Biddle decision relates only to dividends and ‘‘a

patentee and his licensee are * * persons in conflict-

ing interest, unlike a corporation and its shareholders: the

tax in the end comes out of the patentee’s pocket, not out

14

of the licensee’s, whatever the form.’’ (Irving Air Chute

Co., Inc, v. Commissioner, 1 'T. C. 880; 143 F. (2d) 256,

In citing The Commissioners of Inland Revenue y,

Dalgety (1930), 1 K. B. 1; 46 T.L.R. 349; 15 Tax Cases

216, the majority of the Circuit Court below overlooked

the true import of that House of Lords decision. While

holding that the company literally paid the United King.

dom tax on income from Australia and New Zealand,

which had been taxed there and was therefore entitled to

the relief from double taxation allowed under the United

Kingdom Income Tax Act, the House of Lords stated that,

‘‘having paid, the Company was entitled to deduct that tax

from the debenture interest, and, to the extent of that de-

duction, it was the debentwre-holders’ tax that was thus

discharged’’, 15 Tax Cases 216, at page 245 (italics ours).

The operation of the British law was even more graphi-

cally described by the Court of Appeal, ibid., at page 232,

whose decision was upheld, in the statement, ‘‘the com-

pany is a taxpayer and has to pay income tax on its

profits before deductions and * * * the person entitled

to the yearly interest of money is also a separate taxpayer

independently liable to pay his tax.’’ This applies also to

royalties.

There is no essential difference between such a pay-

ment and one made under sections 143(b) and 144, LR.C,

which require all persons paying royalties to a foreign

corporation not engaged in business in the United States

to deduct and withhold a tax equal to 30 per centum of the

amount of the royalty, and section 143(¢), which requires

said persons to make a return and pay the tax to the

authorized official.

The reasoning of the majority opinion of the Circuit

Court to the effect that the taxpayer’s royalty contract is

te ee ae a ~%

15

by British law ‘‘made so elastic that the licensee is per-

mitted to reduce the amount of petitioner’s income re-

ceivable as royalties under it’’ merely serves to dispose of

a tax that cannot otherwise be explained away. It is to be

hoped that this honorable Court will not permit to stand

such a judicial nullification of a tax which, in accordance

with the above decision of the House of Lords, is clearly

the tax of the licensor.

Contrary to the surmise of the majority of the Cireuit

Court as to the intent of Congress, its intent is so liberal

that it not only allows the credit for any income tax under

subsection (a)(1) of section 131, I.R.C., but also for a

‘tax paid in lieu of a tax upon income * * * otherwise

generally imposed by any foreign country * * *7’,

under section 131(h). Certainly this manifestation of the

generous intent of Congress would justify the Court in

upholding the minority opinion in the present case.

Conclusion

The Court is therefore urged to grant the petitioner’s

prayer that a writ of certiorari be issued to the United

States Circuit Court of Appeals for the Second Circuit to

review a judgment of that Court in the above case entered

on July 3, 1944 (R. 181), affirming a decision of the Tax

Court of the United States (R. 160) that there is a de-

ficiency in the income tax of the petitioner for the calen-

dar vear 1935.

Respectfully submitted,

MitcHety B. Carro..,

Amicus Curiae.

October 31, 1944.